SAI

497 1 cpf-497e.htm AUGUST 30, 2005 SAI SAI

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SECURITY INCOME FUND(R)
o SECURITY CAPITAL PRESERVATION FUND

One Security Benefit Place, Topeka, Kansas 66636-0001
(785) 438-3127
(800) 888-2461

This Statement of Additional Information ("SAI") is not a Prospectus. It is
intended to provide additional information regarding those activities and
operations of the Security Capital Preservation Fund and should be read in
conjunction with the Prospectus dated July 1, 2005, as it may be supplemented
from time to time. The Prospectus provides the basic information investors
should know before investing. A Prospectus may be obtained by writing Security
Distributors, Inc., One Security Benefit Place, Topeka, Kansas 66636-0001, or by
calling (785) 438-3127 or (800) 888-2461. The Fund's financial statements
included in the Fund's September 30, 2004 Annual Report and March 31, 2005
Semi-Annual Report are incorporated herein by reference.

STATEMENT OF ADDITIONAL INFORMATION
JULY 1, 2005, AS SUPPLEMENTED AUGUST 30, 2005
RELATING TO THE PROSPECTUS DATED JULY 1, 2005
AS IT MAY BE SUPPLEMENTED FROM TIME TO TIME
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FUND ADMINISTRATOR
Security Management Co., LLC
One Security Benefit Place
Topeka, Kansas 66636-0001

DISTRIBUTOR
Security Distributors, Inc.
One Security Benefit Place
Topeka, Kansas 66636-0001

CUSTODIAN
UMB Bank, N.A.
928 Grand Avenue
Kansas City, Missouri 64106

INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Ernst & Young LLP
200 Clarendon Street
Boston, Massachusetts 02116

TABLE OF CONTENTS

GENERAL INFORMATION........................................................ 3
INVESTMENT METHODS AND ADDITIONAL RISK FACTORS............................. 3
Short-Term Instruments.................................................. 3
U.S. Government Securities.............................................. 3
Certificates of Deposit and Bankers' Acceptances........................ 4
Commercial Paper........................................................ 4
U.S. Dollar-Denominated Foreign Securities.............................. 4
U.S. Dollar-Denominated Sovereign and
Supranational Fixed Income Securities................................. 4
Put Bond................................................................ 5
Senior Loans............................................................ 5
Variable and Floatig Rate Instruments................................... 6
Warrants................................................................ 7
Municipal Securities.................................................... 7
Municipal Leases, Certificates of Participation
and Other Participation Interests..................................... 8
Municipal Notes......................................................... 8
Private Activity and Industrial Development Bonds....................... 9
Tax Exempt Commercial Paper............................................. 9
Pre-Refunded Municipal Securities....................................... 9
Tender Option Bonds..................................................... 9
Auction Rate Securities................................................. 10
Private Activity Bonds.................................................. 10
Mortgage- and Asset-Backed Securities................................... 10
Illiquid Securities..................................................... 15
When-Issued and Delayed Delivery Securities............................. 16
Lower-Rated Debt Securities ("Junk Bonds").............................. 16
Securities of Foreign Issuers - Investment in Emerging Markets.......... 17
Currency Management Techniques.......................................... 17
Forward Foreign Currency Exchange Contracts............................. 17
Derivatives............................................................. 18
Swaps................................................................... 19
Futures Contracts and Options on Futures Contracts - General............ 20
Futures Contracts....................................................... 21
Options on Futures Contracts............................................ 22
Options on Securities................................................... 23
Limitations and Risks Associated with Transactions in Options,
Futures Contracts and Options on Futures Contracts.................... 25
Other Considerations.................................................... 26
Repurchase Agreements................................................... 26
Reverse Repurchase Agreements........................................... 27
Borrowing............................................................... 27
Other Investment Companies.............................................. 27
Asset Coverage.......................................................... 28
Rating Services......................................................... 29
Investment Restrictions................................................. 29
DISCLOSURE OF PORTFOLIO HOLDINGS........................................... 30
MANAGEMENT OF THE FUND..................................................... 31
Officers and Directors of Security Income Fund.......................... 31
COMMITTEES................................................................. 32
Audit Committees........................................................ 32
Nominating Committee.................................................... 33
REMUNERATION OF DIRECTORS AND OTHERS....................................... 33
Security Income Fund Director Compensation Table........................ 33
Principal Holders of Securities ........................................ 33
Directors' Ownership of Securities ..................................... 33
DETERMINATION OF THE NET ASSET VALUE....................................... 34
Overview of TSA Accounts................................................ 35
OVERVIEW OF THE TYPES OF INDIVIDUAL RETIREMENT ACCOUNTS.................... 35
Traditional IRAs........................................................ 35
Roth IRAs............................................................... 36
SEP-IRAs................................................................ 36
SIMPLE IRAs............................................................. 36
Keogh Plans............................................................. 36
Coverdell Education Savings Accounts.................................... 37
PENSION AND PROFIT SHARING PLANS........................................... 37
403(b) Retirement Plans................................................. 37
Simplified Employee Pension (SEP) Plans................................. 37
OWNERSHIP OF SHARES THROUGH PLANS.......................................... 37
HOW TO PURCHASE SHARES..................................................... 37
Alternative Purchase Options............................................ 38
Class A Shares.......................................................... 38
Class A Distribution Plan............................................... 38
Class B Shares.......................................................... 39
Class B Distribution Plan............................................... 39
Class C Shares.......................................................... 40
Class C Distribution Plan............................................... 40
Rule 12b-1 Plan Expenses................................................ 40
Calculation and Waiver of Contingent Deferred Sales Charges............. 40
Arrangements with Broker-Dealers and Others............................. 41
Purchases at Net Asset Value............................................ 41
Purchases for Employer-Sponsored Retirement Plans....................... 42
OTHER DISTRIBUTION OF SERVICE ARRANGEMENTS................................. 42
HOW TO REDEEM SHARES....................................................... 44
INVESTMENT MANAGER......................................................... 45
Evaluation of Investment Advisory Contract by the Board................. 46
Previous Investment Manager............................................. 47
PORTFOLIO MANAGERS......................................................... 47
Ownership of Fund Shares................................................ 48
Conflicts of Interest................................................... 48
Compensation............................................................ 49
DISTRIBUTOR................................................................ 49
ADMINISTRATOR AND TRANSFER AGENT........................................... 50
CODE OF ETHICS............................................................. 51
PROXY VOTING............................................................... 51
CUSTODIAN.................................................................. 51
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM.............................. 51
ORGANIZATION OF SECURITY INCOME FUND....................................... 51
DIVIDENDS AND TAXES........................................................ 52
Options, Futures and Forward Contracts and Swap Agreements.............. 54
Market Discount......................................................... 55
Original Issue Discount................................................. 55
Constructive Sales...................................................... 55
Foreign Taxation........................................................ 55
New Tax Legislation..................................................... 55
Other Taxes............................................................. 56
ALLOCATION OF PORTFOLIO BROKERAGE.......................................... 56
Portfolio Turnover...................................................... 57
PERFORMANCE INFORMATION.................................................... 57
Standard Performance Information........................................ 57
Comparison of Fund Performance.......................................... 58
FINANCIAL STATEMENTS....................................................... 58
APPENDIX A................................................................. 60

GENERAL INFORMATION

Security Capital Preservation Fund (the "Fund") is a separate series of Security
Income Fund, an open-end, management investment company (mutual fund) of the
series type, offering shares of the Fund ("Shares") as described herein.

As described in the Fund's Prospectus, the Fund seeks to achieve its investment
objective by investing in investment grand fixed income securities including,
without limitation, corporate bonds and other corporate debt securities,
securities issued by the U.S. Government or its agencies and instrumentalities,
and mortgage-backed and asset-backed securities. Prior to the date of this SAI,
the Fund sought to achieve its investment objective by investing all its net
investable assets in PreservationPlus Income Portfolio ("Portfolio"), a
diversified open end management investment company having the same investment
objective as the Fund.

Security Management Company, LLC ("SMC" or "Investment Manager") currently
serves as the Fund's investment manager.

Shares of the Fund are sold by Security Distributors, Inc., the Fund's
distributor (the "Distributor"), to individuals and others that meet the minimum
investment and other requirements for investing in the Fund, as discussed in the
Prospectus.

Shares are offered either directly, through broker/ dealers, or through vehicles
such as bank collective funds or insurance company separate accounts. Shares are
also available to employee benefit plans which invest in the Fund through an
omnibus account or similar arrangement.

This SAI is not an offer by the Fund to an investor that has not received a
Prospectus. Capitalized terms not otherwise defined in this SAI have the
meanings ascribed to them in the Prospectus.

INVESTMENT METHODS AND ADDITIONAL RISK FACTORS

SHORT-TERM INSTRUMENTS -- When the Fund experiences large cash inflows, for
example, through the sale of securities, and investments deemed attractive by
the Investment Manager are unavailable in sufficient quantities, the Fund may
hold short-term investments (or shares of money market mutual funds) for a
limited time pending availability of such investments. In addition, when in the
Investment Manager's opinion, it is advisable to adopt a temporary defensive
position because of unusual and adverse market or other conditions, up to 100%
of the Fund's assets may be invested in such short-term instruments.

Short-term instruments consist of foreign and domestic: (1) short-term
obligations of sovereign governments, their agencies, instrumentalities,
authorities or political subdivisions; (2) other short-term debt securities
rated AA or higher by S&P or Aa or higher by Moody's or, if unrated, are deemed
to be of comparable quality in the opinion of the Investment Manager; (3)
commercial paper; (4) bank obligations, including negotiable certificates of
deposit, time deposits and banker's acceptances; and (5) repurchase agreements.
At the time the Fund invests in commercial paper, bank obligations or repurchase
agreements, the issuer or the issuer's parent must have outstanding debt rated
AA or higher by S&P or Aa or higher by Moody's; outstanding commercial paper or
bank obligations rated A-1 by S&P or Prime-1 by Moody's; or, if no such ratings
are available, the instrument must be deemed to be of comparable quality in the
opinion of the Investment Manager. These instruments may be denominated in U.S.
dollars.

U.S. GOVERNMENT SECURITIES -- The Fund may invest in obligations issued or
guaranteed by the U.S. government including: (1) direct obligations of the U.S.
Treasury and (2) obligations issued by U.S. government agencies and
instrumentalities. Included among direct obligations of the U.S. are Treasury
Bills, Treasury Notes and Treasury Bonds, which differ in terms of their
interest rates, maturities and dates of issuance. Treasury Bills have maturities
of less than one year, Treasury Notes have maturities of one to 10 years and
Treasury Bonds generally have maturities of greater than 10 years at the date of
issuance. Included among the obligations issued by agencies and
instrumentalities of the U.S. are: instruments that are supported by the full
faith and credit of the U.S. (such as certificates issued by the Government
National Mortgage Association ("GNMA" or "Ginnie Mae"); instruments that are
supported by the right of the issuer to borrow from the U.S. Treasury (such as
securities of Federal Home Loan Banks); and instruments that are supported
solely by the credit of the instrumentality (such as Federal National Mortgage
Association ("FNMA" or "Fannie Mae") and Federal Home Loan Mortgage Corporation
("FHLMC" or "Freddie Mac").

Other U.S. government securities the Fund may invest in include (but are not
limited to) securities issued or guaranteed by the Federal Housing
Administration, Farmers Home Loan Administration, Export-Import Bank of the
U.S., Small Business Administration, General Services Administration, Central
Bank for Cooperatives, Federal Farm Credit Banks, Federal Intermediate Credit
Banks, Federal Land Banks, Maritime Administration, Tennessee Valley Authority,
District of Columbia Armory Board and Student Loan Marketing Association.
Because the U.S. government is not obligated by law to provide support to an
instrumentality it sponsors, the Fund will invest in obligations issued by such
an instrumentality only if the Investment Manager determines that the credit
risk with respect to the instrumentality does not make its securities unsuitable
for investment by the Fund.

The Fund may also invest in separately traded principal and interest components
of securities guaranteed or issued by the U.S. Government or its agencies,
instrumentalities or sponsored enterprises if such components trade
independently under the Separate Trading of Registered Interest and Principal of
Securities program ("STRIPS") or any similar program sponsored by the U.S.
Government. STRIPS may be sold as zero coupon securities. See "Zero Coupon
Securities and Deferred Interest Bonds."

CERTIFICATES OF DEPOSIT AND BANKERS' ACCEPTANCES -- Certificates of deposit are
receipts issued by a depository institution in exchange for the deposit of
funds. The issuer agrees to pay the amount deposited plus interest to the bearer
of the receipt on the date specified on the certificate. The certificate usually
can be traded in the secondary market prior to maturity. Bankers' acceptances
typically arise from short-term credit arrangements designed to enable
businesses to obtain funds to finance commercial transactions. Generally, an
acceptance is a time draft drawn on a bank by an exporter or an importer to
obtain a stated amount of funds to pay for specific merchandise. The draft is
then "accepted" by a bank that, in effect, unconditionally guarantees to pay the
face value of the instrument on its maturity date. The acceptance may then be
held by the accepting bank as an earning asset or it may be sold in the
secondary market at the going rate of discount for a specific maturity. Although
maturities for acceptances can be as long as 270 days, most acceptances have
maturities of six months or less.

COMMERCIAL PAPER -- The Fund may invest in commercial paper. The Fund may invest
in fixed rate or variable rate commercial paper, issued by U.S. or foreign
entities. Commercial paper consists of short-term (usually from 1 to 270 days)
unsecured promissory notes issued by U.S. or foreign corporations in order to
finance their current operations. Any commercial paper issued by a foreign
entity corporation and purchased by the Fund must be U.S. dollar-denominated and
must not be subject to foreign withholding tax at the time of purchase.

Commercial paper when purchased by the Fund must be rated in the highest
short-term rating category by any two NRSROs (or one NRSRO if that NRSRO is the
only such NRSRO which rates such security) or, if not so rated, must be believed
by the Investment Manager, acting under the supervision of the Board of
Directors of the Fund, to be of comparable quality. Investing in foreign
commercial paper generally involves risks relating to obligations of foreign
banks or foreign branches and subsidiaries of U.S. and foreign banks.

The Fund may also invest in variable rate master demand notes. A variable rate
master demand note (which is a type of commercial paper) represents a direct
borrowing arrangement involving periodically fluctuating rates of interest under
a letter agreement between a commercial paper issuer and an institutional lender
pursuant to which the lender may determine to invest varying amounts.

For a description of commercial paper ratings, see the Appendix to this SAI.

U.S. DOLLAR-DENOMINATED FOREIGN SECURITIES -- The Fund may invest a portion of
its assets in U.S. dollar-denominated debt securities of foreign companies.
Investing in the securities of foreign companies involves more risks than
investing in securities of U.S. companies. Their value is subject to economic
and political developments in the countries where the companies operate and to
changes in foreign currency values. Values may also be affected by foreign tax
laws, changes in foreign economic or monetary policies, exchange control
regulations and regulations involving prohibitions on the repatriation of
foreign currencies.

In general, less information may be available about foreign companies than about
U.S. companies, and foreign companies are generally not subject to the same
accounting, auditing and financial reporting standards as are U.S. companies.
Foreign securities markets may be less liquid and subject to less regulation
than the U.S. securities markets. The costs of investing outside the United
States frequently are higher than those in the United States. These costs
include relatively higher brokerage commissions and foreign custody expenses.

U.S. DOLLAR-DENOMINATED SOVEREIGN AND SUPRANATIONAL FIXED INCOME SECURITIES --
The Fund may invest in U.S. dollar-denominated foreign government debt
securities, which include debt obligations issued or guaranteed by national,
state or provincial governments or similar political subdivisions and
quasi-governmental and supranational entities (collectively, "sovereign debt
obligations"). Sovereign debt obligations may involve a high degree of risk. The
issuer of such an obligation or the governmental authorities that control the
repayment of the obligation may be unable or unwilling to repay principal and
interest when due and may require renegotiations or rescheduling of debt
payments. In addition, prospects for repayment of principal and interest may
depend on political as well as economic factors. Quasi-governmental and
supranational entities include international organizations designated or
supported by governmental entities to promote economic reconstruction or
development and international banking institutions and related government
agencies. Examples include (but are not limited to) the International Bank for
Reconstruction and Development (the "World Bank"), the Japanese Development
Bank, the Asian Development Bank and the Inter-American Development Bank.
Currently, the Fund intends to invest only in obligations issued or guaranteed
by the Asian Development Bank, the Inter-American Development Bank, the World
Bank, the African Development Bank, the European Economic Community, the
European Investment Bank and the Nordic Investment Bank. Foreign government
securities also include mortgage-related securities issued or guaranteed by
national, state or provincial governmental instrumentalities, including
quasi-governmental agencies.

FIXED INCOME SECURITY RISK. Fixed income securities generally expose the Fund to
four types of risk: (1) interest rate risk (the potential for fluctuations in
bond prices due to changing interest rates); (2) income risk (the potential for
a decline in the Fund's income due to falling market interest rates); (3) credit
risk (the possibility that a bond issuer will fail to make timely payments of
either interest or principal to the Fund); and (4) prepayment risk or call risk
(the likelihood that, during period of falling interest rates, securities with
high stated interest rates will be prepaid, or "called" prior to maturity,
requiring the Fund to invest the proceeds at generally lower interest rates).
Investing in U.S. dollar-denominated foreign government debt securities may
involve more risk than investing in U.S. government debt securities. See "U.S.
Dollar-Denominated Foreign Securities above.

PUT BONDS -- A put bond (also referred to as a tender option or third party
bond) is a bond created by coupling an intermediate or long-term fixed rate bond
with an agreement giving the holder the option of tendering the bond to receive
its par value. As consideration for providing this tender option, the sponsor of
the bond (usually a bank, broker-dealer or other financial intermediary)
receives periodic fees that equal the difference between the bond's fixed coupon
rate and the rate (determined by a remarketing or similar agent) that would
cause the bond, coupled with the tender option, to trade at par. By paying the
tender offer fees, the Fund in effect holds a demand obligation that bears
interest at the prevailing short-term rate.

In selecting put bonds, the Adviser takes into consideration the
creditworthiness of the issuers of the underlying bonds and the creditworthiness
of the providers of the tender option features. A sponsor may withdraw the
tender option feature if the issuer of the underlying bond defaults on interest
or principal payments or the bond's rating is downgraded.

SENIOR LOANS -- The Fund invests in Senior Loans (i.e., senior secured floating
rate corporate loans).

Senior Loans are loans made to corporations. In return, the corporation pays
interest and principal to the lenders. Senior Loans also include participation
interests in Senior Loans or assignments of Senior Loans. A Senior Loan in which
the Fund may invest typically is structured by an agent bank acting on behalf of
a group of lenders to whom the loan will be syndicated. The syndicate of lenders
often consists of commercial and investment banks, thrift institutions,
insurance companies, finance companies, mutual funds and other institutional
investment vehicles or other financial institutions. Typically, the agent bank
administers the Loan on behalf of all the lenders. This lender is referred to as
the agent bank.

The Fund may invest in a Senior Loan in one of two ways. It may purchase a
participation interest or it may purchase an assignment. Participation interests
are interests issued by a lender or other financial institution, which represent
a fractional interest in a Senior Loan. The Fund may acquire participation
interests from a lender or other holders of participation interests. Holders of
participation interests are referred to as participants. An assignment
represents a portion of a Senior Loan previously attributable to a different
lender. Unlike a participation interest, the Fund will generally become a lender
for the purposes of the relevant loan agreement by purchasing an assignment.

The Fund will not originate loans. As such, it will not be buying in the
"primary" market. When Fund purchases an existing assignment of a Senior Loan,
or purchases a participation interest in a Senior Loan, it is said to be
purchasing in the "secondary" market. Purchases of Senior Loans in the secondary
market may take place at, above, or below the par value of a Senior Loan.
Purchases above par will effectively reduce the amount of interest being
received by Fund through the amortization of the purchase price premium, whereas
purchases below par will effectively increase the amount of interest being
received by Fund through the amortization of the purchase price discount. The
Fund may be able to invest in Senior Loans only through participation interests
or assignments at certain times when reduced direct investment opportunities in
Senior Loans may exist.

If the Fund purchases an assignment from a lender, the Fund will generally have
direct contractual rights against the borrower in favor of the lenders. On the
other hand, if the Fund purchases a participation interest either from a lender
or a participant, the Fund typically will have established a direct contractual
relationship with the seller of the participation interest, but not with the
borrower. Consequently, the Fund is subject to the credit risk of the lender or
participant who sold the participation interest to the Fund, in addition to the
usual credit risk of the borrower. Therefore, when the Fund invests in Senior
Loans through the purchase of participation interests, the Fund's sub-adviser
must consider the creditworthiness of the agent bank and any lenders and
participants interposed between the Fund and a borrower.

Typically, Senior Loans are secured by collateral that, at the time of
origination, has a fair market value at least equal to the amount of such Senior
Loan. The Fund's sub-adviser generally will determine the value of the
collateral by customary valuation techniques that it considers appropriate.
However, the value of the collateral may decline following the Fund's
investment. Also, collateral may be difficult to sell and there are other risks
which may cause the collateral to be insufficient in the event of a default.
Consequently, the Fund might not receive payments to which it is entitled. The
collateral may consist of various types of assets or interests including
intangible assets. It may include working capital assets, such as accounts
receivable or inventory, or tangible fixed assets, such as real property,
buildings and equipment. It may include intangible assets, such as trademarks,
copyrights and patent rights, or security interests in securities of
subsidiaries or affiliates. The borrower's owners may provide additional
collateral, typically by pledging their ownership interest in the Borrower as
collateral for the loan. The borrower under a Senior Loan must comply with
various restrictive covenants contained in any Senior Loan agreement between the
borrower and the syndicate of lenders. A restrictive covenant is a promise by
the borrower to not take certain action that may impair the rights of lenders.
These covenants, in addition to requiring the scheduled payment of interest and
principal, may include restrictions on dividend payments and other distributions
to shareholders, provisions requiring the borrower to maintain specific
financial ratios or relationships and limits on total debt. In addition, a
covenant may require the borrower to prepay the Senior Loan with any excess cash
flow. Excess cash flow generally includes net cash flow after scheduled debt
service payments and permitted capital expenditures, among other things, as well
as the proceeds from asset dispositions or sales of securities. A breach of a
covenant (after giving effect to any cure period) in a Senior Loan agreement
which is not waived by the agent bank and the lending syndicate normally is an
event of acceleration. This means that the agent bank has the right to demand
immediate repayment in full of the outstanding Senior Loan.

The Fund will make an investment in a Senior Loan only after the Fund's
sub-adviser determines that the investment is suitable for the Fund based on the
sub-adviser's independent credit analysis. Generally, this means that the
sub-adviser has determined that the likelihood that the corporation will meet
its obligations is acceptable.

The rate of interest payable on Senior Loans is established as the sum of a base
lending rate plus a specified margin. These base lending rates generally are the
London Interbank Offered Rate ("LIBOR"), the interest rate quoted by major U.S.
money center commercial banks at which such banks are willing to lend U.S.
dollars to their most creditworthy borrowers, as quoted daily in the Wall Street
Journal (Prime Rate), the certificate of deposit ("CD") rate, or another base
lending rate used by commercial lenders. The interest rate on Prime Rate-based
Senior Loans floats daily as the Prime Rate changes, while the interest rate on
LIBOR-based Senior Loans is reset periodically, typically between 30 days and 90
days. Certain of the Senior Loans in which the Fund will invest may permit the
borrower to select an interest rate reset period of up to one year. A portion of
the Fund's investments may consist of loans with interest rates that are fixed
for the term of the loan. Investment in Senior Loans with longer interest rate
reset periods or loans with fixed interest rates may increase fluctuations in
the Fund's net asset value as a result of changes in interest rates. However,
the Fund may attempt to hedge its fixed rate loans against interest rate
fluctuations by entering into interest rate swap or other derivative
transactions.

VARIABLE AND FLOATING RATE INSTRUMENTS -- The Fund may invest in variable or
floating rate instruments and variable rate demand instruments, including
variable amount master demand notes. These instruments will normally involve
industrial development or revenue bonds that provide that the rate of interest
is set as a specific percentage of a designated base rate (such as the prime
rate) at a major commercial bank. In addition, the interest rate on these
securities may be reset daily, weekly or on some other reset period and may have
a floor or ceiling on interest rate changes. The Fund can demand payment of the
obligation at all times or at stipulated dates on short notice (not to exceed 30
days) at par plus accrued interest.

Debt instruments purchased by the Fund may be structured to have variable or
floating interest rates. These instruments may include variable amount master
demand notes that permit the indebtedness to vary in addition to providing for
periodic adjustments in the interest rates.

Other variable and floating rate instruments include but are not limited to
corporates, ABS, CMBS, MBS, CMOs, government and agency securities. The Adviser
will consider the earning power, cash flows and other liquidity ratios of the
issuers and guarantors of such instruments and, if the instrument is subject to
a demand feature, will continuously monitor their financial ability to meet
payment on demand. Where necessary to ensure that a variable or floating rate
instrument is equivalent to the quality standards applicable to the Fund's fixed
income investments, the issuer's obligation to pay the principal of the
instrument will be backed by an unconditional bank letter or line of credit,
guarantee or commitment to lend. Any bank providing such a bank letter, line of
credit, guarantee or loan commitment will meet the Fund's investment quality
standards relating to investments in bank obligations. The Adviser will also
continuously monitor the creditworthiness of issuers of such instruments to
determine whether the Fund should continue to hold the investments.

The absence of an active secondary market for certain variable and floating rate
notes could make it difficult to dispose of the instruments, and the Fund could
suffer a loss if the issuer defaults or during periods in which the Fund is not
entitled to exercise its demand rights.

Variable and floating rate instruments held by the Fund will be subject to the
Fund's limitation on investments in illiquid securities when a reliable trading
market for the instruments does not exist and the Fund may not demand payment of
the principal amount of such instruments within seven days.

WARRANTS -- The Fund may invest in warrants. Warrants generally entitle the
holder to buy a specified number of shares of common stock at a specified price,
which is often higher than the market price at the time of issuance, for a
period of years or in perpetuity. Warrants may be issued in units with other
securities or separately, and may be freely transferable and traded on
exchanges. While the market value of a warrant tends to be more volatile than
that of the securities underlying the warrant, the market value of a warrant may
not necessarily change with that of the underlying security. A warrant ceases to
have value if it is not exercised prior to any expiration date to which the
warrant is subject. The purchase of warrants involves a risk that the Fund could
lose the purchase value of a warrant if the right to subscribe to additional
shares is not exercised prior to the warrant's expiration. Also, the purchase of
warrants involves the risk that the effective price paid for the warrant added
to the subscription price of the related security may exceed the value of the
subscribed security's market price, such as when there is no movement in the
level of the underlying security.

MUNICIPAL SECURITIES -- The Fund may invest to a limited extent in municipal
securities. Municipal securities consist of bonds, notes and other instruments
issued by or on behalf of states, territories and possessions of the U.S.
(including the District of Columbia) and their political subdivisions, agencies
or instrumentalities, the interest on which is exempt from regular federal
income tax (i.e., excluded from gross income for federal income tax purposes but
not necessarily exempt from the federal alternative minimum tax or from state
and local taxes). Municipal securities may also be issued on a taxable basis
(i.e., the interest on such securities is not exempt from regular federal income
tax).

Municipal securities are often issued to obtain funds for various public
purposes, including the construction of a wide range of public facilities such
as bridges, highways, housing, hospitals, mass transportation, schools, streets
and water and sewer works. Other public purposes for which municipal securities
may be issued include refunding outstanding obligations, obtaining funds for
general operating expenses, and obtaining funds to lend to other public
institutions and facilities. Municipal securities also include "private
activity" or industrial development bonds, which are issued by or on behalf of
public authorities to provide financing aid to acquire sites or construct or
equip facilities within a municipality for privately or publicly owned
corporations.

The two principal classifications of municipal securities are "general
obligations" and "revenue obligations." General obligations are secured by the
issuer's pledge of its full faith and credit for the payment of principal and
interest although the characteristics and enforcement of general obligations may
vary according to the law applicable to the particular issuer. Revenue
obligations, which include, but are not limited to, private activity bonds,
resource recovery bonds, certificates of participation and certain municipal
notes, are not backed by the credit and taxing authority of the issuer and are
payable solely from the revenues derived from a particular facility or class of
facilities or, in some cases, from the proceeds of a special excise or other
specific revenue source. Nevertheless, the obligations of the issuer may also be
backed by a letter of credit, guarantee or insurance. General obligations and
revenue obligations may be issued in a variety of forms, including commercial
paper, fixed, variable and floating rate securities, tender option bonds,
auction rate bonds and capital appreciation bonds.

In addition to general obligations and revenue obligations, there are a variety
of hybrid and special types of municipal securities. There are also numerous
differences in the credit backing of municipal securities both within and
between these two principal classifications.

For the purpose of applying the Fund's investment restrictions, the
identification of the issuer of a municipal security which is not a general
obligation is made by the Adviser based on the characteristics of the municipal
security, the most important of which is the source of funds for the payment of
principal and interest on such securities.

One or a small number of institutional investors such as the Fund may purchase
an entire issue of municipal securities. Thus, the issue may not be said to be
publicly offered. Unlike some securities that are not publicly offered, a
secondary market exists for many municipal securities that were not publicly
offered initially and such securities can be readily marketable.

The obligations of an issuer to pay the principal of and interest on a municipal
security are subject to the provisions of bankruptcy, insolvency and other laws
affecting the rights and remedies of creditors, such as the Federal Bankruptcy
Act, and laws, if any, that may be enacted by Congress or state legislatures
extending the time for payment of principal or interest or imposing other
constraints upon the enforcement of such obligations. There is also the
possibility that, because of litigation or other conditions, the power or
ability of the issuer to pay when due principal of or interest on a municipal
security may be materially affected.

MUNICIPAL LEASES, CERTIFICATES OF PARTICIPATION AND OTHER PARTICIPATION
INTERESTS -- A municipal lease is an obligation in the form of a lease or
installment purchase contract that is issued by a state or local government to
acquire equipment and facilities. Income from such obligations is generally
exempt from state and local taxes in the state of issuance (as well as regular
federal income tax). Municipal leases frequently involve special risks not
normally associated with general obligation or revenue bonds. Leases and
installment purchase or conditional sale contracts (which normally provide for
title to the leased asset to pass eventually to the governmental issuer) have
evolved as a means for governmental issuers to acquire property and equipment
without meeting the constitutional and statutory requirements for the issuance
of debt. The debt issuance limitations are deemed to be inapplicable because of
the inclusion in many leases or contracts of `non-appropriation' clauses that
relieve the governmental issuer of any obligation to make future payments under
the lease or contract unless money is appropriated for such purpose by the
appropriate legislative body on a yearly or other periodic basis. Thus, the
Fund's investment in municipal leases will be subject to the special risk that
the governmental issuer may not appropriate funds for lease payments.

In addition, such leases or contracts may be subject to the temporary abatement
of payments in the event the issuer is prevented from maintaining occupancy of
the leased premises or utilizing the leased equipment. Although the obligations
may be secured by the leased equipment or facilities, the disposition of the
property in the event of nonappropriation or foreclosure might prove difficult,
time consuming and costly, and result in an unsatisfactory or delayed recoupment
of the Fund's original investment.

Certificates of participation represent undivided interests in municipal leases,
installment purchase contracts or other instruments. The certificates are
typically issued by a trust or other entity that has received an assignment of
the payments to be made by the state or political subdivision under such leases
or installment purchase contracts.

Certain municipal lease obligations and certificates of participation may be
deemed illiquid for the purpose of the Fund's limitations on investments in
illiquid securities. Other municipal lease obligations and certificates of
participation acquired by the Fund may be determined by the Investment Manager,
pursuant to guidelines adopted by the Board of Directors, to be liquid
securities for the purpose of the Fund's limitation on investments in illiquid
securities. In determining the liquidity of municipal lease obligations and
certificates of participation, the Investment Manager will consider a variety of
factors including: (1) the willingness of dealers to bid for the security; (2)
the number of dealers willing to purchase or sell the obligation and the number
of other potential buyers; (3) the frequency of trades or quotes for the
obligation; and (4) the nature of the marketplace trades. In addition, the
Adviser will consider factors unique to particular lease obligations and
certificates of participation affecting the marketability thereof. These include
the general creditworthiness of the issuer, the importance to the issuer of the
property covered by the lease and the likelihood that the marketability of the
obligation will be maintained throughout the time the obligation is held by the
Fund. The Fund may not invest more than 5% of its net assets in municipal
leases.

The Fund may purchase participations in municipal securities held by a
commercial bank or other financial institution. Such participations provide the
Fund with the right to a pro rata undivided interest in the underlying municipal
securities. In addition, such participations generally provide the Fund with the
right to demand payment, on not more than seven days notice, of all or any part
of the Fund's participation interest in the underlying municipal security, plus
accrued interest.

MUNICIPAL NOTES -- Municipal securities in the form of notes generally are used
to provide for short-term capital needs, in anticipation of an issuer's receipt
of other revenues or financing, and typically have maturities of up to three
years. Such instruments may include Tax Anticipation Notes, Revenue Anticipation
Notes, Bond Anticipation Notes, Tax and Revenue Anticipation Notes and
Construction Loan Notes. Tax Anticipation Notes are issued to finance the
working capital needs of governments. Generally, they are issued in anticipation
of various tax revenues, such as income, sales, property, use and business
taxes, and are payable from these specific future taxes. Revenue Anticipation
Notes are issued in expectation of receipt of other kinds of revenue, such as
federal revenues available under federal revenue sharing programs. Bond
Anticipation Notes are issued to provide interim financing until long-term bond
financing can be arranged. In most cases, the long-term bonds then provide the
funds needed for repayment of the notes. Tax and Revenue Anticipation Notes
combine the funding sources of both Tax Anticipation Notes and Revenue
Anticipation Notes. Construction Loan Notes are sold to provide construction
financing. These notes are secured by mortgage notes insured by the Federal
Housing Authority; however, the proceeds from the insurance may be less than the
economic equivalent of the payment of principal and interest on the mortgage
note if there has been a default. The obligations of an issuer of municipal
notes are generally secured by the anticipated revenues from taxes, grants or
bond financing. An investment in such instruments, however, presents a risk that
the anticipated revenues will not be received or that such revenues will be
insufficient to satisfy the issuer's payment obligations under the notes or that
refinancing will be otherwise unavailable.

PRIVATE ACTIVITY AND INDUSTRIAL DEVELOPMENT BONDS -- The Fund may invest in
private activity and industrial development bonds, which are obligations issued
by or on behalf of public authorities to raise money to finance various
privately owned or operated facilities for business and manufacturing, housing,
sports and pollution control. These bonds are also used to finance public
facilities such as airports, mass transit systems, ports, parking or sewage or
solid waste disposal facilities, as well as certain other facilities or
projects. The payment of the principal and interest on such bonds is generally
dependent solely on the ability of the facility's user to meet its financial
obligations and the pledge, if any, of real and personal property so financed as
security for such payment.

TAX EXEMPT COMMERCIAL PAPER -- Issues of tax-exempt commercial paper typically
represent short-term, unsecured, negotiable promissory notes. These obligations
are issued by state and local governments and their agencies to finance working
capital needs of municipalities or to provide interim construction financing and
are paid from general revenues of municipalities or are refinanced with
long-term debt. In most cases, tax-exempt commercial paper is backed by letters
of credit, lending agreements, note repurchase agreements or other credit
facility agreements offered by banks or other institutions.

PRE-REFUNDED MUNICIPAL SECURITIES -- The principal of and interest on municipal
securities that have been pre-refunded are no longer paid from the original
revenue source for the securities. Instead, after pre-refunding the source of
such payments of the principal of and interest on these securities are typically
paid from an escrow fund consisting of obligations issued or guaranteed by the
U.S. Government. The assets in the escrow fund are derived from the proceeds of
refunding bonds issued by the same issuer as the pre-refunded municipal
securities. Issuers of municipal securities use this advance refunding technique
to obtain more favorable terms with respect to securities that are not yet
subject to call or redemption by the issuer. For example, advance refunding
enables an issuer to refinance debt at lower market interest rates, restructure
debt to improve cash flow or eliminate restrictive covenants in the indenture or
other governing instrument for the pre-refunded municipal securities. However,
except for a change in the revenue source from which principal and interest
payments are made, the pre-refunded municipal securities remain outstanding on
their original terms until they mature or are redeemed by the issuer.
Pre-refunded municipal securities are usually purchased at a price which
represents a premium over their face value.

TENDER OPTION BONDS -- A tender option bond is a municipal security (generally
held pursuant to a custodial arrangement) having a relatively long maturity and
bearing interest at a fixed rate substantially higher than prevailing short-term
tax-exempt rates. The bond is typically issued in conjunction with the agreement
of a third party, such as a bank, broker-dealer or other financial institution,
pursuant to which such institution grants the security holders the option, at
periodic intervals, to tender their securities to the institution and receive
the face value thereof.

As consideration for providing the option, the financial institution receives
periodic fees equal to the difference between the bond's fixed coupon rate and
the rate, as determined by a remarketing or similar agent at or near the
commencement of such period, that would cause the securities, coupled with the
tender option, to trade at par on the date of such determination. Thus, after
payment of this fee, the security holder effectively holds a demand obligation
that bears interest at the prevailing short-term tax-exempt rate.

However, an institution will not be obligated to accept tendered bonds in the
event of certain defaults or a significant downgrade in the credit rating
assigned to the issuer of the bond. The liquidity of a tender option bond is a
function of the credit quality of both the bond issuer and the financial
institution providing liquidity. Tender option bonds are deemed to be liquid
unless, in the opinion of the Adviser, the credit quality of the bond issuer and
the financial institution is deemed, in light of the Fund's credit quality
requirements, to be inadequate. The Fund intends to invest only in tender option
bonds the interest on which will, in the opinion of bond counsel, counsel for
the issuer of interests therein or counsel selected by the Adviser, be exempt
from regular federal income tax. However, because there can be no assurance that
the IRS will agree with such counsel's opinion in any particular case, there is
a risk that the Fund will not be considered the owner of such tender option
bonds and thus will not be entitled to treat such interest as exempt from such
tax. Additionally, the federal income tax treatment of certain other aspects of
these investments, including the proper tax treatment of tender option bonds and
the associated fees, in relation to various regulated investment company tax
provisions is unclear. The Fund intends to manage its portfolio in a manner
designed to eliminate or minimize any adverse impact from the tax rules
applicable to these investments.

AUCTION RATE SECURITIES -- Auction rate securities in which the Fund may invest
consist of auction rate municipal securities and auction rate preferred
securities issued by closed-end investment companies that invest primarily in
municipal securities. Provided that the auction mechanism is successful, auction
rate securities usually permit the holder to sell the securities in an auction
at par value at specified intervals. The dividend is reset by "Dutch" auction in
which bids are made by broker-dealers and other institutions for a certain
amount of securities at a specified minimum yield. The dividend rate set by the
auction is the lowest interest or dividend rate that covers all securities
offered for sale. While this process is designed to permit auction rate
securities to be traded at par value, there is the risk that an auction will
fail due to insufficient demand for the securities.

Dividends on auction rate preferred securities issued by a closed-end fund may
be designated as exempt from federal income tax to the extent they are
attributable to tax-exempt interest income earned by the fund on the securities
in its portfolio and distributed to holders of the preferred securities,
provided that the preferred securities are treated as equity securities for
federal income tax purposes and the closed-end fund complies with certain
requirements under the Internal Revenue Code of 1986, as amended (the "Code").

The Fund's investments in auction rate preferred securities of closed-end funds
are subject to limitations on investments in other U.S. registered investment
companies, which limitations are prescribed by the 1940 Act. These limitations
include prohibitions against acquiring more than 3% of the voting securities of
any other such investment company, and investing more than 5% of the Fund's
assets in securities of any one such investment company or more than 10% of its
assets in securities of all such investment companies.

PRIVATE ACTIVITY BONDS -- Certain types of municipal securities, generally
referred to as industrial development bonds (and referred to under current tax
law as private activity bonds), are issued by or on behalf of public authorities
to obtain funds for privately-operated housing facilities, airport, mass transit
or port facilities, sewage disposal, solid waste disposal or hazardous waste
treatment or disposal facilities and certain local facilities for water supply,
gas or electricity. Other types of industrial development bonds, the proceeds of
which are used for the construction, equipment, repair or improvement of
privately operated industrial or commercial facilities, may constitute municipal
securities, although the current federal tax laws place substantial limitations
on the size of such issues. The interest from certain private activity bonds
owned by the Fund (including the Fund's distributions attributable to such
interest) may be a preference item for purposes of the alternative minimum tax.

MORTGAGE- AND ASSET-BACKED SECURITIES -- The Fund may invest in mortgage-backed
securities. A mortgage-backed security consists of a pool of mortgage loans
evidenced by promissory notes secured by first mortgages or first deeds of trust
or other similar security instruments creating a first lien on owner occupied
and non-owner occupied one-unit to four-unit residential properties, multifamily
(i.e., five or more) properties, agriculture properties, commercial properties
and mixed use properties.

The investment characteristics of adjustable and fixed rate mortgage-backed
securities differ from those of traditional fixed-income securities. The major
differences include the payment of interest and principal on mortgage-backed
securities on a more frequent (usually monthly) schedule, and the possibility
that principal may be prepaid at any time due to prepayments on the underlying
mortgage loans or other assets. These differences can result in significantly
greater price and yield volatility than is the case with traditional
fixed-income securities. As a result, if the Fund purchases mortgage-backed
securities at a premium, a faster than expected prepayment rate will decrease
both the market value and the yield to maturity from those which were
anticipated. A prepayment rate that is slower than expected will have the
opposite effect of increasing yield to maturity and market value. Conversely, if
the Fund purchases mortgage-backed securities at a discount, faster than
expected prepayments will increase, while slower than expected prepayments will
decrease, yield to maturity and market values. To the extent that the Fund
invests in mortgage-backed securities, the Investment Manager may seek to manage
these potential risks by investing in a variety of mortgage-backed securities
and by using certain hedging techniques. The Fund may invest in securities
generally referred to as asset-backed securities. Asset-backed securities are
secured by and payable from, or directly or indirectly represent undivided
fractional interests in, pools of corporate and consumer loans (unrelated to
mortgage loans) held in a trust. Asset-backed securities may provide periodic
payments that consist of interest and/or principal payments. Consequently, the
life of an asset-backed security varies with the prepayment and loss experience
of the underlying assets. Payments of principal and interest are typically
supported by some form of credit enhancement, such as a letter of credit, surety
bond, limited guarantee or senior/subordination. The degree of credit
enhancement varies, but generally amounts to only a fraction of the asset-backed
security's par value until exhausted. If the credit enhancement is exhausted,
certificate-holders may experience losses or delays in payment if the required
payments of principal and interest are not made to the trust with respect to the
underlying loans. The value of the securities also may change because of changes
in the market's perception of creditworthiness of the servicing agent for the
loan pool, the originator of the loans or the financial institution providing
the credit enhancement. Asset-backed securities are ultimately dependent upon
payment of corporate and consumer loans, and the certificate-holder generally
has no recourse against the entity that originated the loans.

Asset-backed securities have structural characteristics similar to
mortgage-backed securities. However, the underlying assets are not first lien
mortgage loans or interests therein but include assets such as (but not limited
to) motor vehicle installment sale contracts, other installment sale contracts,
home equity loans, leases of various types of real and personal property, and
receivables from revolving credit (credit card) agreements. Such assets are
securitized through the use of trusts or special purpose corporations. Payments
or distributions of principal and interest on asset-backed securities may be
guaranteed up to certain amounts and for a certain time period by a letter of
credit or a pool insurance policy issued by a financial institution unaffiliated
with the issuer, or other credit enhancements may be present.

Asset-backed securities present certain additional risks that are not presented
by mortgage-backed securities. Primarily, these securities do not have the
benefit of the same type of security interest in the related collateral. Credit
card receivables are generally unsecured, and the debtors are entitled to the
protection of a number of state and federal consumer credit laws, many of which
give such debtors the right to avoid payment of 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.

The market for privately issued asset-backed securities is smaller and less
liquid than the market for U.S. government mortgage-backed securities. The
asset-backed securities in which the Fund may invest are limited to those which
are readily marketable, dollar-denominated and rated BBB or higher by S&P or Baa
or higher by Moody's.

The yield characteristics of the mortgage- and asset-backed securities in which
the Fund may invest differ from those of traditional debt securities. Among the
major differences are that interest and principal payments are made more
frequently on the mortgage- and asset-backed securities (usually monthly) and
that principal may be prepaid at any time because the underlying assets
generally may be prepaid at any time. As a result, if the Fund purchases these
securities at a premium, a prepayment rate that is faster than expected will
reduce their yield, while a prepayment rate that is slower than expected will
have the opposite effect of increasing yield. Conversely, if the Fund purchases
these securities at a discount, faster than expected prepayments will increase,
while slower than expected prepayments will reduce, the yield on these
securities. Amounts available for reinvestment by the Fund are likely to be
greater during a period of declining interest rates and, as a result, are likely
to be reinvested at lower interest rates than during a period of rising interest
rates. Mortgage-backed securities and asset-backed securities are often backed
by a pool of assets representing the obligations of a number of different
parties. To lessen the effect of failure by obligors on underlying assets to
make payments, such securities may contain elements of credit support. Such
credit support falls into two categories: (1) liquidity protection and (2)
protection against losses resulting from ultimate default by an obligor on the
underlying assets. Liquidity protection refers to the provision of advances,
generally by the entity administering the pool of assets, to ensure that the
pass-through of payments due on the underlying pool occurs in a timely fashion.
Protection against losses resulting from ultimate default enhances the
likelihood of ultimate payment of the obligations on at least a portion of the
assets in the pool. Such protection may be provided through guarantees,
insurance policies or letters of credit obtained by the issuer or sponsor from
third parties; through various means of structuring the transaction; or through
a combination of such approaches. The Fund may not pay any additional fees for
such credit support, although the existence of credit support may increase the
price of a security.

The ratings of mortgage-backed securities and asset-backed securities for which
third-party credit enhancement provides liquidity protection or protection
against losses from default are generally dependent upon the continued
creditworthiness of the provider of the credit enhancement. The ratings of such
securities could be subject to reduction in the event of deterioration in the
creditworthiness of the credit enhancement provider even in cases where the
delinquency and loss experience on the underlying pool of assets is better than
expected.

Examples of credit support arising out of the structure of the transaction
include "senior-subordinated securities" (multiple class securities with one or
more classes subordinate to other classes as to the payment of principal thereof
and interest thereon, with the result that defaults on the underlying assets are
borne first by the holders of the subordinated class), creation of "reserve
funds" (where cash or investments, sometimes funded from a portion of the
payments on the underlying assets, are held in reserve against future losses)
and "over-collateralization" (where the scheduled payments on, or the principal
amount of, the underlying assets exceed those required to make payment of the
securities and pay any servicing or other fees). The degree of credit support
provided for each issue is generally based on historical information with
respect to the level of credit risk associated with the underlying assets.
Delinquency or loss in excess of that which is anticipated could adversely
affect the return on an investment in such a security.

GOVERNMENT GUARANTEED MORTGAGE-BACKED SECURITIES. The Fund's investments in
mortgage-backed securities may include securities issued or guaranteed by the
U.S. Government or one of its agencies, authorities, instrumentalities or
sponsored enterprises, such as Ginnie Mae, Fannie Mae and Freddie Mac. There are
several types of guaranteed mortgage-backed securities currently available,
including guaranteed mortgage pass-through certificates and multiple class
securities, which include guaranteed Real Estate Mortgage Investment Conduit
Certificates ("REMIC Certificates"), collateralized mortgage obligations and
stripped mortgage-backed securities. The Fund is permitted to invest in other
types of mortgage-backed securities that may be available in the future to the
extent consistent with its investment policies and objective.

GINNIE MAE CERTIFICATES. Ginnie Mae is a wholly-owned corporate instrumentality
of the United States within the Department of Housing and Urban Development. The
National Housing Act of 1934, as amended (the "Housing Act"), authorizes Ginnie
Mae to guarantee the timely payment of the principal of and interest on
certificates that are based on and backed by a pool of mortgage loans insured by
the Federal Housing Administration under the Housing Act, or Title V of the
Housing Act of 1949 ("FHA Loans"), or guaranteed by the Department of Veterans
Affairs under the Servicemen's Readjustment Act of 1944, as amended ("VA
Loans"), or by pools of other eligible mortgage loans. The Housing Act provides
that the full faith and credit of the U.S. government is pledged to the payment
of all amounts that may be required to be paid under any Ginnie Mae guaranty. In
order to meet its obligations under such guaranty, Ginnie Mae is authorized to
borrow from the U.S. Treasury with no limitations as to amount.

The Ginnie Mae Certificates in which the Fund invests represent a pro rata
interest in one or more pools of the following types of mortgage loans: (1)
fixed-rate level payment mortgage loans; (2) fixed-rate graduated payment
mortgage loans; (3) fixed-rate growing equity mortgage loans; (4) fixed-rate
mortgage loans secured by manufactured (mobile) homes; (5) mortgage loans on
multifamily residential properties under construction; (6) mortgage loans on
completed multifamily projects; (7) fixed-rate mortgage loans as to which
escrowed funds are used to reduce the borrower's monthly payments during the
early years of the mortgage loans ("buy down" mortgage loans); (8) mortgage
loans that provide for adjustments in payments based on periodic changes in
interest rates or in other payment terms of the mortgage loans; and (9)
mortgage-backed serial notes.

FANNIE MAE CERTIFICATES. Fannie Mae is a federally chartered and privately owned
corporation organized and existing under the Federal National Mortgage
Association Charter Act of 1938. The obligations of Fannie Mae are obligations
solely of Fannie Mae and are not backed by the full faith and credit of the U.S.
government.

Each Fannie Mae Certificate represents a pro rata interest in one or more pools
of FHA Loans, VA Loans or conventional mortgage loans (i.e., mortgage loans that
are not insured or guaranteed by any governmental agency) of the following
types: (1) fixed-rate level payment mortgage loans; (2) fixed-rate growing
equity mortgage loans; (3) fixed-rate graduated payment mortgage loans; (4)
variable rate mortgage loans; (5) other adjustable rate mortgage loans; and (6)
fixed-rate and adjustable mortgage loans secured by multifamily projects.

FREDDIE MAC CERTIFICATES. Freddie Mac is a federally chartered and privately
owned corporation of the United States created pursuant to the Emergency Home
Finance Act of 1970, as amended (the "FHLMC Act"). The obligations of Freddie
Mac are obligations solely of Freddie Mac and are not backed by the full faith
and credit of the U.S. government.

Freddie Mac Certificates represent a pro rata interest in a group of mortgage
loans (a "Freddie Mac Certificate group") purchased by Freddie Mac. The mortgage
loans underlying the Freddie Mac Certificates consist of fixed-rate or
adjustable rate mortgage loans with original terms to maturity of between ten
and thirty years, substantially all of which are secured by first liens on one-
to four-family residential properties or multifamily projects. Each mortgage
loan must meet the applicable standards set forth in the FHLMC Act. A Freddie
Mac Certificate group may include whole loans, participating interests in whole
loans and undivided interests in whole loans and participations comprising
another Freddie Mac Certificate group.

MULTIPLE CLASS MORTGAGE-BACKED SECURITIES. The Fund may invest in multiple class
mortgage-backed securities including collateralized mortgage obligations
("CMOs") and real estate mortgage investments conduits ("REMIC") Certificates.
These securities may be issued by U.S. Government agencies and instrumentalities
such as Fannie Mae or Freddie Mac or by trusts formed by private originators of,
or investors in, mortgage loans, including savings and loan associations,
mortgage bankers, commercial banks, insurance companies, investment banks and
special purpose subsidiaries of the foregoing. In general, CMOs are debt
obligations of a legal entity that are collateralized by a pool of mortgage
loans or mortgage-backed securities the payments on which are used to make
payments on the CMOs or multiple class mortgage-backed securities. REMIC
Certificates represent beneficial ownership interests in a REMIC trust,
generally consisting of mortgage loans or Fannie Mae, Freddie Mac or Ginnie Mae
guaranteed mortgage-backed securities (the "Mortgage Assets"). The obligations
of Fannie Mae or Freddie Mac under their respective guaranty of the REMIC
Certificates are obligations solely of Fannie Mae or Freddie Mac, respectively.
Although investors may purchase beneficial interests in REMICs, which are known
as "regular" interests or "residual" interests, the Fund does not intend to
purchase such residual interests in REMICs.

Fannie Mae REMIC Certificates are issued and guaranteed as to timely
distribution of principal and interest by Fannie Mae. These Certificates are
obligations solely of Fannie Mae and are not backed by the full faith and credit
of the U.S. Government. In addition, Fannie Mae will be obligated to distribute
the principal balance of each class of REMIC Certificates in full, whether or
not sufficient funds are otherwise available.

Freddie Mac guarantees the timely payment of interest on Freddie Mac REMIC
Certificates and also guarantees the payment of principal as payments are
required to be made on the underlying mortgage participation certificates
("PCs"). These PCs are obligations solely of Freddie Mac and are not backed by
the full faith and credit of the U.S. Government. PCs represent undivided
interests in specified level payment, residential mortgages or participation
therein purchased by Freddie Mac and placed in a PC pool. With respect to
principal payments on PCs, Freddie Mac generally guarantees ultimate collection
of all principal of the related mortgage loans without offset or deduction.
Freddie Mac also guarantees timely payment of principal of certain PCs.

CMOs and REMIC Certificates are issued in multiple classes. Each class of CMOs
or REMIC Certificates, often referred to as a "tranche," is issued at a specific
adjustable or fixed interest rate and must be fully retired no later than its
final distribution date. Principal prepayments on the underlying mortgage loans
or the mortgaged assets underlying the CMOs or REMIC Certificates may cause some
or all of the classes of CMOs or REMIC Certificates to be retired substantially
earlier than their final distribution dates. Generally, interest is paid or
accrues on all classes of CMOs or REMIC Certificates on a monthly basis.

The principal of and interest on the mortgaged assets may be allocated among the
several tranches in various ways. In certain structures (known as "sequential
pay" CMOs or REMIC Certificates), payments of principal, including any principal
prepayments, on the Mortgage Assets generally are applied to the classes of CMOs
or REMIC Certificates in the order of their respective final distribution dates.
Thus, no payment of principal will be made on any class of sequential pay CMOs
or REMIC Certificates until all other classes having an earlier final
distribution date have been paid in full. Additional structures of CMOs and
REMIC Certificates include, among others, "parallel pay" CMOs and REMIC
Certificates. Parallel pay CMOs or REMIC Certificates are those which are
structured to apply principal payments and prepayments of the mortgaged assets
to two or more classes concurrently on a proportionate or disproportionate
basis. These simultaneous payments are taken into account in calculating the
final distribution date of each class.

A wide variety of REMIC Certificates may be issued in parallel pay or sequential
pay structures. These securities include accrual certificates (also known as
"Z-Bonds"), which only accrue interest at a specified rate until all other
certificates having an earlier final distribution date have been retired and are
converted thereafter to an interest-paying security, and planned amortization
class ("PAC") certificates, which are parallel pay REMIC Certificates that
generally require that specified amounts of principal be applied on each payment
date to one or more classes or REMIC Certificates (the "PAC Certificates"), even
though all other principal payments and prepayments of the Mortgage Assets are
then required to be applied to one or more other classes of the PAC
Certificates. The scheduled principal payments for the PAC Certificates
generally have the highest priority on each payment date after interest due has
been paid to all classes entitled to receive interest currently. Shortfalls, if
any, are added to the amount payable on the next payment date. The PAC
Certificate payment schedule is taken into account in calculating the final
distribution date of each class of PAC. In order to create PAC tranches, one or
more tranches generally must be created that absorb most of the volatility in
the underlying mortgage assets. These tranches tend to have market prices and
yields that are much more volatile than other PAC classes.

STRIPPED MORTGAGE-BACKED SECURITIES. The Fund may purchase stripped
mortgage-backed securities ("SMBS"), which are derivative multiclass mortgage
securities. Although the market for such securities is increasingly liquid,
certain SMBS may not be readily marketable and will be considered illiquid for
purposes of the Fund's limitation on investments in illiquid securities. The
market value of the class consisting entirely of principal payments generally is
unusually volatile in response to changes in interest rates. The yields on a
class of SMBS that receives all or most of the interest from the mortgaged
assets are generally higher than prevailing market yields on other
mortgage-backed securities because their cash flow patterns are more volatile
and there is a greater risk that the initial investment will not be fully
recouped.

ADJUSTABLE RATE MORTGAGES-INTEREST RATE INDICES. Adjustable rate mortgages in
which the Fund invests may be adjusted on the basis of one of several indices.
The One Year Treasury Index is the figure derived from the average weekly quoted
yield on U.S. Treasury Securities adjusted to a constant maturity of one year.
The Cost of Funds Index reflects the monthly weighted average cost of funds of
savings and loan associations and savings banks whose home offices are located
in Arizona, California and Nevada (the "FHLB Eleventh District") that are member
institutions of the Federal Home Loan Bank of San Francisco (the "FHLB of San
Francisco"), as computed from statistics tabulated and published by the FHLB of
San Francisco. The FHLB of San Francisco normally announces the Cost of Funds
Index on the last working day of the month following the month in which the cost
of funds was incurred.

A number of factors affect the performance of the Cost of Funds Index and may
cause the Cost of Funds Index to move in a manner different from indices based
upon specific interest rates, such as the One Year Treasury Index. Because of
the various origination dates and maturities of the liabilities of members of
the FHLB Eleventh District upon which the Cost of Funds Index is based, among
other things, at any time the Cost of Funds Index may not reflect the average
prevailing market interest rates on new liabilities of similar maturities. There
can be no assurance that the Cost of Funds Index will necessarily move in the
same direction or at the same rate as prevailing interest rates since as longer
term deposits or borrowings mature and are renewed at market interest rates, the
Cost of Funds Index will rise or fall depending upon the differential between
the prior and the new rates on such deposits and borrowings. In addition,
dislocations in the thrift industry in recent years have caused and may continue
to cause the cost of funds of thrift institutions to change for reasons
unrelated to changes in general interest rate levels. Furthermore, any movement
in the Cost of Funds Index as compared to other indices based upon specific
interest rates may be affected by changes instituted by the FHLB of San
Francisco in the method used to calculate the Cost of Funds Index. To the extent
that the Cost of Funds Index may reflect interest changes on a more delayed
basis than other indices, in a period of rising interest rates, any increase may
produce a higher yield later than would be produced by such other indices, and
in a period of declining interest rates, the Cost of Funds Index may remain
higher than other market interest rates which may result in a higher level of
principal prepayments on mortgage loans which adjust in accordance with the Cost
of Funds Index than mortgage loans which adjust in accordance with other
indices.

LIBOR, the London interbank offered rate, is the interest rate that the most
creditworthy international banks dealing in U.S. dollar-denominated deposits and
loans charge each other for large dollar-denominated loans. LIBOR is also
usually the base rate for large dollar-denominated loans in the international
market. LIBOR is generally quoted for loans having rate adjustments at one,
three, six or twelve month intervals.

ZERO COUPON SECURITIES AND DEFERRED INTEREST BONDS. The Fund may invest in zero
coupon securities that are "stripped" U.S. Treasury notes and bonds and in
deferred interest bonds. Zero Coupon Securities, including CATS, TIGRs and TRs,
are the separate income or principal components of a debt instrument. Zero
coupon and deferred interest bonds are debt obligations which are issued at a
significant discount from face value. The original discount approximates the
total amount of interest the bonds will accrue and compound over the period
until maturity or the first interest accrual date at a rate of interest
reflecting the market rate of the security at the time of issuance. Zero coupon
securities are redeemed at face value at their maturity date without interim
cash payments of interest or principal. The amount of this discount is accrued
over the life of the security, and the accrual constitutes the income earned on
the security for both accounting and tax purposes. Because of these features,
the market prices of zero coupon securities are generally more volatile than the
market prices of securities that have similar maturity but that pay interest
periodically.

While zero coupon bonds do not require the periodic payment of interest,
deferred interest bonds generally provide for a period of delay before the
regular payment of interest begins. Although this period of delay is different
for each deferred interest bond, a typical period is approximately one-third of
the bond's term to maturity. Such investments benefit the issuer by mitigating
its initial need for cash to meet debt service, but some also provide a higher
rate of return to attract investors who are willing to defer receipt of such
cash.

The Fund will accrue income on such investments for tax and accounting purposes,
as required, which is distributable to shareholders and which, because no cash
is generally received at the time of accrual, may require the liquidation of
other portfolio securities to satisfy the Fund's distribution obligations. See
"Taxes."

ILLIQUID SECURITIES -- Historically, illiquid securities have included
securities subject to contractual or legal restrictions on resale because they
have not been registered under the Securities Act of 1933, as amended (the "1933
Act"), securities which are otherwise not readily marketable and repurchase
agreements having a maturity of longer than seven days. Securities which have
not been registered under the 1933 Act are referred to as private placements or
restricted securities and are purchased directly from the issuer or in the
secondary market. Non-publicly traded securities (including Rule 144A
Securities) may involve a high degree of business and financial risk and may
result in substantial losses. These securities may be less liquid than publicly
traded securities, and it may take longer to liquidate these positions than
would be the case for publicly traded securities. Companies whose securities are
not publicly traded may not be subject to the disclosure and other investor
protection requirements applicable to companies whose securities are publicly
traded. Limitations on resale may have an adverse effect on the marketability of
portfolio securities and a mutual fund might be unable to dispose of restricted
or other illiquid securities promptly or at prices deemed reasonable by the
Investment Manager and might thereby experience difficulty satisfying
redemptions within seven days. An investment in illiquid securities is subject
to the risk that should the Fund desire to sell any of these securities when a
ready buyer is not available at a price that is deemed to be representative of
their value, the value of the Fund's net assets could be adversely affected.

Mutual funds do not typically hold a significant amount of these restricted or
other illiquid securities because of the potential for delays on resale and
uncertainty in valuation. A mutual fund might also have to register such
restricted securities in order to dispose of them, resulting in additional
expense and delay. Adverse market conditions could impede such a public offering
of securities.

A large institutional market has developed for certain securities that are not
registered under the 1933 Act, including but not limited to repurchase
agreements, commercial paper, non-U.S. securities, municipal securities and
corporate bonds and notes. Institutional investors depend on an efficient
institutional market in which the unregistered security can be readily resold or
on an issuer's ability to honor a demand for repayment. The fact that there are
contractual or legal restrictions on resale of such investments to the general
public or to certain institutions may not be indicative of their liquidity.

The Securities and Exchange Commission ("SEC") has adopted Rule 144A, which
allows a broader institutional trading market for securities otherwise subject
to restriction on their resale to the general public. Rule 144A establishes a
"safe harbor" from the registration requirements of the 1933 Act for resales of
certain securities to qualified institutional buyers. The Investment Manager
anticipates that the market for certain restricted securities such as
institutional commercial paper will expand further as a result of this
regulation and the development of automated systems for the trading, clearance
and settlement of unregistered securities of domestic and non-U.S. issuers, such
as the PORTAL System sponsored by NASD, Inc.

An investment in Rule 144A Securities will be considered illiquid and therefore
subject to the Fund's limit on the purchase of illiquid securities unless the
Board or its delegates determines that the Rule 144A Securities are liquid. In
reaching liquidity decisions, the Board and its delegates may consider, inter
alia, the following factors: (i) the unregistered nature of the security; (ii)
the frequency of trades and quotes for the security; (iii) the number of dealers
wishing to purchase or sell the security and the number of other potential
purchasers; (iv) dealer undertakings to make a market in the security; and (v)
the nature of the security and the nature of the marketplace trades (e.g., the
time needed to dispose of the security, the method of soliciting offers and the
mechanics of the transfer).

Investing in Rule 144A Securities could have the effect of increasing the level
of illiquidity in the Fund to the extent that qualified institutional buyers are
unavailable or uninterested in purchasing such securities from the Fund. The
Board has adopted guidelines and delegated to the Investment Manager the daily
function of determining and monitoring the liquidity of Rule 144A Securities,
although the Board will retain ultimate responsibility for any liquidity
determinations.

TBA PURCHASE COMMITMENTS. The Fund may enter into `To Be Announced' ("TBA")
purchase commitments to purchase securities for a fixed price at a future date,
typically not exceeding 75-90 days. TBA purchase commitments may be considered
securities in themselves, and involve a risk of loss if the value of the
security to be purchased declines prior to settlement date, which risk is in
addition to the risk of decline in the value of the Fund's other assets.
Unsettled TBA purchase commitments are valued at the current market value of the
underlying securities. To facilitate such acquisitions, the Fund identifies on
its books cash or liquid assets in an amount at least equal to such commitments.
It may be expected that the Fund's net assets will fluctuate to a greater degree
when it sets aside portfolio securities to cover such purchase commitments than
when it sets aside cash. On delivery dates for such transactions, the Fund will
meet its obligations from maturities or sales of the segregated securities
and/or from cash flow. If the Fund chooses to dispose of the TBA security prior
to its settlement, it could, as with the disposition of any other portfolio
obligation, incur a gain or loss due to market fluctuation.

WHEN-ISSUED AND DELAYED DELIVERY SECURITIES -- The Fund may purchase securities
on a when-issued or delayed delivery basis. Delivery of and payment for these
securities can take place a month or more after the date of the purchase
commitment. The purchase price and the interest rate payable, if any, on the
securities are fixed on the purchase commitment date or at the time the
settlement date is fixed. The value of such securities is subject to market
fluctuation, and no interest accrues to the Fund until settlement takes place.
At the time the Fund makes the commitment to purchase securities on a
when-issued or delayed delivery basis, it will record the transaction, reflect
the value each day of such securities in determining its NAV and, if applicable,
calculate the maturity for the purposes of average maturity from that date. At
the time of settlement, a when-issued security may be valued at less than the
purchase price. To facilitate such acquisitions, the Fund identifies on its
books liquid assets, cash or U.S. government securities or other appropriate
securities, in an amount at least equal to such commitments. On delivery dates
for such transactions, the Fund will meet its obligations from maturities or
sales of the securities held in the segregated account and/or from cash flow. If
the Fund chooses to dispose of the right to acquire a when-issued security prior
to its acquisition, it could, as with the disposition of any other portfolio
obligation, realize a gain or loss due to market fluctuation. It is the current
policy of the Fund not to enter into when-issued commitments exceeding in the
aggregate 15% of the market value of its total assets, less liabilities other
than the obligations created by when-issued commitments. When the Fund engages
in when-issued or delayed-delivery transactions, it relies on the other party to
consummate the trade. Failure of the seller to do so may result in the Fund's
incurring a loss or missing an opportunity to obtain a price considered being
advantageous.

LOWER-RATED DEBT SECURITIES ("JUNK BONDS") -- The Fund may invest in debt
securities rated below the fourth long-term rating category by S&P, Moody's and
Fitch or comparably rated by another NRSRO, or if not rated by a NRSRO, of
comparable quality as determined by The Investment Manager, Inc. in its sole
discretion. These securities, often referred to as junk bonds or high yield debt
securities, are considered speculative and, while generally offering greater
income than investments in higher quality securities, involve greater risk of
loss of principal and income, including the possibility of default or bankruptcy
of the issuers of such securities, and have greater price volatility, especially
during periods of economic uncertainty or change. These lower quality bonds tend
to be affected by economic changes and short-term corporate and industry
developments, as well as public perception of those changes and developments, to
a greater extent than higher quality securities, which react primarily to
fluctuations in the general level of interest rates. The market for lower-rated
debt securities may be thinner and less active than that for higher-rated debt
securities, which can adversely affect the prices at which the former are sold.
If market quotations are not available, lower-rated debt securities will be
valued in accordance with procedures established by the Board of Directors of
the Fund, including the use of outside pricing services. Judgment plays a
greater role in valuing high yield corporate debt securities than is the case
for securities for which more external sources for quotations and last sale
information is available. Adverse publicity and changing investor perception may
affect the availability of outside pricing services to value lower-rated debt
securities and the Fund's ability to dispose of these securities. In addition,
such securities generally present a higher degree of credit risk. Issuers of
lower-rated debt securities are often highly leveraged and may not have more
traditional methods of financing available to them so that their ability to
service their obligations during an economic downturn or during sustained
periods of rising interest rates may be impaired. The risk of loss due to
default by such issuers is significantly greater because below investment grade
securities generally are unsecured and frequently are subordinated to the prior
payment of senior indebtedness.

Since the risk of default is higher for lower-rated debt securities, The
Investment Manager, Inc.'s research and credit analysis are an especially
important part of managing securities of this type held by the Fund. In
considering investments for the Fund, the Investment Manager will attempt to
identify those issuers of high yield debt securities whose financial conditions
are adequate to meet future obligations, have improved or are expected to
improve in the future. The Investment Manager's analysis focuses on relative
values based on such factors as interest on dividend coverage, asset coverage,
earnings prospects and the experience and managerial strength of the issuer.

The Fund may choose, at its expense or in conjunction with others, to pursue
litigation or otherwise exercise its rights as a security holder to seek to
protect the interest of security holders if it determines this to be in the
interest of the Fund. The Investment Manager may invest in an affiliated mutual
fund to gain exposure to lower rated debt securities. The affiliated fund is
permitted to invest in securities of lower credit ratings than the Fund could
invest in if it makes direct purchases of high yield debt securities.

SECURITIES OF FOREIGN ISSUERS -- INVESTMENT IN EMERGING MARKETS -- The Fund may
invest to varying degrees in one or more countries with emerging securities
markets. These countries are generally located in Latin America, Europe, the
Middle East, Africa and Asia. Political and economic structures in many of these
countries may be undergoing significant evolution and rapid development, and
these countries may lack the social, political and economic stability
characteristic of more developed countries. Certain of these countries may have
in the past failed to recognize private property rights and, at times, may have
nationalized, or expropriated the assets of private companies. As a result,
these risks, including the risk of nationalization or expropriation of assets,
may be heightened. In addition, unanticipated political or social developments
may affect the value of the Fund's investments in these countries, as well as
the availability of additional investments in these countries. The small size
and inexperience of the securities markets in certain of these countries and the
limited volume of trading in securities in these countries may make the Fund's
investments in these countries illiquid and more volatile than investments in
most Western European countries, and the Fund may be required to establish
special custodial or other arrangements before making certain investments in
some of these countries. There may be little financial or accounting information
available with respect to issuers located in certain of these countries, and may
be difficult as a result to assess the value or prospects of an investment in
those countries. The laws of some foreign countries may limit the Fund's ability
to invest in securities of certain issuers located in those countries.

CURRENCY MANAGEMENT TECHNIQUES -- The instruments involved in currency-related
transactions may be considered derivative instruments. The Fund may enter into
currency-related transactions to attempt to protect against an anticipated rise
in the U.S. dollar price of securities that it intends to purchase. In addition,
the Fund may enter into currency-related transactions to attempt to protect
against the decline in value of its foreign currency denominated or quoted
portfolio securities, or a decline in the value of anticipated dividends or
interest from such securities, due to a decline in the value of the foreign
currency against the U.S. dollar. The forecasting of currency market movements
is extremely difficult and there can be no assurance that currency hedging
strategies will be successful. If the Investment Manager is incorrect in its
forecast, currency hedging strategies may result in investment performance worse
than if the strategies were not attempted. In addition, forward contracts and
over-the-counter currency options may be illiquid and are subject to the risk
that the counterparty will default on its obligations.

FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS -- The Fund may exchange currencies
in the normal course of managing its investments in foreign securities and may
incur costs in doing so because a foreign exchange dealer may charge a fee for
conversion. The Fund may conduct foreign currency exchange transactions on a
"spot" basis (i.e., for prompt delivery and settlement) at the prevailing spot
rate for purchasing or selling currency in the foreign currency exchange market.
The Fund also may enter into forward foreign currency exchange contracts
("forward currency contracts") or other contracts to purchase and sell
currencies for settlement at a future date. A foreign exchange dealer, in that
situation, will expect to realize a profit based on the difference between the
price at which a foreign currency is sold to the Fund and the price at which the
dealer will cover the purchase in the foreign currency market. Foreign exchange
transactions are entered into at prices quoted by dealers, which may include a
mark-up over the price that the dealer must pay for the currency.

A forward currency contract involves an obligation to purchase or sell a
specific currency at a future date, which may be any fixed number of days from
the date of the contract agreed upon by the parties, at a price set at the time
of the contract. These 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 generally charged at any stage for trades, but currency dealers
seek to obtain a "spread" or profit on each transaction.

At the maturity of a forward contract, the Fund may either accept or make
delivery of the currency specified in the contract or, at or prior to maturity,
enter into a closing purchase transaction involving the purchase or sale of an
offsetting contract.

The Fund may use forward currency transactions in an attempt to hedge against
losses, or where possible, to add to investment returns. For the purposes of
hedging, when the Fund enters into a contract for the purchase or sale of a
security denominated in a foreign currency, or when the Fund anticipates the
receipt in a foreign currency of dividend or interest payments on such a
security which it holds, the Fund may desire to "lock in" the U.S. dollar price
of the security or the U.S. dollar equivalent of such dividend or interest
payment, as the case may be. By entering into a forward contract for the
purchase or sale, for a fixed amount of U.S. dollars, of the amount of foreign
currency involved in the underlying transactions, the Fund will attempt to
protect itself against an adverse change in the relationship between the U.S.
dollar and the subject 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.

Additionally, when management of the Fund believes that the currency of a
particular foreign country may suffer a substantial decline against the U.S.
dollar, it may cause the Fund to enter into a forward contract to sell, for a
fixed amount of U.S. dollars, the amount of foreign currency approximating the
value of some or all of the Fund's portfolio securities denominated in such
foreign currency. The precise matching of the forward contract amounts and the
value of the securities involved will not generally be possible because the
future value of such securities in foreign currencies will change as a
consequence of market movements in the value of those securities between the
date on which the contract is entered into and the date it matures.

Using forward currency contracts in an attempt to protect the value of the
Fund's portfolio securities against a decline in the value of a currency does
not eliminate fluctuations in the underlying prices of the securities. It simply
establishes a rate of exchange which the Fund can achieve at some future point
in time. The precise projection of short-term currency market movements is not
possible, and short-term hedging provides a means of fixing the dollar value of
only a portion of the Fund's foreign assets.

If the value of the securities placed in the segregated account declines,
additional cash or liquid securities will be placed in the account on a daily
basis so that the value of the account will equal the amount of the Fund's
commitments with respect to such contracts. The segregated account will be
marked-to-market on a daily basis. Although forward currency contracts are not
presently regulated by the Commodity Futures Trading Commission (the "CFTC"),
the CFTC may in the future assert authority to regulate these contracts. In such
event, the Fund's ability to utilize forward currency contracts may be
restricted. In addition, a particular forward currency contract and assets used
to cover such contract may be illiquid.

The Fund generally will not enter into a forward currency contract with a term
of greater than one year. The forecasting of short-term currency market
movements is extremely difficult and there can be no assurance that short-term
hedging strategies will be successful.

While the Fund will enter into forward currency contracts to reduce currency
exchange rate risks, transactions in such contracts involve certain other risks.
Thus, while the Fund may benefit from currency transactions, unanticipated
changes in currency prices may result in a poorer overall performance for the
Fund than if it had not engaged in any such transactions. Moreover, there may be
an imperfect correlation between the Fund's portfolio holdings of securities
denominated in a particular currency and forward contracts entered into by the
Fund. Such imperfect correlation may cause the Fund to sustain losses which will
prevent the Fund from achieving a complete hedge or expose the Fund to risk of
foreign currency exchange loss. Forward currency contracts may be considered
derivative instruments.

DERIVATIVES --

GENERAL. The Fund may invest in various instruments that are commonly known as
"derivatives." Generally, a derivative is a financial arrangement, the value of
which is based on, or "derived" from, a traditional security, asset or market
index. Some "derivatives," such as mortgage-related and other asset-backed
securities, are in many respects like any other investment, although they may be
more volatile and/or less liquid than more traditional debt securities. There
are, in fact, many different types of derivatives and many different ways to use
them. There are a range of risks associated with those uses. For example, the
Fund may use futures and options as a low-cost method of gaining exposure to a
particular securities market without investing directly in those securities and
for traditional hedging purposes to attempt to protect the Fund from exposure to
changing interest rates, securities prices or currency exchange rates and for
cash management or other investment purposes. The use of derivatives may result
in leverage, which tends to magnify the effects of an instrument's price changes
as market conditions change. Leverage involves the use of a small amount of
money to control a large amount of financial assets, and can in some
circumstances lead to significant losses. The Fund will limit the leverage
created by its use of derivatives for investment purposes by "covering" such
positions as required by the SEC. The Investment Manager may use derivatives in
circumstances where the Investment Manager believes they offer an economical
means of gaining exposure to a particular asset class. Derivatives will not be
used to increase portfolio risk above the level that could be achieved using
only traditional investment securities or to acquire exposure to changes in the
value of assets or indexes that by themselves would not be purchased for the
Fund. The use of derivatives for non-hedging purposes may be considered
speculative.

The Fund's investment in options, futures, forward contracts, and similar
strategies depend on the Investment Manager's judgment as to the potential risks
and rewards of different types of strategies. Options and futures can be
volatile investments, and may not perform as expected. If the Investment Manager
applies a hedge at an inappropriate time or judges price trends incorrectly,
options and futures strategies may lower the Fund's return. The Fund could also
experience losses if the prices of its options and futures positions were poorly
correlated with its other investments, or if it could not close out its
positions because of an illiquid secondary market. Options and futures traded on
foreign exchanges generally are not regulated by U.S. authorities, and may offer
less liquidity and less protection to the Fund in the event of default by the
other party to the contract.

HEDGING STRATEGIES. The Fund may use certain strategies designed to adjust the
overall risk of its investment portfolio. These "hedging" strategies involve
derivative contracts, including U.S. Treasury and Eurodollar futures contracts
and exchange-traded put and call options on such futures contracts. New
financial products and risk management techniques continue to be developed and
may be used if consistent with the Fund's investment objective and policies.
Among other purposes, these hedging strategies may be used to effectively
maintain a desired portfolio duration or to protect against market risk should
the Fund change its investments among different types of Fixed Income
Securities.

The Fund might not use any hedging strategies, and there can be no assurance
that any strategy used will succeed. If the Investment Manager is incorrect in
its judgment on market values, interest rates or other economic factors in using
a hedging strategy, the Fund may have lower net income and a net loss on the
investment. Each of these strategies involves certain risks, which include:

o the fact that the skills needed to use hedging instruments are different from
those needed to select securities for the Fund;

o the possibility of imperfect correlation, or even no correlation, between the
price movements of hedging instruments and price movements of the securities
or currencies being hedged;

o possible constraints placed on the Fund's ability to purchase or sell
portfolio investments at advantageous times due to the need for the Fund to
maintain "cover" or to segregate securities; and

o the possibility that the Fund will be unable to close out or liquidate its
hedged position.

A hedge is designed to offset a loss in a portfolio position with a gain in the
hedged position; at the same time, however, a properly correlated hedge will
result in a gain in the portfolio position being offset by a loss in the hedged
position. As a result, the use of options, futures and currency exchange
transactions for hedging purposes could limit any potential gain from an
increase in the value of the position hedged. With respect to futures contracts,
since the value of portfolio securities will far exceed the value of the futures
contracts sold by the Fund, an increase in the value of the futures contracts
could only mitigate, but not totally offset, the decline in the value of the
Fund's assets.

To the extent that the Fund engages in the strategies described above, the Fund
may experience losses greater than if these strategies had not been utilized. In
addition to the risks described above, these instruments may be illiquid and/or
subject to trading limits, and the Fund may be unable to close out a position
without incurring substantial losses, if at all. The Fund is also subject to the
risk of default by a counterparty to an off-exchange transaction. See "Illiquid
Securities."

SWAPS -- Among the Strategic Transactions into which the Fund may enter are
currency, and other types of swaps and the purchase or sale of related caps,
floors and collars. The Fund 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 Fund
anticipates purchasing at a later date. The Fund will not sell interest rate
caps or floors where it does not own securities or other instruments providing
the income stream the Fund may be obligated to pay. Interest rate swaps involve
the exchange by the Fund 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 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.

Swaps have special risks associated including possible default by the
counterparty to the transaction, illiquidity and, where swaps are used for
hedges, the risk that the use of a swap could result in losses greater than if
the swap had not been employed. Whether the use of swap agreements will be
successful in furthering its investment objective will depend on the Investment
Manager's ability to correctly predict whether certain types of investments are
likely to produce greater returns than other investments. Certain swap
agreements may be considered to be illiquid because they are two party contracts
and because they may have terms of greater than seven days. Moreover, the Fund
bears the risk of loss of the amount expected to be received under a swap
agreement in the event of the default or bankruptcy of a swap agreement
counterparty.

CREDIT DEFAULT SWAPS. The Fund may invest up to 15% of its total assets in
credit default swaps. A credit default swap is a contract between a buyer and a
seller of protection against a pre-defined credit event. The buyer of protection
pays the seller a fixed regular fee provided that no event of default on an
underlying reference obligation has occurred. If an event of default occurs, the
seller must pay the buyer the full notional value, or "par value", of the
reference obligation in exchange for the reference obligation. Credit default
swaps are used as a means of "buying" credit protection, i.e., attempting to
mitigate the risk of default or credit quality deterioration in some portion of
the Fund's holdings, or "selling" credit protection, i.e., attempting to gain
exposure to an underlying issuer's credit quality characteristics without
directly investing in that issuer. No more than 5% of the Fund's assets may be
invested in credit default swaps for purposes of buying credit protection for
non-hedging purposes. Where the Fund is a seller of credit protection, it
effectively adds leverage to its portfolio because, in addition to its total net
assets, the Fund would be subject to investment exposure on the notional amount
of the swap. The Fund will only sell credit protection with respect to
securities in which it would be authorized to invest directly. The Fund
currently considers credit default swaps to be illiquid and treats the market
value of the contract as illiquid for purposes of determining compliance with
the Fund's restrictions on investing in illiquid securities.

If the Fund is a buyer of a credit default swap and no event of default occurs,
the Fund will lose its investment and recover nothing. However, if the Fund is a
buyer and an event of default occurs, the Fund will receive the full notional
value of the reference obligation that may have little or no value. As a seller,
the Fund receives a fixed rate of income through the term of the contract
(typically between six months and three years), provided that there is no
default event. If an event of default occurs, the seller must pay the buyer the
full notional value of the reference obligation. Credit default swaps involve
greater risks than if the Fund had invested in the reference obligation
directly.

The Fund may use credit default swaps to gain exposure to particular issuers or
particular markets through investments in portfolios of credit default swaps,
such as Dow Jones CDX.NA.HY certificates. By investing in certificates
representing interests in a basket of credit default swaps, the Fund is taking
credit risk with respect to an entity or group of entities and providing credit
protection to the swap counterparties. For example, the CDX EM is a tradable
basket of 19 credit default swaps on country credits which seeks to replicate
the returns on the indices of a broad group of emerging markets countries. The
credits are a subset of the countries represented by the JPMorgan Emerging
Markets Bond Index Global Diversified. By purchasing interests in CDX EM, the
Fund is gaining emerging markets exposure through a single investment. Unlike
other types of credit default swaps which are generally considered illiquid,
credit default swap certificates generally can be sold within seven days and are
not subject to the Fund's restrictions on investing in illiquid securities.

FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS -- GENERAL -- The Fund may
enter into futures contracts on securities, securities indices, foreign
currencies and interest rates, and purchase and write (sell) options thereon
which are traded on exchanges designated by the CFTC or, if consistent with CFTC
regulations, on foreign exchanges. These futures contracts are standardized
contracts for the future delivery of, among other things, a commodity, a
non-U.S. currency, an interest rate sensitive security or, in the case of index
futures contracts or certain other futures contracts, a cash settlement with
reference to a specified multiplier times the change in the index. An option on
a futures contract gives the purchaser the right, in return for the premium
paid, to assume a position in a futures contract.

The Fund may enter into futures contracts and options on futures contracts on
securities, securities indices and currencies both to manage its exposure to
changing interest rates, security prices and currency exchange rates and as an
efficient means of managing allocations between asset classes.

The successful use of these instruments draws upon the Investment Manager's
skill and experience with respect to such instruments and usually depends on its
ability to forecast interest rate movements correctly. If interest rates move in
an unexpected manner, the Fund may not achieve the anticipated benefits of
futures contracts or options thereon or may realize losses and thus will be in a
worse position than if such strategies had not been used. In addition, the
correlation between movements in the price of futures contracts or options
thereon and movements in the price of the securities hedged or used for cover
will not be perfect and could produce unanticipated losses.

The Fund is operated by persons who have claimed an exclusion from the
definition of the term "commodity pool operator" under the Commodity Exchange
Act and, therefore, who are not subject to registration or regulation under the
Commodity Exchange Act.

FUTURES CONTRACTS -- Futures contracts are contracts to purchase or sell a fixed
amount of an underlying instrument, commodity or index at a fixed time and place
in the future. U.S. futures contracts have been designed by exchanges which have
been designated "contracts markets" by the CFTC, and must be executed through a
futures commission merchant, or brokerage firm, which is a member of the
relevant contract market. Futures contracts trade on a number of exchange
markets, and, through their clearing corporations, the exchanges guarantee
performance of the contracts as between the clearing members of the exchange.
The Fund may enter into contracts for the purchase or sale for future delivery
of fixed-income securities, foreign currencies, or financial indices, including
any index of U.S. government securities, foreign government securities or
corporate debt securities. The Fund may enter into futures contracts which are
based on debt securities that are backed by the full faith and credit of the
U.S. government, such as long-term U.S. Treasury Bonds, Treasury Notes and U.S.
Treasury Bills. The Fund may also enter into futures contracts which are based
on bonds issued by governments other than the U.S. government. Futures contracts
on foreign currencies may be used to hedge against securities that are
denominated in foreign currencies.

At the same time a futures contract is purchased or sold, the Fund must allocate
cash or securities as a deposit payment. Daily thereafter, the futures contract
is valued and "variation margin" may be required (that is, the Fund may have to
provide or may receive cash that reflects any decline or increase in the
contract's value).

At the time of delivery of securities pursuant to a futures contract,
adjustments are made to recognize differences in value arising from the delivery
of securities with a different interest rate from that specified in the
contract. In some (but not many) cases, securities called for by a futures
contract may not have been issued when the contract was written.

Although futures contracts by their terms call for the actual delivery or
acquisition of securities, in most cases the contractual obligation is fulfilled
before the termination date of the contract without having to make or take
delivery of the securities. The offsetting of a contractual obligation is
accomplished by buying (or selling, as the case may be) on a commodities
exchange an identical futures contract calling for delivery in the same month.
Such a transaction, which is effected through a member of an exchange, cancels
the obligation to make or take delivery of the securities. Since all
transactions in the futures market are made, offset or fulfilled through a
clearinghouse associated with the exchange on which the contracts are traded,
the Fund will incur brokerage fees when it purchases or sells futures contracts.

The purpose of the Fund's acquisition or sale of a futures contract, in cases
where the Funds holds or intends to acquire fixed income securities is to
attempt to protect the Fund from fluctuations in interest rates without actually
buying or selling fixed-income securities. For example, if interest rates were
expected to increase (which thus would cause the prices of debt securities to
decline), the Fund might enter into futures contracts for the sale of debt
securities. Such a sale would have much the same effect as selling an equivalent
value of the debt securities owned by the Fund. If interest rates did increase,
the value of the debt securities held by the Fund would decline, but the value
of the futures contracts to the Fund would increase at approximately the same
rate, thereby keeping the Fund's NAV from declining as much as it otherwise
would have. The Fund could accomplish similar results by selling debt securities
and investing in bonds with short maturities when interest rates are expected to
increase. However, since the futures market is more liquid than the cash market,
the use of futures contracts as an investment technique allows the Fund to
maintain a defensive position without having to sell its portfolio securities.
Similarly, when it is expected that interest rates may decline (thus increasing
the value of debt securities), futures contracts for the acquisition of debt
securities may be purchased to attempt to hedge against anticipated purchases of
debt securities at higher prices. Since the fluctuations in the value of futures
contracts should be similar to those of the underlying debt securities, the Fund
could take advantage of the anticipated rise in the value of debt securities
without actually buying them until the market had stabilized. At that time, the
futures contracts could be liquidated and the Fund could then buy debt
securities on the cash market. To the extent the Fund enters into futures
contracts for this purpose, the segregated assets maintained to cover the Fund's
obligations with respect to such futures contracts will consist of cash, cash
equivalents or high quality liquid debt securities from its portfolio in an
amount equal to the difference between the fluctuating market value of such
futures contracts and the aggregate value of the initial and variation margin
payments made by the Fund with respect to such futures contracts.

The ordinary spreads between prices in the cash and futures market, due to
differences in the nature of those markets, are subject to distortions. First,
all participants in the futures market are subject to initial and variation
margin requirements. Rather than meeting additional variation margin
requirements, investors may close futures contracts through offsetting
transactions that could distort the normal relationship between the cash and
futures markets. Second, the liquidity of the futures market depends on
participants entering into offsetting transactions rather than making or taking
delivery. To the extent participants decide to make or take delivery, liquidity
in the futures market could be reduced, thus producing distortion. Third, from
the point of view of speculators, the margin deposit requirements in the futures
market are less onerous than margin requirements in the securities market.
Therefore, increased participation by speculators in the futures market may
cause temporary price distortions. Due to the possibility of distortion, a
correct forecast of general interest rate trends by the Investment Manager may
still not result in a successful transaction.

In addition, futures contracts entail significant risks. Although the Investment
Manager believes that use of such contracts will benefit the Fund, if its
investment judgment about the general direction of interest rates is incorrect,
the Fund's overall performance would be poorer than if it had not entered into
any such contract. For example, if the Fund has hedged against the possibility
of an increase in interest rates that would adversely affect the price of debt
securities held in its portfolio and interest rates decrease instead, the Fund
will lose part or all of the benefit of the increased value of its debt
securities that it has hedged because it will have offsetting losses in its
futures positions. In addition, in such situations, if the Fund has insufficient
cash, it may have to sell debt securities from its portfolio to meet daily
variation margin requirements. Such sales of securities may be, but will not
necessarily be, at increased prices that reflect the rising market. The Fund may
have to sell securities at a time when it may be disadvantageous to do so.

FUTURES CONTRACTS ON SECURITIES INDICES. The Fund may also enter into futures
contracts providing for the making and acceptance of a cash settlement based
upon changes in the value of an index of U.S. or non-U.S. securities. This
investment technique may be used as a low-cost method of gaining exposure to a
particular securities market without investing directly in those securities or
to hedge against anticipated future changes in general market prices which
otherwise might either adversely affect the value of securities held by the Fund
or adversely affect the prices of securities which are intended to be purchased
at a later date for the Fund or as an efficient means of managing allocation
between asset classes. A futures contract may also be entered into to close out
or offset an existing futures position.

When used for hedging purposes, each futures contract on a securities index
transaction involves the establishment of a position which, the Investment
Manager believes, will move in a direction opposite to that of the investment
being hedged. If these hedging transactions are successful, the futures
positions taken for the Fund will rise in value by an amount which approximately
offsets the decline in value of the portion of the Fund's investments that are
being hedged. Should general market prices move in an unexpected manner, the
full anticipated benefits of futures contracts may not be achieved or a loss may
be realized.

The Fund has adopted certain non-fundamental policies concerning option
transactions that are discussed below.

OPTIONS ON FUTURES CONTRACTS (INCLUDING FUTURES CONTRACTS ON SECURITIES INDICES)
-- The Fund may purchase and write (sell) options on futures contracts for
hedging purposes. For example, as with the purchase of futures contracts, when
the Fund is not fully invested, it may purchase a call option on an interest
rate sensitive futures contract to hedge against a potential price increase on
debt securities due to declining interest rates. The purchase of a call option
on a futures contract is similar in some respects to the purchase of a call
option on an individual security. Depending on the pricing of the option
compared to either the price of the futures contract upon which it is based or
the price of the underlying debt securities, it may or may not be less risky
than ownership of the futures contract or underlying debt securities.

The writing of a call option on a futures contract may constitute a partial
hedge against declining prices of the security that is deliverable upon exercise
of the futures contract. If the futures price at expiration of the option is
below the price specified in the option ("exercise price"), the Fund will retain
the full amount of the net premium (the premium received for writing the option
less any commission), which will provide a partial hedge against any decline
that may have occurred in its portfolio holdings. The writing of a put option on
a futures contract constitutes a partial hedge against increasing prices of the
underlying securities or foreign currency that are deliverable upon exercise of
the futures contract. If the futures price at expiration of the option is higher
than the exercise price, the Fund will retain the full amount of the option net
premium, which will provide a partial hedge against any increase in the price of
securities that the Fund intends to purchase. If a put or call option the Fund
has written is exercised, the Fund may incur a loss that will be reduced by the
amount of the net premium it receives. Depending on the degree of correlation
between changes in the value of its portfolio securities and changes in the
value of its futures positions, such losses from existing options on futures may
to some extent be reduced or increased by changes in the value of portfolio
securities.

The purchase of a call or put option on a futures contract with respect to an
index is similar in some respects to the purchase of a call or protective put
option on an index. For example, the Fund may purchase a put option on an index
futures contract to hedge against the risk of lowering securities values.

The amount of risk the Fund assumes when it purchases an option on a futures
contract is the premium paid for the option plus related transaction costs. In
addition to the correlation risks discussed above, the purchase of an option
also entails the risk that changes in the value of the underlying futures
contract will not be fully reflected in the value of the option purchased.

OPTIONS ON SECURITIES -- The Fund may purchase and write (sell) put and call
options on stocks. A call option gives the purchaser of the option the right to
buy, and obligates the writer to sell, the underlying stock at the exercise
price at any time during the option period. Similarly, a put option gives the
purchaser of the option the right to sell, and obligates the writer to buy, the
underlying stock at the exercise price at any time during the option period.

The Fund may write (sell) covered call and put options to a limited extent on
its portfolio securities ("covered options") in an attempt to increase income
through the premiums it receives for writing the option(s). However, in return
for the premium, the Fund may forgo the benefits of appreciation on securities
sold or may pay more than the market price on securities acquired pursuant to
call and put options written by the Fund.

A call option written by the Fund is "covered" if the Fund owns the underlying
security covered by the call or has an absolute and immediate right to acquire
that security without additional cash consideration (or for additional cash
consideration held in a segregated account by its custodian) upon conversion or
exchange of other securities held in its portfolio. A call option is also
covered if the Fund holds a call option on the same security and in the same
principal amount as the written call option where the exercise price of the call
option so held (a) is equal to or less than the exercise price of the written
call option or (b) is greater than the exercise price of the written call option
if the difference is maintained by the Fund in cash, U.S. government securities
and other high quality liquid securities in a segregated account with its
custodian.

When the Fund writes a covered call option, it gives the purchaser of the option
the right to buy the underlying security at the exercise price by exercising the
option at any time during the option period. If the option expires unexercised,
the Fund will realize income in an amount equal to the premium received for
writing the option. If the option is exercised, a decision over which the Fund
has no control, the Fund must sell the underlying security to the option holder
at the exercise price. By writing a covered call option, the Fund forgoes, in
exchange for the net premium, the opportunity to profit during the option period
from an increase in the market value of the underlying security above the
exercise price. In addition, the Fund may continue to hold a stock which might
otherwise have been sold to protect against depreciation in the market price of
the stock.

A put option written by the Fund is "covered" when, among other things, cash or
liquid securities acceptable to the broker are placed in a segregated account to
fulfill the obligations undertaken.

When the Fund writes a covered put option, it gives the purchaser of the option
the right to sell the underlying security to the Fund at the exercise price at
any time during the option period. If the option expires unexercised, the Fund
will realize income in the amount of the net premium received for writing the
option. If the put option is exercised, a decision over which the Fund has no
control, the Fund must purchase the underlying security from the option holder
at the exercise price. By writing a covered put option, the Fund, in exchange
for the net premium, accepts the risk of a decline in the market value of the
underlying security below the exercise price. The Fund will only write put
options involving securities for which a determination is made at the time the
option is written that the Fund wishes to acquire the securities at the exercise
price.

The Fund may terminate its obligation as the writer of a call or put option by
purchasing an option with the same exercise price and expiration date as the
option previously written. This transaction is called a "closing purchase
transaction." The Fund will realize a profit or loss on a closing purchase
transaction if the amount paid to purchase the option is less or more, as the
case may be, than the amount received from the sale thereof. To close out a
position as a purchaser of an option, the Fund may enter into a "closing sale
transaction," which involves liquidating the Fund's position by selling the
option previously purchased. Where the Fund cannot effect a closing purchase
transaction, it may be forced to incur brokerage commissions or dealer spreads
in selling securities it receives or it may be forced to hold underlying
securities until an option is exercised or expires.

When the Fund writes an option, an amount equal to the net premium received is
included in the liability section of its Statement of Assets and Liabilities as
a deferred credit. The amount of the deferred credit will be subsequently marked
to market to reflect the current market value of the option. The current market
value of a traded option is the last sale price or, in the absence of a sale,
the mean between the closing bid and asked prices. If an option expires or if
the Fund enters into a closing purchase transaction, the Fund will realize a
gain (or loss if the cost of the closing purchase transaction exceeds the net
premium received when the option was sold), and the deferred credit related to
such option will be eliminated. If a call option is exercised, the Fund will
realize a gain or loss from the sale of the underlying security and the proceeds
of the sale will be increased by the premium originally received. The writing of
covered call options may be deemed to involve the pledge of the securities
against which the option is being written. Securities against which call options
are written will be identified on the Fund's books of the custodian for the
Fund.

The Fund may purchase call and put options on any securities in which it may
invest. The Fund would normally purchase a call option in anticipation of an
increase in the market value of such securities. The purchase of a call option
would entitle the Fund, in exchange for the premium paid, to purchase a security
at a specified price during the option period. The Fund would ordinarily have a
gain if the value of the securities increased above the exercise price
sufficiently to cover the premium and would have a loss if the value of the
securities remained at or below the exercise price during the option period.

The Fund would normally purchase put options in anticipation of a decline in the
market value of securities in its portfolio ("protective puts") or securities of
the type in which it is permitted to invest. The purchase of a put option would
entitle the Fund, in exchange for the premium paid, to sell a security, which
may or may not be held in the Fund's holdings, at a specified price during the
option period. The purchase of protective puts is designed merely to offset or
hedge against a decline in the market value of the Fund's holdings. Put options
also may be purchased by the Fund for the purpose of benefiting from a decline
in the price of securities that the Fund does not own. The Fund would ordinarily
recognize a gain if the value of the securities decreased below the exercise
price sufficiently to cover the premium and would recognize a loss if the value
of the securities remained at or above the exercise price. Gains and losses on
the purchase of protective put options would tend to be offset by countervailing
changes in the value of underlying portfolio securities.

The Fund has adopted certain non-fundamental policies concerning option
transactions that are discussed below.

The hours of trading for options on securities may not conform to the hours
during which the underlying securities are traded if the option markets close
before the markets for the underlying securities, significant price and rate
movements can take place in the underlying securities markets that will not be
reflected in the option markets. It is impossible to predict the volume of
trading that may exist in such options, and there can be no assurance that
viable exchange markets will develop or continue.

The Fund may engage in over-the-counter options transactions with broker-dealers
who make markets in these options. At present, approximately ten broker-dealers,
including several of the largest primary dealers in U.S. government securities,
make these markets. The ability to terminate over-the-counter option positions
is more limited than with exchange-traded option positions because the
predominant market is the issuing broker rather than an exchange and may involve
the risk that broker-dealers participating in such transactions will not fulfill
their obligations. To reduce this risk, the Fund will purchase such options only
from broker-dealers who are primary U.S. government securities dealers
recognized by the Federal Reserve Bank of New York and who agree to (and are
expected to be capable of) entering into closing transactions, although there
can be no guarantee that any such option will be liquidated at a favorable price
prior to expiration. the Investment Manager will monitor the creditworthiness of
dealers with whom the Fund enters into such options transactions under the
general supervision of the Board. Unless the Directors conclude otherwise, the
Fund intends to treat OTC options purchased and the assets used to "cover" OTC
options written as not readily marketable and therefore subject to the Fund's
limit on investments in illiquid securities.

OPTIONS ON SECURITIES INDICES. The Fund may also purchase and write
exchange-listed and OTC put and call options on securities indices. A securities
index measures the movement of a certain group of securities by assigning
relative values to the securities included in the index, fluctuating with
changes in the market values of the securities included in the index. Some
securities index options are based on a broad market index, such as the NYSE
Composite Index, or a narrower market index, such as the S&P 100. Indices may
also be based on a particular industry or market segment.

Options on securities indices are similar to options on securities except that
(1) the expiration cycles of securities index options are monthly, while those
of securities options are currently quarterly, and (2) the delivery requirements
are different. Instead of giving the right to take or make delivery of stock at
a specified price, an option on a securities index gives the holder the right to
receive a cash "exercise settlement amount" equal to (a) the amount, if any, 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 exercise, multiplied by (b) a fixed "index multiplier." Receipt
of this cash amount will depend upon the closing level of the securities index
upon which the option is based being greater than, in the case of a call, or
less than, in the case of a put, the exercise price of the index and the
exercise price of the option times a specified multiple. The writer of the
option is obligated, in return for the premium received, to make delivery of
this amount. Securities index options may be offset by entering into closing
transactions as described above for securities options.

As discussed in "Options on Securities," the Fund would normally purchase a call
option in anticipation of an increase in the market value of the relevant index.
The purchase of a call option would entitle the Fund, in exchange for the
premium paid, to purchase the underlying securities at a specified price during
the option period. The Fund would ordinarily have a gain if the value of the
underlying securities increased above the exercise price sufficiently to cover
the premium and would have a loss if the value of the securities remained at or
below the exercise price during the option period.

As discussed in "Options on Securities," the Fund would normally purchase put
options in anticipation of a decline in the market value of the relevant index
("protective puts"). The purchase of a put option would entitle the Fund, in
exchange for the premium paid, to sell the underlying securities at a specified
price during the option period. The purchase of protective puts is designed
merely to offset or hedge against a decline in the market value of the index.
The Fund would ordinarily recognize a gain if the value of the index decreased
below the exercise price sufficiently to cover the premium and would recognize a
loss if the value of the index remained at or above the exercise price. Gains
and losses on the purchase of protective put options would tend to be offset by
countervailing changes in the value of the index.

Because the value of an index option depends upon movements in the level of the
index rather than the price of a particular stock, whether the Fund will realize
a gain or loss from the purchase or writing of options on an index depends upon
movements in the level of stock prices in the stock market generally or, in the
case of certain indices, in an industry or market segment, rather than movements
in the price of a particular stock. Accordingly, successful use by the Fund of
options on stock indices will be subject to the Investment Manager's ability to
predict correctly movements in the direction of the stock market generally or of
a particular industry. This requires different skills and techniques than
predicting changes in the price of individual stocks.

Options on securities indices entail risks in addition to the risks of options
on securities. The absence of a liquid secondary market to close out options
positions on securities indices is more likely to occur, although the Fund
generally will only purchase or write such an option if the Investment Manager
believes the option can be closed out. Use of options on securities indices also
entails the risk that trading in such options may be interrupted if trading in
certain securities included in the index is interrupted. The Fund will not
purchase such options unless the Investment Adviser believes the market is
sufficiently developed such that the risk of trading in such options is no
greater than the risk of trading in options on securities.

Price movements in the Fund's investment portfolio may not correlate precisely
with movements in the level of an index and, therefore, the use of options on
indices cannot serve as a complete hedge. Because options on securities indices
require settlement in cash, the Investment Adviser may be forced to liquidate
portfolio securities to meet settlement obligations. The Fund's activities in
index options may also be restricted by the requirements of the Code for
qualification as a regulated investment company.

In addition, the hours of trading for options on the securities indices may not
conform to the hours during which the underlying securities are traded. To the
extent that the option markets close before the markets for the underlying
securities, significant price and rate movements can take place in the
underlying securities markets that cannot be reflected in the option markets. It
is impossible to predict the volume of trading that may exist in such options,
and there can be no assurance that viable exchange markets will develop or
continue.

LIMITATIONS AND RISKS ASSOCIATED WITH TRANSACTIONS IN OPTIONS, FUTURES CONTRACTS
AND OPTIONS ON FUTURES CONTRACTS -- Options and futures transactions involve (1)
liquidity risk that contractual positions cannot be easily closed out in the
event of market changes or generally in the absence of a liquid secondary
market, (2) correlation risk that changes in the value of hedging positions may
not match the securities market fluctuations intended to be hedged, and (3)
market risk that an incorrect prediction of securities prices by the Investment
Manager may cause the Fund to perform worse than if such positions had not been
taken. The ability to terminate over-the-counter options is more limited than
with exchange traded options and may involve the risk that the counterparty to
the option will not fulfill its obligations. In accordance with a position taken
by the Commission, the Fund will limit its investments in illiquid securities to
15% of the Fund's net assets.

Options and futures transactions are highly specialized activities which involve
investment techniques and risks that are different from those associated with
ordinary portfolio transactions. Gains and losses on investments in options and
futures depend on the Investment Manager's ability to predict the direction of
stock prices and other economic factors. The loss that may be incurred by the
Fund in entering into futures contracts and written options thereon is
potentially unlimited. There is no assurance that higher than anticipated
trading activity or other unforeseen events might not, at times, render certain
facilities of an options clearing entity or other entity performing the
regulatory and liquidity functions of an options clearing entity inadequate, and
thereby result in the institution by an exchange of special procedures which may
interfere with the timely execution of customers' orders. Most futures exchanges
limit the amount of fluctuation permitted in a futures contract's prices during
a single trading day. Once the limit has been reached no further trades may be
made that day at a price beyond the limit. The price limit will not limit
potential losses, and may in fact prevent the prompt liquidation of futures
positions, ultimately resulting in further losses.

OTHER CONSIDERATIONS -- The Fund will engage in futures and related options
transactions only for bona fide hedging or non-hedging purposes as permitted by
CFTC regulations which permit principals of an investment company registered
under the 1940 Act to engage in such transactions without registering as
commodity pool operators. The Fund will determine that the price fluctuations in
the futures contracts and options on futures used by it for hedging purposes are
substantially related to price fluctuations in securities or instruments held by
the Fund or securities or instruments which it expects to purchase.

The Fund will be required, in connection with transactions in futures contracts
and the writing of options on futures contracts, to make margin deposits, which
will be held by its custodian for the benefit of the futures commission merchant
through whom the portfolio engages in such futures and option transactions.
These transactions involve brokerage costs, require margin deposits and, in the
case of futures contracts and options obligating the Fund to purchase
securities, require the Fund to segregate cash or liquid securities in an
account maintained with its custodian to cover such contracts and options.

While transactions in futures contracts and options on futures may reduce
certain risks, such transactions themselves entail certain other risks. Thus,
unanticipated changes in interest rates or securities prices may result in a
poorer overall performance for the Fund than if it had not entered into any
futures contracts or options transactions. The other risks associated with the
use of futures contracts and options thereon are (i) imperfect correlation
between the change in market value of the securities held by the Fund and the
prices of the futures and options and (ii) the possible absence of a liquid
secondary market for a futures contract or option and the resulting inability to
close a futures position prior to its maturity date.

In the event of an imperfect correlation between a futures position and
portfolio position which is intended to be protected, the desired protection may
not be obtained and the Fund may be exposed to risk of loss. The risk of
imperfect correlation may be minimized by investing in contracts whose price
behavior is expected to resemble that of the Fund's underlying securities. The
Fund will attempt to minimize the risk that it will be unable to close out
futures positions by entering into such transactions on a national exchange with
an active and liquid secondary market.

REGULATORY LIMITATIONS. The Fund will engage in transactions in futures
contracts and options thereon only for bona fide hedging, yield enhancement and
risk management purposes, in each case in accordance with the rules and
regulations of the CFTC.

Pursuant to claims for exemption filed with the CFTC and/or the National Futures
Association on behalf of the Fund and the Investment Manager, the Fund and the
Investment Manager are not deemed to be a "commodity pool" or "commodity pool
operator" under the Commodity Exchange Act and are not subject to registration
or regulation as such under the Commodity Exchange Act. By virtue of changes to
CFTC regulations, the substantive limitations set forth in the Fund's exemption
filing with respect to its use of futures contracts are no longer applicable.

The Fund' use of futures contracts will not result in leverage. Therefore, to
the extent necessary, in instances involving the purchase of futures contracts
or call options thereon or the writing of put options thereon by the Fund, an
amount of cash or liquid securities, equal to the market value of the futures
contracts and options thereon (less any related margin deposits), will be
identified in an account with the Fund's custodian or on the books of the Fund
to cover the position, or alternative cover will be employed.

In addition, CFTC regulations may impose limitations on the Fund's ability to
engage in certain yield enhancement and risk management strategies. If the CFTC
or other regulatory authorities adopt different (including less stringent) or
additional restrictions, the Fund would comply with such new restrictions.

REPURCHASE AGREEMENTS -- The Fund may engage in repurchase agreement
transactions with member banks of the Federal Reserve System and certain
non-bank dealers, including governmental securities dealers approved by the
Fund's Board of Directors. Under the terms of a typical repurchase agreement,
the Fund would acquire any underlying security for a relatively short period
(usually not more than one week), subject to an obligation of the seller to
repurchase, and the Fund to resell, the obligation at an agreed price and time,
thereby determining the yield during the Fund's holding period. This arrangement
results in a fixed rate of return that is not subject to market fluctuations
during the Fund's holding period. The value of the underlying securities will be
at least equal at all times to the total amount of the repurchase obligations,
including interest. The Fund bears a risk of loss in the event of default by or
bankruptcy of the other party to a repurchase agreement. The Fund may be delayed
in, or prevented from, exercising its rights to dispose of the collateralized
securities. To the extent that, in the meantime, the value of the securities
repurchased had decreased or the value of the securities had increased, the Fund
could experience a loss. The Investment Manager reviews the creditworthiness of
those banks and dealers with which the Fund enters into repurchase agreements
and monitors on an ongoing basis the value of the securities subject to
repurchase agreements to ensure that it is maintained at the required level. A
repurchase agreement is considered to be a loan under the Investment Company Act
of 1940, as amended (the "1940 Act").

REVERSE REPURCHASE AGREEMENTS -- The Fund may borrow funds for temporary or
emergency purposes, such as for meeting larger than anticipated redemption
requests, and not for leverage, by, among other things, agreeing to sell
portfolio securities to financial institutions such as member banks of the
Federal Reserve System and certain non-bank dealers and to repurchase them at a
mutually agreed date and price (a "reverse repurchase agreement"). At the time
the Fund enters into a reverse repurchase agreement it will segregate cash or
liquid securities having a value equal to the repurchase price, including
accrued interest. The segregated assets will be marked-to-market daily and
additional assets will be segregated on any day in which the assets fall below
the repurchase price (plus accrued interest). The Fund's liquidity and ability
to manage its assets might be affected when it sets aside cash or portfolio
securities to cover such commitments. Reverse repurchase agreements involve the
risk that the market value of the securities sold by the Fund may decline below
the repurchase price of those securities. In the event the buyer of securities
under a reverse repurchase agreement files for bankruptcy or becomes insolvent,
such buyer or its trustee or receiver may receive an extension of time to
determine whether to enforce the Fund's obligation to repurchase the securities,
and the Fund's use of the proceeds of the reverse repurchase agreement may
effectively be restricted pending such decision. Reverse repurchase agreements
are considered to be borrowings by the Fund.

MORTGAGE DOLLAR ROLLS. The Fund may enter into mortgage "dollar rolls" in which
the Fund sells securities for delivery in the current month and simultaneously
contracts to repurchase substantially similar, but not identical (same dealer,
type, coupon and maturity), securities on a specified future date. During the
roll period, the Fund forgoes principal and interest paid on the securities. The
Fund is compensated by the difference between the current sales price and the
lower forward price for the future purchase (often referred to as the "drop") or
fee income and by the interest earned on the cash proceeds of the initial sale.
A "covered roll" is a specific type of dollar roll for which there is an
offsetting cash position or a cash equivalent security position which matures on
or before the forward settlement date of the dollar roll transaction. The Fund
may enter into both covered and uncovered rolls. At the time the Fund enters
into a dollar roll transaction, it will segregate, with an approved custodian,
cash or liquid securities having a value not less than the repurchase price
(including accrued interest) and will subsequently monitor the segregated assets
to ensure that its value is maintained.

BORROWING -- The Fund will not borrow money (including through reverse
repurchase agreements or dollar roll transactions) for any purpose in excess of
5% of its net assets, except that it may borrow for temporary or emergency
purposes up to 1/3 of its total assets. Under the 1940 Act, the Fund is required
to maintain continuous asset coverage of 300% with respect to such borrowings
and to sell (within three days) sufficient portfolio holdings to restore such
coverage if it should decline to less than 300% due to market fluctuations or
otherwise, even if such liquidation of the Fund's holdings may be
disadvantageous from an investment standpoint.

Leveraging by means of borrowing may exaggerate the effect of any increase or
decrease in the Fund's NAV per Share, and money borrowed by the Fund will be
subject to interest and other costs (which may include commitment fees and/or
the cost of maintaining minimum average balances) that may exceed the income
received from the securities purchased with the borrowed funds. It is not the
intention of the Investment Manager to use leverage as a normal practice in the
investment of the Fund's assets.

There can be no assurance that the use of these portfolio strategies will be
successful.

OTHER INVESTMENT COMPANIES -- Securities of other investment companies may be
acquired by the Fund to the extent permitted under the 1940 Act, that is, the
Fund may invest a maximum of up to 10% of its total assets in securities of
other investment companies so long as not more than 3% of the total outstanding
voting stock of any one investment company is held by the Fund. In addition, not
more than 5% of the Fund's total assets may be invested in the Fund's total
assets may be invested in the securities of any one investment company. The Fund
may be permitted to exceed these limitations by an exemptive order of the SEC.
Pursuant to exemptive orders granted by the SEC, the Fund may invest up to 25%
of its total assets in affiliated money market funds. It should be noted that
investment companies incur certain expenses such as management, custodian, and
transfer agency fees, and therefore any investment by the Fund in shares of
other investment companies would be subject to such duplicate expenses. The Fund
will indirectly bear its proportionate share of any management or other fees
paid by investment companies in which it invests, in addition to its own fees.
No advisory fee is charged on assets invested in affiliated money market funds.

ASSET COVERAGE -- The Fund will comply with the segregation or coverage
guidelines established by the SEC and other applicable regulatory bodies with
respect to certain transactions, including (but not limited to) options written
on securities and indexes; currency, interest rate and security index futures
contracts and options on these futures contracts; and forward currency
contracts. These guidelines may, in certain instances, require segregation by
the Fund of cash or liquid securities to the extent the Fund's obligations with
respect to these strategies are not otherwise covered through ownership of the
underlying security or financial instrument, by other portfolio positions or by
other means consistent with applicable regulatory policies. Unless the
transaction is covered, the segregated assets must at all times equal or exceed
the Fund's obligations with respect to these strategies. Segregated assets
cannot be sold or transferred unless equivalent assets are substituted in their
place or it is no longer necessary to segregate them. As a result, there is a
possibility that segregation of a large percentage of the Fund's assets could
impede the Investment Manager or the Fund's ability to meet redemption requests
or other current obligations.

For example, a call option written on securities may require the Fund to hold
the securities subject to the call (or securities convertible into the
securities without additional consideration) or to segregate assets (as
described above) sufficient to purchase and deliver the securities if the call
is exercised. A call option written on an index may require the Fund to own
portfolio securities that correlate with the index or to segregate assets (as
described above) equal to the excess of the index value over the exercise price
on a current basis. A put option written by the Fund may require the Fund to
segregate assets (as described above) equal to the exercise price. The Fund
could purchase a put option if the strike price of that option is the same or
higher than the strike price of a put option sold by the Fund. If the Fund holds
a futures contract, the Fund could purchase a put option on the same futures
contract with a strike price as high or higher than the price of the contract
held. The Fund may enter into fully or partially offsetting transactions so that
its net position, coupled with any segregated assets (equal to any remaining
obligation), equals its net obligation. Asset coverage may be achieved by other
means when consistent with applicable regulatory policies.

The Board of Directors of the Fund has adopted the requirement that futures
contracts and options on futures contracts be used as a hedge and that stock
index futures may be used on a continual basis to equitize cash so that the Fund
may maintain 100% equity exposure. The Fund is operated by persons who have
claimed an exclusion from the definition of the term "commodity pool operator"
under the Commodity Exchange Act and, therefore, who are not subject to
registration or regulation under the Commodity Exchange Act.

The use of options, futures and foreign currency contracts is a highly
specialized activity which involves investment techniques and risks that are
different from those associated with ordinary portfolio transactions. Gains and
losses on investments in options and futures depend on the Investment Manager's
ability to predict the direction of stock prices, interest rates, currency
movements and other economic factors. The loss that may be incurred by the Fund
in entering into futures contracts and written options thereon and forward
currency contracts is potentially unlimited. There is no assurance that higher
than anticipated trading activity or other unforeseen events might not, at
times, render certain facilities of an options clearing entity or other entity
performing the regulatory and liquidity functions of an options clearing entity
inadequate, and thereby result in the institution by an exchange of special
procedures which may interfere with the timely execution of customers' orders.
Most futures exchanges limit the amount of fluctuation permitted in a futures
contract's prices during a single trading day. Once the limit has been reached
no further trades may be made that day at a price beyond the limit. The price
limit will not limit potential losses, and may in fact prevent the prompt
liquidation of futures positions, ultimately resulting in further losses.
Options and futures traded on foreign exchanges generally are not regulated by
U.S. authorities, and may offer less liquidity and less protection to the Fund
in the event of default by the other party to the contract.

Except as set forth above under "Derivative Securities: Futures Contracts and
Options on Futures Contracts" (and the sub-sections thereunder), there is no
limit on the percentage of the assets of the Fund that may be at risk with
respect to futures contracts and related options or forward currency contracts.
The Fund may not invest more than 15% of its total assets in purchased
protective put options. The Fund's transactions in options, forward currency
contracts, futures contracts and options on futures contracts may be limited by
the requirements for qualification of the Fund as a regulated investment company
for tax purposes. See "Taxes." There can be no assurance that the use of these
portfolio strategies will be successful.

RATING SERVICES -- The ratings of rating services represent their opinions as to
the quality of the securities that they undertake to rate. It should be
emphasized, however, that ratings are relative and subjective and are not
absolute standards of quality. Although these ratings are an initial criterion
for selection of portfolio investments, the Investment Manager also makes its
own evaluation of these securities, subject to review by the Fund's Board. After
purchase by the Fund, an obligation may cease to be rated or its rating may be
reduced below the minimum required for purchase by the Fund. Neither event would
require the Fund to eliminate the obligation from its portfolio, but the
Investment Manager will consider such an event in its determination of whether
the Fund should continue to hold the obligation. A description of the ratings
referred to herein and in the Prospectus is set forth in the Appendix.

INVESTMENT RESTRICTIONS -- The following investment restrictions are
"fundamental policies" of the Fund and may not be changed without the approval
of a "majority of the outstanding voting securities" of the Fund. The phrase
"majority of the outstanding voting securities" under the 1940 Act, and as used
in this SAI and the Prospectus, means, with respect to the Fund, the lesser of
(1) 67% or more of the outstanding voting securities of the Fund's shareholders
present at a meeting, if the holders of more than 50% of the outstanding voting
securities of the Fund are present or represented by proxy or (2) more than 50%
of the outstanding voting securities of the Fund.

None of the fundamental and non-fundamental policies described below shall
prevent the Fund from investing all of its assets in an open-end investment
company with substantially the same investment objective. The following
discussion applies to the Fund.

FUNDAMENTAL RESTRICTIONS. As a matter of fundamental policy, the Fund may not:

1. Borrow money (including through reverse repurchase or dollar roll
transactions) in excess of 5% of the Fund's total assets (taken at cost),
except that the Fund may borrow for temporary or emergency purposes up to
1/3 of its net assets. The Fund may pledge, mortgage or hypothecate not more
than 1/3 of such assets to secure such borrowings provided that collateral
arrangements with respect to options and futures, including deposits of
initial and variation margin, are not considered a pledge of assets for
purposes of this restriction and except that assets may be pledged to secure
letters of credit solely for the purpose of participating in a captive
insurance company sponsored by the Investment Company Institute;

2. Underwrite securities issued by other persons except insofar as the Fund may
be deemed an underwriter under the 1933 Act in selling a portfolio security;

3. Make loans to other persons except (a) through the lending of the Fund's
portfolio securities and provided that any such loans not exceed 30% of its
total assets (taken at market value); (b) through the use of repurchase
agreements or the purchase of short-term obligations; or (c) by purchasing a
portion of an issue of debt securities of types distributed publicly or
privately;

4. Purchase or sell real estate (including limited partnership interests but
excluding securities secured by real estate or interests therein), interests
in oil, gas or mineral leases, commodities or commodity contracts (except
futures and option contracts) in the ordinary course of business (except
that the Fund may hold and sell, for its portfolio, real estate acquired as
a result of the Fund's ownership of securities);

5. Concentrate its investments in any particular industry (excluding U.S.
government securities), but if it is deemed appropriate for the achievement
of the Fund's investment objective, up to 25% of its total assets may be
invested in any one industry;

6. Issue any senior security (as that term is defined in the 1940 Act) if such
issuance is specifically prohibited by the 1940 Act or the rules and
regulations promulgated thereunder, provided that collateral arrangements
with respect to options and futures contracts, including deposits of initial
and variation margin, are not considered to be the issuance of a senior
security for purposes of this restriction;

7. Purchase, with respect to 75% of the Fund's total assets, securities of any
issuer if such purchase at the time thereof would cause the Fund to hold
more than 10% of any class of securities of such issuer, for which purposes
all indebtedness of an issuer shall be deemed a single class and all
preferred stock of an issuer shall be deemed a single class, except that
options or futures contracts shall not be subject to this restriction; and

8. Invest, with respect to 75% of the Fund's total assets, more than 5% of its
total assets in the securities (excluding U.S. government securities) of any
one issuer.

NON-FUNDAMENTAL RESTRICTIONS. In order to comply with certain statutes and
policies and for other reasons, the Fund will not, as a matter of operating
policy (these restrictions may be changed without shareholder approval):

(i) purchase any security or evidence of interest therein on margin, except
that short-term credits necessary for the clearance of purchases and
sales of securities may be obtained and deposits of initial and variation
margin may be made in connection with the purchase, ownership, holding or
sale of futures contracts;

(ii) sell securities it does not own (short sales). (This restriction does not
preclude short sales "against the box" (that is, sales of securities (a)
the Fund contemporaneously owns or (b) where the Fund has the right to
obtain securities equivalent in kind and amount to those sold). The Fund
has no current intention to engage in short selling);

(iii) purchase securities issued by any investment company except to the extent
permitted by the 1940 Act (including any exemptions or exclusions
therefrom), except that this limitation does not apply to securities
received or acquired as dividends, through offers of exchange, or as a
result of reorganization, consolidation or merger; and

(iv) An investment restriction will not be considered violated if that
restriction is complied with at the time the relevant action is taken,
notwithstanding a later change in the market value of an investment, in
net or total assets or in the change of securities rating of the
investment or any other later change.

DISCLOSURE OF PORTFOLIO HOLDINGS

It is the policy of the Fund to protect the confidentiality of its holdings and
prevent the selective disclosure of non-public information about its portfolio
holdings. The Fund's service providers, to which the Series may disclose
non-public information about portfolio holdings, are required to comply with
this policy. No information concerning the portfolio holdings of any Series may
be disclosed to any unaffiliated third party, except as provided below. The
Board has adopted formal procedures governing compliance with this policy.

The Fund or its duly authorized service providers may publicly disclose holdings
of the Fund in accordance with regulatory requirements, such as periodic
portfolio disclosure in filings with the SEC. A summary or list of the Fund's
completed purchases and sales may only be made available after the public
disclosure of its portfolio holdings.

The Fund publishes a complete list of its month-end portfolio holdings on its
website at www.securitybenefit.com generally within one to two days after the
end of each calendar month. Such information will remain online for 4 months.
The day following such publication, the information is deemed to be publicly
disclosed for the purposes of the policies and procedures adopted by the Fund.
The Fund may then forward the information to investors, consultants and others
at their request.

There are numerous mutual fund evaluation services such as Standard & Poor's,
Morningstar or Lipper, and due diligence departments of broker-dealers and other
financial intermediaries that regularly analyze the portfolio holdings of mutual
funds in order to monitor and report on various attributes, including style,
capitalization, maturity, yield, beta, etc. These services and departments then
distribute the results of their analysis to the public, paid subscribers and/or
in-house brokers. In order to facilitate the review of the Series by these
services and departments, the Fund may at any time as deemed necessary,
consistent with its policies and procedures, distribute (or authorize its
service providers to distribute) the Fund's securities holdings to such services
and departments before their public disclosure is required or authorized,
provided that: (i) the recipient does not distribute the portfolio holdings to
third parties, other departments, or persons who are likely to use the
information for purposes of purchasing or selling the Series (or any other fund
that invests in one of the Series) before the portfolio holdings become public
information; and (ii) the recipient signs a written confidentiality agreement,
which includes provisions that require the recipient to limit access to such
information only to its employees who are subject to a duty not to trade on
non-public information. Persons and entities unwilling to execute an acceptable
confidentiality agreement may only receive portfolio holdings information that
has otherwise been publicly disclosed.

Neither the Fund nor its service providers receive any compensation from such
services and departments. Subject to such departures as the Fund's chief
compliance officer ("CCO") believes reasonable and consistent with protecting
the confidentiality of the portfolio information, each confidentiality agreement
should generally provide that, among other things: the portfolio information is
the confidential property of the respective Fund (and its service providers, if
applicable) and may not be shared or used directly or indirectly for any purpose
except as expressly provided in the confidentiality agreement; the recipient of
the portfolio information agrees to limit access to the portfolio information to
its employees (and agents) who, on a need to know basis, are (1) authorized to
have access to the portfolio information and (2) subject to confidentiality
obligations, including duties not to trade on non-public information, no less
restrictive than the confidentiality obligations contained in the
confidentiality agreement; and upon written request, the recipient agrees to
promptly return or destroy, as directed, the portfolio information.

Only the CCO may authorize disclosure of the Fund's securities holdings. In
addition to the Board, the CCO may, on a case-by-case basis, impose additional
restrictions on the dissemination of portfolio information and waive certain
requirements. To the extent required by law, the CCO reports to the Board any
violations of the Fund's policies and procedures on disclosure of portfolio
holdings.

Any disclosure of the Series' securities holdings must serve a legitimate
business purpose of the Fund and must be in the best interest of the Fund's
shareholders. In making such a determination, the CCO must conclude that the
anticipated benefits and risks to the Fund and its shareholders justify the
purpose of the disclosure. A further determination must be made to ensure that
any conflicts of interest between the Fund, its shareholders, and any third
party are resolved prior to disclosure. The Fund reserves then right to request
certifications from senior officers of authorized recipients that the recipient
is using the portfolio holdings information only in a manner consistent with the
Fund's policy and any applicable confidentiality agreement. Neither the Fund nor
the Investment Manager receives any compensation or other consideration in
connection with these arrangements.

As an oversight procedure, the CCO reports all arrangements to disclose
portfolio holdings information to the Fund's Board of Directors on a periodic
basis. If the Board determines that any such arrangement is or would be
inappropriate, the Fund will promptly terminate the disclosure arrangement.

MANAGEMENT OF THE FUND

The Board of Directors of Security Income Fund is composed of persons
experienced in financial matters who meet throughout the year to oversee the
activities of the Fund. In addition, the Directors review contractual
arrangements with companies that provide services to the Fund and review the
Fund's performance.

OFFICERS AND DIRECTORS OF SECURITY INCOME FUND -- The Directors and officers of
the Security Income Fund their birth dates, and their principal occupations
during the past five years are set forth below.

=====================================================================================================
NUMBER OF
PORTFOLIOS
IN THE
SECURITY
TERM FUNDS OTHER
OF OFFICE COMPLEX DIRECTOR-
POSITION(S) AND LENGTH OVERSEEN SHIPS
HELD WITH OF TIME PRINCIPAL OCCUPATION(S) BY HELD BY
NAME, ADDRESS AND AGE FUND SERVED(1) DURING THE PAST 5 YEARS DIRECTOR DIRECTOR
-----------------------------------------------------------------------------------------------------
INDEPENDENT DIRECTORS
-----------------------------------------------------------------------------------------------------
Donald A. Chubb, Jr. Director Since 1994 Business broker, 35
(Age 58) Griffith & Blair
2222 SW 29th Street Realtors.
Topeka, KS 66611
-----------------------------------------------------------------------------------------------------
Harry W. Craig, Jr. Director Since 2004 Chairman, CEO, Secretary 35
(Age 65) and Director, The Martin
One Security Tractor Company, Inc.
Benefit Place
Topeka, KS 66636
-----------------------------------------------------------------------------------------------------
Penny A. Lumpkin Director Since 1993 Partner, Vivian's Gift 35
(Age 65) Shop (Corporate Retail).
3616 Canterbury Vice President, Palmer
Town Rd Companies, Inc. (Small
Topeka, KS 66610 Business and Shopping
Center Development), PLB
(Real Estate Equipment
Leasing), and Town Crier
(Retail). Prior to 1999,
Vice President and
Treasurer, Palmer News,
Inc.; Vice President,
M/S News, Inc. and
Secretary, Kansas City
Periodicals. Prior to
2002, Vice President,
Bellairre Shopping
Center (Managing and
Leasing); Partner,
Goodwin Enterprises
(Retail).
-----------------------------------------------------------------------------------------------------
Maynard. F. Oliverius Director Since 1998 President and Chief 35
(Age 61) Executive Officer,
1500 SW 10th Avenue Stormont-Vail
Topeka, KS 66604 HealthCare.
-----------------------------------------------------------------------------------------------------
DIRECTORS WHO
ARE "INTERESTED
PERSONS"(2)
-----------------------------------------------------------------------------------------------------
John D. Cleland Chairaman Since 1991 Retired. Prior to 35
(Age 68) of the (Director)/ January 1, 2003, Senior
One Security Board and Since 2000 Vice President, Security
Benefit Place Director (Chairman) Benefit Group, Inc. and
Topeka, KS 66636-0001 Security Benefit Life
Insurance Company.
-----------------------------------------------------------------------------------------------------
Michael G. Odlum Director Since 2004 President and Managing 35
(Age 52) and Member Representative,
One Security President Security Management
Benefit Place Company, LLC; Senior
Topeka, KS 66636-0001 Vice President and Chief
Investment Officer,
Security Benefit Group,
Inc. and Security
Benefit Life Insurance
Company, Director,
Security Distributors,
Inc.; Director, Vice
President and Chief
Investment Officer,
First Security Benefit
Life Insurance and
Annuity Company of New
York.
-----------------------------------------------------------------------------------------------------
1 Directors serve until their successors are duly elected and qualified.

2 These directors are deemed to be "interested persons" of the Fund under the 1940 Act, by reason of
their positions with the Fund's administrator, Security Management Company, LLC ("SMC" or
"Investment Adviser") and/or the parent of SMC.
=====================================================================================================

==========================================================================================
TERM
OF OFFICE
POSITION(S) AND LENGTH
HELD WITH OF TIME PRINCIPAL OCCUPATION(S)
NAME, ADDRESS AND AGE FUND SERVED(1) DURING THE PAST 5 YEARS
------------------------------------------------------------------------------------------
OFFICERS
------------------------------------------------------------------------------------------
Steven M. Bowser (Age 44) Vice Since 1998 Vice President and Senior
One Security Benefit Place President Portfolio Manager, Security
Topeka, KS 66636-0001 Management Company, LLC; Vice
President and Senior Portfolio
Manager, Security Benefit Group,
Inc. and Security Benefit Life
Insurance Company.
------------------------------------------------------------------------------------------
Brenda M. Harwood (Age 41) Treasurer Since 1998 Assistant Vice President and
One Security Benefit Place and Chief Treasurer, Security Management
Topeka, KS 66636-0001 Compliance Company, LLC; Assistant Vice
Officer President, Security Benefit Group,
Inc. and Security Benefit Life
Insurance Company; Vice President
and Director, Security
Distributors, Inc.
------------------------------------------------------------------------------------------
Amy J. Lee (Age 43) Secretary Since 1987 Secretary, Security Management
One Security Benefit Place Company, LLC and Security
Topeka, KS 66636-0001 Distributors, Inc.; Vice
President, Associate General
Counsel and Assistant Secretary,
Security Benefit Group, Inc. and
Security Benefit Life Insurance
Company.
------------------------------------------------------------------------------------------
Michael G. Odlum (Age 52) President Since 2004 President and Managing Member
One Security Benefit Place and Representative, Security
Topeka, KS 66636-0001 Director Management Company, LLC; Senior
Vice President and Chief
Investment Officer, Security
Benefit Group, Inc. and Security
Benefit Life Insurance Company,
Director, Security Distributors,
Inc.; Director, Vice President and
Chief Investment Officer, First
Security Benefit Life Insurance
and Annuity Company of New York.
------------------------------------------------------------------------------------------
Christopher L. Phalen Vice Since 2002 Assistant Vice President and
(Age 34) President Portfolio Manager, Security
One Security Benefit Place Management Company, LLC, Security
Topeka, KS 66636-0001 Benefit Life Insurance Company and
Security Benefit Group, Inc.
------------------------------------------------------------------------------------------
David G. Toussaint Vice Since 2001 Assistant Vice President and
(Age 38) President Portfolio Manager, Security
One Security Benefit Place Management Company, LLC, Security
Topeka, KS 66636-0001 Benefit Life Insurance Company and
Security Benefit Group, Inc.
------------------------------------------------------------------------------------------
Christopher D. Swickard Assistant Since 1996 Assistant Secretary, Security
(Age 39) Secretary Management Company, LLC; Second
One Security Benefit Place Vice President and Assistant
Topeka, KS 66636-0001 Counsel, Security Benefit Group,
Inc. and Security Benefit Life
Insurance Company.
------------------------------------------------------------------------------------------
1 Officers serve until their successors are duly elected and qualified.
==========================================================================================

The officers of the Fund hold identical offices with each of the other mutual
funds in the Security Funds Family, except Messrs. Bowser and Toussaint, who
hold the same office only with respect to SBL Fund. The directors of the Fund
also serve as directors of each of the other Security Funds. Ms. Lee is also
Secretary of the Distributor, and Ms. Harwood is a director and Vice President
of the Distributor.

COMMITTEES

AUDIT COMMITTEES -- The Board of Directors has an audit committee, the purpose
of which is to meet with the independent registered public accounting firm, to
review the work of the independent registered public accounting firm, and to
oversee the handling of the accounting functions with respect to the Fund. The
Audit Committee currently consists of Messrs. Chubb and Oliverius and Ms.
Lumpkin, each of whom is an independent Director. The Audit Committee held two
meetings during the calendar year ended December 31, 2004.

NOMINATING COMMITTEE -- The Board of Directors has established a Nominating
Committee for the purpose of considering and presenting to the Board candidates
it proposes for nomination to fill Independent Director vacancies on the Board.
Specific qualifications of candidates for Board membership will be based on the
needs of the Board at the time of nomination. The Nominating Committee is
willing to consider nominations received from shareholders and shall assess
shareholder nominees in the same manner as it reviews its own nominees. A
shareholder nominee for director should be submitted in writing to the Fund's
Secretary. Any such shareholder nomination should include, at a minimum, the
following information as to each individual proposed for nominations as
director: such individual's written consent to be named in the proxy statement
as a nominee (if nominated) and to serve as a director (if elected), and all
information relating to such individual that is required to be disclosed in the
solicitation of proxies for election of directors, or is otherwise required, in
each case under applicable federal securities laws, rules and regulations. The
Nominating Committee consists of Messrs. Chubb and Oliverius and Ms. Lumpkin,
each of whom is an independent Director. During the calendar year ended December
31, 2004, the Nominating Committee held no meetings.

REMUNERATION OF DIRECTORS AND OTHERS

The Fund's directors, except those directors who are "interested persons" of the
Fund, receive from the Security Funds Complex an annual retainer of $30,000 and
a fee of $4,500 per meeting, plus reasonable travel costs, for each meeting of
the board attended. In addition, certain directors who are members of the audit
committee receive a fee of $3,000 per meeting and reasonable travel costs for
each meeting of the Fund's audit committee attended. The Fund pays its
respective share of directors' fees, audit committee fees and travel costs based
on relative net assets. (The Directors do not receive compensation upon retiring
as Director of the Fund.)

The Fund does not pay any fees to, or reimburse expenses of, directors who are
considered "interested persons" of the Fund. The aggregate compensation paid by
the Fund to each of the directors during the fiscal year ended September 30,
2004, and the aggregate compensation paid to each of the directors during
calendar year 2004 by all seven of the registered investment companies to which
SMC provides investment advisory and administration services (collectively, the
"Security Fund Complex"), are set forth below. Each of the directors is a
director of each of the other registered investment companies in the Security
Fund Complex.

SECURITY INCOME FUND DIRECTOR COMPENSATION TABLE --

================================================================================
AGGREGATE TOTAL
COMPENSATION FROM COMPENSATION FROM
NAME SECURITY INCOME FUND SECURITY FUND COMPLEX
--------------------------------------------------------------------------------
Donald A. Chubb, Jr. ............. $9,708 $75,250
John D. Cleland .................. N/A N/A
Harry W. Craig, Jr. .............. 3,219 38,625
Michael G. Odlum ................. N/A N/A
Penny A. Lumpkin ................. 9,708 75,250
Maynard Oliverius ................ 9,542 75,250
Mark L. Morris, Jr.* ............. 9,708 75,250
--------------------------------------------------------------------------------
*Mr. Morris retired from serving as a director of the Fund in November of 2004.
================================================================================

PRINCIPAL HOLDERS OF SECURITIES -- As of May 31, 2005, the officers and
directors of Security Income Fund as a group beneficially owned less than 1% of
the total outstanding voting shares of the Fund.

As of April 30, 2005, no person beneficially owned of record 5% or more of a
class of the Fund's outstanding securities.

DIRECTORS' OWNERSHIP OF SECURITIES -- As of May 31, 2005, the directors of the
Fund beneficially owned shares of the Fund in the dollar ranges set forth below
and also beneficially owned shares of other mutual funds in the family of mutual
funds overseen by the directors in the dollar ranges set forth below:

========================================================================
AGGREGATE DOLLAR RANGE
OF EQUITY SECURITIES IN
ALL REGISTERED INVESTMENT
DOLLAR RANGE OF COMPANIES OVERSEEN
NAME OF EQUITY SECURITIES BY DIRECTOR IN FAMILY
DIRECTOR IN THE FUND OF INVESTMENT COMPANIES
------------------------------------------------------------------------
Donald A. Chubb, Jr. None over $100,000
Harry W. Craig, Jr. None None
Penny A. Lumpkin None $50,001-$100,000
Maynard Oliverius over $100,000 over $100,000
========================================================================

The following directors who are "interested persons" of the Security Income Fund
beneficially owned shares of the Fund (in the dollar ranges set forth below) and
also beneficially owned shares of other mutual funds (in the dollar ranges set
forth below)in the family of mutual funds overseen by the directors:

========================================================================
AGGREGATE DOLLAR RANGE
OF EQUITY SECURITIES IN
ALL REGISTERED INVESTMENT
DOLLAR RANGE OF COMPANIES OVERSEEN
NAME OF EQUITY SECURITIES BY DIRECTOR IN FAMILY
DIRECTOR IN THE FUND OF INVESTMENT COMPANIES
------------------------------------------------------------------------
Michael G. Odlum $10,001-$50,000 $10,001-$50,000
John D. Cleland None over $100,000
========================================================================

DETERMINATION OF NET ASSET VALUE

The NAV per share of the Fund is determined as of the close of regular trading
hours on the NYSE (normally 3:00 p.m. Central time) on each day that the
Exchange is open for trading, which is Monday through Friday except for the
following dates when the Exchange is closed in observance of Federal holidays:
New Year's Day, Martin Luther King, Jr. Day, Presidents' Day, Good Friday,
Memorial Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day.
The determination is made by dividing the total value of the portfolio
securities of each Fund, plus any cash or other assets (including dividends
accrued but not collected), less all liabilities, by the number of shares
outstanding of the Fund.

Securities listed or traded on a national securities exchange are valued at the
last sale price. If there are no sales on a particular day, then the securities
are valued at the last bid price. All other securities held by the Fund, except
as otherwise provided herein, for which market quotations are readily available,
are valued on the basis of the last current bid price. If there is no bid price,
or if the bid price is deemed to be unsatisfactory by the Board of Directors,
then the securities shall be valued in good faith by such method as the Board of
Directors determines will reflect fair market value. Valuations of the Fund's
securities are supplied by a pricing service approved by the Board of Directors.

Valuations furnished by the pricing service with respect to the Fund's municipal
securities are based upon appraisals from recognized municipal securities
dealers derived from information concerning market transactions and quotations.
Securities for which market quotations are readily available are valued at the
last reported sale price, or, if no sales are reported on that day, at the mean
between the latest available bid and asked prices. Securities for which market
quotations are not readily available are valued at the best available current
bid price by the pricing service, considering such factors as yields or prices
of municipal bonds of comparable quality, type of issue, coupon, maturity and
rating, indications as to value from dealers, and general market conditions. The
Fund's officers, under the general supervision of the Board of Directors, will
regularly review procedures used by, and valuations provided by, the pricing
service. The Fund's taxable short-term securities for which market quotations
are readily available will be valued at market value, which is the last reported
sale price or, if no sales are reported on that day, at the mean between the
latest available bid and asked prices except that securities having 60 days or
less remaining to maturity may be valued at their amortized cost as discussed
below.

As discussed in the Fund's Prospectus and this Statement of Additional
Information, the loans (including Senior Loans) in which the Fund may invest are
not listed on any securities exchange or board of trade. Senior Loans are
typically bought and sold by institutional investors in individually negotiated
private transactions that function in many respects like an over-the-counter
secondary market, although typically no formal market-makers exist. This market,
while having substantially grown in the past several years, generally has fewer
trades and less liquidity than the secondary markets for other types of
securities. Some loans have few or no trades, or trade infrequently, and
information regarding a specific Senior Loan may not be widely available or may
be incomplete. Accordingly, determinations of the market value of Senior Loans
may be based on infrequent and dated information. Because there is less
reliable, objective data available, elements of judgment may play a greater role
in valuation of loans than for other types of securities.

Typically Senior Loans are valued using information provided by an independent
third party pricing service. If the pricing service cannot or does not provide a
valuation for a particular Senior Loan or such valuation is deemed unreliable,
such loan is fair valued. In fair valuing, consideration is given to several
factors, which may include, among others, one or more of the following: the
fundamental business data relating to the issuer or borrower; an evaluation of
the forces which influence the market in which these Senior Loans are purchased
and sold; type of holding; financial statements of the borrower; cost at date of
purchase; size of holding; credit quality and cash flow of issuer; information
as to any transactions in or offers for the holding; price and extent of public
trading in similar securities (or equity securities) of the issuer/borrower, or
comparable companies; coupon payments; quality, value and saleability of
collateral securing the loan; business prospects of the issuer/borrower,
including any ability to obtain money or resources from a parent or affiliate;
the sub-adviser's and/or the market's assessment of the borrower's management;
prospects for the borrower's industry, and multiples (of earnings and/or cash
flow) being paid for similar businesses in that industry; borrower's competitive
position within the industry; borrower's ability to access additional liquidity
through public and/or private markets; and other relevant factors. The Security
Income Fund's officers, under the general supervision of the Board of Directors,
will regularly review procedures used by, and valuations provided by, the
pricing service for the Fund.

The Fund may use the amortized cost valuation technique for high quality
securities with maturities of 60 days or less. In addition, the Fund may use a
similar procedure for such securities having 60 days or less remaining to
maturity with the value of the security on the 61st day being used rather than
the cost.

OVERVIEW OF TSA ACCOUNTS -- In general, Section 403(b)(7) of the Code permits
public school employees and employees of certain types of charitable,
educational and scientific organizations specified in Section 501(c)(3) of the
Code to purchase shares of a mutual fund through a custodial account, and,
subject to certain limitations, to exclude the amount of purchase payments from
gross income for tax purposes. Shares of the Fund may be purchased in connection
with a TSA custodial account. TSA Accounts may provide significant tax savings
to individuals, but are governed by a complex set of tax rules under the Code
and the regulations promulgated by the Department of the Treasury thereunder.

If you do not presently have a Security Funds TSA custodial account and you meet
the requirements of the applicable tax rules, you may be able to create a
Security Funds TSA custodial account (or a TSA custodial account from another
provider that makes shares of the Fund available to its customers) and invest in
shares of the Fund through that TSA. Class A shares may not be available to TSA
custodial accounts opened on or after June 5, 2000. The minimum initial or
subsequent investment in a Security Funds TSA custodial account is $50. An
annual administration fee of $25 is required for each Security Funds TSA
custodial account with a balance less than $25,000 and a $5 withdrawal fee will
be charged when any Security Funds TSA custodial account is closed.

TSA OWNERS AND OTHER PROSPECTIVE INVESTORS SHOULD CONSULT WITH THEIR
PROFESSIONAL TAX AND FINANCIAL ADVISERS BEFORE ESTABLISHING A TSA OR OTHERWISE
INVESTING IN SHARES.

OVERVIEW OF THE TYPES OF INDIVIDUAL RETIREMENT ACCOUNTS

In general, an IRA is a trust or custodial account established in the United
States for the exclusive benefit of an individual or his or her beneficiaries.
(Keogh Plans are established by self-employed persons, including partnerships,
and also cover eligible non-owner employees.) Most IRAs are designed principally
as retirement savings vehicles. Coverdell Education Savings Account IRAs are
designed to provide a tax-favored means of saving for a child's educational
expenses. IRAs may provide significant tax savings to individuals, but are
governed by a complex set of tax rules set out under the Code and the
regulations promulgated by the Department of the Treasury thereunder. If you
already have an IRA or Keogh Plan, the Plan may be able to invest in the Fund.
If you do not presently have an IRA or Keogh Plan, and you meet the requirements
of the applicable tax rules, you may be able to create an IRA or Keogh Plan, and
invest in Shares of the Fund through that Plan. Included below is a general
discussion of some IRA and Keogh Plan features. However, IRA and Keogh Plan
owners ("IRA/ Keogh owners") and other prospective investors should consult with
their IRA and Keogh Plan provider and/or professional tax and financial advisors
before establishing an IRA or Keogh Plan, or investing in Shares. Certain types
of the IRAs and Keogh Plans described below may not be available through
Deutsche Asset Management mutual funds. For more information call
1-800-621-1048.

TRADITIONAL IRAS -- If you are under age 70 1/2, and you (or if you file a joint
return, your spouse) have taxable compensation, you may set up a Traditional IRA
and make annual IRA contributions for 2005, up to $4,000 ($4,500 if you are age
50 or older) but not more than 100% of your taxable compensation. These dollar
limits will be adjusted in future years. Taxable income includes wages,
salaries, and other amounts reported in box 1 of Form W-2, as well as earnings
from self-employment. If you file a joint return and your taxable compensation
is less than that of your spouse, you may make annual contributions to a
Traditional IRA equal to, for 2005, the lesser of $4,000 ($4,500, if you are age
50 or older) or the sum of (i) your taxable compensation and (ii) the taxable
compensation of your spouse, reduced by the amount of his or her IRA deduction
for the year. Amounts contributed to a Traditional IRA generally are deductible
for federal income tax purposes. However, if you were covered by an employer
retirement plan, the amount of your contribution to a Traditional IRA that you
may deduct will be reduced or eliminated if your modified adjusted gross income
exceeds certain amounts (for 2005, $70,000 for a married couple filing a joint
return and $50,000 for a single taxpayer). If your spouse is covered by an
employer retirement plan but you are not, you may be able to deduct your
contributions to a Traditional IRA; however, the deduction will be reduced or
eliminated if your adjusted gross income on a joint return exceeds $150,000.
Even if your ability to deduct contributions to a Traditional IRA is limited,
you may still make contributions up to the limits described above. In general,
you may also make a contribution to a Traditional IRA by "rolling over" all or a
portion of a distribution you receive from an eligible retirement plan (such as
a pension or profit-sharing plan or a 401(k) plan) or another Traditional IRA.
Amounts distributed from a Traditional IRA and eligible rollover distributions
from qualified retirement plans will not be includible in income if they are
contributed to a Traditional IRA in a rollover transaction which meets certain
conditions; however, a federal withholding tax may be imposed on such
distributions. Consult your Service Agent (which is a broker, financial advisor
or other bank, dealer or other institution that has a sub-shareholder servicing
agreement with SMC) and professional tax advisor for complete details on
Traditional IRAs.

ROTH IRAS -- Regardless of your age, you may be able to establish a Roth IRA.
Contributions to Roth IRAs are not deductible for federal income tax purposes.
However, if all of the applicable requirements are met, earnings in the account
accumulate tax free, and all withdrawals are also tax free. Generally, you may
make annual contributions ($4,000 for 2005 or, if you are age 50 or older,
$4,500) to a Roth IRA; however, your ability to contribute to a Roth IRA will be
reduced or eliminated if your adjusted gross income exceeds certain amounts
(currently $150,000 for a married couple filing a joint return and $95,000 for a
single taxpayer). In addition, if you make contributions to both a Traditional
IRA and a Roth IRA, your contribution limit for the Roth IRA will be reduced by
the amount of the contribution you make to the Traditional IRA. If certain
requirements are met, and (i) your modified adjusted gross income is not more
than $100,000, and (ii) you are not married and filing a separate tax return,
you can roll over amounts from a Traditional IRA to a Roth IRA. The amount
rolled over generally will be included in your taxable income. You may also roll
over amounts from one Roth IRA to another Roth IRA. Consult your Service Agent
and professional tax advisor for complete details on Roth IRAs.

SEP-IRAS -- SEP-IRAs are IRAs that are created in connection with a simplified
employee pension ("SEP") established and maintained by a self-employed
individual, a partnership or a corporation. SEP-IRAs must be created for each
qualifying employee of the employer that establishes a SEP. In general, a
qualifying employee is an employee who has: (i) reached the age of 21; (ii)
worked for the employer at least three out of the past five years; and (iii) has
received at least $450 in compensation for 2005 (subject to adjustment in future
years). Each SEP-IRA is owned by the employee for whom it is created; assets of
a SEP are not pooled together. SEPs must provide for discretionary employer
contributions. In other words, employers are not required to make contributions
to SEP-IRAs each year, but if they do make contributions for any year, the
contributions must be based on a specific allocation formula set forth in the
SEP, and must not discriminate in favor of highly compensated employees.
Contributions to SEP-IRAs generally are deductible by the employer, subject to
certain limitations. Contributions to SEP-IRAs of self-employed individuals are
subject to certain additional limitations. SEP-IRAs generally are subject to the
same distribution and rollover rules that apply to Traditional IRAs.

SIMPLE IRAS -- In general, a SIMPLE plan may be established by any employer,
including a sole proprietorship, partnership or corporation, with 100 or fewer
employees, and must be the only retirement plan maintained by the employer.
Under a SIMPLE plan using SIMPLE IRAs, a SIMPLE IRA is created for each eligible
employee which, in general, includes all employees who received at least $5,000
in compensation during any two years preceding the year for which eligibility is
being determined (i.e., the current year) and is reasonably expected to earn at
least $5,000 during the current year. As with SEP-IRAs, SIMPLE IRAs are
individual accounts owned by each eligible employee. Under a SIMPLE IRA plan,
eligible employees can elect to contribute a portion of their salary to their
SIMPLE IRA. (These contributions are referred to as "salary reduction
contributions" or "elective deferrals.") Elective deferrals are based on a
stated percentage of the employee's compensation, and are limited for 2005 to
$10,000 ($12,000, if you are age 50 or older) (indexed for inflation). Elective
deferrals are included in employees' gross income only for Social Security and
Medicare tax purposes (i.e., they are not included in wages for federal income
tax purposes).In addition to elective deferrals by employees, under a SIMPLE IRA
plan, employers must make either: (i) matching contributions equal to each
employee's elective deferral, up to a maximum of 3% of the employee's
compensation, or (ii) nonelective contributions of 2% of compensation for each
eligible employee (subject to certain limits). Employer contributions to SIMPLE
IRAs are excluded from employees' gross income and are deductible by the
employer. SIMPLE IRAs generally are subject to the same distribution and
rollover rules that apply to Traditional IRAs. However, a rollover from a SIMPLE
IRA to a Traditional IRA can be made tax free only after the employee has
participated in the SIMPLE IRA plan for at least two years.

KEOGH PLANS -- Keogh Plans are qualified retirement plans established by sole
proprietors or partnerships. As with other qualified retirement plans, in
general, contributions to Keogh Plans are deductible, and neither such
contributions nor the investment earnings thereon are subject to tax until they
are distributed by the plan. A number of different types of plans may qualify as
Keogh Plans. In certain circumstances, Keogh Plans may provide greater tax
advantages than other types of retirement plans. However, Keogh Plans must
satisfy a number of complex rules, including minimum participation requirements,
under which certain employees must be covered by the plan, and in some cases,
minimum funding requirements. Professional assistance generally is required to
establish and maintain a Keogh Plan.

COVERDELL EDUCATION SAVINGS ACCOUNTS -- A Coverdell Education Savings Account
("ESA") is a trust or custodial account created for the purpose of paying the
qualified higher education expenses of a designated beneficiary, i.e., a child
under the age of 18 or special needs beneficiary at the time of the
contributions. In general, qualified higher education expenses include expenses
for tuition, fees, books, supplies and equipment required for the designated
beneficiary to attend an eligible educational institution. Any individual may
make contributions to an ESA so long as his or her modified adjusted gross
income is less than $110,000 ($220,000 for married taxpayers filing jointly).The
maximum total contributions that may be made to an ESA for each child is $2,000
per year. Generally, amounts may be rolled over from one ESA to another ESA
established for the same beneficiary or for certain members of the beneficiary's
family. Beneficiaries may make tax free withdrawals from ESAs to pay qualified
higher education expenses. Other withdrawals generally will be subject to tax.
Consult your Service Agent and or professional tax advisor for complete details.

PENSION AND PROFIT SHARING PLANS

Prototype corporate pension or profit-sharing plans meeting the requirements of
Code Section 401(a) are available. Information concerning these plans may be
obtained from the Distributor.

403(b) RETIREMENT PLANS -- Employees of public school systems and tax-exempt
organizations meeting the requirements of Code Section 501(c)(3) may purchase
shares of the Fund or of other funds in the Security Group under a Section
403(b) Plan. Class A shares may not be available to custodial accounts of the
Administrator opened on or after June 5, 2000. The minimum initial or subsequent
investment in a custodial account under a Section 403(b) Plan is $50. An annual
administration fee of $25 is required for each custodial account with a balance
less than $25,000 and a $5 withdrawal fee will be charged when any custodial
account is closed.

Section 403(b) Plans are subject to numerous restrictions on the amount that may
be contributed, the persons who are eligible to participate, the time when
distributions may commence, and the number and amount of any loans requested.

SIMPLIFIED EMPLOYEE PENSION (SEP) PLANS -- A prototype SEP is available for
corporations, partnerships or sole proprietors desiring to adopt such a plan for
purchases of IRAs for their employees. Employers establishing a SEP may
contribute a maximum of $40,000 a year to an IRA for each employee. This maximum
is subject to a number of limitations.

OWNERSHIP OF SHARES THROUGH PLANS

Fund Shares owned by Plan Participants through Plans are held either directly by
the respective Plan, or beneficially through vehicles such as bank collective
funds or insurance company separate accounts consisting solely of such Plans
(collectively, "Plan Pools"), which will in turn offer the Fund as an investment
option to their participants. Investments in the Fund may by themselves
represent an investment option for a Plan or may be combined with other
investments as part of a pooled investment option for the Plan. In the latter
case, the Fund may require Plans to provide information regarding the withdrawal
order and other characteristics of any pooled investment option in which the
Shares are included prior to a Plan's initial investment in the Fund.
Thereafter, the Fund will require the Plan to provide information regarding any
changes to the withdrawal order and other characteristics of the pooled
investment option before such changes are implemented. The Fund in its sole
discretion may decline to sell Shares to Plans if the governing withdrawal order
or other characteristics of any pooled investment option in which the Shares are
included is determined at any time to be disadvantageous to the Fund. Plan
Participants should contact their Plan administrator or the organization that
provides recordkeeping services if they have questions concerning their account.
Plan administrators and fiduciaries should call 1-800-888-2461 for information
regarding a Plan's account with the Fund.

HOW TO PURCHASE SHARES

Investors may purchase shares of the Fund through authorized broker-dealers who
are members of the NASD. In addition, banks and other financial institutions may
make shares of the Fund available to their customers. (Banks and other financial
institutions that make shares of the Fund available to their customers in Texas
must be registered with that state as securities dealers.) The minimum initial
investment is $100. The minimum subsequent investment is $100 unless made
through an Accumulation Plan which allows for subsequent investments of $20. An
application may be obtained from the Administrator.

As a convenience to investors and to save operating expenses, the Fund does not
issue certificates for full shares except upon written request by the investor
or his or her investment dealer. Certificates will be issued at no cost to the
stockholder. No certificates will be issued for fractional shares and fractional
shares may be withdrawn only by redemption for cash.

Orders for the purchase of shares of the Fund will be confirmed at an offering
price equal to the net asset value ("NAV") per share next determined after
receipt and acceptance of the order in proper form by Security Distributors,
Inc. (the "Distributor") (generally as of the close of the Exchange on that day)
plus the sales charge in the case of Class A shares. Orders received by dealers
or other firms prior to the close of the Exchange and received by the
Distributor prior to the close of its business day will be confirmed at the
offering price effective as of the close of the Exchange on that day. Dealers
and other financial services firms are obligated to transmit orders promptly.

The Fund reserves the right to withdraw all or any part of the offering made by
this prospectus and to reject purchase orders.

ALTERNATIVE PURCHASE OPTIONS -- The Fund offers three classes of shares:

CLASS A SHARES - FRONT-END LOAD OPTION. Class A shares are sold with a sales
charge at the time of purchase. Class A shares are not subject to a sales charge
when they are redeemed (except that shares sold in an amount of $1,000,000 or
more without a front-end sales charge will be subject to a contingent deferred
sales charge of 1% for one year).

CLASS B SHARES - BACK-END LOAD OPTION. Class B shares are sold without a sales
charge at the time of purchase, but are subject to a deferred sales charge if
they are redeemed within five years of the date of purchase. Class B shares will
automatically convert to Class A shares at the end of eight years after
purchase.

CLASS C SHARES - LEVEL LOAD OPTION. Class C shares are sold without a sales
charge at the time of purchase, but are subject to a contingent deferred sales
charge if they are redeemed within one year of the date of purchase.

The decision as to which class is more beneficial to an investor depends on the
amount and intended length of the investment. Investors who would rather pay the
entire cost of distribution at the time of investment, rather than spreading
such cost over time, might consider Class A shares. Other investors might
consider Class B or Class C shares, in which case 100% of the purchase price is
invested immediately, depending on the amount of the purchase and the intended
length of investment.

Dealers or others may receive different levels of compensation depending on
which class of shares they sell.

CLASS A SHARES -- Class A shares are offered at NAV plus an initial sales charge
as follows:

================================================================================
SALES CHARGE
--------------------------------------------
PERCENTAGE OF PERCENTAGE
AMOUNT OF PURCHASE PERCENTAGE OF NET AMOUNT REALLOWABLE
AT OFFERING PRICE OFFERING PRICE INVESTED TO DEALERS
--------------------------------------------------------------------------------
Less than $100,000 3.50% 3.63% 3.00%
$100,000 but less than $500,000 2.50 2.56 2.00
$500,000 but less than $1,000,000 1.50 1.52 1.00
$1,000,000 and over None None (See below)
================================================================================

The Distributor will pay a commission to dealers on purchases of $1,000,000 or
more as follows: 0.50% on sales up to $5,000,000, plus 0.25% on sales of
$5,000,000 or more up to $10,000,000, and 0.10% on any amount of $10,000,000 or
more.

CLASS A DISTRIBUTION PLAN -- As discussed in the prospectus, the Fund has a
Distribution Plan for its Class A shares pursuant to Rule 12b-1 under the 1940
Act. The Plan authorizes the Fund to pay an annual fee to the Distributor of
0.25% of the average daily NAV of the Class A shares of the Fund to finance
various activities relating to the distribution of such shares of the Fund to
investors and the provision of services to such investors. These expenses
include, but are not limited to, the payment of compensation (including
compensation to securities dealers and other financial institutions and
organizations) to obtain various administrative services for the Fund. These
services include, among other things, processing new shareholder account
applications and serving as the primary source of information to customers in
answering questions concerning the Fund and their transactions with the Fund.
The Plan may also be used to pay for sub-administration and/or sub-transfer
agency services provided for the benefit of the Fund. The Distributor is also
authorized to engage in advertising, the preparation and distribution of sales
literature and other promotional activities on behalf of the Fund. The
Distributor is required to report in writing to the Board of Directors of
Security Income Fund and the board will review at least quarterly the amounts
and purpose of any payments made under the Plan. The Distributor is also
required to furnish the board with such other information as may reasonably be
requested in order to enable the board to make an informed determination of
whether the Plan should be continued.

The Plan became effective on February 10, 1999. The Plan will continue from year
to year, provided that such continuance is approved at least annually by a vote
of a majority of the Board of Directors of the Fund, including a majority of the
independent directors cast in person at a meeting called for the purpose of
voting on such continuance. The Plan can be terminated at any time on 60 days'
written notice, without penalty, if a majority of the disinterested directors or
the Class A shareholders vote to terminate the Plan. Any agreement relating to
the implementation of the Plan terminates automatically if it is assigned. The
Plan may not be amended to increase materially the amount of payments thereunder
without approval of the Class A shareholders of the Fund.

Because all amounts paid pursuant to the Distribution Plan are paid to the
Distributor, the Fund Administrator and its officers, directors and employees,
including Mr. Odlum (director of the Fund), Messrs. Toussaint, Swickard, Bowser,
Phalen, Ms. Harwood and Ms. Lee (officers of the Fund), all may be deemed to
have a direct or indirect financial interest in the operation of the
Distribution Plan. None of the independent directors have a direct or indirect
financial interest in the operation of the Distribution Plan.

Benefits from the Distribution Plan may accrue to the Fund and its stockholders
from the growth in assets due to sales of shares to the public pursuant to the
Distribution Agreement with the Distributor. Increases in the net assets of the
Fund from sales pursuant to its Distribution Plan and Agreement may benefit
shareholders by reducing per share expenses, permitting increased investment
flexibility and diversification of such Fund's assets, and facilitating
economies of scale (e.g., block purchases) in the Fund's securities
transactions.

CLASS B SHARES -- Class B shares are offered at NAV, without an initial sales
charge. With certain exceptions, the Fund may impose a deferred sales charge on
shares redeemed within five years of the date of purchase. No deferred sales
charge is imposed on amounts redeemed thereafter. If imposed, the deferred sales
charge is deducted from the redemption proceeds otherwise payable to you. The
deferred sales charge is retained by the Distributor.

Whether a contingent deferred sales charge is imposed and the amount of the
charge will depend on the number of years since the investor made a purchase
payment from which an amount is being redeemed, according to the following
schedule:

=======================================
CONTINGENT
YEAR SINCE PURCHASE DEFERRED
PAYMENT WAS MADE SALES CHARGE
---------------------------------------
1 5%
2 4%
3 3%
4 3%
5 2%
6 and more 0%
=======================================

Class B shares (except shares purchased through the reinvestment of dividends
and other distributions paid with respect to Class B shares) will automatically
convert, on the eighth anniversary of the date such shares were purchased, to
Class A shares which are subject to a lower distribution fee. This automatic
conversion of Class B shares will take place without imposition of a front-end
sales charge or exchange fee. (Conversion of Class B shares represented by stock
certificates will require the return of the stock certificates to the transfer
agent.) All shares purchased through reinvestment of dividends and other
distributions paid with respect to Class B shares ("reinvestment shares") will
be considered to be held in a separate subaccount. Each time any Class B shares
(other than those held in the subaccount) convert to Class A shares, a pro rata
portion of the reinvestment shares held in the subaccount will also convert to
Class A shares. Class B shares so converted will no longer be subject to the
higher expenses borne by Class B shares. Because the NAV per share of the Class
A shares may be higher or lower than that of the Class B shares at the time of
conversion, although the dollar value will be the same, a shareholder may
receive more or less Class A shares than the number of Class B shares converted.
Under current law, it is the Fund's opinion that such a conversion will not
constitute a taxable event under federal income tax law. In the event that this
ceases to be the case, the Board of Directors will consider what action, if any,
is appropriate and in the best interests of the Class B stockholders.

CLASS B DISTRIBUTION PLAN -- The Fund bears some of the costs of selling its
Class B shares under a Distribution Plan adopted with respect to its Class B
shares ("Class B Distribution Plan") pursuant to Rule 12b-1 under the 1940 Act.
This Plan provides for payments at an annual rate of 0.75% of the average daily
NAV of Class B shares. Amounts paid by the Fund are currently used to pay
dealers and other firms that make Class B shares available to their customers
(1) a commission at the time of purchase normally equal to 2.75% of the value of
each share sold and (2) a service fee for account maintenance and personal
service to shareholders payable for the first year, initially, and for each year
thereafter, quarterly, in an amount equal to 0.25% annually of the average daily
NAV of Class B shares sold by such dealers and other firms and remaining
outstanding on the books of the Fund. The service fee may also be used to pay
for sub-administration and/or sub-transfer agency services provided for the
benefit of the Fund.

Rules of the NASD limit the aggregate amount that a Fund may pay annually in
distribution costs for the sale of its Class B shares to 6.25% of gross sales of
Class B shares since the inception of the Distribution Plan, plus interest at
the prime rate plus 1% on such amount (less any contingent deferred sales
charges paid by Class B shareholders to the Distributor). The Distributor
intends, but is not obligated, to continue to pay or accrue distribution charges
incurred in connection with the Class B Distribution Plan which exceed current
annual payments permitted to be received by the Distributor from the Fund. The
Distributor intends to seek full payment of such charges from the Fund (together
with annual interest thereon at the prime rate plus 1%) at such time in the
future as, and to the extent that, payment thereof by the Fund would be within
permitted limits.

The Fund's Class B Distribution Plan may be terminated at any time by vote of
its directors who are not interested persons of the Fund as defined in the 1940
Act or by vote of a majority of the outstanding Class B shares. In the event the
Class B Distribution Plan is terminated by the Class B stockholders or the
Funds' Board of Directors, the payments made to the Distributor pursuant to the
Plan up to that time would be retained by the Distributor. Any expenses incurred
by the Distributor in excess of those payments would be absorbed by the
Distributor. The Fund makes no payments in connection with the sales of its
shares other than the distribution fee paid to the Distributor.

CLASS C SHARES -- Class C shares of the Fund are offered at NAV, without an
initial sales charge. With certain exceptions, the Fund may impose a deferred
sales charge on shares redeemed within one year of the date of purchase. No
deferred sales charge is imposed on amounts redeemed thereafter. If imposed, the
deferred sales charge is deducted from the redemption proceeds otherwise payable
to you. The deferred sales charge is retained by the Distributor.

CLASS C DISTRIBUTION PLAN -- The Fund bears some of the costs of selling its
Class C shares under a Distribution Plan adopted with respect to its Class C
shares ("Class C Distribution Plan") pursuant to Rule 12b-1 under the 1940 Act.
This Plan provides for payments at an annual rate of 0.50% of the average daily
NAV of Class C shares. Amounts paid by the Fund are currently used to pay
dealers and other firms that make Class C shares available to their customers
(1) a commission at the time of purchase normally equal to 0.25% of the value of
each share sold, and for each year thereafter, quarterly, in an amount equal to
0.25% annually of the average daily NAV of Class C shares sold by such dealers
and other firms and remaining outstanding on the books of the Fund and (2) a
service fee payable for the first year initially, and for each year thereafter,
quarterly, in an amount equal to 0.25% annually of the average daily net asset
value of Class C shares sold by such dealers and other firms and remaining
outstanding on the books of the Fund. The service fee may also be used to pay
for sub-administration and/or sub-transfer agency services provided for the
benefit of the Fund.

Rules of the NASD limit the aggregate amount that a Fund may pay annually in
distribution costs for the sale of its Class C shares to 6.25% of gross sales of
Class C shares since the inception of the Distribution Plan, plus interest at
the prime rate plus 1% on such amount (less any contingent deferred sales
charges paid by Class C shareholders to the Distributor). The Distributor
intends, but is not obligated, to continue to pay or accrue distribution charges
incurred in connection with the Class C Distribution Plan which exceed current
annual payments permitted to be received by the Distributor from the Fund. The
Distributor intends to seek full payment of such charges from the Fund (together
with annual interest thereon at the prime rate plus 1%) at such time in the
future as, and to the extent that, payment thereof by the Fund would be within
permitted limits.

The Fund's Class C Distribution Plan may be terminated at any time by vote of
its directors who are not interested persons of the Fund as defined in the 1940
Act or by vote of a majority of the outstanding Class C shares. In the event the
Class C Distribution Plan is terminated by the Class C stockholders or the
Fund's Board of Directors, the payments made to the Distributor pursuant to the
Plan up to that time would be retained by the Distributor. Any expenses incurred
by the Distributor in excess of those payments would be absorbed by the
Distributor. The Fund makes no payments in connection with the sales of their
shares other than the distribution fee paid to the Distributor.

RULE 12b-1 PLAN EXPENSES -- For the fiscal year ended September 30, 2004, the
following 12b-1 payments were made under the Rule 12b-1 Distribution Plans:

====================================================================
CLASS A CLASS B CLASS C
--------------------------------------------------------------------
Compensation to Underwriters* $809,900 $280,854 $874,699
--------------------------------------------------------------------
*The Plan is a compensation plan. The Fund paid no fees for
advertising, printing and mailing of prospectuses to other than
current shareholders, compensation to broker/dealers, compensation
to sales personal, or interest carrying or other financing charges.
====================================================================

CALCULATION AND WAIVER OF CONTINGENT DEFERRED SALES CHARGES -- Any contingent
deferred sales charge imposed upon redemption of Class A shares (purchased in
amounts of $1,000,000 or more), Class B shares and Class C shares is a
percentage of the lesser of (1) the NAV of the shares redeemed or (2) the net
cost of such shares. No contingent deferred sales charge is imposed upon
redemption of amounts derived from (1) increases in the value above the net cost
of such shares due to increases in the NAV per share of the Fund; (2) shares
acquired through reinvestment of income dividends and capital gain
distributions; or (3) Class A shares (purchased in amounts of $1,000,000 or
more) or Class C shares held for more than one year or Class B shares held for
more than five years. Upon request for redemption, shares not subject to the
contingent deferred sales charge will be redeemed first. Thereafter, shares held
the longest will be the first to be redeemed.

The contingent deferred sales charge is waived: (1) following the death of a
stockholder if redemption is made within one year after death; (2) upon the
disability (as defined in Section 72(m)(7) of the Code) of a stockholder prior
to age 65 if redemption is made within one year after the disability, provided
such disability occurred after the stockholder opened the account; (3) in
connection with required minimum distributions in the case of an IRA, SAR-SEP or
Keogh or any other retirement plan qualified under Section 401(a), 401(k) or
403(b) of the Code; and (4) in the case of distributions from retirement plans
qualified under Section 401(a) or 401(k) of the Code due to (i) returns of
excess contributions to the plan, (ii) retirement of a participant in the plan,
(iii) a loan from the plan (repayment of loans, however, will constitute new
sales for purposes of assessing the contingent deferred sales charge), (iv)
"financial hardship" of a participant in the plan, as that term is defined in
Treasury Regulation Section 1.401(k)-1(d)(2), as amended from time to time, (v)
termination of employment of a participant in the plan, (vi) any other
permissible withdrawal under the terms of the plan.

ARRANGEMENTS WITH BROKER-DEALERS AND OTHERS -- To the extent permitted by
applicable law, the Fund's Administrator or Distributor, from time to time, will
pay a bonus, to certain dealers whose representatives have sold or are expected
to sell significant amounts of the Fund and/or certain other funds managed by
the Fund Administrator. Bonus compensation may include reallowance of the entire
sales charge and may also include, with respect to Class A shares, an amount
which exceeds the entire sales charge and, with respect to Class B or Class C
shares, an amount which exceeds the maximum commission. The Distributor, or the
Fund Administrator, may also provide financial assistance to certain dealers in
connection with conferences, sales or training programs for their employees,
seminars for the public, advertising, sales campaigns, and/or shareholder
services and programs regarding one or more of the funds managed by the Fund
Administrator. In addition, the Fund Administrator or Distributor may sponsor
training or education meetings at various locations. In connection with such
meetings it is expected that the Fund Administrator or Distributor would pay the
travel, lodging and other expenses of representatives of the dealers in
attendance. The Fund Administrator or Distributor may also pay certain
transaction or order processing costs incurred by dealers who sell Fund shares
through clearing dealers. Certain of the foregoing arrangements may be financed
by payments to the Distributor under a Rule 12b-1 Distribution Plan. These
arrangements will not change the price an investor will pay for shares or the
amount that the Fund will receive from such sale. No compensation will be
offered to the extent it is prohibited by the laws of any state or
self-regulatory agency, such as the NASD. A dealer to whom substantially the
entire sales charge of Class A shares is reallowed may be deemed to be an
"underwriter" under federal securities laws.

The Distributor also may pay banks and other financial services firms that
facilitate transactions in shares of the Fund for their clients a transaction
fee up to the level of the payments made allowable to dealers for the sale of
such shares as described above.

PURCHASES AT NET ASSET VALUE -- Class A shares of the Fund may be purchased at
NAV by (1) directors, officers and employees of the Fund, the Fund's
Administrator or Distributor; directors, officers and employees of Security
Benefit Life Insurance Company and its subsidiaries; agents licensed with SBL;
spouses or minor children of any such agents; as well as the following relatives
of any such directors, officers and employees (and their spouses): spouses,
grandparents, parents, children, grandchildren, siblings, nieces and nephews;
(2) any trust, pension, profit sharing or other benefit plan established by any
of the foregoing corporations for persons described above; (3) retirement plans
where third party administrators of such plans have entered into certain
arrangements with the Distributor or its affiliates provided that no commission
is paid to dealers; and (4) officers, directors, partners or registered
representatives (and their spouses and minor children) of broker-dealers who
have a selling agreement with the Distributor. Such sales are made upon the
written assurance of the purchaser that the purchase is made for investment
purposes and that the securities will not be transferred or resold except
through redemption or repurchase by or on behalf of the Fund.

Class A shares of the Fund may also be purchased at NAV when the purchase is
made on the recommendation of (i) a registered investment adviser, trustee or
financial intermediary who has authority to make investment decisions on behalf
of the investor; or (ii) a certified financial planner or registered
broker-dealer who either charges periodic fees to its customers for financial
planning, investment advisory or asset management services, or provides such
services in connection with the establishment of an investment account for which
a comprehensive "wrap fee" is imposed. The Distributor must be notified when a
purchase is made that qualifies under this provision.

PURCHASES FOR EMPLOYER-SPONSORED RETIREMENT PLANS -- Security Financial
Resources, Inc., an affiliated company of the Distributor, offers plan
recordkeeping services on a fee basis to employer-sponsored retirement plans.
Employer-sponsored retirement plans that have entered into an agreement to
receive such services from Security Financial Resources, Inc. may purchase Class
A shares of Capital Preservation Fund at NAV under certain circumstances. Such
plans would first purchase Class C shares of the Fund for an initial period of
time that would vary with the size of the plan, amount of assets flowing into
the plan and level of service provided by the dealer. After that initial period
of time has elapsed, the plan would exchange at NAV existing Class C shares for
Class A shares of Capital Preservation Fund, and new purchases under the plans
would be made in Class A shares at NAV.

The schedule below sets forth the amount of time that retirement plan assets
would remain invested in Class C shares before they would be eligible for
exchange to Class A shares of Capital Preservation Fund. The schedule below also
sets forth the commissions paid to dealers in connection with sales of Fund
shares with respect to such retirement plans, which commissions replace those
normally paid in connection with sales of Class C shares.

================================================================================
NUMBER OF YEARS COMMISSION BY YEAR OF PURCHASE*
INVESTED IN --------------------------------
ELIGIBLE PLANS CLASS C SHARES 1 2 3 4 5+
--------------------------------------------------------------------------------
Less than $1.5 mil. in
assets or $400,000 in flow 8 years 5% 4% 3% 2% 1%
--------------------------------------------------------------------------------
Less than $1.5 mil. in
assets or $400,000 in flow 8 years 6% 4% 2% 1% 1%
--------------------------------------------------------------------------------
Less than $5 mil. in
assets or $1 mil. in flow 6 years 4% 3% 2% 1% 1%
--------------------------------------------------------------------------------
Less than $5 mil. in
assets or $1 mil. in flow 5 years 3% 2% 1% 1% 1%
--------------------------------------------------------------------------------
Less than $10 mil. in
assets or $2 mil. in flow 3 years 2% 1% 1% 1% 1%
--------------------------------------------------------------------------------
Less than $10 mil. in
assets or $2 mil. in flow 0 years** 1%++ 1% 1% 1% 1%
--------------------------------------------------------------------------------
*The commission is a percentage of the amount invested. The year of purchase is
measured from the date of the plan's initial investment in the Fund.
Notwithstanding the foregoing schedule, if 50% or more of the plan assets
allocated to the Fund is redeemed within the four-year period beginning on the
date of the plan's initial investment in the Fund, the commission will
immediately drop to 1% for all subsequent purchases.

**Amounts will be invested in Class A shares at NAV. ++Certain dealers may
receive 1.25% in year 1.
================================================================================

The Distributor may also enter into arrangements with dealers whereby it agrees
to "annualize" the first-year commission expected to be paid on the purchase of
Fund shares by retirement plans receiving plan recordkeeping services from
Security Financial Resources, Inc. Such arrangements will typically provide for
an up-front payment by the Distributor to the dealer of a specified percentage
of the first-year's expected commissions attributable to a particular retirement
plan.

In some circumstances, a retirement plan that was not previously receiving plan
recordkeeping services from Security Financial Resources, Inc. may transfer its
assets in an arrangement where it does receive such services. In such
circumstances, the Distributor may pay the dealer a commission on the
transferred assets that is different from the commission otherwise set forth in
the table above, but typically not in excess of 1.25% of the transferred amount.

In addition to the commissions set forth above, dealers will receive a service
fee payable beginning in the 13th month following the plan's initial investment.
The Distributor pays service fees quarterly, in an amount equal to 0.25%
annually of the average daily NAV of Class C shares sold by dealers in
connection with such employer-sponsored retirement plans and remaining
outstanding on the books of Capital Preservation Fund.

OTHER DISTRIBUTION OR SERVICE ARRANGEMENTS

The Distributor or its affiliates, out of its own resources and not out of Fund
assets (i.e., without additional cost to the Fund or its shareholders), may also
provide additional cash payments or non-cash compensation to some, but not all,
broker/dealers and other financial intermediaries who sell shares of the Fund or
render investor services to Fund shareholders (directly or indirectly via sales
of variable insurance contracts or the provision of services in connection with
retirement plans). Such payments and compensation are in addition to any sales
charges paid by investors or Rule 12b-1 plan fees, service fees and other fees
paid, directly or indirectly, by the Fund to such brokers and other financial
intermediaries. These arrangements are sometimes referred to as "revenue
sharing" arrangements. Revenue sharing arrangements are not financed by the
Fund, and thus, do not result in increased Fund expenses. They are not reflected
in the fees and expenses listed in the fees and expenses sections of the Fund's
prospectuses, and they do not change the price paid by investors for the
purchase of the Fund's shares or the amount received by a shareholder as
proceeds from the redemption of Fund shares.

Such additional cash payments may be made to brokers and other financial
intermediaries that provide services to the Fund and/or shareholders in the
Fund, including (without limitation) shareholder servicing, marketing support
and/or access to sales meetings, sales representatives and management
representatives of the broker or other financial intermediary. Cash compensation
may also be paid to brokers and other financial intermediaries for inclusion of
the Fund on a sales list, including a preferred or select sales list, in other
sales programs, or as an expense reimbursement or compensation in cases where
the broker or other financial intermediary provides services to Fund
shareholders. To the extent permitted by applicable law, the Distributor and
other parties may pay or allow other incentives and compensation to such
financial intermediaries. The Distributor generally assesses the advisability of
continuing to make these payments periodically.

These payments may take a variety of forms, including (without limitation)
compensation for sales, "trail" fees for shareholder servicing and maintenance
of investor accounts, and finder's fees [that may vary depending on the Fund or
share class and the dollar amount of shares sold] Revenue sharing payments may
be structured: (i) as a percentage of net sales; (ii) as a percentage of net
assets; and/or (iii) as a fixed dollar-amount.

As of the date of this Statement of Additional Information, the Distributor has
revenue sharing arrangements with the following financial intermediaries.

========================================================================================
PAYMENTS
DURING LAST
BROKER-DEALER NAME BASIS OF PAYMENT FISCAL YEAR AFFECTED FUNDS
----------------------------------------------------------------------------------------
Brecek & Young 0.50% of sales $237,278.98 All funds in the
Advisors, Inc. Security Funds
(wholly-owned Complex except
subsidiary of Security Cash
Security Benefit Fund and SBL Fund
Corporation and
an affiliate of
the Distributor)
----------------------------------------------------------------------------------------
CUSO Financial 0.10% of sales 15,608.60 All funds in the
Services, L.P. Security Funds
Complex except
Security Cash
Fund and SBL Fund
----------------------------------------------------------------------------------------
Investment Advisors & 0.10% of sales 19,215.00 All funds in the
Consultants, Inc. Security Funds
Complex except
Security Cash
Fund and SBL Fund
----------------------------------------------------------------------------------------
Legend Equities For calendar year, 0.10% 141,211.11 All funds in the
Corporation of sales if less than Security Funds
$10 million; 0.15% of Complex except
sales if $10 million or Security Cash
more but less than $30 Fund and SBL Fund
million; and 0.25% of
sales if $30 million
or more; plus 0.05% of
assets
----------------------------------------------------------------------------------------
Lincoln Investment 0.25% of sales 142,203.00 All funds in the
Planning, Inc. Security Funds
Complex except
Security Cash
Fund and SBL Fund
----------------------------------------------------------------------------------------
Ohio Savings 0.10% of sales 13,218.82 All funds in the
Securities, Inc.* Security Funds
Complex except
Security Cash
Fund and SBL Fund
----------------------------------------------------------------------------------------
PlanMember Securities In lieu of standard Not All funds in the
Corporation commissions, 0.25% of applicable Security Funds
net sales under mutual for 2004 Complex except
fund wrap program (Class SBL Fund
A shares at NAV) during
each calendar quarter
beginning in 2005. Also
receive 12b-1 fees if
available.

In lieu of standard
commissions, one-time
commission of 1.33% of
Class A shares trans-
ferred to funds in
2003 under PlanMember's
Advantage Program.
----------------------------------------------------------------------------------------
Trustmark 0.10% of sales 1,202.70 All funds in the
Securities, Inc.* Security Funds
Complex except
Security Cash
Fund and SBL Fund
----------------------------------------------------------------------------------------
Vision 0.10% of sales 6,870.96 All funds in the
Security Funds
Complex except
Security Cash
Fund and SBL Fund
----------------------------------------------------------------------------------------
VSR Financial For calendar year, 0.00% 27,039.02 All funds in the
Services, Inc. of sales is less than Security Funds
$5 million; 0.10% of Complex except
sales if $5 million or Security Cash
more but less than $15 Fund and SBL Fund
million; 0.12% of sales
if $15 million or more
but less than $25
million; and 0.15% of
sales if $25 million or
more
========================================================================================

The Distributor may enter into revenue sharing arrangements with other financial
intermediaries, and may modify existing revenue sharing arrangements with the
intermediaries indicated above.

In addition, while the Distributor typically pays most of the sales charge
applicable to the sale of fund shares to brokers and other financial
intermediaries through which purchases are made, the Distributor may, on
occasion, pay the entire sales charge.

From time to time, the Distributor and its affiliates may also pay non-cash
compensation to brokers and other financial intermediaries in the form of, for
example: (i) occasional gifts; (ii) occasional meals, tickets or other
entertainment; and/or (iii) sponsorship support of regional or national events.
For example, representatives of the Distributor visit brokers and other
financial intermediaries on a regular basis to educate them about the Fund and
to encourage the sale of Fund shares to their clients. The costs and expenses
associated with these efforts may include travel, lodging, sponsorship at
educational seminars and conferences, entertainment and meals to the extent
permitted by law.

The compensation or reimbursement received by brokers and other financial
intermediaries through sales charges, fees payable from the Fund, and/or revenue
sharing arrangements for selling shares of the Fund may be more or less than the
overall compensation or reimbursement on similar or other products and may
influence your broker or other financial intermediary to present and recommend
the Fund over other investment options available in the marketplace. In
addition, depending on the arrangements in place at any particular time, your
broker or other financial intermediary may have a financial incentive for
recommending a particular class of Fund shares over other share classes.

Shareholders may obtain more information about these arrangements, including the
conflicts of interests that such arrangements may create, from their brokers and
other financial intermediaries, and should so inquire if they would like
additional information. A shareholder may ask his/her broker or financial
intermediary how he/she will be compensated for investments made in the Funds.

Although a Fund may use financial firms that sell Fund shares to effect
transactions for the Fund's portfolio, the Fund, and SMC will not consider the
sale of Fund shares as a factor when choosing financial firms to effect those
transactions.

HOW TO REDEEM SHARES

Shareholders may turn in their shares directly to the Fund Administrator for
redemption at NAV (which may be more or less than the investor's cost). The
redemption price will be the NAV next determined after the time when such shares
are tendered for redemption less any applicable contingent deferred sales
charge. Shares may be redeemed in cash or in-kind. (See "Valuation of Assets")

Shares will be redeemed on request of the shareholder in proper order to the
Fund Administrator, which serves as the Funds' transfer agent. A request is made
in proper order by submitting the following items to the Fund Administrator: (1)
a written request for redemption signed by all registered owners exactly as the
account is registered, including fiduciary titles, if any, and specifying the
account number and the dollar amount or number of shares to be redeemed; (2) a
guarantee of all signatures on the written request or on the share certificate
or accompanying stock power; (3) any share certificates issued for any of the
shares to be redeemed; and (4) any additional documents which may be required by
the Fund Administrator for redemption by corporations or other organizations,
executors, administrators, trustees, custodians or the like. Transfers of shares
are subject to the same requirements. A signature guarantee is not required for
redemptions of $25,000 or less, requested by and payable to all shareholders of
record for an account, to be sent to the address of record. The signature
guarantee must be provided by an eligible guarantor institution, such as a bank,
broker, credit union, national securities exchange or savings association. The
Fund Administrator reserves the right to reject any signature guarantee pursuant
to its written procedures which may be revised in the future. To avoid delay in
redemption or transfer, shareholders having questions should contact the Fund
Administrator.

The Articles of Incorporation of Security Income Fund provide that the Board of
Directors, without the vote or consent of the shareholders, may adopt a plan to
redeem at NAV all shares in any shareholder account in which there has been no
investment (other than the reinvestment of income dividends or capital gains
distributions) for the last six months and in which there are fewer than 50
shares or such fewer number of shares as may be specified by the Board of
Directors. Any plan of involuntary redemption adopted by the Board of Directors
shall provide that the plan is in the economic best interests of the Fund or is
necessary to reduce disproportionately burdensome expenses in servicing
shareholder accounts. Such plan shall further provide that prior notice of at
least six months shall be given to a shareholder before involuntary redemption,
and that the shareholder will have at least six months from the date of the
notice to avoid redemption by increasing his or her account to at least the
minimum number of shares established in the Articles of Incorporation, or such
fewer shares as are specified in the plan.

When investing in the Fund, shareholders are required to furnish their tax
identification number and to state whether or not they are subject to
withholding for prior underreporting, certified under penalties of perjury as
prescribed by the Internal Revenue Code. To the extent permitted by law, the
redemption proceeds of shareholders who fail to furnish this information will be
reduced by $50 to reimburse for the IRS penalty imposed for failure to report
the tax identification number on information reports.

Payment of the amount due on redemption, less any applicable deferred sales
charge will be made within seven days after tender, except that the Fund may
suspend the right of redemption during any period when trading on the New York
Stock Exchange is restricted by the Securities and Exchange Commission or such
Exchange is closed for other than weekends or holidays, or any emergency is
deemed to exist by the Securities and Exchange Commission. When a redemption
request is received, the redemption proceeds are deposited into a redemption
account established by the Distributor and the Distributor sends a check in the
amount of redemption proceeds to the shareholder. The Distributor earns interest
on the amounts maintained in the redemption account. Conversely, the Distributor
causes payments to be made to the Fund in the case of orders for purchase of
Fund shares before it actually receives federal funds.

In addition to the foregoing redemption procedure, the Fund repurchases shares
from broker-dealers at the price determined as of the close of business on the
day such offer is confirmed. The Distributor has been authorized, as agent, to
make such repurchases for the Fund's account. Dealers may charge a commission on
the repurchase of shares.

The repurchase or redemption of shares held in a tax-qualified retirement plan
must be effected through the trustee of the plan and may result in adverse tax
consequences.

At various times the Fund may be requested to redeem shares for which it has not
yet received good payment. Accordingly, the Fund may delay the mailing of a
redemption check until such time as it has assured itself that good payment
(e.g., cash or certified check on a U.S. bank) has been collected for the
purchase of such shares.

INVESTMENT MANAGER

Security Management Company, LLC, One Security Benefit Place, Topeka, Kansas, as
served as investment adviser to Capital Preservation Fund since July 1, 2005.
SMC also serves as Investment Manager to the Diversified Income Series, High
Yield Series, and Income Opportunity Series, each a series of Security Income
Fund.

The current investment advisory agreement ("Investment Advisory Contract") for
the Capital Preservation Fund is dated July 1, 2005. The Investment Manager also
acts as investment adviser to Security Equity Fund, Security Large Cap Value
Fund, Security Mid Cap Growth Fund, Security Municipal bond Fund, Security Cash
Fund and SBL Fund. The Investment Manager is a limited liability company
controlled by its members, SBL and Security Benefit Corporation ("SBC"). SBC is
incorporated under the laws of Kansas and is wholly-owned by Security Benefit
Mutual Holding Company, One Security Benefit Place, Topeka, Kansas 66636-0001.
SBL, a stock life insurance company incorporated under the laws of Kansas and is
wholly-owned by SBC. Security Benefit Mutual Holding Company, which is
controlled by SBL policyholders. SBC together with its subsidiaries, has
approximately $16.4 billion of assets under management.

Pursuant to the Investment Advisory Contract, the Investment Manager furnishes
investment advisory, statistical and research services to the Fund, supervises
and arranges for the purchase and sale of securities on behalf of the Fund,
provides for the maintenance and compilation of records pertaining to the
investment advisory functions, and also makes certain guarantees with respect to
the Fund's annual expenses. The Investment Manager guarantees that the aggregate
annual expenses of the Fund (including for any fiscal year, the management fee,
but excluding interest, taxes, brokerage commissions, extraordinary expenses and
Class B and Class C distribution fees) shall not exceed the level of expenses
which the Fund is permitted to bear under the most restrictive expense
limitation imposed by any state in which shares of the Fund is then qualified
for sale and shall not exceed 1.50% of the Fund's average net assets for the
year. (The Investment Manager is not aware of any state that currently imposes
limits on the level of mutual fund expenses.) The Investment Manager will
contribute such funds or waive such portion of its management fee as may be
necessary to insure that the aggregate expenses of the Fund does not exceed the
guaranteed maximum.

For services provided to the Fund, the Investment Manager is entitled to receive
compensation on an annual basis equal to 0.35% of the average daily net assets.

The Fund will pay all of its expenses not assumed by the Investment Manager or
the Distributor including organization expenses; directors' fees; fees and
expenses of custodian; taxes and governmental fees; interest charges; membership
dues; brokerage commissions; reports; proxy statements; costs of shareholder and
other meetings; any distribution fees; and legal, auditing and accounting
expenses. The Fund will also pay for the preparation and distribution of the
Prospectus to its shareholders and all expenses in connection with its
registration under federal and state securities laws. The Fund will pay
nonrecurring expenses as may arise, including litigation affecting it.

The Investment Advisory Contract between the Investment Manager and the Fund is
renewable annually by the Fund's Board of Directors or by a vote of a majority
of a Fund's outstanding securities and, in either event, by a majority of the
board who are not parties to the contract or interested persons of any such
party. The contract provides that it may be terminated without penalty at any
time by either party on 60 days' notice and is automatically terminated in the
event of assignment.

Pursuant to a Fund Accounting and Administration Agreement with the Fund dated
as of July 1, 2005, the Investment Manager also acts as the administrative agent
for the Fund and as such performs administrative functions and the bookkeeping,
accounting and pricing functions for the Fund. For these services, the
Investment Manager receives, on an annual basis, a fee of 0.09% of the average
daily net assets of the Fund, or if greater, $25,000, calculated daily and
payable monthly.

Pursuant to a Transfer Agency Agreement with the Fund also dated July 1, 2005,
the Investment Manager also acts as the transfer agent for the Fund. As such,
the Investment Manager performs all shareholder servicing functions, including
transferring record ownership, processing purchase and redemption transactions,
answering inquiries, mailing shareholder communications and acting as the
dividend disbursing agent. For these services, the Investment Manager receives:
(1) an annual maintenance fee of $8.00 per account ($6.50 per account with
respect to accounts which are Matrix Level III pursuant to the NSCC networking
systems and $5 per account with respect to closed accounts that are maintained
on the transfer agency system), (2) a transaction fee of $1.10 per shareholder
transaction ($0.60 per transaction for Matrix Level III accounts), and (3) a fee
to open an account of $4.00 per new account. For purposes of calculating the
annual maintenance fee, the shareholder transaction and dividend transaction
fee, the Investment Manager is permitted to count as a shareholder, each person
that holds a beneficial interest in the Fund through an omnibus account provided
that the Investment Manager is paying a third party, such as a bank, insurance
company or third-party administrator for sub-administration, sub-accounting
and/or sub-transfer agency fees for keeping individual shareholder records.

EVALUATION OF INVESTMENT ADVISORY CONTRACT BY THE BOARD -- At a meeting of the
Board held on April 15, 2005, called for the purpose of, among other things,
voting on approval of the Investment Advisory Contract, the Board, including the
Independent Directors, unanimously approved the Investment Advisory Contract. In
reaching this conclusion, the Board requested and obtained from the Investment
Manager such information as it deemed reasonably necessary to approve SMC as the
investment adviser to the Fund. The Board carefully evaluated this information,
and was advised by legal counsel with respect to its deliberations.

In approving the Investment Advisory Contract, the Independent Directors
considered numerous factors, including, among others, (1) the nature, extent,
and quality of the services to be provided by SMC; (2) the investment
performance of the Fund and SMC; (3) the costs of the services to be provided
and profits to be realized by SMC and its affiliates from the relationship with
the Fund; (4) the extent to which economies of scale would be realized as the
Fund grows; and (5) whether fee levels reflect these economies of scale for the
benefit of Fund investors. The Board also took into account other considerations
that it believed, in light of the legal advice furnished to the Independent
Directors by their independent legal counsel and the Directors' own business
judgment, to be relevant. The factors considered by the Board in reviewing the
Investment Advisory Contract included, but were not limited to, the following:

THE NATURE, EXTENT AND QUALITY OF THE SERVICES TO BE PROVIDED BY SMC TO THE
FUND. The Board placed particular emphasis on SMC's ability to readily provide,
without interruption, advisory services in light of termination of the Fund's
wrapper agreements, withdrawal from the master-feeder structure and change in
its investment objective. The Board specifically noted that SMC is already
investment manager to the other series offered by the Company and its knowledge
of and experience with the Company puts it in a unique position to be able to
efficiently implement an investment program for the Fund. In concluding that SMC
is able to provide high quality services to the Fund, the Board took note of the
strong compliance track record of SMC and other investment companies advised by
it, and determined that SMC is able to provide investment and related services
that are appropriate in scope and extent in light of the Fund's operations, the
competitive landscape of the investment company business and investor needs;

THE INVESTMENT PERFORMANCE OF THE FUND. The Board determined that the Fund's
performance to date has been acceptable. On the basis of information supplied by
SMC with respect to the investment track record of other fixed income funds
managed by SMC, the Board concluded that SMC has the investment management
capabilities to generate a level of investment performance that is appropriate
for a relatively short duration fixed income fund that seeks to minimize
principal fluctuation, and is capable of doing so at a lower level of expense
than currently associated with an investment in the Fund;

THE COSTS OF THE SERVICES TO BE PROVIDED AND THE PROFITS TO BE REALIZED BY SMC
AND ITS AFFILIATES FROM THE RELATIONSHIP WITH THE FUND. The Board concluded
that, with respect to the Fund, the level of proposed investment advisory fees
under the Investment Advisory Contract is appropriate in light of the advisory
fees and overall expense ratios of comparable investment companies and the
anticipated profitability of the relationship between the Fund and SMC (based on
SMC profit projections for the Fund and review of SMC's current profitability).
On the basis of comparative information provided by Lipper and Morningstar, the
Board determined that the advisory fee and overall expense ratio of the Fund is
consistent with industry averages, particularly with respect to investment
companies of comparable size. The Board noted particularly that the advisory
fee, other related expenses and overall estimated operating expenses represent
reductions of the corresponding fees currently associated with an investment in
the Fund as part of the master-feeder structure;

THE EXTENT TO WHICH ECONOMIES OF SCALE WOULD BE REALIZED AS THE FUND GROWS AND
WHETHER FEE LEVELS REFLECT THESE ECONOMIES OF SCALE FOR THE BENEFIT OF THE FUND.
In considering the extent to which the management fees payable under the
Investment Advisory Contract reflect economies of scale or will permit economies
of scale to be realized in the future, the Board took note of the level of
assets in the Fund. The Board determined that the Fund has yet to achieve
meaningful economies of scale, which therefore cannot be reflected in the
advisory fee payable under the Investment Advisory Contract. While the advisory
fee payable under the Investment Advisory Contract does not reduce should Fund
assets grow meaningfully, the Board determined that the advisory fee payable
under the Investment Advisory Contract already reflects potential future
economies of scale to some extent by virtue of its relatively low level
determined with reference to the fee payable under the Current Agreement and
industry standards as reported by Lipper and Morningstar, as well as SMC's
anticipated profitability. The Board also noted that it would have the
opportunity to periodically re-examine whether the Fund had achieved economies
of scale, and the appropriateness of advisory fees payable to SMC, in the
future; and

OTHER CONSIDERATIONS. In approving the Investment Advisory Contract and its
submission to Fund shareholders, the Board also considered the high quality of
SMC's portfolio management personnel who will manage the Fund under the
Investment Advisory Contract, and SMC's overall portfolio management
capabilities. The Board determined that SMC has made a substantial commitment to
the recruitment and retention of high quality personnel, and maintains the
financial and operational resources reasonably necessary to manage the Fund. The
Board also favorably considered SMC's entrepreneurial commitment to the
management and success of the Fund, which could entail a substantial financial
and professional commitment to the successful operation of the Fund.

In approving the Investment Advisory Contract, the Board, including the
Independent Directors, did not identify any single factor as all-important or
controlling. On the basis of considerations discussed above and other relevant
information, the Board determined that the Investment Advisory Contract is fair
and reasonable and in the best interest of the Fund and its shareholders. Based
on all of the foregoing, the Board, including the Independent Directors,
unanimously voted to approve the Investment Advisory Contract and to recommend
it to Fund shareholders for their approval.

PREVIOUS INVESTMENT MANAGER -- Prior to July 1, 2005, the Fund operated as a
"feeder" fund that invested substantially all of its assets in the Portfolio, an
investment company that is managed by Deutsche Asset Management, Inc. ("DeAm
Inc."). For the fiscal years ended September 30, 2004, September 30, 2003 and
September 30, 2002, DeAM, Inc. earned $16,152,288, $11,339,303, and $3,475,084,
respectively, for compensation of investment advisory services provided to the
Portfolio. For the same periods, DeAm, Inc. reimbursed $2,503,417, $1,492,773,
and $752,588, respectively, to the Fund to cover expenses.

PORTFOLIO MANAGERS

STEVEN M. BOWSER is responsible for the day-to-day management of the Fund. Mr.
Bowser may also manage other registered investment companies, other pooled
investment vehicles and other accounts, as indicated below. The following table
identifies, as of December 31, 2004 (i) the number of, and total assets of,
other registered investment companies, other pooled investment vehicles and
other accounts managed and (ii) the total assets of such companies, vehicles and
accounts with respect to which the advisory fee is based on performance.

=================================================================
NUMBER TOTAL ASSETS
-----------------------------------------------------------------
Other Registered Investment Companies 4 $184 million
Other Pooled Investment Vehicles 1 $14 million
Other Accounts 2 $5.7 billion
=================================================================

As of December 31, 2004, Mr. Bowser managed two other registered investment
companies with assets totaling $17.5 million with respect to which the advisory
fee is based on performance. He manages no other pooled investment vehicles or
other accounts with respect to which the advisory fee is based on performance.

CHRISTOPHER L. PHALEN is responsible for the day-to-day management of the Fund.
Mr. Phalen also manages other registered investment companies, other pooled
investment vehicles and other accounts, as indicated below. The following table
identifies, as of December 31, 2004 (i) the number of, and total assets of,
other registered investment companies, other pooled investment vehicles and
other accounts managed and (ii) the total assets of such companies, vehicles and
accounts with respect to which the advisory fee is based on performance.

=================================================================
NUMBER TOTAL ASSETS
-----------------------------------------------------------------
Other Registered Investment Companies 2 $84 million
Other Pooled Investment Vehicles 1 $5.7 million
Other Accounts 1 $5 billion
=================================================================

As of December 31, 2004, Mr. Phalen managed no other registered investment
companies, other pooled investment vehicles or other accounts with respect to
which the advisory fee is based on performance.

OWNERSHIP OF FUND SHARES-- As of December 31, 2004, Mr. Bowser and Mr. Phalen
owned no Shares of the Fund.

CONFLICTS OF INTEREST -- From time to time, potential conflicts of interest may
arise between a portfolio manager's management of the investments of the Fund on
the one hand, and the management of other registered investment companies,
pooled investment vehicles and other accounts (collectively, "other accounts")
on the other. The other accounts might have similar investment objectives or
strategies as the Fund, track the same indexes the Fund tracks or otherwise
holds, purchase, or sell securities that are eligible to be held, purchased or
sold by the Fund. The other accounts might also have different investment
objectives or strategies than the Fund.

ALLOCATION OF LIMITED TIME AND ATTENTION. A portfolio manager who is responsible
for managing multiple funds and/or accounts may devote unequal time and
attention to the management of those funds and/or accounts. As a result, the
portfolio manager may not be able to formulate as complete a strategy or
identify equally attractive investment opportunities for each of those accounts
as might be the case if he or she were to devote substantially more attention to
the management of a single fund. The effects of this potential conflict may be
more pronounced where funds and/or accounts overseen by a particular portfolio
manager have different investment strategies.

KNOWLEDGE AND TIMING OF SERIES TRADES. A potential conflict of interest may
arise as a result of the portfolio manager's day-to-day management of the Fund.
Because of his or her position with the Fund, the portfolio manager knows the
size, timing and possible market impact of the Fund's trades. It is
theoretically possible that the portfolio manager could use this information to
the advantage of other accounts they manage and to the possible detriment of the
Fund.

INVESTMENT OPPORTUNITIES. A potential conflict of interest may arise as a result
of the portfolio manager's management of a number of accounts with comparable
investment guidelines. An investment opportunity may be suitable for both the
Fund and other accounts managed by the portfolio manager, but may not be
available in sufficient quantities for both the Fund and the other accounts to
participate fully. Similarly, there may be limited opportunity to sell an
investment held by the Fund and another account. The Investment Manager has
adopted policies and procedures reasonably designed to allocate investment
opportunities on a fair and equitable basis over time.

SELECTION OF BROKERS/DEALERS. Portfolio managers may be able to select or
influence the selection of the brokers and dealers that are used to execute
securities transactions for the funds and/or accounts that they supervise. In
addition to executing trades, some brokers and dealers provide portfolio
managers with brokerage and research services (as those terms are defined in
Section 28(e) of the Securities Exchange Act of 1934), which may result in the
payment of higher brokerage fees than might otherwise be available. These
services may be more beneficial to certain funds or accounts than to others.
Although the payment of brokerage commissions is subject to the requirement that
the portfolio manager determine in good faith that the commissions are
reasonable in relation to the value of the brokerage and research services
provided to the fund, a portfolio manager's decision as to the selection of
brokers and dealers could yield disproportionate costs and benefits among the
funds and/or accounts that he or she manages.

PERFORMANCE FEES. A portfolio manager may advise certain accounts with respect
to which the advisory fee is based entirely or partially on performance.
Performance fee arrangements may create a conflict of interest for the portfolio
manager in that the manager may have an incentive to allocate the investment
opportunities that he or she believes might be the most profitable to accounts
with a heavily performance-oriented basis of portfolio manager compensation.

COMPENSATION -- The Investment Manager's portfolio managers are compensated with
a combination of three components:

BASE COMPENSATION. A portfolio manager's base compensation is reviewed and fixed
annually. The Investment Manager seeks to maintain base salary ranges at the
median salary ranges of its national peer group (banks, insurance companies and
mutual fund companies) by utilizing national surveys of financial services and
investment management markets to identify market practices regarding salary
levels to assist in developing portfolio manager compensation and performance
expectation benchmarks. Total cash compensation is targeted at the market median
using a combination of base compensation and annual incentive plans.

ANNUAL INCENTIVE. A portfolio manager may be paid an annual discretionary
incentive based on short-term corporate performance, business unit performance,
and individual performance. Portfolio managers may also participate in an annual
incentive plan which is determined at the beginning of each calendar year to
establish performance criteria. A plan may include a variety of individual and
group measures that combine quantitative and qualitative criteria.

Generally, portfolio managers incentive plans are based on the complexity of the
funds they manage and their direct impact on investment management results.
Plans include a target and maximum opportunity level based on a percentage of
base compensation. Plans vary from targets of 40% of base compensation to a
maximum of 125%.

A plan may include a variety of individual and group measures that combine
quantitative and qualitative criteria. Factors used in the computation of annual
incentive plans are assigned weights. Factors are not required to be weighted
equally for all portfolio managers. Calculation of a portfolio manager's
incentive is formula-driven based on factor weight, annual incentive target and
maximum opportunity levels, and past performance against established performance
criteria. The result is then measured against the portfolio manager's target
performance after factoring in the manager's performance above threshold
performance expectations, his or her maximum opportunity level target percentage
and factor weights. A significant portion of the incentive bonus awarded is
based upon the one-year, three-year and five-year pre-tax gross performance of
the portfolio manager's accounts relative to the performance of the appropriate
Lipper peer group.

Also factored into portfolio managers compensation is a corporate performance
measure of net income growth relative to the Investment Manager's corporate
incentive plan. All participants in the Investment Manager's annual incentive
plan have at least 20% of their annual incentive tied to corporate performance.
Further, business unit measures measure one or more elements of performance for
an operating unit, department, or segment of the company. Business unit measure
weights may vary from 5% to 15%, depending the duties of the portfolio manager.

LONG TERM INCENTIVE, DEFERRED COMPENSATION AND PENSION AND RETIREMENT PLANS.
Portfolio managers who are at the vice president or higher level are eligible
for the Investment Manager's long-term incentive, deferred compensation and
retirement and pension plans. Under the long-term incentive plan, awards are
made based on corporate performance over the long-term and are not tied to the
performance of individual funds. The deferred compensation plan allows eligible
participants to defer all or a designated portion of their annual and long-term
incentive awards. The Investment Manager's retirement and pension plan is open
to all eligible employees and is not specifically designed or administered for
portfolio managers.

DISTRIBUTOR

The Distributor, a Kansas corporation and wholly owned subsidiary of Security
Benefit Group ("SBG), serves as the principal underwriter for shares of the Fund
pursuant to a Distribution Agreement. The Distributor acts in such capacity on a
best-efforts basis, and offers shares of the Fund on a continuous basis. The
Distributor also acts as principal underwriter for Security Income Fund,
Security Equity Fund, Security Large Cap Value Fund, Security Mid Cap Growth
Fund, Security Municipal Bond Fund and SBL Fund. The Distributor receives a
maximum commission on sales of Class A shares of 3.50% and allows a maximum
discount of 3% from the offering price to authorized dealers on the Fund shares
sold. The discount is the same for all dealers, but the Distributor at its
discretion may increase the discount for specific periods. Salespersons employed
by dealers may also be licensed to sell insurance with Security Benefit Life.
For the fiscal years ended September 30, 2002, 2003 and 2004, the Distributor
(i) received gross underwriting commissions on Class A shares, (ii) retained net
underwriting commissions on Class A shares, and (iii) received contingent
deferred sales charges on redemptions of Class B and Class C shares in the
amounts set forth in the tables below.

======================================================================
2004 2003 2002
----------------------------------------------------------------------
Gross Underwriting Commissions $249,761 $207,920 $130,018
Net Underwriting Commissions 160,828 34,442 (26,288)
Compensation on Redemptions 151,545 94,579 48,219
======================================================================

The Distributor, on behalf of the Fund, may act as a broker in the purchase and
sale of securities, provided that any such transactions and any commissions
shall comply with requirements of the 1940 Act and all rules and regulations of
the SEC. The Distributor has not acted as a broker.

The Fund's Distribution Agreement is renewable annually either by its Board of
Directors or by the vote of a majority of the Fund's outstanding securities,
and, in either event, by a majority of the board who are not parties to the
contract or interested persons of any such party. The contract may be terminated
by either party upon 60 days' written notice.

ADMINISTRATOR AND TRANSFER AGENT

Pursuant to a Fund Accounting and Administration Agreement with Security Income
Fund, dated February 1, 2004, Security Management Company, LLC acts as the
administrative agent for the Fund and as such performs administrative functions
and the bookkeeping, accounting and pricing function for the Fund. For these
services, SMC receives 0.09% of the Fund's average daily net assets, or $25,000
per year, whichever is greater. The fee is calculated daily and payable monthly.

Under a Transfer Agency Agreement dated February 1, 2004, SMC also performs the
transfer agency function for the Fund. As such, SMC performs all shareholder
servicing functions, mailing shareholder communications and acting as dividend
disbursing agent. For these services, SMC receives the following fees:

1. Account Set-Up Charge - A fee of $4 to open an account on SMC's transfer
agency system to hold shares of the Fund.

2. Annual Maintenance Charge - An annual per account fee of (i) $8 per open
account for regular accounts; (ii) $6.50 per open account with respect to
accounts which are Matrix Level III pursuant to the National Securities
Clearing Corporation networking systems; and (iii) $5 per account for closed
accounts that remain outstanding on the Administrator's transfer agency
system (regardless of whether such accounts are regular or Matrix Level
III).

3. Transaction Charge - A per transaction charge of (i) $1.10 per transaction
for regular accounts; and (ii) $0.60 per transaction for accounts that are
Matrix Level III.

The Fund is also subject to a minimum fee per year of $25,000. In addition, the
Fund has agreed to reimburse SMC for expenses SMC pays to third-party
administrators, broker-dealers, banks, insurance companies or other entities for
providing sub-transfer agency services to beneficial shareholders in the Fund
where such shares are held in an omnibus account.

During the fiscal years ended September 30, 2004, September 30, 2003, and
September 30, 2002, the Fund paid (under a prior Fund Accounting and
Administration Agreement and Transfer Agency Agreement with SMC) the following
amounts to SMC for the services noted above.

================================================================================
2004 2003 2002
--------------------------------------------------------------------------------
Administrative service
fees paid to Administrator $513,522 $473,982 $305,235
--------------------------------------------------------------------------------
Transfer Agency service
fees paid to Administrator 505,940 321,862 103,176
--------------------------------------------------------------------------------
Reimbursement of expenses by Administrator --- --- ---
================================================================================

For the fiscal years ended September 30, 2004, September 30, 2003, and September
30, 2002, Investment Company Capital Corp. ("ICCC"), an indirect wholly owned
subsidiary of Deutsche Bank, N.A., or its affiliate, Bankers Trust Company,
earned $1,319,427, $907,875, and $266,592, respectively, as compensation for
administrative and other services provided to the Fund.

Pursuant to a separate Management Services Agreement, SMC formerly performed
certain other services on behalf of the Fund when it operated as a feeder fund.
Under this Agreement, SMC provided feeder fund management and administrative
services to the Fund which included monitoring the performance of the Portfolio,
coordinating the Fund's relationship with the Portfolio, communicating with the
Fund's Board of Directors and shareholders regarding the Portfolio's performance
and the Fund's two tier structure, and in general, assisting the Board of
Directors of the Fund in all aspects of the administration and operation of the
Fund. For these services, the Fund paid SMC a fee at the annual rate of 0.05% of
its average daily net assets, calculated daily and payable monthly. Prior to
November 17, 2004, this fee was 0.20% of average daily net assets.

For the fiscal years ended September 30, 2004 and September 30, 2003, the fees
paid pursuant to the Management Services Agreement with SMC were $1,098,161 and
$1,053,282, respectively.

CODE OF ETHICS

The Fund, the Investment Manager, and the Fund's Distributor have each adopted
codes of ethics under rule 17j-1 under the 1940 Act. Board members, officers of
the Fund and employees of the Investment Manager and distributor are permitted
to make personal securities transactions, including transactions in securities
that may be purchased or held by the Fund, subject to requirements and
restrictions set forth in the applicable Code of Ethics. The Investment
Manager's Code of Ethics contains provisions and requirements designed to
identify and address certain conflicts of interest between personal investment
activities and the interests of the Fund. Among other things, the Investment
Manager's Code of Ethics prohibits certain types of transactions absent prior
approval, imposes time periods during which personal transactions may not be
made in certain securities, and requires the submission of duplicate broker
confirmations and quarterly reporting of securities transactions. Additional
restrictions apply to portfolio managers, traders, research analysts and others
involved in the investment advisory process. Exceptions to these and other
provisions of the Investment Manager's Code of Ethics may be granted in
particular circumstances after review by appropriate personnel.

PROXY VOTING

The Board of Directors of the Fund has delegated to the Investment Manager the
final authority and responsibility for voting proxies with respect to the Fund's
underlying securities holdings.

The Investment Manager may retain outside consultants for analyses of issues and
to act as voting agent. General voting guidelines are followed for routine
matters of corporate governance. The Investment Manager generally will vote in
accordance with corporate management's recommendations on matters such as
uncontested director nominees unless such nominees have poor records,
ratification of accountants, changing corporate names and similar matters, and
against management's recommendations on matters such as proposals which would
reduce the rights or options of shareholders, reduce the value of shareholders'
investments, poison pills or provisions requiring supermajority approval of
mergers and other matters that are designed to limit the ability of shareholders
to approve merger transactions. Other matters, such as finance, merger,
acquisition and restructuring proposals, shareholder proposals and proposals to
ratify or cancel golden or tin parachutes, may be evaluated on a case-by-case
basis, and the Investment Manager may vote for or against corporate management's
recommendations on such matters. The Investment Manager will monitor situations
that may result in a potential conflict of interest, in particular between the
Fund's shareholders and the Investment Manager or any of its affiliates or an
affiliate of the Fund. In case of a conflict, the Investment Manager has adopted
procedures to ensure that the vote made is in the best interest of the Fund and
its shareholders.

The Fund is required to file SEC Form N-PX, with its complete proxy voting
records for the 12 months ended June 30, no later than August 31 of each year.
Once filed, the Form will be available without charge: (1) from the Fund, upon
request by calling 1-800-888-2461; and (2) on the SEC's website at www.sec.gov.

CUSTODIAN

UMB Bank, N.A. 928 Grand Avenue, Kansas City, Missouri 64106 serves as Custodian
for the Fund and as such, holds all the Fund's assets.

INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The firm of Ernst & Young LLP, 200 Clarendon Street, Boston, Massachusetts,
02116, has been selected by the Fund to serve as the Fund's independent
registered public accounting firm, and as such, will perform the annual audit of
the Fund's financial statements.

ORGANIZATION OF SECURITY INCOME FUND

Security Income Fund was organized as a Kansas corporation on April 20, 1965 and
is registered with the SEC as an investment company. Such registration does not
involve supervision by the SEC of the management or policies of the Fund.

The Articles of Incorporation of Security Income Fund provides for the issuance
of shares of common stock in one or more classes or series.

Security Income Fund has authorized the issuance of an indefinite number of
shares of capital stock of $1.00 par value and currently issues its shares in
four series, Diversified Income Fund, High Yield Fund, Income Opportunity Fund,
and Capital Preservation Fund. The shares of each Fund of Security Income Fund
represent a pro rata beneficial interest in that Fund's net assets and in the
earnings and profits or losses derived from the investment of such assets.

Each series of Security Income Fund currently issues three classes of shares.
Each class of shares participates proportionately, based on its relative NAV, in
dividends and distributions and has equal voting, liquidation and other rights
except that (i) expenses related to the distribution of each class of shares or
other expenses that the Board of Directors may designate as class expenses from
time to time, are borne solely by each class; (ii) each class of shares has
exclusive voting rights with respect to any Distribution Plan adopted for that
class; (iii) each class has different exchange privileges; and (iv) each class
has a different designation. When issued and paid for, the shares of each series
of Security Income Fund will be fully paid and nonassessable. Shares may be
exchanged as described under "Exchange Privilege," in the Prospectus but will
have no other preference, conversion, exchange or preemptive rights. Shares are
transferable, redeemable and assignable and have cumulative voting privileges
for the election of directors.

On certain matters, such as the election of directors, all shares of the series
of Security Income Fund vote together with each share having one vote. Under
certain circumstances, the shareholders of one series of Security Income Fund
could control the outcome of these votes. On other matters affecting a
particular series, such as the investment advisory contract or the fundamental
policies, only shares of that series are entitled to vote, and a majority vote
of the shares of that series is required for approval of the proposal.

Security Income Fund does not generally hold annual meetings of shareholders and
will do so only when required by law. Shareholders may remove directors from
office by vote cast in person or by proxy at a meeting of shareholders. Such a
meeting will be called at the written request of 10% of Security Income Fund's
outstanding shares.

DIVIDENDS AND TAXES

The following summarizes certain federal income tax considerations generally
affecting the Fund and its shareholders. No attempt is made to present a
detailed explanation of the tax treatment of the Fund or its shareholders, and
the discussion here is not intended as a substitute for careful tax planning.
The discussion is based upon present provisions of the Code, the regulations
promulgated thereunder, and judicial and administrative ruling authorities, all
of which are subject to change, which change may be retroactive. Prospective
investors should consult their own tax advisors with regard to the federal tax
consequences of the purchase, ownership, and disposition of Fund shares, as well
as the tax consequences arising under the laws of any state, foreign country, or
other taxing jurisdiction.

The Fund intends to qualify annually and to elect to be treated as a regulated
investment company under the Internal Revenue Code of 1986, as amended (the
"Code"). To qualify as a regulated investment company, the Fund must, among
other things: (i) derive in each taxable year at least 90% of its gross income
from dividends, interest, payments with respect to certain securities loans, and
gains from the sale or other disposition of stock, securities or foreign
currencies, or other income derived with respect to its business of investing in
such stock, securities, or currencies ("Qualifying Income Test"); (ii) diversify
its holdings so that, at the end of each quarter of the taxable year, (a) at
least 50% of the market value of the Fund's assets is represented by cash, cash
items, U.S. Government securities, the securities of other regulated investment
companies, and other securities, with such other securities of any one issuer
limited for the purposes of this calculation to an amount not greater than 5% of
the value of the Fund's total assets and 10% of the outstanding voting
securities of such issuer, and (b) not more than 25% of the value of its total
assets is invested in the securities of any one issuer (other than U.S.
Government securities or the securities of other regulated investment
companies), or of two or more issuers which the Fund controls (as that term is
defined in the relevant provisions of the Code) and which are determined to be
engaged in the same or similar trades or businesses or related trades or
businesses; and (iii) distribute at least 90% of the sum of its investment
company taxable income (which includes, among other items, dividends, interest,
and net short-term capital gains in excess of any net long-term capital losses)
and its net tax-exempt interest each taxable year. The Treasury Department is
authorized to promulgate regulations under which foreign currency gains would
constitute qualifying income for purposes of the Qualifying Income Test only if
such gains are directly related to investing in securities (or options and
futures with respect to securities). To date, no such regulations have been
issued.

Assuming that the Fund qualifies as a regulated investment company, it generally
will not be subject to U.S. federal income tax on its investment company taxable
income and net capital gains (any net long-term capital gains in excess of the
net short-term capital losses), if any, that it distributes to shareholders. The
Fund intends to distribute to its shareholders, at least annually, substantially
all of its investment company taxable income and any net capital gains.

Generally, regulated investment companies, like the Fund, must distribute
amounts on a timely basis in accordance with a calendar year distribution
requirement in order to avoid a nondeductible 4% excise tax. Generally, to avoid
the tax, a regulated investment company must distribute during each calendar
year, (i) at least 98% of its ordinary income (not taking into account any
capital gains or losses) for the calendar year, (ii) at least 98% of its capital
gains in excess of its capital losses (adjusted for certain ordinary losses) for
the 12-month period ending on October 31 of the calendar year, and (iii) all
ordinary income and capital gains for previous years that were not distributed
during such years. To avoid application of the excise tax, the Fund intends to
make its distributions in accordance with the calendar year distribution
requirement. A distribution, including an "exempt-interest dividend," will be
treated as paid on December 31 of the calendar year if it is declared by the
Fund in October, November or December of that year to shareholders of record on
a date in such a month and paid by the Fund during January of the following
calendar year. Such distributions are taxable to shareholders in the calendar
year in which the distributions are declared, rather than the calendar year in
which the distributions are received.

If the Fund were unable to distribute an amount equal to substantially all of
its investment company taxable income (as determined for U.S. tax purposes)
within applicable time periods, the Fund would not qualify for the favorable
federal income tax treatment afforded regulated investment companies, or, even
if it did so qualify, it might become liable for federal taxes on undistributed
income. In addition, the ability of the Fund to obtain timely and accurate
information relating to its investments is a significant factor in complying
with the requirements applicable to regulated investment companies in making
tax-related computations. Thus, if the Fund was unable to obtain accurate
information on a timely basis, it might be unable to qualify as a regulated
investment company, or its tax computations might be subject to revisions (which
could result in the imposition of taxes, interest and penalties).

Because Class A shares of the Fund bear most of the costs of distribution of
such shares through payment of a front-end sales charge, while Class B and Class
C shares of the Fund bear such costs through a higher distribution fee, expenses
attributable to Class B and Class C shares, generally will be higher and as a
result, distributions paid by the Fund with respect to Class B and Class C
shares generally will be lower than those paid with respect to Class A shares.
All dividends and distributions are automatically reinvested on the payable date
in shares of the Fund at NAV, as of the record date (reduced by an amount equal
to the amount of the dividend or distribution), unless the investment manager is
previously notified in writing by the shareholder that such dividends or
distributions are to be received in cash. A shareholder may request that such
dividends or distributions be directly deposited to the shareholder's bank
account. A shareholder who elected not to reinvest dividends or distributions
paid with respect to Class A shares may, at any time within 30 days after the
payment date, reinvest the dividend check without imposition of a sales charge.

The Fund will not pay dividends or distributions of less than $25 in cash but
will automatically reinvest them. Distributions of net investment income and any
short-term capital gains are taxable as ordinary income whether received in cash
or reinvested in additional shares. Such dividends generally do not qualify for
the dividends-received deduction for corporations.

The excess of net long-term capital gains over short-term capital losses
realized and distributed by the Fund or reinvested in Fund shares will generally
be taxable to shareholders as long-term capital gain. Net capital gains from
assets held for one year or less will be taxed as ordinary income. Distributions
will be subject to these capital gains rates regardless of how long a
shareholder has held Fund shares. Advice as to the tax status of each year's
dividends and distributions will be mailed annually.

Current tax law generally provides for a maximum tax rate for individual
taxpayers of 15% on long-term capital gains and on certain qualifying dividend
income. The rate reductions do not apply to corporate taxpayers or to foreign
shareholders. The Fund will be able to separately designate distributions of any
qualifying long-term capital gains or qualifying dividends earned by the Fund
that would be eligible for the lower maximum rate. A shareholder would also have
to satisfy a more than 60-day holding period with respect to any distributions
of qualifying dividends in order to obtain the benefit of the lower rate.
Distributions from income derived from interest on bonds and other debt
instruments will not generally qualify for the lower rates. Further, because
many companies in which the Fund invests do not pay significant dividends on its
stock, the Fund may not derive significant amounts of qualifying dividend income
that would be eligible for the lower rate on qualifying dividends.

Upon redemption, sale or exchange of Fund shares, shareholders will realize gain
or loss depending upon the shareholders' basis in their shares. Such gain or
loss will be capital gain or loss if the shares are capital assets in the
shareholder's hands, and will be taxable to shareholders as long-term capital
gains if the shares had been held for more than one year at the time of sale or
redemption. Net capital gains on shares held for less than one year will be
taxable to shareholders at the same rates as ordinary income. Investors should
be aware that any loss realized upon the sale, exchange or redemption of shares
held for six months or less will be treated as a long-term capital loss to the
extent of any distribution of long-term capital gain to the shareholder with
respect to such shares. In addition, any loss realized on a sale, exchange or
redemption of shares will be disallowed to the extent the shares disposed of are
replaced within a period of 61 days, beginning 30 days before and ending 30 days
after the date the shares are disposed of, such as pursuant to the reinvestment
of dividends. In such case, the basis of the shares acquired will be adjusted to
reflect the disallowed loss.

Under certain circumstances, the sales charge incurred in acquiring Class A
shares of the Fund may not be taken into account in determining the gain or loss
on the disposition of those shares. This rule applies in circumstances when
shares of the Fund are exchanged within 90 days after the date they were
purchased and new shares in a regulated investment company are acquired without
a sales charge or at a reduced sales charge. In that case, the gain or loss
recognized on the exchange will be determined by excluding from the tax basis of
the shares exchanged all or a portion of the sales charge incurred in acquiring
those shares. This exclusion applies to the extent that the otherwise applicable
sales charge with respect to the newly acquired shares is reduced as a result of
having incurred the sales charge initially. Instead, the portion of the sales
charge affected by this rule will be treated as an amount paid for the new
shares.

The fund generally will be required to withhold federal income tax at a rate of
28% ("backup withholding") from dividends paid (other than exempt-interest
dividends), capital gain distributions and redemption proceeds to shareholders
if (1) the shareholder fails to furnish the applicable Fund with the
shareholder's correct taxpayer identification number or social security number;
(2) the IRS notifies the shareholder or the applicable Fund that the shareholder
has failed to report properly certain interest and dividend income to the IRS
and to respond to notices to that effect; or (3) when required to do so, the
shareholder fails to certify that he or she is not subject to backup
withholding. Any amounts withheld may be credited against the shareholder's
federal income tax liability.

A purchase of shares shortly before payment of a dividend or distribution would
be disadvantageous because the dividend or distribution to the purchaser would
have the effect of reducing the per share NAV of his or her shares by the amount
of the dividends or distributions. In addition all or a portion of such
dividends or distributions, although in effect a return of capital, are subject
to taxes, which may be at ordinary income tax rates.

OPTIONS, FUTURES AND FORWARD CONTRACTS AND SWAP AGREEMENTS -- Certain options,
futures contracts, and forward contracts in which the Fund may invest may be
"Section 1256 contracts." Gains or losses on Section 1256 contracts generally
are considered 60% long-term and 40% short-term capital gains or losses;
however, foreign currency gains or losses arising from certain Section 1256
contracts may be treated as ordinary income or loss. Also, Section 1256
contracts held by the Fund at the end of each taxable year (and at certain other
times as prescribed pursuant to the Code) are "marked to market" with the result
that unrealized gains or losses are treated as though they were realized.

Generally, the hedging transactions undertaken by the Fund may result in
"straddles" for U.S. federal income tax purposes. The straddle rules may affect
the character of gains (or losses) realized by the Fund. In addition, losses
realized by the Fund on positions that are part of a straddle may be deferred
under the straddle rules, rather than being taken into account in calculating
the taxable income for the taxable year in which such losses are realized.
Certain carrying charges (including interest expense) associated with positions
in a straddle may be required to be capitalized rather than deducted currently.
Because only a few regulations implementing the straddle rules have been
promulgated, the tax consequences of transactions in options, futures, forward
contracts, swap agreements and other financial contracts to the Fund are not
entirely clear. The transactions may increase the amount of short-term capital
gain realized by the Fund which is taxed as ordinary income when distributed to
shareholders.

The Fund may make one or more of the elections available under the Code which
are applicable to straddles. If the Fund makes any of the elections, the amount,
character and timing of the recognition of gains or losses from the affected
straddle positions will be determined under rules that vary according to the
election(s) made. The rules applicable under certain of the elections may
operate to accelerate the recognition of gains or losses from the affected
straddle positions.

Because application of the straddle rules may affect the character of gains or
losses, defer losses and/or accelerate the recognition of gains or losses from
the affected straddle positions, the amount which must be distributed to
shareholders, and which will be taxed to shareholders as ordinary income or
long-term capital gain, may be increased or decreased as compared to a fund that
did not engage in such hedging transactions.

Because only a few regulations regarding the treatment of swap agreements, and
related caps, floors and collars, have been implemented, the tax consequences of
such transactions are not entirely clear. The Fund intends to account for such
transactions in a manner deemed by it to be appropriate, but the Internal
Revenue Service might not necessarily accept such treatment. If it did not, the
status of the Fund as a regulated investment company might be affected.

The requirements applicable to the Fund's qualification as a regulated
investment company may limit the extent to which the Fund will be able to engage
in transactions in options, futures contracts, forward contracts, swap
agreements and other financial contracts.

Certain hedging activities may cause a dividend that would otherwise be subject
to the lower tax rate applicable to a "qualifying dividend," to instead be taxed
as the rate of tax applicable to ordinary income.

MARKET DISCOUNT -- If the Fund purchases a debt security at a price lower than
the stated redemption price of such debt security, the excess of the stated
redemption price over the purchase price is "market discount." If the amount of
market discount is more than a de minimis amount, a portion of such market
discount must be included as ordinary income (not capital gain) by the Fund in
each taxable year in which the Fund owns an interest in such debt security and
receives a principal payment on it. In particular, the Fund will be required to
allocate that principal payment first to the portion of the market discount on
the debt security that has accrued but has not previously been includable in
income. In general, the amount of market discount that must be included for each
period is equal to the lesser of (i) the amount of market discount accruing
during such period (plus any accrued market discount for prior periods not
previously taken into account) or (ii) the amount of the principal payment with
respect to such period. Generally, market discount accrues on a daily basis for
each day the debt security is held by the Fund at a constant rate over the time
remaining to the debt security's maturity or, at the election of the Fund, at a
constant yield to maturity which takes into account the semi-annual compounding
of interest. Gain realized on the disposition of a market discount obligation
must be recognized as ordinary interest income (not capital gain) to the extent
of the "accrued market discount."

ORIGINAL ISSUE DISCOUNT -- Certain debt securities acquired by the Fund may be
treated as debt securities that were originally issued at a discount. Very
generally, original issue discount is defined as the difference between the
price at which a security was issued and its stated redemption price at
maturity. Although no cash income on account of such discount is actually
received by the Fund, original issue discount that accrues on a debt security in
a given year generally is treated for federal income tax purposes as interest
and, therefore, such income would be subject to the distribution requirements
applicable to regulated investment companies.

Some debt securities may be purchased by the Fund at a discount that exceeds the
original issue discount on such debt securities, if any. This additional
discount represents market discount for federal income tax purposes (see above).

CONSTRUCTIVE SALES -- Under certain circumstances the Fund may recognize gain
from a constructive sale of an "appreciated financial position" it holds if it
enters into a short sale, forward contract or other transaction that
substantially reduces the risk of loss with respect to the appreciated position.
In that event, the Fund would be treated as if it had sold and immediately
repurchased the property and would be taxed on any gain (but not loss) from the
constructive sale. The character of gain from a constructive sale would depend
upon the Fund's holding period in the property. Loss from a constructive sale
would be recognized when the property was subsequently disposed of, and its
character would depend on the Fund's holding period and the application of
various loss deferral provisions of the Code. Constructive sale treatment does
not apply to transactions if such transaction is closed before the end of the
30th day after the close of the Fund's taxable year and the Fund holds the
appreciated financial position throughout the 60-day period beginning with the
day such transaction was closed, if certain conditions are met.

FOREIGN TAXATION -- Income received by the Fund from sources within a foreign
country may be subject to withholding and other taxes imposed by that country.
Tax conventions between certain countries and the U.S. may reduce or eliminate
such taxes. The payment of such taxes will reduce the amount of dividends and
distributions paid to the Fund's shareholders.

Furthermore, the amount of the foreign tax credit that is available may be
limited to the extent that dividends from a foreign corporation qualify for the
lower tax rate on "qualifying dividends."

NEW TAX LEGISLATION -- Pursuant to recently passed tax legislation, a regulated
investment company (a "RIC") such as the Fund that earns certain interest income
that would not be subject to U.S. tax if earned by a foreign person directly
will be permitted, to the extent of such income, to designate a dividend it pays
as derived from such interest income. A foreign person who is a shareholder in
the RIC generally will treat such a dividend as exempt from gross-basis U.S.
tax, as if the foreign person had earned the interest directly.

Similarly, a RIC that earns an excess of net short-term capital gains over net
long-term capital losses, which excess would not be subject to U.S. tax if
earned by a foreign person, generally may, to the extent of such excess,
designate a dividend it pays as derived from such excess. A foreign person who
is a shareholder in the RIC generally will treat such a dividend as exempt from
gross-basis U.S. tax, as if the foreign person had realized the excess directly.

The new law also provides that the estate of a foreign decedent is exempt from
U.S. estate tax on a transfer of stock in the RIC in the proportion that the
assets held by the RIC are debt obligations, deposits, or other property that
will generally be treated as situated outside the United States if held directly
by the estate.

The new law generally applies to dividends with respect to taxable years of RICs
beginning after December 31, 2004 and before January 1, 2008. With respect to
the treatment of a RIC for estate tax purposes, the new law applies to estates
of decedents dying after December 31, 2004 and before January 1, 2008.

OTHER TAXES -- The foregoing discussion is general in nature and is not intended
to provide an exhaustive presentation of the tax consequences of investing in
the Fund. Distributions may also be subject to additional state, local and
foreign taxes, depending on each shareholder's particular situation. Depending
upon the nature and extent of the Fund's contacts with a state or local
jurisdiction, the Fund may be subject to the tax laws of such jurisdiction if it
is regarded under applicable law as doing business in, or as having income
derived from, the jurisdiction. Shareholders are advised to consult their own
tax advisers with respect to the particular tax consequences to them of an
investment in the Fund.

ALLOCATION OF PORTFOLIO BROKERAGE

Transactions in portfolio securities shall be effected in such manner as deemed
to be in the best interest of each respective Fund. In reaching a judgment
relative to the qualifications of a broker or dealer to obtain the best
execution of a particular transaction, all relevant factors and circumstances
will be taken into account by the Investment Manager, including consideration of
the overall reasonableness of commissions paid to a broker, the firm's general
execution and operational capabilities, its responsiveness (which includes such
things as the willingness of the broker to commit capital and how accommodative
the brokers representatives are), and its reliability and financial condition.
The Fund does not anticipate that it will incur a significant amount of
brokerage commissions because fixed income securities are generally traded on a
"net" basis--that is, in principal amount without the addition or deduction of a
stated brokerage commission, although the net price usually includes a profit to
the dealer. The Fund will deal directly with the selling or purchasing principal
without incurring charges for the services of a broker on its behalf unless it
is determined that a better price or execution may be obtained by utilizing the
services of a broker. The Fund also may purchase portfolio securities in
underwritings where the price includes a fixed underwriter's concession or
discount. Money market instruments may be purchased directly from the issuer at
no commission or discount.

Portfolio transactions that require a broker may be directed to brokers who
furnish investment information or research services to the Investment Manager.
Such investment information and research services include advice as to the value
of securities, the advisability of investing in, purchasing or selling
securities and the availability of securities and purchasers or sellers of
securities, and furnishing analyses and reports concerning issues, industries,
securities, economic factors and trends, portfolio strategy, and performance of
accounts. Such investment information and research services may be furnished by
brokers in many ways, including: (1) on-line data base systems, the equipment
for which is provided by the broker, that enable registrant to have real-time
access to market information, including quotations; (2) economic research
services, such as publications, chart services and advice from economists
concerning macroeconomic information; and (3) analytical investment information
concerning particular corporations. If a transaction is directed to a broker
supplying such information or services, the transaction charges (i.e., a
commission or a charge that is deemed to be the equivalent of a commission) paid
for such transaction may be in excess of the transaction charges another broker
would have charged for effecting that transaction, provided that the Investment
Manager shall have determined in good faith that the transaction charges are
reasonable in relation to the value of the investment information or the
research services provided, viewed in terms of either that particular
transaction or the overall responsibilities of the Investment Manager with
respect to all accounts as to which it exercises investment discretion. The
Investment Manager may use all, none, or some of such information and services
in providing investment advisory services to each of the mutual funds under its
management, including the Funds.

In some cases, the computer and other equipment furnished by the broker may have
additional uses that are not related to the investment services and research
information. In such cases, the Investment Manager must allocate the value of
the computer and other equipment into research and non-research categories.
Since that portion allocable to research can be paid from Fund brokerage
commissions rather than being paid by the Investment Manager, the Investment
Manager will have a conflict of interest in making the allocation. Finally, the
investment services or research information provided to the Investment Manager
may be produced by parties other than the broker effecting the portfolio
transaction.

In addition, brokerage transactions may be placed with broker/dealers who sell
shares of the Fund managed by the Investment Manager who may or may not provide
investment information and research services.

The Fund may buy securities from, or sell securities to, dealers acting as
principals or market makers. Except as noted below, the Investment Manager
generally will not obtain investment information or research services in
connection with such principal transactions. The Investment Manager, however,
may obtain investment information or research services in connection with
riskless principal transactions that are reported pursuant to certain NASD rules
that ensure transparency as to security price and transaction charges, or in
connection with transactions in other markets having regulations that ensure
comparable transparency of security prices and charges. In addition, the
Investment Manager may purchase investment information or research services in
connection with investments in underwritten fixed price offerings consistent
with the so-called "Papilisky" rules of the NASD.

Securities held by the Fund may also be held by other investment advisory
clients of the Investment Manager, including other investment companies. In
addition, the Investment Manager's parent company, SBL, may also hold some of
the same securities as the Funds. When selecting securities for purchase or sale
for a Fund, the Investment Manager may at the same time be purchasing or selling
the same securities for one or more of such other accounts. Subject to the
Investment Manager's obligation to seek best execution, such purchases or sales
may be executed simultaneously or "bunched." It is the policy of the Investment
Manager not to favor one account over the other. Any purchase or sale orders
executed simultaneously (which may also include orders from SBL)are allocated at
the average price and as nearly as practicable on a pro rata basis (transaction
costs will also generally be shared on a pro rata basis) in proportion to the
amounts desired to be purchased or sold by each account. In those instances
where it is not practical to allocate purchase or sale orders on a pro rata
basis, then the allocation will be made on a rotating or other equitable basis.
While it is conceivable that in certain instances this procedure could adversely
affect the price or number of shares involved in the Fund's transaction, it is
believed that the procedure generally contributes to better overall execution of
the Fund's portfolio transactions. The Board of Directors of the Fund has
adopted guidelines governing this procedure and will monitor the procedure to
determine that the guidelines are being followed and that the procedure
continues to be in the best interest of the Fund and its shareholders. With
respect to the allocation of initial public offerings ("IPOs"), the Investment
Manager may determine not to purchase such offerings for certain of its clients
(including investment company clients) due to the limited number of shares
typically available to the Investment Manager.

For the years ended September 30, 2002, September 30, 2003, and September 30,
2004, the Portfolio paid brokerage commissions in the amount of $81,162,
$247,160, and $410,987, respectively.

The Fund is required to identify any securities of its "regular brokers or
dealers" (as such term is defined in the 1940 Act) which the Fund has acquired
during its most recent fiscal year. As of September 30, 2004, the Portfolio held
the following securities of its regular brokers or dealers:

==========================================================
VALUE OF SECURITIES
NAME OF REGULAR BROKER OR OWNED AS OF
DEALER OR PARENT (ISSUER) SEPTEMBER 30, 2004
----------------------------------------------------------
Citigroup Inc. $ 3,364,682
Bank of America Corp. $ 6,822,142
Nomura Asset Securities Corp. $ 6,573,931
Goldman Sachs Group, Inc. $ 1,129,300
Bank One Corp. $ 8,502,395
Wachovia Corp. $ 1,629,449
Credit Suisse First Boston USA, Inc. $17,402,513
Morgan Stanley Dean Witter & Co. $35,062,782
Suntrust Banks, Inc. $ 2,446,740
Bank of New York, Inc. $ 2,303,844
Toronto Dominion Bank $ 1,651,739
Barclays Bank plc $ 1,156,820
PNC Funding Corp. $16,215,632
First Union National Bank $36,993,686
==========================================================

PORTFOLIO TURNOVER -- Portfolio turnover rate measures the frequency that the
Fund sells and replaces the value of its securities within a given period. A
100% annual turnover rate would occur, for example, if all portfolio securities
(excluding short-term obligations) were replaced once in a period of one year,
or if 10% of the portfolio securities were replaced ten times in one year. The
rate of portfolio turnover of the Fund may exceed that of certain other mutual
funds with the same investment objectives. The amount of brokerage commissions
and taxes on realized capital gains to be borne by the shareholders of the Fund
tend to increase as the level of portfolio activity increases.

PERFORMANCE INFORMATION

STANDARD PERFORMANCE INFORMATION -- From time to time, quotations of the Fund's
performance may be included in advertisements, sales literature or shareholder
reports. These performance figures are calculated in the following manner:

YIELD. Yield refers to the income generated by an investment over a given period
of time, expressed as an annual percentage rate. Yields are calculated according
to a standard that is required for all stock and bond mutual funds. Because this
differs from other accounting methods, the quoted yield may not equal the income
actually paid to shareholders.

Per SEC regulations, the yield of the Fund (the "SEC yield") shall be calculated
on any determination date as follows:

2{[(a - b)/(c * d) + 1]^6 - 1}

where a = current income measured over a 30-day period.

b = Expenses accrued during the same 30-day period.

c = Average daily number of shares outstanding during the same 30-day
period.

d = Maximum offering price per share on the last day of the period.

The "annual effective yield" of the fund is intended to represent one day's
investment income expressed as an annualized yield and compounded annually. It
shall be expressed as a percentage and calculated on each business day as
follows based on the dividend declared for the previous day.

[ (previous day's dividend factor)]^365
[1 + (------------------------------)] - 1
[ ( NAV per share )]

Example: If on March 1, the Fund's dividend factor is 0.00174163 and the Fund's
NAV per share is $10, then the Fund's annual effective yield for March 2 equals
6.56%.

Performance information or advertisements may include comparisons of the Fund's
investment results to various unmanaged indices or results of other mutual funds
or investment or savings vehicles. From time to time, the Fund's ranking may be
quoted from various sources, such as Lipper Analytical Services, Inc., Value
Line, Inc. and Morningstar, Inc.

Unlike some bank deposits or other investments that pay a fixed yield for a
stated period of time, the total return of the Shares will vary depending upon
interest rates, the current market value of the securities held by the Fund and
changes in the expenses of the Shares and the Fund. In addition, during certain
periods for which total return may be provided, SMC may have voluntarily agreed
to waive portions of its fees, or to reimburse certain operating expenses of the
Fund , on a month-to-month basis. Such waivers will have the effect of
increasing the Fund's net income (and therefore its yield and total return)
during the period such waivers are in effect.

TOTAL RETURN. Total return is the change in value of an investment in the shares
over a given period, assuming reinvestment of any dividends and capital gain
distributions. A cumulative total return reflects actual performance over a
stated period of time. An average annual total return is a hypothetical rate of
return that, if achieved annually, would have produced the same cumulative total
return if performance had been constant over the entire period. Average annual
total return calculations smooth out variations in performance; they are not the
same as actual year-by-year results. Average annual total returns covering
periods of less than one year assume that performance will remain constant for
the rest of the year.

The Fund's average annual total return is calculated for certain periods by
determining the average annual compounded rates of return over those periods
that would cause an investment of $1,000 (made at the maximum public offering
price with all distributions reinvested) to reach the value of that investment
at the end of the periods. The Fund may also calculate total return figures that
represent aggregate performance over a period or year-by-year performance.

PERFORMANCE RESULTS. Any performance information provided for the Fund should
not be considered as representative of its performance in the future, because
the NAV and public offering price of Shares will vary based not only on the
type, quality and maturities of the securities held by the Fund but also on
changes in the current value of such securities and on changes in the expenses
of the Fund. Total return reflects the performance of both principal and income.

Unless noted otherwise, the Fund's total return and average annual total return
will reflect deduction of the maximum initial sales load in the case of Class A
shares or the applicable deferred sales charge in the case of Class B and Class
C shares. From time to time the Fund may include performance information in
advertisements and sales literature without deduction of the sales charge,
which, if deducted, would reduce the performance data quoted.

Investors should note that the performance of the Fund before November 17, 2004,
was obtained while the Fund had a different investment objective and investment
strategies, and different fees and expenses.

COMPARISON OF FUND PERFORMANCE -- Comparison of the quoted non-standardized
performance of various investments is valid only if performance is calculated in
the same manner. Since there are different methods of calculating performance,
investors should consider the effect of the methods used to calculate
performance when comparing performance of the Fund with performance quoted with
respect to other investment companies or types of investments.

FINANCIAL STATEMENTS

The financial statements for the Fund and the Portfolio for the fiscal year
ended September 30, 2004, and the fiscal six-month period ended March 31, 2005
are incorporated herein by reference to the September 30, 2004 Annual Report and
March 31, 2005 Semi-Annual Report to shareholders. Copies of the Fund's Annual
Report and Semi-Annual Report are provided to every person requesting the
Statement of Additional Information.

APPENDIX A

DESCRIPTION OF MOODY'S CORPORATE BOND RATINGS

Aaa -- Bonds rated Aaa are judged to be of the best quality. They carry the
smallest degree of investment risk and are generally referred to as "gilt edge."
Interest payments are protected by a large or by an exceptionally stable margin
and principal is secure. While the various protective elements are likely to
change, such changes as can be visualized are most unlikely to impair the
fundamentally strong position of such issues.

Aa -- Bonds rated Aa are judged to be of high quality by all standards. Together
with the Aaa group they comprise what are generally known as high-grade bonds.
They are rated lower than the best bonds because margins of protection may not
be as large as in Aaa securities or fluctuation of protective elements may be of
greater amplitude or there may be other elements present which make the
long-term risks appear somewhat larger than in Aaa securities.

A -- Bonds rated A possess many favorable investment attributes and are to be
considered as upper-medium-grade obligations. Factors giving security to
principal and interest are considered adequate but elements may be present which
suggest a susceptibility to impairment sometime in the future.

Baa -- Bonds rated Baa are considered as medium-grade obligations, i.e. they are
neither highly protected nor poorly secured. Interest payments and principal
security appear adequate for the present but certain protective elements may be
lacking or may be characteristically unreliable over any great length of time.
Such, bonds lack outstanding investment characteristics and in fact have
speculative characteristics as well.

Ba -- Bonds rated Ba are judged to have speculative elements. Their future
cannot be considered as well assured. Often the protection of interest and
principal payments may be very moderate and thereby not well safeguarded during
both (good and bad times over the future). Uncertainty of position characterizes
bonds in this class.

B -- Bonds rated B generally lack characteristics of a desirable investment.
Assurance of interest and principal payments or of maintenance of other terms of
the contract over any long period of time may be small.

Caa -- Bonds rated Caa are of poor standing. Such issues may be in default or
there may be present elements of danger with respect to principal or interest.

Ca -- Bonds rated Ca represent obligations which are speculative in a high
degree. Such issues are often in default or have other marked short-comings.

C -- Bonds rated C are the lowest-rated class of bonds and issued so rated can
be regarded as having extremely poor prospects of ever attaining any real
investment standing.

Moody's applies numerical modifiers, 1, 2, and 3, in each generic rating
classification from Aa through B in its corporate bond system. The modifier 1
indicates that the security ranks in the higher end of its generic rating
category; the modifier 2 indicates a mid-range ranking; and the modifier 3
indicates that the issue ranks in the lower end of its generic rating category.

DESCRIPTION OF S&P'S CORPORATE BOND RATINGS

AAA -- Debt rated AAA has the highest rating assigned by Standard & Poor's to a
debt obligation. Capacity to pay interest and repay principal is extremely
strong.

AA -- Debt rated AA has a very strong capacity to pay interest and repay
principal and differs from the higher-rated issues only in small degree.

A -- Debt rated A has a strong capacity to pay interest and repay principal,
although it is somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions.

BBB -- Debt rated BBB is regarded as having an adequate capacity to pay interest
and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to weakened capacity to pay interest and repay principal for debt
in this category than in higher-rated categories.

BB -- Debt rate BB has less near-term vulnerability to default than other
speculative issues. However, it faces major ongoing uncertainties or exposure to
adverse business, financial, or economic conditions which could lead to
inadequate capacity to meet timely interest and principal payments.

B -- Debt rated B has a greater vulnerability to default but currently has the
capacity to meet interest payments and principal repayments. Adverse business,
financial, or economic conditions will likely impair capacity or willingness to
pay interest and repay principal. The B rating category is also used for debt
subordinated to senior debt that is assigned an actual or implied BB- rating.

CCC -- Debt rated CCC has a currently identifiable vulnerability to default, and
is dependent upon favorable business, financial, and economic conditions to meet
timely payment of interest and repayment of principal. In the event of adverse
business, financial, or economic conditions, it is not likely to have the
capacity to pay interest and repay principal.

CC -- Debt rated CC is typically applied to debt subordinated to senior debt
which is assigned an actual or implied CCC debt rating.

C -- The rating C is typically applied to debt subordinated to senior debt which
is assigned an actual or implied CCC- debt rating. The C rating may be used to
cover a situation where a bankruptcy petition has been filed but debt service
payments are continued.

CI -- The rating CI is reserved for income bonds on which no interest is being
paid.

D -- Debt rated D is in payment default. The D rating category is used when
interest payments or principal payments are not made on the date due even if the
applicable grace period has not expired, unless S&P believes that such payments
will be made during such grace period. The D rating will also be used upon the
filing of a bankruptcy petition if debt service payments are jeopardized.

Plus (+) or minus (-): The ratings from "AA" to "CCC" may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.

FITCH'S LONG-TERM DEBT RATINGS

INVESTMENT GRADE

AAA (HIGHEST CREDIT QUALITY) -- 'AAA' ratings denote the lowest expectation of
credit risk. They are assigned only in case of exceptionally strong capacity for
timely payment of financial commitments. This capacity is highly unlikely to be
adversely affected by foreseeable events.

AA (VERY HIGH CREDIT QUALITY) -- 'AA' ratings denote a very low expectation of
credit risk. They indicate very strong capacity for timely payment of financial
commitments. This capacity is not significantly vulnerable to foreseeable
events.

A (HIGH CREDIT QUALITY) -- 'A' ratings denote a low expectation of credit risk.
The capacity for timely payment of financial commitments is considered strong.
This capacity may, nevertheless, be more vulnerable to changes in circumstances
or in economic conditions than is the case for higher ratings.

BBB (GOOD CREDIT QUALITY) -- 'BBB' ratings indicate that there is currently a
low expectation of credit risk. The capacity for timely payment of financial
commitments is considered adequate, but adverse changes in circumstances and in
economic conditions are more likely to impair this capacity. This is the lowest
investment-grade category.

SPECULATIVE GRADE

BB (SPECULATIVE) -- 'BB' ratings indicate that there is a possibility of credit
risk developing, particularly as the result of adverse economic change over
time; however, business or financial alternatives may be available to allow
financial commitments to be met. Securities rated in this category are not
investment grade.

B (HIGHLY SPECULATIVE) -- 'B' ratings indicate that significant credit risk is
present, but a limited margin of safety remains. Financial commitments are
currently being met; however, capacity for continued payment is contingent upon
a sustained, favorable business and economic environment.

CCC, CC, C (HIGH DEFAULT RISK) -- Default is a real possibility. Capacity for
meeting financial commitments is solely reliant upon sustained, favorable
business or economic developments. A 'CC' rating indicates that default of some
kind appears probable. 'C' ratings signal imminent default.

DDD, DD, D (DEFAULT) -- The ratings of obligations in this category are based on
their prospects for achieving partial or full recovery in a reorganization or
liquidation of the obligor. While expected recovery values are highly
speculative and cannot be estimated with any precision, the following serve as
general guidelines. 'DDD' obligations have the highest potential for recovery,
around 90%-100% of outstanding amounts and accrued interest. 'DD' indicates
potential recoveries in the range of 50%-90% and 'D' the lowest recovery
potential, i.e., below 50%.

Entities rated in this category have defaulted on some or all of their
obligations. Entities rated 'DDD' have the highest prospect for resumption of
performance or continued operation with or without a formal reorganization
process. Entities rated 'DD' and 'D' are generally undergoing a formal
reorganization or liquidation process; those rated 'DD' are likely to satisfy a
higher portion of their outstanding obligations, while entities rated 'D' have a
poor prospect of repaying all obligations.

NOTES -- "+" or "-" may be appended to a rating to denote relative status within
major rating categories. Such suffixes are not added to the 'AAA' category or to
categories below 'CCC'.

'NR' indicates that Fitch Ratings does not publicly rate the issuer or issue in
question.

'Withdrawn': A rating is withdrawn when Fitch Ratings deems the amount of
information available to be inadequate for rating purposes, or when an
obligation matures, is called, or refinanced.

Rating Watch: Ratings are placed on Rating Watch to notify investors that there
is a reasonable probability of a rating change and the likely direction of such
change. These are designated as "Positive," indicating a potential upgrade,
"Negative," for a potential downgrade, or "Evolving," if ratings may be raised,
lowered or maintained. Rating Watch is typically resolved over a relatively
short period.

A Rating Outlook indicates the direction a rating is likely to move over a one
to two-year period. Outlooks may be positive, stable, or negative. A positive or
negative Rating Outlook does not imply a rating change is inevitable. Similarly,
ratings for which outlooks are "stable" could be upgraded or downgraded before
an outlook moves to positive or negative if circumstances warrant such an
action. Occasionally, Fitch may be unable to identify the fundamental trend and
in these cases, the Rating Outlook may be described as "evolving."

DESCRIPTION OF MOODY'S SHORT-TERM DEBT RATINGS

Issuers rated PRIME-1 (or related supporting institutions) have a superior
capacity for repayment of short-term promissory obligations. Prime-1 repayment
capacity will normally be evidenced by the following characteristics: leasing
market positions in well-established industries; high rates of return on funds
employed; conservative capitalization structures with moderate reliance on debt
and ample asset protection; broad margins in earnings coverage of fixed
financial charges and high internal cash generation; well-established access to
a range of financial markets and assured sources of alternate liquidity.

Issuers rated PRIME-2 (or related supporting institutions) have a strong
capacity for repayment of short-term promissory obligations. This will normally
be evidenced by many of the characteristics cited above but to a lesser degree.
Earnings trends and coverage ratios, while sound, will be more subject to
variation. Capitalization characteristics, while still appropriate, may be more
affected by external conditions. Ample alternate liquidity is maintained.

Issuers rated PRIME-3 (or related supporting institutions) have an acceptable
capacity for repayment of short-term promissory obligations. The effect of
industry characteristics and market composition may be more pronounced.
Variability in earnings and profitability may result in changes in the level of
debt protection measurements and the requirement for relatively high financial
leverage. Adequate alternate liquidity is maintained.

DESCRIPTION OF S&P SHORT-TERM ISSUER CREDIT RATINGS

A-1 -- An obligor rated `A-1' has STRONG capacity to meet its financial
commitments. It is rated in the highest category by Standard & Poor's. Within
this category, certain obligors are designated with a plus sign (+). This
indicates that the obligor's capacity to meet its financial commitments is
EXTREMELY STRONG.

A-2 -- An obligor rated `A-2' has SATISFACTORY capacity to meet its financial
commitments. However, it is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than obligors in the highest
rating category.

A-3 -- An obligor rated `A-3' has ADEQUATE capacity to meet its financial
obligations. However, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity of the obligor to meet its financial
commitments.

DESCRIPTION OF FITCH'S COMMERCIAL PAPER RATINGS

F1 (HIGHEST CREDIT QUALITY) -- Indicates the strongest capacity for timely
payment of financial commitments; may have an added "+" to denote any
exceptionally strong credit feature.

F2 (GOOD CREDIT QUALITY) -- A satisfactory capacity for timely payment of
financial commitments, but the margin of safety is not as great as in the case
of the higher ratings.

F3 (FAIR CREDIT QUALITY) -- The capacity for timely payment of financial
commitments is adequate; however, near-term adverse changes could result in a
reduction to non-investment grade.

B (SPECULATIVE) -- Minimal capacity for timely payment of financial commitments,
plus vulnerability to near-term adverse changes in financial and economic
conditions.

C (HIGH DEFAULT RISK) -- Default is a real possibility. Capacity for meeting
financial commitments is solely reliant upon a sustained, favorable business and
economic environment.

D (DEFAULT) -- Denotes actual or imminent payment default.

NOTES -- "+" or "-" may be appended to an 'F1' rating class to denote relative
status within the category.

'NR' indicates that Fitch Ratings does not publicly rate the issuer or issue in
question.

'Withdrawn': A rating is withdrawn when Fitch Ratings deems the amount of
information available to be inadequate for rating purposes, or when an
obligation matures, is called, or refinanced.

DESCRIPTION OF MOODY'S INSURANCE FINANCIAL STRENGTH RATINGS

Aaa -- Insurance companies rated Aaa offer exceptional financial security. While
the financial strength of these companies is likely to change, such changes as
can be visualized are most unlikely to impair their fundamentally strong
position.

Aa -- Insurance companies rated Aa offer excellent financial security. Together
with the Aaa group they constitute what are generally known as high grade
companies. They are rated lower than Aaa companies because long-term risks
appear somewhat larger.

A -- Insurance companies rated A offer good financial security. However,
elements may be present which suggest a susceptibility to impairment sometime in
the future.

Baa -- Insurance companies rated Baa offer adequate financial security. However,
certain protective elements may be lacking or may be characteristically
unreliable over any great length of time.

Ba -- Insurance companies rated Ba offer questionable financial security. Often
the ability of these companies to meet policyholder obligations maybe very
moderate and thereby not well safeguarded in the future.

B -- Insurance companies rated B offer poor financial security. Assurance of
punctual payment of policyholder obligations over any long period of time is
small.

Caa -- Insurance companies rated Caa offer very poor financial security. They
may be in default on their policyholder obligations or there may be present
elements of danger with respect to punctual payment of policyholder obligations
and claims.

Ca -- Insurance companies rated Ca offer extremely poor financial security. Such
companies are often in default on their policyholder obligations or have other
marked shortcomings.

C -- Insurance companies rated C are the lowest rated class of insurance company
and can be regarded as having extremely poor prospects of ever offering
financial security.

Numeric modifiers: Numeric modifiers are used to refer to the ranking within the
group -- one being the highest and three being the lowest. However, the
financial strength of companies within a generic rating symbol (Aa, for example)
is broadly the same.

DESCRIPTION OF S&P CLAIMS PAYING ABILITY RATING DEFINITIONS

SECURE RANGE -- AAA to BBB

"AAA" -- Superior financial security on an absolute and relative basis. Capacity
to meet policyholder obligations is overwhelming under a variety of economic and
underwriting conditions.

"AA" -- Excellent financial security. Capacity to meet policyholder obligations
is strong under a variety of economic and underwriting conditions.

"A" -- Good financial security, but capacity to meet policyholder obligations is
somewhat susceptible to adverse economic and underwriting conditions.

"BBB" -- Adequate financial security, but capacity to meet policyholder
obligations is susceptible to adverse economic and underwriting conditions.

VULNERABLE RANGE -- BB to CCC

"BB" -- Financial security may be adequate, but capacity to meet policyholder
obligations, particularly with respect to long-term or "long-tail" policies, is
vulnerable to adverse economic and underwriting conditions.

"B" -- Vulnerable financial security. Currently able to meet policyholder
obligations, but capacity to meet policyholder obligations is particularly
vulnerable to adverse economic and underwriting conditions.

"CCC" -- Extremely vulnerable financial security. Continued capacity to meet
policyholder obligations is highly questionable unless favorable economic and
underwriting conditions prevail.

"R" -- Regulatory action. As of the date indicated, the insurer is under
supervision of insurance regulators following rehabilitation, receivership,
liquidation, or any other action that reflects regulatory concern about the
insurer's financial condition. Information on this status is provided by the
National Association of Insurance Commissioners and other regulatory bodies.
Although believed to be accurate, this information is not guaranteed. The "R"
rating does not apply to insurers subject only to nonfinancial actions such as
market conduct violations.

Plus (+) or minus (-) Ratings from "AA" to "B" may be modified by the addition
of a plus or minus sign to show relative standing within the major rating
categories.

FITCH'S INSURANCE FINANCIAL STRENGTH RATINGS:

AAA (EXCEPTIONALLY STRONG) -- Insurers assigned this highest rating are viewed
as possessing exceptionally strong capacity to meet policyholder and contract
obligations. For such companies, risk factors are minimal and the impact of any
adverse business and economic factors is expected to be extremely small.

AA (VERY STRONG) -- Insurers are viewed as possessing very strong capacity to
meet policyholder and contract obligations. Risk factors are modest, and the
impact of any adverse business and economic factors is expected to be very
small.

A (STRONG) -- Insurers are viewed as possessing strong capacity to meet
policyholder and contract obligations. Risk factors are moderate, and the impact
of any adverse business and economic factors is expected to be small.

BBB (GOOD) -- Insurers are viewed as possessing good capacity to meet
policyholder and contract obligations. Risk factors are somewhat high, and the
impact of any adverse business and economic factors is expected to be material,
yet manageable.

BB (MODERATELY WEAK) -- Insurers are viewed as moderately weak with an uncertain
capacity to meet policyholder and contract obligations. Though positive factors
are present, overall risk factors are high, and the impact of any adverse
business and economic factors is expected to be significant.

B (WEAK) -- Insurers are viewed as weak with a poor capacity to meet
policyholder and contract obligations. Risk factors are very high, and the
impact of any adverse business and economic factors is expected to be very
significant.

CCC, CC, C (VERY WEAK) -- Insurers rated in any of these three categories are
viewed as very weak with a very poor capacity to meet policyholder and contract
obligations. Risk factors are extremely high, and the impact of any adverse
business and economic factors is expected to be insurmountable. A 'CC' rating
indicates that some form of insolvency or liquidity impairment appears probable.
A 'C' rating signals that insolvency or a liquidity impairment appears imminent.

DDD, DD, D (DISTRESSED) -- These ratings are assigned to insurers that have
either failed to make payments on their obligations in a timely manner, are
deemed to be insolvent, or have been subjected to some form of regulatory
intervention. Within the 'DDD'-'D' range, those companies rated 'DDD' have the
highest prospects for resumption of business operations or, if liquidated or
wound down, of having a vast majority of their obligations to policyholders and
contract holders ultimately paid off, though on a delayed basis (with recoveries
expected in the range of 90%-100%). Those rated 'DD' show a much lower
likelihood of ultimately paying off material amounts of their obligations in a
liquidation or wind down scenario (in a range of 50%-90%). Those rated 'D' are
ultimately expected to have very limited liquid assets available to fund
obligations, and therefore any ultimate payoffs would be quite modest (at under
50%).

NOTES -- "+" or "-" may be appended to a rating to indicate the relative
position of a credit within the rating category. Such suffixes are not added to
ratings in the 'AAA' category or to ratings below the 'CCC' category.

Ratings of 'BBB-` and higher are considered to be "secure," and those of 'BB+'
and lower are considered to be "vulnerable."

A Rating Outlook indicates the direction a rating is likely to move over a one
to two-year period. Outlooks may be positive, stable or negative. A positive or
negative Rating Outlook does not imply a rating change is inevitable. Similarly,
ratings for which outlooks are "stable" could be upgraded or downgraded before
an outlook moves to positive or negative if circumstances warrant such an
action. Occasionally, Fitch Ratings may be unable to identify the fundamental
trend, and in these cases, the Rating Outlook may be described as "evolving."