-----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, TLdx8+HsT6taT5hCugH/iPfSYoXsnYYaH6y/tMT9MYxuHsPwumkLsBVg8/d1Mle9 cwzuYEFNEw6+lCXL1b6Www== 0000908737-99-000289.txt : 19990827 0000908737-99-000289.hdr.sgml : 19990827 ACCESSION NUMBER: 0000908737-99-000289 CONFORMED SUBMISSION TYPE: 485BPOS PUBLIC DOCUMENT COUNT: 4 FILED AS OF DATE: 19990826 EFFECTIVENESS DATE: 19990826 FILER: COMPANY DATA: COMPANY CONFORMED NAME: MENTOR FUNDS CENTRAL INDEX KEY: 0000883428 STANDARD INDUSTRIAL CLASSIFICATION: UNKNOWN SIC - 0000 [0000] IRS NUMBER: 251679376 STATE OF INCORPORATION: MA FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 485BPOS SEC ACT: SEC FILE NUMBER: 333-82853 FILM NUMBER: 99700295 BUSINESS ADDRESS: STREET 1: RIVERFRONT PLAZA STREET 2: WEST TOWER 901 E BYRD STREET CITY: RICHMOND STATE: VA ZIP: 23219 BUSINESS PHONE: 8047823648 MAIL ADDRESS: STREET 1: RIVERFRONT PLAZA STREET 2: WEST TOWER 901 E BYRD STREET CITY: RICHMOND STATE: VA ZIP: 23219 FORMER COMPANY: FORMER CONFORMED NAME: CAMBRIDGE SERIES TRUST DATE OF NAME CHANGE: 19920717 485BPOS 1 1933 Act Registration No. 333-82853 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form N-14AE REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 [ ] Pre-Effective [X] Post-Effective Amendment No. Amendment No. 1 MENTOR FUNDS (Mentor Balanced Portfolio) [Exact Name of Registrant as Specified in Charter] Area Code and Telephone Number: (804) 782-3648 901 East Byrd Street Richmond, Virginia 23219 ----------------------------------- (Address of Principal Executive Offices) Paul F. Costello, Esq. 901 East Byrd Street Richmond, Virginia 23219 ----------------------------------------- (Name and Address of Agent for Service) Copies of All Correspondence to: Timothy W. Diggins, Esq. Robert N. Hickey, Esq. Ropes & Gray Sullivan Worcester LLP One International Plaza 1025 Connecticut Avenue, N.W. Boston, Massachusetts 02110 Washington, D.C. 20036 It is proposed that this filing will become effective X immediately on filing pursuant to paragraph (b) __ on __________ pursuant to paragraph (b) __ 60 days after filing pursuant to paragraph (a)(1) __ on __________ pursuant to paragraph (a)(1) __ 75 days after filing pursuant to paragraph (a)(2) __ on __________ pursuant to paragraph (a)(2) of Rule 485 __ This post-effective amendment designates a new effective date for a previously filed post-effective amendment. [Logo] Prospectus/Proxy Statement August 1999 Important News for Shareholders of Mentor Income and Growth Portfolio The following answers to common shareholder questions may provide helpful information; however, we strongly encourage you to read the attached Prospectus/Proxy Statement in full. Q. Why is Mentor Funds sending me this Prospectus/Proxy Statement? Mutual fund companies are required to obtain shareholders' votes for certain types of changes affecting their funds. As a shareholder, you have the right to vote on major policy decisions, such as those included here. Q. What are the issues contained in this Prospectus/Proxy Statement? You are being asked to vote to approve: 1. A proposal to convert Mentor Income and Growth Portfolio from a series of a Massachusetts business trust to a series of a Delaware business trust. 2. A proposal to change the fund's fundamental investment objective to nonfundamental. 3. A proposal to adopt standardized investment restrictions. 4. A proposal to merge Mentor Income and Growth Portfolio into Mentor Balanced Portfolio. Q. Why is Mentor proposing this fund merger? Mentor Income and Growth Portfolio and Mentor Balanced Portfolio are funds that have similar investment objectives and strategies; however, Mentor Balanced Portfolio has a larger asset base and offers the potential for greater yield and overall investment returns. -1- Q. How will the broad-based proposals affect me as a fund shareholder? The conversion of the fund into a series of a Delaware business trust will provide consistency across the fund family and flexibility compared to the previous form of organization. In addition, Delaware law offers certain advantages for business trusts and some important protections for shareholders. See Part I of the Prospectus/Proxy Statement for more information. Changing the fundamental investment objective to nonfundamental and changing certain fundamental restrictions to nonfundamental gives the fund and its investment adviser greater flexibility to respond to market, regulatory or industry changes. These reclassifications are not intended to alter the fund's investment objective or its investment approach. Adopting standardized investment restrictions across all funds will help provide operational efficiencies and make it easier to monitor compliance with these restrictions. Standardized investment restrictions will also make it easier for the funds and their investment advisers to respond quickly to market, regulatory or industry developments. These changes will not substantially affect the way the fund is currently managed. Q. Why is Mentor proposing these changes? The portfolios, or funds, of Mentor Funds are advised by affiliates of First Union National Bank ("FUNB"). Other investment advisory affiliates of FUNB serve as investment advisers to the Evergreen family of funds. The Evergreen Funds were converted into series of Delaware business trusts beginning in December 1997 and their investment restrictions were standardized and modernized at the same time. These proposals represent some final steps we are undertaking to unify the Evergreen and Mentor fund families. Shareholders can anticipate the following benefits: -2- o A comprehensive fund family with a broad range of investment options. o The elimination of any overlap or gaps in fund offerings. o Uniformity of privileges associated with each fund, specifically regarding letters of intent, rights of accumulation and exchangeability, which will provide flexibility for investors to exchange their shares into a broad range of investment vehicles as their objectives change. o An easily accessible product line for both shareholders and investment professionals with a line of investment choices from conservative to aggressive funds. o A single location for fund information, whether you are looking up funds in the newspaper or locating Morningstar reports on the Internet. o Possible economies of scale that could result in cost savings as a result of smaller Mentor funds becoming part of the larger Evergreen family of funds including possible reductions in fund general expenses such as legal and accounting fees, custody fees and Trustees' fees and expenses. o The fund's conversion and merger are anticipated to be tax-free events. Please see pages __ and __ of the attached Proxy Statement/Prospectus for a discussion of the merger's effect on fees and expenses. Q. How do the Trustees recommend I vote? The Trustees of Mentor Funds recommend you vote in favor of or FOR all of the proposals on the enclosed Proxy Card. Q. Whom do I call for more information or to place my vote? Please call Shareholder Communications Corporation at 1-800-645-7816 for additional information. You may vote using any of the following methods: -3- 1. Use the enclosed Proxy Card to record your vote--either FOR, AGAINST or ABSTAIN for each issue--then return the card in the postage paid envelope provided, or 2. Complete and sign the enclosed Proxy Card and FAX both sides of the card to 1-800-451-8683, or 3. Call 1-800-690-6903 and record your vote by telephone. Please have your Proxy Card at hand when you call and enter the 12 digit Control Number found on the card, then follow the simple instructions, or 4. Vote on the Internet by going to the website www.proxyvote.com or go to the Proxy Voting link on the Evergreen Funds website at www.evergreen-funds.com. Enter the 12 digit Control Number found on your Proxy Card, then follow the simple instructions. -4- MENTOR LOGO August 27, 1999 Dear Shareholder, I am writing to shareholders of Mentor Income and Growth Portfolio (the "Fund") to inform you of a Special Shareholders' Meeting to be held on October 15, 1999. Before that meeting, I would like your vote on the important issues affecting your Fund as described in the attached Prospectus/Proxy Statement. The meeting being held is to vote on four proposals designed to integrate your Fund into the Evergreen family of funds. Your Fund will merge with Mentor Balanced Portfolio after each Fund is converted into a newly organized series of Evergreen Equity Trust. The proposals contemplate that each of the conversions to series of Evergreen Equity Trust will occur in October 1999 and that the combination of the two Funds will occur in March 2000. This two-step consolidation is caused by certain timing issues. The Prospectus/Proxy Statement includes four proposals. The first proposal requests that shareholders consider and vote upon the conversion of the Fund to a series of Evergreen Equity Trust, a Delaware business trust. If approved, the Fund will change its name to Evergreen Capital Income and Growth Fund and Class A, Class B and Class Y shares of the Fund will be converted to Class A, Class C and Class Y shares, respectively, of Evergreen Capital Income and Growth Fund. After the conversion, the Fund will continue to conduct its business until the effective date of the reorganization described below. The second proposal requests that shareholders consider the reclassification of the Fund's investment objective from fundamental to nonfundamental. This proposal is intended to provide consistency and increased flexibility throughout the Evergreen fund family. By making the investment objectives nonfundamental all the Evergreen Funds will be consistent and the Trustees will have the flexibility to make minor revisions as markets change, avoiding the expense of a shareholders' meeting. The third proposal requests that shareholders consider the adoption of standardized investment restrictions for the Fund. -1- This proposal is intended to provide consistency and increased flexibility throughout the Evergreen fund family. The fourth proposal requests that shareholders consider and act upon an Agreement and Plan of Reorganization whereby all of the assets of the Fund would be acquired by Evergreen Capital Balanced Fund (the successor to Mentor Balanced Portfolio) in exchange for either Class A, Class C or Class Y shares of Evergreen Capital Balanced Fund and the assumption by Evergreen Capital Balanced Fund of the identified liabilities of the Fund. You will receive shares of Evergreen Capital Balanced Fund having an aggregate net asset value equal to the aggregate net asset value of your Fund shares. Details about Evergreen Capital Balanced Fund's investment objective, portfolio management team and performance are contained in the attached Prospectus/Proxy Statement. In a separate proxy statement, the shareholders of Mentor Balanced Portfolio will vote on the conversion of that fund into Evergreen Capital Balanced Fund. The investment advisory services will be assumed by Mentor Investment Advisors, LLC, the Fund's current investment adviser. For federal income tax purposes, the transaction is a non-taxable event for shareholders. The Board of Trustees of Mentor Funds has approved the proposals and recommends that you vote FOR these proposals. I realize that this Prospectus/Proxy Statement will take time to review, but your vote is very important. Please take the time to familiarize yourself with the proposals. If you attend the meeting, you may vote your shares in person. If you do not expect to attend the meeting, either complete, date, sign and return the enclosed proxy card in the enclosed postage paid envelope, or vote by calling toll free 1-800-690-6903, 24 hours a day, or vote through the Internet. You may also FAX your completed and signed proxy card (both front and back sides) to Management Information Services, an ADP Company, our proxy tabulator at 1-800-451-8683. Instructions on how to complete the proxy card, vote by telephone or vote through the Internet are included immediately after the Notice of Special Meeting. If you have any questions about the proxy, please call our proxy solicitor, Shareholder Communications Corporation at 1-800- 645-7816. If we do not receive your completed proxy card or your telephone or Internet vote within several weeks, you may be contacted by Shareholder Communications Corporation, who will remind you to vote your shares. -2- Thank you for taking this matter seriously and participating in this important process. Sincerely, /s/Paul F. Costello ------------------- Paul F. Costello President Mentor Funds -3- MENTOR INCOME AND GROWTH PORTFOLIO 901 East Byrd Street Richmond, Virginia 23219 NOTICE OF SPECIAL MEETING OF SHAREHOLDERS TO BE HELD ON OCTOBER 15, 1999 Notice is hereby given that a Special Meeting of Shareholders (the "Meeting") of Mentor Income and Growth Portfolio (the "Fund"), a series of Mentor Funds, will be held at the offices of the Mentor Funds, 901 East Byrd Street, Richmond, Virginia 23219 on October 15, 1999 at 2:00 p.m. for the following purposes: 1. To consider and act upon an Agreement and Plan of Conversion and Termination (the "Conversion Plan") providing for the reorganization of the Fund as a series (the "Successor Fund") of Evergreen Equity Trust, a Delaware business trust, and in connection therewith, the acquisition of all of the assets of the Fund in exchange for shares of the Successor Fund, and the assumption by the Successor Fund of all of the liabilities of the Fund. The Conversion Plan also provides for the distribution of such shares of the Successor Fund to shareholders of the Fund in liquidation and subsequent termination of the Fund. 2. To consider and act upon the reclassification of the Fund's investment objective from fundamental to nonfundamental. 3. To consider and act upon the adoption of standardized fundamental investment restrictions by amending or reclassifying the current fundamental investment restrictions of the Fund. 4. To consider and act upon an Agreement and Plan of Reorganization (the "Reorganization Plan") providing for the acquisition of all of the assets of the Successor Fund by Evergreen Capital Balanced Fund (the successor to Mentor Balanced Portfolio), a series of Evergreen Equity Trust ("Evergreen Capital Balanced"), in exchange for shares of Evergreen Capital Balanced and the assumption by Evergreen Capital Balanced of the identified liabilities of the Successor Fund. The Reorganization Plan also provides for distribution of these shares of Evergreen Capital Balanced to shareholders of the Successor Fund in liquidation and subsequent termination of the Successor Fund. A vote in favor of the Reorganization Plan is a vote in favor of the liquidation and dissolution of the Successor Fund. -1- 5. To transact any other business which may properly come before the Meeting or any adjournment or adjournments thereof. On behalf of the Fund, the Trustees of Mentor Funds have fixed the close of business on August 17, 1999 as the record date for the determination of shareholders of the Fund entitled to notice of and to vote at the Meeting or any adjournment thereof. IT IS IMPORTANT THAT PROXIES BE RETURNED PROMPTLY. SHAREHOLDERS WHO DO NOT EXPECT TO ATTEND IN PERSON ARE URGED TO SIGN WITHOUT DELAY AND RETURN THE ENCLOSED PROXY IN THE ENCLOSED ENVELOPE, WHICH REQUIRES NO POSTAGE, OR FOLLOW THE INSTRUCTIONS IMMEDIATELY AFTER THIS NOTICE RELATING TO TELEPHONE OR INTERNET VOTING SO THAT THEIR SHARES MAY BE REPRESENTED AT THE MEETING. YOUR PROMPT ATTENTION TO THE ENCLOSED PROXY WILL HELP TO AVOID THE EXPENSE OF FURTHER SOLICITATION. By Order of the Board of Trustees Michael H. Koonce Secretary August 27, 1999 -2- INSTRUCTIONS FOR EXECUTING PROXY CARDS The following general rules for signing proxy cards may be of assistance to you and may help to avoid the time and expense involved in validating your vote if you fail to sign your proxy card properly. 1. INDIVIDUAL ACCOUNTS: Sign your name exactly as it appears in the Registration on the proxy card. 2. JOINT ACCOUNTS: Either party may sign, but the name of the party signing should conform exactly to a name shown in the Registration on the proxy card. 3. ALL OTHER ACCOUNTS: The capacity of the individual signing the proxy card should be indicated unless it is reflected in the form of Registration. For example: REGISTRATION VALID SIGNATURE CORPORATE ACCOUNTS (1) ABC Corp. ABC Corp. (2) ABC Corp. John Doe, Treasurer (3) ABC Corp. John Doe, Treasurer c/o John Doe, Treasurer (4) ABC Corp. Profit Sharing Plan John Doe, Trustee TRUST ACCOUNTS (1) ABC Trust Jane B. Doe, Trustee (2) Jane B. Doe, Trustee Jane B. Doe u/t/d 12/28/78 CUSTODIAL OR ESTATE ACCOUNTS (1) John B. Smith, Cust. John B. Smith f/b/o John B. Smith, Jr. UGMA (2) John B. Smith John B. Smith, Jr., Executor -1- INSTRUCTIONS FOR TELEPHONE VOTING To vote by telephone follow the three easy steps below: 1. Call 1-800-690-6903. 2. Please have your Proxy Card at hand when you call. 3. Enter the twelve-digit "Control No." found on the card, then follow the simple recorded instructions. INSTRUCTIONS FOR INTERNET VOTING To vote by Internet follow the three easy steps below: 1. Go to website www.proxyvote.com or go to the Proxy Voting Link on the Evergreen Funds website at www.evergreen-funds.com. 2. Please have your Proxy Card at hand. 3. Enter the twelve-digit "Control No." found on the card, then follow the simple instructions. -2- PROSPECTUS/PROXY STATEMENT DATED AUGUST 27, 1999 CONVERSION OF MENTOR INCOME AND GROWTH PORTFOLIO a series of Mentor Funds 901 East Byrd Street Richmond, Virginia 23219 Into a Series of Evergreen Equity Trust 200 Berkeley Street Boston, Massachusetts 02116 AND ACQUISITION OF ASSETS OF MENTOR INCOME AND GROWTH PORTFOLIO By and in Exchange for Shares of EVERGREEN CAPITAL BALANCED FUND a series of Evergreen Equity Trust Introduction This Prospectus/Proxy Statement is being furnished to the shareholders of Mentor Income and Growth Portfolio ("Mentor Income and Growth") in connection with a Special Meeting of Shareholders to be held on October 15, 1999 at 2:00 p.m. at the offices of Mentor Funds, 901 East Byrd Street, Richmond, Virginia 23219, and any adjournments thereof (the "Meeting"). The Prospectus/Proxy Statement, which consists of four parts, proposes that Mentor Income and Growth, a series of Mentor Funds, a Massachusetts business trust, become a part of the Evergreen mutual fund family. Shareholders of the other Mentor funds are also being asked to approve mergers or conversions of their funds into the Evergreen family of funds which are managed by subsidiaries of First Union Corporation. The mergers and conversions are designed to integrate and enhance the investment management and operations of all the mutual funds in the Evergreen and Mentor families of funds. -3- The ultimate objective is for Mentor Income and Growth to be merged into Evergreen Capital Balanced Fund ("Evergreen Capital Balanced") whose investment objective and policies will be similar to those of Mentor Income and Growth. Evergreen Capital Balanced will be the successor to Mentor Balanced Portfolio if shareholders of Mentor Balanced Portfolio approve that Portfolio's conversion to a series of Evergreen Equity Trust at a shareholders' meeting also scheduled for October 15, 1999. Because of certain timing issues which are described in Part III of this Prospectus/Proxy Statement, it is proposed that Mentor Income and Growth first convert to a series of Evergreen Equity Trust, a Delaware business trust (the "Conversion"). Evergreen Capital Balanced and Mentor Income and Growth are hereinafter sometimes referred to as the "Fund" and collectively as the "Funds." Part I describes the Conversion. In Part II it is proposed, consistent with all Evergreen Funds, that Mentor Income and Growth's investment objective be reclassified from fundamental to nonfundamental. In addition, Part II relates to the adoption by Mentor Income and Growth of fundamental investment restrictions common to all Evergreen Funds. If approved by shareholders, the Conversion, the reclassification of Mentor Income and Growth's investment objective and the adoption of common fundamental investment restrictions will be effective on or about October 15, 1999 and Mentor Income and Growth's name will change to Evergreen Capital Income and Growth Fund ("Evergreen Capital Income and Growth"). At the Meeting, shareholders of Mentor Income and Growth are also being asked to approve the merger of their Fund with Evergreen Capital Balanced. This merger is scheduled to take place in March 2000. This transaction is described in Part III. In Part IV, voting information concerning the Meeting is presented. -4- TABLE OF CONTENTS
Page PART I .........................................................................................................5 Introduction .............5 Selection of Delaware Business Trust Form of Organization .............5 Description of the Conversion ........... 6 Evergreen Trust .............8 Certain Comparative Information About Mentor Funds and Evergreen Trust .............9 Current and Successor Advisory Agreements ............14 Administration Agreements ............15 Current and Successor Distribution Arrangements ............15 Name ............15 Certain Votes to be Taken Prior to the Conversion ............16 Investment Objectives and Restrictions ............16 Federal Income Tax Consequences ............16 Appraisal Rights ............17 Recommendation of Trustees ............17 PART II ........................................................................................................18 Reclassification of Fundamental Investment Objective as Nonfundamental ............18 Recommendation of Trustees ......... 18 Adoption of Standardized Investment Restrictions (Proposals 3A-3H) ............19 Reclassification of Fundamental Restrictions as Nonfundamental (Proposal 3I) ............20 Recommendation of Trustees ............20 PART III ..................................................................................................... 28 COMPARISON OF FEES AND EXPENSES..................................................................................32 SUMMARY ........................................................................................................37 Proposed Plan of Reorganization ............38 Tax Consequences ............39 Investment Objectives and Policies of the Funds ............40 Comparative Performance Information for Each Fund ............40 Management of the Funds ............42 Investment Advisers ............42 Administrator ............43 Portfolio Management ............43 Distribution of Shares ............43 -5- Purchase and Redemption Procedures ......... 46 Exchange Privileges ............47 Dividend Policy ......... 47 Risk Factors ............48 REASONS FOR THE REORGANIZATION................................................................................ 51 Agreement and Plan of Reorganization ............53 Federal Income Tax Consequences ............55 Pro-forma Capitalization ......... 57 Shareholder Information ............58 COMPARISON OF INVESTMENT OBJECTIVES AND POLICIES.............................................................. 59 ADDITIONAL INFORMATION........................................................................................ 63 FINANCIAL STATEMENTS AND EXPERTS.............................................................................. 64 LEGAL MATTERS................................................................................................. 64 PART IV ........................................................................................................64 VOTING INFORMATION CONCERNING THE MEETING........................................................................64 OTHER BUSINESS...................................................................................................67 EXHIBIT A.......................................................................................................A-1 EXHIBIT B.......................................................................................................B-1 EXHIBIT C.......................................................................................................C-1 EXHIBIT D.......................................................................................................D-1 EXHIBIT E.......................................................................................................E-1
-6- PART I PROPOSAL 1 - THE CONVERSION OF MENTOR INCOME AND GROWTH TO A CORRESPONDING SERIES OF A DELAWARE BUSINESS TRUST Introduction At the Meeting, the shareholders of Mentor Income and Growth will be asked to approve an Agreement and Plan of Conversion and Termination (the "Conversion Plan") which provides for the Conversion of the Fund into a corresponding series (the "Successor Fund") of Evergreen Equity Trust, a Delaware business trust ("Evergreen Trust"). The Conversion is part of an overall restructuring of the Mentor family of funds, each of which is advised by an affiliate of First Union National Bank ("FUNB"). FUNB and its other investment adviser affiliates serve as investment advisers to the Evergreen Funds. The Evergreen Funds were reorganized into series of Delaware business trusts beginning in December 1997. The restructuring into a series of the Evergreen Trust involves, among other components, the Conversion, the reclassification of the investment objective of Mentor Income and Growth from "fundamental" (i.e., changeable by shareholder vote only) to "nonfundamental" (i.e., changeable by vote of the Trustees), the adoption of standardized fundamental investment restrictions, and the reclassification of certain investment restrictions from fundamental to nonfundamental. The reclassification of the investment objective, the adoption of standardized investment restrictions and the reclassification of certain investment restrictions from fundamental to nonfundamental are discussed in Part II of this Prospectus/Proxy Statement. Selection of Delaware Business Trust Form of Organization On July 13, 1999, the Board of Trustees of Mentor Funds unanimously approved reorganizing the Fund as a separate series of Evergreen Trust. Mentor Funds is currently organized as a Massachusetts business trust. Mentor Income and Growth is proposed to be structured as a series of a Delaware business trust . The principal reason for reorganizing Mentor Income and Growth in Delaware is the availability of certain advantages of Delaware law with respect to business trusts. The Delaware Business Trust -7- Act (the "Delaware Act") has been specifically drafted to accommodate the unique governance needs of investment companies and provides that its policy is to give maximum freedom of contract to the trust instrument of a Delaware business trust. Under the Delaware Act, a shareholder of a Delaware business trust is entitled to the same limitation of personal liability extended to stockholders of Delaware corporations. No similar statutory or other authority limiting business trust shareholder liability exists in Massachusetts. As a result, Delaware law is generally considered to afford more protection against potential shareholder liability than is afforded to shareholders of Massachusetts business trusts. See "Certain Comparative Information About Mentor Funds and Evergreen Trust - Shareholder Liability." Similarly, Delaware law provides that, should a Delaware trust issue multiple series of shares, each series will not be liable for the debts of another series, another potential though remote risk in the case of other business trusts, including those, such as Mentor Funds, that are organized under Massachusetts law. Delaware has obtained a favorable national reputation for its business laws and business environment. The Delaware courts, which may be called upon to interpret the Delaware Act, are among the nation's most highly respected and have an expertise in corporate matters which in part grew out of the fact that Delaware legal issues are concentrated in the Court of Chancery where there are no juries and where judges issue written opinions explaining their decisions. Accordingly, there is a well established body of precedent which may be relevant in deciding issues pertaining to a Delaware business trust. There are other advantages that may be afforded by a Delaware business trust. Under Delaware law, the Successor Fund will have the flexibility to respond to future business contingencies. For example, the Trustees of Evergreen Trust will have the power to incorporate Evergreen Trust, to merge or consolidate it with another entity, to cause each series to become a separate trust, and to change Evergreen Trust's domicile without a shareholder vote. This flexibility could help to assure that Evergreen Trust operates under the most advanced form of organization and could reduce the expense and frequency of future shareholder meetings for non-investment related issues. This increased flexibility may reduce to some extent shareholders' participation in management of the Fund. Description of the Conversion -8- The detailed terms and conditions of the Conversion are contained in the Conversion Plan. The information in this Prospectus/Proxy Statement with respect to the Conversion Plan is qualified in its entirety by reference to, and made subject to, the complete text of the Conversion Plan, a copy of which is attached to this Prospectus/Proxy Statement as Exhibit A. If shareholders of Mentor Income and Growth do not approve the Conversion, the Fund will continue as currently organized. If the shareholders of Mentor Income and Growth approve the Conversion and the conditions of the Conversion are satisfied, all of the assets and liabilities of the Fund will be transferred to the Successor Fund and each shareholder of the Fund will receive shares of the Successor Fund (the "New Shares"). The New Shares of the Successor Fund will be issued to Mentor Income and Growth in consideration of the transfer to the Successor Fund by the Fund of all assets and liabilities of Mentor Income and Growth. Immediately thereafter, Mentor Income and Growth will liquidate and distribute the New Shares to its shareholders. Holders of Class A and Class B shares of Mentor Income and Growth will receive Class A and Class C New Shares, respectively, of the Successor Fund. Holders of Class Y Shares of the Fund will receive Class Y New Shares of the Successor Fund. Each class of shares of the Successor Fund has similar distribution- related and shareholder servicing-related fees, if any, as the shares of Mentor Income and Growth held prior to the Conversion. As a result of the Conversion, each shareholder will receive, in exchange for his or her Mentor Income and Growth shares, New Shares with a total net asset value equal to the total net asset value of the shareholder's Fund shares immediately prior to the consummation of the Conversion. The contingent deferred sales charge ("CDSC") schedule applicable to the Class C shares of the Successor Fund received in the Conversion will be the CDSC schedule of Class B shares of Mentor Income and Growth in effect at the time Class B shares of Mentor Income and Growth were originally purchased. For information on classes of shares of the Successor Fund, see Part III - "Summary - Distribution of Shares." It will not be necessary for holders of share certificates of Mentor Income and Growth to exchange their certificates for new certificates following consummation of the Conversion. Certificates for shares of the Fund issued prior to the Conversion will represent outstanding shares of the Successor Fund after the Conversion. Shareholders of the Fund who have not been issued certificates and whose shares are held in an open -9- account will automatically have those shares designated as shares of the Successor Fund. If approved by shareholders of Mentor Income and Growth, it is currently contemplated that the Conversion will become effective on or about the close of business on October 15, 1999. However, the Conversion may become effective at another time and date should the Meeting be adjourned to a later date or should any other condition to the Conversion not be satisfied at that time. Notwithstanding prior shareholder approval, the Conversion Plan may be terminated at any time prior to its implementation by the mutual agreement of the parties thereto. Evergreen Trust Evergreen Trust was established pursuant to an Agreement and Declaration of Trust ("Declaration of Trust") under the laws of the State of Delaware. Evergreen Trust is organized as a "series company" as that term is used in Rule 18f-2 under the Investment Company Act of 1940, as amended (the "1940 Act"). Evergreen Trust consists of the Successor Fund and other mutual funds of the same asset class. The Board of Trustees of Evergreen Trust is currently comprised of individuals who do not serve as Trustees of Mentor Funds. Accordingly, different Trustees will have ultimate responsibility for the oversight and management of the Successor Fund subsequent to the Conversion. It is anticipated that subsequent to the Conversion, two current Trustees of Mentor Funds, Arnold H. Dreyfuss and Louis W. Moelchert, Jr., will be nominated and elected as Trustees of Evergreen Trust. Information with respect to the current Trustees of Evergreen Trust, including compensation received, is set forth in Exhibit B. Evergreen Trust is authorized to issue shares divisible into an indefinite number of different series. The interests of investors in the various series of Evergreen Trust will be separate and distinct. All consideration received for the sales of shares of a particular series of Evergreen Trust, all assets in which such consideration is invested, and all income, earnings and profits derived from such investments, will be allocated to that series. The Declaration of Trust of Evergreen Trust provides that the Board of Trustees may: (i) establish one or more additional series thereof; (ii) issue the shares of any series in any number of classes; (iii) issue shares of a series to different groups of investors; and (iv) convert a series into -10- a pooled fund structure, without any further action by the shareholders of Evergreen Trust. The Declaration of Trust of Evergreen Trust provides for shareholder voting only for the following matters: (a) the election or removal of Trustees as provided in the Declaration of Trust; and (b) with respect to such additional matters relating to Evergreen Trust as may be required by (i) applicable law, (ii) any by-laws adopted by the Trustees, or (iii) as the Trustees may consider necessary or desirable. Certain of the foregoing matters will involve separate votes of one or more of the affected series (or affected classes of a series) of Evergreen Trust, while others will require a vote of Evergreen Trust's shareholders as a whole. All shares of all series vote together as a single class for the election or removal of Trustees of Evergreen Trust with each share having one vote for each dollar of net asset value applicable to such share, regardless of series. See "Certain Comparative Information About Mentor Funds and Evergreen Trust -Voting Rights" below. As required by the 1940 Act, shareholders of each series of Evergreen Trust, voting separately, will have the power to vote at special meetings for, among other things, changes in fundamental investment restrictions applicable to such series, approval of any new or amended investment advisory agreement, approval of any new or amended Rule 12b-1 plan and certain other matters that affect the shareholders of that series. If, at any time, less than a majority of the Trustees holding office has been elected by the shareholders, the Trustees then in office will call a shareholders' meeting for the purpose of electing Trustees of Evergreen Trust. Certain Comparative Information About Mentor Funds and Evergreen Trust As a Delaware business trust, Evergreen Trust's operations will be governed by its Declaration of Trust and By-laws, and applicable Delaware law, rather than by the Massachusetts Declaration of Trust of Mentor Funds. As discussed below, certain of the differences between Mentor Funds and Evergreen Trust derive from provisions of Evergreen Trust's Declaration of Trust and By-laws. Shareholders entitled to vote at the Meeting may obtain a copy of Evergreen Trust's Declaration of Trust and By-laws, without charge, -11- by calling Shareholder Communications Corporation at 1- 800-645-7816. Capitalization. The beneficial interests in Evergreen Trust are issued as transferable shares of beneficial interest, $.001 par value per share. The Declaration of Trust permits the Trustees to issue an unlimited number of shares and to divide such shares into an unlimited number of series or classes thereof, all without shareholder approval. Each share of a series of Evergreen Trust represents an equal proportionate interest in the assets and liabilities belonging to that series (or class) as declared by the Board of Trustees. Mentor Funds is authorized to divide its shares into an unlimited number of series, and the Trustees are empowered to establish separate classes of shares. Mentor Funds has the authority to issue an unlimited number of transferable shares of beneficial interest, without par value, of each series and class. Amendments to Governing Instrument. Generally, the provisions of the Declaration of Trust of Evergreen Trust may be amended without shareholder approval so long as such amendment is not in contravention of applicable law, by an instrument in writing signed by a majority of the then Trustees of Evergreen Trust (or by an officer of Evergreen Trust pursuant to the vote of a majority of such Trustees). Under the Declaration of Trust of Evergreen Trust, except as provided by applicable law, a quorum is 25% of the shares entitled to vote. The quorum requirement of Mentor Funds is more than 50% of the total number of outstanding shares of all series and classes entitled to vote. The affirmative vote of a majority of the shares of all series and classes then outstanding and entitled to vote is generally required to amend the Declaration of Trust of Mentor Funds (unless any larger vote may be required by applicable law), except that the Declaration of Trust may be amended by the Trustees of Mentor Funds without the vote of shareholders in certain limited circumstances. Voting Rights. Mentor Funds' Declaration of Trust and Evergreen Trust's Declaration of Trust provide that a Trustee may be removed at any special meeting of shareholders by a vote of two-thirds of the outstanding shares. The Declaration of Trust of Mentor Funds further provides that special meetings of shareholders shall be called by the Trustees upon the written request of shareholders representing 10% of the outstanding shares of all series and classes entitled to vote. If the Secretary fails to call the meeting or give notice for more than two days following the shareholders' written request, then the shareholders representing 10% of the outstanding shares may -12- call such meeting by giving notice thereof. The By-laws of Evergreen Trust provide that, to the extent required by the 1940 Act, meetings of the shareholders for the purpose of voting on the removal of any Trustee shall be called promptly by the Trustees upon the written request of shareholders holding at least 10% of the outstanding shares of Evergreen Trust entitled to vote. Like Mentor Funds, Evergreen Trust will not be required to hold annual meetings of its shareholders and, at this time, does not intend to do so. Under Mentor Funds' Declaration of Trust, the record date may not be more than 60 days preceding the scheduled meeting date. Under the By-laws of Evergreen Trust, the record date may not be more than 90 days nor less than 10 days preceding the scheduled meeting date. The Declaration of Trust of Evergreen Trust provides for shareholder voting in certain circumstances. See "Evergreen Trust" above. Shareholders of Mentor Funds have the power to vote with respect to the election of Trustees, the removal of Trustees, the approval or termination of any investment advisory or management agreement, certain amendments to the Declaration of Trust, to the same extent as the shareholders of a Massachusetts business corporation as to whether or not a court action, proceeding or claim should be brought or maintained derivatively or as a class action on behalf of Mentor Funds, and as required by law or as the Trustees may consider desirable. The Declaration of Trust of Evergreen Trust provides that a majority of the shares voted at a meeting at which a quorum is present shall decide any questions and that a plurality shall elect a Trustee, except when a different vote is required or permitted by any provision of the 1940 Act or other applicable law or by the Declaration of Trust or the By-laws of Evergreen Trust. Similar requirements apply to Mentor Funds. Shareholders of Evergreen Trust are not required to approve the termination of Evergreen Trust. Under the Declaration of Trust of Evergreen Trust, each share of the Successor Fund is entitled to one vote for each dollar of net asset value applicable to such share. Under the current Declaration of Trust of Mentor Funds, each whole share of beneficial interest is entitled to one vote, and each fractional share is entitled to a proportionate fractional vote. Under -13- Mentor Funds' Declaration of Trust or applicable law, except with respect to matters as to which a particular series or class is affected, all shares of each series or class will vote as a single class. Generally, the Declaration of Trust further provides that, where required by law or applicable regulation, certain matters will be voted on separately by each fund. In all other matters, all funds vote together as a group. Over time, the net asset values of funds in the Mentor Funds have changed in relation to one another and are expected to continue to do so in the future. Because of the divergence in net asset values, a given dollar investment in a fund with a lower net asset value will purchase more shares, and under Mentor Funds' current voting provisions, have more votes, than the same investment in a fund with a higher net asset value. Under the Declaration of Trust of Evergreen Trust, voting power is related to the dollar value of the shareholders' investments rather than to the number of shares held. As a consequence of changing from share voting to dollar voting, shareholders with a larger investment will have an increased influence in management of the Fund. Shareholder Liability. Under Delaware law, shareholders of a Delaware business trust are entitled to the same limitation of personal liability extended to stockholders of Delaware corporations. No similar statutory authority limiting business trust shareholder liability exists under Massachusetts law . As a result, to the extent that Evergreen Trust or a shareholder is subject to the jurisdiction of courts in other states, the courts may not apply Delaware law, and may thereby subject shareholders of a Delaware trust to liability. To guard against this risk, the Declaration of Trust: (a) provides that any written obligation of Evergreen Trust may contain a statement that such obligation may only be enforced against the assets of Evergreen Trust; however, the omission of such a disclaimer will not operate to create personal liability for any shareholder; and (b) provides for indemnification out of trust property of any shareholder held personally liable for the obligations of Evergreen Trust. Accordingly, the risk of a shareholder of Evergreen Trust incurring financial loss beyond that shareholder's investment because of shareholder liability is limited to circumstances in which: (i) a court refuses to apply Delaware law; (ii) no contractual limitation of liability was in effect; and (iii) Evergreen Trust itself would be unable to meet its obligations. In view of Delaware law, the nature of Evergreen Trust's business, and the nature of its assets, the risk of personal liability to a shareholder of Evergreen Trust is remote. -14- Shareholders of Mentor Funds as shareholders of a Massachusetts business trust may, under certain circumstances, be held personally liable under the applicable state law for the obligations of Mentor Funds. However, the Declaration of Trust of Mentor Funds contains an express disclaimer of shareholder liability and requires that notice of such disclaimer be given in each agreement entered into or executed by Mentor Funds or the Trustees of Mentor Funds. The Declaration of Trust also provides for shareholder indemnification out of the assets of Mentor Income and Growth. Liability and Indemnification of Trustees. Under the Declaration of Trust of Evergreen Trust, a Trustee is liable to the Trust and its shareholders only for such Trustee's own willful misfeasance, bad faith, gross negligence, or reckless disregard of the duties involved in the conduct of the office of Trustee or the discharge of the duties of a Trustee. Trustees and officers of Evergreen Trust are entitled to be indemnified for the expenses of litigation against them except with respect to any matter as to which it has been determined that such person (i) did not act in good faith in the reasonable belief that his or her action was in or not opposed to the best interests of Evergreen Trust; or (ii) had acted with willful misfeasance, bad faith, gross negligence or reckless disregard of his or her duties; and (iii) for a criminal proceeding, had reasonable cause to believe that his or her conduct was unlawful, such determination to be based upon the outcome of a court action or administrative proceeding or a reasonable determination, following a review of the facts, by (a) a vote of a majority of those Trustees who are neither "interested persons" within the meaning of the 1940 Act nor parties to the proceeding, or (b) an independent legal counsel in a written opinion. Evergreen Trust may also advance money to any Trustee or officer involved in a proceeding discussed above provided that the Trustee or officer undertakes to repay Evergreen Trust if his or her conduct is later determined to preclude indemnification and certain other conditions are met. It is currently the view of the staff of the Securities and Exchange Commission ("SEC") that to the extent that any provisions such as those described above are inconsistent with the 1940 Act, the provisions of the 1940 Act may preempt the foregoing provisions. The Declaration of Trust of Mentor Funds generally provides that its Trustees shall not be liable to Mentor Funds or its shareholders, except for the Trustees' acts of willful misfeasance, bad faith, gross negligence, or reckless disregard of duties involved in the conduct of their office. The Declaration of Trust generally also provides that Trustees and -15- officers of Mentor Funds will be indemnified against liability and expenses of litigation against them unless their conduct constituted willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in the conduct of their office. Right of Inspection. The By-laws of Evergreen Trust provide that no shareholder of Evergreen Trust shall have any right to inspect any account or book or document of Evergreen Trust except as conferred by law or otherwise by the Trustees or by resolution of the shareholders. The By-Laws of Mentor Funds provide that the Trustees may from time to time determine what rights, if any, shareholders have to inspect Mentor Funds' books and records. The foregoing is only a summary of certain of the differences between the governing instruments and laws generally applicable to Mentor Funds and Evergreen Trust. It is not a complete list of differences. Shareholders should refer directly to the provisions of the governing instruments and applicable law for more complete information. Current and Successor Advisory Agreements As a result of the Conversion, the Successor Fund will be subject to a new investment advisory agreement (the "Successor Advisory Agreement") between Evergreen Trust on behalf of the Successor Fund and Mentor Investment Advisors, LLC ("Mentor"), the current investment adviser of Mentor Income and Growth. The current investment advisory agreement of Mentor Income and Growth (the "Current Advisory Agreement") is similar in many respects to the Successor Advisory Agreement. Most importantly, the rate at which fees are required to be paid by Mentor Income and Growth for investment advisory services, as a percentage of average daily net assets, will remain the same for the Successor Fund. The following summarizes certain aspects of the Current Advisory Agreement and the Successor Advisory Agreement for each Fund. -16- Brokerage Transactions. The Successor Advisory Agreement sets forth specific terms as to brokerage transactions and the investment adviser's use of broker-dealers. For example, the investment adviser will be obligated to use its best efforts to seek to execute portfolio transactions at prices which, under the circumstances, result in total costs or proceeds being most favorable to the Successor Fund. In assessing the best overall terms available for any transaction, the investment adviser will consider all factors it deems relevant, including the breadth of the market in the security, the price of the security, the financial condition and execution capability of the broker or dealer, research services provided and the reasonableness of the commission, if any, both for the specific transaction and on a continuing basis. The Successor Advisory Agreement also incorporates the provisions of Section 28(e) of the Securities Exchange Act of 1934, as amended (the "1934 Act"), which permits an investment adviser to have its client, including an investment company, pay more than the lowest available commission for executing a securities trade in return for research services and products. The Current Advisory Agreement of Mentor Income and Growth permits the investment adviser to execute portfolio transactions and select brokers pursuant to the provisions of Section 28(e) of the 1934 Act. Liability. Both the Successor Advisory Agreement and the Current Advisory Agreement provide that the investment adviser shall have no liability in connection with rendering services thereunder, other than liabilities resulting from the adviser's willful misfeasance, bad faith, gross negligence or reckless disregard of its duties. Amendments. The Current Advisory Agreement of Mentor Income and Growth provides that all changes must be approved by a majority of the shares of the Fund. The Successor Advisory Agreement provides that only amendments of substance require shareholder approval. Administration Agreements Evergreen Investment Services, Inc. ("EIS"), located at 200 Berkeley Street, Boston, Massachusetts 02116, currently serves as administrator to Mentor Income and Growth for the same fees (determined by formula to currently equal 0.10% of the Fund's average daily net assets) charged by the Fund's former administrator. After the Conversion, EIS will serve as -17- administrator to the Successor Fund. It is anticipated that no material change will occur in Mentor Income and Growth's administrative fees or arrangements as a result of the Conversion. Current and Successor Distribution Arrangements Mentor Distributors, LLC, located at 3435 Stelzer Road, Columbus, Ohio 43219, is the principal distributor for Mentor Funds. Mentor Distributors, LLC is a wholly-owned subsidiary of BISYS Fund Services, Inc. ("BISYS") of the same address. After the Conversion, Evergreen Distributor, Inc. ("EDI"), an affiliate of BISYS located at 125 West 55th Street, New York, New York 10019, will serve as principal underwriter for the Successor Fund. It is anticipated that no material change will occur in Mentor Funds' distribution agreement or Mentor Income and Growth's aggregate amount payable under the Fund's distribution-related and shareholder servicing-related expenses as a result of the Conversion. Name At the time of its Conversion into the Successor Fund, the name of Mentor Income and Growth Portfolio will change to Evergreen Capital Income and Growth Fund. Certain Votes to be Taken Prior to the Conversion Prior to the Conversion, EDI will own a single outstanding share of the Successor Fund. The purpose of the issuance by the Successor Fund of this nominal share prior to the effective time of the Conversion is to enable Evergreen Trust to eliminate the need to incur the additional expense by Evergreen Trust of having to hold a separate meeting of shareholders of the Successor Fund in order to comply with certain shareholder approval requirements of the 1940 Act. EDI will vote on various organizational matters including the approval of the investment advisory contract, the selection of auditors and the election of Trustees. Investment Objectives and Restrictions The Successor Fund will have the same investment objective as Mentor Income and Growth except that, if Proposal 2 in this Prospectus/Proxy Statement is approved by shareholders, the Successor Fund's investment objective will not be considered "fundamental". As a result, the Successor Fund's investment -18- objective could be changed by its Trustees without shareholder approval, after prior notice to shareholders. The investment restrictions of Mentor Income and Growth are proposed to be changed as described in Part II below. Except as described in Part II below, the investment adviser does not presently intend to change in any material way for the Successor Fund the investment strategy or operations currently employed for Mentor Income and Growth. Federal Income Tax Consequences It is anticipated that the transactions contemplated by the Conversion will be tax-free. Sullivan & Worcester LLP, 1025 Connecticut Avenue, N.W., Washington,, D.C. 20036, counsel to the Successor Fund, has informed the Board of Trustees of Mentor Funds and the Board of Trustees of Evergreen Trust that if all of the assets and liabilities of Mentor Income and Growth are transferred to the Successor Fund, it will issue an opinion that the Conversion will not give rise to the recognition of income, gain or loss to Mentor Income and Growth, the Successor Fund, or shareholders of Mentor Income and Growth for federal income tax purposes pursuant to sections 361, 1032(a) and 354(a)(1), respectively, of the Internal Revenue Code of 1986, as amended (the "Code"). Such opinion will be based upon customary representations of Mentor Funds and Evergreen Trust and certain customary assumptions. The receipt of such an opinion is a condition to the consummation of the Conversion. A shareholder's adjusted basis for tax purposes in shares of the Successor Fund after the Conversion will be the same as the shareholder's adjusted basis for tax purposes in the shares of Mentor Income and Growth immediately before the Conversion. The holding period for the shares of the Successor Fund received in the Conversion will include a shareholder's holding period for shares of Mentor Income and Growth (provided that the shares of Mentor Income and Growth were held as capital assets on the date of the Conversion). Shareholders should consult their own tax advisers with respect to the state and local tax consequences of the proposed transaction. Appraisal Rights Neither Mentor Funds' Declaration of Trust nor Massachusetts law grants shareholders of Mentor Funds any rights in the nature of appraisal or dissenters' rights with respect to any action upon which such shareholders may be entitled to vote. However, -19- the right of mutual fund shareholders to redeem their shares is not affected by the proposed Conversion. Recommendation of Trustees In evaluating the Conversion Plan, the Board of Trustees reviewed the potential benefits associated with the proposed Conversion . In this regard, the Trustees of Mentor Funds considered: (i) the potential disadvantages which apply to operating Mentor Income and Growth under its current form of organization; (ii) the advantages which apply to operating the Successor Fund as a series of a Delaware business trust; (iii) the advantages of operating under Evergreen Trust's Declaration of Trust under Delaware law; (iv) the possible economies of scale (including a reduction in Fund general expenses, such as legal and accounting fees, custody fees and Trustees' fees and expenses) that could result in cost savings as a result of the smaller Mentor fund family becoming part of the larger Evergreen family of funds; (v) the fact that there will essentially be no change in the management of the Fund's portfolio securities; and (vi) the expected federal income tax consequences to Mentor Income and Growth, the Successor Fund and shareholders of Mentor Income and Growth resulting from the proposed Conversion, and the likelihood that no recognition of income, gain or loss for federal income tax purposes will occur as a result thereof. At the meeting of the Board called for the purpose on July 13, 1999, the Board of Trustees of Mentor Funds voted to approve the proposed Plan of Conversion for Mentor Income and Growth and determined that participation in the Conversion is in the best interests of the Fund and that the interests of existing shareholders will not be diluted as a result of the Conversion. THE TRUSTEES OF MENTOR FUNDS RECOMMEND THAT THE SHAREHOLDERS OF MENTOR INCOME AND GROWTH APPROVE PROPOSAL 1. PART II PROPOSAL 2 - RECLASSIFICATION OF MENTOR INCOME AND GROWTH'S INVESTMENT OBJECTIVE FROM FUNDAMENTAL TO NONFUNDAMENTAL Reclassification of Fundamental Investment Objective as Nonfundamental Under the 1940 Act, the Fund's investment objective is not required to be classified as "fundamental." A fundamental -20- investment objective may be changed only by vote of the Fund's shareholders. In order to provide the Fund with enhanced investment management flexibility to respond to market, industry or regulatory changes, the Trustees of Mentor Funds have approved the reclassification of the Fund's investment objective from fundamental to nonfundamental. A nonfundamental investment objective may be changed at any time by the Trustees without approval by the Fund's shareholders. The investment objective of the Fund is to provide a conservative combination of income and growth of capital with capital protection. The reclassification of the Fund's investment objective from fundamental to nonfundamental will not alter the Fund's investment objective. If at any time in the future, the Trustees approve a material change in the Fund's nonfundamental investment objective, shareholders of the Successor Fund will be given notice of such change prior to its implementation; however, if such a change were to occur, shareholders would not be asked to approve such change. If the reclassification of the Fund's investment objective from fundamental to nonfundamental is not approved by shareholders of the Fund, the Fund's investment objective will remain fundamental and shareholder approval (and its attendant costs and delays) will continue to be required prior to any change in investment objective. Recommendation of Trustees The Trustees of Mentor Funds have considered the enhanced management flexibility to respond to market, industry or regulatory changes that would result if the Fund's fundamental investment objective was reclassified as nonfundamental. At the meeting of the Trustees called for the purpose on July 13, 1999, the Trustees of Mentor Funds voted to approve the reclassification of the investment objective of the Fund from fundamental to nonfundamental. THE TRUSTEES OF MENTOR FUNDS RECOMMEND THAT THE SHAREHOLDERS OF MENTOR INCOME AND GROWTH APPROVE PROPOSAL 2. PROPOSAL 3 - CHANGES TO FUNDAMENTAL INVESTMENT RESTRICTIONS -21- Adoption of Standardized Investment Restrictions (Proposals 3A- 3H) The primary purpose of Proposals 3A through 3H below is to revise and standardize the Fund's fundamental investment restrictions (the "Restrictions"). The Trustees have reviewed the investment advisers' analysis of the fundamental and nonfundamental investment restrictions of the various funds offered by the Mentor and Evergreen families of mutual funds and, where practicable and appropriate to a fund's investment objective and policies as in the case of Mentor Income and Growth, the Trustees are submitting the adoption of standardized Restrictions to shareholders. It is not anticipated that any of the changes will substantially affect the way Mentor Income and Growth is currently managed. These proposals are being presented to shareholders for approval because it is believed that increased standardization will help to promote operational efficiencies and facilitate monitoring of compliance with the Restrictions by making it easier to monitor the Fund's investments. Because the proposed standardized fundamental Restrictions in general are phrased relatively more broadly than the Fund's current fundamental Restrictions, the Fund and the investment adviser are expected to be able to respond more expeditiously to market, industry or regulatory developments. Set forth below, as subsections of this Proposal, are general descriptions of each of the proposed changes. You will be given the option to approve all, some, or none of the proposed changes on the proxy card enclosed with this Prospectus/Proxy Statement. A listing of the current fundamental Restrictions of the Fund is set forth in Exhibit C. Those fundamental Restrictions that you are being requested to vote to standardize are shown in Exhibit C by an "S", which stands for "To be Standardized." If a particular change is not approved by shareholders, the current fundamental Restriction will remain in place. If approved by shareholders, the revised fundamental Restrictions described in Proposals 3A through 3H will remain fundamental and, as such, cannot be changed without a further shareholder vote. If a proposed standardized fundamental Restriction is not approved by shareholders, the current Restriction will remain fundamental and shareholder approval (and -22- its attendant costs and delays) will continue to be required prior to any change in the Restriction. Reclassification of Fundamental Restrictions as Nonfundamental (Proposal 3I) The reclassification from fundamental to nonfundamental of certain of the Fund's other current fundamental Restrictions will enhance the ability of the Fund to achieve its investment objective because the Fund and its investment adviser will have greater investment management flexibility to respond to changed market, industry or regulatory conditions without the delay and expense of the solicitation of shareholder approval. Recommendation of Trustees The Trustees of Mentor Funds have reviewed the potential benefits associated with the proposed standardization of the Fund's fundamental Restrictions (Proposals 3A through 3H below) as well as the potential benefits associated with the reclassification of certain of the Fund's other fundamental Restrictions to nonfundamental (Proposal 3I). At the meeting of the Trustees called for the purpose on July 13, 1999, the Trustees of Mentor Funds voted to approve the proposed standardization of the Fund's fundamental Restrictions (Proposals 3A through 3H below) and the reclassification from fundamental to nonfundamental of certain of the Fund's other fundamental Restrictions (Proposal 3I below). THE TRUSTEES OF MENTOR FUNDS RECOMMEND THAT THE SHAREHOLDERS OF MENTOR INCOME AND GROWTH APPROVE PROPOSAL 3. Proposal 3A: To Amend The Fundamental Restriction Concerning Diversification of Investments The current fundamental Restriction of the Fund concerning diversification of investments provides generally that the Fund cannot purchase the securities of an issuer if the purchase would cause more than 5% of the Fund's total assets taken at current value to be invested in the securities of such issuer, except U.S. government securities or if the purchase would cause more than 10% of the outstanding voting securities of any one issuer to be held in the Fund's portfolio. The Fund applies the 5% of assets test to 75% of its total assets and the 10% of outstanding voting securities test to 100% of its total assets. It is proposed that shareholders approve new language standardizing -23- these Restrictions including the percentage of total assets to which the Restriction is applied. The Fund has elected to be a "diversified" open-end management investment company under the 1940 Act, which requires the 5% of assets and 10% of outstanding voting securities tests described above to apply to 75% of the total assets of the Fund. As mentioned above, the current policy of the Fund is for the 10% voting securities of an issuer test to be applied to 100% of the Fund's assets, rather than to 75% of its assets. The primary purpose of the proposed change with respect to the Fund is to allow the Fund to invest in accordance with the less restrictive limits contained in the 1940 Act for diversified investment companies. The proposed change would allow the Fund the flexibility to purchase larger amounts of issuers' securities when its investment adviser deems an opportunity attractive. The new policy would allow the investment policies of the Fund to conform with the definition of "diversified" as it appears in the 1940 Act. The amendment of the fundamental Restriction will allow the Fund to respond more quickly to changes of the 1940 Act standard, as well as to other legal, regulatory, and market developments without the delay or expense of a shareholder vote. The amendment of the fundamental Restriction would also standardize the Restrictions across the Evergreen and Mentor families of funds. Adoption of this change is not expected to materially affect the operation of the Fund. The Fund is not changing its current classification as a diversified fund. As proposed, the Fund's fundamental Restriction regarding diversification will be replaced with the following fundamental Restriction: "The Fund may not make any investment inconsistent with the Fund's classification as a diversified investment company under the Investment Company Act of 1940." Proposal 3B: To Amend the Fundamental Restriction Concerning Concentration of the Fund's Assets in a Particular Industry The Fund currently has a fundamental Restriction concerning the concentration of investments in a particular industry. The staff of the SEC takes the position that a mutual fund "concentrates" its investments in a particular industry if more -24- than 25% of the mutual fund's assets exclusive of cash and U.S. government securities are invested in the securities of issuers in such industry. The Restriction embodies the SEC staff interpretation by stating that the Fund will not concentrate its investments in a particular industry by investing more than 25% of its total assets, exclusive of cash and U.S. government obligations, in securities of issuers in any one industry. Shareholders of the Fund are being asked to approve an amendment of the foregoing fundamental Restriction. As proposed, the Fund's current fundamental Restriction regarding concentration of the Fund's assets in a particular industry will be replaced by the following fundamental Restriction: "The Fund may not concentrate its investments in the securities of issuers primarily engaged in any particular industry (other than securities issued or guaranteed by the U.S. government or its agencies or instrumentalities)." The primary purpose of the proposed amendment is to adopt insofar as possible a standardized Restriction regarding concentration for Mentor Income and Growth and those funds in the Evergreen and Mentor families of mutual funds that do not concentrate their investments. If in the future the SEC staff changed its interpretation on concentration in an industry, the Fund would comply and avoid the expense of a shareholder vote. Adoption of this change is not expected to materially affect the operation of the Fund. Proposal 3C: To Amend The Fundamental Restriction Concerning the Issuance of Senior Securities The Fund's current fundamental Restriction regarding the issuance of senior securities states that the Fund shall not issue any senior security, except that the Fund may borrow money to the extent contemplated by the restriction on borrowing which is discussed below. It is proposed that shareholders approve replacing the Fund's current fundamental Restriction concerning the issuance of senior securities with the following fundamental Restriction governing the issuance of senior securities: "Except as permitted under the Investment Company Act of 1940, the -25- Fund may not issue senior securities." The primary purpose of this proposed change is to standardize the Fund's fundamental Restriction regarding senior securities. The proposed fundamental Restriction clarifies that the Fund may issue senior securities to the full extent permitted under the 1940 Act. Although the definition of a "senior security" involves complex statutory and regulatory concepts, a senior security is generally an obligation of the Fund which has a claim to the Fund's assets or earnings that takes precedence over the claims of the Fund's shareholders. The 1940 Act generally prohibits open-end investment companies (i.e. mutual funds) from issuing any senior securities; however, under current SEC staff interpretations, mutual funds are permitted to engage in certain types of transactions that might be considered "senior securities" as long as certain conditions are satisfied. For example, a transaction that obligates a Fund to pay money at a future date (e.g., the purchase of securities to be settled on a date that is farther away than the normal settlement period) may be considered a "senior security." A mutual fund is permitted to enter into this type of transaction if it maintains a segregated account containing liquid securities in an amount equal to its obligation to pay cash for the securities at a future date. The Fund would engage in transactions that could be considered to involve "senior securities" only in accordance with applicable regulatory requirements under the 1940 Act. Adoption of the proposed fundamental Restriction concerning senior securities is not expected to materially affect the operation of the Fund. However, adoption of a standardized fundamental Restriction will facilitate the Fund's investment adviser's investment compliance efforts and will allow the Fund to respond to legal, regulatory and market developments which may make the use of permissible senior securities advantageous to the Fund and its shareholders. Proposal 3D: To Amend The Fundamental Restriction Concerning Borrowing The Fund's current fundamental Restriction concerning borrowing states that the Fund shall not borrow more than 33 1/3% of the value of its net assets less all liabilities and indebtedness (other than such borrowings) not represented by senior securities. When reviewing the Fund's policies on borrowings as set forth in Exhibit C, you should also review the -26- Fund's policy on the issuance of senior securities since the topics are interrelated. In general, under the 1940 Act, the Fund may not borrow money, except that (i) the Fund may borrow from banks (as defined in the 1940 Act) or enter into reverse repurchase agreements, in amounts up to 33 1/3% of its total assets (including the amount borrowed), (ii) the Fund may borrow up to an additional 5% of its total assets for temporary purposes, and (iii) the Fund may obtain such short-term credit as may be necessary for the clearance of purchases and sales of portfolio securities. It is proposed that shareholders approve replacing the Fund's current fundamental Restriction regarding borrowing with the following fundamental Restriction: "The Fund may not borrow money, except to the extent permitted by applicable law." Currently, Mentor Balanced may use leverage. The Successor Fund will continue to have the ability to leverage subsequent to the Conversion. The primary purpose of the proposed change to the fundamental Restriction concerning borrowing is to standardize the Restriction. Adoption of the proposed Restriction is not currently expected to materially affect the operations of the Fund. Proposal 3E: To Amend The Fundamental Restriction Concerning Underwriting The Fund is currently subject to a fundamental Restriction concerning underwriting. The Restriction provides that the Fund will not underwrite any securities of other issuers except to the extent that, in connection with the disposition of portfolio securities, it may be deemed to be an underwriter under certain federal securities laws. It is proposed that shareholders approve replacing the current fundamental Restriction with the following fundamental Restriction concerning underwriting: "The Fund may not underwrite securities of other issuers, except insofar as the Fund may technically -27- be deemed an underwriter in connection with the disposition of its portfolio securities." The primary purpose of the proposed change is to standardize the language of the Fund's fundamental Restriction regarding underwriting. While the proposed change will have no current impact on the Fund, adoption of the proposed standardized fundamental Restriction will advance the goals of standardization. Proposal 3F: To Amend The Fundamental Restriction Concerning Investment in Real Estate The Fund currently has a fundamental Restriction concerning the purchase of real estate. The Restriction states that the Fund may not purchase or sell real estate or interests in real estate except the Fund may, however, purchase and sell securities which are secured by real estate and securities of companies that invest or deal in real estate. Shareholders are being asked to approve an amended Restriction similar to that described above. As proposed, the Fund's current fundamental Restriction will be replaced by the following fundamental Restriction: "The Fund may not purchase or sell real estate, except that, to the extent permitted by applicable law, the Fund may invest in (a) securities directly or indirectly secured by real estate, or (b) securities issued by issuers that invest in real estate." The primary purpose of the proposed amendment is to standardize the Fund's fundamental Restriction concerning real estate. To the extent that the Fund buys securities and instruments of companies in the real estate business, the Fund's performance will be affected by the condition of the real estate market. This industry is sensitive to factors such as changes in real estate values and property taxes, overbuilding, variations in rental income, and interest rates. Performance could also be affected by the structure, cash flow, and management skill of real estate companies. -28- While the proposed change will have no current impact on the Fund, adoption of the proposed standardized fundamental Restriction will advance the goals of standardization. Proposal 3G: To Amend The Fundamental Investment Restriction Concerning Commodities The Fund is currently subject to a fundamental Restriction that provides that the Fund shall not invest in commodities or commodity contracts, except that the Fund may engage in transactions involving futures contracts or options on futures contracts. It is proposed that shareholders approve replacing the current fundamental Restriction with the following fundamental Restriction concerning commodities: "The Fund may not purchase or sell commodities or contracts on commodities except to the extent that the Fund may engage in financial futures contracts and related options and currency contracts and related options and may otherwise do so in accordance with applicable law without registering as a commodity pool operator under the Commodity Exchange Act." Although the use of these types of futures for such purposes is intended to increase the Fund's investment returns, these practices could, if they do not perform as expected by the investment adviser, reduce returns or increase volatility. The Fund currently has the ability to invest in financial futures. Under the proposed amendment, these types of futures may be used for hedging or for investment purposes and involve certain risks. While the proposed change will have no material impact on the operation of the Fund, adoption of the proposed fundamental Restriction will advance the goals of standardization. -29- Proposal 3H: To Amend The Fundamental Investment Restriction Concerning Lending The Fund's current fundamental Restriction concerning lending states that the Fund shall not lend its portfolio securities except under certain percentage and other limitations. In general, it is the Fund's current policy that such loans must be secured continuously by U.S. government securities, cash or cash collateral maintained on a current basis in an amount at least equal to the market value of the securities loaned. During the existence of the loan, the Fund must continue to receive the equivalent of the interest and dividends paid by the issuer on the securities loaned and interest on the investment of the collateral; the Fund must have the right to call the loan and obtain the securities loaned at any time on reasonable notice, including the right to call the loan to enable the Fund to vote the securities. It is proposed that shareholders approve replacing the current fundamental Restriction with the following amended fundamental Restriction concerning lending: "The Fund may not make loans to other persons, except that the Fund may lend its portfolio securities in accordance with applicable law. The acquisition of investment securities or other investments shall not be deemed to be the making of a loan." The proposal is not currently expected to materially affect the operations of the Fund. Gains or losses in the market value of a loaned security will affect the Fund and its shareholders. When the Fund lends it securities, it runs the risk that it will not be able to retrieve the securities on a timely basis, possibly losing the opportunity to sell the securities at a desirable price. Also, if the borrower files for bankruptcy or becomes insolvent, the Fund's ability to dispose of the securities may be delayed. -30- The adoption of the standardized fundamental Restriction will advance the goals of standardization. Proposal 3I: Reclassification as Nonfundamental of All Current Fundamental Restrictions Other than the Fundamental Restrictions Described in the Foregoing Proposals 3A through 3H Like all mutual funds, when the Fund was established the Trustees adopted certain investment Restrictions that would govern the efforts of the Fund's investment adviser in seeking the Fund's investment objective. Some of these Restrictions were designated as "fundamental" and, as such, may not be changed unless the change has first been approved by the Trustees and then by the shareholders of the Fund. Many of the Fund's investment restrictions were required to be classified as fundamental under the securities laws of various states. Since October 1996, such state securities laws and regulations regarding fundamental investment restrictions have been preempted by federal law and no longer apply. The Fund's fundamental Restrictions were established to reflect certain regulatory, business or industry conditions as they existed at the time the Fund was established. Many such conditions no longer exist. The 1940 Act requires only that the Restrictions discussed in Proposals 3A through 3H above be classified as fundamental. As a result, this Proposal 3I proposes to reclassify as nonfundamental all current fundamental Restrictions of the Fund other than the fundamental Restrictions discussed in the foregoing Proposals 3A through 3H. Nonfundamental Restrictions may be changed or eliminated by the Trustees at any time without approval of the Fund's shareholders. The current fundamental Restrictions proposed to be reclassified as nonfundamental are shown in Exhibit C by an "R", which stands for "To be Reclassified." None of the proposed changes will materially alter the way in which the Fund is currently managed. The Trustees believe that approval of the reclassification of fundamental Restrictions to nonfundamental Restrictions will enhance the ability of the Fund to achieve its investment objective because the Fund and its investment adviser will have greater investment management flexibility to respond to changed market, -31- industry or regulatory conditions without the delay and expense of the solicitation of shareholder approval. PART III PROPOSAL 4 - MERGER OF MENTOR INCOME AND GROWTH INTO EVERGREEN CAPITAL BALANCED This Prospectus/Proxy Statement is also being furnished to shareholders of Mentor Income and Growth in connection with a proposed Agreement and Plan of Reorganization (the "Reorganization Plan") to be submitted to shareholders of Mentor Income and Growth for consideration at the Meeting. As discussed above in Part I regarding the Conversion Plan, prior to the Reorganization, Mentor Income and Growth will be converted to a series of a Delaware business trust (Evergreen Trust) to be known as Evergreen Capital Income and Growth . Shareholders of Mentor Balanced Portfolio ("Mentor Balanced"), another series of Mentor Funds, are also being asked to approve that Portfolio's conversion into a series of Evergreen Trust to be known as Evergreen Capital Balanced Fund. Subject to shareholder approval, both conversions will occur on or about October 15, 1999. Because of programming freezes in place as a result of upcoming year 2000 and other issues, the Reorganization cannot occur during the period between October 1, 1999 and March 1, 2000. In order for shareholders of Mentor Income and Growth to have an understanding about the main purpose of this Prospectus/Proxy Statement and the Reorganization, the discussion in this Part III refers to Mentor Income and Growth and not Evergreen Capital Income and Growth. Further, since Evergreen Capital Balanced is the successor to Mentor Balanced, and since the effect of the Reorganization is to merge Mentor Income and Growth with Mentor Balanced, except as otherwise specified, the discussion below will refer to the acquiring fund as Evergreen/Mentor Balanced and not to Evergreen Capital Balanced or Mentor Balanced. The Reorganization Plan provides for all of the assets of Mentor Income and Growth to be acquired by Evergreen/Mentor Balanced in exchange for shares of Evergreen/Mentor Balanced and the assumption by Evergreen/Mentor Balanced of the identified liabilities of Mentor Income and Growth (hereinafter referred to as the "Reorganization"). Following the Reorganization, shares of -32- Evergreen/Mentor Balanced will be distributed to shareholders of Mentor Income and Growth in liquidation of Mentor Income and Growth and such Fund will be terminated. Holders of Class A, Class B and Class Y shares of Mentor Income and Growth will receive Class A, Class C and Class Y shares, respectively, of Evergreen/Mentor Balanced. The Class A, Class C and Class Y shares of Evergreen/Mentor Balanced have similar distribution-related fees and shareholder servicing-related fees, if any, as the shares of Mentor Income and Growth held prior to the Reorganization. See "Comparison of Fees and Expenses." No sales charge will be imposed in connection with Class A shares of Evergreen/Mentor Balanced received by holders of Class A shares of Mentor Income and Growth. In addition, no CDSC will be deducted at the time of the Reorganization in connection with the Class C shares of Evergreen/Mentor Balanced received by holders of Class B shares of Mentor Income and Growth. Holders of Class C shares of Evergreen/Mentor Balanced received in the Reorganization will be subject to the schedule of CDSCs applicable to the Class B shares of Mentor Income and Growth and not the schedule of CDSCs presently applicable to Class C shares of Evergreen/Mentor Balanced. As a result of the proposed Reorganization, each shareholder of Mentor Income and Growth will receive that number of full and fractional shares of Evergreen/Mentor Balanced having an aggregate net asset value equal to the aggregate net asset value of such shareholder's shares of Mentor Income and Growth. The Reorganization is being structured as a tax-free reorganization for federal income tax purposes. Evergreen/Mentor Balanced is a separate series of Evergreen Trust. The investment objective of Evergreen/Mentor Balanced is to seek capital growth and current income. The investment objective of Mentor Income and Growth is similar - -- to provide a conservative combination of income and growth of capital consistent with capital protection. Evergreen/Mentor Balanced invests in a diversified portfolio of equity and investment grade fixed income securities which the investment adviser believes will produce both capital growth and current income. Mentor Income and Growth invests in a diversified portfolio of equity securities of companies that its investment adviser believes exhibit sound fundamental characteristics and in investment grade fixed income securities and U.S. government securities. -33- This Prospectus/Proxy Statement, which should be retained for future reference, sets forth concisely the information about Evergreen/Mentor Balanced that shareholders of Mentor Income and Growth should know when voting on the Reorganization. Certain relevant documents listed below, which have been filed with the SEC, are incorporated in whole or in part by reference into this Prospectus/Proxy Statement. A Statement of Additional Information dated August 27, 1999 relating to this Prospectus/Proxy Statement and the Reorganization which includes the financial statements of Mentor Balanced dated September 30, 1998 and March 31, 1999 and of Mentor Income and Growth dated September 30, 1998 and March 31, 1999, has been filed with the SEC and is incorporated by reference in its entirety into this Prospectus/Proxy Statement. A copy of such Statement of Additional Information is available upon request and without charge by writing to Mentor Funds at 901 East Byrd Street, Richmond, Virginia 23219 or by calling toll-free 1-800-645-7816. The two Prospectuses of Mentor Balanced dated December 15, 1998 as supplemented August 27, 1999 (together, the "Supplemented Prospectuses"), its Annual Report for the fiscal year ended September 30, 1998 and its Semi-Annual Report for the six month period ended March 31, 1999 are incorporated herein by reference in their entirety, insofar as they relate to Evergreen/Mentor Balanced only, and not to any other fund described therein. The Supplemented Prospectuses, which pertain (i) to Class A and Class C shares of Evergreen/Mentor Balanced and (ii) to Class Y shares of Evergreen/Mentor Balanced, differ only insofar as they describe the separate distribution and shareholder servicing arrangements applicable to the classes. Shareholders of Mentor Income and Growth will receive, with this Prospectus/Proxy Statement, copies of the Supplemented Prospectus pertaining to the class of shares of Evergreen/Mentor Balanced that they will receive as a result of the consummation of the Reorganization. Additional information about Evergreen/Mentor Balanced is contained in Mentor Balanced's Statement of Additional Information dated December 15, 1998, which has been filed with the SEC and which is available upon request and without charge by writing to or calling Mentor Balanced at the address or telephone number listed in the paragraph above. The two Prospectuses of Mentor Income and Growth which pertain (i) to Class A and Class B shares and (ii) to Class Y shares dated December 15, 1998 as supplemented, insofar as they relate to Mentor Income and Growth only, and not to any other -34- fund described therein, are incorporated herein in their entirety by reference. Copies of the Prospectuses, the related Statement of Additional Information dated December 15, 1998, the Annual Report for the fiscal year ended September 30, 1998 and the SemiAnnual Report for the six month period ended March 31, 1999, are available upon request and without charge by writing to Mentor Income and Growth at the address listed above or by calling toll-free 1-800-645-7816. THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS/PROXY STATEMENT. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. The shares offered by this Prospectus/Proxy Statement are not deposits or obligations of any bank and are not insured or otherwise protected by the U.S. government, the Federal Deposit Insurance Corporation, the Federal Reserve Board or any other government agency and involve investment risk, including possible loss of capital. COMPARISON OF FEES AND EXPENSES The amounts for Class A, Class B and Class Y shares of Mentor Balanced set forth in the following tables and in the examples are based on the expenses of Mentor Balanced for the twelve month period ended March 31, 1999. The estimated expenses for the Class A and Class Y shares, which were first issued in September 1998, are annualized for a twelve month period. The amounts for Class A, Class B and Class Y shares of Mentor Income and Growth set forth in the following tables and in the examples are based on the expenses of Mentor Income and Growth for the twelve month period ended March 31, 1999. The pro forma amounts for Class A, Class C and Class Y shares of Evergreen/Mentor Balanced are based on what the estimated combined expenses would have been for the twelve month period ended March 31, 1999. The following tables show for Mentor Balanced, Mentor Income and Growth and Evergreen/Mentor Balanced pro forma, assuming consummation of the Reorganization, the shareholder transaction expenses and annual fund operating expenses associated with an investment in -35- the Class A, Class B, Class C and Class Y shares, as applicable of each Fund. Comparison of Class A, Class C and Class Y Shares of Evergreen/Mentor Balanced With Class A, Class B and Class Y Shares of Mentor Balanced and Mentor Income and Growth
Mentor Mentor Income and Growth Balanced Shareholder Class A Class B Class Y Class A Class B Class Y ------- ------- ------- ------- ------- ------- Transaction Expenses Maximum Sales Load 5.75% None None 5.75% None None Imposed on Purchases (as a percentage of offering price) Contingent Deferred None(1) 4.00% in None None(1) 4.00% in None Sales Charge (as a the first the first percentage of year year original purchase declining declining price or redemption to 1.00% to 1.00% proceeds, whichever in the in the is lower) fifth year fifth year and 0.00% and 0.00% there- there- after(2) after (2) Annual Fund Operating Expenses (as a percentage of average daily net assets) Management Fee(3) 0.75% 0.75% 0.75% 0.75% 0.75% 0.75% 12b-1 Fees(4) 0.75% None None 0.75% None None Shareholder Servicing Plan Fees 0.25% None 0.25% 0.25% None 0.25% Other Expenses 0.39% 0.39% 0.39% 0.31% 0.31% 0.31% ----- ----- ----- ----- ----- ----- Annual Fund 1.39% 2.14% 1.14% 1.31% 2.06% 1.06% ===== ===== ===== ===== ===== ===== Operating Expenses(5)
-36-
Evergreen/Mentor Balanced Pro Forma Shareholder Transaction Class A Class C(6) Class Y ------- ---------- ------- Expenses Maximum Sales Load Imposed 5.75% None None on Purchases (as a percentage of offering price) Contingent Deferred Sales None 4.00% in None Charge (as a percentage of the first original purchase price or year redemption proceeds, declining whichever is lower) to 1.00% in the fifth year and 0.00% thereafter Annual Fund Operating Expenses (as a percentage of average daily net assets) Management Fee 0.75% 0.75% 0.75% 12b-1 Fees(7) 0.25% 1.00% None Shareholder Servicing Plan Fees None None None Other Expenses 0.34% 0.34% 0.34% ------- ------ ----- Annual Fund Operating 1.34% 2.09% 1.09% Expenses ======= ====== ======
- ------------------- (1) Investments of $1 million or more are not subject to a front-end sales charge, but may be subject to a CDSC of 1% upon redemption within one year after the month of purchase. (2) Shares purchased as part of asset-allocation plans pursuant to the BL Purchase Program are subject to a CDSC of 1% if the shares are redeemed within one year of purchase. -37- (3) The investment adviser of Mentor Balanced waived 0.01% of its management fee resulting in a net management fee of 0.74% of average daily net assets. (4) Including waivers, Class B 12b-1 fees of Mentor Balanced were 0.73% of average daily net assets . (5) Including waivers, the Annual Fund Operating Expenses for the Class A, Class B and Class Y shares of Mentor Balanced for the twelve month period ended March 31, 1999 were 1.38%, 2.11% and 1.13%, respectively. (6) Holders of Class C shares of Evergreen/Mentor Balanced received in the Reorganization will be subject to the schedule of CDSCs currently applicable to Class B shares of Mentor Income and Growth and not the schedule of CDSCs applicable to Class C shares of Evergreen/Mentor Balanced. (7) Class A shares of Evergreen/Mentor Balanced pro forma can pay up to 0.75% of average daily net assets as a 12b-1 fee. The current Class A 12b-1 fees are 0.25% of average daily net assets. For the foreseeable future, the Class A 12b-1 fees will be limited to 0.25% of average daily net assets. Examples. The following tables show for Mentor Balanced and Mentor Income and Growth, and for Evergreen/Mentor Balanced pro forma, assuming consummation of the Reorganization, examples of the cumulative effect of shareholder transaction expenses and annual fund operating expenses indicated above on a $10,000 investment in each class of shares for the periods specified, assuming (i) a 5% annual return, and (ii) redemption at the end of such period. For Class B and Class C shares, the tables also show the effect if the shares are not redeemed. In the case of Evergreen/Mentor Balanced pro forma, -38- the examples for Class C shares reflect, as described in footnote 6 above, the CDSC schedule applicable to Class B shares of Mentor Income and Growth. The tables assume the reinvestment of dividends and capital gain distributions. -39-
Mentor Balanced Three Five One Year Years Years Ten Years Class A $708 $990 $1,292 $2,148 Class B $617 $970 $1,249 $2,472 (assuming redemption at the end of the period) Class B $217 $670 $1,149 $2,472 (assuming no redemption at the end of the period) Class Y $116 $362 $628 $1,386 Mentor Income and Growth Three Five One Year Years Years Ten Years Class A $701 $966 $1,252 $2,063 Class B $609 $946 $1,208 $2,390 (assuming redemption at the end of the period) Class B $209 $646 $1,108 $2,390 (assuming no redemption at the end of the period) Class Y $108 $337 $585 $1,294 -40- Evergreen/Mentor Balanced Pro Forma Three Five One Year Years Years Ten Years Class A $605 $879 $1,174 $2,011 Class C $612 $955 $1,224 $2,421 (assuming redemption at the end of the period) Class C $212 $655 $1,124 $2,421 (assuming no redemption at the end of the period) Class Y $111 $347 $601 $1,329
The purpose of the foregoing examples is to assist Mentor Income and Growth shareholders in understanding the various costs and expenses that an investor in Evergreen/Mentor Balanced as a result of the Reorganization would bear directly and indirectly, as compared with the various direct and indirect expenses currently borne by a shareholder in Mentor Income and Growth. These examples should not be considered a representation of past or future expenses or annual return. Actual expenses may be greater or less than those shown. SUMMARY This summary is qualified in its entirety by reference to the additional information contained elsewhere in this Prospectus/Proxy Statement, the Supplemented Prospectuses of Mentor Balanced dated December 15, 1998 and the Prospectuses of Mentor Income and Growth dated December 15, 1998 as supplemented (which are incorporated herein by reference) and the Reorganization Plan, the form of which is attached to this Prospectus/Proxy Statement as Exhibit D. -41- Proposed Plan of Reorganization The Reorganization Plan provides for the transfer of all of the assets of Mentor Income and Growth (which at the time of the Reorganization will be known as Evergreen Capital Income and Growth pursuant to the Conversion Plan described above) in exchange for shares of Evergreen/Mentor Balanced and the assumption by Evergreen/Mentor Balanced of the identified liabilities of Mentor Income and Growth. The identified liabilities consist only of those liabilities reflected on the Fund's statement of assets and liabilities determined immediately preceding the Reorganization. The Reorganization Plan also calls for the distribution of shares of Evergreen/Mentor Balanced to Mentor Income and Growth shareholders in liquidation of Mentor Income and Growth as part of the Reorganization. As a result of the Reorganization, the holders of Class A, Class B and Class Y shares of Mentor Income and Growth will become the owners of that number of full and fractional Class A, Class C and Class Y shares, respectively, of Evergreen/Mentor Balanced having an aggregate net asset value equal to the aggregate net asset value of the shareholders' shares of Mentor Income and Growth, as of the close of business immediately prior to the date that Mentor Income and Growth's assets are exchanged for shares of Evergreen/Mentor Balanced. See "Reasons for the Reorganization Agreement and Plan of Reorganization." The Trustees of Mentor Funds, including the Trustees who are not "interested persons," as such term is defined in the 1940 Act (the "Independent Trustees"), have concluded that the Reorganization would be in the best interests of shareholders of Mentor Income and Growth. Accordingly, the Trustees have submitted the Reorganization Plan for the approval of Mentor Income and Growth's shareholders. In addition, subsequent to the Conversion of Mentor Income and Growth to Evergreen Capital Income and Growth, the Trustees of Evergreen Trust will review the Reorganization Plan on behalf of Evergreen Capital Income and Growth (referred to in this Part III as Mentor Income and Growth) to determine whether the Reorganization remains in the best interests of the shareholders of Evergreen Capital Income and Growth and that the interests of the shareholders of Evergreen Capital Income and Growth will not be diluted as a result of the transactions contemplated by the Reorganization, even though shareholders of Mentor Income and Growth have previously approved the Reorganization. -42- THE BOARD OF TRUSTEES OF MENTOR FUNDS RECOMMENDS APPROVAL BY SHAREHOLDERS OF MENTOR INCOME AND GROWTH OF THE REORGANIZATION PLAN EFFECTING THE REORGANIZATION. The Trustees of Evergreen Trust have also approved the Reorganization Plan on behalf of Evergreen/Mentor Balanced. Approval of the Reorganization on the part of Mentor Income and Growth will require the affirmative vote of a majority of Mentor Income and Growth's shares voted and entitled to vote, with all classes voting together as a single class, at a Meeting at which a quorum of the Fund's shares is present. More than fifty percent of the outstanding shares entitled to vote, represented in person or by proxy, is required to constitute a quorum at the Meeting. See "Voting Information Concerning the Meeting." The Reorganization is scheduled to take place on or about March 11, 2000. If the shareholders of Mentor Balanced and/or Mentor Income and Growth do not vote to approve the Conversions and/or the Reorganization, the Trustees of Mentor Funds or Evergreen Trust, as the case may be, will consider other possible courses of action in the best interests of shareholders. Tax Consequences Prior to or at the completion of the Reorganization, Mentor Income and Growth will have received an opinion of Sullivan & Worcester LLP that the Reorganization has been structured so that no gain or loss will be recognized by the Fund or its shareholders for federal income tax purposes as a result of the receipt of shares of Evergreen/Mentor Balanced in the Reorganization. The holding period and aggregate tax basis of shares of Evergreen/Mentor Balanced that are received by Mentor Income and Growth's shareholders will be the same as the holding period and aggregate tax basis of shares of the Fund previously held by such shareholders, provided that shares of the Fund are held as capital assets. In addition, the holding period and tax basis of the assets of Mentor Income and Growth in the hands of Evergreen/Mentor Balanced as a result of the Reorganization will be the same as in the hands of the Fund immediately prior to the Reorganization, and no gain or loss will be recognized by Evergreen/Mentor Balanced upon the receipt of the assets of the Fund in exchange for shares of Evergreen/Mentor Balanced and the assumption by Evergreen/Mentor -43- Balanced of the identified liabilities of Mentor Income and Growth. Investment Objectives and Policies of the Funds The investment objectives and policies of Evergreen/Mentor Balanced and Mentor Income and Growth are similar. The investment objective of Evergreen/Mentor Balanced is to seek capital growth and current income. The Fund invests in a diversified portfolio of equity and fixed income securities which the investment adviser believes will produce both capital growth and current income. The Fund may invest in almost any type of security, except that its investments in debt securities must be investment grade. The Fund's securities will include some securities selected primarily to provide for growth in value, others selected for current income, and others for stability of principal. The Fund's investment adviser adjusts the proportions of the Fund's assets invested in the different types of securities in response to changing market conditions. Under normal circumstances, the Fund will invest at least 25% of its assets in fixed income securities and 25% of its assets in equity securities. The investment objective of Mentor Income and Growth Fund is to provide a conservative combination of income and growth of capital consistent with capital protection. The Fund invests in a diversified portfolio of equity securities of companies the Fund's investment adviser believes exhibit sound fundamental characteristics and in investment grade fixed income securities and U.S. government securities. The Fund's investment adviser manages the allocation of assets among asset classes based upon its analysis of economic conditions, relative fundamental values and the attractiveness of each asset class, and expected future returns of each asset class. The Fund will normally have some portion of its assets invested in each asset class at all times but may invest without limit in any asset class. Comparative Performance Information for Each Fund Discussions of the manner of calculation of total return are contained in the Prospectuses and Statements of Additional Information of the Funds. The following tables set forth, as applicable, the total return of the Class A, Class B and Class Y shares of Mentor Balanced and of the Class A, Class B and Class Y shares of Mentor Income and Growth for the one year and five year -44- periods ended December 31, 1998, and for the period from inception through December 31, 1998. After the performance information for Mentor Balanced, shareholders of Mentor Income and Growth can compare Mentor Balanced's performance with a composite index consisting of the Lehman Brothers Aggregate Bond Index ("LBABI") and the Standard & Poor's Composite Index of 500 Stocks ("S&P 500"). The LBABI is made up of the Government/Corporate Index, the Mortgage-Backed Securities Index and the Asset-Backed Securities Index. The S&P 500 is an unmanaged index tracking the performance of 500 publicly traded U.S. stocks. The composite index represents an asset allocation of 60% S&P 500 and 40% LBABI. Neither Index is an actual investment. The calculations of total return assume the reinvestment of all dividends and capital gains distributions on the reinvestment date and the deduction of all recurring expenses (including sales charges) that were charged to shareholders' accounts. Past performance is not an indication of future results. Wellington Management Company, LLP served as sub-adviser to Mentor Income and Growth until June 30, 1999 and in that capacity made investment decisions for the Fund.
Average Annual Total Return (1) 1 Year 5 Years From Ended Ended Inception To December December December 31, Inception 31, 1998 31,1998 1998 Date ------- ------- --------- --------- Mentor Balanced Class A shares N/A N/A 5.46% 9/16/98 Class B shares 16.34% N/A 19.57% 6/21/94 Class Y shares N/A N/A 12.15% 9/16/98 LBABI/S&P 500(2) 20.62% 17.34% 20.46% 6/30/94 Mentor Income and Growth Class A shares 6.24% 13.54% 13.83% 5/20/93 -45- Class B shares 7.90% 13.91% 14.20% 5/20/93 Class Y shares 13.01% N/A 14.42% 11/19/97
- -------------- (1) Reflects waiver of advisory fees and reimbursements and/or waivers of expenses. Without such reimbursements and/or waivers, the average annual total returns during the periods would have been lower. (2) The composite index average annual total return for the period 9/30/98 to 12/31/98 was 12.92%. Important information about Mentor Balanced is also contained in management's discussion of Mentor Balanced's performance, attached hereto as Exhibit E. This information also appears in Mentor Balanced's most recent Annual Report. Management of the Funds The overall management of Mentor Balanced and of Mentor Income and Growth is the responsibility of, and is supervised by, the Board of Trustees of Mentor Funds. Subsequent to the Conversion, the overall management of Mentor Income and Growth and Evergreen/Mentor Balanced will be the responsibility of, and will be supervised by, the Board of Trustees of Evergreen Trust. Investment Advisers Mentor serves as the investment adviser for Mentor Income and Growth and Mentor Balanced and will serve as investment adviser for Evergreen/Mentor Balanced. Mentor has overall responsibility for portfolio management of the Funds. For its services as investment adviser, Mentor is entitled to receive from each Fund a fee equal to 0.75% of the Fund's average daily net assets. Mentor may, at its discretion, reduce or waive its fee or reimburse a Fund for certain of its other expenses in order to -46- reduce its expense ratios. Mentor may reduce or cease these voluntary waivers and reimbursements at any time. Year 2000 Risks. Like other investment companies, financial and business organizations and individuals around the world, Evergreen/Mentor Balanced could be adversely affected if the computer systems used by the Fund's investment adviser and the Fund's other service providers 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." The Fund's investment adviser is taking steps to address the Year 2000 Problem with respect to the computer systems that it uses and to obtain assurances that comparable steps are being taken by the Fund's other major service providers. At this time, however, there can be no assurance that these steps will be sufficient to avoid any adverse impact on the Fund. In addition, issuers of securities in which the Fund invests, especially foreign issuers, may be adversely affected by Year 2000 Problems. Such problems could negatively impact the value of the Fund's portfolio securities. Administrator As described in Part I - "Administration Agreements," EIS currently acts as administrator for Mentor Income and Growth. EIS also acts as the administrator for Mentor Balanced. Subsequent to the Reorganization, EIS will act as administrator for Evergreen/Mentor Balanced and will provide the Fund with facilities, equipment and personnel. EIS is entitled to receive an administration fee from Evergreen/Mentor Balanced based on the aggregate average daily net assets of all the mutual funds advised by FUNB and its affiliates for which EIS serves as administrator, calculated in accordance with the following schedule: 0.050% on the first $7 billion, 0.035% on the next $3 billion, 0.030% on the next $5 billion, 0.020% on the next $10 billion, 0.015% on the next $5 billion and 0.010% on assets in excess of $30 billion. Portfolio Management All investment decisions made for Mentor Balanced are made by an investment management team and it is expected that Mentor's investment management team will make the investment decisions for Evergreen/Mentor Balanced subsequent to the Reorganization. -47- Distribution of Shares Subsequent to the Reorganization, EDI, an affiliate of BISYS , will act as underwriter of shares of Evergreen/Mentor Balanced. EDI distributes the Fund's shares directly or through broker-dealers, banks (including FUNB), or other financial intermediaries. Evergreen/Mentor Balanced offers four classes of shares: Class A, Class B, Class C and Class Y. The Class B shares of Evergreen/Mentor Balanced are not involved in the Reorganization. Each Class has separate distribution arrangements. (See "Distribution-Related and Shareholder Servicing-Related Expenses" below.) No Class bears the distribution expenses relating to the shares of any other Class. In the proposed Reorganization, Class A shareholders of Mentor Income and Growth will receive Class A shares of Evergreen/Mentor Balanced, Class B shareholders of Mentor Income and Growth will receive Class C shares of Evergreen/Mentor Balanced, and Class Y shareholders of Mentor Income and Growth will receive Class Y shares of Evergreen/Mentor Balanced. The Class A, Class C and Class Y shares of Evergreen/Mentor Balanced will have similar arrangements with respect to the imposition of distribution and service fees as the Class A, Class B and Class Y shares of Mentor Income and Growth. Because the Reorganization will be effected at net asset value without the imposition of a sales charge, Evergreen/Mentor Balanced shares acquired by shareholders of Mentor Income and Growth pursuant to the proposed Reorganization would not be subject to any initial sales charge or CDSC as a result of the Reorganization. However, Class C shares acquired as a result of the Reorganization would continue to be subject to a CDSC upon subsequent redemption to the same extent as if shareholders had continued to hold their Class B shares of Mentor Income and Growth. The CDSC schedule applicable to Class C shares of Evergreen/Mentor Balanced will be the CDSC schedule of Class B shares of Mentor Income and Growth in effect at the time Class B shares of Mentor Income and Growth were originally purchased. The following is a summary description of charges and fees for the Class A, Class C and Class Y shares of Evergreen/Mentor Balanced which will be received by Mentor Income and Growth shareholders in the Reorganization. More detailed descriptions of the distribution arrangements applicable to the classes of shares are contained in the respective Prospectuses of -48- Mentor Income and Growth, the Supplemented Prospectuses of Mentor Balanced and in each Fund's Statement of Additional Information. Class A Shares. Class A shares are sold at net asset value plus an initial sales charge and, as indicated below, are subject to a 12b-1 fee. For a description of the initial sales charges applicable to purchases of Class A shares, see "Purchase of Shares" in the applicable Supplemented Prospectus for Mentor Balanced. No initial sales charge will be imposed on Class A shares of Evergreen/Mentor Balanced received by Mentor Income and Growth's shareholders in the Reorganization. However, additional purchases of Class A shares will be subject to applicable initial sales charges. Class C Shares. Class C shares are sold without initial sales charges and are subject to distribution-related and shareholder servicing-related fees which are higher than Class A shares. Class C shares will continue the CDSC arrangement which currently applies to the Class B shares of Mentor Income and Growth. The CDSC is 4.0% in the first year, declining to 1.0% in the fifth year and eliminated thereafter. No new Class C shares of Evergreen/Mentor Balanced with the CDSC described above will be offered following the Conversion. Class Y Shares. Class Y shares are sold at net asset value without any initial or deferred sales charge and are not subject to distribution-related or shareholder servicing-related fees. Class Y shares are only available to certain classes of investors as is more fully described in the Supplemented Prospectuses for Mentor Balanced. Mentor Income and Growth shareholders who receive Evergreen/Mentor Balanced Class Y shares in the Reorganization and who wish to make subsequent investments in Evergreen/Mentor Balanced will be able to purchase Class Y shares. Additional information regarding the classes of shares of each Fund is included in the Supplemented Prospectuses of Mentor Balanced, the Prospectuses of Mentor Income and Growth and Statement of Additional Information. Distribution-Related and Shareholder Servicing-Related Expenses. Evergreen/Mentor Balanced has adopted a 12b-1 plan with respect to its Class A shares under which the Class may pay for distribution-related expenses at an annual rate which may not exceed 0.75% of average daily net assets attributable to the Class. Payments with respect to the Class A shares are limited to 0.25% of average daily net assets attributable to the Class. This amount may be increased to the -49- full plan amount for the Fund by the Trustees without shareholder approval at any time, although there is no intention or expectation that the rate at which payments are made under the plan will be increased. Mentor Income and Growth has adopted a Shareholder Servicing Plan with respect to its Class A shares under which the Class may pay for shareholder servicing-related expenses at an annual rate of 0.25% of the average daily net assets attributable to the Class. Evergreen/Mentor Balanced does not impose a Shareholder Servicing Plan fee. Each of Evergreen/Mentor Balanced and Mentor Income and Growth has adopted a 12b-1 plan with respect to its Class C and Class B shares, respectively, under which the Class may pay for distribution-related expenses at an annual rate which may not exceed 1.00% (0.75% with respect to Mentor Income and Growth) of average daily net assets attributable to the Class. Mentor Income and Growth has also adopted for its Class B shares a Shareholder Servicing Plan whereby the Fund may incur a fee for shareholder services of up to 0.25% of average daily net assets attributable to the Class. The Class C 12b-1 plan of Evergreen/Mentor Balanced provides that, of the total 1.00% 12b-1 fee, up to 0.25% may be for payment in respect of shareholder services. Consistent with the requirements of Rule 12b-1 and the applicable rules of the National Association of Securities Dealers, Inc., following the Conversion and the Reorganization Evergreen/Mentor Balanced may make distribution-related and shareholder servicing-related payments with respect to Mentor Income and Growth shares sold prior to the Conversion and the Reorganization including payments to in Mentor Income and Growth's former underwriter. Additional information regarding the applicable 12b-1 plans adopted by each Fund and the Shareholder Servicing Plan adopted by Mentor Income and Growth is included in the Supplemented Prospectuses of Mentor Balanced, the Prospectuses of Mentor Income and Growth and Statement of Additional Information. Purchase and Redemption Procedures Information concerning applicable sales charges and distribution-related and shareholder servicing-related fees is provided above. Investments in the Funds are not insured. Generally, the minimum initial purchase requirement for each Fund is $1,000 ($500,000 for Class Y shares of Mentor Income and -50- Growth ). There will be no minimum for subsequent purchases of shares of Evergreen/Mentor Balanced. For Mentor Income and Growth , the minimum for subsequent investments is $50 for Class A and Class B shares and $25,000 for Class Y shares. Each Fund provides for telephone, mail or wire redemption of shares at net asset value, less any CDSC, as next determined after receipt of a redemption request on each day the New York Stock Exchange ("NYSE") is open for trading. Additional information concerning purchases and redemptions of shares, including how each Fund's net asset value is determined, is contained in the respective Prospectuses for each Fund. Unlike Mentor Income and Growth, Evergreen/Mentor Balanced may involuntarily redeem shareholders' accounts that have less than $1,000 of invested funds. A shareholder has 60 days during which to bring the account current before involuntary redemption takes effect. All funds invested in each Fund are invested in full and fractional shares. The Funds reserve the right to reject any purchase order. Exchange Privileges Shares of Mentor Income and Growth can be exchanged for shares of the same class of certain funds in the Mentor fund family. Holders of shares of a class of Evergreen/Mentor Balanced may exchange their shares for shares of the same class of any other Evergreen fund. Mentor Income and Growth shareholders will be receiving Class A, Class C and Class Y shares of Evergreen/Mentor Balanced in the Reorganization and, accordingly, with respect to shares of Evergreen/Mentor Balanced received in the Reorganization, the exchange privilege will be limited to Class A, Class C and Class Y shares, as applicable, of other Evergreen funds. Evergreen/Mentor Balanced limits exchanges to five per calendar year and three per calendar quarter. No sales charge is imposed on an exchange. An exchange which represents an initial investment in another Evergreen fund must amount to at least $1,000. The current exchange privileges, and the requirements and limitations attendant thereto, are described in the Supplemented Prospectuses of Mentor Balanced, the Prospectuses of Mentor Income and Growth and Statement of Additional Information. Dividend Policy Mentor Income and Growth and Evergreen/Mentor Balanced each distributes its investment company taxable income quarterly and -51- each Fund distributes its net realized gains at least annually. Dividends and distributions are reinvested in additional shares of the same class of the respective Fund, or paid in cash, as a shareholder has elected. See the respective Prospectuses of each Fund for further information concerning dividends and distributions. After the Reorganization, shareholders of Mentor Income and Growth who have elected to have their dividends and/or distributions reinvested will have dividends and/or distributions received from Evergreen/Mentor Balanced reinvested in shares of Evergreen/Mentor Balanced. Shareholders of Mentor Income and Growth who have elected to receive dividends and/or distributions in cash will receive dividends and/or distributions from Evergreen/Mentor Balanced in cash after the Reorganization, although they may, after the Reorganization, elect to have such dividends and/or distributions reinvested in additional shares of Evergreen/Mentor Balanced. Each of Mentor Balanced and Mentor Income and Growth has qualified and intends to continue to qualify, and Evergreen/Mentor Balanced intends to qualify, to be treated as a regulated investment company under the Code. While so qualified, so long as each Fund distributes all of its net investment company taxable income and any net realized gains to shareholders, it is expected that a Fund will not be required to pay any federal income taxes on the amounts so distributed. A 4% nondeductible excise tax will be imposed on amounts not distributed if a Fund does not meet certain distribution requirements by the end of each calendar year. Each Fund anticipates meeting such distribution requirements. Risk Factors An investment in each Fund is subject to certain risks. There is no assurance that investment performances will be positive and that the Funds will meet their investment objectives. For a discussion of each Fund's investment objective and policies, see "Comparison of Investment Objectives and Policies." Stock Market Risk. The Funds are subject to stock market risk. Investment in the Funds will be affected by general economic conditions such as prevailing economic growth, inflation -52- and interest rates. When economic growth slows, or interest or inflation rates increase, securities tend to decline in value. Such events could also cause companies to decrease the dividends they pay. If these events were to occur, the value of and dividend yield and total return earned on your investment would likely decline. Even if general economic conditions do not change, your investment may decline in value if the particular industries, issuers or sectors the Funds invest in do not perform well. In addition, each Fund invests a portion of its assets in debt securities. The main risks of investing in debt securities are: Interest Rate Risk. Bond prices move inversely to interest rates, i.e., as interest rates decline the values of the bonds increase, and vice versa. The longer the maturity of a bond, the greater the exposure to market price fluctuations. The same market factors are reflected in the share price or net asset value of bond funds which will vary with interest rates. Prices of longer-term bonds tend to be more volatile in periods of changing interest rates than prices of shorter-term securities. At June 30, 1999, the dollar-weighted average maturity of Mentor Income and Growth's portfolio of debt securities was 6.5 years, and the dollar-weighted average maturity of Mentor Balanced's portfolio of debt securities was 8.7 years. At June 30, 1999, the dollar-weighted average duration of Mentor Income and Growth's portfolio was 4.1 years and that of Mentor Balanced's portfolio was 4.8 years. Mentor Balanced's portfolio may include debt securities of a longer maturity and therefore the risks involved in the fixed-income portion of the portfolio may be more than in Mentor Income and Growth's portfolio. Credit Risk. The Fund's income and/or share price may be adversely affected if the issuer of a debt security has its credit rating reduced or fails to make scheduled interest and principal payments. Neither Fund is required to sell or otherwise dispose of any security that loses its rating or has its rating reduced after the Fund has purchased it. Derivatives Risk. Each Fund may invest in derivatives, including options, futures , options on futures, and structured securities. Structured securities are securities whose values are dependent upon and fluctuate with an independent index. The market values of derivatives or structured securities may vary depending upon the manner in which the investments have been structured and may fluctuate much more rapidly and to a much greater extent than investments in other -53- securities. As a result, the values of such investments may change at rates in excess of the rates at which traditional fixed income securities change and, depending on the structure of a derivative, could change in a manner opposite to the change in the market value of a traditional fixed income security. A risk involved in investing in derivatives is the possibility of loss greater than the amount invested in the security. See the Supplemented Prospectuses and Statement of Additional Information of Mentor Balanced for further discussion of the risks inherent in the use of certain derivatives. Foreign Investment Risk. Each Fund may purchase obligations of foreign governments and corporations. Investment in foreign securities generally entails more risk than investment in domestic issuers for the following reasons: publicly available information on issuers and securities may be scarce; many foreign countries do not follow the same accounting, auditing and financial reporting standards as are used in the United States; market trading volumes may be smaller, resulting in less liquidity and more price volatility compared to U.S. securities; there may be less regulation of securities trading and its participants; unfavorable changes in a foreign country's currency may adversely affect the value of foreign securities held by the Fund; the possibility may exist for expropriation, confiscatory taxation, nationalization, establishment of price controls, political or social instability or negative diplomatic developments; and dividend or interest withholding may be imposed at the source. When a Fund invests in foreign securities, they usually will be denominated in foreign currencies and the Fund temporarily may hold funds in foreign securities. Thus, the value of the Fund's shares may be affected by changes in exchange rates. European Currency Conversion Risk. Certain countries in Europe converted their different currencies to a single, common currency on January 1, 1999. In connection with this change, investment advisers, mutual funds and their service providers have modified their accounting and recordkeeping systems to handle the new currency. If a Fund invests in foreign securities, a shareholder's investment in the Fund may be adversely affected if these technical modifications have not been implemented properly. Also, the conversion to a single currency -54- may impair the markets for securities denominated in the currencies eliminated, which may also adversely impact the shareholder's investment. Borrowing Risk. Unlike Mentor Income and Growth, Evergreen/Mentor Balanced may borrow money to invest in additional securities. The use of borrowed money, known as "leverage", increases the Fund's market exposure and risk and may result in losses. Mortgage-Backed and Asset-Backed Securities Risk. Each Fund may invest in mortgage-backed and asset-backed securities. Early repayment of the mortgages or other collateral underlying these securities may expose a Fund to a lower rate of return when it reinvests the principal. The rate of repayments will affect the price and volatility of the mortgage-backed security and may have the effect of shortening or extending the effective maturity beyond what the Fund's investment adviser anticipated at the time of purchase. In addition, asset-backed securities present certain risks. For instance, in the case of credit card receivables, these securities may not have the benefit of any security interest in the related collateral. Credit card receivables are generally unsecured and the debts are entitled to the protection of a number of state and federal consumer credit laws, many of which give such debtors the right to set off certain amounts owed on the credit cards, thereby reducing the balance due. Most issuers of automobile receivables permit the servicer to retain possession of the underlying obligations. If the servicer were to sell these obligations to another party, there is a risk that the purchaser would acquire an interest superior to that of the holders of the related automobile receivables. In addition, because of the large number of vehicles involved in a typical issuance and technical requirements under state laws, the trustee for the holders of the automobile receivables may not have a proper security interest in all of the obligations backing such receivables. Therefore, there is the possibility that recoveries on repossessed collateral may not, in some cases, be available to support payments on these securities. Evergreen/Mentor Balanced, unlike Mentor Income and Growth, may invest in collateralized mortgage obligation ("CMO") residual interests, whose values are extremely sensitive to changes in interest rates and in prepayment rates on the underlying mortgages. In the event of a significant change in interest rates or other market conditions, the value of an investment by the Fund in such interests could be substantially reduced and the Fund may be unable to dispose of its interests at prices -55- approximating the values the Fund had previously assigned to them or to recoup its initial investment in the interests. REASONS FOR THE REORGANIZATION In order to combine and simplify the offering of mutual funds that are advised by FUNB and its affiliates, the Mentor funds are being brought into the Evergreen fund family. Certain Mentor funds will continue as series of applicable Evergreen Delaware business trusts. Other Mentor funds are in the process of being combined with existing Evergreen funds in cases where the funds have similar investment objectives and policies. Mentor Balanced and Mentor Income and Growth, which have similar investment objectives and policies, are to be combined after each is converted to a series of Evergreen Trust. Mentor is an indirect majority-owned subsidiary of First Union Capital Markets Corp., which is in turn a wholly-owned subsidiary of First Union. EVEREN Capital Corporation currently has a 45% ownership interest in Mentor. It is anticipated that First Union will acquire EVEREN Capital Corporation in September 1999. At a meeting of the Board of Trustees of Mentor Funds held on July 13, 1999, all of the Trustees, including the Independent Trustees, considered and approved the Conversion and the Reorganization as being in the best interests of shareholders of Mentor Income and Growth and Mentor Balanced. In approving the Reorganization Plan, the Trustees reviewed various factors about the Funds and the proposed Reorganization. There are similarities between Evergreen/Mentor Balanced and Mentor Income and Growth. Specifically, Evergreen/Mentor Balanced and Mentor Income and Growth have similar investment objectives and policies and comparable risk profiles. See "Comparison of Investment Objectives and Policies" below. At the same time, the Board of Trustees evaluated the potential economies of scale associated with larger mutual funds and concluded that operational efficiencies may be achieved by combining Mentor Income and Growth with Mentor Balanced. Economies of scale tend to reduce a mutual fund's expenses and facilitate coordination of the various services provided by the investment adviser, principal underwriter, administrator, transfer agent, custodial bank and professionals such as lawyers and accountants. As of June 30, 1999, Mentor Balanced's net assets were approximately $354 -56- million and Mentor Income and Growth's net assets were approximately $278 million. In addition, assuming that an alternative to the Reorganization would be that Mentor Income and Growth continue its existence and be separately managed by FUNB or one of its affiliates, Mentor Income and Growth would be offered through common distribution channels with Evergreen/Mentor Balanced. Mentor Income and Growth would also have to bear the cost of maintaining its separate existence. Mentor and FUNB believe that the prospect of dividing the resources of the Evergreen mutual fund organization between two similar funds could result in each Fund being disadvantaged due to an inability to achieve optimum size, performance levels and greater economies of scale. Accordingly, for the reasons noted above and recognizing that there can be no assurance that any economies of scale or other benefits will be realized, Mentor and FUNB believe that the proposed Reorganization would be in the best interests of each Fund and its shareholders. The Board of Trustees of Mentor Funds met and considered the recommendation of Mentor and FUNB, and, in addition, considered among other factors, (i) the terms and conditions of the Reorganization; (ii) expense ratios, fees and expenses of the Funds; (iii) the comparative performance records of each of the Funds; (iv) compatibility of their investment objectives and policies; (v) the investment experience, expertise and resources of FUNB; (vi) the service and distribution resources available to the Evergreen funds and the broad array of investment alternatives available to shareholders of the Evergreen funds; (vii) the personnel and financial resources of First Union and its affiliates; (viii) the fact that the acquiring Fund will assume the identified liabilities of Mentor Income and Growth; and (ix) the expected federal income tax consequences of the Reorganization. During their consideration of the Reorganization the Trustees met with Fund counsel and counsel to the Independent Trustees regarding the legal issues involved. THE TRUSTEES OF MENTOR FUNDS RECOMMEND THAT THE SHAREHOLDERS OF MENTOR INCOME AND GROWTH APPROVE THE PROPOSED REORGANIZATION. -57- The Trustees of Evergreen Trust also concluded at a meeting on June 18, 1999 that the proposed Reorganization would be in the best interests of shareholders of Evergreen/Mentor Balanced. Subsequent to the Conversions of Mentor Balanced and Mentor Income and Growth into series of Evergreen Trust, which are scheduled to occur on or about October 15, 1999, the Trustees of Evergreen Trust will review the proposed Reorganization to determine whether the proposed Reorganization remains in the best interests of the shareholders of Evergreen/Mentor Balanced and Evergreen Capital Income and Growth and that the interests of the shareholders will not be diluted as a result of the transactions contemplated by the Reorganization. Agreement and Plan of Reorganization The following summary is qualified in its entirety by reference to the Reorganization Plan (Exhibit D hereto). The Reorganization Plan provides that Evergreen/Mentor Balanced will acquire all of the assets of Mentor Income and Growth in exchange for shares of Evergreen/Mentor Balanced and the assumption by Evergreen/Mentor Balanced of the identified liabilities of Mentor Income and Growth on or about March 11, 2000 or such other date as may be agreed upon by the parties (the "Closing Date"). Prior to the Closing Date, Mentor Income and Growth will endeavor to discharge all of its known liabilities and obligations. Evergreen/Mentor Balanced will not assume any liabilities or obligations of Mentor Income and Growth other than those reflected in an unaudited statement of assets and liabilities of Mentor Income and Growth prepared as of the close of regular trading on the NYSE, currently 4:00 p.m. Eastern time, on the business day immediately prior to the Closing Date. The number of full and fractional shares of each class of Evergreen/Mentor Balanced to be received by the shareholders of Mentor Income and Growth will be determined by multiplying the respective outstanding class of shares of Mentor Income and Growth by a factor which shall be computed by dividing the net asset value per share of the respective class of shares of Mentor Income and Growth by the net asset value per share of the respective class of shares of Evergreen/Mentor Balanced. Such computations will take place as of the close of regular trading on the NYSE on the business day immediately prior to the Closing Date. The net asset value per share of each class -58- will be determined by dividing assets, less liabilities, in each case attributable to the respective class, by the total number of outstanding shares. State Street Bank and Trust Company, the custodian for Evergreen/Mentor Balanced, will compute the value of each Fund's respective portfolio securities. The method of valuation employed will be consistent with the procedures set forth in the Supplemented Prospectuses and Statement of Additional Information of Mentor Balanced, Rule 22c-1 under the 1940 Act, and with the interpretations of such Rule by the SEC's Division of Investment Management. At or prior to the Closing Date, Mentor Income and Growth will have declared a dividend or dividends and distribution or distributions which, together with all previous dividends and distributions, shall have the effect of distributing to the Fund's shareholders (in shares of the Fund, or in cash, as the shareholder has previously elected) all of the Fund's net investment company taxable income for the taxable period ending on the Closing Date (computed without regard to any deduction for dividends paid) and all of its net capital gains realized in all taxable periods ending on the Closing Date (after reductions for any capital loss carryforward). As soon after the Closing Date as conveniently practicable, Mentor Income and Growth will liquidate and distribute pro rata to shareholders of record as of the close of business on the Closing Date the full and fractional shares of Evergreen/Mentor Balanced received by Mentor Income and Growth. Such liquidation and distribution will be accomplished by the establishment of accounts in the names of the Fund's shareholders on Evergreen/Mentor Balanced's share records. Each account will represent the respective pro rata number of full and fractional shares of Evergreen/Mentor Balanced due to the Fund's shareholders. All issued and outstanding shares of Mentor Income and Growth, including those represented by certificates, will be canceled. The shares of Evergreen/Mentor Balanced to be issued will have no preemptive or conversion rights. After these distributions and the winding up of its affairs, Mentor Income and Growth will be terminated. The consummation of the Reorganization is subject to the conditions set forth in the Reorganization Plan, including approval by Mentor Income and Growth's shareholders and the determination by the Trustees of Evergreen Trust, subsequent to the meeting of Mentor Income and Growth's shareholders, that the Reorganization remains in the best interests of the shareholders of both Funds, and the interests of each Fund's shareholders will -59- not be diluted as a result of the transactions contemplated by the Reorganization, accuracy of various representations and warranties and receipt of opinions of counsel, including opinions with respect to those matters referred to in "Federal Income Tax Consequences" below. Notwithstanding approval of Mentor Income and Growth's shareholders, the Reorganization Plan may be terminated (a) by the mutual agreement of Mentor Income and Growth and Evergreen/Mentor Balanced; or (b) at or prior to the Closing Date by either party (i) because of a breach by the other party of any representation, warranty, or agreement contained therein to be performed at or prior to the Closing Date if not cured within 30 days, or (ii) because a condition to the obligation of the terminating party has not been met and it reasonably appears that it cannot be met. The expenses of the Funds in connection with the Conversion and the Reorganization (including the cost of any proxy soliciting agent) will be borne equally by the Funds whether or not the Conversion and the Reorganization are consummated. It is expected that the cost of retaining Shareholder Communications Corporation to assist in the proxy solicitation process will not exceed $17,200. If the Conversions and/or the Reorganization are not approved by the shareholders of Mentor Income and Growth and/or Mentor Balanced, the Board of Trustees of Mentor Funds or Evergreen Trust, as the case may be, will consider other possible courses of action in the best interests of shareholders. Federal Income Tax Consequences The Reorganization is intended to qualify for federal income tax purposes as a tax-free reorganization under section 368(a) of the Code. As a condition to the closing of the Reorganization, Mentor Income and Growth will receive an opinion of Sullivan & Worcester LLP to the effect that, on the basis of the existing provisions of the Code, U.S. Treasury regulations issued thereunder, current administrative rules, pronouncements and court decisions, for federal income tax purposes, upon consummation of the Reorganization: (1) The transfer of all of the assets of Mentor Income and Growth solely in exchange for shares of Evergreen/Mentor Balanced and the assumption by Evergreen/Mentor Balanced of the identified liabilities, followed by the distribution of Evergreen/Mentor Balanced's shares by Mentor Income and Growth in dissolution and liquidation of Mentor Income and Growth, will constitute a -60- "reorganization" within the meaning of section 368(a)(1)(C) of the Code, and Evergreen/Mentor Balanced and Mentor Income and Growth will each be a "party to a reorganization" within the meaning of section 368(b) of the Code; (2) No gain or loss will be recognized by Mentor Income and Growth on the transfer of all of its assets to Evergreen/Mentor Balanced solely in exchange for Evergreen/Mentor Balanced's shares and the assumption by Evergreen/Mentor Balanced of the identified liabilities of Mentor Income and Growth or upon the distribution of Evergreen/Mentor Balanced's shares to Mentor Income and Growth's shareholders in exchange for their shares of Mentor Income and Growth; (3) The tax basis of the assets transferred will be the same to Evergreen/Mentor Balanced as the tax basis of such assets to Mentor Income and Growth immediately prior to the Reorganization, and the holding period of such assets in the hands of Evergreen/Mentor Balanced will include the period during which the assets were held by Mentor Income and Growth; (4) No gain or loss will be recognized by Evergreen/Mentor Balanced upon the receipt of the assets from Mentor Income and Growth solely in exchange for the shares of Evergreen/Mentor Balanced and the assumption by Evergreen/Mentor Balanced of the identified liabilities of Mentor Income and Growth; (5) No gain or loss will be recognized by Mentor Income and Growth's shareholders upon the issuance of the shares of Evergreen/Mentor Balanced to them, provided they receive solely such shares (including fractional shares) in exchange for their shares of Mentor Income and Growth; and (6) The aggregate tax basis of the shares of Evergreen/Mentor Balanced, including any fractional shares, received by each of the shareholders of Mentor Income and Growth pursuant to the Reorganization will be the same as the aggregate tax basis of the shares of Mentor Income and Growth held by such shareholder immediately prior to the Reorganization, and the holding period of the shares of Evergreen/Mentor Balanced, including fractional shares, received by each such shareholder will include the period during which the shares of Mentor Income and Growth exchanged therefor were held by such shareholder (provided that the shares of Mentor Income -61- and Growth were held as a capital asset on the date of the Reorganization). Opinions of counsel are not binding upon the Internal Revenue Service or the courts. If the Reorganization is consummated but does not qualify as a tax-free reorganization under the Code, a shareholder of Mentor Income and Growth would recognize a taxable gain or loss equal to the difference between his or her tax basis in his or her Fund shares and the fair market value of Evergreen/Mentor Balanced shares he or she received. Shareholders of Mentor Income and Growth should consult their tax advisers regarding the effect, if any, of the proposed Reorganization in light of their individual circumstances. Since the foregoing discussion relates only to the federal income tax consequences of the Reorganization, shareholders of Mentor Income and Growth should also consult their tax advisers as to the state and local tax consequences, if any, of the Reorganization. Pro-forma Capitalization The following table sets forth the capitalizations of Mentor Balanced and Mentor Income and Growth as of March 31, 1999, and the capitalization of Evergreen/Mentor Balanced on a pro forma basis as of that date, giving effect to the proposed acquisition of assets at net asset value. The pro forma data reflects an exchange ratio of approximately 1.28, 1.28 and 1.30 Class A, Class C and Class Y shares respectively, of Evergreen/Mentor Balanced issued for each Class A, Class B and Class Y share, respectively, of Mentor Income and Growth. Capitalization of Mentor Income and Growth, Mentor Balanced and Evergreen/Mentor Balanced (Pro Forma)
Mentor Income Mentor Evergreen/Mentor and Growth Balanced Balanced (After ------------- ------------- Reorganization) ---------- Net Assets Class A........................ $118,695,506 $114,360,319 $233,055,825 Class B........................ $152,648,937 $226,733,302 0 Class C........................ N/A N/A $379,382,239 Class Y........................ $ 1,142 $ 199,945 $ 201,087 ------------ ------------ ------------ -62- Total Net $271,345,585 $341,293,566 $612,639,151 Assets . . . Net Asset Value Per Share Class A........................ $19.42 $15.17 $15.17 Class B........................ $19.40 $15.16 $ 0 Class C........................ N/A N/A $15.16 Class Y........................ $19.69 $15.16 $15.16 Shares Outstanding Class A........................ 6,112,024 7,538,584 15,362,940 Class B........................ 7,869,390 14,958,738 0 Class C........................ N/A N/A 25,029,063 Class Y........................ 58 13,189 13,264 ----------- ---------- ---------- All Classes.................... 13,981,472 22,510,511 40,405,267
The table set forth above should not be relied upon to reflect the number of shares to be received in the Reorganization; the actual number of shares to be received will depend upon the net asset value and number of shares outstanding of each Fund at the time of the Reorganization. Shareholder Information As of August 17, 1999 (the "Record Date"), the following number of each Class of shares of beneficial interest of Mentor Income and Growth was outstanding: Class of Shares - --------------- Class A................................................. 5,773,279 Class B................................................. 7,317,869 Class Y................................................. 57 All Classes............................................. ------------ 13,091,205 As of June 30, 1999, the officers and Trustees of Mentor Funds beneficially owned as a group less than 1% of the outstanding shares of Mentor Income and Growth. To Mentor Funds' knowledge, the following persons owned beneficially or of record more than 5% of Mentor Income and Growth's total outstanding shares as of June 30, 1999: -63-
Percentage of Percentage of Shares of Shares of Class After Class Before Reorgani- Reorgani- zation Name and Address Class No. of Shares zation --------- - ---------------- ----- ------------- --------- Daniel J. Ludeman Y 57 100% 0.57% 5105 Stratford Cres Richmond, VA 23226
COMPARISON OF INVESTMENT OBJECTIVES AND POLICIES The following discussion is based upon and qualified in its entirety by the descriptions of the respective investment objectives, policies and restrictions set forth in Mentor Balanced's Supplemented Prospectuses, Mentor Income and Growth's Prospectus and the Funds' Statement of Additional Information. The investment objectives, policies and restrictions of each Fund can be found in the Prospectuses under the caption "Investment Objectives and Policies." The Supplemented Prospectuses for Mentor Balanced also offer additional funds including Mentor Income and Growth advised by Mentor or its affiliates. Other than Mentor Income and Growth, these additional funds are not involved in the Reorganization, their investment objectives and policies are not discussed in this Prospectus/Proxy Statement, and their shares are not offered hereby. If approved by shareholders, the investment objectives of Mentor Balanced and Mentor Income and Growth will be nonfundamental and can be changed by the Board of Trustees without shareholder approval. The investment objective of Evergreen/Mentor Balanced is nonfundamental. The investment objective of Evergreen/Mentor Balanced is to seek capital growth and current income. The Fund invests in a diversified portfolio of equity and fixed income securities which Mentor believes will produce both capital growth and current income. The Fund may invest in almost any type of security, except that its investments in debt securities must be investment grade. The Fund's securities will include some securities selected primarily to provide for growth in value, -64- others selected for current income, and others for stability of principal. Mentor will adjust the proportions of the Fund's assets invested in the different types of securities in response to changing market conditions. For example, under certain market conditions, Mentor may judge that most of the Fund's assets should be invested in equity securities, and that only a relatively small portion of the Fund's assets should be invested in fixed-income securities. At other times, Mentor may invest most of the Fund's assets in fixed income securities, with a corresponding reduction in the portion of the Fund's assets invested in equity securities. Under normal circumstances, the Fund will invest at least 25% of its assets in fixed income securities and 25% of its assets in equity securities. The Fund may invest without limit in foreign securities. The Fund will invest in debt securities and preferred stocks of investment grade, and the Fund will seek under normal market conditions to maintain a portfolio of such securities with a dollar-weighted average rating of A or better. A security will be considered to be of "investment grade" if, at the time of investment by the Fund, it is rated at least Baa3 by Moody's Investors Service, Inc. ("Moody's") or BBB- by Standard & Poor's Ratings Services ("S&P") or the equivalent by another nationally recognized rating organization or, if unrated, determined by Mentor to be of comparable quality. Securities rated Baa or BBB lack outstanding investment characteristics and have speculative characteristics and are subject to greater credit and market risks than higher-rated securities. At times Mentor may decide that conditions in the securities markets make pursuing the Fund's basic investment strategy inconsistent with the best interests of its shareholders. At such times, Mentor may temporarily use alternative investment strategies primarily designed to reduce fluctuations in the value of the Fund's assets. In implementing these "defensive" strategies, the Fund would be permitted to hold all or any portion of its assets in high quality fixed income securities, cash or money market instruments. Like Mentor Income and Growth, Evergreen/Mentor Balanced may invest in -65- mortgage-backed certificates and other securities representing ownership interests in mortgage pools, including CMOs. However, unlike Mentor Income and Growth, Evergreen/Mentor Balanced may invest in stripped mortgage-backed securities and CMO residual interests. Stripped mortgage-backed securities are usually structured with two classes that receive different portions of the interest and principal distributions on a pool of mortgage assets. The Fund may invest in both the interest-only -- or "IO" -- class and the principal-only -- or "PO" -- class. The yield to maturity and price of an IO class are extremely sensitive to the rate of principal payments (including prepayments) on the related underlying mortgage assets, and a rapid rate of principal payments may have a material adverse effect on the Fund's net asset value. This would typically be the case in an environment of falling interest rates. If the underlying mortgage assets experience greater than anticipated prepayments of principal, the Fund may under some circumstances fail to fully recoup its initial investment in these securities. Conversely, POs tend to increase in value if prepayments are greater than anticipated and decline if prepayments are slower than anticipated. The secondary market for stripped mortgage-backed securities may be more volatile and less liquid than that for other mortgage-backed securities, potentially limiting the Fund's ability to buy or sell those securities at any particular time. CMO residual interests are mortgage-related securities which represent a participation interest in, or are secured by and payable from, mortgage loans or real property. These interests represent the right to any excess cash flow remaining after all -66- other payments are made among the various tranches of interests issued by structured mortgage-backed vehicles. Each Fund may also invest in securities representing interests in other types of financial assets, such as automobile- finance receivables or credit-card receivables. Such securities may or may not be secured by the receivables themselves or may be unsecured obligations of the issuers. The investment objective of Mentor Income and Growth is to provide a conservative combination of income and growth of capital consistent with capital protection. The Fund invests in a diversified portfolio of equity securities of companies Mentor believes exhibit sound fundamental characteristics and in investment-grade fixed-income securities and U.S. government securities. Mentor will manage the allocation of assets among asset classes based upon its analysis of economic conditions, relative fundamental values and the attractiveness of each asset class, and expected future returns of each asset class. The Fund will normally have some portion of its assets invested in each asset class at all times but may invest without limit in any asset class. The Fund may invest in a wide variety of equity securities, such as common stocks and preferred stocks, as well as debt securities convertible into equity securities or that are accompanied by warrants or other equity securities. In selecting equity investments, Mentor will attempt to identify securities it believes are conservatively valued. Within the equity asset class, the Fund seeks to achieve long-term appreciation of capital and a moderate income level by selecting investments in out-of-favor companies with sound fundamentals. These decisions are based primarily on Mentor's fundamental research and security valuations. Within the fixed income asset class, Mentor seeks to invest in a portfolio that provides as high a level of current income as is consistent with prudent investment risk. The Fund may invest in debt securities of any maturity, preferred stocks, and other fixed-income instruments, including, for example, U.S. government securities, corporate debt securities (including zero- coupon securities) and debt securities issued by foreign governments and by companies located outside the United States (up to 15% of its assets). The Fund will only invest in debt securities which are rated at the time of purchase Baa or better -67- by Moody's or BBB or better by S&P or which, if unrated, are deemed by Mentor to be of comparable quality. The Fund may invest up to 10% of its assets in securities secured by real estate or interests therein or issued by companies which invest in real estate or interests in real estate. The Fund will limit its investment in real estate investment trusts to 10% of its total assets. Such investments may involve many of the risks of direct investment in real estate, such as declines in the value of real estate, risks related to general and local economic conditions, and adverse changes in interest rates. Other risks associated with real estate investment trusts include lack of diversification, borrower default, and voluntary liquidation. Unlike Mentor Income and Growth, Evergreen/Mentor Balanced has no specific limitation on investing in securities secured by real estate, including CMOs described above. After the Reorganization, Evergreen/Mentor Balanced may dispose of a portion of the securities received from Mentor Income and Growth in the ordinary course of business. This may result in additional transaction costs (and/or capital gains) to shareholders of Evergreen/Mentor Balanced. The characteristics of each investment policy and the associated risks are described in the Supplemented Prospectuses of Mentor Balanced, the Prospectus of Mentor Income and Growth and the Funds' Statement of Additional Information. The Funds have other investment policies and restrictions which are also set forth in such Prospectuses and Statement of Additional Information of each Fund. ADDITIONAL INFORMATION Mentor Balanced. Information concerning the operation and management of Mentor Balanced is incorporated herein by reference from the Supplemented Prospectuses dated December 15, 1998, copies of which are enclosed, and the Statement of Additional Information of the same date. A copy of such Statement of Additional Information is available upon request and without charge by writing to Mentor Funds at the address listed on the cover page of this Prospectus/Proxy Statement or by calling toll-free 1-800-645-7816. Mentor Income and Growth. Information about the Fund is included in its current Prospectuses dated December 15, 1998 as -68- supplemented and in the Statement of Additional Information of the same date, that have been filed with the SEC, all of which are incorporated herein by reference. Copies of the Prospectuses and Statement of Additional Information are available upon request and without charge by writing to Mentor Funds at the address listed on the cover page of this Prospectus/Proxy Statement or by calling toll-free 1-800-645-7816. The Prospectus of Mentor Balanced and the Prospectus of Mentor Income and Growth are combined in one document. In addition, the Statement of Additional Information of each Fund is combined in one document. Mentor Balanced and Mentor Income and Growth are each subject to the informational requirements of the 1934 Act and the 1940 Act, and in accordance therewith file reports and other information including proxy material, and charter documents with the SEC. These items can be inspected and copies obtained 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 located at Northwest Atrium Center, 500 West Madison Street, Chicago, Illinois 60661-2511 and Seven World Trade Center, Suite 1300, New York, New York 10048. The SEC maintains a Web site (http://www.sec.gov) that contains the Funds' Statement of Additional Information and other material incorporated by reference herein together with other information regarding Mentor Balanced and Mentor Income and Growth. FINANCIAL STATEMENTS AND EXPERTS The Annual Report of Mentor Balanced and Mentor Income and Growth as of September 30, 1998, and the financial statements and financial highlights for the periods indicated therein, have been incorporated by reference herein and in the Registration Statement in reliance upon the reports of KPMG LLP, independent certified public accountants, incorporated by reference herein, and upon the authority of said firm as experts in accounting and auditing. LEGAL MATTERS Certain legal matters concerning the issuance of shares of Evergreen/Mentor Balanced will be passed upon by Sullivan & Worcester LLP, Washington, D.C. PART IV -69- VOTING INFORMATION CONCERNING THE MEETING This Prospectus/Proxy Statement is furnished in connection with a solicitation of proxies by the Trustees of Mentor Funds, to be used at the Special Meeting of Shareholders to be held at 2:00 p.m., October 15, 1999, at the offices of the Mentor Funds, 901 East Byrd Street, Richmond, Virginia 23219, and at any adjournments thereof. This Prospectus/Proxy Statement, along with a Notice of the Meeting and a proxy card, is first being mailed to shareholders of Mentor Income and Growth on or about August 27, 1999. Only shareholders of record as of the close of business on the Record Date will be entitled to notice of, and to vote at, the Meeting or any adjournment thereof. The holders of more than fifty percent (50%) of the total number of outstanding shares entitled to vote at the Meeting present in person or represented by proxy will constitute a quorum for the Meeting. If the enclosed form of proxy is properly executed and returned in time to be voted at the Meeting, the proxies named therein will vote the shares represented by the proxy in accordance with the instructions marked thereon. Unmarked proxies will be voted FOR the proposed Conversion, FOR the reclassification of the Fund's investment objective from fundamental to nonfundamental, FOR the adoption of standardized fundamental investment restrictions, FOR the proposed Reorganization and FOR any other matters deemed appropriate. Proxies that reflect abstentions and "broker non- votes" (i.e., shares held by brokers or nominees as to which (i) instructions have not been received from the beneficial owners or the persons entitled to vote and (ii) the broker or nominee does not have discretionary voting power on a particular matter) will be counted as shares that are present and entitled to vote for purposes of determining the presence of a quorum, but will not have the effect of being counted as votes against either the Conversion Plan or the Reorganization Plan, which must be approved by a majority of the votes cast and entitled to vote. However, such abstentions and "broker non-votes" will have the effect of being counted as votes against the reclassification of the Fund's investment objective from fundamental to nonfundamental and the adoption of standardized fundamental investment restrictions, which must be approved by a certain percentage of the Fund's outstanding voting securities as described below. A proxy may be revoked at any time on or before the Meeting by written notice to the Secretary of Mentor Funds at the address set forth on the cover of this Prospectus/Proxy Statement. -70- Approval of the Conversion Plan and the Reorganization Plan will require the affirmative vote of a majority of the votes cast and entitled to vote, with all classes voting together as a single class at the Meeting at which a quorum of the Fund's shares is present. Each full share outstanding is entitled to one vote and each fractional share outstanding is entitled to a proportionate share of one vote. Pursuant to the 1940 Act, the affirmative vote of the holders of a majority of the outstanding voting securities of the Fund is required to approve the reclassification of the Fund's investment objective from fundamental to nonfundamental (proposal 2) and the adoption of standardized fundamental investment restrictions (proposals 3A to 3I). Under the 1940 Act, the affirmative vote of a "majority of the outstanding voting securities" of the Fund is defined as the lesser of (a) 67% or more of the voting securities of the Fund present or represented by proxy at the Meeting, if the holders of more than 50% of the outstanding voting securities of the Fund are present or represented by proxy, or (b) more than 50% of the outstanding voting securities of the Fund. Proxy solicitations will be made primarily by mail, but proxy solicitations may also be made by telephone, e-mail or personal solicitations conducted by officers and employees of Mentor or FUNB, their affiliates or other representatives of Mentor Income and Growth (who will not be paid for their solicitation activities). Shareholder Communications Corporation and its agents have been engaged by Mentor Income and Growth to assist in soliciting proxies. If you wish to participate in the Meeting, you may submit the proxy card included with this Prospectus/Proxy Statement, vote by fax, vote by telephone , vote by Internet or attend in person. Any proxy given by you is revocable. In the event that sufficient votes to approve the Conversion and the Reorganization are not received by October 15, 1999, the persons named as proxies may propose one or more adjournments of the Meeting to permit further solicitation of proxies. In determining whether to adjourn the Meeting , the following factors may be -71- considered: the percentage of votes actually cast, the percentage of negative votes actually cast, the nature of any further solicitation and the information to be provided to shareholders with respect to the reasons for the solicitation. Any such adjournment will require an affirmative vote of a plurality of the votes cast on the question in person or by proxy at the session of the Meeting to be adjourned. The persons named as proxies will vote upon such adjournment after consideration of all circumstances which may bear upon a decision to adjourn the Meeting. A shareholder who objects to the proposed Conversion or Reorganization will not be entitled under either Delaware or Massachusetts law or the Declaration of Trust of Evergreen Trust or Mentor Funds to demand payment for, or an appraisal of, his or her shares. However, shareholders should be aware that the Conversion and the Reorganization as proposed are not expected to result in recognition of gain or loss to shareholders for federal income tax purposes and that, if the Conversion and the Reorganization are consummated, shareholders will be free to redeem the shares of Evergreen/Mentor Balanced which they receive in the transaction at their then-current net asset value. In addition, shares of Mentor Income and Growth may be redeemed at any time prior to the consummation of the Conversion or the Reorganization. Shareholders of Mentor Income and Growth may wish to consult their tax advisers as to any differing consequences of redeeming Fund shares prior to the Conversion or the Reorganization or exchanging such shares in the Conversion or the Reorganization. Mentor Income and Growth does not hold annual shareholder meetings. If the Conversion or the Reorganization is not approved, shareholders wishing to submit proposals for consideration for inclusion in a proxy statement for a subsequent shareholder meeting should send their written proposals to the Secretary of Mentor Funds (or, if the Conversion is approved but not the Reorganization, to the Secretary of Evergreen Trust) at the address set forth on the cover of this Prospectus/Proxy Statement such that they will be received by the Fund in a reasonable period of time prior to any such meeting. The votes of the shareholders of Mentor Balanced and Evergreen/Mentor Balanced are not being solicited by this Prospectus/Proxy Statement and are not required to carry out the Reorganization. NOTICE TO BANKS, BROKER-DEALERS AND VOTING TRUSTEES AND THEIR NOMINEES. Please advise Mentor Income and Growth whether -72- other persons are beneficial owners of shares for which proxies are being solicited and, if so, the number of copies of this Prospectus/Proxy Statement needed to supply copies to the beneficial owners of the respective shares. OTHER BUSINESS The Trustees of Mentor Funds do not intend to present any other business at the Meeting. If, however, any other matters are properly brought before the Meeting, the persons named in the accompanying form of proxy will vote thereon in accordance with their judgment. THE TRUSTEES OF MENTOR FUNDS RECOMMEND APPROVAL OF THE CONVERSION PLAN, THE RECLASSIFICATION OF THE FUND'S INVESTMENT OBJECTIVE FROM FUNDAMENTAL TO NONFUNDAMENTAL, THE ADOPTION OF STANDARDIZED FUNDAMENTAL INVESTMENT RESTRICTIONS, AND THE APPROVAL OF THE REORGANIZATION PLAN AND ANY UNMARKED PROXIES WITHOUT INSTRUCTIONS TO THE CONTRARY WILL BE VOTED IN FAVOR OF THESE PROPOSALS. August 27, 1999 -73- EXHIBIT A AGREEMENT AND PLAN OF CONVERSION AND TERMINATION AGREEMENT AND PLAN OF CONVERSION AND TERMINATION dated August 10, 1999 (the "Agreement"), between Mentor Funds, a Massachusetts business trust having its principal office at 901 East Byrd Street, Richmond, Virginia 23219 (the "Original Trust") on behalf of its Mentor Income and Growth Portfolio (the "Original Fund"), one of the Original Trust's series portfolios, and Evergreen Equity Trust, a Delaware business trust having its principal office at 200 Berkeley Street, Boston, Massachusetts 02116 (the "Successor Trust") on behalf of its Evergreen Capital Income and Growth Fund (the "Successor Fund"), one of the Successor Trust's series portfolios. WHEREAS, the Board of Trustees of the Original Trust and the Board of Trustees of the Successor Trust have respectively determined that it is in the best interests of the Original Fund and the Successor Fund, respectively, that the assets of the Original Fund be acquired by the Successor Fund pursuant to this Agreement and in accordance with, respectively, the applicable laws of the Commonwealth of Massachusetts and the State of Delaware; and WHEREAS, the parties desire to enter into a plan of exchange which would constitute a reorganization within the meaning of Section 368 of the Internal Revenue Code of 1986, as amended (the "Code"): NOW THEREFORE, in consideration of the premises and of the covenants and agreements hereinafter set forth, the parties hereto agree as follows: 1. PLAN OF EXCHANGE. (a) Subject to the terms and conditions set forth herein, on the Exchange Date (as defined herein), the Original Fund shall assign, transfer and convey the assets, including all securities and cash held by the Original Fund (subject to the liabilities of the Original Fund) to the Successor Fund and the Successor Fund shall acquire all of the assets of the Original Fund (subject to the liabilities of the Original Fund) in exchange for full and fractional shares of beneficial interest of the Successor Fund, $.001 par value per share (the "Successor Fund Shares"), to be issued by the Successor Trust on behalf of the Successor Fund, having, in the case of the Successor Fund, an A-74 aggregate net asset value equal to the value of the net assets of the Original Fund acquired. The value of the assets of the Original Fund and the net asset value per share of the Successor Fund Shares shall be determined as of the Valuation Date (as defined herein) in accordance with the procedures for determining the value of the Original Fund's assets set forth in the Successor Fund's Declaration of Trust and the then-current prospectus and statement of additional information for the Successor Fund that forms a part of the Successor Fund's Registration Statement on Form N-1A (the "Registration Statement"). In lieu of delivering certificates for the Successor Fund Shares, the Successor Trust shall credit the Successor Fund Shares to the Original Fund's account on the share record books of the Successor Trust and shall deliver a confirmation thereof to the Original Fund. The Original Fund shall then deliver written instructions to the Successor Trust's transfer agent to establish accounts for the shareholders on the share record books relating to the Original Fund. Holders of Class A shares, Class B shares and Class Y shares of the Original Fund shall receive in the transaction described above, Class A shares, Class C shares and Class Y shares, respectively, of the Successor Fund. Successor Fund Shares of each such class shall have the same aggregate net asset value as the aggregate net asset value of the corresponding class of the Original Fund. (b) Delivery of the assets of the Original Fund shall be made not later than the next business day following the Valuation Date (the "Exchange Date"). Assets transferred shall be delivered to State Street Bank and Trust Company, the Successor Trust's custodian (the "Custodian"), for the account of the Successor Trust and the Successor Fund, with all securities not in bearer or book entry form duly endorsed, or accompanied by duly executed separate assignments or stock powers, in proper form for transfer, with signatures guaranteed, and with all necessary stock transfer stamps, sufficient to transfer good and marketable title thereto (including all accrued interest and dividends and rights pertaining thereto) to the Custodian for the account of the Successor Trust and the Successor Fund free and clear of all liens, encumbrances, rights, restrictions and claims. All cash delivered shall be in the form of immediately available funds payable to the order of the Custodian for the account of the Successor Trust and the Successor Fund. All assets delivered to the Custodian as provided herein shall be allocated by the Successor Trust to the Successor Fund. (c) The Original Fund will pay or cause to be paid to the Successor Trust any interest received on or after the Exchange Date with respect to assets transferred from the Original Fund to the Successor Fund hereunder and to the Successor Trust any distributions, rights or other assets received by the Original Fund after the Exchange Date as distributions on or with respect to the securities transferred from the Original Fund to the Successor Fund hereunder and the Successor Trust shall allocate any such distributions, rights or other assets to the Successor Fund. All such assets shall be deemed included in assets transferred to the Successor Fund on the Exchange Date and shall not be separately valued. (d) The Valuation Date shall be October 15, 1999, or such earlier or later date as may be mutually agreed upon by the parties. (e) As soon as practicable after the Exchange Date, the Original Fund shall distribute all of the Successor Fund Shares received by it among the shareholders of the Original Fund in proportion to the number of shares each such shareholder holds in the Original Fund and, upon the effecting of such a distribution on behalf of the Fund, the Original Fund will dissolve and terminate. After the Exchange Date, the Original Fund shall not conduct any business except in connection with its dissolution and termination. 2. THE ORIGINAL TRUST'S REPRESENTATIONS AND WARRANTIES. The Original Trust represents and warrants to and agrees with the Successor Trust as follows: (a) The Original Trust is a business trust duly organized, validly existing and in good standing under the laws of the Commonwealth of Massachusetts and has power to own all of its properties and assets and, subject to the approval of its shareholders as contemplated hereby, to carry out this Agreement on behalf of the Original Fund. (b) The Original Trust is registered under the Investment Company Act of 1940, as amended (the "1940 Act"), as an open-end management investment company, and such registration has not been revoked or rescinded and is in full force and effect. (c) On the Exchange Date, the Original Trust will have full right, power and authority to sell, assign, transfer and deliver the assets to be transferred by it hereunder. (d) The current prospectuses and statement of additional information of the Original Fund conform in all material respects to the applicable requirements of the Securities Act of 1933, as amended (the "1933 Act"), and the 1940 Act and the rules and regulations of the Securities and Exchange Commission (the "Commission") thereunder and do not include any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading. (e) The Original Fund is not, and the execution, delivery, and performance of this Agreement (subject to shareholder approval) will not result, in violation of any provision of the Original Trust's Declaration of Trust or By-Laws or of any material agreement, indenture, instrument, contract, lease, or other undertaking to which the Original Trust or the Original Fund is a party or by which it is bound. (f) Except as otherwise disclosed in writing to and accepted by the Successor Fund, no litigation, administrative proceeding, or investigation of or before any court or governmental body is presently pending or to its knowledge threatened against the Original Trust or the Original Fund or any of their properties or assets, which, if adversely determined, would materially and adversely affect their financial condition, the conduct of their business, or the ability of the Original Trust or the Original Fund to carry out the transactions contemplated by this Agreement. The Original Trust and the Original Fund know of no facts that might form the basis for the institution of such proceedings and are not parties to or subject to the provisions of any order, decree, or judgment of any court or governmental body that materially and adversely affects their business or their ability to consummate the transactions herein contemplated. (g) The unaudited semi-annual financial statements of the Original Fund at March 31, 1999 are in accordance with generally accepted accounting principles consistently applied, and such statements (copies of which have been furnished to the Successor Fund) fairly reflect the financial condition of the Original Fund as of such date, and there are no known contingent liabilities of the Original Fund as of such date not disclosed therein. (h) Since March 31, 1999 there has not been any material adverse change in the Original Fund's financial condition, assets, liabilities, or business other than changes occurring in the ordinary course of business, or any incurrence by the Original Fund of indebtedness maturing more than one year from the date such indebtedness was incurred, except as otherwise disclosed to and accepted by the Successor Trust. For the purposes of this subparagraph (h), a decline in the net asset value of the Original Fund shall not constitute a material adverse change. (i) At the Exchange Date, all federal and other tax returns and reports of the Original Fund required by law to have been filed by such dates shall have been filed, and all federal and other taxes shown due on said returns and reports shall have been paid, or provision shall have been made for the payment thereof. To the best of the Original Trust's knowledge, no such return is currently under audit, and no assessment has been asserted with respect to such returns. (j) For each fiscal year of its operation, the Original Fund has met the requirements of Subchapter M of the Code for qualification and treatment as a regulated investment company and has distributed in each such year all net investment income and realized capital gains required to so qualify. (k) All issued and outstanding shares of the Original Fund are, and at the Exchange Date will be, duly and validly issued and outstanding, fully paid and non-assessable by the Original Fund. All of the issued and outstanding shares of the Original Fund will, at the time of the Exchange Date, be held by the persons and in the amounts set forth in the records of the transfer agent. The Original Fund does not have outstanding any options, warrants, or other rights to subscribe for or purchase any of the Original Fund shares, nor is there outstanding any security convertible into any of the Original Fund shares. (l) At the Exchange Date, the Original Trust will have good and marketable title to the Original Fund's assets to be transferred to the Successor Fund pursuant to Section 1 and full right, power, and authority to sell, assign, transfer, and deliver such assets hereunder, and, upon delivery and payment for such assets, the Successor Trust will acquire good and marketable title thereto, subject to no restrictions on the full transfer thereof, including such restrictions as might arise under the 1933 Act, other than as disclosed to the Successor Trust and accepted by the Successor Trust. (m) The execution, delivery, and performance of this Agreement have been duly authorized by all necessary action on the part of the Original Fund and, subject to the approval of the shareholders of the Original Fund, this Agreement constitutes a valid and binding obligation of the Original Trust on behalf of the Original Fund, enforceable in accordance with its terms, subject as to enforcement, to bankruptcy, insolvency, reorganization, moratorium, and other laws relating to or affecting creditors' rights and to general equity principles. (n) The information furnished by the Original Fund for use in no-action letters, applications for orders, registration statements, proxy materials, and other documents that may be necessary in connection with the transactions contemplated hereby is accurate and complete in all material respects and complies in all material respects with federal securities and other laws and regulations thereunder applicable thereto. 3. THE SUCCESSOR TRUST'S REPRESENTATIONS AND WARRANTIES. The Successor Trust represents and warrants to and agrees with the Original Trust as follows: (a) The Successor Trust is a business trust duly organized, validly existing and in good standing under the laws of the State of Delaware and has power to carry on its business as it is now being conducted and to carry out this Agreement on behalf of the Successor Fund. (b) The Successor Trust is registered as an open-end management investment company and adopts the Registration Statement of the Original Trust and the Original Fund, for purposes of the 1933 Act. (c) At the Exchange Date, the Successor Fund Shares to be issued to the Original Fund will have been duly authorized and, when issued and delivered pursuant to this Agreement, will be legally and validly issued and will be fully paid and non-assessable by the Successor Trust. No Successor Trust or Successor Fund shareholder will have any preemptive right of subscription or purchase in respect thereof. (d) The current prospectuses and statement of additional information of the Successor Fund conform in all material respects to the applicable requirements of the 1933 Act and the 1940 Act and the rules and regulations of the Commission thereunder and do not include any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading. (e) The Successor Fund is not, and the execution, delivery and performance of this Agreement will not result, in violation of the Successor Trust's Declaration of Trust or By-Laws or of any material agreement, indenture, instrument, contract, lease, or other undertaking to which the Successor Trust is a party or by which it is bound. (f) Except as otherwise disclosed in writing to the Original Trust and accepted by the Original Trust, no litigation, administrative proceeding or investigation of or before any court or governmental body is presently pending or to its knowledge threatened against the Successor Trust or any of its properties or assets, which, if adversely determined, would materially and adversely affect its financial condition and the conduct of its business or the ability of the Successor Trust to carry out the transactions contemplated by this Agreement. The Successor Trust knows of no facts that might form the basis for the institution of such proceedings and is not a party to or subject to the provisions of any order, decree, or judgment of any court or governmental body that materially and adversely affects its business or its ability to consummate the transactions contemplated herein. (g) Successor Fund has no known liabilities of a material amount, contingent or otherwise. (h) At the Exchange Date there has not been any material adverse change in the Successor Fund's financial condition, assets, liabilities, or business other than changes occurring in the ordinary course of business, or any incurrence by the Successor Fund of indebtedness maturing more than one year from the date such indebtedness was incurred, except as otherwise disclosed to and accepted by the Original Trust. For the purposes of this subparagraph (h), a decline in the net asset value of the Successor Fund shall not constitute a material adverse change. (i) At the Exchange Date, all federal and other tax returns and reports of the Successor Fund required by law then to be filed by such date shall have been filed, and all federal and other taxes shown due on said returns and reports shall have been paid or provision shall have been made for the payment thereof. To the best of the Successor Trust's knowledge, no such return is currently under audit, and no assessment has been asserted with respect to such returns. (j) For each fiscal year of its operation, the Successor Fund has met the requirements of Subchapter M of the Code for qualification and treatment as a regulated investment company and has distributed in each such year all net investment income and realized capital gains required to so qualify. (k) All issued and outstanding Successor Fund Shares are, and at the Exchange Date will be, duly and validly issued and outstanding, fully paid and non-assessable. The Successor Fund does not have outstanding any options, warrants, or other rights to subscribe for or purchase any Successor Fund Shares, nor is there outstanding any security convertible into any Successor Fund Shares. (l) The execution, delivery, and performance of this Agreement have been duly authorized by all necessary action on the part of the Successor Trust, and this Agreement constitutes a valid and binding obligation of the Successor Trust enforceable in accordance with its terms, subject as to enforcement, to bankruptcy, insolvency, reorganization, moratorium, and other laws relating to or affecting creditors' rights and to general equity principles. (m) The Successor Fund Shares to be issued and delivered to the Original Trust, for the account of the Original Fund shareholders, pursuant to the terms of this Agreement will, at the Exchange Date, have been duly authorized and, when so issued and delivered, will be duly and validly issued Successor Fund Shares, and will be fully paid and non-assessable. (n) The information furnished by the Successor Trust for use in no-action letters, applications for orders, registration statements, proxy materials, and other documents that may be necessary in connection with the transactions contemplated hereby is accurate and complete in all material respects and complies in all material respects with federal securities and other laws and regulations applicable thereto. 4. THE SUCCESSOR TRUST'S CONDITIONS PRECEDENT. The obligations of the Successor Trust hereunder shall be subject to the following conditions: (a) The Original Trust shall have furnished to the Successor Trust a statement of the Original Fund's assets, including a list of securities owned by the Original Fund with their respective tax costs and values determined as provided in Section 1 hereof, all as of the Exchange Date. (b) As of the Exchange Date, all representations and warranties of the Original Trust on behalf of the Original Fund made in this Agreement shall be true and correct as if made at and as of such date, and the Original Trust on behalf of the Original Fund shall have complied with all the agreements and satisfied all the conditions on its part to be performed or satisfied at or prior to such date. (c) For the Original Trust, a vote approving this Agreement and the transactions and exchange contemplated hereby shall have been duly adopted by the shareholders of the Original Fund. (d) The Successor Trust shall have received on the Exchange Date an opinion of Ropes & Gray, counsel to the Original Trust, dated as of the Exchange Date, in a form satisfactory to the Successor Trust covering the following points: (i) The Original Fund is a separate investment series of a Massachusetts business trust duly organized and validly existing under the laws of the Commonwealth of Massachusetts and has the power to own all of its properties and assets and to carry on its business as presently conducted. (ii) The Original Fund is a separate investment series of a Massachusetts business trust registered as an investment company under the 1940 Act, and, to such counsel's knowledge, such registration with the Commission as an investment company under the 1940 Act is in full force and effect. (iii) This Agreement has been duly authorized, executed and delivered by the Original Trust and, assuming due authorization, execution, and delivery of this Agreement by the Successor Trust, is a valid and binding obligation of the Original Fund enforceable against the Original Trust in accordance with its terms, subject as to enforcement, to bankruptcy, insolvency, reorganization, moratorium and other laws relating to or affecting creditors' rights generally and to general equity principles. (iv) The execution and delivery of this Agreement did not, and the consummation of the transactions contemplated hereby will not, result in a violation of the Original Trust's Declaration of Trust or By-laws, or any provision of any material agreement, indenture, instrument, contract, lease or other undertaking (in each case known to such counsel) to which the Original Trust is a party or by which it or any of its properties may be bound or, to the knowledge of such counsel, result in the acceleration of any obligation or the imposition of any penalty, under any agreement, judgment, or decree to which the Original Trust is a party or by which it is bound. (v) To the knowledge of such counsel, no litigation or administrative proceeding or investigation of or before any court or governmental body is presently pending or threatened as to the Original Trust or the Original Fund or any of their respective properties or assets and the Original Trust and the Original Fund are neither parties to nor subject to the provisions of any order, decree or judgment of any court or governmental body, which materially and adversely affects their business other than as previously disclosed in the proxy materials. Such opinion shall contain such other assumptions and limitations as shall be in the opinion of Ropes & Gray appropriate to render the opinions expressed therein. 5. THE ORIGINAL TRUST'S CONDITIONS PRECEDENT. The obligations of the Original Trust hereunder shall be subject to the following conditions: (a) that as of the Exchange Date all representations and warranties of the Successor Trust made in the Agreement shall be true and correct as if made at and as of such date, and that the Successor Trust shall have complied with all of the agreements and satisfied all the conditions on its part to be performed or satisfied at or prior to such date. (b) The Original Trust shall have received on the Exchange Date an opinion from Sullivan & Worcester LLP, counsel to the Successor Trust, dated as of the Exchange Date, in a form reasonably satisfactory to the Original Trust, covering the following points: (i) The Successor Fund is a separate investment series of a Delaware business trust duly organized, validly existing and in good standing under the laws of the State of Delaware and has the power to own all of its properties and assets and to carry on its business as presently conducted. (ii) The Successor Fund is a separate investment series of a Delaware business trust registered as an investment company under the 1940 Act, and, to such counsel's knowledge, such registration with the Commission as an investment company under the 1940 Act is in full force and effect. (iii) This Agreement has been duly authorized, executed, and delivered by the Successor Trust and, assuming due authorization, execution and delivery of this Agreement by the Original Trust, is a valid and binding obligation of the Successor Fund enforceable against the Successor Trust in accordance with its terms, subject as to enforcement, to bankruptcy, insolvency, reorganization, moratorium, and other laws relating to or affecting creditors' rights generally and to general equity principles. (iv) The Successor Fund Shares to be issued and delivered to the Original Trust on behalf of the Original Fund shareholders as provided by this Agreement are duly authorized and upon such delivery will be legally issued and outstanding and fully paid and non-assessable, and no shareholder of the Successor Fund has any preemptive rights in respect thereof. (v) To the knowledge of such counsel, no consent, approval, authorization or order of any court or governmental authority of the United States or the State of Delaware is required for consummation by the Successor Trust of the transactions contemplated herein, except such as have been obtained under the 1933 Act, the Securities Exchange Act of 1934, as amended, and the 1940 Act, and as may be required under state securities laws. (vi) The execution and delivery of this Agreement did not, and the consummation of the transactions contemplated hereby will not, result in a violation of the Successor Trust's Declaration of Trust or By-Laws or any provision of any material agreement, indenture, instrument, contract, lease or other undertaking (in each case known to such counsel) to which the Successor Trust is a party or by which it or any of its properties may be bound or to the knowledge of such counsel, result in the acceleration of any obligation or the imposition of any penalty, under any agreement, judgment, or decree to which the Successor Trust is a party or by which it is bound. (vii) Only insofar as they relate to the Successor Trust, the descriptions in the proxy materials of statutes, legal and governmental proceedings and material contracts, if any, are accurate and fairly present the information required to be shown. (viii) Such counsel does not know of any legal or governmental proceedings, only insofar as they relate to the Successor Trust and the Successor Fund, existing on or before the effective date of the proxy materials or the Exchange Date required to be described in the proxy materials which are not described or filed as required. (ix) To the knowledge of such counsel, no litigation or administrative proceeding or investigation of or before any court or governmental body is presently pending or threatened as to the Successor Trust or any of its properties or assets and the Successor Trust is not a party to or subject to the provisions of any order, decree or judgment of any court or governmental body, which materially and adversely affects its business, other than as previously disclosed in the proxy materials. Such opinion shall contain such assumptions and limitations as shall be in the opinion of Sullivan & Worcester LLP appropriate to render the opinions expressed therein. 6. THE SUCCESSOR TRUST'S AND THE ORIGINAL TRUST'S CONDITIONS PRECEDENT. The obligations of both the Successor Trust and the Original Trust hereunder as to the Successor Fund and the Original Fund respectively, shall be subject to the following conditions: (a) The receipt of such authority, including "no-action" letters and orders from the Commission or state securities commissions, as may be necessary to permit the parties to carry out the transaction contemplated by this Agreement shall have been received. (b) The Successor Trust's adoption of the Registration Statement on Form N-1A under the 1933 Act shall have become effective, and any post-effective amendments to such Registration Statement as are determined by the Trustees of the Successor Trust to be necessary and appropriate shall have been filed with the Commission and shall have become effective. (c) The Commission shall not have issued an unfavorable advisory report under Section 25(b) of the 1940 Act nor instituted nor threatened to institute any proceeding seeking to enjoin consummation of the reorganization transactions contemplated hereby under Section 25(c) of the 1940 Act and no other action, suit or other proceeding shall be threatened or pending before any court or governmental agency which seeks to restrain or prohibit, or obtain damages or other relief in connection with, this Agreement or the transactions contemplated herein. (d) All required consents of other parties and all other consents, orders, and permits of federal, state and local regulatory authorities (including those of the Commission and of state Blue Sky securities authorities, including any necessary "no-action" positions of and exemptive orders from such federal and state authorities) to permit consummation of the transactions contemplated hereby shall have been obtained, except where failure to obtain any such consent, order, or permit would not involve a risk of a material adverse effect on the assets or properties of the Successor Fund or the Original Fund, provided that either party hereto may for itself waive any of such conditions. (e) The parties shall have received a favorable opinion of Sullivan & Worcester LLP addressed to the Successor Trust and the Original Trust substantially to the effect that for federal income tax purposes: (i) The transfer of all of the Original Fund assets in exchange for the Successor Fund Shares and the assumption by the Successor Fund of all the liabilities of the Original Fund followed by the distribution of the Successor Fund Shares to the Original Fund shareholders in dissolution and liquidation of the Original Fund will constitute a "reorganization" within the meaning of Section 368(a)(1)(F) of the Code and the Successor Fund and the Original Fund will each be a "party to a reorganization" within the meaning of Section 368(b) of the Code. (ii) No gain or loss will be recognized by the Successor Fund upon the receipt of the assets of the Original Fund solely in exchange for the Successor Fund Shares and the assumption by the Successor Fund of the liabilities of the Original Fund. (iii) No gain or loss will be recognized by the Original Fund upon the transfer of the Original Fund assets to the Successor Fund in exchange for the Successor Fund Shares and the assumption by the Successor Fund of the liabilities of the Original Fund or upon the distribution (whether actual or constructive) of the Successor Fund Shares to Original Fund shareholders in exchange for their shares of the Original Fund. (iv) No gain or loss will be recognized by the Original Fund shareholders upon the exchange of their Original Fund shares for the Successor Fund Shares in liquidation of the Original Fund. (v) The aggregate tax basis for the Successor Fund Shares received by each Original Fund shareholder pursuant to the transactions contemplated by this Agreement will be the same as the aggregate tax basis of the Original Fund shares held by such shareholder immediately prior to the transactions contemplated by this Agreement, and the holding period of the Successor Fund Shares to be received by each Original Fund shareholder will include the period during which the Original Fund shares exchanged therefor were held by such shareholder (provided the Original Fund shares were held as capital assets on the date of the transactions contemplated by this Agreement). (vi) The tax basis of the Original Fund assets acquired by the Successor Fund will be the same as the tax basis of such assets to the Original Fund immediately prior to the transactions contemplated by this Agreement, and the holding period of the assets of the Original Fund in the hands of the Successor Fund will include the period during which those assets were held by the Original Fund. Notwithstanding anything herein to the contrary, neither the Successor Fund nor the Original Fund may waive the conditions set forth in this Section 6. 7. INDEMNIFICATION. The Successor Trust hereby agrees with the Original Trust and each Trustee of the Original Trust: (i) to indemnify each Trustee of the Original Trust against all liabilities and expenses referred to in the indemnification provisions of the Original Trust's organizational documents, to the extent provided therein, incurred by any Trustee of the Original Trust; and (ii) in addition to the indemnification provided in (i) above, to indemnify each Trustee of the Original Trust against all liabilities and expenses and pay the same as they arise and become due, without any exception, limitation or requirement of approval by any person, and without any right to require repayment thereof by any such Trustee (unless such Trustee has had the same repaid to him or her) based upon any subsequent or final disposition or findings made in connection therewith or otherwise, if such action, suit or other proceeding involves such Trustee's participation in authorizing or permitting or acquiescing in, directly or indirectly, by action or inaction, the making of any distribution in any manner of all or any assets of the Original Fund without making provision for the payment of any liabilities of any kind, fixed or contingent, of the Original Fund, which liabilities were not actually and consciously personally known to such Trustee to exist at the time of such Trustee's participation in so authorizing or permitting or acquiescing in the making of any such distribution. 8. TERMINATION OF AGREEMENT. As to the Original Fund and the Successor Fund, this Agreement and the transactions contemplated hereby may be terminated and abandoned by resolution of the Board of Trustees of the Original Trust or the Board of Trustees of the Successor Trust, at any time prior to the Exchange Date (and notwithstanding any vote of the shareholders of the Original Fund) if circumstances should develop that, in the opinion of either the Board of Trustees of the Original Trust or the Board of Trustees of the Successor Trust, make proceeding with this Agreement inadvisable. As to the Original Fund and the Successor Fund, if this Agreement is terminated and the exchange contemplated hereby is abandoned pursuant to the provisions of this Section 8, this Agreement shall become void and have no effect, without any liability on the part of any party hereto or the Trustees, officers or shareholders of the Successor Trust or the Trustees, officers or shareholders of the Original Trust, in respect of this Agreement. 9. WAIVER AND AMENDMENTS. At any time prior to the Exchange Date, any of the conditions set forth in Section 4 may be waived by the Board of Trustees of the Successor Trust, and any of the conditions set forth in Section 5 may be waived by the Board of Trustees of the Original Trust, if, in the judgment of the waiving party, such waiver will not have a material adverse effect on the benefits intended under this Agreement to the shareholders of the Original Fund or the shareholders of the Successor Fund, as the case may be. In addition, prior to the Exchange Date, any provision of this Agreement may be amended or modified by the Board of Trustees of the Original Trust and the Board of Trustees of the Successor Trust in such manner as may be mutually agreed upon in writing by such Trustees if such amendment or modification would not have a material adverse effect upon the benefits intended under this Agreement and would be consistent with the best interests of shareholders. 10. NO SURVIVAL OF REPRESENTATIONS. None of the representations and warranties included or provided for herein shall survive consummation of the transactions contemplated hereby. 11. GOVERNING LAW. This Agreement shall be governed and construed in accordance with the laws of the State of Delaware, without giving effect to principles of conflict of laws; provided, however, that the due authorization, execution and delivery of this Agreement, in the case of the Original Trust, shall be governed and construed in accordance with the laws of the Commonwealth of Massachusetts without giving effect to principles of conflict of laws. 12. CAPACITY OF TRUSTEES, ETC. With respect to both the Original Trust and the Successor Trust, the names used herein refer respectively to the Trust created and, as the case may be, the Trustees, as trustees but not individually or personally, acting from time to time under organizational documents filed in Massachusetts in the case of the Original Trust and Delaware, in the case of the Successor Trust, which are hereby referred to and are also on file at the principal offices of the Original Trust or, as the case may be, the Successor Trust. The obligations of the Original Trust or of the Successor Trust entered into in the name or on behalf thereof by any of the Trustees, representatives or agents of the Original Trust or the Successor Trust, as the case may be, are made not individually, but in such capacities, and are not binding upon any of the Trustees, shareholders or representatives of the Original Trust or, as the case may be, the Successor Trust personally, but bind only the trust property, and all persons dealing with any Original Fund of the Original Trust or any Successor Fund of the Successor Trust must look solely to the trust property belonging to such Original Fund or, as the case may be, Successor Fund for the enforcement of any claims against the Original Fund or, as the case may be, Successor Fund. 13. COUNTERPARTS. This Agreement may be executed in counterparts, each of which, when executed and delivered, shall be deemed to be an original. IN WITNESS WHEREOF, the Original Trust and the Successor Trust have caused this Agreement and Plan of Conversion and Termination to be executed as of the date above first written. MENTOR FUNDS on behalf of Mentor Income and Growth Portfolio ATTEST:_______________________ By: /s/Michael H. Koonce --------------------- Title: Secretary EVERGREEN EQUITY TRUST on behalf of Evergreen Capital Income and Growth Fund ATTEST:_______________________ By: /s/Anthony A. Fischer -------------------- Title: President EXHIBIT B MANAGEMENT OF EVERGREEN TRUST Evergreen Trust is supervised by a Board of Trustees that is responsible for representing the interests of the shareholders. The Trustees meet periodically throughout the year to oversee the Successor Fund's activities, reviewing, among other things, each Successor Fund's performance and its contractual arrangements with various service providers. Each Trustee is paid a fee for his or her services. Evergreen Trust has an Executive Committee which consists of the Chairman of the Board, James Howell, and Messrs. Scofield and Salton, each of whom is an Independent Trustee. The Executive Committee recommends Trustees to fill vacancies, prepares the agenda for Board meetings and acts on routine matters between scheduled Board meetings. Set forth below are the Trustees and officers of Evergreen Trust and their principal occupations and affiliations over the last five years. Unless otherwise indicated, the address for each Trustee and officer is 200 Berkeley Street, Boston, Massachusetts 02116. Each Trustee is also a Trustee of each of the other Trusts in the Evergreen Fund complex.
Name Position Principal Occupations for Last with Trust Five Years Laurence B. Ashkin Trustee Real estate developer and (DOB: 2/2/28) construction consultant; and President of Centrum Equities (real estate development) and Centrum Properties, Inc. (real estate development). Charles A. Austin Trustee Investment Counselor to Appleton III Partners, Inc. (DOB: 10/23/34) (investment advice); former Director, Executive Vice President and Treasurer, State Street Research & Management Company (investment advice); Director, The Andover Companies (Insurance); and Trustee, Arthritis Foundation of New England. K. Dun Gifford Trustee Trustee, Treasurer and Chairman (DOB: 10/12/38) of the Finance Committee, Cambridge College; Chairman Emeritus and Director, American Institute of Food and Wine; Chairman and President, Oldways Preservation and Exchange Trust (education); former Chairman of the Board, Director, and Executive Vice President, The London Harness Company (leather goods purveyor); former Managing Partner, Roscommon Capital Corp.; former Chief Executive Officer, Gifford Gifts of Fine Foods; former Chairman, Gifford, Drescher & Associates (environmental consulting). James S. Howell Chairman of Former Chairman of the (DOB: 8/13/24) the Board of Distribution Committee, Trustees Foundation for the Carolinas; and former Vice President of Lance Inc. (food manufacturing). Leroy Keith, Jr. Trustee Chairman of the Board and Chief (DOB: 2/14/39) Executive Officer, Carson Products Company (manufacturing); Director of Phoenix Total Return Fund and Equifax, Inc. (worldwide information management); Trustee of Phoenix Series Fund, Phoenix Multi-Portfolio Fund, and The Phoenix Big Edge Series Fund; and former President, Morehouse College. Gerald M. McDonnell Trustee Sales Representative with Nucor- (DOB: 7/14/39) Yamoto, Inc. (steel producer). Thomas L. McVerry Trustee Former Vice President and (DOB: 8/2/39) Director of Rexham Corporation (manufacturing); and former Director of Carolina Cooperative Federal Credit Union. William Walt Pettit Trustee Partner in the law firm of (DOB: 8/26/55) William Walt Pettit, P.A. David M. Richardson Trustee Vice Chair and former Executive (DOB: 9/14/41) Vice President, DHR International, Inc. (executive recruitment); former Senior Vice President, Boyden International Inc. (executive recruitment); and Director, Commerce and Industry Association of New Jersey, 411 International, Inc. (communications), and J&M Cumming Paper Co. Russell A. Salton, Trustee Medical Director, U.S. Health III, MD Care/Aetna Health Services; (DOB: 6/2/47) former Managed Health Care Consultant; and former President, Primary Physician Care. Michael S. Scofield Vice Attorney, Law Offices of Michael (DOB: 2/20/43) Chairman of S. Scofield. the Board of Trustees Richard J. Shima Trustee Former Chairman, Environmental (DOB: 8/11/39) Warranty, Inc. (insurance agency); Executive Consultant, Drake Beam Morin, Inc. (executive outplacement); Director of Connecticut Natural Gas Corporation, Hartford Hospital, Old State House Association, Middlesex Mutual Assurance Company (property casualty insurance), and Enhance Financial Services, Inc. (financial guaranty insurance); Chairman, Board of Trustees, Hartford Graduate Center; Trustee, Greater Hartford YMCA; former Director, Vice Chairman and Chief Investment Officer, The Travelers Corporation; former Trustee, Kingswood-Oxford School; and former Managing Director and Consultant, Russell Miller, Inc. (investment banking specializing in the insurance industry). Anthony J. Fischer* President Vice President/Client Services, (DOB: 2/10/59) and BISYS Fund Services. Treasurer Nimish S. Bhatt** Vice Vice President, (DOB: 6/6/63) President Tax, BISYS Fund and Services; Assistant Vice Assistant President, Evergreen Asset Treasurer Management Corp./First Union National Bank; former Senior Tax Consulting/Acting Manager, Investment Companies Group, PricewaterhouseCoopers LLP, New York. Bryan Haft** Vice Team Leader, Fund (DOB: 1/23/65) President Administration, BISYS Fund Services. Michael H. Koonce Secretary Senior Vice President and (DOB: 4/20/60) Assistant General Counsel, First Union Corporation; former Senior Vice President and General Counsel, Colonial Management Associates, Inc.
*Address: BISYS , 90 Park Avenue, New York, New York 10016 **Address: BISYS, 3435 Stelzer Road, Columbus, Ohio 43219-8001 Trustee Compensation Listed below is the Trustee compensation paid by Evergreen Trust and the other trusts in the Evergreen Fund Complex for the twelve months ended April 30, 1999. The Trustees do not receive pension or retirement benefits from the Funds.
Aggregate Total Compensation Compensation from the Trust and Trustee from the Trust Fund Complex Paid to Trustees* Laurence B. Ashkin $22,911 $75,000 Charles A. Austin, III $22,911 $75,000 K. Dun Gifford $22,141 $72,500 James S. Howell $29,532 $97,500 Leroy Keith, Jr. $22,141 $72,500 Gerald M. McDonnell $22,911 $75,000 Thomas L. McVerry $26,295 $86,000 William Walt Pettit $22,141 $72,500 David M. Richardson $22,928 $71,875 Russell A. Salton, III $23,378 $77,500 MD Michael S. Scofield $23,378 $77,500 Richard J. Shima $22,141 $72,500
*Certain Trustees have elected to defer all or part of their total compensation for the twelve months ended April 30, 1999. The amounts listed below will be payable in later years to the respective Trustees: Austin $11,250 Howell $77,600 McDonnell $75,000 McVerry $86,000 Pettit $72,500 Salton $77,000 Scofield $11,250 EXHIBIT C MENTOR FUNDS CURRENT FUNDAMENTAL INVESTMENT RESTRICTIONS "S": Fundamental Restriction to be Standardized "R": Fundamental Restriction to be Reclassified as Non Fundamental
Topic MENTOR INCOME AND GROWTH PORTFOLIO 1. Diversification With respect to 75% of the value of (S) its respective total assets, the Portfolio will not purchase securities issued by any one issuer (other than cash or securities issued or guaranteed by the government of the United States or its agencies or instrumentalities and repurchase agreements collateralized by such securities), if as a result more than 5% of the value of its total assets would be invested in the securities of that issuer. The Portfolio will not acquire more than 10% of the outstanding voting securities of any one issuer. 2. Concentration The Portfolio will not invest 25% or (S) more of the value of its total assets in any one industry (other than securities issued by the U.S. Government, its agencies or instrumentalities.) 3. Issuing Senior The Portfolio will not issue senior Securities securities. (See "Borrowing.") (S) 4. Borrowing The Portfolio may borrow money (Including Reverse directly or through reverse Repurchase repurchase agreements in amounts of Agreements) up to one-third of the value of its (S) net assets, including the amount borrowed. The Portfolio will not borrow money or engage in reverse repurchase agreements for investment leverage, but rather as a temporary, extraordinary, or emergency measure or to facilitate management of the Portfolio by enabling it to meet redemption requests when the liquidation of portfolio securities is deemed to be inconvenient or disadvantageous. The Portfolio will not purchase any securities while any borrowings in excess of 5% of its total assets are outstanding. Notwithstanding this restriction, the Portfolio may enter into when-issued and delayed delivery transactions. 5. Underwriting The Portfolio will not underwrite any Securities of Other issue of securities, except as the Issuers Portfolio may be deemed to be an (S) underwriter under the Securities Act of 1933 in connection with the sale of securities in accordance with its investment objective, policies, and limitations. 6. Real Estate The Portfolio may not purchase or (S) sell real estate, including limited partnership interests, except to the extent the securities the Portfolio may invest in are considered to be interests in real estate, although the Portfolio may invest in securities of issuers whose business involves the purchase or sale of real estate or in securities which are secured by real estate or interests in real estate. 7. Commodities The Portfolio will not invest in (S) commodities, except to the extent that the Portfolio may engage in transactions involving futures contracts or options on futures contracts. 8. Loans to Others The Portfolio will not lend any of (S) its respective assets except portfolio securities up to one-third of the value of total assets. This shall not prevent the Portfolio from purchasing or holding U.S. government obligations, money market instruments, variable amount demand master notes, bonds, debentures, notes, certificates of indebtedness, or other debt securities, entering into repurchase agreements, or engaging in other transactions where permitted by the Portfolio's investment objective, policies and limitations or Declaration of Trust. 9. Short Sales The Portfolio will not sell any (R) securities short or purchase any securities on margin, but may obtain such short-term credits as are necessary for clearance of purchases and sales of securities. The deposit or payment by the Portfolio of initial or variation margin in connection with futures contracts or related options transactions is not considered the purchase of a security on margin. 10. Margin Purchases The Portfolio will not mortgage, (R) pledge, or hypothecate any assets, except to secure permitted borrowings. In these cases the Portfolio may pledge assets having a value of 10% of assets taken at cost. For purposes of this restriction, (a) the deposit of assets in escrow in connection with the writing of covered put or call options and the purchase of securities on a when- issued basis; and (b) collateral arrangements with respect to (i) the purchase and sale of stock options (and options on stock indexes) and (ii) initial or variation margin for futures contracts, will not be deemed to be pledges of the Portfolio's assets. Margin deposits for the purchase and sale of futures contracts and related options are not deemed to be a pledge.
EXHIBIT D AGREEMENT AND PLAN OF REORGANIZATION THIS AGREEMENT AND PLAN OF REORGANIZATION (the "Agreement") is made as of this __th day of ________, 1999, by and between Evergreen Equity Trust, a Delaware business trust, with its principal place of business at 200 Berkeley Street, Boston, Massachusetts 02116 (the "Trust"), with respect to its Evergreen Capital Balanced Fund series (the "Acquiring Fund"), and the Trust, with respect to its Evergreen Capital Income and Growth Fund series (the "Selling Fund"). For purposes of this Agreement, the Selling Fund shall be deemed to include, as applicable, the Selling Fund's predecessor, Mentor Income and Growth Portfolio, a series of Mentor Funds ("Mentor Income and Growth"). This Agreement is intended to be, and is adopted as, a plan of reorganization and liquidation within the meaning of Section 368(a)(1)(C) of the United States Internal Revenue Code of 1986, as amended (the "Code"). The reorganization (the "Reorganization") will consist of (i) the transfer of all of the assets of the Selling Fund in exchange solely for Class A, Class C and Class Y shares of beneficial interest, $.001 par value per share, of the Acquiring Fund (the "Acquiring Fund Shares"); (ii) the assumption by the Acquiring Fund of the identified liabilities of the Selling Fund; and (iii) the distribution, after the Closing Date hereinafter referred to, of the Acquiring Fund Shares to the shareholders of the Selling Fund in liquidation of the Selling Fund as provided herein, all upon the terms and conditions hereinafter set forth in this Agreement. WHEREAS, pursuant to an Agreement and Plan of Conversion and Termination approved by the shareholders of Mentor Income and Growth, on October 15, 1999 Mentor Income and Growth was reorganized as a series of the Trust. WHEREAS, the Selling Fund and the Acquiring Fund are each a separate investment series of an open-end, registered investment company of the management type and the Selling Fund owns securities that generally are assets of the character in which the Acquiring Fund is permitted to invest; WHEREAS, both Funds are authorized to issue their shares of beneficial interest; WHEREAS, the Trustees of the Trust have determined that the exchange of all of the assets of the Selling Fund for Acquiring Fund Shares and the assumption of the identified liabilities of the Selling Fund by the Acquiring Fund on the terms and conditions hereinafter set forth are in the best interests of the Acquiring Fund's shareholders; WHEREAS, the Trustees of the Trust have determined that the Selling Fund should exchange all of its assets and the identified liabilities for Acquiring Fund Shares and that the interests of the existing shareholders of the Selling Fund will not be diluted as a result of the transactions contemplated herein; NOW, THEREFORE, in consideration of the premises and of the covenants and agreements hereinafter set forth, the parties hereto covenant and agree as follows: ARTICLE I TRANSFER OF ASSETS OF THE SELLING FUND IN EXCHANGE FOR THE ACQUIRING FUND SHARES AND ASSUMPTION OF SELLING FUND LIABILITIES AND LIQUIDATION OF THE SELLING FUND 1.1 THE EXCHANGE. Subject to the terms and conditions herein set forth and on the basis of the representations and warranties contained herein, the Selling Fund agrees to transfer all of the Selling Fund's assets as set forth in paragraph 1.2 to the Acquiring Fund. The Acquiring Fund agrees in exchange therefor (i) to deliver to the Selling Fund the number of Acquiring Fund Shares, including fractional Acquiring Fund Shares, computed in the manner and as of the time and date set forth in paragraphs 2.2 and 2.3; and (ii) to assume the identified liabilities of the Selling Fund, as set forth in paragraph 1.3. Such transactions shall take place on the Closing Date provided for in paragraph 3.1. 1.2 ASSETS TO BE ACQUIRED. The assets of the Selling Fund to be acquired by the Acquiring Fund shall consist of all property, including, without limitation, all cash, securities, commodities, interests in futures and dividends or interest receivables, that is owned by the Selling Fund and any deferred or prepaid expenses shown as an asset on the books of the Selling Fund on the Closing Date. The Selling Fund has provided the Acquiring Fund with its most recent audited financial statements, which contain a list of all of Selling Fund's assets as of the date thereof. The Selling Fund hereby represents that as of the date of the execution of this Agreement there have been no changes in its financial position as reflected in said financial statements other than those occurring in the ordinary course of its business in connection with the purchase and sale of securities and the payment of its normal operating expenses. The Selling Fund reserves the right to sell any of such securities, but will not, without the prior written approval of the Acquiring Fund, acquire any additional securities other than securities of the type in which the Acquiring Fund is permitted to invest. The Acquiring Fund will, within a reasonable time prior to the Closing Date, furnish the Selling Fund with a list of the securities, if any, on the Selling Fund's list referred to in the second sentence of this paragraph that do not conform to the Acquiring Fund's investment objectives, policies, and restrictions. The Selling Fund will, within a reasonable period of time prior to the Closing Date, furnish the Acquiring Fund with a list of its portfolio securities and other investments. In the event that the Selling Fund holds any investments that the Acquiring Fund may not hold, the Selling Fund, if requested by the Acquiring Fund, will dispose of such securities prior to the Closing Date. In addition, if it is determined that the Selling Fund and the Acquiring Fund portfolios, when aggregated, would contain investments exceeding certain percentage limitations imposed upon the Acquiring Fund with respect to such investments, the Selling Fund if requested by the Acquiring Fund will dispose of a sufficient amount of such investments as may be necessary to avoid violating such limitations as of the Closing Date. Notwithstanding the foregoing, nothing herein will require the Selling Fund to dispose of any investments or securities if, in the reasonable judgment of the Selling Fund, such disposition would adversely affect the tax-free nature of the Reorganization or would violate the Selling Fund's fiduciary duty to its shareholders. 1.3 LIABILITIES TO BE ASSUMED. The Selling Fund will endeavor to discharge all of its known liabilities and obligations prior to the Closing Date. The Acquiring Fund shall assume only those liabilities, expenses, costs, charges and reserves reflected on a Statement of Assets and Liabilities of the Selling Fund prepared on behalf of the Selling Fund, as of the Valuation Date (as defined in paragraph 2.1), in accordance with generally accepted accounting principles consistently applied from the prior audited period. The Acquiring Fund shall assume only those liabilities of the Selling Fund reflected in such Statement of Assets and Liabilities and shall not assume any other liabilities, whether absolute or contingent, known or unknown, accrued or unaccrued, all of which shall remain the obligation of the Selling Fund. In addition, upon completion of the Reorganization, for purposes of calculating the maximum amount of sales charges (including asset based sales charges) permitted to be imposed by the Acquiring Fund under the National Association of Securities Dealers, Inc. Conduct Rule 2830 ("Aggregate NASD Cap"), the Acquiring Fund will add to its Aggregate NASD Cap immediately prior to the Reorganization the Aggregate NASD Cap of the Selling Fund immediately prior to the Reorganization, in each case calculated in accordance with such Rule 2830. 1.4 LIQUIDATION AND DISTRIBUTION. On or as soon after the Closing Date as is conveniently practicable (the "Liquidation Date"), (a) the Selling Fund will liquidate and distribute pro rata to the Selling Fund's shareholders of record, determined as of the close of business on the Valuation Date (the "Selling Fund Shareholders"), the Acquiring Fund Shares received by the Selling Fund pursuant to paragraph 1.1; and (b) the Selling Fund will thereupon proceed to dissolve as set forth in paragraph 1.8 below. Such liquidation and distribution will be accomplished by the transfer of the Acquiring Fund Shares then credited to the account of the Selling Fund on the books of the Acquiring Fund to open accounts on the share records of the Acquiring Fund in the names of the Selling Fund Shareholders and representing the respective pro rata number of the Acquiring Fund Shares due such shareholders. All issued and outstanding shares of the Selling Fund will simultaneously be canceled on the books of the Selling Fund. The Acquiring Fund shall not issue certificates representing the Acquiring Fund Shares in connection with such exchange. 1.5 OWNERSHIP OF SHARES. Ownership of Acquiring Fund Shares will be shown on the books of the Acquiring Fund's transfer agent. Shares of the Acquiring Fund will be issued in the manner described in the Prospectus/Proxy Statement on Form N-14 which has been distributed to shareholders of the Selling Fund as described in paragraph 4.1(o). 1.6 TRANSFER TAXES. Any transfer taxes payable upon issuance of the Acquiring Fund Shares in a name other than the registered holder of the Selling Fund shares on the books of the Selling Fund as of that time shall, as a condition of such issuance and transfer, be paid by the person to whom such Acquiring Fund Shares are to be issued and transferred. 1.7 REPORTING RESPONSIBILITY. Any reporting responsibility of the Selling Fund is and shall remain the responsibility of the Selling Fund up to and including the Closing Date and such later date on which the Selling Fund is terminated. 1.8 TERMINATION. The Selling Fund shall be terminated promptly following the Closing Date and the making of all distributions pursuant to paragraph 1.4. ARTICLE II VALUATION 2.1 VALUATION OF ASSETS. The value of the Selling Fund's assets to be acquired by the Acquiring Fund hereunder shall be the value of such assets computed as of the close of business on the New York Stock Exchange on the business day next preceding the Closing Date (such time and date being hereinafter called the "Valuation Date"), using the valuation procedures set forth in the Trust's Declaration of Trust and the Acquiring Fund's then current prospectuses and statement of additional information or such other valuation procedures as shall be mutually agreed upon by the parties. 2.2 VALUATION OF SHARES. The net asset value per share of the Acquiring Fund Shares shall be the net asset value per share computed as of the close of business on the New York Stock Exchange on the Valuation Date, using the valuation procedures set forth in the Trust's Declaration of Trust and the Acquiring Fund's then current prospectuses and statement of additional information. 2.3 SHARES TO BE ISSUED. The number of the Acquiring Fund Shares of each class to be issued (including fractional shares, if any) in exchange for the Selling Fund's assets shall be determined by multiplying the shares outstanding of each class of the Selling Fund by the ratio computed by dividing the net asset value per share of the Selling Fund attributable to each of its classes by the net asset value per share of the respective classes of the Acquiring Fund determined in accordance with paragraph 2.2. Holders of Class A, Class B and Class Y shares of the Selling Fund will receive Class A, Class C and Class Y shares, respectively, of the Acquiring Fund. 2.4 DETERMINATION OF VALUE. All computations of value shall be made by State Street Bank and Trust Company in accordance with its regular practice in pricing the shares and assets of the Acquiring Fund. ARTICLE III CLOSING AND CLOSING DATE 3.1 CLOSING DATE. The closing of the Reorganization (the "Closing") shall take place on or about March 11, 2000 or such other date as the parties may agree to in writing (the "Closing Date"). All acts taking place at the Closing shall be deemed to take place simultaneously immediately prior to the opening of business on the Closing Date unless otherwise provided. The Closing shall be held as of 9:00 a.m. at the offices of the Evergreen Funds, 200 Berkeley Street, Boston, MA 02116, or at such other time and/or place as the parties may agree. 3.2 CUSTODIAN'S CERTIFICATE. State Street Bank and Trust Company, as custodian for the Selling Fund (the "Custodian"), shall deliver at the Closing a certificate of an authorized officer stating that (a) the Selling Fund's portfolio securities, cash, and any other assets have been delivered in proper form to the Acquiring Fund on the Closing Date; and (b) all necessary taxes including all applicable federal and state stock transfer stamps, if any, have been paid, or provision for payment have been made, in conjunction with the delivery of portfolio securities by the Selling Fund. 3.3 EFFECT OF SUSPENSION IN TRADING. In the event that on the Valuation Date (a) the New York Stock Exchange or another primary trading market for portfolio securities of the Acquiring Fund or the Selling Fund shall be closed to trading or trading thereon shall be restricted; or (b) trading or the reporting of trading on said Exchange or elsewhere shall be disrupted so that accurate appraisal of the value of the net assets of the Acquiring Fund or the Selling Fund is impracticable, the Valuation Date shall be postponed until the first business day after the day when trading shall have been fully resumed and reporting shall have been restored. 3.4 TRANSFER AGENT'S CERTIFICATE. Evergreen Service Company, as transfer agent for the Selling Fund, shall deliver at the Closing a certificate of an authorized officer stating that its records contain the names and addresses of the Selling Fund Shareholders and the number and percentage ownership of outstanding shares owned by each such shareholder immediately prior to the Closing. The Acquiring Fund shall issue and deliver or cause Evergreen Service Company, its transfer agent, to issue and deliver a confirmation evidencing the Acquiring Fund Shares to be credited on the Closing Date to the Secretary of the Trust or provide evidence satisfactory to the Selling Fund that such Acquiring Fund Shares have been credited to the Selling Fund's account on the books of the Acquiring Fund. At the Closing, each party shall deliver to the other such bills of sale, checks, assignments, share certificates, if any, receipts and other documents as such other party or its counsel may reasonably request. ARTICLE IV REPRESENTATIONS AND WARRANTIES 4.1 REPRESENTATIONS OF THE SELLING FUND. The Selling Fund represents and warrants to the Acquiring Fund as follows: (a) The Selling Fund is a separate investment series of a Delaware business trust duly organized, validly existing, and in good standing under the laws of the State of Delaware. (b) The Selling Fund is a separate investment series of a Delaware business trust that is registered as an investment company classified as a management company of the open-end type, and its registration with the Securities and Exchange Commission (the "Commission") as an investment company under the Investment Company Act of 1940, as amended (the "1940 Act"), is in full force and effect. (c) The current prospectuses and statement of additional information of the Selling Fund conform in all material respects to the applicable requirements of the Securities Act of 1933, as amended (the "1933 Act"), and the 1940 Act and the rules and regulations of the Commission thereunder and do not include any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading. (d) The Selling Fund is not, and the execution, delivery, and performance of this Agreement (subject to shareholder approval) will not result, in violation of any provision of the Trust's Declaration of Trust or By-Laws or of any material agreement, indenture, instrument, contract, lease, or other undertaking to which the Selling Fund is a party or by which it is bound. (e) The Selling Fund has no material contracts or other commitments (other than this Agreement) that will be terminated with liability to it prior to the Closing Date, except for liabilities, if any, to be discharged or reflected in the Statement of Assets and Liabilities as provided in paragraph 1.3 hereof. (f) Except as otherwise disclosed in writing to and accepted by the Acquiring Fund, no litigation, administrative proceeding, or investigation of or before any court or governmental body is presently pending or to its knowledge threatened against the Selling Fund or any of its properties or assets, which, if adversely determined, would materially and adversely affect its financial condition, the conduct of its business, or the ability of the Selling Fund to carry out the transactions contemplated by this Agreement. The Selling Fund knows of no facts that might form the basis for the institution of such proceedings and is not a party to or subject to the provisions of any order, decree, or judgment of any court or governmental body that materially and adversely affects its business or its ability to consummate the transactions herein contemplated. (g) The unaudited semi-annual financial statements of the Selling Fund at March 31, 1999 are in accordance with generally accepted accounting principles consistently applied, and such statements (copies of which have been furnished to the Acquiring Fund) fairly reflect the financial condition of the Selling Fund as of such date, and there are no known contingent liabilities of the Selling Fund as of such date not disclosed therein. (h) Since March 31, 1999 there has not been any material adverse change in the Selling Fund's financial condition, assets, liabilities, or business other than changes occurring in the ordinary course of business, or any incurrence by the Selling Fund of indebtedness maturing more than one year from the date such indebtedness was incurred, except as otherwise disclosed to and accepted by the Acquiring Fund. For the purposes of this subparagraph (h), a decline in the net asset value of the Selling Fund shall not constitute a material adverse change. (i) At the Closing Date, all federal and other tax returns and reports of the Selling Fund required by law to have been filed by such dates shall have been filed, and all federal and other taxes shown due on said returns and reports shall have been paid, or provision shall have been made for the payment thereof. To the best of the Selling Fund's knowledge, no such return is currently under audit, and no assessment has been asserted with respect to such returns. (j) For each fiscal year of its operation, the Selling Fund has met the requirements of Subchapter M of the Code for qualification and treatment as a regulated investment company and has distributed in each such year all net investment income and realized capital gains. (k) All issued and outstanding shares of the Selling Fund are, and at the Closing Date will be, duly and validly issued and outstanding, fully paid and non-assessable by the Selling Fund. All of the issued and outstanding shares of the Selling Fund will, at the time of the Closing Date, be held by the persons and in the amounts set forth in the records of the transfer agent as provided in paragraph 3.4. The Selling Fund does not have outstanding any options, warrants, or other rights to subscribe for or purchase any of the Selling Fund shares, nor is there outstanding any security convertible into any of the Selling Fund shares. (l) At the Closing Date, the Selling Fund will have good and marketable title to the Selling Fund's assets to be transferred to the Acquiring Fund pursuant to paragraph 1.2 and full right, power, and authority to sell, assign, transfer, and deliver such assets hereunder, and, upon delivery and payment for such assets, the Acquiring Fund will acquire good and marketable title thereto, subject to no restrictions on the full transfer thereof, including such restrictions as might arise under the 1933 Act, other than as disclosed to the Acquiring Fund and accepted by the Acquiring Fund. (m) The execution, delivery, and performance of this Agreement have been duly authorized by all necessary action on the part of the Selling Fund including the shareholders of the Selling Fund and this Agreement constitutes a valid and binding obligation of the Selling Fund, enforceable in accordance with its terms, subject as to enforcement, to bankruptcy, insolvency, reorganization, moratorium, and other laws relating to or affecting creditors' rights and to general equity principles. (n) The information furnished by the Selling Fund for use in no-action letters, applications for orders, registration statements, proxy materials, and other documents that may be necessary in connection with the transactions contemplated hereby is accurate and complete in all material respects and complies in all material respects with federal securities and other laws and regulations thereunder applicable thereto. (o) The Selling Fund has provided the Acquiring Fund with information reasonably necessary for the preparation of a prospectus, which included the proxy statement of the Selling Fund (the "Prospectus/Proxy Statement"), all of which was included in a Registration Statement on Form N-14 of the Acquiring Fund (the "Registration Statement"), in compliance with the 1933 Act, the Securities Exchange Act of 1934, as amended (the "1934 Act") and the 1940 Act in connection with the meeting of the shareholders of the Selling Fund to approve this Agreement and the transactions contemplated hereby. The Prospectus/Proxy Statement included in the Registration Statement (other than information therein that relates to the Acquiring Fund) does 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, in light of the circumstances under which such statements were made, not misleading. 4.2 REPRESENTATIONS OF THE ACQUIRING FUND. The Acquiring Fund represents and warrants to the Selling Fund as follows: (a) The Acquiring Fund is a separate investment series of a Delaware business trust duly organized, validly existing and in good standing under the laws of the State of Delaware. (b) The Acquiring Fund is a separate investment series of a Delaware business trust that is registered as an investment company classified as a management company of the open-end type, and its registration with the Commission as an investment company under the 1940 Act is in full force and effect. (c) The current prospectuses and statement of additional information of the Acquiring Fund conform in all material respects to the applicable requirements of the 1933 Act and the 1940 Act and the rules and regulations of the Commission thereunder and do not include any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading. (d) The Acquiring Fund is not, and the execution, delivery and performance of this Agreement will not result, in violation of the Trust's Declaration of Trust or By-Laws or of any material agreement, indenture, instrument, contract, lease, or other undertaking to which the Acquiring Fund is a party or by which it is bound. (e) Except as otherwise disclosed in writing to the Selling Fund and accepted by the Selling Fund, no litigation, administrative proceeding or investigation of or before any court or governmental body is presently pending or to its knowledge threatened against the Acquiring Fund or any of its properties or assets, which, if adversely determined, would materially and adversely affect its financial condition and the conduct of its business or the ability of the Acquiring Fund to carry out the transactions contemplated by this Agreement. The Acquiring Fund knows of no facts that might form the basis for the institution of such proceedings and is not a party to or subject to the provisions of any order, decree, or judgment of any court or governmental body that materially and adversely affects its business or its ability to consummate the transactions contemplated herein. (f) The unaudited semi-annual financial statements of the Acquiring Fund at March 31, 1999 are in accordance with generally accepted accounting principles consistently applied, and such statements (copies of which have been furnished to the Selling Fund) fairly reflect the financial condition of the Acquiring Fund as of such date, and there are no known contingent liabilities of the Acquiring Fund as of such date not disclosed therein. (g) Since March 31, 1999 there has not been any material adverse change in the Acquiring Fund's financial condition, assets, liabilities, or business other than changes occurring in the ordinary course of business, or any incurrence by the Acquiring Fund of indebtedness maturing more than one year from the date such indebtedness was incurred, except as otherwise disclosed to and accepted by the Selling Fund. For the purposes of this subparagraph (g), a decline in the net asset value of the Acquiring Fund shall not constitute a material adverse change. (h) At the Closing Date, all federal and other tax returns and reports of the Acquiring Fund required by law then to be filed by such dates shall have been filed, and all federal and other taxes shown due on said returns and reports shall have been paid or provision shall have been made for the payment thereof. To the best of the Acquiring Fund's knowledge, no such return is currently under audit, and no assessment has been asserted with respect to such returns. (i) For each fiscal year of its operation, the Acquiring Fund has met the requirements of Subchapter M of the Code for qualification and treatment as a regulated investment company and has distributed in each such year all net investment income and realized capital gains. (j) All issued and outstanding Acquiring Fund Shares are, and at the Closing Date will be, duly and validly issued and outstanding, fully paid and non-assessable. The Acquiring Fund does not have outstanding any options, warrants, or other rights to subscribe for or purchase any Acquiring Fund Shares, nor is there outstanding any security convertible into any Acquiring Fund Shares. (k) The execution, delivery, and performance of this Agreement have been duly authorized by all necessary action on the part of the Acquiring Fund, and this Agreement constitutes a valid and binding obligation of the Acquiring Fund enforceable in accordance with its terms, subject as to enforcement, to bankruptcy, insolvency, reorganization, moratorium, and other laws relating to or affecting creditors' rights and to general equity principles. (l) The Acquiring Fund Shares to be issued and delivered to the Selling Fund, for the account of the Selling Fund Shareholders, pursuant to the terms of this Agreement will, at the Closing Date, have been duly authorized and, when so issued and delivered, will be duly and validly issued Acquiring Fund Shares, and will be fully paid and non-assessable. (m) The information furnished by the Acquiring Fund for use in no-action letters, applications for orders, registration statements, proxy materials, and other documents that may be necessary in connection with the transactions contemplated hereby is accurate and complete in all material respects and complies in all material respects with federal securities and other laws and regulations applicable thereto. (n) The Prospectus/Proxy Statement included in the Registration Statement (only insofar as it relates to the Acquiring Fund) does 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, in light of the circumstances under which such statements were made, not misleading. (o) The Acquiring Fund agrees to use all reasonable efforts to obtain the approvals and authorizations required by the 1933 Act, the 1940 Act, and such of the state Blue Sky or securities laws as it may deem appropriate in order to continue its operations after the Closing Date. ARTICLE V COVENANTS OF THE ACQUIRING FUND AND THE SELLING FUND 5.1 OPERATION IN ORDINARY COURSE. The Acquiring Fund and the Selling Fund each will operate its business in the ordinary course between the date hereof and the Closing Date, it being understood that such ordinary course of business will include customary dividends and distributions. 5.2 INVESTMENT REPRESENTATION. The Selling Fund covenants that the Acquiring Fund Shares to be issued hereunder are not being acquired for the purpose of making any distribution thereof other than in accordance with the terms of this Agreement. 5.3 ADDITIONAL INFORMATION. The Selling Fund will assist the Acquiring Fund in obtaining such information as the Acquiring Fund reasonably requests concerning the beneficial ownership of the Selling Fund shares. 5.4 FURTHER ACTION. Subject to the provisions of this Agreement, the Acquiring Fund and the Selling Fund will each take, or cause to be taken, all action, and do or cause to be done, all things reasonably necessary, proper or advisable to consummate and make effective the transactions contemplated by this Agreement, including any actions required to be taken after the Closing Date. 5.5 STATEMENT OF EARNINGS AND PROFITS. As promptly as practicable, but in any case within sixty days after the Closing Date, the Selling Fund shall furnish the Acquiring Fund, in such form as is reasonably satisfactory to the Acquiring Fund, a statement of the earnings and profits of the Selling Fund for federal income tax purposes that will be carried over by the Acquiring Fund as a result of Section 381 of the Code, and which will be reviewed by KPMG LLP and certified by the Trust's President and Treasurer. 5.6 CAPITAL LOSS CARRYFORWARDS. As promptly as practicable, but in any case within sixty days after the Closing Date, the Acquiring Fund and the Selling Fund shall cause KPMG LLP to issue a letter addressed to the Acquiring Fund and the Selling Fund, in form and substance satisfactory to the Funds, setting forth the federal income tax implications relating to capital loss carryforwards (if any) of the Selling Fund. ARTICLE VI CONDITIONS PRECEDENT TO OBLIGATIONS OF THE SELLING FUND The obligations of the Selling Fund to consummate the transactions provided for herein shall be subject, at its election, to the performance by the Acquiring Fund of all the obligations to be performed by it hereunder on or before the Closing Date, and, in addition thereto, the following further conditions: 6.1 All representations, covenants, and warranties of the Acquiring Fund contained in this Agreement shall be true and correct as of the date hereof and as of the Closing Date with the same force and effect as if made on and as of the Closing Date, and the Acquiring Fund shall have delivered to the Selling Fund a certificate executed in its name by the Trust's President or Vice President and its Treasurer or Assistant Treasurer, in form and substance reasonably satisfactory to the Selling Fund and dated as of the Closing Date, to such effect and as to such other matters as the Selling Fund shall reasonably request. 6.2 The Selling Fund shall have received on the Closing Date an opinion from Sullivan & Worcester LLP, counsel to the Acquiring Fund, dated as of the Closing Date, in a form reasonably satisfactory to the Selling Fund, covering the following points: (a) The Acquiring Fund is a separate investment series of a Delaware business trust duly organized, validly existing and in good standing under the laws of the State of Delaware and has the power to own all of its properties and assets and to carry on its business as presently conducted. (b) The Acquiring Fund is a separate investment series of a Delaware business trust registered as an investment company under the 1940 Act, and, to such counsel's knowledge, such registration with the Commission as an investment company under the 1940 Act is in full force and effect. (c) This Agreement has been duly authorized, executed, and delivered by the Acquiring Fund and, assuming due authorization, execution and delivery of this Agreement by the Selling Fund, is a valid and binding obligation of the Acquiring Fund enforceable against the Acquiring Fund in accordance with its terms, subject as to enforcement, to bankruptcy, insolvency, reorganization, moratorium, and other laws relating to or affecting creditors' rights generally and to general equity principles. (d) Assuming that a consideration therefor not less than the net asset value thereof has been paid, the Acquiring Fund Shares to be issued and delivered to the Selling Fund on behalf of the Selling Fund Shareholders as provided by this Agreement are duly authorized and upon such delivery will be legally issued and outstanding and fully paid and non-assessable, and no shareholder of the Acquiring Fund has any preemptive rights in respect thereof. (e) The Registration Statement, to such counsel's knowledge, has been declared effective by the Commission and no stop order under the 1933 Act pertaining thereto has been issued, and to the knowledge of such counsel, no consent, approval, authorization or order of any court or governmental authority of the United States or the State of Delaware is required for consummation by the Acquiring Fund of the transactions contemplated herein, except such as have been obtained under the 1933 Act, the 1934 Act and the 1940 Act, and as may be required under state securities laws. (f) The execution and delivery of this Agreement did not, and the consummation of the transactions contemplated hereby will not, result in a violation of the Trust's Declaration of Trust or By-Laws or any provision of any material agreement, indenture, instrument, contract, lease or other undertaking (in each case known to such counsel) to which the Acquiring Fund is a party or by which it or any of its properties may be bound or to the knowledge of such counsel, result in the acceleration of any obligation or the imposition of any penalty, under any agreement, judgment, or decree to which the Acquiring Fund is a party or by which it is bound. (g) Only insofar as they relate to the Acquiring Fund, the descriptions in the Prospectus/Proxy Statement of statutes, legal and governmental proceedings and material contracts, if any, are accurate and fairly present the information required to be shown. (h) Such counsel does not know of any legal or governmental proceedings, only insofar as they relate to the Acquiring Fund, existing on or before the effective date of the Registration Statement or the Closing Date required to be described in the Registration Statement or to be filed as exhibits to the Registration Statement which are not described or filed as required. (i) To the knowledge of such counsel, no litigation or administrative proceeding or investigation of or before any court or governmental body is presently pending or threatened as to the Acquiring Fund or any of its properties or assets and the Acquiring Fund is not a party to or subject to the provisions of any order, decree or judgment of any court or governmental body, which materially and adversely affects its business, other than as previously disclosed in the Registration Statement. Such opinion shall contain such assumptions and limitations as shall be in the opinion of Sullivan & Worcester LLP appropriate to render the opinions expressed therein. In this paragraph 6.2, references to the Prospectus/Proxy Statement include and relate to only the text of such Prospectus/Proxy Statement and not to any exhibits or attachments thereto or to any documents incorporated by reference therein. ARTICLE VII CONDITIONS PRECEDENT TO OBLIGATIONS OF THE ACQUIRING FUND The obligations of the Acquiring Fund to complete the transactions provided for herein shall be subject, at its election, to the performance by the Selling Fund of all the obligations to be performed by it hereunder on or before the Closing Date and, in addition thereto, the following conditions: 7.1 All representations, covenants, and warranties of the Selling Fund contained in this Agreement shall be true and correct as of the date hereof and as of the Closing Date with the same force and effect as if made on and as of the Closing Date, and the Selling Fund shall have delivered to the Acquiring Fund on the Closing Date a certificate executed in its name by the Trust's President or Vice President and the Treasurer or Assistant Treasurer, in form and substance satisfactory to the Acquiring Fund and dated as of the Closing Date, to such effect and as to such other matters as the Acquiring Fund shall reasonably request. 7.2 The Selling Fund shall have delivered to the Acquiring Fund a statement of the Selling Fund's assets and liabilities, together with a list of the Selling Fund's portfolio securities showing the tax costs of such securities by lot and the holding periods of such securities, as of the Closing Date, certified by the Treasurer of the Trust. 7.3 The Acquiring Fund shall have received on the Closing Date an opinion of Sullivan & Worcester LLP, counsel to the Selling Fund, in a form satisfactory to the Acquiring Fund covering the following points: (a) The Selling Fund is a separate investment series of a Delaware business trust duly organized, validly existing and in good standing under the laws of the State of Delaware and has the power to own all of its properties and assets and to carry on its business as presently conducted. (b) The Selling Fund is a separate investment series of a Delaware business trust registered as an investment company under the 1940 Act, and, to such counsel's knowledge, such registration with the Commission as an investment company under the 1940 Act is in full force and effect. (c) This Agreement has been duly authorized, executed and delivered by the Selling Fund and, assuming due authorization, execution, and delivery of this Agreement by the Acquiring Fund, is a valid and binding obligation of the Selling Fund enforceable against the Selling Fund in accordance with its terms, subject as to enforcement, to bankruptcy, insolvency, reorganization, moratorium and other laws relating to or affecting creditors' rights generally and to general equity principles. (d) To the knowledge of such counsel, no consent, approval, authorization or order of any court or governmental authority of the United States or the State of Delaware is required for consummation by the Selling Fund of the transactions contemplated herein, except such as have been obtained under the 1933 Act, the 1934 Act and the 1940 Act, and as may be required under state securities laws. (e) The execution and delivery of this Agreement did not, and the consummation of the transactions contemplated hereby will not, result in a violation of the Trust's Declaration of Trust or By-laws, or any provision of any material agreement, indenture, instrument, contract, lease or other undertaking (in each case known to such counsel) to which the Selling Fund is a party or by which it or any of its properties may be bound or, to the knowledge of such counsel, result in the acceleration of any obligation or the imposition of any penalty, under any agreement, judgment, or decree to which the Selling Fund is a party or by which it is bound. (f) Only insofar as they relate to the Selling Fund, the descriptions in the Prospectus/Proxy Statement of statutes, legal and government proceedings and material contracts, if any, are accurate and fairly present the information required to be shown. (g) To the knowledge of such counsel, no litigation or administrative proceeding or investigation of or before any court or governmental body is presently pending or threatened as to the Selling Fund or any of its respective properties or assets and the Selling Fund is neither a party to nor subject to the provisions of any order, decree or judgment of any court or governmental body, which materially and adversely affects its business other than as previously disclosed in the Prospectus/Proxy Statement. (h) Assuming that a consideration therefor of not less than the net asset value thereof has been paid, and assuming that such shares were issued in accordance with the terms of the Selling Fund's registration statement, or any amendment thereto, in effect at the time of such issuance, all issued and outstanding shares of the Selling Fund are legally issued and fully paid and non-assessable. Such opinion shall contain such other assumptions and limitations as shall be in the opinion of Sullivan & Worcester LLP appropriate to render the opinions expressed therein. In this paragraph 7.3, references to the Prospectus/Proxy Statement include and relate to only the text of such Prospectus/Proxy Statement and not to any exhibits or attachments thereto or to any documents incorporated by reference therein. ARTICLE VIII FURTHER CONDITIONS PRECEDENT TO OBLIGATIONS OF THE ACQUIRING FUND AND THE SELLING FUND If any of the conditions set forth below do not exist on or before the Closing Date with respect to the Selling Fund or the Acquiring Fund, the other party to this Agreement shall, at its option, not be required to consummate the transactions contemplated by this Agreement: 8.1 On the Closing Date, the Commission shall not have issued an unfavorable report under Section 25(b) of the 1940 Act, nor instituted any proceeding seeking to enjoin the consummation of the transactions contemplated by this Agreement under Section 25(c) of the 1940 Act and 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 transactions contemplated herein. 8.2 All required consents of other parties and all other consents, orders, and permits of federal, state and local regulatory authorities (including those of the Commission and of state Blue Sky securities authorities, including any necessary "no-action" positions of and exemptive orders from such federal and state authorities) to permit consummation of the transactions contemplated hereby shall have been obtained, except where failure to obtain any such consent, order, or permit would not involve a risk of a material adverse effect on the assets or properties of the Acquiring Fund or the Selling Fund, provided that either party hereto may for itself waive any of such conditions. 8.3 No stop orders suspending the effectiveness of the Registration Statement shall have been issued and, to the best knowledge of the parties hereto, no investigation or proceeding for that purpose shall have been instituted or be pending, threatened or contemplated under the 1933 Act. 8.4 The Selling Fund shall have declared a dividend or dividends which, together with all previous such dividends, shall have the effect of distributing to the shareholders of the Selling Fund all of the Selling Fund's net investment company taxable income for all taxable periods ending on or prior to the Closing Date (computed without regard to any deduction for dividends paid) and all of its net capital gains realized in all taxable periods ending on or prior to the Closing Date (after reduction for any capital loss carryforward). 8.5 The parties shall have received a favorable opinion of Sullivan & Worcester LLP addressed to the Acquiring Fund and the Selling Fund substantially to the effect that for federal income tax purposes: (a) The transfer of all of the Selling Fund assets in exchange for the Acquiring Fund Shares and the assumption by the Acquiring Fund of the identified liabilities of the Selling Fund followed by the distribution of the Acquiring Fund Shares to the Selling Fund Shareholders in dissolution and liquidation of the Selling Fund will constitute a "reorganization" within the meaning of Section 368(a)(1)(C) of the Code and the Acquiring Fund and the Selling Fund will each be a "party to a reorganization" within the meaning of Section 368(b) of the Code. (b) No gain or loss will be recognized by the Acquiring Fund upon the receipt of the assets of the Selling Fund solely in exchange for the Acquiring Fund Shares and the assumption by the Acquiring Fund of the identified liabilities of the Selling Fund. (c) No gain or loss will be recognized by the Selling Fund upon the transfer of the Selling Fund assets to the Acquiring Fund in exchange for the Acquiring Fund Shares and the assumption by the Acquiring Fund of the identified liabilities of the Selling Fund or upon the distribution (whether actual or constructive) of the Acquiring Fund Shares to Selling Fund Shareholders in exchange for their shares of the Selling Fund. (d) No gain or loss will be recognized by the Selling Fund Shareholders upon the exchange of their Selling Fund shares for the Acquiring Fund Shares in liquidation of the Selling Fund. (e) The aggregate tax basis for the Acquiring Fund Shares received by each Selling Fund Shareholder pursuant to the Reorganization will be the same as the aggregate tax basis of the Selling Fund shares held by such shareholder immediately prior to the Reorganization, and the holding period of the Acquiring Fund Shares to be received by each Selling Fund Shareholder will include the period during which the Selling Fund shares exchanged therefor were held by such shareholder (provided the Selling Fund shares were held as capital assets on the date of the Reorganization). (f) The tax basis of the Selling Fund assets acquired by the Acquiring Fund will be the same as the tax basis of such assets to the Selling Fund immediately prior to the Reorganization, and the holding period of the assets of the Selling Fund in the hands of the Acquiring Fund will include the period during which those assets were held by the Selling Fund. Notwithstanding anything herein to the contrary, neither the Acquiring Fund nor the Selling Fund may waive the conditions set forth in this paragraph 8.5. 8.6 The Acquiring Fund shall have received from KPMG LLP a letter addressed to the Acquiring Fund, in form and substance satisfactory to the Acquiring Fund, to the effect that: (a) they are independent certified public accountants with respect to the Selling Fund within the meaning of the 1933 Act and the applicable published rules and regulations thereunder; (b) on the basis of limited procedures agreed upon by the Acquiring Fund and described in such letter (but not an examination in accordance with generally accepted auditing standards), the Capitalization Table appearing in the Registration Statement and Prospectus/Proxy Statement has been obtained from and is consistent with the accounting records of the Selling Fund; and (c) on the basis of limited procedures agreed upon by the Acquiring Fund and described in such letter (but not an examination in accordance with generally accepted auditing standards), the pro forma financial statements that are included in the Registration Statement and Prospectus/Proxy Statement agree to the underlying accounting records of the Acquiring Fund and the Selling Fund or with written estimates provided by officers of the Trust who have responsibility for financial and reporting matters, and were found to be mathematically correct; and (d) on the basis of limited procedures agreed upon by the Acquiring Fund and described in such letter (but not an examination in accordance with generally accepted auditing standards), the data utilized in the calculations of the pro forma expense ratios appearing in the Registration Statement and Prospectus/Proxy Statement agree with underlying accounting records of the Selling Fund or with written estimates by the Selling Fund's management and were found to be mathematically correct. In addition, unless waived by the Acquiring Fund, the Acquiring Fund shall have received from KPMG LLP a letter addressed to the Acquiring Fund dated on the Closing Date, in form and substance satisfactory to the Acquiring Fund, to the effect that on the basis of limited procedures agreed upon by the Acquiring Fund (but not an examination in accordance with generally accepted auditing standards), the net asset value per share of the Selling Fund as of the Valuation Date was computed and the valuation of the portfolio was consistent with the valuation practices of the Acquiring Fund. 8.7 The Selling Fund shall have received from KPMG LLP a letter addressed to the Selling Fund, in form and substance satisfactory to the Selling Fund, to the effect that: (a) they are independent certified public accountants with respect to the Acquiring Fund within the meaning of the 1933 Act and the applicable published rules and regulations thereunder; (b) they had performed limited procedures agreed upon by the Selling Fund and described in such letter (but not an examination in accordance with generally accepted auditing standards) which consisted of a reading of any unaudited pro forma financial statements included in the Registration Statement and Prospectus/Proxy Statement, and making inquiries of appropriate officials of the Trust responsible for financial and accounting matters whether such unaudited pro forma financial statements comply as to form in all material respects with the applicable accounting requirements of the 1933 Act and the published rules and regulations thereunder; (c) on the basis of limited procedures agreed upon by the Selling Fund and described in such letter (but not an examination in accordance with generally accepted auditing standards), the Capitalization Table appearing in the Registration Statement and Prospectus/Proxy Statement has been obtained from and is consistent with the accounting records of the Acquiring Fund; and (d) on the basis of limited procedures agreed upon by the Selling Fund (but not an examination in accordance with generally accepted auditing standards), the data utilized in the calculations of the pro forma expense ratios appearing in the Registration Statement and Prospectus/Proxy Statement agree with written estimates by each Fund's management and were found to be mathematically correct. 8.8 The Board of Trustees of the Trust, subsequent to the vote of the shareholders of Mentor Income and Growth, shall have considered and approved the Reorganization as in the best interests of both the Selling Fund and the Acquiring Fund. ARTICLE IX EXPENSES 9.1 Except as otherwise provided for herein, all expenses of the transactions contemplated by this Agreement incurred by the Selling Fund and the Acquiring Fund, whether incurred before or after the date of this Agreement, will be borne equally by the Selling Fund and the Acquiring Fund. Such expenses include, without limitation, (a) expenses incurred in connection with the entering into and the carrying out of the provisions of this Agreement; (b) expenses associated with the preparation and filing of the Registration Statement under the 1933 Act covering the Acquiring Fund Shares to be issued pursuant to the provisions of this Agreement; (c) registration or qualification fees and expenses of preparing and filing such forms as are necessary under applicable state securities laws to qualify the Acquiring Fund Shares to be issued in connection herewith in each state in which the Selling Fund Shareholders are resident as of the date of the mailing of the Prospectus/Proxy Statement to such shareholders; (d) postage; (e) printing; (f) accounting fees; (g) legal fees; and (h) solicitation costs of the transaction. Notwithstanding the foregoing, the Acquiring Fund shall pay its own federal and state registration fees. ARTICLE X ENTIRE AGREEMENT; SURVIVAL OF WARRANTIES 10.1 The Acquiring Fund and the Selling Fund agree that neither party has made any representation, warranty or covenant not set forth herein and that this Agreement constitutes the entire agreement between the parties. 10.2 The representations, warranties, and covenants contained in this Agreement or in any document delivered pursuant hereto or in connection herewith shall not survive the consummation of the transactions contemplated hereunder. ARTICLE XI TERMINATION 11.1 This Agreement may be terminated by the mutual agreement of the Acquiring Fund and the Selling Fund. In addition, either the Acquiring Fund or the Selling Fund may at its option terminate this Agreement at or prior to the Closing Date because: (a) of a breach by the other of any representation, warranty, or agreement contained herein to be performed at or prior to the Closing Date, if not cured within 30 days; or (b) a condition herein expressed to be precedent to the obligations of the terminating party has not been met and it reasonably appears that it will not or cannot be met. 11.2 In the event of any such termination, in the absence of willful default, there shall be no liability for damages on the part of either the Acquiring Fund, the Selling Fund, the Trust, its Trustees or officers, to the other party, but each shall bear the expenses incurred by it incidental to the preparation and carrying out of this Agreement as provided in paragraph 9.1. ARTICLE XII AMENDMENTS 12.1 This Agreement may be amended, modified, or supplemented in such manner as may be mutually agreed upon in writing by the authorized officers of the Selling Fund and the Acquiring Fund; provided, however, that no such amendment may have the effect of changing the provisions for determining the number of the Acquiring Fund Shares to be issued to the Selling Fund Shareholders under this Agreement to the detriment of such Shareholders without their further approval. ARTICLE XIII HEADINGS; COUNTERPARTS; GOVERNING LAW; ASSIGNMENT; LIMITATION OF LIABILITY 13.1 The Article and paragraph headings contained in this Agreement are for reference purposes only and shall not affect in any way the meaning or interpretation of this Agreement. 13.2 This Agreement may be executed in any number of counterparts, each of which shall be deemed an original. 13.3 This Agreement shall be governed by and construed in accordance with the laws of the State of Delaware, without giving effect to the conflicts of laws provisions thereof. 13.4 This Agreement shall bind and inure to the benefit of the parties hereto and their respective successors and assigns, but, except as provided in this paragraph, no assignment or transfer hereof or of any rights or obligations hereunder shall be made by any party without the written consent of the other party. Nothing herein expressed or implied is intended or shall be construed to confer upon or give any person, firm, or corporation, other than the parties hereto and their respective successors and assigns, any rights or remedies under or by reason of this Agreement. 13.5 It is expressly agreed that the obligations of the Acquiring Fund and the Selling Fund hereunder shall not be binding upon any of the Trustees, shareholders, nominees, officers, agents, or employees of the Trust personally, but shall bind only the trust property of the Acquiring Fund and of the Selling Fund, as provided in the Declaration of Trust of the Trust. The execution and delivery of this Agreement have been authorized by the Trustees of the Trust on behalf of the Acquiring Fund and the Selling Fund and signed by authorized officers of the Trust, acting as such, and neither such authorization by such Trustees nor such execution and delivery by such officers shall be deemed to have been made by any of them individually or to impose any liability on any of them personally, but shall bind only the trust property of the Acquiring Fund and of the Selling Fund as provided in the Declaration of Trust of the Trust. IN WITNESS WHEREOF, the parties have duly executed this Agreement, all as of the date first written above. EVERGREEN EQUITY TRUST ON BEHALF OF EVERGREEN CAPITAL INCOME AND GROWTH FUND By: Name: Title: EVERGREEN EQUITY TRUST ON BEHALF OF EVERGREEN CAPITAL BALANCED FUND By: Name: Title: EXHIBIT E MENTOR BALANCED PORTFOLIO MANAGERS' COMMENTARY: THE BALANCED MANAGEMENT TEAM SEPTEMBER 30, 1998 - -------------------------------------------------------------------------------- The Mentor Balanced Portfolio, which has been in existence since 1994, became available to investors in multiple retail mutual fund share classes for the first time in September. This commentary, therefore, marks the first opportunity for the managers of the Portfolio to provide their market perspective to many of our new shareholders. At quarter end the asset allocation mix in the Mentor Balanced Portfolio was 58% stocks, 41% bonds, and 1% cash. MARKET OVERVIEW The first three quarters of 1998 culminated an unprecedented trend of 14 consecutive quarterly gains for the S&P 500. The July-September period, however, saw a dramatic departure from this trend, with the S&P 500 declining 10%. Despite poor equity returns, U.S. government fixed-income markets were extremely strong. In fact, the July-September period marked one of the few times in recent years that bonds significantly outperformed stocks. However, the broad rally in treasury bonds was not shared by more credit-sensitive fixed-income sectors, as investors aggressively shifted assets into low risk instruments only. EQUITY REVIEW AND OUTLOOK For some time we have been emphatically cautioning that the stock market would have to adjust to considerably lower corporate earnings prospects, and this transition would likely result in increased volatility and lower returns than experienced over the past several years. Finally, this scenario is unfolding in full force. Earnings estimates for a broad range of companies are being sharply reduced. It is now quite possible, in fact likely in our opinion, that the earnings of the S&P 500 will continue to decline during the remainder of this year and 1999. These trends present a significant change from the strong, better-than-expected earnings growth that has been a key pillar supporting the bull market since 1990, one of the best on record by almost any measure. But this change was inevitable. It is part of the natural cyclical patterns of the economy, corporate profitability, and the stock market. After nearly perfect growth conditions during much of the 1990's, corporate profitability is coming under pressure as global excess capacity is chasing falling demand. And as should be expected at this point, lenders are sharply curtailing credit and thereby reinforcing these developing pressures. Fear and greed are a long-term investor's best asset and worst threat. It is exceedingly difficult for both individual and institutional investors to look through an emotionally charged volatile market and focus on the fundamentals. To us, fundamental analysis does not mean trying to figure out cyclical swings in the economy and markets over the next year. It means concentrating on longer-term business qualities. We know that consistently implementing a well-defined investment discipline through the ups and downs of an entire cycle is the best way to ensure long-term success. We focus on a diversified group of companies with excellent operating records and leading competitive positions. We are biased toward companies with above-average business predictability. We have thoroughly analyzed their results and prospects. We own them at prices we believe offer attractive relative values. It is a very simple approach. Not an easy one, but a straightforward one. We will at times be wrong in our analysis, but we will strive to be as objective as possible. Of course, we expect to be right more 54 MENTOR BALANCED PORTFOLIO MANAGERS' COMMENTARY: THE BALANCED MANAGEMENT TEAM SEPTEMBER 30, 1998 - -------------------------------------------------------------------------------- often than not. We will not alter this approach just because those around us are becoming more complacent or fearful. Over the long-term, cyclical swings wash out and business fundamentals prevail. FIXED INCOME REVIEW AND OUTLOOK On the fixed-income side, our short-term strategy in this tumultuous environment has been to tilt portfolio durations somewhat long relative to our benchmarks, as well as more heavily weight sector allocations toward treasury securities. Given our long-term confidence in the U.S. economy, we are waiting for an opportunity to aggressively move into domestic spread sectors. Prior to such a move, we will have to be convinced that these markets have stabilized. In our opinion such stabilization will require the Fed to continue to move forcefully to further ease credit conditions. The primary risk we see to our outlook is timing. The U.S. economy has tremendous forward momentum and the current yield curve is already pricing in an aggressive Fed ease. Should events unfold more slowly than the market hopes, the bond market could encounter some short-term turbulence. We would view these sell-offs as short term in nature and would utilize the higher yield levels to extend our duration further. November 1998 55 MENTOR BALANCED PORTFOLIO SEPTEMBER 30, 1998 - -------------------------------------------------------------------------------- PERFORMANCE COMPARISON Comparison of change in value of a hypothetical $10,000 investment in Mentor Balanced Portfolio Class A Shares, the S&P 500 and the Lehman Brothers Aggregate Bond Index.+ [GRAPH] 9/16/98 9/30/98 Class A 9,422 9,433 LAGG/S&P 500 10,000 10,464 Total Returns as of 9/30/98 1-Year Since Inception++ Class n/a (5.78%) PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE PERFORMANCE. YOUR INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO WHEN SHARES ARE REDEEMED, THEY MAY BE WORTH MORE OR LESS THAN ORIGINAL COST. MUTUAL FUNDS ARE NOT OBLIGATIONS OF OR GUARANTEED BY ANY BANK AND ARE NOT FEDERALLY INSURED. * Represents a hypothetical investment of $10,000 in Mentor Balanced Portfolio Class A Shares after deducting the maximum sales charge of 5.75% ($10,000 investment minus $575 sales charge). The Class A Shares' performance assumes the reinvestment of all dividends and distributions. + The Standard & Poor's Index (S&P 500) is an unmanaged, market-value-weighted index of 500 widely held domestic common stocks. An unmanaged index does not reflect expenses and may not correspond to the performance of a managed portfolio in which expenses are incurred. The Lehman Brothers Aggregate Index is made up of the Government/Corporate Index, the Mortgage-Backed Securities Index, and the Asset-Backed Securities Index. The Lehman Brothers Aggregate Bond Index and S&P 500 are adjusted to reflect reinvestment of interest and dividends on securities in the indexes. The Lehman Brothers Aggregate Bond Index and S&P 500 are not adjusted to reflect sales loads, expenses, or other fees that the SEC requires to be reflected in the Portfolio's performance. This index represents an asset allocation of 60% S&P 500 stocks and 40% Lehman Brothers Aggregate Bond Index. ++ Reflects operations of Mentor Balanced Portfolio Class A Shares from the date of issuance on 9/16/98 through 9/30/98. Comparison of change in value of a hypothetical $10,000 investment in Mentor Balanced Portfolio Class Y Shares, the S&P 500 and the Lehman Brothers Aggregate Bond Index.+ [GRAPH] 9/16/98 9/30/98 Class Y 10,000 10,000 LAGG/S&P 500 10,000 10,464 Total Returns as of 9/30/98 1-Year Since Inception** Class Y n/a 0.00% PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE PERFORMANCE. YOUR INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO WHEN SHARES ARE REDEEMED, THEY MAY BE WORTH MORE OR LESS THAN ORIGINAL COST. MUTUAL FUNDS ARE NOT OBLIGATIONS OF OR GUARANTEED BY ANY BANK AND ARE NOT FEDERALLY INSURED. ** Represents a hypothetical investment of $10,000 in Mentor Balanced Portfolio Class Y Shares. These shares are not subject to any sales or contingent deferred sales charges. The Class Y Shares' performance assumes the reinvestment of all dividends and distributions. *** Reflects operations of Mentor Balanced Portfolio Class Y Shares from the date of issuance on 9/16/98 through 9/30/98. 56 MENTOR BALANCED PORTFOLIO SEPTEMBER 30, 1998 - -------------------------------------------------------------------------------- PERFORMANCE COMPARISON Comparison of change in value of a hypothetical $10,000 investment in Mentor Balanced Portfolio Class B Shares, the S&P 500 and the Lehman Brothers Aggregate Bond Index.+ [GRAPH] S&P 500 and Class B Class B* Lehman Brothers Aggregate Bond Index 6/21/94 10000 10000 10000 12/31/94 10108 9610 10336 6/30/95 11561 11161 12054 9/30/95 12085 11685 12723 9/30/96 14260 13960 14506 9/30/97 18042 17842 18496 9/30/98 20181 19760 20446 Average Annual Return as of 9/30/98 Average Annual Return as of 9/30/98 Without Sales Charges Including Sales Charges 1-Year Since Inception++ 1-Year Since Inception++ Class B 11.86% 17.83% Class B 8.75% 17.69% PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE PERFORMANCE. YOUR INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO WHEN SHARES ARE REDEEMED, THEY MAY BE WORTH MORE OR LESS THAN ORIGINAL COST. MUTUAL FUNDS ARE NOT OBLIGATIONS OF OR GUARANTEED BY ANY BANK AND ARE NOT FEDERALLY INSURED. ~ Represents a hypothetical investment of $10,000 in Mentor Balanced Portfolio Class B Shares. A contingent deferred sales charge will be imposed, if applicable, on Class B shares at rates ranging from a maximum of 4.00% of amounts redeemed during the first year following the date of purchase to 1.00% of amounts redeemed during the five-year period following the date of purchase. The value of Class B Shares reflects a redemption fee in effect at the end of each of the stated periods. Prior to September 16, 1998, contingent deferred sales charges of 5.00% were waived. The Class B Shares' performance assumes the reinvestment of all dividends and distributions. + The Standard & Poor's Index (S&P 500) is an unmanaged, market- value-weighted index of 500 widely held domestic common stocks. An unmanaged index does not reflect expenses and may not correspond to the performance of a managed portfolio in which expenses are incurred. The Lehman Brothers Aggregate Index is made up of the Government/Corporate Index, the Mortgage-Backed Securities Index, and the Asset-Backed Securities Index. The Lehman Brothers Aggregate Bond Index and S&P 500 are adjusted to reflect reinvestment of interest and dividends on securities in the indexes. The Lehman Brothers Aggregate Bond Index and S&P 500 are not adjusted to reflect sales loads, expenses, or other fees that the SEC requires to be reflected in the Portfolio's performance. This index represents an asset allocation of 60% S&P 500 stocks and 40% Lehman Brothers Aggregate Bond Index. ++ Reflects operations of Mentor Balanced Portfolio Class B Shares from the date of commencement of operations on 6/21/94 through 9/30/98. * Includes maximum Contingent Deferred Sales Charge (CDSC) of 5%. 57 D-125 STATEMENT OF ADDITIONAL INFORMATION CONVERSION OF MENTOR INCOME AND GROWTH PORTFOLIO a series of MENTOR FUNDS 901 East Byrd Street Richmond, Virginia 23219 (800) 869-6042 Into a Series of EVERGREEN EQUITY TRUST 200 Berkeley Street Boston, Massachusetts 02116 (800) 343-2898 AND ACQUISITION OF THE ASSETS OF MENTOR INCOME AND GROWTH PORTFOLIO By and In Exchange For Shares of EVERGREEN CAPITAL BALANCED FUND a series of EVERGREEN EQUITY TRUST This Statement of Additional Information, relating specifically to the proposed transfer of the assets and liabilities of Mentor Income and Growth Portfolio ("Mentor Income and Growth"), a series of Mentor Funds, to Evergreen Capital Balanced Fund ("Evergreen Capital Balanced"), a series of Evergreen Equity Trust, in exchange for Class A shares (to be issued to holders of Class A shares of Mentor Income and Growth), Class C shares (to be issued to holders of Class B shares of Mentor Income and Growth), and Class Y shares (to be issued to holders of Class Y shares of Mentor Income and Growth) of beneficial interest, $.001 par value per share, of Evergreen Capital Balanced, consists of this cover page and the following described documents, each of which is attached hereto and incorporated by reference herein: -126- (1) The Statement of Additional Information of Mentor Income and Growth dated December 15, 1998; (2) The Statement of Additional Information of Mentor Balanced dated December 15, 1998; (3) Annual Report of Mentor Income and Growth for the year ended September 30, 1998; (4) Semi-Annual Report of Mentor Income and Growth for the six month period ended March 31, 1999; (5) Annual Report of Mentor Balanced for the year ended September 30, 1998; (6) Semi-Annual Report of Mentor Balanced for the six month period ended March 31, 1999; and (7) Pro-Forma Combining Financial Statements for March 31, 1999 and the twelve months then ended (unaudited). This Statement of Additional Information, which is not a prospectus, supplements, and should be read in conjunction with, the Prospectus/Proxy Statement of Mentor Balanced and Mentor Income and Growth dated August 27, 1999. A copy of the Prospectus/Proxy Statement may be obtained without charge by calling or writing to Mentor Balanced or Mentor Income and Growth at the telephone numbers or addresses set forth above or by calling toll free 1-800-645-7816. The date of this Statement of Additional Information is August 27, 1999. MENTOR FUNDS STATEMENT OF ADDITIONAL INFORMATION (MENTOR GROWTH PORTFOLIO, MENTOR PERPETUAL GLOBAL PORTFOLIO, MENTOR CAPITAL GROWTH PORTFOLIO, MENTOR BALANCED PORTFOLIO, MENTOR INCOME AND GROWTH PORTFOLIO, MENTOR MUNICIPAL INCOME PORTFOLIO, MENTOR QUALITY INCOME PORTFOLIO, MENTOR SHORT-DURATION INCOME PORTFOLIO, MENTOR HIGH INCOME PORTFOLIO) December 15, 1998 Mentor Funds (the "Trust") is an open-end series investment company. This Statement of Additional Information is not a prospectus and should be read in conjunction with the relevant prospectus of the Trust. A copy of a prospectus in respect of a Portfolio can be obtained upon request by writing to Mentor Services Company, Inc., at 901 East Byrd Street, Richmond, Virginia 23219, or by calling Mentor Services Company at 1-800-869-6042. This Statement is in parts. Part I contains information with respect to Mentor Capital Growth Portfolio, Mentor Quality Income Portfolio, Mentor Municipal Income Portfolio, Mentor Income and Growth Portfolio, and Mentor Perpetual Global Portfolio. Part II contains information with respect to Mentor Growth Portfolio, Mentor Short-Duration Income Portfolio, and Mentor Balanced Portfolio. Part III contains information with respect to Mentor High Income Portfolio. Part IV provides general information with respect to the Trust and all of the Portfolios. TABLE OF CONTENTS Introduction ............................................................................. ii PART I ................................................................................... 1 Investment Restrictions ................................................................ 1 PART II .................................................................................. 4 Investment Restrictions ................................................................ 4 PART III ................................................................................. 7 Investment Restrictions ................................................................ 7 PART IV .................................................................................. 8 Certain Investment Techniques .......................................................... 8 Management of the Trust ................................................................ 27 Principal Holders of Securities ........................................................ 30 Investment Advisory Services ........................................................... 31 Administrative Services ................................................................ 33 Shareholder Servicing Plan ............................................................. 35 Brokerage Transactions ................................................................. 36 How to Buy Shares ...................................................................... 39 Distribution ........................................................................... 39 Determining Net Asset Value ............................................................ 40 Redemptions in Kind .................................................................... 42 Taxes .................................................................................. 42 Independent Accountants ................................................................ 46 Custodian .............................................................................. 46 Performance Information ................................................................ 47 Equivalent Yields: Tax-exempt Versus Taxable Securities for the Municipal Income Portfolio .............................................................................. 49 Mentor Municipal Income Portfolio -- Federal Taxable Equivalent Yield Table-1998 Rates . 50 Members of Investment Management Teams ................................................. 51 Performance Comparisons ................................................................ 54 Shareholder Liability .................................................................. 59
i INTRODUCTION Mentor Funds is a Massachusetts business trust organized on January 20, 1992 as Cambridge Series Trust. This Statement relates to the following nine portfolios of the Trust (collectively, the "Portfolios" and each individually, the "Portfolio"): Mentor Growth Portfolio (the "Growth Portfolio"); Mentor Quality Income Portfolio (the "Quality Income Portfolio"); Mentor Balanced Portfolio (the "Balanced Portfolio"); Mentor Capital Growth Portfolio (the "Capital Growth Portfolio"); Mentor Perpetual Global Portfolio (the "Global Portfolio"); Mentor Income and Growth Portfolio (the "Income and Growth Portfolio"); Mentor Municipal Income Portfolio (the "Municipal Income Portfolio"); Mentor Short-Duration Income Portfolio (the "Short-Duration Income Portfolio"); and Mentor High Income Portfolio ("the High Income Portfolio"). Each Portfolio has three classes of shares of beneficial interest, Class A shares, Class B shares, and Class Y (Institutional) shares. With respect to the investment restrictions described below, all percentage limitations on investments will apply at the time of investment and shall not be considered violated unless an excess or deficiency occurs or exists immediately after and as a result of such investment. Except for the investment restrictions listed below as fundamental or to the extent designated as such in the Prospectus in respect of a Portfolio, the other investment policies described in this Statement or in the Prospectus are not fundamental and may be changed by approval of the Trustees. As a matter of policy, the Trustees would not materially change a Portfolio's investment objective without shareholder approval. The Investment Company Act of 1940, as amended (the "1940 Act"), provides that a "vote of a majority of the outstanding voting securities" of a Portfolio means the affirmative vote of the lesser of (1) more than 50% of the outstanding shares of the Portfolio, or (2) 67% or more of the shares present at a meeting if more than 50% of the outstanding shares are represented at the meeting in person or by proxy. ii PART I The following information relates to each of the Capital Growth, Quality Income, Municipal Income, Income and Growth, and the Global Portfolios, except where otherwise noted. INVESTMENT RESTRICTIONS The following investment restrictions are fundamental and may not be changed without a vote of a majority of the outstanding voting securities of a Portfolio: 1. (not applicable to the Quality Income Portfolio) The Portfolios will not issue senior securities except that a Portfolio (other than the Municipal Income Portfolio) may borrow money directly or through reverse repurchase agreements in amounts of up to one-third of the value of its net assets, including the amount borrowed; and except to the extent that a Portfolio may enter into futures contracts. The Municipal Income Portfolio may borrow money from banks for temporary purposes in amounts of up to 5% of its total assets. The Portfolios will not borrow money or engage in reverse repurchase agreements for investment leverage, but rather as a temporary, extraordinary, or emergency measure or to facilitate management of the Portfolio by enabling it to meet redemption requests when the liquidation of portfolio securities is deemed to be inconvenient or disadvantageous. The Portfolios will not purchase any securities while any borrowings in excess of 5% of its total assets are outstanding. During the period any reverse repurchase agreements are outstanding, the Quality Income Portfolio will restrict the purchase of portfolio securities to money market instruments maturing on or before the expiration date of the reverse repurchase agreements, but only to the extent necessary to assure completion of the reverse repurchase agreements. Notwithstanding this restriction, the Portfolios may enter into when-issued and delayed delivery transactions. 2. The Portfolios will not sell any securities short or purchase any securities on margin, but may obtain such short-term credits as are necessary for clearance of purchases and sales of securities. The deposit or payment by a Portfolio of initial or variation margin in connection with futures contracts or related options transactions is not considered the purchase of a security on margin. 3. (not applicable to the Quality Income Portfolio) The Portfolios will not mortgage, pledge, or hypothecate any assets, except to secure permitted borrowings. In these cases the Portfolios may pledge assets having a value of 10% of assets taken at cost. For purposes of this restriction, (a) the deposit of assets in escrow in connection with the writing of covered put or call options and the purchase of securities on a when-issued basis; and (b) collateral arrangements with respect to (i) the purchase and sale of stock options (and options on stock indexes) and (ii) initial or variation margin for futures contracts, will not be deemed to be pledges of a Portfolio's assets. Margin deposits for the purchase and sale of futures contracts and related options are not deemed to be a pledge. 4. The Portfolios will not lend any of their respective assets except portfolio securities up to one-third of the value of total assets. (The Municipal Income Portfolio will not lend portfolio securities.) This shall not prevent a Portfolio from purchasing or holding U.S. government obligations, money market instruments, variable amount demand master notes, bonds, debentures, notes, certificates of indebtedness, or other debt 1 securities, entering into repurchase agreements, or engaging in other transactions where permitted by a Portfolio's investment objective, policies and limitations or Declaration of Trust. The Municipal Income Portfolio will not make loans except to the extent the obligations the Portfolio may invest in are considered to be loans. 5. The Portfolios (other than the Quality Income Portfolio) will not invest more than 10% of the value of their net assets in restricted securities; the Quality Income Portfolio will not invest more than 15% of the value of its net assets in restricted securities. 6. None of the Portfolios will invest in commodities, except to the extent that the Portfolios may engage in transactions involving futures contracts or options on futures contracts, and except to the extent the securities the Municipal Income Portfolio invests in are considered interests in commodities or commodities contracts or to the extent the Portfolio exercises its rights under agreements relating to such municipal securities. 7. None of the Portfolios will purchase or sell real estate, including limited partnership interests, except to the extent the securities the Income and Growth Portfolio and Municipal Income Portfolio may invest in are considered to be interests in real estate or to the extent the Municipal Income Portfolio exercises its rights under agreements relating to such municipal securities (in which case the Portfolio may liquidate real estate acquired as a result of a default on a mortgage), although the Portfolios may invest in securities of issuers whose business involves the purchase or sale of real estate or in securities which are secured by real estate or interests in real estate. 8. With respect to 75% of the value of its respective total assets, a Portfolio will not purchase securities issued by any one issuer (other than cash or securities issued or guaranteed by the government of the United States or its agencies or instrumentalities and repurchase agreements collateralized by such securities), if as a result more than 5% of the value of its total assets would be invested in the securities of that issuer. A Portfolio will not acquire more than 10% of the outstanding voting securities of any one issuer. 9. A Portfolio will not invest 25% or more of the value of its respective total assets in any one industry (other than securities issued by the U.S. Government, its agencies or instrumentalities). As described in the Trust's Prospectus, the Municipal Income Portfolio may from time to time invest more than 25% of its assets in a particular segment of the municipal bond market; however, that Portfolio will not invest more than 25% of its assets in industrial development bonds in a single industry except as described in the Trust's Prospectus. 10. A Portfolio will not underwrite any issue of securities, except as a Portfolio may be deemed to be an underwriter under the Securities Act of 1933 in connection with the sale of securities in accordance with its investment objective, policies, and limitations. 11. The Quality Income Portfolio will not issue any class of securities which are senior to the Portfolio's shares except that the Portfolio may borrow money as contemplated by the following restriction. 12. The Quality Income Portfolio will not borrow more than 33 1/3% of the value of its total assets less all liabilities and indebtedness (other than such borrowings). 2 In addition, the following practices are contrary to the current policy of each of the Portfolios (except as otherwise noted), and may be changed without shareholder approval: investing in (a) securities which at the time of such investment are not readily marketable, (b) securities restricted as to resale (excluding securities determined by the Trustees of the fund (or the person designated by the Trustees of the fund to make such determinations) to be readily marketable), and (c) repurchase agreements maturing in more than seven days, if, as a result, more than 15% of the Portfolio's net assets (taken at current value) would be invested in securities described in (a), (b) and (c) above. 3 PART II The following information relates to each of the Balanced, Growth, and Short-Duration Income Portfolios, except where otherwise noted. INVESTMENT RESTRICTIONS As fundamental investment restrictions, which may not be changed with respect to a Portfolio without a vote of a majority of the outstanding shares of that Portfolio, a Portfolio may not: 1. Issue any securities which are senior to the Portfolio's shares as described herein and in the relevant prospectus, except that each of the Portfolios other than the Growth Portfolio may borrow money to the extent contemplated by Restriction 4 below. 2. Purchase securities on margin (but a Portfolio may obtain such short-term credits as may be necessary for the clearance of transactions). (Margin payments in connection with transactions in futures contracts, options, and other financial instruments are not considered to constitute the purchase of securities on margin for this purpose.) 3. Make short sales of securities or maintain a short position, unless at all times when a short position is open, it owns an equal amount of such securities or securities convertible into or exchangeable, without payment of any further consideration, for securities of the same issue as, and equal in amount to, the securities sold short ("short sale against-the-box"), and unless not more than 25% of the Portfolio's net assets (taken at current value) is held as collateral for such sales at any one time. 4. (Growth Portfolio) Borrow money or pledge its assets except that a Portfolio may borrow from banks for temporary or emergency purposes (including the meeting of redemption requests which might otherwise require the untimely disposition of securities) in amounts not exceeding 10% (taken at the lower of cost or market value) of its total assets (not including the amount borrowed) and pledge its assets to secure such borrowings; provided that a Portfolio will not purchase additional portfolio securities when such borrowings exceed 5% of its total assets. (Collateral or margin arrangements with respect to options, futures contracts, or other financial instruments are not considered to be pledges.) (All other Portfolios included in Part II) Borrow more than 33 1/3% of the value of its total assets less all liabilities and indebtedness (other than such borrowings) not represented by senior securities. 5. Act as underwriter of securities of other issuers except to the extent that, in connection with the disposition of portfolio securities, it may be deemed to be an underwriter under certain federal securities laws. 6. Purchase any security if as a result the Portfolio would then have more than 5% of its total assets (taken at current value) invested in securities of companies (including predecessors) less than three years old or (in the case of Growth Portfolio) in equity securities for which market quotations are not readily available. 7. (as to the Growth Portfolio only) Purchase any security if as a result the Portfolio would then hold more than 10% of any class of securities of an issuer (taking all common stock issues of an issuer as a single class, all preferred stock issues as a single class, and all debt issues as a single class) or more than 10% of the outstanding voting securities of an issuer. 4 8. Purchase any security (other than obligations of the U.S. Government, its agencies or instrumentalities) if as a result: (i) more than 5% of the Portfolio's total assets (taken at current value) would then be invested in securities of a single issuer, or (ii) more than 25% of the Portfolio's total assets (taken at current value) would be invested in a single industry; provided that the restriction set out in (i) above shall apply, in the case of each Portfolio other than the Growth Portfolio, only as to 75% of such Portfolio's total assets. 9. Invest in securities of any issuer if, to the knowledge of the Trust, any officer or Trustee of the Trust or of Mentor Investment Advisors, LLC as the case may be, owns more than 1/2 of 1% of the outstanding securities of such issuer, and such officers and Trustees who own more than 1/2 of 1% own in the aggregate more than 5% of the outstanding securities of such issuer. 10. Purchase or sell real estate or interests in real estate, including real estate mortgage loans, although it may purchase and sell securities which are secured by real estate and securities of companies that invest or deal in real estate (or, in the case of any Portfolio other than the Growth Portfolio, real estate or limited partnership interests). (For purposes of this restriction, investments by a Portfolio in mortgage-backed securities and other securities representing interests in mortgage pools shall not constitute the purchase or sale of real estate or interests in real estate or real estate mortgage loans.) 11. Make investments for the purpose of exercising control or management. 12. (as to the Growth Portfolio only) Participate on a joint or a joint and several basis in any trading account in securities. 13. (as to the Growth Portfolio only) Purchase any security restricted as to disposition under federal securities laws if as a result more than 5% of the Portfolio's total assets (taken at current value) would be invested in restricted securities. 14. (as to the Growth Portfolio only) Invest in securities of other registered investment companies, except by purchases in the open market involving only customary brokerage commissions and as a result of which not more than 5% of its total assets (taken at current value) would be invested in such securities, or except as part of a merger, consolidation or other acquisition. 15. Invest in interests in oil, gas or other mineral exploration or development programs or leases, although it may invest in the common stocks of companies that invest in or sponsor such programs. 16. (as to the Growth Portfolio only) Make loans, except through (i) repurchase agreements (repurchase agreements with a maturity of longer than 7 days together with other illiquid assets being limited to 10% of the Portfolio's assets,) and (ii) loans of portfolio securities (limited to 33% of the Portfolio's total assets). 17. (as to the Growth Portfolio only) Purchase foreign securities or currencies except foreign securities which are American Depository Receipts listed on exchanges or otherwise traded in the United States and certificates of deposit, bankers' acceptances and other obligations of foreign banks and foreign branches of U.S. banks if, giving effect to such purchase, such obligations would constitute less than 10% of the Trust's total assets (at current value). 5 18. (as to the Growth Portfolio only) Purchase warrants if as a result the Portfolio would then have more than 5% of its total assets (taken at current value) invested in warrants. 19. (as to each Portfolio other than the Growth Portfolio) Acquire more than 10% of the voting securities of any issuer. 20. (as to each Portfolio other than the Growth Portfolio) Make loans, except by purchase of debt obligations in which the Portfolio may invest consistent with its investment policies, by entering into repurchase agreements with respect to not more than 25% of its total assets (taken at current value), or through the lending of its portfolio securities with respect to not more than 25% of its total assets. 21. Purchase or sell commodities or commodity contracts, except that a Portfolio may purchase or sell financial futures contracts, options on financial futures contracts, and futures contracts, forward contracts, and options with respect to foreign currencies, and may enter into swap transactions. (This restriction applies to the Growth Portfolio.) In addition, it is contrary to the current policy of each of the Portfolios, which policy may be changed without shareholder approval, to invest in (a) securities which at the time of such investment are not readily marketable, (b) securities restricted as to resale (excluding securities determined by the Trustees of the fund (or the person designated by the Trustees of the fund to make such determinations) to be readily marketable), and (c) repurchase agreements maturing in more than seven days, if, as a result, more than 15% of the Portfolio's net assets (taken at current value) would be invested in securities described in (a), (b) and (c) above. 6 PART III The following information relates to the High Income Portfolio. INVESTMENT RESTRICTIONS As fundamental investment restrictions, which may not be changed with respect to the Portfolio without approval by the holders of a majority of the outstanding shares of the Portfolio, the Portfolio may not: 1. Purchase any security (other than U.S. Government securities) if as a result: (i) as to 75% of such Portfolio's total assets, more than 5% of the Portfolio's total assets (taken at current value) would then be invested in securities of a single issuer, or (ii) more than 25% of the Portfolio's total assets would be invested in a single industry. 2. Acquire more than 10% of the voting securities of any issuer. 3. Act as underwriter of securities of other issuers except to the extent that, in connection with the disposition of portfolio securities, it may be deemed to be an underwriter under certain federal securities laws. 4. Issue any class of securities which is senior to the Portfolio's shares of beneficial interest, except as contemplated by restriction 6 below. 5. Purchase or sell real estate or interests in real estate, including real estate mortgage loans, although it may purchase and sell securities which are secured by real estate and securities of companies that invest or deal in real estate or real estate limited partnership interests. (For purposes of this restriction, investments by a Portfolio in mortgage-backed securities and other securities representing interests in mortgage pools shall not constitute the purchase or sale of real estate or interests in real estate or real estate mortgage loans.) 6. Borrow more than 33 1/3% of the value of its total assets less all liabilities and indebtedness (other than such borrowings) 7. Purchase or sell commodities or commodity contracts, except that a Portfolio may purchase or sell financial futures contracts, options on futures contracts, and futures contracts, forward contracts, and options with respect to foreign currencies, and may enter into swap transactions. 8. Make loans, except by purchase of debt obligations in which the Portfolio may invest consistent with its investment policies, by entering into repurchase agreements, or by lending its portfolio securities. In addition, it is contrary to the current policy of the Portfolio, which policy may be changed without shareholder approval, to invest in (a) securities which at the time of such investment are not readily marketable, (b) securities restricted as to resale (excluding securities determined by the Trustees of the Trust (or the person designated by the Trustees to make such determinations) to be readily marketable), and (c) repurchase agreements maturing in more then seven days, if, as a result, more than 15% of the Portfolio's net assets (taken at current value) would then be invested in securities described in (a), (b), and (c). 7 PART IV All percentage limitations on investments (including those described in Parts I, II, and III above) will apply at the time of investment and shall not be considered violated unless an excess or deficiency occurs or exists immediately after and as a result of such investment. Except for the investment restrictions listed above as fundamental or to the extent designated as such in a Prospectus with respect to a Portfolio, the other investment policies described in this Statement or in a Prospectus are not fundamental and may be changed by approval of the Trustees. As a matter of policy, the Trustees would not materially change a Portfolio's investment objective without shareholder approval. The Investment Company Act of 1940, as amended (the "1940 Act"), provides that a "vote of a majority of the outstanding voting securities" of the Portfolio means the affirmative vote of the lesser of (1) more than 50% of the outstanding shares of the Portfolio, and (2) 67% or more of the shares present at a meeting if more than 50% of the outstanding shares are represented at the meeting in person or by proxy. All information with respect to fees, expenses, and performance (except where otherwise indicated) is based on a Portfolio's fiscal year end. All of the Portfolios have a September 30 fiscal year end. Certain information with respect to certain Portfolios is given for partial fiscal years. See "Financial Highlights" in the Trust's prospectuses for information concerning the commencement of operations of each of the Portfolios. CERTAIN INVESTMENT TECHNIQUES Set forth below is information concerning certain investment techniques in which one or more of the Portfolios may engage, and certain of the risks they may entail. Certain of the investment techniques may not be available to a Portfolio. See the Prospectus relating to a particular Portfolio for a description of the investment techniques generally applicable to that Portfolio. For purposes of this section, a Portfolio's investment adviser or subadviser (if any) is referred to as an "Adviser". OPTIONS A Portfolio may purchase and sell put and call options on its portfolio securities to enhance investment performance or to protect against changes in market prices. COVERED CALL OPTIONS. A Portfolio may write covered call options on its securities to realize a greater current return through the receipt of premiums than it would realize on its securities alone. Such option transactions may also be used as a limited form of hedging against a decline in the price of securities owned by the Portfolio. A call option gives the holder the right to purchase, and obligates the writer to sell, a security at the exercise price at any time before the expiration date. A call option is "covered" if the writer, at all times while obligated as a writer, either owns the underlying securities (or comparable securities satisfying the cover requirements of the securities exchanges), or has the right to acquire such securities through immediate conversion of securities. In return for the premium received when it writes a covered call option, a Portfolio gives up some or all of the opportunity to profit from an increase in the market price of the securities covering the call option during the life of the option. The Portfolio retains the risk of loss should the price of such securities decline. If the option expires unexercised, the Portfolio realizes a gain equal to the premium, which may be offset by a decline 8 in price of the underlying security. If the option is exercised, the Portfolio realizes a gain or loss equal to the difference between the Portfolio's cost for the underlying security and the proceeds of sale (exercise price minus commissions) plus the amount of the premium. A Portfolio may terminate a call option that it has written before it expires by entering into a closing purchase transaction. A Portfolio may enter into closing purchase transactions in order to free itself to sell the underlying security or to write another call on the security, realize a profit on a previously written call option, or protect a security from being called in an unexpected market rise. Any profits from a closing purchase transaction may be offset by a decline in the value of the underlying security. Conversely, because increases in the market price of a call option will generally reflect increases in the market price of the underlying security, any loss resulting from a closing purchase transaction is likely to be offset in whole or in part by unrealized appreciation of the underlying security owned by the Portfolio. COVERED PUT OPTIONS. A Portfolio may write covered put options in order to enhance its current return. Such options transactions may also be used as a limited form of hedging against an increase in the price of securities that the Portfolio plans to purchase. A put option gives the holder the right to sell, and obligates the writer to buy, a security at the exercise price at any time before the expiration date. A put option is "covered" if the writer segregates cash and high-grade short-term debt obligations or other permissible collateral equal to the price to be paid if the option is exercised. In addition to the receipt of premiums and the potential gains from terminating such options in closing purchase transactions, a Portfolio also receives interest on the cash and debt securities maintained to cover the exercise price of the option. By writing a put option, the Portfolio assumes the risk that it may be required to purchase the underlying security for an exercise price higher than its then current market value, resulting in a potential capital loss unless the security later appreciates in value. A Portfolio may terminate a put option that it has written before it expires by a closing purchase transaction. Any loss from this transaction may be partially or entirely offset by the premium received on the terminated option. PURCHASING PUT AND CALL OPTIONS. A Portfolio may also purchase put options to protect portfolio holdings against a decline in market value. This protection lasts for the life of the put option because the Portfolio, as a holder of the option, may sell the underlying security at the exercise price regardless of any decline in its market price. In order for a put option to be profitable, the market price of the underlying security must decline sufficiently below the exercise price to cover the premium and transaction costs that the Portfolio must pay. These costs will reduce any profit the Portfolio might have realized had it sold the underlying security instead of buying the put option. A Portfolio may purchase call options to hedge against an increase in the price of securities that the Portfolio wants ultimately to buy. Such hedge protection is provided during the life of the call option since the Portfolio, as holder of the call option, is able to buy the underlying security at the exercise price regardless of any increase in the underlying security's market price. In order for a call option to be profitable, the market price of the underlying security must rise sufficiently above the exercise price to cover the premium and transaction costs. These costs will reduce any profit the Portfolio might have realized had it bought the underlying security at the time it purchased the call option. A Portfolio may also purchase put and sell options to enhance its current return. 9 OPTIONS ON FOREIGN SECURITIES. A Portfolio may purchase and sell options on foreign securities if in the opinion of its Adviser the investment characteristics of such options, including the risks of investing in such options, are consistent with the Portfolio's investment objectives. It is expected that risks related to such options will not differ materially from risks related to options on U.S. securities. However, position limits and other rules of foreign exchanges may differ from those in the U.S. In addition, options markets in some countries, many of which are relatively new, may be less liquid than comparable markets in the U.S. RISKS INVOLVED IN THE SALE OF OPTIONS. Options transactions involve certain risks, including the risks that a Portfolio's Adviser will not forecast interest rate or market movements correctly, that a Portfolio may be unable at times to close out such positions, or that hedging transactions may not accomplish their purpose because of imperfect market correlations. The successful use of these strategies depends on the ability of a Portfolio's Adviser to forecast market and interest rate movements correctly. An exchange-listed option may be closed out only on an exchange which provides a secondary market for an option of the same series. There is no assurance that a liquid secondary market on an exchange will exist for any particular option or at any particular time. If no secondary market were to exist, it would be impossible to enter into a closing transaction to close out an option position. As a result, a Portfolio may be forced to continue to hold, or to purchase at a fixed price, a security on which it has sold an option at a time when its Adviser believes it is inadvisable to do so. Higher than anticipated trading activity or order flow or other unforeseen events might cause The Options Clearing Corporation or an exchange to institute special trading procedures or restrictions that might restrict the Portfolio's use of options. The exchanges have established limitations on the maximum number of calls and puts of each class that may be held or written by an investor or group of investors acting in concert. It is possible that the Portfolio and other clients of the Portfolio's Adviser may be considered such a group. These position limits may restrict the Portfolio's ability to purchase or sell options on particular securities. Options which are not traded on national securities exchanges may be closed out only with the other party to the option transaction. For that reason, it may be more difficult to close out unlisted options than listed options. Furthermore, unlisted options are not subject to the protection afforded purchasers of listed options by The Options Clearing Corporation. Government regulations, particularly the requirements for qualification as a "regulated investment company" under the Internal Revenue Code, may also restrict the Portfolio's use of options. FUTURES CONTRACTS In order to hedge against the effects of adverse market changes a Portfolio that may invest in debt securities may buy and sell futures contracts on debt securities of the type in which the Portfolio may invest and on indexes of debt securities. In addition, a Portfolio that may invest in equity securities may purchase and sell stock index futures to hedge against changes in stock market prices. A Portfolio may also, to the extent permitted by applicable law, buy and sell futures contracts and options on futures contracts to increase its current return. All such futures and related options will, as may be required by applicable law, be traded on exchanges that are licensed and regulated by the Commodity Futures Trading Commission (the "CFTC"). 10 FUTURES ON DEBT SECURITIES AND RELATED OPTIONS. A futures contract on a debt security is a binding contractual commitment which, if held to maturity, will result in an obligation to make or accept delivery, during a particular month, of securities having a standardized face value and rate of return. By purchasing futures on debt securities -- assuming a "long" position -- a Portfolio will legally obligate itself to accept the future delivery of the underlying security and pay the agreed price. By selling futures on debt securities -- assuming a "short" position -- it will legally obligate itself to make the future delivery of the security against payment of the agreed price. Open futures positions on debt securities will be valued at the most recent settlement price, unless that price does not, in the judgment of persons acting at the direction of the Trustees as to the valuation of a Portfolio's assets, reflect the fair value of the contract, in which case the positions will be valued by the Trustees or such persons. Positions taken in the futures markets are not normally held to maturity, but are instead liquidated through offsetting transactions that may result in a profit or a loss. While futures positions taken by a Portfolio will usually be liquidated in this manner, a Portfolio may instead make or take delivery of the underlying securities whenever it appears economically advantageous to do so. A clearing corporation associated with the exchange on which futures are traded assumes responsibility for such closing transactions and guarantees that a Portfolio's sale and purchase obligations under closed-out positions will be performed at the termination of the contract. Hedging by use of futures on debt securities seeks to establish with more certainty than would otherwise be possible the effective rate of return on securities. A Portfolio may, for example, take a "short" position in the futures market by selling contracts for the future delivery of debt securities held by the Portfolio (or securities having characteristics similar to those held by the Portfolio) in order to hedge against an anticipated rise in interest rates that would adversely affect the value of the Portfolio's securities. When hedging of this character is successful, any depreciation in the value of securities may substantially be offset by appreciation in the value of the futures position. On other occasions, the Portfolio may take a "long" position by purchasing futures on debt securities. This would be done, for example, when the Portfolio expects to purchase particular securities when it has the necessary cash, but expects the rate of return available in the securities markets at that time to be less favorable than rates currently available in the futures markets. If the anticipated rise in the price of the securities should occur (with its concomitant reduction in yield), the increased cost to the Portfolio of purchasing the securities may be offset, at least to some extent, by the rise in the value of the futures position taken in anticipation of the subsequent purchase. Successful use by a Portfolio of futures contracts on debt securities is subject to its Adviser's ability to predict correctly movements in the direction of interest rates and other factors affecting markets for debt securities. For example, if a Portfolio has hedged against the possibility of an increase in interest rates which would adversely affect the market prices of debt securities held by it and the prices of such securities increase instead the Portfolio will lose part or all of the benefit of 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 margin maintenance requirements. The Portfolio may have to sell securities at a time when it may be disadvantageous to do so. 11 A Portfolio may purchase and write put and call options on certain debt futures contracts, as they become available. Such options are similar to options on securities except that options on futures contracts give the purchaser the right, in return for the premium paid, to assume a position in a futures contract (a long position if the option is a call and a short position if the option is a put) at a specified exercise price at any time during the period of the option. As with options on securities, the holder or writer of an option may terminate his position by selling or purchasing an option of the same series. There is no guarantee that such closing transactions can be effected. A Portfolio will be required to deposit initial margin and maintenance margin with respect to put and call options on futures contracts written by it pursuant to brokers' requirements, and, in addition, net option premiums received will be included as initial margin deposits. See "Margin Payments" below. Compared to the purchase or sale of futures contracts, the purchase of call or put options on futures contracts involves less potential risk to a Portfolio because the maximum amount at risk is the premium paid for the options plus transactions costs. However, there may be circumstances when the purchase of call or put options on a futures contract would result in a loss to a Portfolio when the purchase or sale of the futures contracts would not, such as when there is no movement in the prices of debt securities. The writing of a put or call option on a futures contract involves risks similar to those risks relating to the purchase or sale of futures contracts. INDEX FUTURES CONTRACTS AND OPTIONS. A Portfolio may invest in debt index futures contracts and stock index futures contracts, and in related options. A debt index futures contract is a contract to buy or sell units of a specified debt index at a specified future date at a price agreed upon when the contract is made. A unit is the current value of the index. (Debt index futures in which the Portfolios are presently expected to invest are not now available, although such futures contracts are expected to become available in the future.) A stock index futures contract is a contract to buy or sell units of a stock index at a specified future date at a price agreed upon when the contract is made. A unit is the current value of the stock index. For example, the Standard & Poor's 100 Stock Index is composed of 100 selected common stocks, most of which are listed on the New York Stock Exchange. The S&P 100 Index assigns relative weightings to the common stocks included in the Index, and the Index fluctuates with changes in the market values of those common stocks. In the case of the S&P 100 Index, contracts are to buy or sell 100 units. Thus, if the value of the S&P 100 Index were $180, one contract would be worth $18,000 (100 units x $180). The stock index futures contract specifies that no delivery of the actual stocks making up the index will take place. Instead, settlement in cash must occur upon the termination of the contract, with the settlement being the difference between the contract price and the actual level of the stock index at the expiration of the contract. For example, if a Portfolio enters into a futures contract to buy 100 units of the S&P 100 Index at a specified future date at a contract price of $180 and the S&P 100 Index is at $184 on that future date, the Portfolio will gain $400 (100 units x gain of $4). If the Portfolio enters into a futures contract to sell 100 units of the stock index at a specified future date at a contract price of $180 and the S&P 100 Index is at $182 on that future date, the Portfolio will lose $200 (100 units x loss of $2). A Portfolio may purchase or sell futures contracts with respect to any securities indexes. Positions in index futures may be closed out only on an exchange or board of trade which provides a secondary market for such futures. In order to hedge a Portfolio's investments successfully using futures contracts and related options, a Portfolio must invest in futures contracts with respect to indexes or sub-indexes the movements of which will, in its judgment, have a significant correlation with movements in the prices of the Portfolio's securities. 12 OPTIONS ON STOCK INDEX FUTURES. Options on index futures contracts are similar to options on securities except that options on index futures contracts give the purchaser the right, in return for the premium paid, to assume a position in an index futures contract (a long position if the option is a call and a short position if the option is a put) at a specified exercise price at any time during the period of the option. Upon exercise of the option, the holder would assume the underlying futures position and would receive a variation margin payment of cash or securities approximating the increase in the value of the holder's option position. If an option is exercised on the last trading day prior to the expiration date of the option, the settlement will be made entirely in cash based on the difference between the exercise price of the option and the closing level of the index on which the futures contract is based on the expiration date. Purchasers of options who fail to exercise their options prior to the exercise date suffer a loss of the premium paid. OPTIONS ON INDICES. As an alternative to purchasing and selling call and put options on index futures contracts, each of the Portfolios which may purchase and sell index futures contracts may purchase and sell call and put options on the underlying indexes themselves to the extent that such options are traded on national securities exchanges. Index options are similar to options on individual securities in that the purchaser of an index option acquires the right to buy (in the case of a call) or sell (in the case of a put), and the writer undertakes the obligation to sell or buy (as the case may be), units of an index at a stated exercise price during the term of the option. Instead of giving the right to take or make actual delivery of securities, the holder of an index option has the right to receive a cash "exercise settlement amount". This amount is equal to the amount by which the fixed exercise price of the option exceeds (in the case of a put) or is less than (in the case of a call) the closing value of the underlying index on the date of the exercise, multiplied by a fixed "index multiplier". A Portfolio may purchase or sell options on stock indices in order to close out its outstanding positions in options on stock indices which it has purchased. A Portfolio may also allow such options to expire unexercised. Compared to the purchase or sale of futures contracts, the purchase of call or put options on an index involves less potential risk to a Portfolio because the maximum amount at risk is the premium paid for the options plus transactions costs. The writing of a put or call option on an index involves risks similar to those risks relating to the purchase or sale of index futures contracts. MARGIN PAYMENTS. When a Portfolio purchases or sells a futures contract, it is required to deposit with its custodian an amount of cash, U.S. Treasury bills, or other permissible collateral equal to a small percentage of the amount of the futures contract. This amount is known as "initial margin". The nature of initial margin is different from that of margin in security transactions in that it does not involve borrowing money to finance transactions. Rather, initial margin is similar to a performance bond or good faith deposit that is returned to a Portfolio upon termination of the contract, assuming a Portfolio satisfies its contractual obligations. Subsequent payments to and from the broker occur on a daily basis in a process known as "marking to market". These payments are called "variation margin" and are made as the value of the underlying futures contract fluctuates. For example, when a Portfolio sells a futures contract and the price of the underlying security rises above the delivery price, the Portfolio's position declines in value. The Portfolio then pays the broker a variation margin payment equal to the difference between the delivery price of the futures contract and the market price of the securities underlying the futures contract. Conversely, if the price of the underlying security falls below the delivery price of the contract, the Portfolio's futures position increases in value. The broker then must 13 make a variation margin payment equal to the difference between the delivery price of the futures contract and the market price of the securities underlying the futures contract. When a Portfolio terminates a position in a futures contract, a final determination of variation margin is made, additional cash is paid by or to the Portfolio, and the Portfolio realizes a loss or a gain. Such closing transactions involve additional commission costs. SPECIAL RISKS OF TRANSACTIONS IN FUTURES CONTRACTS AND RELATED OPTIONS LIQUIDITY RISKS. Positions in futures contracts may be closed out only on an exchange or board of trade which provides a secondary market for such futures. Although the Portfolio intends to purchase or sell futures only on exchanges or boards of trade where there appears to be an active secondary market, there is no assurance that a liquid secondary market on an exchange or board of trade will exist for any particular contract or at any particular time. If there is not a liquid secondary market at a particular time, it may not be possible to close a futures position at such time 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 financial futures are used to hedge portfolio securities, such securities will not generally be sold until the financial futures can be terminated. In such circumstances, an increase in the price of the portfolio securities, if any, may partially or completely offset losses on the financial futures. In addition to the risks that apply to all options transactions, there are several special risks relating to options on futures contracts. The ability to establish and close out positions in such options will be subject to the development and maintenance of a liquid secondary market. It is not certain that such a market will develop. Although a Portfolio generally will purchase only those options for which there appears to be an active secondary market, there is no assurance that a liquid secondary market on an exchange will exist for any particular option or at any particular time. In the event no such market exists for particular options, it might not be possible to effect closing transactions in such options with the result that a Portfolio would have to exercise the options in order to realize any profit. HEDGING RISKS. There are several risks in connection with the use by a Portfolio of futures contracts and related options as a hedging device. One risk arises because of the imperfect correlation between movements in the prices of the futures contracts and options and movements in the underlying securities or index or movements in the prices of a Portfolio's securities which are the subject of a hedge. A Portfolio's Adviser will, however, attempt to reduce this risk by purchasing and selling, to the extent possible, futures contracts and related options on securities and indexes the movements of which will, in its judgment, correlate closely with movements in the prices of the underlying securities or index and the securities sought to be hedged. Successful use of futures contracts and options by a Portfolio for hedging purposes is also subject to its Adviser's ability to predict correctly movements in the direction of the market. It is possible that, where a Portfolio has purchased puts on futures contracts to hedge its portfolio against a decline in the market, the securities or index on which the puts are purchased may increase in value and the value of securities held in the portfolio may decline. If this occurred, the Portfolio would lose money on the puts and also experience a decline in value in its portfolio securities. In addition, the prices of futures, for a number of reasons, may not correlate perfectly with movements in the underlying securities or index due to certain market distortions. First, all participants in the futures market are subject to margin deposit requirements. Such requirements may cause investors to close futures contracts through offsetting transactions which could distort the normal relationship between the 14 underlying security or index and futures markets. Second, the margin requirements in the futures markets are less onerous than margin requirements in the securities markets in general, and as a result the futures markets may attract more speculators than the securities markets do. Increased participation by speculators in the futures markets may also cause temporary price distortions. Due to the possibility of price distortion, even a correct forecast of general market trends by a Portfolio's Adviser may still not result in a successful hedging transaction over a short time period. OTHER RISKS. Portfolios will incur brokerage fees in connection with their futures and options transactions. In addition, while futures contracts and options on futures will be purchased and sold to reduce certain risks, those transactions themselves entail certain other risks. Thus, while a Portfolio may benefit from the use of futures and related options, unanticipated changes in interest rates or stock price movements may result in a poorer overall performance for the Portfolio than if it had not entered into any futures contracts or options transactions. Moreover, in the event of an imperfect correlation between the futures position and the portfolio position which is intended to be protected, the desired protection may not be obtained and the Portfolio may be exposed to risk of loss. FORWARD COMMITMENTS A Portfolio may enter into contracts to purchase securities for a fixed price at a future date beyond customary settlement time ("forward commitments") if the Portfolio holds, and maintains until the settlement date in a segregated account, cash or high-grade debt obligations in an amount sufficient to meet the purchase price, or if the Portfolio enters into offsetting contracts for the forward sale of other securities it owns. Forward 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 the settlement date, which risk is in addition to the risk of decline in the value of the Portfolio's other assets. Where such purchases are made through dealers, the Portfolios rely on the dealer to consummate the sale. The dealer's failure to do so may result in the loss to the Portfolio of an advantageous yield or price. Although a Portfolio will generally enter into forward commitments with the intention of acquiring securities for its portfolio or for delivery pursuant to options contracts it has entered into, a Portfolio may dispose of a commitment prior to settlement if its Adviser deems it appropriate to do so. A Portfolio may realize short-term profits or losses upon the sale of forward commitments. REPURCHASE AGREEMENTS A Portfolio may enter into repurchase agreements. A repurchase agreement is a contract under which the Portfolio acquires a security subject to the obligation of the seller to repurchase and the Portfolio to resell such security at a fixed time and price (representing the Portfolio's cost plus interest). It is the Trust's present intention to enter into repurchase agreements only with member banks of the Federal Reserve System and securities dealers meeting certain criteria as to creditworthiness and financial condition established by the Trustees of the Trust and only with respect to obligations of the U.S. government or its agencies or instrumentalities or other high quality short term debt obligations. Repurchase agreements may also be viewed as loans made by a Portfolio which are collateralized by the securities subject to repurchase. A Portfolio's Adviser will monitor such transactions to ensure that the value of the underlying securities will be at least equal at all times to the total amount of the repurchase obligation, including the interest factor. If the seller defaults, a Portfolio could realize a loss on the sale of the underlying security to the extent that the proceeds of sale including accrued interest are less than the resale price provided in the agreement including interest. In addition, if the seller should be involved 15 in bankruptcy or insolvency proceedings, a Portfolio may incur delay and costs in selling the underlying security or may suffer a loss of principal and interest if a Portfolio is treated as an unsecured creditor and required to return the underlying collateral to the seller's estate. LOANS OF PORTFOLIO SECURITIES A Portfolio may lend its portfolio securities, provided: (1) the loan is secured continuously by collateral consisting of U.S. Government securities, cash, or cash equivalents adjusted daily to have market value at least equal to the current market value of the securities loaned; (2) the Portfolio may at any time call the loan and regain the securities loaned; (3) a Portfolio will receive any interest or dividends paid on the loaned securities; and (4) the aggregate market value of securities loaned will not at any time exceed one-third (or such other limit as the Trustee may establish) of the total assets of the Portfolio. In addition, it is anticipated that a Portfolio may share with the borrower some of the income received on the collateral for the loan or that it will be paid a premium for the loan. The risks in lending portfolio securities, as with other extensions of credit, consist of possible delay in recovery of the securities or possible loss of rights in the collateral should the borrower fail financially. Although voting rights or rights to consent with respect to the loaned securities pass to the borrower, a Portfolio retains the right to call the loans at any time on reasonable notice, and it will do so in order that the securities may be voted by a Portfolio if the holders of such securities are asked to vote upon or consent to matters materially affecting the investment. A Portfolio will not lend portfolio securities to borrowers affiliated with the Portfolio. COLLATERALIZED MORTGAGE OBLIGATIONS; OTHER MORTGAGE-RELATED SECURITIES Collateralized mortgage obligations or "CMOs" are debt obligations or pass-through certificates collateralized by mortgage loans or mortgage pass-through securities. Typically, CMOs are collateralized by certificates issued by the Government National Mortgage Association, ("GNMA"), the Federal National Mortgage Association ("FNMA"), or the Federal Home Loan Mortgage Corporation ("FHLMC"), but they also may be collateralized by whole loans or private pass-through certificates (such collateral collectively hereinafter referred to as "Mortgage Assets"). CMOs may be issued by agencies or instrumentalities of the U.S. Government, or by private originators of, or investors in, mortgage loans. In a CMO, a series of bonds or certificates is generally issued in multiple classes. Each class of CMOs is issued at a specific fixed or floating rate coupon and has a stated maturity or final distribution date. Principal prepayments on the mortgage assets may cause the CMOs to be retired substantially earlier than their stated maturities or final distribution dates. Interest is paid or accrues on most classes of the CMOs on a monthly, quarterly, or semi-annual basis. The principal of and interest on the mortgage assets may be allocated among the several classes of a series of a CMO in innumerable ways. In a CMO, payments of principal, including any principal prepayments, on the mortgage assets are applied to the classes of the series in a pre-determined sequence. RESIDUAL INTERESTS. Residual interests are derivative mortgage securities issued by agencies or instrumentalities of the U.S. Government or by private originators of, or investors in, mortgage loans. The cash flow generated by the mortgage assets underlying a series of mortgage securities is applied first to make required payments of principal of and interest on the mortgage securities and second to pay the related administrative expenses of the issuer. The residual generally represents the right to any excess cash flow remaining after making the foregoing payments. Each payment of such excess cash flow to a holder of the related residual represents income 16 and/or a return of capital. The amount of residual cash flow resulting from a series of mortgage securities will depend on, among other things, the characteristics of the mortgage assets, the coupon rate of each class of the mortgage securities, prevailing interest rates, the amount of administrative expenses, and the prepayment experience on the mortgage assets. In particular, the yield to maturity on residual interests may be extremely sensitive to prepayments on the related underlying mortgage assets in the same manner as an interest-only class of stripped mortgage-backed securities. In addition, if a series of mortgage securities includes a class that bears interest at an adjustable rate, the yield to maturity on the related residual interest may also be extremely sensitive to changes in the level of the index upon which interest rate adjustments are based. In certain circumstances, there may be little or no excess cash flow payable to residual holders. The Portfolio may fail to recoup fully its initial investment in a residual. Residuals are generally purchased and sold by institutional investors through several investment banking firms acting as brokers or dealers. The residual interest market has only recently developed and residuals currently may not have the liquidity of other more established securities trading in other markets. Residuals may be subject to certain restrictions on transferability. FOREIGN SECURITIES A Portfolio may invest in foreign securities and in certificates of deposit issued by United States branches of foreign banks and foreign branches of United States banks. Investments in foreign securities may involve considerations different from investments in domestic securities. There may be less publicly available information about a foreign company than about a U.S. company, and foreign companies may not be subject to accounting, auditing and financial reporting standards and requirements comparable to those applicable to U.S. companies. Securities of some foreign companies are less liquid or more volatile than securities of U.S. companies, and foreign brokerage commissions and custodian fees are generally higher than in the United States. Investments in foreign securities can involve other risks different from those affecting U.S. investments, including local political or economic developments, expropriation or nationalization of assets and imposition of withholding taxes on dividend or interest payments. It may be more difficult to obtain and enforce a judgment against a foreign issuer. In addition, foreign investments may be affected favorably or unfavorably by changes in currency exchange rates, exchange control regulations, foreign withholding taxes and restrictions or prohibitions on the repatriation of foreign currencies. A Portfolio may incur costs in connection with conversion between currencies. In determining whether to invest in securities of foreign issuers, the Adviser of a Portfolio seeking current income will consider the likely impact of foreign taxes on the net yield available to the Portfolio and its shareholders. Income received by a Portfolio from sources within foreign countries may be reduced by withholding and other taxes imposed by such countries. Tax conventions between certain countries and the United States may reduce or eliminate such taxes. It is impossible to determine the effective rate of foreign tax in advance since the amount of a Portfolio's assets to be invested in various countries is not known, and tax laws and their interpretations may change from time to time and may change without advance notice. Any such taxes paid by a Portfolio will reduce its net income available for distribution to shareholders. 17 FOREIGN CURRENCY TRANSACTIONS Except as otherwise described in the relevant Prospectus, a Portfolio may engage without limit in currency exchange transactions, including foreign currency forward and futures contracts, to protect against uncertainty in the level of future foreign currency exchange rates. In addition, a Portfolio may purchase and sell call and put options on foreign currency futures contracts and on foreign currencies for hedging purposes. A Portfolio may engage in both "transaction hedging" and "position hedging". When a Portfolio engages in transaction hedging, it enters into foreign currency transactions with respect to specific receivables or payables of the Portfolio generally arising in connection with the purchase or sale of its securities. A Portfolio will engage in transaction hedging when it desires to "lock in" the U.S. dollar price of a security it has agreed to purchase or sell, or the U.S. dollar equivalent of a dividend or interest payment in a foreign currency. By transaction hedging a Portfolio will attempt to protect against a possible loss resulting from an adverse change in the relationship between the U.S. dollar and the applicable foreign currency during the period between the date on which the security is purchased or sold or on which the dividend or interest payment is declared, and the date on which such payments are made or received. A Portfolio may purchase or sell a foreign currency on a spot (or cash) basis at the prevailing spot rate in connection with transaction hedging. A Portfolio 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. For transaction hedging purposes, a Portfolio may purchase exchange-listed and over-the-counter call and put options on foreign currency futures contracts and on foreign currencies. A put option on a futures contract gives a Portfolio the right to assume a short position in the futures contract until expiration of the option. A put option on currency gives a Portfolio the right to sell a currency at an exercise price until the expiration of the option. A call option on a futures contract gives a Portfolio the right to assume a long position in the futures contract until the expiration of the option. A call option on currency gives a Portfolio the right to purchase a currency at the exercise price until the expiration of the option. A Portfolio will engage in over-the-counter transactions only when appropriate exchange-traded transactions are unavailable and when, in the opinion of its Adviser, the pricing mechanism and liquidity are satisfactory and the participants are responsible parties likely to meet their contractual obligations. When a Portfolio engages in position hedging, it enters into foreign currency exchange transactions to protect against a decline in the values of the foreign currencies in which securities held by the Portfolio are denominated or are quoted in their principle trading markets or an increase in the value of currency for securities which a Portfolio expects to purchase. In connection with position hedging, a Portfolio may purchase put or call options on foreign currency and foreign currency futures contracts and buy or sell forward contracts and foreign currency futures contracts. A Portfolio may also purchase or sell foreign currency on a spot basis. The precise matching of the amounts of foreign currency exchange transactions and the value of the portfolio securities involved will not generally be possible since the future value of such securities in foreign currencies will change as a consequence of market movements in the values of those securities between the dates the currency exchange transactions are entered into and the dates they mature. It is impossible to forecast with precision the market value of a Portfolio's securities at the expiration or maturity of a forward or futures contract. Accordingly, it may be necessary for a Portfolio to purchase additional foreign currency on the spot market (and bear the expense of such purchase) if the market value of the security 18 or securities being hedged is less than the amount of foreign currency a Portfolio is obligated to deliver and if a decision is made to sell the security or securities and make delivery of the foreign currency. Conversely, it may be necessary to sell on the spot market some of the foreign currency received upon the sale of the security or securities of a Portfolio if the market value of such security or securities exceeds the amount of foreign currency the Portfolio is obligated to deliver. To offset some of the costs to a Portfolio of hedging against fluctuations in currency exchange rates, the Portfolio may write covered call options on those currencies. Transaction and position hedging do not eliminate fluctuations in the underlying prices of the securities which a Portfolio owns or intends to purchase or sell. They simply establish a rate of exchange which one can achieve at some future point in time. Additionally, although these techniques tend to minimize the risk of loss due to a decline in the value of the hedged currency, they tend to limit any potential gain which might result from the increase in the value of such currency. CURRENCY FORWARD AND FUTURES CONTRACTS. A forward foreign currency exchange contract involves an obligation to purchase or sell a specific currency at a future date, which may be any fixed number of days from the date of the contract as agreed by the parties, at a price set at the time of the contract. In the case of a cancelable forward contract, the holder has the unilateral right to cancel the contract at maturity by paying a specified fee. The contracts are traded in the interbank market conducted directly between currency traders (usually large commercial banks) and their customers. A forward contract generally has no deposit requirement, and no commissions are charged at any stage for trades. A foreign currency futures contract is a standardized contract for the future delivery of a specified amount of a foreign currency at a future date at a price set at the time of the contract. Foreign currency futures contracts traded in the United States are designed by and traded on exchanges regulated by the CFTC, such as the New York Mercantile Exchange. Forward foreign currency exchange contracts differ from foreign currency futures contracts in certain respects. For example, the maturity date of a forward contract may be any fixed number of days from the date of the contract agreed upon by the parties, rather than a predetermined date in a given month. Forward contracts may be in any amounts agreed upon by the parties rather than predetermined amounts. Also, forward foreign exchange contracts are traded directly between currency traders so that no intermediary is required. A forward contract generally requires no margin or other deposit. At the maturity of a forward or futures contract, a Portfolio may either accept or make delivery of the currency specified in the contract, or at or prior to maturity enter into a closing transaction involving the purchase or sale of an offsetting contract. Closing transactions with respect to forward contracts are usually effected with the currency trader who is a party to the original forward contract. Closing transactions with respect to futures contracts are effected on a commodities exchange; a clearing corporation associated with the exchange assumes responsibility for closing out such contracts. Positions in foreign currency futures contracts and related options may be closed out only on an exchange or board of trade which provides a secondary market in such contracts or options. Although a Portfolio will normally purchase or sell foreign currency futures contracts and related options only on exchanges or boards of trade where there appears to be an active secondary market, there is no assurance that a secondary market on an exchange or board of trade will exist for any particular contract or option or at any particular time. In such event, 19 it may not be possible to close a futures or related option position and, in the event of adverse price movements, a Portfolio would continue to be required to make daily cash payments of variation margin on its futures positions. FOREIGN CURRENCY OPTIONS. Options on foreign currencies operate similarly to options on securities, and are traded primarily in the over-the-counter market, although options on foreign currencies have recently been listed on several exchanges. Such options will be purchased or written only when a Portfolio's Adviser believes that a liquid secondary market exists for such options. There can be no assurance that a liquid secondary market will exist for a particular option at any specific time. Options on foreign currencies are affected by all of those factors which influence exchange rates and investments generally. The value of a foreign currency option is dependent upon the value of the foreign currency and the U.S. dollar, and may have no relationship to the investment merits of a foreign security. Because foreign currency transactions occurring in the interbank market involve substantially larger amounts than those that may be involved in the use of foreign currency options, investors may be disadvantaged by having to deal in an odd lot market (generally consisting of transactions of less than $1 million) for the underlying foreign currencies at prices that are less favorable than for round lots. There is no systematic reporting of last sale information for foreign currencies and there is no regulatory requirement that quotations available through dealers or other market sources be firm or revised on a timely basis. Available quotation information is generally representative of very large transactions in the interbank market and thus may not reflect relatively smaller transactions (less than $1 million) where rates may be less favorable. The interbank market in foreign currencies is a global, around-the-clock market. To the extent that the U.S. options markets are closed while the markets for the underlying currencies remain open, significant price and rate movements may take place in the underlying markets that cannot be reflected in the U.S. options markets. SETTLEMENT PROCEDURES. Settlement procedures relating to investments in foreign securities and to foreign currency exchange transactions may be more complex than settlements with respect to investments in debt or equity securities of U.S. issuers, and may involve certain risks not present in domestic investments. For example, settlement of transactions involving foreign securities or foreign currency may occur within a foreign country, and the Portfolio may be required to accept or make delivery of the underlying securities or currency in conformity with any applicable U.S. or foreign restrictions or regulations, and may be required to pay any fees, taxes or charges associated with such delivery. Such investments may also involve the risk that an entity involved in the settlement may not meet its obligations. FOREIGN CURRENCY CONVERSION. Although foreign exchange dealers do not charge a feefor currency conversion, they do realize a profit based on the difference (the "spread") between prices at which they buy and sell various currencies. Thus, a dealer may offer to sell a foreign currency to a Portfolio at one rate, while offering a lesser rate of exchange should a Portfolio desire to resell that currency to the dealer. ZERO-COUPON SECURITIES Zero-coupon securities in which a Portfolio may invest are debt obligations which are generally issued at a discount and payable in full at maturity, and which do not provide for current payments of interest prior to maturity. Zero-coupon securities usually trade at a deep discount from their face or par value and are subject to 20 greater market value fluctuations from changing interest rates than debt obligations of comparable maturities which make current distributions of interest. As a result, the net asset value of shares of a Portfolio investing in zero-coupon securities may fluctuate over a greater range than shares of other mutual funds investing in securities making current distributions of interest and having similar maturities. Zero-coupon securities may include U.S. Treasury bills issued directly by the U.S. Treasury or other short-term debt obligations, and longer-term bonds or notes and their unmatured interest coupons which have been separated by their holder, typically a custodian bank or investment brokerage firm. A number of securities firms and banks have stripped the interest coupons from the underlying principal (the "corpus") of U.S. Treasury securities and resold them in custodial receipt programs with a number of different names, including Treasury Income Growth Receipts ("TIGRS") and Certificates of Accrual on Treasuries ("CATS"). The underlying U.S. Treasury bonds and notes themselves are held in book-entry form at the Federal Reserve Bank or, in the case of bearer securities (i.e., unregistered securities which are owned ostensibly by the bearer or holder thereof), in trust on behalf of the owners thereof. In addition, the Treasury has facilitated transfers of ownership of zero-coupon securities by accounting separately for the beneficial ownership of particular interest coupons and corpus payments on Treasury securities through the Federal Reserve book-entry record-keeping system. The Federal Reserve program as established by the Treasury Department is known as "STRIPS" or "Separate Trading of Registered Interest and Principal of Securities." Under the STRIPS program, a Portfolio will be able to have its beneficial ownership of U.S. Treasury zero-coupon securities recorded directly in the book-entry record-keeping system in lieu of having to hold certificates or other evidences of ownership of the underlying U.S. Treasury securities. When debt obligations have been stripped of their unmatured interest coupons by the holder, the stripped coupons are sold separately. The principal or corpus is sold at a deep discount because the buyer receives only the right to receive a future fixed payment on the security and does not receive any rights to periodic cash interest payments. Once stripped or separated, the corpus and coupons may be sold separately. Typically, the coupons are sold separately or grouped with other coupons with like maturity dates and sold in such bundled form. Purchasers of stripped obligations acquire, in effect, discount obligations that are economically identical to the zero-coupon securities issued directly by the obligor. WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS The Portfolios may engage in when-issued and delayed delivery transactions. These transactions are arrangements in which a Portfolio purchases securities with payment and delivery scheduled for a future time. A Portfolio engages in when-issued and delayed delivery transactions only for the purpose of acquiring securities consistent with its investment objective and policies, not for investment leverage, but a Portfolio may sell such securities prior to settlement date if such a sale is considered to be advisable. No income accrues to a Portfolio on securities in connection with such transactions prior to the date the Portfolio actually takes delivery of securities. In when-issued and delayed delivery transactions, a Portfolio relies on the seller to complete the transaction. The seller's failure to complete the transaction may cause a Portfolio to miss a price or yield considered to be advantageous. These transactions are made to secure what is considered to be an advantageous price or yield for a Portfolio. Settlement dates may be a month or more after entering into these transactions, and the market values of 21 the securities purchased may vary from the purchase prices. No fees or other expenses, other than normal transaction costs, are incurred. However, liquid assets of a Portfolio sufficient to make payment for the securities to be purchased are segregated at the trade date. These securities are marked to market daily and are maintained until the transaction is settled. BANK INSTRUMENTS A Portfolio may invest in the instruments of banks and savings and loans whose deposits are insured by the Bank Insurance Fund or the Savings Association Insurance Fund, both of which are administered by the Federal Deposit Insurance Corporation ("FDIC"), such as certificates of deposit, demand and time deposits, savings shares, and bankers' acceptances. However, the above-mentioned instruments are not necessarily guaranteed by those organizations. In addition to domestic bank obligations, such as certificates of deposit, demand and time deposits, savings shares, and bankers' acceptances, a Portfolio may invest in: Eurodollar Certificates of Deposit ("ECDs") issued by foreign branches of U.S. or foreign banks; Eurodollar Time Deposits ("ETDs"), which are U.S. dollar-denominated deposits in foreign branches of U.S. or foreign banks; Canadian Time Deposits, which are U.S. dollar-denominated deposits issued by branches of major Canadian banks located in the U.S.; and Yankee Certificates of Deposit ("Yankee CDS"), which are U.S. dollar-denominated certificates of deposit issued by U.S. branches of foreign banks and held in the U.S. DOLLAR ROLLS AND REVERSE REPURCHASE AGREEMENTS A Portfolio may enter into dollar rolls, in which the Portfolio sells securities and simultaneously contracts to repurchase substantially similar securities on a specified future date. In the case of dollar rolls involving mortgage-related securities, the mortgage-related securities that are purchased typically will be of the same type and will have the same or similar interest rate and maturity as those sold, but will be supported by different pools of mortgages. The Portfolio forgoes principal and interest paid during the roll period on the securities sold in a dollar roll, but it is compensated by the difference between the current sales price and the price for the future purchase as well as by any interest earned on the proceeds of the securities sold. A Portfolio could also be compensated through the receipt of fee income. A Portfolio may also enter into reverse repurchase agreements in which the Portfolio sells securities and agrees to repurchase them at a mutually agreed date and price. Generally, the effect of such a transaction is that the Portfolio can recover all or most of the cash invested in the portfolio securities involved during the term of the reverse repurchase agreement, while it will be able to keep the interest income associated with those portfolio securities. Such transactions are advantageous if the interest cost to the Portfolio of the reverse repurchase transaction is less than the cost of otherwise obtaining the cash. Dollar rolls and reverse repurchase agreements may be viewed as a borrowing by the Portfolio, secured by the security which is the subject of the agreement. In addition to the general risks involved in leveraging, dollar rolls and reverse repurchase agreements involve the risk that, in the event of the bankruptcy or insolvency of the Portfolio's counterparty, the Portfolio would be unable to recover the security which is the subject of the agreement, the amount of cash or other property transferred by the counterparty to the Portfolio under the agreement prior to such insolvency or bankruptcy is less than the value of the security subject to the agreement, or the Portfolio may be delayed or prevented, due to such insolvency or bankruptcy, from using such cash or property or may be required to return it to the counterparty or its trustee or receiver. 22 CONVERTIBLE SECURITIES A Portfolio may invest in convertible securities. Convertible securities are fixed income securities which may be exchanged or converted into a predetermined number of the issuer's underlying common stock at the option of the holder during a specified time period. Convertible securities may take the form of convertible preferred stock, convertible bonds or debentures, units consisting of "usable" bonds and warrants or a combination of the features of several of these securities. The investment characteristics of each convertible security vary widely, which allows convertible securities to be employed for a variety of investment strategies. A Portfolio will exchange or convert the convertible securities held in its portfolio into shares of the underlying common stock when, in its Adviser's opinion, the investment characteristics of the underlying common shares will assist the Portfolio in achieving its investment objectives. Otherwise, the Portfolio may hold or trade convertible securities. In selecting convertible securities for the Portfolio, the Portfolio's Adviser evaluates the investment characteristics of the convertible security as a fixed income instrument and the investment potential of the underlying equity security for capital appreciation. In evaluating these matters with respect to a particular convertible security, the Portfolio's Adviser considers numerous factors, including the economic and political outlook, the value of the security relative to other investment alternatives, trends in the determinants of the issuer's profits, and the issuer's management capability and practices. WARRANTS A Portfolio may invest in warrants. Warrants are basically options to purchase common stock at a specific price (usually at a premium above the market value of the optioned common stock at issuance) valid for a specific period of time. Warrants may have a life ranging from less than a year to twenty years or may be perpetual. However, most warrants have expiration dates after which they are worthless. In addition, if the market price of the common stock does not exceed the warrant's exercise price during the life of the warrant, the warrant will expire as worthless. Warrants have no voting rights, pay no dividends, and have no rights with respect to the assets of the corporation issuing them. The percentage increase or decrease in the market price of the warrant may tend to be greater than the percentage increase or decrease in the market price of the optioned common stock. Warrants acquired in units or attached to securities may be deemed to be without value for purposes of a Portfolio's policy. SWAPS, CAPS, FLOORS AND COLLARS A Portfolio may enter into interest rate, currency and index swaps and the purchase or sale of related caps, floors and collars. A Portfolio expects to enter into these transactions primarily to preserve a return or spread on a particular investment or portion of its portfolio, to protect against currency fluctuations, as a duration management technique or to protect against any increase in the price of securities the Portfolio anticipates purchasing at a later date. A Portfolio would use these transactions as hedges and not as speculative investments and would not sell interest rate caps or floors where it does not own securities or other instruments providing the income stream the Portfolio may be obligated to pay. 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 with respect to a notional amount of principal. A currency swap is an agreement to exchange cash flows on a notional amount of two or more currencies based on the relative value differential among them and an index swap is an agreement to swap cash flows on a notional amount based on changes in the values of 23 the reference indices. The purchase of a cap entitles the purchaser to receive payments on a notional principal amount from the party selling such cap to the extent that a specified index exceeds a predetermined interest rate or amount. The purchase of a floor entitles the purchaser to receive payments on a notional principal amount from the party selling such floor to the extent that a specified index falls below a predetermined interest rate or amount. A collar is a combination of a cap and a floor that preserves a certain return within a predetermined range of interest rates or values. A Portfolio will usually enter into swaps on a net basis, i.e., the two payment streams are netted out in a cash settlement on the payment date or dates specified in the instrument, with the Portfolio receiving or paying, as the case may be, only the net amount of the two payments. A Portfolio will not enter into any swap, cap, floor or collar transaction unless, at the time of entering into such transaction, the unsecured long-term debt of the counterparty, combined with any credit enhancements, is rated at least A by S&P or Moody's or has an equivalent rating from another nationally recognized securities rating organization or is determined to be of equivalent credit quality by the Portfolio's Adviser. If there is a default by the counterparty, a Portfolio may have contractual remedies pursuant to the agreements related to the transaction. As a result, the swap market has become relatively liquid. Caps, floors and collars are more recent innovations for which standardized documentation has not yet been fully developed and, accordingly, they are less liquid than swaps. LOWER-RATED SECURITIES A Portfolio may invest in lower-rated fixed-income securities (commonly known as "junk bonds") to the extent described in the relevant Prospectus. The lower ratings of certain securities held by a Portfolio reflect a greater possibility that adverse changes in the financial condition of the issuer or in general economic conditions, or both, or an unanticipated rise in interest rates, may impair the ability of the issuer to make payments of interest and principal. The inability (or perceived inability) of issuers to make timely payment of interest and principal would likely make the values of securities held by a Portfolio more volatile and could limit the Portfolio's ability to sell its securities at prices approximating the values the Portfolio had placed on such securities. In the absence of a liquid trading market for securities held by it, a Portfolio may be unable at times to establish the fair value of such securities. The rating assigned to a security by Moody's Investors Service, Inc. or Standard & Poor's (or by any other nationally recognized securities rating organization) does not reflect an assessment of the volatility of the security's market value or the liquidity of an investment in the security. Like those of other fixed-income securities, the values of lower-rated securities fluctuate in response to changes in interest rates. Thus, a decrease in interest rates will generally result in an increase in the value of the Portfolio's assets. Conversely, during periods of rising interest rates, the value of the Portfolio's assets will generally decline. In addition, the values of such securities are also affected by changes in general economic conditions and business conditions affecting the specific industries of their issuers. Changes by recognized rating services in their ratings of any fixed-income security and in the ability of an issuer to make payments of interest and principal may also affect the value of these investments. Changes in the value of portfolio securities generally will not affect cash income derived from such securities, but will affect the Portfolio's net asset value. A Portfolio will not necessarily dispose of a security when its rating is reduced below its rating at the time of purchase, although its Adviser will monitor the investment to determine whether its retention will assist in meeting the Portfolio's investment objective. 24 The amount of information about the financial condition of an issuer of tax exempt securities may not be as extensive as that which is made available by corporations whose securities are publicly traded. Therefore, to the extent a Portfolio invests in tax exempt securities in the lower rating categories, the achievement of the Portfolio's goals is more dependent on its Adviser's investment analysis than would be the case if the Portfolio were investing in securities in the higher rating categories. INDEXED SECURITIES A Portfolio may invest in indexed securities, the values of which are linked to currencies, interest rates, commodities, indices or other financial indicators ("reference instruments"). Most indexed securities have maturities of three years or less. Indexed securities differ from other types of debt securities in which a Portfolio may invest in several respects. First, the interest rate or, unlike other debt securities, the principal amount payable at maturity of an indexed security may vary based on changes in one or more specified reference instruments, such as an interest rate compared with a fixed interest rate or the currency exchange rates between two currencies (neither of which need be the currency in which the instrument is denominated). The reference instrument need not be related to the terms of the indexed security. For example, the principal amount of a U.S. dollar denominated indexed security may vary based on the exchange rate of two foreign currencies. An indexed security may be positively or negatively indexed; that is, its value may increase or decrease if the value of the reference instrument increases. Further, the change in the principal amount payable or the interest rate of an indexed security may be a multiple of the percentage change (positive or negative) in the value of the underlying reference instrument(s). Investment in indexed securities involves certain risks. In addition to the credit risk of the security's issuer and the normal risks of price changes in response to changes in interest rates, the principal amount of indexed securities may decrease as a result of changes in the value of reference instruments. Further, in the case of certain indexed securities in which the interest rate is linked to a reference instrument, the interest rate may be reduced to zero, and any further declines in the value of the security may then reduce the principal amount payable on maturity. Finally, indexed securities may be more volatile than the reference instruments underlying indexed securities. To reduce the effect of currency fluctuations on the value of existing or anticipated holdings of portfolio securities, a Portfolio may also engage in proxy hedging. 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. The amount of the contract would not exceed the value of the Portfolio's securities denominated in linked currencies. For example, if a Portfolio's Adviser considers that the Austrian schilling is linked to the German deutschmark (the "D-mark"), the Portfolio holds securities denominated in schillings and the Adviser believes that the value of schillings will decline against the U.S. dollar, the Adviser may enter into a contract to sell D-marks and buy dollars. EURODOLLAR INSTRUMENTS A Portfolio may make investments in Eurodollar instruments. Eurodollar instruments are U.S. dollar-denominated futures contracts or options thereon which are linked to the London Interbank Offered Rate ("LIBOR"), 25 although foreign currency-denominated instruments are available from time to time. Eurodollar futures contracts enable purchasers to obtain a fixed rate for the lending of funds and sellers to obtain a fixed rate for borrowings. A Portfolio might use Eurodollar futures contracts and options thereon to hedge against changes in LIBOR, to which many interest rate swaps and fixed-income instruments are linked. SEGREGATION OF ASSETS A Portfolio may at times segregate assets in respect of certain transactions in which the Portfolio enters into a commitment to pay money or deliver securities at some future date (such as futures contracts or reverse repurchase agreements, to the extent not used for leverage). Any such segregated account will be maintained by the Trust's custodian and may contain cash, U.S. government securities, liquid high grade debt obligations, or other appropriate assets. 26 MANAGEMENT OF THE TRUST The following table provides biographical information with respect to each Trustee and officer of the Trust. Each Trustee who is an "interested person" of the Trust, as defined in the 1940 Act, is indicated by an asterisk.
POSITION HELD NAME AND ADDRESS WITH A FUND PRINCIPAL OCCUPATION DURING PAST FIVE YEARS - -------------------------- -------------- --------------------------------------------------------------- Daniel J. Ludeman* Chairman Chairman and Chief Executive Officer Mentor Investment c/o Mentor Funds and Trustee Group, Inc.; Managing Director of Wheat First Butcher 901 E. Byrd Street Singer, Inc. Director, Wheat, First Securities, Inc.; Chairman Richmond, VA 23219 and Director Mentor Income Fund, Inc., and America's Utility Fund, Inc.; Chairman and Trustee, Cash Resource Trust, Mentor Variable Investment Portfolios and Mentor Institutional Trust. Arnold H. Dreyfuss Trustee Chairman, Eskimo Pie Corporation; Trustee, Cash Resource P.O. Box 18156 Trust, Mentor Variable Investment Portfolios and Mentor Richmond, Virginia 23226 Institutional Trust; Director, Mentor Income Fund, Inc. and America's Utility Fund, Inc.; formerly, Chairman and Chief Executive Officer, Hamilton Beach/Proctor-Silex, Inc. Thomas F. Keller Trustee R.J. Reynolds Industries Professor of Business Adminis- Fuqua School of Business tration and Former Dean of Fuqua School of Business, Duke Duke University University; Director of LADD Furniture, Inc., Wendy's Durham, NC 27706 International, Inc., American Business Products, Inc., Dimon, Inc., and Biogen, Inc.; Director of Nations Balanced Target Maturity Fund, Inc., Nations Government Income Term Trust 2003, Inc., Nations Government Income Term Trust 2004, Inc., Hatteras Income Securities, Inc., Nations Institutional Reserves, Nations Fund Trust, Nations Fund, Inc., Nations Fund Portfolios, Inc., and Nations LifeGoal Funds, Inc. Trustee, Cash Resource Trust, Mentor Variable Investment Portfolios and Mentor Institutional Trust; Director, Mentor Income Fund, Inc. and America's Utility Fund, Inc. Louis W. Moelchert, Jr. Trustee Vice President for Investments, University of Richmond; University of Richmond Trustee, Cash Resource Trust, Mentor Variable Investment Richmond, VA 23173 Portfolios and Mentor Institutional Trust; Director, Mentor Income Fund, Inc. and America's Utility Fund, Inc. Troy A. Peery, Jr. Trustee President, Heilig-Meyers Company; Trustee, Cash Resource Heilig-Meyers Company Trust, Mentor Variable Investment Portfolios and Mentor 2235 Staples Mill Road Institutional Trust; Director, Mentor Income Fund, Inc. and Richmond, Virginia 23230 America's Utility Fund, Inc.
27
POSITION HELD NAME AND ADDRESS WITH A FUND PRINCIPAL OCCUPATION DURING PAST FIVE YEARS - ---------------------- -------------- ------------------------------------------------------------- Peter J. Quinn, Jr.* Trustee Formerly, President, Mentor Distributors, Inc.; Managing c/o Mentor Funds Director, Mentor Investment Group, LLC, and Wheat First 901 E. Byrd Street Butcher Singer, Inc.; formerly, Senior Vice President/ Richmond, VA 23219 Director of Mutual Funds, Wheat First Butcher Singer, Inc.; Trustee, Cash Resource Trust, Mentor Variable Investment Portfolios and Mentor Institutional Trust; Director, Mentor Income Fund, Inc. and America's Utility Fund, Inc. Arch T. Allen, III Trustee Attorney at law, Raleigh, North Carolina; Trustee, Cash c/o Mentor Funds Resource Trust, Mentor Variable Investment Portfolios and 901 E. Byrd Street Mentor Institutional Trust; Director, Mentor Income Fund, Richmond, VA 23219 Inc. and America's Utility Fund, Inc.; formerly, Vice Chancellor for Development and University Relations, University of North Carolina at Chapel Hill. Weston E. Edwards Trustee President, Weston Edwards & Associates; Trustee Cash c/o Mentor Funds Resource Trust, Mentor Variable Investment Portfolios and 901 E. Byrd Street Mentor Institutional Trust; Director, Mentor Income Fund, Richmond, VA 23219 Inc. and America's Utility Fund, Inc.; Founder and Chairman, The Housing Roundtable; formerly, President, Smart Mortgage Access, Inc. Jerry R. Barrentine Trustee President, J.R. Barretine & Associates; Trustee, Cash c/o Mentor Funds Resource Trust, Mentor Variable Investment Portfolios and 901 E. Byrd Street Mentor Institutional Trust; Director, Mentor Income Fund, Richmond, VA 23219 Inc. and America's Utility Fund, Inc.; formerly, Executive Vice President and Chief Financial Officer, Barclays/ American Mortgage Director Corporation; Managing Partner, Barrentine Lott & Associates. J. Garnett Nelson Trustee Consultant, Mid-Atlantic Holdings, LLC; Trustee, Cash c/o Mentor Funds Resource Trust, Mentor Variable Investment Portfolios and 901 E. Byrd Street Mentor Institutional Trust; Director, Mentor Income Fund, Richmond, VA 23219 Inc., America's Utility Fund, Inc., GE Investment Funds, Inc., and Lawyers Title Corporation; Member, Investment Advisory Committee, Virginia Retirement System; formerly, Senior Vice President, The Life Insurance Company of Virginia. Paul F. Costello President Managing Director, Wheat First Butcher Singer, Inc. and c/o Mentor Funds Mentor Investment Group, LLC; President, Cash Resource 901 E. Byrd Street Trust, Mentor Income Fund, Inc., Mentor Institutional Trust, Richmond, VA 23219 Mentor Variable Investment Portfolios and America's Utility Fund, Inc.; Director, Mentor Perpetual Advisors, LLC.
28
POSITION HELD NAME AND ADDRESS WITH A FUND PRINCIPAL OCCUPATION DURING PAST FIVE YEARS - -------------------- -------------- ------------------------------------------------------------ Terry L. Perkins Treasurer Senior Vice President, Mentor Investment Group, LLC; c/o Mentor Funds Treasurer, Mentor Institutional Trust, Cash Resource Trust, 901 E. Byrd Street Mentor Variable Investment Portfolios, Mentor Income Fund, Richmond, VA 23219 Inc., America's Utility Fund, Inc.; formerly, Treasurer and Comptroller, Ryland Capital Management, Inc. Michael Wade Assistant Vice President, Mentor Investment Group, LLC Assistant c/o Mentor Funds Treasurer Treasurer, Mentor Income Fund, Inc., Cash Resource Trust, 901 E. Byrd Street Mentor Institutional Trust, Mentor Variable Investment Richmond, VA 23219 Portfolios and America's Utility Fund; formerly, Senior Accountant, Wheat First Butcher Singer, Inc., Audit Senior, BDO Seidman. Geoffrey B. Sale Secretary Associate Vice President Mentor Investment Group, LLC; c/o Mentor Funds Secretary, Cash Resource Trust, Mentor Institutional Trust, 901 E. Byrd Street Mentor Variable Investment Portfolios; Clerk, America's Richmond, VA 23219 Utility Fund, Inc., Mentor Income Fund, Inc.
The table below shows the fees paid to each Trustee by the Trust for the 1998 fiscal year and the fees paid to each Trustee by all funds in the Mentor family (including the Trust) during the 1997 calendar year.
AGGREGATE COMPENSATION TOTAL COMPENSATION FROM ALL FROM THE TRUST COMPLEX FUNDS (27 FUNDS) (FISCAL YEAR END 1998) (CALENDAR YEAR 1997) ------------------------ ---------------------------- Daniel J. Ludeman ............... $ 0 $ 0 Arnold H. Dreyfuss .............. $5,808 $32,000 Thomas F. Keller ................ $4,859 $32,000 Louis W. Moelchert, Jr. ......... $5,606 $32,000 J. Garnett Nelson ............... $5,393 $40,000 Troy A. Peery, Jr. .............. $5,405 $32,000 Peter J. Quinn, Jr. ............. $ 0 $ 0 Jerry R. Barrentine ............. $5,660 $40,000 Weston E. Edwards ............... $5,479 $42,000 Arch T. Allen III ............... $5,399 $35,000
- ---------- The Trustees do not receive pension or retirement benefits from the Trust. The Declaration of Trust of the Trust provides that the Trust will indemnify its Trustees and officers against liabilities and expenses incurred in connection with litigation in which they may be involved because of their offices with the Trust, except if it is determined in the manner specified in the Agreement and Declaration of Trust that they have not acted in good faith in the reasonable belief that their actions were in the best interests of the Trust or that such indemnification would relieve any officer or Trustee of any liability to the Trust or its Shareholders by reason of willful misfeasance, bad faith, gross negligence, or reckless disregard of his or her duties. The Trust, at its expense, provides liability insurance for the benefit of its Trustees and officers. 29 PRINCIPAL HOLDERS OF SECURITIES As of November 2, 1998, the officers and Trustees of the Trust owned as a group less than 1% of the outstanding shares of any class of the Balanced Portfolio. To the knowledge of the Trust, no person owned of record or beneficially more than 5% of the outstanding shares of any class of the Portfolios as of that date, except as set forth below:
PORTFOLIO HOLDER PERCENTAGE OWNERSHIP - --------------------------------- ------------------------------- --------------------- Short Duration-Income Portfolio Partnership Healthplan of Cal 7.60% Class A Attn: Marion R. Schales CFO 421 Executive Ct North Ste #A Suisun City, CA 94585-4019 Short Duration-Income Portfolio EVEREN Clearing Corp. 5.91% Class A A/C 1902-3741 Calaveras County Water Dist 111 East Kilbourn Avenue Milwaukee, WI 53202-6611
30 INVESTMENT ADVISORY SERVICES Mentor Investment Advisors, LLC ("Mentor Advisors") serves as investment adviser to each Portfolio other than the Global Portfolio. Van Kampen Management, Inc. ("Van Kampen") serves as sub-adviser to the Municipal Income Portfolio and the High Income Portfolio; Wellington Management Company, LLP ("Wellington Management") serves as sub-adviser to the Income and Growth Portfolio. Each of these sub-advisers has complete discretion to purchase and sell portfolio securities for its respective Portfolio consistent with the particular Portfolio's investment objective, restrictions, and policies. Mentor Perpetual Advisors, LLC ("Mentor Perpetual") serves as investment adviser to the Global Portfolio. Mentor Advisors is a wholly owned subsidiary of Mentor Investment Group, LLC, ("Mentor Investment Group") which is a subsidiary of Wheat First Butcher Singer, Inc. ("WFBS"). Mentor Perpetual is owned equally by Mentor Advisors and Perpetual plc, a diversified financial services holding company. EVEREN Capital Corporation has a 20% ownership in Mentor Investment Group and may acquire additional ownership based principally on the amount of Mentor Investment Group's revenues derived from assets attributable to clients of EVEREN Securities, Inc. and its affiliates. On October 31, 1996, Commonwealth Investment Counsel, Inc., the investment adviser to the Short-Duration Income and Balanced Portfolios, was reorganized as Mentor Investment Advisors, LLC. Also on October 31, 1996, each of Commonwealth Advisors, Inc., the investment adviser to the Capital Growth, Income and Growth, Municipal Income, and Quality Income Portfolios, Charter Asset Management, Inc., the investment adviser to the Growth Portfolio, and Wellesley Advisors, Inc., the investment adviser to the Strategy Portfolio, transferred its rights and obligations under its respective advisory contract with the Trust to Mentor Investment Advisors, LLC. In addition, Mentor Investment Group, Inc. and Mentor Distributors, Inc. were reorganized as Mentor Investment Group, LLC and Mentor Distributors, LLC, respectively. On October 29, 1996, shareholders of the Municipal Income Portfolio approved a new sub-advisory agreement with Van Kampen which became a subsidiary of Morgan Stanley Group, Inc. Subject to the general oversight of the Trustees, each investment adviser and/or sub-adviser manages the applicable Portfolio in accordance with the stated policies of that Portfolio and of the Trust. Each makes investment decisions for the Portfolio and places the purchase and sale orders for portfolio transactions. The investment advisers and sub-advisers bear all their expenses in connection with the performance of their services (except as may be approved from time to time by the Trustees) and pay the salaries of all officers and employees who are employed by them and the Trust. Each Portfolio's investment adviser and/or sub-adviser provides the Trust with investment officers who are authorized to execute purchases and sales of securities. Investment decisions for the Trust and for the other investment advisory clients of the investment advisers and sub-advisers and their affiliates are made with a view to achieving their respective investment objectives. Investment decisions are the product of many factors in addition to basic suitability for the particular client involved. Thus, a particular security may be bought or sold for certain clients even though it could have been bought or sold for other clients at the same time. Likewise, a particular security may be bought for one or more clients when one or more other clients are selling the security. In some instances, one client may sell a particular security to another client. It also sometimes happens that two or more clients simultaneously purchase or sell the same security, in which event each day's transactions in such security are, insofar as possible, averaged as to price and allocated between such clients in a manner which in 31 the investment adviser's or sub-adviser's opinion is equitable to each and in accordance with the amount being purchased or sold by each. There may be circumstances when purchases or sales of securities for one or more clients will have an adverse effect on other clients. In the case of short-term investments, the Treasury area of Mentor Investment Group handles purchases and sales under guidelines approved by investment officers of the Trust. Each investment adviser and sub-adviser employs professional staffs of portfolio managers who draw upon a variety of resources for research information for the Trust. Expenses incurred in the operation of a Portfolio or otherwise allocated to a Portfolio, including but not limited to taxes, interest, brokerage fees and commissions, compensation paid under a Portfolio's 12b-1 plan and the Shareholder Service Plan, fees to Trustees who are not officers, directors, stockholders, or employees of Wheat, First Securities, Inc. and its subsidiaries, SEC fees and related expenses, state Blue Sky qualification fees, charges of the custodian and transfer and dividend disbursing agents, outside auditing, accounting, and legal services, charges for the printing of prospectuses and statements of additional information for regulatory purposes or for distribution, and certain costs incurred by Mentor Investment Group in responding to shareholder inquiries as approved by the Trustees from time to time, to shareholders, certain shareholder report charges and charges relating to corporate matters are borne by the Portfolio. Under the applicable Management Contract with the Trust in respect of each Portfolio, subject to such policies as the Trustees may determine, Mentor Advisors or Mentor Perpetual, as the case may be, at its expense, furnishes continuously an investment program for the Portfolio and makes investment decisions on behalf of the Portfolio. Mentor Advisors or Mentor Perpetual, as the case may be, may place portfolio transactions with broker-dealers which furnish Mentor Advisors or Mentor Perpetual, without cost to it, certain research, statistical and quotation services of value to Mentor Advisors or Mentor Perpetual and their affiliates in advising the Portfolio and other clients. In so doing, Mentor Advisors or Mentor Perpetual may cause a Portfolio to pay greater brokerage commissions than it might otherwise pay. Each Management Contract provides that Mentor Advisors or Mentor Perpetual, as the case may be, shall not be subject to any liability to a Portfolio or to any shareholder of a Portfolio for any act or omission in the course of or connected with rendering services to a Portfolio in the absence of its willful misfeasance, bad faith, gross negligence, or reckless disregard of its duties. Each of the Management Contracts is subject to annual approval (beginning in 2000) by (i) the Trustees or (ii) vote of a majority (as defined in the 1940 Act) of the outstanding voting securities of the affected Portfolio, provided that in either event the continuance is also approved by a majority of the Trustees who are not "interested persons" (as defined in the 1940 Act) of the Trust or the investment adviser in question, by vote cast in person at a meeting called for the purpose of voting on such approval. The Management Contracts are terminable without penalty, on not more than sixty days' notice and not less than thirty days' notice, by the Trustees, by vote of the holders of a majority of the affected Portfolio's shares, or by the applicable investment adviser. Each terminates automatically in the event of its assignment (as defined in the 1940 Act). MANAGEMENT FEES The investment adviser of each Portfolio receives an annual management fee from such Portfolio (which is described in the relevant Prospectus). The investment adviser pays a portion of that fee to any sub-adviser to the Portfolio. 32 The Portfolios paid investment advisory fees in the amounts and for the periods indicated below (amounts shown reflect fee waivers where applicable):
FISCAL YEAR FISCAL YEAR FISCAL YEAR 1998 1997 1996 ------------- ------------- ------------ Growth Portfolio ........................ $4,204,377 $3,238,498 $2,313,470 Capital Growth Portfolio ................ 2,153,467 1,063,903 728,536 Income and Growth Portfolio ............. 1,638,729 947,267 575,647 Global Portfolio ........................ 1,612,495 998,592 368,592 Quality Income Portfolio ................ 821,411 449,325 278,216 Municipal Income Portfolio .............. 557,332 370,232 344,784 Short-Duration Income Portfolio ......... 323,574 129,833 54,833 Balanced Portfolio ...................... 31,721 8,854 6,790
The investment advisers of the following Portfolios waived investment advisory fees in the following amounts for the periods indicated below:
FISCAL YEAR FISCAL YEAR FISCAL YEAR 1998 1997 1996 ------------- ------------- ------------ Quality Income Portfolio ................ $204,530 $123,214 $217,329 Short-Duration Income Portfolio ......... 180,523 55,521 83,567 Balanced Portfolio ...................... -- 20,072 18,976 High Income Portfolio ................... 175,891 -- --
The investment advisers of the following Portfolios paid sub-advisory fees to the Portfolios' sub-advisers in the following amounts for the periods indicated below:
FISCAL YEAR FISCAL YEAR FISCAL YEAR 1998 1997 1996 ------------- ------------- ------------ Income and Growth Portfolio ......... $575,028 $373,115 $236,071 Municipal Income Portfolio .......... 216,114 153,577 172,392
ADMINISTRATIVE SERVICES Mentor Investment Group, LLC serves as administrator to each of the Portfolios pursuant to an Administration Agreement. Pursuant to the Administration Agreement, Mentor Investment Group provides continuous business management services to the Portfolios and, subject to the general oversight of the Trustees, manages all of the business and affairs of the Portfolios subject to the provisions of the Trust's Declaration of Trust, By-laws and the 1940 Act, and other policies and instructions the Trustees may from time to time establish. Mentor Investment Group pays the compensation of all officers and executive employees of the Trust (except those employed by or serving at the request of an investment adviser or sub-adviser) and makes available to the Trust the services of its directors, officers, and employees as elected by the Trustees or officers of the Trust. In addition, Mentor 33 Investment Group provides all clerical services relating to the Portfolios' business. As compensation for its services, Mentor Investment Group receives a fee from each Portfolio calculated daily at the annual rate of .10% of a Portfolio's average daily net assets. The Administration Agreement must be approved at least annually with respect to each Portfolio by a vote of a majority of the Trustees who are not interested persons of Mentor Investment Group or the Trust. The Agreement may be terminated at any time without penalty on 30 days notice by Mentor Investment Group, or immediately in respect of any Portfolio upon notice by the Trustees or by vote of a majority of the outstanding voting securities of that Portfolio. The Agreement terminates automatically in the event of any assignment (as defined in the 1940 Act). The Portfolios paid administrative service fees in the following amounts for the periods indicated below (amounts shown reflect fee waivers where applicable):
FISCAL YEAR FISCAL YEAR FISCAL YEAR 1998 1997 1996 ------------- ------------- ------------ Growth Portfolio .................... $600,625 $462,643 $330,496 Capital Growth Portfolio ............ 269,183 132,988 91,067 Income and Growth Portfolio ......... 218,497 126,302 76,753 Global Portfolio .................... 153,750 92,753 33,508 Quality Income Portfolio ............ 174,343 95,423 82,591 Municipal Income Portfolio .......... 92,888 61,705 57,464 High Income Portfolio ............... 24,979 -- --
The administrators waived administrative fees in the amounts and for the periods indicated below:
FISCAL YEAR FISCAL YEAR FISCAL YEAR 1998 1997 1996 ------------- ------------- ------------ Short-Duration Income Portfolio ......... $101,237 37,151 $27,680 Balanced Portfolio ...................... 8,127 -- --
The Portfolios also provided direct reimbursement to Mentor for certain legal and compliance administration, investor relation and operation costs not covered under the Investment Management Agreement. These direct reimbursements were as follows:
FISCAL YEAR FISCAL YEAR FISCAL YEAR 1998 1997 1996 ------------- ------------- ------------ Growth Portfolio ........................ $26,735 17,457 23,289 Capital Growth Portfolio ................ 12,494 5,036 5,901 Income and Growth Portfolio ............. 10,079 4,851 5,210 Global Portfolio ........................ 6,902 3,672 2,752 Quality Income Portfolio ................ 7,964 3,617 5,005 Municipal Income Portfolio .............. 4,318 2,293 3,465 Short-Duration Income Portfolio ......... 5,085 1,443 1,842
34 SHAREHOLDER SERVICING PLAN The Trust has adopted a Shareholder Servicing Plan (the "Service Plan") with Mentor Distributors, LLC with respect to the Class A and Class B shares of each Portfolio. Pursuant to the Service Plan, financial institutions will enter into shareholder service agreements to provide administrative support services to their customers who from time to time may be record or beneficial owners of shares of one or more Portfolios. In return for providing these support services, a financial institution may receive payments from one or more Portfolios at a rate not exceeding .25% of the average daily net assets of the Class A or Class B shares of the particular Portfolio or Portfolios owned by the financial institution's customers for whom it is the holder of record or with whom it has a servicing relationship. The Service Plan is designed to stimulate financial institutions to render administrative support services to the Portfolios and their shareholders. These administrative support services include, but are not limited to, the following functions: providing office space, equipment, telephone facilities, and various personnel including clerical, supervisory, and computer personnel as necessary or beneficial to establish and maintain shareholder accounts and records; processing purchase and redemption transactions and automatic investments of client account cash balances; answering routine client inquiries regarding the Portfolios; assisting clients in changing dividend options, account designations and addresses; and providing such other services as the Portfolios reasonably request. In addition to receiving payments under the Service Plan, financial institutions may be compensated by the investment adviser, a sub-adviser, and/or Mentor Investment Group, or affiliates thereof, for providing administrative support services to holders of Class A or Class B shares of the Portfolios. These payments will be made directly by the investment adviser, a sub-adviser, and/or Mentor Investment Group or affiliates, as applicable, and will not be made from the assets of any of the Portfolios. SHAREHOLDER SERVICES FEES During fiscal year 1998, the Portfolios incurred shareholder service fees in respect of Class A and Class B shares under the Service Plan as follows (amounts shown reflect fee waivers where applicable):
CLASS A CLASS B ----------- ------------- Growth Portfolio ......................... $255,596 $1,233,864 Capital Growth Portfolio ................. 283,728 389,229 Income and Growth Portfolio .............. 222,501 323,741 Global Portfolio ......................... 146,546 237,827 Quality Income Portfolio ................. 195,196 232,278 Municipal Income Portfolio ............... 108,151 124,069 Short-Duration Income Portfolio .......... 160,078 91,969 Balanced Portfolio ....................... 3,517 6,695 High Income Portfolio .................... 28,187 34,631
35 BROKERAGE TRANSACTIONS Transactions on U.S. stock exchanges, commodities markets, and futures markets and other agency transactions involve the payment by a Portfolio of negotiated brokerage commissions. Such commissions vary among different brokers. A particular broker may charge different commissions according to such factors as the difficulty and size of the transaction. Transactions in foreign investments often involve the payment of fixed brokerage commissions, which may be higher than those in the United States. There is generally no stated commission in the case of securities traded in the over-the-counter markets, but the price paid by the Trust usually includes an undisclosed dealer commission or mark-up. In underwritten offerings, the price paid by the Trust includes a disclosed, fixed commission or discount retained by the underwriter or dealer. It is anticipated that most purchases and sales of securities by funds investing primarily in certain fixed-income securities will be with the issuer or with underwriters of or dealers in those securities, acting as principal. Accordingly, those funds would not ordinarily pay significant brokerage commissions with respect to securities transactions. It has for many years been a common practice in the investment advisory business for advisers of investment companies and other institutional investors to receive brokerage and research services (as defined in the Securities Exchange Act of 1934, as amended (the "1934 Act")) from broker-dealers that execute portfolio transactions for the clients of such advisers and from third parties with which such broker-dealers have arrangements. Consistent with this practice, each investment adviser or sub-adviser may receive brokerage and research services and other similar services from many broker-dealers with which such investment adviser or sub- adviser places a Portfolio's portfolio transactions and from third parties with which these broker-dealers have arrangements. These services include such matters as general economic and market reviews, industry and company reviews, evaluations of investments, recommendations as to the purchase and sale of investments, newspapers, magazines, pricing services, quotation services, news services and personal computers utilized by the investment adviser's or sub-adviser's managers and analysts. Where the services referred to above are not used exclusively by the investment adviser or sub-adviser for research purposes, the investment adviser or sub-adviser, based upon its own allocations of expected use, bears that portion of the cost of these services which directly relates to its non-research use. Some of these services are of value to the investment adviser or sub-adviser and its affiliates in advising various of its clients (including the Portfolios), although not all of these services are necessarily useful and of value in managing all or any of the Portfolios. The management fee paid by a Portfolio is not reduced because its investment adviser or sub-adviser or any of their affiliates receive these services even though the investment adviser or sub-adviser might otherwise be required to purchase some of these services for cash. A Portfolio's investment adviser or sub-adviser, as the case may be, places all orders for the purchase and sale of portfolio investments for the Portfolio and buys and sells investments for the Portfolio through a substantial number of brokers and dealers. The investment adviser or sub- adviser seeks the best overall terms available for the Portfolio, except to the extent the investment adviser or sub-adviser may be permitted to pay higher brokerage commissions as described below. In doing so, the investment adviser or sub-adviser, having in mind the Portfolio's best interests, considers all factors it deems relevant, including, by way of illustration, price, the size of the transaction, the nature of the market for the security or other investment, the amount of the commission, the timing of the transaction taking into account market prices and trends, the reputation, experience and financial stability of the broker-dealer involved and the quality of service rendered by the broker-dealer in other transactions. 36 As permitted by Section 28(e) of the 1934 Act, and by the advisory and sub-advisory agreements, a Portfolio's investment adviser or sub-adviser may cause the Portfolio to pay a broker-dealer which provides "brokerage and research services" (as defined in the 1934 Act) to that adviser an amount of disclosed commission for effecting securities transactions on stock exchanges and other transactions for the Portfolio on an agency basis in excess of the commission which another broker-dealer would have charged for effecting that transaction. The investment adviser's or sub-adviser's authority to cause a Portfolio to pay any such greater commissions is also subject to such policies as the Trustees may adopt from time to time. It is the position of the staff of the Securities and Exchange Commission that Section 28(e) does not apply to the payment of such greater commissions in "principal" transactions. Accordingly, each investment adviser and sub-adviser will use its best efforts to obtain the best overall terms available with respect to such transactions, as described above. Consistent with the Rules of Fair Practice of the National Association of Securities Dealers, Inc. and subject to such other policies as the Trustees may determine, an investment adviser or sub-adviser may consider sales of shares of a Portfolio (and, if permitted by law, of the other funds in the Mentor family) as a factor in the selection of broker-dealers to execute portfolio transactions for a Portfolio. The Trustees have determined that portfolio transactions for the Trust may be effected through Wheat, First Securities, Inc. ("Wheat"), First Union Brokerage Services ("FUBS"), and EVEREN Securities, Inc. ("EVEREN"), broker-dealers affiliated with Mentor Advisors and Mentor Perpetual. The Trustees have adopted certain policies incorporating the standards of Rule 17e-l issued by the SEC under the 1940 Act which requires, among other things, that the commissions paid to Wheat, FUBS, and EVEREN must be reasonable and fair compared to the commissions, fees, or other remuneration received by other brokers in connection with comparable transactions involving similar securities during a comparable period of time. Wheat, FUBS, and EVEREN will not participate in brokerage commissions given by a Portfolio to other brokers or dealers. Over-the-counter purchases and sales are transacted directly with principal market makers except in those cases in which better prices and executions may be obtained elsewhere. A Portfolio will in no event effect principal transactions with Wheat, FUBS, and EVEREN in over-the-counter securities in which Wheat, FUBS, or EVEREN makes a market. Under rules adopted by the SEC, Wheat, FUBS, and EVEREN may not execute transactions for a Portfolio on the floor of any national securities exchange, but may effect transactions for a Portfolio by transmitting orders for execution and arranging for the performance of this function by members of the exchange not associated with them. Wheat, FUBS, and EVEREN will be required to pay fees charged to those persons performing the floor brokerage elements out of the brokerage compensation they receive from a Portfolio. The Trust has been advised by Wheat that on most transactions, the floor brokerage generally constitutes from 5% and 10% of the total commissions paid. 37 BROKERAGE COMMISSIONS The Portfolios paid brokerage commissions on brokerage transactions in the following aggregate amounts for the periods indicated:
FISCAL YEAR FISCAL YEAR FISCAL YEAR 1998 1997 1996 ------------- ------------- ------------ Growth Portfolio ........................ $2,620,649 $1,482,817 $1,864,300 Capital Growth Portfolio ................ 920,105 275,151 299,554 Income and Growth Portfolio ............. 183,991 302,628 146,323 Global Portfolio ........................ 1,272,077 838,045 359,217 Quality Income Portfolio ................ -- 900 24,990 Municipal Income Portfolio .............. 18,968 5,044 2,422 Short-Duration Income Portfolio ......... -- -- 1,560 Balanced Portfolio ...................... 12,356 4,752 7,385
The following table shows brokerage commissions paid by each of the Portfolios to Wheat for the periods indicated:
FISCAL YEAR FISCAL YEAR FISCAL YEAR 1998 1997 1996 ------------- ------------- ------------ Growth Portfolio .................... $148,289 $101,434 $72,923 Capital Growth Portfolio ............ 104,188 29,226 54,642 Income and Growth Portfolio ......... 73,192 101,434 52,534 Balanced Portfolio .................. 193 50 --
The following table shows brokerage commissions paid by each of the Portfolios to EVEREN for the period indicated.
FISCAL YEAR FISCAL YEAR 1998 1997 ------------- ------------ Growth Portfolio ................. $20,738 $2,331 Capital Growth Portfolio ......... 63,266 9,793 Balanced Portfolio ............... 2,023 --
The brokerage commissions paid to Wheat for fiscal year 1998 amounted to the following percentages of the aggregate brokerage commissions and brokerage transactions paid by each Portfolio:
PERCENT OF AGGREGATE PERCENT OF AGGREGATE DOLLAR AMOUNT OF COMMISSIONS BROKERAGE TRANSACTIONS ---------------------- ----------------------- Growth Portfolio .................... 5.66% 5.19% Capital Growth Portfolio ............ 11.32% 14.26% Income and Growth Portfolio ......... 39.78% 29.39% Balanced Portfolio .................. 1.56% 0.32%
38 The brokerage commissions paid to EVEREN for fiscal year 1998 amounted to the following percentages of the aggregate brokerage commissions and brokerage transactions paid by each Portfolio:
PERCENT OF AGGREGATE PERCENT OF AGGREGATE DOLLAR AMOUNT OF COMMISSIONS BROKERAGE TRANSACTIONS ---------------------- ----------------------- Growth Portfolio ................. 0.79% 0.71% Capital Growth Portfolio ......... 6.88% 6.29% Balanced Portfolio ............... 16.37% 3.89%
HOW TO BUY SHARES Except under certain circumstances described in the Trust's or an individual Portfolio's prospectus, Class A shares of the Portfolios are sold at their net asset value plus an applicable sales charge on days the New York Stock Exchange is open for business. Class B shares of the Portfolios and Institutional Shares of the Portfolios are sold at their net asset value with no sales charge on days the New York Stock Exchange is open for business. The procedure for purchasing Class A, Class B, and Institutional Shares of the Portfolios is explained in the relevant Prospectus under the section entitled "How to Buy Shares." DISTRIBUTION Each of the Portfolios makes payments to Mentor Distributors, LLC in accordance with its respective Distribution Plan adopted in respect of Class B shares pursuant to Rule 12b-1 under the Investment Company Act of 1940. During fiscal year 1998, the Portfolios paid the following 12b-1 fees in respect of Class B shares to Mentor Distributors as shown below: Growth Portfolio ........................ $3,638,580 Capital Growth Portfolio ................ 1,227,717 Balanced Portfolio ...................... 30,319 Income and Growth Portfolio ............. 986,604 Global Portfolio ........................ 734,020 Quality Income Portfolio ................ 467,042 Municipal Income Portfolio .............. 257,381 Short-Duration Income Portfolio ......... 133,476 High Income Portfolio ................... 68,461
During fiscal year 1998, 12b-1 fees of $29,451 of the number above were waived in respect of Class B shares of the Balanced Portfolio. 39 CONTINGENT DEFERRED SALES CHARGES During fiscal year 1998, Mentor Distributors received the following contingent deferred sales charges with respect to Class B shares: Growth Portfolio ........................ $500,690 Capital Growth Portfolio ................ 132,159 Income and Growth Portfolio ............. 163,091 Global Portfolio ........................ 179,805 Quality Income Portfolio ................ 137,341 Municipal Income Portfolio .............. 26,436 Short-Duration Income Portfolio ......... 90,668 High Income Portfolio ................... 17,592
UNDERWRITING COMMISSIONS The following table shows the approximate amount of underwriting commissions retained by Mentor Distributors (and any predecessor) in respect of Class A and Class B shares for each Portfolio for the periods indicated:
FISCAL YEAR FISCAL YEAR FISCAL YEAR 1998 1997 1996 ------------- ------------- ------------ Growth Portfolio ........................ $231,016 $116,796 38,398 Capital Growth Portfolio ................ 320,353 63,786 $10,477 Income and Growth Portfolio ............. 169,108 59,230 15,762 Global Portfolio ........................ 113,331 66,416 23,038 Quality Income Portfolio ................ 104,891 37,516 9,062 Municipal Income Portfolio .............. 80,007 21,433 4,110 Short-Duration Income Portfolio ......... 4,833 867 186 High Income Portfolio ................... 56,138 -- --
DETERMINING NET ASSET VALUE A Portfolio determines the net asset value per share of each class once each day the New York Exchange (the "Exchange") is open as of the close of regular trading on the Exchange. Currently, the Exchange is closed Saturdays, Sundays and the following holidays: New Year's Day, Dr. Martin Luther King, Jr. Day, Presidents' Day, Good Friday, Memorial Day, the Fourth of July, Labor Day, Thanksgiving and Christmas. Securities for which market quotations are readily available are valued at prices which, in the opinion of a Portfolio's investment adviser or sub-adviser, most nearly represent the market values of such securities. Currently, such prices are determined using the last reported sale price or, if no sales are reported (as in the case of some securities traded over-the-counter), the last reported bid price, except that certain U.S. Government securities are stated at the mean between the last reported bid and asked prices. Short-term investments having remaining maturities of 60 days or less are stated at amortized cost, which approximates market value. All other 40 securities and assets are valued at their fair value following procedures approved by the Trustees. Liabilities are deducted from the total, and the resulting amount is divided by the number of shares of the class outstanding. Reliable market quotations are not considered to be readily available for long-term corporate bonds and notes, certain preferred stocks, tax-exempt securities, or certain foreign securities. These investments are stated at fair value on the basis of valuations furnished by pricing services approved by the Trustees, which determine valuations for normal, institutional- size trading units of such securities using methods based on market transactions for comparable securities and various relationships between securities which are generally recognized by institutional traders. If any securities held by a Portfolio are restricted as to resale, the Portfolio's investment adviser or sub-adviser determines their fair values. The fair value of such securities is generally determined as the amount which a Portfolio could reasonably expect to realize from an orderly disposition of such securities over a reasonable period of time. The valuation procedures applied in any specific instance are likely to vary from case to case. However, consideration is generally given to the financial position of the issuer and other fundamental analytical data relating to the investment and to the nature of the restrictions on disposition of the securities (including any registration expenses that might be borne by the Portfolio in connection with such disposition). In addition, specific factors are also generally considered, such as the cost of the investment, the market value of any unrestricted securities of the same class (both at the time of purchase and at the time of valuation), the size of the holding, the prices of any recent transactions or offers with respect to such securities and any available analysts' reports regarding the issuer. In the case of certain fixed-income securities, including certain less common mortgage-backed securities, market quotations are not readily available to the Portfolios on a daily basis, and pricing services may not provide price quotations. In such cases, the Portfolio's investment adviser or sub-adviser is typically able to obtain dealer quotations for each of the securities on at least a weekly basis. On any day when it is not practicable for the investment adviser or sub- adviser to obtain an actual dealer quotation for a security, the investment adviser or sub-adviser may reprice the securities based on changes in the value of a U.S. Treasury security of comparable duration. When the next dealer quotation is obtained, the investment adviser or sub-adviser compares the dealer quote against the price obtained by it using its U.S. Treasury-spread calculation, and makes any necessary adjustments to its calculation methodology. The investment adviser or sub-adviser attempts to obtain dealer quotes for each security at least weekly, and on any day when there has been an unusual occurrence affecting the securities which, in the investment adviser or sub-adviser's view, makes pricing the securities on the basis of U.S. Treasuries unlikely to provide a fair value of the securities. Generally, trading in certain securities (such as foreign securities) is substantially completed each day at various times prior to the close of the Exchange. The values of these securities used in determining the net asset value of a class of shares are computed as of such times. Also, because of the amount of time required to collect and process trading information as to large numbers of securities issues, the values of certain securities (such as convertible bonds, U.S. Government securities, and tax-exempt securities) are determined based on market quotations collected earlier in the day at the latest practicable time prior to the close of the Exchange. Occasionally, events affecting the value of such securities may occur between such times and the close of the Exchange which will not be reflected in the computation of net asset value. If events materially affecting the value of such securities occur during such period, then these securities will be valued at their fair value following procedures approved by the Trustees. 41 Trading in securities on European and Far Eastern securities exchanges and over-the-counter markets is normally completed well before the close of business on each business day in New York (i.e., a day on which the Exchange is open). In addition, European or Far Eastern securities trading generally or in a particular country or countries may not take place on all business days in New York. Furthermore, trading takes place in Japanese markets on certain Saturdays and in various foreign markets on days which are not business days in New York and on which net asset value is not calculated. A Portfolio calculates net asset value per share of each class, and therefore effects sales, redemptions and repurchases of its shares, as of the close of the Exchange once on each day on which the Exchange is open. Such calculation does not take place contemporaneously with the determination of the prices of the majority of the portfolio securities used in such calculation. If events materially affecting the value of such securities occur between the time when their price is determined and the time when a classes' net asset value is calculated, such securities will be valued at fair value as determined in good faith by procedures approved as required by the Trustees. REDEMPTIONS IN KIND Although each Portfolio intends to redeem Class A, Class B and Institutional Shares in cash, it reserves the right under certain circumstances to pay the redemption price in whole or in part by a distribution of securities from its investment portfolio. Redemptions in kind will be made in conformity with applicable SEC rules, taking such securities at the same value employed in determining net asset value and selecting the securities in a manner that the Trustees determine to be fair and equitable. The Trust has elected to be governed by Rule 18f-1 of the 1940 Act, under which a Portfolio is obligated to redeem shares for any one shareholder in cash only up to the lesser of $250,000 or 1% of the respective classes' net asset value during any 90-day period. TAXES Each Portfolio intends to qualify each year and elect to be taxed as a regulated investment company under Subchapter M of the United States Internal Revenue Code of 1986, as amended (the "Code"). As a regulated investment company qualifying to have its tax liability determined under Subchapter M, a Portfolio will not be subject to federal income tax on any of its net investment income or net realized capital gains that are distributed to shareholders. A Portfolio will not under present law be subject to any excise or income taxes in Massachusetts. In order to qualify as a "regulated investment company," a Portfolio must, among other things, (a) derive at least 90% of its gross income from dividends, interest, payments with respect to securities loans, gains from the sale or other dispositions of stock, securities, or foreign currencies, and other income (including but not limited to gains from options, futures, or forward contracts) derived with respect to its business of investing in such stock, securities, or currencies; and (b) diversify its holdings so that, at the close of each quarter of its taxable year, (i) at least 50% of the market value of its total assets consists of cash and cash items, U.S. Government Securities, securities of other regulated investment companies, and other securities limited generally with respect to any one issuer to not more than 5% of the value of its total assets and not more than 10% of the outstanding voting securities of such issuer, and (ii) not more than 25% of the value of its total assets is invested in the securities (other than those of the U.S. Government or other regulated investment companies) of any issuer or of two or more issuers which the Portfolio controls and which are engaged in the same, similar, or related trades or 42 businesses. In order to receive the favorable tax treatment accorded regulated investment companies and their shareholders, moreover, a Portfolio must in general distribute at least 90% of the sum of its taxable net investment income, its net tax-exempt income, and the excess, if any, of net short-term capital gains over net long-term capital losses for such year. If a Portfolio failed to qualify as a regulated investment company accorded special tax treatment in any taxable year, the Portfolio would be subject to tax on its taxable income at corporate rates, and all distributions from earnings and profits, including any distributions of net tax-exempt income and net long-term capital gains, would be taxable to shareholders as ordinary income. In addition, a Portfolio could be required to recognize unrealized gains, pay substantial taxes and interest and make substantial distributions before requalifying as a regulated investment company that is accorded special tax treatment. If a Portfolio fails to distribute in a calendar year substantially all of its taxable ordinary income for such year and substantially all of its capital gain net income for the one-year period ending October 31, plus any retained amount from the prior year, the Portfolio will be subject to a 4% excise tax on the undistributed amounts. A dividend paid to shareholders by a Portfolio in January of a year generally is deemed to have been paid by the Portfolio on December 31 of the preceding year, if the dividend was declared and payable to shareholders of record on a date in October, November or December of that preceding year. Each Portfolio intends generally to make distributions sufficient to avoid imposition of the 4% excise tax. Distributions from a Portfolio (other than exempt-interest dividends, as discussed below) will be taxable to shareholders as ordinary income to the extent derived from the Portfolio's investment income and net short-term gains. Distributions of net capital gain (that is, the excess of net gains from capital assets held by the Portfolio for more than one year over net losses from capital assets held for not more than one year) that are designed as capital gain dividends will be taxable to shareholders as long-term capital gain, which is generally taxable to individuals at a 20% rate. Dividends and distributions on a Portfolio's shares are generally subject to federal income tax as described herein to the extent they do not exceed the Portfolio's realized income and gains, even though such dividends and distributions may economically represent a return of a particular shareholder's investment. Such distributions are likely to occur in respect of shares purchased at a time when a Portfolio's net asset value reflects gains that are either unrealized, or realized but not distributed. Such realized gains may be required to be distributed even when a Portfolio's net asset value also reflects unrealized losses. EXEMPT-INTEREST DIVIDENDS. A Portfolio will be qualified to pay exempt-interest dividends to its shareholders only if, at the close of each quarter of the Portfolio's taxable year, at least 50% of the total value of the Portfolio's assets consists of obligations the interest on which is exempt from federal income tax. Distributions that a Portfolio properly designates as exempt-interest dividends are treated by shareholders as interest excludable from their gross income for federal income tax purposes but may be taxable for federal alternative minimum tax purposes and for state and local purposes. If a Portfolio intends to be qualified to pay exempt-interest dividends, the Portfolio may be limited in its ability to enter into taxable transactions involving forward commitments, or repurchase agreements, financial futures, and options contracts on financial futures, tax-exempt bond indices, and other assets. Part or all of the interest on indebtedness, if any, incurred or continued by a shareholder to purchase or carry shares of a Portfolio paying exempt-interest dividends is not deductible. The portion of interest that is not 43 deductible is equal to the total interest paid or accrued on the indebtedness, multiplied by the percentage of a Portfolio's total distributions (not including distributions from net capital gain) paid to the shareholder that are exempt-interest dividends. Under rules used by the Internal Revenue Service for determining when borrowed funds are considered used for the purpose of purchasing or carrying particular assets, the purchase of shares may be considered to have been made with borrowed funds even though such funds are not directly traceable to the purchase of shares. In general, exempt-interest dividends, if any, attributable to interest received on certain private activity obligations and certain industrial development bonds will not be tax-exempt to any shareholders who are "substantial users" of the facilities financed by such obligations or bonds or who are "related persons" of such substantial users. A Portfolio which is qualified to pay exempt-interest dividends will inform investors within 60 days of the Portfolio's fiscal year-end of the percentage of its income distributions designated as tax-exempt. The percentage is applied uniformly to all distributions made during the year. The percentage of income designated as tax-exempt for any particular distribution may be substantially different from the percentage of the Portfolio's income that was tax-exempt during the period covered by the distribution. HEDGING TRANSACTIONS. If a Portfolio engages in hedging transactions, including hedging transactions in options, futures contracts, and straddles, or other similar transactions, it will be subject to special tax rules (including constructive sale, mark-to-market, straddle, wash sale, and short sale rules), the effect of which may be to accelerate income to the Portfolio, defer losses to the Portfolio, cause adjustments in the holding periods of the Portfolio's securities, or convert short-term capital losses into long-term capital losses. These rules could therefore affect the amount, timing and character of distributions to shareholders. Each Portfolio will endeavor to make any available elections pertaining to such transactions in a manner believed to be in the best interests of the Portfolio. RETURN OF CAPITAL DISTRIBUTIONS. If a Portfolio makes a distribution to you in excess of its current and accumulated "earnings and profits" allocable to such distribution, the excess distribution will be treated as a return of capital to the extent of your tax basis in your shares, and thereafter as capital gain. A return of capital is not taxable, but it reduces your tax basis in your shares, thus reducing any loss or increasing any gain on a subsequent taxable disposition by you or your shares. SECURITIES ISSUED OR PURCHASED AT A DISCOUNT. A Portfolio's investment in securities issued at a discount and certain other obligations will (and investments in securities purchased at a discount may) require the Portfolio to accrue and distribute income not yet received. In order to generate sufficient cash to make the requisite distributions, a Portfolio may be required to sell securities in its portfolio that it otherwise would have continued to hold. FOREIGN CURRENCY-DENOMINATED SECURITIES AND RELATED HEDGING TRANSACTIONS. A Portfolio's transactions in foreign currencies, foreign currency-denominated debt securities and certain foreign currency options, futures contracts, and forward contacts (and similar instruments) may give rise to ordinary income or loss to the extent such income or loss results from fluctuations in the value of the foreign currency concerned. Certain of a Portfolio's transactions, if any, in foreign currencies or foreign currency-denominated instruments are likely to produce a difference between its book income and its taxable income. If a Portfolio's book 44 income exceeds its taxable income, the distribution (if any) of such excess will be treated as a dividend to the extent of the Portfolio's remaining earnings and profits (including earnings and profits arising from tax-exempt income), and thereafter as a return of capital or as gain from the sale or exchange of a capital asset, as the case may be. If a Portfolio's book income is less than its taxable income, the Portfolio could be required to make distributions exceeding book income to qualify as a regulated investment company that is accorded special tax treatment. FOREIGN TAX CREDIT. If more than 50% of a Portfolio's assets at year end consists of the stock or securities of foreign corporations, the Portfolio may elect to permit shareholders to claim a credit or deduction on their income tax returns for their pro rata portion of qualified taxes paid by the Portfolio to foreign countries in respect of foreign securities the Portfolio has held for at least the minimum period, if any, specified in the Code. In such a case, shareholders will include in gross income from foreign sources their pro rata shares of such taxes. A shareholder's ability to claim a foreign tax credit or deduction in respect of foreign taxes paid by the Portfolio may be subject to certain limitations imposed by the Code, as a result of which a shareholder may not get a full credit or deduction for the amount of such taxes. Shareholders who do not itemize on their federal income tax returns may claim a credit (but no deduction) for such foreign taxes. PASSIVE FOREIGN INVESTMENT COMPANIES. Investment by a Portfolio in certain "passive foreign investment companies" ("PFICs") could subject the Portfolio to a U.S. federal income tax (including interest charges) on distributions received from the company or on proceeds received from the disposition of shares in the company, which tax cannot be eliminated by making distributions to Portfolio shareholders. However, the Portfolio in certain circumstances, may elect to treat a passive foreign investment company as a "qualified electing fund," in which case the Portfolio will be required to include its share of the company's income and net capital gain in income annually, regardless of whether it receives any distribution from the company. The Portfolio also may make an election to mark the gains (and to a limited extent losses) in such holdings "to the market" as though it had sold and repurchased its holdings in those PFICs on the last day of the Portfolio's taxable year. Such gains and losses are treated as ordinary income and loss, as are gains on disposition of the stock and losses on disposition of the stock is to the extent of previous inclusions in income. The qualified electing fund and mark-to-market elections may have the effect of accelerating the recognition of income (without the receipt of cash) and increasing the amount required to be distributed for the Portfolio to avoid taxation. Making either of these elections therefore may require a Portfolio to liquidate other investments (including when it is not advantageous to do so) to meet its distribution requirement, which also may accelerate the recognition of gain and affect a Portfolio's total return. SALE OR REDEMPTION OF SHARES. The sale, exchange or redemption of Portfolio shares may give rise to a gain or loss. In general, any gain realized upon a taxable disposition of shares held for more than one year will be taxed as long-term capital gain. Such gain is, in the case of an individual, generally taxed at a 20% rate. However, if a shareholder sells shares at a loss within six months of purchase, any loss will be disallowed for federal income tax purposes to the extent of any exempt-interest dividends received on such shares. In addition, any loss (not already disallowed as provided in the preceding sentence) realized upon a taxable disposition of shares held for six months or less will be treated as long-term, rather than short-term, capital loss to the extent of any long-term capital gain distributions received by the shareholder with respect to the shares. All or a portion of any loss realized upon a taxable disposition of Portfolio shares will be disallowed if other Portfolio shares 45 are purchased within 30 days before or after the disposition. In such a case, the basis of the newly purchased shares will be adjusted to reflect the disallowed loss. SHARES PURCHASED THROUGH TAX-QUALIFIED PLANS. Special tax rules apply to investments through defined contribution plans and other tax-qualified plans. Shareholders should consult their tax adviser to determine the suitability of shares of a Portfolio as an investment through such plans and the precise effect of an investment on their particular tax situation. BACKUP WITHHOLDING. A Portfolio generally is required to withhold and remit to the U.S. Treasury 31% of the taxable dividends and other distributions (including in redemption of Portfolio shares) paid to any individual shareholder who fails to furnish the Portfolio with a correct taxpayer identification number (TIN), who has under- reported dividend or interest income, or who fails to certify to the Portfolio that he or she is not subject to such withholding. Shareholders who fail to furnish their current TIN are subject to a penalty of $50 for each such failure unless the failure is due to reasonable cause and not wilful neglect. An individual's taxpayer identification number is his or her social security number. The foregoing is a general and abbreviated summary of the applicable provisions of the Code and related regulations currently in effect. For the complete provisions, reference should be made to the pertinent Code sections and regulations. The Code and regulations are subject to change by legislative or administrative actions. Dividends, distributions, and redemption proceeds also may be subject to state, local, foreign and other taxes. Shareholders are urged to consult their tax advisers regarding specific questions as to federal, state, local or foreign taxes. The foregoing discussion relates solely to U.S. federal income tax law. Non-U.S. investors should consult their tax advisers concerning the tax consequences of ownership of shares of the Portfolio, including the possibility that distributions may be subject to a 30% United States withholding tax (or a reduced rate of withholding provided by treaty). INDEPENDENT ACCOUNTANTS KPMG Peat Marwick LLP, located at 99 High Street, Boston, Massachusetts 02110, are the Trust's independent accountants, providing audit services, tax return review and other tax consulting services. CUSTODIAN Investors Fiduciary Trust Company, located at 127 West 10th Street, Kansas City, Missouri, is the custodian of each Portfolio, except that State Street Bank & Trust Company, P.O. Box 8602, Boston, Massachusetts serves as custodian to the Global Portfolio and as the foreign custodian to each of the other Portfolios in respect of foreign assets. A custodian's responsibilities include generally safeguarding and controlling a Portfolio's cash and securities, handling the receipt and delivery of securities, and collecting interest and dividends on a Portfolio's investments. 46 PERFORMANCE INFORMATION (SHOWN THROUGH SEPTEMBER 30, 1998) The table below shows the average annual total return of Class A shares and Class B shares for the one-, five- and ten-year periods (or for the life of a class if shorter)**:
SINCE INCEPTION CLASS A SHARES 1 YEAR 5 YEARS OR 10 YEARS - ------------------------------------------ ------------ ----------- ---------------- Growth Portfolio* ........................ -26.57% N/A 11.47% Capital Growth Portfolio ................. 4.34% 15.75% 13.57% Balanced Portfolio ....................... N/A N/A -5.78% Income and Growth Portfolio .............. -0.29% 12.62% 12.84% Global Portfolio ......................... -10.44% N/A 8.50% Quality Income Portfolio ................. 4.71% 5.31% 5.51% Municipal Income Portfolio ............... 3.12% 4.53% 6.79% Short-Duration Income Portfolio* ......... 5.89% N/A 5.94% High Income Portfolio .................... N/A N/A -11.19%
SINCE INCEPTION CLASS B SHARES 1 YEAR 5 YEARS OR 10 YEARS - ------------------------------------------ ------------ --------- ---------------- Growth Portfolio* ........................ -25.53% 9.87% 8.19% Capital Growth Portfolio ................. 5.86% 16.17% 13.84% Balanced Portfolio ....................... 8.75% N/A 17.69% Income and Growth Portfolio .............. 1.22% 12.67% 14.70% Global Portfolio ......................... -9.23% N/A 8.89% Quality Income Portfolio ................. 5.46% 5.65% 7.14% Municipal Income Portfolio ............... 3.70% 4.85% 6.90% Short-Duration Income Portfolio* ......... 2.68% N/A 5.52% High Income Portfolio .................... N/A N/A -7.86%
SINCE INCEPTION CLASS Y SHARES 1 YEAR 5 YEARS OR 10 YEARS - ------------------------------------------ -------- --------- ---------------- Growth Portfolio* ........................ N/A N/A -18.36% Capital Growth Portfolio ................. N/A N/A 10.56% Balanced Portfolio* ...................... N/A N/A 0.00% Income and Growth Portfolio .............. N/A N/A 7.29% Global Portfolio ......................... N/A N/A 1.60% Quality Income Portfolio ................. N/A N/A 8.94% Municipal Income Portfolio ............... N/A N/A 7.51% Short-Duration Income Portfolio* ......... N/A N/A 6.64% High Income Portfolio .................... N/A N/A N/A
- ---------- * Prior to May 30, 1995, the Balanced, Growth, and Short-Duration Income Portfolios only offered one class of shares. Total return information prior to this date is shown under the Class B share table. As a result, the annual total return information beyond the one-year period shown above for the Balanced, Growth, and 47 Short-Duration Income Portfolios reflects various sales charges currently not applicable to the Portfolios. The Balanced, Growth, and Short-Duration Portfolios are the successors to Mentor Balanced Fund, Mentor Growth Fund, and Mentor Short-Duration Income Fund, respectively, each of which was previously a series of shares of beneficial interest of Mentor Series Trust. For fiscal 1994, none of these Funds bore a front-end sales charge, but each of them was subject to a maximum contingent deferred sales charge of 5%. ** No Institutional Shares were outstanding for these periods. Total return for the one-, five-, and ten-year periods for each class of shares of a Portfolio (or for the life of a class, if shorter) is determined by calculating the actual dollar amount of investment return on a $1,000 investment in shares of that class at the beginning of the period, and then calculating the annual compounded rate of return which would produce that amount. Total return for a period of one year is equal to the actual return of the particular class of a Portfolio during that period. Total return calculations assume deduction of a classes' maximum front-end or contingent deferred sales charge, if any, and reinvestment of all distributions at net asset value on their respective reinvestment dates. All data are based on past performance and do not predict future results. YIELD AND TAX-EQUIVALENT YIELD The thirty-day yield for Class A shares and Class B shares of certain of the Portfolios for the period ending September 30, 1998, was as follows*:
CLASS A CLASS B --------- ---------- Quality Income Portfolio ................. 4.59% 4.32% Municipal Income Portfolio ............... 3.99% 3.69% Short-Duration Income Portfolio .......... 4.81% 4.57% High Income Portfolio .................... 10.37% 10.36%
The tax-equivalent yield for the Municipal Income Portfolio for the thirty-day period ended September 30. Class A ............... 6.61% Class B ............... 6.11%
- ---------- * No Institutional Shares were outstanding for these periods. Yield for each class is presented for a specified thirty-day period (the "base period"). Yield is based on the amount determined by (i) calculating the aggregate amount of dividends and interest earned by a class of shares of a Portfolio during the base period less expenses accrued for that period, and (ii) dividing that amount by the product of (A) the average daily number of shares of the class outstanding during the base period and entitled to receive dividends and (B) the net asset value per share of the class on the last day of the base period. The result is annualized on a compounding basis to determine the yield. For this calculation, interest earned on debt obligations held by a Portfolio is generally calculated using the yield to maturity (or first expected call date) of such obligations based on their market values (or, in the case of receivables-backed securities such as GNMA's, based on costs). Dividends on equity securities are accrued daily at their stated dividend rates. 48 To the extent that financial institutions and broker/dealers charge fees in connection with services provided in conjunction with an investment in a Portfolio, the performance will be reduced for those shareholders paying those fees. The tax-equivalent yield for Class A shares of the Municipal Income Portfolio for the thirty-day period ending September 30, 1998, was 6.61%. The tax-equivalent yield for that Portfolio's Class B shares was 6.11% for the same period. The tax-equivalent yield for all classes of shares of the Municipal Income Portfolio is calculated similarly to the yield, but is adjusted to reflect the taxable yield that the Portfolio would have had to earn to equal its actual yield, assuming a 39.6% tax rate (the maximum effective federal rate for individuals) and assuming that income is 100% tax-exempt. The Municipal Income Portfolio may also use a tax-equivalency table in advertising and sales literature. The interest earned by the municipal bonds in the Portfolio's investment portfolio generally remains free from federal regular income tax but may be subject to state and local taxes. (Some portion of the Portfolio's income may be subject to federal alternative minimum tax and state and local taxes.) Capital gains, if any, are subject to federal, state and local tax. At times, a Portfolio's investment adviser or sub-adviser may reduce its compensation or assume expenses of the Portfolio in order to reduce the Portfolio's expenses. Any such fee reduction or assumption of expenses would increase a classes' yield and total return during the period of the fee reduction or assumption of expenses. Total return may be presented for other periods or without giving effect to any contingent deferred sales charge. Any quotation of total return or yield not reflecting the front-end or contingent deferred sales charge would be reduced if such sales charges were reflected. EQUIVALENT YIELDS: TAX-EXEMPT VERSUS TAXABLE SECURITIES FOR THE MUNICIPAL INCOME PORTFOLIO The table below shows the effect of the tax status of tax-exempt securities on the effective yield received by their individual holders under the federal income tax laws currently in effect for 1998. It gives the approximate yield a taxable security must earn at various income levels to produce after-tax yields equivalent to those of tax-exempt securities yielding from 2.0% to 10.0%. 49 MENTOR MUNICIPAL INCOME PORTFOLIO -- FEDERAL TAXABLE EQUIVALENT YIELD TABLE-1998 RATES
EFFECTIVE FEDERAL FEDERAL FEDERAL TAXPAYER TAXABLE TAX TAX YEAR STATUS INCOME BRACKET RATE - -------- ---------- ------------------ ----------- ---------- 1998 MARRIED $ 0-42,350 15.00% 15.00% $ 42,351-102,300 28.00% 28.00% $102,301-124,500 31.00% 31.00% $124,501-155,950 31.00% 31.93% $155,951-278,450 36.00% 37.08% OVER $278,450 39.60% 40.79% 1998 SINGLE $ 0-25,350 15.00% 15.00% $ 25,351-61,400 28.00% 28.00% $ 61,401-124,500 31.00% 31.00% $124,501-128,500 31.00% 31.93% 128,101-278,450 36.00% 37.08% OVER $278,450 39.60% 40.79% TAX-FREE YIELD ---------------------------------------------------------------------------------------------------- 2.00% 3.00% 4.00% 5.00% 6.00% 7.00% 8.00% 9.00% 10.00% ---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------- ----------- YEAR - -------- TAXABLE EQUIVALENT YIELD 1998 2.35% 3.53% 4.71% 5.88% 7.06% 8.24% 9.41% 10.59% 11.76% 2.78% 4.17% 5.56% 6.94% 8.33% 9.72% 11.11% 12.50% 13.89% 2.90% 4.35% 5.80% 7.25% 8.70% 10.14% 11.59% 13.04% 14.49% 2.94% 4.41% 5.88% 7.35% 8.81% 10.28% 11.75% 13.22% 14.69% 3.18% 4.77% 6.36% 7.95% 9.54% 11.13% 12.71% 14.30% 15.89% 3.38% 5.07% 6.76% 8.44% 10.13% 11.82% 13.51% 15.20% 16.89% 1998 2.35% 3.53% 4.71% 5.88% 7.06% 8.24% 9.41% 10.59% 11.76% 2.78% 4.17% 5.56% 6.94% 8.33% 9.72% 11.11% 12.50% 13.89% 2.90% 4.35% 5.80% 7.25% 8.70% 10.14% 11.59% 13.04% 14.49% 2.94% 4.41% 5.88% 7.35% 8.81% 10.28% 11.75% 13.22% 14.69% 3.18% 4.77% 6.36% 7.95% 9.54% 11.13% 12.71% 14.30% 15.89% 3.38% 5.07% 6.76% 8.44% 10.13% 11.82% 13.51% 15.20% 16.89%
- --------- Note: This tables reflects the following: 1 Taxable Income, as reflected in the above table, equals Federal adjusted gross income (AGI), less personal exemptions and itemized deductions. However, certain itemized deductions are reduced by the lesser of (i) three percent of the amount of the taxpayer's AGI over $124,500, or (ii) 80 percent of the amount of such itemized deductions otherwise allowable. The effect of the three percent phase out on all itemized deductions and not just those deductions subject to the phase out is reflected above in the combined Federal and state tax rates through the use of higher effective Federal tax rates. In addition, the effect of the 80 percent cap on overall percent cap on overall itemized deductions is not reflected on this tables. Federal income tax rules also provide that personal exemptions are phased out at a rate of two percent for each $2,500 (or fraction thereof) of AGI in excess of $186,800 for married taxpayers filing a joint tax return and $124,500 for single taxpayers. The effect of the phase out of personal exemmptions is not reflected in the above table. 2 The effect of state income taxes are not considered in the above table. Such consideration would increase the taxable equivalent yield to the extent that the municipal obligations are issued by the taxpayer's state o f residence. 3 Interest earned on municipal obligations may be subject to the federal alternative minimum tax. This provision is not incorporated into the table. 4 The taxable equivalent yield table does not incorporate the effect of graduated rate structures in determinig yields. Instead, the tax rates used are the highest marginal tax rates applicable to the income levcels indicated within each bracket. 5 Interest earned on all municipal obligations may cause certain investors to be subject to tax on a portion of their Social Security an/dor railroad retirement benefits. The effect of this provision is not included in the above table. 50 MEMBERS OF INVESTMENT MANAGEMENT TEAMS The following persons are investment personnel of the Portfolio's investment advisers, as indicated. MENTOR INVESTMENT ADVISORS, LLC LARGE CAPITALIZATION QUALITY EQUITY GROWTH JOHN G. DAVENPORT, CFA -- MANAGING DIRECTOR, CHIEF INVESTMENT OFFICER Mr. Davenport has 12 years of investment management experience. He joined the firm after leading equity research at the investment management firm of Lowe, Brockenbrough, & Tattersall, Inc. Mr. Davenport graduated from the University of Richmond and has an MBA from the University of Virginia. RICHARD H. SKEPPSTROM II -- SENIOR VICE PRESIDENT, PORTFOLIO MANAGER Mr. Skeppstrom has 7 years of investment management experience. Before joining the firm he was a global portfolio analyst for Saudi International Bank Portfolio Advisors. Mr. Skeppstrom began his career as a pension and benefit analyst at Johnson & Higgins of Virginia. He has earned both an undergraduate degree and an MBA from the University of Virginia. CHRISTOPHER W. RUSBULDT, CFA -- VICE PRESIDENT, PORTFOLIO MANAGER Mr. Rusbuldt joined the firm in 1995 and has 7 years' investment experience. Previously, he was an equity research analyst for Wheat First Butcher Singer. He began his career as a banker in the corporate group at NationsBank. Mr. Rusbuldt is a graduate of the University of Virginia. RICHARD L. RICE -- VICE PRESIDENT, PORTFOLIO MANAGER Mr. Rice has 22 years' experience in the securities industry. Before joining Mentor, he was a partner in Parata Analytics Research. Prior responsibilities include research for Signet Asset Management, senior research analyst for Capitoline Investment Services, and positions in research at Atlanta Corporation and Southwest Banking, Inc. Mr. Rice is a graduate of the University of Florida and has completed graduate work at Georgia State University. STEVEN A. CERTO -- VICE PRESIDENT, PORTFOLIO MANAGER Mr. Certo joined the firm in 1997, from the equity research department of Wheat First Butcher Singer where he was a research analyst following the software industry. Mr. Certo served five years as an intelligence officer in the US Navy. His professional background also includes a year as an investment representative for Edward Jones and Co. He is a graduate of Iona College and is a level III candidate in the CFA program. ACTIVE FIXED-INCOME P. MICHAEL JONES, CFA -- MANAGING DIRECTOR, CHIEF INVESTMENT OFFICER Mr. Jones has 12 years of investment management experience. He is the manager of Mentor Short-Duration Income Portfolio and Mentor Quality Income Portfolio, as well as Mentor Income Fund, a $120 million closed-end bond fund. Mr. Jones is responsible for the design and implementation of the fixed-income group's proprietary analytical system. He has worked as an investment manager at Ryland Capital Management, Alliance Capital Management, and Central Fidelity Bank. Mr. Jones earned an undergraduate degree from the College of William and Mary, and an MBA from the Wharton School of the University of Pennsylvania. DENNIS F. CLARY, CFA -- SENIOR VICE PRESIDENT, PORTFOLIO MANAGER Mr. Clary joined Mentor in 1998 and has over 20 years of investment management experience. Prior to joining Mentor's Fixed Income Team, he worked for three years as a Vice President and Senior Portfolio Manager for 51 First America Investment Corporation. He previously was employed for four years as a Vice President and Portfolio Manager at CSI Asset Management, Inc. and prior to that for four years in a similar role by Investment & Capital Management Corporation. Mr. Clary received his BA and MBA degrees from Ohio State University. TIMOTHY ANDERSON, CFA -- SENIOR VICE PRESIDENT, PORTFOLIO MANAGER Mr. Anderson has 8 years of investment management experience. He joined Mentor in June, 1998. Prior to joining Mentor's Fixed-Income Team, he worked for two years as a Senior Fixed Income Analyst at Investment Advisors, Inc. Previous to that he was employed for five years as a Senior Investment Analyst at St. Paul Fire & Marine Insurance Company and for two years as an Analyst for Duff & Phelps Credit Rating Company. He received a BS degree from DePaul University and an MBA degree from the University of Chicago. TODD C. KUIMJIAN -- PORTFOLIO MANAGER Mr. Kuimjian has 4 years of investment management experience. He joined the Fixed-Income Team in January, 1997, initially as a Research Analyst and later as a Portfolio Manager. Prior to joining the Fixed-Income Team, Mr. Kuimjian served Mentor as an investment accountant/systems analyst and later as a senior investment administrator within Mentor's investment services group. Mr. Kuimjian is a Certified Public Accountant and received his BS degree from Virginia Polytechnic Institute. SMALL CAPITALIZATION EQUITY GROWTH THEODORE W. PRICE, CFA -- MANAGING DIRECTOR, CHIEF INVESTMENT OFFICER Mr. Price has 30 years of investment management experience. Prior to establishing the small/mid cap. management style, Mr. Price served for 10 years as vice chairman and portfolio manager of the investment management subsidiary of Wheat First Butcher Singer. In 1985, he established the equity retail mutual fund, Mentor Growth Portfolio, which today represents nearly $600 million in assets. He is a member of the Richmond Society of Financial Analysts. Mr. Price earned both BA and MBA degrees from the University of Virginia. LINDA A. ZIGLAR, CFA -- MANAGING DIRECTOR, PORTFOLIO MANAGER Ms. Ziglar has 19 years investment management experience. Ms. Ziglar joined the firm in 1991 after serving seven years as vice president of Federal Investment Counseling and Federated Research Corporation in Pittsburgh. While at Federated, Ms. Ziglar shared responsibility for the management of more than $300 million in mutual fund and separate account assets. She is a member of the Richmond Society of Financial Analysts, the Financial Analysts Federation, and a former officer of the Pittsburgh Society of Financial Analysts. Ms. Ziglar is a summa cum laude, Phi Beta Kappa graduate of Randolph-Macon Woman's College. She earned an MBA from the University of Pittsburgh. JEFFREY S. DRUMMOND, CFA -- SENIOR VICE PRESIDENT, PORTFOLIO MANAGER Mr. Drummond joined the firm in 1993 after five years in investment strategy at Wheat First Butcher Singer. While working with Wheat's chief investment strategist, he shared responsibility for the management of the Strategic Sectors Portfolio. He is a member of the Richmond Society of Financial Analysts. Mr. Drummond graduated cum laude from the University of Richmond. CASH MANAGEMENT R. PRESTON NUTTALL, CFA -- MANAGING DIRECTOR, CHIEF INVESTMENT OFFICER Mr. Nuttall has more than 30 years of investment management experience. Prior to Mentor Advisors, he led 52 short-term fixed-income management for fifteen years at Capitoline Investment Services, Inc. He has his undergraduate degree in economics from the University of Richmond and his graduate degree in finance from the Wharton School at the University of Pennsylvania. HUBERT R. WHITE III -- SENIOR VICE PRESIDENT, PORTFOLIO MANAGER Mr. White has 12 years of investment management experience. Prior to joining Mentor Advisors, he served for five years as portfolio manager with Capitoline Investment Services. He has his undergraduate degree in business from the University of Richmond. GREGORY S. KAPLAN -- ASSOCIATE VICE PRESIDENT, PORTFOLIO MANAGER Mr. Kaplan brings over 6 years of analytical and investment experience to Mentor. Prior to joining the firm, Mr. Kaplan served for four years as a credit specialist analyzing commercial credit for NationsBank. He began his career in the Investment Services division of Prudential Insurance. Mr. Kaplan is a graduate of Rutgers University and earned his MBS from the Pamplin College of Business at Virginia Polytechnic Institute and State University. MENTOR PERPETUAL ADVISORS, LLC MARTIN ARBIB -- CHAIRMAN, PERPETUAL PORTFOLIO MANAGEMENT Mr. Arbib is chairman and founder of Perpetual, a partner in the Mentor Perpetual Advisors joint venture, where he currently leads investment management. A chartered Accountant, he has 22 years' investment management experience. BOB YERBURY -- CHIEF INVESTMENT OFFICER Mr. Yerbury has 24 years' investment management experience, with over 21 years' experience in North American stock markets, and has been part of the Perpetual team for 13 years. Before joining Perpetual, he was a portfolio manager with Equity & Law Assurance Company. Mr. Yerbury is a graduate of Cambridge University. STEPHEN WHITTAKER -- UK TEAM LEADER Mr. Whittaker joined Perpetual eight years ago and has 16 years' investment management experience. Prior to joining Perpetual, he was responsible for UK equity funds for the Save & Prosper Group. He began his fund management career with Rowe & Pitman after graduation from Manchester University. MARGARET RODDAN -- EUROPE TEAM LEADER Ms. Roddan has 11 years of investment management experience, three years with Perpetual. She joined Perpetual from Mercury Asset Management, where she shared responsibility for management of continental European equity holdings. She began her career with the National Provident Institution. Ms. Roddan is a graduate of the Investment Management Program at the London Business School. She studied finance at City University and is a graduate of Bristol University. SCOTT MCGLASHAN -- FAR EAST TEAM LEADER Mr. McGlashan has 19 years' management experience, 13 years specializing in the Far East, and 11 years' tenure at Perpetual. He is a graduate of Yale and Cambridge University. 53 KATHRYN LANGRIDGE -- SOUTHEAST ASIA TEAM LEADER Ms. Langridge shares responsibility with Mr. McGlashan for Far East equity investments. Before joining Perpetual in 1990, she spent eight years in Hong Kong with the investment firm of Jardine Fleming. She specializes in equity investments in the non-Japanese stock markets of the Far East. Ms. Langridge is a graduate of Cambridge University. IAN BRADY -- AMERICAN TEAM LEADER Mr. Brady is head of the North American team at Perpetual. He has 12 years' investment management experience. Before joining Perpetual in 1997, he worked for Britannia Investment Management, Legal & General and Standard Life. He is a graduate of Aberdeen and Strathclyde Universities. PERFORMANCE COMPARISONS The performance of a Portfolio depends upon such variables as: portfolio quality; average portfolio maturity; type of instruments in which the particular Portfolio is invested; changes in the expenses of a particular Portfolio and class of shares; and various other factors. The performance of each Portfolio fluctuates on a daily basis largely because net earnings and net asset value per share of each class fluctuate daily. Both net earnings and net asset value per share are factors in the computation of yield and total return for each class of the Portfolios. Independent statistical agencies measure a Portfolio's investment performance and publish comparative information showing how a Portfolio, and other investment companies, performed in specified time periods. Agencies whose reports are commonly used for such comparisons are set forth below. From time to time, a Portfolio may distribute these comparisons to its shareholders or to potential investors. The agencies listed below measure performance based on their own criteria rather than on the standardized performance measures described in the preceding section. Lipper Analytical Services, Inc., ranks funds in various fund categories by making comparative calculations using total return. Total return assumes the reinvestment of all capital gains distributions and income dividends and takes into account any change in net asset value over a specified period of time. From time to time, a Portfolio will quote its Lipper ranking in advertising and sales literature. Morningstar, Inc. distributes mutual fund ratings twice a month. The ratings are divided into five groups: highest, above average, neutral, below average, and lowest. They represent a Portfolio's historical risk/reward ratio relative to other funds with similar objectives. The performance factor is a weighted-average assessment of the Portfolio's 3-year, 5-year, and 10-year total return performance (if available) reflecting deduction of expenses and sales charges. Performance is adjusted using quantitative techniques to reflect the risk profile of the Portfolio. The ratings are derived from a purely quantitative system that does not utilize the subjective criteria customarily employed by rating agencies such as Standard & Poor's Corporation and Moody's Investor Service, Inc. Weisenberger's Management Results publishes mutual fund rankings and is distributed monthly. The rankings are based entirely on total return calculated by Weisenberger for periods such as year-to-date, 1-year, 3-year, 5-year and 10-year performance. Mutual funds are ranked in general categories (e.g., international bond, international equity, municipal bond, and maximum capital gain). Weisenberger rankings do not reflect deduction of sales charges or fees. 54 A Portfolio's shares also may be compared to the following indices: Dow Jones Industrial Average ("DJIA") is an unmanaged index representing share prices of major industrial corporations, public utilities, and transportation companies. Produced by Dow Jones & Company, it is cited as a principal indicator of market conditions. Standard & Poor's Daily Stock Price Index of 500 Common Stocks, a composite index of common stocks in industry, transportation, and financial and public utility companies, can be used to compare to the total returns of funds whose portfolios are invested primarily in common stocks. In addition, the Standard & Poor's listed on its index. Taxes due on any of these distributions are not included, nor are brokerage or other fees calculated, in the Standard & Poor's figures. Consumer Price Index is generally considered to be a measure of inflation. CDA Mutual Fund Growth Index is a weighted performance average of other mutual funds with growth of capital objectives. Lipper Growth Fund Index is an average of the net asset-valuated total returns for the top 30 growth funds tracked by Lipper Analytical Services, Inc., an independent mutual fund rating service. Lehman Brothers Government/Corporate (total) Index is comprised of approximately 5,000 issues, which include non-convertible bonds publicly issued by the U.S. government or its agencies; corporate bonds guaranteed by the U.S. government and quasi-federal corporations; and publicly issued, fixed-rate, non-convertible domestic bonds of companies in industry, public utilities and finance. The average maturity of these bonds approximates nine years. Tracked by Shearson Lehman Brothers Inc., the index calculates total returns for one month, three month, twelve month and ten year periods and year-to-date. Lehman Brothers Government Index is an unmanaged index comprised of all publicly issued, non-convertible domestic debt of the U.S. government, or any agency thereof, or any quasi-federal corporation and of corporate debt guaranteed by the U.S. government. Only notes and bonds with a minimum outstanding principal of $1 million and a minimum maturity of one year are included. Russell Growth 1000 (Russell 1000 Index) is a broadly diversified index consisting of approximately 1,000 common stocks of companies with market values between $20 million and $300 million that can be used to compare the total returns of funds whose portfolios are invested primarily in growth common stocks. Lehman Brothers Aggregate Bond Index is a total return index measuring both the capital price changes and income provided by the underlying universe of securities, weighted by market value outstanding. The Aggregate Bond Index is comprised of the Shearson Lehman Government Bond Index, Corporate Bond Index, Mortgage-Backed Securities Index, and Yankee Bond Index. These indices include: U.S. Treasury obligations, including bonds and notes; U.S. agency obligations, including those of the Federal Farm Credit Bank, Federal Land Bank, and the Bank for Cooperatives; foreign obligations; and U.S. investment-grade corporate debt and mortgage-backed obligations. All corporate debt included in the Aggregate Bond Index has a minimum S&P rating of BBB, a minimum Moody's rating of Baa, or a minimum Fitch rating of BBB. Salomon Brothers Mortgage-Backed Securities Index-15 Years includes the average of all 15-year mortgage securities, which include Federal Home Loan Mortgage Corporation (Freddie Mac), Federal National Mortgage Association (Fannie Mae), and Government National Mortgage Association (Ginnie Mae). 55 Lehman Brothers Municipal Bond Index is a total return performance benchmark for the long-term, investment-grade tax-exempt bond market. Returns and attributes for the Index are calculated semi-monthly using approximately 29,000 municipal bonds, which are priced by Muller Data Corporation. From time to time, certain of the Portfolios that invest in foreign securities may advertise the performance of their classes of shares compared to similar funds or portfolios using certain indices, reporting services, and financial publications. These may include the following: Morgan Stanley Capital International World Index, The Morgan Stanley Capital International EAFE (Europe, Australia, Far East) index, J.P. Morgan Global Traded Bond Index, Salomon Brothers World Government Bond Index, and the Standard & Poor's 500 Composite Stock Price Index (S&P 500). A Portfolio also may compare its performance to the performance of unmanaged stock and bond indices, including the total returns of foreign government bond markets in various countries. All index returns are translated into U.S. dollars. The total return calculation for these unmanaged indices may assume the reinvestment of dividends and any distributions, if applicable, may include withholding taxes, and generally do not reflect deductions for administrative and management costs. Investors may use such indices or reporting services in addition to the Trust or an individual Portfolio's prospectus to obtain a more complete view of a particular Portfolio's performance before investing. Of course, when comparing a Portfolio's performance to any index, conditions such as composition of the index and prevailing market conditions should be considered in assessing the significance of such comparisons. When comparing portfolios using reporting services, or total return and yield, investors should take into consideration any relevant differences in portfolios, such as permitted portfolio compositions and methods used to value portfolio securities and compute net asset value. Advertisements and other sales literature for a Portfolio may quote total returns which are calculated on non-standardized base periods. These total returns also represent the historic change in the value of an investment in a Portfolio based on monthly reinvestment of dividends over a specified period of time. From time to time the Portfolios may advertise their performance, using charts, graphs, and descriptions, compared to federally insured bank products, including certificates of deposit and time deposits, and to monthly market funds using the Lipper Analytical Service money market instruments average. Advertisements may quote performance information which does not reflect the effect of the sales load. Independent publications may also evaluate a Portfolio's performance. Certain of those publications are listed below, at the request of Mentor Distributors, which bears full responsibility for their use and the descriptions appearing below. From time to time any or all of the Portfolios may distribute evaluations by or excerpts from these publications to its shareholders or to potential investors. The following illustrates the types of information provided by these publications. Business Week publishes mutual fund rankings in its Investment Figures of the Week column. The rankings are based on 4-week and 52-week total return reflecting changes in net asset value and the reinvestment of all distributions. They do not reflect deduction of any sales charges. Funds are not categorized; they compete in a large universe of over 2,000 funds. The source for rankings is data generated by Morningstar, Inc. 56 Investor's Business Daily publishes mutual fund rankings on a daily basis. The rankings are depicted as the top 25 funds in a given category. The categories are based loosely on the type of fund, e.g., growth funds, balanced funds, U.S. government funds, GNMA funds, growth and income funds, corporate bond funds, etc. Performance periods for sector equity funds can vary from 4 weeks to 39 weeks; performance periods for other fund groups vary from 1 year to 3 years. Total return performance reflects changes in net asset value and reinvestment of dividends and capital gains. The rankings are based strictly on total return. They do not reflect deduction of any sales charges Performance grades are conferred from A+ to E. An A+ rating means that the fund has performed within the top 5% of a general universe of over 2000 funds; an A rating denotes the top 10%; an A- is given to the top 15%, etc. Barron's periodically publishes mutual fund rankings. The rankings are based on total return performance provided by Lipper Analytical Services. The Lipper total return data reflects changes in net asset value and reinvestment of distributions, but does not reflect deduction of any sales charges. The performance periods vary from short-term intervals (current quarter or year-to-date, for example) to long-term periods (five-year or ten-year performance, for example). Barron's classifies the funds using the Lipper mutual fund categories, such as Capital Appreciation Funds, Growth Funds, U.S. Government Funds, Equity Income Funds, Global Funds, etc. Occasionally, Barron's modifies the Lipper information by ranking the funds in asset classes. "Large funds" may be those with assets in excess of $25 million; "small funds" may be those with less than $25 million in assets. The Wall Street Journal publishes its Mutual Fund Scorecard on a daily basis. Each Scorecard is a ranking of the top-15 funds in a given Lipper Analytical Services category. Lipper provides the rankings based on its total return data reflecting changes in net asset value and reinvestment of distributions and not reflecting any sales charges. The Scorecard portrays 4-week, year-to-date, one-year and 5-year performance; however, the ranking is based on the one-year results. The rankings for any given category appear approximately once per month. Fortune magazine periodically publishes mutual fund rankings that have been compiled for the magazine by Morningstar, Inc. Funds are placed in stock or bond fund categories (for example, aggressive growth stock funds, growth stock funds, small company stock funds, junk bond funds, Treasury bond funds etc.), with the top-10 stock funds and the top-5 bond funds appearing in the rankings. The rankings are based on 3-year annualized total return reflecting changes in net asset value and reinvestment of distributions and not reflecting sales charges. Performance is adjusted using quantitative techniques to reflect the risk profile of the fund. Money magazine periodically publishes mutual fund rankings on a database of funds tracked for performance by Lipper Analytical Services. The funds are placed in 23 stock or bond fund categories and analyzed for five-year risk adjusted return. Total return reflects changes in net asset value and reinvestment of all dividends and capital gains distributions and does not reflect deduction of any sales charges. Grades are conferred (from A to E): the top 20% in each category receive an A, the next 20% a B, etc. To be ranked, a fund must be at least one year old, accept a minimum investment of $25,000 or less and have had assets of at least $25 million as of a given date. Financial World publishes its monthly Independent Appraisals of Mutual Funds, a survey of approximately 1000 mutual funds. Funds are categorized as to type, e.g., balanced funds, corporate bond funds, global bond funds, growth and income funds, U.S. government bond funds, etc. To compete, funds must be over one year old, have over $1 million in assets, require a maximum of $10,000 initial investment, and should be available in at least 10 states in the United States. The funds receive a composite past performance rating, which weighs 57 the intermediate- and long-term past performance of each fund versus its category, as well as taking into account its risk, reward to risk, and fees. An A+ rated fund is one of the best, while a D- rated fund is one of the worst. The source for Financial World rating is Schabacker investment management in Rockville, Maryland. Forbes magazine periodically publishes mutual fund ratings based on performance over at least two bull and bear market cycles. The funds are categorized by type, including stock and balanced funds, taxable bond funds, municipal bond funds, etc. Data sources include Lipper Analytical Services and CDA Investment Technologies. The ratings are based strictly on performance at net asset value over the given cycles. Funds performing in the top 5% receive an A+ rating; the top 15% receive an A rating; and so on until the bottom 5% receive an F rating. Each fund exhibits two ratings, one for performance in "up" markets and another for performance in "down" markets. Kiplinger's Personal Finance Magazine (formerly Changing Times), periodically publishes rankings of mutual funds based on one-, three- and five-year total return performance reflecting changes in net asset value and reinvestment of dividends and capital gains and not reflecting deduction of any sales charges. Funds are ranked by tenths: a rank of 1 means that a fund was among the highest 10% in total return for the period; a rank of 10 denotes the bottom 10%. Funds compete in categories of similar funds -- aggressive growth funds, growth and income funds, sector funds, corporate bond funds, global governmental bond funds, mortgage-backed securities funds, etc. Kiplinger's also provides a risk-adjusted grade in both rising and falling markets. Funds are graded against others with the same objective. The average weekly total return over two years is calculated. Performance is adjusted using quantitative techniques to reflect the risk profile of the fund. U.S. News and World Report periodically publishes mutual fund rankings based on an overall performance index (OPI) devised by Kanon Bloch Carre & Co., a Boston research firm. Over 2000 funds are tracked and divided into 10 equity, taxable bond and tax-free bond categories. Funds compete within the 10 groups and three broad categories. The OPI is a number from 0-100 that measures the relative performance of funds at least three years old over the last 1, 3, 5 and 10 years and the last six bear markets. Total return reflects changes in net asset value and the reinvestment of any dividends and capital gains distributions and does not reflect deduction of any sales charges. Results for the longer periods receive the most weight. The 100 Best Mutual Funds You Can Buy authored by Gordon K. Williamson. The author's list of funds is divided into 12 equity and bond fund categories, and the 100 funds are determined by applying four criteria. First, equity funds whose current management teams have been in place for less than five years are eliminated. (The standard for bond funds is three years.) Second, the author excludes any fund that ranks in the bottom 20 percent of its category's risk level. Risk is determined by analyzing how many months over the past three years the fund has underperformed a bank CD or a U.S. Treasury bill. Third, a fund must have demonstrated strong results for current three-year and five-year performance. Fourth, the fund must either possess, in Mr. Williamson's judgment, "excellent" risk-adjusted return or "superior" return with low levels of risk. Each of the 100 funds is ranked in five categories: total return, risk/volatility, management, current income and expenses. The rankings follow a five-point system: zero designates "poor"; one point means "fair"; two points denote "good"; three points qualify as a "very good"; four points rank as "superior"; and five points mean "excellent." 58 SHAREHOLDER LIABILITY Under Massachusetts law, shareholders could, under certain circumstances, be held personally liable for the obligations of the Trust. However, the Agreement and Declaration of Trust disclaims shareholder liability for acts or obligations of the Trust and requires that notice of such disclaimer be given in each agreement, obligation, or instrument entered into or executed by the Trust or the Trustees. The Agreement and Declaration of Trust provides for indemnification out of a Portfolio's property for all loss and expense of any shareholder held personally liable for the obligations of a Portfolio. Thus the risk of a shareholder's incurring financial loss on account of shareholder liability is limited to circumstances in which the Portfolio would be unable to meet its obligations. 59 Mentor Funds --------------- Annual Report --------------- September 30, 1998 [Mentor Logo] MENTOR FUNDS ANNUAL REPORT TABLE OF CONTENTS SEPTEMBER 30, 1998 - --------------------------------------------------------------------------------
PAGE ------------------ Message from the Chairman and President ................. 1 Growth Portfolio ........................................ 3 Global Portfolio ........................................ 14 Capital Growth Portfolio ................................ 28 Strategy Portfolio ...................................... 35 Income and Growth Portfolio ............................. 44 Balanced Portfolio ...................................... 54 Municipal Income Portfolio .............................. 63 Quality Income & Short-Duration Income Portfolios ....... 73 High Income Portfolio ................................... 88 Notes to Financial Statements ........................... 97 Shareholder Information ................................. Inside back cover
MENTOR FUNDS MESSAGE FROM THE CHAIRMAN AND PRESIDENT SEPTEMBER 30, 1998 - -------------------------------------------------------------------------------- TO OUR SHAREHOLDERS: On behalf of all the associates at the Mentor Investment Group, we would like to take this opportunity to thank you for your investment in the Mentor Family of Funds. This Annual Report reaffirms our commitment to our shareholders and details the financial performance of the Mentor Family of Funds for the period ended September 30, 1998. Founded in 1970, Mentor Investment Group is an investment advisory firm with more than $13 billion under management. We pride ourselves on a strong heritage of providing quality service and a variety of investment choices that help meet our shareholders' financial objectives by offering mutual funds and separately-invested portfolios. In the commentaries that follow, Mentor's investment teams present insightful perspectives on the markets and strategies that shaped their investment decisions for the past fiscal year. During this year, Mentor capitalized on its ability to bring products to new market to serve the needs of our investors. Specifically, two funds were introduced to our retail investors. The Mentor Balanced Portfolio is designed to help investors seek capital growth and current income through investment in fixed income and equity securities. The Mentor High Income Portfolio was developed to seek high current income as well as capital appreciation by tapping the potential of high yield bonds. MENTOR INVESTMENT GROUP* [Graph] Six Investment Styles Small-Capitalization Growth Global/International Growth Equity Large-Capitalization Quality Growth Balanced Management Active Fixed Income Cash Management * Mentor Investment Advisors, LLC is a wholly-owned subsidiary of Mentor Investment Group, LLC 1 MENTOR FUNDS MESSAGE FROM THE CHAIRMAN AND PRESIDENT SEPTEMBER 30, 1998 (CONTINUED) - -------------------------------------------------------------------------------- With a commitment to excellence in investing, Mentor meets the challenges of product expansion by focusing on clarity, simplicity, and efficiency. Our investment teams operate with these priorities: FOCUS -- In most money management companies, each investment manager has multiple responsibilities. At Mentor, our investment managers are singularly focused on enhancing the value of the portfolios. This means that you can be assured of a consistent, proven approach to developing a winning financial strategy. OPPORTUNITIES -- By offering six different management styles, portfolio diversification is simplified. By offering multiple styles, Mentor gives investors the tools for long-term investment success through diversification and accommodation of changing investment needs. SERVICE -- To help serve our shareholders, Mentor has a dedicated Investor Relations Center. Our Relationship Coordinators are professionally trained and licensed to serve clients' needs. TECHNOLOGY -- Abreast of the most advanced technology and using the latest analytical tools, our investment managers have the ability to survey the financial markets and make informed decisions about the best place to invest. We at Mentor are honored to be a partner in the management of your financial assets. Mentor Investment Group provides diversified investment styles and services to over one million shareholders. We serve individuals, corporations, endowments, foundations, public funds, and municipalities. To learn more about Mentor, please contact your consultant or us at (800) 382-0016. We look forward to making the Mentor formula work for you and to a mutually beneficial relationship. Sincerely, /s/ Daniel Ludeman /s/ Paul F. Costello Daniel J. Ludeman Paul F. Costello CHAIRMAN PRESIDENT [Mentor Logo] THE MENTOR MISSION TO PROVIDE PROFESSIONAL INVESTMENT MANAGEMENT SERVICES THROUGH A FIRM THAT IS SECOND TO NONE IN THE QUALITY OF ITS INVESTMENT PROCESS, THE SKILL AND TRAINING OF ITS PROFESSIONALS, AND THE COMMITMENT, SHARED BY ALL ITS ASSOCIATES, TO DELIVER THE HIGHEST LEVEL OF SERVICE AND ETHICAL BEHAVIOR TO CLIENTS. FOR MORE INFORMATION AND A PROSPECTUS FOR THE FUNDS, PLEASE CALL US, (800)382-0016, OR CONTACT YOUR CONSULTANT. THE PROSPECTUS CONTAINS COMPLETE INFORMATION ABOUT FEES, SALES CHARGES, AND EXPENSES. PLEASE READ IT CAREFULLY BEFORE INVESTING OR SENDING MONEY. 2 MENTOR GROWTH PORTFOLIO MANAGERS' COMMENTARY: THE SMALL-CAPITALIZATION GROWTH TEAM SEPTEMBER 30, 1998 - -------------------------------------------------------------------------------- The 12 months ended September 30, 1998 were particularly difficult ones for small-cap. managers. The Mentor Growth Portfolio suffered along with most managers. The problems began late in the third quarter of 1997 as the Far East economic situation began to deteriorate and investors worried about the eventual impact of this on the U.S. economy. Fear in the financial markets often leads to a flight to perceived or real safety and investors fled small-caps for bonds and large-cap. stocks. Proof of this lay in the Russell 2000's negative 3.4% return in the fourth quarter of 1997 versus the S&P 500's 2.9% gain. In the first and second quarters of 1998 the relative performance of small-caps remained much the same as the final quarter of 1997. Small-cap. growth stocks, in spite of very strong earnings results continued to under perform their large-cap. brethren. By mid-year 1998 the forward P/E of the Mentor Growth Portfolio (based on the next 12 months earnings) for only the second time in its history, was at a discount to the P/E of the S&P 500. In the third quarter of 1998, matters seemed to come to a head as small-caps as represented by the Russell 2000 were down 16.2% year-to-date and 19% for the trailing 12 months. The S&P 500 return for the trailing 12-month period was 9.1%, emphasizing the disparate market returns. It is particularly interesting to review where the strength in the market was on a capitalization basis as shown below.
AVERAGE YTD NUMBER BY CAPITALIZATION DECLINE (1/1/98-9/30/98) OF ISSUES - --------------------- -------------------------- ---------- $250 million (28.6%) 5,757 $250-2 Billion (25.1%) 1,905 $2-5 Billion (19.3%) 372 $5-20 Billion (8.9%) 316 >$20 Billion 2.06% 138
What is interesting from these numbers is the fact that the only group that seemed to attract much buying interest was the very small group of stocks over $20 billion in market capitalization. The vast predominance of stocks under $2 billion in capitalization were hammered in performance terms. The flight to perceived investment safety, as illustrated above and caused largely by the worry over the Asian (and later Russian and South American) economic contagion, continued to impact small-caps despite the fact that this sector of the world would have little if any influence on the profit prospects of small-cap. stocks whose operations are mainly domestic. It is also interesting to note that as Mentor Growth Portfolio's small-caps stocks were being penalized by the market, these same companies were reporting superb earnings results for the second quarter. 84% of the Portfolio's holdings reported earnings that were in line with or better that the consensus expectation. Growth rates for earnings averaged 35% over the year ago period. These results followed on the heels of more than 85% positive or as expected earnings results in the first quarter and earnings growth rates exceeding 30%. In view of the unusual deterioration of small-cap. stock prices, it may be helpful to examine these recent events within a broader historical context. History has illustrated time and again, that small-cap. stocks tend to discount economic events by as much as six to nine months. The economic and market events of 1989 to 1991 were a case in point. The last time small-cap. valuations suffered as they have this year was the crash of 1990. Small-caps under performed larger companies throughout the latter part of 1989 and then through the bulk of 3 MENTOR GROWTH PORTFOLIO MANAGERS' COMMENTARY: THE SMALL-CAPITALIZATION GROWTH TEAM SEPTEMBER 30, 1998 - -------------------------------------------------------------------------------- 1990. This was a period leading up to a recession, which officially began in the third quarter of 1990 and lasted through the first quarter of 1991. A recession is simple to identify in hindsight but extremely difficult to predict or identify definitively at the time it is taking place. The only hint of slowing economic growth that we had in 1990 was from late summer conversations with a number of our companies where management expressed concerns that business trends were slowing from the robust levels earlier in the year. What makes the above review interesting is the action of our portfolio during that period. The Mentor Growth Portfolio declined by nearly 30% from September through the end of October of 1990, the period marking the beginning of the 1990 recession. In late October and early November the stocks in the Portfolio bottomed out and began what would become a very strong upward move. Between October 1990 and August 1991, the Portfolio gained over 74%, easily erasing the declines of the previous year. This upward trend continued until mid-1994, rewarding patient holders with excellent returns. During 1998, we have remarked periodically that the spread between the performance of large and small companies may be forecasting a coming economic slowdown. This type of flight to the perceived quality of large-capitalization stocks is often associated with such times. And for the first time since the economic expansion of the 1990s began, a small group of economic forecasters are suggesting the possibility of negative economic growth or recession. With the third quarter now over and earnings about to be reported for our companies, we are guardedly optimistic about the pending results. There are many companies in the portfolio that we know will report very good earnings, and there are a smaller number that we suspect will not meet analysts' estimates. However, we also believe that with the P/E of the Portfolio currently at less than 13 times estimated 1999 earnings results, much of a pending slowdown in earnings growth expectations is already reflected in our stocks. It does seem likely that the 30% growth rate in earnings which is projected for our companies will contract somewhat as analysts become less enthusiastic over the next year, much as happened as we entered the recessionary period of 1990 and 1991. However, particularly when compared to the anemic 2% growth in earnings presently projected for the S&P 500, we continue to believe that small-caps. represent a compelling value. We believe that on the whole, the companies in the Portfolio are excellent ones and as the unknowns of a possible recession become better recognized, the market will once again recognize the outstanding investment characteristics of these companies. November 1998 4 MENTOR GROWTH PORTFOLIO SEPTEMBER 30, 1998 - -------------------------------------------------------------------------------- PERFORMANCE COMPARISON Comparison of change in value of a hypothetical $10,000 investment in Mentor Growth Portfolio Class A and the Russell 2000.~ [GRAPH] Class A Russell 2,000 6/5/95 9425 10000 9/30/95 11251 11557 9/30/96 14640 13076 9/30/97 18418 17416 9/30/98 14352 14103 Average Annual Returns as of 9/30/98 Including Sales Charges 1-Year Since Inception+++ Class A (26.57%) 11.47% PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE PERFORMANCE. YOUR INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO WHEN SHARES ARE REDEEMED, THEY MAY BE WORTH MORE OR LESS THAN ORIGINAL COST. MUTUAL FUNDS ARE NOT OBLIGATIONS OF OR GUARANTEED BY ANY BANK AND ARE NOT FEDERALLY INSURED. ~ The Russell 2000 is composed of the 2,000 smallest stocks in the Russell 3000 Index and represents approximately 7% of the U.S. equity market capitalization. The Russell 3000 is composed of the 3,000 largest U.S. companies by market capitalization and represents approximately 98% of the U.S. market. The indexes are not adjusted for sales charges or other fees. ++ Represents a hypothetical investment of $10,000 in Mentor Growth Portfolio Class A Shares, after deducting the maximum sales charge of 5.75% ($10,000 investment minus $575 sales charge = $9,425). The Class A Shares' performance assumes the reinvestment of all dividends and distributions. +++ Reflects operations of Mentor Growth Portfolio Class A Shares from the date of issuance on 6/5/95 through 9/30/98. 5 MENTOR GROWTH PORTFOLIO SEPTEMBER 30, 1998 - -------------------------------------------------------------------------------- PERFORMANCE COMPARISON Comparison of change in value of a hypothetical $10,000 investment in Mentor Growth Portfolio Class B Shares and the Russell 2000.~ [GRAPH] Class B Russell 2000 9/30/88 10000 10000 12/31/88 8737 8860 12/31/89 10252 10835 12/31/90 9096 8290 12/31/91 13667 12108 12/31/92 15796 14337 12/31/93 18260 17048 12/31/94 17443 16737 9/30/95 23042 21041 9/30/96 29535 23804 9/30/97 36817 31706 9/30/98 32972 28788 Average Annual Returns as of 9/30/98 Including Sales Charges 1-Year 5-Year 10-Year Class B (25.53%) 9.87% 8.19% PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE PERFORMANCE. YOUR INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO WHEN SHARES ARE REDEEMED, THEY MAY BE WORTH MORE OR LESS THAN ORIGINAL COST. MUTUAL FUNDS ARE NOT OBLIGATIONS OF OR GUARANTEED BY ANY BANK AND ARE NOT FEDERALLY INSURED. ~ The Russell 2000 is composed of the 2,000 smallest stocks in the Russell 3000 Index and represents approximately 7% of the U.S. equity market capitalization. The Russell 3000 is composed of the 3,000 largest U.S. companies by market capitalization and represents approximately 98% of the U.S. market. The indexes are not adjusted for sales charges or other fees. + Represents a hypothetical investment of $10,000 in Mentor Growth Portfolio Class B Shares. A contingent deferred sales charge will be imposed, if applicable, on Class B Shares at rates ranging from a maximum of 4.00% of amounts redeemed during the first year following the date of purchase to 1.00% of amounts redeemed during the five-year period following the date of purchase. The value of the Class B Shares reflects a redemption fee in effect at the end of each of the stated periods. The Class B Shares' performance assumes the reinvestment of all dividends and distributions. 6 MENTOR GROWTH PORTFOLIO SEPTEMBER 30, 1998 - -------------------------------------------------------------------------------- PERFORMANCE COMPARISON Comparison of change in value of a hypothetical $10,000 investment in Mentor Growth Portfolio Class Y and the Russell 2000.~ [GRAPH] Class Y Shares Russell 2,000 11/19/97 10000 10000 12/31/97 10021 10109 3/31/98 11314 11126 6/30/98 10713 10607 9/30/98 8301 8470 Total Returns as of 9/30/98 1-Year Since Inception++ Class Y n/a (18.36%) PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE PERFORMANCE. YOUR INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO WHEN SHARES ARE REDEEMED, THEY MAY BE WORTH MORE OR LESS THAN ORIGINAL COST. MUTUAL FUNDS ARE NOT OBLIGATIONS OF OR GUARANTEED BY ANY BANK AND ARE NOT FEDERALLY INSURED. ~ The Russell 2000 is composed of the 2,000 smallest stocks in the Russell 3000 Index and represents approximately 7% of the U.S. equity market capitalization. The Russell 3000 is composed of the 3,000 largest U.S. companies by market capitalization and represents approximately 98% of the U.S. market. The indexes are not adjusted for sales charges or other fees. + Represents a hypothetical investment of $10,000 in Mentor Growth Portfolio Class Y Shares. These shares are not subject to any sales or contingent deferred sales charges. The Class Y Shares' performance assumes the reinvestment of all dividends and distributions. ++ Reflects operations of Mentor Growth Portfolio Class Y Shares from the date of issuance on 11/19/97 through 9/30/98. 7 MENTOR GROWTH PORTFOLIO PORTFOLIO OF INVESTMENTS SEPTEMBER 30, 1998 - --------------------------------------------------------------------------------
SHARES MARKET VALUE COMMON STOCKS - 84.17% CAPITAL GOODS & CONSTRUCTION - 3.67% Conrad Industries, Inc. * 225,700 $ 1,495,262 Denali, Inc. * 180,950 2,442,825 Motivepower Industries, Inc. * 282,500 6,603,437 Pentacon, Inc. * 159,500 1,016,813 Rental Service Corporation * 237,900 4,282,200 Waste Industries, Inc. * 95,750 1,986,812 ----------- 17,827,349 ----------- CONSUMER CYCLICAL - 14.81% Cadmus Communications Corporation 192,900 3,761,550 Central Garden & Pet Company * 237,200 4,388,200 Chancellor Media Corporation * 110,950 3,702,956 Chattem, Inc. 121,100 3,307,544 Clear Channel Communications 113,712 5,401,320 Dollar General Corporation 105,116 2,798,720 Dollar Tree Stores, Inc. * 136,575 4,276,505 Fairfield Communities, Inc. * 239,450 2,394,500 Family Dollar Stores 348,900 5,495,175 Galey & Lord, Inc. * 171,700 2,049,669 Keystone Automotive Industries, Inc. * 303,300 5,990,175 Lamar Advertising Company * 111,300 3,116,400 Mail Well Holdings, Inc. * 76,300 653,319 Media Arts Group, Inc. * 190,300 1,736,487 Metro Networks, Inc. * 75,600 2,768,850 Outdoor Systems, Inc. * 469,589 9,156,986 Papa John's International, Inc. * 112,500 3,712,500 SCP Pool Corporation * 253,075 3,289,975 Suburban Lodges of America * 195,150 1,305,066 Travel Services International, Inc. * 198,250 2,688,766 ----------- 71,994,663 ----------- CONSUMER STAPLES - 5.70% Celestial Seasonings, Inc. * 154,800 2,341,350 Natrol, Inc. * 171,900 1,525,612 Omega Protein Corporation * 158,000 878,875 Rexall Sundown, Inc. * 196,700 3,036,556 Richfood Holdings, Inc. 274,725 4,223,897 Twinlab Corporation * 117,000 2,998,125 US Foodservice * 151,100 6,289,537 Wild Oats Markets, Inc. * 112,300 3,046,137 Whole Foods Market, Inc. * 80,050 3,372,106 ----------- 27,712,195 -----------
SHARES MARKET VALUE COMMON STOCKS (CONTINUED) ENERGY - 2.14% Core Laboratories N.V. * 340,500 $ 5,873,625 Global Industries, Limited * 265,850 3,073,891 Unifab International, Inc. * 140,000 1,470,000 ----------- 10,417,516 ----------- FINANCIAL - 7.28% Concord EFS, Inc. * 351,316 9,068,344 Hibernia Corporation - Class A 196,000 2,829,750 Markel Corporation * 66,360 10,119,900 National Commerce Bancorporation 424,834 7,009,761 NOVA Corporation * 208,423 6,395,965 ----------- 35,423,720 ----------- HEALTH - 19.18% American Dental Partners, Inc. * 68,600 591,675 Assisted Living Concepts, Inc. * 132,600 1,881,262 Brookdale Living Communities * 213,800 4,489,800 Curative Health Services, Inc. * 185,450 5,679,406 Express Scripts, Inc. - Class A * 77,300 6,357,925 Health Management Associates, Inc. * 310,061 5,658,613 Henry Schein, Inc. * 120,250 4,178,687 Mecon, Inc. * 184,600 1,384,500 Medquist, Inc. * 217,050 6,864,206 Molecular Devices Corporation * 232,000 3,973,000 Monarch Dental Corporation * 113,000 1,490,187 NCS Healthcare, Inc. - Class A * 131,350 2,315,044 Omnicare, Inc. 140,660 4,958,265 Osteotech, Inc. * 190,450 5,046,925 Pharmaceutical Product Development * 117,450 3,288,600 Priority Healthcare Corporation - Class B * 120,700 2,761,013 Province Healthcare Company * 222,700 7,585,719 QuadraMed Corporation * 201,400 4,053,175 Serologicals Corporation * 376,050 9,448,256 Sunrise Assisted Living, Inc. * 175,200 6,011,550 United Payors & Providers, Inc. * 171,450 3,343,275 Wesley Jessen Visioncare, Inc. * 90,000 1,912,500 ----------- 93,273,583 -----------
8 MENTOR GROWTH PORTFOLIO PORTFOLIO OF INVESTMENTS SEPTEMBER 30, 1998 - --------------------------------------------------------------------------------
SHARES MARKET VALUE COMMON STOCKS (CONTINUED) TECHNOLOGY - 18.23% ADE Corporation * 246,400 $2,402,400 Applied Micro Circuits * 135,100 2,009,612 Aspect Development, Inc. * 54,050 2,128,219 ATMI, Inc. * 147,950 2,052,806 Benchmark Electronics, Inc. * 289,440 6,602,850 Billing Concepts Corporation * 214,350 3,000,900 Black Box Corporation * 111,350 2,700,237 C&D Technologies, Inc. 150,600 3,595,575 Carrier Access Corporation * 30,100 538,037 Cerprobe Corporation 278,800 3,066,800 CSG Systems International, Inc. * 119,600 5,292,300 Cumulus Media - Class A * 220,550 1,791,969 E.spire Communications, Inc. * 196,600 1,769,400 FORE Systems, Inc. * 196,400 3,265,150 Genesis Microchip, Inc. * 25,000 235,937 ICG Communications * 167,500 2,826,562 ITC DeltaCom * 209,100 4,338,825 Medialink Worldwide, Inc. * 180,000 3,015,000 Network Appliance, Inc. * 37,100 1,878,187 Optek Technology, Inc. * 222,900 3,956,475 Parlex Corporation * 219,950 2,020,791 PCD, Inc. * 216,200 2,702,500 Powerwave Technologies, Inc. * 158,300 1,345,550 PRI Automation, Inc. * 238,800 2,985,000 RF Micro Devices, Inc. * 163,400 2,961,625 SCB Computer Technology, Inc. * 498,150 3,860,663 Segue Software, Inc. * 223,000 3,679,500 Sipex Corporation * 239,500 6,077,313 Speedfam International, Inc. * 236,700 2,544,525 World Access, Inc. 197,750 4,004,438 ---------- 88,649,146 ---------- TRANSPORTATION - 6.05% Atlantic Coast Airlines, Inc. * 222,750 5,206,781 Carey International, Inc. * 107,850 1,617,750 Coach USA, Inc. * 180,350 4,452,391 Comair Holdings, Inc. 190,225 5,468,969 Covenant Transport, Inc. - Class A * 217,700 2,476,338 Hunt (JB) Transportation Services, Inc. 86,850 1,259,325 Mesaba Holdings, Inc. 379,775 5,506,738 M.S. Carriers, Inc. * 89,850 1,785,769 US Xpress Enterprises - Class A * 135,650 1,661,713 ---------- 29,435,774 ----------
SHARES OR PRINCIPAL AMOUNT MARKET VALUE COMMON STOCKS (CONTINUED) MISCELLANEOUS - 7.11% ABR Information Services, Inc. * 130,500 $ 1,786,219 AccuStaff, Inc. * 145,635 2,120,810 AHL Services, Inc. * 261,050 8,549,388 Butler International, Inc. * 150,600 3,002,588 Gulf Island Fabrication, Inc. * 184,350 3,133,950 Kulicke & Soffa Industries, Inc. 186,400 2,493,100 Meta Group, Inc. * 76,750 2,508,766 NFO Worldwide, Inc. * 188,750 1,875,703 Rock of Ages Corporation * 129,800 1,444,025 Romac International, Inc. * 186,667 3,360,006 Select Appointments Holding~ 133,850 2,325,644 StaffMark, Inc. * 106,850 1,950,013 ------------ 34,550,212 ------------ TOTAL COMMON STOCKS (COST $392,590,559) 409,284,158 ------------ SHORT-TERM INVESTMENT - 14.75% REPURCHASE AGREEMENT Goldman Sachs & Company Dated 9/30/98, 5.60%, due 10/01/98, collateralized by $72,638,658 Federal National Mortgage Association, 6.00%, 8/01/13, market value $73,365,044 (cost $71,719,983) $71,719,983 71,719,983 ------------ TOTAL INVESTMENTS (COST $464,310,542)-98.92% 481,004,141 OTHER ASSETS LESS LIABILITIES - 1.08% 5,256,518 ------------ NET ASSETS - 100.00% $486,260,659 ============
* Non-income producing. ~ American Depository Receipts. 9 MENTOR GROWTH PORTFOLIO PORTFOLIO OF INVESTMENTS SEPTEMBER 30, 1998 - -------------------------------------------------------------------------------- INVESTMENT TRANSACTIONS Cost of purchases and proceeds from sales of securities, other than short-term securities, aggregated $476,835,969 and $493,255,955, respectively. INCOME TAX INFORMATION At September 30, 1998, the aggregated cost of investment securities for federal income tax purposes was $465,111,603. Net unrealized appreciation aggregated $15,892,538, of which $88,762,155, related to appreciated investment securities and $72,869,617, related to depreciated investment securities. SEE NOTES TO FINANCIAL STATEMENTS. 10 MENTOR GROWTH PORTFOLIO - -------------------------------------------------------------------------------- STATEMENT OF ASSETS AND LIABILITIES SEPTEMBER 30, 1998 ASSETS Investments, at market value (Note 2) Investment securities $409,284,158 Repurchase agreements 71,719,983 ------------ Total investments (cost $464,310,542) 481,004,141 Collateral for securities loaned (Note 2) 115,219,699 Receivables Investments sold 9,099,966 Fund shares sold 958,924 Dividends and interest 60,844 Other 74,079 ------------ TOTAL ASSETS 606,417,653 ------------ LIABILITIES Payables Investments purchased $ 1,944,829 Securities loaned (Note 2) 115,219,699 Fund shares redeemed 2,791,991 Accrued expenses and other liabilities 200,475 ----------- TOTAL LIABILITIES 120,156,994 ------------ NET ASSETS $486,260,659 ============ Net Assets represented by: (Note 2) Additional paid-in capital $451,922,136 Accumulated undistributed net investment income - Accumulated net realized gain on investment transactions 17,644,924 Net unrealized appreciation of investments 16,693,599 ------------ NET ASSETS $486,260,659 ============ NET ASSET VALUE PER SHARE Class A Shares $ 14.60 Class B Shares $ 14.18 Class Y Shares $ 14.63 OFFERING PRICE PER SHARE Class A Shares $ 15.49 (a) Class B Shares $ 14.18 Class Y Shares $ 14.63 SHARES OUTSTANDING Class A Shares 5,323,225 Class B Shares 27,027,617 Class Y Shares 1,732,865
(a) Computation of offering price: 100/94.25 of net asset value. SEE NOTES TO FINANCIAL STATEMENTS. STATEMENT OF OPERATIONS YEAR ENDED SEPTEMBER 30, 1998 INVESTMENT INCOME Dividends $ 524,466 Interest 3,725,963 ------------- TOTAL INVESTMENT INCOME (NOTE 2) 4,250,429 EXPENSES Management fee (Note 4) $ 4,204,377 Distribution fee (Note 5) 3,638,580 Shareholder service fee (Note 5) 1,489,460 Transfer agent fee 800,563 Administration fee (Note 4) 600,625 Shareholder reports and postage expenses 142,288 Registration expenses 130,378 Custodian and accounting fees 84,516 Legal fees 22,254 Directors' fees and expenses 17,864 Audit fees 12,320 Organizational expenses 8,526 Miscellaneous 61,523 ------------ Total expenses 11,213,274 ------------- NET INVESTMENT LOSS (6,962,845) ------------- REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS Net realized gain on investments (Note 2) 37,565,972 Change in unrealized appreciation on investments (173,567,460) ------------ NET LOSS ON INVESTMENTS (136,001,488) ------------- NET DECREASE IN NET ASSETS RESULTING FROM OPERATIONS $(142,964,333) =============
SEE NOTES TO FINANCIAL STATEMENTS. 11 MENTOR GROWTH PORTFOLIO - -------------------------------------------------------------------------------- STATEMENTS OF CHANGES IN NET ASSETS
YEAR ENDED YEAR ENDED 9/30/98 9/30/97 NET INCREASE (DECREASE) IN NET ASSETS Operations Net investment loss $ (6,962,845) $ (6,118,383) Net realized gain on investments 37,565,972 35,210,825 Change in unrealized appreciation on investments (173,567,460) 90,598,141 -------------- ------------- Increase (decrease) in net assets resulting from operations (142,964,333) 119,690,583 -------------- ------------- Distributions to Shareholders From net realized gain on investments Class A (6,599,466) (5,768,516) Class B (31,307,757) (52,589,913) Class Y (10) - -------------- ------------- Total distributions to shareholders (37,907,233) (58,358,429) -------------- ------------- Capital Share Transactions (Note 7) Proceeds from sale of shares 313,753,597 168,560,541 Reinvested distributions 36,935,409 57,233,448 Cost of shares redeemed (294,819,420) (87,713,664) -------------- ------------- Change in net assets resulting from capital share transactions 55,869,586 138,080,325 -------------- ------------- Increase (decrease) in net assets (125,001,980) 199,412,479 Net Assets Beginning of year 611,262,639 411,850,160 -------------- ------------- End of year $ 486,260,659 $ 611,262,639 ============== =============
SEE NOTES TO FINANCIAL STATEMENTS. FINANCIAL HIGHLIGHTS CLASS A SHARES
YEAR YEAR YEAR PERIOD ENDED ENDED ENDED ENDED 9/30/98 9/30/97 9/30/96 9/30/95 (b) PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 19.94 $ 18.47 $ 16.08 $ 13.37 ------- --------- ------- --------- Income from investment operations Net investment loss (0.12) ( 0.17) (0.10) ( 0.01) Net realized and unrealized gain (loss) on investments (4.03) 4.19 4.23 2.72 -------- --------- -------- ---------- Total from investment operations (4.15) 4.02 4.13 2.71 -------- --------- -------- ---------- Less distributions From capital gains (1.19) (2.55) (1.74) - -------- --------- -------- ---------- Net asset value, end of period $ 14.60 $ 19.94 $ 18.47 $ 16.08 ======== ========= ======== ========== TOTAL RETURN* (22.08%) 25.81% 29.15% 20.27% RATIOS/SUPPLEMENTAL DATA Net assets, end of period (in thousands) $ 77,720 $ 105,033 $ 40,272 $ 20,368 Ratio of expenses to average net assets 1.26% 1.28% 1.28% 1.36% (a) Ratio of net investment loss to average net assets (0.56%) (0.67%) (0.39%) (0.65%)(a) Portfolio turnover rate 88% 77% 105% 70% Average commission rate on portfolio transactions $ 0.0658 $ 0.0651 $ 0.0602
(a) Annualized. (b) For the period from June 5, 1995 (initial offering of Class A Shares) to September 30, 1995. * Total return does not reflect sales commissions and is not annualized. SEE NOTES TO FINANCIAL STATEMENTS. 12 MENTOR GROWTH PORTFOLIO - -------------------------------------------------------------------------------- FINANCIAL HIGHLIGHTS CLASS B SHARES
YEAR YEAR YEAR ENDED ENDED ENDED 9/30/98 9/30/97 9/30/96 PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 19.53 $ 18.29 $ 16.05 -------- --------- --------- Income from investment operations Net investment loss (0.23) (0.22) (0.17) Net realized and unrealized gain (loss) on investments (3.93) 4.01 4.15 -------- --------- --------- Total from investment operations (4.16) 3.79 3.98 -------- --------- --------- Less distributions From capital gains (1.19) (2.55) (1.74) -------- --------- --------- Net asset value, end of period $ 14.18 $ 19.53 $ 18.29 ======== ========= ========= TOTAL RETURN* (22.62%) 24.66% 28.18% RATIOS / SUPPLEMENTAL DATA Net assets, end of period (in thousands) $ 383,188 $ 506,230 $ 371,578 Ratio of expenses to average net assets 2.01% 2.03% 2.03% Ratio of net investment loss to average net assets (1.30%) (1.42%) (1.13%) Portfolio turnover rate 88% 77% 105% Average commission rate on portfolio transactions $ 0.0658 $ 0.0651 $ 0.0602 PERIOD YEAR YEAR ENDED ENDED ENDED 9/30/95 (b) 12/31/94 12/31/93 PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 12.15 $ 13.78 $ 12.81 ---------- ------- ------- Income from investment operations Net investment loss (0.13) (0.15) (0.08) Net realized and unrealized gain (loss) on investments 4.03 (0.47) 2.07 ----------- ------- ------- Total from investment operations 3.90 (0.62) 1.99 ----------- ------- ------- Less distributions From capital gains -- (1.01) (1.02) ----------- ------- ------- Net asset value, end of period $ 16.05 $ 12.15 $ 13.78 =========== ======= ======= TOTAL RETURN* 32.10% (4.48%) 15.60% RATIOS / SUPPLEMENTAL DATA Net assets, end of period (in thousands) $ 246,326 $190,126 $186,978 Ratio of expenses to average net assets 2.08% (a) 2.01% 2.02% Ratio of net investment loss to average net assets (1.20%)(a) (1.20%) (1.12%) Portfolio turnover rate 70% 77% 64% Average commission rate on portfolio transactions
CLASS Y SHARES
PERIOD ENDED 9/30/98 (c) PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 18.12 --------- Income from investment operations Net investment loss (0.02) Net realized and unrealized loss on investments (3.28) ----------- Total from investment operations (3.30) ----------- Less distributions From capital gains (0.19) ----------- Net asset value, end of period $ 14.63 =========== TOTAL RETURN* (18.36%) RATIOS / SUPPLEMENTAL DATA Net assets, end of period (in thousands) $ 25,353 Ratio of expenses to average net assets 1.01% (a) Ratio of net investment loss to average net assets (0.04%)(a) Portfolio turnover rate 88% Average commission rate on portfolio transactions $ 0.0658
(a) Annualized. (b) For the period from January 1, 1995 to September 30, 1995. (c) For the period from November 19, 1997 (initial offering of Class Y shares) to September 30, 1998. * Total return does not reflect sales commissions and is not annualized. SEE NOTES TO FINANCIAL STATEMENTS. 13 MENTOR PERPETUAL GLOBAL PORTFOLIO MANAGERS' COMMENTARY: THE GLOBAL/INTERNATIONAL MANAGEMENT TEAM SEPTEMBER 30, 1998 - -------------------------------------------------------------------------------- MARKETS REVIEW The 12-month period ended September 30, 1998 marked a turbulent period for world markets. For the period the Mentor Perpetual Global Portfolio A shares returned (4.97%) while the B shares returned (5.65%), exclusive of sales charges. This compares favorably to the (7.57%) average return for its Lipper Global Funds peer group. This performance placed both share classes in the 2nd quartile of that Lipper category. The Portfolio's Morgan Stanley World Index benchmark returned 0.51% for the period due to its overweighting in Japan as compared to most managers, including Mentor. UNITED STATES The year began with the U.S. enjoying healthy economic growth, subdued inflation and rising corporate profits. The market began to run out of steam, however, during the second quarter of 1998 as investors became somewhat nervous about the effect of the Asian economic collapse on U.S. corporate earnings growth and concerns that the strength of the domestic economy might provoke tightening by the Federal Reserve. Mid- and small-cap. stocks fell increasingly out of favor, despite their higher expected growth rates, and significantly trailed their larger counterparts. A significant factor behind this phenomenon was the increasing nervousness of U.S. retail investors who sought reassurance by buying very large, well-known companies. Despite this, we remain reluctant to buy the mega-cap. stocks where valuations bear no rational relationship to current or foreseeable earnings. The Federal Reserve, through its chairman, has already voiced its concern over the possible effects of international turmoil on financial markets and the U.S. economy. Interest rates have already been cut twice by 25 basis points, liquidity is being injected into U.S. money markets, and there are strong expectations of more rate cuts to come. As always, the question for investors is what exactly has been priced into the market. Intense focus on a very small range of very large companies has largely obscured the fact that most stocks have already experienced a substantial bear market. For much of the U.S. equity market, the gloomy prognostications of economic slowdown and earnings stagnation have largely been discounted. Indeed, relative to the market as a whole, small- and mid-cap. stocks stand at historically low valuations, raising the possibility that sharp reductions in interest rates and massive increases in money supply could herald a rerun of the 1989-1992 bull-run in this sector. UNITED KINGDOM In common with equity markets worldwide, the U.K. sharply corrected early in the fourth quarter of 1997. However, in November, despite an unexpected 0.25% rise in interest rates, the market rallied and continued to move forward strongly through the end of the first quarter 1998. In June, the Monetary Policy Committee (MPC) surprised many by raising interest rates a further 0.25% to 7.5%. Almost coincidentally, stronger than expected numbers for inflation, average earnings growth, and retail spending prompted fears of yet another rise in U.K. interest rates. In common with other world equity markets, the U.K. has seen recent indiscriminate declines and opinion appears to have shifted towards expectation of a hard landing -- or technical recession -- later in 1998. The corporate sector today enjoys robust financial strength and any downturn is unlikely to be as severe as the stock market is suggesting. With growing international pressure for cuts in Western interest rates, coupled with weakening domestic economic data and recent downward revisions to wages growth, future interest 14 MENTOR PERPETUAL GLOBAL PORTFOLIO MANAGERS' COMMENTARY: THE GLOBAL/INTERNATIONAL MANAGEMENT TEAM SEPTEMBER 30, 1998 - -------------------------------------------------------------------------------- rate cuts seem likely. With venture capitalists and directors already taking active advantage of current low valuations among small- and mid-cap. stocks, with U.K. interest rates set to fall farther, and with weaker sterling providing support to exports and protection against imports, we find ourselves more positive than the consensus about prospects for the U.K. equity market. CONTINENTAL EUROPE Early in the fourth quarter of 1997, Asia's deepening travails provoked corrections to European markets. However, a strong bounce in December 1997 extended into a rally that continued well into the first quarter of 1998. By the end of the first quarter, equity markets, supported by cross-border mergers and acquisitions, corporate restructuring, low interest rates, and strong mutual funds inflows, had reached new record highs. Despite sharp corrections in April and June on concerns over renewed turmoil in Asia and a possible rise in core European interest rates, European equity markets generally continued their strong upward progress throughout the second quarter. However, in the final weeks of the third quarter, European markets, already uneasy over growing signs of a downturn in exports and hesitancy in Germany's economic recovery, fell prey to the same global issues affecting other Western equity markets and corrected sharply. It seems increasingly likely that the EMU's interest rate will be set at a fairly low level. Lower interest rates among Europe's peripheral countries will provide added support for their economies and equity markets. We expect the recent extreme market volatility to continue as the leverage that has built up in markets unwinds. This outlook is clouded by the as yet unquantifiable effects of international financial turmoil and the credit crunch resulting from extreme risk aversion within international capital markets. The disorderly markets and indiscriminate selling of recent months has introduced a number of significant valuation anomalies, and suggests that investment on the basis of fundamental analysis should be rewarded once order and a measure of calm returns to the market place. JAPAN In October 1997, the collapse of Asian currencies and equity markets provoked a sharp correction in the Japanese equity market. In January 1998, the market rallied strongly on hopes of successful action by the government to stimulate the domestic economy. However, as the first quarter of 1998 progressed, optimism gave way to resigned gloom as the government once more proved incapable of revitalizing an economy that was slipping back into recession, and the equity market drifted resignedly downward. For some time, economic statistics have been universally and unremittingly dire. The manufacturing sector has been shedding labor for the last five years, and this has now spread to the service sector. Production, productivity and real wages are all declining steeply, capacity utilization has fallen off a cliff, and wholesale prices are collapsing. The recent dramatic strengthening of the yen relative to the U.S. dollar, however, coupled with an unexpected political consensus, has provided the government with a window of opportunity. They can create massive new liquidity as part of the vital rehabilitation of a banking system which is suffocating under a mountain of unrepayable loans to failed property companies and bankrupt Asian corporations. Recession is forcing corporate restructuring, and a new focus on shareholder value is sowing the seeds of Japan's next bull market. However, shorter term, this 15 MENTOR PERPETUAL GLOBAL PORTFOLIO MANAGERS' COMMENTARY: THE GLOBAL/INTERNATIONAL MANAGEMENT TEAM SEPTEMBER 30, 1998 - -------------------------------------------------------------------------------- is likely to mean higher unemployment, further depressing consumer confidence and deepening the severity of Japan's economic contraction. ASIA Asian markets plunged during October 1997, as currencies throughout the region buckled, revealing extreme levels of government and corporate foreign debt. At the same time, investor confidence was further undermined by ineffective, inappropriate, and occasionally ill-considered responses by regional governments. From mid-January, markets and currencies bounced dramatically from their oversold lows and, despite unhappiness at the austerity involved, South Korea and Thailand made valuable initial progress in implementing IMF reform programs. However, in April 1998, increasing unrest in Indonesia and the prospect of serious political and economic instability sparked renewed region-wide concerns. Regional currencies and equity markets sank throughout the remainder of the second quarter. A rapidly escalating financial crisis in Russia, followed by effective default on its sovereign debt, triggered a massive worldwide flight to quality and profound risk aversion. Investor confidence in emerging markets, already weak, evaporated, and Asia's equity markets sank to new lows. Little real progress has been made in restructuring the region's commercial, financial, or legal infrastructure. Regionally, any progress in achieving long-lasting and soundly-based economic recovery remains severely hampered by a mountainous burden of foreign debt. Although there appears to be a growing acceptance amongst G-7 banks and politicians that, faced with a choice between forgiveness or default, the former is likely to prove more rewarding, actual implementation is likely to prove both difficult and protracted. In the meantime, the potential for further civil unrest and political uncertainty suggest that markets are likely to remain volatile and that, at present levels, optimism has already been discounted and further upside potential -- at least in the medium term -- is limited. LATIN AMERICA In October 1997, the collapse of Asian currencies and equity markets triggered dramatic declines in Latin American equity markets, with investors particularly concerned over possible devaluation of the Brazilian currency. Prompt action by the Brazilian authorities in raising interest rates to punitively high levels, and instituting government spending reforms resulted in a successful defense of the currency. Brazil's privatization program remained on course, and fading concerns over the stability of the currency allowed the government to wind down interest rates gradually, although these remained at high levels. In April 1998, renewed turmoil in Asia triggered affected investor confidence in emerging markets worldwide, and Latin America's equity markets sank throughout the remainder of the second quarter. A brief rally in Asia fed through to Latin American equity markets but, in the closing months of the period under review, financial disarray in Russia, and fears over worldwide contagion, effectively destroyed the last vestiges of investor confidence in emerging markets. The ensuing `flight to quality' sent Latin American equity markets tumbling past their earlier New Year lows. The region continues to suffer from investor concern over fiscal imbalances, with deficits in both government expenditure and trade accounts. The latter have, in part, been due to weak commodity prices, but much has been the product of strong 16 MENTOR PERPETUAL GLOBAL PORTFOLIO MANAGERS' COMMENTARY: THE GLOBAL/INTERNATIONAL MANAGEMENT TEAM SEPTEMBER 30, 1998 - -------------------------------------------------------------------------------- domestic growth that has sucked in imports. The re-election of President Cardoso has raised hopes that, together with support from international lending institutions, Brazil's government will be able to institute the fiscal reforms necessary to restore confidence in the country's currency. This could provide something of a role model for other Latin American countries, such as Argentina, Chile and Mexico, also experiencing trade deficits and fiscal imbalances. November 1998 17 MENTOR PERPETUAL GLOBAL PORTFOLIO SEPTEMBER 30, 1998 - -------------------------------------------------------------------------------- PERFORMANCE COMPARISON Comparison of change in value of a hypothetical $10,000 purchase in Mentor Perpetual Global Portfolio Class A and Class B Shares and the Morgan Stanley Capital International (MSCI) World Index.* [GRAPH] Morgan Stanley A Shares B Shares 3/29/94 10000 9425 10000 9/30/94 10546 9982 9487 9/30/95 12125 10655 10587 9/30/96 13846 12501 12677 9/30/97 17256 15200 15668 9/30/98 17344 14445 14580 Average Annual Returns as of 9/30/98 Including Sales Charges 1-Year Since Inception++ Class A (10.44%) 8.50% Class B (9.23%) 8.89% PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE PERFORMANCE. YOUR INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO WHEN SHARES ARE REDEEMED, THEY MAY BE WORTH MORE OR LESS THAN ORIGINAL COST. MUTUAL FUNDS ARE NOT OBLIGATIONS OF OR GUARANTEED BY ANY BANK AND ARE NOT FEDERALLY INSURED. * MSCI World Index is an arithmetic average, weighted by market value, of the performance of approximately 1,450 securities listed on the stock exchanges of 20 countries including the U.S., Europe, Canada, Australia, New Zealand, and the Far East. The average company in the index has a market capitalization of about $3.5 billion. This is a total return index with gross dividends reinvested. MSCI World Index is not adjusted to reflect reinvestment of dividends on securities in the index, and is not adjusted to reflect sales loads, expenses, or other fees that the SEC requires to be reflected in the Portfolio's performance. + Represents a hypothetical investment of $10,000 in Mentor Perpetual Global Portfolio Class A Shares, after deducting the maximum sales charge of 5.75% ($10,000 investment minus $575 sales charges = $9,425). The Class A Shares' performance assumes the reinvestment of all dividends and distributions. ~ Represents a hypothetical investment of $10,000 in Mentor Perpetual Global Portfolio Class B Shares. A contingent deferred sales charge will be imposed, if applicable, on Class B Shares at rates ranging from a maximum of 4.00% of amounts redeemed during the first year following the date of purchase to 1.00% of amounts redeemed during the five-year period following the date of purchase. The value of the Class B Shares reflects a redemption fee in effect at the end of each of the stated periods. The Class B Shares' performance assumes the reinvestment of all dividends and distributions. ++ Reflects operations of Mentor Perpetual Global Portfolio Class A and Class B Shares from the date of commencement of operations on 3/29/94 through 9/30/98. 18 MENTOR PERPETUAL GLOBAL PORTFOLIO SEPTEMBER 30, 1998 - -------------------------------------------------------------------------------- PERFORMANCE COMPARISON Comparison of change in value of a hypothetical $10,000 purchase in Mentor Perpetual Global Portfolio Class Y Share and the Morgan Stanley Capital International (MSCI) World Index.* [GRAPH] MSCI World Inc Class Y Shares 11/19/97 10000 10000 12/31/97 10278 10304 3/31/98 11832 11791 6/30/98 11714 12041 9/30/98 10187 10608 Total Returns as of 9/30/98 1-Year Since Inception++ Class Y Shares n/a 1.60% PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE PERFORMANCE. YOUR INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO WHEN SHARES ARE REDEEMED, THEY MAY BE WORTH MORE OR LESS THAN ORIGINAL COST. MUTUAL FUNDS ARE NOT OBLIGATIONS OF OR GUARANTEED BY ANY BANK AND ARE NOT FEDERALLY INSURED. * MSCI World Index is an arithmetic average, weighted by market value, of the performance of approximately 1,450 securities listed on the stock exchanges of 20 countries including the U.S., Europe, Canada, Australia, New Zealand, and the Far East. The average company in the index has a market capitalization of about $3.5 billion. This is a total return index with gross dividends reinvested. MSCI World Index is not adjusted to reflect reinvestment of dividends on securities in the index, and is not adjusted to reflect sales loads, expenses, or other fees that the SEC requires to be reflected in the Portfolio's performance. + Represents a hypothetical investment of $10,000 in Mentor Perpetual Global Portfolio Class Y Shares. These shares are not subject to any sales or contingent deferred sales charges. The Class Y Shares' performance assumes the reinvestment of all dividends and distributions. ++ Reflects operations of Mentor Perpetual Global Portfolio Class Y Shares from the date of issuance on 11/19/97 through 9/30/98. 19 MENTOR PERPETUAL GLOBAL PORTFOLIO PORTFOLIO OF INVESTMENTS SEPTEMBER 30, 1998 - --------------------------------------------------------------------------------
SHARES MARKET VALUE COMMON STOCKS - 88.49% ARGENTINA - 0.10% Perez Company SA~ 4,437 $ 36,609 Telecom Argentina SA~ 2,100 62,344 Telefonica de Argentina SA~ 2,020 59,464 ---------- 158,417 ---------- AUSTRIA - 0.34% Bank Austria AG 14,000 535,988 ---------- BELGIUM - 1.18% Cofinimmo 7,576 920,068 Fortis AG 1,550 382,327 G.I.B. Group SA 11,200 557,400 ---------- 1,859,795 ---------- BRAZIL - 0.33% Cemig CIA Energetic~ (a) 1,700 37,593 CIA Brasil Petro Ipiranga 4,900,000 31,374 Companhia Cervejaria Brahma- 3,500 27,344 Companhia Vale do Rio Doce~ 2,450 35,140 Compania Paulista de Forca e Luz 370,000 30,589 Electrobras - Centrais Eletricas Brasileiras SA 2,930 32,507 Electropaulo Metropolitana - Electricidade de Sao Paulo SA 690,000 35,443 Pao de Acucar# 2,630,000 34,611 Petroleo Brasileiro SA~ 2,520 25,833 Telecomonicacoes Brasileiras SA~ 2,030 142,988 Telecomunicacoes de Sao Paulo SA 240,000 34,824 Telecomunicacoes de Minas Gerais 1,130,000 40,037 Telerj Celular SA* 240,000 10,326 ---------- 518,609 ---------- CHILE - 0.09% Chilectra SA~ 3,450 56,411 Embotelladora Andina SA~* 1,200 16,500 Enersis SA~ 1,500 30,563 Telecomunicaciones de Chile~ 1,700 32,513 ---------- 135,987 ---------- CHINA - 0.25% Heilongjiang Electric Power Company 180,000 66,600 Huaneng Power International, Inc. - Class A~* 15,000 153,750 Yanzhou Coal Mining Company 1,000,000 174,216 ---------- 394,566 ----------
SHARES MARKET VALUE COMMON STOCKS (CONTINUED) FINLAND - 1.49% Huhtamaki 7,472 $ 230,812 Metra Oyj - Class B 38,220 744,472 Nokia Oyj - Class A 17,410 1,383,894 ---------- 2,359,178 ---------- FRANCE - 7.04% Accor SA 5,000 1,049,463 Atos SA 5,230 931,443 Axa 10,940 1,002,522 Casino Guichard Perrachn 7,350 741,814 Compagnie de Saint - Gobain 3,250 431,352 Colas 1,730 329,121 Comptoirs Modernes 1,320 825,280 Elf Aquitaine SA 10,400 1,283,721 Entrelec 12,000 531,609 Genset SA~* 30,000 772,500 ISIS 5,460 370,626 SEB SA 1,270 98,821 Serp Recyclage 3,039 295,317 Societe Generale D'Enterprises 12,610 471,909 Total SA - Class B 8,450 1,065,664 Vivendi 4,760 948,922 ---------- 11,150,084 ---------- GERMANY - 5.41% Allianz AG 3,785 1,172,150 Ava Allg Handels Der Verbrau 3,400 1,384,887 Porsche AG 805 1,408,009 Prosieben Media AG 12,650 697,116 Sauer, Inc. 34,050 270,272 Siemens AG 13,850 757,438 Veba AG 35,920 1,864,742 Viag AG 1,550 1,014,331 ---------- 8,568,945 ---------- GREAT BRITAIN - 10.50% Abbey National PLC 31,250 538,886 Allied Zurich PLC* 28,500 291,247 Arcadia Group 55,700 228,062 Arriva PLC 35,000 223,582 Asda Group 108,000 313,762 BAA PLC 32,250 327,925 Barclays PLC 26,000 422,733 Bass PLC 23,571 285,127 BAT Industries PLC 32,500 244,054 Britannic Assurance PLC 15,000 322,885 British Aerospace PLC 81,000 488,189 British Airways PLC 34,500 213,208 British Biotech PLC* 150,000 89,832
20 MENTOR PERPETUAL GLOBAL PORTFOLIO PORTFOLIO OF INVESTMENTS SEPTEMBER 30, 1998 - --------------------------------------------------------------------------------
SHARES MARKET VALUE COMMON STOCKS (CONTINUED) GREAT BRITAIN (CONTINUED) British Petroleum Company PLC 24,000 $ 366,565 Burmah Castrol PLC 25,000 353,806 Celltech PLC* 25,000 112,555 Centrica PLC* 149,500 288,282 Debenhams PLC 40,000 226,640 Dixons Group 16,000 163,507 Emap PLC 25,000 397,554 Enterprise Oil PLC 75,000 506,499 Glaxo Wellcome PLC 31,000 912,727 Granada Group PLC 36,000 470,032 Great Universal Stores PLC 22,000 245,379 Greenalls Group PLC 40,000 197,078 House of Fraser 50,000 70,506 Iceland Group PLC 31,250 101,169 III Group PLC 30,000 257,136 Imperial Chemical Industries PLC 30,000 236,239 Inchcape PLC 90,000 177,370 Lloyds TSB Group PLC 54,000 603,212 Medeva PLC 80,000 125,043 Meggitt PLC 50,000 113,830 National Westminster Bank 28,250 377,963 Northern Foods PLC 73,400 223,218 PowerGen PLC 44,000 653,348 Prudential Corporation PLC 33,000 479,639 Rank Group PLC 61,750 251,784 Reckitt & Colman PLC 13,300 198,506 Reuters Group PLC 32,000 268,298 Rolls-Royce PLC 138,000 478,875 Sainsbury (J.) PLC 51,000 489,119 Scotia Holdings * 30,000 50,968 Signet Group 312,500 136,712 Smith (H.W.) Group PLC 33,750 280,104 SmithKline Beecham PLC 47,000 518,630 Spirax-Sarco Engineering PLC 30,000 221,203 Stakis PLC 260,000 375,468 Standard Chartered 51,500 366,389 Tate & Lyle PLC 35,282 195,412 Tesco PLC 112,400 332,274 Trinity PLC 35,000 241,421 United Assurance Group PLC 23,000 229,180 United News & Media PLC 35,000 331,210 ---------- 16,614,342 ---------- GREECE - 0.00% Heilenic Telecommunication organization SA 122 2,926 ----------
SHARES MARKET VALUE COMMON STOCKS (CONTINUED) HONG KONG - 1.84% Cheung Kong 20,000 $ 92,657 China Foods Holdings, Limited * 575,000 143,954 China Telecom * 40,000 62,976 Citic Pacific, Limited 70,000 122,855 Elec & Eltek International Company, Limited 735,000 132,791 First Tractor Company 305,000 78,720 GZI Transport, Limited - Warrants 60,000 77 GZI Transport, Limited 484,000 101,185 HKR International, Limited 840,000 260,163 Hong Kong Electric 35,000 120,370 Hong Kong & China Gas 100,000 122,596 HSBC Holdings PLC 33,454 613,683 Hung Hing Printing Group 238,000 79,088 Hutchison Whampoa, Limited 48,000 252,729 National Mutual Asia, Limited 280,000 136,405 New World Development 130,951 175,750 Road King Infrastructure, Limited 464,544 254,783 Swire Pacific, Limited - Class A 50,000 157,440 ---------- 2,908,222 ---------- INDIA - 0.34% BSES, Limited #* 8,000 103,000 Hindalco Industries, Limited # 5,000 54,500 Indian Opportunity Fund, Limited* 11,000 93,390 Mahanagar Telephone Nigam, Limited #* 2,000 22,700 Tata Electric # 1,500 262,500 ---------- 536,090 ---------- INDONESIA - 0.06% Bat Indonesia 36,000 50,131 Gudang Garam 80,000 42,804 ---------- 92,935 ---------- IRELAND - 2.05% Bank of Ireland 72,465 1,289,008 CRH PLC 80,000 1,007,138 Elan Corporation PLC~ * 13,250 954,828 ---------- 3,250,974 ---------- ITALY - 4.77% Assicurazioni Generali 15,020 488,729 ENI SPA 192,000 1,177,350 Finmeccanica SPA 192,030 159,526 Grupo Editoriale L'Espresso 174,000 1,370,618 Ina SPA 185,000 470,809
21 MENTOR PERPETUAL GLOBAL PORTFOLIO PORTFOLIO OF INVESTMENTS SEPTEMBER 30, 1998 - --------------------------------------------------------------------------------
SHARES MARKET VALUE COMMON STOCKS (CONTINUED) ITALY (CONTINUED) Istituto Mobiliare Italiano 76,000 $1,003,908 Rinascente SPA 90,850 797,108 Telecom Italia Mobile 105,500 614,966 Telecom Italia SPA 185,000 1,275,108 Telecom Moblit 61,000 196,267 ---------- 7,554,389 ---------- JAPAN - 8.87% Asahi Glass Company, Limited 275,000 1,327,239 Daiwa House Industry Company, Limited 170,000 1,541,499 Kirin Brewery Company, Limited 160,000 1,277,660 Kokusai Securities Company, Limited 200,000 1,396,709 Mitsui Chemicals, Inc. 500,000 1,429,616 Nippon Steel Corporation 880,000 1,261,280 Sony Music Entertainment, Inc. 40,000 1,310,420 Sumitomo Warehouse 360,000 1,376,819 Tokyo Electric Power Company 75,000 1,431,444 Tokio Marine & Fire Insurance 190,000 1,695,064 ---------- 14,047,750 ---------- KOREA - 0.08% Atlantis Korean Smaller Companies * 20,000 100,200 CITC Seoul Excel * 2 3,700 LG Electronics # 6,400 8,000 Samsung Electronics # (a) 475 7,030 ---------- 118,930 ---------- MALAYSIA - 0.08% Boustead Holdings Berhad (c) 84,000 46,802 IOI Corporation (c) 100,000 37,319 Nanyang Press Berhad (c) 60,000 48,568 ---------- 132,689 ---------- MEXICO - 0.31% Cemex SA~* 5,600 27,368 Cifra SA 34,500 41,982 Coca-Cola Femsa SA~ 2,900 35,344 Corporacion Geo SA* 9,600 17,881 DESC SA~ 2,002 27,528 Empresas La Moderna SA~ 1,800 43,030 Grupo Carso SA~ 7,800 46,539 Grupo Televisa #* 1,400 26,928 Kimberly-Clark de Mexico SA~ 2,680 35,845 Panamerican Beverages - Class A * 2,000 35,625
SHARES MARKET VALUE COMMON STOCKS (CONTINUED) MEXICO (CONTINUED) Telefonos de Mexico SA 3,500 $ 154,875 ---------- 492,945 ---------- NETHERLANDS - 1.14% Baan Company NV * 23,000 595,117 Royal Dutch Petroleum 12,748 633,285 Vendex International NV 15,325 569,960 Vendex International NV - Coupon 15,325 2,036 ---------- 1,800,398 ---------- PERU - 0.01% Telefonica del Peru SA~ 2,500 30,625 ---------- PHILIPPINES - 0.13% Benpres Holdings #* 68,000 187,000 Benpres Holdings - Rights 27,200 27,336 ---------- 214,336 ---------- PORTUGAL - 1.38% BPI SGPS SA 28,060 773,990 Cimpor Cimentos de Portugal 15,000 418,391 Elec de Portugal 29,600 681,196 Jeronimo Martins 9,050 306,623 ---------- 2,180,200 ---------- SINGAPORE - 0.72% City Developments, Limited 30,000 65,700 GP Batteries International, Limited 190,000 245,161 Marco Polo Developments, Limited 120,000 62,504 Overseas Chinese Bank * 80,287 201,490 Overseas Union Bank, Limited 80,000 114,117 Singapore Airlines, Limited 20,000 109,500 Singapore Press Holdings 10,000 82,865 United Overseas Bank 87,000 253,353 ---------- 1,134,690 ---------- SPAIN - 6.22% Acciona SA 5,000 1,252,952 Argentaria Corp Bancaria de Espana SA 45,143 898,946 Baron de Ley* 30,000 1,015,050 Centros Comerciales Continente, SA 50,560 1,286,587 Gas Natural SDG SA 11,600 821,767 Prosegur CIA de Seguridad SA 116,895 1,450,218 Tabacalera SA 64,000 1,405,280 Telefonica SA 24,745 903,529 Viscofan Envolturas Celulosicas SA 29,960 779,279
22 MENTOR PERPETUAL GLOBAL PORTFOLIO PORTFOLIO OF INVESTMENTS SEPTEMBER 30, 1998 - --------------------------------------------------------------------------------
SHARES MARKET VALUE COMMON STOCKS (CONTINUED) SPAIN (CONTINUED) Viscofan Envolturas Celulosicas SA - Warrants 29,960 $ 38,647 --------- 9,852,255 --------- SWEDEN - 1.88% BPA AB 265,000 673,829 Celsius AB - Class B 56,360 1,060,489 ForeningsSparbanken AB 54,040 1,236,692 --------- 2,971,010 --------- SWITZERLAND - 4.19% Jelmoli Holding AG 880 1,026,295 Nestle SA 790 1,575,994 Novartis AG 1,056 1,697,402 Roche Holding AG - Genussshein 152 1,640,565 UBS AG* 3,525 689,424 --------- 6,629,680 --------- TAIWAN - 0.20% Formosa Growth Fund * 5,000 88,125 Taipei Fund * 20 161,000 Taiwan Semiconductor~ 5,900 75,228 --------- 324,353 --------- THAILAND - 0.08% Cogenaration PLC 67,000 30,493 Electricity Generating Public Company 40,000 95,575 --------- 126,068 --------- UNITED STATES - 27.41% AccuStaff, Inc. * 25,000 364,063 American Home Products Company 14,000 733,250 American Tower Corporation * 10,000 255,000 Anadarko Petroleum Corporation 12,000 471,750 Anheuser-Busch Companies, Inc. 11,000 594,000 Associates First Capital 19,100 1,246,275 Aurora Foods, Inc.* 9,800 134,750 BankBoston Corporation* 10,800 356,400 Baxter International, Inc. 14,500 862,750 Bell Atlantic Corporation 18,900 915,469 Borders Group, Inc. * 18,000 400,500 Bristol-Myers Squibb Company* 9,700 1,007,588 Burlington Northern 16,500 528,000 Cardinal Health, Inc. 5,800 598,850 Chase Manhattan Corporation 11,700 506,025 Chevron Corporation 10,000 840,625
SHARES MARKET VALUE COMMON STOCKS (CONTINUED) UNITED STATES (CONTINUED) Columbia/HCA Healthcare Corporation 27,900 $ 559,744 Comcast Corporation - Class A 15,000 704,063 Compaq Computer Corporation 24,500 774,813 CompUSA, Inc. 7,600 131,576 Conseco, Inc. 20,600 629,588 Consolidated Stores Corporation* 15,000 294,375 Duke Energy Corporation 7,700 509,644 El Paso Energy Corporation 20,000 648,750 EMC Corporation* 15,000 857,813 Federal National Mortgage Association 6,300 404,775 HealthSouth Corporation * 50,000 528,125 Intel Corporation 19,600 1,680,700 International Business Machines, Inc. 11,000 1,408,000 Lilly (Eli) & Company 9,000 704,813 Lockheed Martin Corporation 6,100 614,956 Mail-Well Holdings* 19,600 167,825 MBNA Corporation 29,200 835,850 McDonald's Corporation 9,000 537,188 MCI WorldCom, Inc. 29,000 1,417,375 Medicis Pharmaceutical* 22,000 871,750 Meditrust Corporation 27,654 471,846 Microsoft Corporation * 5,000 550,313 NationsBank Corporation 15,500 829,250 Newbridge Networks Corporation 24,500 439,469 Newcourt Credit Group, Inc. 11,000 287,375 Nextel Communications, Inc. 11,000 222,063 Ocular Sciences * 5,000 105,000 Omnicare, Inc. 15,000 528,750 Pfizer, Inc. 8,200 868,688 Philip Morris Companies, Inc. 15,000 690,938 Phillips Petroleum Company 7,100 320,388 Provident Companies, Inc. 20,000 675,000 Ralston-Purina Group 12,400 362,700 Republic Services, Inc.* 9,000 175,500 SBC Communications, Inc. 28,800 1,279,800 Staples, Inc.* 53,150 1,561,281 Stewart Enterprises 22,000 368,500 Sun Microsystems, Inc.* 9,000 448,313 Sybron International Corporation * 25,000 478,125 Tele-Communications International * 16,000 626,000 Texaco, Inc. 15,000 940,313 Texas Instruments, Inc. 7,500 395,625
23 MENTOR PERPETUAL GLOBAL PORTFOLIO PORTFOLIO OF INVESTMENTS SEPTEMBER 30, 1998 - --------------------------------------------------------------------------------
SHARES OR PRINCIPAL AMOUNT MARKET VALUE COMMON STOCKS (CONTINUED) UNITED STATES (CONTINUED) 3Com Corporation* 10,000 $ 300,625 Time Warner, Inc. 17,500 1,532,340 Travelers Group, Inc. 12,500 468,750 Travelers Property and Casualty Corporation 18,000 574,875 Tyco International, Ltd. 10,000 552,500 U.S. Foodservice* 29,600 1,232,100 Viacom Industries, Inc. - Class A 20,000 1,150,000 Westpoint Stevens, Inc. - Class A * 16,000 488,000 Williams Companies, Inc. 12,500 359,375 ----------- 43,380,820 ----------- TOTAL COMMON STOCKS (COST $148,319,820) 140,078,196 ----------- CORPORATE BONDS - 0.29% GREAT BRITIAN Scotia Holdings, 8.50%, 3/26/02 $ 19,000 23,403 ----------- KOREA Republic of Korea, 8.88%, 4/15/08 208,000 177,450 ----------- MALAYSIA Telekom Malaysia Berhad, 4.00%, 10/03/04 ~ (9/22/94, $70,000) (a) (b) 70,000 37,800 ----------- THAILAND PTTEP International, Limited, 7.63%, 10/01/06 300,000 223,500 ----------- TOTAL CORPORATE BONDS (COST $461,458) 462,153 ----------- 140,540,349 ----------- SHORT-TERM INVESTMENT - 10.07% REPURCHASE AGREEMENT Goldman Sachs & Company Dated 9/30/98, 5.60%, due 10/01/98, collateralized by Federal National Mortgage Association, $16,141,372 6.00%, 8/01/13, market value $16,302,785 (cost $15,936,519) 15,936,519 15,936,519 -----------
MARKET VALUE TOTAL INVESTMENTS (COST $164,717,797)-98.85% $156,476,868 OTHER ASSETS LESS LIABILITIES - 1.15% 1,812,839 ------------ NET ASSETS - 100.00% $158,289,707 ============
* Non-income producing. # Global Depository Receipts. ~ American Depository Receipts. (a) These are securities that may be resold to "qualified institutional buyers" under Rule 144A or securities offered pursuant to Section 4 (2) of the Securities Act of 1933, as amended. These securities have been determined to be liquid under guidelines established by the Board of Trustees. (b) All or a portion of these securities are restricted (i.e., securities which may not be publicly sold without registration under the Federal Securities Act of 1933). Dates of acquisition and costs are set forth in parentheses after the title of the restricted securities. (c) These securities are considered illiquid due to a one year moratorium on the repatriation of assets from Malaysia. INVESTMENT TRANSACTIONS Cost of purchases and proceeds from sales of securities, other than short-term securities, aggregated $248,291,695 and $235,288,192, respectively. INCOME TAX INFORMATION At September 30, 1998, the aggregated cost of investment securities for federal income tax purposes was $165,477,184. Net unrealized depreciation aggregated $9,000,316, of which $11,442,631, related to appreciated investment securities and $20,442,947, related to depreciated investment securities. SEE NOTES TO FINANCIAL STATEMENTS. 24 MENTOR PERPETUAL GLOBAL PORTFOLIO - -------------------------------------------------------------------------------- STATEMENT OF ASSETS AND LIABILITIES SEPTEMBER 30, 1998 ASSETS Investments, at market value (Note 2) Investment securities $ 140,540,349 Repurchase agreements 15,936,519 ------------- Total investments (cost $164,717,797) 156,476,868 Receivables Collateral for securities loaned (Note 2) 12,707,641 Investments sold 6,315,010 Fund shares sold 354,472 Dividends and interest 443,615 Unrealized appreciation on forward foreign currency exchange contracts (Note 6) 617 Deferred expenses (Note 2) 5,424 ------------- TOTAL ASSETS 176,303,647 ------------- LIABILITIES Payables Investments purchased $ 2,697,553 Securities loaned (Note 2) 12,707,641 Fund shares redeemed 2,446,454 Unrealized depreciation on forward foreign currency exchange contracts (Note 6) 35,060 Accrued expenses and other liabilities 127,232 ----------- TOTAL LIABILITIES 18,013,940 ------------- NET ASSETS $ 158,289,707 ============= Net Assets represented by: (Note 2) Additional paid-in capital $ 153,975,854 Accumulated undistributed net investment income 3,616 Accumulated net realized gain on investment transactions 12,574,725 Net unrealized depreciation of investments and foreign currency related transactions (8,264,488) ------------- NET ASSETS $ 158,289,707 ============= NET ASSET VALUE PER SHARE Class A Shares $ 18.92 Class B Shares $ 18.21 Class Y Shares $ 18.96 OFFERING PRICE PER SHARE Class A Shares $ 20.07(a) Class B Shares $ 18.21 Class Y Shares $ 18.96 SHARES OUTSTANDING Class A Shares 3,118,915 Class B Shares 5,452,526 Class Y Shares 53
(a) Computation of offering price: 100/94.25 of net asset value. SEE NOTES TO FINANCIAL STATEMENTS. STATEMENT OF OPERATIONS YEAR ENDED SEPTEMBER 30, 1998 INVESTMENT INCOME Dividends (b) $ 2,176,556 Interest 499,605 ------------ TOTAL INVESTMENT INCOME (NOTE 2) 2,676,161 EXPENSES Management fee (Note 4) $ 1,612,495 Distribution fee (Note 5) 734,020 Shareholder service fee (Note 5) 384,373 Transfer agent fee 220,815 Custodian and accounting fees 188,561 Administration fee (Note 4) 153,750 Registration expenses 67,081 Shareholder reports and postage expenses 36,249 Organizational expenses 11,067 Legal fees 4,542 Directors' fees and expenses 3,591 Audit fees 3,143 Miscellaneous 14,317 ----------- Total expenses 3,434,004 ------------ NET INVESTMENT LOSS (757,843) ------------ REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS AND FOREIGN CURRENCY RELATED TRANSACTIONS Net realized gain on investments and foreign currency related transactions (Note 2) 14,799,387 Change in unrealized appreciation (depreciation) on investments and foreign currency related transactions (25,459,714) ----------- NET LOSS ON INVESTMENTS AND FOREIGN CURRENCY RELATED TRANSACTIONS (10,660,327) ------------ NET DECREASE IN NET ASSETS RESULTING FROM OPERATIONS $(11,418,170) ============
(b) Net of withholding taxes of $206,565. SEE NOTES TO FINANCIAL STATEMENTS. 25 MENTOR PERPETUAL GLOBAL PORTFOLIO - -------------------------------------------------------------------------------- STATEMENTS OF CHANGES IN NET ASSETS
YEAR ENDED YEAR ENDED 9/30/98 9/30/97 NET INCREASE IN NET ASSETS Operations Net investment loss $ (757,843) $ (416,666) Net realized gain on investments and foreign currency related transactions 14,799,387 6,084,166 Change in unrealized appreciation (depreciation) on investments (25,459,714) 13,678,454 ------------- ------------- Increase (decrease) in net assets resulting from operations (11,418,170) 19,345,954 ------------- ------------- Distributions to Shareholders From net realized gain on investments Class A (2,382,830) (476,590) Class B (4,553,653) (1,576,577) Class Y (8) -- --------------- ------------- Total distributions to shareholders (6,936,491) (2,053,167) -------------- ------------- Capital Share Transactions (Note 7) Proceeds from sale of shares 78,893,773 74,523,622 Reinvested distributions 6,732,722 2,007,927 Shares redeemed (44,567,723) (13,467,704) -------------- ------------- Change in net assets resulting from capital share transactions 41,058,772 63,063,845 -------------- ------------- Increase in net assets 22,704,111 80,356,632 Net Assets Beginning of year 135,585,596 55,228,964 -------------- ------------- End of year (including accumulated undistributed net investment income (loss) of $3,616 and ($97,957), respectively) $158,289,707 $ 135,585,596 ============== =============
SEE NOTES TO FINANCIAL STATEMENTS. FINANCIAL HIGHLIGHTS CLASS A SHARES
YEAR YEAR ENDED ENDED 9/30/98 9/30/97 PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 20.94 $ 17.86 --------- --------- Income from investment operations Net investment income (loss) (0.03) 0.04 Net realized and unrealized gain (loss) on investments (0.97) 3.67 --------- --------- Total from investment operations (1.00) 3.71 --------- --------- Less distributions From capital gains (1.02) (0.63) --------- ---------- Net asset value, end of period $ 18.92 $ 20.94 ========= ========== TOTAL RETURN* (4.97%) 21.59% RATIOS / SUPPLEMENTAL DATA Net assets, end of period (in thousands) $ 59,012 $ 46,556 Ratio of expenses to average net assets 1.75% 1.89% Ratio of expenses to average net assets excluding waiver 1.75% 1.89% Ratio of net investment income (loss) to average net assets (0.01%) 0.07% Portfolio turnover rate 162% 128% Average commission rate on portfolio transactions $ 0.0188 $ 0.0319 YEAR YEAR YEAR ENDED ENDED ENDED 9/30/96 9/30/95 9/30/94 (C) PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 15.88 $ 14.23 $ 14.18 -------- -------- ----------- Income from investment operations Net investment income (loss) (0.04) 0.05 (0.01) Net realized and unrealized gain (loss) on investments 2.82 1.60 0.06 --------- -------- ------------ Total from investment operations 2.78 1.65 0.05 --------- -------- ------------ Less distributions From capital gains (0.80) -- -- --------- --------- ------------ Net asset value, end of period $ 17.86 $ 15.88 $ 14.23 ========= ========= ============ TOTAL RETURN* 18.40% 11.60% 0.35% RATIOS / SUPPLEMENTAL DATA Net assets, end of period (in thousands) $ 13,098 $ 6,854 $ 8,882 Ratio of expenses to average net assets 1.95% 2.06% 2.09% (a) Ratio of expenses to average net assets excluding waiver 1.95% 2.11% 3.18% (a) Ratio of net investment income (loss) to average net assets (0.21%) 0.26% (0.10%)(a) Portfolio turnover rate 130% 155% 2% Average commission rate on portfolio transactions $ 0.0320
(a) Annualized. (c) For the period from March 29, 1994 (commencement of operations), to September 30, 1994. * Total return does not reflect sales commissions and is not annualized. SEE NOTES TO FINANCIAL STATEMENTS. 26 MENTOR PERPETUAL GLOBAL PORTFOLIO - -------------------------------------------------------------------------------- FINANCIAL HIGHLIGHTS CLASS B SHARES
YEAR YEAR ENDED ENDED 9/30/98 9/30/97 PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 20.32 $ 17.46 --------- -------- Income from investment operations Net investment loss (0.12) (0.02) Net realized and unrealized gain (loss) on investments (0.97) 3.51 --------- --------- Total from investment operations (1.09) 3.49 --------- --------- Less distributions From capital gains (1.02) (0.63) --------- --------- Net asset value, end of period $ 18.21 $ 20.32 ========= ========= TOTAL RETURN* (5.65%) 20.74% RATIOS / SUPPLEMENTAL DATA Net assets, end of period (in thousands) $ 99,277 $ 89,030 Ratio of expenses to average net assets 2.50% 2.64% Ratio of expenses to average net assets excluding waiver 2.51% 2.64% Ratio of net investment loss to average net assets (0.77%) (0.68%) Portfolio turnover rate 162% 128% Average commission rate on portfolio transactions $ 0.0188 $ 0.0319 YEAR YEAR PERIOD ENDED ENDED ENDED 9/30/96 9/30/95 9/30/94 (d) PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 15.67 $ 14.15 $ 14.18 -------- -------- ----------- Income from investment operations Net investment loss (0.05) (0.05) (0.04) Net realized and unrealized gain (loss) on investments 2.64 1.57 0.01 --------- -------- ------------ Total from investment operations 2.59 1.52 (0.03) --------- -------- ------------ Less distributions From capital gains (0.80) -- -- --------- -------- ------------ Net asset value, end of period $ 17.46 $ 15.67 $ 14.15 ========= ======== ============ TOTAL RETURN* 17.39% 10.74% (0.21%) RATIOS / SUPPLEMENTAL DATA Net assets, end of period (in thousands) $ 42,131 $ 12,667 $ 7,987 Ratio of expenses to average net assets 2.70% 2.72% 2.79% (a) Ratio of expenses to average net assets excluding waiver 2.70% 2.79% 3.93% (a) Ratio of net investment loss to average net assets (0.91%) (0.40%) (0.82%)(a) Portfolio turnover rate 130% 155% 2% Average commission rate on portfolio transactions $ 0.0320
CLASS Y SHARES
PERIOD ENDED 9/30/98 (e) PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 18.81 --------- Income from investment operations Net investment income 0.00 (f) Net realized and unrealized gain on investments 0.30 --------- Total from investment operations 0.30 --------- Less distributions From capital gains (0.15) ----------- Net asset value, end of period $ 18.96 =========== TOTAL RETURN* 1.60% RATIOS/SUPPLEMENTAL DATA Net assets, end of period (in thousands) $ 1 Ratio of expenses to average net assets 1.50% (a) Ratio of net investment loss to average net assets (0.02%)(a) Portfolio turnover rate 162% Average commission rate on portfolio transactions $ 0.0188
(a) Annualized. (d) For the period from March 29, 1994 (commencement of operations) to September 30, 1994. (e) For the period from November 19, 1997 (initial offering of Class Y shares) to September 30, 1998. (f) Income is less than $0.005 per share. * Total return does not reflect sales commissions and is not annualized. SEE NOTES TO FINANCIAL STATEMENTS. 27 MENTOR CAPITAL GROWTH PORTFOLIO MANAGERS' COMMENTARY: THE LARGE-CAPITALIZATION QUALITY GROWTH MANAGEMENT TEAM SEPTEMBER 30, 1998 - -------------------------------------------------------------------------------- The S&P 500 declined approximately 10% in the third quarter of 1998 after a remarkable string of 14 consecutive quarterly gains that began in the first quarter of 1995. This year we have been more emphatically cautioning that the stock market would have to adjust to considerably lower corporate earnings prospects, and this transition would likely result in increased volatility and lower returns than experienced over the past several years. Clearly this scenario is unfolding in full force. Over the past 12 months the market has been extremely volatile while the total return on the S&P 500 has been just 9%. Earnings estimates for a broad range of companies are being sharply reduced. It is now quite possible, in fact likely in our opinion, that the earnings of the S&P 500 will decline in the second half of this year and in 1999. These trends present a significant change from the strong, better-than-expected earnings growth that has been a key pillar supporting the bull market since 1990, one of the best on record by almost any measure. But this change was inevitable. It is part of the natural cyclical patterns of the economy, corporate profitability, and the stock market. Supply and demand forces will always cycle around each other at uneven rates with their crisscross progressions being amplified by credit expansions and contractions. The 16% compound annual earnings growth of the S&P 500 between 1991 and 1997 was certainly not sustainable, particularly in an economy showing only 4-5% nominal growth. After nearly perfect growth conditions during much of the 1990's, corporate profitability is coming under pressure as global excess capacity is chasing falling demand. And as should be expected at this point, lenders are sharply curtailing credit and thereby reinforcing these developing pressures. The most obvious target of blame for current concerns is the Asian crisis and its ripples. However, we would still be facing some type of similar macro-pressures even if Asia's problems had never surfaced. There will always be countervailing forces to slow abnormally high growth. The current retrenchment may be different from other recent ones as a matter of degree. The prolonged expansion seems to have created an unusually high level of complacency regarding the expected returns from risky assets - stocks, venture capital, high-yield bonds, etc. Now this extreme complacency is coming home to roost. Less certain investors are increasingly disengaging from riskier assets. The resulting price declines are trapping traders who left themselves too little room to maneuver. The incredibly telling recent downfall of a large hedge fund illustrates the depth of this problem. Hordes of so-called sophisticated investors and institutions blindly poured money into this highly leveraged speculative scheme. Of course, we all know about the initial disastrous consequences. Amazingly, it involved some of the financial markets' most respected participants. It is a very ominous event that appears far from being resolved. There is an undeterminably large amount of unstable money in the global financial markets beyond the case of this large hedge fund. These players are being squeezed out one after another as liquidity in almost all risky asset classes contracts. This ongoing purging should keep volatility historically high with the possibility of inflicting more serious damage to the global economy than already seen. Reacting to these developments the stock market is taking on more and more of a panicked feel. There is now a strong preference for the apparently "safest" sectors such as electric utility, regional 28 MENTOR CAPITAL GROWTH PORTFOLIO MANAGERS' COMMENTARY: THE LARGE-CAPITALIZATION QUALITY GROWTH MANAGEMENT TEAM SEPTEMBER 30, 1998 - -------------------------------------------------------------------------------- telephone, large integrated energy, and domestic food stocks. These "defensive" stocks have meaningfully outperformed the broader market. Our relative performance has suffered because we have almost no exposure to these sectors, since they do not meet our requirements of above average, consistent earnings growth. This flight-to-safety is typical at this point in the cycle and its primary motivation is fear. And why not? The Asian problems are developing into a full-blown global crisis. Global financial liquidity has all but evaporated. Analysts are repeatedly slashing earnings projections. Many companies that were once considered infallible such as Coca-Cola, Disney, Gillette, and Procter & Gamble have issued earnings warnings. Imagine what could happen if individual investors start bailing out of mutual funds. And at a time when the world needs strong leadership, the political situations in several key nations are a mess. Obviously there is a lot to fear. Fear and greed are a long-term investor's best asset and worst threat. These emotions are an asset when they belong to others and a threat when they are your own. Anyone operating in the stock market should know this truism well. But the majority cannot adhere to it. It is exceedingly difficult for both individual and institutional investors to look through an emotionally charged volatile market and focus on the fundamentals. To us, fundamental analysis does not mean trying to figure out cyclical swings in the economy and markets over the next year. It means concentrating on longer-term business qualities. We know that consistently implementing a well-defined investment discipline through the ups and downs of an entire cycle is the best way to ensure long-term success. We are well aware that current conditions in the economy and stock market could worsen. You need to be too. There is no way to predict the ultimate extent of the pressures now unfolding, and we will not pretend to try. We approach our portfolio no differently today than we did a year ago. We focus on a diversified group of companies with excellent operating records and leading competitive positions. We are biased toward companies with above-average business predictability. We have thoroughly analyzed their results and prospects. We own them at prices we believe offer attractive relative values. It is a very simple approach. Not an easy one, but a straightforward one. We will at times be wrong in our analysis, but we will strive to be as objective as possible. Of course we expect to be right more often than not. We will not alter this approach just because those around us are becoming more complacent or fearful. Over the long-term cyclical swings wash out and business fundamentals prevail. November 1998 29 MENTOR CAPITAL GROWTH PORTFOLIO SEPTEMBER 30, 1998 - -------------------------------------------------------------------------------- PERFORMANCE COMPARISON Comparison of change in value of a hypothetical $10,000 investment in Mentor Capital Growth Portfolio Class A and Class B Shares and the S&P 500.~ [GRAPH] A Shares B Shares S&P 500 4/29/92 9450 10000 10000 9/30/92 9524 10061 10215 9/30/93 10306 10818 11543 9/30/94 10165 10601 11965 9/30/95 12216 12443 15521 9/30/96 15185 15532 18680 9/30/97 20467 20928 26236 9/30/98 22660 22767 28608 Average Annual Returns as of 9/30/98 Including Sales Charges 1-Year 5-Year Since Inception+++ Class A 4.34% 15.75% 13.57% Class B 5.86% 16.17% 13.84% PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE PERFORMANCE. YOUR INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO WHEN SHARES ARE REDEEMED, THEY MAY BE WORTH MORE OR LESS THAN ORIGINAL COST. MUTUAL FUNDS ARE NOT OBLIGATIONS OF OR GUARANTEED BY ANY BANK AND ARE NOT FEDERALLY INSURED. ~ The S&P 500 is adjusted to reflect reinvestment of dividends on securities in the index. The S&P 500 is not adjusted to reflect sales loads, expenses, or other fees that the SEC requires to be reflected in the Portfolio's performance. + Represents a hypothetical investment of $10,000 in Mentor Capital Growth Portfolio Class B Shares. A contingent deferred sales charge will be imposed, if applicable, on Class B Shares of rates ranging from a maximum of 4.00% of amounts redeemed during the first year following the date of purchase to 1.00% of amounts redeemed during the five-year period following the date of purchase. The value of the Class B Shares reflects a redemption fee in effect at the end of each of the stated periods. The Class B Shares' performance assumes the reinvestment of all dividends and distributions. ++ Represents a hypothetical investment of $10,000 in Mentor Capital Growth Portfolio Class A Shares, after deducting the maximum sales charge of 5.75% ($10,000 investment minus $575 sales charges = $9,425). The Class A Shares' performance assumes the reinvestment of all dividends and distributions. +++ Reflects operations of Mentor Capital Growth Portfolio Class A and Class B Shares from the date of commencement of operations on 4/29/92 through 9/30/98. Comparison of change in value of a hypothetical $10,000 investment in Mentor Capital Growth Portfolio Class Y Shares and the S&P 500.~ [GRAPH] Y Shares S&P 500 11/19/97 10000 10000 12/31/97 10300 10643 3/31/98 11835 12127 6/30/98 12285 12528 9/30/98 10895 11281 Total Returns as of 9/30/98 1-Year Since Inception++ Class Y Shares n/a 10.56% PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE PERFORMANCE. YOUR INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO WHEN SHARES ARE REDEEMED, THEY MAY BE WORTH MORE OR LESS THAN ORIGINAL COST. MUTUAL FUNDS ARE NOT OBLIGATIONS OF OR GUARANTEED BY ANY BANK AND ARE NOT FEDERALLY INSURED. ~ The S&P 500 is adjusted to reflect reinvestment of dividends on securities in the index. The S&P 500 is not adjusted to reflect sales loads, expenses, or other fees that the SEC requires to be reflected in the Portfolio's performance. + Represents a hypothetical investment of $10,000 in Mentor Capital Growth Portfolio Class Y Shares. These shares are not subject to any sales or contingent deferred sales charges. The Class Y Shares' performance assumes the reinvestment of all dividends and distributions. ++ Reflects operations of Mentor Capital Growth Portfolio Class Y from the date of issuance on 11/19/97 through 9/30/98. 30 MENTOR CAPITAL GROWTH PORTFOLIO PORTFOLIO OF INVESTMENTS SEPTEMBER 30, 1998 - --------------------------------------------------------------------------------
SHARES MARKET VALUE COMMON STOCKS - 97.19% BASIC MATERIALS - 2.72% Bemis Company, Inc. 265,400 $9,305,587 ---------- CAPITAL GOODS & CONSTRUCTION - 9.68% Emerson Electric Company 191,000 11,889,750 Illinois Tool Works 223,700 12,191,650 W.W. Grainger, Inc. 214,300 9,027,387 ---------- 33,108,787 ---------- CONSUMER CYCLICAL - 14.08% Chancellor Media Corporation * 213,000 7,108,875 Clear Channel Communications 157,750 7,493,125 Gannett, Inc. 194,000 10,391,125 Interpublic Group Companies 210,800 11,370,025 Newell Company 255,650 11,775,878 ---------- 48,139,028 ---------- CONSUMER STAPLES - 10.75% Philip Morris Companies, Inc. 260,000 11,976,250 Sherwin-Williams Company 546,600 11,820,225 Sysco Corporation 549,500 12,947,594 ---------- 36,744,069 ---------- FINANCIAL - 20.44% Ahmanson HF & Company 210,500 11,682,750 American Express Company 139,500 10,828,687 Federal National Mortgage Association 171,600 11,025,300 NationsBank Corporation 199,150 10,654,525 Norwest Corporation 346,200 12,398,288 SouthTrust Corporation 32,700 1,142,456 UNUM Corporation 244,100 12,128,719 ---------- 69,860,725 ---------- HEALTH - 14.79% Bristol-Myers Squibb Company 128,250 13,321,969 HealthSouth Corporation 1,281,000 13,530,563 Johnson & Johnson 153,600 12,019,200 Tenet Healthcare Corporation 407,000 11,701,250 ---------- 50,572,982 ---------- TECHNOLOGY - 18.41% Automatic Data Processing 162,750 12,165,563 Computer Associates International, Inc. 362,300 13,405,100 Computer Sciences Corporation 226,900 12,366,050 MCI WorldCom, Inc. 254,750 12,450,906 Sun Microsystems, Inc. * 251,850 12,545,278 ---------- 62,932,897 ----------
SHARES OR PRINCIPAL AMOUNT MARKET VALUE COMMON STOCKS (CONTINUED) TRANSPORTATION & SERVICES - 2.04% Werner Enterprises, Inc. 443,312 $ 6,982,164 ------------- MISCELLANEOUS - 4.28% Tyco International Limited 264,600 14,619,150 ------------- TOTAL COMMON STOCKS (COST $325,801,368) 332,265,389 ------------- SHORT-TERM INVESTMENT - 5.06% REPURCHASE AGREEMENT Goldman Sachs & Company Dated 9/30/98, 5.60%, due 10/01/98, collateralized by $17,523,355 Federal National Mortgage Association, 6.00%, 8/01/13, market value $17,698,589 (cost $17,301,645) $ 17,301,645 17,301,645 ------------- TOTAL INVESTMENTS (COST $343,103,013)-102.25% 349,567,034 OTHER ASSETS LESS LIABILITIES - (2.25%) (7,698,090) ------------- NET ASSETS - 100.00% $ 341,868,944 =============
* Non-income producing. INVESTMENT TRANSACTIONS Cost of purchases and proceeds from sales of securities, other than short-term securities, aggregated $411,684,003 and $263,413,957, respectively. INCOME TAX INFORMATION At September 30, 1998, the aggregated cost of investment securities for federal income tax purposes was $343,119,643. Net unrealized appreciation aggregated $6,447,391, of which $28,966,561, related to appreciated investment securities and $22,519,170, related to depreciated investment securities. SEE NOTES TO FINANCIAL STATEMENTS. 31 MENTOR CAPITAL GROWTH PORTFOLIO - -------------------------------------------------------------------------------- STATEMENT OF ASSETS AND LIABILITIES SEPTEMBER 30, 1998 ASSETS Investments, at market value (Note 2) Investment securities $332,265,389 Repurchase agreements 17,301,645 ------------ Total investments (cost $343,103,013) 349,567,034 Collateral for securities loaned (Note 2) 15,562,984 Receivables Fund shares sold 3,633,968 Dividends and interest 315,098 ------------ TOTAL ASSETS 369,079,084 ------------ LIABILITIES Payables Investments purchased $10,840,843 Securities loaned (Note 2) 15,562,984 Fund shares redeemed 755,755 Accrued expenses and other liabilities 50,558 ----------- TOTAL LIABILITIES 27,210,140 ------------ NET ASSETS $341,868,944 ============ Net Assets represented by: (Note 2) Additional paid-in capital $298,264,898 Accumulated undistributed net investment income - Accumulated net realized gain on investment transactions 37,140,025 Net unrealized appreciation of investments 6,464,021 ------------ NET ASSETS $341,868,944 ============ NET ASSET VALUE PER SHARE Class A Shares $ 22.71 Class B Shares $ 21.72 Class Y Shares $ 22.74 OFFERING PRICE PER SHARE Class A Shares $ 24.09 (a) Class B Shares $ 21.72 Class Y Shares $ 22.74 SHARES OUTSTANDING Class A Shares 6,391,508 Class B Shares 9,059,483 Class Y Shares 49
(a) Computation of offering price: 100/94.25 of net asset value. SEE NOTES TO FINANCIAL STATEMENTS. STATEMENT OF OPERATIONS YEAR ENDED SEPTEMBER 30, 1998 INVESTMENT INCOME Dividends $ 2,936,795 Interest 804,494 ------------ TOTAL INVESTMENT INCOME (NOTE 2) 3,741,289 EXPENSES Management fee (Note 4) $ 2,153,467 Distribution fee (Note 5) 1,227,717 Shareholder service fee (Note 5) 672,957 Transfer agent fee 324,574 Administration fee (Note 4) 269,183 Shareholder reports and postage expenses 57,979 Registration expenses 52,663 Custodian and accounting fees 37,488 Legal fees 8,462 Directors' fees and expenses 6,830 Audit fees 4,556 Miscellaneous 25,373 ----------- Total expenses 4,841,249 ------------ NET INVESTMENT LOSS (1,099,960) ------------ REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS Net realized gain on investments (Note 2) 45,438,253 Change in unrealized appreciation on investments (32,273,002) ----------- NET GAIN ON INVESTMENTS 13,165,251 ------------ NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $ 12,065,291 ============
SEE NOTES TO FINANCIAL STATEMENTS. 32 MENTOR CAPITAL GROWTH PORTFOLIO - -------------------------------------------------------------------------------- STATEMENTS OF CHANGES IN NET ASSETS
YEAR ENDED YEAR ENDED 9/30/98 9/30/97 NET INCREASE IN NET ASSETS Operations Net investment income (loss) $ (1,099,960) $ 55,807 Net realized gain on investments 45,438,253 14,469,617 Change in unrealized appreciation on investments (32,273,002) 24,877,344 ------------- ------------- Increase in net assets resulting from operations 12,065,291 39,402,768 ------------- ------------- DISTRIBUTIONS TO SHAREHOLDERS From net investment income Class A (29,728) - Class B (52,910) - From net realized gain on investments Class A (5,934,313) (4,657,749) Class B (10,484,517) (10,198,967) Class Y (12) - ------------- ------------- Total distributions to shareholders (16,501,480) (14,856,716) ------------- ------------- Capital Share Transactions (Note 7) Proceeds from sale of shares 220,347,637 61,493,267 Reinvested distributions 16,089,732 14,535,885 Shares redeemed (69,421,744) (21,387,389) ------------- ------------- Change in net assets resulting from capital share transactions 167,015,625 54,641,763 ------------- ------------- Increase in net assets 162,579,436 79,187,815 Net Assets Beginning of year 179,289,508 100,101,693 ------------- ------------- End of year (including accumulated undistributed net investment income of $0 and $59,668, respectively) $ 341,868,944 $ 179,289,508 ============= =============
SEE NOTES TO FINANCIAL STATEMENTS. FINANCIAL HIGHLIGHTS CLASS A SHARES
YEAR YEAR YEAR YEAR YEAR ENDED ENDED ENDED ENDED ENDED 9/30/98 9/30/97 9/30/96 9/30/95 9/30/94 PER SHARE OPERATING PERFORMANCE Net asset value, beginning of year $ 22.42 $ 19.36 $ 16.02 $ 14.88 $ 15.26 --------- --------- --------- -------- -------- Income from investment operations Net investment income (loss) (0.10) (0.02) 0.11 0.02 0.09 Net realized and unrealized gain (loss) on investments 2.34 5.87 3.73 2.91 (0.30) ---------- ---------- --------- -------- -------- Total from investment operations 2.24 5.85 3.84 2.93 (0.21) ---------- ---------- --------- -------- -------- Less distributions From net investment income (0.01) - - - (0.04) From capital gains (1.94) (2.79) (0.50) (1.79) (0.13) ---------- ---------- ---------- -------- -------- Total distributions (1.95) (2.79) (0.50) (1.79) (0.17) ---------- ---------- ---------- -------- -------- Net asset value, end of year $ 22.71 $ 22.42 $ 19.36 $ 16.02 $ 14.88 ========== ========== ========== ======== ======== TOTAL RETURN* 10.72% 34.78% 24.63% 20.18% (1.37%) RATIOS / SUPPLEMENTAL DATA Net assets, end of year (in thousands) $145,117 $ 65,703 $ 31,889 $ 29,582 $ 21,181 Ratio of expenses to average net assets 1.34% 1.41% 1.43% 1.87% 1.70% Ratio of net investment income to average net assets 0.06% 0.53% 0.51% 0.27% 0.53% Portfolio turnover rate 104% 64% 98% 157% 149% Average commission rate on portfolio transactions $ 0.0692 $ 0.0697 $ 0.0688
* Total return does not reflect sales commissions and is not annualized. SEE NOTES TO FINANCIAL STATEMENTS. 33 MENTOR CAPITAL GROWTH PORTFOLIO - -------------------------------------------------------------------------------- FINANCIAL HIGHLIGHTS CLASS B SHARES
YEAR YEAR YEAR YEAR YEAR ENDED ENDED ENDED ENDED ENDED 9/30/98 9/30/97 9/30/96 9/30/95 9/30/94 PER SHARE OPERATING PERFORMANCE Net asset value, beginning of year $ 21.68 $ 18.92 $ 15.79 $ 14.80 $ 15.23 ---------- ---------- -------- -------- -------- Income from investment operations Net investment income (loss) (0.08) - (0.04) 0.25 (0.04) Net realized and unrealized gain (loss) on investments 2.07 5.55 3.67 2.53 (0.26) ---------- ---------- --------- -------- -------- Total from investment operations 1.99 5.55 3.63 2.78 (0.30) ---------- ---------- --------- -------- -------- Less distributions From net investment income (0.01) - - - - From capital gains (1.94) (2.79) (0.50) (1.79) (0.13) ---------- ---------- --------- -------- -------- Total distributions (1.95) (2.79) (0.50) (1.79) (0.13) ---------- ---------- --------- -------- -------- Net asset value, end of year $ 21.72 $ 21.68 $ 18.92 $ 15.79 $ 14.80 ========== ========== ========= ======== ======== TOTAL RETURN* 9.86% 33.88% 23.64% 19.26% (2.00%) RATIOS / SUPPLEMENTAL DATA Net assets, end of year (in thousands) $ 196,751 $ 113,587 $ 68,213 $ 57,648 $ 41,106 Ratio of expenses to average net assets 2.09% 2.16% 2.18% 2.56% 2.46% Ratio of net investment loss to average net assets (0.70%) (0.22%) (0.24%) (0.41%) (0.22%) Portfolio turnover rate 104% 64% 98% 157% 149% Average commission rate on portfolio transactions $ 0.0692 $ 0.0697 $ 0.0688
CLASS Y SHARES
PERIOD ENDED 9/30/98 (b) PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 20.81 -------- Income from investment operations Net investment income 0.02 Net realized and unrealized gain on investments 2.16 -------- Total from investment operations 2.18 -------- Less distributions From capital gains (0.25) ---------- Net asset value, end of period $ 22.74 ========== TOTAL RETURN* 10.56% RATIOS / SUPPLEMENTAL DATA Net assets, end of period (in thousands) $ 1 Ratio of expenses to average net assets 1.09% (a) Ratio of net investment income to average net assets 0.38% (a) Portfolio turnover rate 104% Average commission rate on portfolio transactions $ 0.0692
(a) Annualized. (b) Reflects operations for the period from November 19, 1997 (initial offering of Class Y shares) to September 30, 1998. * Total return does not reflect sales commissions and is not annualized. SEE NOTES TO FINANCIAL STATEMENTS. 34 MENTOR STRATEGY PORTFOLIO MANAGERS' COMMENTARY: THE MENTOR STRATEGY TEAM SEPTEMBER 30, 1998 - -------------------------------------------------------------------------------- The Mentor Strategy Portfolio has historically been managed according to a top-down tactical asset allocation investment methodology that relies on periodic and sometimes aggressive asset allocation shifts between stocks, bonds, and cash. During the 12-month period ended September 30, 1998 there were a number of significant changes affecting the Strategy Portfolio. Don Hays, the chief investment manager of the Portfolio, announced that he would be reducing his workload and would consequently have less time available to devote to the Strategy Portfolio. While Don continued to maintain involvement in asset allocation decision making, responsibility for stock and bond selection within the Portfolio was assumed by Mentor's Large Capitalization Quality Growth Equity and Active Fixed-Income teams. At the November 12, 1998 Mentor Strategy Portfolio Shareholders Meeting a Plan of Reorganization was adopted by shareholders vote under which the Mentor Strategy Portfolio was merged into the Mentor Balanced Portfolio. The Mentor Balanced Portfolio is a mutual fund managed by the same Mentor Large Capitalization Quality Growth Equity and Active Fixed-Income teams that currently manage the Strategy Portfolio. The Mentor Balanced Portfolio employs the same stock and bond selection criteria currently used in the Strategy Portfolio. It does, however, maintain relatively stable asset allocation blends rather than employ significant tactical allocation shifts among asset classes. MARKET OVERVIEW The first three quarters of the fiscal year ended September 30, 1998 culminated an unprecedented trend of 14 consecutive quarterly gains for the S&P 500. The July-September period, however, saw a dramatic departure from this trend, with the S&P 500 declining 10%. Despite poor equity returns, U.S. government fixed-income markets were extremely strong. In fact the July-September period marked one of the few times in recent years that bonds significantly outperformed stocks. However, the broad rally in treasury bonds was not shared by more credit-sensitive fixed-income sectors, as investors aggressively shifted assets into low risk instruments only. EQUITY REVIEW AND OUTLOOK For some time we have been emphatically cautioning that the stock market would have to adjust to considerably lower corporate earnings prospects, and this transition would likely result in increased volatility and lower returns than experienced over the past several years. Finally this scenario is unfolding in full force. Earnings estimates for a broad range of companies are being sharply reduced. It is now quite possible, in fact likely in our opinion, that the earnings of the S&P 500 will decline in the second half of this year and in 1999. These trends present a significant change from the strong, better-than-expected earnings growth that has been a key pillar supporting the bull market since 1990, one of the best on record by almost any measure. But this change was inevitable. It is part of the natural cyclical patterns of the economy, corporate profitability, and the stock market. After nearly perfect growth conditions during much of the 1990's, corporate profitability is coming under pressure as global excess capacity is chasing falling demand. And as should be expected at this point, lenders are sharply curtailing credit and thereby reinforcing these developing pressures. 35 MENTOR STRATEGY PORTFOLIO MANAGERS' COMMENTARY: THE MENTOR STRATEGY TEAM SEPTEMBER 30, 1998 - -------------------------------------------------------------------------------- Fear and greed are a long-term investor's best asset and worst threat. It is exceedingly difficult for both individual and institutional investors to look through an emotionally charged volatile market and focus on the fundamentals. To us, fundamental analysis does not mean trying to figure out cyclical swings in the economy and markets over the next year. It means concentrating on longer-term business qualities. We know that consistently implementing a well-defined investment discipline through the ups and downs of an entire cycle is the best way to ensure long-term success. We focus on a diversified group of companies with excellent operating records and leading competitive positions. We are biased toward companies with above-average business predictability. We have thoroughly analyzed their results and prospects. We own them at prices we believe offer attractive relative values. It is a very simple approach. Not an easy one, but a straightforward one. We will at times be wrong in our analysis, but we will strive to be as objective as possible. Of course we expect to be right more often than not. We will not alter this approach just because those around us are becoming more complacent or fearful. Over the long-term cyclical swings wash out and business fundamentals prevail. FIXED INCOME REVIEW AND OUTLOOK On the fixed-income side, our short-term strategy in this tumultuous environment has been to tilt portfolio durations somewhat long relative to our benchmarks, as well as more heavily weight sector allocations toward treasury securities. Given our long-term confidence in the U.S. economy we are waiting for an opportunity to aggressively move into domestic spread sectors. Prior to such a move, we will have to be convinced that these markets have stabilized. In our opinion such stabilization will require the Fed to continue to move forcefully to further ease credit conditions. The primary risk we see to our outlook is timing. The U.S. economy has tremendous forward momentum and the current yield curve is already pricing in an aggressive Fed ease. Should events unfold more slowly than the market hopes, the bond market could encounter some short-term turbulence. We would view these sell-offs as short term in nature and would utilize the higher yield levels to extend our duration further. CURRENT PORTFOLIO POSITIONING At year end the asset allocation mix in the Mentor Strategy Portfolio was 52% stocks, 42% bonds, and 6% cash. This compares to 62% stocks, 23% bonds, and 15% cash on September 30, 1997. This time a year ago the equity holdings were largely small capitalization whereas today they are large capitalization growth companies. The fixed-income portfolio today targets the Lehman Brothers Aggregate Bond Index as its benchmark. This is a more conservative posture than the fixed-income investments at the beginning of the fiscal year which were primarily in long-term, and hence more volatile, treasury securities. We believe that each of these changes positions us appropriately for what we anticipate to be continued market volatility in the months ahead. November 1998 36 MENTOR STRATEGY PORTFOLIO SEPTEMBER 30, 1998 - -------------------------------------------------------------------------------- PERFORMANCE COMPARISON Comparison of change of value of hypothetical $10,000 investment in Mentor Strategy Portfolio Class A Shares and the S&P 500.~ [GRAPH] Class A S&P 500 6/5/95 9425 10000 9/30/95 10554 10890 9/30/96 12747 13291 9/30/97 14273 18668 9/30/98 14318 20356 Average Annual Returns as of 9/30/98 Including Sales Charges 1-Year Since Inception** Class A (5.47%) 11.41% PAST PERFORMANCE DOES NOT GUARANTEE FUTURE COMPARABLE RESULTS. INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO THAT AN INVESTOR'S SHARES, WHEN REDEEMED, MAY BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST. PERFORMANCE FIGURES REPRESENT CHANGE IN INVESTMENT VALUE AFTER REINVESTING ALL DISTRIBUTIONS. ~ The S&P 500 is adjusted to reflect reinvestment of dividends on securities in the index. The S&P 500 is not adjusted to reflect sales loads, expenses or other fees that the SEC requires to be reflected in the Portfolio's performance. * Represents a hypothetical investment of $10,000 in Mentor Strategy Portfolio Class A Shares, after deducting the maximum sales charge of 5.75% ($10,000 investment minus $575 sales charges = $9,425). The Class A Shares' performance assumes the reinvestment of all dividends and distributions. ** Reflects operations of Mentor Strategy Portfolio Class A from the date of issuance on 6/5/95 through 9/30/98. Comparison of change of value of hypothetical $10,000 investment in Mentor Strategy Portfolio Class B Shares and the S&P 500.~ [GRAPH] Class B S&P 500 10/29/93 10000 10000 12/31/94 9798 10157 9/30/95 12175 13180 9/30/96 14125 15860 9/30/97 15838 22275 9/30/98 15864 24290 Average Annual Returns as of 9/30/98 Including Sales Charges 1-Year Since Inception+ Class B (3.74%) 9.81% PAST PERFORMANCE DOES NOT GUARANTEE FUTURE COMPARABLE RESULTS. INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO THAT AN INVESTOR'S SHARES, WHEN REDEEMED, MAY BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST. PERFORMANCE FIGURES REPRESENT CHANGE IN INVESTMENT VALUE AFTER REINVESTING ALL DISTRIBUTIONS. *** Represents a hypothetical investment of $10,000 in Mentor Strategy Portfolio Class B Shares. A contingent deferred sales charge will be imposed, if applicable, on Class B shares at rates ranging from a maximum of 4.00% of amounts redeemed during the first year following the date of purchase to 1.00% of amounts redeemed during the five-year period following the date of purchase. The value of the Class B Shares reflects a redemption fee in effect at the end of each of the stated periods. The Class B Shares' performance assumes the reinvestment of all dividends and distributions. + Reflects operations of Mentor Strategy Portfolio Class B from the date of commencement of operations on 10/29/93 through 9/30/98. 37 MENTOR STRATEGY PORTFOLIO SEPTEMBER 30, 1998 - -------------------------------------------------------------------------------- PERFORMANCE COMPARISON Comparison of change of value of hypothetical $10,000 investment in Mentor Strategy Portfolio Class Y Shares and the S&P 500.~ [GRAPH] Class Y S&P 500 11/19/97 10000 10000 12/31/97 10060 10760 3/31/98 10707 12249 6/30/98 11027 12394 9/30/98 10294 11281 Total Returns as of 9/30/98 1-Year Since Inception** Class Y n/a 2.87% PAST PERFORMANCE DOES NOT GUARANTEE FUTURE COMPARABLE RESULTS. INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO THAT AN INVESTOR'S SHARES, WHEN REDEEMED, MAY BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST. PERFORMANCE FIGURES REPRESENT CHANGE IN INVESTMENT VALUE AFTER REINVESTING ALL DISTRIBUTIONS. ~ The S&P 500 is adjusted to reflect reinvestment of dividends on securities in the index. The S&P 500 is not adjusted to reflect sales loads, expenses or other fees that the SEC requires to be reflected in the Portfolio's performance. * Represents a hypothetical investment of $10,000 in Mentor Strategy Portfolio Class Y Shares. These shares are not subject to any sales or contingent deferred sales charges. The Class Y Shares' performance assumes the reinvestment of all dividends and distributions. ** Reflects operations of Mentor Strategy Portfolio Class Y from the date of issuance on 11/19/97 through 9/30/98. 38 MENTOR STRATEGY PORTFOLIO PORTFOLIO OF INVESTMENTS SEPTEMBER 30, 1998 - --------------------------------------------------------------------------------
SHARES MARKET VALUE COMMON STOCKS - 52.08% CAPITAL GOODS & CONSTRUCTION - 5.59% Emerson Electric Company 75,100 $ 4,674,975 Illinois Tool Works 78,000 4,251,000 W.W. Grainger, Inc. 86,900 3,660,662 ------------ 12,586,637 ------------ COMMERCIAL SERVICES - 0.88% Omnicom Group 43,800 1,971,000 ------------ CONSUMER CYCLICAL - 8.43% Chancellor Media Corporation * 47,000 1,568,625 Clear Channel Communications 41,600 1,976,000 Gannett, Inc. 42,600 2,281,763 General Motors Corporation 19,100 1,044,531 Interpublic Group Company 54,600 2,944,987 Newell Company 90,200 4,154,837 Time Warner 25,800 2,259,113 Tribune Company 35,300 1,776,031 Walt Disney Company 39,000 987,188 ------------ 18,993,075 ------------ CONSUMER STAPLES - 4.38% Philip Morris Companies, Inc. 61,400 2,828,238 Sherwin-Williams Company 133,200 2,880,450 Sysco Corporation 176,000 4,147,000 ------------ 9,855,688 ------------ ENERGY - 0.43% Williams Companies 33,500 963,125 ------------ FINANCIAL - 11.48% Ahmanson HF & Company 25,500 1,415,250 Charter One Financial, Inc. 97,873 2,410,113 Dime Bancorp, Inc. 61,700 1,561,781 M & T Bank Corporation 2,901 1,337,361 Marsh & McLennan Companies, Inc. 14,700 731,325 North Fork Bancorp 111,750 2,235,000 Northern Trust Corporation 35,200 2,402,400 Old Republic International Corporation 92,550 2,082,375 Price (T. Rowe) & Associates, Inc. 70,000 2,056,250 Torchmark Corporation 52,000 1,868,750 Travelers Group, Inc. 45,300 1,698,750 UNUM Corporation 77,000 3,825,937 U S Bancorp 62,700 2,229,769 ------------ 25,855,061 ------------ HEALTH - 6.81% Bristol-Myers Squibb Company 37,600 3,905,700 HealthSouth Corporation * 188,700 1,993,144 Johnson & Johnson 62,600 4,898,450 Tenet Healthcare Corporation 158,000 4,542,500 ------------ 15,339,794 ------------
SHARES OR PRINCIPAL AMOUNT MARKET VALUE COMMON STOCKS (CONTINUED) RETAIL - 1.27% Safeway, Inc. * 61,600 $ 2,856,700 ------------ TECHNOLOGY - 10.42% Automatic Data Processing 60,100 4,492,475 Computer Associates International, Inc. 22,600 836,200 Computer Sciences Corporation 69,500 3,787,750 GTE Corporation 31,400 1,727,000 MCI WorldCom, Inc. 90,000 4,398,750 Sprint Corporation 23,900 1,720,800 Sun Microsystems, Inc. * 103,500 5,155,594 U S West, Inc. 25,905 1,358,393 ------------ 23,476,962 ------------ TRANSPORTATION - 0.70% Werner Enterprises, Inc. 100,000 1,575,000 ------------ MISCELLANEOUS - 1.69% Tyco International Limited 69,100 3,817,775 ------------ TOTAL COMMON STOCKS (COST $119,416,670) 117,290,817 ------------ U.S. GOVERNMENT SECURITIES - 41.72% U.S. Treasury Bond, 5.50%, 1/31/03 (a) $12,000,000 12,531,120 U.S. Treasury Bond, 6.50%, 11/15/26 68,323,000 81,437,600 ------------ TOTAL U.S. GOVERNMENT SECURITIES (COST $78,253,007) 93,968,720 ------------ 211,259,537 ------------ SHORT-TERM INVESTMENT - 6.03% REPURCHASE AGREEMENT Goldman Sachs & Company Dated 9/30/98, 5.60%, due 10/01/98, collateralized by $13,769,132 Federal National Mortgage Association, 6.00%, 8/01/13, market value $13,906,823, (cost $13,594,355) 13,594,355 13,594,355 ------------ TOTAL INVESTMENTS (COST $211,264,032)-99.83% 224,853,892 OTHER ASSETS LESS LIABILITIES - 0.17% 379,555 ------------ NET ASSETS - 100.00% $225,233,447 ============
* Non-income producing. (a) A portion of this security is pledged as collateral for open futures contracts. 39 MENTOR STRATEGY PORTFOLIO PORTFOLIO OF INVESTMENTS SEPTEMBER 30, 1998 - -------------------------------------------------------------------------------- INVESTMENT TRANSACTIONS Cost of purchases and proceeds from sales of securities, other than short-term securities, aggregated $196,774,571 and $286,670,918, respectively. INCOME TAX INFORMATION At September 30, 1998, the aggregated cost of investment securities for federal income tax purposes was $211,280,993. Net unrealized appreciation aggregated $13,572,899, of which $25,354,232, related to appreciated investment securities and $11,781,333, related to depreciated investment securities. SEE NOTES TO FINANCIAL STATEMENTS. 40 MENTOR STRATEGY PORTFOLIO - -------------------------------------------------------------------------------- STATEMENT OF ASSETS AND LIABILITIES SEPTEMBER 30, 1998 ASSETS Investments, at market value (Note 2) Investment securities $ 211,259,537 Repurchase agreements 13,594,355 ------------- Total investments (cost $211,264,032) 224,853,892 Collateral for securities loaned (Note 2) 60,165,776 Receivables Fund shares sold 61,401 Dividends and interest 1,908,750 Deferred expenses (Note 2) 5,034 ------------- TOTAL ASSETS 286,994,853 ------------- LIABILITIES Payables Securities loaned (Note 2) $ 60,165,776 Fund shares redeemed 502,685 Variation margin 1,032,188 Accrued expenses and other liabilities 60,757 ------------ TOTAL LIABILITIES 61,761,406 ------------- NET ASSETS $ 225,233,447 ============= Net Assets represented by: (Note 2) Additional paid-in capital $ 192,886,301 Accumulated undistributed net investment income 2,163,583 Accumulated net realized gain on investment transactions 20,465,541 Net unrealized appreciation of investments and open futures contracts 9,718,022 ------------- NET ASSETS $ 225,233,447 ============= NET ASSET VALUE PER SHARE Class A Shares $ 15.41 Class B Shares $ 14.97 Class Y Shares $ 15.43 OFFERING PRICE PER SHARE Class A Shares $ 16.35(a) Class B Shares $ 14.97 Class Y Shares $ 15.43 SHARES OUTSTANDING Class A Shares 1,602,162 Class B Shares 13,393,973 Class Y Shares 67
(a) Computation of offering price: 100/94.25 of net asset value. SEE NOTES TO FINANCIAL STATEMENTS. STATEMENT OF OPERATIONS YEAR ENDED SEPTEMBER 30, 1998 INVESTMENT INCOME Dividends (b) $ 1,264,309 Interest 7,295,963 ----------- TOTAL INVESTMENT INCOME (NOTE 2) 8,560,272 EXPENSES Management fee (Note 4) $ 2,420,122 Distribution fee (Note 5) 1,875,172 Shareholder service fee (Note 5) 711,799 Transfer agent fee 375,675 Administration fee (Note 4) 284,720 Shareholder reports and postage expenses 67,926 Custodian and accounting fees 64,615 Registration expenses 47,295 Organizational expenses 20,152 Legal fees 10,523 Directors' fees and expenses 8,296 Audit fees 5,661 Miscellaneous 29,147 ----------- Total expenses 5,921,103 ----------- NET INVESTMENT INCOME 2,639,169 ----------- REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS Net realized gain on investments (Note 2) 24,557,938 Change in unrealized appreciation on investments and futures contracts (26,287,481) ----------- NET LOSS ON INVESTMENTS (1,729,543) ----------- NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $ 909,626 ===========
(b) Net of foreign withholding taxes of $8,800. SEE NOTES TO FINANCIAL STATEMENTS. 41 MENTOR STRATEGY PORTFOLIO - -------------------------------------------------------------------------------- STATEMENTS OF CHANGES IN NET ASSETS
YEAR ENDED YEAR ENDED 9/30/98 9/30/97 NET INCREASE (DECREASE) IN NET ASSETS Operations Net investment income $ 2,639,169 $ 5,345,384 Net realized gain on investments 24,557,938 54,534,179 Change in unrealized appreciation on investments and futures contracts (26,287,481) (24,297,952) -------------- ------------- Increase in net assets resulting from operations 909,626 35,581,611 -------------- ------------- Distributions to Shareholders From net investment income Class A (617,602) - Class B (4,725,533) - From net realized gain on investments Class A (6,308,309) (1,531,137) Class B (48,272,257) (21,767,428) -------------- ------------- Total distributions to shareholders (59,923,701) (23,298,565) -------------- ------------- Capital Share Transactions (Note 7) Proceeds from sale of shares 16,612,646 71,646,650 Reinvested distributions 58,353,501 22,750,654 Shares redeemed (133,155,402) (73,109,779) -------------- ------------- Change in net assets resulting from capital share transactions (58,189,255) 21,287,525 -------------- ------------- Increase (decrease) in net assets (117,203,330) 33,570,571 Net Assets Beginning of year 342,436,777 308,866,206 -------------- ------------- End of year (including accumulated undistributed net investment income of $2,163,583 and $5,365,536, respectively) $ 225,233,447 $ 342,436,777 ============== =============
SEE NOTES TO FINANCIAL STATEMENTS. FINANCIAL HIGHLIGHTS CLASS A SHARES
YEAR ENDED YEAR ENDED YEAR ENDED PERIOD ENDED 9/30/98 9/30/97 9/30/96 9/30/95 (B) PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 18.61 $ 17.96 $ 15.24 $ 13.45 --------- --------- --------- ---------- Income from investment operations Net investment income 0.40 0.31 0.08 - Net realized and unrealized gain (loss) on investments (0.35) 1.68 2.86 1.79 ---------- --------- --------- ----------- Total from investment operations 0.05 1.99 2.94 1.79 ---------- --------- --------- ----------- Less distributions From net investment income (0.29) - - - From capital gains (2.96) (1.34) (0.22) - ---------- ---------- ---------- ----------- Total distributions (3.25) (1.34) (0.22) - ---------- ---------- ---------- ----------- Net asset value, end of period $ 15.41 $ 18.61 $ 17.96 $ 15.24 ========== ========== ========== =========== TOTAL RETURN* 0.32% 11.97% 19.36% 13.31% RATIOS / SUPPLEMENTAL DATA Net assets, end of period (in thousands) $ 24,685 $ 40,552 $ 20,372 $ 10,503 Ratio of expenses to average net assets 1.42% 1.45% 1.42% 1.65% (a) Ratio of net investment income (loss) to average net assets 1.59% 2.29% 0.62% (0.06%)(a) Portfolio turnover rate 77% 192% 125% 122% Average commission rate on portfolio transactions $ 0.0708 $ 0.0644 $ 0.0669
(a) Annualized. (b) For the period from June 5, 1995 (initial offering of Class A Shares) to September 30, 1995. * Total return does not reflect sales commissions and is not annualized. SEE NOTES TO FINANCIAL STATEMENTS. 42 MENTOR STRATEGY PORTFOLIO - -------------------------------------------------------------------------------- FINANCIAL HIGHLIGHTS CLASS B SHARES
YEAR ENDED YEAR ENDED YEAR ENDED 9/30/98 9/30/97 9/30/96 PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 18.29 $ 17.79 $ 15.21 -------- --------- ---------- Income from investment operations Net investment income (loss) 0.16 0.26 (0.03) Net realized and unrealized gain (loss) on investments (0.23) 1.58 2.83 --------- --------- ---------- Total from investment operations (0.07) 1.84 2.80 --------- --------- ---------- Less distributions From net investment income (0.29) - - From capital gains (2.96) (1.34) (0.22) --------- ---------- ---------- Total distributions (3.25) (1.34) (0.22) --------- ---------- ---------- Net asset value, end of period $ 14.97 $ 18.29 $ 17.79 ========= ========== ========== TOTAL RETURN* (0.46%) 11.19% 18.48% RATIOS / SUPPLEMENTAL DATA Net assets, end of period (in thousands) $ 200,547 $ 301,885 $ 288,494 Ratio of expenses to average net assets 2.17% 2.20% 2.19% Ratio of net investment income (loss) to average net assets 0.84% 1.54% (0.19%) Portfolio turnover rate 77% 192% 125% Average commission rate on portfolio transactions $ 0.0708 $ 0.0644 $ 0.0669 PERIOD PERIOD ENDED YEAR ENDED ENDED 9/30/95 (c) 12/31/94 12/31/93 (d) PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 12.24 $ 12.70 $ 12.50 ---------- -------- --------- Income from investment operations Net investment income (loss) - ( 0.06) - Net realized and unrealized gain (loss) on investments 2.97 ( 0.40) 0.20 ---------- -------- --------- Total from investment operations 2.97 ( 0.46) 0.20 ---------- -------- --------- Less distributions From net investment income - - - From capital gains - - - ---------- -------- --------- Total distributions - - - ---------- -------- --------- Net asset value, end of period $ 15.21 $ 12.24 $ 12.70 ========== ======== ========= TOTAL RETURN* 24.26% (3.61%) 1.60% RATIOS / SUPPLEMENTAL DATA Net assets, end of period (in thousands) $ 224,643 $179,274 $ 122,177 Ratio of expenses to average net assets 2.31%(a) 2.19% 2.06%(a) Ratio of net investment income (loss) to average net assets 0.02%(a) (0.54%) 0.08%(a) Portfolio turnover rate 122% 143% 0% Average commission rate on portfolio transactions
CLASS Y SHARES
PERIOD ENDED 9/30/98 (e) PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 15.01 -------- Income from investment operations Net investment income 0.25 Net realized and unrealized gain on investments 0.18 -------- Total from investment operations 0.43 -------- Less distributions From capital gains (0.01) ---------- Net asset value, end of period $ 15.43 ========== TOTAL RETURN* 2.87% RATIOS / SUPPLEMENTAL DATA Net assets, end of period (in thousands) $ 1 Ratio of expenses to average net assets 1.17% (a) Ratio of net investment income to average net assets 2.18% (a) Portfolio turnover rate 77% Average commission rate on portfolio transactions $ 0.0708
(a) Annualized. (c) For the period from January 1, 1995 to September 30, 1995. (d) For the period from October 29, 1993 (commencement of operations) to December 31, 1993. (e) For the period from November 19, 1997 (initial offering of Class Y Shares) to September 30, 1998. * Total return does not reflect sales commissions and is not annualized. SEE NOTES TO FINANCIAL STATEMENTS. 43 MENTOR INCOME AND GROWTH PORTFOLIO MANAGERS' COMMENTARY: THE INCOME AND GROWTH MANAGEMENT TEAM SEPTEMBER 30, 1998 - -------------------------------------------------------------------------------- REVIEW OF MARKETS Investors who had come to expect double-digit positive returns were brought back to earth over the last 12 months -- and most especially in the quarter just ended. The S&P 500 rose 9% in the 12 month period ending September 30, 1998, but that positive return masks two factors: the pain inflicted by a (9.9%) result in the third calendar quarter and the performance dominance of the largest stocks in that index. Over the year, we have experienced a significant disparity throughout sectors of the market: large-capitalization growth stocks rose 11.1%, while their large-cap. value brethren returned a meager 3.6%. In marked contrast, small stocks returned (19%) during the past 12 months. Bond investors, on the other hand, were well rewarded during the period, due in large part to stunning declines in longer-term yields. For the period the Lehman Brothers Aggregate Index returned 11.5%. PORTFOLIO PERFORMANCE For the 12 month period ended September 30, 1998, the Mentor Income and Growth Portfolio returned 5.81% for the A shares and 5.01% for the B shares, exclusive of sales charges, compared to 3.26% for the Lipper Balanced Average. The Portfolio's performance over all relevant time periods places it in the first or second quartile of its competitive peer group as ranked by Lipper Analytical Services. MARKET OUTLOOK Perhaps the most important question at present is whether the U.S. economy will continue to grow, or if the economic problems in many of the emerging markets and Japan will result in a domestic recession. We believe the odds still favor expansion. Importantly, the Federal Reserve has taken note of world events and very low levels of domestic inflation and has chosen to ease monetary policy. Given the benign rate of inflation, there is plenty of room for the Fed to lower rates further. Also, with the Federal government running a large budget surplus, there is some room to adopt a more stimulative fiscal policy. Finally, the consumer normally leads the economy either into or out of a recession, and at present, the fundamentals for consumer spending remain quite healthy. Nevertheless, the risk of a recession is certainly higher than it was at any time in the last twelve months. Declines in exports and corporate profit pressures could lead to layoffs, and significantly impinge on consumer confidence and spending plans. PORTFOLIO STRATEGY As of September 30, 1998, the Portfolio's asset allocation was 59% equity, 41% bonds and 0% cash. Our concerns about equity valuations, and consequently, our underweighting of stocks in the Portfolio, proved painful for most of the last 12 months, but provided "shelter from the storm" for shareholders in the quarter just ended. We are considering increasing the Portfolio's equity weighting slightly over the next several months due to attractive buying opportunities in a number of stocks. EQUITY STRATEGY The market correction we have experienced is painful, but holds a silver lining. We are beginning to see a growing list of stocks selling at valuation levels that would have attracted our attention anytime in the last 10 years. These valuations become even more attractive in light of the lowest levels of inflation and interest rates since the first half of the 1960's. In the present environment, we 44 MENTOR INCOME AND GROWTH PORTFOLIO MANAGERS' COMMENTARY: THE INCOME AND GROWTH MANAGEMENT TEAM SEPTEMBER 30, 1998 - -------------------------------------------------------------------------------- will be focusing on attractively valued stocks of companies that have strong industry positions, healthy cash flows, and sound balance sheets. We will prefer, but not limit ourselves to, companies with a below-average exposure to foreign markets. FIXED INCOME STRATEGY The 30-year Treasury bond is rapidly achieving the lowest yield levels since the government began issuing these securities in 1977. Short- and intermediate-term yields have not fallen to their 1993 lows, but are getting close. There is little question that the Treasury market is assuming a substantially weaker U.S. economy and a period of monetary ease from the Federal Reserve. In our view, both of these are likely to come to pass. Based upon this outlook, we are retaining a portfolio duration longer than benchmark, because we believe that interest rates can fall modestly from current levels, although long-term rates are unlikely to fall much from here. During the prior year, we have gradually increased the Portfolio's modest exposure to corporate bonds and have been noticeably underweight in mortgage-backed securities. We anticipate adding to our holdings of high quality non-Treasury sectors over the coming months. November 1998 45 MENTOR INCOME AND GROWTH PORTFOLIO SEPTEMBER 30, 1998 - -------------------------------------------------------------------------------- PERFORMANCE COMPARISON Comparison of change in value of a hypothetical $10,000 investment in Mentor Income and Growth Portfolio Class A and Class B Shares, the S&P 500 and the Lehman Brothers Aggregate Bond Index.+ [GRAPH] Class Class A Shares B Shares LAGG/S&P 500 5/24/93 9425 10133 10000 9/30/93 9909 10506 10353 9/30/94 10578 11239 10446 9/30/95 12402 12614 12879 9/30/96 14802 15140 14686 9/30/97 18076 18499 18723 9/30/98 19126 19302 20692 Average Annual Returns as of 9/30/98 Including Sales Charges 1-Year 5-Year Since Inception++ Class A (0.29%) 12.62% 12.84% Class B 1.22% 12.67% 14.70% PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE PERFORMANCE. YOUR INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO WHEN SHARES ARE REDEEMED, THEY MAY BE WORTH MORE OR LESS THAN ORIGINAL COST. MUTUAL FUNDS ARE NOT OBLIGATIONS OF OR GUARANTEED BY ANY BANK AND ARE NOT FEDERALLY INSURED. ** Represents a hypothetical investment of $10,000 in Mentor Income and Growth Portfolio Class B Shares. A contingent deferred sales charge will be imposed, if applicable, on Class B shares at rates ranging from a maximum of 4.00% of amounts redeemed during the first year following the date of purchase to 1.00% of amounts redeemed during the five-year period following the date of purchase. The value of the Class B Shares reflects a redemption fee in effect at the end of each of the stated periods. The Class B Shares' performance assumes the reinvestment of all dividends and distributions. *** Represents a hypothetical investment of $10,000 in Mentor Income and Growth Portfolio Class A Shares, after deducting the maximum sales charge of 5.75% ($10,000 investment minus $575 sales charges = $9,425). The Class A Shares' performance assumes the reinvestment of all dividends and distributions. + The Standard & Poor's Index (S&P 500) is an unmanaged, market-value-weighted index of 500 widely held domestic common stocks. An unmanaged index does not reflect expenses and may not correspond to the performance of a managed portfolio in which expenses are incurred. The Lehman Brothers Aggregate Index is made up of the Government/Corporate Index, the Mortgage-Backed Securities Index, and the Asset-Backed Securities Index. The Lehman Brothers Aggregate Bond Index and S&P 500 are adjusted to reflect reinvestment of interest and dividends on securities in the indexes. The Lehman Brothers Aggregate Bond Index and S&P 500 are not adjusted to reflect sales loads, expenses, or other fees that the SEC requires to be reflected in the Portfolio's performance. This index represents an asset allocation of 60% S&P 500 stocks and 40% Lehman Brothers Aggregate Bond Index. ++ Reflects operations of Mentor Income and Growth Portfolio Class A and Class B Shares from the date of commencement of operations on 5/24/93 through 9/30/98. 46 MENTOR INCOME AND GROWTH PORTFOLIO SEPTEMBER 30, 1998 - -------------------------------------------------------------------------------- PERFORMANCE COMPARISON Comparison of change in value of a hypothetical $10,000 investment in Mentor Income and Growth Portfolio Class Y Shares, the S&P 500 and the Lehman Brothers Aggregate Bond Index.+ [GRAPH] Class Y Shares LAGG/S&P 500 11/19/97 10000 10000 12/31/97 10217 10435 3/31/98 10860 11374 6/30/98 10796 11706 9/30/98 10660 11211 Total Returns as of 9/30/98 1-Year Since Inception++ Class Y n/a 7.29% PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE PERFORMANCE. YOUR INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO WHEN SHARES ARE REDEEMED, THEY MAY BE WORTH MORE OR LESS THAN ORIGINAL COST. MUTUAL FUNDS ARE NOT OBLIGATIONS OF OR GUARANTEED BY ANY BANK AND ARE NOT FEDERALLY INSURED. *** Represents a hypothetical investment of $10,000 in Mentor Income and Growth Portfolio Class Y Shares. These shares are not subject to any sales or contingent deferred sales charges. The Class Y Shares' performance assumes the reinvestment of all dividends and distributions. + The Standard & Poor's Index (S&P 500) is an unmanaged, market-value-weighted index of 500 widely held domestic common stocks. An unmanaged index does not reflect expenses and may not correspond to the performance of a managed portfolio in which expenses are incurred. The Lehman Brothers Aggregate Index is made up of the Government/Corporate Index, the Mortgage-Backed Securities Index, and the Asset-Backed Securities Index. The Lehman Brothers Aggregate Bond Index and S&P 500 are adjusted to reflect reinvestment of interest and dividends on securities in the indexes. The Lehman Brothers Aggregate Bond Index and S&P 500 are not adjusted to reflect sales loads, expenses, or other fees that the SEC requires to be reflected in the Portfolio's performance. This index represents an asset allocation of 60% S&P 500 stocks and 40% Lehman Brothers Aggregate Bond Index. ++ Reflects operations of Mentor Income and Growth Portfolio Class Y Shares from the date of issuance on 11/19/97 through 9/30/98. 47 MENTOR INCOME AND GROWTH PORTFOLIO PORTFOLIO OF INVESTMENTS SEPTEMBER 30, 1998 - --------------------------------------------------------------------------------
SHARES MARKET VALUE COMMON STOCKS - 58.78% BASIC MATERIALS - 4.46% AlliedSignal, Inc. 92,300 $ 3,265,113 Aluminum Company of America 24,000 1,704,000 British Steel PLC~ 137,000 2,491,687 Westvaco Corporation 68,300 1,639,200 Willamette Industries, Inc. 60,000 1,721,250 ----------- 10,821,250 ----------- CAPITAL GOODS & CONSTRUCTION - 4.46% Caterpillar, Inc. 50,000 2,228,125 Cooper Industries, Inc. 47,500 1,935,625 Cooper Tire & Rubber 125,000 2,250,000 Hubbell, Inc. 65,000 2,307,500 Thomas & Betts Corporation 55,000 2,093,438 ----------- 10,814,688 ----------- COMMERCIAL SERVICES - 3.17% Foster Wheeler Corporation 111,200 1,529,000 Supervalu, Inc. 91,300 2,128,431 Wallace Computer Services, Inc. 225,300 4,041,319 ----------- 7,698,750 ----------- CONSUMER CYCLICAL - 3.99% American Stores Company 58,900 1,895,844 Ford Motor Company 75,500 3,543,781 Maytag Corporation 28,900 1,379,975 Sears Roebuck & Company 65,000 2,872,188 ----------- 9,691,788 ----------- CONSUMER STAPLES - 7.94% American Home Products Corporation 53,200 2,786,350 Baxter International, Inc. 62,000 3,689,000 Dimon Incorporated 280,000 2,957,500 Hormel Foods Corporation 136,400 3,691,325 Kimberly-Clark Corporation 72,000 2,916,000 Philip Morris Companies, Inc. 70,000 3,224,375 ----------- 19,264,550 ----------- ENERGY - 6.52% Amoco Corporation 23,200 1,249,900 Baker Hughes, Inc. 89,800 1,880,187 Chevron Corporation 26,400 2,219,250 Phillips Petroleum Company 22,000 992,750 Repsol SA~ 50,000 2,109,375 Total SA~ 37,700 2,368,031 Unocal Corporation 65,800 2,385,250 USX-Marathon Group, Inc. 74,000 2,622,375 ----------- 15,827,118 -----------
SHARES MARKET VALUE COMMON STOCKS (CONTINUED) FINANCIAL - 10.96% Ace Limited 73,700 $ 2,211,000 Citicorp 36,600 3,401,513 Federal National Mortgage Association 78,600 5,050,050 First Union Corporation (b) 43,200 2,211,300 Jefferson-Pilot Corporation 33,750 2,041,875 Spieker Properties, Inc. 65,000 2,388,750 US Bancorp 99,000 3,520,687 Wachovia Corporation 39,000 3,324,750 Wilmington Trust Corporation 46,900 2,438,800 ----------- 26,588,725 ----------- HEALTH - 4.61% Abbott Laboratories 43,900 1,906,906 Columbia HCA Healthcare Corporation 150,000 3,009,375 Johnson & Johnson 41,000 3,208,250 Pharmacia & UpJohn 61,000 3,061,438 ----------- 11,185,969 ----------- TECHNOLOGY - 4.63% Amp, Inc. 45,700 1,633,775 International Business Machines Corporation 32,700 4,185,600 Lockheed Martin Corporation 21,700 2,187,631 Xerox Corporation 38,000 3,220,500 ----------- 11,227,506 ----------- TRANSPORTATION & SERVICES - 1.58% KLM Royal Dutch Air * 43,428 1,074,826 Union Pacific Corporation 65,000 2,770,625 ----------- 3,845,451 ----------- UTILITIES - 6.46% Bell Atlantic Corporation 78,900 3,821,719 BellSouth Corporation 33,000 2,483,250 DPL, Inc. 95,000 1,864,375 DQE, Inc. 43,000 1,660,875 Pinnacle West Capital 41,700 1,868,681 SBC Communications, Inc. 89,200 3,963,825 ----------- 15,662,725 ----------- TOTAL COMMON STOCKS (COST $137,623,841) 142,628,520 -----------
48 MENTOR INCOME AND GROWTH PORTFOLIO PORTFOLIO OF INVESTMENTS SEPTEMBER 30, 1998 - --------------------------------------------------------------------------------
PRINCIPAL AMOUNT MARKET VALUE CORPORATE BONDS - 13.43% INDUSTRIAL - 6.03% Aluminum Company of America, 5.75%, 2/01/01 $ 250,000 $ 254,350 Archer-Daniels-Midland, 6.75%, 12/15/27 2,000,000 2,078,040 Computer Associates International, 6.50%, 4/15/08 (a) 1,000,000 997,900 Gap, Inc., 6.90%, 9/15/07 1,000,000 1,114,180 Gillette Company, 5.75%, 10/15/05 250,000 260,167 Hershey Foods Corporation, 7.20%, 8/15/27 1,000,000 1,119,310 ICI Wilmington, Inc., 6.95%, 9/15/04 1,000,000 1,065,060 Mead Corporation, 7.35%, 3/01/17 750,000 814,223 Praxair, Inc., 6.15%, 4/15/03 1,000,000 1,027,020 Rockwell International Corporation, 6.70%, 1/15/28 1,500,000 1,589,775 Scripps (E.W.) Company, 6.38%, 10/15/02 1,000,000 1,037,830 Tenneco, Inc., 7.50%, 4/15/07 500,000 548,365 Williams Company, Inc., 6.50%, 11/15/02 1,000,000 1,032,510 Zeneca Wilmington, 7.00%, 11/15/23 1,500,000 1,688,745 ----------- 14,627,475 ----------- FINANCIAL - 5.08% Allmerica Financial Corporation, 7.63%, 10/15/25 1,130,000 1,252,729 Allstate Corporation, 6.75%, 5/15/18 1,000,000 1,028,290 American General Finance., 5.88%, 7/01/00 250,000 252,987 Associates Corporation of North America, 5.25%, 3/30/00 250,000 250,645 BankAmerica Corporation, 7.88%, 12/01/02 1,000,000 1,092,980 Bank One Texas, 6.25%, 2/15/08 1,000,000 1,043,010 Chase Manhattan Corporation, 7.75%, 11/01/99 250,000 255,697 Comerica Bank, 7.13%, 12/01/13 250,000 267,703 Finova Capital Corporation, 6.39%, 10/08/02 1,000,000 1,036,390 First National Bank of Boston, 8.00%, 9/15/04 250,000 277,367 Fleet Financial Group, 6.88%, 1/15/28 1,000,000 1,029,320
PRINCIPAL AMOUNT MARKET VALUE CORPORATE BONDS (CONTINUED) FINANCIAL (CONTINUED) Great Western Financial, 6.38%, 7/01/00 $ 250,000 $ 254,623 Heller Financial, 6.38%, 11/10/00 1,000,000 1,026,960 Home Savings of Americas, 6.00%, 11/01/00 250,000 253,330 MBIA, Inc., 7.00%, 12/15/25 1,000,000 1,063,240 NationsBank Corporation, 7.80%, 9/15/16 1,000,000 1,134,400 Security Benefits Life Company, 8.75%, 5/15/16 (a) 500,000 549,375 Toronto Dominion Bank, 6.13%, 11/01/08 250,000 260,930 ----------- 12,329,976 ----------- UTILITIES - 2.32% Florida Power & Light Company, 5.38%, 4/01/00 250,000 251,090 New York Telephone, 6.00%, 4/15/08 1,000,000 1,052,340 Northern Natural Gas, 6.75%, 9/15/08 2,000,000 2,096,000 Pacific Gas & Electric Company, 5.93%, 10/08/03 250,000 262,700 Philadelphia Electric Company, 7.50%, 1/15/99 100,000 100,835 Southwestern Public Service Company, 6.88%, 12/01/99 250,000 255,188 System Energy Resources, 7.71%, 8/01/01 500,000 525,535 Union Electric Company, 6.75%, 10/15/99 250,000 254,688 US West Capital Funding Inc., 6.88%, 7/15/28 785,000 833,489 ----------- 5,631,865 ----------- TOTAL CORPORATE BONDS (COST $31,414,967) 32,589,316 ----------- U.S. GOVERNMENT SECURITIES AND AGENCIES - 27.27% Government National Mortgage Association 6.50% - 7.00%, 1/15/24 - 6/15/28 8,509,957 8,721,623 U.S. Treasury Bonds, 7.25%, 5/15/16 4,110,000 5,103,469 U.S. Treasury Notes, 5.63% - 7.50%, 11/15/99 - 10/15/06 48,550,000 52,331,514 ----------- TOTAL U.S. GOVERNMENT SECURITIES AND AGENCIES (COST $61,636,227) 66,156,606 ----------- 241,374,442 -----------
49 MENTOR INCOME AND GROWTH PORTFOLIO PORTFOLIO OF INVESTMENTS SEPTEMBER 30, 1998 - --------------------------------------------------------------------------------
PRINCIPAL AMOUNT MARKET VALUE SHORT-TERM INVESTMENT - 0.18% REPURCHASE AGREEMENT Paribas Corporation Dated 9/30/98, 5.54%, due 10/01/98, collateralized by $368,000 U.S. Treasury Note, 7.88%, 11/13/04, market value $435,735 (cost $435,000) $435,000 $ 435,000 ------------ TOTAL INVESTMENTS (COST $231,110,035)-99.66% 241,809,442 OTHER ASSETS LESS LIABILITIES - 0.34% 831,534 ------------ NET ASSETS - 100.00% $242,640,976 ============
* Non-income producing. ~ American Depository Receipts. (a) These are securities that may be resold to "qualified institutional buyers" under rule 144A or securities offered pursuant to section 4(2) of the Securities Act of 1933, as amended. These securites have been determined to be liquid under guidelines established by the Board of Trustees. (b) At September 30, 1998, the Portfolio owned 43,200 shares of common stock of First Union Corporation at a cost of $1,599,696 and market value of $2,211,300. These shares were purchased by the Portfolio prior to the acquisition of Wheat First Union by First Union. INVESTMENT TRANSACTIONS Cost of purchases and proceeds from sales of securities, other than short-term securities, aggregated $159,489,535 and $86,643,249, respectively. INCOME TAX INFORMATION At September 30, 1998, the aggregated cost of investment securities for federal income tax purposes was $231,143,009. Net unrealized appreciation aggregated $10,666,433, of which $24,490,485, related to appreciated investment securities and $13,824,052, related to depreciated investment securities. SEE NOTES TO FINANCIAL STATEMENTS. 50 MENTOR INCOME AND GROWTH PORTFOLIO - -------------------------------------------------------------------------------- STATEMENT OF ASSETS AND LIABILITIES SEPTEMBER 30, 1998 ASSETS Investments, at market value (Note 2) Investment securities $ 241,374,442 Repurchase agreements 435,000 ------------- Total investments (cost $231,110,035) 241,809,442 Collateral for securities loaned (Note 2) 40,344,784 Receivables Fund shares sold 290,524 Dividends and interest 1,702,285 Other 500 ------------- TOTAL ASSETS 284,147,535 ------------- LIABILITIES Payables Investments purchased $ 662,932 Securities loaned (Note 2) 40,344,784 Fund shares redeemed 426,881 Accrued expenses and other liabilities 71,962 ---------- TOTAL LIABILITIES 41,506,559 ------------- NET ASSETS $ 242,640,976 ============= Net Assets represented by: (Note 2) Additional paid-in capital $ 221,635,180 Accumulated undistributed net investment income 91,952 Accumulated net realized gain on investment transactions 10,214,437 Net unrealized appreciation of investments 10,699,407 ------------- NET ASSETS $ 242,640,976 ============= NET ASSET VALUE PER SHARE Class A Shares $ 19.54 Class B Shares $ 19.53 Class Y Shares $ 19.54 OFFERING PRICE PER SHARE Class A Shares $ 20.73(a) Class B Shares $ 19.53 Class Y Shares $ 19.54 SHARES OUTSTANDING Class A Shares 5,055,017 Class B Shares 7,364,927 Class Y Shares 55
(a) Computation of offering price: 100/94.25 of net asset value. SEE NOTES TO FINANCIAL STATEMENTS. STATEMENT OF OPERATIONS YEAR ENDED SEPTEMBER 30, 1998 INVESTMENT INCOME Dividends (b) $ 2,856,521 Interest 5,943,480 ------------ TOTAL INVESTMENT INCOME (NOTE 2) 8,800,001 EXPENSES Management fee (Note 4) $1,638,729 Distribution fee (Note 5) 986,604 Shareholder service fee (Note 5) 546,242 Transfer agent fee 292,933 Administration fee (Note 4) 218,497 Registration expenses 50,615 Custodian and accounting fees 48,726 Shareholder reports and postage expenses 43,522 Legal fees 7,495 Directors' fees and expenses 5,917 Audit fees 4,195 Miscellaneous 26,008 ----------- Total expenses 3,869,483 ------------ NET INVESTMENT INCOME 4,930,518 ------------ REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS Net realized gain on investments (Note 2) 10,845,766 Change in unrealized appreciation on investments (5,423,416) ----------- NET GAIN ON INVESTMENTS 5,422,350 ------------ NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $ 10,352,868 ============
(b) Net of foreign withholding taxes of $50,731. SEE NOTES TO FINANCIAL STATEMENTS. 51 MENTOR INCOME AND GROWTH PORTFOLIO - -------------------------------------------------------------------------------- STATEMENTS OF CHANGES IN NET ASSETS
YEAR ENDED YEAR ENDED 9/30/98 9/30/97 NET INCREASE IN NET ASSETS Operations Net investment income $ 4,930,518 $ 2,672,361 Net realized gain on investments 10,845,766 15,016,540 Change in unrealized appreciation on investments (5,423,416) 6,704,657 ------------ ------------- Increase in net assets resulting from operations 10,352,868 24,393,558 ------------ ------------- Distributions to Shareholders From net investment income Class A (2,350,498) (1,097,197) Class B (2,488,039) (1,691,306) Class Y (29) - From net realized gain on investments Class A (5,325,307) (2,474,556) Class B (8,807,307) (6,846,186) Class Y (1) - -------------- ------------- Total distributions to shareholders (18,971,181) (12,109,245) -------------- ------------- Capital Share Transactions (Note 7) Proceeds from sale of shares 101,090,596 74,239,398 Reinvested distributions 17,902,342 11,495,496 Shares redeemed (39,059,107) (17,451,330) -------------- ------------- Change in net assets resulting from capital share transactions 79,933,831 68,283,564 -------------- ------------- Increase in net assets 71,315,518 80,567,877 Net Assets Beginning of year 171,325,458 90,757,581 -------------- ------------- End of year (including accumulated undistributed net investment income of $91,952 and $0, respectively) $242,640,976 $ 171,325,458 ============== =============
SEE NOTES TO FINANCIAL STATEMENTS. FINANCIAL HIGHLIGHTS CLASS A SHARES
YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED 9/30/98 9/30/97 9/30/96 9/30/95 9/30/94 PER SHARE OPERATING PERFORMANCE Net asset value, beginning of year $ 20.60 $ 19.16 $ 17.13 $ 15.27 $ 14.88 --------- --------- --------- -------- -------- Income from investment operations Net investment income 0.51 0.44 0.37 0.40 0.31 Net realized and unrealized gain on investments 0.60 3.39 2.75 2.14 0.64 --------- --------- --------- -------- -------- Total from investment operations 1.11 3.83 3.12 2.54 0.95 --------- --------- --------- -------- -------- Less distributions From net investment income (0.51) (0.47) (0.35) (0.43) (0.30) From capital gains (1.66) (1.92) (0.74) (0.25) (0.26) ---------- ---------- ---------- -------- -------- Total distributions (2.17) (2.39) (1.09) (0.68) (0.56) ---------- ---------- ---------- -------- -------- Net asset value, end of year $ 19.54 $ 20.60 $ 19.16 $ 17.13 $ 15.27 ========== ========== ========== ======== ======== TOTAL RETURN* 5.81% 22.11% 19.13% 17.24% 6.54% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (in thousands) $ 98,794 $ 63,509 $ 24,210 $ 19,888 $ 17,773 Ratio of expenses to average net assets 1.32% 1.35% 1.36% 1.69% 1.75% Ratio of net investment income to average net assets 2.70% 2.63% 2.08% 2.53% 2.20% Portfolio turnover rate 40% 75% 72% 62% 78% Average commission rate on portfolio transactions $ 0.0540 $ 0.0515 $ 0.0492
* Total return does not reflect sales commissions and is not annualized. SEE NOTES TO FINANCIAL STATEMENTS. 52 MENTOR INCOME AND GROWTH PORTFOLIO - -------------------------------------------------------------------------------- FINANCIAL HIGHLIGHTS CLASS B SHARES
YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED 9/30/98 9/30/97 9/30/96 9/30/95 9/30/94 PER SHARE OPERATING PERFORMANCE Net asset value, beginning of year $ 20.59 $ 19.18 $ 17.14 $ 15.28 $ 14.91 --------- --------- --------- -------- -------- Income from investment operations Net investment income 0.37 0.34 0.23 0.28 0.21 Net realized and unrealized gain on investments 0.59 3.35 2.76 2.14 0.61 --------- --------- --------- -------- -------- Total from investment operations 0.96 3.69 2.99 2.42 0.82 --------- --------- --------- -------- -------- Less distributions From net investment income (0.36) (0.36) (0.21) (0.31) (0.19) From capital gains (1.66) (1.92) (0.74) (0.25) (0.26) ---------- ---------- ---------- -------- -------- Total distributions (2.02) (2.28) (0.95) (0.56) (0.45) ---------- ---------- ---------- -------- -------- Net asset value, end of year $ 19.53 $ 20.59 $ 19.18 $ 17.14 $ 15.28 ========== ========== ========== ======== ======== TOTAL RETURN* 5.01% 21.24% 18.26% 16.32% 5.66% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (in thousands) $143,846 $ 107,816 $ 66,548 $ 46,678 $ 43,219 Ratio of expenses to average net assets 2.07% 2.10% 2.13% 2.43% 2.44% Ratio of net investment income to average net assets 1.95% 1.87% 1.32% 1.78% 1.51% Portfolio turnover rate 40% 75% 72% 62% 78% Average commission rate on portfolio transactions $ 0.0540 $ 0.0515 $ 0.0492
CLASS Y SHARES
PERIOD ENDED 9/30/98 (C) PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 18.75 -------- Income from investment operations Net investment income 0.54 Net realized and unrealized gain on investments 0.82 -------- Total from investment operations 1.36 -------- Less distributions From net investment income (0.54) From capital gains (0.03) ---------- Total distributions (0.57) ---------- Net asset value, end of period $ 19.54 ========== TOTAL RETURN* 7.29% RATIOS/SUPPLEMENTAL DATA Net assets, end of period (in thousands) $ 1 Ratio of expenses to average net assets 1.07% (a) Ratio of net investment income to average net assets 3.15% (a) Portfolio turnover rate 40% Average commission rate on portfolio transactions $ 0.0540
(a) Annualized. (c) For the period from November 19, 1997 (initial offering of Class Y shares) to September 30, 1998. * Total return does not reflect sales commissions and is not annualized. SEE NOTES TO FINANCIAL STATEMENTS. 53 MENTOR BALANCED PORTFOLIO MANAGERS' COMMENTARY: THE BALANCED MANAGEMENT TEAM SEPTEMBER 30, 1998 - -------------------------------------------------------------------------------- The Mentor Balanced Portfolio, which has been in existence since 1994, became available to investors in multiple retail mutual fund share classes for the first time in September. This commentary, therefore, marks the first opportunity for the managers of the Portfolio to provide their market perspective to many of our new shareholders. At quarter end the asset allocation mix in the Mentor Balanced Portfolio was 58% stocks, 41% bonds, and 1% cash. MARKET OVERVIEW The first three quarters of 1998 culminated an unprecedented trend of 14 consecutive quarterly gains for the S&P 500. The July-September period, however, saw a dramatic departure from this trend, with the S&P 500 declining 10%. Despite poor equity returns, U.S. government fixed-income markets were extremely strong. In fact, the July-September period marked one of the few times in recent years that bonds significantly outperformed stocks. However, the broad rally in treasury bonds was not shared by more credit-sensitive fixed-income sectors, as investors aggressively shifted assets into low risk instruments only. EQUITY REVIEW AND OUTLOOK For some time we have been emphatically cautioning that the stock market would have to adjust to considerably lower corporate earnings prospects, and this transition would likely result in increased volatility and lower returns than experienced over the past several years. Finally, this scenario is unfolding in full force. Earnings estimates for a broad range of companies are being sharply reduced. It is now quite possible, in fact likely in our opinion, that the earnings of the S&P 500 will continue to decline during the remainder of this year and 1999. These trends present a significant change from the strong, better-than-expected earnings growth that has been a key pillar supporting the bull market since 1990, one of the best on record by almost any measure. But this change was inevitable. It is part of the natural cyclical patterns of the economy, corporate profitability, and the stock market. After nearly perfect growth conditions during much of the 1990's, corporate profitability is coming under pressure as global excess capacity is chasing falling demand. And as should be expected at this point, lenders are sharply curtailing credit and thereby reinforcing these developing pressures. Fear and greed are a long-term investor's best asset and worst threat. It is exceedingly difficult for both individual and institutional investors to look through an emotionally charged volatile market and focus on the fundamentals. To us, fundamental analysis does not mean trying to figure out cyclical swings in the economy and markets over the next year. It means concentrating on longer-term business qualities. We know that consistently implementing a well-defined investment discipline through the ups and downs of an entire cycle is the best way to ensure long-term success. We focus on a diversified group of companies with excellent operating records and leading competitive positions. We are biased toward companies with above-average business predictability. We have thoroughly analyzed their results and prospects. We own them at prices we believe offer attractive relative values. It is a very simple approach. Not an easy one, but a straightforward one. We will at times be wrong in our analysis, but we will strive to be as objective as possible. Of course, we expect to be right more 54 MENTOR BALANCED PORTFOLIO MANAGERS' COMMENTARY: THE BALANCED MANAGEMENT TEAM SEPTEMBER 30, 1998 - -------------------------------------------------------------------------------- often than not. We will not alter this approach just because those around us are becoming more complacent or fearful. Over the long-term, cyclical swings wash out and business fundamentals prevail. FIXED INCOME REVIEW AND OUTLOOK On the fixed-income side, our short-term strategy in this tumultuous environment has been to tilt portfolio durations somewhat long relative to our benchmarks, as well as more heavily weight sector allocations toward treasury securities. Given our long-term confidence in the U.S. economy, we are waiting for an opportunity to aggressively move into domestic spread sectors. Prior to such a move, we will have to be convinced that these markets have stabilized. In our opinion such stabilization will require the Fed to continue to move forcefully to further ease credit conditions. The primary risk we see to our outlook is timing. The U.S. economy has tremendous forward momentum and the current yield curve is already pricing in an aggressive Fed ease. Should events unfold more slowly than the market hopes, the bond market could encounter some short-term turbulence. We would view these sell-offs as short term in nature and would utilize the higher yield levels to extend our duration further. November 1998 55 MENTOR BALANCED PORTFOLIO SEPTEMBER 30, 1998 - -------------------------------------------------------------------------------- PERFORMANCE COMPARISON Comparison of change in value of a hypothetical $10,000 investment in Mentor Balanced Portfolio Class A Shares, the S&P 500 and the Lehman Brothers Aggregate Bond Index.+ [GRAPH] 9/16/98 9/30/98 Class A 9,422 9,433 LAGG/S&P 500 10,000 10,464 Total Returns as of 9/30/98 1-Year Since Inception++ Class n/a (5.78%) PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE PERFORMANCE. YOUR INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO WHEN SHARES ARE REDEEMED, THEY MAY BE WORTH MORE OR LESS THAN ORIGINAL COST. MUTUAL FUNDS ARE NOT OBLIGATIONS OF OR GUARANTEED BY ANY BANK AND ARE NOT FEDERALLY INSURED. * Represents a hypothetical investment of $10,000 in Mentor Balanced Portfolio Class A Shares after deducting the maximum sales charge of 5.75% ($10,000 investment minus $575 sales charge). The Class A Shares' performance assumes the reinvestment of all dividends and distributions. + The Standard & Poor's Index (S&P 500) is an unmanaged, market-value-weighted index of 500 widely held domestic common stocks. An unmanaged index does not reflect expenses and may not correspond to the performance of a managed portfolio in which expenses are incurred. The Lehman Brothers Aggregate Index is made up of the Government/Corporate Index, the Mortgage-Backed Securities Index, and the Asset-Backed Securities Index. The Lehman Brothers Aggregate Bond Index and S&P 500 are adjusted to reflect reinvestment of interest and dividends on securities in the indexes. The Lehman Brothers Aggregate Bond Index and S&P 500 are not adjusted to reflect sales loads, expenses, or other fees that the SEC requires to be reflected in the Portfolio's performance. This index represents an asset allocation of 60% S&P 500 stocks and 40% Lehman Brothers Aggregate Bond Index. ++ Reflects operations of Mentor Balanced Portfolio Class A Shares from the date of issuance on 9/16/98 through 9/30/98. Comparison of change in value of a hypothetical $10,000 investment in Mentor Balanced Portfolio Class Y Shares, the S&P 500 and the Lehman Brothers Aggregate Bond Index.+ [GRAPH] 9/16/98 9/30/98 Class Y 10,000 10,000 LAGG/S&P 500 10,000 10,464 Total Returns as of 9/30/98 1-Year Since Inception** Class Y n/a 0.00% PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE PERFORMANCE. YOUR INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO WHEN SHARES ARE REDEEMED, THEY MAY BE WORTH MORE OR LESS THAN ORIGINAL COST. MUTUAL FUNDS ARE NOT OBLIGATIONS OF OR GUARANTEED BY ANY BANK AND ARE NOT FEDERALLY INSURED. ** Represents a hypothetical investment of $10,000 in Mentor Balanced Portfolio Class Y Shares. These shares are not subject to any sales or contingent deferred sales charges. The Class Y Shares' performance assumes the reinvestment of all dividends and distributions. *** Reflects operations of Mentor Balanced Portfolio Class Y Shares from the date of issuance on 9/16/98 through 9/30/98. 56 MENTOR BALANCED PORTFOLIO SEPTEMBER 30, 1998 - -------------------------------------------------------------------------------- PERFORMANCE COMPARISON Comparison of change in value of a hypothetical $10,000 investment in Mentor Balanced Portfolio Class B Shares, the S&P 500 and the Lehman Brothers Aggregate Bond Index.+ [GRAPH] S&P 500 and Class B Class B* Lehman Brothers Aggregate Bond Index 6/21/94 10000 10000 10000 12/31/94 10108 9610 10336 6/30/95 11561 11161 12054 9/30/95 12085 11685 12723 9/30/96 14260 13960 14506 9/30/97 18042 17842 18496 9/30/98 20181 19760 20446 Average Annual Return as of 9/30/98 Average Annual Return as of 9/30/98 Without Sales Charges Including Sales Charges 1-Year Since Inception++ 1-Year Since Inception++ Class B 11.86% 17.83% Class B 8.75% 17.69% PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE PERFORMANCE. YOUR INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO WHEN SHARES ARE REDEEMED, THEY MAY BE WORTH MORE OR LESS THAN ORIGINAL COST. MUTUAL FUNDS ARE NOT OBLIGATIONS OF OR GUARANTEED BY ANY BANK AND ARE NOT FEDERALLY INSURED. ~ Represents a hypothetical investment of $10,000 in Mentor Balanced Portfolio Class B Shares. A contingent deferred sales charge will be imposed, if applicable, on Class B shares at rates ranging from a maximum of 4.00% of amounts redeemed during the first year following the date of purchase to 1.00% of amounts redeemed during the five-year period following the date of purchase. The value of Class B Shares reflects a redemption fee in effect at the end of each of the stated periods. Prior to September 16, 1998, contingent deferred sales charges of 5.00% were waived. The Class B Shares' performance assumes the reinvestment of all dividends and distributions. + The Standard & Poor's Index (S&P 500) is an unmanaged, market- value-weighted index of 500 widely held domestic common stocks. An unmanaged index does not reflect expenses and may not correspond to the performance of a managed portfolio in which expenses are incurred. The Lehman Brothers Aggregate Index is made up of the Government/Corporate Index, the Mortgage-Backed Securities Index, and the Asset-Backed Securities Index. The Lehman Brothers Aggregate Bond Index and S&P 500 are adjusted to reflect reinvestment of interest and dividends on securities in the indexes. The Lehman Brothers Aggregate Bond Index and S&P 500 are not adjusted to reflect sales loads, expenses, or other fees that the SEC requires to be reflected in the Portfolio's performance. This index represents an asset allocation of 60% S&P 500 stocks and 40% Lehman Brothers Aggregate Bond Index. ++ Reflects operations of Mentor Balanced Portfolio Class B Shares from the date of commencement of operations on 6/21/94 through 9/30/98. * Includes maximum Contingent Deferred Sales Charge (CDSC) of 5%. 57 MENTOR BALANCED PORTFOLIO PORTFOLIO OF INVESTMENTS SEPTEMBER 30, 1998 - --------------------------------------------------------------------------------
SHARES MARKET VALUE COMMON STOCKS - 51.46% BASIC MATERIALS - 1.89% Emerson Electric Company 3,890 $ 242,152 --------- CAPITAL GOODS & CONSTRUCTION - 5.56% Bemis Company 6,245 218,966 Illinois Tool Works 4,635 252,607 W. W. Grainger, Inc. 5,730 241,377 --------- 712,950 --------- CONSUMER CYCLICAL - 8.42% Chancellor Media Corporation - Class A * 5,245 175,052 Clear Channel Communications * 4,445 211,137 Gannett Company 4,105 219,874 Interpublic Group Companies, Inc. 4,335 233,819 Newell Company 5,220 240,446 --------- 1,080,328 --------- CONSUMER STAPLES - 5.52% Philip Morris Companies, Inc. 4,840 222,942 Sherwin-Williams Company 11,285 244,038 Sysco Corporation 10,235 241,162 --------- 708,142 --------- FINANCIAL - 10.84% Ahmanson (HF) & Company 3,950 219,225 American Express Company 2,860 222,007 Federal National Mortgage Association 3,510 225,517 NationsBank Corporation 2,990 159,965 Norwest Corporation 4,495 160,977 UNUM Corporation 4,720 234,525 SouthTrust Corporation 4,800 167,700 --------- 1,389,916 --------- HEALTH - 6.95% Bristol-Myers Squibb Company 2,345 243,587 HealthSouth Corporation * 18,340 193,716 Johnson & Johnson 2,805 219,492 Tenet Healthcare Corporation * 8,170 234,888 --------- 891,683 --------- TECHNOLOGY - 9.20% Automatic Data Processing 3,190 238,452 Computer Associates International, Inc. 6,770 250,490 Computer Sciences Corporation 4,145 225,903 MCI WorldCom, Inc. * 4,685 228,980 Sun Microsystems, Inc. * 4,725 235,364 --------- 1,179,189 --------- TRANSPORTATION & SERVICES - 1.16% Werner Enterprises, Inc. 9,472 149,184 --------- MISCELLANEOUS - 1.92% Tyco International, Inc. 4,445 245,586 --------- TOTAL COMMON STOCKS (COST $6,531,760) 6,599,130 ---------
PRINCIPAL AMOUNT MARKET VALUE FIXED INCOME SECURITIES - 36.99% U.S. GOVERNMENT SECURITIES AND AGENCIES - 34.26% Federal National Mortgage Association, MTN, 6.64%, 7/02/07 $ 130,000 $ 145,240 Government National Mortgage Association, MBS, 6.50%, 5/15/09 102,065 104,453 7.00%, 8/15/28 ARM 84,047 86,674 Government National Mortgage Association II, ARM, 6.88%, 4/20/22 71,868 73,307 7.00%, 11/20/22 - 8/15/28 78,240 79,458 U.S. Treasury Bonds, 6.00% - 7.50%, 2/15/23 - 2/15/26 725,000 910,182 U.S. Treasury Notes, 5.63% - 6.75%, 4/30/00 - 5/15/08 2,790,000 2,995,171 --------- TOTAL U.S. GOVERNMENT SECURITIES AND AGENCIES (COST $4,274,484) 4,394,485 --------- COLLATERALIZED MORTGAGE OBLIGATIONS - 1.22% AFG Receivables Trust, 6.65%, 10/15/02 32,527 32,782 CS First Boston, 7.18%, 2/25/18 25,000 26,800 Key Auto Finance Trust Series 1997-2 Class A3, 6.10%, 11/15/00 50,000 50,172 Union Acceptance Corporation, 6.48%, 5/10/04 45,000 46,240 --------- TOTAL COLLATERALIZED MORTGAGE OBLIGATIONS (COST $152,201) 155,994 --------- CORPORATE BONDS - 1.51% Ford Motor Credit Company, 7.20%, 6/15/07 45,000 50,256 Norwest Corporation, 6.80%, 5/15/02 60,000 63,625 PNC Student Loan Trust I, 6.73%, 1/25/07, ARM 75,000 79,726 --------- TOTAL CORPORATE BONDS (COST $181,746) 193,607 --------- TOTAL FIXED INCOME SECURITIES (COST $4,608,431) 4,744,086 ---------
58 MENTOR BALANCED PORTFOLIO PORTFOLIO OF INVESTMENTS SEPTEMBER 30, 1998 - --------------------------------------------------------------------------------
PRINCIPAL AMOUNT MARKET VALUE SHORT-TERM INVESTMENT REPURCHASE AGREEMENT - 0.98% Goldman Sachs & Company Dated 09/30/98, 5.60%, due 10/01/98, collateralized by $127,262 Federal National Mortgage Association, 6.00%, 08/01/13, market value $128,534 (cost $125,344) $125,344 $ 125,344 ----------- TOTAL INVESTMENTS (COST $11,265,535)-89.43% 11,468,560 OTHER ASSETS LESS LIABILITIES - 10.57% 1,352,413 ----------- NET ASSETS - 100.00% $12,820,973 ===========
* Non-income producing. ARM - Adjustable Rate Mortgage MBS - Mortgage Backed Securities MTN - Medium Term Note INVESTMENT TRANSACTIONS Cost of purchases and proceeds from sales of securities, other than short-term securities, aggregated $11,028,839 and $3,760,750, respectively. INCOME TAX INFORMATION At September 30, 1998, the aggregated cost of investment securities for federal income tax purposes was $11,265,535. Net unrealized appreciation aggregated $203,025, of which $449,651, related to appreciated investment securities and $246,626, related to depreciated investment securities. SEE NOTES TO FINANCIAL STATEMENTS. 59 MENTOR BALANCED PORTFOLIO - -------------------------------------------------------------------------------- STATEMENT OF ASSETS AND LIABILITIES SEPTEMBER 30, 1998 ASSETS Investments, at market value (Note 2) Investment securities $ 11,343,216 Repurchase agreements 125,344 ------------ Total investments (cost $11,265,535) 11,468,560 Collateral for securities loaned (Note 2) 2,639,420 Cash 477,253 Receivables Investments sold 90,763 Fund shares sold 3,356,473 Dividends and interest 68,997 ------------ TOTAL ASSETS 18,101,466 ------------ LIABILITIES Investments purchased $ 2,537,038 Securities loaned (Note 2) 2,639,420 Fund shares redeemed 100,000 Accrued expenses and other liabilities 4,035 ----------- TOTAL LIABILITIES 5,280,493 ------------ NET ASSETS $12,820,973 ============ Net Assets represented by: (Note 2) Additional paid-in capital $ 12,530,663 Accumulated undistributed net investment income 18,259 Accumulated net realized gain on investment transactions 69,026 Net unrealized appreciation of investments 203,025 ------------ NET ASSETS $ 12,820,973 ============ NET ASSET VALUE PER SHARE Class A Shares $ 13.69 Class B Shares $ 13.69 Class Y Shares $ 13.69 OFFERING PRICE PER SHARE Class A Shares $ 14.53(a) Class B Shares $ 13.69 Class Y Shares $ 13.69 SHARES OUTSTANDING Class A Shares 258,246 Class B Shares 412,394 Class Y Shares 266,111
(a) Computation of offering price: 100/94.25 of net asset value. SEE NOTES TO FINANCIAL STATEMENTS. STATEMENT OF OPERATIONS YEAR ENDED SEPTEMBER 30, 1998 INVESTMENT INCOME Dividends $ 29,221 Interest 104,135 -------- Total investment income (Note 2) 133,356 -------- EXPENSES Management fee (Note 4) $ 31,721 Distribution fee (Note 5) 30,319 Shareholder service fee (Note 5) 10,212 Administration fee (Note 4) 4,219 Custodian and accounting fees 5,842 Registration expenses 2,363 Shareholder reports and postage expenses 2,043 Legal fees 115 Directors' fees and expenses 60 Audit fees 59 Miscellaneous 465 -------- Total expenses 87,418 Deduct Waiver of distribution fee (Note 5) (29,451) Waiver of management fee (Note 4) (20,856) Waiver of shareholder servicing fee (Note 5) (9,738) Waiver of administration fee (Note 4) (4,219) -------- NET EXPENSES 23,154 -------- NET INVESTMENT INCOME 110,202 -------- REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS Net realized gain on investments (Note 2) 822,291 Change in unrealized appreciation on investments (583,942) -------- NET GAIN ON INVESTMENTS 238,349 -------- NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $348,551 ========
SEE NOTES TO FINANCIAL STATEMENTS. 60 MENTOR BALANCED PORTFOLIO - -------------------------------------------------------------------------------- STATEMENTS OF CHANGES IN NET ASSETS
YEAR ENDED YEAR ENDED 9/30/98 9/30/97 NET INCREASE IN NET ASSETS Operations Net investment income $ 110,202 $ 107,324 Net realized gain on investments 822,291 408,111 Change in unrealized appreciation on investments (583,942) 397,175 ------------ ----------- Increase in net assets resulting from operations 348,551 912,610 ------------ ----------- Distributions to Shareholders From net investment income (159,807) (108,705) From net realized gain on investments (1,140,442) (449,369) ------------ ----------- Total distributions to shareholders (1,300,249) (558,074) ------------ ----------- Capital Share Transactions (Note 7) Proceeds from sale of shares 9,280,672 108,705 Reinvested distributions 1,300,249 449,370 Shares redeemed (910,125) (636,137) ------------ ----------- Change in net assets resulting from capital share transactions 9,670,796 (78,062) ------------ ----------- Increase in net assets 8,719,098 276,474 Net Assets Beginning of period 4,101,875 3,825,401 ------------ ----------- End of period (including accumulated undistributed net investement income of $18,259 and $67,864, respectively) $ 12,820,973 $ 4,101,875 ============ ===========
SEE NOTES TO FINANCIAL STATEMENTS. FINANCIAL HIGHLIGHTS CLASS A SHARES
PERIOD ENDED 9/30/98 (b) PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 13.69 -------- Income from investment operations Net investment income 0.00** Net realized and unrealized gain (loss) on investments 0.00** ---------- Total from investment operations 0.00** ---------- Net asset value, end of period $ 13.69 ========== TOTAL RETURN* 0.00% RATIOS / SUPPLEMENTAL DATA Net assets, end of period (in thousands) $ 3,534 Ratio of expenses to average net assets 1.35% (a) Ratio of net investment income to average net assets 1.52% (a) Portfolio turnover rate 89% Average commission rate on portfolio transactions $ 0.0687
(a) Annualized. (b) For the period from September 16, 1998 (initial offering of Class A) to September 30, 1998. * Total return does not reflect sales commissions and is not annualized. ** Income for the period was less than $0.005 per share. SEE NOTES TO FINANCIAL STATEMENTS. 61 MENTOR BALANCED PORTFOLIO - -------------------------------------------------------------------------------- FINANCIAL HIGHLIGHTS CLASS B SHARES (F)
YEAR ENDED YEAR ENDED YEAR ENDED 9/30/98 9/30/97 9/30/96 PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 17.61 $ 16.28 $ 14.85 --------- --------- --------- Income from investment operations Net investment income 0.45 0.43 0.42 Net realized and unrealized gain (loss) on investments 1.43 3.35 2.09 --------- --------- --------- Total from investment operations 1.88 3.78 2.51 --------- --------- --------- Less distributions From net investment income (0.71) (0.43) (0.48) From net realized capital gain (5.09) (2.02) (0.60) ---------- ---------- ---------- Total distributions (5.80) (2.45) (1.08) ---------- ---------- ---------- Net asset value, end of period $ 13.69 $ 17.61 $ 16.28 ========== ========== ========== TOTAL RETURN* 11.86% 26.09% 18.00% RATIOS / SUPPLEMENTAL DATA Net assets, end of period (in thousands) $ 5,645 $ 4,102 $ 3,825 Ratio of expenses to average net assets 0.52% 0.50% 0.50% Ratio of expenses to average net assets excluding waiver 2.12% 2.13% 2.06% Ratio of net investment income to average net assets 2.63% 2.78% 2.83% Portfolio turnover rate 89% 80% 103% Average commission rate on portfolio transactions $ 0.0687 $ 0.0696 $ 0.0694 PERIOD ENDED PERIOD ENDED 9/30/95 (c) 12/31/94 (d) PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 12.44 $ 12.50 ----------- ----------- Income from investment operations Net investment income 0.36 0.22 Net realized and unrealized gain (loss) on investments 2.08 (0.09) ----------- ----------- Total from investment operations 2.44 0.13 ----------- ----------- Less distributions From net investment income (0.03) (0.19) From net realized capital gain -- -- ----------- ----------- Total distributions (0.03) (0.19) ----------- ----------- Net asset value, end of period $ 14.85 $ 12.44 =========== =========== TOTAL RETURN* 19.28% 1.00% RATIOS / SUPPLEMENTAL DATA Net assets, end of period (in thousands) $ 3,210 $ 2,911 Ratio of expenses to average net assets 0.50% (a) 0.50% (a) Ratio of expenses to average net assets excluding waiver 2.12% (a) 2.72% (a) Ratio of net investment income to average net assets 3.26% (a) 3.32% (a) Portfolio turnover rate 65% 71% Average commission rate on portfolio transactions
CLASS Y SHARES (f)
PERIOD ENDED 9/30/98 (e) PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 13.69 -------- Income from investment operations Net investment income 0.01 Net realized and unrealized loss on investments (0.01) --------- Total from investment operations 0.00 --------- Net asset value, end of period $ 13.69 ========= TOTAL RETURN* 0.00% RATIOS / SUPPLEMENTAL DATA Net assets, end of period (in thousands) $ 3,642 Ratio of expenses to average net assets 1.10%(a) Ratio of net investment income to average net assets 2.31%(a) Portfolio turnover rate 89% Average commission rate on portfolio transactions $ 0.0687
(a) Annualized. (c) For the period from January 1, 1995 to September 30, 1995. (d) For the period from June 21, 1994 (commencement of operations) to December 31, 1994. (e) For the period from September 16, 1998 (initial offering of Class Y) to September 30, 1998. (f) Prior to September 16, 1998, all shareholders of the Balanced Portfolio were Class B shareholders. On September 16, 1998, shares of Class B were converted to Class Y shares. * Total return does not reflect sales commissions and is not annualized. SEE NOTES TO FINANCIAL STATEMENTS. 62 MENTOR MUNICIPAL INCOME PORTFOLIO MANAGERS' COMMENTARY: THE TAX-EXEMPT MANAGEMENT TEAM SEPTEMBER 30, 1998 - -------------------------------------------------------------------------------- ECONOMIC FACTORS Unlike many countries in the world, the U.S. economy was strong throughout the reporting period, characterized by record low unemployment, good growth and low inflation. Driving economic growth in recent months has been the strength in the housing market, which benefited from strong employment and low interest rates. Housing starts in July 1998 reached an all-time high, 17% above the same period a year ago. While the housing market has been largely insulated from the overseas financial crises, the manufacturing sector has begun to show signs of a slowdown. In April, the National Association of Purchasing Management Index slipped from 54.8 to 52.9. This Index, which compares the changes in various market areas on a month to month basis, is a widely recognized measure of manufacturing activity. By June, the Index fell to 49.6, below the 50% level that marks the difference between growth and contraction. The news that manufacturing activity was slowing down was welcomed by the Federal Reserve. In part, this eliminated the need for the Fed to raise interest rates to head off inflation, which was the market's concern through the July meeting. In early August, the Fed concluded that the risks of inflation were evenly balanced against the risks of recession. By September, however, it appeared that recession was more of a concern given the declines in the Japanese stock market, the financial collapse of Russia, and the large drops in the U.S. stock market. As a result the Fed lowered the Fed Funds target by 25 basis points to 5.25% in late September. The Fed is in the difficult position of having to set U.S. policy based on international factors. With the prices of gold and oil recovering from their lows, the disinflationary effects of declining commodity prices may be coming to an end. Continued low inflation appears to be fostering higher wage demands. If world financial markets can be stabilized, the Fed could find that the balance of risks might shift just as quickly back toward inflation. MARKET REVIEW While we saw several periods of volatility during the past 12 months, overall the market rallied, with U.S. Treasuries strongly outperforming the municipal market. The 30-year Treasury, which began the reporting period yielding 6.40%, ended 143 basis point lower at 4.97%. 30-year AAA-rated general obligation municipals yielded 5.17% one year ago, dropping to 4.78% one year later. The divergent paths taken by the treasury and municipal markets can be primarily attributed to the impact of the Asian financial crisis. As problems in Asia have continued and the U.S. dollar has risen relative to Asian currencies, demand for treasuries has increased. This "flight to quality" has driven the yield on the long bond down to the lowest levels seen since the government began issuing the 30-year bond in 1977. At the same time, surpluses of the federal government have caused a reduction in issuance resulting in fewer bonds to meet strong demand. Technical conditions have been exactly the opposite in the tax-exempt market, with lukewarm retail demand due to low absolute yields and a strong increase in supply from a year ago. Although new issue volume has slowed somewhat in the past couple of months, year-to-date issuance is 37% over the comparable period a year ago. In addition to encouraging the number of refunding issues (up 63 MENTOR MUNICIPAL INCOME PORTFOLIO MANAGERS' COMMENTARY: THE TAX-EXEMPT MANAGEMENT TEAM SEPTEMBER 30, 1998 - -------------------------------------------------------------------------------- 59%), the low interest rate environment has also boosted new money issues which are up 20% year to date. As has been the trend in recent years, over 51% of new securities were issued with bond insurance, and yield spreads between quality and lower rated bonds remained tight. Since municipal prices did not rise as sharply as taxable securities during the period, tax-exempt yields are now very attractive relative to treasuries. At the end of the reporting period, the Bond Buyer Revenue Bond Index yielded 5.17% or 104% of 30-year treasuries, even before taking into consideration any tax advantage. The Revenue Bond Index consists of 25 revenue bonds with a 30-year maturity and an average rating of A1. The bonds that comprise this index are very similar to those we purchase for your Portfolio. MANAGEMENT STRATEGY Our outlook during most of the reporting period was positive, and we maintained duration slightly long relative to our benchmark to allow the fund to take full advantage of the rally. At the end of the fiscal year, the duration of the portfolio was 7.82 years compared to the Lehman Municipal Bond Index duration of 7.55 years. The high percentage of new issues that came to market insured continued to create a scarcity of lower-rated higher-yielding offerings. This resulted in continued tight yield spreads between AAA-rated and lower quality paper. While we did add a number of non-rated or lower-rated securities to the portfolio, we concentrated more on insured offerings as we felt they offered more attractive relative yields. The lower quality securities we selectively added helped maximize the portfolio's dividend paying ability. We kept the portfolio well diversified by industry, increasing our positions in the healthcare and industrial revenue sectors, which traditionally have performed slightly stronger than other sectors in the Revenue Bond Index. At the end of the reporting period, our exposure to healthcare stood at 21% of assets, with industrial revenue the second largest sector at 13% of assets. Our research expertise in these two areas allows us to find value in individual issues. OUTLOOK The Federal Reserve's recent 25 basis point interest rate cut and the slowing down of the U.S. economy are likely to sustain the low interest rate environment, which is favorable for the bond markets. It appears that we will see a record year of municipal issuance as the low absolute yields spark further refundings as well as new money issues. We are satisfied with the current structure of the portfolio and do not expect to make any major changes over the next few months unless credit spreads widen between AAA-rated and lower-rated issues. If that occurs, we would redeploy some assets toward higher-yielding securities to strengthen the portfolio's dividend. We also continue to closely monitor those securities that are vulnerable to calls and to extend the call protection of the portfolio. Combined with the recent declines in the equity market, the very attractive ratio of municipal yields to taxable yields could turn investor focus from stocks to the fixed-income market. November 1998 64 MENTOR MUNICIPAL INCOME PORTFOLIO SEPTEMBER 30, 1998 - -------------------------------------------------------------------------------- PERFORMANCE COMPARISON Comparison of change in value of a hypothetical $10,000 purchase in Mentor Municipal Income Portfolio Class A and Class B Shares and Lehman Municipal Bond Index.~ [GRAPH] A Shares B Shares Lehman Municipal Bond Index 4/29/92 9525 10000 10000 9/30/92 10034 10528 10561 9/30/93 11637 12134 11906 9/30/94 11101 11511 11616 9/30/95 12151 12348 12916 9/30/96 12935 13184 13818 9/30/97 14085 14291 14933 9/30/98 15245 15289 16232 Average Annual Returns as of 9/30/98 Including Sales Charges 1-Year 5-Year Since Inception* Class A 3.12% 4.53% 6.79% Class B 3.70% 4.85% 6.90% PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE PERFORMANCE. YOUR INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO WHEN SHARES ARE REDEEMED, THEY MAY BE WORTH MORE OR LESS THAN ORIGINAL COST. MUTUAL FUNDS ARE NOT OBLIGATIONS OF OR GUARANTEED BY ANY BANK AND ARE NOT FEDERALLY INSURED. ~ The Lehman Municipal Bond Index is adjusted to reflect reinvestment of interests on securities in the index. The Lehman Municipal Bond Index is not adjusted to reflect sales loads, expenses, or other fees that the SEC requires to be reflected in the Portfolio's performance. + Represents a hypothetical investment of $10,000 in Mentor Municipal Income Portfolio Class B Shares. A contingent deferred sales charge will be imposed, if applicable, on Class B Shares at rates ranging from a maximum of 4.00% of amounts redeemed during the first year following the date of purchase to 1.00% of amounts redeemed during the six-year period following the date of purchase. The value of Class B Shares reflects a redemption fee in effect at the end of each stated periods. The Class B Shares' performance assumes the reinvestment of all dividends and distributions. ++ Represents a hypothetical investment of $10,000 in Mentor Municipal Income Portfolio Class A Shares, after deducting the maximum sales charge of 4.75% ($10,000 investment minus $475 sales charge = $9,525). The Class A Shares' performance assumes the reinvestment of all dividends and distributions. * Reflects operations of Mentor Municipal Income Portfolio Class A and Class B Shares from the date of commencement of operations on 4/29/92 through 9/30/98. Comparison of change in value of a hypothetical $10,000 purchase in Mentor Municipal Income Portfolio Class Y Shares and Lehman Municipal Bond Index.- [GRAPH] Y Shares Lehman Municipal Bond Index 11/19/97 10000 10000 12/31/97 10147 10206 3/31/98 10263 10323 6/30/98 10410 10480 9/30/98 10689 10802 Total Returns as of 9/30/98 1-Year Since Inception** Class Y n/a 7.51% PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE PERFORMANCE. YOUR INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO WHEN SHARES ARE REDEEMED, THEY MAY BE WORTH MORE OR LESS THAN ORIGINAL COST. MUTUAL FUNDS ARE NOT OBLIGATIONS OF OR GUARANTEED BY ANY BANK AND ARE NOT FEDERALLY INSURED. ~ The Lehman Municipal Bond Index is adjusted to reflect reinvestment of interests on securities in the index. The Lehman Municipal Bond Index is not adjusted to reflect sales loads, expenses, or other fees that the SEC requires to be reflected in the Portfolio's performance. +++ Represents a hypothetical investment of $10,000 in Mentor Municipal Income Portfolio Class Y Shares. These shares are not subject to any sales or contingent deferred sales charges. The Class Y Shares' performance assumes the reinvestment of all dividends and distributions. ** Reflects operations of Mentor Municipal Income Portfolio Class Y Shares from the date of issuance on 11/19/97 through 9/30/98. 65 MENTOR MUNICIPAL INCOME PORTFOLIO PORTFOLIO OF INVESTMENTS SEPTEMBER 30, 1998 - --------------------------------------------------------------------------------
PRINCIPAL AMOUNT MARKET VALUE LONG-TERM MUNICIPAL SECURITIES - 99.42% ARIZONA - 1.56% Pima County Arizona IDA, 7.25%, 7/15/10 (c) $1,550,000 $ 1,733,830 ------------- ARKANSAS - 1.12% Pulaski County Health Facilities, 5.00%, 12/01/28 1,250,000 1,248,950 ------------- CALIFORNIA - 10.51% California State Water Reserve Center, 4.75%, 12/01/29 3,500,000 3,427,270 California Statewide Community Development Authority, 5.63%, 10/01/34 2,070,000 2,132,514 Carson Improvement Board Act 1915, Special Assessment District 92, 7.38%, 9/02/22 700,000 770,392 East Bay Municipal Utility District, 4.75%, 6/01/21 1,915,000 1,887,424 Orange County Community Facilities District, Series A, 7.35%, 8/15/18 (c) 300,000 346,779 San Francisco City & County Airport, 6.30%, 5/01/25 1,000,000 1,101,250 University of California Revenues, 4.75%, 9/01/16 2,000,000 2,012,240 ------------- 11,677,869 ------------- COLORADO - 3.36% Colorado Housing Authority, 7.00%, 11/01/24 525,000 560,873 Denver City & County Airport Revenue, 7.75% - 8.50%, 11/15/13 - 11/15/23 2,700,000 3,167,089 ------------- 3,727,962 ------------- CONNECTICUT - 0.99% Connecticut State Development Authority, 6.15%, 4/01/35 1,000,000 1,104,860 ------------- DISTRICT OF COLUMBIA - 0.80% Metropolitan Washington, General Airport Revenue, Series A, 6.63%, 10/01/19 (c) 800,000 884,496 ------------- FLORIDA - 2.54% Hillsborough County, 6.25%, 12/01/34 1,250,000 1,396,750 Sarasota County Health Facilities Authority Revenue, 10.00%, 7/01/22 1,160,000 1,418,831 ------------- 2,815,581 -------------
PRINCIPAL AMOUNT MARKET VALUE LONG-TERM MUNICIPAL SECURITIES (CONTINUED) GEORGIA - 2.92% Fulton County Georgia Housing Authority Multifamily, Housing Revenue, 6.38%, 2/01/08 $ 520,000 $ 528,346 George Smith World Congress Center, 5.50%, 7/01/20 1,500,000 1,509,345 Monroe County Development Authority PCRB, 6.75%, 1/01/10 1,000,000 1,205,240 ------------- 3,242,931 ------------- ILLINOIS - 9.53% Broadview Tax Increment Revenue, 8.25%, 7/01/13 1,000,000 1,145,030 Chicago Capital Appreciation, (effective yield-1.99%) (a), 7/01/16 2,000,000 718,080 Chicago Heights Residential Mortgage, (effective yield-3.29%) (a), 6/01/09 3,465,000 1,655,300 Illinois Health Facilities Authority Revenue, 5.50% - 9.50%, 11/15/19 - 10/01/22 2,250,000 2,527,477 Illinois Educational Facilities Authority Revenue, 6.00%, 10/01/24 1,000,000 1,042,200 Kane County School District No. 129, 5.50%, 2/01/11 2,000,000 2,167,620 Metropolitan Pier & Exposition, (effective yield-1.39%) (a), 6/15/21 1,950,000 644,962 Saint Clair County Public Building, (effective yield-1.99%) (a), 12/01/16 1,650,000 690,789 ------------- 10,591,458 ------------- INDIANA - 0.36% Indiana Transportation Finance Authority, Series A, (effective yield-1.92%) (a), 6/01/17 1,000,000 403,560 ------------- IOWA - 0.61% Student Loan Liquidity Corporation, Student Loan Revenue, Series C, 6.95%, 3/01/06 (c) 625,000 674,525 -------------
66 MENTOR MUNICIPAL INCOME PORTFOLIO PORTFOLIO OF INVESTMENTS SEPTEMBER 30, 1998 - --------------------------------------------------------------------------------
PRINCIPAL AMOUNT MARKET VALUE LONG-TERM MUNICIPAL SECURITIES (CONTINUED) KENTUCKY - 4.58% Jefferson County Hospital Revenue, 8.70%, 10/01/08 (b) $ 500,000 $ 599,375 Kenton County Airport Board Revenue, OID, 7.50%, 2/01/20 1,400,000 1,546,342 Warren County Hospital Facility Revenue Bowling 4.88%, 4/01/27 3,000,000 2,945,580 ---------- 5,091,297 ---------- LOUISIANA - 3.38% Louisiana Public Facilities Authority Revenue, Dillard University-Louisiana, 5.00%, 2/01/28 2,750,000 2,755,720 Louisiana State University & Agriculture and Mechanical College, University Revenues, 5.00%, 10/01/30 1,000,000 1,001,340 ---------- 3,757,060 ---------- MAINE - 0.86% Maine State Housing Authority, Series C, 6.88%, 11/15/23 885,000 956,030 ---------- MASSACHUSETTS - 1.92% Massachusetts State Health and Education, 6.00%, 10/01/23 1,000,000 1,018,850 Massachusetts State Health and Educational Facilities Authority, OID Revenue Bonds, Series A, 6.88%, 4/01/22 1,000,000 1,119,950 ---------- 2,138,800 ---------- MICHIGAN - 4.93% Detroit Michigan Water Supply Systems, 5.00%, 7/01/27 1,000,000 1,000,310 Grand Traverse County Hospital, 5.00%, 7/01/28 2,500,000 2,486,375 Michigan State Hospital Financial Authority Revenue, 5.00%, 5/15/28 2,000,000 1,995,280 ---------- 5,481,965 ----------
PRINCIPAL AMOUNT MARKET VALUE LONG-TERM MUNICIPAL SECURITIES (CONTINUED) NEBRASKA - 1.22% Nebraska Investment Finance Authority, SFM, 9.42%, 9/15/24 (b) $ 300,000 $ 339,375 Nebraska Public Gas Agency Gas supply System, 5.00%, 4/01/00 1,000,000 1,017,810 ---------- 1,357,185 ---------- NEVADA - 2.26% Clark County, 5.90%, 10/01/30 2,000,000 2,050,800 Henderson Local Improvement District, Special Assessment, Series A, 8.50%, 11/01/12 440,000 458,876 ---------- 2,509,676 ---------- NEW JERSEY - 2.10% East Orange County Board of Education, Participation Notes, (effective yield-1.67%) (a), 2/01/20 1,000,000 365,000 New Jersey State Housing & Mortgage Finance, 5.40%, 11/01/28 1,170,000 1,209,406 Union Utilities Authority, 5.00%, 6/15/28 750,000 757,568 ---------- 2,331,974 ---------- NEW MEXICO - 0.92% Santa Fe Educational Facilities Revenue Bonds, 5.50% 3/01/24 1,000,000 1,020,210 ---------- NEW YORK - 4.93% Clifton Springs Hospital Refunding & Improvement, 8.00%, 1/01/20 700,000 786,947 Metropolitan Transportation Authority, 4.75%, 7/01/19 1,000,000 962,240 New York City Municipal Water Facility, 5.13%, 6/15/21 1,000,000 1,008,300 New York, Series H, 7.20%, 2/01/13 1,500,000 1,680,946 New York State Dormitory Authority Revenue Hospital, 5.20%, 2/15/14 1,000,000 1,034,250 ---------- 5,472,683 ----------
67 MENTOR MUNICIPAL INCOME PORTFOLIO PORTFOLIO OF INVESTMENTS SEPTEMBER 30, 1998 - --------------------------------------------------------------------------------
PRINCIPAL AMOUNT MARKET VALUE LONG-TERM MUNICIPAL SECURITIES (CONTINUED) NORTH CAROLINA - 2.12% Cumberland County, 5.00%, 12/01/24 $1,250,000 $1,253,875 North Carolina Eastern Municipal Power Agency Systems Revenue, 5.70%, 1/01/13 1,000,000 1,097,700 ---------- 2,351,575 ---------- NORTH DAKOTA - 0.91% Devils Lake Health Care, 6.10%, 10/01/23 1,000,000 1,012,690 ---------- OHIO - 1.91% Batavia Local School District Reference, 5.63%,12/01/22 1,000,000 1,121,040 Cuyahoga County Health Care Facilities, 5.50%, 12/01/28 1,000,000 1,001,990 ---------- 2,123,030 ---------- OKLAHOMA - 0.50% Oklahoma City, Industrial and Cultural Facilities Trust, 6.75%, 9/15/17 540,000 551,993 ---------- PENNSYLVANIA - 6.39% Beaver County Hospital Authority Revenue, 5.00%, 5/15/28 1,000,000 997,640 Delaware IDA, 6.20%, 7/01/19 2,000,000 2,191,040 Pennsylvania Economic Development, 6.40%, 1/01/09 500,000 534,620 Philadelphia Gas Works Revenue, 5.00%, 7/01/28 2,250,000 2,250,698 Philadelphia Hospital and Higher Education Facilities, 6.50%, 11/15/08 1,000,000 1,121,430 ---------- 7,095,428 ---------- RHODE ISLAND - 0.31% West Warwick, Series A, GO Bonds, 7.30%, 7/15/08 310,000 348,372 ---------- SOUTH CAROLINA - 1.81% Cayce South Carolina Waterworks & Sewage Revenue, 5.00%, 7/01/20 2,000,000 2,006,740 ----------
PRINCIPAL AMOUNT MARKET VALUE LONG-TERM MUNICIPAL SECURITIES (CONTINUED) TENNESSEE - 3.73% Memphis Shelby County Airport Authority Special Facilities Revenue Refunding, 7.88%, 9/01/09 $1,500,000 $1,675,485 Metropolitan Government Nashville & Davidson County, 4.75% - 5.00%, 1/01/22 - 10/01/28 2,500,000 2,472,795 ---------- 4,148,280 ---------- TEXAS - 9.94% Abilene Health Facilities Development Corporation, 5.90%, 11/15/25 1,000,000 1,002,500 Alliance Airport Authority, 6.38%, 4/01/21 2,000,000 2,192,620 Brazos Higher Education Authority Student Loan Revenue, 7.10%, 11/01/04 416,000 472,410 Brazos River Authority Revenue, 4.90%, 10/01/15 2,000,000 2,054,760 Dallas Fort Worth International Airport Facility Revenue Bonds, 7.25%, 11/01/30 1,000,000 1,112,260 Edinburg Consolidated School District Public Facilities, 5.00%, 8/15/19 1,500,000 1,516,815 Lufkin Health Memorial East Texas, 5.70%, 2/15/28 1,000,000 1,025,010 Rockwall Independent School District, OID, 5.55%, 8/15/22 2,450,000 689,822 Texas State Department of Housing and Community Affairs Refunding, Series C, 9.74%, 7/02/24 (b) 750,000 973,125 ---------- 11,039,322 ---------- UTAH - 3.40% Bountiful Hospital Revenue, 9.50%, 12/15/18 230,000 281,237 Intermountain Power Agency Power Supply, 5.00%, 7/01/19 2,500,000 2,472,225 Utah State Housing Finance Agency, SFM, 7.20%, 1/01/27 945,000 1,025,108 ---------- 3,778,570 ----------
68 MENTOR MUNICIPAL INCOME PORTFOLIO PORTFOLIO OF INVESTMENTS SEPTEMBER 30, 1998 - --------------------------------------------------------------------------------
PRINCIPAL AMOUNT MARKET VALUE LONG-TERM MUNICIPAL SECURITIES (CONTINUED) WEST VIRGINIA - 3.61% Harrison County, 6.75%, 8/01/24 $2,000,000 $ 2,271,020 West Virginia State Hospital Finance Authority Revenue, 8.80%, 1/01/18 (b) 1,500,000 1,742,445 ------------ 4,013,465 ------------ WISCONSIN - 3.39% Southeast Wisconsin Professional Baseball, 5.50%, 12/15/26 2,000,000 2,229,960 Wisconsin State Health & Educational Facility Authority Revenues, 5.50%, 2/15/28 1,500,000 1,537,530 ------------ 3,767,490 ------------ TOTAL LONG-TERM MUNICIPAL SECURITIES (COST $102,611,970) 110,459,857 ------------ SHORT-TERM MUNICIPAL SECURITIES - 2.16% CALIFORNIA - 0.45% California PCRB Series A, VRDN, 3.65%, 2/28/08 500,000 500,000 ------------ NEVADA - 0.54% Reno Nevada Hospital Revenue, VRDN, 4.10%, 5/15/23 600,000 600,000 ------------ NEW YORK - 0.54% City of New York VRDN, 4.25%, 8/01/16 200,000 200,000 New York City GO Bonds, VRDN, 3.95%, 8/15/19 200,000 200,000 New York State Energy Residential Housing & Development, VRDN, 4.10%, 7/01/15 200,000 200,000 ------------ 600,000 ------------ TEXAS - 0.45% North Central Texas Health Facility, Presbyterian Medical Center, VRDN, 4.10%, 12/01/15 500,000 500,000 ------------
PRINCIPAL AMOUNT MARKET VALUE SHORT-TERM MUNICIPAL SECURITIES (CONTINUED) WASHINGTON - 0.18% Washington Health Care, Sisters of Providence, Series I, VRDN, 4.05%, 10/01/05 $ 200,000 $ 200,000 ------------ TOTAL SHORT-TERM MUNICIPAL SECURITIES (COST $2,400,000) 2,400,000 ------------ TOTAL INVESTMENTS (COST $105,011,970)-101.58% 112,859,857 OTHER ASSETS LESS LIABILITIES - (1.58%) (1,750,720) ------------ NET ASSETS - 100.00% $111,109,137 ============
INVESTMENT ABBREVIATIONS GO - General Obligation IDA - Industrial Development Authority OID - Original Issue Discount PCRB - Pollution Control Revenue Bond SFM - Single Family Mortgage VRDN - Variable Rate Demand Note (a) Effective yield is the yield as calculated at time of purchase at which the bond accretes on an annual basis until its maturity date. (b) Represents inverse floating rate securities. (c) A portion of this security is held as collateral for open futures contracts. INVESTMENT TRANSACTIONS Cost of purchases and proceeds from sales of securities, other than short-term securities, aggregated $91,099,135 and $56,728,625, respectively. INCOME TAX INFORMATION At September 30, 1998, the aggregated cost of investment securities for federal income tax purposes was $105,011,970. Net unrealized appreciation aggregated $7,847,887, of which $7,847,887 is related to appreciated investment securities. SEE NOTES TO FINANCIAL STATEMENTS. 69 MENTOR MUNICIPAL INCOME PORTFOLIO - -------------------------------------------------------------------------------- STATEMENT OF ASSETS AND LIABILITIES SEPTEMBER 30, 1998 ASSETS Investments, at market value (cost $105,011,970) (Note 2) $112,859,857 Cash 84,254 Receivables Investments sold 985,674 Fund shares sold 870,855 Interest 1,685,891 ------------- TOTAL ASSETS 116,486,531 ------------- LIABILITIES Payables Investments purchased $4,840,799 Fund shares redeemed 60,067 Dividends 349,921 Variation margin (Note 2) 90,000 Accrued expenses and other liabilities 36,607 ---------- TOTAL LIABILITIES 5,377,394 ------------- NET ASSETS $111,109,137 ============= Net Assets represented by: (Note 2) Additional paid-in capital $105,840,947 Accumulated distributions in excess of net investment income (349,922) Accumulated net realized loss on investment transactions (2,004,046) Net unrealized appreciation of investments and open futures contracts 7,622,158 ------------- NET ASSETS $111,109,137 ============= NET ASSET VALUE PER SHARE Class A Shares $ 15.99 Class B Shares $ 15.94 Class Y Shares $ 16.00 OFFERING PRICE PER SHARE Class A Shares $ 16.79(a) Class B Shares $ 15.94 Class Y Shares $ 16.00 SHARES OUTSTANDING Class A Shares 3,237,676 Class B Shares 3,722,547 Class Y Shares 67
(a) Computation of offering price: 100/95.25 of net asset value. SEE NOTES TO FINANCIAL STATEMENTS. STATEMENT OF OPERATIONS YEAR ENDED SEPTEMBER 30, 1998 INVESTMENT INCOME Interest (Note 2) $ 5,400,238 EXPENSES Management fee (Note 4) $ 557,332 Distribution fee (Note 5) 257,381 Shareholder service fee (Note 5) 232,220 Transfer agent fee 102,171 Administration fee (Note 4) 92,888 Registration expenses 53,355 Custodian and accounting fees 26,161 Shareholder reports and postage expenses 8,237 Legal fees 2,878 Directors' fees and expenses 2,275 Audit fees 1,991 Miscellaneous 9,070 --------- Total expenses 1,345,959 ----------- NET INVESTMENT INCOME 4,054,279 ----------- REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS, FUTURES AND OPTIONS CONTRACTS Net realized loss on investments, futures and options contracts (Note 2) (41,138) Change in unrealized appreciation on investments 3,077,428 --------- NET GAIN ON INVESTMENTS, FUTURES AND OPTIONS CONTRACTS 3,036,290 ----------- NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $ 7,090,569 ===========
SEE NOTES TO FINANCIAL STATEMENTS. 70 MENTOR MUNICIPAL INCOME PORTFOLIO - -------------------------------------------------------------------------------- STATEMENTS OF CHANGES IN NET ASSETS
YEAR ENDED YEAR ENDED 9/30/98 9/30/97 NET INCREASE IN NET ASSETS Operations Net investment income $ 4,054,279 $ 2,950,727 Net realized gain (loss) on investments, futures and options contracts (41,138) 548,498 Change in unrealized appreciation on investments 3,077,428 1,603,630 ------------- ------------- Increase in net assets resulting from operations 7,090,569 5,102,855 ------------- ------------- Distributions to Shareholders From net investment income Class A (1,979,908) (1,179,998) Class B (2,308,071) (1,981,316) Class Y (43) -- From net realized gain on investments Class A -- (39,820) Class B -- (66,849) ------------- ------------- Total distributions to shareholders (4,288,022) (3,267,983) ------------- ------------- Capital Share Transactions (Note 7) Proceeds from sale of shares 45,477,369 25,738,018 Reinvested distributions 2,625,084 1,904,347 Shares redeemed (13,461,719) (10,560,419) ------------- ------------- Change in net assets resulting from capital share transactions 34,640,734 17,081,946 ------------- ------------- Increase in net assets 37,443,281 18,916,818 Net Assets Beginning of year 73,665,856 54,749,038 ------------- ------------- End of year (including accumulated distributions in excess of net investment income of ($349,922) and ($300,191), respectively) $ 111,109,137 $ 73,665,856 ============= =============
SEE NOTES TO FINANCIAL STATEMENTS. FINANCIAL HIGHLIGHTS CLASS A SHARES
YEAR YEAR YEAR YEAR YEAR ENDED ENDED ENDED ENDED ENDED 9/30/98 9/30/97 9/30/96 9/30/95 9/30/94 PER SHARE OPERATING PERFORMANCE Net asset value, beginning of year $ 15.50 $ 15.04 $ 14.92 $ 14.42 $ 16.05 ------- ------- ------- ------- ------- Income from investment operations Net investment income 0.66 0.81 0.82 0.81 0.82 Net realized and unrealized gain (loss) on investments 0.59 0.49 0.12 0.51 (1.54) ------- ------- ------- ------- ------- Total from investment operations 1.25 1.30 0.94 1.32 (0.72) ------- ------- ------- ------- ------- Less distributions From net investment income (0.76) (0.81) (0.82) (0.82) (0.81) From capital gains -- (0.03) -- - (0.10) ------- ------- ------- ------- ------- Total distributions (0.76) (0.84) (0.82) (0.82) (0.91) ------- ------- ------- ------- ------- Net asset value, end of year $ 15.99 $ 15.50 $ 15.04 $ 14.92 $ 14.42 ======= ======= ======= ======= ======= TOTAL RETURN* 8.24% 8.89% 6.46% 9.46% (4.83%) RATIOS / SUPPLEMENTAL DATA Net assets, end of year (in thousands) $51,757 $29,394 $17,558 $20,460 $25,056 Ratio of expenses to average net assets 1.17% 1.22% 1.24% 1.43% 1.24% Ratio of expenses to average net assets excluding waiver 1.17% 1.22% 1.24% 1.43% 1.33% Ratio of net investment income to average net assets 4.63% 5.09% 5.47% 5.56% 5.43% Portfolio turnover rate 62% 59% 46% 43% 87%
* Total return does not reflect sales commissions and is not annualized. SEE NOTES TO FINANCIAL STATEMENTS. 71 MENTOR MUNICIPAL INCOME PORTFOLIO - -------------------------------------------------------------------------------- FINANCIAL HIGHLIGHTS CLASS B SHARES
YEAR YEAR YEAR YEAR YEAR ENDED ENDED ENDED ENDED ENDED 9/30/98 9/30/97 9/30/96 9/30/95 9/30/94 PER SHARE OPERATING PERFORMANCE Net asset value, beginning of year $ 15.49 $ 15.05 $ 14.95 $ 14.43 $ 16.06 ------- ------- ------- ------- ------- Income from investment operations Net investment income 1.30 0.71 0.75 0.74 0.74 Net realized and unrealized gain (loss) on investments ( 0.14) 0.52 0.11 0.52 ( 1.54) ------- ------- ------- ------- ------- Total from investment operations 1.16 1.23 0.86 1.26 ( 0.80) ------- ------- ------- ------- ------- Less distributions From net investment income ( 0.71) ( 0.71) ( 0.76) ( 0.74) ( 0.73) From capital gains -- ( 0.08) -- ( 0.10) ------- ------- ------- ------- Total distributions ( 0.71) ( 0.79) ( 0.76) ( 0.74) ( 0.83) ------- ------- ------- ------- ------- Net asset value, end of year $ 15.94 $ 15.49 $ 15.05 $ 14.95 $ 14.43 ======= ======= ======= ======= ======= TOTAL RETURN* 7.70% 8.33% 5.87% 9.01% ( 5.34%) RATIOS / SUPPLEMENTAL DATA Net assets, end of year (in thousands) $59,351 $44,272 $37,191 $39,493 $46,157 Ratio of expenses to average net assets 1.67% 1.72% 1.74% 1.92% 1.74% Ratio of expenses to average net assets excluding waiver 1.67% 1.72% 1.74% 1.92% 1.86% Ratio of net investment income to average net assets 4.13% 4.60% 4.95% 5.07% 4.93% Portfolio turnover rate 62% 59% 46% 43% 87%
CLASS Y SHARES
PERIOD ENDED 9/30/98 (b) PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 15.51 -------- Income from investment operations Net investment income 1.39 Net realized and unrealized loss on investments (0.23) -------- Total from investment operations 1.16 -------- Less distributions From net investment income (0.67) -------- Net asset value, end of period $ 16.00 ======== TOTAL RETURN* 7.51% RATIOS / SUPPLEMENTAL DATA Net assets, end of period (in thousands) $ 1 Ratio of expenses to average net assets 0.92%(a) Ratio of net investment income to average net assets 5.66%(a) Portfolio turnover rate 62%
(a) Annualized. (b) For the period from November 19, 1997 (initial offering of Class Y shares) to September 30, 1998. * Total return does not reflect sales commissions and is not annualized. SEE NOTES TO FINANCIAL STATEMENTS. 72 MENTOR QUALITY INCOME PORTFOLIO MENTOR SHORT-DURATION INCOME PORTFOLIO MANAGERS' COMMENTARY: THE ACTIVE FIXED-INCOME MANAGEMENT TEAM SEPTEMBER 30, 1998 - -------------------------------------------------------------------------------- MARKET CONDITIONS The 12-month period ending September 30, 1998 saw a dramatic decline in the level of interest rates across the yield curve. At quarter end, long-term interest rates were at levels not seen since the 1960s. The 30-year Treasury ended the quarter yielding under 5%, at 4.97%, a full 1.44% below its level at the beginning of the period. Two-year Treasury yields saw an even more substantial decline, falling 1.51% to 4.27% over the course of the period. On September 29th, the Federal Reserve initiated its first monetary intervention in over two years, a 0.25% reduction in the Federal Funds rate. And at the end of September, the short-to-intermediate portion of the yield curve was actually inverted, as 6-month Treasury Bills were yielding more than 5-year Treasury Bonds. This implied market expectations of future monetary easing by the Federal Reserve, continued benign domestic inflation, and a slowing economy. In the past few months the market has grown increasingly concerned that a global deflationary spiral could unfold. The IMF policy prescription of currency devaluation coupled with tight monetary and fiscal policies appears to be making economic conditions even worse for Korea, Indonesia, Russia, etc. The large debt burdens and faltering growth rates of the economies under IMF supervision have raised the specter of wide scale defaults despite IMF intervention. Russia's August announcement that it would simultaneously devalue the ruble and unilaterally reschedule the repayment terms of its debt brought this fear home to many global investors. As the implicit guarantee of the IMF loses its credibility, the emerging markets that had been relatively healthy are being put under increasing pressure. Concerns about the credit quality of these nations have elevated interest rates in these economies to the point where a slowdown in economic growth is becoming inevitable. Such a global slowdown cannot help but put significant downward pressure on U.S. growth and inflation rates. The U.S. has not been immune to global credit quality anxiety. The yield spread between treasury rates and high-quality corporate bonds, a traditional measure of credit concerns within the economy, ballooned toward quarter end to levels not seen since the last recession. The high-yield market has come under even more stress as investors abandon markets with any hint of credit risk. The underperformance of spread sectors has caused leveraged investors, such as hedge funds and real estate investment trusts, to come under severe funding pressure. As lenders call their loans or demand more collateral, these leveraged investors are left with few alternatives but to sell assets into an already depressed market. These forced asset liquidations have further depressed prices in corporate bonds and mortgage-backed securities, and in many instances trading activity has all but ceased in many market sectors. PERFORMANCE For the 12-month period ending September 30, 1998, the Mentor Quality Income Portfolio A shares returned 9.95% and the B shares 9.46%, compared to 8.30% for its Lipper U.S. Mortgage peer group. The Mentor Short-Duration Income Portfolio A and B shares returned 6.87% and 6.68%, respectively, exclusive of sales charges for the 12-month period, compared to 8.04% for its Lipper Short-Intermediate Investment Grade peer group. The period saw massive outperformance of treasury markets as compared to corporate bonds, 73 MENTOR QUALITY INCOME PORTFOLIO MENTOR SHORT-DURATION INCOME PORTFOLIO MANAGERS' COMMENTARY: THE ACTIVE FIXED-INCOME MANAGEMENT TEAM SEPTEMBER 30, 1998 - -------------------------------------------------------------------------------- mortgage-backed, asset-backed, and all other spread product securities. This resulted in our trailing the Merrill Lynch 7-year Treasury and 3-year Treasury Index benchmarks, which returned 15.78% and 10.03% respectively for the 12-month period. MARKET OUTLOOK Economic growth is almost certain to slow in the upcoming year, as the impact of slower growth overseas and distressed domestic credit markets takes effect. We do not, however, anticipate a recession for 1999. The United States has ample policy alternatives to fight any slowing in the domestic economy. As inflation has fallen, real interest rates (the nominal interest rate minus inflation) implied by the Fed Funds rate has risen appreciably. Assuming that the turmoil overseas will place continued downward pressure on inflation rates, the Fed could lower Fed Funds by over 150 basis points (1.50%) and still maintain a real interest rate higher than the historical average. Unlike Japan, the U.S. has a healthy, well-capitalized banking system and therefore any easing in monetary conditions will help stimulate demand. For the first time in many decades, the current budget surplus means that an expansionary fiscal policy could be implemented without necessarily driving up real interest rates and therefore crowding out private investment. Given sufficient aggressive action on the part of the Fed, a recession can be avoided. With an easing Fed and declining inflation, the backdrop for bonds remains positive. The market could see rates last observed in the 1950s. Furthermore, as the Fed provides liquidity to the currently distressed credit markets, corporate bonds and mortgage-backed securities have the potential for significant outperformance in the upcoming year. THE PORTFOLIOS Our short-term strategy in this tumultuous environment has been to tilt portfolio durations somewhat long relative to our benchmarks, as well as weighting sector allocations more heavily toward treasury securities. Given our long-term confidence in the U.S. economy we are waiting for an opportunity to aggressively move into domestic spread sectors. Prior to such a move, we will have to be convinced that these markets have stabilized. In our opinion such stabilization will require the Fed to continue to move forcefully to further ease credit conditions. The primary risk we see to our outlook is timing. The U.S. economy has tremendous forward momentum and the current yield curve is already pricing in an aggressive Fed ease. Should events unfold more slowly than the market hopes, the bond market could encounter some short-term turbulence. We would view these sell-offs as short term in nature and would utilize the higher yield levels to extend our duration further. November 1998 74 MENTOR QUALITY INCOME PORTFOLIO SEPTEMBER 30, 1998 - -------------------------------------------------------------------------------- PERFORMANCE COMPARISON Comparison of change in value of a hypothetical $10,000 purchase in Mentor Quality Income Portfolio Class A and Class B Shares and the Merrill Lynch 7-Year Treasury Index.~ [GRAPH] A Shares B Shares Merrill Lynch 7-Year Treasury Index 4/29/92 9525 10000 10000 9/30/92 9846 10324 11041 9/30/93 10378 10827 12345 9/30/94 10036 10406 11721 9/30/95 11222 11585 13533 9/30/96 11681 11999 14043 9/30/97 12833 13113 15388 9/30/98 14110 14071 17815 Average Annual Returns as of 9/30/98 Including Sales Charges 1-Year 5-Year Since Inception+++ Class A 4.71% 5.31% 5.51% Class B 5.46% 5.65% 7.14% PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE PERFORMANCE. YOUR INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO WHEN SHARES ARE REDEEMED, THEY MAY BE WORTH MORE OR LESS THAN ORIGINAL COST. MUTUAL FUNDS ARE NOT OBLIGATIONS OF OR GUARANTEED BY ANY BANK AND ARE NOT FEDERALLY INSURED. ~ The Merrill Lynch 7-Year Treasury Index is adjusted to reflect reinvestment of interest on securities in the index. The Merrill Lynch 7-Year Treasury Index is not adjusted to reflect sales loads, expenses, or other fees that the SEC requires to be reflected in the Portfolio's performance. + Represents a hypothetical investment of $10,000 in Mentor Quality Income Portfolio Class B Shares. A contingent deferred sales charge will be imposed, if applicable, on Class B Shares at rates ranging from a maximum of 4.00% of amounts redeemed during the first year following the date of purchase to 1.00% of amounts redeemed during the six-year period following the date of purchase. The value of Class B Shares reflects a redemption fee in effect at the end of each of the stated periods. The Class B Shares' performance assumes the reinvestment of all dividends and distributions. ++ Represents a hypothetical investment of $10,000 in Mentor Quality Income Portfolio Class A Shares, after deducting the maximum sales charge of 4.75% ($10,000 investment minus $475 sales charge = $9,525). The Class A Shares' performance assumes the reinvestment of all dividends and distributions. +++ Reflects operations of Mentor Quality Income Portfolio Class A and Class B Shares from the date of commencement of operations on 4/29/92 through 9/30/98. Comparison of change in value of a hypothetical $10,000 purchase in Mentor Quality Income Portfolio Class Y Shares and the Merrill Lynch 7-Year Treasury Index.~ [GRAPH] Y Shares Merrill Lynch 7-Year Treasury Index 11/19/97 10000 10000 12/31/97 10038 10142 3/31/98 10144 10311 6/30/98 10378 10562 9/30/98 10869 11364 Total Returns as of 9/30/98 1-Year Since Inception** Class Y n/a 8.94% PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE PERFORMANCE. YOUR INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO WHEN SHARES ARE REDEEMED, THEY MAY BE WORTH MORE OR LESS THAN ORIGINAL COST. MUTUAL FUNDS ARE NOT OBLIGATIONS OF OR GUARANTEED BY ANY BANK AND ARE NOT FEDERALLY INSURED. * Represents a hypothetical investment of $10,000 in Mentor Quality Income Portfolio Class Y Shares. These shares are not subject to any sales or contingent deferred sales charges. The Class Y Shares' performance assumes the reinvestment of all dividends and distributions. ** Reflects operations of Mentor Quality Income Portfolio Class Y Shares from the date of issuance on 11/19/97 through 9/30/98. 75 MENTOR SHORT-DURATION INCOME PORTFOLIO SEPTEMBER 30, 1998 - -------------------------------------------------------------------------------- PERFORMANCE COMPARISON Comparison of change in value of hypothetical $10,000 purchase in Mentor Short-Duration Income Portfolio Class A Shares and the Merrill Lynch 3-Year Treasury.~ [GRAPH] Class A 3-Year Treasury 6/16/95 9900 10000 9/30/95 9931 10139 9/30/96 10532 11038 9/30/97 11304 11571 9/30/98 12093 12732 Average Annual Returns as of 9/30/98 Including Sales Charges 1-Year Since Inception** Class A 5.89% 5.94% Comparison of change in value of hypothetical $10,000 purchase in Mentor Short-Duration Income Portfolio Class B Shares and Merrill Lynch 3-year Treasury.~ [GRAPH] Class B 3-Year Treasury 4/29/94 10000 10000 12/31/94 10093 10075 9/30/95 10623 ` 11051 9/30/96 11225 11709 9/30/97 12125 12600 9/30/98 12945 13053 Average Annual Returns as of 9/30/98 Including Sales Charges 1-Year Since Inception++ Class B 2.68% 5.52% PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE PERFORMANCE. YOUR INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO WHEN SHARES ARE REDEEMED, THEY MAY BE WORTH MORE OR LESS THAN ORIGINAL COST. MUTUAL FUNDS ARE NOT OBLIGATIONS OF OR GUARANTEED BY ANY BANK AND ARE NOT FEDERALLY INSURED. ~ The Merrill Lynch 3-Year Treasury Index is adjusted to reflect reinvestment of interest on securities in the index. It is not adjusted to reflect sales loads, expenses, or other fees that the SEC requires to be reflected in the Portfolio's performance. The Portfolio invests in securities other than Treasuries. * Represents a hypothetical investment of $10,000 in Mentor Short-Duration Income Portfolio Class A Shares, after deducting the maximum sales charge of 1.00% ($10,000 investment minus $100 sales charges = $9,900. The Class A Shares' performance assumes the reinvestment of all dividends and distributions. ** Reflects operations of Mentor Short-Duration Income Portfolio Class A from the date of issuance on 6/16/95 through 9/30/98. + Represents a hypothetical investment of $10,000 in Mentor Short-Duration Income Portfolio Class B Shares. A contingent deferred sales charge will be imposed, if applicable on Class B Shares at rates ranging from a maximum of 4.00% of amounts redeemed during the first year following the date of purchase to 1.00% of amounts redeemed during the six-year period following the date of purchase. The value of Class B Shares reflects a redemption fee in effect at the end of each of the stated periods. The Class B Shares' performance assumes the reinvestment of all dividends and distributions. ++ Reflects operations of Mentor Short-Duration Income Portfolio Class B Shares from the date of commencement of operations on 4/29/94 through 9/30/98. 76 MENTOR SHORT-DURATION INCOME PORTFOLIO SEPTEMBER 30, 1998 - -------------------------------------------------------------------------------- PERFORMANCE COMPARISON Comparison of change in value of hypothetical $10,000 purchase in Mentor Short-Duration Income Portfolio Class Y Shares and the Merrill Lynch 3-Year Treasury.~ [GRAPH] Class Y 3-Year Treasury 11/19/97 10000 10000 12/31/97 10032 10081 3/31/98 10167 10239 6/30/98 10317 10413 9/30/98 10638 10875 Total Returns as of 9/30/98 1-Year Since Inception** Class Y n/a 6.64% ~ The Merrill Lynch 3-Year Treasury Index is adjusted to reflect reinvestment of interest on securities in the index. It is not adjusted to reflect sales loads, expenses, or other fees that the SEC requires to be reflected in the Portfolio's performance. The Portfolio invests in securities other than Treasuries. * Represents a hypothetical investment of $10,000 in Mentor Short-Duration Income Portfolio Class Y Shares. These shares are not subject to any sales or contingent deferred sales charges. The Class Y Shares' performance assumes the reinvestment of all dividends and distributions. ** Reflects operations of Mentor Short-Duration Income Portfolio Class Y from the date of issuance on 11/19/97 through 9/30/98. 77 MENTOR QUALITY INCOME PORTFOLIO PORTFOLIO OF INVESTMENTS SEPTEMBER 30, 1998 - --------------------------------------------------------------------------------
PRINCIPAL AMOUNT MARKET VALUE LONG-TERM INVESTMENTS - 143.47% PREFERRED STOCK - 2.11% Home Ownership Funding Corporation (cost $3,939,796) $4,350,000 $ 4,373,725 ----------- ASSET-BACKED SECURITIES - 7.61% Advanta Mortgage Loan Trust, Series 1993-4, 5.55%, 3/25/10 - 1/25/25 1,960,695 1,985,118 AFG Receivables Trust, 7.00%, 2/15/03 (a) 1,250,918 1,260,091 CS First Boston, Series 1996-2 A6, 7.18%, 2/25/18 6,500,000 6,968,124 Equifax Credit Corporation, Series 1994-1 B, 5.75%, 3/15/09 1,504,448 1,509,739 Fifth Third Bank Auto Grantor Trust, 6.20%, 9/15/01 702,998 706,572 NASCOR, Series 1997-18, 6.75%, 12/25/27 2,587,927 2,697,132 Old Stone Credit Corporation Home Equity Trust, Series 1993-1 B1, 6.00%, 3/15/08 624,707 630,054 ----------- TOTAL ASSET-BACKED SECURITIES (COST $14,997,748) 15,756,830 ----------- U.S. GOVERNMENT SECURITIES AND AGENCIES - 102.27% Federal Home Loan Mortgage Corporation 6.50%, Series 1647B, 11/15/08, REMIC 3,263,696 3,263,696 6.00%, Series 1693Z, 3/15/09, REMIC 6,116,037 6,218,120 6.50%, Series 26C, 7/25/18 7,000,000 7,241,864 Federal National Mortgage Association 6.50%, 5/18/28 2,992,041 2,977,081 6.00% - 6.50%, 9/25/08 - 8/01/28 68,855,587 69,140,559 Government National Mortgage Association 7.00%, 12/15/08 2,974,460 3,094,571 6.00% - 7.00%, 3/15/28 - 8/15/28 44,411,497 45,459,522 Government National Mortgage Association II 4.50% - 7.00%, 4/20/22 - 1/20/28 7,152,832 7,209,007 U.S. Treasury Bonds, 6.13%, 11/15/27 8,600,000 9,909,178 U.S. Treasury Notes, 5.38% - 5.63% 7/31/00 - 5/15/08 53,650,000 57,369,396 ----------- TOTAL U.S. GOVERNMENT SECURITIES AND AGENCIES (COST $205,742,125) 211,882,994 -----------
PRINCIPAL AMOUNT MARKET VALUE CORPORATE BONDS - 11.63% Capital One Bank, 7.15% - 7.20%, 7/19/99 - 9/15/06 $4,750,000 $ 4,948,018 Ford Capital, 9.88%, 5/15/02 2,525,000 2,929,000 Lehman Brothers Holdings, 8.50%, 5/01/07 3,000,000 3,345,159 Lehman Brothers, Inc., 7.50%, 8/01/26 3,500,000 3,635,943 ReliaStar Financial Corporation, 6.63%, 9/15/03 5,000,000 5,259,300 Salomon, Inc., 7.30%, 5/15/02 2,000,000 2,140,834 United Dominion Realty, 7.07%, 11/15/06 1,700,000 1,827,512 ----------- TOTAL CORPORATE BONDS (COST $23,143,699) 24,085,766 ----------- MISCELLANEOUS - 0.97% CSC Holdings, Inc., 7.25%, 7/15/08 1,000,000 1,007,239 Playtex Family Production Corporation, 9.00%, 12/15/03 1,000,000 1,007,685 ----------- TOTAL MISCELLANEOUS (COST $2,024,403) 2,014,924 ----------- COLLATERALIZED MORTGAGE OBLIGATIONS - 14.75% Chase Mortgage Finance Corporation, Series 1993-L2 M, 7.00%, 10/25/24 2,958,977 3,113,602 Equifax Credit Corporation, Series 1998-2, 6.16%, 4/15/08 2,370,000 2,407,761 General Electric Capital Mortgage Services, Inc., Series 1993-18 B1, 6.00%, 2/25/09 1,924,384 1,946,511 General Electric Capital Mortgage Services, Inc., Series 1998-11, 6.50% - 7.00%, 1/25/13 - 1/25/28 4,607,307 4,786,961 Key Auto Finance Trust, 6.15%, 10/15/01 1,500,000 1,513,112 NASCOR, Series 1996-2 Class M, 7.00%, 9/25/11 1,751,689 1,855,812 Prudential Home, Series 1995-5 B1, 7.25%, 9/25/25 (a) 1,453,140 1,515,504 Prudential Home, Series 1995-5 M, 7.25%, 9/25/25 2,562,369 2,667,547 Prudential Home, Series 1995-7 M, 7.00%, 11/25/25 2,813,484 2,959,016
78 MENTOR QUALITY INCOME PORTFOLIO PORTFOLIO OF INVESTMENTS SEPTEMBER 30, 1998 - --------------------------------------------------------------------------------
PRINCIPAL AMOUNT MARKET VALUE COLLATERALIZED MORTGAGE OBLIGATIONS (CONTINUED) Prudential Home, Series 1996-4 M, 6.50%, 4/25/26 $5,172,223 $ 5,342,964 Prudential Home, Series 1996-8 M, 6.75%, 6/25/26 2,340,523 2,448,236 ------------ TOTAL COLLATERALIZED MORTGAGE OBLIGATIONS (COST $28,983,412) 30,557,026 ------------ RESIDUAL INTERESTS (A) - 4.13% Capital Mortgage Funding I, Inc., 1998-1, 1/22/27 43,831 689,073 General Mortgage Securities II, Inc., 1995-1, 1998, 6/25/20 14,918 419,119 General Mortgage Securities II, Inc., 1995-4, 1998, 6/25/23 8,768 397,338 General Mortgage Securities II, Inc., 1997-4, 1998, 5/20/22 11,724 506,284 General Mortgage Securities II, Inc., 1997-5, 1998, 7/20/23 23,164 735,034 National Mortgage Funding I, Inc., 1995-4, 1998, 3/20/21 7,182 127,547 National Mortgage Funding I, Inc., 1997-6, 9/20/21 32,943 640,712 National Mortgage Funding I, Inc., 1997-7, 7/20/22 35,133 648,314 National Mortgage Funding I, Inc., 1997-9, 10/20/24 25,739 632,940 National Mortgage Funding I, Inc., 1997-10, 10/20/24 34,246 475,067 National Mortgage Funding I, Inc., 1998-1, 10/20/22 17,335 440,254 National Mortgage Funding I, Inc., 1998-2, 10/20/23 19,397 462,999 National Mortgage Funding I, Inc., 1998-3, 11/20/23 19,847 469,598 National Mortgage Funding I, Inc., 1998-5, 11/25/22 7,274 381,156 National Mortgage Funding I, Inc., 1998-8, 5/20/24 34,593 498,670 National Mortgage Funding I, Inc., 1998-9, 11/20/22 28,893 502,352 National Mortgage Funding I, Inc., 1998-10, 1/20/23 17,413 540,932 ------------ TOTAL RESIDUAL INTERESTS (COST $9,933,404) 8,567,389 ------------ 297,238,654 ------------
PRINCIPAL AMOUNT MARKET VALUE SHORT-TERM INVESTMENT - 0.67% REPURCHASE AGREEMENT Goldman Sachs & Company Dated 9/30/98, 5.60%, due 10/01/98, collateralized by $1,417,776 Federal National Mortgage Association, 6.00%, 8/01/13, market value $1,431,511 (cost $1,399,604) $1,399,604 $ 1,399,604 ---------- ------------ TOTAL INVESTMENTS (COST $290,164,191) -144.14% $298,638,258 OTHER ASSETS LESS LIABILITIES - (44.14%) (91,456,993) ------------ NET ASSETS - 100.00% $207,181,265 ============
INVESTMENT ABBREVIATIONS ARM - Adjustable Rate Mortgage MBS - Mortgage-Backed Security REMIC - Real Estate Mortgage Investment Conduit (a) These are securities that may be resold to "qualified institutional buyers" under Rule 144A or securities offered pursuant to Section 4 (2) of the Securities Act of 1933, as amended. These securities have been determined to be liquid under guidelines established by the Board of Trustees. INVESTMENT TRANSACTIONS Cost of purchases and proceeds from sales of securities, other than short-term securities, aggregated $426,685,104 and $225,275,749, respectively. INCOME TAX INFORMATION At September 30, 1998, the aggregated cost of investment securities for federal income tax purposes was $290,164,191. Net unrealized appreciation aggregated $8,474,067, of which $9,931,057, related to appreciated investment securities and $1,456,990, related to depreciated investment securities. SEE NOTES TO FINANCIAL STATEMENTS. 79 MENTOR QUALITY INCOME PORTFOLIO - -------------------------------------------------------------------------------- STATEMENT OF ASSETS AND LIABILITIES SEPTEMBER 30, 1998 ASSETS Investments, at market value (Note 2) Investment securities $297,238,654 Repurchase agreements 1,399,604 ------------ Total investments (cost $290,164,191) 298,638,258 Collateral for securities loaned (Note 2) 1,605,500 Cash 118,918 Receivables Fund shares sold 1,324,653 Dividends and interest 2,790,157 Other assets 35,189 ------------ TOTAL ASSETS 304,512,675 ------------ LIABILITIES Payables Securities loaned (Note 2) $ 1,605,500 Reverse repurchase agreement 94,533,000 Fund shares redeemed 101,673 Dividends 923,573 Accrued expenses and other liabilities 167,664 ----------- TOTAL LIABILITIES 97,331,410 ------------ NET ASSETS $207,181,265 ============ Net Assets represented by: (Note 2) Additional paid-in capital $213,925,048 Accumulated distributions in excess of net investment income (923,573) Accumulated net realized loss on investment transactions (14,294,277) Net unrealized appreciation of investments 8,474,067 ------------ NET ASSETS $207,181,265 ============ NET ASSET VALUE PER SHARE Class A Shares $ 13.61 Class B Shares $ 13.61 Class Y Shares $ 13.69 OFFERING PRICE PER SHARE Class A Shares $ 14.29(a) Class B Shares $ 13.61 Class Y Shares $ 13.69 SHARES OUTSTANDING Class A Shares 6,927,132 Class B Shares 8,297,359 Class Y Shares 80
(a) Computation of offering price: 100/95.25 of net asset value. SEE NOTES TO FINANCIAL STATEMENTS. STATEMENT OF OPERATIONS YEAR ENDED SEPTEMBER 30, 1998 INVESTMENT INCOME Interest (b) (Note 2) $ 11,610,166 EXPENSES Management fee (Note 4) $ 1,025,941 Distribution fee (Note 5) 467,042 Shareholder service fee (Note 5) 427,474 Transfer agent fee 212,090 Administration fee (Note 4) 174,343 Registration expenses 84,362 Custodian and accounting fees 34,008 Shareholder reports and postage expenses 24,577 Legal fees 5,369 Directors' fees and expenses 4,244 Audit fees 3,715 Miscellaneous 16,925 ----------- Total expenses 2,480,090 Deduct Waiver of management fee (Note 4) (204,530) ------------ NET INVESTMENT INCOME 9,334,606 ------------ REALIZED AND UNREALIZED GAIN ON INVESTMENTS AND INTEREST-RATE SWAP CONTRACTS Net realized gain on investments and interest-rate swap contracts (Note 2) 713,191 Change in unrealized appreciation on investments 6,558,180 ----------- NET GAIN ON INVESTMENTS AND INTEREST-RATE SWAP CONTRACTS 7,271,371 ------------ NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $ 16,605,977 ============
(b) Net of interest expense of $1,961,350 ($921,496 related to interest- rate swaps and $1,039,854 related to borrowings). SEE NOTES TO FINANCIAL STATEMENTS. 80 MENTOR QUALITY INCOME PORTFOLIO - -------------------------------------------------------------------------------- STATEMENTS OF CHANGES IN NET ASSETS
YEAR ENDED YEAR ENDED 9/30/98 9/30/97 NET INCREASE IN NET ASSETS Operations Net investment income $ 9,334,606 $ 6,390,445 Net realized gain on investments and interest-rate swap contracts 713,191 222,072 Change in unrealized appreciation on investments 6,558,180 2,224,113 ------------- ------------- Increase in net assets resulting from operations 16,605,977 8,836,630 ------------- ------------- Distributions to Shareholders From net investment income Class A (4,831,082) (2,180,277) Class B (5,431,749) (4,210,168) Class Y (51) - In excess of net investment income Class A - (150,441) Class B - (212,242) ------------- ------------- Total distributions to shareholders (10,262,882) (6,753,128) ------------- ------------- Capital Share Transactions (Note 7) Proceeds from sale of shares 106,644,051 63,942,122 Reinvested distributions 6,677,759 4,044,282 Shares redeemed (40,705,601) (21,179,174) ------------- ------------- Change in net assets resulting from capital share transactions 72,616,209 46,807,230 ------------- ------------- Increase in net assets 78,959,304 48,890,732 Net Assets Beginning of year 128,221,961 79,331,229 ------------- ------------- End of year (including accumulated distributions in excess of net investment income of ($923,573) and ($390,590), respectively) $ 207,181,265 $ 128,221,961 ============= =============
SEE NOTES TO FINANCIAL STATEMENTS. FINANCIAL HIGHLIGHTS CLASS A SHARES
YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED 9/30/98 9/30/97 9/30/96 9/30/95 9/30/94 PER SHARE OPERATING PERFORMANCE Net asset value, beginning of year $ 13.18 $ 12.91 $ 13.29 $ 12.75 $ 14.04 -------- -------- -------- -------- -------- Income from investment operations Net investment income 0.79 0.97 0.89 0.84 0.84 Net realized and unrealized gain (loss) on investments 0.47 0.26 (0.37) 0.61 (1.30) -------- -------- -------- -------- -------- Total from investment operations 1.26 1.23 0.52 1.45 (0.46) -------- -------- -------- -------- -------- Less distributions From net investment income (0.83) (0.96) (0.90) (0.91) (0.83) -------- -------- -------- -------- -------- Net asset value, end of year $ 13.61 $ 13.18 $ 12.91 $ 13.29 $ 12.75 ======== ======== ======== ======== ======== TOTAL RETURN* 9.95% 9.86% 4.09% 11.82% (3.39%) RATIOS/SUPPLEMENTAL DATA Net assets, end of year (in thousands) $ 94,279 $ 53,176 $ 21,092 $ 24,472 $ 30,142 Ratio of expenses to average net assets 1.05% 1.05% 1.05% 1.32% 1.38% Ratio of expenses to average net assets excluding waiver 1.18% 1.18% 1.31% 1.36% 1.39% Ratio of net investment income to average net assets 5.73% 7.01% 6.84% 6.73% 6.33% Portfolio turnover rate 114% 100% 254% 368% 455%
* Total return does not reflect sales commissions and is not annualized. SEE NOTES TO FINANCIAL STATEMENTS. 81 MENTOR QUALITY INCOME PORTFOLIO - -------------------------------------------------------------------------------- FINANCIAL HIGHLIGHTS CLASS B SHARES
YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED 9/30/98 9/30/97 9/30/96 9/30/95 9/30/94 PER SHARE OPERATING PERFORMANCE Net asset value, beginning of year $ 13.18 $ 12.93 $ 13.31 $ 12.76 $ 14.06 -------- -------- -------- -------- -------- Income from investment operations Net investment income 0.72 0.86 0.84 0.79 0.82 Net realized and unrealized gain (loss) on investments 0.48 0.30 (0.38) 0.61 (1.37) -------- -------- -------- -------- -------- Total from investment operations 1.20 1.16 0.46 1.40 (0.55) -------- -------- -------- -------- -------- Less distributions From net investment income (0.77) (0.91) (0.84) (0.85) (0.75) --------- -------- -------- -------- -------- Net asset value, end of year $ 13.61 $ 13.18 $ 12.93 $ 13.31 $ 12.76 ========= ======== ======== ======== ======== TOTAL RETURN* 9.46% 9.29% 3.57% 11.33% (3.97%) RATIOS/SUPPLEMENTAL DATA Net assets, end of year (in thousands) $ 112,901 $75,046 $ 58,239 $ 62,155 $ 77,888 Ratio of expenses to average net assets 1.55% 1.55% 1.55% 1.74% 1.88% Ratio of expenses to average net assets excluding waiver 1.67% 1.68% 1.81% 1.79% 1.90% Ratio of net investment income to average net assets 5.22% 6.51% 6.36% 6.24% 6.21% Portfolio turnover rate 114% 100% 254% 368% 455%
CLASS Y SHARES
PERIOD ENDED 9/30/98 (b) PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 13.20 ---------- Income from investment operations Net investment income 0.78 Net realized and unrealized gain on investments 0.39 ---------- Total from investment operations 1.17 ---------- Less distributions From net investment income (0.68) ---------- Net asset value, end of period $ 13.69 ========== TOTAL RETURN* 8.94% RATIOS/SUPPLEMENTAL DATA Net assets, end of period (in thousands) $ 1 Ratio of expenses to average net assets 0.80% (a) Ratio of expenses to average net assets exluding waiver 0.93% (a) Ratio of net investment income to average net assets 7.09% (a) Portfolio turnover rate 114%
(a) Annualized. (b) for the period from November 19, 1997 (initial offering of Class Y shares) to September 30, 1998. * Total return does not reflect sales commissions and is not annualized. SEE NOTES TO FINANCIAL STATEMENTS. 82 MENTOR SHORT-DURATION INCOME PORTFOLIO PORTFOLIO OF INVESTMENTS SEPTEMBER 30, 1998 - --------------------------------------------------------------------------------
PRINCIPAL AMOUNT MARKET VALUE ASSET-BACKED SECURITIES - 12.18% Advanta Home Equity Loan, 6.15%, 10/25/09 $ 766,206 $ 780,265 Advanta Mortgage Loan Trust 1993-3 A3, 4.75% - 5.55%, 2/25/10 - 3/25/10 948,868 947,007 AFC Home Equity Loan Trust, 6.60%, 2/25/27 1,499,955 1,514,193 AFG Receivables Trust, 6.20% - 7.05%, 9/15/00 - 2/15/03 (a) 3,098,596 3,116,978 CS First Boston 1996-2, 6.32% - 7.18%, 2/25/18 5,428,834 5,722,852 Equifax Credit Corporation 1994-1B, 5.75%, 3/15/09 478,313 479,995 Fifth Third Auto Grantor Trust, 6.20%, 9/15/01 351,859 353,648 Old Stone Credit Corporation, 6.20%, 6/15/08 274,327 277,455 Olympic Automobiles Receivables Trust, 6.85% - 7.35%, 6/15/01 - 10/15/01 1,431,929 1,440,041 Union Acceptance Corporation, 6.45% - 6.70%, 6/08/03 - 5/10/04 3,211,430 3,274,164 ----------- TOTAL ASSET-BACKED SECURITIES (COST $17,569,230) 17,906,598 ----------- U.S. GOVERNMENT SECURITIES AND AGENCIES - 74.00% Federal National Mortgage Association 6.00%, 5/01/13, ARM 13,278,924 13,415,870 10.00%, 6/01/05, MBS 188,066 197,098 Government National Mortgage Association 7.00%, 12/15/08 1,123,686 1,169,061 6.50%, 3/15/28 2,940,243 3,003,643 7.00%, 8/15/28 9,991,943 10,304,191 Government National Mortgage Association II 4.50%, 10/20/27 - 1/20/28 6,599,445 6,581,813
PRINCIPAL AMOUNT MARKET VALUE U.S. GOVERNMENT SECURITIES AND AGENCIES (CONTINUED) Government National Mortgage Association II 7.00%, 7/20/22 - 9/20/23 $9,244,030 $ 9,411,333 U.S. Treasury Notes, 5.38% - 6.63%, 7/31/00 - 5/15/08 61,950,000 64,731,078 ----------- TOTAL U.S. GOVERNMENT SECURITIES AND AGENCIES (COST $107,576,668) 108,814,087 ----------- COLLATERALIZED MORTGAGE OBLIGATIONS - 3.68% Equifax Credit Corporation, 6.16%, 4/15/08 1,362,750 1,384,463 Key Auto Finance Trust, 6.15%, 10/15/01 4,000,000 4,034,964 ----------- TOTAL COLLATERALIZED MORTGAGE OBLIGATIONS (COST $5,359,496) 5,419,427 ----------- CORPORATE BONDS - 16.63% Association Corporation NA, 7.88%, 9/30/01 1,000,000 1,077,892 Capital One Bank, 7.15% - 7.20%, 7/19/99 - 9/15/06 2,500,000 2,577,034 Dayton Hudson Company, 6.63%, 3/01/03 2,000,000 2,121,698 Ford Capital, 9.88%, 5/15/02 2,525,000 2,929,000 General Motors Acceptance Corporation, 5.63% - 6.88%, 2/01/99 - 7/15/01 2,750,000 2,854,932 Lehman Brothers, 6.20% - 6.63%, 11/15/00 - 1/15/02 3,750,000 3,799,689 Playtex Family Production Corporation, 9.00%, 12/15/03 1,000,000 1,007,685 Salomon Incorporated, 5.50% - 7.30%, 1/15/99 - 5/15/02 3,750,000 3,935,117 The Money Store, 6.28%, 12/15/22 4,000,000 4,143,804 ----------- TOTAL CORPORATE BONDS (COST $23,808,616) 24,446,851 -----------
83 MENTOR SHORT-DURATION INCOME PORTFOLIO PORTFOLIO OF INVESTMENTS SEPTEMBER 30, 1998 - --------------------------------------------------------------------------------
PRINCIPAL AMOUNT MARKET VALUE RESIDUAL INTERESTS (A) - 1.57% General Mortgage Securities II, Inc., 1997-4, 1998, 5/20/22 $ 3,908 $ 167,785 National Mortgage Funding, Inc., 1998-7, 7/20/23 49,685 674,478 National Mortgage Funding, Inc., 1998-6, 1/20/23 53,627 706,457 National Mortgage Funding, Inc., 1998-8, 5/20/24 23,062 332,447 National Mortgage Funding, Inc., 1997-9, 11/20/24 17,159 421,960 ------------ TOTAL RESIDUAL INTERESTS (COST $2,666,160) 2,303,127 ------------ SHORT-TERM INVESTMENTS - 2.88% VARIABLE RATE DEMAND NOTE Hilander Finance, LLC, 5.70%, 12/01/25 1,850,000 1,850,000 ------------ REPURCHASE AGREEMENT Goldman Sachs & Company Dated 9/30/98, 5.60%, due 10/01/98, collateralized by $2,422,945 Federal National Mortgage Association, 6.00%, 8/01/13, market value $2,446,418 2,391,457 2,391,457 ------------ TOTAL SHORT-TERM INVESTMENTS (COST $4,241,457) 4,241,457 ------------ TOTAL INVESTMENTS (COST $161,221,627)-110.94% 163,131,547 OTHER ASSETS LESS LIABILITIES - (10.94%) (16,087,108) ------------ NET ASSETS - 100.00% $147,044,439 ============
INVESTMENT ABBREVIATIONS ARM - Adjustable Rate Mortgage MBS - Mortgage Backed Securities (a) These are securities that may be resold to "qualified institutional buyers" under rule 144A or securities offered pursuant to section 4(2) of the Securities Act of 1933, as amended. These securites have been determined to be liquid under guidelines established by the Board of Trustees. INVESTMENT TRANSACTIONS Cost of purchases and proceeds from sales of securities, other than short-term securities, aggregated $296,888,520 and $175,441,302, respectively. INCOME TAX INFORMATION At September 30, 1998, the aggregated cost of investment securities for federal income tax purposes was $161,223,032. Net unrealized appreciation aggregated $1,908,515 of which $2,467,650, related to appreciated investment securities and $559,135, related to depreciated investment securities. SEE NOTES TO FINANCIAL STATEMENTS. 84 SHORT-DURATION INCOME PORTFOLIO - -------------------------------------------------------------------------------- STATEMENT OF ASSETS AND LIABILITIES SEPTEMBER 30, 1998 ASSETS Investments, at market value (Note 2) Investment securities $160,740,090 Repurchase agreements 2,391,457 ------------ Total investments (cost $161,221,627) 163,131,547 Receivables Fund shares sold 4,126,138 Dividends and interest 1,260,809 Deferred expenses (Note 2) 25,241 ------------ TOTAL ASSETS 168,543,735 ------------ LIABILITIES Payables Reverse repurchase agreement $ 18,555,000 Fund shares redeemed 2,139,010 Dividends 544,779 Accrued expenses and other liabilities 260,507 ------------ TOTAL LIABILITIES 21,499,296 ------------ NET ASSETS $147,044,439 ============ Net Assets represented by: (Note 2) Additional paid-in capital $145,502,924 Accumulated distributions in excess of net investment income (512,293) Accumulated net realized gain on investment transactions 143,888 Net unrealized appreciation of investments and interest-rate swap contracts 1,909,920 ------------ NET ASSETS $147,044,439 ============ NET ASSET VALUE PER SHARE Class A Shares $ 12.74 Class B Shares $ 12.75 Class Y Shares $ 12.79 OFFERING PRICE PER SHARE Class A Shares $ 12.87(a) Class B Shares $ 12.75 Class Y Shares $ 12.79 SHARES OUTSTANDING Class A Shares 7,313,315 Class B Shares 4,228,466 Class Y Shares 83
(a) Computation of offering price: 100/99 of net asset value. SEE NOTES TO FINANCIAL STATEMENTS. STATEMENT OF OPERATIONS YEAR ENDED SEPTEMBER 30, 1998 INVESTMENT INCOME Interest (b) (Note 2) $ 6,170,420 EXPENSES Management fee (Note 4) $ 504,097 Shareholder service fee (Note 5) 252,047 Transfer agent fee 148,709 Distribution fee (Note 5) 133,476 Administration fee (Note 4) 101,237 Registration expenses 74,882 Custodian and accounting fees 26,595 Shareholder reports and postage expenses 14,335 Miscellaneous 12,548 Organizational expenses 7,337 Legal fees 3,980 Directors' fees and expenses 3,147 Audit fees 2,754 --------- Total expenses 1,285,144 Deduct Waiver of administration fee (Note 4) (101,237) Waiver of management fee (Note 4) (180,523) ----------- NET INVESTMENT INCOME 5,167,036 ----------- REALIZED AND UNREALIZED GAIN ON INVESTMENTS AND INTEREST-RATE SWAP CONTRACTS Net realized gain on investments and interest-rate swap contracts (Note 2) 325,954 Change in unrealized appreciation on investments 1,608,387 --------- NET GAIN ON INVESTMENTS 1,934,341 ----------- NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $ 7,101,377 ===========
(b) Net of interest expenses of $588,099 ($283,529 related to interest-rate swaps and $304,570 related to borrowings). SEE NOTES TO FINANCIAL STATEMENTS. 85 SHORT-DURATION INCOME PORTFOLIO - -------------------------------------------------------------------------------- STATEMENTS OF CHANGES IN NET ASSETS
YEAR ENDED YEAR ENDED 9/30/98 9/30/97 NET INCREASE IN NET ASSETS Operations Net investment income $ 5,167,036 $ 2,155,953 Net realized gain on investments 325,954 7,748 Change in unrealized appreciation on investments 1,608,387 386,023 ------------- ------------- Increase in net assets resulting from operations 7,101,377 2,549,724 ------------- ------------- Distributions to Shareholders From net investment income Class A (3,203,099) (763,890) Class B (2,394,223) (1,415,914) Class Y (49) -- ------------- ------------- Total distributions to shareholders (5,597,371) (2,179,804) ------------- ------------- Capital Share Transactions (Note 7) Proceeds from sale of shares 169,053,248 39,889,219 Reinvested distributions 4,352,285 1,755,339 Shares redeemed (82,572,822) (19,273,346) ------------- ------------- Change in net assets resulting from capital share transactions 90,832,711 22,371,212 ------------- ------------- Increase in net assets 92,336,717 22,741,132 Net Assets Beginning of year 54,707,722 31,966,590 ------------- ------------- End of year (including accumulated distributions in excess of net investment income of ($512,293) and ($95,798), respectively) $ 147,044,439 $ 54,707,722 ============= =============
SEE NOTES TO FINANCIAL STATEMENTS. FINANCIAL HIGHLIGHTS CLASS A SHARES
YEAR YEAR YEAR PERIOD ENDED ENDED ENDED ENDED 9/30/98 9/30/97 9/30/96 9/30/95 (c) PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 12.62 $ 12.50 $ 12.68 $ 12.74 -------- -------- -------- ---------- Income from investment operations Net investment income 0.70 0.77 0.82 0.22 Net realized and unrealized gain (loss) on investments 0.15 0.12 (0.23) (0.03) -------- -------- --------- ---------- Total from investment operations 0.85 0.89 0.59 0.19 -------- -------- --------- ---------- Less distributions From net investment income (0.73) (0.77) (0.77) (0.25) -------- -------- --------- ---------- Net asset value, end of period $ 12.74 $ 12.62 $ 12.50 $ 12.68 ======== ======== ========= ========== TOTAL RETURN* 6.98% 7.33% 4.80% 1.51% RATIOS/SUPPLEMENTAL DATA Net assets, end of period (in thousands) $ 93,135 $ 27,619 $ 7,450 $ 1,002 Ratio of expenses to average net assets 0.86% 0.86% 0.86% 0.71% (a) Ratio of expenses to average net assets excluding waiver 1.14% 1.12% 1.26% 1.00% (a) Ratio of net investment income to average net assets 5.24% 6.00% 5.90% 4.10% (a) Portfolio turnover rate 171% 75% 411% 126%
(a) Annualized. (c) For the period from June 16, 1995 (initial offering of Class A Shares) to September 30, 1995. * Total return does not reflect sales commissions and is not annualized. SEE NOTES TO FINANCIAL STATEMENTS. 86 SHORT-DURATION INCOME PORTFOLIO - -------------------------------------------------------------------------------- FINANCIAL HIGHLIGHTS CLASS B SHARES
YEAR YEAR YEAR ENDED ENDED ENDED 9/30/98 9/30/97 9/30/96 PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 12.62 $ 12.50 $ 12.67 -------- -------- -------- Income from investment operations Net investment income 0.66 0.73 0.73 Net realized and unrealized gain (loss) on investments 0.16 0.12 (0.17) -------- -------- --------- Total from investment operations 0.82 0.85 0.56 -------- -------- --------- Less distributions From net investment income (0.69) (0.73) (0.73) --------- --------- --------- Net asset value, end of period $ 12.75 $ 12.62 $ 12.50 ========= ========= ========= TOTAL RETURN* 6.68% 6.96% 4.53% RATIOS/SUPPLEMENTAL DATA Net assets, end of period (in thousands) $ 53,908 $ 27,089 $ 24,517 Ratio of expenses to average net assets 1.16% 1.16% 1.16% Ratio of expenses to average net assets excluding waiver 1.44% 1.42% 1.56% Ratio of net investment income to average net assets 4.94% 5.70% 5.60% Portfolio turnover rate 171% 75% 411% PERIOD PERIOD ENDED ENDED 9/30/95 (d) 12/31/94 (e) PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 12.18 $ 12.50 ----------- ----------- Income from investment operations Net investment income 0.59 0.41 Net realized and unrealized gain (loss) on investments 0.52 (0.29) ----------- ----------- Total from investment operations 1.11 0.12 ----------- ----------- Less distributions From net investment income (0.62) (0.44) ----------- ----------- Net asset value, end of period $ 12.67 $ 12.18 =========== =========== TOTAL RETURN* 9.22% 0.95% RATIOS/SUPPLEMENTAL DATA Net assets, end of period (in thousands) $ 19,871 $ 17,144 Ratio of expenses to average net assets 1.20% (a) 1.29% (a) Ratio of expenses to average net assets excluding waiver 1.70%(a) 1.29% (a) Ratio of net investment income to average net assets 5.04%(a) 4.90% (a) Portfolio turnover rate 126% 166%
CLASS Y SHARES
PERIOD ENDED 9/30/98 (f) PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 12.57 ---------- Income from investment operations Net investment income 0.67 Net realized and unrealized gain on investments 0.16 ---------- Total from investment operations 0.83 ---------- Less distributions From net investment income ( 0.61) ---------- Net asset value, end of period $ 12.79 ========== TOTAL RETURN* 6.64% RATIOS/SUPPLEMENTAL DATA Net assets, end of period (in thousands) $ 1 Ratio of expenses to average net assets 0.61% (a) Ratio of expenses to average net assets excluding waiver 0.87% (a) Ratio of net investment income to average net assets 6.10% (a) Portfolio turnover rate 171%
(a) Annualized. (d) For the period from January 1, 1995 to September 30, 1995. (e) For the period from April 29, 1994 (commencement of operations) to December 31, 1994. (f) For the period from November 19, 1997 (initial offering of Class Y shares) to September 30, 1998. * Total return does not reflect sales commissions and is not annualized. SEE NOTES TO FINANCIAL STATEMENTS. 87 MENTOR HIGH INCOME PORTFOLIO MANAGERS' COMMENTARY: THE HIGH INCOME MANAGEMENT TEAM SEPTEMBER 30, 1998 - -------------------------------------------------------------------------------- The Mentor High Income Portfolio was launched in June 1998. This commentary, therefore, marks the first opportunity for the managers of the Portfolio to provide their market perspective to shareholders. The third quarter of 1998, in addition to marking the first full quarter of performance for the fund, also was a period of unusual volatility for high-yield markets. ECONOMIC FACTORS After years of steady economic growth and fairly consistent stock market appreciation, equity markets tumbled in the final weeks of the summer in response to a downward spiral in global economies. Earlier in the year, the U.S. economy was expanding at a robust pace, with gross domestic product (GDP) growth measuring 5.4% in the first quarter alone. Despite the generally solid pace of economic activity, inflation remained benign. Falling commodity prices and a strong dollar were helping to offset the inflationary implications of a tight labor market and active consumer spending. By the third quarter of 1998, U.S. financial markets were coming under increasing stress as repercussions from the Asian crisis spread to other areas of the globe. During this period, Russia abandoned its currency peg versus the dollar and defaulted on its sovereign debt. Other markets, particularly Latin America, came under increasing pressure as market participants attempted to avoid additional international risks. International developments finally began to meaningfully impact domestic markets early in the third quarter. Starting with the Russian devaluation, highly leveraged hedge funds began to incur substantial losses. Many hedge fund participants had levered portfolios for greater returns, so the unwinding of those positions drove yield spreads wider. A flight to quality drove long-term Treasury yields down to levels not seen in 30 years. In response to these deteriorating conditions the Federal Reserve reduced its target Fed Funds rate by 25 basis points to 5.25%. Market participants had anticipated greater credit easing and the third quarter closed amid unusually high volatility. CORPORATE HIGH-YIELD FACTORS During the third quarter, 10-year Treasury yields declined by 108 basis points, to a 4.40% yield. This strength in Treasuries, however, was not shared by other fixed-income sectors. In fact, the investment landscape for all spread products changed dramatically in the third quarter of 1998. A major flight-to-quality dramatically expanded risk premiums for non-Treasury securities. The degree of this shift is demonstrated by the 1281 basis point (12.81%) underperformance of the Merrill Lynch High Yield Master Index versus 10-year Treasuries during the July-September time period. High-yield spreads widened from 350 to 575 basis points over comparable maturity Treasuries. The spread on the Chase Securities High Yield Index expanded to 666 basis points, its highest level since January of 1992. Asset performance for the third quarter was closely tied to credit quality. As risk exposure increased, returns decreased dramatically. While the 10-year Treasury returned 9.22% for the July through September time period, the Chase High Yield Index lost 5.79%, the S&P 500 posted a loss of 9.95%, and the EMBI (Emerging Markets Brady Index) lost 11.57%. New issuance of high-yield securities has declined markedly in these deteriorating conditions. In the 88 MENTOR HIGH INCOME PORTFOLIO MANAGERS' COMMENTARY: THE HIGH INCOME MANAGEMENT TEAM SEPTEMBER 30, 1998 - -------------------------------------------------------------------------------- quarter ended September 30, total issuance was at $20.4 billion, compared with $56.3 billion raised in the second quarter of this year, and $37.4 billion in the third quarter of 1997. Outflows of $1.9 billion from high-yield mutual funds in August reversed somewhat in September, with overall cash inflows of $259 million into high-yield funds. MANAGEMENT STRATEGY We invested initial proceeds into a broadly diversified cross-section of the high-yield universe, with 77% of holdings rated B, 13.4% rated BB, and 1.1% rated BBB. At the end of September, the Portfolio still held 15.7% of its assets in cash, as full investment with deteriorating market conditions was imprudent. The greatest industry concentration lies in the telecommunications area, with a 19% exposure. OUTLOOK Spreads have widened in high-yield markets due to heavy new issuance and fears of default. Default fears, however, seem premature given Moody's recently reported trailing 12-month default rate of 2.62%, down slightly from 2.69% in August. That number can be expected to increase during the fourth quarter, however, since four high-yield issuers have already defaulted during the month of October. Given the market's current unsettled state in the wake of August's dramatic sell-off, we expect spreads to remain at these wide levels through the end of the year. The equity market's recent volatility makes it unlikely that spreads will narrow meaningfully until the level of next year's economic growth becomes clearer. November 1998 PERFORMANCE COMPARISON Comparison of change in value of a hypothetical $10,000 purchase in Mentor High Income Portfolio Class A and Class B Shares and the Merrill Lynch High Yield Master II Bond Index.~ [GRAPH] A Shares B Shares Merrill Lynch High Yield Master II Bond Index 6/23/98 9525 10000 10000 7/31/98 9614 10081 10349 8/31/98 8904 9332 10586 9/30/98 8882 9305 10567 Average Annual Returns as of 9/30/98 Including Sales Charges 1-Year Since Inception+++ Class A n/a (11.19%) Class B n/a (7.86%) PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE PERFORMANCE. YOUR INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO WHEN SHARES ARE REDEEMED, THEY MAY BE WORTH MORE OR LESS THAN ORIGINAL COST. MUTUAL FUNDS ARE NOT OBLIGATIONS OF OR GUARANTEED BY ANY BANK AND ARE NOT FEDERALLY INSURED. ~ The Merrill Lynch High Yield Master II Bond Index provides a broad-based measure of the performance of the non-investment grade U.S. domestic bond market. The index currently captures close to $200 billion of the outstanding debt of domestic market issuers rated below investment grade but not in default. + Represents a hypothetical investment of $10,000 in Mentor High Income Portfolio Class B Shares. A contingent deferred sales charge will be imposed, if applicable, on Class B Shares at rates ranging from a maximum of 4.00% of amounts redeemed during the first year following the date of purchase to 1.00% of amounts redeemed during the six-year period following the date of purchase. The Class B Shares reflects a redemption fee in effect at the end of each of the stated periods. The Class B Shares' performance assumes the reinvestment of all dividends and distributions. ++ Represents a hypothetical investment of $10,000 in Mentor High Income Portfolio Class A Shares, after deducting the maximum sales charge of 4.75% ($10,000 investment minus $475 sales charge = $9,525). The Class A Shares' performance assumes the reinvestment of all dividends and distributions. +++ Reflects operations of Mentor High Income Portfolio Class A and Class B Shares from the date of commencement of operations on 6/23/98 through 9/30/98. 89 MENTOR HIGH INCOME PORTFOLIO PORTFOLIO OF INVESTMENTS SEPTEMBER 30, 1998 - --------------------------------------------------------------------------------
PRINCIPAL AMOUNT MARKET VALUE CORPORATE BONDS - 79.65% CONSUMER DISTRIBUTION - 7.13% Aurora Foods, Inc. Senior Subordinated Notes, Series D, 9.88%, 2/15/07 $ 1,000,000 $ 1,075,000 Big 5 Corporation Senior Notes, Series B, 10.88%, 11/15/07 1,000,000 955,000 CHS Electronics, Inc. Senior Notes, 9.88%, 4/15/05 1,000,000 925,000 Del Monte Foods Company Senior Discount Notes, 12.50%, 12/15/07 (a) 1,500,000 870,000 Disco S.A. Notes, 9.88%, 5/15/08 (a) 1,000,000 675,000 Musicland Group, Inc. Senior Subordinated Notes-B, 9.88%, 3/15/08 1,500,000 1,432,500 Pantry, Inc. Senior Notes, 12.50%, 11/15/00 1,148,000 1,202,530 Pantry, Inc. Senior Subordinated Notes, 10.25%, 10/15/07 1,000,000 980,000 ------------ 8,115,030 ------------ CONSUMER DURABLES - 9.48% Aetna Industries, Inc. Senior Notes, 11.88%, 10/01/06 1,500,000 1,530,000 Cluett American Corporation Senior Subordinated Notes, 10.13%, 5/15/08 (a) 1,000,000 920,000 Consoltex Group Senior Notes, 11.00%, 10/01/03 200,000 208,000 Decora Industries, Inc. Secured Notes, 11.00%, 5/01/05 (a) 1,000,000 907,500 Derby Cycle Corporation Senior Notes, 10.00%, 5/15/08 (a) 1,000,000 930,000 Galey & Lord, Inc. Senior Subordinated Notes, 9.13%, 3/01/08 1,500,000 1,316,250 MCII Holdings Senior Secured Discount Notes, 15.00%, 11/15/02 1,000,000 825,000 Outsourcing Services Group Senior Subordinated Notes, 10.88%, 3/01/06 (a) 1,150,000 1,092,500 Oxford Automotive, Inc., 10.13%, 6/15/07 1,000,000 965,000 Talon Automotive Group Senior Subordinated Notes, 9.63%, 5/01/08 (a) 1,000,000 935,000
PRINCIPAL AMOUNT MARKET VALUE CORPORATE BONDS (CONTINUED) CONSUMER DURABLES (CONTINUED) Venture Holdings Trust Senior Notes-B, 9.50%, 7/01/05 $ 1,175,000 $ 1,151,500 ------------ 10,780,750 ------------ CONSUMER SERVICES - 14.23% Americredit Corporation, 9.25%, 2/01/04 (a) 1,000,000 965,000 Argosy Gaming Company, 13.25%, 6/01/04 (a) 1,500,000 1,597,500 Booth Creek Ski Holdings Senior Notes-B, 12.50%, 3/15/07 1,000,000 985,000 Capstar Broadcasting Senior Discount Notes, 12.75%, 2/01/09 (a) 1,000,000 755,000 Carrols Corporation Senior Notes, 11.50%, 8/15/03 1,000,000 1,045,000 Diamond Cable Communications Senior Discount Notes, 11.75%, 12/15/05 1,500,000 1,207,500 Globo Communicacoes Senior Notes, 10.63%, 12/05/08 (a) 1,000,000 520,000 Grupo Televisa S.A. Senior Discount Notes-Euro, 13.25%, 5/15/08 1,000,000 695,000 Hollywood Casino Corporation Senior Notes, 12.75%, 11/01/03 1,000,000 1,045,000 Interep National Radio Sales, 10.00%, 7/01/08 (a) 1,000,000 980,000 Isles of Capri Casinos, 12.50%, 8/01/03 1,000,000 1,085,000 La Petite Academy LPA Holdings-B, 10.00%, 5/15/08 1,250,000 1,212,500 Majestic Star Casino, LLC, 12.75%, 5/15/03 1,500,000 1,556,250 Northland Cable Television Senior Subordinated Notes, 10.25%, 11/15/07 1,000,000 1,060,000 Silver Cinemas, Inc. Senior Subordinated Notes, 10.50%, 4/15/05 (a) 1,000,000 955,000 Young American Corporation Senior Subordinated Notes, 11.63%, 2/15/06 (a) 1,000,000 530,000 ------------ 16,193,750 ------------
90 MENTOR HIGH INCOME PORTFOLIO PORTFOLIO OF INVESTMENTS SEPTEMBER 30, 1998 - --------------------------------------------------------------------------------
PRINCIPAL AMOUNT MARKET VALUE CORPORATE BONDS (CONTINUED) ENERGY - 8.14% Abraxas Petroleum Senior Notes, Series D, 11.50%, 11/01/04 $ 1,000,000 $ 780,000 Dawson Production Services, Inc. Senior Notes, 9.38%, 2/01/07 1,000,000 1,002,500 Gothic Production Corporation, 11.13%, 5/01/05 1,000,000 760,000 Houston Exploration Company Senior Subordinated Notes-B, 8.63%, 1/01/08 1,000,000 960,000 Hurricane Hydrocarbons Senior Notes, 11.75%, 11/01/04 (a) 1,000,000 560,000 Moll Industries Senior Subordinated Notes, 10.50%, 7/01/08 (a) 1,100,000 1,023,000 Ocean Energy, Inc. Senior Subordinated Notes-B, 8.88%, 7/15/07 1,000,000 1,010,000 Tesoro Petroleum Corporation Senior Subordinated Notes, 9.00%, 7/01/08 (a) 1,000,000 967,500 Universal Compression, Inc. Senior Discount Notes, 9.88%, 2/15/08 (a) 2,000,000 1,190,000 Vintage Petroleum Senior Subordinated Notes, 8.63%, 2/01/09 1,000,000 1,010,000 ------------ 9,263,000 ------------ HEALTH CARE - 0.97% Mariner Post-Acute Network Senior Subordinated Notes, 10.50%, 11/01/07 1,500,000 832,500 Vencor, Inc. Senior Subordinated Notes, 9.88%, 5/01/05 (a) 350,000 276,500 ------------ 1,109,000 ------------ PRODUCER MANUFACTURING - 8.22% Anthony Crane Rentals, 10.38%, 8/01/08 (a) 1,000,000 940,000 Compass Aerospace Corporation, 10.13%, 4/15/05 (a) 1,000,000 985,000 Del Webb Corporation Senior Subordinated Debentures, 9.38%, 5/01/09 750,000 720,000 Dine S.A. de C.V., 8.75%, 10/15/07 (a) 1,000,000 720,000
PRINCIPAL AMOUNT MARKET VALUE CORPORATE BONDS (CONTINUED) PRODUCER MANUFACTURING (CONTINUED) Hydrochemical Industrial Service Senior Subordinated Notes-B, 10.38%, 8/01/07 $ 1,000,000 $ 940,000 Kevco, Inc. Senior Subordinated Notes, 10.38%, 12/01/07 1,000,000 955,000 Outboard Marine Corporation, 10.75%, 6/01/08 (a) 1,000,000 945,000 Schuler Homes Senior Notes, 9.00%, 4/15/08 (a) 750,000 701,250 Tekni-Plex, Inc. Senior Subordinated Notes-B, 11.25%, 4/01/07 500,000 522,500 Terex Corporation Senior Subordinated Notes, 8.88%, 4/01/08 (a) 1,000,000 932,500 W. R. Carpenter North America Senior Subordinated Notes, 10.63%, 6/15/07 1,000,000 985,000 ------------ 9,346,250 ------------ RAW MATERIALS/PRODUCTS INDUSTRIES - 4.28% Acetex Corporation Senior Notes, 9.75%, 10/01/03 900,000 859,500 Anchor Lamina, Inc. Senior Subordinated Notes, 9.88%, 2/01/08 800,000 656,000 GS Technologies Operation, Inc. Senior Notes, 12.25%, 10/01/05 875,000 748,125 Hylsa S.A. de C.V. Bonds, 9.25%, 9/15/07 (a) 1,000,000 685,000 Pioneer Americas Acquisition Senior Notes, 9.25%, 6/15/07 1,500,000 1,230,000 Vicap S.A.Guaranteed Notes, 11.38%, 5/15/07 (a) 1,000,000 685,000 ------------ 4,863,625 ------------ TECHNOLOGY - 3.10% Advanced Micro Devices Senior Notes, 11.00%, 8/01/03 2,000,000 2,030,000 DecisionOne Holdings Discount Notes, 11.50%, 8/01/08 1,500,000 562,500 Dictaphone Corporation Senior Subordinated Notes, 11.75%, 8/01/05 1,000,000 930,000 ------------ 3,522,500 ------------
91 MENTOR HIGH INCOME PORTFOLIO PORTFOLIO OF INVESTMENTS SEPTEMBER 30, 1998 - --------------------------------------------------------------------------------
PRINCIPAL AMOUNT MARKET VALUE CORPORATE BONDS (CONTINUED) TRANSPORTATION - 4.02% Atlas Air, Inc. Senior Notes, 10.75%, 8/01/05 $ 1,000,000 $ 985,000 American Communication Lines, LLC Bonds, 10.25%, 6/30/08 (a) 1,000,000 990,000 Cenargo International PLC-1st Mortgage, 9.75%, 6/15/08 (a) 1,000,000 820,000 Greyhound Lines Senior Notes, 11.50%, 4/15/07 1,250,000 1,337,500 Pegasus Shipping Hellas Notes-A, 11.88%, 11/15/04 500,000 435,000 ----------- 4,567,500 ----------- UTILITIES - 20.08% American Cellular Corporation Senior Notes, 10.50%, 5/15/08 (a) 500,000 487,500 Cathay International Limited Senior Notes, 13.00%, 4/15/08 (a) 1,000,000 600,000 CIA Transporte Energia Notes, 9.25%, 4/01/08 (a) 1,000,000 760,000 Clearnet Communications Senior Discount Notes, 14.75%, 12/15/05 1,500,000 1,248,750 Comcast Cellular Holdings Senior Notes, 9.50%, 5/01/07 1,000,000 1,030,000 Crown Castle International Corporation Senior Discount Notes, 10.63%, 11/15/07 750,000 453,750 e.spire Communications, Inc. Senior Discount Notes, 12.75% - 13.75%, 4/01/06 - 7/15/07 1,050,000 985,000 Esprit Telecommunications Group PLC Senior Notes, 11.50%, 10.88% - 11.50%, 12/15/07 - 6/15/08 (a) 1,000,000 922,500 ICG Holdings, Inc. Discount Notes, 11.63% - 13.50%, 9/15/05 - 3/15/07 1,500,000 1,103,750 Intermedia Communications Senior Discount Notes, 8.60%, 6/01/08 525,000 527,625 Intermedia Communications of Florida, 12.50%, 5/15/06 600,000 492,000 McLeodusa, Inc. Senior Discount Notes, 10.50%, 3/01/07 1,250,000 912,500
PRINCIPAL AMOUNT MARKET VALUE CORPORATE BONDS (CONTINUED) UTILITIES (CONTINUED) MetroNet Communications Senior Discount Notes, 9.95%, 6/15/08 (a) $ 1,500,000 $ 832,500 Microcell Telecommuni- cations Senior Discount Notes-B, 14.00%, 6/01/06 1,000,000 715,000 Millicom International Cellular Senior Discount Notes, 13.50%, 6/01/06 1,250,000 793,750 MJD Communications, Inc., 9.50%, 5/01/08 (a) 750,000 753,750 Netia Holdings Senior Discount Notes-B, 11.25%, 11/01/07 1,500,000 660,000 Optel Inc. Senior Notes, 11.50%, 7/01/08 (a) 500,000 470,000 Pinnacle Holdings, Inc. Senior Discount Notes, 10.00%, 3/15/08 (a) 750,000 401,250 Price Communications Wireless, Inc. Senior Subordinated Notes, 11.75%, 7/15/07 1,000,000 1,035,000 Primus Telecommunications Group Strips, 11.75%, 8/01/04 1,000,000 945,000 PSINet, Inc. Senior Notes, Series B, 10.00%, 2/15/05 1,000,000 1,005,000 Rogers Cantel, Inc.Debentures, 9.38%, 6/01/08 1,000,000 1,020,000 Satelites Mexicanos Senior Notes, 10.13%, 11/01/04 (a) 1,000,000 685,000 SBA Communications Corporation Senior Discount Notes, 12.00%, 3/01/08 (a) 1,000,000 520,000
92 MENTOR HIGH INCOME PORTFOLIO PORTFOLIO OF INVESTMENTS SEPTEMBER 30, 1998 - --------------------------------------------------------------------------------
SHARES OR PRINCIPAL AMOUNT MARKET VALUE CORPORATE BONDS (CONTINUED) UTILITIES (CONTINUED) Spectrasite Holdings, Inc. Senior Discount Notes, 12.00%, 7/15/08 (a) $1,000,000 $ 480,000 Sprint Spectrum Senior Notes, 11.00%, 8/15/06 1,000,000 1,140,000 Startec Global Communications Units, 12.00%, 5/15/08 (a) 1,000,000 870,000 Verio, Inc. Senior Notes, 10.38%, 4/01/05 (a) 1,000,000 995,000 ------------ 22,844,625 ------------ TOTAL CORPORATE BONDS (COST $99,855,713) 90,606,030 ------------ FOREIGN GOVERNMENT - 0.75% Republic of Korea Bond, 8.88%, 4/15/08 (cost $938,803) 1,000,000 855,000 ------------ PREFERRED STOCK - 0.80% Rural Cellular Corporation (cost $900,000) 10,000 910,000 ------------ 92,371,030 ------------ SHORT TERM INVESTMENT - 14.24% U.S. Government Agency Federal Home Loan Bank 5.00%, 10/01/98 (cost $16,195,000) 16,195,000 16,195,000 ------------ TOTAL INVESTMENTS (COST $117,889,516)-95.44% 108,566,030 OTHER ASSETS LESS LIABILITIES - 4.56% 5,190,110 ------------ NET ASSETS - 100.00% $113,756,140 ============
(a) These are securities that may be resold to "qualified institutional buyers" under Rule 144A or securities offered pursuant to Section 4(2) of the Securities Act of 1933, as amended. These securities have been determined to be liquid under guidelines established by the Board of Trustees. INVESTMENT TRANSACTIONS Cost of purchases and proceeds from sales of securities, other than short-term securities, aggregated $107,457,273 and $5,763,938, respectively. INCOME TAX INFORMATION At September 30, 1998, the aggregated cost of investment securities for federal income tax purposes was $117,889,516. Net unrealized depreciation aggregated $9,323,486, of which $286,135, related to appreciated investment securities and $9,609,621, related to depreciated investment securities. SEE NOTES TO FINANCIAL STATEMENTS. 93 MENTOR HIGH INCOME PORTFOLIO - -------------------------------------------------------------------------------- STATEMENT OF ASSETS AND LIABILITIES SEPTEMBER 30, 1998 ASSETS Investments, at market value (cost $117,889,516)(Note 2) Investment securities $108,566,030 Cash 2,492,668 Receivables Investments sold 485,622 Fund shares sold 3,115,774 Dividends and interest 2,576,302 Deferred expenses (Note 2) 17,486 ------------ TOTAL ASSETS 117,253,882 ------------ LIABILITIES Payables Investments purchased $ 2,981,590 Fund shares redeemed 110,985 Dividends 371,873 Accrued expenses and other liabilities 33,294 ----------- TOTAL LIABILITIES 3,497,742 ------------ NET ASSETS $113,756,140 ============ Net Assets represented by: (Note 2) Additional paid-in capital $123,540,215 Accumulated distributions in excess of net investment income (371,874) Accumulated net realized loss on investment transactions (88,715) Net unrealized depreciation of investments (9,323,486) ------------ NET ASSETS $113,756,140 ============ NET ASSET VALUE PER SHARE Class A Shares $ 10.92 Class B Shares $ 10.91 OFFERING PRICE PER SHARE Class A Shares $ 11.46(a) Class B Shares $ 10.91 SHARES OUTSTANDING Class A Shares 4,658,188 Class B Shares 5,762,202
(a) Computation of offering price: 100/95.25 of net asset value. (b) For the period from June 23, 1998 (commencement of operations) to September 30, 1998. SEE NOTES TO FINANCIAL STATEMENTS. STATEMENT OF OPERATIONS PERIOD ENDED SEPTEMBER 30, 1998 (b) INVESTMENT INCOME Interest (Note 2) $ 2,037,403 EXPENSES Management fee (Note 4) $ 175,891 Distribution fee (Note 5) 68,461 Shareholder service fee (Note 5) 62,818 Administration fee (Note 4) 24,979 Transfer agent fee 23,292 Custodian and accounting fees 16,350 Registration expenses 11,840 Shareholder reports and postage expenses 3,449 Legal fees 753 Directors' fees and expenses 596 Audit fees 521 Miscellaneous 6,164 ---------- Total expenses 395,114 Deduct Waiver of management fee (Note 4) (175,891) ------------ NET INVESTMENT INCOME 1,818,180 ------------ REALIZED AND UNREALIZED LOSS ON INVESTMENTS Net realized loss on investments (88,715) Change in unrealized depreciation on investments (9,323,486) ---------- NET LOSS ON INVESTMENTS (9,412,201) ------------ NET DECREASE IN NET ASSETS RESULTING FROM OPERATIONS $ (7,594,021) ============
SEE NOTES TO FINANCIAL STATEMENTS. 94 MENTOR HIGH INCOME PORTFOLIO - -------------------------------------------------------------------------------- STATEMENT OF CHANGES IN NET ASSETS
PERIOD ENDED 9/30/98 (b) NET INCREASE IN NET ASSETS Operations Net investment income $ 1,818,180 Net realized loss on investments (88,715) Change in unrealized depreciation on investments (9,323,486) ------------- Decrease in net assets resulting from operations (7,594,021) ------------- Distributions to Shareholders From net investment income Class A (1,040,534) Class B (1,178,956) In excess of net investment income Class A - Class B - ------------- Total distributions to shareholders (2,219,490) ------------- Capital Share Transactions (Note 7) Proceeds from sale of shares 126,286,107 Reinvested distributions 1,281,553 Shares redeemed (3,998,009) ------------- Change in net assets resulting from capital share transactions 123,569,651 ------------- Increase in net assets 113,756,140 Net Assets Beginning of period - ------------- End of period (including accumulated distributions in excess of net investment income of ($371,874) ) $ 113,756,140 =============
SEE NOTES TO FINANCIAL STATEMENTS. FINANCIAL HIGHLIGHTS CLASS A SHARES
PERIOD ENDED 9/30/98 (b) PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 12.00 ---------- Income from investment operations Net investment income 0.24 Net realized and unrealized loss on investments (1.04) ---------- Total from investment operations (0.80) ---------- Less distributions From net investment income (0.28) ---------- Net asset value, end of period $ 10.92 ========== TOTAL RETURN* (6.75%) RATIOS/SUPPLEMENTAL DATA Net assets, end of period (in thousands) $ 50,887 Ratio of expenses to average net assets 0.60% (a) Ratio of expenses to average net asset excluding waiver 1.30% (a) Ratio of net investment income to average net assets 7.36% (a) Portfolio turnover rate 27%
(a) Annualized. (b) For the period from June 23, 1998 (commencement of operations) to September 30, 1998. * Total return does not reflect sales commissions and is not annualized. SEE NOTES TO FINANCIAL STATEMENTS. 95 MENTOR HIGH INCOME PORTFOLIO - -------------------------------------------------------------------------------- FINANCIAL HIGHLIGHTS CLASS B SHARES
PERIOD ENDED 9/30/98 (c) PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 12.00 ---------- Income from investment operations Net investment income 0.22 Net realized and unrealized loss on investments ( 1.05) ---------- Total from investment operations ( 0.83) ---------- Less distributions From net investment income ( 0.26) ---------- Net asset value, end of period $ 10.91 ========== TOTAL RETURN* ( 6.95%) RATIOS/SUPPLEMENTAL DATA Net assets, end of period (in thousands) $ 62,869 Ratio of expenses to average net assets 1.10% (a) Ratio of expenses to average net asset excluding waiver 1.80% (a) Ratio of net investment income to average net assets 6.87% (a) Portfolio turnover rate 27%
(a) Annualized. (c) For the period from June 23, 1998 (commencement of operations) to September 30, 1998. * Total return does not reflect sales commissions and is not annualized. SEE NOTES TO FINANCIAL STATEMENTS. 96 MENTOR FUNDS NOTES TO FINANCIAL STATEMENTS SEPTEMBER 30, 1998 - -------------------------------------------------------------------------------- NOTE 1: ORGANIZATION Mentor Funds is registered under the Investment Company Act of 1940, as amended, as an open-end management investment company. Mentor Funds consists of twelve separate Portfolios (hereinafter each individually referred to as a "Portfolio" or collectively as the "Portfolios") at September 30, 1998, as follows: Mentor Growth Portfolio ("Growth Portfolio") Mentor Perpetual Global Portfolio ("Global Portfolio") Mentor Capital Growth Portfolio ("Capital Growth Portfolio") Mentor Strategy Portfolio ("Strategy Portfolio") Mentor Income and Growth Portfolio ("Income and Growth Portfolio") Mentor Balanced Portfolio ("Balanced Portfolio") Mentor Municipal Income Portfolio ("Municipal Income Portfolio") Mentor Quality Income Portfolio ("Quality Income Portfolio") Mentor Short-Duration Income Portfolio ("Short-Duration Income Portfolio") Mentor High Income Portfolio ("High Income Portfolio") Mentor U.S. Government Money Market Portfolio ("Government Portfolio") Mentor Money Market Portfolio ("Money Market Portfolio") The assets of each Portfolio are segregated and a shareholder's interest is limited to the Portfolio in which shares are held. These financial statements do not include Money Market Portfolio and the U.S. Government Money Market Portfolio. Mentor Funds currently issues three classes of shares. Class A shares are sold subject to a maximum sales charge of 5.75% (4.75% for the Quality Income Portfolio, Municipal Income Portfolio and High Income Portfolio and 1% for Short-Duration Income Portfolio) payable at the time of purchase. Class B shares are sold subject to a contingent deferred sales charge payable upon redemption which decreases depending on when shares were purchased and how long they have been held. Class Y shares are sold to institutions and high net-worth individual investors and are not subject to any sales or contingent deferred sales charges. During the year, the Balanced Portfolio added two classes of shares designated as Class A and Class Y and designated its existing class of shares as Class B. Shareholders of the Balanced Portfolio who on September 16, 1998, held Class B shares had such shares converted to Class Y shares having an aggregate value equal to that of the shareholder's Class B shares prior to the conversion. NOTE 2: SIGNIFICANT ACCOUNTING POLICIES The following is a summary of significant accounting policies consistently followed by the Portfolios in the preparation of their financial statements. The policies are in conformity with generally accepted accounting principles which require management to make estimates and assumptions that affect amounts reported therein. Although actual results could differ from these estimates, any such differences are expected to be immaterial to the net assets of the Portfolios. (a) Valuation of Securities - Listed securities held by the Growth Portfolio, Global Portfolio, Capital Growth Portfolio, Strategy Portfolio, Income and Growth Portfolio, and Balanced Portfolio traded on national stock exchanges and over-the-counter securities quoted on the NASDAQ National Market 97 MENTOR FUNDS NOTES TO FINANCIAL STATEMENTS (CONTINUED) - -------------------------------------------------------------------------------- System are valued at the last reported sales price or, lacking any sales, at the last available bid price. In cases where securities are traded on more than one exchange, the securities are valued on the exchange determined by the advisor of the Portfolios as the primary market. Securities traded in the over-the-counter market, other than those quoted on the NASDAQ National Market System, are valued at the last available bid price. Short-term investments with remaining maturities of 60 days or less are carried at amortized cost, which approximates market value. Securities for which market quotations are not readily available are valued at fair value as determined in good faith under procedures established by the Board of Trustees. U.S. Government obligations held by the Income and Growth Portfolio, Balanced Portfolio, Quality Income Portfolio, Short-Duration Income Portfolio, and High Income Portfolio are valued at the mean between the over-the-counter bid and asked prices as furnished by an independent pricing service. Listed corporate bonds, other fixed income securities, mortgage backed securities, mortgage related, asset-backed and other related securities are valued at the prices provided by an independent pricing service. Security valuations not available from an independent pricing service are provided by dealers approved by the Portfolios' Board of Trustees. In determining value, the pricing services use information with respect to transactions in such securities, market transactions in comparable securities, various relationships between securities, and yield to maturity. Municipal bonds, held by the Municipal Income Portfolio, are valued at fair value. An independent pricing service values the Portfolio's municipal bonds taking into consideration yield, stability, risk, quality, coupon, maturity, type of issue, trading characteristics, special circumstances of a security or trading market, and any other factors or market data it deems relevant in determining valuations for normal institutional size trading units of debt securities. The pricing service does not rely exclusively on quoted prices. Short-term investments with remaining maturities of 60 days or less shall be their amortized cost value unless the particular circumstances of the security indicate otherwise. Foreign currency amounts are translated into United States dollars as follows: market value of investments, other assets and liabilities at the daily rate of exchange, purchases and sales of investments, income and expenses at the rate of exchange prevailing on the respective dates of such transactions. Net unrealized foreign exchange gains/losses are a component of unrealized appreciation/depreciation of investments. Net realized foreign currency gains and losses include foreign currency gains and losses between trade date and settlement date on investment securities transactions, foreign currency transactions and the difference between the amounts of interest and dividends recorded on the books of the Portfolio and the amount actually received. The portion of investment gains and losses related to foreign currency fluctuations in exchange rates between the initial purchase trade date and subsequent sale trade date is included in realized gains and losses on security transactions. (b) Repurchase Agreements -- It is the policy of Mentor Funds to require the custodian bank to take possession, to have legally segregated in the Federal Reserve Book entry system all securities held as collateral in support of repurchase agreement investments. Additionally, procedures have been established by Mentor Funds to monitor, on a daily basis, the market value of each repurchase agreement's 98 MENTOR FUNDS NOTES TO FINANCIAL STATEMENTS (CONTINUED) - -------------------------------------------------------------------------------- underlying securities to ensure the existence of a proper level of collateral. Mentor Funds will only enter into repurchase agreements with banks and other recognized financial institutions such as broker/dealers which are deemed by Mentor Funds' advisor to be creditworthy pursuant to guidelines established by the Mentor Funds' Trustees. Risks may arise from the potential inability of counterparties to honor the terms of the repurchase agreement. Accordingly, Mentor Funds could receive less than the repurchase price on the sale of collateral securities. (c) Borrowings -- Each of the Portfolios (except for the Growth Portfolio, Strategy Portfolio and Municipal Income Portfolio) may, under certain circumstances, borrow money directly or through dollar-roll and reverse repurchase agreements (arrangements in which the Portfolio sells a security for a percentage of its market value with an agreement to buy it back on a set date). Each Portfolio may borrow up to one-third of the value of its net assets. The average daily balance of reverse repurchase agreements outstanding for Quality Income Portfolio during the year ended September 30, 1998, was approximately $16,388,088 or $1.24 per share based on average shares outstanding during the period at a weighted average interest rate of 5.16%. The maximum amount of borrowings outstanding for any day during the period was $71,061,218 (including accrued interest), as of September 17, 1998, at an interest rate of 5.52% and was 26.09% of total assets at that date. The average daily balance of reverse repurchase agreements outstanding for Short-Duration Income Portfolio during the year ended September 30, 1998, was approximately $6,026,021 or $0.72 per share based on average shares outstanding during the period at a weighted average interest rate of 5.55%. The maximum amount of borrowings outstanding for any day during the period was $35,037,791 (including accrued interest), as of September 3, 1998, at an interest rate of 5.55% and was 18.35% of total assets at that date. (d) Portfolio Securities Loaned -- Each of the Portfolios (except for Municipal Income Portfolio) is authorized by the Board of Trustees to participate in securities lending transactions. The Portfolios may receive fees for participating in lending securities transactions. During the period that a security is out on loan, Portfolios continue to receive interest or dividends on the securities loaned. The Portfolio receives collateral in an amount at least equal to, at all times, the fair value of the securities loaned plus interest. When cash is received as collateral, the Portfolios record an asset and obligation for the market value of that collateral. Cash received as collateral may be reinvested, in which case that security is recorded as an asset of the Portfolio. Variations in the market value of the securities loaned occurring during the term of the loan are reflected in the value of the Portfolio. At September 30, 1998, certain Portfolios had loaned securities to brokers which were collateralized by cash, U.S. Treasury securities and letters of credit. Cash collateral at September 30, 1998 was reinvested in U.S. Treasury and high quality money market instruments. Income from securities lending activities amounted to $283,424, $50,923, $25,753, $88,906, $47,564, $702, and $46,419, for the Growth Portfolio, Global Portfolio, Capital Growth Portfolio, Strategy Portfolio, Income and Growth Portfolio, Balanced Portfolio and Quality Income Portfolio, respectively for the year ended September 30, 1998. 99 MENTOR FUNDS NOTES TO FINANCIAL STATEMENTS (CONTINUED) - -------------------------------------------------------------------------------- Among the risks to a Portfolio from securities lending are that the borrower may not provide additional collateral when required or return the securities when due. At September 30, 1998, the value of the securities on loan and the value of the related collateral were as follows:
SECURITIES CASH SECURITIES TRI-PARTY PORTFOLIO ON LOAN COLLATERAL COLLATERAL COLLATERAL - ------------------- --------------- --------------- ------------ ------------ Growth $106,657,061 $115,219,699 $771,567 $ - Global 11,714,972 12,707,641 - - Capital Growth 14,483,537 15,562,984 - - Strategy 58,005,353 60,165,776 215,110 - Income and Growth 47,343,071 40,344,784 6,360 7,911,321 Balanced 2,544,039 2,639,420 - 39,456 Quality Income 3,244,448 1,605,500 - 1,687,662 - ------------------- ------------ ------------ -------- ---------
(e) Dollar Roll Transactions -- Each of the Portfolios (except for the Growth, Strategy and Municipal Income Portfolios) may engage in dollar roll transactions with respect to mortgage-backed securities issued by GNMA, FNMA, and FHLMC. In a dollar-roll transaction, a Portfolio sells a mortgage-backed security to a financial institution, such as a bank or broker/dealer, and simultaneously agrees to repurchase a substantially similar (i.e., same type, coupon, and maturity) security from the institution at a later date at an agreed upon price. The mortgage-backed securities that are repurchased will bear the same interest rate as those sold, but generally will be collateralized by different pools of mortgages with different prepayment histories. (f) Security Transactions and Investment Income -- Security transactions for the Portfolios are accounted for on trade date. Dividend income is recorded on the ex-dividend date. Interest income is recorded on the accrual basis. Interest income (except for Municipal Income Portfolio) includes interest and discount earned (net of premium) on short-term obligations, and interest earned on all other debt securities including original issue discount as required by the Internal Revenue Code. Dividends to shareholders and capital gain distributions, if any, are recorded on the ex-dividend date. Interest income for the Municipal Income Portfolio includes interest earned net of premium, and original issue discount as required by the Internal Revenue Code. (g) Federal Income Taxes -- No provision for federal income taxes has been made since it is each Portfolio's policy to comply with the provisions applicable to regulated investment companies under the Internal Revenue Code and to distribute to its shareholders within the allowable time limit substantially all taxable income and realized capital gains. Dividends paid by the Municipal Income Portfolio representing net interest received on tax-exempt municipal securities are not includable by shareholders as gross income for federal income tax purposes because the Portfolio intends to meet certain requirements of the Internal Revenue Code applicable to regulated investment companies which will enable the Portfolio to pay tax-exempt interest dividends. The portion of such interest, if any, earned on private purpose municipal bonds issued after August 7, 1986, may by considered a tax preference item to shareholders. 100 MENTOR FUNDS NOTES TO FINANCIAL STATEMENTS (CONTINUED) - -------------------------------------------------------------------------------- At September 30, 1998, capital loss carryforwards for federal tax purposes were as follows:
MUNICIPAL QUALITY EXPIRES INCOME PORTFOLIO INCOME PORTFOLIO - ----------- ------------------ ----------------- 9/30/2001 $ - $ 244,512 9/30/2002 - 3,678,547 9/30/2003 317,478 7,326,035 9/30/2004 1,616,817 1,708,773 9/30/2005 - 1,325,149 9/30/2006 295,480 - ---------- ----------- $2,229,775 $14,283,016 ========== ===========
Such capital loss carryforwards will reduce the Portfolios' taxable income arising from future net realized gains on investments, if any, to the extent permitted by the Internal Revenue Code, and thus will reduce the amount of the distributions to shareholders which would otherwise relieve the Portfolios of any liability for federal tax. (h) When-Issued and Delayed Delivery Transactions -- The Portfolios may engage in when-issued or delayed delivery transactions. To the extent the Portfolios engage in such transactions, they will do so for the purpose of acquiring portfolio securities consistent with their investment objectives and policies and not for the purpose of investment leverage. The Portfolios will record a when-issued security and the related liability on the trade date. Until the securities are received and paid for, the Portfolios will maintain security positions such that sufficient liquid assets will be available to make payment for the securities purchased. Securities purchased on a when-issued or delayed delivery basis are marked to market daily, and begin earning interest on the settlement date. (i) Futures Contracts -- In order to gain exposure to or protect against declines in security values, the Portfolios may buy and sell futures contracts. The Portfolios may also buy or write put or call options on futures contracts. The Portfolios may sell futures contracts to hedge against declines in the value of portfolios securities. The Portfolios may also purchase futures contracts to gain exposure to market changes as it may be more efficient or cost effective than actually buying securities. The Portfolios will segregate assets to cover its commitments under such speculative futures contracts. Upon entering into a futures contract, the Portfolios are required to deposit either cash or securities in an amount (initial margin) equal to a certain percentage of the contract value. Subsequent payments (variation margin) are made or received by the Portfolios each day. The variation margin payments are equal to the daily changes in the contract value and are recorded as unrealized gains and losses. The Portfolios recognize a realized gain or loss when the contract is closed. For the year ended September 30, 1998, Strategy Portfolio, Municipal Income Portfolio and Short-Duration Income Portfolio had realized losses of $1,950,741, $923,251, and $88,910, respectively, on closed futures contracts. Risks of entering into futures contracts (and related options) include the possibility that there may be an illiquid market and that a change in the value of the contract or option may not correlate with changes in the value of the underlying securities. At September 30, 1998, Strategy Portfolio and Municipal Income Portfolio had open positions in the following futures contracts: 101 MENTOR FUNDS NOTES TO FINANCIAL STATEMENTS (CONTINUED) - --------------------------------------------------------------------------------
NET NUMBER OF NOTIONAL UNREALIZED PORTFOLIO CONTRACTS POSITION CONTRACTS EXPIRATION VALUE DEPRECIATION - ------------------ ----------- ---------- ------------------ ------------ -------------- ---------------- Strategy 734 Short U.S. Long Bond Dec-98 $73,400,000 ($3,871,838) Municipal Income 90 Short Muni Bond Future Dec-98 $ 9,000,000 ($ 225,729) - ------------------ --- ---------- ------------------ ------ ----------- ----------
(j) Options - In order to produce incremental earnings or protect against changes in the value of portfolio securities, the Portfolios may buy and sell put and call options, write covered call options on portfolio securities and write cash-secured put options. The Portfolios generally purchase put options or write covered call options to hedge against adverse movements in the value of portfolio holdings. The Portfolios may also use options for speculative purposes, although they do not employ options for this at the present time. The Portfolios will segregate assets to cover their obligations under option contracts. Options contracts are valued daily based upon the last sales price on the principal exchange on which the option is traded and unrealized appreciation or depreciation is recorded. The Portfolios will realize a gain or loss upon the expiration or closing of the option transaction. When an option is exercised, the proceeds on sales for a written call option, the purchase cost for a written put option, or the cost of the security for a purchased put or call option is adjusted by the amount of premium received or paid. For the year ended September 30, 1998, Municipal Income Portfolio had a net realized gain of $10,940 on closed option contracts. The risk in writing a call option is that the Portfolios give up the opportunity for profit if the market price of the security increases and the option is exercised. The risk in writing a put option is that the Portfolio may incur a loss if the market price of the security decreases and the option is exercised. The risk in buying an option is that the Portfolio pays a premium whether or not the option is exercised or the counterparty is unwilling or unable to perform. The Portfolio also has the additional risk of not being able to enter into a closing transaction if a liquid secondary market does not exist. The Portfolio may also write over-the-counter options where the completion of the obligation is dependent upon the credit standing of the counterparty. Activity in written options for the Municipal Income Portfolio for the year ended September 30, 1998, was as follows:
PREMIUM RECEIVED FACE VALUE ------------ --------------- Options outstanding at September 30, 1997 $ 36,693 $ 10,000,000 Options written 53,274 21,000,000 Options closed (49,292) (20,000,000) Options expired (40,675) (11,000,000) - ----------------------- -------- ------------ Options outstanding at September 30, 1998 $ - $ - - ----------------------- -------- ------------
(k) Residual Interests - A derivative security is any investment that derives its value from an underlying security, asset, or market index. Quality Income Portfolio and Short-Duration Income Portfolio invest in mortgage security residual interests ("residuals") which are considered derivative securities. The Portfolios' investments in residuals have been primarily in securities issued by proprietary mortgage trusts. While these entities have been highly leveraged, often having indebtedness of up to 95% of their total value, the Portfolios have not incurred any indebtedness in the course of making these residual investments; nor have the Portfolios' assets been 102 MENTOR FUNDS NOTES TO FINANCIAL STATEMENTS (CONTINUED) - -------------------------------------------------------------------------------- pledged to secure the indebtedness of the issuing structure or the Portfolios' investment in the residuals. In consideration of the risk associated with investment in residual securities, it is the Portfolios' policy to limit their exposure at the time of purchase to no more than 20% of their total assets. (l) Interest-Rate Swap - An interest-rate swap is a contract between two parties on a specified principal amount (referred to as the notional principal) for a specified period. In the most common instance, a swap involves the exchange of streams of variable and fixed-rate interest payments. During the term of the swap, changes in the value of the swap are recognized as unrealized gains or losses by marking-to-market the value of the swap. When the swap is terminated, the Fund will record a realized gain or loss. At September 30, 1998, there were no open interest rate swap agreements. (m) Deferred Expenses - Costs incurred by the Portfolios in connection with their initial share registration and organization costs were deferred by the Portfolios and are being amortized on a straight-line basis over a five-year period. (n) Distributions - Income distributions and capital gain distributions are determined in accordance with income tax regulations which may differ from generally accepted accounting principles. These differences are primarily due to differing treatments for net operating losses, certain futures and deferral of wash sales and equalization deficits. The Growth Portfolio, Capital Growth Portfolio and Strategy Portfolio also utilized earnings and profits distributed to shareholders on redemption of shares as a part of the distributions for income tax purposes. NOTE 3: DIVIDENDS Dividends will be declared daily and paid monthly to all shareholders invested in Municipal Income Portfolio, Quality Income Portfolio, Short-Duration Income Portfolio and High Income Portfolio. Dividends are declared and paid annually to all shareholders invested in the Growth Portfolio, Capital Growth Portfolio, Strategy Portfolio, Global Portfolio and Balanced Portfolio. Dividends are declared and paid quarterly to all shareholders invested in Income and Growth Portfolio. Dividends will be reinvested in additional shares of the same class and Portfolio on payment dates at the ex-dividend date net asset value without a sales charge unless cash payments are requested by shareholders in writing to Mentor Investment Group, LLC. Dividends of all Portfolios are paid to shareholders of record on the record date. Capital gains realized by each Portfolio, if any, are paid annually. NOTE 4: INVESTMENT ADVISORY AND MANAGEMENT AND ADMINISTRATION AGREEMENTS Mentor Investment Advisors, LLC ("Mentor Advisors"), the Portfolios' investment advisor, receives for its services an annual investment advisory fee not to exceed the following percentages of the average daily net assets of the particular Portfolio: Growth Portfolio, 0.70%; Capital Growth Portfolio, 0.80%; Strategy Portfolio, 0.85%; Income and Growth Portfolio, 0.75%; Balanced Portfolio, 0.75%; Municipal Income Portfolio, 0.60%; Quality Income Portfolio, 0.60%; Short-Duration Income Portfolio, 0.50%; and High Income Portfolio, 0.70%. Mentor Advisors pays Van Kampen American Capital Management, Inc., the sub-advisor to Municipal Income Portfolio, an annual fee expressed as a percentage of the Portfolio's average net assets as 103 MENTOR FUNDS NOTES TO FINANCIAL STATEMENTS (CONTINUED) - -------------------------------------------------------------------------------- follows: 0.25% of the first $60 million of the Portfolio's average net assets and 0.20% of the Portfolio's average net assets over $60 million. For the period from October 1, 1997 to June 30, 1998, Wellington Management Company, LLC, the sub-advisor to the Income and Growth Portfolio, received from the Investment Advisor an annual fee expressed as a percentage of that Portfolio's assets as follows: 0.325% on the first $50 million of the Portfolio's average net assets, 0.275% on the next $150 million of the Portfolio's average net assets, 0.225% of the next $300 million of the Portfolio's average net assets, and 0.200% of the Portfolio's net assets over $500 million. Effective July 1, 1998, the sub-advisor to the Income and Growth Portfolio received the following fees: 0.325% on the first $50 million of the Portfolio's average net assets, 0.250% on the next $150 million of the Portfolio's average net assets, and 0.200% of the Portfolio's average net assets over $150 million. Van Kampen American Capital Management, Inc., the sub-advisor to the High Income Portfolio receives from the Investment Advisor an annual fee of 0.20% of the Portfolio's average daily net assets. No performance or incentive fees are paid to the sub-advisors. Under certain Sub-Advisory Agreements, the particular sub-advisor may, from time to time, voluntarily waive some or all of its sub-advisory fee charged to the Investment Advisor and may terminate any such voluntary waiver at any time in its sole discretion. The Global Portfolio has entered into an Investment Advisory Agreement with Mentor Perpetual Advisors, LLC ("Mentor Perpetual"). Mentor Perpetual is owned equally by Mentor and Perpetual PLC, a diversified financial services holding company. Under this agreement, Mentor Perpetual's management fee is accrued daily and paid monthly at an annual rate of 1.10% applied to the average daily net assets of the Portfolio up to and including $75 million and 1.00% of its average daily net assets in excess of $75 million. For the year ended September 30, 1998, Mentor Advisors and sub-advisors, earned and voluntarily waived the following management fees:
MANAGEMENT MANAGEMENT FEE SUB ADVISOR FEE VOLUNTARILY FEE PORTFOLIO EARNED WAIVED EARNED/(WAIVED) - ----------------------- ------------ ------------- ---------------- Growth $4,204,377 $ - $ - Global 1,612,495 - - Capital Growth 2,153,467 - - Strategy 2,420,122 - - Income and Growth 1,638,729 - 575,028 Balanced 31,721 - 20,856 Municipal Income 557,332 - 216,114 Quality Income 1,025,941 204,530 - Short-Duration Income 504,097 180,523 - High Income 175,891 175,891 (51,279) - ----------------------- ---------- ------- -------
Administrative personnel and services are provided by Mentor, under an Administration Agreement, at an annual rate of 0.10% of the average daily net assets of each Portfolio. For the year ended September 30, 1998, Mentor earned the following administration fees:
ADMINISTRATION ADMINISTRATION FEE VOLUNTARILY PORTFOLIO FEE EARNED WAIVED - ----------------------- ---------------- ---------------- Growth $600,625 $ - Global 153,750 - Capital Growth 269,183 - Strategy 284,720 - Income and Growth 218,497 - Balanced 4,219 4,219 Municipal Income 92,888 - Quality Income 174,343 - Short-Duration Income 101,237 101,237 High Income 24,979 - - ----------------------- -------- -------
104 MENTOR FUNDS NOTES TO FINANCIAL STATEMENTS (CONTINUED) - -------------------------------------------------------------------------------- The Portfolios also provide direct reimbursement to Mentor for certain legal and compliance administration, investor relation and operation related costs not covered under the Investment Management Agreement. For the year ended September 30, 1998, these direct reimbursements were as follows:
DIRECT PORTFOLIO REIMBURSEMENTS - ----------------------- --------------- Growth $26,735 Global 6,902 Capital Growth 12,494 Strategy 12,317 Income and Growth 10,079 Municipal Income 4,318 Quality Income 7,964 Short-Duration Income 5,085 - ----------------------- -------
NOTE 5: DISTRIBUTION AGREEMENT AND OTHER TRANSACTIONS WITH AFFILIATES The Class B shares of the Portfolios have adopted a Distribution Plan (the Plan) pursuant to Rule 12b-1 under the Investment Company Act of 1940. Under a Distribution Agreement between the Portfolios and Mentor Distributors, LLC ("Mentor Distributors") a wholly-owned subsidiary of BYSIS Fund Services, Inc., Mentor Distributors was appointed distributor of the Portfolios. To compensate Mentor Distributors for the services it provides and for the expenses it incurs under the Distribution Agreement, the Portfolios pay a distribution fee, which is accrued daily and paid monthly at the annual rate of 0.75% of the Portfolios' average daily net assets for the Growth Portfolio, Capital Growth Portfolio, Strategy Portfolio, Income and Growth Portfolio, Balanced Portfolio and Global Portfolio, 0.50% of the average daily net assets of the Quality Income Portfolio, High Income Portfolio and Municipal Income Portfolio, and 0.30% of the average daily net assets for the Short-Duration Income Portfolio. Mentor Distributors may select financial institutions, such as investment dealers and banks to provide sales support services as agents for their clients or customers who beneficially own Class B shares of the Portfolios. Financial institutions will receive fees from Mentor Distributors based upon Class B shares owned by their clients or customers. Mentor Funds has adopted a Shareholder Servicing Plan (the "Service Plan") with Mentor Distributors with respect to Class A and Class B shares of each Portfolio. Under the Service Plan, financial institutions will enter into shareholder service agreements with the Portfolios to provide administrative support services to their customers who from time to time may be owners of record or beneficial owners of Class A or Class B shares of one or more Portfolios. In return for providing these support services, a financial institution may receive payments from one or more Portfolios at a rate not exceeding 0.25% of the average daily net assets of the Class A or Class B shares of the particular Portfolio or Portfolios beneficially owned by the financial institution's customers for whom it is holder of record or with whom it has a servicing relationship. 105 MENTOR FUNDS NOTES TO FINANCIAL STATEMENTS (CONTINUED) - -------------------------------------------------------------------------------- Presently, the Portfolios' class specific expenses are limited to expenses incurred by a class of shares pursuant to its respective Distribution Plan. Under the Distribution Plan, shareholder service fees are charged in Class A and B and distribution fees are charged to Class B. For the year ended September 30, 1998, distribution fees and shareholder servicing fees were as follows:
CLASS B CLASS B SHAREHOLDER SERVICE FEE DISTRIBUTION DISTRIBUTION --------------------------- SHAREHOLDER SERVICE PORTFOLIO FEE FEE WAVIED CLASS A CLASS B FEE WAIVED - ----------------------- -------------- -------------- ----------- ------------- -------------------- Growth $3,638,580 $ -- $255,596 $1,233,864 $ -- Global 734,020 -- 146,546 237,827 -- Capital Growth 1,227,717 -- 283,728 389,229 -- Strategy 1,875,172 -- 77,994 633,805 -- Income and Growth 986,604 -- 222,501 323,741 -- Balanced 30,319 29,451 3,517 6,695 9,738 Municipal Income 257,381 -- 108,151 124,069 -- Quality Income 467,042 -- 195,196 232,278 -- Short-Duration Income 133,476 -- 160,078 91,969 -- High Income 68,461 -- 28,187 34,631 -- - ----------------------- ---------- ------- -------- ---------- ------
NOTE 6: FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS In connection with portfolio purchases and sales of securities denominated in a foreign currency, Global Portfolio may enter into forward foreign currency exchange contracts ("contracts"). Additionally, from time to time Global Portfolio may enter into contracts to hedge certain foreign currency assets. Contracts are recorded at market value. Realized gains and losses arising from such transactions are included in net gain (loss) on investments and forward foreign currency exchange contracts. The Portfolio is subject to the credit risk that the other party will not complete the obligations of the contract. At September 30, 1998, Global Portfolio had outstanding forward contracts as set forth below.
CONTRACTS NET UNREALIZED TO DELIVER/ IN EXCHANGE APPRECIATION/ SETTLEMENT DATE RECEIVE VALUE FOR (DEPRECIATION) - ----------------------------- ------------- ------------ ------------- --------------- PURCHASES 10/01/98 British Pound 34,560 $ 58,716 $ 58,925 $ (209) 10/01/98 British Pound 19,415 32,985 33,102 (117) SALES 10/01/98 British Pound 32,471 55,166 55,362 196 10/02/98 British Pound 33,054 56,156 56,356 200 10/02/98 British Pound 36,586 62,159 62,380 221 10/30/98 French Franc 3,859,918 689,505 685,598 (3,907) 3/18/99 Hong Kong Dollar 7,928,000 1,006,040 1,000,000 (6,040) 11/30/98 Singapore Dollar 885,000 524,787 500,000 (24,787) - -------- ------------------ --------- --------- ---------- ---------
106 MENTOR FUNDS NOTES TO FINANCIAL STATEMENTS (CONTINUED) - -------------------------------------------------------------------------------- NOTE 7: CAPITAL SHARE TRANSACTIONS The Declaration of Trust permits the Trustees to issue an unlimited number of full and fractional shares of beneficial interest. Transactions in Portfolio shares were as follows:
MENTOR GROWTH PORTFOLIO ------------------------------------------------------------------- YEAR ENDED YEAR ENDED 9/30/98 9/30/97 ---------------------------------- -------------------------------- SHARES DOLLARS SHARES DOLLARS ---------------- ----------------- --------------- ---------------- CLASS A: Shares sold 12,016,618 $ 210,103,016 5,018,131 $ 82,270,375 Shares issued upon reinvestment of distributions 346,751 6,474,795 369,088 5,744,163 Shares redeemed (12,306,743) (213,035,017) (2,301,180) (37,823,031) ----------- -------------- ---------- ------------- Change in net assets from capital share transactions 56,626 $ 3,542,794 3,086,039 $ 50,191,507 =========== ============== ========== ============= CLASS B: Shares sold 4,138,131 $ 73,047,883 5,392,199 $ 86,290,167 Shares issued upon reinvestment of distributions 1,667,456 30,460,604 3,348,283 51,489,284 Shares redeemed (4,698,527) (80,890,251) (3,140,076) (49,890,633) ----------- -------------- ---------- ------------- Change in net assets from capital share transactions 1,107,060 $ 22,618,236 5,600,406 $ 87,888,818 =========== ============== ========== ============= CLASS Y: (a) Shares sold 1,786,672 $ 30,602,698 - - Shares issued upon reinvestment of distributions 1 10 - - Shares redeemed (53,808) (894,152) - - ----------- -------------- ---------- ------------- Change in net assets from capital share transactions 1,732,865 $ 29,708,556 - - =========== ============== ========== =============
MENTOR PERPETUAL GLOBAL PORTFOLIO ------------------------------------------------------------------- YEAR ENDED YEAR ENDED 9/30/98 9/30/97 ---------------------------------- ------------------------------ SHARES DOLLARS SHARES DOLLARS --------------- ---------------- ------------- -------------- CLASS A: Shares sold 2,057,945 $ 42,154,809 1,732,413 $ 32,107,036 Shares issued upon reinvestment of distributions 113,726 2,255,270 26,897 463,738 Shares redeemed (1,275,534) (25,637,616) (270,161) (5,115,471) ---------- ------------- --------- ------------ Change in net assets from capital share transactions 896,137 $ 18,772,463 1,489,149 $ 27,455,303 ========== ============= ========= ============ CLASS B: Shares sold 1,821,588 $ 36,737,964 2,325,365 $ 42,416,589 Shares issued upon reinvestment of distributions 232,932 4,477,444 91,695 1,544,189 Shares redeemed (983,971) (18,930,107) (447,724) (8,352,236) ---------- ------------- --------- ------------ Change in net assets from capital share transactions 1,070,549 $ 22,285,301 1,969,336 $ 35,608,542 ========== ============= ========= ============ CLASS Y: (a) Shares sold 53 $ 1,000 - - Shares issued upon reinvestment of distributions - 8 - - Shares redeemed - - - - ---------- ------------- --------- ------------ Change in net assets from capital share transactions 53 $ 1,008 - - ========== ============= ========= ============
(a) For the period from November 19, 1997 (initial offering of Class Y Shares) to September 30, 1998. 107 MENTOR FUNDS NOTES TO FINANCIAL STATEMENTS (CONTINUED) - -------------------------------------------------------------------------------- NOTE 7: CAPITAL SHARE TRANSACTIONS (CONTINUED)
MENTOR CAPITAL GROWTH PORTFOLIO -------------------------------------------------------------------- YEAR ENDED YEAR ENDED 9/30/98 9/30/97 --------------------------------- -------------------------------- SHARES DOLLARS SHARES DOLLARS --------------- --------------- ------------- ---------------- CLASS A: Shares sold 5,110,051 $ 121,415,173 1,422,449 $ 28,161,248 Shares issued upon reinvestment of distributions 278,288 5,833,664 264,769 4,552,490 Shares redeemed (1,926,775) (45,709,577) (404,403) (7,959,184) ---------- ------------- --------- ------------- Change in net assets from capital share transactions 3,461,564 $ 81,539,260 1,282,815 $ 24,754,554 ========== ============= ========= ============= CLASS B: Shares sold 4,375,173 $ 98,931,464 1,749,992 $ 33,332,019 Shares issued upon reinvestment of distributions 507,715 10,256,056 596,606 9,983,395 Shares redeemed (1,063,324) (23,712,167) (711,342) (13,428,205) ---------- ------------- --------- ------------- Change in net assets from capital share transactions 3,819,564 $ 85,475,353 1,635,256 $ 29,887,209 ========== ============= ========= ============= CLASS Y: (a) Shares sold 48 $ 1,000 - - Shares issued upon reinvestment of distributions 1 12 - - Shares redeemed - - - ---------- ------------- --------- ------------- Change in net assets from capital share transactions 49 $ 1,012 - - ========== ============= ========= =============
MENTOR STRATEGY PORTFOLIO ------------------------------------------------------------------ YEAR ENDED YEAR ENDED 9/30/98 9/30/97 --------------------------------- -------------------------------- SHARES DOLLARS SHARES DOLLARS --------------- ----------------- --------------- ---------------- CLASS A: Shares sold 508,748 $ 7,933,524 1,695,322 $ 28,517,096 Shares issued upon reinvestment of distributions 444,548 6,836,196 91,017 1,513,610 Shares redeemed (1,529,689) (24,220,890) (742,169) (12,677,413) ---------- ------------- --------- ------------- Change in net assets from capital share transactions (576,393) ($ 9,451,170) 1,044,170 $ 17,353,293 ========== ============= ========= ============= CLASS B: Shares sold 564,916 $ 8,678,121 2,587,894 $ 43,129,553 Shares issued upon reinvestment of distributions 3,423,558 51,517,305 1,291,000 21,237,045 Shares redeemed (7,097,154) (108,934,512) (3,591,125) (60,432,366) ---------- ------------- ---------- ------------- Change in net assets from capital share transactions (3,108,680) ($ 48,739,086) 287,769 $ 3,934,232 ========== ============= ========== ============= CLASS Y: (a) Shares sold 67 $ 1,001 - - Shares redeemed - - - - ---------- ------------- ---------- ------------- Change in net assets from capital share transactions 67 $ 1,001 - - ========== ============= ========== =============
(a) For the period from November 19, 1997 (initial offering of Class Y Shares) to September 30, 1998. 108 MENTOR FUNDS NOTES TO FINANCIAL STATEMENTS (CONTINUED) - -------------------------------------------------------------------------------- NOTE 7: CAPITAL SHARE TRANSACTIONS (CONTINUED)
MENTOR INCOME AND GROWTH PORTFOLIO --------------------------------------------------------------------- YEAR ENDED YEAR ENDED 9/30/98 9/30/97 ---------------------------------- -------------------------------- SHARES DOLLARS SHARES DOLLARS --------------- ---------------- ------------- ---------------- CLASS A: Shares sold 2,515,923 $ 49,323,113 1,945,245 $ 37,552,063 Shares issued upon reinvestment of distributions 371,373 7,153,831 179,904 3,303,336 Shares redeemed (915,370) (18,005,450) (305,497) (5,925,176) --------- ------------- --------- ------------- Change in net assets from capital share transactions 1,971,926 $ 38,471,494 1,819,652 $ 34,930,223 ========= ============= ========= ============= CLASS B: Shares sold 2,642,784 $ 51,766,483 1,913,241 $ 36,687,335 Shares issued upon reinvestment of distributions 559,471 10,748,481 450,665 8,192,160 Shares redeemed (1,074,795) (21,053,657) (596,371) (11,526,154) ---------- ------------- --------- ------------- Change in net assets from capital share transactions 2,127,460 $ 41,461,307 1,767,535 $ 33,353,341 ========== ============= ========= ============= CLASS Y: (a) Shares sold 53 $ 1,000 - - Shares issued upon reinvestment of distributions 2 30 - - Shares redeemed - - - - ---------- ------------- --------- ------------- Change in net assets from capital share transactions 55 $ 1,030 - - ========== ============= ========= =============
MENTOR BALANCED PORTFOLIO ------------------------------------------------------------- PERIOD ENDED YEAR ENDED 9/30/98 9/30/97 ------------------------------ ---------------------------- SHARES DOLLARS SHARES DOLLARS ------------ --------------- ------------ ------------- CLASS A: (b) Shares sold 258,246 $ 3,577,935 - $ - Shares issued upon reinvestment of distributions - - - - Shares redeemed - - - - ------- ------------ ----------- ---------- Change in net assets from capital share transactions 258,246 $ 3,577,935 - $ - ======= ============ ========== ========== CLASS B: Shares sold 412,403 $ 5,702,737 - $ - Shares issued upon reinvestment of distributions 88,886 1,300,249 37,773 558,075 Shares redeemed (48,378) (810,125) (39,915) (636,137) Conversion of Class B Shares to Class Y Shares (273,416) (3,350,117) - - -------- ------------ ------- ---------- Change in net assets from capital share transactions 179,495 $ 2,842,744 (2,142) $ (78,062) ======== ============ ======= ========== CLASS Y: (b) Shares sold - $ - - $ - Shares issued upon reinvestment of distributions - - - - Shares redeemed (7,305) (100,000) - - Conversion of Class B Shares to Class Y Shares 273,416 3,350,117 - - -------- ------------ ------- ---------- Change in net assets from capital share transactions 266,111 $ 3,250,117 - $ - ======== ============ ======= ==========
(a) For the period from November 19, 1997 (initial offering of Class Y Shares) to September 30, 1998. (b) For the period from September 16, 1998 (initial offering of Class A and Class Y Shares) to September 30, 1998. 109 MENTOR FUNDS NOTES TO FINANCIAL STATEMENTS (CONTINUED) - -------------------------------------------------------------------------------- NOTE 7: CAPITAL SHARE TRANSACTIONS (CONTINUED)
MENTOR MUNICIPAL INCOME PORTFOLIO ------------------------------------------------------------------- YEAR ENDED YEAR ENDED 9/30/98 9/30/97 -------------------------------- -------------------------------- SHARES DOLLARS SHARES DOLLARS ------------- ---------------- ------------- ---------------- CLASS A Shares sold 1,688,990 $ 26,509,509 901,683 $ 13,789,961 Shares issued upon reinvestment of distributions 75,715 1,188,701 41,778 635,539 Shares redeemed (423,337) (6,641,364) (214,874) (3,272,170) --------- ------------ -------- ------------ Change in net assets from capital share transactions 1,341,368 $ 21,056,846 728,587 $ 11,153,330 ========= ============ ======== ============ CLASS B: Shares sold 1,208,341 $ 18,966,860 782,655 $ 11,948,057 Shares issued upon reinvestment of distributions 91,662 1,436,340 83,433 1,268,808 Shares redeemed (436,001) (6,820,355) (478,013) (7,288,249) --------- ------------ -------- ------------ Change in net assets from capital share transactions 864,002 $ 13,582,845 388,075 $ 5,928,616 ========= ============ ======== ============ CLASS Y: (a) Shares sold 64 $ 1,000 - - Shares issued upon reinvestment of distributions 3 43 - - Shares redeemed - - - - --------- ------------ -------- ------------ Change in net assets from capital share transactions 67 $ 1,043 - - ========= ============ ======== ============
MENTOR QUALITY INCOME PORTFOLIO ---------------------------------------------------------------------- YEAR ENDED YEAR ENDED 9/30/98 9/30/97 ---------------------------------- --------------------------------- SHARES DOLLARS SHARES DOLLARS --------------- ---------------- --------------- --------------- CLASS A: Shares sold 4,256,782 $ 56,191,423 2,838,801 $ 37,052,906 Shares issued upon reinvestment of distributions 233,015 3,077,659 91,837 1,196,422 Shares redeemed (1,597,720) (21,178,895) (529,521) (6,928,329) ---------- ------------- --------- ------------- Change in net assets from capital share transactions 2,892,077 $ 38,090,187 2,401,117 $ 31,320,999 ========== ============= ========= ============= CLASS B: Shares sold 3,811,046 $ 50,451,628 2,058,671 $ 26,889,217 Shares issued upon reinvestment of distributions 272,551 3,600,049 218,332 2,847,859 Shares redeemed (1,478,885) (19,526,706) (1,089,318) (14,250,845) ---------- ------------- ---------- ------------- Change in net assets from capital share transactions 2,604,712 $ 34,524,971 1,187,685 $ 15,486,231 ========== ============= ========== ============= CLASS Y: (a) Shares sold 76 $ 1,000 - - Shares issued upon reinvestment of distributions 4 51 - - Shares redeemed - - - - ---------- ------------- ---------- ------------- Change in net assets from capital share transactions 80 $ 1,051 - - ========== ============= ========== =============
(a) For the period from November 19, 1997 (initial offering of Class Y Shares) to September 30, 1998. 110 MENTOR FUNDS NOTES TO FINANCIAL STATEMENTS (CONTINUED) - -------------------------------------------------------------------------------- NOTE 7: CAPITAL SHARE TRANSACTIONS (CONTINUED)
MENTOR SHORT-DURATION INCOME PORTFOLIO ---------------------------------------------------------------------- YEAR ENDED YEAR ENDED 9/30/98 9/30/97 --------------------------------- ---------------------------------- SHARES DOLLARS SHARES DOLLARS --------------- --------------- --------------- ---------------- CLASS A: Shares sold 9,921,692 $124,978,729 2,047,670 $ 25,768,187 Shares issued upon reinvestment of distributions 200,895 2,525,409 49,602 623,647 Shares redeemed (4,997,458) (62,897,886) (505,078) (6,351,983) ---------- ------------ --------- ------------- Change in net assets from capital share transactions 5,125,129 $64,606,252 1,592,194 $ 20,039,851 ========== ============ ========= ============= CLASS B: Shares sold 3,500,465 $44,073,519 1,121,483 $ 14,121,033 Shares issued upon reinvestment of distributions 145,226 1,826,827 89,996 1,131,691 Shares redeemed (1,563,684) (19,674,936) (1,027,042) (12,921,363) ---------- ------------ ---------- ------------- Change in net assets from capital share transactions 2,082,007 $26,225,410 184,437 $ 2,331,361 ========== ============ ========== ============= CLASS Y: (a) Shares sold 79 $ 1,000 - - Shares issued upon reinvestment of distributions 4 49 - - Shares redeemed - - - - ---------- ------------ ---------- ------------- Change in net assets from capital share transactions 83 $ 1,049 - - ========== ============ ========== =============
MENTOR HIGH INCOME PORTFOLIO ------------------------------ PERIOD ENDED 9/30/98 (C) ------------------------------ SHARES DOLLARS ------------- -------------- CLASS A: Shares sold 4,775,208 $ 56,602,255 Shares issued upon reinvestment of distributions 51,541 580,207 Shares redeemed (168,561) (1,889,222) --------- ------------ Change in net assets from capital share transactions 4,658,188 $ 55,293,240 ========= ============ CLASS B: Shares sold 5,890,307 $ 69,683,852 Shares issued upon reinvestment of distributions 62,441 701,346 Shares redeemed (190,546) (2,108,787) --------- ------------ Change in net assets from capital share transactions 5,762,202 $ 68,276,411 ========= ============
(a) For the period from November 19, 1997 (initial offering of Class Y Shares) to September 30, 1998. (c) For the period from June 23, 1998 (commencement of operations) to September 30, 1998. NOTE 8: SUBSEQUENT EVENT Effective November 16, 1998, the Balanced Portfolio acquired substantially all the assets and assumed the liabilities of the Strategy Portfolio in exchange for Class A, Class B and Class Y shares of the Balanced Portfolio. The acquisition was accomplished by a tax-free exchange of the respective shares of the Balanced Portfolio for the net assets of the Strategy Portfolio. The net assets acquired amounted to $222,601,303. The aggregate net assets of the Balanced Portfolio immediately after the acquisition were $255,551,169. 111 MENTOR FUNDS INDEPENDENT AUDITORS' REPORT - -------------------------------------------------------------------------------- THE TRUSTEES AND SHAREHOLDERS MENTOR FUNDS We have audited the accompanying statements of assets and liabilities, including the portfolios of investments of Growth Portfolio, Global Portfolio, Capital Growth Portfolio, Strategy Portfolio, Income and Growth Portfolio, Balanced Portfolio, Municipal Income Portfolio, Quality Income Portfolio, Short-Duration Income Portfolio and High Income Portfolio, portfolios of Mentor Funds as of September 30, 1998 and the related statements of operations for the year or period then ended, the statements of changes in net assets for each of the years or periods in the two-year period then ended and the financial highlights for each of the years or periods in the five-year period ended September 30, 1998 as described more fully in each of the financial highlights of each of the funds. These financial statements and financial highlights are the responsibility of the Funds' management. Our responsibility is to express an opinion on these financial statements and financial highlights based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and financial highlights are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and financial highlights. Our procedures included confirmation of securities owned as of September 30, 1998 by correspondence with the custodian and brokers. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements and financial highlights referred to above present fairly, in all material respects, the financial position of Growth Portfolio, Global Portfolio, Capital Growth Portfolio, Strategy Portfolio, Income and Growth Portfolio, Balanced Portfolio, Municipal Income Portfolio, Quality Income Portfolio, Short-Duration Income Portfolio and High Income Portfolio, portfolios of Mentor Funds as of September 30, 1998, the results of their operations for the year or period then ended, the changes in their net assets for each of the years or periods in the two-year period then ended, and the financial highlights for each of the years or periods in the five-year period ended September 30, 1998, in conformity with generally accepted accounting principles. /s/ KPMG PEAT MARWICK LLP Boston, Massachusetts November 20, 1998 112 MENTOR FUNDS ADDITIONAL INFORMATION SEPTEMBER 30, 1998 - -------------------------------------------------------------------------------- YEAR 2000 (UNAUDITED) The Portfolios receive services from a number of providers which rely on the effective functioning of their respective systems and the systems of others to perform those services. It is generally recognized that certain systems in use today may not be able to perform their intended functions adequately after 1999 because of the inability of computer software to distinguish the year 2000 from the year 1900. Mentor Advisors is taking steps that it believes are reasonably designed to address this potential "Year 2000" problem and to obtain satisfactory assurances that comparable steps are being taken by each of the Portfolios' other major service providers. There can be no assurance, however, that these steps will be sufficient to avoid any adverse impact on the Portfolios from this problem. FEDERAL TAX STATUS OF DIVIDENDS DECLARED (UNAUDITED) Long-term capital gain dividends paid during the period are presented below. For federal income tax purposes, dividends from short-term capital gains are classified as ordinary income. All net investment income dividends were ordinary income, except for Municipal Income Portfolio that paid exempt income dividends. The percentage of qualifying dividends eligible for the corporate dividends received deduction are also listed below for the applicable Portfolios.
LONG-TERM TAX-EXEMPT CAPITAL GAIN INCOME QUALIFYING PORTFOLIO DIVIDENDS DIVIDENDS DIVIDENDS - ----------------------- -------------- ------------ ----------- Growth $37,907,233 $ - - Global 3,028,816 - - Capital Growth 9,208,016 - 21.04% Strategy 41,130,602 - 9.69% Income and Growth 8,656,201 - 37.12% Municipal Income - 3,949,481 - Balanced 893,299 - 11.33% High Income - - - Quality Income - - - Short-Duration Income - - - - ----------------------- ----------- ---------- -----
Shareholders of Mentor Strategy Portfolio (the "Strategy Portfolio") considered and acted upon the proposal listed below at a special meeting of shareholders held on Thursday November 12, 1998. In addition, below the proposal are the results of that vote. 1. To approve or disapprove an Agreement and Plan of Reorganization providing for the transfer of all of the assets of Strategy Portfolio to Mentor Balanced Portfolio (the "Balanced Portfolio") in exchange for shares of the Balanced Portfolio and the assumption by the Balanced Portfolio of all of the liabilities of the Strategy Portfolio, and the distribution of such shares to the shareholders of the Strategy Portfolio in complete liquidation of the Strategy Portfolio: Affirmative 7,281,296 Against 313,087 Abstain 331,983
113 MENTOR FUNDS SHAREHOLDER INFORMATION - -------------------------------------------------------------------------------- TRUSTEES DANIEL J. LUDEMAN, TRUSTEE & CHAIRMAN Chairman and Chief Executive Officer Mentor Investment Group, LLC ARCH T. ALLEN III, TRUSTEE Attorney at Law Allen & Moore, LLP JERRY R. BARRENTINE, TRUSTEE President J.R. Barrentine & Associates ARNOLD H. DREYFUSS, TRUSTEE Chairman Eskimo Pie Corporation WESTON E. EDWARDS, TRUSTEE President Weston Edwards & Associates THOMAS F. KELLER, TRUSTEE Former Dean, Fuqua School of Business Duke University LOUIS W. MOELCHERT, JR., TRUSTEE Vice President for Business & Finance University of Richmond J. GARNETT NELSON, TRUSTEE Consultant Mid-Atlantic Holdings, LLC TROY A. PEERY, JR., TRUSTEE President Heilig-Meyers Company PETER J. QUINN, JR., TRUSTEE Managing Director Mentor Investment Group, LLC OFFICERS PAUL F. COSTELLO, PRESIDENT Managing Director Mentor Investment Group, LLC TERRY L. PERKINS, TREASURER Senior Vice President Mentor Investment Group, LLC GEOFFREY B. SALE, SECRETARY Associate Vice President Mentor Investment Group, LLC MICHAEL A. WADE, ASSISTANT TREASURER Vice President Mentor Investment Group, LLC This report is authorized for distribution to prospective investors only when preceded or accompanied by a Mentor Funds prospectus, which contains complete information about fees, sales charges and expenses. Please read it carefully before you invest or send money. [Mentor Logo] ---------------------- BULK RATE U.S. POSTAGE PAID RIVERFRONT PLAZA MENTOR 901 EAST BYRD STREET ---------------------- RICHMOND, VIRGINIA 23219 (800) 382-0016 1998 MENTOR DISTRIBUTORS, LLC MK835 Mentor Funds ---------------------- Semi-Annual Report ---------------------- March 31, 1999 [MENTOR INVESTMENT GROUP LOGO] MENTOR FUNDS SEMI-ANNUAL REPORT TABLE OF CONTENTS MARCH 31, 1999 - --------------------------------------------------------------------------------
PAGE ----------- Message from the Chairman and President .................. 1 Growth Portfolio ......................................... 2 Perpetual Global Portfolio ............................... 12 Capital Growth Portfolio ................................. 25 Income and Growth Portfolio .............................. 33 Balanced Portfolio ....................................... 43 Municipal Income Portfolio ............................... 53 Quality Income & Short-Duration Income Portfolios ........ 64 High Income Portfolio .................................... 81 Notes to Financial Statements ............................ 90 Shareholder Information .................................. Inside back cover
MENTOR FUNDS MESSAGE FROM THE CHAIRMAN AND PRESIDENT MARCH 31, 1999 - -------------------------------------------------------------------------------- TO OUR SHAREHOLDERS: On behalf of all the associates at Mentor Investment Group, we would like to take this opportunity to thank you for your investment in the Mentor Family of Funds. This Semi-Annual Report reaffirms our commitment to our shareholders and details the financial performance of these investments for the period ended March 31, 1999. Founded in 1970, Mentor Investment Group is an investment advisory firm with more than $16 billion under management. We pride ourselves on a strong heritage of providing quality service and a variety of investment choices that help meet our shareholders' financial objectives by offering mutual funds and separately-invested portfolios. In the commentary that follows, Mentor's investment team presents an insightful perspective on the markets and strategies that shaped their investment decisions for the past fiscal year. Our investment teams operate with these priorities: FOCUS -- In most money management companies, each investment manager has multiple responsibilities. At Mentor, our investment managers are singularly focused on enhancing the value of the portfolios. This means that you can be assured of a consistent, proven approach to developing a winning financial strategy. OPPORTUNITIES -- By offering multiple management styles, portfolio diversification is simplified. Mentor gives investors the tools for long-term investment success through diversification and accommodation of changing investment needs. SERVICE -- To help serve our shareholders, Mentor has a fully dedicated Investor Relations Center. Our Relationship Coordinators are professionally trained and licensed to serve clients' needs. TECHNOLOGY -- Abreast of the most advanced technology and using the latest analytical tools, our investment managers have the ability to survey the financial markets and make informed decisions about where the best place is to invest. We at Mentor are honored to be a partner in the management of your financial assets. Mentor Investment Group provides diversified investment styles and services to over one million shareholders. We serve individuals, corporations, endowments, foundations, public funds, and municipalities. To learn more about Mentor, please contact your consultant or us at (800) 382-0016. We look forward to making the Mentor formula work for you, and to a mutually beneficial relationship. Sincerely, /s/ Daniel J. Ludeman /s/ Paul F. Costello Daniel J. Ludeman Paul F. Costello CHAIRMAN PRESIDENT [MENTOR INVESTMENT GROUP GRAPHIC] THE MENTOR MISSION TO PROVIDE PROFESSIONAL INVESTMENT MANAGEMENT SERVICES THROUGH A FIRM THAT IS SECOND TO NONE IN THE QUALITY OF ITS INVESTMENT PROCESS, THE SKILL AND TRAINING OF ITS PROFESSIONALS, AND THE COMMITMENT, SHARED BY ALL ITS ASSOCIATES, TO DELIVER THE HIGHEST LEVEL OF SERVICE AND ETHICAL BEHAVIOR TO CLIENTS. FOR MORE INFORMATION AND A PROSPECTUS FOR THE FUNDS, PLEASE CALL US, (800)382-0016, OR CONTACT YOUR CONSULTANT. THE PROSPECTUS CONTAINS COMPLETE INFORMATION ABOUT FEES, SALES CHARGES, AND EXPENSES. PLEASE READ IT CAREFULLY BEFORE INVESTING OR SENDING MONEY. 1 MENTOR GROWTH PORTFOLIO MANAGERS' COMMENTARY: THE SMALL-CAPITALIZATION GROWTH TEAM MARCH 31, 1999 - -------------------------------------------------------------------------------- MARKET REVIEW After an extremely strong fourth quarter of 1998, the first quarter of 1999 was one of the most difficult we have encountered in the nearly 15 years of the Small-Capitalization Growth Portfolio's existence. Not difficult in terms of company fundamentals, but rather in terms of market psychology. It seemed throughout the quarter that positive investment returns could only be achieved by buying the largest companies or by purchasing companies with ".com" after their names. The latter, of course, typically have no earnings streams at all. The market largely ignored our small-cap growth companies whose unit sales grew at double-digit rates and whose real earnings growth ranged from 25% and higher. The narrowness of the market has been mentioned often in the financial press recently, but a few facts and figures may be illustrative. The Russell 2000 Index has a total market capitalization of roughly $1 trillion dollars. This seems like a fairly sizeable amount of money until one realizes that the sum of the market capitalizations of the three largest companies in the Standard and Poor's 500 index, Microsoft, General Electric and Wal-Mart, exceed that amount! In fact, the 30 largest companies in the S&P 500 represent a third of the capitalization of the 8,000 public companies. The narrowness of the market has not been confined to size alone, although this was a very important factor in performance in the first quarter. During the quarter, 56% of all industries in the Russell 2000 saw market values decline by more than 10%. Indeed, 65% of all industries underperformed the index itself. Strange as it may seem, companies in the Russell 2000 losing money or having no income appreciated on average over 10% during the quarter while those companies with net income declined in value. MANAGEMENT STRATEGY We continue to believe that the company and industry diversification in our Portfolio makes great sense. We own over 125 rapidly growing companies with average market capitalizations of $950 million. Technology and healthcare companies figure heavily in the make up of the Portfolio with a combined weighting of over 40% of the assets. Consumer oriented industries such as broadcasting and retailing are also important holdings of the Portfolio and are sectors in which we believe earnings growth will be particularly strong this year. We are adding to our telecommunication holdings, believing that unit growth, particularly among the long distance and broadband companies, will be very strong. We are reducing our weighting in the transportation industries due to the fact that energy prices seem to have found a bottom, and at the same time we are investigating the potential for new investments in the energy sector. PERFORMANCE REVIEW For the six-month period ending March 31, 1999 the Mentor Growth Portfolio A shares returned 4.99%. The shift in investor psychology regarding small-capitalization equities can be seen by comparing the 22.87% return for the Portfolio in the September-December period and the -14.55% decline for the January-March period. Over the course of the first quarter we have seen the Portfolio's P/E multiple contract by 20%. For the six months we trailed the 10.00% return of our Russell 2000 index benchmark. This was due in part to our lack of Internet exposure as these companies do not meet our earnings growth requirements. Despite the first quarter decline, we 2 MENTOR GROWTH PORTFOLIO MANAGERS' COMMENTARY: THE SMALL-CAPITALIZATION GROWTH TEAM MARCH 31, 1999 - -------------------------------------------------------------------------------- are seeing some of the best fundamentals for our companies in some time. Fourth quarter earnings growth was in excess of 40% over the previous year and positive earnings surprises outnumbered negatives ones by nearly five to one. With its earnings expected to grow in excess of 30%, the Portfolio is selling at 19 times estimated 1999 earnings. Compare this to the S&P 500, which saw its earnings contract 2% in the final quarter of the year, whose earnings growth is expected to be in the single digits this year, and much is selling at a record level of 32 times those estimated earnings. MARKET OUTLOOK We do not believe that the present polarization of the market can continue indefinitely. Several times in the past similar market conditions have evolved in which a very small number of companies drove performance. This has typically led to severe P/E compression among many of the smaller growth companies and eventually to very strong outperformance by these same companies. The longest period of underperformance of small-caps relative to large-caps was six years and occurred during the Great Depression. Although the Portfolio has underperformed large-caps since the second half of 1996, small-cap growth stocks in general have now underperformed for over four years. At present, the top 50 stocks in the S&P 500 are selling at twice their long-term growth rates. Companies in the Growth Portfolio are selling at roughly 60% of their long-term growth rates. We remain convinced that over time, valuations revert to the mean and earnings ultimately drive stock prices. We believe that the present situation presents one of the more extraordinary periods of small cap undervaluation in market history. We are unaware of any time over the past 40 years when smaller companies have sold at greater discounts to larger-cap stocks than at the present. We suspect that when one looks back a few years from now, it will be clear that 1999 marked a historic low point in small-cap valuations, particularly relative to larger-cap issues. PERFORMANCE COMPARISON Comparison of change in value of a hypothetical $10,000 investment in Mentor Growth Portfolio Class A and the Russell 2000.~ Class A Russell 2,000 6/5/95 9425 10000 9/30/95 11251 11557 9/30/96 14640 13076 9/30/97 18418 17416 9/30/98 14352 14103 3/31/99 15068 15514 Average Annual Returns as of 3/31/99 Including Sales Charges 1-Year Since Inception+++ Class A (27.56%) 11.32% PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE PERFORMANCE. YOUR INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO WHEN SHARES ARE REDEEMED, THEY MAY BE WORTH MORE OR LESS THAN ORIGINAL COST. MUTUAL FUNDS ARE NOT OBLIGATIONS OF OR GUARANTEED BY ANY BANK AND ARE NOT FEDERALLY INSURED. ~ The Russell 2000 is composed of the 2,000 smallest stocks in the Russell 3000 Index and represents approximately 7% of the U.S. equity market capitalization. The Russell 3000 is composed of the 3,000 largest U.S. companies by market capitalization and represents approximately 98% of the U.S. market. The indexes are not adjusted for sales charges or other fees. ++ Represents a hypothetical investment of $10,000 in Mentor Growth Portfolio Class A Shares, after deducting the maximum sales charge of 5.75% ($10,000 investment minus $575 sales charge = $9,425). The Class A Shares' performance assumes the reinvestment of all dividends and distributions. +++ Reflects operations of Mentor Growth Portfolio Class A Shares from the date of issuance on 6/5/95 through 3/31/99. 3 MENTOR GROWTH PORTFOLIO MARCH 31, 1999 - -------------------------------------------------------------------------------- PERFORMANCE COMPARISON Comparison of change in value of a hypothetical $10,000 investment in Mentor Growth Portfolio Class B Shares and the Russell 2000.- Class B Russell 2000~ 9/30/88 10000 10000 12/31/88 8737 8859.93 12/31/89 10252 10835.34 12/31/90 9096 8289.97 12/31/91 13667 12107.64 12/31/92 15796 14336.85 12/31/93 18260 17047.50 12/31/94 17443 16736.97 9/30/95 23042 21041.03 9/30/96 29535 23804.37 9/30/97 36817 31705.64 9/30/98 32972 28788 3/31/99 46963 31667 Average Annual Returns as of 3/31/99 Including Sales Charges 1-Year 5-Year 10-Year Class B (26.58%) 10.67% 12.20% PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE PERFORMANCE. YOUR INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO WHEN SHARES ARE REDEEMED, THEY MAY BE WORTH MORE OR LESS THAN ORIGINAL COST. MUTUAL FUNDS ARE NOT OBLIGATIONS OF OR GUARANTEED BY ANY BANK AND ARE NOT FEDERALLY INSURED. + Represents a hypothetical investment of $10,000 in Mentor Growth Portfolio Class B Shares. A contingent deferred sales charge will be imposed, if applicable, on Class B Shares at rates ranging from a maximum of 4.00% of amounts redeemed during the first year following the date of purchase to 1.00% of amounts redeemed during the five-year period following the date of purchase. The value of the Class B Shares reflects a redemption fee in effect at the end of each of the stated periods. The Class B Shares' performance assumes the reinvestment of all dividends and distributions. ~ The Russell 2000 is composed of the 2,000 smallest stocks in the Russell 3000 Index and represents approximately 7% of the U.S. equity market capitalization. The Russell 3000 is composed of the 3,000 largest U.S. companies by market capitalization and represents approximately 98% of the U.S. market. The indexes are not adjusted for sales charges or other fees. 4 MENTOR GROWTH PORTFOLIO MARCH 31, 1999 - -------------------------------------------------------------------------------- PERFORMANCE COMPARISON Comparison of change in value of a hypothetical $10,000 investment in Mentor Growth Portfolio Class Y and the Russell 2000.~ Class Y Russell 2000~ 11/19/97 10000 10000 12/31/97 10021 10109 3/31/98 11314 11126 6/30/98 10500 10580 9/30/98 8301 8470 3/31/99 8721 9318 Total Returns as of 3/31/99 1-Year Since Inception++ Class Y (22.92%) (10.67%) PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE PERFORMANCE. YOUR INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO WHEN SHARES ARE REDEEMED, THEY MAY BE WORTH MORE OR LESS THAN ORIGINAL COST. MUTUAL FUNDS ARE NOT OBLIGATIONS OF OR GUARANTEED BY ANY BANK AND ARE NOT FEDERALLY INSURED. ~ The Russell 2000 is composed of the 2,000 smallest stocks in the Russell 3000 Index and represents approximately 7% of the U.S. equity market capitalization. The Russell 3000 is composed of the 3,000 largest U.S. companies by market capitalization and represents approximately 98% of the U.S. market. The indexes are not adjusted for sales charges or other fees. + Represents a hypothetical investment of $10,000 in Mentor Growth Portfolio Class Y Shares. These shares are not subject to any sales or contingent deferred sales charges. The Class Y Shares' performance assumes the reinvestment of all dividends and distributions. ++ Reflects operations of Mentor Growth Portfolio Class Y Shares from the date of issuance on 11/19/97 through 3/31/99. 5 MENTOR GROWTH PORTFOLIO PORTFOLIO OF INVESTMENTS MARCH 31, 1999 (UNAUDITED) - --------------------------------------------------------------------------------
SHARES MARKET VALUE COMMON STOCKS - 93.84% CAPITAL GOODS & CONSTRUCTION - 4.48% Aviation Sales Company 98,250 $4,372,125 Communications Holdings, Inc. 62,700 2,899,875 Conrad Industries, Inc. 226,700 821,787 Denali, Inc. * 205,250 1,821,594 MotivePower Industries, Inc. 326,950 8,214,619 Rental Service Corporation * 222,700 3,897,250 ---------- 22,027,250 ---------- CONSUMER CYCLICAL - 17.37% Avis Rent A Car * 244,700 6,775,131 Cadmus Communications Corporation 265,500 3,816,562 Carey International, Inc. * 170,100 2,764,125 Chancellor Media Corporation * 64,750 3,051,344 Chattem, Inc. 175,450 5,482,812 Citadel Communications Corporation * 77,750 2,585,188 Clear Channel Communications 45,662 3,062,208 Cox Radio, Inc. - Class A * 103,400 5,299,250 Cumulus Media - Class A * 312,300 3,669,525 Dollar General Corporation 42,716 1,452,344 Dollar Tree Stores, Inc. * 155,425 4,808,461 Entercom Communications Corporation * 151,800 5,369,925 Family Dollar Stores 469,800 10,805,400 Lamar Advertising Company * 144,900 4,917,544 Media Arts Group, Inc. * 108,700 978,300 Papa John's International, Inc.* 165,900 7,320,337 SCP Pool Corporation * 330,075 4,621,050 SkyWest, Inc. 149,000 4,302,375 The Men's Wearhouse, Inc. 146,400 4,218,150 ---------- 85,300,031 ---------- CONSUMER STAPLES - 4.17% Bindley Western Industries 62,650 1,789,441 Celestial Seasonings, Inc. 103,250 2,232,781 Natrol, Inc. * 105,800 641,413 Parexel International Corporation 129,500 2,679,031 Richfood Holdings, Inc. 188,675 4,068,305 US Foodservice * 126,500 5,882,250 Wild Oats Markets, Inc. 118,050 3,202,106 ---------- 20,495,327 ---------- ENERGY - 2.87% Core Laboratories N.V. 252,200 4,429,263 Global Industries, Limited 378,250 3,829,781
SHARES MARKET VALUE COMMON STOCKS (CONTINUED) ENERGY (CONTINUED) Hanover Compressor Company * 221,250 $5,863,125 ---------- 14,122,169 ---------- FINANCIAL - 8.47% CCB Financial Corporation 81,550 4,408,797 Commerce Bancorp, Inc. 92,350 3,809,438 Concord EFS, Inc. 111,716 3,079,172 Markel Corporation 55,760 10,050,740 National Commerce Bancorp 418,184 9,539,822 NOVA Corporation * 270,622 7,103,828 Pinnacle Holdings, Inc. 189,950 2,872,994 U.S. Trust Corporation 10,450 775,259 ---------- 41,640,050 ---------- HEALTH - 18.11% Biomatrix, Inc. * 41,600 3,244,800 Brookdale Living Communities * 299,400 5,164,650 CareMatrix Corporation * 180,750 3,434,250 Chirex, Inc. * 93,000 2,278,500 Express Scripts, Inc. - Class A * 122,950 10,566,016 Health Management Associates, Inc. * 78,961 962,337 Henry Schein, Inc. * 87,150 2,200,537 Mecon, Inc. * 235,400 1,647,800 Medquist, Inc. * 235,150 7,054,500 Molecular Devices Corporation * 206,000 5,562,000 NCS Healthcare, Inc. - Class A * 256,250 3,075,000 Omnicare, Inc. 254,010 4,842,066 Pharmaceutical Product Development * 180,700 6,064,744 Priority Healthcare Corporation - Class A * 28,067 1,270,032 Priority Healthcare Corporation - Class B * 161,100 7,289,775 Province Healthcare Company * 392,000 7,252,000 PSS World Medical, Inc. * 229,000 2,018,062 QuadraMed Corporation * 166,950 1,272,994 Serologicals Corporation * 288,050 3,906,678 Sunrise Assisted Living, Inc. * 51,750 2,357,859 United Payors & Providers, Inc. 219,900 5,071,444 Wesley Jessen Visioncare, Inc. * 90,000 2,480,625 ---------- 89,016,669 ----------
6 MENTOR GROWTH PORTFOLIO PORTFOLIO OF INVESTMENTS MARCH 31, 1999 (UNAUDITED) - --------------------------------------------------------------------------------
SHARES MARKET VALUE COMMON STOCKS (CONTINUED) TECHNOLOGY - 23.44% ADE Corporation * 262,600 $2,494,700 Applied Micro Circuits * 89,700 3,834,675 ATMI, Inc. * 114,750 2,295,000 Axent Technologies, Inc. * 62,250 1,497,890 BEA Systems, Inc. * 101,600 1,587,500 Benchmark Electronics, Inc. * 245,940 7,378,200 Black Box Corporation * 54,400 1,686,400 C&D Technologies, Inc. 102,100 2,539,738 Cerprobe Corporation 418,900 5,340,975 Check Point Software Technology * 33,250 1,429,750 Concord Communications, Inc. * 38,400 2,188,800 Condor Technology Solutions * 115,000 1,092,500 CSG Systems International, Inc. * 118,400 4,669,400 Digital Microwave Corporation * 388,400 3,252,850 Galileo Technology Limited * 177,300 5,186,025 International Integration, Inc. * 10,000 320,000 ITC DeltaCom * 359,550 7,842,684 Medialink Worldwide, Inc. * 234,250 2,957,406 Metro Networks, Inc. * 95,350 5,244,250 Mylex Corporation * 149,750 973,375 Network Appliance, Inc. * 90,750 4,594,219 Optek Technology, Inc. * 66,400 975,250 P-Com, Inc. * 503,350 3,838,044 Parlex Corporation * 279,900 2,659,050 PCD, Inc. * 244,300 2,213,969 Peerless Systems * 379,450 3,225,325 Peregrine Systems, Inc. * 66,500 2,219,437 Photronics, Inc. * 190,700 3,551,787 Powerwave Technologies, Inc. * 181,400 5,147,225 PRI Automation, Inc. * 129,550 2,720,550 Remedy Corporation * 139,900 1,958,600 Research In Motion * 253,800 2,664,900 SCB Computer Technology, Inc. 514,300 2,346,494 Segue Software, Inc. * 116,600 1,122,275 Sensormatic Electronics Corporation 368,050 3,496,475 SIPEX Corporation * 113,950 1,488,472 Smith-Gardner & Associates * 80,000 1,130,000 Speedfam International, Inc. * 98,850 1,186,200 Vantive Corporation * 180,900 2,182,106
SHARES MARKET VALUE COMMON STOCKS (CONTINUED) TECHNOLOGY (CONTINUED) Winstar Communications, Inc. * 73,500 $ 2,671,266 ----------- 115,203,762 ------------ TRANSPORTATION - 5.42% Atlantic Coast Airlines, Inc. * 236,650 6,655,781 Coach USA, Inc. * 182,650 5,022,875 Covenant Transport, Inc. - Class A * 218,700 3,253,162 Mesaba Holdings, Inc. 491,175 6,584,815 M.S. Carriers, Inc. * 144,900 3,830,794 US Xpress Enterprises - Class A * 110,750 1,287,469 ------------ 26,634,896 ------------ MISCELLANEOUS - 9.51% ABR Information Services, Inc. * 194,950 3,387,256 Action Performance Companies, Inc. * 114,800 3,429,650 AHL Services, Inc. * 281,300 5,766,650 Butler International, Inc. 181,550 3,335,981 Copart, Inc. * 245,050 5,084,788 Corporate Executive Board 41,100 1,073,738 Dendrite International, Inc. * 115,400 2,574,862 Global Vacation Group, Inc. * 106,000 1,258,750 Gulf Island Fabrication, Inc. 78,450 823,725 Imax Corporation * 44,400 865,800 Kulicke & Soffa Industries, Inc. 107,750 2,707,219 Outdoor Systems, Inc. * 336,489 10,094,670 Rent-Way, Inc. * 119,500 2,868,000 Select Appointments - 130,550 3,484,053 ------------ 46,755,142 ------------ TOTAL COMMON STOCKS (COST $414,597,391) 461,195,296 ------------
7 MENTOR GROWTH PORTFOLIO PORTFOLIO OF INVESTMENTS MARCH 31, 1999 (UNAUDITED) - --------------------------------------------------------------------------------
PRINCIPAL AMOUNT MARKET VALUE SHORT-TERM INVESTMENT - 5.84% REPURCHASE AGREEMENT Goldman Sachs & Company Dated 3/31/99, 4.95%, due 4/01/99, collateralized by $28,512,021 Federal Home Loan Mortgage Corporation, 7.50%, 11/01/27, market value $ 9,296,102 (cost $28,692,449) $28,692,449 $ 28,692,449 ------------ TOTAL INVESTMENTS (COST $ 443,289,840)-99.68% 489,887,745 OTHER ASSETS LESS LIABILITIES - 0.32% 1,588,809 ------------ NET ASSETS - 100.00% $491,476,554 ============
* Non-income producing. ~ American Depository Receipts. INVESTMENT TRANSACTIONS Cost of purchases and proceeds from sales of securities, other than short-term securities, aggregated $281,329,944 and $258,350,078, respectively. INCOME TAX INFORMATION At March 31, 1999, the aggregated cost of investment securities for federal income tax purposes was $443,289,840. Net unrealized appreciation aggregated $46,597,905, of which $89,157,037 related to appreciated investment securities and $42,559,132 related to depreciated investment securities. SEE NOTES TO FINANCIAL STATEMENTS. 8 MENTOR GROWTH PORTFOLIO - -------------------------------------------------------------------------------- STATEMENT OF ASSETS AND LIABILITIES MARCH 31, 1999 (UNAUDITED) ASSETS Investments, at market value (Note 2) Investment securities $461,195,296 Repurchase agreements 28,692,449 ------------ Total investments (cost $443,289,840) 489,887,745 Collateral for securities loaned (Note 2) 83,131,779 Receivables Investments sold 3,366,115 Fund shares sold 1,440,088 Dividends and interest 114,547 ------------ TOTAL ASSETS 577,940,274 ------------ LIABILITIES Payables Investments purchased $1,746,758 Securities loaned (Note 2) 83,131,779 Fund shares redeemed 1,399,468 Accrued expenses and other liabilities 185,715 ---------- TOTAL LIABILITIES 86,463,720 ------------ NET ASSETS $491,476,554 ============ Net Assets represented by: (Note 2) Additional paid-in capital $450,296,488 Accumulated undistributed net investment loss (3,050,768) Accumulated net realized loss on investment transactions (2,367,071) Net unrealized appreciation of investments 46,597,905 ------------ NET ASSETS $491,476,554 ============ NET ASSET VALUE PER SHARE Class A Shares $ 14.74 Class B Shares $ 14.24 Class Y Shares $ 14.78 OFFERING PRICE PER SHARE Class A Shares $ 15.64 Class B Shares $ 14.24 Class Y Shares $ 14.78 SHARES OUTSTANDING Class A Shares 6,608,296 Class B Shares 25,411,548 Class Y Shares 2,178,068
SEE NOTES TO FINANCIAL STATEMENTS. STATEMENT OF OPERATIONS SIX MONTHS ENDED MARCH 31, 1999 (UNAUDITED) INVESTMENT INCOME Dividends $ 312,809 Interest 1,530,633 ----------- TOTAL INVESTMENT INCOME (NOTE 2) 1,843,442 EXPENSES Management fee (Note 4) $1,879,581 Distribution fee (Note 5) 1,518,365 Shareholder service fee (Note 5) 631,890 Transfer agent fee 379,384 Administration fee (Note 4) 268,512 Shareholder reports and postage expenses 72,800 Custodian and accounting fees 60,193 Registration expenses 46,425 Legal fees 11,955 Audit fees 8,405 Directors' fees and expenses 6,209 Miscellaneous 10,491 ---------- Total expenses 4,894,210 ----------- NET INVESTMENT LOSS (3,050,768) ----------- REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS Net realized loss on investments (Note 2) (973,034) Change in unrealized appreciation (depreciation) on investments 29,904,306 ---------- NET GAIN ON INVESTMENTS 28,931,272 ----------- NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $25,880,504 ===========
SEE NOTES TO FINANCIAL STATEMENTS. 9 MENTOR GROWTH PORTFOLIO - -------------------------------------------------------------------------------- STATEMENTS OF CHANGES IN NET ASSETS
SIX MONTHS ENDED 3/31/99 YEAR ENDED (UNAUDITED) 9/30/98 NET INCREASE IN NET ASSETS Operations Net investment loss $ (3,050,768) $ (6,962,845) Net realized gain (loss) on investments (973,034) 37,565,972 Change in unrealized appreciation (depreciation) on investments 29,904,306 (173,567,460) -------------- -------------- Increase (decrease) in net assets resulting from operations 25,880,504 (142,964,333) -------------- -------------- Distributions to Shareholders From net realized gain on investments Class A (2,988,326) (6,599,466) Class B (15,034,514) (31,307,757) Class Y (1,016,636) (10) -------------- -------------- Total distributions to shareholders (19,039,476) (37,907,233) -------------- -------------- Capital Share Transactions (Note 7) Proceeds from sale of shares 351,383,493 313,753,597 Reinvested distributions 18,495,506 36,935,409 Cost of shares redeemed (371,504,132) (294,819,420) -------------- -------------- Change in net assets resulting from capital share transactions (1,625,133) 55,869,586 -------------- -------------- Increase (decrease) in net assets 5,215,895 (125,001,980) Net Assets Beginning of period 486,260,659 611,262,639 -------------- -------------- End of period (including accumulated undistributed net investment income (loss) of ($3,050,768) and $0, respectively) $ 491,476,554 $ 486,260,659 ============== ==============
SEE NOTES TO FINANCIAL STATEMENTS. FINANCIAL HIGHLIGHTS CLASS A SHARES
SIX MONTHS YEAR ENDED 3/31/99 ENDED (UNAUDITED) 9/30/98 PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 14.60 $ 19.94 -------- -------- Income from investment operations Net investment loss (0.10) (0.12) Net realized and unrealized gain (loss) on investments 0.80 (4.03) -------- -------- Total from investment operations 0.70 (4.15) -------- -------- Less distributions From capital gains (0.56) (1.19) -------- --------- Net asset value, end of period $ 14.74 $ 14.60 ======== ======== TOTAL RETURN* 4.99% (22.08%) RATIOS / SUPPLEMENTAL DATA Net assets, end of period (in thousands) $ 97,406 $ 77,720 Ratio of expenses to average net assets 1.27%(a) 1.26% Ratio of net investment loss to average net assets (0.57%)(a) (0.56%) Portfolio turnover rate 52% 88% YEAR YEAR PERIOD ENDED ENDED ENDED 9/30/97 9/30/96 9/30/95 (b) PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 18.47 $ 16.08 $ 13.37 -------- -------- ----------- Income from investment operations Net investment loss (0.17) (0.10) (0.01) Net realized and unrealized gain (loss) on investments 4.19 4.23 2.72 -------- -------- ------------ Total from investment operations 4.02 4.13 2.71 -------- -------- ------------ Less distributions From capital gains (2.55) (1.74) -- -------- -------- ------------ Net asset value, end of period $ 19.94 $ 18.47 $ 16.08 ======== ======== ============ TOTAL RETURN* 25.81% 29.15% 20.27% RATIOS / SUPPLEMENTAL DATA Net assets, end of period (in thousands) $105,033 $ 40,272 $ 20,368 Ratio of expenses to average net assets 1.28% 1.28% 1.36% (a) Ratio of net investment loss to average net assets (0.67%) (0.39%) (0.65%)(a) Portfolio turnover rate 77% 105% 70%
(a) Annualized. (b) For the period from June 5, 1995 (initial offering of Class A Shares) to September 30, 1995. * Total return does not reflect sales commissions and is not annualized. SEE NOTES TO FINANCIAL STATEMENTS. 10 MENTOR GROWTH PORTFOLIO - -------------------------------------------------------------------------------- FINANCIAL HIGHLIGHTS CLASS B SHARES
SIX MONTHS YEAR ENDED 3/31/99 ENDED (UNAUDITED) 9/30/98 PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 14.18 $ 19.53 ----------- -------- Income from investment operations Net investment loss (0.11) (0.23) Net realized and unrealized gain (loss) on investments 0.73 (3.93) ----------- -------- Total from investment operations 0.62 (4.16) ----------- -------- Less distributions From capital gains (0.56) (1.19) ----------- -------- Net asset value, end of period $ 14.24 $ 14.18 =========== ======== TOTAL RETURN* 4.56% (22.62%) RATIOS / SUPPLEMENTAL DATA Net assets, end of period (in thousands) $ 361,878 $383,188 Ratio of expenses to average net assets 2.02% (a) 2.01% Ratio of net investment loss to average net assets (1.32%)(a) (1.30%) Portfolio turnover rate 52% 88% YEAR YEAR PERIOD YEAR ENDED ENDED ENDED ENDED 9/30/97 9/30/96 9/30/95 (b) 12/31/94 PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 18.29 $ 16.05 $ 12.15 $ 13.78 -------- -------- ----------- -------- Income from investment operations Net investment loss (0.22) (0.17) (0.13) (0.15) Net realized and unrealized gain (loss) on investments 4.01 4.15 4.03 (0.47) -------- -------- ----------- -------- Total from investment operations 3.79 3.98 3.90 (0.62) -------- -------- ----------- -------- Less distributions From capital gains (2.55) (1.74) -- (1.01) -------- -------- ----------- -------- Net asset value, end of period $ 19.53 $ 18.29 $ 16.05 $ 12.15 ======== ======== =========== ======== TOTAL RETURN* 24.66% 28.18% 32.10% (4.48%) RATIOS / SUPPLEMENTAL DATA Net assets, end of period (in thousands) $506,230 $ 371,578 $ 246,326 $190,126 Ratio of expenses to average net assets 2.03% 2.03% 2.08% (a) 2.01% Ratio of net investment loss to average net assets (1.42%) (1.13%) (1.20%)(a) (1.20%) Portfolio turnover rate 77% 105% 70% 77%
(a) Annualized. (b) For the period from January 1, 1995 to September 30, 1995. * Total return does not reflect sales commissions and is not annualized. SEE NOTES TO FINANCIAL STATEMENTS. CLASS Y SHARES
SIX MONTHS PERIOD ENDED 3/3/99 ENDED (UNAUDITED) 9/30/98 (c) PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 14.63 $ 18.12 ---------- ---------- Income from investment operations Net investment loss (0.01) (0.02) Net realized and unrealized gain (loss) on investments 0.72 (3.28) ----------- ---------- Total from investment operations 0.71 (3.30) ----------- ---------- Less distributions From capital gains (0.56) (0.19) ----------- ---------- Net asset value, end of period $ 14.78 $ 14.63 =========== ========== TOTAL RETURN* 5.05% 18.36% RATIOS / SUPPLEMENTAL DATA Net assets, end of period (in thousands) $ 32,193 $ 25,353 Ratio of expenses to average net assets 1.02% (a) 1.01% (a) Ratio of net investment loss to average net assets (0.33%)(a) (0.04%)(a) Portfolio turnover rate 52% 88%
(a) Annualized. (c) For the period from November 19, 1997 (initial offering of Class Y shares) to September 30, 1998. * Total return does not reflect sales commissions and is not annualized. SEE NOTES TO FINANCIAL STATEMENTS. 11 MENTOR PERPETUAL GLOBAL PORTFOLIO MANAGERS' COMMENTARY: THE GLOBAL/INTERNATIONAL MANAGEMENT TEAM MARCH 31, 1999 - -------------------------------------------------------------------------------- MARKET REVIEW UK During the period ending March 31, we initiated a process of judiciously building exposure to the mid- and small-cap sectors of the U.K. market. This strategy was aimed at taking advantage of the substantial valuation disparities existing between large companies and much of the rest of the market. During the fourth quarter of 1998 we also began a process of selective investment in cyclical stocks. Considerations such as wage growth, employment outlook, and greatly reduced home ownership costs suggested to us that the gloom surrounding many consumer cyclical stocks had been overdone. We also continued to build an exposure to selected commodity-related and economically sensitive stocks with international activities. At period-end, we maintained our relatively positive view of the domestic consumer market, causing us to add selectively to property, house construction, and building materials companies. During the six-month period we reduced our exposure to telecom stocks, feeling that stock valuations did not fully reflect the likely negative impact on future earnings of increasingly aggressive price competition. We also profitably disposed of the Portfolio's major pharmaceutical holdings, taking advantage of what we perceived as overly generous valuations. U.S. The intense focus on a very narrow range of ultra-large companies continued throughout the six-month period ending March 31, with the first quarter of 1999 being the worst quarter of the last two decades in terms of market breadth. Everything fundamentally now points to a broadenng out of the market. Among some of the very large caps there has been a modest change in leadership away from technology stocks towards cyclicals and commodity-related stocks. We currently maintain an overweight position at the cyclical/commodity end of the market, and an underweight position in technology. A recent survey by Ibbotson of the 8,000 largest U.S. companies indicated that, over the past year, only 1750 had seen their share price actually rise, and the median fall was 26%. The implication of this is that, while we might see a flattening of the S&P trajectory, there are still a lot of companies that represent very good value. Given the added support of growing money supply, we are relatively optimistic about the prospects for share prices generally. EUROPE Investments in Europe continue to focus on the peripheral states, such as Ireland, Portugal and Spain, where low interest rates are supporting already buoyant economies. During the first quarter of 1999, we began a shift towards commodity-related and more cyclical stocks, in line with our view that the global economic outlook is improving more rapidly than anticipated. Recently this move on our part has begun to be echoed by European equity markets. We continue to maintain an underweight position in telecommunication stocks, which hurt our performance early in the year but has helped us more recently. JAPAN In Japan, early indicators of economic recovery were beginning to appear in the final quarter of 1998. There were also very encouraging signs of genuine corporate restructuring that offered the 12 MENTOR PERPETUAL GLOBAL PORTFOLIO MANAGERS' COMMENTARY: THE GLOBAL/INTERNATIONAL MANAGEMENT TEAM MARCH 31, 1999 - -------------------------------------------------------------------------------- prospect of significantly improved earnings in the years to come. We began to increase the exposure of the Portfolio to Japan during the last quarter of 1998, building to its present significantly overweight position. The Portfolio benefited from both the Japanese equity market's strong rally and our holdings' outperformance within that market. It should, however, be noted that our Japanese weighting still represents a relatively modest portion of the overall Portfolio's holdings. ASIA In Asia, the perception increasingly took hold that the worst of the regions' difficulties were behind it, with interest rates declining, debt service costs falling, the regional consumer beginning to spend again, and exports to the rest of the world starting to pick up. Worries over possible devaluation of the Chinese rnminbi were increasingly replaced by optimism over possible membership in the World Trade Organisation. We began the period under review slightly overweight in this region, and maintained this weighting as the regions' markets picked up. LATIN AMERICA In Brazil the economic outlook has improved. The IMF released a further $9 billion in aid, part of which can be used for foreign exchange intervention, and Congress passed a key element of the fiscal reform package. Better than expected figures for inflation have enabled the Central Bank to cut rates more quickly than expected. Each of these developments was positively received by the market. The privatization program is set to continue with further issues in the next few months. In short, the market has come a long way since the real's devaluation in January. We have consequently adopted a slightly overweight position in Brazil. MANAGEMENT STRATEGY The principal asset allocation shift during the six months ending March 31, 1999 was to modestly reduce the Portfolio's exposure to Europe and the UK, and increase its weighting in Japan. This increased weighting to Japan positioned the Portfolio to benefit from the combination of a strong rally in the Japanese equity market and a firm yen during the first quarter of 1999. Additionally, our Japanese stock selection, with its focus on companies likely to be able to both implement and benefit from the new found zeal for restructuring and cost cutting, further enhanced returns. PERFORMANCE REVIEW The performance impact of our allocation to sectors sensitive to economic cyclicality proved increasingly positive as the period progressed. For the six-month period ending March 31, 1999 the Mentor Global Portfolio A shares returned 21.52%. This compares to 25.66% for our Morgan Stanley World Index benchmark. Realistically speaking, given the World Index's large allocation to U.S. equities, outperformance by the Global Portfolio versus its index is likely only once non-U.S. markets begin to outperform domestic markets. MARKET OUTLOOK Although commodity prices, particularly those for oil, have firmed, and inflation in the U.S. and parts of Continental Europe have risen modestly, worldwide excess capacity and global competition should continue to restrain the prices of manufactured goods. The outlook for global interest rates, therefore, remains relatively positive. The US economy continues robust, and while retail price inflation has ticked up it still remains relatively 13 MENTOR PERPETUAL GLOBAL PORTFOLIO MANAGERS' COMMENTARY: THE GLOBAL/INTERNATIONAL MANAGEMENT TEAM MARCH 31, 1999 - -------------------------------------------------------------------------------- benign. The Federal Reserve appears to have readjusted its views of the linkage between tight labor markets and inflationary pressures. In the UK, despite the continued challenge of sterling strength for manufacturers, there are increasing signs of renewed buoyancy in the domestic economy. Japan appears to be bottoming out, even if with glacial slowness. Asia is experiencing lower interest rates, falling debt service costs, a return of consumer expenditure, and a modest upturn in exports. In Europe, domestic demand remains buoyant, particularly in the periphery, and the gloom surrounding the steep decline in exports and depressed German business confidence may have been overdone. The general improvement in the outlook for the global economy has encouraged a recent shift of investment emphasis in all major equity markets towards economically cyclical and commodity-related stocks. In the light of this assessment, and barring any unforeseen shocks to global financial markets, we remain optimistic that 1999 will continue to provide positive investment opportunities. 14 MENTOR PERPETUAL GLOBAL PORTFOLIO MARCH 31, 1999 - -------------------------------------------------------------------------------- PERFORMANCE COMPARISON Comparison of change in value of a hypothetical $10,000 purchase in Mentor Perpetual Global Portfolio Class A and Class B Shares and the Morgan Stanley Capital International (MSCI) World Index.* Morgan Stanley A Shares B Shares 3/29/94 10000 9425 10000 9/30/94 10546 9982 9487 9/30/95 12125 10655 10587 9/30/96 13846 12501 12677 9/30/97 17256 15200 15668 9/30/98 17344 14445 14580 3/31/99 21794 17554 17715 Average Annual Returns as of 3/31/99 Including Sales Charges 1-Year 5-Year Since Inception++ Class A (1.48%) 11.93% 11.89% Class B 2.90% 12.38% 12.35% PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE PERFORMANCE. YOUR INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO WHEN SHARES ARE REDEEMED, THEY MAY BE WORTH MORE OR LESS THAN ORIGINAL COST. MUTUAL FUNDS ARE NOT OBLIGATIONS OF OR GUARANTEED BY ANY BANK AND ARE NOT FEDERALLY INSURED. * MSCI World Index is an arithmetic average, weighted by market value, of the performance of approximately 1,450 securities listed on the stock exchanges of 20 countries including the U.S., Europe, Canada, Australia, New Zealand, and the Far East. The average company in the index has a market capitalization of about $3.5 billion. This is a total return index with gross dividends reinvested. MSCI World Index is not adjusted to reflect reinvestment of dividends on securities in the index, and is not adjusted to reflect sales loads, expenses, or other fees that the SEC requires to be reflected in the Portfolio's performance. ~ Represents a hypothetical investment of $10,000 in Mentor Perpetual Global Portfolio Class B Shares. A contingent deferred sales charge will be imposed, if applicable, on Class B Shares at rates ranging from a maximum of 4.00% of amounts redeemed during the first year following the date of purchase to 1.00% of amounts redeemed during the five-year period following the date of purchase. The value of the Class B Shares reflects a redemption fee in effect at the end of each of the stated periods. The Class B Shares' performance assumes the reinvestment of all dividends and distributions. + Represents a hypothetical investment of $10,000 in Mentor Perpetual Global Portfolio Class A Shares, after deducting the maximum sales charge of 5.75% ($10,000 investment minus $575 sales charges = $9,425). The Class A Shares' performance assumes the reinvestment of all dividends and distributions. ++ Reflects operations of Mentor Perpetual Global Portfolio Class A and Class B Shares from the date of commencement of operations on 3/29/94 through 3/31/99. 15 MENTOR PERPETUAL GLOBAL PORTFOLIO MARCH 31, 1999 - -------------------------------------------------------------------------------- PERFORMANCE COMPARISON Comparison of change in value of a hypothetical $10,000 purchase in Mentor Perpetual Global Portfolio Class Y Share and the Morgan Stanley Capital International (MSCI) World Index.* MSCI World Index Class Y Shares 11/19/97 10000 10000 12/31/97 10304 10278 3/31/98 11790 11832 6/30/98 12050 11600 9/30/98 10608 10187 3/31/99 13329 12410 Total Returns as of 3/31/99 1-Year Since Inception++ Class Y Shares 4.89% 16.91% PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE PERFORMANCE. YOUR INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO WHEN SHARES ARE REDEEMED, THEY MAY BE WORTH MORE OR LESS THAN ORIGINAL COST. MUTUAL FUNDS ARE NOT OBLIGATIONS OF OR GUARANTEED BY ANY BANK AND ARE NOT FEDERALLY INSURED. * MSCI World Index is an arithmetic average, weighted by market value, of the performance of approximately 1,450 securities listed on the stock exchanges of 20 countries including the U.S., Europe, Canada, Australia, New Zealand, and the Far East. The average company in the index has a market capitalization of about $3.5 billion. This is a total return index with gross dividends reinvested. MSCI World Index is not adjusted to reflect reinvestment of dividends on securities in the index, and is not adjusted to reflect sales loads, expenses, or other fees that the SEC requires to be reflected in the Portfolio's performance. + Represents a hypothetical investment of $10,000 in Mentor Perpetual Global Portfolio Class Y Shares. These shares are not subject to any sales or contingent deferred sales charges. The Class Y Shares' performance assumes the reinvestment of all dividends and distributions. ++ Reflects operations of Mentor Perpetual Global Portfolio Class Y Shares from the date of issuance on 11/19/97 through 3/31/99. 16 MENTOR PERPETUAL GLOBAL PORTFOLIO PORTFOLIO OF INVESTMENTS MARCH 31, 1999 (UNAUDITED) - --------------------------------------------------------------------------------
SHARES MARKET VALUE PREFERRED STOCK - 0.04% BRAZIL - 0.04% Embratel Participacoes SA (cost $76,209) 4,700,000 $ 78,379 ---------- COMMON STOCKS - 96.93% ARGENTINA - 0.09% Perez Company SA~ 6,637 61,994 Telecom Argentina SA~ 2,100 57,619 Telefonica de Argentina SA~ 2,020 61,105 ---------- 180,718 ---------- BELGIUM - 0.08% Cofinimmo 1,366 168,065 ---------- BRAZIL - 0.29% CIA Paranaense Energy~ 8,500 63,750 Companhia Energetica 1,700 37,914 Electrobras - Centrais Eletricas Brasileiras SA 2,200,000 46,181 Forca Paulista 740,000 53,504 Petroleo Brasileiro SA~ 560,000 78,008 Tele Centro Sul Participacoes SA~ 1,100 50,806 Tele Norte Leste Participacoes SA-* 3,800 58,425 Telecomonicacoes Brasileiras SA~ 920 74,175 Telerj Celular SA * 980,000 36,114 Telesp Participacoes SA~* 2,000 41,250 Vale do Rio Doche- 3,650 53,205 ---------- 593,332 ---------- CANADA - 0.58% Canadian Natural Resources * 27,500 473,824 MacMillan Bloedel 17,100 188,678 Newbridge Networks Corporation * 4,000 124,000 Northern Telecom 6,100 378,962 ---------- 1,165,464 ---------- CHILE - 0.11% Banco Santiago SA~ 1,600 28,200 Chilectra SA- 3,450 74,587 Cia de Telecomunicaciones de Chile SA~ 1,700 40,056 Enersis SA~ 3,000 80,438 ---------- 223,281 ---------- CHINA - 0.20% First Tractor 305,000 57,857 Huaneng Power International, Inc. - Class A~* 8,000 79,500 Pohang Iron & Steel~ 7,500 134,062 Yanzhou Coal Mining Company - Class H 800,000 133,173 ---------- 404,592 ----------
SHARES MARKET VALUE COMMON STOCKS (CONTINUED) CROATIA - 0.13% Zagrebacka Banka 27,000 $ 260,550 ---------- CZECH REPUBLIC - 0.14% Ceske Radiokomunikace * 8,100 277,627 ---------- ESTONIA - 0.24% Eesti Telekom # 21,700 479,027 ---------- FINLAND - 2.68% Hansabank * 18,000 104,903 Huhtamaki 15,332 546,053 Metra Oyj - Class B 47,770 964,093 Nokia Oyj - Class A 15,508 2,495,488 Upm-Kymmene Oyj 47,670 1,317,065 ---------- 5,427,602 ---------- FRANCE - 8.22% Accor SA 3,500 868,796 Alstom SA 22,640 671,941 Atos SA 14,100 1,293,481 Axa 7,520 996,640 BQE Paribas 4,280 477,624 Casino Guichard-Perrachon 8,800 780,686 Coflexip 7,770 545,075 Colas 1,730 334,585 Compagnie de Saint - Gobain 10,645 1,688,827 Elf Aquitaine SA 8,200 1,113,311 Entrelec 10,892 410,844 Imetal 5,130 592,411 ISIS 5,460 357,687 Sanofi SA 6,111 1,028,866 Schneider 17,436 964,412 Serp Recyclage 3,039 459,178 Societe Generale D'Enterprises 12,610 593,367 Total SA - Class B 15,050 1,853,294 Usinor SA 49,160 647,439 Vivendi 3,883 955,067 ---------- 16,633,531 ---------- GERMANY - 3.58% AVA Allgemeine Handelsge~ sellschaft der Verbraucher AG 2,420 901,066 Daimler-Chrysler Benz 14,193 1,234,614 Deutsche Lufthansa 44,250 976,627 Metro AG 4,400 279,224 Porsche AG 655 1,615,286 Siemens AG 9,241 606,380 Veba AG 31,100 1,636,278 ---------- 7,249,475 ---------- GREAT BRITAIN - 14.50% Abbey National PLC 44,550 924,254 Allied Zurich PLC * 20,951 282,174 Arcadia Group PLC 55,700 186,311 Arriva PLC 35,000 219,192 Asda Group 158,000 387,138 BAA PLC 34,250 380,404
17 MENTOR PERPETUAL GLOBAL PORTFOLIO PORTFOLIO OF INVESTMENTS MARCH 31, 1999 (UNAUDITED) - --------------------------------------------------------------------------------
SHARES MARKET VALUE COMMON STOCKS (CONTINUED) GREAT BRITAIN (CONTINUED) Barclays PLC 36,500 $1,059,672 Bass PLC 35,571 482,520 BBA Group PLC 25,397 173,176 BG PLC 42,000 247,966 Blue Circle Industries 46,333 269,627 Britannic Assurance PLC 19,000 296,785 British Aerospace PLC 97,000 646,956 British Airways PLC 62,500 434,988 British-American Tobacco PLC 62,500 519,366 British Biotech PLC * 150,000 41,106 Burmah Castrol PLC 25,000 381,037 Canary Wharf Group 16,000 85,500 Carlton Communications 13,500 132,422 Celltech PLC* 25,000 161,805 Centrica PLC* 100,000 176,514 Chelsfield PLC 29,000 136,738 Coats Viyella 90,000 63,835 Debenhams PLC 44,000 335,844 Dixons Group 13,500 283,776 Emap PLC 35,200 690,555 Enterprise Oil PLC 75,000 430,102 Express Dairies PLC 48,000 88,209 Fairview Holdings 89,300 174,181 Frogmore Estates PLC 35,000 234,143 Gallaher Group PLC 40,000 234,385 Garban PLC 14,800 57,855 Glaxo Wellcome PLC 1,286 42,974 Granada Group PLC 36,000 735,846 Great Universal Stores PLC 18,000 196,293 Greenalls Group PLC 60,000 323,045 HSBC Holdings PLC 58,454 1,853,295 Iceland Group PLC 50,750 209,840 III Group PLC 51,000 514,647 Imperial Chemical Industries PLC 40,000 356,574 Inchcape PLC 90,000 206,014 Ladbroke Group 145,412 651,645 Land Securities 16,000 211,365 Lloyds TSB Group PLC 86,000 1,310,072 Medeva PLC 80,000 159,266 Meggitt PLC 75,000 226,688 National Westminster Bank 47,250 1,096,805 Next PLC 38,626 438,658 Northern Foods PLC 93,400 167,122 Nycomed Amersham PLC 54,500 469,799 Powderject Pharmaceuticals 31,559 460,402 PowerGen PLC 26,000 286,888 Prudential Corporation PLC 45,250 592,662 Railtrack Group PLC 6,000 137,149 Rank Group PLC 61,750 225,212 Reckitt & Colman PLC 17,300 186,707 Reuters Group PLC 30,000 438,383 Rio Tinto 25,000 348,595 Rolls-Royce PLC 161,000 687,111
SHARES MARKET VALUE COMMON STOCKS (CONTINUED) GREAT BRITAIN (CONTINUED) Sainsbury (J.) PLC 65,000 $ 400,783 Scotia Holdings * 30,000 49,569 Scottish Power PLC 22,000 192,392 Securicor PLC 39,050 348,106 Shell 85,000 573,771 Signet Group 528,500 408,932 Smith (H.W.) Group PLC 44,750 479,350 Smiths Industries PLC 23,000 336,650 Spirax-Sarco Engineering PLC 31,000 245,862 Standard Chartered 63,500 901,297 Sun Life & Provin Holdings 32,330 266,834 Tate & Lyle PLC 35,282 235,745 Telewest Communications * 48,500 211,091 Tesco PLC 134,400 359,102 TI Group PLC 27,000 174,858 Trinity PLC 39,000 330,686 United Assurance Group PLC 43,000 304,297 United News & Media PLC 48,000 454,971 United Utilities 19,000 228,944 Wolseley 12,622 95,324 ---------- 29,350,157 ---------- GREECE - 0.19% Alpha Credit Bank 2,600 172,817 Chipita 6,000 218,579 ---------- 391,396 ---------- HONG KONG - 1.43% Aeon Credit Services 608,000 109,058 Axa China Region, Limited 433,000 304,524 Cafe de Coral Holdings, Limited 450,000 126,302 Cheung Kong 40,000 304,544 Dah Sing Financial Group 100,000 246,474 Henderson Investment, Limited 200,000 124,527 HKR International, Limited 640,000 394,358 Hong Kong Telecom 108,000 213,301 Hung Hing Printing Group 181,000 60,143 Hutchison Whampoa, Limited 48,000 377,841 New World Development 133,218 262,162 Road King Infrastructure, Limited 432,544 253,964 Swire Pacific, Limited - Class A 24,000 111,494 Wheelock & Company, Limited 3,000 2,333 ---------- 2,891,025 ---------- INDIA - 0.14% BSES Limited #* 8,000 78,000 Hindalco Industries, Limited # 5,000 61,125 Indian Opportunity Fund, Limited * 11,000 118,250 Mahanagar Telephone Nigam, Limited #* 2,000 20,200 ---------- 277,575 ---------- INDONESIA - 0.15% Bat Indonesia 36,000 74,913
18 MENTOR PERPETUAL GLOBAL PORTFOLIO PORTFOLIO OF INVESTMENTS MARCH 31, 1999 (UNAUDITED) - --------------------------------------------------------------------------------
SHARES MARKET VALUE COMMON STOCKS (CONTINUED) INDONESIA (CONTINUED) PT Hajaya Mandala Sampoerna 200,000 $ 164,162 PT Indofoods Sukses Mak 114,000 71,168 ---------- 310,243 ---------- IRELAND - 2.18% Bank of Ireland 72,465 1,509,816 CRH PLC 83,100 1,427,984 Elan Corporation PLC~* 13,250 924,187 Irish Permanent 36,580 551,341 ---------- 4,413,328 ---------- ITALY - 3.14% Assicurazioni Generali 15,020 601,403 Finmeccanica SPA 882,030 889,103 Grupo Editoriale L'Espresso 111,550 1,252,060 Ina SPA 304,000 918,658 Rinascente SPA 90,850 708,901 Telecom Italia Mobile 146,600 985,698 Telecom Italia SPA 94,800 1,006,759 ---------- 6,362,582 ---------- JAPAN - 13.75% Asahi Bank 450,000 2,369,119 Asahi Glass Company, Limited 360,000 2,607,927 Chugai Pharmaceuticals 240,000 2,765,615 DDI Corporation 550 2,594,449 Funai Electric Company, Limited 24,000 2,213,705 Kokusai Securities Company, Limited 220,000 2,464,726 Nichiei Company 27,000 2,413,090 Nippon Steel Corporation 1,250,000 2,558,649 Ricoh Company, Limited 270,000 2,813,377 Shin-Etsu Chemical 100,000 2,619,719 Teijin, Limited 600,000 2,415,870 ---------- 27,836,246 ---------- KOREA - 0.23% Atlantic Korean Company 20,000 211,400 CITC Seoul Exel @ * 2 8,750 LG Electronics # 6,400 18,400 Samsung Electric # (a) 501 21,029 Samsung Electronics #(a) 13,500 209,250 ---------- 468,829 ---------- LUXEMBOURG - 0.24% Benpres Holdings (a)* 95,200 251,600 Quilmes Industries SA 2,100 19,819 Tata Electric Companies 1,500 209,400 ---------- 480,819 ---------- MALAYSIA - 0.08% Boustead Holdings Berhad (c) 84,000 65,432 IOI Corporation (c) 100,000 49,474 Nanyang Press Berhad (c) 60,000 46,106 ---------- 161,012 ----------
SHARES MARKET VALUE COMMON STOCKS (CONTINUED) MEXICO - 0.41% Carso Global Telecom 7,000 $ 36,287 Cemex SA-* 5,600 47,029 Cifra SA- 71,500 110,705 DESC SA- 3,002 80,116 Fomento Economico~ 2,000 61,875 Grupo Carso SA- 6,700 54,579 Grupo Continental SA~ 15,000 42,227 Grupo Fin Bancomer 154,000 51,603 Grupo Televisa #* 1,400 43,925 Kimberly-Clark de Mexico SA~ 2,680 48,562 Telefonos de Mexico SA - Class L~ 3,890 254,795 ---------- 831,703 ---------- NETHERLANDS - 2.62% Akzo Nobel 33,060 1,223,824 ING Groep NV 29,030 1,599,429 Royal Dutch Petroleum 32,738 1,740,125 Vendex International NV 30,325 731,477 ---------- 5,294,855 ---------- PHILIPPINES - 0.06% Bank of the Philippines Island 47,000 117,652 ---------- PORTUGAL - 0.80% BPI SGPS SA 28,060 852,488 Cimpor Cimentos de Portugal 13,920 389,100 Jeronimo Martins 12,066 428,871 ---------- 1,670,459 ---------- SINGAPORE - 0.84% DBS Land 100,000 147,655 GP Batteries International, Limited 190,000 278,344 Hong Leong Finance 100,000 163,289 Marco Polo Developments, Limited 60,000 75,738 Overseas Chinese Bank * 30,287 205,187 Overseas Chinese Bank ~ Warrants * 300,000 203,243 Overseas Union Bank, Limited 50,000 176,607 United Overseas Bank 73,000 456,514 ---------- 1,706,577 ---------- SPAIN - 4.46% Argentaria Corp Bancaria de Espana SA 24,109 579,197 Autopistas Cesa 17,390 222,778 Baron de Ley * 30,000 1,102,454 Centros Comerciales Continente SA 40,460 1,124,848 Dragados & Construcciones SA 18,700 613,532 Endesa SA 50,450 1,272,998 Prosegur CIA de Seguridad SA 116,895 1,267,897 Tabacalera SA 65,280 1,322,411 Telefonica SA 26,626 1,129,042
19 MENTOR PERPETUAL GLOBAL PORTFOLIO PORTFOLIO OF INVESTMENTS MARCH 31, 1999 (UNAUDITED) - --------------------------------------------------------------------------------
SHARES MARKET VALUE COMMON STOCKS (CONTINUED) SPAIN (CONTINUED) Viscofan Envolturas Celulosicas SA - Warrants 29,960 $ 396,419 --------- 9,031,576 --------- SWEDEN - 1.97% BPA AB 265,000 746,361 Celsius AB - Class B 51,760 848,288 Ericsson LM - Class B 38,920 944,970 ForeningsSparbanken AB 45,740 1,074,465 Kinnevik AB 19,927 381,011 --------- 3,995,095 --------- SWITZERLAND - 1.80% Jelmoli Holding AG 785 744,538 Novartis AG 896 1,453,284 UBS AG * 4,565 1,433,983 --------- 3,631,805 --------- TAIWAN - 0.20% Formosa Growth Fund * 5,000 83,125 Taipei Fund * 20 159,500 Taiwan Semiconductor~ 5,900 134,778 --------- 377,403 --------- THAILAND - 0.08% Electricity Generating Public Company 40,000 79,819 Thai Airways - Alien Marketing * 50,000 75,163 --------- 154,982 --------- TURKEY - 0.26% Akbank 5,000,000 160,836 Haci Omer Sabanci~ 42,000 248,850 Turkiye IS Bankasi 2,700,000 117,612 --------- 527,298 --------- UNITED STATES - 31.02% Alcoa, Inc. 28,800 1,186,200 AlliedSignal, Inc. 16,000 787,000 Allstate Corporation 21,000 778,312 Anadarko Petroleum Corporation 12,000 453,000 Anheuser-Busch Companies, Inc. 7,000 533,312 Arden Realty Group, Inc. 25,000 556,250 Associates First Capital Corporation 21,200 954,000 AT&T Corporation 10,878 868,200 Aurora Foods, Inc. * 9,800 160,475 Avon Products 14,500 682,406 BankAmerica Corporation 13,300 939,312
SHARES MARKET VALUE COMMON STOCKS (CONTINUED) UNITED STATES (CONTINUED) BankBoston Corporation * 18,000 $ 779,625 Bell Atlantic Corporation 5,300 273,944 Bethlehem Steel Corporation 57,000 470,727 Bristol-Myers Squibb Company * 9,400 604,538 Cardinal Health, Inc. 8,700 574,200 Case Corporation 16,000 406,000 Chancellor Media Corporation * 12,000 565,500 Chase Manhattan Corporation 4,700 382,169 Chevron Corporation 7,000 619,063 Citigroup, Inc. 20,700 1,322,213 Columbia/HCA Healthcare Corporation 39,100 740,456 Compuware Corporation * 14,000 334,250 Conseco, Inc. 39,100 1,207,212 Dayton-Hudson Corporation 15,000 999,375 El Paso Energy Corporation 20,000 653,750 Enron Corporation 11,000 706,750 Federal National Mortgage Association 10,300 713,275 Federated Department Stores, Inc. * 37,000 1,484,625 General Electric Company 32,800 3,628,500 Global Telesystems Group, Inc. * 5,900 330,031 Halliburton Company 17,500 673,750 HealthSouth Corporation * 65,400 690,735 Hewlett-Packard 30,600 2,075,062 Home Depot, Inc. 22,200 1,381,950 Honeywell, Inc. 10,000 758,125 Household International 15,000 684,375 Infinity Broadcasting * 15,000 386,250 Intel Corporation 6,700 798,138 International Business Machines, Inc. 5,400 957,150 Johnson & Johnson 8,500 796,344 Lilly (Eli) & Company 6,000 509,250 Mail-Well Holdings* 19,600 262,150 MBNA Corporation 11,800 281,725 McDonald's Corporation 18,000 815,625 MCI WorldCom, Inc. * 13,400 1,186,738 McKesson HBOC, Inc. 9,000 594,000 Mead Corporation 51,000 1,568,250 Merck & Company, Inc. 9,000 721,688 Microsoft Corporation * 20,500 1,837,312
20 MENTOR PERPETUAL GLOBAL PORTFOLIO PORTFOLIO OF INVESTMENTS MARCH 31, 1999 (UNAUDITED) - --------------------------------------------------------------------------------
SHARES OR PRINCIPAL AMOUNT MARKET VALUE COMMON STOCKS (CONTINUED) UNITED STATES (CONTINUED) Monsanto 15,500 $ 712,031 Motorola, Inc. 14,300 1,047,475 Noble Affiliates, Inc. 11,000 319,000 Ocular Sciences, Inc. * 5,000 143,438 Pharmacia & Upjohn 15,000 935,625 Philip Morris Companies, Inc. 28,000 985,250 Platinum Technology International * 49,800 1,269,900 Procter & Gamble Company 8,500 832,469 Provident Companies, Inc. 20,000 691,250 Republic Services, Inc. * 19,000 307,562 SBC Communications, Inc. 6,200 292,175 Sears Roebuck & Company 7,700 347,944 Smurfit-Stone Container Corporation * 27,400 529,162 Stewart Enterprises 37,000 594,312 Suiza Foods Corporation * 10,100 340,244 Sybron International Corporation * 25,000 625,000 Symantec Corporation * 11,000 186,312 Texaco, Inc. 13,000 737,750 Time Warner, Inc. 10,000 710,625 Tosco Corporation 12,800 317,600 Travelers Property and Casualty - Class A 9,000 321,750 Tyco International Limited 15,000 1,076,250 U.S. Foodservice * 29,600 1,376,400 Wal-Mart Stores, Inc. 14,100 1,299,844 Warner-Lambert Company 15,000 992,812 Washington Mutual, Inc. 38,500 1,573,688 Waste Management, Inc. 33,800 1,499,875 Wells Fargo Company 23,500 823,969 Xerox Corporation 4,500 240,187 ----------- 62,803,186 ----------- TOTAL COMMON STOCKS (COST $184,297,637) 196,149,066 ----------- CORPORATE BONDS - 0.19% GREAT BRITIAN - 0.01% Scotia Holdings, 8.50%, 3/26/02 $19,000 18,530 ----------- MALAYSIA - 0.03% Telekom Malaysia Berhad, 4.00%, 10/03/04-(a)(b) 70,000 58,625 ----------- THAILAND - 0.15% PTTEP International, Limited, 7.63%, 10/01/06 300,000 280,500 ----------- TOTAL CORPORATE BONDS (COST $311,140) 357,655 ----------- TOTAL LONG-TERM INVESTMENTS (COST $184,684,986) 196,585,101 -----------
PRINCIPAL AMOUNT MARKET VALUE SHORT-TERM INVESTMENT - 1.63% REPURCHASE AGREEMENT Goldman Sachs & Company Dated 3/31/99, 4.95%, due 4/01/99, collateralized by Federal National Mortgage Association $3,312,248, 7.50%, 11/01/27, market value $3,403,335 (cost $3,333,062) $3,333,062 $ 3,333,062 ------------ TOTAL INVESTMENTS (COST $188,574,104)-98.75% 199,918,163 OTHER ASSETS LESS LIABILITIES - 1.25% 2,528,545 ------------ NET ASSETS - 100.00% $202,446,708 ============
* Non-income producing. ~ American Depository Receipts. # Global Depoistory Receipts. @ International Depository Receipts. (a) These are securities that may be resold to "qualified institutional buyers" under Rule 144A or securities offered pursuant to Section 4(2) of the Securities Act of 1933, as amended. These securities have been determined to be liquid under guidelines established by the Board of Trustees. (b) All or a portion of these securities are restricted (i.e., securities which may not be publicly sold without registration under the Federal Securities Act of 1933). Dates of acquisition and costs are set forth in parentheses after the title of the restricted securities. (c) These securities are considered illiquid due to a one year moratorium on the repatriation of assets from Malaysia. INVESTMENT TRANSACTIONS Cost of purchases and proceeds from sales of securities, other than short-term securities, aggregated $162,300,760 and $140,685,888, respectively. INCOME TAX INFORMATION At March 31, 1999, the aggregated cost of investment securities for federal income tax purposes was $188,574,104. Net unrealized appreciation aggregated $11,344,059, of which $22,716,961 related to appreciated investment securities and $11,372,902 related to depreciated investment securities. SEE NOTES TO FINANCIAL STATEMENTS. 21 MENTOR PERPETUAL GLOBAL PORTFOLIO - -------------------------------------------------------------------------------- STATEMENT OF ASSETS AND LIABILITIES MARCH 31, 1999 (UNAUDITED) ASSETS Investments, at market value (Note 2) Investment securities $196,585,101 Repurchase agreements 3,333,062 ------------ Total investments (cost $188,574,104) 199,918,163 Receivables Collateral for securities loaned (Note 2) 38,767,594 Investments sold 4,458,626 Fund shares sold 1,228,840 Dividends and interest 1,030,879 Unrealized appreciation on forward foreign currency exchange contracts (Note 6) 1,140 ------------ TOTAL ASSETS 245,405,242 ------------ LIABILITIES Payables Investments purchased $ 3,776,771 Securities loaned (Note 2) 38,767,594 Fund shares redeemed 261,608 Unrealized depreciation on forward foreign currency exchange contracts (Note 6) 2,596 Accrued expenses and other liabilities 149,965 ---------- TOTAL LIABILITIES 42,958,534 ------------ NET ASSETS $202,446,708 ============ Net Assets represented by: (Note 2) Additional paid-in capital $177,809,623 Accumulated undistributed net investment loss (350,537) Accumulated net realized gain on investment transactions 13,606,911 Net unrealized appreciation of investments and foreign currency related transactions 11,380,711 ------------ NET ASSETS $202,446,708 ============ NET ASSET VALUE PER SHARE Class A Shares $ 21.19 Class B Shares $ 20.25 Class Y Shares $ 21.27 OFFERING PRICE PER SHARE Class A Shares $ 22.48(a) Class B Shares $ 20.25 Class Y Shares $ 21.27 SHARES OUTSTANDING Class A Shares 3,998,046 Class B Shares 5,812,536 Class Y Shares 58
(a) Computation of offering price: 100/94.25 of net asset value. SEE NOTES TO FINANCIAL STATEMENTS. STATEMENT OF OPERATIONS SIX MONTHS ENDED MARCH 31, 1999 (UNAUDITED) INVESTMENT INCOME Dividends (b) $ 1,405,493 Interest 256,459 ----------- TOTAL INVESTMENT INCOME (NOTE 2) 1,661,952 EXPENSES Management fee (Note 4) $ 945,039 Distribution fee (Note 5) 416,023 Shareholder service fee (Note 5) 226,909 Transfer agent fee 146,975 Custodian and accounting fees 122,065 Administration fee (Note 4) 90,764 Registration expenses 26,761 Shareholder reports and postage expenses 26,262 Legal fees 4,063 Audit fees 2,856 Organizational expenses 2,712 Directors' fees and expenses 2,110 Miscellaneous 3,565 ---------- Total expenses 2,016,104 ----------- NET INVESTMENT LOSS (354,152) ----------- REALIZED AND UNREALIZED GAIN ON INVESTMENTS AND FOREIGN CURRENCY RELATED TRANSACTIONS Net realized gain on investments and foreign currency related transactions (Note 2) 14,279,955 Change in unrealized appreciation (depreciation) on investments and foreign currency related transactions 19,653,366 ---------- NET GAIN ON INVESTMENTS AND FOREIGN CURRENCY RELATED TRANSACTIONS 33,933,321 ----------- NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $33,579,169 ===========
(b) Net of withholding taxes of $117,672. SEE NOTES TO FINANCIAL STATEMENTS. 22 MENTOR PERPETUAL GLOBAL PORTFOLIO - -------------------------------------------------------------------------------- STATEMENTS OF CHANGES IN NET ASSETS
SIX MONTHS ENDED 3/31/99 YEAR ENDED (UNAUDITED) 9/30/98 NET INCREASE IN NET ASSETS Operations Net investment loss $ (354,152) $ (757,843) Net realized gain on investments 14,279,955 14,799,387 Change in unrealized appreciation (depreciation) on investments 19,653,366 (25,459,714) ------------- ------------- Increase (decrease) in net assets resulting from operations 33,579,169 (11,418,170) ------------- ------------- Distributions to Shareholders From net realized gain on investments Class A (4,794,385) (2,382,830) Class B (8,453,299) (4,553,653) Class Y (85) (8) ------------- --------------- Total distributions to shareholders (13,247,769) (6,936,491) ------------- -------------- Capital Share Transactions (Note 7) Proceeds from sale of shares 58,623,898 78,893,773 Reinvested distributions 12,654,682 6,732,722 Shares redeemed (47,452,979) (44,567,723) ------------- -------------- Change in net assets resulting from capital share transactions 23,825,601 41,058,772 ------------- -------------- Increase in net assets 44,157,001 22,704,111 Net Assets Beginning of period 158,289,707 135,585,596 ------------- -------------- End of period (including accumulated undistributed net investment income (loss) of ($350,537) and $3,616, respectively) $ 202,446,708 $158,289,707 ============= ==============
SEE NOTES TO FINANCIAL STATEMENTS. FINANCIAL HIGHLIGHTS CLASS A SHARES
SIX MONTHS YEAR YEAR ENDED 3/31/99 ENDED ENDED (UNAUDITED) 9/30/98 9/30/97 PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 18.92 $ 20.94 $ 17.86 ----------- -------- -------- Income from investment operations Net investment income (loss) (0.04) (0.03) 0.04 Net realized and unrealized gain (loss) on investments 3.90 (0.97) 3.67 ----------- -------- -------- Total from investment operations 3.86 (1.00) 3.71 ----------- -------- -------- Less distributions From capital gains (1.59) (1.02) (0.63) ----------- -------- -------- Net asset value, end of period $ 21.19 $ 18.92 $ 20.94 =========== ======== ======== TOTAL RETURN* 21.52% (4.97%) 21.59% RATIOS / SUPPLEMENTAL DATA Net assets, end of period (in thousands) $ 84,733 $ 59,012 $ 46,556 Ratio of expenses to average net assets 1.76% (a) 1.75% 1.89% Ratio of expenses to average net asset excluding waiver 1.76% (a) 1.75% 1.89% Ratio of net investment income (loss) to average net assets (0.07%)(a) (0.01%) 0.07% Portfolio turnover rate 80% 162% 128% YEAR YEAR PERIOD ENDED ENDED ENDED 9/30/96 9/30/95 9/30/94 (c) PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 15.88 $ 14.23 $ 14.18 -------- -------- ---------- Income from investment operations Net investment income (loss) (0.04) 0.05 (0.01) Net realized and unrealized gain (loss) on investments 2.82 1.60 0.06 -------- -------- ----------- Total from investment operations 2.78 1.65 0.05 -------- -------- ----------- Less distributions From capital gains (0.80) -- -- -------- --------- ----------- Net asset value, end of period $ 17.86 $ 15.88 $ 14.23 ======== ========= =========== TOTAL RETURN* 18.40% 11.60% 0.35% RATIOS / SUPPLEMENTAL DATA Net assets, end of period (in thousands) $ 13,098 $ 6,854 $ 8,882 Ratio of expenses to average net assets 1.95% 2.06% 2.09% (a) Ratio of expenses to average net asset excluding waiver 1.95% 2.11% 3.18% (a) Ratio of net investment income (loss) to average net assets (0.21%) 0.26% (0.10%) (a) Portfolio turnover rate 130% 155% 2%
(a) Annualized. (c) For the period from March 29, 1994 (commencement of operations), to September 30, 1994. * Total return does not reflect sales commissions and is not annualized. SEE NOTES TO FINANCIAL STATEMENTS. 23 MENTOR PERPETUAL GLOBAL PORTFOLIO - -------------------------------------------------------------------------------- FINANCIAL HIGHLIGHTS CLASS B SHARES
SIX MONTHS YEAR ENDED 3/31/99 ENDED (UNAUDITED) 9/30/98 PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 18.21 $ 20.32 ----------- -------- Income from investment operations Net investment loss (0.06) (0.12) Net realized and unrealized gain (loss) on investments 3.69 (0.97) ----------- -------- Total from investment operations 3.63 (1.09) ----------- -------- Less distributions From capital gains (1.59) (1.02) ----------- -------- Net asset value, end of period $ 20.25 $ 18.21 =========== ======== TOTAL RETURN* 21.20% (5.65%) RATIOS / SUPPLEMENTAL DATA Net assets, end of period (in thousands) $ 117,713 $ 99,277 Ratio of expenses to average net assets 2.51% (a) 2.51% Ratio of expenses to average net asset excluding waiver 2.51% (a) 2.51% Ratio of net investment loss to average net assets (0.68%)(a) (0.77%) Portfolio turnover rate 80% 162% YEAR YEAR YEAR PERIOD ENDED ENDED ENDED ENDED 9/30/97 9/30/96 9/30/95 9/30/94 (d) PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 17.46 $ 15.67 $ 14.15 $ 14.18 -------- -------- -------- ----------- Income from investment operations Net investment loss (0.02) (0.05) (0.05) (0.04) Net realized and unrealized gain (loss) on investments 3.51 2.64 1.57 0.01 -------- -------- -------- ------------ Total from investment operations 3.49 2.59 1.52 (0.03) -------- -------- -------- ------------ Less distributions From capital gains (0.63) (0.80) -- -- -------- -------- -------- ------------ Net asset value, end of period $ 20.32 $ 17.46 $ 15.67 $ 14.15 ======== ======== ======== ============ TOTAL RETURN* 20.74% 17.39% 10.74% (0.21%) RATIOS / SUPPLEMENTAL DATA Net assets, end of period (in thousands) $ 89,030 $ 42,131 $ 12,667 $ 7,987 Ratio of expenses to average net assets 2.64% 2.70% 2.72% 2.79% (a) Ratio of expenses to average net asset excluding waiver 2.64% 2.70% 2.79% 3.93% (a) Ratio of net investment loss to average net assets (0.68%) (0.91%) (0.40%) (0.82%)(a) Portfolio turnover rate 128% 130% 155% 2%
(a) Annualized. (d) For the period from March 29, 1994 (commencement of operations) to September 30, 1994. * Total return does not reflect sales commissions and is not annualized. SEE NOTES TO FINANCIAL STATEMENTS. CLASS Y SHARES
SIX MONTHS PERIOD ENDED 3/31/99 ENDED (UNAUDITED) 9/30/98 (e) PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 18.96 $ 18.81 --------- --------- Income from investment operations Net investment income -- -- Net realized and unrealized gain on investments 3.90 0.30 ---------- ---------- Total from investment operations 3.90 0.30 ---------- ---------- Less distributions From capital gains ( 1.59) ( 0.15) ---------- ---------- Net asset value, end of period $ 21.27 $ 18.96 ========== ========== TOTAL RETURN 21.83% 1.60% RATIOS / SUPPLEMENTAL DATA Net assets, end of period (in thousands) $ 1 $ 1 Ratio of expenses to average net assets 1.50% (a) 1.50% (a) Ratio of net investment loss to average net assets (0.07%)(a) (0.02%)(a) Portfolio turnover rate 80% 162%
(a) Annualized. (e) For the period from November 19, 1997 (initial offering of Class Y shares) to September 30, 1998. (f) Income is less than $0.005 per share. * Total return doesnot reflect sales commissions and is not annualized. SEE NOTES TO FINANCIAL STATEMENTS. 24 MENTOR CAPITAL GROWTH PORTFOLIO MANAGERS' COMMENTARY: THE LARGE-CAPITALIZATION GROWTH MANAGEMENT TEAM MARCH 31, 1999 - -------------------------------------------------------------------------------- MARKET REVIEW It is now becoming increasingly apparent that the stock market may be evolving into a once-in-a-lifetime event, one to be written and talked about long after we are all gone. What was once a great bull market powered by strong earnings and declining inflation expectations has become an emotionally-charged environment where fundamental considerations are giving way to price momentum and speculation on a historic scale. As we have commented on repeatedly, most of the market's action has narrowed to a fairly limited group of stocks, the mega-sized blue chip growth stocks and Internet concepts, both of which have been in the spotlight for quite a while. This narrowness can be illustrated innumerable ways. The number of stocks reaching new highs is extremely low despite repeated records by the major indexes. On the day the Dow Jones Industrial Average first closed above 10,000 only 44 New York Stock Exchange stocks hit new highs and 88 made new lows. While the S&P 500 has returned 18% over the past twelve months, about 60% of the stocks in the index have actually DECLINED over the same period and the largest 50 stocks in the index are up an average 47%. It is starkly clear that the recent record breaking advances are riding on a select group. There is no doubt many of today's most popular mega-cap stocks have shown fantastic earnings growth. But in most cases these stocks have now far outpaced their earnings as price momentum has become the driving force. The largest five stocks in the NASDAQ composite gained an average 110% over the last 12 months and now trade at an average 67 times trailing earnings. This valuation level implies very little perceived risk to these companies' outlooks, despite the inherently volatile nature of this sector. Naturally, the higher these stocks' valuations rise, the more people seem to consider valuation irrelevant. Several thoughtful observers including Warren Buffett, Bill Gates, and Alan Greenspan have warned about these valuations, but most consider their rhetoric out-of- date. The performances, and particularly the valuations, of most Internet stocks are beyond adequate description. We never imagined we would see this level of speculation. Companies that were conceptualized less than two years ago and organized less than one year ago have since gone public with multi-billion dollar market values on minuscule revenues, income losses, and vague plans. The enticement of apparently easy gains in the obvious stocks that continue to go up without pause is incredible, but we know temptation is a deadly investment platform. Many people chasing today's most popular stocks decry the notion of temptation. They say they are buying these stocks with an eye toward the long-term, and this view obviates short-term valuation concerns. We believe the truth is precisely the opposite, that current demand is proportional to recent gains, and it's the long-term view that often crystallizes the level of speculation. For instance, if we assume the stock of America Online appreciates 20% a year over the next 10 years, a rate probably well below virtually all current owners' expectations, and its shares outstanding increase by 5% a year due to employee options, then it will have a market value exceeding $1.9 TRILLION. Assuming at that size the market will have priced the stock at a lower but arguably extreme P/E ratio of 50 then America Online will need net income of $39 billion, all in just ten years. 25 MENTOR CAPITAL GROWTH PORTFOLIO MANAGERS' COMMENTARY: THE LARGE-CAPITALIZATION GROWTH MANAGEMENT TEAM MARCH 31, 1999 - -------------------------------------------------------------------------------- By comparison, Microsoft currently has net income of $6.6 billion. It may happen, but it certainly seems a stretch. MANAGEMENT STRATEGY Fortunately, we know that long-term investment success is founded on consistent execution of a sound fundamental discipline, not popularity contests. In fact, we are increasingly comfortable with our current holdings. These are substantial companies and their results are generally tracking our expectations including average estimated earnings growth of 14-15% this quarter and year. These stocks trade at an average P/E ratio of 21.5 times estimated 1999 earnings-per-share, about 20% below the S&P 500's valuation, despite our belief that their outlooks are better than average. PERFORMANCE REVIEW Our "quality-growth-at-a-reasonable-price" investment philosophy and strategy are clearly out of sync with prevailing sentiment. After a few excellent years, our recent returns have slipped behind the S&P 500. This under-performance mostly reflects our lack of exposure to today's most popular stocks, not fundamental disappointments in our holdings. For the six-month period ending March 31, 1999 the Mentor Capital Growth A shares returned 19.63%, compared to 27.34% for the S&P 500. MARKET OUTLOOK We have no idea how the stock market will progress over the remainder of the year. The economy appears to be in remarkably good shape with solid growth and low inflation likely to continue. If market momentum continues along current lines our performance will continue to compare poorly to the major averages. In fact, it is very possible that current trends may grow even more extreme. At some point the speculative excess building today will be quashed. We have no idea when or what the catalyst may be, but it will certainly seem obvious when we look back. Between now and then the market could experience some significant volatility. Our singular goal is to get through this highly unusual period with our discipline intact, as we know most others will not. 26 MENTOR CAPITAL GROWTH PORTFOLIO MARCH 31, 1999 - -------------------------------------------------------------------------------- PERFORMANCE COMPARISON Comparison of change in value of a hypothetical $10,000 investment in Mentor Capital Growth Portfolio Class A and Class B Shares and the S&P 500.~ Class A Shares Class B Shares S&P 550 4/29/92 9450 10000 10000 9/30/92 9524 10061 10215 9/30/93 10306 10818 11543 9/30/94 10165 10601 11965 9/30/95 12216 12443 15521 9/30/96 15185 15532 18680 9/30/97 20467 20928 26236 9/30/98 22660 22767 28608 3/31/99 27116 27129 36430 Average Annual Returns as of 3/31/99 Including Sales Charges 1-Year 5-Year Since Inception+++ Class A 3.67% 20.91% 15.49% Class B 8.01% 21.42% 15.64% PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE PERFORMANCE. YOUR INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO WHEN SHARES ARE REDEEMED, THEY MAY BE WORTH MORE OR LESS THAN ORIGINAL COST. MUTUAL FUNDS ARE NOT OBLIGATIONS OF OR GUARANTEED BY ANY BANK AND ARE NOT FEDERALLY INSURED. ~ The S&P 500 is adjusted to reflect reinvestment of dividends on securities in the index. The S&P 500 is not adjusted to reflect sales loads, expenses, or other fees that the SEC requires to be reflected in the Portfolio's performance. + Represents a hypothetical investment of $10,000 in Mentor Capital Growth Portfolio Class B Shares. A contingent deferred sales charge will be imposed, if applicable, on Class B Shares of rates ranging from a maximum of 4.00% of amounts redeemed during the first year following the date of purchase to 1.00% of amounts redeemed during the five-year period following the date of purchase. The value of the Class B Shares reflects a redemption fee in effect at the end of each of the stated periods. The Class B Shares' performance assumes the reinvestment of all dividends and distributions. ++ Represents a hypothetical investment of $10,000 in Mentor Capital Growth Portfolio Class A Shares, after deducting the maximum sales charge of 5.75% ($10,000 investment minus $575 sales charges = $9,425). The Class A Shares' performance assumes the reinvestment of all dividends and distributions. +++ Reflects operations of Mentor Capital Growth Portfolio Class A and Class B Shares from the date of commencement of operations on 4/29/92 through 3/31/99. Comparison of change in value of a hypothetical $10,000 investment in Mentor Capital Growth Portfolio Class Y Shares and the S&P 500.~ Class Y Shares S&P 500 11/19/97 10000 10000 12/31/97 10300 10643 3/31/98 11835 12127 6/30/98 12200 12450 9/30/98 10895 11281 3/31/99 13055 14366 Total Returns as of 3/31/99 1-Year Since Inception++ Class Y Shares 10.32% 22.87% PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE PERFORMANCE. YOUR INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO WHEN SHARES ARE REDEEMED, THEY MAY BE WORTH MORE OR LESS THAN ORIGINAL COST. MUTUAL FUNDS ARE NOT OBLIGATIONS OF OR GUARANTEED BY ANY BANK AND ARE NOT FEDERALLY INSURED. ~ The S&P 500 is adjusted to reflect reinvestment of dividends on securities in the index. The S&P 500 is not adjusted to reflect sales loads, expenses, or other fees that the SEC requires to be reflected in the Portfolio's performance. + Represents a hypothetical investment of $10,000 in Mentor Capital Growth Portfolio Class Y Shares. These shares are not subject to any sales or contingent deferred sales charges. The Class Y Shares' performance assumes the reinvestment of all dividends and distributions. ++ Reflects operations of Mentor Capital Growth Portfolio Class Y from the date of issuance on 11/19/97 through 3/31/99. 27 MENTOR CAPITAL GROWTH PORTFOLIO PORTFOLIO OF INVESTMENTS MARCH 31, 1999 (UNAUDITED) - --------------------------------------------------------------------------------
SHARES MARKET VALUE COMMON STOCKS - 95.00% BASIC MATERIALS - 4.88% Bemis, Inc. 172,784 $ 5,367,103 Sherwin-Williams Company 736,600 20,716,875 ----------- 26,083,978 ----------- CAPITAL GOODS & CONSTRUCTION - 9.45% Emerson Electric Company 358,600 18,983,388 Illinois Tool Works 331,700 20,523,938 W. W. Grainger, Inc. 256,300 11,036,918 ----------- 50,544,244 ----------- CONSUMER CYCLICAL - 13.32% Chancellor Media Corporation * 379,750 17,895,719 Interpublic Group Companies, Inc. 252,800 19,686,800 Newell Rubbermaid, Inc. 501,419 23,817,383 Royal Caribbean Cruises, Limited 252,600 9,851,400 ----------- 71,251,302 ----------- CONSUMER STAPLES - 8.17% Bristol-Myers Squibb Company 341,500 21,962,719 Sysco Corporation 826,500 21,747,281 ----------- 43,710,000 ----------- FINANCIAL - 16.74% American Express Company 156,500 18,388,750 Federal National Mortgage Association 219,600 15,207,300 SouthTrust Corporation 481,500 17,965,969 Washington Mutual, Inc. 483,640 19,768,785 Wells Fargo Company 519,800 18,225,487 ----------- 89,556,291 ----------- HEALTH - 7.86% Johnson & Johnson 240,600 22,541,212 Tenet Healthcare Corporation 1,031,000 19,524,563 ----------- 42,065,775 ----------- TECHNOLOGY - 22.45% Automatic Data Processing 515,000 21,308,125 Computer Sciences Corporation 339,150 18,716,841 MCI WorldCom, Inc. 185,750 16,450,484 Sun Microsystems, Inc.* 183,350 22,907,291 SunGard Data Systems, Inc.* 550,000 22,000,000 Xerox Corporation 350,000 18,681,250 ----------- 120,063,991 -----------
SHARES OR PRINCIPAL AMOUNT MARKET VALUE COMMON STOCKS (CONTINUED) TRANSPORTATION & SERVICES - 1.31% Werner Enterprises, Inc. 446,312 $ 7,029,414 ------------ UTILITY - 2.67% MediaOne Group* 225,000 14,287,500 ------------ MISCELLANEOUS - 8.15% Tyco International Limited 295,600 21,209,300 UNUM Corporation 471,100 22,406,694 ------------ 43,615,994 ------------ TOTAL COMMON STOCKS (COST $451,750,680) 508,208,489 ------------ SHORT-TERM INVESTMENT - 3.32% REPURCHASE AGREEMENT Goldman Sachs & Company Dated 3/31/99, 4.95%, due 4/01/99 collateralized by $28,720,000 Federal Home Loan Mortgage Corporation, 7.50%, 11/01/27, market value $18,147,748 (cost $17,773,445) $17,773,445 17,773,445 ------------ TOTAL INVESTMENTS (COST $469,524,125)-98.32% 525,981,934 OTHER ASSETS LESS LIABILITIES - 1.68% 8,960,759 ------------ NET ASSETS - 100.00% $534,942,693 ============
* Non-income producing. INVESTMENT TRANSACTIONS Cost of purchases and proceeds from sales of securities, other than short-term securities, aggregated $289,346,132 and $182,295,844, respectively. INCOME TAX INFORMATION At March 31, 1999, the aggregated cost of investment securities for federal income tax purposes was $469,524,125. Net unrealized appreciation aggregated $56,457,809, of which $71,039,062 related to appreciated investment securities and $14,581,253 related to depreciated investment securities. SEE NOTES TO FINANCIAL STATEMENTS. 28 MENTOR CAPITAL GROWTH PORTFOLIO - -------------------------------------------------------------------------------- STATEMENT OF ASSETS AND LIABILITIES MARCH 31, 1999 (UNAUDITED) ASSETS Investments, at market value (Note 2) Investment securities $508,208,489 Repurchase agreements 17,773,445 ------------ Total investments (cost $469,524,125) 525,981,934 Collateral for securities loaned (Note 2) 22,282,979 Receivables Investments sold 8,481,730 Fund shares sold 1,910,950 Dividends and interest 452,073 ------------ TOTAL ASSETS 559,109,666 ------------ LIABILITIES Payables Investments purchased $1,095,869 Securities loaned (Note 2) 22,282,979 Fund shares redeemed 703,600 Accrued expenses and other liabilities 84,525 ---------- TOTAL LIABILITIES 24,166,973 ------------ NET ASSETS $534,942,693 ============ Net Assets represented by: (Note 2) Additional paid-in capital $463,096,410 Accumulated undistributed net investment loss (1,003,192) Accumulated net realized gain on investment transactions 16,391,666 Net unrealized appreciation of investments 56,457,809 ------------ NET ASSETS $534,942,693 ============ NET ASSET VALUE PER SHARE Class A Shares $ 24.27 Class B Shares $ 22.95 Class Y Shares $ 24.34 OFFERING PRICE PER SHARE Class A Shares $ 25.75(a) Class B Shares $ 22.95 Class Y Shares $ 24.34 SHARES OUTSTANDING Class A Shares 11,553,848 Class B Shares 11,088,831 Class Y Shares 54
(a) Computation of offering price: 100/94.25 of net asset value. SEE NOTES TO FINANCIAL STATEMENTS. STATEMENT OF OPERATIONS SIX MONTHS ENDED MARCH 31, 1999 (UNAUDITED) INVESTMENT INCOME Dividends $ 2,337,247 Interest 607,297 ----------- TOTAL INVESTMENT INCOME (NOTE 2) 2,944,544 EXPENSES Management fee (Note 4) $1,796,157 Distribution fee (Note 5) 881,368 Shareholder service fee (Note 5) 561,297 Transfer agent fee 323,963 Administration fee (Note 4) 224,520 Shareholder reports and postage expenses 56,547 Custodian and accounting fees 38,746 Registration expenses 32,333 Legal fees 10,583 Audit fees 7,440 Directors' fees and expenses 5,496 Miscellaneous 9,286 ---------- Total expenses 3,947,736 ----------- NET INVESTMENT LOSS (1,003,192) ----------- REALIZED AND UNREALIZED GAIN ON INVESTMENTS Net realized gain on investments (Note 2) 18,899,025 Change in unrealized appreciation (depreciation) on investments 49,993,788 ---------- NET GAIN ON INVESTMENTS 68,892,813 ----------- NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $67,889,621 ===========
SEE NOTES TO FINANCIAL STATEMENTS. 29 MENTOR CAPITAL GROWTH PORTFOLIO - -------------------------------------------------------------------------------- STATEMENTS OF CHANGES IN NET ASSETS
SIX MONTHS ENDED 3/31/99 YEAR ENDED (UNAUDITED) 9/30/98 NET INCREASE IN NET ASSETS Operations Net investment loss $ (1,003,192) $ (1,099,960) Net realized gain on investments 18,899,025 45,438,253 Change in unrealized appreciation (depreciation) on investments 49,993,788 (32,273,002) ------------- ------------- Increase in net assets resulting from operations 67,889,621 12,065,291 ------------- ------------- Distributions to Shareholders From net investment income Class A -- (29,728) Class B -- (52,910) From net realized gain on investments Class A (16,354,928) (5,934,313) Class B (23,292,331) (10,484,517) Class Y (124) (12) ------------- ------------- Total distributions to shareholders (39,647,383) (16,501,480) ------------- ------------- Capital Share Transactions (Note 7) Proceeds from sale of shares 202,131,046 220,347,636 Reinvested distributions 38,811,637 16,089,732 Shares redeemed (76,111,172) (69,421,743) ------------- ------------- Change in net assets resulting from capital share transactions 164,831,511 167,015,625 ------------- ------------- Increase in net assets 193,073,749 162,579,436 Net Assets Beginning of period 341,868,944 179,289,508 ------------- ------------- End of period (including accumulated undistributed net investment income (loss) of ($1,003,192) and $0, respectively) $ 534,942,693 $ 341,868,944 ============= =============
SEE NOTES TO FINANCIAL STATEMENTS. 30 MENTOR CAPITAL GROWTH PORTFOLIO - -------------------------------------------------------------------------------- FINANCIAL HIGHLIGHTS CLASS A SHARES
SIX MONTHS YEAR YEAR YEAR YEAR YEAR ENDED 3/31/99 ENDED ENDED ENDED ENDED ENDED (UNAUDITED) 9/30/98 9/30/97 9/30/96 9/30/95 9/30/94 PER SHARE OPERATING PERFORMANCE Net asset value, beginning of year $ 22.71 $ 22.42 $ 19.36 $ 16.02 $ 14.88 $ 15.26 --------- ------- ------- ------- ------- ------- Income from investment operations Net investment income (loss) (0.08) (0.10) (0.02) 0.11 0.02 0.09 Net realized and unrealized gain (loss) on investments 4.19 2.34 5.87 3.73 2.91 (0.30) ---------- -------- ------- ------- ------- ------- Total from investment operations 4.11 2.24 5.85 3.84 2.93 (0.21) ---------- -------- ------- ------- ------- ------- Less distributions From net investment loss - (0.01) - - - (0.04) From net realized capital loss (2.55) (1.94) (2.79) (0.50) (1.79) (0.13) ---------- -------- ------- ------- ------- ------- Total distributions (2.55) (1.95) (2.79) (0.50) (1.79) (0.17) ---------- -------- ------- ------- ------- ------- Net asset value, end of year $ 24.27 $ 22.71 $ 22.42 $ 19.36 $ 16.02 $ 14.88 ========== ======== ======= ======= ======= ======= TOTAL RETURN* 19.66% 10.72% 34.78% 24.63% 20.18% (1.37%) RATIOS / SUPPLEMENTAL DATA Net assets, end of year (in thousands) $ 280,401 $145,117 $65,703 $31,889 $29,582 $ 21,181 Ratio of expenses to average net assets 1.36% (a) 1.34% 1.41% 1.43% 1.87% 1.70% Ratio of net investment income (loss) to average net assets (0.05%)(a) 0.06% 0.53% 0.51% 0.27% 0.53% Portfolio turnover rate 42% 104% 64% 98% 157% 149%
(a) Annualized. * Total return does not reflect sales commissions and is not annualized. SEE NOTES TO FINANCIAL STATEMENTS. CLASS B SHARES
SIX MONTHS YEAR YEAR YEAR YEAR YEAR ENDED 3/31/99 ENDED ENDED ENDED ENDED ENDED (UNAUDITED) 9/30/98 9/30/97 9/30/96 9/30/95 9/30/94 PER SHARE OPERATING PERFORMANCE Net asset value, beginning of year $ 21.72 $ 21.68 $ 18.92 $ 15.79 $ 14.80 $ 15.23 --------- ------- ------- ------- ------- ------- Income from investment operations Net investment income (loss) (0.06) (0.08) - (0.04) 0.25 (0.04) Net realized and unrealized gain (loss) on investments 3.84 2.07 5.55 3.67 2.53 (0.26) ---------- ------- ------- ------- ------- ------- Total from investment operations 3.78 1.99 5.55 3.63 2.78 (0.30) ---------- ------- ------- ------- ------- ------- Less distributions From net investment loss - (0.01) - - - - From capital loss (2.55) (1.94) (2.79) (0.50) (1.79) (0.13) ---------- ------- ------- ------- ------- ------- Total distributions (2.55) (1.95) (2.79) (0.50) (1.79) (0.13) ---------- ------- ------- ------- ------- ------- Net asset value, end of year $ 22.95 $ 21.72 $ 21.68 $ 18.92 $ 15.79 $ 14.80 ========== ======= ======= ======= ======= ======= TOTAL RETURN* 18.97% 9.86% 33.88% 23.64% 19.26% (2.00%) RATIOS / SUPPLEMENTAL DATA Net assets, end of year (in thousands) $ 254,541 $196,751 $113,587 $68,213 $57,648 $41,106 Ratio of expenses to average net assets 2.11% (a) 2.09% 2.16% 2.18% 2.56% 2.46% Ratio of net investment loss to average net assets (0.80%)(a) (0.70%) (0.22%) (0.24%) (0.41%) (0.22%) Portfolio turnover rate 42% 104% 64% 98% 157% 149%
(a) Annualized. * Total return does not reflect sales commissions and is not annualized. SEE NOTES TO FINANCIAL STATEMENTS. 31 MENTOR CAPITAL GROWTH PORTFOLIO - -------------------------------------------------------------------------------- FINANCIAL HIGHLIGHTS CLASS Y SHARES
SIX MONTHS PERIOD ENDED 3/31/99 ENDED (UNAUDITED) 9/30/98 (b) PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 22.74 $ 20.81 --------- -------- Income from investment operations Net investment income 0.16 0.02 Net realized and unrealized gain on investments 1.44 2.16 --------- -------- Total from investment operations 1.60 2.18 --------- -------- Less distributions From net realized capital gain - (0.25) --------- -------- Total distributions - (0.25) --------- -------- Net asset value, end of period $ 24.34 $ 22.74 ========= ======== TOTAL RETURN* 19.83% 10.56% RATIOS / SUPPLEMENTAL DATA Net assets, end of period (in thousands) $ 1 $ 1 Ratio of expenses to average net assets 1.09%(a) 1.09%(a) Ratio of net investment income to average net assets ( 0.04%)(a) 0.38%(a) Portfolio turnover rate 42% 104%
(a) Annualized. (b) Reflects operations for the period from November 19, 1997 (initial offering of Class Y shares) to September 30, 1998. * Total return does not reflect sales commissions and is not annualized. SEE NOTES TO FINANCIAL STATEMENTS. 32 MENTOR INCOME AND GROWTH PORTFOLIO MANAGERS' COMMENTARY: THE INCOME AND GROWTH MANAGEMENT TEAM MARCH 31, 1999 - -------------------------------------------------------------------------------- MARKET REVIEW A number of milestones have been reached so far in 1999. The Dow Jones Industrial Average exceeded 10,000 for the first time. The Senate refused to oust President Clinton from office. The US economy continued its robust growth, with few signs of inflation. After four years of consecutive 20% plus returns, the stock market has gotten off to another good start, with the S&P500 returning 5.0% in the first quarter. The trends at play in 1998 continued to prevail, with a narrow group of stocks led by large-capitalization growth stocks, dominating the market. Large-capitalization technology issues, especially Internet-related companies, and capital markets-oriented financial stocks provided the leadership. Growth continued to outperform value. Interest rates rose again during the first quarter of 1999 as the bond market realigned yields in response to a somewhat stronger worldwide economic environment. Following three easing moves by the Federal Reserve in 1998, the bond market had established a yield curve that clearly envisioned further aggressive easing by the Fed. The Fed has now stated that global economic and financial situations have, for the moment, stabilized and that further lowering of the short rate is not warranted. With little immediate hope of further actions by the Fed to lower short-term yields, focus has moved to the strength of the US economy. The strong economy and generally rising interest rates have permitted both corporate and mortgage sectors to perform well. Corporate bonds have been supported by the fact that the robust US economy means that corporate balance sheets are strong and can easily support the current ratings of their debt. Rising interest rates mean lower refinancing volume, a clear benefit for mortgage-backed securities. PORTFOLIO PERFORMANCE For the six month period ended March 31, 1999, the Mentor Income & Growth Portfolio A shares returned 5.73% compared to 15.74% for its 60%S&P500/40%Lehman Brothers Aggregate Bond Index benchmark. Our value investment bias and consequent lack of exposure to the very large growth stocks, especially in the technology sector (with the exception of our large holding in IBM) was a major cause of our shortfall in performance. The recent disparity between growth and value investment performance can be seen by the difference in returns of the Russell 1000 Growth Index, up 34.8% over the past six months, and the Russell 1000 Value Index up 18.3%. EQUITY OUTLOOK AND STRATEGY While still ten months short of the mark, it appears the US economy will set a record for the longest expansion in the post-World War II era. At this stage of the cycle, the economy is in far better shape than it was during the record expansion of the 1960's. Inflation remains low, productivity is high, manufacturing labor costs continue to decline, and capacity utilization is below normal levels. The strength in the economy over the next few quarters is likely to be greater than many are now expecting. We have increased our estimate of real GDP growth to 3.5% for 1999. If world economic activity improves as we think it will, the market could broaden and reduce the significant dispersion in valuations. The Portfolio is broadly diversified and well positioned to take advantage of the change when it occurs. Two sectors that should be beneficiaries are industrial cyclicals and materials. Increased shipments on lean cost structures should enable industrial companies to show strong earnings gains. Improved demand 33 MENTOR INCOME AND GROWTH PORTFOLIO MANAGERS' COMMENTARY: THE INCOME AND GROWTH MANAGEMENT TEAM MARCH 31, 1999 - -------------------------------------------------------------------------------- for materials could result in a quick upward move in the price for certain commodities that would benefit the stock prices of the producers. The very recent performance of energy-related equities is an example of the sharp and rapid rally that can occur when a commodity price moves up from a very depressed level. FIXED INCOME OUTLOOK AND STRATEGY The bond market is clearly in uncharted waters. Not in recent memory has rapid economic growth this late in an economic expansion been accompanied by stable and even falling inflation. We believe that the economy will continue to grow at a reasonably rapid pace, though not as rapid as that of 1998. Furthermore, inflation should remain low, most likely between one and two percent. The Fed will not move toward either higher or lower rates during 1999, and as a result bond yields will move around within the context of a Fed Funds Rate stable at 4.75%. As a result, both mortgage-backed securities and corporate bonds will in all likelihood provide better total returns than Treasury securities. We therefore expect to permit the Portfolio's duration to drift downward and to de-emphasize Treasury securities in favor of the corporate and mortgage-backed sectors. 34 MENTOR INCOME AND GROWTH PORTFOLIO MARCH 31, 1999 - -------------------------------------------------------------------------------- PERFORMANCE COMPARISON Comparison of change in value of a hypothetical $10,000 investment in Mentor Income and Growth Portfolio Class A and Class B Shares, the S&P 500 and the Lehman Brothers Aggregate Bond Index.+ Class A Shares Class B Shares LAGG/S&P 500 5/24/93 9425 10133 10000 9/30/93 9909 10506 10353 9/30/94 10578 11239 10446 9/30/95 12402 12614 12879 9/30/96 14802 15140 14686 9/30/97 18076 18499 18723 9/30/98 19126 19302 20692 3/31/99 20068 20192 23979 Average Annual Returns as of 3/31/99 Including Sales Charges 1-Year 5-Year Since Inception++ Class A (2.31%) 13.58% 12.75% Class B 1.95% 14.09% 13.09% PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE PERFORMANCE. YOUR INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO WHEN SHARES ARE REDEEMED, THEY MAY BE WORTH MORE OR LESS THAN ORIGINAL COST. MUTUAL FUNDS ARE NOT OBLIGATIONS OF OR GUARANTEED BY ANY BANK AND ARE NOT FEDERALLY INSURED. + The Standard & Poor's Index (S&P 500) is an unmanaged, market-value-weighted index of 500 widely held domestic common stocks. An unmanaged index does not reflect expenses and may not correspond to the performance of a managed portfolio in which expenses are incurred. The Lehman Brothers Aggregate Index is made up of the Government/Corporate Index, the Mortgage-Backed Securities Index, and the Asset-Backed Securities Index. The Lehman Brothers Aggregate Bond Index and S&P 500 are adjusted to reflect reinvestment of interest and dividends on securities in the indexes. The Lehman Brothers Aggregate Bond Index and S&P 500 are not adjusted to reflect sales loads, expenses, or other fees that the SEC requires to be reflected in the Portfolio's performance. This index represents an asset allocation of 60% S&P 500 stocks and 40% Lehman Brothers Aggregate Bond Index. ** Represents a hypothetical investment of $10,000 in Mentor Income and Growth Portfolio Class B Shares. A contingent deferred sales charge will be imposed, if applicable, on Class B shares at rates ranging from a maximum of 4.00% of amounts redeemed during the first year following the date of purchase to 1.00% of amounts redeemed during the five-year period following the date of purchase. The value of the Class B Shares reflects a redemption fee in effect at the end of each of the stated periods. The Class B Shares' performance assumes the reinvestment of all dividends and distributions. *** Represents a hypothetical investment of $10,000 in Mentor Income and Growth Portfolio Class A Shares, after deducting the maximum sales charge of 5.75% ($10,000 investment minus $575 sales charges = $9,425). The Class A Shares' performance assumes the reinvestment of all dividends and distributions. ++ Reflects operations of Mentor Income and Growth Portfolio Class A and Class B Shares from the date of commencement of operations on 5/24/93 through 3/31/99. 35 MENTOR INCOME AND GROWTH PORTFOLIO MARCH 31, 1999 - -------------------------------------------------------------------------------- PERFORMANCE COMPARISON Comparison of change in value of a hypothetical $10,000 investment in Mentor Income and Growth Portfolio Class Y Shares, the S&P 500 and the Lehman Brothers Aggregate Bond Index.+ Class Y Shares LAGG/S&P 500 11/19/97 10000 10000 12/31/97 10217 10443 3/31/98 10860 11374 6/30/98 10750 11800 9/30/98 10660 11211 3/31/99 11289 12987 Total Returns as of 3/31/99 1-Year Since Inception++ Class Y 3.95% 9.82% PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE PERFORMANCE. YOUR INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO WHEN SHARES ARE REDEEMED, THEY MAY BE WORTH MORE OR LESS THAN ORIGINAL COST. MUTUAL FUNDS ARE NOT OBLIGATIONS OF OR GUARANTEED BY ANY BANK AND ARE NOT FEDERALLY INSURED. + The Standard & Poor's Index (S&P 500) is an unmanaged, market-value-weighted index of 500 widely held domestic common stocks. An unmanaged index does not reflect expenses and may not correspond to the performance of a managed portfolio in which expenses are incurred. The Lehman Brothers Aggregate Index is made up of the Government/Corporate Index, the Mortgage-Backed Securities Index, and the Asset-Backed Securities Index. The Lehman Brothers Aggregate Bond Index and S&P 500 are adjusted to reflect reinvestment of interest and dividends on securities in the indexes. The Lehman Brothers Aggregate Bond Index and S&P 500 are not adjusted to reflect sales loads, expenses, or other fees that the SEC requires to be reflected in the Portfolio's performance. This index represents an asset allocation of 60% S&P 500 stocks and 40% Lehman Brothers Aggregate Bond Index. *** Represents a hypothetical investment of $10,000 in Mentor Income and Growth Portfolio Class Y Shares. These shares are not subject to any sales or contingent deferred sales charges. The Class Y Shares' performance assumes the reinvestment of all dividends and distributions. ++ Reflects operations of Mentor Income and Growth Portfolio Class Y Shares from the date of issuance on 11/19/97 through 3/31/99. 36 MENTOR INCOME AND GROWTH PORTFOLIO PORTFOLIO OF INVESTMENTS MARCH 31, 1999 (UNAUDITED) - --------------------------------------------------------------------------------
SHARES MARKET VALUE COMMON STOCKS - 56.10% BASIC MATERIALS - 4.99% Air Products & Chemicals, Inc. 98,900 $3,387,325 Alcoa, Inc. 48,000 1,977,000 AlliedSignal, Inc. 92,300 4,540,006 British Steel PLC- 108,900 2,198,419 Westvaco Corporation 68,300 1,434,300 ---------- 13,537,050 ---------- CAPITAL GOODS & CONSTRUCTION - 4.73% Caterpillar, Inc. 48,000 2,205,000 Cooper Industries, Inc. 47,500 2,024,687 Cooper Tire & Rubber 125,000 2,296,875 Hubbell, Inc. - Class B 89,400 3,576,000 Thomas & Betts Corporation 72,400 2,719,525 ---------- 12,822,087 ---------- COMMERCIAL SERVICES - 2.95% Supervalu, Inc. 143,900 2,967,938 Wallace Computer Services, Inc. 254,500 5,042,281 ---------- 8,010,219 ---------- CONSUMER CYCLICAL - 4.54% AvalonBay Communities, Inc. 51,000 1,612,875 Delphi Automotive Systems 130,000 2,307,500 Ford Motor Company 74,000 4,199,500 Maytag Corporation 28,900 1,744,838 Premark International, Inc. 74,100 2,440,668 ---------- 12,305,381 ---------- CONSUMER STAPLES - 6.33% American Home Products Corporation 36,100 2,355,525 Baxter International, Inc. 54,300 3,583,800 Bestfoods 49,700 2,336,158 Dimon, Inc. 228,100 869,631 Hormel Foods Corporation 118,100 4,207,312 Kimberly-Clark Corporation 28,600 1,371,013 Philip Morris Companies, Inc. 70,000 2,463,125 ---------- 17,186,564 ---------- ENERGY - 7.01% Baker Hughes, Inc. 193,100 4,694,744 Chevron Corporation 26,400 2,334,750 Phillips Petroleum Company 37,900 1,790,775 Repsol SA- 50,000 2,562,500 Total SA- 39,500 2,409,500 Unocal Corporation 65,800 2,422,262 USX-Marathon Group, Inc. 102,100 2,807,750 ---------- 19,022,281 ---------- FINANCIAL - 11.74% ACE Limited 119,300 3,720,669 CIT Group, Inc. - A 77,900 2,380,819 Citigroup, Inc. 71,900 4,592,612
SHARES OR PRINCIPAL AMOUNT MARKET VALUE COMMON STOCKS (CONTINUED) FINANCIAL (CONTINUED) Federal National Mortgage Association 58,900 $ 4,078,825 Jefferson Pilot Corporation 26,850 1,819,088 Spieker Properties, Inc. 65,000 2,291,250 U. S. Bancorp 163,800 5,579,976 UnionBanCal Corporation 56,100 1,910,906 Wachovia Corporation 39,000 3,166,312 Wilmington Trust Corporation 40,700 2,324,988 ----------- 31,865,445 ----------- HEALTH - 4.49% Abbott Laboratories 41,000 1,919,312 Columbia/HCA Healthcare Corporation 213,600 4,045,050 Johnson & Johnson 25,700 2,407,769 Pharmacia & Upjohn 61,000 3,804,875 ----------- 12,177,006 ----------- TECHNOLOGY - 3.55% Alcatel Alsthom SA- 75,500 1,722,344 International Business Machines Corporation 21,800 3,864,050 Xerox Corporation 76,000 4,056,500 ----------- 9,642,894 ----------- TRANSPORTATION & SERVICES - 1.28% Union Pacific Corporation 65,000 3,473,438 ----------- UTILITIES - 4.49% Bell Atlantic Corporation 67,700 3,499,244 DPL, Inc. 95,000 1,567,500 DQE, Inc. 43,000 1,650,125 Pinnacle West Capital 60,400 2,197,050 SBC Communications, Inc. 69,300 3,265,762 ----------- 12,179,681 ----------- TOTAL COMMON STOCKS (COST $139,059,876) 152,222,046 ----------- CORPORATE BONDS - 14.71% INDUSTRIAL - 7.15% Aluminum Company of America, 5.75%, 2/01/01 $ 250,000 250,790 Archer-Daniels-Midland, 6.75%, 12/15/27 2,000,000 2,018,700 AT&T Corporation, 6.00%, 3/15/09 1,500,000 1,492,305 Computer Associates International, 6.50%, 4/15/08 (a) 1,000,000 969,040
37 MENTOR INCOME AND GROWTH PORTFOLIO PORTFOLIO OF INVESTMENTS MARCH 31, 1999 (UNAUDITED) - --------------------------------------------------------------------------------
PRINCIPAL AMOUNT MARKET VALUE CORPORATE BONDS (CONTINUED) INDUSTRIAL (CONTINUED) Computer Science, 6.25%, 3/15/09 $1,275,000 $1,279,488 Gap, Inc., 6.90%, 9/15/07 1,000,000 1,056,980 Gillette Company, 5.75%, 10/15/05 250,000 247,218 Hershey Foods Corporation, 7.20%, 8/15/27 1,000,000 1,069,470 ICI Wilmington, Inc., 6.95%, 9/15/04 1,000,000 1,005,280 International Business Machines Corporation, 5.50%, 1/15/09 1,500,000 1,448,175 Lucent Technologies, 6.45%, 3/15/29 1,250,000 1,222,337 Mead Corporation, 7.35%, 3/01/17 750,000 772,935 Praxair, Inc., 6.15%, 4/15/03 1,000,000 990,980 Rockwell International Corporation, 6.70%, 1/15/28 1,500,000 1,477,260 Scripps (E. W.) Company, 6.38%, 10/15/02 1,000,000 1,014,300 Tenneco, Inc, 7.50%, 4/15/07 500,000 518,045 Williams Companies, Inc., 6.50%, 11/15/02 1,000,000 1,008,170 Zeneca Wilmington, 7.00%, 11/15/23 1,500,000 1,562,100 ---------- 19,403,573 ---------- FINANCIAL - 4.90% Allmerica Financial Corporation, 7.63%, 10/15/25 1,130,000 1,179,664 Allstate Corporation, 6.75%, 5/15/18 1,000,000 1,000,270 American General Finance, 5.88%, 7/01/00 250,000 250,942 Associates Corporation of North America, 5.25%, 3/30/00 250,000 249,898 Bank One Texas, 6.25%, 2/15/08 1,000,000 996,690 BankAmerica Corporation, 7.88%, 12/01/02 1,000,000 1,063,990 Chase Manhattan Corporation, 7.75%, 11/01/99 250,000 253,490 Comerica Bank, 7.13%, 12/01/13 250,000 250,702 Finova Capital Corporation, 6.39%, 10/08/02 1,000,000 1,008,440 First National Bank of Boston, 8.00%, 9/15/04 250,000 270,345 Fleet Financial Group, 6.88%, 1/15/28 1,000,000 994,300
PRINCIPAL AMOUNT MARKET VALUE CORPORATE BONDS (CONTINUED) FINANCIAL (CONTINUED) Great Western Financial, 6.38%, 7/01/00 $ 250,000 $ 252,265 Heller Financial, 6.38%, 11/10/00 1,000,000 1,009,980 Home Savings of America, 6.00%, 11/01/00 250,000 251,200 Key Bank, NA, 5.80%, 4/01/04 1,375,000 1,369,252 MBIA Inc., 7.00%, 12/15/25 1,000,000 1,007,760 NationsBank Corporation, 7.80%, 9/15/16 1,000,000 1,099,800 Security Benefits Life Company, 8.75%, 5/15/16 (a) 500,000 524,375 Toronto Dominion Bank, 6.13%, 11/01/08 250,000 245,828 ---------- 13,279,191 ---------- UTILITIES - 2.66% Duke Energy Corporation, 6.00%, 12/01/28 1,000,000 915,100 Florida Power & Light, 5.38%, 4/01/00 250,000 249,992 National Fuel Gas Company, 6.00%, 3/01/09 1,000,000 983,780 New York Telephone, 6.00%, 4/15/08 1,000,000 995,920 Northern Natural Gas, 6.75%, 9/15/08 (a) 2,000,000 2,011,540 Pacific Gas & Electric Company, 5.93%, 10/08/03 250,000 249,465 Southwestern Public Service Company, 6.88%, 12/01/99 250,000 252,748 System Energy Resources, 7.71%, 8/01/01 500,000 517,120 Union Electric Company, 6.75%, 10/15/99 250,000 252,353 U.S. West Capital Funding, Inc., 6.88%, 7/15/28 785,000 796,280 ---------- 7,224,298 ---------- TOTAL CORPORATE BONDS (COST $40,147,348) 39,907,062 ---------- U.S. GOVERNMENT SECURITIES AND AGENCIES - 26.58% Government National Mortgage Association 7.00%, 1/15/24 - 7/15/24 3,239,198 3,293,413 6.50%, 4/15/28 - 6/15/28 4,849,197 4,827,958 6.00%, 12/15/28 5,032,131 4,889,018 U.S. Treasury Bond, 6.25%, 8/15/23 3,000,000 3,134,130 U.S. Treasury Notes 5.63%, 11/30/00 10,400,000 10,504,312 6.25%, 6/30/02 12,000,000 12,385,200
38 MENTOR INCOME AND GROWTH PORTFOLIO PORTFOLIO OF INVESTMENTS MARCH 31, 1999 (UNAUDITED) - --------------------------------------------------------------------------------
PRINCIPAL AMOUNT MARKET VALUE U.S. GOVERNMENT SECURITIES AND AGENCIES (CONTINUED) U.S. Treasury Notes 6.38%, 8/15/02 $3,000,000 $ 3,110,160 7.50%, 2/15/05 3,000,000 3,323,040 6.50%, 8/15/05 - 10/15/06 14,000,000 14,870,960 6.13%, 12/31/01 - 8/15/07 11,350,000 11,774,273 ------------ TOTAL U.S. GOVERNMENT SECURITIES AND AGENCIES (COST $72,234,297) 72,112,464 ------------ SHORT-TERM INVESTMENT - 1.33% REPURCHASE AGREEMENT Paine Webber, Inc. Dated 3/31/99, 4.90% due 4/01/99, collateralized by $2,700,000 (original face value) U.S. Treasury Bond, 9.25%, 2/15/14, market value $3,657,656 (cost $3,619,000) 3,619,000 3,619,000 ------------ TOTAL INVESTMENTS (COST $255,060,521)-98.72% 267,860,572 OTHER ASSETS LESS LIABILITIES - 1.28% 3,485,013 ------------ NET ASSETS - 100.00% $271,345,585 ============
* Non-income producing. ~ American Depository Receipts. (a) These are securities that may be resold to "qualified institutional buyers" under rule 144A or securities offered pursuant to Section 4(2) of the Securities Act of 1933, as amended. These securities have been determined to be liquid under guidelines established by the Board of Trustees. INVESTMENT TRANSACTIONS Cost of purchases and proceeds from sales of securities, other than short-term securities, aggregated $88,104,642 and $74,687,844, respectively. INCOME TAX INFORMATION At March 31, 1999, the aggregated cost of investment securities for federal income tax purposes was $255,060,521. Net unrealized appreciation aggregated $12,800,051, of which $24,402,582 related toappreciated investment securities and $11,602,531 related to depreciated investment securities. SEE NOTES TO FINANCIAL STATEMENTS. 39 MENTOR INCOME AND GROWTH PORTFOLIO - -------------------------------------------------------------------------------- STATEMENT OF ASSETS AND LIABILITIES MARCH 31, 1999 (UNAUDITED) ASSETS Investments, at market value (Note 2) Investment securities $264,241,572 Repurchase agreements 3,619,000 ------------ Total investments (cost $255,060,521) 267,860,572 Collateral for securities loaned (Note 2) 57,206,916 Receivables Investments sold 2,260,145 Fund shares sold 1,054,367 Dividends and interest 1,788,988 ------------ TOTAL ASSETS 330,170,988 ------------ LIABILITIES Payables Investments purchased $ 852,634 Securities loaned (Note 2) 57,206,916 Fund shares redeemed 668,713 Accrued expenses and other liabilities 97,140 ---------- TOTAL LIABILITIES 58,825,403 ------------ NET ASSETS $271,345,585 ============ Net Assets represented by: (Note 2) Additional paid-in capital $252,240,342 Accumulated undistributed net investment income 38,706 Accumulated net realized gain on investment transactions 6,266,485 Net unrealized appreciation of investments 12,800,052 ------------ NET ASSETS $271,345,585 ============ NET ASSET VALUE PER SHARE Class A Shares $ 19.42 Class B Shares $ 19.40 Class Y Shares $ 19.69 OFFERING PRICE PER SHARE Class A Shares $ 20.60(a) Class B Shares $ 19.40 Class Y Shares $ 19.69 SHARES OUTSTANDING Class A Shares 6,112,024 Class B Shares 7,869,390 Class Y Shares 58
(a) Computation of offering price: 100/94.25 of net asset value. SEE NOTES TO FINANCIAL STATEMENTS. STATEMENT OF OPERATIONS SIX MONTHS ENDED MARCH 31, 1999 (UNAUDITED) INVESTMENT INCOME Dividends (b) $ 1,797,684 Interest 3,300,603 ----------- TOTAL INVESTMENT INCOME (NOTE 2) 5,098,287 EXPENSES Management fee (Note 3) $ 984,781 Distribution fee (Note 3) 571,335 Shareholder service fee (Note 5) 328,259 Transfer agent fee (Note 3) 197,877 Administration fee (Note 4) 131,304 Custodian and accounting fees (Note 3) 33,039 Shareholder reports and postage expenses 30,827 Registration expenses 29,662 Legal fees 6,223 Audit fees 4,375 Directors' fees and expenses 3,232 Miscellaneous 5,462 --------- Total expenses 2,326,376 ----------- NET INVESTMENT INCOME 2,771,911 ----------- REALIZED AND UNREALIZED GAIN ON INVESTMENTS Net realized gain on investments (Note 2) 8,229,407 Change in unrealized appreciation (depreciation) on investments 2,100,645 --------- NET GAIN ON INVESTMENTS 10,330,052 ----------- NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $13,101,963 ===========
(b) Net of withholding taxes of $18,656. SEE NOTES TO FINANCIAL STATEMENTS. 40 MENTOR INCOME AND GROWTH PORTFOLIO - -------------------------------------------------------------------------------- STATEMENTS OF CHANGES IN NET ASSETS
SIX MONTHS ENDED 3/31/99 YEAR ENDED (UNAUDITED) 9/30/98 NET INCREASE IN NET ASSETS Operations Net investment income $ 2,771,911 $ 4,930,518 Net realized gain on investments 8,229,407 10,845,766 Change in unrealized appreciation (depreciation) on investments 2,100,645 (5,423,416) ------------- ------------- Increase in net assets resulting from operations 13,101,963 10,352,868 ------------- ------------- Distributions to Shareholders From net investment income Class A (1,406,404) (2,350,498) Class B (1,418,753) (2,488,039) Class Y -- (29) From net realized gain on investments Class A (4,931,050) (5,325,307) Class B (7,246,255) (8,807,307) Class Y (54) (1) ------------- --------------- Total distributions to shareholders (15,002,516) (18,971,181) ------------- -------------- Capital Share Transactions (Note 7) Proceeds from sale of shares 40,262,800 101,090,596 Reinvested distributions 14,251,560 17,902,342 Shares redeemed (23,909,198) (39,059,107) ------------- -------------- Change in net assets resulting from capital share transactions 30,605,162 79,933,831 ------------- -------------- Increase in net assets 28,704,609 71,315,518 Net Assets Beginning of period 242,640,976 171,325,458 ------------- -------------- End of period (including accumulated undistributed net investment income of $38,706 and $91,952, respectively) $ 271,345,585 $242,640,976 ============= ==============
SEE NOTES TO FINANCIAL STATEMENTS. FINANCIAL HIGHLIGHTS CLASS A SHARES
SIX MONTHS YEAR ENDED 3/31/99 ENDED (UNAUDITED) 9/30/98 PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 19.54 $ 20.60 --------- ------- Income from investment operations Net investment income 0.24 0.51 Net realized and unrealized gain on investments 0.86 0.60 --------- ------- Total from investment operations 1.10 1.11 --------- ------- Less distributions From net investment income (0.24) (0.51) From net realized capital gain (0.98) (1.66) --------- ------- Total distributions (1.22) (2.17) --------- ------- Net asset value, end of period $ 19.42 $ 19.54 ========= ======= TOTAL RETURN* 5.73% 5.81% RATIOS / SUPPLEMENTAL DATA Net assets, end of period (in thousands) $ 118,711 $98,794 Ratio of expenses to average net assets 1.34%(a) 1.32% Ratio of net investment income to average net assets 2.54%(a) 2.70% Portfolio turnover rate 28% 40% YEAR YEAR YEAR YEAR ENDED ENDED ENDED ENDED 9/30/97 9/30/96 9/30/95 9/30/94 PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 19.16 $ 17.13 $ 15.27 $ 14.88 ------- ------- ------- ------- Income from investment operations Net investment income 0.44 0.37 0.40 0.31 Net realized and unrealized gain on investments 3.39 2.75 2.14 0.64 ------- ------- ------- ------- Total from investment operations 3.83 3.12 2.54 0.95 ------- ------- ------- ------- Less distributions From net investment income (0.47) (0.35) (0.43) (0.30) From net realized capital gain (1.92) (0.74) (0.25) (0.26) ------- ------- ------- ------- Total distributions (2.39) (1.09) (0.68) (0.56) ------- ------- ------- ------- Net asset value, end of period $ 20.60 $ 19.16 $ 17.13 $ 15.27 ======= ======= ======= ======= TOTAL RETURN* 22.11% 19.13% 17.24% 6.54% RATIOS / SUPPLEMENTAL DATA Net assets, end of period (in thousands) $63,509 $24,210 $19,888 $17,773 Ratio of expenses to average net assets 1.35% 1.36% 1.69% 1.75% Ratio of net investment income to average net assets 2.63% 2.08% 2.53% 2.20% Portfolio turnover rate 75% 72% 62% 78%
(a) Annualized. * Total return does not reflect sales commissions and is not annualized. SEE NOTES TO FINANCIAL STATEMENTS. 41 MENTOR INCOME AND GROWTH PORTFOLIO - -------------------------------------------------------------------------------- FINANCIAL HIGHLIGHTS CLASS B SHARES
SIX MONTHS ENDED YEAR YEAR YEAR YEAR YEAR 3/31/99 ENDED ENDED ENDED ENDED ENDED (UNAUDITED) 9/30/98 9/30/97 9/30/96 9/30/95 9/30/94 PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 19.53 $ 20.59 $ 19.18 $ 17.14 $ 15.28 $ 14.91 -------- ------- ------- ------- ------- ------- Income from investment operations Net investment income 0.17 0.37 0.34 0.23 0.28 0.21 Net realized and unrealized gain on investments 0.86 0.59 3.35 2.76 2.14 0.61 -------- ------- ------- ------- ------- ------- Total from investment operations 1.03 0.96 3.69 2.99 2.42 0.82 -------- ------- ------- ------- ------- ------- Less distributions From net investment income (0.18) (0.36) (0.36) (0.21) (0.31) (0.19) From net realized capital gain (0.98) (1.66) (1.92) (0.74) (0.25) (0.26) -------- -------- -------- ------- ------- ------- Total distributions (1.16) (2.02) (2.28) (0.95) (0.56) (0.45) -------- -------- -------- ------- ------- ------- Net asset value, end of period $ 19.40 $ 19.53 $ 20.59 $ 19.18 $ 17.14 $ 15.28 ======== ======== ======== ======= ======= ======= TOTAL RETURN 5.36% 5.01% 21.24% 18.26% 16.32% 5.66% RATIOS / SUPPLEMENTAL DATA Net assets, end of period (in thousands) $152,634 $143,846 $107,816 $66,548 $46,678 $43,219 Ratio of expenses to average net assets 2.08%(a) 2.07% 2.10% 2.13% 2.43% 2.44% Ratio of net investment income to average net assets 1.79%(a) 1.95% 1.87% 1.32% 1.78% 1.51% Portfolio turnover rate 28% 40% 75% 72% 62% 78%
(a) Annualized. * Total return does not reflect sales commissions and is not annualized. SEE NOTES TO FINANCIAL STATEMENTS. CLASS Y SHARES
SIX MONTHS ENDED 3/31/99 PERIOD ENDED (UNAUDITED) 9/30/98 (c) PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 19.54 $ 18.75 -------- -------- Income from investment operations Net investment income 0.24 0.54 Net realized and unrealized gain on investments 0.89 0.82 -------- -------- Total from investment operations 1.13 1.36 -------- -------- Less distributions From net investment income -- (0.54) From net realized capital gain (0.98) (0.03) -------- -------- Total distributions (0.98) (0.57) -------- -------- Net asset value, end of period $ 19.69 $ 19.54 ======== ======== TOTAL RETURN 5.89% 7.29% RATIOS / SUPPLEMENTAL DATA Net assets, end of period (in thousands) $ 1 1 Ratio of expenses to average net assets 1.07%(a) 1.07%(a) Ratio of net investment income to average net assets 2.54%(a) 3.15%(a) Portfolio turnover rate 28% 40%
(a) Annualized. (c) For the period from November 19, 1997 (initial offering of Class Y shares) to September 30, 1998. * Total return does not reflect sales commissions and is not annualized. SEE NOTES TO FINANCIAL STATEMENTS. 42 MENTOR BALANCED PORTFOLIO MANAGERS' COMMENTARY: THE BALANCED MANAGEMENT TEAM MARCH 31, 1999 - -------------------------------------------------------------------------------- MARKET REVIEW What was once a great bull market powered by strong earnings and declining inflation expectations has become an emotionally-charged environment where fundamental considerations are giving way to price momentum and speculation on a historic scale. As we have commented on repeatedly, most of the "action" has narrowed to a fairly limited group of stocks -- the mega-sized blue chip growth stocks and Internet concepts, both of which have been in the spotlight for quite a while. While the S&P 500 has returned 18% over the past twelve months, about 60% of the stocks in the index have actually DECLINED over the same period and the largest 50 stocks in the index are up an average 47%. Several thoughtful observers including Warren Buffett, Bill Gates, and Alan Greenspan have warned about these valuations, but most consider their rhetoric out-of-date. The performances, and particularly the valuations, of most Internet stocks are beyond adequate description. We never imagined we would see this level of speculation. Companies that were conceptualized less than two years ago and organized less than one year ago have since gone public with multi-billion dollar market values on minuscule revenues, income losses, and vague plans. The enticement of apparently easy gains in the obvious stocks that continue to go up without pause is incredible, but we know temptation is a deadly investment platform. Treasury rates increased sharply during the six-month period ending March 31, 1999, with the 2-year note climbing 71 basis points (0.71%) to 4.98% and the long bond rising 66 basis points (0.66%) to 5.62%. The market sold off in reaction to much stronger than anticipated economic growth during both the final quarter of 1998 and the first quarter of 1999. Indeed, economic growth in the final quarter of 1998 surged more than 6.0% on an annualized basis. Despite turmoil in financial markets and in Brazil, the much-anticipated slowdown in U.S. economic growth has yet to materialize and the economy has continued its robust growth into 1999. MANAGEMENT STRATEGY We are increasingly comfortable with our current holdings. Our equity investments are substantial companies with average estimated earnings growth of 14-15% this quarter and year. These stocks trade at an average P/E ratio of 21.5 times estimated 1999 earnings-per-share, about 20% below the S&P 500's valuation, despite our belief that their outlooks are better than average. During the first quarter economic data has painted an ever-clearer picture of a robust U.S. economy. Consequently, we have cut back on the duration of our fixed-income holdings to approximately neutral levels and sector allocations have been tilted toward spread product. Mortgage-backed securities have been particularly emphasized given their high yield and strong performance potential in a stable to rising rate environment. The stronger economic growth also prompted us to increase allocation to lower rated corporate bonds, including high yield securities. PERFORMANCE DISCUSSION For the six-month period ending March 31, 1999 the Mentor Balanced Portfolio A shares returned 11.93% compared to 15.74% for our 60% S&P500/40% Lehman Brothers Aggregate Bond Index benchmark. Our "quality-growth-at-a- reasonable-price" equity investment philosophy and 43 MENTOR BALANCED PORTFOLIO MANAGERS' COMMENTARY: THE BALANCED MANAGEMENT TEAM MARCH 31, 1999 - -------------------------------------------------------------------------------- strategy are clearly out of sync with prevailing sentiment. Our recent under-performance mostly reflects lack of exposure to today's most popular stocks, not fundamental disappointments in our holdings. Our asset allocation weighting between stocks, bonds, and cash remains a conservative 52%, 46%, and 2%. MARKET OUTLOOK We have no idea how the stock market will progress over the remainder of the year. The economy appears to be in remarkably good shape with solid growth and low inflation likely to continue. It is very possible that current trends may grow even more extreme. At some point the speculative excess building today will be quashed. We have no idea when or what the catalyst may be, but it will certainly seem obvious when we look back. Between now and then the market could experience some significant volatility. Our singular goal is to get through this highly unusual period with our discipline intact, as we know most others will not. Our long-term fixed-income market outlook is for continued declines in inflation and therefore continued lower interest rates. This optimism is fueled by structural economic changes such as the Internet that offer the potential to substantially increase economic efficiency and reduce costs. In addition, slowing global economic growth and excess manufacturing capacity will continue to moderate price levels and therefore interest rates. As the summer wears on, we expect that stumbling growth in Europe and Latin America will exert significant pressure on the U.S. economy. This pressure on domestic economic growth and global inflation should allow bond prices to rally. We anticipate reducing our exposure to mortgages and corporate bonds at that time and aggressively extending portfolio durations. 44 MENTOR BALANCED PORTFOLIO MARCH 31, 1999 - -------------------------------------------------------------------------------- PERFORMANCE COMPARISON Comparison of change in value of a hypothetical $10,000 investment in Mentor Balanced Portfolio Class A, Class B and Class Y Shares, the S&P 500 and the Lehman Brothers Aggregate Bond Index.+
Class A Shares Class B Shares Class Y Shares S&P 500 6/21/94 10000 10000 10000 10000 12/31/94 9182 10108 9182 10335 6/30/95 10503 11561 10503 12055 9/30/95 10978 12085 10978 12723 9/30/96 12954 14260 12954 14505 9/30/97 16396 18048 16396 18499 9/30/98 18340 20181 18340 20462 3/31/99 20527 22429 20461 23683
Average Annual Returns as of 3/31/99 Without Sales Charges 1-Year Since Inception+++ Class B 9.62% 18.54% Average Annual Returns as of 3/31/99 Including Sales Charges 1-Year Since Inception+++ Class A 3.56% 14.81% Class B 6.15% 18.43% Average Annual Returns as of 3/31/99 Without Sales Charges 1-Year Since Inception+++ Class Y 9.55% 18.52% PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE PERFORMANCE. YOUR INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO WHEN SHARES ARE REDEEMED, THEY MAY BE WORTH MORE OR LESS THAN ORIGINAL COST. MUTUAL FUNDS ARE NOT OBLIGATIONS OF OR GUARANTEED BY ANY BANK AND ARE NOT FEDERALLY INSURED. + The Standard & Poor's Index (S&P 500) is an unmanaged, market- value-weighted index of 500 widely held domestic common stocks. An unmanaged index does not reflect expenses and may not correspond to the performance of a managed portfolio in which expenses are incurred. The Lehman Brothers Aggregate Index is made up of the Government/Corporate Index, the Mortgage-Backed Securities Index, and the Asset-Backed Securities Index. The Lehman Brothers Aggregate Bond Index and S&P 500 are adjusted to reflect reinvestment of interest and dividends on securities in the indexes. The Lehman Brothers Aggregate Bond Index and S&P 500 are not adjusted to reflect sales loads, expenses, or other fees that the SEC requires to be reflected in the Portfolio's performance. This index represents an asset allocation of 60% S&P 500 stocks and 40% Lehman Brothers Aggregate Bond Index. ~ Represents a hypothetical investment of $10,000 in Mentor Balanced Portfolio Class B Shares. A contingent deferred sales charge will be imposed, if applicable, on Class B shares at rates ranging from a maximum of 4.00% of amounts redeemed during the first year following the date of purchase to 1.00% of amounts redeemed during the five-year period following the date of purchase. The value of Class B Shares reflects a redemption fee in effect at the end of each of the stated periods. Prior to September 16, 1998, contingent deferred sales charges of 5.00% were waived. The Class B Shares' performance assumes the reinvestment of all dividends and distributions. * Represents a hypothetical investment of $10,000 in Mentor Balanced Portfolio Class A Shares after deducting the maximum sales charge of 5.75% ($10,000 investment minus $575 sales charge). The Class A Shares' performance assumes the reinvestment of all dividends and distributions. ** Represents a hypothetical investment of $10,000 in Mentor Balanced Portfolio Class Y Shares. These shares are not subject to any sales or contingent deferred slaes charges. The Class Y Shares' performance assumes the reinvestment of all dividends and distributions. ++ Reflects operations of Mentor Balanced Portfolio Class A, Class B and Class Y Shares from the date of commencement of operations on 6/21/94 through 3/31/99. 45 MENTOR BALANCED PORTFOLIO PORTFOLIO OF INVESTMENTS MARCH 31, 1999 (UNAUDITED) - --------------------------------------------------------------------------------
SHARES MARKET VALUE COMMON STOCKS - 51.78% BASIC MATERIALS - 2.76% Bemis Company 91,062 $2,828,614 Sherwin-Williams Company 234,985 6,608,953 ---------- 9,437,567 ---------- CAPITAL GOODS & CONSTRUCTION - 5.33% Emerson Electric Company 116,190 6,150,808 Illinois Tool Works 109,135 6,752,728 W. W. Grainger, Inc. 122,530 5,276,448 ---------- 18,179,984 ---------- CONSUMER CYCLICAL - 7.76% Chancellor Media Corporation - Class A * 129,600 6,107,400 Interpublic Group Companies, Inc. 87,335 6,801,213 Newell-Rubbermaid, Inc. 159,594 7,580,730 Royal Caribbean Cruises Limited 91,900 3,584,100 The Walt Disney Company 39,000 1,213,875 Tribune Company 18,300 1,197,506 ---------- 26,484,824 ---------- CONSUMER STAPLES - 1.86% Sysco Corporation 240,935 6,339,602 ---------- FINANCIAL - 9.00% American Express Company 36,860 4,331,050 Charter One Financial, Inc. 97,872 2,826,054 Citigroup, Inc. 45,300 2,893,537 Federal National Mortgage Association 52,910 3,664,018 M & T Bank Corporation 2,901 1,389,579 Marsh & McLennan 14,700 1,090,556 North Fork Bancorporation 111,750 2,360,719 SouthTrust Corporation 141,500 5,279,719 Washington Mutual, Inc. 70,880 2,897,220 Wells Fargo Company 113,495 3,979,418 ---------- 30,711,870 ---------- HEALTH - 5.95% Bristol-Myers Squibb Company 108,890 7,002,988 Johnson & Johnson 80,205 7,514,206 Tenet Healthcare Corporation * 304,970 5,775,369 ---------- 20,292,563 ---------- TECHNOLOGY - 11.89% Automatic Data Processing 167,800 6,942,725 Computer Sciences Corporation * 107,645 5,940,658 MCI WorldCom, Inc. * 54,585 4,834,184 Sun Microsystems, Inc. * 74,925 9,360,942
SHARES OR PRINCIPAL AMOUNT MARKET VALUE COMMON STOCKS (CONTINUED) TECHNOLOGY (CONTINUED) SunGard Data Systems, Inc.* 184,100 $ 7,364,000 Xerox Corporation 114,650 6,119,444 ----------- 40,561,953 ----------- TRANSPORTATION & SERVICES - 0.80% Werner Enterprises, Inc. 174,272 2,744,784 ----------- UTILITIES - 1.69% MediaOne Group * 91,000 5,778,500 ----------- MISCELLANEOUS - 4.74% Omnicom Group, Inc. 24,800 1,982,450 Tyco International, Inc. 104,145 7,472,404 UNUM Corporation 141,620 6,735,801 ----------- 16,190,655 ----------- TOTAL COMMON STOCKS (COST $161,484,581) 176,722,302 ----------- FIXED INCOME SECURITIES - 40.04% U.S. GOVERNMENT SECURITIES AND AGENCIES - 32.05% Federal Home Loan Bank 4.97%, 2/01/01 $2,000,000 1,989,272 Federal National Mortgage Association 4.63% - 6.64%, 10/15/01 - 7/02/07 1,480,000 1,463,992 Government National Mortgage Association 6.50%, 5/15/09 89,637 91,121 U.S. Treasury Notes 4.75% - 6.63%, 2/28/02 - 11/15/08 21,992,000 22,144,232 U.S. Treasury Bonds 4.25% - 7.50%, 11/15/03 - 8/15/28 78,098,000 83,682,925 ----------- TOTAL U.S. GOVERNMENT SECURITIES AND AGENCIES (COST $101,957,708) 109,371,542 ----------- COLLATERALIZED MORTGAGE OBLIGATIONS - 0.87% AFG Receivables Trust, 6.65%, 10/15/02 23,927 24,001 Capital One Master Trust Series 1998-4, 5.43%, 1/15/07 125,000 122,957 CS First Boston, 7.18%, 2/25/18 25,000 25,108 Equifax Credit Corporation, 6.33%, 1/15/22 900,000 902,392
46 MENTOR BALANCED PORTFOLIO PORTFOLIO OF INVESTMENTS MARCH 31, 1999 (UNAUDITED) - --------------------------------------------------------------------------------
SHARES OR PRINCIPAL AMOUNT MARKET VALUE COLLATERALIZED MORTGAGE OBLIGATIONS (CONTINUED) Key Auto Finance Trust Series 1999-1, 5.63%, 7/15/03 $1,500,000 $ 1,500,288 Key Auto Finance Trust Series 1997-2 6.10%, 11/15/00 29,219 29,245 PNC Student Loan Trust, 6.73%, 1/25/07 75,000 77,993 Union Acceptance Corporation Series 97A, 6.48%, 5/10/04 45,000 45,486 Union Acceptance Corporation 5.75%, 6/09/03 250,000 249,119 ------------ TOTAL COLLATERALIZED MORTGAGE OBLIGATIONS (COST $2,978,346) 2,976,589 ------------ CORPORATE BONDS - 7.12% Associates Corporation, 6.25%, 11/01/08 1,500,000 1,508,504 Continental Airlines, Inc., 7.46%, 4/01/15 1,711,944 1,818,085 Dayton Hudson Company, 6.65%, 8/01/28 1,700,000 1,660,278 Discover Series 1998-7, 5.60%, 5/15/06 125,000 123,545 Enron Corporation, 6.73%, 11/17/08 1,000,000 1,006,879 Ford Motor Credit Company, 5.80%, 1/12/09 1,250,000 1,211,687 General Electric Capital Corporation, 6.29%, 12/15/07 300,000 302,721 Georgia Power Company, 5.50% - 6.00%, 3/01/00 - 12/01/05 2,500,000 2,457,390 GTE California, 5.50%, 1/15/09 1,515,000 1,447,826 GTE North, Inc., 5.65%, 11/15/08 1,500,000 1,450,421 Household Financial Company, 5.88%, 2/01/09 800,000 768,552 IBM Corporation, 5.10%, 11/10/03 1,000,000 967,183
SHARES OR PRINCIPAL AMOUNT MARKET VALUE CORPORATE BONDS (CONTINUED) Merrill Lynch & Company, 6.00%, 2/17/09 $1,250,000 $ 1,208,559 National City Corporation, 5.75%, 2/01/09 800,000 769,479 National Rural Utilities, 5.50%, 1/15/05 1,300,000 1,271,409 Norwest Corporation, 6.80%, 5/15/02 60,000 61,747 Pepsi Bottling Holdings, Inc., 5.63%, 2/17/09 1,800,000 1,735,674 PSI Energy, Inc., 6.00%, 12/14/01 1,000,000 987,764 Safeway, Inc., 5.75% - 6.50%, 11/15/00 - 11/15/08 1,650,000 1,670,989 SmithKline Beechum, 6.63%, 10/01/01 330,000 338,762 Sprint Capital Corporation, 6.13%, 11/15/08 1,450,000 1,427,457 Toyota Motor Credit, 5.63%, 11/13/03 100,000 99,215 ------------ TOTAL CORPORATE BONDS (COST $24,650,350) 24,294,126 ------------ TOTAL FIXED INCOME SECURITIES (COST $129,586,404) 136,642,257 ------------ SHORT-TERM INVESTMENT - 6.14% REPURCHASE AGREEMENT Goldman Sachs & Company Dated 3/31/99, 4.95%, due 4/01/99, collateralized by $33,830,000 Federal Home Loan Mortgage Corporation, 7.50%, 11/01/27, market value $21,376,682 (cost $20,936,014) 20,936,014 20,936,014 ------------ TOTAL INVESTMENTS (COST $312,006,999)-97.96% 334,300,573 OTHER ASSETS LESS LIABILITIES - 2.04% 6,992,993 ------------ NET ASSETS - 100.00% $341,293,566 ============
* Non-income producing. 47 MENTOR BALANCED PORTFOLIO PORTFOLIO OF INVESTMENTS MARCH 31, 1999 (UNAUDITED) - -------------------------------------------------------------------------------- INVESTMENT TRANSACTIONS Cost of purchases and proceeds from sales of securities, other than short-term securities, aggregated $350,988,737 and $74,148,245, respectively. INCOME TAX INFORMATION At March 31, 1999, the aggregated cost of investment securities for federal income tax purposes was $312,006,999. Net unrealized appreciation aggregated $22,293,574, of which $30,714,052 related to appreciated investment securities and $8,420,478 related to depreciated investment securities. SEE NOTES TO FINANCIAL STATEMENTS. 48 MENTOR BALANCED PORTFOLIO - -------------------------------------------------------------------------------- STATEMENT OF ASSETS AND LIABILITIES MARCH 31, 1999 (UNAUDITED) ASSETS Investments, at market value (Note 2) Investment securities $313,364,559 Repurchase agreements 20,936,014 ------------ Total investments (cost $312,006,999) 334,300,573 Collateral for securities loaned (Note 2) 87,189,594 Receivables Investments sold 1,002,666 Fund shares sold 4,851,369 Dividends and interest 2,689,063 Variation margin (Note 2) 366,563 Other 2,495 Prepaid expense 140,000 ------------ TOTAL ASSETS 430,542,323 ------------ LIABILITIES Investments purchased $1,514,077 Securities loaned (Note 2) 87,189,594 Fund shares redeemed 535,285 Accrued expenses and other liabilities 9,801 ---------- TOTAL LIABILITIES 89,248,757 ------------ NET ASSETS $341,293,566 ============ Net Assets represented by: (Note 2) Additional paid-in capital $312,761,476 Accumulated undistributed net investment loss (210,671) Accumulated net realized gain on investment transactions 3,689,030 Net unrealized appreciation of investments 25,053,731 ------------ NET ASSETS $341,293,566 ============ NET ASSET VALUE PER SHARE Class A Shares $ 15.17 Class B Shares $ 15.16 Class Y Shares $ 15.16 OFFERING PRICE PER SHARE Class A Shares $ 16.10(a) Class B Shares $ 15.16 Class Y Shares $ 15.16 SHARES OUTSTANDING Class A Shares 7,538,584 Class B Shares 14,958,738 Class Y Shares 13,189
(a) Computation of offering price: 100/94.25 of net asset value. SEE NOTES TO FINANCIAL STATEMENTS. STATEMENT OF OPERATIONS SIX MONTHS ENDED MARCH 31, 1999 (UNAUDITED) INVESTMENT INCOME Dividends $ 810,724 Interest net of premium 2,879,894 ----------- TOTAL INVESTMENT INCOME (NOTE 2) 3,690,618 EXPENSES Management fee (Note 4) $ 871,032 Distribution fee (Note 5) 631,992 Shareholder service fee (Note 5) 288,984 Transfer agent fee 169,791 Administration fee (Note 4) 116,138 Registration expenses 55,851 Shareholder reports and postage expenses 52,503 Custodian and accounting fees 39,139 Legal fees 5,855 Audit fees 4,116 Directors' fees and expenses 3,041 Miscellaneous 5,139 ---------- Total expenses 2,243,581 ----------- NET INVESTMENT INCOME 1,447,037 ----------- REALIZED AND UNREALIZED GAIN ON INVESTMENTS Net realized gain on investments (Note 2) 4,564,399 Change in unrealized appreciation (depreciation) on investments 24,850,706 ---------- NET GAIN ON INVESTMENTS 29,415,105 ----------- NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $30,862,142 ===========
SEE NOTES TO FINANCIAL STATEMENTS. 49 MENTOR BALANCED PORTFOLIO - -------------------------------------------------------------------------------- STATEMENTS OF CHANGES IN NET ASSETS
SIX MONTHS ENDED 3/31/99 YEAR ENDED (UNAUDITED) 9/30/98 NET INCREASE IN NET ASSETS Operations Net investment income $ 1,447,037 $ 110,202 Net realized gain on investments 4,564,399 822,291 Change in unrealized appreciation (depreciation) on investments 24,850,706 (583,942) ------------- ------------ Increase in net assets resulting from operations 30,862,142 348,551 ------------- ------------ Distributions to Shareholders From net investment income Class A (630,596) -- Class B (1,044,583) -- Class Y (788) (159,807) From net realized gain on investments Class A (207,511) -- Class B (736,229) -- Class Y (655) (1,140,442) ------------- ------------ Total distributions to shareholders (2,620,362) (1,300,249) ------------- ------------ Capital Share Transactions (Note 7) Proceeds from sale of shares 327,679,217 9,280,672 Reinvested distributions 2,518,683 1,300,249 Shares redeemed (29,967,087) (910,125) ------------- ------------ Change in net assets resulting from capital share transactions 300,230,813 9,670,796 ------------- ------------ Increase in net assets 328,472,593 8,719,098 Net Assets Beginning of period 12,820,973 4,101,875 ------------- ------------ End of period (including accumulated undistributed net investement income of ($210,671) and $18,259, respectively) $ 341,293,566 $ 12,820,973 ============= ============
SEE NOTES TO FINANCIAL STATEMENTS. 50 MENTOR BALANCED PORTFOLIO - -------------------------------------------------------------------------------- FINANCIAL HIGHLIGHTS CLASS A SHARES (B)
SIX MONTHS YEAR YEAR ENDED 3/31/99 ENDED ENDED (UNAUDITED) 9/30/98 9/30/97 PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 13.69 $ 17.61 $ 16.28 --------- ------- ------- Income from investment operations Net investment income 0.04 0.47 0.43 Net realized and unrealized gain (loss) on investments 1.59 1.41 3.35 --------- ------- ------- Total from investment operations 1.63 1.88 3.78 --------- ------- ------- Less distributions From net investment income ( 0.10) ( 0.71) ( 0.43) From net realized capital gain ( 0.05) ( 5.09) ( 2.02) --------- -------- -------- Total distributions ( 0.15) ( 5.80) ( 2.45) --------- -------- -------- Net asset value, end of period $ 15.17 $ 13.69 $ 17.61 ========= ======== ======== TOTAL RETURN* 11.93% 11.86% 26.09% RATIOS / SUPPLEMENTAL DATA Net assets, end of period (in thousands) $ 114,384 $ 3,534 $ 4,102 Ratio of expenses to average net assets 1.37%(a) 0.36% 0.50% Ratio of expenses to average net assets excluding waiver 1.37%(a) 1.56% 2.13% Ratio of net investment income to average net assets 1.75%(a) 1.99% 2.78% Portfolio turnover rate 35% 89% 80% YEAR PERIOD PERIOD ENDED ENDED ENDED 9/30/96 9/30/95 (C) 12/31/94 (D) PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 14.85 $ 12.44 $ 12.50 ------- --------- --------- Income from investment operations Net investment income 0.42 0.36 0.22 Net realized and unrealized gain (loss) on investments 2.09 2.08 ( 0.09) ------- --------- --------- Total from investment operations 2.51 2.44 0.13 ------- --------- --------- Less distributions From net investment income ( 0.48) ( 0.03) ( 0.19) From net realized capital gain ( 0.60) -- -- -------- --------- --------- Total distributions ( 1.08) ( 0.03) ( 0.19) -------- --------- --------- Net asset value, end of period $ 16.28 $ 14.85 $ 12.44 ======== ========= ========= TOTAL RETURN* 18.00% 19.28% 1.00% RATIOS / SUPPLEMENTAL DATA Net assets, end of period (in thousands) $ 3,825 $ 3,210 $ 2,911 Ratio of expenses to average net assets 0.50% 0.50%(a) 0.50%(a) Ratio of expenses to average net assets excluding waiver 2.06% 2.12%(a) 2.72%(a) Ratio of net investment income to average net assets 2.83% 3.26%(a) 3.32%(a) Portfolio turnover rate 103% 65% 71%
(a) Annualized. (b) Prior to September 16, 1998, all shareholders of the Balanced Portfolio were Class A shareholders. On September 16, 1998, shares of Class A were converted to Class Y shares. (c) For the period from January 1, 1995 to September 30, 1995. (d) For the period from June 21, 1994 (commencement of operations) to December 31, 1994. * Total return does not reflect sales commissions and is not annualized. SEE NOTES TO FINANCIAL STATEMENTS. FINANCIAL HIGHLIGHTS CLASS B SHARES
SIX MONTHS PERIOD ENDED 3/31/99 ENDED (UNAUDITED) 9/30/98 (E) PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 13.69 $ 13.69 -------- -------- Income from investment operations Net investment income 0.06 -- Net realized and unrealized gain on investments 1.53 -- -------- -------- Total from investment operations 1.59 -- -------- -------- Less distributions From net investment income ( 0.07) -- From net realized capital gain ( 0.05) -- -------- -------- Total distributions ( 0.12) -- -------- -------- Net asset value, end of period $ 15.16 $ 13.69 ======== ======== TOTAL RETURN* 11.63% 0.00% RATIOS / SUPPLEMENTAL DATA Net assets, end of period (in thousands) $226,710 $ 5,645 Ratio of expenses to average net assets 2.12%(a) 1.50%(a) Ratio of expenses to average net assets excluding waiver 2.12%(a) 1.50%(a) Ratio of net investment income to average net assets 0.99%(a) 0.42%(a) Portfolio turnover rate 35% 89%
(a) Annualized. (e) For the period from September 16, 1998 (initial offering of Class B) to September 30, 1998. * Total return does not reflect sales commissions and is not annualized. SEE NOTES TO FINANCIAL STATEMENTS. 51 MENTOR BALANCED PORTFOLIO - -------------------------------------------------------------------------------- FINANCIAL HIGHLIGHTS CLASS Y SHARES (G)
SIX MONTHS PERIOD ENDED 3/31/99 ENDED (UNAUDITED) 9/30/98 (F) PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 13.69 $ 13.69 -------- --------- Income from investment operations Net investment income 0.97 0.01 Net realized and unrealized gain (loss) on investments 0.61 ( 0.01) -------- --------- Total from investment operations 1.58 -- -------- --------- Less distributions From net investment income ( 0.06) -- From net realized capital gain ( 0.05) -- -------- --------- Total distributions ( 0.11) -- -------- --------- Net asset value, end of period $ 15.16 $ 13.69 ======== ========= TOTAL RETURN* 11.57% 0.00% RATIOS / SUPPLEMENTAL DATA Net assets, end of period (in thousands) $ 200 $ 3,642 Ratio of expenses to average net assets 1.12%(a) 1.10% (a) Ratio of net investment income to average net assets 1.75%(a) 2.32% (a) Portfolio turnover rate 35% 89%
(a) Annualized. (f) For the period from September 16, 1998 (initial offering of Class Y) to September 30, 1998. (g) Prior to September 16, 1998, all shareholders of the Balanced Portfolio were Class A shareholders. On September 16, 1998, shares of Class A were converted to Class Y shares. * Total return does not reflect sales commissions and is not annualized. SEE NOTES TO FINANCIAL STATEMSNTS. 52 MENTOR MUNICIPAL INCOME PORTFOLIO MANAGERS' COMMENTARY: THE MUNICIPAL INCOME PORTFOLIO MARCH 31, 1999 - -------------------------------------------------------------------------------- MARKET REVIEW Although most of the financial markets experienced significant volatility over the six-month period ending March 31, 1999 the municipal market remained relatively stable. For the majority of the six months, long-term municipal bond yields stayed within a range of 5.20 to 5.40 percent, even as the Federal Reserve cut interest rates and the 30-year U.S. Treasury bond reached its lowest yield on record. In large part, this stability in tax-exempt rates can be attributed to the municipal market's isolation from turbulence abroad. Concerns about the financial conditions in Asia and Latin America hurt the stock and high-yield bond markets last fall, but had little effect on municipals. The positive domestic economic and market conditions encouraged more municipalities to take advantage of low interest rates and issue new bonds. In 1998, we experienced the second-highest level of municipal issuance in history. Although the volume of municipal debt increased, the credit quality of most issuers was not compromised -- in fact, it improved as the positive economic environment led to stronger balance sheets. As a result, we saw a larger number of issuers financing special growth and expansion projects, as opposed to using municipal bonds to finance their regular operations. The proportion of higher-yielding municipal bonds also increased during the period as the percentage of insured bonds declined slightly. Because bond insurers tightened their underwriting criteria, more issuers came to market without insurance. As a result, these bonds offered higher yields to compensate investors for the increased credit risk. This benefited the Portfolio because it allowed our experienced research staff to seek out those higher-yielding bonds that we felt had strong underlying quality. Toward the end of 1998, the yields on 30-year insured municipal bonds and comparable U.S. Treasury bonds were equal -- something that rarely occurs. Typically, investment-grade municipal bonds offer about 80 to 90 percent as much yield as comparable Treasury bonds because their interest payments are exempt from federal income taxes. However, as Treasury yields fell and municipal yields remained stable during the reporting period, the yield difference between the two types of bonds compressed and municipal yields became very attractive. Early in 1999, investors realized the tremendous opportunities available in the municipal market, and demand for municipals began to increase. In conjunction with a recent slowdown in supply, this boost in municipal demand pushed the municipal-to-Treasury yield ratio back to more traditional but still attractive levels. MANAGEMENT STRATEGY During the reporting period, we focused on the insured sector of the market, increasing our exposure to triple-A rated securities by nearly five percent. Although the percentage of insured issuance dropped slightly, we found a good selection of securities from which to choose. We also selectively purchased several positions of non-rated and lower-rated securities that help support the Portfolio's dividend. Regarding specific sector exposure, we have become more cautious with respect to health care and the electric utility industries. Although many health care bonds remain attractive, the challenges imposed by managed care and changing Medicare 53 MENTOR MUNICIPAL INCOME PORTFOLIO MANAGERS' COMMENTARY: THE MUNICIPAL INCOME PORTFOLIO MARCH 31, 1999 - -------------------------------------------------------------------------------- reimbursement policies have put financial pressures on an increasing number of medical facilities. Due to deregulation as well as problems at specific utility plants, this sector is also experiencing some weakness. As a result, we are modestly decreasing our exposure to both sectors. Many purchases were bonds with maturities in the intermediate range of the yield curve as we felt they offered the most value compared to other maturity ranges. By purchasing securities in the 10 to 20 year maturity range rather than longer term securities, we were able to add almost as much yield with significantly less volatility. We also looked for areas of the municipal marketplace where a heavy issuance caused bond prices to be temporarily reduced. For example, smaller states often do not have enough instate demand to absorb a large volume of new bond issuance immediately. We took advantage of those situations to purchase bonds at what we felt were below-market prices and then sold them when prices had risen. PERFORMANCE REVIEW For the six-month period ending March 31, 1999 the Mentor Municipal Income Portfolio A shares returned 0.52% compared to 1.49% for its Lehman Brothers Municipal Bond Index benchmark. MARKET OUTLOOK Strong economic performance continues to bolster the credit conditions of municipal issuers -- a trend we expect to continue. As we mentioned earlier, economic strength has made issuers more likely to issue debt for special projects rather than for general operating financing. We believe that as long as municipalities remain economically healthy, this situation is likely to continue. Although insured debt has been increasing in recent years, we have started to see a reversal of this trend, as municipal bond insurers have become more cautious. If, as anticipated, this caution continues, credit spreads may widen as the proportion of higher-yielding uninsured bonds increases. Inflation remains low, so we don't foresee any significant increase in interest rates in the near term -- a favorable situation for bond prices. Because we don't expect interest rates to rise in the near term, we believe the supply of municipal debt will be lower than last year's, helping to restore the price relationship between municipals and Treasuries to more traditional levels. Finally, we see the potential for changes in traditional economic activity toward the end of the year because of investor concerns about the Year 2000 computer problem. These temporary concerns, however, may result in attractive investment opportunities that our research staff can explore to uncover value. 54 MENTOR MUNICIPAL INCOME PORTFOLIO MARCH 31, 1999 - -------------------------------------------------------------------------------- PERFORMANCE COMPARISON Comparison of change in value of a hypothetical $10,000 purchase in Mentor Municipal Income Portfolio Class A and Class B Shares and Lehman Municipal Bond Index.- [GRAPH]
4/29/92 9/30/92 9/30/93 9/30/94 9/30/95 9/30/96 9/30/97 9/30/98 3/31/99 Class A Shares(double dagger) 9,525 10,034 11,637 11,101 12,151 12,935 14,085 15,245 15,324 Class B Shares(dagger) 10,000 10,528 12,134 11,511 12,348 13,184 14,291 15,289 15,338 Lehman Municipal Bond Index~ 10,000 10,561 11,906 11,616 12,916 13,818 14,933 16,232 16,475
Average Annual Returns as of 3/31/99 Including Sales Charges 1-Year 5-Year Since Inception* Class A (0.33%) 5.89% 6.36% Class B 3.10% 6.38% 6.58% PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE PERFORMANCE. YOUR INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO WHEN SHARES ARE REDEEMED, THEY MAY BE WORTH MORE OR LESS THAN ORIGINAL COST. MUTUAL FUNDS ARE NOT OBLIGATIONS OF OR GUARANTEED BY ANY BANK AND ARE NOT FEDERALLY INSURED. ~ The Lehman Municipal Bond Index is adjusted to reflect reinvestment of interests on securities in the index. The Lehman Municipal Bond Index is not adjusted to reflect sales loads, expenses, or other fees that the SEC requires to be reflected in the Portfolio's performance. + Represents a hypothetical investment of $10,000 in Mentor Municipal Income Portfolio Class B Shares. A contingent deferred sales charge will be imposed, if applicable, on Class B Shares at rates ranging from a maximum of 4.00% of amounts redeemed during the first year following the date of purchase to 1.00% of amounts redeemed during the six-year period following the date of purchase. The value of Class B Shares reflects a redemption fee in effect at the end of each stated periods. The Class B Shares' performance assumes the reinvestment of all dividends and distributions. ++ Represents a hypothetical investment of $10,000 in Mentor Municipal Income Portfolio Class A Shares, after deducting the maximum sales charge of 4.75% ($10,000 investment minus $475 sales charge = $9,525). The Class A Shares' performance assumes the reinvestment of all dividends and distributions. * Reflects operations of Mentor Municipal Income Portfolio Class A and Class B Shares from the date of commencement of operations on 4/29/92 through 3/31/99. Comparison of change in value of a hypothetical $10,000 purchase in Mentor Municipal Income Portfolio Class Y Shares and Lehman Municipal Bond Index.- [GRAPH]
11/19/97 12/31/97 3/31/98 6/30/98 9/30/98 3/31/99 Class Y Shares(triple dagger) 10,000 10,147 10,263 10,390 10,689 10,763 Lehman Municipal Bond Index~ 10,000 10,206 10,323 10,490 10,802 10,963
Total Returns as of 3/31/99 1-Year Since Inception* Class Y 4.87% 6.00% PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE PERFORMANCE. YOUR INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO WHEN SHARES ARE REDEEMED, THEY MAY BE WORTH MORE OR LESS THAN ORIGINAL COST. MUTUAL FUNDS ARE NOT OBLIGATIONS OF OR GUARANTEED BY ANY BANK AND ARE NOT FEDERALLY INSURED. - The Lehman Municipal Bond Index is adjusted to reflect reinvestment of interests on securities in the index. The Lehman Municipal Bond Index is not adjusted to reflect sales loads, expenses, or other fees that the SEC requires to be reflected in the Portfolio's performance. +++ Represents a hypothetical investment of $10,000 in Mentor Municipal Income Portfolio Class Y Shares. These shares are not subject to any sales or contingent deferred sales charges. The Class Y Shares' performance assumes the reinvestment of all dividends and distributions. ** Reflects operations of Mentor Municipal Income Portfolio Class Y Shares from the date of issuance on 11/19/97 through 3/31/99. 55 MENTOR MUNICIPAL INCOME PORTFOLIO PORTFOLIO OF INVESTMENTS MARCH 31, 1999 (UNAUDITED) - --------------------------------------------------------------------------------
PRINCIPAL AMOUNT MARKET VALUE LONG-TERM MUNICIPAL SECURITIES - 98.38% ALABAMA - 6.15% Birmingham, Alabama Water & Sewer Revenue, 4.75%, 1/01/29 $1,000,000 $ 930,030 Montgomery, Alabama Special Care Facilities, 5.00%, 11/15/25 7,500,000 7,221,000 ---------- 8,151,030 ---------- ARIZONA - 1.20% Pima County, Arizona IDA, 7.25%, 7/15/10 1,430,000 1,582,939 ---------- CALIFORNIA - 6.44% Alameda Corridor Transportation, (effective yield-1.00%) (a), 10/01/30 2,000,000 389,360 California Statewide Community Development Authority, 5.63%, 10/01/34 2,070,000 2,125,662 Carson Improvement Board Act 1915, Special Assessment District 1992, 7.38%, 9/02/22 700,000 758,835 East Bay Municipal Utility District, 4.75%, 6/01/21 1,915,000 1,840,009 Orange County Community Facilities District Series A, 7.35%, 8/15/18 300,000 341,706 San Francisco City & County Airport, 6.30%, 5/01/25 1,000,000 1,101,110 University of California Revenue, 4.75%, 9/01/16 2,000,000 1,977,740 ---------- 8,534,422 ---------- COLORADO - 2.61% Colorado Housing Authority, 7.00%, 11/01/24 475,000 514,083 Denver City & County Airport Revenue, 7.75% - 8.50%, 11/15/13 - 11/15/23 2,555,000 2,938,480 ---------- 3,452,563 ---------- CONNECTICUT - 0.82% Connecticut State Development Authority, 6.15%, 4/01/35 1,000,000 1,085,430 ---------- DISTRICT OF COLUMBIA - 0.66% Metropolitan Washington, General Airport Revenue Series A, 6.63%, 10/01/19 800,000 876,784 ---------- FLORIDA - 3.95% Governmental Utilities Authority Utility Revenue, 5.00%, 10/01/29 2,453,900 2,453,865
PRINCIPAL AMOUNT MARKET VALUE LONG-TERM MUNICIPAL SECURITIES (CONTINUED) FLORIDA (CONTINUED) Hillsborough County, 6.25%, 12/01/34 $1,250,000 $1,381,988 Sarasota County Health Facilities Authority Revenue, 10.00%, 7/01/22 1,160,000 1,391,768 ---------- 5,227,621 ---------- GEORGIA - 4.11% Fulton County Georgia Housing Authority, Housing Revenue, 6.38%, 2/01/08 520,000 525,184 Fulton County Georgia Water & Sewer Revenue, 4.75%, 1/01/28 2,350,000 2,224,769 George Smith World Congress Center, 5.50%, 7/01/20 1,500,000 1,507,695 Monroe County Development Authority PCRB, 6.75%, 1/01/10 1,000,000 1,174,600 ---------- 5,432,248 ---------- ILLINOIS - 10.83% Broadview Tax Increment Revenue, 8.25%, 7/01/13 1,000,000 1,127,790 Chicago Capital Appreciation, (effective yield-2.09%) (a), 7/01/16) 2,000,000 766,520 Chicago Heights Residential Mortgage, (effective yield-3.42%) (a), 6/01/09 3,175,000 1,558,989 Chicago School Reform Board Series A, 5.50%, 12/01/26 2,000,000 2,125,480 Chicago State University Revenue, 5.50%, 12/01/23 1,000,000 1,060,800 Illinois Development Finance Authority Revenue, 5.70%, 1/01/18 1,680,000 1,822,951 Illinois Health Facilities Authority Revenue, 5.50% - 9.50%, 11/15/19 - 10/01/22 2,250,000 2,456,200 Kane County School District No. 129, 5.50%, 2/01/11 2,000,000 2,121,120 Metropolitan Pier & Exposition, (effective yield-1.44%) (a), 6/15/21 1,950,000 616,434 Saint Clair County Public Building, (effective yield-2.06%) (a), 12/01/16 1,650,000 670,807 ---------- 14,327,091 ----------
56 MENTOR MUNICIPAL INCOME PORTFOLIO PORTFOLIO OF INVESTMENTS MARCH 31, 1999 (UNAUDITED) - --------------------------------------------------------------------------------
PRINCIPAL AMOUNT MARKET VALUE LONG-TERM MUNICIPAL SECURITIES (CONTINUED) INDIANA - 2.55% Fort Wayne, Indiana Hospital Authority Revenue, 4.75%, 11/15/28 $3,250,000 $2,986,425 Indiana Transportation Finance Authority Series A, (effective yield-1.99%) (a), 6/01/17 1,000,000 394,230 ---------- 3,380,655 ---------- IOWA - 0.50% Student Loan Liquidity Corporation, Student Loan Revenue Series C, 6.95%, 3/01/06 625,000 664,888 ---------- KANSAS - 0.74% Wyandotte County Kansas City Utility Revenue, 4.30%, 9/01/10 1,000,000 981,650 ---------- KENTUCKY - 1.60% Jefferson County Hospital Revenue, 8.92%, 10/01/08 (b) 500,000 590,625 Kenton County Airport Board Revenue, 7.50%, 2/01/20 1,400,000 1,524,936 ---------- 2,115,561 ---------- LOUISIANA - 4.90% Louisiana Public Facilities Authority Revenue, Dillard University-Louisiana, 5.00%, 2/01/28 2,750,000 2,690,215 Louisiana State University & Agriculture and Mechanical College, University Revenues, 5.00%, 10/01/30 1,000,000 972,950 New Orleans, Louisiana, 4.75%, 12/01/26 3,000,000 2,821,740 ---------- 6,484,905 ---------- MAINE - 0.72% Maine State Housing Authority Series C, 6.88%, 11/15/23 885,000 959,676 ---------- MARYLAND - 0.67% Baltimore Series B, 4.25%, 10/01/09 900,000 891,360 ---------- MASSACHUSETTS - 1.59% Massachusetts State Health and Education, 6.00%, 10/01/23 1,000,000 997,450
PRINCIPAL AMOUNT MARKET VALUE LONG-TERM MUNICIPAL SECURITIES (CONTINUED) MASSACHUSETTS (CONTINUED) Massachusetts State Health and Educational Facilities Authority, OID Revenue Bonds Series A, 6.88%, 4/01/22 $1,000,000 $1,106,840 ---------- 2,104,290 ---------- MICHIGAN - 0.69% Michigan State Hospital Financial Authority Revenue, 5.25%, 8/15/28 1,000,000 909,730 ---------- MINNESOTA - 0.38% Dakota County Housing & Redevelopment Authority Multifamily Housing Revenue, 6.25%, 5/01/29 500,000 500,000 ---------- MISSISSIPPI - 0.75% Municipal Facility Authority Natural Gas Project, 4.13%, 1/01/07 1,000,000 989,160 ---------- MISSOURI - 1.47% Missouri State Health & Educational Facilities Revenue, 5.00%, 5/15/28 1,000,000 960,690 Ozarks Tech Community College Project, 5.00%, 3/01/19 1,000,000 986,920 ---------- 1,947,610 ---------- NEBRASKA - 1.75% Nebraska Investment Finance Authority, SFM, 9.42%, 9/15/24 (b) 280,000 312,200 Nebraska Public Gas Agency, Gas Supply System, 5.00%, 4/01/00 1,000,000 1,014,520 Omaha Nebraska Airport Authority Revenue, 4.20%, 1/01/07 1,000,000 992,310 ---------- 2,319,030 ---------- NEVADA - 1.87% Clark County, 5.90%, 10/01/30 2,000,000 2,042,840 Henderson Local Improvement District, Special Assessment Series A, 8.50%, 11/01/12 415,000 439,755 ---------- 2,482,595 ----------
57 MENTOR MUNICIPAL INCOME PORTFOLIO PORTFOLIO OF INVESTMENTS MARCH 31, 1999 (UNAUDITED) - --------------------------------------------------------------------------------
PRINCIPAL AMOUNT MARKET VALUE LONG-TERM MUNICIPAL SECURITIES (CONTINUED) NEW JERSEY - 1.77% East Orange County Board of Education, (effective rate-1.75%) (a) 2/01/20 $1,000,000 $ 348,810 New Jersey Economic Development Authority Revenue, 6.00%, 5/15/28 1,000,000 978,380 Ocean County Utilities Authority, 4.00%, 1/01/08 1,040,000 1,022,975 --------- 2,350,165 --------- NEW MEXICO - 1.87% New Mexico State Hospital Equipment Lane Council, 5.50%, 6/01/28 1,500,000 1,469,985 Santa Fe Educational Facilities Revenue, 5.50%, 3/01/24 1,000,000 1,001,000 --------- 2,470,985 --------- NEW YORK - 5.56% Clifton Springs Hospital Refunding & Improvement, 8.00%, 1/01/20 625,000 685,462 Metropolitan Transportation Authority, 4.75%, 7/01/19 1,000,000 935,070 New York State Dormitory Authority Revenue Hospital, WYCKOFF, 5.20%, 2/15/14 1,000,000 1,013,790 New York Series H, 7.20%, 2/01/13 1,500,000 1,656,973 New York Series F - Ambac TCRS, 5.25%, 8/01/14 2,000,000 2,074,340 Suffolk County Industrial Development Agency 4.25%, 2/01/07 1,000,000 1,002,270 --------- 7,367,905 --------- NORTH CAROLINA - 1.91% North Carolina Eastern Municipal Power Agency Systems Revenue, 5.70%, 1/01/13 1,000,000 1,077,170 Sampson Area Development Corporation, 4.70%, 6/01/14 1,500,000 1,455,565 --------- 2,532,735 --------- NORTH DAKOTA - 0.74% Devils Lake Health Care, 6.10%, 10/01/23 1,000,000 983,160 --------- OHIO - 3.91% Batavia Local School District Reference, 5.63%, 12/01/22 1,000,000 1,080,980
PRINCIPAL AMOUNT MARKET VALUE LONG-TERM MUNICIPAL SECURITIES (CONTINUED) OHIO (CONTINUED) Canton, Ohio Pension Reference, 4.75%, 12/01/18 $1,000,000 $ 973,140 Cleveland, Ohio, 4.50%, 10/01/12 1,015,000 996,364 Cuyahoga County Health Care Facilities, 5.50%, 12/01/28 1,000,000 985,530 Ohio University General Receipts, 4.60%, 12/01/11 1,145,000 1,142,859 --------- 5,178,873 --------- OKLAHOMA - 0.41% Oklahoma City Industrial and Cultural Facilities Trust, 6.75%, 9/15/17 540,000 546,804 --------- PENNSYLVANIA - 1.28% Pennsylvania Economic Development, 6.40%, 1/01/09 500,000 524,605 Philadelphia Hospital and Higher Education Facilities, 6.50%, 11/15/08 1,075,000 1,171,008 --------- 1,695,613 --------- RHODE ISLAND - 0.26% West Warwick, Series A, GO Bonds, 7.30%, 7/15/08 310,000 345,002 --------- TENNESSEE - 3.62% Chattanooga, Tennessee Health Educational & Housing Facility, 5.00%, 12/01/28 1,500,000 1,440,555 Memphis Shelby County Airport Authority Special Facilities Revenue Refunding, 7.88%, 9/01/09 1,500,000 1,654,485 Metropolitan Government, Nashville & Davidson County, 4.75% - 5.00%, 1/01/22 - 10/01/28 250,000 244,900 Municipal Energy Corporation, Tennessee Gas, 4.13%, 3/01/09 1,500,000 1,455,930 --------- 4,795,870 --------- TEXAS - 9.06% Abilene Health Facilities Development Corporation, 5.90%, 11/15/25 1,000,000 966,740 Alliance Airport Authority, 6.38%, 4/01/21 2,000,000 2,161,280 Brazos Higher Education Authority Student Loan Revenue, 7.10%, 11/01/04 416,000 465,462
58 MENTOR MUNICIPAL INCOME PORTFOLIO PORTFOLIO OF INVESTMENTS MARCH 31, 1999 (UNAUDITED) - --------------------------------------------------------------------------------
PRINCIPAL AMOUNT MARKET VALUE LONG-TERM MUNICIPAL SECURITIES (CONTINUED) TEXAS (CONTINUED) Brazos River Authority Revenue, 4.90%, 10/01/15 $2,000,000 $ 2,016,940 Dallas Fort Worth International Airport Facility Revenue Bonds, 7.25%, 11/01/30 1,000,000 1,096,770 Houston, Texas School District, 4.75%, 2/15/26 1,500,000 1,412,085 Lufkin Health Memorial East Texas, 5.70%, 2/15/28 1,000,000 994,730 Matagorda County Revenue, 5.13%, 11/01/28 2,000,000 1,978,860 Texas State Department of Housing and Community Affairs Refunding, Series C, 10.12%, 7/02/24 (b) 750,000 907,500 ----------- 12,000,367 ----------- UTAH - 2.53% Bountiful Hospital Revenue, 9.50%, 12/15/18 230,000 294,633 Intermountain Power Agency Power Supply, 5.00%, 7/01/19 2,500,000 2,463,800 Utah State Housing Finance Agency, 7.20%, 1/01/27 585,000 596,998 ----------- 3,355,431 ----------- WASHINGTON - 1.41% Central Puget Sound Water Regional Transportation, 4.75%, 2/01/28 2,000,000 1,869,000 ----------- WEST VIRGINIA - 2.96% Harrison County, 6.75%, 8/01/24 2,000,000 2,244,180 West Virginia State Hospital Finance Authority Revenue, 9.70%, 1/01/18 (b) 1,500,000 1,681,005 ----------- 3,925,185 ----------- WISCONSIN - 4.14% Southeast Wisconsin Professional Baseball, 5.50%, 12/15/26 2,000,000 2,141,080 Wisconsin State Health & Educational Facility Authority Revenues, 4.75% - 5.50%, 2/15/28 - 6/01/28 3,500,000 3,342,325 ----------- 5,483,405 ----------- TOTAL LONG-TERM MUNICIPAL SECURITIES (COST $ 125,609,460) 130,301,738 -----------
PRINCIPAL AMOUNT MARKET VALUE SHORT-TERM MUNICIPAL SECURITIES - 5.21% MISSOURI - 1.13% Kansas City, Missouri Individual Development, 5.00%, 10/15/14 (c) $1,500,000 $ 1,500,000 ------------ NEW YORK - 1.66% New York State Energy Research & Development, 5.00%, 7/01/15 (c) 1,700,000 1,700,000 City of New York A-7, 5.00%, 10/01/22 (c) 500,000 500,000 ------------ 2,200,000 ------------ TEXAS - 1.74% Harris County, Texas Health Facilities, 5.00%, 2/15/27 (c) 2,300,000 2,300,000 ------------ WASHINGTON - 0.68% Washington Health Care, Sisters of Providence Series I, 4.05%, 10/01/05 (c) 900,000 900,000 ------------ TOTAL SHORT-TERM MUNICIPAL SECURITIES (COST $ 6,900,000) 6,900,000 ------------ TOTAL INVESTMENTS (COST $ 132,509,460)-103.59% 137,201,738 OTHER ASSETS LESS LIABILITIES - (3.59%) (4,751,557) ------------ NET ASSETS - 100.00% $132,450,181 ============
INVESTMENT ABBREVIATIONS GO - General Obligation IDA - Industrial Development Authority OID - Original Issue Discount PCRB - Pollution Control Revenue Bond SFM - Single Family Mortgage VRDN - Variable Rate Demand Note (a) Effective yield is the yield as calculated at time of purchase at which the bond accretes on an annual basis until its maturity date. (b) Represents inverse floating rate securities. (c) Floating Rate Securities - The rates shown are the effective rates at March 31, 1999. * Certain of these securities are used as collateral for options written contracts. 59 MENTOR MUNICIPAL INCOME PORTFOLIO PORTFOLIO OF INVESTMENTS MARCH 31, 1999 (UNAUDITED) - -------------------------------------------------------------------------------- INVESTMENT TRANSACTIONS Cost of purchases and proceeds from sales of securities, other than short-term securities, aggregated $90,312,688 and $68,279,000, respectively. INCOME TAX INFORMATION At March 31, 1999, the aggregated cost of investment securities for federal income tax purposes was $132,509,460. Net unrealized depreciation aggregated $4,692,278, of which $5,127,601 related to appreciated investment securities and $435,323 related to depreciated investment securities. SEE NOTES TO FINANCIAL STATEMENTS. 60 MENTOR MUNICIPAL INCOME PORTFOLIO - -------------------------------------------------------------------------------- STATEMENT OF ASSETS AND LIABILITIES MARCH 31, 1999 (UNAUDITED) ASSETS Investments, at market value (cost $132,509,460) (Note 2) $137,201,738 Cash 62,828 Receivables Fund shares sold 1,859,153 Dividends and interest 2,036,819 Variation margin (Note 2) 60,938 ------------ TOTAL ASSETS 141,221,476 ------------ LIABILITIES Payables Investments purchased $7,967,465 Fund shares redeemed 317,601 Dividends 420,673 Accrued expenses and other liabilities 65,556 ---------- TOTAL LIABILITIES 8,771,295 ------------ NET ASSETS $132,450,181 ============ Net Assets represented by: (Note 2) Additional paid-in capital $129,086,452 Accumulated distributions in excess of net investment income (329,232) Accumulated net realized loss on investment transactions (1,046,267) Net unrealized appreciation of investments 4,739,228 ------------ NET ASSETS $132,450,181 ============ NET ASSET VALUE PER SHARE Class A Shares $ 15.73 Class B Shares $ 15.69 Class Y Shares $ 16.11 OFFERING PRICE PER SHARE Class A Shares $ 16.51(a) Class B Shares $ 15.69 Class Y Shares $ 16.11 SHARES OUTSTANDING Class A Shares 4,558,605 Class B Shares 3,869,243 Class Y Shares 67
(a) Computation of offering price: 100/95.25 of net asset value. SEE NOTES TO FINANCIAL STATEMENTS. STATEMENT OF OPERATIONS SIX MONTHS ENDED MARCH 31, 1999 (UNAUDITED) INVESTMENT INCOME Interest (Note 2) $3,296,816 ---------- EXPENSES Management fee (Note 4) $ 360,928 Shareholder service fee (Note 5) 150,385 Distribution fee (Note 5) 150,302 Administration fee (Note 4) 60,155 Transfer agent fee 53,330 Registration expenses 23,924 Custodian and accounting fees 21,040 Shareholder reports and postage expenses 11,834 Legal fees 2,909 Audit fees 2,045 Directors' fees and expenses 1,511 Miscellaneous 2,553 ---------- Total expenses 840,916 ---------- NET INVESTMENT INCOME 2,455,900 ---------- REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS, FUTURES AND OPTIONS CONTRACTS Net realized gain on investments, futures and options contracts (Note 2) 957,780 Change in unrealized appreciation (depreciation) on investments (2,882,930) ---------- NET LOSS ON INVESTMENTS, FUTURES AND OPTIONS CONTRACTS (1,925,150) ---------- NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $ 530,750 ==========
SEE NOTES TO FINANCIAL STATEMENTS. 61 MENTOR MUNICIPAL INCOME PORTFOLIO - -------------------------------------------------------------------------------- STATEMENTS OF CHANGES IN NET ASSETS
SIX MONTHS ENDED 3/31/99 YEAR ENDED (UNAUDITED) 9/30/98 NET INCREASE IN NET ASSETS Operations Net investment income $ 2,455,900 $ 4,054,279 Net realized gain (loss) on investments, futures and options contracts 957,780 (41,138) Change in unrealized appreciation (depreciation) on investments (2,882,930) 3,077,428 ------------ ------------- Increase in net assets resulting from operations 530,750 7,090,569 ------------ ------------- Distributions to Shareholders From net investment income Class A (1,293,015) (1,979,908) Class B (1,142,196) (2,308,071) Class Y -- (43) ------------ ------------- Total distributions to shareholders (2,435,211) (4,288,022) ------------ ------------- Capital Share Transactions (Note 7) Proceeds from sale of shares 30,176,197 45,477,369 Reinvested distributions 1,362,987 2,625,084 Shares redeemed (8,293,679) (13,461,719) ------------ ------------- Change in net assets resulting from capital share transactions 23,245,505 34,640,734 ------------ ------------- Increase in net assets 21,341,044 37,443,281 Net Assets Beginning of period 111,109,137 73,665,856 ------------ ------------- End of period (including accumulated distributions in excess of net investment income of ($329,232) and ($349,922), respectively) $132,450,181 $ 111,109,137 ============ =============
SEE NOTES TO FINANCIAL STATEMENTS. FINANCIAL HIGHLIGHTS CLASS A SHARES
SIX MONTHS ENDED YEAR 3/31/99 ENDED (UNAUDITED) 9/30/98 PER SHARE OPERATING PERFORMANCE Net asset value, beginning of year $ 15.99 $ 15.50 --------- ------- Income from investment operations Net investment income 0.35 0.66 Net realized and unrealized gain (loss) on investments ( 0.27) 0.59 --------- ------- Total from investment operations 0.08 1.25 --------- ------- Less distributions From net investment income ( 0.34) ( 0.76) From net realized capital gain -- -- --------- ------- Total distributions ( 0.34) ( 0.76) --------- ------- Net asset value, end of year $ 15.73 $ 15.99 ========= ======= TOTAL RETURN* 0.52% 8.24% RATIOS / SUPPLEMENTAL DATA Net assets, end of year (in thousands) $ 71,724 $51,757 Ratio of expenses to average net assets 1.14%(a) 1.17% Ratio of expenses to average net asset excluding waiver 1.14%(a) 1.17% Ratio of net investment income to average net assets 4.33%(a) 4.63% Portfolio turnover rate 56% 62% YEAR YEAR YEAR YEAR ENDED ENDED ENDED ENDED 9/30/97 9/30/96 9/30/95 9/30/94 PER SHARE OPERATING PERFORMANCE Net asset value, beginning of year $ 15.04 $ 14.92 $ 14.42 $ 16.05 ------- ------- ------- ------- Income from investment operations Net investment income 0.81 0.82 0.81 0.82 Net realized and unrealized gain (loss) on investments 0.49 0.12 0.51 ( 1.54) ------- ------- ------- ------- Total from investment operations 1.30 0.94 1.32 ( 0.72) ------- ------- ------- ------- Less distributions From net investment income ( 0.81) ( 0.82) ( 0.82) ( 0.81) From net realized capital gain ( 0.03) -- -- ( 0.10) ------- ------- ------- ------- Total distributions ( 0.84) ( 0.82) ( 0.82) ( 0.91) ------- ------- ------- ------- Net asset value, end of year $ 15.50 $ 15.04 $ 14.92 $ 14.42 ======= ======= ======= ======= TOTAL RETURN* 8.89% 6.46% 9.46% ( 4.83%) RATIOS / SUPPLEMENTAL DATA Net assets, end of year (in thousands) $29,394 $17,558 $20,460 $25,056 Ratio of expenses to average net assets 1.22% 1.24% 1.43% 1.24% Ratio of expenses to average net asset excluding waiver 1.22% 1.24% 1.43% 1.33% Ratio of net investment income to average net assets 5.09% 5.47% 5.56% 5.43% Portfolio turnover rate 59% 46% 43% 87%
(a) Annualized. * Total return does not reflect sales commissions and is not annualized. See notes to financial statements. SEE NOTES TO FINANCIAL STATEMENTS. 62 MENTOR MUNICIPAL INCOME PORTFOLIO - -------------------------------------------------------------------------------- FINANCIAL HIGHLIGHTS CLASS B SHARES
SIX MONTHS ENDED YEAR 3/31/99 ENDED (UNAUDITED) 9/30/98 PER SHARE OPERATING PERFORMANCE Net asset value, beginning of year $ 15.94 $ 15.49 --------- ------- Income from investment operations Net investment income 0.31 1.30 Net realized and unrealized gain (loss) on investments ( 0.26) ( 0.14) --------- ------- Total from investment operations 0.05 1.16 --------- ------- Less distributions From net investment income ( 0.30) ( 0.71) From net realized capital gain -- -- --------- ------- Total distributions ( 0.30) ( 0.71) --------- ------- Net asset value, end of year $ 15.69 $ 15.94 ========= ======= TOTAL RETURN* 0.32% 7.70% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (in thousands) $ 60,725 $59,351 Ratio of expenses to average net assets 1.65%(a) 1.67% Ratio of expenses to average net asset excluding waiver 1.65%(a) 1.67% Ratio of net investment income to average net assets 3.83%(a) 4.13% Portfolio turnover rate 56% 62% YEAR YEAR YEAR YEAR ENDED ENDED ENDED ENDED 9/30/97 9/30/96 9/30/95 9/30/94 PER SHARE OPERATING PERFORMANCE Net asset value, beginning of year $ 15.05 $ 14.95 $ 14.43 $ 16.06 ------- ------- ------- ------- Income from investment operations Net investment income 0.71 0.75 0.74 0.74 Net realized and unrealized gain (loss) on investments 0.52 0.11 0.52 ( 1.54) ------- ------- ------- ------- Total from investment operations 1.23 0.86 1.26 ( 0.80) ------- ------- ------- ------- Less distributions From net investment income ( 0.71) ( 0.76) ( 0.74) ( 0.73) From net realized capital gain ( 0.08) -- -- ( 0.10) ------- ------- ------- ------- Total distributions ( 0.79) ( 0.76) ( 0.74) ( 0.83) ------- ------- ------- ------- Net asset value, end of year $ 15.49 $ 15.05 $ 14.95 $ 14.43 ======= ======= ======= ======= TOTAL RETURN* 8.33% 5.87% 9.01% ( 5.34%) RATIOS/SUPPLEMENTAL DATA Net assets, end of year (in thousands) $44,272 $37,191 $39,493 $46,157 Ratio of expenses to average net assets 1.72% 1.74% 1.92% 1.74% Ratio of expenses to average net asset excluding waiver 1.72% 1.74% 1.92% 1.86% Ratio of net investment income to average net assets 4.60% 4.95% 5.07% 4.93% Portfolio turnover rate 59% 46% 43% 87%
(a) Annualized. * Total return does not reflect sales commissions and is not annualized. SEE NOTES TO FINANCIAL STATEMENTS. CLASS Y SHARES
SIX MONTHS ENDED PERIOD 3/31/99 ENDED (UNAUDITED) 9/30/98 (B) PER SHARE OPERATING PERFORMANCE NET ASSET VALUE, BEGINNING OF PERIOD $ 16.00 $ 15.51 -------- -------- Income from investment operations Net investment income 0.35 1.39 Net realized and unrealized loss on investments ( 0.24) ( 0.23) -------- -------- Total from investment operations 0.11 1.16 -------- -------- Less distributions From net investment income -- ( 0.67) -------- -------- Net asset value, end of period $ 16.11 $ 16.00 ======== ======== TOTAL RETURN* 0.69% 7.51% RATIOS / SUPPLEMENTAL DATA Net assets, end of period (in thousands) $ 1 $ 1 Ratio of expenses to average net assets 0.92%(a) 0.92%(a) Ratio of net investment income to average net assets 4.33%(a) 5.66%(a) Portfolio turnover rate 56% 62%
(a) Annualized. (b) For the period from November 19, 1997 (initial offering of Class Y shares) to September 30, 1998. * Total return does not reflect sales commissions and is not annualized. SEE NOTES TO FINANCIAL STATEMENTS. 63 MENTOR QUALITY INCOME PORTFOLIO MENTOR SHORT-DURATION INCOME PORTFOLIO MANAGERS' COMMENTARY: THE ACTIVE FIXED-INCOME MANAGEMENT TEAM MARCH 31, 1999 - -------------------------------------------------------------------------------- MARKET REVIEW The six-month period ending March 31, 1999 was not kind to the bond market. Treasury rates increased sharply, with the 2-year note climbing 71 basis points to 4.98% and the long bond rising 66 basis points to 5.62%. The market sold off in reaction to much stronger than anticipated economic growth during both the final quarter of 1998 and the first quarter of 1999. In early October of 1998, the stock market was weak, world markets were in turmoil and fears of global deflation were rampant. The crisis in world financial markets was prompted by Russia's default on its debt obligations, and was exacerbated by the bankruptcy of the highly leveraged investment firm Long Term Capital Management. Over the ensuing three-month period the Federal Reserve lowered the Federal Funds rate 0.75% in response to these alarming market conditions. Economists expected U.S. economic growth in 1999 to be significantly depressed by the severe shock that financial markets experienced during September and October. These forecasts for slower growth garnered support in early January when the Brazilian government was forced to devalue their currency, the real. The sudden drop in the value of the real implied that Brazil would suffer a fairly deep recession in 1999. In addition, the lower currency value has made American exports too expensive for Brazilian markets. Despite turmoil in financial markets and in Brazil, the much-anticipated slowdown in U.S. economic growth has yet to materialize. Indeed, economic growth in the final quarter of 1998 surged more than 6.0% on an annualized basis. Economic indicators for the first quarter of 1999 suggest that the economy has continued its robust growth into 1999. Some market observers are beginning to question the aggressiveness with which the Federal Reserve reacted to the market crisis in late 1998. These economists have gone so far as to suggest that the Fed should reverse course and raise rates in response to a potentially overheating American economy. The fear that the Federal Reserve may move to increase short-term borrowing rates prompted the bond market's severe price declines and interest rate increases during the first quarter of 1999. MANAGEMENT STRATEGY Portfolio durations were 5% to 10% longer than their benchmark indices at the beginning of 1999. This long duration tilt led to strong relative performance early in January as the bond market responded to the Brazilian devaluation. However, as economic data painted an ever-clearer picture of a robust U.S. economy, portfolio durations were cut back to approximately neutral levels. Sector allocations were heavily tilted toward spread product. Mortgage backed securities were particularly emphasized given their high yield and strong performance potential in a stable to rising rate environment. The stronger economic growth prompted an increased allocation to lower-rated corporate bonds, including high yield securities. Portfolio weightings in high yield were increased from roughly 5% to 10%. PERFORMANCE REVIEW Portfolio performance during the six-month period ending March 31, 1999 was superior to index objectives. Our mortgage overweight and our lower-rated corporate bond investments allowed our portfolios to outpace indices comprised of treasury obligations. For the period the Mentor 64 MENTOR QUALITY INCOME PORTFOLIO MENTOR SHORT-DURATION INCOME PORTFOLIO MANAGERS' COMMENTARY: THE ACTIVE FIXED-INCOME MANAGEMENT TEAM MARCH 31, 1999 - -------------------------------------------------------------------------------- Quality Income A share returned -1.16% compared to -2.76% for the Merrill Lynch 7-Year Treasury Index. The Mentor Short-Duration Income Portfolio A shares returned 0.83% for the period compared to 0.44% for the Merrill Lynch 3-Year Treasury Index. MARKET OUTLOOK Our long-term market outlook is for continued declines in inflation and therefore continued lower interest rates. This optimism is fueled by structural economic changes such as the Internet that offer the potential to substantially increase economic efficiency and reduce costs. In addition, the increasing productivity of the U.S. labor force suggests that the economy can grow faster than previously thought without generating inflationary pressures. However, short-term prospects for the bond market are less clear. The long-term picture for bonds has continued to improve in recent months. Brazil's currency devaluation has made their products extremely price competitive with U.S. made products. Since Brazil is the dominant economy in Latin America, their devaluation implies falling growth rates for every economy within the region. Lower growth in Latin America has coincided with slow growth in Europe. The introduction of a single currency across much of Europe, the euro, has yet to ignite economic growth in the region. Indeed, the newly created European central bank has repeatedly revised down its growth estimates for 1999, and is currently forecasting growth of little more than 2% for the year. Despite the good news for bonds overseas, domestic U.S. conditions continue to put upward pressure on interest rates. The U.S. economy has repeatedly defied predictions of an imminent slowdown. With unemployment as of March hitting 4.2%, inflation fears are mounting. Despite these fears, most broad measures of inflation have continued to trend downward. This combination of robust economic growth and benign inflation is almost unprecedented. As a result, the Federal Reserve is examining whether old models of the growth and inflation trade-off accurately describe the new American economy. Although the Federal Reserve is considering whether or not the U.S. has entered a new economic era, market participants are understandably reluctant to gamble on such theoretical notions. Without some evidence of slowing economic growth, the bond market is likely to at best trade within a fairly narrow range around current interest rate levels and at worst could continue to decline somewhat. Given that no signs of a slacking in economic activity are yet apparent, we are anticipating a range-bound market in the weeks and months ahead. In such an environment our overweight position in mortgage backed securities and lower-rated corporate bonds should continue to perform well. As the summer wears on, we expect that stumbling growth in Europe and Latin America will exert pressure on the U.S. economy. This pressure on domestic economic growth and global inflation should allow the rally in bond prices to continue. We anticipate significantly reducing our exposure to mortgages and corporate bonds at that time and extending portfolio durations. 65 MENTOR QUALITY INCOME PORTFOLIO MENTOR SHORT-DURATION INCOME PORTFOLIO MANAGERS' COMMENTARY: THE ACTIVE FIXED-INCOME MANAGEMENT TEAM MARCH 31, 1999 - -------------------------------------------------------------------------------- PERFORMANCE COMPARISON Comparison of change in value of a hypothetical $10,000 purchase in Mentor Quality Income Portfolio Class A and Class B Shares and the Merrill Lynch 7-Year Treasury Index.- [GRAPH]
4/29/92 9/30/92 9/30/93 9/30/94 9/30/95 9/30/96 9/30/97 9/30/98 3/31/99 Class A Shares(dagger) 9,525 9,846 10,378 10,036 11,222 11,681 12,833 14,110 13,861 Class B Shares(double dagger) 10,000 10,324 10,827 10,406 11,585 11,999 13,113 14,071 13,946 Merrill Lynch 7-Year Treasury Index~ 10,000 11,041 12,345 11,721 13,533 14,043 15,388 17,815 17,324
Average Annual Returns as of 3/31/99 Including Sales Charges 1-Year 5-Year Since Inception(triple dagger) Class A 0.76% 5.69% 4.92% Class B 4.21% 6.18% 5.13% PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE PERFORMANCE. YOUR INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO WHEN SHARES ARE REDEEMED, THEY MAY BE WORTH MORE OR LESS THAN ORIGINAL COST. MUTUAL FUNDS ARE NOT OBLIGATIONS OF OR GUARANTEED BY ANY BANK AND ARE NOT FEDERALLY INSURED. - The Merrill Lynch 7-Year Treasury Index is adjusted to reflect reinvestment of interest on securities in the index. The Merrill Lynch 7-Year Treasury Index is not adjusted to reflect sales loads, expenses, or other fees that the SEC requires to be reflected in the Portfolio's performance. + Represents a hypothetical investment of $10,000 in Mentor Quality Income Portfolio Class A Shares, after deducting the maximum sales charge of 4.75% ($10,000 investment minus $475 sales charge = $9,525). The Class A Shares' performance assumes the reinvestment of all dividends and distributions. ++ Represents a hypothetical investment of $10,000 in Mentor Quality Income Portfolio Class B Shares. A contingent deferred sales charge will be imposed, if applicable, on Class B Shares at rates ranging from a maximum of 4.00% of amounts redeemed during the first year following the date of purchase to 1.00% of amounts redeemed during the six-year period following the date of purchase. The value of Class B Shares reflects a redemption fee in effect at the end of each of the stated periods. The Class B Shares' performance assumes the reinvestment of all dividends and distributions. +++ Reflects operations of Mentor Quality Income Portfolio Class A and Class B Shares from the date of commencement of operations on 4/29/92 through 3/31/99. Comparison of change in value of a hypothetical $10,000 purchase in Mentor Quality Income Portfolio Class Y Shares and the Merrill Lynch 7-Year Treasury Index.- [GRAPH]
11/19/97 12/31/97 3/31/98 6/30/98 9/30/98 3/31/99 Class Y Shares* 10,000 10,038 10,144 10,378 10,869 10,758 Merrill Lynch 7-Year Treasury Index~ 10,000 10,142 10,311 10,562 11,364 11,050
Total Returns as of 3/31/99 1-Year Since Inception** Class Y 6.06% 5.69% PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE PERFORMANCE. YOUR INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO WHEN SHARES ARE REDEEMED, THEY MAY BE WORTH MORE OR LESS THAN ORIGINAL COST. MUTUAL FUNDS ARE NOT OBLIGATIONS OF OR GUARANTEED BY ANY BANK AND ARE NOT FEDERALLY INSURED. - The Merrill Lynch 7-Year Treasury Index is adjusted to reflect reinvesment of interest on securities in the index. Ther Merrill Lynch 7-year Treasury Index is not adjusted to reflect sales loads, expenses, or other fees that the SEC requries to be reflect in the Portfolio's performance. * Represents a hypothetical investment of $10,000 in Mentor Quality Income Portfolio Class Y Shares. These shares are not subject to any sales or contingent deferred sales charges. The Class Y Shares' performance assumes the reinvestment of all dividends and distributions. ** Reflects operations of Mentor Quality Income Portfolio Class Y Shares from the date of issuance on 11/19/97 through 3/31/99. 66 MENTOR QUALITY INCOME PORTFOLIO MENTOR SHORT-DURATION INCOME PORTFOLIO MANAGERS' COMMENTARY: THE ACTIVE FIXED-INCOME MANAGEMENT TEAM MARCH 31, 1999 - -------------------------------------------------------------------------------- PERFORMANCE COMPARISON Comparison of change in value of hypothetical $10,000 purchase in Mentor Short-Duration Income Portfolio Class A Shares and the Merrill Lynch 3-Year Treasury Index.- [GRAPH]
6/16/95 9/30/95 9/30/96 9/30/97 9/30/98 3/31/99 Class A Shares* 9,900 9,931 10,532 11,304 12,093 12,194 Merrill Lynch 3-Year Treasury Index~ 10,000 10,139 11,038 11,571 12,732 12,788
Average Annual Returns as of 3/31/99 Including Sales Charges 1-Year Since Inception** Class A 4.28% 5.37% PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE PERFORMANCE. YOUR INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO WHEN SHARES ARE REDEEMED, THEY MAY BE WORTH MORE OR LESS THAN ORIGINAL COST. MUTUAL FUNDS ARE NOT OBLIGATIONS OF OR GUARANTEED BY ANY BANK AND ARE NOT FEDERALLY INSURED. - The Merrill Lynch 3-Year Treasury Index is adjusted to reflect reinvestment of interest on securities in the index. It is not adjusted to reflect sales loads, expenses, or other fees that the SEC requires to be reflected in the Portfolio's performance. The Portfolio invests in securities other than Treasuries. * Represents a hypothetical investment of $10,000 in Mentor Short-Duration Income Portfolio Class A Shares, after deducting the maximum sales charge of 1.00% ($10,000 investment minus $100 sales charges = $9,900. The Class A Shares' performance assumes the reinvestment of all dividends and distributions. ** Reflects operations of Mentor Short-Duration Income Portfolio Class A from the date of issuance on 6/16/95 through 3/31/99. Comparison of change in value of hypothetical $10,000 purchase in Mentor Short-Duration Income Portfolio Class B Shares and Merrill Lynch 3-year Treasury Index.- [GRAPH]
4/29/94 12/31/94 9/30/95 9/30/96 9/30/97 9/30/98 3/31/99 Class B Shares(dagger) 10,000 10,093 10,623 11,225 12,125 12,945 13,043 Merrill Lynch 3-Year Treasury Index~ 10,000 10,075 11,051 11,709 12,600 13,053 13,924
Average Annual Returns as of 3/31/99 Including Sales Charges 1-Year Since Inception(double dagger) Class B 4.12% 5.87% PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE PERFORMANCE. YOUR INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO WHEN SHARES ARE REDEEMED, THEY MAY BE WORTH MORE OR LESS THAN ORIGINAL COST. MUTUAL FUNDS ARE NOT OBLIGATIONS OF OR GUARANTEED BY ANY BANK AND ARE NOT FEDERALLY INSURED. - The Merrill Lynch 3-Year Treasury Index is adjusted to reflect reinvestment of interest on securities in the index. It is not adjusted to reflect sales loads, expenses, or other fees that the SEC requires to be reflected in the Portfolio's performance. The Portfolio invests in securities other than Treasuries. + Represents a hypothetical investment of $10,000 in Mentor Short-Duration Income Portfolio Class B Shares. A contingent deferred sales charge will be imposed, if applicable on Class B Shares at rates ranging from a maximum of 4.00% of amounts redeemed during the first year following the date of purchase to 1.00% of amounts redeemed during the six-year period following the date of purchase. The value of Class B Shares reflects a redemption fee in effect at the end of each of the stated periods. The Class B Shares' performance assumes the reinvestment of all dividends and distributions. ++ Reflects operations of Mentor Short-Duration Income Portfolio Class B Shares from the date of commencement of operations on 4/29/94 through 3/31/99. 67 MENTOR QUALITY INCOME PORTFOLIO MENTOR SHORT-DURATION INCOME PORTFOLIO MANAGERS' COMMENTARY: THE ACTIVE FIXED-INCOME MANAGEMENT TEAM MARCH 31, 1999 - -------------------------------------------------------------------------------- PERFORMANCE COMPARISON Comparison of change in value of hypothetical $10,000 purchase in Mentor Short-Duration Income Portfolio Class Y Shares and the Merrill Lynch 3-Year Treasury Index.- [GRAPH]
11/19/97 12/31/97 3/31/98 6/30/98 9/30/98 3/31/99 Class Y Shares* 10,000 10,032 10,167 10,317 10,638 10,746 Merrill Lynch 3-Year Treasury Index~ 10,000 10,081 10,239 10,413 10,875 10,923
Total Returns as of 3/31/99 1-Year Since Inception** Class Y 5.70% 5.61% PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE PERFORMANCE. YOUR INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO WHEN SHARES ARE REDEEMED, THEY MAY BE WORTH MORE OR LESS THAN ORIGINAL COST. MUTUAL FUNDS ARE NOT OBLIGATIONS OF OR GUARANTEED BY ANY BANK AND ARE NOT FEDERALLY INSURED. - The Merrill Lynch 3-Year Treasury Index is adjusted to reflect reinvestment of interest on securities in the index. It is not adjusted to reflect sales loads, expenses, or other fees that the SEC requires to be reflected in the Portfolio's performance. The Portfolio invests in securities other than Treasuries. * Represents a hypothetical investment of $10,000 in Mentor Short-Duration Income Portfolio Class Y Shares. These shares are not subject to any sales or contingent deferred sales charges. The Class Y Shares' performance assumes the reinvestment of all dividends and distributions. ** Reflects operations of Mentor Short-Duration Income Portfolio Class Y from the date of issuance on 11/19/97 through 3/31/99. 68 MENTOR QUALITY INCOME PORTFOLIO PORTFOLIO OF INVESTMENTS MARCH 31, 1999 (UNAUDITED) - --------------------------------------------------------------------------------
PRINCIPAL MARKET AMOUNT VALUE LONG-TERM INVESTMENTS - 134.54% PREFERRED STOCK - 1.84% Home Ownership, Inc., 12/30/26 (cost $3,796,225) $4,350,000 $ 4,075,438 ----------- ASSET-BACKED SECURITIES - 20.93% Advanta Mortgage Loan Trust Series 1993-4 AZ, 5.55%, 3/25/10 693,663 682,548 Advanta Mortgage Loan Trust Series 1993-3 A5, 5.55%, 1/25/25 990,524 962,672 AFG Receivables Trust Series 1997-B C, 7.00%, 2/15/03 941,241 943,079 Capital One Master Trust Series 1998-4 A, 5.43%, 1/15/07 2,535,000 2,493,557 CS First Boston Mortgage Series 1996-2 A6, 7.18%, 2/25/18 6,500,000 6,528,190 Discover Card Master Trust Series 1998-7 A, 5.60%, 5/15/06 3,005,000 2,970,016 Equifax Credit Corporation of America Series 1998-2 A6F, 6.16%, 4/15/08 2,370,000 2,371,822 Series 1994-1 B, 5.75%, 3/15/09 1,253,328 1,251,187 Series 1999-1 A6F, 6.20%, 9/20/09 5,250,000 5,217,834 Series 1998-2 A4F, 6.33%, 1/15/22 1,800,000 1,804,784 Fifth Third Auto Grantor Trust Series 1996-A A, 6.20%, 9/15/01 435,617 436,476 First USA Credit Card Master Trust, 1998-9 A, 5.28%, 9/18/06 2,700,000 2,652,729 General Electric Capital Mortgage, - 6.27%, Series 1999-HE1 A7, 4/25/29 4,000,000 3,961,951 Green Tree Home Equity, Series 1999-A A5, 6.13%, 2/15/19 3,900,000 3,896,482 J.C. Penney Master Credit Card Trust, Series 1998-E A, 5.50%, 6/15/07 4,000,000 3,931,427 Key Auto Finance Trust Series 1997-2 A4, 6.15%, 10/15/01 1,500,000 1,505,792 Old Stone Credit Corporation, Series 93-1 B1, 6.00%, 3/15/08 520,913 521,875
PRINCIPAL MARKET AMOUNT VALUE ASSET-BACKED SECURITIES (CONTINUED) Saxon Asset Securities Series 1999-1 AF6, 6.35%, 2/25/29 $4,000,000 $ 4,012,999 ----------- TOTAL ASSET-BACKED SECURITIES (COST $24,821,467) 46,145,420 ----------- U.S. GOVERNMENT SECURITIES AND AGENCIES -- 69.94% Federal Home Loan Mortgage Association Series 26 C, 6.50%, 7/25/18 7,000,000 7,032,774 Series 1693 Z, 6.00%, 3/15/09, REMIC 6,301,827 6,138,331 Series 1647 B, 6.50%, 11/15/08, REMIC 2,201,275 2,204,038 Federal National Mortgage Association Series 1993-181 O, 6.50%, 9/25/08 2,335,000 2,333,916 6.00% - 6.50%, 1/01/00 20,500,000 20,175,313 6.00%, 12/01/13 3,479,988 3,456,991 Series 1998-24 JZ, 6.50%, 5/18/28 2,028,936 2,008,577 Government National Mortgage Association I 6.00% - 6.50%, 3/15/28 - 1/15/29 ARM 39,414,072 38,749,338 6.00% - 7.00%, 12/15/08 - 3/15/29 67,400,000 69,309,762 Government National Mortgage Association II 6.13% - 6.88%, 4/20/22 - 12/20/22, ARM 2,765,717 2,820,511 ----------- TOTAL U.S. GOVERNMENT SECURITIES AND AGENCIES (COST $ 154,747,659) 154,229,551 ----------- CORPORATE BONDS - 19.95% FINANCIAL - 6.28% Capital One Bank, 7.15% - 7.20%, 7/19/99 - 9/15/06 4,750,000 4,780,917 CIT Group, Inc. 5.91%, 11/23/05 3,000,000 2,937,333 Ford Capital, 9.88%, 5/15/02 2,525,000 2,813,162 Household Financial Company, 5.88%, 2/01/09 1,300,000 1,248,897 Salomon, Inc., 7.30%, 5/15/02 2,000,000 2,078,222 ----------- 13,858,531 ----------- INDUSTRIAL - 13.27% Adelphia Communications, 9.88%, 3/01/05 625,000 678,125
69 MENTOR QUALITY INCOME PORTFOLIO PORTFOLIO OF INVESTMENTS MARCH 31, 1999 (UNAUDITED) - --------------------------------------------------------------------------------
PRINCIPAL MARKET AMOUNT VALUE CORPORATE BONDS (CONTINUED) INDUSTRIAL (CONTINUED) Capstar Broadcasting, 9.25%, 7/01/07 $ 700,000 $ 740,250 Century Communications, 9.50%, 8/15/00 1,400,000 1,441,774 Chancellor Media Corporation, 9.00%, 10/01/08 800,000 856,000 Charter Communications, 8.63%, 4/01/09 (a) 1,200,000 1,227,000 Clearnet Communications, 12/15/05 550,000 504,625 Comcast Cellular, 9.50%, 5/01/07 1,750,000 1,986,250 CSC Holdings, Inc., 9.88%, 5/15/06 750,000 819,375 Enron Corporation, 6.73%, 11/17/08 4,000,000 4,027,516 JCAC, Inc., 10.13%, 6/15/06 750,000 823,125 Jitney-Jingle Stores, 12.00%, 3/01/06 1,500,000 1,668,750 Lenfest Communications, 7.63%, 2/15/08 530,000 540,600 McLeodUSA, Inc., 9.25%, 7/15/07 1,400,000 1,466,500 Metromedia Fiber, 10.00%, 11/15/08 1,120,000 1,201,200 Microcell Telecomm, 14.00%, 6/01/06 420,000 343,350 Nextel Communications, 10.65%, 9/15/07 750,000 551,250 PSINet, Inc., 10.00%, 2/15/05 785,000 828,175 Randall's Food Marketings, 9.38%, 7/01/07 1,145,000 1,242,325 RBF Finance, 11.38%, 3/15/09 (a) 250,000 263,750 Rogers Cablesystems, 9.63% - 10.00%, 8/01/02 - 3/15/05 1,600,000 1,762,000 Rogers Cantel, 8.80%, 10/01/07 1,250,000 1,306,250 Safeway, Inc., 6.50%, 11/15/08 2,000,000 2,028,692 Sprint Capital Corporation, 6.13%, 11/15/08 3,000,000 2,953,358 ----------- 29,260,240 ----------- UTILITY - 0.40% CMS Energy Corporation, 6.75%, 1/15/04 900,000 885,600 -----------
PRINCIPAL MARKET AMOUNT VALUE CORPORATE BONDS (CONTINUED) TOTAL CORPORATE BONDS (COST $46,813,941) $44,004,371 ----------- MISCELLANEOUS - 0.47% Platex Family Production Corporation 8.88%, 7/15/04 (cost $ 1,050,599) $1,000,000 1,035,000 ----------- COLLATERALIZED MORTGAGE OBLIGATIONS - 17.71% BA Mortgage Securities B1, 6.50%, 7/25/13 420,848 411,549 BA Mortgage Securities M, 6.50%, 7/25/13 649,696 642,073 Chase Mortgage Finance Corporation Series 1993-C B1, 7.00%, 10/25/24 2,854,534 2,858,996 General Electric Capital Mortgage Series 1993-18 B1, 6.00%, 2/25/09 1,827,816 1,769,918 Series 1998-13 M, 6.50%, 6/25/13 1,122,946 1,111,956 Series 1998-01 M, 6.75%, 1/25/13 716,397 715,215 Series 1998-03 M, 7.00%, 1/25/28 2,713,700 2,713,145 Norwest Asset Securities Corporation Series 1996-2 M, 7.00%, 9/25/11 1,706,660 1,713,853 Series 1997-18 B1, 6.75%, 12/25/27 2,574,548 2,529,457 Series 1998-22 B1, 6.25%, 9/25/28 2,146,841 2,069,647 Series 1998-22 B2, 6.25%, 9/25/28 3,109,938 2,968,642 NationsBanc Montgomery Funding Corporation Series 1998-5 M, 6.00%, 11/25/13 2,089,024 1,997,678 Series 1998-5 B1, 6.00, 11/25/13 974,520 919,168 Series 1998-4 B2, 6.25%, 10/25/28 2,583,242 2,428,918 Prudential Homes Series 1996-4 B1, 6.50%, 4/25/26 871,544 848,835 Series 1996-4 M, 6.50%, 4/25/26 4,269,598 4,191,860
70 MENTOR QUALITY INCOME PORTFOLIO PORTFOLIO OF INVESTMENTS MARCH 31, 1999 (UNAUDITED) - --------------------------------------------------------------------------------
PRINCIPAL MARKET AMOUNT VALUE COLLATERALIZED MORTGAGE OBLIGATIONS (CONTINUED) Prudential Homes Series 1996-8 M, 6.75%, 6/25/26 $2,326,163 $ 2,312,068 Series 1995-7 M, 7.00%, 11/25/25 2,795,735 2,807,699 Series 1995-5 B1, 7.25%, 9/25/25 (a) 1,444,123 1,455,785 Series 1995-5 M, 7.25%, 9/25/25 2,546,471 2,584,484 ------------ TOTAL COLLATERALIZED MORTGAGE OBLIGATIONS (COST $ 57,268,043) 39,050,946 ------------ RESIDUAL INTERESTS - 3.70% Capital Mortgage Funding 1999-1, 10/20/22 14,088 410,616 Capital Mortgage Funding 1999-2, 10/20/23 15,369 422,935 Capital Mortgage Funding 1999-3, 11/20/23 15,928 432,212 Capital Mortgage Funding 1998-1, 1999, 1/22/27 40,016 671,630 General Mortgage Securities II 1995-1, 1998, 6/25/20 9,057 304,207 General Mortgage Securities II 1998-5, 9/20/21 28,489 628,261 General Mortgage Securities II 1997-4 1998, 5/20/22 9,802 438,928 General Mortgage Securities II 1998-6, 7/20/22 30,853 648,487 General Mortgage Securities II 1995-4, 1998, 6/25/23 6,267 339,970 General Mortgage Securities II 1997-5 1998, 7/20/23 18,194 641,663 General Mortgage Securities II 1999-1, 8/20/24 40,000 658,476 General Mortgage Securities II 1998-1, 10/20/24 21,132 590,657 General Mortgage Securities II 1998-2, 10/20/24 27,670 434,402 National Mortgage Funding 1995-4, 1998, 3/20/21 5,019 102,273 National Mortgage Funding 1998-9, 11/20/22 24,128 460,073 National Mortgage Funding 1998-10, 1/20/23 13,573 503,279 National Mortgage Funding 1998-8, 5/20/24 28,801 480,355 ------------
PRINCIPAL MARKET AMOUNT VALUE RESIDUAL INTERESTS (CONTINUED) TOTAL RESIDUAL INTERESTS (COST $ 8,635,785) 8,168,424 ------------ TOTAL LONG-TERM INVESTMENTS (COST $297,133,719) $296,709,150 ------------ SHORT-TERM INVESTMENT - 0.21% REPURCHASE AGREEMENT Goldman Sachs & Company Dated 3/31/99, 4.95%, due 4/01/99, collateralized by $445,241 Federal Home Loan Mortgage Corporation, 7.50%, 11/01/27, market value $457,485 (cost $447,914) $ 447,914 447,914 ------------ TOTAL INVESTMENTS (COST $297,581,633)- 134.75% 297,157,064 OTHER ASSETS LESS LIABILITIES - (34.75%) (76,639,834) ------------ NET ASSETS - 100.00% $220,517,230 ============
INVESTMENT ABBREVIATIONS ARM -- Adjustable Rate Mortgage REMIC -- Real Estate Mortgage Investment Conduit (a)These are securities that may be resold to "qualified institutional buyers" under Rule 144A or securities offered pursuant to Section 4(2) of the Securities Act of 1933, as amended. These securities have been determined to be liquid under guidelines established by the Board of Trustees. INVESTMENT TRANSACTIONS Cost of purchases and proceeds from sales of securities, other than short-term securities, aggregated $384,867,076 and $357,935,935, respectively. INCOME TAX INFORMATION At March 31, 1999, the aggregated cost of investment securities for federal income tax purposes was $297,581,633. Net unrealized depreciation aggregated $424,569, of which $2,019,646 related to appreciated investment securities and $2,444,215 related to depreciated investment securities. SEE NOTES TO FINANCIAL STATEMENTS. 71 MENTOR SHORT-DURATION INCOME PORTFOLIO PORTFOLIO OF INVESTMENTS MARCH 31, 1999 (UNAUDITED) - --------------------------------------------------------------------------------
PRINCIPAL AMOUNT MARKET VALUE ASSET-BACKED SECURITIES - 11.60% Advanta Home Equity Loan, 6.15%, 10/25/09 $ 617,283 $ 616,032 Advanta Mortgage Loan Trust, 5.05%, 3/25/10 277,581 273,134 Advanta Mortgage Loan Trust 1993-3 A3, 4.75%, 2/25/10 402,385 397,700 AFC Home Equity Loan Trust, 6.60%, 2/25/27 1,395,483 1,394,227 AFG Receivables Trust, 6.45%, 9/15/00 (a) 145,295 145,295 7.05%, 4/15/01 (a) 239,677 239,889 7.00%, 2/15/03 (a) 705,931 707,309 AFG Receivables Trust 1997 A, 6.35%, 10/15/02 1,036,846 1,041,669 AFG Receivables Trust 1997 B, 6.20%, 2/15/2003 94,118 94,114 Capital One Master Trust 1998-4, 5.43%, 1/15/07 2,000,000 1,967,303 CS First Boston 1996-2, 6.39%, 2/25/18 675,598 673,292 7.18%, 2/25/18 4,000,000 4,017,347 Equifax Credit Corporation 1994-1 B, 5.75%, 3/15/09 398,474 397,793 Fifth Third Bank Auto Grantor Trust, 6.20%, 9/15/01 218,032 218,462 MMCA Automobile Trust 1999-1, 5.50%, 7/15/05 3,000,000 2,993,466 Old Stone Credit Corporation 1993-2, 6.20%, 6/15/08 230,854 231,783 Olympic Automobiles Receivables Trust 1994-B A2, 6.85%, 6/15/01 388,097 388,097 Olympic Automobiles Receivables Trust, 7.35%, 10/15/01 605,458 607,451 Perpetual Savings Bank 1990-1, 7.17%, 3/01/20 2,319,946 2,311,340 Union Acceptance Corporation Auto Trust 1997 A, 6.48%, 5/10/04 430,000 434,644 Union Acceptance Corporation, 6,70%, 6/08/03 2,020,000 2,036,827 6.45%, 7/09/03 593,504 597,274 Union Acceptance Corporation 1998-D A3, 5.75%, 6/09/03 2,400,000 2,391,536 ----------- TOTAL ASSET-BACKED SECURITIES (COST $24,212,755) 24,175,984 -----------
PRINCIPAL AMOUNT MARKET VALUE U.S. GOVERNMENT SECURITIES AND AGENCIES - 49.00% Federal National Mortgage Association 10.00%, 6/01/05 MBS $ 136,411 $ 141,174 6.00%, 11/01/13 - 4/01/14 37,051,196 36,750,156 9.00%, 5/01/14 ARM 4,580,657 4,626,474 7.00%, 12/15/08 ARM 24,470,286 24,844,881 6.00%, 11/15/13 1,985,917 1,977,229 6.00%, 12/15/13 - 1/15/14 ARM 7,787,433 7,753,363 6.63%, 7/20/22 3,101,843 3,173,415 6.50%, 3/15/28 ARM 2,879,888 2,866,389 6.50%, 6/15/28 MBS 2,799,999 2,786,874 Government National Mortgage Association II 7.00%, 11/20/22 2,083,124 2,124,688 6.88%, 4/20/22 5,227,054 5,347,726 6.13%, 10/20/22-12/20/22 4,084,247 4,163,533 6.63%, 9/20/23 732,024 748,693 U.S. Treasury Bonds, 4.25%, 11/15/03 5,000,000 4,834,000 ----------- TOTAL U.S. GOVERNMENT SECURITIES AND AGENCIES (COST $102,541,046) 102,138,595 ----------- COLLATERALIZED MORTGAGE OBLIGATION - 22.39% Chase 1999-S3 B1, 6.25%, 3/25/14 401,178 387,032 Chase 1999-S3 M, 6.25%, 3/25/14 1,260,846 1,233,774 Citigroup 1992-18 A-A, 6.60%, 11/25/22 7,570,244 7,617,880 Equifax Credit Corporation, 1998-2, 6.16%, 4/15/08 1,926,750 1,928,231 1999-1 A6F, 6.20%, 9/20/09 4,750,000 4,720,897 1998-A, 6.33%, 1/15/22 1,350,000 1,353,588 First USA Credit Card Master Trust 1998-9 1997, 5.28%, 9/18/06 2,300,000 2,259,732 Glendale Federal Bank 1990-1 A, 6.60%, 10/25/29 5,222,348 5,222,253 Green Tree Home Equity Loan Trust 1999-4, 6.13%, 2/15/19 3,100,000 3,097,204 J.C. Penney Master Credit Card Trust 1998-E, 5.50%, 6/15/07 3,575,000 3,513,713 Key Auto Finance Trust, 6.15%, 10/15/01 4,000,000 4,015,444 Saxon 1995-1A A1, 7.52%, 4/25/25 3,693,031 3,713,644
72 MENTOR SHORT-DURATION INCOME PORTFOLIO PORTFOLIO OF INVESTMENTS MARCH 31, 1999 (UNAUDITED) - --------------------------------------------------------------------------------
PRINCIPAL AMOUNT MARKET VALUE COLLATERALIZED MORTGAGE OBLIGATION (CONTINUED) Saxon Asset Securities Trust 1999-1 AF3, 6.17%, 8/25/21 $ 3,000,000 $ 2,997,277 Saxon Asset Securities Trust, 6.27%, 7/25/23 3,800,000 3,805,955 Structured Asset Securities Corporation, 6.19%, 10/25/28 816,176 816,177 ------------ TOTAL COLLATERIZED MORTGAGE OBLIGATIONS (COST $46,792,705) 46,682,801 ------------ CORPORATE BONDS - 20.26% Adelphia Communications, 7.50%, 1/15/04 1,000,000 996,250 Argosy Gaming Company, 13.25%, 6/01/04 (a) 1,000,000 1,132,500 Associates Corporation, NA, 7.88%, 9/30/01 1,000,000 1,051,554 Capital One Bank, 7.20%, 7/19/99 1,500,000 1,509,421 7.15%, 9/15/06 1,000,000 1,006,642 Carr-Gottstein Foods Company, 12.00%, 11/15/05 1,500,000 1,725,000 Century Communications, 9.50%, 8/15/00 1,207,000 1,243,210 Clearnet Communications, 14.75%, 12/15/05 850,000 779,875 CMS Energy Corporation, 6.75%, 1/15/04 1,000,000 984,000 CSC Holdings, Inc., 9.88%, 5/15/06 750,000 819,375 Discover Card Master Trust I, 1998-7, 5.60%, 5/15/06 2,000,000 1,976,716 Ford Capital, 9.88%, 5/15/02 2,525,000 2,813,162 General Motors Acceptance Corporation, 6.88%, 7/15/01 2,250,000 2,306,781 JCAC Inc., 10.13%, 6/15/06 1,250,000 1,371,875 Jitney-Jungle Stores, 12.00%, 3/01/06 1,500,000 1,668,750 Lehman, 6.20%, 1/15/02 2,000,000 1,978,146 Nextel Communications, 9.75%, 8/15/04 1,000,000 1,037,500 Playtex Products, 8.88%, 7/15/04 1,000,000 1,035,000 PSI Energy, Inc., 6.00%, 12/14/01 (a) 2,000,000 1,975,529 PSINet, Inc., 10.00%, 2/15/05 750,000 791,250 Randall's Food Marketings, 9.38%, 7/01/07 925,000 1,003,625
PRINCIPAL AMOUNT MARKET VALUE CORPORATE BONDS (CONTINUED) Rogers Cablesystems, 9.63%, 8/01/02 $ 1,057,000 $ 1,133,632 Rogers Cablesystems, 10.00%, 3/15/05 650,000 734,500 Salomon, Inc., 7.25%, 5/01/01 2,250,000 2,317,981 Salomon, Inc., 7.30%, 5/15/02 1,000,000 1,039,111 Shoppers Food Warehouse, 9.75%, 6/15/04 1,500,000 1,631,250 Sprint Capital Corporation, 5.70%, 11/15/03 2,155,000 2,129,921 The Money Store, 6.28%, 12/15/22 4,000,000 4,034,731 ------------ TOTAL CORPORATE BONDS (COST $42,208,731) 42,227,287 ------------ RESIDUAL INTERESTS (A) - 1.29% General Mortgage Funding II, 1997-4 1998, 5/20/22 3,267 145,339 General Mortgage Funding II, 1998-1, 10/20/24 14,088 393,771 General Mortgage Funding II, 1999-1, 8/20/24 30,000 492,850 National Mortgage Funding I, 1998-6, 1/20/23 47,266 669,012 National Mortgage Funding I, 1998-7, 7/20/23 44,360 670,734 National Mortgage Funding I, 1998-8, 5/20/24 19,201 320,236 ------------ TOTAL RESIDUAL INTERESTS (COST $2,815,666) 2,691,942 ------------ SHORT-TERM INVESTMENT - 7.93% REPURCHASE AGREEMENT Goldman Sachs & Company Dated 3/31/99, 4.95%, due 4/01/99, collateralized by $19,026,000 Federal Home Loan Mortgage Corporation, 7.00%, 5/01/28, market value $16,887,351 (cost $16,529,179) 16,529,179 16,529,179 ------------ TOTAL INVESTMENTS (COST $235,100,082)-112.47% 234,445,788 OTHER ASSETS LESS LIABILITIES - (12.47%) (25,998,859) ------------ NET ASSETS - 100.00% $208,446,929 ============
73 MENTOR SHORT-DURATION INCOME PORTFOLIO PORTFOLIO OF INVESTMENTS MARCH 31, 1999 (UNAUDITED) - -------------------------------------------------------------------------------- INVESTMENT ABBREVIATIONS ARM - Adjustable Rate Mortgage MBS - Mortgage Backed Securities (a) These are securities that may be resold to "qualified institutional buyers" under rule 144A or securities offered pursuant to Section 4(2) of the Securities Act of 1933, as amended. These securities have been determined to be liquid under guidelines established by the Board of Trustees. INVESTMENT TRANSACTIONS Cost of purchases and proceeds from sales of securities, other than short-term securities, aggregated $447,271,432 and $361,018,924, respectively. INCOME TAX INFORMATION At March 31, 1999, the aggregated cost of investment securities for federal income tax purposes was $235,100,082. Net unrealized depreciation aggregated $654,294 of which $535,181 related to appreciated investment securities and $1,189,475 related to depreciated investment securities. SEE NOTES TO FINANCIAL STATEMENTS. 74 MENTOR QUALITY INCOME PORTFOLIO - -------------------------------------------------------------------------------- STATEMENT OF ASSETS AND LIABILITIES MARCH 31, 1999 (UNAUDITED) ASSETS Investments, at market value (Note 2) Investment securities $296,709,150 Repurchase agreements 447,914 ------------ Total investments (cost $297,581,633) 297,157,064 Collateral for securities loaned (Note 2) 341,000 Receivables Investments sold 13,304,297 Fund shares sold 573,083 Dividends and interest 2,710,870 Other 43,892 ------------ TOTAL ASSETS 314,130,206 ------------ LIABILITIES Payables Securities loaned (Note 2) $ 341,000 Reverse repurchase agreement 71,419,000 Investments purchased 20,334,685 Fund shares redeemed 287,986 Dividends 1,007,199 Accrued expenses and other liabilities 223,106 ---------- TOTAL LIABILITIES 93,612,976 ------------ NET ASSETS $220,517,230 ============ Net Assets represented by: (Note 2) Additional paid-in capital $236,027,963 Accumulated distributions in excess of net investment income (1,194,808) Accumulated net realized loss on investment transactions (13,891,356) Net unrealized depreciation of investments (424,569) ------------ NET ASSETS $220,517,230 ============ NET ASSET VALUE PER SHARE Class A Shares $ 13.05 Class B Shares $ 13.04 Class Y Shares $ 13.55 OFFERING PRICE PER SHARE Class A Shares $ 13.70(a) Class B Shares $ 13.04 Class Y Shares $ 13.55 SHARES OUTSTANDING Class A Shares 8,450,057 Class B Shares 8,453,227 Class Y Shares 80
(a) Computation of offering price: 100/95.25 of net asset value. SEE NOTES TO FINANCIAL STATEMENTS. STATEMENT OF OPERATIONS SIX MONTHS ENDED MARCH 31, 1999 (UNAUDITED) INVESTMENT INCOME Interest (b) (Note 2) $ 7,236,750 ----------- EXPENSES Management fee (Note 4) $ 631,092 Distribution fee (Note 5) 273,958 Shareholder service fee (Note 5) 262,954 Transfer agent fee 153,950 Administration fee (Note 4) 105,182 Registration expenses 43,688 Custodian and accounting fees 42,537 Shareholder reports and postage expenses 31,474 Audit fees 11,021 Legal fees 7,259 Directors' fees and expenses 3,771 Miscellaneous 6,372 ---------- Total expenses 1,573,258 ----------- Deduct Waiver of management fee (Note 4) (194,745) ----------- NET INVESTMENT INCOME 5,858,237 ----------- REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS Net realized gain on investments (Note 2) 402,920 Change in unrealized appreciation (depreciation) on investments (8,898,636) ---------- NET LOSS ON INVESTMENTS (8,495,716) ----------- NET DECREASE IN NET ASSETS RESULTING FROM OPERATIONS $(2,637,479) ===========
(b) Net of interest expense of $1,604,124 related to borrowings. SEE NOTES TO FINANCIAL STATEMENTS. 75 MENTOR QUALITY INCOME PORTFOLIO - -------------------------------------------------------------------------------- STATEMENTS OF CHANGES IN NET ASSETS
SIX MONTHS ENDED 3/31/99 YEAR ENDED (UNAUDITED) 9/30/98 NET INCREASE IN NET ASSETS Operations Net investment income $ 5,858,237 $ 9,334,606 Net realized gain on investments 402,920 713,191 Change in unrealized appreciation (depreciation) on investments (8,898,636) 6,558,180 ------------- ------------- Increase in net assets resulting from operations (2,637,479) 16,605,977 ------------- ------------- Distributions to Shareholders From net investment income Class A (3,050,569) (4,831,082) Class B (3,078,903) (5,431,749) Class Y -- (51) ------------- ------------- Total distributions to shareholders (6,129,472) (10,262,882) ------------- ------------- Capital Share Transactions (Note 7) Proceeds from sale of shares 51,165,151 106,644,051 Reinvested distributions 4,065,893 6,677,759 Shares redeemed (33,128,128) (40,705,601) ------------- ------------- Change in net assets resulting from capital share transactions 22,102,916 72,616,209 ------------- ------------- Increase in net assets 13,335,965 78,959,304 Net Assets Beginning of period 207,181,265 128,221,961 ------------- ------------- End of period (including accumulated distributions in excess of net investment income of ($1,194,808) and ($923,573), respectively) $ 220,517,230 $ 207,181,265 ============= =============
SEE NOTES TO FINANCIAL STATEMENTS. FINANCIAL HIGHLIGHTS CLASS A SHARES
SIX MONTHS YEAR ENDED 3/31/99 ENDED (UNAUDITED) 9/30/98 PER SHARE OPERATING PERFORMANCE Net asset value, beginning of year $ 13.61 $ 13.18 --------- ------- Income from investment operations Net investment income 0.39 0.79 Net realized and unrealized gain (loss) on investments (0.55) 0.47 --------- ------- Total from investment operations (0.16) 1.26 --------- ------- Less distributions From net investment income (0.40) (0.83) --------- ------- Net asset value, end of year $ 13.05 $ 13.61 ========= ======= TOTAL RETURN* (1.16%) 9.95% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (in thousands) $ 110,263 $94,279 Ratio of expenses to average net assets 1.05%(a) 1.05% Ratio of expenses to average net asset excluding waiver 1.14%(a) 1.18% Ratio of net investment income to average net assets 5.83%(a) 5.73% Portfolio turnover rate 121% 114% YEAR YEAR YEAR YEAR ENDED ENDED ENDED ENDED 9/30/97 9/30/96 9/30/95 9/30/94 PER SHARE OPERATING PERFORMANCE Net asset value, beginning of year $ 12.91 $ 13.29 $ 12.75 $ 14.04 ------- ------- ------- ------- Income from investment operations Net investment income 0.97 0.89 0.84 0.84 Net realized and unrealized gain (loss) on investments 0.26 (0.37) 0.61 (1.30) ------- ------- ------- ------- Total from investment operations 1.23 0.52 1.45 (0.46) ------- ------- ------- ------- Less distributions From net investment income (0.96) (0.90) (0.91) (0.83) ------- ------- ------- ------- Net asset value, end of year $ 13.18 $ 12.91 $ 13.29 $ 12.75 ======= ======= ======= ======= TOTAL RETURN* 9.86% 4.09% 11.82% (3.39%) RATIOS/SUPPLEMENTAL DATA Net assets, end of year (in thousands) $53,176 $21,092 $24,472 $30,142 Ratio of expenses to average net assets 1.05% 1.05% 1.32% 1.38% Ratio of expenses to average net asset excluding waiver 1.18% 1.31% 1.36% 1.39% Ratio of net investment income to average net assets 7.01% 6.84% 6.73% 6.33% Portfolio turnover rate 100% 254% 368% 455%
(a) Annualized. * Total return does not reflect sales commissions and is not annualized. SEE NOTES TO FINANCIAL STATEMENTS. 76 MENTOR QUALITY INCOME PORTFOLIO - -------------------------------------------------------------------------------- FINANCIAL HIGHLIGHTS CLASS B SHARES
SIX MONTHS YEAR ENDED 3/31/99 ENDED (UNAUDITED) 9/30/98 PER SHARE OPERATING PERFORMANCE Net asset value, beginning of year $ 13.61 $ 13.18 --------- -------- Income from investment operations Net investment income 0.35 0.72 Net realized and unrealized gain (loss) on investments (0.55) 0.48 --------- -------- Total from investment operations (0.20) 1.20 --------- -------- Less distributions From net investment income (0.37) (0.77) --------- -------- Net asset value, end of year $ 13.04 $ 13.61 ========= ======== TOTAL RETURN* (1.46%) 9.46% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (in thousands) $ 110,253 $112,901 Ratio of expenses to average net assets 1.55%(a) 1.55% Ratio of expenses to average net asset excluding waiver 1.74%(a) 1.67% Ratio of net investment income to average net assets 5.33%(a) 5.22% Portfolio turnover rate 121% 114% YEAR YEAR YEAR YEAR ENDED ENDED ENDED ENDED 9/30/97 9/30/96 9/30/95 9/30/94 PER SHARE OPERATING PERFORMANCE Net asset value, beginning of year $ 12.93 $ 13.31 $ 12.76 $ 14.06 ------- ------- ------- ------- Income from investment operations Net investment income 0.86 0.84 0.79 0.82 Net realized and unrealized gain (loss) on investments 0.30 (0.38) 0.61 (1.37) ------- ------- ------- ------- Total from investment operations 1.16 0.46 1.40 (0.55) ------- ------- ------- ------- Less distributions From net investment income (0.91) (0.84) (0.85) (0.75) ------- ------- ------- ------- Net asset value, end of year $ 13.18 $ 12.93 $ 13.31 $ 12.76 ======= ======= ======= ======= TOTAL RETURN* 9.29% 3.57% 11.33% (3.97%) RATIOS/SUPPLEMENTAL DATA Net assets, end of year (in thousands) $75,046 $58,239 $62,155 $77,888 Ratio of expenses to average net assets 1.55% 1.55% 1.74% 1.88% Ratio of expenses to average net asset excluding waiver 1.68% 1.81% 1.79% 1.90% Ratio of net investment income to average net assets 6.51% 6.36% 6.24% 6.21% Portfolio turnover rate 100% 254% 368% 455%
(a) Annualized. * Total return does not reflect sales commissions and is not annualized. SEE NOTES TO FINANCIAL STATEMENTS. CLASS Y SHARES
SIX MONTHS PERIOD ENDED 3/31/99 ENDED (UNAUDITED) 9/30/98 (b) PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 13.69 $ 13.20 -------- -------- Income from investment operations Net investment income 0.39 0.78 Net realized and unrealized gain (loss) on investments (0.53) 0.39 -------- -------- Total from investment operations (0.14) 1.17 -------- -------- Less distributions From net investment income -- (0.68) -------- -------- Net asset value, end of period $ 13.55 $ 13.69 ======== ======== TOTAL RETURN* (1.02%) 8.94% RATIOS/SUPPLEMENTAL DATA Net assets, end of period (in thousands) $ 1 $ 1 Ratio of expenses to average net assets 0.80%(a) 0.80%(a) Ratio of expenses to average net assets exluding waiver 0.99%(a) 0.93%(a) Ratio of net investment income to average net assets 5.83%(a) 7.09%(a) Portfolio turnover rate 121% 114%
(a) Annualized. (b) for the period from November 19, 1997 (initial offering of Class Y shares) to September 30, 1998. * Total return does not reflect sales commissions and is not annualized. SEE NOTES TO FINANCIAL STATEMENTS. 77 MENTOR SHORT-DURATION INCOME PORTFOLIO - -------------------------------------------------------------------------------- STATEMENT OF ASSETS AND LIABILITIES MARCH 31, 1999 (UNAUDITED) ASSETS Investments, at market value (Note 2) Investment securities $217,916,609 Repurchase agreements 16,529,179 ------------ Total investments (cost $235,100,082) 234,445,788 Cash Receivables 30,939 Investments sold 12,842,753 Fund shares sold 6,342,238 Dividends and interest 2,078,786 Deferred expenses (Note 2) 21,970 ------------ TOTAL ASSETS 255,762,474 ------------ LIABILITIES Payables Investments purchased $16,346,132 Reverse repurchase agreement 29,000,000 Fund shares redeemed 1,006,854 Dividends 828,582 Accrued expenses and other liabilities 133,977 ----------- TOTAL LIABILITIES 47,315,545 ------------ NET ASSETS $208,446,929 ============ Net Assets represented by: (Note 2) Additional paid-in capital $209,980,897 Accumulated distributions in excess of net investment income (764,158) Accumulated net realized loss on investment transactions (115,517) Net unrealized depreciation of investments (654,293) ------------ NET ASSETS $208,446,929 ============ NET ASSET VALUE PER SHARE Class A Shares $ 12.49 Class B Shares $ 12.51 Class Y Shares $ 12.92 OFFERING PRICE PER SHARE Class A Shares $ 12.62(a) Class B Shares $ 12.51 Class Y Shares $ 12.92 SHARES OUTSTANDING Class A Shares 12,368,595 Class B Shares 4,310,930 Class Y Shares 83
(a) Computation of offering price: 100/99 of net asset value. SEE NOTES TO FINANCIAL STATEMENTS. STATEMENT OF OPERATIONS SIX MONTHS ENDED MARCH 31, 1999 (UNAUDITED) INVESTMENT INCOME Interest (Note 2) $5,246,726 ---------- EXPENSES Management fee (Note 4) $ 439,105 Shareholder service fee (Note 5) 219,551 Administration fee (Note 4) 88,030 Distribution fee (Note 5) 82,684 Transfer agent fee 64,278 Custodian and accounting fees 25,415 Registration expenses 24,322 Organizational expenses 12,620 Shareholder reports and postage expenses 11,143 Legal fees 3,965 Audit fees 2,788 Directors' fees and expenses 2,059 Miscellaneous 3,479 ---------- Total expenses 979,439 ---------- Deduct Waiver of administration fee (Note 4) (88,030) Waiver of management fee (Note 4) (52,159) ---------- NET INVESTMENT INCOME 4,407,476 ---------- REALIZED AND UNREALIZED LOSS ON INVESTMENTS Net realized loss on investments (Note 2) (102,249) Change in unrealized appreciation (depreciation) on investments (2,564,213) ---------- NET LOSS ON INVESTMENTS (2,666,462) ---------- NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $1,741,014 ==========
(a) Net of interest expense of $163,166 related to borrowings. SEE NOTES TO FINANCIAL STATEMENTS. 78 MENTOR SHORT-DURATION INCOME PORTFOLIO - -------------------------------------------------------------------------------- STATEMENTS OF CHANGES IN NET ASSETS
SIX MONTHS ENDED 3/31/99 YEAR ENDED (UNAUDITED) 9/30/98 NET INCREASE IN NET ASSETS Operations Net investment income $ 4,407,476 $ 5,167,036 Net realized gain (loss) on investments (102,249) 325,954 Change in unrealized appreciation (depreciation) on investments (2,564,213) 1,608,387 ------------- ------------- Increase in net assets resulting from operations 1,741,014 7,101,377 ------------- ------------- Distributions to Shareholders From net investment income Class A (3,256,831) (3,203,099) Class B (1,402,510) (2,394,223) Class Y -- (49) From net realized gain on investments Class A (110,579) -- Class B (46,577) -- ------------- ------------- Total distributions to shareholders (4,816,497) (5,597,371) ------------- ------------- Capital Share Transactions (Note 7) Proceeds from sale of shares 111,629,716 169,053,248 Reinvested distributions 3,456,128 4,352,285 Shares redeemed (50,607,871) (82,572,822) ------------- ------------- Change in net assets resulting from capital share transactions 64,477,973 90,832,711 ------------- ------------- Increase in net assets 61,402,490 92,336,717 Net Assets Beginning of period 147,044,439 54,707,722 ------------- ------------- End of period (including accumulated distributions in excess of net investment income of ($764,158) and ($512,293), respectively) $ 208,446,929 $ 147,044,439 ============= =============
SEE NOTES TO FINANCIAL STATEMENTS. FINANCIAL HIGHLIGHTS CLASS A SHARES
SIX MONTHS YEAR YEAR YEAR PERIOD ENDED 3/31/99 ENDED ENDED ENDED ENDED (UNAUDITED) 9/30/98 9/30/97 9/30/96 9/30/95 (c) PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 12.74 $ 12.62 $ 12.50 $ 12.68 $ 12.74 -------- ------- ------- ------- -------- Income from investment operations Net investment income 0.35 0.70 0.77 0.82 0.22 Net realized and unrealized gain (loss) on investments (0.25) 0.15 0.12 (0.23) (0.03) -------- ------- ------- -------- -------- Total from investment operations 0.10 0.85 0.89 0.59 0.19 -------- ------- ------- -------- -------- Less distributions From net investment income (0.35) (0.73) (0.77) (0.77) (0.25) -------- ------- ------- -------- -------- Net asset value, end of period $ 12.49 $ 12.74 $ 12.62 $ 12.50 $ 12.68 ======== ======= ======= ======== ======== TOTAL RETURN* 0.84% 6.98% 7.33% 4.80% 1.51% RATIOS / SUPPLEMENTAL DATA Net assets, end of period (in thousands) $154,509 $93,135 $27,619 $ 7,450 $ 1,002 Ratio of expenses to average net assets 0.86%(a) 0.86% 0.86% 0.86% 0.71%(a) Ratio of expenses to average net asset excluding waiver 1.02%(a) 1.14% 1.12% 1.26% 1.00%(a) Ratio of net investment income to average net assets 5.10%(a) 5.24% 6.00% 5.90% 4.10%(a) Portfolio turnover rate 186% 171% 75% 411% 126%
(a) Annualized. (c) For the period from June 16, 1995 (initial offering of Class A Shares) to September 30, 1995. * Total return does not reflect sales commissions and is not annualized. SEE NOTES TO FINANCIAL STATEMENTS. 79 MENTOR SHORT-DURATION INCOME PORTFOLIO - -------------------------------------------------------------------------------- FINANCIAL HIGHLIGHTS CLASS B SHARES
SIX MONTHS YEAR YEAR ENDED 3/31/99 ENDED ENDED (UNAUDITED) 9/30/98 9/30/97 PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 12.75 $ 12.62 $ 12.50 --------- ------- ------- Income from investment operations Net investment income 0.31 0.66 0.73 Net realized and unrealized gain (loss) on investments (0.22) 0.16 0.12 --------- ------- ------- Total from investment operations 0.09 0.82 0.85 --------- ------- ------- Less distributions From net investment income (0.33) (0.69) (0.73) --------- ------- ------- Net asset value, end of period $ 12.51 $ 12.75 $ 12.62 ========= ======= ======= TOTAL RETURN* 0.72% 6.68% 6.96% RATIOS/SUPPLEMENTAL DATA Net assets, end of period (in thousands) $ 53,937 $53,908 $27,089 Ratio of expenses to average net assets 1.16%(a) 1.16% 1.16% Ratio of expenses to average net asset excluding waiver 1.32%(a) 1.44% 1.42% Ratio of net investment income to average net assets 4.80%(a) 4.94% 5.70% Portfolio turnover rate 186% 171% 75% YEAR PERIOD PERIOD ENDED ENDED ENDED 9/30/96 9/30/95 (D) 12/31/94 (e) PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 12.67 $ 12.18 $ 12.50 ------- ------- --------- Income from investment operations Net investment income 0.73 0.59 0.41 Net realized and unrealized gain (loss) on investments (0.17) 0.52 (0.29) ------- ------- --------- Total from investment operations 0.56 1.11 0.12 ------- ------- --------- Less distributions From net investment income (0.73) (0.62) (0.44) ------- ------- --------- Net asset value, end of period $ 12.50 $ 12.67 $ 12.18 ======= ======= ========= TOTAL RETURN* 4.53% 9.22% 0.95% RATIOS/SUPPLEMENTAL DATA Net assets, end of period (in thousands) $24,517 $19,871 $ 17,144 Ratio of expenses to average net assets 1.16% 1.20% 1.29%(a) Ratio of expenses to average net asset excluding waiver 1.56% 1.70% 1.29%(a) Ratio of net investment income to average net assets 5.60% 5.04% 4.90%(a) Portfolio turnover rate 411% 126% 166%
(a) Annualized. (d) For the period from January 1, 1995 to September 30, 1995. (e) For the period from April 29, 1994 (commencement of operations) to December 31, 1994. * Total return does not reflect sales commissions and is not annualized. SEE NOTES TO FINANCIAL STATEMENTS. CLASS Y SHARES
SIX MONTHS PERIOD ENDED 3/31/99 ENDED (UNAUDITED) 9/30/98 (f) PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 12.79 $ 12.57 -------- -------- Income from investment operations Net investment income 0.33 0.67 Net realized and unrealized gain (loss) on investments (0.20) 0.16 -------- -------- Total from investment operations 0.13 0.83 -------- -------- Less distributions From net investment income -- (0.61) -------- -------- Net asset value, end of period $ 12.92 $ 12.79 ======== ======== TOTAL RETURN* 1.02% 6.64% RATIOS/SUPPLEMENTAL DATA Net assets, end of period (in thousands) $ 1 $ 1 Ratio of expenses to average net assets 0.61%(a) 0.61%(a) Ratio of expenses to average net asset excluding waiver 0.77%(a) 0.87%(a) Ratio of net investment income to average net assets 5.10%(a) 6.10%(a) Portfolio turnover rate 186% 171%
(a) Annualized. (f) For the period from November 19, 1997 (initial offering of Class Y shares) to September 30, 1998. * Total return does not reflect sales commissions and is not annualized. SEE NOTES TO FINANCIAL STATEMENTS. 80 MENTOR HIGH INCOME PORTFOLIO COMMENTARY: THE MENTOR HIGH INCOME PORTFOLIO TEAM MARCH 31, 1999 - -------------------------------------------------------------------------------- MARKET REVIEW For the six-month period ending March 31, 1999 fixed-income Treasury yields rose across the yield curve. Two-year notes increased 71 basis points to 4.98% and 30-year rates increased 66 basis points to 5.62%. Despite the rise in Treasury yields the quarter saw good returns for high yield. Against this rise in interest rates, the spread between high yield debt and Treasuries declined during the early months of 1999, dropping from 631 basis points at year-end to 579 basis points at first quarter-end, according to the Chase High Yield Index. This leaves the spread, representing risk premium, much lower than last year's third quarter flight to quality level, but well above historical norms. New issuance for the first quarter of 1999 remained somewhat lower than the first quarter of 1998. This year's new issuance of $30.1 billion compares to $49.7 billion from last year. Inflows into the high yield market have remained lower as well, with cash inflows of $4.3 billion for this year's first quarter, against inflows of $8.9 billion for the same period in 1998. MANAGEMENT STRATEGY Significant cash flow into the Mentor High Income Portfolio increased total assets in the Fund from approximately $207 million at the end of the fourth quarter of 1998 to $267 million at 1999 first quarter-end. In spite of this 29% increase in the size of Portfolio assets, we were able to continue to find many attractive investment opportunities for the new funds. In fact, the percentage of Portfolio assets invested in cash has actually declined from 6.6% to 6.2% so far this year. The number of securities held increased from 152 to 167, with no single issuer representing more than 1.5% of the total portfolio. Over the course of the period we increased our emphasis on wider-spread paper, thereby allowing the Portfolio to outperform as spreads compressed with favorable economic conditions. By the end of March we had increased the single-B component of the Portfolio to 71.2%. This increase in single-B paper serves to make the portfolio more highly correlated to changes in the rate of growth in gross domestic product, and less correlated to the level of Treasury yields. We have continued to increase the Portfolio's concentration in telecommunication and media credits, these credits have outperformed against a background of consolidation and favorable regulatory developments. Our March 31 telecom/ media weighting of 34.7%, however, still represents a minor underweight against the high yield universe. PERFORMANCE REVIEW Corporate high yield assets performed well during the six-month period compared to other fixed-income asset classes. This is a trend that has been in place since the Federal Reserve lowered rates in October of last year. For the six-month period ended March 31, 1999 the Mentor High Income Portfolio A shares returned 6.97%, comparing favorably to a 4.64% return for its Merrill Lynch High Yield Index benchmark. MARKET OUTLOOK Positive news for bonds overseas is offset by domestic U.S. conditions that continue to put upward pressure on interest rates. The U.S. economy has repeatedly defied predictions of an imminent slowdown. With unemployment hitting 4.2% in March, inflation fears are mounting. Despite these fears, most broad measures of inflation have continued to trend downward. 81 MENTOR HIGH INCOME PORTFOLIO COMMENTARY: THE MENTOR HIGH INCOME PORTFOLIO TEAM MARCH 31, 1999 - -------------------------------------------------------------------------------- Without some new evidence of slowing economic growth, the bond market seems likely to trade within a fairly narrow range around current interest rate levels. In such an environment, lower-rated corporate bonds should continue to perform well. The outlook for high yield bonds continues to look favorable. Our forecast for continued strong domestic growth and benign inflation provides a favorable backdrop for the high yield market. The emerging markets, which detonated last fall's melt down, have been star performers this year after shrugging off Brazil's currency devaluation. While the equity markets have bounced off their early October lows to set new records, high yield spreads have only retraced about one half of their third quarter 1998 widening. Some potential pitfalls for our six-month outlook would include a resurgence in inflation, the continued escalation in default rates, or another flight-to-quality move caused by some extraneous event. PERFORMANCE COMPARISON Comparison of change in value of a hypothetical $10,000 purchase in Mentor High Income Portfolio Class A and Class B Shares and the Merrill Lynch High Yield Master II Bond Index.~ [GRAPH]
6/23/98 7/31/98 8/31/98 9/30/98 3/31/99 Class A Shares(double dagger) 9,525 9,614 8,904 8,882 9,876 Class B Shares(dagger) 10,000 10,081 9,332 9,305 9,919 Merrill Lynch High Yield Master II Bond Index~ 10,000 10,064 9,556 9,581 10,025
Average Annual Returns as of 3/31/99 Including Sales Charges 1-Year Since Inception(triple dagger) Class A n/a (1.60%) Class B n/a (5.82%) PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE PERFORMANCE. YOUR INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE SO WHEN SHARES ARE REDEEMED, THEY MAY BE WORTH MORE OR LESS THAN ORIGINAL COST. MUTUAL FUNDS ARE NOT OBLIGATIONS OF OR GUARANTEED BY ANY BANK AND ARE NOT FEDERALLY INSURED. ~ The Merrill Lynch High Yield Master II Bond Index provides a broad-based measure of the performance of the non-investment grade U.S. domestic bond market. The index currently captures close to $200 billion of the outstanding debt of domestic market issuers rated below investment grade but not in default. + Represents a hypothetical investment of $10,000 in Mentor High Income Portfolio Class B Shares. A contingent deferred sales charge will be imposed, if applicable, on Class B Shares at rates ranging from a maximum of 4.00% of amounts redeemed during the first year following the date of purchase to 1.00% of amounts redeemed during the six-year period following the date of purchase. The Class B Shares reflects a redemption fee in effect at the end of each of the stated periods. The Class B Shares' performance assumes the reinvestment of all dividends and distributions. ++ Represents a hypothetical investment of $10,000 in Mentor High Income Portfolio Class A Shares, after deducting the maximum sales charge of 4.75% ($10,000 investment minus $475 sales charge = $9,525). The Class A Shares' performance assumes the reinvestment of all dividends and distributions. +++ Reflects operations of Mentor High Income Portfolio Class A and Class B Shares from the date of commencement of operations on 6/23/98 through 3/31/99. 82 MENTOR HIGH INCOME PORTFOLIO PORTFOLIO OF INVESTMENTS MARCH 31, 1999 (UNAUDITED) - --------------------------------------------------------------------------------
PRINCIPAL AMOUNT MARKET VALUE CORPORATE BONDS - 93.20% CONSUMER DISTRIBUTION - 13.19% Agrilink Foods, 11.88%, 11/01/08 $2,500,000 $2,693,750 Big 5 Corporation Senior Notes, Series B, 10.88%, 11/15/07 2,000,000 2,040,000 CHS Electronics, Inc. Senior Notes, 9.88%, 4/15/05 2,000,000 1,640,000 Community Distributors, 10.25%, 10/15/04 1,250,000 1,156,250 Del Monte Foods Company Senior Discount Notes, 12.50%, 12/15/07 (a) 2,625,000 1,968,750 Disco S.A. Notes, 9.13% - 9.88%, 5/15/03 - 5/15/08 (a) 2,000,000 1,808,750 Fleming Companies, Inc., 10.50%, 12/01/04 2,300,000 2,167,750 Gruma S.A. de C.V. Senior Notes, 7.63%, 10/15/07 2,000,000 1,780,000 Jitney-Jungle Stores, 12.00%, 3/01/06 1,500,000 1,672,500 Kmart Corporation Debentures, 7.95%, 2/01/23 2,500,000 2,525,000 Luigino's Inc. Senior Subordinated Notes, 10.00%, 2/01/06 2,500,000 2,509,375 Musicland Group, Inc. Senior Subordinated Notes-B, 9.88%, 3/15/08 2,500,000 2,562,500 Owens & Minor, Inc., 10.88%, 6/01/06 2,000,000 2,170,000 Packaging Corporation of America, 9.63%, 4/01/09 1,000,000 1,027,500 Pantry, Inc. Senior Subordinated Notes, 10.25%, 10/15/07 2,500,000 2,637,500 Pathmark Stores Senior Subordinated Notes, 9.63%, 5/01/03 2,000,000 2,065,000 Phar-Mor, Inc. Senior Notes, 11.72%, 9/11/02 1,635,000 1,684,050 Supreme International Corporation, 12.25%, 4/01/06 2,000,000 1,990,000 ---------- 36,098,675 ---------- CONSUMER DURABLES - 5.79% Aetna Industries, Inc. Senior Notes, 11.88%, 10/01/06 1,500,000 1,567,500 Cluett American Corporation Senior Subordinated Notes, 10.13%, 5/15/08 (a) 2,000,000 1,840,000 Consoltex Group Senior Notes, 11.00%, 10/01/03 200,000 204,000 Decora Industries, Inc. Secured Notes, 11.00%, 5/01/05 (a) 2,000,000 1,930,000 French Fragrances, Inc. Senior Notes, 10.38%, 5/15/07 1,500,000 1,537,500 Galey & Lord, Inc. Senior Subordinated Notes, 9.13%, 3/01/08 2,225,000 1,724,375
PRINCIPAL AMOUNT MARKET VALUE CORPORATE BONDS (CONTINUED) CONSUMER DURABLES (CONTINUED) MCII Holdings Senior Secured Discount Notes, 12.00%, 11/15/02 1,500,000 1,297,500 Outsourcing Services Group Senior Subordinated Notes, 10.88%, 3/01/06 (a) 1,150,000 1,121,250 Simmons Company Senior Subordinated Notes, 10.25%, 3/15/09 500,000 519,375 Talon Automotive Group Senior Subordinated Notes, 9.63%, 5/01/08 (a) 1,855,000 1,632,400 Venture Holdings Trust Senior Notes, 9.75%, 4/01/04 2,500,000 2,462,500 ---------- 15,836,400 ---------- CONSUMER SERVICES - 25.36% American Media Operations, 11.63%, 11/15/04 2,380,000 2,576,350 AmeriCredit Corporation, 9.25%, 2/01/04 (a) 2,000,000 1,980,000 Argosy Gaming Company, 12.00%, 6/01/01 1,000,000 1,030,000 Argosy Gaming Company, 13.25%, 6/01/04 (a) 1,500,000 1,700,625 Booth Creek Ski Holdings Senior Notes-B, 12.50%, 3/15/07 2,250,000 2,148,750 Capstar Broadcasting Senior Discount Notes, 12.75%, 2/01/09 (a) 1,000,000 850,000 Casino America, 12.50%, 8/01/03 1,000,000 1,150,000 Centennial Cellular Senior Subordinated Notes, 10.75%, 12/15/08 2,350,000 2,496,875 Charter Communications, 8.63%, 4/01/09 (a) 2,000,000 2,050,000 Citadel Broadcasting Company Senior Subordinated Notes, 9.25%, 11/15/08 400,000 431,000 ContiFinancial Corporation, 7.50%, 3/15/02 2,000,000 1,560,000 CTI Holdings S.A. Senior Notes, 11.50%, 4/15/08 $3,000,000 $1,650,000 Diamond Cable Communi- cations Senior Discount Notes, 11.75%, 12/15/05 1,500,000 1,331,250 Filtronic PLC Senior Notes, 10.00%, 12/01/05 2,500,000 2,612,500 Frontiervision LP Senior Discount Notes, 11.88%, 9/15/07 2,375,000 2,075,156 Globo Communicacoes Senior Notes, 10.63%, 12/05/08 (a) 2,000,000 1,310,000 Group Maintenance America Senior Subordinated Notes, 9.75%, 1/15/09 500,000 512,500
83 MENTOR HIGH INCOME PORTFOLIO PORTFOLIO OF INVESTMENTS MARCH 31, 1999 (UNAUDITED) - --------------------------------------------------------------------------------
PRINCIPAL AMOUNT MARKET VALUE CORPORATE BONDS (CONTINUED) CONSUMER SERVICES (CONTINUED) Grupo Televisa S.A. Senior Discount Notes-Euro, 13.25%, 5/15/08 $ 2,335,000 $ 1,973,075 Hermes Europe Railtel Senior Notes, 10.38%, 1/15/09 2,500,000 2,687,500 Hollywood Casino Corporation Senior Notes, 12.75%, 11/01/03 2,000,000 2,195,000 Hollywood Park, Inc. Senior Subordinated Notes, 9.50%, 8/01/07 2,000,000 2,030,000 Integrated Electric Services Senior Subordinated Notes, 9.38%, 2/01/09 1,000,000 1,023,750 Intrawest Corporation Senior Notes, 9.75%, 8/15/08 2,000,000 2,062,500 IXC Communications, Inc. Senior Subordinated Notes, 9.00%, 4/15/08 2,000,000 2,090,000 La Petite Academy LPA Holdings-B, 10.00%, 5/15/08 1,250,000 1,231,250 Level 3 Communications Senior Discount Notes, 10.50%, 12/01/08 2,000,000 1,260,000 Mail-Well Corporation Senior Subordinated Notes, 8.75%, 12/15/08 (a) 1,000,000 1,030,000 Majestic Star Casino, LLC, 12.75%, 5/15/03 1,500,000 1,665,000 Multicanal Participacoes, 12.63%, 6/18/04 1,000,000 865,000 Northland Cable Television Senior Subordinated Notes, 10.25%, 11/15/07 700,000 749,000 NTL Incorporated Senior Notes, 12.38%, 10/01/08 2,000,000 1,370,000 Oxford Automotive, Inc. 10.13%, 6/15/07 2,000,000 2,070,000 Premier Graphics, Inc. Senior Notes, 11.50%, 12/01/05 2,500,000 2,462,500 Premier Parks, Inc. Senior Discount Notes, 10.00%, 4/01/08 3,000,000 2,111,250 Sinclair Broadcast Group Senior Subordinated Notes, 8.75% - 9.00%, 7/15/07 - 12/15/07 2,750,000 2,811,250 Splitrock Services Inc., 11.75%, 7/15/08 2,000,000 1,910,000 Splitrock Services Inc., 11.75%, 7/15/08 - Warrants 2,000 40,000 Telewest Communication PLC Debentures, 11.00%, 10/01/07 1,500,000 1,320,000 Triton PCS, Inc., 11.63%, 5/01/08 4,000,000 2,380,000 United International Holdings Senior Discount Notes, 10.75%, 2/15/08 3,000,000 2,055,000
PRINCIPAL AMOUNT MARKET VALUE CORPORATE BONDS (CONTINUED) CONSUMER SERVICES (CONTINUED) Webb Corporation Senior Subordinated Notes, 10.25%, 2/15/10 $ 2,000,000 $ 2,030,000 Young American Corporation Senior Subordinated Notes, 11.63%, 2/15/06 (a) 1,000,000 500,000 ---------- 69,387,081 ---------- ENERGY - 4.47% Canadian Forest Oil Limited, 8.75%, 9/15/07 2,500,000 2,412,500 Cross Timbers Oil Company Senior Subordinated Notes, 8.75%-9.25%, 4/01/07- 11/01/09 2,120,000 2,054,600 Gulf Canada Resources Limited Debentures, 9.00%, 8/15/99 1,000,000 1,012,500 Houston Exploration Company Senior Subordinated Notes-B, 8.63%, 1/01/08 1,000,000 1,000,000 Hurricane Hydrocarbons Senior Notes, 11.75%, 11/01/04 (a) 1,000,000 460,000 Nationsrent, Inc, 10.38%, 12/15/08 2,000,000 2,100,000 Pride International, Inc., 9.38%, 5/01/07 1,000,000 980,000 Tesoro Petroleum Corporation Senior Subordinated Notes, 9.00%, 7/01/08 (a) 1,000,000 997,500 Universal Compression, Inc. Senior Discount Notes, 9.88%, 2/15/08 (a) 2,000,000 1,200,000 ---------- 12,217,100 ---------- HEALTH CARE - 4.02% Biovail Corporation International Senior Notes, 10.88%, 11/15/05 (a) 2,600,000 2,671,500 Columbia/HCA Healthcare, 6.91%, 6/15/05 1,000,000 922,500 King Pharmaceutical, Inc., 10.75%, 2/15/09 2,000,000 2,070,000 Mariner Post-Acute Network Senior Subordinated Notes, 10.50%, 11/01/07 1,500,000 270,000 Oxford Health Plans Senior Notes, 11.00%, 5/15/05 2,500,000 2,562,500 Tenet Healthcare Corporation, 8.63%, 1/15/07 2,500,000 2,500,000 ---------- 10,996,500 ---------- PRODUCER MANUFACTURING - 12.26% Agriculture Minerals & Chemicals, 10.75%, 9/30/03 3,000,000 3,030,000 Cambridge Industries, Inc., 10.25%, 7/15/07 2,000,000 1,700,000 CMI Industries Senior Subordinated Notes, 9.50%, 10/01/03 2,760,000 2,718,600
84 MENTOR HIGH INCOME PORTFOLIO PORTFOLIO OF INVESTMENTS MARCH 31, 1999 (UNAUDITED) - --------------------------------------------------------------------------------
PRINCIPAL AMOUNT MARKET VALUE CORPORATE BONDS (CONTINUED) PRODUCER MANUFACTURING (CONTINUED) Compass Aerospace Corporation, 10.13%, 4/15/05 (a) $ 2,250,000 $2,160,000 Delta Mills, Inc., 9.63%, 9/01/07 1,500,000 1,511,250 Dine S.A. de C.V., 8.75%, 10/15/07 (a) 1,000,000 835,000 Globe Manufacturing Corporation Senior Subordinated Notes, 10.00%, 8/01/08 2,250,000 1,788,750 Hayes Lemmerz International Inc., 9.13%, 7/15/07 1,500,000 1,578,750 Hydrochemical Industrial Service Senior Subordinated Notes-B, 10.38%, 8/01/07 1,000,000 885,000 K&F Industries Senior Subordinated Notes, 9.25%, 10/15/07 2,000,000 2,065,000 Muzak LLC Senior Subordinated Notes, 9.88%, 3/15/09 2,000,000 2,035,000 Pacifica Papers, Inc. Senior Notes, 10.00%, 3/15/09 2,000,000 2,065,000 Repap New Brunswick, 9.00%, 6/01/04 2,000,000 1,950,000 Schuler Homes Senior Notes, 9.00%, 4/15/08 (a) 750,000 723,750 Tekni-Plex, Inc. Senior Subordinated Notes-B, 11.25%, 4/01/07 2,500,000 2,737,500 Terex Corporation Senior Subordinated Notes, 8.88%, 4/01/08 (a) 2,000,000 1,975,000 United Industries Group Senior Subordinated Notes, 9.88%, 4/01/09 1,750,000 1,802,500 W. R. Carpenter North America Senior Subordinated Notes, 10.63%, 6/15/07 2,000,000 1,995,000 ---------- 33,556,100 ---------- RAW MATERIALS/PRODUCTS INDUSTRIES - 6.86% Acetex Corporation Senior Notes, 9.75%, 10/01/03 2,250,000 2,126,250 Ackerley Group, 9.00%, 1/15/09 2,000,000 2,070,000 Advanced Micro Devices Senior Notes, 11.00%, 8/01/03 2,000,000 2,080,000 AEP Industries, 9.88%, 11/15/07 1,750,000 1,802,500 Anchor Lamina, Inc. Senior Subordinated Notes, 9.88%, 2/01/08 800,000 746,000 GS Technologies Operation, Inc. Senior Notes, 12.25%, 10/01/05 875,000 678,125 Hylsa S.A. de C.V. Bonds, 9.25%, 9/15/07 (a) 2,000,000 1,540,000
PRINCIPAL AMOUNT MARKET VALUE CORPORATE BONDS (CONTINUED) RAW MATERIALS/PRODUCTS INDUSTRIES (CONTINUED) Metromedia Fiber Network Senior Notes, 10.00%, 11/15/08 $1,000,000 $ 1,077,500 Panolam Industries International Senior Subordinated Notes, 11.50%, 2/15/09 1,000,000 1,030,000 Pioneer Americas Acquisition Senior Notes, 9.25%, 6/15/07 2,450,000 2,070,250 Ucar Global Enterprises Senior Subordinated Notes, 12.00%, 1/15/05 1,500,000 1,601,250 Vicap S.A. Guaranteed Notes, 10.25% - 11.38%, 5/15/02 - 5/15/07 (a) 2,000,000 1,940,250 ---------- 18,762,125 ---------- TECHNOLOGY - 3.50% Amazon.Com, Inc., 10.00%, 5/01/08 4,000,000 2,735,000 DecisionOne Holdings Discount Notes, 11.50%, 8/01/08 1,500,000 45,000 Dictaphone Corporation Senior Subordinated Notes, 11.75%, 8/01/05 1,000,000 730,000 Fairchild Semiconductor Senior Subordinated Notes, 10.38%, 10/01/07 2,500,000 2,543,750 Nextel Communications Senior Discount Notes, 9.75% - 12.00%, 8/15/04 - 11/01/08 3,500,000 3,520,000 ---------- 9,573,750 ---------- TRANSPORTATION - 2.37% Atlas Air, Inc. Senior Notes, 9.38% - 10.75%, 8/01/05 - 11/15/06 2,600,000 2,683,375 American Communication Lines, LLC Bonds, 10.25%, 6/30/08 (a) 1,000,000 1,032,500 Cenargo International PLC-1st Mortgage, 9.75%, 6/15/08 (a) 1,000,000 900,000 Greyhound Lines Senior Notes, 11.50%, 4/15/07 1,335,000 1,541,925 Pegasus Shipping Hellas Notes-A, 11.88%, 11/15/04 500,000 330,000 ---------- 6,487,800 ---------- UTILITIES - 15.38% American Cellular Corporation Senior Notes, 10.50%, 5/15/08 (a) 500,000 523,750 Cathay International Limited Senior Notes, 13.00%, 4/15/08 (a) 1,000,000 250,000 CIA Transporte Energia Senior Notes, 9.25%, 4/01/08 1,155,000 1,053,938 Clearnet Communications Senior Discount Notes, 14.75%, 12/15/2005 2,500,000 2,325,000
85 MENTOR HIGH INCOME PORTFOLIO PORTFOLIO OF INVESTMENTS MARCH 31, 1999 (UNAUDITED) - --------------------------------------------------------------------------------
PRINCIPAL AMOUNT MARKET VALUE CORPORATE BONDS (CONTINUED) UTILITIES (CONTINUED) Crown Castle International Corporation Senior Discount Notes, 10.63%, 11/15/07 $1,500,000 $ 1,042,500 E.Spire Communications, Inc. Senior Discount Notes, 12.75% - 13.75%, 11/01/05 - 7/15/07 2,300,000 1,912,500 ICG Holdings, Inc. Discount Notes, 12.50%, 5/01/06 1,770,000 1,380,600 Intermedia Communications of Florida, 12.50%, 5/15/06 3,500,000 3,045,000 McLeodusa, Inc. Senior Discount Notes, 10.50%, 3/01/07 2,000,000 1,612,500 MetroNet Communications Senior Discount Notes, 9.95%, 6/15/08 (a) 1,500,000 1,166,250 Microcell Telecommunications Senior Discount Notes-B, 14.00%, 6/01/06 2,000,000 1,650,000 Millicom International Cellular Senior Discount Notes, 13.50%, 6/01/06 2,250,000 1,687,500 Netia Holdings Senior Discount Notes-B, 11.25%, 11/01/07 $2,500,000 $ 1,725,000 Optel, Inc. Senior Notes, 13.00%, 2/15/05 (a) 500,000 482,500 Pinnacle Holdings, Inc. Senior Discount Notes, 10.00%, 3/15/08 (a) 2,000,000 1,215,000 Price Communications Cellular, 11.25%, 8/15/08 750,000 727,500 Price Communications Wireless, Inc. Senior Subordinated Notes, 11.75%, 7/15/07 2,000,000 2,210,000 Primus Telecommunications Group Strips, 11.25% - 11.75%, 8/01/04 - 1/15/09 1,750,000 1,811,875 PSINet, Inc. Senior Notes, Series B, 11.50%, 11/01/08 2,000,000 2,260,000 Rogers Cantel, Inc. Debentures, 9.38%, 6/01/08 2,000,000 2,200,000 Rural Cellular Corporation, 9.63% - 11.38%, 5/15/08 - 5/15/10 1,260,577 2,350,235 Satelites Mexicanos Senior Notes, 10.13%, 11/01/04 (a) 2,000,000 1,650,000 SBA Communications Corporation Senior Discount Notes, 12.00%, 3/01/08 (a) 2,000,000 1,270,000 Sprint Spectrum Senior Notes, 11.00% - 12.50%, 8/15/06 2,000,000 2,067,500
PRINCIPAL AMOUNT MARKET VALUE CORPORATE BONDS (CONTINUED) UTILITIES (CONTINUED) Startec Global Communications Units, 12.00%, 5/15/08 (a) $ 2,000,000 $ 1,830,000 Startec Global Communications Units, 12.00%, 5/15/08 - Warrants (a) 2,000 500 Verio, Inc. Senior Notes, 10.38% - 11.25%, 4/01/05 - 12/01/08 2,400,000 2,629,500 ------------ 42,079,148 ------------ TOTAL CORPORATE BONDS (COST $257,187,903) 254,994,679 ------------ SHORT TERM INVESTMENT - 6.07% U.S. Government Agency Federal Home Loan Bank 5.00%, 4/01/99 (cost $16,617,000) 16,617,000 16,617,000 ------------ TOTAL INVESTMENTS (COST $ 273,804,903)-99.27% 271,611,679 OTHER ASSETS LESS LIABILITIES - 0.73% 1,989,123 ------------ NET ASSETS - 100.00% $273,600,802 ============
(a) These are securities that may be resold to "qualified institutional buyers" under Rule 144A or securities offered pursuant to Section 4(2) of the Securities Act of 1933, as amended. These securities have been determined to be liquid under guidelines established by the Board of Trustees. INVESTMENT TRANSACTIONS Cost of purchases and proceeds from sales of securities, other than short-term securities, aggregated $196,856,099 and $40,074,143, respectively. INCOME TAX INFORMATION At March 31, 1999, the aggregated cost of investment securities for federal income tax purposes was $273,804,903. Net unrealized depreciation aggregated $2,193,224, of which $6,150,546 related to appreciated investment securities and $8,343,770 related to depreciated investment securities. SEE NOTES TO FINANCIAL STATEMENTS. 86 MENTOR HIGH INCOME PORTFOLIO - -------------------------------------------------------------------------------- STATEMENT OF ASSETS AND LIABILITIES MARCH 31, 1999 (UNAUDITED) ASSETS Investments, at market value (Note 2) Investment securities $254,994,679 Repurchase agreements 16,617,000 ------------ Total investments securities (cost $273,804,903) 271,611,679 ------------ Receivables Investments sold 991,194 Fund shares sold 4,740,070 Dividends and interest 5,969,856 Deferred expenses (Note 2) 17,586 ------------ TOTAL ASSETS 283,330,385 ------------ LIABILITIES Payables Investments purchased $7,393,451 Fund shares redeemed 128,615 Dividends 2,014,498 Accrued expenses and other liabilities 193,019 ---------- TOTAL LIABILITIES 9,729,583 ------------ NET ASSETS $273,600,802 ============ Net Assets represented by: (Note 2) Additional paid-in capital $280,028,597 Accumulated distributions in excess of net investment income (1,387,486) Accumulated net realized loss on investment transactions (2,847,085) Net unrealized depreciation of investments (2,193,224) ------------ NET ASSETS $273,600,802 ============ NET ASSET VALUE PER SHARE Class A Shares $ 11.11 Class B Shares $ 11.09 OFFERING PRICE PER SHARE Class A Shares $ 11.66(a) Class B Shares $ 11.09 SHARES OUTSTANDING Class A Shares 14,968,702 Class B Shares 9,672,181
(a) Computation of offering price: 100/95.25 of net asset value. SEE NOTES TO FINANCIAL STATEMENTS. STATEMENT OF OPERATIONS SIX MONTHS ENDED MARCH 31, 1999 (UNAUDITED) INVESTMENT INCOME Interest (a) (Note 2) $ 9,734,692 ----------- EXPENSES Management fee (Note 4) $ 683,266 Shareholder service fee (Note 5) 244,024 Distribution fee (Note 5) 216,898 Transfer agent fee 189,210 Administration fee (Note 4) 97,610 Registration expenses 62,253 Shareholder reports and postage expenses 33,072 Custodian and accounting fees 32,590 Legal fees 9,128 Audit fees 6,417 Directors' fees and expenses 4,741 Organizational expenses 1,748 Miscellaneous 8,012 ---------- Total expenses 1,588,969 ----------- Deduct Waiver of management fee (Note 4) (269,733) Waiver of administration fee (Note 4) (38,398) ----------- NET INVESTMENT INCOME 8,453,854 ----------- REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS Net realized loss on investments (2,758,369) Change in unrealized appreciation (depreciation) on investments 7,130,262 ---------- NET GAIN ON INVESTMENTS 4,371,893 ----------- NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $12,825,747 ===========
SEE NOTES TO FINANCIAL STATEMENTS. 87 MENTOR HIGH INCOME PORTFOLIO - -------------------------------------------------------------------------------- STATEMENTS OF CHANGES IN NET ASSETS
SIX MONTHS ENDED 3/31/99 PERIOD ENDED (UNAUDITED) 9/30/98 (a) NET INCREASE IN NET ASSETS Operations Net investment income $ 8,453,854 $ 1,818,180 Net realized loss on investments (2,758,369) (88,715) Change in unrealized appreciation (depreciation) on investments 7,130,262 (9,323,486) ------------- ------------ Increase in net assets resulting from operations 12,825,747 (7,594,021) ------------- ------------ Distributions to Shareholders From net investment income Class A (5,362,802) (1,040,534) Class B (4,106,664) (1,178,956) ------------- ------------ Total distributions to shareholders (9,469,466) (2,219,490) ------------- ------------ Capital Share Transactions (Note 7) Proceeds from sale of shares 164,826,318 126,286,107 Reinvested distributions 4,363,177 1,281,553 Shares redeemed (12,701,114) (3,998,009) ------------- ------------ Change in net assets resulting from capital share transactions 156,488,381 123,569,651 ------------- ------------ Increase in net assets 159,844,662 113,756,140 Net Assets Beginning of period 113,756,140 -- ------------- ------------ End of period (including accumulated distributions in excess of net investment income of ($1,387,486) and ($371,874), respectively) $ 273,600,802 $113,756,140 ============= ============
(a) For the period from June 23, 1998 (commencement of operations) to September 30, 1998. SEE NOTES TO FINANCIAL STATEMENTS. FINANCIAL HIGHLIGHTS CLASS A SHARES
SIX MONTHS PERIOD ENDED 3/31/99 ENDED (UNAUDITED) 9/30/98 (b) PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 10.92 $ 12.00 -------- -------- Income from investment operations Net investment income 0.91 0.24 Net realized and unrealized loss on investments (0.17) (1.04) -------- -------- Total from investment operations 0.74 (0.80) -------- -------- Less distributions From net investment income (0.55) (0.28) -------- -------- Net asset value, end of period $ 11.11 $ 10.92 ======== ======== TOTAL RETURN* 6.97% (6.75%) RATIOS/SUPPLEMENTAL DATA Net assets, end of period (in thousands) $166,294 $ 50,887 Ratio of expenses to average net assets 1.00%(a) 0.60%(a) Ratio of expenses to average net asset excluding waiver 1.11%(a) 1.30%(a) Ratio of net investment income to average net assets 9.07%(a) 7.36%(a) Portfolio turnover rate 29% 27%
(a) Annualized. (b) For the period from June 23, 1998 (commencement of operations) to September 30, 1998. * Total return does not reflect sales commissions and is not annualized. SEE NOTES TO FINANCIAL STATEMENTS. 88 MENTOR HIGH INCOME PORTFOLIO - -------------------------------------------------------------------------------- FINANCIAL HIGHLIGHTS CLASS B SHARES
SIX MONTHS PERIOD ENDED 3/31/99 ENDED (UNAUDITED) 9/30/98 (c) PER SHARE OPERATING PERFORMANCE Net asset value, beginning of period $ 10.91 $ 12.00 -------- -------- Income from investment operations Net investment income 0.37 0.22 Net realized and unrealized gain (loss) on investments 0.33 (1.05) -------- -------- Total from investment operations 0.70 (0.83) -------- -------- Less distributions From net investment income (0.52) (0.26) -------- -------- Net asset value, end of period $ 11.09 $ 10.91 ======== ======== TOTAL RETURN* 6.60% (6.95%) RATIOS/SUPPLEMENTAL DATA Net assets, end of period (in thousands) $107,307 $ 62,869 Ratio of expenses to average net assets 1.50%(a) 1.10%(a) Ratio of expenses to average net asset excluding waiver 1.61%(a) 1.80%(a) Ratio of net investment income to average net assets 8.57%(a) 6.87%(a) Portfolio turnover rate 29% 27%
(a) Annualized. (c) For the period from June 23, 1998 (commencement of operations) to September 30, 1998. * Total return does not reflect sales commissions and is not annualized. SEE NOTES TO FINANCIAL STATEMENTS. 89 MENTOR FUNDS NOTES TO FINANCIAL STATEMENTS MARCH 31, 1999 - -------------------------------------------------------------------------------- NOTE 1: ORGANIZATION Mentor Funds is registered under the Investment Company Act of 1940, as amended, as an open-end management investment company. Mentor Funds consists of twelve separate Portfolios (hereinafter each individually referred to as a "Portfolio" or collectively as the "Portfolios") at March 31, 1999, as follows: Mentor Growth Portfolio ("Growth Portfolio") Mentor Perpetual Global Portfolio ("Global Portfolio") Mentor Capital Growth Portfolio ("Capital Growth Portfolio") Mentor Income and Growth Portfolio ("Income and Growth Portfolio") Mentor Balanced Portfolio ("Balanced Portfolio") Mentor Municipal Income Portfolio ("Municipal Income Portfolio") Mentor Quality Income Portfolio ("Quality Income Portfolio") Mentor Short-Duration Income Portfolio ("Short-Duration Income Portfolio") Mentor High Income Portfolio ("High Income Portfolio") Mentor Money Market Portfolio ("Money Market Portfolio") Mentor U.S. Government Money Market Portfolio ("Government Portfolio") Mentor Tax-Exempt Money Market Portfolio ("Tax-Exempt Portfolio") The assets of each Portfolio are segregated and a shareholder's interest is limited to the Portfolio in which shares are held. These financial statements do not include the Money Market Portfolio, Government Portfolio and Tax-Exempt Portfolio. Mentor Funds currently issues three classes of shares. Class A shares are sold subject to a maximum sales charge of 5.75% (4.75% for the Quality Income Portfolio, Municipal Income Portfolio and High Income Portfolio and 1% for Short-Duration Income Portfolio) payable at the time of purchase. Class B shares are sold subject to a contingent deferred sales charge payable upon redemption which decreases depending on when shares were purchased and how long they have been held. Class Y shares are sold to institutions and high net-worth individual investors and are not subject to any sales or contingent deferred sales charges. Effective November 16, 1998, the Balanced Portfolio acquired substantially all the assets and assumed the liabilities of the Strategy Portfolio in exchange for Class A, Class B and Class Y shares of the Balanced Portfolio. The acquisition was accomplished by a tax-free exchange of the respective shares of the Balanced Portfolio for the net assets of the Strategy Portfolio. The net assets acquired amounted to $222,601,303. The aggregate net assets of the Balanced Portfolio immediately after the acquisition were $255,551,169. NOTE 2: SIGNIFICANT ACCOUNTING POLICIES The following is a summary of significant accounting policies consistently followed by the Portfolios in the preparation of their financial statements. The policies are in conformity with generally accepted accounting principles which require management to make estimates and assumptions that affect amounts reported therein. Although actual results could differ from these estimates, any such differences are expected to be immaterial to the net assets of the Portfolios. (a) Valuation of Securities - Listed securities held by the Growth Portfolio, Global Portfolio, Capital Growth Portfolio, Income and Growth Portfolio, and 90 MENTOR FUNDS NOTES TO FINANCIAL STATEMENTS (CONTINUED) - -------------------------------------------------------------------------------- Balanced Portfolio traded on national stock exchanges and over-the-counter securities quoted on the NASDAQ National Market System are valued at the last reported sales price or, lacking any sales, at the last available bid price. In cases where securities are traded on more than one exchange, the securities are valued on the exchange determined by the advisor of the Portfolios as the primary market. Securities traded in the over-the-counter market, other than those quoted on the NASDAQ National Market System, are valued at the last available bid price. Short-term investments with remaining maturities of 60 days or less are carried at amortized cost, which approximates market value. Securities for which market quotations are not readily available are valued at fair value as determined in good faith under procedures established by the Board of Trustees. U.S. Government obligations held by the Income and Growth Portfolio, Balanced Portfolio, Quality Income Portfolio, Short-Duration Income Portfolio, and High Income Portfolio are valued at the mean between the over-the-counter bid and asked prices as furnished by an independent pricing service. Listed corporate bonds, other fixed income securities, mortgage-backed securities, mortgage related, asset-backed and other related securities are valued at the prices provided by an independent pricing service. Security valuations not available from an independent pricing service are provided by dealers approved by the Portfolios' Board of Trustees. In determining value, the pricing services use information with respect to transactions in such securities, market transactions in comparable securities, various relationships between securities, and yield to maturity. Municipal bonds, held by the Municipal Income Portfolio, are valued at fair value. An independent pricing service values the Portfolio's municipal bonds taking into consideration yield, stability, risk, quality, coupon, maturity, type of issue, trading characteristics, special circumstances of a security or trading market, and any other factors or market data it deems relevant in determining valuations for normal institutional size trading units of debt securities. The pricing service does not rely exclusively on quoted prices. Short-term investments with remaining maturities of 60 days or less shall be their amortized cost value unless the particular circumstances of the security indicate otherwise. Foreign currency amounts are translated into United States dollars as follows: market value of investments, other assets and liabilities at the daily rate of exchange, purchases and sales of investments, income and expenses at the rate of exchange prevailing on the respective dates of such transactions. Net unrealized foreign exchange gains/losses are a component of unrealized appreciation/depreciation of investments. Net realized foreign currency gains and losses include foreign currency gains and losses between trade date and settlement date on investment securities transactions, foreign currency transactions and the difference between the amounts of interest and dividends recorded on the books of the Portfolio and the amount actually received. The portion of investment gains and losses related to foreign currency fluctuations in exchange rates between the initial purchase trade date and subsequent sale trade date is included in realized gains and losses on security transactions. (b) Repurchase Agreements - It is the policy of Mentor Funds to require the custodian bank to take possession, to have legally segregated in the Federal Reserve Book entry system all securities held as collateral in support of repurchase agreement investments. Additionally, procedures have been 91 MENTOR FUNDS NOTES TO FINANCIAL STATEMENTS (CONTINUED) - -------------------------------------------------------------------------------- established by Mentor Funds to monitor, on a daily basis, the market value of each repurchase agreement's underlying securities to ensure the existence of a proper level of collateral. Mentor Funds will only enter into repurchase agreements with banks and other recognized financial institutions such as broker/dealers which are deemed by Mentor Funds' adviser to be creditworthy pursuant to guidelines established by the Mentor Funds' Trustees. Risks may arise from the potential inability of counterparties to honor the terms of the repurchase agreement. Accordingly, Mentor Funds could receive less than the repurchase price on the sale of collateral securities. (c) Borrowings - Each of the Portfolios (except for the Growth Portfolio and Municipal Income Portfolio) may, under certain circumstances, borrow money directly or through dollar-roll and reverse repurchase agreements (arrangements in which the Portfolio sells a security for a percentage of its market value with an agreement to buy it back on a set date). Each Portfolio may borrow up to one-third of the value of its net assets. The average daily balance of reverse repurchase agreements outstanding for Quality Income Portfolio during the six months ended March 31, 1999, was approximately $19,877,322 or $1.23 per share based on average shares outstanding during the period at a weighted average interest rate of 4.57%. The maximum amount of borrowings outstanding for any day during the period was $83,156,353 (including accrued interest), as of February 10, 1999, at an interest rate of 4.84% and was 27.46% of total assets at that date. The average daily balance of reverse repurchase agreements outstanding for Short-Duration Income Portfolio during the six months ended March 31, 1999, was approximately $7,799,523 or $0.09 per share based on average shares outstanding during the period at a weighted average interest rate of 4.35%. The maximum amount of borrowings outstanding for any day during the period was $22,005,806 (including accrued interest), as of January 25, 1999, at an interest rate of 4.75% and was 7.31% of total assets at that date. (d) Portfolio Securities Loaned - Each of the Portfolios (except for Municipal Income Portfolio) is authorized by the Board of Trustees to participate in securities lending transactions. The Portfolios may receive fees for participating in lending securities transactions. During the period that a security is out on loan, Portfolios continue to receive interest or dividends on the securities loaned. The Portfolio receives collateral in an amount at least equal to, at all times, the fair value of the securities loaned plus interest. When cash is received as collateral, the Portfolios record an asset and obligation for the market value of that collateral. Cash received as collateral may be reinvested, in which case that security is recorded as an asset of the Portfolio. Variations in the market value of the securities loaned occurring during the term of the loan are reflected in the value of the Portfolio. At March 31, 1999, certain Portfolios had loaned securities to brokers which were collateralized by cash, U.S. Treasury securities and letters of credits. Cash collateral at March 31, 1999 was reinvested in U.S. Treasury and high quality money market instruments. Income from securities lending activities amounted to $233,048, $60,254, $28,592, $51,219, $65,533, and $14,285, for the Growth Portfolio, Global Portfolio, Capital Growth Portfolio, Income and Growth Portfolio, Balanced Portfolio and Quality Income 92 MENTOR FUNDS NOTES TO FINANCIAL STATEMENTS (CONTINUED) - -------------------------------------------------------------------------------- Portfolio, respectively for the six months ended March 31, 1999. Among the risks to a Portfolio from securities lending are that the borrower may not provide additional collateral when required or return the securities when due. At March 31, 1999, the value of the securities on loan and the value of the related collateral were as follows:
SECURITIES CASH SECURITIES TRI-PARTY PORTFOLIO ON LOAN COLLATERAL COLLATERAL COLLATERAL - ------------------- -------------- -------------- ------------ ------------- Growth $81,699,455 $83,131,779 $510,369 - Global 37,467,506 38,767,594 - - Capital Growth 21,805,109 22,282,979 - - Income and Growth 64,983,143 57,206,916 - $9,826,621 Balanced 85,449,627 87,189,594 92,520 521,991 Quality Income 332,669 341,000 - - - ------------------- ----------- ----------- -------- ----------
(e) Dollar Roll Transactions - Each of the Portfolios (except for the Growth and Municipal Income Portfolios) may engage in dollar roll transactions with respect to mortgage-backed securities issued by GNMA, FNMA, and FHLMC. In a dollar-roll transaction, a Portfolio sells a mortgage-backed security to a financial institution, such as a bank or broker/dealer, and simultaneously agrees to repurchase a substantially similar (i.e., same type, coupon, and maturity) security from the institution at a later date at an agreed upon price. The mortgage-backed securities that are repurchased will bear the same interest rate as those sold, but generally will be collateralized by different pools of mortgages with different prepayment histories. (f) Security Transactions and Investment Income - Security transactions for the Portfolios are accounted for on trade date. Dividend income is recorded on the ex-dividend date. Interest income is recorded on the accrual basis. Interest income (except for Municipal Income Portfolio) includes interest and discount earned (net of premium) on short-term obligations, and interest earned on all other debt securities including original issue discount as required by the Internal Revenue Code. Dividends to shareholders and capital gain distributions, if any, are recorded on the ex-dividend date. Interest income for the Municipal Income Portfolio includes interest earned net of premium, and original issue discount as required by the Internal Revenue Code. (g) Federal Income Taxes - No provision for federal income taxes has been made since it is each Portfolio's policy to comply with the provisions applicable to regulated investment companies under the Internal Revenue Code and to distribute to its shareholders within the allowable time limit substantially all taxable income and realized capital gains. Dividends paid by the Municipal Income Portfolio representing net interest received on tax-exempt municipal securities are not includable by shareholders as gross income for federal income tax purposes because the Portfolio intends to meet certain requirements of the Internal Revenue Code applicable to regulated investment companies which will enable the Portfolio to pay tax-exempt interest dividends. The portion of such interest, if any, earned on private purpose municipal bonds issued after August 7, 1986, 93 MENTOR FUNDS NOTES TO FINANCIAL STATEMENTS (CONTINUED) - -------------------------------------------------------------------------------- may by considered a tax preference item to shareholders. At September 30, 1998, capital loss carryforwards for federal tax purposes were as follows:
MUNICIPAL QUALITY EXPIRES INCOME PORTFOLIO INCOME PORTFOLIO - -------------- ------------------ ----------------- 9/30/2001 $ - $ 244,512 9/30/2002 - 3,678,547 9/30/2003 317,478 7,326,035 9/30/2004 1,616,817 1,708,773 9/30/2005 - 1,325,149 9/30/2006 295,480 - - ------------ ----------- ------------ $ 2,229,775 $ 14,283,016 - ------------ ----------- ------------
Such capital loss carryforwards will reduce the Portfolios' taxable income arising from future net realized gains on investments, if any, to the extent permitted by the Internal Revenue Code, and thus will reduce the amount of the distributions to shareholders which would otherwise relieve the Portfolios of any liability for federal tax. (h) When-Issued and Delayed Delivery Transactions - The Portfolios may engage in when-issued or delayed delivery transactions. To the extent the Portfolios engage in such transactions, they will do so for the purpose of acquiring portfolio securities consistent with their investment objectives and policies and not for the purpose of investment leverage. The Portfolios will record a when-issued security and the related liability on the trade date. Until the securities are received and paid for, the Portfolios will maintain security positions such that sufficient liquid assets will be available to make payment for the securities purchased. Securities purchased on a when-issued or delayed delivery basis are marked to market daily, and begin earning interest on the settlement date. (i) Futures Contracts - In order to gain exposure to or protect against declines in security values, the Portfolios may buy and sell futures contracts. The Portfolios may also buy or write put or call options on futures contracts. The Portfolios may sell futures contracts to hedge against declines in the value of portfolios securities. The Portfolios may also purchase futures contracts to gain exposure to market changes as it may be more efficient or cost effective than actually buying securities. The Portfolios will segregate assets to cover its commitments under such speculative futures contracts. Upon entering into a futures contract, the Portfolios are required to deposit either cash or securities in an amount (initial margin) equal to a certain percentage of the contract value. Subsequent payments (variation margin) are made or received by the Portfolios each day. The variation margin payments are equal to the daily changes in the contract value and are recorded as unrealized gains and losses. The Portfolios recognize a realized gain or loss when the contract is closed. For the six months ended March 31, 1999, Balanced Portfolio and Municipal Income Portfolio had net realized gains of $1,366,401 and $47,700, respectively, on closed futures contracts. Risks of entering into futures contracts (and related options) include the possibility that there may be an illiquid market and that a change in the value of the contract or option may not correlate with changes in the value of the underlying securities. At March 31, 1999, Balanced Portfolio and Municipal Income Portfolio had open positions in the following futures contracts: 94 MENTOR FUNDS NOTES TO FINANCIAL STATEMENTS (CONTINUED) - --------------------------------------------------------------------------------
NET UNREALIZED NUMBER OF NOTIONAL APPRECIATION PORTFOLIO CONTRACTS POSITION CONTRACTS EXPIRATION VALUE (DEPRECIATION) - ------------------ ----------- ---------- ------------------ ------------ -------------- --------------- Balanced 690 Short U.S. Long Bond Jun-99 $69,000,000 ($2,760,157) Municipal Income 130 Short Muni Bond Future Jun-99 $13,000,000 ($ 41,000) - ------------------ --- ---------- ------------------ ------ ----------- ----------
(j) Options - In order to produce incremental earnings or protect against changes in the value of portfolio securities, the Portfolios may buy and sell put and call options, write covered call options on portfolio securities and write cash-secured put options. The Portfolios generally purchase put options or write covered call options to hedge against adverse movements in the value of portfolio holdings. The Portfolios may also use options for speculative purposes, although they do not employ options for this at the present time. The Portfolios will segregate assets to cover their obligations under option contracts. Options contracts are valued daily based upon the last sales price on the principal exchange on which the option is traded and unrealized appreciation or depreciation is recorded. The Portfolios will realize a gain or loss upon the expiration or closing of the option transaction. When an option is exercised, the proceeds on sales for a written call option, the purchase cost for a written put option, or the cost of the security for a purchased put or call option is adjusted by the amount of premium received or paid. For the six months ended March 31, 1999, Municipal Income Portfolio had a net realized gain of $61,690 on closed option contracts. The risk in writing a call option is that the Portfolios give up the opportunity for profit if the market price of the security increases and the option is exercised. The risk in writing a put option is that the Portfolio may incur a loss if the market price of the security decreases and the option is exercised. The risk in buying an option is that the Portfolio pays a premium whether or not the option is exercised or the counterparty is unwilling or unable to perform. The Portfolio also has the additional risk of not being able to enter into a closing transaction if a liquid secondary market does not exist. The Portfolio may also write over-the-counter options where the completion of the obligation is dependent upon the credit standing of the counterparty. Activity in written options for the Muncipal Income Portfolio for the six months ended March 31, 1999, was as follows:
PREMIUM RECEIVED FACE VALUE ------------ ------------- Options outstanding at September 30, 1998 $ - - Options written 110,880 200,000 Options closed (61,690) (100,000) - ------------------------ ------- -------- Options outstanding at March 31, 1999 $49,190 100,000 - ------------------------ ------- --------
(k) Residual Interests - A derivative security is any investment that derives its value from an underlying security, asset, or market index. Quality Income Portfolio and Short-Duration Income Portfolio invest in mortgage security residual interests ("residuals") which are considered derivative securities. The Portfolios' investments in residuals have been primarily in securities issued by proprietary mortgage trusts. While these entities have been highly leveraged, often having indebtedness of up to 95% of their total value, the Portfolios have not incurred any indebtedness in the course of making these residual investments; nor have the Portfolios' assets been pledged to secure 95 MENTOR FUNDS NOTES TO FINANCIAL STATEMENTS (CONTINUED) - -------------------------------------------------------------------------------- the indebtedness of the issuing structure or the Portfolios' investment in the residuals. In consideration of the risk associated with investment in residual securities, it is the Portfolios' policy to limit their exposure at the time of purchase to no more than 20% of their total assets. (l) Interest-Rate Swap - An interest-rate swap is a contract between two parties on a specified principal amount (referred to as the notional principal) for a specified period. In the most common instance, a swap involves the exchange of streams of variable and fixed-rate interest payments. During the term of the swap, changes in the value of the swap are recognized as unrealized gains or losses by marking-to-market the value of the swap. When the swap is terminated, the Fund will record a realized gain or loss. At of March 31, 1999, there was no open interest rate swap agreement. (m) Deferred Expenses - Costs incurred by the Portfolios in connection with their initial share registration and organization costs were deferred by the Portfolios and are being amortized on a straight-line basis over a five-year period. (n) Distributions - Income distributions and capital gain distributions are determined in accordance with income tax regulations which may differ from generally accepted accounting principles. These differences are primarily due to differing treatments for net operating losses, certain futures and deferral of wash sales and equalization deficits. The Growth Portfolio and Capital Growth Portfolio also utilized earnings and profits distributed to shareholders on redemption of shares as a part of the distributions for income tax purposes. NOTE 3: DIVIDENDS Dividends will be declared daily and paid monthly to all shareholders invested in Municipal Income Portfolio, Quality Income Portfolio, Short-Duration Income Portfolio and High Income Portfolio. Dividends are delared and paid annually to all shareholders invested in the Growth Portfolio, Capital Growth Portfolio, Global Portfolio and Balanced Portfolio. Dividends are declared and paid quarterly to all shareholders invested in Income and Growth Portfolio. Dividends will be reinvested in additional shares of the same class and Portfolio on payment dates at the ex-dividend date net asset value without a sales charge unless cash payments are requested by shareholders in writing to the Mentor Investment Group, LLC. Dividends of all Portfolios are paid to shareholders of record on the record date. Capital gains realized by each Portfolio, if any, are paid annually. NOTE 4: INVESTMENT ADVISORY AND MANAGEMENT AND ADMINISTRATION AGREEMENTS Mentor Investment Advisors, LLC ("Mentor Advisors") is a wholly owned subsidiary of Mentor Investment Group, LLC ("Mentor") and its affiliates. Mentor is a subsidiary of Wheat First Butcher Singer, Inc., which in turn is a wholly owned subsidiary of First Union Corporation ("First Union"). First Union is a leading financial services company; First Union has announced plans to acquire EVEREN Capital Corporation, which currently has a minority ownership interest in Mentor. Mentor Advisors, the Portfolios' investment adviser, receives for its services an annual investment advisory fee not to exceed the following percentages of the average daily net assets of the particular 96 MENTOR FUNDS NOTES TO FINANCIAL STATEMENTS (CONTINUED) - -------------------------------------------------------------------------------- Portfolio: Growth Portfolio, 0.70%; Capital Growth Portfolio, 0.80%; Income and Growth Portfolio, 0.75%; Balanced Portfolio, 0.75%; Municipal Income Portfolio, 0.60%; Quality Income Portfolio, 0.60%; Short-Duration Income Portfolio, 0.50%; and High Income Portfolio, 0.70%. Mentor Advisors pays Van Kampen American Capital Management, Inc., the sub-adviser to Municipal Income Portfolio, an annual fee expressed as a percentage of the Portfolio's average net assets as follows: 0.25% of the first $60 million of the Portfolio's average net assets and 0.20% of the Portfolio's average net assets over $60 million. For the period from October 1, 1997 to June 30, 1998, Wellington Management Company, LLC, the sub-adviser to the Income and Growth Portfolio, received from the Investment Adviser an annual fee expressed as a percentage of that Portfolio's assets as follows: 0.325% on the first $50 million of the Portfolio's average net assets, 0.275% on the next $150 million of the Portfolio's average net assets, 0.225% of the next $300 million of the Portfolio's average net assets, and 0.200% of the Portfolio's net assets over $500 million. Effective July 1, 1998, the sub-advisor to the Income and Growth Portfolio received the following fees: 0.325% on the first $50 million of the Portfolio's average net assets, 0.250% on the next $150 million of the Portfolio's average net assets, and 0.200% of the Portfolio's average net assets over $150 million. Van Kampen American Capital Management, Inc., the sub-adviser to the High Income Portfolio receives from the Investment Adviser an annual fee of 0.20% of the Portfolio's average daily net assets. No performance or incentive fees are paid to the sub-advisers. Under certain Sub-Advisory Agreements, the particular sub-adviser may, from time to time, voluntarily waive some or all of its sub-advisory fee charged to the Investment Adviser and may terminate any such voluntary waiver at any time in its sole discretion. The Global Portfolio has entered into an Investment Advisory Agreement with Mentor Perpetual Advisors, LLC ("Mentor Perpetual"). Mentor Perpetual is owned equally by Mentor and Perpetual PLC, a diversified financial services holding company. Under this agreement, Mentor Perpetual's management fee is accrued daily and paid monthly at an annual rate of 1.10% applied to the average daily net assets of the Portfolio up to and including $75 million on and 1.00% of its average daily net assets in excess of $75 million. For the six months ended March 31, 1999, Mentor Advisors and sub-advisers, earned and voluntarily waived the following management fees:
MANAGEMENT MANAGEMENT FEE SUB ADVISER FEE VOLUNTARILY FEE PORTFOLIO EARNED WAIVED EARNED/(WAIVED) - ------------------ ------------ ------------- ---------------- Growth $1,879,581 - - Global 945,039 - - Capital Growth 1,796,157 - - Income and Growth 984,781 - $318,695 Balanced 871,032 - - Municipal Income 360,928 - 135,265 Quality Income 631,092 $194,745 - Short-Duration Income 439,105 52,159 - High Income 683,266 269,733 118,103 - ------------------ ---------- -------- --------
Administrative personnel and services are provided by Mentor, under an Administration Agreement, at an annual rate of 0.10% of the average daily net assets of each Portfolio. For the six months ended 97 MENTOR FUNDS NOTES TO FINANCIAL STATEMENTS (CONTINUED) - -------------------------------------------------------------------------------- March 31, 1999, Mentor earned the following administrative fees:
ADMINISTRATIVE ADMINISTRATIVE FEE FEE VOLUNTARILY PORTFOLIO EARNED WAIVED - ----------------------- ---------------- --------------- Growth $268,512 - Global 90,764 - Capital Growth 224,520 - Income and Growth 131,304 - Balanced 116,138 - Municipal Income 60,155 - Quality Income 105,182 - Short-Duration Income 88,030 $88,030 High Income 97,610 38,398 - ----------------------- -------- -------
The Portfolios also provide direct reimbursement to Mentor for certain legal and compliance administration, investor relation and operation related costs not covered under the Investment Management Agreement. For the six months ended March 31, 1999, these direct reimbursements were as follows:
DIRECT PORTFOLIO REIMBURSEMENTS - ----------------------- --------------- Growth $16,887 Global 5,918 Capital Growth 15,307 Income and Growth 8,269 Balanced 9,752 Municipal Income 3,857 Quality Income 6,561 Short-Duration Income 6,006 - ----------------------- -------
NOTE 5: DISTRIBUTION AGREEMENT AND OTHER TRANSACTIONS WITH AFFILIATES The Class B shares of the Portfolios have adopted a Distribution Plan (the Plan) pursuant to Rule 12b-1 under the Investment Company Act of 1940. Under a Distribution Agreement between the Portfolios and Mentor Distributors, LLC ("Mentor Distributors") a wholly-owned subsidiary of BYSIS Fund Services, Inc., Mentor Distributors was appointed distributor of the Portfolios. To compensate Mentor Distributors for the services it provides and for the expenses it incurs under the Distribution Agreement, the Portfolios pay a distribution fee, which is accrued daily and paid monthly at the annual rate of 0.75% of the Portfolios' average daily net assets for the Growth Portfolio, Capital Growth Portfolio, Income and Growth Portfolio, Balanced Portfolio and Global Portfolio, 0.50% of the average daily net assets of the Municiap Income Portfolio, Quality Income Portfolio and High Income Portfolio, and 0.30% of the average daily net assets for the Short-Duration Income Portfolio. Mentor Distributors may select financial institutions, such as investment dealers and banks to provide sales support services as agents for their clients or customers who beneficially own Class B shares of the Portfolios. Financial institutions will receive fees from Mentor Distributors based upon Class B shares owned by their clients or customers. Mentor Funds has adopted a Shareholder Servicing Plan (the "Service Plan") with Mentor Distributors with respect to Class A and Class B shares of each Portfolio. Under the Service Plan, financial institutions will enter into shareholder service agreements with the Portfolios to provide administrative support services to their customers who from time to time may be owners of record or beneficial owners of Class A or Class B shares of one or more Portfolios. In return for providing these support services, a financial institution may receive payments from one or more Portfolios at a rate not exceeding 0.25% of the average daily net assets of the Class A or Class B shares of the particular Portfolio or Portfolios beneficially owned by the financial institution's customers for whom it is holder of record or with whom it has a servicing relationship. 98 MENTOR FUNDS NOTES TO FINANCIAL STATEMENTS (CONTINUED) - -------------------------------------------------------------------------------- Presently, the Portfolios' class specific expenses are limited to expenses incurred by a class of shares pursuant to its respective Distribution Plan. Under the Distribution Plan, shareholder service fees are charged in Class A and B and distribution fees are charged to Class B. For the six months ended March 31, 1999, distribution fees and shareholder servicing fees were as follows:
SHAREHOLDER SERVICING FEE CLASS B ------------------------- PORTFOLIO DISTRIBUTION FEE CLASS A CLASS B - ----------------------- ----------------- ----------- ----------- Growth $1,518,365 $125,769 $506,121 Global 416,023 88,235 138,674 Capital Growth 881,368 267,508 293,790 Income and Growth 571,335 137,814 190,445 Balanced 631,992 78,320 210,664 Municipal Income 150,302 75,234 75,151 Quality Income 273,958 125,975 136,979 Short-Duration Income 82,684 150,647 68,903 High Income 216,898 135,872 108,152 - ----------------------- ---------- -------- --------
NOTE 6: FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS In connection with portfolio purchases and sales of securities denominated in a foreign currency, Global Portfolio may enter into forward foreign currency exchange contracts ("contracts"). Additionally, from time to time Global Portfolio may enter into contracts to hedge certain foreign currency assets. Contracts are recorded at market value. Realized gains and losses arising from such transactions are included in net gain (loss) on investments and forward foreign currency exchange contracts. The Portfolio is subject to the credit risk that the other party will not complete the obligations of the contract. At March 31, 1999, Global Portfolio had outstanding forward contracts as set forth below.
CONTRACTS NET UNREALIZED TO DELIVER/ IN EXCHANGE APPRECIATION/ SETTLEMENT DATE RECEIVE VALUE FOR (DEPRECIATION) - ----------------- ---------------- ---------- ------------- ---------------- PURCHASES 4/01/99 British Pound 52,800 $ 85,113 $ 85,483 $ (370) 4/01/99 British Pound 92,130 148,513 149,158 (645) 4/01/99 British Pound 2,175 3,506 3,521 (15) 4/01/99 British Pound 14,584 23,509 23,611 (102) 4/01/99 British Pound 70,256 113,253 113,745 (492) 4/01/99 British Pound 24,996 40,294 40,469 (175) 4/06/99 British Pound 15,488 24,967 25,075 (108) 4/06/99 British Pound 39,804 64,164 64,443 (279) 4/06/99 British Pound 8,419 13,571 13,630 (59) 4/30/99 Eruo 213,787 230,730 230,249 481 4/01/99 Singapore Dollar 267,060 154,638 154,281 357 4/01/99 Singapore Dollar 90,042 52,137 52,017 120 4/06/99 Turkish Lira 6,092,812,500 163,324 163,675 (351) SALES 4/01/99 British Pound 25,808 41,602 41,784 182 - ------- ------------------ ------------- -------- -------- ------
99 MENTOR FUNDS NOTES TO FINANCIAL STATEMENTS (CONTINUED) - -------------------------------------------------------------------------------- NOTE 7: CAPITAL SHARE TRANSACTIONS The Declaration of Trust permits the Trustees to issue an unlimited number of full and fractional shares of beneficial interest. Transactions in Portfolio shares were as follows:
MENTOR GROWTH PORTFOLIO --------------------------------------------------------------------- SIX MONTHS ENDED YEAR ENDED 3/31/99 9/30/98 ---------------------------------- ---------------------------------- SHARES DOLLAR SHARES DOLLAR ---------------- ----------------- ---------------- ----------------- CLASS A: Shares sold 20,554,242 $ 317,331,063 12,016,618 $ 210,103,016 Shares issued upon reinvestment of distributions 209,824 2,939,628 346,751 6,474,795 Shares redeemed (19,478,995) (302,983,556) (12,306,743) (213,035,017) ----------- -------------- ----------- -------------- Change in net assets from capital share transactions 1,285,071 $ 17,287,135 56,626 $ 3,542,794 =========== ============== =========== ============== CLASS B: Shares sold 1,528,098 $ 22,897,224 4,138,130 $ 73,047,883 Shares issued upon reinvestment of distributions 1,070,622 14,539,244 1,667,456 30,460,604 Shares redeemed (4,214,789) (62,923,290) (4,698,525) (80,890,251) ----------- -------------- ----------- -------------- Change in net assets from capital share transactions (1,616,069) $ (25,486,822) 1,107,061 $ 22,618,236 =========== ============== =========== ============== CLASS Y: (A) Shares sold 738,165 $ 11,155,206 1,786,672 $ 30,602,698 Shares issued upon reinvestment of distributions 72,358 1,016,634 1 10 Shares redeemed (365,320) (5,597,286) (53,808) (894,152) ----------- -------------- ----------- -------------- Change in net assets from capital share transactions 445,203 $ 6,574,554 1,732,865 $ 29,708,556 =========== ============== =========== ==============
MENTOR PERPETUAL GLOBAL PORTFOLIO ----------------------------------------------------------------------- SIX MONTHS ENDED YEAR ENDED 3/31/99 9/30/98 ---------------------------------- ---------------------------------- SHARES DOLLARS SHARES DOLLARS --------------- ---------------- --------------- ---------------- CLASS A: Shares sold 2,369,455 $ 47,572,822 2,057,945 $ 42,154,809 Shares issued upon reinvestment of distributions 247,790 4,601,451 113,726 2,255,270 Shares redeemed (1,738,114) (34,619,252) (1,275,534) (25,637,616) ---------- ------------- ---------- ------------- Change in net assets from capital share transactions 879,131 $ 17,555,021 896,137 $ 18,772,463 ========== ============= ========== ============= CLASS B: Shares sold 575,905 $ 11,051,076 1,821,588 $ 36,737,964 Shares issued upon reinvestment of distributions 452,424 8,053,146 232,932 4,477,444 Shares redeemed (668,319) (12,833,727) (983,971) (18,930,107) ---------- ------------- ---------- ------------- Change in net assets from capital share transactions 360,010 $ 6,270,495 1,070,549 $ 22,285,301 ========== ============= ========== ============= CLASS Y: (A) Shares sold - $ - 53 $ 1,000 Shares issued upon reinvestment of distributions 5 85 - 8 Shares redeemed - - - - ---------- ------------- ---------- ------------- Change in net assets from capital share transactions 5 $ 85 53 $ 1,008 ========== ============= ========== =============
(a) For the year ended 9/30/98 - For the period from November 19, 1997 (initial offering of Class Y Shares) to September 30, 1998. 100 MENTOR FUNDS NOTES TO FINANCIAL STATEMENTS (CONTINUED) - -------------------------------------------------------------------------------- NOTE 7: CAPITAL SHARE TRANSACTIONS (CONTINUED)
MENTOR CAPITAL GROWTH PORTFOLIO ---------------------------------------------------------------- SIX MONTHS ENDED YEAR ENDED 3/31/99 9/30/98 -------------------------------- ------------------------------- SHARES DOLLARS SHARES DOLLARS --------------- ---------------- --------------- --------------- CLASS A: Shares sold 6,564,289 $ 156,453,797 5,110,051 $ 121,415,173 Shares issued upon reinvestment of distributions 741,596 16,051,578 278,288 5,833,664 Shares redeemed (2,143,545) (51,113,253) (1,926,775) (45,709,577) ---------- ------------- ---------- ------------- Change in net assets from capital share transactions 5,162,340 $ 121,392,122 3,461,564 $ 81,539,260 ========== ============= ========== ============= CLASS B: Shares sold 2,032,338 $ 45,677,249 4,375,173 $ 98,931,464 Shares issued upon reinvestment of distributions 1,106,815 22,759,934 507,715 10,256,056 Shares redeemed (1,109,805) (24,997,919) (1,063,324) (23,712,167) ---------- ------------- ---------- ------------- Change in net assets from capital share transactions 2,029,348 $ 43,439,264 3,819,564 $ 85,475,353 ========== ============= ========== ============= CLASS Y: (A) Shares sold -- $ -- 48 $ 1,000 Shares issued upon reinvestment of distributions 5 125 1 12 Shares redeemed -- -- -- -- ========== ============= ========== ============= Change in net assets from capital share transactions 5 $ 125 49 $ 1,012 ========== ============= ========== =============
MENTOR INCOME AND GROWTH PORTFOLIO --------------------------------------------------------------------- SIX MONTHS ENDED YEAR ENDED 3/31/99 9/30/98 -------------------------------- ---------------------------------- SHARES DOLLARS SHARES DOLLARS ------------- ---------------- --------------- ---------------- CLASS A: Shares sold 1,370,480 $ 27,029,221 2,515,923 $ 49,323,113 Shares issued upon reinvestment of distributions 307,537 5,973,032 371,373 7,153,831 Shares redeemed (621,010) (12,256,523) (915,370) (18,005,450) --------- ------------- --------- ------------- Change in net assets from capital share transactions 1,057,007 $ 20,745,730 1,971,926 $ 38,471,494 ========= ============= ========= ============= CLASS B: Shares sold 672,499 $ 13,233,579 2,642,784 $ 51,766,483 Shares issued upon reinvestment of distributions 426,951 8,278,473 559,471 10,748,481 Shares redeemed (594,987) (11,652,675) (1,074,795) (21,053,657) --------- ------------- ---------- ------------- Change in net assets from capital share transactions 504,463 $ 9,859,377 2,127,460 $ 41,461,307 ========= ============= ========== ============= CLASS Y: (A) Shares sold -- $ -- 53 $ 1,000 Shares issued upon reinvestment of distributions 3 55 2 30 Shares redeemed -- -- -- -- --------- ------------- ---------- ------------- Change in net assets from capital share transactions 3 $ 55 55 $ 1,030 ========= ============= ========== =============
(a) For the year ended 9/30/98 - For the period from November 19, 1997 (initial offering of Class Y Shares) to September 30, 1998. 101 MENTOR FUNDS NOTES TO FINANCIAL STATEMENTS (CONTINUED) - -------------------------------------------------------------------------------- NOTE 7: CAPITAL SHARE TRANSACTIONS (CONTINUED)
MENTOR BALANCED PORTFOLIO ---------------------------------------------------------------------- SIX MONTHS ENDED YEAR ENDED 3/31/99 9/30/98 ---------------------------------- --------------------------------- SHARES DOLLARS SHARES DOLLARS --------------- ---------------- --------------- --------------- CLASS A: Shares sold 7,357,872* $ 113,523,480 258,246 $ 3,577,935 Shares issued upon reinvestment of distributions 53,133 797,522 88,886 1,300,249 Shares redeemed (130,667) (3,234,796) (48,369) (810,000) Conversion of Class A Shares to Class Y Shares -- -- (273,416) (3,350,117) --------- ------------- -------- ------------ Change in net assets from capital share transactions 7,280,338 $ 111,086,206 25,347 $ 718,067 ========= ============= ======== ============ CLASS B: Shares sold 15,954,616* $ 214,154,434 412,403 $ 5,702,737 Shares issued upon reinvestment of distributions 115,470 1,719,720 -- -- Shares redeemed (1,523,742) (23,070,275) (9) (125) ---------- ------------- ----------- ------------ Change in net assets from capital share transactions 14,546,344 $ 192,803,879 412,394 $ 5,702,612 ========== ============= ========== ============ CLASS Y: (A) Shares sold 89 $ 1,303 -- $ -- Shares issued upon reinvestment of distributions 98 1,441 -- -- Shares redeemed (253,109) (3,662,016) (7,305) (100,000) Conversion of Class A Shares to Class Y Shares -- -- 273,416 3,350,117 ---------- ------------- ---------- ------------ Change in net assets from capital share transactions (252,922) $ (3,659,272) 266,111 $ 3,250,117 ========== ============= ========== ============
MENTOR MUNICIPAL INCOME PORTFOLIO ------------------------------------------------------------------ SIX MONTHS ENDED YEAR ENDED 3/31/99 9/30/98 ------------------------------- -------------------------------- SHARES DOLLARS SHARES DOLLARS ------------- --------------- ------------- ---------------- CLASS A Shares sold 1,504,089 $ 23,829,403 1,688,990 $ 26,509,509 Shares issued upon reinvestment of distributions 42,336 672,278 75,715 1,188,701 Shares redeemed (225,496) (3,573,184) (423,337) (6,641,364) --------- ------------ --------- ------------ Change in net assets from capital share transactions 1,320,929 $ 20,928,497 1,341,368 $ 21,056,846 ========= ============ ========= ============ CLASS B: Shares sold 401,215 $ 6,346,794 1,208,341 $ 18,966,860 Shares issued upon reinvestment of distributions 43,605 690,709 91,662 1,436,340 Shares redeemed (298,124) (4,720,495) (436,001) (6,820,355) --------- ------------ --------- ------------ Change in net assets from capital share transactions 146,696 $ 2,317,008 864,002 $ 13,582,845 ========= ============ ========= ============ CLASS Y: (A) Shares sold -- $ -- 64 $ 1,000 Shares issued upon reinvestment of distributions -- -- 3 43 Shares redeemed -- -- -- -- --------- ------------ --------- ------------ Change in net assets from capital share transactions -- $ -- 67 $ 1,043 ========= ============ ========= ============
(a)For the year ended 9/30/98 - For the period from November 19, 1997 (initial offering of Class Y Shares) to September 30, 1998. * Includes the following shares acquired from Strategy Portfolio in the tax-free exchange into the Balanced Portfolio on 11/13/98: Class A: 1,671,179 shares and Class B: 13,702,270 shares. 102 MENTOR FUNDS NOTES TO FINANCIAL STATEMENTS (CONTINUED) - -------------------------------------------------------------------------------- NOTE 7: CAPITAL SHARE TRANSACTIONS (CONTINUED)
MENTOR QUALITY INCOME PORTFOLIO ---------------------------------------------------------------------- SIX MONTHS ENDED YEAR ENDED 3/31/99 9/30/98 ---------------------------------- --------------------------------- SHARES DOLLARS SHARES DOLLARS --------------- ---------------- --------------- --------------- CLASS A: Shares sold 2,563,679 $ 33,699,152 4,256,782 $ 56,191,423 Shares issued upon reinvestment of distributions 143,437 1,900,220 233,015 3,077,659 Shares redeemed (1,184,191) (15,537,997) (1,597,720) (21,178,895) ---------- ------------- ---------- ------------- Change in net assets from capital share transactions 1,522,925 $ 20,061,375 2,892,077 $ 38,090,187 ========== ============= ========== ============= CLASS B: Shares sold 1,324,721 $ 17,465,999 3,811,046 $ 50,451,628 Shares issued upon reinvestment of distributions 163,492 2,165,673 272,551 3,600,049 Shares redeemed (1,332,345) (17,590,131) (1,478,885) (19,526,706) ---------- ------------- ---------- ------------- Change in net assets from capital share transactions 155,868 $ 2,041,541 2,604,712 $ 34,524,971 ========== ============= ========== ============= CLASS Y: (A) Shares sold -- $ -- 76 $ 1,000 Shares issued upon reinvestment of distributions -- -- 4 51 Shares redeemed -- -- -- -- ---------- ------------- ---------- ------------- Change in net assets from capital share transactions -- $ -- 80 $ 1,051 ========== ============= ========== =============
MENTOR SHORT-DURATION INCOME PORTFOLIO ---------------------------------------------------------------- SIX MONTHS ENDED YEAR ENDED 3/31/99 9/30/98 -------------------------------- ------------------------------- SHARES DOLLAR SHARES DOLLAR --------------- ---------------- --------------- --------------- CLASS A: Shares sold 7,806,852 $ 97,941,814 9,921,692 $ 124,978,729 Shares issued upon reinvestment of distributions 183,533 2,308,531 200,895 2,525,409 Shares redeemed (2,935,105) (36,833,260) (4,997,458) (62,897,886) ---------- ------------- ---------- ------------- Change in net assets from capital share transactions 5,055,280 $ 63,417,085 5,125,129 $ 64,606,252 ========== ============= ========== ============= CLASS B: Shares sold 1,087,645 $ 13,687,902 3,500,465 $ 44,073,519 Shares issued upon reinvestment of distributions 91,026 1,147,597 145,226 1,826,827 Shares redeemed (1,096,207) (13,774,611) (1,563,684) (19,674,936) ---------- ------------- ---------- ------------- Change in net assets from capital share transactions 82,464 $ 1,060,888 2,082,007 $ 26,225,410 ========== ============= ========== ============= CLASS Y: (A) Shares sold -- $ -- 79 $ 1,000 Shares issued upon reinvestment of distributions -- -- 4 49 ---------- ------------- ---------- ------------- Change in net assets from capital share transactions -- $ -- 83 $ 1,049 ========== ============= ========== =============
(a) For the year ended 9/30/98 - For the period from November 19, 1997 (initial offering of Class Y Shares) to September 30, 1998. 103 MENTOR FUNDS NOTES TO FINANCIAL STATEMENTS (CONTINUED) - -------------------------------------------------------------------------------- NOTE 7: CAPITAL SHARE TRANSACTIONS (CONTINUED)
MENTOR HIGH INCOME PORTFOLIO ------------------------------------------------------------------ SIX MONTHS ENDED PERIOD ENDED 3/31/99 9/30/1998 (B) --------------------------------- ------------------------------ SHARES DOLLAR SHARES DOLLAR -------------- ---------------- ------------- -------------- CLASS A: Shares sold 10,801,852 $119,005,627 4,775,208 $ 56,602,255 Shares issued upon reinvestment of distributions 204,356 2,252,051 51,541 580,207 Shares redeemed (695,694) (7,699,179) (168,561) (1,889,222) ---------- ------------ --------- ------------ Change in net assets from capital share transactions 10,310,514 $113,558,499 4,658,188 $ 55,293,240 ========== ============ ========= ============ CLASS B: Shares sold 4,173,805 $ 45,820,691 5,890,307 $ 69,683,852 Shares issued upon reinvestment of distributions 192,281 2,111,126 62,441 701,346 Shares redeemed (456,107) (5,001,935) (190,546) (2,108,787) ---------- ------------ --------- ------------ Change in net assets from capital share transactions 3,909,979 $ 42,929,882 5,762,202 $ 68,276,411 ========== ============ ========= ============
(b) For the period from June 23, 1998 (commencement of operations) to March 31, 1999. ADDITIONAL INFORMATION YEAR 2000 (UNAUDITED) The Portfolio receives services from a number of providers which rely on the effective functioning of their respective systems and the systems of others to perform those services. It is generally recognized that certain systems in use today may not be able to perform their intended functions adequately after 1999 because of the inability of computer software to distinguish the year 2000 from the year 1900. Mentor Advisors is taking steps that it believes are reasonably designed to address this potential "Year 2000" problem and to obtain satisfactory assurances that comparable steps are being taken by each of the Portfolios' other major service providers. There can be no assurance, however, that these steps will be sufficient to avoid any adverse impact on the Portfolio from this problem. 104 MENTOR FUNDS SHAREHOLDER INFORMATION - -------------------------------------------------------------------------------- TRUSTEES DANIEL J. LUDEMAN, TRUSTEE & CHAIRMAN Chairman and Chief Executive Officer Mentor Investment Group, LLC ARCH T. ALLEN III, TRUSTEE Attorney at Law Allen & Moore, LLP JERRY R. BARRENTINE, TRUSTEE President J.R. Barrentine & Associates ARNOLD H. DREYFUSS, TRUSTEE Former Chairman & Chief Executive Officer Hamilton Beach/Proctor-Silex, Inc. WESTON E. EDWARDS, TRUSTEE President Weston Edwards & Associates THOMAS F. KELLER, TRUSTEE Former Dean, Fuqua School of Business Duke University LOUIS W. MOELCHERT, JR., TRUSTEE Vice President for Business & Finance University of Richmond J. GARNETT NELSON, TRUSTEE Consultant Mid-Atlantic Holdings, LLC TROY A. PEERY, JR., TRUSTEE Former President Heilig-Meyers Company PETER J. QUINN, JR., TRUSTEE Managing Director Mentor Investment Group, LLC OFFICERS PAUL F. COSTELLO, PRESIDENT Managing Director Mentor Investment Group, LLC TERRY L. PERKINS, TREASURER AND SECRETARY Senior Vice President Mentor Investment Group, LLC MICHAEL A. WADE, ASSISTANT TREASURER Vice President Mentor Investment Group, LLC This report is authorized for distribution to prospective investors only when preceded or accompanied by a Mentor Funds prospectus, which contains complete information about fees, sales charges and expenses. Please read it carefully before you invest or send money. [MENTOR INVESTMENT GROUP LOGO] RIVERFRONT PLAZA 901 EAST BYRD STREET RICHMOND, VIRGINIA 23219 (800) 382-0016 1999 MENTOR DISTRIBUTORS, LLC MK 364 ---------- BULK RATE U.S. POSTAGE PAID RICHMOND, VIRGINIA PERMIT NO. 1209 ---------- Mentor Balanced Portfolio Pro Forma Combining Financial Statements (Unaudited) Schedules of Investments March 31, 1999
Mentor Balanced Mentor Income and Portfolio Growth Portfolio ProForma Combined - --------------------------------------------------------------------------------------------------------------------------- Shares Value Shares Value Shares Value - --------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS - 53.69% Basic Materials - 3.75% Air Products & Chemicals, Inc. 98,900 $ 3,387,325 98,900 $ 3,387,325 Alcoa, Inc. 48,000 1,977,000 48,000 1,977,000 AlliedSignal, Inc. 92,300 4,540,006 92,300 4,540,006 Bemis Co. 91,062 $ 2,828,614 91,062 2,828,614 British Steel PLC, ADR 108,900 2,198,419 92,300 2,198,419 Sherwin-Williams Co. 234,985 6,608,953 234,985 6,608,953 Westvaco Corp. 68,300 1,434,300 68,300 1,434,300 ----------- ----------- ----------- 9,437,567 13,537,050 22,974,617 ----------- ----------- ----------- Capital Goods & Construction - 5.06% Caterpillar, Inc. 48,000 2,205,000 48,000 2,205,000 Cooper Industries, Inc. 47,500 2,024,687 47,500 2,024,687 Cooper Tire & Rubber 125,000 2,296,875 125,000 2,296,875 Emerson Electric Co. 116,190 6,150,808 116,190 6,150,808 Hubbell, Inc. - Class B 89,400 3,576,000 89,400 3,576,000 Illinois Tool Works 109,135 6,752,728 109,135 6,752,728 Thomas & Betts Corp. 72,400 2,719,525 72,400 2,719,525 W. W. Grainger, Inc. 122,530 5,276,448 122,530 5,276,448 ----------- ----------- ----------- 18,179,984 12,822,087 31,002,071 ----------- ----------- ----------- Commercial Services - 1.31% Supervalu, Inc. 143,900 2,967,938 143,900 2,967,938 Wallace Computer Services, Inc. 254,500 5,042,281 254,500 5,042,281 ----------- ----------- 8,010,219 8,010,219 ----------- ----------- Consumer Cyclical - 6.33% Avalonbay Communities, Inc. 51,000 1,612,875 51,000 1,612,875 Chancellor Media Corp. - Class A * 129,600 6,107,400 129,600 6,107,400 Delphi Automotive Systems 130,000 2,307,500 130,000 2,307,500 Ford Motor Co. 74,000 4,199,500 74,000 4,199,500 Interpublic Group Companies, Inc. 87,335 6,801,213 87,335 6,801,213 Maytag Corp. 28,900 1,744,838 28,900 1,744,838 Newell-Rubbermaid, Inc. 159,594 7,580,730 159,594 7,580,730 Premark International, Inc. 74,100 2,440,668 74,100 2,440,668 Royal Caribbean Cruises Ltd. 91,900 3,584,100 91,900 3,584,100 The Walt Disney Co. 39,000 1,213,875 39,000 1,213,875 Tribune Co. 18,300 1,197,506 18,300 1,197,506 ----------- ----------- ----------- 26,484,824 12,305,381 38,790,205 ----------- ----------- ----------- Consumer Staples - 3.84% American Home Products Corp. 36,100 2,355,525 36,100 2,355,525 Baxter International, Inc. 54,300 3,583,800 54,300 3,583,800 Bestfoods 49,700 2,336,158 49,700 2,336,158 Dimon, Inc. 228,100 869,631 228,100 869,631 Hormel Foods Corp. 118,100 4,207,312 118,100 4,207,312 Kimberly Clark Corp. 28,600 1,371,013 28,600 1,371,013 Philip Morris Companies, Inc. 70,000 2,463,125 70,000 2,463,125 Sysco Corp. 240,935 6,339,602 240,935 6,339,602 ----------- ----------- ----------- 6,339,602 17,186,564 23,526,166 ----------- ----------- ----------- Energy - 3.10% Baker Hughes, Inc. 193,100 4,694,744 193,100 4,694,744 Chevron Corp. 26,400 2,334,750 26,400 2,334,750 Phillips Petroleum Co. 37,900 1,790,775 37,900 1,790,775 Repsol SA, ADR 50,000 2,562,500 50,000 2,562,500 Total SA, ADR 39,500 2,409,500 39,500 2,409,500 Unocal Corp. 65,800 2,422,262 65,800 2,422,262 USX-Marathon Group, Inc. 102,100 2,807,750 102,100 2,807,750 ----------- ----------- 19,022,281 19,022,281 ----------- -----------
Mentor Balanced Portfolio Pro Forma Combining Financial Statements (Unaudited) Schedules of Investments March 31, 1999
Mentor Balanced Mentor Income and Portfolio Growth Portfolio ProForma Combined - ---------------------------------------------------------------------------------------------------------------------------------- Shares Value Shares Value Shares Value - ---------------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS - continued Financial - 10.22% Ace Ltd. 119,300 3,720,669 119,300 3,720,669 American Express Co. 36,860 4,331,050 36,860 4,331,050 Charter One Financial, Inc. 97,872 2,826,054 97,872 2,826,054 Citigroup, Inc. 45,300 2,893,537 71,900 4,592,612 117,200 7,486,149 Citigroup, Inc., Cl. A 77,900 2,380,819 77,900 2,380,819 Federal National Mortgage Association 52,910 3,664,018 58,900 4,078,825 111,810 7,742,843 Jefferson Pilot Corp. 26,850 1,819,088 26,850 1,819,088 M & T Bank Corp. 2,901 1,389,579 2,901 1,389,579 Marsh & McLennan 14,700 1,090,556 14,700 1,090,556 North Fork BanCorp. 111,750 2,360,719 111,750 2,360,719 SouthTrust Corp. 141,500 5,279,719 141,500 5,279,719 Spieker Properties, Inc. 65,000 2,291,250 65,000 2,291,250 U.S. Bancorp 163,800 5,579,976 163,800 5,579,976 UnionBanCal Corp. 56,100 1,910,906 56,100 1,910,906 Wachovia Corp. 39,000 3,166,312 39,000 3,166,312 Washington Mutual, Inc. 70,880 2,897,220 70,880 2,897,220 Wells Fargo Co. 113,495 3,979,418 113,495 3,979,418 Wilmington Trust Corp. 40,700 2,324,988 40,700 2,324,988 ------------ ------------ ------------ 30,711,870 31,865,445 62,577,315 ------------ ------------ ------------ Health - 5.31% Abbott Laboratories 41,000 1,919,312 41,000 1,919,312 Bristol-Myers Squibb Co. 108,890 7,002,988 108,890 7,002,988 Columbia/HCA Healthcare Corp. 213,600 4,045,050 213,600 4,045,050 Johnson & Johnson 80,205 7,514,206 25,700 2,407,769 105,905 9,921,975 Pharmacia & Upjohn 61,000 3,804,875 61,000 3,804,875 Tenet Healthcare Corp. * 304,970 5,775,369 304,970 5,775,369 ------------ ------------ ------------ 20,292,563 12,177,006 32,469,569 ------------ ------------ ------------ Technology - 8.19% Alcatel Alsthom SA, ADR 75,500 1,722,344 75,500 1,722,344 Automatic Data Processing 167,800 6,942,725 167,800 6,942,725 Computer Sciences Corp. * 107,645 5,940,658 107,645 5,940,658 International Business Machines Corp. 21,800 3,864,050 21,800 3,864,050 MCI WorldCom, Inc. * 54,585 4,834,184 54,585 4,834,184 Sun Microsystems, Inc. * 74,925 9,360,942 74,925 9,360,942 SunGard Data Systems, Inc. * 184,100 7,364,000 184,100 7,364,000 Xerox Corp. 114,650 6,119,444 76,000 4,056,500 190,650 10,175,944 ------------ ------------ ------------ 40,561,953 9,642,894 50,204,847 ------------ ------------ ------------ Transportation & Services - 1.01% Union Pacific Corp. 65,000 3,473,438 65,000 3,473,438 Werner Enterprises, Inc. 174,272 2,744,784 174,272 2,744,784 ------------ ------------ ------------ 2,744,784 3,473,438 6,218,222 ------------ ------------ ------------ Utilities - 2.93% Bell Atlantic Corp. 67,700 3,499,244 67,700 3,499,244 DPL, Inc. 95,000 1,567,500 95,000 1,567,500 DQE, Inc. 43,000 1,650,125 43,000 1,650,125 MediaOne Group * 91,000 5,778,500 91,000 5,778,500 Pinnacle West Capital 60,400 2,197,050 60,400 2,197,050 SBC Communications, Inc. 69,300 3,265,762 69,300 3,265,762 ------------ ------------ ------------ 5,778,500 12,179,681 17,958,181 ------------ ------------ ------------ Miscellaneous - 2.64% Omnicom Group, Inc. 24,800 1,982,450 24,800 1,982,450 Tyco International, Inc. 104,145 7,472,404 104,145 7,472,404 UNUM Corp. 141,620 6,735,801 141,620 6,735,801 ------------ ------------ 16,190,655 16,190,655 ------------ ------------ - ---------------------------------------------------------------------------------------------------------------------------------- Total Common Stocks (cost - $161,484,581, $139,059,876 and $300,544,457, respectively) 176,722,302 152,222,046 328,944,348 - ----------------------------------------------------------------------------------------------------------------------------------
Mentor Balanced Portfolio Pro Forma Combining Financial Statements (Unaudited) Schedules of Investments March 31, 1999
Mentor Balanced Mentor Income and Portfolio Growth Portfolio - --------------------------------------------------------------------------------------------------------------------------- Principal Principal Amount Value Amount Value - --------------------------------------------------------------------------------------------------------------------------- FIXED INCOME SECURITIES - 40.59% U.S. Government Securities and Agencies - 29.62% Federal Home Loan Bank, 4.97%, 2/01/01 $ 2,000,000 $ 1,989,272 Federal National Mortgage Association 4.63%-6.64%, 10/15/01 - 7/02/07 1,480,000 1,463,992 Government National Mortgage Association 6.50%, 5/15/09 89,637 91,121 7.00%, 1/15/24 - 7/15/24 $ 3,239,198 $ 3,293,413 6.50%, 4/15/28 - 6/15/28 4,849,197 4,827,958 6.00%, 12/15/28 5,032,131 4,889,018 U.S. Treasury Bonds 4.25% - 7.50%, 11/15/03 - 8/15/28 78,098,000 83,682,925 6.25%, 8/15/23 3,000,000 3,134,130 U.S. Treasury Notes 5.63%, 11/30/00 10,400,000 10,504,312 4.75% - 6.63%, 2/28/02 - 11/15/08 21,992,000 22,144,232 6.25%, 6/30/02 12,000,000 12,385,200 6.38%, 8/15/02 3,000,000 3,110,160 7.50%, 2/15/05 3,000,000 3,323,040 6.50%, 8/15/05 - 10/15/06 14,000,000 14,870,960 6.13%, 12/31/01 - 8/15/07 11,350,000 11,774,273 - --------------------------------------------------------------------------------------------------------------------------- Total U.S. Government Securities and Agencies (cost $101,957,708, $72,234,297 and $174,192,005, respectively) 109,371,542 72,112,464 - --------------------------------------------------------------------------------------------------------------------------- Collateralized Mortgage Obligations - 0.49% AFG Receivables Trust, 6.65%, 10/15/02 23,927 24,001 Capital One Master Trust Series 1998-4, 5.43%, 1/15/07 125,000 122,957 CS First Boston, 7.18%, 2/25/18 25,000 25,108 Equifax Credit Corp., 6.33%, 1/15/22 900,000 902,392 Key Auto Finance Trust Series 1999-1, 5.63%, 7/15/03 1,500,000 1,500,288 Key Auto Finance Trust Series 1997-2, 6.1%, 11/15/00 29,219 29,245 PNC Student Loan Trust, 6.73%, 1/25/07 75,000 77,993 Union Acceptance Corp. Series 97A, 6.48%, 5/10/04 45,000 45,486 Union Acceptance Corp. 5.75%, 6/09/03 250,000 249,119 - --------------------------------------------------------------------------------------------------------------------------- Total Collateralized Mortgage Obligations (cost $2,978,346,$0) and $2,978,346, respectively) 2,976,589 - --------------------------------------------------------------------------------------------------------------------------- CORPORATE BONDS - 10.48% Industrial - 5.07% Aluminum Co. of America, 5.75%, 2/01/01 250,000 250,790 Archer-Daniels-Midland, 6.75%, 12/15/27 2,000,000 2,018,700 AT&T Corp., 6.00%, 3/15/09 1,500,000 1,492,305 Computer Associates International, 6.50%, 4/15/08, 144A 1,000,000 969,040 Computer Science, 6.25%, 3/15/09 1,275,000 1,279,488 Continental Airlines, Inc., 7.46%, 4/01/15 1,711,944 1,818,085 Dayton Hudson Co., 6.65%, 8/01/28 1,700,000 1,660,278 Enron Corp., 6.73%, 11/17/08 1,000,000 1,006,879 Gap, Inc., 6.90%, 9/15/07 1,000,000 1,056,980 Georgia Power Co., 5.50% - 6.00%, 3/01/00 - 12/01/05 2,500,000 2,457,390 Gillette Co., 5.75%, 10/15/05 250,000 247,218 Hershey Foods Corp., 7.20%, 8/15/27 1,000,000 1,069,470 IBM Corp., 5.10%, 11/10/03 1,000,000 967,183 ICI Wilmington, Inc., 6.95%, 9/15/04 1,000,000 1,005,280 International Business Machines Corp., 5.50%, 1/15/09 1,500,000 1,448,175 Lucent Technologies, 6.45%, 3/15/29 1,250,000 1,222,337 Mead Corp., 7.35%, 3/01/17 750,000 772,935 Pepsi Bottling Holdings, Inc., 5.63%, 2/17/09 1,800,000 1,735,674 Praxair, Inc., 6.15%, 4/15/03 1,000,000 990,980 Rockwell International Corp., 6.70%, 1/15/28 1,500,000 1,477,260 Safeway, Inc., 5.75% - 6.50%, 11/15/00 - 11/15/08 1,650,000 1,670,989 SmithKline Beechum, 6.63%, 10/01/01 330,000 338,762 Scripps (E. W.) Co., 6.38%, 10/15/02 1,000,000 1,014,300 Tenneco, Inc, 7.50%, 4/15/07 500,000 518,045 Williams Companies, Inc., 6.50%, 11/15/02 1,000,000 1,008,170 Zeneca Wilmington, 7.00%, 11/15/23 1,500,000 1,562,100 ----------- ----------- 11,655,240 19,403,573 ----------- ----------- ProForma Combined - --------------------------------------------------------------------------------------------- Principal Amount Value - --------------------------------------------------------------------------------------------- FIXED INCOME SECURITIES - 40.59% U.S. Government Securities and Agencies - 29.62% Federal Home Loan Bank, 4.97%, 2/01/01 $ 2,000,000 $ 1,989,272 Federal National Mortgage Association 4.63%-6.64%, 10/15/01 - 7/02/07 1,480,000 1,463,992 Government National Mortgage Association 6.50%, 5/15/09 89,637 91,121 7.00%, 1/15/24 - 7/15/24 3,239,198 3,293,413 6.50%, 4/15/28 - 6/15/28 4,849,197 4,827,958 6.00%, 12/15/28 5,032,131 4,889,018 U.S. Treasury Bonds 4.25% - 7.50%, 11/15/03 - 8/15/28 78,098,000 83,682,925 6.25%, 8/15/23 3,000,000 3,134,130 U.S. Treasury Notes 5.63%, 11/30/00 10,400,000 10,504,312 4.75% - 6.63%, 2/28/02 - 11/15/08 21,992,000 22,144,232 6.25%, 6/30/02 12,000,000 12,385,200 6.38%, 8/15/02 3,000,000 3,110,160 7.50%, 2/15/05 3,000,000 3,323,040 6.50%, 8/15/05 - 10/15/06 14,000,000 14,870,960 6.13%, 12/31/01 - 8/15/07 11,350,000 11,774,273 - --------------------------------------------------------------------------------------------- Total U.S. Government Securities and Agencies (cost $101,957,708, $72,234,297 and $174,192,005, respectively) 181,484,006 - --------------------------------------------------------------------------------------------- Collateralized Mortgage Obligations - 0.49% AFG Receivables Trust, 6.65%, 10/15/02 23,927 24,001 Capital One Master Trust Series 1998-4, 5.43%, 1/15/07 125,000 122,957 CS First Boston, 7.18%, 2/25/18 25,000 25,108 Equifax Credit Corp., 6.33%, 1/15/22 900,000 902,392 Key Auto Finance Trust Series 1999-1, 5.63%, 7/15/03 1,500,000 1,500,288 Key Auto Finance Trust Series 1997-2, 6.1%, 11/15/00 29,219 29,245 PNC Student Loan Trust, 6.73%, 1/25/07 75,000 77,993 Union Acceptance Corp. Series 97A, 6.48%, 5/10/04 45,000 45,486 Union Acceptance Corp. 5.75%, 6/09/03 250,000 249,119 - --------------------------------------------------------------------------------------------- Total Collateralized Mortgage Obligations (cost $2,978,346,$0) and $2,978,346, respectively) 2,976,589 - --------------------------------------------------------------------------------------------- CORPORATE BONDS - 10.48% Industrial - 5.07% Aluminum Co. of America, 5.75%, 2/01/01 250,000 250,790 Archer-Daniels-Midland, 6.75%, 12/15/27 2,000,000 2,018,700 AT&T Corp., 6.00%, 3/15/09 1,500,000 1,492,305 Computer Associates International, 6.50%, 4/15/08, 144A 1,000,000 969,040 Computer Science, 6.25%, 3/15/09 1,275,000 1,279,488 Continental Airlines, Inc., 7.46%, 4/01/15 1,711,944 1,818,085 Dayton Hudson Co., 6.65%, 8/01/28 1,700,000 1,660,278 Enron Corp., 6.73%, 11/17/08 1,000,000 1,006,879 Gap, Inc., 6.90%, 9/15/07 1,000,000 1,056,980 Georgia Power Co., 5.50% - 6.00%, 3/01/00 - 12/01/05 2,500,000 2,457,390 Gillette Co., 5.75%, 10/15/05 250,000 247,218 Hershey Foods Corp., 7.20%, 8/15/27 1,000,000 1,069,470 IBM Corp., 5.10%, 11/10/03 1,000,000 967,183 ICI Wilmington, Inc., 6.95%, 9/15/04 1,000,000 1,005,280 International Business Machines Corp., 5.50%, 1/15/09 1,500,000 1,448,175 Lucent Technologies, 6.45%, 3/15/29 1,250,000 1,222,337 Mead Corp., 7.35%, 3/01/17 750,000 772,935 Pepsi Bottling Holdings, Inc., 5.63%, 2/17/09 1,800,000 1,735,674 Praxair, Inc., 6.15%, 4/15/03 1,000,000 990,980 Rockwell International Corp., 6.70%, 1/15/28 1,500,000 1,477,260 Safeway, Inc., 5.75% - 6.50%, 11/15/00 - 11/15/08 1,650,000 1,670,989 SmithKline Beechum, 6.63%, 10/01/01 330,000 338,762 Scripps (E. W.) Co., 6.38%, 10/15/02 1,000,000 1,014,300 Tenneco, Inc, 7.50%, 4/15/07 500,000 518,045 Williams Companies, Inc., 6.50%, 11/15/02 1,000,000 1,008,170 Zeneca Wilmington, 7.00%, 11/15/23 1,500,000 1,562,100 ----------- 31,058,813 -----------
Mentor Balanced Portfolio Pro Forma Combining Financial Statements (Unaudited) Schedules of Investments March 31, 1999
Mentor Income and Growth Mentor Balanced Portfolio Portfolio - -------------------------------------------------------------------------------------------------------------------------------- Principal Principal Amount Value Amount Value - -------------------------------------------------------------------------------------------------------------------------------- CORPORATE BONDS - continued Financial - 3.36% Allmerica Financial Corp., 7.63%, 10/15/25 $1,130,000 $ 1,179,664 Allstate Corp., 6.75%, 5/15/18 1,000,000 1,000,270 American General Finance, 5.88%, 7/01/00 250,000 250,942 Associates Corp. of North America: 5.25%, 3/30/00 250,000 249,898 6.25%, 11/01/08 $1,500,000 $ 1,508,504 Bank One Texas, 6.25%, 2/15/08 1,000,000 996,690 BankAmerica Corp., 7.88%, 12/01/02 1,000,000 1,063,990 Chase Manhattan Corp., 7.75%, 11/01/99 250,000 253,490 Comerica Bank, 7.13%, 12/01/13 250,000 250,702 Discover Series 1998-7, 5.60%, 5/15/06 125,000 123,545 Finova Capital Corp., 6.39%, 10/08/02 1,000,000 1,008,440 First National Bank of Boston., 8.00%, 9/15/04 250,000 270,345 Fleet Financial Group, 6.88%, 1/15/28 1,000,000 994,300 Ford Motor Credit Co., 5.80%, 1/12/09 1,250,000 1,211,687 General Electric Capital Corp., 6.29%, 12/15/07 300,000 302,721 Great Western Financial, 6.38%, 7/01/00 250,000 252,265 Heller Financial, 6.38%, 11/10/00 1,000,000 1,009,980 Home Savings of America, 6.00%, 11/01/00 250,000 251,200 Household Financial Co., 5.88%, 2/01/09 800,000 768,552 Key Bank, NA, 5.80%, 4/01/04 1,375,000 1,369,252 MBIA Inc., 7.00%, 12/15/25 1,000,000 1,007,760 Merrill Lynch & Co., 6.00%, 2/17/09 1,250,000 1,208,559 National City Corp., 5.75%, 2/01/09 800,000 769,479 National Rural Utilities, 5.50%, 1/15/05 1,300,000 1,271,409 NationsBank Corp., 7.80%, 9/15/16 1,000,000 1,099,800 Norwest Corp., 6.80%, 5/15/02 60,000 61,747 Security Benefits Life Co., 8.75%, 5/15/16, 144A 500,000 524,375 Toronto Dominion Bank, 6.13%, 11/01/08 250,000 245,828 Toyota Motor Credit, 5.63%, 11/13/03 100,000 99,215 ----------- ----------- 7,325,418 13,279,191 ----------- ----------- Utilities - 2.05% Duke Energy Corp., 6.00%, 12/01/28 1,000,000 915,100 Florida Power & Light, 5.38%, 4/01/00 250,000 249,992 GTE California, 5.50%, 1/15/09 1,515,000 1,447,826 GTE North, Inc., 5.65%, 11/15/08 1,500,000 1,450,421 National Fuel Gas Co., 6.00%, 3/01/09 1,000,000 983,780 New York Telephone, 6.00%, 4/15/08 1,000,000 995,920 Northern Natural Gas, 6.75%, 9/15/08, 144A 2,000,000 2,011,540 Pacific Gas & Electric Co., 5.93%, 10/08/03 250,000 249,465 PSI Energy, Inc., 6.00%, 12/14/01 1,000,000 987,764 Southwestern Public Service Co., 6.88%, 12/01/99 250,000 252,748 Sprint Capital Corp., 6.13%, 11/15/08 1,450,000 1,427,457 System Energy Resources, 7.71%, 8/01/01 500,000 517,120 Union Electric Co., 6.75%, 10/15/99 250,000 252,353 U.S. West Capital Funding, Inc., 6.88%, 7/15/28 785,000 796,280 ------------ ------------ 5,313,468 7,224,298 - -------------------------------------------------------------------------------------------------------------------------------- Total Corporate Bonds (cost $24,650,350, $40,147,348 and $64,797,698, respectively) 24,294,126 39,907,062 - -------------------------------------------------------------------------------------------------------------------------------- Total Fixed Income Securities (cost $129,586,404, $112,381,645 and $241,968,049, respectively) 136,642,257 112,019,526 - -------------------------------------------------------------------------------------------------------------------------------- SHORT-TERM INVESTMENTS - 4.01% Repurchase Agreements - 4.01% Goldman Sachs & Co. dated 3/31/99, 4.95%, due 4/01/99, collateralized by $33,830,000 Federal Home Loan Mortgage Corp., 7.50%, 11/01/27, market value $21,376,682 (cost $20,936,014) 20,936,014 20,936,014 Paine Webber, Inc. dated 3/31/99, 4.90% due 4/01/99, collateralized by $2,700,000 U.S. Treasury Bond, 9.25%, 2/15/14, market value $3,657,656 (cost $3,619,000) 3,619,000 3,619,000 - -------------------------------------------------------------------------------------------------------------------------------- Total Short-Term Investments (cost - $20,936,014, $3,619,000 and $24,555,014, respectively) 20,936,014 3,619,000 - -------------------------------------------------------------------------------------------------------------------------------- ProForma Combined - ------------------------------------------------------------------------------------------------------ Principal Amount Value - ------------------------------------------------------------------------------------------------------ CORPORATE BONDS - continued Financial - 3.36% Allmerica Financial Corp., 7.63%, 10/15/25 $ 1,130,000 $ 1,179,664 Allstate Corp., 6.75%, 5/15/18 1,000,000 1,000,270 American General Finance, 5.88%, 7/01/00 250,000 250,942 Associates Corp. of North America: 5.25%, 3/30/00 250,000 249,898 6.25%, 11/01/08 1,500,000 1,508,504 Bank One Texas, 6.25%, 2/15/08 1,000,000 996,690 BankAmerica Corp., 7.88%, 12/01/02 1,000,000 1,063,990 Chase Manhattan Corp., 7.75%, 11/01/99 250,000 253,490 Comerica Bank, 7.13%, 12/01/13 250,000 250,702 Discover Series 1998-7, 5.60%, 5/15/06 125,000 123,545 Finova Capital Corp., 6.39%, 10/08/02 1,000,000 1,008,440 First National Bank of Boston., 8.00%, 9/15/04 250,000 270,345 Fleet Financial Group, 6.88%, 1/15/28 1,000,000 994,300 Ford Motor Credit Co., 5.80%, 1/12/09 1,250,000 1,211,687 General Electric Capital Corp., 6.29%, 12/15/07 300,000 302,721 Great Western Financial, 6.38%, 7/01/00 250,000 252,265 Heller Financial, 6.38%, 11/10/00 1,000,000 1,009,980 Home Savings of America, 6.00%, 11/01/00 250,000 251,200 Household Financial Co., 5.88%, 2/01/09 800,000 768,552 Key Bank, NA, 5.80%, 4/01/04 1,375,000 1,369,252 MBIA Inc., 7.00%, 12/15/25 1,000,000 1,007,760 Merrill Lynch & Co., 6.00%, 2/17/09 1,250,000 1,208,559 National City Corp., 5.75%, 2/01/09 800,000 769,479 National Rural Utilities, 5.50%, 1/15/05 1,300,000 1,271,409 NationsBank Corp., 7.80%, 9/15/16 1,000,000 1,099,800 Norwest Corp., 6.80%, 5/15/02 60,000 61,747 Security Benefits Life Co., 8.75%, 5/15/16, 144A 500,000 524,375 Toronto Dominion Bank, 6.13%, 11/01/08 250,000 245,828 Toyota Motor Credit, 5.63%, 11/13/03 100,000 99,215 ------------ 20,604,609 ------------ Utilities - 2.05% Duke Energy Corp., 6.00%, 12/01/28 1,000,000 915,100 Florida Power & Light, 5.38%, 4/01/00 250,000 249,992 GTE California, 5.50%, 1/15/09 1,515,000 1,447,826 GTE North, Inc., 5.65%, 11/15/08 1,500,000 1,450,421 National Fuel Gas Co., 6.00%, 3/01/09 1,000,000 983,780 New York Telephone, 6.00%, 4/15/08 1,000,000 995,920 Northern Natural Gas, 6.75%, 9/15/08, 144A 2,000,000 2,011,540 Pacific Gas & Electric Co., 5.93%, 10/08/03 250,000 249,465 PSI Energy, Inc., 6.00%, 12/14/01 1,000,000 987,764 Southwestern Public Service Co., 6.88%, 12/01/99 250,000 252,748 Sprint Capital Corp., 6.13%, 11/15/08 1,450,000 1,427,457 System Energy Resources, 7.71%, 8/01/01 500,000 517,120 Union Electric Co., 6.75%, 10/15/99 250,000 252,353 U.S. West Capital Funding, Inc., 6.88%, 7/15/28 785,000 796,280 ------------ 12,537,766 - ------------------------------------------------------------------------------------------------------ Total Corporate Bonds (cost $24,650,350, $40,147,348 and $64,797,698, respectively) 64,201,188 - ------------------------------------------------------------------------------------------------------ Total Fixed Income Securities (cost $129,586,404, $112,381,645 and $241,968,049, respectively) 248,661,783 - ------------------------------------------------------------------------------------------------------ SHORT-TERM INVESTMENTS - 4.01% Repurchase Agreements - 4.01% Goldman Sachs & Co. dated 3/31/99, 4.95%, due 4/01/99, collateralized by $33,830,000 Federal Home Loan Mortgage Corp., 7.50%, 11/01/27, market value $21,376,682 (cost $20,936,014) 20,936,014 20,936,014 Paine Webber, Inc. dated 3/31/99, 4.90% due 4/01/99, collateralized by $2,700,000 U.S. Treasury Bond, 9.25%, 2/15/14, market value $3,657,656 (cost $3,619,000) 3,619,000 3,619,000 - ------------------------------------------------------------------------------------------------------ Total Short-Term Investments (cost - $20,936,014, $3,619,000 and $24,555,014, respectively) 24,555,014 - ------------------------------------------------------------------------------------------------------
Mentor Balanced Portfolio Pro Forma Combining Financial Statements (Unaudited) Schedules of Investments March 31, 1999
Mentor Income and Growth Mentor Balanced Portfolio Portfolio - --------------------------------------------------------------------------------------------------------------------------------- Value Value - --------------------------------------------------------------------------------------------------------------------------------- Total Investments (cost - $312,006,999 $255,060,520 and 567,067,519, respectively) - 98.29% 334,300,573 267,860,572 Other Assets and Liabilities - net - 1.71% 6,992,993 3,485,013 - --------------------------------------------------------------------------------------------------------------------------------- TOTAL NET ASSETS - 100.0% $ 341,293,566 $ 271,345,585 - --------------------------------------------------------------------------------------------------------------------------------- ProForma Combined - ----------------------------------------------------------------------------------------------------- Value - ----------------------------------------------------------------------------------------------------- Total Investments (cost - $312,006,999 $255,060,520 and 567,067,519, respectively) - 98.29% 602,161,145 Other Assets and Liabilities - net - 1.71% 10,478,006 - ----------------------------------------------------------------------------------------------------- TOTAL NET ASSETS - 100.0% $ 612,639,151 - -----------------------------------------------------------------------------------------------------
* Non-income producing security. 144A Security that may be resold to "qualified institutional buyers" under Rule 144A of the Securities Act of 1933. This security has been determined to be liquid under guidelines established by the Board of Trustees. Summary of Abbreviations ADR American Depository Receipts FUTURES CONTRACTS - SHORT POSITIONS
Number of Portfolio Contracts Position Contracts Expiration - ---------------------------------------------------------------------------------------------------------------------------------- Mentor Balanced Portfolio 690 Short U.S. Long Bond Jun-99 Net Unrealized Notional Appreciation Portfolio Value (Depreciation) - ----------------------------------------------------------------------------------------------------------------- Mentor Balanced Portfolio $ 69,000,000 $ (2,760,157)
See Notes to Pro Forma Combining Financial Statements. Mentor Balanced Portfolio Pro Forma Combining Financial Statements (Unaudited) Statements of Assets and Liabilities March 31, 1999
Mentor Mentor Income Balanced and Growth ProForma Portfolio Portfolio Adjustments Combined - ---------------------------------------------------------------------------------------------------------------------------------- Assets Identified cost of securities $ 312,006,999 $ 255,060,520 $ 567,067,519 Net unrealized gains or losses on securities 22,293,574 12,800,052 35,093,626 - ---------------------------------------------------------------------------------------------------------------------------------- Market value of securities 334,300,573 267,860,572 602,161,145 Collateral for securities loaned 87,189,594 57,206,916 144,396,510 Receivable for securities sold 1,002,666 2,260,145 3,262,811 Receivable for Fund shares sold 4,851,369 1,054,367 5,905,736 Dividends and interest receivable 2,689,063 1,788,988 4,478,051 Receivable for variation margin on open futures contracts 366,563 0 366,563 Prepaid expenses and other assets 142,495 0 142,495 - ---------------------------------------------------------------------------------------------------------------------------------- Total assets 430,542,323 330,170,988 760,713,311 - ---------------------------------------------------------------------------------------------------------------------------------- Liabilities Payable for securities purchased 1,514,077 852,634 2,366,711 Payable for securities on loan 87,189,594 57,206,916 144,396,510 Payable for Fund shares redeemed 535,285 668,713 1,203,998 Accrued expenses and other liabilities 9,801 97,140 106,941 - ---------------------------------------------------------------------------------------------------------------------------------- Total liabilities 89,248,757 58,825,403 148,074,160 - ---------------------------------------------------------------------------------------------------------------------------------- Net Assets $ 341,293,566 $ 271,345,585 $ 612,639,151 - ---------------------------------------------------------------------------------------------------------------------------------- Net assets represented by Paid-in capital $ 312,761,476 $ 252,240,342 $ 565,001,818 Undistributed (overdistributed) net investment income (210,671) 38,706 (171,965) Accumulated net realized gains or losses on securities 3,689,030 6,266,485 9,955,515 Net unrealized gains or losses on securities 25,053,731 12,800,052 37,853,783 - ---------------------------------------------------------------------------------------------------------------------------------- Net Assets $ 341,293,566 $ 271,345,585 $ 612,639,151 - ---------------------------------------------------------------------------------------------------------------------------------- Class A Net assets $ 114,360,319 $ 118,695,506 $ 233,055,825 Shares outstanding 7,538,584 6,112,024 1,712,332 (a) 15,362,940 Net asset value $ 15.17 $ 19.42 $ 15.17 Maximum offering price (based on sales charge of 5.75%) $ 16.10 $ 20.60 $ 16.10 Class C (Target - Class B) Net assets $ 226,733,302 $ 152,648,937 $ 379,382,239 Shares outstanding 14,958,738 7,869,390 2,200,935 (a) 25,029,063 Net asset value $ 15.16 $ 19.40 $ 15.16 Class Y Net assets $ 199,945 $ 1,142 $ 201,087 Shares outstanding 13,189 58 17 (a) 13,264 Net asset value $ 15.16 $ 19.69 $ 15.16
(a) Reflects the impact of converting shares of the target fund into the survivor fund. See Notes to Pro Forma Combining Financial Statements. Mentor Balanced Portfolio Pro Forma Combining Financial Statements (Unaudited) Statements of Operations March 31, 1999
Mentor Income Mentor Balanced and Growth Pro Forma Portfolio Portfolio Adjustments Combined - --------------------------------------------------------------------------------------------------------------------------------- Investment income Dividends (net of foreign withholding taxes of $0, $63,820 and $63,820, respectively) $ 824,308 $ 3,511,583 $ 4,335,891 Interest 2,936,362 6,581,584 9,517,946 - --------------------------------------------------------------------------------------------------------------------------------- Total investment income 3,760,670 10,093,167 13,853,837 - --------------------------------------------------------------------------------------------------------------------------------- Expenses Advisory fee 887,447 1,888,818 2,776,265 Distribution Plan expenses 941,099 1,742,327 2,683,426 Transfer agent fee 169,791 360,733 530,524 Administrative services fees 118,311 251,842 370,153 Trustees' fees and expenses 3,044 6,478 9,522 Printing and postage expenses 54,453 22,509 76,962 Custodian fee 41,159 59,490 28,123 (a) 128,772 Registration and filing fees 57,936 57,883 (19,704) (b) 96,115 Professional fees 10,038 17,010 (7,350) (c) 19,698 Other 5,414 903 10,619 (a) 16,936 - --------------------------------------------------------------------------------------------------------------------------------- Total expenses 2,288,692 4,407,993 11,688 6,708,373 Less: Fee waivers and expense reimbursements (31,724) 0 31,724 (d) 0 - --------------------------------------------------------------------------------------------------------------------------------- Net expenses 2,256,968 4,407,993 43,412 6,708,373 - --------------------------------------------------------------------------------------------------------------------------------- Net investment income 1,503,702 5,685,174 (43,412) 7,145,464 - --------------------------------------------------------------------------------------------------------------------------------- Net realized and unrealized gains or losses on securities and foreign currency related transactions Net realized gains or losses on securities and foreign currency related transactions 4,881,247 15,608,789 20,490,036 - --------------------------------------------------------------------------------------------------------------------------------- Net change in unrealized gains or losses on securities and foreign currency related transactions 24,293,314 (13,601,682) 10,691,632 - --------------------------------------------------------------------------------------------------------------------------------- Net realized and unrealized gains or losses on securities and foreign currency related transactions 29,174,561 2,007,107 31,181,668 - --------------------------------------------------------------------------------------------------------------------------------- Net increase in net assets resulting from operations $ 30,678,263 $ 7,692,281 (43,412) $ 38,327,132 - ----------------------------------------------------------------------------------------------------------------------------------
(a) Reflects an increase based on the combined fund. (c) Reflects a savings resulting from duplicate state registration fees being eliminated. (c) Reflects a savings resulting from duplicate audit fees being eliminated. (d) No waiver required on combined fund. See Notes to Pro Forma Combining Financial Statements. Mentor Balanced Portfolio Notes to Pro Forma Combining Financial Statements (Unaudited) March 31, 1999 1. Basis of Combination - The Pro Forma Combining Statement of Assets and Liabilities, including the Pro Forma Schedule of Investments and the related Pro Forma Combining Statement of Operations ("Pro Forma Statements"), reflect the accounts of Mentor Balanced Portfolio ("Balanced Portfolio") and Mentor Income and Growth Portfolio ("Income and Growth Portfolio") at March 31, 1999 and for the respective periods then ended. The Pro Forma Statements give effect to the proposed Agreement and Plan of Reorganization (the "Reorganization") to be submitted to shareholders of Income and Growth Portfolio. The Reorganization provides for the acquisition of all assets and the identified liabilities of Income and Growth Portfolio by Balanced Portfolio, in exchange for Class A, Class C and Class Y of Balanced Portfolio. Thereafter, there will be a distribution of Class A, Class C and Class Y of Balanced Portfolio to the Class A, Class B and Class Y shareholders of Income and Growth Portfolio in liquidation and subsequent termination thereof. As a result of the Reorganization, the shareholders of Income and Growth Portfolio will become the owners of that number of full and fractional Class A, Class C and Class Y shares of Balanced Portfolio having an aggregate net asset value equal to the aggregate net asset value of their shares of Income and Growth Portfolio as of the close of business immediately prior to the date that Income and Growth Portfolio net assets are exchanged for Class A, Class C and Class Y shares of Balanced Portfolio. The Pro Forma Statements reflect the expenses of each Fund in carrying out its obligations under the Reorganization as though the merger occurred at the beginning of the respective periods presented. The information contained herein is based on the experience of each Fund for the respective periods then ended and is designed to permit shareholders of the consolidating mutual funds to evaluate the financial effect of the proposed Reorganization. The expenses of Income and Growth Portfolio in connection with the Reorganization (including the cost of any proxy soliciting agents) will be borne equally by Balanced Portfolio and Income and Growth Portfolio. It is not anticipated that the securities of the combined portfolio will be sold in significant amounts in order to comply with the policies and investment practices of Balanced Portfolio. The Pro Forma Statements should be read in conjunction with the historical financial statements of each Fund incorporated by reference in the Statement of Additional Information. 2. Shares of Beneficial Interest - The Pro Forma net asset values per share assume the issuance of Class A, Class C and Class Y shares of Balanced Portfolio which would have been issued at March 31, 1999 in connection with the proposed Reorganization. Class A, Class B and Class Y shareholders of Income and Growth Portfolio would receive Class A, Class C and Class Y shares, respectively, of Balanced Portfolio based on conversion ratios determined on March 31, 1999. The conversion ratios are calculated by dividing the net asset value of Class A, Class B and Class Y of Income and Growth Portfolio by the net asset value per share of Class A, Class C and Class Y, respectively, of Balanced Portfolio. 3. Pro Forma Operations - The Pro Forma Combining Statement of Operations assumes similar rates of gross investment income for the investments of each Fund. Accordingly, the combined gross investment income is equal to the sum of each Fund's gross investment income. Pro Forma operating expenses include the actual expenses of the Funds adjusted to reflect the expected expenses of the combined entity. The combined pro forma expenses were calculated by determining the expense rates based on the combined average net assets of the two funds and applying those rates to the average net assets of the Balanced Portfolio for the twelve months ended March 31, 1999 and to the average net assets of the Income and Growth Portfolio for the twelve months ended March 31, 1999. The adjustments reflect those amounts needed to adjust the combined expenses to these rates. -127- MENTOR FUNDS Form N-14 PART C OTHER INFORMATION Item 15. Indemnification. Under the terms of Article VI of Registrant's Declaration of Trust, the Registrant is required to reimburse Trustees for all expenses incurred in connection with litigation, proceedings and claims and the obligations of the Trust under Article XI thereof and the By-Laws to indemnify its Trustees, officers, employees, shareholders and agents, and any contract obligation to indemnify principal underwriters under Section 3 of Article VII of the Registrant's Declaration of Trust. Under the terms of Article XI of Registrant's Declaration of Trust, the Trustees, officers, employees, and agents of the Trust, in incurring any liabilities or obligations, or in taking or omitting any other actions for or in connection with the Trust, shall be deemed to be acting as a Trustee, officer, employee, or agent of the Trust, and not in his own individual capacity. If, notwithstanding Section 3 of Article XI of Registrant's Declaration of Trust, and any of the Trustees, officers, employees, and agents of the Trust shall be held liable to any other person by omission of an express exculpatory clause from any agreement, undertaking or obligation, the shareholder, Trustee, officer, employee or agent shall be indemnified and reimbursed by the Trust. This summary is qualified in its entirety by reference to the Registrant's Declaration of Trust, incorporated by reference as Exhibit (1). Item 16. Exhibits. (1) (i) Conformed copy of Declaration of Trust of the Registrant, with Amendments No. 1 and 2 (2); (ii) Amendment No. 5 to the Declaration of Trust of the Registrant (4); -128- (iii) Form of Amendment to the Declaration of Trust of the Registrant (5); (iv) Form of Proposed Amendment to the Declaration of Trust of the Registrant to be dated as of May 12, 1998 (6); (v) Amendment No. 6 to the Declaration of Trust of the Registrant (8); (vi) Amendment No. 7 to the Declaration of Trust of the Registrant (8); (vii) Amendment No. 8 to the Declaration of Trust of the Registrant(8); (viii) Amendment No. 9 to the Declaration of Trust of the Registrant (9); (2) (i) Copy of By-Laws of the Registrant (1); (ii) Amendment to By-Laws (8); (3) Not applicable; (4) Agreement and Plan of Reorganization. Exhibit D to the Prospectus contained in Part A of this Registration Statement; (5) Applicable Sections of Registrant's Declaration of Trust and By-Laws (1)(2)(4)(5); (6) (i) Form of Investment Advisory Agreement (Income and Growth Portfolio) (6); (ii) Form of Investment Advisory and Management Agreement (Balanced Portfolio) (6); (7) Form of Distribution Agreement of the Registrant (6); (8) Not applicable; (9) (i) Conformed copy of Custodian Contract of the Registrant with Investors Fiduciary Trust Company (2); (ii) Conformed copy of Custodian Contract of the Registrant with State Street Bank and Trust Company (2); -129- (iii) Form of Administration Agreement of the Registrant in respect of certain Portfolios (9); (iv) Form of Custodian Contract with State Street Bank and Trust Company in respect of foreign securities (3); (10) (i) Plan of Distribution (10); (ii) Amended and Restated Rule 18f-3(d) Plan (10); (11) Opinion and Consent of Counsel as to legality of the Securities being registered (11); (12) Opinion and Consent of counsel as to tax matters (11); (13) Not applicable; (14) Consent of Independent Auditors (9); (15) Not applicable; (16) Powers of Attorney (8) ; (17) Form of Proxy Card (11). - ------------------------------------------ (1) Incorporated by reference to Registrant's Pre-Effective Amendment No. 1 on Form N-1A filed April 14, 1992. (2) Incorporated by reference to Registrant's Post-Effective Amendment No. 3 on Form N-1A filed May 14, 1993. (3) Incorporated by reference to Registrant's Post-Effective Amendment No. 10 on Form N-1A filed January 15, 1996. (4) Incorporated by reference to Registrant's Post-Effective Amendment No. 15 on Form N-1A filed December 22, 1997. (5) Incorporated by reference to Registrant's Post-Effective Amendment No. 16 on Form N-1A filed January 30, 1998. (6) Incorporated by reference to Registrant's Post-Effective Amendment No. 17 filed on May 12, 1998. (7) Incorporated by reference to Registrant's Post-Effective Amendment No. 20 filed on July 10, 1998. (8) Incorporated by reference to Registrant's Post-Effective Amendment No. 21 filed on November 30, 1998. (9) Previously filed . (10) Incorporated by reference to Registrant's Post-Effective Amendment No. 22 filed on January 29, 1999. (11) Filed herewith. -130- 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 a part of this Registration Statement by any person or party who is deemed to be an underwriter within the meaning of Rule 145(c) under the Securities Act of 1933, the reoffering prospectus will contain the information called for by the applicable registration form for the 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 a part of an amendment to this Registration Statement and will not be used until the amendment is effective, and that, in determining any liability under the Securities Act of 1933, 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. -131- SIGNATURES As required by the Securities Act of 1933, this Post- Effective Amendment No.1 to the Registration Statement has been signed on behalf of the Registrant, in the City of Richmond in the State of Virginia on the 23rd day of August, 1999. Mentor Funds By: /s/Paul F. Costello ------------------------------ Paul F. Costello President and Principal Executive Officer As required by the Securities Act of 1933, this Post- Effective Amendment No. 1 to the Registration Statement has been signed by the following persons in the capacities and on the 23rd day of August, 1999.
Signature Title - ------------ ------ */s/Daniel J. Ludeman Chairman and Trustee (Chief - ------------------------------ Executive Officer) Daniel J. Ludeman */s/Peter J. Quinn, Jr. Trustee - ------------------------------ Peter J. Quinn, Jr. */s/Arnold H. Dreyfuss Trustee - ------------------------------ Arnold H. Dreyfuss */s/Thomas F. Keller Trustee - ------------------------------ Thomas F. Keller */s/Louis W. Moelchert, Jr. Trustee - ------------------------------ Louis W. Moelchert, Jr. -132- Trustee - ------------------------------ Troy A. Peery, Jr. */s/Arch T. Allen, III Trustee - ------------------------------ Arch T. Allen, III */s/Weston E. Edwards Trustee - ------------------------------ Weston E. Edwards Trustee - ------------------------------ Jerry R. Barrentine */s/J. Garnett Nelson Trustee - ------------------------------ J. Garnett Nelson /s/Paul F. Costello President - ------------------------------ Paul F. Costello /s/Michael A. Wade Assistant Treasurer (Principal - ------------------------------ Financial and Accounting Michael A. Wade Officer) */s/Paul F. Costello Attorney-in-fact - ------------------------------ Paul F. Costello
-133- EX-99.B11 2 LEGAL OPINION SULLIVAN & WORCESTER LLP 1025 CONNECTICUT AVENUE, N.W. WASHINGTON, D.C. 20036 TELEPHONE: 202-775-8190 FACSIMILE: 202-293-2275 767 THIRD AVENUE ONE POST OFFICE SQUARE NEW YORK, NEW YORK 10017 BOSTON, MASSACHUSETTS 02109 TELEPHONE: 212-486-8200 TELEPHONE: 617-338-2800 FACSIMILE: 212-758-2151 FACSIMILE: 617-338-2880 August 23, 1999 Evergreen Equity Trust 200 Berkeley Street Boston, Massachusetts 02116 Ladies and Gentlemen: We have been requested by the Evergreen Equity Trust, a Delaware business trust with transferable shares (the "Trust") established under an Agreement and Declaration of Trust dated September 18, 1997, as amended (the "Declaration"), for our opinion with respect to certain matters relating to Evergreen Capital Balanced Fund (the "Acquiring Fund"), a series of the Trust. We understand that Mentor Funds is about to file an amendment to its Registration Statement on Form N-14 for the purpose of registering shares of Mentor Balanced Portfolio (which, subject to shareholder approval, will be converted in October 1999 into the Acquiring Fund) under the Securities Act of 1933, as amended (the "1933 Act"), in connection with the proposed acquisition by the Acquiring Fund of all of the assets of Mentor Income and Growth Portfolio (which, subject to shareholder approval, will be converted in October 1999 into a series of the Trust) (the "Acquired Fund"), a series of Mentor Funds, in exchange solely for shares of the Acquiring Fund and the assumption by the Acquiring Fund of the identified liabilities of the Acquired Fund pursuant to an Agreement and Plan of Reorganization, the form of which is included in the Form N-14 Registration Statement (the "Plan"). Subsequent to October 1999, the Trust will adopt the Form N-14 Registration Statement of Mentor Funds. We have, as counsel, participated in various business and other proceedings relating to the Trust. We have examined copies, either certified or otherwise proved to be genuine to our satisfaction, of the Trust's Declaration and By-Laws, and other documents relating to its organization, operation, and proposed operation, including the proposed Plan and we have made such other investigations as, in our judgment, are necessary or appropriate to enable us to render the opinion expressed below. Evergreen Equity Trust August 23, 1999 Page 2 We are admitted to the Bars of The Commonwealth of Massachusetts and the District of Columbia and generally do not purport to be familiar with the laws of the State of Delaware. To the extent that the conclusions based on the laws of the State of Delaware are involved in the opinion set forth herein below, we have relied, in rendering such opinions, upon our examination of Chapter 38 of Title 12 of the Delaware Code Annotated, as amended, entitled "Treatment of Delaware Business Trusts" (the "Delaware business trust law") and on our knowledge of interpretation of analogous common law of The Commonwealth of Massachusetts. Based upon the foregoing, and assuming the approval by shareholders of the Acquired Fund of certain matters scheduled for their consideration at a meeting presently anticipated to be held on October 15, 1999, it is our opinion that the shares of the Acquiring Fund currently being registered, when issued in accordance with the Plan and the Trust's Declaration and By-Laws, will be legally issued, fully paid and non-assessable by the Trust, subject to compliance with the 1933 Act, the Investment Company Act of 1940, as amended and applicable state laws regulating the offer and sale of securities. We hereby consent to the filing of this opinion with and as a part of the Registration Statement on Form N-14 and to the reference to our firm under the caption "Legal Matters" in the Prospectus/Proxy Statement filed as part of the Registration Statement. In giving such consent, we do not thereby admit that we come within the category of persons whose consent is required under Section 7 of the 1933 Act or the rules and regulations promulgated thereunder. Very truly yours, /s/SULLIVAN & WORCESTER LLP --------------------------- SULLIVAN & WORCESTER LLP EX-99.B12 3 TAX OPINION SULLIVAN & WORCESTER LLP 1025 CONNECTICUT AVENUE, N.W. WASHINGTON, D.C. 20036 TELEPHONE: 202-775-8190 FACSIMILE: 202-293-2275 767 THIRD AVENUE ONE POST OFFICE SQUARE NEW YORK, NEW YORK 10017 BOSTON, MASSACHUSETTS 02109 TELEPHONE: 212-486-8200 TELEPHONE: 617-338-2800 FACSIMILE: 212-758-2151 FACSIMILE: 617-338-2880 August 23, 1999 Evergreen Capital Balanced Fund Evergreen Capital Income and Growth Fund 200 Berkeley Street Boston, Massachusetts 02116 Re: Acquisition of Assets of Evergreen Capital Income and Growth Fund by Evergreen Capital Balanced Fund Ladies and Gentlemen: You have asked for our opinion as to certain Federal income tax consequences of the transaction described below. Parties to the Transaction Evergreen Capital Income and Growth Fund ("Target Fund") is a series of Evergreen Equity Trust, a Delaware business trust. Evergreen Capital Balanced Fund ("Acquiring Fund") is also a series of Evergreen Equity Trust, a Delaware business trust. Description of Proposed Transaction In the proposed transaction (the "Reorganization"), Acquiring Fund will acquire all of the assets of Target Fund in exchange for shares of Acquiring Fund of equivalent value and the assumption of the identified liabilities of Target Fund. Target Fund will then dissolve and distribute all of the Acquiring Fund shares which it holds to its shareholders pro rata in proportion to their shareholdings in Target Fund, in complete redemption of all outstanding shares of Target Fund. Scope of Review and Assumptions In rendering our opinion, we have reviewed and relied upon the form of Agreement and Plan of Reorganization between Evergreen Capital Balanced Fund Evergreen Capital Income and Growth Fund August 23, 1999 Page 2 Acquiring Fund and Target Fund (the "Reorganization Agreement") which is enclosed in a prospectus/proxy statement, registration number 333-82853, to be filed with the United States Securities and Exchange Commission on or about August 24, 1999, which describes the proposed transactions, and on the information provided in such prospectus/proxy statement. We have relied, without independent verification, upon the factual statements made therein, and assume that there will be no change in material facts disclosed therein between the date of this letter and the date of the closing of the transaction. We further assume that the transaction will be carried out in accordance with the Reorganization Agreement. Representations Written representations, copies of which are attached hereto, have been made to us by the appropriate officers of Target Fund and Acquiring Fund, and we have without independent verification relied upon such representations in rendering our opinions. Opinions Based on and subject to the foregoing, and our examination of the legal authority we have deemed to be relevant, we have the following opinions: 1. The transfer of all of the assets of Target Fund in exchange for shares of Acquiring Fund and assumption by Acquiring Fund of the identified liabilities of Target Fund followed by the distribution of said Acquiring Fund shares to the shareholders of Target Fund in dissolution and liquidation of Target Fund will constitute a reorganization within the meaning of Section 368(a)(1)(C) of the Internal Revenue Code of 1986, as amended (the "Code"), and Acquiring Fund and Target Fund will each be "a party to a reorganization" within the meaning of Section 368(b) of the Code. 2. No gain or loss will be recognized by Acquiring Fund upon the receipt of the assets of Target Fund solely in exchange for Acquiring Fund shares and the assumption by Acquiring Fund of the identified liabilities of Target Fund. 3. No gain or loss will be recognized to Target Fund upon the transfer of its assets to Acquiring Fund in exchange for Acquiring Fund shares and the assumption by Acquiring Fund of the identified liabilities of Target Fund, or upon the distribution (whether actual or constructive) of such Acquiring Fund shares to Evergreen Capital Balanced Fund Evergreen Capital Income and Growth Fund August 23, 1999 Page 3 the shareholders of Target Fund in exchange for their Target Fund shares. 4. The shareholders of Target Fund will recognize no gain or loss upon the exchange of their Target Fund shares for Acquiring Fund shares in liquidation of Target Fund. 5. The aggregate basis of the Acquiring Fund shares received by each Target Fund shareholder pursuant to the Reorganization will be the same as the aggregate basis of the Target Fund shares held by such shareholder immediately prior to the Reorganization. 6. The holding period of the Acquiring Fund shares to be received by each Target Fund shareholder will include the period during which the Target Fund shares exchanged therefor were held by such shareholder, provided the Target Fund shares were held as a capital asset on the date of the Reorganization. 7. The basis of the assets of Target Fund acquired by Acquiring Fund will be the same as the basis of those assets in the hands of Target Fund immediately prior to the Reorganization, and the holding period of the assets of Target Fund in the hands of Acquiring Fund will include the period during which those assets were held by Target Fund. This opinion letter is delivered to you in satisfaction of the requirements of Section 8.5 of the Reorganization Agreement. We hereby consent to the filing of this opinion as an exhibit to the Registration Statement on Form N-14 relating to the Reorganization and to use of our name and any reference to our firm in such Registration Statement or in the prospectus/proxy statement constituting a part thereof. In giving such consent, we do not thereby admit that we come within the category of persons whose consent is required under Section 7 of the Securities Act of 1933, as amended, or the rules and regulations of the Securities and Exchange Commission thereunder. Very truly yours, /s/SULLIVAN & WORCESTER LLP ---------------------------- SULLIVAN & WORCESTER LLP EX-99.B17 4 PROXY CARD EVERY SHAREHOLDER'S VOTE IS IMPORTANT! THE BOARD OF TRUSTEES RECOMMENDS A VOTE "FOR" EACH PROPOSAL. PLEASE VOTE, SIGN, DATE AND PROMPTLY RETURN YOUR PROXY TODAY! Please detach at perforation before mailing. - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - MENTOR INCOME AND GROWTH PORTFOLIO, a series of Mentor Funds PROXY FOR THE MEETING OF SHAREHOLDERS TO BE HELD ON OCTOBER 15, 1999 The undersigned, revoking all Proxies heretofore given, hereby appoints Paul F. Costello, Gordon Forrester, Michael H. Koonce and Maureen E. Towle or any of them as Proxies of the undersigned, with full power of substitution, to vote on behalf of the undersigned all shares of Mentor Income and Growth Portfolio, a series of Mentor Funds ("Mentor Income and Growth"), that the undersigned is entitled to vote at the special meeting of shareholders of Mentor Income and Growth to be held at 2:00 p.m. on Friday, October 15, 1999 at the offices of Mentor Funds, 901 East Byrd Street, Richmond, Virginia 23219 and at any adjournments thereof, as fully as the undersigned would be entitled to vote if personally present. NOTE: PLEASE SIGN EXACTLY AS YOUR NAME(S) APPEAR ON THIS PROXY. If joint owners, EITHER may sign this Proxy. When signing as attorney, executor, administrator, trustee, guardian, or custodian for a minor, please give your full title. When signing on behalf of a corporation or as a partner for a partnership, please give the full corporate or partnership name and your title, if any. Date , 1999 ---------------------------------------- ---------------------------------------- Signature(s) and Title(s), if applicable -1- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF TRUSTEES OF MENTOR FUNDS. THIS PROXY WILL BE VOTED AS SPECIFIED BELOW WITH RESPECT TO THE ACTION TO BE TAKEN ON THE FOLLOWING PROPOSALS. THE SHARES REPRESENTED HEREBY WILL BE VOTED AS INDICATED OR FOR THE PROPOSALS IF NO CHOICE IS INDICATED. THE BOARD OF TRUSTEES OF MENTOR FUNDS RECOMMENDS A VOTE FOR THE PROPOSALS. PLEASE MARK YOUR VOTE BELOW IN BLUE OR BLACK INK. DO NOT USE RED INK. EXAMPLE: X 1. To approve an Agreement and Plan of Conversion and Termination whereby Mentor Income and Growth will be reorganized as a series of Evergreen Equity Trust. --- --- --- /__/ FOR /__/ AGAINST /__/ ABSTAIN 2. To approve the proposed reclassification of the investment objective of Mentor Income and Growth from fundamental to nonfundamental. --- --- --- /__/ FOR /__/ AGAINST /__/ ABSTAIN 3. To approve the proposed changes to Mentor Income and Growth's fundamental investment restrictions. --- --- --- /__/ FOR ALL /__/ AGAINST ALL /__/ ABSTAIN ALL --- /__/ To vote against or to abstain from voting on one or more of the proposed changes to the specific fundamental investment restrictions, but to approve all others, check the box on the left and indicate the number(s) of the investment restriction(s) you do not want to change --- in the appropriate boxes below. Please see Exhibit C of the Prospectus/Proxy Statement to determine which sub-proposal topics are applicable to Mentor Income and Growth. If you choose to vote differently on individual restrictions you must mail in your proxy card. If you choose to vote the same on all restrictions pertaining to Mentor Income and -2- Growth, telephone and Internet voting are available. 3A. Diversification 3B. Concentration 3C. Senior securities 3D. Borrowing 3E. Underwriting 3F. Real estate 3G. Commodities 3H. Lending 3I. To reclassify as nonfundamental certain fundamental restrictions that are no longer required to be fundamental: 3I(i). Short sales To vote against a 3I(ii). Margin purchases particular proposed 3I(iii). Pledging change applicable to 3I(iv). Restricted securities Mentor Income and 3I(v). Unseasoned issuers Growth write the 3I(vi). Illiquid securities number(s) in the box 3I(vii). Officers' and directors' below. ownership of securities ___________________ 3I(viii). Control or management /_________________/ 3I(ix). Joint trading 3I(x). Other investment To abstain from companies voting on a 3I(xi). Oil, gas and minerals particular proposed 3I(xii). Foreign securities change applicable to 3I(xiii). Warrants Mentor Income and Growth write the number(s) in the box below. ------------------- /-----------------/ 4. To approve an Agreement and Plan of Reorganization whereby Evergreen Capital Balanced Fund, a series of Evergreen Equity Trust, will (i) acquire all of the assets of Mentor Income and Growth in exchange for shares of Evergreen Capital Balanced Fund; and (ii) assume the identified liabilities of Mentor Income and Growth, as substantially described in the accompanying Prospectus/Proxy Statement. --- --- --- /__/ FOR /__/ AGAINST /__/ ABSTAIN 5. To consider and vote upon such other matters as may properly come before said meeting or any adjournments thereof. -3- --- --- --- /__/ FOR /__/ AGAINST /__/ ABSTAIN -4- This redlined draft, generated by CompareRite - The Instant Redliner, shows the differences between original document : F:\JAD\SALEM29\CAPBAL\N14PROXY.C and revised document: F:\JAD\SALEM29\CAPBAL\PEA1PROX.C CompareRite found 29 change(s) in the text CompareRite found 0 change(s) in the notes Deletions appear as struck-through text Additions appear as "redlined" text -5- -----END PRIVACY-ENHANCED MESSAGE-----