-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, JBwRVN3lRzbLraS5g7jbbPDCnWt561xY/3sMHPVIZuhbNmawlVQShAHrAMg8VP8H du/wYKdQNFuXo40C+vM2sQ== 0000950130-00-000093.txt : 20000202 0000950130-00-000093.hdr.sgml : 20000202 ACCESSION NUMBER: 0000950130-00-000093 CONFORMED SUBMISSION TYPE: N-14 PUBLIC DOCUMENT COUNT: 9 FILED AS OF DATE: 20000113 FILER: COMPANY DATA: COMPANY CONFORMED NAME: BLACKROCK FUNDS CENTRAL INDEX KEY: 0000844779 STANDARD INDUSTRIAL CLASSIFICATION: UNKNOWN SIC - 0000 [0000] STATE OF INCORPORATION: MA FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: N-14 SEC ACT: SEC FILE NUMBER: 333-94605 FILM NUMBER: 506785 BUSINESS ADDRESS: STREET 1: 103 BELLEVIEW PKWY STE 152 STREET 2: BELLEVIEW CORPORATE CTR CITY: WILMINGTON STATE: DE ZIP: 19809 MAIL ADDRESS: STREET 1: 103 BELLEVUE PARKWAY STE 152 CITY: WILMINGTON STATE: DE ZIP: 19809 FORMER COMPANY: FORMER CONFORMED NAME: COMPASS CAPITAL FUNDS\ DATE OF NAME CHANGE: 19961114 FORMER COMPANY: FORMER CONFORMED NAME: PNC FUND DATE OF NAME CHANGE: 19920703 FORMER COMPANY: FORMER CONFORMED NAME: NCP FUNDS DATE OF NAME CHANGE: 19890511 N-14 1 BLACKROCK FUNDS As filed with the Securities and Exchange Commission on January 13, 2000 Registration No.__ ================================================================================ U.S. Securities and Exchange Commission Washington, DC 20549 FORM N-14 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 [_]Pre-Effective Amendment No. ___ [_]Post-Effective Amendment No. ___ (Check appropriate box or boxes) Exact Name of Registrant as Specified in Charter: BLACKROCK FUNDS(SM) Area Code and Telephone Number: (800) 441-7762 Address of Principal Executive Offices: Bellevue Park Corporate Center 400 Bellevue Parkway Wilmington, DE 19809 Name and Address of Agent for Service: BRIAN P. KINDELAN, ESQ. BlackRock Advisors, Inc. 1600 Market Street, 28/th/ Floor Philadelphia, PA 19103 Copies to: MICHAEL P. MALLOY, ESQ. CYNTHIA G. COBDEN, ESQ. Drinker Biddle & Reath LLP Simpson Thacher & Bartlett One Logan Square 425 Lexington Avenue 18/th/ and Cherry Streets New York, NY 10017-3954 Philadelphia, PA 19103-6996 Approximate Date of Proposed Public Offering: As soon as practicable after the Registration Statement becomes effective under the Securities Act of 1933. It is proposed that this filing will become effective on February 12, 2000 pursuant to Rule 488 under the Securities Act of 1933. Calculation of Registration Fee under the Securities Act of 1933: No filing fee is required because an indefinite number of shares have previously been registered on Form N-1A (Registration No. 33-26305/811-5742) pursuant to Rule 24f-2 under the Investment Company Act of 1940, as amended. The Registrant's Form 24f-2 for the fiscal year ended September 30, 1999 was filed on December 8, 1999. Pursuant to Rule 429, this Registration Statement relates to the aforesaid Registration Statement on Form N-1A. BLACKROCK FUNDS(SM) FORM N-14 CROSS REFERENCE SHEET PURSUANT TO RULE 481(a) Item No. Heading - ------- ------- Part A - ------ 1. Beginning of Registration Statement and Outside Front Cover Page of Prospectus............................ Cover Page 2. Beginning and Outside Back Cover Page of Prospectus............ Table of Contents 3. Synopsis and Risk Factors................ Summary; Risk Factors 4. Information About the Transaction........ Summary; Information Relating to the Proposed Reorganization; 5. Information About the Registrant......... Summary;Information Relating to the Proposed Reorganization; Comparison of Investment Policies and Risk Factors; Additional Information About BlackRock 6. Information About the Company Being Acquired........................... Summary; Information Relating to the Proposed Reorganization; Comparison of Investment Policies and Risk Factors; Additional Information About ISIS 7. Voting Information....................... Summary; Information Relating to Voting Matters 8. Interest of Certain Persons and Experts.............................. Information Relating to Voting Matters 9. Additional Information Required for Reoffering by Persons Deemed to be Underwriters....................... Inapplicable Part B - ------ 10. Cover Page............................... Statement of Additional Information Cover Page 11. Table of Contents........................ Table of Contents 12. Additional Information About the Registrant.................... Statement of Additional Information of the Series B Investor Shares of the High Yield Bond Portfolio of BlackRock Funds dated January 28, 1999* 13. Additional Information About the Company Being Acquired................................ Inapplicable 14. Financial Statements..................... Financial Statements; Pro Forma Financial Statements Part C - ------ Items 15-17. Information required to be included in Part C is set forth under the appropriate Item, so numbered, in Part C of this Registration Statement. * Incorporated herein by reference thereto. INDEPENDENCE SQUARE INCOME SECURITIES, INC. One Aldwyn Center Villanova, Pennsylvania 19085 February __, 2000 Dear Shareholder: A special meeting of the shareholders of Independence Square Income Securities, Inc. (the "Fund") has been called for March __, 2000 at _____ a.m./p.m., Eastern time. Formal notice of the meeting appears on the next page, followed by materials regarding the meeting. Shareholders will be asked at the special meeting to consider and vote upon the proposed reorganization of the Fund into the High Yield Bond Portfolio of BlackRock Funds(SM) and related matters. Please see the enclosed Combined Prospectus/Proxy Statement for detailed information regarding the proposed reorganization and a comparison of the funds. THE BOARD OF DIRECTORS OF THE FUND RECOMMENDS THAT YOU VOTE "FOR" THE PROPOSED REORGANIZATION. A proxy card is enclosed for your use in the shareholder meeting. This card represents shares you held as of the record date, February __, 2000. IT IS IMPORTANT THAT YOU COMPLETE, SIGN, AND RETURN YOUR PROXY CARD IN THE ENVELOPE PROVIDED AS SOON AS POSSIBLE. This will ensure that your shares will be represented at the Special Shareholders Meeting to be held on March __, 2000. Sincerely, Robert R. Fortune Chairman of the Board and President INDEPENDENCE SQUARE INCOME SECURITIES, INC. c/o Bellevue Park Corporate Center 400 Bellevue Parkway Wilmington, DE 19809 NOTICE OF SPECIAL MEETING OF SHAREHOLDERS To be held on March __, 2000 To the Shareholders of Independence Square Income Securities, Inc.: NOTICE IS HEREBY GIVEN THAT a Special Meeting of the Shareholders ("Shareholders") of Independence Square Income Securities, Inc. ("ISIS") will be held at the offices of BlackRock Institutional Management Corporation, Bellevue Park Corporate Center, 400 Bellevue Parkway, Fourth Floor Conference Room, Wilmington, Delaware 19809, on March __, 2000 at __:__ a.m./p.m. (Eastern time) for the following purposes: ITEM 1. To consider and act upon a proposal to approve an Agreement and Plan of Reorganization (the "Reorganization Agreement") by and between ISIS and BlackRock Funds(SM) ("BlackRock") and the transactions contemplated thereby, including (a) the transfer of all of the assets and liabilities of ISIS to BlackRock's High Yield Bond Portfolio (the "High Yield Bond Portfolio") in exchange for Series B Investor Shares of the High Yield Bond Portfolio; (b) the distribution of such Series B Investor Shares to the Shareholders of ISIS in connection with its liquidation; (c) the amendment to ISIS' by-laws and fundamental investment limitation to provide that ISIS may purchase securities of another investment company in connection with a merger, consolidation, reorganization, sale or purchase of assets approved by stockholders, or as otherwise permitted by the Investment Company Act of 1940, as amended; and (d) the dissolution under state law and the de-registration under the Investment Company Act of 1940, as amended, of ISIS. ITEM 2. To transact such other business as may properly come before the Special Meeting or any adjournment(s) thereof. YOUR DIRECTORS RECOMMEND THAT YOU VOTE IN FAVOR OF ITEM 1. The proposed reorganization and related matters are described in the attached Combined Prospectus/Proxy Statement. Attached as Appendix A to the Combined Prospectus/Proxy Statement is a copy of the Reorganization Agreement. Shareholders of record as of the close of business on February __, 2000 are entitled to notice of, and to vote at, the Special Meeting or any adjournment(s) thereof. SHAREHOLDERS ARE REQUESTED TO EXECUTE AND RETURN PROMPTLY IN THE ENCLOSED ENVELOPE THE ACCOMPANYING PROXY CARD WHICH IS BEING SOLICITED BY ISIS' BOARD OF DIRECTORS. THIS IS IMPORTANT TO ENSURE A QUORUM AT THE SPECIAL MEETING. PROXIES MAY BE REVOKED AT ANY TIME BEFORE THEY ARE EXERCISED BY SUBMITTING TO ISIS A WRITTEN NOTICE OF REVOCATION OR A SUBSEQUENTLY EXECUTED PROXY OR BY ATTENDING THE SPECIAL MEETING AND VOTING IN PERSON. Gary M. Gardner Secretary February __, 2000 COMBINED PROSPECTUS/PROXY STATEMENT Dated February __, 2000 INDEPENDENCE SQUARE INCOME SECURITIES, INC. c/o Bellevue Park Corporate Center 400 Bellevue Parkway Wilmington, DE 19809 (610) 964-8882 BLACKROCK FUNDS(SM) Bellevue Park Corporate Center 400 Bellevue Parkway Wilmington, DE 19809 (800) 441-7762 This Combined Prospectus/Proxy Statement is furnished in connection with the solicitation of proxies by the Board of Directors of Independence Square Income Securities, Inc. ("ISIS") in connection with a Special Meeting (the "Meeting") of Shareholders ("Shareholders") to be held on March __, 2000 at __:__ a.m./p.m. (Eastern time) at the offices of BlackRock Institutional Management Corporation, Bellevue Park Corporate Center, 400 Bellevue Parkway, Fourth Floor Conference Room, Wilmington, Delaware 19809, at which Shareholders will be asked to consider and approve a proposed Agreement and Plan of Reorganization dated December __, 1999 (the "Reorganization Agreement"), by and between ISIS and BlackRock Funds(SM) ("BlackRock"), and the matters contemplated therein (the "Reorganization"). A copy of the Reorganization Agreement is attached as Appendix A. ISIS is registered as a closed-end management investment company under the Investment Company Act of 1940, as amended (the "1940 Act"). BlackRock is registered as an open-end management investment company under the 1940 Act. BlackRock Institutional Management Corporation ("BIMC") currently serves as investment adviser to ISIS. BlackRock Advisors, Inc. ("BlackRock Advisors") currently serves as investment adviser for BlackRock and BlackRock Financial Management, Inc. ("BFM") currently serves as sub-adviser for BlackRock with respect to its High Yield Bond Portfolio (the "High Yield Bond Portfolio"). BIMC, BlackRock Advisors and BFM are each majority-owned, indirect subsidiaries of PNC Bank, N.A. ("PNC Bank"). In reviewing the proposed Reorganization, the Board of Directors of ISIS considered among other things: the reasons for the Reorganization; the terms of the Reorganization; the opportunity to combine ISIS and the High Yield Bond Portfolio to create a single, larger consolidated asset base; the investment objectives and policies of each of the Funds; BlackRock's service providers; the recommendations of BIMC and BlackRock Advisors with respect to the Reorganization; the effect of the Reorganization on ISIS; the fact that the Reorganization would constitute a tax-free reorganization; and the fact that the interests of Shareholders would not be diluted as a result of the Reorganization. The Reorganization Agreement provides that ISIS will transfer all of its assets and liabilities to the High Yield Bond Portfolio. In exchange for the transfer of these assets and liabilities, BlackRock will issue Series B Investor Shares of the High Yield Bond Portfolio to ISIS. The transaction is expected to occur on March ___, 2000, or as soon thereafter as is practicable. ISIS offers one class of shares. The High Yield Bond Portfolio offers six classes of shares. One class of shares offered by the High Yield Bond Portfolio, Series B Investor Shares, is the class of shares which Shareholders of ISIS will receive in the Reorganization, as further described in "Information Relating to the Proposed Reorganization -- Description of the Reorganization Agreement." ISIS will make a liquidating distribution of Series B Investor Shares to the Shareholders of ISIS, so that a holder of shares in ISIS will receive Series B Investor Shares of the High Yield Bond Portfolio with the same aggregate net asset value as the ISIS shares held by the Shareholder immediately before the transaction. Following the Reorganization, Shareholders of ISIS will be shareholders of the High Yield Bond Portfolio, and ISIS will be dissolved under state law and de-registered under the 1940 Act. The High Yield Bond Portfolio is currently conducting investment operations as described in this Combined Prospectus/Proxy Statement. This Combined Prospectus/Proxy Statement sets forth the information that a Shareholder of ISIS should know before voting on the Reorganization Agreement (and related transactions), and should be retained for future reference. The Prospectus relating to Series B Investor Shares of the High Yield Bond Portfolio, which describes the High Yield Bond Portfolio, 2 accompanies this Combined Prospectus/Proxy Statement and is incorporated herein by reference. Additional information is set forth in the Statements of Additional Information relating to the Series B Investor Shares of the High Yield Bond Portfolio and this Combined Prospectus/Proxy Statement, which are dated January 28, 1999 and February __, 2000, respectively, each of which is incorporated herein by reference. Each of these documents is on file with the Securities and Exchange Commission (the "SEC"), and is available without charge upon oral or written request by writing or calling either ISIS or BlackRock at the respective addresses or telephone numbers indicated above. This Combined Prospectus/Proxy Statement constitutes the Proxy Statement of ISIS for the meeting of its Shareholders, and BlackRock's Prospectus for Series B Investor Shares of the High Yield Bond Portfolio that have been registered with the SEC and are to be issued in connection with the Reorganization. This Combined Prospectus/Proxy Statement is expected to first be sent to Shareholders on or about February __, 2000. THE SECURITIES AND EXCHANGE COMMISSION HAS NOT APPROVED OR DISAPPROVED THESE SECURITIES OR PASSED UPON THE ADEQUACY OF THIS COMBINED PROSPECTUS/PROXY STATEMENT. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS COMBINED PROSPECTUS/PROXY STATEMENT AND IN THE MATERIALS EXPRESSLY INCORPORATED HEREIN BY REFERENCE AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY ISIS OR BLACKROCK. SHARES OF THE HIGH YIELD BOND PORTFOLIO ARE SUBJECT TO INVESTMENT RISKS INCLUDING THE POSSIBLE LOSS OF PRINCIPAL, ARE NOT BANK DEPOSITS AND ARE NOT ENDORSED BY, INSURED BY, GUARANTEED BY, OBLIGATIONS OF OR OTHERWISE SUPPORTED BY THE U.S. GOVERNMENT, THE FEDERAL DEPOSIT INSURANCE CORPORATION, THE FEDERAL RESERVE BOARD, PNC BANK, N.A. OR ANY OF ITS AFFILIATES OR ANY OTHER GOVERNMENTAL AGENCY OR BANK. 3 TABLE OF CONTENTS
Page ---- SUMMARY.......................................................................................... Proposed Reorganization..................................................................... Reasons for the Reorganization.............................................................. Federal Income Tax Consequences............................................................. Overview of ISIS and the High Yield Bond Portfolio.......................................... Certain Arrangements with Service Providers - ISIS.......................................... Certain Arrangements with Service Providers - The High Yield Bond Portfolio................. Comparative Fee and Expense Tables.......................................................... Expense Ratio - ISIS........................................................................ Expense Ratio - Series B Investor Shares of the High Yield Bond Portfolio................... Organization................................................................................ Purchase, Redemption and Exchange Procedures................................................ Dividends, Distributions and Pricing........................................................ Voting Information.......................................................................... RISK FACTORS..................................................................................... INFORMATION RELATING TO THE PROPOSED REORGANIZATION.............................................. Description of the Reorganization Agreement................................................. Board Considerations........................................................................ Federal Income Tax Consequences............................................................. Capitalization.............................................................................. COMPARISON OF INVESTMENT POLICIES AND RISK FACTORS............................................... General..................................................................................... Investment Limitations...................................................................... Other Information........................................................................... INFORMATION RELATING TO VOTING MATTERS........................................................... General Information......................................................................... Shareholder and Board Approvals............................................................. Appraisal Rights............................................................................ Quorum...................................................................................... Annual Meetings............................................................................. ADDITIONAL INFORMATION ABOUT BLACKROCK........................................................... ADDITIONAL INFORMATION ABOUT ISIS................................................................ FINANCIAL STATEMENTS AND EXPERTS................................................................. OTHER BUSINESS................................................................................... LITIGATION....................................................................................... SHAREHOLDER INQUIRIES............................................................................ Appendix A--Agreement and Plan of Reorganization................................................. A-1 Appendix B--Management's Discussion of Fund Performance.......................................... B-1 Appendix C--Share Price Data for ISIS............................................................ C-1 Appendix D---Sections 3-202 through 3-213 of the Maryland General Corporation Law................ D-1
4 SUMMARY The following is a summary of certain information relating to the proposed Reorganization, the parties thereto and the transactions contemplated thereby, and is qualified by reference to the more complete information contained elsewhere in this Combined Prospectus/Proxy Statement, the Prospectus and Statement of Additional Information of the Series B Investor Shares of the High Yield Bond Portfolio, and the Reorganization Agreement attached to this Combined Prospectus/Proxy Statement as Appendix A. ISIS' Semi-Annual Report to Shareholders and its Annual Report to Shareholders may be obtained free of charge by calling 1-800-852-4750 or writing c/o Bellevue Park Corporate Center, 400 Bellevue Parkway, Wilmington, DE 19809. The High Yield Bond Portfolio's Annual Report to Shareholders may be obtained free of charge by calling 1-800- 441-7762 or writing Bellevue Park Corporate Center, 400 Bellevue Parkway, Wilmington, Delaware 19809. Proposed Reorganization. Based upon their evaluation of the relevant information presented to them, and in light of their fiduciary duties under federal and state law, the Board of Directors of ISIS and the Board of Trustees of BlackRock, including a majority of their members who are not "interested persons" within the meaning of the 1940 Act, have determined that the proposed Reorganization is in the best interests of their Fund's respective shareholders and that the interests of such shareholders will not be diluted as a result of such Reorganization. Reasons for the Reorganization. When ISIS was organized in 1971, a closed- end structure was chosen as most appropriate for ISIS' method of operation because it was believed that such a structure, among other things, would permit management of its portfolio consistent with its investment objective and policies without the pressures and constraints to which open-end investment companies are subject as a result of cash inflows and redemptions. However, as a result of the relatively modest size of ISIS' assets (approximately $31.3 million as of September 30, 1999), changes in the securities markets, and changes to the way mutual funds account for certain securities, it has become increasingly difficult for ISIS to maintain its competitive level of dividends to Shareholders. BIMC and BlackRock Advisors have recommended that ISIS be reorganized into the High Yield Bond Portfolio as described in this Combined Prospectus/Proxy Statement. In light of this recommendation, after consideration of the reasons therefor and the proposed operations of the High 5 Yield Bond Portfolio after the Reorganization, and in consideration of the fact that the Reorganization will be tax-free and will not dilute the interests of Shareholders, the Board of Directors of ISIS has authorized the Reorganization Agreement and recommended approval of the Reorganization by Shareholders. Federal Income Tax Consequences. Drinker Biddle & Reath LLP, counsel to ISIS and to its Board of Directors, will issue an opinion (based on certain assumptions) as of the effective time of the Reorganization that the transaction will not give rise to the recognition of income, gain or loss for federal income tax purposes to ISIS, the High Yield Bond Portfolio or their respective shareholders. See "Information Relating to the Proposed Reorganization - Federal Income Tax Consequences." Overview of ISIS and the High Yield Bond Portfolio. The investment objective of ISIS is to seek as high a level of current income as is consistent with prudent investment. The High Yield Bond Portfolio's investment objective is to seek to provide current income by investing primarily in non-investment grade bonds. Each pursues its investment objective by investing primarily in debt securities. However, there are differences in each Fund's investment policies. For example, ISIS must invest at least 60% of its assets in: (1) marketable straight debt securities which are rated at the time of purchase within the four highest grades assigned by Moody's Investors Service, Inc. (Aaa, Aa, A or Baa), Standard & Poor's Ratings Group, Division of McGraw Hill (AAA, AA, A or BBB) or Fitch IBCA, Inc. (AAA, AA, A or BBB); (2) securities of, or guaranteed by, the United States government, its agencies or instrumentalities; (3) securities (payable in U.S. dollars) of, or guaranteed by, the government of Canada or of a Province of Canada under circumstances that would not subject the Fund to payment of U.S. Interest Equalization Tax; (4) commercial paper of companies having, at the time of purchase, an issue of outstanding debt securities rated as described in (1) above; and (5) cash or cash equivalents. ISIS may invest up to 40% of its assets in non-investment grade debt securities (i.e., rated lower than Baa by Moody's Investor Services, Inc. or rated lower than BBB by Standard & Poor's Ratings Group and Fitch-IBCA, Inc.). At least 25% of ISIS' assets must be invested in the securities of utility companies. As stated in its objective, the High Yield Bond Portfolio invests primarily in non-investment grade bonds. The High Yield Bond Portfolio normally invests at least 80% of its total assets 6 in bonds or convertible securities and at least 65% of its total assets in non- investment grade bonds. Non-investment grade bonds are commonly referred to as "junk bonds." The High Yield Bond Portfolio is not permitted to invest 25% or more of its assets in the utility industry or any one industry. See "Comparison of Investment Policies and Risk Factors" below and the High Yield Bond Portfolio's Prospectus, which is incorporated by reference herein, for a more detailed description of the investment objectives and policies of ISIS and the High Yield Bond Portfolio. Certain Arrangements with Service Providers -- ISIS. BIMC serves as the investment adviser for ISIS. BIMC is an indirect, majority-owned subsidiary of PNC Bank. Until June 18, 1998, PNC Bank served as sub-adviser to ISIS. On June 18, 1998, BIMC assumed PNC Bank's obligations as described below. For investment advisory services rendered to ISIS, BIMC is entitled to receive a quarterly fee of .05% (annually .20%) of ISIS' average net assets and .50% (annually 2.00%) of ISIS' gross income for such quarter. For the fiscal year ended December 31, 1998, BIMC received investment advisory fees of $119,712, which represents .36% of ISIS' average net assets during this period. Pursuant to the terms of ISIS' investment advisory agreement, and subject to the general supervision of the Board of Directors, BIMC is responsible for, makes decisions with respect to, and places orders for, all purchases and sales of ISIS' portfolio securities, and maintaining records relating to such purchases and sales. Pursuant to the investment advisory agreement, BIMC also serves as administrative agent for ISIS. BIMC maintains ISIS' financial accounts and records, prepares various returns and reports, and performs all other functions necessary to maintain its corporate existence and its relations with Shareholders, all at the request and subject to the supervision of ISIS' Board of Directors. These services are performed without additional cost to ISIS. Until June 18, 1998, PNC Bank, as sub-adviser to ISIS, provided investment research and credit analysis concerning prospective and existing fund investments, made recommendations with respect to ISIS' continuous investment program, recommended to BIMC the portion of ISIS' assets to be invested or held uninvested in cash or cash equivalents, supplied BIMC computer facilities and operating personnel, and provided certain statistical services. BIMC has assumed PNC Bank's 7 responsibilities under the sub-advisory agreement; BIMC's obligation to pay a fee to PNC Bank has been terminated; and the obligation of PNC Bank to provide facilities, personnel, services and to pay related expenses under the sub- advisory agreement were transferred to BIMC. Wilmington Trust Company ("WTC") serves as ISIS' custodian and automatic dividend investment plan agent. PFPC Inc. ("PFPC") serves as ISIS' transfer agent, registrar and dividend disbursing agent. Prior to December 31, 1998, PNC Bank served as ISIS' transfer agent, registrar and dividend disbursing agent. On December 31, 1998, PNC Bank assigned its rights and delegated its duties as transfer agent, registrar and dividend disbursing agent to PFPC. PFPC is an indirect, wholly-owned subsidiary of PNC Bank. For its services as transfer agent, PFPC is entitled to a fee payable at the rate of $0.4166 per month for each Shareholder account existing during such month, plus out-of-pocket expenses. Certain Arrangements with Service Providers -- the High Yield Bond Portfolio. BlackRock Advisors serves as the investment adviser and BFM serves as the sub-adviser for the High Yield Bond Portfolio. BlackRock Advisors and BFM are each indirect, majority-owned subsidiaries of PNC Bank. For its investment advisory services, BlackRock Advisors is entitled to fees computed daily and payable monthly at the maximum annual rate of .50% of the first $1 billion of average daily net assets, .45% of the next $1 billion of average daily not assets, .425% of the next $1 billion of average daily net assets, and .40% of average daily net assets over $3 billion. Out of these fees, BlackRock Advisors pays BFM a sub-advisory fee equal to .35% of the first $1 billion of average daily net assets, .30% of the next $1 billion of average daily net assets, .275% of the next $1 billion of average daily net assets, and .25% of average daily net assets over $3 billion. BlackRock Advisors has entered into an expense limitation agreement with BlackRock which requires BlackRock Advisors to waive or reimburse fees and expenses if operating expenses (which apply to expenses charged on Fund assets as a whole, but not expenses separately charged to the Series B Investor Shares) exceed .525% of average daily net assets. This expense limitation agreement continues until January 28, 2001. However, the High Yield Bond Portfolio may be required to repay such waived or reimbursed fees and expenses in the following two years if the repayments can be made within the expense limit noted above. For the fiscal year ended September 30, 1999, BlackRock Advisors received fees of $3,325, which represents .01% of the High Yield Bond Portfolio's average daily net assets during the period. Pursuant to the terms of the investment advisory agreement with BlackRock, BlackRock Advisors is responsible for the 8 overall investment management of the High Yield Bond Portfolio. BFM is responsible for the High Yield Bond Portfolio's day-to-day management and generally makes all buy and sell decisions. BFM also provides research and credit analysis. BlackRock Advisors and PFPC serve as co-administrators to BlackRock. Under the Administration Agreement, PFPC has agreed to: (i) maintain office facilities for BlackRock; (ii)furnish BlackRock with statistical and research data, clerical, accounting and bookkeeping services; (iii) provide and supervise the operation of an automated data processing system to process purchase and redemption orders; (iv) provide information and distribute written communications to shareholders; (v) handle shareholder problems and calls; (vi) research issues raised by financial intermediaries relating to investments in shares of any fund offered by BlackRock; (vii) review and provide advice with respect to communications for shares of any fund offered by BlackRock; (viii) monitor the investor programs that are offered in connection with shares of funds offered by BlackRock; (ix) provide oversight and related support services that are intended to ensure the delivery of quality services to the holders of shares of funds offered by BlackRock; and (x) provide certain other services required by BlackRock. Under the Administration Agreement, BlackRock Advisors is responsible for: (i) the supervision and coordination of BlackRock's service providers; (ii) the negotiation of service contracts and arrangements between BlackRock and its service providers; (iii) acting as a liaison between the trustees of BlackRock and BlackRock's service providers; and (iv) providing ongoing business management and support services in connection with BlackRock's operations. Pursuant to the terms of the Administration Agreement, BlackRock Advisors has delegated certain of its duties to BlackRock Distributors Inc. ("BDI"), the distributor for BlackRock. For their services as co-administrators, BlackRock Advisors and PFPC are entitled to receive fees computed daily and payable monthly at an aggregate annual rate of (i) .085% of the first $500 million of the High Yield Bond Portfolio's average daily net assets, .075% of the next $500 million of average daily net assets and .065% of the High Yield Bond Portfolio's average daily net assets in excess of $1 billion; and (ii) .145% of the first $500 million of average daily net assets allocated to the Series B Investor Shares of the High Yield Bond Portfolio, .135% of the next $500 million of such average daily net assets and 9 .125% of the average daily net assets of Series B Investor Shares of the High Yield Bond Portfolio in excess of $1 billion. PFPC also serves as the transfer agent and dividend disbursing agent for BlackRock. For its services in this capacity, PFPC is entitled to receive per account fees, with minimum annual fees of $24,000, plus disbursements, with respect to the Series B Investor Shares. Until further notice, transfer agency fees for Series B Investor Shares of the High Yield Bond Portfolio will not exceed the annual rate of .10% of the Series B Investor Shares' average daily net assets. PFPC Trust Company serves as the custodian to BlackRock. Prior to January 1, 1999, PNC Bank served as custodian to BlackRock. On January 1, 1999, PNC Bank assigned its rights and delegated its duties as custodian to PFPC Trust Company. PFPC Trust Company is an indirect, wholly-owned subsidiary of PNC Bank. For its services as custodian, PFPC Trust Company is entitled to receive fees at the rate of .015% of the first $500 million of average daily gross assets for Series B Investor Shares of the High Yield Bond Portfolio and .01% of the average daily gross assets in excess of $500 million. PFPC Trust Company is also entitled to out-of-pocket expenses and certain transaction charges. BDI serves as the distributor for BlackRock. BlackRock has adopted a distribution and service plan pursuant to Rule 12b- 1 under the 1940 Act which covers its Series B Investor Shares (the "BlackRock 12b-1 Plan"). Under the BlackRock 12b-1 Plan, Series B Investor Shares of the High Yield Bond Portfolio bear the expense of distribution and service fees payable to BDI, BlackRock Advisors or any other affiliate of PNC Bank at an annual rate of 1.15% of the average daily net assets attributable to such Series B Investor Shares. Of this amount, .75% represents distribution fees payable under the BlackRock 12b-1 Plan to BDI for distribution and Sales Support Services and affiliates of PNC Bank for sales support services provided in connection with the sale of Series B Investor Shares. This distribution fee may also be used by BDI and affiliates of PNC Bank to pay brokers, dealers, financial institutions and industry professionals (collectively, "Service Organizations") for sales support services and other related expenses. The remaining .40% represents shareholder service and shareholder processing fees. The service fee is .25% of average daily net assets and is paid to Service Organizations for the provision of general shareholder liaison services. The 10 shareholder processing fee is .15% of average daily net assets and is paid to Service Organizations for providing additional services to their clients who own Series B Investor Shares. Such additional services are intended to supplement the services provided to shareholders by the co-administrators or transfer agent. BlackRock Advisors determines the amount of shareholder service and shareholder processing fees paid to Service Organizations. BlackRock Advisors or any other affiliate of PNC Bank may serve as a Service Organization and receive fees under the BlackRock 12b-1 Plan. The BlackRock 12b-1 Plan is a "compensation" plan as opposed to a "reimbursement" plan. Accordingly, payments under the BlackRock 12b-1 Plan are based on a stated fee rather than on the specific amounts expended by BDI, BlackRock Advisors and BlackRock Advisors' affiliates for distribution and shareholder services. BDI, BlackRock Advisors and BlackRock Advisors' affiliates may be able to recover such amounts or may earn a profit from payments made by Series B Investor Shares of the High Yield Bond Portfolio under the BlackRock 12b-1 Plan. Comparative Fee and Expense Tables. The table below shows (i) information regarding the fees and expenses paid by ISIS during its most recent fiscal year, (ii) information regarding the fees and expenses paid by the High Yield Bond Portfolio's Series B Investor Shares during its most recent fiscal year, and (iii) estimated fees and expenses on a pro forma basis giving effect to the proposed Reorganization. The table indicates that total operating expenses for current ISIS Shareholders are going to significantly increase as a result of the Reorganization. 11
------------------------------------------------------------------ The High Yield Bond Portfolio -- Series B Pro Forma ISIS Investor Shares Combined ---- ------------------ --------- SHAREHOLDER TRANSACTION EXPENSES (fees paid directly from your None None None investment) Maximum Sales Load Imposed on Purchases (as a percentage of offering price) Maximum Sales Load Imposed on None None None Reinvested Dividends (as a percentage of offering price) Contingent Deferred Sales None 4.50%/(1)/ 3.00%/(2)/ Charge (as a percentage of original purchase price or redemption proceeds, as applicable) Redemption Fee (as a None None None percentage of amount redeemed, if applicable) Exchange Fee None None None ------------------------------------------------------------------ ANNUAL FUND OPERATING EXPENSES (expenses that are deducted from Fund assets) (as a percentage of average net assets) Management Fees 0.36%/(3)/ 0.50% 0.50% Distribution and Service (12b-1) Fees 0.00% 1.15% 1.15% Interest Expenses 0.00% 0.39% 0.39% Other Expenses 0.40% 0.90%/(4)/ 0.90%/(4)/ ---- ---- ---- Total Annual Fund Operating Expenses 0.76% 2.94% 2.94% Fee Waivers and Expense Reimbursement 0.00% 0.63%/(5)/ 0.63%/(5)/ Net Expenses 0.76% 2.31%/(5)/ 2.31%/(5)/ ==== ==== ==== -----------------------------------------------------------------
_____________________________ (1) The Contingent Deferred Sales Charge ("CDSC") is 4.50% if shares are redeemed in less than one year. The CDSC for Series B Investor Shares decreases for redemptions made in subsequent years. After six years there is no CDSC on Series B Investor Shares. (2) Shareholders of ISIS will be given credit for a three year holding period for purposes of calculating the CDSC. See "Purchase, Redemption and Exchange Procedures." (3) ISIS pays BIMC a quarterly fee of .05% (annually .20%) of its average net assets and .50% (annually 2.00%) of the Fund's gross income for such quarter. (4) "Other Expenses" are based on estimated amounts for the current fiscal year. (5) BlackRock Advisors has contractually agreed to waive or reimburse fees or expenses in order to limit Fund expenses to 1.92% (excluding interest expense) of average daily net assets until January 28, 2001. The High Yield Bond Portfolio may have to repay some of these waivers and reimbursements to BlackRock Advisors in the following two years. 12 Example: This Example assumes that you invest $10,000 in the Funds for the time periods indicated. The Example also assumes that your investment has a 5% return each year and that each Fund's operating expenses remain the same. Although actual costs may be higher or lower, based upon these assumptions your costs would be: 1 Year 3 Years 5 Years 10 Years ------ ------- ------- -------- ISIS $ 78 $ 243 $ 422 $ 942 The High Yield Bond Portfolio -- Series B Investor Shares Redemption of shares at the end of the period/(1)/ $684 $1,300 $1,792 $2,991/(3)/ No redemption of shares at the end of the period $234 $ 850 $1,492 $2,991/(3)/ Pro Forma Combined Redemption of shares at the end of the period/(2)/ $534 $ 950 $1,422/(4)/ $2,795/(4)/ No redemption of shares at the end of the period $234 $ 850 $1,422/(4)/ $2,795/(4)/ _____________________________ (1) Reflects the deduction of the CDSC of 4.50% after the first year, 3.00% after the third year and 1.00% after the fifth year. (2) Reflects the deduction of the CDSC of 3.00% after the first year and 1.00% after the third year. (3) Based on the conversion of the Series B Investor Shares to Series A Investor Shares after seven years. (4) Based on the conversion of the Series B Investor Shares to Series A Investor Shares on the fourth anniversary of the Reorganization. 13 Expense Ratio -- ISIS. The ratio of operating expenses to average net assets of ISIS for the fiscal year ended December 31, 1998 was 0.76%. Expense Ratio -- Series B Investor Shares of The High Yield Bond Portfolio. The ratio of operating expenses to average net assets of Series B Investor Shares of the High Yield Bond Portfolio for the fiscal period ended September 30, 1999 was 1.92% (excluding interest expense), after waivers by BlackRock Advisors. Organization. ISIS is organized as a Maryland corporation and BlackRock is organized as a Massachusetts business trust. Purchase, Redemption and Exchange Procedures. ISIS' shares currently trade on The NASDAQ Small Cap Market/(SM)/ ("NASDAQ") and may only be purchased or sold through a broker or dealer at the current market price plus a brokerage commission. ISIS' shares have frequently traded at a discount from its net asset value. After the Reorganization, ISIS will no longer trade on the NASDAQ. If the Reorganization is approved by the Shareholders, any premium or discount existing on the date of such approval might be reduced prior to the date of the Reorganization to the extent purchasers of ISIS' shares in the open market are willing to pay less of a premium or accept less of a discount in anticipation of the Reorganization. There is no exchange privilege for shares of ISIS. Additional information concerning the trading of ISIS' shares on the NASDAQ is contained in Appendix C. Series B Investor Shares of the High Yield Bond Portfolio are offered to the public on a continuous basis at net asset value per share. There is no sales charge when you purchase Series B Investor Shares. Shareholders do pay a contingent deferred sales charge ("CDSC") when they redeem shares. The CDSC declines over six years from a high of 4.50% of the net assets redeemed. The CDSC is not charged under certain circumstances, including share exchanges and redemptions made in connection with certain retirement plans and in connection with certain shareholder services offered by BlackRock. After seven years, the Series B Investor Shares automatically convert to Series A Investor Shares, which have lower fees and no CDSC, as described more fully below. Series B Investor Shares may be redeemed through a shareholder's registered investment professional, who may charge for this service, or by sending a written redemption request to BlackRock Funds, c/o PFPC, P.O. Box 8907, Wilmington, DE 19899- 14 8907. BlackRock will redeem shares at the next net asset value calculated after the redemption request is received by PFPC minus any applicable CDSC. In connection with the Reorganization, Shareholders of ISIS will receive three years of holding period credit for purposes of calculating the CDSC and conversion to Series A Investor Shares with respect to the Series B Investor Shares received in the Reorganization. Accordingly, shareholders redeeming within one year of the Reorganization would be subjected to a 3.00% CDSC. After one year, the CDSC would decrease to 2.00%, and after two years the CDSC would decrease to 1.00%. There would be no CDSC after three years, and the Series B Investor Shares would automatically convert to Series A Investor Shares on the fourth anniversary of the Reorganization without any CDSC being charged. The conversion will take place at net asset value and, as a result, a shareholder will receive dollar-for-dollar the same value of Series A Investor Shares as the shareholder had of Series B Investor Shares. Because of this conversion feature, certain disclosures are necessary about Series A Investor Shares. Series A Investor Shares and Series B Investor Shares are both invested in the same portfolio of securities. These two classes differ in the fees and expenses charged to shareholders. Series A Investor Shares have no CDSC, but are subject to a front-end sales charge of 5.00%, which is subject to reduction for certain large purchases. No front-end sales charge will be charged on the conversion from Series B Investor Shares to Series A Investor Shares. In addition, the distribution and service fees charged to Series A Investor Shares are lower than those charged to Series B Investor Shares. Series A Investor Shares bear distribution and service fees at an annual rate of .50% of the average daily net assets of such shares. Of this amount, .10% represents distribution fees payable under the BlackRock 12b-1 Plan. The remaining .40% represents shareholder service and shareholder processing fees identical to those paid on Series B Investor Shares. After the Reorganization, shareholders may exchange their shares received in the Reorganization for other Series B Investor Shares of funds offered by BlackRock. 15 Dividends, Distributions and Pricing. Shareholders of ISIS and the High Yield Bond Portfolio are entitled to dividends and distributions declared from the net investment income and net realized gains, if any, earned on investments in each Fund's investment portfolio. ISIS and the High Yield Bond Portfolio each distributes its net investment income monthly and distributes its net realized capital gains, if any, at least annually. Dividends and distributions are paid to Shareholders of ISIS in cash unless they have elected to participate in the Automatic Dividend Investment Plan (the "DRIP"). Pursuant to the DRIP, the reinvestment of dividends and distributions in additional shares of ISIS are made at the lower of net asset value or market value (but not less than 95% of market value). Dividends and distributions of the High Yield Bond Portfolio are automatically reinvested in additional shares at net asset value unless PFPC, the Fund's transfer agent, is instructed in writing to pay such dividends and distributions in cash. The net asset value per share of ISIS is determined once a week, on the last business day of the week, and on the last business day of the month. The net asset value per share of the High Yield Bond Portfolio is determined each day that the New York Stock Exchange is open, at 4:00 p.m. Eastern time. Voting Information. This Combined Prospectus/Proxy Statement is being furnished in connection with the solicitation of proxies by ISIS' Board of Directors for use at the Meeting. Only Shareholders of record at the close of business on February _____, 2000 will be entitled to vote at the Meeting or any adjournment thereof. Shares represented by a properly executed proxy will be voted in accordance with the instructions thereon or if no specification is made, the persons named as proxies will vote in favor of the proposal set forth in the Notice of Meeting. Proxies may be revoked at any time before they are exercised by the subsequent execution and submission of a revised proxy, by written notice of revocation to ISIS, or by voting in person at the Meeting. RISK FACTORS The following discussion highlights the principal risk factors associated with an investment in ISIS and the High Yield Bond Portfolio and is qualified in its entirety by the more extensive discussion of risk factors set forth below under 16 "Comparison of Investment Policies and Risk Factors" and in the Prospectus and Statement of Additional Information of the High Yield Bond Portfolio, which are incorporated herein by reference. Each Fund seeks to achieve its investment objective through investments in debt securities. The investment adviser for each Fund attempts to choose debt securities that may provide above average current income, however, there is no guarantee that shares of each Fund will not lose value. The market value of securities held by the Funds is expected to vary according to, among other factors, changes in prevailing interest rates. The variation tends to be greater for portfolios with longer average weighted maturities. In general, if interest rates increase from the time a fixed income security is purchased, the market value of that security will decline. Similarly, if interest rates decrease from the time a fixed income security is purchased, the market value of that security is likely to increase. Each Fund is also subject to call risk, credit risk and event risk. Call risk is the possibility that during periods of falling interest rates, certain debt securities with high interest rates may be pre-paid (or "called") by the issuers prior to maturity. This may cause a Fund's average weighted maturity to fluctuate, and may require a Fund to invest the resulting proceeds at lower interest rates. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. Event risk is the possibility that securities may suffer declines in credit quality and market value due to issuer restructuring or other factors. Each Fund's ability to invest in debt securities rated below investment grade (i.e., rated lower than Baa by Moody's Investor Services, Inc. or rated lower than BBB by Standard & Poor's Ratings Group and Fitch-IBCA, Inc.) also involves risk. Lower-rated securities will usually offer higher yields than investment grade securities. However, there is more risk associated with these investments because of reduced creditworthiness and increased risk of default. In addition, the market values of certain lower-rated debt securities tend to reflect specific developments with respect to the issuer to a greater extent then do higher rated securities, which react primarily to fluctuations in the general level of interest rates, and tend to be more sensitive to economic conditions than higher rated securities. Issuers of lower-rated debt securities often are highly leveraged and may not have available to them more traditional methods of financing. 17 Securities rated below BBB or Baa by a rating agency are characterized by the rating agencies as predominantly speculative; the future of the issuers cannot be considered as well assured, and often the protection of interest and principal payments may be very moderate and may face major ongoing uncertainties or exposure to adverse business, financial or economic conditions which could lead to inadequate capacity to meet timely interest and principal payments. Factors adversely affecting the market price and yield of lower-rated securities, will adversely affect a Fund's net asset value. In addition, the retail secondary market for these securities may be less liquid than that for higher rated securities; adverse conditions could make it difficult at times for a Fund to sell certain securities or could result in lower prices than those used in calculating its net asset value. Like other investment companies, financial and business organizations and individuals around the world, the Funds could be adversely affected if the computer systems used by BIMC, BlackRock Advisors and the Funds' other service providers, and by persons with whom they have transactions, do not properly process and calculate date-related information and data from and after January 1, 2000. This is commonly known as the "Year 2000 Problem." BIMC and BlackRock Advisors are taking steps to solve the Year 2000 Problem with respect to the computer systems that they use before January 1, 2000 and are working with the Funds' other major service providers to determine their systems' ability to handle Year 2000 problems. At this time, however, there can be no assurance that these steps will be sufficient to avoid any adverse impact on a Fund as a result of the Year 2000 Problem. Year 2000 problems may also hurt issuers whose securities the Funds hold or security markets in general There is no assurance that either Fund will achieve its investment objective. INFORMATION RELATING TO THE PROPOSED REORGANIZATION The terms and conditions under which the Reorganization may be consummated are set forth in the Reorganization Agreement. Significant provisions of the Reorganization Agreement are summarized below; however, this summary is qualified in its entirety by reference to the Reorganization Agreement, a copy of which is attached as Appendix A to this Combined Prospectus/Proxy Statement and which is incorporated herein by reference. 18 Description of the Reorganization Agreement. The Reorganization Agreement provides that at the Effective Time of the Reorganization (as defined in Article VIII of the Reorganization Agreement), the assets and liabilities of ISIS will be transferred to and assumed by the High Yield Bond Portfolio. In exchange for the transfer of the assets of, and the assumption of the liabilities of ISIS, BlackRock will issue at the Effective Time of the Reorganization full and fractional Series B Investor Shares of the High Yield Bond Portfolio equal in aggregate dollar value to the aggregate net assest value of full and fractional outstanding shares of ISIS as determined at the valuation time specified in the Reorganization Agreement. The Reorganization Agreement provides that ISIS will declare a dividend or dividends prior to the Effective Time of the Reorganization which, together with all previous dividends, will have the effect of distributing to the Shareholders of ISIS all undistributed net investment income earned and net capital gains realized up to and including the Effective Time of the Reorganization. Following the transfer of assets to, and the assumption of the liabilities of ISIS by, the High Yield Bond Portfolio, ISIS will distribute the Series B Investor Shares of the High Yield Bond Portfolio received from BlackRock to the Shareholders of ISIS in liquidation of ISIS. Each Shareholder of ISIS at the Effective Time of the Reorganization will receive an amount of Series B Investor Shares with a total net asset value equal to the net asset value of their shares of common stock of ISIS, plus the right to receive any dividends or distributions which were declared before the Effective Time of the Reorganization but that remained unpaid at that time with respect to the shares of ISIS. Following the Reorganization, the registration of ISIS as an investment company under the 1940 Act will be terminated, and ISIS will be dissolved under state law. Approval of the Reorganization Agreement shall constitute the approval of a change in ISIS' by-laws and its fundamental limitations which may be deemed to prevent ISIS from taking the actions necessary to effectuate the Reorganization. The change is: Current Proposed ------- -------- The Fund may not purchase This limitation/by-law would be securities of other investment restated as follows: companies except by purchase of 19 Current Proposed ------- -------- securities of closed-end The Fund may not acquire any companies in the open market other investment company or involving only customary investment company security broker's commissions or except in connection with a acquisition of such securities merger, consolidation, as part of a merger, reorganization, sale or acquisition consolidation, reorganization of assets or where otherwise or purchase of assets approved permitted by the Investment by the Fund's shareholders, if Company Act of 1940. required by law. After the Reorganization all of the issued and outstanding shares of ISIS shall be cancelled on the books of ISIS and the stock transfer books of ISIS will be permanently closed. The Reorganization is subject to a number of conditions, including without limitation approval of the Reorganization Agreement and the transactions contemplated thereby described in this Combined Prospectus/Proxy Statement by the Shareholders of ISIS; the receipt of certain legal opinions described in the Reorganization Agreement (which include an opinion of Ropes & Gray that the shares of the High Yield Bond Portfolio issued to Shareholders of ISIS in accordance with the terms of the Reorganization Agreement will be validly issued, fully paid and non-assessable); the receipt of certain certificates from the parties concerning the continuing accuracy of the representations and warranties in the Reorganization Agreement and other matters; and the parties' performance in all material respects of their respective agreements and undertakings in the Reorganization Agreement. Assuming satisfaction of the conditions in the Reorganization Agreement, the Effective Time of the Reorganization will be on March _______, 2000 or such other date as is agreed to by the parties, provided, however, that unless an officer of BlackRock and ISIS determine otherwise, the Effective Time of the Reorganization shall not occur until the period has run for any objecting Shareholder of ISIS to make a written demand for payment for his or her stock pursuant to the Maryland General Corporation Law, as described more fully below under "Information Relating to Voting Matters - Appraisal Rights." The expenses of ISIS and BlackRock in connection with the Reorganization will be borne by BIMC. 20 The Reorganization Agreement and the Reorganization described herein may be abandoned at any time prior to the Effective Time of the Reorganization by the mutual consent of the parties to the Reorganization Agreement. The Reorganization Agreement provides further that at any time prior to or (to the fullest extent permitted by law) after approval of the Reorganization Agreement by the Shareholders of ISIS (a) the parties thereto may, by written agreement authorized by their respective Boards or executive officers, and with or without the approval of their respective shareholders, amend any of the provisions of the Reorganization Agreement and (b) any party may waive any breach by the other party or the failure to satisfy any of the conditions to its obligations (such waiver to be in writing and authorized by an officer of the waiving party with or without the approval of such party's shareholders). Board Considerations. In its consideration and approval of the Reorganization at meetings held on March 12, 1999, May 20, 1999, June 23, 1999, September 9, 1999 and October 12, 1999, the Board of Directors of ISIS considered and discussed the future of ISIS and how to best serve the Shareholders' interests. The directors discussed the size of ISIS' investment portfolio (approximately $31.3 million as of September 30, 1999) and the increasing difficulty in maintaining a high current rate of dividend income. The Board discussed ISIS' concentration in utility securities and changes affecting the utilities industry. They discussed proposed changes to general accounting rules which would change the way ISIS amortizes and/or accretes the premiums and discounts on portfolio securities, and the impact of such changes on the Fund's dividend income. The Board of Directors employed an independent consultant to review ISIS' present operations. The directors and the independent consultant reviewed proposals to: modify the Fund's investment policies to change it into a non-investment grade portfolio; liquidate the assets; increase assets through a private placement or a rights offering; change investment advisers; convert ISIS to an open-end fund; merge ISIS with other closed-end investment companies; and merge ISIS into a fund of BlackRock. After discussions, it was decided to pursue the Reorganization with the High Yield Bond Portfolio. In considering the High Yield Bond Portfolio as opposed to an investment grade investment portfolio offered by BlackRock, the Board of Directors reviewed the history of ISIS, noting that the Fund has traditionally been an income-producing investment for its Shareholders, and that the High Yield Bond Portfolio was probably a more likely investment vehicle to sustain the 21 competitive dividend level. The directors did consider, however, that investments in high yield securities involve greater risks than investments in investment grade securities. The directors noted that Shareholders wishing an investment grade bond fund would be able to exchange into such a fund of BlackRock without being charged a CDSC. Such an exchange would be, however, a taxable event. With regard to the CDSC, it was noted that ISIS has frequently traded on the NASDAQ at a discount to its net asset value. The Board also considered that as shareholders of the High Yield Bond Portfolio, ISIS' Shareholders could redeem their Series B Investor Shares at net asset value and pay a 3.00% CDCS (or less in later years) upon redemption. Currently, ISIS' Shareholders have to sell shares at current market value, which has frequently been less than net asset value, and pay brokerage commissions. The directors also considered the fee structure of the Series B Investor Shares of the High Yield Bond Portfolio, noting that total operating expenses were higher than those of ISIS. They also considered the fact that BlackRock Advisors and its affiliates may benefit from these increased fees. In its consideration and approval of the Reorganization, the Board of Directors of ISIS considered, among other things: the terms of the Reorganization Agreement; a comparison of each Fund's historical and projected expense ratios; the comparative investment performance of the Funds; the effect of such Reorganization on ISIS and its Shareholders; the fact that the day-to-day portfolio management would be unchanged by the Reorganization; the investment advisory services supplied by BlackRock Advisors; the management and other fees payable by the High Yield Bond Portfolio; the similarities and differences of the investment objective and policies of the Funds; the opportunity to combine ISIS and the High Yield Bond Portfolio into a single, larger asset base; the recommendations of BIMC and BlackRock Advisors with respect to the proposed Reorganization; the fact that the Reorganization would constitute a tax-free reorganization; the determination that the proposed Reorganization is in the best interests of the shareholders and the fact that the interests of Shareholders would not be diluted as a result of the Reorganization. After considering the foregoing factors, together with such other information as they believed to be relevant, the Board of Directors of ISIS approved the Reorganization Agreement and directed that it be submitted to Shareholders for approval. 22 THE BOARD OF DIRECTORS OF ISIS RECOMMENDS THAT SHAREHOLDERS VOTE "FOR" APPROVAL OF THE REORGANIZATION AGREEMENT. The Board of Directors of ISIS has not determined what action ISIS will take in the event Shareholders fail to approve the Reorganization Agreement or for any reason the Reorganization is not consummated. In either such event, the Board will consider other appropriate courses of action, including the sale of assets to, or merger with, another investment company, the possible liquidation of ISIS, or continuing the operations of ISIS in its present form. Similarly, at meetings held on August 11, 1999 and October 4, 1999, the Board of Trustees of BlackRock considered the proposed Reorganization. Based upon its evaluation of the relevant information provided to it, and in light of its fiduciary duties under federal and state law, the Board of Trustees determined that (i) the proposed Reorganization is in the best interests of the shareholders of the High Yield Bond Portfolio and (ii) the interests of the High Yield Bond Portfolio's shareholders would not be diluted as a result of the Reorganization. Federal Income Tax Consequences. Consummation of the Reorganization is subject to the condition that ISIS and BlackRock receive an opinion from Drinker Biddle & Reath LLP to the effect that for federal income tax purposes: (i) the transfer of all of the assets and liabilities of ISIS to the High Yield Bond Portfolio in exchange for Series B Investor Shares of the High Yield Bond Portfolio and the liquidating distributions to Shareholders of Series B Investor Shares of the High Yield Bond Portfolio so received, as described in the Reorganization Agreement, will constitute a reorganization within the meaning of Section 368(a) of the Internal Revenue Code of 1986, as amended (the "Code"), and with respect to the Reorganization, ISIS and the High Yield Bond Portfolio will each be considered "a party to a reorganization" within the meaning of 368(b) of the Code; (ii) no gain or loss will be recognized by ISIS as a result of such transaction; (iii) no gain or loss will be recognized by the High Yield Bond Portfolio as a result of such transaction; (iv) no gain or loss will be recognized by the Shareholders of ISIS on the distribution to such Shareholders of Series B Investor Shares of the High Yield Bond Portfolio in exchange for their shares of ISIS; (v) the aggregate basis of Series B Investor Shares of the High Yield Bond Portfolio received by a Shareholder of ISIS will be the 23 same as the aggregate basis of the Shareholder's shares of ISIS immediately prior to the Reorganization; (vi) the basis of the High Yield Bond Portfolio in the assets of ISIS received pursuant to such transaction will be the same as the basis of such assets in the hands of ISIS immediately before such transaction; (vii) a Shareholder's holding period for Series B Investor Shares of the High Yield Bond Portfolio will be determined by including the period for which the Shareholder held ISIS shares exchanged therefor, provided that the Shareholder held such shares in ISIS as a capital asset; and (viii) the High Yield Bond Portfolio's holding period with respect to the assets received in the Reorganization will include the period for which such assets were held by ISIS. BlackRock and ISIS have not sought a tax ruling from the Internal Revenue Service ("IRS"), but are acting in reliance upon the opinion of counsel discussed in the previous paragraph. That opinion is not binding on the IRS and does not preclude the IRS from adopting a contrary position. Shareholders should consult their own advisers concerning the potential tax consequences to them, including state and local income taxes. Capitalization. Because ISIS will be combined with the High Yield Bond Portfolio in the Reorganization, the total capitalization of the High Yield Bond Portfolio after the Reorganization is expected to be greater than the current capitalization of ISIS. The following table sets forth as of September 30, 1999: (i) the capitalization of ISIS; (ii) the capitalization of the High Yield Bond Portfolio; and (iii) the pro forma capitalization of the High Yield Bond Portfolio as adjusted to give effect to the proposed Reorganization. There is, of course, no assurance that the Reorganization will be consummated. Moreover, if consummated, the capitalizations of the High Yield Bond Portfolio and ISIS are likely to be different at the Effective Time of the Reorganization as a result of fluctuations in the value of portfolio securities of both Funds and daily share purchase and redemption activity in the High Yield Bond Portfolio. 24 ================================================================================ The High Yield Bond Pro Forma ------------------- ISIS Portfolio Combined ---- --------- -------- - -------------------------------------------------------------------------------- Total Net Assets ($) 31,274,404 83,325,011 114,599,415 - -------------------------------------------------------------------------------- Shares Outstanding 1,822,752 1,274,781 (Series B 4,489,005 (Series B Investor shares) Investor Shares) - -------------------------------------------------------------------------------- Net Asset Value Per 17.16 9.73 (Series B 9.73 (Series B Share ($) Investor Shares) Investor Shares) ================================================================================ COMPARISON OF INVESTMENT POLICIES AND RISK FACTORS The following discussion summarizes some of the similarities and differences in the investment policies and risk factors of the Funds, and is qualified in its entirety by the discussion in the Prospectus and Statement of Additional Information of the High Yield Bond Portfolio, which are incorporated herein by reference. The investment objective of ISIS is to seek as high a level of current income as is consistent with prudent investment. The investment objective of the High Yield Bond Portfolio is to seek current income by investing primarily in non-investment grade bonds. The investment objective of ISIS is fundamental, meaning that it may not be changed without the affirmative vote of the holders of a majority of its outstanding shares, as defined in the 1940 Act. The investment objective of the High Yield Bond Portfolio is not fundamental and may be changed by its Board of Trustees without shareholder approval, although shareholders will be given 30 days' notice of any such change. General. Both Funds invest in debt securities. The High Yield Bond Portfolio invests primarily in non-investment grade bonds (i.e., rated lower than Baa by Moody's Investor Services, Inc. or rated lower than BBB by Standard & Poor's Ratings Group and Fitch-IBCA, Inc.) in the ten to fifteen year maturity range. The High Yield Bond Portfolio normally invests at least 80% of its total assets in bonds or convertible securities and at least 65% of its total assets in non-investment grade (i.e., junk) bonds. The High Yield Bond Portfolio may invest up to 10% of its total assets in bonds of foreign issuers. 25 ISIS must invest at least 60% of its assets in: (1) marketable straight debt securities which are rated at the time of purchase within the four highest grades assigned by Moody's Investors Service, Inc. (Aaa, Aa, A or Baa), Standard & Poor's Ratings Group, Division of McGraw Hill (AAA, AA, A or BBB) or Fitch IBCA, Inc. (AAA, AA, A or BBB); (2) securities of, or guaranteed by, the United States government, its agencies or instrumentalities; (3) securities (payable in U.S. dollars) of, or guaranteed by, the government of Canada or of a Province of Canada under circumstances that would not subject the Fund to payment of U.S. Interest Equalization Tax; (4) commercial paper of companies having, at the time of purchase, an issue of outstanding debt securities rated as described in (1) above; and (5) cash or cash equivalents. ISIS is permitted to invest up to 40% of its assets in non-investment grade securities. ISIS is required to invest at least 25% of its assets in the securities of utility companies. A principal difference in investment policies is that ISIS invests primarily in investment grade securities while the High Yield Bond Portfolio invests primarily in non-investment grade securities. Another principal difference is the range of securities and investment techniques available to the High Yield Bond Portfolio. The following summarizes those investment policies and compares them to ISIS' policies. The High Yield Bond Portfolio can invest in a wide range of securities including mezzanine investments, collateralized bond obligations ("CBOs"), bank loans, and mortgage-backed and asset-backed securities. ISIS does not have a stated policy to invest in these types of securities; however, it has no investment policy or limitation which would prohibit investments in these securities. The High Yield Bond Portfolio may invest in mezzanine investments. Mezzanine investments are subordinated debt securities which receive payments of interest and principal after other more senior security holders are paid. They are generally issued in private placements in connection with an equity security. Mezzanine securities carry the risk that the issuer will not be able to meet its obligations and that the equity securities purchased with the mezzanine investments may lose value. The High Yield Bond Portfolio may invest in CBOs, which are securities backed by a diversified pool of high yield securities. The pool of high yield securities underlying CBOs 26 is typically separated into groupings, called tranches, representing different degrees of credit quality. The higher quality tranches have greater degrees of protection and pay lower interest rates. The lower tranches, with greater risk, pay higher interest rates. The High Yield Bond Portfolio may invest in bank loans. Bank loans are fixed and floating rate loans arranged through private negotiations between a company or a foreign government and one or more financial institutions. The Fund considers such investments to be debt securities. The market for bank loans may not be highly liquid and the Fund may have difficulty selling them. These investments expose a fund to the risk of investing in both the financial institution and the underlying borrower. The High Yield Bond Portfolio may make investments in residential and commercial mortgage-backed securities ("CMBS")and other asset-backed securities. CMBS are bonds that are backed by a mortgage loan or pool of loans secured by commercial property, not residential mortgages. Asset-backed securities are bonds that are backed by a pool of assets, usually loans such as installment sale contracts or credit card receivables. The characteristics of these mortgage-backed and asset-backed securities differ from traditional fixed income securities. A main difference is that the principal on mortgage- or asset-backed securities may normally be prepaid at any time, which will reduce the yield and market value of these securities. Asset-backed securities and CMBS generally experience less prepayment than residential mortgage-backed securities. In periods of falling interest rates, the rate of prepayments tends to increase (as does price fluctuation) as borrowers are motivated to pay off debt and refinance at new lower rates. During such periods, reinvestment of the prepayment proceeds by the investment adviser will generally be at lower rates of return than the return on the assets which were prepaid. Certain commercial mortgage-backed securities are issued in several classes with different levels of yield and credit protection. The High Yield Bond Portfolio's investments in commercial mortgage-backed securities with several classes will normally be in the lower classes that have less credit protection. Certain asset-backed securities are based on loans that are unsecured, which means that there is no collateral to seize if 27 the underlying borrower defaults. Other asset-backed securities may not have the benefit of as much collateral as mortgage-backed securities. The High Yield Bond Portfolio may, when consistent with the Fund's investment objective, use options or futures (commonly known as derivatives). The primary purpose of using derivatives is to attempt to reduce risk to the Fund as a whole (i.e., to hedge) but they also may be used to maintain liquidity, commit cash pending investment or to increase returns. The High Yield Bond Portfolio may also enter into interest rate or foreign currency transactions as a hedging technique. In these transactions, the Fund exchanges its right to pay or receive interest or currencies with another party for their right to pay or receive interest or another currency in the future. ISIS does not have a stated policy to invest in these types of securities; however, it has no investment policy or limitation which would prohibit investments in these securities. The High Yield Bond Portfolio's use of derivatives, interest rate and foreign currency transactions may reduce its returns and/or increase volatility, which is defined as the characteristic of a security or a market to fluctuate significantly in price within a short period of time. The High Yield Bond Portfolio may invest up to 10% of its total assets in bonds of foreign issuers. ISIS has no explicit investment policy or limitation concerning investments in foreign issuers. Foreign securities involve risks not typically associated with investing in U.S. securities. These risks include but are not limited to: currency risks (the risk that the value of interest paid on foreign securities, or the value of the securities themselves, may fall if currency exchange rates change), the risk that a security's value will be hurt by changes in foreign political or social conditions, the possibility of heavy taxation or expropriation and more difficulty obtaining information on foreign securities or companies. In addition, a portfolio of foreign securities may be harder to sell and may be subject to wider price movements than comparable investments in U.S. companies. There is also less government regulation of foreign securities markets. In addition, political and economic structures in developing countries may be undergoing rapid change and these countries may lack the social, political and economic stability of more developed countries. As a result some of the risks described above, including the risks of nationalization or expropriation of assets and the existence of smaller, more 28 volatile and less regulated markets, may be increased. The value of many investments in emerging market countries recently has dropped significantly due to economic and political turmoil in many of these countries. On January 1, 1999, eleven European countries implemented a new currency unit called the "Euro" which is expected to reshape financial markets, banking systems and monetary policies in Europe and other parts of the world. While it is impossible to predict the impact of the "Euro," it is possible that it could increase volatility in financial markets worldwide which could hurt the value of shares of the High Yield Bond Portfolio. The High Yield Bond Portfolio may invest in securities rated as low as "C." These securities are very risky and have uncertainties regarding the issuer's ability to make interest and principal payments. As stated above, ISIS can invest up to 40% of its assets in securities rated below investment grade, including securities rated "C." ISIS has no explicit limitation on what ratings are acceptable. Accordingly, ISIS could invest in securities rated "C" or below. Each Fund can borrow money to buy additional securities. This practice is known as "leverage." The High Yield Bond Portfolio may borrow from banks or other financial institutions or through reverse repurchase agreements (under which the Fund sells securities and agrees to buy them back at a particular date and price). The High Yield Bond Portfolio currently may borrow up to 33-1/3% of the value of its total assets, and may borrow an additional 5% of its total assets for temporary purposes. ISIS also may borrow money to purchase securities. ISIS currently may borrow up to 25% of the value of its total assets. ISIS also may borrow money from banks for temporary or emergency purposes. Leverage is a speculative technique which may expose a Fund to greater risk and increase its costs. Increases and decreases in the value of a Fund's portfolio will be magnified when the Fund uses leverage. A Fund will also have to pay interest on its borrowings, reducing return. The High Yield Bond Portfolio may lend some of its securities on a short- term basis in order to earn extra income. The High Yield Bond Portfolio will receive collateral in cash or high quality securities equal to the current value of the loaned securities. These loans will be limited to 33-1/3% of the value of the Fund's total assets. Securities loans involve the risk of a delay in receiving additional collateral if the value of the securities goes up while they are on loan. There is also 29 the risk of delay in recovering the loaned securities and of losing rights to the collateral if a borrower goes bankrupt. ISIS may also lend securities. These loans are limited to 20% of the value of its total assets. Investment Limitations. Neither ISIS nor the High Yield Bond Portfolio may change their fundamental investment limitations without the affirmative vote of a majority of the outstanding shares, as defined in the 1940 Act. The following discusses the similarities and differences in their fundamental limitations. Each Fund is a diversified investment portfolio and, therefore, has a fundamental policy limiting investments in securities of any one issuer to 5% of total assets and excludes securities issued or guaranteed by the U.S. Government, its agencies, enterprises or instrumentalities. This limitation applies to 100% of ISIS' total assets. This limitation only applies to 75% of the High Yield Bond Portfolio's total assets. Consequently, up to 25% of the High Yield Bond Portfolio's total assets may be invested without regard to this 5% limitation. Neither Fund will invest more than 25% of its total assets in the securities of issuers in any one industry, except that, as stated above, ISIS is required to invest at least 25% of its total assets in securities of utility companies. Neither Fund will make loans, except that: (a) each may purchase or hold certain debt instruments and engage in repurchase agreements; and (b) each may lend portfolio securities as described above. Neither Fund will issue senior securities, except that: (a) each may borrow money for temporary or emergency purposes up to 5% of total assets; and (b) each may borrow money to purchase additional securities as described above. Neither Fund may purchase or sell real estate, except that the Funds may purchase securities of issuers which deal in real estate and may purchase securities which are secured by interests in real estate. The High Yield Bond Portfolio may not acquire any other investment company or investment company security except in connection with a merger, consolidation, reorganization or acquisition of assets or where otherwise permitted by the 1940 Act. ISIS is only permitted to purchase shares of other closed- 30 end funds in the open market involving only customary broker's commissions or acquire shares of other investment companies in connection with a merger, consolidation, reorganization or purchase of assets approved by the Fund's Shareholders, if required by law. However, as described above under "Information Relating to the Proposed Reorganization - Description of the Reorganization Agreement," approval of the Reorganization Agreement will constitute the approval of a change to this limitation which will make it substantially the same as the High Yield Bond Portfolio's limitation. Neither Fund will act as an underwriter of securities within the meaning of the Securities Act of 1933 except to the extent that the purchase of obligations directly from the issuer thereof, or the disposition of securities, may be deemed to be an underwriting. Neither Fund may purchase securities of companies for the purpose of exercising control. Neither Fund may purchase or sell commodities or commodity contracts. The High Yield Bond Portfolio may, however, invest in companies engaging in whole or in part in such activities. Additionally, the High Yield Bond Portfolio does not consider currency contracts, futures contracts and related options to be covered by this limitation. Neither Fund may purchase securities on margin, make short sales or maintain a short position. However, the High Yield Bond Portfolio does not consider futures contracts and related options to be covered by this limitation. In addition, the High Yield Bond Portfolio would be allowed to sell a security short-against-the-box. The following fundamental limitations of the High Yield Bond Portfolio have no counterpart in ISIS. The High Yield Bond Portfolio may not: write or sell put options, call options, straddles, spreads, or any combination thereof, except for transactions in options on securities, securities indices, futures contracts and options thereon; or invest in oil, gas or mineral exploration or development programs, but may invest in companies engaged in whole or in part in such activities. See "Additional Investment Limitations" in the High Yield Bond Portfolio's Statement of Additional Information which is incorporated by reference herein for the complete list of fundamental investment limitations. 31 Other Information. ISIS is registered as a closed-end management investment company under the 1940 Act. BlackRock is registered as an open-end management investment company under the 1940 Act. Currently, ISIS offers one investment portfolio and BlackRock offers 36 investment portfolios. ISIS is organized as a Maryland corporation and is subject to the provisions of its Articles of Incorporation and By-laws. BlackRock is organized as a Massachusetts business trust and is subject to the provisions of its Declaration of Trust and Amended and Restated Code of Regulations. Shares of both ISIS and BlackRock: (i) are entitled to one vote for each full share held and a proportionate fractional vote for each fractional share held; and (ii) are entitled to participate equally in the dividends and distributions that are declared with respect to a particular investment portfolio and in the net distributable assets of such portfolio on liquidation. In addition, shares of BlackRock will vote in the aggregate and not by class except as otherwise expressly required by law or when class voting is permitted by the Board of Trustees. Shares of ISIS have a par value of $0.10 and shares of BlackRock have a par value of $.001. Shares of both ISIS and BlackRock have no preemptive rights and only such conversion and exchange rights as the respective Boards of Directors or Trustees may grant in their discretion. When issued for payment as described in its Prospectus, shares of BlackRock are fully paid and non-assessable. The foregoing is only a summary. Shareholders may obtain copies of the Articles of Incorporation and By-laws of ISIS and the Declaration of Trust and Amended and Restated Code of Regulations of BlackRock upon written request at the addresses shown on the cover page of this Combined Prospectus/Proxy Statement. 32 INFORMATION RELATING TO VOTING MATTERS General Information. This Combined Prospectus/Proxy Statement is being furnished in connection with the solicitation of proxies by the Board of Directors of ISIS for use at the Meeting. It is expected that the solicitation of proxies will be primarily by mail. ISIS' officers and service providers may also solicit proxies by telephone, facsimile machine, telegraph or personal interview. In addition, although it has not done so to date, ISIS may retain the services of one or more outside organizations to aid in the solicitation of proxies. Such organizations normally charge a fee plus out-of-pocket expenses. Any Shareholder giving a proxy may revoke it at any time before it is exercised by submitting to ISIS a written notice of revocation or a subsequently executed proxy or by attending the Meeting and electing to vote in person. Only Shareholders of record at the close of business on February __, 2000 will be entitled to vote at the Meeting. On that date, there were outstanding and entitled to be voted _________ shares. Each share or fraction thereof is entitled to one vote or fraction thereof. If the accompanying proxy is executed and returned in time for the Meeting, the shares covered thereby will be voted in accordance with the proxy on all matters that may properly come before the meeting (or any adjournment thereof). Shareholder and Board Approvals. Approval of the Reorganization Agreement (and the transactions contemplated thereby) requires the affirmative vote of at least a majority of the outstanding shares of ISIS. In tallying Shareholder votes, abstentions and broker non-votes (i.e., proxies sent in by brokers and other nominees that cannot be voted on a proposal because instructions have not been received from the beneficial owners) will be counted for purposes of determining whether or not a quorum is present for purposes of convening the Meeting. On the Reorganization proposal, abstentions and broker non-votes will be considered to be a vote against the Reorganization proposal. The approval of the Reorganization by the shareholders of the High Yield Bond Portfolio is not being solicited because their approval or consent is not legally required. 33 At February __, 2000, the directors and officers of ISIS as a group owned ____% of the outstanding shares of ISIS. At February __, 2000, the name, address and percentage ownership of the persons who owned beneficially more than 5% of the outstanding shares of ISIS and the percentage of Series B Investor Shares of the High Yield Bond Portfolio that would be owned by such persons upon consummation of the Reorganization based upon their holdings at February __, 2000 are as follows: ================================================================================ Percentage of ISIS Percentage of Series B Name and Amount of Shares Shares Owned on Investor Shares of the Address Owned Record Date High Yield Bond ------- ----- ----------- Portfolio Owned Upon Consummation ------------ - -------------------------------------------------------------------------------- ISIS ================================================================================ At February __, 2000, the trustees and officers of BlackRock as a group owned less than 1% of the outstanding shares of the High Yield Bond Portfolio. At February __, 2000, the name, address and share ownership of the persons who owned beneficially more than 5% of any class of the High Yield Bond Portfolio and the percentage of shares that would be owned by such person upon consummation of the Reorganization based upon their holdings at February __, 2000 were as follows:
=================================================================================================================== Percentage of Fund Percentage of Percentage of Shares Class Owned The High Yield Name and Class and Amount Class Owned on Owned on Upon Bond Portfolio Address of Shares Owned Record Date Record Date Consummation - -------------- ------- --------------- ----------- ----------- ------------ - ------------------------------------------------------------------------------------------------------------------- - ------------------------------------------------------------------------------------------------------------------- ===================================================================================================================
Appraisal Rights. Under the Maryland General Corporation Law, certain relevant sections of which are attached to this Combined Prospectus/Proxy Statement as Appendix D, each Shareholder of ISIS will be entitled to demand and receive payment of the "fair value" of his or her shares in cash, if he or she (i) prior to or at the Meeting, files with ISIS a written objection to the Reorganization, (ii) does not vote in favor of the Reorganization by person or by proxy and (iii) within 20 days after the Articles of Transfer with respect to the Reorganization have been accepted for record by the Maryland State Department of Assessments and Taxation (the "Maryland 34 SDAT") makes a written demand on BlackRock for payment of his or her shares (a "Payment Demand"), stating the number of shares for which payment is demanded. A Payment Demand should be sent to BlackRock at Bellevue Park Corporate Center, 400 Bellevue Parkway, Wilmington, Delaware 19809, Attn: Brian P. Kindelan, Secretary. Any Shareholder of ISIS who fails to comply with the requirements described above will be bound by the terms of the Reorganization. Under the Maryland General Corporation Law, "fair value" would be determined as of the close of business on the day that the Shareholders vote on the Reorganization and would not include any appreciation or depreciation that results, directly or indirectly, from the Reorganization or from its proposal. Moreover, in that regard, a Shareholder who makes a Payment Demand for his or her shares would not be entitled to receive any of the dividends or distributions that will be payable to Shareholders of record of those shares on a record date that is after the close of business on the day the Shareholders vote on the Reorganization. BlackRock will promptly deliver or send by certified mail, return receipt requested, to each Shareholder of ISIS who has filed a written objection to the proposed Reorganization with BlackRock, written notice of the date of acceptance of the Articles of Transfer with respect to the Reorganization for record by the Maryland SDAT and of the Effective Time of the Reorganization. Such notice may include a written offer by BlackRock to pay the objecting Shareholder what BlackRock considers to be the fair value of their shares of common stock of ISIS. Within 50 days after the Reorganization, any Shareholder who has made a Payment Demand but has not received payment for his or her shares may petition a court of equity in Baltimore City, Maryland, for an appraisal to determine the "fair value" of such shares. If the court finds that a Shareholder is entitled to appraisal of his or her stock, the court will appoint three disinterested appraisers to determine the "fair value" of such shares on terms and conditions the court considers proper, and the appraisers will, within 60 days after appointment (or such longer period as the court may direct), file with the court and mail to each party to the proceeding their report stating their conclusion as to the "fair value" of the shares. Within 15 days after the filing of the report, any party may object to the report and request a hearing thereon. The court will, upon motion of any party, enter an order either confirming, modifying or rejecting the report and, if confirmed or modified, enter judgment directing the time within which payment must be made. If the appraisers' report is rejected, the court may determine the "fair value" of the shares of common stock of the Shareholder of ISIS requesting appraisal or may remit the proceeding to the same or other appraisers. Any judgment entered pursuant to a court proceeding will include interest from the date of the Meeting unless the court finds that the Shareholder's refusal to accept a written offer to 35 purchase the stock which may previously have been made by BlackRock in accordance with Section 3-207 of the Maryland General Corporation Law, was arbitrary and vexatious or not in good faith. BlackRock's costs of the proceeding (not including attorneys' fees) will be determined by the court and will be assessed against BlackRock or, under certain circumstances, the Shareholder, or both. At any time after the filing of a petition for appraisal, the court may require a Shareholder who has filed such petition to submit his or her certificates representing shares to the clerk of the court for notation of the pendency of the appraisal proceedings. In order to receive payment, whether by agreement with BlackRock or pursuant to a judgment, such Shareholder of ISIS must surrender the stock certificates endorsed in blank and in proper form for transfer. A Shareholder who has made a Payment Demand will not have the right to receive any dividends or distributions payable to holders of record after the close of business on the date of the Meeting and shall cease to have any rights as a Shareholder of ISIS with respect to the shares except the right to receive payment of the "fair value" thereof. The rights of a Shareholder who has made a Payment Demand may be restored only upon the withdrawal, with the consent of BlackRock, of the Payment Demand, failure to file a petition for appraisal within the time required, a determination of the court that the Shareholder is not entitled to an appraisal, or the abandonment or recession of the Reorganization. For information relating to the exercise of appraisal rights, see Appendix D to this Combined Prospectus/Proxy Statement. 36 Quorum. In the event that a quorum is not present at the Meeting, or in the event that a quorum is present at the Meeting but sufficient votes to approve the Reorganization Agreement are not received, the persons named as proxies, or their substitutes, may propose one or more adjournments of the Meeting to permit further solicitation of proxies. Any such adjournment will require the affirmative vote of a majority of those shares affected by the adjournment represented at the Meeting in person or by proxy. If a quorum is present, the persons named as proxies will vote those proxies which they are entitled to vote FOR the Reorganization Agreement in favor of such adjournment, and will vote those proxies required to be voted AGAINST such proposal, against any adjournment. A quorum is constituted with respect to ISIS by the presence in person or by proxy of the holders of a majority of the outstanding shares of ISIS entitled to vote at the Meeting. Proxies properly executed and marked with a negative vote, broker non-votes or an abstention will be considered to be present at the Meeting for the purposes of determining the existence of a quorum for the transaction of business. Annual Meetings. BlackRock does not presently intend to hold annual meetings of shareholders for the election of trustees and other business unless and until such time as required by law. Under certain circumstances, however, shareholders have the right to call a meeting of shareholders, and such meetings will be called when requested by the holders of record of 10% or more of BlackRock's outstanding shares of beneficial interest. To the extent required by law, BlackRock will assist in shareholder communications in such matters. In addition, BlackRock will hold special meetings of shareholders when required under the 1940 Act or in accordance with SEC policy. 37 ADDITIONAL INFORMATION ABOUT BLACKROCK Information about the High Yield Bond Portfolio and its Series B Investor Shares is included in the Prospectus dated January 28, 1999 accompanying this Combined Prospectus/Proxy Statement, which is incorporated by reference herein. Additional information about the High Yield Bond Portfolio and its Series B Investor Shares is included in the Fund's Statement of Additional Information dated January 28, 1999 which has been filed with the SEC and which is incorporated herein by reference. Copies of the Statement of Additional information may be obtained without charge by calling 1-800-441-7762. BlackRock is subject to the requirements of the 1940 Act and, in accordance with such requirements, files reports and other information with the SEC. These materials can be inspected and copied at the Public Reference Facilities maintained by the SEC at 450 Fifth Street, N.W., Washington, D.C. 20549, and at the SEC's Regional Offices at 7 World Trade Center, Suite 1300, New York 10048 and 500 West Madison Street, Suite 1400, Chicago, Illinois 60661. Copies of such material can also be obtained from the Public Reference Branch, Office of Consumer Affairs and Information Services, Securities and Exchange Commission, Washington, D.C. 20549, at prescribed rates, and is also available on the SEC's web site at http://www.sec.gov. ADDITIONAL INFORMATION ABOUT ISIS Information about ISIS is included in this Combined Prospectus/Proxy Statement and the Statement of Additional Information related to this Combined Prospectus/Proxy Statement. Reports and other information filed by ISIS can be inspected and copied at the Public Reference Facilities maintained by the SEC at 450 Fifth Street, N.W., Washington, DC 20549, and copies of such materials can be obtained from the Public Reference Branch, Office of Consumer Affairs and Information Services, Securities and Exchange Commission, Washington, DC 20549, at prescribed rates. In addition, the shares of common stock of ISIS are listed on The NASDAQ SmallCap MarketSM. Reports and other information concerning ISIS can be inspected by contacting NASDAQ at 1735 K Street NW, Washington, D.C. 20006. 38 FINANCIAL STATEMENTS AND EXPERTS The unaudited financial statements and notes thereto of ISIS for the six month period ended June 30, 1999, and the audited financial statements and notes thereto of ISIS for the fiscal year ended December 31, 1998, are incorporated by reference into the Statement of Additional Information related to this Combined Prospectus/Proxy Statement. The financial statements and financial highlights for ISIS for the fiscal year ended December 31, 1998 have been incorporated herein by reference in reliance on the report of PricewaterhouseCoopers LLP, independent auditors, given on their authority as experts in auditing and accounting. The audited financial statements and notes thereto of the High Yield Bond Portfolio for the fiscal period ended September 30, 1999 are incorporated by reference into the Statement of Additional Information related to this Combined Prospectus/Proxy Statement. The financial statements and financial highlights for the High Yield Bond Portfolio for the fiscal period ended September 30, 1999 have been incorporated herein by reference in reliance on the report of PricewaterhouseCoopers LLP, independent auditors, given on their authority as experts in auditing and accounting. 39 OTHER BUSINESS The Board of Directors of ISIS knows of no other business to be brought before the Meeting. However, if any other matters come before the Meeting, it is the intention of the Board that proxies that do not contain specific restrictions to the contrary will be voted on such matters in accordance with the judgment of the persons named in the enclosed form of proxy. LITIGATION Neither ISIS nor BlackRock is involved in any litigation which would have any material adverse effect upon either ISIS or the High Yield Bond Portfolio. SHAREHOLDER INQUIRIES Shareholder inquiries may be addressed to ISIS in writing at the address on the cover page of this Combined Prospectus/Proxy Statement or by telephoning (610) 964-8882. * * * SHAREHOLDERS WHO DO NOT EXPECT TO BE PRESENT AT THE MEETING ARE REQUESTED TO DATE AND SIGN THE ENCLOSED PROXY AND RETURN IT IN THE ENCLOSED ENVELOPE. NO POSTAGE IS REQUIRED IF MAILED IN THE UNITED STATES. 40 APPENDIX A AGREEMENT AND PLAN OF REORGANIZATION AGREEMENT AND PLAN OF REORGANIZATION BY AND BETWEEN BLACKROCK FUNDS(SM) on behalf of itself and its High Yield Bond Portfolio and INDEPENDENCE SQUARE INCOME SECURITIES, INC. Dated December __, 1999
CONTENTS I. Transfer of Assets ................................................ 2 II. Liquidating Distribution and Termination of ISIS............................................................... 4 III. Valuation Time..................................................... 5 IV. Certain Representations, Warranties and Agreements of ISIS......... 5 V. Certain Representations, Warranties and Agreements of BlackRock.... 12 VI. Stockholder Action on Behalf of ISIS............................... 16 VII. N-14 Registration Statement and Proxy Solicitation Materials.......................................................... 18 VIII. Effective Time of the Reorganization............................... 18 IX. Covenants.......................................................... 19 X. BlackRock Conditions............................................... 22 XI. ISIS Conditions.................................................... 30 XII. Tax Documents...................................................... 35 XIII. Finder's Fees...................................................... 36 XIV. Announcements...................................................... 36 XV. Further Assurances................................................. 36 XVI. Termination of Representations and Warranties...................... 37 XVII. Termination of Agreement........................................... 37 XVIII. Amendment and Waiver............................................... 38 XIX. Governing Law...................................................... 39 XX. Successors and Assigns............................................. 39 XXI. Beneficiaries...................................................... 39 XXII. BlackRock Liability................................................ 39 XXIII. Expenses........................................................... 40 XXIV. Entire Agreement................................................... 41 XXV. Counterparts....................................................... 41 XXVI. Notices............................................................ 41
AGREEMENT AND PLAN OF REORGANIZATION AGREEMENT AND PLAN OF REORGANIZATION (the "Agreement") made as of December ___, 1999 between BlackRock Funds(SM), a Massachusetts business trust ("BlackRock"), and Independence Square Income Securities, Inc., a Maryland corporation ("ISIS"). WHEREAS, the parties intend that all of the assets and liabilities of ISIS be transferred to, and be acquired and assumed by, the BlackRock High Yield Bond Portfolio (the "Acquiring Fund"), an investment portfolio offered by BlackRock, in exchange for Series B Investor Shares of the Acquiring Fund (the "Series B Investor Shares") which shall thereafter be distributed by ISIS to the holders of its shares, all as described in this Agreement (the "Reorganization"); WHEREAS, the parties intend that the transfer of assets, assumption of liabilities, and distribution of the Series B Investor Shares be treated as a tax-free reorganization under Section 368(a) of the Internal Revenue Code of 1986, as amended (the "Code"); and WHEREAS, the parties intend that after the Reorganization, the registration of ISIS as an investment company under the Investment Company Act of 1940, as amended (the "1940 Act") shall be terminated and ISIS shall be dissolved under state law as provided in this Agreement. NOW, THEREFORE, in consideration of the mutual covenants and agreements hereinafter set forth and subject to the terms and conditions hereof, and intending to be legally bound hereby, BlackRock and ISIS agree as follows: I. Transfer of Assets. ------------------ 1.01 At the Effective Time of the Reorganization (as defined in Article VIII), all property of every description, and all interests, rights, privileges and powers of ISIS except (i) cash in an amount necessary to pay any unpaid dividends and distributions as provided in Article IV(h) and (ii) corporate records of ISIS (such assets, the "Assets") shall be transferred and conveyed by ISIS to BlackRock on behalf of the Acquiring Fund, and shall be acquired by BlackRock on behalf of the Acquiring Fund, and BlackRock, on behalf of the Acquiring Fund, shall assume all liabilities, whether accrued, absolute, contingent or otherwise, of ISIS, which liabilities shall also include without limitation the obligation of ISIS to indemnify the directors and officers of ISIS to the fullest extent permitted by ISIS' Articles of Incorporation, as in effect at of the date of this Agreement (the "Liabilities"), so that at and after the Effective Time of the Reorganization: (i) the Assets shall become and be the assets of BlackRock on behalf of the Acquiring Fund; and (ii) the Liabilities shall be assumed by BlackRock on behalf of the Acquiring Fund. Without limiting the generality of the foregoing, the Assets shall include all property and assets of any nature whatsoever, including, without 2 limitation, all cash, cash equivalents, securities, claims and receivables (including dividend and interest receivables) owned by ISIS, and all deferred or prepaid expenses shown as assets on the books of ISIS, at the Effective Time of the Reorganization, and all good will, all other intangible property and all financial books and records belonging to ISIS. Recourse by any person for the Liabilities shall, at and after the Effective Time of the Reorganization, be limited to the Acquiring Fund. 1.02 In exchange for the transfer of the Assets and the assumption of the Liabilities, BlackRock shall simultaneously issue at the Effective Time of the Reorganization to ISIS that number of full and fractional (to the third decimal place) Series B Investor Shares of the Acquiring Fund that then have an aggregate net asset value equal to the aggregate net asset value at such time of the outstanding shares of common stock of ISIS. 1.03 The net asset value of the Series B Investor Shares of the Acquiring Fund shall be computed in the manner set forth in the Acquiring Fund's then current prospectus under the Securities Act of 1933, as amended (the "1933 Act"). The net asset value of the outstanding shares of common stock of ISIS shall be computed by the investment adviser of ISIS in accordance with the policies and procedures of ISIS that are then in effect, shall be reviewed by the independent auditors of ISIS and shall be subject to adjustment by the amount, if any, agreed to by BlackRock and 3 ISIS. ISIS shall deliver a copy of its valuation report to BlackRock at the Valuation Time (as defined in Article III). In the event that the value of a security in the portfolio of ISIS as determined in accordance with the policies and procedures of ISIS differs from the value of such security as determined in accordance with the valuation procedures of the Acquiring Fund, the Acquiring Fund's accounting agent shall make a final determination as to the value of such security, except that, if such valuation differs because of the amortization and/or accretion of premiums and discounts on such security, then such security shall be valued using ISIS' current methodology on premiums and discounts. 1.04 ISIS shall file Articles of Transfer for recordation with the Department of Assessments and Taxation of the State of Maryland, and shall take, in accordance with the Maryland General Corporation Law, all other steps as shall be necessary to effect the Reorganization. II. Liquidating Distribution and Termination of ISIS. Immediately after ------------------------------------------------ the Effective Time of the Reorganization, ISIS shall distribute in complete liquidation pro rata to its stockholders as of the Effective Time of the Reorganization the Series B Investor Shares of the Acquiring Fund received by ISIS in the Reorganization. In addition, the stockholders of ISIS shall have the right to receive any unpaid dividends or other distributions payable to them which were declared by ISIS before 4 the Effective Time of the Reorganization. In accordance with instructions it receives from ISIS, BlackRock shall record on its books the ownership of Series B Investor Shares of the Acquiring Fund by the record stockholders of ISIS. All of the outstanding shares of ISIS shall be cancelled on its books at the Effective Time of the Reorganization and shall thereafter represent only the right to receive the Series B Investor Shares of the Acquiring Fund, and the transfer books of ISIS shall be closed permanently. As soon as practicable after the Effective Time of the Reorganization, ISIS shall file an application pursuant to Section 8(f) of the 1940 Act for an order declaring that it has ceased to be an investment company and, upon receipt of such order, shall make all filings and take all other steps as shall be necessary and proper to effect its complete dissolution. After the Effective Time of the Reorganization, ISIS shall not conduct any business except in connection with its liquidation, deregistration, and dissolution. III. Valuation Time. The Valuation Time for the Reorganization shall be -------------- 4:00 p.m., Eastern time, on such date as may be agreed in writing by the duly authorized officers of BlackRock and ISIS. IV. Certain Representations, Warranties and Agreements of ISIS. ISIS ---------------------------------------------------------- represents and warrants to, and agrees with, BlackRock as follows: 5 (a) It is a Maryland corporation which was duly organized and is validly existing and in good standing under the laws of the State of Maryland. It is registered with the Securities and Exchange Commission (the "SEC") as a closed-end, management investment company under the 1940 Act and such registration is in full force and effect. (b) It has power to own all of its properties and assets and, subject to the approval of stockholders referred to herein, to carry out and consummate the transactions contemplated hereby, and has all necessary federal, state and local authorizations to carry on its business as now being conducted and to consummate the transactions contemplated by this Agreement. (c) This Agreement has been duly authorized, executed and delivered by ISIS, and is valid and binding on ISIS, enforceable in accordance with its terms, subject to bankruptcy, insolvency, reorganization, arrangement, moratorium, and other similar laws of general applicability relating to or affecting creditor's rights and to general principles of equity. The execution and delivery of this Agreement does not and will not, and the consummation of the transactions contemplated by 6 this Agreement will not, violate the Articles of Incorporation or By-laws of ISIS or any agreement or arrangement to which it is a party or by which it is bound. (d) ISIS has elected to qualify and has qualified as a "regulated investment company" under Subtitle A, Chapter 1, Subchapter M, Part I of the Code, as of and since its first taxable year; has been a regulated investment company at all times since the end of its first taxable year when it so qualified; and qualifies and shall continue to qualify as a regulated investment company until the Effective Time of the Reorganization. (e) All federal, state, local and foreign income, profits, franchise, sales, withholding, customs, transfer and other taxes, including interest, additions to tax and penalties (collectively, "Taxes") relating to the Assets due or properly shown to be due on any return filed by ISIS with respect to taxable periods ending on or prior to, and the portion of any interim period up to, the date hereof have been fully and timely paid or provided for; and there are no levies, liens, or other encumbrances relating to Taxes existing, threatened or pending with respect to the Assets. 7 At the Effective Time of the Reorganization, all returns and reports of ISIS respecting Taxes required by law to have been filed by such time shall have been filed. (f) The financial statements of ISIS for its fiscal year ended December 31, 1998, audited by PricewaterhouseCoopers LLP, copies of which have been previously furnished to BlackRock, present fairly the financial position of ISIS as of December 31, 1998 and the results of its operations and the changes in its net assets for the period then ended, in conformity with generally accepted accounting principles. In addition, the financial statements of ISIS for its fiscal year ended December 31, 1999, audited by PricewaterhouseCoopers LLP, will be furnished to BlackRock when available, and shall present fairly the financial position of ISIS as of December 31, 1999 and the results of its operations and the changes in its net assets for the period then ended, in conformity with generally accepted accounting principles. (g) The unaudited financial statements of ISIS for the six-month period ended June 30, 1999, copies of which have been previously furnished to BlackRock, present fairly the financial position of ISIS as 8 of June 30, 1999 and the results of its operations for the period then ended, in conformity with generally accepted accounting principles. (h) Prior to the Valuation Time, ISIS shall have declared a dividend or dividends, with a record date and ex-dividend date prior to the Valuation Time, which, together with all previous dividends, shall have the effect of distributing to its stockholders all of its net investment company income, if any, for the taxable year ended on December 31, 1999 and for the period from said date to and including the Effective Time of the Reorganization (computed without regard to any deduction for dividends paid), and all of its net capital gain, if any, realized in the taxable year ended December 31, 1999 and for the period from said date to and including the Effective Time of the Reorganization. (i) At both the Valuation Time and the Effective Time of the Reorganization, there shall be no known liabilities of ISIS, whether accrued, absolute, contingent or otherwise, not reflected in the net asset value per share of its outstanding shares. 9 (j) There are no legal, administrative or other proceedings pending or, to the knowledge of ISIS, threatened against ISIS which could result in liability on the part of ISIS. (k) Subject to the approval of stockholders referred to herein, at both the Valuation Time and the Effective Time of the Reorganization, ISIS shall have full right, power and authority to sell, assign, transfer and deliver the Assets and, upon delivery and payment for the Assets as contemplated herein, BlackRock on behalf of the Acquiring Fund shall acquire good and marketable title thereto, free and clear of all liens and encumbrances, and subject to no restrictions on the ownership or transfer thereof (except as imposed by federal or state securities laws). (l) No consent, approval, authorization or order of any court or governmental authority is required for the consummation by ISIS of the transactions contemplated by this Agreement, except such as may be required under the 1933 Act, the Securities Exchange Act of 1934, as amended (the "1934 Act"), the 1940 Act, the rules and regulations under those Acts, state securities laws and the filing of Articles of Transfer under Maryland law. 10 (m) Insofar as the following relate to ISIS, the registration statement filed by BlackRock on Form N-14 relating to the shares of the Acquiring Fund that will be distributed to ISIS pursuant to this Agreement, which, without limitation, shall include a proxy statement of ISIS and the prospectus of BlackRock with respect to the transactions contemplated by this Agreement, and any supplement or amendment thereto, and the documents contained or incorporated therein by reference (the "N-14 Registration Statement"), on the effective date of the N-14 Registration Statement, at the time of any stockholder's meeting referred to herein and at the Effective Time of the Reorganization: (i) shall comply in all material respects with the provisions of the 1933 Act, the 1934 Act and the 1940 Act, the rules and regulations thereunder, and state securities laws, and (ii) shall not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading. (n) All of the issued and outstanding shares of ISIS have been duly and validly issued, are fully paid 11 and non-assessable, and were offered for sale and sold in conformity with all applicable federal and state securities laws, and no stockholder of ISIS has any preemptive right of subscription or purchase in respect of such shares. (o) ISIS shall not sell or otherwise dispose of any shares of the Acquiring Fund to be received in the transaction contemplated herein, except in distribution to its stockholders as contemplated herein. (p) To the best of its knowledge, ISIS' service agreements with BlackRock Institutional Management Corporation, PNC Bank, N.A. and Wilmington Trust Company represent all of its material contracts (other than this Agreement and investment contracts such as options contracts, futures contracts, forward contracts, repurchase agreements and the like). V. Certain Representations, Warranties and Agreements of BlackRock. --------------------------------------------------------------- BlackRock, on behalf of itself and the Acquiring Fund, represents and warrants to, and agrees with, ISIS as follows: 12 (a) It is a Massachusetts business trust duly established and validly existing under the laws of, and duly authorized to transact business in, the Commonwealth of Massachusetts. It is registered with the SEC as an open-end management investment company under the 1940 Act and such registration is in full force and effect. (b) It has power to own all of its properties and assets and to carry out and consummate the transactions contemplated herein, and has all necessary federal, state and local authorizations to carry on its business as now being conducted and to consummate the transactions contemplated by this Agreement. (c) This Agreement has been duly authorized, executed and delivered by BlackRock, and is valid and binding on BlackRock, enforceable in accordance with its terms, subject to bankruptcy, insolvency, reorganization, arrangement, moratorium, and other similar laws of general applicability relating to or affecting creditor's rights and to general principles of equity. The execution and delivery of this Agreement does not and will not, and the consummation of the transactions contemplated by this Agreement will not, violate BlackRock's 13 Declaration of Trust or Amended and Restated Code of Regulations or any agreement or arrangement to which it is a party or by which it is bound. (d) The Acquiring Fund has elected or will elect to qualify as a "regulated investment company" under Subtitle A, Chapter 1, Subchapter M, Part I of the Code, as of and since its first taxable year; has been a regulated investment company at all times since the end of its first taxable year when it so qualified and intends to continue to qualify as a regulated investment company. (e) The financial statements of the Acquiring Fund for its fiscal year ended September 30, 1999, audited by PricewaterhouseCoopers LLP, copies of which have been previously furnished to ISIS, present fairly the financial position of the Acquiring Fund as of September 30, 1999 and the results of its operations and changes in its net assets for the period then ended, in conformity with generally accepted accounting principles. (f) At both the Valuation Time and the Effective Time of the Reorganization, there shall be no known liabilities of the Acquiring Fund, whether accrued, absolute, contingent or otherwise, not 14 reflected in the net asset value per share of its Series B Investor Shares to be issued pursuant to this Agreement. (g) There are no legal, administrative or other proceedings pending or, to its knowledge, threatened against BlackRock or the Acquiring Fund which could result in liability on the part of BlackRock or the Acquiring Fund. (h) No consent, approval, authorization or order of any court or governmental authority is required for the consummation by BlackRock of the transactions contemplated by this Agreement, except such as may be required under the 1933 Act, the 1934 Act, the 1940 Act, the rules and regulations under those Acts, state securities laws and the filing of Articles of Transfer under Maryland law. (i) Insofar as the following relate to BlackRock, the N-14 Registration Statement on its effective date, at the time of any stockholder's meetings referred to herein and at the Effective Time of the Reorganization: (i) shall comply in all material respects with the provisions of the 1933 Act, the 1934 Act and the 1940 Act, the rules and 15 regulations thereunder, and state securities laws, and (ii) shall not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading. (j) The Series B Investor Shares of the Acquiring Fund to be issued and delivered to ISIS for the account of record holders of shares of ISIS, pursuant to the terms hereof, shall have been duly authorized as of the Effective Time of the Reorganization and, when so issued and delivered, shall be registered under the 1933 Act and under applicable state securities laws, shall be duly and validly issued, fully paid and non-assessable, and shall have been offered for sale and sold in conformity with all applicable federal and state securities laws and no shareholder of BlackRock shall have any preemptive right of subscription or purchase in respect thereto. VI. Stockholder Action on Behalf of ISIS. As soon as practicable ------------------------------------ after the effective date of the N-14 Registration Statement, but in any event prior to the Effective Time of the Reorganization and as a condition thereto, ISIS shall hold a meeting of its stockholders for the purposes of considering and voting upon: 16 (a) Approval of this Agreement and the transactions contemplated hereby, including, without limitation: (i) The transfer of the Assets to BlackRock on behalf of the Acquiring Fund, and the assumption by BlackRock on behalf of the Acquiring Fund of the Liabilities, in exchange for Series B Investor Shares of the Acquiring Fund. (ii) The liquidation of ISIS through the distribution to its record holders of Series B Investor Shares of the Acquiring Fund as described in this Agreement. (b) Approval of a change to ISIS' fundamental limitations and Article VII, Section 1(j) of its By-laws to provide that ISIS may purchase the securities of another investment company in connection with a merger, consolidation, reorganization, sale or purchase of assets approved by stockholders, or as otherwise permitted by the 1940 Act. 17 (c) Such other matters as may be determined by the parties hereto. VII. N-14 Registration Statement and Proxy Solicitation Materials. ------------------------------------------------------------ BlackRock shall file the N-14 Registration Statement under the 1933 Act, which shall include or incorporate by reference the proxy statement of ISIS and the prospectus of the Acquiring Fund, and any supplement or amendment thereto or to the documents contained or incorporated by reference, with the SEC as promptly as practicable. Each of BlackRock and ISIS has cooperated and shall continue to cooperate with the other, and has furnished and shall continue to furnish the other with the information relating to itself that is required by the 1933 Act, the 1934 Act, the 1940 Act, the rules and regulations under each of those Acts and state securities laws, to be included in the N-14 Registration Statement. VIII. Effective Time of the Reorganization. Delivery of the Assets and the ------------------------------------ Series B Investor Shares of the Acquiring Fund to be issued pursuant to Article I and the liquidation of ISIS pursuant to Article II shall occur at the opening of business on the next business day following the Valuation Time, or on such other date, and at such place and time and date, as may be determined by an officer of BlackRock and ISIS, provided, however, that unless an officer of BlackRock and ISIS determine otherwise, the Effective Time of the Reorganization shall not occur until the period has run for any objecting stockholder of 18 ISIS to make a written demand for payment for his or her shares pursuant to the Maryland General Corporation Law. The date and time at which such actions are taken are referred to herein as the "Effective Time of the Reorganization." To the extent any Assets are, for any reason, not transferred at the Effective Time of the Reorganization, ISIS shall cause the Assets to be transferred in accordance with this Agreement at the earliest practicable date thereafter. IX. Covenants. --------- (a) Each of BlackRock (on behalf of the Acquiring Fund) and ISIS covenants to operate its respective business in the ordinary course between the date hereof and the Effective Time of the Reorganization, it being understood that: (i) such ordinary course will include without limitation declaring and paying customary dividends and other distributions and changes in operations contemplated by each of the Acquiring Fund and ISIS' normal business activities, and (ii) each of the Acquiring Fund and ISIS will retain exclusive control of the 19 composition of its portfolio until the Effective Time of the Reorganization. (b) ISIS covenants that it will use commercially reasonable efforts to assist BlackRock in obtaining information BlackRock reasonable requests concerning the beneficial ownership of any outstanding securities of ISIS. (c) Each of BlackRock (on behalf of the Acquiring Fund) and ISIS will notify the other party hereto of any material adverse change in such party's business, prospects, results of operations or financial condition as soon as practicable following such change. (d) ISIS shall terminate its service agreements with each of BlackRock Institutional Management Corporation, PNC Bank, N.A. and Wilmington Trust Company by the Effective Time of the Reorganization. (e) ISIS shall file Articles of Transfer for recordation with the Department of Assessments and Taxation of the State of Maryland. 20 (f) BlackRock Institutional Management Corporation ("BIMC") shall obtain fully pre-paid liability insurance providing coverage to the former and current directors and officers of ISIS for claims made against them after the Effective Time of the Reorganization for acts, errors or omissions committed or attempted, or allegedly committed or attempted, by them in their capacity as such directors or officers at any time prior to the Effective Time of the Reorganization, such coverage to be on terms no less favorable to the former and current directors and officers of ISIS than the terms of coverage in effect with respect to them immediately prior to the Effective Time of the Reorganization. BIMC, or its successors or assigns, shall maintain such insurance or cause such insurance to be maintained in full force and effect for a period of at least six (6) years after the Effective Time of the Reorganization. The former and current directors and officers of ISIS are express third party beneficiaries of this Article IX(f). (g) BIMC shall obtain fully pre-paid liability insurance providing coverage to BlackRock and its former and current trustees and officers for claims made against them after the Effective Time 21 of the Reorganization relating to acts, errors or omissions committed or attempted, or allegedly committed or attempted, by ISIS or its former and current directors and officers in their capacity as such directors or officers at any time after the inception of ISIS, such coverage to be on terms no less favorable to BlackRock and its former and current trustees and officers than the terms of coverage in effect with respect to them immediately prior to the Effective Time of the Reorganization. The former and current trustees and officers of BlackRock are express third party beneficiaries of this Articles IX(g). X. BlackRock Conditions. The obligations of BlackRock hereunder -------------------- shall be subject to the following conditions precedent: (a) This Agreement, the transactions contemplated by this Agreement and the amendment to ISIS' By-laws and fundamental limitation specified in Article VI hereof shall have been approved by both the Board of Directors and the stockholders of ISIS, in the manner required by law. (b) ISIS shall have duly executed and delivered to BlackRock such bills of sale, assignments, certificates and other instruments of transfer 22 ("Transfer Documents") as may be necessary or desirable to transfer all right, title and interest of ISIS in and to the Assets. The Assets shall be accompanied by all necessary state stock transfer stamps or cash for the appropriate purchase price therefor. (c) All representations and warranties of ISIS made in this Agreement shall be true and correct in all material respects as if made at and as of the Valuation Time and the Effective Time of the Reorganization. As of the Valuation Time and the Effective Time of the Reorganization there shall have been no material adverse change in the financial condition of ISIS since December 31, 1999 other than those changes incurred in the ordinary course of business as an investment company. No action, suit or other proceeding involving ISIS shall be threatened or pending before any court or governmental agency. (d) BlackRock shall have received an opinion of Drinker Biddle & Reath LLP, in form reasonably satisfactory to BlackRock and dated the Effective Time of the Reorganization, substantially to the effect that: (i) ISIS is a Maryland corporation duly organized and validly existing in good 23 standing under the laws of the State of Maryland; (ii) this Agreement has been duly authorized, executed and delivered by ISIS and is a legal, valid and binding obligation of ISIS, enforceable against ISIS in accordance with its terms, subject to applicable bankruptcy, insolvency, reorganization, arrangement, moratorium, fraudulent conveyance and other similar laws relating to or affecting creditors' rights generally, and court decisions with respect thereto, and such counsel shall not be required to express an opinion with respect to the application of equitable principles in any proceeding, whether at law or in equity, provided, however, that no opinion need be given as to the enforceability of any provision of the Agreement relating to indemnification; (iii) the execution and delivery of this Agreement did not, and the consummation of the transactions contemplated by this Agreement will not, violate the Articles of Incorporation or By-laws of ISIS or any material agreement known to such counsel to which ISIS is a party or by which ISIS is bound; and (iv) to such counsel's knowledge, no consent, approval, authorization or order of any federal, Pennsylvania or Maryland court or governmental authority is required for the consummation by ISIS of the transactions 24 contemplated by this Agreement, except such as have been obtained under the 1933 Act, the 1934 Act, the 1940 Act, the rules and regulations under those Acts, such as may be required under state securities laws, and the filing of Articles of Transfer under Maryland law. Such opinion may rely on the opinion of Venable, Baetjer and Howard, LLP with respect to matters governed by Maryland law. (e) BlackRock shall have received an opinion of Drinker Biddle & Reath LLP, in form reasonably satisfactory to BlackRock and dated the Effective Time of the Reorganization, substantially to the effect that for federal income tax purposes (i) the transfer of the Assets hereunder, and the assumption by the Acquiring Fund of the Liabilities, in exchange for Series B Investor Shares of the Acquiring Fund, and the distribution of said shares to the stockholders of ISIS, as provided in this Agreement, will constitute a reorganization within the meaning of Section 368(a) of the Code and with respect to the reorganization, ISIS and the Acquiring Fund will each be considered "a party to a reorganization" within the meaning of Section 368(b) of the Code; (ii) in accordance with Sections 361(a), 361(c)(1) and 357(a) of the Code, no gain or loss will be recognized by ISIS 25 as a result of such transactions; (iii) in accordance with Section 1032(a) of the Code, no gain or loss will be recognized by the Acquiring Fund as a result of such transactions; (iv) in accordance with Section 354(a)(1) of the Code, no gain or loss will be recognized by the stockholders of ISIS on the distribution to them by ISIS of Series B Investor Shares of the Acquiring Fund in exchange for their shares of ISIS; (v) in accordance with Section 358(a)(1) of the Code, the aggregate basis of Series B Investor Shares of the Acquiring Fund received by each holder of shares of ISIS will be the same as the aggregate basis of the shares of ISIS held by such holder immediately prior to the Reorganization; (vi) in accordance with Section 362(b) of the Code, the basis of the Assets to the Acquiring Fund will be the same as the basis of the Assets in the hands of ISIS immediately prior to the exchange; (vii) in accordance with Section 1223 of the Code, a stockholder's holding period for Acquiring Fund shares will be determined by including the period for which the stockholder held the shares of ISIS exchanged therefor, provided that the stockholder held such shares of ISIS as a capital asset; and (viii) in accordance with Section 1223(2) of the Code, the holding 26 period of the Acquiring Fund with respect to the Assets will include the period for which the Assets were held by ISIS. (f) The SEC shall not have issued any unfavorable advisory report under Section 25(b) of the 1940 Act nor instituted any proceeding seeking to enjoin consummation of the transaction contemplated by this Agreement under Section 25(c) of the 1940 Act. (g) The N-14 Registration Statement shall have become effective under the 1933 Act and no stop order suspending such effectiveness shall have been instituted or, to the knowledge of BlackRock, contemplated by the SEC and the parties shall have received all permits and other authorizations necessary under state securities laws to consummate the transactions contemplated by this Agreement. (h) ISIS shall have delivered or caused to be delivered to BlackRock each account, book, record or other document of ISIS which is required to be maintained by Section 31(a) of the 1940 Act and Rules 31a-1, 31a-2 and 31a-3 thereunder (regardless of what person possesses the same), 27 and a copy of all agreements and instruments to which ISIS is a party. ISIS shall have instructed its service contractors to provide BlackRock upon request with access to and copies of all documents belonging to ISIS. (i) ISIS shall have, and the President or any Vice President of ISIS shall have provided to BlackRock a certificate that ISIS has, performed and complied in all material respects with each of its agreements and covenants required by this Agreement to be performed or complied with by it prior to or at the Valuation Time and the Effective Time of the Reorganization. (j) ISIS shall provide to BlackRock a certificate of its President or any Vice President dated the Effective Time of the Reorganization to the effect set forth in Article X (a) and (c). (k) BIMC shall provide BlackRock with evidence in form satisfactory to BlackRock that BIMC shall have obtained fully pre-paid liability insurance providing coverage to BlackRock and its former and current trustees and officers for claims made against them after the Effective Time of the Reorganization relating to acts, errors or 28 omissions committed or attempted, or allegedly committed or attempted, by ISIS or its former and current directors and officers in their capacity as such directors or officers at any time after the inception of ISIS, such coverage to be on terms no less favorable to BlackRock and its former and current trustees and officers than the terms of coverage in effect with respect to them immediately prior to the Effective Time of the Reorganization. (l) BIMC shall provide BlackRock with evidence in form satisfactory to BlackRock that BIMC shall have obtained fully pre-paid liability insurance providing coverage to the former and current directors and officers of ISIS for claims made against them after the Effective Time of the Reorganization for acts, errors or omissions committed or attempted, or allegedly committed or attempted, by them in their capacity as such directors or officers at any time prior to the Effective Time of the Reorganization, such coverage to be on terms no less favorable to the former and current directors and officers of ISIS than the terms of coverage in effect with respect to them immediately prior to the Effective Time of the Reorganization. 29 XI. ISIS Conditions. The obligations of ISIS hereunder shall be --------------- subject to the following conditions precedent: (a) This Agreement and the transactions contemplated by this Agreement shall have been approved by both: (i) the Board of Trustees of BlackRock; and (ii) the stockholders of ISIS in the manner required by law, and the amendment to ISIS' By-laws and fundamental limitation specified in Article VI hereof shall have been approved by the stockholders of ISIS in the manner required by law. (b) BlackRock shall have duly executed and delivered to ISIS an assumption of liabilities certificate and other instruments as ISIS may deem necessary or desirable dated as of the Effective Time of the Reorganization pursuant to which the Acquiring Fund will assume all of the Liabilities in connection with the transactions contemplated by this Agreement. (c) All representations and warranties of BlackRock made in this Agreement shall be true and correct in all material respects as if made at and as of the Valuation Time and the Effective Time of the Reorganization. As of the Valuation Time and the 30 Effective Time of the Reorganization. As of the Valuation Time and the Effective Time of the Reorganization there shall have been no material adverse change in the financial condition of BlackRock or the Acquiring Fund since September 30, 1999 other than those changes incurred in the ordinary course of business as an investment company. No action, suit or other proceeding shall be threatened or pending before any court or governmental agency in which it is sought to restrain or prohibit, or obtain damages or other relief in connection with, this Agreement or the transaction contemplated herein. (d) ISIS shall have received an opinion of Ropes & Gray with respect to matters governed by Massachusetts law and of Simpson Thacher & Bartlett as to other matters, in form reasonably satisfactory to ISIS and dated the Effective Time of the Reorganization, substantially to the effect that: (i) BlackRock is, under the laws of the Commonwealth of Massachusetts, a duly established and validly existing unincorporated voluntary association with transferable shares (commonly known as a "Massachusetts business trust"); (ii) the Series B Investor Shares are duly authorized and, upon delivery to ISIS following receipt by the Acquiring Fund of the Assets of ISIS as 31 provided in the Agreement, will be validly issued, fully paid and non-assessable, and will not be subject to any preemptive rights arising under the Massachusetts General Laws or under the Declaration of Trust; (iii) to such counsel's knowledge, no shareholder of the Acquiring Fund has any option or warrant to subscribe or purchase in respect to the Series B Investor Shares; (iv) the Agreement has been duly authorized, executed and delivered by BlackRock and represents the valid and binding obligation of BlackRock, enforceable in accordance with its terms, subject to the effects of bankruptcy, insolvency, reorganization, moratorium, fraudulent conveyance and similar laws relating to or affecting creditors' rights generally and to equitable principles, whether such enforceability is considered in a proceeding in equity or at law, provided, however, that no opinion need be given as to the enforceability of any provisions of the Agreement relating to indemnification; (v) the execution and delivery of the Agreement by BlackRock did not, and the performance by BlackRock of its obligations under the Agreement will not, violate the Declaration of Trust or the Amended and Restated Code of Regulations of BlackRock; (vi) the execution and delivery of the 32 Agreement did not, and the compliance by BlackRock with all the provisions of the Agreement will not, violate any contract identified on an annexed schedule furnished to such counsel by BlackRock and which BlackRock has represented lists all material contracts to which it is a party or by which it is bound, and which, to the best of such counsel's knowledge, represents all of the material contracts to which BlackRock is a party or by which it is bound, or to which any of the property or assets of BlackRock is subject; (vii) no consent, approval, authorization, order, registration or qualification of or with any federal, New York or Massachusetts governmental agency or body, or any federal, New York or Massachusetts court, is required for BlackRock to enter into the Agreement or to comply with all of the provisions of the Agreement, except such as have been obtained under the 1933 Act, the 1934 Act, the 1940 Act, the rules and regulations thereunder and such consents, approvals, authorizations, registrations or qualifications as may be required under state securities or Blue Sky laws. (e) ISIS shall have received an opinion of Drinker Biddle & Reath LLP, in form reasonably 33 satisfactory to BlackRock and dated the Effective Time of the Reorganization, with respect to the matters specified in Article X(e). (f) The N-14 Registration Statement shall have become effective under the 1933 Act and no stop order suspending such effectiveness shall have been instituted, or, to the knowledge of BlackRock, contemplated by the SEC and the parties shall have received all permits and other authorizations necessary under state securities laws to consummate the transactions contemplated by this Agreement. (g) The SEC shall not have issued any unfavorable advisory report under Section 25(b) of the 1940 Act nor instituted any proceeding seeking to enjoin consummation of the transactions contemplated by this Agreement under Section 25(c) of the 1940 Act. (h) BlackRock shall have, and the President or any Vice President of BlackRock shall have provided to ISIS a certificate that BlackRock has, performed and complied in all material respects with each of its agreements and covenants required by this Agreement to be performed or complied with by it 34 prior to or at the Valuation Time and the Effective Time of the Reorganization. (i) BlackRock shall have provided to ISIS a certificate of its President or any Vice President dated the Effective Time of the Reorganization to the effect set forth in Article XI (a)(i) and (c). (j) BIMC shall provide ISIS with evidence in form satisfactory to ISIS that BIMC shall have obtained fully pre-paid liability insurance providing coverage to the former and current directors and officers of ISIS for claims made against them after the Effective Time of the Reorganization for acts, errors or omissions committed or attempted, or allegedly committed or attempted, by them in their capacity as such directors or officers at any time prior to the Effective Time of the Reorganization, such coverage to be on terms no less favorable to the former and current directors and officers of ISIS than the terms of coverage in effect with respect to them immediately prior to the Effective Time of the Reorganization. XII. Tax Documents. ISIS shall deliver to BlackRock at the Effective Time ------------- of the Reorganization confirmations or other adequate evidence as to the adjusted tax basis of the Assets 35 delivered to the Acquiring Fund in accordance with the terms of this Agreement. XIII. Finder's Fees. Each party represents and warrants to each of the ------------- other parties hereto that there is no person who is entitled to any finder's or other similar fee or commission arising out of the transactions contemplated by this Agreement. XIV. Announcements. No announcements or similar publicity with respect to ------------- this Agreement or the transactions contemplated herein shall be made at any time and in any manner unless specifically agreed upon and approved by each of ISIS, BlackRock and the investment adviser for BlackRock, BlackRock Advisors, Inc.; provided, that nothing herein shall prevent either party upon notice to the - -------- other party from making such public announcements as such party's counsel may consider advisable in order to satisfy the party's legal and contractual obligations. XV. Further Assurances. Subject to the terms and conditions herein ------------------ provided, each of the parties hereto shall use its best efforts to take, or cause to be taken, such action, to execute and deliver, or cause to be executed and delivered, such additional documents and instruments and to do, or cause to be done, all things necessary, proper or advisable under the provisions of this Agreement and under applicable law to consummate and make effective the transactions contemplated by this Agreement. 36 XVI. Termination of Representations and Warranties. The representations --------------------------------------------- and warranties of the parties set forth in this Agreement shall terminate upon the delivery of the Assets to the Acquiring Fund and the issuance of the Series B Investor Shares of the Acquiring Fund at the Effective Time of the Reorganization. Notwithstanding anything herein to the contrary, Article IX(f), Article IX(g) and Article XXIII shall not terminate as of, and shall remain in full force and effect after, the Effective Time of the Reorganization. XVII. Termination of Agreement. ------------------------ 17.01 This Agreement may be terminated at any time at or prior to the Effective Time of the Reorganization by an authorized officer of ISIS or of BlackRock, as provided below: (a) By BlackRock if any of the conditions set forth in Article X are not satisfied as specified in said Article; (b) By ISIS if any of the conditions set forth in Article XI are not satisfied as specified in said Article; or (c) By the mutual consent of BlackRock and ISIS. 37 17.02 If BlackRock or ISIS terminates this Agreement because one or more of the conditions precedent have not been fulfilled, or if this Agreement is terminated by mutual consent of BlackRock and ISIS, this Agreement, other than Article XXIII, will become null and void without any liability of either party to the other; provided, however, that if such termination is by BlackRock pursuant to Article XVII, Section 17.01(a) as a result of a breach by ISIS of any of its representations, warranties or covenants in this Agreement, or such termination is by ISIS pursuant to Article XVII, Section 17.01(b) as a result of a breach by BlackRock of any of its representations, warranties or covenants in this Agreement, nothing herein shall affect the non-breaching party's right to damages on account of such other party's breach. XVIII. Amendment and Waiver. At any time prior to or (to the fullest extent -------------------- permitted by law) after approval of this Agreement by the stockholders of ISIS, (a) the parties hereto may, by written agreement authorized by their respective Boards of Directors or Trustees, as the case may be, or their respective Presidents or any Vice Presidents, and with or without the approval of their shareholders, amend any of the provisions of this Agreement, and (b) either party may waive any breach by the other party or the failure to satisfy any of the conditions to its obligations (such waiver to be in writing and authorized by the President or any Vice President of the waiving party with or without the approval of such party's shareholders). 38 XIX. Governing Law. This Agreement and the transaction contemplated ------------- hereby shall be governed, construed and enforced in accordance with the laws of the State of Maryland, without giving effect to the conflicts of law principles otherwise applicable therein. XX. Successors and Assigns. This Agreement shall be binding upon the ---------------------- respective successors and permitted assigns of the parties hereto. This Agreement and the rights, obligations and liabilities hereunder may not be assigned by either party without the consent of the other party. XXI. Beneficiaries. Except as stated herein, nothing contained in this ------------- Agreement shall be deemed to create rights in or eliminate liabilities of persons not parties hereto, other than the successors and permitted assigns of the parties. XXII. BlackRock Liability. ------------------- 22.01 Each party specifically acknowledges and agrees that all obligations of BlackRock under this Agreement are binding only with respect to the Acquiring Fund; that any liability of BlackRock under this Agreement with respect to the Acquiring Fund, or in connection with the transactions contemplated herein with respect to the Acquiring Fund, shall be discharged only out of the assets of the Acquiring Fund; and that no other portfolio 39 of BlackRock shall be liable with respect to this Agreement or in connection with the transactions contemplated herein. 22.02 "BlackRock Funds" and "Trustees of BlackRock Funds" refer respectively to the trust created and the Trustees, as trustees but not individually or personally, acting from time to time under a Declaration of Trust dated December 22, 1988, as amended, which is hereby referred to and a copy of which is on file at the office of the State Secretary of the Commonwealth of Massachusetts and at the principal office of BlackRock. The obligations of "BlackRock Funds" entered into in the name or on behalf thereof by any of the Trustees, officers, representatives or agents are made not individually, but in such capacities, and are not binding upon any of the Trustees, shareholders, officers, representatives or agents of BlackRock personally, but bind only the Trust Property (as defined in the Declaration of Trust), and all persons dealing with any class of shares of BlackRock must look solely to the Trust Property belonging to such class for the enforcement of any claims against BlackRock. XXIII. Expenses. BIMC shall pay all expenses incurred by BlackRock and -------- ISIS in connection with this Agreement and the transactions contemplated hereby, including without limitation, all legal, accounting, printing, mailing, proxy and stockholder solicitation expenses, as well as any expenses incurred by the Board of Directors of ISIS in evaluating the transactions contemplated by this Agreement and the future direction of ISIS, 40 including the cost of an independent consultant retained by the Board of Directors of ISIS, but excluding expenses customarily incurred in connection with regular meetings of the Board of Directors of ISIS that would have been held in the absence of the transactions contemplated by this Agreement. XXIV. Entire Agreement. This Agreement embodies the entire agreement and ---------------- understanding of the parties hereto with respect to the subject matter hereof and supercedes any and all prior agreements, arrangements and understandings relating to matters provided for herein. XXV. Counterparts. This Agreement may be executed in any number of ------------ counterparts, each of which, when executed and delivered shall be deemed to be an original, but all of which together shall constitute one and the same instrument. XXVI. Notices. All notices required or permitted herein shall be in ------- writing and shall be deemed to be properly given when delivered personally or by telecopier to the party entitled to receive the notice or when sent by certified or registered mail, postage prepaid, or delivered to a nationally recognized overnight courier service, in each case properly addressed to the party entitled to receive such notice at the address or telecopier number stated below or to such other address or telecopier number as may hereafter be furnished in writing by notice similarly given by one party to the other party hereto: 41 If to BlackRock: Karen H. Sabath Assistant Secretary 345 Park Avenue New York, NY 10154 Telecopier Number: (212) 754-8775 With a copy to: Cynthia G. Cobden, Esq. Simpson Thacher & Bartlett 425 Lexington Avenue New York, NY 10017 Telecopier Number: (212) 455-2502 If to ISIS: Edward J. Roach Vice President and Treasurer Bellevue Park Corporate Center 400 Bellevue Parkway Wilmington, DE 19809 Telecopier Number: (302) 791-4830 With a copy to: Michael P. Malloy, Esq. Drinker Biddle & Reath LLP One Logan Square 18th and Cherry Streets Philadelphia, PA 19103 Telecopier Number: (215) 988-2757 42 IN WITNESS WHEREOF, the parties hereto have caused this instrument to be executed by their duly authorized officers designated below as of the date first written above. ATTEST: BLACKROCK FUNDS(SM) ___________________________ _____________________________ Name: Name: Title: Title: ATTEST: INDEPENDENCE SQUARE INCOME SECURITIES, INC. ___________________________ ______________________________ Name: Name: Title: Title: BlackRock Institutional Management Corporation joins in this Agreement with respect to, and agrees to be bound by, Article IX(f), Article IX(g), Article X(k), Article X(1) Article XI(j), Article XVI and Article XXIII. ATTEST: BLACKROCK INSTITUTIONAL MANAGEMENT CORPORATION ___________________________ _________________________ Name: Name: Title: Title: 43 APPENDIX B HIGH YIELD BOND PORTFOLIO TOTAL ASSETS (9/30/99): $91.6 MILLION PERFORMANCE BENCHMARK: LEHMAN HIGH YIELD INDEX INVESTMENT APPROACH: SEEKS CURRENT INCOME BY INVESTING PRIMARILY IN NON-INVESTMENT GRADE SECURITIES (RATED C OR HIGHER OR DEEMED TO BE OF COMPARABLE QUALITY) WHICH YIELD A HIGH LEVEL OF CURRENT INCOME. RECENT PORTFOLIO MANAGEMENT ACTIVITY: . SINCE THE PORTFOLIO'S INCEPTION IN NOVEMBER 1998 THE HIGH YIELD MARKET HAS PERFORMED WELL AS YIELD SPREADS HAVE NARROWED COMPARED TO TREASURIES. INVESTORS CONTINUE TO EMPHAZISE HIGHER QUALITY NON-INVESTMENT GRADE CREDITS INSTEAD OF LOWER TIER CREDITS. THE MANAGER HAS TAKEN ADVANTAGE OF THIS DURING THE PERIOD BY FOCUSING ON B-RATED CREDITS, WHERE YIELD SPREADS CONTINUE TO TIGHTEN, WHILE UNDERWEIGHTING CCC-RATED SECURITIES. . THE PORTFOLIO HAS BENEFITED FROM BEING OVERWEIGHT RELATIVE TO THE INDEX IN THE TELECOM, OIL AND GAS AND CABLE SECTORS. PARTICULAR EMPHASIS HAS BEEN PLACED ON THESE SECTORS AS IMPROVING FUNDAMENTALS AND THE POTENTIAL FOR CONSOLIDATION CONTINUE TO BE A MAJOR CONTRIBUTOR TO THEIR STRONG PERFORMANCE. THE PORTFOLIO HAS BEEN UNDERWEIGHT THE HEALTHCARE AND TEXTILE SECTORS, WHICH HAVE BEEN WEAK PERFORMERS. . THE MANAGER BELIEVES THAT THE SUPPLY AND DEMAND TECHNICALS OF THE HIGH YIELD MARKET APPEAR TO BE FAVORABLE, AS STRONG MONEY INFLOWS AND LOWER SUPPLY RELATIVE TO LAST YEAR MAY BODE WELL FOR HIGH YIELD INVESTORS. Although the portfolio holdings and sectors listed above were current as of the end of the annual period ended September 30, 1999, the Portfolio is actively managed and the composition will vary. COMPARISON OF CHANGE IN VALUE OF A $10,000 INVESTMENT IN THE HIGH YIELD BOND PORTFOLIO AND THE LEHMAN HIGH YIELD INDEX FROM INCEPTION AND AT EACH MONTH-END. [GRAPHIC OMITTED] EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
Institutional Service Investor A Investor B Investor C BlackRock Lehman High Class Class Class Class Class Class Yield Index 11/19/98 $10,000 $10,000 $9,500 $10,000 $10,000 $10,000 $10,000 12/31/98 10,128 10,106 9,616 10,113 10,113 10,110 10,160 1/31/99 10,395 10,370 9,866 10,369 10,369 10,378 10,310 2/28/99 10,380 10,351 9,847 10,343 10,343 10,363 10,250 3/31/99 10,466 10,435 9,926 10,418 10,418 10,451 10,347 4/30/99 10,853 10,819 10,289 10,794 10,794 10,840 10,548 5/31/99 10,586 10,551 10,032 10,517 10,517 10,576 10,405 6/30/99 10,622 10,584 10,062 10,542 10,542 10,613 10,383 7/31/99 10,637 10,597 10,072 10,547 10,547 10,630 10,425 8/31/99 10,599 10,557 10,032 10,498 10,498 10,593 10,309 9/30/99 10,592 10,548 10,022 10,010 10,377 10,587 10,235
For period ending September 30, 1999 - -------------------------------------------------------------------------------- TOTAL RETURN From Inception BlackRock Class 5.87% Institutional Class 5.93% Service Class 5.47% Investor A Class (Load Adjusted) 0.22% Investor A Class (NAV) 5.50% Investor B Class (Load Adjusted) 0.06% Investor B Class (NAV) 4.78% Investor C Class (Load Adjusted) 3.64% Investor C Class (NAV) 4.69% - -------------------------------------------------------------------------------- The performance information above includes information relating to each class of the Portfolio since the commencement of operations of the Portfolio, rather than the date such class was introduced. The inception dates of the Portfolio's share classes were as follows: BlackRock Shares; Institutional Shares; Service Shares; Investor A Shares; Investor B Shares; and Investor C Shares, 11/19/98. See "Note on Performance Information" on page 12 for further information on how performance data was calculated. Past performance is not predictive of future results. 1 APPENDIX C SHARE PRICE DATA FOR ISIS ISIS' common stock is publicly held and is listed and traded on the NASDAQ SmallCap Market(SM) under the symbol "ISIS." The following table sets forth for the periods indicated the high and low closing sales prices for the shares on the NASDAQ Small Cap Market(SM), the net asset values per share most recently calculated before the date of the high and low closing sales prices, and the discount or premium that each sales price represented as a percentage of the preceding net asset value:
Net High Sales Low Sales Asset Values Discount (-) or Quarter or Other Price Price Per Share/2/ Premium (+)/3/ ----------------- ----------------- Period Ended Per Share/1/ Per Share/1/ High Low High Low - -------------------- ----------- ----------- ------- -------- ------- ------- March 31, 1997 17.000 15.750 17.850 17.760 (4.76) (11.32) June 30, 1997 16.750 15.875 18.050 17.640 (7.20) (10.01) September 30, 1997 17.750 15.875 18.340 18.110 (3.22) (12.34) December 31, 1997 17.625 15.125 18.560 18.380 (5.04) (17.71) March 31, 1998 18.000 16.750 18.400 18.300 (2.17) (8.47) June 30, 1998 18.125 16.750 18.720 18.490 (3.18) (9.41) September 30, 1998 18.000 16.750 18.480 18.210 (2.60) (8.02) December 31, 1998 19.000 17.000 18.850 18.350 2.43 (7.36) March 31, 1999 18.000 16.375 18.150 17.900 (0.83) (8.52) June 30, 1999 17.375 15.500 18.180 17.950 (4.43) (13.65) September 30, 1999 16.750 15.125 17.690 17.180 (5.31) (11.96) December 31, 1999 16.500 13.750 17.090 17.080 (3.45) (19.50)
_________________________________________ 1. As reported on the NASDAQ SmallCap Market(SM). During periods in which ISIS' shares traded at the high or low price for more than one day, the information is provided with respect to the trading day on which the discount or premium was greatest. 2. The net asset value per share calculated by ISIS as of the Friday preceding the date of each high sales price in the first column and each low sales price in the second column. Thus, this column does not necessarily show the highest or the lowest net asset value per share during the period. 3. This column shows the discount or premium that the high and low sales prices in the first two columns bore to the respective, preceding net asset values in the third column. It does not necessarily show the highest or lowest discount or premium during the period. 1 The net asset value of ISIS as of December 31, 1999 was $16.89 and the high and low sales price were $15.50 and $15.1875, respectively. ISIS' common stock has frequently traded for an amount less than net asset value. ISIS has no program to reduce the discount other than the management of its portfolio. 2 APPENDIX D SECTIONS 3-202 THROUGH 3-213 OF THE MARYLAND GENERAL CORPORATION LAW (S) 3-202. Right to fair value of stock. (a) General rule. - Except as provided in subsection (c) of this section, a stockholder of a Maryland corporation has the right to demand and receive payment of the fair value of the stockholder's stock from the successor if: (1) The corporation consolidates or merges with another corporation; (2) The stockholder's stock is to be acquired in a share exchange; (3) The corporation transfers its assets in a manner requiring action under (S) 3-105(e) of this title; (4) The corporation amends its charter in a way which alters the contract rights, as expressly set forth in the charter, of any outstanding stock and substantially adversely affects the stockholder's rights, unless the right to do so is reserved by the charter of the corporation; or (5) The transaction is governed by (S) 3-602 of this title or exempted by (S) 3-603(b) of this title. (b) Basis of fair value. - (1) Fair value is determined as of the close of business: (i) With respect to a merger under (S) 3-106 of this title of a 90 percent or more owned subsidiary with or into its parent corporation, on the day notice is given or waived under (S) 3-106; or (ii) With respect to any other transaction, on the day the stockholders voted on the transaction objected to. (2) Except as provided in paragraph (3) of this subsection, fair value may not include any appreciation or depreciation which directly or indirectly results from the transaction objected to or from its proposal. (3) In any transaction governed by (S) 3-602 of this title or exempted by (S) 3-603(b) of this title, fair value shall D-1 be value determined in accordance with the requirements of (S) 3-603(b) of this title. (c) When right to fair value does not apply. - Unless the transaction is governed by (S) 3-602 of this title or is exempted by (S) 3-603(b) of this title, a stockholder may not demand the fair value of his stock and is bound by the terms of the transaction if: (1) The stock is listed on a national securities exchange or is designated as a national market system security on an interdealer quotation system by the National Association of Securities Dealers, Inc. : (i) With respect to a merger under (S) 3-106 of this title of a 90 percent or more owned subsidiary with or into its parent corporation, on date notice is given or waived under (S) 3-106; or (ii) With respect to any other transaction, on the record date for determining stockholders entitled to vote on the transaction objected to; (2) The stock is that of the successor in a merger, unless: (i) The merger alters the contract rights of the stock as expressly set forth in the charter, and the charter does not reserve the right to do so; or (ii) The stock is to be changed or converted in whole or in part in the merger into something other than either stock in the successor or cash, scrip, or other rights or interests arising out of provisions for the treatment of fractional shares of stock in the successor; or (3) The stock is that of an open-end investment company registered with the Securities and Exchange Commission under the Investment Company Act of 1940 and the value placed on the stock in the transaction is its net asset value. (S) 3-203. Procedure by stockholder. (a) Specific duties. - A stockholder of a corporation who desires to receive payment of the fair value of his stock under his subtitle: D-2 (1) Shall file with the corporation a written objection to the proposed transaction: (i) With respect to a merger under (S) 3-106 of this title of a 90 percent or more owned subsidiary with or into its parent corporation, within 30 days after notice is given or waived under (S) 3- 106; or (ii) With respect to any other transaction, at or before the stockholders' meeting at which the transaction will be considered; (2) May not vote in favor of the transaction; and (3) Within 20 days after the Department accepts the articles for record, shall make a written demand on the successor for payment for his stock, stating the number and class of shares for which he demands payment. (b) Failure to comply with section. - A stockholder who fails to comply with this section is bound by the terms of the consolidation, merger, share exchange, transfer of assets, or charter amendment. (S) 3-204. Effect of demand on dividend and other rights. A stockholder who demands payment for his stock under this subtitle: (1) Has no right to receive any dividends or distributions payable to holders of record of that stock on a record date after the close of business on the day as at which fair value is to be determined under (S) 3-202 of this subtitle; and (2) Ceases to have any rights of a stockholder with respect to that stock, except the right to receive payment of its fair value. (S) 3-205. Withdrawal of demand. A demand for payment may be withdrawn only with the consent of the successor. D-3 (S) 3-206. Restoration of dividend and other rights. (a) When rights restored. - The rights of a stockholder who demands payment are restored in full, if: (1) The demand for payment is withdrawn; (2) A petition for an appraisal is not filed within the time required by this subtitle; (3) A court determines that the stockholder is not entitled to relief; or (4) The transaction objected to is abandoned or rescinded. (b) Effect of restoration. - The restoration of a stockholder's rights entitles him to receive the dividends, distributions, and other rights he would have received if he had not demanded payment for his stock. However, the restoration does not prejudice any corporate proceeding taken before the restoration. (S) 3-207. Notice and offer to stockholders. (a) Duty of successor. - (1) The successor promptly shall notify each objecting stockholder in writing of the date the articles are accepted for record by the Department. (2) The successor also may send a written offer to pay the objecting stockholder what it considers to be the fair value of his stock. Each offer shall be accompanied by the following information relating to the corporation which issued the stock: (i) A balance sheet as of a date not more than six months before the date of the offer; (ii) A profit and loss statement for the 12 months ending on the date of the balance sheet; and (iii) Any other information the successor considers pertinent. (b) Manner of sending notice. - The successor shall deliver the notice and offer to each objecting stockholder D-4 personally or mail them to him by certified mail, return receipt requested, bearing a postmark from the United States Postal Service, at the address he gives the successor in writing, or, if none, at his address as it appears on the records of the corporation which issued the stock. (S) 3-208. Petition for appraisal; consolidation of proceedings; jointer of objectors. (a) Petition for appraisal. - Within 50 days after the Department accepts the articles for record, the successor or an objecting stockholder who has not received payment for his stock may petition a court of equity in the county where the principal office of the successor is located or, if it does not have a principal office in this State, where the resident agent of the successor is located, for an appraisal to determine the fair value of the stock. (b) Consolidation of suits; joinder of objectors. - (1) If more than one appraisal proceeding is instituted, the court shall direct the consolidation of the proceedings on terms and conditions it considers proper. (2) Two or more objecting stockholders may join or be joined in an appraisal proceeding. (S) 3-209. Notation on stock certificate. (a) Submission of certificate. - At any time after a petition for appraisal is filed, the court may require the objecting stockholders parties to the proceeding to submit their stock certificates to the clerk of the court for notation on them that the appraisal proceeding is pending. If a stockholder fails to comply with the order, the court may dismiss the proceeding as to him or grant other appropriate relief. (b) Transfer of stock bearing notation. - If any stock represented by a certificate which bears a notation is subsequently transferred, the new certificate issued for the stock shall bear a similar notation and the name of the original objecting stockholder. The transferee of this stock does not acquire rights of any character with respect to the stock other than the rights of the original objecting stockholder. D-5 (S) 3-210. Appraisal of fair value. (a) Court to appoint appraisers. - If the court finds that the objecting stockholder is entitled to an appraisal of his stock, it shall appoint three disinterested appraisers to determine the fair value of the stock on terms and conditions the court considers proper. Each appraiser shall take an oath to discharge his duties honestly and faithfully. (b) Report of appraisers - Filing. - Within 60 days after their appointment, unless the court sets a longer time, the appraisers shall determine the fair value of the stock as of the appropriate date and file a report stating the conclusion of the majority as to the fair value of the stock. (c) Same - Contents. - The report shall state the reasons for the conclusion and shall include a transcript of all testimony and exhibits offered. (d) Same - Service; objection. - (1) On the same day that the report is filed, the appraisers shall mail a copy of it to each party to the proceedings. (2) Within 15 days after the report is filed, any party may object to it and request a hearing. (S) 3-211. Action by court on appraisers' report. (a) Order of court. - The court shall consider the report and, on motion of any party to the proceeding, enter an order which : (1) Confirms, modifies, or rejects it; and (2) If appropriate, sets the time for payment to the stockholder. (b) Procedure after order. - (1) If the appraisers' report is confirmed or modified by the order, judgment shall be entered against the successor and in favor of each objecting stockholder party to the proceeding for the appraised fair value of his stock. (2) If the appraisers; report is rejected, the court may: D-6 (i) Determine the fair value of the stock and enter judgment for the stockholder; or (ii) Remit the proceedings to the same or other appraisers on terms and conditions it considers proper. (c) Judgment includes interest. - (1) Except as provided in paragraph (2) of this subsection, a judgment for the stockholder shall award the value of the stock and interest from the date as at which fair value is to be determined under (S) 3-202 of this subtitle. (2) The court may not allow interest if it finds that the failure of the stockholder to accept an offer for the stock made under (S) 3-207 of this subtitle was arbitrary and vexatious or not in good faith. In making this finding, the court shall consider: (i) The price which the successor offered for the stock; (ii) The financial statements and other information furnished to the stockholder; and (iii) Any other circumstances it considers relevant. (d) Costs of proceedings. - (1) The cost of the proceedings, including reasonable compensation and expenses of the appraisers, shall be set by the court and assessed against the successor. However, the court may direct the costs to be apportioned and assessed against any objecting stockholder if the court finds that the failure of the stockholder to accept an offer for the stock made under (S) 3-207 of this subtitle was arbitrary and vexatious or not in good faith. In making this finding, the court shall consider: (i) The price which the successor offered for the stock; (ii) The financial statements and other information furnished to the stockholder; and (iii) Any other circumstances it considers relevant. D-7 (2) Costs may not include attorney's fees or expenses. The reasonable fees and expenses of experts may be included only if: (i) The successor did not make an offer for the stock under (S) 3-207 of this subtitle; or (ii) The value of the stock determined in the proceeding materially exceeds the amount offered by the successor. (e) Effect of judgment. - The judgment is final and conclusive on all parties and has the same force and effect as other decrees in equity. The judgment constitutes a lien on the assets of the successor with priority over any mortgage or other lien attaching on or after the effective date of the consolidation, merger, transfer, or charter amendment. (S) 3-212 Surrender of stock. The successor is not required to pay for the stock of an objecting stockholder or to pay a judgment rendered against it in a proceeding for an appraisal unless, simultaneously with payment: (1) The certificates representing he stock are surrendered to it, indorsed in blank, and in proper form for transfer; or (2) Satisfactory evidence of the loss or destruction of the certificates and sufficient indemnity bond are furnished. (S) 3-213. Rights of successor with respect to stock. (a) General rule. - A successor which acquires the stock of an objecting stockholder is entitled to any dividends or distributions payable to holders of record of that stock on a record date after the close of business on the day as at which fair value is to be determined under (S) 3-202 of this subtitle. (b) Successor in transfer of assets. - After acquiring the stock of an objecting stockholder, a successor in a transfer of assets may exercise all the rights of an owner of the stock. (c) Successor in consolidation, merger, or share exchange. - Unless the articles provide otherwise, stock in the successor of a consolidation, merger, or share exchange otherwise deliverable in exchange for the stock of an objecting D-8 stockholder has the status of authorized but unissued stock of the successor. However, a proceeding for reduction of the capital of the successor is not necessary to retire the stock or to reduce the capital of the successor represented by the stock. D-9 INDEPENDENCE SQUARE INCOME SECURITIES, INC. c/o Bellevue Park Corporate Center 400 Bellevue Parkway Wilmington, DE 19809 (610) 964-8882 BLACKROCK FUNDS(SM) Bellevue Park Corporate Center 400 Bellevue Parkway Wilmington, Delaware 19809 (800) 441-7762 STATEMENT OF ADDITIONAL INFORMATION (Special Meeting of Shareholders of Independence Square Income Securities, Inc.) This Statement of Additional Information is not a prospectus but should be read in conjunction with the Combined Prospectus/Proxy Statement dated February __, 2000 for the Special Meeting of Shareholders of Independence Square Income Securities, Inc.("ISIS"), to be held on March __, 2000. Copies of the Combined Prospectus/Proxy Statement may be obtained at no charge by calling ISIS at 1- 610-964-8882. Unless otherwise indicated, capitalized terms used herein and not otherwise defined have the same meanings as are given to them in the Combined Prospectus/Proxy Statement. Further information about Series B Investor Shares of the High Yield Bond Portfolio is contained in said Fund's Statement of Additional Information dated January 28, 1999, which is incorporated herein by reference. The date of this Statement of Additional Information is February __, 2000. TABLE OF CONTENTS
Page ---- General Information................................................... Financial Statements.................................................. Pro Forma Financial Statements........................................
GENERAL INFORMATION The Shareholders of ISIS are being asked to approve or disapprove an Agreement and Plan of Reorganization (the "Reorganization Agreement") dated as of December __, 1999 by and between BlackRock FundsSM ("BlackRock") and ISIS and the transactions contemplated thereby. The Reorganization Agreement contemplates the transfer of all of the assets and liabilities of ISIS to BlackRock's High Yield Bond Portfolio in exchange for Series B Investor Shares. Series B Investor Shares issued by BlackRock will have an aggregate net asset value equal to the aggregate net asset value of the shares of ISIS that are outstanding immediately before the Effective Time of the Reorganization. Following the exchange, ISIS will make a liquidating distribution of the Series B Investor Shares to its Shareholders, so that a holder of shares in ISIS will receive Series B Investor Shares of the High Yield Bond Portfolio of equal value, plus the right to receive any unpaid dividends and distributions that were declared before the Effective Time of the Reorganization. Upon completion of the Reorganization, ISIS will be dissolved under state law and will de- register under the 1940 Act. A Special Meeting of Shareholders of ISIS to consider the Reorganization Agreement and the related transaction will be held at the offices of BlackRock Institutional Management Corporation, Bellevue Park Corporate Center, 400 Bellevue Parkway, Fourth Floor Conference Room, Wilmington, Delaware 19809, on March __, 2000 at __:__ a.m./p.m. Eastern time. For further information about the transaction, see the Combined Prospectus/Proxy Statement. SAI-1 FINANCIAL STATEMENTS The unaudited financial statements and notes thereto of ISIS contained in its Semi-Annual Report to Shareholders dated June 30, 1999, and the audited financial statements and notes thereto of ISIS contained in its Annual Report to Shareholders dated December 31, 1998, are incorporated by reference into this Statement of Additional Information related to this Combined Prospectus/Proxy Statement. The financial statements and notes thereto which appear in ISIS' Annual Report to Shareholders have been audited by PricewaterhouseCoopers LLP, whose report thereon also appears in such Annual Report and is also incorporated herein by reference. No other parts of the Semi-Annual or Annual Reports are incorporated herein by reference. The financial statements and notes thereto for ISIS for the fiscal year ended December 31, 1998 have been incorporated herein by reference in reliance on the report of PricewaterhouseCoopers LLP, independent auditors, given on their authority as experts in auditing and accounting. The audited financial statements and notes thereto of the High Yield Bond Portfolio contained in its Annual Report to Shareholders dated September 30, 1999 are incorporated by reference into this Statement of Additional Information related to this Combined Prospectus/Proxy Statement. The financial statements and notes thereto which appear in the High Yield Bond Portfolio's Annual Report to Shareholders have been audited by PricewaterhouseCoopers LLP, whose report thereon also appears in such Annual Report and is also incorporated herein by reference. No other parts of the Annual Report are incorporated herein by reference. The financial statements and notes thereto for the High Yield Bond Portfolio for the fiscal period ended September 30, 1999 have been incorporated herein by reference in reliance on the report of PricewaterhouseCoopers LLP, independent auditors, given on their authority as experts in auditing and accounting. SAI-2 PRO FORMA FINANCIAL STATEMENTS (UNAUDITED) The following tables set forth the unaudited Pro Forma Combined Portfolio of Investments as of September 30, 1999, Pro Forma Combined Statement of Assets and Liabilities as of September 30, 1999, and Pro Forma Combined Statement of Operations for the twelve month period ended September 30, 1999, and give effect to the proposed merger of Independence Square Income Securities, Inc. into BlackRock Funds High Yield Bond Portfolio. The merger provides for the transfer of all or substantially all of the assets of Independence Square Income Securities, Inc. to BlackRock Funds High Yield Bond Portfolio in exchange for BlackRock Funds High Yield Bond Portfolio Class B shares, the distribution of such BlackRock Funds High Yield Bond Portfolio Class B shares to shareholders of Independence Square Income Securities, Inc., and the subsequent liquidation of Independence Square Income Securities, Inc. SAI-3 BlackRock Funds High Yield Bond Portfolio and Independence Square Income Securities, Inc. Reorganization Pro Forma Combined Portfolio of Investments (Unaudited) As of September 30, 1999
------------------------------------------------------------------------------- BlackRock Funds Independence Square Proforma High Yield Bond Portfolio Income Securities, Inc. Combined ------------------------------------------------------------------------------- Description and Percentage of Portfolio Par(000)/Shares Value Par(000) Value Par(000)/Shares Value - ----------------------------------------------------------------------------------------------------------------------------------- PREFERRED STOCK Hyperion Telecommunications, Inc., Series B (PIK), 12.875%, 0.01 3,231 $ 2,876,093 3,231 $ 2,876,093 Key Energy Services, Inc. Warrant 1,000 2,000 1,000 2,000 Nextel Communications, Inc., Series D (PIK), 13.00%, 0.01 1,032 1,083,600 1,032 1,083,600 Nextel Communications, Inc., Series E (PIK), 11.125%, 0.01 1,084 1,051,480 1,084 1,051,480 Nextlink Communications, Inc. (PIK) ,14.00%, 0.01 31,462 1,557,369 31,462 1,557,369 ----------- ----------- TOTAL PREFERRED STOCKS 6,570,542 6,570,542 ----------- ----------- U.S. TREASURY NOTES U.S. Treasury Note, 6.125%, 08/15/07 $ 410 $ 410,339 410 410,339 U.S. Treasury Note, 4.75%, 11/15/08 200 181,968 200 181,968 ---------- ----------- TOTAL U.S. TREASURY NOTES 592,307 592,307 ---------- ----------- U.S. AGENCY OBLIGATIONS Federal National Mortgage Association, 7.50%, 08/01/06 900 903,600 900 903,600 ---------- ----------- COMMERCIAL MORTGAGE BACKED SECURITIES Donaldson, Lufkin & Jenrette, Inc., Commercial Mortgage Corp., Series 98-CG1, Class B4, 7.35%, 01/10/13 $ 2,531 1,806,273 2,531 1,806,273 ----------- ----------- CORPORATE BONDS Electronics Amkor Technologies, Inc., Series 144A, 10.50%, 05/01/09 2,000 1,920,000 2,000 1,920,000 Condor Systems, Inc., Series 144A, 11.87%, 05/01/09 1,000 890,000 1,000 890,000 ----------- ----------- 2,810,000 2,810,000 ----------- ----------- Financial BGLS, Inc., Series B ,15.75% , 01/31/01 700 700,000 700 700,000 ----------- ----------- Industrial American Plumbing & Mechanical, Inc., Series 144A, 11.62%,10/15/08 1,000 900,000 1,000 900,000 Ameriserve Food Distributor, 8.87%, 10/15/06 750 570,000 750 570,000 Charles River Laboratories, Inc., 13.50%, 10/01/09 1,000 1,010,000 1,000 1,010,000 Concentra Operating Corp., Series 144A, 13.00%, 08/15/09 2,000 2,000,000 2,000 2,000,000 Fountain View, Inc., Series B, 11.25%, 04/15/08 1,000 720,000 1,000 720,000 Golden Northwest Aluminum First Mortgage Notes, 12.00%, 12/15/06 1,750 1,802,500 1,000 1,030,000 2,750 2,832,500 Hudson Respiratory Care, Inc., 9.12%, 04/15/08 2,000 1,560,000 2,000 1,560,000 Huntsman ICI Hldgs., Series 144A (STEP) 13.00%, 12/31/09 (C) 3,500 910,000 3,500 910,000 Kasper A.S.L. Ltd., 12.75% 03/31/04 1,500 1,447,500 1,500 1,447,500 Knology Hldgs., Inc. (STEP) 13.36%,10/15/07 (C) 2,000 1,100,000 2,000 1,100,000 Knowles Electronics, Inc., 13.12%, 10/01/09 1,000 979,540 1,000 979,540 Lyondell Chemical, 10.875%, 05/01/09 2,600 2,613,000 1,000 1,005,000 3,600 3,618,000 National Equipment Services, Series D, 10.00%, 11/30/04 2,000 1,980,000 2,000 1,980,000 Nebco Evans Hldg. Co. (STEP) 17.25%, 07/15/07 (C) 800 296,000 800 296,000 Northeast Optic Network, 12.75%, 08/15/08 2,000 2,040,000 2,000 2,040,000 Pogo Producing Co., Series 144A, 10.37%, 02/15/09 1,000 1,037,500 1,000 1,037,500 Polaroid Corp., 11.50%, 02/15/06 1,000 1,043,750 1,000 1,043,750 Psinet, Inc., Series 144A, 11.00%, 08/01/09 1,000 985,000 1,000 985,000 Repap New Brunswick, 10.62%, 04/15/05 1,000 872,500 1,000 872,500 Republic Tech RTI Capital, Series 144A, 13.75%, 07/15/09 1,000 950,000 1,000 950,000 Revlon Consumer Products, 8.62%, 02/01/08 2,000 1,630,000 2,000 1,630,000 Sinclair Broadcast Group., 9.00%, 07/15/07 2,000 1,895,000 2,000 1,895,000 St. John Knits Intl., Series 144A, 12.50%, 07/01/09 1,000 915,000 1,000 915,000 U.S. Home, 8.87%, 02/15/09 1,000 910,000 1,000 910,000 Veritas DGC Inc., 9.75%, 10/15/03 1,000 1,012,500 1,000 1,012,500 2,000 2,025,000 Waterford Gaming, LLC Sr. Notes, Series 144A, 9.50%, 03/15/10 1,000 972,500 500 486,250 1,500 1,458,750 Wec Co., Series 144A, 12.00%, 07/15/09 1,000 980,000 1,000 980,000 Willis Corroon Corp., 9.00%, 02/01/09 1,000 905,000 1,000 905,000 ----------- ----------- 34,037,290 34,037,290 ----------- ----------- Oil and Gas Chesapeake Energy Corp., 9.12%, 04/15/06 1,500 1,380,000 1,500 1,380,000 Dual Drilling Co., 9.87%, 01/15/04 100 104,000 100 104,000 Grey Wolf Inc., Series C, 8.87%, 07/01/07 1,500 1,350,000 1,500 1,350,000 Key Energy Services, Inc., Series B, 14.00%, 01/15/09 1,000 1,065,000 1,000 1,065,000 R&B Falcon Corp., 12.25%, 03/15/06 2,000 2,110,000 2,000 2,110,000 Swift Energy Co., 10.25%, 08/01/09 1,550 1,557,750 1,550 1,557,750 Western Gas Resources, Series 144A, 10.00%, 06/15/09 1,500 1,533,750 1,500 1,533,750 ----------- ----------- 9,100,500 9,100,500 ----------- ----------- Retail Group One Automotive, Inc., 10.87%, 03/01/09 1,000 950,000 1,000 950,000 J. Crew Group, Inc., Series B (STEP) 13.44%, 10/15/08 (C) 1,500 787,500 1,500 787,500 J.H. Heafner Co., Series D, 10.00%, 05/15/08 1,000 940,000 1,000 940,000 Mattress Discounters Corp., 12.62%, 07/15/07 1,000 950,000 1,000 950,000 Sbarro Inc. 144A Sr. Notes, 11.00%, 09/15/09 1,000 988,750 1,000 988,750 Sonic Automotive, Inc., Series B, 11.00%, 08/01/08 2,000 1,910,000 2,000 1,910,000 ----------- ----------- 6,526,250 6,526,250 ----------- -----------
---------------------------------------------------------------------------- BlackRock Funds Independence Square Proforma High Yield Bond Portfolio Income Securities, Inc. Combined --------------------------------------------------------------------------- Decription and Percentage of Portfolio Par (000) Shares Value Par (000) Shares Value Par (000) Shares - --------------------------------------------------------------------------------------------------------------------------------- Special Purpose Nextel Partners, Inc., (STEP) 13.57%, 02/01/09 (C) $ 4,100 $ 2,439,500 $ 4,100 Penhall Acquisition Corp., 12.00%, 08/01/06 2,000 1,960,000 2,000 Pinnacle Hldgs., (STEP) 12.26%, 03/15/08 (C) 3,000 1,732,500 3,000 Zais Investment Grade Ltd., 9.95%, 09/23/14 1,000 990,000 1,000 ----------- 7,122,000 ----------- Telecommunications Allegiance Telecom Inc. Units 144A (STEP) 12.52%, 02/15/08 (C) 3,000 1,935,000 3,000 Diamond Cable Communications PLC, 12/15/05 1,000 902,500 1,000 Echostar DBS Corp., 9.37%, 02/01/09 2,000 1,975,000 2,000 Echostar DBS Corp. Series 144A Industrial, 9.25%, 02/01/06 1,000 987,500 1,000 Globenet Communications Group Ltd., Series 144A, 13.00%, 07/15/07 1,500 1,485,000 1,500 Hyperion Telecommunications, Series B, 04/15/03 2,000 1,690,000 2,000 IPC Info. Systems (STEP) 11.92%, 05/01/08 (C) 3,000 2,280,000 3,000 James Cable Partners LP, Series B, 10.75%, 08/15/04 1,000 1,005,000 1,000 Spectrasite Holdings Inc., Series 144A (STEP) 11.25%, 04/15/09 (C) 2,000 1,000,000 2,000 Teligent, Inc., 11.50%, 12/01/07 2,000 1,840,000 2,000 United Pan-Europe Communications, Series 144A (STEP) 12.50%, 08/01/09 (C) 4,000 2,240,000 4,000 United Pan-Europe Communications, NV., Series 144A, 10.87%, 08/01/09 1,500 1,522,500 1,500 Versatel Telecom BV, Sr. Notes, 11.87%, 07/15/09 1,000 950,000 1,000 Viatel, Inc., (STEP) 11.93%, 04/15/08 (C) 1,600 928,000 1,600 Williams Communications Group, Inc. Sr. Notes, 10.87%, 10/01/09 1,000 992,490 1,000 Worldwide Fiber, Inc., Series 144A, 12.00%, 08/01/09 1,000 975,000 1,000 ----------- 22,707,990 ----------- Ahmanson (H.F.) & Company, 9.875%, 11/15/1999 $ 1,000 $ 1,005,014 1,000 BankAmerica, 9.50%, 04/01/01 500 520,757 500 Calpine Corp., 9.250%, 02/01/04 550 555,500 550 CenCall Communications Corp. Sr. Disc. Notes, 10.13%, 01/15/04 1,000 1,002,500 1,000 Cleveland Electric Illuminating, 9.00%, 07/01/23 1,000 1,006,708 1,000 Comerica Bank, 8.375%, 07/15/24 1,000 1,004,585 1,000 Delta Airlines, Inc., 9.25%, 03/15/22 1,000 1,082,078 1,000 Federal Express, 9.625%, 10/15/19 500 520,070 500 First Chicago NBD Corp., 8.875%, 03/15/02 500 524,583 500 First Interstate Bancorp., 9.00%, 11/15/04 1,000 1,003,420 1,000 First Union Corp., 8.00%, 08/15/09 500 511,836 500 Ford Motor Credit Co., 9.14%, 12/30/14 1,000 1,079,177 1,000 GTE California, Inc., 8.07%, 04/15/24 300 299,695 300 Gulf States Utilities 8.70%, 04/01/24 1,000 1,014,420 1,000 Harris Bancorp, 9.375%, 06/01/01 500 520,583 500 Horton (D.R.), Inc. Co. Guarantee Notes, 10.00%, 04/15/06 250 250,000 250 Hydro-Quebec, 8.875%, 03/01/26 1,000 1,153,296 1,000 Jersey Central Power and Light, 8.45%, 03/24/25 1,000 1,051,590 1,000 New York State Electric & Gas Corp., 9.875%, 05/01/20 800 847,000 800 News America Holdings, 9.50%, 07/15/24 1,000 1,116,066 1,000 Nextlink Communications, Inc. Sr. Notes, 12.50%, 04/15/06 1,000 1,060,000 1,000 Participation in Asset Exchange, 7.00%, 12/01/20 (A) 5 5,081 5 Penney (J.C.) & Company, 8.25%, 08/15/22 500 497,805 500 RBF Finance Co., 11.38%, 03/15/09 1,000 1,055,000 1,000 Reynolds (R.J.) Tobacco Holdings, Inc., 7.375%, 05/15/03 1,000 973,864 1,000 Sinclair Broadcast Group Sr. Sub. Notes, 10.00%, 09/30/05 200 200,000 200 Sonic Automotive, Inc., 11.00%, 08/01/08 500 478,750 500 TCI Communications, 8.75%, 02/15/23 1,000 1,042,876 1,000 Time Warner Entertainment, Inc., 8.375%, 07/15/33 1,000 1,065,589 1,000 U.S. West, 8.875%, 06/01/31 1,000 1,037,479 1,000 United Air Lines, 9.210%, 01/21/17 450 490,500 450 Virginia Electric & Power Corp. Series B, 8.625%, 10/01/24 1,000 989,488 1,000 Zurich Capital Trust I, 8.376%, 06/01/37 500 487,478 500 ----------- TOTAL CORPORATE BONDS 83,004,030 $28,986,538 ----------- ----------- SHORT TERM INVESTMENTS Galileo Money Market Fund 194,162 194,162 194,162 ----------- TOTAL SHORT TERM INVESTMENTS 194,162 - ----------- ----------- TOTAL INVESTMENTS (BlackRock High Yield Bond Portfolio cost - $94,176,716) (Independence Square Income Securties, Inc. cost - $30,525,353(B)) ----------- ----------- (Proforma combined cost - $124,702,069) $91,575,007 $30,482,445 =========== =========== Decription and Percentage of Portfolio Value - ---------------------------------------------------------------------------------- Special Purpose $ 2,439,500 Nextel Partners, Inc., (STEP) 13.57%, 02/01/09 (C) 1,960,000 Penhall Acquisition Corp., 12.00%, 08/01/06 1,732,500 Pinnacle Hldgs., (STEP) 12.26%, 03/15/08 (C) ------------ 990,000 Zais Investment Grade Ltd., 9.95%, 09/23/14 ------------ 7,122,000 ------------ Telecommunications Allegiance Telecom Inc. Units 144A (STEP) 12.52%, 02/15/08 (C) 1,935,000 Diamond Cable Communications PLC, 12/15/05 902,500 Echostar DBS Corp., 9.37%, 02/01/09 1,975,000 Echostar DBS Corp. Series 144A Industrial, 9.25%, 02/01/06 987,500 Globenet Communications Group Ltd., Series 144A, 13.00%, 07/15/07 1,485,000 Hyperion Telecommunications, Series B, 04/15/03 1,690,000 IPC Info. Systems (STEP) 11.92%, 05/01/08 (C) 2,280,000 James Cable Partners LP, Series B, 10.75%, 08/15/04 1,005,000 Spectrasite Holdings Inc., Series 144A (STEP) 11.25 04/15/09 (C) 1,000,000 Teligent, Inc., 11.50%, 12/01/07 1,840,000 United Pan-Europe Communications, Series 144A (STEP 12.50%, 08/01/09 (C) 2,240,000 United Pan-Europe Communications, NV., Series 144A, 10.87%, 08/01/09 1,522,500 Versatel Telecom BV, Sr. Notes, 11.87%, 07/15/09 950,000 Viatel, Inc., (STEP) 11.93%, 04/15/08 (C) 928,000 Williams Communications Group, Inc. Sr. Notes, 10.87%, 10/01/09 992,490 Worldwide Fiber, Inc., Series 144A, 12.00%, 08/01/0 975,000 ------------ 22,707,990 ------------ Ahmanson (H.F.) & Company, 9.875%, 11/15/1999 1,005,014 BankAmerica, 9.50%, 04/01/01 520,757 Calpine Corp., 9.250%, 02/01/04 555,500 CenCall Communications Corp. Sr. Disc. Notes, 10.13%, 01/15/04 1,002,500 Cleveland Electric Illuminating, 9.00%, 07/01/23 1,006,708 Comerica Bank, 8.375%, 07/15/24 1,004,585 Delta Airlines, Inc., 9.25%, 03/15/22 1,082,078 Federal Express, 9.625%, 10/15/19 520,070 First Chicago NBD Corp., 8.875%, 03/15/02 524,583 First Interstate Bancorp., 9.00%, 11/15/04 1,003,420 First Union Corp., 8.00%, 08/15/09 511,836 Ford Motor Credit Co., 9.14%, 12/30/14 1,079,177 GTE California, Inc., 8.07%, 04/15/24 299,695 Gulf States Utilities 8.70%, 04/01/24 1,014,420 Harris Bancorp, 9.375%, 06/01/01 520,583 Horton (D.R.), Inc. Co. Guarantee Notes, 10.00%, 04/15/06 250,000 Hydro-Quebec, 8.875%, 03/01/26 1,153,296 Jersey Central Power and Light, 8.45% 03/24/25 1,051,590 New York State Electric & Gas Corp., 9.875%, 05/01/20 847,000 News America Holdings, 9.50%, 07/15/24 1,116,066 Nextlink Communications, Inc. Sr. Notes, 12.50%, 04/15/06 1,060,000 Participation in Asset Exchange, 7.00%, 12/01/20 (A) 5,081 Penney (J.C.) & Company, 8.25%, 08/15/22 497,805 RBF Finance Co., 11.38%, 03/15/09 1,055,000 Reynolds (R.J.) Tobacco Holdings, Inc., 7.375%, 05/15/03 973,864 Sinclair Broadcast Group Sr. Sub. Notes, 10.00%, 09/30/05 200,000 Sonic Automotive, Inc., 11.00%, 08/01/08 478,750 TCI Communications, 8.75%, 02/15/23 1,042,876 Time Warner Entertainment, Inc., 8.375%, 07/15/33 1,065,589 U.S. West, 8.875%, 06/01/31 1,037,479 United Air Lines, 9.210%, 01/21/17 490,500 Virginia Electric & Power Corp. Series B, 8.625%, 10/01/24 989,488 Zurich Capital Trust I, 8.376%, 06/01/37 487,478 ------------ TOTAL CORPORATE BONDS 111,990,568 ------------ SHORT TERM INVESTMENTS Galileo Money Market Fund 194,162 ------------ TOTAL SHORT TERM INVESTMENTS 194,162 ------------ TOTAL INVESTMENTS (BlackRock High Yield Bond Portfolio cost - $94,176,716) (Independence Square Income Securties, Inc. cost - $30,525,353(B)) ------------ (Proforma combined cost - $124,702,069) $122,057,452 ============
____________________________________________ (A) Non-income producing security (B) Reflects amortization of premium and accretion of discount (C) Rates shown are the effecive yields as of September 30, 1999 See accompanying notes to the Pro Forma Financial Statements. BlackRock Funds High Yield Bond portfolio and Independence Square Income Securities, Inc. Reorganization Combined Statement of Assets and Liabilities (Unaudited) As of September 30, 1999
-------------------------------------------------------------------------------------------- BlackRock Funds Independence Square Adjustments Pro Forma High Yield Bond Portfolio Income Securities, Inc. Combined -------------------------------------------------------------------------------------------- Investments $ 91,575,007 $ 30,482,445 $ 122,057,452 Cash - 39,589 39,589 Receivable - interest 1,593,994 760,428 2,354,422 Receivable - investments sold 3,068,771 - 3,068,771 Receivable - fund shares sold 177,857 - 177,857 Receivable from investment advisor - 27,584 27,584 Other assets 30,644 - 30,644 -------------------------------------------------------------------------------------------- Total assets 96,446,273 31,310,046 127,756,319 -------------------------------------------------------------------------------------------- Payable - investments purchased 5,475,188 - 5,475,188 Payable - fund shares repurchased 5,964 - 5,964 Payable - distributions 696,704 - 696,704 Payable - management fee - 9,666 9,666 Payable - 12b-1 fees - - - Reverse repurchase agreements payable 6,831,443 - 6,831,443 Accrued Expenses 111,963 25,976 137,939 -------------------------------------------------------------------------------------------- Total liabilities 13,121,262 35,642 13,156,904 -------------------------------------------------------------------------------------------- Net assets $ 83,325,011 $ 31,274,404 $ 114,599,415 ============================================================================================ Net Asset Value and Redemption Price per Blackrock, Institutional, Service and Investor A Share ($68,271,709 / 7,014,949) $ 9.73 $ 9.73 Offering price per BlackRock, Institutional and Service Share $ 9.73 $ 9.73 Maximum offering price per Investor A Share ($9.73 / 0.950) $ 10.24 $ 10.24 Net Asset Value and Redemption Price (subject to a maximum contingent deferred sales charge of 4.5%) per Investor B Share ($12,408,541 / 1,274,781) $ 9.73 Net Asset Value and Redemption Price (subject to a maximum contingent deferred sales charge of 1.0%) per Investor C Share ($2,646,761 / 271,952) $ 9.73 $ 9.73 Net Asset Value per ISIS Share ($31,274,404 / 1,822,752) $ 17.16 Net Asset Value and Redemption Price per Pro Forma Combined Investor B Share ($43,680,945 / 4,489,005) $ 9.73
See accompanying notes to the Pro Forma Financial Statements. BlackRock Funds High Yield Bond Portfolio and Independence Square Income Securities, Inc. Reorganization Combined Statement of Operations (Unaudited)
----------------------------------------------------------------------------------------------- BlackRock Funds Independence Square Adjustments Pro Forma High Yield Bond Portfolio Income Securities, Inc. Combined for the period ended for the year ended September 30, 1999* September 30, 1999 ----------------------------------------------------------------------------------------------- Dividend Income $ $ - $ - Interest Income 6,141,856 2,620,915 (9,594) 8,753,177 ----------------------------------------------------------------------------------------------- Investment Income 6,141,856 2,620,915 (9,594) (a) 8,753,177 ----------------------------------------------------------------------------------------------- Investment advisory services 263,946 117,758 45,588 (b) 427,292 Administrative services fees 94,182 - 75,139 (c) 169,321 Transfer agent fees 26,377 19,913 12,756 (d) 59,046 Custodian fees 17,609 19,729 (14,829) (e) 22,509 Professional fees 146,826 52,546 (50,259) (f) 149,113 Shareholder reports 94,238 12,839 (9,245) (g) 97,832 Trustees' fees 818 32,855 (32,202) (h) 1,471 Shareholder servicing fees 25,179 - 81,673 (i) 106,852 Shareholder processing fees 15,107 - 49,004 (j) 64,111 Distribution fees 57,531 - 245,019 (k) 302,550 Registration fees and expenses 74,621 - 8,694 (l) 83,315 Other 9,175 14,839 (11,395) (m) 12,619 ----------------------------------------------------------------------------------------------- 825,609 270,479 399,943 1,496,031 Expenses waived or reimbursed (346,897) - (43,173) (n) (390,070) ----------------------------------------------------------------------------------------------- Total operating expenses 478,712 270,479 356,770 1,105,961 Interest expense 175,871 - - 175,871 ----------------------------------------------------------------------------------------------- Total expenses 654,583 270,479 356,770 1,281,832 ----------------------------------------------------------------------------------------------- Net investment income $ 5,487,273 $ 2,350,436 $ (366,364) $ 7,471,345 ===============================================================================================
- --------------------- * Commencement of operations was November 19, 1998 See accompanying notes to the Pro Forma Financial Statements. BlackRock Funds High Yield Portfolio/Independence Square Income Securities, Inc. Notes to Pro Forma Financial Statements (Unaudited) September 30, 1999 1. Basis of Combination The unaudited Pro Forma Combined Portfolio of Investments, Pro Forma Combined Statement of Assets and Liabilities and Pro Forma Combined Statement of Operations give effect to the proposed merger of Independence Square Income Securities, Inc. into BlackRock Funds High Yield Bond Portfolio. The proposed merger will be accounted for by the method of accounting for tax-free reorganizations of investment companies (sometimes referred to as the pooling- of-interest basis). The reorganization provides for the transfer of all or substantially all of the assets of Independence Square Income Securities, Inc. to BlackRock Funds High Yield Bond Portfolio in exchange for BlackRock Funds High Yield Bond Portfolio Class B shares, the distribution of such BlackRock Funds High Yield Bond Portfolio Class B shares to shareholders of Independence Square Income Securities, Inc., and the subsequent liquidation of Independence Square Income Securities, Inc. The pro forma combined statements should be read in conjunction with the historical financial statements of the constituent fund and the notes thereto incorporated by reference in the Statement of Additional Information. BlackRock Funds High Yield Bond Portfolio, an open-end, management investment company, and Independence Square Income Securities, Inc., a closed- end, management investment company, are both registered under the Investment Company Act of 1940, as amended. Pro Forma Adjustments: The Pro Forma adjustments below reflect the impact of the reorganization between BlackRock Funds High Yield Portfolio and Independence Square Income Securities, Inc. a) to reflect amortization of premium and discount. b) to increase Independence Square Income Securities, Inc. advisory fee to BlackRock Funds High Yield Portfolio's rate of 0.50% c) to record administrative service fee of 0.23%. Independence Square Income Securities, Inc. does not charge an administrative service fee. d) to increase Independence Square Income Securities, Inc. transfer agent fees to BlackRock Funds HighYield Portfolio's rate of 0.10%. e) to decrease Independence Square Income Securities, Inc. custodian fees to BlackRock Funds High Yield Portfolio's rate of 0.015%. f) to decrease Independence Square Income Securities, Inc. professional fees (consisting of legal and audit fees) to reflect BlackRock Funds High Yield Portfolio's ending proportionate allocation of BlackRock Funds' professional fees. 10 g) to decrease Independence Square Income Securities, Inc. shareholder reporting fees to reflect BlackRock Funds High Yield Portfolio's ending proportionate allocation of BlackRock Funds' shareholder reporting fees. h) to decrease Independence Square Income Securities, Inc. trustees' fees to reflect BlackRock Funds High Yield Portfolio's ending proportionate allocation of BlackRock Funds' trustees' fees. i) to record shareholder servicing fees of 0.25%. Independence Square Income Securities, Inc. does not charge a shareholder servicing fee. j) to record shareholder processing fees of 0.15%. Independence Square Income Securities, Inc. does not charge a shareholder processing fee. k) to record distribution fees of 0.75%. Independence Square Income Securities, Inc. does not charge a distribution fee. l) to record additional SEC registration fees on the value of the shares increased from the merger. m) to decrease Independence Square Income Securities, Inc. insurance and other expenses to reflect BlackRock Funds High Yield Portfolio's ending proportionate allocation of BlackRock Funds' insurance and other expenses. n) to limit the operation expenses (excluding interest expense) to 1.92%. 2. Summary of Significant Accounting Policies Following is a summary of significant accounting policies which are consistently followed by BlackRock Funds High Yield Bond Portfolio/Independence Square Income Securities, Inc. in the preparation of its financial statements. The policies are in conformity with generally accepted accounting principles. Preparation of the financial statements includes the use of management estimates. Actual results could differ from those estimates. Security Valuation - Portfolio securities for which market quotations are readily available are valued at market value that is currently determined using the last reported sales price. If no sales are reported, for BlackRock Funds High Yield Portfolio, portfolio securities are valued at the mean between the last reported bid and asked prices. For Independence Square Income Securities, Inc. securities not listed or not traded on that day are valued at their most recent quoted bid prices or at prices determined by investment bankers or brokers. Short-term obligations with maturities of 60 days or less are valued at amortized cost, which approximates market value. For BlackRock Funds High yield Portfolio discounts and premiums on debt securities are amortized for book and tax purposes using the effective yield-to-maturity method over the term of the instrument. Independence Square Income Securities, Inc. does not amortize premiums or discounts on bonds held for investment for financial reporting or federal income tax purposes. Security Transactions and Investment Income - Investment transactions are accounted for on the trade date. The cost of investments sold is determined by use of the specific identification method for both financial reporting and federal income tax purposes. Interest income is recorded on the accrual basis. Federal Income Taxes - BlackRock Funds High Yield Portfolio/Independence Square Income Securities, Inc. intends to qualify for tax treatment applicable to regulated investment companies under the Internal Revenue Code of 1986 (the "Code"), as amended, and distribute all of its taxable income to its shareholders. Therefore, no provision has been recorded for Federal income or excise taxes. Distributions to Shareholders - Distributions from net investment income are declared by BlackRock Funds High Yield Bond Portfolio each day and monthly by Independence Square Income Securities, Inc. on "settled" shares. Both funds pay the net investment income monthly. Net realized capital gains, if any will be distributed annually. 12 FORM N-14 --------- Part C - Other Information -------------------------- Item 15. Indemnification. --------------- Indemnification of Registrant's principal underwriter against certain losses is provided for in Section 7 of the Distribution Agreement incorporated by reference herein as Exhibit 5(a). Indemnification of Registrant's Custodian, Transfer Agent and Administrators is provided for, respectively, in Section 22 of the Custodian Agreement incorporated by reference herein as Exhibit 7(a), Section 17 of the Transfer Agency Agreement incorporated by reference herein as Exhibit 8(c) and Section 11 of the Administration Agreement which is Exhibit 8(a) hereof. Registrant intends to obtain from a major insurance carrier a trustees and officers liability policy covering certain types of errors and omissions. In addition, Section 9.3 of the Registrant's Declaration of Trust incorporated by reference herein as Exhibit 1(a) provides as follows: Indemnification of Trustees, Officers, Representatives and Employees. -------------------------------------------------------------------- The Trust shall indemnify each of its Trustees against all liabilities and expenses (including amounts paid in satisfaction of judgments, in compromise, as fines and penalties, and as counsel fees) reasonably incurred by him in connection with the defense or disposition of any action, suit or other proceeding, whether civil or criminal, in which he may be involved or with which he may be threatened, while as a Trustee or thereafter, by reason of his being or having been such a Trustee except ------ with respect to any matter as to which he shall have been adjudicated to have acted in bad faith, willful misfeasance, gross negligence or reckless disregard of his duties, provided that as to any matter disposed of by a -------- compromise payment by such person, pursuant to a consent decree or otherwise, no indemnification either for said payment or for any other expenses shall be provided unless the Trust shall have received a written opinion from independent legal counsel approved by the Trustees to the effect that if either the matter of willful misfeasance, gross negligence or reckless disregard of duty, or the matter of bad faith had been adjudicated, it would in the opinion of such counsel have been adjudicated in favor of such person. The rights accruing to any person under these provisions shall not exclude any other right to which he may be lawfully entitled, provided that no person may satisfy any right of indemnity or -------- reimbursement hereunder except out of the property of the Trust. The Trustees may make advance payments in connection with the indemnification under this Section 9.3, provided that the indemnified person shall have -------- given a written undertaking to reimburse the Trust in the event it is subsequently determined that he is not entitled to such indemnification. The Trustee shall indemnify officers, representatives and employees of the Trust to the same extent that Trustees are entitled to indemnification pursuant to this Section 9.3. C-1 Insofar as indemnification for liability arising under the Securities Act of 1933 may be permitted to trustees, officers and controlling persons of Registrant pursuant to the foregoing provisions, or otherwise, Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by Registrant of expenses incurred or paid by a trustee, officer or controlling person of Registrant in the successful defense of any action suit or proceeding) is asserted by such trustee, officer or controlling person in connection with the securities being registered, registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue. Section 9.6 of the Registrant's Declaration of Trust, filed herein as Exhibit 1(a), also provides for the indemnification of shareholders of the Registrant. Section 9.6 states as follows: Indemnification of Shareholders. In case any Shareholder or former ------------------------------- Shareholder shall be held to be personally liable solely by reason of his being or having been a Shareholder and not because of his acts or omissions or for some other reason, the Shareholder or former Shareholder (or his heirs, executors, administrators or other legal representatives or, in the case of a corporation or other entity, its corporate or other general successor) shall be entitled out of the assets belonging to the classes of Shares with the same alphabetical designation as that of the Shares owned by such shareholder to be held harmless from and indemnified against all loss and expense arising from such liability. The Trust shall, upon request by the Shareholder, assume the defense of any claim made against any Shareholder for any act or obligations of the Trust and satisfy any judgment thereon from such assets. Item 16. Exhibits. -------- (1) Articles of Incorporation (a) Declaration of Trust of the Registrant dated December 22, 1988 is incorporated herein by reference to Exhibit (1)(a) of Post-Effective Amendment No. 33 to Registrant's Registration Statement on Form N-1A (File Nos. 33-26305/811- 05742) filed on January 27, 1998 ("PEA No. 33"). C-2 (b) Amendment No. 1 to Declaration of Trust dated May 4, 1989 is incorporated herein by reference to Exhibit (1)(b) of PEA No. 33. (c) Amendment No. 2 to the Declaration of Trust dated December 23, 1993 is incorporated herein by reference to Exhibit (1)(c) of PEA No. 33. (d) Amendment No. 3 to the Declaration of Trust dated January 5, 1996 is incorporated herein by reference to Exhibit (1)(d) of Post-Effective Amendment No. 23 to Registrant's Registration Statement on Form N-1A (File Nos. 33-26305/811- 05742 filed on October 18, 1996. (e) Amendment No. 4 to the Declaration of Trust dated December 23, 1997 is incorporated herein by reference to Exhibit (1)(e) of PEA No. 33. (2) By-laws (a) Amended and Restated Code of Regulations is incorporated herein by reference to Exhibit 2(a) of Post-Effective Amendment No. 42 to Registrant's Registration Statement on Form N-1A (File Nos. 33-26305/ 811-05742) filed on June 11, 1999 ("PEA No. 42"). (3) Voting Trust Agreement(s) None. (4) Plan of Reorganization filed herewith as Appendix A to the Combined Prospectus/Proxy Statement. (5) Instruments Defining Rights of Security Holders. (a) Sections V, VIII and IX of Registrant's Declaration of Trust dated December 22, 1988 are incorporated herein by reference to Exhibit (1)(a) of PEA No. 33; Article II of Registrant's Code of Regulations is incorporated herein by reference to Exhibit (2) of PEA No. 33. C-3 (6) Investment Advisory Contracts. (a) Investment Advisory Agreement between Registrant and PNC Asset Management Group, Inc. relating to all Portfolios except the Multi-Sector Mortgage Securities Portfolio III and Index Equity Portfolio is incorporated herein by reference to Exhibit (5)(a) of Post-Effective Amendment No. 21 to Registrant's Registration Statement on Form N-1A (File Nos. 33-26305/811-05742) filed on May 30, 1996 ("PEA No. 21"). (b) Investment Advisory Agreement between Registrant and BlackRock Financial Management, Inc. with respect to the Multi-Sector Mortgage Securities Portfolio III is incorporated herein by reference to Exhibit (5)(b) of PEA No. 21. (c) Addendum No. 1 to Investment Advisory Agreement between Registrant and PNC Asset Management Group, Inc. with respect to the Mid-Cap Value Equity and Mid-Cap Growth Equity Portfolios is incorporated herein by reference to Exhibit (5)(c) of Post-Effective Amendment No. 27 to Registrant's Registration Statement on Form N-1A (File Nos. 33-26305/811-05742) filed on January 28, 1997 ("PEA No. 27"). (d) Form of Addendum No. 1 to Investment Advisory Agreement between Registrant and BlackRock Financial Management, Inc. with respect to BlackRock Strategic Portfolio I and BlackRock Strategic Portfolio II is incorporated herein by reference to Exhibit (5)(d) of Post-Effective Amendment No. 26 to Registrant's Registration Statement on Form N-1A (File Nos. 33-26305/811-05742) filed on December 18, 1996. (e) Form of Addendum No. 2 to Investment Advisory Agreement between Registrant and PNC Asset Management Group, Inc. with respect to the International Small Cap Equity Portfolio is incorporated herein by reference to Exhibit (5)(e) of Post-Effective Amendment No. 30 to Registrant's Registration Statement on Form N-1A (File Nos. 33-26305/811-05742) filed on August 19, 1997 ("PEA No. 30"). (f) Sub-Advisory Agreement between PNC Asset Management Group, Inc. and BlackRock Financial Management, Inc. with respect to the Managed Income, Tax-Free Income, Intermediate Government Bond, Ohio Tax-Free Income, Pennsylvania Tax-Free Income, Low Duration Bond, Intermediate Bond, Government Income, New Jersey Tax-Free Income and Core Bond Portfolios is incorporated herein by reference to Exhibit (5)(c) of PEA No. 21. C-4 (g) Sub-Advisory Agreement between PNC Asset Management Group, Inc. and Provident Capital Management, Inc. with respect to the Large Cap Value Equity, Small Cap Value Equity and Select Equity Portfolios is incorporated herein by reference to Exhibit (5)(c) of PEA No. 21. (h) Sub-Advisory Agreement between PNC Asset Management Group, Inc. and PNC Equity Advisors Company with respect to the Large Cap Growth Equity and Small Cap Growth Equity Portfolios is incorporated herein by reference to Exhibit (5)(c) of PEA No. 21. (i) Sub-Advisory Agreement between PNC Asset Management Group, Inc. and PNC Institutional Management Corporation with respect to the Money Market, U.S. Treasury Money Market, Municipal Money Market, Pennsylvania Municipal Money Market, Ohio Municipal Money Market, North Carolina Municipal Money Market, Virginia Municipal Money Market and New Jersey Municipal Money Market Portfolios is incorporated herein by reference to Exhibit (5)(c) of PEA No. 21. (j) Sub-Advisory Agreement between PNC Asset Management Group, Inc. and CastleInternational Asset Management Limited with respect to the International Equity and International Emerging Markets Portfolios is incorporated herein by reference to Exhibit (5)(c) of PEA No. 21. (k) Sub-Advisory Agreement among PNC Asset Management Group, Inc., Provident Capital Management, Inc. and BlackRock Financial Management, Inc. with respect to the Balanced Portfolio is incorporated herein by reference to exhibit (5)(c) of PEA No. 21. (l) Sub-Advisory Agreement between PNC Asset Management Group, Inc. and Provident Capital Management, Inc. with respect to the Mid Cap Value Equity Portfolio is incorporated herein by reference to Exhibit (5)(k) of PEA No. 27. (m) Sub-Advisory Agreement between PNC Asset Management Group, Inc. and PNC Equity Advisors Company with respect to the Mid Cap Growth Equity Portfolio is incorporated herein by reference to Exhibit (5)(l) of PEA No. 27. (n) Sub-Advisory Agreement between PNC Asset Management Group, Inc. and BlackRock Financial Management, Inc. with C-5 respect to the International Bond Portfolio is incorporated herein by reference to Exhibit (5)(m) of PEA No. 27. (o) Form of Sub-Advisory Agreement between PNC Asset Management Group, Inc. and CastleInternational Asset Management Limited with respect to the International Small Cap Equity Portfolio is incorporated herein by reference to Exhibit (5)(o) of PEA No. 30. (p) Form of Addendum No. 3 to Investment Advisory Agreement between Registrant and PNC Asset Management Group, Inc. with respect to the Micro-Cap Equity Portfolio, GNMA Portfolio, Delaware Tax-Free Income Portfolio and Kentucky Tax-Free Income Portfolio is incorporated herein by reference to Exhibit (5)(p) of PEA No. 33. (q) Form of Sub-Advisory Agreement between PNC Asset Management Group, Inc. and PNC Equity Advisors Company with respect to the Micro-Cap Equity Portfolio is incorporated herein by reference to Exhibit (5)(q) of Post-Effective Amendment No. 33 to Registrant's Registration Statement on Form N-1A (File Nos. 33-26305/811-05742) filed January 27, 1998 ("PEA No. 33"). (r) Form of Sub-Advisory Agreement between BlackRock, Inc. and BlackRock Financial Management, Inc. with respect to the GNMA, Delaware Tax-Free Income and Kentucky Tax-Free Income Portfolios is incorporated herein by reference to Exhibit (5)(r) of Post- Effective Amendment No. 34 to Registrant's Registration Statement on Form N-1A (File Nos. 33-26305/811-05742) filed on February 13, 1998 ("PEA No. 34"). (s) Form of Addendum No. 4 to Investment Advisory Agreement between Registrant and BlackRock Advisors, Inc. with respect to the High Yield Bond Portfolio is incorporated herein by reference to Exhibit (5)(s) of Post-Effective Amendment No. 37 to Registrant's Registration Statement on Form N-1A (File Nos. 33-26305/811- 05742) filed on August 7, 1998 ("PEA No. 37"). (t) Form of Sub-Advisory Agreement between BlackRock Advisors, Inc. and BlackRock Financial Management, Inc. with respect to the High Yield Bond Portfolio is incorporated herein by reference to Exhibit (5)(t) of PEA No. 37. (u) Form of Addendum No. 2 to Investment Advisory Agreement between Registrant and BlackRock Financial Management, Inc. with respect to the Multi-Sector Mortgage Securities Portfolio IV is incorporated herein by reference to Exhibit (4)(u) of PEA No. 42. C-6 (7) Underwriting Contracts. (a) Distribution Agreement between Registrant and BlackRock Distributors Inc. dated as of June 25, 1999 is incorporated herein by reference to Exhibit 5(a) of Post-Effective Amendment No. 45 to Registrant's Registration Statement on Form N-1A filed on August 24, 1999. (b) Form of Appendix A to Distribution Agreement between Registrant and BlackRock Distributors, Inc. is incorporated herein by reference to Exhibit 5(b) of Post-Effective Amendment No. 45 to Registrant's Registration Statement on Form N-1A filed on August 24, 1999 ("PEA No. 45"). (8) Bonus or Profit Sharing Contracts. None. (9) Custodian Agreements. (a) Custodian Agreement dated October 4, 1989 between Registrant and PNC Bank, National Association is incorporated herein by reference to Exhibit (8)(a) of PEA No. 33. (b) Amendment No. 1 to Custodian Agreement between Registrant and PNC Bank, National Association is incorporated herein by reference to Exhibit (8)(b) of PEA No. 33. (c) Amendment No. 2 dated March 1, 1993 to Custodian Agreement between Registrant and PNC Bank National Association with respect to the Short-Term Bond, Intermediate-Term Bond, Core Equity, Small Cap Growth Equity and North Carolina Municipal Money Market Portfolios is incorporated herein by reference to Exhibit (8)(c) of PEA No. 33. C-7 (d) Form of Appendix B to Custodian Agreement between Registrant and PFPC Trust Company is incorporated herein by reference to Exhibit (7)(d) of PEA No. 42. (e) Sub-Custodian Agreement dated April 27, 1992 among the Registrant, PNC Bank, National Association and The Chase Manhattan Bank is incorporated herein by reference to Exhibit (8)(e) of PEA No. 34. (f) Global Custody Agreement between Barclays Bank PLC and PNC Bank, National Association dated October 28, 1992 is incorporated herein by reference to Exhibit (8)(f) of PEA No. 33. (g) Custodian Agreement between State Street Bank and Trust Company and PNC Bank, National Association dated June 13, 1993 is incorporated herein by reference to Exhibit (8)(g) of PEA No. 34. (h) Amendment No. 1 to Custodian Agreement between State Street Bank and Trust Company and PNC Bank, National Association dated November 21, 1989 is incorporated herein by reference to Exhibit (8)(h) of PEA No. 34. (i) Subcustodial Services Agreement dated January 10, 1996 between PNC Bank, National Association and Citibank, N.A. is incorporated herein by reference to Exhibit (8)(j) of PEA No. 27. (10) Rule 12b-1 and Rule 18f-3 Plans. (a) Amended and Restated Distribution and Service Plan for Service, Series A Investor, Series B Investor, Series C Investor, Institutional BlackRock and HL Shares is incorporated herein by reference to Exhibit 15 of PEA No. 21. (b) Form of Appendix A to Amended and Restated Distribution and Service Plan is incorporated herein by reference to Exhibit 13(b) to Post-Effective Amendment No. 44 to Registrant's Registration Statement on Form N-1A filed on August 11, 1999. (c) Amended and Restated Plan Pursuant to Rule 18f-3 for Operation of a Multi-Class Distribution System is incorporated herein by reference to Exhibit 15(a) of PEA No. 45. (11) Legal Opinion. None. (12) Opinion as to Tax Consequences. Opinion and Consent of Drinker Biddle & Reath LLP as to Tax Consequences. C-8 (13) Other Material Contracts. (a) Form of Administration Agreement among Registrant, BlackRock Advisors, Inc. and PFPC Inc. is incorporated herein by reference to Exhibit 8(a) to PEA No. 42. (b) Forms of Appendix A and Appendix B to Administration Agreement among Registrant, BlackRock Advisors, Inc. and PFPC Inc. are incorporated herein by reference to Exhibit 8(b) to PEA No. 44. (c) Transfer Agency Agreement dated October 4, 1989 between Registrant and PFPC, Inc. is incorporated herein by reference to Exhibit (9)(e) of PEA No. 33. (d) Amendment No. 1 to Transfer Agency Agreement dated October 4, 1989 between Registrant and PFPC, Inc. relating to the Tax-Free Income Portfolio is incorporated herein by reference to Exhibit (9)(f) of PEA No. 33. (e) Amendment No. 2 to Transfer Agency Agreement dated October 4, 1989 between Registrant and PFPC, Inc. relating to the Pennsylvania Municipal Money Market, Ohio Municipal Money Market, Intermediate Government, Ohio Tax-Free Income, Pennsylvania Tax- Free Income, Large Cap Value Equity, Index Equity and Small Cap Value Equity Portfolios is incorporated herein by reference to Exhibit (9)(g) of PEA No. 33. (f) Amendment No. 3 to Transfer Agency Agreement dated October 4, 1989 between Registrant and PFPC, Inc. relating to the Short Term Bond, Intermediate Term Bond, Core Equity, Small Cap Growth Equity and North Carolina Municipal Money Market Portfolios is incorporated herein by reference to Exhibit (9)(h) of PEA No. 33. (g) Amendment No. 4 to Transfer Agency Agreement dated October 4, 1989 between Registrant and PFPC, Inc. relating to Series B Investor Shares of the Money Market, Managed Income, Tax-Free Income, Intermediate Government, Ohio Tax-Free Income, Pennsylvania Tax-Free Income, Large Cap Value Equity, Large Cap Growth Equity, Index Equity, Small Cap Value Equity, Intermediate Term Bond, Small Cap Growth Equity, Core Equity, International Fixed Income, Government Income, International Emerging Markets, International Equity and Balanced Portfolios is incorporated herein by reference to Exhibit (9)(i) of PEA No. 33. C-9 (h) Form of Appendix C to Transfer Agency Agreement between Registrant and PFPC, Inc. is incorporated herein by reference to Exhibit 8(h) of PEA No. 42. (i) License Agreement dated as of December 1, 1995 between the Registrant and Compass Capital Group, Inc. is incorporated herein by reference to Exhibit (9)(q) of PEA No. 27. (j) Share Acquisition Agreement dated April 29, 1998 by and among Registrant and PNC Bank National Association and PNC Bank Delaware, respectively; each as a trustee for certain of the common trust funds listed therein is incorporated herein by reference to Exhibit (9)(l) of Post-Effective Amendment No. 36 to Registrant's Registration Statement on Form N-1A (File Nos. 33- 26305/811-05742) filed on April 29, 1998. (k) Form of Expense Limitation Agreement dated as of January 28, 1999 between Registrant and BlackRock Advisors, Inc. is incorporated herein by reference to Exhibit (8)(k) of Post-Effective Amendment No. 41 to Registrant's Registration Statement on Form N-1A (File Nos. 33-26305/811-05742) filed on January 28, 1999. (14) Other Opinions. Consent of PriceWaterhouseCoopers LLP. (15) Financial Statements Omitted Pursuant to Item 14(a)(1). None. (16) Powers of Attorney. None. (17) Additional Exhibits. (a) Form of Proxy Card. (b) Prospectus for Investor Shares of the Bond Portfolios of BlackRock Funds(SM) dated January 28, 1999 as supplemented through November 22, 1999. C-10 (c) Statement of Additional Information of BlackRock Funds(SM) dated January 28, 1999 as supplemented through November 22, 1999. (d) Annual Report to Shareholders for Investor Shares of the Bond Portfolios of BlackRock Funds(SM) dated September 30, 1999. (e) Annual Report to Shareholders of ISIS dated December 31, 1998. (f) Semi-Annual Report to Shareholders of ISIS dated June 30, 1999. Item 17. Undertakings. ------------ (1) The undersigned Registrant agrees that prior to any public reoffering of the securities registered through the use of a prospectus which is part of this registration statement by any person or party who is deemed to be an underwriter within the meaning of Rule 145(c) of the Securities Act of 1933, as amended (the "1933 Act"), the reoffering prospectus will contain the information called for by the applicable registration form for reofferings by persons who may be deemed underwriters, in addition to the information called for by the other items of the applicable form. (2) The undersigned Registrant agrees that every prospectus that is filed under paragraph (1), above, will be filed as part of an amendment to the registration statement and will not be used until the amendment is effective, and that, in determining any liability under the 1933 Act, each post-effective amendment shall be deemed to be a new registration statement for the securities offered therein, and the offering of the securities at that time shall be deemed to be the initial bona fide offering of them. C-11 SIGNATURES ---------- As required by the Securities Act of 1933, this registration statement has been signed on behalf of the registrant, in the City of New York and the State of New York, on the 13th day of January, 2000. BLACKROCK FUNDS Registrant By: /s/ Raymond J. Clark -------------------- Raymond J. Clark President and Treasurer (Principal Executive Officer) As required by the Securities Act of 1933, this registration statement has been signed by the following persons in the capacities and on the dates indicated. Signature Title Date - --------- ----- ---- /s/ Raymond J. Clark Trustee, President and January 13, 2000 - ------------------------------ Raymond J. Clark Treasurer /s/ David R. Wilmerding, Jr. Chairman of the Board January 13, 2000 - ------------------------------ David R. Wilmerding, Jr. /s/ Anthony M. Santomero Vice-Chairman of the Board January 13, 2000 - ------------------------------ Anthony M. Santomero /s/ William C. Albertini Trustee January 13, 2000 - ------------------------------ William C. Albertini /s/ Robert M. Hernandez Trustee January 13, 2000 - ------------------------------ Robert M. Hernandez C-12 Exhibits Item Description - ---- ----------- (12) Opinion and Consent of Drinker Biddle & Reath LLP as to Tax Consequences. (14) Consent of PriceWaterhouseCoopers LLP. (17) (a) Form of Proxy Card. (b) Prospectus for Investor Shares of the Bond Portfolios of BlackRock Funds(SM) dated January 28, 1999 as supplemented through November 22, 1999. (c) Statement of Additional Information of BlackRock Funds(SM) dated January 28, 1999 as supplemented through November 22, 1999. (d) Annual Report to Shareholders for Investor Shares of the Bond Portfolios of BlackRock Funds(SM) dated September 30, 1999. (e) Annual Report to Shareholders of ISIS dated December 31, 1998. (f) Semi-Annual Report to Shareholders of ISIS dated June 30, 1999. EX-19.12 2 OPINION AND CONSENT OF DRINKER BIDDLE & REATH LLP EXHIBIT 12 March __, 2000 Independence Square Income Securities, Inc. One Aldwyn Center Villanova, PA 19085 Blackrock Funds(SM) Bellevue Park Corporate Center 400 Bellevue Parkway Wilmington, DE 19809 Re: Agreement and Plan of Reorganization by and between Independence Square Income Securities, Inc. and Blackrock Funds(SM) ------------------------------------------------------------------- Dear Ladies and Gentlemen: You have asked for our opinion as to certain Federal income tax consequences of the transactions contemplated in the above-referenced Agreement and Plan of Reorganization (the "Reorganization Agreement"). Background - ---------- Independence Square Income Securities, Inc. (the "Transferor Fund") is a closed-end management investment company registered with the Securities and Exchange Commission (the "SEC") under the Investment Company Act of 1940, as amended (the "Act"). Blackrock Funds(SM) ("Blackrock") is an open-end management investment company registered with the SEC under the Act. Blackrock has several portfolios, one of which is the High Yield Bond Portfolio (the "Surviving Fund"). At the Effective Time of the Reorganization (as defined in the Reorganization Agreement), it is contemplated that the Transferor Fund will transfer all of its assets and liabilities to the Surviving Fund in exchange for Series B Investor Shares of the Surviving Fund. The Transferor Fund will then distribute the Series B Investor Shares to the shareholders of the Transferor Fund in exchange for all outstanding shares of the Transferor Fund, and the existence of the Transferor Fund will be terminated. All of the above steps constitute the "Transactions." For purposes of this opinion, we have relied on certain written representations of Officers of the Transferor Fund and Blackrock, copies of which are attached hereto, and have assumed such representations to be true. We have also assumed that the Reorganization Agreement substantially in the form included as Appendix A to the Combined Proxy Statement/Prospectus (the "Proxy Statement"), a draft of which is part of the Registration Statement (the "Registration Statement") being filed this day with the SEC on Form N-14, will be duly authorized by the parties and approved by the shareholders of the Transferor Fund, and the appropriate documents will be filed with the appropriate government agencies. Conclusions - ----------- Based upon the Internal Revenue Code of 1986, as amended (the "Code"), applicable Treasury Department regulations in effect as of the date hereof, current published administrative positions of the Internal Revenue Service contained in revenue rulings and procedures, and judicial decisions, and upon the assumptions and representations referred to herein and the documents provided to us by you (including the Proxy Statement and the Reorganization Agreement), it is our opinion for Federal income tax purposes that: (i) the acquisition of the assets and assumption of the liabilities of the Transferor Fund by the Surviving Fund in return for Series B Investor Shares of the Surviving Fund followed by the distribution of such shares to the shareholders of the Transferor Fund, as provided in the Reorganization Agreement, will constitute a "reorganization" within the meaning of section 368(a)(1)(C) or 368(a)(1)(D) of the Code, and each such Fund will be "a party to the reorganization" within the meaning of section 368(b) of the Code; (ii) in accordance with sections 361(a), 361(c)(1) and 357(a) of the Code, no gain or loss will be recognized by the Transferor Fund as a result of the Transactions; (iii) in accordance with section 1032(a) of the Code, no gain or loss will be recognized by the Surviving Fund as a result of the Transactions; (iv) in accordance with section 354(a)(1) of the Code, no gain or loss will be recognized by the shareholders of the Transferor Fund upon the receipt of the Series B Investor Shares of the Surviving Fund in exchange for their shares of the Transferor Fund; (v) in accordance with section 358(a)(1) of the Code, the tax basis of the Series B Investor Shares of the Surviving Fund received by the shareholders of the Transferor Fund will be the same as the tax basis of the shares of the Transferor Fund exchanged therefor in the Transactions; (vi) in accordance with section 362(b) of the Code, the tax basis of the assets received by the Surviving Fund in the Transactions will be the same as the tax basis of such assets in the hands of the Transferor Fund immediately before the Transactions; (vii) in accordance with section 1223(1) of the Code, the holding period of the Series B Investor Shares of the Surviving Fund received by the shareholders of the Transferor Fund will include the holding period of the shares of the Transferor Fund exchanged therefor, provided that at the time of the exchange the shares of the Transferor Fund were held as capital assets; -2- (viii) in accordance with section 1223(2) of the Code, the holding period of the Surviving Fund with respect to the assets acquired in the Transactions will include the period during which such assets were held by the Transferor Fund; and (ix) in accordance with section 381(a) of the Code, the Surviving Fund will succeed to the tax attributes of the Transferor Fund described in section 381(c) of the Code. This opinion represents our best legal judgment, but it has no binding effect or official status of any kind, and no assurance can be given that contrary positions may not be taken by the Internal Revenue Service or a court concerning the issues. We express no opinion relating to any Federal income tax matter except on the basis of the facts described above. Additionally, we express no opinion on the tax consequences under foreign, state or local laws. In issuing our opinion, we have relied solely upon existing provisions of the Code, existing and proposed regulations thereunder, and current administrative positions and judicial decisions. Such laws, regulations, administrative positions and judicial decisions are subject to change at any time. Any such change could affect the validity of the opinion set forth above. Also, future changes in Federal income tax laws and the interpretation thereof can have retroactive effect. We hereby consent to the filing of this opinion with the SEC as an exhibit to the Registration Statement. We also consent to the references to our firm under the captions "Summary--Federal Income Tax Consequences" and "Information Relating to the Proposed Reorganization--Federal Income Tax Consequences" in the Proxy Statement. In furnishing these consents, we do not concede that we come within the categories of persons whose consent is required under section 7 of the Securities Act of 1933 or under the rules and regulations of the SEC issued thereunder. Very truly yours, DRINKER BIDDLE & REATH LLP WMG:SDDH:FCM -3- INDEPENDENCE SQUARE INCOME SECURITIES, INC. One Aldwyn Center Villanova, Pennsylvania 19085 March __, 2000 Drinker Biddle & Reath LLP One Logan Square 18/th/ & Cherry Streets Philadelphia, PA 19103-6996 Re: Agreement and Plan of Reorganization by and between Independence Square Income Securities, Inc. And Blackrock Funds(SM) ------------------------------------------------------------------- Dear Ladies and Gentlemen: Blackrock Funds(SM) ("Blackrock") and we have requested your opinion as to certain Federal income tax matters in connection with the proposed reorganization (the "Reorganization") of Independence Square Income Securities, Inc. (the "Transferor Fund") into the High Yield Bond Portfolio of Blackrock (the "Surviving Fund") pursuant to the above-referenced Agreement and Plan of Reorganization (the "Reorganization Agreement") by and between the Transferor Fund and Blackrock. At the Effective Time of the Reorganization (as defined in the "Reorganization Agreement"), it is contemplated that the Transferor Fund will transfer all of its assets and liabilities to the Surviving Fund in exchange for Series B Investor Shares of the Surviving Fund. The Transferor Fund will then distribute the Series B Investor Shares of the Surviving Fund to the shareholders of the Transferor Fund in exchange for all outstanding shares of the Transferor Fund, and the existence of the Transferor Fund will be terminated. All of the above steps constitute the "Transactions." To enable you to render such opinion, we are furnishing the following representations: 1. The Transferor Fund qualified as a "regulated investment company" under Part I of Subchapter M of Subtitle A, Chapter 1, of the Internal Revenue Code of 1986, as amended, for its most recently ended taxable year and will so qualify for its current taxable year. 2. The Transferor Fund will transfer to the Surviving Fund assets consisting of at least 90% of the fair market value of the Transferor Fund's net assets and at least 70% of the fair market value of its gross assets immediately prior to the Transactions. For purposes of this assumption, all of the following shall be considered as assets of the Transferor Fund held immediately prior to the Transactions: (a) amounts used by the Transferor Fund to pay its expenses in connection with the Transactions and (b) all amounts used to make redemptions of or distributions on such Transferor Fund's shares (except for distributions of net investment company taxable income and net capital gains, other than net capital gains resulting from sales of assets for the purpose of satisfying investment objectives of the Surviving Fund, if any, that differ from the existing investment objectives of the Transferor Fund). 3. The Transferor Fund will, as of the Effective Time, distribute the Series B Investor Shares of the Surviving Fund received in the Transactions to the Transferor Fund's shareholders in complete liquidation of the Transferor Fund and, having made such distributions, will take all necessary steps to terminate its existence. 4. Prior to the Transactions, the Transferor Fund will continue its historic business within the meaning of Treasury Regulations section 1.368-1(d) and will not dispose of more than fifty percent (50%) of the fair market value of its assets for the purpose of satisfying investment objectives of the Surviving Fund, if any, that differ from the existing investment objectives of the Transferor Fund. 5. At the time of the Transactions, the adjusted income tax basis and the fair market value of the assets to be transferred by the Transferor Fund to the Surviving Fund will each equal or exceed the sum of the liabilities to be assumed by such Surviving Fund or to which such transferred assets are subject. 6. At the time of the Transactions, there will be no plan or intention by the shareholders of the Transferor Fund who own five percent (5%) or more of the Transferor Fund's stock and, to the best of the knowledge of the management of the Transferor Fund, no plan or intention on the part of the remaining shareholders of the Transferor Fund, to redeem or exchange a number of Series B Investor Shares of the Surviving Fund's stock to be received in the Transactions that would reduce the Transferor Fund shareholders' ownership of Surviving Fund stock to a number of shares having a value, as of the time of the Transactions, of less than fifty percent (50%) of the value of all of the formerly outstanding stock of the Transferor Fund immediately prior to the Transactions. For purposes of this assumption, (a) shares of the Transferor Fund surrendered by dissenters will be treated as outstanding Transferor Fund stock immediately prior to the Transactions, and (b) shares of the Transferor Fund and the Surviving Fund held by Transferor Fund shareholders and otherwise redeemed (except for redemptions occurring in the ordinary course of the Surviving Fund's business as an open-end investment company) in anticipation of the Transactions, or subsequent to the Transactions pursuant to a plan or intention that existed at the time of the Transactions, also will be taken into account. 7. The Transferor Fund is not and will not be under the jurisdiction of a court in a case under Title 11 of the United States Code or a receivership, foreclosure or similar proceeding in any Federal or State court. 8. The liabilities of the Transferor Fund that will be assumed by the Surviving Fund and the liabilities, if any, to which the transferred assets will be subject were incurred by the Transferor Fund in the ordinary course of its business. -2- 9. The Transactions have been proposed for the purposes set forth in the Combined Proxy Statement/Prospectus, a draft of which is part of the Registration Statement being filed this day with the Securities and Exchange Commission. We understand that you will, and expressly authorize you to, rely upon each of the foregoing representations in rendering your opinion of even date herewith. We undertake to advise you promptly if we become aware of any facts or circumstances that would cause any representation that we have given to be incorrect. Very truly yours, INDEPENDENCE SQUARE INCOME SECURITIES, INC. By: _______________________________ Title: -3- BLACKROCK FUNDS(SM) Bellevue Park Corporate Center 400 Bellevue Parkway Wilmington, Delaware 19809 March __, 2000 Drinker Biddle & Reath LLP One Logan Square 18/th/ & Cherry Streets Philadelphia, PA 19103-6996 Re: Agreement and Plan of Reorganization by and between Independence Square Income Securities, Inc. and Blackrock Funds(SM) ------------------------------------------------------------------- Dear Ladies and Gentlemen: Independence Square Income Securities, Inc. (the "Transferor Fund") and we have requested your opinion as to certain Federal income tax matters in connection with the proposed reorganization (the "Reorganization") of the Transferor Fund into the High Yield Bond Portfolio (the "Surviving Fund") of Blackrock Funds(SM) ("Blackrock") pursuant to the above-referenced Agreement and Plan of Reorganization (the "Reorganization Agreement") by and between the Transferor Fund and Blackrock. At the Effective Time of the Reorganization (as defined in the Reorganization Agreement), it is contemplated that the Transferor Fund will transfer all of its assets and liabilities to the Surviving Fund in exchange for Series B Investor Shares of the Surviving Fund. The Transferor Fund will then distribute the Series B Investor Shares of the Surviving Fund to the shareholders of the Transferor Fund in exchange for all outstanding shares of the Transferor Fund, and the existence of the Transferor Fund will be terminated. All of the above steps constitute the "Transactions." To enable you to render such opinion, we are furnishing the following representations: 1. The Surviving Fund qualified as a "regulated investment company" under Part I of Subchapter M of Subtitle A, Chapter 1, of the Internal Revenue Code of 1986, as amended, for its most recently ended taxable year and will so qualify for its current taxable year. 2. Following the Transactions, the Surviving Fund will continue the historic business of the Transferor Fund or will use a significant portion of the Transferor Fund's historic business assets in a business. In particular, the Surviving Fund will retain at least fifty percent (50%) of the assets of the Transferor Fund immediately after the Transactions, and will retain at least thirty-three and one-third percent (33-1/3%) of the assets of the Transferor Fund for at least twelve months after the Transactions. 3. At the time of the Transactions, the Surviving Fund will not have any plan or intention to reacquire any of its Series B Investor Shares issued in the Transactions, except in the ordinary course of business. 4. At the time of the Transactions, the Surviving Fund will not have any plan or intention to sell or otherwise to dispose of any of the assets of the Transferor Fund acquired in the Transactions, except for dispositions made in the ordinary course of business. 5. There is and will be no intercorporate indebtedness between the Surviving Fund and the Transferor Fund that was issued, acquired or will be settled at a discount. 6. The Surviving Fund does not own, will not own and has not owned during the past five years, directly or indirectly, any stock of the Transferor Fund. 7. The Transactions will be accomplished for the purposes set forth in the Combined Proxy Statement/Prospectus, a draft of which is part of the Registration Statement being filed this day with the Securities and Exchange Commission. We understand that you will, and expressly authorize you to, rely upon each of the foregoing representations in rendering your opinion of even date herewith. We undertake to advise you promptly if we become aware of any facts or circumstances that would cause any representation that we have given to be incorrect. Very truly yours, BLACKROCK FUNDS(SM) By: ___________________________ Title: -2- EX-99.14 3 CONSENT OF PRICEWATERHOUSECOOPERS LLP EXHIBIT 14 CONSENT OF INDEPENDENT ACCOUNTANTS We consent to the incorporation by reference in the Registration Statement of the BlackRock Funds on Form N-14 of our report dated November 15, 1999 on our audit of the financial statements and financial highlights of the BlackRock Taxable Bond Portfolios, which report is included in the Annual Report to Shareholders for the year ended September 30, 1999, which is incorporated by reference in the Registration Statement. We also consent to the reference to our Firm under the headings "Financial Statements and Experts" in the Registration Statement and "Financial Statements" in the Statement of Additional Information. PricewaterhouseCoopers LLP Philadelphia, PA January 11, 2000 CONSENT OF INDEPENDENT ACCOUNTANTS We consent to the incorporation by reference in the Registration Statement of the BlackRock Funds on Form N-14 of our report dated January 22, 1999 on our audit of the financial statements and financial highlights of the Independence Square Income Securities, Inc., which report is included in the Annual Report to Shareholders for the year ended December 30, 1998, which is incorporated by reference in the Registration Statement. We also consent to the reference to our Firm under the headings "Financial Statements and Experts" in the Registration Statement and "Financial Statements" in the Statement of Additional Information. PricewaterhouseCoopers LLP Philadelphia, PA January 11, 2000 EX-99.17A 4 FORM OF PROXY CARD EXHIBIT 17(a) PROXY CARD INDEPENDENCE SQUARE INCOME SECURITIES, INC. Special Meeting of Shareholders - March ___, 2000 The undersigned hereby appoints _______________ and _______________ (the "Proxies") and each of them, attorneys and Proxies of the undersigned, each with power of substitution and resubstitution, to attend, vote and act for the undersigned at the Special Meeting of Shareholders of Independence Square Income Securities, Inc. ("ISIS") to be held at the offices of BlackRock Institutional Management Corporation, Bellevue Park Corporate Center, 400 Bellevue Parkway, Fourth Floor Conference Room, Wilmington, Delaware 19809 at __ a.m./ p.m. (Eastern Time) on March __, 2000, and at any adjournment or adjournments thereof (the "Meeting"). The Proxies will cast votes according to the number of shares of ISIS which the undersigned may be entitled to vote with respect to the proposals set forth below, in accordance with the specification indicated, if any, and with all the powers which the undersigned would possess if personally present. The undersigned hereby revokes any prior proxy to vote at such meeting, and hereby ratifies and confirms all that said attorneys and Proxies, or either of them, may lawfully do by virtue thereof. The undersigned hereby acknowledges receipt of the Notice of Special Meeting of Shareholders and the Combined Prospectus/Proxy Statement, dated January ____, 2000. This proxy is solicited by the Board of Directors of ISIS, which unanimously recommends that you vote in favor of the proposal. This proxy will be voted as specified below with respect to the action to be taken on the following proposal. (1) To approve the Agreement and Plan of Reorganization, attached to the Combined Prospectus/Proxy Statement for the Meeting, by and between ISIS and BlackRock FundsSM ("BlackRock") which provides for (a) the transfer of all of the assets and liabilities of ISIS to BlackRock's High Yield Bond Portfolio in exchange for Series B Investor Shares of the High Yield Bond Portfolio; (b) the distribution of such Series B Investor Shares to the shareholders of ISIS in connection with its liquidation; (c) the amendment to ISIS' by-laws and fundamental investment limitation to provide that ISIS may purchase securities of another investment company in connection with a merger, consolidation, reorganization or purchase of assets approved by stockholders, or as otherwise permitted by the Investment Company Act of 1940, as amended ("1940 Act"); and (d) the dissolution under state law and the deregistration under the 1940 Act, of ISIS. [_] For [_] Against [_] Abstain (2) In their discretion, the proxies are authorized to vote upon such other business as may properly come before the Meeting. Please sign, date and return the proxy card promptly using the enclosed envelope. Every properly signed proxy will be voted in the manner specified hereon and, in the absence of specification, will be treated as granting authority to vote "FOR" the proposal. Please sign exactly as name(s) appear hereon. When shares are held by joint tenants, both should sign. When signing as attorney or executor, administrator, trustee or guardian, please give full title as such. If a corporation, please sign in full corporate name by president or other authorized officer. If a partnership, please sign in partnership name by authorized person. _____________________________ ________________________________________ SIGNATURE DATE SIGNATURE (JOINT OWNER) DATE EX-99.17B 5 PROSPECTUS FOR INVESTOR SHARES OF BOND PORT. EXHIBIT 17(b) NOT FDIC- INSURED May lose value No bank guarantee Bond Portfolios ================================================================================ INVESTOR SHARES BlackRock Funds (SM) is a mutual fund family with 36 investment portfolios, 15 of which are described in this prospectus. BlackRock Funds are sold principally through licensed investment professionals. PROSPECTUS January 28, 1999 [LOGO OF BLACKROCK FUNDS] The securities described in this prospectus have been registered with the Securities and Exchange Commission (SEC). The SEC, however, has not judged these securities for their investment merit and has not determined the accuracy or adequacy of this prospectus. Anyone who tells you otherwise is committing a criminal offense. Table of Contents - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- How to find the information you need How to find the information you need........................................ 1 THE BLACKROCK BOND FUNDS Low Duration Bond........................................................... 2 Intermediate Government Bond................................................ 10 Intermediate Bond........................................................... 17 Core Bond................................................................... 24 Government Income........................................................... 31 GNMA Portfolio.............................................................. 38 Managed Income.............................................................. 45 International Bond.......................................................... 52 High Yield Bond............................................................. 60 Tax-Free Income............................................................. 67 Delaware Tax-Free Income.................................................... 75 Ohio Tax-Free Income........................................................ 83 Kentucky Tax-Free Income.................................................... 91 New Jersey Tax-Free Income.................................................. 99 Pennsylvania Tax-Free Income................................................ 107 About Your Investment How to Sell Shares.......................................................... 115 Dividends/Distribution/Taxes................................................ 128 Services for Shareholders................................................... 130
How to Find the Information You Need About BlackRock Funds - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Welcome to the new BlackRock Bond Portfolios Prospectus. It's easy to use and we've tried to make it easy to understand. The prospectus has been written to provide you with the information you need to make an informed decision about whether to invest in BlackRock Funds (the Com- pany). This prospectus contains information on all 15 of the BlackRock Bond funds. To save you time, the prospectus has been organized so that each fund has its own short section. All you have to do is turn to the section for any particular fund. Once you read the important facts about the funds that interest you, read the sections that tell you about buying and selling shares, certain fees and expenses, shareholder features of the funds and your rights as a shareholder. These sections apply to all the funds. If you have questions after reading the prospectus, ask your registered repre- sentative for help. Your investment professional has been trained to help you decide which investments are right for you. 1 [GRAPHIC BlackRock APPEARS Low Duration Bond HERE] Portfolio - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Investment Goal The fund seeks to realize a rate of return that exceeds the total return of the Merrill Lynch 1-3 Year Treasury Index (the benchmark). Primary Investment Strategies In pursuit of this goal, the fund manager invests primarily in investment grade bonds in the three to five year maturity range. The fund normally invests at least 80% of its total assets in bonds diversified among several categories. The fund manager may also invest up to 20% of the fund's total assets in non-investment grade bonds or convertible securities with a minimum rating of "B" and up to 20% of its total assets in bonds of foreign issuers. The fund manager selects securities from several categories including: U.S. Treasuries and agency securities, asset-backed securities, CMOs, corporate bonds and commercial mortgage-backed securities. The management team evaluates categories of the bond market and individual securities within these categories. Securities are purchased for the fund when the manager determines that they have the potential for above-average total return. The fund measures its performance against the benchmark. If a security's rating falls below "B," the manager will decide whether to continue to hold the security. A security will be sold if, in the opinion of the fund manager, the risk of continuing to hold the security is unacceptable when compared to the total return potential. The fund manager will normally attempt to structure the fund's portfolio to have comparable duration to its benchmark. Duration, which measures price sen- sitivity to interest rate changes, is not necessarily equal to average maturi- ty. The fund manager may, when consistent with the fund's investment objective, use options or futures (commonly known as derivatives). The primary purpose of using derivatives is to attempt to reduce risk to the fund as a whole (hedge) but they may also be used to maintain liquidity, commit cash pending invest- ment or to increase returns. The fund may also enter into interest rate or foreign currency transactions as a hedging technique. In these transactions, the fund exchanges its right to pay or receive interest or IMPORTANT DEFINITIONS Asset-Backed Securi- ties: Bonds that are backed by a pool of assets, usually loans such as installment sale contracts or credit card receiv- ables. Bonds: Debt obligations such as bonds and debentures, U.S. Gov- ernment securities, debt obligations of domestic and foreign corporations, debt obligations of foreign governments and their political subdivisions, asset-backed securi- ties, various mortgage- backed securities (both residential and commer- cial), other floating or variable rate obli- gations, municipal obligations and zero coupon debt securities. Collateralized Mortgage Obligations (CMO): Bonds that are backed by cash flows from pools of mortgages. CMOs may have multiple classes with different payment rights and protections. Commercial Mortgage- Backed Securities (CMBS): Bonds that are backed by a mortgage loan or pool of loans secured by commercial property, not residen- tial mortgages. Duration: A mathemati- cal calculation of the average life of a bond (or bonds in a bond fund) that serves as a useful measure of its price risk. Each year of duration represents an expected 1% change in the price of a bond for every 1% change in interest rates. For example, if a bond fund has an average duration of four years, its price will fall about 4% when interest rates rise by one percentage point. Conversely, the bond fund's price will rise about 4% when interest rates fall by one percentage point. Investment Grade: Secu- rities which are rated in the four highest categories by at least one of the major rating agencies or determined by the fund manager to be of similar quality. Generally, the higher the rating of a bond, the higher the likeli- hood that interest and principal payments will be made on time. Secu- rities rated in the fourth highest category by the rating agencies are considered invest- ment grade but they are also considered specu- lative, meaning that they carry more risk than higher rated secu- rities and may have problems making princi- pal and interest pay- ments in difficult eco- nomic climates. Investment grade rat- ings do not guarantee that bonds will not lose value. 2 currencies with another party for their right to pay or receive interest or another currency in the future. The fund can borrow money to buy additional securities. This practice is known as "leverage." The fund may borrow from banks or other financial institutions or through reverse repurchase agreements (under which the fund sells securities and agrees to buy them back at a particular date and price). The fund normally may borrow up to 33 1/3% of the value of its total assets. The fund may lend some of its securities on a short-term basis in order to earn extra income. The fund will receive collateral in cash or high quality securi- ties equal to the current value of the loaned securities. These loans will be limited to 33 1/3% of the value of the fund's total assets. Should the Company's Board of Trustees determine that the investment objective of the fund should be changed, shareholders will be given at least 30 days notice before any such change is made. Key Risks Key Risks While the fund manager chooses bonds he believes can provide above average total returns, there is no guarantee that shares of the fund will not lose val- ue. This means you could lose money. Two of the main risks of investing in the fund are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds such as those held by the fund. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. The fund may make investments in residential and commercial mortgage-backed securities and other asset-backed securities. The characteristics of these mortgage-backed and asset-backed securities differ from traditional fixed income securities. A main difference is that the principal on mortgage- or asset-backed securities may normally be prepaid at any time, which will reduce the yield and market value of these securities. Asset-backed securities and CMBS generally experi- ence less prepayment than residential mortgage-backed securities. In periods of falling interest rates, the rate of prepayments tends to increase (as does price fluctuation) as borrowers are motivated to pay off debt and refinance at new lower rates. During such periods, reinvestment of the prepayment proceeds by the manager will generally be at lower rates of return than the return on the assets which were prepaid. Certain asset-backed securities are based on loans that are unsecured, which means that there is no collateral to seize if the IMPORTANT DEFINITIONS Maturity: The date upon which debt securities are due to be repaid, that is, the date when the issuer must pay back the face amount of the security. Merrill Lynch 1-3 Year Treasury Index: An unmanaged index com- prised of Treasury securities with maturi- ties of from 1 to 2.99 years. Mortgage-Backed Securi- ties: Asset-backed securities based on a particular type of asset, a mortgage. There is a wide variety of mortgage backed securities involving commercial or residen- tial, fixed rate or adjustable rate mort- gages and mortgages issued by banks or gov- ernment agencies. Total Return: A way of measuring fund perfor- mance. Total return is based on a calculation that takes into account income dividends, capi- tal gain distributions and the increase or decrease in share price. 3 underlying borrower defaults. Other asset-based securities may not have the benefit of as much collateral as mortgage-backed securities. Treasury obligations differ only in their interest rates, maturities and times of issuance. Obligations of U.S. Government agencies and authorities are sup- ported by varying degrees of credit. No assurance can be given that the U.S. Government will provide financial support to its agencies and authorities if it is not obligated by law to do so. The fund's use of derivatives, interest rate and foreign currency transactions may reduce the fund's returns and/or increase volatility, which is defined as the characteristic of a security or a market to fluctuate significantly in price within a short period of time. Leverage is a speculative technique which may expose the fund to greater risk and increase its costs. Increases and decreases in the value of the fund's portfolio will be magnified when the fund uses leverage. The fund will also have to pay interest on its borrowings, reducing the fund's return. The fund may invest up to 20% of its total assets in bonds of foreign issuers. Foreign securities involve risks not typically associated with investing in U.S. securities. These risks include but are not limited to: currency risks (the risk that the value of interest paid on foreign securities, or the value of the securities themselves, may fall if currency exchange rates change), the risk that a security's value will be hurt by changes in foreign political or social conditions, the possibility of heavy taxation or expropriation and more difficulty obtaining information on foreign securities or companies. In addi- tion, a portfolio of foreign securities may be harder to sell and may be sub- ject to wider price movements than comparable investments in U.S. companies. There is also less government regulation of foreign securities markets. On January 1, 1999, eleven European countries implemented a new currency unit called the "Euro" which is expected to reshape financial markets, banking sys- tems and monetary policies in Europe and other parts of the world. While it is impossible to predict the impact of the "Euro," it is possible that it could increase volatility in financial markets worldwide which could hurt the value of shares of the fund. The fund may invest in non-investment grade or "high yield" fixed income or convertible securities commonly known to investors as "junk bonds." The fund may not invest more than 20% of its total assets in high yield securities and all such securities must be rated "B" or higher at the time of purchase by at least one major rating agency. A "B" rating generally indicates that while the issuer can currently make its interest and principal payments, it probably will not be able to do so in times of financial difficulty. Non-investment grade debt securities may carry greater 4 risks than securities which have higher credit ratings, including a high risk of default. The yields of non-investment grade securities will move up and down over time. The credit rating of a high yield security does not necessarily address its market value risk. Ratings and market values may change from time to time, pos- itively or negatively, to reflect new developments regarding the issuer. High yield securities are considered speculative, meaning there is a significant risk that companies issuing these securities may not be able to repay principal and pay interest or dividends on time. Also, the market for high yield securi- ties is not as liquid as the market for higher rated securities. This means that it may be harder to buy and sell high yield securities, especially on short notice. Securities loans involve the risk of a delay in receiving additional collateral if the value of the securities goes up while they are on loan. There is also the risk of delay in recovering the loaned securities and of losing rights to the collateral if a borrower goes bankrupt. The fund, like any business, could be affected if the computer systems on which it relies do not properly process information beginning on January 1, 2000. While Year 2000 issues could have a negative effect on the fund, BlackRock, the fund's investment adviser, is currently working to avoid such problems. Black- Rock is also working with other systems providers and vendors to determine their systems' ability to handle Year 2000 problems. There is no guarantee, however, that systems will work properly on January 1, 2000. Year 2000 problems may also hurt issuers whose securities the fund holds or securities markets generally. When you invest in this fund you are not making a bank deposit. Your investment is not insured or guaranteed by the Federal Deposit Insurance Corporation or by any bank or governmental agency. 5 Risk / Return Information The chart and table below give you a picture of the fund's long-term perfor- mance for Investor A Shares (in the chart) and for Investor A, B and C Shares (in the table). The information shows you how the fund's performance has varied year by year and provides some indication of the risks of investing in the fund. The table compares the fund's performance to that of the Merrill Lynch 1- 3 Year Treasury Index, a recognized unmanaged index of bond market performance. The chart and the table both assume reinvestment of dividends and distribu- tions. As with all such investments, past performance is not an indication of future results. Sales charges are not reflected in the bar chart. If they were, returns would be less than those shown. The performance for the period before Investor Shares were launched is based upon performance for older share classes of the fund. Investor A Shares were launched in January 1996, Investor B Shares were launched in November 1996 and Investor C Shares were launched in February 1997. The actual return of Investor Shares would have been lower than shown because Investor Shares have higher expenses than these older classes. Also, the actual returns of Investor B and C Shares would have been lower compared to Investor A Shares. As of 12/31 Investor A Shares - -------------------------------------------------------------------------------- A N N U A L T O T A L R E T U R N S - -------------------------------------------------------------------------------- [BAR CHART APPEARS HERE] Best Quarter 93 5.66 Q1 '95: 3.26% 94 1.39 95 10.51 96 4.53 Worst Quarter 97 5.56 Q1 '94: -0.18% 98 6.14 As of 12/31/98 - -------------------------------------------------------------------------------- A V E R A G E A N N U A L T O T A L R E T U R N S - -------------------------------------------------------------------------------- Since Inception 1 Year 3 Years 5 Years Inception Date - -------------------------------------------------------------------------------- Low Duration Bond; Inv A 2.96% 4.34% 4.94% 4.91% 07/01/92 - -------------------------------------------------------------------------------- Low Duration Bond; Inv B 0.61% 3.63% 4.83% 5.16% 07/01/92 - -------------------------------------------------------------------------------- Low Duration Bond; Inv C 4.30% 4.86% 5.26% 5.16% 07/01/92 - -------------------------------------------------------------------------------- ML 1-3 Yr. Treasury 7.00% 6.21% 5.99% 5.93% N/A - -------------------------------------------------------------------------------- These returns assume payment of applicable sales charges. 6 Expenses and Fees Expenses and Fees As a shareholder you pay certain fees and expenses. Shareholder transaction fees are paid out of your investment and annual fund operating expenses are paid out of fund assets and are reflected in the fund's price. This prospectus offers shareholders different ways to invest with three sepa- rate pricing options. You need to understand your choices so that you can choose the pricing option that is most suitable for you. With one option (In- vestor A Shares) you pay a one-time front-end transaction fee each time you buy shares. The other options (Investor B and Investor C Shares) have no front-end charges but have higher on-going fees, which are paid over the life of the investment, and have a contingent deferred sales charge (CDSC) that you may pay when you redeem your Shares. Which option should you choose? It depends on your individual circumstances. You should know that the lowest sales charge won't necessarily be the least expensive option over time. For example, if you intend to hold your shares long term it may cost less to buy A Shares than B or C Shares. The tables below explain your pricing options and describe the fees and expenses that you may pay if you buy and hold Investor A, B and C Shares of the fund. The "Annual Fund Operating Expenses" table is based on expenses for the most recent fiscal year. Shareholder Fees (Fees paid directly from your investment)
A Shares B Shares C Shares Maximum Front-End Sales Charge* 3.0% 0.0% 0.0% (as percentage of offering price) Maximum Deferred Sales Charge 0.0% 4.5%** 1.00%*** (as percentage of offering price)
* Reduced front-end sales charges may be available. A CDSC of up to 1.00% is assessed on certain redemptions of Investor A Shares that are purchased with no initial sales charge as part of an investment of $1,000,000 or more. ** The CDSC is 4.5% if shares are redeemed in less than one year. The CDSC for Investor B Shares decreases for redemptions made in subsequent years. After six years there is no CDSC on B Shares. (See page 120 for complete schedule of CDSCs.) *** There is no CDSC on C Shares after one year. 7 Annual Fund Operating Expenses (Expenses that are deducted from fund assets)
A Shares B Shares C Shares Advisory Fees .50% .50% .50% Distribution and service (12b-1) fees .50% 1.15% 1.15% Other expenses .52% .52% .52% Total annual fund operating expenses 1.52% 2.17% 2.17% Fee waivers and expense reimbursements* .50% .40% .40% Net Expenses* 1.02% 1.77% 1.77%
* BlackRock has contractually agreed to waive or reimburse fees or expenses in order to limit certain (but not all) fund expenses for the next year. The fund may have to repay these waivers and reimbursements to BlackRock in the following two years if the repayment can be made within these expense limits. In addition, BlackRock Distributors, Inc., the fund's distributor, has contractually agreed to waive all 12b-1 distribution fees on Investor A Shares (otherwise payable at the maximum annual rate of .10% of average daily net assets) for the next year. "Net Expenses" in the table have been restated to reflect these waivers and reimbursements. The table does not reflect charges or credits which investors might incur if they invest through a financial institution. Example: This example is intended to help you compare the cost of investing in the fund with the cost of investing in other mutual funds. We are assuming an initial investment of $10,000, 5% total return each year with no changes in operating expenses (except for the waivers in the first year discussed above), redemption at the end of each time period and, with respect to B Shares and C Shares only, no redemption at the end of each time period. Although your actual cost may be higher or lower, based on these assumptions your costs would be:
1 Year 3 Years 5 Years 10 Years A Shares* $401 $718 $1,058 $2,017 B Shares** Redemption $630 $991 $1,328 $2,229*** B Shares No Redemption $180 $641 $1,128 $2,229*** C Shares** Redemption $280 $641 $1,128 $2,472 C Shares No Redemption $180 $641 $1,128 $2,472
* Reflects imposition of sales charge. ** Reflects deduction of CDSC. *** Based on the conversion of the Investor B Shares to Investor A Shares after seven years. Fund Management Robert Kapito and Scott Amero co-manage the fund at BlackRock Financial Manage- ment, Inc. (BFM). Robert Kapito has been Vice Chairman of BFM since 1988 and portfolio co-manager since inception. Scott Amero has been a Managing Director of BFM since 1990 and portfolio co-manager since inception. IMPORTANT DEFINITIONS Advisory Fees: Fees paid to the investment adviser for portfolio management services. Service Fees: Fees that are paid to BlackRock and /or its affiliates for shareholder account service and mainte- nance. Distribution Fees: A method of charging dis- tribution-related expenses against fund assets. Other Expenses: Include administration, trans- fer agency, custody, professional fees and registration fees. 8 Financial Highlights The financial information in the table below shows the fund's financial perfor- mance for the periods indicated. Certain information reflects results for a single fund share. The term "Total Return" indicates how much your investment would have increased or decreased during this period of time and assumes that you have reinvested all dividends and distributions. These figures have been audited by PricewaterhouseCoopers LLP, the fund's independent accountants. The auditor's report, along with the fund's financial statements, are included in the Company's annual report, which is available upon request (see back cover for ordering instructions). FINANCIAL HIGHLIGHTS - -------------------------------------------------------------------------------- (For an Investor A, B or C Share Outstanding Throughout Each Period) Low Duration Bond Portfolio
INVESTOR A INVESTOR B SHARES SHARES -------------------------------------------------- --------------------------- For the period Year Year 4/1/96 1/12/96/1/ Year 11/18/96/1/ Ended Ended through through Ended through 9/30/98 9/30/97 9/30/96 3/31/96 9/30/98 9/30/97 -------------------------------------------------- --------------------------- Net asset value at beginning of period $ 9.89 $ 9.79 $ 9.79 $ 9.91 $ 9.89 $ 9.86 ------ ------ ------ ------ ------ ------ Income from investment operations Net investment income 0.51 0.52 0.25 0.10 0.41 0.41 Net gain (loss) on investments (both realized and unrealized) 0.14 0.09 (0.01) (0.12) 0.17 - - ------ ------ ------ ------ ------ ------ Total from investment operations 0.65 0.61 0.24 (0.02) 0.58 0.41 ------ ------ ------ ------ ------ ------ Less distributions Distributions from net investment income (0.51) (0.51) (0.24) (0.10) (0.44) (0.38) Distributions from net realized capital gains - - - - - - - - - - - - ------ ------ ------ ------ ------ ------ Total distributions (0.51) (0.51) (0.24) (0.10) (0.44) (0.38) ------ ------ ------ ------ ------ ------ Net asset value at end of period $10.03 $ 9.89 $ 9.79 $ 9.79 $10.03 $ 9.89 ====== ====== ====== ====== ====== ====== Total return/3/ 6.78% 6.39% 2.46% (0.15)% 5.99% 4.31% Ratios/Supplemental data Net assets at end of period (in thousands) $2,850 $1,079 $ 938 $ 719 $ 398 $ 13 Ratios of expenses to average net assets After advisory/administration fee waivers 1.02%/4/ 1.02%/4/ 1.02%/2/,/4/ 1.01%/2/,/4/ 1.76%/4/ 1.73%/2/,/4/ Before advisory/administration fee waivers 1.42% 1.35% 1.30%/2/ 1.21%/2/ 2.16% 2.06%/2/ Ratios of net investment income to average net assets After advisory/administration fee waivers 6.59% 5.72% 5.20%/2/ 4.94%/2/ 5.82% 4.96%/2/ Before advisory/administration fee waivers 6.19% 5.39% 4.92%/2/ 4.74%/2/ 5.42% 4.63%/2/ Portfolio turnover rate 227% 371% 228% 185% 227% 371% INVESTOR C SHARES ------------------------ Year Year Ended Ended 9/30/98 9/30/97 ------------------------ Net asset value at beginning of period $ 9.89 $ 9.87 ----------- ---------------- Income from investment operations Net investment income 0.44 0.26 Net gain (loss) on investments (both realized and unrealized) 0.14 0.02 ----------- ---------------- Total from investment operations 0.58 0.28 ----------- ---------------- Less distributions Distributions from net investment income (0.44) (0.26) Distributions from net realized capital gains - - - - ----------- ---------------- Total distributions (0.44) (0.26) ----------- ---------------- Net asset value at end of period $10.03 $ 9.89 =========== ================ Total return/3/ 5.99% 2.91% Ratios/Supplemental data Net assets at end of period (in thousands) $ 342 $ 72 Ratios of expenses to average net assets After advisory/administration fee waivers 1.75%/4/ 1.72%/2/,/4/ Before advisory/administration fee waivers 2.15% 2.05%/2/ Ratios of net investment income to average net assets After advisory/administration fee waivers 5.70% 5.00%/2/ Before advisory/administration fee waivers 5.30% 4.67%/2/ Portfolio turnover rate 227% 371%
---------------------------------------------------- /1/Commencement of operations of share class. /2/Annualized. /3/Neither front-end sales load nor contingent deferred sales load is reflected. /4/Including interest expense, ratios for the Investor A, Investor B and Investor C Shares would have been 2.32%, 3.08% and 2.98%, respectively, for the year ended September 30, 1998, 2.02%, 2.19% and 2.23%, respectively, for the year ended September 30, 1997, 1.12% for the year ended September 30, 1996 and 1.34% for the year ended March 31, 1996. 9 [GRAPHIC BlackRock APPEARS Intermediate Government HERE] Bond Portfolio - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Investment Goal The fund seeks current income consistent with the preservation of capital. Primary Investment Strategies In pursuit of this goal, the fund manager invests primarily in the highest rated intermediate government and agency bonds. The fund normally invests at least 80% of its total assets in bonds and at least 65% of its total assets in intermediate bonds issued or guaranteed by the U.S. Government and its agen- cies. The fund defines intermediate bonds as those with maturities of between five and ten years. Securities purchased by the fund are rated in the highest rating category (AAA or Aaa) at the time of purchase by at least one major rating agency or are determined by the fund manager to be of similar quality. The management team evaluates categories of the government/agency market and individual bonds within these categories. The manager selects bonds from sev- eral categories including: U.S. Treasuries and agency securities, commercial and residential mortgage-backed securities, asset-backed securities and corpo- rate bonds. Securities are purchased for the fund when the manager determines that they have the potential for above-average current income. The fund mea- sures its performance against the Lehman Brothers Intermediate Government Index (the benchmark). If a security falls below the highest rating, the manager will decide whether to continue to hold the security. A security will be sold if, in the opinion of the fund manager, the risk of continuing to hold the security is unaccept- able when compared to the total return potential. The fund manager will normally attempt to structure the fund's portfolio to have comparable duration to its benchmark. Duration, which measures price sen- sitivity to interest rate changes, is not necessarily equal to average maturi- ty. The fund manager may, when consistent with the fund's investment objective, use options or futures (commonly known as derivatives). The primary purpose of using derivatives is to attempt to reduce risk to the fund as a whole (hedge) but they may also be IMPORTANT DEFINITIONS Asset-Backed Securi- ties: Bonds that are backed by a pool of assets, usually loans such as installment sale contracts or credit card receiv- ables. Bonds: Debt obligations such as bonds and debentures, U.S. Gov- ernment securities, debt obligations of domestic and foreign corporations, debt obligations of foreign governments and their political subdivisions, asset-backed securi- ties, various mortgage- backed securities (both residential and commer- cial), other floating or variable rate obli- gations, municipal obligations and zero coupon debt securities. Commercial Mortgage- Backed Securities (CMBS): Bonds that are backed by a mortgage loan or pools of loans secured by commercial property, not residen- tial mortgages. Duration: A mathemati- cal calculation of the average life of a bond (or bonds in a bond fund) that serves as a useful measure of its price risk. Each year of duration represents an expected 1% change in the price of a bond for every 1% change in interest rates. For example, if a bond fund has an average duration of four years, its price will fall about 4% when interest rates rise by one percentage point. Conversely, the bond fund's price will rise about 4% when interest rates fall by one percentage point. Lehman Brothers Inter- mediate Government Index: An unmanaged index comprised of Treasury and Agency issues from the more comprehensive Lehman Aggregate Index. This index concentrates on intermediate maturity bonds and thus excludes all maturities from the broader index below one year and above 9.9 years. Maturity: The date upon which debt securities are due to be repaid, that is, the date when the issuer generally must pay back the face amount of the security. 10 used to maintain liquidity, commit cash pending investment or to increase returns. The fund may also enter into interest rate transactions as a hedging technique. In these transactions, the fund exchanges its right to pay or receive interest with another party for their right to pay or receive interest. The fund can borrow money to buy additional securities. This practice is known as "leverage." The fund may borrow from banks or other financial institutions or through reverse repurchase agreements (under which the fund sells securities and agrees to buy them back at a particular date and price). The fund normally may borrow up to 33 1/3% of the value of its total assets. The fund may lend some of its securities on a short-term basis in order to earn extra income. The fund will receive collateral in cash or high quality securi- ties equal to the current value of the loaned securities. These loans will be limited to 33 1/3% of the value of the fund's total assets. Should the Company's Board of Trustees determine that the investment objective of the fund should be changed, shareholders will be given at least 30 days notice before any such change is made. Key Risks Key Risks While the fund manager chooses bonds he believes can provide above average cur- rent income, there is no guarantee that shares of the Fund will not lose value. This means you could lose money. A main risk of investing in the fund is interest rate risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds such as those held by the fund. The fund may make investments in residential and commercial mortgage-backed securities and other asset-backed securities. The characteristics of these mortgage-backed and asset-backed securities differ from traditional fixed income securities. A main difference is that the principal on mortgage-or asset-backed securities may normally be prepaid at any time, which will reduce the yield and market value of these securities. Asset-backed securities and CMBS generally experi- ence less prepayment than residential mortgage-backed securities. In periods of falling interest rates, the rate of prepayments tends to increase (as does price fluctuations) as borrowers are motivated to pay off debt and refinance at new lower rates. During such periods, reinvestment of the prepayment proceeds by the manager will generally be at lower rates of return than the return on the assets which were prepaid. IMPORTANT DEFINITIONS Mortgage-Backed Securi- ties: Asset-backed securities based on a particular type of asset, a mortgage. There is a wide variety of mortgage backed securities involving commercial or residen- tial, fixed rate or adjustable rate mort- gages and mortgages issued by banks or gov- ernment agencies. Total Return: A way of measuring fund perfor- mance. Total return is based on a calculation that takes into account income dividends, capi- tal gain distributions and the increase or decrease in share price. 11 Certain asset-backed securities are based on loans that are unsecured, which means that there is no collateral to seize if the underlying borrower defaults. Other asset-based securities may not have the benefit of as much collateral as mortgage-backed securities. Treasury obligations differ only in their interest rates, maturities and times of issuance. Obligations of U.S. Government agencies and authorities are sup- ported by the full faith and credit of the United States. Others are supported by the right of the issuer to borrow from the Treasury, and others are sup- ported only by the credit of the entity. No assurance can be given that the U.S. Government will provide financial support to its agencies and authorities if it is not obligated by law to do so. The fund's use of derivatives and interest rate transactions may reduce the fund's returns and/or increase volatility, which is defined as the character- istic of a security or a market to fluctuate significantly in price within a short period of time. Leverage is a speculative technique which may expose the fund to greater risk and increase its costs. Increases and decreases in the value of the fund's portfolio will be magnified when the fund uses leverage. The fund will also have to pay interest on its borrowings, reducing the fund's return. Securities loans involve the risk of a delay in receiving additional collat- eral if the value of the securities goes up while they are on loan. There is also the risk of delay in recovering the loaned securities and of losing rights to the collateral if a borrower goes bankrupt. The fund, like any business, could be affected if the computer systems on which it relies do not properly process information beginning on January 1, 2000. While Year 2000 issues could have a negative effect on the fund, Black- Rock, the fund's investment adviser, is currently working to avoid such prob- lems. BlackRock is also working with other systems providers and vendors to determine their systems' ability to handle Year 2000 problems. There is no guarantee, however, that systems will work properly on January 1, 2000. Year 2000 problems may also hurt issuers whose securities the fund holds or securi- ties markets generally. When you invest in this fund you are not making a bank deposit. Your invest- ment is not insured or guaranteed by the Federal Deposit Insurance Corporation or by any bank or governmental agency. 12 These returns assume payment of applicable sales charges. Risk / Return Information The chart and table below give you a picture of the fund's long-term perfor- mance for Investor A Shares (in the chart) and for Investor A, B and C Shares (in the table). The information shows you how the fund's performance has varied year by year and provides some indication of the risks of investing in the fund. The table compares the fund's performance to that of the Lehman Brothers Intermediate Government Index, a recognized unmanaged index of bond market per- formance. The chart and the table both assume reinvestment of dividends and distributions. As with all such investments, past performance is not an indica- tion of future results. Sales charges are not reflected in the bar chart. If they were, returns would be less than those shown. The performance for the period before Investor Shares were launched is based upon performance for older share classes of the fund. Investor A Shares were launched in May 1992 and Investor B and C Shares were launched in October 1996. The actual return of Investor Shares would have been lower than shown because Investor Shares have higher expenses than these older classes. Also, the actual returns of Investor B and C Shares would have been lower compared to Investor A Shares. As of 12/31 Investor A Shares - -------------------------------------------------------------------------------- A N N U A L T O T A L R E T U R N S - -------------------------------------------------------------------------------- [BAR CHART APPEARS HERE] Best Quarter 93 7.68 Q1 '95: 4.42% 94 -3.60 95 13.53 96 3.83 Worst Quarter 97 7.23 Q1 '94: -2.45% 98 7.13 As of 12/31/98 - -------------------------------------------------------------------------------- A V E R A G E A N N U A L T O T A L R E T U R N S - -------------------------------------------------------------------------------- Since Inception 1 Year 3 Years 5 Years Inception Date - -------------------------------------------------------------------------------- Intermediate Govt. Bond; Inv A 2.87% 4.62% 4.61% 5.52% 04/20/92 - -------------------------------------------------------------------------------- Intermediate Govt. Bond; Inv B 1.54% 4.22% 4.70% 5.91% 04/20/92 - -------------------------------------------------------------------------------- Intermediate Govt. Bond; Inv C 5.26% 5.46% 5.12% 5.91% 04/20/92 - -------------------------------------------------------------------------------- LB Intermediate Govt. 8.48% 6.74% 6.45% 7.14% N/A* - -------------------------------------------------------------------------------- These returns assume payment of applicable sales charges. * For comparative purposes, the value of the index on 05/01/92 is used as the beginning value on 04/20/92. 13 Expenses and Fees Expenses and Fees As a shareholder you pay certain fees and expenses. Shareholder transaction fees are paid out of your investment and annual fund operating expenses are paid out of fund assets and are reflected in the fund's price. This prospectus offers shareholders different ways to invest with three sepa- rate pricing options. You need to understand your choices so that you can choose the pricing option that is most suitable for you. With one option (In- vestor A Shares) you pay a one-time front-end transaction fee each time you buy shares. The other options (Investor B and Investor C Shares) have no front-end charges but have higher on-going fees, which are paid over the life of the investment, and have a contingent deferred sales charge (CDSC) that you may pay when you redeem your shares. Which option should you choose? It depends on your individual circumstances. You should know that the lowest sales charge won't necessarily be the least expensive option over time. For example, if you intend to hold your shares long term it may cost less to buy A Shares than B or C Shares. The tables below explain your pricing options and describe the fees and expenses that you may pay if you buy and hold Investor A, B and C Shares of the fund. The "Annual Fund Operating Expenses" table is based on expenses for the most recent fiscal year. Shareholder Fees (Fees paid directly from your investment)
A Shares B Shares C Shares Maximum Front-End Sales Charge* 4.0% 0.0% 0.0% (as percentage of offering price) Maximum Deferred Sales Charge 0.0% 4.5%** 1.00%*** (as percentage of offering price)
* Reduced front-end sales charges may be available. A CDSC of up to 1.00% is assessed on certain redemptions of Investor A Shares that are purchased with no initial sales charge as part of an investment of $1,000,000 or more. ** The CDSC is 4.5% if shares are redeemed in less than one year. The CDSC for Investor B Shares decreases for redemptions made in subsequent years. After six years there is no CDSC on B Shares. (See page 120 for complete schedule of CDSCs.) *** There is no CDSC on C Shares after one year. 14 IMPORTANT DEFINITIONS Advisory Fees: Fees paid to the investment adviser for portfolio management services. Service Fees: Fees that are paid to BlackRock and /or its affiliates for shareholder account service and mainte- nance. Distribution Fees: A method of charging dis- tribution-related expenses against fund assets. Other Expenses: Include administration, trans- fer agency, custody, professional fees and registration fees. Annual Fund Operating Expenses (Expenses that are deducted from fund assets)
A Shares B Shares C Shares Advisory Fees .50% .50% .50% Distribution and service (12b- 1) fees .50% 1.15% 1.15% Other expenses .42% .42% .42% Total annual fund operating expenses 1.42% 2.07% 2.07% Fee waivers and expense reimbursements* .35% .25% .25% Net Expenses* 1.07% 1.82% 1.82%
* BlackRock has contractually agreed to waive or reimburse fees or expenses in order to limit certain (but not all) fund expenses for the next year. The fund may have to repay these waivers and reimbursements to BlackRock in the following two years if the repayment can be made within these expense limits. In addition, BlackRock Distributors, Inc., the fund's distributor, has contractually agreed to waive all 12b-1 distribution fees on Investor A Shares (otherwise payable at the maximum annual rate of .10% of average daily net assets) for the next year. "Net Expenses" in the table have been restated to reflect these waivers and reimbursements. The table does not reflect charges or credits which investors might incur if they invest through a financial institution. Example: This example is intended to help you compare the cost of investing in the fund with the cost of investing in other mutual funds. We are assuming an initial investment of $10,000, 5% total return each year with no changes in operating expenses (except for the waivers in the first year discussed above), redemption at the end of each time period and, with respect to B Shares and C Shares only, no redemption at the end of each time period. Although your actual cost may be higher or lower, based on these assumptions your costs would be:
1 Year 3 Years 5 Years 10 Years A Shares* $505 $798 $1,113 $2,005 B Shares** Redemption $635 $975 $1,291 $2,136*** B Shares No Redemption $185 $625 $1,091 $2,136*** C Shares** Redemption $285 $625 $1,091 $2,380 C Shares No Redemption $185 $625 $1,091 $2,380
*Reflects imposition of sales charge. **Reflects deduction of CDSC. *** Based on the conversion of the Investor B Shares to Investor A Shares after seven years. Fund Management The co-managers of the fund are Robert Kapito, Vice Chairman of BlackRock Financial Management, Inc (BFM) since 1988, Scott Amero, Managing Director of BFM since 1990 and Michael Lustig, Director of BFM since 1989. They have all co-managed the fund since 1995. 15 Financial Highlights The financial information in the table below shows the fund's financial perfor- mance for the periods indicated. Certain information reflects results for a single fund share. The term "Total Return" indicates how much your investment would have increased or decreased during this period of time and assumes that you have reinvested all dividends and distributions. These figures have been audited by PricewaterhouseCoopers LLP, the fund's independent accountants. The auditor's report, along with the fund's financial statements, are included in the Company's annual report which is available upon request (see back cover for ordering instructions). FINANCIAL HIGHLIGHTS - -------------------------------------------------------------------------------- (For an Investor A, B or C Share Outstanding Throughout Each Period) Intermediate Government Bond Portfolio
INVESTOR INVESTOR A SHARES B SHARES ------------------------------------------------------- ------------------------ For the Period Year Year Year Year Year Year 10/11/96/1/ Ended Ended Ended Ended Ended Ended through 9/30/98 9/30/97 9/30/96 9/30/95 9/30/94 9/30/98 9/30/97 Net asset value at beginning of period $10.11 $ 9.92 $10.03 $ 9.64 $10.60 $10.11 $ 9.98 ------ ------ ------ ------ ------ ------ ------ Income from investment operations Net investment income 0.53 0.54 0.55 0.55 0.53 0.47 0.45 Net gain (loss) on investments (both realized and unrealized) 0.38 0.19 (0.13) 0.39 (0.87) 0.37 0.13 ------ ------ ------ ------ ------ ------ ------ Total from investment operations 0.91 0.73 0.42 0.94 (0.34) 0.84 0.58 ------ ------ ------ ------ ------ ------ ------ Less distributions Distributions from net investment income (0.54) (0.54) (0.53) (0.55) (0.52) (0.47) (0.45) Distributions from net realized capital gains - - - - - - - - (0.10) - - - - ------ ------ ------ ------ ------ ------ ------ Total distributions (0.54) (0.54) (0.53) (0.55) (0.62) (0.47) (0.45) ------ ------ ------ ------ ------ ------ ------ Net asset value at end of period $10.48 $10.11 $ 9.92 $10.03 $ 9.64 $10.48 $10.11 ====== ====== ====== ====== ====== ====== ====== Total return/3/ 9.32% 7.57% 4.36% 9.98% (3.36)% 8.51% 5.94% Ratios/Supplemental data Net assets at end of period (in thousands) $7,972 $5,374 $5,903 $9,802 $8,508 $ 361 $ 28 Ratios of expenses to average net assets After advisory/administration fee waivers 1.05%/4/ 1.02%/4/ 0.95%/4/ 0.70%/4/ 0.65% 1.79%/4/ 1.77%/2/,/4/ Before advisory/administration fee waivers 1.31% 1.33% 1.25% 1.07% 1.05% 2.05% 2.08%/2/ Ratios of net investment income to average net assets After advisory/administration fee waivers 5.37% 5.54% 5.64% 5.67% 5.24% 4.66% 4.75%/2/ Before advisory/administration fee waivers 5.11% 5.23% 5.35% 5.30% 4.84% 4.40% 4.44%/2/ Portfolio turnover rate 272% 291% 580% 247% 9% 272% 291% INVESTOR C SHARES ---------------------------- Year Ended Year Ended 9/30/98 9/30/97 Net asset value at beginning of period $10.11 $ 9.98 ----------- ---------------- Income from investment operations Net investment income 0.47 0.45 Net gain (loss) on investments (both realized and unrealized) 0.37 0.13 ----------- ---------------- Total from investment operations 0.84 0.58 ----------- ---------------- Less distributions Distributions from net investment income (0.47) (0.45) Distributions from net realized capital gains - - - - ----------- ---------------- Total distributions (0.47) (0.45) ----------- ---------------- Net asset value at end of period $10.48 $10.11 =========== ================ Total return/3/ 8.51% 5.94% Ratios/Supplemental data Net assets at end of period (in thousands) $ 299 $ 51 Ratios of expenses to average net assets After advisory/administration fee waivers 1.78%/4/ 1.71%/2/,/4/ Before advisory/administration fee waivers 2.04% 2.02%/2/ Ratios of net investment income to average net assets After advisory/administration fee waivers 4.51% 4.57%/2/ Before advisory/administration fee waivers 4.25% 4.26%/2/ Portfolio turnover rate 272% 291%
--------------------------------------------------------- /1/Commencement of operations of share class. /2/Annualized. /3/Neither front-end sales load nor contingent deferred sales load is reflected. /4/Including interest expense, ratios for the Investor A, Investor B and Investor C Shares would have been 1.09%, 1.84% and 1.81%, respectively, for the year ended September 30, 1998, 1.14%, 1.90% and 1.78%, respectively, for the year ended September 30, 1997, 1.14% for the year ended September 30, 1996 and 0.70% for the year ended September 30, 1995. 16 [GRAPHIC BlackRock APPEARS Intermediate Bond HERE] Portfolio - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Investment Goal The fund seeks current income consistent with the preservation of capital. Primary Investment Strategies In pursuit of this goal, the fund manager invests primarily in intermediate bonds. The fund normally invests at least 80% of its total assets in bonds and at least 65% of its total assets in intermediate bonds. The fund defines inter- mediate bonds as those with maturities of between five and ten years. The fund only buys securities that are rated investment grade at the time of purchase by at least one major rating agency or determined by the manager to be of similar quality. The management team evaluates categories of the bond market and individual securities within those categories. The manager selects bonds from several cat- egories including: U.S. Treasuries and agency securities, commercial and resi- dential mortgage-backed securities, asset-backed securities and corporate bonds. Securities are purchased for the fund when the manager determines that they have the potential for above-average current income. The fund measures its performance against the Lehman Brothers Intermediate Government/Corporate Index (the benchmark). If a security falls below investment grade, the manager will decide whether to continue to hold the security. A security will be sold if, in the opinion of the fund manager, the risk of continuing to hold the security is unacceptable when compared to the total return potential. The fund manager will normally attempt to structure the fund's portfolio to have comparable duration to its benchmark. Duration, which measures price sen- sitivity to interest rate changes, is not necessarily equal to average maturi- ty. The fund manager may, when consistent with the fund's investment objective, use options or futures (commonly known as derivatives). The primary purpose of using derivatives is to attempt to reduce risk to the fund as a whole (hedge) but they may also be used to maintain liquidity, commit cash pending investment or to IMPORTANT DEFINITIONS Asset-Backed Securi- ties: Bonds that are backed by a pool of assets, usually loans such as installment sale contracts or credit card receiv- ables. Bonds: Debt obligations such as bonds and debentures, U.S. Gov- ernment securities, debt obligations of domestic and foreign corporations, debt obligations of foreign governments and their political subdivisions, asset-backed securi- ties, various mortgage- backed securities (both residential and commer- cial), other floating or variable rate obli- gations, municipal obligations and zero coupon debt securities. Commercial Mortgage- Backed Securities (CMBS): Bonds that are backed by a mortgage loan or pools of loans secured by commercial property, not residen- tial mortgages. Duration: A mathemati- cal calculation of the average life of a bond (or bonds in a bond fund) that serves as a useful measure of its price risk. Each year of duration represents an expected 1% change in the price of a bond for every 1% change in interest rates. For example, if a bond fund has an average duration of four years, its price will fall about 4% when interest rates rise by one percentage point. Conversely, the bond fund's price will rise about 4% when interest rates fall by one percentage point. Investment Grade: Secu- rities which are rated in the four highest categories by at least one of the major rating agencies or determined by the fund manager to be of similar quality. Generally, the higher the rating of a bond, the higher the likeli- hood that interest and principal payments will be made on time. Secu- rities rated in the fourth highest category by the rating agencies are considered invest- ment grade but they are also considered specu- lative, meaning that they carry more risk than higher rated secu- rities and may have problems making princi- pal and interest pay- ments in difficult eco- nomic climates. Investment grade rat- ings do not guarantee that bonds will not lose value. 17 increase returns. The fund may also enter into interest rate transactions as a hedging technique. In these transactions, the fund exchanges its right to pay or receive interest with another party for their right to pay or receive interest. The fund can borrow money to buy additional securities. This practice is know as "leverage." The fund may borrow from banks or other financial institutions or through reverse repurchase agreements (under which the fund sells securi- ties and agrees to buy them back at a particular date and price). The fund normally may borrow up to 33 1/3% of the value of its total assets. The fund may lend some of its securities on a short-term basis in order to earn extra income. The fund will receive collateral in cash or high quality securities equal to the current value of the loaned securities. These loans will be limited to 33 1/3% of the value of the fund's total assets. Should the Company's Board of Trustees determine that the investment objective of the fund should be changed, shareholders will be given at least 30 days notice before any such change is made. Key Risks Key Risks While the fund manager chooses bonds he believes can provide above average current income, there is no guarantee that shares of the fund will not lose value. This means you could lose money. Two of the main risks of investing in the fund are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds such as those held by the fund. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. The fund may make investments in residential and commercial mortgage-backed securities and other asset-backed securities. The characteristics of these mortgage-backed and asset-backed securities differ from traditional fixed income securities. A main difference is that the principal on mortgage- or asset-backed securi- ties may normally be prepaid at any time, which will reduce the yield and mar- ket value of these securities. Asset-backed securities and CMBS generally experience less prepayment than residential mortgage-backed securities. In periods of falling interest rates, the rate of prepayments tends to increase (as does price fluctuation) as borrowers are motivated to pay off debt and refinance at new lower rates. During such periods, reinvestment of the prepay- ment proceeds by the manager will generally be at lower rates of return than the return on the assets which were prepaid. IMPORTANT DEFINITIONS Lehman Brothers Inter- mediate Government/Corporate Index: An unmanaged index comprised of Treasury, agency and corporate issues from the more comprehensive Lehman Aggregate Index. This index concentrates on intermediate matu- rity bonds and thus excludes all maturities from the broader index below one year and above 9.9 years. Maturity: The date upon which debt securities are due to be repaid, that is, the date when the issuer generally must pay back the face amount of the security. Mortgage-Backed Securi- ties: Asset-backed securities based on a particular type of asset, a mortgage. There is a wide variety of mortgage backed securities involving commercial or residen- tial, fixed rate or adjustable rate mort- gages and mortgages issued by banks or gov- ernment agencies. Total Return: A way of measuring fund perfor- mance. Total return is based on a calculation that takes into account income dividends, capi- tal gain distributions and the increase or decrease in share price. 18 Certain asset-backed securities are based on loans that are unsecured, which means that there is no collateral to seize if the underlying borrower defaults. Other asset-based securities may not have the benefit of as much collateral as mortgage-backed securities. Treasury obligations differ only in their interest rates, maturities and times of issuance. Obligations of U.S. Government agencies and authorities are sup- ported by varying degrees of credit. No assurance can be given that the U.S. Government will provide financial support to its agencies and authorities if it is not obligated by law to do so. The fund's use of derivatives and interest rate transactions may reduce the fund's returns and/or increase volatility, which is defined as the characteris- tic of a security or a market to fluctuate significantly in price within a short period of time. Leverage is a speculative technique which may expose the fund to greater risk and increase its costs. Increases and decreases in the value of the fund's portfolio will be magnified when the fund uses leverage. The fund will also have to pay interest on its borrowings, reducing the fund's return. Securities loans involve the risk of a delay in receiving additional collateral if the value of the securities goes up while they are on loan. There is also the risk of delay in recovering the loaned securities and of losing rights to the collateral if a borrower goes bankrupt. The fund, like any business, could be affected if the computer systems on which it relies do not properly process information beginning on January 1, 2000. While Year 2000 issues could have a negative effect on the fund, BlackRock, the fund's investment adviser, is currently working to avoid such problems. Black- Rock is also working with other systems providers and vendors to determine their systems' ability to handle Year 2000 problems. There is no guarantee, however, that systems will work properly on January 1, 2000. Year 2000 problems may also hurt issuers whose securities the fund holds or securities markets generally. When you invest in this fund you are not making a bank deposit. Your investment is not insured or guaranteed by the Federal Deposit Insurance Corporation or by any bank or governmental agency. 19 Risk / Return Information The chart and table below give you a picture of the fund's long-term perfor- mance for Investor A Shares (in the chart) and for Investor A, B and C Shares (in the table). The information shows you how the fund's performance has varied year by year and provides some indication of the risks of investing in the fund. The table compares the fund's performance to that of the Lehman Brothers Intermediate Government/Corporate Index, a recognized unmanaged index of bond market performance. The chart and the table both assume reinvestment of divi- dends and distributions. As with all such investments, past performance is not an indication of future results. Sales charges are not reflected in the bar chart. If they were, returns would be less than those shown. The performance for the period before Investor Shares were launched is based upon performance for older share classes of the fund. Investor A Shares were launched in May 1994, Investor B Shares were launched in February 1998 and Investor C Shares were launched in October 1998. The actual return of Investor Shares would have been lower than shown because Investor Shares have higher expenses than these older classes. Also, the actual returns of Investor B and C Shares would have been lower compared to Investor A Shares. As of 12/31 Investor A Shares - -------------------------------------------------------------------------------- A N N U A L T O T A L R E T U R N S - -------------------------------------------------------------------------------- [BAR CHART APPEARS HERE] Best Quarter Q2 '95: 4.40% 94 14.10 95 3.92 96 7.11 Worst Quarter 97 6.59 Q1 '94: -2.86% The bar of 1994 is based upon performance for Institutional Shares of the fund. As of 12/31/98 - ---------------------------------------------------------------------------- A V E R A G E A N N U A L T O T A L R E T U R N S - ---------------------------------------------------------------------------- Since Inception 1 Year 3 Years 5 Years Inception Date - ---------------------------------------------------------------------------- Intermediate Bond; Inv A 5.42% 8.45% 8.07% 9.02% 09/15/93 - ---------------------------------------------------------------------------- Intermediate Bond; Inv B 5.19% 8.28% 8.30% 9.47% 09/15/93 - ---------------------------------------------------------------------------- Intermediate Bond; Inv C 9.05% 9.57% 8.74% 9.47% 09/15/93 - ---------------------------------------------------------------------------- LB Intermediate Govt./Corp. 8.43% 6.76% 6.60% 6.29% N/A* - ---------------------------------------------------------------------------- These returns assume payment of applicable sales charges. * For comparative purposes, the value of the index on 09/01/93 is used as the beginning value on 09/15/93. Expenses and Fees Expenses and Fees As a shareholder you pay certain fees and expenses. Shareholder transaction fees are paid out of your investment and annual fund operating expenses are paid out of fund assets and are reflected in the fund's price. 20 This prospectus offers shareholders different ways to invest with three sepa- rate pricing options. You need to understand your choices so that you can choose the pricing option that is most suitable for you. With one option (In- vestor A Shares) you pay a one-time front-end transaction fee each time you buy shares. The other options (Investor B and Investor C Shares) have no front-end charges but have higher on-going fees, which are paid over the life of the investment, and have a contingent deferred sales charge (CDSC) that you may pay when you redeem your shares. Which option should you choose? It depends on your individual circumstances. You should know that the lowest sales charge won't necessarily be the least expensive option over time. For example, if you intend to hold your shares long term it may cost less to buy A Shares than B or C Shares. The tables below explain your pricing options and describe the fees and expenses that you may pay if you buy and hold Investor A, B and C Shares of the fund. The "Annual Fund Operating Expenses" table is based on expenses for the most recent fiscal year.
A Shares B Shares C Shares Maximum Front-End Sales Charge* 4.0% 0.0% 0.0% (as percentage of offering price) Maximum Deferred Sales Charge 0.0% 4.5%** 1.00%*** (as percentage of offering price)
* Reduced front-end sales charges may be available. A CDSC of up to 1.00% is assessed on certain redemptions of Investor A Shares that are purchased with no initial sales charge as part of an investment of $1,000,000 or more. ** The CDSC is 4.5% if shares are redeemed in less than one year. The CDSC for Investor B Shares decreases for redemptions made in subsequent years. After six years there is no CDSC on B Shares. (See page 120 for complete schedule of CDSCs.) *** There is no CDSC on C Shares after one year. Annual Fund Operating Expenses (Expenses that are deducted from fund assets)
A Shares B Shares C Shares Advisory Fees .50% .50% .50% Distribution and service (12b- 1) fees .50% 1.15% 1.15% Other expenses .43% .43% .43% Total annual fund operating expenses 1.43% 2.08% 2.08% Fee waivers and expense reimbursements* .36% .26% .26% Net Expenses* 1.07% 1.82% 1.82%
* BlackRock has contractually agreed to waive or reimburse fees or expenses in order to limit certain (but not all) fund expenses for the next year. The fund may have to repay these waivers and reimbursements to BlackRock in the following two years if the repayment can be made within these expense limits. In addition, BlackRock Distributors Inc., the fund's distributor, has contractually agreed to waive all 12b-1 distribution fees on Investor A Shares (otherwise payable at the maximum annual rate of .10% of average daily net assets) for the next year. "Net Expenses" in the table have been restated to reflect these waivers and reimbursements. The table does not reflect charges or credits which investors might incur if they invest through a financial institution. IMPORTANT DEFINITIONS Advisory Fees: Fees paid to the investment adviser for portfolio management services. Service Fees: Fees that are paid to BlackRock and /or its affiliates for shareholder account service and mainte- nance. Distribution Fees: A method of charging dis- tribution-related expenses against fund assets. Other Expenses: Include administration, trans- fer agency, custody, professional fees and registration fees. 21 Example: This example is intended to help you compare the cost of investing in the fund with the cost of investing in other mutual funds. We are assuming an initial investment of $10,000, 5% total return each year with no changes in operating expenses (except for the waivers in the first year discussed above), redemption at the end of each time period and, with respect to B Shares and C Shares only, no redemption at the end of each time period. Although your actual cost may be higher or lower, based on these assumptions your costs would be:
1 Year 3 Years 5 Years 10 Years A Shares* $505 $800 $1,117 $2,015 B Shares** Redemption $635 $977 $1,295 $2,145*** B Shares No Redemption $185 $627 $1,095 $2,145*** C Shares** Redemption $285 $627 $1,095 $2,390 C Shares No Redemption $185 $627 $1,095 $2,390
* Reflects imposition of sales charge. ** Reflects deduction of CDSC. *** Based on the conversion of the Investor B Shares to Investor A Shares after seven years. Fund Management The co-managers of the fund are Robert Kapito, Vice Chairman of BlackRock Financial Management, Inc. (BFM) since 1988, Scott Amero, Managing Director of BFM since 1990, and Michael Lustig, Director of BFM since 1989. They have all co-managed the fund since 1995. 22 Financial Highlights The financial information in the table below shows the fund's financial per- formance for the periods indicated. Certain information reflects results for a single fund share. The term "Total Return" indicates how much your investment would have increased or decreased during this period of time and assumes that you have reinvested all dividends and distributions. These figures have been audited by PricewaterhouseCoopers LLP, the fund's independent accountants. The auditor's report, along with the fund's financial statements, are included in the Company's annual report which is available upon request (see back cover for ordering instructions). FINANCIAL HIGHLIGHTS - -------------------------------------------------------------------------------- (For an Investor A or B Share Outstanding Throughout Each Period) Intermediate Bond Portfolio
INVESTOR A INVESTOR B SHARES SHARES For the For the Period Period Year Year Year Year 5/20/94/1 9/5/98/1 Ended Ended Ended Ended / through / through 9/30/98 9/30/97 9/30/96 9/30/95 9/30/94 9/30/98 Net asset value at beginning of period $ 9.49 $ 9.32 $9.43 $9.05 $9.23 $9.51 ------ ------ ----- ----- ----- ----- Income from investment operations Net investment income 0.53 0.53 0.52 0.54 0.20 0.29 Net gain (loss) on investments (both realized and unrealized) 0.23 0.17 (0.09) 0.38 (0.17) 0.21 ------ ------ ----- ----- ----- ----- Total from investment operations 0.76 0.70 0.43 0.92 0.03 0.50 ------ ------ ----- ----- ----- ----- Less distributions Distributions from net investment income (0.53) (0.53) (0.51) (0.54) (0.21) (0.29) Distributions from net realized capital gains (0.05) - - (0.03) - - - - (0.05) ------ ------ ----- ----- ----- ----- Total distributions (0.58) (0.53) (0.54) (0.54) (0.21) (0.34) ------ ------ ----- ----- ----- ----- Net asset value at end of period $ 9.67 $ 9.49 $9.32 $9.43 $9.05 $9.67 ====== ====== ===== ===== ===== ===== Total return/3/ 8.30% 7.89% 4.74% 10.35% 0.31% 7.83% Ratios/Supplemental data Net assets at end of period (in thousands) $1,648 $1,116 $ 935 $ 647 $ 87 $ 111 Ratios of expenses to average net assets After advisory/administration fee waivers 1.06%/4/ 1.00%/4/ 0.97%/4/ 0.76%/4/ 0.85%/2/ 1.75%/2/, /4/ Before advisory/administration fee waivers 1.33% 1.29% 1.27% 1.11% 1.28%/2/ 2.02%/2/ Ratios of net investment income to average net assets After advisory/administration fee waivers 6.80% 6.14% 5.83% 5.89% 5.35%/2/ 5.59%/2/ Before advisory/administration fee waivers 6.53% 5.85% 5.53% 5.55% 4.92%/2/ 5.07%/2/ Portfolio turnover rate 221% 321% 670% 262% 92% 221%
------------------------------------------------------- /1/Commencement of operations of share class. /2/Annualized. /3/Neither front-end sales load nor contingent deferred sales load is reflected. /4/Including interest expense, ratios for the Investor A and Investor B would have been 2.22% and 2.79%, respectively, for the year ended September 30, 1998, 1.44% for the year ended September 30, 1997, 1.27% for the year ended September 30, 1996 and 0.84% for the year ended September 30, 1995. 23 [GRAPHIC BlackRock APPEARS Core Bond HERE] Portfolio - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Investment Goal The fund seeks to realize a total return that exceeds that of the Lehman Brothers Aggregate Index (the benchmark). Primary Investment Strategies In pursuit of this goal, the fund normally invests at least 80% of its total assets in bonds and at least 65% of its total assets in bonds with maturities of between five and fifteen years. The fund may invest up to 10% of its total assets in bonds of foreign issuers. The fund only buys securities that are rated investment grade at the time of purchase by at least one major rating agency or determined by the manager to be of similar quality. The management team evaluates several categories of the bond market and indi- vidual securities within these categories. The fund manager selects bonds from several categories including: U.S. Treasuries and agency securities, commer- cial and residential mortgage-backed securities, asset-backed securities and corporate bonds. Securities are purchased for the fund when the manager deter- mines that they have the potential for above-average total return. The Fund measures its performance against the benchmark. If a security falls below investment grade, the manager will decide whether to continue to hold the security. A security will be sold if, in the opinion of the fund manager, the risk of continuing to hold the security is unacceptable when compared to the total return potential. The fund manager will normally attempt to structure the fund's portfolio to have comparable duration to its benchmark. Duration, which measures price sen- sitivity to interest rate changes, is not necessarily equal to average maturi- ty. The fund manager may, when consistent with the fund's investment objective, use options or futures (commonly known as derivatives). The primary purpose of using derivatives is to attempt to reduce risk to the fund as a whole (hedge) but they may also be used to maintain liquidity, commit cash pending invest- ment or to increase returns. The fund may also enter into interest rate or foreign currency transactions as a hedging technique. In these transactions, the fund exchanges its right to pay or receive interest or currencies with another party for their right to pay or receive interest or another currency in the future. IMPORTANT DEFINITIONS Asset-Backed Securi- ties: Bonds that are backed by a pool of assets, usually loans such as installment sale contracts or credit card receivables. Bonds: Debt obligations such as bonds and debentures, U.S. Gov- ernment securities, debt obligations of domestic and foreign corporations, debt obligations of foreign governments and their political subdivisions, asset-backed securi- ties, various mortgage- backed securities (both residential and commer- cial), other floating or variable rate obli- gations, municipal obligations and zero coupon debt securities. Commercial Mortgage- Backed Securities (CMBS): Bonds that are backed by a mortgage loan or pools of loans secured by commercial property, not residen- tial mortgages. Duration: A mathemati- cal calculation of the average life of a bond (or bonds in a bond fund) that serves as a useful measure of its price risk. Each year of duration represents an expected 1% change in the price of a bond for every 1% change in interest rates. For example, if a bond fund has an average duration of four years, its price will fall about 4% when interest rates rise by one percentage point. Conversely, the bond fund's price will rise about 4% when interest rates fall by one percentage point. Investment Grade: Secu- rities which are rated in the four highest categories by at least one of the major rating agencies or determined by the fund manager to be of similar quality. Generally, the higher the rating of a bond, the higher the likeli- hood that interest and principal payments will be made on time. Secu- rities rated in the fourth highest category by the rating agencies are considered invest- ment grade but they are also considered specu- lative, meaning that they carry more risk than higher rated secu- rities and may have problems making princi- pal and interest pay- ments in difficult eco- nomic climates. Investment grade rat- ings do not guarantee that bonds will not lose value. Lehman Brothers Aggre- gate Index: An unman- aged index comprised of more than 5,000 taxable bonds. This is an index of investment grade bonds; all securities included must be rated investment grade by Moody's or Standard & Poor's. 24 The fund can borrow money to buy additional securities. This practice is known as "leverage." The fund may borrow from banks or other financial institutions or through reverse repurchase agreements (under which the fund sells securities and agrees to buy them back at a particular date and price).The fund (normally) may borrow up to 33 1/3% of the value of its assets. The fund may lend some of its securities on a short-term basis in order to earn extra income. The fund will receive collateral in cash or high quality securi- ties equal to the current value of the loaned securities. These loans will be limited to 33 1/3% of the value of the fund's total assets. Should the Company's Board of Trustees determine that the investment objective of the fund should be changed, shareholders will be given at least 30 days notice before any such change is made. Key Risks Key Risks While the fund manager chooses bonds he believes can provide above average total returns, there is no guarantee that shares of the fund will not lose val- ue. This means you could lose money. Two of the main risks of investing in the fund are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds such as those held by the fund. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. The fund may make investments in residential and commercial mortgage-backed securities and other asset-backed securities. The characteristics of these mortgage-backed and asset-backed securities differ from traditional fixed income securities. A main difference is that the principal on mortgage- or asset-backed securities may normally be prepaid at any time, which will reduce the yield and market value of these securities. Asset-backed securities and CMBS generally experi- ence less prepayment than residential mortgage-backed securities. In periods of falling interest rates, the rate of prepayments tends to increase (as does price fluctuation) as borrowers are motivated to pay off debt and refinance at new lower rates. During such periods, reinvestment of the prepayment proceeds by the manager will generally be at lower rates of return than the return on the assets which were prepaid. Certain asset-backed securities are based on loans that are unsecured, which means that there is no collateral to seize if the underlying borrower defaults. Other asset-based securities may not have the benefit of as much collateral as mortgage-backed securities. Treasury obligations differ only in their interest rates, maturities and times of issuance. Obligations of U.S. Government agencies IMPORTANT DEFINITIONS Maturity: The date upon which debt securities are due to be repaid, that is, the date when the issuer generally must pay back the face amount of the security. Mortgage-Backed Securi- ties: Asset-backed securities based on a particular type of asset, a mortgage. There is a wide variety of mortgage backed securities involving commercial or residen- tial, fixed rate or adjustable rate mort- gages and mortgages issued by banks or gov- ernment agencies. Total Return: A way of measuring fund perfor- mance. Total return is based on a calculation that takes into account income dividends, capi- tal gain distributions and the increase or decrease in share price. 25 and authorities are supported by varying degrees of credit. No assurance can be given that the U.S. Government will provide financial support to its agen- cies and authorities if it is not obligated by law to do so. The fund's use of derivatives, interest rate and foreign currency transactions may reduce the fund's returns and/or increase volatility, which is defined as the characteristic of a security or a market to fluctuate significantly in price within a short period of time. Leverage is a speculative technique which may expose the fund to greater risk and increase its costs. Increases and decreases in the value of the fund's portfolio will be magnified when the fund uses leverage. The fund will also have to pay interest on its borrowings, reducing the fund's return. The fund may invest up to 10% of its total assets in bonds of foreign issuers. Foreign securities involve risks not typically associated with investing in U.S. securities. These risks include but are not limited to: currency risks (the risk that the value of interest paid on foreign securities, or the value of the securities themselves, may fall if currency exchange rates change), the risk that a security's value will be hurt by changes in foreign political or social conditions, the possibility of heavy taxation or expropriation and more difficulty obtaining information on foreign securities or companies. In addi- tion, a portfolio of foreign securities may be harder to sell and may be sub- ject to wider price movements than comparable investments in U.S. companies. There is also less government regulation of foreign securities markets. On January 1, 1999, eleven European countries implemented a new currency unit called the "Euro" which is expected to reshape financial markets, banking sys- tems and monetary policies in Europe and other parts of the world. While it is impossible to predict the impact of the "Euro," it is possible that it could increase volatility in financial markets worldwide which could hurt the value of shares of the fund. Securities loans involve the risk of a delay in receiving additional collat- eral if the value of the securities goes up while they are on loan. There is also the risk of delay in recovering the loaned securities and of losing rights to the collateral if a borrower goes bankrupt. The fund, like any business, could be affected if the computer systems on which it relies do not properly process information beginning on January 1, 2000. While Year 2000 issues could have a negative effect on the fund, Black- Rock, the fund's investment adviser, is currently working to avoid such prob- lems. BlackRock is also working with other systems providers and vendors to determine their systems' ability to handle Year 2000 problems. There is no guarantee, however, that systems will work properly on January 1, 2000. Year 2000 problems may also hurt issuers whose securities the fund holds or securi- ties markets generally. 26 When you invest in this fund you are not making a bank deposit. Your investment is not insured or guaranteed by the Federal Deposit Insurance Corporation or by any bank or governmental agency. Risk / Return Information The chart and table below give you a picture of the fund's long-term perfor- mance for Investor A Shares (in the chart) and for Investor A, B and C Shares (in the table). The information shows you how the fund's performance has varied year by year and provides some indication of the risks of investing in the fund. The table compares the fund's performance to that of the Lehman Brothers Aggregate Index, a recognized unmanaged index of bond market performance. The chart and the table both assume reinvestment of dividends and distributions. As with all such investments, past performance is not an indication of future results. Sales charges are not reflected in the bar chart. If they were, returns would be less than those shown. The performance for the period before Investor Shares were launched is based upon performance for older share classes of the fund. Investor A Shares were launched in January 1996, Investor B Shares were launched in March 1996 and Investor C Shares were launched in February 1997. The actual return of Investor Shares would have been lower than shown because Investor Shares have higher expenses than these older classes. Also, the actual returns of Investor B and C Shares would have been lower compared to Investor A Shares. As of 12/31 Investor A Shares - -------------------------------------------------------------------------------- A N N U A L T O T A L R E T U R N S - -------------------------------------------------------------------------------- [BAR CHART APPEARS HERE] Best Quarter Q2 '95: 5.87% Worst Quarter Q1 '94: -2.63% The bars for 1993-1996 are based upon performance for Institutional Shares of the Fund 93 94 95 96 97 98 ----- ------ ------ ------ ------ ----- 9.69% -2.33% 18.18% 3.19% 8.51% 7.66% These returns assume payment of applicable sales charges. As of 12/31/98 - -------------------------------------------------------------------------------- AVERAGE ANNUAL TOTAL RETURNS - -------------------------------------------------------------------------------- Since Inception 1 Year 3 Years 5 Years Inception Date - -------------------------------------------------------------------------------- Core Bond; Inv A 3.34% 4.99% 5.96% 6.56% 12/01/92 Core Bond; Inv B 2.01% 4.44% 5.96% 6.91% 12/01/92 Core Bond; Inv C 5.75% 5.69% 6.39% 6.91% 12/01/92 Lehman Aggregate 8.69% 7.29% 7.27% 7.85% N/A 27 Expenses and fees Expenses and Fees As a shareholder you pay certain fees and expenses. Shareholder transaction fees are paid out of your investment and annual fund operating expenses are paid out of fund assets and are reflected in the fund's price. This prospectus offers shareholders different ways to invest with three sepa- rate pricing options. You need to understand your choices so that you can choose the pricing option that is most suitable for you. With one option (In- vestor A Shares) you pay a one-time front-end transaction fee each time you buy shares. The other options (Investor B and Investor C Shares) have no front-end charges but have higher on-going fees, which are paid over the life of the investment, and have a contingent deferred sales charge (CDSC) that you may pay when you redeem your shares. Which option should you choose? It depends on your individual circumstances. You should know that the lowest sales charge won't necessarily be the least expensive option over time. For example, if you intend to hold your shares long term it may cost less to buy A Shares than B or C Shares. The tables below explain your pricing options and describe the fees and expenses that you may pay if you buy and hold Investor A, B and C Shares of the fund. The "Annual Fund Operating Expenses" table is based on expenses for the most recent fiscal year. Shareholder Fees (Fees paid directly from your investment)
A Shares B Shares C Shares Maximum Front-End Sales Charge* 4.0% 0.0% 0.0% (as percentage of offering price) Maximum Deferred Sales Charge 0.0% 4.5%** 1.00%*** (as percentage of offering price)
* Reduced front-end sales charges may be available. A CDSC of up to 1.00% is assessed on certain redemptions of Investor A Shares that are purchased with no initial sales charge as part of an investment of $1,000,000 or more. ** The CDSC is 4.5% if shares are redeemed in less than one year. The CDSC for Investor B Shares decreases for redemptions made in subsequent years. After six years there is no CDSC on B Shares. (See page 120 for complete schedule of CDSCs.) *** There is no CDSC on C Shares after one year. Annual Fund Operating Expenses (Expenses that are deducted from fund assets)
A Shares B Shares C Shares Advisory Fees .50% .50% .50% Distribution and service (12b- 1) fees .50% 1.15% 1.15% Other expenses .46% .46% .46% Total annual fund operating expenses 1.46% 2.11% 2.11% Fee waivers and expense reimbursements* .44% .34% .34% Net Expenses* 1.02% 1.77% 1.77%
* BlackRock has contractually agreed to waive or reimburse fees or expenses in order to limit certain (but not all) fund expenses for the next year. The fund may have to repay these waivers and reimbursements to BlackRock in the following two years if the repayment can be made within these expense limits. In addition, BlackRock Distributors, Inc., the fund's distributor, has contractually agreed to waive all 12b-1 distribution fees on Investor A Shares (otherwise payable at the maximum annual rate of .10% of average daily net assets) for the next year. "Net Expenses" in the table have been restated to reflect these waivers and reimbursements. IMPORTANT DEFINITIONS Advisory Fees: Fees paid to the investment adviser for portfolio management services. Service Fees: Fees that are paid to BlackRock and /or its affiliates for shareholder account service and mainte- nance. Distribution Fees: A method of charging dis- tribution-related expenses against fund assets. Other Expenses: Include administration, trans- fer agency, custody, professional fees and registration fees. 28 The table does not reflect charges or credits which investors might incur if they invest through a financial institution. Long-term shareholders in mutual funds with 12b-1 fees may pay more than the economic equivalent of the maximum front-end sales charge permitted by the rules of the National Association of Securities Dealers, Inc. Example: This example is intended to help you compare the cost of investing in the fund with the cost of investing in other mutual funds. We are assuming an initial investment of $10,000, 5% total return each year with no changes in operating expenses (except for the waivers in the first year discussed above), redemption at the end of each time period and, with respect to B Shares and C Shares only, no redemption at the end of each time period. Although your actual cost may be higher or lower, based on these assumptions your costs would be:
1 Year 3 Years 5 Years 10 Years A Shares* $500 $802 $1,125 $2,040 B Shares** Redemption $630 $978 $1,303 $2,171*** B Shares No Redemption $180 $628 $1,103 $2,171*** C Shares** Redemption $280 $628 $1,103 $2,415 C Shares No Redemption $180 $628 $1,103 $2,415
*Reflects imposition of sales charge. **Reflects deduction of CDSC. *** Based on the conversion of the Investor B Shares to Investor A Shares after seven years. Fund Management The manager of the fund is Keith Anderson, Managing Director at BlackRock Financial Management, Inc. since 1988. He has served as fund manager since June 1997. 29 Financial Highlights The financial information in the table below shows the fund's financial per- formance for the periods indicated. Certain information reflects results for a single fund share. The term "Total Return" indicates how much your investment would have increased or decreased during this period of time and assumes that you have reinvested all dividends and distributions. These figures have been audited by PricewaterhouseCoopers LLP, the fund's independent accountants. The auditor's report, along with the fund's financial statements, are included in the Company's annual report which is available upon request (see back cover for ordering instructions). FINANCIAL HIGHLIGHTS - -------------------------------------------------------------------------------- (For an Investor A, B or C Share Outstanding Throughout Each Period) Core Bond Portfolio
INVESTOR A SHARES - ----------------------------------------------------------------------------------------------------------- For the For the Period Period Year Year 4/1/96 1/31/96/1 Ended Ended through / through 9/30/98 9/30/97 9/30/96 3/31/96 Net asset value at beginning of period $ 9.82 $ 9.55 $ 9.61 $ 9.99 ------ ------ ------ ------ Income from investment operations Net investment income 0.55 0.58 0.28 0.08 Net gain (loss) on investments (both realized and unrealized) 0.40 0.26 (0.06) (0.38) ------ ------ ------ ------ Total from investment operations 0.95 0.84 0.22 (0.30) ------ ------ ------ ------ Less distributions Distributions from net investment income (0.56) (0.57) (0.28) (0.08) Distributions from net realized capital gains (0.09) - - - - - - ------ ------ ------ ------ Total distributions (0.65) (0.57) (0.28) (0.08) ------ ------ ------ ------ Net asset value at end of period $10.12 $ 9.82 $ 9.55 $ 9.61 ====== ====== ====== ====== Total returns/3/ 10.04% 9.52% 2.36% (2.96)% Ratios/Supplemental data Net assets at end of period (in thousands) $5,108 $2,441 $ 320 $ 80 Ratios of expenses to average net assets After advisory/administration fee waivers 0.98%/4/ 1.01%/4/ 1.02%/2/,/4/ 1.02%/2/,/4/ Before advisory/administration fee waivers 1.32% 1.30% 1.31%/2/ 1.27%/2/ Ratios of net investment income to average net assets After advisory/administration fee waivers 5.78% 6.31% 6.29%/2/ 5.43%/2/ Before advisory/administration fee waivers 5.44% 6.02% 6.00%/2/ 5.19%/2/ Portfolio turnover rate 405% 441% 308% 723% Net asset value at beginning of period $ 9.82 $ 9.55 $ 9.61 $ 9.58 $ 9.82 $ 9.64 ----------- ----------- --------------- ---------------- ----------- ---------------- Income from investment operations Net investment income 0.47 0.51 0.26 0.01 0.47 0.29 Net gain (loss) on investments (both realized and unrealized) 0.40 0.26 (0.07) 0.03 0.40 0.17 ----------- ----------- --------------- ---------------- ----------- ---------------- Total from investment operations 0.87 0.77 0.19 0.04 0.87 0.46 ----------- ----------- --------------- ---------------- ----------- ---------------- Less distributions Distributions from net investment income (0.48) (0.50) (0.25) (0.01) (0.48) (0.28) Distributions from net realized capital gains (0.09) - - - - - - (0.09) - - ----------- ----------- --------------- ---------------- ----------- ---------------- Total distributions (0.57) (0.50) (0.25) (0.01) (0.57) (0.28) ----------- ----------- --------------- ---------------- ----------- ---------------- Net asset value at end of period $ 10.12 $ 9.82 $ 9.55 $ 9.61 $10.12 $ 9.82 =========== =========== =============== ================ =========== ================ Total returns/3/ 9.20% 8.71% 1.98% (0.33)% 9.20% 4.82% Ratios/Supplemental data Net assets at end of period (in thousands) $11,734 $5,295 $1,497 $ 77 $2,035 $ 128 Ratios of expenses to average net assets After advisory/administration fee waivers 1.76%/4/ 1.75%/4/ 1.72%/2/,/4/ 1.77%/2/,/4/ 1.73%/4/ 1.74%/2/,/4/ Before advisory/administration fee waivers 2.10% 2.04% 2.01%/2/ 2.02%/2/ 2.07% 2.03%/2/ Ratios of net investment income to average net assets After advisory/administration fee waivers 5.03% 5.61% 5.68%/2/ 4.71%/2/ 4.92% 5.41%/2/ Before advisory/administration fee waivers 4.69% 5.32% 5.39%/2/ 4.46%/2/ 4.58% 5.12%/2/ Portfolio turnover rate 405% 441% 308% 723% 405% 441%
------------------------------------------------------------ /1/Commencement of operations of share class. /2/Annualized. /3/Neither front-end sales load nor contingent deferred sales load is reflected. /4/Including interest expense, ratios for the Investor A, Investor B and Investor C Shares would have been 1.27%, 2.01% and 1.90%, respectively, for the year ended September 30, 1998, 1.36%, 2.17% and 1.93%, respectively, for the year ended September 30, 1997, 1.27% and 2.00%, respectively, for the period ended September 30, 1996, and 1.11% and 1.86% for the period ended March 31, 1996. 30 [GRAPHIC BlackRock APPEARS Government Income HERE] Portfolio - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Investment Goal The fund seeks current income consistent with the preservation of capital. Primary Investment Strategies In pursuit of this goal, the fund manager invests primarily in the highest rated government and agency bonds in the ten to fifteen year maturity range. The fund normally invests at least 80% of its total assets in bonds and at least 65% of its total assets in obligations issued or guaranteed by the U.S. Government and its agencies. Securities purchased by the fund are rated in the highest rating category (AAA or Aaa) at the time of purchase by at least one major rating agency or are determined by the fund manager to be of similar quality. The management team evaluates categories of the government/agency market and individual bonds within these categories. The manager selects bonds from sev- eral categories including: U.S. Treasuries and agency securities, commercial and residential mortgage-backed securities (including CMOs), asset-backed secu- rities and corporate bonds. Securities are purchased for the fund when the man- ager determines that they have the potential for above-average current income. The fund measures its performance against the Lehman Mortgage/10 Year Treasury Index (the benchmark). If a security falls below the highest rating, the manager will decide whether to continue to hold the security. A security will be sold if, in the opinion of the fund manager, the risk of continuing to hold the security is unacceptable when compared to the total return potential. The fund manager will normally attempt to structure the fund's portfolio to have comparable duration to its benchmark. Duration, which measures price sen- sitivity to interest rate changes, is not necessarily equal to average maturi- ty. The fund manager may, when consistent with the fund's investment objective, use options or futures (commonly known as derivatives). The primary purpose of using derivatives is to attempt to reduce risk to the fund as a whole (hedge) but they may also be used to maintain liquidity, commit cash pending investment or to increase returns. The fund may also enter into interest rate trans- IMPORTANT DEFINITIONS Asset-Backed Securi- ties: Bonds that are backed by a pool of assets, usually loans such as installment sale contracts or credit card receiv- ables. Bonds: Debt obligations such as bonds and debentures, U.S. Gov- ernment securities, debt obligations of domestic and foreign corporations, debt obligations of foreign governments and their political subdivisions, asset-backed securi- ties, various mortgage- backed securities (both residential and commer- cial), other floating or variable rate obli- gations, municipal obligations and zero coupon debt securities. Collateralized Mortgage Obligations (CMO): Are Bonds that are backed by cash flows from pools of mortgages. CMOs may have multiple classes with different payment rights and protections. Commercial Mortgage- Backed Securities (CMBS): A fixed-income security that is backed by a mortgage loan or pools of loans secured by commercial property, not residential mort- gages. Duration: A mathemati- cal calculation of the average life of a bond (or bonds in a bond fund) that serves as a useful measure of its price risk. Each year of duration represents an expected 1% change in the price of a bond for every 1% change in interest rates. For example, if a bond fund has an average duration of four years, its price will fall about 4% when interest rates rise by one percentage point. Conversely, the bond fund's price will rise about 4% when interest rates fall by one percentage point. Lehman Mortgage/10 Year Treasury Index: An unmanaged index com- prised of 50% alloca- tion to the mortgage component of the Lehman Brothers Aggregate Index and a 50% alloca- tion of the Merrill Lynch 10 year Treasury Index. 31 actions as a hedging technique. In these transactions, the fund exchanges its right to pay or receive interest with another party for their right to pay or receive interest. The fund can borrow money to buy additional securities. This practice is known as "leverage." The fund may borrow from banks or other financial institutions or through reverse repurchase agreements (under which the fund sells securi- ties and agrees to buy them back at a particular date and price). The fund normally may borrow up to 33 1/3% of the value of its total assets. The fund may lend some of its securities on a short-term basis in order to earn extra income. The fund will receive collateral in cash or high quality securities equal to the current value of the loaned securities. These loans will be limited to 33 1/3% of the value of the fund's total assets. Should the Company's Board of Trustees determine that the investment objective of the fund should be changed, shareholders will be given at least 30 days notice before any such change is made. Key Risks Key Risks While the fund manager chooses bonds he believes can provide above average current income, there is no guarantee that shares of the fund will not lose value. This means you could lose money. A main risk of investing in the fund is interest rate risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds such as those held by the fund. The fund may make investments in residential and commercial mortgage-backed securities and other asset-backed securities. The characteristics of these mortgage-backed and asset-backed securities differ from traditional fixed income securities. A main difference is that the principal on mortgage-or asset-backed securities may normally be prepaid at any time, which will reduce the yield and market value of these securities. Asset-backed securities and CMBS generally experi- ence less prepayment than residential mortgage-backed securities. In periods of falling interest rates, the rate of prepayments tends to increase (as does price fluctuation) as borrowers are motivated to pay off debt and refinance at new lower rates. During such periods, reinvestment of the prepayment proceeds by the manager will generally be at lower rates of return than the return on the assets which were prepaid. IMPORTANT DEFINITIONS Maturity: The date upon which debt securities are due to be repaid, that is, the date when the issuer generally must pay back the face amount of the security. Mortgage-Backed Securi- ties: Asset-backed securities based on a particular type of asset, a mortgage. There is a wide variety of mortgage backed securities involving commercial or residen- tial, fixed rate or adjustable rate mort- gages and mortgages issued by banks or gov- ernment agencies. Total Return: A way of measuring fund perfor- mance. Total return is based on a calculation that takes into account income dividends, capi- tal gain distributions and the increase or decrease in share price. 32 Certain asset-backed securities are based on loans that are unsecured, which means that there is no collateral to seize if the underlying borrower defaults. Other asset-based securities may not have the benefit of as much collateral as mortgage-backed securities. Treasury obligations differ only in their interest rates, maturities and times of issuance. Obligations of U.S. Government agencies and authorities are sup- ported by the full faith and credit of the United States. Others are supported by the right of the issuer to borrow from the Treasury, and others are sup- ported only by the credit of the entity. No assurance can be given that the U.S. Government will provide financial support to its agencies and authorities if it is not obligated by law to do so. The fund's use of derivative and interest rate transactions may reduce the fund's returns and/or increase volatility, which is defined as the characteris- tic of a security or a market to fluctuate significantly in price within a short period of time. Leverage is a speculative technique which may expose the fund to greater risk and increase its cost. Increases and decreases in the value of the fund's portfolio will be magnified when the fund uses leverage. The fund will also have to pay interest on its borrowings, reducing the fund's return. Securities loans involve the risk of a delay in receiving additional collateral if the value of the securities goes up while they are on loan. There is also the risk of delay in recovering the loaned securities and of losing rights to the collateral if a borrower goes bankrupt. The fund, like any business, could be affected if the computer systems on which it relies do not properly process information beginning on January 1, 2000. While Year 2000 issues could have a negative effect on the fund, BlackRock, the fund's investment adviser, is currently working to avoid such problems. Black- Rock is also working with other systems providers and vendors to determine their systems' ability to handle Year 2000 problems. There is no guarantee, however, that systems will work properly on January 1, 2000. Year 2000 problems may also hurt issuers whose securities the fund holds or securities markets generally. When you invest in this fund you are not making a bank deposit. Your investment is not insured or guaranteed by the Federal Deposit Insurance Corporation or by any bank or governmental agency. 33 Risk / Return Information The chart and table below give you a picture of the fund's long-term perfor- mance for Investor A Shares (in the chart) and for Investor A, B and C Shares (in the table). The information shows you how the fund's performance has varied year by year and provides some indication of the risks of investing in the fund. The table compares the fund's performance to that of the Lehman Mort- gage/10 Year Treasury Index, a recognized unmanaged index of bond market per- formance. The chart and the table both assume reinvestment of dividends and distributions. As with all such investments, past performance is not an indica- tion of future results. Sales charges are not reflected in the bar chart. If they were, returns would be less than those shown. The performance for the period before Investor C Shares were launched is based upon performance for Investor B Shares of the fund. Investor C Shares were launched in February 1997. As of 12/31 Investor A Shares - -------------------------------------------------------------------------------- A N N U A L T O T A L R E T U R N S - -------------------------------------------------------------------------------- [BAR CHART APPEARS HERE] Best Quarter Q2 '95: 6.92% Worst Quarter Q1 '96: -1.94% 95 96 97 98 ------ ------ ------ ------ 18.99% 3.41% 10.52% 8.00% As of 12/31/98 - -------------------------------------------------------------------------------- A V E R A G E A N N U A L T O T A L R E T U R N S - -------------------------------------------------------------------------------- Since Inception 1 Year 3 Years Inception Date - -------------------------------------------------------------------------------- Government Income; Inv A 3.10% 5.63% 8.27% 10/03/94 - -------------------------------------------------------------------------------- Government Income; Inv B 2.38% 5.21% 7.50% 10/03/94 - -------------------------------------------------------------------------------- Government Income; Inv C 6.13% 6.46% 8.68% 10/03/94 - -------------------------------------------------------------------------------- Leh. Mtg./10 Yr. Tsy. 9.86% 7.57% 10.03% N/A* - -------------------------------------------------------------------------------- * For comparative purposes, the value of the index on 10/01/94 is used as the beginning value on 10/03/94. EXPENSES AND FEES Expenses and Fees As a shareholder you pay certain fees and expenses. Shareholder transaction fees are paid out of your investment and annual fund operating expenses are paid out of fund assets and are reflected in the fund's price. This prospectus offers shareholders different ways to invest with three sepa- rate pricing options. You need to understand your choices so that you can choose the pricing option that is most suitable for you. With one option (In- vestor A Shares) you pay a one- These returns assume payment of applicable sales charges. 34 time front-end transaction fee each time you buy shares. The other options (In- vestor B and Investor C Shares) have no front-end charges but have higher on- going fees, which are paid over the life of the investment, and have a contin- gent deferred sales charge (CDSC) that you may pay when you redeem your shares. Which option should you choose? It depends on your individual circumstances. You should know that the lowest sales charge won't necessarily be the least expensive option over time. For example, if you intend to hold your shares long term it may cost less to buy A Shares than B or C Shares. The tables below explain your pricing options and describe the fees and expenses that you may pay if you buy and hold Investor A, B and C Shares of the fund. The "Annual Fund Operating Expenses" table is based on expenses for the most recent fiscal year. Shareholder Fees (Fees paid directly from your investment)
A Shares B Shares C Shares Maximum Front-End Sales Charge* 4.5% 0.0% 0.0% (as percentage of offering price) Maximum Deferred Sales Charge 0.0% 4.5%** 1.00%*** (as percentage of offering price)
* Reduced front-end sales charges may be available. A CDSC of up to 1.00% is assessed on certain redemptions of Investor A Shares that are purchased with no initial sales charge as part of an investment of $1,000,000 or more. ** The CDSC is 4.5% if shares are redeemed in less than one year. The CDSC for Investor B Shares decreases for redemptions made in subsequent years. After six years there is no CDSC on B Shares. (See page 120 for complete schedule of CDSCs.) *** There is no CDSC on C Shares after one year. Annual Fund Operating Expenses (Expenses that are deducted from fund assets)
A Shares B Shares C Shares Advisory Fees .50% .50% .50% Distribution and service (12b-1) fees .50% 1.15% 1.15% Other expenses .73% .73% .73% Total annual fund operating expenses 1.73% 2.38% 2.38% Fee waivers and expense reimbursements* .66% .56% .56% Net Expenses* 1.07% 1.82% 1.82%
* BlackRock has contractually agreed to waive or reimburse fees or expenses in order to limit certain (but not all) fund expenses for the next year. The fund may have to repay these waivers and reimbursements to BlackRock in the following two years if the repayment can be made within these expense limits. In addition, BlackRock Distributors, Inc., the fund's distributor, has contractually agreed to waive all 12b-1 distribution fees on Investor A Shares (otherwise payable at the maximum annual rate of .10% of average daily net assets) for the next year. "Net Expenses" in the table have been restated to reflect these waivers and reimbursements. The table does not reflect charges or credits which investors might incur if they invest through a financial institution. IMPORTANT DEFINITIONS Advisory Fees: Fees paid to the investment adviser for portfolio management services. Service Fees: Fees that are paid to BlackRock and /or its affiliates for shareholder account service and mainte- nance. Distribution Fees: A method of charging dis- tribution-related expenses against fund assets. Other Expenses: Include administration, trans- fer agency, custody, professional fees and registration fees. 35 Example: This example is intended to help you compare the cost of investing in the fund with the cost of investing in other mutual funds. We are assuming an initial investment of $10,000, 5% total return each year with no changes in operating expenses (except for the waivers in the first year discussed above), redemption at the end of each time period and, with respect to B Shares and C Shares only, no redemption at the end of each time period. Although your actual cost may be higher or lower, based on these assumptions your costs would be:
1 Year 3 Years 5 Years 10 Years A Shares* $554 $ 910 $1,287 $2,347 B Shares** Redemption $635 $1,039 $1,420 $2,435*** B Shares No Redemption $185 $ 689 $1,220 $2,435*** C Shares** Redemption $285 $ 689 $1,220 $2,674 C Shares No Redemption $185 $ 689 $1,220 $2,674
*Reflects imposition of sales charge. **Reflects deduction of CDSC. *** Based on the conversion of the Investor B Shares to Investor A Shares after seven years. Fund Management The co-managers of the fund are Robert Kapito, Vice Chairman of BlackRock Financial Management, Inc. (BFM) since 1988, Scott Amero, Managing Director of BFM since 1990 and Michael Lustig, Director of BFM since 1989. They have all co-managed the fund since 1995. 36 Financial Highlights The financial information in the table below shows the fund's financial perfor- mance for the periods indicated. Certain information reflects results for a single fund share. The term "Total Return" indicates how much your investment would have increased or decreased during this period of time and assumes that you have reinvested all dividends and distributions. These figures have been audited by PricewaterhouseCoopers LLP, the fund's independent accountants. The auditor's report, along with the fund's financial statements, are included in the Company's annual report which is available upon request (see back cover for ordering instructions). FINANCIAL HIGHLIGHTS - -------------------------------------------------------------------------------- (For an Investor A, B or C Share Outstanding Throughout Each Period) Government Income Portfolio
INVESTOR A SHARES - -------------------------------------------------------------------------------- For the Period Year Year Year 10/03/94/1 Ended Ended Ended / through 9/30/98 9/30/97 9/30/96 9/30/95 Net asset value at beginning of period $10.49 $10.20 $10.68 $10.00 ------ ------ ------ ------ Income from investment operations Net investment income 0.53 0.73 0.68 0.55 Net gain (loss) on investments (both realized and unrealized) 0.54 0.30 (0.22) 0.68 ------ ------ ------ ------ Total from investment operations 1.07 1.03 0.46 1.23 ------ ------ ------ ------ Less distributions Distributions from net investment income (0.61) (0.74) (0.66) (0.55) Distributions from net realized capital gains (0.11) - - (0.28) - - ------ ------ ------ ------ Total distributions (0.72) (0.74) (0.94) (0.55) ------ ------ ------ ------ Net asset value at end of period $10.84 $10.49 $10.20 $10.68 ====== ====== ====== ====== Total return/3/ 11.13% 10.48% 4.43% 14.27% Ratios/Supplemental data Net assets at end of period (in thousands) $6,045 $4,876 $3,651 $2,990 Ratios of expenses to average net assets After advisory/administration fee waivers 1.05%/4/ 1.02%/4/ 0.91%/4/ 0.37%/2/, /4/ Before advisory/administration fee waivers 1.63% 1.74% 1.67% 1.81%/2/ Ratios of net investment income to average net assets After advisory/administration fee waivers 5.86% 8.02% 8.59% 6.89%/2/ Before advisory/administration fee waivers 5.28% 7.30% 7.83% 5.44%/2/ Portfolio turnover rate 477% 393% 434% 258% INVESTOR B INVESTOR SHARES C SHARES ------------------------------------------------------ ----------------------------- Year Year Year Year Year Year Ended Ended Ended Ended Ended Ended 9/30/98 9/30/97 9/30/96 9/30/95 9/30/98 9/30/97 Net asset value at beginning of period $ 10.49 $ 10.20 $10.68 $ 10.00 $10.49 $10.30 ----------- ----------- ----------- ------------------ ----------- ----------------- Income from investment operations Net investment income 0.54 0.66 0.60 0.50 0.51 0.37 Net gain (loss) on investments (both realized and unrealized) 0.50 0.30 (0.21) 0.68 0.53 0.20 ----------- ----------- ----------- ------------------ ----------- ----------------- Total from investment operations 1.04 0.96 0.39 1.18 1.04 0.57 ----------- ----------- ----------- ------------------ ----------- ----------------- Less distributions Distributions from net investment income (0.58) (0.67) (0.59) (0.50) (0.58) (0.38) Distributions from net realized capital gains (0.11) - - (0.28) - - (0.11) - - ----------- ----------- ----------- ------------------ ----------- ----------------- Total distributions (0.69) (0.67) (0.87) (0.50) (0.69) (0.38) ----------- ----------- ----------- ------------------ ----------- ----------------- Net asset value at end of period $ 10.84 $ 10.49 $10.20 $ 10.68 $10.84 $10.49 =========== =========== =========== ================== =========== ================= Total return/3/ 10.31% 9.66% 3.68% 13.52% 10.31% 5.64% Ratios/Supplemental data Net assets at end of period (in thousands) $25,165 $14,796 $11,119 $10,188 $1,551 $ 849 Ratios of expenses to average net assets After advisory/administration fee waivers 1.80%/4/ 1.77%/4/ 1.64%/4/ 1.05%/2/, /4/ 1.80%/4/ 1.70%/2/, /4/ Before advisory/administration fee waivers 2.38% 2.49% 2.40% 2.50%/2/ 2.38% 2.42%/2/ Ratios of net investment income to average net assets After advisory/administration fee waivers 5.03% 7.26% 7.81% 6.17%/2/ 4.98% 7.11%/2/ Before advisory/administration fee waivers 4.45% 6.54% 7.05% 4.72%/2/ 4.40% 6.39%/2/ Portfolio turnover rate 477% 393% 434% 258% 477% 393%
- ------------------------------------------------------------- /1/Commencement of operations of share class. /2/Annualized. /3/Neither front-end sales load nor contingent deferred sales load is reflected. /4/Including interest expense, ratios for the Investor A, Investor B and Investor C Shares would have been 1.46%, 2.01% and 2.14%, respectively, for the year ended September 30, 1998, 1.41%, 2.14% and 3.24%, respectively, for the year ended September 30, 1997, 2.96% and 3.69%, respectively, for the year ended September 30, 1996, and 0.92% and 1.60%, respectively, for the period ended September 30, 1995. 37 [GRAPHIC BlackRock APPEARS GNMA HERE] Portfolio - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Investment Goal The fund seeks current income consistent with the preservation of capital. Primary Investment Strategies In pursuit of this goal, the fund manager invests primarily in securities issued by the Government National Mortgage Association (GNMA) as well as other U.S. Government securities in the five to ten year maturity range. The fund normally invests at least 80% of its total assets in bonds (including U.S. Treasuries and agency securities and mortgage-backed and asset-backed securi- ties) and at least 65% of its total assets in GNMA securities. Securities purchased by the fund are rated in the highest rating category (AAA or Aaa) at the time of purchase by at least one major rating agency or are determined by the fund manager to be of similar quality. Securities are purchased for the fund when the manager determines that they have the potential for above-average current income. The fund measures its per- formance against the Lehman GNMA Index (the benchmark). If a security falls below the highest rating, the manager will decide whether to continue to hold the security. A security will be sold if, in the opinion of the fund manager, the risk of continuing to hold the security is unacceptable when compared to the total return potential. The fund manager will normally attempt to structure the fund's portfolio to have comparable duration to its benchmark. Duration, which measures price sen- sitivity to interest rate changes, is not necessarily equal to average maturi- ty. The fund manager may, when consistent with the fund's investment objective, use options or futures (commonly known as derivatives). The primary purpose of using derivatives is to attempt to reduce risk to the fund as a whole (hedge) but they may also be used to maintain liquidity, commit cash pending investment or to increase returns. The fund may also enter into interest rate transactions as a hedging technique. In these transactions, the fund exchanges its right to pay or receive interest with another party for their right to pay or receive interest. IMPORTANT DEFINITIONS Asset-Backed Securi- ties: Bonds that are backed by a pool of assets, usually loans such as installment sale contracts or credit card receivables. Bonds: Debt obligations such as bonds and debentures, U.S. Gov- ernment securities, debt obligations of domestic and foreign corporations, debt obligations of foreign governments and their political subdivisions, asset-backed securi- ties, various mortgage- backed securities (both residential and commer- cial), other floating or variable rate obli- gations, municipal obligations and zero coupon debt securities. Commercial Mortgage- Backed Securities (CMBS): Bonds that are backed by a mortgage loan or pool of loans secured by commercial property, not residen- tial mortgages. Duration: A mathemati- cal calculation of the average life of a bond (or bonds in a bond fund) that serves as a useful measure of its price risk. Each year of duration represents an expected 1% change in the price of a bond for every 1% change in interest rates. For example, if a bond fund has an average duration of four years, its price will fall about 4% when interest rates rise by one percentage point. Conversely, the bond fund's price will rise about 4% when interest rates fall by one percentage point. GNMA Securities: Secu- rities issued by the Government National Mortgage Association (GNMA). These securi- ties represent inter- ests in pools of resi- dential mortgage loans originated by private lenders and pass income from the initial debt- ors (homeowners) through intermediaries to investors. GNMA securities are backed by the full faith and credit of the U.S. Gov- ernment. Lehman GNMA Index: An unmanaged index com- prised of mortgage- backed pass through securities of the Gov- ernment National Mort- gage Association (GNMA). Maturity: The date upon which debt securities are due to be repaid, that is, the date when the issuer generally must pay back the face amount of the security. 38 The fund can borrow money to buy additional securities. This practice is known as "leverage." The fund may borrow from banks or other financial institutions or through reverse repurchase agreements (under which the fund sells securities and agrees to buy them back at a particular date and price). The fund normally may borrow up to 33 1/3% of the value of its total assets. The fund may lend some of its securities on a short-term basis in order to earn extra income. The fund will receive collateral in cash or high quality securi- ties equal to the current value of the loaned securities. These loans will be limited to 33 1/3% of the value of the fund's total assets. Should the Company's Board of Trustees determine that the investment objective of the fund should be changed, shareholders will be given at least 30 days notice before any such change is made. KEY RISKS Key Risks While the fund manager chooses bonds he believes can provide above average cur- rent income, there is no guarantee that shares of the fund will not lose value. This means you could lose money. A main risk of investing in the fund is interest rate risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds such as those held by the fund. In addition to GNMA securities, the fund may make investments in other residen- tial and commercial mortgage-backed securities and other asset-backed securi- ties. The characteristics of mortgage-backed and asset-backed securities differ from traditional fixed income securities. A main difference is that the principal on mortgage-or asset-backed securities may normally be prepaid at any time, which will reduce the yield and market value of these securities. Asset-backed securities and CMBS generally experi- ence less prepayment than residential mortgage-backed securities. In periods of falling interest rates, the rate of prepayments tends to increase (as does price fluctuation) as borrowers are motivated to pay off debt and refinance at new lower rates. During such periods, reinvestment of the prepayment proceeds by the manager will generally be at lower rates of return than the return on the assets which were prepaid. Certain asset-backed securities are based on loans that are unsecured, which means that there is no collateral to seize if the underlying borrower defaults. Other asset-based securities may not have the benefit of as much collateral as mortgage-backed securities. IMPORTANT DEFINITIONS Mortgage-Backed Securi- ties: Asset-backed securities based on a particular type of asset, a mortgage. There is a wide variety of mortgage backed securities involving commercial or residen- tial, fixed rate or adjustable rate mort- gages and mortgages issued by banks or gov- ernment agencies. Total Return: A way of measuring fund perfor- mance. Total return is based on a calculation that takes into account income dividends, capi- tal gain distributions and the increase or decrease in share price. 39 Treasury obligations differ only in their interest rates, maturities and times of issuance. Obligations of U.S. Government agencies and authorities are sup- ported by varying degrees of credit. No assurance can be given that the U.S. Government will provide financial support to its agencies and authorities if it is not obligated by law to do so. The fund's use of derivatives and interest rate transactions may reduce the fund's returns and/or increase volatility, which is defined as the character- istic of a security or a market to fluctuate significantly in price within a short period of time. Leverage is a speculative technique which may expose the fund to greater risk and increase its costs. Increases and decreases in the value of the fund's portfolio will be magnified when the fund uses leverage. The fund will also have to pay interest on its borrowings, reducing the fund's return. Securities loans involve the risk of a delay in receiving additional collat- eral if the value of the securities goes up while they are on loan. There is also the risk of delay in recovering the loaned securities and of losing rights to the collateral if a borrower goes bankrupt. The fund, like any business, could be affected if the computer systems on which it relies do not properly process information beginning on January 1, 2000. While Year 2000 issues could have a negative effect on the fund, Black- Rock, the fund's investment adviser, is currently working to avoid such prob- lems. BlackRock is also working with other systems providers and vendors to determine their systems' ability to handle Year 2000 problems. There is no guarantee, however, that systems will work properly on January 1, 2000. Year 2000 problems may also hurt issuers whose securities the fund holds or securi- ties markets generally. When you invest in this fund you are not making a bank deposit. Your invest- ment is not insured or guaranteed by the Federal Deposit Insurance Corporation or by any bank or governmental agency. 40 Risk / Return Information The chart and table below give you a picture of the fund's long-term perfor- mance for Investor A Shares (in the chart) and for Investor A, B and C Shares (in the table). The information shows you how the fund's performance has varied year by year and provides some indication of the risks of investing in the fund. The table compares the fund's performance to that of the Lehman GNMA Index, a recognized unmanaged index of bond market performance. The chart and the table both assume reinvestment of dividends and distributions. As with all such investments, past performance is not an indication of future results. Sales charges are not reflected in the bar chart. If they were, returns would be less than those shown. The performance for the period before the fund was launched is based upon per- formance for a predecessor common trust fund which transferred its assets and liabilities to the fund. The fund was launched in May 1998. As of 12/31 Investor A Shares - -------------------------------------------------------------------------------- A N N U A L T O T A L R E T U R N S - -------------------------------------------------------------------------------- [BAR CHART APPEARS HERE] Best Quarter Q2 '95: 5.71% Worst Quarter Q1 '94: -3.77% 91 92 93 94 95 96 97 98 ------ ------ ------ ------ ------ ----- ----- ------ 15.49% 6.22% 7.36% -3.99% 17.18% 4.23% 9.19% 7.05% As of 12/31/98 - -------------------------------------------------------------------------------- A V E R A G E A N N U A L T O T A L R E T U R N S - -------------------------------------------------------------------------------- Since Inception 1 Year 3 Years 5 Years Inception Date - -------------------------------------------------------------------------------- GNMA; Inv A 2.81% 5.35% 5.65% 7.39% 05/31/90 - -------------------------------------------------------------------------------- GNMA; Inv B 1.49% 4.75% 5.29% 7.11% 05/31/90 - -------------------------------------------------------------------------------- GNMA; Inv C 5.21% 6.00% 5.72% 7.11% 05/31/90 - -------------------------------------------------------------------------------- Lehman GNMA Index 6.92% 7.31% 7.33% 8.09% N/A* - -------------------------------------------------------------------------------- * For comparative purposes, the value of the index on 06/01/90 is used as the beginning value on 05/31/90. These returns assume payment of applicable sales charge. 41 EXPENSES AND FEES Expenses and Fees As a shareholder you pay certain fees and expenses. Shareholder transaction fees are paid out of your investment and annual fund operating expenses are paid out of fund assets and are reflected in the fund's price. This prospectus offers shareholders different ways to invest with three sepa- rate pricing options. You need to understand your choices so that you can choose the pricing option that is most suitable for you. With one option (In- vestor A Shares) you pay a one-time front-end transaction fee each time you buy shares. The other options (Investor B and Investor C Shares) have no front-end charges but have higher on-going fees, which are paid over the life of the investment, and have a contingent deferred sales charge (CDSC) that you may pay when you redeem your shares. Which option should you choose? It depends on your individual circumstances. You should know that the lowest sales charge won't necessarily be the least expensive option over time. For example, if you intend to hold your shares long term it may cost less to buy A Shares than B or C Shares. The tables below explain your pricing options and describe the fees and expenses that you may pay if you buy and hold Investor A, B and C Shares of the fund. The "Annual Fund Operating Expenses" table is based on expenses for the most recent fiscal year. Shareholder Fees (Fees paid directly from your investment)
A Shares B Shares C Shares Maximum Front-End Sales Charge* 4.0% 0.0% 0.0% (as percentage of offering price) Maximum Deferred Sales Charge 0.0% 4.5%** 1.00%*** (as percentage of offering price)
* Reduced front-end sales charges may be available. A CDSC of up to 1.00% is assessed on certain redemptions of Investor A Shares that are purchased with no initial sales charge as part of an investment of $1,000,000 or more. ** The CDSC is 4.5% if shares are redeemed in less than one year. The CDSC for Investor B Shares decreases for redemptions made in subsequent years. After six years there is no CDSC on B Shares. (See page 120 for complete schedule of CDSCs.) *** There is no CDSC on C Shares after one year. 42 IMPORTANT DEFINITIONS Advisory Fees: Fees paid to the investment adviser for portfolio management services. Service Fees: Fees that are paid to BlackRock and /or its affiliates for shareholder account service and mainte- nance. Distribution Fees: A method of charging dis- tribution-related expenses against fund assets. Other Expenses: Include administration, trans- fer agency, custody, professional fees and registration fees. Annual Fund Operating Expenses (Expenses that are deducted from fund assets)
A Shares B Shares C Shares Advisory Fees .55% .55% .55% Distribution and service (12b- 1) fees .50% 1.15% 1.15% Other expenses* .49% .49% .49% Total annual fund operating expenses 1.54% 2.19% 2.19% Fee waivers and expense reimbursements** .47% .37% .37% Net Expenses** 1.07% 1.82% 1.82%
* "Other expenses" are based on estimated amounts for the current fiscal year. ** BlackRock has contractually agreed to waive or reimburse fees or expenses in order to limit certain (but not all) fund expenses for the next year. The fund may have to repay these waivers and reimbursements to BlackRock in the following two years if the repayment can be made within these expense limits. In addition, BlackRock Distributors, Inc., the fund's distributor, has contractually agreed to waive all 12b-1 distribution fees on Investor A Shares (otherwise payable at the maximum annual rate of .10% of average daily net assets) for the next year. "Net Expenses" in the table have been restated to reflect these waivers and reimbursements. The table does not reflect charges or credits which investors might incur if they invest through a financial institution. Example: This example is intended to help you compare the cost of investing in the fund with the cost of investing in other mutual funds. We are assuming an initial investment of $10,000, 5% total return each year with no changes in operating expenses (except for the waivers in the first year discussed above), redemption at the end of each time period and, with respect to B Shares and C Shares only, no redemption at the end of each time period. Although your actual cost may be higher or lower, based on these assumptions your costs would be:
1 Year 3 Years A Shares* $505 $ 823 B Shares** Redemption $635 $1,000 B Shares No Redemption $185 $ 650 C Shares** Redemption $285 $ 650 C Shares No Redemption $185 $ 650
*Reflects imposition of sales charge. **Reflects deduction of CDSC. 43 Fund Management The co-managers of the fund are Robert Kapito, Vice Chairman of BlackRock Financial Management, Inc. (BFM) since 1988, Scott Amero, Managing Director of BFM since 1990, and Michael Lustig, Director of BFM since 1989. They have all co-managed the fund since inception. Financial Highlights The financial information in the table below shows the fund's financial perfor- mance for the period indicated. Certain information reflects results for a sin- gle fund share. The term "Total Return" indicates how much your investment would have increased or decreased during this period of time and assumes that you have reinvested all dividends and distributions. These figures have been audited by PricewaterhouseCoopers LLP, the fund's independent accountants. The auditor's report, along with the fund's financial statements, are included in the Company's annual report, which is available upon request (see back cover for ordering instructions). FINANCIAL HIGHLIGHTS - -------------------------------------------------------------------------------- (For an Investor A, B or C Share Outstanding Throughout Each Period) GNMA Portfolio
INVESTOR INVESTOR INVESTOR A SHARES B SHARES C SHARES For the For the For the Period Period Period 5/18/98/1 5/18/98/1 5/18/98/1 / through / through / through 9/30/98 9/30/98 9/30/98 Net asset value at beginning of period $10.00 $10.00 $10.00 ------ ------ ------ Income from investment operations Net investment income 0.20 0.17 0.23 Net gain (loss) on investments (both realized and unrealized) 0.11 0.11 0.05 ------ ------ ------ Total from investment operations 0.31 0.28 0.28 ------ ------ ------ Less distributions Distributions from net investment income (0.20) (0.17) (0.17) Distributions from net realized capital gains - - - - - - ------ ------ ------ Total distributions (0.20) (0.17) (0.17) ------ ------ ------ Net asset value at end of period $10.11 $10.11 $10.11 ====== ====== ====== Total return/3/ 3.12% 2.85% 2.85% Ratios/Supplemental data Net assets at end of period (in thousands) $ 535 $ 166 $ - - Ratios of expenses to average net assets After advisory/administration fee waivers 1.06%/2/,/4/ 1.70%/2/,/4/ 0.57%/2/,/4/ Before advisory/administration fee waivers 1.43%/2/ 2.07%/2/ 0.94%/2/ Ratios of net investment income to average net assets After advisory/administration fee waivers 5.69%/2/ 4.53%/2/ 5.26%/2/ Before advisory/administration fee waivers 5.32%/2/ 4.16%/2/ 4.90%/2/ Portfolio turnover rate 56% 56% 56%
/1/Commencement of operations of share class. /2/Annualized. /3/Neither front-end sales load nor contingent deferred sales load is reflected. /4/Including interest expense, ratios for the Investor A, Investor B and Investor C Shares would have been 1.10%, 1.73% and 0.08%, respectively, for the year ended September 30, 1998. 44 [GRAPHIC BlackRock APPEARS Managed Income HERE] Portfolio - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Investment Goal The fund seeks current income consistent with the preservation of capital. Primary Investment Strategies In pursuit of this goal, the fund manager invests primarily in investment grade bonds in the five to ten year maturity range. The fund normally invests at least 80% of its total assets in bonds and only buys securities rated invest- ment grade at the time of purchase by at least one major rating agency or determined by the manager to be of similar quality. The fund may invest up to 10% of its total assets in bonds of foreign issuers. The management team evaluates categories of the bond market and individual bonds within those categories. The manager selects bonds from several catego- ries including: U.S. Treasuries and agency securities, commercial and residen- tial mortgage-backed securities, asset-backed securities and corporate bonds. Securities are purchased for the fund when the manager determines that they have the potential for above-average current income. The fund measures its per- formance against the Lehman Brothers Aggregate Index (the benchmark). If a security falls below investment grade, the manager will decide whether to continue to hold the security. A security will be sold if, in the opinion of the fund manager, the risk of continuing to hold the security is unacceptable when compared to the total return potential. The fund manager will normally attempt to structure the fund's portfolio to have comparable duration to its benchmark. Duration, which measures price sen- sitivity to interest rate changes, is not necessarily equal to average maturi- ty. The fund manager may, when consistent with the fund's investment objective, use options or futures (commonly known as derivatives). The primary purpose of using derivatives is to attempt to reduce risk to the fund as a whole (hedge) but they may also be used to maintain liquidity, commit cash pending investment or to increase returns. The fund may also enter into interest rate or foreign currency transactions as a hedging technique. In these transactions, the fund exchanges its right to pay or receive interest or currencies with another party for their right to pay or receive interest or another currency in the future. IMPORTANT DEFINITIONS Asset-Backed Securi- ties: Bonds that are backed by a pool of assets, usually loans such as installment sale contracts or credit card receiv- ables. Bonds: Debt obligations such as bonds and debentures, U.S. Gov- ernment securities, debt obligations of domestic and foreign corporations, debt obligations of foreign governments and their political subdivisions, asset-backed securi- ties, various mortgage- backed securities (both residential and commer- cial), other floating or variable rate obli- gations, municipal obligations and zero coupon debt securities. Commercial Mortgage- Backed Securities (CMBS): Bonds that are backed by a mortgage loan or pools of loans secured by commercial property, not residen- tial mortgages. Duration: A mathemati- cal calculation of the average life of a bond (or bonds in a bond fund) that serves as a useful measure of its price risk. Each year of duration represents an expected 1% change in the price of a bond for every 1% change in interest rates. For example, if a bond fund has an average duration of four years, its price will fall about 4% when interest rates rise by one percentage point. Conversely, the bond fund's price will rise about 4% when interest rates fall by one percentage point. Investment Grade: Secu- rities which are rated in the four highest categories by at least one of the major rating agencies or determined by the fund manager to be of similar quality. Generally, the higher the rating of a bond, the higher the likeli- hood that interest and principal payments will be made on time. Secu- rities rated in the fourth highest category by the rating agencies are considered invest- ment grade but they are also considered specu- lative, meaning that they carry more risk than higher rated secu- rities and may have problems making princi- pal and interest pay- ments in difficult eco- nomic climates. Investment grade rat- ings do not guarantee that bonds will not lose value. Lehman Brothers Aggre- gate Index: An unman- aged index comprised of more than 5,000 taxable bonds. This is an index of investment grade bonds; all securities included must be rated investment grade by Moody's or Standard & Poor's. 45 The fund can borrow money to buy additional securities. This practice is known as "leverage." The fund may borrow from banks or other financial institutions or through reverse repurchase agreements (under which the fund sells securi- ties and agrees to buy them back at a particular date and price). The Fund normally may borrow up to 33 1/3% of the value of its total assets. The fund may lend some of its securities on a short-term basis in order to earn extra income. The fund will receive collateral in cash or high quality securities equal to the current value of the loaned securities. These loans will be limited to 33 1/3% of the value of the fund's total assets. Should the Company's Board of Trustees determine that the investment objective of the fund should be changed, shareholders will be given at least 30 days notice before any such change is made. KEY RISKS Key Risks While the fund manager chooses bonds he believes can provide above average current income, there is no guarantee that shares of the fund will not lose value. This means you could lose money. Two of the main risks of investing in the fund are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds such as those held by the fund. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. The fund may make investments in residential and commercial mortgage-backed securities and other asset-backed securities. The characteristics of these mortgage-backed and asset-backed securities differ from traditional fixed income securities. A main difference is that the principal on mortgage- or asset-backed securi- ties may normally be prepaid at any time, which will reduce the yield and mar- ket value of these securities. Asset-backed securities and CMBS generally experience less prepayment than residential mortgage-backed securities. In periods of falling interest rates, the rate of prepayments tends to increase (as does price fluctuation) as borrowers are motivated to pay off debt and refinance at new lower rates. During such periods, reinvestment of the prepay- ment proceeds by the manager will generally be at lower rates of return than the return on the assets which were prepaid. Certain asset-backed securities are based on loans that are unsecured, which means that there is no collateral to seize if the underlying borrower defaults. Other asset-based securities may not have the benefit of as much collateral as mortgage-backed securities. Treasury obligations differ only in their interest rates, maturities and times of issuance. Obligations of U.S. Government agencies IMPORTANT DEFINITIONS Maturity: The date upon which debt securities are due to be repaid, that is, the date when the issuer generally must pay back the face amount of the security. Mortgage-Backed Securi- ties: Asset-backed securities based on a particular type of asset, a mortgage. There is a wide variety of mortgage backed securities involving commercial or residen- tial, fixed rate or adjustable rate mort- gages and mortgages issued by banks or gov- ernment agencies. Total Return: A way of measuring fund perfor- mance. Total return is based on a calculation that takes into account income dividends, capi- tal gain distributions and the increase or decrease in share price. 46 and authorities are supported by varying degrees of credit. No assurance can be given that the U.S. Government will provide financial support to its agencies and authorities if it is not obligated by law to do so. The fund's use of derivatives, interest rate and foreign currency transactions may reduce the fund's returns and/or increase volatility, which is defined as the characteristic of a security or a market to fluctuate significantly in price within a short period of time. Leverage is a speculative technique which may expose the fund to greater risk and increase its costs. Increases and decreases in the value of the fund's portfolio will be magnified when the fund uses leverage. The fund will also have to pay interest on its borrowings, reducing the fund's return. The fund may invest up to 10% of its total assets in bonds of foreign issuers. Foreign securities involve risks not typically associated with investing in U.S. securities. These risks include but are not limited to: currency risks (the risk that the value of interest paid on foreign securities, or the value of the securities themselves, may fall if currency exchange rates change), the risk that a security's value will be hurt by changes in foreign political or social conditions, the possibility of heavy taxation or expropriation and more difficulty obtaining information on foreign securities or companies. In addi- tion, a portfolio of foreign securities may be harder to sell and may be sub- ject to wider price movements than comparable investments in U.S. companies. There is also less government regulation of foreign securities markets. On January 1, 1999, eleven European countries implemented a new currency unit called the "Euro" which is expected to reshape financial markets, banking sys- tems and monetary policies in Europe and other parts of the world. While it is impossible to predict the impact of the "Euro," it is possible that it could increase volatility in financial markets worldwide which could hurt the value of shares of the fund. Securities loans involve the risk of a delay in receiving additional collateral if the value of the securities goes up while they are on loan. There is also the risk of delay in recovering the loaned securities and of losing rights to the collateral if a borrower goes bankrupt. The fund, like any business, could be affected if the computer systems on which it relies do not properly process information beginning on January 1, 2000. While Year 2000 issues could have a negative effect on the fund, BlackRock, the fund's investment adviser, is currently working to avoid such problems. Black- Rock is also working with other systems providers and vendors to determine their systems' ability to handle Year 2000 problems. There is no guarantee, however, that systems will work properly on 47 January 1, 2000. Year 2000 problems may also hurt issuers whose securities the fund holds or securities markets generally. When you invest in this fund you are not making a bank deposit. Your investment is not insured or guaranteed by the Federal Deposit Insurance Corporation or by any bank or governmental agency. Risk / Return Information The chart and table below give you a picture of the fund's long-term perfor- mance for Investor A Shares (in the chart) and for Investor A and B Shares (in the table). The information shows you how the fund's performance has varied year by year and provides some indication of the risks of investing in the fund. The table compares the fund's performance to that of the Lehman Brothers Aggregate Index, a recognized unmanaged index of bond market performance. The chart and the table both assume reinvestment of dividends and distributions. As with all such investments, past performance is not an indication of future results. Sales charges are not reflected in the bar chart. If they were, returns would be less than those shown. The performance for the period before Investor Shares were launched is based upon performance for older share classes of the fund. Investor A Shares were launched in February 1992 and Investor B Shares were launched in July 1997. The actual return of Investor Shares would have been lower than shown because Investor Shares have higher expenses than these older classes. Also, the actual return of Investor B Shares would have been lower compared to Investor A Shares. As of 12/31 Investor A Shares - -------------------------------------------------------------------------------- A N N U A L T O T A L R E T U R N S - -------------------------------------------------------------------------------- [BAR CHART APPEARS HERE] Best Quarter Q3 '91: 5.78% Worst Quarter Q1 '94: -3.50% 90 91 92 93 94 95 96 97 98 ------ ------ ------ ------ ------ ------ ----- ----- ------ 8.30% 14.96% 5.91% 11.50% -4.90% 16.94% 2.95% 8.95% 6.79% As of 12/31/98 - -------------------------------------------------------------------------------- A V E R A G E A N N U A L T O T A L R E T U R N S - -------------------------------------------------------------------------------- Since Inception 1 Year 3 Years 5 Years Inception Date - -------------------------------------------------------------------------------- Managed Income; Inv A 2.01% 4.57% 4.93% 7.19% 11/01/89 - -------------------------------------------------------------------------------- Managed Income; Inv B 1.23% 4.60% 5.27% 7.61% 11/01/89 - -------------------------------------------------------------------------------- Lehman Aggregate 8.69% 7.29% 7.27% 8.66% N/A - -------------------------------------------------------------------------------- These returns assume payment of applicable sales charges. 48 EXPENSES AND FEES Expenses and Fees As a shareholder you pay certain fees and expenses. Shareholder transaction fees are paid out of your investment and annual fund operating expenses are paid out of fund assets and are reflected in the fund's price. This prospectus offers shareholders different ways to invest with three sepa- rate pricing options. You need to understand your choices so that you can choose the pricing option that is most suitable for you. With one option (In- vestor A Shares) you pay a one-time front-end transaction fee each time you buy shares. The other options (Investor B and Investor C Shares) have no front-end charges but have higher on-going fees, which are paid over the life of the investment, and have a contingent deferred sales charge (CDSC) that you may pay when you redeem your shares. Which option should you choose? It depends on your individual circumstances. You should know that the lowest sales charge won't necessarily be the least expensive option over time. For example, if you intend to hold your shares long term it may cost less to buy A Shares than B or C Shares. The tables below explain your pricing options and describe the fees and expenses that you may pay if you buy and hold Investor A, B and C Shares of the fund. The "Annual Fund Operating Expenses" table is based on expenses for the most recent fiscal year. Shareholder Fees (Fees paid directly from your investment)
A Shares B Shares C Shares Maximum Front-End Sales Charge* 4.5% 0.0% 0.0% (as percentage of offering price) Maximum Deferred Sales Charge 0.0% 4.5%** 1.00%*** (as percentage of offering price)
* Reduced front-end sales charges may be available. A CDSC of up to 1.00% is assessed on certain redemptions of Investor A Shares that are purchased with no initial sales charge as part of an investment of $1,000,000 or more. ** The CDSC is 4.5% if shares are redeemed in less than one year. The CDSC for Investor B Shares decreases for redemptions made in subsequent years. After six years there is no CDSC on B Shares. (See page 120 for complete schedule of CDSCs.) *** There is no CDSC on C Shares after one year. 49 Annual Fund Operating Expenses (Expenses that are deducted from fund assets)
A Shares B Shares C Shares Advisory Fees .49% .49% .49% Distribution and service (12b-1) fees .50% 1.15% 1.15% Other expenses .39% .39% .39% Total annual fund operating expenses 1.38% 2.03% 2.03% Fee waivers and expense reimbursements* .26% .16% .16% Net Expenses* 1.12% 1.87% 1.87%
* BlackRock has contractually agreed to waive or reimburse fees or expenses in order to limit certain (but not all) fund expenses for the next year. The fund may have to repay these waivers and reimbursements to BlackRock in the following two years if the repayment can be made within these expense limits. In addition, BlackRock Distributors, Inc., the fund's distributor, has contractually agreed to waive all 12b-1 distribution fees on Investor A Shares (otherwise payable at the maximum annual rate of .10% of average daily net assets) for the next year. "Net Expenses" in the table have been restated to reflect these waivers and reimbursements. The table does not reflect charges or credits which investors might incur if they invest through a financial institution. Example: This example is intended to help you compare the cost of investing in the fund with the cost of investing in other mutual funds. We are assuming an initial investment of $10,000, 5% total return each year with no changes in operating expenses (except for the waivers in the first year discussed above), redemption at the end of each time period and, with respect to B Shares and C Shares only, no redemption at the end of each time period. Although your actual cost may be higher or lower, based on these assumptions your costs would be:
1 Year 3 Years 5 Years 10 Years A Shares* $559 $842 $1,146 $2,008 B Shares** Redemption $640 $971 $1,278 $2,100*** B Shares No Redemption $190 $621 $1,078 $2,100*** C Shares** Redemption $290 $621 $1,078 $2,346 C Shares No Redemption $190 $621 $1,078 $2,346
*Reflects imposition of sales charge. **Reflects deduction of CDSC. *** Based on the conversion of the Investor B Shares to Investor A Shares after seven years. Fund Management The manager of the fund is Keith Anderson. He has been a Managing Director at BlackRock Financial Management, Inc. since 1988 and manager of the fund since June 1997. IMPORTANT DEFINITIONS Advisory Fees: Fees paid to the investment adviser for portfolio management services. Service Fees: Fees that are paid to BlackRock and /or its affiliates for shareholder account service and mainte- nance. Distribution Fees: A method of charging dis- tribution-related expenses against fund assets. " Other Expenses: Include administration, trans- fer agency, custody, professional fees and registration fees. 50 Financial Highlights The financial information in the table below shows the fund's financial perfor- mance for the periods indicated. Certain information reflects results for a single fund share. The term "Total Return" indicates how much your investment would have increased or decreased during this period of time and assumes that you have reinvested all dividends and distributions. These figures have been audited by PricewaterhouseCoopers LLP, the fund's independent accountants. The auditor's report, along with the fund's financial statements, are included in the Company's annual report which is available upon request (see back cover for ordering instructions). FINANCIAL HIGHLIGHTS - -------------------------------------------------------------------------------- (For an Investor A or B Share Outstanding Throughout Each Period) Managed Income Portfolio
INVESTOR INVESTOR A SHARES B SHARES For the Period Year Year Year Year Year Year 7/15/97/1/ Ended Ended Ended Ended Ended Ended through 9/30/98 9/30/97 9/30/96 9/30/95 9/30/94 9/30/98 9/30/97 Net asset value at beginning of period $ 10.41 $ 10.09 $10.38 $ 9.79 $ 11.18 $10.41 $10.39 ------- ------- ------- ------- ------- ------ ------ Income from investment operations Net investment income 0.59 0.65 0.59 0.60 0.57 0.52 0.09 Net gain (loss) on investments (both realized and unrealized) 0.29 0.31 (0.20) 0.60 (1.19) 0.29 0.02 ------- ------- ------- ------- ------- ------ ------ Total from investment operations 0.88 0.96 0.39 1.20 (0.62) 0.81 0.11 ------- ------- ------- ------- ------- ------ ------ Less distributions Distributions from net investment income (0.60) (0.64) (0.58) (0.60) (0.60) (0.53) (0.09) Distribution in excess of net investment income - - - - - - (0.01) (0.02) - - - - Distributions from net realized capital gains (0.05) - - (0.10) - - (0.14) (0.05) - - Distributions in excess of net realized gains - - - - - - - - (0.01) - - - - ------- ------- ------- ------- ------- ------ ------ Total distributions (0.65) (0.64) (0.68) (0.61) (0.77) (0.58) (0.09) ------- ------- ------- ------- ------- ------ ------ Net asset value at end of period $10.64 $ 10.41 $ 10.09 $ 10.38 $ 9.79 $10.64 $10.41 ======= ======= ======= ======= ======= ====== ====== Total return/3/ 8.74% 9.74% 3.83% 12.74% (5.76)% 7.94% 1.35% Ratios/Supplemental data Net assets at end of period (in thousands) $14,897 $15,230 $11,193 $11,977 $10,921 $4,639 $ 468 Ratios of expenses to average net assets After advisory/administration fee waivers 1.10%/4/ 1.05%/4/ 1.05% 1.05% 1.00% 1.82%/4/ 1.31%/2/,/4/ Before advisory/administration fee waivers 1.28% 1.30% 1.29% 1.25% 1.22% 2.00% 1.56%/2/ Ratios of net investment income to average net assets After advisory/administration fee waivers 6.44% 6.54% 5.67% 5.96% 5.66% 5.32% 4.68%/2/ Before advisory/administration fee waivers 6.26% 6.29% 5.44% 5.76% 5.44% 5.14% 4.43%/2/ Portfolio turnover rate 376% 428% 638% 203% 61% 376% 428%
------------------------------------------------ /1/Commencement of operations of share class. /2/Annualized. /3/Neither front-end sales load nor contingent deferred sales load is reflected. /4/Including interest expense, ratios for Investor A and Investor B Shares would have been 1.90% and 2.43%, respectively, for the year ended September 30, 1998, 1.41% and 2.14% respectively, for the year ended September 30, 1997. For the periods prior to September 30, 1997, interest income was pre- sented net of interest expense. 51 [GRAPHIC BlackRock APPEARS International Bond HERE] Portfolio - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Investment Goal The fund seeks current income consistent with the preservation of capital. Primary Investment Strategies In pursuit of this goal, the fund manager invests primarily in bonds of foreign issuers in the five to fifteen year maturity range. The fund normally invests at least 80% of its total assets in bonds and at least 65% of its total assets in bonds of a diversified group of foreign issuers from at least three devel- oped countries. The fund may invest more than 25% of its total assets in the securities of issuers located in Canada, France, Germany, Japan and the United Kingdom. The Fund may from time to time invest in bonds of issuers in emerging market countries. The fund may also invest in foreign currencies. The fund may only buy securities rated investment grade at the time of purchase by at least one major rating agency or determined by the manager to be of similar quality. The management team evaluates categories of the bond markets of various world economies and seeks individual securities within those categories. Securities are purchased for the fund when the manager determines that they have the potential for above-average current income. The fund measures its performance against the Salomon Non-U.S. Hedged World Government Bond Index (the bench- mark). If a security falls below investment grade, the manager will decide whether to continue to hold the security. A security will be sold if, in the opinion of the fund manager, the risk of continuing to hold the security is unacceptable when compared to the total return potential. The fund manager will normally attempt to structure the fund's portfolio to have comparable duration to its benchmark. Duration, which measures price sen- sitivity to interest rate changes, is not necessarily equal to average maturi- ty. The fund manager may, when consistent with the fund's investment objective, use options or futures (commonly known as derivatives). The primary purpose of using derivatives is to attempt to reduce risk to the fund as a whole (hedge) but they may also be used to maintain liquidity, commit cash pending investment or to IMPORTANT DEFINITIONS Bonds: Debt obligations such as bonds and debentures, U.S. Gov- ernment securities, debt obligations of domestic and foreign corporations, debt obligations of foreign governments and their political subdivisions, asset-backed securi- ties, various mortgage- backed securities (both residential and commer- cial), other floating or variable rate obli- gations, municipal obligations and zero coupon debt securities. Duration: A mathemati- cal calculation of the average life of a bond (or bonds in a bond fund) that serves as a useful measure of its price risk. Each year of duration represents an expected 1% change in the price of a bond for every 1% change in interest rates. For example, if a bond fund has an average duration of four years, its price will fall about 4% when interest rates rise by one percentage point. Conversely, the bond fund's price will rise about 4% when interest rates fall by one percentage point. Investment Grade: Secu- rities which are rated in the four highest categories by at least one of the major rating agencies or determined by the fund manager to be of similar quality. Generally, the higher the rating of a bond, the higher the likeli- hood that interest and principal payments will be made on time. Secu- rities rated in the fourth highest category by the rating agencies are considered invest- ment grade but they are also considered specu- lative, meaning that they carry more risk than higher rated secu- rities and may have problems making princi- pal and interest pay- ments in difficult eco- nomic climates. Investment grade rat- ings do not guarantee that bonds will not lose value. Maturity: The date upon which debt securities are due to be repaid, that is, the date when the issuer generally must pay back the face amount of the security. 52 increase returns. The fund may also enter into interest rate or foreign cur- rency transactions as a hedging technique. In these transactions, the fund exchanges its right to pay or receive interest or currencies with another party for their right to pay or receive interest or another currency in the future. The fund can borrow money to buy additional securities. This practice is known as "leverage." The fund may borrow from banks or other financial institutions or through reverse repurchase agreements (under which the fund sells securities and agrees to buy them back at a particular date and price). The Fund normally may borrow up to 33 1/3% of the value of its total assets. The fund may lend some of its securities on a short-term basis in order to earn extra income. The fund will receive collateral in cash or high quality securi- ties equal to the current value of the loaned securities. These loans will be limited to 33 1/3% of the value of the fund's total assets. Should the Company's Board of Trustees determine that the investment objective of the fund should be changed, shareholders will be given at least 30 days notice before any such change is made. KEY RISKS Key Risks While the fund manager chooses bonds he believes can provide above average cur- rent income, there is no guarantee that shares of the fund will not lose value. This means you could lose money. Three of the main risks of investing in the fund are interest rate risk, credit risk and the risks associated with investing in bonds of foreign issuers. Typi- cally, when interest rates rise, there is a corresponding decline in the market value of bonds such as those held by the fund. Credit risk refers to the possi- bility that the issuer of the bond will not be able to make principal and interest payments. Foreign securities involve risks not typically associated with investing in U.S. securities. These risks include but are not limited to: currency risks (the risk that the value of interest paid on foreign securities, or the value of the securities themselves, may fall if currency exchange rates change), the risk that a security's value will be hurt by changes in foreign political or social conditions, the possibility of heavy taxation or expropriation and more difficulty obtaining information on foreign securities or companies. In addi- tion, a portfolio of foreign securities may be harder to sell and may be sub- ject to wider price movements than comparable investments in U.S. companies. There is also less government regulation of foreign securities markets. IMPORTANT DEFINITIONS Salomon Non-U.S. Hedged World Government Bond Index: An unmanaged index that tracks the performance of 13 gov- ernment bond markets: Australia, Austria, Belgium, Canada, Den- mark, France, Germany, Italy, Japan, the Neth- erlands, Spain, Sweden and the United Kingdom. Total Return: A way of measuring fund perfor- mance. Total return is based on a calculation that takes into account income dividends, capi- tal gain distributions and the increase or decrease in share price. 53 In addition, political and economic structures in emerging market countries may be undergoing rapid change and these countries may lack the social, polit- ical and economic stability of more developed countries. As a result some of the risks described above, including the risks of nationalization or expropri- ation of assets and the existence of smaller, more volatile and less regulated markets may be increased. The value of many investments in emerging market countries recently has dropped significantly due to economic and political turmoil in many of these countries. Investing a significant portion of assets in one country makes the fund more dependent upon the political and economic circumstances of a particular coun- try than a mutual fund that is more widely diversified. For example, the Japa- nese economy (especially Japanese banks, securities firms and insurance compa- nies) has experienced considerable difficulty recently. In addition, the Japanese Yen has gone up and down in value versus the U.S. dollar. Japan may also be affected by recent turmoil in other Asian countries. The ability to concentrate in Canada, France, Germany and the United Kingdom may make the fund's performance more dependent on developments in those countries. On January 1, 1999, eleven European countries implemented a new currency unit called the "Euro" which is expected to reshape financial markets, banking sys- tems and monetary policies in Europe and other parts of the world. While it is impossible to predict the impact of the "Euro," it is possible that it could increase volatility in financial markets worldwide which could hurt the value of shares of the fund. The fund's expenses can be expected to be higher than those of funds investing primarily in domestic securities because the costs related to investing abroad are usually higher than domestic expenses. The fund's use of derivatives, interest rate and foreign currency transactions may reduce the fund's returns and/or increase volatility, which is defined as the characteristic of a security or a market to fluctuate significantly in price within a short period of time. Leverage is a speculative technique which may expose the fund to greater risk and increase its costs. Increases and decreases in the value of the fund's portfolio will be magnified when the fund uses leverage. The fund will also have to pay interest on its borrowings, reducing the fund's return. Forward foreign currency exchange do not eliminate fluctuations in the value of foreign securities but rather allow the fund to establish a fixed rate of exchange for a future point in time. These strategies can have the effect of reducing returns and minimizing opportunities for gain. 54 Securities loans involve the risk of a delay in receiving additional collateral if the value of the securities goes up while they are on loan. There is also the risk of delay in recovering the loaned securities and of losing rights to the collateral if a borrower goes bankrupt. The fund, like any business, could be affected if the computer systems on which it relies do not properly process information beginning on January 1, 2000. While Year 2000 issues could have a negative effect on the fund, BlackRock, the fund's investment adviser, is currently working to avoid such problems. Black- Rock is also working with other systems providers and vendors to determine their systems' ability to handle Year 2000 problems. There is no guarantee, however, that systems will work properly on January 1, 2000. Year 2000 problems may also hurt issuers whose securities the fund holds or securities markets generally. When you invest in this fund you are not making a bank deposit. Your investment is not insured or guaranteed by the Federal Deposit Insurance Corporation or by any bank or governmental agency. 55 Risk / Return Information The chart and table below give you a picture of the fund's long-term perfor- mance for Investor A Shares (in the chart) and for Investor A, B and C Shares (in the table). The information shows you how the fund's performance has varied year by year and provides some indication of the risks of investing in the fund. The table compares the fund's performance to that of the Salomon Non-U.S. Hedged World Government Bond Index, a recognized unmanaged index of bond market performance. The chart and the table both assume reinvestment of dividends and distributions. As with all such investments, past performance is not an indica- tion of future results. Sales charges are not reflected in the bar chart. If they were, returns would be less than those shown. The performance for the period before Investor Shares were launched is based upon performance for older share classes of the fund. Investor A and B Shares were launched in April 1996 and Investor C Shares were launched in September 1996. The actual return of Investor Shares would have been lower than shown because Investor Shares have higher expenses than these older classes. Also, the actual returns of Investor B and C Shares would have been lower compared to Investor A Shares. As of 12/31 Investor A Shares - -------------------------------------------------------------------------------- A N N U A L T O T A L R E T U R N S - -------------------------------------------------------------------------------- [BAR CHART APPEARS HERE] Best Quarter Q1 '95: 8.40% Worst Quarter Q2 '94: -2.06% The bars for 1992-1996 are based upon performance for Service Shares of the fund. 92 93 94 95 96 97 98 ------ ------ ------ ------ ----- ----- ------ 6.17% 15.31% -3.71% 20.02% 10.26% 9.75% 10.97% As of 12/31/98 - -------------------------------------------------------------------------------- A V E R A G E A N N U A L T O T A L R E T U R N S - -------------------------------------------------------------------------------- Since Inception 1 Year 3 Years 5 Years Inception Date - -------------------------------------------------------------------------------- International Bond; Inv A 2.37% 4.43% 4.66% 4.29% 07/01/91 - -------------------------------------------------------------------------------- International Bond; Inv B 1.16% 4.40% 4.96% 4.77% 07/01/91 - -------------------------------------------------------------------------------- International Bond; Inv C 4.87% 5.64% 5.39% 4.97% 07/01/91 - -------------------------------------------------------------------------------- Salomon Non-U.S. Hedged Govt. 11.54% 11.48% 9.41% 10.06% N/A - -------------------------------------------------------------------------------- These returns assume payment of applicable sales charges. Expenses and Fees Expenses and Fees As a shareholder you pay certain fees and expenses. Shareholder transaction fees are paid out of your investment and annual fund operating expenses are paid out of fund assets and are reflected in the fund's price. 56 This prospectus offers shareholders different ways to invest with three sepa- rate pricing options. You need to understand your choices so that you can choose the pricing option that is most suitable for you. With one option (In- vestor A Shares) you pay a one-time front-end transaction fee each time you buy shares. The other options (Investor B and Investor C Shares) have no front-end charges but have higher on-going fees, which are paid over the life of the investment, and have a contingent deferred sales charge (CDSC) that you may pay when you redeem your shares. Which option should you choose? It depends on your individual circumstances. You should know that the lowest sales charge won't necessarily be the least expensive option over time. For example, if you intend to hold your shares long term it may cost less to buy A Shares than B or C Shares. The tables below explain your pricing options and describe the fees and expenses that you may pay if you buy and hold Investor A, B and C Shares of the fund. The "Annual Fund Operating Expenses" table is based on expenses for the most recent fiscal year. Shareholder Fees (Fees paid directly from your investment)
A Shares B Shares C Shares Maximum Front-End Sales Charge* 5.0% 0.0% 0.0% (as percentage of offering price) Maximum Deferred Sales Charge 0.0% 4.5%** 1.00%*** (as percentage of offering price)
* Reduced front-end sales charges may be available. A CDSC of up to 1.00% is assessed on certain redemptions of Investor A Shares that are purchased with no initial sales charge as part of an investment of $1,000,000 or more. ** The CDSC is 4.5% if shares are redeemed in less than one year. The CDSC for Investor B Shares decreases for redemptions made in subsequent years. After six years there is no CDSC on B Shares. (See page 120 for complete schedule of CDSCs.) *** There is no CDSC on C Shares after one year. Annual Fund Operating Expenses (Expenses that are deducted from fund assets)
A Shares B Shares C Shares Advisory Fees .55% .55% .55% Distribution and service (12b-1) fees .50% 1.15% 1.15% Other expenses .68% .68% .68% Total annual fund operating expenses 1.73% 2.38% 2.38% Fee waivers and expense reimbursements* .23% .13% .13% Net Expenses* 1.50% 2.25% 2.25%
* BlackRock has contractually agreed to waive or reimburse fees or expenses in order to limit certain (but not all) fund expenses for the next year. The fund may have to repay these waivers and reimbursements to BlackRock in the following two years if the repayment can be made within these expense lim- its. In addition, BlackRock Distributors, Inc., the fund's distributor, has contractually agreed to waive all 12b-1 distribution fees on Investor A Shares (otherwise payable at the maximum annual rate of .10% of average daily net assets) for the next year. "Net Expenses" in the table have been restated to reflect these waivers and reimbursements. The table does not reflect charges or credits which investors might incur if they invest through a financial institution. IMPORTANT DEFINITIONS Advisory Fees: Fees paid to the investment adviser for portfolio management services. Service Fees: Fees that are paid to BlackRock and /or its affiliates for shareholder account service and mainte- nance. Distribution Fees: A method of charging dis- tribution-related expenses against fund assets. Other Expenses: Include administration, trans- fer agency, custody, professional fees and registration fees. 57 Example: This example is intended to help you compare the cost of investing in the fund with the cost of investing in other mutual funds. We are assuming an initial investment of $10,000, 5% total return each year with no changes in operating expenses (except for the waivers in the first year discussed above), redemption at the end of each time period and, with respect to B Shares and C Shares only, no redemption at the end of each time period. Although your actual cost may be higher or lower, based on these assumptions your costs would be:
1 Year 3 Years 5 Years 10 Years A Shares* $645 $ 996 $1,371 $2,421 B Shares** Redemption $678 $1,080 $1,459 $2,469*** B Shares No Redemption $228 $ 730 $1,259 $2,469*** C Shares** Redemption $328 $ 730 $1,259 $2,706 C Shares No Redemption $228 $ 730 $1,259 $2,706
*Reflects imposition of sales charge. **Reflects deduction of CDSC. *** Based on the conversion of the Investor B Shares to Investor A Shares after seven years. Fund Management The fund's manager is Andrew Gordon, a Managing Director at BlackRock Financial Management, Inc. (BFM) since 1996. Prior to joining BFM he was responsible for non-dollar (international) research at Barclay Investments from 1994 to 1996 and at CS First Boston from 1986 to 1994. He has served as fund manager since 1997. 58 Financial Highlights The financial information in the table below shows the fund's financial perfor- mance for the periods indicated. Certain information reflects results for a single fund share. The term "Total Return" indicates how much your investment would have increased or decreased during this period of time and assumes that you have reinvested all dividends and distributions. These figures have been audited by PricewaterhouseCoopers LLP, the fund's independent accountants. The auditor's report, along with the fund's financial statements, are included in the Company's annual report which is available upon request (see back cover for ordering instructions). Financial Highlights - -------------------------------------------------------------------------------- (For an Investor A, B or C Share Outstanding Throughout Each Period) International Bond Portfolio
INVESTOR A SHARES INVESTOR B SHARES ------------------------------------------------------------------------------ For the For the Period Period Year Year 4/22/96/1/ Year Year 4/19/96/1/ Ended Ended through Ended Ended through 9/30/98 9/30/97 9/30/96 9/30/98 9/30/97 9/30/96 Net asset value at beginning of period $10.95 $11.71 $11.37 $10.95 $11.71 $11.36 ------ ------ ------ ------ ------ ------ Income from investment operations Net investment income 0.47 1.10 0.26 0.40 1.06 0.22 Net gain (loss) on investments (both realized and unrealized) 0.76 0.05 0.32 0.75 - - 0.33 ------ ------ ------ ------ ------ ------ Total from investment operations 1.23 1.15 0.58 1.15 1.06 0.55 ------ ------ ------ ------ ------ ------ Less distributions Distributions from net investment income (0.52) (1.42) (0.24) (0.43) (1.33) (0.20) Distributions from net realized capital gains (0.42) (0.49) - - (0.42) (0.49) - - ------ ------ ------ ------ ------ ------ Total distributions (0.94) (1.91) (0.24) (0.85) (1.82) (0.20) ------ ------ ------ ------ ------ ------ Net asset value at end of period $11.24 $10.95 $11.71 $11.24 $10.95 $11.71 ====== ====== ====== ====== ====== ====== Total return/3/ 11.98% 11.02% 5.13% 11.15% 10.11% 4.90% Ratios/Supplemental data Net assets at end of period (in thousands) $1,705 $1,015 $ 176 $1,512 $ 979 $ 136 Ratios of expenses to average net assets After advisory/administration fee waivers 1.48%/4/ 1.42%/3/,/4/ 1.45%/2/ 2.22%/4/ 2.12%/3/,/4/ 2.09%/2/ Before advisory/administration fee waivers 1.63% 1.52% 1.86%/2/ 2.37% 2.22% 2.49%/2/ Ratios of net investment income to average net assets After advisory/administration fee waivers 3.59% 4.49% 5.29%/2/ 2.83% 3.65% 4.61%/2/ Before advisory/administration fee waivers 3.44% 4.39% 4.88%/2/ 2.68% 3.55% 4.21%/2/ Portfolio turnover rate 225% 272% 108% 225% 272% 108% INVESTOR C SHARES --------------------------------------- For the Period Year Year 4/19/96/1/ Ended Ended through 9/30/98 9/30/97 9/30/96 Net asset value at beginning of period $10.95 $11.71 $11.58 ----------- --------------- ------------ Income from investment operations Net investment income 0.54 1.15 0.02 Net gain (loss) on investments (both realized and unrealized) 0.61 (0.09) 0.12 ----------- --------------- ------------ Total from investment operations 1.15 1.06 0.14 ----------- --------------- ------------ Less distributions Distributions from net investment income (0.43) (1.33) (0.01) Distributions from net realized capital gains (0.42) (0.49) - - ----------- --------------- ------------ Total distributions (0.85) (1.82) (0.01) ----------- --------------- ------------ Net asset value at end of period $11.24 $10.95 $11.71 =========== =============== ============ Total return/3/ 11.15% 10.13% 1.24% Ratios/Supplemental data Net assets at end of period (in thousands) $1,249 $ 474 $ 19 Ratios of expenses to average net assets After advisory/administration fee waivers 2.22%/4/ 2.11%/2/,/4/ 1.53%/2/ Before advisory/administration fee waivers 2.37% 2.21% 1.93%/2/ Ratios of net investment income to average net assets After advisory/administration fee waivers 2.83% 3.57% 2.79%/2/ Before advisory/administration fee waivers 2.68% 3.47% 2.38%/2/ Portfolio turnover rate 225% 272% 108%
-------------------------------------------------------- /1/Commencement of operations of share class. /2/Annualized. /3/Neither front-end sales load nor contingent deferred sales load is reflected. /4/Including interest expense, ratios for the Investor A, Investor B and Investor C Shares would have been 1.48%, 2.22% and 2.22%, respectively, for the year ended September 30, 1998, 1.42%, 2.12% and 2.11%, respectively, for the year ended September 30, 1997. 59 [GRAPHIC BlackRock APPEARS High Yield Bond HERE] Portfolio - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Investment Goal The fund seeks to provide current income by investing primarily in non-invest- ment grade bonds. Primary Investment Strategies In pursuit of this goal, the fund manager invests primarily in non-investment grade bonds in the ten to fifteen year maturity range. The fund normally invests at least 80% of its total assets in bonds or convertible securities and at least 65% of its total assets in high yield bonds. The high yield secu- rities (commonly called "junk bonds") acquired by the fund will generally be in the lower rating categories of the major rating agencies (BB or lower by Standard & Poor's or Ba or lower by Moody's) or will be determined by the fund manager to be of similar quality. The fund may invest up to 10% of its total assets in bonds of foreign issuers. The management team evaluates categories of the high yield market and individ- ual bonds within these categories. Securities are purchased for the fund when the manager determines that they have the potential for above-average current income. The fund measures its performance against the Lehman High Yield Index (the benchmark). To add additional diversification, the portfolio manager can invest in a wide range of securities including mezzanine investments, collateralized bond obli- gations, bank loans and mortgage-backed and asset-backed securities. The fund can also invest, to the extent consistent with its investment objective, in foreign and emerging market securities and currencies. The fund may invest in securities rated as low as "C." These securities are very risky and have uncertainties regarding the issuer's ability to make interest and principal payments. If a security falls below the fund's minimum rating, the manager will decide whether to continue to hold the security. A security will be sold if, in the opinion of the fund manager, the risk of continuing to hold the security is unacceptable when compared to the total return potential. The fund manager will normally attempt to structure the fund's portfolio to have comparable duration to its benchmark. Duration, which measures price sen- sitivity to interest rate changes, is not necessarily equal to average maturi- ty. IMPORTANT DEFINITIONS Asset-Backed Securi- ties: Bonds that are backed by a pool of assets, usually loans such as installment sale contracts or credit card receiv- ables. Bank Loans: The fund may invest in fixed and floating rate loans arranged through pri- vate negotiations between a company or a foreign government and one or more financial institutions. The fund considers such invest- ments to be debt secu- rities. Bonds: Debt obligations such as bonds and debentures, U.S. Gov- ernment securities, debt obligations of domestic and foreign corporations, debt obligations of foreign governments and their political subdivisions, asset-backed securi- ties, various mortgage- backed securities (both residential and commer- cial), other floating or variable rate obli- gations, municipal obligations and zero coupon debt securities. Collateralized Bond Obligations (CBO): The fund many invest in collateralized bond obligations which are securities backed by a diversified pool of high yield securities. Commercial Mortgage- Backed Securities (CMBS): Bonds that are backed by a mortgage loan or pool of loans secured by commercial property, not residen- tial mortgages. Duration: A mathemati- cal calculation of the average life of a bond (or bonds in a bond fund) that serves as a useful measure of its price risk. Each year of duration represents an expected 1% change in the price of a bond for every 1% change in interest rates. For example, if a bond fund has an average duration of four years, its price will fall about 4% when interest rates rise by one percentage point. Conversely, the bond fund's price will rise about 4% when interest rates fall by one percentage point. High Yield Bonds: Some- times referred to as "junk bonds" these are debt securities, which are, rated less than investment grade (below the fourth highest rat- ing of the major rating agencies). These secu- rities generally pay more interest than higher rated securi- ties. The higher yield is an incentive to investors who otherwise may be hesitant to pur- chase the debt of such a low-rated issuer. 60 The fund manager may, when consistent with the fund's investment objective, use options or futures (commonly known as derivatives). The primary purpose of using derivatives is to attempt to reduce risk to the fund as a whole (hedge) but they also may be used to maintain liquidity, commit cash pending investment or to increase returns. The fund may also enter into interest rate or foreign currency transactions as a hedging technique. In these transactions, the fund exchanges its right to pay or receive interest or currencies with another party for their right to pay or receive interest or another currency in the future. The fund can borrow money to buy additional securities. This practice is known as "leverage." The fund may borrow from banks or other financial institutions or through reverse repurchase agreements (under which the fund sells securities and agrees to buy them back at a particular date and price). The fund currently may borrow up to 33 1/3% of the value of its total assets. The fund may lend some of its securities on a short-term basis in order to earn extra income. The fund will receive collateral in cash or high quality securi- ties equal to the current value of the loaned securities. These loans will be limited to 33 1/3% of the value of the fund's total assets. Should the Company's Board of Trustees determine that the investment objective of the fund should be changed, shareholders will be given at least 30 days notice before any such change is made. KEY RISKS Key Risks While the fund manager chooses bonds he believes can provide above average cur- rent income, there is no guarantee that shares of the fund will not lose value. This means you could lose money. Two of the main risks of investing in the fund are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds such as those held by the fund. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. Non-investment grade bonds carry greater risks than securities which have higher credit ratings, including a high risk of default. The yields of non- investment grade securities will move up and down over time. The credit rating of a high yield security does not necessarily address its market value risk. Ratings and market value may change from time to time, positively or negative- ly, to reflect new developments regarding the issuer. These companies are often young and growing and have a lot of debt. High yield bonds are considered spec- ulative, meaning there is a significant risk that companies issuing these secu- rities may not be able to IMPORTANT DEFINITIONS Lehman High Yield Index: An unmanaged index that is comprised of issues that meet the following criteria: at least $100 million par value outstanding, max- imum credit rating of B1 (including defaulted issues) and at least one year to maturity. Maturity: The date upon which debt securities are due to be repaid, that is, the date when the issuer generally must pay back the face amount of the security. Mezzanine Investments: These are subordinated debt securities which receive payments of interest and principal after other more senior security holders are paid. They are gener- ally issued in private placements in connec- tion with an equity security. Mortgage-Backed Securi- ties: Asset-backed securities based on a particular type of asset, a mortgage. There is a wide variety of mortgage backed securities involving commercial or residen- tial, fixed rate or adjustable rate mort- gages and mortgages issued by banks or gov- ernment agencies. Total Return: A way of measuring fund perfor- mance. Total return is based on a calculation that takes into account income dividends, capi- tal gain distributions and the increase or decrease in share price. 61 repay principal and pay interest or dividends on time. In addition, other cred- itors of a high yield issuer may have the right to be paid before the high yield bond holder. During an economic downturn, a period of rising interest rates or a recession, issuers of high yield securities who have a lot of debt may experience finan- cial problems. They may not have enough cash to make their principal and inter- est payments. An economic downturn could also hurt the market for lower-rated securities and the fund. The market for high yield bonds is not as liquid as the markets for higher rated securities. This means that it may be harder to buy and sell high yield bonds, especially on short notice. The market could also be hurt by legal or tax changes. Mezzanine securities carry the risk that the issuer will not be able to meet its obligations and that the equity securities purchased with the mezzanine investments may lose value. The market for bank loans may not be highly liquid and the fund may have diffi- culty selling them. These investments expose the fund to the risk of investing in both the financial institution and the underlying borrower. The pool of high yield securities underlying CBOs is typically separated into groupings called tranches representing different degrees of credit quality. The higher quality tranches have greater degrees of protection and pay lower inter- est rates. The lower tranches, with greater risk, pay higher interest rates. The expenses of the fund will be higher than those of mutual funds investing primarily in investment grade securities. The costs of investing in the high yield market are usually higher for several reasons, such as the higher costs for investment research and higher commission costs. The fund may make investments in residential and commercial mortgage-backed securities and other asset-backed securities. The characteristics of these mortgage-backed and asset-backed securities differ from traditional fixed income securities. A main difference is that the principal on mortgage-or asset-backed securities may normally be prepaid at any time, which will reduce the yield and market value of these securities. Asset-backed securities and CMBS generally experi- ence less prepayment than residential mortgage-backed securities. In periods of falling interest rates, the rate of prepayments tends to increase (as does price fluctuation) as borrowers are motivated to pay off debt and refinance at new lower rates. During such periods, reinvestment of the prepayment proceeds by the manager will generally be at lower rates of return than the return on the assets which were prepaid. Certain commercial mortgage-backed securi- 62 ties are issued in several classes with different levels of yield and credit protection. The fund's investments in commercial mortgage-backed securities with several classes will normally be in the lower classes that have less credit protection. Certain asset-backed securities are based on loans that are unsecured, which means that there is no collateral to seize if the underlying borrower defaults. Other asset-based securities may not have the benefit of as much collateral as mortgage-backed securities. The fund's use of derivatives, interest rate and foreign currency transactions may reduce the fund's returns and/or increase volatility, which is defined as the characteristic of a security or a market to fluctuate significantly in price within a short period of time. Leverage is a speculative technique which may expose the fund to greater risk and increase its costs. Increases and decreases in the value of the fund's portfolio will be magnified when the fund uses leverage. The fund will also have to pay interest on its borrowings, reducing the fund's return. The fund may invest up to 10% of its total assets in bonds of foreign issuers. Foreign securities involve risks not typically associated with investing in U.S. securities. These risks include but are not limited to: currency risks (the risk that the value of interest paid on foreign securities, or the value of the securities themselves, may fall if currency exchange rates change), the risk that a security's value will be hurt by changes in foreign political or social conditions, the possibility of heavy taxation or expropriation and more difficulty obtaining information on foreign securities or companies. In addi- tion, a portfolio of foreign securities may be harder to sell and may be sub- ject to wider price movements than comparable investments in U.S. companies. There is also less government regulation of foreign securities markets. In addition, political and economic structures in developing countries may be undergoing rapid change and these countries may lack the social, political and economic stability of more developed countries. As a result some of the risks described above, including the risks of nationalization or expropriation of assets and the existence of smaller, more volatile and less regulated markets, may be increased. The value of many investments in emerging market countries recently has dropped significantly due to economic and political turmoil in many of these countries. On January 1, 1999, eleven European countries implemented a new currency unit called the "Euro" which is expected to reshape financial markets, banking sys- tems and monetary policies in Europe and other parts of the world. While it is impossible to predict the impact of the "Euro," it is possible that it could increase volatility in financial markets worldwide which could hurt the value of shares of the fund. 63 Securities loans involve the risk of a delay in receiving additional collat- eral if the value of the securities goes up while they are on loan. There is also the risk of delay in recovering the loaned securities and of losing rights to the collateral if a borrower goes bankrupt. The fund, like any business, could be affected if the computer systems on which it relies do not properly process information beginning on January 1, 2000. While Year 2000 issues could have a negative effect on the fund, Black- Rock, the fund's investment adviser, is currently working to avoid such prob- lems. BlackRock is also working with other systems providers and vendors to determine their systems' ability to handle Year 2000 problems. There is no guarantee, however, that systems will work properly on January 1, 2000. Year 2000 problems may also hurt issuers whose securities the fund holds or securi- ties markets generally. When you invest in this fund you are not making a bank deposit. Your invest- ment is not insured or guaranteed by the Federal Deposit Insurance Corporation or by any bank or governmental agency. EXPENSES AND FEES Expenses and Fees As a shareholder you pay certain fees and expenses. Shareholder transaction fees are paid out of your investment and annual fund operating expenses are paid out of fund assets and are reflected in the fund's price. This prospectus offers shareholders different ways to invest with three sepa- rate pricing options. You need to understand your choices so that you can choose the pricing option that is most suitable for you. With one option (In- vestor A Shares) you pay a one-time front-end transaction fee each time you buy shares. The other options (Investor B and Investor C Shares) have no frontend charges but have higher on-going fees, which are paid over the life of the investment, and have a contingent deferred sales charge (CDSC) that you may pay when you redeem your shares. Which option should you choose? It depends on your individual circumstances. You should know that the lowest sales charge won't necessarily be the least expensive option over time. For example, if you intend to hold your shares long term it may cost less to buy A Shares than B or C Shares. 64 The tables below explain your pricing options and describe the fees and expenses that you may pay if you buy and hold Investor A, B or C Shares of the fund. The "Annual Fund Operating Expenses" table is based on expenses for the most recent fiscal year. Shareholder Fees (Fees paid directly from your investment)
A Shares B Shares C Shares Maximum Front-End Sales Charge* 5.0% 0.0% 0.0% (as percentage of offeringn price) Maximum Deferred Sales Charge 0.0% 4.5%** 1.00%*** (as percentage of offering price)
* Reduced front-end sales charges may be available. A CDSC of up to 1.00% is assessed on certain redemptions of Investor A Shares that are purchased with no initial sales charge as part of an investment of $1,000,000 or more. ** The CDSC is 4.5% if shares are redeemed in less than one year. The CDSC for Investor B Shares decreases for redemptions made in subsequent years. After six years there is no CDSC on B Shares. (See page 120 for complete schedule of CDSCs.) *** There is no CDSC on C Shares after one year. Annual Fund Operating Expenses (Expenses that are deducted from fund assets)
A Shares B Shares C Shares Advisory Fees .50% .50% .50% Distribution and service (12b-1) fees .50% 1.15% 1.15% Other expenses* .40% .40% .40% Total annual fund operating expenses 1.40% 2.05% 2.05% Fee waivers and expense reimbursements** .23% .13% .13% Net Expenses** 1.17% 1.92% 1.92%
* "Other expenses" are based on estimated amounts for the current fiscal year. ** BlackRock has contractually agreed to waive or reimburse fees or expenses in order to limit certain (but not all) fund expenses for the next year. The fund may have to repay these waivers and reimbursements to BlackRock in the following two years if the repayment can be made within these expense limits. In addition, BlackRock Distributors, Inc., the fund's distributor, has contractually agreed to waive all 12b-1 distribution fees on Investor A Shares (otherwise payable at the maximum annual rate of .10% of average daily net assets) for the next year. "Net Expenses" in the table have been restated to reflect these waivers and reimbursements. The table does not reflect charges or credits which investors might incur if they invest through a financial institution. IMPORTANT DEFINITIONS Advisory Fees: Fees paid to the investment adviser for portfolio management services. Service Fees: Fees that are paid to BlackRock and /or its affiliates for shareholder account service and mainte- nance. Distribution Fees: A method of charging dis- tribution-related expenses against fund assets. Other Expenses: Include administration, trans- fer agency, custody, professional fees and registration fees. 65 Example: This example is intended to help you compare the cost of investing in the fund with the cost of investing in other mutual funds. We are assuming an initial investment of $10,000, 5% total return each year with no changes in operating expenses (except for the waivers in the first year discussed above), redemp- tion at the end of each time period and, with respect to B Shares and C Shares only, no redemption at the end of each time period. Although your actual cost may be higher or lower, based on these assumptions your costs would be:
1 Year 3 Years A Shares* $613 $900 B Shares** Redemption $645 $980 B Shares No Redemption $195 $630 C Shares** Redemption $295 $630 C Shares No Redemption $195 $630
*Reflects imposition of sales charge. **Reflects deduction of CDSC. Fund Management The fund is co-managed by Dennis Schaney and Keith Anderson. Dennis Schaney is co-leader of the High Yield Team and a Managing Director of BlackRock Finan- cial Management, Inc. (BFM) since February 1998. Prior to joining BFM he was a Managing Director in the Global Fixed Income Research and Economics Department of Merrill Lynch for nine years. Keith Anderson, co-leader of the High Yield Team, has served as Managing Director of BFM since 1988. Both have co-managed the fund since its inception. 66 [GRAPHIC BlackRock APPEARS Tax-Free Income HERE] Portfolio - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- IMPORTANT DEFINITIONS Bonds: Debt obligations such as bonds and debentures, U.S. Gov- ernment securities, debt obligations of domestic and foreign corporations, debt obligations of foreign governments and their political subdivisions, asset-backed securi- ties, various mortgage- backed securities (both residential and commer- cial), other floating or variable rate obli- gations, municipal obligations and zero coupon debt securities. General Obligation Bonds: Bonds which are secured by the issuer's pledge of its full faith, credit and tax- ing power for the pay- ment of principal and interest. Investment Grade: Secu- rities which are rated in the four highest categories by at least one of the major rating agencies or determined by the fund manager to be of similar quality. Generally, the higher the rating of a bond, the higher the likeli- hood that interest and principal payments will be made on time. Secu- rities rated in the fourth highest category by the rating agencies are considered invest- ment grade but they are also considered specu- lative, meaning that they carry more risk than higher rated secu- rities and may have problems making princi- pal and interest pay- ments in difficult eco- nomic climates. Investment grade rat- ings do not guarantee that bonds will not lose value. Lehman Municipal Bond Index: An unmanaged index of municipal bonds with the follow- ing characteristics: minimum credit rating of Baa-3, outstanding par value of at least $3 million, issued as part of a deal of at least $50 million, and issued within the last 5 years remaining matu- rities of not less than one year. Maturity: The date upon which debt securities are due to be repaid, that is, the date when the issuer must pay back the face amount of the security. Investment Goal: The fund seeks as high a level of current income exempt from Federal income tax as is consistent with preservation of capital. Primary Investment Strategies: In pursuit of this goal, the fund manager invests primarily in bonds issued by or on behalf of states and possessions of the United States, their political subdivisions and their agencies and authorities (and related tax-exempt deriva- tive securities) the interest on which the manager believes is exempt from Fed- eral income tax (municipal securities). The fund normally invests at least 80% of its net assets in municipal securities, including both general obligation and revenue bonds, from a diverse range of issuers. The other 20% of net assets can be invested in securities which are subject to regular Federal income tax or the Federal Alternative Minimum Tax. The fund emphasizes municipal securi- ties in the ten to twenty year maturity range. The fund may only buy securities rated investment grade at the time of purchase by at least one major rating agency or determined by the manager to be of similar quality. The fund intends to invest so that no more than 25% of its net assets are represented by the municipal securities of issuers located in the same state. The management team evaluates sectors of the municipal market and individual bonds within those categories. The fund measures its performance against the Lehman Municipal Bond Index (the benchmark). If a security falls below investment grade, the manager will decide whether to continue to hold the security. A security will be sold if, in the opinion of the fund manager, the risk of continuing to hold the security is unacceptable when compared to the total return potential. It is possible that in extreme market conditions the fund may invest more than 20% of its assets in securities that are not municipal securities (and there- fore are subject to federal income tax) and may hold an unlimited amount of uninvested cash reserves. If market conditions improve, these strategies could result in reducing the potential gain from the market upswing, thus reducing the fund's opportunity to achieve its investment objective. 67 The fund manager will normally attempt to structure the fund's portfolio to have comparable duration to its benchmark. Duration, which measures price sen- sitivity to interest rate changes, is not necessarily equal to average maturi- ty. The fund manager may, when consistent with the fund's investment objective, use options or futures (commonly known as derivatives). The primary purpose of using derivatives is to attempt to reduce risk to the fund as a whole (hedge) but they may also be used to maintain liquidity, commit cash pending invest- ment or to increase returns. The fund may also enter into interest rate trans- actions as a hedging technique. In these transactions, the fund exchanges its right to pay or receive interest with another party for their right to pay or receive interest. The fund can borrow money to buy additional securities. This practice is known as "leverage." The fund may borrow from banks or other financial institutions or through reverse repurchase agreements (under which the fund sells securi- ties and agrees to buy them back at a particular date and price). The fund normally may borrow up to 33 1/3% of the value of its total assets. The fund may lend some of its securities on a short-term basis in order to earn extra income. The fund will receive collateral in cash or high quality securities equal to the current value of the loaned securities. These loans will be limited to 33 1/3% of the value of the fund's total assets. Should the Company's Board of Trustees determine that the investment objective of the fund should be changed, shareholders will be given at least 30 days notice before any such change is made. The fund may not change the requirement that it normally invest at least 80% of its net assets in municipal securities without shareholder approval. KEY RISKS Key Risks There is no guarantee that shares of the fund will not lose value. This means you could lose money. Two of the main risks of investing in the fund are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds such as those held by the fund. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. Revenue bonds include private activity bonds, which are not payable from the general revenues of the issuer. Consequently, the IMPORTANT DEFINITIONS Revenue Bonds: Bonds which are secured only by the revenues from a particular facility or class of facilities, such as a water or sewer system, or from the proceeds of a spe- cial excise tax or other revenue source. Total Return: A way of measuring fund perfor- mance. Total return is based on a calculation that takes into account income dividends, capi- tal gain distributions and the increase or decrease in share price. 68 credit quality of private activity bonds is usually directly related to the credit standing of the corporate user of the facility involved. To the extent that the fund's assets are invested in private activity bonds, the fund will be subject to the particular risks presented by the laws and economic conditions relating to such projects and bonds to a greater extent than if its assets were not so invested. Municipal securities also include "moral obligation" bonds, which are normally issued by special purpose public authorities. If the issuer of moral obligation bonds is unable to pay its debts from current revenues, it may draw on a reserve fund the restoration of which is a moral but not a legal obligation of the state or municipality which created the issuer. The fund may invest in bonds the interest on which may be subject to the Fed- eral Alternative Minimum Tax. The fund may invest up to 20% of its total assets in these bonds when added together with any of the fund's other taxable invest- ments. Interest on these bonds that is received by taxpayers subject to the Federal Alternative Minimum Tax is taxable. The fund may invest 25% or more of its assets in municipal securities whose interest is paid solely from revenues of similar projects. For example, the fund may invest more than 25% of its assets in municipal securities related to water or sewer systems. This type of concentration exposes the fund to the legal and economic risks relating to those projects. There may be less information available on the financial condition of issuers of municipal securities than for public corporations. The market for municipal bonds may be less liquid than for taxable bonds. This means that it may be harder to buy and sell municipal securities, especially on short notice. The fund will rely on legal opinions of counsel to issuers of municipal securi- ties as to the tax-free status of investments and will not do its own analysis. The fund's use of derivatives and interest rate transactions may reduce the fund's returns and/or increase volatility, which is defined as the characteris- tic of a security or a market to fluctuate significantly in price within a short period of time. The income from certain derivatives may be subject to Federal income tax. Leverage is a speculative technique which may expose the fund to greater risk and increase its costs. Increases and decreases in the value of the fund's portfolio will be magnified when the fund uses leverage. The fund will also have to pay interest on its borrowings, reducing the fund's return. Securities loans involve the risk of a delay in receiving additional collateral if the value of the securities goes up while they are on loan. There is also the risk of delay in recovering the loaned securities and of losing rights to the collateral if a borrower goes bankrupt. 69 The fund, like any business, could be affected if the computer systems on which it relies do not properly process information beginning on January 1, 2000. While Year 2000 issues could have a negative effect on the fund, Black- Rock, the fund's investment adviser, is currently working to avoid such prob- lems. BlackRock is also working with other systems providers and vendors to determine their systems' ability to handle Year 2000 problems. There is no guarantee, however, that systems will work properly on January 1, 2000. Year 2000 problems may also hurt issuers whose securities the fund holds or securi- ties markets generally. When you invest in this fund you are not making a bank deposit. Your invest- ment is not insured or guaranteed by the Federal Deposit Insurance Corporation or by any bank or governmental agency. Risk / Return Information The chart and table below give you a picture of the fund's long-term perfor- mance for Investor A Shares (in the chart) and for Investor A, B and C Shares (in the table). The information shows you how the fund's performance has var- ied year by year and provides some indication of the risks of investing in the fund. The table compares the fund's performance to that of the Lehman Munici- pal Bond Index, a recognized unmanaged index of bond market performance. The chart and the table both assume reinvestment of dividends and distributions. As with all such investments, past performance is not an indication of future results. Sales charges are not reflected in the bar chart. If they were, returns would be less than those shown. 70 The performance for the period before Investor B and C Shares were launched is based upon performance for older share classes of the fund. Investor B Shares were launched in July 1996 and Investor C Shares were launched in February 1997. The actual returns of Investor B and C Shares would have been lower than shown because Investor B and C Shares have higher expenses than these other Classes. Also, the actual returns of Investor B and C Shares would have been lower compared to Investor A Shares. As of 12/31 Investor A Shares - -------------------------------------------------------------------------------- A N N U A L T O T A L R E T U R N S - -------------------------------------------------------------------------------- [BAR CHART APPEARS HERE] Best Quarter Q1 '95: 8.06% Worst Quarter Q1 '94: -6.93% 91 92 93 94 95 96 97 98 ------ ------ ------ ------ ------ ----- ----- ------ 11.36% 8.85% 12.88% -7.09% 17.76% 5.36% 9.61% 5.92% As of 12/31/98 - -------------------------------------------------------------------------------- A V E R A G E A N N U A L T O T A L R E T U R N S - -------------------------------------------------------------------------------- Since Inception 1 Year 3 Years 5 Years Inception Date - -------------------------------------------------------------------------------- Tax-Free Income; Inv A 1.67% 5.47% 5.13% 7.37% 05/14/90 - -------------------------------------------------------------------------------- Tax-Free Income; Inv B 0.40% 5.03% 5.18% 7.64% 05/14/90 - -------------------------------------------------------------------------------- Tax-Free Income; Inv C 4.08% 6.28% 5.61% 7.64% 05/14/90 - -------------------------------------------------------------------------------- Lehman Municipal 6.48% 6.69% 6.23% 8.29% N/A* - -------------------------------------------------------------------------------- * For comparative purposes, the value of the index on 05/01/90 is used as the beginning value on 05/14/90. Expenses and Fees Expenses and Fees As a shareholder you pay certain fees and expenses. Shareholder transaction fees are paid out of your investment and annual fund operating expenses are paid out of fund assets and are reflected in the fund's price. This prospectus offers shareholders different ways to invest with three sepa- rate pricing options. You need to understand your choices so that you can choose the pricing option that is most suitable for you. With one option (In- vestor A Shares) you pay a one-time front-end transaction fee each time you buy shares. The other options (Investor B and Investor C Shares) have no front-end charges but have higher on-going fees, which are paid over the life of the investment, and have a contingent deferred sales charge (CDSC) that you may pay when you redeem your shares. Which option should you choose? It depends on your individual circumstances. You should know that the lowest sales charge won't necessarily be the least expensive option over time. For example, if you intend to hold your shares long term it may cost less to buy A Shares than B or C Shares. These returns assume payment of applicable sales charge. 71 The tables below explain your pricing options and describe the fees and expenses that you may pay if you buy and hold Investor A, B and C shares of the fund. The "Annual Fund Operating Expenses" table is based on expenses for the most recent fiscal year. Shareholder Fees (Fees paid directly from your investment)
A Shares B Shares C Shares Maximum Front-End Sales Charge* 4.0% 0.0% 0.0% (as percentage of offering price) Maximum Deferred Sales Charge 0.0% 4.5%** 1.00%*** (as percentage of offering price)
* Reduced front-end sales charges may be available. A CDSC of up to 1.00% is assessed on certain redemptions of Investor A Shares that are purchased with no initial sales charge as part of an investment of $1,000,000 or more. ** The CDSC is 4.5% if shares are redeemed in less than one year. The CDSC for Investor B Shares decreases for redemptions made in subsequent years. After six years there is no CDSC on B Shares. (See page 120 for complete schedule of CDSCs.) *** There is no CDSC on C Shares after one year. Annual Fund Operating Expenses (Expenses that are deducted from fund assets)
A Shares B Shares C Shares Advisory Fees .50% .50% .50% Distribution and service (12b- 1) fees .50% 1.15% 1.15% Other expenses .45% .45% .45% Total annual fund operating expenses 1.45% 2.10% 2.10% Fee waivers and expense reimbursements* .38% .28% .28% Net Expenses* 1.07% 1.82% 1.82%
* BlackRock has contractually agreed to waive or reimburse fees or expenses in order to limit certain (but not all) fund expenses for the next year. The fund may have to repay these waivers and reimbursements to BlackRock in the following two years if the repayment can be made within these expense limits. In addition, BlackRock Distributors, Inc., the fund's distributor, has contractually agreed to waive all 12b-1 distribution fees on Investor A Shares (otherwise payable at the maximum annual rate of .10% of average daily net assets) for the next year. "Net Expenses" in the table have been restated to reflect these waivers and reimbursements. The table does not reflect charges or credits which investors might incur if they invest through a financial institution. IMPORTANT DEFINITIONS Advisory Fees: Fees paid to the investment adviser for portfolio management services. Service Fees: Fees that are paid to BlackRock and /or its affiliates for shareholder account service and mainte- nance. Distribution Fees: A method of charging dis- tribution-related expenses against fund assets. Other Expenses: Include administration, trans- fer agency, custody, professional fees and registration fees. 72 Example: This example is intended to help you compare the cost of investing in the fund with the cost of investing in other mutual funds. We are assuming an initial investment of $10,000, 5% total return each year with no changes in operating expenses (except for the waivers in the first year discussed above), redemption at the end of each time period and, with respect to B Shares and C Shares only, no redemption at the end of each time period. Although your actual cost may be higher or lower, based on these assumptions your costs would be:
1 Year 3 Years 5 Years 10 Years A Shares* $505 $804 $1,126 $2,035 B Shares** Redemption $635 $981 $1,303 $2,165*** B Shares No Redemption $185 $631 $1,103 $2,165*** C Shares** Redemption $285 $631 $1,103 $2,409 C Shares No Redemption $185 $631 $1,103 $2,409
*Reflects imposition of sales charge. **Reflects deduction of CDSC. *** Based on the conversion of the Investor B Shares to Investor A Shares after seven years. Fund Management The manager for the fund is Kevin Klingert, Managing Director at BlackRock Financial Management, Inc. (BFM) since 1991. Before joining BFM he was Assis- tant Vice President at Merrill Lynch, Pierce, Fenner & Smith. He has been fund manager since 1995. 73 Financial Highlights The financial information in the table below shows the fund's financial perfor- mance for the periods indicated. Certain information reflects results for a single fund share. The term "Total Return" indicates how much your investment would have increased or decreased during this period of time and assumes that you have reinvested all dividends and distributions. These figures have been audited by PricewaterhouseCoopers LLP, the fund's independent accountants. The auditor's report, along with the fund's financial statements, are included in the Company's annual report which is available upon request (see back cover for ordering instructions). FINANCIAL HIGHLIGHTS - -------------------------------------------------------------------------------- (For an Investor A, B or C Share Outstanding Throughout Each Period) Tax-Free Income Portfolio
INVESTOR A SHARES INVESTOR B SHARES INVESTOR C SHARES For the For the Period Period Year Year Year Year Year Year Year 7/18/96/1 Year 2/28/97/1 Ended Ended Ended Ended Ended Ended Ended / through Ended / through 9/30/98 9/30/97 9/30/96 9/30/95 9/30/94 9/30/98 9/30/97 9/30/96 9/30/98 9/30/97 Net asset value at beginning of period $11.34 $10.84 $10.61 $10.04 $11.31 $11.34 $10.84 $10.74 $11.34 $11.04 ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Income from investment operations Net investment income 0.47 0.50 0.45 0.48 0.48 0.40 0.44 0.08 0.36 0.28 Net gain (loss) on investments (both realized and unrealized) 0.45 0.51 0.21 0.59 (0.93) 0.44 0.49 0.10 0.48 0.27 ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Total from investment operations 0.92 1.01 0.66 1.07 (0.45) 0.84 0.93 0.18 0.84 0.55 ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Less distributions Distributions from net investment income (0.48) (0.51) (0.43) (0.48) (0.48) (0.40) (0.43) (0.08) (0.40) (0.25) Distributions from net realized capital gains (0.05) - - - - (0.02) (0.34) (0.05) - - - - (0.05) - - ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Total distributions (0.53) (0.51) (0.43) (0.50) (0.82) (0.45) (0.43) (0.08) (0.45) (0.25) ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Net asset value at end of period $11.73 $11.34 $10.84 $10.61 $10.04 $11.73 $11.34 $10.84 $11.73 $11.34 ====== ====== ====== ====== ====== ====== ====== ====== ====== ====== Total return3 8.34% 9.58% 6.94% 10.99% (4.19)% 7.53% 8.77% 1.72% 7.53% 5.02% Ratios/Supplemental data Net assets at end of period (in thousands) $6,440 $5,530 $4,873 $6,591 $6,972 $2,034 $ 926 $ 10 $1,024 - - Ratios of expenses to average net assets After advisory/administration fee waivers 1.05% 1.02% 1.04% 1.00% 0.95 % 1.79% 1.75% 1.65%/2/ 1.70% 1.70%2 Before advisory/administration fee waivers 1.33% 1.37% 1.37% 1.78% 2.18 % 2.07% 2.10% 1.98%/2/ 1.98% 2.05%2 Ratios of net investment income to average net assets After advisory/administration fee waivers 4.17% 4.60% 4.67% 4.74% 4.53 % 3.39% 3.65% 3.84%/2/ 3.19% 3.95%2 Before advisory/administration fee waivers 3.89% 4.25% 4.35% 3.96% 3.30 % 3.11% 3.30% 3.51%/2/ 2.91% 3.60%2 Portfolio turnover rate 100% 262% 268% 92% 40 % 100% 262% 268% 100% 262%
----------------------------------------------------------- /1/Commencement of operations of share class. /2/Annualized. /3/Neither front-end sales load nor contingent deferred sales load is reflected. 74 [GRAPHIC BlackRock APPEARS Delaware Tax-Free Income HERE] Portfolio - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Investment Goal The fund seeks as high a level of current income exempt from Federal income tax and, to the extent possible, Delaware state income tax, as is consistent with preservation of capital. Primary Investment Strategies In pursuit of this goal, the fund manager invests primarily in bonds issued by or on behalf of states and possessions of the United States, their political subdivisions and their agencies and authorities (and related tax-exempt deriva- tive securities) the interest on which the manager believes is exempt from Fed- eral income tax (municipal securities). The fund normally invests at least 65% of its total assets in municipal securities of issuers located in the state of Delaware. The fund normally invests at least 80% of its net assets in municipal securities, including both general obligation and revenue bonds, from a diverse range of issuers. The other 20% of net assets can be invested in securities which are subject to regular Federal income tax or the Federal Alternative Min- imum Tax. The fund emphasizes municipal securities in the ten to twenty year maturity range. The fund may only buy securities rated investment grade at the time of purchase by at least one major rating agency or determined by the man- ager to be of similar quality. The management team evaluates sectors of the municipal market and individual bonds within those categories. The fund measures it performance against the Lehman Municipal Bond Index (the benchmark). If a security falls below investment grade, the manager will decide whether to continue to hold the security. A security will be sold if, in the opinion of the fund manager, the risk of continuing to hold the security is unacceptable when compared to the total return potential. It is possible that in extreme market conditions the fund may invest more than 20% of its assets in securities that are not municipal securities (and there- fore are subject to federal income tax) and may hold an unlimited amount of uninvested cash reserves. If market conditions improve, these strategies could result in reducing the potential gain from the market upswing, thus reducing the fund's opportunity to achieve its investment objective. IMPORTANT DEFINITIONS Bonds: Debt obligations such as bonds and debentures, U.S. Gov- ernment securities, debt obligations of domestic and foreign corporations, debt obligations of foreign governments and their political subdivisions, asset-backed securi- ties, various mortgage- backed securities (both residential and commer- cial), other floating or variable rate obli- gations, municipal obligations and zero coupon debt securities. General Obligation Bonds: Bonds which are secured by the issuer's pledge of its full faith, credit and tax- ing power for the pay- ment of principal and interest. Investment Grade: Secu- rities which are rated in the four highest categories by at least one of the major rating agencies or determined by the fund manager to be of similar quality. Generally, the higher the rating of a bond, the higher the likeli- hood that interest and principal payments will be made on time. Secu- rities rated in the fourth highest category by the rating agencies are considered invest- ment grade but they are also considered specu- lative, meaning that they carry more risk than higher rated secu- rities and may have problems making princi- pal and interest pay- ments in difficult eco- nomic climates. Investment grade rat- ings do not guarantee that bonds will not lose value. Lehman Municipal Bond Index: An unmanaged index of municipal bonds with the follow- ing characteristics: minimum credit rating of Baa-3, outstanding par value of at least $3 million, issued as part of a deal of at least $50 million, and issued within the last 5 years remaining matu- rities of not less than one year. Maturity: The date upon which debt securities are due to be repaid, that is, the date when the issuer must pay back the face amount of the security. 75 The fund manager will normally attempt to structure the fund's portfolio to have comparable duration to its benchmark. Duration, which measures price sen- sitivity to interest rate changes, is not necessarily equal to average maturi- ty. The fund manager may, when consistent with the fund's investment objective, use options or futures (commonly known as derivatives). The primary purpose of using derivatives is to attempt to reduce risk to the fund as a whole (hedge) but they may also be used to maintain liquidity, commit cash pending invest- ment or to increase returns. The fund may also enter into interest rate trans- actions as a hedging technique. In these transactions, the fund exchanges its right to pay or receive interest with another party for their right to pay or receive interest. The fund can borrow money to buy additional securities. This practice is know as "leverage." The fund may borrow from banks or other financial institutions or through reverse repurchase agreements (under which the fund sells securi- ties and agrees to buy them back at a particular date and price). The fund normally may borrow up to 33 1/3% of the value of its total assets. The fund may lend some of its securities on a short-term basis in order to earn extra income. The fund will receive collateral in cash or high quality securities equal to the current value of the loaned securities. These loans will be limited to 33 1/3% of the value of the fund's total assets. Should the Company's Board of Trustees determine that the investment objective of the fund should be changed, shareholders will be given at least 30 days notice before any such change is made. The fund may not change the requirement that it normally invest at least 80% of its net assets in municipal securities without shareholder approval. Key Risks Key Risks There is no guarantee that shares of the fund will not lose value. This means you could lose money. Two of the main risks of investing in the fund are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds such as those held by the fund. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. The fact that the fund concentrates its investments in securities of issuers located in Delaware raises special concerns. In particular, changes in the economic conditions and governmental policies of Delaware and its political subdivisions could hurt the value of the fund's shares. IMPORTANT DEFINITIONS Revenue Bonds: Bonds which are secured only by the revenues from a particular facility or class of facilities, such as a water or sewer system, or from the proceeds of a spe- cial excise tax or other revenue source. Total Return: A way of measuring fund perfor- mance. Total return is based on a calculation that takes into account income dividends, capi- tal gain distributions and the increase or decrease in share price. 76 Revenue bonds include private activity bonds, which are not payable from the general revenues of the issuer. Consequently, the credit quality of private activity bonds is usually directly related to the credit standing of the corpo- rate user of the facility involved. To the extent that the fund's assets are invested in private activity bonds, the fund will be subject to the particular risks presented by the laws and economic conditions relating to such projects and bonds to a greater extent than if its assets were not so invested. Munici- pal securities also include "moral obligation" bonds, which are normally issued by special purpose public authorities. If the issuer of moral obligation bonds is unable to pay its debts from current revenues, it may draw on a reserve fund the restoration of which is a moral but not a legal obligation of the state or municipality which created the issuer. The fund may invest in bonds the interest on which may be subject to the Fed- eral Alternative Minimum Tax. The fund may invest up to 20% of its total assets in these bonds when added together with any of the fund's other taxable invest- ments. Interest on these bonds that is received by taxpayers subject to the Federal Alternative Minimum Tax is taxable. The fund may invest 25% or more of its assets in municipal securities whose interest is paid solely from revenues of similar projects. For example, the fund may invest more than 25% of its assets in municipal securities related to water or sewer systems. This type of concentration exposes the fund to the legal and economic risks relating to those projects. There may be less information available on the financial condition of issuers of municipal securities than for public corporations. The market for municipal bonds may be less liquid than for taxable bonds. This means that it may be harder to buy and sell municipal securities, especially on short notice. The fund will rely on legal opinions of counsel to issuers of municipal securi- ties as to the tax-free status of investments and will not do its own analysis. The fund's use of derivatives and interest rate transactions may reduce the fund's returns and/or increase volatility, which is defined as the characteris- tic of a security or a market to fluctuate significantly in price within a short period of time. The income from certain derivatives may be subject to Federal income tax. Leverage is a speculative technique which may expose the fund to greater risk and increase its costs. Increases and decreases in the value of the fund's portfolio will be magnified when the fund uses leverage. The fund will also have to pay interest on its borrowings, reducing the fund's return. Securities loans involve the risk of a delay in receiving additional collateral if the value of the securities goes up while they are on 77 loan. There is also the risk of delay in recovering the loaned securities and of losing rights to the collateral if a borrower goes bankrupt. The fund, like any business, could be affected if the computer systems on which it relies do not properly process information beginning on January 1, 2000. While Year 2000 issues could have a negative effect on the fund, Black- Rock, the fund's investment adviser, is currently working to avoid such prob- lems. BlackRock is also working with other systems providers and vendors to determine their systems' ability to handle Year 2000 problems. There is no guarantee, however, that systems will work properly on January 1, 2000. Year 2000 problems may also hurt issuers whose securities the fund holds or securi- ties markets generally. When you invest in this fund you are not making a bank deposit. Your invest- ment is not insured or guaranteed by the Federal Deposit Insurance Corporation or by any bank or governmental agency. The fund is a non-diversified portfolio under the Investment Company Act, which means that fund performance is more dependent on the performance of a smaller number of securities and issuers than in a diversified portfolio. The change in value of any one security may affect the overall value of the fund more than it would a diversified fund's. 78 Risk / Return Information The chart and table below give you a picture of the fund's long-term perfor- mance for Investor A Shares (in the chart) and for Investor A, B and C Shares (in the table). The information shows you how the fund's performance has var- ied year by year and provides some indication of the risks of investing in the fund. The table compares the fund's performance to that of the Lehman Munici- pal Bond Index, a recognized unmanaged index of bond market performance. The chart and the table both assume reinvestment of dividends and distributions. As with all such investments, past performance is not an indication of future results. Sales charges are not reflected in the bar chart. If they were, returns would be less than those shown. The performance for the period before the fund was launched is based upon per- formance for a predecessor common trust fund which transferred its assets and liabilities to the fund. The fund was launched in May 1998. As of 12/31 Investor A Shares - -------------------------------------------------------------------------------- A N N U A L T O T A L R E T U R N S - -------------------------------------------------------------------------------- [BAR CHART APPEARS HERE] Best Quarter Q1 '95: 4.66% Worst Quarter Q1 '94: -4.71% 89 90 91 92 93 94 95 96 97 98 - ------- ------ ------ ------ ------ ------ ------ ----- ----- ------ 6.86% 6.10% 8.61% 5.25% 7.78% -3.76% 12.55% 3.09% 5.98% 6.20%
As of 12/31/98 - -------------------------------------------------------------------------------- A V E R A G E A N N U A L T O T A L R E T U R N S - -------------------------------------------------------------------------------- Since Inception 1 Year 3 Years 5 Years 10 Years Inception Date - -------------------------------------------------------------------------------- DE Tax-Free; Inv A 1.95% 3.66% 3.83% 5.40% 5.23% 09/30/86 - -------------------------------------------------------------------------------- DE Tax-Free; Inv B 0.68% 3.07% 3.48% 5.05% 4.79% 09/30/86 - -------------------------------------------------------------------------------- DE Tax-Free; Inv C 4.37% 4.31% 3.90% 5.05% 4.79% 09/30/86 - -------------------------------------------------------------------------------- Lehman Municipal 6.48% 6.69% 6.23% 8.22% 7.94% N/A* - -------------------------------------------------------------------------------- * For comparative purposes, the value of the index on 10/01/86 is used as the beginning value on 09/30/86. These returns assume payment of applicable sales charges. 79 EXPENSES AND FEES Expenses and Fees As a shareholder you pay certain fees and expenses. Shareholder transaction fees are paid out of your investment and annual fund operating expenses are paid out of fund assets and are reflected in the fund's price. This prospectus offers shareholders different ways to invest with three sepa- rate pricing options. You need to understand your choices so that you can choose the pricing option that is most suitable for you. With one option (In- vestor A Shares) you pay a one- time front-end transaction fee each time you buy shares. The other options (Investor B and Investor C Shares) have no front-end charges but have higher on-going fees, which are paid over the life of the investment, and have a contingent deferred sales charge (CDSC) that you may pay when you redeem your shares. Which option should you choose? It depends on your individual circumstances. You should know that the lowest sales charge won't necessarily be the least expensive option over time. For example, if you intend to hold your shares long term it may cost less to buy A Shares than B or C Shares. The tables below explain your pricing options and describe the fees and expenses that you may pay if you buy and hold Investor A, B and C Shares of the fund. The "Annual Fund Operating Expenses" table is based on expenses for the most recent fiscal year. Shareholder Fees (Fees paid directly from your investment)
A Shares B Shares C Shares Maximum Front-End Sales Charge* 4.0% 0.0% 0.0% (as percentage of offering price) Maximum Deferred Sales Charge 0.0% 4.5%** 1.00%*** (as percentage of offering price)
* Reduced front-end sales charges may be available. A CDSC of up to 1.00% is assessed on certain redemptions of Investor A Shares that are purchased with no initial sales charge as part of an investment of $1,000,000 or more. ** The CDSC is 4.5% if shares are redeemed in less than one year. The CDSC for Investor B Shares decreases for redemptions made in subsequent years. After six years there is no CDSC on B Shares. (See page 120 for complete schedule of CDSCs.) *** There is no CDSC on C Shares after one year. 80 Annual Fund Operating Expenses (Expenses that are deducted from fund assets)
A Shares B Shares C Shares Advisory Fees .55% .55% .55% Distribution and service (12b- 1) fees .50% 1.15% 1.15% Other expenses* .40% .40% .40% Total annual fund operating expenses 1.45% 2.10% 2.10% Fee waivers and expense reimbursements** .28% .18% .18% Net Expenses** 1.17% 1.92% 1.92%
* "Other expenses" are based on estimated amounts for the current fiscal year. ** BlackRock has contractually agreed to waive or reimburse fees or expenses in order to limit certain (but not all) fund expenses for the next year. The fund may have to repay these waivers and reimbursements to BlackRock in the following two years if the repayment can be made within these expense limits. In addition, BlackRock Distributors, Inc., the fund's distributor, has contractually agreed to waive all 12b-1 distribution fees on Investor A Shares (otherwise payable at the maximum annual rate of .10% of average daily net assets) for the next year. "Net Expenses" in the table have been restated to reflect these waivers and reimbursements. The table does not reflect charges or credits which investors might incur if they invest through a financial institution. Example: This example is intended to help you compare the cost of investing in the fund with the cost of investing in other mutual funds. We are assuming an initial investment of $10,000, 5% total return each year with no changes in operating expenses (except for the waivers in the first year discussed above), redemption at the end of each time period and, with respect to B Shares and C Shares only, no redemption at the end of each time period. Although your actual cost may be higher or lower, based on these assumptions your costs would be:
1 Year 3 Years A Shares* $514 $814 B Shares** Redemption $645 $991 B Shares No Redemption $195 $641 C Shares** Redemption $295 $641 C Shares No Redemption $195 $641
*Reflects imposition of sales charge. **Reflects deduction of CDSC. IMPORTANT DEFINITIONS Advisory Fees: Fees paid to the investment adviser for portfolio management services. Service Fees: Fees that are paid to BlackRock and /or its affiliates for shareholder account service and mainte- nance. Distribution Fees: A method of charging dis- tribution-related expenses against fund assets. Other Expenses: Include administration, trans- fer agency, custody, professional fees and registration fees. 81 Fund Management The manager for the fund is Kevin Klingert, Managing Director at BlackRock Financial Management, Inc. (BFM) since 1991. Before joining BFM he was Assis- tant Vice President at Merrill Lynch, Pierce, Fenner & Smith. He has been fund manager since 1995. Financial Highlights The financial information in the table below shows the fund's financial perfor- mance for the periods indicated. Certain information reflects results for a single fund share. The term "Total Return" indicates how much your investment would have increased or decreased during this period of time and assumes that you have reinvested all dividends and distributions. These figures have been audited by PricewaterhouseCoopers LLP, the fund's independent accountants. The auditor's report, along with the fund's financial statements, are included in the Company's annual report which is available upon request (see back cover for ordering instructions). FINANCIAL HIGHLIGHTS - -------------------------------------------------------------------------------- (For an Investor A, B or C Share Outstanding Throughout Each Period) Delaware Tax-Free Income Portfolio
INVESTOR INVESTOR INVESTOR A SHARES B SHARES C SHARES For the For the For the Period Period Period 5/11/98/1 5/11/98/1 5/11/98/1 / through / through / through 9/30/98 9/30/98 9/30/98 Net asset value at beginning of period $10.00 $10.00 $10.00 ------ ------ ------ Income from investment operations Net investment income 0.15 0.12 0.12 Net gain (loss) on investments (both realized and unrealized) 0.34 0.34 0.34 ------ ------ ------ Total from investment operations 0.49 0.46 0.46 ------ ------ ------ Less distributions Distributions from net investment income (0.16) (0.13) (0.13) Distributions from net realized capital gains - - - - - - ------ ------ ------ Total distributions (0.16) (0.13) (0.13) ------ ------ ------ Net asset value at end of period $10.33 $10.33 $10.33 ====== ====== ====== Total return/3/ 4.97% 4.67% 4.67% Ratios/Supplemental data Net assets at end of period (in thousands) $2,546 $1,740 $ 716 Ratios of expenses to average net assets After advisory/administration fee waivers 1.15%/2/ 1.83%/2/ 1.89%/2/ Before advisory/administration fee waivers 1.33%/2/ 2.01%/2/ 2.07%/2/ Ratios of net investment income to average net assets After advisory/administration fee waivers 3.68%/2/ 2.89%/2/ 2.81%/2/ Before advisory/administration fee waivers 3.50%/2/ 2.71%/2/ 2.63%/2/ Portfolio turnover rate 54% 54% 54%
-------------------------------------- /1/Commencement of operations of share class. /2/Annualized. /3/Neither front-end sales load nor contingent deferred sales load is reflected. 82 [GRAPHIC BlackRock APPEARS Ohio Tax-Free Income HERE] Portfolio - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Investment Goal The fund seeks as high a level of current income exempt from Federal income tax and, to the extent possible, Ohio state income tax, as is consistent with pres- ervation of capital. Primary Investment Strategies In pursuit of this goal, the fund manager invests primarily in bonds issued by or on behalf of states and possessions of the United States, their political subdivisions and their agencies and authorities (and related tax-exempt deriva- tive securities) the interest on which the manager believes is exempt from Fed- eral income tax (municipal securities). The fund normally invests at least 65% of its net assets in municipal securities of issuers located in the state of Ohio. The fund normally invests at least 80% of its net assets in municipal securities, including both general obligation and revenue bonds, from a diverse range of issuers. The other 20% of net assets can be invested in securities which are subject to regular Federal income tax or the Federal Alternative Min- imum Tax. The fund emphasizes municipal securities in the ten to twenty year maturity range. The fund may only buy securities rated investment grade at the time of purchase by at least one major rating agency or determined by the man- ager to be of similar quality. The management team evaluates categories of the municipal market and individual bonds within those categories. The fund measures it performance against the Lehman Municipal Bond Index (the benchmark). If a security falls below investment grade, the manager will decide whether to continue to hold the security. A security will be sold if, in the opinion of the fund manager, the risk of continuing to hold the security is unacceptable when compared to the total return potential. It is possible that in extreme market conditions the fund may invest more than 20% of its assets in securities that are not municipal securities (and there- fore are subject to regular federal income tax) and may hold an unlimited amount of uninvested cash reserves. If market conditions improve, these strate- gies could result in reducing the potential gain from the market upswing, thus reducing the fund's opportunity to achieve its investment objective. IMPORTANT DEFINITIONS Bonds: Debt obligations such as bonds and debentures, U.S. Gov- ernment securities, debt obligations of domestic and foreign corporations, debt obligations of foreign governments and their political subdivisions, asset-backed securi- ties, various mortgage- backed securities (both residential and commer- cial), other floating or variable rate obli- gations, municipal obligations and zero coupon debt securities. General Obligation Bonds: Bonds which are secured by the issuer's pledge of its full faith, credit and tax- ing power for the pay- ment of principal and interest. Investment Grade: Secu- rities which are rated in the four highest categories by at least one of the major rating agencies or determined by the fund manager to be of similar quality. Generally, the higher the rating of a bond, the higher the likeli- hood that interest and principal payments will be made on time. Secu- rities rated in the fourth highest category by the rating agencies are considered invest- ment grade but they are also considered specu- lative, meaning that they carry more risk than higher rated secu- rities and may have problems making princi- pal and interest pay- ments in difficult eco- nomic climates. Investment grade rat- ings do not guarantee that bonds will not lose value. Lehman Municipal Bond Index: An unmanaged index of municipal bonds with the follow- ing characteristics; minimum credit rating of Baa-3, outstanding par value of at least $3 million, issued as part of a deal of at least $50 million, and issued within the last 5 years remaining matu- rities of not less than one year. Maturity: The date upon which debt securities are due to be repaid, that is, the date when the issuer must pay back the face amount of the security. 83 The fund manager will normally attempt to structure the fund's portfolio to have comparable duration to its benchmark. Duration, which measures price sen- sitivity to interest rate changes, is not necessarily equal to average maturi- ty. The fund manager may, when consistent with the fund's investment objective, use options or futures (commonly known as derivatives). The primary purpose of using derivatives is to attempt to reduce risk to the fund as a whole (hedge) but they may also be used to maintain liquidity, commit cash pending invest- ment or to increase returns. The fund may also enter into interest rate trans- actions as a hedging technique. In these transactions, the fund exchanges its right to pay or receive interest with another party for their right to pay or receive interest. The fund can borrow money to buy additional securities. This practice is known as "leverage." The fund may borrow from banks or other financial institutions or through reverse repurchase agreements (under which the fund sells securi- ties and agrees to buy them back at a particular date and price). The fund normally may borrow up to 33 1/3% of the value of its total assets. The fund may lend some of its securities on a short-term basis in order to earn extra income. The fund will receive collateral in cash or high quality securities equal to the current value of the loaned securities. These loans will be limited to 33 1/3% of the value of the fund's total assets. Should the Company's Board of Trustees determine that the investment objective of the fund should be changed, shareholders will be given at least 30 days notice before any such change is made. The fund may not change the requirement that it normally invest at least 80% of its net assets in municipal securities without shareholder approval. KEY RISKS Key Risks There is no guarantee that shares of the fund will not lose value. This means you could lose money. Two of the main risks of investing in the fund are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds such as those held by the fund. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. The fact that the fund concentrates its investments in securities of issuers located in Ohio raises special concerns. In particular, changes in the eco- nomic conditions and governmental policies of Ohio and its political subdivi- sions could hurt the value of the fund's shares. IMPORTANT DEFINITIONS Revenue Bonds: Bonds which are secured only by the revenues from a particular facility or class of facilities, such as a water or sewer system, or from the proceeds of a special excise tax or other revenue source. Total Return: A way of measuring fund perfor- mance. Total return is based on a calculation that takes into account income dividends, capi- tal gain distributions and the increase or decrease in share price. 84 Revenue bonds include private activity bonds, which are not payable from the general revenues of the issuer. Consequently, the credit quality of private activity bonds is usually directly related to the credit standing of the corpo- rate user of the facility involved. To the extent that the fund's assets are invested in private activity bonds, the fund will be subject to the particular risks presented by the laws and economic conditions relating to such projects and bonds to a greater extent than if its assets were not so invested. Munici- pal securities also include "moral obligation" bonds, which are normally issued by special purpose public authorities. If the issuer of moral obligation bonds is unable to pay its debts from current revenues, it may draw on a reserve fund the restoration of which is a moral but not a legal obligation of the state or municipality which created the issuer. The fund may invest in bonds the interest on which may be subject to the Fed- eral Alternative Minimum Tax. The fund may invest up to 20% of its total assets in these bonds when added together with any of the fund's other taxable invest- ments. Interest on these bonds that is received by taxpayers subject to the Federal Alternative Minimum Tax is taxable. The fund may invest 25% or more of its assets in municipal securities whose interest is paid solely from revenues of similar projects. For example, the fund may invest more than 25% of its assets in municipal securities related to water or sewer systems. This type of concentration exposes the fund to the legal and economic risks relating to those projects. There may be less information available on the financial condition of issuers of municipal securities than for public corporations. The market for municipal bonds may be less liquid than for taxable bonds. This means that it may be harder to buy and sell municipal securities, especially on short notice. The fund will rely on legal opinions of counsel to issuers of municipal securi- ties as to the tax-free status of investments and will not do its own analysis. The fund's use of derivatives and interest rate transactions may reduce the fund's returns and/or increase volatility, which is defined as the characteris- tic of a security or a market to fluctuate significantly in price within a short period of time. The income from certain derivatives may be subject to Federal income tax. Leverage is a speculative technique which may expose the fund to greater risk and increase its costs. Increases and decreases in the value of the fund's portfolio will be magnified when the fund uses leverage. The fund will also have to pay interest on its borrowings, reducing the fund's return. Securities loans involve the risk of a delay in receiving additional collateral if the value of the securities goes up while they are on 85 loan. There is also the risk of delay in recovering the loaned securities and of losing rights to the collateral if a borrower goes bankrupt. The fund, like any business, could be affected if the computer systems on which it relies do not properly process information beginning on January 1, 2000. While Year 2000 issues could have a negative effect on the fund, Black- Rock, the fund's investment adviser, is currently working to avoid such prob- lems. BlackRock is also working with other systems providers and vendors to determine their systems' ability to handle Year 2000 problems. There is no guarantee, however, that systems will work properly on January 1, 2000. Year 2000 problems may also hurt issuers whose securities the fund holds or securi- ties markets generally. When you invest in this fund you are not making a bank deposit. Your invest- ment is not insured or guaranteed by the Federal Deposit Insurance Corporation or by any bank or governmental agency. The fund is a non-diversified portfolio under the Investment Company Act, which means that fund performance is more dependent on the performance of a smaller number of securities and issuers than in a diversified portfolio. The change in value of any one security may affect the overall value of the fund more than it would a diversified fund's. 86 Risk / Return Information The chart and table below give you a picture of the fund's long-term perfor- mance for Investor A Shares (in the chart) and for Investor A, B and C Shares (in the table). The information shows you how the fund's performance has varied year by year and provides some indication of the risks of investing in the fund. The table compares the fund's performance to that of the Lehman Municipal Bond Index, a recognized unmanaged index of bond market performance. The chart and the table both assume reinvestment of dividends and distributions. As with all such investments, past performance is not an indication of future results. Sales charges are not reflected in the bar chart. If they were, returns would be less than those shown. The performance for the period before Investor B and C Shares were launched is based upon performance for older share classes of the fund. Investor B Shares were launched in October 1994 and Investor C Shares were launched in August 1998. The actual returns of Investor B and C Shares would have been lower than shown because Investor B and C Shares have higher expenses than these other classes. Also, the actual returns of Investor B and C Shares would have been lower compared to Investor A Shares. As of 12/31 Investor A Shares - -------------------------------------------------------------------------------- A N N U A L T O T A L R E T U R N S - -------------------------------------------------------------------------------- [BAR CHART APPEARS HERE] Best Quarter Q1 '95: 7.36% Worst Quarter Q1 '94: -6.15% 93 94 95 96 97 98 ----- ------ ------ ------ ------ ----- 10.14% -6.51% 17.45% 3.64% 8.15% 5.86% As of 12/31/98 - -------------------------------------------------------------------------------- A V E R A G E A N N U A L T O T A L R E T U R N S - -------------------------------------------------------------------------------- Since Inception 1 Year 3 Years 5 Years Inception Date - -------------------------------------------------------------------------------- OH Tax-Free; Inv A 1.66% 4.44% 4.58% 5.42% 12/01/92 OH Tax-Free; Inv B 0.34% 3.85% 4.34% 5.57% 12/01/92 OH Tax-Free; Inv C 4.02% 5.09% 4.76% 5.57% 12/01/92 Lehman Municipal 6.48% 6.69% 6.23% 7.92% N/A - -------------------------------------------------------------------------------- These returns assume payment of applicable sales charges. 87 EXPENSES AND FEES Expenses and Fees As a shareholder you pay certain fees and expenses. Shareholder transaction fees are paid out of your investment and annual fund operating expenses are paid out of fund assets and are reflected in the fund's price. This prospectus offers shareholders different ways to invest with three sepa- rate pricing options. You need to understand your choices so that you can choose the pricing option that is most suitable for you. With one option (In- vestor A Shares) you pay a one- time front-end transaction fee each time you buy shares. The other options (Investor B and Investor C Shares) have no front-end charges but have higher on-going fees, which are paid over the life of the investment, and have a con- tingent deferred sales charge (CDSC) that you may pay when you redeem your shares. Which option should you choose? It depends on your individual circum- stances. You should know that the lowest sales charge won't necessarily be the least expensive option over time. For example, if you intend to hold your shares long term it may cost less to buy A Shares than B or C Shares. The tables below explain your pricing options and describe the fees and expenses that you may pay if you buy and hold Investor A, B and C Shares of the fund. The "Annual Fund Operating Expenses" table is based on expenses for the most recent fiscal year. Shareholder Fees (Fees paid directly from your investment)
A Shares B Shares C Shares Maximum Front-End Sales Charge* 4.0% 0.0% 0.0% (as percentage of offering price) Maximum Deferred Sales Charge 0.0% 4.5%** 1.00%*** (as percentage of offering price)
* Reduced front-end sales charges may be available. A CDSC of up to 1.00% is assessed on certain redemptions of Investor A Shares that are purchased with no initial sales charge as part of an investment of $1,000,000 or more. ** The CDSC is 4.5% if shares are redeemed in less than one year. The CDSC for Investor B Shares decreases for redemptions made in subsequent years. After six years there is no CDSC on B Shares. (See page 120 for complete schedule of CDSCs.) *** There is no CDSC on C Shares after one year. 88 IMPORTANT DEFINITIONS Advisory Fees: Fees paid to the investment adviser for portfolio management services. Service Fees: Fees that are paid to BlackRock and /or its affiliates for shareholder account service and mainte- nance. Distribution Fees: A method of charging dis- tribution-related expenses against fund assets. Other Expenses: Include administration, trans- fer agency, custody, professional fees and registration fees. Annual Fund Operating Expenses (Expenses that are deducted from fund assets)
A Shares B Shares C Shares Advisory Fees .50% .50% .50% Distribution and service (12b- 1) fees .50% 1.15% 1.15% Other expenses .50% .50% .50% Total annual fund operating expenses 1.50% 2.15% 2.15% Fee waivers and expense reimbursements* .43% .33% .33% Net Expenses* 1.07% 1.82% 1.82%
* BlackRock has contractually agreed to waive or reimburse fees or expenses in order to limit certain (but not all) fund expenses for the next year. The fund may have to repay these waivers and reimbursements to BlackRock in the following two years if the repayment can be made within these expense lim- its. In addition, BlackRock Distributors, Inc., the fund's distributor, has contractually agreed to waive all 12b-1 distribution fees on Investor A Shares (otherwise payable at the maximum annual rate of .10% of average daily net assets) for the next year. Net Expenses in the table have been restated to reflect these waivers and reimbursements. The table does not reflect charges or credits which investors might incur if they invest through a financial institution. Example: This example is intended to help you compare the cost of investing in the fund with the cost of investing in other mutual funds. We are assuming an initial investment of $10,000, 5% total return each year with no changes in operating expenses (except for the waivers in the first year discussed above), redemption at the end of each time period and, with respect to B Shares and C Shares only, no redemption at the end of each time period. Although your actual cost may be higher or lower, based on these assumptions your costs would be:
1 Year 3 Years 5 Years 10 Years A Shares* $505 $815 $1,147 $2,084 B Shares** Redemption $635 $991 $1,324 $2,214*** B Shares No Redemption $185 $641 $1,124 $2,214*** C Shares** Redemption $285 $641 $1,124 $2,457 C Shares No Redemption $185 $641 $1,124 $2,457
*Reflects imposition of sales charge. **Reflects deduction of CDSC. *** Based on the conversion of the Investor B Shares to Investor A Shares after seven years. Fund Management The manager for the fund is Kevin Klingert, Managing Director at BlackRock Financial Management, Inc. (BFM) since 1991. Before joining BFM he was Assis- tant Vice President at Merrill Lynch, Pierce, Fenner & Smith. He has been fund manager since 1995. 89 Financial Highlights The financial information in the table below shows the fund's financial perfor- mance for the periods indicated. Certain information reflects results for a single fund share. The term "Total Return" indicates how much your investment would have increased or decreased during this period of time and assumes that you have reinvested all dividends and distributions. These figures have been audited by PricewaterhouseCoopers LLP, the fund's independent accountants. The auditor's report, along with the fund's financial statements, are included in the Company's annual report which is available upon request (see back cover for ordering instructions). FINANCIAL HIGHLIGHTS - -------------------------------------------------------------------------------- (For an Investor A, B or C Share Outstanding Throughout Each Period) Ohio Tax-Free Income Portfolio
INVESTOR A INVESTOR B INVESTOR C SHARES SHARES SHARES For the For the Period Period Year Year Year Year Year Year Year Year 10/13/94/1/ 8/26/98/1 Ended Ended Ended Ended Ended Ended Ended Ended through / through 9/30/98 9/30/97 9/30/96 9/30/95 9/30/94 9/30/98 9/30/97 9/30/96 9/30/95 9/30/98 Net asset value at beginning of period $10.50 $10.15 $10.05 $ 9.60 $10.53 $10.50 $10.15 $10.05 $ 9.58 $10.74 ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Income from investment operations Net investment income 0.45 0.45 0.46 0.52 0.53 0.37 0.37 0.38 0.42 0.03 Net gain (loss) on investments (both realized and unrealized) 0.38 0.35 0.10 0.45 (0.91) 0.38 0.35 0.10 0.47 0.14 ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Total from investment operations 0.83 0.80 0.56 0.97 (0.38) 0.75 0.72 0.48 0.89 0.17 ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Less distributions Distributions from net investment income (0.45) (0.45) (0.46) (0.52) (0.53) (0.37) (0.37) (0.38) (0.42) (0.03) Distributions from net realized capital gains - - - - - - - - (0.02) - - - - - - - - - - ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Total distributions (0.45) (0.45) (0.46) (0.52) (0.55) (0.37) (0.37) (0.38) (0.42) (0.03) ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Net asset value at end of period $10.88 $10.50 $10.15 $10.05 $ 9.60 $10.88 $10.50 $10.15 $10.05 $10.88 ====== ====== ====== ====== ====== ====== ====== ====== ====== ====== Total return/3/ 8.05% 8.03% 5.66% 10.46% (3.75)% 7.25% 7.23% 4.87% 9.33% 1.60% Ratios/Supplemental data Net assets at end of period (in thousands) $2,774 $2,614 $2,833 $3,303 $3,825 $1,116 $ 622 $ 161 $ 106 $ 527 Ratios of expenses to average net assets After advisory/administration fee waivers 1.06% 1.02% 0.91% 0.38% 0.10% 1.79% 1.75% 1.66% 1.17%/2/ 1.71%/2/ Before advisory/administration fee waivers 1.39% 1.53% 1.50% 1.45% 1.49% 2.12% 2.26% 2.26% 2.25%/2/ 2.04%/2/ Ratios of net investment income to average net assets After advisory/administration fee waivers 4.22% 4.35% 4.57% 5.42% 5.18% 3.41% 3.52% 3.80% 4.48%/2/ 2.82%/2/ Before advisory/administration fee waivers 3.89% 3.84% 3.98% 4.35% 3.79% 3.08% 3.01% 3.21% 3.41%/2/ 2.49%/2/ Portfolio turnover rate 77% 87% 136% 63% 61% 77% 87% 136% 63% 77%
------------------------------------------------------------ /1/Commencement of operations of share class. /2/Annualized. /3/Neither front-end sales load nor contingent deferred sales load is reflected. 90 [GRAPHIC BlackRock APPEARS Kentucky Tax-Free Income HERE] Portfolio - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Investment Goal The fund seeks as high a level of current income exempt from Federal income tax and, to the extent possible, Kentucky state income tax, as is consistent with preservation of capital. Primary Investment Strategies In pursuit of this goal, the fund manager invests primarily in bonds issued by or on behalf of states and possessions of the United States, their political subdivisions and their agencies and authorities (and related tax-exempt deriva- tive securities) the interest on which the manager believes is exempt from Fed- eral income tax (municipal securities). The fund normally invests at least 65% of its total assets in municipal securities of issuers located in the state of Kentucky. The fund normally invests at least 80% of its net assets in municipal securities, including both general obligation and revenue bonds, from a diverse range of issuers. The other 20% of net assets can be invested in securities which are subject to regular Federal income tax or the Federal Alternative Min- imum Tax. The fund emphasizes municipal securities in the ten to twenty year maturity range. The fund may only buy securities rated investment grade at the time of purchase by at least one major rating agency or determined by the man- ager to be of similar quality. The management team evaluates categories of the municipal market and individual bonds within those categories. The fund measures it performance against the Lehman Municipal Bond Index (the benchmark). If a security falls below investment grade, the manager will decide whether to continue to hold the security. A security will be sold if, in the opinion of the fund manager, the risk of continuing to hold the security is unacceptable when compared to the total return potential. It is possible that in extreme market conditions the fund may invest more than 20% of its assets in securities that are not municipal securities (and there- fore are subject to regular federal income tax) and may hold an unlimited amount of uninvested cash reserves. If market conditions improve, these strate- gies could result in reducing the potential gain from the market upswing, thus reducing the fund's opportunity to achieve its investment objective. IMPORTANT DEFINITIONS Bonds: Debt obligations such as bonds and debentures, U.S. Gov- ernment securities, debt obligations of domestic and foreign corporations, debt obligations of foreign governments and their political subdivisions, asset-backed securi- ties, various mortgage- backed securities (both residential and commer- cial), other floating or variable rate obli- gations, municipal obligations and zero coupon debt securities. General Obligation Bonds: Bonds which are secured by the issuer's pledge of its full faith, credit and tax- ing power for the pay- ment of principal and interest. Investment Grade: Secu- rities which are rated in the four highest categories by at least one of the major rating agencies or determined by the fund manager to be of similar quality. Generally, the higher the rating of a bond, the higher the likeli- hood that interest and principal payments will be made on time. Secu- rities rated in the fourth highest category by the rating agencies are considered invest- ment grade but they are also considered specu- lative, meaning that they carry more risk than higher rated secu- rities and may have problems making princi- pal and interest pay- ments in difficult eco- nomic climates. Investment grade rat- ings do not guarantee that bonds will not lose value. Lehman Municipal Bond Index: An unmanaged index of municipal bonds with the follow- ing characteristics: minimum credit rating of Baa-3, outstanding par value of at least $3 million, issued as part of a deal of at least $50 million, and issued within the last 5 years remaining matu- rities of not less than one year. Maturity: The date upon which debt securities are due to be repaid, that is, the date when the issuer must pay back the face amount of the security. 91 The fund manager will normally attempt to structure the fund's portfolio to have comparable duration to its benchmark. Duration, which measures price sen- sitivity to interest rate changes, is not necessarily equal to average maturi- ty. The fund manager may, when consistent with the fund's investment objective, use options or futures (commonly known as derivatives). The primary purpose of using derivatives is to attempt to reduce risk to the fund as a whole (hedge) but they may also be used to maintain liquidity, commit cash pending invest- ment or to increase returns. The fund may also enter into interest rate trans- actions as a hedging technique. In these transactions, the fund exchanges its right to pay or receive interest with another party for their right to pay or receive interest. The fund can borrow money to buy additional securities. This practice is known as "leverage." The fund may borrow from banks or other financial institutions or through reverse repurchase agreements (under which the fund sells securi- ties and agrees to buy them back at a particular date and price). The Fund normally may borrow up to 33 1/3% of the value of its total assets. The fund may lend some of its securities on a short-term basis in order to earn extra income. The fund will receive collateral in cash or high quality securities equal to the current value of the loaned securities. These loans will be limited to 33 1/3% of the value of the fund's total assets. Should the Company's Board of Trustees determine that the investment objective of the fund should be changed, shareholders will be given at least 30 days notice before any such change is made. The fund may not change the requirement that it normally invest at least 80% of its net assets in municipal securities without shareholder approval. Key Risks Key Risks There is no guarantee that shares of the fund will not lose value. This means you could lose money. Two of the main risks of investing in the fund are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds such as those held by the fund. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. The fact that the fund concentrates its investments in securities of issuers located in Kentucky raises special concerns. In particular, changes in the economic conditions and governmental policies of Kentucky and its political subdivisions could hurt the value of the fund's shares. IMPORTANT DEFINITIONS Revenue Bonds: Bonds which are secured only by the revenues from a particular facility or class of facilities, such as a water or sewer system, or from the proceeds of a spe- cial excise tax or other revenue source. Total Return: A way of measuring fund perfor- mance. Total return is based on a calculation that takes into account income dividends, capi- tal gain distributions and the increase or decrease in share price. 92 Revenue bonds include private activity bonds, which are not payable from the general revenues of the issuer. Consequently, the credit quality of private activity bonds is usually directly related to the credit standing of the corpo- rate user of the facility involved. To the extent that the fund's assets are invested in private activity bonds, the fund will be subject to the particular risks presented by the laws and economic conditions relating to such projects and bonds to a greater extent than if its assets were not so invested. Munici- pal securities also include "moral obligation" bonds, which are normally issued by special purpose public authorities. If the issuer of moral obligation bonds is unable to pay its debts from current revenues, it may draw on a reserve fund the restoration of which is a moral but not a legal obligation of the state or municipality which created the issuer. The fund may invest in bonds the interest on which may be subject to the Fed- eral Alternative Minimum Tax. The fund may invest up to 20% of its total assets in these bonds when added together with any of the fund's other taxable invest- ments. Interest on these bonds that is received by taxpayers subject to the Federal Alternative Minimum Tax is taxable. The fund may invest 25% or more of its assets in municipal securities whose interest is paid solely from revenues of similar projects. For example, the fund may invest more than 25% of its assets in municipal securities related to water or sewer systems. This type of concentration exposes the fund to the legal and economic risks relating to those projects. There may be less information available on the financial condition of issuers of municipal securities than for public corporations. The market for municipal bonds may be less liquid than for taxable bonds. This means that it may be harder to buy and sell municipal securities, especially on short notice. The fund will rely on legal opinions of counsel to issuers of municipal securi- ties as to the tax-free status of investments and will not do its own analysis. The fund's use of derivatives and interest rate transactions may reduce the fund's returns and/or increase volatility, which is defined as the characteris- tic of a security or a market to fluctuate significantly in price within a short period of time. The income from certain derivatives may be subject to Federal income tax. Leverage is a speculative technique which may expose the fund to greater risk and increase its costs. Increases and decreases in the value of the fund's portfolio will be magnified when the fund uses leverage. The fund will also have to pay interest on its borrowings, reducing the fund's return. 93 Securities loans involve the risk of a delay in receiving additional collat- eral if the value of the securities goes up while they are on loan. There is also the risk of delay in recovering the loaned securities and of losing rights to the collateral if a borrower goes bankrupt. The fund, like any business, could be affected if the computer systems on which it relies do not properly process information beginning on January 1, 2000. While Year 2000 issues could have a negative effect on the fund, Black- Rock, the fund's investment adviser, is currently working to avoid such prob- lems. BlackRock is also working with other systems providers and vendors to determine their systems' ability to handle Year 2000 problems. There is no guarantee, however, that systems will work properly on January 1, 2000. Year 2000 problems may also hurt issuers whose securities the fund holds or securi- ties markets generally. When you invest in this fund you are not making a bank deposit. Your invest- ment is not insured or guaranteed by the Federal Deposit Insurance Corporation or by any bank or governmental agency. The fund is a non-diversified portfolio under the Investment Company Act, which means that fund performance is more dependent on the performance of a smaller number of securities and issuers than in a diversified portfolio. The change in value of any one security may affect the overall value of the fund more than it would a diversified fund's. 94 Risk / Return Information The chart and table below give you a picture of the fund's long-term perfor- mance for Investor A Shares (in the chart) and for Investor A, B and C Shares (in the table). The information shows you how the fund's performance has varied year by year and provides some indication of the risks of investing in the fund. The table compares the fund's performance to that of the Lehman Municipal Bond Index, a recognized unmanaged index of bond market performance. The chart and the table both assume reinvestment of dividends and distributions. As with all such investments, past performance is not an indication of future results. Sales charges are not reflected in the bar chart. If they were, returns would be less than those shown. The performance for the period before the fund was launched is based upon per- formance for a predecessor common trust fund which transferred its assets and liabilities to the fund. The fund was launched in May 1998. As of 12/31 Investor A Shares - -------------------------------------------------------------------------------- A N N U A L T O T A L R E T U R N S - -------------------------------------------------------------------------------- [BAR CHART APPEARS HERE] Best Quarter Q1 '95: 5.25% Worst Quarter Q1 '94: -4.49% 89 90 91 92 93 94 95 96 97 98 - ------ ------ ------ ------ ------ ------ ------ ----- ----- ------ 7.59% 7.01% 8.66% 6.79% 9.03% -3.69% 12.90% 3.17% 6.42% 5.85%
As of 12/31/98 - -------------------------------------------------------------------------------- A V E R A G E A N N U A L T O T A L R E T U R N S - -------------------------------------------------------------------------------- Since Inception 1 Year 3 Years 5 Years 10 Years Inception Date - -------------------------------------------------------------------------------- KY Tax-Free; Inv A 1.62% 3.83% 4.01% 5.91% 6.00% 11/30/87 - -------------------------------------------------------------------------------- KY Tax-Free; Inv B 0.34% 3.25% 3.67% 5.55% 5.60% 11/30/87 - -------------------------------------------------------------------------------- KY Tax-Free; Inv C 4.02% 4.48% 4.09% 5.55% 5.60% 11/30/87 - -------------------------------------------------------------------------------- Lehman Municipal 6.48% 6.69% 6.23% 8.22% 8.47% N/A - -------------------------------------------------------------------------------- These returns assume payment of applicable sales charges. 95 Expenses and Fees Expenses and Fees As a shareholder you pay certain fees and expenses. Shareholder transaction fees are paid out of your investment and annual fund operating expenses are paid out of fund assets and are reflected in the fund's price. This prospectus offers shareholders different ways to invest with three sepa- rate pricing options. You need to understand your choices so that you can choose the pricing option that is most suitable for you. With one option (In- vestor A Shares) you pay a one-time front-end transaction fee each time you buy shares. The other options (Investor B and Investor C Shares) have no front-end charges but have higher on-going fees, which are paid over the life of the investment, and have a contingent deferred sales charge (CDSC) that you may pay when you redeem your shares. Which option should you choose? It depends on your individual circumstances. You should know that the lowest sales charge won't necessarily be the least expensive option over time. For example, if you intend to hold your shares long term it may cost less to buy A Shares than B or C Shares. The tables below explain your pricing options and describe the fees and expenses that you may pay if you buy and hold Investor A, B and C Shares of the fund. The "Annual Fund Operating Expenses" table is based on expenses for the most recent fiscal year. Shareholder Fees (Fees paid directly from your investment)
A Shares B Shares C Shares Maximum Front-End Sales Charge* 4.0% 0.0% 0.0% (as percentage of offering price) Maximum Deferred Sales Charge 0.0% 4.5%** 1.00%*** (as percentage of offering price)
* Reduced front-end sales charges may be available. A CDSC of up to 1.00% is assessed on certain redemptions of Investor A Shares that are purchased with no initial sales charge as part of an investment of $1,000,000 or more. ** The CDSC is 4.5% if shares are redeemed in less than one year. The CDSC for Investor B Shares decreases for redemptions made in subsequent years. After six years there is no CDSC on B Shares. (See page 120 for complete schedule of CDSCs.) *** There is no CDSC on C Shares after one year. 96 Annual Fund Operating Expenses (Expenses that are deducted from fund assets)
A Shares B Shares C Shares Advisory Fees .55% .55% .55% Distribution and service (12b- 1) fees .50% 1.15% 1.15% Other expenses* .47% .47% .47% Total annual fund operating expenses 1.52% 2.17% 2.17% Fee waivers and expense reimbursements** .35% .25% .25% Net Expenses** 1.17% 1.92% 1.92%
* "Other expenses" are based on estimated amounts for the current fiscal year. ** BlackRock has contractually agreed to waive or reimburse fees or expenses in order to limit certain (but not all) fund expenses for the next year. The fund may have to repay these waivers and reimbursements to BlackRock in the following two years if the repayment can be made within these expense limits. In addition, BlackRock Distributors, Inc., the fund's distributor, has contractually agreed to waive all 12b-1 distribution fees on Investor A Shares (otherwise payable at the maximum annual rate of .10% of average daily net assets) for the next year. "Net Expenses" in the table have been restated to reflect these waivers and reimbursements. The table does not reflect charges or credits which investors might incur if they invest through a financial institution. Example: This example is intended to help you compare the cost of investing in the fund with the cost of investing in other mutual funds. We are assuming an initial investment of $10,000, 5% total return each year with no changes in operating expenses (except for the waivers in the first year discussed above), redemption at the end of each time period and, with respect to B Shares and C Shares only, no redemption at the end of each time period. Although your actual cost may be higher or lower, based on these assumptions your costs would be:
1 Year 3 Years A Shares* $514 $ 828 B Shares** Redemption $645 $1,005 B Shares No Redemption $195 $ 655 C Shares** Redemption $295 $ 655 C Shares No Redemption $195 $ 655
*Reflects imposition of sales charge. **Reflects deduction of CDSC. IMPORTANT DEFINITIONS Advisory Fees: Fees paid to the investment adviser for portfolio management services. Service Fees: Fees that are paid to BlackRock and /or its affiliates for shareholder account service and mainte- nance. Distribution Fees: A method of charging dis- tribution-related expenses against fund assets. Other Expenses: Include administration, trans- fer agency, custody, professional fees and registration fees. 97 Fund Management The manager for the fund is Kevin Klingert, Managing Director at BlackRock Financial Management, Inc. (BFM) since 1991. Before joining BFM he was Assis- tant Vice President at Merrill Lynch, Pierce, Fenner & Smith. He has been man- ager since 1995. Financial Highlights The financial information in the table below shows the fund's financial perfor- mance for the periods indicated. Certain information reflects results for a single fund share. The term "Total Return" indicates how much your investment would have increased or decreased during this period of time and assumes that you have reinvested all dividends and distributions. These figures have been audited by PricewaterhouseCoopers LLP, the fund's independent accountants. The auditor's report, along with the fund's financial statements, are included in the Company's annual report which is available upon request (see back cover for ordering instructions). FINANCIAL HIGHLIGHTS - -------------------------------------------------------------------------------- (For an Investor A, B or C Share Outstanding Throughout Each Period) Kentucky Tax-Free Income Portfolio
INVESTOR INVESTOR INVESTOR A SHARES B SHARES C SHARES For the For the For the Period Period Period 5/11/98/1/ 5/11/98/1/ 5/11/98/1/ through through through 9/30/98 9/30/98 9/30/98 Net asset value at beginning of period $10.00 $10.00 $10.00 ------ ------ ------ Income from investment operations Net investment income 0.16 0.15 0.15 Net gain (loss) on investments (both realized and unrealized) 0.31 0.29 0.29 ------ ------ ------ Total from investment operations 0.47 0.44 0.44 ------ ------ ------ Less distributions Distributions from net investment income (0.16) (0.13) (0.13) Distributions from net realized capital gains - - - - - - ------ ------ ------ Total distributions (0.16) (0.13) (0.13) ------ ------ ------ Net asset value at end of period $10.31 $10.31 $10.31 ====== ====== ====== Total return/3/ 4.76% 4.45% 4.45% Ratios/Supplemental data Net assets at end of period (in thousands) $ 975 $ - - $ - - Ratios of expenses to average net assets After advisory/administration fee waivers 1.17%/2/ 0.67%/2/ 0.67%/2/ Before advisory/administration fee waivers 1.42%/2/ 0.92%/2/ 0.92%/2/ Ratios of net investment income to average net assets After advisory/administration fee waivers 4.07%/2/ 0.64%/2/ 5.00%/2/ Before advisory/administration fee waivers 3.82%/2/ 0.39%/2/ 4.75%/2/ Portfolio turnover rate 7% 7% 7%
-------------------------------------- /1/Commencement of operations of share class. /2/Annualized. /3/Neither front-end sales load nor contingent deferred sales load is reflected. 98 [GRAPHIC BlackRock APPEARS New Jersey Tax-Free Income HERE] Portfolio - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Investment Goal The fund seeks as high a level of current income exempt from Federal income tax and, to the extent possible, New Jersey state income tax, as is consistent with preservation of capital. Primary Investment Strategies In pursuit of this goal, the fund manager invests primarily in bonds issued by or on behalf of states and possessions of the United States, their political subdivisions and their agencies and authorities (and related tax-exempt deriva- tive securities) the interest on which the manager believes is exempt from Fed- eral income tax (municipal securities). The fund normally invests at least 65% of its net assets in municipal securities of issuers located in the state of New Jersey. The fund normally invests at least 80% of its net assets in munici- pal securities, including both general obligation and revenue bonds, from a diverse range of issuers. The other 20% of net assets can be invested in secu- rities which are subject to regular Federal income tax or the Federal Alterna- tive Minimum Tax. In addition, for New Jersey tax purposes, the fund intends to invest at least 80% of its total assets in municipal securities of issuers located in the state of New Jersey and in securities issued by the U.S. Govern- ment, its agencies and authorities. The fund emphasizes municipal securities in the ten to twenty year maturity range. The fund may only buy securities rated investment grade at the time of purchase by at least one major rating agency or determined by the manager to be of similar quality. The management team evaluates categories of the municipal market and individual bonds within those categories. The fund measures it performance against the Lehman Municipal Bond Index (the benchmark). If a security falls below investment grade, the manager will decide whether to continue to hold the security. A security will be sold if, in the opinion of the fund manager, the risk of continuing to hold the security is unacceptable when compared to the total return potential. It is possible that in extreme market conditions the fund may invest more than 20% of its assets in securities that are not municipal securities (and there- fore are subject to regular federal income tax) and may hold an unlimited amount of uninvested IMPORTANT DEFINITIONS Bonds: Debt obligations such as bonds and debentures, U.S. Gov- ernment securities, debt obligations of domestic and foreign corporations, debt obligations of foreign governments and their political subdivisions, asset-backed securi- ties, various mortgage- backed securities (both residential and commer- cial), other floating or variable rate obli- gations, municipal obligations and zero coupon debt securities. General Obligation Bonds: Bonds which are secured by the issuer's pledge of its full faith, credit and tax- ing power for the pay- ment of principal and interest. Investment Grade: Secu- rities which are rated in the four highest categories by at least one of the major rating agencies or determined by the fund manager to be of similar quality. Generally, the higher the rating of a bond, the higher the likeli- hood that interest and principal payments will be made on time. Secu- rities rated in the fourth highest category by the rating agencies are considered invest- ment grade but they are also considered specu- lative, meaning that they carry more risk than higher rated secu- rities and may have problems making princi- pal and interest pay- ments in difficult eco- nomic climates. Investment grade rat- ings do not guarantee that bonds will not lose value. Lehman Municipal Bond Index: An unmanaged index of municipal bonds with the follow- ing characteristics: minimum credit rating of Baa-3, outstanding par value of at least $3 million, issued as part of a deal of at least $50 million, and issued within the last 5 years remaining matu- rities of not less than one year. Maturity: The date upon which debt securities are due to be repaid, that is, the date when the issuer must pay back the face amount of the security. 99 cash reserves. If market conditions improve, these strategies could result in reducing the potential gain from the market upswing, thus reducing the fund's opportunity to achieve its investment objective. The fund manager will normally attempt to structure the fund's portfolio to have comparable duration to its benchmark. Duration, which measures price sen- sitivity to interest rate changes, is not necessarily equal to average maturi- ty. The fund manager may, when consistent with the fund's investment objective, use options or futures (commonly known as derivatives). The primary purpose of using derivatives is to attempt to reduce risk to the fund as a whole (hedge) but they may also be used to maintain liquidity, commit cash pending invest- ment or to increase returns. The fund may also enter into interest rate trans- actions as a hedging technique. In these transactions, the fund exchanges its right to pay or receive interest with another party for their right to pay or receive interest. The fund can borrow money to buy additional securities. The fund may borrow from banks or other financial institutions or through reverse repurchase agreements (under which the fund sells securities and agrees to buy them back at a particular date and price). The fund normally may borrow up to 33 1/3% of the value of its total assets. The fund may lend some of its securities on a short-term basis in order to earn extra income. The fund will receive collateral in cash or high quality securities equal to the current value of the loaned securities. These loans will be limited to 33 1/3% of the value of the fund's total assets. Should the Company's Board of Trustees determine that the investment objective of the fund should be changed, shareholders will be given at least 30 days notice before any such change is made. The fund may not change the requirement that it normally invest at least 80% of its net assets in municipal securities without shareholder approval. Key Risks Key Risks There is no guarantee that shares of the fund will not lose value. This means you could lose money. Two of the main risks of investing in the fund are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds such as those held by the fund. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. IMPORTANT DEFINITIONS Revenue Bonds: Bonds which are secured only by the revenues from a particular facility or class of facilities, such as a water or sewer system, or from the proceeds of a spe- cial excise tax or other revenue source. Total Return: A way of measuring fund perfor- mance. Total return is based on a calculation that takes into account income dividends, capi- tal gain distributions and the increase or decrease in share price. 100 The fact that the fund concentrates its investments in securities of issuers located in New Jersey raises special concerns. In particular, changes in the economic conditions and governmental policies of New Jersey and its political subdivisions could hurt the value of the fund's shares. Revenue bonds include private activity bonds, which are not payable from the general revenues of the issuer. Consequently, the credit quality of private activity bonds is usually directly related to the credit standing of the cor- porate user of the facility involved. To the extent that the fund's assets are invested in private activity bonds, the fund will be subject to the particular risks presented by the laws and economic conditions relating to such projects and bonds to a greater extent than if its assets were not so invested. Munici- pal securities also include "moral obligation" bonds, which are normally issued by special purpose public authorities. If the issuer of moral obliga- tion bonds is unable to pay its debts from current revenues, it may draw on a reserve fund the restoration of which is a moral but not a legal obligation of the state or municipality which created the issuer. The fund may invest in bonds the interest on which may be subject to the Fed- eral Alternative Minimum Tax. The fund may invest up to 20% of its total assets in these bonds when added together with any of the fund's other taxable investments. Interest on these bonds that is received by taxpayers subject to the Federal Alternative Minimum Tax is taxable. The fund may invest 25% or more of its assets in municipal securities whose interest is paid solely from revenues of similar projects. For example, the fund may invest more than 25% of its assets in municipal securities related to water or sewer systems. This type of concentration exposes the fund to the legal and economic risks relating to those projects. There may be less information available on the financial condition of issuers of municipal securities than for public corporations. The market for municipal bonds may be less liquid than for taxable bonds. This means that it may be harder to buy and sell municipal securities, especially on short notice. The fund will rely on legal opinions of counsel to issuers of municipal secu- rities as to the tax-free status of investments and will not do its own analy- sis. The fund's use of derivatives and interest rate transactions may reduce the fund's returns and/or increase volatility, which is defined as the character- istic of a security or a market to fluctuate significantly in price within a short period of time. The income from certain derivatives may be subject to Federal income tax. Leverage is a speculative technique which may expose the fund to greater risk and increase its costs. Increases and decreases in 101 the value of the fund's portfolio will be magnified when the fund uses lever- age. The fund will also have to pay interest on its borrowings, reducing the fund's return. Securities loans involve the risk of a delay in receiving additional collat- eral if the value of the securities goes up while they are on loan. There is also the risk of delay in recovering the loaned securities and of losing rights to the collateral if a borrower goes bankrupt. The fund, like any business, could be affected if the computer systems on which it relies do not properly process information beginning on January 1, 2000. While Year 2000 issues could have a negative effect on the fund, Black- Rock, the fund's investment adviser, is currently working to avoid such prob- lems. BlackRock is also working with other systems providers and vendors to determine their systems' ability to handle Year 2000 problems. There is no guarantee, however, that systems will work properly on January 1, 2000. Year 2000 problems may also hurt issuers whose securities the fund holds or securi- ties markets generally. When you invest in this fund you are not making a bank deposit. Your invest- ment is not insured or guaranteed by the Federal Deposit Insurance Corporation or by any bank or governmental agency. The fund is a non-diversified portfolio under the Investment Company Act, which means that fund performance is more dependent on the performance of a smaller number of securities and issuers than in a diversified portfolio. The change in value of any one security may affect the overall value of the fund more than it would a diversified fund's. 102 Risk / Return Information The chart and table below give you a picture of the fund's long-term perfor- mance for Investor A Shares (in the chart) and for Investor A, B and C Shares (in the table). The information shows you how the fund's performance has var- ied year by year and provides some indication of the risks of investing in the fund. The table compares the fund's performance to that of the Lehman Munici- pal Bond Index, a recognized unmanaged index of bond market performance. The chart and the table both assume reinvestment of dividends and distributions. As with all such investments, past performance is not an indication of future results. Sales charges are not reflected in the bar chart. If they were, returns would be less than those shown. The performance for the period before Investor Shares were launched is based upon performance for older share classes of the fund. Investor A Shares were launched in January 1996, Investor B Shares were launched in July 1996 and Investor C Shares were launched in December 1998. The actual return of Investor Shares would have been lower than shown because Investor Shares have higher expenses than these older classes. Also, the actual returns of Investor B and C Shares would have been lower compared to Investor A Shares. As of 12/31 Investor A Shares - -------------------------------------------------------------------------------- A N N U A L T O T A L R E T U R N S - -------------------------------------------------------------------------------- [BAR CHART APPEARS HERE] 92 8.90% Best Quarter 93 11.58% Q1 '95: 6.13% 94 -4.70% 95 14.94% 96 3.44% Worst Quarter 97 8.08% Q1 '94: -5.17% 98 5.80% The bars for 1992-1996 are based upon performance for Service Shares of the fund As of 12/31/98 - ---------------------------------------------------------------------------- A V E R A G E A N N U A L T O T A L R E T U R N S - ---------------------------------------------------------------------------- Since Inception 1 Year 3 Years 5 Years Inception Date - ---------------------------------------------------------------------------- NJ Tax-Free; Inv A 1.56% 4.33% 4.46% 6.66% 07/01/91 - ---------------------------------------------------------------------------- NJ Tax-Free; Inv B 0.28% 3.86% 4.50% 6.98% 07/01/91 - ---------------------------------------------------------------------------- NJ Tax-Free; Inv C 3.96% 5.10% 4.92% 6.98% 07/01/91 - ---------------------------------------------------------------------------- Lehman Municipal 6.48% 6.69% 6.23% 7.95% N/A - ---------------------------------------------------------------------------- These returns assume payment of applicable sales charges. 103 Expenses and Fees Expenses and Fees As a shareholder you pay certain fees and expenses. Shareholder transaction fees are paid out of your investment and annual fund operating expenses are paid out of fund assets and are reflected in the fund's price. This prospectus offers shareholders different ways to invest with three sepa- rate pricing options. You need to understand your choices so that you can choose the pricing option that is most suitable for you. With one option (In- vestor A Shares) you pay a one-time front-end transaction fee each time you buy shares. The other options (Investor B and Investor C Shares) have no front-end charges but have higher on-going fees, which are paid over the life of the investment, and have a contingent deferred sales charge (CDSC) that you may pay when you redeem your shares. Which option should you choose? It depends on your individual circumstances. You should know that the lowest sales charge won't necessarily be the least expensive option over time. For example, if you intend to hold your shares long term it may cost less to buy A Shares than B or C Shares. The tables below explain your pricing options and describe the fees and expenses that you may pay if you buy and hold Investor A, B and C Shares of the fund. The "Annual Fund Operating Expenses" table is based on expenses for the most recent fiscal year. Shareholder Fees (Fees paid directly from your investment)
A Shares B Shares C Shares Maximum Front-End Sales Charge* 4.0% 0.0% 0.0% (as percentage of offering price) Maximum Deferred Sales Charge 0.0% 4.5%** 1.00%*** (as percentage of offering price)
* Reduced front-end sales charges may be available. A CDSC of up to 1.00% is assessed on certain redemptions of Investor A Shares that are purchased with no initial sales charge as part of an investment of $1,000,000 or more. ** The CDSC is 4.5% if shares are redeemed in less than one year. The CDSC for Investor B Shares decreases for redemptions made in subsequent years. After six years there is no CDSC on B Shares. (See page 120 for complete schedule of CDSCs.) *** There is no CDSC on C Shares after one year. 104 Annual Fund Operating Expenses (Expenses that are deducted from fund assets)
A Shares B Shares C Shares Advisory Fees .50% .50% .50% Distribution and service (12b- 1) fees .50% 1.15% 1.15% Other expenses 47% .47% .47% Total annual fund operating expenses 1.47% 2.12% 2.12% Fee waivers and expense reimbursements* .40% .30% .30% Net Expenses* 1.07% 1.82% 1.82%
* BlackRock has contractually agreed to waive or reimburse fees or expenses in order to limit certain (but not all) fund expenses for the next year. The fund may have to repay these waivers and reimbursements to BlackRock in the following two years if the repayment can be made within these expense limits. In addition, BlackRock Distributors, Inc., the fund's dis- tributor, has contractually agreed to waive all 12b-1 distribution fees on Investor A Shares (otherwise payable at the maximum annual rate of .10% of average daily net assets) for the next year. "Net Expenses" in the table have been restated to reflect these waivers and reimbursements. The table does not reflect charges or credits which investors might incur if they invest through a financial institution. Example: This example is intended to help you compare the cost of investing in the fund with the cost of investing in other mutual funds. We are assuming an initial investment of $10,000, 5% total return each year with no changes in operating expenses (except for the waivers in the first year discussed above), redemp- tion at the end of each time period and, with respect to B Shares and C Shares only, no redemption at the end of each time period. Although your actual cost may be higher or lower, based on these assumptions your costs would be:
1 Year 3 Years 5 Years 10 Years A Shares* $505 $812 $1,141 $2,071 B Shares** Redemption $635 $985 $1,312 $2,185*** B Shares No Redemption $185 $635 $1,112 $2,185*** C Shares** Redemption $285 $635 $1,112 $2,428 C Shares No Redemption $185 $635 $1,112 $2,428
*Reflects imposition of sales charge. **Reflects deduction of CDSC. *** Based on the conversion of the Investor B Shares to Investor A Shares after seven years. IMPORTANT DEFINITIONS Advisory Fees: Fees paid to the investment adviser for portfolio management services. Service Fees: Fees that are paid to BlackRock and /or its affiliates for shareholder account service and mainte- nance. Distribution Fees: A method of charging dis- tribution-related expenses against fund assets. Other Expenses: Include administration, trans- fer agency, custody, professional fees and registration fees. 105 Fund Management The manager for the fund is Kevin Klingert, Managing Director at BlackRock Financial Management, Inc. (BFM) since 1991. Before joining BFM he was Assis- tant Vice President at Merrill Lynch, Pierce, Fenner & Smith. He has been fund manager since 1995. Financial Highlights The financial information in the table below shows the fund's financial perfor- mance for the periods indicated. Certain information reflects results for a single fund share. The term "Total Return" indicates how much your investment would have increased or decreased during this period of time and assumes that you have reinvested all dividends and distributions. These figures have been audited by PricewaterhouseCoopers LLP, the fund's independent accountants. The auditor's report, along with the fund's financial statements, are included in the Company's annual report which is available upon request (see back cover for ordering instructions). FINANCIAL HIGHLIGHTS - -------------------------------------------------------------------------------- (For an Investor A or B Share Outstanding Throughout Each Period) New Jersey Tax-Free Income Portfolio
INVESTOR A SHARES INVESTOR B SHARES For the For the For the Period Period Period Year Year 2/1/96 1/26/96/1/ Year Year 7/2/96/1/ Ended Ended through through Ended Ended through 9/30/98 9/30/97 9/30/96 1/31/96 9/30/98 9/30/97 9/30/96 Net asset value at beginning of period $11.65 $11.27 $11.61 $11.54 $11.65 $11.27 $11.15 ------ ------ ------ ------ ------ ------ ------ Income from investment operations Net investment income 0.50 0.51 0.34 - - 0.41 0.41 0.09 Net gain (loss) on investments (both realized and unrealized) 0.42 0.37 (0.34) 0.07 0.42 0.38 0.12 ------ ------ ------ ------ ------ ------ ------ Total from investment operations 0.92 0.88 0.00 0.07 0.83 0.79 0.21 ------ ------ ------ ------ ------ ------ ------ Less distributions Distributions from net investment income (0.50) (0.50) (0.34) - - (0.41) (0.41) (0.09) ------ ------ ------ ------ ------ ------ ------ Total distributions (0.50) (0.50) (0.34) - - (0.41) (0.41) (0.09) ------ ------ ------ ------ ------ ------ ------ Net asset value at end of period $12.07 $11.65 $11.27 $11.61 $12.07 $11.65 $11.27 ====== ====== ====== ====== ====== ====== ====== Total return/3/ 8.10% 7.94% (0.01)% 0.63% 7.30% 7.14% 2.04% Ratios/Supplemental data Net assets at end of period (in thousands) $1,432 $1,548 $ 894 $ 14 $1,051 $ 767 $ 30 Ratios of expenses to average net assets After advisory/administration fee waivers 1.06% 1.02% 1.01%/2/ 1.02%/2/ 1.80% 1.74% 1.74%/2/ Before advisory/administration fee waivers 1.36% 1.34% 1.33%/2/ 1.36%/2/ 2.10% 2.06% 2.06%/2/ Ratios of net investment income to average net assets After advisory/administration fee waivers 4.26% 4.41% 4.29%/2/ 2.79%/2/ 3.43% 3.60% 3.48%/2/ Before advisory/administration fee waivers 3.96% 4.09% 3.98%/2/ 2.45%/2/ 3.13% 3.28% 3.16%/2/ Portfolio turnover rate 24% 77% 109% 26% 24% 77% 109%
----------------------------------------------- /1/Commencement of operations of share class. /2/Annualized. /3/Neither front-end sales load nor contingent deferred sales load is reflected in total return. 106 [GRAPHIC BlackRock APPEARS Pennsylvania Tax-Free Income HERE] Portfolio - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Investment Goal The fund seeks as high a level of current income exempt from Federal income tax and, to the extent possible, Pennsylvania state income tax, as is consistent with preservation of capital. Primary Investment Strategies: In pursuit of this goal, the fund manager invests primarily in bonds issued by or on behalf of states and possessions of the United States, their political subdivisions and their agencies and authorities (and related tax-exempt deriva- tive securities) the interest on which the manager believes is exempt from Fed- eral income tax (municipal securities). The fund normally invests at least 65% of its net assets in municipal securities of issuers located in the state of Pennsylvania. The fund normally invests at least 80% of its net assets in municipal securities including both general obligation and revenue bonds from a diverse range of issuers. The other 20% of net assets can be invested in secu- rities which are subject to regular Federal income tax or the Federal Alterna- tive Minimum Tax. The fund emphasizes municipal securities in the ten to twenty year maturity range. The fund may only buy securities rated investment grade at the time of purchase by at least one major rating agency or determined by the manager to be of similar quality. The management team evaluates categories of the municipal market and individual bonds within those categories. The fund measures it performance against the Lehman Municipal Bond Index (the benchmark). If a security falls below investment grade, the manager will decide whether to continue to hold the security. A security will be sold if, in the opinion of the fund manager, the risk of continuing to hold the security is unacceptable when compared to the total return potential. It is possible that in extreme market conditions the fund may invest more than 20% of its assets in securities that are not municipal securities (and there- fore are subject to regular federal income tax) and may hold an unlimited amount of uninvested cash reserves. If market conditions improve, these strate- gies could result in reducing the potential gain from the market upswing, thus reducing the fund's opportunity to achieve its investment objective. IMPORTANT DEFINITIONS Bonds: Debt obligations such as bonds and debentures, U.S. Gov- ernment securities, debt obligations of domestic and foreign corporations, debt obligations of foreign governments and their political subdivisions, asset-backed securi- ties, various mortgage- backed securities (both residential and commer- cial), other floating or variable rate obli- gations, municipal obligations and zero coupon debt securities. General Obligation Bonds: Bonds which are secured by the issuer's pledge of its full faith, credit and taxing power for the payment of principal and interest. Investment Grade: Secu- rities which are rated in the four highest categories by at least one of the major rating agencies or determined by the fund manager to be of similar quality. Generally, the higher the rating of a bond, the higher the likeli- hood that interest and principal payments will be made on time. Secu- rities rated in the fourth highest category by the rating agencies are considered invest- ment grade but they are also considered specu- lative, meaning that they carry more risk than higher rated secu- rities and may have problems making princi- pal and interest pay- ments in difficult eco- nomic climates. Investment grade rat- ings do not guarantee that bonds will not lose value. Lehman Municipal Bond Index: An unmanaged index of municipal bonds with the follow- ing characteristics: minimum credit rating of Baa-3, outstanding par value of at least $3 million, issued as part of a deal of at least $50 million, and issued within the last 5 years remaining matu- rities of not less than one year. Maturity: The date upon which debt securities are due to be repaid, that is, the date when the issuer must pay back the face amount of the security. 107 The fund manager will normally attempt to structure the fund's portfolio to have comparable duration to its benchmark. Duration, which measures price sen- sitivity to interest rate changes, is not necessarily equal to average maturi- ty. The fund manager may, when consistent with the fund's investment objective, use options or futures (commonly known as derivatives). The primary purpose of using derivatives is to attempt to reduce risk to the fund as a whole (hedge) but they may also be used to maintain liquidity, commit cash pending invest- ment or to increase returns. The fund may also enter into interest rate trans- actions as a hedging technique. In these transactions, the fund exchanges its right to pay or receive interest with another party for their right to pay or receive interest. The fund can borrow money to buy additional securities. This practice is known as "leverage." The fund may borrow from banks or other financial institutions or through reverse repurchase agreements (under which the fund sells securi- ties and agrees to buy them back at a particular date and price). The fund normally may borrow up to 33 1/3% of the value of its total assets. The fund may lend some of its securities on a short-term basis in order to earn extra income. The fund will receive collateral in cash or high quality securities equal to the current value of the loaned securities. These loans will be limited to 33 1/3% of the value of the fund's total assets. Should the Company's Board of Trustees determine that the investment objective of the fund should be changed, shareholders will be given at least 30 days notice before any such change is made. The fund may not change the requirement that it normally invest at least 80% of its net assets in municipal securities without shareholder approval. Key Risks Key Risks There is no guarantee that shares of the fund will not lose value. This means you could lose money. Two of the main risks of investing in the fund are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds such as those held by the fund. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. The fact that the fund concentrates its investments in securities of issuers located in Pennsylvania raises special concerns. In particular, changes in the economic conditions and governmental policies of Pennsylvania and its politi- cal subdivisions could hurt the value of the fund's shares. IMPORTANT DEFINITIONS Revenue Bonds: Bonds which are secured only by the revenues from a particular facility or class of facilities, such as a water or sewer system, or from the proceeds of a spe- cial excise tax or other revenue source. Total Return: A way of measuring fund perfor- mance. Total return is based on a calculation that takes into account income dividends, capi- tal gain distributions and the increase or decrease in share price. 108 Revenue bonds include private activity bonds, which are not payable from the general revenues of the issuer. Consequently, the credit quality of private activity bonds is usually directly related to the credit standing of the corpo- rate user of the facility involved. To the extent that the fund's assets are invested in private activity bonds, the fund will be subject to the particular risks presented by the laws and economic conditions relating to such projects and bonds to a greater extent than if its assets were not so invested. Munici- pal securities also include "moral obligation" bonds, which are normally issued by special purpose public authorities. If the issuer of moral obligation bonds is unable to pay its debts from current revenues, it may draw on a reserve fund the restoration of which is a moral but not a legal obligation of the state or municipality which created the issuer. The fund may invest in bonds the interest on which may be subject to the Fed- eral Alternative Minimum Tax. The fund may invest up to 20% of its total assets in these bonds when added together with any of the fund's other taxable invest- ments. Interest on these bonds that is received by taxpayers subject to the Federal Alternative Minimum Tax is taxable. The fund may invest 25% or more of its assets in municipal securities whose interest is paid solely from revenues of similar projects. For example, the fund may invest more than 25% of its assets in municipal securities related to water or sewer systems. This type of concentration exposes the fund to the legal and economic risks relating to those projects. There may be less information available on the financial condition of issuers of municipal securities than for public corporations. The market for municipal bonds may be less liquid than for taxable bonds. This means that it may be harder to buy and sell municipal securities, especially on short notice. The fund will rely on legal opinions of counsel to issuers of municipal securi- ties as to the tax-free status of investments and will not do its own analysis. The fund's use of derivatives and interest rate transactions may reduce the fund's returns and/or increase volatility, which is defined as the characteris- tic of a security or a market to fluctuate significantly in price within a short period of time. The income from certain derivatives may be subject to Federal income tax. Leverage is a speculative technique which may expose the fund to greater risk and increase its costs. Increases and decreases in the value of the fund's portfolio will be magnified when the fund uses leverage. The fund will also have to pay interest on its borrowings, reducing the fund's return. Securities loans involve the risk of a delay in receiving additional collateral if the value of the securities goes up while they are on 109 loan. There is also the risk of delay in recovering the loaned securities and of losing rights to the collateral if a borrower goes bankrupt. The fund, like any business, could be affected if the computer systems on which it relies do not properly process information beginning on January 1, 2000. While Year 2000 issues could have a negative effect on the fund, Black- Rock, the fund's investment adviser, is currently working to avoid such prob- lems. BlackRock is also working with other systems providers and vendors to determine their systems' ability to handle Year 2000 problems. There is no guarantee, however, that systems will work properly on January 1, 2000. Year 2000 problems may also hurt issuers whose securities the fund holds or securi- ties markets generally. When you invest in this fund you are not making a bank deposit. Your invest- ment is not insured or guaranteed by the Federal Deposit Insurance Corporation or by any bank or governmental agency. The fund is a non-diversified portfolio under the Investment Company Act, which means that fund performance is more dependent on the performance of a smaller number of securities and issuers than in a diversified portfolio. The change in value of any one security may affect the overall value of the fund more than it would a diversified fund's. 110 Risk / Return Information The chart and table below give you a picture of the fund's long-term perfor- mance for Investor A Shares (in the chart) and for Investor A, B and C Shares (in the table). The information shows you how the fund's performance has varied year by year and provides some indication of the risks of investing in the fund. The table compares the fund's performance to that of the Lehman Municipal Bond Index, a recognized unmanaged index of bond market performance. The chart and the table both assume reinvestment of dividends and distributions. As with all such investments, past performance is not an indication of future results. Sales charges are not reflected in the bar chart. If they were, returns would be less than those shown. The performance for the period before Investor B and C Shares were launched is based upon performance for other share classes of the fund. Investor B Shares were launched in October 1994 and Investor C Shares were launched in August 1998. The actual returns of Investors B and C Shares would have been lower than shown because Investor B and C Shares have higher expenses than those older Classes. Also, the actual returns of Investor B and C Shares would have been lower compared to Investor A Shares. As of 12/31 Investor A Shares - -------------------------------------------------------------------------------- A N N U A L T O T A L R E T U R N S - -------------------------------------------------------------------------------- [BAR CHART APPEARS HERE] Best Quarter 93 12.62 Q1 '95: 7.54% 94 -7.12 95 17.86 96 4.10 Worst Quarter 97 8.23 Q1 '94: -6.29% 98 5.65 As of 12/31/98 - ---------------------------------------------------------------------------- A V E R A G E A N N U A L T O T A L R E T U R N S - ---------------------------------------------------------------------------- Since Inception 1 Year 3 Years 5 Years Inception Date - ---------------------------------------------------------------------------- PA Tax-Free; Inv A 1.39% 4.56% 4.59% 5.91% 12/01/92 - ---------------------------------------------------------------------------- PA Tax-Free; Inv B 0.59% 4.08% 4.45% 6.18% 12/01/92 - ---------------------------------------------------------------------------- PA Tax-Free; Inv C 4.28% 5.33% 4.87% 6.18% 12/01/92 - ---------------------------------------------------------------------------- Lehman Municipal 6.48% 6.69% 6.23% 7.92% N/A - ---------------------------------------------------------------------------- These returns assume payment of applicable sales charges. 111 Expenses and Fees Expenses and Fees As a shareholder you pay certain fees and expenses. Shareholder transaction fees are paid out of your investment and annual fund operating expenses are paid out of fund assets and are reflected in the fund's price. This prospectus offers shareholders different ways to invest with three sepa- rate pricing options. You need to understand your choices so that you can choose the pricing option that is most suitable for you. With one option (In- vestor A Shares) you pay a one-time front-end transaction fee each time you buy shares. The other options (Investor B and Investor C Shares) have no frontend charges but have higher on-going fees, which are paid over the life of the investment, and have a contingent deferred sales charge (CDSC) that you may pay when you redeem your shares. Which option should you choose? It depends on your individual circumstances. You should know that the lowest sales charge won't necessarily be the least expensive option over time. For example, if you intend to hold your shares long term it may cost less to buy A Shares than B or C Shares. The tables below explain your pricing options and describe the fees and expenses that you may pay if you buy and hold Investor A, B and C Shares of the fund. The "Annual Fund Operating Expenses" table is based on expenses for the most recent fiscal year. Shareholder Fees (Fees paid directly from your investment)
A Shares B Shares C Shares Maximum Front-End Sales Charge* 4.0% 0.0% 0.0% (as percentage of offering price) Maximum Deferred Sales Charge 0.0% 4.5%** 1.00%*** (as percentage of offering price)
* Reduced front-end sales charges may be available. A CDSC of up to 1.00% is assessed on certain redemptions of Investor A Shares that are purchased with no initial sales charge as part of an investment of $1,000,000 or more. ** The CDSC is 4.5% if shares are redeemed in less than one year. The CDSC for Investor B Shares decreases for redemptions made in subsequent years. After six years there is no CDSC on B Shares. (See page 120 for complete schedule of CDSCs.) *** There is no CDSC on C Shares after one year. 112 Annual Fund Operating Expenses (Expenses that are deducted from fund assets)
A Shares B Shares C Shares Advisory Fees .50% .50% .50% Distribution and service (12b- 1) fees .50% 1.15% 1.15% Other expenses .39% .39% .39% Total annual fund operating expenses 1.39% 2.04% 2.04% Fee waivers and expense reimbursements* .32% .22% .22% Net Expenses* 1.07% 1.82% 1.82%
* BlackRock has contractually agreed to waive or reimburse fees or expenses in order to limit certain (but not all) fund expenses for the next year. The fund may have to repay these waivers and reimbursements to BlackRock in the following two years if the repayment can be made within these expense limits. In addition, BlackRock Distributors, Inc., the fund's distributor, has contractually agreed to waive all 12b-1 distribution fees on Investor A Shares (otherwise payable at the maximum annual rate of .10% of average daily net assets) for the next year. "Net Expenses" in the table have been restated to reflect these waivers and reimbursements. The table does not reflect charges or credits which investors might incur if they invest through a financial institution. Example: This example is intended to help you compare the cost of investing in the fund with the cost of investing in other mutual funds. We are assuming an initial investment of $10,000, 5% total return each year with no changes in operating expenses (except for the waivers in the first year discussed above), redemption at the end of each time period and, with respect to B Shares and C Shares only, no redemption at the end of each time period. Although your actual cost may be higher or lower, based on these assumptions your costs would be:
1 Year 3 Years 5 Years 10 Years A Shares* $505 $792 $1,101 $1,975 B Shares** Redemption $635 $968 $1,278 $2,106*** B Shares No Redemption $185 $618 $1,078 $2,106*** C Shares** Redemption $285 $618 $1,078 $2,351 C Shares No Redemption $185 $618 $1,078 $2,351
*Reflects imposition of sales charge. **Reflects deduction of CDSC. *** Based on the conversion of the Investor B Shares to Investor A Shares after seven years. Fund Management The manager for the fund is Kevin Klingert, Managing Director at BlackRock Financial Management, Inc. (BFM) since 1991. Before joining BFM he was Assis- tant Vice President at Merrill Lynch, Pierce, Fenner & Smith. He has been fund manager since 1995. IMPORTANT DEFINITIONS Advisory Fees: Fees paid to the investment adviser for portfolio management services. Service Fees: Fees that are paid to BlackRock and /or its affiliates for shareholder account service and maintenance. Distribution Fees: A method of charging dis- tribution-related expenses against fund assets. Other Expenses: Include administration, trans- fer agency, custody, professional fees and registration fees. 113 Financial Highlights The financial information in the table below shows the fund's financial perfor- mance for the periods indicated. Certain information reflects results for a single fund share. The term "Total Return" indicates how much your investment would have increased or decreased during this period of time and assumes that you have reinvested all dividends and distributions. These figures have been audited by PricewaterhouseCoopers LLP, the fund's independent accountants. The auditor's report, along with the fund's financial statements, are included in the Company's annual report which is available upon request (see back cover for ordering instructions). FINANCIAL HIGHLIGHTS - -------------------------------------------------------------------------------- (For an Investor A, B or C Share Outstanding Throughout Each Period) Pennsylvania Tax-Free Income Portfolio
INVESTOR A INVESTOR B INVESTOR C SHARES SHARES SHARES For the For the Period Period Year Year Year Year Year Year Year Year 10/03/94/1/ 8/14/98 Ended Ended Ended Ended Ended Ended Ended Ended through through 9/30/98 9/30/97 9/30/96 9/30/95 9/30/94 9/30/98 9/30/97 9/30/96 9/30/95 9/30/98 Net asset value at beginning of period $ 10.77 $ 10.44 $ 10.33 $ 9.82 $ 10.70 $ 10.77 $ 10.44 $10.33 $ 9.82 $11.00 ------- ------- ------- ------- ------- ------- ------- ------ ------ ------ Income from investment operations Net investment income 0.45 0.48 0.48 0.48 0.52 0.39 0.40 0.40 0.42 0.42 Net gain (loss) on investments (both realized and unrealized) 0.40 0.33 0.11 0.51 (0.85) 0.41 0.33 0.11 0.51 0.15 ------- ------- ------- ------- ------- ------- ------- ------ ------ ------ Total from investment operations 0.85 0.81 0.59 0.99 (0.33) 0.80 0.73 0.51 0.93 0.57 ------- ------- ------- ------- ------- ------- ------- ------ ------ ------ Less distributions Distributions from net investment income (0.47) (0.48) (0.48) (0.48) (0.52) (0.42) (0.40) (0.40) (0.42) (0.42) Distributions from net realized capital gains - - - - - - - - (0.03) - - - - - - - - - - ------- ------- ------- ------- ------- ------- ------- ------ ------ ------ Total distributions (0.47) (0.48) (0.48) (0.48) (0.55) (0.42) (0.40) (0.40) (0.42) (0.42) ------- ------- ------- ------- ------- ------- ------- ------ ------ ------ Net asset value at end of period $ 11.15 $ 10.77 $ 10.44 $ 10.33 $ 9.82 $ 11.15 $ 10.77 $10.44 $10.33 $11.15 ======= ======= ======= ======= ======= ======= ======= ====== ====== ====== Total return/3/ 8.04% 7.95% 5.81% 10.30% (3.06)% 7.56% 7.12% 5.04% 9.69% 7.56% Ratios/Supplemental data Net assets at end of period (in thousands) $34,712 $32,900 $38,031 $42,775 $46,563 $17,601 $12,388 $7,974 $4,008 $ 184 Ratios of expenses to average net assets After advisory/administration fee waivers 1.01% 0.97% 1.00% 0.98% 0.41% 1.78% 1.76% 1.74% 1.57%/2/ 1.58%/2/ Before advisory/administration fee waivers 1.25% 1.30% 1.30% 1.30% 1.01% 2.02% 2.07% 2.03% 1.89%/2/ 1.82%/2/ Ratios of net investment income to average net assets After advisory/administration fee waivers 4.25% 4.54% 4.58% 4.88% 5.06% 3.46% 3.73% 3.81% 4.07%/2/ 2.98%/2/ Before advisory/administration fee waivers 4.01% 4.23% 4.29% 4.56% 4.46% 3.22% 3.42% 3.51% 3.75%/2/ 2.74%/2/ Portfolio turnover rate 43% 97% 119% 66% 30% 43% 97% 119% 66% 43%
--------------------------------------------------------------- /1/Commencement of operations of share class. /2/Annualized. /3/Neither front-end sales load nor contingent deferred sales load is reflected in total return. 114 [GRAPHIC APPEARS HERE] About Your Investment - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Buying Shares from a Registered Investment Professional BlackRock Funds believes that investors can benefit from the advice and ongoing assistance of a registered investment professional. Accordingly, when you buy or sell BlackRock Funds Investor Shares, you may pay a sales charge, which is used to compensate your investment professional for services provided to you. As a shareholder you pay certain fees and expenses. Shareholder fees are paid directly from your investment and annual fund operating expenses are paid out of fund assets and are reflected in the fund's price. Your registered representative can help you to buy shares by telephone. Before you place your order make sure that you have read the prospectus and have a discussion with your registered representative about the details of your investment - -------------------------------------------------------------------------------- What Price Per Share Will You Pay? The price of mutual fund shares generally changes every business day. A mutual fund is a pool of investors' money that is used to purchase a portfolio of securities, which in turn is owned in common by the investors. Investors put money into a mutual fund by buying shares. If a mutual fund has a portfolio worth $50 million and has 5 million shares outstanding, the net asset value (NAV) per share is $10. When you buy Investor Shares you pay the NAV/share plus the sales charge if you are purchasing Investor A Shares. The funds' investments are valued based on market value, or where market quota- tions are not readily available, based on fair value as determined in good faith by or under the direction of the Company's Board of Trustees. Under some circumstances certain short-term debt securities will be valued using the amor- tized cost method. Since the NAV changes daily, the price of your shares depends on the time that your order is received by the BlackRock Funds' transfer agent, whose job it is to keep track of shareholder records. PFPC, the Company's transfer agent, will probably receive your order from your registered representative, who takes your order. However, you can also fill out a purchase application and mail it to the transfer agent with your check. Please call (800) 441-7762 115 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- for a purchase application. Purchase orders received by the transfer agent before the close of regular trading on the New York Stock Exchange (NYSE) (currently 4 p.m. (Eastern time)) on each day the NYSE is open will be priced based on the NAV calculated at the close of trading on that day plus any applicable sales charge. NAV is calculated separately for each class of shares of each fund at 4 p.m. (Eastern time) each day the NYSE is open. Shares will not be priced on days the NYSE is closed. Purchase orders received after the close of trading will be priced based on the next calculation of NAV. Foreign securities and certain other securities held by a fund may trade on days when the NYSE is closed. In these cases, net asset value of shares may change when fund shares cannot be bought or sold. When you place a purchase order, you need to specify whether you want Investor A, B or C Shares. If you do not specify a class, you will receive Investor A Shares. - -------------------------------------------------------------------------------- When Must You Pay? Payment for an order must be made by your registered representative in immedi- ately available funds by 4 p.m. (Eastern time) on the third business day fol- lowing PFPC's receipt of the order. If payment is not received by this time, the order will be cancelled and you and your registered representative will be responsible for any loss to a fund. For shares purchased directly from the transfer agent, a check payable to BlackRock Funds and bearing the name of the fund you are purchasing must accompany a completed purchase application. The Company does not accept third-party checks. You may also wire Federal funds to the transfer agent to purchase shares, but you must call PFPC at (800) 441- 7762 before doing so to confirm the wiring instructions. - -------------------------------------------------------------------------------- How Much is the Minimum Investment? The minimum investment for the initial purchase of Investor Shares is $500. There is a $50 minimum for all later investments. The Company permits a lower initial investment if you are an employee of the Company or one of its service providers or you participate in the Automatic Investment Plan in which you make regular, periodic investments through a savings or checking account. Your investment professional can advise you on how to begin an Automatic Investment Plan. The Company won't accept a purchase order of $1 million or more for Investor 116 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- B or Investor C Shares. The fund may reject any purchase order, modify or waive the minimum investment requirements and suspend and resume the sale of any share class of the Company at any time. - -------------------------------------------------------------------------------- Which Pricing Option Should You Choose? BlackRock Funds offers different pricing options to investors in the form of different share classes. Your registered representative can help you decide which option works best for you. Through this prospectus, you can choose from Investor A, B, or C Shares. A Shares (Front-End Load) . One time sales charge paid at time of purchase . Never a charge for redeeming shares . Lower ongoing fees . Free exchange with other A Shares in BlackRock Funds family . Advantage: Makes sense for investors who have long-term investment horizon because ongoing fees are less than for other Investor Share classes. . Disadvantage: You pay sales charge up-front, and therefore you start off owning fewer shares. B Shares (Back-End Load) . No front-end sales charge when you buy shares . You pay sales charge when you redeem shares. It is called a contingent deferred sales charge (CDSC) and it declines over 6 years from a high of 4.5%. . Higher ongoing fees than A Shares . Free exchange with other B Shares in BlackRock Funds family . Automatically convert to A Shares seven years from purchase . Advantage: No up-front sales charge so you start off owning more shares. . Disadvantage: You pay higher ongoing fees than on A Shares each year you own shares, which means that you can expect lower total performance per share. C Shares (Level Load) . No front-end sales charge when you buy shares . Contingent deferred sales charge (CDSC) of 1.00% if shares are redeemed within 12 months of purchase . Higher ongoing fees than A Shares . Free exchange with other C Shares in BlackRock Funds family 117 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- . Advantage: No up-front sales charge so you start off owning more shares. These shares may make sense for investors who have a shorter investment horizon relative to A or B Shares. . Disadvantage: You pay higher ongoing fees than on A shares each year you own shares, which means that you can expect lower total performance per share. Shares do not convert to A Shares. Investor B Shares received through the reinvestment of dividends and distribu- tions convert to A Shares 7 years after the reinvestment or at the same time as the conversion of the investor's most recently purchased B Shares that were not received through reinvestment (whichever is earlier). If a shareholder acquiring Investor A Shares on or after May 1, 1998 later meets the requirements for purchasing Institutional Shares of a fund (other than due to changes in market value), then the shareholder's Investor A Shares will automatically be converted to Institutional Shares of the same fund having the same total net asset value as the shares converted. - -------------------------------------------------------------------------------- How Much is the Sales Charge? The tables below show the schedule of sales charges that you may pay if you buy and sell Investor A, B and C Shares of a fund. - -------------------------------------------------------------------------------- Purchase of Investor A Shares The following tables show the front-end sales charges that you may pay if you buy Investor A Shares. The offering price for Investor A Shares includes any front-end sales charge. The following schedule of front-end sales charges and quantity discounts applies to the Low Duration Bond Portfolio.
AMOUNT OF SALES CHARGE AS SALES CHARGE AS TRANSACTION AT % OF OFFERING % OF NET ASSET OFFERING PRICE PRICE* VALUE* Less than $25,000 3.00% 3.09% $25,000 but less than $50,000 2.75% 2.83% $50,000 but less than $100,000 2.50% 2.56% $100,000 but less than $250,000 2.00% 2.04% $250,000 but less than $500,000 1.50% 1.52% $500,000 but less than $1,000,000 1.00% 1.01% $1million or more 0.0% 0.0%
* There is no initial sales charge on purchases of $1,000,000 or more of Investor A shares; however you will pay a contingent deferred sales charge of 1.00% of the offering price or the net asset value of the shares on the redemption date (whichever is less) for shares redeemed within 18 months after purchase. 118 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- The following schedule of front-end sales charges and quantity discounts applies to the Intermediate Government Bond, Intermediate Bond, Core Bond, Tax- Free Income, Pennsylvania Tax-Free Income, New Jersey Tax-Free Income, Ohio Tax-Free Income, Kentucky Tax-Free Income, Delaware Tax-Free Income and GNMA Portfolios.
AMOUNT OF SALES CHARGE AS SALES CHARGE AS TRANSACTION AT % OF OFFERING % OF NET ASSET OFFERING PRICE PRICE* VALUE* Less than $25,000 4.00% 4.17% $25,000 but less than $50,000 3.75% 3.90% $50,000 but less than $100,000 3.50% 3.63% $100,000 but less than $250,000 3.00% 3.09% $250,000 but less than $500,000 2.00% 2.04% $500,000 but less than $1,000,000 1.00% 1.01% $1 million or more 0.0% 0.0%
* There is no initial sales charge on purchases of $1,000,000 or more of Investor A shares; however you will pay a contingent deferred sales charge of 1.00% of the offering price or the net asset value of the shares on the redemption date (whichever is less) for shares redeemed within 18 months after purchase. The following schedule of front-end sales charges and quantity discounts applies to the Government Income and Managed Income Portfolios.
AMOUNT OF SALES CHARGE AS SALES CHARGE AS TRANSACTION AT % OF OFFERING % OF NET ASSET OFFERING PRICE PRICE* VALUE* Less than $25,000 4.50% 4.71% $25,000 but less than $50,000 4.25% 4.70% $50,000 but less than $100,000 4.00% 4.17% $100,000 but less than $250,000 3.50% 3.63% $250,000 but less than $500,000 2.50% 2.56% $500,000 but less than $1,000,000 1.50% 1.52% $1 million or more 0.0% 0.0%
* There is no initial sales charge on purchases of $1,000,000 or more of Investor A shares; however you will pay a contingent deferred sales charge of 1.00% of the offering price or the net asset value of the shares on the redemption date (whichever is less) for shares redeemed within 18 months after purchase. 119 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- The following schedule of front-end sales charges and quantity discounts applies to the International Bond Portfolio and the High Yield Bond Portfolio.
AMOUNT OF SALES CHARGE AS SALES CHARGE AS TRANSACTION AT % OF OFFERING % OF NET ASSET OFFERING PRICE PRICE* VALUE* Less than $25,000 5.00% 5.26% $25,000 but less than $50,000 4.75% 4.99% $50,000 but less than $100,000 4.50% 4.71% $100,000 but less than $250,000 4.00% 4.17% $250,000 but less than $500,000 3.00% 3.09% $500,000 but less than $1,000,000 2.00% 2.04% $1 million or more 0.0% 0.0%
* There is no initial sales charge on purchases of $1,000,000 or more of Investor A shares; however you will pay a contingent deferred sales charge of 1.00% of the offering price or the net asset value of the shares on the redemption date (whichever is less) for shares redeemed within 18 months after purchase. - -------------------------------------------------------------------------------- Purchase of Investor B Shares Investor B Shares are subject to a CDSC at the rates shown in the chart below if they are redeemed within six years of purchase. The CDSC is based on the offer- ing price or the net asset value of the B Shares on the redemption date (which- ever is less). The amount of any CDSC an investor must pay depends on the num- ber of years that elapse between the date of purchase and the date of redemption.
CONTINGENT DEFERRED SALES CHARGE (AS % OF DOLLAR AMOUNT NUMBER OF YEARS SUBJECT TO THE ELAPSED SINCE PURCHASE CHARGE) Up to one year 4.50% More than one but less than two years 4.00% More than two, but less than three years 3.50% More than three but less than four years 3.00% More than four but less than five years 2.00% More than five but less than six years 1.00% More than six years 0.00%
- -------------------------------------------------------------------------------- Purchase of Investor C Shares Investor C Shares are subject to a CDSC of 1.00% if they are redeemed within 12 months after purchase. The 1.00% is based on the offering price or the net asset value of the C Shares on the redemption date (whichever is less). There is no CDSC on C Shares redeemed after 12 months. 120 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- When an investor redeems Investor B Shares or Investor C Shares, the redemption order is processed so that the lowest CDSC is charged. Investor B Shares and Investor C Shares that are not subject to the CDSC are redeemed first. After that, the Company redeems the Shares that have been held the longest. - -------------------------------------------------------------------------------- Can the Sales Charge be Reduced or Eliminated? There are several ways in which the sales charge can be reduced or eliminated. Purchases of Investor A Shares at certain fixed dollar levels, known as "break- points," cause a reduction in the front-end sale charge. The CDSC on Investor B Shares can be reduced depending on how long you own the shares. (Schedules of these reductions are listed above in the "Purchase of Investor A Shares" and "Purchase of Investor B Shares" sections.) Purchases by certain individuals and groups may be combined in determining the sales charge on Investor A Shares. The following are also ways the sales charge can be reduced or eliminated. - -------------------------------------------------------------------------------- Right of Accumulation (Investor A Shares) Investors have a "right of accumulation" under which the current value of an investor's existing Investor A Shares in any fund that is subject to a front- end sales charge, or the total amount of an initial investment in such shares less redemptions (whichever is greater), may be combined with the amount of the current purchase in the same fund in determining the amount of the sales charge. In order to use this right, the investor must alert the Company's transfer agent, PFPC, of the existence of previously purchased shares. - -------------------------------------------------------------------------------- Letter of Intent (Investor A Shares) An investor may qualify for a reduced front-end sales charge immediately by signing a "Letter of Intent" stating the investor's intention to buy a speci- fied amount of Investor A Shares within the next 13 months that would, if bought all at once, qualify the investor for a reduced sales charge. The Letter of Intent may be signed anytime within 90 days after the first investment to be covered by the letter. The initial investment must meet the minimum initial purchase requirement and represent at least 5% of the total intended purchase. The investor must tell PFPC that later purchases are subject to the Letter of Intent. During the 121 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- term of the Letter of Intent, PFPC will hold Investor A Shares representing 5% of the indicated amount in an escrow account for payment of a higher sales load if the full amount indicated in the Letter of Intent is not purchased. Any redemptions made during the term of the Letter of Intent will be subtracted from the amount of the total purchase indicated in the letter. If the full amount indicated is not purchased within the 13-month period, and the investor does not pay the higher sales load within 20 days, PFPC will redeem enough of the Investor A Shares held in escrow to pay the difference. - -------------------------------------------------------------------------------- Reinvestment Privilege (Investor A Shares) Upon redeeming Investor A Shares, an investor has a one-time right, for a period of up to 60 days, to reinvest the proceeds in A Shares of another fund without any sales charge. To exercise this right, PFPC must be notified of the rein- vestment in writing at the time of purchase by the purchaser or his or her reg- istered representative. Investors should consult a tax adviser concerning the tax consequences of using this reinvestment privilege. - -------------------------------------------------------------------------------- Quantity Discounts (Investor A Shares) In addition to quantity discounts for individuals which we discussed above, there are ways for you to reduce the front-end sales charge by combining your order with the orders of certain members of your family and members of certain groups you may belong to. For more information on these discounts, please con- tact PFPC at 800-441-7762 or see the SAI. - -------------------------------------------------------------------------------- Waiving the Sales Charge (Investor A Shares) Certain investors, including some people associated with the Company and its service providers, may buy Investor A Shares without paying a sales charge. For more information on the waivers, please contact PFPC at (800) 441-7762 or see the SAI. 122 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Waiving the Contingent Deferred Sales Charge (Investor B and Investor C Shares) The CDSC on Investor B and Investor C Shares is not charged in certain circum- stances, including share exchanges and redemptions made in connection with cer- tain retirement plans and in connection with certain shareholder services offered by the Company. For more information on these waivers, please contact PFPC at (800) 441-7762 or see the SAI. - -------------------------------------------------------------------------------- Distribution and Service Plan The Company has adopted a plan under Rule 12b-1 of the Investment Company Act of 1940 (the Plan) that allows the Company to pay distribution and other fees for the sale of its shares and for certain services provided to its shareholders. Under the Plan, Investor Shares pay a fee (distribution fees) to BlackRock Dis- tributors, Inc. (the Distributor) or affiliates of PNC Bank for distribution and sales support services. The distribution fees may be used to pay the Dis- tributor for distribution services and to pay the Distributor and PNC Bank affiliates for sales support services provided in connection with the sale of Investor Shares. The distribution fees may also be used to pay brokers, deal- ers, financial institutions and industry professionals (Service Organizations) for sales support services and related expenses. Investor A Shares pay a maxi- mum distribution fee of .10% per year of the average daily net asset value of each fund. Investor B and C Shares pay a maximum of .75% per year. The Plan also allows the Distributor, PNC Bank affiliates and other companies that receive fees from the Company to make payments relating to distribution and sales support activities out of their past profits or other sources. Under the Plan, the Company may enter into arrangements with Service Organiza- tions (including PNC Bank and its affiliates). Under these arrangements, Serv- ice Organizations will provide certain support services to their customers who own Investor Shares. The Company may pay a shareholder servicing fee of up to .25% per year of the average daily net asset value of Investor Shares owned by each Service Organization's customers. In return for that fee, Service Organi- zations may provide one or more of the following services: (1) Responding to customer questions on the services performed by the Service Organization and investments in Investor Shares; 123 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- (2) Assisting customers in choosing and changing dividend options, account designations and addresses; and (3) Providing other similar shareholder liaison services. For a separate shareholder processing fee of up to .15% per year of the average daily net asset value of Investor Shares owned by each Service Organization's customers, Service Organizations may provide one or more of these additional services: (1) Processing purchase and redemption requests from customers and plac- ing orders with the Company's transfer agent or the Distributor; (2) Processing dividend payments from the Company on behalf of customers; (3) Providing sub-accounting for Investor Shares beneficially owned by customers or the information necessary for sub-accounting; and (4) Providing other similar services. Service Organizations may charge their clients additional fees for account services. Customers of Service Organizations who own Investor Shares should keep the terms and fees governing their accounts with Service Organizations in mind as they read this prospectus. The shareholder servicing fees and shareholder processing fees payable pursuant to the Plan are fees payable for the administration and servicing of share- holder accounts and not costs which are primarily intended to result in the sale of a fund's shares. Because the fees paid by the Company under the Plan are paid out of Company assets on an on-going basis, over time these fees will increase the cost of your investment and may cost you more than paying other types of sales charges. - -------------------------------------------------------------------------------- How to Sell Shares You can redeem shares at any time (although certain verification may be required for redemptions in excess of $25,000 or in certain other cases). The Company will redeem your shares at the next net asset value (NAV) calculated after your order is received by the fund's transfer agent minus any applicable CDSC. Except when CDSCs are applied, BlackRock Funds will 124 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- not charge for redemptions. Shares may be redeemed by sending a written redemp- tion request to BlackRock Funds c/o PFPC, P.O. Box 8907, Wilmington, DE 19899- 8907. You can also make redemption requests through your registered investment pro- fessional, who may charge for this service. Shareholders should indicate whether they are redeeming Investor A, Investor B or Investor C Shares. If a shareholder owns more than one class of a fund and does not indicate which class he or she is redeeming, the fund will redeem shares so as to minimize the CDSC charged. Unless another option is requested, payment for redeemed shares is normally made by check mailed within seven days after PFPC receives the redemption request. If the shares to be redeemed have been recently purchased by check, PFPC may delay the payment of redemption proceeds for up to 15 days after the purchase date to make sure that the check has cleared. - -------------------------------------------------------------------------------- Expedited Redemptions If a shareholder has given authorization for expedited redemption, shares can be redeemed by telephone and the proceeds sent by check to the shareholder or by Federal wire transfer to a single previously designated bank account. You are responsible for any charges imposed by your bank for this service. Once autho- rization is on file, PFPC will honor requests by telephone at (800) 441-7762. The Company is not responsible for the efficiency of the Federal wire system or the shareholder's firm or bank. The Company may refuse a telephone redemption request if it believes it is advisable to do so and may use reasonable proce- dures to make sure telephone instructions are genuine. The Company and its service providers will not be liable for any loss that results from acting upon telephone instructions that they reasonably believed to be genuine in accor- dance with those procedures. The Company may alter the terms of or terminate this expedited redemption privilege at any time. Any redemption request of $25,000 or more must be in writing. 125 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- The Company's Rights The Company may: . Suspend the right of redemption . Postpone date of payment upon redemption . Redeem shares involuntarily . Redeem shares for property other than cash in accordance with its rights under the Investment Company Act of 1940. - -------------------------------------------------------------------------------- Accounts with Low Balances The Company may redeem a shareholder's account in any fund at any time the net asset value of the account in such fund falls below the required minimum ini- tial investment as the result of a redemption or an exchange request. The shareholder will be notified in writing that the value of the account is less than the required amount and the shareholder will be allowed 30 days to make additional investments before the redemption is processed. - -------------------------------------------------------------------------------- Management BlackRock Funds' Adviser is BlackRock Advisors, Inc. (BlackRock). BlackRock was organized in 1994 to perform advisory services for investment companies and is located at 345 Park Avenue, New York, NY 10154. BlackRock is a subsidiary of PNC Bank Corp., one of the largest diversified financial services companies in the United States. BlackRock Financial Management, Inc. (BFM), an affiliate of BlackRock located at 345 Park Avenue, New York, New York 10154, acts as sub- adviser to the funds. 126 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- IMPORTANT DEFINITIONS Adviser: The Adviser of a mutual fund is responsible for the overall investment man- agement of the Fund. The Adviser for Black- Rock Funds is BlackRock Advisors, Inc. Sub-Adviser: The sub- adviser of a fund is responsible for its day-to-day management and will generally make all buy and sell deci- sions. Sub-advisers also provide research and credit analysis. The sub-adviser for all the funds is BlackRock Financial Management, Inc. For their investment advisory and sub-advisory services, BlackRock and BFM, as applicable, are entitled to fees computed daily on a fund-by-fund basis and payable monthly. For the fiscal year ended September 30, 1998, the aggregate advisory fees paid by the funds to BlackRock as a percentage of average daily net assets were: Low Duration Bond 0.16% Intermediate Government Bond 0.30% Intermediate Bond 0.26% Core Bond 0.18% Government Income 0.07% Managed Income 0.34% International Bond 0.23% GNMA 0.17% Tax-Free Income 0.28% Pennsylvania Tax-Free Income 0.29% New Jersey Tax-Free Income 0.26% Ohio Tax-Free Income 0.22% Delaware Tax-Free Income 0.17% Kentucky Tax-Free Income 0.15%
The maximum annual advisory fees that can be paid to BlackRock (as a percentage of average daily net assets) are as follows: Maximum Annual Contractual Fee Rate (Before Waivers)
Each Fund Except Int'l Bond, GNMA, Int'l Bond, GNMA, KY Tax-Free, KY Tax-Free, DE Tax Free DE Tax-Free INVESTMENT INVESTMENT AVG DAILY NET ASSETS ADVISORY FEE ADVISORY FEE first $1 billion .500% .550% $1 billion--$2 billion .450% .500% $2 billion--$3 billion .425% .475% greater than $3 billion .400% .450%
BlackRock is a global money management firm with expertise in domestic and international equities, domestic and global fixed income, cash management and risk management services. BlackRock has over $120 billion in assets under man- agement and currently manages money for over half of the Fortune 100, including seven out of ten of the largest Fortune 100 companies. Information about the portfolio manager for each of the funds is presented in the appropriate fund section. BlackRock and the Company have entered into an expense limitation agreement. The agreement sets a limit on certain of the 127 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- operating expenses of each fund for the next year and requires BlackRock to waive or reimburse fees or expenses if these operating expenses exceed that limit. These expense limits (which apply to expenses charged on fund assets as a whole, but not expenses separately charged to the different share classes of a fund) as a percentage of average daily net assets are: Low Duration Bond .385% Intermediate Government Bond .475% Intermediate Bond .435% Core Bond .380% Government Income .550% GNMA .485% Managed Income .485% International Bond .865% High Yield Bond .525% Tax-Free Income .485% Delaware Tax-Free Income .585% Ohio Tax-Free Income .515% Kentucky Tax-Free Income .585% New Jersey Tax-Free Income .475% Pennsylvania Tax-Free Income .470%
If in the following two years the operating expenses of a fund that previously received a waiver or reimbursement from BlackRock are less than the expense limit for that fund, the fund is required to repay BlackRock up to the amount of fees waived or expenses reimbursed under the agreement if: (1) the fund has more than $50 million in assets, (2) BlackRock continues to be the fund's investment adviser and (3) the Board of Trustees of the Company has approved the payments to BlackRock on a quarterly basis. - -------------------------------------------------------------------------------- Dividends and Distributions BlackRock Funds makes two kinds of distributions to shareholders: dividends and net capital gain. Dividends are the net investment income derived by a fund and are paid within 10 days after the end of each month. The Company's Board of Trustees may change the timing of dividend payments. Net capital gain occurs when the fund manager sells securities at a profit. Net capital gain (if any) is distributed to shareholders at least annually at a date determined by the Company's Board of Trustees. Your distributions will be reinvested at net asset value in new shares of the same class of the fund unless you instruct PFPC in writing to pay them in cash. There are no sales charges on these reinvestments. 128 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Taxation of Distributions Fund dividends and distributions are taxable to investors as ordinary income or capital gains. Unless your fund shares are in an IRA or other tax-advantaged account, you are required to pay taxes on distributions whether you receive them in cash or in the form of additional shares. Distributions paid out of a fund's "net capital gain" will be taxed to share- holders as long-term capital gains, regardless of how long a shareholder has owned shares. All other distributions will be taxed to shareholders as ordinary income. Your annual tax statement from the Company will present in detail the tax sta- tus of your distributions for each year. Use of the exchange privilege will be treated as a taxable event and may be subject to federal, state and local income tax. Each of the Tax-Free Income, Pennsylvania Tax-Free Income, New Jersey Tax-Free Income, Ohio Tax-Free Income, Delaware Tax-Free Income and Kentucky Tax-Free Income Portfolios intends to pay most of its dividends as exempt interest divi- dends, which means such dividends are exempt from regular federal income tax (but not necessarily other federal taxes). These dividends will generally be subject to state and local taxes. The state or municipality where you live may not charge you state and local taxes on dividends earned on certain securities. The funds will have to meet certain requirements in order for their dividends to be exempt from these federal, state and local taxes. Dividends earned on securities issued by the U.S. government and its agencies may also be exempt from some types of state and local taxes. These tax-free income funds may invest a portion of their assets in securities that generate income that is not exempt from federal, state or local income tax. Any capital gains distributed by the funds may be taxable as well. If more than half of the total asset value of a fund is invested in foreign stock or securities, the fund may elect to "pass through" to its shareholders the amount of foreign taxes paid. In such case, each shareholder would be required to include his proportionate share of such taxes in his income and may be entitled to deduct or credit such taxes when computing his taxable income. Because every investor has an individual tax situation, and also because the tax laws are subject to periodic changes, you should always consult your tax professional about federal, state and local tax consequences of owning shares of the Company. 129 [GRAPHIC APPEARS HERE] Services for Shareholders - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- BlackRock Funds offers shareholders many special features which can enable investors to have greater investment flexibility as well as more access to information about the Company. Additional information about these features is available by calling PFPC at (800) 441-7762. - -------------------------------------------------------------------------------- Exchange Privilege BlackRock Funds offers 36 different funds, enough to meet virtually any invest- ment need. Once you are a shareholder, you have the right to exchange Investor A, B, or C Shares from one fund to another to meet your changing financial needs. For example, if you are in a fund that has an investment objective of long term capital growth and you are nearing retirement, you may want to switch into another fund that has current income as an investment objective. You can exchange $500 (or any other applicable minimum) or more from one Black- Rock Fund into another. Investor A, Investor B and Investor C Shares of each fund may be exchanged for shares of the same class of other funds which offer that class of shares, based on their respective net asset values. (You can exchange less than $500 if you already have an account in the fund into which you are exchanging.) Because different funds have different sales charges, the exchange of Investor A Shares may be subject to the difference between the sales charge already paid and the higher sales charge (if any) payable on the shares acquired as a result of the exchange. For Federal income tax a share exchange is a taxable event and a capital gain or loss may be realized. Please consult your tax or other financial adviser before making an exchange request. The exchange of Investor B and Investor C Shares will not be subject to a CDSC. The CDSC will continue to be measured from the date of the original purchase and will not be affected by the exchange. To make an exchange, you must send a written request to PFPC at P.O. Box 8907, Wilmington, DE 19899-8907. You can also make exchanges via telephone automati- cally, unless you previously indicated that you did not want this option. If so, you may not use telephone exchange privileges until completing a Telephone Exchange Authorization Form. To receive a copy of the 130 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- form contact PFPC. The Company has the right to reject any telephone request. The Company reserves the right to modify, limit the use of, or terminate the exchange privilege at any time. - -------------------------------------------------------------------------------- Automatic Investment Plan (AIP) If you would like to establish a regular, affordable investment program, Black- Rock Funds makes it easy to set up. As an investor in any BlackRock Fund port- folio, you can arrange for periodic investments in that fund through automatic deductions from a checking or savings account by completing the AIP Application Form. The minimum investment amount for an automatic investment plan is $50. AIP Application Forms are available from PFPC. - -------------------------------------------------------------------------------- Retirement Plans Shares may be purchased in conjunction with individual retirement accounts (IRAs) and rollover IRAs where PNC Bank or any of its affiliates acts as custo- dian. For more information about applications or annual fees, please contact the Distributor at Four Falls Corporate Center, 6th floor, West Conshohocken, PA 19428-2961. To determine if you are eligible for an IRA and whether an IRA will benefit you, you should consult with a tax adviser. - -------------------------------------------------------------------------------- Statements Every BlackRock shareholder automatically receives regular account statements. In addition, for tax purposes, shareholders also receive a yearly statement describing the characteristics of any dividends or other distributions received. - -------------------------------------------------------------------------------- Systematic Withdrawal Plan (SWP) This feature can be used by investors who want to receive regular distributions from their accounts. To start a SWP a shareholder must have a current invest- ment of $10,000 or more in a fund. Shareholders can elect to receive cash pay- ments of $50 or more monthly, every other month, quarterly, three times a year, semi-annually or annually. Shareholders may sign up by completing the SWP Application Form which may be obtained from PFPC. Shareholders should realize that if withdrawals 131 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- exceed income the invested principal in their account will be depleted. To participate in the SWP, shareholders must have their dividends automatically reinvested and may not hold share certificates. Shareholders may change or can- cel the SWP at any time, upon written notice to PFPC. If an investor purchases additional Investor A Shares of a fund at the same time he or she redeems shares through the SWP, that investor may lose money because of the sales charge involved. No CDSC will be assessed on redemptions of Investor B or Investor C Shares made through the SWP that do not exceed 12% of the account's net asset value on an annualized basis. For example, monthly, quarterly and semi-annual SWP redemp-tions of Investor B or Investor C Shares will not be subject to the CDSC if they do not exceed 1%, 3% and 6%, respectively, of an account's net asset value on the redemption date. SWP redemptions of Investor B or Investor C Shares in excess of this limit will still pay the applicable CDSC. 132 For More Information: This prospectus contains important information you should know before you invest. Read it carefully and keep it for future reference. More information about the BlackRock Funds is available free, upon request, including: Annual/Semi-Annual Report These reports contain additional information about each of the Funds' investments, describe the Funds' performance, list portfolio holdings, and discuss recent market conditions, economic trends and Fund strategies for the last fiscal year. Statement of Additional Information (SAI) A Statement of Additional Information, dated January, 28, 1999, has been filed with the Securities and Exchange Commission (SEC). The SAI, which includes additional information about the BlackRock Funds, may be obtained free of charge, along with the Company's annual and semi-annual reports, by calling (800) 441-7762. The SAI, as supplemented from time to time is incorporated by reference into this Prospectus. Shareholder Account Service Representatives Representatives are available to discuss account balance information, mutual fund prospectuses, literature and to discuss programs and services available. Hours: 8 a.m. to 6 p.m. (Eastern time), Monday-Friday. Call: (800) 441-7762 Purchases and Redemptions Call your registered representative or 800-441-7762. World Wide Web Access general fund information and specific fund performance. Request mutual fund prospectuses and literature. Forward mutual fund inquiries. Available 24 hours a day, 7 days a week. http://www.blackrock.com Email Request prospectuses, SAI, Annual or Semi-Annual Reports and literature. Forward mutual fund inquiries. Available 24 hours a day, 7 days a week. Mail to: funds@blackrock.com Written Correspondence Post Office Address: BlackRock Funds c/o PFPC, Inc. PO Box 8907, Wilmington, DE 19899-8907 Street Address: BlackRock Funds, c/o PFPC, Inc. 400 Bellevue Parkway, Wilmington, DE 19809 Internal Wholesalers/Broker Dealer Support Available to support investment professionals 9 a.m. to 6 p.m. (Eastern time), Monday-Friday. Call: (888) 8BLACKROCK Securities and Exchange Commission (SEC) You may also view information about the BlackRock Funds, including the SAI, by visiting the SEC Web site (http://www.sec.gov) or the SEC's Public Reference Room in Washington, D.C. Information about the operation of the public reference room can be obtained by calling the SEC directly at 1-800-SEC-0330. Copies of this information can be obtained, for a duplicating fee, by writing to the Public Reference Section of the SEC, Washington, D.C. 20549-6009. INVESTMENT COMPANY ACT FILE NO. 811-05742 [GRAPHIC] BLACKROCK FUNDS BLACKROCK FUNDS SM THE BOND PORTFOLIOS/INVESTOR CLASSES SUPPLEMENT TO PROSPECTUS DATED JANUARY 28, 1999 BlackRock Low Duration Bond Portfolio Fund Management The section "Fund Management" on page 8 has been amended to read in its entirety as follows: The fund is managed by a team of investment professionals at BlackRock Financial Management, Inc. (BFM), including the following individuals who have day-to-day responsibility: Scott Amero, Managing Director of BFM since 1990, Keith Anderson, Managing Director of BFM since 1988 and Rajiv Sobti, Managing Director of BFM since March 1998. Prior to joining BFM, Rajiv Sobti was a Managing Director and head of Quantitative Research with Don- aldson Lufkin & Jenrette for 12 years. Scott Amero has been a member of the team managing the fund since 1992, Keith Anderson since 1992 and Rajiv Sobti since 1998. Scott Amero has been a portfolio co-manager since incep- tion, Keith Anderson since 1999 and Rajiv Sobti since 1999. BlackRock Intermediate Government Bond Portfolio Fund Management The section "Fund Management" on page 15 has been amended to read in its entirety as follows: The fund is managed by a team of investment professionals at BlackRock Financial Management, Inc. (BFM), including the following individuals who have day-to-day responsibility: Scott Amero, Managing Director of BFM since 1990, Keith Anderson, Managing Director of BFM since 1988 and Rajiv Sobti, Managing Director of BFM since March 1998. Prior to joining BFM, Rajiv Sobti was a Managing Director and head of Quantitative Research with Don- aldson Lufkin & Jenrette for 12 years. Scott Amero has been a member of the team managing the fund since 1995, Keith Anderson since 1995 and Rajiv Sobti since 1998. Scott Amero has been a portfolio co-manager since 1995, Keith Anderson since 1999 and Rajiv Sobti since 1999. BlackRock Intermediate Bond Portfolio Fund Management The section "Fund Management" on page 22 has been amended to read in its entirety as follows: The fund is managed by a team of investment professionals at BlackRock Financial Management, Inc. (BFM), including the following individuals who have day-to-day responsibility: Scott Amero, Managing Director of BFM since 1990, Keith Anderson, Managing Director of BFM since 1988 and Rajiv Sobti, Managing Director of BFM since March 1998. Prior to joining BFM, Rajiv Sobti was a Managing Director and head of Quantitative Research with Don- aldson Lufkin & Jenrette for 12 years. Scott Amero has been a member of the team managing the fund since 1995, Keith Anderson since 1995 and Rajiv Sobti since 1998. Scott Amero has been a portfolio co-manager since 1995, Keith Anderson since 1999 and Rajiv Sobti since 1999. BlackRock Core Bond Portfolio Fund Management The section "Fund Management" on page 29 has been amended to read in its entirety as follows: The fund is managed by a team of investment professionals at BlackRock Financial Management, Inc. (BFM), including the following individuals who have day-to-day responsibility: Keith Anderson, Managing Director of BFM since 1988, Scott Amero, Managing Director of BFM since 1990 and Rajiv Sobti, Managing Director of BFM since March 1998. Prior to joining BFM, Rajiv Sobti was a Managing Director and head of Quantitative Research with Donaldson Lufkin & Jenrette for 12 years. Keith Anderson has been a member of the team managing the fund since 1997, Scott Amero since 1992 and Rajiv Sobti since 1998. Keith Anderson has been a portfolio co-manager since 1997, Scott Amero since 1999 and Rajiv Sobti since 1999. BlackRock Government Income Portfolio Fund Management The section "Fund Management" on page 36 has been amended to read in its entirety as follows: The fund is managed by a team of investment professionals at BlackRock Financial Management, Inc. (BFM), including the following individuals who have day-to-day responsibility: Rajiv Sobti, Managing Director of BFM since March 1998 and Andrew Phillips, Managing Director of BFM since 1991. Prior to joining BFM, Rajiv Sobti was a Managing Director and head of Quantita- tive Research with Donaldson Lufkin & Jenrette for 12 years. Rajiv Sobti has been a member of the team managing the fund since 1998 and Andrew Phil- lips since 1995. Both have been portfolio co-managers since 1999. BlackRock GNMA Portfolio Fund Management The section "Fund Management" on page 44 has been amended to read in its entirety as follows: The fund is managed by a team of investment professionals at BlackRock Financial Management, Inc. (BFM), including the following individuals who have day-to-day responsibility: Rajiv Sobti, Managing Director of BFM since March 1998 and Andrew Phillips, Managing Director of BFM since 1991. Prior to joining BFM, Rajiv Sobti was a Managing Director and head of Quantita- tive Research with Donaldson Lufkin & Jenrette for 12 years. Rajiv Sobti and Andrew Phillips have been members of the team managing the fund since 1998 and portfolio co-managers since 1999. BlackRock Managed Income Portfolio Fund Management The section "Fund Management" on page 50 has been amended to read in its entirety as follows: The fund is managed by a team of investment professionals at BlackRock Financial Management, Inc. (BFM), including the following individuals who have day-to-day responsibility: Keith Anderson, Managing Director of BFM since 1988, Scott Amero, Managing Director of BFM since 1990 and Rajiv Sobti, Managing Director of BFM since March 1998. Prior to joining BFM, Rajiv Sobti was a Managing Director and head of Quantitative Research with Donaldson 2 Lufkin & Jenrette for 12 years. Keith Anderson has been a member of the team managing the fund since 1997, Scott Amero since 1990 and Rajiv Sobti since 1998. Keith Anderson has been a portfolio co-manager since 1997, Scott Amero since 1999 and Rajiv Sobti since 1999. BlackRock International Bond Portfolio Fund Management The section "Fund Management" on page 58 has been amended to read in its entirety as follows: The fund is managed by a team of investment professionals at BlackRock Financial Management, Inc. (BFM), including the following individuals who have day-to-day responsibility: Andrew Gordon, Managing Director of BFM since 1996 and Keith Anderson, Managing Director of BFM since 1988. Prior to joining BFM, Andrew Gordon was responsible for non-dollar (internation- al) research at Barclay Investments from 1994 to 1996 and at CS First Bos- ton from 1986 to 1994. Andrew Gordon has been a member of the team managing the fund since 1997 and Keith Anderson since 1996. Andrew Gordon has been a portfolio co-manager since 1997 and Keith Anderson since 1999. BlackRock High Yield Bond Portfolio Fund Management The section "Fund Management" on page 66 has been amended to read in its entirety as follows: The fund is managed by a team of investment professionals at BlackRock Financial Management, Inc. (BFM), including the following individuals who have day-to-day responsibility: Dennis Schaney and Michael Buchanan. Dennis Schaney is co-leader of the High Yield Team and a Managing Director of BFM since February 1998. Prior to joining BFM, he was a Managing Director in the Global Fixed Income Research and Economics Department of Merrill Lynch for nine years. Michael Buchanan, co-leader of the High Yield Team, has served as Director of BFM since June 1998. Prior to joining BFM, Michael Buchanan was Vice President of Investments at Conseco Capital Management where he was a portfolio manager responsible for high yield debt, bank loan, and emerging markets debt trading. Dennis Schaney and Michael Buchanan have been members of the team managing the fund since inception. Dennis Schaney has been a portfolio co-manager since inception and Michael Buchanan since 1999. Annual Fund Operating Expenses The footnote to the Annual Fund Operating Expenses table regarding waivers for each of the funds appearing on pages 8, 15, 21, 28, 35, 43, 50, 57, 65, 72, 81, 89, 97, 105 and 113 has been amended to read in its entirety as follows: BlackRock has contractually agreed to waive or reimburse fees or expenses in order to limit certain (but not all) fund expenses for the next year. The fund may have to repay these waivers and reimbursements to BlackRock in the following two years if the repayment can be made within these expense limits. In addition, BlackRock Distributors, Inc., the fund's distributor, has contractually agreed to waive 12b-1 distribution fees on Investor A Shares in the amount of .095% of average daily net assets (otherwise pay- able at the maximum annual rate of .10% of average daily net assets) for the next year. "Net Expenses" in the table have been restated to reflect these waivers and reimbursements. 3 The section "Purchase of Investor B Shares" on page 120 is amended by adding the following after the chart: Investor B Shares of the Intermediate Government Bond and Managed Income Portfolios purchased from December 1, 1999 to December 31, 1999 are subject to a CDSC at the rates shown in the chart below: CONTINGENT DEFERRED SALES NUMBER OF YEARS CHARGE (AS % OF DOLLAR AMOUNT ELAPSED SINCE PURCHASE SUBJECT TO THE CHARGE) ---------------------- ----------------------------- Up to one year 3.50% More than one but less than two years 3.00% More than two but less than three years 2.00% More than three but less than four years 1.00% More than four years 0.00% This supplement is dated November 22, 1999. 4 EX-99.17C 6 SAI OF BLACKROCK FUNDS EXHIBIT 17(c) 1 BLACKROCK FUNDS(SM) STATEMENT OF ADDITIONAL INFORMATION This Statement of Additional Information provides supplementary information pertaining to shares representing interests in the Money Market, Municipal Money Market, U.S. Treasury Money Market, Ohio Municipal Money Market, Pennsylvania Municipal Money Market, North Carolina Municipal Money Market, Virginia Municipal Money Market, New Jersey Municipal Money Market, Large Cap Value Equity, Large Cap Growth Equity, Index Equity, Small Cap Value Equity, Mid-Cap Value Equity, Micro-Cap Equity, International Equity, International Emerging Markets, International Small Cap Equity, Balanced, Small Cap Growth Equity, Mid- Cap Growth Equity, Select Equity, Managed Income, Tax-Free Income, Intermediate Government Bond, Delaware Tax-Free Income, Kentucky Tax-Free Income, Ohio Tax- Free Income, Pennsylvania Tax-Free Income, Low Duration Bond, Intermediate Bond, Government Income, International Bond, New Jersey Tax-Free Income, Core Bond, GNMA and High Yield Bond Portfolios (collectively, the "Portfolios") of BlackRock Funds(SM) (the "Fund"). The Money Market, Municipal Money Market, U.S. Treasury Money Market, Ohio Municipal Money Market, Pennsylvania Municipal Money Market, North Carolina Municipal Money Market, Virginia Municipal Money Market and New Jersey Municipal Money Market Portfolios are called "Money Market Portfolios," the Municipal Money Market, Ohio Municipal Money Market, Pennsylvania Municipal Money Market, North Carolina Municipal Money Market, Virginia Municipal Money Market and New Jersey Municipal Money Market Portfolios are called "Municipal Money Market Portfolios," the Large Cap Value Equity, Large Cap Growth Equity, Index Equity, Small Cap Value Equity, Mid-Cap Value Equity, Micro-Cap Equity, International Equity, International Emerging Markets, International Small Cap Equity, Balanced, Small Cap Growth Equity, Mid-Cap Growth Equity and Select Equity Portfolios are called "Equity Portfolios" and the Managed Income, Tax-Free Income, Intermediate Government Bond, Delaware Tax- Free Income, Kentucky Tax-Free Income, Ohio Tax-Free Income, Pennsylvania Tax- Free Income, Low Duration Bond, Intermediate Bond, Government Income, International Bond, New Jersey Tax-Free Income, Core Bond, GNMA and High Yield Bond Portfolios are called "Bond Portfolios." The Equity Portfolios and the Bond Portfolios are also called "Non-Money Market Portfolios." This Statement of Additional Information is not a prospectus, and should be read only in conjunction with the Prospectuses of the Fund dated January 28, 1999, each as amended from time to time (the "Prospectuses"). Certain information contained in the Fund's and The U.S. Large Company Series of The DFA Investment Trust Company's annual reports to shareholders is incorporated by reference herein. Prospectuses and current shareholder reports of the Fund may be obtained from the Fund's distributor at no charge by calling toll-free (800) 441-7379. This Statement of Additional Information is dated January 28, 1999. 2 TABLE OF CONTENTS
Page INVESTMENT POLICIES....................................................................... 1 SPECIAL CONSIDERATIONS FOR STATE-SPECIFIC PORTFOLIOS...................................... 23 ADDITIONAL INVESTMENT LIMITATIONS......................................................... 44 TRUSTEES AND OFFICERS THE FUND............................................................ 48 SHAREHOLDER AND TRUSTEE LIABILITY OF THE FUND............................................. 55 INVESTMENT ADVISORY, ADMINISTRATION,DISTRIBUTION AND SERVICING ARRANGEMENTS............... 55 EXPENSES.................................................................................. 75 PORTFOLIO TRANSACTIONS.................................................................... 75 PURCHASE AND REDEMPTION INFORMATION....................................................... 79 VALUATION OF PORTFOLIO SECURITIES......................................................... 96 PERFORMANCE INFORMATION................................................................... 98 TAXES..................................................................................... 127 ADDITIONAL INFORMATION CONCERNING SHARES.................................................. 135 MISCELLANEOUS............................................................................. 136 FINANCIAL STATEMENTS...................................................................... 140 APPENDIX A................................................................................ A-1 APPENDIX B................................................................................ B-1
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS NOT CONTAINED IN THIS STATEMENT OF ADDITIONAL INFORMATION OR THE PROSPECTUSES IN CONNECTION WITH THE OFFERING MADE BY THE PROSPECTUSES AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE FUND OR ITS DISTRIBUTOR. THE PROSPECTUSES DO NOT CONSTITUTE AN OFFERING BY THE FUND OR BY THE FUND'S DISTRIBUTOR IN ANY JURISDICTION IN WHICH SUCH OFFERING MAY NOT LAWFULLY BE MADE. INVESTMENT POLICIES The following supplements information contained in the Prospectuses concerning the Portfolios' investment policies. Except as indicated, the information below relates only to those Portfolios that are authorized to invest in the instruments or securities described below. The Index Equity Portfolio invests all of its investable assets in The U.S. Large Company Series (the "Index Master Portfolio") of The DFA Investment Trust Company (the "Trust"). Accordingly, the following discussion relates to: (i) the investment policies of all the Portfolios including the Index Equity Portfolio; and (ii) where indicated the investment policies of the Index Master Portfolio. ADDITIONAL INFORMATION ON INVESTMENT STRATEGY EQUITY PORTFOLIOS. Equity securities include common stock and 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 depositary receipts. The Large Cap Value Equity, Large Cap Growth Equity, Mid-Cap Value Equity and Mid-Cap Growth Equity Portfolios will invest primarily in securities of established companies. For this purpose, an established company is one which, together with its predecessors, has at least three years of continuous operating history. INDEX EQUITY AND INDEX MASTER PORTFOLIOS. During normal market conditions, the Index Master Portfolio (in which all of the assets of the Index Equity Portfolio are invested) invests at least 95% of the value of its total assets in securities included in the Standard & Poor's 5007 Composite Stock Price Index (the "S&P 500 Index")*. The Index Master Portfolio intends to invest in all of the stocks that comprise the S&P 500 Index in approximately the same proportions as they are represented in the Index. The Index Master Portfolio operates as an index portfolio and, therefore, is not actively managed (through the use of economic, financial or market analysis). Adverse performance will ordinarily not result in the elimination of a stock from the Portfolio. The Portfolio will remain fully invested in common stocks even when stock prices are generally falling. Ordinarily, portfolio securities will not be sold except to reflect additions or deletions of the stocks that comprise the S&P 500 Index, including mergers, reorganizations and similar transactions and, to the extent necessary, to provide cash to pay redemptions of the Portfolio's shares. The investment performance of the Index Master Portfolio and the Index Equity Portfolio is expected to approximate the investment performance of the S&P 500 Index, which tends to be cyclical in nature, reflecting periods when stock prices generally rise or fall. Neither the Index Equity Portfolio nor the Index Master Portfolio are sponsored, endorsed, sold or promoted by S&P. S&P makes no representation or warranty, express or implied, to the owners of the Index Equity Portfolio or the Index Master Portfolio or any member of the public regarding the advisability of investing in securities generally or in the Index Equity Portfolio or the Index Master Portfolio particularly or the ability of the S&P 500 Index to track general stock market performance. S&P's only relationship to the Index Equity Portfolio and the Index Master Portfolio is the licensing of certain trademarks and trade names ____________________ "Standard & Poor's(R)," "S&P(R)," "S&P500(R)," "Standard & Poor's 500(R)" and "500" are trademarks of The McGraw-Hill Companies, Inc. and have been licensed for use by the Fund and The DFA Investment Trust Company. 1 of S&P and of the S&P 500 Index which is determined, composed and calculated by S&P without regard to the Index Equity Portfolio or the Index Master Portfolio. S&P has no obligation to take the needs of the Index Equity Portfolio or the Index Master Portfolio or their respective owners into consideration in determining, composing or calculating the S&P 500 Index. S&P is not responsible for and has not participated in the determination of the prices and amount of the Index Equity Portfolio or the Index Master Portfolio or the timing of the issuance or sale of the Index Equity Portfolio or the Index Master Portfolio or in the determination or calculation of the equation by which the Index Equity Portfolio or the Index Master Portfolio is to be converted into cash. S&P has no obligation or liability in connection with the administration, marketing or trading of the Index Equity Portfolio or Index Master Portfolio. S&P DOES NOT GUARANTEE THE ACCURACY AND/OR THE COMPLETENESS OF THE S&P 500 INDEX OR ANY DATA INCLUDED THEREIN, AND S&P SHALL HAVE NO LIABILITY FOR ANY ERRORS, OMISSIONS OR INTERRUPTIONS THEREIN. S&P MAKES NO WARRANTY, EXPRESS OR IMPLIED, AS TO RESULTS TO BE OBTAINED BY LICENSEE, OWNERS OF THE PRODUCT, OR ANY OTHER PERSON OR ENTITY FROM THE USE OF THE S&P 500 INDEX OR ANY DATA INCLUDED THEREIN. S&P MAKES NO EXPRESS OR IMPLIED WARRANTIES, AND EXPRESSLY DISCLAIMS ALL WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE WITH RESPECT TO THE S&P 500 INDEX OR ANY DATA INCLUDED THEREIN. WITHOUT LIMITING ANY OF THE FOREGOING, IN NO EVENT SHALL S&P HAVE ANY LIABILITY FOR ANY SPECIAL, PUNITIVE, INDIRECT, OR CONSEQUENTIAL DAMAGES (INCLUDING LOST PROFITS), EVEN IF NOTIFIED OF THE POSSIBILITY OF SUCH DAMAGES. BALANCED PORTFOLIO. Fixed income securities purchased by the Balanced Portfolio may include domestic and dollar-denominated foreign debt securities, including bonds, debentures, notes, equipment lease and trust certificates, mortgage-related and asset-backed securities, guaranteed investment contracts (GICs), obligations issued or guaranteed by the U.S. Government or its agencies or instrumentalities and state and local municipal obligations. These securities will be rated at the time of purchase within the four highest rating groups assigned by Moody's Investors Service, Inc. ("Moody's"), Standard & Poors Ratings Group ("S&P") or another nationally recognized statistical rating organization. If unrated, the securities will be determined at the time of purchase to be of comparable quality by the sub-adviser. Securities rated "Baa" by Moody's or "BBB" by S&P, respectively, are generally considered to be investment grade although they have speculative characteristics. If a fixed income security is reduced below Baa by Moody's or BBB by S&P, the Portfolio's sub-adviser will dispose of the security in an orderly fashion as soon as practicable. Investments in securities of foreign issuers, which present additional investment considerations as described below under "Foreign Investments," will be limited to 5% of the Portfolio's total assets. The Balanced Portfolio may also purchase zero-coupon bonds (i.e., discount debt obligations that do not make periodic interest payments) and state and local government obligations. Zero-coupon bonds are subject to greater market fluctuations from changing interest rates than debt obligations of comparable maturities which make current distributions of interest. Municipal obligations may be purchased when the Portfolio's sub-adviser believes that their return, on a pre-tax basis, will be comparable to the returns of other permitted investments. Dividends paid by the Portfolio that are derived from interest on municipal obligations will be taxable to shareholders. BOND PORTFOLIOS. Each Bond Portfolio will normally invest at least 80% of the value of its total assets in debt securities. The Pennsylvania Tax-Free Income Portfolio, New Jersey Tax-Free Income Portfolio and Ohio Tax-Free Income Portfolio, Delaware Tax-Free Income Portfolio and Kentucky Tax-Free Income Portfolio (the "State-Specific Tax-Free Portfolios") and the Tax-Free Income Portfolio (together with the State-Specific Tax-Free Portfolios, the "Tax-Free Portfolios") will invest, during normal market conditions, at least 80% of their net assets in obligations issued by or on behalf of states, territories and possessions of the United States, the District of Columbia and their political sub-divisions, agencies, instrumentalities and authorities and related tax- exempt derivative securities the interest on which the portfolio manager believes is exempt from regular Federal income tax and is not an item of tax preference for purposes of the Federal alternative minimum tax ("Municipal Obligations"). Each State-Specific Tax-Free Portfolio also intends to invest at least 65% of its net assets (65% of its total assets with respect to the Delaware and Kentucky Tax-Free Income Portfolios) in Municipal Obligations of issuers located in the particular state indicated by its name ("State-Specific Obligations"). In addition, the New Jersey Tax-Free Income Portfolio intends to invest at least 80% of its total assets in New Jersey state-specific obligations and in securities issued by the U.S. Government, its agencies and instrumentalities ("U.S. Government Obligations"). 2 The Low Duration Bond Portfolio will seek to maintain a duration for its portfolio in a range of +/-20% of the current duration of the Merrill Lynch 1-3 Year Treasury Index. The Government Income Portfolio will seek to maintain an interest rate sensitivity within a range comparable to that of 7 to 10 year U.S. Treasury bonds. MONEY MARKET PORTFOLIOS. The investment objective of the Money Market Portfolio is to provide as high a level of current interest income as is consistent with maintaining liquidity and stability of principal. The Portfolio may invest in a broad range of short-term, high quality, U.S. dollar-denominated instruments, such as government, bank, commercial and other obligations, that are available in the money markets. In particular, the Portfolio may invest in: (a) U.S. dollar-denominated obligations issued or supported by the credit of U.S. or foreign banks or savings institutions with total assets in excess of $1 billion (including obligations of foreign branches of such banks); (b) high quality commercial paper and other obligations issued or guaranteed by U.S. and foreign corporations and other issuers rated (at the time of purchase) A-2 or higher by S&P, Prime-2 or higher by Moody's, Duff 2 or higher by Duff & Phelps Credit Co. ("D&P"), F-2 or higher by Fitch Investors Service, Inc. ("Fitch") or TBW-2 or higher by Thomson BankWatch, Inc. ("TBW"), as well as high quality corporate bonds rated (at the time of purchase) AA or higher by S&P, D&P, Fitch or TBW or AA or higher by Moody's; (c) unrated notes, paper and other instruments that are of comparable quality as determined by the Portfolio's sub-adviser under guidelines established by the Fund's Board of Trustees; (d) asset-backed securities (including interests in pools of assets such as mortgages, installment purchase obligations and credit card receivables); (e) securities issued or guaranteed as to principal and interest by the U.S. Government or by its agencies or instrumentalities and related custodial receipts; (f) dollar-denominated securities issued or guaranteed by foreign governments or their political subdivisions, agencies or instrumentalities; (g) guaranteed investment contracts issued by highly-rated U.S. insurance companies; (h) securities issued or guaranteed by state or local governmental bodies; and (i) repurchase agreements relating to the above instruments. The investment objective of the U.S. Treasury Money Market Portfolio is to provide as high a level of current interest income as is consistent with maintaining liquidity and stability of principal. It pursues this objective by investing exclusively in short-term bills, notes and other obligations issued or guaranteed by the U.S. Treasury and repurchase agreements relating to such obligations. The investment objective of the Municipal Money Market Portfolio is to provide as high a level of current interest income exempt from Federal income taxes as is consistent with maintaining liquidity and stability of principal. It pursues this objective by investing substantially all of its assets in short- term obligations issued by or on behalf of states, territories and possessions of the United States, the District of Columbia, and their political subdivisions, agencies, instrumentalities and authorities ("Municipal Obligations"). The investment objective of the New Jersey Municipal Money Market Portfolio, North Carolina Municipal Money Market Portfolio, Ohio Municipal Money Market Portfolio, Pennsylvania Municipal Money Market Portfolio and Virginia Municipal Money Market Portfolio (the "State-Specific Municipal Portfolios") is, for each Portfolio, to seek as high a level of current income exempt from Federal, and to the extent possible, state income tax of the specific state in which a Portfolio concentrates, as is consistent with maintaining liquidity and stability of principal. The Municipal Money Market Portfolio and the State-Specific Municipal Portfolios (together, the "Municipal Portfolios") seek to achieve their investment objectives by primarily investing in: 3 (a) fixed and variable rate notes and similar debt instruments rated MIG- 2, VMIG-2 or Prime-2 or higher by Moody's, SP-2 or A-2 or higher by S&P, D-2 or higher by D&P or F-2 or higher by Fitch; (b) tax-exempt commercial paper and similar debt instruments rated Prime-2 or higher by Moody's, A-2 or higher by S&P, Duff 2 or higher by D&P or F-2 or higher by Fitch; (c) municipal bonds rated Aa or higher by Moody's or AA or higher by S&P, D&P or Fitch; (d) unrated notes, paper or other instruments that are of comparable quality as determined by the Portfolios' sub-adviser under guidelines established by the Fund's Board of Trustees; and (e) municipal bonds and notes which are guaranteed as to principal and interest by the U.S. Government or an agency or instrumentality thereof or which otherwise depend directly or indirectly on the credit of the United States. All securities acquired by the Portfolios will be determined at the time of purchase by the Portfolios' sub-adviser, under guidelines established by the Fund's Board of Trustees, to present minimal credit risks and will be "Eligible Securities" as defined by the SEC. Eligible Securities are (a) securities that either (i) have short-term debt ratings at the time of purchase in the two highest rating categories by at least two unaffiliated nationally recognized statistical rating organizations ("NRSROs") (or one NRSRO if the security is rated by only one NRSRO), or (ii) are comparable in priority and security with an instrument issued by an issuer which has such ratings, and (b) securities that are unrated (including securities of issuers that have long-term but not short-term ratings) but are of comparable quality as determined in accordance with guidelines approved by the Board of Trustees. Each Portfolio is managed so that the average maturity of all instruments held by it (on a dollar-weighted basis) will not exceed 90 days. In no event will a Portfolio purchase securities which mature more than 397 days from the date of purchase (except for certain variable and floating rate instruments and securities collateralizing repurchase agreements). Securities in which the Portfolios invest may not earn as high a level of income as longer term or lower quality securities, which generally have greater market risk and more fluctuation in market value. ADDITIONAL INFORMATION ON PORTFOLIO INVESTMENTS Reverse REPURCHASE AGREEMENTS AND OTHER BORROWINGS. Each Equity and Bond Portfolio (including the Index Master Portfolio) is authorized to borrow money. If the securities held by a Portfolio should decline in value while borrowings are outstanding, the net asset value of the Portfolio's outstanding shares will decline in value by proportionately more than the decline in value suffered by the Portfolio's securities. Borrowings may be made by each Portfolio through reverse repurchase agreements under which the Portfolio sells portfolio securities to financial institutions such as banks and broker-dealers and agrees to repurchase them at a particular date and price. Such Agreements are considered to be borrowings under the Investment Company Act of 1940 (the "1940 Act"). A Portfolio may use the proceeds of reverse repurchase agreements to purchase other securities either maturing, or under an agreement to resell, on a date simultaneous with or prior to the expiration of the reverse repurchase agreement. The Index Master Portfolio does not intend to invest in reverse repurchase agreements. The Bond Portfolios (except the Tax-Free Portfolios) and the Balanced Portfolio may utilize reverse repurchase agreements when it is anticipated that the interest income to be earned from the investment of the proceeds of the transaction is greater than the interest expense of the transaction. This use of reverse repurchase agreements may be regarded as leveraging and, therefore, speculative. Reverse repurchase agreements involve the risks that the interest income earned in the investment of the proceeds will be less than the interest expense, that the market value of the securities sold by a Portfolio may decline below the price of the securities the Portfolio is obligated to repurchase and that the securities may not be returned to the Portfolio. During the time a reverse repurchase agreement is outstanding, a Portfolio will maintain a segregated account with the Fund's custodian containing cash, U.S. Government or other appropriate liquid securities having a value at least equal to the repurchase price. A Portfolio's reverse repurchase agreements, together with any other borrowings, will not exceed, in the aggregate, 33 1/3% of the value of its total assets (33% in the case of the Index Master Portfolio). In addition, the Bond Portfolios (except the Tax-Free Portfolios) and the Balanced Portfolio may borrow up to an additional 5% of its total assets for temporary purposes. Whenever borrowings exceed 5% of a Portfolio's total assets, the Equity Portfolios (other than the Index Master Portfolio and the Balanced Portfolio) will not make any investments. 4 Each Money Market Portfolio may enter into reverse repurchase agreements for temporary purposes (such as to obtain cash to meet redemption requests when the liquidation of portfolio securities is deemed disadvantageous or inconvenient). VARIABLE AND FLOATING RATE INSTRUMENTS. The Balanced and Bond Portfolios may purchase rated and unrated variable and floating rate instruments. These instruments may include variable amount master demand notes that permit the indebtedness thereunder to vary in addition to providing for periodic adjustments in the interest rate. The Portfolios may invest up to 10% of their total assets in leveraged inverse floating rate debt instruments ("inverse floaters"). The interest rate of an inverse floater resets in the opposite direction from the market rate of interest to which it is indexed. An inverse floater may be considered to be leveraged to the extent that its interest rate varies by a magnitude that exceeds the magnitude of the change in the index rate of interest. The higher degree of leverage inherent in inverse floaters is associated with greater volatility in their market values. Issuers of unrated variable and floating rate instruments must satisfy the same criteria as set forth above for a Portfolio. The absence of an active secondary market with respect to particular variable and floating rate instruments, however, could make it difficult for a Portfolio to dispose of a variable or floating rate instrument if the issuer defaulted on its payment obligation or during periods when the Portfolio is not entitled to exercise its demand rights. Each Money Market Portfolio may purchase rated and unrated variable and floating rate instruments, which may have a stated maturity in excess of 13 months but will, in any event, permit a Portfolio to demand payment of the principal of the instrument at least once every 13 months upon not more than thirty days' notice (unless the instrument is guaranteed by the U.S. Government or an agency or instrumentality thereof). These instruments may include variable amount master demand notes that permit the indebtedness thereunder to vary in addition to providing for periodic adjustments in the interest rate. Issuers of unrated variable and floating rate instruments must satisfy the same criteria as set forth above for the particular Portfolio. The absence of an active secondary market with respect to particular variable and floating rate instruments, however, could make it difficult for a Portfolio to dispose of a variable or floating rate instrument if the issuer defaulted on its payment obligation or during periods when the Portfolio is not entitled to exercise its demand rights. With respect to purchasable variable and floating rate instruments, the adviser or sub-adviser will consider the earning power, cash flows and liquidity ratios of the issuers and guarantors of such instruments and, if the instruments are subject to a demand feature, will monitor their financial status to meet payment on demand. Such instruments may include variable amount master demand notes that permit the indebtedness thereunder to vary in addition to providing for periodic adjustments in the interest rate. The absence of an active secondary market with respect to particular variable and floating rate instruments could make it difficult for a Portfolio to dispose of a variable or floating rate note if the issuer defaulted on its payment obligation or during periods that the Portfolio is not entitled to exercise its demand rights, and the Portfolio could, for these or other reasons, suffer a loss with respect to such instruments. In determining average-weighted portfolio maturity, an instrument will be deemed to have a maturity equal to either the period remaining until the next interest rate adjustment or the time the Portfolio involved can recover payment of principal as specified in the instrument, depending on the type of instrument involved. Each of the Equity Portfolios of the Fund does not intend to invest more than 5% of its net assets in variable and floating rate instruments. BANK LOANS. The High Yield Bond Portfolio may invest in fixed and floating rate loans ("Loans") arranged through private negotiations between a corporate borrower or a foreign sovereign entity and one or more financial institutions ("Lenders"). The High Yield Bond Portfolio may invest in such Loans in the form of participations in Loans ("Participations") and assignments of all or a portion of Loans from third parties ("Assignments"). The High Yield Bond Portfolio considers these investments to be investments in debt securities for purposes of its investment policies. Participations typically will result in the High Yield Bond Portfolio having a contractual relationship only with the Lender, not with the borrower. The Portfolio will have the right to receive payments of principal, interest and any fees to which it is entitled only from the Lender selling the Participation and only upon receipt by the Lender of the payments from the borrower. In connection with purchasing Participations, the Portfolio generally will have no right to enforce compliance by the borrower with the terms of the loan agreement relating to the Loans, nor any rights of set-off against the borrower, and the Portfolio may not benefit directly from any collateral supporting the Loan in which it has purchased the Participation. As a result, the Portfolio will assume the credit risk of both the borrower and the Lender that is selling the Participation. In the event of the insolvency of the Lender selling the Participation, the Portfolio may be treated as a general creditor of the Lender and may not benefit from any set-off between the Lender and the borrower. The Portfolio will acquire Participations only if the Lender interpositioned between the Portfolio and the borrower is determined by the Portfolio's sub-adviser to be creditworthy. When the Portfolio purchases Assignments from Lenders, the Portfolio will 5 acquire direct rights against the borrower on the Loan, except that under certain circumstances such rights may be more limited than those held by the assigning Lender. The High Yield Bond Portfolio may have difficulty disposing of Assignments and Participations. In certain cases, the market for such instruments is not highly liquid, and therefore the Portfolio anticipates that in such cases such instruments could be sold only to a limited number of institutional investors. The lack of a highly liquid secondary market will have an adverse impact on the value of such instruments and on the Portfolio's ability to dispose of particular Assignments or Participations in response to a specific economic event, such as deterioration in the creditworthiness of the borrower. The Fund's Board of Trustees has adopted procedures for the Portfolio to determine whether Assignments and Participations purchased by the Portfolio are liquid or illiquid for purposes of the Portfolio's limitation on investment in illiquid securities. Pursuant to those procedures, these securities will not be considered illiquid so long as it is determined by the Portfolio's sub-adviser that an adequate trading market exists for these securities. To the extent that liquid Assignments and Participations that the Portfolio holds become illiquid, due to the lack of sufficient buyers or market or other conditions, the percentage of the Portfolio's assets invested in illiquid assets would increase. PREFERRED STOCK. The High Yield Bond Portfolio may invest in preferred stocks. Preferred stock has a preference over common stock in liquidation (and generally dividends as well) but is subordinated to the liabilities of the issuer in all respects. As a general rule, the market value of preferred stock with a fixed dividend rate and no conversion element varies inversely with interest rates and perceived credit risk, while the market price of convertible preferred stock generally also reflects some element of conversion value. Because preferred stock is junior to debt securities and other obligations of the issuer, deterioration in the credit quality of the issuer will cause greater changes in the value of a preferred stock than in a more senior debt security with similar stated yield characteristics. Unlike interest payments on debt securities, preferred stock dividends are payable only if declared by the issuer's board of directors. Preferred stock also may be subject to optional or mandatory redemption provisions. CONVERTIBLE SECURITIES. The High Yield Bond Portfolio may invest in convertible securities. A convertible security is a bond, debenture, note, preferred stock or other security that may be converted into or exchanged for a prescribed amount of common stock or other equity security of the same or a different issuer within a particular period of time at a specified price or formula. A convertible security entitles the holder to receive interest paid or accrued on debt or the dividend paid on preferred stock until the convertible security matures or is redeemed, converted or exchanged. Before conversion, convertible securities have characteristics similar to nonconvertible income securities in that they ordinarily provide a stable stream of income with generally higher yields than those of common stocks of the same or similar issuers, but lower yields than comparable nonconvertible securities. The value of a convertible security is influenced by changes in interest rates, with investment value declining as interest rates increase and increasing as interest rates decline. The credit standing of the issuer and other factors also may have an effect on the convertible security's investment value. Convertible securities rank senior to common stock in a corporation's capital structure but are usually subordinated to comparable nonconvertible securities. Convertible securities may be subject to redemption at the option of the issuer at a price established in the convertible security's governing instrument. The High Yield Bond Portfolio will treat investments in convertible debt securities as debt securities for purposes of its investment policies. PAY-IN-KIND BONDS. The High Yield Bond Portfolio may invest in Pay-in-kind, or PIK, bonds. PIK bonds are bonds which pay interest through the issuance of additional debt or equity securities. Similar to zero coupon obligations, pay- in-kind bonds also carry additional risk as holders of these types of securities realize no cash until the cash payment date unless a portion of such securities is sold and, if the issuer defaults, the High Yield Bond Portfolio may obtain no return at all on its investment. The market price of pay-in-kind bonds is affected by interest rate changes to a greater extent, and therefore tends to be more volatile, than that of securities which pay interest in cash. Additionally, current federal tax law requires the holder of certain pay-in-kind bonds to accrue income with respect to these securities prior to the receipt of cash payments. To maintain its qualification as a regulated investment company and avoid liability for federal income and excise taxes, the High Yield Bond Portfolio may be required to distribute income accrued with respect to these securities and may have to dispose of portfolio securities under disadvantageous circumstances in order to generate cash to satisfy these distribution requirements. MONEY MARKET OBLIGATIONS OF DOMESTIC BANKS, FOREIGN BANKS AND FOREIGN BRANCHES OF U.S. BANKS. Each Portfolio may purchase bank obligations, such as certificates of deposit, notes, bankers' acceptances and time deposits, including instruments issued or supported by the credit of U.S. or foreign banks or savings institutions having total assets at the time of 6 purchase in excess of $1 billion. These obligations may be general obligations of the parent bank or may be limited to the issuing branch or subsidiary by the terms of a specific obligation or by government regulation. The assets of a bank or savings institution will be deemed to include the assets of its domestic and foreign branches for purposes of each Portfolio's investment policies. Investments in short-term bank obligations may include obligations of foreign banks and domestic branches of foreign banks, and also foreign branches of domestic banks. Each of the Equity Portfolios of the Fund does not intend to invest more than 5% of its net assets in bank obligations. The Index Master Portfolio may purchase obligations of U.S. banks and savings and loan associations and dollar-denominated obligations of U.S. subsidiaries and branches of foreign banks, such as certificates of deposit (including marketable variable rate certificates of deposit) and bankers' acceptances. Bank certificates of deposit will only be acquired by the Index Master Portfolio if the bank has assets in excess of $1 billion. To the extent consistent with their investment objectives, the Money Market and Bond Portfolios (except the Tax-Free Portfolios) may invest in debt obligations of domestic or foreign corporations and banks, and may acquire commercial obligations issued by Canadian corporations and Canadian counterparts of U.S. corporations, as well as Europaper, which is U.S. dollar-denominated commercial paper of a foreign issuer. The Bond Portfolios and the Money Market Portfolio may also make interest-bearing savings deposits in commercial and savings banks in amounts not in excess of 5% of their respective total assets. MORTGAGE RELATED AND ASSET-BACKED SECURITIES. The Balanced and Bond Portfolios (except the Tax-Free Portfolios) may make significant investments in residential and commercial mortgage-related and other asset-backed securities (i.e., securities backed by home equity loans, installment sale contracts, credit card receivables or other assets) issued by governmental entities and private issuers. Asset-backed securities are generally issued as pass-through certificates, which represent undivided fractional ownership interests in an underlying pool of assets, or as debt instruments, which are also known as collateralized obligations, and are generally issued as the debt of a special purpose entity organized solely for the purpose of owning such assets and issuing such debt. Asset-backed securities are often backed by a pool of assets representing the obligations of a number of different parties. Non-mortgage asset-backed securities involve risks that are not presented by mortgage-related securities. Primarily, these securities do not have the benefit of the same security interest in the underlying collateral. Credit card receivables are generally unsecured, and the debtors are entitled to the protection of a number of state and Federal consumer credit laws which give 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 an effective security interest in all of the obligations backing such receivables. Therefore, there is a possibility that recoveries on repossessed collateral may not, in some cases, be able to support payments on these securities. The yield and maturity characteristics of mortgage-related and other asset- backed securities differ from traditional debt securities. A major difference is that the principal amount of the obligations may normally be prepaid at any time because the underlying assets (i.e., loans) generally may be prepaid at any time. In calculating the average weighted maturity of a Portfolio, the maturity of mortgage-related and other asset-backed securities held by the Portfolio will be based on estimates of average life which take prepayments into account. The average life of a mortgage-related instrument, in particular, is likely to be substantially less than the original maturity of the mortgage pools underlying the securities as the result of scheduled principal payments and mortgage prepayments. In general, the collateral supporting non-mortgage asset-backed securities is of shorter maturity than mortgage loans and is less likely to experience substantial prepayments. Like other fixed-income securities, when interest rates rise the value of an asset-backed security generally will decline; however, when interest rates decline, the value of an asset-backed security with prepayment features may not increase as much as that of other fixed-income securities. The relationship between prepayments and interest rates may give some high- yielding mortgage- related and asset-backed securities less potential for growth in value than conventional bonds with comparable maturities. In addition, in periods of falling interest rates, the rate of prepayments tends to increase. During such periods, the reinvestment of prepayment proceeds by a 7 Portfolio will generally be at lower rates than the rates that were carried by the obligations that have been prepaid. Because of these and other reasons, an asset-backed security's total return and maturity may be difficult to predict precisely. To the extent that a Portfolio purchases asset-backed securities at a premium, prepayments (which may be made without penalty) may result in loss of the Portfolio's principal investment to the extent of premium paid. The Portfolios may from time to time purchase in the secondary market certain mortgage pass-through securities packaged and master serviced by PNC Mortgage Securities Corp. ("PNC Mortgage") or Midland Loan Services, Inc. ("Midland") (or Sears Mortgage if PNC Mortgage succeeded to rights and duties of Sears Mortgage) or mortgage-related securities containing loans or mortgages originated by PNC Bank or its affiliates. It is possible that under some circumstances, PNC Mortgage, Midland or their affiliates could have interests that are in conflict with the holders of these mortgage-backed securities, and such holders could have rights against PNC Mortgage, Midland or their affiliates. The GNMA Portfolio will invest primarily in GNMAs, and may make significant investments in other residential and commercial mortgage-related and other asset-backed securities (i.e., securities backed by home equity loans, installment sale contracts, credit card receivables or other assets) issued by governmental entities and private issuers. The GNMA Portfolio may acquire several types of mortgage-related securities. GNMAs are typically mortgage pass-through certificates, which provide the holder with a pro rata interest in the underlying mortgages. To maintain greater flexibility, the GNMA Portfolio may invest in instruments which have the characteristics of futures contracts. These instruments may take a variety of forms, such as debt securities with interest or principal payments determined by reference to the value of a commodity at a future point in time. The risks of such investments could reflect the risks of investing in futures and securities, including volatility and illiquidity. Although under normal market conditions they do not expect to do so, each Money Market Portfolio may invest in mortgage-related securities issued by the U.S. Government or its agencies or instrumentalities or issued by private companies. There are a number of important differences among the agencies and instrumentalities of the U.S. Government that issue mortgage-related securities and among the securities that they issue. Mortgage-related securities guaranteed by the Government National Mortgage Association ("GNMA") include GNMA Mortgage Pass-Through Certificates (also known as "Ginnie Maes") which are guaranteed as to the timely payment of principal and interest by GNMA and such guarantee is backed by the full faith and credit of the United States. GNMA is a wholly-owned U.S. Government corporation within the Department of Housing and Urban Development. GNMA certificates also are supported by the authority of GNMA to borrow funds from the U.S. Treasury to make payments under its guarantee. Mortgage-related securities issued by the Federal National Mortgage Association ("FNMA") include FNMA guaranteed Mortgage Pass-Through Certificates (also known as "Fannie Maes") which are solely the obligations of the FNMA, are not backed by or entitled to the full faith and credit of the United States and are supported by the right of the issuer to borrow from the Treasury. FNMA is a government-sponsored organization owned entirely by private stockholders. Fannie Maes are guaranteed as to timely payment of principal and interest by FNMA. Mortgage-related securities issued by the Federal Home Loan Mortgage Corporation ("FHLMC") include FHLMC Mortgage Participation Certificates (also known as "Freddie Macs" or "Pcs"). FHLMC is a corporate instrumentality of the United States, created pursuant to an Act of Congress, which is owned entirely by Federal Home Loan Banks. Freddie Macs are not guaranteed by the United States or by any Federal Home Loan Banks and do not constitute a debt or obligation of the United States or of any Federal Home Loan Bank. Freddie Macs entitle the holder to timely payment of interest, which is guaranteed by the FHLMC. FHLMC guarantees either ultimate collection or timely payment of all principal payments on the underlying mortgage loans. When FHLMC does not guarantee timely payment of principal, FHLMC may remit the amount due on account of its guarantee of ultimate payment of principal at any time after default on an underlying mortgage, but in no event later than one year after it becomes payable. The Bond Portfolios and the Balanced Portfolio may invest in multiple class pass-through securities, including collateralized mortgage obligations ("CMOs") and real estate mortgage investment conduit ("REMIC") pass-through or participation certificates ("REMIC Certificates"). These multiple class securities may be issued by U.S. Government agencies or instrumentalities, including FNMA and FHLMC, or by trusts formed by private originators of, or investors in, mortgage loans. In general, CMOs and REMICs are debt obligations of a legal entity that are collateralized by, and multiple class pass-through securities represent 8 direct ownership interests in, a pool of residential or commercial mortgage loans or mortgage pass-through securities (the "Mortgage Assets"), the payments on which are used to make payments on the CMOs or multiple pass-through securities. Investors may purchase beneficial interests in CMOs and REMICs, which are known as "regular" interests or "residual" interests. The residual in a CMO or REMIC structure generally represents the interest in any excess cash flow remaining after making required payments of principal of and interest on the CMOs or REMICs, as well as the related administrative expenses of the issuer. Residual interests generally are junior to, and may be significantly more volatile than, "regular" CMO and REMIC interests. The Portfolios do not currently intend to purchase residual interests. The markets for CMOs and REMICs may be more illiquid than those of other securities. Each class of CMOs or REMIC Certificates, often referred to as a "tranche," is issued at a specific adjustable or fixed interest rate and must be fully retired no later than its final distribution date. Principal prepayments on the Mortgage Assets underlying the CMOs or REMIC Certificates may cause some or all of the classes of CMOs or REMIC Certificates to be retired substantially earlier than their final distribution dates. Generally, interest is paid or accrues on all classes of CMOs or REMIC Certificates on a monthly basis. The principal of and interest on the Mortgage Assets may be allocated among the several classes of CMOs or REMIC Certificates in various ways. In certain structures (known as "sequential pay" CMOs or REMIC Certificates), payments of principal, including any principal prepayments, on the Mortgage Assets generally are applied to the classes of CMOs or REMIC Certificates in the order of their respective final distribution dates. Thus, no payment of principal will be made on any class of sequential pay CMOs or REMIC Certificates until all other classes having an earlier final distribution date have been paid in full. Additional structures of CMOs or REMIC Certificates include, among others, "parallel pay" CMOs and REMIC Certificates. Parallel pay CMOs or REMIC Certificates are those which are structured to apply principal payments and prepayments of the Mortgage Assets to two or more classes concurrently on a proportionate or disproportionate basis. These simultaneous payments are taken into account in calculating the final distribution date of each class. A wide variety of REMIC Certificates may be issued in the parallel pay or sequential pay structures. These securities include accrual certificates (also known as "Z-Bonds"), which only accrue interest at a specified rate until all other certificates having an earlier final distribution date have been retired and are converted thereafter to an interest-paying security, and planned amortization class ("PAC") certificates, which are parallel pay REMIC Certificates which generally require that specified amounts of principal be applied on each payment date to one or more classes of REMIC Certificates (the "PAC Certificates"), even though all other principal payments and prepayments of the Mortgage Assets are then required to be applied to one or more other classes of the Certificates. The scheduled principal payments for the PAC Certificates generally have the highest priority on each payment date after interest due has been paid to all classes entitled to receive interest currently. Shortfalls, if any, are added to the amount payable on the next payment date. The PAC Certificate payment schedule is taken into account in calculating the final distribution date of each class of PAC. In order to create PAC tranches, one or more tranches generally must be created that absorb most of the volatility in the underlying Mortgage Assets. These tranches tend to have market prices and yields that are much more volatile than the PAC classes. FNMA REMIC Certificates are issued and guaranteed as to timely distribution of principal and interest by FNMA. In addition, FNMA will be obligated to distribute on a timely basis to holders of FNMA REMIC Certificates required installments of principal and interest and to distribute the principal balance of each class of REMIC Certificates in full, whether or not sufficient funds are otherwise available. For FHLMC REMIC Certificates, FHLMC guarantees the timely payment of interest, and also guarantees the ultimate payment of principal as payments are required to be made on the underlying mortgage participation certificates ("Pcs"). Pcs represent undivided interests in specified level payment, residential mortgages or participations therein purchased by FHLMC and placed in a PC pool. With respect to principal payments on Pcs, FHLMC generally guarantees ultimate collection of all principal of the related mortgage loans without offset or deduction. FHLMC also guarantees timely payment of principal on certain Pcs, referred to as "Gold Pcs." U.S. GOVERNMENT OBLIGATIONS. The Balanced and Bond Portfolios (and, to the extent consistent with their investment objectives, the Money Market Portfolios) may purchase obligations issued or guaranteed by the U.S. Government and U.S. 9 Government agencies and instrumentalities. Obligations of certain agencies and instrumentalities of the U.S. Government are supported by the full faith and credit of the U.S. Treasury. Others are supported by the right of the issuer to borrow from the U.S. Treasury; and still others are supported only by the credit of the agency or instrumentality issuing the obligation. No assurance can be given that the U.S. Government will provide financial support to U.S. Government-sponsored instrumentalities if it is not obligated to do so by law. Certain U.S. Treasury and agency securities may be held by trusts that issue participation certificates (such as Treasury income growth receipts ("TIGRs") and certificates of accrual on Treasury certificates ("CATs")). The Balanced Portfolio may purchase these certificates, as well as Treasury receipts and other stripped securities, which represent beneficial ownership interests in either future interest payments or the future principal payments on U.S. Government obligations. These instruments are issued at a discount to their "face value" and may (particularly in the case of stripped mortgage-backed securities) exhibit greater price volatility than ordinary debt securities because of the manner in which their principal and interest are returned to investors. Examples of the types of U.S. Government obligations which the Portfolios may hold include U.S. Treasury bills, Treasury instruments and Treasury bonds and the obligations of Federal Home Loan Banks, Federal Farm Credit Banks, Federal Land Banks, the Federal Housing Administration, the Farmers Home Administration, the Export-Import Bank of the United States, the Small Business Administration, FNMA, GNMA, the General Services Administration, the Student Loan Marketing Association, the Central Bank for Cooperatives, FHLMC, the Federal Intermediate Credit Banks, the Maritime Administration, the International Bank for Reconstruction and Development (the "World Bank"), the Asian-American Development Bank and the Inter-American Development Bank. Each of the Equity Portfolios of the Fund does not intend to invest more than 5% of its net assets in U.S. Government obligations. The Index Master Portfolio may purchase (i) debt securities issued by the U.S. Treasury which are direct obligations of the U.S. Government, including bills, notes and bonds, and (ii) obligations issued or guaranteed by U.S. Government- sponsored instrumentalities and federal agencies, including FNMA, Federal Home Loan Bank and the Federal Housing Administration. SUPRANATIONAL ORGANIZATION OBLIGATIONS. The Portfolios may purchase debt securities of supranational organizations such as the European Coal and Steel Community, the European Economic Community and the World Bank, which are chartered to promote economic development. Each of the Equity Portfolios of the Fund does not intend to invest more than 5% of its net assets in supranational organization obligations. LEASE OBLIGATIONS. The Portfolios (other than the Index Master Portfolio) may hold participation certificates in a lease, an installment purchase contract, or a conditional sales contract ("lease obligations"). The Sub-Adviser will monitor the credit standing of each municipal borrower and each entity providing credit support and/or a put option relating to lease obligations. In determining whether a lease obligation is liquid, the Sub- Adviser will consider, among other factors, the following: (i) whether the lease can be cancelled; (ii) the degree of assurance that assets represented by the lease could be sold; (iii) the strength of the lessee's general credit (e.g., its debt, administrative, economic, and financial characteristics); (iv) the likelihood that the municipality would discontinue appropriating funding for the leased property because the property is no longer deemed essential to the operations of the municipality (e.g., the potential for an "event of nonappropriation"); (v) legal recourse in the event of failure to appropriate; (vi) whether the security is backed by a credit enhancement such as insurance; and (vii) any limitations which are imposed on the lease obligor's ability to utilize substitute property or services other than those covered by the lease obligation. The Municipal Money Market Portfolios will only invest in lease obligations with puts that (i) may be exercised at par on not more than seven days notice, and (ii) are issued by institutions deemed by the sub-adviser to present minimal credit risks. Such obligations will be considered liquid. However, a number of puts are not exercisable at the time the put would otherwise be exercised if the municipal borrower is not contractually obligated to make payments (e.g., an event of nonappropriation with a "nonappropriation" lease obligation). Under such circumstances, the lease obligation while previously considered liquid would become illiquid, and a Portfolio might lose its entire investment in such obligation. Municipal leases, like other municipal debt obligations, are subject to the risk of non-payment. The ability of issuers of municipal leases to make timely lease payments may be adversely impacted in general economic downturns and as relative governmental cost burdens are allocated and reallocated among federal, state and local governmental units. Such non-payment 10 would result in a reduction of income to a Portfolio, and could result in a reduction in the value of the municipal lease experiencing non-payment and a potential decrease in the net asset value of a Portfolio. Issuers of municipal securities might seek protection under the bankruptcy laws. In the event of bankruptcy of such an issuer, a Portfolio could experience delays and limitations with respect to the collection of principal and interest on such municipal leases and a Portfolio may not, in all circumstances, be able to collect all principal and interest to which it is entitled. To enforce its rights in the event of a default in lease payments, the Fund might take possession of and manage the assets securing the issuer's obligations on such securities, which may increase a Portfolio's operating expenses and adversely affect the net asset value of a Portfolio. When the lease contains a non- appropriation clause, however, the failure to pay would not be a default and a Portfolio would not have the right to take possession of the assets. Any income derived from a Portfolio's ownership or operation of such assets may not be tax- exempt. In addition, a Portfolio's intention to qualify as a "regulated investment company" under the Internal Revenue Code of 1986, as amended, may limit the extent to which a Portfolio may exercise its rights by taking possession of such assets, because as a regulated investment company a Portfolio is subject to certain limitations on its investments and on the nature of its income. COMMERCIAL PAPER. The Money Market Portfolios may purchase commercial paper rated in one of the two highest rating categories of a nationally recognized statistical rating organization ("NRSRO"). The Non-Money Market Portfolios, except the High Yield Bond Portfolio and the Index Master Portfolio, may purchase commercial paper rated (at the time of purchase) "A-1" by S&P or "Prime-1" by Moody's or, when deemed advisable by a Portfolio's adviser or sub- adviser, "high quality" issues rated "A-2" or "Prime-2" by S&P or Moody's, respectively. The High Yield Bond Portfolio may purchase commercial paper of any rating. The Index Master Portfolio may purchase commercial paper rated (at the time of purchase) "A-1" or better by S&P or "Prime-1" by Moody's, or, if not rated, issued by a corporation having an outstanding unsecured debt issue rated "Aaa" by Moody's or "AAA" by S&P, and having a maximum maturity of nine months. These ratings symbols are described in Appendix A. Commercial paper purchasable by each Portfolio includes "Section 4(2) paper," a term that includes debt obligations issued in reliance on the "private placement" exemption from registration afforded by Section 4(2) of the Securities Act of 1933. Section 4(2) paper is restricted as to disposition under the Federal securities laws, and is frequently sold (and resold) to institutional investors such as the Fund through or with the assistance of investment dealers who make a market in the Section 4(2) paper, thereby providing liquidity. Certain transactions in Section 4(2) paper may qualify for the registration exemption provided in Rule 144A under the Securities Act of 1933. Each of the Equity Portfolios of the Fund does not intend to invest more than 5% of its net assets in commercial paper. REPURCHASE AGREEMENTS. Each Equity and Bond Portfolio may agree to purchase securities from financial institutions subject to the seller's agreement to repurchase them at an agreed upon time and price ("repurchase agreements"). Repurchase agreements are, in substance, loans. Default by or bankruptcy of a seller would expose a Portfolio to possible loss because of adverse market action, expenses and/or delays in connection with the disposition of the underlying obligations. Each Money Market Portfolio may enter into repurchase agreements. The securities held subject to a repurchase agreement by a Money Market Portfolio may have stated maturities exceeding 13 months, so long as the repurchase agreement itself matures in less than 13 months. The repurchase price under the repurchase agreements generally equals the price paid by a Portfolio involved plus interest negotiated on the basis of current short-term rates (which may be more or less than the rate on securities underlying the repurchase agreement). The financial institutions with which a Portfolio may enter into repurchase agreements will be banks and non-bank dealers of U.S. Government securities that are listed on the Federal Reserve Bank of New York's list of reporting dealers, if such banks and non-bank dealers are deemed creditworthy by the Portfolio's adviser or sub-adviser. A Portfolio's adviser or sub-adviser will continue to monitor creditworthiness of the seller under a repurchase agreement, and will require the seller to maintain during the term of the agreement the value of the securities subject to the agreement to equal at least the repurchase price (including accrued interest). In addition, the Portfolio's adviser or sub-adviser will require that the value of this collateral, after transaction costs (including loss of interest) reasonably expected to be incurred on a default, be equal to or greater than the repurchase price (including accrued premium) provided in the repurchase agreement. The accrued premium is the amount specified in the repurchase agreement or the daily amortization of the difference between the purchase price and the repurchase price specified in the repurchase agreement. The Portfolio's adviser or sub- adviser will mark-to-market daily the value of the securities. Securities subject to repurchase agreements will be held by the Fund's custodian (or sub- custodian) in the 11 Federal Reserve/Treasury book-entry system or by another authorized securities depository. Repurchase agreements are considered to be loans by the Portfolios under the 1940 Act. The use of repurchase agreements involves certain risks. For example, if the seller of securities under a repurchase agreement defaults on its obligation to repurchase the underlying securities, as a result of its bankruptcy or otherwise, a Portfolio will seek to dispose of such securities, which action could involve costs or delays. If the seller becomes insolvent and subject to liquidation or reorganization under applicable bankruptcy or other laws, a Portfolio's ability to dispose of the underlying securities may be restricted. Finally, it is possible that a Portfolio may not be able to substantiate its interest in the underlying securities. To minimize this risk, the securities underlying the repurchase agreement will be held by the custodian at all times in an amount at least equal to the repurchase price, including accrued interest. If the seller fails to repurchase the securities, a Portfolio may suffer a loss to the extent proceeds from the sale of the underlying securities are less than the repurchase price. The Index Master Portfolio may enter into repurchase agreements, but will not enter into a repurchase agreement with a duration of more than seven days if, as a result, more than 10% of the value of its total assets would be so invested. The Index Master Portfolio will also only invest in repurchase agreements with a bank if the bank has at least $1 billion in assets and is approved by the Investment Committee of Dimensional Fund Advisors Inc, ("DFA"). DFA will monitor the market value of transferred securities plus any accrued interest thereon so that the value of such securities will at least equal the repurchase price. The securities underlying the repurchase agreements will be limited to U.S. Government and agency obligations described under "U.S. Government Obligations" above. INVESTMENT GRADE DEBT OBLIGATIONS. Each of the Money Market Portfolios may invest in securities in the two highest rating categories of NRSROs. The Non- Money Market Portfolios, except the Index Master Portfolio and the Intermediate Government Bond, Government Income and GNMA Portfolios, may invest in "investment grade securities," which are securities rated in the four highest rating categories of an NRSRO. The Intermediate Government Bond, Government Income and GNMA Portfolios may invest in debt securities rated Aaa by Moody's or AAA by S&P. It should be noted that debt obligations rated in the lowest of the top four ratings (i.e., "Baa" by Moody's or "BBB" by S&P) are considered to have some speculative characteristics and are more sensitive to economic change than higher rated securities. The Index Master Portfolio may invest in non-convertible corporate debt securities which are issued by companies whose commercial paper is rated "Prime- 1" by Moody's or "A-1" by S&P and dollar-denominated obligations of foreign issuers issued in the U.S. If the issuer's commercial paper is unrated, then the debt security would have to be rated at least "AA" by S&P or "Aa2" by Moody's. If there is neither a commercial paper rating nor a rating of the debt security, then the Index Master Portfolio's investment adviser must determine that the debt security is of comparable quality to equivalent issues of the same issuer rated at least "AA" or "Aa2." See Appendix A to this Statement of Additional Information for a description of applicable securities ratings. NON-INVESTMENT GRADE SECURITIES. Each of the High Yield Bond and Low Duration Bond Portfolios may invest in non-investment grade or "high yield" fixed income or convertible securities commonly known to investors as "junk bonds." High yield securities are bonds that are issued by a company whose credit rating (based on rating agencies' evaluation of the likelihood of repayment) necessitates offering a higher coupon and yield on its issues when selling them to investors who may otherwise be hesitant in purchasing the debt of such a company. While generally providing greater income and opportunity for gain, non- investment grade debt securities may be subject to greater risks than securities which have higher credit ratings, including a high risk of default, and their yields will fluctuate over time. High yield securities will generally be in the lower rating categories of recognized rating agencies (rated "Ba" or lower by Moody's or "BB" or lower by S&P) or will be non-rated. The credit rating of a high yield security does not necessarily address its market value risk, and ratings may from time to time change, positively or negatively, to reflect developments regarding the issuer's financial condition. High yield securities are considered to be speculative with respect to the capacity of the issuer to timely repay principal and pay interest or dividends in accordance with the terms of the obligation and may have more credit risk than higher rated securities. While the market values of high yield securities tend to react less to fluctuations in interest rates than do those of higher rated securities, the values of high yield securities often reflect individual corporate developments and have a high sensitivity to economic changes to a greater extent than do higher rated securities. Issuers of high yield securities are often in the growth stage 12 of their development and/or involved in a reorganization or takeover. The companies are often highly leveraged (have a significant amount of debt relative to shareholders' equity) and may not have available to them more traditional financing methods, thereby increasing the risk associated with acquiring these types of securities. In some cases, obligations with respect to high yield securities are subordinated to the prior repayment of senior indebtedness, which will potentially limit a Portfolio's ability to fully recover principal or to receive interest payments when senior securities are in default. Thus, investors in high yield securities have a lower degree of protection with respect to principal and interest payments then do investors in higher rated securities. During an economic downturn, a substantial period of rising interest rates or a recession, highly leveraged issuers of high yield securities may experience financial distress possibly resulting in insufficient revenues to meet their principal and interest payment obligations, to meet projected business goals and to obtain additional financing. An economic downturn could also disrupt the market for lower-rated securities and adversely affect the value of outstanding securities, the Portfolio's net asset value and the ability of the issuers to repay principal and interest. If the issuer of a security held by a Portfolio defaulted, the Portfolio may not receive full interest and principal payments due to it and could incur additional expenses if it chose to seek recovery of its investment. The secondary markets for high yield securities are not as liquid as the secondary markets for higher rated securities. The secondary markets for high yield securities are concentrated in relatively few market makers and participants in the markets are mostly institutional investors, including insurance companies, banks, other financial institutions and mutual funds. In addition, the trading volume for high yield securities is generally lower than that for higher rated securities and the secondary markets could contract under adverse market or economic conditions independent of any specific adverse changes in the condition of a particular issuer. Under certain economic and/or market conditions, a Portfolio may have difficulty disposing of certain high yield securities due to the limited number of investors in that sector of the market. An illiquid secondary market may adversely affect the market price of the high yield security, which may result in increased difficulty selling the particular issue and obtaining accurate market quotations on the issue when valuing a Portfolio's assets. Market quotations on high yield securities are available only from a limited number of dealers, and such quotations may not be the actual prices available for a purchase or sale. The high yield markets may react strongly to adverse news about an issuer or the economy, or to the perception or expectation of adverse news, whether or not it is based on fundamental analysis. Additionally, prices for high yield securities may be affected by legislative and regulatory developments. These developments could adversely affect a Portfolio's net asset value and investment practices, the secondary market for high yield securities, the financial condition of issuers of these securities and the value and liquidity of outstanding high yield securities, especially in a thinly traded market. For example, federal legislation requiring the divestiture by federally insured savings and loan associations of their investments in high yield bonds and limiting the deductibility of interest by certain corporate issuers of high yield bonds adversely affected the market in recent years. When the secondary market for high yield securities becomes more illiquid, or in the absence of readily available market quotations for such securities, the relative lack of reliable objective data makes it more difficult to value a Portfolio's securities, and judgment plays a more important role in determining such valuations. Increased illiquidity in the junk bond market, in combination with the relative youth and growth of the market for such securities, also may affect the ability of a Portfolio to dispose of such securities at a desirable price. Additionally, if the secondary markets for high yield securities contract due to adverse economic conditions or for other reasons, certain of a Portfolio's liquid securities may become illiquid and the proportion of the Portfolio's assets invested in illiquid securities may significantly increase. The rating assigned by a rating agency evaluates the safety of a non- investment grade security's principal and interest payments, but does not address market value risk. Because such ratings of the ratings agencies may not always reflect current conditions and events, in addition to using recognized rating agencies and other sources, the sub-adviser performs its own analysis of the issuers whose non-investment grade securities the Portfolio holds. Because of this, the Portfolio's performance may depend more on the sub-adviser's own credit analysis than in the case of mutual funds investing in higher-rated securities. For a description of these ratings, see Appendix A. In selecting non-investment grade securities, the sub-adviser considers factors such as those relating to the creditworthiness of issuers, the ratings and performance of the securities, the protections afforded the securities and the diversity of the Portfolio. The sub-adviser continuously monitors the issuers of non-investment grade securities held by the Portfolio for their ability to 13 make required principal and interest payments, as well as in an effort to control the liquidity of the Portfolio so that it can meet redemption requests. If a security's rating is reduced below the minimum credit rating that is permitted for a Portfolio, the Portfolio's sub-adviser will consider whether the Portfolio should continue to hold the security. In the event that a Portfolio investing in high yield securities experiences an unexpected level of net redemptions, the Portfolio could be forced to sell its holdings without regard to the investment merits, thereby decreasing the assets upon which the Portfolio's rate of return is based. The costs attributable to investing in the high yield markets are usually higher for several reasons, such as higher investment research costs and higher commission costs. The High Yield Bond Portfolio may invest in securities rated in the category "C" and above or determined by the sub-adviser to be of comparable quality. Securities rated "C" are considered highly speculative and may be used to cover a situation where the issuer has filed a bankruptcy petition but debt service payments are continued. While such debt will likely have some quality and protective characteristics, those are outweighed by large uncertainties or major risk exposure to adverse conditions. MEZZANINE INVESTMENTS. The High Yield Bond Portfolio may invest in certain high yield securities known as mezzanine investments, which are subordinated debt securities which are generally issued in private placements in connection with an equity security (e.g., with attached warrants). Such mezzanine investments may be issued with or without registration rights. Similar to other high yield securities, maturities of mezzanine investments are typically seven to ten years, but the expected average life is significantly shorter at three to five years. Mezzanine investments are usually unsecured and subordinate to other obligations of the issuer. COLLATERALIZED BOND OBLIGATIONS. The High Yield Bond Portfolio may invest in collateralized bond obligations ("CBOs"), which are structured products backed by a diversified pool of high yield public or private fixed income securities. The pool of high yield securities is typically separated into tranches representing different degrees of credit quality. The top tranche of CBOs, which represents the highest credit quality in the pool, has the greatest collateralization and pays the lowest interest rate. Lower CBO tranches represent lower degrees of credit quality and pay higher interest rates to compensate for the attendant risks. The bottom tranche specifically receives the residual interest payments (i.e., money that is left over after the higher tiers have been paid) rather than a fixed interest rate. The return on the bottom tranche of CBOs is especially sensitive to the rate of defaults in the collateral pool. WHEN-ISSUED PURCHASES AND FORWARD COMMITMENTS. Each Portfolio (other than the Index Master Portfolio) may purchase securities on a "when-issued" basis and may purchase or sell securities on a "forward commitment," including "TBA" (to be announced) basis. These transactions involve a commitment by a Portfolio to purchase or sell particular securities with payment and delivery taking place at a future date (perhaps one or two months later), and permit a Portfolio to lock in a price or yield on a security it owns or intends to purchase, regardless of future changes in interest rates or market action. When-issued and forward commitment transactions involve the risk, however, that the price or yield obtained in a transaction may be less favorable than the price or yield available in the market when the securities delivery takes place. When a Portfolio agrees to purchase securities on this basis, the custodian will set aside liquid assets equal to the amount of the commitment in a separate account. Normally, the custodian will set aside portfolio securities to satisfy a purchase commitment, and in such a case the Portfolio may be required subsequently to place additional assets in the separate account in order to ensure that the value of the account remains equal to the amount of the Portfolio's commitments. It may be expected that the market value of a Portfolio's net assets will fluctuate to a greater degree when it sets aside portfolio securities to cover such purchase commitments than when it sets aside cash. Because a Portfolio's liquidity and ability to manage its portfolio might be affected when it sets aside cash or portfolio securities to cover such purchase commitments, each Portfolio expects that its forward commitments and commitments to purchase when-issued or TBA securities will not exceed 25% of the value of its total assets absent unusual market conditions. If deemed advisable as a matter of investment strategy, a Portfolio may dispose of or renegotiate a commitment after it has been entered into, and may sell securities it has committed to purchase before those securities are delivered to the Portfolio on the settlement date. In these cases the Portfolio may realize a taxable capital gain or loss. 14 When a Portfolio engages in when-issued, TBA or forward commitment transactions, it relies on the other party to consummate the trade. Failure of such party to do so may result in the Portfolio's incurring a loss or missing an opportunity to obtain a price considered to be advantageous. The market value of the securities underlying a commitment to purchase securities, and any subsequent fluctuations in their market value, is taken into account when determining the market value of a Portfolio starting on the day the Portfolio agrees to purchase the securities. The Portfolio does not earn interest on the securities it has committed to purchase until they are paid for and delivered on the settlement date. RIGHTS OFFERINGS AND WARRANTS TO PURCHASE. Each Equity Portfolio (except the Index Master Portfolio, which may only acquire warrants as a result of corporate actions involving its holdings of other equity securities) and the High Yield Bond Portfolio (in connection with its purchase of mezzanine investments) may participate in rights offerings and may purchase warrants, which are privileges issued by corporations enabling the owners to subscribe to and purchase a specified number of shares of the corporation at a specified price during a specified period of time. Subscription rights normally have a short life span to expiration. The purchase of rights or warrants involves the risk that a Portfolio could lose the purchase value of a right or warrant if the right to subscribe to additional shares is not exercised prior to the rights' and warrants' expiration. Also, the purchase of rights and/or warrants involves the risk that the effective price paid for the right and/or warrant added to the subscription price of the related security may exceed the value of the subscribed security's market price such as when there is no movement in the level of the underlying security. A Portfolio will not invest more than 5% of its net assets, taken at market value, in warrants, or more than 2% of its net assets, taken at market value, in warrants not listed on the New York or American Stock Exchanges. Warrants acquired by a Portfolio in units or attached to other securities are not subject to this restriction. FOREIGN INVESTMENTS. Investing in foreign securities involves considerations not typically associated with investing in securities of companies organized and operated in the United States. Because foreign securities generally are denominated and pay dividends or interest in foreign currencies, the value of a Portfolio that invests in foreign securities as measured in U.S. dollars will be affected favorably or unfavorably by changes in exchange rates. A Portfolio's investments in foreign securities may also be adversely affected by changes in foreign political or social conditions, diplomatic relations, confiscatory taxation, expropriation, limitation on the removal of funds or assets, or imposition of (or change in) exchange control regulations. In addition, changes in government administrations or economic or monetary policies in the U.S. or abroad could result in appreciation or depreciation of portfolio securities and could favorably or adversely affect a Portfolio's operations. In general, less information is publicly available with respect to foreign issuers than is available with respect to U.S. companies. Most foreign companies are also not subject to the uniform accounting and financial reporting requirements applicable to issuers in the United States. While the volume of transactions effected on foreign stock exchanges has increased in recent years, it remains appreciably below that of the New York Stock Exchange. Accordingly, a Portfolio's foreign investments may be less liquid and their prices may be more volatile than comparable investments in securities in U.S. companies. In addition, there is generally less government supervision and regulation of securities exchanges, brokers and issuers in foreign countries than in the United States. The International Bond Portfolio will invest primarily, and the High Yield Bond Portfolio may invest, in debt securities of foreign issuers and foreign currencies. Each of the Managed Income and Core Bond Portfolios may invest up to 10% of its total assets and the Low Duration Bond Portfolio may invest up to 20% of its total assets in debt securities of foreign issuers. These investments may be on either a currency hedged or unhedged basis, and may hold from time to time various foreign currencies pending investment or conversion into U.S. dollars. Some of these instruments may have the characteristics of futures contracts. In addition, each Bond Portfolio may engage in foreign currency exchange transactions to seek to protect against changes in the level of future exchange rates which would adversely affect the Portfolio's performance. These investments and transactions involving foreign securities, currencies, options (including options that relate to foreign currencies), futures, hedging and cross-hedging are described below and under "Interest Rate and Currency Transactions" and "Options and Futures Contracts." To maintain greater flexibility, a Bond Portfolio may invest in instruments which have the characteristics of futures contracts. These instruments may take a variety of forms, such as debt securities with interest or principal payments determined by reference 15 to the value of a currency or commodity at a future point in time. The risks of such investments could reflect the risks of investing in futures, currencies and securities, including volatility and illiquidity. Foreign investments of the Bond Portfolios may include: (a) debt obligations issued or guaranteed by foreign sovereign governments or their agencies, authorities, instrumentalities or political subdivisions, including a foreign state, province or municipality; (b) debt obligations of supranational organizations such as the World Bank, Asian Development Bank, European Investment Bank, and European Economic Community; (c) debt obligations of foreign banks and bank holding companies; (d) debt obligations of domestic banks and corporations issued in foreign currencies; (e) debt obligations denominated in the European Currency Unit (ECU); and (f) foreign corporate debt securities and commercial paper. Such securities may include loan participations and assignments, convertible securities and zero-coupon securities. The International Emerging Markets Portfolio will invest its assets in countries with emerging economies or securities markets. The High Yield Bond Portfolio may invest up to 10% of its total assets in securities of emerging markets issuers, although typically it will not hold any of these investments. The International Bond Portfolio may also invest in emerging markets issuers. Political and economic structures in many of these countries may be undergoing significant evolution and rapid development, and these countries may lack the social, political and economic stability characteristic of more developed countries. Some of these countries may have in the past failed to recognize private property rights and have at times nationalized or expropriated the assets of private companies. As a result the risks described above, including the risks of nationalization or expropriation of assets, may be heightened. In addition, unanticipated political or social developments may affect the value of investments in these countries and the availability to a Portfolio of additional investments in emerging market countries. The small size and inexperience of the securities markets in certain of these countries and the limited volume of trading in securities in these countries may make investments in the countries illiquid and more volatile than investments in Japan or most Western European countries. There may be little financial or accounting information available with respect to issuers located in certain emerging market countries, and it may be difficult to assess the value or prospects of an investment in such issuers. The expense ratios of the Portfolios investing significantly in foreign securities can be expected to be higher than those of Portfolios investing primarily in domestic securities. The costs attributable to investing abroad are usually higher for several reasons, such as the higher cost of investment research, higher cost of custody of foreign securities, higher commissions paid on comparable transactions on foreign markets and additional costs arising from delays in settlements of transactions involving foreign securities. BRADY BONDS. The High Yield Bond Portfolio's emerging market debt securities may include emerging market governmental debt obligations commonly referred to as Brady Bonds. Brady Bonds are debt securities, generally denominated in U.S. dollars, issued under the framework of the Brady Plan, an initiative announced by U.S. Treasury Secretary Nicholas F. Brady in 1989 as a mechanism for debtor nations (primarily emerging market countries) to restructure their outstanding external indebtedness (generally, commercial bank debt). Brady Bonds are created through the exchange of existing commercial bank loans to foreign entities for new obligations in connection with debt restructuring. A significant amount of the Brady Bonds that the High Yield Bond Portfolio may purchase have no or limited collateralization, and the High Yield Bond Portfolio will be relying for payment of interest and (except in the case of principal collateralized Brady Bonds) principal primarily on the willingness and ability of the foreign government to make payment in accordance with the terms of the Brady Bonds. A substantial portion of the Brady Bonds and other sovereign debt securities in which the Portfolio may invest are likely to be acquired at a discount. ADRS, EDRS AND GDRS. Each Equity Portfolio (other than the Index Master Portfolio) may invest in both sponsored and unsponsored American Depository Receipts ("ADRs"), European Depository Receipts ("EDRs"), Global Depository Receipts ("GDRs") and other similar global instruments. ADRs typically are issued by an American bank or trust company and evidence ownership of underlying securities issued by a foreign corporation. EDRs, which are sometimes referred to as Continental Depository Receipts, are receipts issued in Europe, typically by foreign banks and trust companies, that evidence ownership of either foreign or domestic underlying securities. GDRs are depository receipts structured like global debt issues to facilitate trading on an international basis. Unsponsored ADR, EDR and GDR programs are organized independently and without the cooperation of the issuer of the underlying securities. As a result, available information concerning the issuer may not be as current as for sponsored ADRs, EDRs and GDRs, and the prices of unsponsored ADRs, EDRs and GDRs may be more volatile than if such instruments were sponsored by the issuer. Investments in ADRs, EDRs and GDRs present additional investment considerations as described under "Foreign Investments." 16 THE EURO. On January 1, 1999, 11 European countries implemented a new currency unit, the Euro, which is expected to reshape financial markets, banking systems and monetary policies in Europe and other parts of the world. The countries that initially converted or tied their currencies to the Euro are Austria, Belgium, France, Germany, Luxembourg, the Netherlands, Ireland, Finland, Italy, Portugal and Spain. Implementation of this plan means that financial transactions and market information, including share quotations and company accounts, in participating countries will be denominated in Euros. Participating governments will issue their bonds in Euros, and monetary policy for participating countries will be uniformly managed by a new central bank, the European Central Bank. Although it is not possible to predict the impact of the Euro implementation plan on the Portfolios, the transition to the Euro may change the economic environments and behavior of investors, particularly in European markets. For example, investors may begin to view those countries using the Euro as a single entity, and the Portfolios' sub-advisers may need to adapt its investment strategy accordingly. The process of implementing the Euro also may adversely affect financial markets world-wide and may result in changes in the relative strength and value of the U.S. dollar or other major currencies, as well as possible adverse tax consequences. The transition to the Euro is likely to have a significant impact on fiscal and monetary policy in the participating countries and may produce unpredictable effects on trade and commerce generally. These resulting uncertainties could create increased volatility in financial markets world-wide. OPTIONS AND FUTURES CONTRACTS. To the extent consistent with its investment objective, each Equity and Bond Portfolio (other than the Index Master Portfolio) may write (i.e. sell) covered call options, buy put options, buy call options and write secured put options for the purpose of hedging or earning additional income, which may be deemed speculative or, with respect to the International Bond, International Equity, International Emerging Markets and International Small Cap Equity Portfolios, cross-hedging. For the payment of a premium, the purchaser of an option obtains the right to buy (in the case of a call option) or to sell (in the case of a put option) the item which is the subject of the option at a stated exercise price for a specific period of time. These options may relate to particular securities, securities indices, or the yield differential between two securities, or, in the case of the International Bond, International Equity, International Emerging Markets and International Small Cap Equity Portfolios, foreign currencies, and may or may not be listed on a securities exchange and may or may not be issued by the Options Clearing Corporation. A Portfolio will not purchase put and call options when the aggregate premiums on outstanding options exceed 5% of its net assets at the time of purchase, and will not write options on more than 25% of the value of its net assets (measured at the time an option is written). Options trading is a highly specialized activity that entails greater than ordinary investment risks. In addition, unlisted options are not subject to the protections afforded purchasers of listed options issued by the Options Clearing Corporation, which performs the obligations of its members if they default. To the extent consistent with its investment objective, each Equity and Bond Portfolio may also invest in futures contracts and options on futures contracts (interest rate futures contracts or index futures contracts, as applicable) to commit funds awaiting investment or maintain cash liquidity or, except with respect to the Index Master Portfolio, for other hedging purposes. These instruments are described in Appendix B to this Statement of Additional Information. The value of a Portfolio's contracts may equal or exceed 100% of its total assets, although a Portfolio will not purchase or sell a futures contract unless immediately afterwards the aggregate amount of margin deposits on its existing futures positions plus the amount of premiums paid for related futures options entered into for other than bona fide hedging purposes is 5% or less of its net assets. To maintain greater flexibility, the High Yield Bond Portfolio may invest in instruments which have the characteristics of futures contracts. These instruments may take a variety of forms, such as debt securities with interest or principal payments determined by reference to the value of a commodity at a future point in time. The risks of such investments could reflect the risks of investing in futures and securities, including volatility and illiquidity. Futures contracts obligate a Portfolio, at maturity, to take or make delivery of securities, the cash value of a securities index or a stated quantity of a foreign currency. A Portfolio may sell a futures contract in order to offset an expected decrease in the value of its portfolio positions that might otherwise result from a market decline or currency exchange fluctuation. A Portfolio may do so either to hedge the value of its securities portfolio as a whole, or to protect against declines occurring prior to sales of securities in the value of the securities to be sold. In addition, a Portfolio may utilize futures contracts in anticipation of changes in the composition of its holdings or in currency exchange rates. 17 A Portfolio may purchase and sell call and put options on futures contracts traded on an exchange or board of trade. When a Portfolio purchases an option on a futures contract, it has the right to assume a position as a purchaser or a seller of a futures contract at a specified exercise price during the option period. When a Portfolio sells an option on a futures contract, it becomes obligated to sell or buy a futures contract if the option is exercised. In connection with a Portfolio's position in a futures contract or related option, the Fund will create a segregated account of liquid assets or will otherwise cover its position in accordance with applicable SEC requirements. The primary risks associated with the use of futures contracts and options are (a) the imperfect correlation between the change in market value of the instruments held by a Portfolio and the price of the futures contract or option; (b) possible lack of a liquid secondary market for a futures contract and the resulting inability to close a futures contract when desired; (c) losses caused by unanticipated market movements, which are potentially unlimited; (d) the sub- adviser's inability to predict correctly the direction of securities prices, interest rates, currency exchange rates and other economic factors; and (e) the possibility that the counterparty will default in the performance of its obligations. The Fund intends to comply with the regulations of the Commodity Futures Trading Commission exempting the Portfolios from registration as a "commodity pool operator." Options trading is a highly specialized activity which entails greater than ordinary investment risks. Options on particular securities may be more volatile than the underlying securities, and therefore, on a percentage basis, an investment in the underlying securities themselves. A Portfolio will write call options only if they are "covered." In the case of a call option on a security, the option is "covered" if a Portfolio owns the security underlying the call or has an absolute and immediate right to acquire that security without additional cash consideration (or, if additional cash consideration is required, liquid assets in such amount as are held in a segregated account by its custodian) upon conversion or exchange of other securities held by it. For a call option on an index, the option is covered if a Portfolio maintains with its custodian liquid assets equal to the contract value. A call option is also covered if a Portfolio holds a call on the same security or index as the call written where the exercise price of the call held is (i) equal to or less than the exercise price of the call written, or (ii) greater than the exercise price of the call written provided the difference is maintained by the Portfolio in liquid assets in a segregated account with its custodian. When a Portfolio purchases a put option, the premium paid by it is recorded as an asset of the Portfolio. When a Portfolio writes an option, an amount equal to the net premium (the premium less the commission) received by the Portfolio is included in the liability section of the Portfolio's statement of assets and liabilities as a deferred credit. The amount of this asset or deferred credit will be subsequently marked-to-market to reflect the current value of the option purchased or written. The current value of the traded option is the last sale price or, in the absence of a sale, the mean between the last bid and asked prices. If an option purchased by a Portfolio expires unexercised the Portfolio realizes a loss equal to the premium paid. If the Portfolio enters into a closing sale transaction on an option purchased by it, the Portfolio will realize a gain if the premium received by the Portfolio on the closing transaction is more than the premium paid to purchase the option, or a loss if it is less. If an option written by a Portfolio expires on the stipulated expiration date or if the Portfolio enters into a closing purchase transaction, it will realize a gain (or loss if the cost of a closing purchase transaction exceeds the net premium received when the option is sold) and the deferred credit related to such option will be eliminated. If an option written by a Portfolio is exercised, the proceeds of the sale will be increased by the net premium originally received and the Portfolio will realize a gain or loss. There are several risks associated with transactions in options on securities and indexes. For example, there are significant differences between the securities and options markets that could result in an imperfect correlation between these markets, causing a given transaction not to achieve its objectives. In addition, a liquid secondary market for particular options, whether traded over-the-counter or on a national securities exchange ("Exchange") may be absent for reasons which include the following: there may be insufficient trading interest in certain options; restrictions may be imposed by an Exchange on opening transactions or closing transactions or both; trading halts, suspensions or other restrictions may be imposed with respect to particular classes or series of options or underlying securities; unusual or unforeseen circumstances may interrupt normal operations on an Exchange; the facilities of an Exchange or the Options Clearing Corporation may not at all times be adequate to handle current trading volume; or 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 on that Exchange (or in that class or series of options) would cease to exist, although outstanding options that had been issued by the 18 Options Clearing Corporation as a result of trades on that Exchange would continue to be exercisable in accordance with their terms. INTEREST RATE TRANSACTIONS AND CURRENCY SWAPS. The Balanced and Bond Portfolios may enter into interest rate swaps and may purchase or sell interest rate caps and floors. The Portfolios may enter into these transactions primarily to preserve a return or spread on a particular investment or portion of their holdings, as a duration management technique or to protect against an increase in the price of securities a Portfolio anticipates purchasing at a later date. The Portfolios intend to use these transactions as a hedge and not as a speculative investment. In addition, the International Bond Portfolio may engage in foreign currency exchange transactions to protect against uncertainty in the level of future exchange rates. The Portfolio may engage in foreign currency exchange transactions in connection with the purchase and sale of portfolio securities (transaction hedging) and to protect the value of specific portfolio positions (position hedging). The Portfolio may purchase or sell a foreign currency on a spot (or cash) basis at the prevailing spot rate in connection with the settlement of transactions in portfolio securities denominated in that foreign currency, and may also enter into contracts to purchase or sell foreign currencies at a future date ("forward contracts") and purchase and sell foreign currency futures contracts (futures contracts). The Portfolio may also purchase exchange-listed and over-the-counter call and put options on futures contracts and on foreign currencies, and may write covered call options on up to 100% of the currencies in its portfolio. In order to protect against currency fluctuations, the International Bond Portfolio may enter into currency swaps. Currency swaps involve the exchange of the rights of the Portfolio and another party to make or receive payments in specified currencies. The Bond and Balanced Portfolios may enter into interest rate swaps, caps and floors on either an asset-based or liability-based basis, depending on whether a Portfolio is hedging its assets or its liabilities. Interest rate swaps involve the exchange by a Portfolio with another party of their respective commitments to pay or receive interest (e.g., an exchange of floating rate payments for fixed rate payments). The purchase of an interest rate floor entitles the purchaser, to the extent that a specified index falls below a predetermined interest rate, to receive payments of interest on a notional principal amount from the party selling such interest rate floor. The purchase of an interest rate cap entitles the purchaser, to the extent that a specified index exceeds a predetermined interest rate, to receive payments of interest on a notional principal amount from the party selling such interest rate cap. The International Bond Portfolio may also enter into currency swaps, which involve the exchange of the rights of a Portfolio and another party to make or receive payments in specified currencies. A Portfolio will usually enter into interest rate swaps on a net basis, i.e., the two payment streams are netted out, with the Portfolio receiving or paying, as the case may be, only the net amount of the two payments. In contrast, currency swaps usually involve the delivery of the entire principal value of one designated currency in exchange for the other designated currency. A Portfolio will accrue the net amount of the excess, if any, of its obligations over its entitlements with respect to each interest rate or currency swap on a daily basis and will deliver an amount of liquid assets having an aggregate net asset value at least equal to the accrued excess to a custodian that satisfies the requirements of the 1940 Act. If the other party to an interest rate swap defaults, a Portfolio's risk of loss consists of the net amount of interest payments that the Portfolio is contractually entitled to receive. Because currency swaps usually involve the delivery of the entire principal value of one designated currency in exchange for the other designated currency, the entire principal value of a currency swap is subject to the risk that the other party to the swap will default on its contractual delivery obligations. A Portfolio will not enter into any interest rate or currency swap unless the unsecured commercial paper, senior debt or claims paying ability of the other party is rated either "A" or "A-1" or better by S&P, Duff & Phelps or Fitch, or "A" or "P-1" or better by Moody's. A Portfolio will enter into currency or interest rate swap, cap and floor transactions only with institutions deemed the creditworthy by the Portfolio's adviser or sub-adviser. If there is a default by the other party to such a transaction, a Portfolio will have contractual remedies pursuant to the agreements related to the transaction. The swap market has grown substantially in recent years with a large number of banks and investment banking firms acting both as principals and as agents utilizing standardized swap documentation. As a result, the swap market has become relatively liquid. Caps and floors are more recent innovations and, accordingly, they are less liquid than swaps. 19 FOREIGN CURRENCY TRANSACTIONS. Forward foreign currency exchange contracts involve an obligation to purchase or sell a specified currency at a future date at a price set at the time of the contract. Forward currency contracts do not eliminate fluctuations in the values of portfolio securities but rather allow a Portfolio to establish a rate of exchange for a future point in time. A Portfolio may use forward foreign currency exchange contracts to hedge against movements in the value of foreign currencies (including the "ECU" used in the European Community) relative to the U.S. dollar in connection with specific portfolio transactions or with respect to portfolio positions. A Portfolio may enter into forward foreign currency exchange contracts when deemed advisable by its adviser or sub-adviser under two circumstances. First, when entering into a contract for the purchase or sale of a security, a Portfolio may enter into a forward foreign currency exchange contract for the amount of the purchase or sale price to protect against variations, between the date the security is purchased or sold and the date on which payment is made or received, in the value of the foreign currency relative to the U.S. dollar or other foreign currency. Second, when a Portfolio's adviser or sub-adviser anticipates that a particular foreign currency may decline relative to the U.S. dollar or other leading currencies, in order to reduce risk, the Portfolio may enter into a forward contract to sell, for a fixed amount, the amount of foreign currency approximating the value of some or all of the Portfolio's securities denominated in such foreign currency. With respect to any forward foreign currency contract, it will not generally be possible to match precisely the amount covered by that contract and the value of the securities involved due to the changes in the values of such securities resulting from market movements between the date the forward contract is entered into and the date it matures. In addition, while forward contracts may offer protection from losses resulting from declines in the value of a particular foreign currency, they also limit potential gains which might result from increases in the value of such currency. A Portfolio will also incur costs in connection with forward foreign currency exchange contracts and conversions of foreign currencies and U.S. dollars. A Portfolio may also engage in proxy hedging transactions to reduce the effect of currency fluctuations on the value of existing or anticipated holdings of portfolio securities. Proxy hedging is often used when the currency to which the Portfolio is exposed is difficult to hedge or to hedge against the dollar. Proxy hedging entails entering into a forward contract to sell a currency whose changes in value are generally considered to be linked to a currency or currencies in which some or all of the Portfolio's securities are, or are expected to be, denominated, and to buy U.S. dollars. Proxy hedging involves some of the same risks and considerations as other transactions with similar instruments. Currency transactions can result in losses to the Portfolio if the currency being hedged fluctuates in value to a degree or in a direction that is not anticipated. In addition, there is the risk that the perceived linkage between various currencies may not be present or may not be present during the particular time that a Portfolio is engaging in proxy hedging. A Portfolio may also cross-hedge currencies by entering into forward contracts to sell one or more currencies that are expected to decline in value relative to other currencies to which the Portfolio has or in which the Portfolio expects to have portfolio exposure. For example, a Portfolio may hold both French government bonds and German government bonds, and the Adviser or Sub-Adviser may believe that French francs will deteriorate against German marks. The Portfolio would sell French francs to reduce its exposure to that currency and buy German marks. This strategy would be a hedge against a decline in the value of French francs, although it would expose the Portfolio to declines in the value of the German mark relative to the U.S. dollar. In general, currency transactions are subject to risks different from those of other portfolio transactions, and can result in greater losses to a Portfolio than would otherwise be incurred, even when the currency transactions are used for hedging purposes. A separate account of a Portfolio consisting of liquid assets equal to the amount of the Portfolio's assets that could be required to consummate forward contracts entered into under the second circumstance, as set forth above, will be established with the Fund's custodian. For the purpose of determining the adequacy of the securities in the account, the deposited securities will be valued at market or fair value. If the market or fair value of such securities declines, additional cash or securities will be placed in the account daily so that the value of the account will equal the amount of such commitments by the Portfolio. STAND-BY COMMITMENTS. Under a stand-by commitment for a Municipal Obligation, a dealer agrees to purchase at the Portfolio's option a specified Municipal Obligation at a specified price. Stand-by commitments for Municipal Obligations may be exercisable by a Portfolio at any time before the maturity of the underlying Municipal Obligations and may be sold, transferred or assigned only with the instruments involved. It is expected that such stand-by commitments will generally be available without the payment of any direct or indirect consideration. However, if necessary or advisable, a Portfolio may pay for such a stand-by commitment either separately in cash or by paying a higher price for Municipal Obligations which are acquired subject to the commitment for Municipal Obligations (thus reducing the yield to maturity otherwise available for the same securities). The total 20 amount paid in either manner for outstanding stand-by commitments for Municipal Obligations held by a Portfolio will not exceed 1/2 of 1% of the value of such Portfolio's total assets calculated immediately after each stand-by commitment is acquired. Stand-by commitments will only be entered into with dealers, banks and broker- dealers which, in a sub-adviser's opinion, present minimal credit risks. A Portfolio will acquire stand-by commitments solely to facilitate portfolio liquidity and not to exercise its rights thereunder for trading purposes. Stand-by commitments will be valued at zero in determining net asset value. Accordingly, where a Portfolio pays directly or indirectly for a stand-by commitment, its cost will be reflected as an unrealized loss for the period during which the commitment is held by such Portfolio and will be reflected as a realized gain or loss when the commitment is exercised or expires. MUNICIPAL INVESTMENTS. The two principal classifications of Municipal Obligations 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. Revenue securities include private activity bonds which are not payable from the unrestricted revenues of the issuer. Consequently, the credit quality of private activity bonds is usually directly related to the credit standing of the corporate user of the facility involved. Municipal Obligations may also include "moral obligation" bonds, which are normally issued by special purpose public authorities. If the issuer of moral obligation bonds 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. Also included within the general category of Municipal Obligations are participation certificates in a lease, an installment purchase contract, or a conditional sales contract ("lease obligations") entered into by a state or political subdivision to finance the acquisition or construction of equipment, land, or facilities. Although lease obligations are not general obligations of the issuer for which the state or other governmental body's unlimited taxing power is pledged, certain lease obligations are backed by a covenant to appropriate money to make the lease obligation payments. However, under certain lease obligations, the state or governmental body has no obligation to make these payments in future years unless money is appropriated on a yearly basis. Although "non-appropriation" lease obligations are secured by the leased property, disposition of the property in the event of foreclosure might prove difficult. These securities represent a relatively new type of financing that is not yet as marketable as more conventional securities. Each Tax-Free and Municipal Portfolio may acquire "stand-by commitments" with respect to Municipal Obligations held by it. Under a stand-by commitment, a dealer agrees to purchase, at the Portfolio's option, specified Municipal Obligations at a specified price. The acquisition of a stand-by commitment may increase the cost, and thereby reduce the yield, of the Municipal Obligations to which the commitment relates. The Tax-Free and Municipal Portfolios may also invest in tax-exempt derivative securities relating to Municipal Obligations, including tender option bonds, participations, beneficial interests in trusts and partnership interests. The amount of information regarding the financial condition of issuers of Municipal Obligations may be less extensive than the information for public corporations, and the secondary market for Municipal Obligations may be less liquid than that for taxable obligations. Accordingly, the ability of a Portfolio to buy and sell Municipal Obligations may, at any particular time and with respect to any particular securities, be limited. In addition, Municipal Obligations purchased by the Portfolios include obligations backed by letters of credit and other forms of credit enhancement issued by domestic and foreign banks, as well as other financial institutions. Changes in the credit quality of these institutions could cause loss to a Tax-Free Portfolio and affect its share price. Opinions relating to the validity of Municipal Obligations and to the exemption of interest thereon from Federal and state income tax are rendered by counsel to the respective issuers and sponsors of the obligations at the time of issuance. The Fund and its service providers will rely on such opinions and will not review independently the underlying proceedings relating to the issuance of Municipal Obligations, the creation of any tax-exempt derivative securities, or the bases for such opinions. TAX-EXEMPT DERIVATIVES. The Municipal Money Market Portfolios and the Tax- Free Income, Ohio Tax-Free Income, Pennsylvania Tax-Free Income, New Jersey Tax- Free Income, Delaware Tax-Free Income and Kentucky Tax-Free Income 21 Portfolios (collectively, the "Money and Non-Money Market Municipal Portfolios") may hold tax-exempt derivatives which may be in the form of tender option bonds, participations, beneficial interests in a trust, partnership interests or other forms. A number of different structures have been used. For example, interests in long-term fixed-rate municipal debt obligations, held by a bank as trustee or custodian, are coupled with tender option, demand and other features when the tax-exempt derivatives are created. Together, these features entitle the holder of the interest to tender (or put) the underlying municipal debt obligation to a third party at periodic intervals and to receive the principal amount thereof. In some cases, municipal debt obligations are represented by custodial receipts evidencing rights to receive specific future interest payments, principal payments, or both, on the underlying securities held by the custodian. Under such arrangements, the holder of the custodial receipt has the option to tender the underlying securities at their face value to the sponsor (usually a bank or broker dealer or other financial institution), which is paid periodic fees equal to the difference between the securities' fixed coupon rate and the rate that would cause the securities, coupled with the tender option, to trade at par on the date of a rate adjustment. The Money and Non-Money Market Municipal Portfolios may hold tax-exempt derivatives, such as participation interests and custodial receipts, for municipal debt obligations which give the holder the right to receive payment of principal subject to the conditions described above. The Internal Revenue Service has not ruled on whether the interest received on tax-exempt derivatives in the form of participation interests or custodial receipts is tax-exempt, and accordingly, purchases of any such interests or receipts are based on the opinions of counsel to the sponsors of such derivative securities. Neither the Fund nor its investment adviser or sub-advisers will review the proceedings related to the creation of any tax-exempt derivatives or the basis for such opinions. SECURITIES LENDING. A Portfolio may seek additional income by lending securities on a short-term basis. The securities lending agreements will require that the loans be secured by collateral in cash, U.S. Government securities or (except for the Index Master Portfolio) irrevocable bank letters of credit maintained on a current basis equal in value to at least the market value of the loaned securities. A Portfolio may not make such loans in excess of 33 1/3% of the value of its total assets. Securities loans involve risks of delay in receiving additional collateral or in recovering the loaned securities, or possibly loss of rights in the collateral if the borrower of the securities becomes insolvent. A Portfolio would continue to accrue interest on loaned securities and would also earn income on investment collateral for such loans. Any cash collateral received by a Portfolio in connection with such loans may be invested in a broad range of high quality, U.S. dollar-denominated money market instruments that meet Rule 2a-7 restrictions for money market funds. Specifically, cash collateral may be invested in any of the following instruments: (a) securities issued or guaranteed as to principal and interest by the U.S. Government or by its agencies or instrumentalities and related custodial receipts; (b) "first tier" quality commercial paper and other obligations issued or guaranteed by U.S. and foreign corporations and other issuers rated (at the time of purchase) in the highest rating category by at least two NRSRO's, or one if only rated by one NRSRO; (c) U.S. dollar-denominated obligations issued or supported by the credit of U.S. or foreign banks or savings institutions with total assets in excess of $1 billion (including obligations of foreign branches of such banks) (i.e. CD's, BA's and time deposits); (d) repurchase agreements relating to the above instruments, as well as corporate debt; and (e) unaffiliated money market funds. Any such investments must be rated "first tier" and must have a maturity of 397 days or less from the date of purchase. While the Index Master Portfolio may earn additional income from lending securities, such activity is incidental to the investment objective of the Index Master Portfolio. The value of securities loaned may not exceed 33 1/3% of the value of the Index Master Portfolio's total assets. In connection with such loans, the Index Master Portfolio will receive collateral consisting of cash or U.S. Government securities, which will be maintained at all times in an amount equal to at least 100% of the current market value of the loaned securities. In addition, the Index Master Portfolio will be able to terminate the loan at any time, will receive reasonable interest on the loan, as well as amounts equal to any dividends, interest or other distributions on the loaned securities. In the event of the bankruptcy of the borrower, the Trust could experience delay in recovering the loaned securities. Management of the Trust believes that this risk can be controlled through careful monitoring procedures. YIELDS AND RATINGS. The yields on certain obligations are dependent on a variety of factors, including general market conditions, conditions in the particular market for the obligation, the financial condition of the issuer, the size of the offering, the maturity of the obligation and the ratings of the issue. The ratings of Moody's, Duff & Phelps Credit Co. ("Duff & Phelps"), Fitch Investor Services, Inc. ("Fitch") and S&P represent their respective opinions as to the quality of the obligations they undertake to rate. Ratings, however, are general and are not absolute standards of quality. Consequently, obligations with the same rating, maturity and interest rate may have different market prices. Subsequent to its purchase by a Portfolio, a rated 22 security may cease to be rated. A Portfolio's adviser or sub-adviser will consider such an event in determining whether the Portfolio should continue to hold the security. INVESTMENT COMPANIES. In connection with the management of their daily cash positions, the Equity Portfolios (other than the Index Master Portfolio) may invest in securities issued by other investment companies which invest in short- term debt securities and which seek to maintain a $1.00 net asset value per share. Such Portfolios may also invest in securities issued by other investment companies with similar investment objectives. The Bond Portfolios may invest in securities issued by other investment companies within the limits prescribed by the 1940 Act. The International Equity, International Emerging Markets and International Small Cap Equity Portfolios may purchase shares of investment companies investing primarily in foreign securities, including so-called "country funds." Country funds have portfolios consisting exclusively of securities of issuers located in one foreign country. The Index Equity Portfolio may also invest in Standard & Poor's Depository Receipts (SPARS) and shares of other investment companies that are structured to seek a similar correlation to the performance of the S&P 500 Index. Securities of other investment companies will be acquired within limits prescribed by the Investment Company Act of 1940 (the "1940 Act"). As a shareholder of another investment company, a Portfolio would bear, along with other shareholders, its pro rata portion of the other investment company's expenses, including advisory fees. These expenses would be in addition to the advisory fees and other expenses the Portfolio bears directly in connection with its own operations. The Money Market Portfolios may invest in securities issued by other investment companies which invest in short-term, high quality debt securities and which determine their net asset value per share based on the amortized cost or penny-rounding method of valuation. Securities of other investment companies will be acquired by a Portfolio within the limits prescribed by the 1940 Act. As a shareholder of another investment company, a Portfolio would bear, along with other shareholders, its pro rata portion of the other investment company's expenses, including advisory fees. These expenses would be in addition to the advisory fees and other expenses the Portfolio bears directly in connection with its own operations. Each Portfolio, other than the Index Equity Portfolio, currently intends to limit its investments so that, as determined immediately after a securities purchase is made: (i) not more than 5% of the value of its total assets will be invested in the securities of any one investment company; (ii) not more than 10% of the value of its total assets will be invested in the aggregate in securities of investment companies as a group; and (iii) not more than 3% of the outstanding voting stock of any one investment company will be owned by the Portfolio or by the Fund as a whole. STRIPPED AND ZERO COUPON OBLIGATIONS. To the extent consistent with their investment objectives, the Bond Portfolios may purchase Treasury receipts and other "stripped" securities that evidence ownership in either the future interest payments or the future principal payments on U.S. Government and other obligations. These participations, which may be issued by the U.S. Government (or a U.S. Government agency or instrumentality) or by private issuers such as banks and other institutions, are issued at a discount to their "face value," and may include stripped mortgage-backed securities ("SMBS"). Stripped securities, particularly SMBS, may exhibit greater price volatility than ordinary debt securities because of the manner in which their principal and interest are returned to investors. The International Bond Portfolio also may purchase "stripped" securities that evidence ownership in the future interest payments or principal payments on obligations of foreign governments. SMBS are usually structured with two or more classes that receive different proportions of the interest and principal distributions from a pool of mortgage- backed obligations. A common type of SMBS will have one class receiving all of the interest, while the other class receives all of the principal. However, in some cases, one class will receive some of the interest and most of the principal while the other class will receive most of the interest and the remainder of the principal. If the underlying obligations experience greater than anticipated prepayments of principal, a Portfolio may fail to fully recoup its initial investment. The market value of SMBS can be extremely volatile in response to changes in interest rates. The yields on a class of SMBS that receives all or most of the interest are generally higher than prevailing market yields on other mortgage-related obligations because their cash flow patterns are also volatile and there is a greater risk that the initial investment will not be fully recouped. Each Bond Portfolio and the Balanced Portfolio may invest in zero-coupon bonds, which are normally issued at a significant discount from face value and do not provide for periodic interest payments. Zero-coupon bonds may experience greater volatility in market value than similar maturity debt obligations which provide for regular interest payments. Additionally, current federal tax law requires the holder of certain zero-coupon bonds to accrue income with respect to these securities prior to the receipt of 23 cash payments. To maintain its qualification as a regulated investment company and avoid liability for federal income and excise taxes, a Portfolio may be required to distribute income accrued with respect to these securities and may have to dispose of portfolio securities under disadvantageous circumstances in order to generate cash to satisfy these distribution requirements. See "Taxes." GUARANTEED INVESTMENT CONTRACTS. The Bond Portfolios and the Money Market Portfolio may make limited investments in guaranteed investment contracts ("GICs") issued by highly rated U.S. insurance companies. Under these contracts, a Portfolio makes cash contributions to a deposit fund of the insurance company's general account. The insurance company then credits to the Portfolio, on a monthly basis, interest which is based on an index (such as the Salomon Brothers CD Index), but is guaranteed not to be less than a certain minimum rate. Each Portfolio does not expect to invest more than 5% of its net assets in GICs at any time during the current fiscal year. DOLLAR ROLL TRANSACTIONS. To take advantage of attractive opportunities in the mortgage market and to enhance current income, the Balanced Portfolio and each Bond Portfolio (except the Tax-Free Portfolios) may enter into dollar roll transactions. A dollar roll transaction involves a sale by the Portfolio of a mortgage-backed or other security concurrently with an agreement by the Portfolio to repurchase a similar security at a later date at an agreed-upon price. The securities that are repurchased will bear the same interest rate and stated maturity as those sold, but pools of mortgages collateralizing those securities may have different prepayment histories than those sold. During the period between the sale and repurchase, a Portfolio will not be entitled to receive interest and principal payments on the securities sold. Proceeds of the sale will be invested in additional instruments for the Portfolio, and the income from these investments will generate income for the Portfolio. If such income does not exceed the income, capital appreciation and gain or loss that would have been realized on the securities sold as part of the dollar roll, the use of this technique will diminish the investment performance of a Portfolio compared with what the performance would have been without the use of dollar rolls. At the time a Portfolio enters into a dollar roll transaction, it will place in a segregated account maintained with its custodian cash, U.S. Government securities or other liquid securities having a value equal to the repurchase price (including accrued interest) and will subsequently monitor the account to ensure that its value is maintained. A Portfolio's dollar rolls, together with its reverse repurchase agreements and other borrowings, will not exceed, in the aggregate, 33 1/3% of the value of its total assets. Dollar roll transactions involve the risk that the market value of the securities a Portfolio is required to purchase may decline below the agreed upon repurchase price of those securities. If the broker/dealer to whom a Portfolio sells securities becomes insolvent, the Portfolio's right to purchase or repurchase securities may be restricted. Successful use of mortgage dollar rolls may depend upon the sub-adviser's ability to correctly predict interest rates and prepayments. There is no assurance that dollar rolls can be successfully employed. SHORT SALES. The Balanced and Bond Portfolios may only make short sales of securities "against-the-box." A short sale is a transaction in which a Portfolio sells a security it does not own in anticipation that the market price of that security will decline. The Portfolios may make short sales both as a form of hedging to offset potential declines in long positions in similar securities and in order to maintain portfolio flexibility. In a short sale "against-the-box," at the time of sale, the Portfolio owns or has the immediate and unconditional right to acquire the identical security at no additional cost. When selling short "against-the-box," a Portfolio forgoes an opportunity for capital appreciation in the security. INTEREST RATE AND EXTENSION RISK. The value of fixed income securities in the Balanced and Bond Portfolios can be expected to vary inversely with changes in prevailing interest rates. Fixed income securities with longer maturities, which tend to produce higher yields, are subject to potentially greater capital appreciation and depreciation than securities with shorter maturities. The Portfolios are not restricted to any maximum or minimum time to maturity in purchasing individual portfolio securities, and the average maturity of a Portfolio's assets will vary. Although the Bond Portfolios' sub-adviser will normally attempt to structure each Portfolio to have a comparable duration to its benchmark as stated for that section, there can be no assurance that it will be able to do so at all times. LIQUIDITY MANAGEMENT. Each Money Market Portfolio may hold uninvested cash reserves pending investment during temporary defensive periods or if, in the opinion of the Portfolios' sub-adviser, suitable obligations are unavailable. During normal market periods, no more than 20% of a Portfolio's assets will be held uninvested. Uninvested cash reserves will not earn income. 24 As a temporary defensive measure if its sub-adviser determines that market conditions warrant, each Equity Portfolio (other than the Index Master Portfolio) may invest without limitation in high quality money market instruments. The Equity Portfolios may also invest in high quality money market instruments pending investment or to meet anticipated redemption requests. The Balanced Portfolio may also invest in these securities in furtherance of its investment objective. The Index Master Portfolio may invest a portion of its assets, normally not more than 5% of its net assets, in certain short-term fixed income obligations in order to maintain liquidity or to invest temporarily uncommitted cash balances. High quality money market instruments include U.S. government obligations, U.S. government agency obligations, dollar denominated obligations of foreign issuers, bank obligations, including U.S. subsidiaries and branches of foreign banks, corporate obligations, commercial paper, repurchase agreements and obligations of supranational organizations. Generally, such obligations will mature within one year from the date of settlement, but may mature within two years from the date of settlement. ILLIQUID SECURITIES. No Equity or Bond Portfolio will invest more than 15% (10% with respect to the Index Master Portfolio) and no Money Market Portfolio will invest more than 10% of the value of its net assets in securities that are illiquid. GICs, variable and floating rate instruments that cannot be disposed of within seven days, and repurchase agreements and time deposits that do not provide for payment within seven days after notice, without taking a reduced price, are subject to these limits. Each Equity, Bond and Money Market Portfolio may purchase securities which are not registered under the Securities Act of 1933 (the "1933 Act") but which can be sold to "qualified institutional buyers" in accordance with Rule 144A under the 1933 Act. These securities will not be considered illiquid so long as it is determined by the adviser or sub- adviser that an adequate trading market exists for the securities. This investment practice could have the effect of increasing the level of illiquidity in a Portfolio during any period that qualified institutional buyers become uninterested in purchasing these restricted securities. PORTFOLIO TURNOVER RATES. A Portfolio's annual portfolio turnover rate will not be a factor preventing a sale or purchase when the adviser or sub-adviser believes investment considerations warrant such sale or purchase. Portfolio turnover may vary greatly from year to year as well as within a particular year. High portfolio turnover rates (i.e., 100% or more) will generally result in higher transaction costs to a Portfolio and may result in the realization of short-term capital gains that are taxable to shareholders as ordinary income. SPECIAL CONSIDERATION REGARDING THE OHIO TAX-FREE INCOME PORTFOLIO. The Ohio Tax-Free Income Portfolio will not trade its securities for the purpose of seeking profits. For purposes of this policy, the Portfolio may vary its portfolio securities if (i) there has been an adverse change in a security's credit rating or in that of its issuer or in the adviser's or sub-adviser's credit analysis of the security or its issuer; (ii) there has been, in the opinion of the adviser and sub-adviser, a deterioration or anticipated deterioration in general economic or market conditions affecting issuers of Ohio Municipal Obligations, or a change or anticipated change in interest rates; (iii) adverse changes or anticipated changes in market conditions or economic or other factors temporarily affecting the issuers of one or more portfolio securities make necessary or desirable the sale of such security or securities in anticipation of the Portfolio's repurchase of the same or comparable securities at a later date; or (iv) the adviser or sub-adviser engages in temporary defensive strategies. SPECIAL CONSIDERATIONS FOR STATE-SPECIFIC PORTFOLIOS The following information regarding the State-Specific Portfolios is derived from official statements of certain issuers published in connection with their issuance of securities and from other publicly available information, and is believed to be accurate. No independent verification has been made of any of the following information. SPECIAL CONSIDERATIONS REGARDING INVESTMENTS IN OHIO STATE-SPECIFIC OBLIGATIONS. The Ohio Municipal Money Market and Ohio Tax-Free Income Portfolios (the "Ohio Portfolios") will each invest most of its net assets in securities issued by or on behalf of (or in certificates of participation in lease-purchase obligations of) the State of Ohio, political subdivisions of the State, or agencies or instrumentalities of the State or its political subdivisions ("Ohio State-Specific Obligations"). The Ohio Portfolios are therefore susceptible to general or particular economic, political or regulatory factors that may affect issuers of Ohio State-Specific Obligations. The following information constitutes only a brief summary of some of the many complex factors that may have an effect. The information does not apply to "conduit" obligations on which the public issuer itself has no financial responsibility. The following information is derived from official statements of certain Ohio issuers published in connection with their issuance of securities and from other publicly available information, and is believed to be accurate. No independent verification has been made of any of the following information. 25 Generally, the creditworthiness of Ohio State-Specific Obligations of local issuers is unrelated to that of obligations of the State itself, and the State has no responsibility to make payments on those local obligations. There may be specific factors that at particular times apply in connection with investment in particular Ohio State-Specific Obligations or in those obligations of particular Ohio issuers. It is possible that the investment may be in particular Ohio State-Specific Obligations, or in those of particular issuers, as to which those factors apply. However, the information below is intended only as a general summary, and is not intended as a discussion of any specific factors that may affect any particular obligation or issuer. Ohio is the seventh most populous state. The 1990 Census count of 10,847,000 indicated a 0.5% population increase from 1980. The Census estimate for 1996 is 11,173,000. While diversifying more into the service and other non-manufacturing areas, the Ohio economy continues to rely in part on durable goods manufacturing largely concentrated in motor vehicles and equipment, steel, rubber products and household appliances. As a result, general economic activity, as in many other industrially-developed states, tends to be more cyclical than in some other states and in the nation as a whole. Agriculture is an important segment of the economy, with over half the State's area devoted to farming and approximately 16% of total employment in agribusiness. In prior years, the State's overall unemployment rate was commonly somewhat higher than the national figure. For example, the reported 1990 average monthly State rate was 5.7%, compared to the 5.5% national figure. However, for the last seven years the State rates were below the national rates (4.6% versus 4.9% in 1997). The unemployment rate and its effects vary among geographic areas of the State. There can be no assurance that future national, regional or state-wide economic difficulties, and the resulting impact on State or local government finances generally, will not adversely affect the market value of Ohio State- Specific Obligations held in the Ohio Portfolios or the ability of particular obligors to make timely payments of debt service on (or lease payments relating to) those Obligations. The State operates on the basis of a fiscal biennium for its appropriations and expenditures, and is precluded by law from ending its July 1 to June 30 fiscal year (FY) or fiscal biennium in a deficit position. Most State operations are financed through the General Revenue Fund (GRF), for which the personal income and sales-use taxes are the major sources. Growth and depletion of GRF ending fund balances show a consistent pattern related to national economic conditions, with the ending FY balance reduced during less favorable and increased during more favorable economic periods. The State has well- established procedures for, and has timely taken, necessary actions to ensure resource/expenditure balances during less favorable economic periods. Those procedures included general and selected reductions in appropriations spending. The 1992-93 biennium presented significant challenges to State finances successfully addressed. To allow time to resolve certain budget differences an interim appropriations act was enacted effective July 1, 1991; it included GRF debt service and lease rental appropriations for the entire 1992-93 biennium, while continuing most other appropriations for a month. Pursuant to the general appropriations act for the entire biennium, passed on July 11, 1991, $200 million was transferred from the Budget Stabilization Fund (BSF, a cash and budgetary management fund) to the GRF in FY 1992. Based on updated results and forecasts in the course of that FY, both in light of a continuing uncertain nationwide economic situation, there was projected, and then timely addressed an FY 1992 imbalance in GRF resources and expenditures. In response, the Governor ordered most State agencies to reduce GRF spending in the last six months of FY 1992 by a total of approximately $184 million; the $100.4 million BSF balance and additional amounts from certain other funds were transferred late in the FY to the GRF; and adjustments were made in the timing of certain tax payments. A significant GRF shortfall (approximately $520 million) was then projected for FY 1993. It was addressed by appropriate legislative and administrative actions, including the Governor's ordering $300 million in selected GRF spending reductions and subsequent executive and legislative action (a combination of tax revisions and additional spending reductions). The June 30, 1993 ending GRF fund balance was approximately $111 million, of which, as a first step to BSF replenishment, $21 million was deposited in the BSF. 26 None of the spending reductions were applied to appropriations needed for debt service on or lease rentals relating to any State obligations. The 1994-95 biennium presented a more affirmative financial picture. Based on June 30, 1994 balances, an additional $260 million was deposited in the BSF. The biennium ended June 30, 1995 with a GRF ending fund balance of $928 million, of which $535.2 million was transferred into the BSF. The significant GRF fund balance, after leaving in the GRF an unreserved and undesignated balance of $70 million, was transferred to the BSF, and other funds including school assistance funds and, in anticipation of possible federal program changes, a human services stabilization fund. From a higher than forecast 1996-97 mid-biennium GRF fund balance, $100 million was transferred for elementary and secondary school computer network purposes and $30 million to a new State transportation infrastructure fund. Approximately $400.8 million served as a basis for temporary 1996 personal income tax reductions aggregating that amount. The 1996-97 biennium-ending GRF fund balance was $834.9 million. Of that, $250 million went to school building construction and renovation, $94 million to the school computer network, $44.2 million for school textbooks and instructional materials and a distance learning program, and $34 million to the BSF, and the $263 million balance to a State income tax reduction fund. The GRF appropriations act for the current 1998-99 biennium was passed on June 25, 1997 and promptly signed (after selective vetoes) by the Governor. All necessary GRF appropriations for State debt service and lease rental payments then projected for the biennium were included in that act. Subsequent legislation increased the fiscal year 1999 GRF appropriation level for elementary and secondary education, with the increase to be funded in part by mandated small percentage reductions in State appropriations for various State agencies and institutions. Expressly exempt from those reductions are all appropriations for debt service, including lease rental payments. The BSF had a December 2, 1998 balance of over $906 million. The State's incurrence or assumption of debt without a vote of the people is, with limited exceptions, prohibited by current State constitutional provisions. The State may incur debt, limited in amount to $750,000, to cover casual deficits or failures in revenues or to meet expenses not otherwise provided for. The Constitution expressly precludes the State from assuming the debts of any local government or corporation. (An exception is made in both cases for any debt incurred to repel invasion, suppress insurrection or defend the State in war.) By 14 constitutional amendments approved from 1921 to date (the latest adopted in 1995), Ohio voters authorized the incurrence of State debt and the pledge of taxes or excises to its payment. At December 2, 1998, $1.12 billion (excluding certain highway bonds payable primarily from highway use receipts) of this debt was outstanding. The only such State debt at that date still authorized to be incurred were portions of the highway bonds, and the following: (a) up to $100 million of obligations for coal research and development may be outstanding at any one time ($26.7 million outstanding); (b) $240 million of obligations previously authorized for local infrastructure improvements, no more than $120 million of which may be issued in any calendar year (over $1 billion outstanding); and (c) up to $200 million in general obligation bonds for parks, recreation and natural resources purposes which may be outstanding at any one time ($85.1 million outstanding, with no more than $50 million to be issued in any one year). The electors in 1995 approved a constitutional amendment extending the local infrastructure bond program (authorizing an additional $1.2 billion of State full faith and credit obligations to be issued over 10 years for the purpose), and authorizing additional highway bonds (expected to be payable primarily from highway use receipts). The latter supersedes the prior $500 million outstanding authorization, and authorizes not more than $1.2 billion to be outstanding at any time and not more than $220 million to be issued in a fiscal year. The Constitution also authorizes the issuance of State obligations for certain purposes, the owners of which do not have the right to have excises or taxes levied to pay debt service. Those special obligations include obligations issued by the Ohio Public Facilities Commission and the Ohio Building Authority, and certain obligations issued by the State Treasurer, over $5.2 billion of which were outstanding or awaiting delivery at December 2, 1998. 27 The State estimates that aggregate FY 1998 rental payments under various capital lease and lease purchase agreements were approximately $9.1 million. In recent years, State agencies have also participated in transportation and office building projects that may have some local as well as State use and benefit, in connection with which the State enters into lease purchase agreements with terms ranging from 7 to 20 years. Certificates of participation, or special obligation bonds of the State or a local agency, are issued that represent fractionalized interests in or are payable from the State's anticipated payments. The State estimates highest future FY payments under those agreements (as of December 2, 1998) to be approximately $27.3 million (of which $23.6 million is payable from sources other than the GRF, such as federal highway money distributions). State payments under all those agreements are subject to biennial appropriations, with the lease terms being two years subject to renewal if appropriations are made. A 1990 constitutional amendment authorizes greater State and political subdivision participation (including financing) in the provision of housing. The General Assembly may for that purpose authorize the issuance of State obligations secured by a pledge of all or such portion as it authorizes of State revenues or receipts (but not by a pledge of the State's full faith and credit). A 1994 constitutional amendment pledges the full faith and credit and taxing power of the State to meeting certain guarantees under the State's tuition credit program which provides for purchase of tuition credits, for the benefit of State residents, guaranteed to cover a specified amount when applied to the cost of higher education tuition. (A 1965 constitutional provision that authorized student loan guarantees payable from available State moneys has never been implemented, apart from a "guarantee fund" approach funded essentially from program revenues.) State and local agencies issue obligations that are payable from revenues from or relating to certain facilities (but not from taxes). By judicial interpretation, these obligations are not "debt" within constitutional provisions. In general, payment obligations under lease-purchase agreements of Ohio public agencies (in which certificates of participation may be issued) are limited in duration to the agency's fiscal period, and are renewable only upon appropriations being made available for the subsequent fiscal period. Local school districts in Ohio receive a major portion (state-wide aggregate approximately 44% in recent years) of their operating moneys from State subsidies, but are dependent on local property taxes, and in 119 districts (as of December 2, 1998) from voter-authorized income taxes, for significant portions of their budgets. Litigation, similar to that in other states, is pending questioning the constitutionality of Ohio's system of school funding. The Ohio Supreme Court has concluded that aspects of the system (including basic operating assistance and the loan program referred to below) are unconstitutional, and ordered the State to provide for and fund a system complying with the Ohio Constitution, staying its order to permit time for responsive corrective actions. The parties await eventual trial court decision on the adequacy of steps taken to date by the State to enhance school funding consistent with the Supreme Court decision. A small number of the State's 612 local school districts have in any year required special assistance to avoid year-end deficits. A program has provided for school district cash need borrowing directly from commercial lenders, with diversion of State subsidy distributions to repayment if needed. Recent borrowings under this program totalled $71.1 million for 29 districts in FY 1995 (including $29.5 million for one), $87.2 million for 20 districts in FY 1996 (including $42.1 million for one), $113.2 million for 12 districts in FY 1997 (including $90 million to one for restructuring its prior loans), and $23.4 million for 10 districts in FY 1998. Ohio's 943 incorporated cities and villages rely primarily on property and municipal income taxes for their operations. With other subdivisions, they also receive local government support and property tax relief moneys distributed by the State. For those few municipalities and school districts that on occasion have faced significant financial problems, there are statutory procedures for a joint State/local commission to monitor the fiscal affairs and for development of a financial plan to 28 eliminate deficits and cure any defaults. (Similar procedures have recently been extended to counties and townships.) Since inception for municipalities in 1979, these "fiscal emergency" procedures have been applied to 26 cities and villages; for 19 of them the fiscal situation was resolved and the procedures terminated (two cities are in preliminary "fiscal watch" status). As of December 2, 1998, a 1996 school district "fiscal emergency" provision was applied to six districts, and 10 were on preliminary "fiscal watch" status. At present the State itself does not levy ad valorem taxes on real or tangible personal property. Those taxes are levied by political subdivisions and other local taxing districts. The Constitution has since 1934 limited to 1% of true value in money the amount of the aggregate levy (including a levy for unvoted general obligations) of property taxes by all overlapping subdivisions, without a vote of the electors or a municipal charter provision, and statutes limit the amount of that aggregate levy to 10 mills per $1 of assessed valuation (commonly referred to as the "ten-mill limitation"). Voted general obligations of subdivisions are payable from property taxes that are unlimited as to amount or rate. SPECIAL CONSIDERATIONS REGARDING INVESTMENT IN PENNSYLVANIA STATE-SPECIFIC OBLIGATIONS. The concentration of investments in Pennsylvania State-Specific Obligations by the Pennsylvania Municipal Money Market and Pennsylvania Tax-Free Income Portfolios raises special investment considerations. In particular, changes in the economic condition and governmental policies of the Commonwealth of Pennsylvania and its municipalities could adversely affect the value of those Portfolios and their portfolio securities. This section briefly describes current economic trends in Pennsylvania. Although the General Fund of the Commonwealth (the principal operating fund of the Commonwealth) experienced deficits in fiscal 1990 and 1991, tax increases and spending decreases resulted in surpluses the following six years. As of June 30, 1997, the General Fund had a surplus of $1,365 million. A relatively high proportion of persons 65 and older in the Commonwealth, court ordered increases in healthcare reimbursement rates and higher correctional program costs place increased pressures on the tax resources of the Commonwealth and its municipalities. The Commonwealth's debt burden remains moderate. Employment growth has shifted to the trade and service sectors, with losses in more high- paid manufacturing positions. A new governor took office in January 1995, but the Commonwealth has continued to show fiscal restraint. Pennsylvania has historically been dependent on heavy industry, although declines over the past thirty years in the coal, steel and railroad industries have led to diversification of the Commonwealth's economy. Recent sources of economic growth in Pennsylvania are in the service sector, including trade, medical and health services, education and financial institutions. Agriculture continues to be an important component of the Commonwealth's economic structure, with nearly one-third of the Commonwealth's total land area devoted to cropland, pasture and farm woodlands. The population of Pennsylvania experienced a slight increase in the period 1988 through 1997, and has a high proportion of persons 65 or older. The Commonwealth is highly urbanized, with almost 79% of the 1990 census population residing in metropolitan statistical areas. The two largest metropolitan statistical areas, those containing the Cities of Philadelphia and Pittsburgh, together comprise approximately 44% of the Commonwealth's total population. The Commonwealth utilizes the fund method of accounting and over 150 funds have been established for purposes of recording receipts and disbursements of the Commonwealth, of which the General Fund is the largest. Most of the Commonwealth's operating and administrative expenses are payable from the General Fund. The major tax sources for the General Fund are the sales tax, the personal income tax and the corporate net income tax. Major expenditures of the Commonwealth include funding for education, public health and welfare and transportation. The constitution of the Commonwealth provides that operating budget appropriations of the Commonwealth may not exceed the estimated revenues and available surplus in the fiscal year for which funds are appropriated. Annual budgets are enacted for the General Fund (the principal operating fund of the Commonwealth) and for certain special revenue funds which together represent the majority of expenditures of the Commonwealth. Although a negative balance was experienced applying generally accepted accounting principles ("GAAP") in the General Fund for fiscal 1990 and 1991, tax increases and spending decreases have resulted in surpluses in subsequent years; and as of June 30, 1997, the General Fund had a surplus of $1,365 million. The deficit in the Commonwealth's unreserved/undesignated funds also had been eliminated. Certain litigation is pending against the Commonwealth that could adversely affect the ability of the Commonwealth to pay debt service on its obligations including suits relating to the following matters: (a) the ACLU has filed suit in Federal court 29 demanding additional funding for child welfare services; the Commonwealth settled a similar suit in the Commonwealth Court of Pennsylvania and is seeking the dismissal of the federal suit, inter alia, because of that Appeals, the ----- ---- district court granted class certification to the ACLU. The parties are negotiating a settlement; (b) in 1987, the Supreme Court of Pennsylvania held the statutory scheme for county funding of the judicial system to be in conflict with the constitution of the Commonwealth, but stayed judgment pending enactment by the legislature of funding consistent with the opinion, and the legislature has yet to consider legislation implementing the judgment. In 1992, a new action in mandamus was filed seeking to compel the Commonwealth to comply with the original decision; (c) litigation has been filed in both state and Federal court by an association of rural and small schools and several individual school districts and parents challenging the constitutionality of the Commonwealth's system for funding local school districts -- the Federal case has been stayed pending resolution of the state case. The State court dismissed the petitioner's claim, and held that the Commonwealth's system of school funding is Constitutional. Petitioners have appealed; (d) both the Commonwealth and the City of Philadelphia are involved in cases currently before the Pennsylvania Supreme Court that may result in their being required to fund remedies for the unintentional racial segregation in the Philadelphia public schools; and (e) the School District of Philadelphia and others have brought suit in Federal court to declare the Commonwealth's system of funding public schools to be racially discriminatory and therefore illegal. The City of Philadelphia (the "City") experienced severe financial difficulties during the early 1990's which impaired its access to public credit markets. The City experienced a series of General Fund deficits for fiscal years 1988 through 1992. Legislation was enacted in 1991 to create an Intergovernmental Cooperation Authority (the "Authority") to provide deficit reduction financing and fiscal oversight for Philadelphia. In order for the Authority to issue bonds on behalf of the City, the City and the Authority entered into an intergovernmental cooperation agreement providing the Authority with certain oversight powers with respect to the fiscal affairs of the City. Philadelphia currently is operating under a five year plan approved by the Authority on June 8, 1998. The unaudited balance of the City's General Fund as of June 30, 1998 was approximately $169.8 million. The Authority's power to issue further bonds to finance capital projects or deficit expired on December 31, 1994, and its power to issue debt to finance a cash flow deficit expired December 31, 1996. Its ability to refund outstanding bonds is unrestricted. The Authority had $1,055 million in special revenue bonds outstanding as of June 30, 1998. Most recently, Moody's has rated the long-term general obligation bonds of the Commonwealth "Aa3," Standard & Poor's has rated such bonds "AA" and Fitch has rated such bonds "AA." There can be no assurance that the economic conditions on which these ratings are based will continue or that particular bond issues may not be adversely affected by changes in economic or political conditions. SPECIAL CONSIDERATIONS REGARDING INVESTMENT IN NORTH CAROLINA STATE- SPECIFIC OBLIGATIONS. The concentration of investments in North Carolina State- Specific Obligations by the North Carolina Municipal Money Market Portfolio raises special investment considerations. In particular, changes in the economic condition and governmental policies of North Carolina and its political subdivisions, agencies, instrumentalities, and authorities could adversely affect the value of the Portfolio and its portfolio securities. This section briefly describes current economic trends in North Carolina. The State of North Carolina has three major operating funds: the General Fund, the Highway Fund and the Highway Trust Fund. North Carolina derives most of its revenue from taxes, including individual income tax, corporation income tax, sales and use taxes, corporation franchise tax, alcoholic beverage tax, insurance tax and tobacco products tax. State sales taxes on food, as well as the inheritance and soft drink taxes, are being phased out. North Carolina receives other non-tax revenues which are also deposited in the General Fund. The most important are Federal funds collected by North Carolina agencies, university fees and tuition, interest earned by the North Carolina Treasurer on investments of General Fund moneys and revenues from the judicial branch. The proceeds from the motor fuel tax, highway use tax and motor vehicle license tax are deposited in the Highway Fund and the Highway Trust Fund. 30 Fiscal year 1997 ended with a positive General Fund balance of approximately $874.8 million. Along with additional reserves, $135 million was reserved in the Reserve for Repair and Renovation of State Facilities, in addition to a supplemental reserve of $39.3 million for repairs and renovations (bringing the total reserve to $221.2 million after prior withdrawals). An additional $49.4 million was transferred to the Clean Water Management Trust Fund (bringing the total reserve to $49.4 million after prior withdrawals) and $115 million and $156 million were reserved in newly-created Disaster Relief and Intangible Tax Refund Reserves, respectively. The Disaster Relief Reserve was used to cover disaster relief funds spent during fiscal year 1997. An additional $61 million was reserved for the State to acquire the shares of the North Carolina Railroad Company not held by the State. No additional amounts were transferred to the Savings Reserve for the year (the existing balance of $500.9 million having met the statutory reserve requirements). After additional reserves, the unreserved General Fund balance at the end of fiscal year 1997 was approximately $318.7 million. Fiscal year 1998 ended with a positive General Fund balance of approximately $784.2 million. Along with additional reserves, $145 million was reserved in the Repairs and Renovations Reserve Account (bringing the total reserve to $174.2 million after prior withdrawals). An additional $47.4 million was placed in the Clean Water Management Trust Fund. The General Assembly reserved $55 million to fund public school employee performance bonuses, longevity payments, school bus purchases and school technology purchases. $21.6 million was transferred to the Savings Rescue Account to meet the statutory cap at $522.5 million. After additional reserves, the unreserved General Fund balance at the end of fiscal year 1998 was approximately $515.2 million. The foregoing results are presented on a budgetary basis. Accounting principles used to develop data on a budgetary basis differ significantly from those principles used to present financial statements in accordance with generally accepted accounting principles (GAAP). Based on a modified accrual basis (GAAP), the General Fund balance at June 30, 1997 and 1998 was approximately $1,704 million and $1,665 million, respectively. On October 28, 1998, the North Carolina General Assembly adopted the biennium budget for 1998 to 2000. The $12.6 billion budget for fiscal year 1999 included over $100 million in new spending for the state's universities and community colleges, over $90 million in new spending for health and human services, including $42.5 million for expansion of North Carolina's Smart Start program for preschool children, and almost $30 million in new spending on law enforcement. The legislature also approved teacher pay raises averaging 6.5 percent. The General Assembly also took action to reduce some taxes, including elimination of the sales tax on food (estimated cost $185.5 million 1999-2000) and the inheritance tax (estimated cost $52.5 million 1999-2000). 31 The North Carolina budget is based upon a number of existing and assumed State and non-State factors, including State and national economic conditions, international activity, Federal government policies and legislation and the activities of the State's General Assembly. Such factors are subject to change which may be material and affect the budget. The Congress of the United States is considering a number of matters affecting the federal government's relationship with State governments that, if enacted into law, could affect fiscal and economic policies of the states, including North Carolina. During recent years North Carolina has moved from an agricultural to a service and goods producing economy. According to the North Carolina Employment Security Commission (the "Commission"), in July 1997, North Carolina ranked tenth among the states in non-agricultural employment and eighth in manufacturing employment. According to the Commission, for the past several years, North Carolina's unemployment rate has consistently been below the national average. The Commission estimated North Carolina's seasonally adjusted unemployment rate in October 1998 to be 3.3% of the labor force, as compared with an unemployment rate of 4.2% nationwide. The following are certain cases pending in which the State of North Carolina faces the risk of either a loss of revenue or an unanticipated expenditure which, in the opinion of the North Carolina Department of State Treasurer, would not materially adversely affect the State's ability to meet its financial obligations: 1. Swanson v. State of North Carolina C State Tax Refunds - Federal Retirees. In Davis v. Michigan (1989), the United States Supreme Court ruled ----------------- that a Michigan income tax statute which taxed federal retirement benefits while exempting those paid by state and local governments violated the constitutional doctrine of intergovernmental tax immunity. At the time of the Davis decision, ----- North Carolina law contained similar exemptions in favor of state and local retirees. Those exemptions were repealed prospectively, beginning with the 1989 tax year. All public pension and retirement benefits are now entitled to a $4,000 annual exclusion. Following Davis, federal retirees filed a class action suit in federal ----- court in 1989 seeking damages equal to the North Carolina income tax paid on federal retirement income by the class members (Swanson). A companion suit was ------- filed in state court in 1990. The complaints alleged that the amount in controversy exceeded $140 million. The North Carolina Department of Revenue estimate of refunds and interest liability is $280.89 million as of June 30, 1994. In 1991, the North Carolina Supreme Court ruled in favor of the State in the state court action, concluding that Davis could only be applied ----- prospectively and that the taxes collected from the federal retirees were thus not improperly collected. In 1993, the United States Supreme Court vacated that decision and remanded the case back to the North Carolina Supreme Court. The North Carolina Supreme Court then ruled in favor of the State on the grounds that the federal retirees had failed to comply with state procedures for challenging unconstitutional taxes. Plaintiffs petitioned the United States Supreme Court for review of that decision, which petition was denied. The United States District Court ruled in favor of the defendants in the companion federal case, and a petition for reconsideration was denied. Plaintiffs appealed to the United States Court of Appeals, which concurred with the lower court's ruling. The United States Supreme Court rejected an appeal, ruling that the lawsuit was a state matter, leaving the North Carolina Supreme Court's ruling in force. Despite these victories in court, the General Assembly in its 1996 Special Session adopted legislation allowing for a refund of taxes for federal retirees. Effective for tax years beginning on or after January 1, 1996, federal retirees are entitled to a North Carolina income tax credit for taxes paid on their pension benefits during tax years 1985 through 1988. In the alternative, a partial refund may be claimed in lieu of a credit for eligible taxpayers. 2. Patton v. State of North Carolina and Bailey v. State of North Carolina C State Tax Refunds - Federal and State Retirees. An additional lawsuit was filed in 1995 in State Court by federal pensioners to recover State income taxes paid on federal retirement benefits (Patton). Theis case grew out of a claim by federal pensioners in the original ------ federal court case in Swanson. In the new lawsuit, the plaintiffs allege that ------- when the State granted an increase in retirement benefits to State retirees in the same legislation that equalized tax treatment between state and federal retirees, the increased benefits to State retirees constituted an indirect violation of Davis. The lawsuit seeks a refund of taxes paid by federal retirees ----- on federal retirement benefits received in the years 1989 through 1993 and refunds or monetary relief sufficient to equalize the alleged on-going discriminatory treatment for those years. 32 State and local governmental retirees filed a class action suit in 1990 as a result of the repeal of the income tax exemptions for state and local government retirement benefits. The original suit was dismissed after the North Carolina Supreme Court ruled in 1991 that the plaintiffs had failed to comply with state law requirements for challenging unconstitutional taxes and the United States Supreme Court denied review. In 1992, many of the same plaintiffs filed a new lawsuit alleging essentially the same claims, including breach of contract, unconstitutional impairment of contract rights by the State in taxing benefits that were allegedly promised to be tax-exempt and violation of several state constitutional provisions. On May 31, 1995 the Superior Court issued an order ruling in favor of the plaintiffs. Under the terms of the order, the Superior Court found that the act of the General Assembly that repealed the tax exemption on State and local government retirement benefits is null, void, and unenforceable and that retirement benefits which were vested before August 1989 are exempt from taxation. The North Carolina Attorney General has appealed this order, which appeal is pending in the North Carolina Supreme Court. In June 1998, the plaintiff classes in the Bailey and Patton cases reached a tentative settlement with the State of North Carolina. Under the terms of the settlement, the General Assembly will appropriate $400,000,000 in the 1998-1999 fiscal year, and $399,000,000 by July 15, 1999 in the 1999-2000 fiscal year, to a settlement fund. Amounts in the fund will be paid to the state, local and federal retirees in the cases. The terms of the settlement provide that such payments will completely extinguish all of the state's liability to the retirees arising from the taxation of state, local and federal retirement income and benefits from 1989 through 1997. The tentative court settlement was made subject to the appropriation of funds by the General Assembly, and to court approval following notice to the class members. The $400,000,000 appropriation was made by action of the General Assembly in September, 1998, and on October 7, 1998, the court entered an order approving the settlement. In order to achieve final consummation of the settlement, the General Assembly must appropriate the $399,000,000 amount for the 1 999-2000 fiscal year at its 1999 session, which begins in January, 1999. In its 1996 Short Session, the North Carolina General Assembly approved additional North Carolina general obligation bonds in the amount of $950 million for highways and $1.8 billion for schools. These bonds were approved by the voters of the State in November, 1996. In 1997 and 1998, North Carolina issued a total of $900 million of the authorized school bonds (Public School Building Bonds). In November 1997, North Carolina issued $250 million of the authorized highway bonds (Highway Bonds). The offering of the remaining $1.6 billion of these authorized bonds is anticipated to occur over the next one to four years. On November 3, 1998, North Carolina voters approved the issuance of $800,000,000 in clean water bonds and $200,000,000 natural gas facilities bonds. The clean water bonds will provide grants and loans for needed water and sewer improvement projects for the state's municipalities, and fund programs to reduce pollution in the state's waterways. The natural gas bond issue will provide grants, loans and other financing for local distribution companies or state or local government agencies to build natural gas facilities, in part to help attract industry to the state's rural regions. 33 Currently, Moody's, S&P and Fitch rate North Carolina general obligation bonds "Aaa," "AAA," and "AAA," respectively. See Appendix A. SPECIAL CONSIDERATIONS REGARDING INVESTMENT IN VIRGINIA STATE-SPECIFIC OBLIGATIONS. The Virginia State-Specific Money Market Portfolio will invest primarily in Virginia State-Specific Obligations. For this reason, the Portfolio is affected by political, economic, regulatory or other developments that constrain the taxing, revenue-collecting and spending authority of Virginia issuers or otherwise affect the ability of Virginia issuers to pay interest, principal or any premium. The following information constitutes only a brief summary of certain of these developments and does not purport to be a complete description of them. The information has been obtained from recent official statements prepared by the Commonwealth of Virginia relating to its securities, and no independent investigation has been undertaken to verify its accuracy. Moreover, the information relates only to the state itself and not to the numerous special purpose or local government units whose issues may also be held by the Portfolio. The credits represented by such issues may be affected by a wide variety of local factors or structuring concerns, and no disclosure is made here relating to such matters. The rate of economic growth in the Commonwealth of Virginia has increased steadily over the past decade. Per capita income in Virginia has been consistently above national levels during that time. The services sector in Virginia generates the largest number of jobs, followed by wholesale and retail trade, manufacturing and state and local government. Because of Northern Virginia, with its proximity to Washington, D.C. and Hampton Roads, which has the nation's largest concentration of military installations, the Federal government has a greater economic impact on Virginia relative to its size than any state other than Alaska and Hawaii. According to statistics published by the U.S. Department of Labor, Virginia typically has one of the lowest unemployment rates in the nation. This is generally attributed to the balance among the various sectors represented in the economy. Virginia is one of twenty states with a right-to-work law and is generally regarded as having a favorable business climate marked by few strikes or work stoppages. Virginia is also one of the least unionized among the industrialized states. Virginia's state government operates on a two-year budget. The Constitution vests the ultimate responsibility and authority for levying taxes and appropriating revenue in the General Assembly, but the Governor has broad authority to manage the budgetary process. Once an appropriation act becomes law, revenue collections and expenditures are constantly monitored by the Governor, assisted by the Secretary of Finance and the Department of Planning and Budget, to ensure that a balanced budget is maintained. If projected revenue collections fall below amounts appropriated at any time, the Governor must reduce expenditures and withhold allotments of appropriations (other than for debt service and other specified purposes) to restore balance. An amendment to the Constitution, effective January 1, 1993, established a Revenue Stabilization Fund. This Fund is used to offset a portion of anticipated shortfalls in revenues in years when appropriations based on previous forecasts exceed expected revenues in subsequent forecasts. The Revenue Stabilization Fund consists of an amount not to exceed 10 percent of Virginia's average annual tax revenues derived from taxes on income and retail sales for the three preceding fiscal years. General Fund revenues are principally comprised of direct taxes. In recent fiscal years, most of the total tax revenues have been derived from five major taxes imposed by Virginia on individual and fiduciary income, sales and use, corporate income, public service corporations and premiums of insurance companies. In September 1991, the Debt Capacity Advisory Committee was created by the Governor through an executive order. The committee is charged with annually estimating the amount of tax-supported debt that may prudently be authorized, consistent with the financial goals, capital needs and policies of Virginia. The committee annually reviews the outstanding debt of all agencies, institutions, boards and authorities of Virginia for which Virginia has either a direct or indirect pledge of tax revenues or moral obligation. The Committee provides its recommendations on the prudent use of such obligations to the Governor and the General Assembly. The Constitution of Virginia prohibits the creation of debt by or on behalf of Virginia that is backed by Virginia's full faith and credit, except as provided in Section 9 of Article X. Section 9 of Article X contains several different provisions for the issuance of general obligation and other debt, and Virginia is well within its limit for each: Section 9(a)(2) provides that the General Assembly may incur general obligation debt to meet certain types of emergencies, subject to limitations on amount and duration; to meet casual deficits in the revenue or in anticipation of the collection of 34 revenues of Virginia; and to redeem a previous debt obligation of Virginia. Total indebtedness issued pursuant to this Section may not exceed 30 percent of an amount equal to 1.15 times the annual tax revenues derived from taxes on income and retail sales, as certified by the Auditor of Public Accounts for the preceding fiscal year. Section 9(b) provides that the General Assembly may authorize the creation of general obligation debt for capital projects. Such debt is required to be authorized by an affirmative vote of a majority of each house of the General Assembly and approved in a statewide election. The outstanding amount of such debt is limited to an amount equal to 1.15 times the average annual tax revenues derived from taxes on income and retail sales, as certified by the Auditor of Public Accounts for the three preceding fiscal years less the total amount of bonds outstanding. The amount of 9(b) debt that may be authorized in any single fiscal year is limited to 25 percent of the limit on all 9(b) debt less the amount of 9(b) debt authorized in the current and prior three fiscal years. Section 9(c) provides that the General Assembly may authorize the creation of general obligation debt for revenue-producing capital projects (so-called "double-barrel" debt). Such debt is required to be authorized by an affirmative vote of two-thirds of each house of the General Assembly and approved by the Governor. The Governor must certify before the enactment of the authorizing legislation and again before the issuance of the debt that the net revenues pledged are expected to be sufficient to pay principal of and interest on the debt. The outstanding amount of 9(c) debt is limited to an amount equal to 1.15 times the average annual tax revenues derived from taxes on income and retail sales, as certified by the Auditor of Public Accounts for the three preceding fiscal years. While the debt limits under Sections 9(b) and 9(c) are each calculated as the same percentage of the same average tax revenues, these debt limits are separately computed and apply separately to each type of debt. Section 9(d) provides that the restrictions of Section 9 are not applicable to any obligation incurred by Virginia or any of its institutions, agencies or authorities if the full faith and credit of Virginia is not pledged or committed to the payment of such obligation. There are currently outstanding various types of such 9(d) revenue bonds. Certain of these bonds, however, are paid in part or in whole from revenues received as appropriations by the General Assembly from general tax revenues, while others are paid solely from revenues of the applicable project. The repayment of debt issued by the Virginia Public Building Authority, the Virginia Port Authority, the Virginia College Building Authority Equipment Leasing Program, The Innovative Technology Authority and the Virginia Biotechnology Research Park Authority is supported in large part by General Fund appropriations. The Commonwealth Transportation Board is a substantial issuer of bonds for highway projects. These bonds are secured by and are payable from funds appropriated by the General Assembly from the Transportation Trust Fund for such purpose. The Transportation Trust Fund was established by the General Assembly in 1986 as a special non-reverting fund administered and allocated by the Transportation Board to provide increased funding for construction, capital and other needs of state highways, airports, mass transportation and ports. The Virginia Port Authority has also issued bonds that are secured by a portion of the Transportation Trust Fund. Virginia is involved in numerous leases that are subject to appropriation of funding by the General Assembly. Virginia also finances the acquisition of certain personal property and equipment through installment purchase agreements. Bonds issued by the Virginia Housing Development Authority, the Virginia Resources Authority and the Virginia Public School Authority are designed to be self-supporting from their individual loan programs. A portion of the Virginia Housing Development Authority and Virginia Public School Authority bonds and all of the Virginia Resources Authority bonds are secured in part by a moral obligation pledge of Virginia. Should the need arise, Virginia may consider funding deficiencies in the respective debt service reserves for such moral obligation debt. To date, none of these authorities has advised Virginia that any such deficiencies exist. Local government in Virginia is comprised of 95 counties, 40 incorporated cities, and 190 incorporated towns. Virginia is unique among the several states in that cities and counties are independent, and their land areas do not overlap. The largest expenditures by local governments in Virginia are for education, but local governments also provide other services such as water and sewer, police and fire protection and recreational facilities. The Virginia Constitution imposes numerous restrictions on local indebtedness, affecting both its incurrence and amount. 35 In Davis v. Michigan (decided March 28, 1989), the United States Supreme Court ruled unconstitutional states' exempting from state income tax the retirement benefits paid by the state or local governments without exempting retirement benefits paid by the Federal government. At that time, Virginia exempted state and local retirement benefits but not Federal retirement benefits. At a Special Session held in April 1989, the General Assembly repealed the exemption of state and local retirement benefits. Following Davis, at least five suits, some with multiple plaintiffs, for refunds of Virginia income taxes, were filed by Federal retirees. These suits were consolidated under the name of Harper v. Virginia Department of Taxation. In a Special Session, the Virginia General Assembly on July 9, 1994, passed emergency legislation to provide payments in five annual installments to Federal retirees in a settlement of the retirees' claims as a result of Davis. In 1995 and 1996, the General Assembly passed legislation allowing more retirees to participate in the settlement. As of June 30, 1997, the estimated total cost to Virginia for the settlement was approximately $316.2 million. On September 15, 1995, the Supreme Court of Virginia rendered its decision in Harper, reversing the judgment of the trial court, entering final judgment in favor of the taxpayers, and directing that the amounts unlawfully collected be refunded with statutory interest. Virginia issued refund checks on November 9, 1995, and interest stopped accruing as of November 3, 1995. The cost of refunding all Virginia income taxes paid on Federal government pensions for taxable years 1985, 1986, 1987 and 1988 to Federal government pensioners who opted out of the settlement was approximately $78.7 million, including interest earnings. The total cost of refunding all Virginia income taxes paid on Federal pensions on account of the settlement (approximately $316.2 million) and the judgment ($78.7 million) is approximately $394.9 million, of which $329 million ($250.2 million in respect of the settlement and the entire $78.7 million in respect of the judgment) has been paid as of June 30, 1998, leaving $66 million payable in respect of the settlement. During the 1998 Session of the Virginia General Assembly, legislation was approved providing for early payment on the remaining balance on September 20, 1998 (subject to appropriation), provided that undesignated and unreserved general fund balances were met on August 15, 1998. Since such balances were not met, a special installment payment of the remaining balance (approximately $34.88 million) was made on September 30, 1998, with a payment of the final balance ($31.1 million) occurring no later than March 31, 1999. Most recently, Moody's has rated the long-term general obligation bonds of Virginia Aaa, and Standard & Poor's has rated such bonds AAA. There can be no assurance that the economic conditions on which these ratings are based will continue or that particular bond issues may not be adversely affected by changes in economic or political conditions. SPECIAL CONSIDERATIONS REGARDING INVESTMENT IN NEW JERSEY STATE-SPECIFIC OBLIGATIONS. The following information constitutes only a brief summary, does not purport to be a complete description and is largely based on information drawn from official statements relating to securities offerings of New Jersey municipal obligations available as of the date of this Statement of Additional Information. The accuracy and completeness of the information contained in such offering statements has not been independently verified. State Finance/Economic Information. ---------------------------------- 36 New Jersey is the ninth largest state in population and the fifth smallest in land area. With an average of 1,077 people per square mile, it is the most densely populated of all the states. New Jersey's economic base is diversified, consisting of a variety of manufacturing, construction and service industries, supplemented by rural areas with selective commercial agriculture. Business investment expenditures and consumer spending have increased substantially in New Jersey. Capital and consumer spending may continue to rise due to the sustained character of economic growth and the interest-sensitive homebuilding industry may continue to provide stimulus in New Jersey. It is expected that the employment and income growth that has and is taking place will lead to further growth in consumer outlays. Reasons for continued optimism in New Jersey include increasing employment levels and a higher-than-national level of per capita personal income. Also, several expansions of existing hotel- casinos and plans for several new casinos in Atlantic City will mean additional job creation. While growth is likely to be slower than in the nation, the locational advantages that have served New Jersey well for many years will still be there. Structural changes that have been going on for years can be expected to continue, with job creation concentrated most heavily in the service industries. New Jersey's Budget and Appropriation System. New Jersey operates on a -------------------------------------------- fiscal year ending on June 30. The General fund is the fund into which all New Jersey revenues not otherwise restricted by statute are deposited and from which appropriations are made. The largest part of the total financial operations of New Jersey is accounted for in the General Fund, which includes revenues received from taxes and unrestricted by statute, most federal revenues, and certain miscellaneous revenue items. The Appropriation Acts enacted by the New Jersey Legislature and approved by the Governor provide the basic framework for the operation of the General Fund. The undesignated General Fund balance at year end for fiscal year 1995 was $569.2 million, for fiscal year 1996 was $442.0 million and for fiscal year 1997 was 280.5 million. For fiscal year 1998, the balance in the undesignated General Fund is estimated to be $143.9 million, subject to change upon completion of the year-end audit. The estimated balance for fiscal year 1999 is $198.9 million, based on the amounts contained in the fiscal year 1999 Appropriations Act. The fund balances are available for appropriation in succeeding fiscal years. Should revenues be less than the amount anticipated in the budget for a fiscal year, the Governor may by statutory authority prevent any expenditure under any appropriation. No supplemental appropriation may be enacted after adoption of an appropriation act except where there are sufficient revenues on hand or anticipated to meet such appropriation. In the past when actual revenues have been less than 37 the amount anticipated in the budget, the Governor has exercised plenary powers leading to, among other actions, a hiring freeze for all New Jersey departments and discontinuation of programs for which appropriations were budgeted but not yet spent. General Obligation Bonds. New Jersey finances capital projects primarily ------------------------ through the sale of its general obligation bonds. These bonds are backed by the full faith and credit of New Jersey. Tax revenues and certain other fees are pledged to meet the principal and interest payments required to pay the debt fully. The aggregate outstanding general obligation bonded indebtedness of New Jersey as of June 30, 1998 was $3.5729 billion. The appropriation for the debt service obligation on outstanding indebtedness is $501.1 million for fiscal year 1998. In addition to payment from bond proceeds, capital construction can also be funded by appropriation of current revenues on a pay-as-you-go basis. In fiscal year 1999 the amount appropriated to this purpose is $615.6 million. Tax and Revenue Anticipation Notes. In fiscal year 1992 New Jersey ---------------------------------- initiated a program under which it issued tax and revenue anticipation notes to aid in providing effective cash flow management to fund imbalances which occur in the collection and disbursement of the General Fund and Property Tax Relief Fund revenues. Such tax and revenue anticipation notes do not constitute a general obligation of New Jersey or a debt or liability within the meaning of the New Jersey Constitution. Such notes constitute special obligations of New Jersey payable solely from moneys on deposit in the General Fund and Property Tax Relief Fund and are legally available for such payment. "Moral Obligation" Financing. The authorizing legislation for certain New ---------------------------- Jersey entities provides for specific budgetary procedures with respect to certain obligations issued by such entities. Pursuant to such legislation, a designated official is required to certify any deficiency in a debt service reserve fund maintained to meet payments of principal 38 of and interest on the obligations, and a New Jersey appropriation in the amount of the deficiency is to be made. However, the New Jersey Legislature is not legally bound to make such an appropriation. Bonds issued pursuant to authorizing legislation of this type are sometimes referred to as "moral obligation" bonds. There is no statutory limitation on the amount of "moral obligations" bonds which may be issued by eligible New Jersey entities. As of June 30, 1998, outstanding "moral obligation" bonded indebtedness issued by New Jersey entities totaled $658,084,400 and maximum annual debt service subject to "moral obligation" is $81,577,873. New Jersey Housing and Mortgage Finance Agency. Neither the New Jersey ---------------------------------------------- Housing and Mortgage Finance Agency nor its predecessors, the New Jersey Housing Finance Agency and the New Jersey Mortgage Finance Agency, have had a deficiency in a debt service reserve fund which required New Jersey to appropriate funds to meet its "moral obligation". It is anticipated that this agency's revenues will continue to be sufficient to cover debt service on its bonds. South Jersey Port Corporation. New Jersey has previously provided the South ----------------------------- Jersey Port Corporation (the "Corporation") with funds to cover all debt service and property tax requirements, when earned revenues are anticipated to be insufficient to cover these obligations. For calendar years 1990 through 1998, New Jersey has made appropriations totalling $47,785,848.25 which covered deficiencies in revenues of the Corporation, for debt service and property tax payments. Higher Education Assistance Authority. The Higher Education Assistance ------------------------------------- Authority ("HEAA") has not had a revenue deficiency which required New Jersey to appropriate funds to meet its "moral obligation". It is anticipated that the HEAA's revenues will be sufficient to cover debt service on its bonds. Obligations Guaranteed by New Jersey. The New Jersey Sports and Exposition ------------------------------------ Authority ("NJSEA") has issued New Jersey guaranteed bonds of which $111,910,000 are outstanding as of June 30, 1998. To date, the NJSEA has not had a revenue deficiency requiring New Jersey to make debt service payments pursuant to its guarantee. It is anticipated that the NJSEA's revenues will continue to be sufficient to pay debt service on these bonds without recourse to New Jersey's guarantee. Obligations Supported by New Jersey Revenue Subject to Annual Appropriation. --------------------------------------------------------------------------- New Jersey has entered into a number of leases and contracts described below (collectively, the "Agreements") with several governmental authorities to secure the financing of various New Jersey projects. Under the terms of the Agreements, New Jersey has agreed to make payments equal to the debt service on, and other costs related to, the obligations sold to finance the projects. New Jersey's obligation to make payments under the Agreements is subject to and dependent upon annual appropriations being made by the New Jersey Legislature for such purposes. The New Jersey Legislature has no legal obligation to enact such appropriations, but has done so to date for all such obligations. New Jersey Economic Development Authority. Pursuant to legislation, the New ----------------------------------------- Jersey Economic Development Authority ("EDA") has been authorized to issue Economic Recovery Bonds, State Pension Funding Bonds and Market Transition Facility Bonds. The Economic Recovery Bonds have been issued pursuant to legislation enacted during 1992 to finance various economic development purposes. Pursuant to that legislation, the EDA and the New Jersey Treasurer entered into an agreement through which the EDA has agreed to undertake the financing of certain projects and the New Jersey Treasurer has agreed to credit to the Economic Recovery Fund from the General Fund amounts equivalent to payments due to New Jersey under an agreement with the Port Authority of New York and New Jersey subject to appropriation by the New Jersey Legislature. The State Pension Funding Bonds have been issued pursuant to legislation enacted in June 1997 to pay a portion of New Jersey's unfunded accrued pension liability for its retirement system, which together with amounts derived from the revaluation of pension assets pursuant to companion legislation enacted at the same time, will be sufficient to fully fund the unfunded accrued pension liability. 39 The Market Transition Facility Bonds have been issued pursuant to legislation enacted in June 1994 to pay the current and anticipated liabilities and expenses of the Market Transition Facility, which issued private passenger automobile insurance policies for drivers who could not be insured by private insurance companies on a voluntary basis. In addition, New Jersey has entered into a number of leases with the EDA relating to the financing of certain real property, office buildings and equipment for (i) the New Jersey Performing Arts Center; (ii) Liberty State Park in the City of Jersey City; (iii) various office buildings located in Trenton known as the Trenton Office Complex; (iv) a facility located in Trenton; and (v) certain energy saving equipment installed in various New Jersey office buildings. The rental payments required to be made by New Jersey under these lease agreements are sufficient to pay debt service on the bonds issued by the EDA to finance the acquisition and construction of such projects and other amounts payable to the EDA, including certain administrative expenses of the EDA. New Jersey Building Authority. Legislation enacted in 1981 established the New ----------------------------- Jersey Building Authority ("NJBA") to undertake the acquisition, construction, renovation and rehabilitation of various New Jersey office buildings, historic buildings, and correctional facilities. The NJBA finances the cost of such projects through the issuance of bonds, the payment of debt service on which is made pursuant to a lease between the NJBA and New Jersey. New Jersey Educational Facilities Authority. The New Jersey Educational ------------------------------------------- Facilities Authority issues bonds pursuant to three separate legislative programs, enacted in 1993 and 1997, to finance (i) the purchase of equipment to be leased to institutions of higher learning; (ii) grants to New Jersey's public and private institutions of higher education for the development, construction and improvement of instructional, laboratory, communication and research facilities; and (iii) grants to public and private institutions of higher education to develop a technology infrastructure within and among the State's institutions of higher education. New Jersey Sports and Exposition Authority. Legislation enacted in 1992 ------------------------------------------ authorizes the New Jersey Sports and Exposition Authority (the "NJSEA") to issue bonds for various purposes payable from a contract between the NJSEA and the New Jersey Treasurer (the "NJSEA State Contract"). Pursuant to the NJSEA State Contract, the NJSEA undertakes certain projects and the New Jersey Treasurer credits to the NJSEA amounts from the General Fund sufficient to pay debt service and other costs related to the bonds. State Transportation System Bonds. In July 1994, New Jersey created the New --------------------------------- Jersey Transportation Trust Fund Authority (the "TTFA"), an instrumentality of New Jersey pursuant to the New Jersey Transportation Trust Fund Authority Act of 1984, as amended (the "TTFA Act") for the purpose of funding a portion of New Jersey's share of the cost of improvements to its transportation system. Pursuant to the TTFA Act, the principal amount of the TTFA's bonds, notes or other obligations which may be issued in any fiscal year generally may not exceed $700 million plus amounts carried over from prior fiscal years. The debt issued by the TTFA are 40 special obligations of the TTFA payable from a contract among the TTFA, the New Jersey Treasurer and the Commissioner of Transportation. New Jersey Transit Corporation Hudson-Bergen Light Rail Transit System. The ---------------------------------------------------------------------- TTFA has entered into a Standby Deficiency Agreement (the "Standby Deficiency Agreement") with the trustee for grant anticipation notes (see "GANS") issued by New Jersey Transit Corporation ("NJT") for the financing of the construction of the Hudson-Bergen Light Rail Transit System. The GANS are primarily payable from federal grant monies. To the extent that the GANS are not paid by NJT from federal grant monies, the GANS are payable by the TTFA pursuant to the Standby Deficiency Agreement. To date, federal grant payments have been sufficient such that the TTFA has not been required to make payments pursuant to the Standby Deficiency Agreement. State of New Jersey Certificates of Participation. Beginning in April 1984, ------------------------------------------------- New Jersey, acting through the Director of the Division of Purchase and Property, has entered into a series of lease purchase agreements which provide for the acquisition of equipment, services and real property to be used by various departments and agencies of New Jersey. Certificates of Participation in such lease purchase agreements have been issued. A Certificate of Participation represents a proportionate interest of the owner thereof in the lease payments to be made by New Jersey under the terms of the lease purchase agreement. New Jersey Supported School and County College Bonds. Legislation provides for ---------------------------------------------------- future appropriations for New Jersey Aid to local school districts equal to debt service on bonds issued by such local school districts for construction and renovation of school facilities (P.L. 1968, c. 177; P.L. 1971, c. 10; and P.L. 1978, c. 74) and for New Jersey Aid to counties equal to debt service on bonds issued by counties for construction of county college facilities (P.L. 1971, c 12, as amended). The New Jersey Legislature has no legal obligations to make such appropriations, but has done so to date for all obligations issued under these laws. Community Mental Health Loan Program. The EDA issues revenue bonds from time ------------------------------------ to time on behalf of non-profit community mental health service providers. The payment of debt service on these revenue bonds as well as the payment of certain other provider expenses is made by New Jersey pursuant to service contracts between the State Department of Human Services and these providers. The contracts have one year terms, subject to annual renewal. State Pension Funding Bonds. Legislation enacted in June 1997 authorizes the --------------------------- EDA to issue bonds to pay a portion of New Jersey's unfunded accrued pension liability for New Jersey's retirement system (the "Unfunded Accrued Pension Liability"), which together with amounts derived from the revaluation of pension assets pursuant to companion legislation enacted at the same time, will be sufficient to fully fund the Unfunded Accrued Pension Liability. The Unfunded Accrued Pension Liability represents pension benefits earned in prior years which, pursuant to standard actuarial practices, are not yet fully funded. On June 30, 1997, the EDA issued $2,803,042,498.56 aggregate principal amount of State Pension Funding Bonds, Series 1997A-1997C. The EDA and the New Jersey Treasurer have entered 41 into an agreement which provides for the payment to the EDA of monies sufficient to pay debt service on the bonds. Such payments are subject to and dependent upon appropriations being made by the New Jersey Legislature. Municipal Finance. New Jersey's local finance system is regulated by various ----------------- statutes designated to assure that all local governments and their issuing authorities remain on a sound financial basis. Regulatory and remedial statutes are enforced by the Division of Local Government Services (the "Division") in the New Jersey State Department of Community Affairs. Counties and Municipalities. The Local Budget Law (N.J.S.A. 40A:4-1 et seq.) --------------------------- imposes specific budgetary procedures upon counties and municipalities ("local units"). Every local unit must adopt an operating budget which is balanced on a cash basis, and items of revenue and appropriation must be examined by the Director of the Division of Local Government Services in the Department of Community Affairs (the "Director"). The accounts of each local unit must be independently audited by a registered municipal accountant. New Jersey law provides that budgets must be submitted in a form promulgated by the Division and further provides for limitations on estimates of tax collection and for reserves in the event of any shortfalls in collections by the local unit. The Division reviews all municipal and county annual budgets prior to adoption for compliance with the Local Budget Law. The Director is empowered to require changes for compliance with law as a condition of approval; to disapprove budgets not in accordance with law; and to prepare the budget of a local unit, within the limits of the adopted budget of the previous year with suitable adjustments for legal compliance, if the local unit fails to adopt a budget in accordance with law. This process insures that every municipality and county annually adopts a budget balanced on a cash basis, within limitations on appropriations or tax levies, respectively, and making adequate provision for principal of and interest on indebtedness falling due in the fiscal year, deferred charges and other statutory expenditure requirements. The Director also oversees changes to local budgets after adoption as permitted by law, and enforces regulations pertaining to execution of adopted budgets and financial administration. In addition to the exercise of regulatory and oversight functions, the Division offers expert technical assistance to local units in all aspects of financial administration, including revenue collection and cash management procedures, contracting procedures, debt management and administrative analysis. The Local Government Cap Law (N.J.S.A. 40A:4-45.1 et seq.) (the "Cap Law") generally limits the year-to-year increase of the total appropriations of any municipality and the tax levy of any county to either 5 percent or an index rate determined annually by the Director, whichever is less. However, where the index percentage rate exceeds 5 percent, the Cap Law permits the governing body of any municipality or county to approve the use of a higher percentage rate up to the index rate. Further, where the index percentage rate is less than 5 percent, the Cap Law also permits the governing body of any municipality or county to approve the use of a higher percentage rate up to 5 percent. Regardless of the rate utilized, certain exceptions exist to the Cap Law's limitation on increases in appropriations. The principal exceptions to these limitations are municipal and county appropriations to pay debt service requirements; to comply with certain other New Jersey or federal mandates; appropriations of private and public dedicated funds; amounts approved by referendum; and, in the case of municipalities only, to fund the preceding year's cash deficit or to reserve for shortfalls in tax collections, and amounts required pursuant to contractual obligations for specified services. The Cap Law was re-enacted in 1990 with amendments and made a permanent part of the municipal finance system. New Jersey law also regulates the issuance of debt by local units. The Local Budget Law limits the amount of tax anticipation notes that may be issued by local units and requires the repayment of such notes within 120 days of the end of the fiscal year (six months in the case of the counties) in which issued. The Local Bond Law (N.J.S.A. 40A:2-1 et seq.) governs the issuance of bonds and notes by the local units. No local unit is permitted to issue bonds for the payment of current expenses (other than Fiscal Year Adjustment Bonds described more fully below). Local units may not issue bonds to pay outstanding bonds, except for refunding purposes, and then only with the approval of the Local Finance Board. Local units may issue bond anticipation notes for temporary periods not exceeding in the aggregate approximately ten years from the date of issue. The debt that any local unit may authorize is limited to a percentage of its equalized valuation basis, which is the average of the equalized value of all taxable real property and improvements within the geographic boundaries of the local unit, as annually determined by the Director of the Division of Taxation, for each of the three most recent years. In the calculation of debt capacity, the Local Bond Law and certain other statutes permit the deduction of certain classes of debt ("statutory deduction") from all authorized debt of the local unit ("gross capital debt") in computing whether a local unit has exceeded its statutory debt limit. Statutory deductions from gross capital debt consist of bonds or notes (i) authorized for school purposes by a regional school district or by a municipality or a school district with boundaries 42 coextensive with such municipality to the extent permitted under certain percentage limitations set forth in the School Bond Law (as hereinafter defined); (ii) authorized for purposes which are self liquidating, but only to the extent permitted by the Local Bond Law; (iii) authorized by a public body other than a local unit the principal of and interest on which is guaranteed by the local unit, but only to the extent permitted by law; (iv) that are bond anticipation notes; (v) for which provision for payment has been made; or (vi) authorized for any other purpose for which a deduction is permitted by law. Authorized net capital debt (gross capital debt minus statutory deductions) is limited to 3.5 percent of the equalized valuation basis in the case of municipalities and 2 percent of the equalized valuation basis in the case of counties. The debt limit of a county or municipality, with certain exceptions, may be exceeded only with the approval of the Local Finance Board. Chapter 75 of the Pamphlet Laws of 1991, signed into law on March 28, 1991, of New Jersey required certain municipalities and permits all other municipalities to adopt the New Jersey fiscal year in place of the existing calendar fiscal year. Municipalities that change fiscal years must adopt a six month transition year budget funded by Fiscal Year Adjustment Bonds. Notes issued in anticipation of Fiscal Year Adjustment Bonds, including renewals, can only be issued for up to one year unless the Local Finance Board permits the municipality to renew them for a further period of time. The Local Finance Board must confirm the actual deficit experienced by the municipality. The municipality may then issue Fiscal Year Adjustment Bonds to finance the deficit on a permanent basis. School Districts. New Jersey's school districts operate under the same ---------------- comprehensive review and regulation as do its counties and municipalities. Certain exceptions and differences are provided, but New Jersey supervision of school finance closely parallels that of local governments. All New Jersey school districts are coterminous with the boundaries of one or more municipalities. They are characterized by the manner in which the board of education, the governing body of the school districts takes office. Type I school districts, most commonly found in cities, have a board of education appointed by the mayor or the chief executive officer of the municipality constituting the school district. In a Type II school district, the board of education is elected by the voters of the district. Nearly all regional and consolidated school districts are Type II school districts. The New Jersey Department of Education has been empowered with the necessary and effective authority to abolish an existing school board and create a State- operated school district where the existing school board has failed or is unable to take the corrective actions necessary to provide a thorough and efficient system of education in that school district pursuant to N.J.S.A. 18A:7A-15 et seq. (the "School Intervention Act"). The State-operated school district, under the direction of a New Jersey appointed superintendent, has all of the powers and authority of the local board of education and of the local district superintendent. Pursuant to the authority granted under the School Intervention Act, on October 4, 1989, the New Jersey Board of Education ordered the creation of a State-operated school district in the city of Jersey City. Similarly, on August 7, 1991, the New Jersey Board of Education ordered the creation of a State-operated school district in the City of Paterson, and on July 5, 1995 the creation of a State-operated school district in the City of Newark. School Budgets. In every school district having a board of school estimate, -------------- the board of school estimate examines the budget request and fixes the appropriate amounts for the next year's operating budget after a public hearing at which the taxpayers and other interested persons shall have an opportunity to raise objections and to be heard with respect to the budget. This board certifies the budget to the municipal governing bodies and to the local board of education. If the local board of education disagrees, it must appeal to the New Jersey Commissioner of Education (the "Commissioner") to request changes. In a Type II school district without a board of school estimate, the elected board of education develops the budget proposal and, after public hearing, submits it to the voters of such district for approval. Previously authorized debt service is not subject to referendum in the annual budget process. If approved, the budget goes into effect. If defeated, the governing body of each municipality in the school district has until May 19 in any year to determine the amount necessary to be appropriated for each item appearing in such budget. Should the governing body fail to certify any amount determined by the board of education to be necessary, the board of education may appeal the action to the Commissioner. 43 The State laws governing the distribution of State aid to local school districts limit the annual increase of a school district's net current expense budget. The Commissioner certifies the allowable amount of increase for each school district but may grant a higher level of increase in certain limited instances. A school district may also submit a proposal to the voters to raise amounts above the allowable amount of increase. If defeated, such a proposal is subject to further review or appeal to the Commissioner only if the Commissioner determines that additional funds are required to provide a thorough and efficient education. In State-operated school districts the New Jersey District Superintendent has the responsibility for the development of the budget subject to appeal by the governing body of the municipality to the commissioner and the Director of the Division of Local Government Services in the New Jersey Department of Community Affairs. Based upon his review, the Director is required to certify the amount of revenues which can be raised locally to support the budget of the State- operated district. Any difference between the amount which the Director certifies and the total amount of local revenues required by the budget approved by the commissioner is to be paid by New Jersey in the fiscal year in which the expenditure are made subject to the availability of appropriations. School District Bonds. School district bonds and temporary notes are issued --------------------- in conformity with N.J.S.A. 18A:24-1 et seq. (the "School Bond Law"), which closely parallels the Local Bond Law (for further information relating to the Local Bond Law, see "Municipal Finance-Counties and Municipalities" herein). Although school districts are exempted from the 5 percent down payment provision generally applied to bonds issued by municipalities and counties, they are subject to debt limits (which vary depending on the type of school system provided) and to New Jersey regulation of their borrowing. The debt limitation on school district bonds depends upon the classification of the school district, but may be as high as 4 percent of the average equalized valuation basis on the constituent municipality. In certain cases involving school districts in cities with populations exceeding 150,000, the debt limit is 8 percent of the average equalized valuation basis of the constituent municipality, and in cities with population in excess of 80,000 the debt limit is 6 percent of the aforesaid average equalized valuation. School bonds are authorized by (i) an ordinance adopted by the governing body of a municipality within a Type I school district; (ii) adoption of a proposal by resolution by the board of education of a Type II school district having a board of school estimate; (iii) adoption of a proposal by resolution by the board of education and approval of the proposal by the legal voters of any other Type II school district; or (iv) adoption of a proposal by resolution by a capital project control board for projects in a State operated school district. If school bonds will exceed the school district borrowing capacity, a school district (other than a regional school district) may use the balance of the municipal borrowing capacity. If the total amount of debt exceeds the school district's borrowing capacity, the Commissioner and the Local Finance Board must approve the proposed authorization before it is submitted to the voters. All authorizations of debt in a Type II school district without a board of school estimate require an approving referendum, except where, after hearing, the Commissioner and the New Jersey Board of Education determine that the issuance of such debt is necessary to meet the constitutional obligation to provide a thorough and efficient system of public schools. When such obligations are issued, they are issued by, and in the name of, the school district. In Type I and II school districts with a board of school estimate, that board examines the capital proposal of the board of education and certifies the amount of bonds to be authorized. When it is necessary to exceed the borrowing capacity of the municipality, the approval of a majority of the legally qualified voters of the municipality is required, together with the approval of the Commissioner and the Local Finance Board. When such bonds are issued by a Type I school district, they are issued by the municipality and identified as school bonds. When bonds are issued by a Type II school district having a board of school estimate, they are issued by, and in the name of, the school district. All authorizations of debt must be reported to the Division of Local Government Services by a supplemental debt statement prior to final approval. School District Lease Purchase Financings. In 1982, school districts were ----------------------------------------- given an alternative to the traditional method of bond financing capital improvements pursuant to N.J.S.A. 18A:20-4.2(f) (the "Lease Purchase Law"). The Lease Purchase Law permits school districts to acquire a site and school building through a lease purchase agreement with a private lessor corporation. The lease purchase agreement does not require voter approval. The rent payments attributable to the lease purchase agreement are subject to annual appropriation by the school district and are required to be included in the annual current expense budget of the school district. Furthermore, the rent payments attributable to the lease 44 purchase agreement do not constitute debt of the school district and therefore do not impact on the school district's debt limitation. Lease purchase agreements in excess of five years require the approval of the Commissioner and the Local Finance Board. Qualified Bonds. In 1976, legislation was enacted (P.L. 1976, c. 38 and c. --------------- 39) which provides for the issuance by municipalities and school districts of "qualified bonds". Whenever a local board of education or the governing body of a municipality determines to issue bonds, it may file an application with the Local Finance Board, and, in the case of a local board of education, the Commissioner, to qualify bonds pursuant to P.L. 1976 c. 38 or c. 39. Upon approval of such an application, the New Jersey Treasurer shall, in the case of qualified bonds for school districts, withhold from the school aid payable to such municipality or school district and, in the case of qualified bonds for municipalities, withhold from the amount of business personal property tax replacement revenues, gross receipts tax revenues, municipal purposes tax assistance fund distributions, New Jersey urban aid, New Jersey revenue sharing, and any other funds appropriated as New Jersey aid and not otherwise dedicated to specific municipal programs, payable to such municipalities, an amount sufficient to cover debt service on such bonds. These "qualified bonds" are not direct, guaranteed or moral obligations of New Jersey, and debt service on such bonds will be provided by New Jersey only if the above mentioned appropriations are made by New Jersey. Total outstanding indebtedness for "qualified bonds" consisted of $327,981,850 by various school districts as of June 30, 1998 and $932,410,709 by various municipalities as of June 30, 1998. New Jersey School Bond Reserve Act. The New Jersey School Bond Reserve Act ---------------------------------- (N.J.S.A. 18A:56-17 et seq) establishes a school bond reserve within the constitutionally dedicated Fund for the Support of Free Public Schools. Under this law the reserve is maintained at an amount equal to 1.5 percent of the aggregate outstanding bonded indebtedness of counties, municipalities or school districts for school purposes (exclusive of bonds whose debt service is provided by New Jersey appropriations), but not in excess of monies available in such Fund. If a municipality, county or school district is unable to meet payment of the principal of or interest on any of its school bonds, the trustee of the school bond reserve will purchase such bonds at the face amount thereof or pay the holders thereof the interest due or to become due. There has never been an occasion to call upon this Fund. New Jersey provides support of certain bonds of counties, municipalities and school districts through various statutes. Local Financing Authorities. The Local Authorities Fiscal Control Law --------------------------- (N.J.S.A. 40A:5A-1 et seq.) provides for state supervision of the fiscal operations and debt issuance practices of independent local authorities and special taxing districts by the New Jersey Department of Community Affairs. The Local Authorities Fiscal Control Law applies to all autonomous public bodies created by counties or municipalities, which are empowered to issue bonds, to impose facility or service charges, or to levy taxes in their districts. This encompasses most autonomous local authorities (sewerage, municipal utilities, parking, pollution control, improvement, etc.) and special taxing districts (fire, water, etc.). Authorities which are subject to differing New Jersey or federal financial restrictions are exempted, but only to the extent of that difference. Financial control responsibilities over local authorities and special districts are assigned to the Local Finance Board and the Director of the Division of Local Government Services. The Local Finance Board exercises approval over creation of new authorities and special districts as well as their dissolution. The Local Finance Board reviews, conducts public hearings and issues findings and recommendations on any proposed project financing of an authority or district, and on any proposed financing agreement between a municipality or county and an authority or special district. The Local Finance Board prescribes minimum audit requirements to be followed by authorities and special districts in the conduct of their annual audits. The Director of the Division of Local Government Services reviews and approves annual budgets of authorities and special districts. LITIGATION. At any given time, there are various numbers of claims and cases pending against the State of New Jersey, New Jersey agencies and employees, seeking recovery of monetary damages that are primarily paid out of the fund created pursuant to the New Jersey Tort Claims Act (N.J.S.A. 59:1-1 et seq.). New Jersey does not formally estimate its reserve representing potential exposure for these claims and cases. New Jersey is unable to estimate its exposure for these claims and cases. New Jersey routinely receives notices of claim seeking substantial sums of money. The majority of those claims have historically proven to be of substantially less value than the amount originally claimed. Under the New Jersey Tort Claims Act, 45 any tort litigation against New Jersey must be preceded by a notice of claim, which affords New Jersey the opportunity for a six-month investigation prior to the filing of any suit against it. At any given time, there are various numbers of claims and cases pending against the University of Medicine and Dentistry and its employees, seeking recovery of monetary damages that are primarily paid out of the Self Insurance Reserve Fund created pursuant to the New Jersey Tort Claims Act. An independent study estimated an aggregate potential exposure of $85,300,000 for tort and medical malpractice claims pending as of December 31, 1997. In addition, at any given time, there are various numbers of contract and other claims against the University of Medicine and Dentistry, seeking recovery of monetary damages or other relief which, if granted, would require the expenditure of funds. New Jersey is unable to estimate its exposure for these claims. Other lawsuits presently pending or threatened in New Jersey has the potential for either a significant loss of revenue or a significant unanticipated expenditures include the following: Interfaith Community Organization v. Shinn, a suit filed by a coalition of churches and church leaders in Hudson County against the Governor, the Commissioners of the Department of Environmental Protection and the Department of Health, concerning chromium contamination in Liberty State Park in Jersey City. American Trucking Associations, Inc. and Tri-State Motor Transit Co. v. State of New Jersey, challenging the constitutionality of annual hazardous and solid waste licensure fees collected by the Department of Environmental Protection, seeking permanent injunction enjoining future collection of fees and refund of all renewal fees, fines and penalties collected. Buena Regional Commercial Township et al. v. New jersey Department of Education et al. This lawsuit was filed on behalf of 17 rural school districts seeking the same type of relief as has been mandated to be provided to the poor urban school districts in Abbot v. Burke, which included, without limitation, sufficient funds to allow the school districts to spend at the average of wealthy suburban school districts, to implement additional programs and to upgrade school facilities. The Buena school districts are seeking to be treated as special needs districts and to receive parity funding the with Abbot school districts as a remedial measure. They also are seeking additional funding as may be necessary to provide an educational equivalent to that being provided in the Abbot districts. Berner Stabaus, et al. v. State of New Jersey, et al. Plaintiffs, 25 middle income school districts, have filed a complaint alleging that New Jersey's system of funding for their schools is violative of the constitutional rights of equal protection and a thorough and efficient education. Affiliated FM Insurance Company v. State of New Jersey, an action by certain members of the New Jersey Property-Liability Insurance Guaranty Association challenging the constitutionality of assessments used for the Market Transition Fund and seeking repayment of assessments paid since 1990. 46 On July 28, 1997, the court denied plaintiff's application for emergent relief, denied New Jersey's motion for summary disposition and granted plaintiff's motion to accelerate. The Appellate Division has affirmed the assessment. Appellant's petition for certification to the New Jersey Supreme Court has been denied. C.F. v. Terhune (formerly Fauver) a class action in federal district court by prisoners with serious mental disorders who are confined within the facilities of the New Jersey Department of Corrections seeking injunctive relief in the form of changes to the manner in which the mental health services are provided to inmates. Cleary v. Waldman, the plaintiffs claim that the Medicare Catastrophic Coverage Act, providing funds to spouses of institutionalized individuals sufficient funds to live in the community, requires that a certain system be used to provide the funds and another system is being used instead. Estimate of exposure if the Court were to find for the plaintiffs are in the area of $50 million per year from both New Jersey and Federal sources combined. Plaintiffs motion for a preliminary injunction was denied and is being appealed. Subsequently, plaintiffs filed for class certification which was granted. United Hospitals v. State of New Jersey 18 New Jersey hospitals are challenging the Medicaid reimbursements made since February 1995 claiming that New Jersey failed to comply with certain federal requirements, the reimbursements regulations are arbitrary, capricious and unreasonable, rates were incorrectly calculated, the hospitals were denied due process, the Medicaid reimbursement provisions violate the New Jersey Constitution, and Medicaid State Plan was violated by the New Jersey Department of Human Services implementation of hospital rates in 1995 and 1996. Trump Hotels & Casino Resorts, Inc. v. Mirage Resorts Incorporated, the plaintiff is suing Mirage Resorts and New Jersey in an attempt to enjoin their efforts to build a highway and tunnel funded by Mirage Resorts and $55 million in bonds collateralized by future casino obligations, claiming that the project violates the New Jersey Constitution provision that requires all revenues the state receives from gaming operations to benefit the elderly and disabled. The plaintiff also claims (i) the failure to disclose this constitutional infirmity is a material omission within the meaning of Rule 10B-5 of the Securities and Exchange Act of 1934, (ii) the defendants have sought to avoid the requirements of the Clean Water Act, Clean Air Act, Federal Highway Act and the New Jersey Coastal Area Facility Review Act. On May 1, 1997, the federal district court granted the defendants' motion to dismiss and the Third Circuit has affirmed the District Court's determinations. In a related action, State of New Jersey v. Trump Hotels & Casino Resorts, Inc., New Jersey filed a declaratory judgment action seeking a declaration that the use of certain funds New Jersey statutory provisions existed that permitted use of certain funds to be used for other purposes than the elderly or disabled. Declaratory judgment was entered in favor of New Jersey on May 14, 1997 and the Appellate Division has affirmed the decision on April 8, 1998. United Alliance v. State of New Jersey, plaintiffs allege that the Casino Reinvestment Development Authority funding mechanisms are illegal including the gross receipts tax, the parking tax, and the Atlantic City fund. This matter has been placed on the inactive list. Five additional cases have been filed in opposition to the road and tunnel project which also contain related challenges. Merolla and Brandy v. Casino Reinvestment Development Authority, Middlesex County v. Casino Reinvestment Development Authority, Gallagher v. Casino Reinvestment Development Authority and George Harms v. State of New Jersey. Summary judgment has been granted in favor of the New Jersey or its agencies in Merolla, Middlesex and Gallagher but the plaintiffs have filed an appeal. Blecker v. State of New Jersey, a class action filed on behalf of providers of medicare Part B services to Qualified Medicare Beneficiaries seeking reimbursement for Medicare co-insurance and deductibles not paid by the New Jersey Medicaid program from 1988 to February 10, 1995. Plaintiffs claim a breach of contract and violation of federal civil rights laws. On August 11, 1997, New Jersey filed a motion to dismiss the matter and on September 15, 1997, it filed a motion for summary judgement. Both motions were granted on April 3, 1998 and the plaintiff has filed an appeal. 47 Camden County Energy Recovery Associates v. New Jersey Department of Environmental Protection, the plaintiff owns and operates a resource facility in Camden County and has filed suit seeking to have the solid waste reprocurement process halted to clarify bid specification. The court did not halt the bid process but did require clarifications. Co-defendant Pollution Control Financing Authority of Camden County counterclaimed, seeking reformation of the contract between it and the plaintiff and cross-claimed against New Jersey for contribution and indemnification. Communications Workers of America, et al. v. James A. DiEleuterio, Jr., et al. Appellants in this case have filed an appeal from the decision of the New Jersey Treasurer to award a contract for the design, construction, and operation and maintenance of the New Jersey motor vehicle inspection system. New Jersey estimates that unless the new inspection system is operational by December 12, 1999, New Jersey may be exposed to significant federal sanctions, including the loss of federal transportation funds and the federal imposition of stricter pollution standards that will restrict economic development in New Jersey. Sojourner A. et al. v. Dept. of Human Services. The plaintiffs in this action filed a complaint and motion for preliminary injunction, seeking damages and declaratory and injunctive relief overturning, on New Jersey Constitutional grounds, the "family cap" provisions of the New Jersey Work First New Jersey Act N.J.S.A. 44:10-1 et seq. SPECIAL CONSIDERATIONS REGARDING INVESTMENT IN DELAWARE STATE-SPECIFIC OBLIGATIONS. The concentration of investments in Delaware State-Specific Obligations by the Delaware Tax-Free Income Portfolio raises special investment considerations. In particular, changes in the economic condition and governmental policies of Delaware and its political subdivisions, agencies, instrumentalities and authorities could adversely affect the value of the Delaware Tax-Free Income Portfolio. This section briefly describes current economic trends in Delaware. The information set forth in this section relates only to the State itself and not to the special purpose or local government units whose issues may also be held by the Delaware Tax-Free Income Portfolio. The credits represented by such issuers may be affected by a wide variety of local factors or structuring concerns, and no disclosure is made herein relating to such matters. Delaware has enjoyed expansion throughout most sectors of its economy during the 1990s. Much of Delaware's success in maintaining a healthy economy over this time period can be attributed to efforts to diversify its economic base. Delaware's employment base has expanded beyond its historical emphasis in chemical and automobile manufacturing to include strong banking and service sectors. According to recent Dun & Bradstreet figures, Delaware has the lowest business failure rate in the United States. Delaware has experienced above-average population growth through the 1990s. Net immigration accounts for a significant share of the growth. Delaware's total personal income grew 7.1% in 1996, compared with 4.9% for the Mid-Atlantic region and 5.6% for the nation. Delaware's non-agricultural employment accounts for approximately 98% of the workforce. In 1997, a 3.2% increase in non- agricultural employment occurred (greater than the 1.7% increase for the mid- Atlantic region and the 2.3% increase for the nation). The State's unemployment rate for 1997 was 4% lower than both the Mid-Atlantic region rate and the national rate. The State's general obligation debt outstanding was $626.7 million on December 31, 1997, with approximately 80% scheduled to mature within ten years and approximately 95% scheduled to mature within fifteen years. The State's general obligation debt outstanding was $686.1 million on June 30, 1998. Delaware's debt burden reflects the centralized role of the State government in undertaking capital projects typically funded at local government levels elsewhere, such as highways, correctional facilities and schools. There is no state constitutional debt limit applicable to Delaware. However, Delaware has instituted several measures designed to manage and reduce its indebtedness. In 1991, the State enacted legislation putting a three-part debt limit in place, one part of which restricts new debt authorization to 5% of the budgetary General Fund revenue as projected on June 30 for the next fiscal year. Delaware voluntarily retires its general obligation debt. Delaware has 48 implemented and maintained a "pay-as-you-go" financing program for capital projects. In fiscal 1986, 1989 and 1996, available cash was used to defease an aggregate of $69.4 million of high coupon general obligation debt. In fiscal 1997, $10 million of previously authorized general obligation bonds were deauthorized. Delaware has also undertaken a series of bond refundings to lower the overall debt service on its obligations. Delaware budgets and controls its financial activities on the cash basis of accounting. State law requires Delaware to record its financial transactions in either of two major categories -- the budgetary General Fund or the budgetary Special Funds. The General Fund provides for the cost of the State's general operations and is credited with all tax and other revenue of Delaware not dedicated to Special Funds. All disbursements from the General Fund must be authorized by appropriations of the Delaware General Assembly. The Special Funds are designated for specific purposes, and the appropriate fund is credited with the tax or other revenue allocated to such fund and is charged with the related disbursements. The principal receipts credited to the appropriate Special Fund are unemployment insurance taxes, transportation-related taxes for the Transportation Trust Fund, certain taxes on insurance companies and property taxes levied by local school districts. The Delaware Constitution limits annual appropriations by majority vote of both houses of the General Assembly to 98% of estimated budgetary General Fund revenue plus the unencumbered budgetary General Fund balance, if any, from the previous year. The State Constitution also provides for the deposit of the excess of any unencumbered budgetary General Funds at the end of the fiscal year into a reserve account (the "Budget Reserve Account"), provided that the amount of the Budget Reserve Account does not exceed 5% of the estimated appropriations used to determine the appropriation limit for that fiscal year. Transfers of $100.9 million were made to fund the Budget Reserve Account in fiscal 1998. The Budget Reserve Account provides a cushion and money from the account can be accessed only with the approval of a three-fifths vote of each house of the General Assembly and only to fund an unanticipated budgetary General Fund deficit or to provide funds required as a result of the enactment of legislation causing a reduction in revenue. Delaware concluded fiscal year 1998 with a cumulative cash balance of $539 million. This balance reflects an increase from the fiscal year 1997 cumulative cash balance of $392.8 million. At the conclusion of fiscal year 1998, the Budget Reserve Account contained an unencumbered cash balance of $214.2 million. These results are presented on a budgetary basis. Accounting principles applied to develop data on a budgetary basis differ from those principles used to present financial statements in conformity with generally accepted accounting principles (GAAP). The principal source of Delaware revenue is personal income tax. Delaware does not levy ad valorem taxes on real or personal property and does not impose a general sales or use tax. In May 1980, the Delaware Constitution was amended to limit tax and license fee increases and the imposition of new taxes or fees. Any tax or license fee increase or new tax or license fee must be passed by a three-fifths vote of each house of the General Assembly, rather than by a simple majority vote. Certain litigation is pending against the State. From time to time Delaware has been and may continue to be a defendant in various suits alleging matters such as wrongful discharge, use of excessive force by State police officers, sexual assault, civil rights violations and discrimination claims. The State believes that it has valid defenses to all currently pending actions; however, the State has potential liability exposure. Delaware is exposed to risks and losses related to employee health and accident, worker's compensation, environmental and a portion of property and casualty claims. Delaware does not purchase commercial insurance to cover these risks because of prohibitive costs. The State covers all claim settlements or judgments from its budgetary General Fund. It continues to carry commercial insurance for all other risks. SPECIAL CONSIDERATIONS REGARDING INVESTMENTS IN KENTUCKY STATE-SPECIFIC OBLIGATIONS. Kentucky is a leader among the states in the production of coal and tobacco. The Coal Severance Tax is a significant revenue producer for the Commonwealth and its political subdivisions, and any substantial decrease in the amount of coal or other minerals produced could 49 result in revenue shortfalls. Additionally, any federal legislation or litigation adversely affecting the tobacco and/or cigarette industries would have a negative impact on Kentucky's economy. There is significant diversification in Kentucky's manufacturing sector, which includes, among other things, tobacco processing plants, distilleries and durable goods production. No single segment of the Commonwealth's economy consists of as much as one-fourth of the overall state domestic product. The Commonwealth continues to experience a high unemployment rate in non-urbanized areas. Although revenue obligations of the Commonwealth or its political subdivisions may be payable from a specific project, there can be no assurances that economic difficulties and the resulting impact on state and local government finances will not adversely affect the market value of Kentucky State-Specific Obligations or the ability of the respective entities to pay debt service. Because of constitutional limitations, the Commonwealth cannot enter into a financial obligation of more than two year's duration, and, until recently, no other municipal issuer within the Commonwealth could enter into a financial obligation of more than one year's duration. As a consequence, the payment and security arrangements applicable to Kentucky State-Specific Obligations differ significantly from those generally applicable to municipal revenue obligations in other states. The Kentucky General Assembly enacted legislation in 1996 pursuant to an amendment to the Kentucky Constitution permitting local governments to issue general obligation indebtedness without voter approval, but subject to prescribed limitations on the maximum amount of indebtedness that may be incurred based on the assessed value of taxable property within the jurisdiction and other limitations and conditions. A final judgment of the Kentucky courts upheld the validity of the constitutional amendment, and local governments have now begun to issue general obligation indebtedness. The Kentucky Tax-Free Income Portfolio will invest primarily in Kentucky State-Specific Obligations. Such obligations generally include tax-free securities issued by the Commonwealth of Kentucky ("Kentucky" or the "Commonwealth"), its counties and various other local authorities to finance such long-term public purpose projects as schools, universities, housing, transportation, utilities, hospitals and water and sewer facilities throughout the Commonwealth. Kentucky is a leader among the states in the production of coal. Tobacco is the dominant agricultural product, and Kentucky ranks second among the U.S. in the total cash value of tobacco raised. Potential federal regulation of the tobacco industry, including action by Congress and the recent settlement agreement between the states and the tobacco industry may impact the tobacco industry, though the degree of the impact cannot be predicted with any certainty. The Commonwealth's economy in many ways resembles a scaled-down version of the U.S. economy in its diversity. The Kentucky economy, once dominated by coal, horses, bourbon and tobacco has become more diversified and now includes manufacturing of industrial machinery, automobiles and automobile parts, consumer appliances, and nondurable goods such as apparel. In addition, Kentucky's non-manufacturing industries have grown in recent years, with gains in air transportation, health and business services, and retail trade. The Commonwealth's parks, horse breeding and racing industry, symbolized by the Kentucky Derby, play an important role in expanding the tourism industry in the Commonwealth. Kentucky now ranks fourth among all U.S. auto-producing states and four of the current top-selling vehicles manufactured in the U.S. are manufactured in Kentucky. No single segment of the economy of Kentucky accounts for as much as one fourth of the overall Commonwealth domestic product. The economy is diversified to the extent that an economic decline in a single segment would not necessarily lead to the non-payment of debt service on Kentucky State-Specific Obligations. A national economic decline, however, could impact the ability of issuers to pay debt service, if the decline impacted various segments within the Commonwealth. Economic problems include a continuing high unemployment rate in the non- urbanized areas of the Commonwealth. The Coal Severance Tax is a significant revenue producer for the Commonwealth and its political subdivisions, and any substantial decrease in the amount of coal or other minerals produced could result in revenue shortfalls. Additionally, any Federal legislation adversely affecting the tobacco industry would have a negative impact on Kentucky's economy. Although revenue obligations of the Commonwealth or its political subdivisions may be payable from a specific project, there can be no assurances that further economic difficulties and the resulting impact on state and local government finances will not adversely affect the market value of the obligations issued by the Commonwealth and its political subdivisions or the ability of the respective entities to pay debt service on their obligations. The Commonwealth relies heavily upon sales and use taxes, individual income taxes, property taxes, corporate income taxes, insurance premium taxes, alcoholic beverage taxes, corporate license taxes, cigarette taxes, mineral severance taxes, motor fuel 50 taxes, motor vehicle usage taxes and horse racing taxes for its revenue. The cities, counties and other local governments are essentially limited to property taxes, occupational license taxes, utility taxes, transit and restaurant meals taxes and various license fees for their revenue. Kentucky State-Specific Obligations are subject to the risks of general economic and other factors as well. There are several general types of Kentucky State-Specific Obligations. General obligation securities are secured by the issuer's pledge of its full faith, credit and/or taxing power for the payment of principal and interest. General obligation securities of the Commonwealth are rare since they must be authorized by a two-thirds vote of the electorate of the issuer. As a consequence, the Commonwealth cannot enter into a final obligation of more than two years duration. Local governments have only recently begun to issue to general obligation indebtedness. Revenue obligations are payable from and secured by a particular revenue stream, such as lease rentals, utility usage and connection charges, student registration or housing fees, bridge or highway tolls, parking fees and sports event gate receipts. Although industrial building revenue obligations are issued by municipal authorities, they are secured by revenue derived from some form of contractual arrangement with a non- governmental user. Some revenue obligations, including industrial building revenue obligations, are secured by a mortgage on the real property. Improvement assessment obligations are obligations secured by a special assessment (e.g., a sewer charge) that the governmental issuer imposes on each owner of property benefitted by the improvement (e.g., a sanitary sewer project). The assessments are similar to taxes and have a priority which is similar to a tax lien. Refunded or defeased bonds are secured by an escrow fund, which usually is invested in United States government securities and occasionally in bank certificates of deposit or similar instruments. Housing obligations are usually secured by mortgages pledged for the payment of the obligations. Local housing authorities sometimes issue obligations that are secured by rentals from the operation of a housing project. Housing obligations may also have additional security in the form of federal guarantees of the mortgages or rentals constituting the primary security. There are variations in the security of Kentucky State-Specific Obligations, both within a particular classification and between classifications, depending on numerous factors. For example, most local school construction is financed from obligations nominally issued by a larger city or county government, which holds legal title to the school, subject to a year-to-year renewable leaseback arrangement with the local school district. However, there is no reported instance in which a Kentucky school bond has gone into default. Similar arrangements are used to finance many city and county construction projects but in these cases, the obligations are nominally issued in the name of a public corporation, which holds title to the project and leases the project back to the city or county on a year-to-year renewable basis. In such situations, the rent that the nominal issuer receives from the actual user of the property financed by the obligations is the only source of any security for the payment of the obligations. Overview of the Commonwealth's Debt Authorities. The Commonwealth's ----------------------------------------------- indebtedness is comprised of obligations which are either direct obligations of the Commonwealth or obligations of one of the debt-issuing entities created by the legislature to finance various projects or programs. Direct debt is general obligation debt that pledges the full faith, credit, and taxing powers of the Commonwealth as security for the repayment of the debt. There are currently no general obligations outstanding. The second type of debt incurred by the Commonwealth is project revenue debt. Project revenue debt pledges as security for repayment of the debt only the revenues produced by the projects funded from the debt. Project revenue obligations are not a direct obligation of the Commonwealth. Project revenues are, in some cases, derived partially, or solely, from legislative appropriations which are subject to biennial renewal. In other cases, revenues generated from the project financed by the debt are used to make the debt service payments in full. The third type of debt incurred by the Commonwealth is moral obligation debt. These obligations are not direct obligations of the Commonwealth and no appropriations of the Commonwealth are pledged to pay the debt service. Rather these entities covenant to request funds from the Governor and the legislature in the event of a shortfall in the debt service. The entities which utilize this process are discussed in the following section. 51 Debt Issuing Entities of the Commonwealth. Project revenue debt has been ----------------------------------------- incurred by seventeen of the commissions, corporations, authorities, or boards created by the Commonwealth. Seven of the debt issuing authorities issue obligations to finance projects that are not repaid by Commonwealth revenues. These are the Kentucky Housing Corporation, the Kentucky Infrastructure Authority, the Kentucky Higher Education Student Loan Corporation, the School Facilities Construction Commission, the Kentucky Economic Development Finance Authority, the Kentucky Local Correctional Facilities Construction Authority and the Kentucky Agricultural Finance Corporation. None of these entities, except for some of the obligations of the School Facilities Construction Commission and the Kentucky Infrastructure Authority, receive appropriations for the payment of debt service. Project revenues are used to repay debt service for these debt authorities. The legislature has placed specific debt limitations on the principal debt outstanding of the Kentucky Housing Corporation ($1.125 billion), the Kentucky Higher Education Student Loan Corporation ($553 million) and the Kentucky Agricultural Finance Corporation ($500 million). The debt of the Kentucky Local Correctional Facilities Construction Authority is limited to the level of debt service supported by a fee collected from certain cases in the District Courts of the Commonwealth. Currently, no debt limitation exists for the Kentucky Economic Development Finance Authority. The remaining debt issuing entities of the Commonwealth receive a appropriations biennially for the payment of debt service. The appropriation to the School Facilities Construction Commission is used to subsidize the debt service payments, in whole or in part, made by local school districts on local school construction projects. The subsidy has varied by project. Two financing programs of the Kentucky Infrastructure Authority, the Governmental Agencies Program and the Multiple Projects Construction Loan Program, receive no appropriations and have a debt ceiling. The three other financing programs of the Kentucky Infrastructure Authority, the Federally Assisted Wastewater Program, the Infrastructure Revolving Fund Program and the Solid Waste Revolving Loan and Grant Program, have been appropriated monies. The State Property and Buildings Commission, the Turnpike Authority of Kentucky and the State Universities cannot incur debt for any project without prior approval of the projects and appropriation of debt service by the legislature. In 1997, the Commonwealth created the Kentucky Asset/Liability Commission to develop and implement programs to assist in the management of the Commonwealth's net interest margin, and it may issue tax and revenue anticipation notes project notes, and funding notes to achieve its purpose. Default Record. Neither the Commonwealth nor any of its agencies have ever -------------- defaulted in the payment of principal or interest on general obligation indebtedness or project revenue obligations. ADDITIONAL INVESTMENT LIMITATIONS Each Portfolio is subject to the investment limitations enumerated in this subsection which may be changed with respect to a particular Portfolio only by a vote of the holders of a majority of such Portfolio's outstanding shares (as defined below under "Miscellaneous"). The Index Master Portfolio's fundamental investment limitations are described separately. MONEY MARKET PORTFOLIOS: 1) Each of the Money Market, Municipal Money Market and U.S. Treasury Money Market Portfolios may not purchase securities of any one issuer (other than securities issued or guaranteed by the U.S. Government, its agencies or instrumentalities or certificates of deposit for any such securities) if more than 5% of the value of the Portfolio's total assets (taken at current value) would be invested in the securities of such issuer, or more than 10% of the issuer's outstanding voting securities would be owned by the Portfolio or the Fund, except that up to 25% of the value of the Portfolio's total assets (taken at current value) may be invested without regard to these limitations. For purposes of this limitation, a security is considered to be issued by the entity (or entities) whose assets and revenues back the security. A guarantee of a security is not deemed to be a security issued by the guarantor when the value of all securities issued and guaranteed by the guarantor, and owned by the Portfolio, does not exceed 10% of the value of the Portfolio's total assets. 2) No Portfolio may borrow money or issue senior securities, except that each Portfolio may borrow from banks and (other than a Municipal Money Market Portfolio) enter into reverse repurchase agreements for temporary purposes in amounts up to one-third of the value of its total assets at the time of such borrowing; or mortgage, pledge or hypothecate any assets, except in connection with any such borrowing and then in amounts not in excess of one-third of the value of the Portfolio's total assets at the time of such borrowing. No Portfolio will purchase securities while its aggregate borrowings (including reverse repurchase 52 agreements and borrowings from banks) in excess of 5% of its total assets are outstanding. Securities held in escrow or separate accounts in connection with a Portfolio's investment practices are not deemed to be pledged for purposes of this limitation. 3) Each of the Municipal Money Market, U.S. Treasury Money Market, Ohio Municipal Money Market, Pennsylvania Municipal Money Market, North Carolina Municipal Money Market, Virginia Municipal Money Market and New Jersey Municipal Money Market Portfolios may not purchase securities which would cause 25% or more of the value of its total assets at the time of purchase to be invested in the securities of one or more issuers conducting their principal business activities in the same industry. The Money Market Portfolio, on the other hand, may not purchase any securities which would cause, at the time of purchase, less than 25% of the value of its total assets to be invested in the obligations of issuers in the banking industry, or in obligations, such as repurchase agreements, secured by such obligations (unless the Portfolio is in a temporary defensive position) or which would cause, at the time of purchase, more than 25% of the value of its total assets to be invested in the obligations of issuers in any other industry. In applying the investment limitations stated in this paragraph, (i) there is no limitation with respect to the purchase of (a) instruments issued (as defined in Investment Limitation number 1 above) or guaranteed by the United States, any state, territory or possession of the United States, the District of Columbia or any of their authorities, agencies, instrumentalities or political subdivisions, (b) instruments issued by domestic banks (which may include U.S. branches of foreign banks) and (c) repurchase agreements secured by the instruments described in clauses (a) and (b); (ii) wholly-owned finance companies will be considered to be in the industries of their parents if their activities are primarily related to financing the activities of the parents; and (iii) utilities will be divided according to their services, for example, gas, gas transmission, electric and gas, electric and telephone will be each considered a separate industry. 4) Each of the Ohio Municipal Money Market, Pennsylvania Municipal Money Market, North Carolina Municipal Money Market, Virginia Municipal Money Market and New Jersey Municipal Money Market Portfolios will invest at least 80% of its net assets in AMT Paper and instruments the interest on which is exempt from regular Federal income tax, except during defensive periods or during periods of unusual market conditions. 5) The Municipal Money Market Portfolio will invest at least 80% of its net assets in instruments the interest on which is exempt from regular Federal income tax and is not an item of tax preference for purposes of Federal alternative minimum tax, except during defensive periods or during periods of unusual market conditions. NON-MONEY MARKET PORTFOLIOS: Each of the Non-Money Market Portfolios (other than the Ohio Tax-Free Income, Pennsylvania Tax-Free Income, New Jersey Tax-Free Income, Delaware Tax Free Income and Kentucky Tax-Free Income Portfolios) may not: 1) Purchase securities of any one issuer (other than securities issued or guaranteed by the U.S. Government, its agencies or instrumentalities or certificates of deposit for any such securities) if more than 5% of the value of the Portfolio's total assets would (taken at current value) be invested in the securities of such issuer, or more than 10% of the issuer's outstanding voting securities would be owned by the Portfolio or the Fund, except that up to 25% of the value of the Portfolio's total assets may (taken at current value) be invested without regard to these limitations. For purposes of this limitation, a security is considered to be issued by the entity (or entities) whose assets and revenues back the security. A guarantee of a security shall not be deemed to be a security issued by the guarantors when the value of all securities issued and guaranteed by the guarantor, and owned by the Portfolio, does not exceed 10% of the value of the Portfolio's total assets. Each of the Non-Money Market Portfolios may not: 2) Purchase any securities which would cause 25% or more of the value of the Portfolio's total assets at the time of purchase to be invested in the securities of one or more issuers conducting their principal business activities in the same industry, provided that (a) there is no limitation with respect to (i) instruments issued (as defined in Investment Limitation No. 1 above) or guaranteed by the United States, any state, territory or possession of the United States, the District of Columbia or any of their authorities, agencies, instrumentalities or political subdivisions, and (ii) repurchase agreements secured by the instruments described in clause (i); (b) wholly-owned finance companies will be considered to be in the industries of their parents if their activities are primarily related to financing the activities of the parents; and (c) utilities will be divided according to their services; for example, gas, gas transmission, electric and gas, electric and telephone will each be considered a separate industry. 53 Each Non-Money Market Portfolio (other than the Managed Income, Intermediate Government Bond, Low Duration Bond, Intermediate Bond, Government Income, International Bond, Core Bond, High Yield Bond, Balanced and GNMA Portfolios) may not: 3) Borrow money or issue senior securities, except that each Portfolio may borrow from banks and enter into reverse repurchase agreements for temporary purposes in amounts up to one-third of the value of its total assets at the time of such borrowing; or mortgage, pledge or hypothecate any assets, except in connection with any such borrowing and then in amounts not in excess of one- third of the value of the Portfolio's total assets at the time of such borrowing. No Portfolio will purchase securities while its aggregate borrowings (including reverse repurchase agreements and borrowings from banks) in excess of 5% of its total assets are outstanding. Securities held in escrow or separate accounts in connection with a Portfolio's investment practices are not deemed to be pledged for purposes of this limitation. None of the Managed Income, Intermediate Government Bond, Low Duration Bond, Intermediate Bond, Government Income, Core Bond, International Bond, High Yield Bond, Balanced and GNMA Portfolios may: 4) Issue senior securities, borrow money or pledge its assets, except that a Portfolio may borrow from banks or enter into reverse repurchase agreements or dollar rolls in amounts aggregating not more than 33 1/3% of the value of its total assets (calculated when the loan is made) to take advantage of investment opportunities and may pledge up to 33 1/3% of the value of its total assets to secure such borrowings. Each Portfolio is also authorized to borrow an additional 5% of its total assets without regard to the foregoing limitations for temporary purposes such as clearance of portfolio transactions and share redemptions. For purposes of these restrictions, the purchase or sale of securities on a "when-issued," delayed delivery or forward commitment basis, the purchase and sale of options and futures contracts and collateral arrangements with respect thereto are not deemed to be the issuance of a senior security, a borrowing or a pledge of assets. ALL PORTFOLIOS: No Portfolio may: 1. Purchase or sell real estate, except that each Portfolio may purchase securities of issuers which deal in real estate and may purchase securities which are secured by interests in real estate. 2. Acquire any other investment company or investment company security except in connection with a merger, consolidation, reorganization or acquisition of assets or where otherwise permitted by the 1940 Act. 3. Act as an underwriter of securities within the meaning of the Securities Act of 1933 except to the extent that the purchase of obligations directly from the issuer thereof, or the disposition of securities, in accordance with the Portfolio's investment objective, policies and limitations may be deemed to be underwriting. 4. Write or sell put options, call options, straddles, spreads, or any combination thereof, except for transactions in options on securities, securities indices, futures contracts and options on futures contracts and, in the case of the International Bond Portfolio, currencies. 5. Purchase securities of companies for the purpose of exercising control. 6. Purchase securities on margin, make short sales of securities or maintain a short position, except that (a) this investment limitation shall not apply to a Portfolio's transactions in futures contracts and related options or a Portfolio's sale of securities short against the box, and (b) a Portfolio may obtain short-term credit as may be necessary for the clearance of purchases and sales of portfolio securities. 7. Purchase or sell commodity contracts, or invest in oil, gas or mineral exploration or development programs, except that each Portfolio may, to the extent appropriate to its investment policies, purchase securities (publicly traded securities in the case of each Money Market Portfolio) of companies engaging in whole or in part in such activities and may enter into futures contracts and related options. 8. Make loans, except that each Portfolio may purchase and hold debt instruments and enter into repurchase agreements in accordance with its investment objective and policies and may lend portfolio securities. 54 9. Purchase or sell commodities except that each Portfolio may, to the extent appropriate to its investment policies, purchase securities of companies engaging in whole or in part in such activities, may engage in currency transactions and may enter into futures contracts and related options. 10. Notwithstanding the investment limitations of the Index Equity Portfolio, the Index Equity Portfolio may invest all of its assets in shares of an open-end management investment company with substantially the same investment objective, policies and limitations as the Portfolio. Although the foregoing investment limitations would permit the Money Market Portfolios to invest in options, futures contracts and options on futures contracts, and to sell securities short against the box, those Portfolios do not currently intend to trade in such instruments or engage in such transactions during the next twelve months (except to the extent a portfolio security may be subject to a "demand feature" or "put" as permitted under SEC regulations for money market funds). Prior to making any such investments, a Money Market Portfolio would notify its shareholders and add appropriate descriptions concerning the instruments and transactions to its Prospectus. INDEX MASTER PORTFOLIO: The investment limitations of the Index Master Portfolio, the Portfolio in which the Index Equity Portfolio invests all of its investable assets, are separate from those of the Index Equity Portfolio. The Index Master Portfolio may not: 1. Invest in commodities or real estate, including limited partnership interests therein, although it may purchase and sell securities of companies which deal in real estate and securities which are secured by interests in real estate, and may purchase or sell financial futures contracts and options thereon; 2. Make loans of cash, except through the acquisition of repurchase agreements and obligations customarily purchased by institutional investors; 3. As to 75% of the total assets of the Index Master Portfolio, invest in the securities of any issuer (except obligations of the U.S. Government and its instrumentalities) if, as a result, more than 5% of the Index Master Portfolio's total assets, at market, would be invested in the securities of such issuer; 4. Purchase or retain securities of an issuer if those officers and trustees of the Trust or officers and directors of the Trust's investment adviser owning more than 2 of 1% of such securities together own more than 5% of such securities; 5. Borrow, except from banks and as a temporary measure for extraordinary or emergency purposes and then, in no event, in excess of 5% of the Index Master Portfolio's gross assets valued at the lower of market or cost; provided that it may borrow amounts not exceeding 33% of its net assets from banks and pledge not more than 33% of such assets to secure such loans; 6. Pledge, mortgage, or hypothecate any of its assets to an extent greater than 10% of its total assets at fair market value, except as described in (5) above; 7. Invest more than 10% of the value of its total assets in illiquid securities which include certain restricted securities, repurchase agreements with maturities of greater than seven days, and other illiquid investments; 8. Engage in the business of underwriting securities issued by others; 9. Invest for the purpose of exercising control over management of any company; 10. Invest its assets in securities of any investment company, except in connection with a merger, acquisition of assets, consolidation or reorganization; 11. Invest more than 5% of its total assets in securities of companies which have (with predecessors) a record of less than three years' continuous operation; 12. Acquire any securities of companies within one industry if, as a result of such acquisition, more than 25% of the value of its total assets would be invested in securities of companies within such industry; 55 13. Write or acquire options (except as described in (1) above) or interests in oil, gas or other mineral exploration, leases or development programs; 14. Purchase warrants; however, it may acquire warrants as a result of corporate actions involving its holdings of other equity securities; 15. Purchase securities on margin or sell short; or 16. Acquire more than 10% of the voting securities of any issuer. 17. Issue senior securities (as such term is defined in Section 18(f) of the 1940 Act), except as permitted under the 1940 Act. The investment limitations described in (1) and (15) above do not prohibit the Index Master Portfolio from making margin deposits to the extent permitted under applicable regulations. Although (2) above prohibits cash loans, the Index Master Portfolio is authorized to lend portfolio securities. With respect to (7) above, pursuant to Rule 144A under the 1993 Act, the Index Master Portfolio may purchase certain unregistered (i.e. restricted) securities upon a determination that a liquid institutional market exists for the securities. If it is decided that a liquid market does exist, the securities will not be subject to the 10% limitation on holdings of illiquid securities stated in (7) above. While maintaining oversight, the Board of Trustees of the Trust has delegated the day-to-day function of making liquidity determinations to DFA, the Index Master Portfolio's adviser. For Rule 144A securities to be considered liquid, there must be at least two dealers making a market in such securities. After purchase, the Board of Trustees of the Trust and DFA will continue to monitor the liquidity of Rule 144A securities. Subject to future regulatory guidance, for purposes of those investment limitations identified above that are based on total assets, "total assets" refers to the assets that the Index Master Portfolio owns, and does not include assets which the Index Master Portfolio does not own but over which it has effective control. For example, when applying a percentage investment limitation that is based on total assets, the Index Master Portfolio will exclude from its total assets those assets which represent collateral received by the Index Master Portfolio for its securities lending transactions. Unless otherwise indicated, all limitations applicable to the Index Master Portfolio's investments apply only at the time that a transaction is undertaken. Any subsequent change in a rating assigned by any rating service to a security or change in the percentage of the Index Master Portfolio=s assets invested in certain securities or other instruments resulting from market fluctuations or other changes in the Index Master Portfolio's total assets will not require the Index Master Portfolio to dispose of an investment until DFA determines that it is practicable to sell or close out the investment without undue market or tax consequences. In the event that ratings services assign different ratings to the same security, DFA will determine which rating it believes best reflects the security's quality and risk at that time, which may be the higher of the several assigned ratings. Because the structure of the Index Master Portfolio is based on the relative market capitalizations of eligible holdings, it is possible that the Index Master Portfolio might include at least 5% of the outstanding voting securities of one or more issuers. In such circumstances, the Trust and the issuer would be deemed "affiliated persons" under the 1940 Act, and certain requirements of the Act regulating dealings between affiliates might become applicable. TRUSTEES AND OFFICERS THE FUND The business and affairs of the Fund are managed under the direction of its Board of Trustees. The trustees and executive officers of the Fund, and their business addresses and principal occupations during the past five years, are: 56
PRINCIPAL OCCUPATION NAME AND ADDRESS POSITION WITH FUND DURING PAST FIVE YEARS - ---------------- ------------------ ---------------------- William O. Albertini Bell Atlantic Global Trustee Executive Vice President and Chief Financial Wireless Officer since August, 1997, Bell Atlantic Global 1717 Arch Street Wireless (global wireless communications); 29th Floor East Executive Vice President, Chief Financial Officer Philadelphia, PA 19103 and Director from February 1995-August 1997, Vice Age: 55 President and Chief Financial Officer from January 1991 - February 1995, Bell Atlantic Corporation (a diversified telecommunications company); Director, Groupo Iusacell, S.A. de C.V. (cellular communications company) since June 1994; Director, American Waterworks, Inc. (water utility) since May 1990; Trustee, The Carl E. & Emily I. Weller Foundation since October 1991. Raymond J. Clark* Trustee, President Treasurer of Princeton University since 1987; Office of the Treasurer and Treasurer Trustee, The Compass Capital Group of Funds from Princeton University 1987 to 1996; Trustee, Chemical Bank, New Jersey 3 New South Building Advisory Board from 1994 until 1995; Trustee, P.O. Box 35 American Red Cross - Mercer County Chapter since Princeton, NJ 08540 1995; Trustee, Medical Center of Princeton; and Age: 63 Trustee, United Way-Greater Mercer County from 1996-1997. Robert M. Hernandez Trustee Director since 1991, Vice Chairman and Chief USX Corporation Financial Officer since 1994, Executive Vice 600 Grant Street President -Accounting and Finance and Chief 6105 USX Tower Financial Officer from 1991 to 1994, USX Pittsburgh, PA 15219 Corporation (a diversified company principally Age: 54 engaged in energy and steel businesses); Director and Chairman of the Executive Committee, ACE Limited (insurance company); Trustee, Allegheny University Hospitals, Allegheny General; and Allegheny University Hospitals-West, Director, Marinette Marine Corporation; Director, Transtar, Inc. (transportation company) since 1996; and Director and Chairman of the Board, RTI International Metals, Inc. Anthony M. Santomero Vice Chairman of Deputy Dean from 1990 to 1994, Richard K. Mellon The Wharton School the Board Professor of Finance since April 1984, Director, University of Pennsylvania Wharton Financial Institutions Center since July Room 2344 1995, and Dean's Advisory Council Member since Steinberg Hall-Dietrich July 1984, The Wharton School, University of Hall Pennsylvania; Associate Editor, Journal of Banking Philadelphia, and Finance since June 1978; Associate Editor, PA 19104-6367 Journal of Economics and Business since October
_________________ * This trustee may be deemed an "interested person" of the Fund as defined in the 1940 Act. 57
PRINCIPAL OCCUPATION NAME AND ADDRESS POSITION WITH FUND DURING PAST FIVE YEARS - ---------------- ------------------ ---------------------- Age: 52 1979; Associate Editor, Journal of Money, Credit and Banking since January 1980; Research Associate, New York University Center for Japan - U.S. Business and Economic Studies since July 1989; Editorial Advisory Board, Open Economics Review since November 1990; Director, The Zweig Fund and The Zweig Total Return Fund; Director of Municipal Fund for California Investors, Inc. and Municipal Fund for New York Investors, Inc. David R. Wilmerding, Jr. Chairman of the Chairman, Gee, Wilmerding & Associates, Inc. One Aldwyn Center Board (investment advisers) since February 1989; Villanova, PA 19085 Director, Beaver Management Corporation (land Age: 63 management corporation); Managing General Partner, Chestnut Street Exchange Fund; Director, Independence Square Income Securities, Inc.; Director, The Mutual Fire, Marine and Inland Insurance Company; Director, U.S. Retirement Communities, Inc.; Director, Trustee or Managing General Partner of a number of investment companies advised by BIMC and its affiliates. Karen H. Sabath Assistant Secretary Managing Director, BlackRock Advisors, Inc. since BlackRock Advisors, Inc. February 1998; President, Compass Capital Group, 345 Park Avenue Inc. from 1995 to March 1998; Managing Director New York, NY 10154 of BlackRock Financial Management, Inc. since Age: 33 1993; prior to 1993, Vice President of BlackRock Financial Management, Inc. Ellen L. Corson Assistant Treasurer Vice President and Director of Mutual Fund PFPC Inc. Accounting and Administration, PFPC Inc. since 103 Bellevue Parkway November 1997; Assistant Vice President, PFPC Wilmington, DE 19809 Inc. from March 1997 to November 1997; Senior Age: 34 Accounting Officer, PFPC Inc. from March 1993 to March 1997. Brian P. Kindelan Secretary Vice President and Senior Counsel, BlackRock BlackRock Financial Financial Management, Inc. since April 1998; Management, Inc. Senior Counsel, PNC Bank Corp. from May 1995 to 1600 Market Street April 1998; Associate, Stradley, Ronon, Stevens & 28th Fl. Young, LLP from March 1990 to May 1995. Philadelphia, PA 19103 Age: 39
The Fund pays trustees who are not affiliated with BlackRock Advisors, Inc. ("BlackRock") or BlackRock Distributors, Inc. ("BDI" or the "Distributor") $20,000 annually ($30,000 annually in the event that the assets of the Fund exceed $40 billion) and $350 per Portfolio for each full in-person meeting of the Board that they attend. The Fund pays the Chairman and Vice Chairman of the Board an additional $10,000 and $5,000 per year, respectively, for their service in such capacities. Trustees who are not affiliated with BlackRock or the Distributor are reimbursed for any expenses incurred in attending meetings of the Board of Trustees or any committee thereof. The term of office of each trustee will automatically terminate when such trustee reaches 72 years of age. No officer, director or employee of BlackRock, BlackRock Institutional Management Corporation ("BIMC"), 58 BlackRock Financial Management, Inc. ("BFM"), BlackRock International, Ltd. ("BIL"), PFPC Inc. ("PFPC") (with BlackRock, the "Administrators"), BDI, or PNC Bank, National Association ("PNC Bank") currently receives any compensation from the Fund. As of the date of this Statement of Additional Information, the trustees and officers of the Fund, as a group, owned less than 1% of the outstanding shares of each class of each Portfolio. The table below sets forth the compensation actually received from the Fund and the Fund Complex of which the Fund is a part by the trustees for the fiscal year ended September 30, 1998: 59
PENSION OR TOTAL COMPENSATION AGGREGATE RETIREMENT BENEFITS ESTIMATED FROM REGISTRANT AND COMPENSATION ACCRUED AS PART ANNUAL BENEFITS FUND COMPLEX NAME OF PERSON, POSITION FROM REGISTRANT OF FUND EXPENSES UPON RETIREMENT PAID TO TRUSTEES - ------------------------ --------------- ------------------- --------------- ------------------- Anthony M. Santomero, Vice $57,675 N/A N/A (3)/2/ $70,175 Chairman of the Board David R. Wilmerding, Jr., $62,675 N/A N/A (3)/2/ $76,675 Chairman of the Board William O. Albertini, Trustee $52,675 N/A N/A (1)/2/ $52,675 Raymond J. Clark, Trustee $52,675 N/A N/A (1)/2/ $52,675 Robert M. Hernandez, Trustee $52,675 N/A N/A (1)/2/ $52,675
____________________ 1. A Fund Complex means two or more investment companies that hold themselves out to investors as related companies for purposes of investment and investment services, or have a common investment adviser or have an investment adviser that is an affiliated person of the investment adviser of any of the other investment companies. 2. Total number of investment company boards trustees served on within the Fund Complex. 60 THE TRUST The names, addresses and dates of birth of the trustees and officers of the Trust and a brief statement of their present positions and principal occupations during the past five years are set forth below. As used below, "DFA Entities" refers to the following: Dimensional Fund Advisors Inc., Dimensional Fund Advisors Ltd., DFA Australia Limited, DFA Investment Dimensions Group Inc. (Registered Investment Company), Dimensional Emerging Markets Value Fund Inc. (Registered Investment Company), Dimensional Investment Group Inc. (Registered Investment Company) and DFA Securities Inc.
PRINCIPAL OCCUPATION TRUSTEES POSITION WITH TRUST DURING LAST FIVE YEARS -------- ------------------- ---------------------- David G. Booth* Trustee, President and President, Chairman-Chief Executive Officer and Santa Monica, CA Chairman-Chief Executive Director of all DFA Entities, except Dimensional Birthdate: 12/2/46 Officer Fund Advisors Ltd., of which he is Chairman and Director George M. Trustee Leo Melamed Professor of Finance, Graduate Constantinides School of Business, University of Chicago. Chicago, IL Director, DFA Investment Dimensions Group Inc., Birthdate: 9/22/47 Dimensional Investment Group Inc. and Dimensional Emerging Markets Value Fund Inc. John P. Gould Trustee Steven G. Rothmeier Distinguished Service Chicago, IL Professor of Economics, Graduate School of Birthdate: 1/19/39 Business, University of Chicago. Trustee, First Prairie Funds (registered investment companies). Director, DFA Investment Dimensions Group Inc., Dimensional Investment Group Inc., Dimensional Emerging Markets Value Fund Inc. and Harbor Investment Advisors. Executive Vice President, Lexecon Inc. (economics, law, strategy and finance consulting). Roger G. Ibbotson Trustee Professor in Practice of Finance, Yale School of New Haven, CT Management. Director, DFA Investment Dimensions Birthdate: 5/27/43 Group Inc., Dimensional Investment Group Inc., Dimensional Emerging Markets Value Fund Inc., Hospital Fund, Inc. (investment management services) and BIRR Portfolio Analysis, Inc. (software products). Chairman, Ibbotson Associates, Inc., Chicago, IL (software, data, publishing and consulting). Merton H. Miller Trustee Robert R. McCormick Distinguished Service Chicago, IL Professor Emeritus, Graduate School of Business, Birthdate: 5/16/23 University of Chicago. Director, DFA Investment Dimensions Group Inc., Dimensional Investment Group Inc. and Dimensional Emerging Markets Value Fund Inc. Public Director, Chicago Mercantile Exchange.
* Interested Trustee of the Trust. 61
PRINCIPAL OCCUPATION TRUSTEES POSITION WITH TRUST DURING LAST FIVE YEARS -------- ------------------- ---------------------- Myron S. Scholes Trustee Limited Partner, Long-Term Capital Management Greenwich, CT L.P. (money manager). Frank E. Buck Professor Birthdate: 7/1/42 Emeritus of Finance, Graduate School of Business and Professor of Law, Law School, Senior Research Fellow, Hoover Institution, (all) Stanford University. Director, DFA Investment Dimensions Group Inc., Dimensional Investment Group Inc., Dimensional Emerging Markets Value Fund Inc., Benham Capital Management Group of Investment Companies and Smith Breedon Group of Investment Companies. Rex A. Sinquefield* Trustee, Chairman Chairman-Chief Investment Officer and Director Santa Monica, CA and Chief Investment Officer of all DFA Entities, except Dimensional Fund Birthdate: 9/7/44 Advisors Ltd., of which he is Chairman, Chief Executive Officer and Director. Arthur Barlow Vice President Vice President of all DFA Entities. Santa Monica, CA Birthdate: 11/7/55 Truman Clark Vice President Vice President of all DFA Entities. Consultant Santa Monica, CA until October 1995 and Principal and Manager of Birthdate: 4/8/41 Product Development, Wells Fargo Nikko Investment Advisors from 1990-1994. Robert Deere Vice President Vice President of all DFA Entities. Santa Monica, CA Birthdate: 10/8/57
* Interested Trustee of the Trust. 62
PRINCIPAL OCCUPATION TRUSTEES POSITION WITH TRUST DURING LAST FIVE YEARS -------- ------------------- ---------------------- Irene R. Diamant Vice President and Secretary Vice President and Secretary of all DFA Santa Monica, CA Entities, except Dimensional Fund Advisors Ltd., Birthdate: 7/16/50 for which she is Vice President. Richard Eustice Vice President and Vice President of all DFA entities. Santa Monica, CA Assistant Secretary 8/5/65 Eugene Fama, Jr. Vice President Vice President of all DFA Entities. Santa Monica, CA Birthdate: 1/21/61 Kamyab Hashemi-Nejad, Vice President, Controller Vice President, Controller and Assistant Santa Monica, CA and Assistant Treasurer Treasurer of all DFA Entities. Birthdate: 1/22/61 Stephen P. Manus, Vice President Managing Director, ANB Investment Management and Santa Monica, CA Trust Company from 1985-1993; President, ANB Birthdate: 12/26/50 Investment Management and Trust Company from 1993-1997. Vice President of all DFA Entities. Karen McGinley, Vice President Vice President of all DFA Entities. Santa Monica, CA Birthdate: 3/10/66 Catherine L. Newell, Vice President and Associate, Morrison & Foerster, LLP from Santa Monica, CA Assistant Secretary 1989-1996. Vice President and Assistant Birthdate: 5/7/64 Secretary of all DFA Entities, except Dimensional Fund Advisors Ltd., for which she is a Vice President. David Plecha Vice President Vice President of all DFA Entities. Santa Monica, CA Birthdate: 10/26/61 George Sands Vice President Vice President of all DFA Entities. Santa Monica, CA Birthdate: 2/8/56 Michael T. Scardina Vice President, Vice President, Chief Financial Officer, and Santa Monica, CA Chief Financial Officer, Treasurer of all DFA Entities. Birthdate: 10/12/55 and Treasurer Jeanne C. Sinquefield, Executive Vice President Executive Vice President of all DFA Entities. Ph.D. Santa Monica, CA Birthdate: 12/2/46 Scott Thornton Vice President Vice President of all DFA Entities. Santa Monica, CA Birthdate: 3/1/63
63
PRINCIPAL OCCUPATION TRUSTEES POSITION WITH TRUST DURING LAST FIVE YEARS -------- ------------------- ---------------------- Weston Wellington, Santa Monica, CA Vice President Vice President of all DFA Entities. Vice Birthdate: 3/1/51 President, Director of Research, LPL Financial Services, Inc., Boston, MA, 1987-1994.
Rex A. Sinquefield, Trustee, Chairman and Chief Investment Officer of the Trust, and Jeanne C. Sinquefield, Executive Vice President of the Trust, are husband and wife. David G. Booth and Rex A. Sinquefield, both of whom are trustees and officers of the Trust and directors, officers and shareholders of DFA, may be deemed controlling persons of DFA. Set forth below is a table listing, for each trustee of the Trust entitled to receive compensation, the compensation received from the Trust during the fiscal year ended November 30, 1998 and the total compensation received from all four registered investment companies for which Dimensional Fund Advisors Inc. ("DFA") served as investment adviser during that same fiscal year.
TOTAL PENSION OR COMPENSATION AGGREGATE RETIREMENT ESTIMATED FROM COMPENSATION BENEFITS ACCRUED ANNUAL BENEFITS TRUST AND TRUST FROM AS PART OF TRUST UPON COMPLEX* PAID TO NAME OF PERSON, POSITION TRUST EXPENSES RETIREMENT TRUSTEES - ---------------------------------------- -------------- ------------------ ----------------- ----------------- George M. Constantinides, Trustee $5,000 N/A N/A $30,000 John P. Gould, Trustee $5,000 N/A N/A $30,000 Roger G. Ibbotson, Trustee $5,000 N/A N/A $30,000 Merton H. Miller, Trustee $5,000 N/A N/A $30,000 Myron S. Scholes, Trustee $5,000 N/A N/A $30,000
SHAREHOLDER AND TRUSTEE LIABILITY OF THE FUND Under Massachusetts law, shareholders of a business trust may, under certain circumstances, be held personally liable as partners for the obligations of the trust. However, the Fund's Declaration of Trust provides that shareholders shall not be subject to any personal liability in connection with the assets of the Fund for the acts or obligations of the Fund, and that every note, bond, contract, order or other undertaking made by the Fund shall contain a provision to the effect that the shareholders are not personally liable thereunder. The Declaration of Trust provides for indemnification out of the trust property of any shareholder held personally liable solely by reason of his being or having been a shareholder and not because of his acts or omissions or some other reason. The Declaration of Trust also provides that the Fund shall, upon request, assume the defense of any claim made against any shareholder for any act or obligation of the Fund, and shall satisfy any judgment thereon. The Declaration of Trust further provides that all persons having any claim against the trustees or Fund shall look solely to the trust property for payment; that no trustee of the Fund shall be personally liable for or on account of any contract, debt, tort, claim, damage, judgment or decree arising out of or connected with the administration or preservation of the trust property or the conduct of any business of the Fund; and that no trustee shall be personally liable to any person for any action or failure to act except by reason of his own bad faith, willful misfeasance, gross negligence or reckless disregard of his duties as a trustee. ________________ * Trust Complex means all registered investment companies for which DFA, the Trust's investment adviser, performs advisory or administration services and for which the individuals listed above serve as directors/trustees. 64 With the exception stated, the Declaration of Trust provides that a trustee is entitled to be indemnified against all liabilities and expenses reasonably incurred by him in connection with the defense or disposition of any proceeding in which he may be involved or with which he may be threatened by reason of his being or having been a trustee, and that the Fund will indemnify officers, representatives and employees of the Fund to the same extent that trustees are entitled to indemnification. INVESTMENT ADVISORY, ADMINISTRATION, DISTRIBUTION AND SERVICING ARRANGEMENTS ADVISORY AND SUB-ADVISORY AGREEMENTS. The advisory and sub-advisory services provided by BlackRock, BIMC, BFM, BIL and, with respect to the Index Master Portfolio, Dimensional Fund Advisors Inc. ("DFA"), and the fees received by BlackRock and DFA for such services, are described in the Prospectuses. For their advisory and subadvisory services, BlackRock, BIMC, BFM, BIL and DFA, as applicable, are entitled to fees, computed daily on a portfolio-by- portfolio basis and payable monthly, at the maximum annual rates set forth below. MAXIMUM ANNUAL CONTRACTUAL FEE RATE FOR EACH EQUITY PORTFOLIO EXCEPT THE INDEX EQUITY, MID- CAP VALUE EQUITY, MID-CAP GROWTH EQUITY, MICRO-CAP EQUITY AND THE INTERNATIONAL PORTFOLIOS (BEFORE WAIVERS)
INVESTMENT SUB-ADVISORY AVERAGE DAILY NET ASSETS ADVISORY FEE FEE TO BFM first $1 billion .550% .400% $1 billion C $2 billion .500 .350 $2 billion C $3 billion .475 .325 greater than $3 billion .450 .300
MAXIMUM ANNUAL CONTRACTUAL FEE RATE FOR THE MID-CAP VALUE EQUITY AND MID-CAP GROWTH EQUITY PORTFOLIOS (BEFORE WAIVERS)
INVESTMENT SUB-ADVISORY AVERAGE DAILY NET ASSETS ADVISORY FEE FEE TO BFM first $1 billion .800% .650% $1 billion C $2 billion .700 .550 $2 billion C $3 billion .675 .500 greater than $3 billion .625 .475
MAXIMUM ANNUAL CONTRACTUAL FEE RATE FOR THE INTERNATIONAL EQUITY PORTFOLIO (BEFORE WAIVERS)
INVESTMENT SUB-ADVISORY AVERAGE DAILY NET ASSETS ADVISORY FEE FEE TO BIL first $1 billion .750% .600% $1 billion C $2 billion .700 .550 $2 billion C $3 billion .675 .525 greater than $3 billion .650 .500
65 MAXIMUM ANNUAL CONTRACTUAL FEE RATE FOR THE INTERNATIONAL EMERGING MARKETS PORTFOLIO (BEFORE WAIVERS)
INVESTMENT SUB-ADVISORY AVERAGE DAILY NET ASSETS ADVISORY FEE FEE TO BIL first $1 billion 1.250% 1.100% $1 billion C $2 billion 1.200 1.050 $2 billion C $3 billion 1.155 1.005 greater than $3 billion 1.100 .950
66 MAXIMUM ANNUAL CONTRACTUAL FEE RATE FOR THE INTERNATIONAL SMALL CAP EQUITY PORTFOLIO (BEFORE WAIVERS)
INVESTMENT SUB-ADVISORY AVERAGE DAILY NET ASSETS ADVISORY FEE FEE TO BIL first $1 billion 1.00% .85% $1 billion C $2 billion .95 .80 $2 billion C $3 billion .90 .75 greater than $3 billion .85 .70
MAXIMUM ANNUAL CONTRACTUAL FEE RATE FOR THE MICRO-CAP EQUITY PORTFOLIO (BEFORE WAIVERS)
INVESTMENT SUB-ADVISORY AVERAGE DAILY NET ASSETS ADVISORY FEE FEE TO BFM first $1 billion 1.10% .950% $1 billion C $2 billion 1.05 .900 $2 billion C $3 billion 1.025 .875 greater than $3 billion 1.00 .850
MAXIMUM ANNUAL CONTRACTUAL FEE RATE FOR THE BOND PORTFOLIOS (BEFORE WAIVERS)
EACH PORTFOLIO EXCEPT THE INTERNATIONAL BOND, GNMA, DE INTERNATIONAL BOND, GNMA, DE TAX-FREE INCOME AND KY TAX-FREE TAX-FREE INCOME AND KY INCOME PORTFOLIOS TAX-FREE INCOME PORTFOLIOS ---------------------------------- ---------------------------------- INVESTMENT SUB-ADVISORY INVESTMENT SUB-ADVISORY AVERAGE DAILY NET ASSETS ADVISORY FEE FEES TO BFM ADVISORY FEE FEES TO BFM - ------------------------ ---------------- ---------------- ---------------- ---------------- first $1 billion .500% .350% .550% .400% $1 billion C $2 billion .450 .300 .500 .350 $2 billion C $3 billion .425 .275 .475 .325 greater than $3 billion .400 .250 .450 .300
MAXIMUM ANNUAL CONTRACTUAL FEE RATE FOR THE MONEY MARKET PORTFOLIOS (BEFORE WAIVERS)
INVESTMENT SUB-ADVISORY AVERAGE DAILY NET ASSETS ADVISORY FEE FEE TO BIMC first $1 billion .450% .400% $1 billion C $2 billion .400 .350 $2 billion C $3 billion .375 .325 greater than $3 billion .350 .300
67 BlackRock, a majority-owned indirect subsidiary of PNC Bank Corp., renders advisory services to each of the Portfolios, except the Index Equity Portfolio, pursuant to an Investment Advisory Agreement. From the commencement of operations of each Portfolio (other than the New Jersey Municipal Money Market, New Jersey Tax-Free Income, Core Bond, Low Duration Bond and International Bond Portfolios) until January 4, 1996 (June 1, 1996 in the case of the Index Equity Portfolio), BIMC served as adviser. From July 1, 1991 to December 31, 1995, Midlantic Bank, N.A. ("Midlantic Bank") served as investment adviser to the predecessor portfolios of the International Bond, New Jersey Tax-Free Income and New Jersey Municipal Money Market Portfolios. From January 1, 1996 through January 12, 1996 (February 12, 1996 with respect to the predecessor portfolio of the International Bond Portfolio): (i) BlackRock and Morgan Grenfell Investment Services Limited ("Morgan Grenfell") served as investment adviser and sub-adviser, respectively, to the predecessor portfolio to the International Bond Portfolio; (ii) BIMC served as investment adviser to the predecessor portfolio to the New Jersey Municipal Money Market Portfolio; and (iii) BFM served as investment adviser to the predecessor portfolio to the New Jersey Tax-Free Income Portfolio pursuant to interim advisory and sub-advisory agreements approved by the shareholders of the Compass Capital Group of Funds. From December 9, 1992 to January 13, 1996, BFM served as investment adviser to the predecessor portfolio of the Core Bond Portfolio. From July 17, 1992 to January 13, 1996, BFM served as investment adviser to the predecessor portfolio of the Low Duration Bond Portfolio. BFM renders sub-advisory services to the Balanced, Large Cap Value Equity, Mid-Cap Value Equity, Small Cap Value Equity, Select Equity, Large Cap Growth Equity, Mid-Cap Growth Equity, Small Cap Growth Equity, Micro-Cap Equity, Managed Income, Intermediate Government Bond, Tax-Free Income, Ohio Tax-Free Income, Pennsylvania Tax-Free Income, Low Duration Bond, Intermediate Bond, New Jersey Tax-Free Income, Delaware Tax-Free Income, Kentucky Tax-Free Income, Core Bond, Government Income, International Bond, High Yield Bond and GNMA Portfolios pursuant to Sub-Advisory Agreements. BIL renders sub-advisory services to the International Equity, International Emerging Markets and International Small Cap Equity Portfolios pursuant to Sub-Advisory Agreements. BIMC renders sub- advisory services to the Money Market, U.S. Treasury Money Market, Municipal Money Market, Ohio Municipal Money Market, Pennsylvania Municipal Money Market, North Carolina Municipal Money Market, Virginia Municipal Money Market and New Jersey Municipal Money Market Portfolios pursuant to Sub-Advisory Agreements. DFA renders advisory services to the Index Master Portfolio, the registered investment company in which the Index Equity Portfolio invests all of its assets, pursuant to an Investment Management Agreement. The Investment Advisory Agreement with BlackRock, the Investment Management Agreement with DFA and the above-referenced Sub-Advisory Agreements are collectively referred to as the "Advisory Contracts." Provident Capital Management, Inc. (a predecessor entity of BFM) ("PCM") served as sub-adviser to the International Equity and International Emerging Markets Portfolios from commencement of operations (April 27, 1992 in the case of the International Equity Portfolio; June 17, 1994 in the case of the International Emerging Markets Portfolio) to April 19, 1996. PNC Bank served as sub-adviser for the Money Market Portfolio from October 4, 1989 (commencement of operations) to January 4, 1996; for the Municipal Money Market Portfolio from September 10, 1993 to January 4, 1996; for the U.S. Treasury Money Market Portfolio from November 1, 1989 (commencement of operations) to January 4, 1996; for the Ohio Municipal Money Market Portfolio from June 1, 1993 (commencement of operations) to January 4, 1996; for the Pennsylvania Municipal Money Market Portfolio from June 1, 1993 (commencement of operations) to January 4, 1996; for the North Carolina Municipal Money Market Portfolio from May 4, 1993 (commencement of operations) to January 4, 1996; for the Virginia Municipal Money Market Portfolio from July 25, 1994 (commencement of operations) to January 4, 1996; and for the New Jersey Municipal Money Market Portfolio from January 13, 1996 to June 6, 1996. From April 4, 1990 (commencement of operations) to January 4, 1996, PNC Bank served as sub-adviser to the Balanced Portfolio. From March 1, 1993 to January 4, 1996, PNC Equity Advisors Company (a predecessor entity of BlackRock) ("PEAC") served as sub- adviser to the Select Equity Portfolio. From March 29, 1995 to June 1, 1996, PEAC served as sub-adviser to the Index Equity Portfolio. From July 1, 1996 through December 31, 1996, Morgan Grenfell served as sub-adviser to the International Bond Portfolio. Under the relevant Advisory Contracts, BlackRock, BIMC, BFM and BIL are not liable for any error of judgment or mistake of law or for any loss suffered by the Fund or a Portfolio in connection with the performance of the Advisory Contracts. Under the Advisory Contracts, BlackRock, BIMC, BFM, BIL and DFA are liable for a loss resulting from willful misfeasance, bad faith or gross negligence in the performance of their respective duties or from reckless disregard of their respective duties and 68 obligations thereunder. Each of the Advisory Contracts (except the Advisory Contract relating to the Index Master Portfolio) is terminable as to a Portfolio by vote of the Fund's Board of Trustees or by the holders of a majority of the outstanding voting securities of the relevant Portfolio, at any time without penalty, on 60 days' written notice to BlackRock, BIMC, BFM or BIL, as the case may be. BlackRock, BIMC, BFM and BIL may also terminate their advisory relationship with respect to a Portfolio on 60 days' written notice to the Fund. The Advisory Contract relating to the Index Master Portfolio is terminable by vote of the Trust's Board of Trustees or by the holders of a majority of the outstanding voting securities of the Index Master Portfolio at any time without penalty on 60 days' written notice to DFA. DFA may also terminate its advisory relationship with respect to the Index Master Portfolio on 90 days' written notice to the Trust. Each of the Advisory Contracts terminates automatically in the event of its assignment. For the period from October 1, 1997 (May 1, 1998 in the case of the Micro- Cap Equity Portfolio; May 11, 1998 in the case of the Delaware Tax-Free Income and Kentucky Tax-Free Income Portfolios; and May 18, 1998 in the case of the GNMA Portfolio) through September 30, 1998, the Fund paid BlackRock advisory fees, and BlackRock waived advisory fees and reimbursed expenses, as follows:
FEES PAID PORTFOLIOS (AFTER WAIVERS) WAIVERS REIMBURSEMENTS - --------------------------------------------------- --------------------- ------------------- ---------------------- Money Market....................................... $ 4,995,812 $ 6,990,461 $0 U.S. Treasury Money Market......................... 1,455,174 3,050,276 0 Municipal Money Market............................. 589,271 1,560,040 0 New Jersey Municipal Money Market.................. 117,098 509,669 0 North Carolina Municipal Money Market.............. 67,431 780,226 0 Ohio Municipal Money Market........................ 119,244 460,253 0 Pennsylvania Municipal Money Market................ 782,010 1,948,681 0 Virginia Municipal Money Market.................... 15,607 307,363 0 Low Duration Bond.................................. 472,357 1,018,534 0 Intermediate Government Bond....................... 814,750 524,055 0 Intermediate Bond.................................. 1,123,779 996,975 0 Core Bond.......................................... 1,296,895 2,294,530 0 Government Income.................................. 17,520 110,545 0 Managed Income..................................... 3,810,648 1,717,518 0 International Bond................................. 203,495 66,216 0 GNMA............................................... 112,096 130,075 0 Tax-Free Income.................................... 465,903 352,304 0 Pennsylvania Tax-Free Income....................... 1,444,081 1,038,853 0 New Jersey Tax-Free Income......................... 319,096 296,294 0 Ohio Tax-Free Income............................... 107,019 136,991 0 Delaware Tax-Free Income........................... 197,418 57,976 0 Kentucky Tax-Free Income........................... 321,405 134,676 0 Large Cap Value Equity............................. 10,148,888 4,823 0 Large Cap Growth Equity............................ 5,401,230 1,583 0 Mid-Cap Value Equity............................... 1,595,030 77,992 0 Mid-Cap Growth Equity.............................. 1,592,876 78,173 0 Small Cap Value Equity............................. 3,420,178 25,656 0 Small Cap Growth Equity............................ 5,973,190 0 0 Micro-Cap Equity................................... 42 60,524 0 International Equity............................... 6,687,983 402,953 0 International Small Cap Equity..................... 55,673 142,318 0
69
FEES PAID PORTFOLIOS (AFTER WAIVERS) WAIVERS REIMBURSEMENTS - --------------------------------------------------- --------------------- ------------------- ---------------------- International Emerging Markets..................... 1,613,829 129,596 0 Select Equity...................................... 6,235,046 0 0 Balanced........................................... 2,666,850 8,135 0 Totals............................................. $64,238,904 $25,414,264 $0
For the period from October 1, 1996 (December 27, 1996 in the case of the Mid-Cap Growth Equity and Mid-Cap Value Equity Portfolios; and September 26, 1997 in the case of the International Small Cap Equity Portfolio) through September 30, 1997, the Fund paid BlackRock advisory fees, and BlackRock waived advisory fees and reimbursed expenses, as follows:
FEES PAID PORTFOLIOS (AFTER WAIVERS) WAIVERS REIMBURSEMENTS - --------------------------------------------------- --------------------- ------------------- ---------------------- Money Market...................................... $2,648,951 $8,355,021 $ 0 U.S. Treasury Money Market........................ 865,528 3,842,169 0 Municipal Money Market............................ 247,591 1,482,338 0 New Jersey Municipal Money Market................. 67,821 483,238 0 North Carolina Municipal Money Market............. 94,458 602,236 0 Ohio Municipal Money Market....................... 66,919 434,972 0 Pennsylvania Municipal Money Market............... 378,571 2,048,282 0 Virginia Municipal Money Market................... 4,280 267,307 18,025 Low Duration Bond................................. 599,206 517,845 0 Intermediate Government Bond...................... 462,943 308,628 0 Intermediate Bond................................. 973,237 648,825 0 Core Bond......................................... 1,040,492 1,005,843 0 Government Income................................. 465 84,527 47,550 Managed Income.................................... 2,629,559 1,126,954 0 International Bond................................ 220,526 12,573 0 Tax-Free Income................................... 158,143 123,004 0 Pennsylvania Tax-Free Income...................... 268,228 178,819 0 New Jersey Tax-Free Income........................ 254,415 179,069 0 Ohio Tax-Free Income.............................. 10,355 43,390 0 Large Cap Value Equity............................ 6,487,065 480,085 0 Large Cap Growth Equity........................... 3,718,080 233,396 0 Mid-Cap Value Equity.............................. 499,380 4,043 0 Mid-Cap Growth Equity............................. 499,026 4,087 0 Small Cap Value Equity............................ 2,036,977 6,910 0 Small Cap Growth Equity........................... 3,169,739 32,560 0 International Equity.............................. 4,101,006 556,548 0 International Small Cap Equity.................... 0 0 0 International Emerging Markets.................... 1,786,671 152,118 0 Select Equity..................................... 2,562,623 154,197 0 Balanced.......................................... 1,486,866 92,278 0
For the period from October 1, 1995 through January 4, 1996, the Fund paid BIMC advisory fees, and BIMC waived advisory fees and reimbursed expenses, as follows:
FEES PAID PORTFOLIOS (AFTER WAIVERS) WAIVERS REIMBURSEMENTS - --------------------------------------------------- --------------------- ------------------- ---------------------- Money Market....................................... $321,268 $1,818,401 $0
70
FEES PAID PORTFOLIOS (AFTER WAIVERS) WAIVERS REIMBURSEMENTS - --------------------------------------------------------- ------------------ ------------- ----------------- Municipal Money Market.................................... 46,804 304,226 0 U.S. Treasury Money Market................................ 114,639 745,150 0 Ohio Municipal Money Market............................... 11,052 71,841 0 Pennsylvania Municipal Money Market....................... 64,257 417,675 0 North Carolina Municipal Money Market..................... 11,026 71,666 0 Virginia Municipal Money Market........................... 0 7,024 0 Managed Income............................................ 520,724 223,168 0 Government Income......................................... 0 17,234 0 Tax-Free Income........................................... 3,933 11,137 0 Intermediate Government Bond.............................. 114,345 130,122 0 Ohio Tax-Free Income...................................... 723 10,100 0 Pennsylvania Tax-Free Income.............................. 43,145 37,663 0 Intermediate Bond......................................... 136,544 119,059 0 Large Cap Value Equity.................................... 829,764 147,027 0 Large Cap Growth Equity................................... 361,240 95,914 0 Small Cap Growth Equity................................... 304,284 23,327 0 Select Equity............................................. 369,071 97,791 0 Index Equity.............................................. 4,647 88,292 0 Small Cap Value Equity.................................... 320,588 24,942 0 International Equity...................................... 697,319 127,354 0 International Emerging Markets............................ 144,937 11,380 0 Balanced.................................................. 201,642 53,929 0
For the period from January 5, 1996 (February 1, 1996 in the case of the New Jersey Tax-Free Income and New Jersey Municipal Money Market Portfolios; February 13, 1996 in the case of the International Bond Portfolio; and April 1, 1996 in the case of the Core Bond and Low Duration Bond Portfolios) through September 30, 1996 (June 1, 1996 in the case of the Index Equity Portfolio), the Fund paid BlackRock (BIMC in the case of the Index Equity Portfolio) advisory fees, and BlackRock (BIMC in the case of the Index Equity Portfolio) waived advisory fees and reimbursed expenses, as follows:
FEES PAID (AFTER PORTFOLIOS WAIVERS) WAIVERS REIMBURSEMENTS - ------------------------------------------------------ ------------------ ------------- ------------------ Money Market........................................... $1,443,913 $6,290,596 $ 0 Municipal Money Market................................. 158,379 1,029,459 0 U.S. Treasury Money Market............................. 691,448 3,584,858 0 Ohio Municipal Money Market............................ 32,275 209,784 0 Pennsylvania Municipal Money Market.................... 240,350 1,562,271 0 North Carolina Municipal Money Market.................. 45,997 298,983 0 Virginia Municipal Money Market........................ 0 180,685 14,604 New Jersey Municipal Money Market...................... 32,663 212,365 0 Managed Income......................................... 1,796,762 770,041 0 Government Income...................................... 0 52,817 7,027 Tax-Free Income........................................ 109,211 74,939 0 Intermediate Government Bond........................... 425,069 283,380 0 Ohio Tax-Free Income................................... 4,764 31,253 3,479 Pennsylvania Tax-Free Income........................... 185,302 123,326 0 Intermediate Bond...................................... 514,322 342,880 0 New Jersey Tax-Free Income............................. 184,448 122,966 0 International Bond..................................... 133,797 4,580 0 Core Bond.............................................. 424,691 283,127 0 Low Duration Bond...................................... 338,287 225,525 0 Large Cap Value Equity................................. 4,159,395 421,173 0
71
FEES PAID (AFTER PORTFOLIOS WAIVERS) WAIVERS REIMBURSEMENTS - ------------------------------------------------------ ------------------ ------------- ------------------ Large Cap Growth Equity................................ 2,109,685 210,969 0 Small Cap Growth Equity................................ 1,596,126 7,204 0 Select Equity.......................................... 1,457,052 145,705 0 Index Equity........................................... 28,380 174,535 0 Small Cap Value Equity................................. 1,223,651 0 0 International Equity................................... 2,836,323 202,595 0 International Emerging Markets......................... 740,140 63,810 0 Balanced............................................... 917,400 91,740 0
For the period from October 1, 1997 (May 1, 1998 in the case of the Micro-Cap Equity Portfolio; May 11, 1998 in the case of the Delaware Tax-Free Income and Kentucky Tax-Free Income Portfolios and May 18, 1998 in the case of the GNMA Portfolio) through September 30, 1998, BlackRock paid sub-advisory fees to the specified Portfolios' sub-advisers, after waivers, and such sub-advisers waived sub-advisory fees, as follows:
FEES PAID (AFTER PORTFOLIOS WAIVERS) WAIVERS - --------------------------------------------------------------- ------------------- --------------- Money Market.................................................... $ 1,473,942 $ 0 U.S. Treasury Money Market...................................... 501,588 0 Municipal Money Market.......................................... 258,731 0 New Jersey Municipal Money Market............................... 84,548 0 North Carolina Municipal Money Market........................... 95,193 0 Ohio Municipal Money Market..................................... 89,640 0 Pennsylvania Municipal Money Market............................. 321,314 0 Virginia Municipal Money Market................................. 31,202 0 Low Duration Bond............................................... 148,896 0 Intermediate Government Bond.................................... 97,580 0 Intermediate Bond............................................... 137,758 0 Core Bond....................................................... 269,603 0 Government Income............................................... 6,476 0 Managed Income.................................................. 478,498 0 International Bond.............................................. 29,036 0 GNMA............................................................ 31,017 0 Tax-Free Income................................................. 75,876 0 Pennsylvania Tax-Free Income.................................... 275,140 0 New Jersey Tax-Free Income...................................... 82,241 0 Ohio Tax-Free Income............................................ 21,499 0 Delaware Tax-Free Income........................................ 20,245 0 Kentucky Tax-Free Income........................................ 52,134 0 Large Cap Value Equity.......................................... 2,157,328 0 Large Cap Growth Equity......................................... 1,392,973 0 Mid-Cap Value Equity............................................ 226,692 0 Mid-Cap Growth Equity........................................... 310,057 0 Small Cap Value Equity.......................................... 659,000 0 Small Cap Growth Equity......................................... 1,671,007 0 Micro-Cap Equity................................................ 6,568 0 International Equity............................................ 896,720 0
72
FEES PAID (AFTER PORTFOLIOS WAIVERS) WAIVERS - ---------------------------------------------------------------- --------------- ---------------- International Small Cap Equity.................................. 14,026 0 International Emerging Markets.................................. 83,941 0 Select Equity................................................... 1,400,970 0 Balanced........................................................ 799,193 0
For the period from October 1, 1996 (December 27, 1996 in the case of the Mid-Cap Growth Equity and Mid-Cap Value Equity Portfolios; and September 26, 1997 in the case of the International Small Cap Equity Portfolio) through September 30, 1997, BlackRock paid sub-advisory fees to the specified Portfolios' sub-advisers, after waivers, and such sub-advisers waived sub- advisory fees as follows:
FEES PAID (AFTER PORTFOLIOS WAIVERS) WAIVERS - -------------------------------------------------------- --------------- ---------------- Money Market............................................ $1,300,023 $9,370,873 U.S. Treasury Money Market.............................. 577,321 3,631,808 Municipal Money Market.................................. 212,376 1,325,338 New Jersey Municipal Money Market....................... 75,204 414,553 North Carolina Municipal Money Market................... 81,568 536,785 Ohio Municipal Money Market............................. 62,070 384,055 Pennsylvania Municipal Money Market..................... 298,167 1,859,027 Virginia Municipal Money Market......................... 350 241,044 Low Duration Bond....................................... 36,930 745,005 Intermediate Government Bond............................ 14,450 525,649 Intermediate Bond....................................... 15,164 1,120,194 Core Bond............................................... 104,500 1,327,935 Government Income....................................... 0 59,494 Managed Income.......................................... 86,420 2,542,897 International Bond...................................... 79,789 89,738 Tax-Free Income......................................... 48,652 148,151 Pennsylvania Tax-Free Income............................ 34,191 278,742 New Jersey Tax-Free Income.............................. 26,000 277,439 Ohio Tax-Free Income.................................... 38,606 0 Large Cap Value Equity.................................. 583,448 4,590,272 Large Cap Growth Equity................................. 172,041 2,701,759 Mid-Cap Value Equity.................................... 15,821 413,497 Mid-Cap Growth Equity................................... 15,422 413,851 Small Cap Value Equity.................................. 383,789 1,102,690 Small Cap Growth Equity................................. 725,498 1,603,447 International Equity.................................... 269,395 3,456,696 International Small Cap Equity.......................... 0 727 International Emerging Markets.......................... 107,739 1,598,368 Select Equity........................................... 105,481 1,870,387 Balanced................................................ 297,047 851,422
73 For the period from October 1, 1995 through January 4, 1996, BIMC paid sub- advisory fees to the specified Portfolios' sub-advisers, after waivers, and such sub-advisers waived sub-advisory fees as follows:
FEES PAID (AFTER PORTFOLIOS WAIVERS) WAIVERS - --------------------------------------------------------------- -------------- ------------ Money Market................................................... $ 0 $235,363 Municipal Money Market......................................... 0 38,613 U.S. Treasury Money Market..................................... 0 94,577 Ohio Municipal Money Market.................................... 0 9,118 Pennsylvania Municipal Money Market............................ 0 53,013 North Carolina Municipal Money Market.......................... 0 9,096 Virginia Municipal Money Market................................ 0 773 Managed Income................................................. 497,581 82,654 Government Income.............................................. 0 12,063 Tax-Free Income................................................ 3,693 9,207 Intermediate Government Bond................................... 73,585 97,542 Ohio Tax-Free Income........................................... 3,258 4,318 Pennsylvania Tax-Free Income................................... 24,323 32,242 Intermediate Bond.............................................. 76,937 101,986 Large Cap Value Equity......................................... 213,057 0 Large Cap Growth Equity........................................ 333,722 0 Small Cap Growth Equity........................................ 239,156 0 Select Equity.................................................. 340,809 0 Index Equity................................................... 12,385 73,920 Small Cap Value Equity......................................... 252,237 0 International Equity........................................... 659,738 0 International Emerging Markets................................. 137,559 0 Balanced....................................................... 186,567 0
For the period from January 5, 1996 (February 1, 1996 in the case of the New Jersey Tax-Free Income and New Jersey Municipal Money Market Portfolios; February 13, 1996 in the case of the International Bond Portfolio; and April 1, 1996 in the case of the Core Bond and Low Duration Bond Portfolios) through September 30, 1996 (June 1, 1996 in the case of the Index Equity Portfolio), BlackRock (BIMC in the case of the Index Equity Portfolio) paid sub-advisory fees to the specified Portfolios' sub-advisers, after waivers, and such sub- advisers waived sub-advisory fees as follows:
FEES PAID (AFTER PORTFOLIOS WAIVERS) WAIVERS - ------------------------------------------------------------ -------------- ------------ Money Market................................................ $1,443,913 $5,342,421 Municipal Money Market...................................... 158,382 897,064 U.S. Treasury Money Market.................................. 694,221 3,095,647 Ohio Municipal Money Market................................. 32,275 182,796 Pennsylvania Municipal Money Market......................... 240,350 1,361,445 North Carolina Municipal Money Market....................... 45,997 260,560 Virginia Municipal Money Market............................. 0 160,601 New Jersey Municipal Money Market........................... 32,663 149,411 Managed Income.............................................. 1,488,836 248,415
74
FEES PAID (AFTER PORTFOLIOS WAIVERS) WAIVERS - ----------------------------------------------------------------------------- Government Income............................ 0 36,973 Tax-Free Income.............................. 95,609 50,559 Intermediate Government Bond................. 412,698 2,499 Ohio Tax-Free Income......................... 1,428 23,786 Pennsylvania Tax-Free Income................. 170,395 84,589 Intermediate Bond............................ 402,873 188,333 New Jersey Tax-Free Income................... 153,707 61,483 International Bond........................... 106,486 0 Core Bond.................................... 353,907 141,564 Low Duration Bond............................ 281,905 112,763 Large Cap Value Equity....................... 3,314,383 0 Large Cap Growth Equity...................... 1,686,503 0 Small Cap Growth Equity...................... 1,164,980 0 Select Equity................................ 1,164,368 0 Index Equity................................. 20,642 123,200 Small Cap Value Equity....................... 888,986 0 International Equity......................... 2,431,134 0 International Emerging Markets............... 707,475 0 Balanced..................................... 733,223 0
For the services it provides as investment adviser to the Index Master Portfolio, DFA is paid a monthly fee calculated at the annual rate of .025% of the Index Master Portfolio's average daily net assets. For the fiscal years ending November 30, 1996, 1997 and 1998, the Index Master Portfolio paid advisory fees to DFA totaling $62,405, $160,156 and $293,240, respectively. The Index Equity Portfolio did not invest in the Index Master Portfolio until June 2, 1996. The predecessor portfolio to the New Jersey Tax-Free Income Portfolio was advised by Midlantic Bank from July 1, 1991 through December 31, 1995, and by BlackRock from January 1, 1996 through January 12, 1996. For the period from January 1, 1996 through January 12, 1996, the predecessor portfolio to the New Jersey Tax-Free Income Portfolio paid $20,165 in advisory fees to BFM. For the period from March 1, 1995 through December 31, 1995 and for the fiscal years ended February 28, 1995 and 1994, the predecessor portfolio to the New Jersey Tax-Free Income Portfolio paid $496,305, $607,485 and $159,582, respectively, in investment advisory fees to Midlantic Bank pursuant to its prior investment advisory contract. In addition, during the period from March 1, 1995 through December 31, 1995 and during the fiscal year ended February 28, 1995, Midlantic Bank waived $0 and $2,451, respectively, in investment advisory fees. During the period from January 13, 1996 through January 31, 1996, the New Jersey Tax- Free Income Portfolio paid BlackRock $12,779 in investment advisory fees, and BlackRock waived $8,520 in investment advisory fees. During the period from January 13, 1996 through January 31, 1996, BlackRock paid BFM $8,945 in sub- advisory fees with respect to the New Jersey Tax-Free Income Portfolio and BFM waived $5,964 in sub-advisory fees. The predecessor portfolio to the International Bond Portfolio was advised by Midlantic Bank from July 1, 1991 through December 31, 1995, and by BlackRock from January 1, 1996 through February 12, 1996. For the period from February 1, 1996 through February 12, 1996, the predecessor portfolio to the International Bond Portfolio paid $4,134 in advisory fees to BlackRock and BlackRock waived advisory fees and reimbursed expenses totaling $0 and $0, respectively. For the period from February 1, 1996 through February 12, 1996, BlackRock paid Morgan Grenfell $4,898 in sub-advisory fees with respect to the predecessor portfolio to the International Bond Portfolio, and Morgan Grenfell waived sub-advisory fees totaling $0. For the period from January 1, 1996 through January 31, 1996, the predecessor portfolio to the International Bond Portfolio paid $24,832 75 in advisory fees to BlackRock. For the period from January 1, 1996 through January 31, 1996, BlackRock paid Morgan Grenfell $20,176 in sub-advisory fees with respect to the predecessor portfolio to the International Bond Portfolio. For the period from March 1, 1995 through December 31, 1995 and for the fiscal year ended February 28, 1995, the predecessor portfolio to the International Bond Portfolio paid $305,176 and $361,620, respectively, in investment advisory fees to Midlantic Bank pursuant to its prior investment advisory contract. The predecessor portfolio to the New Jersey Municipal Money Market Portfolio was advised by Midlantic Bank from July 1, 1991 through December 31, 1995, and by BIMC from January 1, 1996 through January 12, 1996. For the period from January 1, 1996 through January 12, 1996, the predecessor portfolio to the New Jersey Municipal Money Market Portfolio paid $8,000 in advisory fees to BIMC. For the period from March 1, 1995 through December 31, 1995, the predecessor portfolio to the New Jersey Municipal Money Market Portfolio paid $155,696 in investment advisory fees to Midlantic Bank pursuant to its prior investment advisory contract. During the period from January 13, 1996 through January 31, 1996, the New Jersey Municipal Money Market Portfolio paid BIMC $2,128 in investment advisory fees, and BIMC waived $13,826 in investment advisory fees. During the period from January 13, 1996 through January 31, 1996, PNC Bank waived all of the sub-advisory fees (in the amount of $1,125) with respect to the New Jersey Municipal Money Market Portfolio. The predecessor portfolio to the Core Bond Portfolio was advised by BFM. For the period from July 1, 1995 through January 12, 1996, the predecessor portfolio to the Core Bond Portfolio paid BFM $53,125 in investment advisory fees and BFM waived $21,255 in investment advisory fees. For the fiscal years ended June 30, 1995 and 1994, BFM waived its investment advisory fee with respect to the predecessor portfolio to the Core Bond Portfolio in the amounts of $56,894 and $34,010, respectively, and reimbursed expenses amounting to $137,364 and $137,179, respectively. During the period from January 13, 1996 through March 31, 1996, the Core Bond Portfolio paid BlackRock $182,709 in investment advisory fees, and BlackRock waived $121,806 in investment advisory fees. During the period from January 13, 1996 through March 31, 1996, BlackRock paid BFM $127,896 in sub-advisory fees with respect to the Core Bond Portfolio, and BFM waived $85,264 in sub-advisory fees. The predecessor portfolio to the Low Duration Bond Portfolio was advised by BFM. For the period from July 1, 1995 through January 12, 1996, the predecessor portfolio to the Low Duration Bond Portfolio paid BFM $56,481 in investment advisory fees and BFM waived $11,186 in investment advisory fees. For the fiscal years ended June 30, 1995 and 1994, BFM waived its investment advisory fee with respect to the predecessor portfolio to the Low Duration Bond Portfolio in the amounts of $102,707 and $110,232, respectively, and reimbursed expenses amounting to $61,195 and $55,582, respectively. During the period from January 13, 1996 through March 31, 1996, the Low Duration Bond Portfolio paid BlackRock $149,488 in investment advisory fees, and BlackRock waived $99,659 in investment advisory fees. During the period from January 13, 1996 through March 31, 1996, BlackRock paid BFM $104,642 in sub-advisory fees with respect to the Low Duration Bond Portfolio, and BFM waived $69,761 in sub-advisory fees. ADMINISTRATION AGREEMENT. BlackRock and PFPC serve as the Fund's co- administrators pursuant to an administration agreement (the "Administration Agreement"). PFPC has agreed to maintain office facilities for the Fund; furnish the Fund with statistical and research data, clerical, accounting, and bookkeeping services; provide and supervise the operation of an automated data processing system to process purchase and redemption orders; provide information and distribute written communications to shareholders; handle shareholder problems and calls; research issues raised by financial intermediaries relating to investments in a Portfolio's shares; review and provide advice with respect to communications for a Portfolio's shares; monitor the investor programs that are offered in connection with a Portfolio's shares; provide oversight and related support services that are intended to ensure the delivery of quality service to the holders of the Portfolio's shares; and provide certain other services required by the Fund. The Administrators may from time to time voluntarily waive administration fees with respect to a Portfolio and may voluntarily reimburse the Portfolios for expenses. Under the Administration Agreement, BlackRock is responsible for: (i) the supervision and coordination of the performance of the Fund's service providers; (ii) the negotiation of service contracts and arrangements between the Fund and its service providers; (iii) acting as liaison between the trustees of the Fund and the Fund's service providers; and (iv) providing ongoing business management and support services in connection with the Fund's operations. Pursuant to the terms of the Administration Agreement, BlackRock has delegated certain of its duties thereunder to BDI. 76 The Administration Agreement provides that BlackRock and PFPC will not be liable for any error of judgment or mistake of law or for any loss suffered by the Fund or a Portfolio in connection with the performance of the Administration Agreement, except a loss resulting from willful misfeasance, bad faith or gross negligence in the performance of their respective duties or from reckless disregard of their respective duties and obligations thereunder. In addition, the Fund will indemnify each of BAI and PFPC and their affiliates against any loss arising in connection with their provision of services under the Administration Agreement, except that neither BAI nor PFPC nor their affiliates shall be indemnified against any loss arising out of willful misfeasance, bad faith, gross negligence or reckless disregard of their duties under the Administration Agreement. PFPC serves as the administrative services agent for the Index Master Portfolio pursuant to an Administration and Accounting Services Agreement. The services provided by PFPC are subject to supervision by the executive officers and the Board of Trustees of the Trust, and include day-to-day keeping and maintenance of certain records, calculation of the offering price of the shares, preparation of reports and acting as liaison with the Trust's custodians and dividend and disbursing agents. For its services, PFPC is entitled to compensation from the Index Master Portfolio at the annual rate of .015% of the Index Master Portfolio's average daily net assets. The Index Equity Portfolio bears its pro rata portion of the Index Master Portfolio's administrative services expenses. From February 1, 1993 until January 13, 1996, PFPC and Provident Distributors, Inc. ("PDI") served as co-administrators to the Fund. From January 16, 1996 until September 30, 1997, PFPC and BDI served as co-administrators to the Fund. From December 1, 1995 to September 30, 1997, Compass Capital Group, Inc. ("CCG") served as co-administrator to the Fund. BlackRock became co-administrator to the Fund on January 28, 1998. For the purposes of the following fee information, CCG and BDI are also considered "Administrators." For the period from October 1, 1997 (May 1, 1998 in the case of the Micro-Cap Equity Portfolio; May 11, 1998 in the case of the Delaware Tax-Free Income and Kentucky Tax-Free Income Portfolios; and May 18, 1998 in the case of the GNMA Portfolio) through September 30, 1998, the Fund paid the Administrators combined administration fees (after waivers), and the Administrators waived combined administration fees and reimbursed expenses, as follows:
FEES PAID (AFTER WAIVERS) WAIVERS REIMBURSEMENTS --------------- ------- -------------- Money Market................................... $ 3,868,646 $ 2,843 $0 U.S. Treasury Money Market..................... 1,466,150 57,355 0 Municipal Money Market......................... 772,350 0 0 New Jersey Municipal Money Market.............. 223,282 3,124 0 North Carolina Municipal Money Market.......... 253,209 51,557 0 Ohio Municipal Money Market.................... 207,860 726 0 Pennsylvania Municipal Money Market............ 956,857 0 0 Virginia Municipal Money Market................ 78,661 38,462 0 Low Duration Bond.............................. 454,591 182,710 0 Intermediate Government Bond................... 424,492 166,417 0 Intermediate Bond.............................. 757,472 153,769 0 Core Bond...................................... 1,372,756 119,595 0 Government Income.............................. 19,344 35,146 0 Managed Income................................. 1,984,691 294,140 0 International Bond............................. 98,952 5,267 0 GNMA........................................... 68,501 31,374 0 Tax-Free Income................................ 259,703 102,782 0 Pennsylvania Tax-Free Income................... 892,483 158,366 0 New Jersey Tax-Free Income..................... 190,198 77,833 0 Ohio Tax-Free Income........................... 76,296 27,711 0 Delaware Tax-Free Income....................... 82,578 24,917 0 Kentucky Tax-Free Income....................... 142,042 49,754 0
77
FEES PAID (AFTER WAIVERS) WAIVERS REIMBURSEMENTS ------------------- -------------- ------------------ Large Cap Value Equity............................. 3,731,258 0 0 Large Cap Growth Equity............................ 2,021,620 0 0 Mid-Cap Value Equity............................... 413,908 39,124 0 Mid-Cap Growth Equity.............................. 413,572 39,770 0 Small Cap Value Equity............................. 1,317,733 6,509 0 Small Cap Growth Equity............................ 2,230,497 0 0 Micro-Cap Equity................................... 118 12,502 0 International Equity............................... 1,874,280 84,764 0 International Small Cap Equity..................... 22,772 19,575 0 International Emerging Markets..................... 294,225 14,409 0 Select Equity...................................... 2,343,503 0 0 Index Equity....................................... 270,743 958,992 0 Balanced........................................... 1,041,218 0 0 Totals............................................. 30,626,561 2,759,493 0
For the period from October 1, 1996 (December 27, 1996 in the case of the Mid-Cap Growth Equity and Mid-Cap Value Equity Portfolios; and September 26, 1997 in the case of the International Small Cap Equity Portfolio) through September 30, 1997, the Fund paid the Administrators combined administration fees (after waivers), and the Administrators waived combined administration fees and reimbursed expenses, as follows:
FEES PAID PORTFOLIOS (AFTER WAIVERS) WAIVERS REIMBURSEMENTS - ------------------------------------------------------ ------------------- -------------- ------------------ Money Market....................................... $3,006,036 $161,687 $0 U.S. Treasury Money Market......................... 1,391,777 83,462 0 Municipal Money Market............................. 510,438 66,205 0 New Jersey Municipal Money Market.................. 134,020 49,666 0 North Carolina Municipal Money Market.............. 149,859 81,039 0 Ohio Municipal Money Market........................ 136,900 30,397 0 Pennsylvania Municipal Money Market................ 701,182 105,262 0 Virginia Municipal Money Market.................... 13,709 76,820 0 Low Duration Bond.................................. 266,343 180,478 0 Intermediate Government Bond....................... 136,304 172,324 0 Intermediate Bond.................................. 359,159 291,462 0 Core Bond.......................................... 628,096 188,359 0 Government Income.................................. 910 33,087 0 Managed Income..................................... 696,869 755,201 0 International Bond................................. 56,066 28,697 0 Tax-Free Income.................................... 36,907 75,552 0 Pennsylvania Tax-Free Income....................... 84,673 94,146 0 New Jersey Tax-Free Income......................... 77,981 95,412 0 Ohio Tax-Free Income............................... 9,942 11,556 0 Large Cap Value Equity............................. 2,173,719 195,769 0 Large Cap Growth Equity............................ 1,146,084 247,130 0 Mid-Cap Value Equity............................... 106,481 19,571 0 Mid-Cap Growth Equity.............................. 106,838 19,149 0 Small Cap Value Equity............................. 713,311 29,928 0
78
FEES PAID PORTFOLIOS (AFTER WAIVERS) WAIVERS REIMBURSEMENTS - ------------------------------------------------------ ------------------- -------------- ------------------ Small Cap Growth Equity............................ 1,156,894 0 0 International Equity............................... 1,149,080 68,733 0 International Small Cap Equity..................... 0 0 0 International Emerging Markets..................... 379,822 596 0 Select Equity...................................... 794,449 189,515 0 Index Equity....................................... 134,085 549,869 0 Balanced........................................... 501,727 72,507 0
For the period from October 1, 1995 through January 13, 1996, the Fund paid CCG, PFPC and PDI combined administration fees (after waivers), and CCG, PFPC and PDI waived combined administration fees and reimbursed expenses, as follows:
FEES PAID (AFTER PORTFOLIOS WAIVERS) WAIVERS REIMBURSEMENTS - ------------------------------------------------------ ------------------- -------------- ------------------ Money Market........................................ $645,001 $51,681 $0 Municipal Money Market.............................. 117,010 8,088 0 U.S. Treasury Money Market.......................... 242,075 52,266 0 Ohio Municipal Money Market......................... 17,189 12,366 0 Pennsylvania Municipal Money Market................. 143,962 28,455 0 North Carolina Municipal Money Market............... 11,644 17,455 0 Virginia Municipal Money Market..................... 0 12,768 0 Managed Income...................................... 226,271 82,078 0 Government Income................................... 353 6,893 0 Tax-Free Income..................................... 1,455 4,890 0 Intermediate Government Bond........................ 69,369 33,385 0 Ohio Tax-Free Income................................ 604 3,942 0 Pennsylvania Tax-Free Income........................ 23,054 10,922 0 Intermediate Bond................................... 70,091 37,396 0 Large Cap Value Equity.............................. 287,181 75,970 0 Large Cap Growth Equity............................. 142,578 32,289 0 Small Cap Growth Equity............................. 105,681 19,886 0 Select Equity....................................... 150,292 28,337 0 Index Equity........................................ 32,455 65,337 0 Small Cap Value Equity.............................. 127,936 4,181 0 International Equity................................ 200,396 30,791 0 International Emerging Markets...................... 26,329 0 0 Balanced............................................ 73,163 24,504 0
For the period from January 14, 1996 (February 1, 1996 in the case of the New Jersey Tax-Free Income and New Jersey Municipal Money Market Portfolios; February 13, 1996 in the case of the International Bond Portfolio; and April 1, 1996 in the case of the Core Bond and Low Duration Bond Portfolios) through September 30, 1996, the Fund paid the Administrators combined administration fees (after waivers), and the Administrators waived combined administration fees and reimbursed expenses, as follows: 79
FEES PAID (AFTER PORTFOLIOS WAIVERS) WAIVERS REIMBURSEMENTS - ------------------------------------------------------ ------------------- -------------- ------------------ Money Market...................................... $2,319,935 $460,119 $ 0 Municipal Money Market............................ 303,192 171,943 0 U.S. Treasury Money Market........................ 1,325,463 264,620 0 Ohio Municipal Money Market....................... 57,595 37,497 0 Pennsylvania Municipal Money Market............... 576,488 139,781 0 North Carolina Municipal Money Market............. 57,612 78,873 0 Virginia Municipal Money Market................... 0 60,792 4,868 New Jersey Municipal Money Market................. 47,930 52,585 0 Managed Income.................................... 740,845 412,076 0 Government Income................................. 1,394 22,902 0 Tax-Free Income................................... 47,371 37,838 0 Intermediate Government Bond...................... 207,399 118,488 0 Ohio Tax-Free Income.............................. 10,045 6,523 0 Pennsylvania Tax-Free Income...................... 85,441 56,528 0 Intermediate Bond................................. 221,810 172,503 0 New Jersey Tax-Free Income........................ 68,934 69,374 0 International Bond................................ 27,454 28,993 0 Core Bond......................................... 196,853 128,743 0 Low Duration Bond................................. 175,769 83,391 0 Large Cap Value Equity............................ 1,589,313 235,958 0 Large Cap Growth Equity........................... 729,234 236,170 0 Small Cap Growth Equity........................... 652,784 17,700 0 Select Equity..................................... 471,931 198,312 0 Index Equity...................................... 55,265 345,636 0 Small Cap Value Equity............................ 511,980 3,984 0 International Equity.............................. 727,738 201,501 0 International Emerging Markets.................... 147,927 0 0 Balanced.......................................... 339,671 80,233 0
The predecessor portfolios to the New Jersey Municipal Money Market, International Bond and New Jersey Tax-Free Income Portfolios received administrative services from SEI Financial Management Corporation ("SEI"). During the period from March 1, 1995 through January 12, 1996 and during the fiscal year ended February 28, 1995, the predecessor portfolio to the New Jersey Municipal Money Market Portfolio paid $73,663 and $44,863, respectively, in administration fees to SEI pursuant to the prior administration agreement, and SEI waived $0 and $26,345, respectively, in administration fees. During the period from January 13, 1996 through January 31, 1996, the New Jersey Municipal Money Market Portfolio paid the Administrators $3,050 in administration fees, and the Administrators waived $3,691 in administration fees. During the period from March 1, 1995 through January 12, 1996 and during the fiscal year ended February 28, 1995, the predecessor portfolio to the New Jersey Tax-Free Income Portfolio paid $154,232 and $105,029, respectively, in administrative fees to SEI pursuant to the prior administration agreement, and SEI waived $4 and $77,951, respectively, in administrative fees. During the period from January 13, 1996 through January 31, 1996, the New Jersey Tax-Free Income Portfolio paid the Administrators $4,443 in administration fees, and the Administrators waived $5,347 in administration fees. During the period from March 1, 1995 through January 12, 1996 and during the fiscal year ended February 28, 1995, the predecessor portfolio to the International Bond Portfolio paid $77,924 and $81,364, respectively, in administrative fees to SEI pursuant to the prior administration agreement. During the period from January 13, 1996 through January 31, 1996, the predecessor portfolio to the International Bond Portfolio paid the Administrators $2,141 in administrative fees. During the period from February 1, 1996 through February 12, 1996, the 80 predecessor portfolio to the International Bond Portfolio paid the Administrators $2,357 in administrative fees, and the Administrators waived fees and reimbursed expenses totaling $1,212 and $0, respectively. The predecessor portfolios to the Low Duration Bond and Core Bond Portfolios received administrative services from State Street Bank and Trust Company ("State Street"). During the period from July 1, 1995 through January 12, 1996 and during the fiscal year ended June 30, 1995, the predecessor portfolio to the Core Bond Portfolio paid $29,752 and $73,257, respectively, in administrative fees to State Street pursuant to the prior administration agreement, and State Street waived $0 and $0, respectively, in administrative fees. During the period from January 13, 1996 through March 31, 1996, the Core Bond Portfolio paid the Administrators $79,269 in administration fees, and the Administrators waived $60,808 in administration fees. During the period from July 1, 1995 through January 12, 1996 and during the fiscal year ended June 30, 1995, the predecessor portfolio to the Low Duration Bond Portfolio paid $31,578 and $69,234, respectively, in administrative fees to State Street pursuant to the prior administration agreement. During the period from January 13, 1996 through March 31, 1996, the Low Duration Bond Portfolio paid the Administrators $74,552 in administration fees, and the Administrators waived $40,055 in administration fees. The Fund and its service providers may engage third party plan administrators who provide trustee, administrative and recordkeeping services for certain employee benefit, profit-sharing and retirement plans as agent for the Fund with respect to such plans, for the purpose of accepting orders for the purchase and redemption of shares of the Fund. CUSTODIAN AND TRANSFER AGENCY AGREEMENTS. Pursuant to the terms of a custodian agreement (the "Custodian Agreement") between the Fund and PNC Bank, as of January 1, 1999 PNC Bank has assigned its rights and delegated its duties as the Fund's custodian to its affiliate, PFPC Trust Company ("PTC"). Under the Custodian Agreement, PTC or a sub-custodian (i) maintains a separate account or accounts in the name of each Portfolio, (ii) holds and transfers portfolio securities on account of each Portfolio, (iii) accepts receipts and makes disbursements of money on behalf of each Portfolio, (iv) collects and receives all income and other payments and distributions on account of each Portfolio's securities and (v) makes periodic reports to the Board of Trustees concerning each Portfolio's operations. PTC is authorized to select one or more banks or trust companies to serve as sub-custodian on behalf of the Fund, provided that, with respect to sub-custodians other than sub-custodians for foreign securities, PTC remains responsible for the performance of all its duties under the Custodian Agreement and holds the Fund harmless from the acts and omissions of any sub-custodian. Citibank, N.A. serves as the international sub-custodian for various Portfolios of the Fund. For its services to the Fund under the Custodian Agreement, PTC receives a fee which is calculated based upon each investment portfolio's average gross assets, with a minimum monthly fee of $1,000 per investment portfolio. PTC is also entitled to out-of-pocket expenses and certain transaction charges. PTC has undertaken to waive its custody fees with respect to the Index Equity Portfolio, which invests substantially all of its assets in the Index Master Portfolio. PFPC, which has its principal offices at 400 Bellevue Parkway, Wilmington, DE 19809 and is an affiliate of PNC Bank, serves as the transfer and dividend disbursing agent for the Fund pursuant to a Transfer Agency Agreement (the "Transfer Agency Agreement"), under which PFPC (i) issues and redeems Service, Investor, Institutional and BlackRock classes of shares in each Portfolio, (ii) addresses and mails all communications by each Portfolio to record owners of its shares, including reports to shareholders, dividend and distribution notices and proxy materials for its meetings of shareholders, (iii) maintains shareholder accounts and, if requested, sub-accounts and (iv) makes periodic reports to the Board of Trustees concerning the operations of each Portfolio. PFPC may, on 30 days' notice to the Fund, assign its duties as transfer and dividend disbursing agent to any other affiliate of PNC Bank Corp. For its services with respect to the Fund's Institutional and Service Shares under the Transfer Agency Agreement, PFPC receives fees at the annual rate of .03% of the average net asset value of outstanding Institutional and Service Shares in each Portfolio, plus per account fees and disbursements. For its services with respect to the Fund's BlackRock Shares under the Transfer Agency Agreement, PFPC receives fees at the annual rate of .01% of the average net asset value of outstanding BlackRock Shares in each Portfolio, plus per account fees and disbursements. For its services under the Transfer Agency Agreement with respect to Investor Shares, PFPC receives per account fees, with minimum annual fees of $24,000 for each series of Investor Shares in each Portfolio, plus disbursements. Until further notice, the transfer agency fees for each series of Investor Shares in each Portfolio will not exceed the annual rate of .10% of the series' average daily net assets. 81 PTC serves as the Trust's custodian and PFPC serves as the Trust's transfer and dividend disbursing agent. The Index Equity Portfolio bears its pro rata portion of the Index Master Portfolio's custody and transfer and dividend disbursing fees and expenses. DISTRIBUTOR AND DISTRIBUTION AND SERVICE PLAN. The Fund has entered into a distribution agreement with the Distributor under which the Distributor, as agent, offers shares of each Portfolio on a continuous basis. The Distributor has agreed to use appropriate efforts to effect sales of the shares, but it is not obligated to sell any particular amount of shares. The Distributor's principal business address is Four Falls Corporate Center, 6th Floor, West Conshohocken, PA 19428-2961. Pursuant to the Fund's Amended and Restated Distribution and Service Plan (the "Plan"), the Fund may pay the Distributor and/or BlackRock or any other affiliate of PNC Bank fees for distribution and sales support services. Currently, as described further below, only Investor A Shares, Investor B Shares and Investor C Shares bear the expense of distribution fees under the Plan. In addition, the Fund may pay BlackRock fees for the provision of personal services to shareholders and the processing and administration of shareholder accounts. BlackRock, in turn, determines the amount of the service fee and shareholder processing fee to be paid to brokers, dealers, financial institutions and industry professionals (collectively, "Service Organizations"). The Plan provides, among other things, that: (i) the Board of Trustees shall receive quarterly reports regarding the amounts expended under the Plan and the purposes for which such expenditures were made; (ii) the Plan will continue in effect for so long as its continuance is approved at least annually by the Board of Trustees in accordance with Rule 12b-1 under the 1940 Act; (iii) any material amendment thereto must be approved by the Board of Trustees, including the trustees who are not "interested persons" of the Fund (as defined in the 1940 Act) and who have no direct or indirect financial interest in the operation of the Plan or any agreement entered into in connection with the Plan (the "12b-1 Trustees"), acting in person at a meeting called for said purpose; (iv) any amendment to increase materially the costs which any class of shares may bear for distribution services pursuant to the Plan shall be effective only upon approval by a vote of a majority of the outstanding shares of such class and by a majority of the 12b-1 Trustees; and (v) while the Plan remains in effect, the selection and nomination of the Fund's trustees who are not "interested persons" of the Fund shall be committed to the discretion of the Fund's non-interested trustees. The Plan is terminable as to any class of shares without penalty at any time by a vote of a majority of the 12b-1 Trustees, or by vote of the holders of a majority of the shares of such class. With respect to Investor A Shares, the front-end sales charge and the distribution fee payable under the Plan (at a maximum annual rate of .10% of the average daily net asset value of each Portfolio's outstanding Investor A Shares) are used to pay commissions and other fees payable to Service Organizations and other broker/dealers who sell Investor A Shares. With respect to Investor B Shares, Service Organizations and other broker/dealers receive commissions from the Distributor for selling Investor B Shares, which are paid at the time of the sale. The distribution fees payable under the Plan (at a maximum annual rate of .75% of the average daily net asset value of each Portfolio's outstanding Investor B Shares) are intended to cover the expense to the Distributor of paying such up-front commissions, as well as to cover ongoing commission payments to broker/dealers. The contingent deferred sales charge is calculated to charge the investor with any shortfall that would occur if Investor B Shares are redeemed prior to the expiration of the conversion period, after which Investor B Shares automatically convert to Investor A Shares. With respect to Investor C Shares, Service Organizations and other broker/dealers receive commissions from the Distributor for selling Investor C Shares, which are paid at the time of the sale. The distribution fees payable under the Plan (at a maximum annual rate of .75% of the average daily net asset value of each Portfolio's outstanding Investor C Shares) are intended to cover the expense to the Distributor of paying such up-front commissions, as well as to cover ongoing commission payments to the broker/dealers. The contingent deferred sales charge is calculated to charge the investor with any shortfall that would occur if Investor C Shares are redeemed within 12 months of purchase. The Fund is not required or permitted under the Plan to make distribution payments with respect to Service, Institutional or BlackRock Shares. However, the Plan permits BDI, BlackRock, PFPC and other companies that receive fees from the Fund to make payments relating to distribution and sales support activities out of their past profits or other sources available to them. The Distributor, BlackRock and their affiliates may pay affiliated and unaffiliated financial institutions, broker/dealers and/or 82 their salespersons certain compensation for the sale and distribution of shares of the Fund or for services to the Fund. These payments ("Additional Payments") would be in addition to the payments by the Fund described in this Statement of Additional Information for distribution and shareholder servicing and processing. These Additional Payments may take the form of "due diligence" payments for a dealer's examination of the Portfolios and payments for providing extra employee training and information relating to Portfolios; "listing" fees for the placement of the Portfolios on a dealer's list of mutual funds available for purchase by its customers; "finders" or "referral" fees for directing investors to the Fund; "marketing support" fees for providing assistance in promoting the sale of the Funds' shares; and payments for the sale of shares and/or the maintenance of share balances. In addition, the Distributor, BlackRock and their affiliates may make Additional Payments to affiliated and unaffiliated entities for subaccounting, administrative and/or shareholder processing services that are in addition to the shareholder servicing and processing fees paid by the Fund. The Additional Payments made by the Distributor, BlackRock and their affiliates may be a fixed dollar amount, may be based on the number of customer accounts maintained by a financial institution or broker/dealer, or may be based on a percentage of the value of shares sold to, or held by, customers of the affiliated and unaffiliated financial institutions or dealers involved, and may be different for different institutions and dealers. Furthermore, the Distributor, BlackRock and their affiliates may contribute to various non-cash and cash incentive arrangements to promote the sale of shares, and may sponsor various contests and promotions subject to applicable NASD regulations in which participants may receive prizes such as travel awards, merchandise and cash. The Distributor, BlackRock and their affiliates may also pay for the travel expenses, meals, lodging and entertainment of broker/dealers, financial institutions and their salespersons in connection with educational and sales promotional programs subject to applicable NASD regulations. Service Organizations may charge their clients additional fees for account- related services. The Fund intends to enter into service arrangements with Service Organizations pursuant to which Service Organizations will render certain support services to their customers ("Customers") who are the beneficial owners of Service, Investor A, Investor B and Investor C Shares. Such services will be provided to Customers who are the beneficial owners of Shares of such classes and are intended to supplement the services provided by the Fund's Administrators and transfer agent to the Fund's shareholders of record. In consideration for payment of a service fee of up to .25% (on an annualized basis) of the average daily net asset value of the Investor A, Investor B and Investor C Shares owned beneficially by their Customers and .15% (on an annualized basis) of the average daily net asset value of the Service Shares beneficially owned by their Customers, Service Organizations may provide general shareholder liaison services, including, but not limited to (i) answering customer inquiries regarding account status and history, the manner in which purchases, exchanges and redemptions of shares may be effected and certain other matters pertaining to the Customers' investments; and (ii) assisting Customers in designating and changing dividend options, account designations and addresses. In consideration for payment of a shareholder processing fee of up to a separate .15% (on an annualized basis) of the average daily net asset value of Service, Investor A, Investor B and Investor C Shares owned beneficially by their Customers, Service Organizations may provide one or more of these additional services to such Customers: (i) providing necessary personnel and facilities to establish and maintain Customer accounts and records; (ii) assistance in aggregating and processing purchase, exchange and redemption transactions; (iii) placement of net purchase and redemption orders with the Distributor; (iv) arranging for wiring of funds; (v) transmitting and receiving funds in connection with Customer orders to purchase or redeem shares; (vi) processing dividend payments; (vii) verifying and guaranteeing Customer signatures in connection with redemption orders and transfers and changes in Customer-designated accounts, as necessary; (viii) providing periodic statements showing Customers' account balances and, to the extent practicable, integrating such information with other Customer transactions otherwise effected through or with a Service Organization; (ix) furnishing (either separately or on an integrated basis with other reports sent to a shareholder by a Service Organization) monthly and year-end statements and confirmations of purchases, exchanges and redemptions; (x) transmitting on behalf of the Fund, proxy statements, annual reports, updating prospectuses and other communications from the Fund to Customers; (xi) receiving, tabulating and transmitting to the Fund proxies executed by Customers with respect to shareholder meetings; (xii) providing subaccounting with respect to shares beneficially owned by Customers or the information to the Fund necessary for subaccounting; (xiii) providing sub-transfer agency services; and (xiv) providing such other similar services as the Fund or a Customer may request. The Fund may pay Janney Montgomery Scott ("AJMS") a fee of up to .10% (on an annualized basis) of the average daily net asset value of Investor A Shares of each of the Ohio Municipal Money Market, Pennsylvania Municipal Money Market, North Carolina Municipal Money Market, Virginia Municipal Money Market and New Jersey Municipal Money Market Portfolios 83 beneficially owned by JMS customers. This fee is intended to compensate JMS for distribution of, and sales support activities regarding, Investor A Shares of these Portfolios. For the twelve months ended September 30, 1998 (from May 1, 1998 through September 30, 1998 in the case of the Micro-Cap Equity Portfolio; from May 11, 1998 through September 30, 1998 in the case of the Delaware Tax-Free Income and Kentucky Tax-Free Income Portfolios; and from May 18, 1998 through September 30, 1998 in the case of the GNMA Portfolio), the Portfolios' share classes bore the following distribution, shareholder servicing and shareholder processing fees under the Portfolios' current plans:
DISTRIBUTION SHAREHOLDER SHAREHOLDER PORTFOLIOS - INVESTOR A SHARES FEES SERVICING FEES PROCESSING FEES - ----------------------------------------------- -------------- ---------------- ----------------- Money Market................................... N/A $753,581 $452,135 U.S. Treasury Money Market..................... N/A 160,095 96,057 Municipal Money Market......................... N/A 17,069 10,241 New Jersey Municipal Money Market.............. N/A 81,401 73,921 North Carolina Municipal Money Market.......... N/A 665 399 Ohio Municipal Money Market.................... N/A 47,144 28,452 Pennsylvania Municipal Money Market............ N/A 278,841 231,985 Virginia Municipal Money Market................ N/A 2,044 2,044 Low Duration Bond.............................. N/A 3,911 2,346 Intermediate Government Bond................... N/A 14,736 8,842 Intermediate Bond.............................. N/A 3,073 1,844 Core Bond...................................... N/A 8,835 5,301 Government Income.............................. N/A 13,760 8,256 Managed Income................................. N/A 34,473 20,683 International Bond............................. N/A 3,438 2,063 GNMA........................................... N/A 104 62 Tax-Free Income................................ N/A 15,523 9,314 Pennsylvania Tax-Free Income................... N/A 82,835 49,701 New Jersey Tax-Free Income..................... N/A 3,275 1,965 Ohio Tax-Free Income........................... N/A 6,550 3,930 Delaware Tax-Free Income....................... N/A 2,153 1,292 Kentucky Tax-Free Income....................... N/A 233 140 Large Cap Value Equity......................... N/A 131,245 78,747 Large Cap Growth Equity........................ N/A 75,068 45,041 Mid-Cap Value Equity........................... N/A 8,997 5,398 Mid-Cap Growth Equity.......................... N/A 8,529 5,117 Small Cap Value Equity......................... N/A 95,165 56,875 Small Cap Growth Equity........................ N/A 142,335 85,400 Micro-Cap Equity............................... N/A 5,416 3,250 International Equity........................... N/A 65,793 39,476 International Small Cap Equity................. N/A 2,088 1,253 International Emerging Markets................. N/A 7,634 4,580 Select Equity.................................. N/A 70,010 42,006 Index Equity................................... N/A 92,367 55,420 Balanced....................................... N/A 232,960 139,776
DISTRIBUTION SHAREHOLDER SHAREHOLDER PORTFOLIOS - INVESTOR B SHARES FEES SERVICING FEES PROCESSING FEES - ----------------------------------------------- -------------- ---------------- ----------------- Money Market................................... $3,756 $1,252 $0 U.S. Treasury Money Market..................... 0 0 0 Municipal Money Market......................... 0 0 0 New Jersey Municipal Money Market.............. 0 0 0 North Carolina Municipal Money Market.......... 0 0 0
84
DISTRIBUTION SHAREHOLDER SHAREHOLDER PORTFOLIOS - INVESTOR B SHARES FEES SERVICING FEES PROCESSING FEES - ----------------------------------------------- -------------- ---------------- ----------------- Ohio Municipal Money Market.................... 0 0 0 Pennsylvania Municipal Money Market............ 0 0 0 Virginia Municipal Money Market................ 0 0 0 Low Duration Bond.............................. 1,480 493 295 Intermediate Government Bond................... 926 305 186 Intermediate Bond.............................. 186 62 37 Core Bond...................................... 62,169 20,723 12,434 Government Income.............................. 141,683 47,228 28,337 Managed Income................................. 17,200 5,733 3,440 International Bond............................. 9,678 3,226 1,936 GNMA........................................... 144 48 29 Tax-Free Income................................ 11,718 3,906 2,344 Pennsylvania Tax-Free Income................... 107,314 35,771 21,463 New Jersey Tax-Free Income..................... 6,491 2,164 1,298 Ohio Tax-Free Income........................... 6,249 2,083 1,250 Delaware Tax-Free Income....................... 3,712 1,237 742 Kentucky Tax-Free Income....................... 0 0 0 Large Cap Value Equity......................... 211,592 68,864 41,319 Large Cap Growth Equity........................ 84,001 28,000 16,833 Mid-Cap Value Equity........................... 42,884 14,295 8,577 Mid-Cap Growth Equity.......................... 27,977 9,326 5,595 Small Cap Value Equity......................... 142,116 47,371 28,423 Small Cap Growth Equity........................ 326,219 108,740 65,244 Micro-Cap Equity............................... 17,359 5,786 3,472 International Equity........................... 50,717 16,906 10,143 International Small Cap Equity................. 12,947 4,316 2,589 International Emerging Markets................. 9,573 3,191 1,915 Select Equity.................................. 239,920 79,973 47,984 Index Equity................................... 535,354 178,187 106,925 Balanced....................................... 266,223 88,741 53,245
DISTRIBUTION SHAREHOLDER SHAREHOLDER PORTFOLIOS - INVESTOR C SHARES FEES SERVICING FEES PROCESSING FEES - ----------------------------------------------- -------------- ---------------- ----------------- Money Market................................... $1,846 $ 615 $ 0 U.S. Treasury Money Market..................... 0 0 0 Municipal Money Market......................... 220 73 0 New Jersey Municipal Money Market.............. 0 0 0 North Carolina Municipal Money Market.......... 0 0 0 Ohio Municipal Money Market.................... 0 0 0 Pennsylvania Municipal Money Market............ 0 0 0 Virginia Municipal Money Market................ 0 0 0 Low Duration Bond.............................. 1,478 493 296 Intermediate Government Bond................... 1,160 383 230 Intermediate Bond.............................. 0 0 0 Core Bond...................................... 4,351 1,451 870 Government Income.............................. 9,560 3,187 1,912 Managed Income................................. 0 0 0 International Bond............................. 6,934 2,311 1,387 GNMA........................................... 0 0 0 Tax-Free Income................................ 1,144 381 229 Pennsylvania Tax-Free Income................... 82 28 16 New Jersey Tax-Free Income..................... 0 0 0
85 Ohio Tax-Free Income........................................... 376 125 75 Delaware Tax-Free Income....................................... 1,370 457 274 Kentucky Tax-Free Income....................................... 0 0 0 Large Cap Value Equity......................................... 17,578 5,859 3,516 Large Cap Growth Equity........................................ 3,353 1,118 671 Mid-Cap Value Equity........................................... 1,154 385 231 Mid-Cap Growth Equity.......................................... 1,140 380 228 Small Cap Value Equity......................................... 36,169 12,056 7,234 Small Cap Growth Equity........................................ 105,766 35,255 21,153 Micro-Cap Equity............................................... 3,863 1,288 773 International Equity........................................... 2,024 667 400 International Small Cap Equity................................. 2,907 969 587 International Emerging Markets................................. 3,843 182 109 Select Equity.................................................. 10,573 3,524 2,115 Index Equity................................................... 318,410 106,002 63,618 Balanced....................................................... 2,426 809 485
86
DISTRIBUTION SHAREHOLDER SHAREHOLDER PORTFOLIOS - SERVICE SHARES FEES SERVICING FEES PROCESSING FEES - -------------------------------------------------------------------------------------------------------------- Money Market................................................... N/A $2,543,502 $2,543,502 U.S. Treasury Money Market..................................... N/A 1,135,869 1,135,869 Municipal Money Market......................................... N/A 541,231 541,231 New Jersey Municipal Money Market.............................. N/A 138,250 138,250 North Carolina Municipal Money Market.......................... N/A 36,664 36,664 Ohio Municipal Money Market.................................... N/A 105,160 105,160 Pennsylvania Municipal Money Market............................ N/A 351,723 351,723 Virginia Municipal Money Market................................ N/A 8,850 8,850 Low Duration Bond.............................................. N/A 114,731 114,731 Intermediate Government Bond................................... N/A 80,491 80,491 Intermediate Bond.............................................. N/A 91,232 91,232 Core Bond...................................................... N/A 242,150 242,150 Government Income.............................................. N/A 0 0 Managed Income................................................. N/A 494,750 494,750 International Bond............................................. N/A 9,736 9,736 GNMA........................................................... N/A 0 0 Tax-Free Income................................................ N/A 87,979 87,979 Pennsylvania Tax-Free Income................................... N/A 86,818 86,818 New Jersey Tax-Free Income..................................... N/A 123,465 123,465 Ohio Tax-Free Income........................................... N/A 11,589 11,589 Delaware Tax-Free Income....................................... N/A 0 0 Kentucky Tax-Free Income....................................... N/A 0 0 Large Cap Value Equity......................................... N/A 960,862 960,862 Large Cap Growth Equity........................................ N/A 449,661 449,661 Mid-Cap Value Equity........................................... N/A 58,632 58,632 Mid-Cap Growth Equity.......................................... N/A 57,336 57,336 Small Cap Value Equity......................................... N/A 198,650 198,650 Small Cap Growth Equity........................................ N/A 333,768 333,768 Micro-Cap Equity............................................... N/A 39 39 International Equity........................................... N/A 327,833 327,833 International Small Cap Equity................................. N/A 534 534 International Emerging Markets................................. N/A 76,187 76,187 Select Equity.................................................. N/A 377,268 377,268 Index Equity................................................... N/A 362,079 362,079 Balanced....................................................... N/A 288,661 288,661
EXPENSES Expenses are deducted from the total income of each Portfolio before dividends and distributions are paid. These expenses include, but are not limited to, fees paid to BlackRock, PFPC, transfer agency fees, fees and expenses of officers and trustees who are not affiliated with BlackRock, the Distributor or any of their affiliates, taxes, interest, legal fees, custodian fees, auditing fees, distribution fees, shareholder processing fees, shareholder servicing fees, fees and expenses in registering and qualifying the Portfolios and their shares for distribution under federal and state securities laws, expenses of preparing prospectuses and statements of additional information and of printing and distributing prospectuses and statements of additional information to existing shareholders, expenses relating to shareholder reports, shareholder meetings and proxy solicitations, fidelity bond and trustees and officers liability insurance premiums, the expense of independent pricing services and other expenses which are not expressly assumed by BlackRock or the Fund's service providers under their agreements with the Fund. Any general expenses of the Fund that do not belong to a particular investment portfolio will be allocated among all investment portfolios by or under the direction of the Board of Trustees in a manner the Board determines to be fair and equitable. 87 PORTFOLIO TRANSACTIONS In executing portfolio transactions, the adviser and sub-advisers seek to obtain the best price and most favorable execution for a Portfolio, taking into account such factors as the price (including the applicable brokerage commission or dealer spread), size of the order, difficulty of execution and operational facilities of the firm involved. While the adviser and sub-advisers generally seek reasonably competitive commission rates, payment of the lowest commission or spread is not necessarily consistent with obtaining the best price and execution in particular transactions. Payments of commissions to brokers who are affiliated persons of the Fund, or the Trust with respect to the Index Master Portfolio, (or affiliated persons of such persons) will be made in accordance with Rule 17e-1 under the 1940 Act. With respect to the Index Master Portfolio, commissions paid on such transactions would be commensurate with the rate of commissions paid on similar transactions to brokers that are not so affiliated. No Portfolio has any obligation to deal with any broker or group of brokers in the execution of Portfolio transactions. The adviser and sub-advisers may, consistent with the interests of a Portfolio, select brokers on the basis of the research, statistical and pricing services they provide to a Portfolio and the adviser's or sub-adviser's other clients. Information and research received from such brokers will be in addition to, and not in lieu of, the services required to be performed by the adviser and sub-advisers under their respective contracts. A commission paid to such brokers may be higher than that which another qualified broker would have charged for effecting the same transaction, provided that the adviser or sub-adviser determines in good faith that such commission is reasonable in terms either of the transaction or the overall responsibility of the adviser or sub-adviser to a Portfolio and its other clients and that the total commissions paid by a Portfolio will be reasonable in relation to the benefits to a Portfolio over the long-term. With respect to the Index Master Portfolio, it will seek to acquire and dispose of securities in a manner which would cause as little fluctuation in the market prices of stocks being purchased or sold as possible in light of the size of the transactions being effected, and brokers will be selected with this goal in view. DFA monitors the performance of brokers which effect transactions for the Index Master Portfolio to determine the effect that the Index Master Portfolio's trading has on the market prices of the securities in which the Index Master Portfolio invests. DFA also checks the rate of commission being paid by the Index Master Portfolio to its brokers to ascertain that they are competitive with those charged by other brokers for similar services. Transactions also may be placed with brokers who provide DFA with investment research, such as reports concerning individual issuers, industries and general economic and financial trends and other research services. The Investment Management Agreement permits DFA knowingly to pay commissions on such transactions which are greater than another broker might charge if DFA, in good faith, determines that the commissions paid are reasonable in relation to the research or brokerage services provided by the broker or dealer when viewed in terms of either a particular transaction or DFA's overall responsibilities to the Trust. Commission rates for brokerage transactions on foreign stock exchanges are generally fixed. In addition, the adviser or sub-adviser may take into account the sale of shares of the Fund in allocating purchase and sale orders for portfolio securities to brokers (including brokers that are affiliated with them or Distributor). For the year or period ended September 30, 1998, the following Portfolios paid brokerage commissions as follows: 88
PORTFOLIOS Brokerage Commissions - --------------------------------------------------------------------------------------------------------------------- Large Cap Value Equity................................................................ $1,667,505 Large Cap Growth Equity............................................................... 1,078,365 Mid-Cap Value Equity.................................................................. 503,594 Mid-Cap Growth Equity................................................................. 603,189 Small Cap Value Equity................................................................ 866,282 Small Cap Growth Equity............................................................... 1,081,442 Micro-Cap Equity...................................................................... 14,712 International Equity.................................................................. 2,629,819 International Small Cap Equity........................................................ 82,564 International Emerging Markets........................................................ 421,405 Select Equity......................................................................... 787,916 Balanced.............................................................................. 69,206
For the year or period ended September 30, 1997, the following Portfolios paid brokerage commissions as follows:
PORTFOLIOS BROKERAGE COMMISSIONS - ------------------------------------------------------------------------------------------------------------------------- Large Cap Value Equity................................................................ $1,309,867 Large Cap Growth Equity............................................................... 1,033,730 Mid-Cap Value Equity.................................................................. 199,394 Mid-Cap Growth Equity................................................................. 152,521 Small Cap Value Equity................................................................ 612,318 Small Cap Growth Equity............................................................... 413,189 International Equity.................................................................. 1,884,858 International Small Cap Equity........................................................ 57,239 International Emerging Markets........................................................ 570,670 Select Equity......................................................................... 317,435 Balanced.............................................................................. 75,685
For the year or period ended September 30, 1996, the following Portfolios paid brokerage commissions as follows:
PORTFOLIOS BROKERAGE COMMISSIONS - --------------------------------------------------------------------------------------------------------------------- Large Cap Value Equity................................................................ $1,455,318 Large Cap Growth Equity............................................................... 696,494 Small Cap Growth Equity............................................................... 165,153 Select Equity......................................................................... 443,114 Index Equity.......................................................................... 44,380 Small Cap Value Equity................................................................ 380,356 International Equity.................................................................. 1,912,522 Balanced.............................................................................. 95,277 International Emerging Markets........................................................ 588,860
For the Index Master Portfolio's fiscal years ended November 30, 1996, 1997 and 1998, the Index Master Portfolio paid brokerage commissions totaling $72,562, $116,563 and $15,841, respectively. Over-the-counter issues, including corporate debt and U.S. Government securities, are normally traded on a "net" basis without a stated commission, through dealers acting for their own account and not as brokers. The Portfolios will primarily 89 engage in transactions with these dealers or deal directly with the issuer unless a better price or execution could be obtained by using a broker. Prices paid to a dealer with respect to both foreign and domestic securities will generally include a "spread," which is the difference between the prices at which the dealer is willing to purchase and sell the specific security at the time, and includes the dealer's normal profit. Purchases of money market instruments by a Portfolio are made from dealers, underwriters and issuers. The Portfolios do not currently expect to incur any brokerage commission expense on such transactions because money market instruments are generally traded on a "net" basis with dealers acting as principal for their own accounts without a stated commission. The price of the security, however, usually includes a profit to the dealer. Each Money Market Portfolio intends to purchase only securities with remaining maturities of 13 months or less as determined in accordance with the rules of the SEC. As a result, the portfolio turnover rates of a Money Market Portfolio will be relatively high. However, because brokerage commissions will not normally be paid with respect to investments made by a Money Market Portfolio, the turnover rates should not adversely affect the Portfolio's net asset values or net income. Securities purchased in underwritten offerings include a fixed amount of compensation to the underwriter, generally referred to as the underwriter's concession or discount. When securities are purchased or sold directly from or to an issuer, no commissions or discounts are paid. The adviser or sub-advisers may seek to obtain an undertaking from issuers of commercial paper or dealers selling commercial paper to consider the repurchase of such securities from a Portfolio prior to maturity at their original cost plus interest (sometimes adjusted to reflect the actual maturity of the securities), if it believes that a Portfolio's anticipated need for liquidity makes such action desirable. Any such repurchase prior to maturity reduces the possibility that a Portfolio would incur a capital loss in liquidating commercial paper, especially if interest rates have risen since acquisition of such commercial paper. Investment decisions for each Portfolio and for other investment accounts managed by the adviser or sub-advisers are made independently of each other in light of differing conditions. However, the same investment decision may be made for two or more such accounts. In such cases, simultaneous transactions are inevitable. Purchases or sales are then averaged as to price and allocated as to amount in a manner deemed equitable to each such account. While in some cases this practice could have a detrimental effect upon the price or value of the security as far as a Portfolio is concerned, in other cases it could be beneficial to a Portfolio. A Portfolio will not purchase securities during the existence of any underwriting or selling group relating to such securities of which BlackRock, BIMC, BFM, PNC Bank, PTC, BIL, the Administrators, the Distributor or any affiliated person (as defined in the 1940 Act) thereof is a member except pursuant to procedures adopted by the Board of Trustees in accordance with Rule 10f-3 under the 1940 Act. In no instance will portfolio securities be purchased from or sold to BlackRock Advisors, Inc., BIMC, BFM, PNC Bank, PTC, BIL, PFPC, the Distributor or any affiliated person of the foregoing entities except as permitted by SEC exemptive order or by applicable law. The portfolio turnover rate of a Portfolio is calculated by dividing the lesser of a Portfolio's annual sales or purchases of portfolio securities (exclusive of purchases or sales of securities whose maturities at the time of acquisition were one year or less) by the monthly average value of the securities held by the Portfolio during the year. The Index Master Portfolio ordinarily will not sell portfolio securities except to reflect additions or deletions of stocks that comprise the S&P 500 Index, including mergers, reorganizations and similar transactions and, to the extent necessary, to provide cash to pay redemptions of the Index Master Portfolio's shares. 90 The Fund is required to identify any securities of its regular brokers or dealers (as defined in Rule 10b-1 under the 1940 Act) or their parents held by the Fund as of the end of its most recent fiscal year. As of September 30, 1998, the following Portfolios held the following securities:
PORTFOLIO Security Value - ------------------------------------------------------------------------------------------------------------ Money Market - ------------ Bear Stearns & Company Variable Rate Obligation $ 12,004,916 Lehman Brothers, Inc. Commercial Paper 138,302,472 Merrill Lynch & Co. Commercial Paper 98,703,149 Morgan Stanley & Co., Inc. Variable Rate Obligation 10,002,416 Paine Webber, Jackson & Curtis, Inc. Paine Webber Liquid Institutional Reserves Money Market Fund 5,396,776 U.S. Treasury Money Market - -------------------------- Bear Stearns & Company Repurchase Agreement 40,000,000 Greenwich Capital Repurchase Agreement 40,000,000 Goldman, Sachs & Co. Repurchase Agreement 40,000,000 J.P. Morgan Securities Corporation Repurchase Agreement 40,000,000 Lehman Brothers Repurchase Agreement 40,000,000 Merrill Lynch & Co. Repurchase Agreement 40,000,000 Morgan Stanley & Co., Inc. Repurchase Agreement 205,800,000 SBC Warburg, Dillon, Reed Repurchase Agreement 40,000,000 Low Duration Bond - ----------------- Bear Stearns & Company Multiple Class Mortgage Pass-Through 5,287,611 J.P. Morgan Securities Corporation Commercial Mortgage-Backed Security 2,000,625 Lehman Brothers, Inc. Corporate Bond 1,573,183 Merrill Lynch & Co. Mortgage Pass-Through 7,274,576 Morgan Stanley & Co., Inc. Commercial Mortgage-Backed Security 2,728,849 Immediate Government Bond - ------------------------- CS First Boston Corporation Commercial Mortgage-Backed Security 18,957 Merrill Lynch & Co. Commercial Mortgage-Backed Security 3,475,748
91
PORTFOLIO Security Value - ------------------------------------------------------------------------------------------------------------ Morgan Stanley Co., Inc. Commercial Mortgage-Backed Security 4,470,236
92
PORTFOLIO Security Value - ------------------------------------------------------------------------------------------------------------ Intermediate Bond - ----------------- Bear Stearns & Company Corporate Bond 5,154,060 Donaldson, Lufkin & Jenrette Securities Corp. Commercial Mortgage-Backed Security 9,435,049 J.P. Morgan Securities Corporation Commercial Mortgage-Backed Security 4,001,250 J.P. Morgan Securities Corporation Corporate Bond 3,340,027 Lehman Brothers Corporate Bond 4,123,880 Merrill Lynch & Co. Mortgage Pass-Through 2,865,214 Morgan Stanley Co., Inc. Commercial Mortgage-Backed Security 9,745,910 Core Bond - --------- CS First Boston Corporation Commercial Mortgage-Backed Security 2,659,677 CS First Boston Corporation Multiple Class Mortgage Pass-Through 5,866,836 Donaldson, Lufkin & Jenrette Securities Corp. Commercial Mortgage-Backed Security 10,825,974 Goldman, Sachs & Co. Commercial Mortgage-Backed Security 3,141,422 Goldman, Sachs & Co. Corporate Bond 3,836,438 J.P. Morgan Securities Corporation Commercial Mortgage-Backed Security 1,983,483 J.P. Morgan Securities Corporation Corporate Bond 90,271 Lehman Brothers, Inc. Corporate Bond 12,887,227 Merrill Lynch & Co. Mortgage Pass-Through 5,588,570 Merrill Lynch & Co. Corporate Bond 4,276,153 Government Income - ----------------- Donaldson, Lufkin & Jenrette Securities Corp. Commercial Mortgage-Backed Security 300,765 Goldman, Sachs & Co. Commercial Mortgage-Backed Security 504,037 Merrill Lynch & Co. Commercial Mortgage-Backed Security 70,197 Morgan Stanley, Dean Witter & Co., Inc. Commercial Mortgage-Backed Security 450,503 GNMA - ---- Morgan Stanley & Co., Inc. Commercial Mortgage-Backed Security 756,819 Managed Income - -------------- CS First Boston Corporation Commercial Mortgage-Backed Security 4,115,812 Donaldson, Lufkin & Jenrette Securities Corp. Commercial Mortgage-Backed Security 19,750,249 Goldman, Sachs & Company Corporate Bonds 18,054,906 J.P. Morgan Securities Corporation Commercial Mortgage-Backed Security 2,479,353 Lehman Brothers, Inc. Corporate Bond 14,838,083 Merrill Lynch & Co. Corporate Bond 8,705,026 Merrill Lynch & Co. Mortgage Pass-Throughs 20,072,154 Morgan Stanley, Dean Witter & Co., Inc. Commercial Mortgage-Backed Security 2,136,379 Paine Webber, Jackson & Curtis, Inc. Corporate Bond 5,020,292 Large Cap Value Equity - ---------------------- Morgan Stanley & Co., Inc. Common Stock 28,389,900 Select Equity - -------------
93
PORTFOLIO Security Value - ------------------------------------------------------------------------------------------------------------ Morgan Stanley & Co., Inc. Common Stock 13,357,987 Balanced - -------- Bear Stearns & Co. Corporate Bond 1,061,130 J.P. Morgan Securities Corporation Commercial Mortgage-Backed Security 495,871 Lehman Brothers, Inc. Corporate Bond 3,790,388 Merrill Lynch & Co. Commercial Mortgage-Backed Security 3,869,950 Merrill Lynch & Co. Corporate Bond 2,036,263 Morgan Stanley & Co., Inc. Common Stock 6,269,900
PURCHASE AND REDEMPTION INFORMATION INVESTOR SHARES PURCHASE OF SHARES. The minimum investment for the initial purchase of shares is $500; there is a $50 minimum for subsequent investments. Purchases through the Automatic Investment Plan are subject to a lower initial purchase minimum. In addition, the minimum initial investment for employees of the Fund, the Fund's investment adviser, sub-advisers, Distributor or transfer agent or employees of their affiliates is $100, unless payment is made through a payroll deduction program in which case the minimum investment is $25. Effective August 15, 1998, the Small Cap Growth Equity Portfolio will be closed to new investors, with the exception of investors who purchase through the following PNC Bank departments: Charitable and Endowment Management; Private Bank; and Institutional Trust, including defined benefit, defined contribution and Vested Interest7 plans. In addition, the Portfolio will continue to be open to wrap and retirement programs that are already invested in the Portfolio and to certain payroll deduction programs. Shareholders of the Portfolio as of August 15, 1998 will be permitted to make additional investments in current accounts. PURCHASES THROUGH BROKERS. It is the responsibility of brokers to transmit purchase orders and payment on a timely basis. If payment is not received within the period described above, the order will be canceled, notice thereof will be given, and the broker and its customers will be responsible for any loss to the Fund or its shareholders. Orders of less than $500 may be mailed by a broker to the transfer agent. PURCHASES THROUGH THE TRANSFER AGENT. Investors may also purchase Investor Shares by completing and signing the Account Application Form and mailing it to the transfer agent, together with a check in at least the minimum initial purchase amount payable to BlackRock Funds. The Fund does not accept third party checks for initial or subsequent investments. An Account Application Form may be obtained by calling (800) 441-7762. The name of the Portfolio with respect to which shares are purchased must also appear on the check or Federal Reserve Draft. Investors may also wire Federal funds in connection with the purchase of shares. The wire instructions must include the name of the Portfolio, specify the class of Investor Shares and include the name of the account registration and the shareholder account number. Before wiring any funds, an investor must call PFPC at (800) 441-7762 in order to confirm the wire instructions. OTHER PURCHASE INFORMATION. Shares of each Portfolio of the Fund are sold on a continuous basis by BDI as the Distributor. BDI maintains its principal offices at Four Falls Corporate Center, 6th Floor, West Conshohocken, PA 19428- 2961. Purchases may be effected on weekdays on which the New York Stock Exchange is open for business (a "Business Day"). Payment for orders which are not received or accepted will be returned after prompt inquiry. The issuance of shares is recorded on the books of the Fund. No certificates will be issued for shares. Payments for shares of a Portfolio may, in the discretion of the Fund's investment adviser, be made in the form of securities that are permissible investments for that Portfolio. The Fund reserves the right to reject any purchase order, to modify or waive the minimum initial or subsequent investment requirement and to suspend and resume the sale of any share class of any Portfolio at any time. In the event that a shareholder acquiring Investor A Shares on or after May 1, 1998 at a future date meets the eligibility standards for purchasing Institutional Shares (other than due to fluctuations in market value), then the shareholders Investor A 94 Shares will, upon the direction of the Fund's distributor, automatically be converted to Institutional Shares of the Portfolio having the same aggregate net asset value as the shares converted. Unless a sales charge waiver applies, Investor B shareholders of a Bond or Equity Portfolio pay a contingent deferred sales charge if they redeem during the first six years after purchase, and Investor C shareholders pay a contingent deferred sales charge if they redeem during the first twelve months after purchase. Investors expecting to redeem during these periods should consider the cost of the applicable contingent deferred sales charge in addition to the aggregate annual Investor B or Investor C distribution fees, as compared with the cost of the initial sales charges applicable to the Investor A Shares. Investor B Shares of the Portfolios purchased on or before January 12, 1996 are subject to a CDSC of 4.50% of the lesser of the original purchase price or the net asset value of Investor B Shares at the time of redemption. This deferred sales charge is reduced for shares held more than one year. Investor B Shares of a Portfolio purchased on or before January 12, 1996 convert to Investor A Shares of the Portfolio at the end of six years after purchase. For more information about Investor B Shares purchased on or before January 12, 1996 and the deferred sales charge payable on their redemption, call PFPC at (800) 441-7762. DEALER REALLOWANCES The following are the front-end sales loads reallowed to dealers as a percentage of the offering price of the Funds' Non-Money Market Investor A Shares.
LOW DURATION BOND PORTFOLIO: Reallowance or PLACEMENT FEES Amount of Transaction TO DEALERS (AS % OF AT OFFERING PRICE OFFERING PRICE)* Less than $25,000 2.50% $25,000 but less than $50,000 2.25 $50,000 but less than $100,000 2.00 $100,000 but less than $250,000 1.75 $250,000 but less than $500,000 1.25 $500,000 but less than $1,000,000 0.75 $1 million but less than $3 million 0.75 $3 million but less than $15 million 0.50 $15 million and above 0.25
INTERMEDIATE GOVERNMENT BOND, INTERMEDIATE BOND, CORE BOND, GNMA, TAX-FREE INCOME, PENNSYLVANIA TAX -FREE INCOME, NEW JERSEY TAX-FREE INCOME, OHIO TAX-FREE INCOME, DELAWARE TAX-FREE INCOME AND KENTUCKY TAX-FREE INCOME PORTFOLIOS:
Reallowance or PLACEMENT FEES Amount of Transaction TO DEALERS (AS % OF AT OFFERING PRICE OFFERING PRICE)* Less than $25,000 3.50% $25,000 but less than $50,000 3.25 $50,000 but less than $100,000 3.00 $100,000 but less than $250,000 2.50
95 $250,000 but less than $500,000 1.50 $500,000 but less than $1,000,000 0.75 $1 million but less than $3 million 0.75 $3 million but less than $15 million 0.50 $15 million and above 0.25
* The Distributor may pay placement fees to dealers as shown on purchases of Investor A Shares of $1,000,000 or more. 96
GOVERNMENT INCOME AND MANAGED INCOME PORTFOLIOS: Reallowance or PLACEMENT FEES Amount of Transaction TO DEALERS (AS % OF AT OFFERING PRICE OFFERING PRICE)* less than $25,000 4.00 % $25,000 but less than $50,000 3.75 $50,000 but less than $100,000 3.50 $100,000 but less than $250,000 3.00 $250,000 but less than $500,000 2.00 $500,000 but less than $1,000,000 1.25 $1 million but less than $3 million 1.00 $3 million but less than $15 million 0.50 $15 million and above 0.25
INTERNATIONAL BOND AND HIGH YIELD BOND PORTFOLIOS: Reallowance or PLACEMENT FEES Amount of Transaction TO DEALERS (AS % OF AT OFFERING PRICE OFFERING PRICE)* Less than $25,000 4.50% $25,000 but less than $50,000 4.25 $50,000 but less than $100,000 4.00 $100,000 but less than $250,000 3.50 $250,000 but less than $500,000 2.50 $500,000 but less than $1,000,000 1.50 $1 million but less than $3 million 1.00 $3 million but less than $15 million 0.50 $15 million and above 0.25
* The Distributor may pay placement fees to dealers as shown on purchases of Investor A Shares of $1,000,000 or more. 97 ALL EQUITY PORTFOLIOS EXCEPT THE MICRO-CAP EQUITY PORTFOLIO, INTERNATIONAL EQUITY, INTERNATIONAL EMERGING MARKETS AND INTERNATIONAL SMALL CAP EQUITY PORTFOLIOS AND INDEX EQUITY PORTFOLIO:
REALLOWANCE OR PLACEMENT FEES AMOUNT OF TRANSACTION TO DEALERS (AS % OF AT OFFERING PRICE OFFERING PRICE)* Less than $25,000 4.00% $25,000 but less than $50,000 3.75 $50,000 but less than $100,000 3.50 $100,000 but less than $250,000 3.00 $250,000 but less than $500,000 2.00 $500,000 but less than $1,000,000 1.25 $1 million but less than $3 million 1.00 $3 million but less than $15 million 0.50 $15 million and above 0.25
MICRO-CAP EQUITY, INTERNATIONAL EQUITY, INTERNATIONAL EMERGING MARKETS AND INTERNATIONAL SMALL CAP EQUITY PORTFOLIOS:
REALLOWANCE OR PLACEMENT FEES AMOUNT OF TRANSACTION TO DEALERS (AS % OF AT OFFERING PRICE OFFERING PRICE)* Less than $25,000 4.50% $25,000 but less than $50,000 4.25 $50,000 but less than $100,000 4.00 $100,000 but less than $250,000 3.50 $250,000 but less than $500,000 2.50 $500,000 but less than $1,000,000 1.50 $1 million but less than $3 million 1.00 $3 million but less than $15 million 0.50 $15 million and above 0.25
98 No front-end sales loads are reallowed to dealers on sales of Index Equity Portfolio Investor A Shares. * The Distributor may pay placement fees to dealers as shown on purchases of Investor A Shares of $1,000,000 or more. During special promotions, the entire sales charge may be reallowed to dealers. Dealers who receive 90% or more of the sales charge may be deemed to be "underwriters" under the 1933 Act. The amount of the sales charge not reallowed to dealers may be paid to broker-dealer affiliates of PNC Bank Corp. who provide sales support services. The Distributor, BlackRock, Inc. and/or their affiliates may also pay additional compensation, out of their assets and not as an additional charge to the Portfolios, to dealers in connection with the sale and distribution of shares (such as additional payments based on new sales), and may, subject to applicable NASD regulations, contribute to various non-cash and cash incentive arrangements to promote the sale of shares, as well as sponsor various educational programs, sales contests and promotions in which participants may receive reimbursement of expenses, entertainment and prizes such as travel awards, merchandise and cash. The following special purchase plans result in the waiver or reduction of sales charges for Investor A, B or C shares of each of the Equity and Bond Portfolios. SALES CHARGE WAIVERS FOR EACH OF THE EQUITY AND BOND PORTFOLIOS-INVESTOR A SHARES QUALIFIED PLANS. In general, the sales charge (as a percentage of the offering price) payable by qualified employee benefit plans ("Qualified Plans") having at least 20 employees eligible to participate in purchases of Investor A Shares of the Portfolios aggregating less than $500,000 will be 1.00%. No sales charge will apply to purchases by such Qualified Plans of Investor A Shares aggregating $500,000 and above. The sales charge payable by Qualified Plans having less than 20 employees eligible to participate in purchases of Investor A Shares of the Portfolio aggregating less than $500,000 will be 2.50% (1.50% with respect to the Index Equity Portfolio). The above schedule will apply to purchases by such Qualified Plans of Investor A Shares aggregating $500,000 and above. The Fund has established different waiver arrangements with respect to the sales charge on Investor A Shares of the Portfolios for purchases through certain Qualified Plans participating in programs whose sponsors or administrators have entered into arrangements with the Fund. Investor A Shares of the Non-Money Market Portfolios will be made available to plan participants at net asset value with the waiver of the initial sales charge on purchases through an eligible 401(k) plan participating in a Merrill Lynch 401(k) Program (an "ML 401(k) Plan") if: 99 (i) the ML 401(k) Plan is record kept on a daily valuation basis by Merrill Lynch and, on the date the ML 401(k) Plan sponsor signs the Merrill Lynch Recordkeeping Service Agreement, the ML 401(k) Plan has $3 million or more in assets invested in broker/dealer funds not advised or managed by Merrill Lynch Asset Management, L.P. ("MLAM") that are made available pursuant to a Services Agreement between Merrill Lynch and the fund's principal underwriter or distributor and in funds advised or managed by MLAM (collectively, the "Applicable Investments"); or (ii) the ML 401(k) Plan is recordkept on a daily valuation basis by an independent recordkeeper whose services are provided through a contract or alliance arrangement with Merrill Lynch, and on the date the ML 401(k) Plan sponsor signs the Merrill Lynch Recordkeeping Service Agreement, the ML 401(k) Plan has $3 million or more in assets, excluding money market funds, invested in Applicable Investments; or (iii) the ML 401(k) Plan has 500 or more eligible employees, as determined by the Merrill Lynch plan conversion manager, on the date the ML 401(k) Plan sponsor signs the Merrill Lynch Recordkeeping Service Agreement. OTHER. The following persons associated with the Fund, the Distributor, the Fund's investment adviser, sub-advisers or transfer agent and their affiliates may buy Investor A Shares of each of the Bond and Equity Portfolios without paying a sales charge to the extent permitted by these firms: (a) officers, directors and partners (and their spouses and minor children); (b) employees and retirees (and their spouses and minor children); (c) registered representatives of brokers who have entered into selling agreements with the Distributor; (d) spouses or children of such persons; and (e) any trust, pension, profit-sharing or other benefit plan for any of the persons set forth in (a) through (c). The following persons may also buy Investor A Shares without paying a sales charge: (a) persons investing through an authorized payroll deduction plan; (b) persons investing through an authorized investment plan for organizations which operate under Section 501(c)(3) of the Internal Revenue Code; (c) registered investment advisers, trust companies and bank trust departments exercising discretionary investment authority with respect to amounts to be invested in a Portfolio, provided that the aggregate amount invested pursuant to this exemption in Investor A Shares that would otherwise be subject to front-end sales charges equals at least $250,000; and (d) persons participating in a "wrap account" or similar program under which they pay advisory fees to a broker-dealer or other financial institution. Investors who qualify for any of these exemptions from the sales charge must purchase Investor A Shares. REDUCED SALES CHARGES FOR EACH OF THE EQUITY AND BOND PORTFOLIOS-INVESTOR A SHARES Because of reductions in the front-end sales charge for purchases of Investor A Shares aggregating $25,000 or more, it may be advantageous for investors purchasing large quantities of Investor Shares to purchase Investor A Shares. In any event, the Fund will not accept any purchase order for $1,000,000 or more of Investor B Shares or Investor C Shares. QUANTITY DISCOUNTS. Larger purchases may reduce the sales charge price. Upon notice to the investor's broker or the transfer agent, purchases of Investor A Shares made at any one time by the following persons may be considered when calculating the sales charge: (a) an individual, his or her spouse and their children under the age of 21; (b) a trustee or fiduciary of a single trust estate or single fiduciary account; or (c) any organized group which has been in existence for more than six months, if it is not organized for the purpose of buying redeemable securities of a registered investment company, and if the purchase is made through a central administrator, or through a single dealer, or by other means which result in economy of sales effort or expense. An organized group does not include a group of individuals whose sole organizational connection is participation as credit card holders of a company, policyholders of an insurance company, customers of either a bank or broker/dealer or clients of an investment adviser. Purchases made by an organized group may include, for example, a trustee or other fiduciary purchasing for a single fiduciary account or other employee benefit plan purchases made through a payroll deduction plan. RIGHT OF ACCUMULATION. Under the Right of Accumulation, the current value of an investor's existing Investor A Shares in any of the Non-Money Market Portfolios that are subject to a front-end sales charge or the total amount of an investor's initial investment in such shares, less redemptions (whichever is greater) may be combined with the amount of the investor's current purchase in determining the applicable sales charge. In order to receive the cumulative quantity reduction, previous purchases of Investor A Shares must be called to the attention of PFPC by the investor at the time of the current purchase. REINVESTMENT PRIVILEGE. Upon redemption of Investor A Shares of a Non-Money Market Portfolio (or Investor A Shares of another Non-Money Market Portfolio of the Fund), a shareholder has a one-time right, to be exercised within 60 days, to reinvest the redemption proceeds without any sales charges. PFPC must be notified of the reinvestment in writing by the 100 purchaser, or by his or her broker, at the time purchase is made in order to eliminate a sales charge. An investor should consult a tax adviser concerning the tax consequences of use of the reinvestment privilege. LETTER OF INTENT. An investor may qualify for a reduced sales charge immediately by signing a Letter of Intent stating the investor's intention to invest during the next 13 months a specified amount in Investor A Shares of a Non-Money Market Portfolio which, if made at one time, would qualify for a reduced sales charge. The Letter of Intent may be signed at any time within 90 days after the first investment to be included in the Letter of Intent. The initial investment must meet the minimum initial investment requirement and represent at least 5% of the total intended investment. The investor must instruct PFPC upon making subsequent purchases that such purchases are subject to a Letter of Intent. All dividends and capital gains of a Portfolio that are invested in additional Investor A Shares of the same Portfolio are applied to the Letter of Intent. During the term of a Letter of Intent, the Fund's transfer agent will hold Investor A Shares representing 5% of the indicated amount in escrow for payment of a higher sales load if the full amount indicated in the Letter of Intent is not purchased. The escrowed Investor A Shares will be released when the full amount indicated has been purchased. Any redemptions made during the 13-month period will be subtracted from the amount of purchases in determining whether the Letter of Intent has been completed. If the full amount indicated is not purchased within the 13-month period, the investor will be required to pay an amount equal to the difference between the sales charge actually paid and the sales charge the investor would have had to pay on his or her aggregate purchases if the total of such purchases had been made at a single time. If remittance is not received within 20 days of the expiration of the 13-month period, PFPC, as attorney-in-fact, pursuant to the terms of the Letter of Intent, will redeem an appropriate number of Investor A Shares held in escrow to realize the difference. PURCHASES OF INVESTOR B SHARES. Investor B Shares of the Non-Money Market Portfolios are subject to a deferred sales charge if they are redeemed within six years of purchase. Dealers will generally receive commissions equal to 4.00% of Investor B Shares sold by them plus ongoing fees under the Fund's Amended and Restated Distribution and Service Plan. Dealers may not receive a commission in connection with sales of Investor B Shares to certain retirement plans sponsored by the Fund, BlackRock or its affiliates, but may receive fees under the Amended and Restated Distribution and Service Plan. These commissions and payments may be different than the reallowances, placement fees and commissions paid to dealers in connection with sales of Investor A Shares and Investor C Shares. PURCHASES OF INVESTOR C SHARES. Investor C Shares of the Non-Money Market Portfolios are subject to a deferred sales charge of 1.00% based on the lesser of the offering price or the net asset value of the Investor C Shares on the redemption date if redeemed within twelve months after purchase. Dealers will generally receive commissions equal to 1.00% of the Investor C Shares sold by them plus ongoing fees under the Fund's Amended and Restated Distribution and Service Plan. Dealers may not receive a commission in connection with sales of Investor C Shares to certain retirement plans sponsored by the Fund, BlackRock or its affiliates, but may receive fees under the Amended and Restated Distribution and Service Plan. These commissions and payments may be different than the reallowances, placement fees and commissions paid to dealers in connection with sales of Investor A Shares and Investor B Shares. EXEMPTIONS FROM THE CONTINGENT DEFERRED SALES CHARGE- INVESTOR B AND INVESTOR C SHARES. The contingent deferred sales charge on Investor B Shares and Investor C Shares of the Non-Money Market Portfolios is not charged in connection with: (1) exchanges described in "Exchange Privilege" below; (2) redemptions made in connection with minimum required distributions from IRA, 403(b)(7) and Qualified Plan accounts due to the shareholder reaching age 702; (3) redemptions made with respect to certain retirement plans sponsored by the Fund, BlackRock or its affiliates; (4) redemptions in connection with a shareholder's death or disability (as defined in the Internal Revenue Code) subsequent to the purchase of Investor B Shares or Investor C Shares; (5) involuntary redemptions of Investor B Shares or Investor C Shares in accounts with low balances as described in "Redemption of Shares" below; and (6) redemptions made pursuant to the Systematic Withdrawal Plan, subject to the limitations set forth under "Systematic Withdrawal Plan" below. In addition, no contingent deferred sales charge is charged on Investor B Shares or Investor C Shares acquired through the reinvestment of dividends or distributions. The Fund also waives the contingent deferred sales charge on redemptions of Investor B Shares of the Portfolio purchased through certain Qualified Plans participating in programs whose sponsors or administrators have entered into arrangements with the Fund. 101 Investor B Shares of the Non-Money Market Portfolios will be made available to plan participants at net asset value with the waiver of the contingent deferred sales charge if the shares were purchased through an ML 401(k) Plan if: (i) the ML 401(k) Plan is recordkept on a daily valuation basis by Merrill Lynch and, on the date the ML 401(k) Plan sponsor signs the Merrill Lynch Recordkeeping Service Agreement, the ML 401(k) Plan has less than $3 million in assets invested in Applicable Investments; or (ii) the ML 401(k) Plan is recordkept on a daily valuation basis by an independent recordkeeper whose services are provided through a contract or alliance arrangement with Merrill Lynch, and on the date the ML 401(k) Plan sponsor signs the Merrill Lynch Recordkeeping Service Agreement, the ML 401(k) Plan has less than $3 million in assets, excluding money market funds, invested in Applicable Investments; or (iii) the ML 401(k) Plan has less than 500 eligible employees, as determined by the Merrill Lynch plan conversion manager, on the date the ML 401(k) Plan sponsor signs the Merrill Lynch Recordkeeping Service Agreement. ML 401(k) Plans recordkept on a daily basis by Merrill Lynch or an independent recordkeeper under a contract with Merrill Lynch that are currently investing in Investor B shares of Non-Money Market Portfolios of the Fund convert to Investor A shares once the ML 401(k) Plan has reached $5 million invested in Applicable Investments. The ML 401(k) Plan will receive a plan- level share conversion. When an investor redeems Investor B Shares or Investor C Shares, the redemption order is processed to minimize the amount of the contingent deferred sales charge that will be charged. Investor B Shares and Investor C Shares are redeemed first from those shares that are not subject to the deferred sales load (i.e., shares that were acquired through reinvestment of dividends or distributions) and after that from the shares that have been held the longest. SHAREHOLDER FEATURES EXCHANGE PRIVILEGE. Investor A, Investor B and Investor C Shares of each Portfolio may be exchanged for shares of the same class of other portfolios of the Fund which offer that class of shares, based on their respective net asset values. Exchanges of Investor A Shares may be subject to the difference between the sales charge previously paid on the exchanged shares and the higher sales charge (if any) payable with respect to the shares acquired in the exchange. Unless an exemption applies, a front-end sales charge will be charged in connection with exchanges of Investor A Shares of the Money Market Portfolios for Investor A Shares of the Fund's Non-Money Market Portfolios. Similarly, exchanges of Investor B or Investor C Shares of a Money Market Portfolio for Investor B or Investor C Shares of a Non-Money Market Portfolio of the Fund will also be subject to a CDSC, unless an exemption applies. Investor A Shares of the Portfolios are only exchangeable for Investor A Shares of the Fund's other Portfolios, Investor B Shares of the Portfolios are only exchangeable for Investor B Shares of the Fund's other Portfolios, and Investor C Shares of the Portfolios are only exchangeable for Investor C Shares of the Fund's other Portfolios. In determining the holding period for calculating the contingent deferred sales charge payable on redemption of Investor B and Investor C Shares, the holding period of the Investor B or Investor C Shares originally held will be added to the holding period of the Investor B or Investor C Shares acquired through exchange. No exchange fee is imposed by the Fund. Investor A Shares of Money Market Portfolios of the Fund that were (1) acquired through the use of the exchange privilege and (2) can be traced back to a purchase of shares in one or more investment portfolios of the Fund for which a sales charge was paid, can be exchanged for Investor A Shares of a portfolio subject to differential sales charges as applicable. The exchange of Investor B and Investor C Shares will not be subject to a CDSC, which will continue to be measured from the date of the original purchase and will not be affected by exchanges. A shareholder wishing to make an exchange may do so by sending a written request to PFPC at the address given above. Shareholders are automatically provided with telephone exchange privileges when opening an account, unless they indicate on the Application that they do not wish to use this privilege. Shareholders holding share certificates are not eligible to exchange Investor A Shares by phone because share certificates must accompany all exchange requests. To add this feature to an existing account that previously did not provide this option, a Telephone Exchange Authorization Form must be filed with PFPC. This form is available from PFPC. Once this election has been made, the shareholder may simply contact PFPC by telephone at (800) 102 441-7762 to request the exchange. During periods of substantial economic or market change, telephone exchanges may be difficult to complete and shareholders may have to submit exchange requests to PFPC in writing. If the exchanging shareholder does not currently own shares of the investment portfolio whose shares are being acquired, a new account will be established with the same registration, dividend and capital gain options and broker of record as the account from which shares are exchanged, unless otherwise specified in writing by the shareholder with all signatures guaranteed by an eligible guarantor institution as defined above. In order to participate in the Automatic Investment Program or establish a Systematic Withdrawal Plan for the new account, however, an exchanging shareholder must file a specific written request. Any share exchange must satisfy the requirements relating to the minimum initial investment requirement, and must be legally available for sale in the state of the investor's residence. For Federal income tax purposes, a share exchange is a taxable event and, accordingly, a capital gain or loss may be realized. Before making an exchange request, shareholders should consult a tax or other financial adviser and should consider the investment objective, policies and restrictions of the investment portfolio into which the shareholder is making an exchange. Brokers may charge a fee for handling exchanges. The Fund reserves the right to modify or terminate the exchange privilege at any time. Notice will be given to shareholders of any material modification or termination except where notice is not required. The Fund reserves the right to reject any telephone exchange request. Telephone exchanges may be subject to limitations as to amount or frequency, and to other restrictions that may be established from time to time to ensure that exchanges do not operate to the disadvantage of any portfolio or its shareholders. The Fund, the Administrators and the Distributor will employ reasonable procedures to confirm that instructions communicated by telephone are genuine. The Fund, the Administrators and the Distributor will not be liable for any loss, liability, cost or expense for acting upon telephone instructions reasonably believed to be genuine in accordance with such procedures. Exchange orders may also be sent by mail to the shareholder's broker or to PFPC at P.O. Box 8907, Wilmington, Delaware 19899-8907. By use of the exchange privilege, the investor authorizes the Fund's transfer agent to act on telephonic or written exchange instructions from any person representing himself to be the investor and believed by the Fund's transfer agent to be genuine. The records of the Fund's transfer agent pertaining to such instructions are binding. The exchange privilege may be modified or terminated at any time upon 60 days' notice to affected shareholders. The exchange privilege is only available in states where the exchange may legally be made. A front-end sales charge or a contingent deferred sales charge will be imposed (unless an exemption from either sales charge applies) when Investor Shares of a Money Market Portfolio are redeemed and the proceeds are used to purchase Investor A Shares, Investor B Shares or Investor C Shares of a Non- Money Market Portfolio. Automatic Investment Plan ("AIP"). Investor Share Shareholders and certain Service Share Shareholders who were shareholders of the Compass Capital Group of Funds at the time of its combination with the PNC(R) Fund in 1996 may arrange for periodic investments in that Portfolio through automatic deductions from a checking or savings account by completing the AIP Application Form which may be obtained from PFPC. The minimum pre-authorized investment amount is $50. Systematic Withdrawal Plan ("SWP"). The Fund offers a Systematic Withdrawal Plan which may be used by Investor Share Shareholders and certain Service Share Shareholders who were shareholders of the Compass Capital Group of Funds at the time of its combination with the PNC(R) Fund in 1996 who wish to receive regular distributions from their accounts. Upon commencement of the SWP, the account must have a current value of $10,000 or more in a Portfolio. Shareholders may elect to receive automatic cash payments of $50 or more either monthly, every other month, quarterly, three times a year, semi-annually, or annually. Automatic withdrawals are normally processed on the 25th day of the applicable month or, if such day is not a Business Day, on the next Business Day and are paid promptly thereafter. An investor may utilize the SWP by completing the SWP application Form which may be obtained from PFPC. Shareholders should realize that if withdrawals exceed income dividends their invested principal in the account will be depleted. To participate in the SWP, shareholders must have their dividends automatically reinvested and may not hold share certificates. Shareholders may change or cancel the SWP at any time, upon written notice to PFPC. Purchases of additional Investor A Shares of the Fund concurrently with withdrawals may be disadvantageous to investors because of the sales charges involved and, therefore, are discouraged. No contingent deferred sales charge will be assessed on the redemptions of Investor B or Investor C Shares made through the SWP that do not exceed 12% of an account's net asset value on an annualized basis. For example, monthly, quarterly and semi-annual SWP redemptions of Investor B or Investor C Shares will not be subject to the CDSC if they do not exceed 1%, 3% and 6%, respectively, of an account's net asset value on the redemption date. SWP redemptions of Investor B or Investor C Shares in excess of this limit are still subject to the applicable CDSC. REDEMPTION OF SHARES. Except as noted below, a request for redemption must be signed by all persons in whose names the shares are registered. Signatures must conform exactly to the account registration. If the proceeds of the redemption would exceed $25,000, or if the proceeds are not to be paid to the record owner at the record address, or if the shareholder is a corporation, partnership, trust or fiduciary, signature(s) must be guaranteed by any eligible guarantor institution. A signature guarantee is designed to protect the shareholders and the Portfolio against fraudulent transactions by unauthorized persons. A signature guarantee may be obtained from a domestic bank or trust company, recognized broker, dealer, clearing agency, savings association who are participants in a medallion program by the Securities Transfer Association, credit unions, national securities exchanges and registered securities associations. The three recognized medallion programs are Securities Transfer Agent Medallion Program (STAMP), Stock Exchanges Medallion Program (SEMP) and New York Stock Exchange, Inc. Medallion Signature Program (MSP). Signature Guarantees which are not a part of these programs will not be accepted. Please note that a notary public stamp or seal is not acceptable. Generally, a properly signed written request with any required signature guarantee is all that is required for a redemption. In some cases, however, other documents may be necessary. Shareholders holding Investor A Share certificates must send their 103 certificates with the redemption request. Additional documentary evidence of authority is required by PFPC in the event redemption is requested by a corporation, partnership, trust, fiduciary, executor or administrator. Investor A shareholders of the Money Market Portfolios may redeem their shares through the checkwriting privilege. Upon receipt of the checkwriting application and signature card by PFPC, checks will be forwarded to the investor. The minimum amount of a check is $100. If more than one shareholder owns the account, each shareholder must sign each check, unless an election has been made to permit check writing by a limited number of signatures and such election is on file with PFPC. Investor A Shares represented by a check redemption will continue to earn daily income until the check is presented for payment. PNC bank, as the investor=s agent, will cause the Fund to redeem a sufficient number of Investor A Shares owned to cover the check. When redeeming Investor A Shares by check, an investor should make certain that there is an adequate number of Investor A Shares in the account to cover the amount of the check. If an insufficient number of Investor A Shares is held or if checks are not properly endorsed, they may not be honored and a service charge may be incurred. Checks may not be presented for cash payments at the offices of PNC Bank. This limitation does not affect checks used for the payment of bills or cash at other banks. PAYMENT OF REDEMPTION PROCEEDS. The Fund may suspend the right of redemption or postpone the date of payment upon redemption for such periods as are permitted under the 1940 Act, and may redeem shares involuntarily or make payment for redemption in securities or other property when determined appropriate in light of the Fund's responsibilities under the 1940 Act. The Fund reserves the right, if conditions exist which make cash payments undesirable, to honor any request for redemption or repurchase of a Portfolio's shares by making payment in whole or in part in securities chosen by the Fund and valued in the same way as they would be valued for purposes of computing a Portfolio's net asset value. If payment is made in securities, a shareholder may incur transaction costs in converting these securities into cash. The Fund has elected, however, to be governed by Rule 18f-1 under the 1940 Act so that a Portfolio is obligated to redeem its shares solely in cash up to the lesser of $250,000 or 1% of its net asset value during any 90-day period for any one shareholder of a Portfolio. With respect to the Index Master Portfolio, when the Trustees of the Trust determine that it would be in the best interests of the Index Master Portfolio, the Index Master Portfolio may pay the redemption price in whole or in part by a distribution of portfolio securities from the Index Master Portfolio of the shares being redeemed in lieu of cash in accordance with Rule 18f-1 under the 1940 Act. Investors, such as the Index Equity Portfolio, may incur brokerage charges and other transaction costs selling securities that were received in payment of redemptions. Under the 1940 Act, a Portfolio may suspend the right to redemption or postpone the date of payment upon redemption for any period during which the New York Stock Exchange (the "NYSE") is closed (other than customary weekend and holiday closings), or during which trading on the NYSE is restricted, or during which (as determined by the SEC by rule or regulation) an emergency exists as a result of which disposal or valuation of portfolio securities is not reasonably practicable, or for such other periods as the SEC may permit. (A Portfolio may also suspend or postpone the recordation of the transfer of its shares upon the occurrence of any of the foregoing conditions.) The Fund may redeem shares involuntarily to reimburse a Portfolio for any loss sustained by reason of the failure of a shareholder to make full-payment for shares purchased by the shareholder or to collect any charge relating to a transaction effected for the benefit of a shareholder. The Fund reserves the express right to redeem shares of each Portfolio involuntarily at any time if the Fund's Board of Trustees determines, in its sole discretion, that failure to do so may have adverse consequences to the holders of shares in the Portfolio. Upon such redemption the holders of shares so redeemed shall have no further right with respect thereto other than to receive payment of the redemption price. COMPUTATION OF PUBLIC OFFERING PRICES FOR INVESTOR A SHARES OF THE NON-MONEY MARKET PORTFOLIOS. An illustration of the computation of the public offering price per Investor A Share of the respective Non-Money Market Portfolios, based on the value of such Portfolios' net assets as of September 30, 1998 follows: 104
LOW INTERMEDIATE INTERMEDIATE CORE GOVERNMENT DURATION GOVERNMENT BOND BOND INCOME BRAND PORTFOLIO BOND PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO ---------------- -------------- ------------ --------- ----------- Net Assets................................. $2,849,832 $7,971,816 $1,648,048 $5,108,250 6,045,305 Outstanding Shares......................... 284,206 760,875 170,349 504,846 557,445 ========== ========== ========== ========== ========== Net Asset Value Per Share.................. $ 10.03 $ 10.48 $ 9.67 $ 10.12 $ 10.84 Maximum Sales Charge, 4.00% of offering price (4.17% of net asset value per share)*.................................. .31 .44 .40 .42 .51 ---------- ---------- ---------- ---------- ---------- Offering to Public......................... $ 10.34 $ 10.92 $ 10.07 $ 10.54 $ 11.35 ========== ========== ========== ========== ==========
_____________________ * 3.00%/3.09% for Low Duration Bond Portfolio; 4.50%/4.71% for Government Income Portfolio.
PENNSYLVANIA NEW JERSEY MANAGED INTERNATIONAL TAX-FREE TAX-FREE TAX-FREE INCOME BOND GNMA INCOME INCOME INCOME PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO --------- ------------- --------- --------- ---------- ----------- Net Assets........................... $14,896,948 $1,705,546 $534,964 $6,440,125 $34,711,436 $1,431,926 Outstanding Shares................... 1,399,501 151,735 52,918 549,031 3,112,945 118,608 =========== ========== ======== ========== =========== ========== Net Asset Value Per Share............ $ 10.64 $ 11.24 $ 10.11 $ 11.73 $ 11.15 $ 12.07 Maximum Sales Charge, 4.00% of offering price (4.17% of net asset value per share)*................... .50 .59 .48 .49 .46 .50 ----------- ---------- -------- ---------- ----------- ---------- Offering to Public................... $ 11.14 $ 11.83 $ 10.59 $ 12.22 $ 11.61 $ 12.57 =========== ========== ======== ========== =========== ==========
_____________________ * 4.50%/4.71% for Managed Income and for GNMA Portfolios; 5.00%/5.26% for International Bond Portfolio.
OHIO LARGE CAP LARGE CAP MID-CAP TAX-FREE DELAWARE VALUE GROWTH VALUE INCOME TAX-FREE KENTUCKY TAX-FREE EQUITY EQUITY EQUITY PORTFOLIO INCOME PORTFOLIO INCOME PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO --------- ---------------- ----------------- ---------- --------- --------- Net Assets...................... $2,774,273 $2,545,965 $974,980 $51,150,997 $33,339,983 $3,983,378 Outstanding Shares.............. 255,026 246,371 94,577 3,483,278 1,845,833 375,407 ========== ========== ======== =========== =========== ========== Net Asset Value Per Share....... $ 10.88 $ 10.33 $ 10.31 $ 14.68 $ 18.06 $ 10.61 Maximum Sales Charge, 4.50% of offering price (4.71% of net asset value per share)*........ .45 .43 .43 .69 .85 .50 ---------- ---------- -------- ----------- ----------- ---------- Offering to Public.............. $ 11.33 $ 10.76 $ 10.74 $ 15.37 $ 18.91 $ 11.11 ========== ========== ======== =========== =========== ========== MID-CAP GROWTH EQUITY PORTFOLIO --------- Net Assets...................... $4,089,848 Outstanding Shares.............. 371,177 ========== Net Asset Value Per Share....... $ 11.02 Maximum Sales Charge, 4.50% of offering price (4.71% of net asset value per share)*........ .52 ---------- Offering to Public.............. $ 11.54 ==========
_____________________ * 4.00%/4.17% for Ohio Tax-Free Income, Delaware Tax-Free Income and Kentucky Tax-Free Income Portfolios. 105
SMALL CAP INTERNATIONAL INTERNATIONAL SMALL CAP GROWTH INTERNATIONAL SMALL CAP EMERGING VALUE EQUITY EQUITY EQUITY EQUITY MARKETS PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO ----------------------------------------------------------------------- Net Assets............................... $34,286,072 $48,190,163 $26,637,346 $848,493 $1,835,321 Outstanding Shares....................... 2,304,673 2,814,694 2,027,205 88,952 420,881 =========== =========== =========== ======== ========== Net Asset Value Per Share................ $ 14.88 $ 17.12 $ 13.14 $ 9.54 $ 4.36 Maximum Sales Charge, 5.00% of offering .70 .81 .69 .50 .23 price ----------- ----------- ----------- -------- ---------- (5.26% of net asset value per share)*.. Offering to Public....................... $ 15.58 $ 17.93 $ 13.83 $ 10.04 $ 4.59 =========== =========== =========== ======== ==========
________________ * 4.50%/4.71% for Small Cap Value Equity and Small Cap Growth Equity Portfolios.
SELECT INDEX MICRO-CAP EQUITY EQUITY EQUITY BALANCED PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO --------------------------------------------------------------- Net Assets...................................... $6,100,311 $35,359,044 $42,891,252 $96,795,124 Outstanding Shares.............................. 650,470 2,079,728 2,183,440 5,280,298 ========== =========== =========== =========== Net Asset Value Per Share....................... $ 9.38 $ 17.00 $ 19.64 $ 18.33 Maximum Sales Charge, 4.50% of offering price .49 .80 .61 .86 (4.71% of net asset value per share)*.......... ---------- ----------- ----------- ----------- Offering to Public.............................. $ 9.87 $ 17.80 $ 20.25 $ 19.19 ========== =========== =========== ===========
__________________ * 5.00%/5.269% for Micro-Cap Equity Portfolio; 3.00%/3.09% for Index Equity Portfolio. Total front-end sales charges paid by shareholders of Investor A Shares of the Portfolios for the year or period ended September 30, 1998 (for the period from May 1, 1998 through September 30, 1998 in the case of the Micro-Cap Equity Portfolio; and for the period from May 11, 1998 through September 30, 1998 in the case of the Delaware Tax-Free Income Portfolio and the Kentucky Tax-Free Income Portfolio; and for the period from May 18, 1998 through September 30, 1998 in the case of the GNMA Portfolio) were as follows:
FRONT-END PORTFOLIOS SALES CHARGES - --------------------------------------------------------------------------------------------------------------------- Low Duration Bond......................................................... $ 3,210 Intermediate Government Bond.............................................. 6,951 Intermediate Bond......................................................... 4,428 Core Bond................................................................. 39,660 Government Income......................................................... 51,567 Managed Income............................................................ 47,124 International Bond........................................................ 21,051 GNMA...................................................................... 607 Tax-Free Income........................................................... 10,786 Pennsylvania Tax-Free Income.............................................. 73,272 New Jersey Tax-Free Income................................................ 5,120 Ohio Tax-Free Income...................................................... 3,344 Delaware Tax-Free Income.................................................. 33,955 Kentucky Tax-Free Income.................................................. 0 Large Cap Value Equity.................................................... 243,863 Large Cap Growth Equity................................................... 150,956 Mid-Cap Value Equity...................................................... 70,975 Mid-Cap Growth Equity..................................................... 41,375 Small Cap Value Equity.................................................... 244,947 Small Cap Growth Equity................................................... 275,225 Micro-Cap Equity.......................................................... 172,918 International Equity...................................................... 57,797 International Small Cap Equity............................................ 15,651 International Emerging Markets............................................ 10,774 Select Equity............................................................. 367,339 Index Equity.............................................................. 258,498 Balanced.................................................................. 295,492
106
FRONT-END PORTFOLIOS SALES CHARGES - --------------------------------------------------------------------------------------------------------- Kentucky Tax-Free Income.................................................. 0 Large Cap Value Equity.................................................... 243,863 Large Cap Growth Equity................................................... 150,956 Mid-Cap Value Equity...................................................... 70,975 Mid-Cap Growth Equity..................................................... 41,375 Small Cap Value Equity.................................................... 244,947 Small Cap Growth Equity................................................... 275,225 Micro-Cap Equity.......................................................... 172,918 International Equity...................................................... 57,797 International Small Cap Equity............................................ 15,651 International Emerging Markets............................................ 10,774 Select Equity............................................................. 367,339 Index Equity.............................................................. 258,498 Balanced.................................................................. 295,492
Total front-end sales charges paid by shareholders of Investor A Shares of the Portfolios for the year or period ended September 30, 1997 (for the period from December 27, 1996 through September 30, 1997 in the case of the Mid-Cap Growth Equity and Mid-Cap Value Equity Portfolios; and for the period from September 26, 1997 through September 30, 1997 in the case of the International Small Cap Equity Portfolio) were as follows:
FRONT-END PORTFOLIOS SALES CHARGES - --------------------------------------------------------------------------------------------------------- Low Duration Bond......................................................... $ 3,758 Intermediate Government Bond.............................................. 11,644 Intermediate Bond......................................................... 7,367 Core Bond................................................................. 39,657 Government Income......................................................... 32,856 Managed Income............................................................ 68,493 International Bond........................................................ 29,718 Tax-Free Income........................................................... 19,830 Pennsylvania Tax-Free Income.............................................. 80,642 New Jersey Tax-Free Income................................................ 4,104 Ohio Tax-Free Income...................................................... 5,336 Large Cap Value Equity.................................................... 277,224 Large Cap Growth Equity................................................... 146,897 Mid-Cap Value Equity...................................................... 55,834 Mid-Cap Growth Equity..................................................... 46,954 Small Cap Value Equity.................................................... 107,051 Small Cap Growth Equity................................................... 668,832 International Equity...................................................... 104,956 International Small Cap Equity............................................ 0 International Emerging Markets............................................ 49,056 Select Equity............................................................. 272,796 Index Equity.............................................................. 159,501 Balanced.................................................................. 223,646
107 Total front-end sales charges paid by shareholders of Investor A Shares of the Portfolios for the year or period ended September 30, 1996 (for the period from February 1, 1996 through September 30, 1996 in the case of the New Jersey Tax-Free Income and International Bond Portfolios; for the period from April 1, 1996 through September 30, 1996 in the case of the Low Duration Bond and Core Bond Portfolios) were as follows:
FRONT-END PORTFOLIOS SALES CHARGES - --------------------------------------------------------------------------------------------------------- Managed Income............................................................... $ 43,417 Tax-Free Income.............................................................. 9,109 Intermediate Government Bond................................................. 22,989 Ohio Tax-Free Income......................................................... 4,649 Pennsylvania Tax-Free Income................................................. 81,436 Intermediate Bond............................................................ 8,598 Large Cap Value Equity....................................................... 141,011 Large Cap Growth Equity...................................................... 95,694 Small Cap Growth Equity...................................................... 344,911 Select Equity................................................................ 44,112 Index Equity................................................................. 78,263 Small Cap Value Equity....................................................... 51,676 International Equity......................................................... 85,795 Balanced..................................................................... 143,547 International Emerging Markets............................................... 18,147 Government Income............................................................ 30,034 Core Bond.................................................................... 8,481 New Jersey Tax Free Income................................................... 17,606 Low Duration Bond............................................................ 6,294 International Bond........................................................... $ 7,565
For the period from January 13, 1996 through January 31, 1996, the total front-end sales charges paid by the shareholders of Investor A Shares of the New Jersey Tax-Free Income Portfolio were $435. For the period from January 13, 1996 through March 31, 1996, the total front-end sales charges paid by the shareholders of Investor A Shares of the Low Duration Bond and Core Bond Portfolios were $3,848 and $1,723, respectively. INSTITUTIONAL AND BLACKROCK SHARES PURCHASE OF SHARES. Institutional Shares are offered to institutional investors, including (a) registered investment advisers with a minimum investment of $500,000 and (b) the trust departments of PNC Bank and its affiliates (collectively, "PNC") on behalf of clients for whom PNC (i) acts in a fiduciary capacity (excluding participant-direct employee benefit plans) or otherwise has investment discretion or (ii) acts as custodian with respect to at least $2,000,000 in assets, and individuals with a minimum investment of $2,000,000. The minimum initial investment for institutions is $5,000. There is no minimum subsequent investment requirement. BlackRock Shares are offered to institutional investors with a minimum investment of $5,000,000. There is no minimum subsequent investment requirement. Payment for Institutional and BlackRock Shares must normally be made in Federal funds or other funds immediately available to the Fund's custodian. Payment may also, in the discretion of the Fund, be made in the form of securities that are permissible investments for the respective Portfolios. The Fund does not accept third party checks for initial or subsequent investments. In the event that a shareholder acquiring Institutional Shares on or after May 1, 1998 ceases to meet the eligibility standards for purchasing Institutional Shares (other than due to fluctuations in market value), then the shareholder's Institutional 108 Shares will, upon the direction of the Fund's distributor, automatically be converted to shares of another class of the Portfolio having the same aggregate net asset value as the shares converted. If, at the time of conversion, an institution offering Service Shares of the Portfolio is acting on the shareholder's behalf, then the shareholder's Institutional Shares will be converted to Service Shares of the Portfolio. If not, then the shareholder's Institutional Shares will be converted to Investor A Shares of the Portfolio. Service Shares are currently authorized to bear additional service and processing fees at the aggregate annual rate of .30% of average daily net assets, while Investor A Shares are currently authorized to bear additional service, processing and distribution fees at the aggregate annual rate of .50% of average daily net assets. The Fund may in its discretion waive or modify the minimum investment amount, may reject any order for Institutional and BlackRock Shares and may suspend and resume the sale of shares of any Portfolio at any time. REDEMPTION OF SHARES. Payment for redeemed shares for which a redemption order is received by PFPC before 4:00 p.m. (Eastern Time) on a Business Day is normally made in Federal funds wired to the redeeming Institution on the next Business Day, provided that the Fund's custodian is also open for business. Payment for redemption orders received after 4:00 p.m. (Eastern Time) or on a day when the Fund's custodian is closed is normally wired in Federal funds on the next Business Day following redemption on which the Fund's custodian is open for business. The Fund reserves the right to wire redemption proceeds within seven days after receiving a redemption order if, in the judgment of BlackRock, an earlier payment could adversely affect a Portfolio. No charge for wiring redemption payments is imposed by the Fund. During periods of substantial economic or market change, telephone redemptions may be difficult to complete. Redemption requests may also be mailed to PFPC at P.O. Box 8907, Wilmington, Delaware 19899-8907. The Fund may also suspend the right of redemption or postpone the date of payment upon redemption for such periods as are permitted under the 1940 Act, and may redeem shares involuntarily or make payment for redemption in securities or other property when determined appropriate in light of the Fund's responsibilities under the 1940 Act. Institutional Shares of the Portfolios may be purchased by customers of broker-dealers and agents which have established a servicing relationship with the Fund on behalf of their customers. These broker-dealers and agents may impose additional or different conditions on the purchase or redemption of Portfolio shares by their customers and may charge their customers transaction, account or other fees on the purchase and redemption of Portfolio shares. Each broker-dealer or agent is responsible for transmitting to its customers a schedule of any such fees and information regarding any additional or different conditions regarding purchases and redemptions. Shareholders who are customers of such broker-dealers or agents should consult them for information regarding these fees and conditions. SERVICE SHARES PURCHASE OF SHARES. Purchase orders for each Portfolio except the U.S. Treasury Money Market Portfolio may be placed by telephoning PFPC at (800) 441- 7450 no later than 12:00 noon (Eastern Time) on a Business Day. Orders received before 12:00 noon (Eastern Time) will be executed at 12:00 noon (Eastern Time). If payment for such orders is not received by 4:00 p.m. (Eastern Time), the order will be canceled and notice thereof will be given to the Institution placing the order. Orders received after 12:00 noon (Eastern Time) will not be accepted. Purchase orders for the U.S. Treasury Money Market Portfolio may be placed by telephoning PFPC at (800) 441-76450 no later than 4:00 p.m. (Eastern time) on a Business Day. Orders received before 12:00 noon (Eastern Time) will be executed at 12:00 noon (Eastern Time); orders received after 12:00 noon (Eastern Time) but before 4:00 p.m. (Eastern Time) will be executed at 4:00 p.m. (Eastern Time). If payment for such orders is not received by 4:00 p.m. (Eastern Time), the order will be canceled and notice thereof will be given to the Institution placing the order. Orders will not be accepted after 4:00 p.m. (Eastern Time). Under certain circumstances, the Fund may reject large individual purchase orders received after 12:00 noon (Eastern Time.) In the event that a shareholder acquiring Service Shares on or after May 1, 1998 (other than a former shareholder of The Compass Capital Group as described above) ceases to meet the eligibility standards for purchasing Service Shares, then the shareholder's Service Shares will, upon the direction of the Fund's distributor, automatically be converted to Investor A Shares of the Portfolio having the same aggregate net asset value as the shares converted. Investor A Shares are currently authorized 109 to bear additional service and distribution fees at the aggregate annual rate of .20% of average daily net assets. In the event that a shareholder acquiring Service Shares on or after May 1, 1998 subsequently satisfies the eligibility standards for purchasing Institutional Shares (other than due to fluctuations in market value), then the shareholder's Service Shares will, upon the direction of the Fund's distributor, automatically be converted to Institutional Shares of Portfolio having the same aggregate net asset value as the shares converted. The Fund may in its discretion waive or modify the minimum investment amount, may reject any order for Service Shares and may suspend and resume the sale of shares of any Portfolio at any time. REDEMPTION OF SHARES. Payment for redeemed shares for which a redemption order is received by PFPC before 12:00 noon (Eastern Time) on a Business Day is normally made in Federal funds wired to the redeeming Institution on the same Business Day, provided that the fund's custodian is also open for business. Payment for redemption orders received between 12:00 noon (Eastern Time) and 4:00 p.m. (Eastern Time) or on a day when the Fund's custodian is closed is normally wired in Federal funds on the next Business Day following redemption on which the Fund's custodian is open for business. The Fund reserves the right to wire redemption proceeds within seven days after receiving a redemption order if, in the judgment of BlackRock, Inc., an earlier payment could adversely affect a Portfolio. No charge for wiring redemption payments is imposed by the Fund, although Institutions may charge their customer accounts for redemption services. Information relating to such redemption services and charges, if any, should be obtained by customers from their Institution. During periods of substantial economic or market change, telephone redemptions may be difficult to complete. Redemption requests may also be mailed to PFPC at 400 Bellevue Parkway, Wilmington, DE 19809. The Fund may redeem Service Shares in any Portfolio account if the account balance drops below $5,000 as the result of redemption requests and the shareholder does not increase the balance to at least $5,000 upon thirty days' written notice. If a customer has agreed with an Institution to maintain a minimum balance in his or her account with the Institution, and the balance in the account falls below that minimum, the customer may be obligated to redeem all or part of his or her shares in the Portfolio to the extent necessary to maintain the minimum balance required. The Fund may also suspend the right of redemption or postpone the date of payment upon redemption for such periods as are permitted under the 1940 Act, and may redeem shares involuntarily or make payment for redemption in securities or other property when determined appropriate in light of the Fund's responsibilities under the 1940 Act. Except as noted below, a request for redemption must be signed by all persons in whose names the shares are registered. Signatures must conform exactly to the account registration. If the proceeds of the redemption would exceed $25,000, or if the proceeds are not to be paid to the record owner at the record address, or if the shareholder is a corporation, partnership, trust or fiduciary, signature(s) must be guaranteed by any eligible guarantor institution. Eligible guarantor institutions generally include banks, broker/dealers, credit unions, national securities exchanges, registered securities associations, clearing agencies and savings associations. Generally, a properly signed written request with any required signature guarantee is all that is required for a redemption. In some cases, however, other documents may be necessary. Shareholders holding share certificates must send their certificates with the redemption request. Additional documentary evidence of authority is required by PFPC in the event redemption is requested by a corporation, partnership, trust, fiduciary, executor or administer. If shareholder has given authorization for expedited redemption, shares can be redeemed by telephone and the proceeds sent by check to the shareholder or by Federal wire transfer to a single previously designated bank account. Once authorization is on file, PFPC will honor requests by any person by telephone at (800) 441-7762 or other means. The minimum amount that may be sent by check is $500, while the minimum amount that may be wired is $10,000. The Fund reserves the right to change these minimums or to terminate these redemptions privileges. If the proceeds of a redemption would exceed $25,000, the redemption request must be in writing and will be subject to the signature guarantee requirement described above. This privilege may not be used to redeem shares in certificated form. 110 Persons who were shareholders of an investment portfolio of Compass Capital Group of Funds at the time of the portfolio's combination with The PNC Fund may also purchase and redeem Service Shares of the same Portfolio and for the same account in which they held shares on that date through the procedures described in this section. DIVIDENDS AND DISTRIBUTIONS EQUITY PORTFOLIOS. Each of the Equity Portfolios of the Fund will distribute substantially all of its net investment income and net realized capital gains, if any, to shareholders. The net investment income of each of the Equity Portfolios is declared quarterly as a dividend to investors who are shareholders of the Portfolio at the close of business on the day of declaration. All dividends are paid not later than ten days after the end of each quarter. Any net realized capital gains (including net short-term capital gains) will be distributed by each Portfolio of the Fund at least annually. The period for which dividends are payable and the time for payment are subject to change by the Fund's Board of Trustees. Distributions are reinvested at net asset value in additional full and fractional shares of the same class on which the distributions are paid, unless a shareholder elects to receive distributions in cash. This election, or any revocation thereof, must be made in writing to PFPC, and will become effective with respect to distributions paid after its receipt by PFPC. The Index Equity Portfolio seeks its investment objective by investing all of its assets in the Index Master Portfolio (which is taxable as a partnership for federal income tax purposes). The Index Equity portfolio is allocated its distributive share of the income, gains (including capital gains), losses, deductions and credits of the Index Master Portfolio. The Index Equity Portfolio's distributive share of such items, plus gain, if any, on the redemption of shares of the Index Master Portfolio, less the Index Equity Portfolio's expenses incurred in operations will constitute the Index Equity Portfolio's net income from which dividends are distributed as described above. BOND PORTFOLIOS. Each of the Bond Portfolios will distribute substantially all of its net investment income and net realized capital gains, if any, to shareholders. All distributions are reinvested at net asset value in the form of additional full and fractional shares of the same class of shares of the relevant Portfolio unless a shareholder elects otherwise. Such election, or any revocation thereof, must be made in writing to PFPC, and will become effective with respect to dividends paid after its receipt by PFPC. Each Portfolio declares a dividend each day on "settled" shares (i.e., shares for which the particular Portfolio has received payment in Federal funds) on the first Business Day after a purchase order is placed with the Fund. Payments by check are normally converted to Federal funds within two Business Days of receipt. Over the course of a year, substantially all of the Portfolio's net investment income will be declared as dividends. The amount of the daily dividend for each Portfolio will be based on periodic projections of its net investment income. All dividends are paid within ten days after the end of each month. Net realized capital gains (including net short-term capital gains), if any, will be distributed by each Portfolio at least annually. MONEY MARKET PORTFOLIOS. Shareholders are entitled to dividends and distributions arising from the net income and capital gains, if any, earned on investments held by the Money Market Portfolio in which they invest. Each Money Market Portfolio's net income is declared daily as a dividend. Shareholders whose purchase orders are executed at 12:00 noon (Eastern Time), 4:00 p.m. (Eastern Time) for the U.S. Treasury Money Market Portfolio, receive dividends for that day. On the other hand, shareholders whose redemption orders have been received by 12:00 noon (Eastern Time) do not receive dividends for that day, while shareholders of each Portfolio whose redemption orders are received after 12:00 noon (Eastern Time) do receive dividends for that day. Dividends are paid monthly by check, or by wire transfer if requested in writing by the shareholder, within five business days after the end of the month. Net short-term capital gains, if any, will be distributed at least annually. The period for which dividends are payable and the time for payment are subject to change by the Fund's Board of Trustees. The Portfolios do not expect to realize net long-term capital gains. Dividends are reinvested in additional full and fractional Investor Shares of the same class on which the dividends are paid, unless a shareholder elects to receive dividends in cash. Such election, or any revocation thereof, must be made in writing to PFPC, and will become effective with respect to dividends paid after receipt by PFPC. 111 VALUATION OF PORTFOLIO SECURITIES In determining the market value of portfolio investments, the Fund may employ outside organizations, which may use, without limitation, a matrix or formula method that takes into consideration market indexes, matrices, yield curves and other specific adjustments. This may result in the securities being valued at a price different from the price that would have been determined had the matrix or formula method not been used. All cash, receivables and current payables are carried on the Fund's books at their face value. Other assets, if any, are valued at fair value as determined in good faith under the supervision of the Board of Trustees. MONEY MARKET PORTFOLIOS. The net asset value for each class of each share of the Money Market Portfolios for the purpose of pricing purchase and redemption orders is determined twice each day, once as of 12:00 noon (Eastern Time) and once as of 4:00 p.m. (Eastern Time) on each day the NYSE is open for business (a "Business Day"). Each Portfolio's net asset value per share is calculated by adding the value of all securities, cash and other assets of the respective classes of the Portfolio, subtracting the liabilities and dividing the result by the number of outstanding shares of such classes. The net asset value per share of each class of each Portfolio is determined independently of the other classes and the other Portfolios. The Fund seeks to maintain for each of the Money Market Portfolios a net asset value of $1.00 per share for purposes of purchase and redemptions and values their portfolio securities on the basis of the amortized cost method of valuation. Under this method the market value of an instrument is approximated by amortizing the difference between the acquisition cost and value at maturity of the instrument on a straight-line basis over the remaining life of the instrument. The effect of changes in the market value of a security as a result of fluctuating interest rates is not taken into account. The market value of debt securities usually reflects yields generally available on securities of similar quality. When such yields decline, market values can be expected to increase, and when yields increase, market values can be expected to decline. As indicated, the amortized cost method of valuation may result in the value of a security being higher or lower than its market price, the price a Money Market Portfolio would receive if the security were sold prior to maturity. The Fund's Board of Trustees has established procedures for the purpose of maintaining a constant net asset value of $1.00 per share for each Money Market Portfolio, which include a review of the extent of any deviation of net asset value per share, based on available market quotations, from the $1.00 amortized cost per share. Should that deviation exceed 2 of 1% for a Money Market Portfolio, the Fund's Board of Trustees will promptly consider whether any action should be initiated to eliminate or reduce material dilution or other unfair results to shareholders. Such action may include redeeming shares in kind, selling portfolio securities prior to maturity, reducing or withholding dividends, shortening the average portfolio maturity, reducing the number of outstanding shares without monetary consideration, and utilizing a net asset value per share as determined by using available market quotations. Each Money Market Portfolio will maintain a dollar-weighted average portfolio maturity of 90 days or less, will not purchase any instrument with a deemed maturity under Rule 2a-7 of the 1940 Act greater than 13 months, and will limit portfolio investments, including repurchase agreements, to those instruments that the adviser or sub-adviser determines present minimal credit risks pursuant to guidelines adopted by the Fund's Board of Trustees. There can be no assurance that a constant net asset value will be maintained for any Money Market Portfolio. EQUITY PORTFOLIOS. Net asset value is calculated separately for each class of shares of each Equity Portfolio as of the close of regular trading hours on the NYSE (currently 4:00 p.m. Eastern Time) on each Business Day by dividing the value of all securities, cash and other assets owned by a Portfolio that are allocated to a particular class of shares, less the liabilities charged to that class, by the total number of outstanding shares of the class. Valuation of securities held by each Equity Portfolio is as follows: securities traded on a national securities exchange or on the NASDAQ National Market System are valued at the last reported sale price that day; securities traded on a national securities exchange or on the NASDAQ National Market System for which there were no sales on that day and securities traded on other over- the-counter markets for which market quotations are readily available are valued at the mean of the bid and asked prices; an option or futures contract is valued at the last sales price prior to 4:00 p.m. (Eastern Time), as quoted on the principal exchange or board of trade on which such option or contract is traded, or in the absence of a sale, the mean between the last bid and asked prices prior to 4:00 p.m. (Eastern Time); and securities for which market quotations are not readily available are valued at fair market value as determined in good faith by or under the direction of the Fund's Board of Trustees. The amortized cost 112 method of valuation will also be used with respect to debt obligations with sixty days or less remaining to maturity unless the investment adviser and/or sub-adviser under the supervision of the Board of Trustees determines such method does not represent fair value. Valuation of securities of foreign issuers is as follows: to the extent sale prices are available, securities which are traded on a recognized stock exchange, whether U.S. or foreign, are valued at the latest sale price on that exchange prior to the time when assets are valued or prior to the close of regular trading hours on the NYSE. In the event that there are no sales, the mean between the last available bid and asked prices will be used. If a security is traded on more than one exchange, the latest sale price on the exchange where the stock is primarily traded is used. An option or futures contract is valued at the last sales price prior to 4:00 p.m. (Eastern Time), as quoted on the principal exchange or board of trade on which such option or contract is traded, or in the absence of a sale, the mean between the last bid and asked prices prior to 4:00 p.m. (Eastern Time). In the event that application of these methods of valuation results in a price for a security which is deemed not to be representative of the market value of such security, the security will be valued by, under the direction of or in accordance with a method specified by the Board of Trustees as reflecting fair value. The amortized cost method of valuation will be used with respect to debt obligations with sixty days or less remaining to maturity unless the investment adviser and/or sub-adviser under the supervision of the Board of Trustees determines such method does not represent fair value. All other assets and securities held by the Portfolios (including restricted securities) are valued at fair value as determined in good faith by the Board of Trustees or by someone under its direction. Any assets which are denominated in a foreign currency are translated into U.S. dollars at the prevailing market rates. Certain of the securities acquired by the International Equity, International Emerging Markets and International Small Cap Equity Portfolios may be traded on foreign exchanges or over-the-counter markets on days on which a Portfolio's net asset value is not calculated. In such cases, the net asset value of the Portfolio's shares may be significantly affected on days when investors can neither purchase nor redeem shares of the Portfolio. A Portfolio may use a pricing service, bank or broker/dealer experienced in such matters to value the Portfolio's securities. The valuation of securities held by the Index Master Portfolio is discussed in its Registration Statement. BOND PORTFOLIOS. Net asset value is calculated separately for each class of shares of each Bond Portfolio as of the close of regular trading hours on the NYSE on each Business Day by dividing the value of all securities, cash and other assets owned by a Portfolio that are allocated to a particular class of shares, less the liabilities charged to that class, by the total number of outstanding shares of the class. Valuation of securities held by each Bond Portfolio is as follows: domestic securities traded on a national securities exchange or on the NASDAQ National Market system are valued at the last reported sale price that day; domestic securities traded on a national securities exchange or on the NASDAQ National Market System for which there were no sales on that day are valued at the mean of the bid and asked prices; foreign securities traded on a recognized stock exchange, whether U.S. or foreign, are valued at the latest sale price on that exchange prior to the time when assets are valued or prior to the close of regular trading hours on the NYSE (if a security is traded on more than one exchange, the latest sale price on the exchange where the stock is primarily traded is used); foreign securities traded on a recognized stock exchange for which there were no sales on that day are valued at the mean of the bid and asked prices; other securities are valued on the basis of valuations provided by a pricing service approved by the Board of Trustees, provided that if the investment adviser or sub-adviser concludes that the price provided by a pricing service does not represent the fair value of a security, such security will be valued at fair value determined by the adviser or sub-adviser based on quotations or the equivalent thereof received from dealers; an option or futures contract is valued at the last sales price prior to 4:00 p.m. (Eastern Time), as quoted on the principal exchange or board of trade on which such option or futures contract is traded, or in the absence of a sale, the mean between the last bid and asked prices prior to 4:00 p.m. (Eastern Time); the amortized cost method of valuation is used with respect to debt obligations with sixty days or less remaining to maturity; and securities for which market quotations are not readily available are valued at fair market value as determined in good faith by or under the direction of the Fund's Board of Trustees. Any securities which are denominated in a foreign currency are translated into U.S. dollars at the prevailing market rates. 113 Certain of the securities acquired by the International Bond Portfolio may be traded on foreign exchanges or over-the-counter markets on days on which the Portfolio's net asset value is not calculated. In such cases, the net asset value of the Portfolio's shares may be significantly affected on days when investors can neither purchase nor redeem shares of the Portfolio. PERFORMANCE INFORMATION A Portfolio may quote performance in various ways. All performance information supplied by a Portfolio in advertising is historical and is not intended to indicate future returns. Each of the Money Market Portfolios may advertise its "yield", "effective yield" and total return for each class of Investor Shares. These performance figures are based on historical earnings and are not intended to indicate future performance. "Yield" refers to the income generated by an investment in a particular class of a Portfolio's Investor shares over a seven-day period. This income is then "annualized." That is, the amount of income generated by the investment during that week is assumed to be generated each week over a 52-week period and is shown as a percentage of the investment. "Effective yield" is calculated similarly but, when annualized, the income earned by an investment in a particular class of a Portfolio's Investor Shares is assumed to be reinvested. The "effective yield" will be slightly higher than the "yield" because of the compounded effect of this assumed reinvestment. A Municipal Portfolio's "tax equivalent yield" may also be quoted, which shows the level of taxable yield needed to produce an after-tax equivalent to the Portfolio's tax-free yield for a particular class of Investor Shares. The performance of each class of Investor Shares of a Portfolio may be compared to the performance of mutual funds with similar investment objectives and to relevant indices, as well as to ratings or rankings prepared by independent services or other financial or industry publications that monitor the performance of mutual funds. For example, the yield of a particular class of Investor Shares of a Portfolio may be compared to data prepared by Lipper Analytical Services, Inc., CDA Investment Technologies, Inc. and Weisenberger Investment Company Service. Performance information may also include evaluations of the Portfolios published in nationally recognized ranking services, and information as reported by financial publications such as Business Week, Fortune, Institutional Investor, Money Magazine, Forbes, Barron's, The Wall Street Journal and The New York Times, or in publications of a local or regional nature. Performance quotations for shares of a Portfolio represent past performance and should not be considered as representative of future results. The yield of any investment is generally a function of portfolio quality and maturity, type of investment and operating expenses. Yields will fluctuate and are not necessarily representative of future results. Any fees charged by affiliates of the Portfolio's investment adviser or other institutions directly to their customers' accounts in connection with investments in the Portfolios will not be included in the Portfolios' calculations of yield and performance. Each Money Market Portfolio's current and effective yields for Service, Investor A, Investor B, Investor C and Institutional Shares are computed separately using standardized methods required by the SEC. The annualized yield for a class of Service, Investor A, Investor B, Investor C or Institutional Shares is computed by: (a) determining the net change in the value of a hypothetical account having a balance of one share at the beginning of a seven- calendar day period; (b) dividing the net change by the value of the account at the beginning of the period to obtain the base period return; and (c) annualizing the results (i.e., multiplying the base period return by 365/7). ---- The net change in the value of the account reflects the value of additional shares purchased with dividends declared and all dividends declared on both the original share and such additional shares, but does not include realized gains and losses or unrealized appreciation and depreciation. Compound effective yields are computed by adding 1 to the base period return (calculated as described above) raising the sum to a power equal to 365/7 and subtracting 1. In addition, a standardized "tax-equivalent current yield" may be quoted for Service, Investor A, Investor B, Investor C and Institutional Shares in the Municipal Money Market, Ohio Municipal Money Market, Pennsylvania Municipal Money Market, North Carolina Municipal Money Market, Virginia Municipal Money Market and New Jersey Municipal Money Market Portfolios, which is computed separately for each class by: (a) dividing that portion of the Fund's yield (as calculated above) that is exempt from Federal or State income tax by one minus a stated Federal or state income tax rate; and (b) adding the quotient to that portion of the Fund's yield that is not tax-exempt. A standardized "tax equivalent effective yield quotation" may be computed separately for each class by:(a) dividing the portion of the Portfolio's effective yield for shares (as calculated above) that is exempt from Federal or state income tax by one minus a stated Federal or state income tax rate; and (b) adding the figure resulting from (a) above to that portion, if any, of the effective yield that is not exempt from Federal and state income tax. 114 The annualized yield information for each Money Market Portfolio for the seven-day period ended September 30, 1998 before waivers was as follows:
TAX-EQUIVALENT TAX-EQUIVALENT CURRENT YIELD EFFECTIVE YIELD (ASSUMES A (ASSUMES A FEDERAL INCOME FEDERAL INCOME PORTFOLIOS YIELD EFFECTIVE YIELD TAX RATE OF 28%) TAX RATE OF 28%) - --------------------------------------------------------------------------------------------------------------------------------- Money Market Institutional Shares 5.02 % 5.15 % 6.97 % 7.15 % Service Shares 4.72 4.83 6.56 6.17 Investor A Shares 4.64 4.75 6.44 6.60 Investor B Shares 3.95 4.03 5.49 5.60 Investor C Shares 3.95 4.03 5.49 5.60 U.S. Treasury Money Market Institutional Shares 4.74 % 4.85 % 6.58 % 6.74 % Service Shares 4.44 4.54 6.17 6.31 Investor A Shares 4.34 4.43 6.03 6.15 Municipal Money Market Institutional Shares 3.05 % 3.10 % 4.24 % 4.31 % Service Shares 2.75 2.79 3.82 3.88 Investor A Shares 2.58 2.61 3.58 3.63 Investor C Shares 1.98 2.00 2.75 2.78 New Jersey Municipal Money Market Institutional Shares 3.04 % 3.09 % 4.22 % 4.29 % Service Shares 2.74 2.78 3.81 3.86 Investor A Shares 2.53 2.56 3.51 3.56 North Carolina Municipal Money Market Institutional Shares 3.12 % 3.17 % 4.33 % 4.40 % Service Shares 2.82 2.86 3.92 3.97 Investor A Shares 2.64 2.67 3.67 3.71 Ohio Municipal Money Market Institutional Shares 3.21 % 3.26 % 4.46 % 4.53 % Service Shares 2.91 2.95 4.04 4.10 Investor A Shares 2.73 2.77 3.79 3.85 Pennsylvania Municipal Money Market Institutional Shares 3.13 % 3.18 % 4.35 % 4.42 % Service Shares 2.83 2.87 3.93 3.99 Investor A Shares 2.67 2.71 3.71 3.76 Virginia Municipal Money Market Institutional Shares 3.25 % 3.30 % 4.51 % 4.58 % Service Shares 2.95 2.99 4.10 4.15 Investor A Shares 2.68 2.72 3.72 3.78
The Investor B Class had not commenced operations as of September 30, 1998, except with respect to the Money Market Portfolio. The Investor C Class had not commenced operations as of September 30, 1998, except with respect to the Money Market Portfolio and the Municipal Money Market Portfolio. The annualized yield information for each Money Market Portfolio for the seven-day period ended September 30, 1998 after waivers was as follows: 115
TAX-EQUIVALENT TAX-EQUIVALENT CURRENT YIELD EFFECTIVE YIELD (ASSUMES A (ASSUMES A FEDERAL INCOME FEDERAL INCOME PORTFOLIOS YIELD EFFECTIVE YIELD TAX RATE OF 28%) TAX RATE OF 28%) - --------------------------------------------------------------------------------------------------------------------------- Money Market Institutional Shares 5.26% 5.40% 7.31% 7.50% ---- ---- ---- ---- Service Shares 4.96 5.08 6.89 7.06 ---- ---- ---- ---- Investor A Shares 4.88 5.00 6.78 6.94 ---- ---- ---- ---- Investor B Shares 4.19 4.28 5.82 5.94 ---- ---- ---- ---- Investor C Shares 4.19 4.28 5.82 5.94 ---- ---- ---- ---- U.S. Treasury Money Market Institutional Shares 5.05% 5.18% 7.01% 7.19% ---- ---- ---- ---- Service Shares 4.75 4.86 6.60 6.75 ---- ---- ---- ---- Investor A Shares 4.65 4.76 6.46 6.61 ---- ---- ---- ---- Municipal Money Market Institutional Shares 3.37% 3.43% 4.68% 4.76% ---- ---- ---- ---- Service Shares 3.07 3.12 4.26 4.33 ---- ---- ---- ---- Investor A Shares 2.90 2.94 4.03 4.08 ---- ---- ---- ---- Investor C Shares 2.30 2.33 3.19 3.24 ---- ---- ---- ---- New Jersey Municipal Money Market Institutional Shares 3.41% 3.47% 4.74% 4.82% ---- ---- ---- ---- Service Shares 3.11 3.16 4.32 4.39 ---- ---- ---- ---- Investor A Shares 2.90 2.94 4.03 4.08 ---- ---- ---- ---- North Carolina Municipal Money Market Institutional Shares 3.57% 3.63% 4.96% 5.04% ---- ---- ---- ---- Service Shares 3.27 3.32 4.54 4.61 ---- ---- ---- ---- Investor A Shares 3.09 3.14 4.29 4.36 ---- ---- ---- ---- Ohio Municipal Money Market Institutional Shares 3.57% 3.63% 4.96% 5.04% ---- ---- ---- ---- Service Shares 3.27 3.32 4.54 4.61 ---- ---- ---- ---- Investor A Shares 3.09 3.14 4.29 4.36 ---- ---- ---- ---- Pennsylvania Municipal Money Market Institutional Shares 3.45% 3.51% 4.79% 4.88% ---- ---- ---- ---- Service Shares 3.15 3.20 4.38 4.44 ---- ---- ---- ---- Investor A Shares 2.99 3.03 4.15 4.21 ---- ---- ---- ---- Virginia Municipal Money Market Institutional Shares 3.72% 3.79% 5.17% 5.26% ---- ---- ---- ---- Service Shares 3.42 3.48 4.75 4.83 ---- ---- ---- ---- Investor A Shares 3.15 3.20 4.38 4.44 ---- ---- ---- ----
The Investor B Class had not commenced operations as of September 30, 1998, except with respect to the Money Market Portfolio. The Investor C Class had not commenced operations as of September 30, 1998, except with respect to the Money Market Portfolio and the Municipal Money Market Portfolio. The fees which may be imposed by institutions on their Customers are not reflected in the calculations of yields for the Money Market Portfolios. Yields on Institutional Shares will generally be higher than yields on Service Shares; yields on Service Shares will generally be higher than yields on Investor A Shares; and yields on Investor A Shares will generally be higher than yields on Investor B Shares and Investor C Shares. From time to time, in advertisements, sale literature, reports to shareholders and other materials, the yields of a Money Market Portfolio's Service, Investor A, Investor B, Investor C or Institutional Shares may be quoted and compared to those of other mutual funds with similar investment objectives and relevant securities indexes. For example, the yield of a Portfolio's Service, Investor A, Investor B, Investor C or Institutional Shares may be compared to the Donoghue's Money Fund Average, 116 which is an average compiled by IBC/Donoghue's MONEY FUND REPORT(R), a widely- recognized independent publication that monitors the performance of money market funds, the average yields reported by the Bank Rate Monitor from money market deposit accounts offered by the 50 leading banks and thrift institutions in the top five standard metropolitan statistical areas, or to the data prepared by Lipper Analytical Services, Inc., a widely-recognized independent service that monitors the performance of mutual funds. Yield may also be compared to yields set forth in the weekly statistical release H.15(519) or the monthly statistical release designated G.13(415) published by the Board of Governors of the Federal Reserve system. In addition, each Money Market Portfolio may quote from time to time its total return in accordance with SEC regulations. TOTAL RETURN. For purposes of quoting and comparing the performance of shares of the Non-Money Market Portfolios to the performance of other mutual funds and to stock or other relevant indexes in advertisements, sales literature, communications to shareholders and other materials, performance may be stated in terms of total return. The total return for each class of a Non- Money Market Portfolio will be calculated independently of the other classes within that Portfolio. Under the rules of the SEC, funds advertising performance must include total return quotes calculated according to the following formula: ERV /1/n/ T = [(-----) - 1] P Where: T = average annual total return. ERV = ending redeemable value at the end of the period covered by the computation of a hypothetical $1,000 payment made at the beginning of the period. P = hypothetical initial payment of $1,000. n = period covered by the computation, expressed in terms of years. In calculating the ending redeemable value for Investor A Shares of the Fund's Non-Money Market Portfolios, the maximum front-end sales charge is deducted from the initial $1,000 payment and all dividends and distributions by the particular Portfolio are assumed to have been reinvested at net asset value on the reinvestment dates during the period. In calculating the ending redeemable value for Investor B Shares of the Non-Money Market Portfolios, the maximum contingent deferred sales charge is deducted at the end of the period and all dividends and distributions by the particular Portfolio are assumed to have been reinvested at net asset value on the reinvestment dates during the period. In calculating the ending redeemable value for Investor C Shares of the Fund's Non-Money Market Portfolios, the maximum contingent deferred sales charge is deducted at the end of the period, and all dividends and distributions by the particular Portfolio are assumed to have been reinvested at net asset value 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 specified periods that would equate the initial amount invested to the ending redeemable value. Performance information presented for the following Non-Money Market Portfolios includes performance information for a corresponding predecessor portfolio which transferred its assets and liabilities to the related Non-Money Market Portfolio pursuant to a reorganization consummated on January 13, 1996 (February 13, 1996 with respect to the International Bond Portfolio):
COMMENCEMENT OF NON-MONEY MARKET PREDECESSOR OPERATIONS OF PORTFOLIO PORTFOLIO PREDECESSOR PORTFOLIO - --------- --------- --------------------- New Jersey Tax-Free Income Compass Capital Group July 1, 1991 Portfolio New Jersey Municipal Bond Fund
117
COMMENCEMENT OF NON-MONEY MARKET PREDECESSOR OPERATIONS OF PORTFOLIO PORTFOLIO PREDECESSOR PORTFOLIO - --------- --------- --------------------- International Bond Portfolio Compass Capital Group July 1, 1991 International Fixed Income Fund Core Bond Portfolio BFM Institutional Trust December 9, 1992 Core Fixed Income Portfolio Low Duration Bond Portfolio BFM Institutional Trust July 17, 1992 Short Duration Portfolio
In connection with the conversion of various common trust funds maintained by PNC Bank and PNC Bank, Delaware ("PNC-DE"), an affiliate of PNC Bank, into the Fund between May 1 and May 15, 1998 (the "CTF Conversion"), the Delaware Tax-Free Income Portfolio was established to receive the assets of the DE Tax- Free Income Fund of PNC-DE, the Kentucky Tax-Free Income Portfolio was established to receive the assets of the KY Tax-Free Income Fund of PNC Bank and the GNMA Portfolio was established to receive the assets of the GNMA Fund of PNC Bank. Performance information presented for the following Non-Money Market Portfolios includes performance information for a corresponding predecessor common trust fund which transferred its assets and liabilities to the related Non-Money Market Portfolio pursuant to the CTF Conversion:
COMMENCEMENT OF NON-MONEY MARKET PREDECESSOR OPERATIONS OF PORTFOLIO PORTFOLIO PREDECESSOR PORTFOLIO - --------- ----------- --------------------- Delaware Tax-Free Income PNC-DE Tax-Free Income Fund October 20, 1965 Portfolio Kentucky Tax Free Income PNC KY Tax-Free Income Fund September 6, 1966 Portfolio GNMA Portfolio PNC GNMA Fund June 1, 1990
Performance information presented for the Delaware Tax-Free Income Portfolio, the Kentucky Tax-Free Income Portfolio and the GNMA Portfolio is based upon the performance of the DE Tax-Free Income Fund, the KY Tax-Free Income Fund and the GNMA Fund, respectively, for periods prior to the CTF Conversion. Each Non-Money Market Portfolio presents performance information for each class thereof since the commencement of operations of that Portfolio (or the related predecessor portfolio), rather than the date such class was introduced. As a result, where a Portfolio includes performance information of a related predecessor portfolio, the Fund Inception Date indicated in the following tables is the inception date of the related predecessor portfolio. Performance information for each class introduced after the commencement of operations of the related Portfolio (or predecessor portfolio) is therefore based on the performance history of a predecessor class or predecessor classes. If a class of shares in a Portfolio (the "Subsequent Class") has more than one predecessor class, the performance data predating the introduction of the Subsequent Class is based initially on the performance of the Portfolio's first operational predecessor class (the "Initial Class"); thereafter, the performance of the Subsequent Class is based upon the performance of any other predecessor class or classes which were introduced after the Initial Class and which had total operating expenses more similar to those of the Subsequent Class. Performance information is restated to reflect the current maximum front-end sales charge (in the case of Investor A Shares) or the maximum contingent deferred sales charge (in the case of Investor B Shares) when presented inclusive of sales charges. Additional performance information is presented which does not reflect the deduction of sales charges. Historical expenses reflected in performance information are 118 based upon the distribution, shareholder servicing and processing fees and other expenses actually incurred during the periods presented and have not been restated, in cases in which the performance information for a particular class includes the performance history of a predecessor class or predecessor classes, to reflect the ongoing expenses currently borne by the particular class. Based on the foregoing, the average annual total returns for each Non-Money Market Portfolio for periods ended September 30, 1998 were as follows*: 119
INVESTOR A SHARES ----------------- INVESTOR A SHARES TOTAL RETURN TOTAL RETURN (NAV) (LOAD ADJUSTED) ------------------------------------------------------------------------------------------------------- 10 YEAR ANN. (OR SINCE FUND FUND INCEPTION CLASS INTRO INCEPTION ANN., DATE DATE 1 YEAR 3 YEAR ANN. 5 YEAR ANN. IF SHORTER) 1 YEAR ------------------------------------------------------------------------------------------------------- Large Cap Value Equity 04/20/92 05/02/92 (2.63) 17.15 15.78 15.32 (7.03) Large Cap Growth Equity 11/01/89 03/14/92 11.16 20.50 14.92 13.42 6.17 Mid Cap Value Equity 12/27/96 12/27/96 (14.06) N/A N/A 5.81 (17.91) Mid Cap Growth Equity 12/27/96 12/27/96 (8.42) N/A N/A 6.20 (12.53) Small Cap Value 04/13/92 06/02/92 (17.43) 4.66 10.98 13.16 (21.14) Small Cap Growth 09/14/93 09/15/93 (22.31) 9.05 13.16 14.07 (25.82) Micro Cap Equity 05/01/98 05/01/98 N/A N/A N/A (14.17) N/A International Equity 04/27/92 06/02/92 (7.56) 4.38 5.04 7.82 (12.20) International Small Cap Equity 09/26/97 09/26/97 (3.98) N/A N/A (4.21) (8.74) International Emerging Markets 06/17/94 06/17/94 (53.79) (18.37) N/A (16.65) (56.12) Select Equity 09/13/93 10/13/93 3.62 20.59 17.01 16.76 (1.02) Index Equity 04/20/92 06/02/92 8.37 21.73 18.98 16.78 5.12 Balanced 05/14/90 05/14/90 10.19 17.12 13.89 13.31 5.22 Low Duration Bond 07/17/92 01/12/96 6.78 5.89 5.64 5.53 3.58 Intermediate Government Bond 04/20/92 05/11/92 9.32 7.06 5.46 6.42 4.96 Intermediate Bond 09/17/93 05/20/94 8.30 6.97 5.36 5.34 3.92 Core Bond 12/09/92 01/31/96 10.04 7.93 6.77 7.59 5.64 Government Income 10/03/94 10/04/94 11.13 8.64 N/A 10.03 6.17 GNMA 06/01/90 05/18/98 8.35 7.55 6.33 8.03 4.03 Managed Income 11/01/89 02/05/92 8.74 7.41 5.65 7.87 3.85 International Bond 07/01/91 04/22/96 11.98 11.57 9.38 9.92 6.38 Tax-Free Income 05/14/90 05/14/90 8.34 8.28 6.19 8.06 4.03 Pennsylvania Tax-Free Income 12/01/92 12/01/92 8.04 7.26 5.70 6.85 3.71 New Jersey Tax-Free Income 07/01/91 01/26/96 8.10 6.84 5.52 7.45 3.78 Ohio Tax-Free Income 12/01/92 12/01/92 8.05 7.24 5.57 6.33 3.71 Delaware Tax-Free Income 10/20/65 05/11/98 7.32 5.81 4.70 5.81 3.01 Kentucky Tax-Free Income 09/06/66 05/11/98 7.48 5.92 4.96 6.42 3.15 TOTAL RETURN (LOAD ADJUSTED) ------------------------------------- 10 YEAR ANN. (OR SINCE FUND INCEPTION ANN., 3 YEAR ANN. 5 YEAR ANN. IF SHORTER) ---------------------------------------------------- Large Cap Value Equity 15.36 14.72 14.50 Large Cap Growth Equity 18.67 13.86 12.83 Mid Cap Value Equity N/A N/A 3.08 Mid Cap Growth Equity N/A N/A 3.46 Small Cap Value 9.08 9.96 12.35 Small Cap Growth 7.38 12.12 13.03 Micro Cap Equity N/A N/A (24.12) International Equity 2.60 3.97 6.96 International Small Cap Equity N/A N/A (8.97) International Emerging Markets (19.76) N/A (17.65) Select Equity 18.76 16.30 15.70 Index Equity 20.50 18.26 16.23 Balanced 15.33 12.84 12.69 Low Duration Bond 4.82 5.00 5.02 Intermediate Government Bond 5.61 4.60 5.74 Intermediate Bond 5.52 4.50 4.49 Core Bond 6.47 5.90 6.84 Government Income 7.00 N/A 8.77 GNMA 6.11 5.47 7.50 Managed Income 5.77 4.68 7.32 International Bond 9.68 8.26 9.14 Tax-Free Income 6.82 5.33 7.53 Pennsylvania Tax-Free Income 5.82 4.84 6.10 New Jersey Tax-Free Income 5.40 4.66 6.84 Ohio Tax-Free Income 5.79 4.71 5.58 Delaware Tax-Free Income 4.39 3.84 5.38 Kentucky Tax-Free Income 4.49 4.11 5.98
121 _______________________ * Operations not yet commenced. 122 105 INVESTOR B SHARES - --- -----------------
INVESTOR B SHARES TOTAL RETURN (NAV) --------------------------------------------------- FUND INCEPTION CLASS INTRO 3 YEAR DATE DATE 1 YEAR ANN. 5 YEAR ANN. -------------- ----------- -------- ------- ------------ Large Cap Value Equity............................ 4/20/92 1/18/96 (3.45) 16.35 15.31 Large Cap Growth Equity........................... 11/1/89 1/24/96 10.33 19.65 14.43 Mid Cap Value Equity.............................. 12/27/96 12/27/96 (14.66) N/A N/A Mid cap Growth Equity............................. 12/27/96 12/27/96 (9.19) N/A N/A SmallCap Value Equity............................. 4/13/92 10/3/94 (18.08) 9.94 10.35 SmallCap Growth Equity............................ 9/14/93 1/18/96 (22.89) 8.25 12.66 Micro-Cap Equity.................................. 5/1/98 5/1/98 N/A N/A N/A International Equity.............................. 4/27/92 10/3/94 (8.19) 3.68 4.49 International Small Cap Equity.................... 9/26/97 9/26/97 (4.73) N/A N/A International Emerging Markets.................... 6/17/94 4/25/96 (54.13) (18.82) N/A Select Equity..................................... 9/13/93 3/27/96 2.90 19.83 16.57 Index Equity...................................... 4/20/92 2/7/96 7.63 20.98 18.54 Balanced.......................................... 5/14/90 10/3/94 9.40 16.26 13.24 Low Duration Bond................................. 7/17/92 11/18/96 5.99 5.41 5.35 Intermediate Government Bond...................... 4/20/92 10/11/96 8.51 6.55 5.15 Intermediate Bond................................. 9/17/93 2/5/98 7.83 6.81 5.27 Core Bond......................................... 12/9/92 3/18/96 9.20 7.24 6.37 Government Income................................. 10/3/94 10/3/94 10.31 7.85 N/A GNMA.............................................. 6/1/90 5/18/98 7.57 6.75 5.55 Managed Income.................................... 11/1/89 7/15/97 7.94 7.12 5.48 International Bond................................ 7/1/91 4/19/96 11.15 10.88 8.97 Tax-Free Income................................... 5/14/90 7/18/96 7.53 7.69 5.83 Pennsylvania Tax-Free Income...................... 12/1/92 10/3/94 7.56 6.57 5.14 New Jersey Tax-Free Income........................ 7/1/91 7/2/96 7.30 6.24 5.16 Ohio Tax-Free Income.............................. 12/1/92 10/13/94 7.25 6.44 4.92 Delaware Tax-Free Income.......................... 10/20/65 5/11/98 6.54 5.02 3.92 Kentucky Tax-Free Income.......................... 9/6/66 5/11/98 6.69 5.14 4.18 TOTAL RETURN (LOAD ADJUSTED) -------------------------------------------------------------------------- 10 YEAR ANN. 10 YEAR ANN. (OR (OR SINCE FUND SINCE FUND INCEPTION INCEPTION ANN., ANN., IF SHORTER) 1 YEAR 3 YEAR ANN. 5 YEAR ANN. IF SHORTER) ----------------- ------- ----------- ----------- -------------- Large Cap Value Equity............................ 14.95 (7.79) 14.98 14.84 14.95 Large Cap Growth Equity........................... 13.15 5.37 18.24 13.97 13.15 Mid Cap Value Equity.............................. 5.25 (18.50) N/A N/A 2.84 Mid Cap Growth Equity............................. 5.55 (13.27) N/A N/A 3.13 SmallCap Value Equity............................. 12.68 (21.74) 8.64 9.91 12.68 SmallCap Growth Equity............................ 13.57 (26.36) 6.97 12.21 13.34 Micro-Cap Equity.................................. (14.39) N/A N/A N/A (23.17) International Equity.............................. 7.38 (12.30) 2.45 4.07 7.38 International Small Cap Equity.................... (4.95) (9.02) N/A N/A (8.70) International Emerging Markets.................... (16.65) (56.12) (19.76) N/A (17.65) Select Equity..................................... 16.32 (1.73) 18.41 16.10 16.09 Index Equity...................................... 16.45 2.79 19.55 18.06 16.45 Balanced.......................................... 12.92 4.48 14.88 12.78 12.92 Low Duration Bond................................. 5.30 1.22 4.16 4.92 5.30 Intermediate Government Bond...................... 6.17 3.63 5.29 4.73 6.17 Intermediate Bond................................. 5.25 2.98 5.55 4.85 5.04 Core Bond......................................... 7.24 4.29 5.98 5.94 7.05 Government Income................................. 9.25 5.35 6.39 N/A 8.00 GNMA.............................................. 7.22 2.73 5.49 5.12 7.22 Managed Income.................................... 7.78 3.08 5.86 5.06 7.78 International Bond................................ 9.63 6.15 9.57 8.53 9.63 Tax-Free Income................................... 7.84 2.69 6.42 5.40 7.84 Pennsylvania Tax-Free Income...................... 6.38 2.72 5.31 4.71 6.20 New Jersey Tax-Free Income........................ 7.20 2.47 4.99 4.74 7.20 Ohio Tax-Free Income.............................. 5.78 2.42 5.19 4.50 5.59 Delaware Tax-Free Income.......................... 5.02 1.75 3.78 3.50 5.02 Kentucky Tax-Free Income.......................... 5.63 1.89 3.89 3.76 5.63
- ----------------- * Operations not yet commenced. 123 INVESTOR C SHARES -----------------
INVESTOR C SHARES TOTAL RETURN (NAV) ----------------------------------------------------------------- 10 YEAR ANN. (OR SINCE FUND FUND INCEPTION CLASS INTRO INCEPTION ANN., DATE DATE 1 YEAR 3 YEAR ANN. 5 YEAR ANN. IF SHORTER) -------------- ----------- ------ ----------- ----------- ---------------- Large Cap Value Equity........................ 04/20/92 08/16/96 (3.45) 16.35 15.31 14.95 Large Cap Growth Equity....................... 11/01/89 01/24/97 10.33 19.65 14.43 13.15 Mid Cap Value Equity.......................... 12/27/96 12/27/96 (14.66) N/A N/A 5.25 Mid Cap Growth Equity......................... 12/27/96 12/27/96 (9.19) N/A N/A 5.55 Small Cap Value Equity........................ 04/13/92 10/01/96 (18.08) 9.94 10.35 12.68 Small Cap Growth Equity....................... 09/14/93 09/06/96 (22.89) 8.25 12.66 13.57 Micro-Cap Equity.............................. 05/01/98 05/01/98 N/A N/A N/A (14.39) International Equity.......................... 04/27/92 12/05/96 (8.19) 3.68 4.49 7.38 International Small Cap Equity................ 09/26/97 09/26/97 (4.73) N/A N/A (4.95) International Emerging Markets................ 06/17/94 03/21/97 (54.13) (18.82) N/A (16.65) Select Equity................................. 09/13/93 09/27/96 2.90 19.83 16.57 16.32 Index Equity.................................. 04/20/92 08/14/96 7.63 20.98 18.54 16.45 Balanced...................................... 05/14/90 12/20/96 9.40 16.26 13.24 12.92 Low Duration Bond............................. 07/17/92 02/24/97 5.99 5.41 5.35 5.30 Intermediate Government Bond.................. 04/20/92 10/08/96 8.51 6.55 5.15 6.17 Core Bond..................................... 12/09/92 02/28/97 9.20 7.24 6.37 7.24 Government Income............................. 10/03/94 02/28/97 10.31 7.85 N/A 9.25 GNMA.......................................... 06/01/90 05/18/98 7.57 6.75 5.55 7.22 International Bond............................ 07/01/91 09/11/96 11.15 10.88 8.97 9.63 Tax-Free Income............................... 05/14/90 02/28/97 7.53 7.69 5.83 7.84 Pennsylvania Tax-Free Income.................. 12/01/92 08/14/98 7.56 6.57 5.14 6.38 Ohio Tax-Free Income.......................... 12/01/92 08/25/98 7.25 6.44 4.92 5.78 Delaware Tax-Free Income...................... 10/20/65 05/11/98 6.54 5.02 3.92 5.02 Kentucky Tax-Free Income...................... 09/06/66 05/11/98 6.69 5.14 4.18 5.63 TOTAL RETURN (LOAD ADJUSTED) ------------------------------------------------------- 10 YEAR ANN. (OR SINCE FUND INCEPTION ANN., 1 YEAR 3 YEAR ANN. 5 YEAR ANN. IF SHORTER) ------- ----------- ----------- ---------------- Large Cap Value Equity........................ (4.42) N/A N/A N/A Large Cap Growth Equity....................... 9.23 N/A N/A N/A Mid Cap Value Equity.......................... (15.51) N/A N/A 5.25 Mid Cap Growth Equity......................... (10.10) N/A N/A 5.55 Small Cap Value Equity........................ (18.90) N/A N/A N/A Small Cap Growth Equity....................... (23.66) N/A N/A N/A Micro-Cap Equity.............................. N/A N/A N/A N/A International Equity.......................... (9.11) N/A N/A N/A International Small Cap Equity................ (5.68) N/A N/A (4.95) International Emerging Markets................ (54.59) N/A N/A N/A Select Equity................................. 1.87 N/A N/A N/A Index Equity.................................. 6.55 N/A N/A N/A Balanced...................................... 8.31 N/A N/A N/A Low Duration Bond............................. 4.93 N/A N/A N/A Intermediate Government Bond.................. 19.75 N/A N/A N/A Core Bond..................................... 8.11 N/A N/A N/A Government Income............................. 9.21 N/A N/A N/A GNMA.......................................... 6.49 N/A N/A N/A International Bond............................ 10.04 N/A N/A N/A Tax-Free Income............................... 6.45 N/A N/A N/A Pennsylvania Tax-Free Income.................. 6.48 N/A N/A N/A Ohio Tax-Free Income.......................... 6.18 N/A N/A N/A Delaware Tax-Free Income...................... 5.47 N/A N/A N/A Kentucky Tax-Free Income...................... 5.62 N/A N/A N/A
________________ * Operations not yet commenced. 124 SERVICE SHARES --------------
Service Shares Total Return (NAV) ------------------------------ Fund Inception Class Intro Date Date 1 Year --------------- ------------- ------------ Large Cap Value Equity....................................... 04/20/92 07/29/93 (2.50) Large Cap Growth Equity...................................... 11/01/89 07/28/93 11.33 Mid Cap Value Equity......................................... 12/27/96 12/27/96 (13.94) Mid Cap Growth Equity........................................ 12/27/96 12/27/96 (8.32) Small Cap Value Equity....................................... 04/13/92 07/29/93 (17.33) Small Cap Growth Equity...................................... 09/14/93 09/15/93 (22.4) Micro-Cap Equity............................................. 05/01/98 05/01/98 N/A International Equity......................................... 04/27/92 07/29/93 (7.34) International Small Cap Equity............................... 09/26/97 09/26/97 (3.62) International Emerging Markets............................... 06/17/94 06/17/94 (53.62) Select Equity................................................ 09/13/93 09/15/93 3.77 Index Equity................................................. 04/20/92 07/29/93 8.54 Balanced..................................................... 05/14/90 07/29/93 10.43 Low Duration Bond............................................ 07/17/92 01/12/96 6.96 Intermediate Government Bond................................. 04/20/92 07/29/93 9.50 Intermediate Bond............................................ 09/17/93 09/23/93 8.48 Core Bond.................................................... 12/09/92 01/12/96 10.24 GNMA......................................................... 06/01/90 05/18/98 8.53 Managed Income............................................... 11/01/89 07/29/93 8.93 International Bond........................................... 07/01/91 07/01/91 12.17 Tax-Free Income.............................................. 05/14/90 07/29/93 8.52 Pennsylvania Tax-Free Income................................. 12/01/92 07/29/93 8.19 New Jersey Tax-Free Income................................... 07/01/91 07/01/91 8.28 Ohio Tax-Free Income......................................... 12/01/92 07/29/93 8.23 Delaware Tax-Free Income..................................... 10/20/65 05/11/98 7.50 Kentucky Tax-Free Income..................................... 09/06/66 05/11/98 7.66 Service Shares Total Return (NAV) --------------------------------------------------- 10 Year Ann. (or Since Fund Inception Ann., 3 Year Ann. 5 Year Ann. if shorter) ----------- ----------- ---------------- Large Cap Value Equity....................................... 17.32 15.95 15.44 Large Cap Growth Equity...................................... 20.67 15.10 13.53 Mid Cap Value Equity......................................... N/A N/A 6.03 Mid Cap Growth Equity........................................ N/A N/A 6.42 Small Cap Value Equity....................................... 10.91 11.11 13.28 Small Cap Growth Equity...................................... 9.18 13.31 14.21 Micro-Cap Equity............................................. N/A N/A (13.95) International Equity......................................... 4.56 5.21 7.96 International Small Cap Equity............................... N/A N/A (3.85) International Emerging Markets............................... (18.19) N/A (53.73) Select Equity................................................ 20.77 17.16 16.93 Index Equity................................................. 21.86 19.14 16.91 Balanced..................................................... 17.30 14.04 13.40 Low Duration Bond............................................ 6.05 5.73 5.61 Intermediate Government Bond................................. 7.23 5.57 6.50 Intermediate Bond............................................ 7.10 5.48 5.46 Core Bond.................................................... 8.10 6.88 7.68 GNMA......................................................... 7.73 6.51 8.21 Managed Income............................................... 7.60 5.87 7.99 International Bond........................................... 11.73 9.47 9.98 Tax-Free Income.............................................. 8.47 6.38 8.18 Pennsylvania Tax-Free Income................................. 7.42 5.81 6.95 New Jersey Tax-Free Income................................... 7.01 5.62 7.51 Ohio Tax-Free Income......................................... 7.41 5.62 6.36 Delaware Tax-Free Income..................................... 5.98 4.87 5.98 Kentucky Tax-Free Income..................................... 6.10 5.14 6.60
_____________________ * Operations not yet commenced. 125
INSTITUTIONAL SHARES -------------------- INSTITUTIONAL SHARES TOTAL RETURN (NAV) ------------------------------------------------------------------- FUND INCEPTION CLASS INTRO DATE DATE 1 YEAR 3 YEAR ANN. 5 YEAR ANN. -------------- ----------- ------ ----------- ----------- Large Cap Value Equity....................................... 04/20/92 04/20/92 (2.27) 17.64 16.26 Large Cap Growth Equity...................................... 11/01/89 11/01/89 11.76 21.04 15.40 Mid Cap Value Equity......................................... 12/27/96 12/27/96 (13.68) N/A N/A Mid Cap Growth Equity........................................ 12/27/96 12/27/96 (8.05) N/A N/A Small Cap Value Equity....................................... 04/13/92 04/13/92 17.03 11.26 11.44 Small Cap Growth Equity...................................... 09/14/93 09/14/93 (21.93) 9.69 13.74 Micro-Cap Equity............................................. 05/01/98 05/01/98 N/A N/A N/A International Equity......................................... 04/27/92 04/27/92 (7.03) 4.88 5.53 International Small Cap Equity............................... 09/26/97 09/26/97 (3.57) N/A N/A International Emerging Markets............................... 06/17/94 06/17/94 (53.59) (17.98) N/A Select Equity................................................ 09/13/93 09/13/93 4.07 21.13 17.49 Index Equity................................................. 04/20/92 04/20/92 8.91 22.24 19.48 Balanced..................................................... 05/14/90 05/01/92 10.82 17.65 14.38 Low Duration Bond............................................ 07/17/92 07/17/92 7.28 6.35 5.91 Intermediate Government Bond................................. 04/20/92 04/20/92 9.83 7.55 5.87 Intermediate Bond............................................ 09/17/93 09/17/93 8.81 7.42 5.78 Core Bond.................................................... 12/09/92 12/09/92 10.57 8.37 7.03 GNMA......................................................... 06/01/90 05/18/98 8.88 8.06 6.84 Managed Income............................................... 11/01/89 11/01/89 9.25 7.91 6.16 International Bond........................................... 07/01/91 06/10/96 12.51 12.00 9.63 Tax-Free Income.............................................. 05/14/90 01/21/93 8.85 8.79 6.69 Pennsylvania Tax-Free Income................................. 12/01/92 12/01/92 8.51 7.74 6.11 New Jersey Tax-Free Income................................... 07/01/91 05/04/98 8.38 7.04 5.64 Ohio Tax-Free Income......................................... 12/01/92 12/01/92 8.56 7.73 5.92 Delaware Tax-Free Income..................................... 10/20/65 05/11/98 7.82 6.30 5.19 Kentucky Tax-Free Income..................................... 09/06/66 05/11/98 7.99 6.42 5.45 INSTITUTIONAL SHARES TOTAL RETURN (NAV) ---------------------------------------------------- 10 YEAR ANN. (OR SINCE FUND INCEPTION ANN., IF SHORTER) -------------------- Large Cap Value Equity....................................... 15.68 Large Cap Growth Equity...................................... 13.71 Mid Cap Value Equity......................................... 6.35 Mid Cap Growth Equity........................................ 6.75 Small Cap Value Equity....................................... 13.54 Small Cap Growth Equity...................................... 14.64 Micro-Cap Equity............................................. (13.95) International Equity......................................... 8.21 International Small Cap Equity............................... (3.81) International Emerging Markets............................... (16.23) Select Equity................................................ 17.24 Index Equity................................................. 17.18 Balanced..................................................... 13.60 Low Duration Bond............................................ 5.76 Intermediate Government Bond................................. 6.74 Intermediate Bond............................................ 5.76 Core Bond.................................................... 7.81 GNMA......................................................... 8.53 Managed Income............................................... 8.17 International Bond........................................... 10.09 Tax-Free Income.............................................. 8.37 Pennsylvania Tax-Free Income................................. 7.18 New Jersey Tax-Free Income................................... 7.53 Ohio Tax-Free Income......................................... 6.62 Delaware Tax-Free Income..................................... 6.30 Kentucky Tax-Free Income..................................... 6.92
_______________________ * Operations not yet commenced. 126
BLACKROCK SHARES ---------------- BLACKROCK SHARES TOTAL RETURN (NAV) ------------------------------------------------------------------------------ 10 YEAR ANN. SINCE FUND INCEPTION FUND INCEPTION CLASS INTRO 1 YEAR 3 YEAR ANN. 5 YEAR ANN. ANN., IF DATE DATE SHORTER) -------------- ----------- ------- ----------- ----------- ----------- Low Duration Bond........................... 07/17/92 06/03/97 7.44 6.43 5.96 5.79 Intermediate Bond........................... 09/17/93 05/01/98 8.86 7.44 5.79 5.77 Core Bond................................... 12/09/92 05/01/97 10.74 8.43 7.07 7.85
127 *Notes ----- Performance information presented for Investor A, Investor B, Investor C and Service Shares of a Portfolio prior to their introduction dates does not reflect shareholder servicing and processing and/or distribution fees and certain other expenses borne by these share classes which, if reflected, would reduce the performance quoted. Performance information presented assumes the reinvestment of dividends and distributions. Performance information presented for Investor A, Investor B, Investor C and Service Shares of a Portfolio prior to their introduction as indicated in the table above is based upon historical expenses of the predecessor class or classes which do not reflect the actual expenses that an investor would incur as a holder of shares of these classes of the Portfolios. The ongoing fees and expenses borne by Investor B Shares and Investor C Shares are greater than those borne by Investor A Shares; the ongoing fees and expenses borne by a Portfolio's Investor A, Investor B and Investor C Shares are greater than those borne by the Portfolio's Service Shares; the ongoing fees and expenses borne by a Portfolio's Investor A, Investor B, Investor C and Service Shares are greater than those borne by the Portfolio's Institutional Shares; and the ongoing fees and expenses borne by a Portfolio's Investor A, Investor B, Investor C, Service and Institutional Shares are greater than those borne by the Portfolio's BlackRock Shares. Performance information presented for Institutional Shares of the Balanced, Tax-Free Income, New Jersey Tax- Free Income and International Bond Portfolios prior to their introduction dates is based upon historical expenses of predecessor classes which are higher than the actual expenses that an investor would incur as a holder of Institutional Shares of the above-mentioned Portfolios. Accordingly, the performance information may be used in assessing each Portfolio's performance history but does not reflect how the distinct classes would have performed on a relative basis prior to the introduction of these classes, which would require an adjustment to the ongoing expenses. For each of the Delaware Tax-Free Income Portfolio, the Kentucky Tax- Free Income Portfolio and the GNMA Portfolio, performance presented in the tables above and in each table that follows is based upon the performance of the respective predecessor fund, adjusted for each class to reflect historical expenses (absent waivers and reimbursements). The original class or classes of shares of each Portfolio were as follows: Balanced - Investor A Shares; Index Equity - Institutional Shares; Select Equity - Institutional Shares; Large Cap Growth Equity - Institutional Shares; Large Cap Value Equity - Institutional Shares; Small Cap Value Equity - Institutional Shares; Small Cap Growth Equity - Institutional Shares; International Equity - Institutional Shares; International Emerging Markets - Investor A, Institutional and Service Shares; Low Duration Bond - Institutional Shares; Intermediate Government Bond - Institutional Shares; Intermediate Bond - Institutional Shares; Core Bond - Institutional Shares; Managed Income - Institutional Shares; Tax-Free Income - Investor A Shares; New Jersey Tax-Free Income - Service Shares; Pennsylvania Tax-Free Income - Investor A and Institutional Shares; Ohio Tax-Free Income - Investor A and Institutional Shares; Government Income - Investor A Shares; International Bond - Service Shares; Mid-Cap Growth Equity - Investor A, Investor B, Investor C, Institutional and Service Shares; Mid-Cap Value Equity - Investor A, Investor B, Investor C, Institutional and Service Shares; and International Small Cap Equity - Investor A, Investor B, Investor C, Institutional and Service Shares. The performance quoted, except with respect to performance shown for the GNMA Portfolio, the Delaware Tax-Free Income Portfolio and the Kentucky Tax-Free Income Portfolio, reflects fee waivers that subsidize and reduce the total operating expenses of each Portfolio. The Portfolios' returns would have been lower if there were not such waivers. Each class of the Non-Money Market Portfolios may also from time to time include in advertisements, sales literature, communications to shareholders and other materials a total return figure that is not calculated according to the 129 formula set forth above in order to compare more accurately the performance of each class of a Non-Money Market Portfolio's shares with other performance measures. For example, in comparing the total return of a Non-Money Market Portfolio's shares with data published by Lipper Analytical Services, Inc., CDA Investment Technologies, Inc. or Weisenberger Investment Company Service, or with the performance of the Standard & Poor's 500 Stock Index, EAFE, the Dow Jones Industrial Average or the Shearson Lehman Hutton Government Corporate Bond Index, as appropriate, a Non-Money Market Portfolio may calculate the aggregate total return for its shares of a certain class for the period of time specified in the advertisement or communication by assuming the investment of $10,000 in such Non-Money Market Portfolio's shares and 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 value of the investment from the ending value and by dividing the remainder by the beginning value. A Non-Money Market Portfolio may not, for these purposes, deduct from the initial value invested or the ending value any amount representing front-end and deferred sales charges charged to purchasers of Investor A, Investor B or Investor C Shares. The Investor A, Investor B and Investor C classes of the Portfolio will, however, disclose, if appropriate, the maximum applicable sales charges and will also disclose that the performance data does not reflect sales charges and that inclusion of sales charges would reduce the performance quoted. In addition to average annual total returns, a Non-Money Market Portfolio may quote unaveraged or cumulative total returns reflecting the simple change in value of an investment over a stated period. Average annual and cumulative total returns may be quoted as a percentage or as a dollar amount, and may be calculated for a single investment, a series of investments, or a series of redemptions, over any time period. Total returns may be broken down into their components of income and capital (including capital gains and changes in share price) in order to illustrate the relationship of these factors and their contributions to total return. Total returns may be quoted on a before-tax or after-tax basis and may be quoted with or without taking sales charges into account. Excluding the sales charge from a total return calculation produces a higher total return figure. Total returns, yields, and other performance information may be quoted numerically or in a table, graph or similar illustration. Performance information for each class of the Equity and Bond Portfolios' shares may be quoted in advertisements and communications to shareholders. Total return will be calculated on an average annual total return basis for various periods. Average annual total return reflects the average annual percentage change in value of an investment in shares of an Equity or Bond Portfolio over the measuring period. Total return may also be calculated on an aggregate total return basis. Aggregate total return reflects the total percentage change in value over the measuring period. Both methods of calculating total return assume that dividend and capital gain distributions made by a Portfolio with respect to a class of shares are reinvested in shares of the same class, and also reflect the maximum sales load charged by the Portfolio with respect to a class of shares. When, however, a Portfolio compares the total return of a share class to that of other funds or relevant indices, total return may also be computed without reflecting the sales load. The yield of a class of shares of each of the Bond Portfolios is computed by dividing the Portfolio's net income per share allocated to that class during a 30-day (or one month) period by the maximum offering price per share on the last day of the period and annualizing the result on a semi-annual basis. Each Tax-Free Portfolio's "tax-equivalent yield" may also be quoted, which shows the level of taxable yield needed to produce an after-tax equivalent to a Portfolio's tax-free yield. This is done by increasing the Portfolio's yield (calculated above) by the amount necessary to reflect the payment of Federal and/or state income tax at a stated tax rate. The yield of a class of shares of the Balanced Portfolio is computed by dividing the net income allocated to that class during a 30-day (or one month) period by the maximum offering price per share on the last day of the period and annualizing the result on a semi-annual basis. The performance of a class of a Portfolio's shares may be compared to the performance of other mutual funds with similar investment objectives and to relevant indices, as well as to ratings or rankings prepared by independent services or other financial or industry publications that monitor the performance of mutual funds. For example, the performance of a class of each of the Bond Portfolio's shares may be compared to data prepared by Lipper Analytical Services, Inc., CDA Investment Technologies, Inc. and Weisenberger Investment Company Service, and with the performance of the Lehman GMNA Index, the T-Bill Index, the "stocks, bonds and inflation index" published annually by Ibbotson Associates and the Lehman Government Corporate Bond Index. The performance of a class of each of the Equity Portfolio's shares may be compared to data prepared by Lipper Analytical Services, Inc., CDA Investment Technologies, Inc. and Weisenberger 130 Investment Company Service, and to the performance of the Dow Jones Industrial Average, the "stocks bonds and inflation Index" published annually by Ibbotson Associates, the Lipper International Fund Index, the Lipper Small Cap International Fund Index, the Lehman Corporate Bond Index and the Financial Times World Stock Index. Performance information may also include evaluations of the Portfolios and their share classes published by nationally recognized ranking services, and information as reported in financial publications such as Business Week, Fortune, Institutional Investor, Money Magazine, Forbes, Barron's, The Wall Street Journal and The New York Times, or in publications of a local or regional nature. In addition to providing performance information that demonstrates the actual yield or return of a class of shares of particular Portfolio, a Portfolio may provide other information demonstrating hypothetical investment returns. This information may include, but is not limited to, illustrating the compounding effects of dividends in a dividend investment plan or the impact on tax-deferring investing. Performance quotations for shares of a Portfolio represent past performance and should not be considered representative of future results. The investment return and principal value of an investment in a Portfolio will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. Since performance will fluctuate, performance data for shares of a Portfolio cannot necessarily be used to compare an investment in such shares with bank deposits, savings accounts and similar investment alternatives which often provide an agreed or guaranteed fixed yield for a stated period of time. Performance is generally a function of the kind and quality of the instruments held in a portfolio, portfolio maturity, operating expenses and market conditions. Any fees charged by brokers or other institutions directly to their customer accounts in connection with investments in shares will not be included in the Portfolio performance calculations. 131 132 NON-MONEY MARKET PORTFOLIO YIELD. The Balanced, Managed Income, Tax-Free Income, Intermediate Government Bond, Ohio Tax-Free Income, Pennsylvania Tax-Free Income, New Jersey Tax-Free Income, Delaware Tax-Free Income, Kentucky Tax-Free Income, Low Duration Bond, Intermediate Bond, Government Income, Core Bond, International Bond, High Yield Bond and GNMA Portfolios may advertise the yields on their Service, Investor A, Investor B, Investor C, Institutional and BlackRock Shares. Under the rules of the SEC, each such Portfolio advertising the respective yields for its Service, Investor A, Investor B, Investor C, Institutional and BlackRock Shares must calculate yield using 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. 133 d = the maximum offering price per share on the last day of the period. For the purpose of determining net investment income earned during the period (variable "a" in the formula), dividend income on equity securities held by a Portfolio is recognized by accruing 1/360th of the stated dividend rate of the security each day that the security is in the Portfolio. Except as noted below, interest earned on any debt obligations held by the Portfolio is calculated by computing the yield to maturity of each obligation held by the Portfolio based on the market value of the obligation (including actual accrued interest) at the close of business on the last business day of each month, or, with respect to obligations purchased during the month, the purchase price (plus actual accrued interest) and dividing the result by 360 and multiplying the quotient by the market value of the obligation (including actual accrued interest) in order to determine the interest income on the obligation for each day of the subsequent month that the obligation is held by the Portfolio. For purposes of this calculation, it is assumed that each month contains 30 days. The maturity of an obligation with a call provision is the next call date on which the obligation reasonably may be expected to be called or, if none, the maturity date. With respect to debt obligations purchased at a discount or premium, the formula generally calls for amortization of the discount or premium. However, interest earned on tax-exempt obligations that are issued without original issue discount and have a current market discount is calculated by using the coupon rate of interest instead of the yield to maturity. In the case of tax-exempt obligations that are issued with original issue discount but which have discounts based on current market value that exceed the then-remaining portion of the original issue discount (market discount), the yield to maturity is the imputed rate based on the original issue discount calculation. On the other hand, in the case of tax-exempt obligations that are issued with original issue discount but which have discounts based on current market value that are less than the then-remaining portion of the original issue discount (market premium), the yield to maturity is based on the market value. With respect to mortgage or other receivables-backed obligations which are expected to be subject to monthly payments of principal and interest ("pay downs"), (a) gain or loss attributable to actual monthly pay downs are accounted for as an increase or decrease to interest income during the period; and (b) a Portfolio may elect either (i) to amortize the discount and premium on the remaining security, based on the cost of the security, to the weighted-average maturity date, if such information is available, or to the remaining term of the security, if any, if the weighted-average maturity date is not available, or (ii) not to amortize discount or premium on the remaining security. The amortization schedule will be adjusted monthly to reflect changes in the market values of debt obligations. Undeclared earned income will be subtracted from the maximum offering price per share (variable "d" in the formula). Undeclared earned income is the net investment income which, at the end of the base period, has not been declared as a dividend, but is reasonably expected to be and is declared and paid as a dividend shortly thereafter. In the case of Investor A Shares of a Non-Money Market Portfolio, a Portfolio's maximum offering price per share for purposes of the formula includes the maximum front-end sales charge imposed by the Portfolio - -- currently as much as 5.00% of the per share offering price. Each of the Tax-Free Income, Ohio Tax-Free Income, New Jersey Tax-Free Income, Pennsylvania Tax-Free Income, Delaware Tax-Free Income and Kentucky Tax- Free Income Portfolios may advertise the tax-equivalent yield for shares of a specified class. Under the rules of the SEC, a Portfolio advertising its tax- equivalent yield must calculate such tax-equivalent yield by dividing that portion of the yield of the Portfolio which is tax-exempt by one minus a stated income tax rate and adding the product to that portion, if any, of the yield of the Portfolio which is not tax-exempt. The annualized yield information for the 30-day period ended September 30, 1998 for the Portfolios referenced below was as follows:
AFTER WAIVERS BEFORE WAIVERS ----------------------------------- ------------------------------- TAX-EQUIVALENT TAX-EQUIVALENT YIELD (ASSUMES A YIELD (ASSUMES A FEDERAL INCOME FEDERAL INCOME PORTFOLIO YIELD TAX RATE OF 28%) YIELD TAX RATE OF 28%) - ----------------------------------------------- ------------ -------------------- ------------ ---------------- Low Duration Bond Institutional Shares 5.63% 7.82% 6.03% 8.38% --------- -------- --------- --------
134
AFTER WAIVERS BEFORE WAIVERS -------------------------------------------------------------------------- TAX-EQUIVALENT TAX-EQUIVALENT YIELDS (ASSUMES A YIELDS (ASSUMES A FEDERAL INCOME FEDERAL INCOME PORTFOLIO YIELD TAX RATE OF 28% YIELD TAX RATE OF 28% - ------------------------------------------------ -------------------------------------------------------------------------- Service Shares 5.33 7.40 5.73 7.96 Investor A Shares 5.15 7.15 5.55 7.71 Investor B Shares 4.40 6.11 4.80 6.67 Investor C Shares 4.40 6.11 4.80 6.67 BlackRock Shares 5.78 8.03 6.18 8.58 Intermediate Government Bond Institutional Shares 5.74% 7.97% 6.00% 8.33% Service Shares 5.43 7.54 5.69 7.90 Investor A Shares 5.26 7.31 5.52 7.67 Investor B Shares 4.51 6.26 4.77 6.63 Investor C Shares 4.51 6.26 4.77 6.63 Intermediate Bond Institutional Shares 5.83% 8.10% 6.10% 8.47% Service Shares 5.53 7.68 5.80 8.06 Investor A Shares 5.35 7.43 5.62 7.81 Investor B Shares 4.60 6.39 4.87 6.76 Black Rock Shares 5.98 8.31 6.25 8.68 Core Bond Institutional Shares 5.92% 8.22% 6.26% 8.69% Service Shares 5.62 7.81 5.96 8.28 Investor A Shares 5.29 7.35 5.63 7.82 Investor B Shares 4.25 5.90 4.59 6.38 Investor C Shares 4.70 6.53 5.04 7.00 BlackRock Shares 6.07 8.43 6.41 8.90 Government Income Investor A Shares 5.76% 8.00% 6.34% 8.81% Investor B Shares 5.01 6.96 5.59 7.76 Investor C Shares 5.01 6.96 5.59 7.76 Managed Income Institutional Shares 6.00% 8.33% 6.18% 8.58% Service Shares 5.70 7.92 5.88 8.17 Investor A Shares 5.53 7.68 5.71 7.93 Investor B Shares 4.77 6.63 4.95 6.88 International Bond Institutional Shares 5.23% 7.26% 5.38% 7.47% Service Shares 4.93 6.85 5.08 7.06 Investor A Shares 4.76 6.61 4.91 6.82 Investor B Shares 4.01 5.57 4.16 5.78 Investor C Shares 4.01 5.57 4.16 5.78 GNMA Institutional Shares 6.15% 8.54% 6.52% 9.06% Service Shares 5.85 8.13 6.22 8.64 Investor A Shares 5.68 7.89 6.05 8.40 Investor B Shares 4.92 6.83 5.29 7.35 Investor C Shares 4.92 6.83 5.29 7.35 Tax-Free Income Institutional Shares 4.54% 6.31% 4.82% 6.69% Service Shares 4.24 5.89 4.52 6.28 Investor A Shares 4.07 5.65 4.35 6.04 Investor B Shares 3.31 4.60 3.59 4.99 Investor C Shares 3.31 4.60 3.59 4.99 Pennsylvania Tax-Free Income
135
After Waivers Before Waivers -------------------------------------------------------------------------- Tax-Equivalent Tax-Equivalent Yields (assumes a Yields (assumes a Federal income Federal income Portfolio Yield tax rate of 28% Yield tax rate of 28% - ------------------------------------------------ -------------------------------------------------------------------------- Institutional Shares 4.72% 6.56% 4.96% 6.89% Service Shares 4.41 6.13 4.65 6.46 Investor A Shares 4.27 5.93 4.51 6.26 Investor B Shares 4.06 5.64 4.30 5.97 Investor C Shares 4.06 5.64 4.30 5.97 New Jersey Tax-Free Income Institutional Shares 4.67% 6.49% 4.97% 6.90% Service Shares 4.36 6.06 4.66 6.47 Investor A Shares 4.19 5.82 4.49 6.24 Investor B Shares 3.44 4.78 3.74 5.19 Ohio Tax-Free Income Institutional Shares 4.73% 6.57% 5.06% 7.03% Service Shares 4.43 6.15 4.76 6.61 Investor A Shares 4.26 5.92 4.59 6.38 Investor B Shares 3.50 4.86 3.83 5.32 Investor C Shares 3.50 4.86 3.83 5.32 Delaware Tax-Free Income Institutional Shares 4.62% 6.42% 4.80% 6.67% Service Shares 4.32 6.00 4.50 6.25 Investor A Shares 4.15 5.76 4.33 6.01 Investor B Shares 3.39 4.71 3.57 4.96 Investor C Shares 3.39 4.71 3.57 4.96 Kentucky Tax-Free Income Institutional Shares 4.58% 6.36% 4.83% 6.71% Service Shares 4.27 5.93 4.52 6.28 Investor A Shares 4.10 5.69 4.35 6.04 Investor B Shares 3.35 4.65 3.60 5.00 Investor C Shares 3.35 4.65 3.60 5.00
OTHER INFORMATION REGARDING INVESTMENT RETURNS. In addition to providing performance information that demonstrates the total return or yield of shares of a particular class of a Portfolio over a specified period of time, the Fund may provide certain other information demonstrating hypothetical investment returns. Such information may include, but is not limited to, illustrating the compounding effects of dividends in a dividend reinvestment plan or the impact of tax-free investing. The Fund may demonstrate, using certain specified hypothetical data, the compounding effect of dividend reinvestment on investments in a Non-Money Market Portfolio. The Money and Non-Money Market Municipal Portfolios may illustrate in advertising, sales literature, communications to shareholders and other materials the benefits of tax-free investing. For example, Table 1 shows taxpayers how to translate Federal tax savings from investments the income on which is not subject to Federal income tax into an equivalent yield from a taxable investment. Similarly, Tables 2, 3, 4, 5, 6, 7 and 8 show Pennsylvania, Ohio, North Carolina, Virginia, New Jersey, Delaware and Kentucky shareholders the approximate yield that a taxable investment must earn at various income brackets to produce after-tax yields equivalent to those of the Pennsylvania Municipal Money Market and Pennsylvania Tax-Free Income Portfolios, the Ohio Municipal Money Market and Ohio Tax-Free Income Portfolios, the North Carolina Municipal Money Market Portfolio, the Virginia Municipal Money Market Portfolio, and the New Jersey Municipal Money Market and New Jersey Tax-Free Income Portfolios, the Delaware Tax-Free Income Portfolio and the Kentucky Tax-Free Income Portfolio, respectively. The yields below are for illustration purposes only and are not intended to represent current or future yields for the Money and Non-Money Market Municipal Portfolios, which may be higher or lower than the yields shown. The following information regarding tax rates and tax-exempt yields is as of January 1, 1999. 136 TABLE 1 - FEDERAL ONLY - ------- ------------
1999 TAXABLE INCOME BRACKET FEDERAL - --------------------------------------------------- MARGINAL TAX-EXEMPT YIELD SINGLE RETURN JOINT RETURN TAX RATE* 3.0% 3.5% 4.0% 4.5% 5.0% 5.5% 6.0% - --------------------------- -------------------- ------------- --------- ------- ------- ------- ------- ------- -------- $ 0 - $ 25,350 $ 0 - $ 42,350 15.0% 3.529% 4.118% 4.706% 5.294% 5.882% 6.471% 7.059% $ 25,351 - $ 61,400 $42,351 - $102,300 28.0% 4.167% 4.861% 5.556% 6.250% 6.944% 7.639% 8.333% $ 61,401 - $128,100 $102,301- $155,950 31.0% 4.348% 5.072% 5.797% 6.522% 7.246% 7.971% 8.696% $128,101 - $278,450 $155,951- $278,450 36.0% 4.688% 5.469% 6.250% 7.031% 7.812% 8.594% 9.375% Over $278,450 Over $278,450 39.6% 4.967% 5.795% 6.623% 7.450% 8.278% 9.106% 9.934%
*Rates do not include the phase out of personal exemptions or itemized deductions. It is assumed that the investor is not subject to the alternative minimum tax. Where applicable, investors should consider that the benefit of certain itemized deductions and the benefit of personal exemptions are limited in the case of higher income individuals. For 1998, taxpayers with adjusted gross income in excess of a threshold amount of approximately $124,500 are subject to an overall limitation on certain itemized deductions, requiring a reduction in such deductions equal to the lesser of (i) 3% of adjusted gross income in excess of the threshold of approximately $124,500 or (ii) 80% of the amount of such itemized deductions otherwise allowable. The benefit of each personal exemption is phased out at the rate of two percentage points for each $2,700 (or fraction thereof) of adjusted gross income in the phase-out zone. For single taxpayers the range of adjusted gross income comprising the phase-out zone for 1998 is estimated to be from $124,500 to $247,000 and for married taxpayers filing a joint return from $186,800 to $309,300. The Federal tax brackets, the threshold amounts at which itemized deductions are subject to reduction, and the range over which personal exemptions are phased out will be further adjusted for inflation for each year after 1998. 137 TABLE 2 - FEDERAL AND PENNSYLVANIA - ------- ------------------------
APPROX. COMBINED FEDERAL 1999 TAXABLE INCOME BRACKET* AND PA - -------------------------------------------------- MARGINAL TAX-EXEMPT YIELD SINGLE RETURN JOINT RETURN TAX RATE* 3.0% 3.5% 4.0% 4.5% 5.0% 5.5% 6.0% - -------------------------- ---------------------- ------------ -------- -------- ------ ------- ------ ------- -------- $ 0 - $ 25,350 $ 0 - $ 42,350 17.380% 3.631% 4.236% 4.841% 5.447% 6.052% 6.657% 7.262% $ 25,351 - $ 61,400 $ 42,351 - $102,300 30.016% 4.287% 5.001% 5.716% 6.430% 7.144% 7.859% 8.573% $ 61,401 - $128,100 $102,301 - $155,950 32.932% 4.473% 5.219% 5.964% 6.710% 7.455% 8.201% 8.946% $128,101 - $278,450 $155,951 - $278,450 37.792% 4.823% 5.626% 6.430% 7.234% 8.038% 8.841% 9.645% Over $278,450 Over $278,450 41.291% 5.110% 5.962% 6.813% 7.665% 8.517% 9.368% 10.220%
*The income amount shown is income subject to Federal income tax reduced by adjustments to income, exemptions, and itemized deductions (including the deduction for state income taxes). If the standard deduction is taken for Federal income tax purposes, the taxable equivalent yield required to equal a specified tax-exempt yield is at least as great as that shown in the table. It is assumed that the investor is not subject to the alternative minimum tax. Where applicable, investors should consider that the benefit of certain itemized deductions and the benefit of personal exemptions are limited in the case of higher income individuals. For 1998, taxpayers with adjusted gross income in excess of a threshold amount of approximately $124,500 are subject to an overall limitation on certain itemized deductions, requiring a reduction in such deductions equal to the lesser of (i) 3% of adjusted gross income in excess of the threshold of approximately $124,500 (ii) 80% of the amount of such itemized deductions otherwise allowable. The benefit of each personal exemption is phased out at the rate of two percentage points for each $2,700 (or fraction thereof) of adjusted gross income in the phase-out zone. For single taxpayers the range of adjusted gross income comprising the phase-out zone for 1998 is estimated to be from $124,500 to $247,000 and for married taxpayers filing a joint return from $186,800 to $309,300. The Federal tax brackets, the threshold amounts at which itemized deductions are subject to reduction, and the range over which personal exemptions are phased out will be further adjusted for inflation for each year after 1998. 138 TABLE 3 - FEDERAL AND OHIO - ------- ----------------
STATE OF OHIO 1999 TAX YEAR - --------------------------------------------------------------------------- TAX EXEMPT YIELD ------------------------------------------------------------ 3 3.5 4 4.5 5 5.5 6 1999 FEDERAL OHIO TAXABLE INCOME MARGINAL MARGINAL COMBINED TAXABLE EQUIVALENT YIELD BRACKETS* TAX RATE TAX RATE* RATE SINGLE RETURN - -------------------------- ------------ ------------ --------- ------------------------------------------------------------- $ 0-25,750 15% 4.457% 18.79% 3.69% 4.31% 4.93% 5.54% 6.16% 6.77% 7.39% 25,751-40,000 28% 4.457% 31.21% 4.36% 5.09% 5.81% 6.54% 7.27% 8.00% 8.72% 40,001-62,450 28% 5.201% 31.74% 4.40% 5.13% 5.86% 6.59% 7.33% 8.06% 8.79% 62,451-80,000 31% 5.201% 34.59% 4.59% 5.35% 6.12% 6.88% 7.64% 8.41% 9.17% 80,001-100,000 31% 5.943% 35.10% 4.62% 5.39% 6.16% 6.93% 7.70% 8.47% 9.25% 100,001-130,250 31% 6.900% 35.76% 4.67% 5.45% 6.23% 7.01% 7.78% 8.56% 9.34% 130,251-200,000 36% 6.900% 40.42% 5.03% 5.87% 6.71% 7.55% 8.39% 9.23% 10.07% 200,001-283,150 36% 7.500% 40.80% 5.07% 5.91% 6.76% 7.60% 8.45% 9.29% 10.14% OVER 283,150 39.6% 7.500% 44.13% 5.37% 6.26% 7.16% 8.05% 8.95% 9.84% 10.74%
139
1999 FEDERAL OHIO TAXABLE INCOME MARGINAL MARGINAL COMBINED TAXABLE EQUIVALENT YIELD BRACKETS* TAX RATE* TAX RATE* RATE JOINT RETURN - ----------------------------- --------------- -------------- ---------- ---------------------------------------------------- $ 0- 40,000 15% 4.457% 18.79% 3.69% 4.31% 4.93% 5.54% 6.16% 6.77% 7.39% 40,001- 43,050 15% 5.201% 19.42% 3.72% 4.34% 4.96% 5.58% 6.20% 6.82% 7.45% 43,051- 80,000 28% 5.201% 31.74% 4.40% 5.13% 5.86% 6.59% 7.33% 8.06% 8.79% 80,001-100,000 28% 5.943% 32.28% 4.43% 5.17% 5.91% 6.64% 7.38% 8.12% 8.86% 100,001-104,050 28% 6.900% 32.97% 4.48% 5.22% 5.97% 6.71% 7.46% 8.21% 8.95% 104,051-158,550 31% 6.900% 35.76% 4.67% 5.45% 6.23% 7.01% 7.78% 8.56% 9.34% 158,551-200,000 36% 6.900% 40.42% 5.03% 5.87% 6.71% 7.55% 8.39% 9.23% 10.07% 200,001-283,150 36% 7.500% 40.80% 5.07% 5.91% 6.76% 7.60% 8.45% 9.29% 10.14% OVER 283,150 39.6% 7.500% 44.13% 5.37% 6.26% 7.16% 8.05% 8.95% 9.84% 10.74%
*The income brackets applicable to the state of Ohio do not correspond to the Federal taxable income brackets. In addition, Ohio taxable income will likely be different than Federal taxable income because it is computed by reference to Federal adjusted gross income with specifically-defined Ohio modifications and exemptions, and does not consider many of the deductions allowed from Federal adjusted gross income in computing Federal taxable income. No other state tax credits, exemptions, or local taxes have been taken into account in arriving at the combined marginal tax rate. In 1998, due to the state having surplus revenue, a 9.339% across the board reduction in the Ohio income tax rates for 1998 only was effected pursuant to Ohio Revised Code sections 131.44 and 5747.02. It is not yet known whether a reduction in the Ohio income tax rates will occur in 1999. A reduction in Ohio income tax rates, such as the 1998 reduction, has the effect of reducing the after-tax advantage of Ohio tax-exempt securities relative to taxable securities. The income amount shown is income subject to Federal income tax reduced by adjustments to income, exemptions, and itemized deductions (including the deduction for state and local income taxes). If the standard deduction is taken for Federal income tax purposes, the taxable equivalent yield required to equal a specified tax-exempt yield is at least as great as that shown in the table. It is assumed that the investor is not subject to the alternative minimum tax. Where applicable, investors should consider that the benefit of certain itemized deductions and the benefit of personal exemptions are limited in the case of higher income individuals. For 1999, taxpayers with adjusted gross income in excess of a threshold amount of approximately $126,600 are subject to an overall limitation on certain itemized deductions, requiring a reduction in such deductions equal to the lesser of (i) 3% of adjusted gross income in excess of the threshold of approximately $126,600 or (ii) 80% of the amount of such itemized deductions otherwise allowable. The benefit of each personal exemption is phased out at the rate of two percentage points for each $2,750 (or fraction thereof) of adjusted gross income in the phase-out zone. For single taxpayers the range of adjusted gross income comprising the phase-out zone for 1999 is estimated to be from $126,600 to $249,100 and for married taxpayers filing a joint return from $189,950 to $312,450. The Federal tax brackets, the threshold amounts at which itemized deductions are subject to reduction, and the range over which personal exemptions are phased out will be further adjusted for inflation for each year after 1999. 140 TABLE 4 - FEDERAL AND NORTH CAROLINA - ------- --------------------------
COMBINED FEDERAL AND NORTH NORTH FEDERAL CAROLINA CAROLINA 1998 TAXABLE INCOME BRACKET MARGINAL MARGINAL MARGINAL TAX-EXEMPT YIELD - -------------------------------------- --------------------------------------------------------- SINGLE RETURN JOINT RETURN TAX RATE TAX RATE TAX RATE* 3.0% 3.5% 4.0% 4.5% 5.0% 5.5% 6.0% - ------------------------------------------------------------------------------------------------------------------------------------ $ 0 - 12,750 $ 0 - 21,250 15.0% 6.00% 20.100% 3.755% 4.380% 5.006% 5.632% 6.258% 6.884% 7.509% 12,751 - 25,350 21,000 - 42,350 15.0% 7.00% 20.950% 3.795% 4.428% 5.060% 5.693% 6.325% 6.598% 7.590% 25,351 - 60,000 42,351 - 100,000 28.0% 7.00% 33.040% 4.480% 5.227% 5.974% 6.720% 7.467% 8.214% 8.961% 60,001 - 61,400 100,001 - 102,300 28.0% 7.75% 33.580% 4.517% 5.269% 6.022% 6.775% 7.528% 8.281% 9.033% 61,401 - 128,100 102,301 - 155,950 31.0% 7.75% 36.348% 4.713% 5.499% 6.284% 7.070% 7.855% 8.641% 9.426% 128,101 - 278,450 155,951 - 278,450 36.0% 7.75% 40.960% 5.081% 5.928% 6.775% 7.622% 8.469% 9.316% 10.163% Over 278,450 Over 278,450 39.6% 7.75% 44.281% 5.384% 6.282% 7.179% 8.076% 8.974% 9.871% 10.768%
*The taxable income brackets applicable to North Carolina do not correspond to the Federal taxable income brackets. The taxable income brackets presented in this table represent the breakpoints for both the Federal and North Carolina marginal tax rate changes. When applying these brackets, Federal taxable income may be different than North Carolina taxable income. No state tax credits, exemptions, or local taxes have been taken into account in arriving at the combined marginal tax rate. The income amount shown is income subject to Federal income tax reduced by adjustments to income, exemptions, and itemized deductions (including the deduction for state and local income taxes). If the standard deduction is taken for Federal income tax purposes, the taxable equivalent yield required to equal a specified tax-exempt yield is at least as great as that shown in the table. It is assumed that the investor is not subject to the alternative minimum tax. Where applicable, investors should consider that the benefit of certain itemized deductions and the benefit of personal exemptions are limited in the case of higher-income individuals. For 1998, taxpayers with adjusted gross income in excess of the threshold of approximately $124,500 are subject to an overall limitation on certain itemized deductions, requiring a reduction in such deductions equal to the lesser of (i) 3% of adjusted gross income in excess of the threshold of approximately $124,500 or (ii) 80% of the amount of such itemized deductions otherwise allowable. The benefit of each personal exemption is phased out at the rate of two percentage points for each $2,700 (or fraction thereof) of adjusted gross income in the phase-out zone. For single taxpayers the range of adjusted gross income comprising the phase-out zone for 1998 is estimated to be from $124,500 to $247,000 and for married taxpayers filing a joint return from $186,800 to $309,300. The Federal tax brackets, the threshold amounts at which itemized deductions are subject to reduction, and the range over which personal exemptions are phased out will be further adjusted for inflation for each year after 1998. 141 TABLE 5 - FEDERAL AND VIRGINIA - ------- --------------------
COMBINED FEDERAL AND FEDERAL VIRGINIA VIRGINIA 1998 TAXABLE INCOME BRACKET MARGINAL MARGINAL MARGINAL TAX-EXEMPT YIELD - ---------------------------------------- ------------------------------------------------------ SINGLE RETURN JOINT RETURN TAX RATE TAX RATE TAX RATE* 3.0% 3.5% 4.0% 4.5% 5.0% 5.5% 6.0% - ------------------------------------------------------------------------------------------------------------------------------------ $ 0 - 25,350 $ 0 - 42,350 15.0% 5.75% 19.888% 3.745% 4.369% 4.993% 5.617% 6.241% 6.865% 7.489% 25,351 - 61,400 42,351 - 102,300 28.0% 5.75% 32.140% 4.421% 5.158% 5.894% 6.631% 7.368% 8.105% 8.842% 61,401 - 128,100 102,301 - 155,950 31.0% 5.75% 34.968% 4.613% 5.382% 6.151% 6.920% 7.688% 8.457% 9.226% 128,101 - 278,450 155,951 - 278,450 36.0% 5.75% 39.680% 4.973% 5.802% 6.631% 7.460% 8.289% 9.118% 9.947% OVER 278,450 OVER 278,450 39.6% 5.75% 43.073% 5.270% 6.148% 7.027% 7.905% 8.783% 9.661% 10.540%
*The taxable income brackets applicable to Virginia do not correspond to the Federal taxable income brackets. Because Virginia imposes a maximum tax rate of 5.75% on taxable income over $17,000, the taxable income brackets presented in this table represent the breakpoints only for the Federal marginal tax rate changes. When applying these brackets, Federal taxable income may be different than Virginia taxable income. No state tax credits, exemptions, or local taxes have been taken into account in arriving at the combined marginal tax rate. The income amount shown is income subject to Federal income tax reduced by adjustments to income, exemptions, and itemized deductions (including the deduction for state and local income taxes). If the standard deduction is taken for Federal income tax purposes, the taxable equivalent yield required to equal a specified tax-exempt yield is at least as great as that shown in the table. It is assumed that the investor is not subject to the alternative minimum tax. Where applicable, investors should consider that the benefit of certain itemized deductions and the benefit of personal exemptions are limited in the case of higher income individuals. For 1998, taxpayers with adjusted gross income in excess of a threshold amount of approximately $124,500 are subject to an overall limitation on certain itemized deductions, requiring a reduction in such deductions equal to the lesser of (i) 3% of adjusted gross income in excess of the threshold of approximately $124,500 or (ii) 80% of the amount of such itemized deductions otherwise allowable. The benefit of each personal exemption is phased out at the rate of two percentage points for each $2,700 (or fraction thereof) of adjusted gross income in the phase-out zone. For single taxpayers the range of adjusted gross income comprising the phase-out zone for 1998 is estimated to be from $124,500 to $247,000 and for married taxpayers filing a joint return from $186,800 to $309,300. The Federal tax brackets, the threshold amounts at which itemized deductions are subject to reduction, and the range over which personal exemptions are phased out will be further adjusted for inflation for each year after 1998. 142 TABLE 6 - FEDERAL AND NEW JERSEY - ------- ----------------------
APPROXIMATE FEDERAL NJ COMBINED FEDERAL 1998 TAXABLE MARGINAL MARGINAL AND NJ TAX-EXEMPT YIELD INCOME BRACKET* TAX RATE TAX RATE MARGINAL TAX RATE 3.0% 3.5% 4.0% 4.5% 5.0% 5.5% 6.0% 6.5% 7.0% - ----------------- ---------- ---------- ----------------- ------ ------ ------ ------ ------ ------ ------ ------ ----- SINGLE RETURN - ----------------- TAXABLE YIELD - SINGLE RETURN $ 0 - 20,000 15.0% 1.400% 16.190% 3.580% 4.176% 4.773% 5.369% 5.966% 6.563% 7.159% 7.756% 8.352% 20,001 - 25,350 15.0% 1.750% 16.488% 3.592% 4.191% 4.790% 5.388% 5.987% 6.586% 7.185% 7.783% 8.382% 25,351 - 35,000 28.0% 1.750% 29.260% 4.241% 4.948% 5.655% 6.361% 7.068% 7.775% 8.482% 9.189% 9.895% 35,001 - 40,000 28.0% 3.500% 30.520% 4.318% 5.037% 5.757% 6.477% 7.196% 7.916% 8.636% 9.355% 10.075% 40,001 - 61,400 28.0% 5.525% 31.978% 4.410% 5.145% 5.881% 6.616% 7.351% 8.086% 8.821% 9.556% 10.291% 61,401 - 75,000 31.0% 5.525% 34.812% 4.602% 5.369% 6.136% 6.903% 7.670% 8.437% 9.204% 9.971% 10.738% 75,001 - 128,100 31.0% 6.370% 35.395% 4.644% 5.418% 6.192% 6.965% 7.739% 8.513% 9.287% 10.061% 10.835% 128,101 - 278,450 36.0% 6.370% 40.077% 5.006% 5.841% 6.675% 7.510% 8.344% 9.178% 10.013% 10.847% 11.682% OVER 278,450 39.6% 6.370% 43.448% 5.305% 6.189% 7.073% 7.957% 8.841% 9.726% 10.610% 11.494% 12.378% JOINT RETURN - ------------------- TAXABLE YIELD - JOINT RETURN $ 0 - 20,000 15.0% 1.400% 16.190% 3.580% 4.176% 4.773% 5.369% 5.966% 6.563% 7.159% 7.756% 8.352% 20,001 - 42,350 15.0% 1.750% 16.488% 3.592% 4.191% 4.790% 5.388% 5.987% 6.586% 7.185% 7.783% 8.382% 42,351 - 50,000 28.0% 1.750% 29.260% 4.241% 4.948% 5.655% 6.361% 7.068% 7.775% 8.482% 9.189% 9.895% 50,001 - 70,000 28.0% 2.450% 29.764% 4.271% 4.983% 5.695% 6.407% 7.119% 7.831% 8.543% 9.255% 9.966% 70,001 - 80,000 28.0% 3.500% 30.520% 4.318% 5.037% 5.757% 6.477% 7.196% 7.916% 8.636% 9.355% 10.075% 80,001 - 102,300 28.0% 5.525% 31.978% 4.410% 5.145% 5.881% 6.616% 7.351% 8.086% 8.821% 9.556% 10.291% 102,301 - 150,000* 31.0% 5.525% 34.812% 4.602% 5.369% 6.136% 6.903% 7.670% 8.437% 9.204% 9.971% 10.738% 150,001 - 155,950 31.0% 6.370% 35.395% 4.644% 5.418% 6.192% 6.965% 7.739% 8.513% 9.287% 10.061% 10.835% 155,951 - 278,450 36.0% 6.370% 40.077% 5.006% 5.841% 6.675% 7.510% 8.344% 9.178% 10.013% 10.847% 11.682%
143 OVER 278,450 39.6% 6.370% 43.448% 5.305% 6.189% 7.073% 7.957% 8.841% 9.726% 10.610% 11.494% 12.378%
144 * The taxable income brackets applicable to New Jersey do not correspond to the Federal taxable income brackets. Except where indicated, the taxable income brackets presented in this table represent the breakpoints for both the Federal and New Jersey marginal tax rate changes. When applying these brackets, Federal taxable income will be different than New Jersey taxable income because New Jersey does not start with Federal taxable income in computing its own state income tax base. No state tax credits, exemptions, or local taxes have been taken into account in arriving at the combined marginal tax rate. The income amount shown is income subject to Federal income tax reduced by adjustments to income, exemptions, and itemized deductions (including the deduction for state and local income taxes). If the standard deduction is taken for Federal income tax purposes, the taxable equivalent yield required to equal a specified tax-exempt yield is at least as great as that shown in the table. It is assumed that the investor is not subject to the alternative minimum tax. Where applicable, investors should consider that the benefit of certain itemized deductions and the benefit of personal exemptions are limited in the case of higher- income individuals. For 1998, taxpayers with adjusted gross income in excess of a threshold amount of approximately $124,500 are subject to an overall limitation on certain itemized deductions, requiring a reduction in such deductions equal to the lesser of (i) 3% of adjusted gross income in excess of the threshold of approximately $124,500 or (ii) 80% of the amount of such itemized deductions otherwise allowable. The benefit of each personal exemption is phased out at the rate of two percentage points for each $2,700 (or fraction thereof) of adjusted gross income in the phase-out zone. For single taxpayers the range of adjusted gross income comprising the phase-out zone for 1998 is estimated to be from $124,500 to $247,000, and for married taxpayers filing a joint return from $186,800 to $309,300. The Federal tax brackets, the threshold amounts at which itemized deductions are subject to reduction, and the range over which personal exemptions are phased out will be further adjusted for inflation for each year after 1998. 145 TABLE 7 - FEDERAL AND DELAWARE (SINGLE RETURN) - ------- --------------------
FEDERAL DELAWARE TAX-EXEMPT YIELD 1999 TAXABLE MARGINAL MARGINAL COMBINED -------------------------------------------------------------- INCOME BRACKETS* TAX RATE TAX RATE RATE* 3.0% 3.5% 4.0% 4.5% 5.0% 5.5% 6.0% - ------------------------------------------------------------------------------------------------------------------------------------ $ 0 - 2,000 15.0% 0.00% 15.00% 3.53% 4.12% 4.71% 5.29% 5.88% 6.47% 7.06% 2,001 - 5,000 15.0% 2.60% 17.21% 3.62% 4.23% 4.83% 5.44% 6.04% 6.64% 7.25% 5,001 - 10,000 15.0% 4.30% 18.66% 3.69% 4.30% 4.92% 5.53% 6.15% 6.76% 7.38% 10,001 - 20,000 15.0% 5.20% 19.42% 3.72% 4.34% 4.96% 5.58% 6.21% 6.83% 7.45% 20,001 - 25,000 15.0% 5.60% 19.76% 3.74% 4.36% 4.99% 5.61% 6.23% 6.85% 7.48% 25,001 - 25,750 15.0% 5.95% 20.06% 3.75% 4.38% 5.00% 5.63% 6.25% 6.88% 7.51% 25,751 - 60,000 28.0% 5.95% 32.28% 4.43% 5.17% 5.91% 6.65% 7.38% 8.12% 8.86%
146 60,001 - 62,450 28.0% 6.40% 32.61% 4.45% 5.19% 5.94% 6.68% 7.42% 8.16% 8.90% 62,451 - 130,250 31.0% 6.40% 35.42% 4.65% 5.42% 6.19% 6.97% 7.74% 8.52% 9.29% 130,251 - 283,150 36.0% 6.40% 40.10% 5.01% 5.84% 6.68% 7.51% 8.35% 9.18% 10.02% Over 283,150 39.6% 6.40% 43.47% 5.31% 6.19% 7.08% 7.96% 8.84% 9.73% 10.61%
147 TABLE 7 (CONT.) - FEDERAL AND DELAWARE (JOINT RETURN)
FEDERAL DELAWARE 1999 TAXABLE MARGINAL MARGINAL COMBINED FEDERAL AND DELAWARE TAX-EXEMPT YIELD ------------------------------------------------------------ INCOME BRACKETS* TAX RATE TAX RATE RATE* 3.0% 3.5% 4.0% 4.5% 5.0% 5.5% 6.0% - -------------------- -------------- -------------- ----------- $ 0 - 2,000 15.0% 0.00% 15.00% 3.53% 4.12% 4.71% 5.29% 5.88% 6.47% 7.06% 2,001 - 5,000 15.0% 2.60% 17.21% 3.62% 4.23% 4.83% 5.44% 6.04% 6.64% 7.25% 5,001 - 10,000 15.0% 4.30% 18.66% 3.69% 4.30% 4.92% 5.53% 6.15% 6.76% 7.38% 10,001 - 20,000 15.0% 5.20% 19.42% 3.72% 4.34% 4.96% 5.58% 6.21% 6.83% 7.45% 20,001 - 25,000 15.0% 5.60% 19.76% 3.74% 4.36% 4.99% 5.61% 6.23% 6.85% 7.48%
148 25,001 - 43,050 15.0% 5.95% 20.06% 3.75% 4.38% 5.00% 5.63% 6.25% 6.88% 7.51% 43,051 - 60,000 28.0% 5.95% 32.28% 4.43% 5.17% 5.91% 6.65% 7.38% 8.12% 8.86% 60,001 - 104,050 28.0% 6.40% 32.61% 4.45% 5.19% 5.94% 6.68% 7.42% 8.16% 8.90% 104,051 - 158,550 31.0% 6.40% 35.42% 4.65% 5.42% 6.19% 6.97% 7.74% 8.52% 9.29% 158,551 - 283,150 36.0% 6.40% 40.10% 5.01% 5.84% 6.68% 7.51% 8.35% 9.18% 10.02% Over 283,150 39.6% 6.40% 43.47% 5.31% 6.19% 7.08% 7.96% 8.84% 9.73% 10.61%
*The taxable income brackets applicable to Delaware do not correspond to the Federal taxable income brackets. The taxable income brackets presented in this table represent the breakpoints for both the Federal and Delaware marginal tax- rate changes. When applying these brackets, Federal taxable income may be different from Delaware taxable income. No state tax credits, exemptions or local taxes have been taken into account in arriving at the combined marginal tax rate. The income amount shown is income subject to Federal 149 income tax reduced by adjustments to income, exemptions and itemized deductions (including the deduction for state income taxes). If the standard deduction is taken for Federal income tax purposes, the taxable-equivalent yield required to equal a specified tax-exempt yield is at least as great as that shown in the table. It is assumed that the investor is not subject to the alternative minimum tax. Where applicable, investors should consider that the benefit of certain itemized deductions and the benefit of personal exemptions are limited in the case of higher-income individuals. For 1999, taxpayers with adjusted gross income in excess of the threshold of $126,600 are subject to an overall limitation on certain itemized deductions, requiring a reduction in such deductions equal to the lesser of (i) 3% of adjusted gross income in excess of the threshold of $126,600, or (ii) 80% of the amount of such itemized deductions otherwise allowable. The benefit of each personal exemption is phased out at the rate of two percentage points for each $2,750 (or fraction thereof) of adjusted gross income in the phase-out zone. For single taxpayers, the range of adjusted gross income comprising the phase-out zone for 1999 is estimated to be from $126,600 to $249,100, and for married taxpayers filing a joint return from $189,950 to $312,450. The Federal tax brackets, the threshold amounts at which itemized deductions are subject to reduction and the range over which personal exemptions are phased out will be further adjusted for inflation for each year after 1999. 150 TABLE 8 - FEDERAL AND KENTUCKY - ------- --------------------
COMBINED FEDERAL AND FEDERAL KENTUCKY KENTUCKY 1999 TAXABLE INCOME BRACKET* MARGINAL MARGINAL MARGINAL TAX-EXEMPT YIELD - ------------------------------------- ---------------------------------------------------------- SINGLE RETURN JOINT RETURN TAX RATE TAX RATE TAX RATE* 3.0% 3.5% 4.0% 4.5% 5.0% 5.5% 6.0% - ----------------- ----------------- --------- --------- ------------ ------- ------- ------- ------ ------- ------- ------- $ 0 - 3,000 $ 0 - 3,000 15.0% 2.00% 16.70% 3.601% 4.202% 4.802% 5.402% 6.002% 6.603% 7.203% 3,001 - 4,000 3,001 - 4,000 15.0% 3.00% 17.55% 3.639% 4.245% 4.851% 5.458% 6.064% 6.671% 7.277% 4,001 - 5,000 4,001 - 5,000 15.0% 4.00% 18.40% 3.676% 4.289% 4.902% 5.515% 6.127% 6.740% 7.353% 5,001 - 8,000 5,001 - 8,000 15.0% 5.00% 19.25% 3.715% 4.334% 4.954% 5.573% 6.192% 6.811% 7.430% 8,001 - 25,750 8,001 - 43,050 15.0% 6.00% 20.10% 3.755% 4.380% 5.006% 5.632% 6.258% 6.884% 7.509% 25,751 - 62,450 43,051 - 104,050 28.0% 6.00% 32.32% 4.433% 5.171% 5.910% 6.649% 7.388% 8.126% 8.865% 62,451 - 130,250 104,051 - 158,550 31.0% 6.00% 35.14% 4.625% 5.396% 6.167% 6.938% 7.709% 8.480% 9.251% 130,251 - 283,150 158,551 - 283,150 36.0% 6.00% 39.84% 4.987% 5.818% 6.649% 7.480% 8.311% 9.142% 9.973% OVER 283,150 OVER 283,150 39.6% 6.00% 43.22% 5.284% 6.165% 7.045% 7.926% 8.807% 9.687% 10.568%
*The taxable income brackets applicable to Kentucky do not correspond to the Federal taxable income brackets. The taxable income brackets presented in this table represent the breakpoints for both the Federal and Kentucky marginal tax rate changes. When applying these brackets, Federal taxable income may be different than Kentucky taxable income. No state tax credits, exemptions, or local taxes have been taken into account in arriving at the combined marginal tax rate. The income amount shown is income subject to Federal income tax reduced by adjustments to income, exemptions, and itemized deductions (including the deduction for state taxes). If the standard deduction is taken for Federal income tax purposes, the taxable equivalent yield required to equal a specified tax-exempt yield is at least as great as that shown in the table. It is assumed that the investor is not subject to the alternative minimum tax. Where applicable, investors should consider that the benefit of certain itemized deductions and the benefit of personal exemptions are limited in the case 151 of higher-income individuals. For 1999, taxpayers with adjusted gross income in excess of the threshold of approximately $126,600 are subject to an overall limitation on certain itemized deductions, requiring a reduction in such deductions equal to the lesser of (i) 3% of adjusted gross income in excess of the threshold of approximately $126,600 or (ii) 80% of the amount of such itemized deductions otherwise allowable. The benefit of each personal exemption is phased out at the rate of two percentage points for each $2,500 (or fraction thereof) of adjusted gross income in the phase-out zone. For single taxpayers the range of adjusted gross income comprising the phase-out zone for 1999 is estimated to be from $126,600 to $251,000 and for married taxpayers filing a joint return from $189,950 to $314,500. The Federal tax brackets, the threshold amounts at which itemized deductions are subject to reduction, and the range over which personal exemptions are phased out will be further adjusted for inflation for each year after 1999. 152 MISCELLANEOUS. Yields on shares of a Portfolio may fluctuate daily and do not provide a basis for determining future yields. Because such yields will fluctuate, they cannot be compared with yields on savings account or other investment alternatives that provide an agreed to or guaranteed fixed yield for a stated period of time. In comparing the yield of one Portfolio to another, consideration should be given to each Portfolio's investment policies, including the types of investments made, lengths of maturities of the portfolio securities, market conditions, operating expenses and whether there are any special account charges which may reduce the effective yield. The fees which may be imposed by Service Organizations and other institutions on their customers are not reflected in the calculations of total returns or yields for the Portfolios. When comparing a Portfolio's performance to stock, bond, and money market mutual fund performance indices prepared by Lipper or other organizations, it is important to remember the risk and return characteristics of each type of investment. For example, while stock mutual funds may offer higher potential returns, they also carry the highest degree of share price volatility. Likewise, money market funds may offer greater stability of principal, but generally do not offer the higher potential returns from stock mutual funds. From time to time, a Portfolio's performance may also be compared to other mutual funds tracked by financial or business publications and periodicals. For example a Portfolio may quote Morningstar, Inc. in its advertising materials. Morningstar, Inc. is a mutual fund rating service that rates mutual funds on the basis of risk-adjusted performance. Rankings that compare the performance of Portfolios to one another in appropriate categories over specific periods of time may also be quoted in advertising. Ibbotson Associates of Chicago, Illinois ("Ibbotson") provides historical returns of the capital markets in the United States, including common stocks, small capitalization stocks, long-term corporate bonds, intermediate-term government bonds, long-term government bonds, Treasury bills, the U.S. rate of inflation (based on the Consumer Price Index), and combinations of various capital markets. The performance of these capital markets is based on the returns of different indices. Portfolios may use the performance of these capital markets in order to demonstrate general risk-versus-reward investment scenarios. Performance comparisons may also include the value of a hypothetical investment in any of these capital markets. The risks associated with the security types in any capital market may or may not correspond directly to those of the Portfolios. The Portfolios may also compare performance to that of other compilations or indices that may be developed and made available in the future. The Fund may also from time to time include discussions or illustrations of the effects of compounding in advertisements. "Compounding" refers to the fact that, if dividends or other distributions on a Portfolio investment are reinvested by being paid in additional Portfolio shares, any future income or capital appreciation of a Portfolio would increase the value, not only of the original investment in the Portfolio, but also of the additional Portfolio shares received through reinvestment. The Fund may also include discussions or illustrations of the potential investment goals of a prospective investor, (including materials that describe general principles of investing, such as asset allocation, diversification, risk tolerance, and goal setting, questionnaires designed to help create a personal financial profile, worksheets used to project savings needs based on assumed rates of inflation and hypothetical rates of return and action plans offering investment alternatives) investment management techniques, policies or investment suitability of a Portfolio (such as value investing, market timing, dollar cost averaging, asset allocation, constant ratio transfer, automatic account rebalancing, the advantages and disadvantages of investing in tax-deferred and taxable investments), economic and political conditions and the relationship between sectors of the economy and the economy as a whole, the effects of inflation and historical performance of various asset classes, including but not limited to, stocks, bonds and Treasury bills. From time to time advertisements, sales literature, communications to shareholders or other materials may summarize the substance of information contained in shareholder reports (including the investment composition of a Portfolio), as well as the views of the Portfolios' adviser and/or sub-advisers as to current market, economy, trade and interest rate trends, legislative, regulatory and monetary developments, investment strategies and related matters believed to be of relevance to a Portfolio. In addition, selected indices may be used to illustrate historic performance of select asset classes. The Fund may also include in advertisements, sales literature, communications to shareholders or other materials, charts, graphs or drawings which illustrate the potential risks and rewards of investment in various investment vehicles, including but not limited to, stocks, bonds, Treasury bills and shares of a Portfolio. In addition, 153 advertisements, sales literature, shareholder communications or other materials may include a discussion of certain attributes or benefits to be derived by an investment in a Portfolio and/or other mutual funds, benefits, characteristics or services associated with a particular class of shares, shareholder profiles and hypothetical investor scenarios, timely information on financial management, tax and retirement planning and investment alternative to certificates of deposit and other financial instruments. Such advertisements or communicators may include symbols, headlines or other material which highlight or summarize the information discussed in more detail therein. Materials may include lists of representative clients of the Portfolios' investment adviser and sub-advisers. Materials may refer to the CUSIP numbers of the various classes of the Portfolios and may illustrate how to find the listings of the Portfolios in newspapers and periodicals. Materials may also include discussions of other Portfolios, products, and services. Charts and graphs using net asset values, adjusted net asset values, and benchmark indices may be used to exhibit performance. An adjusted NAV includes any distributions paid and reflects all elements of return. Unless otherwise indicated, the adjusted NAVs are not adjusted for sales charges, if any. A Portfolio may illustrate performance using moving averages. A long-term moving average is the average of each week's adjusted closing NAV for a specified period. A short-term moving average is the average of each day's adjusted closing NAV for a specified period. Moving Average Activity Indicators combine adjusted closing NAVs from the last business day of each week with moving averages for a specified period to produce indicators showing when an NAV has crossed, stayed above, or stayed below its moving average. A Portfolio may quote various measures of volatility and benchmark correlation in advertising. In addition, a Portfolio may compare these measures to those of other funds. Measures of volatility seek to compare the historical share price fluctuations or total returns to those of a benchmark. Measures of benchmark correlation indicate how valid a comparative benchmark may be. All measures of volatility and correlation are calculated using averages of historical data. Momentum indicators indicate a Portfolio's price movements over specific periods of time. Each point on the momentum indicator represents the Portfolio's percentage change in price movements over that period. A Portfolio may advertise examples of the effects of periodic investment plans, including the principle of dollar cost averaging. In such a program, an investor invests a fixed dollar amount in a fund at periodic intervals, thereby purchasing fewer shares when prices are high and more shares when prices are low. While such a strategy does not assure a profit or guard against loss in a declining market, the investor's average cost per share can be lower than if fixed numbers of shares are purchased at the same intervals. In evaluating such a plan, investors should consider their ability to continue purchasing shares during periods of low price levels. A Portfolio may be available for purchase through retirement plans or other programs offering deferral of, or exemption from, income taxes, which may produce superior after-tax returns over time. A Portfolio may advertise its current interest rate sensitivity, duration, weighted average maturity or similar maturity characteristics. Advertisements and sales materials relating to a Portfolio may include information regarding the background, experience and expertise of the investment adviser and/or portfolio manager for the Portfolio. TAXES The following is only a summary of certain additional tax considerations generally affecting the Portfolios and their shareholders that are not described in the Prospectuses. No attempt is made to present a detailed explanation of the tax treatment of the Portfolios or their shareholders, and the discussion here and in the Prospectuses is not intended as a substitute for careful tax planning. Investors are urged to consult their tax advisers with specific reference to their own tax situation. **4 Please note that for purposes of satisfying certain of the requirements for taxation as a regulated investment company described below, the Index Equity Portfolio is deemed to own a proportionate share of the assets and gross income of the Index Master Portfolio in which the Index Equity Portfolio invests all of its assets. Also, with 154 respect to the Index Equity Portfolio, the discussion below that relates to the taxation of futures contracts and other rules pertaining to the timing and character of income apply to the Index Master Portfolio. **5 Each Portfolio of the Fund has elected and intends to qualify for taxation as a regulated investment company under Subchapter M of the Internal Revenue Code of 1986, as amended (the "Code"). As a regulated investment company, each Portfolio generally is exempt from federal income tax on its net investment income (i.e., its investment company taxable income as that term is defined in the Code without regard to the deduction for dividends paid) and net capital gain (i.e., the excess of its net long-term capital gain over its net short-term capital loss) that it distributes to shareholders, provided that it distributes an amount equal to at least the sum of (a) 90% of its net investment income and (b) 90% of its net tax-exempt interest income, if any, for the year (the "Distribution Requirement") and satisfies certain other requirements of the Code that are described below. Distributions of net investment income and net tax-exempt interest income made during the taxable year or, under specified circumstances, within twelve months after the close of the taxable year will satisfy the Distribution Requirement. **6 In addition to satisfaction of the Distribution Requirement, each Portfolio must derive at least 90% of its gross income from dividends, interest, certain payments with respect to securities loans and gains from the sale or other disposition of stock or securities or foreign currencies (including, but not limited to, gains from forward foreign currency exchange contacts), or from other income derived with respect to its business of investing in such stock, securities, or currencies (the "Income Requirement"). 155 156 In addition to the foregoing requirements, at the close of each quarter of its taxable year, at least 50% of the value of each Portfolio'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 a Portfolio has not invested more than 5% of the value of its total assets in securities of such issuer and as to which a Portfolio does not hold more than 10% of the outstanding voting securities of such issuer), and no more than 25% of the value of each Portfolio's 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 such Portfolio controls and which are engaged in the same or similar trades or businesses. (Meeting these requirements would not necessarily prevent the New jersey Tax- Free Income Portfolio and the New Jersey Money Market Portfolio from qualifying as both qualified investment funds under New Jersey law and regulated investment companies under the Code. However, in order for the New Jersey Tax-Free Income Portfolio and the New Jersey Money Market Portfolio to qualify as both Aqualified investment funds under New Jersey law and regulated investment companies@ under the Code, at least 80% of each Portfolio's total assets would have to be invested only in New Jersey State Specific Obligations or U.S. Government Obligations.) **7 Each of the Money and Non-Money Market Municipal Portfolios is designed to provide investors with tax-exempt interest income. Shares of the Money and Non-Money Market Municipal Portfolios would not be suitable for tax-exempt institutions and may not be suitable for retirement plans qualified under Section 401 of the Code, H.R. 10 plans and individual retirement accounts because such plans and accounts are generally tax-exempt and, therefore, not only would not gain any additional benefit from the Portfolio's dividends being tax-exempt but also such dividends would be taxable when distributed to the beneficiary. In addition, the Money and Non-Money Market Municipal Portfolios may not be an appropriate investment for entities which are "substantial users" of facilities financed by private activity bonds or "related persons" thereof. "Substantial user" is defined under U.S. Treasury Regulations to include a non- exempt person who regularly uses a part of such facilities in his trade or business and (a) whose gross revenues derived with respect to the facilities financed by the issuance of bonds are more than 5% of the total revenues derived by all users of such facilities, (b) who occupies more than 5% of the entire usable area of such facilities, or (c) for whom such facilities or a part thereof were specifically constructed, reconstructed or acquired. "Related persons" include 157 certain related natural persons, affiliated corporations, a partnership and its partners and an S corporation and its shareholders. **8 In order for the Money and Non-Money Market Municipal Portfolios to pay exempt interest dividends for any taxable year, at the close of each quarter of the taxable year at least 50% of the value of each such Portfolio must consist of exempt interest obligations. Exempt interest dividends distributed to shareholders are not included in the shareholder's gross income for regular Federal income tax purposes. However, gain realized by such Portfolios from the disposition of a tax-exempt bond that was acquired after April 30, 1993 for a price less than the principal amount of the bond is taxable to shareholders as ordinary income to the extent of accrued market discount. Also, all shareholders required to file a Federal income tax return are required to report the receipt of exempt interest dividends and other exempt interest on their returns. Moreover, while such dividends and interest are exempt from regular Federal income tax, they may be subject to alternative minimum tax (currently imposed at the rate of 26% (28% on the taxable excess over $175,000) in the case of non- corporate taxpayers and at the rate of 20% in the case of corporate taxpayers) in two circumstances. First, exempt interest dividends derived from certain "private activity" bonds issued after August 7, 1986, generally will constitute an item of tax preference for both corporate and non-corporate taxpayers. Second, exempt interest dividends derived from all bonds, regardless of the date of issue, must be taken into account by corporate taxpayers in determining certain adjustments for alternative minimum tax purposes. Receipt of exempt interest dividends may result in collateral Federal income tax consequences to certain other taxpayers, including financial institutions, property and casualty insurance companies, individual recipients of Social Security or Railroad Retirement benefits, and foreign corporations engaged in trade or business in the United States. Prospective investors should consult their own tax advisors as to such consequences. **9 If a Money or Non-Money Market Municipal Portfolio distributes exempt interest dividends during the shareholder's taxable year, no deduction generally will be allowed for any interest expense on indebtedness incurred to purchase or carry shares of such Portfolio. **10 OHIO TAX CONSIDERATIONS. Individuals and estates that are subject to Ohio personal income tax or municipal or school district income taxes in Ohio will not be subject to such taxes on distributions from the Ohio Tax-Free Income Portfolio or the Ohio Municipal Money Market Portfolio to the extent that such distributions are properly attributable to interest on Ohio State-Specific Obligations or obligations issued by the U.S. Government, its agencies, instrumentalities or territories (if the interest on such obligations is exempt from state income taxation under the laws of the United States). Corporations that are subject to the Ohio corporation franchise tax will not have to include distributions from the Ohio Tax-Free Income Portfolio or the Ohio Municipal Money Market Portfolio in their net income base for purposes of calculating their Ohio corporation franchise tax liability to the extent that such distributions either constitute exempt-interest dividends for Federal income tax purposes or are properly attributable to interest on Ohio State-Specific Obligations or the U.S. obligations described above provided, in the case of U.S. territorial obligations, such interest is excluded from gross income for federal income tax purposes. However, Shares of the Ohio Tax Free Income Portfolio and the Ohio Municipal Money Market Portfolio will be included in a corporation's net worth base for purposes of calculating the Ohio corporation franchise tax. Distributions properly attributable to gain on the sale, exchange or other disposition of Ohio State-Specific Obligations will not be subject to the Ohio personal income tax, or municipal or school district income taxes in Ohio and will not be included in the net income base of the Ohio corporation franchise tax. Distributions attributable to other sources will be subject to the Ohio personal income tax and the Ohio corporation franchise tax. This discussion of Ohio taxes assumes that the Ohio Tax-Free Income Portfolio and the Ohio Municipal Money Market Portfolio will each continue to qualify as a regulated investment company as defined in the Internal Revenue Code and that at all times at least 50% of the value of the total assets of each of the Portfolios consists of Ohio State-Specific Obligations or similar obligations of other states or their subdivisions. In addition, for purposes of this discussion, "Ohio State-Specific Obligations" means obligations of the State of Ohio, political subdivisions thereof or agencies or instrumentalities of Ohio or its political subdivisions. The Ohio Municipal Money Market and Ohio Tax-Free Income Portfolios are not subject to the Ohio personal income tax, school district income taxes in Ohio, the Ohio corporation franchise tax, or the Ohio dealers in intangibles tax, provided that, with respect to the Ohio corporation franchise tax and the Ohio dealers in intangibles tax, the Fund 158 timely files the annual report required by Section 5733.09 of the Ohio Revised Code. The Ohio Tax Commissioner, however, has waived this annual filing requirement for each year (including 1999) since 1990, the first tax year to which such requirement applied. Distributions with respect to shares of the Ohio Municipal Money Market and Ohio Tax-Free Income Portfolios properly attributable to proceeds of insurance paid to those Portfolios that represent maturing or matured interest on defaulted Obligations held by those Portfolios and that are excluded from gross income for Federal income tax purposes will not be subject to Ohio personal income tax or municipal or school district income taxes in Ohio, nor included in the net income base of the Ohio corporation franchise tax. **11 NORTH CAROLINA TAX CONSIDERATIONS. Interest received in the form of dividends from the North Carolina Municipal Money Market Portfolio is exempt from North Carolina state income tax to the extent the distributions represent interest on direct obligations of the U.S. Government or North Carolina State- Specific Obligations. Distributions derived from interest earned on obligations of political subdivisions of Puerto Rico, Guam and the U.S. Virgin Islands, including the governments thereof and their agencies, instrumentalities and authorities, are also exempt from North Carolina state income tax. Distributions paid out of interest earned on obligations that are merely backed or guaranteed by the U.S. Government (e.g., GNMAs, FNMAs), on repurchase agreements collateralized by U.S. Government securities or on obligations of other states (which the Portfolio may acquire and hold for temporary or defensive purposes) are not exempt from North Carolina state income tax. **12 Any distributions of net realized gain earned by the North Carolina Municipal Money Market Portfolio on the sale or exchange of certain obligations of the State of North Carolina or its subdivisions that were issued before July 1, 1995 will also be exempt from North Carolina income tax to the Portfolio's shareholders. Distributions of gains earned by the North Carolina Municipal Money Market Portfolio on the sale or exchange of all other obligations will be subject to North Carolina income tax. **13 Distributions of exempt-interest dividends, to the extent attributable to interest on North Carolina State-Specific Obligations and to interest on direct obligations of the United States (including territories thereof), are not subject to North Carolina individual or corporate income tax. Distributions of gains attributable to certain obligations of the State of North Carolina and its political subdivisions issued prior to July 1, 1995 are not subject to North Carolina individual or corporate income tax; however, distributions of gains attributable to such types of obligations that were issued after June 30, 1995 will be subject to North Carolina individual or corporate income tax. An investment in a Portfolio (including the North Carolina Municipal Money Market Portfolio) by a corporation subject to the North Carolina franchise tax will be included in the capital stock, surplus and undivided profits base in computing the North Carolina franchise tax. Investors in a Portfolio including, in particular, corporate investors which may be subject to the North Carolina franchise tax, should consult their tax advisors with respect to the effects on such tax of an investment in a Portfolio and with respect to their tax situation in general. **14 VIRGINIA TAX CONSIDERATIONS. Dividends paid by the Virginia Municipal Money Market Portfolio and derived from interest on obligations of the Commonwealth of Virginia or of any political subdivision or instrumentality of the Commonwealth or derived from interest or dividends on obligations of the United States excludable from Virginia taxable income under the laws of the United States, which obligations are issued in the exercise of the borrowing power of the Commonwealth or the United States and are backed by the full faith and credit of the Commonwealth or the United States, will generally be exempt from the Virginia income tax. Dividends derived from interest on debt obligations of certain territories and possessions of the United States (those issued by Puerto Rico, the Virgin Islands and Guam) will also be exempt from the Virginia income tax. Dividends derived from interest on debt obligations other than those described above will be subject to the Virginia income tax even though it may be excludable from gross income for Federal income tax purposes. **15 Generally, dividends distributed to shareholders by the Portfolio and derived from capital gains will be taxable to the shareholders. Capital gains distributed to shareholders derived from Virginia obligations issued pursuant to special Virginia enabling legislation which provides a specific exemption for such gains will be exempt from Virginia income tax. 159 When taxable income of a regulated investment company is commingled with exempt income, all distributions of the income are presumed taxable to the shareholders unless the portion of income that is exempt from Virginia income tax can be determined with reasonable certainty and substantiated. Generally, this determination must be made for each distribution to each shareholder. The Virginia Department of Taxation has adopted a policy of allowing shareholders to exclude from their Virginia taxable income the exempt portion of distributions from a regulated investment company even though the shareholders receive distributions monthly but receive reports substantiating the exempt portion of such distributions at less frequent intervals. Accordingly, if the Portfolio receives taxable income, the Portfolio must determine the portion of income that is exempt from Virginia income tax and provide such information to the shareholders in accordance with the foregoing so that the shareholders may exclude from Virginia taxable income the exempt portion of the distribution from the Portfolio. **16 As a regulated investment company, the Virginia Municipal Money Market Portfolio may distribute dividends that are exempt from the Virginia income tax to its shareholders if the Portfolio satisfies all requirements for conduit treatment under Federal law and, at the close of each quarter of its taxable year, at least 50% of the value of its total assets consists of obligations the interest on which is exempt from taxation under Federal law. If the Portfolio fails to qualify, no part of its dividends will be exempt from the Virginia income tax. To the extent any portion of the dividends are derived from taxable interest for Virginia purposes or from net short-term capital gains, such portion will be taxable to the shareholders as ordinary income. The character of long-term capital gains realized and distributed by the Portfolio will follow through to its shareholders regardless of how long the shareholders have held their shares. Generally, interest on indebtedness incurred by shareholders to purchase or carry shares of the Portfolio will not be deductible for Virginia income tax purposes. **17 NEW JERSEY TAX CONSIDERATIONS. It is anticipated that the New Jersey Tax-Free Income Portfolio and the New Jersey Municipal Money Market Portfolio will qualify as a "qualified investment fund" and as a result, substantially all distributions paid by the New Jersey Tax-Free Income Portfolio and the New Jersey Municipal Money Market Portfolio will not be subject to the New Jersey personal income tax. A qualified investment fund is an investment company or trust registered with the Securities and Exchange Commission, or any series of such investment company or trust, which for the calendar year in which the distribution is paid: (a) has no investments other than interest-bearing obligations, obligations issued at a discount, and cash and cash items, including receivables and financial options, futures, forward contracts, or other similar financial instruments related to interest-bearing obligations, obligations issued at a discount or bond indexes related thereto; and (b) has at least 80% of the aggregate principal amount of all of its investments, excluding financial options, futures, forward contracts, or other similar financial instruments related to interest-bearing obligations, obligations issued at a discount or bond indexes related thereto to the extent such instruments are authorized by the regulated investment company rules of the Code, cash and cash items, which cash items shall include receivables, in New Jersey State-Specific Obligations or U.S. Government Obligations. **18 To be classified as a qualified investment fund for New Jersey personal income tax purposes, at least 80% of the aggregate principal amount of the New Jersey Municipal Money Market Portfolio and New Jersey Tax-Free Income Portfolio must consist of New-Jersey State-Specific Obligations or direct U.S. Government obligations excluding financial options, futures, forward contracts, or other similar financial instruments related to interest-bearing obligations, obligations issued at a discount or bond indexes related thereto to the extent such instruments are authorized by the regulated investment company rules of the Internal Revenue Code, cash and cash items, which cash items shall include receivables; and the Portfolios must have no investments other than interest- bearing obligations, obligations issued at a discount, and cash and cash items, which cash items shall include receivables, financial options, futures, forward contracts, or other similar financial instruments related to interest-bearing obligations, obligations issued at a discount or bond indexes related thereto. In addition, to the extent the Portfolios qualify as qualified investment funds, the Portfolios must satisfy certain reporting obligations and provide certain information to shareholders. **19 In accordance with New Jersey law as currently in effect, distributions paid by a qualified investment fund are excluded from personal income tax to the extent that the distributions are attributable to interest or gains from New Jersey State-Specific Obligations or to interest or gains from direct U.S. Government Obligations. New Jersey 160 State-Specific Obligations are obligations issued by or on behalf of New Jersey or any county, municipality, or other political subdivision of New Jersey. U.S. Government Obligations are obligations which are statutorily free from New Jersey State or local taxation under the laws of the United States. Distributions by a qualified investment fund from most other sources will be subject to the New Jersey personal income tax. Shares of the New Jersey Tax-Free Income Portfolio and the New Jersey Municipal Money Market Portfolio are not subject to property taxation by New Jersey. **20 The New Jersey personal income tax is not applicable to corporations. For all corporations subject to the New Jersey Corporation Business Tax, dividends and distributions from a qualified investment fund are included in the net income tax base for purposes of computing the Corporation Business Tax. Furthermore, any gain upon the redemption or sale of shares by a corporate shareholder is also included in the net income tax base for purposes of computing the Corporation Business Tax. **21 DELAWARE TAX CONSIDERATIONS. Individuals, estates and trusts that are subject to Delaware personal income tax will be subject to such tax on distributions from the Delaware Tax-Free Income Portfolio (other than distributions qualifying as "exempt interest dividends" under the Code which are subject to such tax as discussed below and distributions attributable to interest paid on certain U.S. government obligations) to the same extent as such distributions are includible in the gross income of such shareholders for Federal income tax purposes. Unlike the Code, however, Delaware tax law does not provide for different tax rates for distributions paid out of "net capital gain" and other distributions. ** 22 Individuals, estates and trusts that are subject to Delaware personal income tax will not be subject to such tax on distributions that qualify as "exempt interest dividends" under the Code to the extent that such distributions are attributable to interest on Delaware State-Specific Obligations and provided that the Delaware Tax-Free Income Portfolio sends shareholders a written statement of the dollar amount or percentage of the exempt interest dividends that are attributable to interest on Delaware State-Specific Obligations. Similarly, if the Delaware Tax-Free Income Portfolio qualifies as a regulated investment company under the Code, individuals, estates and trusts that are subject to Delaware personal income tax will not be subject to such tax on distributions that are attributable to interest paid on certain U.S. government obligations, provided that the Delaware Tax-Free Income Portfolio sends shareholders a written statement of the dollar amount or percentage of such distributions that are attributable to interest paid on such U.S. government obligations. The Fund will send written notices to shareholders annually regarding the Delaware tax status of distributions made by the Delaware Tax-Free Income Portfolio. **23 For corporations and other entities that are subject to Delaware corporate income tax, distributions will be excluded from the Delaware taxable income of such shareholders to the same extent as such distributions are excluded from the Federal taxable income of such shareholders. **24 So long as the Delaware Tax-Free Income Portfolio qualifies as a regulated investment company under the Code, individuals, estates or trusts that are subject to Delaware personal income tax will not be subject to such tax with respect to (i) "exempt interest dividends" (as defined in the Code) attributable to interest on Delaware State-Specific Obligations and (ii) dividends attributable to interest paid on certain U.S. government obligations, provided that the Delaware Tax-Free Income Portfolio sends shareholders a written statement of the dollar amount or percentage of total distributions by the Delaware Tax-Free Income Portfolio that are described in (i) and (ii). Other distributions made by the Portfolio to its shareholders who are individuals, estates or trusts subject to Delaware personal income tax will be includible in the gross income of such shareholders for Delaware personal income tax purposes to the same extent as such distributions are includible in the gross income of such shareholders for Federal income tax purposes. Distributions made by the Delaware Tax-Free Income Portfolio to its shareholders who are corporations or other entities subject to Delaware corporate income tax will be excluded from the Delaware taxable income of such shareholders to the same extent as such distributions are excluded from the Federal taxable income of such shareholders. **25 KENTUCKY TAX CONSIDERATIONS. Exempt interest dividends paid by the Kentucky Tax-Free Income Portfolio that are attributable to Kentucky State- Specific Obligations will be excludible from a shareholder's gross income for Kentucky income tax purposes. Further, distributions attributable to interest on certain U.S. government 161 obligations will similarly be excluded from gross income for Kentucky income tax purposes. All other distributions by the Kentucky Tax-Free Income Portfolio will be included in a shareholder's gross income for Kentucky income tax purposes. Kentucky taxes distributions of net capital gain at the same rates as ordinary income. According to the Kentucky Revenue Code, shares of mutual funds and money market funds are exempt from Kentucky intangible taxes. PENNSYLVANIA TAX CONSIDERATIONS. Income received by a shareholder attributable to interest realized by the Pennsylvania Tax-Free Income Portfolio or the Pennsylvania Municipal Money Market Portfolio from Pennsylvania State- Specific Obligations is not taxable to individuals, estates or trusts under the Personal Income Tax; to corporations under the Corporate Net Income Tax; nor to individuals under the Philadelphia School District Net Investment Income Tax ("School District Tax"). Income received by a shareholder attributable to gain on the sale or other disposition by the Pennsylvania Tax-Free Income Portfolio or the Pennsylvania Municipal Money Market Portfolio of Pennsylvania State-Specific Obligations is taxable under the Personal Income Tax, the Corporate Net Income Tax, but such income is not taxable under the School District Tax. To the extent that gain on the disposition of a share represents gain realized on Pennsylvania State-Specific Obligations held by the Pennsylvania Tax-Free Income Portfolio, such gain may be subject to the Personal Income Tax and Corporate Net Income Tax. Such gain may also be subject to the School District Tax, except that gain realized with respect to a share held for more than six months is not subject to the School District Tax. This discussion does not address the extent, if any, to which shares of the Pennsylvania Tax-Free Income Portfolio or the Pennsylvania Municipal Money Market Portfolio, or interest and gain thereon, is subject to, or included in the measure of, the special taxes imposed by the Commonwealth of Pennsylvania on banks and other financial institutions or with respect to any privilege, excise, franchise or other tax imposed on business entities not discussed above (including the Corporate Capital Stock/Foreign Franchise Tax). Shareholders of the Pennsylvania Tax-Free Income Portfolio are not subject to the Pennsylvania County Personal Property Tax to the extent that the Portfolio is comprised of Pennsylvania State-Specific Obligations and Federal obligations (if the interest on such obligations is exempt from state and local taxation under the laws of the United States). 162 163 164 Distributions of net investment income will be taxable (other than the possible allowance of the dividends received deduction described below) to shareholders as ordinary income, regardless of whether such distributions are paid in cash or are reinvested in shares. Shareholders receiving any distribution from a Portfolio in the form of additional shares will be treated as receiving a taxable distribution in an amount equal to the fair market value of the shares received, determined as of the reinvestment date. The Money and Non-Money Market Municipal Portfolios may each purchase securities that do not bear tax-exempt interest. Any income on such securities recognized by the Portfolio will be distributed and will be taxable to its shareholders. Each Portfolio intends to distribute to shareholders any of its net capital gain for each taxable year. Such gain is distributed as a capital gain dividend and is taxable to shareholders as long-term capital gain, regardless of the length of time the shareholder has held his shares, whether such gain was recognized by the Portfolio prior to the date on which a shareholder acquired shares of the Portfolio and whether the distribution was paid in cash or reinvested in shares. Under current law, ordinary income of individuals will be taxable at a maximum marginal rate of 39.6%, but because of limitations on itemized deductions otherwise allowable and the phase-out of personal exemptions, the maximum effective marginal rate of tax for some taxpayers may be higher. Under recently enacted legislation, long-term capital gains of individuals are taxed at a maximum rate of 20% with respect to capital assets held for more than one year (10% for gains otherwise taxed at 15%). Capital gains and ordinary income of corporate taxpayers are both taxed at a maximum nominal rate of 35%. Investors should be aware that any loss realized upon the sale, exchange or redemption of shares held for six months or less will be treated as a long-term capital loss to the extent any capital gain dividends have been paid with respect to such shares. Any loss incurred on the sale or exchange of a Portfolio's shares, held six months or less, will be disallowed to the extent of exempt interest dividends paid with respect to such shares, and any loss not so disallowed will be treated as a long-term capital loss to the extent of capital gain dividends received with respect to such shares. Each Non-Money Market Portfolio (other than the Index Master Portfolio) may engage in hedging or derivatives transactions involving foreign currencies, forward contracts, options and futures contracts (including options, futures and forward contracts on foreign currencies) and short sales. Such transactions will be subject to special provisions of the Code that, among other things, may affect the character of gains and losses realized by the Portfolio (that is, may affect whether gains or losses are ordinary or capital), accelerate recognition of income of the Portfolio and defer recognition of certain of the Portfolio's losses. These rules could therefore affect the character, amount and timing of distributions to shareholders. In addition, these provisions (1) will require a Portfolio to "mark-to-market" certain types of positions in its portfolio (that is, treat them as if they were closed out) and (2) may cause a Portfolio to recognize income without receiving cash with which to pay dividends or make distributions in amounts necessary to satisfy the Distribution Requirement and avoid the 4% excise tax (described below). Each Portfolio intends to monitor its transactions, will make the appropriate tax elections and will make the appropriate entries in its books and records when it acquires any option, futures contract, forward contract or hedged investment in order to mitigate the effect of these rules. If a Portfolio purchases shares in a "passive foreign investment company" (a "PFIC"), such Portfolio may be subject to U.S. federal income tax on a portion of any "excess distribution" or gain from the disposition of such shares even if such income is distributed as a taxable dividend by the Portfolio to its shareholders. Additional charges in the nature of interest may be imposed on a Portfolio in respect of deferred taxes arising from such distributions or gains. If a Portfolio were to invest in a PFIC and elected to treat the PFIC as a "qualified electing fund" under the Code (a "QEF"), in lieu of the foregoing requirements, the Portfolio would be required to include in income each year a portion of the ordinary earnings and net capital gain of the qualified electing fund, even if not distributed to the Portfolio. Alternatively, a Portfolio can elect to mark-to-market at the end of each taxable year its shares in a PFIC; in this case, the Portfolio would recognize as ordinary income any increase in the value of such shares, and as ordinary loss any 165 decrease in such value to the extent it did not exceed prior increases included in income. Under either election, a Portfolio might be required to recognize in a year income in excess of its distributions from PFICs and its proceeds from dispositions of PFIC stock during that year, and such income would nevertheless be subject to the Distribution Requirement and would be taken into account for purposes of the 4% excise tax (described below). Investment income that may be received by certain of the Portfolios 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 any such Portfolio to a reduced rate of, or exemption from, taxes on such income. If more than 50% of the value of the total assets at the close of the taxable year of the International Equity Portfolio, International Emerging Markets Portfolio, International Small Cap Equity Portfolio and International Bond Portfolio consist of stock or securities of foreign corporations, such Portfolio may elect to "pass through" to the Portfolio's shareholders the amount of foreign taxes paid by such Portfolio. If a Portfolio 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 Portfolio, 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 Portfolio representing income derived from foreign sources. No deduction for foreign taxes could be claimed by an individual shareholder who does not itemize deductions. In certain circumstances, a shareholder that (i) has held shares of the Portfolio for less than a specified minimum period during which it is not protected from risk of loss or (ii) is obligated to make payments related to the dividends, will not be allowed a foreign tax credit for foreign taxes deemed imposed on dividends paid on such shares. Additionally, such Portfolio must also meet this holding period requirement with respect to its foreign stocks and securities in order for "creditable" taxes to flow-through. Each shareholder should consult his own tax adviser regarding the potential application of foreign tax credits. Ordinary income dividends paid by a Portfolio will qualify for the 70% dividends-received deduction generally available to corporations to the extent of the amount of "qualifying dividends" received by a Portfolio from domestic corporations for the taxable year. A dividend received by a Portfolio will not be treated as a qualifying dividend (i) if it has been received with respect to any share of stock that the Portfolio has held for less than 46 days (91 days in the case of certain preferred stock) during the 90 day period beginning on the date which is 45 days before the date on which such share becomes ex-dividend with respect to such dividend (during the 180 day period beginning 90 days before such date in the case of certain preferred stock), (ii) to the extent that a Portfolio is under an obligation to make related payments with respect to positions in substantially similar or related property or (iii) to the extent the stock on which the dividend is paid is treated as debt-financed. Moreover, the dividends-received deduction for a corporate shareholder may be disallowed if the corporate shareholder fails to satisfy the foregoing requirements with respect to its shares of a Portfolio. If for any taxable year any Portfolio does not qualify as a regulated investment company, all of its taxable income will be subject to tax at regular corporate rates without any deduction for distributions to shareholders, and all distributions (including amounts derived from interest on Municipal Obligations) will be taxable as ordinary dividends to the extent of such Portfolio's current and accumulated earnings and profits. Such distributions will be eligible for the dividends received deduction in the case of corporate shareholders. A 4% non-deductible excise tax is imposed on regulated investment companies that fail to currently distribute specified percentages of their ordinary taxable income and capital gain net income (excess of capital gains over capital losses). Each Portfolio intends to make sufficient distributions or deemed distributions of its ordinary taxable income and any capital gain net income prior to the end of each calendar year to avoid liability for this excise tax. The Fund will be required in certain cases to withhold and remit to the United States Treasury 31% of dividends and gross sale proceeds paid to any shareholder (i) who has provided either an incorrect tax identification number or no number at all, (ii) who is subject to backup withholding by the Internal Revenue Service for failure to report the receipt of interest or dividend income properly, or (iii) who has failed to certify to the Fund when required to do so that he is not subject to backup withholding or that he is an "exempt recipient." 166 Shareholders will be advised annually as to the Federal income tax consequences of distributions made by the Portfolios each year. The foregoing general discussion of federal income tax consequences is based on the Code and the 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. Although each Portfolio expects to qualify as a "regulated investment company" and to be relieved of all or substantially all federal income taxes, depending upon the extent of its activities in states and localities in which its offices are maintained, in which its agents or independent contractors are located or in which it is otherwise deemed to be conducting business, each Portfolio may be subject to the tax laws of such states or localities. Shareholders should consult their tax advisors about state and local tax consequences, which may differ from the federal income tax consequences described above. ADDITIONAL INFORMATION CONCERNING SHARES Shares of each class of each Portfolio of the Fund bear their pro rata portion of all operating expenses paid by a Portfolio, except transfer agency fees, certain administrative/servicing fees and amounts payable under the Fund's Amended and Restated Distribution and Service Plan. Each share of a Portfolio of the Fund has a par value of $.001, represents an interest in that Portfolio and is entitled to the dividends and distributions earned on that Portfolio's assets that are declared in the discretion of the Board of Trustees. The Fund's shareholders are entitled to one vote for each full share held and proportionate fractional votes for fractional shares held, and will vote in the aggregate and not by class, except where otherwise required by law or as determined by the Board of Trustees. Shares of the Fund have noncumulative voting rights and, accordingly, the holders of more than 50% of the Fund's outstanding shares (irrespective of class) may elect all of the trustees. Shares have no preemptive rights and only such conversion and exchange rights as the Board may grant in its discretion. When issued for payment, shares will be fully paid and non-assessable by the Fund. There will normally be no meetings of shareholders for the purpose of electing trustees unless and until such time as required by law. At that time, the trustees then in office will call a shareholders meeting to elect trustees. Except as set forth above, the trustees shall continue to hold office and may appoint successor trustees. The Fund's Declaration of Trust provides that meetings of the shareholders of the Fund shall be called by the trustees upon the written request of shareholders owning at least 10% of the outstanding shares entitled to vote. Rule 18f-2 under the 1940 Act provides that any matter required by the provisions of the 1940 Act or applicable state law, or otherwise, to be submitted to the holders of the outstanding voting securities of an investment company such as the Fund shall not be deemed to have been effectively acted upon unless approved by the holders of a majority of the outstanding shares of each investment portfolio affected by such matter. Rule 18f-2 further provides that an investment portfolio shall be deemed to be affected by a matter unless the interests of each investment portfolio in the matter are substantially identical or the matter does not affect any interest of the investment portfolio. Under the Rule, the approval of an investment advisory agreement, a distribution plan subject to Rule 12b-1 under the 1940 Act or any change in a fundamental investment policy would be effectively acted upon with respect to an investment portfolio only if approved by a majority of the outstanding shares of such investment portfolio. However, the Rule also provides that the ratification of the appointment of independent accountants, the approval of principal underwriting contracts and the election of Trustees may be effectively acted upon by shareholders of the Fund voting together in the aggregate without regard to a particular investment portfolio. The proceeds received by each Portfolio for each issue or sale of its shares, and all net investment income, realized and unrealized gain and proceeds thereof, subject only to the rights of creditors, will be specifically allocated to and constitute the underlying assets of that Portfolio. The underlying assets of each Portfolio will be segregated on the books of account, and will be charged with the liabilities in respect to that Portfolio and with a share of the general 167 liabilities of the Fund. As stated herein, certain expenses of a Portfolio may be charged to a specific class of shares representing interests in that Portfolio. The Funds' Declaration of Trust authorizes the Board of Trustees, without shareholder approval (unless otherwise required by applicable law), to: (i) sell and convey the assets belonging to a class of shares to another management investment company for consideration which may include securities issued by the purchaser and, in connection therewith, to cause all outstanding shares of such class to be redeemed at a price which is equal to their net asset value and which may be paid in cash or by distribution of the securities or other consideration received from the sale and conveyance; (ii) sell and convert the assets belonging to one or more classes of shares into money and, in connection therewith, to cause all outstanding shares of such class to be redeemed at their net asset value; or (iii) combine the assets belonging to a class of shares with the assets belonging to one or more other classes of shares if the Board of Trustees reasonably determines that such combination will not have a material adverse effect on the shareholders of any class participating in such combination and, in connection therewith, to cause all outstanding shares of any such class to be redeemed or converted into shares of another class of shares at their net asset value. The Board of Trustees may authorize the liquidation and termination of any Portfolio or class of shares. Upon any liquidation of a Portfolio, Shareholders of each class of the Portfolio are entitled to share pro rata in the net assets belonging to that class available for distribution. MISCELLANEOUS THE FUND. The Fund was organized as a Massachusetts business trust on December 22, 1988 and is registered under the 1940 Act as an open end, management investment company. Each of the Portfolios except the New Jersey Municipal Money Market, North Carolina Municipal Money Market, Ohio Municipal Money Market, Pennsylvania Municipal Money Market, Virginia Municipal Money Market, Pennsylvania Tax-Free Income, New Jersey Tax-Free Income, Ohio Tax-Free Income, Delaware Tax-Free Income and Kentucky Tax-Free Income Portfolios is diversified. Effective January 31, 1998, the Fund changed its name from Compass Capital Funds(SM) to BlackRock Funds(SM). MASTER-FEEDER STRUCTURE. The Index Equity Portfolio, unlike many other investment companies which directly acquire and manage their own portfolio of securities, seeks to achieve its investment objective by investing all of its investable assets in the Index Master Portfolio. The Index Equity Portfolio purchases shares of the Index Master Portfolio at net asset value. The net asset value of the Index Equity Portfolio shares responds to increases and decreases in the value of the Index Master Portfolio's securities and to the expenses at the Index Master Portfolio allocable to the Index Equity Portfolio (as well as its own expenses). The Index Equity Portfolio may withdraw its investment in the Index Master Portfolio at any time upon 30 days notice to the Index Master Portfolio if the Board of Trustees of the Fund determines that it is in the best interests of the Index Equity Portfolio to do so. Upon withdrawal, the Board of Trustees would consider what action might be taken, including the investment of all of the assets of the Index Equity Portfolio in another pooled investment entity having the same investment objective as the Index Equity Portfolio or the hiring of an investment adviser to manage the Index Equity Portfolio's assets in accordance with the investment policies described above with respect to the Index Equity Portfolio. The Index Master Portfolio is a separate series of the Trust, which is a business trust created under the laws of the State of Delaware. The Index Equity Portfolio and other institutional investors that may invest in the Index Master Portfolio from time to time (e.g. other investment companies) will each bear a share of all liabilities of the Index Master Portfolio. Under the Delaware Business Trust Act, shareholders of the Index Master Portfolio have the same limitation of personal liability as shareholders of a Delaware corporation. Accordingly, Fund management believes that neither the Index Equity Portfolio nor its shareholders will be adversely affected by reason of the Index Equity Portfolio's investing in the Index Master Portfolio. The shares of the Index Master Portfolio are offered to institutional investors in private placements for the purpose of increasing the funds available for investment and achieving economies of scale that might be available at higher asset levels. The expenses of such other institutional investors and their returns may differ from those of the Index Equity Portfolio. While investment in the Index Master Portfolio by other institutional investors offers potential 168 benefits to the Index Master Portfolio (and, indirectly, to the Index Equity Portfolio), economies of scale and related expense reductions might not be achieved. Also, if an institutional investor were to redeem its interest in the Index Master Portfolio, the remaining investors in the Index Master Portfolio could experience higher pro rata operating expenses and correspondingly lower returns. In addition, institutional investors that have a greater pro rata ownership interest in the Index Master Portfolio than the Index Equity Portfolio could have effective voting control over the operation of the Index Master Portfolio. Shares in the Index Master Portfolio have equal, non-cumulative voting rights, except as set forth below, with no preferences as to conversion, exchange, dividends, redemption or any other feature. Shareholders of the Trust have the right to vote only (i) for removal of the Trust's trustees, (ii) with respect to such additional matters relating to the Trust as may be required by the applicable provisions of the 1940 Act and (iii) on such other matters as the trustees of the Trust may consider necessary or desirable. In addition, approval of the shareholders of the Trust is required to adopt any amendments to the Agreement and Declaration of Trust of the Trust which would adversely affect to a material degree the rights and preferences of the shares of the Index Master Portfolio or to increase or decrease their par value. The Index Master Portfolio's shareholders will also be asked to vote on any proposal to change a fundamental investment policy (i.e. a policy that may be changed only with the approval of shareholders) of the Index Master Portfolio. If a shareholder of the Index Master Portfolio becomes bankrupt, a majority in interest of the remaining shareholders in the Portfolio must vote within 120 days to approve the continuing existence of the Index Master Portfolio or the Portfolio will be liquidated. When the Index Equity Portfolio, as a shareholder of the Index Master Portfolio, votes on matters pertaining to the Index Master Portfolio, the Index Equity Portfolio would hold a meeting of its shareholders and would cast its votes proportionately as instructed by Index Equity Portfolio shareholders. The investment objective of the Index Master Portfolio may not be changed without approval of its shareholders. Shareholders of the Portfolio will receive written notice thirty days prior to the effective date of any change in the investment objective of the Master Portfolio. If the Index Master Portfolio changes its investment objective in a manner which is inconsistent with the investment objective of the Index Equity Portfolio and the Fund's Board of Trustees fails to approve a similar change in the investment objective of the Index Equity Portfolio, the Index Equity Portfolio would be forced to withdraw its investment in the Index Master Portfolio and either seek to invest its assets in another registered investment company with the same investment objective as the Index Equity Portfolio, which might not be possible, or retain an investment adviser to manage the Index Equity Portfolio's assets in accordance with its own investment objective, possibly at increased cost. A withdrawal by the Index Equity Portfolio of its investment in the Index Master Portfolio could result in a distribution in kind of portfolio securities (as opposed to a cash distribution) to the Index Equity Portfolio. Should such a distribution occur, the Index Equity Portfolio could incur brokerage fees or other transaction costs in converting such securities to cash in order to pay redemptions. In addition, a distribution in kind to the Index Equity Portfolio could result in a less diversified portfolio of investments and could adversely affect the liquidity of the Portfolio. A distribution to the Index Equity Portfolio will generally only result in a taxable gain for federal income tax purposes to the extent that any cash distributed exceeds the Index Equity Portfolio's tax basis in its shares of the Index Master Portfolio. The conversion of the Index Equity Portfolio into a feeder fund of the Index Master Portfolio was approved by shareholders of the Index Equity Portfolio at a meeting held on November 30, 1995. The policy of the Index Equity Portfolio, and other similar investment companies, to invest their investable assets in funds such as the Index Master Portfolio is a relatively recent development in the mutual fund industry and, consequently, there is a lack of substantial experience with the operation of this policy. There may also be other investment companies or entities through which you can invest in the Index Master Portfolio which may have different sales charges, fees and other expenses which may affect performance. As of the date of this Statement of Additional Information, one other feeder fund invests all of its investable assets in the Index Master Portfolio. For information about other funds that may invest in the Index Master Portfolio, please contact DFA at (310) 395-8005. 169 COUNSEL. The law firm of Simpson Thacher & Bartlett, 425 Lexington Avenue, New York, New York 10017, serves as the Fund's counsel. The law firm of Stradley, Ronon, Stevens & Young, LLP, 2600 One Commerce Square, Philadelphia, Pennsylvania 19103, serves as the Trust's counsel. INDEPENDENT ACCOUNTANTS. PricewaterhouseCoopers LLP, with offices located at 2400 Eleven Penn Center, Philadelphia, Pennsylvania, serves as the Fund's and the Trust's independent accountants. FIVE PERCENT OWNERS. The name, address and percentage ownership of each person that on January 12, 1999 owned of record or beneficially 5% or more of the outstanding shares of a Portfolio which had commenced operations as of that date was as follows: Money Market Portfolio: PNC Bank, Airport Business Center/Int'l Court 2, 200 - ---------------------- Stevens Dr., Lester, PA 19113, 76.677%; BHC Securities Inc., One Commerce Square, 2005 Market Street, Philadelphia, PA 19103-3212, 12.598%; U.S. Treasury ------------- Money Market Portfolio: PNC Bank, Airport Business Center/Int'l Court 2, 200 - ---------------------- Stevens Dr., Lester, PA 19113, 54.445%; Chase Bank of Texas, P.O. Box 2558, Houston, TX 77252-2558, 28.120%; BHC Securities Inc., One Commerce Square, 2005 Market Street, Philadelphia, PA 19103-3212, 6.618%; Large Cap Value Equity ---------------------- Portfolio: PNC Bank, Saxon & Co., Attn: Income Collections, 200 Stevens Dr., - --------- Suite 260, Lester, PA 19113, 88.88%; Intermediate Government Bond Portfolio: -------------------------------------- PNC Bank, Saxon & Co., Attn: Income Collections, 200 Stevens Dr., Suite 260, Lester, PA 19113, 96.119%; Municipal Money Market Portfolio: PNC Bank, Airport -------------------------------- Business Center/Int'l Court 2, 200 Stevens Dr., Lester, PA 19113, 79.331%; PNC Bank Ohio, Attn: Corporate Services, 201 East Fifth Street, 9th Fl., Cincinnati, OH 45202, 6.675%; Small Cap Value Equity Portfolio: PNC Bank, Saxon -------------------------------- & Co., Attn: Income Collections, 200 Stevens Dr., Suite 260, Lester, PA 19113, 76.309%; National City Bank Kentucky, Humana Retirement/Savings Tr., P.O. Box 94984, Cleveland, OH 44101, 5.083%; Large Cap Growth Equity Portfolio: PNC --------------------------------- Bank, Saxon & Co., Attn: Income Collections, 200 Stevens Dr., Suite 260, Lester, PA 19113, 90.195%; Managed Income Portfolio: PNC Bank, Saxon & Co., ------------------------ Attn: Income Collections, 200 Stevens Dr., Suite 260, Lester, PA 19113, 91.996%; Tax-Free Income Portfolio: PNC Bank, Saxon & Co., Attn: Income -------------------------- Collections, 200 Stevens Dr., Suite 260, Lester, PA 19113, 92.974%; Balanced -------- Portfolio: PNC Bank, Saxon & Co., Attn: Income Collections, 200 Stevens Dr., - --------- Suite 260, Lester, PA 19113, 76.895%; International Equity Portfolio: PNC Bank, ------------------------------ Saxon & Co., Attn: Income Collections, 200 Stevens Dr., Suite 260, Lester, PA 19113, 93.721%; Ohio Tax-Free Income Portfolio: PNC Bank, Saxon & Co., Attn: ------------------------------ Income Collections, 200 Stevens Dr., Suite 260, Lester, PA 19113, 94.706%; Pennsylvania Tax-Free Income Portfolio: PNC Bank, Saxon & Co., Attn: Income - -------------------------------------- Collections, 200 Stevens Dr., Suite 260, Lester, PA 19113, 92.515%; North ----- Carolina Municipal Money Market Portfolio: North Carolina Trust Co., 301 North - ----------------------------------------- Elm St., P.O. Box 1108, Greensboro, NC 27402, 63.092%; Branch Banking and Trust Company, Wilbranch & Company, Trust Department, P.O. Box 1847, Wilson, NC 27893, 12.543%; First Citizens Bank, McWood & Company, P.O. Box 29522, Raleigh, NC 27626, 5.232%; Central Carolina Bank & Trust Co., P.O. Box 30010, Durham, NC 27702-3010, 12.543%; Ohio Municipal Money Market Portfolio: PNC Bank, Airport ------------------------------------- Business Center/Int'l Court 2, 200 Stevens Dr., Lester, PA 19113, 39.477%; BHC Securities Inc., One Commerce Square, 2005 Market St., Philadelphia, PA 19103- 3212, 33.937%; Wayne County National Bank, Wayco & Co., P.O. Box 757/1776 Beall Avenue, Wooster, OH 44691, 9.024%; Lebanon Citizens National Bank, PO Box 59, Lebanon, OH 45036, 9.995%; Low Duration Bond Portfolio: PNC Bank, Saxon & Co., --------------------------- Attn: Income Collections, 200 Stevens Dr., Suite 260, Lester, PA 19113, 61.068%; Nexell Therapeutics, Inc., 9 Parker, Irvine, CA 92718, 9.612%; Iowa State University Foundation, Attn: Don Behning, Alumni Suite Memorial Union, 2229 Lincoln Way, Ames, IA 50014-7164, 6.278%; Intermediate Bond Portfolio: PNC --------------------------- Bank, Saxon & Co., Attn: Income Collections, 200 Stevens Dr., Suite 260, Lester, PA 19113, 88.65%; Select Equity Portfolio: PNC Bank, Saxon & Co., Attn: ----------------------- Income Collections, 200 Stevens Dr., Suite 260, Lester, PA 19113, 170 90.061%; Small Cap Growth Equity Portfolio: PNC Bank, Saxon & Co., Attn: Income --------------------------------- Collections, 200 Stevens Dr., Suite 260, Lester, PA 19113, 66.583%; Pennsylvania ------------ Municipal Money Market Portfolio: PNC Bank, Airport Business Center/Int'l Court - --------------------------------- 2, 200 Stevens Dr., Lester, PA 19113, 69.162%; Janney Montgomery Scott, 1801 Market Street, 9th Floor, Philadelphia, PA 19103, 11.914%; BHC Securities, Inc., One Commerce Square, 2005 Market St, Philadelphia, PA 19103-3212, 9.484%; Virginia Municipal Money Market Portfolio: First Virginia Bank Inc., Oldom & - ----------------------------------------- Company, 6400 Arlington Blvd., Falls Church, VA 22042, 46.912%; Main Street Trust Company, Piedmont Company, Attn: Lynn Calaman, P.O. Box 5228, Martinsville, VA 24115-5228, 14.476%; Mentor Investment Group, as advisor for Virginia State Non-Arbitrage Program, 901 East Byrd Street, 6th Fl., Richmond, VA 23219, 14.760%; North Carolina Trust Company, 301 North Elm Street, P.O. Box 1108, Greensboro, NC 27402, 6.428%; F&M Bank-Peoples Warrtrust & Co., P.O. Box 2800, Warrenton, VA 22186, 5.900%; International Bond Portfolio: PNC Bank, Saxon ---------------------------- & Co., 200 Stevens Dr., Suite 260, Lester, PA 19113, 81.818%; International ------------- Emerging Markets Portfolio: PNC Bank, Saxon & Co., Attn: Income Collections, 200 - -------------------------- Stevens Dr., Suite 260, Lester, PA 19113, 90.639%; Government Income Portfolio: --------------------------- Merrill Lynch, Pierce, Fenner & Smith Inc., Financial Data Services 97KN1, 4800 E. Deer Lake Dr., 3rd Fl., Jacksonville, FL 32246, 10.100%; New Jersey Municipal -------------------- Money Market Portfolio: PNC Bank, Airport Business Center/Int'l Court 2, 200 - ---------------------- Stevens Dr., Lester, PA 19113, 62.436%; Janney Montgomery Scott, 1801 Market Street, 9th Fl., Philadelphia, PA 19103, 20.978%; New Jersey Tax-Free Income Portfolio: PNC Bank, Saxon & Co., Attn: Income Collections, 200 Stevens Dr., Suite 260, Lester, PA 19113, 79.451%; BHC Securities Inc., One Commerce Square, 2005 Market Street, Philadelphia, PA 19103-3212, 8.049%; Core Bond Portfolio: ------------------- PNC Bank, Saxon & Co., Attn: Income Collections, 200 Stevens Dr., Suite 260, Lester, PA 19113, 78.245%; Mid-Cap Value Portfolio: PNC Bank, Saxon & Co., 200 ----------------------- Stevens Dr., Suite 260, Lester, PA 19113, 91.061%; Mid-Cap Growth Portfolio: PNC Bank, Saxon & Co., Attn: Income Collections, 200 Stevens Dr., Suite 260, Lester, PA 19113, 92.306%; Index Equity Portfolio: PNC Bank, Saxon & Co., Attn: Income ---------------------- Collections, 200 Stevens Dr., Suite 260, Lester, PA 19113, 62.356%; Merrill Lynch, Pierce, Fenner & Smith, Inc., Financial Data Services, 4800 E. Deer Lake Dr., 3rd Fl., Jacksonville, FL 32246, 8.505%; International Small Cap Equity ------------------------------ Portfolio: PNC Bank, Saxon & Co., Attn: Income Collections, 200 Stevens Drive, - --------- Suite 260, Lester, PA 19113, 86.045%; Merrill Lynch Pierce Fenner Financial Data Services, Attn'd Stock Powers, 4800 E. Deer Lake Dr., 3/rd/ Fl., Jacksonville, FL 32246, 5.000%; Delaware Tax-Free Income Portfolio: PNC Bank, Saxon & Co., ---------------------------------- Attn: Income Collections, 200 Stevens Dr., Lester, PA 19113, 94.439%; Kentucky Tax-Free Income Portfolio: PNC Bank, Saxon & Co., Attn: Income Collections, 200 Stevens Dr., Lester, PA 19113, 99.188%; Micro-Cap Equity Portfolio: PNC Bank, -------------------------- Saxon & Co., Attn: Income Collections, 200 Stevens Dr., Lester, PA 19113, 9.578%; Merrill Lynch, Pierce, Fenner & Smith Inc., Financial Data Services, 4800 E. Deer Lake Dr., 3rd Fl., Jacksonville, FL 32246, 18.632%; GNMA Portfolio: PNC Bank, Saxon & Co., Attn: Income Collections, 200 Stevens Dr., Lester, PA 19113, 98.836%; High Yield Bond Portfolio: Merrill Lynch, Pierce, Fenner & Smith ------------------------- Inc., Financial Data Services, 4800 E. Deer Lake Dr., 3rd Fl., Jacksonville, FL 32246, 27.877%. On January 13, 1999, PNC Bank, which has its principal offices at 1600 Market Street, Philadelphia, Pennsylvania 19103, held of record approximately 72% of the Fund's outstanding shares, and may be deemed a controlling person of the Fund under the 1940 Act. PNC Bank is a national bank organized under the laws of the United States. All of the capital stock of PNC Bank is owned by PNC Bancorp, Inc. All of the capital stock of PNC Bancorp, Inc. is owned by PNC Bank Corp., a publicly-held bank holding company. BANKING LAWS. Banking laws and regulations currently prohibit a bank holding company registered under the Federal Bank Holding Company Act of 1956 or any bank or non-bank affiliate thereof from sponsoring, organizing, controlling or distributing the shares of a registered, open-end investment company continuously engaged in the issuance of its shares, and prohibit banks generally from underwriting securities, but such banking laws and regulations do not prohibit such a holding company or affiliate or banks generally from acting as investment adviser, administrator, transfer 171 agent or custodian to such an investment company, or from purchasing shares of such a company as agent for and upon the order of customers. BlackRock, BIMC, BFM, BIL, PNC Bank, PTC and other institutions that are banks or bank affiliates are subject to such banking laws and regulations. BlackRock, BIMC, BFM, BIL, PNC Bank and PTC believe they may perform the services for the Fund contemplated by their respective agreements with the Fund without violation of applicable banking laws or regulations. It should be noted, however, that there have been no cases deciding whether bank and non-bank subsidiaries of a registered bank holding company may perform services comparable to those that are to be performed by these companies, and future changes in either Federal or state statutes and regulations relating to permissible activities of banks and their subsidiaries or affiliates, as well as further judicial or administrative decisions or interpretations of present and future statutes and regulations, could prevent these companies from continuing to perform such services for the Fund. If such were to occur, it is expected that the Board of Trustees would recommend that the Fund enter into new agreements or would consider the possible termination of the Fund. Any new advisory or sub-advisory agreement would normally be subject to shareholder approval. It is not anticipated that any change in the Fund's method of operations as a result of these occurrences would affect its net asset value per share or result in a financial loss to any shareholder. SHAREHOLDER APPROVALS. As used in this Statement of Additional Information and in the Prospectuses, a "majority of the outstanding shares" of a class, series or Portfolio means, with respect to the approval of an investment advisory agreement, a distribution plan or a change in a fundamental investment policy, the lesser of (1) 67% of the shares of the particular class, series or Portfolio represented at a meeting at which the holders of more than 50% of the outstanding shares of such class, series or Portfolio are present in person or by proxy, or (2) more than 50% of the outstanding shares of such class, series or Portfolio. 172 FINANCIAL STATEMENTS BLACKROCK FUNDS. The audited financial statements and notes thereto in the Fund's Annual Report to Shareholders for the fiscal year ended September 30, 1998 (the "1998 Annual Report") are incorporated in this Statement of Additional Information by reference. No other parts of the 1998 Annual Report are incorporated by reference herein. The financial statements included in the 1998 Annual Report have been audited by the Fund's independent accountants, PricewaterhouseCoopers LLP, except for the financial highlights for the periods ended June 30, 1995, 1994 and 1993 for the Core Bond Portfolio and the Short Government Bond Portfolio (now known as the Low Duration Bond Portfolio) Portfolios which have been audited by other auditors. The reports of PricewaterhouseCoopers LLP are incorporated herein by reference. Such financial statements have been incorporated herein in reliance upon such reports given upon their authority as experts in accounting and auditing. Additional copies of the 1998 Annual Report may be obtained at no charge by telephoning the Distributor at the telephone number appearing on the front page of this Statement of Additional Information. The financial highlights included in the 1998 Annual Report for each of the two years in the period ended June 30, 1995, and for the period from July 17, 1992 through June 30, 1993 for the Short Government Bond Portfolio (now known as the Low Duration Bond Portfolio) and the period from December 9, 1992 through June 30, 1993 for the Core Bond Portfolio have been audited by the former independent accountants of the Predecessor BFM Portfolios, Deloitte & Touche, L.L.P., whose report thereon is also incorporated herein by reference. Such financial statements have been incorporated herein by reference in reliance on the reports of PricewaterhouseCoopers LLP and Deloitte & Touche, L.L.P. given upon their authority as experts in accounting and auditing. INDEX MASTER PORTFOLIO. The audited financial statements and notes thereto for The U.S. Large Company Series of the Trust for the fiscal year ended November 30, 1997 (the "1997 Index Master Report") and the unaudited financial statements and notes thereto for the Trust's U.S. Large Company Series for the period ended September 30, 1998 (the "1998 Index Master Report") contained in the Fund's 1998 Annual Report to Shareholders are incorporated by reference into this Statement of Additional Information. No other parts of the 1997 Index Master Report or 1998 Index Master Report are incorporated by reference herein. The financial statements included in the 1997 Index Master Report have been audited by the Trust's independent accountants, PricewaterhouseCoopers LLP, whose reports thereon are incorporated herein by reference. Such financial statements have been incorporated herein by reference in reliance upon such reports given upon their authority as experts in accounting and auditing. Additional copies of the 1997 Index Master Report may be obtained at no charge by telephoning the Trust at (310) 395-8005. 173 APPENDIX A ---------- Commercial Paper Ratings - ------------------------ A Standard & Poor's commercial paper rating is a current assessment of the likelihood of timely payment of debt considered short-term in the relevant market. The following summarizes the rating categories used by Standard and Poor's for commercial paper: "A-1" - Issue's degree of safety regarding timely payment is strong. Those issues determined to possess extremely strong safety characteristics are denoted "A-1+." "A-2" - Issue's capacity for timely payment is satisfactory. However, the relative degree of safety is not as high as for issues designated "A-1." "A-3" - Issue has an adequate capacity for timely payment. It is, however, somewhat more vulnerable to the adverse effects of changes in circumstances than an obligation carrying a higher designation. "B" - Issue has only a speculative capacity for timely payment. "C" - Issue has a doubtful capacity for payment. "D" - Issue is in payment default. 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 9 months. The following summarizes the rating categories used by Moody's for commercial paper: "Prime-1" - Issuer or related supporting institutions are considered to have a superior capacity for repayment of short-term promissory obligations. Prime-1 repayment capacity will normally be evidenced by the following characteristics: leading market positions in well established industries; high rates of return on funds employed; conservative capitalization structures with moderate reliance on debt and ample asset protection; broad margins in earning coverage of fixed financial charges and high internal cash generation; and well established access to a range of financial markets and assured sources of alternate liquidity. "Prime-2" - Issuer or related supporting institutions are considered to have a strong capacity for repayment of short-term promissory obligations. This will normally be evidenced by many of the characteristics cited above but to a lesser degree. Earnings trends and coverage ratios, while sound, will be more subject to variation. Capitalization characteristics, while still appropriate, may be more affected by external conditions. Ample alternative liquidity is maintained. "Prime-3" - Issuer or related supporting institutions have an acceptable capacity for repayment of short-term promissory obligations. The effects of industry characteristics and market composition may be more pronounced. Variability in earnings and profitability may result in changes in the level of debt protection measurements and the requirement for relatively high financial leverage. Adequate alternate liquidity is maintained. "Not Prime" - Issuer does not fall within any of the Prime rating categories. The three rating categories of Duff & Phelps for investment grade commercial paper and short-term debt are "D-1," "D-2" and "D-3." Duff & Phelps employs three designations, "D-1+," "D-1" and "D-1-," within the highest rating category. The following summarizes the rating categories used by Duff & Phelps for commercial paper: "D-1+" - Debt possesses highest certainty of timely payment. Short-term liquidity, including internal operating factors and/or access to alternative sources of funds, is outstanding, and safety is just below risk-free U.S. Treasury short-term obligations. A-1 "D-1" - Debt possesses very high certainty of timely payment. Liquidity factors are excellent and supported by good fundamental protection factors. Risk factors are minor. "D-1-" - Debt possesses high certainty of timely payment. Liquidity factors are strong and supported by good fundamental protection factors. Risk factors are very small. "D-2" - Debt possesses good certainty of timely payment. Liquidity factors and company fundamentals are sound. Although ongoing funding needs may enlarge total financing requirements, access to capital markets is good. Risk factors are small. "D-3" - Debt possesses satisfactory liquidity, and other protection factors qualify issue as investment grade. Risk factors are larger and subject to more variation. Nevertheless, timely payment is expected. "D-4" - Debt possesses speculative investment characteristics. Liquidity is not sufficient to ensure against disruption in debt service. Operating factors and market access may be subject to a high degree of variation. "D-5" - Issuer has failed to meet scheduled principal and/or interest payments. Fitch short-term ratings apply to debt obligations that are payable on demand or have original maturities of generally up to three years. The following summarizes the rating categories used by Fitch for short-term obligations: "F-1+" - Securities possess exceptionally strong credit quality. Issues assigned this rating are regarded as having the strongest degree of assurance for timely payment. "F-1" - Securities possess very strong credit quality. Issues assigned this rating reflect an assurance of timely payment only slightly less in degree than issues rated "F-1+." "F-2" - Securities possess good credit quality. Issues assigned 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" - Securities possess fair credit quality. Issues assigned this rating have characteristics suggesting that the degree of assurance for timely payment is adequate; however, near-term adverse changes could cause these securities to be rated below investment grade. "F-S" - Securities possess weak credit quality. Issues assigned this rating have characteristics suggesting a minimal degree of assurance for timely payment and are vulnerable to near-term adverse changes in financial and economic conditions. "D" - Securities are in actual or imminent payment default. Fitch may also use the symbol "LOC" with its short-term ratings to indicate that the rating is based upon a letter of credit issued by a commercial bank. Thomson BankWatch short-term ratings assess the likelihood of an untimely or incomplete payment of principal or interest of unsubordinated instruments having a maturity of one year or less which are issued by United States commercial banks, thrifts and non-bank banks; non-United States banks; and broker-dealers. The following summarizes the ratings used by Thomson BankWatch: "TBW-1" - This designation represents Thomson BankWatch's highest rating category and indicates a very high degree of likelihood that principal and interest will be paid on a timely basis. "TBW-2" - This designation indicates that while the degree of safety regarding timely payment of principal and interest is strong, the relative degree of safety is not as high as for issues rated "TBW-1." "TBW-3" - This designation represents the lowest investment grade category and indicates that while the debt is more susceptible to adverse developments (both internal and external) than obligations with higher ratings, capacity to service principal and interest in a timely fashion is considered adequate. A-2 "TBW-4" - This designation indicates that the debt is regarded as non- investment grade and therefore speculative. IBCA assesses the investment quality of unsecured debt with an original maturity of less than one year which is issued by bank holding companies and their principal bank subsidiaries. The following summarizes the rating categories used by IBCA for short-term debt ratings: "A1+" - Obligations which posses a particularly strong credit feature are supported by the highest capacity for timely repayment. "A1" - Obligations are supported by the highest capacity for timely repayment. "A2" - Obligations are supported by a satisfactory capacity for timely repayment. "A3" - Obligations are supported by a satisfactory capacity for timely repayment. "B" - Obligations for which there is an uncertainty as to the capacity to ensure timely repayment. "C" - Obligations for which there is a high risk of default or which are currently in default. CORPORATE AND MUNICIPAL LONG-TERM DEBT RATINGS - ---------------------------------------------- The following summarizes the ratings used by Standard & Poor's for corporate and municipal debt: "AAA" - This designation represents the highest rating assigned by Standard & Poor's to a debt obligation and indicates an extremely strong capacity to pay interest and repay principal. "AA" - Debt is considered to have a very strong capacity to pay interest and repay principal and differs from AAA issues only in small degree. "A" - Debt is considered to have a strong capacity to pay interest and repay principal although such issues are somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than debt in higher-rated categories. "BBB" - Debt is regarded as having an adequate capacity to pay interest and repay principal. Whereas such issues normally exhibit adequate protection parameters, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity to pay interest and repay principal for debt in this category than in higher-rated categories. "BB," "B," "CCC," "CC" and "C" - Debt 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 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 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 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 A-3 principal. The "CCC" rating category is also used for debt subordinated to senior debt that is assigned an actual or implied "B" or "B-" rating. "CC" - This rating is typically applied to debt subordinated to senior debt that is assigned an actual or implied "CCC" rating. "C" - This rating 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. "CI" - This rating is reserved for income bonds on which no interest is being paid. "D" - Debt is in payment default. This rating 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. "D" rating is also used upon the filing of a bankruptcy petition if debt service payments are jeopardized. PLUS (+) OR MINUS (-) - The ratings from "AA" through "CCC" may be modified by the addition of a plus or minus sign to show relative standing within the major rating categories. "r" - This rating is attached to highlight derivative, hybrid, and certain other obligations that S & P believes may experience high volatility or high variability in expected returns due to non-credit risks. Examples of such obligations are: securities whose principal or interest return is indexed to equities, commodities, or currencies; certain swaps and options; and interest only and principal only mortgage securities. The absence of an "r" symbol should not be taken as an indication that an obligation will exhibit no volatility or variability in total return. The following summarizes the ratings used by Moody's for corporate and municipal long-term debt: "Aaa" - Bonds are judged to be of the best quality. They carry the smallest degree of investment risk and are generally referred to as "gilt edged." Interest payments are protected by a large or by an exceptionally stable margin and principal is secure. While the various protective elements are likely to change, such changes as can be visualized are most unlikely to impair the fundamentally strong position of such issues. "Aa" - Bonds are judged to be of high quality by all standards. Together with the "Aaa" group they comprise what are generally known as high-grade bonds. They are rated lower than the best bonds because margins of protection may not be as large as in "Aaa" securities or fluctuation of protective elements may be of greater amplitude or there may be other elements present which make the long- term risks appear somewhat larger than in "Aaa" securities. "A" - Bonds 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 considered 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," "B," "Caa," "Ca," and "C" - Bonds that possess one of these ratings provide questionable protection of interest and principal ("Ba" indicates some speculative elements; "B" indicates a general lack of characteristics of desirable investment; "Caa" represents a poor standing; "Ca" represents obligations which are speculative in a high degree; and "C" represents the lowest rated class of bonds). "Caa," "Ca" and "C" bonds may be in default. Con. (---) - Bonds for which the security depends upon the completion of some act or the fulfillment of some condition are rated conditionally. These are bonds secured by (a) earnings of projects under construction, (b) earnings of projects unseasoned in operation experience, (c) rentals which begin when facilities are completed, or (d) payments A-4 to which some other limiting condition attaches. Parenthetical rating denotes probable credit stature upon completion of construction or elimination of basis of condition. (P) - When applied to forward delivery bonds, indicates that the rating is provisional pending delivery of the bonds. The rating may be revised prior to delivery if changes occur in the legal documents or the underlying credit quality of the bonds. Note: Those bonds in the Aa, A, Baa, Ba and B groups which Moody's believes possess the strongest investment attributes are designated by the symbols, Aa1, A1, Ba1 and B1. The following summarizes the long-term debt ratings used by Duff & Phelps for corporate and municipal long-term debt: "AAA" - Debt is considered to be of the highest credit quality. The risk factors are negligible, being only slightly more than for risk-free U.S. Treasury debt. "AA" - Debt is considered of high credit quality. Protection factors are strong. Risk is modest but may vary slightly from time to time because of economic conditions. "A" - Debt possesses protection factors which are average but adequate. However, risk factors are more variable and greater in periods of economic stress. "BBB" - Debt possesses below average protection factors but such protection factors are still considered sufficient for prudent investment. Considerable variability in risk is present during economic cycles. "BB," "B," "CCC," "DD," and "DP" - Debt that possesses one of these ratings is considered to be below investment grade. Although below investment grade, debt rated "BB" is deemed likely to meet obligations when due. Debt rated "B" possesses the risk that obligations will not be met when due. Debt rated "CCC" is well below investment grade and has considerable uncertainty as to timely payment of principal, interest or preferred dividends. Debt rated "DD" is a defaulted debt obligation, and the rating "DP" represents preferred stock with dividend arrearages. To provide more detailed indications of credit quality, the "AA," "A," "BBB," "BB" and "B" ratings may be modified by the addition of a plus (+) or minus (-) sign to show relative standing within these major categories. The following summarizes the highest four ratings used by Fitch for corporate and municipal bonds: "AAA" - Bonds considered to be investment grade and of the highest credit quality. The obligor has an exceptionally strong ability to pay interest and repay principal, which is unlikely to be affected by reasonably foreseeable events. "AA" - Bonds considered to be investment grade and of very high credit quality. The obligor's ability to pay interest and repay principal is very strong, although not quite as strong as bonds rated "AAA." Because bonds rated in the "AAA" and "AA" categories are not significantly vulnerable to foreseeable future developments, short-term debt of these issuers is generally rated "F-1+." "A" - Bonds considered to be investment grade and of high credit quality. The obligor's ability to pay interest and repay principal is considered to be strong, but may be more vulnerable to adverse changes in economic conditions and circumstances than bonds with higher ratings. "BBB" - Bonds considered to be investment grade and of satisfactory credit quality. The obligor's ability to pay interest and repay principal is considered to be adequate. Adverse changes in economic conditions and circumstances, however, are more likely to have an adverse impact on these bonds, and therefore, impair timely payment. The likelihood that the ratings of these bonds will fall below investment grade is higher than for bonds with higher ratings. "BB," "B," "CCC," "CC," "C," "DDD," "DD," and "D" - Bonds that possess one of these ratings are considered by Fitch to be speculative investments. The ratings "BB" to "C" represent Fitch's assessment of the likelihood of timely A-5 payment of principal and interest in accordance with the terms of obligation for bond issues not in default. For defaulted bonds, the rating "DDD" to "D" is an assessment of the ultimate recovery value through reorganization or liquidation. To provide more detailed indications of credit quality, the Fitch ratings from and including "AA" to "BBB" may be modified by the addition of a plus (+) or minus (-) sign to show relative standing within these major rating categories. IBCA assesses the investment quality of unsecured debt with an original maturity of more than one year which is issued by bank holding companies and their principal bank subsidiaries. The following summarizes the rating categories used by IBCA for long-term debt ratings: "AAA" - Obligations for which there is the lowest expectation of investment risk. Capacity for timely repayment of principal and interest is substantial such that adverse changes in business, economic or financial conditions are unlikely to increase investment risk substantially. "AA" - Obligations for which there is a very low expectation of investment risk. Capacity for timely repayment of principal and interest is substantial, such that adverse changes in business, economic or financial conditions may increase investment risk, albeit not very significantly. "A" - Obligations for which there is a low expectation of investment risk. Capacity for timely repayment of principal and interest is strong, although adverse changes in business, economic or financial conditions may lead to increased investment risk. "BBB" - Obligations for which there is currently a low expectation of investment risk. Capacity for timely repayment of principal and interest is adequate, although adverse changes in business, economic or financial conditions are more likely to lead to increased investment risk than for obligations in other categories. "BB," "B," "CCC," "CC," and "C" - Obligations are assigned one of these ratings where it is considered that speculative characteristics are present. "BB" represents the lowest degree of speculation and indicates a possibility of investment risk developing. "C" represents the highest degree of speculation and indicates that the obligations are currently in default. IBCA may append a rating of plus (+) or minus (-) to a rating to denote relative status within major rating categories. Thomson BankWatch assesses the likelihood of an untimely repayment of principal or interest over the term to maturity of long term debt and preferred stock which are issued by United States commercial banks, thrifts and non-bank banks; non-United States banks; and broker-dealers. The following summarizes the rating categories used by Thomson BankWatch for long-term debt ratings: "AAA" - This designation represents the highest category assigned by Thomson BankWatch to long-term debt and indicates that the ability to repay principal and interest on a timely basis is extremely high. "AA" - This designation indicates a very strong ability to repay principal and interest on a timely basis with limited incremental risk compared to issues rated in the highest category. "A" - This designation indicates that the ability to repay principal and interest is strong. Issues rated "A" could be more vulnerable to adverse developments (both internal and external) than obligations with higher ratings. "BBB" - This designation represents Thomson BankWatch's lowest investment grade category and indicates an acceptable capacity to repay principal and interest. Issues rated "BBB" are, however, more vulnerable to adverse developments (both internal and external) than obligations with higher ratings. "BB," "B," "CCC," and "CC," - These designations are assigned by Thomson BankWatch to non-investment grade long-term debt. Such issues are regarded as having speculative characteristics regarding the likelihood of timely A-6 payment of principal and interest. "BB" indicates the lowest degree of speculation and "CC" the highest degree of speculation. "D" - This designation indicates that the long-term debt is in default. PLUS (+) OR MINUS (-) - The ratings from "AAA" through "CC" may include a plus or minus sign designation which indicates where within the respective category the issue is placed. MUNICIPAL NOTE RATINGS - ---------------------- A Standard and Poor's rating reflects the liquidity concerns and market access risks unique to notes due in three years or less. The following summarizes the ratings used by Standard & Poor's Ratings Group for municipal notes: "SP-1" - The issuers of these municipal notes exhibit very strong or strong capacity to pay principal and interest. Those issues determined to possess overwhelming safety characteristics are given a plus (+) designation. "SP-2" - The issuers of these municipal notes exhibit satisfactory capacity to pay principal and interest. "SP-3" - The issuers of these municipal notes exhibit speculative capacity to pay principal and interest. Moody's ratings for state and municipal notes and other short-term loans are designated Moody's Investment Grade ("MIG") and variable rate demand obligations are designated Variable Moody's Investment Grade ("VMIG"). Such ratings recognize the differences between short-term credit risk and long-term risk. The following summarizes the ratings by Moody's Investors Service, Inc. for short-term notes: "MIG-1"/"VMIG-1" - Loans bearing this designation are of the best quality, enjoying strong protection by established cash flows, superior liquidity support or demonstrated broad-based access to the market for refinancing. "MIG-2"/"VMIG-2" - Loans bearing this designation are of high quality, with margins of protection ample although not so large as in the preceding group. "MIG-3"/"VMIG-3" - Loans bearing this designation are of favorable quality, with all security elements accounted for but lacking the undeniable strength of the preceding grades. Liquidity and cash flow protection may be narrow and market access for refinancing is likely to be less well established. "MIG-4"/"VMIG-4" - Loans bearing this designation are of adequate quality, carrying specific risk but having protection commonly regarded as required of an investment security and not distinctly or predominantly speculative. "SG" - Loans bearing this designation are of speculative quality and lack margins of protection. Fitch and Duff & Phelps use the short-term ratings described under Commercial Paper Ratings for municipal notes. A-7 APPENDIX B ---------- Certain Portfolios of the Fund may enter into certain futures transactions. Such transactions are described in this Appendix. I. Interest Rate Futures Contracts ------------------------------- Use of Interest Rate Futures Contracts. Bond prices are established in -------------------------------------- both the cash market and the futures market. In the cash market, bonds are purchased and sold with payment for the full purchase price of the bond being made in cash, generally within five business days after the trade. In the futures market, only a contract is made to purchase or sell a bond in the future for a set price on a certain date. Historically, the prices for bonds established in the futures markets have tended to move generally in the aggregate in concert with the cash market prices and have maintained fairly predictable relationships. Accordingly, a Portfolio may use interest rate futures contracts as a defense, or hedge, against anticipated interest rate changes and not for speculation. As described below, this would include the use of futures contract sales to protect against expected increases in interest rates and futures contract purchases to offset the impact of interest rate declines. A Portfolio could accomplish a similar result to that which it hopes to achieve through the use of futures contracts by selling bonds with long maturities and investing in bonds with short maturities when interest rates are expected to increase, or conversely, selling short-term bonds and investing in long-term bonds when interest rates are expected to decline. However, because of the liquidity that is often available in the futures market, the protection is more likely to be achieved, perhaps at a lower cost and without changing the rate of interest being earned by the Portfolio, by using futures contracts. Description of Interest Rate Futures Contracts. An interest rate futures ---------------------------------------------- contract sale would create an obligation by a Portfolio, as seller, to deliver the specific type of financial instrument called for in the contract at a specific future time for a specified price. A futures contract purchase would create an obligation by a Portfolio, as purchaser, to take delivery of the specific type of financial instrument at a specific future time at a specific price. The specific securities delivered or taken, respectively, at settlement date, would not be determined until at or near that date. The determination would be in accordance with the rules of the exchange on which the futures contract sale or purchase was made. Although interest rate futures contracts by their terms call for actual delivery or acceptance of securities, in most cases the contracts are closed out before the settlement date without the making or taking of delivery of securities. Closing out a futures contract sale is effected by the Portfolio entering into a futures contract purchase for the same aggregate amount of the specific type of financial instrument and the same delivery date. If the price of the sale exceeds the price of the offsetting purchase, the Portfolio is immediately paid the difference and thus realizes a gain. If the offsetting purchase price exceeds the sale price, the Portfolio pays the difference and realizes a loss. Similarly, the closing out of a futures contract purchase is effected by the Portfolio entering into a futures contract sale. If the offsetting sale price exceeds the purchase price, the Portfolio realizes a gain, and if the purchase price exceeds the offsetting sale price, the Portfolio realizes a loss. Interest rate futures contracts are traded in an auction environment on the floors of several exchanges -- principally, the Chicago Board of Trade, the Chicago Mercantile Exchange and the New York Futures Exchange. Each exchange guarantees performance under contract provisions through a clearing corporation, a nonprofit organization managed by the exchange membership. A public market now exists in futures contracts covering various financial instruments including long-term U.S. Treasury Bonds and Notes; Government National Mortgage Association (GNMA) modified pass-through mortgage backed securities; three-month U.S. Treasury Bills; and ninety-day commercial paper. The Portfolios may trade in any interest rate futures contracts for which there exists a public market, including, without limitation, the foregoing instruments. B-1 With regard to each Portfolio, the Adviser also anticipates engaging in transactions, from time to time, in foreign stock index futures such as the ALL- ORDS (Australia), CAC-40 (France), TOPIX (Japan) and the FTSE-100 (United Kingdom). II. Index Futures Contracts ----------------------- General. A stock or bond index assigns relative values to the stocks or ------- bonds included in the index, which fluctuates with changes in the market values of the stocks or bonds included. Some stock index futures contracts are based on broad market indexes, such as Standard & Poor's 500 or the New York Stock Exchange Composite Index. In contrast, certain exchanges offer futures contracts on narrower market indexes, such as the Standard & Poor's 100 or indexes based on an industry or market indexes, such as Standard & Poor's 100 or indexes based on an industry or market segment, such as oil and gas stocks. Futures contracts are traded on organized exchanges regulated by the Commodity Futures Trading Commission. Transactions on such exchanges are cleared through a clearing corporation, which guarantees the performance of the parties to each contract. With regard to each Portfolio, to the extent consistent with its investment objective, the Adviser anticipates engaging in transactions, from time to time, in foreign stock index futures such as the ALL-ORDS (Australia), CAC-40 (France), TOPIX (Japan) and the FTSE-100 (United Kingdom). A Portfolio may sell index futures contracts in order to offset a decrease in market value of its portfolio securities that might otherwise result from a market decline. A 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 the securities to be sold. Conversely, a Portfolio may purchase index futures contracts in anticipation of purchases of securities. A long futures position may be terminated without a corresponding purchase of securities. In addition, a Portfolio may utilize index futures contracts in anticipation of changes in the composition of its portfolio holdings. For example, in the event that a Portfolio expects to narrow the range of industry groups represented in its holdings it 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. A 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 will decline prior to the time of sale. III. Futures Contracts on Foreign Currencies --------------------------------------- A futures contract on foreign currency creates a binding obligation on one party to deliver, and a corresponding obligation on another party to accept delivery of, a stated quantity of foreign currency, for an amount fixed in U.S. dollars (or another currency). Foreign currency futures may be used by a Portfolio to hedge against exposure to fluctuations in exchange rates between different currencies arising from multinational transactions. IV. Margin Payments --------------- Unlike purchase or sales of portfolio securities, no price is paid or received by a Portfolio upon the purchase or sale of a futures contract. Initially, a Portfolio will be required to deposit with the broker or in a segregated account with a custodian an amount of liquid assets known as initial margin, based on the value of the contract. 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 Portfolio upon termination of the futures contract assuming all contractual obligations have been satisfied. Subsequent payments, called variation margin, to and from the broker, will be made on a daily basis as the price of the underlying instruments fluctuates making the long and short positions in the futures contract more or less valuable, a process known as marking-to-the-market. For example, when a particular Portfolio has purchased a futures contract and the price of the contract has risen in response to a rise in the underlying instruments, that position will have increased in value and the Portfolio will be entitled to receive from the broker a variation margin payment equal to that increase in value. Conversely, where the Portfolio has purchased a futures contract and the price of the future contract has declined in response to a decrease in the underlying instruments, the position would be less valuable and the Portfolio would be required to make a variation margin payment to the broker. Prior to expiration of the futures contract, the Adviser may B-2 elect to close the position by taking an opposite position, subject to the availability of a secondary market, which will operate to terminate the Portfolio's position in the futures contract. A final determination of variation margin is then made, additional cash is required to be paid by or released to the Portfolio, and the Portfolio realizes a loss or gain. V. Risks of Transactions in Futures Contracts ------------------------------------------ There are several risks in connection with the use of futures by a Portfolio as a hedging device. One risk arises because of the imperfect correlation between movements in the price of the futures and movements in the price of the instruments which are the subject of a hedge. The price of the future may move more than or less than the price of the instruments being hedged. If the price of the futures moves less than the price of the instruments which are the subject of the hedge, the hedge will not be fully effective but, if the price of the instruments being hedged has moved in an unfavorable direction, the Portfolio would be in a better position than if it had not hedged at all. If the price of the instruments being hedged has moved in a favorable direction, this advantage will be partially offset by the loss on the futures. If the price of the futures moves more than the price of the hedged instruments, the Portfolio involved will experience either a loss or gain on the futures which will not be completely offset by movements in the price of the instruments which are the subject of the hedge. To compensate for the imperfect correlation of movements in the price of instruments being hedged and movements in the price of futures contracts, a Portfolio may buy or sell futures contracts in a greater dollar amount than the dollar amount of instruments being hedged if the volatility over a particular time period of the prices of such instruments has been greater than the volatility over such time period of the futures, or if otherwise deemed to be appropriate by the Adviser. Conversely, a Portfolio may buy or sell fewer futures contracts if the volatility over a particular time period of the prices of the instruments being hedged is less than the volatility over such time period of the futures contract being used, or if otherwise deemed to be appropriate by the Adviser. It is also possible that, where a Portfolio has sold futures to hedge its portfolio against a decline in the market, the market may advance and the value of instruments held in the Portfolio may decline. If this occurred, the Portfolio would lose money on the futures and also experience a decline in value in its portfolio securities. When futures are purchased to hedge against a possible increase in the price of securities or a currency before a Portfolio is able to invest its cash (or cash equivalents) in an orderly fashion, it is possible that the market may decline instead; if the Portfolio then concludes not to invest its cash at that time because of concern as to possible further market decline or for other reasons, the Portfolio will realize a loss on the futures contract that is not offset by a reduction in the price of the instruments that were to be purchased. In addition to the possibility that there may be an imperfect correlation, or no correlation at all, between movements in the futures and the instruments being hedged, the price of futures may not correlate perfectly with movement in the cash market due to certain market distortions. Rather than meeting additional margin deposit requirements, investors may close futures contracts through off-setting transactions which could distort the normal relationship between the cash and futures markets. Second, with respect to financial futures contracts, the liquidity of the futures market depends on participants entering into off-setting transactions rather than making or taking delivery. To the extent participants decide to make or take delivery, liquidity in the futures market could be reduced thus producing distortions. Third, 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. Due to the possibility of price distortion in the futures market, and because of the imperfect correlation between the movements in the cash market and movements in the price of futures, a correct forecast of general market trends or interest rate movements by the adviser may still not result in a successful hedging transaction over a short time frame. Positions in futures may be closed out only on an exchange or board of trade which provides a secondary market for such futures. Although the Portfolios intend to purchase or sell futures only on exchanges or boards of trade where there appear to be active secondary markets, there is no assurance that a liquid secondary market on any exchange or board of trade will exist for any particular contract or at any particular time. In such event, it may not be possible to close a futures investment position, and in the event of adverse price movements, a Portfolio would continue to be required to make daily cash payments of variation margin. However, in the event futures contracts have been used to hedge portfolio securities, such securities will not be sold until the futures contract can be terminated. In such B-3 circumstances, an increase in the price of the securities, 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 will in fact correlate with the price movements in the futures contract and thus provide an offset on a futures contract. Further, it should be noted that the liquidity of a secondary market in a futures contract may be adversely affected by "daily price fluctuation limits" established by commodity exchanges which limit the amount of fluctuation in a futures contract price during a single trading day. Once the daily limit has been reached in the contract, no trades may be entered into at a price beyond the limit, thus preventing the liquidation of open futures positions. The trading of futures contracts is also subject to the risk of trading halts, suspensions, exchange or clearing house equipment failures, government intervention, insolvency of a brokerage firm or clearing house or other disruptions of normal activity, which could at times make it difficult or impossible to liquidate existing positions or to recover excess variation margin payments. Successful use of futures by a Portfolio is also subject to the Adviser's ability to predict correctly movements in the direction of the market. For example, if a particular Portfolio has hedged against the possibility of a decline in the market adversely affecting securities held by it and securities prices increase instead, the Portfolio will lose part or all of the benefit to the increased value of its securities which it has 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 securities to meet daily variation margin requirements. Such sales of securities may be, but will not necessarily be, at increased prices which reflect the rising market. A Portfolio may have to sell securities at a time when it may be disadvantageous to do so. The risk of loss in trading futures contracts in some strategies can be substantial, due both to the low margin deposits required, and the extremely high degree of leverage involved in futures pricing. As a result, a relatively small price movement in a futures contract may result in immediate and substantial loss (as well as gain) to the investor. For example, if at the time of purchase, 10% of the value of the futures contract is deposited as margin, a subsequent 10% decrease in the value of the futures contract would result in a total loss of the margin deposit, before any deduction for the transaction costs, if the account were then closed out. A 15% decrease would result in a loss equal to 150% of the original margin deposit, before any deduction for the transaction costs, if the contract were closed out. Thus, a purchase or sale of a futures contract may result in losses in excess of the amount invested in the contract. VI. Options on Futures Contracts ---------------------------- A Portfolio may purchase and write options on the futures contracts described above. A futures option gives the holder, in return for the premium paid, the right to buy (call) from or sell (put) to the writer of the option a futures contract at a specified price at any time during the period of the option. Upon exercise, the writer of the option is obligated to pay the difference between the cash value of the futures contract and the exercise price. Like the buyer or seller of a futures contract, the holder, or writer, of an option has the right to terminate its position prior to the scheduled expiration of the option by selling, or purchasing an option of the same series, at which time the person entering into the closing transaction will realize a gain or loss. A Portfolio will be required to deposit initial margin and variation margin with respect to put and call options on futures contracts written by it pursuant to brokers' requirements similar to those described above. Net option premiums received will be included as initial margin deposits. As an example, in anticipation of a decline in interest rates, a Portfolio may purchase call options on futures contracts as a substitute for the purchase of futures contracts to hedge against a possible increase in the price of securities which the Portfolio intends to purchase. Similarly, if the value of the securities held by a Portfolio is expected to decline as a result of an increase in interest rates, the Portfolio might purchase put options or sell call options on futures contracts rather than sell futures contracts. Investments in futures options involve some of the same considerations that are involved in connection with investments in futures contracts (for example, the existence of a liquid secondary market). In addition, the purchase or sale of an option also entails the risk that changes in the value of the underlying futures contract will not correspond to changes in the value of the option purchased. Depending on the pricing of the option compared to either the futures contract upon which it is based, or upon the price of the securities or currencies being hedged, an option may or may B-4 not be less risky than ownership of the futures contract or such securities or currencies. In general, the market prices of options can be expected to be more volatile than the market prices on the underlying futures contract. Compared to the purchase or sale of futures contracts, however, the purchase of call or put options on futures contracts may frequently involve less potential risk to a Portfolio because the maximum amount at risk is the premium paid for the options (plus transaction costs). The writing of an option on a futures contract involves risks similar to those risks relating to the sale of futures contracts. VII. Other Matters ------------- Accounting for futures contracts will be in accordance with generally accepted accounting principles. B-5 BLACKROCK FUNDS /SM/ SUPPLEMENT TO STATEMENT OF ADDITIONAL INFORMATION DATED JANUARY 28, 1999 The section "Investment Policies--Additional Information on Investment Strategy--Balanced Portfolio" is amended by adding the following after the first paragraph: The Balanced Portfolio may invest in the stocks of mid-capitalization companies, which the portfolio defines as companies with market capitalizations of from $2 billion to $10 billion. There is more business risk in investing in mid-capitalization companies than in larger, better capitalized companies. These organizations will normally have more limited product lines, markets and financial resources and will be dependent upon a more limited management group than larger capitalized companies. The section "Investment Policies--Additional Information on Portfolio Investments" is amended as follows: The last sentence of the third paragraph under "Variable and Floating Rate Instruments" has been deleted. The last sentence of the first paragraph under "Money Market Obligations of Domestic Banks, Foreign Banks and Foreign Branches of U.S. Banks" has been deleted. The last sentence of the second paragraph under "U.S. Government Obligations" has been deleted. The last sentence under "Supranational Organization Obligations" has been deleted. The last sentence of the second paragraph under "Commercial Paper" has been deleted. The section "Purchase and Redemption Information--Sales Charge Waivers For Each of the Equity and Bond Portfolios--Investor A Shares" is amended as follows: The second sentence under "Other" has been amended to read in its entirety as follows: The following persons may also buy Investor A Shares without paying a sales charge: (a) persons investing through an authorized payroll deduction plan; (b) persons investing through an authorized investment plan for organizations which operate under Section 501(c)(3) of the Internal Revenue Code; (c) registered investment advisers, trust companies and bank trust departments exercising discretionary investment authority with respect to amounts to be invested in a Portfolio, provided that the aggregate amount invested pursuant to this exemption in Investor A Shares that would otherwise be subject to front-end sales charges equals at least $250,000; (d) persons participating in a "wrap account" or similar program under which they pay advisory fees to a broker- dealer or other financial institution; and (e) persons participating in an account or program under which they pay fees to a broker-dealer or other financial institution for providing transaction processing and other administrative services, but not investment advisory services. This Supplement is dated November 22, 1999. EX-99.17D 7 BOND INVESTOR ANNUAL REPORT TO SHAREHOLDERS EXHIBIT 17(d) September 30, 1999 TAXABLE BOND PORTFOLIOS ANNUAL REPORT TO SHAREHOLDERS Not FDIC Insured May Lose Value No Bank Guarantee BLACKROCK FUNDS (LOGO) PURE INVESTMENT STYLE (REGISTRATION MARK) [GRAPHIC OMITTED] BLACKROCK FUNDS TAXABLE BOND PORTFOLIOS . Low Duration Bond . GNMA . Intermediate Government Bond . Managed Income . Intermediate Bond . International Bond . Core Bond . High Yield Bond . Government Income TABLE OF CONTENTS SHAREHOLDER LETTER................................................... 1 PORTFOLIO SUMMARIES Low Duration Bond.............................................. 3 Intermediate Government Bond................................... 4 Intermediate Bond.............................................. 5 Core Bond...................................................... 6 Government Income.............................................. 7 GNMA........................................................... 8 Managed Income................................................. 9 International Bond............................................. 10 High Yield Bond................................................ 11 Note on Performance Information................................ 12 STATEMENT OF NET ASSETS/SCHEDULE OF INVESTMENTS...................... 13-45 Core Bond Statement of Assets & Liabilities.................... 31 Managed Income Statement of Assets & Liabilities............... 41 High Yield Statement of Assets & Liabilities................... 45 PORTFOLIO FINANCIAL STATEMENTS Statement of Operations........................................ 46-47 Statement of Cash Flows........................................ 48-51 Statement of Changes in Net Assets............................. 52-55 Financial Highlights........................................... 56-63 NOTES TO FINANCIAL STATEMENTS........................................ 64-76 REPORT OF INDEPENDENT ACCOUNTANTS.................................... 77
BLACKROCK FUNDS October 14, 1999 Dear Shareholder: We are pleased to present the Annual Report for the BlackRock Funds for the fiscal year ended September 30, 1999, our last annual report of the millenium. As we look ahead to the new millenium the future looks promising. While the Fed has indicated a bias to tightening, interest rates remain low and stable. Inflation still seems to be in check, despite a general consensus that world economies are strengthening. Over the past twelve months the S&P 500 moved ahead by 27.8%, and the Dow did even better, returning 34.0%. Broadly, stocks performed better than bonds over the same period, as the total return of the Lehman Aggregate Index was -0.38%. However, these numbers tell only part of the story. A closer look reveals that much of the equity market's performance was generated in the last quarter of 1998. As an example, the performance of the S&P 500 for the first nine months of 1999 is only 5.87%. Additionally, performance has been narrow, with the largest growth stocks (and, to some degree, the Internet sector) leading the way. In other words, it looks like the great bull market of recent years may have slowed its charge. It is still moving forward, but with less energy. What should investors do? We believe that the symbolism of the new millenium is appropriate for investors. The idea that we are marking the passing of 1,000 years of human history is a wonderful reminder of the virtue of patience. While we will be hearing much exaggeration and cosmic rhetoric about the "new age" of investing, we believe that this is a good time to call to mind a concept that has proven its worth over many years of investment history. This is the idea of "regression to the mean," which basically means that, over time, markets tend to perform as they have always performed. According to Ibbotson, from 1926 to 1998, the market for large company stocks as measured by the S&P 500 Index has returned 11.22% annually. This is a respectable return but significantly less generous than the S&P has been returning in recent years. Therefore, if you believe that markets will revert to their historical performance, this figure is a more realistic long-term planning tool. On the other hand, if you are mesmerized by the recent dazzling performance of internet stocks, 11.22% may look paltry. Will the concept of "regression to the mean" impact markets in the new millenium as it has in the past? Or have we really entered a new age in which valuations are based on new and non-traditional measures and that markets can continue to climb higher indefinitely. This is what some observers think. For example, consider that the total market capitalization of AOL is approximately $136 billion, which is nearly equal to the COMBINED market capitalizations of Dow Industrial components J.P. Morgan, Alcoa, General Motors and Philip Morris. There is even a best-selling book titled "Dow 36,000" whose authors believe that the DJIA should be three times as high because they believe that "old" methods of valuation are out of date and do not reflect the realities of the new information economy. Of course we cannot predict the future, but we believe that while certain factors may change, markets will continue to fluctuate in the future as they have in the past. 1 BLACKROCK FUNDS BlackRock was founded on the belief that adhering to a disciplined investment approach that seeks to manage risk rather than attempt to time the markets will add value to client portfolios. That's why we continue to believe that the best course of action in the new millenium is the same as it was in the old: 1) work with your financial adviser to set your goals; 2) plan and implement a sensible asset allocation that meets your goals and fits with your personal ability to tolerate risk; and 3) consult with your financial advisor to make ongoing adjustments. We also believe that mutual funds, which provide a diversified investment portfolio and professional management, may be the most appropriate investment vehicle for individual investors. BlackRock Funds takes pride in the completeness of its mutual fund offerings. We currently offer 36 different portfolios which can meet the needs of virtually any investor regardless of investment goal and risk tolerance. In addition to the traditional asset classes, we also offer funds such as International Small Cap Equity, Micro-Cap Equity and High Yield Bond for investors that are interested in more specialized markets. Continued thanks for your confidence in BlackRock Funds. We appreciate the opportunity to help you achieve your long-term investment goals. Sincerely, /s/ KAREN H. SABATH Karen H. Sabath MANAGING DIRECTOR BLACKROCK ADVISORS, INC. 2 BLACKROCK FUNDS LOW DURATION BOND PORTFOLIO TOTAL ASSETS (9/30/99): $265.5 PERFORMANCE BENCHMARK: MERRILL LYNCH 1-3 YEAR TREASURY INDEX INVESTMENT APPROACH: SEEKS A TOTAL RATE OF RETURN THAT EXCEEDS THE TOTAL RETURN OF ITS BENCHMARK BY INVESTING PRIMARILY IN INVESTMENT GRADE SECURITIES WITH MATURITIES FROM 3 TO 5 YEARS. THE PORTFOLIO MAY ALSO INVEST UP TO 20% OF ITS ASSETS IN DEBT SECURITIES OF FOREIGN ISSUERS AND UP TO 20% IN BELOW INVESTMENT GRADE SECURITIES RATED B OR HIGHER BY A MAJOR RATING AGENCY OR DEEMED BY THE MANAGER TO BE OF COMPARABLE CREDIT QUALITY. RECENT PORTFOLIO MANAGEMENT ACTIVITY: . IN SHARP CONTRAST TO THE FIRST NINE MONTHS OF 1998, TREASURY YIELDS ROSE SHARPLY DURING THE FIRST SIX MONTHS OF THE PERIOD AND CONTINUED TO INCREASE THROUGH FISCAL YEAR END. FOR THE PERIOD, THE YIELD OF THE 2-YEAR TREASURY ROSE 133 BASIS POINTS FROM 4.27% TO END THE PERIOD AT 5.60%. . ASSET-BACKED SECURITIES (ABS) CONTINUED TO BE THE PORTFOLIO'S LARGEST SECTOR WEIGHTING DURING THE PERIOD, AS THE MANAGER BELIEVED THIS SECTOR OFFERED ATTRACTIVE TOTAL RETURN OPPORTUNITIES WITHIN THE SHORT DURATION SECTOR. . THE MANAGER INCREASED THE PORTFOLIO'S WEIGHTINGS IN MORTGAGE PASS-THROUGH SECURITIES AND CORPORATE BONDS DURING THE PERIOD. IN THE MORTGAGE SECTOR, EMPHASIS WAS PLACED ON ISSUES THAT OFFERED RELATIVE PREPAYMENT STABILITY. CORPORATES FACED A DIFFICULT THIRD QUARTER AS STEADY SUPPLY CONTINUED TO ENTER THE MARKET AND INVESTORS BECAME CONCERNED THAT ECONOMIC MOMENTUM COULD RECEDE LATE IN THE YEAR. FURTHERMORE, INVESTOR APPETITE FOR CREDIT AND LIQUIDITY RISK CONTINUED TO REMAIN SUPRESSED AFTER LAST YEAR'S VOLATILITY. CORPORATES STILL OUTPERFORMED TREASURIES IN 1999, HOWEVER, BECAUSE OF THEIR STRONG PERFORMANCE IN THE FIRST HALF OF THE YEAR. ALTHOUGH LOWER-RATED INVESTMENT GRADE SECURITIES WERE POPULAR DURING THE FIRST HALF OF THE PERIOD, INVESTORS INCREASINGLY FOCUSED ON HIGHER CREDIT QUALITY ISSUES DURING THE PAST THREE MONTHS. Although the portfolio holdings and sectors listed above were current as of the end of the annual period ended September 30, 1999, the Portfolio is actively managed and the composition will vary. COMPARISON OF CHANGE IN VALUE OF A $10,000 INVESTMENT IN THE LOW DURATION BOND PORTFOLIO AND THE MERRILL 1-3 YEAR TREASURY INDEX FROM INCEPTION AND AT EACH FISCAL YEAR END. [GRAPHIC OMITTED] EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
Institutional Service Investor A Investor B Investor C BlackRock Merrill 1-3 Year Class Class Class Class Class Class Treasury Index 7/17/92 $10,000 $10,000 $9,700 $10,000 $10,000 $10,000 $10,000 Sep-92 10,079 10,079 9,777 10,079 10,079 10,079 10,288 Dec-92 10,137 10,137 9,833 10,137 10,137 10,137 10,595 Mar-93 10,295 10,295 9,986 10,295 10,295 10,295 10,614 Jun-93 10,468 10,468 10,154 10,468 10,468 10,468 10,848 Sep-93 10,620 10,620 10,302 10,620 10,620 10,620 10,965 Dec-93 10,711 10,711 10,390 10,711 10,711 10,711 11,122 Mar-94 10,691 10,691 10,370 10,691 10,691 10,691 11,188 Jun-94 10,713 10,713 10,391 10,713 10,713 10,713 11,132 Sep-94 10,837 10,837 10,512 10,837 10,837 10,837 11,141 Dec-94 10,860 10,860 10,534 10,860 10,860 10,860 11,251 Mar-95 11,214 11,214 10,878 11,214 11,214 11,214 11,251 Jun-95 11,521 11,521 11,175 11,521 11,521 11,521 11,629 Sep-95 11,767 11,767 11,414 11,767 11,767 11,767 12,002 Dec-95 12,001 12,001 11,641 12,001 12,001 12,001 12,182 Mar-96 12,023 12,009 11,644 12,004 12,004 12,023 12,489 Jun-96 12,149 12,125 11,752 12,115 12,115 12,149 12,531 Sep-96 12,347 12,313 11,929 12,298 12,298 12,347 12,657 Dec-96 12,610 12,565 12,168 12,537 12,537 12,610 12,866 Mar-97 12,668 12,614 12,210 12,556 12,556 12,668 13,110 Jun-97 12,938 12,876 12,459 12,789 12,789 12,938 13,197 Sep-97 13,196 13,122 12,692 13,003 13,003 13,199 13,487 Dec-97 13,370 13,286 12,845 13,135 13,135 13,379 13,752 Mar-98 13,588 13,492 13,039 13,309 13,309 13,602 13,983 Jun-98 13,808 13,699 13,235 13,483 13,483 13,828 14,197 Sep-98 14,156 14,035 13,552 13,781 13,781 14,182 14,634 Dec-98 14,256 14,125 13,634 13,838 13,838 14,288 14,745 Mar-99 14,425 14,280 13,778 13,958 13,958 14,461 14,834 Jun-99 14,521 14,366 13,854 14,008 14,008 14,564 14,918 Sep-99 14,709 14,541 14,016 13,651 14,146 14,758 15,106
For period ending September 30, 1999 - -------------------------------------------------------------------------------- AVERAGE ANNUAL TOTAL RETURN 1 Year 3 Year 5 Year From Inception BlackRock Class 4.06% 6.13% 6.37% 5.55% Institutional Class 3.91% 6.01% 6.30% 5.50% Service Class 3.60% 5.70% 6.06% 5.33% Investor A Class (Load Adjusted) 0.32% 4.45% 5.28% 4.79% Investor A Class (NAV) 3.42% 5.52% 5.92% 5.24% Investor B Class (Load Adjusted) (1.95)% 3.54% 5.05% 4.93% Investor B Class (NAV) 2.65% 4.78% 5.48% 4.93% Investor C Class (Load Adjusted) 1.62% 4.78% 5.48% 4.93% Investor C Class (NAV) 2.65% 4.78% 5.48% 4.93% - -------------------------------------------------------------------------------- The performance information above includes information relating to each class of the Portfolio since the commencement of operations of the Portfolio, rather than the date such class was introduced. The inception dates of the Portfolio's share classes were as follows: Institutional Shares, 7/17/92; Service, 1/12/96; Investor A Shares, 1/12/96; Investor B Shares, 11/18/96; Investor C Shares, 2/24/97; and BlackRock Shares, 6/3/97. See "Note on Performance Information" on page 12 for further information on how performance data was calculated. Past performance is not predictive of future results. 3 BLACKROCK FUNDS INTERMEDIATE GOVERNMENT BOND PORTFOLIO TOTAL ASSETS (9/30/99): $424.1 MILLION PERFORMANCE BENCHMARK: LEHMAN BROTHERS INTERMEDIATE GOVERNMENT INDEX INVESTMENT APPROACH: SEEKS CURRENT INCOME CONSISTENT WITH THE PRESERVATION OF CAPITAL BY INVESTING IN SECURITIES ISSUED BY THE U.S. GOVERNMENT OR ITS AGENCIES OR RATED AAA BY A MAJOR RATING AGENCY. THE PORTFOLIO EMPHASIZES SECURITIES WITH MATURITIES FROM 5 TO 10 YEARS. RECENT PORTFOLIO MANAGEMENT ACTIVITY: . IN SHARP CONTRAST TO THE FIRST NINE MONTHS OF 1998, TREASURY YIELDS ROSE SHARPLY DURING THE FIRST SIX MONTHS OF THE PERIOD AND CONTINUED TO INCREASE THROUGH FISCAL YEAR END. FOR THE PERIOD, THE YIELD OF THE 5-YEAR TREASURY ROSE 154 BASIS POINTS FROM 4.22% ON SEPTEMBER 30, 1998 TO 5.76% ON SEPTEMBER 30, 1999. . AS MORTGAGE PRICES DROPPED DURING FOURTH QUARTER 1998, THE PORTFOLIO'S MORTGAGE ALLOCATION INCREASED FROM 32% IN SEPTEMBER 1998 TO 45% BY DECEMBER. IN THE FIRST PART OF 1999, THE MANAGER REDUCED MORTGAGE EXPOSURE AS PRICES ROSE AND PREPAYMENT FEARS INCREASED. RECENTLY, HOWEVER, HIGHER INTEREST RATES HAVE ALLEVIATED PREPAYMENT FEARS, AND A DECREASE IN NEW ISSUANCE HAS PROVIDED A FAVORABLE TECHNICAL ENVIRONMENT FOR MORTGAGES. Although the portfolio holdings and sectors listed above were current as of the end of the annual period ended September 30, 1999, the Portfolio is actively managed and the composition will vary. COMPARISON OF CHANGE IN VALUE OF A $10,000 INVESTMENT IN THE INTERMEDIATE GOVERNMENT BOND PORTFOLIO AND THE LEHMAN BROTHERS INTERMEDIATE GOVERNMENT INDEX FROM INCEPTION AND AT EACH FISCAL YEAR END. [GRAPHIC OMITTED] EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
Institutional Service Investor A Investor B Investor C Lehman Intermediate Class Class Class Class Class Government Index 4/20/92 $10,000 $10,000 $9,600 $10,000 $10,000 $10,000 Jun-92 10,276 10,276 9,865 10,276 10,276 10,000 Sep-92 10,714 10,714 10,286 10,714 10,714 10,746 Dec-92 10,626 10,626 10,201 10,626 10,626 10,746 Mar-93 10,986 10,986 10,547 10,986 10,986 10,746 Jun-93 11,218 11,218 10,769 11,218 11,218 10,746 Sep-93 11,452 11,448 10,990 11,448 11,448 11,567 Dec-93 11,454 11,447 10,984 11,442 11,442 11,567 Mar-94 11,181 11,166 10,715 11,161 11,161 11,567 Jun-94 11,043 11,022 10,576 11,016 11,016 11,567 Sep-94 11,097 11,070 10,621 11,063 11,063 11,393 Dec-94 11,070 11,036 10,589 11,030 11,030 11,383 Mar-95 11,567 11,524 11,057 11,517 11,517 11,857 Jun-95 12,056 12,002 11,515 11,995 11,995 12,411 Sep-95 12,239 12,173 11,680 12,166 12,166 12,605 Dec-95 12,597 12,520 12,022 12,523 12,523 13,026 Mar-96 12,531 12,445 11,933 12,430 12,430 12,919 Jun-96 12,607 12,511 11,991 12,491 12,491 13,006 Sep-96 12,831 12,723 12,190 12,698 12,698 13,229 Dec-96 13,153 13,033 12,482 12,981 12,981 13,535 Mar-97 13,150 13,021 12,464 12,938 12,938 13,531 Jun-97 13,517 13,375 12,797 13,260 13,260 13,910 Sep-97 13,867 13,711 13,112 13,561 13,561 14,266 Dec-97 14,170 14,000 13,383 13,816 13,816 14,581 Mar-98 14,381 14,197 13,567 13,979 13,979 14,800 Jun-98 14,657 14,460 13,811 14,204 14,204 15,075 Sep-98 15,230 15,014 14,334 14,714 14,714 15,779 Dec-98 15,250 15,021 14,336 14,688 14,688 15,819 Mar-99 15,276 15,035 14,343 14,667 14,667 15,776 Jun-99 15,195 14,945 14,251 14,546 14,546 15,746 Sep-99 15,344 15,081 14,375 14,132 14,644 15,907
For period ending September 30, 1999 - -------------------------------------------------------------------------------- AVERAGE ANNUAL TOTAL RETURN 1 Year 3 Year 5 Year From Inception Institutional Class 0.75% 6.14% 6.69% 5.92% Service Class 0.45% 5.83% 6.38% 5.67% Investor A Class (Load Adjusted) (3.76)% 4.23% 5.38% 4.99% Investor A Class (NAV) 0.28% 5.65% 6.24% 5.57% Investor B Class (Load Adjusted) (5.00)% 3.64% 5.35% 5.26% Investor B Class (NAV) (0.47)% 4.88% 5.77% 5.26% Investor C Class (Load Adjusted) (1.47)% 4.88% 5.77% 5.26% Investor C Class (NAV) (0.47)% 4.88% 5.77% 5.26% - -------------------------------------------------------------------------------- The performance information above includes information relating to each class of the Portfolio since the commencement of operations of the Portfolio, rather than the date such class was introduced. The inception dates of the Portfolio's share classes were as follows: Institutional Shares, 4/20/92; Investor A Shares, 5/11/92; Service Shares, 7/29/93; Investor C Shares, 10/8/96; and Investor B Shares, 10/11/96. See "Note on Performance Information" on page 12 for further information on how performance data was calculated. Past performance is not predictive of future results. 4 BLACKROCK FUNDS INTERMEDIATE BOND PORTFOLIO TOTAL ASSETS (9/30/99): $546.7 MILLION PERFORMANCE BENCHMARK: LEHMAN BROTHERS INTERMEDIATE GOVERNMENT/CORPORATE INDEX INVESTMENT APPROACH: SEEKS CURRENT INCOME CONSISTENT WITH THE PRESERVATION OF CAPITAL BY INVESTING IN SECURITIES RATED BBB OR HIGHER BY A MAJOR RATING AGENCY OR DEEMED BY THE MANAGER TO BE OF COMPARABLE CREDIT QUALITY. THE PORTFOLIO EMPHASIZES SECURITIES WITH MATURITIES FROM 5 TO 10 YEARS. RECENT PORTFOLIO MANAGEMENT ACTIVITY: . IN SHARP CONTRAST TO THE FIRST NINE MONTHS OF 1998, TREASURY YIELDS ROSE SHARPLY DURING THE FIRST SIX MONTHS OF THE PERIOD AND CONTINUED TO INCREASE THROUGH FISCAL YEAR END. FOR THE PERIOD, THE YIELD OF 5-YEAR TREASURY ROSE 154 BASIS POINTS FROM 4.22% ON SEPTEMBER 30, 1998 TO 5.76% ON SEPTEMBER 30, 1999. . THE PORTFOLIO'S MORTGAGE ALLOCATION WAS INCREASED DURING THE BEGINNING OF THE PERIOD AS THE MANAGER BELIEVED THESE SECURITIES OFFERED ATTRACTIVE VALUE. AS MORTGAGES RECOVERED, THE MANAGER PARED SOME MORTGAGE EXPOSURE; HOWEVER, THE PORTFOLIO CURRENTLY MAINTAINS AN OVERWEIGHT MORTGAGE ALLOCATION VERSUS THE INDEX WITH AN EMPHASIS ON NON-INDEX SECURITIES. . THE PORTFOLIO'S CORPORATE BOND EXPOSURE WAS MODESTLY INCREASED DURING THE FIRST HALF OF THE PERIOD. DURING THE SECOND HALF, THE PORTFOLIO WAS SLIGHTLY OVERWEIGHT IN CORPORATES, ALTHOUGH BLACKROCK HAS RECENTLY MOVED TO A MORE DEFENSIVE POSITION. ALTHOUGH LOWER-RATED INVESTMENT GRADE SECURITIES WERE POPULAR DURING THE FIRST HALF OF THE PERIOD, LOWER CREDIT QUALITY DID NOT PROVIDE MUCH INCREMENTAL RETURN DURING THE PAST SIX MONTHS. Although the portfolio holdings and sectors listed above were current as of the end of the annual period ended September 30, 1999, the Portfolio is actively managed and the composition will vary. COMPARISON OF CHANGE IN VALUE OF A $10,000 INVESTMENT IN THE INTERMEDIATE BOND PORTFOLIO AND THE LEHMAN BROTHERS INTERMEDIATE GOVERNMENT/CORPORATE INDEX FROM INCEPTION AND AT EACH FISCAL YEAR END. [GRAPHIC OMITTED] EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
Institutional Service Investor A Investor B Investor C BlackRock Lehman Brothers Intermediate Class Class Class Class Class Class Government/Corporate Index 9/17/93 $10,000 $10,000 $9,600 $10,000 $10,000 $10,000 $10,000 Dec-93 9,954 9,945 9,610 9,945 9,945 9,954 10,037 Mar-94 9,675 9,660 9,547 9,660 9,660 9,675 9,833 Jun-94 9,592 9,572 9,274 9,572 9,572 9,592 9,774 Sep-94 9,655 9,628 9,188 9,626 9,626 9,655 9,854 Dec-94 9,644 9,611 9,241 9,610 9,610 9,644 9,843 Mar-95 10,044 10,003 9,225 10,002 10,002 10,044 10,274 Jun-95 10,498 10,447 9,601 10,441 10,441 10,498 10,788 Sep-95 10,696 10,636 10,023 10,620 10,620 10,696 10,965 Dec-95 11,051 10,983 10,194 10,965 10,965 11,051 11,349 Mar-96 10,966 10,890 10,526 10,878 10,878 10,966 11,255 Jun-96 11,046 10,962 10,442 10,945 10,945 11,046 11,325 Sep-96 11,241 11,147 10,506 11,125 11,125 11,241 11,526 Dec-96 11,527 11,422 10,679 11,394 11,394 11,527 11,809 Mar-97 11,522 11,408 10,938 11,375 11,375 11,522 11,247 Jun-97 11,863 11,737 10,920 11,712 11,712 11,863 11,579 Sep-97 12,184 12,047 11,243 12,016 12,016 12,184 11,891 Dec-97 12,403 12,255 11,534 12,217 12,217 12,403 12,145 Mar-98 12,601 12,440 11,728 12,391 12,391 12,601 12,334 Jun-98 12,825 12,652 11,923 12,573 12,573 12,825 12,566 Sep-98 13,257 13,070 12,310 12,958 12,958 13,262 13,130 Dec-98 13,282 13,084 12,319 12,942 12,942 13,293 13,168 Mar-99 13,354 13,146 12,372 12,973 12,973 13,370 13,143 Jun-99 13,298 13,090 12,305 12,880 12,880 13,319 13,092 Sep-99 13,403 13,214 12,418 12,471 12,991 13,428 13,212
For period ending September 30, 1999 - -------------------------------------------------------------------------------- AVERAGE ANNUAL TOTAL RETURN 1 Year 3 Year 5 Year From Inception BlackRock Class 1.25% 6.11% 6.82% 5.01% Institutional Class 1.10% 6.04% 6.78% 4.98% Service Class 0.80% 5.73% 6.47% 4.67% Investor A Class (Load Adjusted) (3.37)% 4.11% 5.46% 3.84% Investor A Class (NAV) 0.62% 5.55% 6.33% 4.55% Investor B Class (Load Adjusted) (4.63)% 3.89% 5.64% 4.34% Investor B Class (NAV) (0.13)% 5.13% 6.07% 4.34% Investor C Class (Load Adjusted) (1.13)% 5.13% 6.07% 4.34% Investor C Class (NAV) (0.13)% 5.13% 6.07% 4.34% - -------------------------------------------------------------------------------- The performance information above includes information relating to each class of the Portfolio since the commencement of operations of the Portfolio, rather than the date such class was introduced. The inception dates of the Portfolio's share classes were as follows: Institutional Shares, 9/17/93; Service Shares, 9/23/93; Investor A Shares, 5/20/94; Investor B Shares, 2/5/98; BlackRock Shares, 5/1/98 and Investor C Shares, 10/16/98. See "Note on Performance Information" on page 12 for further information on how performance data was calculated. Past performance is not predictive of future results. 5 BLACKROCK FUNDS CORE BOND PORTFOLIO TOTAL ASSETS (9/30/99): $967.0 MILLION PERFORMANCE BENCHMARK: LEHMAN BROTHERS AGGREGATE INDEX INVESTMENT APPROACH: SEEKS A TOTAL RATE OF RETURN THAT EXCEEDS THE TOTAL RETURN OF ITS BENCHMARK BY INVESTING IN SECURITIES RATED BBB OR HIGHER BY A MAJOR RATING AGENCY OR DEEMED BY THE MANAGER TO BE OF COMPARABLE CREDIT QUALITY. THE PORTFOLIO EMPHASIZES SECURITIES WITH MATURITIES FROM 5 TO 15 YEARS. RECENT PORTFOLIO MANAGEMENT ACTIVITY: . IN SHARP CONTRAST TO THE FIRST NINE MONTHS OF 1998, TREASURY YIELDS ROSE SHARPLY DURING THE PAST TWELVE MONTHS. FOR THE PERIOD, THE YIELD OF THE 10- YEAR TREASURY ROSE 147 BASIS POINTS FROM 4.41% ON SEPTEMBER 30, 1998 TO 5.88% ON SEPTEMBER 30, 1999. . THE PORTFOLIO MAINTAINED AN OVERWEIGHT POSITION VERSUS THE INDEX IN THE MORTGAGE PASS-THROUGH AND ASSET-BACKED SECURITY SECTORS, AS THE MANAGER BELIEVED THESE SECTORS OFFERED ATTRACTIVE YIELDS AND TOTAL RETURN OPPORTUNITIES RELATIVE TO TREASURIES. . THE PORTFOLIO'S CORPORATE BOND EXPOSURE WAS INCREASED SLIGHTLY DURING THE PERIOD BUT REMAINS UNDERWEIGHT TO THE INDEX, AS THE MANAGER BELIEVES THAT OTHER SPREAD PRODUCTS, SUCH AS MORTGAGES, OFFER BETTER RELATIVE VALUE. THE PORTFOLIO EMPHASIZED HIGH QUALITY LIQUID NAMES, AS LOWER QUALITY CORPORATES OFFERED LITTLE INCREMENTAL RETURN. Although the portfolio holdings and sectors listed above were current as of the end of the annual period ended September 30, 1999, the Portfolio is actively managed and the composition will vary. COMPARISON OF CHANGE IN VALUE OF A $10,000 INVESTMENT IN THE COREBOND PORTFOLIO AND THE LEHMAN BROTHERS AGGREGATE INDEX FROM INCEPTION AND AT EACH FISCAL YEAR END. [GRAPHIC OMITTED] EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
Institutional Service Investor A Investor B Investor C BlackRock Lehman Class Class Class Class Class Class Aggregate Index 12/9/92 $10,000 $10,000 $9,600 $10,000 $10,000 $10,000 $10,000 Dec-92 10,033 10,033 9,631 10,033 10,033 10,033 10,192 Mar-93 10,416 10,416 9,999 10,416 10,416 10,416 10,487 Jun-93 10,688 10,688 10,261 10,688 10,688 10,688 10,751 Sep-93 11,021 11,021 10,581 11,021 11,021 11,021 11,010 Dec-93 11,005 11,005 10,565 11,005 11,005 11,005 11,123 Mar-94 10,715 10,715 10,286 10,715 10,715 10,715 10,574 Jun-94 10,612 10,612 10,188 10,612 10,612 10,612 10,760 Sep-94 10,695 10,695 10,267 10,695 10,695 10,695 10,605 Dec-94 10,749 10,749 10,319 10,749 10,749 10,749 10,866 Mar-95 11,269 11,269 10,818 11,269 11,269 11,269 11,349 Jun-95 11,931 11,931 11,453 11,931 11,931 11,931 11,848 Sep-95 12,166 12,166 11,680 12,166 12,166 12,166 12,265 Dec-95 12,703 12,703 12,195 12,703 12,703 12,703 12,707 Mar-96 12,405 12,399 11,900 12,396 12,396 12,405 12,329 Jun-96 12,473 12,466 11,957 12,432 12,432 12,473 12,503 Sep-96 12,722 12,706 12,182 12,642 12,642 12,722 12,980 Dec-96 13,157 13,134 12,584 13,035 13,035 13,157 13,120 Mar-97 13,121 13,088 12,534 12,940 12,940 13,121 13,007 Jun-97 13,563 13,523 13,026 13,604 13,604 13,564 13,484 Sep-97 14,002 13,950 13,432 14,003 14,003 14,009 13,932 Dec-97 14,348 14,283 13,748 14,305 14,305 14,360 14,342 Mar-98 14,580 14,503 13,954 14,493 14,493 14,599 14,562 Jun-98 14,926 14,836 14,268 14,791 14,791 14,950 14,903 Sep-98 15,483 15,377 14,783 15,297 15,297 15,514 15,534 Dec-98 15,520 15,403 14,801 15,287 15,287 15,557 15,586 Mar-99 15,498 15,371 14,762 15,219 15,219 15,542 15,507 Jun-99 15,346 15,220 14,600 15,024 15,020 15,353 15,236 Sep-99 15,457 15,319 14,687 14,633 15,081 15,469 15,339
For period ending September 30, 1999 - -------------------------------------------------------------------------------- AVERAGE ANNUAL TOTAL RETURN 1 Year 3 Year 5 Year From Inception BlackRock Class (0.02)% 6.83% 7.72% 6.66% Institutional Class (0.17)% 6.70% 7.64% 6.60% Service Class (0.47)% 6.38% 7.42% 6.44% Investor A Class (Load Adjusted) (4.59)% 4.76% 6.41% 5.71% Investor A Class (NAV) (0.64)% 6.19% 7.29% 6.34% Investor B Class (Load Adjusted) (5.83)% 4.15% 6.28% 5.92% Investor B Class (NAV) (1.38)% 5.40% 6.71% 5.92% Investor C Class (Load Adjusted) (2.37)% 5.40% 6.71% 5.92% Investor C Class (NAV) (1.38)% 5.40% 6.71% 5.92% - -------------------------------------------------------------------------------- The performance information above includes information relating to each class of the Portfolio since the commencement of operations of the Portfolio, rather than the date such class was introduced. The inception dates of the Portfolio's share classes were as follows: Institutional Shares, 12/9/92; Service Shares, 1/12/96; Investor A Shares, 1/31/96; Investor B Shares, 3/18/96; Investor C Shares, 2/28/97; and BlackRock Shares, 5/1/97. See "Note on Performance Information" on page 12 for further information on how performance data was calculated. Past performance is not predictive of future results. 6 BLACKROCK FUNDS GOVERNMENT INCOME PORTFOLIO TOTAL ASSETS (9/30/99): $43.9 MILLION PERFORMANCE BENCHMARK: LEHMAN BROTHERS MORTGAGE/MERRILL LYNCH 10-YEAR TREASURY INDEX INVESTMENT APPROACH: SEEKS CURRENT INCOME CONSISTENT WITH THE PRESERVATION OF CAPITAL BY INVESTING IN SECURITIES ISSUED BY THE U.S. GOVERNMENT OR GOVERNMENT AGENCY OR RATED AAA BY A MAJOR RATING AGENCY. THE PORTFOLIO EMPHASIZES SECURITIES WITH MATURITIES FROM 10 TO 15 YEARS. RECENT PORTFOLIO MANAGEMENT ACTIVITY: . IN SHARP CONTRAST TO THE FIRST NINE MONTHS OF 1998, TREASURY YIELDS ROSE SHARPLY DURING THE FIRST SIX MONTHS OF THE PERIOD AND CONTINUED TO INCREASE THROUGH FISCAL YEAR END. FOR THE PERIOD, THE YIELD OF 10-YEAR TREASURY ROSE 147 BASIS POINTS FROM 4.41% ON SEPTEMBER 30, 1998 TO 5.88% ON SEPTEMBER 30, 1999. . THE PORTFOLIO'S MORTGAGE WEIGHTING DECREASED DURING THE FIRST HALF OF THE PERIOD, AS HIGH LEVELS OF PREPAYMENT RESULTED IN CASH COMING INTO THE PORTFOLIO. THE MANAGER REDEPLOYED THESE PROCEEDS INTO TREASURIES AND SPREAD PRODUCTS SUCH AS COMMERCIAL MORTGAGE-BACKED SECURITIES. PREPAYMENT FEARS SUBSIDED TOWARDS THE END OF THE PERIOD AS INTEREST RATES ROSE, AND THE RESULTANT DECREASE IN NEW ISSUANCE PROVIDED A FAVORABLE TECHNICAL ENVIRONMENT FOR MORTGAGES. Although the portfolio holdings and sectors listed above were current as of the end of the annual period ended September 30, 1999, the Portfolio is actively managed and the composition will vary. COMPARISON OF CHANGE IN VALUE OF A $10,000 INVESTMENT IN THE GOVERNMENT INCOME PORTFOLIO AND THE LEHMAN BROTHERS MORTGAGE INDEX/MERRILL LYNCH 10-YEAR TREASURY INDEX FROM INCEPTION AND AT EACH FISCAL YEAR END. [GRAPHIC OMITTED] EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
Investor A Investor B Investor C Lehman Brothers Mortgage Index/ Class Class Class Merrill Lynch 10 Year Treasury Index 10/3/94 $9,550 $10,000 $10,000 $10,000 Dec-94 9,541 9,975 9,975 10,037 Mar-95 10,024 10,462 10,462 10,588 Jun-95 10,718 11,168 11,168 11,335 Sep-95 10,912 11,350 11,350 11,537 Dec-95 11,353 11,793 11,793 12,059 Mar-96 11,132 11,536 11,536 11,779 Jun-96 11,156 11,540 11,540 11,887 Sep-96 11,393 11,766 11,766 12,108 Dec-96 11,740 12,101 12,101 12,497 Mar-97 11,713 12,052 12,052 12,368 Jun-97 12,171 12,499 12,499 12,502 Sep-97 12,588 12,904 12,904 12,906 Dec-97 12,975 13,277 13,277 13,212 Mar-98 13,182 13,464 13,464 13,410 Jun-98 13,510 13,774 13,774 13,641 Sep-98 13,988 14,235 14,235 14,002 Dec-98 14,012 14,233 14,233 13,281 Mar-99 13,894 14,086 14,086 13,132 Jun-99 13,693 13,855 13,855 12,889 Sep-99 13,793 13,651 13,930 12,973
For period ending September 30, 1999 - -------------------------------------------------------------------------------- AVERAGE ANNUAL TOTAL RETURN 1 Year 3 Year From Inception Investor A Class (Load Adjusted) (5.83)% 4.96% 6.65% Investor A Class (NAV) (1.40)% 6.58% 7.64% Investor B Class (Load Adjusted) (6.58)% 4.54% 6.44% Investor B Class (NAV) (2.14)% 5.79% 6.87% Investor C Class (Load Adjusted) (3.12)% 5.79% 6.87% Investor C Class (NAV) (2.14)% 5.79% 6.87% - -------------------------------------------------------------------------------- The performance information above includes information relating to each class of the Portfolio since the commencement of operations of the Portfolio, rather than the date such class was introduced. The inception dates of the Portfolio's share classes were as follows: Investor A Shares, 10/3/94; Investor B Shares, 10/3/94; and Investor C Shares, 2/28/97. See "Note on Performance Information" on page 12 for further information on how performance data was calculated. Past performance is not predictive of future results. 7 BLACKROCK FUNDS GNMA PORTFOLIO TOTAL ASSETS (9/30/99): $111.5 MILLION PERFORMANCE BENCHMARK: LEHMAN GNMA INDEX INVESTMENT APPROACH: SEEKS CURRENT INCOME CONSISTENT WITH THE PRESERVATION OF CAPITAL BY INVESTING IN SECURITIES ISSUED BY THE GOVERNMENT NATIONAL MORTGAGE ASSOCIATION ("GNMAS"), AS WELL AS OTHER U.S. GOVERNMENT SECURITIES. RECENT PORTFOLIO MANAGEMENT ACTIVITY: . IN SHARP CONTRAST TO THE FIRST NINE MONTHS OF 1998, TREASURY YIELDS ROSE SHARPLY DURING THE PAST TWELVE MONTHS. FOR THE PERIOD, THE YIELD OF THE 10- YEAR TREASURY ROSE 147 BASIS POINTS FROM 4.41% ON SEPTEMBER 30, 1998 TO 5.88% ON SEPTEMBER 30, 1999. . THE PORTFOLIO REMAINED PRIMARILY INVESTED IN GNMA MORTGAGE PASS- THROUGHS OVER THE PERIOD. AFTER PARING THE PORTFOLIO'S PASS-THROUGH HOLDINGS DURING LATE 1998, THE MANAGER INCREASED MORTGAGE HOLDINGS DURING THE FIRST QUARTER OF 1999 DUE TO THEIR WIDE YIELD SPREADS AND ATTRACTIVE VALUE. . THE MANAGER INITIATED MINOR POSITIONS IN AAA-RATED NON-PREPAYMENT SENSITIVE COMMERCIAL MORTGAGE-BACKED SECURITIES AND ASSET-BACKED SECURITIES, WHICH THE MANAGER BELIEVED TO REPRESENT EXCELLENT VALUE DUE TO THEIR HIGH CREDIT QUALITY, DOMESTIC PROFILE AND WIDE YIELD SPREADS. Although the portfolio holdings and sectors listed above were current as of the end of the annual period ended September 30, 1999, the Portfolio is actively managed and the composition will vary. COMPARISON OF CHANGE IN VALUE OF A $10,000 INVESTMENT IN THE GNMA INCOME PORTFOLIO AND THE LEHMAN GNMA INDEX FROM INCEPTION AND AT EACH FISCAL YEAR END. [GRAPHIC OMITTED] EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
Institutional Service Investor A Investor B Investor C Lehman Class Class Class Class Class GNMA Index 9/1/86 $10,000 $10,000 $9,550 $10,000 $10,000 $10,000 Dec-86 10,296 10,289 9,822 10,265 10,265 10,357 Mar-87 10,411 10,396 9,919 10,348 10,348 10,588 Jun-87 10,251 10,228 9,756 10,158 10,158 10,450 Sep-87 10,265 10,234 9,757 10,141 10,141 10,191 Dec-87 10,407 10,368 9,880 10,250 10,250 10,801 Mar-88 10,684 10,636 10,132 10,491 10,491 11,256 Jun-88 10,883 10,826 10,308 10,654 10,654 11,461 Sep-88 11,009 10,943 10,415 10,744 10,744 11,719 Dec-88 11,149 11,074 10,536 10,848 10,848 11,754 Mar-89 11,192 11,109 10,564 10,857 10,857 11,888 Jun-89 11,633 11,537 10,967 11,250 11,250 12,865 Sep-89 11,673 11,569 10,992 11,255 11,255 13,052 Dec-89 12,063 11,947 11,347 11,596 11,596 13,597 Mar-90 12,170 12,044 11,434 11,664 11,664 13,593 Jun-90 12,350 12,213 11,590 11,800 11,800 14,109 Sep-90 12,473 12,325 11,691 11,881 11,881 14,285 Dec-90 13,090 12,925 12,255 12,431 12,431 15,036 Mar-91 13,442 13,262 12,570 12,727 12,727 15,498 Jun-91 13,652 13,460 12,751 12,887 12,887 15,801 Sep-91 14,417 14,204 13,451 13,569 13,569 16,659 Dec-91 15,188 14,952 14,153 14,251 14,251 17,448 Mar-92 14,951 14,708 13,916 13,986 13,986 17,314 Jun-92 15,594 15,329 14,498 14,544 14,544 17,998 Sep-92 16,125 15,839 14,974 14,994 14,994 18,562 Dec-92 16,208 15,908 15,033 15,024 15,024 18,741 Mar-93 16,824 16,501 15,586 15,549 15,549 19,275 Jun-93 17,214 16,871 15,929 15,861 15,861 19,636 Sep-93 17,430 17,070 16,111 16,042 16,012 19,785 Dec-93 17,481 17,108 16,140 16,071 16,010 19,974 Mar-94 16,843 16,470 15,531 15,465 15,378 19,491 Jun-94 16,658 16,278 15,343 15,278 15,163 19,384 Sep-94 16,743 16,348 15,403 15,337 15,193 19,544 Dec-94 16,863 16,453 15,495 15,429 15,256 19,674 Mar-95 17,811 17,365 16,348 16,278 16,065 20,712 Jun-95 18,849 18,364 17,281 17,207 16,950 21,807 Sep-95 19,228 18,718 17,608 17,533 17,239 22,294 Dec-95 19,853 19,313 18,159 18,081 17,745 23,029 Mar-96 19,692 19,142 17,990 17,913 17,548 22,957 Jun-96 19,829 19,261 18,094 18,017 17,617 23,120 Sep-96 20,211 19,617 18,420 18,341 17,901 23,606 Dec-96 20,790 20,164 18,927 18,846 18,359 24,303 Mar-97 20,814 20,172 18,927 18,846 18,324 24,335 Jun-97 21,606 20,924 19,625 19,541 18,964 25,284 Sep-97 22,280 21,561 20,214 20,127 19,497 26,029 Dec-97 22,672 21,924 20,545 20,457 19,779 26,620 Mar-98 22,888 22,116 20,716 20,627 19,907 27,051 Jun-98 23,384 22,574 21,136 21,046 20,277 27,509 Sep-98 23,922 23,077 21,599 21,507 20,682 28,212 Dec-98 24,192 23,322 21,817 21,683 20,852 28,463 Mar-99 24,379 23,485 21,959 21,783 20,948 28,747 Jun-99 24,600 23,680 22,133 21,914 21,074 29,009 Sep-99 24,320 23,393 21,856 20,734 20,770 28,887
For period ending September 30, 1999 - -------------------------------------------------------------------------------- AVERAGE ANNUAL TOTAL RETURN 1 Year 3 Year 5 Year From Inception Institutional Class 1.14% 6.68% 7.95% 7.71% Service Class 0.84% 6.35% 7.62% 7.39% Investor A Class (Load Adjusted) (3.35)% 4.73% 6.56% 6.74% Investor A Class (NAV) 0.67% 6.17% 7.44% 7.21% Investor B Class (Load Adjusted) (4.56)% 4.13% 6.22% 6.41% Investor B Class (NAV) (0.09)% 5.39% 6.65% 6.41% Investor C Class (Load Adjusted) (1.13)% 5.39% 6.65% 6.41% Investor C Class (NAV) (0.09)% 5.39% 6.65% 6.41% - -------------------------------------------------------------------------------- In connection with the conversion of various common trust funds maintained by PNC Bank and PNC Bank, Delaware ("PNC-DE"), an affiliate of PNC Bank, into the Fund between May 1 and May 15, 1998 (the "CTF Conversion"), the GNMA Portfolio was established to receive the assets of the GNMA Fund of PNC Bank. Performance information presented for this Portfolio includes performance for the predecessor common trust fund which transferred its assets and liabilities to the related Portfolio pursuant to the CTF Conversion. Performance information presented is based upon the performance of the GNMA Fund for periods prior to the CTF Conversion. Past performance is not predictive of future results. 8 BLACKROCK FUNDS MANAGED INCOME PORTFOLIO TOTAL ASSETS (9/30/99): $1.5 BILLION PERFORMANCE BENCHMARK: LEHMAN BROTHERS AGGREGATE INDEX INVESTMENT APPROACH: SEEKS CURRENT INCOME CONSISTENT WITH THE PRESERVATION OF CAPITAL BY INVESTING IN SECURITIES RATED BBB OR HIGHER BY A MAJOR RATING AGENCY OR DEEMED BY THE MANAGER TO BE OF COMPARABLE CREDIT QUALITY. THE PORTFOLIO EMPHASIZES SECURITIES WITH MATURITIES FROM 5 TO 10 YEARS. RECENT PORTFOLIO MANAGEMENT ACTIVITY: . IN SHARP CONTRAST TO THE FIRST NINE MONTHS OF 1998, TREASURY YIELDS ROSE SHARPLY DURING THE PAST TWELVE MONTHS. FOR THE PERIOD, THE YIELD OF THE 10- YEAR TREASURY ROSE 147 BASIS POINTS FROM 4.41% ON SEPTEMBER 30, 1998 TO 5.88% ON SEPTEMBER 30, 1999. . CONSISTENT WITH THE PORTFOLIO'S INCOME BIAS, THE MANAGER MAINTAINED OVERWEIGHT POSITIONS VERSUS THE INDEX IN SPREAD SECTORS. THE PORTFOLIO INCREASED ITS OVERALL MORTGAGE SECURITY EXPOSURE, FOCUSING ON MORTGAGE PASS-THROUGHS, DUE TO WIDENING YIELD SPREADS DURING THE BEGINNING OF THE PERIOD. . THE PORTFOLIO'S AGGREGATE CORPORATE BOND AND ASSET-BACKED SECURITY EXPOSURE REMAINS OVERWEIGHT RELATIVE TO THE INDEX AFTER BEING MODESTLY REDUCED DURING THE FIRST SIX MONTH PERIOD AND SLIGHTLY INCREASED DURING THE LAST SIX MONTH PERIOD. WITHIN THE PORTFOLIO'S CORPORATE WEIGHTING, THE MANAGER EMPHASIZED LOWER-RATED INVESTMENT GRADE SECURITIES IN THE BEGINNING OF THE PERIOD, BUT HAS SINCE EMPHASIZED HIGH QUALITY LIQUID NAMES AS LOWER RATED SECURITIES PROVIDED LITTLE INCREMENTAL RETURN. Although the portfolio holdings and sectors listed above were current as of the end of the annual period ended September 30, 1999, the Portfolio is actively managed and the composition will vary. COMPARISON OF CHANGE IN VALUE OF A $10,000 INVESTMENT IN THE MANAGED INCOME PORTFOLIO AND THE LEHMAN BROTHERS AGGREGATE INDEX FROM INCEPTION AND AT EACH FISCAL YEAR END. [GRAPHIC OMITTED] EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
Institutional Service Investor A Investor B Investor C Lehman Brothers Class Class Class Class Class Aggregate Index 11/1/89 $10,000 $10,000 $ 9,550 $10,000 $10,000 $10,000 Dec-89 10,105 10,105 9,650 10,000 10,000 10,027 Mar-90 10,004 10,004 9,554 9,900 9,900 9,946 Jun-90 10,306 10,306 9,843 10,199 10,199 10,309 Sep-90 10,380 10,380 9,913 10,272 10,272 10,397 Dec-90 10,943 10,943 10,451 10,830 10,830 10,923 Mar-91 11,161 11,161 10,659 11,045 11,045 11,227 Jun-91 11,259 11,259 10,752 11,142 11,142 11,411 Sep-91 11,910 11,910 11,374 11,786 11,786 12,059 Dec-91 12,580 12,580 12,014 12,449 12,449 12,671 Mar-92 12,290 12,290 11,737 12,162 12,162 12,509 Jun-92 12,749 12,749 12,175 12,617 12,617 13,014 Sep-92 13,316 13,316 12,717 13,177 13,177 13,574 Dec-92 13,323 13,323 12,724 13,185 13,185 13,609 Mar-93 14,022 14,022 13,391 13,876 13,876 14,172 Jun-93 14,457 14,457 13,806 14,306 14,306 14,549 Sep-93 14,935 14,940 14,263 14,780 14,780 14,928 Dec-93 14,881 14,862 14,186 14,701 14,701 14,936 Mar-94 14,370 14,343 13,690 14,186 14,186 14,507 Jun-94 14,110 14,079 13,422 13,909 13,909 14,357 Sep-94 14,145 14,104 13,440 13,927 13,927 14,445 Dec-94 14,215 14,166 13,492 13,981 13,981 14,500 Mar-95 14,894 14,835 14,122 14,634 14,634 15,231 Jun-95 15,744 15,671 14,909 15,449 15,449 16,159 Sep-95 16,022 15,935 15,153 15,702 15,702 16,477 Dec-95 16,701 16,602 15,778 16,350 16,350 17,179 Mar-96 16,369 16,260 15,443 16,003 16,003 16,872 Jun-96 16,437 16,315 15,490 16,051 16,051 16,969 Sep-96 16,716 16,580 15,734 16,304 16,304 17,281 Dec-96 17,277 17,123 16,243 16,831 16,831 17,800 Mar-97 17,227 17,060 16,177 16,762 16,763 17,701 Jun-97 17,848 17,663 16,740 17,346 17,346 18,351 Sep-97 18,432 18,228 17,267 17,892 17,893 18,960 Dec-97 18,913 18,689 17,697 18,338 18,338 19,517 Mar-98 19,189 18,949 17,936 18,585 18,586 19,818 Jun-98 19,692 19,432 18,384 19,050 19,015 20,282 Sep-98 20,137 19,856 18,778 19,457 19,386 21,140 Dec-98 20,292 19,993 18,900 19,582 19,475 21,212 Mar-99 20,304 19,989 18,888 19,570 19,426 21,103 Jun-99 20,097 19,769 18,673 19,312 19,426 20,918 Sep-99 20,252 19,907 18,796 18,723 19,426 21,060
For period ending September 30, 1999 - -------------------------------------------------------------------------------- AVERAGE ANNUAL TOTAL RETURN 1 Year 3 Year 5 Year From Inception Institutional Class 0.57% 6.60% 7.44% 7.38% Service Class 0.26% 6.28% 7.13% 7.19% Investor A Class (Load Adjusted) (4.40)% 4.47% 5.95% 6.57% Investor A Class (NAV) 0.09% 6.10% 6.93% 7.06% Investor B Class (Load Adjusted) (5.16)% 4.31% 6.18% 6.90% Investor B Class (NAV) (0.66)% 5.56% 6.61% 6.90% - -------------------------------------------------------------------------------- The performance information above includes information relating to each class of the Portfolio since the commencement of operations of the Portfolio, rather than the date such class was introduced. The inception dates of the Portfolio's share classes were as follows: Institutional Shares, 11/1/89; Investor A Shares, 2/5/92; Service Shares, 7/29/93; and Investor B Shares, 7/15/97. See "Note on Performance Information" on page 12 for further information on how performance data was calculated. The comparative index from previous years has changed from the Salomon Broad Investment Grade Index to the Lehman Aggregate to more accurately reflect the type of holdings of Managed Income. Past performance is not predictive of future results. 9 BLACKROCK FUNDS INTERNATIONAL BOND PORTFOLIO TOTAL ASSETS (9/30/99): $70.3 MILLION PERFORMANCE BENCHMARK: SALOMON NON-U.S. HEDGED WORLD GOVERNMENT BOND INDEX INVESTMENT APPROACH: PURSUES CURRENT INCOME CONSISTENT WITH THE PRESERVATION OF CAPITAL BY INVESTING IN INVESTMENT GRADE INTERNATIONAL FIXED INCOME SECURITIES. RECENT PORTFOLIO MANAGEMENT ACTIVITY: . DURING THE PERIOD, BOND YIELDS GENERALLY FELL IN JAPAN, EUROPE AND THE DOLLAR BLOC (CANADA AND AUSTRALIA), WHILE U.S. BOND YIELDS ROSE. . THE PORTFOLIO REMAINED PREDOMINANTLY CURRENCY HEDGED INTO U.S. DOLLARS, ALTHOUGH THE MANAGER ESTABLISHED A MODEST LONG EURO POSITION VERSUS THE DOLLAR AND THE YEN. . OVER THE PERIOD THE PORTFOLIO WAS REWARDED FOR ITS OVERWEIGHT POSITION TO CONTINENTAL EUROPE AND THE UNITED KINGDOM, WHICH PERFORMED WELL DUE TO LACK OF INFLATIONARY PRESSURE AND THE CONTINUED EASING OF MONETARY POLICY IN THOSE MARKETS. THE PORTFOLIO BENEFITED FROM ITS SIGNIFICANT UNDERWEIGHT POSITION TO JAPAN DURING THE BEGINNING OF THE PERIOD. THE MANAGER INCREASED THE PORTFOLIO'S WEIGHTING IN JAPAN DURING THE PERIOD AS THAT MARKET SHOWED SIGNS OF RECOVERY, BUT REMAINS UNDERWEIGHT VERSUS THE INDEX. Although the portfolio holdings and sectors listed above were current as of the end of the annual period ended September 30, 1999, the Portfolio is actively managed and the composition will vary. COMPARISON OF CHANGE IN VALUE OF A $10,000 INVESTMENT IN THE INTERNATIONAL BOND PORTFOLIO AND THE SALOMON NON-U.S. HEDGED WORLD GOVERNMENT BOND INDEX FROM INCEPTION AND AT EACH FISCAL YEAR END. [GRAPHIC OMITTED] EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
Institutional Service Investor A Investor B Investor C Salomon Non-U.S. Hedged Class Class Class Class Class World Government Bond Index 7/1/91 $10,000 $10,000 $ 9,500 $10,000 $10,000 $10,000 Sep-91 10,360 10,360 9,894 10,360 10,360 10,482 Dec-91 10,600 10,600 10,123 10,600 10,600 10,090 Mar-92 10,470 10,470 9,999 10,470 10,470 10,846 Jun-92 11,008 11,008 10,513 11,008 11,008 11,157 Sep-92 11,298 11,298 10,789 11,298 11,298 11,581 Dec-92 11,254 11,254 10,747 11,254 11,254 11,766 Mar-93 11,717 11,717 11,190 11,717 11,717 12,169 Jun-93 12,116 12,116 11,571 12,116 12,116 12,483 Sep-93 12,689 12,689 12,118 12,689 12,689 12,932 Dec-93 12,977 12,977 12,393 12,977 12,977 13,225 Mar-94 12,715 12,715 12,143 12,715 12,715 12,803 Jun-94 12,453 12,453 11,892 12,453 12,453 12,561 Sep-94 12,369 12,369 11,812 12,369 12,369 12,580 Dec-94 12,496 12,496 11,933 12,496 12,496 12,732 Mar-95 13,545 13,545 12,936 13,545 13,545 13,323 Jun-95 14,054 14,054 13,421 14,054 14,054 14,016 Sep-95 14,302 14,302 13,658 14,302 14,302 14,427 Dec-95 14,998 14,998 14,323 14,998 14,998 15,032 Mar-96 15,051 15,051 14,374 15,051 15,051 15,011 Jun-96 15,395 15,394 14,697 15,370 15,370 15,291 Sep-96 16,002 15,989 15,259 15,928 15,928 15,797 Dec-96 16,590 16,558 15,793 16,442 16,442 16,340 Mar-97 16,762 16,717 15,938 16,562 16,562 16,458 Jun-97 17,335 17,276 16,378 17,078 17,078 16,988 Sep-97 17,859 17,783 16,853 17,539 17,539 17,565 Dec-97 18,294 18,203 17,244 17,911 17,911 18,069 Mar-98 18,777 18,671 17,679 18,328 18,328 18,527 Jun-98 19,112 18,988 17,972 18,597 18,597 18,955 Sep-98 20,092 19,947 18,872 19,529 19,492 19,942 Dec-98 20,395 20,232 19,135 19,800 19,726 20,052 Mar-99 20,697 20,518 19,397 20,071 19,958 20,395 Jun-99 20,519 20,327 19,209 19,838 19,729 20,266 Sep-99 20,474 20,266 19,143 19,141 19,624 20,167
For period ending September 30, 1999 - -------------------------------------------------------------------------------- AVERAGE ANNUAL TOTAL RETURN 1 Year 3 Year 5 Year From Inception Institutional Class 1.91% 8.56% 10.61% 9.07% Service Class 1.60% 8.22% 10.38% 8.93% Investor A Class (Load Adjusted) (3.63)% 6.21% 9.12% 8.18% Investor A Class (NAV) 1.43% 8.04% 10.25% 8.85% Investor B Class (Load Adjusted) (3.89)% 5.94% 9.23% 8.51% Investor B Class (NAV) 0.67% 7.21% 9.67% 8.51% Investor C Class (Load Adjusted) (0.34)% 7.21% 9.67% 8.51% Investor C Class (NAV) 0.67% 7.21% 9.67% 8.51% - -------------------------------------------------------------------------------- The performance information above includes information relating to each class of the Portfolio since the commencement of operations of the Portfolio, rather than the date such class was introduced. The inception dates of the Portfolio's share classes were as follows: Service Shares, 7/1/91; Investor B Shares, 4/19/96; Investor A Shares, 4/22/96; Institutional Shares, 6/10/96; and Investor C Shares, 9/11/96. See "Note on Performance Information" on page 12 for further information on how performance data was calculated. Past performance is not predictive of future results. 10 BLACKROCK FUNDS HIGH YIELD BOND PORTFOLIO TOTAL ASSETS (9/30/99): $91.6 MILLION PERFORMANCE BENCHMARK: LEHMAN HIGH YIELD INDEX INVESTMENT APPROACH: SEEKS CURRENT INCOME BY INVESTING PRIMARILY IN NON-INVESTMENT GRADE SECURITIES (RATED C OR HIGHER OR DEEMED TO BE OF COMPARABLE QUALITY) WHICH YIELD A HIGH LEVEL OF CURRENT INCOME. RECENT PORTFOLIO MANAGEMENT ACTIVITY: . SINCE THE PORTFOLIO'S INCEPTION IN NOVEMBER 1998 THE HIGH YIELD MARKET HAS PERFORMED WELL AS YIELD SPREADS HAVE NARROWED COMPARED TO TREASURIES. INVESTORS CONTINUE TO EMPHAZISE HIGHER QUALITY NON-INVESTMENT GRADE CREDITS INSTEAD OF LOWER TIER CREDITS. THE MANAGER HAS TAKEN ADVANTAGE OF THIS DURING THE PERIOD BY FOCUSING ON B-RATED CREDITS, WHERE YIELD SPREADS CONTINUE TO TIGHTEN, WHILE UNDERWEIGHTING CCC-RATED SECURITIES. . THE PORTFOLIO HAS BENEFITED FROM BEING OVERWEIGHT RELATIVE TO THE INDEX IN THE TELECOM, OIL AND GAS AND CABLE SECTORS. PARTICULAR EMPHASIS HAS BEEN PLACED ON THESE SECTORS AS IMPROVING FUNDAMENTALS AND THE POTENTIAL FOR CONSOLIDATION CONTINUE TO BE A MAJOR CONTRIBUTOR TO THEIR STRONG PERFORMANCE. THE PORTFOLIO HAS BEEN UNDERWEIGHT THE HEALTHCARE AND TEXTILE SECTORS, WHICH HAVE BEEN WEAK PERFORMERS. . THE MANAGER BELIEVES THAT THE SUPPLY AND DEMAND TECHNICALS OF THE HIGH YIELD MARKET APPEAR TO BE FAVORABLE, AS STRONG MONEY INFLOWS AND LOWER SUPPLY RELATIVE TO LAST YEAR MAY BODE WELL FOR HIGH YIELD INVESTORS. Although the portfolio holdings and sectors listed above were current as of the end of the annual period ended September 30, 1999, the Portfolio is actively managed and the composition will vary. COMPARISON OF CHANGE IN VALUE OF A $10,000 INVESTMENT IN THE HIGH YIELD BOND PORTFOLIO AND THE LEHMAN HIGH YIELD INDEX FROM INCEPTION AND AT EACH MONTH-END. [GRAPHIC OMITTED] EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
Institutional Service Investor A Investor B Investor C BlackRock Lehman High Class Class Class Class Class Class Yield Index 11/19/98 $10,000 $10,000 $9,500 $10,000 $10,000 $10,000 $10,000 12/31/98 10,128 10,106 9,616 10,113 10,113 10,110 10,160 1/31/99 10,395 10,370 9,866 10,369 10,369 10,378 10,310 2/28/99 10,380 10,351 9,847 10,343 10,343 10,363 10,250 3/31/99 10,466 10,435 9,926 10,418 10,418 10,451 10,347 4/30/99 10,853 10,819 10,289 10,794 10,794 10,840 10,548 5/31/99 10,586 10,551 10,032 10,517 10,517 10,576 10,405 6/30/99 10,622 10,584 10,062 10,542 10,542 10,613 10,383 7/31/99 10,637 10,597 10,072 10,547 10,547 10,630 10,425 8/31/99 10,599 10,557 10,032 10,498 10,498 10,593 10,309 9/30/99 10,592 10,548 10,022 10,010 10,377 10,587 10,235
For period ending September 30, 1999 - -------------------------------------------------------------------------------- TOTAL RETURN From Inception BlackRock Class 5.87% Institutional Class 5.93% Service Class 5.47% Investor A Class (Load Adjusted) 0.22% Investor A Class (NAV) 5.50% Investor B Class (Load Adjusted) 0.06% Investor B Class (NAV) 4.78% Investor C Class (Load Adjusted) 3.64% Investor C Class (NAV) 4.69% - -------------------------------------------------------------------------------- The performance information above includes information relating to each class of the Portfolio since the commencement of operations of the Portfolio, rather than the date such class was introduced. The inception dates of the Portfolio's share classes were as follows: BlackRock Shares; Institutional Shares; Service Shares; Investor A Shares; Investor B Shares; and Investor C Shares, 11/19/98. See "Note on Performance Information" on page 12 for further information on how performance data was calculated. Past performance is not predictive of future results. 11 BLACKROCK FUNDS NOTE ON PERFORMANCE INFORMATION The performance information above includes information for each class of each Portfolio since the commencement of operations of the Portfolio, rather than the date such class was introduced. Performance information for each class introduced after the commencement of operations of a Portfolio is therefore based on the performance history of a predecessor class or predecessor classes. If a class of shares in a Portfolio (the "Subsequent Class") has more than one predecessor class, the performance data predating the introduction of the Subsequent Class is based initially on the performance of the Portfolio's first operational predecessor class (the "Initial Class"); thereafter, the performance of the Subsequent Class is based upon the performance of any other predecessor class or classes which were introduced after the Initial Class and which had total operating expenses more similar to those of the Subsequent Class. In the case of Investor A, Investor B, Investor C and Service Shares, the performance information for periods prior to their introduction dates has not been restated to reflect the shareholder servicing and processing and/or distribution fees and certain other expenses borne by these share classes which, if reflected, would reduce the performance quoted. Accordingly, the performance information may be used in assessing each Portfolio's performance history but does not reflect how the distinct classes would have performed on a relative basis prior to the introduction of these classes, which would require an adjustment to the ongoing expenses. Performance information is restated to reflect the current maximum front-end sales charge (in the case of Investor A Shares) or the maximum contingent deferred sales charge (in the case of Investor B and Investor C Shares), and assumes the reinvestment of dividends and distributions. The maximum front-end sales charges for Investor A Shares are as follows: Intermediate Government Bond, Intermediate Bond, Core Bond and GNMA -- 4.00%; Government Income and Managed Income -- 4.50%; International Bond and High Yield Bond -- 5.00%; and Low Duration Bond -- 3.00%. The maximum contingent deferred sales charge for Investor B Shares and Investor C Shares of all of the Portfolios is 4.50% and 1.00%, respectively. The performance information also reflects fee waivers that subsidize and reduce the total operating expenses of each Portfolio. The Portfolios' returns would have been lower if there were not such waivers. BlackRock Advisors Inc. and the Portfolio's Administrators are under no obligation to waive or continue waiving their fees. 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. - -------------------------------------------------------------------------------- IMPORTANT TAX INFORMATION FOR SHAREHOLDERS OF THE BLACKROCK TAXABLE BOND PORTFOLIOS (UNAUDITED) During the fiscal year ended September 30, 1999, the following Portfolios of the BlackRock Funds declared the following dividends from net realized capital gains: SHORT-TERM LONG-TERM CAPITAL GAIN, CAPITAL GAIN, PER SHARE PER SHARE ------------- ------------- Intermediate Government Bond Portfolio ....... $0.0141 $0.0611 Intermediate Bond Portfolio .................. 0.0524 0.0498 Core Bond Portfolio .......................... 0.2043 -- Government Income Portfolio .................. 0.1635 -- GNMA Portfolio ............................... 0.0184 -- Managed Income Portfolio ..................... 0.1516 -- International Bond Portfolio ................. -- 0.0616 Because the Portfolios' fiscal year is not the calendar year, another notification will be sent with respect to calendar year 1999. The second notification, which reflects the amounts to be used by calendar year taxpayers on their U.S. federal income tax returns, has been made in conjunction with Form 1099-DIV and will be mailed in January 2000. 12 BLACKROCK FUNDS STATEMENT OF NET ASSETS LOW DURATION BOND PORTFOLIO
Par AS OF SEPTEMBER 30, 1999 Maturity (000) Value ---------- ------- ----------- U.S. GOVERNMENT & AGENCY OBLIGATIONS -- 19.5% Small Business Administration Participation Certificates, Series 97, Class A 5.85%** 08/15/22 $ 1,370 $ 1,364,944 U.S. Treasury Bonds 8.75%(DAGGER) 11/15/08 9,067 9,923,229 U.S. Treasury Notes 5.00%(DAGGER) 02/28/01 13,245 13,148,306 5.25%(DAGGER) 05/31/01 4,000 3,977,104 5.75%(DAGGER) 06/30/01 9,760 9,776,653 5.50%(DAGGER) 07/01-05/03 5,045 5,019,022 6.50%(DAGGER) 08/31/01 6,090 6,185,633 6.25% 02/28/02 905 916,636 5.63% 12/31/02 1,400 1,395,152 ----------- TOTAL U.S. GOVERNMENT & AGENCY OBLIGATIONS (Cost $51,798,603) 51,706,679 ----------- MORTGAGE PASS-THROUGHS -- 31.4% Federal Home Loan Mortgage Corp. 5.81%** 10/01/00 8,290 8,196,711 7.25% 07/06-06/08 66 66,618 7.50%(DAGGER) 07/01/07 2,356 2,392,139 8.25% 06/01/09 72 74,470 8.75% 01/01/13 1,326 1,381,189 5.72%** 06/01/28 2,139 2,126,768 Federal Home Loan Mortgage Corp. 5 Year Balloon 7.00%(DAGGER) 05/00-11/00 553 555,585 Federal Home Loan Mortgage Corp. 7 Year Balloon 8.00%(DAGGER) 01/01/04 365 371,191 Federal Home Loan Mortgage Corp. 30 Year Balloon 8.25% 09/01/09 73 75,183 7.50% 04/01/22 733 736,711 6.98% 07/01/27 4,219 4,225,759 Federal Home Loan Mortgage Corp. Gold 7.00% 09/01/11 3,092 3,094,673 Federal National Mortgage Association 6.29% 10/04/00 2,000 2,009,839 6.20%(DAGGER) 02/26/01 5,135 5,117,200 6.73% 02/26/01 605 606,833 6.00% 11/03-01/04 5,938 5,783,043 7.00% 06/01/04 1,931 1,898,264 6.50%(DAGGER) 10/08-11/08 5,619 5,550,817 7.50% 05/01/09 1,321 1,325,284 11.50% 05/01/09 236 260,732 5.50%(DAGGER) 07/01/09 2,891 2,722,515 5.81% 03/01/29 837 816,934 Federal National Mortgage Association 10 Year Balloon 6.00% 12/03-02/04 3,844 3,751,697 Federal National Mortgage Association 15 Year Balloon 7.00% 12/08-09/14 6,772 6,767,794 8.00%(DAGGER) 08/01/09 2,800 2,851,626
Par Maturity (000) Value ---------- ------- ----------- MORTGAGE PASS-THROUGHS (CONTINUED) Government National Mortgage Association 7.25% 04/15/06 $ 431 428,470 8.25%(DAGGER) 08/08-09/08 4,052 4,181,153 7.50% 07/16/22 2,700 2,721,094 8.00% 05/16/24 5,391 5,433,877 Government National Mortgage Association 15 Year 7.00% 07/02-05/12 6,600 6,607,059 Government National Mortgage Association 30 Year 6.50%(DAGGER) 03/24-04/24 1,197 1,151,475 ----------- TOTAL MORTGAGE PASS-THROUGHS (Cost $84,156,010) 83,282,703 ----------- MULTIPLE CLASS MORTGAGE PASS-THROUGHS -- 1.9% Bear Stearns Mortgage Securities, Inc., Series 96-6, Class A2 7.00% 11/25/27 1,292 1,286,986 Residential Accredit Loans, Inc., Series 97-QS7, Class A1 7.50% 07/25/27 403 402,111 Residential Asset Securitization Trust, Series 98-A1, Class A1 7.00% 03/25/28 1,570 1,569,013 Residential Asset Securitization Trust, Series 98-A2, Class A1 6.75%(DOUBLE DAGGER) 04/25/28 1,880 1,876,645 ----------- TOTAL MULTIPLE CLASS MORTGAGE PASS-THROUGHS (Cost $5,147,875) 5,134,755 ----------- COMMERCIAL MORTGAGE BACKED SECURITIES -- 28.0% American Business Financial Services, Series 98-A, Class A 6.10% 10/15/05 3,497 3,470,588 Asset Securitization Corp., Series 97-D5, Class A1A 6.50% 02/14/41 2,985 2,965,915 Bayview Financial Acquisition Trust, Series 98-1, Class AI 7.01% 05/25/29 2,748 2,716,239 Bayview Financial Acquisition Trust, Series 98-1, Class AII 5.64%** 05/25/29 2,307 2,296,141 Bosque Asset Corp., Series 97-1, Class A1 7.66% 06/05/02 1,005 1,004,348 Boston Edison Co., Series 99-1, Class A2 6.00% 09/15/05 2,050 2,018,609 Captec Franchise Trust, Series 99-1, Class A1 6.50% 05/25/05 3,965 3,932,580 Citicorp Mortgage Securities, Inc., Series 94-4, Class A6 6.00% 02/25/09 2,116 2,082,938 Copelco Capital Funding Corp., Series 99-A, Class A3 5.67% 03/15/02 2,700 2,664,742 Donaldson, Lufkin and Jenrette, Inc. Mortgage Acceptance Corp., Series 95-CF2, Class AIA 6.65% 12/17/27 956 961,701
See accompanying notes to financial statements. 13 BLACKROCK FUNDS STATEMENT OF NET ASSETS LOW DURATION BOND PORTFOLIO (CONTINUED)
Par AS OF SEPTEMBER 30, 1999 Maturity (000) Value -------- ----- ----- COMMERCIAL MORTGAGE BACKED SECURITIES (CONTINUED) Donaldson, Lufkin and Jenrette, Inc. Mortgage Acceptance Corp., Series 96-CF2, Class A1A 6.86% 11/12/21 $ 2,108 $ 2,105,465 Franchise Loan Trust, Series 98-1, Class A1 6.24% 07/15/04 2,029 1,991,679 Green Tree Recreational Equipment & Construction, Series 98-C, Class A4 6.17% 02/15/11 2,300 2,279,156 Huntton Paige, Series 99-1 7.43% 03/01/19 2,800 2,810,664 ICI Funding Corp. Small Business Administration Loan-Backed Adjustable Rate Certificates, Series 97-1, Class A 6.00%** 01/15/24 2,272 2,249,685 J.P. Morgan Commercial Mortgage Finance Corp., Series 97, Class D 6.36%** 07/25/29 2,000 1,970,000 Merit Securities Corp., Series 98-11, Class 2A2 5.66%** 11/28/22 4,172 4,168,975 Morgan Stanley Capital International, Inc., Series 98-CF1, Class A1 6.33% 10/15/07 1,203 1,166,776 Mortgage Capital Funding, Inc., Series 98-MC2, Class A1 6.33% 10/18/07 2,873 2,791,664 Navistar Financial Corp Owner Trust, Series 99-A, Class A3 5.95% 04/15/03 3,950 3,922,844 PNC Mortgage Securities Corp., Series 97-6, Class A1 6.49% 10/25/26 2,948 2,946,525 Prudential Home Mortgage Securities, Inc., Series 94-19, Class A2 7.05% 05/25/24 3,532 3,537,292 Reilly Mortgage Securities, Series 99-1 7.43% 02/01/23 264 266,168 Republic Bank Home Loan Owner Trust, Series 98-1, Class A1 6.61% 04/25/07 588 585,904 Residential Funding Mortgage Securities, Series 98-NS1, Class A2 6.38% 01/25/09 2,153 2,139,763 Salomon Brothers Mortgage Securities VII, Series 92-5, Class A1 7.69%** 11/25/22 267 267,178 Salomon Brothers Mortgage Securities VII, Series 96-6B, Class A1 5.73%** 06/30/26 11 10,743 Structured Asset Securities Corp., Series 98-C2A, Class B 5.70%** 01/25/13 3,167 3,165,586 SWB Loan Backed Certificates, Series 98-1, Class AV 5.75%** 09/15/24 2,992 2,976,955 Union Planters Mortgage Finance Corp., Series 98-1, Class A1 6.35% 01/25/28 1,764 1,772,892 Par Maturity (000) Value -------- ----- ----- COMMERCIAL MORTGAGE BACKED SECURITIES (CONTINUED) Wilshire Funding Corp., Series 97, Class A 7.25% 08/25/27 $ 1,553 $ 1,526,758 Wilshire Funding Corp., Series 98-2, Class A3 7.00% 12/28/37 5,662 5,583,874 ----------- TOTAL COMMERCIAL MORTGAGE BACKED SECURITIES (Cost $75,018,985) 74,350,347 ----------- PROJECT LOANS -- 5.4% FEDERAL HOUSING AUTHORITY, GENERAL MOTORS ACCEPTANCE CORP. GRANTOR TRUST, SERIES 97-A, CLASS A 7.14% 01/01/21 12,440 12,473,475 Federal Housing Authority, INSD Project, Series 82 7.43% 09/01/22 1,978 1,988,903 ----------- TOTAL PROJECT LOANS (Cost $14,543,388) 14,462,378 ----------- ASSET BACKED SECURITIES -- 41.5% Amresco Independence Funding, Inc., Series 99-1, Class A 6.50% 06/15/20 3,000 3,000,000 Arcadia Automobile Receivables Trust, Series 98-B, Class A3 5.95%+ 11/15/02 6,650 6,654,522 Banc One Auto Grantor Trust, Series 97-A, Class A 6.27% 11/20/03 298 299,986 Barnett Auto Trust, Series 97-A, Class A3 6.03%+ 11/15/01 4,078 4,143,323 Chevy Chase Auto Receivables Trust, Series 97-3, Class A 6.20% 03/20/04 2,280 2,295,547 Dayton Hudson Credit Card Master Trust, Series 97-1, Class A 6.25% 08/25/05 2,300 2,248,810 Fifth Third Auto Grantor Trust, Series 96-B, Class A 6.45% 03/15/02 260 260,833 First Security Auto Grantor Trust, Series 97-A, Class A 6.30% 08/15/03 2,006 2,016,501 First Security Auto Owner Trust, Series 99-2, Class A3 6.00% 10/15/03 4,150 4,130,547 FMAC Loan Receivables Trust, Series 98-CA, Class A1 5.99% 11/15/04 2,139 2,081,463 Ford Credit Auto Owner Trust, Series 99-A, Class A4 5.31% 11/15/01 3,700 3,664,156 Ford Credit Auto Owner Trust, Series 99-C, Class A4 6.08% 09/16/02 4,175 4,158,039 Green Tree Financial Corp., Series 95-A, Class A 7.25% 07/15/05 1,975 1,872,618
See accompanying notes to financial statements. 14 BLACKROCK FUNDS STATEMENT OF NET ASSETS LOW DURATION BOND PORTFOLIO (CONTINUED)
Par AS OF SEPTEMBER 30, 1999 Maturity (000) Value -------- ----- ----- ASSET BACKED SECURITIES (CONTINUED) Green Tree Financial Corp., Series 96-10, Class A4 6.42% 11/15/28 $ 3,139 $ 3,146,751 Green Tree Recreational Equipment & Consumer Trust, Series 97-C, Class A1 6.49% 02/15/18 1,877 1,867,745 Health Care Receivables Securitization Program Notes, NPF VI, Series 98-1, Class A 6.22% 06/01/02 3,300 3,253,331 Honda Auto Lease Trust, Series 99-A, Class A4 6.45% 09/16/02 5,500 5,509,453 Honda Auto Receivables Grantor Trust, Series 98-A, Class A 5.50% 07/15/04 3,286 3,246,847 Missouri Higher Education Loan Authority, Series 97, Class P 5.40%** 07/25/08 3,209 3,166,974 Newcourt Equipment Trust Securities, Series 98-1, Class A3 5.24% 12/20/02 4,250 4,197,295 Nissan Auto Receivables Owner Trust, Series 99-A, Class A3 6.47% 09/15/03 2,275 2,240,875 PBG Equipment Trust, Series 1A, Class A 6.27% 01/20/12 1,376 1,344,562 PMC Capital Limited Partnership, Series 98-1, Class A 6.75%** 04/01/21 4,105 4,104,948 PMC Capital Small Business Administration Loan-Backed Adjustable Rate Certificates, Series 97-1, Class A 6.35%** 09/15/23 1,681 1,664,311 PMC Capital Small Business Administration Loan-Backed Adjustable Rate Certificates, Series 97-1, Class B 6.70%** 09/15/23 894 896,067 Ryder Vehicle Lease Trust, Series 98-A, Class A 6.10% 09/15/08 4,430 4,413,514 Sears Credit Account Master Trust, Series 95-5, Class A 6.05% 01/15/08 3,000 2,955,662 Sears Credit Account Master Trust, Series 97-1, Class A 6.20% 07/16/07 4,030 4,003,865 The Money Store Auto Grantor Trust, Series 97-4, Class A2 6.35% 03/20/04 1,121 1,127,458 The Money Store Business Loan Backed Securities, Series 97-1, Class A 5.53%** 01/15/25 371 370,268 5.65%** 04/15/28 3,083 3,092,608 The Money Store Business Loan Backed Securities, Series 97-1, Class B 6.02%** 01/15/25 1,855 1,838,005 Par Maturity (000) Value -------- ----- ----- ASSET BACKED SECURITIES (CONTINUED) The Money Store Home Equity Trust, Series 98-A, Class MH2 7.23% 05/15/24 $ 2,000 $ 1,873,033 The Money Store Residential Trust, Series 97-II, Class A1 6.65% 11/15/07 216 215,979 Toyota Auto Receivables Owner Trust, Series 99-A, Class A3 6.15% 08/16/04 7,775 7,750,703 USAA Auto Loan Grantor Trust, Series 99-1, Class A 6.10% 02/15/06 5,107 5,086,558 World Omni Automobile Lease Securitization Trust, Series 96-B, Class A3 6.25% 11/15/02 5,973 5,982,508 ------------ TOTAL ASSET BACKED SECURITIES (Cost $110,861,897) 110,175,665 ------------ CORPORATE BONDS -- 10.4% FINANCE -- 7.6% Diageo Capital PLC 6.63% 06/24/04 1,250 1,246,875 Donaldson, Lufkin and Jenrette, Inc. 5.88% 04/01/02 2,900 2,838,375 Firstar Corp. 6.50% 07/15/02 2,700 2,686,627 Goldman Sachs Escrow Corp., Series 144A 6.75% 08/01/01 3,000 2,954,160 Popular North America, Inc. 6.88% 06/15/01 2,550 2,541,435 TransAmerica Finance Corp. 7.25% 08/15/02 4,550 4,585,791 US West Capital Funding, Inc. 6.88% 08/15/01 3,435 3,435,000 ------------ 20,288,263 ------------ INDUSTRIAL -- 0.9% Nabisco, Inc. 6.00% 02/15/01 1,720 1,701,533 Williams Cos., Inc. 6.13% 02/01/01 660 657,525 ------------ 2,359,058 ------------ INSURANCE -- 0.6% METROPOLITAN LIFE INSURANCE CO. 6.30% 11/01/03 1,640 1,590,800 ------------ PIPELINES -- 0.5% El Paso Energy Corp. 6.63% 07/15/01 1,420 1,420,000 ------------ UTILITY -- 0.3% Avon Energy Partnership 6.73% 12/11/02 690 686,550 ------------
See accompanying notes to financial statements. 15 BLACKROCK FUNDS STATEMENT OF NET ASSETS LOW DURATION BOND PORTFOLIO (CONTINUED)
Par AS OF SEPTEMBER 30, 1999 Maturity (000) Value -------- ----- ----- CORPORATE BONDS (CONTINUED) YANKEE -- 0.5% Banco Internacional S.A. 6.03% 07/16/01 $ 1,227 $ 1,225,145 Nordbanken 5.91%** 10/25/01 150 146,850 ------------ 1,371,995 ------------ TOTAL CORPORATE BONDS (Cost $27,784,853) 27,716,666 ------------ FOREIGN BONDS -- 0.7% Newcourt Credit Group 7.63% 06/28/01 2,700 1,859,549 (Cost $1,875,343) ------------ TAXABLE MUNICIPAL BONDS -- 0.2% PHILADELPHIA AUTHORITY INDUSTRIAL DEVELOPMENT TAX CLAIM COLLECTION REVENUE BOND, SERIES 97A 6.49% 06/15/04 538 521,876 (Cost $537,835) ------------ Shares ------ SHORT TERM INVESTMENTS -- 0.2% Galileo Money Market Fund (Cost $443,042) 443,042 443,042 ------------ TOTAL INVESTMENTS IN SECURITIES (Cost $372,167,831*) 139.2% 369,653,660 Par (000) ----- REVERSE REPURCHASE AGREEMENTS -- (39.7%) Aubrey Lanston (Agreement dated 09/30/99 to be repurchased at $2,631,934. Collateralized by $2,600,000 U.s. Treasury Notes 5.25% due 05/31/01. the value of the collateral Is $2,655,824.) 5.25% 10/07/99 $ 2,629 (2,629,633) Commerzbank (Agreement dated 09/24/99 to be repurchased at $6,225,822. Collateralized by $6,090,000 U.S. Treasury Notes 6.50% due 08/31/01. The value of the collateral is $6,219,346.) 5.30% 10/01/99 6,219 (6,225,822) Lehman Brothers (Agreement dated 09/27/99 to be repurchased at $1,299,563. Collateralized by $1,295,000 U.S. Treasury Notes 5.50% due 07/31/01. The value of the collateral is $1,304,205.) 5.25% 10/04/99 1,298 (1,298,995) Lehman Brothers (Agreement dated 09/29/99 to be repurchased at $23,109,145. Collateralized by $23,005,000 U.S. Treasury Notes 5.00-5.75% due 02/28/01 to 06/30/01. The value of the collateral is $23,123,699.) 5.34% 10/06/99 23,085 (23,092,024) Par Maturity (000) Value -------- ----- ----- REVERSE REPURCHASE AGREEMENTS (CONTINUED) Lehman Brothers (Agreement dated 09/29/99 to be repurchased at $6,013,633. Collateralized by $6,000,000 U.S. Treasury Notes 5.50% due 08/31/01. The value of the collateral is $5,995,207.) 5.25% 10/06/99 $ 6,008 $ (6,009,252) Lehman Brothers (Agreement dated 09/29/99 to be repurchased at $10,221,359. Collateralized by $9,067,000 U.S. Treasury Bonds 8.75% due 11/15/08. The value of the collateral is $10,222,896.) 5.29% 10/13/99 10,200 (10,203,373) Lehman Brothers (Agreement dated 09/17/99 to be repurchased at $7,558,617. Collateralized by $7,908,008 Federal National Mortgage Association 5.50-6.50% due 11/01/08 to 07/01/09. The value of the collateral is $7,735,568.) 5.38% 10/19/99 7,526 (7,538,372) Lehman Brothers (Agreement dated 09/20/99 to be repurchased at $8,570,985. Collateralized by $8,289,973 Federal Home Loan Mortgage Corp. 5.80% due 07/01/01 and $602,674 Federal National Mortgage Association 6.50% due 10/01/05. The value of the collateral is $8,818,276.) 5.38% 10/19/99 8,534 (8,548,029) Lehman Brothers (Agreement dated 09/27/99 to be repurchased at $5,344,605. Collateralized by $6,650,000 Arcadia Automobile Receivables Trust 5.95% due 11/15/02. The value of the collateral is $6,672,108.) 5.55% 10/29/99 5,320 (5,321,640) Morgan Stanley (Agreement dated 09/15/99 to be repurchased at $5,459,909. Collateralized by $5,740,314 Federal National Mortgage Association 6.20-6.725% due 02/26/01. The value of the collateral is $5,753,957.) 5.46% 10/14/99 5,436 (5,449,191) Morgan Stanley (Agreement dated 09/28/99 to be repurchased at $7,433,233. Collateralized by $7,629,752 Federal National Mortgage Association 7.00-8.00% due 12/01/08 to 08/01/09. The value of the collateral is $7,726,711.) 5.40% 10/18/99 7,411 (7,414,335)
See accompanying notes to financial statements. 16 BLACKROCK FUNDS STATEMENT OF NET ASSETS LOW DURATION BOND PORTFOLIO (CONCLUDED)
Par AS OF SEPTEMBER 30, 1999 Maturity (000) Value ---------- --------- ------------- REVERSE REPURCHASE AGREEMENTS (CONTINUED) Morgan Stanley (Agreement dated 09/17/99 to be repurchased at $11,484,466. Collateralized by $2,356,062 Federal Home Loan Bank 7.50% due 07/01/07, $5,310,258 Federal National Mortgage Association 6.00% due 01/01/04 and $4,051,996 Government National Mortgage Association 8.25% due 08/15/08 to 09/15/08. The value of the collateral is $11,821,586.) 5.37% 10/19/99 $ 11,435 $(11,453,763) Salomon Brothers (Agreement dated 09/09/99 to be repurchased at $3,731,157. Collateralized by $4,077,634 Barnett Auto Trust 6.03% due 11/15/01 and $442,032 Federal National Mortgage Association 7.00% due 12/01/08. The value of the collateral is $4,598,724.) 5.63% 10/12/99 3,712 (3,724,771) Salomon Brothers (Agreement dated 09/15/99 to be repurchased at $5,423,316. Collateralized by $918,259 Federal Home Loan Mortgage Corp. Gold 7.00-8.00% due 05/01/00 to 01/01/04 and $4,866,440 Federal National Mortgage Association 6.00-7.00% due 12/01/03 to 06/01/04. The value of the collateral is $5,709,767.) 5.36% 10/14/99 5,400 (5,412,864) Salomon Brothers (Agreement dated 09/15/99 to be repurchased at $1,136,888. Collateralized by $1,213,909 Government National Mortgage Association 6.50-7.25% due 04/15/06 to 04/15/24. The value of the collateral is $1,188,262.) 5.36% 10/14/99 1,132 (1,134,697) ------------ TOTAL REVERSE REPURCHASE AGREEMENTS (Cost $105,345,950) (105,456,761) OTHER ASSETS IN EXCESS OF LIABILITIES 0.5% 1,267,396 -------- ------------ NET ASSETS (Applicable to 8,079,707 BlackRock shares, 16,047,318 Institutional shares, 1,718,517 Service shares, 264,237 Investor A shares, 768,840 Investor B shares and 159,937 Investor C shares outstanding) 100% $265,464,295 ======== ============ Value ------------- NET ASSET VALUE AND REDEMPTION PRICE PER BLACKROCK, INSTITUTIONAL, SERVICE AND INVESTOR A SHARE ($256,345,512/26,109,779) $ 9.82 ============ OFFERING PRICE PER BLACKROCK, INSTITUTIONAL AND SERVICE SHARE $ 9.82 ============ MAXIMUM OFFERING PRICE PER INVESTOR A SHARE ($9.82/.970) $ 10.12 ============ NET ASSET VALUE, OFFERING PRICE AND REDEMPTION PRICE (SUBJECT TO A MAXIMUM CONTINGENT DEFERRED SALES CHARGE OF 4.5%) PER INVESTOR B SHARE ($7,548,548/768,840) $ 9.82 ============ NET ASSET VALUE, OFFERING PRICE AND REDEMPTION PRICE (SUBJECT TO A MAXIMUM CONTINGENT DEFERRED SALES CHARGE OF 1.0%) PER INVESTOR C SHARE ($1,570,235/159,937) $ 9.82 ============ ____________________ * Cost for Federal income tax purposes is $372,533,490. The gross unrealized appreciation (depreciation) on a tax basis is as follows: Gross unrealized appreciation $ 296,259 Gross unrealized depreciation (3,176,089) ----------- $(2,879,830) ===========
** Rates shown are the rates as of September 30, 1999. + Partial principal in the amount of $108,114,311 has been pledged as collateral for reverse repurchase agreements. ++ Principal amount of securities pledged as collateral of $1,000,000 on 60 long U.S. Treasury Notes futures contracts and 353 short U.S. Treasury Notes futures contracts expiring December 1999. The value of such contracts on September 30, 1999 was $50,741,344, thereby resulting in an unrealized loss of $80,898. See accompanying notes to financial statements. 17 BLACKROCK FUNDS STATEMENT OF NET ASSETS INTERMEDIATE GOVERNMENT BOND PORTFOLIO Par AS OF SEPTEMBER 30, 1999 Maturity (000) Value -------- ----------- ----------- U.S. GOVERNMENT & AGENCY OBLIGATIONS -- 23.9% Federal Home Loan Bank Bonds 5.00% 09/20/00 $ 3,000 $ 2,978,737 Small Business Administration Participation Certificates, Series 96-20H, Class 1 7.25% 08/01/16 4,846 4,841,254 Small Business Administration Participation Certificates, Series 96-20J, Class 1 7.20% 10/01/16 4,229 4,218,044 Small Business Administration Participation Certificates, Series 98-20J, Class 1 5.50% 10/01/18 4,856 4,451,629 Small Business Investment Cos. Pass-Through, Series 96-P10A, Class 1 6.67% 02/10/06 4,523 4,474,449 U.S. Treasury Bonds 8.75% 11/15/08 20,890 22,862,716 12.75% 11/15/10 11,925 15,852,188 14.00% 11/15/11 7,730 11,135,680 U.S. Treasury Notes 6.50% 10/15/06 29,670 30,356,944 ----------- TOTAL U.S. GOVERNMENT & AGENCY OBLIGATIONS (Cost $104,836,704) 101,171,641 ----------- MORTGAGE PASS-THROUGHS -- 32.9% Federal Home Loan Mortgage Corp. 9.00% 06/01/01 1 513 7.00% 05/02-05/11 5,056 5,060,450 6.50% 04/01/08 2,997 2,955,319 8.00% 11/01/08 1,591 1,644,195 6.45% 04/29/09 4,100 3,914,021 6.00% 05/15/16 900 892,386 Federal National Mortgage Association 6.08% 10/01/99 5,323 5,268,040 6.20% 02/26/01 942 938,936 6.73% 02/26/01 6,381 6,398,585 8.50% 06/03-08/09 4,351 4,454,912 6.50% 08/03-05/15 32,092 31,563,395 6.13% 11/25/03 2,323 2,276,758 6.09% 10/01/08 7,298 6,869,689 6.04% 02/25/09 4,500 4,199,844 7.27% 01/25/11 6,205 6,262,590 7.00% 05/01/11 6,091 6,089,303 5.50% 01/14-06/14 4,983 4,692,227 7.58% 11/01/18 4,864 4,870,104 6.00% 11/23-02/29 2,925 2,769,211 Federal National Mortgage Association 10 Year Balloon 6.00% 02/01/04 3,490 3,403,613 Federal National Mortgage Association Multi-Family 6.50% 10/25/03 1,508 1,506,663 7.71% 12/01/18 4,250 4,370,522 6.32% 10/01/23 9,646 8,874,334 Par Maturity (000) Value ---------- --------- ------------ MORTGAGE PASS-THROUGHS (CONTINUED) Government National Mortgage Association 7.25% 04/15/06 $ 6,627 $ 6,583,802 8.25% 11/08-02/09 3,745 3,864,525 6.50% 10/23-12/23 8,197 7,842,619 7.00% 12/15/27 566 555,333 MLCC Mortgage Investors, Inc., Series 95-C3, Class A1 6.75% 10/01/99 1,507 1,499,179 ------------ TOTAL MORTGAGE PASS-THROUGHS (Cost $142,739,634) 139,621,068 ------------ MULTIPLE CLASS MORTGAGE PASS-THROUGHS -- 2.7% Federal National Mortgage Association Grantor Trust, Series 96-T6, Class A 6.33% 10/25/00 4,571 4,559,589 General Motors Acceptance Corp. Commercial Mortgage Securities, Inc., Series 97-C1, Class X (IO) 7.84%*** 07/15/27 18,269 1,416,413 General Motors Acceptance Corp. Commercial Mortgage Securities, Inc., Series 97-C2, Class A3 6.57% 11/15/07 2,850 2,736,594 Residential Asset Securitization Trust, Series 98-A1, Class A1 7.00% 03/25/28 2,617 2,615,022 --------- ----------- TOTAL MULTIPLE CLASS MORTGAGE PASS-THROUGHS (Cost $11,544,959) 11,327,618 ----------- COMMERCIAL MORTGAGE BACKED SECURITIES -- 2.7% Atherton Franchisee Loan Funding, Series 98-A, Class A2 6.72% 08/15/10 5,150 4,871,929 General Motors Acceptance Corp. Commercial Mortgage Securities, Inc., Series 99-C2, Class A2 6.95% 09/15/33 1,000 985,117 Morgan Stanley Capital International, Inc., Series 97-HF1, Class A1 6.86% 07/15/29 3,886 3,881,619 Residential Funding Mortgage Securities, Series 96-HS2, Class A4 7.55% 09/25/12 127 126,530 Union Planters Mortgage Finance Corp., Series 98-1, Class A1 6.35% 01/25/28 1,472 1,479,448 ----------- TOTAL COMMERCIAL MORTGAGE BACKED SECURITIES (Cost $11,703,561) 11,344,643 ----------- ROJECT LOANS -- 5.1% Federal Housing Authority, General Motors Acceptance Corp. Grantor Trust, Series 97-A, Class A 7.01% 01/01/21 950 952,177 Federal Housing Authority, General Motors Acceptance Corp., Series 93-1 5.94% 04/14/12 2,001 1,834,846 Federal Housing Authority, Merrill Lynch, Series 29, Class 1A1 7.43% 06/01/22 8,028 8,083,071 See accompanying notes to financial statements. 18 BLACKROCK FUNDS STATEMENT OF NET ASSETS INTERMEDIATE GOVERNMENT BOND PORTFOLIO (CONTINUED)
Par AS OF SEPTEMBER 30, 1999 Maturity (000) Value -------- --------- ------------- PROJECT LOANS (CONTINUED) Federal Housing Authority, Merrill Lynch, Series 97-23 7.43% 12/01/21 $ 5,411 $ 5,449,250 Federal Housing Authority, USGI, Series 56 7.46% 01/01/23 5,309 5,348,333 ------------- TOTAL PROJECT LOANS (Cost $22,060,574) 21,667,677 ------------- ASSET BACKED SECURITIES -- 26.2% ACLC Business Loan Receivables Trust, Series 98-1, Class A1 6.44% 09/15/19 8,861 8,628,611 Boston Edison Co., Series 99-1, Class A4 6.91% 09/15/09 4,475 4,430,997 Chevy Chase Auto Receivables Trust, Series 96-1, Class A 6.60%++ 12/15/02 375 376,390 Chevy Chase Auto Receivables Trust, Series 97-3, Class A 6.20% 03/20/04 1,979 1,992,289 Citibank Credit Card Master Trust I, Series 97-6, Class A (PO) 7.05%*** 08/15/06 8,525 6,090,918 Citibank Credit Card Master Trust I, Series 99-2, Class A 5.88% 03/10/11 2,275 2,103,309 Contimortgage Home Equity Loan Trust, Series 95-1, Class A4 8.60% 04/15/10 635 634,110 Dayton Hudson Credit Card Master Trust, Series 98-1, Class A 5.90% 05/25/06 2,200 2,148,630 DVI Receivables Corp., Series 98-1, Class A2 6.04% 04/10/06 2,193 2,202,804 FMAC Loan Receivables Trust, Series 97-C, Class A 6.75% 12/15/19 4,010 3,890,337 Green Tree Financial Corp., Series 97-5, Class A7 7.13% 05/15/29 3,501 3,278,160 Green Tree Home Improvement Loan Trust, Series 97-C, Class HEA2 6.38% 08/15/28 73 73,127 Health Care Receivables Securitization Program Notes, NPF VI, Series 98-1, Class A 6.22% 06/01/02 4,500 4,436,360 Honda Auto Lease Trust, Series 99-A, Class A4 6.45% 09/16/02 4,100 4,107,047 MBNA Master Credit Card Trust, Series 99-B, Class A 5.90% 08/15/11 3,550 3,337,941 National Premier Financial, Series 97-1, Class A 6.82% 07/01/01 2,300 2,306,828 New Century Home Equity Loan Trust, Series 98-NC3, Class A1 6.00% 08/25/28 2,445 2,433,635 People's Bank Credit Card Master Trust, Series 99-1, Class A 5.67%** 05/15/05 6,300 6,300,000
Par/Shares Maturity (000) Value --------- ---------- ------------- ASSET BACKED SECURITIES (CONTINUED) PMC Capital Small Business Administration Loan-Backed Adjustable Rate Certificates, Series 97-1, Class A 6.35%** 09/15/23 $ 2,802 $ 2,773,852 Sears Credit Account Master Trust, Series 97-1, Class A 6.20% 07/16/07 6,560 6,517,458 Sears Credit Account Master Trust, Series 98-1, Class A 5.80% 08/15/05 10,700 10,524,496 Standard Credit Card Master Trust, Series 94-4, Class A 8.25% 11/07/03 5,000 5,208,353 SWB Loan Backed Certificates, Series 99-1, Class A 7.38% 05/15/25 2,041 2,020,227 The Money Store Home Equity Trust, Series 95-A, Class A8 8.13% 06/15/15 2,902 2,940,331 The Money Store Home Equity Trust, Series 96-B, Class A13 6.90% 04/15/10 204 203,524 The Money Store Residential Trust, Series 98-I, Class A4 6.52% 08/15/15 9,000 8,942,493 The Money Store Small Business Administration Loan Trust, Series 99-1, Class A 5.52%** 07/15/25 3,193 3,166,060 Travelers Bank Credit Card Master Trust, Series 98-1, Class A 6.00% 01/18/05 4,900 4,832,674 Union Acceptance Corp., Series 96-A, Class A 5.40% 04/07/03 1,776 1,762,716 USAA Auto Loan Grantor Trust, Series 99-1, Class A 6.10% 02/15/06 3,638 3,623,302 ------------- TOTAL ASSET BACKED SECURITIES (Cost $112,428,698) 111,286,979 ------------- TAXABLE MUNICIPAL BONDS -- 1.4% New Jersey Economic Development Authority State Pension Funding Zero Coupon Revenue Bond, Series 97, Class B 6.98%*** 02/15/02 1,527 1,297,950 Stanislaus County, California Taxable Pension Obligation Refunding Revenue Bond, Series 95 7.15% 08/15/13 4,645 4,546,294 ------------- TOTAL TAXABLE MUNICIPAL BONDS (Cost $5,953,564) 5,844,244 ------------- SHORT TERM INVESTMENTS -- 5.5% Federal Home Loan Bank Discount Notes 5.17% 10/01/99 15,350 15,350,000 Galileo Money Market Fund 8,004,082 8,004,082 ------------- TOTAL SHORT TERM INVESTMENTS (Cost $23,354,082) 23,354,082 -------------
See accompanying notes to financial statements. 19 BLACKROCK FUNDS STATEMENT OF NET ASSETS INTERMEDIATE GOVERNMENT BOND PORTFOLIO (CONCLUDED) AS OF SEPTEMBER 30, 1999 Value ------------- TOTAL INVESTMENTS IN SECURITIES (Cost $433,621,776*) 100.4% $ 425,617,952 LIABILITIES IN EXCESS OF OTHER ASSETS (0.4%) (1,498,262) ---------- ------------- NET ASSETS (Applicable to 39,317,708 Institutional shares, 2,697,887 Service shares, 731,775 Investor A shares, 81,751 Investor B shares and 47,327 Investor C shares outstanding) 100.0% $ 424,119,690 ========== ============= NET ASSET VALUE AND REDEMPTION PRICE PER INSTITUTIONAL, SERVICE AND INVESTOR A SHARE ($422,842,885/42,747,370) $ 9.89 ============= OFFERING PRICE PER INSTITUTIONAL AND SERVICE SHARE $ 9.89 ============= MAXIMUM OFFERING PRICE PER INVESTOR A SHARE ($9.89/0.960) $ 10.30 ============= NET ASSET VALUE, OFFERING AND REDEMPTION PRICE (SUBJECT TO A CONTINGENT DEFERRED SALES CHARGE OF 4.5%) PER INVESTOR B SHARE ($808,654/81,751) $ 9.89 ============= NET ASSET VALUE, OFFERING AND REDEMPTION PRICE (SUBJECT TO A CONTINGENT DEFERRED SALES CHARGE OF 1.0%) PER INVESTOR C SHARE ($468,151/47,327) $ 9.89 ============= _______________________ * Also cost for Federal income tax purposes. The gross unrealized appreciation (depreciation) on a tax basis is as follows: Gross unrealized appreciation $ 394,370 Gross unrealized depreciation (8,398,194) ----------- $(8,003,824) =========== ** Rates shown are the rates as of September 30, 1999. *** Rates shown are the effective yields as of September 30, 1999. ++ Principal amount of securities pledged as collateral of $2,570,124 on 37 short U.S. Treasury Bonds futures contracts, 30 long U.S. Treasury Notes futures contracts and 168 short U.S. Treasury Notes futures contracts expiring December 1999. The value of such contracts on September 30, 1999 was $25,742,188, thereby resulting in an unrealized gain of $21,282. See accompanying notes to financial statements. 20 BLACKROCK FUNDS STATEMENT OF NET ASSETS INTERMEDIATE BOND PORTFOLIO Par AS OF SEPTEMBER 30, 1999 Maturity (000) Value -------- ------- ----------- U.S. GOVERNMENT & AGENCY OBLIGATIONS -- 18.2% Small Business Administration Participation Certificates, Series 92-20H, Class 1 7.40% 08/01/12 $ 3,186 $ 3,206,678 Small Business Administration Participation Certificates, Series 96-20H, Class 1 7.25% 08/01/16 5,526 5,520,728 Small Business Investment Cos. Pass-Through, Series 96-P10A, Class 1 6.67% 02/10/06 3,034 3,001,494 Small Business Investment Cos. Pass-Through, Series 97-P10D, Class 1 6.51% 11/01/07 1,000 967,771 U.S. Treasury Bonds 8.75%+ 11/15/08 21,380 23,398,988 12.75%+ 11/15/10 11,625 15,453,390 14.00% 11/15/11 2,420 3,486,203 5.25% 02/15/29 660 577,250 U.S. TREASURY NOTES 5.50%+ 07/31/01 5,350 5,338,518 5.63% 12/31/02 2,460 2,451,482 5.88% 11/15/05 950 944,872 6.50%+ 10/15/06 34,300 35,094,141 ----------- TOTAL U.S. GOVERNMENT & AGENCY OBLIGATIONS (Cost $100,305,664) 99,441,515 ----------- MORTGAGE PASS-THROUGHS -- 16.0% Federal Home Loan Mortgage Corp. 5.81%** 07/01/01 9,498 9,391,001 9.50% 01/01/05 126 133,384 9.00% 01/05-12/16 75 78,223 8.50% 07/01/06 13 13,653 7.25% 12/01/06 391 389,062 6.50% 04/01/08 3,879 3,824,530 8.00%+ 07/08-09/18 5,013 5,154,088 6.45% 04/29/09 5,000 4,773,196 Federal Home Loan Mortgage Corp. Gold 7.00% 09/01/11 6,236 6,241,798 Federal National Mortgage Association 6.20%+ 02/26/01 5,182 5,164,146 6.00%+ 01/04-07/14 3,781 3,669,247 9.50% 03/01/05 7 7,796 8.00%+ 03/01/08 2,299 2,319,585 6.04% 02/25/09 5,600 5,226,473 7.50%+ 05/01/09 1,748 1,754,052 8.50% 08/01/09 5,514 5,645,199 7.27% 01/25/11 3,250 3,280,235 7.00% 05/01/11 7,768 7,765,258 5.50%+ 12/13-06/14 7,292 6,866,160 Federal National Mortgage Association 10 Year Balloon 6.00% 02/01/04 2,678 2,611,500 Government National Mortgage Association 7.25%+ 04/15/06 1,183 1,175,071 8.25%+ 08/08-11/08 5,907 6,095,563 9.50% 05/16-11/16 189 202,692 8.50% 02/17-03/17 1,608 1,674,442 6.50% 10/23-12/23 4,473 4,278,878 ----------- TOTAL MORTGAGE PASS-THROUGHS (Cost $88,764,547) 87,735,232 ----------- Par Maturity (000) Value -------- ------- ----------- MULTIPLE CLASS MORTGAGE PASS-THROUGHS -- 3.7% Amresco Securitized Net Interest Margin Trust, Series 96-1, Class A 8.10% 04/26/26 $ 1,004 $ 953,397 Federal Home Loan Mortgage Corp., Series 96T-2, Class A 7.00%+ 01/25/21 3,472 3,428,928 Federal National Mortgage Association Grantor Trust, Series 96-T6, Class A 6.33%+ 10/25/00 2,838 2,830,602 Federal National Mortgage Association Strip Notes, Series 279, Class 1 (PO) 6.92%*** 07/01/26 386 309,094 Federal National Mortgage Association, Series 89-16, Class B (PO) 8.79%*** 03/25/19 1,123 825,205 General Motors Acceptance Corp. Commercial Mortgage Securities, Inc., Series 97-C1, Class X (IO) 7.84%*** 07/15/27 27,177 2,107,102 General Motors Acceptance Corp. Commercial Mortgage Securities, Inc., Series 97-C2, Class A3 6.57% 11/15/07 4,325 4,152,901 MLCC Mortgage Investors, Inc., Series 95-C1, Class C 7.58%** 05/25/15 2,022 2,001,568 Residential Asset Securitization Trust, Series 98-A1, Class A1 7.00% 03/25/28 2,617 2,615,022 Residential Asset Securitization Trust, Series 98-A2, Class A1 6.75% 04/25/28 1,245 1,242,176 ----------- TOTAL MULTIPLE CLASS MORTGAGE PASS-THROUGHS (Cost $21,061,144) 20,465,995 ----------- COMMERCIAL MORTGAGE BACKED SECURITIES -- 13.3% Asset Securitization Corp., Series 97-D5, Class A1A 6.50% 02/14/41 6,163 6,123,543 Atherton Franchisee Loan Funding, Series 98-A, Class A2 6.72% 08/15/10 6,000 5,676,034 Bayview Financial Acquisition Trust, Series 98-1, Class AI 7.01% 05/25/29 3,237 3,198,893 Bayview Financial Acquisition Trust, Series 98-1, Class AII 5.64%** 05/25/29 2,374 2,363,057 Bosque Asset Corp., Series 97-1, Class A1 7.66% 06/05/02 1,005 1,004,348 Chase Commercial Mortgage Securities Corp., Series 97-2, Class A1 6.45% 12/19/04 704 688,633 Commercial Mortgage Asset Trust, Series 99-C1, Class A1 6.25% 08/17/06 487 472,960 Deutsche Mortgage and Asset Receiving Corp., Series 98-C1, Class A1 6.22% 09/15/07 284 277,047 Franchise Loan Trust, Series 98-1, Class A1 6.24% 07/15/04 3,784 3,713,652 See accompanying notes to financial statements. 21 BLACKROCK FUNDS STATEMENT OF NET ASSETS INTERMEDIATE BOND PORTFOLIO (CONTINUED) Par AS OF SEPTEMBER 30, 1999 Maturity (000) Value -------- ------- ----------- COMMERCIAL MORTGAGE BACKED SECURITIES (CONTINUED) General Motors Acceptance Corp., Series 97 7.43% 02/21/21 $ 968 $ 974,357 General Motors Acceptance Corp. Commercial Mortgage Securities, Inc., Series 99-C2, Class A2 6.95% 09/15/33 825 812,722 ICI Funding Corp. Secured Assets Corp., Series 97-1, Class A10 7.75% 03/25/28 3,400 3,432,832 ICI Funding Corp. Small Business Administration Loan-Backed Adjustable Rate Certificates, Series 97-1, Class A 6.00%** 01/15/24 2,538 2,512,135 J.P. Morgan Commercial Mortgage Finance Corp., Series 97, Class D 6.36%** 07/25/29 4,000 3,940,000 Lehman Brothers Commercial Conduit Mortgage Trust, Series 96-C2, Class A 7.43%** 10/25/26 8,160 8,280,529 Master Financial Asset Securitization Trust, Series 98-2, Class A3 6.60% 11/20/18 6,000 5,831,250 Merit Securities Corp., Series 98-11, Class 2A2 5.66%** 11/28/22 5,245 5,241,755 Morgan Stanley Capital International, Inc., Series 97-HF1, Class A1 6.86% 07/15/29 4,393 4,387,917 Morgan Stanley Capital International, Inc., Series 98-CF1, Class A1 6.33% 10/15/07 2,359 2,288,676 NYC Mortgage Loan Trust, Series 96, Class A1 6.75% 06/25/06 3,923 3,919,320 Republic Bank Home Loan Owner Trust, Series 98-1, Class A1 6.61% 04/25/07 588 585,904 Salomon Brothers Mortgage Securities VII, Series 96-6B, Class A1 5.73%** 06/30/26 7 7,285 Structured Asset Securities Corp., Series 98-C2A, Class B 5.70%** 01/25/13 3,410 3,409,093 Union Planters Mortgage Finance Corp., Series 98-1, Class A1 6.35% 01/25/28 3,358 3,374,608 ----------- TOTAL COMMERCIAL MORTGAGE BACKED SECURITIES (Cost $73,735,926) 72,516,550 ----------- PROJECT LOANS -- 4.0% FEDERAL HOUSING AUTHORITY, MERRILL LYNCH, SERIES 97-23 7.43% 12/01/21 17,123 17,242,401 Federal Housing Authority, USGI, Series 56 7.46% 01/01/23 4,787 4,822,270 ----------- TOTAL PROJECT LOANS (Cost $22,267,002) 22,064,671 ----------- Par Maturity (000) Value -------- ------- ----------- ASSET BACKED SECURITIES -- 26.1% ACLC Business Loan Receivables Trust, Series 98-1, Class A1 6.44% 09/15/19 $ 3,171 $ 3,088,135 Associates Manufactured Housing Pass- Through, Series 96-1, Class B1 8.00% 03/15/27 4,200 4,007,062 Barnett Auto Trust, Series 97-A, Class A3 6.03% 11/15/01 1,046 1,062,390 Boston Edison Co., Series 99-1, Class A4 6.91% 09/15/09 5,500 5,445,918 Chevy Chase Auto Receivables Trust, Series 97-1, Class A 6.50% 10/15/03 3,794 3,745,806 Chevy Chase Auto Receivables Trust, Series 97-3, Class A 6.20% 03/20/04 2,017 2,030,676 Citibank Credit Card Master Trust I, Series 97-6, Class A (IO) 7.05%*** 08/15/06 10,450 7,466,287 Citibank Credit Card Master Trust I, Series 99-2, Class A 5.88% 03/10/11 3,025 2,796,707 Dayton Hudson Credit Card Master Trust, Series 97-1, Class A 6.25% 08/25/05 4,000 3,910,974 DVI Receivables Corp., Series 98-1, Class A2 6.04% 04/10/06 4,386 4,405,608 FMAC Loan Receivables Trust, Series 97-C, Class A 6.75% 12/15/19 6,817 6,613,575 FMAC Loan Receivables Trust, Series 98-CA, Class A1 5.99% 11/15/04 3,572 3,476,258 Green Tree Financial Corp., Series 94-B, Class A 7.85% 07/15/04 2,444 2,393,729 Green Tree Financial Corp., Series 96-7, Class A6 7.65% 10/15/27 3,300 3,346,922 Green Tree Financial Corp., Series 96-9, Class B1 7.65% 01/15/28 4,000 3,740,613 Green Tree Financial Corp., Series 98-1, Class D 6.35%** 06/15/29 5,800 5,655,586 Green Tree Recreational Equipment & Consumer Trust, Series 97-C, Class A1 6.49% 02/15/18 5,632 5,603,236 Health Care Receivables Securitization Program Notes, NPF VI, Series 98-1, Class A 6.22% 06/01/02 4,400 4,337,774 Honda Auto Lease Trust, Series 99-A, Class A4 6.45% 09/16/02 5,050 5,058,680 MBNA Master Credit Card Trust, Series 99-B, Class A 5.90% 08/15/11 4,400 4,137,166 Mellon Bank Home Equity Loan Trust, Series 96-1, Class B2 5.69%** 04/15/26 871 870,824 National Premier Financial, Series 97-1, Class A 6.82% 07/01/01 3,000 3,008,906 See accompanying notes to financial statements. 22 BLACKROCK FUNDS STATEMENT OF NET ASSETS INTERMEDIATE BOND PORTFOLIO (CONTINUED) Par AS OF SEPTEMBER 30, 1999 Maturity (000) Value -------- ------- ----------- ASSET BACKED SECURITIES (CONTINUED) PBG Equipment Trust, Series 1A, Class A 6.27% 01/20/12 $ 8,068 $ 7,885,675 PMC Capital Limited Partnership, Series 98-1, Class A 6.75%** 04/01/21 2,413 2,413,316 PMC Capital Small Business Administration Loan-Backed Adjustable Rate Certificates, Series 97-1, Class A 6.35%** 09/15/23 4,598 4,551,753 Puget Power Conservation Grantor Trust, Series 97-1, Class A 6.23% 07/11/02 2,536 2,526,802 Sears Credit Account Master Trust, Series 95-5, Class A 6.05% 01/15/08 5,000 4,926,103 Sears Credit Account Master Trust, Series 97-1, Class A 6.20% 07/16/07 6,055 6,015,733 Standard Credit Card Master Trust, Series 94-4, Class A 8.25% 11/07/03 1,650 1,718,756 SWB Loan Backed Certificates, Series 99-1, Class A 7.38% 05/15/25 2,655 2,628,729 The Money Store Home Equity Trust, Series 95-A, Class A8 8.13% 06/15/15 2,435 2,467,513 The Money Store Small Business Administration Loan Trust, Series 99-1, Class A 5.52%** 07/15/25 3,967 3,933,590 Travelers Bank Credit Card Master Trust, Series 98-1, Class A 6.00% 01/18/05 5,800 5,720,308 Union Acceptance Corp., Series 96-A, Class A 5.40% 04/07/03 1,770 1,757,167 USAA Auto Loan Grantor Trust, Series 99-1, Class A 6.10% 02/15/06 10,075 10,033,759 ----------- TOTAL ASSET BACKED SECURITIES (Cost $144,789,580) 142,782,036 ----------- CORPORATE BONDS -- 35.1% AUTOMOTIVE -- 1.0% DAIMLERCHRYSLER HOLDINGS N.A. 6.90% 09/01/04 5,620 5,648,100 ----------- FINANCE -- 18.5% American General Financial Corp. 8.13% 08/15/09 2,250 2,379,375 Associates Corp. 5.75% 11/01/03 3,430 3,297,259 Bear Stearns Capital Trust Investments 7.00% 01/15/27 5,100 5,025,094 Chrysler Financial Co. 5.25% 10/22/01 4,130 4,031,086 Citicorp 6.38% 11/15/08 1,710 1,618,087 Crestar Financial Corp. 8.25% 07/15/02 3,200 3,328,000 Crown Cork & Seal, S.A. 6.75% 12/15/03 2,000 1,961,234 Den Danske Bank 6.38%** 06/15/08 5,600 5,173,000 Par Maturity (000) Value -------- ------- ----------- CORPORATE BONDS (CONTINUED) FINANCE (CONTINUED) Equitable Life Surplus 6.95% 12/01/05 $ 1,750 $ 1,718,575 ERAC USA Finance Co. 6.95% 03/01/04 1,375 1,353,302 Firstar Corp. 6.50% 07/15/02 2,480 2,467,717 Ford Motor Credit Co. 6.50% 02/28/02 5,850 5,828,062 5.80% 01/12/09 2,810 2,560,612 General Motors Acceptance Corp. 6.85% 06/17/04 400 399,769 5.85% 01/14/09 1,705 1,557,944 Goldman Sachs Group 6.65% 05/15/09 5,485 5,228,975 Household Finance Corp. 7.00% 08/01/03 2,400 2,398,977 J.P. Morgan & Co., Inc. 6.77%** 02/15/12 3,700 3,244,530 KeyBank N.A. 5.80% 04/01/04 2,200 2,105,963 Lehman Brothers Holdings, Inc. 8.75% 05/15/02 3,940 4,084,598 Marsh & McLennan Cos., Inc. 6.63% 06/15/04 6,295 6,216,313 Merrill Lynch & Co., Inc. 6.00% 02/17/09 2,800 2,576,000 Newcourt Credit Group 7.13% 12/17/03 5,035 5,061,786 Popular North America, Inc. 6.88% 06/15/01 4,950 4,933,374 Provident Companies, Inc. 7.41% 03/15/38 3,780 3,264,404 Raytheon Co. 6.30% 03/15/05 4,300 4,122,625 TransAmerica Finance Corp. 7.25% 08/15/02 7,125 7,181,047 TXU Eastern Funding Co. 6.15% 05/15/02 3,810 3,723,051 U.S. Bancorp 6.50% 06/15/04 4,140 4,078,491 ----------- 100,919,250 ----------- INDUSTRIAL -- 9.8% Anixter, Inc. 8.00%++ 09/15/03 4,350 4,133,198 Atlantic Richfield 10.88% 07/15/05 2,960 3,496,500 Coca-Cola Enterprises, Inc. 5.71% 03/18/37 5,000 5,001,550 Cox Enterprises, Inc. 6.63% 06/14/02 2,820 2,794,084 Federated Department Stores 6.13%** 09/01/01 3,230 3,201,738 Litton Industries, Inc. 6.05% 04/15/03 4,100 3,987,250 Monsanto Co. 5.75% 12/01/05 4,125 3,856,875 Nabisco, Inc. 6.70% 06/15/02 4,200 4,152,246 6.85% 06/15/05 300 289,956 Rohm & Haas Co. 6.95% 07/15/04 2,520 2,526,300 Southdown, Inc. 10.00% 03/01/06 2,850 3,097,893 Tyco Intl. Group Corp., S.A. 5.88% 11/01/04 5,865 5,557,088 See accompanying notes to financial statements. 23 BLACKROCK FUNDS STATEMENT OF NET ASSETS INTERMEDIATE BOND PORTFOLIO (CONTINUED) Par AS OF SEPTEMBER 30, 1999 Maturity (000) Value -------- ------- ----------- CORPORATE BONDS (CONTINUED) INDUSTRIAL (CONTINUED) Union Carbide Corp. 6.75% 04/01/03 $ 2,100 $ 2,047,500 United Technologies Corp. 7.00% 09/15/06 4,170 4,173,261 Williams Holdings of Delaware 6.13% 12/01/03 5,650 5,387,282 ----------- 53,702,721 ----------- INSURANCE -- 0.6% Metropolitan Life Insurance Co. 6.30% 11/01/03 3,265 3,167,050 ----------- PIPELINES -- 0.5% El Paso Energy Corp. 6.63% 07/15/01 2,745 2,745,000 ----------- TELECOMMUNICATIONS -- 0.5% Sprint Capital Corp. 6.13% 11/15/08 3,010 2,799,300 ----------- UTILITY -- 1.9% National Rural Utilities 5.00% 10/01/02 4,620 4,428,362 US West Capital Funding, Inc. 6.25% 07/15/05 6,440 6,098,422 ----------- 10,526,784 ----------- WASTE MANAGEMENT -- 0.1% USA Waste Management, Inc. 6.13% 07/15/01 825 793,031 ----------- YANKEE -- 2.1% Nordbanken 5.91%** 10/25/01 4,950 4,846,05 Swedbank 7.50%** 09/29/49 2,200 1,975,38 Yorkshire Power Finance 6.15% 02/25/03 5,100 4,888,60 ----------- 11,710,035 ----------- TOTAL CORPORATE BONDS (Cost $197,365,608) 192,011,271 ----------- TAXABLE MUNICIPAL BONDS -- 2.6% New Jersey Economic Development Authority State Pension Funding Zero Coupon Revenue Bond, Series 97-B 6.94%*** 02/15/05 2,900 1,979,250 New York State Power Authority and General Purpose Revenue Bond, Series 98-B 6.11%** 02/15/11 5,600 5,530,000 Philadelphia Authority Industrial Development Tax Claim Collection Revenue Bond, Series 97-A 6.49% 06/15/04 6,860 6,653,916 ----------- TOTAL TAXABLE MUNICIPAL BONDS (Cost $14,471,744) 14,163,166 ----------- Shares ------- SHORT TERM INVESTMENTS -- 0.0% Galileo Money Market Fund (Cost $119,644) 119,644 119,644 ----------- TOTAL INVESTMENTS IN SECURITIES (Cost $662,880,859*) 119.1% 651,300,080 ----------- Par Maturity (000) Value -------- ------- ----------- REVERSE REPURCHASE AGREEMENTS -- (19.0%) Aubrey Lanston (Agreement dated 09/28/99 to be repurchased at $5,174,827. Collateralized by $4,900,000 U.S. Treasury Notes 6.50% due 10/15/06. The value of the collateral is $5,160,512.) 5.30% 10/05/99 $ 5,170 $(5,171,783) Aubrey Lanston (Agreement dated 09/30/99 to be repurchased at $6,945,333. Collateralized by $6,600,000 U.S. Treasury Notes 6.50% due 10/15/06. The value of the collateral is $6,971,217.) 5.25% 10/07/99 6,938 (6,939,262) Lehman Brothers (Agreement dated 09/27/99 to be repurchased at $5,368,850. Collateralized by $5,350,000 U.S. Treasury Notes 5.50% due 7/31/01. The value of the collateral is $5,388,093.) 5.25% 10/04/99 5,363 (5,366,504) Lehman Brothers (Agreement dated 09/27/99 to be repurchased at $10,162,181. Collateralized by $9,600,000 U.S. Treasury Notes 6.50% due 10/15/06. The value of the collateral is $10,110,391.) 5.25% 10/12/99 10,140 (10,145,915) Lehman Brothers (Agreement dated 09/29/99 to be repurchased at $45,144,381. Collateralized by $21,380,000 U.S. Treasury Bonds 8.75% due 11/15/08 and $18,140,000 U.S. Treasury Notes 6.50-12.75% due 10/15/06 to 11/15/10. The value of the collateral is $45,188,364.) 5.29% 10/13/99 45,052 (45,064,940) Lehman Brothers (Agreement dated 09/17/99 to be repurchased at $5,452,529. Collateralized by $5,908,973 Federal National Mortgage Association 5.50% due 06/01/14. The value of the collateral is $5,590,750.) 5.38% 10/19/99 5,429 (5,437,925) Morgan Stanley (Agreement dated 08/23/99 to be repurchased at $6,510,052. Collateralized by $6,803,258 Federal National Mortgage Association 6.20-6.33% due 10/25/00 to 02/26/01. The value of the collateral is $6,763,163.) 5.49% 10/21/99 6,452 (6,490,373) See accompanying notes to financial statements. 24 BLACKROCK FUNDS STATEMENT OF NET ASSETS INTERMEDIATE BOND PORTFOLIO (CONCLUDED) Par AS OF SEPTEMBER 30, 1999 Maturity (000) Value -------- ------- ------------ REVERSE REPURCHASE AGREEMENTS (CONTINUED) Morgan Stanley (Agreement dated 09/29/99 to be repurchased at $6,886,718. Collateralized by $6,946,344 Government National Mortgage Association 7.25-8.25% due 04/15/06 to 11/15/08. The value of the collateral is $7,318,394.) 5.38% 10/28/99 $ 6,857 $ (6,859,049) Salomon Brothers (Agreement dated 07/7/99 to be repurchased at $1,129,411. Collateralized by $1,177,156 Federal National Mortgage Association 6.00% due 02/01/04. The value of the collateral is $1,153,980.) 5.17% 10/05/99 1,115 (1,128,771) Salomon Brothers (Agreement dated 09/15/99 to be repurchased at $9,090,080. Collateralized by $3,866,990 Federal Home Loan Mortgage Corp. 8.00% due 07/01/08 to 09/01/18 and $5,680,642 Federal National Mortgage Association 6.00-7.50% due 01/01/04 to 05/01/09. The value of the collateral is $10,257,230.) 5.36% 10/14/99 9,051 (9,072,561) Salomon Brothers (Agreement dated 07/21/99 to be repurchased at $2,428,401. Collateralized by $610,294 Federal Home Loan Mortgage Corp. 7.00% due 01/25/21 and $2,299,464 Federal National Mortgage Association 8.00% due 03/01/08. The value of the collateral is $2,941,115.) 5.24% 10/19/99 2,397 (2,422,121) ------------- TOTAL REVERSE REPURCHASE AGREEMENTS (Cost $103,963,825) (104,099,204) LIABILITIES IN EXCESS OF OTHER ASSETS (0.1%) (537,965) ------- ------------ NET ASSETS (Applicable to 4,647,402 BlackRock shares, 52,309,786 Institutional shares, 2,668,946 Service shares, 262,157 Investor A shares, 110,931 Investor B shares and 46,134 Investor C shares outstanding) 100.0% $546,662,911 ======= ============ Value ----------- NET ASSET VALUE AND REDEMPTION PRICE PER BLACKROCK, INSTITUTIONAL, SERVICE AND INVESTOR A SHARE ($545,232,962 / 59,888,291) $9.10 ===== OFFERING PRICE PER BLACKROCK, INSTITUTIONAL AND SERVICE SHARE $9.10 ===== MAXIMUM OFFERING PRICE PER INVESTOR A SHARE ($9.10 / 0.960) $9.48 ===== NET ASSET VALUE, OFFERING PRICE AND REDEMPTION PRICE (SUBJECT TO A CONTINGENT DEFERRED SALES CHARGE OF 4.5%) PER INVESTOR B SHARE ($1,009,934 / 110,931) $9.10 ===== NET ASSET VALUE, OFFERING AND REDEMPTION PRICE (subject to a contingent deferred sales charge of 1.0%) PER INVESTOR C SHARE ($420,015 / 46,134) $9.10 ===== - ------------------------- * Cost for Federal income tax purposes is $664,080,781. The gross unrealized appreciation (depreciation) on a tax basis is as follows: Gross unrealized appreciation $ 666,938 Gross unrealized depreciation (13,447,639) ------------ $(12,780,701) ============ ** Rates shown are the rates as of September 30, 1999. ***Rates shown are the effective yields as of September 30, 1999. + Partial principal in the amount of $98,754,060 has been pledged as collateral for reverse repurchase agreements. ++Principal amount of securities pledged as collateral of $600,000 on 29 long U.S. Treasury Notes futures contracts, 315 short U.S. Treasury Notes futures contracts and 29 short U.S. Treasury Bonds futures contracts expiring December 1999. The value of such contracts on September 30, 1999 was $40,665,469, thereby resulting in an unrealized gain of $23,389. See accompanying notes to financial statements. 25 BLACKROCK FUNDS SCHEDULE OF INVESTMENTS CORE BOND PORTFOLIO Par AS OF SEPTEMBER 30, 1999 Maturity (000) Value -------- ---------- -------------- U.S. GOVERNMENT & AGENCY OBLIGATIONS -- 24.0% Overseas Private Investment Co. 5.46%** 02/15/06 $ 303 $ 276,776 5.79%** 02/15/06 273 254,794 6.27%** 12/06-05/12 2,666 2,540,892 5.92%** 12/16/06 2,041 1,961,939 6.38%** 12/16/06 1,887 1,833,761 6.46%** 12/16/06 203 198,373 6.53%** 12/16/06 492 480,602 6.66%** 12/16/06 750 750,938 6.87% 12/16/06 970 941,649 5.88%** 05/29/12 360 340,573 6.81%** 05/29/12 386 386,341 6.84%** 05/29/12 498 491,396 6.91%** 05/29/12 1,020 982,526 Small Business Administration Participation Certificates, Series 92-20H, Class 1 7.40% 08/01/12 191 192,401 Small Business Administration Participation Certificates, Series 96-20J, Class 1 7.20% 10/01/16 1,224 1,220,540 Small Business Administration Participation Certificates, Series 97-20B, Class 1 7.10% 02/01/17 2,318 2,299,651 Small Business Investment Cos. Pass-Through, Series 97-P10C, Class 1 6.85% 08/01/07 5,303 5,244,441 Small Business Investment Cos. Pass-Through, Series 97-P10D, Class 1 6.51% 11/10/07 1,400 1,354,879 Small Business Investment Cos. Pass-Through, Series 98-10A, Class 1 6.12% 02/01/08 875 829,372 Student Loan Marketing Association, Series 97-3, Class A2 5.50%** 10/25/10 3,500 3,410,312 U.S. Treasury Bonds 5.50% 03/31/03 4,245 4,206,517 8.75% 11/15/08 30,615 33,506,082 12.75% 11/15/10 13,400 17,812,940 14.00% 11/15/11 750 1,080,435 7.50% 11/15/16 19,175 21,241,689 8.50% 02/15/20 10,110 12,427,093 5.25% 02/15/29 4,745 4,150,077 U.S. Treasury Bonds (CPI) 3.63%+ 04/15/28 21,010 20,028,161 U.S. Treasury Notes 5.50% 08/31/01 6,950 6,934,684 5.63% 12/31/02 11,945 11,903,637 6.00% 08/04-08/09 27,547 27,776,884 6.50% 10/15/06 52,525 53,741,101 U.S. Treasury Notes (CPI) 3.63% 01/15/08 7,400 7,389,128 3.88% 04/15/29 8,150 7,987,218 U.S. Treasury Strip Principals 6.38% 02/15/11 3,865 1,881,807 -------------- TOTAL U.S. GOVERNMENT & AGENCY OBLIGATIONS (Cost $261,822,666) 258,059,609 -------------- Par Maturity (000) Value -------- ---------- -------------- MORTGAGE PASS-THROUGHS -- 31.8% Federal Home Loan Mortgage Corp. Gold 7.50% 09/05-06/27 $ 2,794 $ 2,823,625 6.00%+ 02/12-07/14 19,218 18,509,611 5.50%+ 12/13-01/14 25,707 24,229,222 8.00% 11/01/15 77 78,784 7.00% 03/01/25 543 534,471 6.50% 11/28-07/29 57,268 54,976,947 Federal National Mortgage Association 6.10% 02/04/09 8,400 7,864,668 6.36% 04/09/09 3,700 3,510,930 6.50%+ 04/09-07/29 33,907 33,049,780 8.00% 10/09-05/22 102 103,714 5.50%+ 06/11-05/24 79,680 75,023,948 7.00%** 09/11-10/25 13,273 13,189,381 6.00% 03/13-05/29 40,655 38,514,901 7.50% 06/29-09/29 20,998 21,070,091 Government National Mortgage Association 8.50% 01/10-04/17 185 192,665 7.00% 12/22-09/28 6,624 6,504,248 6.50% 12/23-08/24 11,978 11,458,154 9.00% 10/15/24 469 467,879 7.50% 05/27-09/29 16,188 16,238,951 9.17% 03/15/37 3,032 3,260,665 7.70% 11/15/38 927 934,097 MLCC Mortgage Investors, Inc., Series 95-C3, Class A1 6.75%** 12/26/25 1,025 1,019,442 MLCC Mortgage Investors, Inc., Series 96-C1, Class A3 7.42% 04/25/28 3,000 3,012,016 Morgan Stanley Capital, Series 99-FNV1, Class A2 6.53% 03/15/31 5,940 5,676,354 -------------- TOTAL MORTGAGE PASS-THROUGHS (Cost $349,817,080) 342,244,544 -------------- MULTIPLE CLASS MORTGAGE PASS-THROUGHS -- 2.9% Amresco Securitized Net Interest Margin Trust, Series 96-1, Class A 8.10% 04/26/26 627 595,864 Chase Commercial Mortgage Securities Corp., Series 97-1, Class X (IO) 8.51%*** 04/19/15 42,570 2,908,143 Credit Suisse First Boston Mortgage Corp., Series 97-C1, Class AX (IO) 8.60%*** 04/20/22 61,842 5,321,274 Federal Home Loan Mortgage Corp., Series 65, Class A (PO) 4.09%*** 03/15/24 955 428,278 Federal National Mortgage Association Strip Notes, Series 279, Class 1 (PO) 6.99%*** 07/01/26 242 193,817 Federal National Mortgage Association, Series 96-3, Class C (PO) 5.00%*** 02/25/24 996 567,464 Federal National Mortgage Association, Series 96-54, Class A (PO) 7.57%*** 04/25/21 953 827,696 Federal National Mortgage Association, Series 97-44, Class L (PO) 4.35%*** 02/25/24 990 534,600 See accompanying notes to financial statements. 26 BLACKROCK FUNDS SCHEDULE OF INVESTMENTS CORE BOND PORTFOLIO (CONTINUED) Par AS OF SEPTEMBER 30, 1999 Maturity (000) Value -------- ---------- -------------- MULTIPLE CLASS MORTGAGE PASS-THROUGHS (CONTINUED) Federal National Mortgage Association, Series 99-17, Class HJ (PO) 4.00%*** 12/25/23 $ 695 $ 297,547 Federal National Mortgage Association, Series 99-17, Class JH (PO) 5.00%*** 04/25/24 865 393,034 Federal National Mortgage Association, Series 99-51, Class L (PO) 5.60%*** 10/25/29 700 357,000 First Union-Lehman Brothers Commercial Mortgage 1, Series 97-C1, Class A3 7.38% 04/18/29 4,700 4,752,880 General Motors Acceptance Corp. Commercial Mortgage Securities, Inc., Series 97-C1, Class X (IO) 7.84%*** 07/15/27 45,812 3,551,867 J.P. Morgan Commercial Mortgage Finance Corp., Series 97-C5, Class A2 7.07% 09/15/29 5,100 5,101,545 Residential Accredit Loans, Inc., Series 97-QS7, Class A1 7.50% 07/25/27 954 952,828 Salomon Brothers Mortgage Securities VI, Series 87-1 (IO) 6.00%*** 02/17/17 1,779 465,774 Salomon Brothers Mortgage Securities VI, Series 87-1 (PO) 6.00%*** 02/17/17 1,816 1,423,615 Salomon Brothers Mortgage Securities VI, Series 87-2 (IO) 6.00%*** 03/06/17 1,110 302,033 Salomon Brothers Mortgage Securities VI, Series 87-2 (PO) 6.00%*** 03/06/17 1,104 863,880 Salomon Brothers Mortgage Securities, Series 87-3, Class A (PO) 5.00%*** 10/23/17 495 405,876 Salomon Brothers Mortgage Securities, Series 87-3, Class B (IO) 5.00%*** 10/23/17 383 94,811 Structured Asset Securities Corp., Series 96-CFL, Class X1 (IO) 5.05%*** 02/25/28 19,700 1,022,020 -------------- TOTAL MULTIPLE CLASS MORTGAGE PASS-THROUGHS (Cost $33,553,460) 31,361,846 -------------- COMMERCIAL MORTGAGE BACKED SECURITIES -- 3.4% Capco America Securitization Corp., Series 98-D7, Class A1B 6.26% 09/15/08 2,700 2,524,469 COMM, Series 99-1, Class A2 6.46% 09/15/08 2,285 2,175,963 Credit Suisse First Boston Mortgage Securities Corp., Series 97-C2, Class AX (IO) 8.32%*** 11/17/22 19,442 1,232,036 Donaldson, Lufkin and Jenrette, Inc. Mortgage Acceptance Corp., Series 97-CF1, Class A 7.60% 04/15/07 2,000 2,029,686 Par Maturity (000) Value -------- ---------- -------------- COMMERCIAL MORTGAGE BACKED SECURITIES (CONTINUED) Empire Funding Home Loan Owner Trust, Series 98-2, Class A4 6.53% 03/25/19 $ 7,000 $ 6,868,750 First Boston Mortgage Securities Corp., Series 93-M1, Class A 6.75% 09/25/06 114 112,289 General Electric Capital Mortgage Services, Series 97-HE1, Class A4 7.78% 03/25/27 1,666 1,676,396 General Motors Acceptance Corp. Commercial Mortgage Securities, Inc., Series 99-C2, Class A2 6.95% 09/15/33 1,605 1,581,113 Goldman Sachs Mortgage Securities Corp. II, Series 96-PL, Class A2 7.41% 02/15/27 2,891 2,906,661 J.P. Morgan Commercial Mortgage Finance Corp., Series 96-C3, Class A1 7.33% 04/25/28 1,437 1,446,208 Lehman Brothers Commercial Conduit Mortgage Trust, Series 98-C4, Class X (IO) 1.00%*** 09/15/23 17,860 648,516 Mid-State Trust, Series 1, Class A1 7.34% 07/01/35 2,372 2,306,783 Mid-State Trust, Series 6, Class A4 7.79% 07/01/35 909 824,966 Midland Royalty Acceptance Corp., Series 96-C2, Class A2 7.23% 01/25/29 4,050 4,023,413 PNC Mortgage Securities Corp., Series 97-6, Class A1 6.49% 10/25/26 5,897 5,893,050 -------------- TOTAL COMMERCIAL MORTGAGE BACKED SECURITIES (Cost $36,851,897) 36,250,299 -------------- PROJECT LOANS -- 1.5% Avon on the Green, Construction Loan Collateral 7.75% 05/01/39 729 736,646 Desert Mirage Apartments, Construction Loan Collateral 7.25% 11/25/37 915 901,067 Desert Mirage Apartments, Construction Loan Committment 7.25% 06/01/01 85 83,988 Evergreen Tower II, Construction Loan Collateral 7.38% 09/01/39 916 901,121 Evergreen Tower II, Construction Loan Committment 7.38% 03/01/00 59 58,179 Federal Housing Authority, Greens at Viera East Apartments 7.88% 12/01/38 928 940,574 Federal Housing Authority, East Point Chelsea 10.23% 05/01/33 98 105,215 Federal Housing Authority, Merrill Lynch, Series 97-23 7.43% 12/01/21 3,150 3,171,952 See accompanying notes to financial statements. 27 BLACKROCK FUNDS SCHEDULE OF INVESTMENTS CORE BOND PORTFOLIO (CONTINUED) Par AS OF SEPTEMBER 30, 1999 Maturity (000) Value -------- ---------- -------------- PROJECT LOANS (CONTINUED) Federal Housing Authority, University Park Apartments 7.88% 10/01/37 $ 7,654 $ 7,691,416 Greens at Viera East Apartments, Construction Loan Collateral 7.88% 12/01/38 0 281 Pheasant Run Manor, Construction Loan Collateral 6.88% 08/01/41 464 439,049 Pheasant Run Manor, Construction Loan Committment 6.88% 08/01/01 799 755,650 Federal Housing Authority, Sakonnet Bay Manor 7.63% 10/01/38 837 840,975 -------------- TOTAL PROJECT LOANS (Cost $16,899,442) 16,626,113 -------------- ASSET BACKED SECURITIES -- 10.4% Arcadia Automobile Receivables Trust, Series 98-B, Class A3 5.95% 11/15/02 17,500 17,511,900 Associates Manufactured Housing Pass-Through, Series 96-1, Class B1 8.00% 03/15/27 2,815 2,685,686 Boston Edison Co., Series 99-1, Class A5 7.03% 03/15/12 2,300 2,281,152 Chevy Chase Auto Receivables Trust, Series 97-2, Class A 6.35% 01/15/04 2,686 2,702,284 Chevy Chase Auto Receivables Trust, Series 97-3, Class A 6.20% 03/20/04 961 967,354 CIT Group Securitization Corp., Series 95-2, Class B 7.65% 05/15/26 300 250,781 FMAC Loan Receivables Trust, Series 97-B, Class A 6.85% 09/15/19 5,396 5,254,380 Ford Credit Auto Owner Trust, Series 99-C, Class A4 6.08% 09/16/02 6,850 6,822,172 Green Tree Financial Corp., Series 93-3, Class B 6.85% 10/15/18 3,246 3,078,164 Green Tree Financial Corp., Series 94-B, Class A 7.85% 07/15/04 114 111,336 Green Tree Financial Corp., Series 95-A, Class A 7.25% 07/15/05 5,534 5,248,259 Green Tree Financial Corp., Series 96-2, Class B2 7.90% 04/15/27 3,650 2,852,315 Green Tree Financial Corp., Series 97-2, Class B 7.56% 06/15/28 5,000 4,678,390 Green Tree Financial Corp., Series 97-3, Class B2 8.03%++ 07/15/28 2,400 1,858,940 Green Tree Home Improvement Loan Trust, Series 94-D, Class M 9.05% 01/15/15 638 645,302 Health Care Receivables Securitization Program Notes, NPF VI, Series 98-1A, Class A 6.22% 06/01/02 6,800 6,703,833 Par Maturity (000) Value -------- ---------- -------------- ASSET BACKED SECURITIES (CONTINUED) Honda Auto Lease Trust, Series 99-A, Class A4 6.45% 09/16/02 $ 9,050 $ 9,065,555 MBNA Master Credit Card Trust, Series 99-B, Class A 5.90% 08/15/11 2,700 2,538,716 MBNA Master Credit Card Trust, Series 99-J, Class A 7.00% 02/15/12 3,950 3,969,134 Mellon Bank Home Equity Loan Trust, Series 96-1, Class B2 5.69%** 04/15/26 1,294 1,293,796 Pegasus Aviation Lease Securitization, Series 99-1A, Class A1 6.30% 03/25/29 1,942 1,898,785 Puget Power Conservation Grantor Trust, Series 97-1, Class A 6.23% 07/11/02 2,384 2,375,194 Sears Credit Account Master Trust, Series 95-5, Class A 6.05% 01/15/08 10,600 10,443,339 Sears Credit Account Master Trust, Series 97-1, Class A 6.20% 07/16/07 10,500 10,431,908 Sears Credit Account Master Trust, Series 98-1, Class A 5.80% 08/15/05 5,400 5,311,428 The Money Store Home Equity Trust, Series 95-A, Class A8 8.13% 06/15/15 904 916,083 World Omni Automobile Lease Securitization Trust, Series 96-B, Class A3 6.25% 11/15/02 533 533,991 -------------- TOTAL ASSET BACKED SECURITIES (Cost $115,240,782 112,430,177 -------------- CORPORATE BONDS -- 21.1% AEROSPACE -- 0.3% United Technology Corp. 6.50% 06/01/09 3,735 3,606,629 -------------- AIR TRANSPORTATION -- 0.1% Continental Airlines 7.06% 09/15/09 965 929,197 -------------- AUTOMOTIVE -- 0.7% DaimlerChrysler Holdings N.A. 7.20% 09/01/09 7,650 7,688,250 -------------- FINANCE -- 7.1% AT&T Capital Corp. 6.25% 05/15/01 4,000 3,965,000 Chase Manhattan Corp. 5.75% 04/15/04 1,580 1,513,617 CIT Group, Inc. 7.13% 10/15/04 2,160 2,159,578 Dresdner Funding Trust 1 8.15% 06/30/31 3,275 3,070,313 FMR Corp. 7.57% 06/15/29 5,185 5,068,338 Ford Motor Credit Co. 6.70% 07/16/04 3,885 3,865,575 5.80% 01/12/09 6,905 6,292,181 Goldman Sachs Escrow Corp., Series 144A 7.00% 08/01/03 860 834,002 See accompanying notes to financial statements. 28 BLACKROCK FUNDS SCHEDULE OF INVESTMENTS CORE BOND PORTFOLIO (CONTINUED) Par AS OF SEPTEMBER 30, 1999 Maturity (000) Value -------- ---------- -------------- CORPORATE BONDS (CONTINUED) FINANCE (CONTINUED) J.P. Morgan & Co., Inc. 5.54%** 02/15/12 $ 100 $ 87,690 Lehman Brothers Holdings, Inc. 6.75% 09/24/01 5,200 5,179,720 6.20% 01/15/02 6,000 5,894,400 6.63% 04/01/04 2,250 2,187,090 Merrill Lynch & Co., Inc. 5.75% 11/04/02 2,445 2,379,254 6.00% 02/17/09 2,175 2,001,000 MidAmerican Funding LLC 5.85% 03/01/01 4,845 4,800,281 National City Corp. 6.88% 05/15/19 5,000 4,576,248 Newcourt Credit Group 6.88% 02/16/05 465 454,644 Pemex Finance Ltd. 9.14% 08/15/04 2,520 2,524,158 Simon Property Group LP, Inc. 6.63% 06/15/03 4,200 4,041,618 TXU Eastern Funding Co. 6.15% 05/15/02 310 302,925 Wachovia Corp 5.63% 12/15/08 4,910 4,413,157 Yorkshire Power Finance 6.50% 02/25/08 5,435 4,945,850 Zurich Capital Trust International 8.38% 06/01/37 5,925 5,821,313 -------------- 76,377,952 -------------- INDUSTRIAL -- 5.5% Atlantic Richfield 9.13% 03/01/11 4,960 5,784,600 7.00% 04/15/38 2,255 2,241,630 Coca-Cola Enterprises, Inc. 5.71% 03/18/37 7,485 7,487,320 Conoco, Inc. 6.95% 04/15/29 2,145 1,994,850 Corning, Inc. 6.30% 03/01/09 3,000 2,822,730 Cox Enterprises, Inc. 6.63% 06/14/02 2,380 2,358,128 Enron Corp. 6.45% 11/15/01 3,000 2,970,350 Ford Motor Co. 7.45% 07/16/31 8,670 8,555,347 Hyder PLC 7.38% 12/15/28 2,585 2,277,705 Jones Apparel Group, Inc. 6.25% 10/01/01 7,050 6,917,813 Nabisco, Inc. 6.00% 02/15/01 2,445 2,418,749 7.55% 06/15/15 1,660 1,581,897 Tyco Intl. Group SA 6.25% 06/15/03 6,340 6,154,327 Williams Cos., Inc. 6.13% 02/01/01 2,290 2,281,413 Williams Holdings of Delaware 6.13% 12/01/03 3,450 3,289,579 -------------- 59,136,438 -------------- INSURANCE -- 0.8% Equitable Cos., Inc. 9.00% 12/15/04 3,480 3,788,850 7.00% 04/01/28 1,565 1,425,527 Par Maturity (000) Value -------- ---------- -------------- CORPORATE BONDS (CONTINUED) INSURANCE (CONTINUED) Florida Windstorm Underwriting Association 7.13% 02/25/19 $ 3,410 $ 3,187,122 -------------- 8,401,499 -------------- TELECOMMUNICATIONS -- 3.3% AT&T Corp. 6.00% 03/15/09 3,400 3,162,000 6.50% 03/15/29 4,995 4,403,692 Chesapeake & Potomac Telephone of Maryland 8.30% 08/01/31 3,375 3,622,569 CSX Corp. 5.85% 12/01/03 1,460 1,393,716 MCI Worldcom, Inc. 7.75% 04/01/27 3,696 3,866,940 7.13% 06/15/27 1,635 1,653,394 SBC Communications, Inc. 7.38% 06/15/25 4,275 4,061,250 Sprint Capital Corp. 5.70% 11/15/03 2,800 2,677,500 6.13% 11/15/08 2,000 1,860,000 6.38% 05/01/09 5,900 5,561,616 U.S. West Capital Funding, Inc. 6.88% 08/01-07/28 3,890 3,784,313 -------------- 36,046,990 -------------- TRANSPORTATION -- 0.4% Federal Express Corp. 7.11% 01/02/14 3,228 3,013,906 6.72% 01/15/22 1,820 1,718,242 -------------- 4,732,148 -------------- UTILITY -- 1.4% Avon Energy Partners Holdings 7.05% 12/11/07 2,215 2,103,586 6.46% 03/04/08 5,000 4,550,650 Illinois Power Co. 7.50% 06/15/09 1,165 1,165,383 Niagara Mohawk Power Corp. 7.75% 10/01/08 2,765 2,820,300 Reliant Energy, Inc. 6.50% 02/01/08 4,910 4,627,675 -------------- 15,267,594 -------------- WASTE MANAGEMENT -- 0.5% USA Waste Management, Inc. 6.13% 07/15/01 5,350 5,142,688 -------------- YANKEE -- 1.0% Den Norske Stats Oljesel 7.38% 05/01/16 950 918,763 Deutsche Bank Capital Funding Trust Investment 7.87%** 12/29/49 2,240 2,135,011 Empresa Electrica Pehuenche 7.30% 05/01/03 4,985 4,808,307 Swedbank 7.50%** 09/29/49 2,800 2,514,120 -------------- 10,376,201 -------------- TOTAL CORPORATE BONDS (Cost $236,052,118) 227,705,586 -------------- See accompanying notes to financial statements. 29 BLACKROCK FUNDS SCHEDULE OF INVESTMENTS CORE BOND PORTFOLIO (CONCLUDED) Par/Shares AS OF SEPTEMBER 30, 1999 Maturity (000) Value -------- ---------- -------------- TAXABLE MUNICIPAL BONDS -- 1.4% New Jersey Economic Development Authority State Pension Funding Zero Coupon Revenue Bond, Series 97-B 6.80%*** 02/15/05 $ 200 $ 136,500 7.56%*** 02/15/16 10,100 3,004,750 7.59%*** 02/15/17 3,575 983,125 7.21%*** 02/15/18 5,500 1,402,500 7.62%*** 02/15/20 6,265 1,378,300 7.63%*** 02/21-02/23 7,810 1,494,581 New York State Power Authority and General Purpose Revenue Bond, Series 98D 6.26% 02/15/03 7,100 7,002,375 -------------- TOTAL TAXABLE MUNICIPAL BONDS (Cost $15,602,843) 15,402,131 -------------- SHORT TERM INVESTMENTS -- 3.1% Federal Home Loan Bank Discount Notes 5.17% 10/01/99 9,700 9,700,000 Federal Home Loan Mortgage Corp. Discount Notes 5.20% 10/01/99 16,250 16,250,000 Galileo Money Market Fund 7,080,314 7,080,314 -------------- TOTAL SHORT TERM INVESTMENTS (Cost $33,030,314) 33,030,314 -------------- PREFERRED STOCK -- 0.4% Centaur Funding Corp., Cumulative 144A 9.08% 4,150 4,290,482 -------------- (Cost $4,150,000) TOTAL INVESTMENTS IN SECURITIES -- 100.0% (Cost $1,103,020,602*) $1,077,401,101 ============== - ---------------------- * Cost for Federal income tax purposes is $1,103,416,734. The gross unrealized appreciation (depreciation) on a tax basis is as follows: Gross unrealized appreciation $ 2,014,633 Gross unrealized depreciation (28,030,266 ------------ $(26,015,633) ============ ** Rates shown are the rates as of September 30, 1999. *** Rates shown are the effective yields as of September 30, 1999. +Partial principal in the amount of $97,450,655 has been pledged as collateral for reverse repurchase agreements. ++Principal amount of securities pledged as collateral of $2,400,000 on 173 long U.S. Treasury Notes futures contracts and 202 short U.S. Treasury Bonds futures contracts expiring December 1999. The value of such contracts on September 30, 1999 was $42,067,000, thereby resulting in an unrealized gain of $193,040. See accompanying notes to financial statements. 30 BLACKROCK FUNDS STATEMENT OF ASSETS AND LIABILITIES CORE BOND PORTFOLIO SEPTEMBER 30, 1999 ASSETS Investments at value (Cost $1,103,020,602) ................ $1,077,401,101 Collateral received for securities loaned ................. 37,971,708 Interest receivable ....................................... 12,545,208 Principal receivable ...................................... 114,977 Investments sold receivable ............................... 8,665,241 Capital shares sold receivable ............................ 1,390,994 Prepaid expenses .......................................... 29,667 -------------- TOTAL ASSETS ....................................... 1,138,118,896 -------------- LIABILITIES Payable upon return of securities loaned .................. 37,971,708 Investments purchased payable ............................. 33,584,229 Reverse repurchase agreements payable ..................... 90,270,868 Capital shares redeemed payable ........................... 3,521,558 Distributions payable ..................................... 5,080,433 Advisory fees payable ..................................... 256,169 Administrative fees payable ............................... 71,716 Transfer agent fees payable ............................... 64,611 Other accrued expenses payable ............................ 190,102 Futures margin payable .................................... 108,644 -------------- TOTAL LIABILITIES .................................. 171,120,038 -------------- NET ASSETS (Applicable to 17,266,409 BlackRock shares, 76,524,752 Institutional shares, 7,062,261 Service shares, 727,748 Investor A shares, 1,544,744 Investor B shares and 726,233 Investor C shares outstanding) .............................................. $ 966,998,858 ============== NET ASSET VALUE AND REDEMPTION PRICE PER BLACKROCK, INSTITUTIONAL, SERVICE AND INVESTOR A SHARE ($945,853,555 / 101,581,170) ............. $ 9.31 ============== OFFERING PRICE PER BLACKROCK, INSTITUTIONAL AND SERVICE SHARE ............................................. $ 9.31 ============== MAXIMUM OFFERING PRICE PER INVESTOR A SHARE ($9.31 / 0.960) ............................................ $ 9.70 ============== NET ASSET VALUE, OFFERING AND REDEMPTION PRICE (subject to a maximum contingent deferred sales charge of 4.5%) PER INVESTOR B SHARE ($14,383,286 / 1,544,744) ................................. $ 9.31 ============== NET ASSET VALUE, OFFERING AND REDEMPTION PRICE (subject to a maximum contingent deferred sales charge of 1.0%) PER INVESTOR C SHARE ($6,762,017 / 726,233) .................................... $ 9.31 ============== See accompanying notes to financial statements. 31 BLACKROCK FUNDS STATEMENT OF NET ASSETS GOVERNMENT INCOME PORTFOLIO Par AS OF SEPTEMBER 30, 1999 Maturity (000) Value -------- ---------- ------------ U.S. GOVERNMENT & AGENCY OBLIGATIONS -- 53.9% Small Business Administration Participation Certificates, Series 96-20J, Class 1 7.20% 10/01/16 $ 405 $ 403,856 Small Business Administration Participation Certificates, Series 98-20J, Class 1 5.50% 10/01/18 236 216,493 U.S. Treasury Bonds 7.50% 11/15/16 1,200 1,329,336 8.50%+ 02/15/20 2,775 3,410,997 U.S. Treasury Notes 5.00% 02/28/01 400 397,080 6.50%+ 08/01-10/06 2,040 2,085,742 6.25% 02/28/02 650 658,358 5.50%+ 05/31/03 15,290 15,139,201 ------------ TOTAL U.S. GOVERNMENT & AGENCY OBLIGATIONS (Cost $23,887,364) 23,641,063 ------------ MORTGAGE PASS-THROUGHS -- 83.5% Federal Home Loan Mortgage Corp. 7.00%++ 08/10-03/11 1,050 1,051,461 6.00% 10/11-07/14 4,749 4,574,322 8.00%++ 05/12-11/26 3,379 3,464,434 5.50% 10/13-05/14 2,409 2,270,262 7.50% 11/01/25 40 39,954 6.92% 07/01/27 410 410,140 6.50% 04/01/29 2,991 2,871,460 Federal Home Loan Mortgage Corp. Gold 6.50% 06/01/29 2,486 2,386,429 Federal Home Loan Mortgage Corp. (TBA) 6.50% 06/15/13 2,000 1,961,250 Federal National Mortgage Association 6.14% 09/10/08 300 282,201 7.00% 08/09-12/11 1,405 1,404,468 8.50% 01/01/13 806 833,877 6.50% 01/13-07/29 1,302 1,263,199 8.00% 11/13-08/14 668 681,890 5.50% 12/13-01/14 900 847,128 6.00% 05/14-01/29 3,746 3,522,332 7.50% 06/24-04/26 763 765,692 Government National Mortgage Association 6.00% 01/14-06/14 989 950,065 6.50% 11/23-06/29 4,333 4,145,825 7.00% 10/27-06/28 2,380 2,337,346 7.50% 04/27-11/27 612 614,707 ------------ TOTAL MORTGAGE PASS-THROUGHS (Cost $37,335,024) 36,678,442 ------------ MULTIPLE CLASS MORTGAGE PASS-THROUGHS -- 1.7% Federal National Mortgage Association, Series 96-54, Class A (PO) 5.85%*** 04/25/21 228 197,772 Residential Accredit Loans, Inc., Series 98-D7, Class CB6 6.75% 05/25/28 215 212,844 Salomon Brothers Mortgage Securities VI, Series 87-1 (IO) 6.00%*** 02/17/17 306 80,033 Par Maturity (000) Value -------- ---------- ------------ MULTIPLE CLASS MORTGAGE PASS-THROUGHS (CONTINUED) Salomon Brothers Mortgage Securities VI, Series 87-1 (PO) 6.00%*** 02/17/17 $ 306 $ 239,620 ------------ TOTAL MULTIPLE CLASS MORTGAGE PASS-THROUGHS (Cost $735,563) 730,269 ------------ COMMERCIAL MORTGAGE BACKED SECURITIES -- 2.5% Capco America Securitization Corp., Series 98-D7, Class A1B 6.26% 09/15/08 70 65,449 Commercial Mortgage Asset Trust, Series 99-C1, Class A1 6.25% 08/17/06 292 283,776 Goldman Sachs Mortgage Securities Corp., Series 98-1, Class A 8.00% 09/20/27 198 202,174 Goldman Sachs Mortgage Securities Corp., Series 98-2, Class A 7.75% 05/19/27 206 208,873 Morgan Stanley Capital International, Inc., Series 98-CF1, Class A1 6.33% 10/15/07 116 112,190 Union Planters Mortgage Finance Corp., Series 98-1, Class A1 6.35% 01/25/28 243 244,537 ------------ TOTAL COMMERCIAL MORTGAGE BACKED SECURITIES (Cost $1,137,227) 1,116,999 ------------ PROJECT LOANS -- 2.3% Federal Housing Authority, Excelsior II Apartments 8.04% 02/01/39 699 721,777 Federal Housing Authority, INSD Project, Series 82 7.43% 09/01/22 282 283,995 ------------ TOTAL PROJECT LOANS (Cost $992,209) 1,005,772 ------------ ASSET BACKED SECURITIES -- 0.7% Chase Manhattan Grantor Trust, Series 96-B, Class A 6.61% 09/15/02 37 36,735 The Money Store Small Business Administration Loan Trust, Series 99-1, Class A 5.52%** 07/15/25 290 287,824 ------------ TOTAL ASSET BACKED SECURITIES (Cost $326,790) 324,559 ------------ Shares ---------- SHORT TERM INVESTMENTS -- 0.1% Galileo Money Market Fund (Cost $31,624) 31,624 31,624 ------------ TOTAL INVESTMENTS IN SECURITIES (Cost $64,445,801*) 144.7% 63,528,728 See accompanying notes to financial statements. 32 BLACKROCK FUNDS STATEMENT OF NET ASSETS GOVERNMENT INCOME PORTFOLIO (CONCLUDED) Par AS OF SEPTEMBER 30, 1999 Maturity (000) Value -------- ---------- ------------ REVERSE REPURCHASE AGREEMENTS -- (42.8%) Aubrey Lanston (Agreement dated 09/30/99 to be repurchased at $263,081. Collateralized by $250,000 U.S. Treasury Notes 6.50% due 10/15/06. The value of the collateral is $264,099.) 5.25% 10/07/99 $ 263 $ (262,851) Lehman Brothers (Agreement dated 09/29/99 to be repurchased at $14,587,631. Collateralized by $14,500,000 U.S. Treasury Notes 5.50% due 05/31/03. The value of the collateral is $14,625,185.) 5.34% 10/06/99 14,573 (14,576,823) Lehman Brothers (Agreement dated 09/27/99 to be repurchased at $529,280. Collateralized by $500,000 U.S. Treasury Notes 6.50% due 10/15/06. The value of the collateral is $528,198.) 5.25% 10/12/99 528 (528,433) Lehman Brothers (Agreement dated 09/29/99 to be repurchased at $3,430,700. Collateralized by $2,775,000 U.S. Treasury Bonds 8.50% due 02/15/20. The value of the collateral is $3,441,122.) 5.29% 10/13/99 3,424 (3,424,662) ----------- TOTAL REVERSE REPURCHASE AGREEMENTS (Cost $18,787,094) (18,792,769) LIABILITIES IN EXCESS OF OTHER ASSETS (1.9%) (836,968) -------- ----------- NET ASSETS (Applicable to 676,578 Investor A shares, 3,502,628 Investor B shares and 245,394 Investor C shares outstanding) 100.0% $ 43,898,991 ======== ============ Value ------------ NET ASSET VALUE AND REDEMPTION PRICE PER INVESTOR A SHARE ($6,712,667 / 676,578) $ 9.92 ====== MAXIMUM OFFERING PRICE PER INVESTOR A SHARE ($9.92 / 0.955) $10.39 ====== NET ASSET VALUE, OFFERING PRICE AND REDEMPTION PRICE (SUBJECT TO A CONTINGENT DEFERRED SALES CHARGE OF 4.5%) PER INVESTOR B SHARE ($34,751,627 / 3,502,628) $ 9.92 ====== NET ASSET VALUE, OFFERING AND REDEMPTION PRICE (SUBJECT TO A CONTINGENT DEFERRED SALES CHARGE OF 1.0%) PER INVESTOR C SHARE ($2,434,697 / 245,394) $ 9.92 ====== - ------------------------- * Cost for Federal income tax purposes is $64,780,030. The gross unrealized appreciation (depreciation) on a tax basis is as follows: Gross unrealized appreciation $ 110,308 Gross unrealized depreciation (1,361,610) ----------- $(1,251,302) =========== ** Rates shown are the rates as of September 30, 1999. ***Rates shown are the effective yields as of September 30, 1999. +Partial principal in the amount of $18,025,000 has been pledged as collateral for reverse repurchase agreements. ++Principal amount of securities pledged as collateral of $672,284 on 61 short U.S. Treasury Notes futures contracts expiring December 1999. The value of such contracts on September 30, 1999 was $6,643,094, thereby resulting in an unrealized gain of $2,952. See accompanying notes to financial statements. 33 BLACKROCK FUNDS STATEMENT OF NET ASSETS GNMA PORTFOLIO
Par AS OF SEPTEMBER 30, 1999 Maturity (000) Value -------- -------- ----------- U.S. GOVERNMENT & AGENCY OBLIGATIONS -- 14.9% U.S. Treasury Bonds 8.50% + 02/15/20 $ 1,600 $ 1,966,701 U.S. Treasury Notes 6.00% 08/15/00 4,020 4,041,341 5.50% + 05/03-05/09 10,460 10,125,775 4.75% 02/15/04 500 480,000 ------------- TOTAL U.S. GOVERNMENT & AGENCY OBLIGATIONS (Cost $16,619,008) 16,613,817 ------------- MORTGAGE PASS-THROUGHS -- 87.2% Federal Home Loan Mortgage Corp. 6.00% 04/11-06/29 9,208 8,721,264 5.50% 04/13-05/14 2,840 2,676,405 7.50% 05/01/27 582 585,045 6.92% 07/01/27 1,127 1,127,885 6.50% 06/01/29 92 88,561 Federal National Mortgage Association 7.00% 05/11-09/11 2,700 2,697,785 6.50% 02/13-07/29 1,393 1,356,308 6.00% 06/13-01/14 1,760 1,692,859 8.00% 11/13-08/14 1,648 1,680,276 5.50% 12/13-03/14 3,142 2,958,611 Government National Mortgage Association 8.00% ++/ + 2/07-06/28 9,677 9,869,232 8.50% 1/17-09/21 2,621 2,726,977 7.00% + 9/17-07/29 20,342 19,944,874 9.00% 5/18-07/21 1,725 1,810,669 7.50% 2/22-11/27 11,349 11,389,296 6.50% 7/23-03/29 29,211 27,945,119 ------------- TOTAL MORTGAGE PASS-THROUGHS (Cost $98,276,428) 97,271,166 ------------- COMMERCIAL MORTGAGE BACKED SECURITIES -- 3.0% Chase Commercial Mortgage Securities Corp., Series 97-2, Class A1 6.45% 12/19/04 1,049 1,026,764 Commercial Mortgage Asset Trust, Series 99-C1, Class A1 6.25% 08/17/06 682 662,145 Morgan Stanley Capital International, Inc., Series 97-HF1, Class A1 6.86% 07/15/29 1,098 1,096,979 Residential Accredit Loans, Inc., Series 98-D7, Class CB6 6.75% 05/25/28 574 567,585 ------------- TOTAL COMMERCIAL MORTGAGE BACKED SECURITIES (Cost $3,418,164) 3,353,473 ------------- PROJECT LOANS -- 15.8% Federal Housing Authority, Castle Terrace 8.00% 10/01/38 1,499 1,533,488 Federal Housing Authority, Excelsior II Apartments 8.04% 02/01/39 999 1,031,108 Federal Housing Authority, Arrowhead Springs Apartments 7.55% 02/01/39 1,115 1,113,335 Par Maturity (000) Value ---------- ---------- ------------- PROJECT LOANS (CONTINUED) Federal Housing Authority, Creekwood Apartments 7.30% 11/15/38 $ 1,993 $ 1,976,158 Greens at Viera East Apartments, Construction Loan Collateral 7.88% 12/01/38 1,340 1,358,607 Prairie District Lofts, Construction Loan Collateral 7.41% 12/01/38 1,186 1,172,431 Prairie District Lofts, Construction Loan Committment 7.41% 12/01/38 299 295,595 Renaissance Place Apartments, Construction Loan Collateral 7.38% 02/01/39 1,878 1,856,735 Federal Housing Authority, Triangle Point Apartments 7.75% 09/30/38 1,967 1,987,137 Federal Housing Administration, Village at Stone Falls 7.38% 01/01/39 1,575 1,555,471 Federal Housing Authority, INSD Project, Series 82 7.43% 09/01/22 1,483 1,490,972 Federal Housing Authority, Timber Ridge Apartments, Project Loan 7.50% 12/15/38 2,199 2,207,149 ------------- TOTAL PROJECT LOANS (Cost $17,491,865) 17,578,186 ------------- ASSET BACKED SECURITIES -- 0.8% The Money Store Small Business Administration Loan Trust, Series 99-1, Class A 5.52%** 07/15/25 871 863,471 (Cost $870,843) ------------- CORPORATE BONDS -- 0.6% FINANCE -- 0.6% Federal National Mortgage Association, Series 98, Class B 6.14% 09/10/08 770 724,316 (Cost $718,114) ------------- Shares ---------- SHORT TERM INVESTMENTS -- 0.1% Galileo Money Market Fund 99,794 99,794 (Cost $99,794) ------------- TOTAL INVESTMENTS IN SECURITIES (Cost $137,494,216*) 122.4% 136,504,223 See accompanying notes to financial statements.
34 BLACKROCK FUNDS STATEMENT OF NET ASSETS GNMA PORTFOLIO (CONCLUDED) Par AS OF SEPTEMBER 30, 1999 Maturity (000) Value -------- ---------- ------------- REVERSE REPURCHASE AGREEMENTS -- (18.7%) Aubrey Lanston (Agreement dated 09/27/99 to be repurchased at $10,402,501. Collateralized by $10,450,000 U.S. Treasury Notes 5.50% due 05/15/09. The value of the collateral is $10,333,968.) 2.35% 10/04/99 $10,398 $(10,400,466) Lehman Brothers (Agreement dated 09/29/99 to be repurchased at $1,978,061. Collateralized by $1,600,000 U.S. Treasury Bonds 8.50% due 02/15/20. The value of the collateral is $1,984,071.) 5.29% 10/13/99 1,974 (1,974,580) Lehman Brothers (Agreement dated 09/24/99 to be repurchased at $8,542,319. Collateralized by $8,819,880 Government National Mortgage Association 7.00-8.00% due 03/20/24 to 08/20/25. The value of the collateral is $8,788,129.) 5.37% 10/25/99 8,503 (8,511,880) ------------- TOTAL REVERSE REPURCHASE AGREEMENTS (Cost $20,874,750) (20,886,926) LIABILITIES IN EXCESS OF OTHER ASSETS (3.7%) (4,102,457) ---------- ------------- NET ASSETS (Applicable to 11,448,311 Institutional shares, 10,011 Service shares, 114,492 Investor A shares, 23,707 Investor B shares and 2,459 Investor C shares outstanding) 100.0% $ 111,514,840 ========== ============= Value ------------- NET ASSET VALUE AND REDEMPTION PRICE PER INSTITUTIONAL, SERVICE AND INVESTOR A SHARE ($111,263,270 (DIVIDE) 11,572,814) $ 9.61 ====== OFFERING PRICE PER INSTITUTIONAL AND SERVICE SHARE $ 9.61 ====== MAXIMUM OFFERING PRICE PER INVESTOR A SHARE ($9.61 (DIVIDE) 0.960) $10.01 ====== NET ASSET VALUE, OFFERING PRICE AND REDEMPTION PRICE (SUBJECT TO A CONTINGENT DEFERRED SALES CHARGE OF 4.5%) PER INVESTOR B SHARE ($227,928 (DIVIDE) 23,707) $ 9.61 ====== NET ASSET VALUE, OFFERING PRICE AND REDEMPTION PRICE (SUBJECT TO A CONTINGENT DEFERRED SALES CHARGE OF 1.0%) PER INVESTOR C SHARE ($23,642 (DIVIDE) 2,459) $ 9.61 ====== - ---------------------------- * Cost for Federal income tax purposes is $137,618,631. The gross unrealized appreciation (depreciation) on a tax basis is as follows: Gross unrealized appreciation $ 788,188 Gross unrealized depreciation (1,902,596) ------------- $ (1,114,408) ============= ** Rates shown are the rates as of September 30, 1999. + Partial principal in the amount of $20,869,880 has been pledged as collateral for reverse repurchase agreements. ++ Principal amount of securities pledged as collateral of $2,206,426 on 257 short U.S. Treasury Notes futures contracts expiring December 1999. The value of such contracts on September 30, 1999 was $28,076,875, thereby resulting in an unrealized loss of $13,242. See accompanying notes to financial statements. 35 BLACKROCK FUNDS SCHEDULE OF INVESTMENTS MANAGED INCOME PORTFOLIO
Par AS OF SEPTEMBER 30, 1999 Maturity (000) Value -------- ------- -------------- U.S. GOVERNMENT & AGENCY OBLIGATIONS -- 17.4% Overseas Private Investment Co. 6.84% 02/15/05 $ 702 $ 692,422 6.46%** 12/06/06 170 165,310 5.92%** 12/16/06 1,701 1,634,950 6.38%** 12/16/06 1,572 1,528,134 6.53% 12/16/06 410 400,502 6.66% 12/16/06 900 901,125 6.87% 12/16/06 808 784,708 6.27% 12/06-05/29 3,251 3,097,672 5.46%** 05/29/12 427 390,003 5.79% 05/29/12 385 359,028 5.88%** 05/29/12 508 479,948 6.81% 05/29/12 544 544,390 6.91% 05/29/12 1,437 1,384,468 Small Business Administration Participation Certificates, Series 96-20B, Class 1 6.38% 02/01/16 6,269 6,018,029 Small Business Administration Participation Certificates, Series 96-20K, Class 1 6.95% 11/10/16 8,813 8,691,747 Small Business Administration Participation Certificates, Series 97, Class A 5.85%** 08/15/22 3,197 3,184,867 Small Business Administration Participation Certificates, Series 97-20B, Class 1 7.10% 02/01/17 6,313 6,263,810 Small Business Administration Participation Certificates, Series 97-20F, Class 1 7.20% 06/01/17 2,070 2,062,944 Small Business Administration Participation Certificates, Series 97-20G, Class 1 6.85% 07/01/17 12,224 11,993,921 Student Loan Marketing Association, Series 97-3, Class A2 5.50%** 10/25/10 6,300 6,138,563 U.S. Treasury Bonds 8.75% 11/15/08 23,380 25,587,855 12.75% 11/15/10 8,725 11,598,351 7.50% 11/15/16 21,820 24,171,768 8.50% 02/15/20 28,245 34,718,421 5.25% 02/15/29 8,320 7,276,847 U.S. Treasury Bonds (CPI) 3.63% + 04/15/28 38,565 36,762,780 3.88% 04/15/29 9,000 8,820,240 U.S. Treasury Notes 5.63% 12/31/02 23,705 23,622,914 6.00% + 08/04-08/09 47,436 47,822,690 6.50% 10/15/06 21,560 22,059,174 U.S. Treasury Notes (CPI) 3.63% 01/15/08 12,625 12,606,452 -------------- TOTAL U.S. GOVERNMENT & AGENCY OBLIGATIONS (Cost $317,607,071) 311,764,033 -------------- Par Maturity (000) Value -------- ------- -------------- MORTGAGE PASS-THROUGHS -- 41.3% Federal Home Loan Mortgage Corp. 9.00% 07/01/01 $ 30 $ 31,336 6.50% 12/02-04/29 85,597 82,365,100 6.28%** 10/15/07 4,469 4,267,755 6.45% 04/29/09 9,750 9,307,732 7.50% 10/09-10/27 12,833 13,005,192 6.00% 11/12-07/14 2,445 2,353,912 7.00% 05/01/26 589 579,301 Federal Home Loan Mortgage Corp. Gold 6.00% 05/01/14 18,888 18,191,794 6.50% + 04/29-06/29 58,803 56,451,012 Federal National Mortgage Association 9.50% 03/01/05 15 15,593 7.00% 06/06-05/26 6,658 6,581,421 6.80% 07/23/07 12,025 11,859,519 6.04% 02/25/09 26,800 25,012,405 6.36% 04/09/09 5,000 4,744,500 6.50% 02/11-08/29 91,042 87,564,875 6.00% + 04/13-01/29 87,423 82,669,075 5.50% + 12/13-05/14 268,784 253,077,210 Government National Mortgage Association 8.20% 06/15/12 291 297,760 8.00% 05/13-05/27 4,589 4,706,588 7.25% 04/15/15 1,209 1,232,064 9.50% 09/16-10/17 212 227,483 8.50% 01/17-11/21 429 445,853 9.00% 03/18-11/20 765 802,655 7.50% 04/23-04/27 976 981,045 6.50% 01/24-12/27 33,213 31,770,624 7.00% 12/27-01/28 22,248 21,844,616 Government National Mortgage Association II 9.50% 05/17-12/24 674 715,230 7.50% 01/29-09/29 2,000 2,007,558 MLCC Mortgage Investors, Inc., Series 95-C, Class D 7.98%** 05/25/15 3,506 3,419,292 MLCC Mortgage Investors, Inc., Series 96-C1, Class A2 7.24% 04/25/28 7,113 7,134,711 MLCC Mortgage Investors, Inc., Series 96-C1, Class A3 7.42% 04/25/28 5,500 5,522,029 -------------- TOTAL MORTGAGE PASS-THROUGHS (Cost $761,723,561) 739,185,240 -------------- MULTIPLE CLASS MORTGAGE PASS-THROUGHS -- 0.3% Federal Home Loan Mortgage Corp., Series 65, Class A (PO) 4.09%*** 03/15/24 1,795 804,984 Federal National Mortgage Association Series 96-3, Class C (PO) 5.00%*** 02/25/24 1,681 958,057 Federal National Mortgage Association Strip Notes, Series 279, Class 1 (PO) 6.00%*** 07/01/26 512 409,729 Federal National Mortgage Association, Series 97-44, Class L (PO) 4.35%*** 02/25/24 1,874 1,011,804
See accompanying notes to financial statements. 36 BLACKROCK FUNDS SCHEDULE OF INVESTMENTS MANAGED INCOME PORTFOLIO (CONTINUED)
Par AS OF SEPTEMBER 30, 1999 Maturity (000) Value -------- ------- -------------- MULTIPLE CLASS MORTGAGE PASS-THROUGHS (CONTINUED) Federal National Mortgage Association, Series 99-51, Class L (PO) 5.00%*** 10/25/29 $ 1,000 $ 510,000 Federal National Mortgage Association, Series 99-17, Class HJ (PO) 4.00%*** 12/25/23 1,290 552,281 Federal National Mortgage Association, Series 99-17, Class JH (PO) 5.00%*** 04/25/24 1,630 740,631 Residential Accredit Loans, Inc., Series 97-QS7, Class A1 7.50% 08/15/27 1,120 1,118,916 -------------- TOTAL MULTIPLE CLASS MORTGAGE PASS-THROUGHS (Cost $6,563,065) 6,106,402 -------------- COMMERCIAL MORTGAGE BACKED SECURITIES -- 4.7% Advanta Mortgage Loan Trust, Series 96-1, Class A7 7.07% 03/25/27 1,600 1,581,000 Capco America Securitization Corp., Series 98-D7, Class A1B 6.26% 09/15/08 3,340 3,122,861 COMM, Series 99-1, Class A2 6.46% 09/15/08 7,833 7,459,384 Commercial Capital Access One, Series 98-3, Class A1 6.30% 11/15/28 6,592 6,367,103 Deutsche Mortgage and Asset Receiving Corp., Series 98-C1, Class A2 6.54% 02/15/08 3,000 2,845,034 Empire Funding Home Loan Owner Trust, Series 98-2, Class A4 6.53% 03/25/19 15,000 14,718,750 FFCA Secured Lending Corp., Series 98-1, Class A1B 6.73% 07/18/13 8,246 7,696,683 FPlus, Series 98-3, Class A8 7.17%** 05/10/24 7,300 6,795,844 General Motors Acceptance Corp. Commercial Mortgage Securities, Inc., Series 99-C2, Class A2 6.95% 09/15/33 1,900 1,871,723 JP Morgan Commercial Mortgage Finance Corp., Series 96-C3, Class A1 7.33% 04/25/28 1,797 1,807,760 Lehman Brothers Commercial Conduit Mortgage Trust, Series 96-c2, Class A 7.43%** 10/25/26 9,267 9,404,263 Midland Royalty Acceptance Corp., Series 96-C, Class A 7.23% 01/25/29 6,200 6,159,299 Morgan Stanley Capital International, Inc., Series 99-RM1, Class A2 6.71% 12/15/31 4,933 4,727,689 Union Planters Mortgage Finance Corp., Series 98-1, Class A3 6.60% 01/25/28 9,094 8,972,727 USGI, Series 87 7.43% 12/01/22 900 905,226 -------------- TOTAL COMMERCIAL MORTGAGE BACKED SECURITIES (Cost $87,151,737) 84,435,346 -------------- Par Maturity (000) Value -------- ------- -------------- PROJECT LOANS -- 2.1% Federal Housing Authority, Audobon Villas 7.94% 11/15/37 $ 5,243 $ 5,376,733 Federal Housing Authority, Lakeland Nursing 7.88% 12/01/34 11,772 11,827,077 Federal Housing Authority, Meadowbrook of Topeka 8.50% 08/01/22 1,651 1,699,044 Federal Housing Authority, Riverwalk 8.22% 06/01/36 1,559 1,590,958 Federal Housing Authority, University Park Project Loans Apartments 7.88% 10/01/37 4,495 4,517,181 Federal Housing Authority, Washington PC94, Non-Public 6.90% 02/01/14 785 754,279 Meadows II Apartments, Construction Loan Collateral 7.00% 12/01/39 1,949 1,874,798 Meadows II Apartments, Construction Loan Committment 7.00% 12/01/00 1,914 1,840,285 Ponds at Punaluu, Construction Loan Collateral 7.63% 04/01/37 284 284,380 Quabbin Valley Healthcare, Construction Loan Collateral 7.66% 06/01/39 937 929,293 Quabbin Valley Healthcare, Construction Loan Committment 7.66% 03/08/00 40 39,522 Villages of Winterset, Construction Loan Collateral 7.13% 10/31/38 443 431,866 Villages of Winterset, Construction Loan Committment 7.13% 06/01/01 57 55,366 Whittier Rehab at Westborough Project Loan 8.13% 02/28/37 7,114 7,228,176 -------------- TOTAL PROJECT LOANS (COST $39,148,787) 38,448,958 -------------- ASSET BACKED SECURITIES -- 15.4% ACLC Business Loan Receivables Trust, Series 98-1, Class A1 6.44% 07/15/13 10,727 10,445,161 Arcadia Automobile Receivables Trust, Series 97-B, Class A3 6.30% 07/16/01 477 477,644 Arcadia Automobile Receivables Trust, Series 98-B, Class A3 5.95% 11/15/02 17,500 17,511,900 Arcadia Automobile Receivables Trust, Series 98-C, Class A2 5.38%** 02/15/02 1,555 1,550,927 Associates Manufactured Housing Pass-Through, Series 96-1, Class B1 8.00% 03/15/27 3,200 3,053,000 Boston Edison Co., Series 99-1, Class A5 7.03% 03/15/12 3,800 3,768,859 Chase Credit Card Master Trust, Series 97-5, Class A 6.19% 08/15/05 25,830 25,641,699
See accompanying notes to financial statements. 37 BLACKROCK FUNDS SCHEDULE OF INVESTMENTS MANAGED INCOME PORTFOLIO (CONTINUED)
Par AS OF SEPTEMBER 30, 1999 Maturity (000) Value -------- ------- -------------- MULTIPLE CLASS MORTGAGE PASS-THROUGHS (CONTINUED) Federal National Mortgage Association, Series 99-51, Class L (PO) 5.00%*** 10/25/29 $ 1,000 $ 510,000 Federal National Mortgage Association, Series 99-17, Class HJ (PO) 4.00%*** 12/25/23 1,290 552,281 Federal National Mortgage Association, Series 99-17, Class JH (PO) 5.00%*** 04/25/24 1,630 740,631 Residential Accredit Loans, Inc., Series 97-QS7, Class A1 7.50% 08/15/27 1,120 1,118,916 -------------- TOTAL MULTIPLE CLASS MORTGAGE PASS-THROUGHS (Cost $6,563,065) 6,106,402 -------------- COMMERCIAL MORTGAGE BACKED SECURITIES -- 4.7% Advanta Mortgage Loan Trust, Series 96-1, Class A7 7.07% 03/25/27 1,600 1,581,000 Capco America Securitization Corp., Series 98-D7, Class A1B 6.26% 09/15/08 3,340 3,122,861 COMM, Series 99-1, Class A2 6.46% 09/15/08 7,833 7,459,384 Commercial Capital Access One, Series 98-3, Class A1 6.30% 11/15/28 6,592 6,367,103 Deutsche Mortgage and Asset Receiving Corp., Series 98-C1, Class A2 6.54% 02/15/08 3,000 2,845,034 Empire Funding Home Loan Owner Trust, Series 98-2, Class A4 6.53% 03/25/19 15,000 14,718,750 FFCA Secured Lending Corp., Series 98-1, Class A1B 6.73% 07/18/13 8,246 7,696,683 FPlus, Series 98-3, Class A8 7.17%** 05/10/24 7,300 6,795,844 General Motors Acceptance Corp. Commercial Mortgage Securities, Inc., Series 99-C2, Class A2 6.95% 09/15/33 1,900 1,871,723 JP Morgan Commercial Mortgage Finance Corp., Series 96-C3, Class A1 7.33% 04/25/28 1,797 1,807,760 Lehman Brothers Commercial Conduit Mortgage Trust, Series 96-c2, Class A 7.43%** 10/25/26 9,267 9,404,263 Midland Royalty Acceptance Corp., Series 96-C, Class A 7.23% 01/25/29 6,200 6,159,299 Morgan Stanley Capital International, Inc., Series 99-RM1, Class A2 6.71% 12/15/31 4,933 4,727,689 Union Planters Mortgage Finance Corp., Series 98-1, Class A3 6.60% 01/25/28 9,094 8,972,727 USGI, Series 87 7.43% 12/01/22 900 905,226 -------------- TOTAL COMMERCIAL MORTGAGE BACKED SECURITIES (Cost $87,151,737) 84,435,346 -------------- Par Maturity (000) Value -------- ------- -------------- PROJECT LOANS -- 2.1% Federal Housing Authority, Audobon Villas 7.94% 11/15/37 $ 5,243 $ 5,376,733 Federal Housing Authority, Lakeland Nursing 7.88% 12/01/34 11,772 11,827,077 Federal Housing Authority, Meadowbrook of Topeka 8.50% 08/01/22 1,651 1,699,044 Federal Housing Authority, Riverwalk 8.22% 06/01/36 1,559 1,590,958 Federal Housing Authority, University Park Project Loans Apartments 7.88% 10/01/37 4,495 4,517,181 Federal Housing Authority, Washington PC94, Non-Public 6.90% 02/01/14 785 754,279 Meadows II Apartments, Construction Loan Collateral 7.00% 12/01/39 1,949 1,874,798 Meadows II Apartments, Construction Loan Committment 7.00% 12/01/00 1,914 1,840,285 Ponds at Punaluu, Construction Loan Collateral 7.63% 04/01/37 284 284,380 Quabbin Valley Healthcare, Construction Loan Collateral 7.66% 06/01/39 937 929,293 Quabbin Valley Healthcare, Construction Loan Committment 7.66% 03/08/00 40 39,522 Villages of Winterset, Construction Loan Collateral 7.13% 10/31/38 443 431,866 Villages of Winterset, Construction Loan Committment 7.13% 06/01/01 57 55,366 Whittier Rehab at Westborough Project Loan 8.13% 02/28/37 7,114 7,228,176 -------------- TOTAL PROJECT LOANS (COST $39,148,787) 38,448,958 -------------- ASSET BACKED SECURITIES -- 15.4% ACLC Business Loan Receivables Trust, Series 98-1, Class A1 6.44% 07/15/13 10,727 10,445,161 Arcadia Automobile Receivables Trust, Series 97-B, Class A3 6.30% 07/16/01 477 477,644 Arcadia Automobile Receivables Trust, Series 98-B, Class A3 5.95% 11/15/02 17,500 17,511,900 Arcadia Automobile Receivables Trust, Series 98-C, Class A2 5.38%** 02/15/02 1,555 1,550,927 Associates Manufactured Housing Pass-Through, Series 96-1, Class B1 8.00% 03/15/27 3,200 3,053,000 Boston Edison Co., Series 99-1, Class A5 7.03% 03/15/12 3,800 3,768,859 Chase Credit Card Master Trust, Series 97-5, Class A 6.19% 08/15/05 25,830 25,641,699
See accompanying notes to financial statements. 37 BLACKROCK FUNDS SCHEDULE OF INVESTMENTS MANAGED INCOME PORTFOLIO (CONTINUED)
Par AS OF SEPTEMBER 30, 1999 Maturity (000) Value -------- ------- ------------ ASSET BACKED SECURITIES (CONTINUED) CIT Group Securitization Corp., Series 95-2, Class B 7.65% 05/15/26 $ 7,650 $ 6,394,922 Daimler-Benz Auto Grantor Trust, Series 97-A, Class A 6.05%**/++ 03/31/05 1,845 1,846,446 Equicon Home Equity Loan Trust, Series 93-1, Class I (IO) 7.00%*** 02/18/13 6,140 46,053 Fifth Third Auto Grantor Trust, Series 96-B, Class A 6.45% 03/15/02 395 396,466 FMAC Loan Receivables Trust, Series 97-B, Class A 6.85% 09/15/19 6,234 6,070,968 FMAC Loan Receivables Trust, Series 97-C, Class A 6.75% 12/15/19 2,406 2,334,203 Ford Credit Auto Owner Trust, Series 98-C, Class A5 5.86% 10/15/02 3,200 3,180,704 Ford Credit Auto Owner Trust, Series 99-C, Class A4 6.08% 09/16/02 11,100 11,054,906 Green Tree Financial Corp., Series 93-3, Class B 6.85% 10/15/18 3,246 3,078,164 Green Tree Financial Corp., Series 94-B, Class A 7.85% 07/15/04 1,195 1,170,144 Green Tree Financial Corp., Series 95-A, Class A 7.25% 07/15/05 5,196 4,927,943 Green Tree Financial Corp., Series 96-2, Class B2 7.90%++ 04/15/27 2,500 1,953,640 Green Tree Financial Corp., Series 96-5, Class A7 8.25% 07/15/27 5,534 5,709,754 Green Tree Financial Corp., Series 96-7, Class A6 7.65% 10/15/27 9,025 9,153,324 Green Tree Financial Corp., Series 96-8, Class B1 7.95% 01/01/05 3,000 2,849,961 Green Tree Financial Corp., Series 97-1, Class B1 7.23% 03/15/28 9,000 8,382,611 Green Tree Financial Corp., Series 97-3, Class B1 7.51% 07/15/28 2,500 2,316,406 Green Tree Financial Corp., Series 97-3, Class B2 8.03% 07/15/28 7,050 5,460,637 Green Tree Home Improvement Loan Trust, Series 94-D, Class M 9.05% 01/15/15 456 460,930 Green Tree Home Improvement Loan Trust, Series 96-C, Class HIB1 7.75% 06/15/21 5,697 5,642,816 Green Tree Home Improvement Loan Trust, Series 97-A, Class HEM2 7.90% 03/15/28 5,150 4,902,156
Par Maturity (000) Value -------- ------- ----------- ASSET BACKED SECURITIES (CONTINUED) Health Care Receivables Securitization Program Notes, NPF VI, Series 98-1, Class A 6.22% 06/01/02 $13,800 13,604,838 Honda Auto Lease Trust, Series 99-A, Class A4 6.45% 09/16/02 14,700 14,725,266 Keycorp Student Loan Trust, Series 95-B, Class A 5.41%** 09/27/24 7,635 7,650,075 MBNA Master Credit Card Trust, Series 99-B, Class A 5.90% 08/15/11 4,400 4,137,166 MBNA Master Credit Card Trust, Series 99-J, Class A 7.00% 02/15/12 6,200 6,230,033 Mellon Bank Home Equity Loan Trust, Series 96-1, Class B2 5.69%** 04/15/26 1,244 1,244,035 Newcourt Equipment Trust Securities, Series 98-2, Class A3 5.45% 10/15/02 15,400 15,209,044 Puget Power Conservation Grantor Trust, Series 97-1, Class A 6.23% 07/11/02 6,757 6,731,399 Railcar Leasing LLC, Series 97-1, Class A1 6.75% 07/15/06 10,047 9,952,695 Sears Credit Account Master Trust, Series 95-5, Class A 6.05% 01/15/08 3,812 3,755,661 Sears Credit Account Master Trust, Series 96-3, Class A 7.00% 07/15/08 11,600 11,743,513 Sears Credit Account Master Trust, Series 96-4, Class A 6.45% 10/16/06 4,200 4,167,009 Sears Credit Account Master Trust, Series 97-1, Class A 6.20% 07/15/07 8,000 7,948,120 Sears Credit Account Master Trust, Series 98-1, Class A 5.80% 08/15/05 7,900 7,770,423 The Money Store Business Loan Backed Securities, Series 97-1, Class A 5.65%** 04/15/28 6,347 6,367,135 The Money Store Home Equity Trust, Series 97-C, Class MH2 7.36% 02/15/24 2,775 2,730,772 Toyota Auto Receivables Owner Trust, Series 99-A, Class A3 6.15% 08/16/04 225 224,297 World Omni Automobile Lease Securitization Trust, Series 97-B, Class A1 6.07% 11/25/03 2,000 2,007,307 ----------- TOTAL ASSET BACKED SECURITIES (Cost $283,684,857) 275,981,132 -----------
See accompanying notes to financial statements. 38 BLACKROCK FUNDS SCHEDULE OF INVESTMENTS MANAGED INCOME PORTFOLIO (CONTINUED)
Par AS OF SEPTEMBER 30, 1999 Maturity (000) Value -------- ------- ----------- CORPORATE BONDS -- 17.2% AEROSPACE -- 0.3% United Tech Corp. 6.50% 06/01/09 $ 6,010 $ 5,803,437 ----------- AIR TRANSPORTATION -- 0.1% CONTINENTAL AIRLINES 7.06% 03/15/11 2,045 1,969,126 ----------- AUTOMOTIVE -- 0.1% DaimlerChrysler Holdings N.A. 6.90% 09/01/04 1,700 1,708,500 ----------- FINANCE -- 7.8% Allmerica Financial Corp. 7.63% 10/15/25 1,640 1,542,593 American General Capital Securities 7.57% 12/01/45 4,480 4,104,800 Associates Corp. 6.25% 11/01/08 5,000 4,731,250 AT&T Capital Corp. 5.48%** 04/09/01 3,500 3,468,080 Chrysler Corp. 7.45% 03/01/27 6,105 6,083,927 Crown Cork & Seal, S.A. 6.75% 12/15/03 3,000 2,941,850 CSW Investments 6.95% 08/01/01 7,705 7,749,073 ERAC USA Finance Co. 6.95% 03/01/04 1,017 1,000,952 Fairfax Financial Hldgs. 7.38% 03/15/06 2,780 2,618,788 FMR Corp. 7.57% 06/15/29 7,095 6,935,363 Ford Motor Credit Co. 6.70% 07/16/04 9,485 9,437,575 Frank Russel Co. 5.63% 01/15/09 6,400 5,748,160 Golden State Holding Corp. 7.00% 08/01/03 10,300 9,988,631 Goldman Sachs Group, Inc. 6.25% 02/01/03 6,030 5,864,970 6.65% 05/15/09 4,665 4,447,250 Great Western Finance 8.21% 02/01/27 5,000 4,800,000 Larwin Group - Participation in Asset Exchange 8.00% 12/01/99 13 12,515 Lehman Brothers Holdings, Inc. 6.75% 09/24/01 8,000 7,968,800 6.20% 01/15/02 4,700 4,617,280 7.38% 05/15/07 1,500 1,516,502 Merrill Lynch & Co., Inc. 5.75% 11/04/02 5,165 5,026,113 6.00% 02/17/09 400 368,000 MidAmerican Funding, LLC 6.93% 03/01/29 8,050 7,344,015 National City Corp. 6.88% 05/15/19 11,000 10,067,746 Newcourt Credit Group 6.88% 02/16/05 900 879,957 Paine Webber, Inc. 6.38% 05/15/04 2,565 2,470,969 Pemex Finance Ltd. 9.14% 08/15/04 4,410 4,417,277 Riggs Capital Trust 8.63% 12/31/26 400 376,500
Par Maturity (000) Value -------- ------- -------------- CORPORATE BONDS (CONTINUED) FINANCE (CONTINUED) Riggs Capital Trust II Preferred Securities, Series C 8.88% 03/15/27 $ 2,000 $ 1,872,910 Washington Mutual Capital, Inc. 8.38% 06/01/27 1,250 1,223,438 Yorkshire Power Finance 6.50% 02/25/08 2,350 2,138,500 Zurich Capital Trust I 8.38% 06/01/27 8,150 8,007,375 -------------- 139,771,159 -------------- INDUSTRIAL -- 4.0% Alberton's, Inc. 7.45% 08/01/29 2,100 2,079,000 Atlantic Richfield 9.88% 03/01/16 4,885 6,100,144 Coca-Cola Enterprises, Inc. 5.71% 03/18/37 12,520 12,523,881 Conoco, Inc. 6.95% 04/15/29 2,995 2,785,350 Dayton Hudson Corp. 5.95% 06/15/00 3,400 3,400,000 Ford Motor Co. 7.45% 07/16/31 15,405 15,201,282 General Motors 8.80% 03/01/21 3,000 3,348,750 Hyder PLC 6.75% 12/15/04 6,500 6,216,925 Nabisco, Inc. 6.85% 06/15/05 8,300 8,022,116 7.05% 07/15/07 3,380 3,269,204 7.55% 06/15/15 3,080 2,935,086 Tyco Intl. Group Corp., S.A. 5.88% 11/01/04 2,910 2,757,225 Xerox Corp. 5.91% 04/01/99 3,600 3,586,500 -------------- 72,225,463 -------------- Insurance -- 1.0% Equitable Cos., Inc. 9.00% 12/15/04 5,555 6,048,006 7.00% 04/01/28 4,670 4,253,810 Florida Windstorm Underwriting Association 7.13% 02/25/19 5,715 5,341,468 Prudential Insurance Co. 6.38% 07/23/06 2,750 2,609,063 -------------- 18,252,347 -------------- TELECOMMUNICATIONS -- 1.9% AT&T Corp. 6.00% 03/15/09 6,290 5,849,700 6.50% 03/15/29 5,615 4,950,296 Sprint Capital Corp. 6.38% 05/01/09 2,540 2,394,323 6.90% 05/01/19 4,060 3,776,746 Time Warner, Inc. 9.13% 01/15/13 2,075 2,334,026 US West Capital Funding, Inc. 6.88% 07/15/28 6,070 5,349,188 Worldcom, Inc. 7.75% 04/01/27 9,710 10,159,088 -------------- 34,813,367 --------------
See accompanying notes to financial statements. 39 BLACKROCK FUNDS SCHEDULE OF INVESTMENTS MANAGED INCOME PORTFOLIO (CONCLUDED)
Par AS OF SEPTEMBER 30, 1999 Maturity (000) Value -------- ------- -------------- CORPORATE BONDS (CONTINUED) TRANSPORTATION -- 0.2% Federal Express Corp. 6.72% 01/15/22 $ 3,017 $ 2,848,046 -------------- REGIONAL AGENCY -- 0.3% Quebec Province 7.50% 09/15/29 4,460 4,482,300 -------------- UTILITY -- 0.6% Avon Energy Partnership 6.73% 12/11/02 1,100 1,094,500 Israel Electric Corp. Ltd. 7.13% 07/15/05 1,915 1,877,658 8.10% 12/15/46 8,860 7,374,574 -------------- 10,346,732 -------------- WASTE MANAGEMENT -- 0.3% USA Waste Management, Inc. 6.13% 07/15/01 5,455 5,243,619 -------------- YANKEE -- 0.6% Empresa Electrica Pehuenche 7.30% 05/01/03 11,000 10,610,106 -------------- TOTAL CORPORATE BONDS (Cost $318,540,187) 308,074,202 -------------- FOREIGN BONDS -- 0.2% Newcourt Credit Group 7.63% 06/28/01 4,690 3,230,106 (Cost $3,263,386) -------------- TAXABLE MUNICIPAL BONDS -- 0.7% Los Angeles County Pension Obligation Revenue Bond, Series 95D 6.97% 06/30/08 7,355 7,299,838 New Jersey Economic Development Authority State Pension Funding Zero Coupon Revenue Bond, Series 97B 7.56%*** 02/15/16 1,600 476,000 7.59%*** 02/15/17 575 158,125 7.21%*** 02/15/18 14,500 3,697,500 7.62%*** 02/20-02/21 1,010 215,337 7.63%*** 02/22-02/23 815 150,925 -------------- TOTAL TAXABLE MUNICIPAL BONDS (Cost $12,934,199) 11,997,725 -------------- SHORT TERM INVESTMENTS -- 0.2% Federal Home Loan Mortgage Corp. Discount Notes 5.17% 10/01/99 3,500 3,500,000 (Cost $3,500,000) -------------- Shares ------ PREFERRED STOCK -- 0.5% Centaur Funding Corp., Cumulative 144A 9.08% 8,000 8,270,808 (Cost $8,000,000) -------------- TOTAL INVESTMENTS IN SECURITIES (Cost $1,842,116,850*) 100.0% $1,790,993,952 ============== REVERSE REPURCHASE AGREEMENTS -- (17.0%) Aubrey Lanston (Agreement dated 09/30/99 to be repurchased at $31,681,812. Collateralized by $31,000,000 U.S. Treasury notes 6.00% Due 08/15/09. The value of the collateral is $31,488,556.) 3.75% 10/04/99 31,349 (31,352,015)
Par Maturity (000) Value -------- -------- ------------- REVERSE REPURCHASE AGREEMENTS (CONTINUED) Aubrey Lanston (Agreement dated 09/23/99 to be repurchased at $37,470,937. Collateralized by $39,715,780 U.S. Treasury Notes (CPI) 3.63% due 04/15/28. The value of the collateral is $37,450,353.) 5.30% 10/22/99 $ 37,312 $ (37,355,582) Lehman Brothers (Agreement dated 09/15/99 to be repurchased at $57,767,354. Collateralized by $58,553,153 Federal Home Loan Mortgage Corp. Gold 6.50% due 04/01/29-06/01/29 and $3,374,088 Federal National Mortgage Association 5.50% due 12/01/13. The value of the collateral is $59,902,726.) 5.36% 10/14/99 57,519 (57,656,023) Lehman Brothers (Agreement dated 09/17/99 to be repurchased at $111,895,852. Collateralized by $121,466,453 Federal National Mortgage Association 5.50-6.00% due 12/01/13 to 01/01/29. The value of the collateral is $114,853,225.) 5.38% 10/19/99 111,413 (111,596,078) Morgan Stanley (Agreement dated 09/15/99 to be repurchased at $24,573,037. Collateralized by $27,067,750 Federal National Mortgage Association 5.50-6.00% due 01/01/14-01/01/29. The value of the collateral is $25,497,471.) 5.38% 10/14/99 24,467 (24,525,503) ------------- TOTAL REVERSE REPURCHASE AGREEMENTS (Cost $262,059,388) $(262,485,201) =============
__________________________ * Cost for Federal income tax purposes is $1,845,288,663. The gross unrealized appreciation (depreciation) on a tax basis is as follows: Gross unrealized appreciation $ 2,982,178 Gross unrealized depreciation (57,276,889) ------------- $ (54,294,711) ============= ** Rates shown are the rates as of September 30, 1999. *** Rates shown are the effective yields as of September 30, 1999. + Partial principal in the amount of $281,177,044 has been pledged as collateral for reverse repurchase agreements. ++ Principal amount of securities pledged as collateral of $8,400,000 on 802 long U.S. Treasury Bonds futures contracts and 85 short U.S. Treasury Notes futures contracts expiring December 1999. The value of such contracts on September 30, 1999 was $100,738,500, thereby resulting in an unrealized gain of $212,024. See accompanying notes to financial statements. 40 BLACKROCK FUNDS STATEMENT OF ASSETS AND LIABILITIES MANAGED INCOME PORTFOLIO SEPTEMBER 30, 1999 ASSETS Investments at value (Cost $1,842,116,850) ......... $1,790,993,952 Collateral received for securities loaned .......... 64,906,405 Interest receivable ................................ 17,558,576 Principal receivable ............................... 1,321 Investments sold receivable ........................ 15,461,982 Capital shares sold receivable ..................... 196,218 Prepaid expenses ................................... 5,995 -------------- TOTAL ASSETS ................................ 1,889,124,449 -------------- LIABILITIES Cash Overdraft ..................................... 140,276 Payable upon return of securities loaned ........... 64,906,405 Investments purchased payable ...................... 6,084,726 Capital shares redeemed payable .................... 819,509 Distributions payable .............................. 8,044,534 Advisory fees payable .............................. 565,290 Administrative fees payable ........................ 181,696 Transfer agent fees payable ........................ 83,645 Other accrued expenses payable ..................... 265,729 Deferred dollar roll income ........................ 8,446 Reverse repurchase agreements payable .............. 262,485,201 Futures margin payable ............................. 685,630 Net unrealized depreciation on forward foreign currency contracts ............... 9,620 -------------- TOTAL LIABILITIES ........................... 344,280,707 -------------- NET ASSETS (Applicable to 126,353,410 Institutional shares, 27,322,500 Service shares, 1,521,912 Investor A shares and 586,681 Investor B shares outstanding) ......... $1,544,843,742 ============== NET ASSET VALUE AND REDEMPTION PRICE PER INSTITUTIONAL, SERVICE AND INVESTOR A SHARE ($1,539,026,022 / 155,197,822) ............... $ 9.92 ====== OFFERING PRICE PER INSTITUTIONAL AND SERVICE SHARE .... $ 9.92 ====== MAXIMUM OFFERING PRICE PER INVESTOR A SHARE ($9.92 / 0.955) .................................... $10.39 ====== NET ASSET VALUE, OFFERING AND REDEMPTION PRICE (subject to a maximum contingent deferred sales charge of 4.5%) PER INVESTOR B SHARE ($5,817,720 / 586,681) ............................. $ 9.92 ====== See accompanying notes to financial statements. 41 BLACKROCK FUNDS STATEMENT OF NET ASSETS INTERNATIONAL BOND PORTFOLIO Par** AS OF SEPTEMBER 30, 1999 Maturity (000) Value ---------- ------- ----------- FOREIGN BONDS -- 60.8% AUSTRIA -- 2.9% Allgemeine Hypobk AG 5.00% 09/02/09 2,000 $ 2,043,707 ----------- CANADA -- 3.7% Canada Trust Company Mortgage 5.63% 01/01/02 1,976 1,334,877 Highway 407 International, Inc. 6.47% 07/27/29 2,000 1,292,149 ----------- 2,627,026 ----------- DENMARK -- 3.4% Kingdom of Denmark 8.00% 05/03-03/06 15,000 2,403,789 ----------- FRANCE -- 5.3% European Investment Bank 5.00% 04/15/08 1,955 2,029,995 Government of France 5.50% 10/25/07 1,524 1,666,584 ----------- 3,696,579 ----------- GERMANY -- 11.9% Bundesobligation 126 4.50% 02/18/03 2,600 2,790,560 Deutsche Telekom International Financial 5.25% 05/20/08 0 1 Deutschland Republic 6.25% 04/26/06 4,000 4,579,437 Dresdner Funding Trust II 5.79% 06/30/11 1,000 982,449 ----------- 8,352,447 ----------- ITALY -- 2.6% Buoni Poliennali del Tes 6.75% 07/01/07 1,549 1,802,354 ----------- NETHERLANDS -- 9.9% Government of Netherlands 7.00% 06/15/05 3,000 3,535,219 5.50% 01/15/28 3,409 3,427,225 ----------- 6,962,444 ----------- SPAIN -- 2.3% Bonos y Oblig del Estado 4.25% 07/30/02 1,543 1,650,832 ----------- SWEDEN -- 4.9% Swedish Government 6.00% 02/09/05 25,000 3,433,434 ----------- UNITED KINGDOM -- 13.9% Abbey National Treasury Services 8.00% 04/02/03 600 1,015,166 Bayerische Landesbank Girozentrale 7.88% 12/07/06 1,100 1,901,626 Federal National Mortgage Assoc. Global Bond 6.88%++ 06/07/02 2,500 4,134,131 Halifax Building Society PLC 6.50% 02/16/04 450 726,505 United Kingdom Treasury 9.00% 10/13/08 1,000 1,988,796 ----------- 9,766,224 ----------- TOTAL FOREIGN BONDS (Cost $43,277,858) 42,738,836 ----------- Par Maturity (000) Value ---------- ------- ----------- U.S. GOVERNMENT & AGENCY OBLIGATIONS -- 0.2% U.S. Treasury Notes 6.50% 10/15/06 $ 160 $ 163,705 (Cost $164,285) ----------- CORPORATE BONDS -- 12.4% First USA Credit Card Master Trust 5.68%** 10/15/99 3,000 3,003,750 Ford Motor Credit Co. 6.70% 07/16/04 3,000 2,985,000 Sears Credit Account Master Trust 7.00% 01/15/04 2,750 2,759,169 ----------- TOTAL CORPORATE BONDS (Cost $8,761,484) 8,747,919 ----------- SHORT TERM INVESTMENTS -- 25.0% Federal Home Loan Mortgage Corp. Discount Notes 5.20% 10/01/99 17,600 17,600,000 (Cost $17,600,000) ----------- TOTAL INVESTMENTS IN SECURITIES (Cost $69,803,627*) 98.4% 69,250,460 OTHER ASSETS IN EXCESS OF LIABILITIES 1.6% 1,098,704 ---------- ----------- NET ASSETS (Applicable to 5,483,834 Institutional shares, 345,169 Service shares, 244,200 Investor A shares, 226,363 Investor B shares, and 209,909 Investor C shares outstanding) 100.0% $70,349,164 ========== =========== NET ASSET VALUE AND REDEMPTION PRICE PER INSTITUTIONAL, SERVICE AND INVESTOR A SHARE ($65,634,014 / 6,073,203) $ 10.81 =========== OFFERING PRICE PER INSTITUTIONAL AND SERVICE SHARE $ 10.81 =========== MAXIMUM OFFERING PRICE PER INVESTOR A SHARE ($10.81 / 0.950) $ 11.38 =========== NET ASSET VALUE, OFFERING PRICE AND REDEMPTION PRICE (SUBJECT TO A CONTINGENT DEFERRED SALES CHARGE OF 4.5%) PER INVESTOR B SHARE ($2,446,599 / 226,363) $10.81 ====== NET ASSET VALUE, OFFERING PRICE AND REDEMPTION PRICE (SUBJECT TO A CONTINGENT DEFERRED SALES CHARGE OF 1.0%) PER INVESTOR C SHARE ($2,268,551 / 209,909) $10.81 ====== - -------------------------------- * Also cost for Federal income tax purposes. The gross unrealized appreciation (depreciation) on a tax basis is as follows: Gross unrealized appreciation $ 544,235 Gross unrealized depreciation (1,097,402) ----------- $ (553,167) =========== ** In local currency. ++ Principal amount of securities pledged as collateral of $1,000,000 on 12 long Japanese Bond futures contracts expiring March 2000. The value of such contracts on September 30, 1999 was $14,874,319, thereby resulting in an unrealized gain of $427,578. See accompanying notes to financial statements. 42 BLACKROCK FUNDS SCHEDULE OF INVESTMENTS HIGH YIELD BOND PORTFOLIO Number AS OF SEPTEMBER 30, 1999 of Shares Value ---------- ----------- PREFERRED STOCKS -- 7.2% Hyperion Telecommunications, Inc., Series B (PIK) 12.875% 3,231 $ 2,876,093 Key Energy Services, Inc. Warrant 1,000 2,000 Nextel Communications, Inc., Series D (PIK) 13.00% 1,032 1,083,600 Nextel Communications, Inc., Cumulative Series E (PIK) 11.125% 1,084 1,051,480 Nextlink Communications, Inc. (PIK) 14.00% 31,462 1,557,369 ----------- TOTAL PREFERRED STOCKS (Cost $6,771,579) 6,570,542 ----------- Par Maturity (000) ---------- ------- COMMERCIAL MORTGAGE BACKED SECURITIES -- 2.0% Donaldson, Lufkin & Jenrette, Inc., Commercial Mortgage Corp., Series 98-CG1, Class B4 7.35%** 01/10/13 $ 2,531 1,806,273 ----------- (Cost $2,003,507) CORPORATE BONDS -- 90.6% ELECTRONICS -- 3.1% Amkor Technologies, Inc., Series 144A 10.50% 05/01/09 2,000 1,920,000 Condor Systems, Inc., Series 144A 11.88% 05/01/09 1,000 890,000 ----------- 2,810,000 ----------- FINANCIAL -- 0.8% BGLS, Inc., Series B 15.75% 01/31/01 700 700,000 ----------- INDUSTRIAL -- 37.1% American Plumbing & Mechanical, Inc., Series 144A 11.63% 10/15/08 1,000 900,000 Ameriserve Food Distributor 8.88%+ 10/15/06 750 570,000 Charles River Laboratories, Inc. 13.50% 10/01/09 1,000 1,010,000 Concentra Operating Corp., Series 144A 13.00% 08/15/09 2,000 2,000,000 Fountain View, Inc., Series B 11.25% 04/15/08 1,000 720,000 Golden Northwest Aluminum First Mortgage Notes 12.00% 12/15/06 1,750 1,802,500 Hudson Respiratory Care, Inc. 9.13% 04/15/08 2,000 1,560,000 Huntsman ICI Hldgs., Series 144A (STEP) 13.00%*** 12/31/09 3,500 910,000 Kasper A.S.L. Ltd. 12.75% 03/31/04 1,500 1,447,500 Knology Hldgs., Inc. (STEP) 13.36%*** 10/15/07 2,000 1,100,000 Knowles Electronics, Inc. 13.13% 10/01/09 1,000 979,540 Lyondell Chemical 10.88% + 05/01/09 2,600 2,613,000 National Equipment Services, Series D 10.00% 11/30/04 2,000 1,980,000 Nebco Evans Hldg. Co. (STEP) 17.25%*** 07/15/07 800 296,000 Par Maturity (000) Value ---------- ------- ----------- CORPORATE BONDS (CONTINUED) INDUSTRIAL (CONTINUED) Northeast Optic Network 12.75% 08/15/08 $ 2,000 $ 2,040,000 Pogo Producing Co., Series 144A 10.38% 02/15/09 1,000 1,037,500 Polaroid Corp. 11.50% 02/15/06 1,000 1,043,750 PSINet Inc., Series 144A 11.00%+ 08/01/09 1,000 985,000 Repap New Brunswick 10.63% 04/15/05 1,000 872,500 Republic Tech RTI Capital, Series 144A 13.75% 07/15/09 1,000 950,000 Revlon Consumer Products 8.63%+ 02/01/08 2,000 1,630,000 Sinclair Broadcast Group 9.00% 07/15/07 2,000 1,895,000 St. John Knits Intl., Inc., Series 144A 12.50% 07/01/09 1,000 915,000 U.S. Home 8.88% 02/15/09 1,000 910,000 Veritas DGC, Inc. 9.75% 10/15/03 1,000 1,012,500 Waterford Gaming, LLC Sr. Notes, Series 144A 9.50% 03/15/10 1,000 972,500 Wec Co., Inc., Series 144A 12.00% 07/15/09 1,000 980,000 Willis Corroon Corp. 9.00% 02/01/09 1,000 905,000 ----------- 34,037,290 ----------- OIL AND GAS -- 9.9% Chesapeake Energy Corp. 9.13%+ 04/15/06 1,500 1,380,000 Dual Drilling Co. 9.88% 01/15/04 100 104,000 Grey Wolf, Inc., Series C 8.88% 07/01/07 1,500 1,350,000 Key Energy Services, Inc., Series B 14.00% 01/15/09 1,000 1,065,000 R&B Falcon Corp. 12.25% 03/15/06 2,000 2,110,000 Swift Energy Co. 10.25% 08/01/09 1,550 1,557,750 Western Gas Resources, Series 144A 10.00% 06/15/09 1,500 1,533,750 ----------- 9,100,500 ----------- RETAIL -- 7.1% Group One Automotive, Inc. 10.88% 03/01/09 1,000 950,000 J. Crew Group, Inc., Series B (STEP) 13.44%*** 10/15/08 1,500 787,500 J.H. Heafner Co., Series D 10.00% 05/15/08 1,000 940,000 Mattress Discounters Corp. 12.63% 07/15/07 1,000 950,000 Sbarro, Inc., Sr. Notes, Series 144A 11.00% 09/15/09 1,000 988,750 Sonic Automotive, Inc., Series B 11.00% 08/01/08 2,000 1,910,000 ----------- 6,526,250 ----------- See accompanying notes to financial statements. 43 BLACKROCK FUNDS SCHEDULE OF INVESTMENTS HIGH YIELD BOND PORTFOLIO (CONCLUDED) Par AS OF SEPTEMBER 30, 1999 Maturity (000) Value ---------- ------- ----------- CORPORATE BONDS (CONTINUED) SPECIAL PURPOSE -- 7.8% Nextel Partners, Inc. (STEP) 13.57%*** 02/01/09 $ 4,100 $ 2,439,500 Penhall Acquisition Corp.(STEP) 12.00%*** 08/01/06 2,000 1,960,000 Pinnacle Hldgs., Inc. (STEP) 12.26%*** 03/15/08 3,000 1,732,500 Zais Investment Grade Ltd. 9.95% 09/23/14 1,000 990,000 ----------- 7,122,000 ----------- TELECOMMUNICATIONS -- 24.8% Allegiance Telecom, Inc., Series 144A (STEP) 12.52%*** 02/15/08 3,000 1,935,000 Diamond Cable Communications PLC 10.62% 12/15/05 1,000 902,500 Echostar DBS Corp. 9.38%+ 02/01/09 2,000 1,975,000 Echostar DBS Corp., Series 144A 9.25% 02/01/06 1,000 987,500 Globenet Communications Group Ltd., Series 144A 13.00% 07/15/07 1,500 1,485,000 Hyperion Telecommunications, Series B (STEP) 12.29%*** 04/15/03 2,000 1,690,000 IPC Info. Systems (STEP) 11.92%*** 05/01/08 3,000 2,280,000 James Cable Partners LP, Series B 10.75% 08/15/04 1,000 1,005,000 Spectrasite Holdings, Inc., Series 144A (STEP) 11.25%*** 04/15/09 2,000 1,000,000 Teligent, Inc. 11.50% 12/01/07 2,000 1,840,000 United Pan-Europe Communications, Series 144A (STEP) 12.50%*** 08/01/09 4,000 2,240,000 United Pan-Europe Communications, NV, Series 144A 10.88% 08/01/09 1,500 1,522,500 Versatel Telecom BV, Sr. Notes 11.88% 07/15/09 1,000 950,000 Viatel, Inc. (STEP) 11.93%*** 04/15/08 1,600 928,000 Williams Communications Group, Inc., Sr. Notes 10.88% 10/01/09 1,000 992,490 Worldwide Fiber, Inc., Series 144A 12.00% 08/01/09 1,000 975,000 ----------- 22,707,990 ----------- TOTAL CORPORATE BONDS (Cost $85,207,468) 83,004,030 ----------- Shares Value ---------- ----------- SHORT TERM INVESTMENTS -- 0.2% Galileo Money Market Fund 194,162 $ 194,162 (Cost $194,162) ----------- TOTAL INVESTMENTS IN SECURITIES -- 100.0% (Cost $94,176,716*) $91,575,007 =========== - ----------------------- * Also cost for Federal income tax purposes. The gross unrealized appreciation (depreciation) on a tax basis is as follows: Gross unrealized appreciation $ 753,363 Gross unrealized depreciation (3,355,072) ----------- $(2,601,709) =========== ** Rates shown are the rates as of September 30, 1999. ***Rates shown are the effective yields as of September 30, 1999. +Partial principal in the amount of $9,250,000 has been pledged as collateral for reverse repurchase agreements. -------------------------------------------------- INVESTMENT ABBREVIATIONS CPI Consumer Price Index IO Interest Only PIK Payment In Kind PO Principal Only STEP Step Bonds -------------------------------------------------- See accompanying notes to financial statements. 44 BLACKROCK FUNDS STATEMENT OF ASSETS AND LIABILITIES HIGH YIELD BOND PORTFOLIO SEPTEMBER 30, 1999 ASSETS Investments at value (Cost $94,176,716) .................... $91,575,007 Interest receivable ........................................ 1,593,994 Investments sold receivable ................................ 3,068,771 Capital shares sold receivable ............................. 177,857 Prepaid expenses ........................................... 30,644 ----------- Total assets ........................................ 96,446,273 ----------- LIABILITIES Investments purchased payable .............................. 5,475,188 Capital shares redeemed payable ............................ 5,964 Distributions payable ...................................... 696,704 Transfer agent fees payable ................................ 8,913 Other accrued expenses payable ............................. 103,050 Reverse repurchase agreements payable ...................... 6,831,443 ----------- Total liabilities ................................... 13,121,262 ----------- NET ASSETS (Applicable to 11 BlackRock shares, 6,561,608 Institutional shares, 11 Service shares, 453,319 Investor A shares, 1,274,781 Investor B shares and 271,952 Investor C shares outstanding) ........................................ $83,325,011 =========== NET ASSET VALUE AND REDEMPTION PRICE PER BLACKROCK, INSTITUTIONAL, SERVICE AND INVESTOR A SHARE ($68,271,709 (DIVIDE) 7,014,949) ........................... $ 9.73 =========== OFFERING PRICE PER BLACKROCK, INSTITUTIONAL AND SERVICE SHARE .......................................... $ 9.73 =========== MAXIMUM OFFERING PRICE PER INVESTOR A SHARE ($9.73 (DIVIDE) 0.950) ..................................... $ 10.24 =========== NET ASSET VALUE AND REDEMPTION PRICE (subject to a maximum contingent deferred sales charge of 4.5%) PER INVESTOR B SHARE ($12,406,541 (DIVIDE) 1,274,781) ........................... $ 9.73 =========== NET ASSET VALUE, OFFERING AND REDEMPTION PRICE (subject to a maximum contingent deferred sales charge of 1.0%) PER INVESTOR C SHARE ($2,646,761 (DIVIDE) 271,952) .............................. $ 9.73 =========== See accompanying notes to financial statements. 45 BLACKROCK FUNDS STATEMENT OF OPERATIONS
Intermediate Low Duration Government Intermediate Core Bond Bond Bond Bond FOR THE PERIOD ENDED SEPTEMBER 30, 1999 Portfolio Portfolio Portfolio Portfolio ------------ ------------ ------------ ------------ Investment income: Interest ...................................... $ 24,421,063 $ 29,864,362 $ 43,481,151 $ 63,329,067 Dividend ...................................... -- -- -- 349,605 ------------ ------------ ------------ ------------ Total Investment Income .............. 24,421,063 29,864,362 43,481,151 63,678,672 ------------ ------------ ------------ ------------ Expenses: Investment advisory fee ....................... 1,474,052 2,269,860 2,765,839 4,630,434 Administration fee ............................ 613,780 1,044,136 1,233,704 1,952,797 Custodian fee ................................. 85,328 100,156 134,224 189,847 Transfer agent fee ............................ 73,232 152,503 168,894 277,362 Shareholders servicing fees ................... 42,659 71,423 46,537 173,513 Shareholders processing fees .................. 36,024 60,266 43,405 148,549 Distribution fees ............................. 29,672 6,773 5,874 140,631 Legal and audit ............................... 16,792 27,917 43,468 44,979 Printing ...................................... 30,105 53,644 56,820 90,126 Registration fees and expenses ................ 42,344 42,853 43,454 89,362 Trustees' fees and officers' salary ........... 5,310 7,481 9,228 15,152 Other ......................................... 26,824 15,506 35,003 54,333 ------------ ------------ ------------ ------------ 2,476,122 3,852,518 4,586,450 7,807,085 Less fees waived .............................. (865,919) (982,062) (1,219,418) (2,378,468) ------------ ------------ ------------ ------------ Total operating expenses .................... 1,610,203 2,870,456 3,367,032 5,428,617 ------------ ------------ ------------ ------------ Interest expense .............................. 5,415,586 931,838 6,296,639 3,507,923 ------------ ------------ ------------ ------------ Total expenses ....................... 7,025,789 3,802,294 9,663,671 8,936,540 ------------ ------------ ------------ ------------ Net investment income ......................... 17,395,274 26,062,068 33,817,480 54,742,132 ------------ ------------ ------------ ------------ Realized and unrealized gain (loss) on investments and foreign currency transactions: Net realized gain (loss) from: Investment transactions ..................... (896,197) (2,881,688) (4,686,514) (14,819,766) Futures, options and swap contracts ......... 774,798 (213,396) 585,468 4,402,103 Foreign currency and forward foreign currency transactions ............ 22,966 -- -- -- ------------ ------------ ------------ ------------ (98,433) (3,095,084) (4,101,046) (10,417,663) ------------ ------------ ------------ ------------ Change in unrealized appreciation (depreciation) from: Investments ................................ (6,238,651) (18,532,012) (22,466,057) (47,011,093) Futures .................................... 110,076 (1,198,976) (1,141,333) 743,381 Foreign currency and forward foreign currency transactions ............ (5,150) -- -- -- ------------ ------------ ------------ ------------ (6,133,725) (19,730,988) (23,607,390) (46,267,712) ------------ ------------ ------------ ------------ Net loss on investments and foreign currency transactions ................. (6,232,158) (22,826,072) (27,708,436) (56,685,375) ------------ ------------ ------------ ------------ Net increase (decrease) in net assets resulting from operations ..................... $ 11,163,116 $ 3,235,996 $ 6,109,044 $ (1,943,243) ============ ============ ============ ============
Government Managed International High Yeild Income GNMA Income Bond Bond FOR THE PERIOD ENDED SEPTEMBER 30, 1999 Portfolio Portfolio Portfolio Portfolio Portfolio 1 ----------- ------------ ------------- -------------- ------------ Investment income: Interest ...................................... $ 3,140,950 $ 8,090,139 $ 120,078,257 $ 2,865,867 $ 5,569,680 Dividend ...................................... -- -- 673,973 -- 572,176 ----------- ------------ ------------- ----------- ----------- Total Investment Income .............. 3,140,950 8,090,139 120,752,230 2,865,867 6,141,856 ----------- ------------ ------------- ----------- ----------- Expenses: Investment advisory fee ....................... 216,293 634,360 7,687,219 327,368 263,946 Administration fee ............................ 99,496 265,278 3,351,362 136,887 94,182 Custodian fee ................................. 34,483 45,845 300,760 70,756 17,609 Transfer agent fee ............................ 46,780 37,296 499,357 24,110 26,377 Shareholders servicing fees ................... 107,761 3,370 471,603 19,062 25,179 Shareholders processing fees .................. 64,657 2,050 449,461 13,206 15,107 Distribution fees ............................. 271,685 1,722 41,453 28,673 57,531 Legal and audit ............................... 2,126 21,776 96,073 2,818 146,826 Printing ...................................... 6,868 29,161 192,888 6,298 94,238 Registration fees and expenses ................ 28,563 46,662 68,866 40,868 74,621 Trustees' fees and officers' salary ........... 2,132 2,331 26,111 1,112 818 Other ......................................... 9,276 9,153 86,236 6,200 9,175 ----------- ------------ ------------- ----------- ----------- 890,120 1,099,004 13,271,389 677,358 825,609 Less fees waived .............................. (156,328) (398,908) (1,897,607) -- (346,897) ----------- ------------ ------------- ----------- ----------- Total operating expenses .................... 733,792 700,096 11,373,782 677,358 478,712 ----------- ------------ ------------- ----------- ----------- Interest expense .............................. 388,568 299,401 12,816,441 -- 175,871 ----------- ------------ ------------- ----------- ----------- Total expenses ....................... 1,122,360 999,497 24,190,223 677,358 654,583 ----------- ------------ ------------- ----------- ----------- Net investment income ......................... 2,018,590 7,090,642 96,562,007 2,188,509 5,487,273 ----------- ------------ ------------- ----------- ----------- Realized and unrealized gain (loss) on investments and foreign currency transactions: Net realized gain (loss) from: Investment transactions ..................... (1,136,136) (1,603,496) (22,540,668) 430,530 (683,582) Futures, options and swap contracts ......... (14,127) 850,856 13,215,459 69,671 -- Foreign currency and forward foreign currency transactions ............ -- -- 50,945 (574,817) -- ----------- ------------ ------------- ----------- ----------- (1,150,263) (752,640) (9,274,264) (74,616) (683,582) ----------- ------------ ------------- ----------- ----------- Change in unrealized appreciation (depreciation) from: Investments ................................ (2,006,796) (5,547,769) (88,092,007) (3,737,533) (2,601,709) Futures .................................... 208,625 630,299 8,228,816 427,893 -- Foreign currency and forward foreign currency transactions ............ -- -- (8,839) 1,758,171 -- ----------- ------------ ------------- ----------- ----------- (1,798,171) (4,917,470) (79,872,030) (1,551,469) (2,601,709) ----------- ------------ ------------- ----------- ----------- Net loss on investments and foreign currency transactions ................. (2,948,434) (5,670,110) (89,146,294) (1,626,085) (3,285,291) ----------- ------------ ------------- ----------- ----------- Net increase (decrease) in net assets resulting from operations ..................... $ (929,844) $ 1,420,532 $ 7,415,713 $ 562,424 $ 2,201,982 =========== ============ ============= =========== ===========
- -------------- 1 For the period November 19, 1998 (commencement of operations) through September 30, 1999. See accompanying notes to financial statements. 46 & 47 BLACKROCK FUNDS STATEMENT OF CASH FLOWS LOW DURATION BOND PORTFOLIO FOR THE YEAR ENDED SEPTEMBER 30, 1999 Cash provided by (used in) Operating Activities Investment income received ................................. $ 24,562,030 Operating expenses paid .................................... (1,666,623) Interest expense paid ...................................... (5,415,586) ------------- Net increase in cash from operating activities ................ 17,479,821 ------------- Cash provided by (used in) Investing Activities Purchases of long-term investments ......................... (750,177,615) Proceeds from disposition of long-term portfolio investments ................................... 812,098,531 Net proceeds from disposition of short-term investments .... 800,520 ------------- Net increase in cash from investing activities ................ 62,721,436 ------------- Cash provided by (used in) Financing Activities Cash dividends paid ........................................ (12,222,198) Net borrowing relative to reverse repurchase agreements .... (4,822,010) Proceeds related to capital stock purchases ................ 153,592,782 Cash paid related to capital stock redemptions ............. (216,749,831) ------------- Net decrease in cash from financing activities ................ (80,201,257) ------------- Net increase (decrease) in cash ............................... -- Cash at beginning of year ..................................... -- ------------- Cash at end of year ........................................... $ -- ============= Net increase in net assets resulting from operations .......... $ 11,163,116 Adjustments: Increase in interest receivable ............................ (160,154) Amortization of premium and accretion of discount .......... 301,121 Decrease in accrued expenses ............................... (32,734) Increase in prepaid expenses ............................... (23,686) Net realized and changes in unrealized gain (loss) on investments .................................... 6,232,158 ------------- Total adjustments ............................................. 6,316,705 ------------- NET INCREASE IN CASH FROM OPERATING ACTIVITIES ................ $ 17,479,821 ============= See accompanying notes to financial statements. 48 BLACKROCK FUNDS STATEMENT OF CASH FLOWS INTERMEDIATE BOND PORTFOLIO FOR THE YEAR ENDED SEPTEMBER 30, 1999 Cash provided by (used in) Operating Activities Investment income received ............................ $ 41,597,201 Operating expenses paid ............................... (3,408,378) Interest expense paid ................................. (6,296,639) --------------- Net increase in cash from operating activities ........... 31,892,184 --------------- Cash provided by (used in) Investing Activities Purchases of long-term investments .................... (1,616,050,671) Proceeds from disposition of long-term portfolio investments ............................... 1,626,300,625 Net proceeds from disposition of short-term investments 4,572,225 --------------- Net increase in cash from investing activities ........... 14,822,179 --------------- Cash provided by (used in) Financing Activities Cash dividends paid ................................... (32,548,025) Net borrowing relative to reverse repurchase agreements (19,518,775) Proceeds related to capital stock purchases ........... 125,647,027 Cash related to capital stock redemptions ............. (120,294,590) --------------- Net decrease in cash from financing activities ........... (46,714,363) --------------- Net increase (decrease) in cash .......................... -- Cash at beginning of year ................................ -- --------------- Cash at end of year ...................................... $ -- =============== Net increase in net assets resulting from operations ..... $ 6,109,044 Adjustments: Increase in interest receivable ....................... (2,433,135) Amortization of premium and accretion of discount ..... 549,185 Decrease in accrued expenses .......................... (15,968) Increase in prepaid expenses .......................... (25,378) Net realized and changes in unrealized gain (loss) on investments ............................... 27,708,436 --------------- Total adjustments ........................................ 25,783,140 --------------- NET INCREASE IN CASH FROM OPERATING ACTIVITIES ........... $ 31,892,184 =============== See accompanying notes to financial statements. 49 BLACKROCK FUNDS STATEMENT OF CASH FLOWS GOVERNMENT INCOME PORTFOLIO FOR THE YEAR ENDED SEPTEMBER 30, 1999 Cash provided by (used in) Operating Activities Investment income received ............................ $ 2,895,655 Operating expenses paid ............................... (685,292) Interest expense paid ................................. (388,568) ------------- Net increase in cash from operating activities ........... 1,821,795 ------------- Cash provided by (used in) Investing Activities Purchases of long-term investments .................... (136,881,669) Proceeds from disposition of long-term portfolio investments ............................... 108,073,146 Net proceeds from disposition of short-term investments ......................................... 142,890 ------------- Net decrease in cash from investing activities ........... (28,665,633) ------------- Cash provided by (used in) Financing Activities Cash dividends paid ................................... (1,211,598) Net proceeds relative to reverse repurchase agreements .......................................... 14,372,726 Proceeds related to capital stock purchases ........... 26,236,581 Cash paid related to capital stock redemptions ........ (12,553,871) ------------- Net increase in cash from financing activities ........... 26,843,838 ------------- Net increase (decrease) in cash .......................... -- Cash at beginning of year ................................ -- ------------- Cash at end of year ...................................... $ -- ============= Net decrease in net assets resulting from operations ..... $ (929,844) Adjustments: Increase in interest receivable ....................... (340,867) Amortization of premium and accretion of discount ..... 95,572 Increase in accrued expenses .......................... 49,370 Increase in prepaid expenses .......................... (870) Net realized and changes in unrealized gain (loss) on investments ................................ 2,948,434 ------------- Total adjustments ........................................ 2,751,639 ------------- NET INCREASE IN CASH FROM OPERATING ACTIVITIES ........... $ 1,821,795 ============= See accompanying notes to financial statements. 50 BLACKROCK FUNDS STATEMENT OF CASH FLOWS MANAGED INCOME PORTFOLIO FOR THE YEAR ENDED SEPTEMBER 30, 1999 Cash provided by (used in) Operating Activities Investment income received ...................... $ 121,912,607 Operating expenses paid ......................... (11,425,363) Interest expense paid ........................... (12,816,441) --------------- Net increase in cash from operating activities ..... 97,670,803 --------------- Cash provided by (used in) Investing Activities Purchases of long-term investments .............. (5,005,986,179) Proceeds from disposition of long-term portfolio investments ......................... 4,843,887,655 Net proceeds from disposition of short-term investments ................................... 36,758,130 --------------- Net decrease in cash from investing activities ..... (125,340,394) --------------- Cash provided by (used in) Financing Activities Cash dividends paid ............................. (92,221,837) Net proceeds relative to reverse repurchase agreements .................................... 101,908,367 Proceeds related to capital stock purchases ..... 464,949,516 Cash paid related to capital stock redemptions .. (447,106,731) --------------- Net increase in cash from financing activities ..... 27,529,315 --------------- Net increase (decrease) in cash .................... (140,276) Cash at beginning of year .......................... -- --------------- Cash at end of year ................................ $ (140,276) =============== Net increase in net assets resulting from operations $ 7,415,713 Adjustments: Decrease in interest receivable ................. 385,655 Amortization of premium and accretion of discount 774,722 Decrease in accrued expenses .................... (45,586) Increase in prepaid expenses .................... (5,995) Net realized and changes in unrealized gain (loss) on investments ......................... 89,146,294 --------------- Total adjustments .................................. 90,255,090 --------------- NET INCREASE IN CASH FROM OPERATING ACTIVITIES ..... $ 97,670,803 =============== See accompanying notes to financial statements. 51 BLACKROCK FUNDS STATEMENT OF CHANGES IN NET ASSETS
Low Duration Intermediate Government Bond Portfolio Bond Portfolio ----------------------------- ----------------------------- For the For the For the For the Year Ended Year Ended Year Ended Year Ended 9/30/99 9/30/98 9/30/99 9/30/98 ------------- ------------- ------------- ------------- Increase (decrease) in net assets: Operations: Net investment income ....................... $ 17,395,274 $ 17,152,014 $ 26,062,068 $ 15,170,724 Net realized gain (loss) on investments, futures, swap contracts and foreign currency related transactions ............. (98,433) 1,489,712 (3,095,084) 5,199,304 Net unrealized gain (loss) on investments, futures contracts and foreign currency related transactions ...................... (6,133,725) 2,743,208 (19,730,988) 9,657,287 ------------- ------------- ------------- ------------- Net increase (decrease) in net assets resulting from operations ................. 11,163,116 21,384,934 3,235,996 30,027,315 ------------- ------------- ------------- ------------- Distributions to shareholders from: Net investment income: BlackRock Class ............................. (6,048,576) (6,991,384) -- -- Institutional Class ......................... (10,205,420) (5,569,323) (23,884,375) (11,983,641) Service Class ............................... (982,999) (4,082,739) (1,570,838) (2,952,271) Investor A Class ............................ (146,545) (80,989) (566,000) (313,796) Investor B Class ............................ (153,762) (8,711) (25,528) (5,639) Investor C Class ............................ (33,050) (8,683) (15,327) (7,054) ------------- ------------- ------------- ------------- Total distribution from net investment income (17,570,352) (16,741,829) (26,062,068) (15,262,401) ------------- ------------- ------------- ------------- Net realized gains: BlackRock Class ............................. -- -- -- -- Institutional Class ......................... -- -- (3,300,185) -- Service Class ............................... -- -- (226,970) -- Investor A Class ............................ -- -- (64,227) -- Investor B Class ............................ -- -- (3,359) -- Investor C Class ............................ -- -- (2,283) -- ------------- ------------- ------------- ------------- Total distributions from net realized gains . -- -- (3,597,024) -- ------------- ------------- ------------- ------------- Total distributions to shareholders ......... (17,570,352) (16,741,829) (29,659,092) (15,262,401) ------------- ------------- ------------- ------------- Capital share transactions ...................... (57,491,456) 69,892,569 (29,475,513) 312,660,657 ------------- ------------- ------------- ------------- Total increase (decrease) in net assets ..... (63,898,692) 74,535,674 (55,898,609) 327,425,571 ------------- ------------- ------------- ------------- Net assets: Beginning of period ......................... 329,362,987 254,827,313 480,018,299 152,592,728 ------------- ------------- ------------- ------------- End of period ............................... $ 265,464,295 $ 329,362,987 $ 424,119,690 $ 480,018,299 ============= ============= ============= =============
Intermediate Core Bond Portfolio Bond Portfolio ----------------------------- ----------------------------- For the For the For the For the Year Ended Year Ended Year Ended Year Ended 9/30/99 9/30/98 9/30/99 9/30/98 ------------- ------------- ------------- ------------- Increase (decrease) in net assets: Operations: Net investment income ....................... $ 33,817,480 $ 25,472,505 $ 54,742,132 $ 42,612,702 Net realized gain (loss) on investments, futures, swap contracts and foreign currency related transactions ............. (4,101,046) 5,387,354 (10,417,663) 17,428,853 Net unrealized gain (loss) on investments, futures contracts and foreign currency related transactions ...................... (23,607,390) 8,072,392 (46,267,712) 13,393,733 ------------- ------------- ------------- ------------- Net increase (decrease) in net assets resulting from operations ................. 6,109,044 38,932,251 (1,943,243) 73,435,288 ------------- ------------- ------------- ------------- Distributions to shareholders from: Net investment income: BlackRock Class ............................. (2,641,213) -- (7,653,342) (5,050,600) Institutional Class ......................... (29,342,529) (20,947,487) (41,755,750) (28,236,789) Service Class ............................... (1,493,193) (3,490,893) (4,174,386) (194,059) Investor A Class ............................ (132,451) (68,932) (341,839) (9,446,081) Investor B Class ............................ (30,269) (1,147) (640,192) (398,527) Investor C Class ............................ (7,995) (817,619) (249,542) (27,851) ------------- ------------- ------------- ------------- Total distribution from net investment income (33,647,650) (25,326,078) (54,815,051) (43,353,907) ------------- ------------- ------------- ------------- Net realized gains: BlackRock Class ............................. (510,365) -- (13,815,881) (3,729,958) Institutional Class ......................... (5,190,232) (1,533,689) (2,995,248) (450,932) Service Class ............................... (290,823) (278,199) (1,570,759) (1,587,760) Investor A Class ............................ (21,977) (5,904) (119,321) (23,612) Investor B Class ............................ (1,947) -- (277,734) (55,299) Investor C Class ............................ (132) -- (73,497) (1,658) ------------- ------------- ------------- ------------- Total distributions from net realized gains . (6,015,476) (1,817,792) (18,852,440) (5,849,219) ------------- ------------- ------------- ------------- Total distributions to shareholders ......... (39,663,126) (27,143,870) (73,667,491) (49,203,126) ------------- ------------- ------------- ------------- Capital share transactions ...................... 13,472,500 205,815,141 187,075,237 259,333,943 ------------- ------------- ------------- ------------- Total increase (decrease) in net assets ..... (20,081,582) 217,603,522 111,464,503 283,566,105 ------------- ------------- ------------- ------------- Net assets: Beginning of period ......................... 566,744,493 349,140,971 855,534,355 571,968,250 ------------- ------------- ------------- ------------- End of period ............................... $ 546,662,911 $ 566,744,493 $ 966,998,858 $ 855,534,355 ============= ============= ============= =============
See accompanying notes to financial statements. 52 & 53 BLACKROCK FUNDS STATEMENT OF CHANGES IN NET ASSETS (CONTINUED)
Government Income Portfolio ----------------------------- For the For the Year Ended Year Ended 9/30/99 9/30/98 ------------- ------------- Increase (decrease) in net assets: Operations: Net investment income .......................................... $ 2,018,590 $ 1,235,776 Net realized gain (loss)on investments, futures, swap contracts and foreign currency related transactions ................................ (1,150,263) 754,990 Net unrealized gain (loss) on investments, futures contracts and foreign currency related transactions ................................ (1,798,171) 607,625 ------------ ------------ Net increase (decrease) in net assets resulting from operations .................................... (929,844) 2,598,391 ------------ ------------ Distributions to shareholders from: Net investment income: BlackRock Class ................................................ -- -- Institutional Class ............................................ -- -- Service Class .................................................. -- -- Investor A Class ............................................... (362,323) (331,498) Investor B Class ............................................... (1,504,558) (965,806) Investor C Class ............................................... (119,390) (69,148) ------------ ------------ Total distribution from net investment income................... (1,986,271) (1,366,452) ------------ ------------ Capital: BlackRock Class ................................................ -- -- Institutional Class ............................................ -- -- Service Class .................................................. -- -- Investor A Class ............................................... (44,311) -- Investor B Class ............................................... (229,401) -- Investor C Class ............................................... (16,072) -- ------------ ------------ Total distributions from capital ............................... (289,784) -- ------------ ------------ Net realized gains: BlackRock Class ................................................ -- -- Institutional Class ............................................ -- -- Service Class .................................................. -- -- Investor A Class ............................................... (101,189) (51,565) Investor B Class ............................................... (445,394) (226,059) Investor C Class ............................................... (37,364) (9,696) ------------ ------------ Total distributions from net realized gains .................... (583,947) (287,320) ------------ ------------ Total distributions to shareholders ............................ (2,860,002) (1,653,772) ------------ ------------ Capital share transactions ......................................... 14,927,649 11,295,834 ------------ ------------ Total increase (decrease) in net assets ........................ 11,137,803 12,240,453 ------------ ------------ Net assets: Beginning of period ............................................ 32,761,188 20,520,735 ------------ ------------ End of period .................................................. $ 43,898,991 $ 32,761,188 ============ ============
GNMA Managed Portfolio Income Portfolio ------------------------------- ---------------------------------- For the For the Period 5/18/98 1 For the For the Year Ended through Year Ended Year Ended 9/30/99 9/30/98 9/30/99 9/30/98 ------------- ---------------- --------------- --------------- Increase (decrease) in net assets: Operations: Net investment income ....................... $ 7,090,642 $ 2,681,619 $ 96,562,007 $ 67,146,905 Net realized gain (loss)on investments, futures, swap contracts and foreign currency related transactions ............. (752,640) 687,615 (9,274,264) 25,885,211 Net unrealized gain (loss) on investments, futures contracts and foreign currency related transactions ............. (4,917,470) 482,471 (79,872,030) 12,918,888 ------------- ---------------- --------------- --------------- Net increase (decrease) in net assets resulting from operations ................. 1,420,532 3,851,705 7,415,713 105,951,004 ------------- ---------------- --------------- --------------- Distributions to shareholders from: Net investment income: BlackRock Class ............................. -- -- -- -- Institutional Class ......................... (6,866,829) (2,564,992) (79,275,756) (47,894,845) Service Class ............................... (2,614) (2) (16,129,657) (19,460,184) Investor A Class ............................ (60,535) (2,179) (938,291) (829,070) Investor B Class ............................ (10,508) (923) (267,898) (111,579) Investor C Class ............................ (485) (2) (1,887) -- ------------- ---------------- --------------- --------------- Total distribution from net investment income (6,940,971) (2,568,098) (96,613,489) (68,295,678) ------------- ---------------- --------------- --------------- Capital: BlackRock Class ............................. -- -- -- -- Institutional Class ......................... -- -- -- -- Service Class ............................... -- -- -- -- Investor A Class ............................ -- -- -- -- Investor B Class ............................ -- -- -- -- Investor C Class ............................ -- -- -- -- ------------- ---------------- --------------- --------------- Total distributions from capital ............ -- -- -- -- ------------- ---------------- --------------- --------------- Net realized gains: BlackRock Class ............................. -- -- -- -- Institutional Class ......................... (216,280) -- (19,011,738) (2,168,258) Service Class ............................... -- -- (3,866,356) (1,199,800) Investor A Class ............................ (1,241) -- (252,718) (70,278) Investor B Class ............................ (413) -- (71,999) (4,924) Investor C Class ............................ (1) -- -- -- ------------- ---------------- --------------- --------------- Total distributions from net realized gains . (217,935) -- (23,202,811) (3,443,260) ------------- ---------------- --------------- --------------- Total distributions to shareholders ......... (7,158,906) (2,568,098) (119,816,300) (71,738,938) ------------- ---------------- --------------- --------------- Capital share transactions ...................... (1,486,779) 117,456,386 45,013,063 758,310,929 ------------- ---------------- --------------- --------------- Total increase (decrease) in net assets ..... (7,225,153) 118,739,993 (67,387,524) 792,522,995 ------------- ---------------- --------------- --------------- Net assets: Beginning of period ......................... 118,739,993 -- 1,612,231,266 819,708,271 ------------- ---------------- --------------- --------------- End of period ............................... $ 111,514,840 $ 118,739,993 $ 1,544,843,742 $ 1,612,231,266 ============= ================ =============== ===============
International High Yield Bond Portfolio Bond Portfolio ----------------------------- ----------------- For the For the For the Year ended Year ended Period 11/19/98 1 9/30/99 9/30/98 through 9/30/99 ------------- ------------ ----------------- Increase (decrease) in net assets: Operations: Net investment income .................................... $ 2,188,509 $ 1,952,167 $ 5,487,273 Net realized gain (loss)on investments, futures, swap contracts and foreign currency related transactions .......................... (74,616) 3,224,013 (683,582) Net unrealized gain (loss) on investments, futures contracts and foreign currency related transactions .......................... (1,551,469) 576,217 (2,601,709) ------------ ------------ ----------------- Net increase (decrease) in net assets resulting from operations .............................. 562,424 5,752,397 2,201,982 ------------ ------------ ----------------- Distributions to shareholders from: Net investment income: BlackRock Class .......................................... -- -- (8) Institutional Class ...................................... (2,894,971) (2,043,103) (4,262,789) Service Class ............................................ (158,774) (320,780) (8) Investor A Class ......................................... (107,062) (64,752) (231,248) Investor B Class ......................................... (88,432) (51,701) (554,384) Investor C Class ......................................... (80,994) (37,046) (124,941) ------------ ------------ ----------------- Total distribution from net investment income............. (3,330,233) (2,517,382) (5,173,378) ------------ ------------ ----------------- Capital: BlackRock Class .......................................... -- -- -- Institutional Class ...................................... -- -- -- Service Class ............................................ -- -- -- Investor A Class ......................................... -- -- -- Investor B Class ......................................... -- -- -- Investor C Class ......................................... -- -- -- ------------ ------------ ----------------- Total distributions from capital ......................... -- -- -- ------------ ------------ ----------------- Net realized gains: BlackRock Class .......................................... -- -- -- Institutional Class ...................................... -- (1,522,323) -- Service Class ............................................ -- (266,359) -- Investor A Class ......................................... -- (41,747) -- Investor B Class ......................................... -- (38,402) -- Investor C Class ......................................... -- (21,891) -- ------------ ------------ ----------------- Total distributions from net realized gains .............. -- (1,890,722) -- ------------ ------------ ----------------- Total distributions to shareholders ...................... (3,330,233) (4,408,104) (5,173,378) ------------ ------------ ----------------- Capital share transactions ................................... 22,619,783 (3,333,959) 86,296,407 ------------ ------------ ----------------- Total increase (decrease) in net assets .................. 19,851,974 (1,989,666) 83,325,011 ------------ ------------ ----------------- Net assets: Beginning of period ...................................... 50,497,190 52,486,856 -- ------------ ------------ ----------------- End of period ............................................ $ 70,349,164 $ 50,497,190 $ 83,325,011 ============ ============ =================
- ------------------- 1 Commencement of operations. See accompanying notes to financial statements. 54 & 55 BLACKROCK FUNDS FINANCIAL HIGHLIGHTS FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD
Net Net gain Distributions Distributions Net asset (loss) on Distributions in excess Distributions in excess asset value Net investments from net of net from net of net value beginning Investment (both realized investment investment realized realized end of of period income and unrealized) income income gains gains period - ------------------------------------------------------------------------------------------------------------------------------------ - --------------------------- LOW DURATION BOND PORTFOLIO - --------------------------- BLACKROCK CLASS 9/30/99 $10.03 $ 0.61 $(0.22) $(0.60) $-- $ -- $-- $ 9.82 9/30/98 9.89 0.59 0.12 (0.57) -- -- -- 10.03 6/3/97 1 through 9/30/97 9.82 0.19 0.07 (0.19) -- -- -- 9.89 INSTITUTIONAL CLASS 9/30/99 $10.03 $ 0.58 $(0.20) $(0.59) $-- $ -- $-- $ 9.82 9/30/98 9.89 0.56 0.14 (0.56) -- -- -- 10.03 9/30/97 9.79 0.58 0.08 (0.56) -- -- -- 9.89 4/1/96 through 9/30/96 9.79 0.28 (0.01) (0.27) -- -- -- 9.79 7/1/95 through 3/31/96 9.83 0.42 -- (0.41) -- (0.01) -- 9.79 6/30/95 9.71 0.58 0.13 (0.58) -- (0.01) -- 9.83 SERVICE CLASS 9/30/99 $10.03 $ 0.55 $(0.20) $(0.56) $-- $ -- $-- $ 9.82 9/30/98 9.89 0.66 0.01 (0.53) -- -- -- 10.03 9/30/97 9.79 0.54 0.09 (0.53) -- -- -- 9.89 4/1/96 through 9/30/96 9.79 0.26 (0.01) (0.25) -- -- -- 9.79 1/12/96 1 through 3/31/96 9.91 0.11 (0.12) (0.11) -- -- -- 9.79 INVESTOR A CLASS 9/30/99 $10.03 $ 0.54 $(0.21) $(0.54) $-- $ -- $-- $ 9.82 9/30/98 9.89 0.51 0.14 (0.51) -- -- -- 10.03 9/30/97 9.79 0.52 0.09 (0.51) -- -- -- 9.89 4/1/96 through 9/30/96 9.79 0.25 (0.01) (0.24) -- -- -- 9.79 1/12/96 1 through 3/31/96 9.91 0.10 (0.12) (0.10) -- -- -- 9.79 INVESTOR B CLASS 9/30/99 $10.03 $ 0.45 $(0.19) $(0.47) $-- $ -- $-- $ 9.82 9/30/98 9.89 0.41 0.17 (0.44) -- -- -- 10.03 11/18/96 1 through 9/30/97 9.86 0.41 -- (0.38) -- -- -- 9.89 INVESTOR C CLASS 9/30/99 $10.03 $ 0.46 $(0.20) $(0.47) $-- $ -- $-- $ 9.82 9/30/98 9.89 0.44 0.14 (0.44) -- -- -- 10.03 2/24/97 1 through 9/30/97 9.87 0.26 0.02 (0.26) -- -- -- 9.89 - -------------------------------------- INTERMEDIATE GOVERNMENT BOND PORTFOLIO - -------------------------------------- INSTITUTIONAL CLASS 9/30/99 $10.48 $ 0.59 $(0.51) $(0.59) $-- $(0.08) $-- $ 9.89 9/30/98 10.11 0.57 0.39 (0.59) -- -- -- 10.48 9/30/97 9.92 0.59 0.19 (0.59) -- -- -- 10.11 9/30/96 10.02 0.58 (0.11) (0.57) -- -- -- 9.92 9/30/95 9.64 0.58 0.38 (0.58) -- -- -- 10.02 SERVICE CLASS 9/30/99 $10.48 $ 0.56 $(0.51) $(0.56) $-- $(0.08) $-- $ 9.89 9/30/98 10.11 0.58 0.35 (0.56) -- -- -- 10.48 9/30/97 9.92 0.56 0.19 (0.56) -- -- -- 10.11 9/30/96 10.02 0.56 (0.12) (0.54) -- -- -- 9.92 9/30/95 9.64 0.56 0.37 (0.55) -- -- -- 10.02 INVESTOR A CLASS 9/30/99 $10.48 $ 0.54 $(0.51) $(0.54) $-- $(0.08) $-- $ 9.89 9/30/98 10.11 0.53 0.38 (0.54) -- -- -- 10.48 9/30/97 9.92 0.54 0.19 (0.54) -- -- -- 10.11 9/30/96 10.03 0.55 (0.13) (0.53) -- -- -- 9.92 9/30/95 9.64 0.55 0.39 (0.55) -- -- -- 10.03 INVESTOR B CLASS 9/30/99 $10.48 $ 0.46 $(0.51) $(0.46) $-- $(0.08) $-- $ 9.89 9/30/98 10.11 0.47 0.37 (0.47) -- -- -- 10.48 10/11/96 1 through 9/30/97 9.98 0.45 0.13 (0.45) -- -- -- 10.11 INVESTOR C CLASS 9/30/99 $10.48 $ 0.46 $(0.51) $(0.46) $-- $(0.08) $-- $ 9.89 9/30/98 10.11 0.47 0.37 (0.47) -- -- -- 10.48 10/8/96 1 through 9/30/97 9.98 0.45 0.13 (0.45) -- -- -- 10.11 - --------------------------- INTERMEDIATE BOND PORTFOLIO - --------------------------- BLACKROCK CLASS 9/30/99 $ 9.67 $ 0.58 $(0.47) $(0.58) $-- $(0.10) $-- $ 9.10 5/1/98 1 through 9/30/98 9.46 0.24 0.26 (0.24) -- (0.05) -- 9.67
Ratio of Net expenses to Ratio of expenses assets Ratio of average net to average Ratio of net end of expenses to assets net assets investment income Total period average net (excluding (excluding to average net return (000) assets interest expense) waivers) assets - ----------------------------------------------------------------------------------------------------------------------------------- - --------------------------- LOW DURATION BOND PORTFOLIO - --------------------------- BLACKROCK CLASS 9/30/99 4.06% $ 79,326 2.26% 0.41% 2.59% 6.04% 9/30/98 7.44 140,493 1.59 0.40 1.99 5.93 6/3/97 1 through 9/30/97 2.68 68,300 1.01 2 0.40 2 1.34 2 5.97 2 INSTITUTIONAL CLASS 9/30/99 3.91% $ 157,553 2.39% 0.56% 2.67% 5.89% 9/30/98 7.28 166,887 1.80 0.55 2.20 5.77 9/30/97 6.89 102,490 1.54 0.55 1.87 5.15 4/1/96 through 9/30/96 2.70 135,686 0.64 2 0.55 2 0.92 2 5.63 2 7/1/95 through 3/31/96 4.25 52,843 0.96 2 0.63 2 1.16 2 4.92 2 6/30/95 6.99 44,486 0.57 0.57 1.05 6.08 SERVICE CLASS 9/30/99 3.60% $ 16,872 2.70% 0.86% 2.97% 5.59% 9/30/98 6.96 18,393 1.98 0.85 2.38 5.49 9/30/97 6.57 82,873 1.85 0.85 2.18 4.86 4/1/96 through 9/30/96 2.54 91,870 0.97 2 0.85 2 1.25 2 5.28 2 1/12/96 1 through 3/31/96 (0.11) 181,670 1.18 2 0.85 2 1.38 2 4.92 2 INVESTOR A CLASS 9/30/99 3.42%3 $ 2,594 2.79% 1.02% 3.07% 5.38% 9/30/98 6.78 3 2,850 2.32 1.02 2.72 5.29 9/30/97 6.39 3 1,079 2.02 1.02 2.35 4.72 4/1/96 through 9/30/96 2.46 3 938 1.12 1.02 2 1.40 2 5.10 2 1/12/96 1 through 3/31/96 (0.15)3 719 1.34 2 1.01 2 1.54 2 4.61 2 INVESTOR B CLASS 9/30/99 2.65%4 $ 7,549 3.41% 1.75% 3.67% 4.59% 9/30/98 5.99 4 398 3.08 1.76 3.48 4.50 11/18/96 1 through 9/30/97 4.31 4 13 2.19 2 1.73 2 2.52 2 4.50 2 INVESTOR C CLASS 9/30/99 2.65%4 $ 1,570 3.47% 1.77% 3.72% 4.62% 9/30/98 5.99 4 342 2.98 1.75 3.38 4.47 2/24/97 1 through 9/30/97 2.91 4 72 2.23 2 1.72 2 2.56 2 4.49 2 - -------------------------------------- INTERMEDIATE GOVERNMENT BOND PORTFOLIO - -------------------------------------- INSTITUTIONAL CLASS 9/30/99 0.75% $ 388,917 0.81% 0.60% 1.02% 5.77% 9/30/98 9.83 441,691 0.63 0.59 0.89 5.72 9/30/97 8.08 96,605 0.67 0.55 0.98 5.88 9/30/96 4.82 126,312 0.70 0.53 1.00 5.86 9/30/95 10.28 134,835 0.42 0.42 0.79 5.94 SERVICE CLASS 9/30/99 0.45% $ 26,687 1.11% 0.90% 1.32% 5.47% 9/30/98 9.50 29,697 0.91 0.88 1.17 5.51 9/30/97 7.75 50,535 0.97 0.85 1.28 5.58 9/30/96 4.51 47,494 1.00 0.83 1.30 5.56 9/30/95 9.99 49,762 0.69 0.69 1.06 5.67 INVESTOR A CLASS 9/30/99 0.28%3 $ 7,239 1.25% 1.06% 1.46% 5.29% 9/30/98 9.32 3 7,972 1.09 1.05 1.35 5.33 9/30/97 7.57 3 5,374 1.14 1.02 1.45 5.42 9/30/96 4.36 3 5,903 1.14 0.95 1.44 5.45 9/30/95 9.98 3 9,802 0.70 0.70 1.07 5.67 INVESTOR B CLASS 9/30/99 (0.47)%4 $ 809 1.97% 1.80% 2.19% 4.57% 9/30/98 8.51 4 361 1.84 1.79 2.10 4.61 10/11/96 1 through 9/30/97 5.94 4 28 1.90 2 1.77 2 2.21 2 4.62 2 INVESTOR C CLASS 9/30/99 (0.47)%4 $ 468 2.00% 1.81% 2.22% 4.56% 9/30/98 8.51 4 299 1.81 1.78 2.07 4.48 10/8/96 1 through 9/30/97 5.94 4 51 1.78 2 1.71 2 2.09 2 4.50 2 - --------------------------- INTERMEDIATE BOND PORTFOLIO - --------------------------- BLACKROCK CLASS 9/30/99 1.25% $ 42,311 1.61% 0.44% 1.87% 6.27% 5/1/98 1 through 9/30/98 8.86 48,365 1.43 2 0.45 2 1.70 2 5.98 2
Ratio of net investment income to average net assets Portfolio (excluding turnover waivers) rate - --------------------------------------------------------------------- - --------------------------- LOW DURATION BOND PORTFOLIO - --------------------------- BLACKROCK CLASS 9/30/99 5.71% 177% 9/30/98 5.53 227 6/3/97 1 through 9/30/97 5.64 2 371 INSTITUTIONAL CLASS 9/30/99 5.62% 177% 9/30/98 5.37 227 9/30/97 4.82 371 4/1/96 through 9/30/96 5.36 2 228 7/1/95 through 3/31/96 4.72 2 185 6/30/95 5.60 586 SERVICE CLASS 9/30/99 5.32% 177% 9/30/98 5.09 227 9/30/97 4.53 371 4/1/96 through 9/30/96 5.01 2 228 1/12/96 1 through 3/31/96 4.72 2 185 INVESTOR A CLASS 9/30/99 5.10% 177% 9/30/98 4.89 227 9/30/97 4.39 371 4/1/96 through 9/30/96 4.82 2 228 1/12/96 1 through 3/31/96 4.41 2 185 INVESTOR B CLASS 9/30/99 4.34% 177% 9/30/98 4.10 227 11/18/96 1 through 9/30/97 4.17 2 371 INVESTOR C CLASS 9/30/99 4.37% 177% 9/30/98 4.07 227 2/24/97 1 through 9/30/97 4.16 2 371 - -------------------------------------- INTERMEDIATE GOVERNMENT BOND PORTFOLIO - -------------------------------------- INSTITUTIONAL CLASS 9/30/99 5.56% 191% 9/30/98 5.46 272 9/30/97 5.57 291 9/30/96 5.56 580 9/30/95 5.57 247 SERVICE CLASS 9/30/99 5.26% 191% 9/30/98 5.25 272 9/30/97 5.27 291 9/30/96 5.26 580 9/30/95 5.30 247 INVESTOR A CLASS 9/30/99 5.08% 191% 9/30/98 5.07 272 9/30/97 5.11 291 9/30/96 5.16 580 9/30/95 5.30 247 INVESTOR B CLASS 9/30/99 4.34% 191% 9/30/98 4.35 272 10/11/96 1 through 9/30/97 4.31 2 291 INVESTOR C CLASS 9/30/99 4.34% 191% 9/30/98 4.22 272 10/8/96 1 through 9/30/97 4.19 2 291 - --------------------------- INTERMEDIATE BOND PORTFOLIO - --------------------------- BLACKROCK CLASS 9/30/99 6.00% 221% 5/1/98 1 through 9/30/98 5.71 2 221
See accompanying notes to financial statements. 56 & 57 BLACKROCK FUNDS FINANCIAL HIGHLIGHTS (CONTINUED) FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD
Net Net gain Distributions Distributions asset (loss) on Distributions in excess Distributions in excess value Net investments from net of net Distributions from net of net beginning investment (both realized investment investment from realized realized of period income and unrealized) income income capital gains gains - ----------------------------------------------------------------------------------------------------------------------------------- INSTITUTIONAL CLASS 9/30/99 $ 9.67 $ 0.57 $(0.47) $(0.57) $-- $ -- $(0.10) $-- 9/30/98 9.49 0.57 0.23 (0.57) -- -- (0.05) -- 9/30/97 9.32 0.58 0.17 (0.58) -- -- -- -- 9/30/96 9.43 0.56 (0.09) (0.55) -- -- (0.03) -- 9/30/95 9.05 0.56 0.38 (0.56) -- -- -- -- SERVICE CLASS 9/30/99 $ 9.67 $ 0.54 $(0.47) $(0.54) $-- $ -- $(0.10) $-- 9/30/98 9.49 0.58 0.20 (0.55) -- -- (0.05) -- 9/30/97 9.32 0.55 0.17 (0.55) -- -- -- -- 9/30/96 9.43 0.53 (0.09) (0.52) -- -- (0.03) -- 9/30/95 9.05 0.54 0.38 (0.54) -- -- -- -- INVESTOR A CLASS 9/30/99 $ 9.67 $ 0.52 $(0.47) $(0.52) $-- $ -- $(0.10) $-- 9/30/98 9.49 0.53 0.23 (0.53) -- -- (0.05) -- 9/30/97 9.32 0.53 0.17 (0.53) -- -- -- -- 9/30/96 9.43 0.52 (0.09) (0.51) -- -- (0.03) -- 9/30/95 9.05 0.54 0.38 (0.54) -- -- -- -- INVESTOR B CLASS 9/30/99 $ 9.67 $ 0.45 $(0.47) $(0.45) $-- $ -- $(0.10) $-- 2/5/98 1 through 9/30/98 9.51 0.29 0.21 (0.29) -- -- (0.05) -- INVESTOR C CLASS 10/16/98 1 THROUGH 9/30/99 $ 9.65 $ 0.43 $(0.45) $(0.43) $-- $ -- $(0.10) $-- - ------------------- CORE BOND PORTFOLIO - ------------------- BLACKROCK CLASS 9/30/99 $10.12 $ 0.59 $(0.60) $(0.58) $-- $ -- $(0.22) $-- 9/30/98 9.82 0.61 0.40 (0.62) -- -- (0.09) -- 5/1/97 1 through 9/30/97 9.57 0.26 0.24 (0.25) -- -- -- -- INSTITUTIONAL CLASS 9/30/99 $10.12 $ 0.57 $(0.59) $(0.57) $-- $ -- $(0.22) $-- 9/30/98 9.82 0.59 0.40 (0.60) -- -- (0.09) -- 9/30/97 9.55 0.62 0.26 (0.61) -- -- -- -- 4/1/96 through 9/30/96 9.61 0.30 (0.06) (0.30) -- -- -- -- 7/1/95 though 3/31/96 9.85 0.47 (0.07) (0.47) -- -- (0.17) -- 6/30/95 9.36 0.62 0.50 (0.62) -- -- (0.01) -- SERVICE CLASS 9/30/99 $10.12 $ 0.54 $(0.59) $(0.54) $-- $ -- $(0.22) $-- 9/30/98 9.82 0.56 0.40 (0.57) -- -- (0.09) -- 9/30/97 9.55 0.59 0.26 (0.58) -- -- -- -- 4/1/96 through 9/30/96 9.61 0.30 (0.07) (0.29) -- -- -- -- 1/12/96 1 through 3/31/96 9.91 0.11 (0.30) (0.11) -- -- -- -- INVESTOR A CLASS 9/30/99 $10.12 $ 0.53 $(0.60) $(0.52) $-- $ -- $(0.22) $-- 9/30/98 9.82 0.55 0.40 (0.56) -- -- (0.09) -- 9/30/97 9.55 0.58 0.26 (0.57) -- -- -- -- 4/1/96 through 9/30/96 9.61 0.28 (0.06) (0.28) -- -- -- -- 1/31/96 1 through 3/31/96 9.99 0.08 (0.38) (0.08) -- -- -- -- Investor B Class 9/30/99 $10.12 $ 0.46 $(0.60) $(0.45) $-- $ -- $(0.22) $-- 9/30/98 9.82 0.47 0.40 (0.48) -- -- (0.09) -- 9/30/97 9.55 0.51 0.26 (0.50) -- -- -- -- 4/1/96 through 9/30/96 9.61 0.26 (0.07) (0.25) -- -- -- -- 3/18/96 1 through 3/31/96 9.58 0.01 0.03 (0.01) -- -- -- -- INVESTOR C CLASS 9/30/99 $10.12 $ 0.47 $(0.61) $(0.45) $-- $ -- $(0.22) $-- 9/30/98 9.82 0.47 0.40 (0.48) -- -- (0.09) -- 2/28/97 1 through 9/30/97 9.64 0.29 0.17 (0.28) -- -- -- -- - --------------------------- GOVERNMENT INCOME PORTFOLIO - --------------------------- INVESTOR A CLASS 9/30/99 $10.84 $ 0.55 $(0.70) $(0.54) $-- $(0.07) $(0.16) $-- 9/30/98 10.49 0.53 0.54 (0.61) -- -- (0.11) -- 9/30/97 10.20 0.73 0.30 (0.74) -- -- -- -- 9/30/96 10.68 0.68 (0.22) (0.66) -- -- (0.28) -- 10/3/94 1 though 9/30/95 10.00 0.55 0.68 (0.55) -- -- -- --
Ratio of Net Net expenses to Ratio of expenses asset assets Ratio of average net to average Ratio of net value end of expenses to assets net assets investment income end of Total period average net (excluding (excluding to average net period return (000) assets interest expense) waivers) assets - -------------------------------------------------------------------------------------------------------------------------------- INSTITUTIONAL CLASS 9/30/99 $ 9.10 1.10% $ 476,236 1.74% 0.60% 1.96% 6.12% 9/30/98 9.67 8.81 490,674 1.72 0.59 1.99 6.05 9/30/97 9.49 8.40 295,709 0.98 0.53 1.27 6.18 9/30/96 9.32 5.10 207,909 0.83 0.53 1.13 5.97 9/30/95 9.43 10.76 124,979 0.55 0.47 0.89 6.10 SERVICE CLASS 9/30/99 $ 9.10 0.80% $ 24,299 2.05% 0.90% 2.26% 5.81% 9/30/98 9.67 8.48 25,946 2.06 0.89 2.33 5.78 9/30/97 9.49 8.07 52,316 1.27 0.83 1.56 5.88 9/30/96 9.32 4.79 45,362 1.14 0.83 1.44 5.67 9/30/95 9.43 10.46 36,718 0.82 0.74 1.17 5.82 INVESTOR A CLASS 9/30/99 $ 9.10 0.62%3 $ 2,387 2.21% 1.08% 2.43% 5.70% 9/30/98 9.67 8.30 3 1,648 2.22 1.06 2.49 5.64 9/30/97 9.49 7.89 3 1,116 1.44 1.00 1.73 5.70 9/30/96 9.32 4.74 3 935 1.27 0.97 1.57 5.53 9/30/95 9.43 10.35 3 647 0.84 0.76 1.19 5.81 INVESTOR B CLASS 9/30/99 $ 9.10 (0.13)%4 $ 1,010 2.81% 1.79% 3.02% 4.89% 2/5/98 1 through 9/30/98 9.67 7.83 4 111 2.79 2 1.75 2 3.06 2 4.50 2 INVESTOR C CLASS 10/16/98 1 THROUGH 9/30/99 $ 9.10 (0.18)%4 $ 420 2.81%2 1.82%2 3.02%2 4.99%2 - ------------------- CORE BOND PORTFOLIO - ------------------- BLACKROCK CLASS 9/30/99 $ 9.31 (0.02)% $ 160,791 0.79% 0.40% 1.07% 6.13% 9/30/98 10.12 10.74 92,723 0.68 0.40 1.02 6.14 5/1/97 1 through 9/30/97 9.82 5.30 48,139 0.56 2 0.40 2 0.85 2 6.54 2 INSTITUTIONAL CLASS 9/30/99 $ 9.31 (0.17)% $ 712,529 0.93% 0.55% 1.19% 5.94% 9/30/98 10.12 10.57 673,823 0.83 0.55 1.17 6.00 9/30/97 9.82 10.03 393,657 0.84 0.55 1.14 6.52 4/1/96 through 9/30/96 9.55 2.55 162,626 0.80 2 0.55 2 1.09 2 6.50 2 7/1/95 though 3/31/96 9.61 3.93 64,707 0.75 2 0.66 2 1.00 2 5.80 2 6/30/95 9.85 11.79 32,191 0.55 0.55 1.75 6.62 SERVICE CLASS 9/30/99 $ 9.31 (0.47)% $ 65,758 1.23% 0.86% 1.48% 5.63% 9/30/98 10.12 10.24 70,111 1.18 0.85 1.52 5.72 9/30/97 9.82 9.71 122,308 1.35 0.85 1.64 6.09 4/1/96 through 9/30/96 9.55 2.40 117,207 1.082 0.85 2 1.372 6.102 1/12/96 1 through 3/31/96 9.61 (1.90) 232,040 0.942 0.85 2 1.192 5.372 INVESTOR A CLASS 9/30/99 $ 9.31 (0.64)%3 $ 6,776 1.41% 1.03% 1.66% 5.48% 9/30/98 10.12 10.04 3 5,108 1.27 0.98 1.61 5.49 9/30/97 9.82 9.52 3 2,441 1.36 1.01 1.65 5.96 4/1/96 through 9/30/96 9.55 2.36 3 320 1.27 2 1.02 2 1.56 2 6.04 2 1/31/96 1 through 3/31/96 9.61 (2.96)3 80 1.11 2 1.02 2 1.36 2 5.34 2 INVESTOR B CLASS 9/30/99 $ 9.31 (1.38)%4 $ 14,383 2.15% 1.77% 2.41% 4.72% 9/30/98 10.12 9.20 4 11,734 2.01 1.76 2.35 4.78 9/30/97 9.82 8.71 4 5,295 2.17 1.75 2.46 5.19 4/1/96 through 9/30/96 9.55 1.98 4 1,497 2.00 2 1.72 2 2.29 2 5.40 2 3/18/96 1 through 3/31/96 9.61 (0.33)4 77 1.86 2 1.77 2 2.11 2 4.62 2 INVESTOR C CLASS 9/30/99 $ 9.31 (1.38)%4 $ 6,762 2.16% 1.76% 2.40% 4.81% 9/30/98 10.12 9.20 4 2,035 1.90 1.73 2.24 4.75 2/28/97 1 through 9/30/97 9.82 4.82 4 128 1.93 2 1.74 2 2.22 2 5.22 2 - ------------------------- GOVERNMENT INCOME PORTFOL - ------------------------- INVESTOR A CLASS 9/30/99 $ 9.92 (1.40)%3 $ 6,713 1.96% 1.07% 2.32% 5.30% 9/30/98 10.84 11.13 3 6,045 1.46 1.05 2.04 5.45 9/30/97 10.49 10.48 3 4,876 1.41 1.02 2.13 7.63 9/30/96 10.20 4.43 3 3,651 2.96 0.91 3.72 6.54 10/3/94 1 though 9/30/95 10.68 14.27 3 2,990 0.92 2 0.37 2 2.36 2 6.34 2
Ratio of net investment income to average net assets Portfolio (excluding turnover waivers) rate - ----------------------------------------------------- INSTITUTIONAL CLASS 9/30/99 5.90% 221% 9/30/98 5.78 221 9/30/97 5.89 321 9/30/96 5.67 670 9/30/95 5.76 262 Service Class 9/30/99 5.60% 221% 9/30/98 5.51 221 9/30/97 5.59 321 9/30/96 5.36 670 9/30/95 5.47 262 INVESTOR A CLASS 9/30/99 5.49% 221% 9/30/98 5.37 221 9/30/97 5.41 321 9/30/96 5.23 670 9/30/95 5.47 262 INVESTOR B CLASS 9/30/99 4.68% 221% 2/5/98 1 through 9/30/98 4.23 2 221 INVESTOR C CLASS 10/16/98 1 THROUGH 9/30/99 4.77%2 221% - ------------------- CORE BOND PORTFOLIO - ------------------- BLACKROCK CLASS 9/30/99 5.85% 328% 9/30/98 5.80 405 5/1/97 1 through 9/30/97 6.25 2 441 INSTITUTIONAL CLASS 9/30/99 5.68% 328% 9/30/98 5.66 405 9/30/97 6.23 441 4/1/96 through 9/30/96 6.20 2 308 7/1/95 though 3/31/96 5.55 2 723 6/30/95 5.43 435 SERVICE CLASS 9/30/99 5.37% 328% 9/30/98 5.38 405 9/30/97 5.81 441 4/1/96 through 9/30/96 5.81 2 308 1/12/96 1 through 3/31/96 5.12 2 723 INVESTOR A CLASS 9/30/99 5.23% 328% 9/30/98 5.15 405 9/30/97 5.67 441 4/1/96 through 9/30/96 5.75 2 308 1/31/96 1 through 3/31/96 5.10 2 723 INVESTOR B CLASS 9/30/99 4.47% 328% 9/30/98 4.44 405 9/30/97 4.90 441 4/1/96 through 9/30/96 5.11 2 308 3/18/96 1 through 3/31/96 4.37 2 723 INVESTOR C CLASS 9/30/99 4.56% 328% 9/30/98 4.41 405 2/28/97 1 through 9/30/97 4.93 2 441 - -------------------------- GOVERNMENT INCOME PORTFOIO - -------------------------- INVESTOR A CLASS 9/30/99 4.94% 195% 9/30/98 4.87 477 9/30/97 6.91 393 9/30/96 5.78 434 10/3/94 1 though 9/30/95 4.89 2 258
See accompanying notes to financial statements. 58 & 59 BLACKROCK FUNDS FINANCIAL HIGHLIGHTS (CONTINUED) FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD
Net Net gain Distributions Distributions asset (loss) on Distributions in excess Net Distributions in excess value Net investments from net of net Distributions from net of net beginning investment (both realized investment investment from realized realized of period income and unrealized) income income capital gains gains - ---------------------------------------------------------------------------------------------------------------------------------- INVESTOR B CLASS 9/30/99 $10.84 $ 0.47 $(0.70) $(0.46) $ -- $(0.07) $(0.16) $-- 9/30/98 10.49 0.54 0.50 (0.58) -- -- (0.11) -- 9/30/97 10.20 0.66 0.30 (0.67) -- -- -- -- 9/30/96 10.68 0.60 (0.21) (0.59) -- -- (0.28) -- 10/3/94 1 through 9/30/95 10.00 0.50 0.68 (0.50) -- -- -- -- INVESTOR C CLASS 9/30/99 $10.84 $ 0.47 $(0.70) $(0.46) $ -- $(0.07) $(0.16) $-- 9/30/98 10.49 0.51 0.53 (0.58) -- -- (0.11) -- 2/28/97 1 through 9/30/97 10.30 0.37 0.20 (0.38) -- -- -- -- - -------------- GNMA PORTFOLIO - -------------- INSTITUTIONAL CLASS 9/30/99 $10.11 $0.61 $(0.49) $(0.60) $ -- $ -- $(0.02) $-- 5/18/98 1 through 9/30/98 10.00 0.23 0.10 (0.22) -- -- -- -- Service Class 9/30/99 $10.11 $ 0.58 $(0.49) $(0.57) $ -- $ -- $(0.02) $-- 5/18/98 1 through 9/30/98 10.00 0.27 0.04 (0.20) -- -- -- -- INVESTOR A CLASS 9/30/99 $10.11 $ 0.56 $(0.49) $(0.55) $ -- $ -- $(0.02) $-- 5/18/98 1 through 9/30/98 10.00 0.20 0.11 (0.20) -- -- -- -- Investor B Class 9/30/99 $10.11 $ 0.48 $(0.49) $(0.47) $ -- $ -- $(0.02) $-- 5/18/98 1 through 9/30/98 10.00 0.17 0.11 (0.17) -- -- -- -- INVESTOR C CLASS 9/30/99 $10.11 $ 0.48 $(0.49) $(0.47) $ -- $ -- $(0.02) $-- 5/18/98 1 through 9/30/98 10.00 0.23 0.05 (0.17) -- -- -- -- - ------------------------ MANAGED INCOME PORTFOLIO - ------------------------ INSTITUTIONAL CLASS 9/30/99 $10.64 $ 0.62 $(0.57) $(0.62) $ -- $ -- $(0.15) $-- 9/30/98 10.41 0.67 0.26 (0.65) -- -- (0.05) -- 9/30/97 10.09 0.68 0.32 (0.68) -- -- -- -- 9/30/96 10.38 0.64 (0.21) (0.62) -- -- (0.10) -- 9/30/95 9.79 0.65 0.60 (0.65) (0.01) -- -- -- SERVICE CLASS 9/30/99 $10.64 $ 0.59 $(0.57) $(0.59) $ -- $ -- $(0.15) $-- 9/30/98 10.41 0.60 0.30 (0.62) -- -- (0.05) -- 9/30/97 10.09 0.66 0.31 (0.65) -- -- -- -- 9/30/96 10.38 0.61 (0.20) (0.60) -- -- (0.10) -- 9/30/95 9.79 0.63 0.60 (0.63) (0.01) -- -- -- INVESTOR A CLASS 9/30/99 $10.64 $ 0.58 $(0.57) $(0.58) $ -- $ -- $(0.15) $-- 9/30/98 10.41 0.59 0.29 (0.60) -- -- (0.05) -- 9/30/97 10.09 0.65 0.31 (0.64) -- -- -- -- 9/30/96 10.38 0.59 (0.20) (0.58) -- -- (0.10) -- 9/30/95 9.79 0.60 0.60 (0.60) (0.01) -- -- -- INVESTOR B CLASS 9/30/99 $10.64 $ 0.50 $(0.57) $(0.50) $ -- $ -- $(0.15) $-- 9/30/98 10.41 0.52 0.29 (0.53) -- -- (0.05) -- 7/15/97 1 through 9/30/97 10.39 0.09 0.02 (0.09) -- -- -- -- INVESTOR C CLASS 5/19/99 1 through 9/30/99 $10.14 $ 0.08 $(0.22) $(0.08) $ -- $ -- $ -- $-- - ---------------------------- INTERNATIONAL BOND PORTFOLIO - ---------------------------- INSTITUTIONAL CLASS 9/30/99 $11.24 $ 0.30 $(0.09) $(0.64) $ -- $ -- $ -- $-- 9/30/98 10.95 0.45 0.83 (0.57) -- -- (0.42) -- 9/30/97 11.71 0.78 0.42 (1.47) -- -- (0.49) -- 6/10/96 1 through 9/30/96 11.37 0.21 0.30 (0.17) -- -- -- -- SERVICE CLASS 9/30/99 $11.24 $ 0.24 $(0.06) $(0.61) $ -- $ -- $ -- $-- 9/30/98 10.95 0.18 1.06 (0.53) -- -- (0.42) -- 9/30/97 11.71 1.36 (0.19) (1.44) -- -- (0.49) -- 2/1/96 through 9/30/96 11.39 0.89 (0.29) (0.28) -- -- -- -- 3/1/95 through 1/31/96 10.52 0.62 1.13 (0.88) -- -- -- -- 2/28/95 10.75 0.62 (0.48) (0.13) -- -- (0.24) --
Ratio of Net Net expenses to Ratio of expenses asset assets Ratio of average net to average Ratio of net value end of expenses to assets net assets investment income end of Total period average net (excluding (excluding to average net period return (000) assets interest expense) waivers) assets - ----------------------------------------------------------------------------------------------------------------------------------- INVESTOR B CLASS 9/30/99 $ 9.92 (2.14)%4 $ 34,753 2.72% 1.81% 3.08% 4.55% 9/30/98 10.84 10.31 4 25,165 2.01 1.80 2.59 4.82 9/30/97 10.49 9.66 4 14,796 2.14 1.77 2.86 6.89 9/30/96 10.20 3.68 4 11,119 3.69 1.64 4.45 5.76 10/3/94 1 through 9/30/95 10.68 13.52 4 10,188 1.60 2 1.05 2 3.05 2 5.62 2 INVESTOR C CLASS 9/30/99 $ 9.92 (2.14)%4 $ 2,435 2.70% 1.81% 3.06% 4.52% 9/30/98 10.84 10.31 4 1,551 2.14 1.80 2.72 4.64 2/28/97 1 through 9/30/97 10.49 5.64 4 849 3.24 2 1.70 2 3.96 2 5.57 2 - -------------- GNMA PORTFOLIO - -------------- INSTITUTIONAL CLASS 9/30/99 $ 9.61 1.14% $ 110,611 0.86% 0.60% 1.21% 6.15% 5/18/98 1 through 9/30/98 10.11 1.36 -- 0.63 2 0.60 2 1.00 2 6.09 2 Service Class 9/30/99 $ 9.61 0.84% $ 97 1.31% 0.88% 1.64% 6.12% 5/18/98 1 through 9/30/98 10.11 3.18 -- 0.74 2 0.57 2 1.11 2 8.78 2 INVESTOR A CLASS 9/30/99 $ 9.61 0.67%3 $ 1,106 1.37% 1.08% 1.69% 5.76% 5/18/98 1 through 9/30/98 10.11 3.12 3 535 1.10 2 1.06 2 1.47 2 5.65 2 Investor B Class 9/30/99 $ 9.61 (0.09)%4 $ 229 2.08% 1.81% 2.43% 4.94% 5/18/98 1 through 9/30/98 10.11 2.85 4 166 1.73 2 1.70 2 2.10 2 4.50 2 INVESTOR C CLASS 9/30/99 $ 9.61 (0.09)%4 $ 24 2.16% 1.71% 2.50% 5.15% 5/18/98 1 through 9/30/98 10.11 2.85 4 -- 0.57 2 0.57 2 0.94 2 5.26 2 - ------------------------ MANAGED INCOME PORTFOLIO - ------------------------ INSTITUTIONAL CLASS 9/30/99 $ 9.92 0.57% $1,252,991 1.45% 0.65% 1.57% 6.11% 9/30/98 10.64 9.25 1,335,054 1.30 0.63 1.48 6.04 9/30/97 10.41 10.25 537,260 0.92 0.58 1.17 6.65 9/30/96 10.09 4.33 564,744 0.58 0.58 0.81 6.17 9/30/95 10.38 13.27 443,148 0.57 0.57 0.77 6.44 SERVICE CLASS 9/30/99 $ 9.92 0.26% $ 270,943 1.76% 0.95% 1.88% 5.81% 9/30/98 10.64 8.93 257,641 1.69 0.93 1.87 5.76 9/30/97 10.41 9.93 266,750 1.27 0.88 1.52 6.37 9/30/96 10.09 4.05 165,073 0.88 0.88 1.11 5.87 9/30/95 10.38 12.97 116,846 0.85 0.85 1.05 6.14 INVESTOR A CLASS 9/30/99 $ 9.92 0.09%3 $ 15,092 1.93% 1.12% 2.04% 5.62% 9/30/98 10.64 8.74 3 14,897 1.90 1.10 2.08 5.64 9/30/97 10.41 9.74 3 15,230 1.41 1.05 1.66 6.18 9/30/96 10.09 3.83 3 11,193 1.05 1.05 1.29 5.67 9/30/95 10.38 12.74 3 11,977 1.05 1.05 1.25 5.96 INVESTOR B CLASS 9/30/99 $ 9.92 (0.66)%4 $ 5,818 2.68% 1.87% 2.80% 4.88% 9/30/98 10.64 7.94 4 4,639 2.43 1.82 2.61 4.71 7/15/97 1 through 9/30/97 10.41 1.35 4 468 2.14 2 1.31 2 2.39 2 3.85 INVESTOR C CLASS 5/19/99 1 through 9/30/99 $ 9.92 --% $ --5 2.53%2 1.79%2 2.64%2 4.93% - ---------------------------- INTERNATIONAL BOND PORTFOLIO - ---------------------------- INSTITUTIONAL CLASS 9/30/99 $10.81 1.91% $ 59,265 1.03% 1.03% 1.03% 3.79% 9/30/98 11.24 12.51 43,672 1.01 1.01 1.16 4.08 9/30/97 10.95 11.59 43,310 0.98 0.98 1.08 5.28 6/10/96 1 through 9/30/96 11.71 4.48 30,882 0.92 2 0.92 2 1.32 2 6.28 2 SERVICE CLASS 9/30/99 $10.81 1.60% $ 3,730 1.33% 1.33% 1.33% 3.50% 9/30/98 11.24 12.17 2,359 1.31 1.31 1.46 3.79 9/30/97 10.95 11.23 6,708 1.30 1.29 1.40 5.01 2/1/96 through 9/30/96 11.71 5.39 7,836 1.09 2 1.09 2 1.20 2 3.82 2 3/1/95 through 1/31/96 11.39 16.79 37,627 1.23 2 1.23 2 1.23 2 5.62 2 2/28/95 10.52 1.50 45,657 1.24 1.24 1.24 5.96
Ratio of net investment income to average net assets Portfolio (excluding turnover waivers) rate - --------------------------------------------------------- INVESTOR B CLASS 9/30/99 4.19% 195% 9/30/98 4.24 477 9/30/97 6.17 393 9/30/96 5.00 434 10/3/94 1 through 9/30/95 4.17 2 258 INVESTOR C CLASS 9/30/99 4.16% 195% 9/30/98 4.06 477 2/28/97 1 through 9/30/97 4.85 2 393 - -------------- GNMA PORTFOLIO - -------------- INSTITUTIONAL CLASS 9/30/99 5.81% 124% 5/18/98 1 through 9/30/98 5.72 2 56 Service Class 9/30/99 5.79% 124% 5/18/98 1 through 9/30/98 8.41 2 56 INVESTOR A CLASS 9/30/99 5.44% 124% 5/18/98 1 through 9/30/98 5.28 2 56 Investor B Class 9/30/99 4.59% 124% 5/18/98 1 through 9/30/98 4.13 2 56 INVESTOR C CLASS 9/30/99 4.81% 124% 5/18/98 1 through 9/30/98 4.90 2 56 - ------------------------ MANAGED INCOME PORTFOLIO - ------------------------ INSTITUTIONAL CLASS 9/30/99 5.99% 239% 9/30/98 5.86 376 9/30/97 6.40 428 9/30/96 5.95 638 9/30/95 6.24 203 SERVICE CLASS 9/30/99 5.69% 239% 9/30/98 5.58 376 9/30/97 6.12 428 9/30/96 5.65 638 9/30/95 5.94 203 INVESTOR A CLASS 9/30/99 5.50% 239% 9/30/98 5.46 376 9/30/97 5.93 428 9/30/96 5.44 638 9/30/95 5.76 203 INVESTOR B CLASS 9/30/99 4.77% 239% 9/30/98 4.53 376 7/15/97 1 through 9/30/97 3.60 2 428 INVESTOR C CLASS 5/19/99 1 through 9/30/99 4.82% 2 239% - ---------------------------- INTERNATIONAL BOND PORTFOLIO - ---------------------------- INSTITUTIONAL CLASS 9/30/99 3.79% 317% 9/30/98 3.93 225 9/30/97 5.18 272 6/10/96 1 through 9/30/96 5.88 2 108 SERVICE CLASS 9/30/99 3.50% 317% 9/30/98 3.64 225 9/30/97 4.91 272 2/1/96 through 9/30/96 3.72 2 108 3/1/95 through 1/31/96 5.62 2 159 2/28/95 5.96 131
See accompanying notes to financial statements. 60 & 61 BLACKROCK FUNDS FINANCIAL HIGHLIGHTS (CONTINUED) FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD
Net Net gain Distributions Distributions Net asset (loss) on Distributions in excess Distributions in excess asset value Net investments from net of net from net of net value beginning investment (both realized investment investment realized realized end of of period income and unrealized) income income gains gains period - ------------------------------------------------------------------------------------------------------------------------------- INVESTOR A CLASS 9/30/99 $11.24 $ 0.23 $(0.07) $(0.59) $-- $ -- $-- $10.81 9/30/98 10.95 0.47 0.76 (0.52) -- (0.42) -- 11.24 9/30/97 11.71 1.10 0.05 (1.42) -- (0.49) -- 10.95 4/22/96 1 through 9/30/96 11.37 0.26 0.32 (0.24) -- -- -- 11.71 INVESTOR B CLASS 9/30/99 $11.24 $ 0.13 $(0.05) $(0.51) $-- $ -- $-- $10.81 9/30/98 10.95 0.40 0.74 (0.43) -- (0.42) -- 11.24 9/30/97 11.71 1.06 -- (1.33) -- (0.49) -- 10.95 4/19/96 1 through 9/30/96 11.36 0.22 0.33 (0.20) -- -- -- 11.71 INVESTOR C CLASS 9/30/99 $11.24 $ 0.13 $(0.05) $(0.51) $-- $ -- $-- $10.81 9/30/98 10.95 0.54 0.60 (0.43) -- (0.42) -- 11.24 9/30/97 11.71 1.15 (0.09) (1.33) -- (0.49) -- 10.95 9/11/96 1 through 9/30/96 11.58 0.02 0.12 (0.01) -- -- -- 11.71 - ------------------------- HIGH YIELD BOND PORTFOLIO - ------------------------- BLACKROCK CLASS 11/19/98 1 through 9/30/99 $10.00 $ 0.90 $(0.32) $(0.85) $-- $ -- $-- $ 9.73 INSTITUTIONAL CLASS 11/19/98 1 through 9/30/99 $10.00 $ 0.90 $(0.31) $(0.86) $-- $ -- $-- $ 9.73 SERVICE CLASS 11/19/98 1 through 9/30/99 $10.00 $ 0.85 $(0.31) $(0.81) $-- $ -- $-- $ 9.73 INVESTOR A CLASS 11/19/98 1 through 9/30/99 $10.00 $ 0.86 $(0.31) $(0.82) $-- $ -- $-- $ 9.73 INVESTOR B CLASS 11/19/98 1 through 9/30/99 $10.00 $ 0.79 $(0.31) $(0.75) $-- $ -- $-- $ 9.73 INVESTOR C CLASS 11/19/98 1 through 9/30/99 $10.00 $ 0.78 $(0.31) $(0.74) $-- $ -- $-- $ 9.73
Ratio of Net expenses to Ratio of expenses assets Ratio of average net to average Ratio of net end of expenses to assets net assets investment income Total period average net (excluding (excluding to average net return (000) assets interest expense) waivers) assets - ---------------------------------------------------------------------------------------------------------------------------- INVESTOR A CLASS 9/30/99 1.43%3 $ 2,638 1.49% 1.49% 1.49% 3.30% 9/30/98 11.98 3 1,705 1.48 1.48 1.63 3.59 9/30/97 11.02 3 1,015 1.42 1.42 1.52 4.49 4/22/96 1 through 9/30/96 5.13 3 176 1.45 2 1.45 2 1.86 2 5.29 2 INVESTOR B CLASS 9/30/99 0.67%4 $ 2,447 2.24% 2.24% 2.24% 2.56% 9/30/98 11.15 4 1,512 2.22 2.22 2.37 2.83 9/30/97 10.11 4 979 2.12 2.12 2.22 3.65 4/19/96 1 through 9/30/96 4.90 4 136 2.09 2 2.09 2 2.49 2 4.61 2 INVESTOR C CLASS 9/30/99 0.67%4 $ 2,269 2.24% 2.24% 2.24% 2.55% 9/30/98 11.15 4 1,249 2.22 2.22 2.37 2.83 9/30/97 10.13 4 474 2.11 2.11 2.21 3.57 9/11/96 1 through 9/30/96 1.24 4 19 1.53 2 1.53 2 1.93 2 2.79 2 - ------------------------- HIGH YIELD BOND PORTFOLIO - ------------------------- BLACKROCK CLASS 11/19/98 1 through 9/30/99 5.87% $ -- 0.33%2 0.28%2 0.41%2 10.45%2 INSTITUTIONAL CLASS 11/19/98 1 through 9/30/99 5.93% $ 63,860 1.02%2 0.71%2 1.67%2 10.49%2 SERVICE CLASS 11/19/98 1 through 9/30/99 5.47% $ -- 2.21%2 1.59%2 3.33%2 9.93%2 INVESTOR A CLASS 11/19/98 1 through 9/30/99 5.50%3 $ 4,412 1.54%2 1.15%2 2.21%2 10.17%2 INVESTOR B CLASS 11/19/98 1 through 9/30/99 4.78%4 $ 12,407 2.27%2 1.88%2 2.94%2 9.41%2 INVESTOR C CLASS 11/19/98 1 through 9/30/99 4.69%4 $ 2,647 2.25%2 1.88%2 2.92%2 9.36%2
Ratio of net investment income to average net assets Portfolio (excluding turnover waivers) rate - ----------------------------------------------------------- INVESTOR A CLASS 9/30/99 3.30% 317% 9/30/98 3.44 225 9/30/97 4.39 272 4/22/96 1 through 9/30/96 4.88 2 108 INVESTOR B CLASS 9/30/99 2.56% 317% 9/30/98 2.68 225 9/30/97 3.55 272 4/19/96 1 through 9/30/96 4.21 2 108 INVESTOR C CLASS 9/30/99 2.55% 317% 9/30/98 2.68 225 9/30/97 3.47 272 9/11/96 1 through 9/30/96 2.38 2 108 - ------------------------- HIGH YIELD BOND PORTFOLIO - ------------------------- BLACKROCK CLASS 11/19/98 1 through 9/30/99 10.38%2 185% INSTITUTIONAL CLASS 11/19/98 1 through 9/30/99 9.85%2 185% SERVICE CLASS 11/19/98 1 through 9/30/99 8.81%2 185% INVESTOR A CLASS 11/19/98 1 through 9/30/99 9.49%2 185% INVESTOR B CLASS 11/19/98 1 through 9/30/99 8.73%2 185% INVESTOR C CLASS 11/19/98 1 through 9/30/99 8.69%2 185% 1 Commencement of operations of share class. 2 Annualized. 3 Sales load not relected in total return. 4 Contingent deferred sales load not relected in total return. 5 There were no Investor C shares outstanding as of September 30, 1999.
See accompanying notes to financial statements. 62 & 63 BLACKROCK FUNDS NOTES TO FINANCIAL STATEMENTS BlackRock Funds SM ("the Fund") was organized on December 22, 1988, as a Massachusetts business trust and is registered under the Investment Company Act of 1940, as amended, as an open-end management investment company. The Fund currently has 36 publicly-offered portfolios, 9 of which are included in these financial statements (the "Portfolios"). Each Portfolio is authorized to issue an unlimited number of shares with a par value of $0.001. Portfolios of the Fund offer as many as six classes of shares. Shares of all classes of a Portfolio represent equal pro rata interests in such Portfolio, except that each class bears different expenses which reflect the difference in the range of services provided to them. The following table provides a list of the Portfolios included in this report along with a summary of their respective class-specific fee arrangements as provided under the Fund's Amended and Restated Distribution and Service Plan (the "Plan"). Fees are expressed as a percentage of average daily net asset values of the respective classes.
- ------------------------------------------------------------------------------------------------------------------------------------ Portfolio Share Classes - ------------------------------------------------------------------------------------------------------------------------------------ BlackRock Institutional Service Investor A Investor B Investor C - ------------------------------------------------------------------------------------------------------------------------------------ Contractual Actual Contractual Actual Contractual Actual Contractual Actual Contractual Actual Contractual Actual Fees Fees(4) Fees Fees(4) Fees(1) Fees(4) Fees(2) Fees(4) Fees(3) Fees(4) Fees(3) Fees(4) - ------------------------------------------------------------------------------------------------------------------------------------ Low Duration Bond None None None None 0.30% 0.30% 0.50% 0.40% 1.15% 1.15% 1.15% 1.15% - ------------------------------------------------------------------------------------------------------------------------------------ Intermediate Government Bond N/A N/A None None 0.30% 0.30% 0.50% 0.40% 1.15% 1.15% 1.15% 1.15% - ------------------------------------------------------------------------------------------------------------------------------------ Intermediate Bond None None None None 0.30% 0.30% 0.50% 0.40% 1.15% 1.15% 1.15% 1.15% - ------------------------------------------------------------------------------------------------------------------------------------ Core Bond None None None None 0.30% 0.30% 0.50% 0.40% 1.15% 1.15% 1.15% 1.15% - ------------------------------------------------------------------------------------------------------------------------------------ Government Income N/A N/A N/A N/A N/A N/A 0.50% 0.40% 1.15% 1.15% 1.15% 1.15% - ------------------------------------------------------------------------------------------------------------------------------------ GNMA N/A N/A None None 0.30% 0.30% 0.50% 0.40% 1.15% 1.15% 1.15% 1.15% - ------------------------------------------------------------------------------------------------------------------------------------ Managed Income N/A N/A None None 0.30% 0.30% 0.50% 0.40% 1.15% 1.15% 1.15% 1.15% - ------------------------------------------------------------------------------------------------------------------------------------ International Bond N/A N/A None None 0.30% 0.30% 0.50% 0.40% 1.15% 1.15% 1.15% 1.15% - ------------------------------------------------------------------------------------------------------------------------------------ High Yield Bond None None None None 0.30% 0.30% 0.50% 0.40% 1.15% 1.15% 1.15% 1.15% - ------------------------------------------------------------------------------------------------------------------------------------
(1) -- the maximum annual contractual fees are comprised of a .15% service fee and .15% shareholder processing fee. (2) -- the maximum annual contractual fees are comprised of a .10% distribution fee, .25% service fee and .15% shareholder processing fee. (3) -- the maximum annual contractual fees are comprised of a .75% distribution fee, .25% service fee and .15% shareholder processing fee. (4) -- the actual fees are as of September 30, 1999. In addition, Institutional and Service shares bear a Transfer Agent fee at an annual rate not to exceed .03% and Investor A, Investor B and Investor C shares bear a Transfer Agent fee at an annual rate not to exceed .10% of the average daily net asset of such respective classes. (A) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The following is a summary of significant accounting policies followed by the Fund in the preparation of its financial statements. The preparation of financial statements in conformity with generally accepted accounting principles requires the use of management estimates. Actual results could differ from these estimates. SECURITY VALUATION -- Portfolio securities for which market quotations are readily available are valued at market value, which is currently determined using the last reported sales price. If no sales are reported, as in the case of some securities traded over-the-counter, portfolio securities are valued at the mean between the last reported bid and asked prices or on the basis of quotations provided by a pricing service or dealer which uses information with respect to transactions on bonds, quotations from bond dealers, market transactions in comparable securities and various relationships between securities in determining value. Short-term obligations with maturities of 60 days or less are valued at amortized cost which approximates market value. Discounts and premiums on debt securities are amortized for book and tax purposes using the effective yield-to-maturity method over the term of the instrument. Securities for which market quotations are not readily available are carried at fair value as determined in accordance with procedures adopted by the Board of Directors. 64 BLACKROCK FUNDS DIVIDENDS TO SHAREHOLDERS -- Dividends from net investment income are declared by each Portfolio each day on "settled" shares (i.e. shares for which the particular Portfolio has received payment in federal funds) and are paid monthly. Over the course of a year, substantially all of each Portfolio's net investment income will be declared as dividends. The amount of the daily dividend for each Portfolio will be based on periodic projections of its net investment income. Net realized capital gains, if any, are distributed at least annually. The character of distributions made during the year from net investment income or net realized gains may differ from their ultimate characterization for federal income tax purposes due to differences between generally accepted accounting principles and tax accounting principles related to the character of income and expense recognition. FEDERAL TAXES -- No provision is made for federal taxes as it is the Fund's intention to have each Portfolio continue to qualify for and elect the tax treatment applicable to regulated investment companies under subchapter M of the Internal Revenue Code of 1986, as amended, and to make the requisite distributions to its shareholders which will be sufficient to relieve it from federal income and excise taxes. FOREIGN CURRENCY TRANSLATION -- The books and records of the Low Duration Bond, Managed Income and International Bond Portfolios are maintained in U.S. dollars. Foreign currency amounts are translated into U.S. dollars on the following basis: (I) market value of investment securities, assets and liabilities at the current rate of exchange; and (II)purchases and sales of investment securities, income and expenses at the relevant rates of exchange prevailing on the respective dates of such transactions. The Portfolios isolate that portion of gains and losses on investment securities which is due to changes in the foreign exchange rates from that which is due to changes in market prices of such securities. The Portfolios report certain foreign currency related transactions as components of realized and unrealized gains for financial reporting purposes, whereas such components are treated as ordinary income for federal income tax purposes. FORWARD FOREIGN CURRENCY CONTRACTS -- The Low Duration Bond, Managed Income and International Bond Portfolios enter into forward foreign currency contracts as a hedge against either specific transactions or portfolio positions. These contracts are adjusted by the daily exchange rate of the underlying currency and any gains or losses are recorded as unrealized until the contract settlement date. Such contracts, which protect the value of the Portfolios' investment securities against a decline in the value of currency, do not eliminate fluctuations in the underlying prices of the securities. They simply establish an exchange rate at a future date. Also, although such contracts tend to minimize the risk of loss due to a decline in the value of a hedged currency, at the same time they tend to limit any potential gain that might be realized should the value of such foreign currency increase. Risks may arise upon entering into these contracts from the potential inability of counterparties to meet the terms of their contracts and from unanticipated movements in the value of a foreign currency relative to the U.S. dollar. The aggregate principal amounts of the contracts are not recorded as the Portfolios intend to settle the contracts prior to delivery. Under the terms of foreign currency contracts open at September 30, 1999, the Portfolios are obligated to deliver or receive currency in exchange for U.S. dollars as indicated below:
Unrealized Value at Foreign Settlement Currency Currency Contract September 30, Exchange Date Amount Sold Amount 1999 Gain/(Loss) - --------- ------------- ----------------------- ----------- ------------- ------------ Low Duration Bond Portfolio 11/05/99 2,742,981 Canadian Dollar .......... $ 1,861,680 $ 1,867,218 $ (5,538) =========== =========== ========= Managed Income Portfolio 11/05/99 4,764,660 Canadian Dollar .......... $ 3,233,808 $ 3,243,428 $ (9,620) =========== =========== ========= International Bond Portfolio 10/18/99 16,000,000 European Currency Unit ... $16,704,000 $17,039,041 $(335,041) 10/18/99 450,000,000 Japanese Yen ............. 4,273,301 4,215,851 57,450 10/27/99 17,338,000 Danish Krone ............. 2,438,537 2,487,089 (48,552) 10/27/99 6,159,000 Great British Pound ...... 10,091,522 10,139,941 (48,419) 10/27/99 26,522,000 Swedish Krone ............ 3,226,521 3,242,378 (15,857) 11/05/99 7,886,000 Canadian Dollar .......... 5,352,283 5,368,205 (15,922) 07/19/00 11,777,700 Hong Kong Dollar ......... 1,500,000 1,505,376 (5,376) ----------- ----------- --------- $43,586,164 $43,997,881 $(411,717) =========== =========== =========
65 BLACKROCK FUNDS NOTES TO FINANCIAL STATEMENTS (CONTINUED)
UNREALIZED VALUE AT FOREIGN SETTLEMENT CURRENCY CURRENCY CONTRACT SEPTEMBER 30, EXCHANGE DATE AMOUNT BOUGHT AMOUNT 1999 GAIN/(LOSS) - --------- --------- ------------------------- ---------- ------------- ----------- International Bond Portfolio 11/05/99 4,000,000 Canadian Dollar ............. $2,713,262 $2,722,903 $9,641 ========== ========== ======
INTEREST RATE SWAPS -- The Fund may enter into interest rate swaps in accordance with its investment objectives. A swap agreement obligates two parties to exchange returns realized on a notional amount agreed upon by both parties. The obligations of the parties are calculated on a net basis on the daily fluctuations in the indices on which the contract is based. The daily net fluctuation is recorded as unrealized gains or losses by the Fund. At the termination of the agreement, the Fund will receive from or pay to the counter party, the accumulated net realized gain or loss, which will then be recorded as realized. The Fund did not hold any interest rate swaps at September 30, 1999. Risk may arise upon entering into interest rate swaps in the event of the default or bankruptcy of a swap agreement counter party. SECURITY TRANSACTIONS AND INVESTMENT INCOME -- Investment transactions are accounted for on the trade date. The cost of investments sold is determined by use of the specific identification method for both financial reporting and federal income tax purposes. Interest income is recorded on the accrual basis. Expenses not directly attributable to a specific Portfolio or class are allocated among all of the Portfolios or classes of the Fund based on their relative net assets. REPURCHASE AGREEMENTS -- Money market instruments may be purchased from banks and non-bank dealers subject to the seller's agreement to repurchase them at an agreed upon date and price. Collateral for repurchase agreements may have longer maturities than the maximum permissible remaining maturity of portfolio investments. The seller is required on a daily basis to maintain the value of the securities subject to the agreement at not less than the repurchase price. The agreements are conditioned upon the collateral being deposited under the Federal Reserve book-entry system or held in a separate account by the Fund's custodian or an authorized securities depository. REVERSE REPURCHASE AGREEMENTS -- The Fund enters into reverse repurchase agreements with qualified, third party brokers-dealers as determined by and under the direction of the Fund's Board of Trustees. Interest on the value of the reverse repurchase agreements issued and outstanding is based upon competitive market rates at the time of issuance. At the time the Fund enters into a reverse repurchase agreement, it identifies for segregation certain liquid securities having a value not less than the repurchase price, including accrued interest, of the reverse repurchase agreement.
Low Duration Intermediate Government Managed Bond Bond Income Income Portfolio Portfolio Portfolio Portfolio --------------- --------------- --------------- --------------- Average daily balance of reverse repurchase agreements outstanding during the period ended September 30, 1999 $ 103,186,593 $ 121,455,918 $ 7,672,140 $ 254,292,397 Weighted Average Interest Rate 4.79% 4.91% 4.95% 4.13% Maximum Amount of reverse repurchase agreements outstanding at any month-end during the period ended September 30, 1999 1 $ 151,662,727 $ 185,041,187 $ 18,792,769 $ 391,893,759 Percentage of total assets 33.55% 24.78% 28.13% 18.86% Amount of reverse repurchase agreements outstanding at September 30, 1999 $ 105,456,761 $ 104,099,204 $ 18,792,769 $ 262,485,201 Percentage of total assets 27.98% 15.64% 28.13% 13.89%
____________ 1 The maximum amount of reverse repurchase agreements outstanding at any month end occurred on December 31, 1998, February 28, 1999, September 30, 1999 and February 28, 1999, respectively. FUTURES TRANSACTIONS -- The Fund invests in financial futures contracts solely for the purpose of hedging its existing portfolio securities, or securities that the Fund intends to purchase, against fluctuations in fair value caused by changes in prevailing market interest rates. Certain Portfolios may enter into futures contracts subject to certain limitations. Upon entering into a futures contract, the Portfolio is required to deposit cash or pledge securities of an initial margin. Subsequent payments, which are dependent on the daily fluctuations in the value of the underlying security or securities, are made or 66 BLACKROCK FUNDS received by the Portfolio each day (daily variation margin) and are recorded as unrealized gains or losses until the contracts are closed. When the contracts are closed, the Portfolio records a realized gain or loss equal to the difference between the proceeds from (or cost of) the closing transaction and the Portfolio's basis in the contracts. Risks of entering into futures contracts include the possibility that there will not be a perfect price correlation between the futures contracts and the underlying securities. Second, it is possible that a lack of liquidity for futures contracts could exist in the secondary market, resulting in an inability to close a futures position prior to its maturity date. Third, the purchase of a futures contract involves the risk that a Portfolio could lose more than the original margin deposit required to initiate a futures transaction. OPTION SELLING/PURCHASING -- The Fund invests in financial options contracts solely for the purpose of hedging its existing portfolio securities, or securities that the Fund intends to purchase, against fluctuations in fair value caused by changes in prevailing market interest rates. When the Fund sells or purchases an option, an amount equal to the premium received or paid by the Fund is recorded as a liability or an asset and is subsequently adjusted to the current market value of the option written or purchased. Premiums received or paid from writing or purchasing options which expire unexercised are treated by the Fund on the expiration date as realized gains or losses. The difference between the premium and the amount paid or received on effecting a closing purchase or sale transaction, including brokerage commissions, is also treated as a realized gain or loss. If an option is exercised, the premium paid or received is added to the cost of the purchase or proceeds from the sale in determining whether the Fund has realized a gain or a loss on investment transactions. The Fund as writer of an option, may have no control over whether the underlying securities may be sold (call) or purchased (put) and as a result bears the market risk of an unfavorable change in the price of the security underlying the written option. Written Option transactions entered into during the year ended September 30, 1999 are summarized as follows:
Intermediate Government Managed Bond Intermediate Bond Core Bond Income --------------------- ---------------------- ---------------------- ---------------------- Number of Number of Number of Number of Contracts Premium Contracts Premium Contracts Premium Contracts Premium --------- -------- --------- -------- --------- -------- --------- -------- Balance at 9/30/98 -- $ -- -- $ -- -- $ -- -- $ -- Written 900 40,781 1,100 49,844 5,450 484,767 8,750 780,080 Closed/Expired (900) (40,781) (1,100) (49,844) (5,450) (484,767) (8,750) (780,080) --------- -------- --------- -------- --------- --------- --------- --------- Balance at 9/30/99 -- $ -- -- $ -- -- $ -- -- $ -- ========= ======== ========= ======== ========= ========= ========= =========
TBA PURCHASE COMMITMENTS -- The Portfolios may enter into "TBA" (to be announced) purchase commitments to purchase securities for a fixed price at a future date, typically not exceeding 45 days. TBA purchase commitments may be considered securities in themselves, and involve a risk of loss if the value of the security to be purchased declines prior to settlement date, which risk is in addition to the risk of decline in the value of a Portfolio's other assets. Unsettled TBA purchase commitments are valued at the current market value of the underlying securities, according to the procedures described under "Security Valuation" above. MORTGAGE DOLLAR ROLLS -- Each Portfolio may enter into mortgage dollar rolls (principally using TBA's) in which the Portfolio sells mortgage securities for delivery in the current month and simultaneously contracts to repurchase similar, but not identical, securities at an agreed-upon price on a fixed date. The Portfolio accounts for such dollar rolls as purchases and sales and receives compensation as consideration for entering into the commitment to repurchase. A Portfolio must maintain liquid securities having a value not less than the repurchase price (including accrued interest) for such dollar rolls. In a "fee" roll, the compensation is recorded as deferred income and amortized to income over the roll period. In a "drop" roll, the compensation is paid via a lower price for the security upon its repurchase. The counterparty receives all principal and interest payments, including prepayments, made in respect of a security subject to such a contract while it is the holder. Mortgage dollar rolls may be renewed with a new purchase and repurchase price and a cash settlement made on settlement date without physical delivery of the securities subject to the contract. A Portfolio engages in dollar rolls for the purpose of enhancing its yield, principally by earning a negotiated fee. 67 BLACKROCK FUNDS NOTES TO FINANCIAL STATEMENTS (CONTINUED) SECURITIES LENDING -- Prior to the close of each business day, loans of securities are secured by collateral at least equal to 102% of the market value of the securities on loan. However, due to market fluctuations, the collateral may fall under 102% of the market value of the securities on loan. On the next business day the collateral is adjusted to meet the 102% requirement based on the prior day's market fluctuations and the current day's security lending activity. However, in the event of default or bankruptcy by the other party to the agreement, realization and/or retention of the collateral may be subject to legal proceedings. The market value of securities on loan to brokers and the value of collateral held by the Fund with respect to such loans (including rights to draw on letters of credit) at September 30, 1999, is as follows:
Value of Income Market Value of Collateral Earned on Portfolio Securities On Loan Received Securities Loaned* --------- ------------------ ----------- ----------------- Intermediate Bond Portfolio .... $ 577,250 $ 605,550 $ 5,362 Core Bond Portfolio ............ 36,753,616 37,971,708 46,127 Managed Income Portfolio ....... 62,884,292 64,906,405 59,415 *Income is included in interest income on the Statement of Operations.
Other -- Securities denominated in currencies other than U.S. dollars are subject to changes in value due to fluctuations in exchange rates. Some countries in which the Portfolios invest require governmental approval for the repatriation of investment income, capital or the proceeds of sales of securities by foreign investors. In addition, if there is a deterioration in a country's balance of payments or for other reasons, a country may impose temporary restrictions on foreign capital remittances abroad. The securities exchanges of certain foreign markets are substantially smaller, less liquid and more volatile than the major securities markets in the United States. Consequently, acquisition and disposition of securities by the Portfolios may be inhibited. (B) TRANSACTIONS WITH AFFILIATES AND RELATED PARTIES Pursuant to an Investment Advisory Agreement, BlackRock Advisors, Inc. ("BlackRock"), a wholly-owned subsidiary of BlackRock, Inc., serves as investment adviser to the Portfolios. BlackRock Financial Management, Inc., ("BFM") a wholly-owned subsidiary of BlackRock, serves as sub-adviser for all of the Portfolios. BlackRock, Inc. is an indirect majority-owned subsidiary of PNC Bank Corp. For its advisory services, BlackRock is entitled to receive fees, computed daily and paid monthly, at the following annual rates, based on each Portfolio's average daily net assets:
Each Portfolio Except the International International Bond Portfolio Bond Portfolio & GNMA Portfolio & GNMA Portfolio ------------------------------- ---------------------------- Investment Investment Average Daily Net Assets Advisory Fee Advisory Fee ----------------------------- ------------------------------- ---------------------------- first $1 billion ..................... .500% .550% $1 billion-- $2 billion .............. .450 .500 $2 billion-- $3 billion .............. .425 .475 greater than $3 billion .............. .400 .450
For the year ended September 30, 1999, advisory fees and waivers for each Portfolio were as follows:
Gross Net Advisory Advisory Fee Waiver Fee -------------- ------------- -------------- Low Duration Bond Portfolio ..................... $ 1,474,052 $ 754,500 $ 719,552 Intermediate Government Bond Portfolio .......... 2,269,860 716,541 1,553,319 Intermediate Bond Portfolio ..................... 2,765,839 1,051,834 1,714,005 Core Bond Portfolio ............................. 4,630,434 2,137,403 2,493,031 Government Income Portfolio ..................... 216,293 106,976 109,317 GNMA Portfolio .................................. 634,360 304,908 329,452 Managed Income Portfolio ........................ 7,687,219 1,600,525 6,086,694 International Bond Portfolio .................... 327,368 -- 327,368 High Yield Bond Portfolio ....................... 263,946 260,621 3,325
BlackRock pays BFM, Inc. fees for its sub-advisory services. 68 BLACKROCK FUNDS PFPC, Inc. ("PFPC"), an indirect wholly-owned subsidiary of PNC Bank Corp., BlackRock and BlackRock Distributors, Inc. ("BDI") act as co-administrators for the Fund. For these services, the co-administrators receive a combined administration fee computed daily and payable monthly, based on a percentage of the average daily net assets of each Portfolio, at the following annual rates: .085% of the first $500 million, .075% of the next $500 million and .065% of assets in excess of $1 billion. In addition, each of the classes, except for the BlackRock Class, are charged an administration fee based on the following percentage of average daily net assets of each respective class: .145% of the first $500 million, .135% of the next $500 million and .125% of assets in excess of $1 billion. The BlackRock Class is charged an administration fee of .035% of the first $500 million, .025% of the next $500 million and .015% of assets in excess of $1 billion based upon average daily net assets of its class. For the year ended September 30, 1999, administration fees and waivers for each Portfolio were as follows:
Gross Net Administration Administration Fee Waiver Fee -------------- ---------- -------------- Low Duration Bond Portfolio ................... $ 613,780 $111,419 $ 502,361 Intermediate Government Bond Portfolio ........ 1,044,136 265,521 778,615 Intermediate Bond Portfolio ................... 1,233,704 167,584 1,066,120 Core Bond Portfolio ........................... 1,952,797 241,065 1,711,732 Government Income Portfolio ................... 99,496 49,352 50,144 GNMA Portfolio ................................ 265,278 94,000 171,278 Managed Income Portfolio ...................... 3,351,362 297,082 3,054,280 International Bond Portfolio .................. 136,887 -- 136,887 High Yield Bond Portfolio ..................... 94,182 86,276 7,906
Prior to February 1, 1999, BlackRock may have, at its discretion, waived all or any portion of its advisory fees for any Portfolio. In addition, PFPC, BlackRock and BDI may have, at their discretion, voluntarily waived all or any portion of their administration fees for any Portfolio. In the interest of limiting the expenses of the Portfolios, BlackRock and the Fund have entered into an expense limitation agreement effective February 1, 1999. The agreement sets a limit on certain of the operating expenses of each Portfolio for the next year and requires BlackRock to waive or reimburse fees or expenses if these operating expenses exceed that limit. These expense limits apply to expenses charged on Portfolio assets as a whole, but not expenses separately charged to the different share classes of a Portfolio. If in the following two years the operating expenses of a Portfolio that previously received a waiver or reimbursement from BlackRock are less than the expense limit for that Portfolio, the Portfolio is required to repay BlackRock up to the amount of fees waived or expenses reimbursed under the agreement if: (1) the Portfolio has more than $50 million in assets, (2) BlackRock continues to be the Portfolio's investment adviser and (3) the Board of Trustees of the Fund has approved the payments to BlackRock on a quarterly basis. The expense limits as a percentage of average daily net assets and amounts subject to possible reimbursement under the expense limitation agreement were as follows: Low Duration Bond Portfolio .................... .385% $ 506,416 Intermediate Government Bond Portfolio ......... .475% 594,654 Intermediate Bond Portfolio .................... .435% 727,071 Core Bond Portfolio ............................ .380% 1,515,671 Government Income Portfolio .................... .550% 104,469 GNMA Portfolio ................................. .485% 213,829 Managed Income Portfolio ....................... .485% 1,187,847 International Bond Portfolio ................... .865% -- High Yield Bond Portfolio ...................... .525% 331,554 PFPC Trust Co. (formerly PNC Bank, National Association) serves as custodian for each of the Fund's Portfolios. PFPC serves as transfer and dividend disbursing agent. Under the Fund's Distribution and Service Plan (the "Plan"), Investor Shares of the Portfolios bear the expense payments ("distribution fees") made to BDI, as the fund's distributor (the "Distributor"), or affiliates of PNC Bank, for distribution and sales support services. Under the Plan, the Fund has entered into arrangements with various Service Organizations (including PNC Bank and its affiliates) that provide support services to their customers who are the beneficial owners of shares in each Investor Class and the Service Class. Refer to the fee table in the "Notes to Financial Statements" for fee information. 69 BLACKROCK FUNDS NOTES TO FINANCIAL STATEMENTS (CONTINUED) (C) PURCHASES AND SALES OF SECURITIES For the year ended September 30, 1999, purchases and sales of securities, other than short-term and government securities, were as follows: Purchases Sales --------------- --------------- Low Duration Bond Portfolio ............. $ 245,016,961 $ 216,797,928 Intermediate Government Bond Portfolio .. 209,730,074 262,393,922 Intermediate Bond Portfolio ............. 571,651,372 519,579,315 Core Bond Portfolio ..................... 1,914,447,722 1,342,111,297 Government Income Portfolio ............. 60,893,283 43,555,706 GNMA Portfolio .......................... 121,211,526 77,461,387 Managed Income Portfolio ................ 2,160,886,839 1,927,868,299 International Bond Portfolio ............ 127,204,430 126,543,804 High Yield Bond Portfolio ............... 208,010,089 116,307,181 For the year ended September 30, 1999, purchases and sales of government securities were as follows: Purchases Sales -------------- -------------- Low Duration Bond Portfolio ............. $ 507,704,420 $ 474,005,359 Intermediate Government Bond Portfolio .. 695,058,750 663,274,452 Intermediate Bond Portfolio ............. 1,037,369,048 972,018,310 Core Bond Portfolio ..................... 1,775,221,918 1,638,293,564 Government Income Portfolio ............. 72,022,414 58,617,167 GNMA Portfolio .......................... 77,342,325 76,714,143 Managed Income Portfolio ................ 2,646,655,414 2,598,852,635 International Bond Portfolio ............ 18,685,823 20,493,594 High Yield Bond Portfolio ............... 2,004,063 2,000,781 (D) CAPITAL SHARES Transactions in capital shares for each period were as follows:
Low Duration Bond Portfolio --------------------------------------------------------- For the Year Ended For the Year Ended 9/30/99 9/30/98 ------------------------- --------------------------- Shares Value Shares Value --------- ------------ ---------- ------------- Shares sold: BlackRock Class ........ 832,804 $ 8,225,913 10,953,938 $ 108,478,776 Institutional Class .... 5,049,746 50,160,391 7,756,306 77,356,855 Service Class .......... 481,738 4,773,870 804,858 7,979,540 Investor A Class ....... 7,997,051 79,368,911 3,255,674 32,355,524 Investor B Class ....... 849,840 8,398,923 44,066 437,617 Investor C Class ....... 295,280 2,913,761 31,759 314,906 Shares issued in conversion: Institutional Class .... -- -- 6,225,309 61,630,555 Shares issued in reinvestment of dividends: BlackRock Class ........ 437,739 4,345,898 506,324 5,019,138 Institutional Class .... 77,974 773,054 111,942 1,108,874 Service Class .......... 32,267 319,928 34,827 345,071 Investor A Class ....... 6,974 69,156 6,222 61,676 Investor B Class ....... 1,678 16,527 48 472 Investor C Class ....... 230 2,256 48 476 Shares redeemed: BlackRock Class ........ (7,196,600) (71,522,179) (4,357,893) (43,261,535) Institutional Class .... (5,717,416) (56,567,681) (7,815,690) (77,483,136) Service Class .......... (629,119) (6,237,880) (7,382,461) (73,660,500) Investor A Class ....... (8,023,994) (79,648,051) (3,086,710) (30,685,324) Investor B Class ....... (122,395) (1,210,268) (5,711) (56,529) Investor C Class ....... (169,657) (1,673,985) (5,037) (49,887) ---------- ------------ ----------- ------------- Net increase (decrease) ..... (5,795,860) $(57,491,456) 7,077,819 $ 69,892,569 ========== ============ =========== =============
70 BLACKROCK FUNDS
Intermediate Government Bond Portfolio ----------------------------------------------------------- For the Year Ended For the Year Ended 9/30/99 9/30/98 --------------------------- ----------------------------- Shares Value Shares Value ---------- ------------- ------------ ------------- Shares sold: Institutional Class .... 3,507,375 $ 35,391,770 5,388,703 $ 55,601,975 Service Class .......... 827,540 8,427,966 2,085,488 21,357,363 Investor A Class ....... 23,464,426 235,348,637 420,548 4,312,104 Investor B Class ....... 81,567 823,939 37,733 387,253 Investor C Class ....... 33,550 335,611 34,215 351,716 Shares issued in conversion: Institutional Class .... -- -- 33,310,235 339,098,189 Shares issued in reinvestment of dividends: Institutional Class .... 290,113 2,975,693 5,852 59,670 Service Class .......... 20,453 209,851 -- -- Investor A Class ....... 33,385 339,213 25,882 264,001 Investor B Class ....... 744 7,498 36 368 Investor C Class ....... 1 11 -- 7 Shares redeemed: Institutional Class .... (6,636,676) (67,012,012) (6,104,045) (62,424,167) Service Class .......... (984,744) (9,969,516) (4,249,778) (43,949,478) Investor A Class ....... (23,526,911) (235,853,068) (217,155) (2,225,240) Investor B Class ....... (35,011) (353,173) (6,083) (62,159) Investor C Class ....... (14,731) (147,933) (10,751) (110,945) ----------- ------------- ----------- ------------- Net increase (decrease) ..... (2,938,919) $ (29,475,513) 30,720,880 $ 312,660,657 =========== ============= =========== =============
Intermediate Bond Portfolio ---------------------------------------------------------- For the Year Ended For the Year Ended 9/30/99 9/30/98 -------------------------- ---------------------------- Shares Value Shares Value ---------- ------------ ----------- ------------- Shares sold: BlackRock Class ........ 1,378,815 $ 12,608,853 4,981,102 $ 47,321,273 Institutional Class .... 10,315,220 96,225,816 11,557,172 110,245,081 Service Class .......... 1,242,448 11,610,084 3,123,968 29,665,129 Investor A Class ....... 370,766 3,469,555 149,506 1,420,708 Investor B Class ....... 109,782 1,027,624 17,767 169,383 Investor C Class ....... 74,567 685,199 -- -- Shares issued in conversion: Institutional Class .... -- -- 25,659,119 242,478,670 Shares issued in reinvestment of dividends: BlackRock Class ........ 134,838 1,259,759 18,335 174,351 Institutional Class .... 533,001 5,011,399 151,911 1,435,680 Service Class .......... 62,444 584,579 33,520 317,235 Investor A Class ....... 9,745 91,018 6,876 65,200 Investor B Class ....... 2,299 21,264 73 697 Investor C Class ....... 112 1,043 -- -- Shares redeemed: BlackRock Class ........ (1,865,426) (17,440,794) (262) (2,485) Institutional Class .... (9,255,425) (86,356,153) (17,805,567) (169,025,115) Service Class .......... (1,317,770) (12,268,337) (5,989,510) (57,406,495) Investor A Class ....... (288,703) (2,680,316) (103,601) (983,789) Investor B Class ....... (12,658) (116,792) (6,332) (60,382) Investor C Class ....... (28,545) (261,301) -- -- ----------- ------------ ----------- ------------- Net increase ................ 1,465,510 $ 13,472,500 21,794,077 $ 205,815,141 =========== ============ =========== =============
71 BLACKROCK FUNDS NOTES TO FINANCIAL STATEMENTS (CONTINUED)
Core Bond Portfolio ----------------------------------------------------------- For the Year Ended For the Year Ended 9/30/99 9/30/98 --------------------------- ----------------------------- Shares Value Shares Value ---------- ------------- ------------ -------------- Shares sold: BlackRock Class ........ 12,304,751 $ 117,815,392 4,306,598 $ 42,116,116 Institutional Class .... 22,622,724 217,677,987 34,726,690 344,428,847 Service Class .......... 3,059,912 29,525,974 8,725,323 86,107,989 Investor A Class ....... 449,024 4,340,261 361,195 3,567,308 Investor B Class ....... 670,156 6,468,706 763,581 7,536,362 Investor C Class ....... 732,575 7,100,978 212,705 2,114,971 Shares issued in reinvestment of dividends: BlackRock Class ........ 686,453 6,616,617 330,228 3,250,694 Institutional Class .... 1,547,546 15,039,732 555,928 5,446,836 Service Class .......... 176,475 1,716,378 168,746 1,651,673 Investor A Class ....... 38,763 373,736 19,882 195,729 Investor B Class ....... 58,104 561,236 31,539 310,362 Investor C Class ....... 6,424 60,884 768 7,570 Shares redeemed: BlackRock Class ........ (4,888,053) (46,820,534) (376,161) (3,709,600) Institutional Class .... (14,235,545) (136,184,476) (8,783,259) (86,598,628) Service Class .......... (3,102,768) (29,354,941) (14,421,591) (143,884,759) Investor A Class ....... (264,885) (2,547,956) (124,790) (1,229,336) Investor B Class ....... (343,118) (3,277,734) (174,749) (1,726,105) Investor C Class ....... (213,866) (2,037,003) (25,456) (252,086) ----------- ------------- ----------- ------------- Net increase ................ 19,304,672 $ 187,075,237 26,297,177 $ 259,333,943 =========== ============= =========== =============
Government Income Portfolio ------------------------------------------------------- For the Year Ended For the Year Ended 9/30/99 9/30/98 ------------------------- ------------------------- Shares Value Shares Value --------- ------------ --------- ------------ Shares sold: Investor A Class ....... 260,226 $ 2,715,739 325,203 $ 3,439,854 Investor B Class ....... 1,949,007 20,327,259 1,133,444 12,022,192 Investor C Class ....... 285,429 3,023,210 111,159 1,177,933 Shares issued in reinvestment of dividends: Investor A Class ....... 30,494 315,789 31,395 330,860 Investor B Class ....... 116,786 1,207,289 67,664 713,719 Investor C Class ....... 5,135 53,075 2,312 24,407 Shares redeemed: Investor A Class ....... (171,587) (1,749,782) (263,954) (2,785,911) Investor B Class ....... (883,791) (9,009,692) (290,930) (3,081,821) Investor C Class ....... (188,143) (1,955,238) (51,448) (545,399) ---------- ------------ ---------- ------------ Net increase ................ 1,403,556 $ 14,927,649 1,064,845 $ 11,295,834 ========== ============ ========== ============
72 BLACKROCK FUNDS
GNMA Portfolio --------------------------------------------------------- For the Year Ended For the Period 9/30/99 5/18/98 1 through 9/30/98 ------------------------- ---------------------------- Shares Value Shares Value --------- ------------ ----------- ------------- Shares sold: Institutional Class .... 1,140,847 $ 11,252,768 647,172 $ 6,506,570 Service Class .......... 10,000 100,000 10 100 Investor A Class ....... 163,262 1,623,804 57,226 576,633 Investor B Class ....... 15,005 149,441 16,426 165,246 Investor C Class ....... 2,509 24,987 10 100 Shares issued in conversion: Institutional Class .... -- -- 12,043,846 120,438,460 Shares issued in reinvestment of dividends: Institutional Class .... 20,941 210,041 -- 2 Service Class .......... 1 7 -- 2 Investor A Class ....... 953 9,420 29 291 Investor B Class ....... 837 8,294 37 370 Investor C Class ....... 1 5 -- 1 Shares redeemed: Institutional Class .... (1,390,033) $(13,772,698) (1,014,462) (10,187,732) Service Class .......... -- -- -- -- Investor A Class ....... (102,641) (1,006,748) (4,337) (43,657) Investor B Class ....... (8,598) (85,468) -- -- Investor C Class ....... (61) (632) -- -- ---------- ------------ ----------- ------------- Net increase (decrease) ..... (146,977) $ (1,486,779) 11,745,957 $ 117,456,386 ========== ============ =========== =============
Managed Income Portfolio ----------------------------------------------------------- For the Year Ended For the Year Ended 9/30/99 9/30/98 --------------------------- ---------------------------- Shares Value Shares Value ---------- ------------- ----------- ------------- Shares sold: Institutional Class .... 19,369,006 $ 198,295,963 28,686,745 $ 301,709,745 Service Class .......... 23,985,008 246,124,482 22,149,435 232,274,400 Investor A Class ....... 1,652,130 17,049,147 9,725,828 101,726,116 Investor B Class ....... 241,920 2,480,512 422,716 4,431,406 Investor C Class ....... 89,834 911,388 -- -- Shares issued in conversion: Institutional Class .... -- -- 70,076,349 730,896,316 Shares issued in reinvestment of dividends: Institutional Class .... 1,741,803 17,972,961 284,166 2,960,491 Service Class .......... 800,827 8,224,822 335,029 3,503,288 Investor A Class ....... 84,338 865,048 65,247 682,731 Investor B Class ....... 25,489 261,167 7,746 81,187 Investor C Class ....... 112 1,120 -- -- Shares redeemed: Institutional Class .... (20,180,012) (206,556,608) (25,254,987) (264,941,084) Service Class .......... (21,667,679) (221,936,261) (23,914,429) (251,581,067) Investor A Class ....... (1,614,057) (16,588,344) (9,855,158) (103,016,193) Investor B Class ....... (116,526) (1,183,067) (39,630) (416,407) Investor C Class ....... (89,946) (909,267) -- -- ----------- ------------- ----------- ------------- Net increase ................ 4,322,247 $ 45,013,063 72,689,057 $ 758,310,929 =========== ============= =========== =============
_____________ 1 Commencement of operations. 73 BLACKROCK FUNDS NOTES TO FINANCIAL STATEMENTS (CONTINUED)
International Bond Portfolio ------------------------------------------------------- For the Year Ended For the Year Ended 9/30/99 9/30/98 ------------------------- -------------------------- Shares Value Shares Value --------- ------------ ---------- ------------ Shares sold: Institutional Class .... 2,263,708 $ 25,360,758 807,871 $ 8,882,021 Service Class .......... 273,669 3,040,289 100,604 1,092,321 Investor A Class ....... 110,247 1,215,695 90,092 969,639 Investor B Class ....... 120,051 1,333,373 63,765 687,221 Investor C Class ....... 146,359 1,627,582 95,780 1,035,900 Shares issued in reinvestment of dividends: Institutional Class .... 23,195 257,254 149,376 1,571,786 Service Class .......... 4,843 53,860 24,714 260,973 Investor A Class ....... 8,011 89,058 8,842 94,462 Investor B Class ....... 4,349 48,278 5,400 57,581 Investor C Class ....... 3,763 41,792 2,650 28,325 Shares redeemed: Institutional Class .... (688,344) (7,645,996) (1,026,741) (11,137,837) Service Class .......... (143,232) (1,588,480) (527,989) (5,850,929) Investor A Class ....... (25,793) (287,680) (39,912) (429,622) Investor B Class ....... (32,536) (356,783) (24,092) (263,096) Investor C Class ....... (51,322) (569,217) (30,616) (332,704) --------- ------------ ---------- ------------ Net increase (decrease) ..... 2,016,968 $ 22,619,783 (300,256) $ (3,333,959) ========= ============ ========== ============
High Yield Bond Portfolio -------------------------- For the Period 11/19/98 1 thru 9/30/99 -------------------------- Shares Value ---------- ------------ Shares sold: BlackRock Class ........ 11 $ 100 Institutional Class .... 6,762,768 68,071,217 Service Class .......... 11 100 Investor A Class ....... 479,652 4,861,542 Investor B Class ....... 1,695,082 17,092,840 Investor C Class ....... 285,616 2,901,857 Shares issued in reinvestment of dividends: BlackRock Class ........ -- 7 Institutional Class .... 88 880 Service Class .......... -- 7 Investor A Class ...... 6,305 63,254 Investor B Class ....... 15,397 154,087 Investor C Class ....... 2,815 28,278 Shares redeemed: BlackRock Class ........ -- -- Institutional Class .... (201,248) (2,030,800) Service Class .......... -- -- Investor A Class ...... (32,638) (329,155) Investor B Class ...... (435,698) (4,353,940) Investor C Class ...... (16,479) (163,867) ---------- ------------ Net increase ................ 8,561,682 $ 86,296,407 ========== ============ ____________ 1 Commencement of operations. 74 BLACKROCK FUNDS On September 30, 1999, one shareholder held approximately 12% of the outstanding shares of the Government Income Portfolio and one shareholder held approximately 15% of the outstanding shares of the High Yield Bond Portfolio. Some of the shareholders are actually omnibus accounts, which are held on behalf of several individual shareholders. (E) AT SEPTEMBER 30, 1999, NET ASSETS CONSISTED OF:
Low Intermediate Duration Government Intermediate Core Bond Bond Bond Bond Portfolio Portfolio Portfolio Portfolio ------------- ------------ ------------ -------------- Capital paid-in ................................... $269,516,553 $437,374,167 $562,998,093 $1,006,877,502 Undistributed net investment income ............... 344,097 -- 514,538 -- Distributions in excess of net investment income ............................... -- -- -- (72,919) Accumulated net realized gain (loss) on investment transactions, futures, options, swap contracts and foreign exchange contracts .................. (1,797,720) (5,273,272) (5,292,619) (14,324,928) Net unrealized depreciation on investment transactions, futures contracts and foreign exchange contracts .................. (2,598,635) (7,981,205) (11,557,101) (25,480,797) ------------- ------------ ------------ -------------- $265,464,295 $424,119,690 $546,662,911 $ 966,998,858 ============= ============ ============ ==============
Government Managed International High Yield Income GNMA Income Bond Bond Portfolio Portfolio Portfolio Portfolio Portfolio ----------- ------------ -------------- ------------- ----------- Capital paid-in $45,989,278 $112,604,456 $1,602,554,335 $ 68,717,324 $86,296,407 Undistributed net investment income 32,319 263,192 -- 944,808 313,895 Accumulated net realized gain (loss) on investment transactions, futures, options, swap contracts and foreign exchange contracts (1,208,762) (282,960) (6,794,296) 1,139,886 (683,582) Net unrealized depreciation on investment transactions, futures contracts and foreign exchange contracts (913,844) (1,069,848) (50,916,307) (452,854) (2,601,709) ----------- ------------ -------------- ------------- ----------- $43,898,991 $111,514,840 $1,544,843,742 $ 70,349,164 $83,325,011 =========== ============ ============== ============= ===========
(F) CAPITAL LOSS CARRYOVERS At September 30, 1999, capital loss carryovers were available to offset possible future realized capital gains as follows: Capital Loss Carryforward Year of Expiration ------------------------- ------------------ Low Duration Bond Portfolio: $470,894 9/30/04 767,646 9/30/03 170,313 9/30/02 High Yield Bond Portfolio: 683,582 9/30/07 On September 30, 1999, deferred post-October losses for the Intermediate Government Bond Portfolio were $5,104,142, for the Intermediate Bond Portfolio were $4,074,417, for the Core Bond Portfolio were $11,549,317, for the Government Income Portfolio were $637,620, for the GNMA Portfolio were $206,164 and for the Managed Income Portfolio were $2,931,382. 75 BLACKROCK FUNDS NOTES TO FINANCIAL STATEMENTS (CONTINUED) (G) CONVERSION OF COMMON TRUST FUNDS On January 13, 1998, January 22, 1998 and February 9, 1998, the Board of Trustees of the Fund, the Board of Directors of PNC Bank and the Board of directors of PNC Bank, Delaware, respectively, approved an asset purchase agreement among the Fund, PNC Bank, Delaware regarding 25 common trust funds for which either PNC Bank or PNC Bank Delaware serve as trustee (each a "PNC Common Trust Fund"). The agreement provided for the acquisition by the Fund of all of the assets and liabilities of each PNC Common Trust Fund managed by the Advisor in a tax-free exchange for Institutional shares of the corresponding portfolio(s) of the Fund and the distribution of such Institutional shares to the participating trusts of the PNC Common Trust Funds in liquidation of the PNC Common Trust Funds. The following is a summary of shares issued, net assets converted, net assets value per share issued and unrealized appreciation of assets acquired as of the conversion date. FUNDS CONVERTED ON MAY 18, 1998:
Unrealized PNC BlackRock Shares Net Assets Net Assets Value Appreciation Common Trust Fund Fund Issued Converted Per Share Issued (Depreciation) - --------------------------- ---------------------- ---------- ------------ ---------------- -------------- PNC Short Term Bond Low Duration Bond 3,805,870 $ 37,678,109 $ 9.90 $ 48,131 PNC Short Term Government Low Duration Bond Bond 2,419,439 23,952,446 9.90 (4,521) PNC Intermediate Government Intermediate Government Bond Bond 33,310,235 339,098,189 10.18 1,048,107 PNC Intermediate Bond Intermediate Bond 25,659,119 242,478,670 9.45 938,554 PNC Managed Income Managed Income 53,447,855 557,461,128 10.43 4,696,910 PNC Income Managed Income 16,628,494 173,435,188 10.43 1,754,561 PNC GNMA GNMA 12,043,846 120,438,460 10.00 3,432,748
76 BLACKROCK FUNDS REPORT OF INDEPENDENT ACCOUNTANTS TO THE SHAREHOLDERS AND BOARD OF TRUSTEES OF THE BLACKROCK FUNDS: In our opinion, the accompanying statements of net assets of the Low Duration Bond, Intermediate Government Bond, Intermediate Bond, Government Income, GNMA, and International Bond Portfolios and the statements of assets and liabilities, including the schedules of investments, of the Core Bond, Managed Income, and High Yield Bond Portfolios of the BlackRock Funds (the "Fund") and the related statements of operations and of changes in net assets, of cash flows of the Low Duration Bond, Intermediate Bond, Government Income and Managed Income Portfolios and the financial highlights present fairly, in all material respects, the financial position of the Low Duration Bond, Intermediate Government Bond, Intermediate Bond, Core Bond, Government Income, GNMA, Managed Income, International Bond, and High-Yield Bond Portfolios of the Fund at September 30, 1999, the results of their operations, the changes in their net assets, their cash flows for the Low Duration Bond, Intermediate Bond, Government Income and Managed Income Portfolios and the financial highlights for each of the periods presented (except for the year ended June 30, 1995 for the Low Duration Bond and Core Bond Portfolios, formerly the BFM Institutional Trust Short Duration and Core Fixed Income Portfolios, respectively, which were audited by other auditors, whose report dated August 7, 1995 expressed an unqualified opinion thereon), 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 owned at September 30, 1999 by correspondence with the custodians and brokers, provide a reasonable basis for the opinion expressed above. PricewaterhouseCoopers LLP Philadelphia, Pennsylvania November 15, 1999 77 [THIS PAGE INTENTIONALLY LEFT BLANK] [THIS PAGE INTENTIONALLY LEFT BLANK] BLACKROCK FUNDS Investment Adviser BlackRock Advisors, Inc. New York, New York 10154 Sub-Adviser BlackRock Financial Management, Inc. New York, New York 10154 Custodian PFPC Trust Co. Philadelphia, Pennsylvania 19103 Co-Administrator and Transfer Agent PFPC Inc. Wilmington, Delaware 19809 Co-Administrator and Distributor BlackRock Distributors, Inc. West Conshohocken, Pennsylvania 19428 Co-Administrator BlackRock Advisors, Inc. New York, New York 10154 Counsel Simpson, Thacher & Bartlett New York, New York 10017 (A partnership which includes professional corporations) Independent Accountants PricewaterhouseCoopers LLP Philadelphia, Pennsylvania 19103 To reduce expenses, the Fund will mail only one copy of annual and semi-annual reports and most prospectuses to your household, even if more than one person in the household has a Fund account. Please call (800) 441-7762 if you would like to receive additional reports or prospectuses. BLACKROCK FUNDS FUND SPECTRUM BLACKROCK FUNDS IS A LEADING MUTUAL FUND COMPANY CURRENTLY MANAGING IN EXCESS OF $25 BILLION IN 36 PORTFOLIOS DESIGNED TO FIT A BROAD RANGE OF INVESTMENT GOALS. EACH PORTFOLIO IS MANAGED BY RECOGNIZED EXPERTS IN EQUITY, FIXED INCOME, INTERNATIONAL, AND TAX-FREE INVESTING WHO ADHERE TO A PURE INVESTMENT STYLE.(REGISTRATION MARK) STOCK PORTFOLIOS - ---------------- Large Cap Value Equity Micro-Cap Equity Large Cap Growth Equity International Equity Mid-Cap Value Equity International Small Cap Equity Mid-Cap Growth Equity International Emerging Markets Small Cap Value Equity Select Equity Small Cap Growth Equity Index Equity STOCK & BOND PORTFOLIOS - ----------------------- Balanced BOND PORTFOLIOS - --------------- Low Duration Bond Intermediate Government Bond GNMA Intermediate Bond Managed Income Core Bond International Bond Government Income High Yield Bond TAX-FREE BOND PORTFOLIOS - ------------------------ Tax-Free Income Ohio Tax-Free Income Pennsylvania Tax-Free Income Delaware Tax-Free Income New Jersey Tax-Free Income Kentucky Tax-Free Income MONEY MARKET PORTFOLIOS - ----------------------- Money Market North Carolina Municipal Money Market U.S. Treasury Money Market Ohio Municipal Money Market Municipal Money Market Pennsylvania Municipal Money Market New Jersey Municipal Money Market Virginia Municipal Money Market SHAREHOLDER PRIVILEGES 24 HOUR ACCOUNT INFORMATION Call us at 1-800-441-7762, 24 hours a day, 7 days a week to get information about your account balances, recent transactions and share prices. Note: Institutional and Service Share Class investors should call 1-800-441-7764. You can also reach us on the Internet through the World Wide Web by accessing http://www.blackrock.com. EXCHANGE PRIVILEGES Should your investment goals change, shareholders in our Investor Class shares may exchange all or part of their investments into the same share class of any other portfolio of BlackRock Funds. (1) AUTOMATIC INVESTMENT PLANS Investor Class shareholders who want to invest regularly can arrange to have $50 or more automatically deducted from their checking or savings account and invested in any of the BlackRock portfolios. SYSTEMATIC WITHDRAWAL PLANS Investor Class shareholders can establish a systematic withdrawal plan and receive periodic payments of $100 or more from their BlackRock portfolios, as long as their account is at least $1,000. RETIREMENT PLANS Shareholders may make investments in conjunction with individual IRAaccounts or rollover IRAs. GENERAL INFORMATION ABOUT THE BLACKROCK FUNDS If you would like additional reports or have questions regarding any of the 36 BlackRock Funds, please call 1-800-FUTURE4 (1-800-388-8734) (1) BLACKROCK FUNDS RESERVES THE RIGHT TO MODIFY OR TERMINATE THE EXCHANGE PRIVILEGES AT ANY TIME. BLACKROCK FUNDS (LOGO) [GRAPHIC OMITTED] P.O. Box 8907 Wilmington, DE 19899 Shares of the Fund are not deposits or obligations of, or guaranteed or endorsed by PNC Bank, National Association or any other bank and shares are not federally insured by, guaranteed by, obligations of or otherwise supported by the U.S. Government, the Federal Deposit Insurance Corporation, The Federal Reserve Board, or any other governmental agency. Investments in shares of the fund involve investment risks, including the possible loss of the principal amount invested. EX-99.17E 8 ISIS ANNUAL REPORT TO SHAREHOLDERS EXHIBIT 17(e) INDEPENDENCE SQUARE INCOME SECURITIES, INC. Robert R. Fortune Chairman and President February 5, 1999 Dear Shareholder: I am pleased to enclose the Annual Report of Independence Square Income Securities, Inc. for the year ended December 31, 1998. Our Fund earned $1.30 per share from net investment income in 1998 compared to $1.36 per share in 1997. In recent years, several higher coupon bonds were called and the proceeds reinvested at a lower coupon. As the Adviser's Letter indicates, purchases of higher yielding non-investment grade bonds were made in 1998 to enhance earnings. Dividends from net investment income declared in 1998 amounted to $1.32 per share, compared to $1.38 per share in 1997. In addition, a long-term capital gain distribution of $.0917 per share was declared in 1998 and paid in January 1999. The gains on securities were realized as bond prices increased due to the continued decline in interest rates. The amounts taxable in 1998 include the $0.11 per share regular dividend and the $0.0917 per share capital gain distribution received by you in January 1999. The accompanying Investment Adviser's Report provides a comparison of our Fund's performance to key indexes and other closed-end bond funds on a total return basis. Yours sincerely, /s/ Robert R. Fortune Robert R. Fortune [THIS PAGE INTENTIONALLY LEFT BLANK] INVESTMENT ADVISER'S REPORT The Fund emphasized adding non-investment grade (or "high yield") corporate bonds during 1998 to enhance the portfolio's income earning capability. The high yield sector experienced significant price weakness between August and October, which was driven by a credit panic precipitated by the Russian default and hedge fund de-leveraging, but provided the Fund an opportunity to add bonds at attractive prices. For the year, the Fund underperformed the Lehman Corporate Index but outperformed its Lipper peer group average. Investment returns are shown in the table below:
TOTAL RETURNS AS OF DECEMBER 31, 1998: Annualized ----------------------------- Quarter 1 Year 2 Years 3 Years 5 Years ------- ------ ------- ------- ------- Independence Square Income Securities*............. 1.34% 7.34% 9.28% 7.08% 7.58% Lehman Corporate Index............................. 0.60% 8.57% 9.40% 7.32% 7.74% Lipper Investment Grade Funds Avg.................. 0.81% 6.66% 8.91% 7.37% 7.45% ISIS Rank........................................ 7/16 5/16 7/16 10/16 7/16 ISIS Percentile.................................. 42 30 42 59 42
______________ Source: Lipper Analytical Services, Inc. * The cumulative total returns are based on the net asset values on the first and last day of the periods presented and assume (i) no payment of any sales load or commissions and (ii) reinvestment of dividends and distributions at the net asset value next determined after each ex-dividend date in the period. The U.S. economy in 1998 was a study in contrast, as economic growth boomed but inflation declined, which is an unusual combination. This is a result of the high investment spending undertaken by businesses and very strong consumer- driven retail sales and housing activity. Both these phenomena have been fueled by record equity market gains, which calls into question the sustainability of this growth. U.S. Treasury yields fell dramatically during the year, as demand for those securities rose due to the flight-to-quality between August and October and a net reduction in Treasury supply. For example, the yield of the 10-year Treasury posted a net decline of 109 basis points (1.09%), beginning 1998 at 5.74% and ending the year at 4.65%. Not surprisingly, both investment grade and non-investment grade corporate bonds underperformed Treasuries during the reporting period, as investors favored government issues and shunned credit risk. Interest rates decreased dramatically across the yield curve as indicated in the table below:
12/31/97 12/31/98 Change -------- -------- -------- 2-year Treasury Note........................ 5.64% 4.53% -1.11% 5-year Treasury Note........................ 5.71% 4.54% -1.17% 10-year Treasury Note....................... 5.74% 4.65% -1.09% 30-year Treasury Bond....................... 5.92% 5.09% -0.83%
We believe that non-Treasury securities, including corporate bonds, are currently attractively valued and offer historically high yield premiums. Even though we expect economic growth to slow during 1999 from its current rate of 3.5% to approximately 2.0%. we expect that corporate bonds will post strong performance versus Treasuries. February 1, 1999 BlackRock Institutional Management Corporation INDEPENDENCE SQUARE INCOME SECURITIES, INC. SCHEDULE OF INVESTMENTS December 31, 1998
Principal Amount Cost Value - --------- ----------- ----------- U.S. AGENCY OBLIGATIONS 8.0% $1,680,000 Federal Home Loan Mortgage Corp., 4.70%, 01/04/99............................... $ 1,679,342 $ 1,679,342 900,000 Federal National Mortgage Association, 7.50%, 8/01/2006......................... 931,235 942,269 ----------- ----------- TOTAL U.S. AGENCY OBLIGATIONS................................................... 2,610,577 2,621,611 ----------- ----------- BONDS AND OTHER DEBT OBLIGATIONS 92.0% 1,000,000 Ahmanson (H.F.) & Company, 9.875%, 11/15/1999................................... 995,465 1,033,099 500,000 BankAmerica, 9.50%, 4/01/2001................................................... 497,265 542,067 550,000 Calpine Corp., 9.25%, 2/01/2004................................................. 555,500 566,500 1,000,000 Citicorp Capital Sub Notes, 9.75%, 8/01/1999.................................... 983,110 1,024,310 1,000,000 Cleveland Electric Illuminating, 9.00%, 7/01/2023............................... 1,061,810 1,080,000 850,000 Comcast Cable Communications, 8.375%, 5/01/2007................................. 944,324 975,669 1,000,000 Comerica Bank, 8.375%, 7/15/2024................................................ 983,750 1,145,747 300,000 Comerica, Inc., 9.75%, 5/01/1999................................................ 288,840 303,409 500,000 Commonwealth Edison Co., 8.625%, 2/01/2022...................................... 537,500 548,437 1,000,000 Delta Airlines, Inc., 9.25%, 3/15/2022.......................................... 1,141,490 1,155,737 500,000 Federal Express, 9.625%, 10/15/2019............................................. 551,345 531,779 500,000 First Chicago NBD Corp., 8.875%, 3/15/2002...................................... 503,660 547,270 1,000,000 First Interstate Bancorp., 9.00%, 11/15/2004.................................... 1,000,000 1,030,000 500,000 First Union Corp., 8.00%, 8/15/2009............................................. 498,965 549,506 1,000,000 Ford Motor Credit Co., 9.14%, 12/30/2014........................................ 997,660 1,150,080 500,000 Great Western Financial Senior Notes, 8.60%, 2/01/2002.......................... 494,710 539,028 300,000 GTE California, Inc., 8.07%, 4/15/2024.......................................... 322,233 329,512 1,000,000 Gulf States Utilities 8.70%, 4/01/2024.......................................... 1,057,420 1,081,250 500,000 Harris Bancorp, 9.375%, 6/01/2001............................................... 493,285 541,715 250,000 Horton (D.R.), Inc. Guarantee Notes, 10.00%, 4/15/2006.......................... 257,500 265,000 500,000 Hydro-Quebec, 8.40%, 1/15/2022.................................................. 508,395 610,123 1,000,000 Hydro-Quebec, 8.875%, 3/01/2026................................................. 1,195,260 1,279,887 1,000,000 Jersey Central Power and Light, 8.45%, 3/24/2025................................ 1,026,150 1,130,400 800,000 New York State Electric & Gas Corp., 9.875%, 5/01/2020.......................... 793,000 839,000 1,000,000 News America Holdings, 9.50%, 7/15/2024......................................... 1,178,140 1,275,831 1,000,000 Nextlink Communications, Inc. Sr. Notes, 12.50%, 4/15/2006...................... 1,065,000 1,080,000 6,369 +Participation in Asset Exchange, 7.00%, 12/01/2020.............................. 6,369 6,369 500,000 Penney (J.C.) & Company, 8.25%, 8/15/2022....................................... 497,445 526,250 200,000 Sinclair Broadcast Group Sr. Sub. Notes, 10.00%, 9/30/2005...................... 205,250 209,000
INDEPENDENCE SQUARE INCOME SECURITIES, INC. SCHEDULE OF INVESTMENTS (Continued) December 31, 1998
Principal Amount Cost Value - --------- ----------- ----------- $1,000,000 TCI Communications, 8.75%, 2/15/2023........................................ $ 957,060 $ 1,127,707 1,000,000 Texas Utilities Co., 8.875%, 2/01/2022...................................... 1,029,240 1,123,500 500,000 Texas Utilities Co., 8.75%, 11/01/2023...................................... 546,545 568,946 1,000,000 Time Warner Entertainment, Inc., 8.375%, 7/15/2033.......................... 990,210 1,234,448 500,000 Time Warner, Inc. Debentures, 9.150%, 2/01/2023............................. 527,845 658,874 1,000,000 U.S. West, 8.875%, 6/01/2031................................................ 1,060,720 1,104,294 450,000 United Air Lines, 9.210%, 1/21/2017......................................... 522,329 510,345 1,000,000 Veritas DGC, Inc., 9.75%, 10/15/2003........................................ 1,023,750 1,015,000 1,000,000 Virginia Electric & Power Corp. Series B, 8.625%, 10/01/2024................ 1,014,120 1,079,813 ----------- ----------- TOTAL BONDS AND OTHER DEBT OBLIGATIONS...................................... 28,312,660 30,319,902 ----------- ----------- TOTAL INVESTMENTS 100.0%.................................................... $30,923,237* $32,941,513 =========== ===========
________________ + Non-income producing. * Aggregate cost for federal income tax purposes at December 31, 1998 was $30,923,237. The aggregate gross unrealized appreciation (depreciation) for all securities is as follows: excess of value over tax cost $2,058,576; excess of tax cost over value ($40,300). STATEMENT OF ASSETS AND LIABILITIES December 31, 1998 ASSETS Investments, at value (cost -- $30,923,237)............................... $32,941,513 Cash...................................................................... 17,640 Accrued interest receivable............................................... 726,705 ----------- Total Assets............................................................ 33,685,858 ----------- LIABILITIES Dividend payable.......................................................... 367,649 Investment advisory fees payable.......................................... 149,786 Other accrued expenses.................................................... 8,140 ----------- Total Liabilities....................................................... 525,575 ----------- NET ASSETS applicable to 1,822,752 capital shares outstanding, $0.10 par value (Authorized 10,000,000 shares)............................ $33,160,283 =========== NET ASSET VALUE PER SHARE ($33,160,283 divided by 1,822,752 shares)......... $ 18.19 ===========
See accompanying notes to financial statements. INDEPENDENCE SQUARE INCOME SECURITIES, INC STATEMENT OF OPERATIONS Year Ended December 31, 1998 INVESTMENT INCOME Interest............................................ $2,636,453 ---------- Expenses Fees Investment adviser.............................. 119,712 Directors and officers.......................... 29,501 Custodian....................................... 16,499 Transfer agent.................................. 17,500 Legal and audit................................. 44,614 Taxes (other than income)........................... 2,498 Printing............................................ 15,209 Insurance........................................... 1,406 Miscellaneous....................................... 7,813 ---------- Total expenses................................ 254,752 ---------- Net investment income............................... $2,381,701 ========== REALIZED AND UNREALIZED GAIN ON INVESTMENTS Net realized gain on investment securities......................................... $ 167,192 ---------- Unrealized appreciation of investments: Beginning of year.................................. 2,183,586 End of year........................................ 2,018,276 ---------- Decrease in unrealized appreciation...................................... (165,310) ---------- Net realized and unrealized gain on investments....................................... 1,882 ---------- NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS.......................... $2,383,583 ========== STATEMENT OF CHANGES IN NET ASSETS Years Ended December 31
1998 1997 ----------- ----------- INCREASE IN NET ASSETS: Operations: Net investment income............................................................. $ 2,381,701 $ 2,470,307 Net realized gain from security transactions...................................... 167,192 185,346 Increase(decrease) in unrealized appreciation of investments...................... (165,310) 833,709 ----------- ----------- Net increase in net assets resulting from operations............................ 2,383,583 3,489,362 Dividends to shareholders: From net investment income ($1.32 in 1998 and $1.38 in 1997)...................... (2,403,446) (2,512,305) From net realized gains ($.09 in both 1998 and 1997).............................. (167,146) (165,302) Net asset value of shares issued in reinvestment of dividends (2,241 shares in 1998).......................................................... 40,841 -- ----------- ----------- Total increase(decrease) in net assets.......................................... (146,168) 811,755 NET ASSETS Beginning of year.................................................................. 33,306,451 32,494,696 ----------- ----------- End of year (including undistributed net investment income of $39,021 in 1998 and $60,766 in 1997)....................................................... $33,160,283 $33,306,451 =========== ===========
See accompanying notes to financial statements. INDEPENDENCE SQUARE INCOME SECURITIES, INC. FINANCIAL HIGHLIGHTS (For a Share of the Fund Outstanding Throughout Each Period)
Year Ended December 31 ------------------------------------------------ 1998 1997 1996 1995 1994 ---- ---- ---- ---- ---- Per Share Operating Performance Net Asset Value, Beginning of Year.......................... $ 18.30 $ 17.85 $ 18.77 $ 16.58 $ 18.57 ------- ------- ------- ------- ------- Net Investment Income...................................... 1.30 1.36 1.40 1.38 1.38 Net Gains (Losses) on Securities (realized and unrealized)........................................... -- 0.56 (0.94) 2.19 (1.99) ------- ------- ------- ------- ------- Total From Investment Operations......................... 1.30 1.92 0.46 3.57 (0.61) ------- ------- ------- ------- ------- Less Distributions Dividends (from net investment income)..................... (1.32) (1.38) (1.38) (1.38) (1.38) Dividends (from net realized gains)........................ (0.09) (0.09) -- -- -- ------- ------- ------- ------- ------- Total Distributions...................................... (1.41) (1.47) (1.38) (1.38) (1.38) ------- ------- ------- ------- ------- Net Asset Value, End of Year................................ $ 18.19 $ 18.30 $ 17.85 $ 18.77 $ 16.58 ======= ======= ======= ======= ======= Per Share Market Value, End of Year......................... $17.875 $ 17.75 $ 16.25 $ 17.25 $ 15.25 ======= ======= ======= ======= ======= Total Investment Return, based on market value/1/................................................... 7.88% 19.22% 3.72% 22.71% (4.00%) Ratios/Supplemental Data Net Assets, End of Year (000's)............................ $33,160 $33,306 $32,495 $34,163 $30,179 Ratio of Expenses to Average Net Assets.................... 0.76% 0.79% 0.68% 0.76% 0.85% Ratio of Net Investment Income to Average Net Assets................................................ 7.11% 7.52% 7.80% 7.64% 7.88% Portfolio Turnover Rate.................................... 10% 20% 33% 22% 28%
___________________ /1/ See Note F. See accompanying notes to financial statements. NOTES TO FINANCIAL STATEMENTS A. Independence Square Income Securities, Inc. (the "Fund") is registered under the Investment Company Act of 1940, as amended, as a diversified closed-end management investment company. Significant accounting policies are as follows: Investments are carried at value in the accompanying financial statements (See Note D). Security transactions are accounted for on the trade date. The cost of investments sold is determined by use of the specific identification method for both financial reporting and income tax purposes. Premiums and discounts on bonds held for investment are not amortized for financial reporting or federal income tax purposes. For federal income tax purposes, discounts on original issue bonds are amortized over the life of the issue. No provision is made for federal taxes as it is the Fund's policy to continue to qualify as a regulated investment company and to make the requisite distribution of taxable income to its shareholders which will relieve it from all or substantially all federal income and excise taxes. Dividends payable are recorded on the ex- dividend and record date. Interest income is recorded on an accrual basis. The preparation of financial statements in conformity with generally accepted principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. B. Under Agreements among the Fund, PNC Bank, National Association (PNC Bank), and BlackRock Institutional Management Corporation ("BIMC", formerly known as PNC Institutional Management Corporation), an indirect majority-owned subsidiary of PNC Bank, BIMC manages the Fund's portfolio and serves as its administrative agent. The Fund pays BIMC, as investment adviser, an annual fee of .20% of the Fund's average net assets and 2% of the Fund's gross income. BIMC has agreed to reimburse the Fund to the extent that the aggregate expenses borne by the Fund in any fiscal year, exclusive of brokerage commissions, interest and taxes, exceed 1 1/2% of average net assets up to $30,000,000 and 1% of any excess. No such fee reimbursement was necessary during the year ended December 31, 1998. C. Purchases and sales of investment securities other than short term obligations for the year ended December 31, 1998 were $4,048,586 and $3,128,384, respectively. D. Values for securities listed on a national securities exchange are based on the latest quoted sale prices on December 31, 1998. Securities not so listed or not traded on that date are valued at their most recent quoted bid prices or at prices determined by investment bankers or brokers. Short- term obligations are valued at amortized cost which approximates market value. E. At December 31, 1998, net assets consisted of: Paid-in capital........................................... $31,102,858 Undistributed net investment income....................... 39,021 Accumulated net realized gain on investments.............. 128 Net unrealized appreciation of investments................ 2,018,276 ----------- Total..................................................... $33,160,283 ===========
F. The "Total Investment Return" is based on a purchase (or sale) at the market price on the first (or last) day of the period assuming (i) no payment of any sales load or commissions and (ii) reinvestment of dividends and distributions at prices obtained by the Fund's Automatic Dividend Investment Plan. REPORT OF INDEPENDENT ACCOUNTANTS To the Shareholders and Board of Directors of Independence Square Income Securities, Inc.: In our opinion, the accompanying statement of assets and liabilities, including the schedule 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 Independence Square Income Securities, Inc. (the "Fund") at December 31, 1998, 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 its financial highlights for each of the five years presented, 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 December 31, 1998 by correspondence with the custodian, provide a reasonable basis for the opinion expressed above. PricewaterhouseCoopers LLP 2400 Eleven Penn Center Philadelphia, Pennsylvania January 22, 1999 INDEPENDENCE SQUARE INCOME SECURITIES, INC. Summary of the Fund's Dividend Investment Plan The Fund has an Automatic Dividend Investment Plan which permits participating shareholders to receive income dividends and capital gain distributions ("Distributions") in additional shares of the Fund's Common Stock. A shareholder may elect to participate in the Plan by completing an Authorization Form. Under the Plan, the number of shares allocated to a shareholder's account in the Plan is determined generally as follows: (i) if the net asset value ("NAV") per share on the Determination Date is higher than the market value per share, shares are purchased on the open market and allocated to each Participant based on the average cost per share, including brokerage commissions; and (ii) if the NAV per share on the Determination Date is equal to or lower than the market price, shares are issued by the company based on NAV on the Payment Date, subject to certain adjustments. Shareholders will receive confirmations of Distributions transactions. Distributions of dividend income and capital gain are treated as being realized for tax purposes, even though received in additional shares of Common Stock rather than cash. The Fund presently pays the costs of participating in the Plan other than brokerage commissions, although Participants may be charged for extra services requested by them in connection with the Plan. The Plan may be modified at any time by the Fund upon 30-days' prior notice to shareholders. Participants may terminate participation in the Plan at any time on 15-days' prior notice, and will receive certificates for shares held in their accounts and cash for any fractional share. Additional information about the Automatic Dividend Investment Plan and an Authorization Form may be obtained by writing: Wilmington Trust Company, Rodney Square North, Wilmington, Delaware 19890, Attention: Corporate Trust Department. [THIS PAGE INTENTIONALLY LEFT BLANK] INDEPENDENCE SQUARE INCOME SECURITIES, INC. One Aldwyn Center Villanova, PA 19085 (610) 964-8882 BOARD OF DIRECTORS ROBERT R. FORTUNE G. WILLING PEPPER LANGHORNE B. SMITH DAVID R. WILMERDING, JR. OFFICERS ROBERT R. FORTUNE, Chairman and President EDWARD J. ROACH, Vice President and Treasurer GARY M. GARDNER, Secretary INVESTMENT ADVISER BLACKROCK INSTITUTIONAL MANAGEMENT CORPORATION 400 Bellevue Parkway Wilmington, DE 19809 TRANSFER AGENT PNC BANK, N.A. c/o PFPC INC. P.O. Box 8950 Wilmington, DE 19899 (800) 852-4750 (302) 791-2748 (Delaware) INDEPENDENCE SQUARE INCOME SECURITIES, INC. Annual Report to Shareholders December 31, 1998 EX-99.17F 9 ISIS SEMI-ANNUAL REPORT TO SHAREHOLDERS INDEPENDENCE SQUARE INCOME SECURITIES, INC. Robert R. Fortune Chairman and President August 4, 1999 Dear Shareholder: Our Fund earned $0.64 per share from net investment income in the first six months of 1999. Earnings in the same period of 1998 were $0.65 per share. Monthly dividends, each of $0.11 per share, were paid from January to July 1999. The January 1999 dividend was earned and was taxable in 1998. Interesting comments on the performance of our Fund compared to its peer group and benchmark are contained in the accompanying Investment Adviser's Report. Your comments or questions about Independence Square Income Securities, Inc. are welcomed. Yours sincerely, /s/ Robert R. Fortune Robert R. Fortune INVESTMENT ADVISER'S REPORT The Fund significantly outperformed both its peer group and benchmark during the six months ended June 30, 1999, returning 1.44% above the Lipper Investment Grade Fund peer group average and 1.92% more than the Lehman Corporate Bond Index. The Fund's non-investment grade holdings aided performance, as those securities greatly outperformed their investment grade counterparts during the first half of 1999. Historical investment returns are shown in the table below:
TOTAL RETURNS AS OF JUNE 30, 1999: Annualized --------------------- Quarter Ytd 1 Year 2 Years 5 Years ------- ------ ------ ------- ------- Independence Square Income Securities*......... -0.50% -0.34% 2.32% 7.15% 8.46% Lehman Corporate Index......................... -1.56% -2.26% 1.89% 6.53% 8.36% Lipper Investment Grade Funds Avg.............. -1.31% -1.78% 0.47% 6.01% 8.15% ISIS Rank.................................... 4/16 2/16 2/16 3/16 6/16 ISIS Percentile.............................. 24 12 12 18 36
- --------------- Source: Lipper Analytical Services, Inc. * The cumulative total returns are based on the net asset values on the first and last day of the periods presented and assume (i) no payment of any sales load or commissions and (ii) reinvestment of dividends and distributions at the net asset value next determined after each ex-dividend date in the period. The past six months have witnessed continued rapid expansion of the U.S. economy, with gross domestic product growth exceeding the historical non-inflationary level of 2%. In spite of strong domestic economic growth, inflationary forces continue to remain contained; still, the Federal Reserve chose to raise its target for the federal funds rate from 4.75% to 5.00% at its June meeting. The Fed cited an easing of financial strain, tight labor markets and a firming of foreign economies in the release accompanying the move. The Fed dropped its tightening bias to a neutral bias, which should reduce the likelihood of another hike at the August 24th meeting. However, an additional 25-50 basis points of tightening by year end is possible, as the combination of a very strong domestic economy and an improving situation in Europe and Japan may allow for tighter monetary policy. Interest rates increased significantly across the yield curve as indicated in the table below: 12/31/98 6/30/99 Change -------- ------- ------ 2-year Treasury Note.......................... 4.53% 5.52% 0.99% 5-year Treasury Note.......................... 4.54% 5.65% 1.11% 10-year Treasury Note......................... 4.65% 5.79% 1.14% 30-year Treasury Bond......................... 5.09% 5.97% 0.88% In tandem with the Fed's recent rate tightening, BlackRock has taken a defensive interest rate stance. With the Treasury curve currently pricing in the possibility of another Fed tightening by year-end, we believe that interest rates will trade in a relatively narrow range until the economy shows signs of slowing. July 28, 1999 BlackRock Institutional Management Corporation INDEPENDENCE SQUARE INCOME SECURITIES, INC. SCHEDULE OF INVESTMENTS June 30, 1999 (Unaudited)
Principal Amount Cost Value - -------------- ------------ ----------- U.S. TREASURY NOTES 2.5% $ 410,000 U.S. Treasury Note, 6.125%, 8/15/2007............................ $ 434,760 $ 414,277 400,000 U.S. Treasury Note, 4.75%, 11/15/2008............................ 385,375 366,965 ------------ ----------- TOTAL U.S. TREASURY NOTES........................................ 820,135 781,242 ------------ ----------- U.S. AGENCY OBLIGATIONS 8.7% 900,000 Federal National Mortgage Association, 7.50%, 8/01/2006.......... 929,638 916,236 1,800,000 Student Loan Marketing Association, 4.60%, 7/01/1999............. 1,800,000 1,800,000 ------------ ----------- TOTAL U.S. AGENCY OBLIGATIONS.................................... 2,729,638 2,716,236 ------------ ----------- BONDS AND OTHER DEBT OBLIGATIONS 88.8% 1,000,000 Ahmanson (H.F.) & Company, 9.875%, 11/15/1999.................... 995,465 1,013,966 500,000 BankAmerica, 9.50%, 4/01/2001.................................... 497,265 526,980 550,000 Calpine Corp., 9.250%, 2/01/2004................................. 555,500 556,875 1,000,000 Citicorp Capital Sub Notes, 9.75%, 8/01/1999..................... 983,110 1,003,551 1,000,000 Cleveland Electric Illuminating, 9.00%, 7/01/2023................ 1,061,810 1,037,537 1,000,000 Comerica Bank, 8.375%, 7/15/2024................................. 983,750 1,059,715 500,000 Commonwealth Edison Company, 8.625%, 2/01/2022................... 537,500 501,780 1,000,000 Delta Airlines, Inc., 9.25%, 3/15/2022........................... 1,141,490 1,132,351 500,000 Federal Express, 9.625%, 10/15/2019.............................. 551,345 520,000 500,000 First Chicago NBD Corp., 8.875%, 3/15/2002....................... 503,660 529,228 1,000,000 First Interstate Bancorp., 9.00%, 11/15/2004..................... 1,000,000 1,098,152 500,000 First Union Corp., 8.00%, 8/15/2009.............................. 498,965 526,178 1,000,000 Ford Motor Credit Co., 9.14%, 12/30/2014......................... 997,660 1,092,324 500,000 Great Western Financial Senior Notes, 8.60%, 2/01/2002........... 494,710 523,505 300,000 GTE California, Inc., 8.07%, 4/15/2024........................... 322,233 307,536 1,000,000 Gulf States Utilities 8.70%, 4/01/2024........................... 1,057,420 1,037,300 500,000 Harris Bancorp, 9.375%, 6/01/2001................................ 493,285 527,908 250,000 Horton (D.R.), Inc. Co. Guarantee Notes, 10.00%, 4/15/2006....... 257,500 260,000 500,000 Hydro-Quebec, 8.40%, 1/15/2022................................... 508,395 559,330 1,000,000 Hydro-Quebec, 8.875%, 3/01/2026.................................. 1,195,260 1,186,778 1,000,000 Jersey Central Power and Light, 8.45%, 3/24/2025................. 1,026,150 1,068,340 800,000 New York State Electric & Gas Corp., 9.875%, 5/01/2020........... 793,000 836,000 1,000,000 News America Holdings, 9.50%, 7/15/2024.......................... 1,178,140 1,176,205 1,000,000 Nextlink Communications, Inc. Sr. Notes, 12.50%, 4/15/2006....... 1,065,000 1,092,500 5,470 +Participation in Asset Exchange, 7.00%, 12/01/2020............... 5,470 5,470 500,000 Penney (J.C.) & Company, 8.25%, 8/15/2022........................ 497,445 492,437
INDEPENDENCE SQUARE INCOME SECURITIES, INC. SCHEDULE OF INVESTMENTS (Continued) June 30, 1999 (Unaudited)
Principal Amount Cost Value - ----------- ----------- ----------- $ 200,000 Sinclair Broadcast Group Sr. Sub. Notes, 10.00%, 9/30/2005..... $ 205,250 $ 209,000 1,000,000 TCI Communications, 8.75%, 2/15/2023........................... 957,060 1,053,942 1,000,000 Texas Utilities Co., 8.875%, 2/01/2022......................... 1,029,240 1,055,256 500,000 Texas Utilities Co., 8.75%, 11/01/2023......................... 546,545 527,220 1,000,000 Time Warner Entertainment, Inc., 8.375%, 7/15/2033............. 990,210 1,087,741 500,000 Time Warner, Inc. Debentures, 9.150%, 2/01/2023................ 527,845 587,014 1,000,000 U.S. West, 8.875%, 6/01/2031................................... 1,060,720 1,102,811 450,000 United Air Lines, 9.210%, 1/21/2017............................ 522,328 490,500 1,000,000 Veritas DGC, Inc., 9.75%, 10/15/2003........................... 1,023,750 1,030,000 1,000,000 Virginia Electric & Power Corp. Series B, 8.625%, 10/01/2024... 1,014,120 1,020,351 ----------- ----------- TOTAL BONDS AND OTHER DEBT OBLIGATIONS......................... 27,078,596 27,835,781 ----------- ----------- TOTAL INVESTMENTS 100.0%....................................... $30,628,369* $31,333,259 =========== ===========
_______________ + Non-income producing. * Aggregate cost for federal income tax purposes at June 30, 1999 was $30,628,369. The aggregate gross unrealized appreciation (depreciation) for all securities is as follows: excess of value over tax cost $959,055; excess of tax cost over value $(254,165). STATEMENT OF ASSETS AND LIABILITIES JUNE 30, 1999 (Unaudited) ASSETS Investments, at value (cost -- $30,628,369)................................ $31,333,259 Cash....................................................................... 12,894 Accrued interest receivable................................................ 721,762 ----------- 32,067,915 ----------- LIABILITIES Accrued expenses........................................................... 22,809 ----------- NET ASSETS applicable to 1,822,752 capital shares outstanding, $0.10 par value (Authorized 10,000,000 shares)......................................... $32,045,106 =========== NET ASSET VALUE PER SHARE ($32,045,106 (divided by) 1,822,752 shares)........ $ 17.58 ===========
See accompanying notes to financial statements. INDEPENDENCE SQUARE INCOME SECURITIES, INC. STATEMENT OF OPERATIONS Six Months Ended June 30, 1999 (Unaudited) INVESTMENT INCOME Interest............................................. $ 1,302,404 ----------- Expenses Fees Investment adviser............................... 58,858 Directors and officers........................... 16,206 Custodian........................................ 10,209 Transfer agent................................... 10,025 Legal and audit.................................. 24,506 Taxes(other than income)........................... 1,249 Printing........................................... 5,060 Insurance.......................................... 690 Miscellaneous...................................... 3,993 ----------- Total expenses............................. 130,796 ----------- Net investment income................................ $ 1,171,608 =========== REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS Net realized gain on investment securities......................................... $ 29,115 ----------- Unrealized appreciation of investments: Beginning of period................................ 2,018,276 End of period...................................... 704,890 ----------- Decrease in unrealized appreciation................ (1,313,386) ----------- Net realized and unrealized loss on investments..................................... (1,284,271) NET DECREASE IN NET ASSETS RESULTING FROM OPERATIONS.................................... $ (112,663) =========== STATEMENT OF CHANGES IN NET ASSETS
Six Months Ended June 30, Year Ended 1999 December 31, (Unaudited) 1998 ------------- ------------ INCREASE IN NET ASSETS: Operations: Net investment income $ 1,171,608 $ 2,381,701 Net realized gain from security transactions 29,115 167,192 Decrease in unrealized appreciation of investments (1,313,386) (165,310) ----------- ----------- Net increase(decrease) in net assets resulting from operations (112,663) 2,383,583 Dividends to shareholders: From net investment income ($.55 in 1999 and $1.32 in 1998) (1,002,514) (2,403,446) From net realized gains ($.09 in 1998) 0 (167,146) Net asset value of shares issued in reinvestment of dividends (2,241 shares in 1998) 0 40,841 ----------- ----------- Total increase(decrease) in net assets (1,115,177) (146,168) NET ASSETS Beginning of period 33,160,283 33,306,451 ----------- ----------- End of period (including undistributed net investment income of $208,115 in 1999 and $39,021 in 1998) $32,045,106 $33,160,283 =========== ===========
See accompanying notes to financial statements. INDEPENDENCE SQUARE INCOME SECURITIES, INC. FINANCIAL HIGHLIGHTS (For a Share of the Fund Outstanding Throughout Each Period)
Six Months Ended Year Ended December 31 June 30, ------------------------------------------------ 1999 1998 1997 1996 1995 1994 ----------- ---- ---- ---- ---- ---- (Unaudited) Per Share Operating Performance Net Asset Value, Beginning of Period................ $ 18.19 $ 18.30 $ 17.85 $ 18.77 $ 16.58 $ 18.57 --------- ------- ------- ------- ------- ------- Net Investment Income............................. 0.64 1.30 1.36 1.40 1.38 1.38 Net Gains (Losses) on Securities (realized and unrealized)....................... (0.70) -- 0.56 (0.94) 2.19 (1.99) --------- ------- ------- ------- ------- ------- Total From Investment Operations.............. (0.06) 1.30 1.92 0.46 3.57 (0.61) --------- ------- ------- ------- ------- ------- Less Distributions Dividends (from net investment income)............ (0.55) (1.32) (1.38) (1.38) (1.38) (1.38) Dividends (from net realized gains)............... -- (0.09) (0.09) -- -- -- --------- ------- ------- ------- ------- ------- Total Distributions........................... (0.55) (1.41) (1.47) (1.38) (1.38) (1.38) --------- ------- ------- ------- ------- ------- Net Asset Value, End of Period ..................... $ 17.58 $ 18.19 $ 18.30 $ 17.85 $ 18.77 $ 16.58 ========= ======= ======= ======= ======= ======= Per Share Market Value, End of Period............... $ 16.75 $17.875 $ 17.75 $ 16.25 $ 17.25 $ 15.25 ========= ======= ======= ======= ======= ======= Total Investment Return, based on market value /1/......................................... (2.22%) 7.88% 19.22% 3.72% 22.71% (4.00%) Ratios/supplemental Data Net Assets, End of Period (in 000's).............. $ 32,045 $33,160 $33,306 $32,495 $34,163 $30,179 Ratio of Expenses to Average Net Assets........... 0.81%/2/ 0.76% 0.79% 0.68% 0.76% 0.85% Ratio of Net Investment Income to Average Net Assets...................................... 7.24%/2/ 7.11% 7.52% 7.80% 7.64% 7.88% Portfolio Turnover Rate........................... 3% 10% 20% 33% 22% 28%
________________ /1/ See Note F. /2/ Annualized. See accompanying notes to financial statements. NOTES TO FINANCIAL STATEMENTS (UNAUDITED) A. Independence Square Income Securities, Inc. (the "Fund") is registered under the Investment Company Act of 1940, as amended, as a diversified closed-end management investment company. Significant accounting policies are as follows: Investments are carried at value in the accompanying financial statements (See Note D). Security transactions are accounted for on the trade date. The cost of investments sold is determined by use of the specific identification method for both financial reporting and income tax purposes. Premiums and discounts on bonds held for investment are not amortized for financial reporting or federal income tax purposes. For federal income tax purposes, discounts on original issue bonds are amortized over the life of the issue. No provision is made for federal taxes as it is the Fund's policy to continue to qualify as a regulated investment company and to make the requisite distribution of taxable income to its shareholders which will relieve it from all or substantially all federal income and excise taxes. Dividends payable are recorded on the ex-dividend and record date. Interest income is recorded on an accrual basis. The preparation of financial statements in conformity with generally accepted principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. B. Under Agreements among the Fund, PNC Bank, National Association (PNC Bank), and BlackRock Institutional Management Corporation ("BIMC", formerly known as PNC Institutional Management Corporation), an indirect majority-owned subsidiary of PNC Bank, BIMC manages the Fund's portfolio and serves as its administrative agent. The Fund pays BIMC, as investment adviser, an annual fee of .20% of the Fund's average net assets and 2% of the Fund's gross income. BIMC has agreed to reimburse the Fund to the extent that the aggregate expenses borne by the Fund in any fiscal year, exclusive of brokerage commissions, interest and taxes, exceed 1 1/2% of average net assets up to $30,000,000 and 1% of any excess. No such fee reimbursement was necessary during the six months ended June 30, 1999. C. Purchases and sales of investment securities other than short term obligations for the period ended June 30, 1999 were $820,135 and $963,179, respectively. D. Values for securities listed on a national securities exchange are based on the latest quoted sale prices on June 30, 1999. Securities not so listed or not traded on that date are valued at their most recent quoted bid prices or at prices determined by investment bankers or brokers. Short-term obligations are valued at amortized cost which approximates market value. E. At June 30, 1999, net assets consisted of: Paid-in capital.................................... $31,102,858 Undistributed net investment income................ 208,115 Accumulated net realized gain on investments....... 29,243 Net unrealized appreciation of investments......... 704,890 ----------- Total.............................................. $32,045,106 =========== F. The "Total Investment Return" is based on a purchase (or sale) at the market price on the first (or last) day of the period assuming (i) no payment of any sales load or commissions and (ii) reinvestment of dividends and distributions at prices obtained by the Fund's Automatic Dividend Investment Plan. INDEPENDENCE SQUARE INCOME SECURITIES, INC. One Aldwyn Center Villanova, PA 19085 (610) 964-8882 BOARD OF DIRECTORS ROBERT R. FORTUNE G. WILLING PEPPER LANGHORNE B. SMITH DAVID R. WILMERDING, JR. OFFICERS ROBERT R. FORTUNE, Chairman and President EDWARD J. ROACH, Vice President and Treasurer GARY M. GARDNER, Secretary INVESTMENT ADVISER BLACKROCK INSTITUTIONAL MANAGEMENT CORPORATION 400 Bellevue Parkway Wilmington, DE 19809 TRANSFER AGENT PNC BANK, N.A. c/o PFPC INC. P.O. Box 8950 Wilmington, DE 19899 (800) 852-4750 (302) 791-2748 (Delaware) INDEPENDENCE SQUARE INCOME SECURITIES, INC. Semiannual Report to Shareholders June 30, 1999 -----END PRIVACY-ENHANCED MESSAGE-----