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Deficient management leads INDITEX on the verge of fail BUCHAREST, ROMANIA - Zara wants to cover losses from theft with employees’ money. The management, theft and losses give headaches to the Spanish group INDITEX, the owner of the ZARA chain. Only 10 months before, on July 25th, 2011, the publication Ziarul Financiar announced the fact that “INDITEX takes the manager from the Douglas perfumeries” pointing at Paul Cuza, who previously had the function of General Manager for Parfumerie Douglas SRL. Currently, the Romanian INDITEX group performs salary and structural changes without precedent, which the management team from Bucharest doesn’t want to explain. The problem of the clothes theft is a known phenomenon, especially when it comes to expensive brands such as ZARA or Massimo Dutti. The phenomenon was publicly recognized even by the management of the INDITEX Group Romania, two years before. Probably worried by this fact, Mihai Cioltea, the development manager of the INDITEX Group from Romania, also named by the press as “the Zara man”, stated in 2010 for the economic website InCont the following: “They steal a lot. Only for the stores in Bucharest we have 10 cases of stealing per day, which we discover and, depending on the severity, we call the police”.[...] Read the rest of the article... |
We respect intellectual property rights and will take appropriate steps to protect these rights. 1933 Act Registration No. 333-49910
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Form N-14AE
REGISTRATION STATEMENT UNDER THE
[ ] Pre-Effective [X] Post-Effective
MET INVESTORS SERIES TRUST
Area Code and Telephone Number: (800)848-3854
610 Newport Center Drive
Newport Beach, California 92660
(Address of Principal Executive Offices)
Elizabeth M. Forget
Met Investors Series Trust
Suite 1350
Newport Beach, California 92660 (Name and Address of Agent for Service)
Copies of All Correspondence to:
It is proposed that this filing will become effective:
[X] immediately on filing pursuant to paragraph (b)
SECURITY FIRST TRUST 11365 West Olympic Boulevard Los Angeles, CA 90064 December 15, 2000 Dear Contract Owner: As an Owner of a variable annuity contract or variable life insurance policy (the "Contract") issued by Security First Life Insurance Company (the "Insurance Company"), you have the right to instruct the Insurance Company how to vote certain shares of the Neuberger Berman Bond Series (the "Portfolio") of Security First Trust (the "Trust") at a Special Meeting of Shareholders to be held on January 26, 2001. Although you are not directly a shareholder of the Portfolio, some or all of your Contract value is invested, as provided by your Contract, in the Portfolio. Accordingly, you have the right under your Contract to instruct the Insurance Company how to vote the Portfolio's shares that are attributable to your Contract at the Special Meeting. Before the Special Meeting, I would like your vote on the important proposal described in the accompanying Prospectus/Proxy Statement. The Prospectus/Proxy Statement describes the proposed reorganization of the Trust's Neuberger Berman Bond Series. All of the assets of the Portfolio would be acquired by a new series of Met Investors Series Trust, the J.P. Morgan Quality Bond Portfolio, in exchange for shares of such new series and the assumption by the series of the identified liabilities of the Portfolio. The new series' investment objective and policies will be similar to those of the Portfolio. In addition, as described in the Prospectus/Proxy Statement, a portfolio of another affiliated investment company is proposed to be merged into the new series of Met Investors Series Trust. You will receive Class A shares of the new series having an aggregate net asset value equal to the aggregate net asset value of your Portfolio's shares. Details about the new series' investment objective, performance, and management team are contained in the attached Prospectus/Proxy Statement. For federal income tax purposes, the transaction is expected to be a non-taxable event for shareholders and Owners. The Board of Trustees has approved the proposal for the Portfolio and recommends that you vote FOR the proposal. I realize that this Prospectus/Proxy Statement will take time to review, but your vote is very important. Please take the time to familiarize yourself with the proposal. If you attend the meeting, you may give your voting instructions in person. If you do not expect to attend the meeting, please complete, date, sign and return the enclosed voting instructions form in the enclosed postage-paid envelope. You may also fax your completed and signed voting instructions form (both front and back sides) to us at 1- 888-796-9932, or vote through the Internet. Instructions on how to complete the voting instructions form or vote through the Internet are included immediately after the Notice of Special Meeting. If you have any questions about the voting instructions form please call the Security First Trust at 1-800- 421-3794. If we do not receive your completed voting instructions form or your Internet vote within several weeks, you may be contacted by ALAMO Direct, our proxy solicitor, who will remind you to pass on your voting instructions. Thank you for taking this matter seriously and participating in this important process. Sincerely, Richard C. Pearson President Security First Trust COVA SERIES TRUST One Tower Lane Suite 3000 Oakbrook Terrace, Illinois 60181 December 15, 2000 Dear Contract Owner: As an Owner of a variable annuity contract or variable life insurance policy (the "Contract") issued by Cova Financial Services Life Insurance Company, Cova Financial Life Insurance Company, or First Cova Life Insurance Company (the "Insurance Companies"), you have the right to instruct the Insurance Companies how to vote certain shares of the Quality Bond Portfolio (the "Portfolio") of Cova Series Trust (the "Trust") at a Special Meeting of Shareholders to be held on January 26, 2001. Although you are not directly a shareholder of the Portfolio, some or all of your Contract value is invested, as provided by your Contract, in the Portfolio. Accordingly, you have the right under your Contract to instruct the Insurance Companies how to vote the Portfolio's shares that are attributable to your Contract at the Special Meeting. Before the Special Meeting, I would like your vote on the important proposal described in the accompanying Prospectus/Proxy Statement. The Prospectus/Proxy Statement describes the proposed reorganization of the Trust's Quality Bond Portfolio. All of the assets of the Portfolio would be acquired by a new series of Met Investors Series Trust, the J.P. Morgan Quality Bond Portfolio, in exchange for shares of such new series and the assumption by the series of the identified liabilities of the Portfolio. The new series' investment objective and policies will be substantially identical to those of the Trust's Quality Bond Portfolio. In addition, as described in the Prospectus/Proxy Statement, a portfolio of another affiliated investment company is proposed to be merged into the new series of Met Investors Series Trust. You will receive Class A shares of the new series having an aggregate net asset value equal to the aggregate net asset value of your Portfolio's shares. Details about the new series' investment objective, performance, and management team are contained in the attached Prospectus/Proxy Statement. For federal income tax purposes, the transaction is expected to be a non-taxable event for shareholders and Owners. The Board of Trustees has approved the proposal for the Portfolio and recommends that you vote FOR the proposal. I realize that this Prospectus/Proxy Statement will take time to review, but your vote is very important. Please take the time to familiarize yourself with the proposal. If you attend the meeting, you may give your voting instructions in person. If you do not expect to attend the meeting, please complete, date, sign and return the enclosed voting instructions form in the enclosed postage-paid envelope. You may also fax your completed and signed voting instructions form (both front and back sides) to us at 1- 888-796-9932, or vote through the Internet. Instructions on how to complete the voting instructions form or vote through the Internet are included immediately after the Notice of Special Meeting. If you have any questions about the voting instructions form please call the Portfolio at 1-800- 343-8496. If we do not receive your completed voting instructions form or your Internet vote within several weeks, you may be contacted by ALAMO Direct, our proxy solicitor, who will remind you to pass on your voting instructions. Thank you for taking this matter seriously and participating in this important process. Sincerely, Mark E. Reynolds President Cova Series Trust SECURITY FIRST TRUST
11365 West Olympic Boulevard
Neuberger Berman Bond Series
NOTICE OF SPECIAL MEETING OF SHAREHOLDERS
To the Shareholders of Security First Trust: NOTICE IS HEREBY GIVEN THAT a Special Meeting of the Shareholders of the Neuberger Berman Bond Series of Security First Trust (the "Trust"), a Massachusetts business trust, will be held at the offices of Met Investors Series Trust, 610 Newport Center Drive, Suite 1350, Newport Beach, California 92660 on January 26, 2001 at 10:30 a.m. Pacific Time and any adjournments thereof (collectively, the "Special Meeting") for the following purpose: To consider and act upon an Agreement and Plan of Reorganization (the "Plan") providing for the acquisition of all of the assets of Neuberger Berman Bond Series by J.P. Morgan Quality Bond Portfolio ("Met JPM Quality Bond" ), a series of Met Investors Series Trust, in exchange for shares of Met JPM Quality Bond and the assumption by Met JPM Quality Bond of the identified liabilities of Neuberger Berman Bond Series. The Plan also provides for distribution of these shares of Met JPM Quality Bond to shareholders of Neuberger Berman Bond Series in liquidation and subsequent termination of Neuberger Berman Bond Series. A vote in favor of the Plan is a vote in favor of the liquidation and dissolution of Neuberger Berman Bond Series. The Board of Trustees has fixed the close of business on November 27, 2000 as the record date for determination of shareholders entitled to notice of and to vote at the Special Meeting. By order of the Board of Trustees
Cheryl J. Finney
December 15, 2000
CONTRACT OWNERS WHO DO NOT EXPECT TO ATTEND THE SPECIAL MEETING ARE REQUESTED TO COMPLETE, SIGN, DATE AND RETURN THE ACCOMPANYING VOTING INSTRUCTIONS FORM IN THE ENCLOSED ENVELOPE, WHICH NEEDS NO POSTAGE IF MAILED IN THE UNITED STATES, OR FOLLOW THE INSTRUCTIONS IN THE MATERIALS RELATING TO INTERNET VOTING. INSTRUCTIONS FOR THE PROPER EXECUTION OF THE VOTING INSTRUCTIONS FORM ARE SET FORTH IMMEDIATELY FOLLOWING THIS NOTICE. IT IS IMPORTANT THAT THE FORM BE RETURNED PROMPTLY. COVA SERIES TRUST
One Tower Lane
Quality Bond Portfolio
NOTICE OF SPECIAL MEETING OF SHAREHOLDERS
To the Shareholders of Cova Series Trust: NOTICE IS HEREBY GIVEN THAT a Special Meeting of the Shareholders of the Quality Bond Portfolio of Cova Series Trust (the "Trust"), a Massachusetts business trust, will be held at the offices of Met Investors Series Trust, 610 Newport Center Drive, Suite 1350, Newport Beach, California 92660 on January 26, 2001 at 10:00 a.m. Pacific Time and any adjournments thereof (collectively, the "Special Meeting") for the following purpose: To consider and act upon an Agreement and Plan of Reorganization (the "Plan") providing for the acquisition of all of the assets of Quality Bond Portfolio by J. P. Morgan Quality Bond Portfolio ("Met JPM Quality Bond"), a series of Met Investors Series Trust, in exchange for shares of Met JPM Quality Bond and the assumption by Met JPM Quality Bond of the identified liabilities of Quality Bond Portfolio. The Plan also provides for distribution of these shares of Met JPM Quality Bond to shareholders of Quality Bond Portfolio in liquidation and subsequent termination of Quality Bond Portfolio. A vote in favor of the Plan is a vote in favor of the liquidation and dissolution of Quality Bond Portfolio. The Board of Trustees has fixed the close of business on November 27, 2000 as the record date for determination of shareholders entitled to notice of and to vote at the Special Meeting. By order of the Board of Trustees
Bernard J. Spaulding
December 15, 2000
CONTRACT OWNERS WHO DO NOT EXPECT TO ATTEND THE SPECIAL MEETING ARE REQUESTED TO COMPLETE, SIGN, DATE AND RETURN THE ACCOMPANYING VOTING INSTRUCTIONS FORM IN THE ENCLOSED ENVELOPE, WHICH NEEDS NO POSTAGE IF MAILED IN THE UNITED STATES, OR FOLLOW THE INSTRUCTIONS IN THE MATERIALS RELATING TO INTERNET VOTING. INSTRUCTIONS FOR THE PROPER EXECUTION OF THE VOTING INSTRUCTIONS FORM ARE SET FORTH IMMEDIATELY FOLLOWING THIS NOTICE. IT IS IMPORTANT THAT THE FORM BE RETURNED PROMPTLY. INSTRUCTIONS FOR SIGNING VOTING INSTRUCTIONS FORM The following general rules for signing voting instructions forms may be of assistance to you and avoid the time and expense to the Trust involved in validating your vote if you fail to sign your voting instructions form properly. 1. Individual Accounts: Sign your name exactly as it appears in the registration on the voting instructions form. 2. Joint Accounts: Either party may sign, but the name of the party signing should conform exactly to the name shown in the registration on the voting instructions form. 3. All Other Accounts: The capacity of the individual signing the voting instructions form should be indicated unless it is reflected in the form of registration. For example: Registration Valid Signature Corporate Accounts
Trust Accounts
Custodial or Estate Accounts
INSTRUCTIONS FOR VOTING OVER THE INTERNET To vote your voting instructions form via the Internet follow the four easy steps below. 1. Read the accompanying proxy information and voting instructions form. 2. Go to https://vote.proxy-direct.com. 3. Enter the 14 - digit "CONTROL NO." from the middle of your voting instructions form. 4. Follow the simple online instructions. You do not need to return your voting instructions form if you vote via an Internet site. ACQUISITION OF ASSETS OF
QUALITY BOND PORTFOLIO
(800) 343-8496 and
NEUBERGER BERMAN BOND SERIES
(800) 421-3794 BY AND IN EXCHANGE FOR SHARES OF
J.P. MORGAN QUALITY BOND PORTFOLIO
PROSPECTUS/PROXY STATEMENT DATED DECEMBER 15, 2000
This Prospectus/Proxy Statement is being furnished in connection with
proposed Agreements and Plans of Reorganization (each a "Plan" and collectively,
the "Plans") which will be submitted to shareholders of Quality Bond Portfolio
GENERAL The Boards of Trustees of Cova Series Trust and Security First Trust have respectively approved the proposed reorganizations of the Cova Portfolio and the SF Portfolio into J.P. Morgan Quality Bond Portfolio, a series of Met Investors Series Trust (the "Met Portfolio"). The Portfolios involved in the proposed reorganizations are referred to in this Prospectus/Proxy Statement as follows:
Cova Series Trust and Security First Trust are each Massachusetts business trusts and Met Investors Series Trust is a recently organized Delaware business trust. The Met Portfolio is a new series organized specifically to receive all the assets and carry on the business of Cova Quality Bond, into which, effectively, SF Bond will be merged. The Cova Portfolio, the SF Portfolio and the Met Portfolio are sometimes referred to in this Prospectus/Proxy Statement individually as a "Portfolio" and collectively as the "Portfolios". Cova Financial Services Life Insurance Company and its affiliated insurance companies are the record owners of the Cova Portfolio's shares and at the Meeting will vote the shares of the Cova Portfolio held in their applicable separate accounts. Security First Life Insurance Company is the record owner of substantially all of the SF Portfolio's shares and at the Meeting will vote the shares of the SF Portfolio held in its separate account. Cova Financial Services Life Insurance Company, its affiliated insurance companies and Security First Life Insurance Company are collectively referred to as the "Insurance Companies". The Insurance Companies are indirect wholly-owned subsidiaries of Metropolitan Life Insurance Company ("MetLife"), a New York life insurance company and a leading provider of insurance and financial products and services to individual and group customers. As an owner of a variable annuity contract or a variable life insurance policy (a "Contract") issued by an Insurance Company, you have the right to instruct the respective Insurance Company how to vote the shares of the Cova Portfolio or the SF Portfolio that are attributable to your Contract at the Meeting. Although you are not directly a shareholder of the Portfolios, you have this right because some or all of your Contract value is invested, as provided by your Contract, in the Cova Portfolio or the SF Portfolio. For simplicity, in this Prospectus/Proxy Statement: o "Record Holder" of the Cova Portfolio or the SF Portfolio refers to the Insurance Company which holds the Cova Portfolio's or SF Portfolio's shares of record; o "shares" refers generally to your shares of beneficial interest in a Portfolio; and o "shareholder" or "Contract Owner" refers to you. In the reorganizations, all of the assets of the Cova Portfolio and the SF Portfolio will be acquired by the Met Portfolio in exchange for Class A shares of the Met Portfolio and the assumption by the Met Portfolio of the identified liabilities of the Cova Portfolio and SF Portfolio (each a "Reorganization" and collectively the "Reorganizations"). If the Reorganizations are approved, Class A shares of the Met Portfolio will be distributed to the Record Holders in liquidation of the Cova Portfolio and the SF Portfolio, and the Cova Portfolio and the SF Portfolio will be terminated as a series of Cova Series Trust or Security First Trust, as applicable. You will then hold that number of full and fractional shares of the Met Portfolio which have an aggregate net asset value equal to the aggregate net asset value of your shares of the Cova Portfolio or SF Portfolio in which you currently are a shareholder. The Cova Portfolio is a separate diversified series of Cova Series Trust, an open-end management investment company registered under the Investment Company Act of 1940, as amended (the "1940 Act"). The SF Portfolio is a separate diversified series of Security First Trust, an open-end management company registered under the 1940 Act. The Met Portfolio is a separate diversified series of Met Investors Series Trust, also an open-end management investment company registered under the 1940 Act. Because Met Investors Series Trust was recently organized, it has conducted no operations to date. The investment objectives of the Cova Portfolio and the SF Portfolio are, respectively, identical to or similar to those of the Met Portfolio, and are as follows:
The investment strategies for Cova Quality Bond and for Met JPM Quality Bond are substantially identical, and the investment strategies for SF Bond are similar to those of Met JPM Quality Bond. This Prospectus/Proxy Statement explains concisely the information about the Met Portfolio that you should know before voting on a Reorganization. Please read it carefully and keep it for future reference. Additional information concerning the Met Portfolio is provided in the "Additional Information" section of this Prospectus/Proxy Statement. Additional information concerning the Cova Portfolio, the SF Portfolio and the Reorganizations is contained in the documents described below, all of which have been filed with the Securities and Exchange Commission ("SEC"):
for the year ended December 31, 1999 Semi-Annual Report of Cova Series Trust relating to Cova Quality Bond, for the six-month period ended June 30, 2000
You can also obtain copies of any of these documents without charge on
the EDGAR database on the SEC's Internet site at http://www.sec.gov. Copies are
available for a fee by electronic request at the following E-mail address:
Information relating to the Cova Portfolio and the SF Portfolio contained in the Prospectuses of Cova Series Trust dated May 1, 2000 (SEC File No. 811-5252) and the Prospectus of Security First Trust dated November 30, 2000 (SEC File No. 811-2480), respectively, is incorporated by reference in this document. (This means that such information is legally considered to be part of this Prospectus/Proxy Statement.) The Statement of Additional Information dated December 15, 2000 relating to this Prospectus/Proxy Statement and the Reorganizations, which includes the financial statements of Cova Series Trust relating to the Cova Portfolio for the year ended December 31, 1999 and the six months ended June 30, 2000, and the financial statements of Security First Trust relating to the SF Portfolio for the year ended July 31, 2000 (the Met Portfolio has not yet issued financial statements), is incorporated by reference in its entirety in this document. THE SECURITIES AND EXCHANGE COMMISSION HAS NOT DETERMINED THAT THE INFORMATION IN THIS PROSPECTUS/PROXY STATEMENT IS ACCURATE OR ADEQUATE, NOR HAS IT APPROVED OR DISAPPROVED THESE SECURITIES. ANYONE WHO TELLS YOU OTHERWISE IS COMMITTING A CRIMINAL OFFENSE. An investment in a Portfolio of Met Investors Series Trust through a Contract: o is not a deposit of, or guaranteed by, any bank o is not insured by the FDIC, the Federal Reserve Board or any other government agency o is not endorsed by any bank or government agency o involves investment risk, including possible loss of the purchase payment of your original investment TABLE OF CONTENTS Page
EXHIBIT B Management's Discussion and Analysis...................B-1 SUMMARY This section summarizes the primary features and consequences of the Reorganizations. It may not contain all of the information that is important to you. To understand the Reorganizations, you should read this entire Prospectus/Proxy Statement and the exhibits. This summary is qualified in its entirety by reference to the additional information contained elsewhere in this Prospectus/Proxy Statement, the Prospectuses and Statement of Additional Information relating to the Cova Portfolio, the Prospectus and Statement of Additional Information relating to the SF Portfolio and the forms of the Agreements and Plans of Reorganization, which are attached to this Prospectus/Proxy Statement as Exhibits A-1 and A-2. Why are the Reorganizations being proposed? The effect of the Reorganization of SF Bond is to merge the Portfolio into Cova Quality Bond, which will become a series of a Delaware business trust. Further, the Reorganizations are also part of an overall restructuring designed to provide operating efficiencies which will result from maintaining a single trust of investment portfolios to be offered in connection with the Insurance Companies' insurance products and to employee benefit plans, consistency across the entire group of those investment portfolios and the enhanced flexibility afforded by a Delaware business trust in comparison to the Cova Portfolio's and the SF Portfolio's previous form of organization. To accomplish the restructuring, the holders of beneficial interests in shares of other portfolios of Cova Series Trust and Security First Trust are also being asked to approve reorganizations of those portfolios into portfolios of Met Investors Series Trust. What are the key features of the Reorganizations? Each Plan sets forth the key features of the Reorganization to which it relates. For a complete description of the Reorganizations, see Exhibits A-1 and A-2. Each Plan generally provides for the following: o the transfer of all of the assets of the Cova Portfolio or the SF Portfolio to the Met Portfolio in exchange for Class A shares of the Met Portfolio; o the assumption by the Met Portfolio of the identified liabilities of the Cova Portfolio or the SF Portfolio, as applicable (the identified liabilities consist only of those liabilities reflected on the Cova Portfolio's or the SF Portfolio's statement of assets and liabilities determined immediately preceding the Reorganization); o the liquidation of the Cova Portfolio or the SF Portfolio by distribution of Class A shares of the Met Portfolio to the Cova Portfolio's or the SF Portfolio's shareholders, as applicable; and o the structuring of each Reorganization as a tax-free reorganization for federal income tax purposes. The Reorganizations are expected to be completed on or about February 5, 2001. After the Reorganizations, what shares of the Met Portfolio will I own? If you own shares of Cova Quality Bond or SF Bond, you will own Class A shares of Met JPM Quality Bond. The new shares you receive will have the same total value as your shares of Cova Quality Bond or SF Bond, respectively, as of the close of business on the day immediately prior to the Reorganizations. How will a Reorganization affect me? It is anticipated that the Reorganizations will benefit you as well as the Record Holders as follows: o COST SAVINGS: The operating expenses of the portfolios offered by Met Investors Series Trust may potentially decrease over the long term in comparison to those of the Cova Portfolio and the SF Portfolio due to the spreading of fixed costs over a larger pool of assets in the Met Investors Series Trust. o OPERATING EFFICIENCIES: Upon the combination of the Cova Portfolio and the SF Portfolio, operating efficiencies may be achieved by the Met Portfolio because it will have a greater level of assets. As of September 30, 2000, Cova Quality Bond's total assets were approximately $92 million, and SF Bond's total assets were approximately $25 million. o MORE INVESTMENT CHOICES: It is anticipated that on the effective date of the Reorganizations, Met Investors Series Trust will offer more investment portfolios than are currently available through Cova Series Trust or Security First Trust. Your Insurance Company may choose to make these additional portfolios available under your Contract. The Reorganizations will not affect your Contract rights. The value of your Contract will remain the same immediately following a Reorganization. Met Investors Series Trust will sell its shares on a continuous basis at net asset value only to insurance companies and to employee benefit plans that are qualified plans under federal tax law. Your Insurance Company will keep the same separate account. Your Contract values will be allocated to the same separate account and that separate account will invest in the Met Portfolio after the Reorganizations. After the Reorganizations your Contract values will depend on the performance of the Met Portfolio rather than that of your Cova Portfolio or SF Portfolio. Neither Cova Series Trust, Security First Trust nor Contract Owners will bear any costs of the Meeting, this proxy solicitation or any adjourned session. All of the costs of the Reorganizations will be paid by MetLife or one of its affiliates. Like the Cova Portfolio and the SF Portfolio, the Met Portfolio will declare and pay dividends from net investment income and will distribute net realized capital gains, if any, to the Insurance Company separate accounts (not to you) at least once a year. These dividends and distributions will continue to be reinvested by your Insurance Company in additional Class A shares of the Met Portfolio. Dividends and distributions paid on the SF Portfolio are automatically reinvested in additional shares of the Portfolio, unless a shareholder elects to have dividends and/or distributions paid in cash. How do the Trustees recommend that I vote? The Trustees of Cova Series Trust, including the Trustees who are not "interested persons" (the "Disinterested Trustees"), as such term is defined in the 1940 Act, have concluded that the Reorganization would be in the best interest of the shareholders of Cova Quality Bond, and that their interests will not be diluted as a result of the Reorganization. Accordingly, the Trustees have submitted the Plan for the approval of the shareholders of Cova Quality Bond. The Trustees of Security First Trust, including the Disinterested Trustees, have concluded that the Reorganization would be in the best interest of the shareholders of SF Bond and that their interests will not be diluted as a result of the Reorganization. Accordingly, the Trustees have submitted the Plan for the approval of the shareholders of SF Bond.
THE TRUSTEES RECOMMEND THAT YOU
The Trustees of Met Investors Series Trust have also approved the Plans on behalf of the Met Portfolio. How do the Portfolios' investment objectives, principal investment strategies and risks compare? The Met Portfolio is a new portfolio organized specifically to receive all the assets and carry on the business of Cova Quality Bond. Consequently, the investment objective of each such Portfolio is identical, and the investment strategies of each such Portfolio are substantially identical. The investment objectives of SF Bond are substantially similar to that of the Met Portfolio, and the investment strategies of such Portfolio are similar. The investment objective of the Cova Portfolio and the Met Portfolio is non-fundamental, which means that it may be changed by vote of the Trustees and without shareholder approval, while the investment objectives of the SF Portfolio are fundamental, which means that they cannot be changed without shareholder approval. The following tables summarize a comparison of the Cova Portfolio, the SF Portfolio and the Met Portfolio with respect to their investment objectives and principal investment strategies, as set forth in the Prospectuses and Statement of Additional Information relating to the Cova Portfolio, the Prospectus and Statement of Additional Information relating to the SF Portfolio, and in the "Additional Information" section of this Prospectus/Proxy Statement relating to the Met Portfolio.
The principal risks of investing in the Met Portfolio are the same as those of investing in the Cova Portfolio and are similar to those of investing in the SF Portfolio. They include: For all Portfolios: o Interest rate risk - the value of investments in debt securities or stocks purchased primarily for dividend income may decline when prevailing interest rates rise or increase when interest rates go down; due to the increasing difficulty of predicting changes in interest rates over longer periods of time, fixed income securities with longer maturities are more volatile than those with shorter maturities o Credit risk - the value of investments in debt securities may be adversely affected if an issuer fails to pay principal and interest on the obligation on a timely basis o Foreign investment risk - investments in foreign securities involve risks relating to political, social and economic developments abroad, as well as risks resulting from differences between the regulations to which U.S. and foreign issuers are subject o Mortgage-related security risk - changes in interest rates generally affect the value of a mortgage-backed security; some mortgage-backed securities may be structured so that they may be particularly sensitive to changes in interest rates; and investments in mortgage-related securities are subject to special risks if the issuer of the security prepays the principal prior to the security's maturity (including increased volatility in the price of the security and wider fluctuations in response to interest rates) o Asset-backed security risk - if non-mortgage asset-backed securities fail to pay interest or repay principal, the assets backing these securities may not be sufficient to support the payments on the securities o High yield debt security risk - high yield debt securities, or junk bonds, range from those for which the prospect for repayment of principal and interest is predominantly speculative to those which are currently in default on principal or interest payments; although these securities have a greater potential return than higher quality bonds, they may be more susceptible to market risk and credit risk because they are less secure financially and more sensitive to market downturns For Cova Quality Bond and Met JPM Quality Bond: o Emerging markets risk - investments in emerging markets include all of the risks of investments in foreign securities and are subject to severe price declines o Derivatives risk - the use of options, futures and other derivatives, although designed to hedge the Portfolio's investments against currency exposure, may not be successful and could result in losses to the Portfolio For a detailed discussion of the Portfolios' risks, see the section entitled "Risks" below. Each Portfolio may invest some or all of its assets in money market instruments or utilize other investment strategies as a temporary defensive measure during, or in anticipation of, adverse market conditions. This strategy, which would be employed only in seeking to avoid losses, is inconsistent with the Portfolios' principal investment objectives and strategies, and could result in lower returns and loss of market opportunities. The Portfolios have other investment policies, practices and restrictions which, together with their related risks, are also set forth in the Prospectuses and Statement of Additional Information relating to the Cova Portfolio, the Prospectus and Statement of Additional Information of the SF Portfolio, the "Additional Information" section below with respect to the Met Portfolio and the Statement of Additional Information relating to this Prospectus/Proxy Statement. Because the Cova Portfolio, the SF Portfolio and the Met Portfolio have either identical or similar investment objectives and identical or similar investment strategies, it is not anticipated that the securities held by the Cova Portfolio or the SF Portfolio will be sold in significant amounts in order to comply with the policies and investment practices of the Met Portfolio in connection with a Reorganization. How do other important features of the Portfolios compare? o Cova Investment Advisory Corporation is the investment adviser of the Cova Portfolio; Met Investors Advisory Corp., formerly known as Security First Investment Management Corporation, is the investment adviser to the SF Portfolio and the Manager of Met Investors Series Trust. o J.P. Morgan Investment Management Inc., the investment sub-adviser of the Cova Portfolio, serves in the same capacity with respect to the Met Portfolio pursuant to an Advisory Agreement with Met Investors Advisory Corp. and is called the Adviser of the Met Portfolio. Unlike the investment adviser to Cova Series Trust or the previous investment adviser to Security First Trust, Met Investors Advisory Corp. will have the authority, upon receipt of permission from the SEC and with the approval of the Board of Trustees of Met Investors Series Trust, to change the Met Portfolio's Adviser without shareholder approval under certain conditions. o As a result of the Reorganizations, the portfolio managers of Cova Quality Bond and the Met Portfolio will be the same. The Met Portfolio's Manager, Adviser and portfolio managers are described in more detail below. How do the Portfolios' fees and expenses compare? The Cova Portfolio and the SF Portfolio offer one class of shares. The Met Portfolio currently offers two classes of shares (Classes A and B) but Class B is not part of the Reorganizations. You will not pay any initial or deferred sales charge in connection with the Reorganizations. The following tables allow you to compare the various fees and expenses that you may pay for buying and holding shares of the Cova Portfolio and the SF Portfolio and Class A shares of the Met Portfolio. The table entitled "Met JPM Quality Bond Pro Forma" shows you what the fees and expenses are estimated to be assuming the Reorganizations take place. The amounts for shares of the Cova Portfolio and the SF Portfolio set forth in the following tables and in the examples are based on the expenses for the Cova Portfolio and the SF Portfolio for the fiscal year ended December 31, 1999 and July 31, 2000, respectively. The Met Portfolio is newly organized and has not commenced operations to date. The amounts for Class A shares of the Met Portfolio set forth in the following table and in the examples are based on what the expenses of the Met Portfolio would have been for the fiscal year ended December 31, 1999. The shares of the Cova Portfolio, the SF Portfolio and the Class A shares of the Met Portfolio are not charged any initial or deferred sales charge, any 12b-1 fees, or any other transaction fees. THESE TABLES DO NOT REFLECT THE CHARGES AND FEES ASSESSED BY THE INSURANCE COMPANY UNDER YOUR CONTRACT. Fees and Expenses (as a percentage of average daily net assets)
* Since January 1, 1999 Cova Investment Advisory Corporation has voluntarily reimbursed operating expenses (exclusive of brokerage, advisory or other portfolio transaction expenses, or expenses of litigation, indemnification, taxes or other extraordinary expenses) in excess of approximately 0.10% of average daily net assets for Cova Quality Bond. Including waivers and reimbursements, the total annual portfolio operating expenses for the year ended December 31, 1999 would have been 0.64% for Cova Quality Bond. ** Met Investors Advisory Corp. and the Met Investors Series Trust have entered into an Expense Limitation Agreement whereby for a period of at least one year from commencement of operations the Total Annual Portfolio Operating Expenses of the Met Portfolio will not exceed 0.60% in any year in which the Agreement is in effect. Under certain circumstances, any fees waived or expenses reimbursed by the Manager may, with the approval of the Trust's Board of Trustees, be repaid to the Manager. If the Expense Limitation Agreement were not in effect, Total Annual Portfolio Operating Expenses would have been 0.70% for Met JPM Quality Bond. The tables below show examples of the total expenses you would pay on a $10,000 investment over one-, three-, five- and ten-year periods. The examples are intended to help you compare the cost of investing in the Cova Portfolio and the SF Portfolio versus the Met Portfolio pro forma, assuming the Reorganizations take place. The examples assume a 5% average annual return, that you redeem all of your shares at the end of each time period, that the Portfolios' operating expenses are before waiver (if applicable), that they remain the same and that you reinvest all of your dividends. To the extent that fees are waived, the expenses would be lower. The examples are for illustration only, and your actual costs may be higher or lower. THE EXAMPLES DO NOT REFLECT THE FEES AND EXPENSES IMPOSED BY THE CONTRACTS FOR WHICH THE PORTFOLIOS SERVE AS INVESTMENT VEHICLES. IF THOSE FEES AND EXPENSES HAD BEEN INCLUDED, YOUR COSTS WOULD BE HIGHER.
Examples of Portfolio Expenses
How do the Portfolios' performance records compare? The following charts show how the Cova Portfolio and the SF Portfolio have performed in the past. Past performance is not an indication of future results. PERFORMANCE DOES NOT REFLECT THE FEES AND EXPENSES IMPOSED BY THE CONTRACTS FOR WHICH THE PORTFOLIOS SERVE AS INVESTMENT VEHICLES. IF THOSE FEES AND EXPENSES HAD BEEN INCLUDED, PERFORMANCE WOULD BE LOWER. The Met Portfolio has been recently organized and has not yet engaged in any operations; consequently, it does not have an investment performance record. After the Reorganizations, Met JPM Quality Bond, as the successor to Cova Quality Bond and SF Bond, will assume and publish the investment performance record of Cova Quality Bond. Year-by-Year Total Return (%) The charts below show the percentage gain or loss for the shares of Cova Quality Bond in each full calendar year since the inception of the Portfolio on May 1, 1996 and for shares of SF Bond for the last ten calendar years. The charts should give you a general idea of the risks of investing in the Cova Portfolio and the SF Portfolio by showing how a Portfolio's return has varied from year-to-year. These charts include the effects of Portfolio expenses. Total return amounts are based on the inception date of each Portfolio, which may have occurred before your Contract began; accordingly, your investment results may differ.
Best Quarter: 3rd Quarter 1998 +4.15% Worst Quarter: 2nd Quarter 1999 -1.46%
Best Quarter: 2nd Quarter 1995+5.61% Worst Quarter: 1st Quarter 1994-2.9% For the quarter ended September 30, 2000, the Portfolio's total return was 2.81%. The next set of tables lists Cova Quality Bond's average annual total return over the past one year and since inception and SF Bond's average annual total return over the past one, five and ten years (through 12/31/1999). These tables include the effects of Portfolio expenses and are intended to provide you with some indication of the risks of investing in each Portfolio by comparing its performance with an appropriate widely recognized index of securities, which you can find at the bottom of each table. An index does not reflect fees or expenses. It is not possible to invest directly in an index. Average Annual Total Return (for the period ended 12/31/1999)
The Salomon Brothers Broad Investment Grade Bond Index is an unmanaged market - capitalized weighted index which includes fixed-rate Treasury, government sponsored, corporate (Baa/BBB or better) and mortgage securities.
The Lehman Government/Corporate Bond Index represents an unmanaged group of securities regarded by investors as representative of the bond market. For a detailed discussion of the manner of calculating total return, please see the Statement of Additional Information relating to this Prospectus/Proxy Statement. Generally, the calculations of total return assume the reinvestment of all dividends and capital gain distributions on the reinvestment date. Important information about Cova Quality Bond is also contained in management's discussion of Cova Quality Bond's performance, attached as Exhibit B to this Prospectus/Proxy Statement. This information also appears in the most recent Annual Report of Cova Series Trust relating to Cova Quality Bond. Will I be able to purchase and redeem shares, change my investment options, annuitize and receive distributions the same way? A Reorganization will not affect your right to purchase and redeem shares, to change among your Insurance Company's separate account options, to annuitize, and to receive distributions as permitted by your Contract. After the Reorganizations, you will be able under your current Contract to purchase additional Class A shares of the Met Portfolio. For more information, see "Purchase and Redemption Procedures", "Exchange Privileges" and "Dividend Policy" below. Who will be the Manager, Adviser and Portfolio Manager of my Portfolio after the Reorganizations? What will the management and advisory fees be after the Reorganizations? Management of the Portfolios The overall management of the Cova Portfolio, the SF Portfolio and the Met Portfolio is the responsibility of, and is supervised by, the Boards of Trustees of Cova Series Trust, Security First Trust and Met Investors Series Trust, respectively. Manager Met Investors Advisory Corp. (the "Manager") is the investment manager for the Met Portfolio. The Manager selects and pays the fees of the Adviser for the Met Portfolio and monitors the Adviser's investment program. Security First Group, Inc., an affiliate of MetLife, owns all of the outstanding common shares of the Manager. Facts about the Manager: o The Manager was formerly known as Security First Investment Management Corporation and is an indirect subsidiary of MetLife. o The Manager manages with its affiliates the family of investment portfolios sold to separate accounts of MetLife's insurance company subsidiaries to fund variable life insurance contracts and variable annuity certificates and contracts, with assets of approximately $423 billion as of September 30, 2000. o The Manager is located at 610 Newport Center Drive, Suite 1350, Newport Beach, California 92660. Adviser J.P. Morgan Investment Management Inc. ("the Adviser") is the investment adviser to the Met Portfolio. Pursuant to an Advisory Agreement with the Manager, the Adviser furnishes continuously an investment program for the Met Portfolio, makes day-to-day investment decisions on behalf of the Portfolio, and arranges for the execution of Portfolio transactions. Facts about the Adviser: o The Adviser is a wholly-owned subsidiary of J.P. Morgan & Co., Incorporated. o The Adviser has assets under management of approximately $373 billion as of September 30, 2000. o The Adviser is located at 522 Fifth Avenue, New York, New York 10036. Portfolio Management The day-to-day management of the Met Portfolio is handled by Jay A. Gladieux and James J. Dougherty. o Jay A. Gladieux, Vice President of the Adviser. Mr. Gladieux is a portfolio manager in the U.S. Fixed Income Group. A J.P. Morgan employee for the past three years, he concentrates on broad market strategies. Prior to that, Mr. Gladieux spent 15 years at Morgan Stanley & Co., of which the last 13 years were in the fixed income division focusing on the mortgage, derivative, and non-dollar businesses. He has managed Cova Quality Bond since October, 2000. o James J. Dougherty, Vice President of the Adviser. Mr. Dougherty joined the Adviser in 1986 and is head of the Fixed Income Trading and Strategy Implementation. Prior to his current assignment, Mr. Dougherty was co-Head of the mortgage investment team with primary responsibility for asset backed and commercial mortgage backed securities investments. He has managed Cova Quality Bond since April, 2000. = Management Fees For its management and supervision of the daily business affairs of the Met Portfolio, the Manager is entitled to receive a monthly fee at the annual rate of 0.55% of the Portfolio's average daily net assets up to $75 million, and 0.50% of such net assets in excess of $75 million. The Manager may, at its discretion, reduce or waive its fee or reimburse the Portfolio for certain of its other expenses in order to reduce the expense ratios. Unless otherwise agreed upon, the Manager may also reduce or cease these voluntary waivers and reimbursements at any time. In addition, as described above, Met Investors Series Trust and the Manager have entered into an Expense Limitation Agreement with respect to the Met Portfolio. Advisory Fee Under the terms of the Advisory Agreement, the Adviser is paid by the Manager for providing advisory services to the Met Portfolio. The Met Portfolio does not pay a fee to the Adviser. What will be the primary federal tax consequences of the Reorganizations? Prior to or at the completion of the Reorganizations, the Cova Portfolio, the SF Portfolio and the Met Portfolio will have received an opinion from the law firm of Sullivan & Worcester LLP that the applicable Reorganization has been structured so that no gain or loss will be realized by the Portfolio or its Record Holders for federal income tax purposes as a result of receiving shares of voting stock of the Met Portfolio in connection with the Reorganization. The holding period and aggregate tax basis of shares of voting stock of the Met Portfolio that are received by the Record Holders of the Cova Portfolio and the SF Portfolio will be the same as the holding period and aggregate tax basis of shares of the Cova Portfolio or the SF Portfolio previously held by such Record Holders, provided that such shares of the Cova Portfolio or SF Portfolio are held as capital assets. In addition, the holding period and tax basis of the assets of the Cova Portfolio and the SF Portfolio in the hands of the Met Portfolio as a result of the Reorganizations will be the same as in the hands of the Cova Portfolio or the SF Portfolio immediately prior to the Reorganizations, and no gain or loss will be recognized by the Met Portfolio upon the receipt of the assets of the Cova Portfolio or the SF Portfolio in exchange for voting stock of the Met Portfolio and the assumption by the Met Portfolio of the Cova Portfolio's or the SF Portfolio's identified liabilities. Met Investors Series Trust believes that the Contract Owners will have no taxable income as a consequence of a Reorganization. RISKS Are the risk factors for the Portfolios the same? Yes. The risk factors are essentially the same or very similar due to the substantial similarities of the investment objectives and policies among the Cova Portfolio, the SF Portfolio and the Met Portfolio. The risks of the Met Portfolio are described in greater detail in the "Additional Information" section below. What are the primary risks of investing in each Portfolio? An investment in each Portfolio is subject to certain risks. There is no assurance that investment performance of the Cova Portfolio, the SF Portfolio or the Met Portfolio will be positive or that the Portfolios will meet their investment objectives. The following tables and discussions highlight the primary risks associated with investment in each of the Portfolios.
A Portfolio's investments in derivatives to manage currency exposure can significantly increase the Portfolio's exposure to market risk or risk of non-performance of the counterparty. Derivatives also involve the risk of mispricing or improper valuation and the risks that changes in value of the derivative may not correlate perfectly with the relevant assets, rates and indices. Are there any other risks of investing in each Portfolio? As of the fiscal year ended July 31, 2000, the portfolio turnover rate for the SF Portfolio was 177% and the portfolio turnover rate for the Cova Portfolio for the year ended December 31, 1999 was approximately 370%. Annual turnover rate of 100% or more is considered high and results in greater brokerage and other transaction costs which are borne by a Portfolio and its shareholders. INFORMATION ABOUT THE REORGANIZATIONS Reasons for the Reorganizations The purposes of the Reorganizations are to merge SF Bond into Cova Quality Bond and to reorganize Cova Quality Bond into a separate series of a Delaware business trust. The Reorganizations are part of an overall restructuring designed to (1) reduce the number of portfolios with overlapping investment objectives and policies, and (2) provide the enhanced flexibility afforded by a Delaware business trust in comparison to the Cova Portfolio's and to the SF Portfolio's previous form of organization, operating efficiencies which will result from maintaining a single trust of investment portfolios to be offered in connection with the Insurance Companies' insurance products and to employee benefit plans, and consistency across the entire group of those investment portfolios. To accomplish the restructuring, the holders of beneficial interests in shares of other portfolios of Cova Series Trust and Security First Trust are also being asked to approve reorganizations of those portfolios into portfolios of Met Investors Series Trust. At a special meeting held on November 1, 2000, all of the Trustees of Cova Series Trust, including the Disinterested Trustees, considered and approved the Reorganization; they determined that the Reorganization was in the best interests of shareholders of Cova Quality Bond, and that the interests of existing shareholders of Cova Quality Bond will not be diluted as a result of the transactions contemplated by the respective Reorganization. At a special meeting held on November 2, 2000, all of the Trustees of Security First Trust, including the Disinterested Trustees, considered and approved the Reorganization; they determined that the Reorganization was in the best interest of shareholders of SF Bond, and that the interests of the existing shareholders of SF Bond will not be diluted as a result of the transactions contemplated by the Reorganization. Cova Series Trust and Security First Trust are each organized as a Massachusetts business trust and Met Investors Series Trust is organized as a Delaware business trust. The primary purpose of the Reorganization of SF Bond is to merge this Portfolio with Cova Quality Bond. The principal reason for reorganizing Cova Quality Bond as a series of a Delaware business trust is the availability of certain advantages of Delaware law with respect to business trusts. The Delaware Business Trust Act (the "Delaware Act") has been specifically drafted to accommodate the unique governance needs of investment companies and provides that its policy is to give maximum freedom of contract to the trust instrument of a Delaware business trust. Under the Delaware Act, a shareholder of a Delaware business trust is entitled to the same limitation of personal liability extended to stockholders of Delaware corporations. No similar statutory or other authority limiting business trust shareholder liability exists in Massachusetts. As a result, Delaware law is generally considered to afford more protection against potential shareholder liability than is afforded to shareholders of Massachusetts business trusts. See "Comparative Information on Shareholders' Rights - Shareholder Liability". Similarly, Delaware law provides that, should a Delaware trust issue multiple series of shares, each series will not be liable for the debts of another series, another potential though remote risk in the case of other business trusts, including those, such as Cova Series Trust and Security First Trust, that are organized under Massachusetts law. Delaware has obtained a favorable national reputation for its business laws and business environment. The Delaware courts, which may be called upon to interpret the Delaware Act, are among the nation's most highly respected and have an expertise in corporate matters which in part grew out of the fact that Delaware legal issues are concentrated in the Court of Chancery where there are no juries and where judges issue written opinions explaining their decisions. Accordingly, there is a well established body of precedent which may be relevant in deciding issues pertaining to a Delaware business trust. There are other advantages that may be afforded by a Delaware business trust. Under Delaware law, the Met Portfolio will have the flexibility to respond to future business contingencies. For example, the Trustees of Met Investors Series Trust will have the power to incorporate the Trust, to merge or consolidate it with another entity, to cause each series to become a separate trust, and to change the Trust's domicile without a shareholder vote. This flexibility could help to assure that Met Investors Series Trust operates under the most advanced form of organization and could reduce the expense and frequency of future shareholder meetings for non-investment related issues. Before approving the Plans, the Trustees evaluated extensive information provided by the management of Cova Series Trust, Security First Trust and Met Investors Series Trust, as applicable, and reviewed various factors about the Portfolios and the proposed Reorganizations. The Trustees noted that the historical performance of Cova Quality Bond for the last three years has exceeded that of SF Bond. In addition, the Trustees considered the relative size of each Cova and SF Portfolio, including the benefits of each Portfolio being associated with a larger entity, as well as their investment styles. As of September 30, 2000, Cova Quality Bond's total assets were approximately $92 million, and SF Bond's total assets were approximately $25 million. The relatively small asset size of Cova Quality Bond and SF Bond may significantly impair each Portfolio's ability to achieve maximum operating efficiency. Moreover, the offering of two Portfolios with essentially similar investment styles could result in each Portfolio being disadvantaged due to inability to achieve optimum size, performance levels and the greatest possible economies of scale. In addition, the Trustees considered, among other things: o the advantages which apply to operating the combined Portfolios as a series of a Delaware business trust as compared to operating each Portfolio as series of Massachusetts business trusts; o the terms and conditions of each Reorganization; o the fact that the Reorganizations would not result in the dilution of shareholders' interests; o the effect of the Reorganizations on the Contract Owners and the value of their Contracts, and the anticipated availability of a broader array of investment choices to Contract Owners of portfolios in the Met Investors Series Trust; o the expense ratios, fees and expenses of the Cova Portfolio and the SF Portfolio and the anticipated expense ratios, fees and expenses of the Met Portfolio; o the fact that the Manager has contractually agreed to limit the total annual operating expenses of the Met Portfolio; o the fact that the Cova Portfolio, the SF Portfolio and the Met Portfolio have identical or similar investment objectives and principal investment strategies; o the investment personnel, expertise and resources of Met Investors Advisory Corp., the Manager for the Met Portfolio, including the fact that it will have access to the resources and personnel of Cova Investment Advisory Corporation, the investment adviser to the Cova Portfolio, and would manage the Portfolio in essentially the same manner; o the fact that the Cova Portfolio Reorganization will provide continuity of money management for shareholders because the sub-adviser for the Cova Portfolio will be the sub-adviser of the Met Portfolio and the same individuals who manage Cova Quality Bond will continue as portfolio managers of the Met Portfolio; o the fact that MetLife or one of its affiliates will bear the expenses incurred by the Cova Portfolio, the SF Portfolio and the Met Portfolio in connection with the Reorganizations; o the benefits to shareholders, including operating efficiencies, to be achieved from participating in the restructuring of the investment portfolios to be offered in connection with the Insurance Companies' insurance products and to employee benefit plans; o the fact that the Met Portfolio will assume the identified liabilities of the Cova Portfolio and the SF Portfolio; o the fact that each Reorganization is expected to be tax free for federal income tax purposes; and o alternatives available to shareholders of the Cova Portfolio and the SF Portfolio, including the ability to redeem their shares. During their consideration of the Reorganizations, the Trustees of Cova Series Trust met with Trust counsel and counsel to the Independent Trustees regarding the legal issues involved. The Trustees of Security First Trust also met with Trust counsel. After consideration of the factors noted above, together with other factors and information considered to be relevant, and recognizing that there can be no assurance that any operating efficiencies or other benefits will in fact be realized, the Trustees of Cova Series Trust and of Security First Trust each concluded that the proposed Reorganizations, as applicable, would be in the best interests of the Cova Portfolio and the SF Portfolio and their respective shareholders. Consequently, they approved the Plans and directed that the respective Plans be submitted to shareholders of the Cova Portfolio and the SF Portfolio for approval. The Trustees of Met Investors Series Trust have also approved the Plans on behalf of the Met Portfolio. Agreements and Plans of Reorganization The following summary is qualified in its entirety by reference to the Plans (the forms of which are attached as Exhibits A-1 and A-2 to this Prospectus/Proxy Statement). Each Plan provides that all of the assets of the Cova Portfolio or the SF Portfolio will be acquired by the Met Portfolio in exchange for Class A shares of the Met Portfolio and the assumption by the Met Portfolio of the identified liabilities of the Cova Portfolio or the SF Portfolio on or about February 5, 2001 or such other date as may be agreed upon by the parties (the "Closing Date"). Prior to the Closing Date, the Cova Portfolio and the SF Portfolio will endeavor to discharge all of its known liabilities and obligations. The Met Portfolio will not assume any liabilities or obligations of the Cova Portfolio and the SF Portfolio other than those reflected in an unaudited statement of assets and liabilities of the Cova Portfolio or the SF Portfolio prepared as of the close of regular trading on the New York Stock Exchange ("NYSE"), normally 4:00 p.m. Eastern Time, on the business day immediately prior to the Closing Date (the "Valuation Time"). At or prior to the Closing Date, the SF Portfolio will declare a dividend or dividends and distribution or distributions which, together with all previous dividends and distributions, shall have the effect of distributing to the Portfolio's shareholders all of the Portfolio's investment company taxable income for the taxable period ending on the Closing Date (computed without regard to any deduction for dividends paid) and all of its net capital gains realized in all taxable periods ending on the Closing Date (after reductions for any capital loss carry forward). The number of full and fractional Class A shares of the Met Portfolio to be received by the shareholders of the Cova Portfolio and the SF Portfolio will be determined by multiplying the number of outstanding full and fractional shares of the Cova Portfolio or the SF Portfolio by a factor which shall be computed by dividing the net asset value per share of the Cova Portfolio or the SF Portfolio by the net asset value per share of the Class A shares of the Met Portfolio. These computations will take place as of the Valuation Time. The net asset value per share will be determined by dividing assets, less liabilities, in each case attributable to the respective class, by the total number of outstanding shares. Investors Bank & Trust Company, the custodian for the Met Portfolio, will compute the value of the Cova Portfolio's and the SF Portfolio's respective portfolio of securities. The method of valuation employed will be consistent with the procedures set forth in the "Additional Information" section below relating to the Met Portfolio, Rule 22c-1 under the 1940 Act, and with the interpretations of that Rule by the SEC's Division of Investment Management. As soon after the Closing Date as conveniently practicable, the Cova Portfolio and the SF Portfolio will liquidate and distribute pro rata to shareholders of record as of the close of business on the Closing Date the full and fractional shares of voting stock of the Met Portfolio received by the Cova Portfolio and the SF Portfolio. The liquidation and distribution will be accomplished by the establishment of accounts in the names of the Cova Portfolio's and the SF Portfolio's shareholders on the Met Portfolio's share records of its transfer agent. Each account will represent the respective pro rata number of full and fractional shares of voting stock of the Met Portfolio due to the Cova Portfolio's and the SF Portfolio's shareholders. All issued and outstanding shares of the Cova Portfolio and the SF Portfolio will be canceled. The shares of voting stock of the Met Portfolio to be issued will have no preemptive or conversion rights and no share certificates will be issued. After these distributions and the winding up of its affairs, the Cova Portfolio and the SF Portfolio will be terminated. The consummation of each Reorganization is subject to the conditions set forth in the respective Plan, including approval, as applicable, by the Cova Portfolio's and the SF Portfolio's shareholders, accuracy of various representations and warranties and receipt of opinions of counsel, including opinions with respect to those matters referred to in "Federal Income Tax Consequences" below. Notwithstanding approval of the Cova Portfolio's or the SF Portfolio's shareholders, a Plan may be terminated (a) by the mutual agreement of the Cova Portfolio or the SF Portfolio and the Met Portfolio; or (b) at or prior to the Closing Date by either party (1) because of a breach by the other party of any representation, warranty, or agreement contained in the Plan to be performed at or prior to the Closing Date if not cured within 30 days, or (2) because a condition to the obligation of the terminating party has not been met and it reasonably appears that it cannot be met. Whether or not a Reorganization is consummated, MetLife or one of its affiliates will pay the expenses incurred by the Cova Portfolio, the SF Portfolio and the Met Portfolio in connection with that Reorganization (including the cost of any proxy-soliciting agent). No portion of the expenses will be borne directly or indirectly by the Cova Portfolio, the SF Portfolio, the Met Portfolio or their shareholders. If the Cova Portfolio's or the SF Portfolio's shareholders do not approve the respective Reorganization, the Trustees will consider other possible courses of action which may be in the best interests of shareholders. Federal Income Tax Consequences Each Reorganization is intended to qualify for federal income tax purposes as a tax free reorganization under section 368(a) of the Internal Revenue Code of 1986, as amended (the "Code"). Met Investors Series Trust believes that the Contract Owners will have no taxable income as a consequence of a Reorganization. As a condition to the closing of a Reorganization, the Met Portfolio, the Cova Portfolio or the SF Portfolio, as applicable, the respective Record Holders and the Met Portfolio will receive an opinion from the law firm of Sullivan & Worcester LLP to the effect that, on the basis of the existing provisions of the Code, U.S. Treasury regulations issued thereunder, current administrative rules, pronouncements and court decisions, for federal income tax purposes, upon consummation of the Reorganization:
(1) The transfer of all of the assets of the Cova Portfolio or the
SF Portfolio solely in exchange for shares of voting stock
("voting stock") of the Met Portfolio and the assumption by the
Met Portfolio of the identified liabilities of the Cova
Portfolio or the SF Portfolio followed by the distribution of
the Met Portfolio's voting stock to the Record Holders of the
Cova Portfolio or the SF Portfolio in dissolution and
liquidation of the Cova Portfolio or the SF Portfolio, will
constitute a "reorganization" within the meaning of section
(2) No gain or loss will be recognized by the Met Portfolio upon the receipt of the assets of the Cova Portfolio or the SF Portfolio solely in exchange for the voting stock of the Met Portfolio and the assumption by the Met Portfolio of the identified liabilities of the Cova Portfolio or the SF Portfolio; (3) No gain or loss will be recognized by the Cova Portfolio or the SF Portfolio on the transfer of its assets to the Met Portfolio in exchange for the Met Portfolio's voting stock and the assumption by the Met Portfolio of the identified liabilities of the Cova Portfolio or the SF Portfolio or upon the distribution (whether actual or constructive) of the Met Portfolio's voting stock to the Cova Portfolio's or the SF Portfolio's Record Holders in exchange for their shares of the Cova Portfolio or the SF Portfolio; (4) No gain or loss will be recognized by the Cova Portfolio's or the SF Portfolio's Record Holders upon the exchange of their shares of the Cova Portfolio or the SF Portfolio for voting stock of the Met Portfolio in liquidation of the Cova Portfolio or the SF Portfolio; (5) The aggregate tax basis of the voting stock of the Met Portfolio
or the courts. If a Reorganization is consummated but does not qualify as a tax free reorganization under the Code, a Record Holder of the Cova Portfolio or the SF Portfolio would recognize a taxable gain or loss equal to the difference between its tax basis in its Portfolio shares and the fair market value of the shares of the Met Portfolio it received. Pro-forma Capitalization The following tables set forth the capitalization of the Cova Portfolio and the SF Portfolio as of June 30, 2000 and the capitalization of the Met Portfolio on a pro forma basis as of that date, giving effect to the proposed acquisitions of assets at net asset value. As a newly created series of Met Investors Series Trust, the Met Portfolio, immediately preceding the Closing Date, will have nominal assets and liabilities. The pro forma data reflects an exchange ratio of approximately 0.3664 Class A shares of the Met Portfolio issued for each share of SF Bond, and an exchange ratio of 1.00 Class A share of the Met Portfolio issued for each share of Cova Quality Bond. It is anticipated that as of the Closing Date, no Class B shares of the Met Portfolio will be outstanding. Capitalization of Cova Quality Bond, SF Bond and Met JPM Quality Bond (Pro Forma)
Distribution of Shares All portfolios of Cova Series Trust and Security First Trust sell shares to the separate accounts of the Insurance Companies as a funding vehicle for the Contracts offered by the Insurance Companies, and Security First Trust offers its shares to qualified pension and retirement plans. The Cova Portfolio and the SF Portfolio offer only one class of shares. Expenses of each Trust are passed through to the Insurance Companies' separate accounts and are ultimately borne by Contract Owners. In addition, other fees and expenses are assessed by the Insurance Companies at the separate account level. (The Cova Contracts Prospectus and the Security First Contracts Prospectus describe all fees and charges relating to a Contract.) Like Cova Series Trust and Security First Trust, Met Investors Series Trust does not sell its shares directly to the public. The Trust continuously sells shares of the Met Portfolio only to Insurance Company separate accounts and to qualified pension and employee profit-sharing plans. It may also offer shares to other separate accounts of other insurers if approved by the Board of Trustees of the Trust. MetLife Distributors, Inc. ("MDI"), an indirect wholly-owned subsidiary of MetLife, serves as the distributor for Met Investors Series Trust's shares. MDI distributes the Met Portfolio's shares directly and through broker-dealers, banks, or other financial intermediaries. The Met Portfolio currently offers two classes of shares: Class A and Class B. (Class B is not part of the Reorganizations.) Each class has a separate distribution arrangement and bears its own distribution expenses, if any. In the proposed Reorganizations, shareholders of the Cova Portfolio and the SF Portfolio will receive Class A shares of the Met Portfolio. Class A shares are sold at net asset value without any initial or deferred sales charges and are not subject to distribution-related or shareholder servicing-related fees. No Rule 12b-1 plan has been adopted for the Class A shares of the Met Portfolio. Class A shares are only available to certain classes of investors, such as shareholders who receive shares of the Met Portfolio in the Reorganizations and for additional purchases under a shareholder's existing Contract. In connection with each Reorganization, no sales charges are imposed. Certain sales or other charges are imposed by the Contracts for which the Met Portfolio serves as an investment vehicle. More detailed descriptions of the Class A shares and the distribution arrangements applicable to this class of shares are contained in the "Additional Information" section below relating to the Met Portfolio. Purchase and Redemption Procedures The Cova Contracts Prospectus and the Security First Contracts Prospectus for your Contract describes the procedures for investing your purchase payments or premiums in shares of the Cova Portfolios and the SF Portfolio. No fee is charged by the Cova Portfolio or the SF Portfolio for selling (redeeming) shares. The Contracts Prospectus describes whether an Insurance Company charges any fees for redeeming your interest in a Contract. The Cova Portfolio and the SF Portfolio buy or sell shares at net asset value per share of each Portfolio for orders received on a given day, and the Insurance Companies use this value to calculate the value of your interest in your Contract. MDI places orders for the purchase or redemption of shares of the Met Portfolio based on, among other things, the amount of net Contract premiums or purchase payments transferred to the separate accounts, transfers to or from a separate account investment division and benefit payments to be effected on a given date pursuant to the terms of the Contracts. Orders are effected at the net asset value per share for each Portfolio determined on that same date, without the imposition of any sales commission or redemption charge. Exchange Privileges The Cova Contracts Prospectus and the Security First Contracts Prospectus indicate whether an Insurance Company charges any fees for moving your assets from one investment option to another. No fees for exchanges are charged by Cova Series Trust, Security First Trust, or Met Investors Series Trust. Dividend Policy The Cova Portfolio, the SF Portfolio and the Met Portfolio have the same distribution policy. Each Portfolio declares and distributes its dividends from net investment income to the Insurance Company separate accounts at least once a year and not to you, the Contract Owner. These distributions are in the form of additional shares of stock and not cash. The result is that a Portfolio's investment performance, including the effect of dividends, is reflected in the cash value of the Contracts. All net realized long- or short-term capital gains of each Portfolio are also declared and distributed once a year and reinvested in the Portfolio. Dividends and distributions paid on the SF Portfolio are automatically reinvested in additional shares of the Portfolio unless a shareholder elects to have dividends and/or distributions paid in cash. The Cova Portfolio and the SF Portfolio have each qualified and intend to continue to qualify, and the Met Portfolio expects to qualify in its initial year, to be treated as regulated investment companies under the Code. To remain qualified as a regulated investment company, a Portfolio must distribute 90% of its taxable and tax-exempt income and diversify its holdings as required by the 1940 Act and the Code. While so qualified, so long as each Portfolio distributes all of its net investment company taxable and tax-exempt income and any net realized gains to the Record Holders, it is expected that a Portfolio will not be required to pay any federal income taxes on the amounts distributed to the Record Holders. COMPARATIVE INFORMATION ON SHAREHOLDERS' RIGHTS As a Delaware business trust, the operations of Met Investors Series Trust will be governed by its Agreement and Declaration of Trust and By-Laws, and applicable Delaware law, rather than by the Agreement and Declaration of Trust and By-Laws of Cova Series Trust, or by the Declaration of Trust and By-Laws of Security First Trust and Massachusetts law. The Agreements and Declarations of Trust and Declaration of Trust are each referred to in this Prospectus/Proxy Statement as a "Declaration of Trust." As discussed below, certain of the differences between Cova Series Trust, Security First Trust and Met Investors Series Trust derive from provisions of Met Investors Series Trust's Declaration of Trust and By-Laws. Shareholders entitled to instruct the Insurance Companies to vote at the Meeting may obtain a copy of Met Investors Series Trust's Declaration of Trust and By-Laws, without charge, upon written request to Met Investors Series Trust at the address and telephone number set forth on the cover of this Prospectus/Proxy Statement. Form of Organization As noted above, Cova Series Trust and Security First Trust are each organized as a Massachusetts business trust, and Met Investors Series Trust is organized as a Delaware business trust. Cova Series Trust, Security First Trust and Met Investors Series Trust are each open-end management investment companies registered with the SEC under the 1940 Act, and each is organized as a "series company" as that term is used in Rule 18f-2 under the 1940 Act. The series of Cova Series Trust consist of the Cova Portfolio and other mutual funds of various asset classes; the series of Security First Trust consist of the SF Portfolio and other mutual funds of various asset classes; the series of Met Investors Series Trust consist of the Met Portfolio and other mutual funds of various asset classes. Cova Series Trust, Security First Trust and Met Investors Series Trust currently offer shares of their portfolios only to insurance company separate accounts to serve as an investment vehicle for variable annuity contracts and variable life insurance policies issued by the Insurance Companies. Security First Trust and Met Investors Series Trust also offer shares of their portfolios to qualified pension and retirement plans. Each Trust is governed by its Declaration of Trust, By-Laws, and a Board of Trustees, and by applicable Massachusetts or Delaware and federal law. The Board of Trustees of Met Investors Series Trust is currently comprised of Stephen M. Alderman and Theodore A. Myers, who serve as Trustees of Cova Series Trust, Jack R. Borsting, who serves as a Trustee of Security First Trust, and five other individuals who do not serve as Trustees of either Cova Series Trust or Security First Trust. Accordingly, most of the Trustees who have ultimate responsibility for the oversight and management of the Met Portfolio are different. Information with respect to the current Trustees of Met Investors Series Trust, including compensation received, is set forth in the Statement of Additional Information dated December 15, 2000 which relates to this Prospectus/Proxy Statement and the Reorganizations. Capitalization The beneficial interests in Cova Series Trust are represented by an unlimited number of transferable shares of beneficial interest, without par value, and may be divided into two or more series. The beneficial interests of Security First Trust are represented by an unlimited number of transferable shares of beneficial interest, without par value, and may be divided into various series. The beneficial interests in Met Investors Series Trust are represented by an unlimited number of transferable shares of beneficial interest, $.001 par value per share, of one or more series. The Declaration of Trust of each of Cova Series Trust, Security First Trust and Met Investors Series Trust permits the Trustees to allocate shares into one or more series, and classes thereof, with rights determined by the Trustees, all without shareholder approval. Fractional shares may be issued by the Cova Portfolio, the SF Portfolio and by the Met Portfolio. Shares of the Cova Portfolio and the SF Portfolio are offered in only one class and represent an equal proportionate interest in the Portfolio. Shares of the Met Portfolio are currently offered in Class A and Class B (Class B is not part of the Reorganizations). Shares of the classes of the Met Portfolio represent an equal pro rata interest in the Portfolio and generally have identical voting, dividend, liquidation and other rights, other than the payment of distribution fees. Shareholders of the Cova Portfolio, the SF Portfolio and the Met Portfolio are entitled to receive dividends and other amounts as determined by the Trustees. Shareholders of the Cova Portfolio, the SF Portfolio and the Met Portfolio vote separately, by Portfolio, as to matters, such as changes in fundamental investment restrictions, that affect only their particular Portfolio. Shareholders of the Met Portfolio vote by class as to matters, such as approval of or amendments to Rule 12b-1 distribution plans, that affect only their particular class. Shareholder Liability Shareholders of Cova Series Trust and Security First Trust as shareholders of Massachusetts business trusts may, under certain circumstances, be held personally liable under the applicable state law for the obligations of the respective Trust. However, the Declarations of Trust of Cova Series Trust and Security First Trust contain an express disclaimer of shareholder liability and require (in the case of Cova Series Trust) or permit (in the case of Security First Trust) that notice of such disclaimer be given in each agreement entered into or executed by Cova Series Trust, Security First Trust or the Trustees or officers of the Trust, as applicable. Each Declaration of Trust also provides for shareholder indemnification out of the assets of the Trust. Under Delaware law, shareholders of a Delaware business trust are entitled to the same limitation of personal liability extended to stockholders of Delaware corporations. No similar statutory or other authority limiting business trust shareholder liability exists under Massachusetts law. As a result, Delaware law is generally considered to afford additional protection against potential shareholder liability. To the extent that Met Investors Series Trust or a shareholder is subject to the jurisdiction of courts in other states, it is possible that a court may not apply Delaware law and may thereby subject shareholders of Met Investors Series Trust to liability. To guard against this risk, the Declaration of Trust of Met Investors Series Trust (a) provides that any written obligation of the Trust may contain a statement that such obligation may only be enforced against the assets of the Trust or the particular series in question and the obligation is not binding upon the shareholders of the Trust; however, the omission of such a disclaimer will not operate to create personal liability for any shareholder; and (b) provides for indemnification out of Trust property of any shareholder held personally liable for the obligations of the Trust. Accordingly, the risk of a shareholder of Met Investors Series Trust incurring financial loss beyond that shareholder's investment because of shareholder liability is limited to circumstances in which: (1) the court refuses to apply Delaware law; (2) no contractual limitation of liability was in effect; and (3) the Trust itself is unable to meet its obligations. In light of Delaware law, the nature of the Trust's business, and the nature of its assets, the risk of personal liability to a shareholder of Met Investors Series Trust is remote. Shareholder Meetings and Voting Rights Neither Cova Series Trust on behalf of the Cova Portfolio, Security First Trust on behalf of the SF Portfolio nor Met Investors Series Trust on behalf of the Met Portfolio is required to hold annual meetings of shareholders. However, a meeting of shareholders for the purpose of voting upon the question of removal of a Trustee must be called when requested in writing by the holders of at least 10% of the outstanding shares of each Trust. A meeting of shareholders of Cova Series Trust or Security First Trust must also be called for any proper purpose upon written request of shareholders holding at least 51% of the outstanding shares of the Trust or of a Portfolio. In addition, each Trust is required to call a meeting of shareholders for the purpose of electing Trustees if, at any time, less than a majority of the Trustees then holding office were elected by shareholders. No Trust currently intends to hold regular shareholder meetings. Cumulative voting is not permitted in the election of Trustees of any Trust. The Declaration of Trust of Cova Series Trust and the By-Laws of Security First Trust provide that the holders of a majority of the outstanding shares constitute a quorum for consideration of a matter at a shareholders' meeting. Except when a larger quorum is required by applicable law or the applicable governing documents, with respect to Met Investors Series Trust, 33 1/3% of the shares issued and outstanding constitutes a quorum for consideration of a matter at a shareholders' meeting but any lesser number is sufficient for adjourned sessions. Approval of a matter by the shareholders of Cova Series Trust requires the affirmative vote of a majority of the shares present and entitled to vote (for Security First Trust, the affirmative vote of a majority of the votes cast at a meeting duly called and at which a quorum is present), subject to applicable law, the Declaration of Trust or with respect to Cova Series Trust, a Trustee resolution specifying a greater or lesser shareholder vote requirement; a Trustee of Cova Series Trust must be elected by the affirmative vote of a plurality of the shares present. For Met Investors Series Trust, when a quorum is present at a meeting, a majority (greater than 50%) of the shares voted is sufficient to act on a matter and a plurality of the shares voted is required to elect a Trustee (unless otherwise specifically required by the applicable governing documents or other law, including the 1940 Act). A Trustee of Cova Series Trust may be removed with cause by a vote of two-thirds of the shareholders or by a vote of two-thirds of the remaining Trustees. A Trustee of Security First Trust may be removed by a vote or a written declaration of two-thirds of the shares outstanding and entitled to vote, or for cause by a vote of two-thirds of the remaining Trustees. A Trustee of Met Investors Series Trust may be removed at a meeting of shareholders by a vote of two-thirds of the outstanding shares of the Trust, or with or without cause by the vote of two-thirds of the number of Trustees prior to removal. Under the Declaration of Trust of each Trust, each whole share of beneficial interest of a Portfolio is entitled to one vote, and each fractional share is entitled to a proportionate vote. In particular, with respect to the Cova Portfolio, this means that each full share of a Portfolio attributable to a variable annuity contract is entitled to one vote and any fractional share is entitled to a fractional vote; each $100 of the account value of a variable life insurance policy allocated to a Portfolio on the record date is entitled to one vote, and fractional votes are counted. With respect to the Met Portfolio, similar voting provisions apply regarding the account value of a variable life insurance policy allocated to the Portfolio. The Declarations of Trust of Cova Series Trust and Security First Trust require shareholder approval to (1) change the Trust to a corporation or other organization, (2) terminate the Trust or in the case of Cova Series Trust a Portfolio, or (3) merge the Trust into another entity, or merge or consolidate (with respect to Cova Series Trust only), or sell or exchange the assets of a Portfolio. The Trustees of Security First Trust may abolish a series or class only if no shares of that series or class are outstanding. The Trustees of Security First Trust may, however, combine series or classes of shares with other series or classes of shares without shareholder approval, provided that in a combination of series the relative net asset ratios of the affected shares is preserved. The Declaration of Trust of Met Investors Series Trust provides that unless otherwise required by applicable law (including the 1940 Act), the Board of Trustees may, without obtaining a shareholder vote: (1) reorganize the Trust as a corporation or other entity, (2) merge the Trust into another entity, or merge, consolidate or transfer the assets and liabilities of a Portfolio or class of shares to another entity, and (3) combine the assets and liabilities held with respect to two or more series or classes into assets and liabilities held with respect to a single series or class. The Trustees of Met Investors Series Trust may also terminate the Trust, a Portfolio, or a class of shares upon written notice to the shareholders. The Declaration of Trust of Cova Series Trust provides that advisory, administrative or management agreements may be entered into subject to shareholder approval. Under the Declarations of Trust of Security First Trust and Met Investors Series Trust, there is no specific requirement for shareholder approval. Under the 1940 Act, absent exemptive relief from the SEC, all investment advisory contracts must be approved by shareholders. As further described in "Additional Information - The Adviser", Met Investors Series Trust and the Manager have filed an application with the SEC seeking an order, which among other things, would permit the Manager to retain or terminate an unaffiliated Adviser to a Portfolio without shareholder approval. No assurances can be given that the Trust and the Manager will receive the requested order. Liquidation After paying all liabilities, the Trustees of Cova Series Trust and Security First Trust may distribute the remaining Trust property of any liquidated Portfolio among the shareholders of the Portfolio according to their respective rights. In the event of the liquidation of Met Investors Series Trust, the Met Portfolio, or a class of shares, the shareholders are entitled to receive, when and as declared by the Trustees, the excess of the assets belonging to the Trust, the Portfolio or attributable to the class over the liabilities belonging to the Trust, the Portfolio or attributable to the class. In either case, the assets so distributable to shareholders of the Portfolio will be distributed among the shareholders in proportion to the number of shares of a class of the Portfolio held by them on the date of distribution. Liability and Indemnification of Trustees Under the Declaration of Trust of Met Investors Series Trust, a Trustee is liable to any person in connection with the assets or affairs of the Trust or any Portfolio only for such Trustee's own willful misfeasance, bad faith, gross negligence, or reckless disregard of the duties involved in the conduct of the office of Trustee or the discharge of such Trustee's functions. As provided in the Declaration of Trust, each Trustee of the Trust is entitled to be indemnified against all liabilities against him or her, including the costs of litigation, unless it is determined that the Trustee (1) did not act in good faith in the reasonable belief that such Trustee's action was in or not opposed to the best interests of the Trust; (2) had acted with willful misfeasance, bad faith, gross negligence or reckless disregard of such Trustee's duties; and (3) in a criminal proceeding, had reasonable cause to believe that such Trustee's conduct was unlawful (collectively, "disabling conduct"). A determination that the Trustee did not engage in disabling conduct and is, therefore, entitled to indemnification may be based upon the outcome of a court action or administrative proceeding or by (a) a vote of a majority of a quorum of those Trustees who are neither "interested persons" within the meaning of the 1940 Act nor parties to the proceeding or (b) an independent legal counsel in a written opinion. A Portfolio may also advance money for such litigation expenses provided that the Trustee undertakes to repay the Portfolio if his or her conduct is later determined to preclude indemnification and certain other conditions are met. The Declarations of Trust of Cova Series Trust and Security First Trust contain similar provisions. The foregoing is only a summary of certain characteristics of the operations of the Declarations of Trust of Met Investors Series Trust, Cova Series Trust and Security First Trust, their By-Laws and Delaware or Massachusetts law and is not a complete description of those documents or law. Shareholders should refer to the provisions of such Declarations of Trust, By-Laws and Delaware or Massachusetts law directly for more complete information. VOTING INFORMATION CONCERNING THE MEETING This Prospectus/Proxy Statement is being sent to shareholders of Cova Quality Bond in connection with a solicitation of voting instructions by the Trustees of Cova Series Trust, and to shareholders of SF Bond in connection with a solicitation of voting instructions by the Trustees of Security First Trust, to be used at the Special Meeting of shareholders (the "Meeting) to be held at 10:00 a.m. Pacific Time for the Cova Portfolio and 10:30 a.m. for the SF Portfolio, January 26, 2001, at the offices of Met Investors Series Trust, 610 Newport Center Drive, Suite 1350, Newport Beach, California 92660, and at any adjournments thereof. This Prospectus/Proxy Statement, along with a Notice of the Meeting and a voting instructions form, is first being mailed to shareholders of the Cova Portfolio and the SF Portfolio on or about December 15, 2000. The Boards of Trustees of Cova Series Trust and Security First Trust have fixed the close of business on November 27, 2000 as the record date (the "Record Date") for determining the shareholders of the Cova Portfolio and the SF Portfolio entitled to receive notice of the Meeting and to give voting instructions, and for determining the number of shares for which such instructions may be given, with respect to the Meeting or any adjournment thereof. The Insurance Companies, through certain of their separate accounts, own all or substantially all of the shares of the Cova Portfolio and the SF Portfolio, as applicable, and are the shareholders of record of each such Portfolio at the close of business on the Record Date. The Insurance Companies are entitled to be present and vote at the Meeting with respect to such shares of the Cova Portfolio and the SF Portfolio. Each Insurance Company has undertaken to vote its shares of the Cova Portfolio or the SF Portfolio for the Contract Owners of that Portfolio in accordance with voting instructions received on a timely basis from those Contract Owners. In connection with the solicitation of such voting instructions, the Insurance Companies will furnish a copy of this Prospectus/Proxy Statement to Contract Owners. The number of shares as to which voting instructions may be given under a Contract is determined by the number of full and fractional shares of the Cova Portfolio or the SF Portfolio held in a separate account with respect to that particular Contract. In voting for a Reorganization, each full share of the SF Portfolio, and each full share of the Cova Portfolio attributable to a variable annuity, is entitled to one vote and any fractional share is entitled to a fractional vote. Each $100 of the account value of a variable life insurance policy allocated to the Cova Portfolio on the Record Date is entitled to one vote and fractional votes are counted. The close of business on January 19, 2001 is the last day on which voting instructions for the Meeting will be accepted by the Insurance Companies. Voting instructions may be revoked by executing and delivering later-dated signed voting instructions to your Insurance Company at any time prior to the close of business on January 19, 2001, or by attending the Meeting in person and instructing the Insurance Company how to vote your shares. Unless revoked, all valid voting instructions will be voted in accordance with the specifications thereon or, in the absence of such specifications, FOR approval of the Plan and the Reorganization contemplated thereby. If you wish to participate in the Meeting, you may submit the voting instructions form included with this Prospectus/Proxy Statement, transmit your voting instructions by fax or by the Internet or attend in person and provide your voting instructions to the Insurance Company. (Guidelines on providing voting instructions are immediately after the Notice of Special Meeting.) If the enclosed voting instructions form is properly executed and returned in time to be voted at the Meeting, the shares of beneficial interest represented by the voting instructions form will be voted in accordance with the instructions marked on the returned voting instructions form. o Unless instructions to the contrary are marked on the voting instructions form, it will be voted FOR a proposed Reorganization and FOR any other matters deemed appropriate. o Voting instructions forms which are properly executed and returned but are not marked with voting instructions will be voted FOR a proposed Reorganization and FOR any other matters deemed appropriate. Interests in Contracts for which no timely voting instructions are received will be voted in the same proportion as an Insurance Company votes shares for which it has received voting instructions from other Contract Owners. An Insurance Company will also vote any shares in its general account which are not attributable to Contracts in the same proportion as it votes shares held in all of the Insurance Company's registered separate accounts, in the aggregate. Shares which represent interests in the Cova Portfolio or the SF Portfolio vote separately on the Reorganization and those matters pertaining only to that Portfolio. Approval of a Reorganization will require the affirmative vote of a majority of the shares of Cova Quality Bond, present in person or by proxy and entitled to vote, assuming a quorum is present (the presence in person or by proxy of a majority, i.e. greater than 50%, of the Portfolio's outstanding shares). Approval of the Reorganization will require the affirmative vote of a majority of the shares of SF Bond cast at a shareholders' meeting duly called and at which a quorum is present (the presence in person or by proxy of holders entitled to cast a majority of the votes at any shareholders' meeting). As of the Record Date, the sole shareholders of record or substantially all of the shareholders of record of Cova Series Trust and Security First Trust were the Insurance Companies. Since the Insurance Companies are the legal owners of all or substantially all of the shares, attendance by the Insurance Companies at the Meeting will constitute a quorum under the Declarations of Trust of Cova Series Trust and Security First Trust. Voting instructions solicitations will be made primarily by mail, but beginning on or about January 3, 2001 voting instructions solicitations may also be made by telephone, through the Internet or personal solicitations conducted by officers and employees of Cova Investment Advisory Corporation, the investment adviser of Cova Series Trust, and Met Investors Advisory Corp., the investment adviser of Security First Trust, their affiliates or other representatives of the Cova Portfolio and the SF Portfolio (who will not be paid for their soliciting activities). In addition, voting instructions solicitations may be made by ALAMO Direct, the Cova Portfolio's and the SF Portfolio's proxy solicitor. The estimated cost of the voting instructions solicitation is approximately $14,500. The costs of solicitation and the expenses incurred in connection with preparing this Prospectus/Proxy Statement and its enclosures will be paid by MetLife or one of its affiliates. Neither Cova Series Trust, the Security First Trust nor the Contract Owners will bear any costs associated with the Meeting, this proxy solicitation or any adjourned session. If shareholders of the Cova Portfolio or of the SF Portfolio do not vote to approve the applicable Reorganization, the Trustees of Cova Series Trust or Security First Trust will consider other possible courses of action in the best interests of shareholders. If sufficient votes to approve a Reorganization are not received, the persons named as proxies on a proxy form sent to the Record Holders may propose one or more adjournments of the Meeting to permit further solicitation of voting instructions. In determining whether to adjourn the Meeting, the following factors may be considered: the percentage of votes actually cast, the percentage of negative votes actually cast, the nature of any further solicitation and the information to be provided to shareholders with respect to the reasons for the solicitation. Any adjournment will require an affirmative vote of a majority of those shares represented at the Meeting in person or by proxy. The persons named as proxies will vote upon such adjournment after consideration of all circumstances which may bear upon a decision to adjourn the Meeting. A shareholder of the Cova Portfolio or the SF Portfolio who objects to the proposed Reorganization will not be entitled under Massachusetts law or with respect to the SF Portfolio, the Declaration of Trust of Security First Trust, to demand payment for, or an appraisal of, his or her shares. However, shareholders should be aware that each Reorganization as proposed is not expected to result in recognition of gain or loss to the Record Holders or Contract Owners for federal income tax purposes. In addition, if a Reorganization is consummated, the rights of shareholders to transfer their account balances among investment options available under the Contracts or to make withdrawals under the Contracts will not be affected. Neither Cova Series Trust nor Security First Trust holds annual shareholder meetings. If a Reorganization is not approved, shareholders wishing to submit proposals to be considered for inclusion in a proxy statement for a subsequent shareholder meeting should send their written proposals to the Secretary of Cova Series Trust or the Secretary of Security First Trust at the addresses set forth on the cover of this Prospectus/Proxy Statement so that they will be received by the Trust in a reasonable period of time prior to that meeting. The votes of the shareholders of the Met Portfolio are not being solicited by this Prospectus/Proxy Statement and are not required to carry out the Reorganizations. Shareholder Information The Record Holders of the Cova Portfolio and the SF Portfolio at the close of business on November 27, 2000 (the Record Date) will be entitled to be present and vote at the Meeting with respect to shares of the Cova Portfolio and the SF Portfolio owned as of the Record Date. As of the Record Date, the total number of shares of the Cova Portfolio and the SF Portfolio outstanding and entitled to vote was as follows:
As of November 27, 2000, the officers and Trustees of Cova Series Trust, of Security First Trust and of Met Investors Series Trust beneficially owned as a group less than 1% of the outstanding shares of the Cova Portfolio, the SF Portfolio and the Met Portfolio, respectively. Control Persons and Principal Holders of Securities On November 27, 2000 to the knowledge of the Trustees and management of Cova Series Trust, the following entities together owned of record over 100% of the shares of Cova Quality Bond:
On November 27, 2000 to the knowledge of the Trustees and management of Security First Trust, Security First Life Separate Account A owned of record 99.57% of the shares of SF Bond, and the Security First Group Employees 401(k) Plan owned 0.43% of the shares of SF Bond. The Insurance Companies have advised Cova Series Trust that as of November 27, 2000 there were no persons owning Contracts which would entitle them to instruct the Insurance Companies with respect to more than 5% of the voting securities of Cova Series Trust. Security First Life Insurance Company has advised Security First Trust that as of November 27, 2000 the following persons owned contracts which would entitle them to instruct Security First Life Insurance Company with respect to more than 5% of the voting securities of Security First Trust: SF Bond:
As of the date of this Prospectus/Proxy Statement, Security First Life Insurance Company owned 100% of the outstanding shares of Met Investors Series Trust and as a result may be deemed to be a control person with respect to the Trust. FINANCIAL STATEMENTS AND EXPERTS The Annual Report of Cova Series Trust relating to Cova Quality Bond, for the year ended as of December 31, 1999, and the financial statements and financial highlights for the periods indicated therein, has been incorporated by reference herein and in the Registration Statement in reliance upon the report of KPMG LLP, independent auditors, incorporated by reference herein, and upon the authority of said firm as experts in accounting and auditing. The Annual Report of Security First Trust relating to the SF Bond, for the year ended as of July 31, 2000, and the financial statements and financial highlights for the periods indicated therein, has been incorporated by reference herein and in the Registration Statement in reliance upon the report of Deloitte & Touche LLP, independent certified public accountants, incorporated by reference herein, and upon the authority of said firm as experts in accounting and auditing. LEGAL MATTERS Certain legal matters concerning the issuance of shares of Met JPM Quality Bond will be passed upon by Sullivan & Worcester LLP, Washington, D.C. ADDITIONAL INFORMATION Cova Series Trust and Security First Trust are, and Met Investors Series Trust will be, each subject to the informational requirements of the Securities Exchange Act of 1934 and the 1940 Act, and in accordance therewith file reports and other information including proxy material and charter documents with the SEC. Met Investors Series Trust has filed a registration statement with the SEC which will also be subject to the SEC's information requirements when it becomes effective. These items can be inspected and copied at the Public Reference Facilities maintained by the SEC at 450 Fifth Street, N.W., Washington, D.C. 20549, and at the SEC's Regional Offices located at Northwest Atrium Center, 500 West Madison Street, Chicago, Illinois 60661-2511 and Seven World Trade Center, Suite 1300, New York, New York 10048. Copies of such materials can also be obtained at prescribed rates from the Public Reference Branch, Office of Consumer Affairs and Information Services, Securities and Exchange Commission, Washington, D.C. 20549. The following additional information supplements information about Met JPM Quality Bond contained elsewhere in the Prospectus/Proxy Statement. Principal Investment Strategies
The Met Portfolio in this Prospectus/Proxy Statement is a mutual fund:
The Adviser may sell a portfolio security when the value of the investment reaches or exceeds its estimated fair value, to take advantage of more attractive fixed income yield opportunities, when the issuer's investment fundamentals begin to deteriorate, when the Portfolio must meet redemptions, or for other investment reasons. Met JPM Quality Bond will invest at least 65% of its total assets in investment grade fixed income securities under normal circumstances. The Portfolio invests in broad sectors of the fixed income market, including U.S. government and agency securities, corporate securities including bonds, debentures and notes, asset-backed securities and mortgage-backed and mortgage related securities. The Adviser actively manages the Portfolio's duration, the allocation of securities across market sectors, and the selection of specific securities within sectors. Based on fundamental, economic and capital markets research, the Adviser adjusts the duration of the Portfolio in light of market conditions and the Adviser's interest rate outlook. For example, if interest rates are expected to fall, the duration may be lengthened to take advantage of the expected associated increase in bond prices. The Adviser selects specific securities which it believes are undervalued for purchase using: advanced quantitative tools, analysis of credit risk, the expertise of a dedicated trading desk, and the judgment of fixed income portfolio managers and analysts. A security is considered undervalued when its price is lower than one would expect for an investment of similar quality, duration and structural characteristics. Under normal market conditions, the Portfolio's duration will range between one year shorter and one year longer than the duration of the U.S. investment grade fixed income universe, as represented by Salomon Brothers Broad Investment Grade Bond Index, the Portfolio's benchmark. Currently, the benchmark's duration is approximately 5 years. The maturities of the individual securities in the Portfolio may vary widely, however. The Portfolio may invest in obligations issued or guaranteed by the U.S. government and backed by the full faith and credit of the United States including Treasury securities and GNMA certificates as well as obligations issued or guaranteed by U.S. government agencies or instrumentalities where the Portfolio must look principally to the issuing or guaranteeing agency for ultimate repayment. Some examples of agencies or instrumentalities issuing these obligations are the Federal Farm Credit System, the Federal Home Loan Banks and the Federal National Mortgage Association. The Portfolio may also invest in municipal obligations that have been issued on a taxable basis or that have an attractive yield excluding tax considerations. It is a current policy of the Portfolio that under normal circumstances at least 65% of its total assets will consist of investment grade securities that are rated at least A by Standard & Poor's Ratings Services ("Standard & Poor's") or that are unrated and in the Adviser's opinion are of comparable quality. In the case of 30% of the Portfolio's investments, the Portfolio may purchase investment grade securities that are rated Baa or better by Moody's Investors Services, Inc. ("Moody's") or BBB or better by Standard & Poor's or are unrated and in the Adviser's opinion are of comparable quality. The Portfolio may invest up to 20% of its assets in foreign debt securities, including Eurodollar bonds and Yankee bonds and securities of foreign governments and governmental entities. The Portfolio may also invest in debt securities of issuers located in emerging market countries. The Portfolio may keep a portion of its assets in cash or cash equivalents such as high quality short-term debt obligations including bankers' acceptances, commercial paper, certificates of deposit, Eurodollar obligations, variable amount master demand notes and money market mutual funds. Investments in cash or similar liquid securities (cash equivalents)generally do not provide as high a return as would assets invested in other types of securities. The Adviser may, when consistent with the Portfolio's investment objective, use options or futures for hedging and for risk management (i.e., to adjust duration or yield curve exposure, or to establish or adjust exposure to particular securities markets, or currencies); risk management may include management of the Portfolio's exposure relative to its benchmark. Additional Investment Strategies In addition to its principal investment strategies discussed above, Met JPM Quality Bond, as indicated, may at times invest a portion of its assets in the investment strategies and may engage in certain investment techniques as described below. The Statement of Additional Information relating to this Prospectus/Proxy Statement provides a more detailed discussion of certain of these and other securities and indicates if the Portfolio is subject to any limitations with respect to a particular investment strategy. These strategies and techniques may involve risks. (Please note that some of these strategies may be a principal investment strategy for the Portfolio and consequently are also described above.) The Portfolio is not limited by this discussion and may invest in other types of securities not precluded by the policies discussed elsewhere in this Prospectus/Proxy Statement. Brady Bonds. Brady Bonds are collateralized or uncollaterlized fixed income securities created through the exchange of existing commercial bank loans to public and private entities in certain emerging markets for new bonds in connection with debt restructurings. Brady Bonds have been issued only recently and, accordingly do not have a long payment history. These securities are subject to credit risk and interest rate risk. Convertible Securities. Convertible securities are preferred stocks or bonds that pay a fixed dividend or interest payment and are convertible into common stock at a specified price or conversion ratio. Traditionally, convertible securities have paid dividends or interest rates higher than common stocks but lower than nonconvertible securities. They generally participate in the appreciation or depreciation of the underlying stock into which they are convertible, but to a lesser degree. These securities are also subject to market risk, and interest rate risk and credit risk. Direct Participation in Corporate Loans. By purchasing a loan, the Portfolio acquires some or all of the interest of a bank or other lending institution in a loan to a corporate borrower. Many such loans are secured, and most impose restrictive covenants which must be met by the borrower. These loans are made generally to finance internal growth, mergers, acquisitions, stock repurchases, leveraged buy-outs and other corporate activities. such loans may be in default at the time of purchase. The Portfolio may also purchase trade or other claims against companies, which generally represent money owed by the company to a supplier of goods or services. These claims may also be purchased at a time when the company is in default. Certain of the loans acquired by the Portfolio may involve revolving credit facilities or other standby financing commitments which obligate the Portfolio to pay additional cash on certain date or on demand. The highly leveraged nature of many such loans may make such loans especially vulnerable to adverse changes in economic or market conditions. Loans and other direct investments may not be in the form of securities or may be subject to restrictions on transfer, and only limited opportunities may exist to resell such instruments. As a result, the Portfolio may be unable to sell such investments at an opportune time or may have to resell them at less than fair market value. Dollar Roll Transactions. Dollar roll transactions are comprised of the sale by the Portfolio of mortgage-based or other fixed income securities, together with a commitment to purchase similar, but not identical, securities at a future date. In addition, the Portfolio is paid a fee as consideration for entering into the commitment to purchase. Dollar rolls may be renewed after cash settlement and initially may involve only a firm commitment agreement by the Portfolio to buy a security. Dollar roll transactions are treated as borrowings for purposes of the 1940 Act, and the aggregate of such transactions and all other borrowings of the Portfolio (including reverse repurchase agreements) will be subject to the requirement that the Portfolio maintain asset coverage of 300% for all borrowings. If the broker-dealer to whom the Portfolio sells the security becomes insolvent, the Portfolio's right to purchase or repurchase the security may be restricted; the value of the security may change adversely over the term of the dollar roll; the security that the Portfolio is required to repurchase may be worth less than the security that the Portfolio originally held; and the return earned by the Portfolio with the proceeds of a dollar roll may not exceed transaction costs. Foreign Currency Transactions. Foreign currency transactions are entered into for the purpose of hedging against foreign exchange risk arising from the Portfolio's investment or anticipated investment in securities denominated in foreign currencies. The Portfolio also may enter into these contracts for purposes of increasing exposure to a foreign currency or to shift exposure to foreign currency fluctuations from one country to another. Foreign currency transactions include the purchase of foreign currency on a spot (or cash) basis, contracts to purchase or sell foreign currencies at a future date (forward contracts), the purchase and sale of foreign currency futures contracts, and the purchase of exchange traded and over-the-counter call and put options on foreign currency futures contracts and on foreign currencies. These hedging transactions do not eliminate fluctuations in the underlying prices of the securities which the Portfolio owns or intends to purchase or sell. They simply establish a rate of exchange which can be achieved at some future point in time. Foreign currency exchange rates may fluctuate significantly over short periods of time. A forward foreign currency exchange contract reduces the Portfolio's exposure to changes in the value of the currency it will deliver and increases its exposure to changes in the value of the currency it will exchange into. Contracts to sell foreign currency will limit any potential gain which might be realized by the Portfolio if the value of the hedged currency increases. In the case of forward contracts entered into for the purpose of increasing return, the Portfolio may sustain losses which will reduce its gross income. Forward foreign currency exchange contracts also involve the risk that the party with which the Portfolio enters the contract may fail to perform its obligations to the Portfolio. The purchase and sale of foreign currency futures contracts and the purchase of call and put options on foreign currency futures contracts and on foreign currencies involve certain risks associated with derivatives.
Forward Commitments, When-Issued and Delayed Delivery Securities. Forward
commitments, when-issued and delayed delivery securities generally involve the
purchase of a security with payment and delivery at some time in the future -
Hybrid Instruments. Hybrid instruments were recently developed and combine the elements of futures contracts or options with those of debt, preferred equity or a depositary instrument. They are often indexed to the price of a commodity, particular currency, or a domestic or foreign debt or equity security index. Examples of hybrid instruments include debt instruments with interest or principal payments or redemption terms determined by reference to the value of a currency or commodity or securities index at a future point in time or preferred stock with dividend rates determined by reference to the value of a currency. Hybrids may bear interest or pay dividends at below market (or even relatively nominal) rates. Under certain conditions, the redemption value of the instrument could be zero. Hybrids can have volatile prices and limited liquidity and their use by the Portfolio may not be successful. Illiquid and Restricted Securities. The Portfolio may invest a portion of its assets in restricted and illiquid securities, which are investments that the Portfolio cannot easily resell within seven days at current value or that have contractual or legal restrictions on resale. If the Portfolio buys illiquid securities it may be unable to quickly resell them or may be able to sell them only at a price below current value or could have difficulty valuing these holdings precisely. Interest Rate Transactions. Interest rate transactions are hedging transactions such as interest rate swaps and the purchase or sale of interest rate caps and floors. They are used by the Portfolio in an attempt to protect the value of its investments from interest rate fluctuations. Interest rate swaps involve the exchange by the Portfolio with another party of their respective commitments to pay or receive interest, e.g., an exchange of floating rate payments for fixed rate payments. The purchase of an interest rate cap entitles the purchaser, to the extent that a specified index exceeds a predetermined interest rate, to receive payments of interest on a notional principal amount from the party selling such interest rate cap. The purchase of an interest rate floor entitles the purchaser, to the extent that a specified index falls below a predetermined interest rate, to receive payments of interest on a notional principal amount from the party selling such interest rate floor. The Adviser enters into these transactions on behalf of the Portfolio primarily to preserve a return or spread on a particular investment or portion of its portfolio or to protect against any increase in the price of securities the Portfolio anticipates purchasing at a later date. The Portfolio will not sell interest rate caps or floors that it does not own. There is the risk that the Adviser may incorrectly predict the direction of interest rates resulting in losses to the Portfolio. Municipal Securities. Municipal securities are debt obligations issued by local, state and regional governments that provide interest income that is exempt from federal income tax. These securities are subject to interest rate risk and credit risk. PIK (pay-in-kind) Debt Securities and Zero-Coupon Bonds. PIK debt securities are debt obligations which provide that the issuer may, at its option, pay interest on such bonds in cash or in the form of additional debt obligations. Such investments benefit the issuer by mitigating its need for cash to meet debt service, but also require a higher rate of return to attract investors who are willing to defer receipt of such cash. Zero-coupon bonds are bonds that provide for no current interest payment and are sold at a discount. These investments pay no interest in cash to their holder during their life and usually trade at a deep discount from their face or par value. These investments may experience greater volatility in market value due to changes in interest rates than debt obligations which make regular payments of interest. The Portfolio will accrue income on such investments for tax accounting purposes, as required, which is distributable to shareholders and which, because no cash is received at the time of accrual, may require the liquidation of other portfolio securities to satisfy the Portfolio's distribution obligations. These securities are subject to credit risk and interest rate risk. Preferred Stocks. Preferred stocks are equity securities that generally pay dividends at a specified rate and have preference over common stock in the payment of dividends and liquidation. Preferred stock generally does not carry voting rights. Preferred stocks are subject to market risk. In addition, because preferred stocks pay fixed dividends, an increase in interest rates may cause the price of a preferred stock to fall. Repurchase Agreements. Repurchase agreements involve the purchase of a security by the Portfolio and a simultaneous agreement by the seller (generally a bank or dealer) to repurchase the security from the Portfolio at a specified date or upon demand. This technique offers a method of earning income on idle cash. Repurchase agreements involve credit risk, i.e. the risk that the seller will fail to repurchase the security, as agreed. In that case, the Portfolio will bear the risk of market value fluctuations until the security can be sold and may encounter delays and incur costs in liquidating the security. Reverse Repurchase Agreements. Reverse repurchase agreements involve the sale of a security by the Portfolio to another party (generally a bank or dealer) in return for cash and an agreement by the Portfolio to buy the security back at a specified price and time. Reverse repurchase agreements will be used primarily to provide cash to satisfy unusually high redemption requests or for other temporary or emergency purposes. Reverse repurchase agreements are considered a form of borrowing by the Portfolio and, therefore, are a form of leverage. Leverage may cause any gains or losses of the Portfolio to be magnified. Securities Loans. The Portfolio may make secured loans of its portfolio securities. The risks in lending Portfolio securities, as with other extensions of secured credit, consist of possible delay in receiving additional collateral, or in the recovery of the securities or possible loss of rights in their collateral should the borrower fail financially. Downgrades in Fixed Income Debt Securities Unless required by applicable law, the Portfolio is not required to sell or dispose of any debt security that either loses its rating or has its rating reduced after the Portfolio purchases the security. Management Met Investors Series Trust's Board of Trustees is responsible for managing the business affairs of the Trust. The Trustees meet periodically to review the affairs of the Trust and to establish certain guidelines which the Manager and Adviser are expected to follow in implementing the investment policies and objectives of the Trust. The Trustees also review the management of the Portfolio's assets by the Adviser. Information about the Trustees and executive officers of the Trust is contained in the Statement of Additional Information relating to this Prospectus/Proxy Statement. Expense Limitation Agreement In the interest of limiting expenses of Met JPM Quality Bond at least until February, 2002, the Manager has entered into an expense limitation agreement with Met Investor Series Trust with respect to the Portfolio ("Expense Limitation Agreement"). Pursuant to that Expense Limitation Agreement, the Manager has agreed to waive or limit its fees and to assume other expenses so that the total annual operating expenses of the Portfolio other than interest, taxes, brokerage commissions, other expenditures which are capitalized in accordance with generally accepted accounting principles, other extraordinary expenses not incurred in the ordinary course of the Portfolio's business and amounts payable pursuant to a plan adopted in accordance with Rule 12b-1 under the 1940 Act, are limited to 0.60% of the Portfolio's daily net assets. The Portfolio may at a later date reimburse to the Manager the management fees waived or limited and other expenses assumed and paid by the Manager pursuant to the Expense Limitation Agreement provided the Portfolio has reached a sufficient asset size to permit such reimbursement to be made without causing the total annual expense ratio of the Portfolio to exceed the percentage limit stated above. Consequently, no reimbursement by the Portfolio will be made unless: (i) the Portfolio's assets exceed $100 million; (ii) the Portfolio's total annual expense ratio is less than the percentage stated above; and (iii) the payment of such reimbursement has been approved by Met Investor Series Trust's Board of Trustees on a quarterly basis. The total amount of reimbursement to which the Manager may be entitled will equal, at any time, the sum of (i) all investment management fees previously waived or reduced by the Manager and (ii) all other payments previously remitted by the Manager to the Portfolio during any of the previous five fiscal years, less any reimbursement that the Portfolio has previously paid to the Manager with respect to (a) such investment management fees previously waived or reduced and (b) such other payments previously remitted by the Manager to the Portfolio. The Adviser Met Investors Series Trust and the Manager have filed an application requesting an exemptive order from the SEC that will permit the Manager, subject to certain conditions, and without the approval of shareholders to: (a) employ a new unaffiliated investment adviser for the Portfolio pursuant to the terms of a new investment advisory agreement, in each case either as a replacement for the existing Adviser or as an additional investment adviser; (b) change the terms of the investment advisory agreement; and (c) continue the employment of the existing Adviser on the same advisory contract terms where a contract has been assigned because of a change in control of the Adviser. In such circumstances, shareholders would receive notice of such action, including the information concerning the Adviser that normally is provided in a proxy statement. The exemptive order would also permit disclosure of fees paid to multiple unaffiliated investment advisers of the Portfolio on an aggregate basis only. There is no assurance that the SEC will grant the Met Investors Series Trust's and the Manager's application. If the SEC grants the exemptive application, the requested order will become effective without the need for further shareholder approval. The Manager pays the Adviser a fee based on the Portfolio's average daily net assets. The Portfolio is not responsible for the fees paid to the Adviser. Taxes Met JPM Quality Bond expects to qualify and to continue to qualify as a regulated investment company under Subchapter M of the Code. As qualified, the Portfolio is not subject to federal income tax on that part of its taxable income that it distributes to the Record Holders. Taxable income consists generally of net investment income, and any capital gains. It is the Portfolio's intention to distribute all such income and gains. Shares of the Portfolio are currently offered only to the separate accounts of the Insurance Companies and to qualified pension and retirement plans. Separate accounts are insurance company separate accounts that fund the policies and the annuity contracts. Under the Code, an insurance company pays no tax with respect to income of a qualifying separate account when the income is properly allocable to the value of eligible variable annuity or variable life insurance contracts. For a discussion of the taxation of life insurance companies and the separate accounts, as well as the tax treatment of the policies and annuity contracts and the holders thereof, see the discussion of federal income tax considerations included in the respective prospectuses for the Contracts. Section 817(h) of the Code and the regulations thereunder impose "diversification" requirements on the assets underlying a Contract. Each Portfolio intends to maintain diversification which will allow each Contract to satisfy these requirements. These requirements are in addition to the diversification requirements imposed on the Portfolio by Subchapter M and the 1940 Act. Technically, the section 817(h) requirements provide that, with limited exceptions, as of the end of each calendar quarter or within thirty days thereafter no more than 55% of the assets underlying a Contract may be represented by any one investment, no more than 70% by any two investments, no more than 80% by any three investments, and no more than 90% by any four investments. For this purpose, an investment in the Portfolio is treated not as a single investment but as an investment in each asset owned by the Portfolio, so long as shares of the Portfolio are owned only by separate accounts of insurance companies, by qualified pension and retirement plans, and by a limited class of other investors. The Portfolio is and will be so owned. Thus so long as the Portfolio meets the section 817(h) diversification tests, each Contract will also meet those tests. The foregoing is only a summary of some of the important federal income tax considerations generally affecting the Portfolio and its shareholders; see the Statement of Additional Information relating to this Prospectus/Proxy Statement for a more detailed discussion. Shareholders are urged to consult their tax advisers. Report to Policyholders The fiscal year of the Portfolio ends on December 31 of each year. Met Investor Series Trust will send its shareholders, at least semi-annually, reports which show the Portfolio's composition and other information. An annual report, with audited information, will be sent to shareholders each year. Sales and Purchases of Shares Met Investors Series Trust does not sell its shares directly to the public. Met Investors Series Trust continuously sells shares of the Portfolio only to the separate accounts of the Insurance Companies and to qualified pension and profit-sharing plans. It could also offer shares to other separate accounts of other insurers if approved by the Board of Trustees. Purchase and Redemption of Shares MDI is the principal underwriter and distributor of the Contracts. MDI places orders for the purchase or redemption of shares of the Portfolio based on, among other things, the amount of net Contract premiums or purchase payments transferred to the separate accounts, transfers to or from a separate account investment division and benefit payments to be effected on a given date pursuant to the terms of the Contracts. Such orders are effected, without sales charge, at the net asset value per share for the Portfolio determined on that same date. Shares are sold and redeemed at their net asset value without the imposition of any sales commission or redemption charge. Class A shares are not subject to a Rule 12b-1 fee. (However, certain sales or other charges may apply to the Contracts, as described in the respective Contract prospectuses.) Right to Restrict Transfers Neither Met Investor Series Trust nor the Contracts are designed for professional market timing organizations, other entities, or individuals using programmed, large and/or frequent transfers. The Insurance Companies, in coordination with the Trust's Manager, the Adviser, and the Trust's other investment advisers, reserve the right to temporarily or permanently refuse exchange requests if, in their judgment, the Portfolio would be unable to invest effectively in accordance with its investment objectives and policies, or would otherwise potentially be adversely affected. In particular, a pattern of exchanges that coincides with a "market timing" strategy may be disruptive to the Portfolio and therefore may be refused. Investors should consult their Contract prospectus for information on other specific limitations on the transfer privilege. Valuation of Shares Met JPM Quality Bond's net asset value per share is ordinarily determined once daily, as of the close of the regular session of business on the New York Stock Exchange (NYSE) (usually at 4:00 p.m., Eastern Time), on each day the NYSE is open. Net asset value of a Met JPM Quality Bond share is computed by dividing the value of the net assets of the Portfolio by the total number of shares outstanding in the Portfolio. Share prices for any transaction are those next calculated after receipt of an order. Except for money market instruments maturing in 60 days or less, securities held by the Portfolio are valued at market value. If market values are not readily available, securities are valued at fair value as determined by the Valuation Committee of Met Investor Series Trust's Board of Trustees. Money market instruments maturing in 60 days or less are valued on the amortized cost basis. OTHER BUSINESS The Trustees of Cova Series Trust and Security First Trust do not intend to present any other business at the Meeting. If, however, any other matters are properly brought before the Meeting, the persons named in the accompanying form of proxy will vote thereon in accordance with their judgment.
THE TRUSTEES OF COVA SERIES TRUST RECOMMEND APPROVAL OF THE PLAN
THE TRUSTEES OF SECURITY FIRST TRUST RECOMMEND APPROVAL OF THE PLAN
December 15, 2000
Exhibit A - 1 FORM OF AGREEMENT AND PLAN OF REORGANIZATION THIS AGREEMENT AND PLAN OF REORGANIZATION (the "Agreement") is made as of this 8th day of December, 2000, by and between Met Investors Series Trust, a Delaware business trust with its principal place of business at 610 Newport Center Drive, Suite 1350, Newport Beach, California 92660 (the "Trust"), with respect to its J.P. Morgan Quality Bond Portfolio series (the "Acquiring Fund"), and Security First Trust, a Massachusetts business trust with its principal place of business at 11365 West Olympic Boulevard, Los Angeles California 90064 ("Security First"), with respect to its Neuberger Berman Bond Series (the "Selling Fund"). This Agreement is intended to be, and is adopted as, a plan of reorganization and liquidation within the meaning of Section 368(a)(1)(C) of the United States Internal Revenue Code of 1986, as amended (the "Code"). The reorganization (the "Reorganization") will consist of (i) the transfer of all of the assets of the Selling Fund in exchange solely for Class A shares of beneficial interest, $.001 par value per share, of the Acquiring Fund (the "Acquiring Fund Shares"); (ii) the assumption by the Acquiring Fund of the identified liabilities of the Selling Fund; and (iii) the distribution, after the Closing Date hereinafter referred to, of the Acquiring Fund Shares to the shareholders of the Selling Fund in liquidation of the Selling Fund as provided herein, all upon the terms and conditions hereinafter set forth in this Agreement. WHEREAS, the Selling Fund and the Acquiring Fund are each a separate investment series of an open-end, registered investment company of the management type and the Selling Fund owns securities that generally are assets of the character in which the Acquiring Fund is permitted to invest; WHEREAS, both Funds are authorized to issue their shares of beneficial interest; WHEREAS, the Trustees of the Trust have determined that the exchange of all of the assets of the Selling Fund for Acquiring Fund Shares and the assumption of the identified liabilities of the Selling Fund by the Acquiring Fund on the terms and conditions hereinafter set forth are in the best interests of the Acquiring Fund's shareholders; WHEREAS, the Trustees of Security First have determined that the Selling Fund should exchange all of its assets and the identified liabilities for Acquiring Fund Shares and that the interests of the existing shareholders of the Selling Fund will not be diluted as a result of the transactions contemplated herein; NOW, THEREFORE, in consideration of the premises and of the covenants and agreements hereinafter set forth, the parties hereto covenant and agree as follows: ARTICLE I
TRANSFER OF ASSETS OF THE SELLING FUND IN EXCHANGE FOR
1.1 THE EXCHANGE. Subject to the terms and conditions herein set forth and on the basis of the representations and warranties contained herein, the Selling Fund agrees to transfer all of the Selling Fund's assets as set forth in paragraph 1.2 to the Acquiring Fund. The Acquiring Fund agrees in exchange therefor (i) to deliver to the Selling Fund the number of Acquiring Fund Shares, including fractional Acquiring Fund Shares, computed in the manner and as of the time and date set forth in paragraphs 2.2 and 2.3; and (ii) to assume the identified liabilities of the Selling Fund, as set forth in paragraph 1.3. Such transactions shall take place on the Closing Date provided for in paragraph 3.1. 1.2 ASSETS TO BE ACQUIRED. The assets of the Selling Fund to be acquired by the Acquiring Fund shall consist of all property, including, without limitation, all cash, securities, commodities, interests in futures and dividends or interest receivables, that is owned by the Selling Fund and any deferred or prepaid expenses shown as an asset on the books of the Selling Fund on the Closing Date. The Selling Fund has provided the Acquiring Fund with its most recent audited financial statements, which contain a list of all of Selling Fund's assets as of the date thereof. The Selling Fund hereby represents that as of the date of the execution of this Agreement there have been no changes in its financial position as reflected in said financial statements other than those occurring in the ordinary course of its business in connection with the purchase and sale of securities and the payment of its normal operating expenses. The Selling Fund reserves the right to sell any of such securities, but will not, without the prior written approval of the Acquiring Fund, acquire any additional securities other than securities of the type in which the Acquiring Fund is permitted to invest. The Acquiring Fund will, within a reasonable time prior to the Closing Date, furnish the Selling Fund with a list of the securities, if any, on the Selling Fund's list referred to in the second sentence of this paragraph that do not conform to the Acquiring Fund's investment objectives, policies, and restrictions. The Selling Fund will, within a reasonable period of time (not less than 30 days) prior to the Closing Date, furnish the Acquiring Fund with a list of its portfolio securities and other investments. In the event that the Selling Fund holds any investments that the Acquiring Fund may not hold, the Selling Fund, if requested by the Acquiring Fund, will dispose of such securities prior to the Closing Date. In addition, if it is determined that the Selling Fund and the Acquiring Fund portfolios, when aggregated, would contain investments exceeding certain percentage limitations imposed upon the Acquiring Fund with respect to such investments, the Selling Fund if requested by the Acquiring Fund will dispose of a sufficient amount of such investments as may be necessary to avoid violating such limitations as of the Closing Date. Notwithstanding the foregoing, nothing herein will require the Selling Fund to dispose of any investments or securities if, in the reasonable judgment of the Selling Fund, such disposition would adversely affect the tax-free nature of the Reorganization or would violate the Selling Fund's fiduciary duty to its shareholders. 1.3 LIABILITIES TO BE ASSUMED. The Selling Fund will endeavor to discharge all of its known liabilities and obligations prior to the Closing Date. The Acquiring Fund shall assume only those liabilities, expenses, costs, charges and reserves reflected on a Statement of Assets and Liabilities of the Selling Fund prepared on behalf of the Selling Fund, as of the Valuation Date (as defined in paragraph 2.1), in accordance with generally accepted accounting principles consistently applied from the prior audited period. The Acquiring Fund shall assume only those liabilities of the Selling Fund reflected in such Statement of Assets and Liabilities and shall not assume any other liabilities, whether absolute or contingent, known or unknown, accrued or unaccrued, all of which shall remain the obligation of the Selling Fund. 1.4 LIQUIDATION AND DISTRIBUTION. On or as soon after the Closing Date as is conveniently practicable (the "Liquidation Date"), (a) the Selling Fund will liquidate and distribute pro rata to the Selling Fund's shareholders of record, determined as of the close of business on the Valuation Date (the "Selling Fund Shareholders"), the Acquiring Fund Shares received by the Selling Fund pursuant to paragraph 1.1; and (b) the Selling Fund will thereupon proceed to dissolve as set forth in paragraph 1.8 below. Such liquidation and distribution will be accomplished by the transfer of the Acquiring Fund Shares then credited to the account of the Selling Fund on the books of the Acquiring Fund to open accounts on the share records of the Acquiring Fund in the names of the Selling Fund Shareholders and representing the respective pro rata number of the Acquiring Fund Shares due such shareholders. All issued and outstanding shares of the Selling Fund will simultaneously be canceled on the books of the Selling Fund. The Acquiring Fund shall not issue certificates representing the Acquiring Fund Shares in connection with such exchange. 1.5 OWNERSHIP OF SHARES. Ownership of Acquiring Fund Shares will be shown on the books of the Acquiring Fund's transfer agent. Shares of the Acquiring Fund will be issued in the manner described in the Prospectus/Proxy Statement on Form N-14 which has been distributed to shareholders of the Selling Fund as described in paragraph 4.1(o). 1.6 TRANSFER TAXES. Any transfer taxes payable upon issuance of the Acquiring Fund Shares in a name other than the registered holder of the Selling Fund shares on the books of the Selling Fund as of that time shall, as a condition of such issuance and transfer, be paid by the person to whom such Acquiring Fund Shares are to be issued and transferred. 1.7 REPORTING RESPONSIBILITY. Any reporting responsibility of the Selling Fund is and shall remain the responsibility of the Selling Fund up to and including the Closing Date and such later date on which the Selling Fund is terminated. 1.8 TERMINATION. The Selling Fund shall be terminated promptly following the Closing Date and the making of all distributions pursuant to paragraph 1.4. ARTICLE II VALUATION 2.1 VALUATION OF ASSETS. The value of the Selling Fund's assets to be acquired by the Acquiring Fund hereunder shall be the value of such assets computed as of the close of business on the New York Stock Exchange on the business day next preceding the Closing Date (such time and date being hereinafter called the "Valuation Date"), using the valuation procedures set forth in the Trust's Agreement and Declaration of Trust and the Acquiring Fund's then current prospectus and statement of additional information or such other valuation procedures as shall be mutually agreed upon by the parties. 2.2 VALUATION OF SHARES. The net asset value per share of the Acquiring Fund Shares shall be the net asset value per share computed as of the close of business on the New York Stock Exchange on the Valuation Date, using the valuation procedures set forth in the Trust's Agreement and Declaration of Trust and the Acquiring Fund's then current prospectus and statement of additional information. 2.3 SHARES TO BE ISSUED. The number of the Acquiring Fund Shares to be issued (including fractional shares, if any) in exchange for the Selling Fund's assets shall be determined by multiplying the outstanding shares of the Selling Fund by the ratio computed by dividing the net asset value per share of the Selling Fund by the net asset value per share of the Acquiring Fund determined in accordance with paragraph 2.2. 2.4 DETERMINATION OF VALUE. All computations of value shall be made by Investors Bank & Trust Company in accordance with its regular practice in pricing the shares and assets of the Acquiring Fund. ARTICLE III CLOSING AND CLOSING DATE 3.1 CLOSING DATE. The closing of the Reorganization (the "Closing") shall take place on or about February 5, 2001 or such other date as the parties may agree to in writing (the "Closing Date"). All acts taking place at the Closing shall be deemed to take place simultaneously immediately prior to the opening of business on the Closing Date unless otherwise provided. The Closing shall be held as of 9:00 a.m. Eastern time at the offices of the Trust, or at such other time and/or place as the parties may agree. 3.2 EFFECT OF SUSPENSION IN TRADING. In the event that on the Valuation Date (a) the New York Stock Exchange or another primary trading market for portfolio securities of the Acquiring Fund or the Selling Fund shall be closed to trading or trading thereon shall be restricted; or (b) trading or the reporting of trading on said Exchange or elsewhere shall be disrupted so that accurate appraisal of the value of the net assets of the Acquiring Fund or the Selling Fund is impracticable, the Valuation Date shall be postponed until the first business day after the day when trading shall have been fully resumed and reporting shall have been restored. 3.3 TRANSFER AGENT'S CERTIFICATE. The Bank of New York, as transfer agent for the Selling Fund at the Closing Date, shall deliver at the Closing a certificate of an authorized officer stating that its records contain the names and addresses of the Selling Fund Shareholders and the number and percentage ownership of outstanding shares owned by each such shareholder immediately prior to the Closing. The Acquiring Fund shall issue and deliver or cause Investors Bank & Trust Company, its transfer agent, to issue and deliver a confirmation evidencing the Acquiring Fund Shares to be credited on the Closing Date to the Secretary of Security First or provide evidence satisfactory to the Selling Fund that such Acquiring Fund Shares have been credited to the Selling Fund's account on the books of the Acquiring Fund. At the Closing, each party shall deliver to the other such bills of sale, checks, assignments, share certificates, if any, receipts and other documents as such other party or its counsel may reasonably request. ARTICLE IV REPRESENTATIONS AND WARRANTIES 4.1 REPRESENTATIONS OF THE SELLING FUND. The Selling Fund represents and warrants to the Acquiring Fund as follows: (a) The Selling Fund is a separate investment series of a business trust duly organized, validly existing, and in good standing under the laws of the Commonwealth of Massachusetts. (b) The Selling Fund is a separate investment series of a Massachusetts business trust that is registered as an investment company classified as a management company of the open-end type, and its registration with the Securities and Exchange Commission (the "Commission") as an investment company under the Investment Company Act of 1940, as amended (the "1940 Act"), is in full force and effect. (c) The current prospectus and statement of additional information of the Selling Fund conform in all material respects to the applicable requirements of the Securities Act of 1933, as amended (the "1933 Act"), and the 1940 Act and the rules and regulations of the Commission thereunder and do not include any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading. (d) The Selling Fund is not, and the execution, delivery, and performance of this Agreement (subject to shareholder approval) will not result, in violation of any provision of Security First's Declaration of Trust or By-Laws or of any material agreement, indenture, instrument, contract, lease, or other undertaking to which the Selling Fund is a party or by which it is bound. (e) The Selling Fund has no material contracts or other commitments (other than this Agreement) that will be terminated with liability to it prior to the Closing Date, except for liabilities, if any, to be discharged or reflected in the Statement of Assets and Liabilities as provided in paragraph 1.3 hereof. (f) Except as otherwise disclosed in writing to and accepted by the Acquiring Fund, no litigation, administrative proceeding, or investigation of or before any court or governmental body is presently pending or to its knowledge threatened against the Selling Fund or any of its properties or assets, which, if adversely determined, would materially and adversely affect its financial condition, the conduct of its business, or the ability of the Selling Fund to carry out the transactions contemplated by this Agreement. The Selling Fund knows of no facts that might form the basis for the institution of such proceedings and is not a party to or subject to the provisions of any order, decree, or judgment of any court or governmental body that materially and adversely affects its business or its ability to consummate the transactions herein contemplated. (g) The financial statements of the Selling Fund at July 31, 2000 are in accordance with generally accepted accounting principles consistently applied, and such statements (copies of which have been furnished to the Acquiring Fund) fairly reflect the financial condition of the Selling Fund as of such date, and there are no known contingent liabilities of the Selling Fund as of such date not disclosed therein. (h) Since July 31, 2000 there has not been any material adverse change in the Selling Fund's financial condition, assets, liabilities, or business other than changes occurring in the ordinary course of business, or any incurrence by the Selling Fund of indebtedness maturing more than one year from the date such indebtedness was incurred, except as otherwise disclosed to and accepted by the Acquiring Fund. For the purposes of this subparagraph (h), a decline in the net asset value of the Selling Fund shall not constitute a material adverse change. (i) At the Closing Date, all federal and other tax returns and reports of the Selling Fund required by law to have been filed by such dates shall have been filed, and all federal and other taxes shown due on said returns and reports shall have been paid, or provision shall have been made for the payment thereof. To the best of the Selling Fund's knowledge, no such return is currently under audit, and no assessment has been asserted with respect to such returns. (j) For each fiscal year of its operation, the Selling Fund has met the requirements of Subchapter M of the Code for qualification and treatment as a regulated investment company, has distributed in each such year all net investment income and realized capital gains and has met the diversification requirements of Section 817 (h) of the Code and the rules thereunder. (k) All issued and outstanding shares of the Selling Fund are, and at the Closing Date will be, duly and validly issued and outstanding, fully paid and non-assessable by the Selling Fund. All of the issued and outstanding shares of the Selling Fund will, at the time of the Closing Date, be held by the persons and in the amounts set forth in the records of the transfer agent as provided in paragraph 3.3. The Selling Fund does not have outstanding any options, warrants, or other rights to subscribe for or purchase any of the Selling Fund shares, nor is there outstanding any security convertible into any of the Selling Fund shares. (l) At the Closing Date, the Selling Fund will have good and marketable title to the Selling Fund's assets to be transferred to the Acquiring Fund pursuant to paragraph 1.2 and full right, power, and authority to sell, assign, transfer, and deliver such assets hereunder, and, upon delivery and payment for such assets, the Acquiring Fund will acquire good and marketable title thereto, subject to no restrictions on the full transfer thereof, including such restrictions as might arise under the 1933 Act, other than as disclosed to the Acquiring Fund and accepted by the Acquiring Fund. (m) The execution, delivery, and performance of this Agreement have been duly authorized by all necessary action on the part of the Selling Fund and, subject to approval by the Selling Fund's shareholders, this Agreement constitutes a valid and binding obligation of the Selling Fund, enforceable in accordance with its terms, subject as to enforcement, to bankruptcy, insolvency, reorganization, moratorium, and other laws relating to or affecting creditors' rights and to general equity principles. (n) The information furnished by the Selling Fund for use in no-action letters, applications for orders, registration statements, proxy materials, and other documents that may be necessary in connection with the transactions contemplated hereby is accurate and complete in all material respects and complies in all material respects with federal securities and other laws and regulations thereunder applicable thereto. (o) The Selling Fund has provided the Acquiring Fund with information reasonably necessary for the preparation of a prospectus, which included the proxy statement of the Selling Fund (the "Prospectus/Proxy Statement"), all of which was included in a Registration Statement on Form N-14 of the Acquiring Fund (the "Registration Statement"), in compliance with the 1933 Act, the Securities Exchange Act of 1934, as amended (the "1934 Act") and the 1940 Act in connection with the meeting of the shareholders of the Selling Fund to approve this Agreement and the transactions contemplated hereby. The Prospectus/Proxy Statement included in the Registration Statement (other than information therein that relates to the Acquiring Fund and any other fund described therein other than the Selling Fund) does not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which such statements were made, not misleading. 4.2 REPRESENTATIONS OF THE ACQUIRING FUND. The Acquiring Fund represents and warrants to the Selling Fund as follows: (a) The Acquiring Fund is a separate investment series of a Delaware business trust duly organized, validly existing and in good standing under the laws of the State of Delaware. (b) The Acquiring Fund is a separate investment series of a Delaware business trust that is registered as an investment company classified as a management company of the open-end type, and its registration with the Commission as an investment company under the 1940 Act is in full force and effect. (c) At the Closing Date, the current prospectus and statement of additional information of the Acquiring Fund will conform in all material respects to the applicable requirements of the 1933 Act and the 1940 Act and the rules and regulations of the Commission thereunder and will not include any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading. (d) The Acquiring Fund is not, and the execution, delivery and performance of this Agreement will not result, in violation of the Trust's Agreement and Declaration of Trust or By-Laws or of any material agreement, indenture, instrument, contract, lease, or other undertaking to which the Acquiring Fund is a party or by which it is bound. (e) Except as otherwise disclosed in writing to the Selling Fund and accepted by the Selling Fund, no litigation, administrative proceeding or investigation of or before any court or governmental body is presently pending or to its knowledge threatened against the Acquiring Fund or any of its properties or assets, which, if adversely determined, would materially and adversely affect its financial condition and the conduct of its business or the ability of the Acquiring Fund to carry out the transactions contemplated by this Agreement. The Acquiring Fund knows of no facts that might form the basis for the institution of such proceedings and is not a party to or subject to the provisions of any order, decree, or judgment of any court or governmental body that materially and adversely affects its business or its ability to consummate the transactions contemplated herein. (f) The Acquiring Fund has no known liabilities of a material amount, contingent or otherwise. (g) At the Closing Date, there will not be any material adverse change in the Acquiring Fund's financial condition, assets, liabilities, or business other than changes occurring in the ordinary course of business, or any incurrence by the Acquiring Fund of indebtedness maturing more than one year from the date such indebtedness was incurred, except as otherwise disclosed to and accepted by the Selling Fund. For the purposes of this subparagraph (g), a decline in the net asset value of the Acquiring Fund shall not constitute a material adverse change. (h) At the Closing Date, all federal and other tax returns and reports of the Acquiring Fund required by law then to be filed by such dates shall have been filed, and all federal and other taxes shown due on said returns and reports shall have been paid or provision shall have been made for the payment thereof. To the best of the Acquiring Fund's knowledge, no such return is currently under audit, and no assessment has been asserted with respect to such returns. (i) The Acquiring Fund expects to qualify for treatment as a regulated investment company under subchapter M of the Code, and expects to meet the diversification requirements of Section 817(h) of the Code and the rules thereunder, for its taxable year which includes the Closing Date. (j) All issued and outstanding Acquiring Fund Shares are, and at the Closing Date will be, duly and validly issued and outstanding, fully paid and non-assessable. The Acquiring Fund does not have outstanding any options, warrants, or other rights to subscribe for or purchase any Acquiring Fund Shares, nor is there outstanding any security convertible into any Acquiring Fund Shares. (k) The execution, delivery, and performance of this Agreement have been duly authorized by all necessary action on the part of the Acquiring Fund, and this Agreement constitutes a valid and binding obligation of the Acquiring Fund enforceable in accordance with its terms, subject as to enforcement, to bankruptcy, insolvency, reorganization, moratorium, and other laws relating to or affecting creditors' rights and to general equity principles. (l) The Acquiring Fund Shares to be issued and delivered to the Selling Fund, for the account of the Selling Fund Shareholders, pursuant to the terms of this Agreement will, at the Closing Date, have been duly authorized and, when so issued and delivered, will be duly and validly issued Acquiring Fund Shares, and will be fully paid and non-assessable. (m) The information furnished by the Acquiring Fund for use in no-action letters, applications for orders, registration statements, proxy materials, and other documents that may be necessary in connection with the transactions contemplated hereby is accurate and complete in all material respects and complies in all material respects with federal securities and other laws and regulations applicable thereto. (n) The Prospectus/Proxy Statement included in the Registration Statement (only insofar as it relates to the Acquiring Fund) does not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which such statements were made, not misleading. (o) The Acquiring Fund agrees to use all reasonable efforts to obtain the approvals and authorizations required by the 1933 Act, the 1940 Act, and such of the state Blue Sky or securities laws as it may deem appropriate in order to continue its operations after the Closing Date. ARTICLE V COVENANTS OF THE ACQUIRING FUND AND THE SELLING FUND 5.1 OPERATION IN ORDINARY COURSE. The Acquiring Fund and the Selling Fund each will operate its business in the ordinary course between the date hereof and the Closing Date, it being understood that such ordinary course of business will include customary dividends and distributions. 5.2 APPROVAL BY SHAREHOLDERS. Security First will call a meeting of the shareholders of the Selling Fund to consider and act upon this Agreement and to take all other action necessary to obtain approval of the transactions contemplated herein. 5.3 INVESTMENT REPRESENTATION. The Selling Fund covenants that the Acquiring Fund Shares to be issued hereunder are not being acquired for the purpose of making any distribution thereof other than in accordance with the terms of this Agreement. 5.4 ADDITIONAL INFORMATION. The Selling Fund will assist the Acquiring Fund in obtaining such information as the Acquiring Fund reasonably requests concerning the beneficial ownership of the Selling Fund shares. 5.5 FURTHER ACTION. Subject to the provisions of this Agreement, the Acquiring Fund and the Selling Fund will each take, or cause to be taken, all action, and do or cause to be done, all things reasonably necessary, proper or advisable to consummate and make effective the transactions contemplated by this Agreement, including any actions required to be taken after the Closing Date. 5.6 STATEMENT OF EARNINGS AND PROFITS. As promptly as practicable, but in any case within sixty days after the Closing Date, the Selling Fund shall furnish the Acquiring Fund, in such form as is reasonably satisfactory to the Acquiring Fund, a statement of the earnings and profits of the Selling Fund for federal income tax purposes that will be carried over by the Acquiring Fund as a result of Section 381 of the Code, and which will be reviewed by Deloitte & Touche LLP and certified by Security First's President, Vice President or Treasurer. ARTICLE VI CONDITIONS PRECEDENT TO OBLIGATIONS OF THE SELLING FUND The obligations of the Selling Fund to consummate the transactions provided for herein shall be subject, at its election, to the performance by the Acquiring Fund of all the obligations to be performed by it hereunder on or before the Closing Date, and, in addition thereto, the following further conditions: 6.1 All representations, covenants, and warranties of the Acquiring Fund contained in this Agreement shall be true and correct as of the date hereof and as of the Closing Date with the same force and effect as if made on and as of the Closing Date, and the Acquiring Fund shall have delivered to the Selling Fund a certificate executed in its name by the Trust's President or Vice President, in form and substance reasonably satisfactory to the Selling Fund and dated as of the Closing Date, to such effect and as to such other matters as the Selling Fund shall reasonably request. 6.2 The Selling Fund shall have received on the Closing Date an opinion from Sullivan & Worcester LLP, counsel to the Acquiring Fund, dated as of the Closing Date, in a form reasonably satisfactory to the Selling Fund, covering the following points: (a) The Acquiring Fund is a separate investment series of a Delaware business trust duly organized, validly existing and in good standing under the laws of the State of Delaware and has the power to own all of its properties and assets and to carry on its business as presently conducted. (b) The Acquiring Fund is a separate investment series of a Delaware business trust registered as an investment company under the 1940 Act, and, to such counsel's knowledge, such registration with the Commission as an investment company under the 1940 Act is in full force and effect. (c) This Agreement has been duly authorized, executed, and delivered by the Acquiring Fund and, assuming due authorization, execution and delivery of this Agreement by the Selling Fund, is a valid and binding obligation of the Acquiring Fund enforceable against the Acquiring Fund in accordance with its terms, subject as to enforcement, to bankruptcy, insolvency, reorganization, moratorium, and other laws relating to or affecting creditors' rights generally and to general equity principles. (d) Assuming that a consideration therefor not less than the net asset value thereof has been paid, the Acquiring Fund Shares to be issued and delivered to the Selling Fund on behalf of the Selling Fund Shareholders as provided by this Agreement are duly authorized and upon such delivery will be legally issued and outstanding and fully paid and non-assessable, and no shareholder of the Acquiring Fund has any preemptive rights in respect thereof. (e) The Registration Statement, to such counsel's knowledge, has been declared effective by the Commission and no stop order under the 1933 Act pertaining thereto has been issued, and to the knowledge of such counsel, no consent, approval, authorization or order of any court or governmental authority of the United States or the State of Delaware is required for consummation by the Acquiring Fund of the transactions contemplated herein, except such as have been obtained under the 1933 Act, the 1934 Act and the 1940 Act, and as may be required under state securities laws. (f) The execution and delivery of this Agreement did not, and the consummation of the transactions contemplated hereby will not, result in a violation of the Trust's Agreement and Declaration of Trust or By-Laws or any provision of any material agreement, indenture, instrument, contract, lease or other undertaking (in each case known to such counsel) to which the Acquiring Fund is a party or by which it or any of its properties may be bound or to the knowledge of such counsel, result in the acceleration of any obligation or the imposition of any penalty, under any agreement, judgment, or decree to which the Acquiring Fund is a party or by which it is bound. (g) Only insofar as they relate to the Acquiring Fund, the descriptions in the Prospectus/Proxy Statement of statutes, legal and governmental proceedings and material contracts, if any, are accurate and fairly present the information required to be shown. (h) Such counsel does not know of any legal or governmental proceedings, only insofar as they relate to the Acquiring Fund, existing on or before the effective date of the Registration Statement or the Closing Date required to be described in the Registration Statement or to be filed as exhibits to the Registration Statement which are not described or filed as required. (i) To the knowledge of such counsel, no litigation or administrative proceeding or investigation of or before any court or governmental body is presently pending or threatened as to the Acquiring Fund or any of its properties or assets and the Acquiring Fund is not a party to or subject to the provisions of any order, decree or judgment of any court or governmental body, which materially and adversely affects its business, other than as previously disclosed in the Registration Statement. Such counsel shall also state that they have participated in conferences with officers and other representatives of the Acquiring Fund at which the contents of the Prospectus/Proxy Statement and related matters were discussed and, although they are not passing upon and do not assume any responsibility for the accuracy, completeness or fairness of the statements contained in the Prospectus/Proxy Statement (except to the extent indicated in paragraph (g) of their above opinion), on the basis of the foregoing (relying as to materiality to a large extent upon the opinions of the Trust's officers and other representatives of the Acquiring Fund), no facts have come to their attention that lead them to believe that the Prospectus/Proxy Statement as of its date, as of the date of the meeting of the shareholders of the Selling Fund, and as of the Closing Date, contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein regarding the Acquiring Fund or necessary, in the light of the circumstances under which they were made, to make the statements therein regarding the Acquiring Fund not misleading. Such opinion may state that such counsel does not express any opinion or belief as to the financial statements or any financial or statistical data, or as to the information relating to the Selling Fund, contained in the Prospectus/Proxy Statement or the Registration Statement, and that such opinion is solely for the benefit of Security First and the Selling Fund. Such opinion shall contain such assumptions and limitations as shall be in the opinion of Sullivan & Worcester LLP appropriate to render the opinions expressed therein. In this paragraph 6.2, references to the Prospectus/Proxy Statement include and relate to only the text of such Prospectus/Proxy Statement and not to any exhibits or attachments thereto or to any documents incorporated by reference therein. ARTICLE VII CONDITIONS PRECEDENT TO OBLIGATIONS OF THE ACQUIRING FUND The obligations of the Acquiring Fund to complete the transactions provided for herein shall be subject, at its election, to the performance by the Selling Fund of all the obligations to be performed by it hereunder on or before the Closing Date and, in addition thereto, the following conditions: 7.1 All representations, covenants, and warranties of the Selling Fund contained in this Agreement shall be true and correct as of the date hereof and as of the Closing Date with the same force and effect as if made on and as of the Closing Date, and the Selling Fund shall have delivered to the Acquiring Fund on the Closing Date a certificate executed in its name by Security First's President or Vice President, in form and substance satisfactory to the Acquiring Fund and dated as of the Closing Date, to such effect and as to such other matters as the Acquiring Fund shall reasonably request. 7.2 The Selling Fund shall have delivered to the Acquiring Fund a statement of the Selling Fund's assets and liabilities, together with a list of the Selling Fund's portfolio securities showing the tax costs of such securities by lot and the holding periods of such securities, as of the Closing Date, certified by the Treasurer of Security First. 7.3 The Acquiring Fund shall have received on the Closing Date an opinion of Richard Pearson, Esq., President of Security First, in a form satisfactory to the Acquiring Fund covering the following points: (a) The Selling Fund is a separate investment series of a Massachusetts business trust duly organized, validly existing and in good standing under the laws of the Commonwealth of Massachusetts and has the power to own all of its properties and assets and to carry on its business as presently conducted. (b) The Selling Fund is a separate investment series of a Massachusetts business trust registered as an investment company under the 1940 Act, and, to such counsel's knowledge, such registration with the Commission as an investment company under the 1940 Act is in full force and effect. (c) This Agreement has been duly authorized, executed and delivered by the Selling Fund and, assuming due authorization, execution, and delivery of this Agreement by the Acquiring Fund, is a valid and binding obligation of the Selling Fund enforceable against the Selling Fund in accordance with its terms, subject as to enforcement, to bankruptcy, insolvency, reorganization, moratorium and other laws relating to or affecting creditors' rights generally and to general equity principles. (d) To the knowledge of such counsel, no consent, approval, authorization or order of any court or governmental authority of the United States or the Commonwealth of Massachusetts is required for consummation by the Selling Fund of the transactions contemplated herein, except such as have been obtained under the 1933 Act, the 1934 Act and the 1940 Act, and as may be required under state securities laws. (e) The execution and delivery of this Agreement did not, and the consummation of the transactions contemplated hereby will not, result in a violation of Security First's Declaration of Trust or By-laws, or to the knowledge of such counsel, any provision of any material agreement, indenture, instrument, contract, lease or other undertaking to which the Selling Fund is a party or by which it or any of its properties may be bound or, to the knowledge of such counsel, result in the acceleration of any obligation or the imposition of any penalty, under any agreement, judgment, or decree to which the Selling Fund is a party or by which it is bound. (f) Only insofar as they relate to the Selling Fund, the descriptions in the Prospectus/Proxy Statement of statutes, legal and government proceedings and material contracts, if any, are accurate and fairly present the information required to be shown. (g) To the knowledge of such counsel, there are no legal or governmental proceedings, only insofar as they relate to the Selling Fund existing on or before the effective date of the Registration Statement or the Closing Date, required to be described in the Registration Statement or to be filed as exhibits to the Registration Statement which are not described or filed as required. (h) To the knowledge of such counsel, no litigation or administrative proceeding or investigation of or before any court or governmental body is presently pending or threatened as to the Selling Fund or any of its respective properties or assets and the Selling Fund is neither a party to nor subject to the provisions of any order, decree or judgment of any court or governmental body, which materially and adversely affects its business other than as previously disclosed in the Prospectus/Proxy Statement. (i) Assuming that a consideration therefor of not less than the net asset value thereof has been paid, and assuming that such shares were issued in accordance with the terms of the Selling Fund's registration statement, or any amendment thereto, in effect at the time of such issuance, all issued and outstanding shares of the Selling Fund are legally issued and fully paid and non-assessable. Richard Pearson, Esq. shall also state that he has participated in conferences with officers and other representatives of the Selling Fund at which the contents of the Prospectus/Proxy Statement and related matters were discussed and, although he is not passing upon and does not assume any responsibility for the accuracy, completeness or fairness of the statements contained in the Prospectus/Proxy Statement (except to the extent indicated in paragraph (f) of his above opinion), on the basis of the foregoing (relying as to materiality to a large extent upon the opinions of Security First's officers and other representatives of the Selling Fund), no facts have come to his attention that lead him to believe that the Prospectus/Proxy Statement as of its date, as of the date of the meeting of the shareholders of the Selling Fund, and as of the Closing Date, contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein regarding the Selling Fund or necessary, in the light of the circumstances under which they were made, to make the statements therein regarding the Selling Fund not misleading. Such opinion may state that such counsel does not express any opinion or belief as to the financial statements or any financial or statistical data, or as to information relating to the Acquiring Fund, contained in the Prospectus/Proxy Statement or Registration Statement, and that such opinion is solely for the benefit of the Trust and the Acquiring Fund. Such opinion shall contain such other assumptions and limitations as shall be in the opinion of Richard Pearson, Esq. appropriate to render the opinions expressed therein, and shall indicate, with respect to matters of Massachusetts law that as Richard Pearson, Esq. is not admitted to the bar of Massachusetts, such opinions are based either upon the review of published statutes, cases and rules and regulations of the Commonwealth of Massachusetts or upon an opinion of Massachusetts counsel. In this paragraph 7.3, references to the Prospectus/Proxy Statement include and relate to only the text of such Prospectus/Proxy Statement and not to any exhibits or attachments thereto or to any documents incorporated by reference therein. ARTICLE VIII
FURTHER CONDITIONS PRECEDENT TO OBLIGATIONS OF THE ACQUIRING
If any of the conditions set forth below do not exist on or before the Closing Date with respect to the Selling Fund or the Acquiring Fund, the other party to this Agreement shall, at its option, not be required to consummate the transactions contemplated by this Agreement: 8.1 This Agreement and the transactions contemplated herein shall have been approved by the requisite vote of the holders of the outstanding shares of the Selling Fund in accordance with the provisions of Security First's Declaration of Trust and By-Laws and certified copies of the resolutions evidencing such approval shall have been delivered to the Acquiring Fund. Notwithstanding anything herein to the contrary, neither the Acquiring Fund or the Selling Fund may waive the conditions set forth in this paragraph 8.1. 8.2 On the Closing Date, the Commission shall not have issued an unfavorable report under Section 25(b) of the 1940 Act, nor instituted any proceeding seeking to enjoin the consummation of the transactions contemplated by this Agreement under Section 25(c) of the 1940 Act and no action, suit or other proceeding shall be threatened or pending before any court or governmental agency in which it is sought to restrain or prohibit, or obtain damages or other relief in connection with, this Agreement or the transactions contemplated herein. 8.3 All required consents of other parties and all other consents, orders, and permits of federal, state and local regulatory authorities (including those of the Commission and of state Blue Sky securities authorities, including any necessary "no-action" positions of and exemptive orders from such federal and state authorities) to permit consummation of the transactions contemplated hereby shall have been obtained, except where failure to obtain any such consent, order, or permit would not involve a risk of a material adverse effect on the assets or properties of the Acquiring Fund or the Selling Fund, provided that either party hereto may for itself waive any of such conditions. 8.4 The Registration Statement shall have become effective under the 1933 Act, and no stop orders suspending the effectiveness of the Registration Statement shall have been issued and, to the best knowledge of the parties hereto, no investigation or proceeding for that purpose shall have been instituted or be pending, threatened or contemplated under the 1933 Act. 8.5 The Selling Fund shall have declared a dividend or dividends which, together with all previous such dividends shall have the effect of distributing to the Selling Fund Shareholders all of the Selling Fund's investment company taxable income for all taxable periods ending on the Closing Date (computed without regard to any deduction for dividends paid) and all of the net capital gains realized in all taxable periods ending on the Closing Date (after reduction for any capital loss carryforward). 8.6 The parties shall have received a favorable opinion of Sullivan & Worcester LLP addressed to the Acquiring Fund and the Selling Fund substantially to the effect that for federal income tax purposes:
(a) The transfer of all of the Selling Fund assets in exchange
solely for the Acquiring Fund Shares and the assumption by the Acquiring Fund of
the identified liabilities of the Selling Fund followed by the distribution of
the Acquiring Fund Shares to the Selling Fund Shareholders in dissolution and
liquidation of the Selling Fund will constitute a "reorganization" within the
meaning of Section 368(a)(1)(C) of the Code, and the Acquiring Fund and the
Selling Fund will each be a "party to a reorganization" within the meaning of
(b) No gain or loss will be recognized by the Acquiring Fund upon the receipt of the assets of the Selling Fund solely in exchange for the Acquiring Fund Shares and the assumption by the Acquiring Fund of the identified liabilities of the Selling Fund. (c) No gain or loss will be recognized by the Selling Fund upon the transfer of the Selling Fund assets to the Acquiring Fund in exchange for the Acquiring Fund Shares and the assumption by the Acquiring Fund of the identified liabilities of the Selling Fund or upon the distribution (whether actual or constructive) of the Acquiring Fund Shares to Selling Fund Shareholders in exchange for their shares of the Selling Fund. (d) No gain or loss will be recognized by the Selling Fund Shareholders upon the exchange of their Selling Fund shares for the Acquiring Fund Shares in liquidation of the Selling Fund. (e) The aggregate tax basis for the Acquiring Fund Shares received by each Selling Fund Shareholder pursuant to the Reorganization will be the same as the aggregate tax basis of the Selling Fund shares held by such shareholder immediately prior to the Reorganization, and the holding period of the Acquiring Fund Shares to be received by each Selling Fund Shareholder will include the period during which the Selling Fund shares exchanged therefor were held by such shareholder (provided the Selling Fund shares were held as capital assets on the date of the Reorganization). (f) The tax basis of the Selling Fund assets acquired by the Acquiring Fund will be the same as the tax basis of such assets to the Selling Fund immediately prior to the Reorganization, and the holding period of the assets of the Selling Fund in the hands of the Acquiring Fund will include the period during which those assets were held by the Selling Fund. Notwithstanding anything herein to the contrary, neither the Acquiring Fund nor the Selling Fund may waive the conditions set forth in this paragraph 8.6. 8.7 The Acquiring Fund shall have received from Deloitte & Touche LLP a letter addressed to the Acquiring Fund, in form and substance satisfactory to the Acquiring Fund, to the effect that: (a) they are independent certified public accountants with respect to the Selling Fund within the meaning of the 1933 Act and the applicable published rules and regulations thereunder; (b) on the basis of limited procedures agreed upon by the Acquiring Fund and described in such letter (but not an examination in accordance with generally accepted auditing standards), the Capitalization Table appearing in the Registration Statement and Prospectus/Proxy Statement has been obtained from and is consistent with the accounting records of the Selling Fund; (c) on the basis of limited procedures agreed upon by the Acquiring Fund and described in such letter (but not an examination in accordance with generally accepted auditing standards), the pro forma financial statements that are included in the Registration Statement and Prospectus/Proxy Statement agree to the accounting records of the Acquiring Fund and the Selling Fund or with written estimates provided by each Fund's management, and were found to be mathematically correct; and (d) on the basis of limited procedures agreed upon by the Acquiring Fund and described in such letter (but not an examination in accordance with generally accepted auditing standards), the data utilized in the calculations of the pro forma expense ratios appearing in the Registration Statement and Prospectus/Proxy Statement agree with underlying accounting records of the Selling Fund or with written estimates by the Selling Fund's management and were found to be mathematically correct. In addition, unless waived by the Acquiring Fund, the Acquiring Fund shall have received from Deloitte & Touche LLP a letter addressed to the Acquiring Fund dated on the Closing Date, in form and substance satisfactory to the Acquiring Fund, to the effect that on the basis of limited procedures agreed upon by the Acquiring Fund (but not an examination in accordance with generally accepted auditing standards), the net asset value per share of the Selling Fund as of the Valuation Date was computed and the valuation of the portfolio was consistent with the valuation practices of the Acquiring Fund. 8.8 The Selling Fund shall have received from Deloitte & Touche LLP a letter addressed to the Selling Fund, in form and substance satisfactory to the Selling Fund, to the effect that: (a) they are independent certified public accountants with respect to the Acquiring Fund within the meaning of the 1933 Act and the applicable published rules and regulations thereunder; (b) they had performed limited procedures agreed upon by the Selling Fund and described in such letter (but not an examination in accordance with generally accepted auditing standards) which consisted of a reading of any unaudited pro forma financial statements included in the Registration Statement and Prospectus/Proxy Statement, and making inquiries of appropriate officials of the Trust responsible for financial and accounting matters whether such unaudited pro forma financial statements comply as to form in all material respects with the applicable accounting requirements of the 1933 Act and the published rules and regulations thereunder; (c) on the basis of limited procedures agreed upon by the Selling Fund and described in such letter (but not an examination in accordance with generally accepted auditing standards), the Capitalization Table appearing in the Registration Statement and Prospectus/Proxy Statement has been obtained from and is consistent with the accounting records of the Acquiring Fund; and (d) on the basis of limited procedures agreed upon by the Selling Fund (but not an examination in accordance with generally accepted auditing standards), the data utilized in the calculations of the pro forma expense ratios appearing in the Registration Statement and Prospectus/Proxy Statement agree with written estimates by each Fund's management and were found to be mathematically correct. ARTICLE IX EXPENSES
9.1 Except as otherwise provided for herein, all expenses of the
transactions contemplated by this Agreement incurred by the Selling Fund and the
Acquiring Fund, whether incurred before or after the date of this Agreement,
will be borne by Metropolitan Life Insurance Company or one of its affiliates.
Such expenses include, without limitation, (a) expenses incurred in connection
with the entering into and the carrying out of the provisions of this Agreement;
ARTICLE X ENTIRE AGREEMENT; SURVIVAL OF WARRANTIES 10.1 The Acquiring Fund and the Selling Fund agree that neither party has made any representation, warranty or covenant not set forth herein and that this Agreement constitutes the entire agreement between the parties. 10.2 The representations, warranties, and covenants contained in this Agreement or in any document delivered pursuant hereto or in connection herewith shall not survive the consummation of the transactions contemplated hereunder. ARTICLE XI TERMINATION 11.1 This Agreement may be terminated by the mutual agreement of the Acquiring Fund and the Selling Fund. In addition, either the Acquiring Fund or the Selling Fund may at its option terminate this Agreement at or prior to the Closing Date because: (a) of a breach by the other of any representation, warranty, or agreement contained herein to be performed at or prior to the Closing Date, if not cured within 30 days; or (b) a condition herein expressed to be precedent to the obligations of the terminating party has not been met and it reasonably appears that it will not or cannot be met. 11.2 In the event of any such termination, in the absence of willful default, there shall be no liability for damages on the part of either the Acquiring Fund, the Selling Fund, the Trust, Security First, the respective Trustees, or officers, to the other party or its Trustees, or officers, but each shall bear the expenses incurred by it incidental to the preparation and carrying out of this Agreement as provided in paragraph 9.1. ARTICLE XII AMENDMENTS 12.1 This Agreement may be amended, modified, or supplemented in such manner as may be mutually agreed upon in writing by the authorized officers of the Selling Fund and the Acquiring Fund; provided, however, that following the meeting of shareholders of the Selling Fund pursuant to paragraph 5.2 of this Agreement, no such amendment may have the effect of changing the provisions for determining the number of the Acquiring Fund Shares to be issued to the Selling Fund Shareholders under this Agreement to the detriment of such Shareholders without their further approval. ARTICLE XIII
HEADINGS; COUNTERPARTS; GOVERNING LAW; ASSIGNMENT;
13.1 The Article and paragraph headings contained in this Agreement are for reference purposes only and shall not affect in any way the meaning or interpretation of this Agreement. 13.2 This Agreement may be executed in any number of counterparts, each of which shall be deemed an original. 13.3 This Agreement shall be governed by and construed in accordance with the laws of the State of Delaware, without giving effect to the conflicts of laws provisions thereof; provided, however, that the due authorization, execution and delivery of this Agreement, in the case of the Selling Fund, shall be governed and construed in accordance with the laws of the Commonwealth of Massachusetts, without giving effect to the conflicts of laws provisions thereof. 13.4 This Agreement shall bind and inure to the benefit of the parties hereto and their respective successors and assigns, but, except as provided in this paragraph, no assignment or transfer hereof or of any rights or obligations hereunder shall be made by any party without the written consent of the other party. Nothing herein expressed or implied is intended or shall be construed to confer upon or give any person, firm, or corporation, other than the parties hereto and their respective successors and assigns, any rights or remedies under or by reason of this Agreement. 13.5 With respect to both Security First and the Trust, the names used herein refer respectively to the trust created and, as the case may be, the Trustees, as trustees but not individually or personally, acting from time to time under organizational documents filed in Massachusetts in the case of Security First and Delaware, in the case of the Trust, which are hereby referred to and are also on file at the principal offices of Security First or, as the case may be, the Trust. The obligations of Security First or of the Trust entered into in the name or on behalf thereof by any of the Trustees, representatives or agents of Security First or the Trust, as the case may be, are made not individually, but in such capacities, and are not binding upon any of the Trustees, shareholders or representatives of Security First or, as the case may be, the Trust personally, but bind only the trust property, and all persons dealing with the Selling Fund or the Acquiring Fund must look solely to the trust property belonging to the Selling Fund or, as the case may be, the Acquiring Fund for the enforcement of any claims against the Selling Fund or, as the case may be, the Acquiring Fund. IN WITNESS WHEREOF, the parties have duly executed this Agreement, all as of the date first written above.
SECURITY FIRST TRUST ON BEHALF OF NEUBERGER BERMAN
By:
Name: Richard C. Pearson
Title: President
MET INVESTORS SERIES TRUST ON BEHALF OF J.P. MORGAN
By: Name: Elizabeth M. Forget Title: President Exhibit A - 2 FORM OF AGREEMENT AND PLAN OF REORGANIZATION THIS AGREEMENT AND PLAN OF REORGANIZATION (the "Agreement") is made as of this 8th day of December, 2000, by and between Met Investors Series Trust, a Delaware business trust with its principal place of business at 610 Newport Center Drive, Suite 1350, Newport Beach, California 92660 (the "Trust"), with respect to its J.P. Morgan Quality Bond Portfolio series (the "Acquiring Fund"), and Cova Series Trust, a Massachusetts business trust with its principal place of business at One Tower Lane, Suite 3000, Oakbrook Terrace, Illinois 60181 ("Cova"), with respect to its Quality Bond Portfolio (the "Selling Fund"). This Agreement is intended to be, and is adopted as, a plan of reorganization and liquidation within the meaning of Section 368(a)(1)(F) of the United States Internal Revenue Code of 1986, as amended (the "Code"). The reorganization (the "Reorganization") will consist of (i) the transfer of all of the assets of the Selling Fund in exchange solely for Class A shares of beneficial interest, $.001 par value per share, of the Acquiring Fund (the "Acquiring Fund Shares"); (ii) the assumption by the Acquiring Fund of the identified liabilities of the Selling Fund; and (iii) the distribution, after the Closing Date hereinafter referred to, of the Acquiring Fund Shares to the shareholders of the Selling Fund in liquidation of the Selling Fund as provided herein, all upon the terms and conditions hereinafter set forth in this Agreement. WHEREAS, the Selling Fund and the Acquiring Fund are each a separate investment series of an open-end, registered investment company of the management type and the Selling Fund owns securities that generally are assets of the character in which the Acquiring Fund is permitted to invest; WHEREAS, both Funds are authorized to issue their shares of beneficial interest; WHEREAS, the Trustees of the Trust have determined that the exchange of all of the assets of the Selling Fund for Acquiring Fund Shares and the assumption of the identified liabilities of the Selling Fund by the Acquiring Fund on the terms and conditions hereinafter set forth are in the best interests of the Acquiring Fund's shareholders; WHEREAS, the Trustees of Cova have determined that the Selling Fund should exchange all of its assets and the identified liabilities for Acquiring Fund Shares and that the interests of the existing shareholders of the Selling Fund will not be diluted as a result of the transactions contemplated herein; NOW, THEREFORE, in consideration of the premises and of the covenants and agreements hereinafter set forth, the parties hereto covenant and agree as follows: ARTICLE I
TRANSFER OF ASSETS OF THE SELLING FUND IN EXCHANGE FOR
1.1 THE EXCHANGE. Subject to the terms and conditions herein set forth and on the basis of the representations and warranties contained herein, the Selling Fund agrees to transfer all of the Selling Fund's assets as set forth in paragraph 1.2 to the Acquiring Fund. The Acquiring Fund agrees in exchange therefor (i) to deliver to the Selling Fund the number of Acquiring Fund Shares, including fractional Acquiring Fund Shares, computed in the manner and as of the time and date set forth in paragraphs 2.2 and 2.3; and (ii) to assume the identified liabilities of the Selling Fund, as set forth in paragraph 1.3. Such transactions shall take place on the Closing Date provided for in paragraph 3.1. 1.2 ASSETS TO BE ACQUIRED. The assets of the Selling Fund to be acquired by the Acquiring Fund shall consist of all property, including, without limitation, all cash, securities, commodities, interests in futures and dividends or interest receivables, that is owned by the Selling Fund and any deferred or prepaid expenses shown as an asset on the books of the Selling Fund on the Closing Date. The Selling Fund has provided the Acquiring Fund with its most recent audited financial statements, which contain a list of all of Selling Fund's assets as of the date thereof. The Selling Fund hereby represents that as of the date of the execution of this Agreement there have been no changes in its financial position as reflected in said financial statements other than those occurring in the ordinary course of its business in connection with the purchase and sale of securities and the payment of its normal operating expenses. The Selling Fund reserves the right to sell any of such securities, but will not, without the prior written approval of the Acquiring Fund, acquire any additional securities other than securities of the type in which the Acquiring Fund is permitted to invest. The Acquiring Fund will, within a reasonable time prior to the Closing Date, furnish the Selling Fund with a list of the securities, if any, on the Selling Fund's list referred to in the second sentence of this paragraph that do not conform to the Acquiring Fund's investment objectives, policies, and restrictions. The Selling Fund will, within a reasonable period of time (not less than 30 days) prior to the Closing Date, furnish the Acquiring Fund with a list of its portfolio securities and other investments. In the event that the Selling Fund holds any investments that the Acquiring Fund may not hold, the Selling Fund, if requested by the Acquiring Fund, will dispose of such securities prior to the Closing Date. In addition, if it is determined that the Selling Fund and the Acquiring Fund portfolios, when aggregated, would contain investments exceeding certain percentage limitations imposed upon the Acquiring Fund with respect to such investments, the Selling Fund if requested by the Acquiring Fund will dispose of a sufficient amount of such investments as may be necessary to avoid violating such limitations as of the Closing Date. Notwithstanding the foregoing, nothing herein will require the Selling Fund to dispose of any investments or securities if, in the reasonable judgment of the Selling Fund, such disposition would adversely affect the tax-free nature of the Reorganization or would violate the Selling Fund's fiduciary duty to its shareholders. 1.3 LIABILITIES TO BE ASSUMED. The Selling Fund will endeavor to discharge all of its known liabilities and obligations prior to the Closing Date. The Acquiring Fund shall assume only those liabilities, expenses, costs, charges and reserves reflected on a Statement of Assets and Liabilities of the Selling Fund prepared on behalf of the Selling Fund, as of the Valuation Date (as defined in paragraph 2.1), in accordance with generally accepted accounting principles consistently applied from the prior audited period. The Acquiring Fund shall assume only those liabilities of the Selling Fund reflected in such Statement of Assets and Liabilities and shall not assume any other liabilities, whether absolute or contingent, known or unknown, accrued or unaccrued, all of which shall remain the obligation of the Selling Fund. 1.4 LIQUIDATION AND DISTRIBUTION. On or as soon after the Closing Date as is conveniently practicable (the "Liquidation Date"), (a) the Selling Fund will liquidate and distribute pro rata to the Selling Fund's shareholders of record, determined as of the close of business on the Valuation Date (the "Selling Fund Shareholders"), the Acquiring Fund Shares received by the Selling Fund pursuant to paragraph 1.1; and (b) the Selling Fund will thereupon proceed to dissolve as set forth in paragraph 1.8 below. Such liquidation and distribution will be accomplished by the transfer of the Acquiring Fund Shares then credited to the account of the Selling Fund on the books of the Acquiring Fund to open accounts on the share records of the Acquiring Fund in the names of the Selling Fund Shareholders and representing the respective pro rata number of the Acquiring Fund Shares due such shareholders. All issued and outstanding shares of the Selling Fund will simultaneously be canceled on the books of the Selling Fund. The Acquiring Fund shall not issue certificates representing the Acquiring Fund Shares in connection with such exchange. 1.5 OWNERSHIP OF SHARES. Ownership of Acquiring Fund Shares will be shown on the books of the Acquiring Fund's transfer agent. Shares of the Acquiring Fund will be issued in the manner described in the Prospectus/Proxy Statement on Form N-14 which has been distributed to shareholders of the Selling Fund as described in paragraph 4.1(o). 1.6 TRANSFER TAXES. Any transfer taxes payable upon issuance of the Acquiring Fund Shares in a name other than the registered holder of the Selling Fund shares on the books of the Selling Fund as of that time shall, as a condition of such issuance and transfer, be paid by the person to whom such Acquiring Fund Shares are to be issued and transferred. 1.7 REPORTING RESPONSIBILITY. Any reporting responsibility of the Selling Fund is and shall remain the responsibility of the Selling Fund up to and including the Closing Date and such later date on which the Selling Fund is terminated. 1.8 TERMINATION. The Selling Fund shall be terminated promptly following the Closing Date and the making of all distributions pursuant to paragraph 1.4. ARTICLE II VALUATION 2.1 VALUATION OF ASSETS. The value of the Selling Fund's assets to be acquired by the Acquiring Fund hereunder shall be the value of such assets computed as of the close of business on the New York Stock Exchange on the business day next preceding the Closing Date (such time and date being hereinafter called the "Valuation Date"), using the valuation procedures set forth in the Trust's Agreement and Declaration of Trust and the Acquiring Fund's then current prospectus and statement of additional information or such other valuation procedures as shall be mutually agreed upon by the parties. 2.2 VALUATION OF SHARES. The net asset value per share of the Acquiring Fund Shares shall be the net asset value per share computed as of the close of business on the New York Stock Exchange on the Valuation Date, using the valuation procedures set forth in the Trust's Agreement and Declaration of Trust and the Acquiring Fund's then current prospectus and statement of additional information. 2.3 SHARES TO BE ISSUED. The number of the Acquiring Fund Shares to be issued (including fractional shares, if any) in exchange for the Selling Fund's assets shall be determined by multiplying the outstanding shares of the Selling Fund by the ratio computed by dividing the net asset value per share of the Selling Fund by the net asset value per share of the Acquiring Fund determined in accordance with paragraph 2.2. 2.4 DETERMINATION OF VALUE. All computations of value shall be made by Investors Bank & Trust Company in accordance with its regular practice in pricing the shares and assets of the Acquiring Fund. ARTICLE III CLOSING AND CLOSING DATE 3.1 CLOSING DATE. The closing of the Reorganization (the "Closing") shall take place on or about February 5, 2001 or such other date as the parties may agree to in writing (the "Closing Date"). All acts taking place at the Closing shall be deemed to take place simultaneously immediately prior to the opening of business on the Closing Date unless otherwise provided. The Closing shall be held as of 9:00 a.m. Eastern time at the offices of the Trust, or at such other time and/or place as the parties may agree. 3.2 EFFECT OF SUSPENSION IN TRADING. In the event that on the Valuation Date (a) the New York Stock Exchange or another primary trading market for portfolio securities of the Acquiring Fund or the Selling Fund shall be closed to trading or trading thereon shall be restricted; or (b) trading or the reporting of trading on said Exchange or elsewhere shall be disrupted so that accurate appraisal of the value of the net assets of the Acquiring Fund or the Selling Fund is impracticable, the Valuation Date shall be postponed until the first business day after the day when trading shall have been fully resumed and reporting shall have been restored. 3.3 TRANSFER AGENT'S CERTIFICATE. Investors Bank & Trust Company, as transfer agent for the Selling Fund at the Closing Date, shall deliver at the Closing a certificate of an authorized officer stating that its records contain the names and addresses of the Selling Fund Shareholders and the number and percentage ownership of outstanding shares owned by each such shareholder immediately prior to the Closing. The Acquiring Fund shall issue and deliver or cause Investors Bank & Trust Company, its transfer agent, to issue and deliver a confirmation evidencing the Acquiring Fund Shares to be credited on the Closing Date to the Secretary of Cova or provide evidence satisfactory to the Selling Fund that such Acquiring Fund Shares have been credited to the Selling Fund's account on the books of the Acquiring Fund. At the Closing, each party shall deliver to the other such bills of sale, checks, assignments, share certificates, if any, receipts and other documents as such other party or its counsel may reasonably request. ARTICLE IV REPRESENTATIONS AND WARRANTIES 4.1 REPRESENTATIONS OF THE SELLING FUND. The Selling Fund represents and warrants to the Acquiring Fund as follows: (a) The Selling Fund is a separate investment series of a business trust duly organized, validly existing, and in good standing under the laws of the Commonwealth of Massachusetts. (b) The Selling Fund is a separate investment series of a Massachusetts business trust that is registered as an investment company classified as a management company of the open-end type, and its registration with the Securities and Exchange Commission (the "Commission") as an investment company under the Investment Company Act of 1940, as amended (the "1940 Act"), is in full force and effect. (c) The current prospectus and statement of additional information of the Selling Fund conform in all material respects to the applicable requirements of the Securities Act of 1933, as amended (the "1933 Act"), and the 1940 Act and the rules and regulations of the Commission thereunder and do not include any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading. (d) The Selling Fund is not, and the execution, delivery, and performance of this Agreement (subject to shareholder approval) will not result, in violation of any provision of Cova's Agreement and Declaration of Trust or By-Laws or of any material agreement, indenture, instrument, contract, lease, or other undertaking to which the Selling Fund is a party or by which it is bound. (e) The Selling Fund has no material contracts or other commitments (other than this Agreement) that will be terminated with liability to it prior to the Closing Date, except for liabilities, if any, to be discharged or reflected in the Statement of Assets and Liabilities as provided in paragraph 1.3 hereof. (f) Except as otherwise disclosed in writing to and accepted by the Acquiring Fund, no litigation, administrative proceeding, or investigation of or before any court or governmental body is presently pending or to its knowledge threatened against the Selling Fund or any of its properties or assets, which, if adversely determined, would materially and adversely affect its financial condition, the conduct of its business, or the ability of the Selling Fund to carry out the transactions contemplated by this Agreement. The Selling Fund knows of no facts that might form the basis for the institution of such proceedings and is not a party to or subject to the provisions of any order, decree, or judgment of any court or governmental body that materially and adversely affects its business or its ability to consummate the transactions herein contemplated. (g) The unaudited financial statements of the Selling Fund at June 30, 2000 are in accordance with generally accepted accounting principles consistently applied, and such statements (copies of which have been furnished to the Acquiring Fund) fairly reflect the financial condition of the Selling Fund as of such date, and there are no known contingent liabilities of the Selling Fund as of such date not disclosed therein. (h) Since June 30, 2000 there has not been any material adverse change in the Selling Fund's financial condition, assets, liabilities, or business other than changes occurring in the ordinary course of business, or any incurrence by the Selling Fund of indebtedness maturing more than one year from the date such indebtedness was incurred, except as otherwise disclosed to and accepted by the Acquiring Fund. For the purposes of this subparagraph (h), a decline in the net asset value of the Selling Fund shall not constitute a material adverse change. (i) At the Closing Date, all federal and other tax returns and reports of the Selling Fund required by law to have been filed by such dates shall have been filed, and all federal and other taxes shown due on said returns and reports shall have been paid, or provision shall have been made for the payment thereof. To the best of the Selling Fund's knowledge, no such return is currently under audit, and no assessment has been asserted with respect to such returns. (j) For each fiscal year of its operation, the Selling Fund has met the requirements of Subchapter M of the Code for qualification and treatment as a regulated investment company, has distributed in each such year all net investment income and realized capital gains and has met the diversification requirements of Section 817 (h) of the Code and the rules thereunder. (k) All issued and outstanding shares of the Selling Fund are, and at the Closing Date will be, duly and validly issued and outstanding, fully paid and non-assessable by the Selling Fund. All of the issued and outstanding shares of the Selling Fund will, at the time of the Closing Date, be held by the persons and in the amounts set forth in the records of the transfer agent as provided in paragraph 3.3. The Selling Fund does not have outstanding any options, warrants, or other rights to subscribe for or purchase any of the Selling Fund shares, nor is there outstanding any security convertible into any of the Selling Fund shares. (l) At the Closing Date, the Selling Fund will have good and marketable title to the Selling Fund's assets to be transferred to the Acquiring Fund pursuant to paragraph 1.2 and full right, power, and authority to sell, assign, transfer, and deliver such assets hereunder, and, upon delivery and payment for such assets, the Acquiring Fund will acquire good and marketable title thereto, subject to no restrictions on the full transfer thereof, including such restrictions as might arise under the 1933 Act, other than as disclosed to the Acquiring Fund and accepted by the Acquiring Fund. (m) The execution, delivery, and performance of this Agreement have been duly authorized by all necessary action on the part of the Selling Fund and, subject to approval by the Selling Fund's shareholders, this Agreement constitutes a valid and binding obligation of the Selling Fund, enforceable in accordance with its terms, subject as to enforcement, to bankruptcy, insolvency, reorganization, moratorium, and other laws relating to or affecting creditors' rights and to general equity principles. (n) The information furnished by the Selling Fund for use in no-action letters, applications for orders, registration statements, proxy materials, and other documents that may be necessary in connection with the transactions contemplated hereby is accurate and complete in all material respects and complies in all material respects with federal securities and other laws and regulations thereunder applicable thereto. (o) The Selling Fund has provided the Acquiring Fund with information reasonably necessary for the preparation of a prospectus, which included the proxy statement of the Selling Fund (the "Prospectus/Proxy Statement"), all of which was included in a Registration Statement on Form N-14 of the Acquiring Fund (the "Registration Statement"), in compliance with the 1933 Act, the Securities Exchange Act of 1934, as amended (the "1934 Act") and the 1940 Act in connection with the meeting of the shareholders of the Selling Fund to approve this Agreement and the transactions contemplated hereby. The Prospectus/Proxy Statement included in the Registration Statement (other than information therein that relates to the Acquiring Fund and any other fund described therein other than the Selling Fund) does not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which such statements were made, not misleading. 4.2 REPRESENTATIONS OF THE ACQUIRING FUND. The Acquiring Fund represents and warrants to the Selling Fund as follows: (a) The Acquiring Fund is a separate investment series of a Delaware business trust duly organized, validly existing and in good standing under the laws of the State of Delaware. (b) The Acquiring Fund is a separate investment series of a Delaware business trust that is registered as an investment company classified as a management company of the open-end type, and its registration with the Commission as an investment company under the 1940 Act is in full force and effect. (c) At the Closing Date, the current prospectus and statement of additional information of the Acquiring Fund will conform in all material respects to the applicable requirements of the 1933 Act and the 1940 Act and the rules and regulations of the Commission thereunder and will not include any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading. (d) The Acquiring Fund is not, and the execution, delivery and performance of this Agreement will not result, in violation of the Trust's Agreement and Declaration of Trust or By-Laws or of any material agreement, indenture, instrument, contract, lease, or other undertaking to which the Acquiring Fund is a party or by which it is bound. (e) Except as otherwise disclosed in writing to the Selling Fund and accepted by the Selling Fund, no litigation, administrative proceeding or investigation of or before any court or governmental body is presently pending or to its knowledge threatened against the Acquiring Fund or any of its properties or assets, which, if adversely determined, would materially and adversely affect its financial condition and the conduct of its business or the ability of the Acquiring Fund to carry out the transactions contemplated by this Agreement. The Acquiring Fund knows of no facts that might form the basis for the institution of such proceedings and is not a party to or subject to the provisions of any order, decree, or judgment of any court or governmental body that materially and adversely affects its business or its ability to consummate the transactions contemplated herein. (f) The Acquiring Fund has no known liabilities of a material amount, contingent or otherwise. (g) At the Closing Date, there will not be any material adverse change in the Acquiring Fund's financial condition, assets, liabilities, or business other than changes occurring in the ordinary course of business, or any incurrence by the Acquiring Fund of indebtedness maturing more than one year from the date such indebtedness was incurred, except as otherwise disclosed to and accepted by the Selling Fund. For the purposes of this subparagraph (g), a decline in the net asset value of the Acquiring Fund shall not constitute a material adverse change. (h) At the Closing Date, all federal and other tax returns and reports of the Acquiring Fund required by law then to be filed by such dates shall have been filed, and all federal and other taxes shown due on said returns and reports shall have been paid or provision shall have been made for the payment thereof. To the best of the Acquiring Fund's knowledge, no such return is currently under audit, and no assessment has been asserted with respect to such returns. (i) All issued and outstanding Acquiring Fund Shares are, and at the Closing Date will be, duly and validly issued and outstanding, fully paid and non-assessable. The Acquiring Fund does not have outstanding any options, warrants, or other rights to subscribe for or purchase any Acquiring Fund Shares, nor is there outstanding any security convertible into any Acquiring Fund Shares. (j) The execution, delivery, and performance of this Agreement have been duly authorized by all necessary action on the part of the Acquiring Fund, and this Agreement constitutes a valid and binding obligation of the Acquiring Fund enforceable in accordance with its terms, subject as to enforcement, to bankruptcy, insolvency, reorganization, moratorium, and other laws relating to or affecting creditors' rights and to general equity principles. (k) The Acquiring Fund Shares to be issued and delivered to the Selling Fund, for the account of the Selling Fund Shareholders, pursuant to the terms of this Agreement will, at the Closing Date, have been duly authorized and, when so issued and delivered, will be duly and validly issued Acquiring Fund Shares, and will be fully paid and non-assessable. (l) The information furnished by the Acquiring Fund for use in no-action letters, applications for orders, registration statements, proxy materials, and other documents that may be necessary in connection with the transactions contemplated hereby is accurate and complete in all material respects and complies in all material respects with federal securities and other laws and regulations applicable thereto. (m) The Prospectus/Proxy Statement included in the Registration Statement (only insofar as it relates to the Acquiring Fund) does not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which such statements were made, not misleading. (n) The Acquiring Fund agrees to use all reasonable efforts to obtain the approvals and authorizations required by the 1933 Act, the 1940 Act, and such of the state Blue Sky or securities laws as it may deem appropriate in order to continue its operations after the Closing Date. ARTICLE V COVENANTS OF THE ACQUIRING FUND AND THE SELLING FUND 5.1 OPERATION IN ORDINARY COURSE. The Acquiring Fund and the Selling Fund each will operate its business in the ordinary course between the date hereof and the Closing Date, it being understood that such ordinary course of business will include customary dividends and distributions. 5.2 APPROVAL BY SHAREHOLDERS. Cova will call a meeting of the shareholders of the Selling Fund to consider and act upon this Agreement and to take all other action necessary to obtain approval of the transactions contemplated herein. 5.3 INVESTMENT REPRESENTATION. The Selling Fund covenants that the Acquiring Fund Shares to be issued hereunder are not being acquired for the purpose of making any distribution thereof other than in accordance with the terms of this Agreement. 5.4 ADDITIONAL INFORMATION. The Selling Fund will assist the Acquiring Fund in obtaining such information as the Acquiring Fund reasonably requests concerning the beneficial ownership of the Selling Fund shares. 5.5 FURTHER ACTION. Subject to the provisions of this Agreement, the Acquiring Fund and the Selling Fund will each take, or cause to be taken, all action, and do or cause to be done, all things reasonably necessary, proper or advisable to consummate and make effective the transactions contemplated by this Agreement, including any actions required to be taken after the Closing Date. 5.6 STATEMENT OF EARNINGS AND PROFITS. As promptly as practicable, but in any case within sixty days after the Closing Date, the Selling Fund shall furnish the Acquiring Fund, in such form as is reasonably satisfactory to the Acquiring Fund, a statement of the earnings and profits of the Selling Fund for federal income tax purposes that will be carried over by the Acquiring Fund as a result of Section 381 of the Code, and which will be reviewed by Deloitte & Touche LLP and certified by Cova's President, Vice President or Treasurer. ARTICLE VI CONDITIONS PRECEDENT TO OBLIGATIONS OF THE SELLING FUND The obligations of the Selling Fund to consummate the transactions provided for herein shall be subject, at its election, to the performance by the Acquiring Fund of all the obligations to be performed by it hereunder on or before the Closing Date, and, in addition thereto, the following further conditions: 6.1 All representations, covenants, and warranties of the Acquiring Fund contained in this Agreement shall be true and correct as of the date hereof and as of the Closing Date with the same force and effect as if made on and as of the Closing Date, and the Acquiring Fund shall have delivered to the Selling Fund a certificate executed in its name by the Trust's President or Vice President, in form and substance reasonably satisfactory to the Selling Fund and dated as of the Closing Date, to such effect and as to such other matters as the Selling Fund shall reasonably request. 6.2 The Selling Fund shall have received on the Closing Date an opinion from Sullivan & Worcester LLP, counsel to the Acquiring Fund, dated as of the Closing Date, in a form reasonably satisfactory to the Selling Fund, covering the following points: (a) The Acquiring Fund is a separate investment series of a Delaware business trust duly organized, validly existing and in good standing under the laws of the State of Delaware and has the power to own all of its properties and assets and to carry on its business as presently conducted. (b) The Acquiring Fund is a separate investment series of a Delaware business trust registered as an investment company under the 1940 Act, and, to such counsel's knowledge, such registration with the Commission as an investment company under the 1940 Act is in full force and effect. (c) This Agreement has been duly authorized, executed, and delivered by the Acquiring Fund and, assuming due authorization, execution and delivery of this Agreement by the Selling Fund, is a valid and binding obligation of the Acquiring Fund enforceable against the Acquiring Fund in accordance with its terms, subject as to enforcement, to bankruptcy, insolvency, reorganization, moratorium, and other laws relating to or affecting creditors' rights generally and to general equity principles. (d) Assuming that a consideration therefor not less than the net asset value thereof has been paid, the Acquiring Fund Shares to be issued and delivered to the Selling Fund on behalf of the Selling Fund Shareholders as provided by this Agreement are duly authorized and upon such delivery will be legally issued and outstanding and fully paid and non-assessable, and no shareholder of the Acquiring Fund has any preemptive rights in respect thereof. (e) The Registration Statement, to such counsel's knowledge, has been declared effective by the Commission and no stop order under the 1933 Act pertaining thereto has been issued, and to the knowledge of such counsel, no consent, approval, authorization or order of any court or governmental authority of the United States or the State of Delaware is required for consummation by the Acquiring Fund of the transactions contemplated herein, except such as have been obtained under the 1933 Act, the 1934 Act and the 1940 Act, and as may be required under state securities laws. (f) The execution and delivery of this Agreement did not, and the consummation of the transactions contemplated hereby will not, result in a violation of the Trust's Agreement and Declaration of Trust or By-Laws or any provision of any material agreement, indenture, instrument, contract, lease or other undertaking (in each case known to such counsel) to which the Acquiring Fund is a party or by which it or any of its properties may be bound or to the knowledge of such counsel, result in the acceleration of any obligation or the imposition of any penalty, under any agreement, judgment, or decree to which the Acquiring Fund is a party or by which it is bound. (g) Only insofar as they relate to the Acquiring Fund, the descriptions in the Prospectus/Proxy Statement of statutes, legal and governmental proceedings and material contracts, if any, are accurate and fairly present the information required to be shown. (h) Such counsel does not know of any legal or governmental proceedings, only insofar as they relate to the Acquiring Fund, existing on or before the effective date of the Registration Statement or the Closing Date required to be described in the Registration Statement or to be filed as exhibits to the Registration Statement which are not described or filed as required. (i) To the knowledge of such counsel, no litigation or administrative proceeding or investigation of or before any court or governmental body is presently pending or threatened as to the Acquiring Fund or any of its properties or assets and the Acquiring Fund is not a party to or subject to the provisions of any order, decree or judgment of any court or governmental body, which materially and adversely affects its business, other than as previously disclosed in the Registration Statement. Such counsel shall also state that they have participated in conferences with officers and other representatives of the Acquiring Fund at which the contents of the Prospectus/Proxy Statement and related matters were discussed and, although they are not passing upon and do not assume any responsibility for the accuracy, completeness or fairness of the statements contained in the Prospectus/Proxy Statement (except to the extent indicated in paragraph (g) of their above opinion), on the basis of the foregoing (relying as to materiality to a large extent upon the opinions of the Trust's officers and other representatives of the Acquiring Fund), no facts have come to their attention that lead them to believe that the Prospectus/Proxy Statement as of its date, as of the date of the meeting of the shareholders of the Selling Fund, and as of the Closing Date, contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein regarding the Acquiring Fund or necessary, in the light of the circumstances under which they were made, to make the statements therein regarding the Acquiring Fund not misleading. Such opinion may state that such counsel does not express any opinion or belief as to the financial statements or any financial or statistical data, or as to the information relating to the Selling Fund, contained in the Prospectus/Proxy Statement or the Registration Statement, and that such opinion is solely for the benefit of Cova and the Selling Fund. Such opinion shall contain such assumptions and limitations as shall be in the opinion of Sullivan & Worcester LLP appropriate to render the opinions expressed therein. In this paragraph 6.2, references to the Prospectus/Proxy Statement include and relate to only the text of such Prospectus/Proxy Statement and not to any exhibits or attachments thereto or to any documents incorporated by reference therein. ARTICLE VII CONDITIONS PRECEDENT TO OBLIGATIONS OF THE ACQUIRING FUND The obligations of the Acquiring Fund to complete the transactions provided for herein shall be subject, at its election, to the performance by the Selling Fund of all the obligations to be performed by it hereunder on or before the Closing Date and, in addition thereto, the following conditions: 7.1 All representations, covenants, and warranties of the Selling Fund contained in this Agreement shall be true and correct as of the date hereof and as of the Closing Date with the same force and effect as if made on and as of the Closing Date, and the Selling Fund shall have delivered to the Acquiring Fund on the Closing Date a certificate executed in its name by Cova's President or Vice President, in form and substance satisfactory to the Acquiring Fund and dated as of the Closing Date, to such effect and as to such other matters as the Acquiring Fund shall reasonably request. 7.2 The Selling Fund shall have delivered to the Acquiring Fund a statement of the Selling Fund's assets and liabilities, together with a list of the Selling Fund's portfolio securities showing the tax costs of such securities by lot and the holding periods of such securities, as of the Closing Date, certified by the Treasurer of Cova. 7.3 The Acquiring Fund shall have received on the Closing Date an opinion of Blazzard, Grodd & Hasenauer, P.C., counsel to the Selling Fund, in a form satisfactory to the Acquiring Fund covering the following points: (a) The Selling Fund is a separate investment series of a Massachusetts business trust duly organized, validly existing and in good standing under the laws of the Commonwealth of Massachusetts and has the power to own all of its properties and assets and to carry on its business as presently conducted. (b) The Selling Fund is a separate investment series of a Massachusetts business trust registered as an investment company under the 1940 Act, and, to such counsel's knowledge, such registration with the Commission as an investment company under the 1940 Act is in full force and effect. (c) This Agreement has been duly authorized, executed and delivered by the Selling Fund and, assuming due authorization, execution, and delivery of this Agreement by the Acquiring Fund, is a valid and binding obligation of the Selling Fund enforceable against the Selling Fund in accordance with its terms, subject as to enforcement, to bankruptcy, insolvency, reorganization, moratorium and other laws relating to or affecting creditors' rights generally and to general equity principles. (d) To the knowledge of such counsel, no consent, approval, authorization or order of any court or governmental authority of the United States or the Commonwealth of Massachusetts is required for consummation by the Selling Fund of the transactions contemplated herein, except such as have been obtained under the 1933 Act, the 1934 Act and the 1940 Act, and as may be required under state securities laws. (e) The execution and delivery of this Agreement did not, and the consummation of the transactions contemplated hereby will not, result in a violation of Cova's Agreement and Declaration of Trust or By-laws, or to the knowledge of such counsel, any provision of any material agreement, indenture, instrument, contract, lease or other undertaking to which the Selling Fund is a party or by which it or any of its properties may be bound or, to the knowledge of such counsel, result in the acceleration of any obligation or the imposition of any penalty, under any agreement, judgment, or decree to which the Selling Fund is a party or by which it is bound. (f) Only insofar as they relate to the Selling Fund, the descriptions in the Prospectus/Proxy Statement of statutes, legal and government proceedings and material contracts, if any, are accurate and fairly present the information required to be shown. (g) To the knowledge of such counsel, there are no legal or governmental proceedings, only insofar as they relate to the Selling Fund existing on or before the effective date of the Registration Statement or the Closing Date, required to be described in the Registration Statement or to be filed as exhibits to the Registration Statement which are not described or filed as required. (h) To the knowledge of such counsel, no litigation or administrative proceeding or investigation of or before any court or governmental body is presently pending or threatened as to the Selling Fund or any of its respective properties or assets and the Selling Fund is neither a party to nor subject to the provisions of any order, decree or judgment of any court or governmental body, which materially and adversely affects its business other than as previously disclosed in the Prospectus/Proxy Statement. (i) Assuming that a consideration therefor of not less than the net asset value thereof has been paid, and assuming that such shares were issued in accordance with the terms of the Selling Fund's registration statement, or any amendment thereto, in effect at the time of such issuance, all issued and outstanding shares of the Selling Fund are legally issued and fully paid and non-assessable. Such counsel shall also state that they have participated in conferences with officers and other representatives of the Selling Fund at which the contents of the Prospectus/Proxy Statement and related matters were discussed and, although they are not passing upon and do not assume any responsibility for the accuracy, completeness or fairness of the statements contained in the Prospectus/Proxy Statement (except to the extent indicated in paragraph (f) of their above opinion), on the basis of the foregoing (relying as to materiality to a large extent upon the opinions of Cova's officers and other representatives of the Selling Fund), no facts have come to their attention that lead them to believe that the Prospectus/Proxy Statement as of its date, as of the date of the meeting of the shareholders of the Selling Fund, and as of the Closing Date, contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein regarding the Selling Fund or necessary, in the light of the circumstances under which they were made, to make the statements therein regarding the Selling Fund not misleading. Such opinion may state that such counsel does not express any opinion or belief as to the financial statements or any financial or statistical data, or as to information relating to the Acquiring Fund, contained in the Prospectus/Proxy Statement or Registration Statement, and that such opinion is solely for the benefit of the Trust and the Acquiring Fund. Such opinion shall contain such other assumptions and limitations as shall be in the opinion of Blazzard, Grodd & Hasenauer, P.C. appropriate to render the opinions expressed therein, and shall indicate, with respect to matters of Massachusetts law that as Blazzard, Grodd & Hasenauer, P.C. are not admitted to the bar of Massachusetts, such opinions are based either upon the review of published statutes, cases and rules and regulations of the Commonwealth of Massachusetts or upon an opinion of Massachusetts counsel. In this paragraph 7.3, references to the Prospectus/Proxy Statement include and relate to only the text of such Prospectus/Proxy Statement and not to any exhibits or attachments thereto or to any documents incorporated by reference therein. ARTICLE VIII FURTHER CONDITIONS PRECEDENT TO OBLIGATIONS OF THE ACQUIRING FUND AND THE SELLING FUND If any of the conditions set forth below do not exist on or before the Closing Date with respect to the Selling Fund or the Acquiring Fund, the other party to this Agreement shall, at its option, not be required to consummate the transactions contemplated by this Agreement: 8.1 This Agreement and the transactions contemplated herein shall have been approved by the requisite vote of the holders of the outstanding shares of the Selling Fund in accordance with the provisions of Cova's Agreement and Declaration of Trust and By-Laws and certified copies of the resolutions evidencing such approval shall have been delivered to the Acquiring Fund. Notwithstanding anything herein to the contrary, neither the Acquiring Fund or the Selling Fund may waive the conditions set forth in this paragraph 8.1. 8.2 On the Closing Date, the Commission shall not have issued an unfavorable report under Section 25(b) of the 1940 Act, nor instituted any proceeding seeking to enjoin the consummation of the transactions contemplated by this Agreement under Section 25(c) of the 1940 Act and no action, suit or other proceeding shall be threatened or pending before any court or governmental agency in which it is sought to restrain or prohibit, or obtain damages or other relief in connection with, this Agreement or the transactions contemplated herein. 8.3 All required consents of other parties and all other consents, orders, and permits of federal, state and local regulatory authorities (including those of the Commission and of state Blue Sky securities authorities, including any necessary "no-action" positions of and exemptive orders from such federal and state authorities) to permit consummation of the transactions contemplated hereby shall have been obtained, except where failure to obtain any such consent, order, or permit would not involve a risk of a material adverse effect on the assets or properties of the Acquiring Fund or the Selling Fund, provided that either party hereto may for itself waive any of such conditions. 8.4 The Registration Statement shall have become effective under the 1933 Act, and no stop orders suspending the effectiveness of the Registration Statement shall have been issued and, to the best knowledge of the parties hereto, no investigation or proceeding for that purpose shall have been instituted or be pending, threatened or contemplated under the 1933 Act. 8.5 The parties shall have received a favorable opinion of Sullivan & Worcester LLP addressed to the Acquiring Fund and the Selling Fund substantially to the effect that for federal income tax purposes:
(a) The transfer of all of the Selling Fund assets in exchange
solely for the Acquiring Fund Shares and the assumption by the Acquiring Fund of
the identified liabilities of the Selling Fund followed by the distribution of
the Acquiring Fund Shares to the Selling Fund Shareholders in dissolution and
liquidation of the Selling Fund will constitute a "reorganization" within the
meaning of Section 368(a)(1)(F) of the Code, and the Acquiring Fund and the
Selling Fund will each be a "party to a reorganization" within the meaning of
(b) No gain or loss will be recognized by the Acquiring Fund upon the receipt of the assets of the Selling Fund solely in exchange for the Acquiring Fund Shares and the assumption by the Acquiring Fund of the identified liabilities of the Selling Fund. (c) No gain or loss will be recognized by the Selling Fund upon the transfer of the Selling Fund assets to the Acquiring Fund in exchange for the Acquiring Fund Shares and the assumption by the Acquiring Fund of the identified liabilities of the Selling Fund or upon the distribution (whether actual or constructive) of the Acquiring Fund Shares to Selling Fund Shareholders in exchange for their shares of the Selling Fund. (d) No gain or loss will be recognized by the Selling Fund Shareholders upon the exchange of their Selling Fund shares for the Acquiring Fund Shares in liquidation of the Selling Fund. (e) The aggregate tax basis for the Acquiring Fund Shares received by each Selling Fund Shareholder pursuant to the Reorganization will be the same as the aggregate tax basis of the Selling Fund shares held by such shareholder immediately prior to the Reorganization, and the holding period of the Acquiring Fund Shares to be received by each Selling Fund Shareholder will include the period during which the Selling Fund shares exchanged therefor were held by such shareholder (provided the Selling Fund shares were held as capital assets on the date of the Reorganization). (f) The tax basis of the Selling Fund assets acquired by the Acquiring Fund will be the same as the tax basis of such assets to the Selling Fund immediately prior to the Reorganization, and the holding period of the assets of the Selling Fund in the hands of the Acquiring Fund will include the period during which those assets were held by the Selling Fund. Notwithstanding anything herein to the contrary, neither the Acquiring Fund nor the Selling Fund may waive the conditions set forth in this paragraph 8.5. 8.6 The Acquiring Fund shall have received from Deloitte & Touche LLP a letter addressed to the Acquiring Fund, in form and substance satisfactory to the Acquiring Fund, to the effect that: (a) they are independent certified public accountants with respect to the Selling Fund within the meaning of the 1933 Act and the applicable published rules and regulations thereunder; (b) on the basis of limited procedures agreed upon by the Acquiring Fund and described in such letter (but not an examination in accordance with generally accepted auditing standards), the Capitalization Table appearing in the Registration Statement and Prospectus/Proxy Statement has been obtained from and is consistent with the accounting records of the Selling Fund; (c) on the basis of limited procedures agreed upon by the Acquiring Fund and described in such letter (but not an examination in accordance with generally accepted auditing standards), the pro forma financial statements that are included in the Registration Statement and Prospectus/Proxy Statement agree to the accounting records of the Acquiring Fund and the Selling Fund or with written estimates provided by each Fund's management, and were found to be mathematically correct; and (d) on the basis of limited procedures agreed upon by the Acquiring Fund and described in such letter (but not an examination in accordance with generally accepted auditing standards), the data utilized in the calculations of the pro forma expense ratios appearing in the Registration Statement and Prospectus/Proxy Statement agree with underlying accounting records of the Selling Fund or with written estimates by the Selling Fund's management and were found to be mathematically correct. In addition, unless waived by the Acquiring Fund, the Acquiring Fund shall have received from Deloitte & Touche LLP a letter addressed to the Acquiring Fund dated on the Closing Date, in form and substance satisfactory to the Acquiring Fund, to the effect that on the basis of limited procedures agreed upon by the Acquiring Fund (but not an examination in accordance with generally accepted auditing standards), the net asset value per share of the Selling Fund as of the Valuation Date was computed and the valuation of the portfolio was consistent with the valuation practices of the Acquiring Fund. 8.7 The Selling Fund shall have received from Deloitte & Touche LLP a letter addressed to the Selling Fund, in form and substance satisfactory to the Selling Fund, to the effect that: (a) they are independent certified public accountants with respect to the Acquiring Fund within the meaning of the 1933 Act and the applicable published rules and regulations thereunder; (b) they had performed limited procedures agreed upon by the Selling Fund and described in such letter (but not an examination in accordance with generally accepted auditing standards) which consisted of a reading of any unaudited pro forma financial statements included in the Registration Statement and Prospectus/Proxy Statement, and making inquiries of appropriate officials of the Trust responsible for financial and accounting matters whether such unaudited pro forma financial statements comply as to form in all material respects with the applicable accounting requirements of the 1933 Act and the published rules and regulations thereunder; (c) on the basis of limited procedures agreed upon by the Selling Fund and described in such letter (but not an examination in accordance with generally accepted auditing standards), the Capitalization Table appearing in the Registration Statement and Prospectus/Proxy Statement has been obtained from and is consistent with the accounting records of the Acquiring Fund; and (d) on the basis of limited procedures agreed upon by the Selling Fund (but not an examination in accordance with generally accepted auditing standards), the data utilized in the calculations of the pro forma expense ratios appearing in the Registration Statement and Prospectus/Proxy Statement agree with written estimates by each Fund's management and were found to be mathematically correct. ARTICLE IX EXPENSES
9.1 Except as otherwise provided for herein, all expenses of the
transactions contemplated by this Agreement incurred by the Selling Fund and the
Acquiring Fund, whether incurred before or after the date of this Agreement,
will be borne by Metropolitan Life Insurance Company or one of its affiliates.
Such expenses include, without limitation, (a) expenses incurred in connection
with the entering into and the carrying out of the provisions of this Agreement;
ARTICLE X ENTIRE AGREEMENT; SURVIVAL OF WARRANTIES 10.1 The Acquiring Fund and the Selling Fund agree that neither party has made any representation, warranty or covenant not set forth herein and that this Agreement constitutes the entire agreement between the parties. 10.2 The representations, warranties, and covenants contained in this Agreement or in any document delivered pursuant hereto or in connection herewith shall not survive the consummation of the transactions contemplated hereunder. ARTICLE XI TERMINATION 11.1 This Agreement may be terminated by the mutual agreement of the Acquiring Fund and the Selling Fund. In addition, either the Acquiring Fund or the Selling Fund may at its option terminate this Agreement at or prior to the Closing Date because: (a) of a breach by the other of any representation, warranty, or agreement contained herein to be performed at or prior to the Closing Date, if not cured within 30 days; or (b) a condition herein expressed to be precedent to the obligations of the terminating party has not been met and it reasonably appears that it will not or cannot be met. 11.2 In the event of any such termination, in the absence of willful default, there shall be no liability for damages on the part of either the Acquiring Fund, the Selling Fund, the Trust, Cova, the respective Trustees, or officers, to the other party or its Trustees, or officers, but each shall bear the expenses incurred by it incidental to the preparation and carrying out of this Agreement as provided in paragraph 9.1. ARTICLE XII AMENDMENTS 12.1 This Agreement may be amended, modified, or supplemented in such manner as may be mutually agreed upon in writing by the authorized officers of the Selling Fund and the Acquiring Fund; provided, however, that following the meeting of shareholders of the Selling Fund pursuant to paragraph 5.2 of this Agreement, no such amendment may have the effect of changing the provisions for determining the number of the Acquiring Fund Shares to be issued to the Selling Fund Shareholders under this Agreement to the detriment of such Shareholders without their further approval. ARTICLE XIII
HEADINGS; COUNTERPARTS; GOVERNING LAW; ASSIGNMENT;
13.1 The Article and paragraph headings contained in this Agreement are for reference purposes only and shall not affect in any way the meaning or interpretation of this Agreement. 13.2 This Agreement may be executed in any number of counterparts, each of which shall be deemed an original. 13.3 This Agreement shall be governed by and construed in accordance with the laws of the State of Delaware, without giving effect to the conflicts of laws provisions thereof; provided, however, that the due authorization, execution and delivery of this Agreement, in the case of the Selling Fund, shall be governed and construed in accordance with the laws of the Commonwealth of Massachusetts, without giving effect to the conflicts of laws provisions thereof. 13.4 This Agreement shall bind and inure to the benefit of the parties hereto and their respective successors and assigns, but, except as provided in this paragraph, no assignment or transfer hereof or of any rights or obligations hereunder shall be made by any party without the written consent of the other party. Nothing herein expressed or implied is intended or shall be construed to confer upon or give any person, firm, or corporation, other than the parties hereto and their respective successors and assigns, any rights or remedies under or by reason of this Agreement. 13.5 With respect to both Cova and the Trust, the names used herein refer respectively to the trust created and, as the case may be, the Trustees, as trustees but not individually or personally, acting from time to time under organizational documents filed in Massachusetts in the case of Cova and Delaware, in the case of the Trust, which are hereby referred to and are also on file at the principal offices of Cova or, as the case may be, the Trust. The obligations of Cova or of the Trust entered into in the name or on behalf thereof by any of the Trustees, representatives or agents of Cova or the Trust, as the case may be, are made not individually, but in such capacities, and are not binding upon any of the Trustees, shareholders or representatives of Cova or, as the case may be, the Trust personally, but bind only the trust property, and all persons dealing with the Selling Fund or the Acquiring Fund must look solely to the trust property belonging to the Selling Fund or, as the case may be, the Acquiring Fund for the enforcement of any claims against the Selling Fund or, as the case may be, the Acquiring Fund. IN WITNESS WHEREOF, the parties have duly executed this Agreement, all as of the date first written above.
COVA SERIES TRUST ON BEHALF OF
By: Name: Mark E. Reynolds Title: President
MET INVESTORS SERIES TRUST ON BEHALF OF
By: Name: Elizabeth M. Forget Title: President Exhibit B
Quality Bond Portfolio For the year ended 12/31/99
Managed by J.P. Morgan Investment Management
The Quality Bond Portfolio provided a total return of -1.54% for the year ending December 31, 1999. The Salomon Broad Investment Grade Index1 returned -0.84% for the same time period. Bond yields ended the year sharply higher as investors reassessed the strengthening economy and anticipated tighter monetary policy after the Y2K turn. Consumption continued to grow rapidly as third quarter final GDP at 5.7% was revised almost a full percentage point above the original estimate. The strong equity rally in December suggests the Fed's tightening action thus far will do little to stem economic growth. Low unemployment, firm wage laws, together with the unprecedented external deficit, imply the need to slow the economy to a more sustainable pace, even in the absence of any significant consumer price pressures. The Salomon BIG Index fell 0.2% for the quarter bringing the full year decline to -0.8%. Earlier in the year, the Portfolio was conservatively positioned in corporate bonds and held a heavy allocation to mortgage backed securities. In addition we maintained an overweight position in AAA rated agency debenture bonds. Towards the end of the year, the Portfolio's largest positions, vis-a-vis the major aggregate indexes, reflected our positive outlook on mortgages relative to U.S. Treasuries. The corporate sector outperformed Treasuries during the last quarter. This was primarily due to the abatement of Y2K fears in the market and the presence of buyers who had built up cash and were stretching for yield ahead of the first quarter. The Portfolio was modestly overweighted in the corporate sector and we remained comfortable with the overweight position in anticipation of a strong economic backdrop and light near-term supply. Following the late October Fed tightening and their move to neutral bias, Treasury yields fell by approximately 30 basis points. With the view that this move put yields below justifiable levels, we shifted the Portfolio's duration position early in November from neutral to a modest short position relative to the index. We maintained this duration position through the end of the year. With little sign of any material slowing in U.S. growth, aside from some moderation in the construction sector, the U.S. bond market lacked fundamental support at year-end. Strong business and consumer confidence, a robust equity market and very buoyant labor market suggest the need for additional Fed policy tightening. The market continues to discount an insufficient amount of tightening this year in order to slow the economy to an acceptable pace. As a result, we expect to continue to remain defensive in the first half of next year in terms of the Portfolio's duration positions as U.S.Treasury yields should continue to move higher.
Harriet T. Huber
J.P. Morgan Investment Management Inc.
Asset Allocation (% of portfolio market value)
As of 12/31/99
JPM qual bond pie chart
Quality Bond Portfolio, managed by J.P. Morgan Investment Management vs. Salomon Brothers Broad Investment-Grade Bond Index Growth Based on $10,000+ [Line Graph] JPM qual bond vs Salomon plot points
+Performance is shown from date of initial public offering, May 1, 1996. 1. "Average Annual Return" is calculated including reinvestment of all income dividends and capital gain distributions. Results represent past performance and do not indicate future results. The value of an investment in the Quality Bond Portfolio managed by J.P. Morgan Investment Management (JPMIM) and the return on the investment will fluctuate, and redemption proceeds may be higher or lower than an investor's original cost. Performance data is historical and includes changes in share price and reinvestment of dividends and capital gains. Performance numbers are net of all Portfolio operating expenses, but they do not include the administrative fee, the insurance risk charge, the annual contract maintenance charge or the 5% withdrawal charge imposed by the Cova variable annuity contract. If this performance information included the effect of the insurance charges, performance numbers would be lower. Graph prepared by Cova. The index returns in the graph above were generated by CDA Wiesenberger HySales software. Comparison line graphs chart the hypothetical growth of $10,000 over a given historical period of time. Although data are gathered from reliable sources, accuracy and completeness cannot be guaranteed.
1 The Salomon Brothers Broad Investment-Grade Bond Index (BIG) is a
market-capitalized weighted index that includes fixed-rate Treasury, government
sponsored, corporate (Baa3/BBB or better) and mortgage securities. The Index is
not available for direct investment and does not reflect any expenses.
STATEMENT OF ADDITIONAL INFORMATION Acquisition of Assets of QUALITY BOND PORTFOLIO a series of
COVA SERIES TRUST
and NEUBERGER BERMAN BOND SERIES a series of
SECURITY FIRST TRUST
By and In Exchange For Shares of J.P. MORGAN QUALITY BOND PORTFOLIO a series of
MET INVESTORS SERIES TRUST
This Statement of Additional Information, dated December 15, 2000, relating specifically to the proposed transfer of the assets and liabilities of Quality Bond Portfolio (the "Cova Portfolio"), a series of Cova Series Trust, and Neuberger Berman Bond Series (the "SF Portfolio"), a series of Security First Trust to J.P. Morgan Quality Bond Portfolio, (the "Met Portfolio" or the "Portfolio"), a series of Met Investors Series Trust, in exchange for Class A shares of beneficial interest, $.001 par value per share, of the Met Portfolio (to be issued to holders of shares of the Cova Portfolio and the SF Portfolio), consists of the information set forth below pertaining to the Met Portfolio and the following described documents, each of which is attached hereto and incorporated by reference herein: (1) The Statement of Additional Information of the Cova Portfolio dated May 1, 2000; (2) The Statement of Additional Information of the SF Portfolio dated November 30, 2000; (3) Annual Report of the Cova Portfolio for the year ended December 31, 1999; (4) Semi-Annual Report of the Cova Portfolio dated June 30, 2000; (5) Annual Report of the SF Portfolio dated July 31, 2000; and (6) Pro Forma Financial Statements dated as of June 30, 2000. This Statement of Additional Information, which is not a prospectus, supplements, and should be read in conjunction with, the Prospectus/Proxy Statement of the Met Portfolio, the Cova Portfolio and the SF Portfolio dated December 15, 2000. A copy of the Prospectus/Proxy Statement may be obtained without charge by calling or writing to the Met Portfolio, the Cova Portfolio or the SF Portfolio at the telephone numbers or addresses set forth above. INVESTMENT OBJECTIVES AND POLICIES The following information supplements the discussion of the investment objectives and policies of the Met Portfolio in the Prospectus/Proxy Statement. Asset-Backed Securities Asset-backed securities include interests in pools of receivables, such as motor vehicle installment purchase obligations and credit card receivables. Such securities are generally issued as pass-through certificates, which represent undivided fractional ownership interests in the underlying pools of assets. Asset-backed securities are not issued or guaranteed by the U.S. government or its agencies or government-sponsored entities; however, the payment of principal and interest on such obligations may be guaranteed up to certain amounts and for a certain time period by a letter of credit issued by a financial institution (such as a bank or insurance company) unaffiliated with the issuers of such securities. In addition, such securities generally will have remaining estimated lives at the time of purchase of five years or less. Due to the possibility that prepayments (on automobile loans and other collateral) will alter the cash flow on asset-backed securities, is not possible to determine in advance the actual final maturity date or average life. Faster prepayment will shorten the average life and shorter prepayments will lengthen it. The purchase of asset-backed securities raises considerations peculiar to the financing of the instruments underlying such securities. For example, most organizations that issue asset-backed securities relating to motor vehicle installment purchase obligations perfect their interests in their respective obligations only by filing a financing statement and by having the servicer of the obligations, which is usually the originator, take custody thereof. In such circumstances, if the servicer were to sell the same obligations to another party, in violation of its duty not to do so, there is a risk that such party could acquire an interest in the obligations superior to that of holders of the asset-backed securities. Also, although most such obligations grant a security interest in the motor vehicle being financed, in most states the security interest in a motor vehicle must be noted on the certificate of title to perfect such security interest against competing claims of other parties. Due to the large number of vehicles involved, however, the certificate of title to each vehicle financed, pursuant to the obligations underlying the asset-backed securities, usually is not amended to reflect the assignment of the seller's security interest for the benefit of the holders of the asset-backed securities. Therefore, there is the possibility that recoveries on repossessed collateral may not, in some cases, be available to support payments on those securities. In addition, various state and federal laws give the motor vehicle owner the right to assert against the holder of the owner's obligation certain defenses such owner would have against the seller of the motor vehicle. The assertion of such defenses could reduce payments on the related asset-backed securities. Insofar as credit card receivables are concerned, credit card holders are entitled to the protection of a number of state and federal consumer credit laws, many of which give such holders the right to set off certain amounts against balances owed on the credit card, thereby reducing the amounts paid on such receivables. In addition, unlike most other asset-backed securities, credit card receivables are unsecured obligations of the card holder. Brady Bonds Brady Bonds are securities created through the exchange of existing commercial bank loans to public and private entities in certain emerging markets for new bonds in connection with debt restructurings under a debt restructuring plan introduced by former U.S. Secretary of the Treasury, Nicholas F. Brady (the "Brady Plan"). Brady Plan debt restructurings have been implemented to date in Argentina, Brazil, Bulgaria, Costa Rica, Croatia, Dominican Republic, Ecuador, Jordan, Mexico, Morocco, Nigeria, Panama, Peru, the Philippines, Poland, Slovenia, Uruguay and Venezuela. Brady Bonds have been issued only recently, and for that reason do not have a long payment history. Brady Bonds may be collateralized or uncollateralized, are issued in various currencies (but primarily the U.S. dollar) and are actively traded in over-the-counter secondary markets. U.S. dollar-denominated, collateralized Brady Bonds, which may be fixed rate bonds or floating-rate bonds, are generally collateralized in full as to principal by U.S. Treasury zero coupon bonds having the same maturity as the bonds. Brady Bonds are often viewed as having three or four valuation components: the collateralized repayment of principal at maturity; the collateralized interest payments; the uncollateralized interest payments; and any uncollateralized repayment of principal at maturity (the uncollateralized amounts constituting the "residual risk"). In light of the residual risk of Brady Bonds and the history of defaults of countries issuing Brady Bonds with respect to commercial bank loans by public and private entities, investments in Brady Bonds may be viewed as speculative. Convertible Securities The Portfolio may invest in convertible securities of domestic and, subject to the Portfolio's investment strategy, foreign issuers. The convertible securities in which the Portfolio may invest include any debt securities or preferred stock which may be converted into common stock or which carry the right to purchase common stock. Convertible securities entitle the holder to exchange the securities for a specified number of shares of common stock, usually of the same company, at specified prices within a certain period of time. Convertible securities may be converted at either a stated price or stated rate into underlying shares of common stock. Although to a lesser extent than with fixed-income securities, the market value of convertible securities tends to decline as interest rates increase and, conversely, tends to increase as interest rates decline. In addition, because of the conversion feature, the market value of convertible securities tends to vary with fluctuations in the market value of the underlying common stock. A unique feature of convertible securities is that as the market price of the underlying common stock declines, convertible securities tend to trade increasingly on a yield basis, and so may not experience market value declines to the same extent as the underlying common stock. When the market price of the underlying common stock increases, the prices of the convertible securities tend to rise as a reflection of the value of the underlying common stock. While no securities investments are without risk, investments in convertible securities generally entail less risk than investments in common stock of the same issuer. Convertible securities are investments that provide for a stable stream of income with generally higher yields than common stocks. There can be no assurance of current income because the issuers of the convertible securities may default on their obligations. A convertible security, in addition to providing fixed income, offers the potential for capital appreciation through the conversion feature, which enables the holder to benefit from increases in the market price of the underlying common stock. There can be no assurance of capital appreciation, however, because securities prices fluctuate. Convertible securities, however, generally offer lower interest or dividend yields than non-convertible securities of similar quality because of the potential for capital appreciation. Subsequent to purchase by the Portfolio, convertible securities may cease to be rated or a rating may be reduced below the minimum required for purchase for the Portfolio. Neither event will require the sale of such securities, although the Portfolio's investment adviser will consider such event in its determination of whether the Portfolio should continue to hold the securities. Dollar Roll Transactions The Portfolio may enter into "dollar roll" transactions, which consist of the sale by the Portfolio to a bank or broker-dealer (the "counterparty") of Government National Mortgage Association certificates, other mortgage-backed securities or other fixed income securities together with a commitment to purchase from the counterparty similar, but not identical, securities at a future date. The counterparty receives all principal and interest payments, including prepayments, made on the security while it is the holder. The Portfolio receives a fee from the counterparty as consideration for entering into the commitment to purchase. Dollar rolls may be renewed over a period of several months with a different repurchase price and a cash settlement made at each renewal without physical delivery of securities. Moreover, the transaction may be preceded by a firm commitment agreement pursuant to which the Portfolio agrees to buy a security on a future date. The Portfolio will not use such transactions for leveraging purposes and, accordingly, will segregate cash, U.S. government securities or other liquid assets in an amount sufficient to meet its purchase obligations under the transactions. The Portfolio will also maintain asset coverage of at least 300% for all outstanding firm commitments, dollar rolls and other borrowings. Dollar rolls are treated for purposes of the Investment Company Act of 1940, as amended ("1940 Act") as borrowings of a Portfolio because they involve the sale of a security coupled with an agreement to repurchase. Like all borrowings, a dollar roll involves costs to the Portfolio. For example, while the Portfolio receives a fee as consideration for agreeing to repurchase the security, the Portfolio forgoes the right to receive all principal and interest payments while the counterparty holds the security. These payments to the counterparty may exceed the fee received by the Portfolio, thereby effectively charging the Portfolio interest on its borrowing. Further, although the Portfolio can estimate the amount of expected principal prepayment over the term of the dollar roll, a variation in the actual amount of prepayment could increase or decrease the cost of the Portfolio's borrowing. The entry into dollar rolls involves potential risks of loss that are different from those related to the securities underlying the transactions. For example, if the counterparty becomes insolvent, a Portfolio's right to purchase from the counterparty might be restricted. Additionally, the value of such securities may change adversely before the Portfolio is able to purchase them. Similarly, the Portfolio may be required to purchase securities in connection with a dollar roll at a higher price than may otherwise be available on the open market. Since, as noted above, the counterparty is required to deliver a similar, but not identical, security to the Portfolio, the security that the Portfolio is required to buy under the dollar roll may be worth less than an identical security. Finally, there can be no assurance that the Portfolio's use of the cash that it receives from a dollar roll will provide a return that exceeds borrowing costs. Eurodollar and Yankee Dollar Obligations Eurodollar bank obligations are U.S. dollar-denominated certificates of deposit and time deposits issued outside the U.S. capital markets by foreign branches of U.S. banks and by foreign banks. Yankee dollar bank obligations are U.S. dollar-denominated obligations issued in the U.S. capital markets by foreign banks. Eurodollar and Yankee dollar obligations are subject to the same risks that pertain to domestic issues, notably credit risk. Additionally, Eurodollar (and to a limited extent, Yankee dollar) obligations are subject to certain sovereign risks. One such risk is the possibility that a sovereign country might prevent capital, in the form of dollars, from flowing across its borders. Other risks include adverse political and economic developments; the extent and quality of government regulation of financial markets and institutions; the imposition of foreign withholding taxes; and the expropriation or nationalization of foreign issuers. Foreign Currency Transactions Foreign Currency Exchange Transactions. The Portfolio may engage in foreign currency exchange transactions to protect against uncertainty in the level of future exchange rates. The investment adviser to the Portfolio may engage in foreign currency exchange transactions in connection with the purchase and sale of portfolio securities ("transaction hedging"), and to protect the value of specific portfolio positions ("position hedging"). The Portfolio may engage in "transaction hedging" to protect against a change in the foreign currency exchange rate between the date on which the Portfolio contracts to purchase or sell the security and the settlement date, or to "lock in" the U.S. dollar equivalent of a dividend or interest payment in a foreign currency. For that purpose, the Portfolio may purchase or sell a foreign currency on a spot (or cash) basis at the prevailing spot rate in connection with the settlement of transactions in portfolio securities denominated in or exposed to that foreign currency. If conditions warrant, the Portfolio may also enter into contracts to purchase or sell foreign currencies at a future date ("forward contracts") and purchase and sell foreign currency futures contracts as a hedge against changes in foreign currency exchange rates between the trade and settlement dates on particular transactions and not for speculation. A foreign currency forward contract is a negotiated agreement to exchange currency at a future time at a rate or rates that may be higher or lower than the spot rate. Foreign currency futures contracts are standardized exchange-traded contracts and have margin requirements. For transaction hedging purposes, the Portfolio may also purchase exchange-listed and over-the-counter call and put options on foreign currency futures contracts and on foreign currencies. A put option on a futures contract gives a Portfolio the right to assume a short position in the futures contract until expiration of the option. A put option on currency gives a Portfolio the right to sell a currency at an exercise price until the expiration of the option. A call option on a futures contract gives a Portfolio the right to assume a long position in the futures contract until the expiration of the option. A call option on currency gives a Portfolio the right to purchase a currency at the exercise price until the expiration of the option. The Portfolio may engage in "position hedging" to protect against a decline in the value relative to the U.S. dollar of the currencies in which its portfolio securities are denominated, or quoted or exposed (or an increase in the value of currency for securities which the Portfolio intends to buy, when it holds cash reserves and short-term investments). For position hedging purposes, the Portfolio may purchase or sell foreign currency futures contracts and foreign currency forward contracts, and may purchase put or call options on foreign currency futures contracts and on foreign currencies on exchanges or over-the-counter markets. In connection with position hedging, the Portfolio may also purchase or sell foreign currency on a spot basis. The precise matching of the amounts of foreign currency exchange transactions and the value of the portfolio securities involved will not generally be possible since the future value of such securities in foreign currencies will change as a consequence of market movements in the value of those securities between the dates the currency exchange transactions are entered into and the dates they mature. It is impossible to forecast with precision the market value of portfolio securities at the expiration or maturity of a forward or futures contract. Accordingly, it may be necessary for the Portfolio to purchase additional foreign currency on the spot market (and bear the expense of such purchase) if the market value of the security or securities being hedged is less than the amount of foreign currency the Portfolio is obligated to deliver and if a decision is made to sell the security or securities and make delivery of the foreign currency. Conversely, it may be necessary to sell on the spot market some of the foreign currency received upon the sale of the portfolio security or securities if the market value of such security or securities exceeds the amount of foreign currency the Portfolio is obligated to deliver. Hedging transactions involve costs and may result in losses. The Portfolio may write covered call options on foreign currencies to offset some of the costs of hedging those currencies. The Portfolio will engage in over-the-counter transactions only when appropriate exchange-traded transactions are unavailable and when, in the opinion of the Portfolio's investment adviser, the pricing mechanism and liquidity are satisfactory and the participants are responsible parties likely to meet their contractual obligations. The Portfolio's ability to engage in hedging and related option transactions may be limited by tax considerations. Transaction and position hedging do not eliminate fluctuations in the underlying prices of the securities which a Portfolio owns or intends to purchase or sell. They simply establish a rate of exchange which one can achieve at some future point in time. Additionally, although these techniques tend to minimize the risk of loss due to a decline in the value of the hedged currency, they tend to limit any potential gain which might result from the increase in the value of such currency. Currency Forward and Futures Contracts. A forward foreign currency exchange contract involves an obligation to purchase or sell a specific currency at a future date, which may be any fixed number of days from the date of the contract as agreed by the parties, at a price set at the time of the contract. In the case of a cancelable forward contract, the holder has the unilateral right to cancel the contract at maturity by paying a specified fee. The contracts are traded in the interbank market conducted directly between currency traders (usually large commercial banks) and their customers. A forward contract generally has no deposit requirement, and no commissions are charged at any stage for trades. A foreign currency futures contract is a standardized contract for the future delivery of a specified amount of a foreign currency at a future date at a price set at the time of the contract. Foreign currency futures contracts traded in the U.S. are designed by and traded on exchanges regulated by the Commodity Futures Trading Commission ("CFTC"), such as the New York Mercantile Exchange. The Portfolio would enter into foreign currency futures contracts solely for hedging or other appropriate investment purposes as defined in CFTC regulations. Forward foreign currency exchange contracts differ from foreign currency futures contracts in certain respects. For example, the maturity date of a forward contract may be any fixed number of days from the date of the contract agreed upon by the parties, rather than a predetermined date in any given month. Forward contracts may be in any amounts agreed upon by the parties rather than predetermined amounts. Also, forward foreign exchange contracts are traded directly between currency traders so that no intermediary is required. A forward contract generally requires no margin or other deposit. At the maturity of a forward or futures contract, the Portfolio may either accept or make delivery of the currency specified in the contract, or at or prior to maturity enter into a closing transaction involving the purchase or sale of an offsetting contract. Closing transactions with respect to forward contracts are usually effected with the currency trader who is a party to the original forward contract. Closing transactions with respect to futures contracts are effected on a commodities exchange; a clearing corporation associated with the exchange assumes responsibility for closing out such contracts. Positions in foreign currency futures contracts may be closed out only on an exchange or board of trade which provides a secondary market in such contracts. Although a Portfolio intends to purchase or sell foreign currency futures contracts only on exchanges or boards of trade where there appears to be an active secondary market, there can be no assurance that a secondary market on an exchange or board of trade will exist for any particular contract or at any particular time. In such event, it may not be possible to close a futures position and, in the event of adverse price movements, a Portfolio would continue to be required to make daily cash payments of variation margin. Foreign Currency Options. Options on foreign currencies operate similarly to options on securities, and are traded primarily in the over-the-counter market, although options on foreign currencies have recently been listed on several exchanges. Such options will be purchased or written only when the Portfolio's investment adviser believes that a liquid secondary market exists for such options. There can be no assurance that a liquid secondary market will exist for a particular option at any specific time. Options on foreign currencies are affected by all of those factors which influence foreign exchange rates and investments generally. The value of a foreign currency option is dependent upon the value of the foreign currency and the U.S. dollar, and may have no relationship to the investment merits of a foreign security. Because foreign currency transactions occurring in the interbank market involve substantially larger amounts than those that may be involved in the use of foreign currency options, investors may be disadvantaged by having to deal in an odd lot market (generally consisting of transactions of less than $1 million) for the underlying foreign currencies at prices that are less favorable than for round lots. There is no systematic reporting of last sale information for foreign currencies and there is no regulatory requirement that quotations available through dealers or other market sources be firm or revised on a timely basis. Available quotation information is generally representative of very large transactions in the interbank market and thus may not reflect relatively smaller transactions (less than $1 million) where rates may be less favorable. The interbank market in foreign currencies is a global, around-the-clock market. To the extent that the U.S. options markets are closed while the markets for the underlying currencies remain open, significant price and rate movements may take place in the underlying markets that cannot be reflected in the options markets. Foreign Currency Conversion. Although foreign exchange dealers do not charge a fee for currency conversion, they do realize a profit based on the difference (the "spread") between prices at which they are buying and selling various currencies. Thus, a dealer may offer to sell a foreign currency to a Portfolio at one rate, while offering a lesser rate of exchange should a Portfolio desire to resell that currency to the dealer. Foreign Securities The Portfolio may invest in foreign equity and debt securities or U.S. securities traded in foreign markets. In addition to securities issued by foreign companies, permissible investments may also consist of obligations of foreign branches of U.S. banks and of foreign banks, including European certificates of deposit, European time deposits, Canadian time deposits, Yankee certificates of deposit, Eurodollar bonds and Yankee bonds. The Portfolio may also invest in Canadian commercial paper and Europaper. These instruments may subject the Portfolio to additional investment risks from those related to investments in obligations of U.S. issuers. In addition, foreign branches of U.S. banks and foreign banks may be subject to less stringent reserve requirements than those applicable to domestic branches of U.S. banks. Foreign investments involve certain risks that are not present in domestic securities. For example, foreign securities may be subject to currency risks or to foreign government taxes which reduce their attractiveness. There may be less information publicly available about a foreign issuer than about a U.S. issuer, and a foreign issuer is not generally subject to uniform accounting, auditing and financial reporting standards and practices comparable to those in the U.S. Other risks of investing in such securities include political or economic instability in the country involved, the difficulty of predicting international trade patterns and the possibility of imposition of exchange controls. The prices of such securities may be more volatile than those of domestic securities. With respect to certain foreign countries, there is a possibility of expropriation of assets or nationalization, imposition of withholding taxes on dividend or interest payments, difficulty in obtaining and enforcing judgments against foreign entities or diplomatic developments which could affect investment in these countries. Losses and other expenses may be incurred in converting between various currencies in connection with purchases and sales of foreign securities. Foreign stock markets are generally not as developed or efficient as, and may be more volatile than, those in the U.S. While growing in volume, they usually have substantially less volume than U.S. markets and the Portfolio's investment securities may be less liquid and subject to more rapid and erratic price movements than securities of comparable U.S. companies. Equity securities may trade at price/earnings multiples higher than comparable U.S. securities and such levels may not be sustainable. There is generally less government supervision and regulation of foreign stock exchanges, brokers, banks and listed companies abroad than in the U.S. Moreover, settlement practices for transactions in foreign markets may differ from those in U.S. markets. Such differences may include delays beyond periods customary in the U.S. and practices, such as delivery of securities prior to receipt of payment, which increase the likelihood of a "failed settlement", which can result in losses to the Portfolio. The value of foreign investments and the investment income derived from them may also be affected unfavorable by changes in currency exchange control regulations. Although the Portfolio will invest only in securities denominated in foreign currencies that are fully exchangeable into U.S. dollars without legal restriction at the time of investment, there can be no assurance that currency controls will not be imposed subsequently. In addition, the value of foreign fixed income investments may fluctuate in response to changes in U.S. and foreign interest rates. Foreign brokerage commissions, custodial expenses and other fees are also generally higher than for securities traded in the U.S. Consequently, the overall expense ratios of international or global funds are usually somewhat higher than those of typical domestic stock funds. Fluctuations in exchange rates may also affect the earning power and asset value of the foreign entity issuing a security, even one denominated in U.S. dollars. Dividend and interest payments will be repatriated based on the exchange rate at the time of disbursement, and restrictions on capital flows may be imposed. The debt obligations of foreign governments and entities may or may not be supported by the full faith and credit of the foreign government. The Portfolio may buy securities issued by certain "supra-national" entities, which include entities designated or supported by governments to promote economic reconstruction or development, international banking organizations and related government agencies. Examples are the International Bank for Reconstruction and Development (commonly called the "World Bank"), the Asian Development Bank and the Inter-American Development Bank. The governmental members of these supranational entities are "stockholders" that typically make capital contributions and may be committed to make additional capital contributions if the entity is unable to repay its borrowings. A supra-national entity's lending activities may be limited to a percentage of its total capital, reserves and net income. There can be no assurance that the constituent foreign governments will continue to be able or willing to honor their capitalization commitments for those entities. The Met Portfolio does not expect to invest more than 25% of its total assets in securities of foreign issuers. Any foreign commercial paper must not be subject to foreign withholding tax at the time of purchase. Emerging Market Securities. Investments in emerging market country securities involve special risks. Political and economic structures in many of such countries may be undergoing significant evolution and rapid development, and such countries may lack the social, political and economic stability characteristic of more developed countries. Certain of such countries may have in the past failed to recognize private property rights and have at times nationalized or expropriated the assets of private companies. As a result, the risks described above, including the risks of nationalization or expropriation of assets, may be heightened. In addition, unanticipated political or social developments may affect the values of the Portfolio's investments in those countries and the availability to the Portfolio of additional investments in those countries. The small size and inexperience of the securities markets in certain of such countries and the limited volume of trading in securities in those countries may make the Portfolio's investments in such countries illiquid and more volatile than investment in more developed countries, and the Portfolio may be required to establish special custodial or other arrangements before making certain investments in those countries. There may be little financial or accounting information available with respect to issuers located in certain of such countries, and it may be difficult as a result to assess the value or prospects of an investment in such issuers. Transaction costs in emerging markets may be higher than in the U.S. and other developed securities markets. As legal systems in emerging markets develop, foreign investors may be adversely affected by new or amended laws and regulations or may not be able to obtain swift and equitable enforcement of existing law. The Portfolio may make investments denominated in emerging markets currencies. Some countries in emerging markets also may have managed currencies, which are not free floating against the U.S. dollar. In addition, emerging markets are subject to the risk of restrictions upon the free conversion of their currencies into other currencies. Any devaluations relative to the U.S. dollar in the currencies in which the Portfolio's securities are quoted would reduce the Portfolio's net asset value. Certain emerging markets limit, or require governmental approval prior to, investments by foreign persons. Repatriation of investment income and capital from certain emerging markets is subject to certain governmental consents. Even where there is no outright restriction on repatriation of capital, the mechanics of repatriation may affect the operation of the Portfolio. Forward Commitments, When-Issued and Delayed Delivery Securities The Portfolio may purchase securities on a when-issued or delayed delivery basis and may purchase or sell securities on a forward commitment basis. Settlement of such transactions normally occurs within a month or more after the purchase or sale commitment is made. The Portfolio may purchase securities under such conditions only with the intention of actually acquiring them, but may enter into a separate agreement to sell the securities before the settlement date. Since the value of securities purchased may fluctuate prior to settlement, the Portfolio may be required to pay more at settlement than the security is worth. In addition, the purchaser is not entitled to any of the interest earned prior to settlement. Upon making a commitment to purchase a security on a when-issued, delayed delivery or forward commitment basis the Portfolio will hold liquid assets in a segregated account at the Portfolio's custodian bank worth at least the equivalent of the amount due. The liquid assets will be monitored on a daily basis and adjusted as necessary to maintain the necessary value. Purchases made under such conditions may involve the risk that yields secured at the time of commitment may be lower than otherwise available by the time settlement takes place, causing an unrealized loss to the Portfolio. In addition, when the Portfolio engages in such purchases, it relies on the other party to consummate the sale. If the other party fails to perform its obligations, the Portfolio may miss the opportunity to obtain a security at a favorable price or yield. Although the Portfolio will generally enter into forward commitments to purchase securities with the intention of actually acquiring the security for its portfolio (or for delivery pursuant to options contracts it has entered into), the Portfolio may dispose of a security prior to settlement if its investment adviser deems it advisable to do so. The Portfolio may realize short-term gains or losses in connection with such sales. High Yield/High Risk Debt Securities Certain lower rated securities purchased by the Portfolio, such as those rated Ba or B by Moody's Investors Service, Inc. ("Moody's") or BB or B by Standard & Poor's Ratings Services ("Standard & Poor's") (commonly known as junk bonds), may be subject to certain risks with respect to the issuing entity's ability to make scheduled payments of principal and interest and to greater market fluctuations. While generally providing greater income than investments in higher quality securities, lower quality fixed income 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 fixed income securities tend to be affected by economic changes and short-term corporate and industry developments to a greater extent than higher quality securities, which react primarily to fluctuations in the general level of interest rates. To the extent that the Portfolio invests in such lower quality securities, the achievement of its investment objective may be more dependent on the investment adviser's own credit analysis. Lower quality fixed income securities are affected by the market's perception of their credit quality, especially during times of adverse publicity, and the outlook for economic growth. Economic downturns or an increase in interest rates may cause a higher incidence of default by the issuers of these securities, especially issuers that are highly leveraged. The market for these lower quality fixed income securities is generally less liquid than the market for investment grade fixed income securities. It may be more difficult to sell these lower rated securities to meet redemption requests, to respond to changes in the market, or to value accurately a Portfolio's portfolio securities for purposes of determining the Portfolio's net asset value. In determining suitability of investment in a particular unrated security, the investment adviser takes into consideration asset and debt service coverage, the purpose of the financing, history of the issuer, existence of other rated securities of the issuer, and other relevant conditions, such as comparability to other issuers. Hybrid Instruments Although there are no percentage limitations on the amount of assets that may be invested in hybrid instruments, the investment adviser to the Portfolio does not anticipate that such investments will exceed 15% of the Portfolio's total assets. Hybrid instruments have recently been developed and combine the elements of futures contracts or options with those of debt, preferred equity or a depository instrument. Often these hybrid instruments are indexed to the price of a commodity, particular currency, or a domestic or foreign debt or equity securities index. Hybrid instruments may take a variety of forms, including, but not limited to, debt instruments with interest or principal payments or redemption terms determined by reference to the value of a currency or commodity or securities index at a future point in time, preferred stock with dividend rates determined by reference to the value of a currency, or convertible securities with the conversion terms related to a particular commodity. Hybrid instruments may bear interest or pay dividends at below market (or even relatively nominal) rates. Under certain conditions, the redemption value of such an instrument could be zero. Hybrid instruments can have volatile prices and limited liquidity and their use by the Portfolio may not be successful. Illiquid Securities The Portfolio may invest up to 15% of its net assets in illiquid securities and other securities which are not readily marketable, including non-negotiable time deposits, certain restricted securities not deemed by the Trust's Board of Trustees to be liquid and repurchase agreements with maturities longer than seven days. Securities eligible for resale pursuant to Rule 144A under the Securities Act of 1933, which have been determined to be liquid, will not be considered by the Portfolio's investment adviser to be illiquid or not readily marketable and, therefore, are not subject to the aforementioned 15% limit. The inability of the Portfolio to dispose of illiquid or not readily marketable investments readily or at a reasonable price could impair the Portfolio's ability to raise cash for redemptions or other purposes. The liquidity of securities purchased by the Portfolio which are eligible for resale pursuant to Rule 144A will be monitored by the Portfolio's investment adviser on an ongoing basis, subject to the oversight of the Trustees. In the event that such a security is deemed to be no longer liquid, the Portfolio's holdings will be reviewed to determine what action, if any, is required to ensure that the retention of such security does not result in the Portfolio having more than 15% of its assets invested in illiquid or not readily marketable securities. Interest Rate Transactions Among the strategic transactions into which the Portfolio may enter are interest rate swaps and the purchase or sale of related caps and floors. The Portfolio expects to enter into these transactions primarily to preserve a return or spread on a particular investment or portion of its portfolio, to protect against currency fluctuations, as a duration management technique or to protect against any increase in the price of securities the Portfolio anticipates purchasing at a later date. The Portfolio intends to use these transactions as hedges and not as speculative investments and will not sell interest rate caps or floors where it does not own securities or other instruments providing the income stream the Portfolio may be obligated to pay. Interest rate swaps involve the exchange by the Portfolio with another party of their respective commitments to pay or receive interest, e.g., an exchange of floating rate payments for fixed rate payments with respect to a notional amount of principal. A currency swap is an agreement to exchange cash flows on a notional amount of two or more currencies based on the relative value differential among them and an index swap is an agreement to swap cash flows on a notional amount based on changes in the values of the reference indices. The purchase of a cap entitles the purchaser, to the extent that a specific index exceeds a predetermined interest rate, to receive payments of interest on a notional principal amount from the party selling such cap. 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. The Portfolio will usually enter into swaps on a net basis, i.e., the two payment streams are netted out in a cash settlement on the payment date or dates specified in the instrument, with the Portfolio receiving or paying, as the case may be, only the net amount of the two payments. Inasmuch as these swaps, caps and floors are entered into for good faith hedging purposes, the investment adviser to the Portfolio and the Trust believe such obligations do not constitute senior securities under the 1940 Act and, accordingly, will not treat them as being subject to its borrowing restrictions. The Portfolio will not enter into any swap, cap and floor transaction unless, at the time of entering into such transaction, the unsecured long-term debt of the counterparty, combined with any credit enhancements, is rated at least "A" by Standard & Poor's or Moody's or has an equivalent rating from another nationally recognized statistical rating organization ("NRSRO") or is determined to be of equivalent credit quality by the investment adviser. For a description of the NRSROs and their ratings, see the Appendix. If there is a default by the counterparty, the Portfolio may have contractual remedies pursuant to the agreements related to the transaction. The swap market has grown substantially in recent years with a large number of banks and investment banking firms acting both as principals and as agents utilizing standardized swap documentation. As a result, the swap market has become relatively liquid. Caps and floors are more recent innovations for which standardized documentation has not yet been fully developed and, accordingly, they are less liquid than swaps. With respect to swaps, the Portfolio will accrue the net amount of the excess, if any, of its obligations over its entitlements with respect to each swap on a daily basis and will segregate an amount of cash or liquid high grade securities having a value equal to the accrued excess. Caps and floors require segregation of assets with a value equal to the Portfolio's net obligations, if any. Investment Grade Corporate Debt Securities Debt securities are rated by NRSROs. Securities rated BBB by Standard & Poor's or Baa by Moody's are considered investment grade securities, but are somewhat riskier than higher rated investment grade obligations because they are regarded as having only an adequate capacity to pay principal and interest, and are considered to lack outstanding investment characteristics and may be speculative. See the Appendix to this Statement of Additional Information for a description of the various securities ratings. Loans and Other Direct Indebtedness By purchasing a loan, the Portfolio acquires some or all of the interest of a bank or other lending institution in a loan to a corporate borrower. Many such loans are secured, and most impose restrictive covenants which must be met by the borrower. These loans are made generally to finance internal growth, mergers, acquisitions, stock repurchases, leveraged buy-outs and other corporate activities. Such loans may be in default at the time of purchase. The Portfolio may also purchase trade or other claims against companies, which generally represent money owed by the company to a supplier of goods or services. These claims may also be purchased at a time when the company is in default. Certain of the loans acquired by the Portfolio may involve revolving credit facilities or other standby financing commitments which obligate the Portfolio to pay additional cash on a certain date or on demand. The highly leveraged nature of many such loans may make such loans especially vulnerable to adverse changes in economic or market conditions. Loans and other direct investments may not be in the form of securities or may be subject to restrictions on transfer, and only limited opportunities may exist to resell such instruments. As a result, the Portfolio may be unable to sell such investments at an opportune time or may have to resell them at less than fair market value. Money Market Securities Money market securities in which the Portfolio may invest include U.S. government securities, U.S. dollar denominated instruments (such as bankers' acceptances, commercial paper, domestic or Yankee certificates of deposit and Eurodollar obligations) issued or guaranteed by bank holding companies in the U.S., their subsidiaries and their foreign branches. These bank obligations may be general obligations of the parent bank holding company or may be limited to the issuing entity by the terms of the specific obligation or by government regulation. Other money market securities in which the Portfolio may invest also include certain variable and floating rate instruments and participations in corporate loans to corporations in whose commercial paper or other short-term obligations the Portfolio may invest. Because the bank issuing the participations does not guarantee them in any way, they are subject to the credit risks generally associated with the underlying corporate borrower. To the extent that the Portfolio may be regarded as a creditor of the issuing bank (rather than of the underlying corporate borrower under the terms of the loan participation), the Portfolio may also be subject to credit risks associated with the issuing bank. The secondary market, if any, for these loan participations is extremely limited and any such participations purchased by the Portfolio will be regarded as illiquid. The Portfolio may also invest in bonds and notes with remaining maturities of thirteen months or less, variable rate notes and variable amount master demand notes. A variable amount master demand note differs from ordinary commercial paper in that it is issued pursuant to a written agreement between the issuer and the holder, its amount may be increased from time to time by the holder (subject to an agreed maximum) or decreased by the holder or the issuer, it is payable on demand, the rate of interest payable on it varies with an agreed formula and it is typically not rated by a rating agency. Transfer of such notes is usually restricted by the issuer, and there is no secondary trading market for them. Any variable amount master demand note purchased by the Portfolio will be regarded as an illiquid security. Generally, the Portfolio will invest only in high quality money market instruments, i.e., securities which have been assigned the highest quality ratings by NRSROs such as "A-1" by Standard & Poor's or "Prime-1" by Moody's, or if not rated, determined to be of comparable quality by the Portfolio's investment adviser. The Portfolio may also invest in money market instruments rated A-3 by Standard & Poor's and Prime-3 by Moody's. Mortgage-Backed Securities A mortgage-backed security may be an obligation of the issuer backed by a mortgage or pool of mortgages or a direct interest in an underlying pool of mortgages. The Portfolio may invest in collaterialized mortgage obligations ("CMOs") and stripped mortgage-backed securities that represent a participation in, or are secured by, mortgage loans. Some mortgage-backed securities, such as CMOs, make payments of both principal and interest at a variety of intervals; others make semi-annual interest payments at a predetermined rate and repay principal at maturity (like a typical bond). Mortgage-backed securities are based on different types of mortgages including those on commercial real estate or residential properties. CMOs may be issued by a U.S. government agency or instrumentality or by a private issuer. Although payment of the principal of, and interest on, the underlying collateral securing privately issued CMOs may be guaranteed by the U.S. government or its agencies or instrumentalities, these CMOs represent obligations solely of the private issuer and are not insured or guaranteed by the U.S. government, its agencies or instrumentalities or any other person or entity. Prepayments could cause early retirement of CMOs. CMOs are designed to reduce the risk of prepayment for investors by issuing multiple classes of securities (or "tranches"), each having different maturities, interest rates and payment schedules, and with the principal and interest on the underlying mortgages allocated among the several classes in various ways. Payment of interest or principal on some classes or series of CMOs may be subject to contingencies or some classes or series may bear some or all of the risk of default on the underlying mortgages. CMOs of different classes or series are generally retired in sequence as the underlying mortgage loans in the mortgage pool are repaid. If enough mortgages are repaid ahead of schedule, the classes or series of a CMO with the earliest maturities generally will be retired prior to their maturities. Thus, the early retirement of particular classes or series of a CMO held by the Portfolio would have the same effect as the prepayment of mortgages underlying other mortgage-backed securities. Conversely, slower than anticipated prepayments can extend the effective maturities of CMOs subjecting them to a greater risk of decline in market value in response to rising interest rates than traditional debt securities, and, therefore, potentially increasing the volatility of the Portfolio that invests in CMOs. The value of mortgage-backed securities may change due to shifts in the market's perception of issuers. In addition, regulatory or tax changes may adversely affect the mortgage securities market as a whole. Non-government mortgage-backed securities may offer higher yields than those issued by government entities, but also may be subject to greater price changes than government issues. Mortgage-backed securities have yield and maturity characteristics corresponding to the underlying assets. Unlike traditional debt securities, which may pay a fixed rate of interest until maturity, when the entire principal amount comes due, payments on certain mortgage-backed securities include both interest and a partial repayment of principal. Besides the scheduled repayment of principal, repayments of principal may result from the voluntary prepayment, refinancing, or foreclosure of the underlying mortgage loans. Mortgage-backed securities are subject to prepayment risk. Prepayment, which occurs when unscheduled or early payments are made on the underlying mortgages, may shorten the effective maturities of these securities and may lower their returns. If property owners make unscheduled prepayments of their mortgage loans, these prepayments will result in early payment of the applicable mortgage-related securities. In that event, the Portfolio may be unable to invest the proceeds from the early payment of the mortgage-related securities in an investment that provides as high a yield as the mortgage-related securities. Consequently, early payment associated with mortgage-related securities may cause these securities to experience significantly greater price and yield volatility than that experienced by traditional fixed income securities. The occurrence of mortgage prepayments is affected by factors including the level of interest rates, general economic conditions, the location and age of the mortgage and other social and demographic conditions. During periods of falling interest rates, the rate of mortgage prepayments tends to increase, thereby tending to decrease the life of mortgage-related securities. During periods of rising interest rates, the rate of mortgage prepayments usually decreases, thereby tending to increase the life of mortgage-related securities. If the life of a mortgage-related security is inaccurately predicted, the Portfolio may not be able to realize the rate of return it expected. Mortgage-backed securities are less effective than other types of securities as a means of "locking in" attractive long-term interest rates. One reason is the need to reinvest prepayments of principal; another is the possibility of significant unscheduled prepayments resulting from declines in interest rates. Prepayments may cause losses on securities purchased at a premium. At times, some of the mortgage-backed securities in which the Portfolio may invest will have higher than market interest rates and, therefore, will be purchased at a premium above their par value. Unscheduled prepayments, which are made at par, will cause the Portfolio to experience a loss equal to any unamortized premium. Stripped mortgage-backed securities are created when a U.S. government agency or a financial institution separates the interest and principal components of a mortgage-backed security and sells them as individual securities. The securities may be issued by agencies or instrumentalities of the U.S. government and private originators of, or investors in, mortgage loans, including savings and loan associations, mortgage banks, commercial banks, investment banks and special purpose entities of the foregoing. Stripped mortgage-backed securities are usually structured with two classes that receive different portions of the interest and principal distributions on a pool of mortgage loans. The holder of the "principal-only" security ("PO") receives the principal payments made by the underlying mortgage-backed security while the holder of the "interest-only" security ("IO") receives interest payments from the same underlying security. The Portfolio may invest in both the IO class and the PO class. The prices of stripped mortgage-backed securities may be particularly affected by changes in interest rates. The yield to maturity on an IO class of stripped mortgage-backed securities is extremely sensitive not only to changes in prevailing interest rates but also to the rate of the principal payments (including prepayments) on the underlying assets. As interest rates fall, prepayment rates tend to increase, which tends to reduce prices of IOs and increase prices of POs. Rising interest rates can have the opposite effect. Prepayments may also result in losses on stripped mortgage-backed securities. A rapid rate of principal prepayments may have a measurable adverse effect on the Portfolio's yield to maturity to the extent it invests in IOs. If the assets underlying the IO experience greater than anticipated prepayments of principal, the Portfolio may fail to recoup fully its initial investments in these securities. Conversely, POs tend to increase in value if prepayments are greater than anticipated and decline if prepayments are slower than anticipated. The secondary market for stripped mortgage-backed securities may be more volatile and less liquid than that for other mortgage-backed securities, potentially limiting the Portfolio's ability to buy and sell those securities at any particular time. The Portfolio may also invest in directly placed mortgages including residential mortgages, multifamily mortgages, mortgages on cooperative apartment buildings, commercial mortgages, and sale-leasebacks. These investments are backed by assets such as office buildings, shopping centers, retail stores, warehouses, apartment buildings and single-family dwellings. In the event that the Portfolio forecloses on any non-performing mortgage, it would end up acquiring a direct interest in the underlying real property and the Portfolio would then be subject to the risks generally associated with the ownership of real property. There may be fluctuations in the market value of the foreclosed property and its occupancy rates, rent schedules and operating expenses. Investment in direct mortgages involve may of the same risks as investments in mortgage-related securities. There may also be adverse changes in local, regional or general economic conditions, deterioration of the real estate market and the financial circumstances of tenants and sellers, unfavorable changes in zoning, building, environmental and other laws, increased real property taxes, rising interest rates, reduced availability and increased cost of mortgage borrowing, the need for anticipated renovations, unexpected increases in the cost of energy, environmental factors, acts of God and other factors which are beyond the control of the Portfolio or its investment adviser. Hazardous or toxic substances may be present on, at or under the mortgaged property and adversely affect the value of the property. In addition, the owners of the property containing such substances may be held responsible, under various laws, for containing, monitoring, removing or cleaning up such substances. The presence of such substances may also provide a basis for other claims by third parties. Costs of clean-up or of liabilities to third parties may exceed the value of the property. In addition, these risks may be uninsurable. In light of these and similar risks, it may be impossible to dispose profitably of properties in foreclosure. Municipal Fixed Income Securities The Portfolio may invest in municipal bonds of any state, territory or possession of the U.S., including the District of Columbia. The Portfolio may also invest in municipal bonds of any political subdivision, agency or instrumentality (e.g., counties, cities, towns, villages, districts, authorities) of the U.S. or its possessions. Municipal bonds are debt instruments issued by or for a state or local government to support its general financial needs or to pay for special projects such as airports, bridges, highways, public transit, schools, hospitals, housing and water and sewer works. Interest payments received by holders of these securities are generally tax-free. Municipal bonds may also be issued to refinance public debt. Municipal bonds are mainly divided between "general obligation" and "revenue" bonds. General obligation bonds are backed by the full faith and credit of governmental issuers with the power to tax. They are repaid from the issuer's general revenues. Payment, however, may be dependent upon legislative approval and may be subject to limitations on the issuer's taxing power. Enforcement of payments due under general obligation bonds varies according to the law applicable to the issuer. In contrast, revenue bonds are supported only by the revenues generated by the project or facility. The Portfolio may also invest in industrial development bonds. Such bonds are usually revenue bonds issued to pay for facilities with a public purpose operated by private corporations. The credit quality of industrial development bonds is usually directly related to the credit standing of the owner or user of the facilities. To qualify as a municipal bond, the interest paid on an industrial development bond must qualify as fully exempt from federal income tax. However, the interest paid on an industrial development bond may be subject to the federal alternative minimum tax. The yields on municipal bonds depend on such factors as market conditions, the financial condition of the issuer and the issue's size, maturity date and rating. Municipal bonds are rated by Standard & Poor's, Moody's and Fitch IBCA, Inc. Such ratings, however, are opinions, not absolute standards of quality. Municipal bonds with the same maturity, interest rates and rating may have different yields, while municipal bonds with the same maturity and interest rate, but different ratings, may have the same yield. Once purchased by the Portfolio, a municipal bond may cease to be rated or receive a new rating below the minimum required for purchase by the Portfolio. Neither event would require the Portfolio to sell the bond, but the Portfolio's investment adviser would consider such events in determining whether the Portfolio should continue to hold it. The ability of the Portfolio to achieve its investment objective depends upon the continuing ability of the issuers of municipal bonds to pay interest and principal when due. Municipal bonds are subject to the provisions of bankruptcy, insolvency and other laws affecting the rights and remedies of creditors. Such laws extend the time for payment of principal and/or interest, and may otherwise restrict the Portfolio's ability to enforce its rights in the event of default. Since there is generally less information available on the financial condition of municipal bond issuers compared to other domestic issuers of securities, the Portfolio's investment adviser may lack sufficient knowledge of an issue's weaknesses. Other influences, such as litigation, may also materially affect the ability of an issuer to pay principal and interest when due. In addition, the market for municipal bonds is often thin and can be temporarily affected by large purchases and sales, including those by the Portfolio. From time to time, Congress has considered restricting or eliminating the federal income tax exemption for interest on municipal bonds. Such actions could materially affect the availability of municipal bonds and the value of those already owned by the Portfolio. If such legislation were passed, the Trust's Board of Trustees may recommend changes in the Portfolio's investment objectives and policies. Options and Futures Strategies The Portfolio may seek to increase the current return on its investments by writing covered call or covered put options. In addition, the Portfolio may at times seek to hedge against either a decline in the value of its portfolio securities or an increase in the price of securities which its investment adviser plans to purchase through the writing and purchase of options including options on stock indices and the purchase and sale of futures contracts and related options. The Portfolio may utilize options or futures contracts and related options for other than hedging purposes to the extent that the aggregate initial margins and premiums do not exceed 5% of the Portfolio's net asset value; provided, however, in the case of an option that is in-the-money at the time of purchase, the in-the-money amount may be excluded in calculating the 5% limitation. Expenses and losses incurred as a result of such hedging strategies will reduce a Portfolio's current return. The ability of the Portfolio to engage in the options and futures strategies described below will depend on the availability of liquid markets in such instruments. Markets in options and futures with respect to stock indices and U.S. government securities are relatively new and still developing. It is impossible to predict the amount of trading interest that may exist in various types of options or futures. Therefore no assurance can be given that the Portfolio will be able to utilize these instruments effectively for the purposes stated below. Writing Covered Options on Securities. The Portfolio may write covered call options and covered put options on optionable securities of the types in which it is permitted to invest from time to time as its investment adviser determines is appropriate in seeking to attain the Portfolio's investment objective. Call options written by the Portfolio give the holder the right to buy the underlying security from the Portfolio at a stated exercise price; put options give the holder the right to sell the underlying security to the Portfolio at a stated price. The Portfolio may only write call options on a covered basis or for cross-hedging purposes and will only write covered put options. A put option would be considered "covered" if the Portfolio owns an option to sell the underlying security subject to the option having an exercise price equal to or greater than the exercise price of the "covered" option at all times while the put option is outstanding. A call option is covered if the Portfolio owns or has the right to acquire the underlying securities subject to the call option (or comparable securities satisfying the cover requirements of securities exchanges) at all times during the option period. A call option is for cross-hedging purposes if it is not covered, but is designed to provide a hedge against another security which the Portfolio owns or has the right to acquire. In the case of a call written for cross-hedging purposes or a put option, the Portfolio will maintain in a segregated account at the Trust's custodian bank liquid assets with a value equal to or greater than the Portfolio's obligation under the option. The Portfolio may also write combinations of covered puts and covered calls on the same underlying security. The Portfolio will receive a premium from writing an option, which increases the Portfolio's return in the event the option expires unexercised or is terminated at a profit. The amount of the premium will reflect, among other things, the relationship of the market price of the underlying security to the exercise price of the option, the term of the option, and the volatility of the market price of the underlying security. By writing a call option, the Portfolio will limit its opportunity to profit from any increase in the market value of the underlying security above the exercise price of the option. By writing a put option, the Portfolio will assume the risk that it may be required to purchase the underlying security for an exercise price higher than its then current market price, resulting in a potential capital loss if the purchase price exceeds the market price plus the amount of the premium received. The Portfolio may terminate an option which it has written prior to its expiration by entering into a closing purchase transaction in which it purchases an option having the same terms as the option written. The Portfolio will realize a profit (or loss) from such transaction if the cost of such transaction is less (or more) than the premium received from the writing of the option. Because increases in the market price of a call option will generally reflect increases in the market price of the underlying security, any loss resulting from the repurchase of a call option may be offset in whole or in part by unrealized appreciation of the underlying security owned by the Portfolio. Purchasing Put and Call Options on Securities. The Portfolio may purchase put options to protect its portfolio holdings in an underlying security against a decline in market value. This protection is provided during the life of the put option since the Portfolio, as holder of the put, is able to sell the underlying security at the exercise price regardless of any decline in the underlying security's market price. For the purchase of a put option to be profitable, the market price of the underlying security must decline sufficiently below the exercise price to cover the premium and transaction costs. By using put options in this manner, any profit which the Portfolio might otherwise have realized on the underlying security will be reduced by the premium paid for the put option and by transaction costs. The Portfolio may also purchase a call option to hedge against an increase in price of a security that it intends to purchase. This protection is provided during the life of the call option since the Portfolio, as holder of the call, is able to buy the underlying security at the exercise price regardless of any increase in the underlying security's market price. For the purchase of a call option to be profitable, the market price of the underlying security must rise sufficiently above the exercise price to cover the premium and transaction costs. By using call options in this manner, any profit which the Portfolio might have realized had it bought the underlying security at the time it purchased the call option will be reduced by the premium paid for the call option and by transaction costs. There are no specific limitations on the Portfolio's purchases of options on securities. Purchase and Sale of Options and Futures on Stock Indices. The Portfolio may purchase and sell options on stock indices and stock index futures contracts either as a hedge against movements in the equity markets or for other investment purposes. Options on stock indices are similar to options on specific securities except that, rather than the right to take or make delivery of the specific security at a specific price, an option on a stock index gives the holder the right to receive, upon exercise of the option, an amount of cash if the closing level of that stock index is greater than, in the case of a call, or less than, in the case of a put, the exercise price of the option. This amount of cash is equal to such difference between the closing price of the index and the exercise price of the option expressed in dollars times a specified multiple. The writer of the option is obligated, in return for the premium received, to make delivery of this amount. Unlike options on specific securities, all settlements of options on stock indices are in cash and gain or loss depends on general movements in the stocks included in the index rather than price movements in particular stocks. Currently options traded include the Standard & Poor's 500 Composite Stock Price Index, the NYSE Composite Index, the AMEX Market Value Index, the NASDAQ 100 Index, the Nikkei 225 Stock Average Index, the Financial Times Stock Exchange 100 Index and other standard broadly based stock market indices. Options are also traded in certain industry or market segment indices such as the Pharmaceutical Index. A stock index futures contract is an agreement in which one party agrees to deliver to the other an amount of cash equal to a specific dollar amount times the difference between the value of a specific stock index at the close of the last trading day of the contract and the price at which the agreement is made. No physical delivery of securities is made. If the Portfolio's investment adviser expects general stock market prices to rise, it might purchase a call option on a stock index or a futures contract on that index as a hedge against an increase in prices of particular equity securities it wants ultimately to buy for the Portfolio. If in fact the stock index does rise, the price of the particular equity securities intended to be purchased may also increase, but that increase would be offset in part by the increase in the value of the Portfolio's index option or futures contract resulting from the increase in the index. If, on the other hand, the Portfolio's investment adviser expects general stock market prices to decline, it might purchase a put option or sell a futures contract on the index. If that index does in fact decline, the value of some or all of the equity securities held by the Portfolio may also be expected to decline, but that decrease would be offset in part by the increase in the value of the Portfolio's position in such put option or futures contract. Purchase and Sale of Interest Rate Futures. The Portfolio may purchase and sell interest rate futures contracts on fixed income securities or indices of such securities, including municipal indices and any other indices of fixed income securities that may become available for trading either for the purpose of hedging its portfolio securities against the adverse effects of anticipated movements in interest rates or for other investment purposes. The Portfolio may sell interest rate futures contracts in anticipation of an increase in the general level of interest rates. Generally, as interest rates rise, the market value of the securities held by the Portfolio will fall, thus reducing the net asset value of the Portfolio. This interest rate risk can be reduced without employing futures as a hedge by selling such securities and either reinvesting the proceeds in securities with shorter maturities or by holding assets in cash. However, this strategy entails increased transaction costs in the form of dealer spreads and brokerage commissions and would typically reduce the Portfolio's average yield as a result of the shortening of maturities. The sale of interest rate futures contracts provides a means of hedging against rising interest rates. As rates increase, the value of the Portfolio's short position in the futures contracts will also tend to increase thus offsetting all or a portion of the depreciation in the market value of the Portfolio's investments that are being hedged. While the Portfolio will incur commission expenses in selling and closing out futures positions (which is done by taking an opposite position in the futures contract), commissions on futures transactions are lower than transaction costs incurred in the purchase and sale of portfolio securities. The Portfolio may purchase interest rate futures contracts in anticipation of a decline in interest rates when it is not fully invested. As such purchases are made, it is expected that an equivalent amount of futures contracts will be closed out. The Portfolio will enter into futures contracts which are traded on national or foreign futures exchanges, and are standardized as to maturity date and the underlying financial instrument. Futures exchanges and trading in the U.S. are regulated under the Commodity Exchange Act by the CFTC. Futures are traded in London at the London International Financial Futures Exchange, in Paris at the MATIF, and in Tokyo at the Tokyo Stock Exchange. Options on Futures Contracts. The Portfolio may purchase and write call and put options on stock index and interest rate futures contracts. The Portfolio may use such options on futures contracts in connection with its hedging strategies in lieu of purchasing and writing options directly on the underlying securities or stock indices or purchasing or selling the underlying futures. For example, the Portfolio may purchase put options or write call options on stock index futures or interest rate futures, rather than selling futures contracts, in anticipation of a decline in general stock market prices or rise in interest rates, respectively, or purchase call options or write put options on stock index or interest rate futures, rather than purchasing such futures, to hedge against possible increases in the price of equity securities or debt securities, respectively, which the Portfolio intends to purchase. In connection with transactions in stock index options, stock index futures, interest rate futures and related options on such futures, the Portfolio will be required to deposit as "initial margin" an amount of cash and short-term U.S. government securities. The current initial margin requirements per contract is range from approximately 2% to 10% of the contract amount. Thereafter, subsequent payments (referred to as "variation margin") are made to and from the broker to reflect changes in the value of the futures contract. Brokers may establish deposit requirements higher than exchange minimums. Limitations. The Portfolio will not purchase or sell futures contracts or options on futures contracts or stock indices for non-hedging purposes if, as a result, the sum of the initial margin deposits on its existing futures contracts and related options positions and premiums paid for options on futures contracts or stock indices would exceed 5% of the net assets of the Portfolio. If this limitation is exceeded at any time, the Portfolio will take prompt action to close out a sufficient number of open contracts to bring its open futures and options positions within this limitation. Risks of Options and Futures Strategies. The effective use of options and futures strategies depends, among other things, on the Portfolio's ability to terminate options and futures positions at times when its investment adviser deems it desirable to do so. Although the Portfolio will not enter into an option or futures position unless its investment adviser believes that a liquid market exists for such option or future, there can be no assurance that the Portfolio will be able to effect closing transactions at any particular time or at an acceptable price. The investment advisers generally expect that options and futures transactions for the Portfolio will be conducted on recognized exchanges. In certain instances, however, the Portfolio may purchase and sell options in the over-the-counter market. The staff of the Securities and Exchange Commission considers over-the-counter options to be illiquid. A Portfolio's ability to terminate option positions established in the over-the-counter market may be more limited than in the case of exchange traded options and may also involve the risk that securities dealers participating in such transactions would fail to meet their obligations to the Portfolio. The use of options and futures involves the risk of imperfect correlation between movements in options and futures prices and movements in the price of the securities that are the subject of the hedge. The successful use of these strategies also depends on the ability of the Portfolio's investment adviser to forecast correctly interest rate movements and general stock market price movements. This risk increases as the composition of the securities held by the Portfolio diverges from the composition of the relevant option or futures contract. Portfolio Turnover While it is impossible to predict portfolio turnover rates, the investment adviser to the Portfolio anticipates that portfolio turnover will exceed 100% per year. Higher portfolio turnover rates usually generate additional brokerage commissions and expenses. Preferred Stocks The Portfolio may purchase preferred stock. Preferred stock, unlike common stock, has a stated dividend rate payable from the corporation's earnings. Preferred stock dividends may be cumulative or non-cumulative, participating, or auction rate. "Cumulative" dividend provisions require all or a portion of prior unpaid dividends to be paid. If interest rates rise, the fixed dividend on preferred stocks may be less attractive, causing the price of preferred stocks to decline. Preferred stock may have mandatory sinking fund provisions, as well as call/redemption provisions prior to maturity, which can be a negative feature when interest rates decline. Preferred stock also generally has a preference over common stock on the distribution of a corporation's assets in the event of liquidation of the corporation. Preferred stock may be "participating" stock, which means that it may be entitled to a dividend exceeding the stated dividend in certain cases. The rights of preferred stock on distribution of a corporation's assets in the event of a liquidation are generally subordinate to the rights associated with a corporation's debt securities. Real Estate Investment Trusts The Portfolio may invest up to 5% of its net assets in investments related to real estate, including real estate investment trusts ("REITs"). Risks associated with investments in securities of companies in the real estate industry include: decline in the value of real estate; risks related to general and local economic conditions; overbuilding and increased competition; increases in property taxes and operating expenses; changes in zoning laws; casualty or condemnation losses; variations in rental income; changes in neighborhood values; the appeal of properties to tenants; and increases in interest rates. In addition, equity REITs may be affected by changes in the values of the underlying property owned by the trusts, while mortgage real estate investment trusts may be affected by the quality of credit extended. REITs are dependent upon management skills, may not be diversified and are subject to the risks of financing projects. Such REITs are also subject to heavy cash flow dependency, defaults by borrowers, self liquidation and the possibility of failing to qualify for tax-free pass-through of income under the Internal Revenue Code of 1986, as amended (the "Code") and to maintain exemption from the 1940 Act. In the event an issuer of debt securities collateralized by real estate defaults, it is conceivable that the REITs could end up holding the underlying real estate. Repurchase Agreements The Portfolio may enter into repurchase agreements with a bank, broker-dealer, or other financial institution but may not invest more than 15% of its net assets in illiquid securities, including repurchase agreements having maturities of greater than seven days. The Portfolio may enter into repurchase agreements, provided the Trust's custodian always has possession of securities serving as collateral whose market value at least equals the amount of the repurchase obligation. To minimize the risk of loss the Portfolio will enter into repurchase agreements only with financial institutions which are considered by its investment adviser to be creditworthy. If an institution enters an insolvency proceeding, the resulting delay in liquidation of the securities serving as collateral could cause the Portfolio some loss, as well as legal expense, if the value of the securities declines prior to liquidation. Reverse Repurchase Agreements The Portfolio may enter into reverse repurchase agreements with brokers, dealers, domestic and foreign banks or other financial institutions. In a reverse repurchase agreement, the Portfolio sells a security and agrees to repurchase it at a mutually agreed upon date and price, reflecting the interest rate effective for the term of the agreement. It may also be viewed as the borrowing of money by the Portfolio. The Portfolio's investment of the proceeds of a reverse repurchase agreement is the speculative factor known as leverage. Leverage may cause any gains or losses of the Portfolio to be magnified. The Portfolio may enter into a reverse repurchase agreement only if the interest income from investment of the proceeds is greater than the interest expense of the transaction and the proceeds are invested for a period no longer than the term of the agreement. At the time the Portfolio enters into a reverse repurchase agreement, it will establish and maintain a segregated account with an approved custodian containing cash or other liquid securities having a value not less than the repurchase price (including accrued interest). If interest rates rise during a reverse repurchase agreement, it may adversely affect the Portfolio's net asset value. Reverse repurchase agreements are considered to be borrowings under the 1940 Act. The assets contained in the segregated account will be marked-to-market daily and additional assets will be placed in such account on any day in which the assets fall below the repurchase price (plus accrued interest). The Portfolio'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 retained in lieu of sale may decline below the price of the securities the Portfolio has sold but is obligated to repurchase. 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 Portfolio's obligation to repurchase the securities, and the Portfolio's use of the proceeds of the reverse repurchase agreement may effectively be restricted pending such decision. Securities Loans All securities loans will be made pursuant to agreements requiring the loans to be continuously secured by collateral in cash or high grade debt obligations at least equal at all times to the market value of the loaned securities. The borrower pays to the Portfolio an amount equal to any dividends or interest received on loaned securities. The Portfolio retains all or a portion of the interest received on investment of cash collateral or receive a fee from the borrower. Lending portfolio securities involves risks of delay in recovery of the loaned securities or in some cases loss of rights in the collateral should the borrower fail financially. Securities loans are made to broker-dealers or institutional investors or other persons, pursuant to agreements requiring that the loans be continuously secured by collateral at least equal at all times to the value of the loaned securities marked-to-market on a daily basis. The collateral received will consist of cash, U.S. government securities, letters of credit or such other collateral as may be permitted under the Portfolio's securities lending program. While the securities are being loaned, the Portfolio will continue to receive the equivalent of the interest or dividends paid by the issuer on the securities, as well as interest on the investment of the collateral or a fee from the borrower. The Portfolio has a right to call each loan and obtain the securities on five business days' notice or, in connection with securities trading on foreign markets, within such longer period for purchases and sales of such securities in such foreign markets. The Portfolio will generally not have the right to vote securities while they are being loaned, but its Manager or investment adviser will call a loan in anticipation of any important vote. The risks in lending portfolio securities, as with other extensions of secured credit, consist of possible delay in receiving additional collateral or in the recovery of the securities or possible loss of rights in the collateral should the borrower fail financially. Loans will only be made to firms deemed by the Portfolio's investment adviser to be of good standing and will not be made unless, in the judgment of the investment adviser, the consideration to be earned from such loans would justify the risk. U.S. Government Securities Securities issued or guaranteed as to principal and interest by the U.S. government or its agencies and government-sponsored entities include U.S. Treasury obligations, consisting of bills, notes and bonds, which principally differ in their interest rates, maturities and times of issuance, and obligations issued or guaranteed by agencies and government-sponsored entities which are supported by (i) the full faith and credit of the U.S. Treasury (such as securities of the Government National Mortgage Association), (ii) the limited authority of the issuer to borrow from the U.S. Treasury (such as securities of the Student Loan Marketing Association) or (iii) the authority of the U.S. government to purchase certain obligations of the issuer (such as securities of the Federal National Mortgage Association). No assurance can be given that the U.S. government will provide financial support to U.S. government agencies or government-sponsored entities as described in clauses (ii) or (iii) above in the future, other than as set forth above, since it is not obligated to do so by law. Zero Coupon Bonds, Deferred Interest Bonds and PIK Bonds Zero coupon and deferred interest bonds are debt obligations which are issued at a significant discount from face value. The discount approximates the total amount of interest the bonds will accrue and compound over the period until maturity or the first interest payment date at a rate of interest reflecting the market rate of the security at the time of issuance. While zero coupon bonds do not require the periodic payment of interest, deferred interest bonds provide for a period of delay before the regular payment of interest begins. Payment-in-kind ("PIK") bonds are debt obligations which provide that the issuer thereof may, at its option, pay interest on such bonds in cash or in the form of additional debt obligations. Such investments benefit the issuer by mitigating its need for cash to meet debt service, but also require a higher rate of return to attract investors who are willing to defer receipt of such cash. Such investments may experience greater volatility in market value due to changes in interest rates than debt obligations which make regular payments of interest. The Portfolio will accrue income on such investments for tax and accounting purposes, as required, which is distributable to shareholders and which, because no cash is received at the time of accrual, may require the liquidation of other portfolio securities to satisfy the Portfolio's distribution obligations. INVESTMENT RESTRICTIONS Fundamental Policies The following investment restrictions are fundamental policies, which may not be changed without the approval of a majority of the outstanding shares of the Portfolio. As provided in the 1940 Act, a vote of a majority of the outstanding shares necessary to amend a fundamental policy means the affirmative vote of the lesser of (1) 67% or more of the shares present at a meeting, if the holders of more than 50% of the outstanding shares of the Portfolio are present or represented by proxy, or (2) more than 50% of the outstanding shares of the Portfolio. 1. Borrowing The Portfolio may not borrow money, except to the extent permitted by applicable law. 2. Diversification The Portfolio may not purchase a security if, as a result, with respect to 75% of the value of its total assets (i) more than 5% of the value of the Portfolio's total assets would be invested in the securities of a single issuer, except securities issued on guaranteed by the U.S. government, its agencies and instrumentalities, or (ii) more than 10% of the outstanding voting securities of any issuer would be held by the Portfolio, other than securities issued by the U.S. government, its agencies and instrumentalities. 3. Concentration The Portfolio may not invest more than 25% of the value of its total assets in any one industry, provided that this limitation does not apply to obligations issued or guaranteed as to interest and principal by the U.S. government, its agencies and instrumentalities, and repurchase agreements secured by such obligations. 4. Underwriting The Portfolio may not underwrite securities issued by other persons, except to the extent that in connection with the disposition of its portfolio investments it may be deemed to be an underwriter under federal securities laws. 5. Real Estate The Portfolio may not purchase or sell real estate, although the Portfolio may purchase securities of issuers which deal in real estate, securities which are secured by interests in real estate and securities representing interests in real estate; provided, however, that the Portfolio may hold and sell real estate acquired as a result of the ownership of securities. 6. Commodities The Portfolio may not purchase or sell physical commodities, except that it may (i) enter into futures contracts and options thereon in accordance with applicable law and (ii) purchase or sell physical commodities if acquired as a result of ownership of securities or other instruments. The Portfolio will not consider stock index futures contracts, currency contracts, hybrid investments, swaps or other similar instruments to be commodities. 7. Loans The Portfolio may not make loans, except through the purchase of debt obligations and, the entry into repurchase agreements or through lending of its portfolio securities. Any loans of portfolio securities will be made according to guidelines established by the Securities and Exchange Commission and the Trust's Board of Trustees. 8. Senior Securities The Portfolio may not issue any senior security (as defined in the 1940 Act) except in compliance with applicable law. Non-Fundamental Policies The following investment restrictions apply to the Portfolio, except as noted. These restrictions may be changed for the Portfolio by the Trust's Board of Trustees without a vote of the Portfolio's shareholders. The Portfolio may not:
(1) Purchase securities on margin, except that the Portfolio may:
(2) Mortgage, pledge, hypothecate or, in any manner, transfer any security owned by the Portfolio as security for indebtedness, except as may be necessary in connection with permissible borrowings or investments; and then such mortgaging, pledging or hypothecating may not exceed 33 1/3 % of the respective total assets of the Portfolio. The deposit of underlying securities and other assets in escrow and collateral arrangements with respect to margin accounts for futures contracts, options, currencies or other permissible investments are not deemed to be mortgages, pledges, or hypothecations for these purposes; (3) Purchase participations or other direct interests in or enter into leases with respect to oil, gas, or other mineral explorations or development programs, except that the Portfolio may invest in securities issued by companies that engage in oil, gas or other mineral exploration or development activities or hold mineral leases acquired as a result of its ownership of securities; (4) Invest in companies for the purpose of exercising management or control. With respect to borrowing, the Portfolio may borrow from banks and enter into reverse repurchase agreements in an amount up to 33 1/3% of its total assets, taken at market value. Each Portfolio may also borrow up to an additional 5% of its total assets from banks or others. The Portfolio may borrow only as a temporary measure for extraordinary or emergency purposes such as the redemption of Portfolio shares. The Portfolio may purchase additional securities so long as borrowings do not exceed 5% of its total assets. With respect to loans of portfolio securities, as a matter of operating policy, the Portfolio will limit the aggregate of such loans to 33 1/3% of the value of the Portfolio's total assets. With respect to real estate investments, as a matter of operating policy, the Portfolio will not invest in real estate limited partnership interests. With respect to foreign currency transactions, the Portfolio may enter into transactions with counterparties which have received (or the guarantors of the obligations of such counterparties have received) a credit rating of A-1 or P-1 by Standard & Poor's or Moody's respectively or that have an equivalent rating from an NRSRO or (except for over-the-counter currency options) are determined to be of equivalent credit quality by the Portfolio's investment adviser. The Portfolio will not enter into a transaction to hedge currency exposure to an extent greater, after settling all transactions intended to wholly or partially offset other transactions, than the aggregate market values (at the time of entering into the transaction) of the securities held in its portfolio that are denominated or generally quoted in or currently convertible into such currency other than with respect or cross hedging or proxy hedging. With respect to swaps, the Portfolio will not enter into any swap, cap, floor or collar transaction unless, at the time of entering into such transaction, the unsecured long-term debt of the counterparty, combined with any credit enhancements, is rated at least A by Standard & Poor's or Moody's or has an equivalent equity rating from an NRSRO or is determined to be of equivalent credit quality of the Portfolio's investment adviser. PERFORMANCE INFORMATION Total return and yield will be computed as described below. Total Return The Portfolio's "average annual total return" figures described and shown in the Prospectus/Proxy Statement are computed according to a formula prescribed by the Securities and Exchange Commission. The formula can be expressed as follows: P(1+T)n = ERV
Where: P = a hypothetical initial payment of $1000
T = average annual total return
n = number of years
The calculations of total return assume the reinvestment of all dividends and capital gain distributions on the reinvestment dates during the period and the deduction of all recurring expenses that were charged to shareholders' accounts. The total return figures do not reflect charges and deductions which are, or may be, imposed under the Contracts. The performance of the Portfolio will vary from time to time in response to fluctuations in market conditions, interest rates, the composition of the Portfolio's investments and expenses. Consequently, the Portfolio's performance figures are historical and should not be considered representative of the performance of the Portfolio for any future period. Yield From time to time, the Trust may quote the Portfolio's yield and effective yield in advertisements or in reports or other communications to shareholders. Yield quotations are expressed in annualized terms and may be quoted on a compounded basis. The 30-day yield for the Portfolio will be calculated according to a formula prescribed by the Securities and Exchange Commission. The formula can be expressed as follows: YIELD = 2[(a-b+1)6-1]
cd
For the purpose of determining the interest earned (variable "a" in the formula) on debt obligations that were purchased by the Portfolio at a discount or premium, the formula generally calls for amortization of the discount or premium; the amortization schedule will be adjusted monthly to reflect changes in the market values of the debt obligations. Yield information is useful in reviewing the Portfolio's performance, but because yields fluctuate, such information cannot necessarily be used to compare an investment in the Portfolio's shares with bank deposits, savings accounts and similar investment alternatives which often provide an agreed or guaranteed fixed yield for a stated period of time. Shareholders should remember that yield is a function of the kind and quality of the instruments in the Portfolios' investment portfolios, portfolio maturity, operating expenses and market conditions. It should be recognized that in periods of declining interest rates the yields will tend to be somewhat higher than prevailing market rates, and in periods of rising interest rates the yields will tend to be somewhat lower. Also, when interest rates are falling, the inflow of net new money to the Portfolio from the continuous sale of its shares will likely be invested in instruments producing lower yields than the balance of the Portfolio's investments, thereby reducing the current yield of the Portfolio. In periods of rising interest rates, the opposite can be expected to occur. Non-Standardized Performance In addition to the performance information described above, the Trust may provide total return information with respect to the Portfolio for designated periods, such as for the most recent six months or most recent twelve months. This total return information is computed as described under "Total Return" above except that no annualization is made. PORTFOLIO TRANSACTIONS Subject to the supervision and control of the Manager and the Trustees of the Trust, the Portfolio's Adviser is responsible for decisions to buy and sell securities for its account and for the placement of its portfolio business and the negotiation of commissions, if any, paid on such transactions. Brokerage commissions are paid on transactions in equity securities traded on a securities exchange and on options, futures contracts and options thereon. Fixed income securities and certain equity securities in which the Portfolio invests are traded in the over-the-counter market. These securities are generally traded on a net basis with dealers acting as principal for their own account without a stated commission, although prices of such securities usually include a profit to the dealer. In over-the-counter transactions, orders are placed directly with a principal market maker unless a better price and execution can be obtained by using a broker. In underwritten offerings, securities are usually purchased at a fixed price which includes an amount of compensation to the underwriter generally referred to as the underwriter's concession or discount. Certain money market securities may be purchased directly from an issuer, in which case no commissions or discounts are paid. U.S. government securities are generally purchased from underwriters or dealers, although certain newly-issued U.S. government securities may be purchased directly from the U.S. Treasury or from the issuing agency or instrumentality. The Portfolio's Adviser is responsible for effecting its portfolio transactions and will do so in a manner deemed fair and reasonable to the Portfolio and not according to any formula. The primary consideration in all portfolio transactions will be prompt execution of orders in an efficient manner at a favorable price. In selecting broker-dealers and negotiating commissions, the Adviser considers the firm's reliability, the quality of its execution services on a continuing basis and its financial condition. When more than one firm is believed to meet these criteria, preference may be given to brokers that provide the Portfolio or its Adviser with brokerage and research services within the meaning of Section 28(e) of the Securities Exchange Act of 1934. The Portfolio's investment adviser is of the opinion that, because this material must be analyzed and reviewed, its receipt and use does not tend to reduce expenses but may benefit the Portfolio by supplementing the Adviser's research. The Adviser, subject to seeking the most favorable price and best execution and in compliance with the Conduct Rules of the National Association of Securities Dealers, Inc., may consider sales of shares of the Trust as a factor in the selection of broker-dealers. The Trust may direct the Manager to cause the Adviser to effect securities transactions through broker-dealers in a manner that would help to generate resources to (i) pay the cost of certain expenses which the Trust is required to pay or for which the Trust is required to arrange payment pursuant to the management agreement with the Manager ("Trust Expenses"); or (ii) finance activities that are primarily intended to result in the sale of Trust shares. At the discretion of the Board of Trustees, such resources may be used to pay or cause the payment of Trust Expenses or may be used to finance activities that are primarily intended to result in the sale of Trust shares. The Adviser may effect portfolio transactions for other investment companies and advisory accounts. Research services furnished by broker-dealers through which the Portfolio effects its securities transactions may be used by the Portfolio's Adviser in servicing all of its accounts; not all such services may be used in connection with the Portfolio. In the opinion of the Adviser, it is not possible to measure separately the benefits from research services to each of its accounts, including the Portfolio. Whenever concurrent decisions are made to purchase or sell securities by the Portfolio and another account, the Portfolio's Adviser will attempt to allocate equitably portfolio transactions among the Portfolio and other accounts. In making such allocations between the Portfolio and other accounts, the main factors to be considered are the respective investment objectives, the relative size of portfolio holdings of the same or comparable securities, the availability of cash for investment, the size of investment commitments generally held, and the opinions of the persons responsible for recommending investments to the Portfolio and the other accounts. In some cases this procedure could have an adverse effect on the Portfolio. In the opinion of the Adviser, however, the results of such procedures will, on the whole, be in the best interest of each of the accounts. The Adviser to the Portfolio may execute portfolio transactions through certain of their affiliated brokers, acting as agent in accordance with the procedures established by the Board of Trustees, but will not purchase any securities from or sell any securities to any such affiliate acting as principal for its own account. For 1999, none of the Portfolio's commissionable transactions were executed through broker-dealers affiliated with an Adviser. The following table shows the amounts of brokerage commissions paid by the Portfolio's predecessor fund during the fiscal years ended December 31, 1999, December 31, 1998 and December 31, 1997.
Brokerage Commissions Paid
MANAGEMENT OF THE TRUST The Trust is supervised by a Board of Trustees that is responsible for representing the interests of shareholders. The Trustees meet periodically throughout the year to oversee the Portfolios' activities, reviewing, among other things, the Portfolio's performance and its contractual arrangements with various service providers. Trustees and Officers The Trustees and executive officers of the Trust, their ages and their principal occupations during the past five years are set forth below. Unless otherwise indicated, the business address of each is 610 Newport Center Drive, Suite 1350, Newport Beach, California 92660.
* "Interested person" of the Trust (as that term is defined in the 1940 Act). Committees of the Board The Trust has a standing Audit Committee consisting of all of the Trustees who are not "interested persons" of the Trust (as that term is defined in the 1940 Act) ("Disinterested Trustees"). The Audit Committee's function is to recommend to the Board independent accountants to conduct the annual audit of the Trust's financial statements; review with the independent accountants the outline, scope and results of the annual audit; and review the performance and fees charged by the independent accountants for professional services. In addition, the Audit Committee meets with the independent accountants and representatives of management to review accounting activities and areas of financial reporting and control. The Trust has a Nominating and Compensation Committee consisting of all the Disinterested Trustees. The Nominating and Compensation Committee's function is to nominate and evaluate independent trustee candidates and review the compensation arrangement for each of the Trustees. The Trust has a Valuation Committee consisting of Elizabeth M. Forget, James A. Shepherdson, Mark Reynolds, and such other officers of the Trust and the Manager, as well as such officers of any Adviser to any Portfolio as are deemed necessary by Ms. Forget, Mr. Shepherdson or Mr. Reynolds from time to time, each of whom shall serve at the pleasure of the Board of Trustees as members of the Valuation Committee. This committee determines the value of any of the Trust's securities and assets for which market quotations are not readily available or for which valuation cannot otherwise be provided. Compensation of the Trustees
Each Trustee, who is not an employee of the Manager or any of its
affiliates, currently receives from the Trust an annual fee of $20,000 plus (i)
an additional fee of $2,000 for each regularly scheduled Board meeting attended,
A deferred compensation plan for the benefit of the Trustees has been adopted by the Trust. Under the deferred compensation plan, each Trustee may defer payment of all or part of the fees payable for such Trustee's services. Each Trustee may defer payment of such fees until his or her retirement as a Trustee or until the earlier attainment of a specified age. Fees deferred under the deferred compensation plan, together with accrued interest thereon, will be disbursed to a participating Trustee in monthly installments over a five to 20 year period elected by such Trustee. The Agreement and Declaration of Trust of the Trust provides that the Trust will indemnify its Trustees and officers against liabilities and expenses incurred in connection with litigation in which they may be involved because of their offices with the Trust, except if it is determined in the manner specified in the Agreement and Declaration of Trust that they have not acted in good faith in the reasonable belief that their actions were in the best interests of the Trust or that such indemnification would relieve any officer or Trustee of any liability to the Trust or its shareholders by reason of willful misfeasance, bad faith, gross negligence or reckless disregard of his duties. The Trust, at its expense, provides liability insurance for the benefit of its Trustees and officers. As of the date of this Statement of Additional Information, the officers and Trustees of the Trust as a group owned less than 1% of the outstanding shares of the Trust. INVESTMENT ADVISORY AND OTHER SERVICES The Manager The Trust is managed by Met Investors Advisory Corp. (the "Manager") (formerly known as Security First Investment Management Corporation) which, subject to the supervision and direction of the Trustees of the Trust, has overall responsibility for the general management and administration of the Trust. Security First Group, Inc., an affiliate of Metropolitan Life Insurance Company, owns all of the outstanding common shares of the Manager and MetLife Distributors, Inc. The Trust and Manager have entered into a Management Agreement dated December 8, 2000 ("Management Agreement"), which was initially approved by the Board of Trustees on December 7, 2000 and by Security First Life Insurance Company, as initial shareholder of the Trust, on December 8, 2000. Subject always to the supervision and direction of the Trustees of the Trust, under the Management Agreement the Manager will have (i) overall supervisory responsibility for the general management and investment of the Portfolio's assets; (ii) full discretion to select new or additional Advisers for the Portfolio; (iii) full discretion to enter into and materially modify investment advisory agreements with Advisers; (iv) full discretion to terminate and replace any Adviser; and (v) full investment discretion to make all determinations with respect to the investment of the Portfolio's assets not then managed by an Adviser. In connection with the Manager's responsibilities under the Management Agreement, the Manager will assess the Portfolio's investment focus and will seek to implement decisions with respect to the allocation and reallocation of the Portfolio's assets among one or more current or additional Advisers from time to time, as the Manager deems appropriate, to enable the Portfolio to achieve its investment goals. In addition, the Manager will monitor compliance of the Adviser with the investment objectives, policies and restrictions of the Portfolio (or portions of the Portfolio) under the management of such Adviser, and review and report to the Trustees of the Trust on the performance of the Adviser. The Manager will furnish, or cause the appropriate Adviser(s) to furnish, to the Trust such statistical information, with respect to the investments that the Portfolio (or portions of the Portfolio) may hold or contemplate purchasing, as the Trust may reasonably request. On the Manager's own initiative, the Manager will apprise, or cause the appropriate Adviser(s) to apprise, the Trust of important developments materially affecting the Portfolio (or any portion of the Portfolio that they advise) and will furnish the Trust, from time to time, with such information as may be appropriate for this purpose. Further, the Manager agrees to furnish, or cause the appropriate Adviser(s) to furnish, to the Trustees of the Trust such periodic and special reports as the Trustees of the Trust may reasonably request. In addition, the Manager has agreed to cause the appropriate Adviser(s) to furnish to third-party data reporting services all currently available standardized performance information and other customary data. Under the Management Agreement, the Manager also is required to furnish to the Trust, at its own expense and without remuneration from or other cost to the Trust, the following: o Office space, all necessary office facilities and equipment. o Necessary executive and other personnel, including personnel for the performance of clerical and other office functions, other than those functions: o related to and to be performed under the Trust's contract or contracts for administration, custodial, accounting, bookkeeping, transfer and dividend disbursing agency or similar services by the entity selected to perform such services; or o related to the investment advisory services to be provided by any Adviser pursuant to an investment advisory agreement with the Manager ("Advisory Agreement"). o Information and services, other than services of outside counsel or independent accountants or investment advisory services to be provided by any Adviser under an Advisory Agreement, required in connection with the preparation of all registration statements, prospectuses and statements of additional information, any supplements thereto, annual, semi-annual, and periodic reports to Trust shareholders, regulatory authorities, or others, and all notices and proxy solicitation materials, furnished to shareholders or regulatory authorities, and all tax returns.
As compensation for these services the Trust pays the Manager a monthly
fee at the annual rate of the Portfolio's average daily net assets as follows:
The Manager and the Trust have also entered into an expense limitation agreement with respect to the Portfolio ("Expense Limitation Agreement"), pursuant to which the Manager has agreed to waive or limit its fees and to assume other expenses so that the total annual operating expenses (with certain exceptions described in the Prospectus/Proxy Statement) of the Portfolio are limited to the extent described in the "Management--Expense Limitation Agreement" section of the Prospectus/Proxy Statement. In addition to the management fees, the Trust pays all expenses not assumed by the Manager, including, without limitation, charges for the services and expenses of the independent accountants and legal counsel retained by the Trust, for itself and its Disinterested Trustees, accounting and auditing services, interest, taxes, costs of printing and distributing reports to shareholders, proxy materials and prospectuses, charges of its administrator, custodian, transfer agent and dividend disbursing agent, registration fees, fees and expenses of the Trustees who are not affiliated persons of the Manager, insurance, brokerage costs, litigation, and other extraordinary or nonrecurring expenses. All general Trust expenses are allocated among and charged to the assets of the Portfolio of the Trust on a basis that the Trustees deem fair and equitable, which may be on the basis of relative net assets of the Portfolio or the nature of the services performed and relative applicability to the Portfolio. In addition, as discussed below under "Distribution of the Trust's Shares," the Class B shares of the Portfolio may pay for certain distribution - related expenses in connection with activities primarily intended to result in the sale of its shares. The Management Agreement continues in force for two years from its commencement date, with respect to the Portfolio, and from year to year thereafter, but only so long as its continuation as to the Portfolio is specifically approved at least annually (i) by the Trustees or by the vote of a majority of the outstanding voting securities of the Portfolio, and (ii) by the vote of a majority of the Disinterested Trustees, by votes cast in person at a meeting called for the purpose of voting on such approval. The Management Agreement provides that it shall terminate automatically if assigned, and that it may be terminated as to the Portfolio without penalty by the Trustees of the Trust or by vote of a majority of the outstanding voting securities of the Portfolio upon 60 days' prior written notice to the Manager, or by the Manager upon 90 days' prior written notice to the Trust, or upon such shorter notice as may be mutually agreed upon. It is anticipated that the Trust will commence operations on or about February 5, 2001. The following table shows the fees paid by the Portfolio's predecessor to the Manager or current affiliates of the Manager and any fee waivers or reimbursements during the fiscal years ended December 31, 1999, December 31, 1998 and December 31, 1997.
The Adviser Pursuant to an Advisory Agreement with the Manager, the Adviser to the Portfolio furnishes continuously an investment program for the Portfolio, makes investment decisions on behalf of the Portfolio, places all orders for the purchase and sale of investments for the Portfolio's account with brokers or dealers selected by such Adviser and may perform certain limited related administrative functions in connection therewith. For its services, the Manager pays the Adviser a fee based on a percentage of the average daily net assets of the Portfolio. The Advisory Agreement will continue in force for one year from its commencement date, and from year to year thereafter, but only so long as its continuation as to the Portfolio is specifically approved at least annually (i) by the Trustees or by the vote of a majority of the outstanding voting securities of the Portfolio, and (ii) by the vote of a majority of the Disinterested Trustees by votes cast in person at a meeting called for the purpose of voting on such approval. The Advisory Agreement provides that it shall terminate automatically if assigned or if the Management Agreement with respect to the Portfolio terminates, and that it may be terminated as to the Portfolio without penalty by the Manager, by the Trustees of the Trust or by vote of a majority of the outstanding voting securities of the Portfolio on not less than 60 days' prior written notice to the Adviser or by the Adviser on not less than 90 days' prior written notice to the Manager, or upon such shorter notice as may be mutually agreed upon. The Advisory Agreement provides that the Adviser shall not be subject to any liability to the Trust or the Manager for any act or omission in the course of or connected with rendering services thereunder in the absence of willful misfeasance, bad faith, gross negligence or reckless disregard of its duties on the part of the Adviser.
The Trust and the Manager have applied for an exemptive order from the
Securities and Exchange Commission ("Multi-Manager Order"). The Multi-Manager
Order will permit the Manager, subject to approval of the Board of Trustees, to:
J.P. Morgan Investment Management Inc. is the Adviser to the Portfolio. The following table shows the fees paid to the Adviser by the Manager or current affiliates of the Manager for the fiscal years ended December 31, 1999, December 31, 1998 and December 31, 1997.
The Administrator Pursuant to an administration agreement ("Administrative Services Agreement"), Investors Bank & Trust Company ("Administrator") assists the Manager in the performance of its administrative services to the Trust and provides the Trust with other necessary administrative services. In addition, the Administrator makes available the office space, equipment, personnel and facilities required to provide such administrative services to the Trust. The Administrator was organized as a Massachusetts Trust Company. Its principal place of business is at 200 Clarendon Street, Boston, Massachusetts 02117. Under the Administrative Services Agreement, the Administrator is entitled to a fee from the Trust, which is calculated daily and paid monthly, at an annual rate of 0.06% of the average daily net assets of the Trust. The Administrative Services Agreement shall remain in effect until July 1, 2001 and shall thereafter continue in effect for successive periods of one year, unless terminated by any party upon not less than ninety (90) days' prior written notice to the other party. The Distributor The Trust has distribution agreements with MetLife Distributors, Inc. ("MDI" or the "Distributor") in which MDI serves as the Distributor for the Trust's Class A shares and Class B shares. MDI is an indirect wholly-owned subsidiary of Security First Group, Inc., which is an indirect wholly-owned subsidiary of Metropolitan Life Insurance Company. MDI's address is 610 Newport Center Drive, Suite 1350, Newport Beach, California 92660. The Trust's distribution agreements with respect to the Class A and Class B shares ("Distribution Agreements") were approved by the Board of Trustees at a Board meeting held on December 7, 2000. The Distribution Agreements will remain in effect from year to year provided each Distribution Agreement's continuance is approved annually by (i) a majority of the Trustees who are not parties to such agreement or "interested persons" (as defined in the 1940 Act) of the Trust or the Portfolio and, if applicable, who have no direct or indirect financial interest in the operation of the Class B Distribution Plan or any such related agreement and (ii) either by vote of a majority of the Trustees or a majority of the outstanding voting securities (as defined in the 1940 Act) of the Trust. The Distributor or its affiliates for the Class A shares will pay for printing and distributing prospectuses or reports prepared for their use in connection with the offering of the Class A shares to prospective contract owners and preparing, printing and mailing any other literature or advertising in connection with the offering of the Class A shares to prospective contract owners. Pursuant to the Class B Distribution Plan, the Trust compensates the Distributor from assets attributable to the Class B and shares for services rendered and expenses borne in connection with activities primarily intended to result in the sale of the Trust's Class B shares. It is anticipated that a portion of the amounts received by the Distributor will be used to defray various costs incurred or paid by the Distributor in connection with the printing and mailing of Trust prospectuses, statements of additional information and any supplements thereto and shareholder reports, and holding seminars and sales meetings with wholesale and retail sales personnel designed to promote the distribution of Class B shares. The Distributor may also use a portion of the amounts received to provide compensation to financial intermediaries and third-party broker-dealers for their services in connection with the distribution of the Class B shares. The Class B Distribution Plan provides that the Trust, on behalf of the Portfolio, may pay annually up to 0.50% of the average daily net assets of the Portfolio attributable to its Class B shares in respect to activities primarily intended to result in the sale of Class B shares. However, under the Distribution Agreement, payments to the Distributor for activities pursuant to the Class B Distribution Plan are limited to payments at an annual rate equal to 0.25% of average daily net assets of the Portfolio attributable to its Class B shares. Under terms of the Class B Distribution Plan and the Distribution Agreement, the Portfolio is authorized to make payments monthly to the Distributor that may be used to pay or reimburse entities providing distribution and shareholder servicing with respect to the Class B shares for such entities' fees or expenses incurred or paid in that regard. The Class B Distribution Plan is of a type known as a "compensation" plan because payments are made for services rendered to the Trust with respect to Class B shares regardless of the level of expenditures by the Distributor. The Trustees will, however, take into account such expenditures for purposes of reviewing operations under the Class B Distribution Plan and in connection with their annual consideration of the Class B Distribution Plan's renewal. The Distributor has indicated that it expects its expenditures to include, without limitation: (a) the printing and mailing of Trust prospectuses, statements of additional information, any supplements thereto and shareholder reports for prospective Contract owners with respect to the Class B shares of the Trust; (b) those relating to the development, preparation, printing and mailing of advertisements, sales literature and other promotional materials describing and/or relating to the Class B shares of the Trust; (c) holding seminars and sales meetings designed to promote the distribution of Class B shares of the Trust; (d) obtaining information and providing explanations to wholesale and retail distributors of contracts regarding Trust investment objectives and policies and other information about the Trust and its Portfolio, including the performance of the Portfolio; (3) training sales personnel regarding the Class B shares of the Trust; and (f) financing any other activity that the Distributor determines is primarily intended to result in the sale of Class B shares. The Distributor for each class of shares will pay all fees and expenses in connection with its qualification and registration as a broker or dealer under federal and state laws. In the capacity of agent, the Distributor currently offers shares of the Portfolio on a continuous basis to the separate accounts of insurance companies offering the Contracts in all states in which the Portfolio or the Trust may from time to time be registered or where permitted by applicable law. The Distribution Agreement provides that the Distributor shall accept orders for shares at net asset value without a sales commission or sale load being charged. The Distributor has made no firm commitment to acquire shares of the Portfolio. On December 7, 2000, the Board of Trustees of the Trust, including the Disinterested Trustees, unanimously approved the Class B Distribution Plan. The Class B Distribution Plan and any Rule 12b-1 related agreement that is entered into by the Trust or the Distributor of the Class B shares in connection with the Class B Distribution Plan will continue in effect for a period of more than one year only so long as continuance is specifically approved at least annually by vote of a majority of the Trust's Board of Trustees, and of a majority of the Disinterested Trustees, cast in person at a meeting called for the purpose of voting on the Class B Distribution Plan or any Rule 12b-1 related agreement, as applicable. In addition, the Class B Distribution Plan and any Rule 12b-1 related agreement may be terminated as to Class B shares of the Portfolio or by vote of a majority of the Disinterested Trustees. The Class B Distribution Plan also provides that it may not be amended to increase materially the amount (up to 0.50%, of average daily net assets annually) that may be spent for distribution of Class B shares of the Portfolio without the approval of Class B shareholders of the Portfolio. Code of Ethics The Trust, its Manager, its Distributor, and the Adviser, have adopted Codes of Ethics pursuant to Rule 17j-1 under the 1940 Act. Each of these Codes of Ethics permits the personnel of their respective organizations to invest in securities for their own accounts. A copy of each of the Codes of Ethics is on public file with, and is available from the Securities and Exchange Commission. Custodian Investors Bank & Trust Company ("IBT"), located at 200 Clarendon Street, Boston, Massachusetts 02117, serves as the custodian of the Trust. Under the custody agreement, IBT holds the Portfolio's securities and keeps all necessary records and documents. Transfer Agent IBT also serves as transfer agent for the Trust. Legal Matters Certain legal matters are passed on for the Trust by Sullivan & Worcester LLP, 1025 Connecticut Avenue, N.W., Washington, D.C. 20036. Independent Auditors Deloitte & Touche LLP, located at 200 Berkeley Street, Boston, Massachusetts 02116, serves as the Trust's independent auditors. REDEMPTION OF SHARES
The Trust may suspend redemption privileges or postpone the date of
payment on shares of the Portfolio for more than seven days during any period
The value of the shares on redemption may be more or less than the shareholder's cost, depending upon the market value of the portfolio securities at the time of redemption. NET ASSET VALUE The net asset value per share of the Portfolio is determined as of the close of regular trading of the New York Stock Exchange (currently 4:00 p.m., New York City time), each day the Exchange is open for trading. Currently, the Exchange is closed on: New Year's Day, Martin Luther King, Jr. Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day. Portfolio securities for which the primary market is on a domestic or foreign exchange or which are traded over-the-counter and quoted on the NASDAQ System will be valued at the last sale price on the day of valuation or, if there was no sale that day, at the last reported bid price, using prices as of the close of trading. Portfolio securities not quoted on the NASDAQ System that are actively traded in the over-the-counter market, including listed securities for which the primary market is believed to be over-the-counter, will be valued at the most recently quoted bid price provided by the principal market makers. In the case of any securities which are not actively traded, reliable market quotations may not be considered to be readily available. These investments are stated at fair value as determined under the direction of the Trustees. Such fair value is expected to be determined by utilizing information furnished by a pricing service which determines valuations for normal, institutional-size trading units of such securities using methods based on market transactions for comparable securities and various relationships between securities which are generally recognized by institutional traders. If any securities held by the Portfolio are restricted as to resale, their fair value will be determined following procedures approved by the Trustees. The fair value of such securities is generally determined as the amount which the Portfolio could reasonably expect to realize from an orderly disposition of such securities over a reasonable period of time. The valuation procedures applied in any specific instance are likely to vary from case to case. However, consideration is generally given to the financial position of the issuer and other fundamental analytical data relating to the investment and to the nature of the restrictions on disposition of the securities (including any registration expenses that might be borne by the Portfolio in connection with such disposition). In addition, specific factors are also generally considered, such as the cost of the investment, the market value of any unrestricted securities of the same class (both at the time of purchase and at the time of valuation), the size of the holding, the prices of any recent transactions or offers with respect to such securities and any available analysts' reports regarding the issuer. Notwithstanding the foregoing, short-term debt securities with maturities of 60 days or less will be valued at amortized cost. Foreign securities traded outside the United States are generally valued as of the time their trading is complete, which is usually different from the close of the New York Stock Exchange. Occasionally, events affecting the value of such securities may occur between such times and the close of the New York Stock Exchange that will not be reflected in the computation of the Portfolio's net asset value. If events materially affecting the value of such securities occur during such period, these securities will be valued at their fair value according to procedures decided upon in good faith by the Trust's Board of Trustees. All securities and other assets of the Portfolio initially expressed in foreign currencies will be converted to U.S. dollar values at the mean of the bid and offer prices of such currencies against U.S. dollars last quoted on a valuation date by any recognized dealer. The Manager and Advisers may, from time to time, under the general supervision of the Board of Trustees or the Valuation Committee, utilize the services of one or more pricing services available in valuating the assets of the Trust. The Manager and Adviser will continuously monitor the performance of these services. FEDERAL INCOME TAXES The Portfolio intends to qualify each year as a "regulated investment company" under the Code. By so qualifying, the Portfolio will not be subject to federal income taxes to the extent that its net investment income and net realized capital gains are distributed.
In order to so qualify, the Portfolio must, among other things, (1)
derive at least 90% of its gross income in each taxable year from dividends,
interest, payments with respect to securities loans, gains from the sale or
other disposition of stocks or securities or foreign currencies, or other income
As a regulated investment company, the Portfolio will not be subject to federal income tax on net investment income and capital gains (short- and long-term), if any, that it distributes to its shareholders if at least 90% of its net investment income and net short-term capital gains for the taxable year are distributed, but will be subject to tax at regular corporate rates on any income or gains that are not distributed. In general, dividends will be treated as paid when actually distributed, except that dividends declared in October, November or December and made payable to shareholders of record in such a month will be treated as having been paid by the Portfolio (and received by shareholders) on December 31, provided the dividend is paid in the following January. The Portfolio intends to satisfy the distribution requirement in each taxable year. The Portfolio will not be subject to the 4% federal excise tax imposed on registered investment companies that do not distribute all of their income and gains each calendar year because such tax does not apply to a registered investment company whose only shareholders are either tax-exempt person trusts or segregated asset accounts of life insurance companies held in connection with variable annuity and/or variable life insurance policies. The Trust intends to comply with section 817(h) of the Code and the regulations issued thereunder. As required by regulations under that section, the only shareholders of the Trust and its Portfolio will be life insurance company segregated asset accounts (also referred to as separate accounts) that fund variable life insurance or annuity contracts, tax-exempt pension trusts, and Security First Life Insurance Company, the initial shareholder of the Portfolio, and its affiliates. See the prospectus or other material for the Contracts for additional discussion of the taxation of segregated asset accounts and of the owner of the particular Contract described therein. Section 817(h) of the Code and Treasury Department regulations thereunder impose certain diversification requirements on the segregated asset accounts investing in the Portfolio of the Trust. These requirements, which are in addition to the diversification requirements applicable to the Trust under the 1940 Act and under the regulated investment company provisions of the Code, may limit the types and amounts of securities in which the Portfolio may invest. Failure to meet the requirements of section 817(h) could result in current taxation of the owner of the Contract on the income of the Contract. The Trust may therefore find it necessary to take action to ensure that a Contract continues to qualify as a Contract under federal tax laws. The Trust, for example, may be required to alter the investment objectives of the Portfolio or substitute the shares of one Portfolio for those of another. No such change of investment objectives or substitution of securities will take place without notice to the shareholders of the affected Portfolio and the approval of a majority of such shareholders and without prior approval of the Securities and Exchange Commission, to the extent legally required. In certain foreign countries, interest and dividends are subject to a tax which is withheld by the issuer. U.S. income tax treaties with certain countries reduce the rates of these withholding taxes. The Trust intends to provide the documentation necessary to achieve the lower treaty rate of withholding whenever applicable or to seek refund of amounts withheld in excess of the treaty rate. A Portfolio that invests in foreign securities may purchase the securities of certain foreign investment funds or trusts called passive foreign investment companies. Such trusts have been the only or primary way to invest in certain countries. In addition to bearing their proportionate share of the Portfolio's expenses (management fees and operating expenses), shareholders will also indirectly bear similar expenses of such trusts. Capital gains on the sale of such holdings are considered ordinary income regardless of how long the Portfolio held its investment. In addition, the Portfolio could be subject to corporate income tax and an interest charge on certain dividends and capital gains earned from these investments, regardless of whether such income and gains are distributed to shareholders. To avoid such tax and interest, the Portfolio's investment adviser intends to treat these securities as sold on the last day of its fiscal year and recognize any gains for tax purposes at that time; deductions for losses are allowable only to the extent of any gains resulting from these deemed sales for prior taxable years. Such gains will be considered ordinary income, which the Portfolio will be required to distribute even though it has not sold the security. ORGANIZATION AND CAPITALIZATION OF THE TRUST The Trust is a Delaware business trust organized on July 27, 2000. A copy of the Trust's Agreement and Declaration of Trust, which is governed by Delaware law, is available from the Trust without charge. The Trustees of the Trust have authority to issue an unlimited number of shares of beneficial interest , par value $.001 per share, of one or more series. Currently, the Trustees have established and designated fourteen series. Each series of shares represents the beneficial interest in a separate Portfolio of assets of the Trust, which is separately managed and has its own investment objective and policies. The Trustees of the Trust have authority, without the necessity of a shareholder vote, to establish additional portfolios and series of shares. The shares outstanding are, and those offered hereby when issued will be, fully paid and nonassessable by the Trust. The shares have no preemptive, conversion or subscription rights and are fully transferable. The Trust currently offers one class of shares on behalf of the Portfolio and on or about February 5, 2001, will offer two classes of shares. Class A shares are offered at net asset value and are not subject to distribution fees imposed pursuant to a distribution plan. Class A shares are only offered to contract owners and qualified plan participants who previously allocated premiums to predecessors of the Trust's Portfolio. In addition, Class A shares will also be offered to additional qualified pension and retirement plans. Class B shares are offered at net asset value and are subject to distribution fees imposed pursuant to the Class' Distribution Plan adopted pursuant to Rule 12b-1 under the 1940 Act. The two classes of shares are offered under the Trust's multi-class distribution system approved by the Trust's Board of Trustees on December 7, 2000, which is designed to allow promotion of insurance products investing in the Trust through alternative distribution channels. Under the Trust's multi-class distribution system, shares of each class of the Portfolio represent an equal pro rata interest in the Portfolio and, generally, will have identical voting, dividend, liquidation, and other rights, other than the payment of distribution fees under the Distribution Plan. Commencing on or about February 5, 2001, the Trust will continuously offer its shares exclusively to separate accounts of insurance companies in connection with the Contracts and to qualified pension and retirement plans. Class A shares are currently being offered only to separate accounts of affiliates of Security First Group, Inc. (collectively "MetLife") and to qualified pension and retirement plans. As of the date of this Statement of Additional Information, MetLife owned 100% of the Trust's outstanding Class A shares and, as a result, may be deemed to be a control person with respect to the Trust. As a "series" type of mutual fund, the Trust issues separate series of share of beneficial interest with respect to the Portfolio. The Portfolio resembles a separate fund issuing a separate class of stock. Because of current federal securities law requirements, the Trust expects that its shareholders will offer to owners of the Contracts ("Contract owners") the opportunity to instruct them as to how shares allocable to their Contracts will be voted with respect to certain matters, such as approval of investment advisory agreements. The Trust may in the future offer its shares to separate accounts of other insurance companies. The Trust does not currently foresee any disadvantages to Contract owners arising from offering the Trust's shares to separate accounts of insurance companies that are unaffiliated with each other. However, it is theoretically possible that, at some time, the interests of various Contract owners participating in the Trust through their separate accounts might conflict. In the case of a material irreconcilable conflict, one or more separate accounts might withdraw their investments in the Trust, which would possibly force the Trust to sell portfolio securities at disadvantageous prices. The Trustees of the Trust intend to monitor events for the existence of any material irreconcilable conflicts between or among such separate accounts and will take whatever remedial action may be necessary. The assets received from the sale of shares of the Portfolio, and all income, earnings, profits and proceeds thereof, subject only to the rights of creditors, constitute the underlying assets of the Portfolio. The underlying assets of the Portfolio are required to be segregated on the Trust's books of account and are to be charged with the expenses with respect to the Portfolio. Any general expenses of the Trust not readily attributable to the Portfolio will be allocated by or under the direction of the Trustees in such manner as the Trustees determine to be fair and equitable, taking into consideration, among other things, the nature and type of expense and the relative sizes of the Portfolio and the other Portfolios. Each share has one vote, with fractional shares voting proportionately. Shareholders of the Portfolio are not entitled to vote on any matter that requires a separate vote of the shares of another Portfolio but which does not affect the Portfolio. The Agreement and Declaration of Trust does not require the Trust to hold annual meetings of shareholders. Thus, there will ordinarily be no annual shareholder meetings, unless otherwise required by the 1940 Act. The Trustees of the Trust may appoint their successors until fewer than a majority of the Trustees have been elected by shareholders, at which time a meeting of shareholders will be called to elect Trustees. Under the Agreement and Declaration of Trust, any Trustee may be removed by vote of the Trustees or vote of two-thirds of the outstanding shares of the Trust. Holders of 10% or more of the outstanding shares can require the Trustees to call a meeting of shareholders for the purpose of voting on the removal of one or more Trustees. If ten or more shareholders who have been such for at least six months and who hold in the aggregate shares with a net asset value of at least $25,000 inform the Trustees that they wish to communicate with other shareholders, the Trustees either will give such shareholders access to the shareholder lists or will inform them of the cost involved if the Trust forwards materials to the shareholders on their behalf. If the Trustees object to mailing such materials, they must inform the Securities and Exchange Commission and thereafter comply with the requirements of the 1940 Act. APPENDIX SECURITIES RATINGS Standard & Poor's Bond Ratings A Standard & Poor's corporate debt rating is a current assessment of the creditworthiness of an obligor with respect to a specific obligation. Debt rated "AAA" has the highest rating assigned by Standard & Poor's. Capacity to pay interest and repay principal is extremely strong. Debt rated "AA" has a very strong capacity to pay interest and to repay principal and differs from the highest rated issues only in small degree. Debt rated "A" has a strong capacity to pay interest and repay principal although it is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than debt of a higher rated category. Debt rated "BBB" is regarded as having an adequate capacity to pay interest and repay principal. Whereas it normally exhibits adequate protection parameters, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity to pay interest and to repay principal for debt in this category than for higher rated categories. Bonds rated "BB", "B", "CCC" and "CC" are regarded, on balance, as predominantly speculative with respect to the issuer's capacity to pay interest and repay principal in accordance with the terms of the obligation. "BB" indicates the lowest degree of speculation and "CC" the highest degree of speculation. While such bonds will likely have some quality and protective characteristics, these are outweighed by large uncertainties or major risk exposures to adverse conditions. The rating "C" is reserved for income bonds on which no interest is being paid. Debt rated "D" is in default, and payment of interest and/or repayment of principal is in arrears. The 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. Moody's Bond Ratings Bonds which are rated "Aaa" are judged to be the best quality. They carry the smallest degree of investment risk and are generally referred to as "gilt-edge." Interest payments are protected by a large or by an exceptionally stable margin, and principal is secure. While the various protective elements are likely to change, such changes as can be visualized are most unlikely to impair the fundamentally strong position of such issues. Bonds which are rated "Aa" are judged to be of high quality by all standards. Together with the Aaa group they comprise what are generally known as high grade bonds. They are rated lower than the best bonds because margins of protection may not be as large as in Aaa securities or fluctuation of protective elements may be of greater amplitude or there may be other elements present which make the long-term risks appear somewhat larger than in Aaa securities. Moody's applies numerical modifiers 1, 2 and 3 in the Aa and A rating categories. The modifier 1 indicates that the security ranks at a higher end of the rating category, modifier 2 indicates a mid-range rating and the modifier 3 indicates that the issue ranks at the lower end of the rating category. Bonds which are rated "A" possess many favorable investment attributes and are to be considered as upper medium grade obligations. Factors giving security to principal and interest are considered adequate but elements may be present which suggest a susceptibility to impairment sometime in the future. Bonds which are rated "Baa" are considered as medium grade obligations, i.e., they are neither highly protected nor poorly secured. Interest payments and principal security appear adequate for the present but certain protective elements may be lacking or may be characteristically unreliable over any great length of time. Such bonds lack outstanding investment characteristics and in fact have speculative characteristics as well. Bonds which are rated "Ba" are judged to have speculative elements; their future cannot be considered as well assured. Often the protection of interest and principal payments may be very moderate, and thereby not well safeguarded during both good and bad times over the future. Uncertainty of position characterizes bonds in this class. Bonds which are rated "B" generally lack characteristics of the desirable investment. Assurance of interest and principal payments or of maintenance of other terms of the contract over any long period of time may be small. Bonds which are rated "Caa" are of poor standing. Such issues may be in default or there may be present elements of danger with respect to principal or interest. Bonds which are rated "Ca" represent obligations which are speculative in a high degree. Such issues are often in default or have other marked shortcomings. Bonds which are rated "C" are the lowest rated class of bonds, and issues so rated can be regarded as having extremely poor prospects of ever attaining any real investment standing. Standard & Poor's Commercial Paper Ratings "A" is the highest commercial paper rating category utilized by Standard & Poor's, which uses the numbers "1+", "1", "2" and "3" to denote relative strength within its "A" classification. Commercial paper issuers rated "A" by Standard & Poor's have the following characteristics. Liquidity ratios are better than industry average. Long-term debt rating is "A" or better. The issuer has access to at least two additional channels of borrowing. Basic earnings and cash flow are in an upward trend. Typically, the issuer is a strong company in a well-established industry and has superior management. Issues rated "B" are regarded as having only an adequate capacity for timely payment. However, such capacity may be damaged by changing conditions or short-term adversities. The rating "C" is assigned to short-term debt obligations with a doubtful capacity for repayment. An issue rated "D" is either in default or is expected to be in default upon maturity. Moody's Commercial Paper Ratings "Prime-1" is the highest commercial paper rating assigned by Moody's, which uses the numbers "1", "2" and "3" to denote relative strength within its highest classification of Prime. Commercial paper issuers rated Prime by Moody's have the following characteristics. Their short-term debt obligations carry the smallest degree of investment risk. Margins of support for current indebtedness are large or stable with cash flow and asset protection well assured. Current liquidity provides ample coverage of near-term liabilities and unused alternative financing arrangements are generally available. While protective elements may change over the intermediate or longer terms, such changes are most unlikely to impair the fundamentally strong position of short-term obligations. Fitch IBCA, Inc. Commercial Paper Ratings. Fitch Investors Service L.P. employs the rating F-1+ to indicate issues regarded as having the strongest degree of assurance for timely payment. The rating F-1 reflects an assurance of timely payment only slightly less in degree than issues rated F-1+, while the rating F-2 indicates a satisfactory degree of assurance for timely payment, although the margin of safety is not as great as indicated by the F-1+ and F-1 categories.
Duff & Phelps Inc. Commercial Paper Ratings. Duff & Phelps Inc. employs the
designation of Duff 1 with respect to top grade commercial paper and bank money
instruments. Duff 1+ indicates the highest certainty of timely payment:
Thomson BankWatch, Inc. ("BankWatch") Commercial Paper Ratings. BankWatch will assign both short-term debt ratings and issuer ratings to the issuers it rates. BankWatch will assign a short-term rating ("TBW-1", "TBW-2", "TBW-3", or "TBW-4") to each class of debt (e.g., commercial paper or non-convertible debt), having a maturity of one-year or less, issued by a holding company structure or an entity within the holding company structure that is rated by BankWatch. Additionally, BankWatch will assign an issuer rating ("A", "A/B", "B", "B/C", "C", "C/D", "D", "D/E", and "E") to each issuer that it rates. Various of the NRSROs utilize rankings within rating categories indicated by a + or -. The Portfolios, in accordance with industry practice, recognize such rankings within categories as graduations, viewing for example Standard & Poor's rating of A-1+ and A-1 as being in Standard & Poor's highest rating category. PART B STATEMENT OF ADDITIONAL INFORMATION COVA SERIES TRUST One Tower Lane, Suite 3000 Oakbrook Terrace, Illinois 60181-4644 The date of this Statement of Additional Information is May 1, 2000 This Statement of Additional Information is not a prospectus. It contains information that supplements the information in the prospectus dated May 1, 2000, for the Trust and its Portfolios. It also contains additional information that may be of interest to you. The prospectus incorporates this Statement of Additional Information by reference. You may obtain a free copy of the prospectus from your registered representative who offered or sold you your variable annuity contract or variable life insurance policy that uses the Portfolios for investment. You may also obtain copies by calling Cova Financial Services Life Insurance Company at 1-800-831-LIFE or by writing to: Cova Financial Services Life Insurance Company, One Tower Lane, Suite 3000, Oakbrook Terrace, Illinois 60181-4644.
THE TRUST History The Trust was established as a Massachusetts business trust under the laws of Massachusetts by a Declaration of Trust dated July 9, 1987 (the "Declaration of Trust"). The Trust changed its name from "Van Kampen Merritt Series Trust" to its current name on May 1, 1996. Classification The Trust is an open-end, management investment company. It is divided into different series, each of which has its own assets, investment objectives and policies. Each is managed separately, using distinct strategies appropriate to its objectives and policies. The Trust currently has seventeen Portfolios. The Trust may authorize additional Portfolios in the future. The Trust cannot change its classification as an open-end, management investment company without the consent of a majority of its shareholders. A Portfolio that is currently diversified cannot change to nondiversified without the approval of a majority of the shareholders of that Portfolio. Shareholder Liability Under Massachusetts law, shareholders of a trust may be held personally liable as partners for the obligations of the trust under certain circumstances. The Declaration of Trust contains an express disclaimer of shareholder liability in connection with Trust property or the acts, obligations, or affairs of the Trust. The Declaration of Trust also provides for indemnification out of a Portfolio's property of any shareholder of that Portfolio held personally liable for the claims and liabilities to which a shareholder may become subject by reason of being or having been a shareholder. Thus, the risk of a shareholder incurring financial loss on account of shareholder liability is limited to circumstances in which the Portfolio itself would be unable to meet its obligations. A copy of the Declaration of Trust is on file with the Secretary of State of The Commonwealth of Massachusetts. INVESTMENT STRATEGIES AND RISKS Summary The prospectus for the Trust describes the principal strategies of each of the Portfolios and the risks of those strategies. This Section describes the strategies that are not principal strategies for the Portfolios, but which the Sub-Advisers may use in managing a Portfolio and the risks of those strategies. Some of these strategies could affect the return of the Portfolio. Additional information on certain Portfolios is also provided. ADDITIONAL INFORMATION - PORTFOLIOS MANAGED BY J.P. MORGAN INVESTMENT MANAGEMENT INC. QUALITY BOND PORTFOLIO. The Quality Bond Portfolio is designed to be an economical and convenient means of making substantial investments in a domestic and foreign issuer, subject to certain quality and other restrictions. See "Quality and Diversification Requirements. The Portfolio's investment objective is to provide a high total return consistent with moderate risk of capital and maintenance of liquidity. Although the net asset value of the Portfolio will fluctuate, the Portfolio attempts to conserve the value of its investments to the extent consistent with its objective. The Portfolio attempts to achieve its investment objective by investing in high grade corporate and government debt obligations and related securities of domestic and foreign issuers described in the Prospectus and this Statement of Additional Information. INVESTMENT PROCESS Duration/yield curve management: The Sub-Adviser's duration decision begins with an analysis of real yields, which its research indicates are generally a reliable indicator of longer term interest rate trends. Other factors the Sub-Adviser studies in regard to interest rates include economic growth and inflation, capital flows and monetary policy. Based on this analysis, the Sub-Adviser forms a view of the most likely changes in the level and shape of the yield curve -- as well as the timing of those changes -- and sets the Portfolio's duration and maturity structure accordingly. The Sub-Adviser typically limits the overall duration of the Portfolio to a range between one year shorter and one year longer than that of the Salomon Brothers Broad Investment Grade Bond Index, the benchmark index.
Sector allocations: Sector allocations are driven by the Sub-Adviser's
fundamental and quantitative analysis of the relative valuation of a broad array
of fixed income sectors. Specifically, the Sub-Adviser utilizes market and
credit analysis to assess whether the current risk-adjusted yield spreads of
various sectors are likely to widen or narrow. The Sub-Adviser then overweights
Security selection: Securities are selected by the portfolio manager, with substantial input from the Sub-Adviser's fixed income analysts and traders. Using quantitative analysis as well as traditional valuation methods, the Sub-Adviser's applied research analysts aim to optimize security selection within the bounds of the Portfolio's investment objective. In addition, credit analysts -- supported by the Sub-Adviser's equity analysts -- assess the creditworthiness of issuers and counterparties. A dedicated trading desk contributes to security selection by tracking new issuance, monitoring dealer inventories, and identifying attractively priced bonds. The traders also handle all transactions for the Portfolio.
SELECT EQUITY PORTFOLIO AND LARGE CAP STOCK PORTFOLIO. The investment
objective of each Portfolio is long-term growth of capital and income. In normal circumstances, at least 65% of each Portfolio's net assets will be invested in equity securities consisting of common stocks and other securities with equity characteristics comprised of preferred stock, warrants, rights, convertible securities, trust certificates, limited partnership interests and equity participations (collectively, "Equity Securities"). Each Portfolio's primary equity investments are the common stock of large and medium sized U.S. corporations and, to a limited extent, similar securities of foreign corporations. INVESTMENT PROCESS Research: The Sub-Adviser's domestic equity analysts, each an industry specialist, follow 700 predominantly large- and medium-sized U.S. companies -- 500 of which form the universe for each Portfolio's investments. Their research goal is to forecast normalized, longer term earnings and dividends for the most attractive companies among those they cover. In doing this, they may work in concert with the Sub-Adviser's international equity analysts in order to gain a broader perspective for evaluating industries and companies in today's global economy. Valuation: The analysts' forecasts are converted into comparable expected returns by a dividend discount model, which calculates those expected returns by comparing a company's current stock price with the "fair value" price forecasted by its estimated long term earnings power. Within each sector, companies are ranked by their expected return and grouped into quintiles: those with the highest expected returns (Quintile 1) are deemed the most undervalued relative to their long-term earnings power, while those with the lowest expected returns (Quintile 5) are deemed the most overvalued. Stock Selection: A diversified portfolio is constructed using disciplined buy and sell rules. The specific names selected reflect the portfolio manager's judgment concerning the soundness of the underlying forecasts, the likelihood that the perceived misevaluation will be corrected within a reasonable time frame and the magnitude of the risks versus the rewards. Portfolio sector weightings are held close to those of the S&P 500 Index, reflecting the Sub-Adviser's belief that its research has the potential to add value at the individual stock level, but not at the sector level. Sector neutrality is also seen as a way to help protect the portfolio from macroeconomic risks, and -- together with diversification -- represents an important element of the Sub-Adviser's risk control strategy. A dedicated trading desk handles all transactions for the Portfolio. SMALL CAP STOCK PORTFOLIO. This Portfolio is designed for investors who are willing to assume the somewhat higher risk of investing in small companies in order to seek a higher return over time than might be expected from a portfolio of stocks of large companies. The Portfolio's investment objective is to provide a high total return from a portfolio of Equity Securities of small companies. The Portfolio attempts to achieve its investment objective by investing primarily in the common stock of small U.S. companies included in the Russell 2000 Index, which is composed of 2000 common stocks of U.S. companies with market capitalizations ranging between $100 million and $2 billion. INVESTMENT PROCESS Research: The Sub-Adviser's domestic equity analysts -- each an industry specialist -- continuously monitor the small cap stocks in their respective sectors with the aim of identifying companies that exhibit superior financial strength and operating returns. Meetings with management and on-site visits play a key role in shaping their assessments. Their research goal is to forecast normalized, long-term earnings and dividends for the most attractive small cap companies among those they monitor -- a universe that generally contains a total of approximately 600 names. Because the Sub-Adviser's analysts follow both the larger and smaller companies in their industries -- in essence, covering their industries from top to bottom -- they are able to bring broad perspective to the research they do on both. Valuation: The analysts' forecasts are converted into comparable expected returns by the Sub-Adviser's dividend discount model, which calculates those returns by comparing a company's current stock price with the "fair value" price forecasted by its estimated long-term earnings power. Within each industry, companies are ranked by their expected returns and grouped into quintiles: those with the highest expected returns (Quintile 1) are deemed the most undervalued relative to their long-term earnings power, while those with the lowest expected returns (Quintile 5) are deemed the most overvalued. Stock Selection: A diversified portfolio is constructed using disciplined buy and sell rules. Purchases are concentrated among the stocks in the top two quintiles of the rankings: the specific names selected reflect the portfolio manager's judgment concerning the soundness of the underlying forecasts, the likelihood that the perceived misevaluation will soon be corrected and the magnitude of the risks versus the rewards. Once a stock falls into the third quintile because its price has risen or its fundamentals have deteriorated -- it generally becomes a sale candidate. The portfolio manager seeks to hold sector weightings close to those of the Russell 2000 Index, the Portfolio's benchmark, reflecting the Sub-Adviser's belief that its research has the potential to add value at the individual stock level, but not at the sector level. Sector neutrality is also seen as a way to help to protect the portfolio from macroeconomic risks, and -- together with diversification -- represents an important element of the Sub-Adviser's investment strategy. INTERNATIONAL EQUITY PORTFOLIO. This Portfolio is designed for investors with a long-term investment horizon who want to diversify their portfolios by investing in an actively managed portfolio of non-U.S. securities that seeks to outperform the Morgan Stanley Capital International Europe, Australia and Far East Index (the "EAFE Index"). The Portfolio's investment objective is to provide a high total return from a portfolio of Equity Securities of foreign corporations. The Portfolio seeks to achieve its investment objective by investing primarily in the Equity Securities of foreign corporations. Under normal circumstances, the Portfolio expects to invest at least 65% of its total assets in such securities. The Portfolio does not intend to invest in U.S. securities (other than money market instruments), except temporarily, when extraordinary circumstances prevailing at the same time in a significant number of developed foreign countries render investments in such countries inadvisable. INVESTMENT PROCESS
Country allocation: The Sub-Adviser's country allocation decision begins
with a forecast of equity risk premiums, which provide a valuation signal by
measuring the relative attractiveness of stocks versus bonds. Using a
proprietary approach, the Sub-Adviser calculates this risk premium for each of
the nations in the Portfolio's universe, determines the extent of its deviation
Stock selection: The Sub-Adviser's international equity analysts, each an industry and country specialist, forecast normalized earnings and dividend payouts for roughly 1,000 non-U.S. companies -- taking a long-term perspective rather than the short time frame common to consensus estimates. These forecasts are converted into comparable expected returns by a dividend discount model, and then companies are ranked from most to least attractive by industry and country. A diversified portfolio is constructed using disciplined buy and sell rules. The portfolio manager's objective is to concentrate the purchases in the top third of the rankings, and to keep sector weightings close to those of the EAFE Index, the Portfolio's benchmark. Once a stock falls into the bottom third of the rankings, it generally becomes a sales candidate. Where available, warrants and convertibles may be purchased instead of common stock if they are deemed a more attractive means of investing in an undervalued company. Currency management: Currency is actively managed, in conjunction with country and stock allocation, with the goal of protecting and possibly enhancing the Portfolio's return. The Sub-Adviser's currency decisions are supported by a proprietary tactical mode which forecasts currency movements based on an analysis of four fundamental factors -- trade balance trends, purchasing power parity, real short-term interest differentials and real bond yields -- plus a technical factor designed to improve the timing of transactions. Combining the output of this model with a subjective assessment of economic, political and market factors, the Sub-Adviser's currency group recommends currency strategies that are implemented in conjunction with the Portfolio's investment strategy. EMERGING MARKETS EQUITY PORTFOLIO. This Portfolio is designed for investors with a long term investment horizon who want exposure to the rapidly growing emerging markets. The Portfolio's investment objective is to provide a high total return from a portfolio of equity securities of companies in emerging markets. The Portfolio seeks to achieve its investment objective by investing primarily in equity securities of emerging markets issuers. Under normal circumstances, the Portfolio expects to invest at least 65% of its total assets in such securities. The Portfolio does not intend to invest in U.S. securities (other than money market instruments), except temporarily, when extraordinary circumstances prevailing at the same time in a significant number of emerging markets countries render investments in such countries inadvisable. INVESTMENT PROCESS Country allocation: The Sub-Adviser's country allocation decision begins with a forecast of the expected return of each market in the Portfolio's universe. These expected returns are calculated using a proprietary valuation method that is forward looking in nature rather than based on historical data. The Sub-Adviser then evaluates these expected returns from two different perspectives: first, it identifies those countries that have high real expected returns relative to their own history and other nations in their universe. Second, it identifies those countries that it expects will provide high returns relative to their currency risk. Countries that rank highly on one or both of these scores are overweighted relative to the Portfolio's benchmark, the MSCI Emerging Markets Free Index, while those that rank poorly are underweighted. To help contain risk, the Sub-Adviser places limits on the total size of the Portfolio's country over- and under-weightings. Stock selection: The Sub-Adviser's 12 emerging market equity analysts-- each an industry specialist--monitor a universe of approximately 900 companies in these countries, developing forecasts of earnings and cash flows for the most attractive among them. Companies are ranked from most to least attractive based on this research, and then a diversified portfolio is constructed using disciplined buy and sell rules. The portfolio manager's objective is to concentrate the Portfolio's holdings in the stocks deemed most undervalued, and to keep sector weightings relatively close to those of the index. Stocks are generally held until they fall into the bottom half of the Sub-Adviser's rankings. MONEY MARKET INSTRUMENTS As discussed in the Prospectus, each Portfolio may invest in money market instruments to the extent consistent with its investment objective and policies. A description of the various types of money market instruments that may be purchased by the Portfolios appears below. See "Quality and Diversification Requirements." U.S. TREASURY SECURITIES. Each of the Portfolios may invest in direct obligations of the U.S. Treasury, including Treasury bills, notes and bonds, all of which are backed as to principal and interest payments by the full faith and credit of the United States. ADDITIONAL U.S. GOVERNMENT OBLIGATIONS. Each of the Portfolios may invest in obligations issued or guaranteed by U.S. Government agencies or instrumentalities. These obligations may or may not be backed by the "full faith and credit" of the United States. In the case of securities not backed by the full faith and credit of the United States, each Portfolio must look principally to the federal agency issuing or guaranteeing the obligations for ultimate repayment, and may not be able to assert a claim against the United States itself in the event the agency or instrumentality does not meet its commitments. Securities in which each Portfolio may invest that are not backed by the full faith and credit of the United States include, but are not limited to, obligations of the Tennessee Valley Authority, the Federal Home Loan Mortgage Corporation and the U.S. Postal Service, each of which has the right to borrow from the U.S. Treasury to meet its obligations, and obligations of the Federal Farm Credit System and the Federal Home Loan Banks, both of whose obligations may be satisfied only by the individual credits of each issuing agency. Securities which are backed by the full faith and credit of the United States include obligations of the Government National Mortgage Association, the Farmers Home Administration, and the Export-Import Bank. FOREIGN GOVERNMENT OBLIGATIONS. Each of the Portfolios, subject to its applicable investment policies, may also invest in short-term obligations of foreign sovereign governments or of their agencies, instrumentalities, authorities or political subdivisions. These securities may be denominated in the U.S. dollar or in another currency. See "Foreign Investments." STRIPPED U.S. GOVERNMENT OBLIGATIONS. As described in the Prospectus and subject to their respective investment policies, certain Portfolios may hold stripped U.S. Treasury securities, including (1) coupons that have been stripped from U.S. Treasury bonds, which are held through the Federal Reserve Bank's book-entry system called "Separate Trading of Registered Interest and Principal of Securities" ("STRIPS") or (2) through a program entitled "Coupon Under Book-Entry Safekeeping" ("CUBES"). Certain Portfolios may also acquire U.S. Government obligations and their unmatured interest coupons that have been stripped by a custodian bank or investment brokerage firm. Having separated the interest coupons from the underlying principal of the U.S. Government obligations, the holder will resell the stripped securities in custodial receipt programs with a number of different names, including "Treasury Income Growth Receipts" ("TIGRS") and "Certificates of Accrual on Treasury Securities" ("CATS"). Such securities may not be as liquid as STRIPS and CUBES and are not viewed by the staff of the SEC as U.S. Government securities for purposes of the 1940 Act. The stripped coupons are sold separately from the underlying principal, which is sold at a deep discount because the buyer receives only the right to receive a future fixed payment on the security and does not receive any rights to periodic interest (cash) payments. Purchasers of stripped principal-only securities acquire, in effect, discount obligations that are economically identical to the zero coupon securities that the Treasury Department sells itself. In the case of bearer securities (i.e., unregistered securities which are owned ostensibly by the bearer or holder), the underlying U.S. Treasury bonds and notes themselves are held in trust on behalf of the owners. The U.S. Government does not issue stripped Treasury securities directly. The STRIPS program, which is ongoing, is designed to facilitate the secondary market in the stripping of selected U.S. Treasury notes and bonds into separate interest and principal components. Under the program, the U.S. Treasury continues to sell its notes and bonds through its customary auction process. A purchaser of those specified notes and bonds who has access to a book-entry account at a Federal Reserve bank, however, may separate the Treasury notes and bonds into interest and principal components. The selected Treasury securities thereafter may be maintained in the book-entry system operated by the Federal Reserve in a manner that permits the separate trading and ownership of the interest and principal payments. For custodial receipts, the underlying debt obligations are held separate from the general assets of the custodian and nominal holder of such securities, and are not subject to any right, charge, security interest, lien or claim of any kind in favor of or against the custodian or any person claiming through the custodian. The custodian is also responsible for applying all payments received on those underlying debt obligations to the related receipts or certificates without making any deductions other than applicable tax withholding. The custodian is required to maintain insurance for the protection of holders of receipts or certificates in customary amounts against losses resulting from the custody arrangement due to dishonest or fraudulent action by the custodian's employees. The holders of receipts or certificates, as the real parties in interest, are entitled to the rights and privileges of the underlying debt obligations, including the right, in the event of default in payment of principal or interest, to proceed individually against the issuer without acting in concert with other holders of those receipts or certificates or the custodian. VARIABLE AND FLOATING RATE INSTRUMENTS. Subject to their respective investment limitations, certain Portfolios may purchase variable and floating rate obligations. The Sub-Advisers will consider the earning power, cash flows and other liquidity ratios of the issuers and guarantors of such obligations and, for obligations subject to a demand feature, will monitor their financial status to meet payment on demand. In determining average weighted portfolio maturity, a variable or floating rate instrument issued or guaranteed by the U.S. Government, its agencies and instrumentalities, or a variable or floating rate instrument scheduled on its face to be paid in 397 days or less, will be deemed to have a maturity equal to the period remaining until the obligation's next interest rate adjustment. Other variable or floating rate notes will be deemed to have a maturity equal to the longer of the period remaining to the next interest rate adjustment or the time the Portfolio can recover payment of principal as specified in the instrument. BANK OBLIGATIONS. Each of the Portfolios, unless otherwise noted in the Prospectus or below, may invest in negotiable certificates of deposit, time deposits and bankers' acceptances of (i) banks, savings and loan associations and savings banks which (for those Portfolios managed by J.P. Morgan Investment Management Inc. except the International Equity Portfolio) have more than $2 billion in total assets and are organized under the laws of the United States or any state, (ii) foreign branches of these banks or of foreign banks of equivalent size (Euros) and (iii) U.S. branches of foreign banks of equivalent size (Yankees) with respect to the Portfolios managed by J.P. Morgan Investment Management Inc. See "Foreign Investments." Bank instruments may include Eurodollar Certificates of Deposit ("ECDs"), Yankee Certificates of Deposit ("Yankee CDs"), Eurodollar Time Deposits ("ETDs") and Canadian Time Deposits. ECDs are issued by foreign branches of U.S. or foreign banks. Yankee CDs are U.S. dollar-denominated certificates of deposit issued by U.S. branches of foreign banks and held in the United States. ETDs are U.S. dollar-denominated deposits in foreign branches of U.S. or foreign banks. Canadian Time Deposits are U.S. dollar-denominated deposits issued by branches of major Canadian banks located in the United States. The Portfolios will not invest in obligations for which J.P. Morgan Investment Management Inc., or any of its affiliated persons, is the ultimate obligor or accepting bank. Each of the Portfolios may also invest in obligations of international banking institutions designated or supported by national governments to promote economic reconstruction, development or trade between nations (e.g., the European Investment Bank, the Inter-American Development Bank, or the World Bank). COMMERCIAL PAPER. Each of the Portfolios may invest in commercial paper, including master demand obligations. Master demand obligations are obligations that provide for a periodic adjustment in the interest rate paid and permit daily changes in the amount borrowed. The monies loaned to the borrower come from accounts managed by a Sub-Adviser or its affiliates, pursuant to arrangements with such accounts. Interest and principal payments are credited to such accounts. The Sub-Adviser, or its affiliates, acting as a fiduciary on behalf of its clients, has the right to increase or decrease the amount provided to the borrower under an obligation. The borrower has the right to pay without penalty all or any part of the principal amount then outstanding on an obligation together with interest to the date of payment. Since these obligations typically provide that the interest rate is tied to the Federal Reserve commercial paper composite rate, the rate on master demand obligations is subject to change. Repayment of a master demand obligation to participating accounts depends on the ability of the borrower to pay the accrued interest and principal of the obligations on demand which is continuously monitored by the Sub-Adviser. Since master demand obligations typically are not rated by credit rating agencies, the Portfolios may invest in such unrated obligations only if at the time of an investment the obligation is determined by the Sub-Adviser to have a credit quality which satisfies the Portfolio's quality restrictions. See "Quality and Diversification Requirements." Although there is no secondary market for master demand obligations, such obligations are considered by the Portfolios to be liquid because they are payable upon demand. The Portfolios do not have any specific percentage limitation on investments in master demand obligations. REPURCHASE AGREEMENTS. Each of the Portfolios may enter into repurchase agreements with brokers, dealers or banks that meet the credit guidelines approved by the Trustees of the Trust. In a repurchase agreement, a Portfolio buys a security from a seller that has agreed to repurchase the same security at a mutually agreed upon date and price. The resale price normally is in excess of the purchase price, reflecting an agreed upon interest rate. This interest rate is effective for the period of time the Portfolio is invested in the agreement and is not related to the coupon rate on the underlying security. A repurchase agreement may also be viewed as a fully collateralized loan of money by a Portfolio to the seller. The period of these repurchase agreements will usually be short, from overnight to one week, and at no time will the Portfolios invest in repurchase agreements for more than thirteen months. The securities which are subject to repurchase agreements, however, may have maturity dates in excess of thirteen months from the effective date of the repurchase agreement. The Portfolios will always receive securities as collateral whose market value is, and during the entire term of the agreement remains, at least equal to 100% of the dollar amount invested by the Portfolios in each agreement plus accrued interest, and the Portfolios will make payment for such securities only upon physical delivery or upon evidence of book entry transfer to the account of the Custodian. If the seller defaults, a Portfolio might incur a loss if the value of the collateral securing the repurchase agreement declines and might incur disposition costs in connection with liquidating the collateral. In addition, if bankruptcy proceedings are commenced with respect to the seller of the security, realization upon disposal of the collateral by a Portfolio may be delayed or limited. Each of the Portfolios may make investments in other debt securities with remaining effective maturities of not more than thirteen months, including without limitation corporate and foreign bonds, asset-backed securities and other obligations described in the prospectus or this Statement of Additional Information. CORPORATE BONDS AND OTHER DEBT SECURITIES As discussed in the Prospectus, certain of the Portfolios may invest in bonds and other debt securities of domestic and foreign issuers to the extent consistent with their investment objectives and policies. A description of these investments appears in the prospectus and below. See "Quality and Diversification Requirements." For information on short-term investments in these securities, see "Money Market Instruments." ASSET-BACKED SECURITIES. Asset-backed securities directly or indirectly represent a participation interest in, or are secured by and payable from, a stream of payments generated by particular assets such as motor vehicle or credit card receivables. Payments of principal and interest may be guaranteed up to certain amounts and for a certain time period by a letter of credit issued by a financial institution unaffiliated with the entities issuing the securities. The asset-backed securities in which a Portfolio may invest are subject to the Portfolio's overall credit requirements. However, asset-backed securities, in general, are subject to certain risks. Most of these risks are related to limited interests in applicable collateral. For example, credit card debt receivables are generally unsecured and the debtors are entitled to the protection of a number of state and federal consumer credit laws, many of which give such debtors the right to set off certain amounts on credit card debt thereby reducing the balance due. Additionally, if the letter of credit is exhausted, holders of asset-backed securities may also experience delays in payments or losses if the full amounts due on underlying sales contracts are not realized. Because asset-backed securities are relatively new, the market experience in these securities is limited and the market's ability to sustain liquidity through all phases of the market cycle has not been tested. COLLATERALIZED MORTGAGE OBLIGATIONS (CMOs). Certain Portfolios may invest in CMOs. Privately issued CMOs generally represent an ownership interest in a pool of federal agency mortgage pass-through securities, such as those issued by the Government National Mortgage Association. The terms and characteristics of the mortgage instruments may vary among pass- through mortgage loan pools. The market for such CMOs has expanded considerably since its inception. The size of the primary issuance market and the active participation in the secondary market by securities dealers and other investors make government-related pools highly liquid. Generally speaking, the mortgages underlying mortgage-backed securities often may be prepaid without penalty or premium. Therefore, mortgage-backed securities are generally subject to higher prepayment risks than most other types of debt instruments. Prepayment risks on mortgage securities tend to increase during periods of declining mortgage interest rates, because many borrowers refinance their mortgages to take advantage of the more favorable rates. Depending upon market conditions, the yield that a Portfolio receives from the reinvestment of such prepayments, or any scheduled principal payments, may be lower than the yield on the original mortgage security. As a consequence, mortgage securities may be a less effective means of "locking in" interest rates than other types of debt securities having the same stated maturity and may also have less potential for capital appreciation. For certain types of asset pools, such as collateralized mortgage obligations, prepayments may be allocated to one tranche of securities ahead of other tranches, in order to reduce the risk of prepayments for the other tranches. Prepayments may result in a capital loss to a Portfolio to the extent that the prepaid mortgage securities were purchased at a market premium over their stated principal amount. Conversely, the prepayment of mortgage securities purchased at a market discount from their stated principal amount will accelerate the recognition of interest income by a Portfolio, which would be taxed as ordinary income when distributed to the shareholders. EQUITY INVESTMENTS As discussed in the prospectus, certain of the Portfolios invest primarily in Equity Securities. The Equity Securities in which these Portfolios invest include those listed on any domestic or foreign securities exchange or traded in the over-the-counter market as well as certain restricted or unlisted securities. A discussion of the various types of equity investments which may be purchased by these Portfolios appears in the prospectus and below. See "Quality and Diversification Requirements." EQUITY SECURITIES. The Equity Securities in which these Portfolios may invest may or may not pay dividends and may or may not carry voting rights. Common stock occupies the most junior position in a company's capital structure. The convertible securities in which these Portfolios may invest include any debt securities or preferred stock which may be converted into common stock or which carry the right to purchase common stock. Convertible securities entitle the holder to exchange the securities for a specified number of shares of common stock, usually of the same company, at specified prices within a certain period of time. The terms of any convertible security determine its ranking in a company's capital structure. In the case of subordinated convertible debentures, the holders' claims on assets and earnings are subordinated to the claims of other creditors, and are senior to the claims of preferred and common shareholders. In the case of convertible preferred stock, the holders' claims on assets and earnings are subordinated to the claims of all creditors and are senior to the claims of common shareholders. RIGHTS AND WARRANTS Certain of the Portfolios may participate in rights offerings and purchase warrants, which are privileges issued by corporations enabling the owners to subscribe to and purchase a specified number of shares of the corporation at a specified price during a specified period of time. Subscription rights normally have a short life span to expiration. Warrants may have a life ranging from less than a year to twenty years or may be perpetual. However, most warrants have expiration dates after which they are worthless. The purchase of rights or warrants involves the risk that the Portfolio could lose the purchase value of a right or warrant if the right to subscribe to additional shares is not exercised prior to the rights' or warrants' expiration. Also, the purchase of rights or warrants involves the risk that the effective price paid for the right or warrant added to the subscription price of the related security may exceed the value of the subscribed security's market price such as when there is no movement in the level of the underlying security. FOREIGN INVESTMENTS Each of the Portfolios may invest in foreign securities. The International Equity Portfolio and the Emerging Markets Equity Portfolio make substantial investments in foreign countries. The Quality Bond, Select Equity, Large Cap Stock and Small Cap Stock Portfolios may invest in certain foreign securities. The Quality Bond Portfolio may invest in U.S. and non-U.S. dollar-denominated fixed income securities of foreign issuers including in countries with emerging economies or securities markets. The Select Equity and Large Cap Stock Portfolios may invest in equity securities of foreign corporations listed on a U.S. securities exchange. The Small Cap Stock Portfolio may invest in equity securities of foreign issuers that are listed on a national securities exchange or denominated or principally traded in the U.S. dollar. The Quality Bond Portfolio, Select Equity Portfolio, Large Cap Stock Portfolio and the Small Cap Stock Portfolio do not expect to invest more than 25%, 5%, 5%, and 5%, respectively, of their total assets at the time of purchase in securities of foreign issuers. In the case of the Quality Bond Portfolio, any foreign commercial paper must not be subject to foreign withholding tax at the time of purchase. Foreign investments may be made directly in securities of foreign issuers or in the form of American Depositary Receipts ("ADRs") and European Depositary Receipts ("EDRs"). (See "ADRs and EDRs", below.) Foreign investments may also include ECDs, ETDs, Yankee CDs, Canadian Commercial Paper and Europaper. Since investments in foreign securities may involve foreign currencies, the value of a Portfolio's assets as measured in U.S. dollars may be affected favorably or unfavorably by changes in currency rates and in exchange control regulations, including currency blockage. Certain of the Portfolios may enter into forward commitments for the purchase or sale of foreign currencies in connection with the settlement of foreign securities transactions or to manage the Portfolios' currency exposure related to foreign investments. Different risks may exist for ECDs, ETDs and Yankee CDs because the banks issuing these instruments, or their domestic or foreign branches, are not necessarily subject to the same regulatory requirements that apply to domestic banks, such as reserve requirements, loan limitations, examinations, accounting, auditing, and recordkeeping, and the public availability of information. Brady Bonds Certain Portfolios may invest in Brady bonds, which are securities created through the exchange of existing commercial bank loans to public and private entities in certain emerging markets for new bonds in connection with debt restructurings. Brady bonds have been issued since 1989 and do not have a long payment history. In light of the history of defaults of countries issuing Brady bonds on their commercial bank loans, investments in Brady bonds may be viewed as speculative. Brady bonds may be fully or partially collateralized or uncollateralized, are issued in various currencies (but primarily the dollar) and are actively traded in over-the-counter secondary markets. Incomplete collateralization of interest or principal payment obligations results in increased credit risk. Dollar-denominated collateralized Brady bonds, which may be fixed-rate bonds or floating-rate bonds, are generally collateralized by U.S. Treasury zero coupon bonds having the same maturity as the Brady bonds. Investing in Emerging Markets Certain Portfolios may invest in countries with emerging economies or securities markets. Political and economic structures in many of such countries may be undergoing significant evolution and rapid development, and such countries may lack the social, political and economic stability characteristic of more developed countries. Certain of such countries may have in the past failed to recognize private property rights and have at times nationalized or expropriated the assets of private companies. As a result, the risks described above, including the risks of nationalization or expropriation of assets, may be heightened. In addition, unanticipated political or social developments may affect the values of a Portfolio's investments in those countries and the availability to a Portfolio of additional investments in those countries. The small size and inexperience of the securities markets in certain of such countries and the limited volume of trading in securities in those countries may make a Portfolio's investments in such countries illiquid and more volatile than investments in more developed countries, and a Portfolio may be required to establish special custodial or other arrangements before making certain investments in those countries. There may be little financial or accounting information available with respect to issuers located in certain of such countries, and it may be difficult as a result to assess the value or prospects of an investment in such issuers. Transaction costs in emerging markets may be higher than in the United States and other developed securities markets. As legal systems in emerging markets develop, foreign investors may be adversely affected by new or amended laws and regulations or may not be able to obtain swift and equitable enforcement of existing law. Certain Portfolios may make investments denominated in emerging markets currencies. Some countries in emerging markets also may have managed currencies, which are not free floating against the U.S. dollar. In addition, emerging markets are subject to the risk of restrictions upon the free conversion of their currencies into other currencies. Any devaluations relative to the U.S. dollar in the currencies in which the Portfolio's securities are quoted would reduce the Portfolio's net asset value. Restrictions on Investment and Repatriation Certain emerging markets limit, or require governmental approval prior to, investments by foreign persons. Repatriation of investment income and capital from certain emerging markets is subject to certain governmental consents. Even where there is no outright restriction on repatriation of capital, the mechanics of repatriation may affect the operation of a Portfolio. CONVERSION TO THE EURO Like other mutual funds, the Trust could be affected by problems relating to the conversion of European currencies into the Euro, which extends from 1/1/99 to 7/1/02. The Trust is taking steps to ensure that the systems used by the Trust's major service providers are compliant with Euro issues. At the same time, it is impossible to know whether the ongoing conversion, which could disrupt Trust operations and investments if problems arise, has been adequately addressed until the conversion is complete. ADRs AND EDRs Certain Portfolios may invest their assets in securities such as ADRs and EDRs, which are receipts issued by a U.S. bank or trust company evidencing ownership of underlying securities issued by a foreign issuer. ADRs and EDRs may be listed on a national securities exchange or may trade in the over-the-counter market. ADR and EDR prices are denominated in U.S. dollars, even though the underlying security may be denominated in a foreign currency. The underlying security may be subject to foreign government taxes which would reduce the yield on such securities. Investments in such instruments involve risks similar to those of investing directly in foreign securities. Such risks include political or economic instability of the issuer or the country of issue, the difficulty of predicting international trade patterns and the possibility of imposition of exchange controls. Such securities may also be subject to greater fluctuations in price than securities of domestic corporations. In addition, there may be less publicly available information about a foreign company than about a domestic company. Foreign companies generally are not subject to uniform accounting, auditing and financial reporting standards comparable to those applicable to domestic companies. With respect to certain foreign countries, there is a possibility of expropriation or confiscatory taxation, or diplomatic developments which could affect investment in those countries. ADDITIONAL INVESTMENTS WHEN-ISSUED AND DELAYED DELIVERY SECURITIES. Each of the Portfolios may purchase securities on a when-issued or delayed delivery basis. For example, 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 a Portfolio until settlement takes place. At the time a Portfolio 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 net asset value 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, each Portfolio will maintain on the Trust's records a segregated account with liquid assets, consisting of cash, U.S. Government securities or other appropriate securities, in an amount at least equal to such commitments. On delivery dates for such transactions, each Portfolio will meet its obligations from maturities or sales of the securities held in the segregated account and/or from cash flow. If a Portfolio 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, incur a gain or loss due to market fluctuation. It is the current policy of each Portfolio not to enter into when-issued commitments exceeding in the aggregate 15% (except for the Quality Bond Portfolio) of the market value of the Portfolio's total assets, less liabilities other than the obligations created by when-issued commitments. There is no current policy limiting the percentage of assets of the Quality Bond Portfolio which may be invested in when-issued commitments. SECURITIES OF OTHER INVESTMENT COMPANIES. Securities of other investment companies may be acquired by each of the Portfolios to the extent permitted under the Investment Company Act of 1940, as amended ("1940 Act"). These limits require that, as determined immediately after a purchase is made, (i) not more than 5% of the value of a Portfolio's total assets will be invested in the securities of any one investment company, (ii) not more than 10% of the value of its total assets will be invested in the aggregate in securities of investment companies as a group, and (iii) not more than 3% of the outstanding voting stock of any one investment company will be owned by a Portfolio. REVERSE REPURCHASE AGREEMENTS. Each of the Portfolios may enter into reverse repurchase agreements. In a reverse repurchase agreement, a Portfolio sells a security and agrees to repurchase the same security at a mutually agreed upon date and price. For purposes of the 1940 Act it is also considered as a borrowing of money by the Portfolio and, therefore, a form of leverage. The Portfolios will invest the proceeds of borrowings under reverse repurchase agreements. In addition, a Portfolio will enter into a reverse repurchase agreement only when the interest income to be earned from the investment of the proceeds is greater than the interest expense of the transaction. A Portfolio will not invest the proceeds of a reverse repurchase agreement for a period which exceeds the duration of the reverse repurchase agreement. A Portfolio may not enter into reverse repurchase agreements exceeding in the aggregate one-third of the market value of its total assets, less liabilities other than the obligations created by reverse repurchase agreements. Each Portfolio will establish and maintain on the Trust's records a separate account with a segregated portfolio of securities in an amount at least equal to its purchase obligations under its reverse repurchase agreements. MORTGAGE DOLLAR ROLL TRANSACTIONS. Certain of the Portfolios of the Trust may engage in mortgage dollar roll transactions with respect to mortgage securities issued by the Government National Mortgage Association, the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation. In a mortgage dollar roll transaction, the Portfolio sells a mortgage backed security and simultaneously agrees to repurchase a similar security on a specified future date at an agreed upon price. During the roll period, the Portfolio will not be entitled to receive any interest or principal paid on the securities sold. The Portfolio is compensated for the lost interest on the securities sold by the difference between the sales price and the lower price for the future repurchase as well as by the interest earned on the reinvestment of the sales proceeds. The Portfolio may also be compensated by receipt of a commitment fee. When the Portfolio enters into a mortgage dollar roll transaction, liquid assets in an amount sufficient to pay for the future repurchase are segregated with the Custodian. Mortgage dollar roll transactions are considered reverse repurchase agreements for purposes of the Portfolio's investment restrictions. LOANS OF PORTFOLIO SECURITIES. Each of the Portfolios may lend its securities if such loans are secured continuously by cash or equivalent collateral or by a letter of credit in favor of the Portfolio at least equal at all times to 100% of the market value of the securities loaned, plus accrued interest. While such securities are on loan, the borrower will pay the Portfolio any income accruing thereon. Loans will be subject to termination by the Portfolios in the normal settlement time, generally five business days after notice, or by the borrower on one day's notice. Borrowed securities must be returned when the loan is terminated. Any gain or loss in the market price of the borrowed securities which occurs during the term of the loan inures to a Portfolio and its respective investors. The Portfolios may pay reasonable finders' and custodial fees in connection with a loan. In addition, a Portfolio will consider all facts and circumstances including the creditworthiness of the borrowing financial institution, and no Portfolio will make any loans in excess of one year. PRIVATELY PLACED AND CERTAIN UNREGISTERED SECURITIES. The Portfolios may invest in privately placed, restricted, Rule 144A or other unregistered securities as described in the Prospectus. As to illiquid investments, a Portfolio is subject to a risk that should the Portfolio decide to sell them when a ready buyer is not available at a price the Portfolio deems representative of their value, the value of the Portfolio's net assets could be adversely affected. Where an illiquid security must be registered under the Securities Act of 1933, as amended (the "1933 Act") before it may be sold, a Portfolio may be obligated to pay all or part of the registration expenses, and a considerable period may elapse between the time of the decision to sell and the time the Portfolio may be permitted to sell a security under an effective registration statement. If, during such a period, adverse market conditions were to develop, a Portfolio might obtain a less favorable price than prevailed when it decided to sell. REAL ESTATE INVESTMENT TRUSTS Certain Portfolios may purchase interests in real estate investment trusts. Risks associated with real estate investments include the fact that equity and mortgage real estate investment trusts are dependent upon management skill and are not diversified, and are, therefore, subject to the risk of financing single projects or unlimited number of projects. They are also subject to heavy cash flow dependency, defaults by borrowers, and self-liquidation. Additionally, equity real estate investment trusts may be affected by any changes in the value of the underlying property owned by the trusts, and mortgage real estate investment trusts may be affected by the quality of any credit extended. These risks may be mitigated by selecting real estate investment trusts diversified by sector (shopping malls, apartments building complexes, and health care facilities) and geographic location. QUALITY AND DIVERSIFICATION REQUIREMENTS Each of the Portfolios intends to meet the diversification requirements of the 1940 Act. To meet these requirements, 75% of the assets of these Portfolios is subject to the following fundamental limitations: (1) the Portfolio may not invest more than 5% of its total assets in the securities of any one issuer, except obligations of the U.S. Government, its agencies and instrumentalities, and (2) the Portfolio may not own more than 10% of the outstanding voting securities of any one issuer. As for the other 25% of the Portfolio's assets not subject to the limitation described above, there is no limitation on investment of these assets under the 1940 Act, so that all of such assets may be invested in securities of any one issuer, subject to the limitation of any applicable state securities laws. Investments not subject to the limitations described above could involve an increased risk to a Portfolio should an issuer, or a state or its related entities, be unable to make interest or principal payments or should the market value of such securities decline. QUALITY BOND PORTFOLIO. The Quality Bond Portfolio invests principally in a diversified portfolio of "high grade" and "investment grade" securities. Investment grade debt is rated, on the date of investment, within the four highest ratings of Moody's, currently Aaa, Aa, A and Baa, or of Standard & Poor's, currently AAA, AA, A and BBB, while high grade debt is rated, on the date of the investment, within the two highest of such ratings. The Quality Bond Portfolio may also invest up to 5% of its total assets in securities which are "below investment grade." Such securities must be rated, on the date of investment, Ba by Moody's or BB by Standard & Poor's. The Portfolio may invest in debt securities which are not rated or other debt securities to which these ratings are not applicable, if in the opinion of the Sub-Adviser, such securities are of comparable quality to the rated securities discussed above. In addition, at the time the Portfolio invests in any commercial paper, bank obligation or repurchase agreement, the issuer must have outstanding debt rated A or higher by Moody's or Standard & Poor's, the issuer's parent corporation, if any, must have outstanding commercial paper rated Prime-1 by Moody's or A-1 by Standard & Poor's, or if no such ratings are available, the investment must be of comparable quality in the Sub-Adviser's opinion. CONVERTIBLE AND OTHER DEBT SECURITIES. Certain of the Portfolios may invest in convertible debt securities, for which there are no specific quality requirements. In addition, at the time a Portfolio invests in any commercial paper, bank obligation or repurchase agreement, the issuer must have outstanding debt rated A or higher by Moody's or Standard & Poor's, the issuer's parent corporation, if any, must have outstanding commercial paper rated Prime-1 by Moody's or A-1 by Standard & Poor's, or if no such ratings are available, the investment must be of comparable quality in the Sub-Adviser's opinion. At the time the Portfolio invests in any other short-term debt securities, they must berated A or higher by Moody's or Standard & Poor's, or if unrated, the investment must be of comparable quality in the Sub-Adviser's opinion. In determining suitability of investment in a particular unrated security, the Sub-Adviser takes into consideration asset and debt service coverage, the purpose of the financing, history of the issuer, existence of other rated securities of the issuer, and other relevant conditions, such as comparability to other issuers. GNMA CERTIFICATES GOVERNMENT NATIONAL MORTGAGE ASSOCIATION. The Government National Mortgage Association is a wholly-owned corporate instrumentality of the United States within the U.S. Department of Housing and Urban Development. GNMA's principal programs involve its guarantees of privately issued securities backed by pools of mortgages. NATURE OF GNMA CERTIFICATES. GNMA Certificates are mortgage-backed securities. The Certificates evidence part ownership of a pool of mortgage loans. The Certificates which a Portfolio purchases are of the modified pass-through type. Modified pass-through Certificates entitle the holder to receive all interest and principal payments owed on the mortgage pool, net of fees paid to the GNMA Certificate issuer and GNMA, regardless of whether or not the mortgagor actually makes the payment. GNMA Certificates are backed by mortgages and, unlike most bonds, their principal amount is paid back by the borrower over the length of the loan rather than in a lump sum at maturity. Principal payments received by the Portfolio will be reinvested in additional GNMA Certificates or in other permissible investments. GNMA GUARANTEE. The National Housing Act authorizes GNMA to guarantee the timely payment of principal of and interest on securities backed by a pool of mortgages insured by the Federal Housing Administration or the Farmers Home Administration or guaranteed by the Veterans Administration. The GNMA guarantee is backed by the full faith and credit of the United States. GNMA is also empowered to borrow without limitation from the U.S. Treasury if necessary to make any payments required under its guarantee. The net asset value and return of the Portfolio will, however, fluctuate depending on market conditions and other factors. LIFE OF GNMA CERTIFICATES. The average life of a GNMA Certificate is likely to be substantially less than the original maturity of the mortgage pools underlying the securities. Prepayments of principal by mortgagors and mortgage foreclosures will result in the return of a portion of principal invested before the maturity of the mortgages in the pool. As prepayment rates of individual mortgage pools will vary widely, it is not possible to predict accurately the average life of a particular issue of GNMA Certificates. However, statistics published by the Federal Housing Administration are normally used as an indicator of the expected average life of GNMA Certificates. YIELD CHARACTERISTICS OF GNMA CERTIFICATES. The coupon rate of interest of GNMA Certificates is lower than the interest rate paid on the VA-guaranteed or FHA-insured mortgages underlying the Certificates, but only by the amount of the fees paid to GNMA and the GNMA Certificate issuer. The coupon rate by itself, however, does not indicate the yield which will be earned on the Certificates for the following reasons: 1. Certificates are usually issued at a premium or discount, rather than at par. 2. After issuance, Certificates usually trade in the secondary market at a premium or discount. 3. Interest is paid monthly rather than semi-annually as is the case for traditional bonds. Monthly compounding has the effect of raising the effective yield earned on GNMA Certificates. 4. The actual yield of each GNMA Certificate is influenced by the prepayment experience of the mortgage pool underlying the Certificate. If mortgagors prepay their mortgages, the principal returned to Certificate holders may be reinvested at higher or lower rates. MARKET FOR GNMA CERTIFICATES. Since the inception of the GNMA mortgage-backed securities program in 1970, the amount of GNMA Certificates outstanding has grown rapidly. The size of the market and the active participation in the secondary market by securities dealers and many types of investors make GNMA Certificates highly liquid instruments. Quotes for GNMA Certificates are readily available from securities dealers and depend on, among other things, the level of market rates, the Certificate's coupon rate and the prepayment experience of the pool of mortgages backing each Certificate. FNMA AND FHLMC CERTIFICATES. Mortgage-backed securities issued by the Federal National Mortgage Association ("FNMA") include FNMA Guaranteed Mortgage Pass-through Certificates (also known as "Fannie Maes") which are solely the obligations of the FNMA and are not backed by or entitled to the full faith and credit of the United States, but are supported by the right of the issuer to borrow from the Treasury. FNMA is a government-sponsored organization owned entirely by private stockholders. Fannie Maes are guaranteed as to timely payment of the principal and interest by FNMA. Mortgage-backed securities issued by the Federal Home Loan Mortgage Corporation ("FHLMC") include FHLMC Mortgage Participation Certificates (also known as "Freddie Macs" or "PCs"). FHLMC is a corporate instrumentality of the United States, created pursuant to an Act of Congress, which is owned entirely by Federal Home Loan Banks. Freddie Macs are not guaranteed by the United States or by any Federal Home Loan Bank. Freddie Macs entitle the holder to timely payment of interest, which is guaranteed by the FHLMC. FHLMC guarantees either ultimate collection or timely payment of all principal payments on the underlying mortgage loans. When FHLMC does not guarantee timely payment of principal, FHLMC may remit the amount due on account of its guarantee of ultimate payment of principal at any time after default on an underlying mortgage, but in no event later than one year after it becomes payable. LOWER GRADE SECURITIES Certain of the Portfolios may invest in lower-grade income securities. (The Bond Debenture Portfolio may invest a substantial portion of its assets in medium and lower grade corporate debt securities entailing certain risks.) Such lower grade securities are rated BB or B by S&P or Ba or B by Moody's and are commonly referred to as "junk bonds." Investment in such securities involves special risks, as described herein. Liquidity relates to the ability of the Portfolio to sell a security in a timely manner at a price which reflects the value of that security. As discussed below, the market for lower grade securities is considered generally to be less liquid than the market for investment grade securities. The relative illiquidity of some of the Portfolio's portfolio securities may adversely affect the ability of the Portfolio to dispose of such securities in a timely manner and at a price which reflects the value of such security in the Sub-Adviser's judgment. The market for less liquid securities tends to be more volatile than the market for more liquid securities and market values of relatively illiquid securities may be more susceptible to change as a result of adverse publicity and investor perceptions than are the market values of higher grade, more liquid securities. The Portfolio's net asset value will change with changes in the value of its portfolio securities. Because the Portfolio will invest in fixed income securities, the Portfolio's net asset value can be expected to change as general levels of interest rates fluctuate. When interest rates decline, the value of a portfolio invested in fixed income securities can be expected to rise. Conversely, when interest rates rise, the value of a portfolio invested in fixed income securities can be expected to decline. Net asset value and market value may be volatile due to the Portfolio's investment in lower grade and less liquid securities. Volatility may be greater during periods of general economic uncertainty. The Portfolio's investments are valued pursuant to guidelines adopted and periodically reviewed by the Board of Trustees. To the extent that there is no established retail market for some of the securities in which the Portfolio may invest, during periods of reduced market liquidity and in the absence of readily available market quotations for securities held in the Portfolio's portfolio, the valuation of such securities becomes more difficult and judgment may play a greater role in the valuation of the Portfolio's securities due to the reduced availability of reliable objective data. To the extent that the Portfolio invests in illiquid securities and securities which are restricted as to resale, the Portfolio may incur additional risks and costs. Illiquid and certain restricted securities are particularly difficult to dispose of. Lower grade securities generally involve greater credit risk than higher grade securities. A general economic downturn or a significant increase in interest rates could severely disrupt the market for lower grade securities and adversely affect the market value of such securities. In addition, in such circumstances, the ability of issuers of lower grade securities to repay principal and to pay interest, to meet projected financial goals and to obtain additional financing may be adversely affected. Such consequences could lead to an increased incidence of default for such securities and adversely affect the value of the lower grade securities in the Portfolio's portfolio and thus the Portfolio's net asset value. The secondary market prices of lower grade securities are less sensitive to changes in interest rates than are those for higher rated securities, but are more sensitive to adverse economic changes or individual issuer developments. Adverse publicity and investor perceptions, whether or not based on rational analysis, may also affect the value and liquidity of lower grade securities. Yields on the Portfolio's portfolio securities can be expected to fluctuate over time. In addition, periods of economic uncertainty and changes in interest rates can be expected to result in increased volatility of the market prices of the lower grade securities in the Portfolio's portfolio and thus in the net asset value of the Portfolio. Net asset value and market value may be volatile due to the Portfolio's investment in lower grade and less liquid securities. Volatility may be greater during periods of general economic uncertainty. The Portfolio may incur additional expenses to the extent it is required to seek recovery upon a default in the payment of interest or a repayment of principal on its portfolio holdings, and the Portfolio may be unable to obtain full recovery thereof. In the event that an issuer of securities held by the Portfolio experiences difficulties in the timely payment of principal or interest and such issuer seeks to restructure the terms of its borrowings, the Portfolio may incur additional expenses and may determine to invest additional capital with respect to such issuer or the project or projects to which the Portfolio's portfolio securities relate. A Portfolio will rely on the Sub-Adviser's judgment, analysis and experience in evaluating the creditworthiness of an issue. In this evaluation, the Sub-Adviser will take into consideration, among other things, the issuer's financial resources, its sensitivity to economic conditions and trends, its operating history, the quality of the issuer's management and regulatory matters. The Sub-Adviser also may consider, although it does not rely primarily on, the credit ratings of S&P and Moody's in evaluating fixed-income securities. Such ratings evaluate only the safety of principal and interest payments, not market value risk. Additionally, because the creditworthiness of an issuer may change more rapidly than is able to be timely reflected in changes in credit ratings, the Sub-Adviser continuously monitors the issuers of such securities held in the Portfolio's portfolio. The Portfolio may, if deemed appropriate by the Sub-Adviser, retain a security whose rating has been downgraded below B by S&P or below B by Moody's, or whose rating has been withdrawn. With respect to Portfolios which may invest in these unrated income securities, achievement by the Portfolio of its investment objective may be more dependent upon the Sub-Adviser's investment analysis than would be the case if the Portfolio were investing exclusively in rated securities. STRATEGIC TRANSACTIONS As described in the Prospectus, certain Portfolios of the Trust may, but are not required to, utilize various other investment strategies as described below to hedge various market risks (such as interest rates, currency exchange rates and broad or specific market movements) or to manage the effective maturity or duration of a Portfolio's income securities. Such strategies are generally accepted by modern portfolio managers and are regularly utilized by many mutual funds and other institutional investors. Techniques and instruments may change over time as new instruments and strategies are developed or regulatory changes occur. In the course of pursuing these investment strategies, a Portfolio may purchase and sell exchange-listed and over-the-counter put and call options on securities, equity and income indices and other financial instruments, purchase and sell financial futures contracts and options thereon, enter into various interest rate transactions such as swaps, caps, floors or collars and enter into various currency transactions such as currency forward contracts, currency futures contracts, currency swaps or options on currencies or currency futures (collectively, all the above are called "Strategic Transactions" or "Derivatives"). Strategic Transactions are hedging transactions which may be used to attempt to protect against possible changes in the market value of securities held in or to be purchased for a Portfolio's portfolio resulting from securities markets or exchange rate fluctuations, to protect a Portfolio's unrealized gains in the value of its portfolio securities, to facilitate the sale of such securities for investment purposes, to manage the effective maturity or duration of a Portfolio's portfolio, or to establish a position in the derivatives markets as a temporary substitute for purchasing or selling particular securities. Any or all of these investment techniques may be used at any time and there is no particular strategy that dictates the use of one technique rather than another, as use of any Strategic Transaction is a function of numerous variables including market conditions. The ability of a Portfolio to utilize these Strategic Transactions successfully will depend on the Sub-Adviser's ability to predict pertinent market movements, which cannot be assured. A Portfolio will comply with applicable regulatory requirements when implementing these strategies, techniques and instruments. Strategic Transactions have risks associated with them including possible default by the other party to the transaction, illiquidity and, to the extent the Sub-Adviser's view as to certain market movements is incorrect, the risk that the use of such Strategic Transactions could result in losses greater than if they had not been used. Use of put and call options may result in losses to a Portfolio, force the sale or purchase of portfolio securities at inopportune times or for prices other than current market values, limit the amount of appreciation a Portfolio can realize on its investments or cause a Portfolio to hold a security it might otherwise sell. The use of currency transactions can result in a Portfolio incurring losses as a result of a number of factors including the imposition of exchange controls, suspension of settlements or the inability to deliver or receive a specified currency. The use of options and futures transactions entails certain other risks. In particular, the variable degree of correlation between price movements of futures contracts and price movements in the related portfolio position of a Portfolio creates the possibility that losses on the hedging instrument may be greater than gains in the value of a Portfolio's position. In addition, futures and options markets may not be liquid in all circumstances and certain over-the-counter options may have no markets. As a result, in certain markets, a Portfolio might not be able to close out a transaction without incurring substantial losses, if at all. Although the use of futures and options transactions for hedging should tend to minimize the risk of loss due to a decline in the value of the hedged position, at the same time they tend to limit any potential gain which might result from an increase in value of such position. Finally, the daily variation margin requirements for futures contracts would create a greater ongoing potential financial risk than would purchases of options, where the exposure is limited to the cost of the initial premium. Losses resulting from the use of Strategic Transactions would reduce net asset value, and possibly income, and such losses can be greater than if the Strategic Transactions had not been utilized. Income earned or deemed to be earned, if any, by a Portfolio from its Strategic Transactions will generally be taxable income of the Trust. See "Tax Status" in the Prospectus. GENERAL CHARACTERISTICS OF OPTIONS. Put options and call options typically have similar structural characteristics and operational mechanics regardless of the underlying instrument on which they are purchased or sold. Thus, the following general discussion relates to each of the particular types of options discussed in greater detail below. In addition, many Strategic Transactions involving options require segregation of Portfolio assets in special accounts, as described below under "Use of Segregated and Other Special Accounts." A put option gives the purchaser of the option, upon payment of a premium, the right to sell, and the writer the obligation to buy, the underlying security, commodity, index, currency or other instrument at the exercise price. For instance, a Portfolio's purchase of a put option on a security might be designed to protect its holdings in the underlying instrument (or, in some cases, a similar instrument) against a substantial decline in the market value by giving the Portfolio the right to sell such instrument at the option exercise price. A call option, upon payment of a premium, gives the purchaser of the option the right to buy, and the seller the obligation to sell, the underlying instrument at the exercise price. A Portfolio's purchase of a call option on a security, financial future, index, currency or other instrument might be intended to protect the Portfolio against an increase in the price of the underlying instrument that it intends to purchase in the future by fixing the price at which it may purchase such instrument. An American style put or call option may be exercised at any time during the option period while a European style put or call option may be exercised only upon expiration or during a fixed period prior thereto. As described in the Prospectus, certain Portfolios of the Trust are authorized to purchase and sell exchange listed options and over-the-counter options ("OTC options"). Exchange listed options are issued by a regulated intermediary such as the Options Clearing Corporation ("OCC"), which guarantees the performance of the obligations of the parties to such options. The discussion below uses the OCC as a paradigm, but is also applicable to other financial intermediaries. With certain exceptions, OCC issued and exchange listed options generally settle by physical delivery of the underlying security or currency, although in the future cash settlement may become available. Index options and Eurodollar instruments are cash settled for the net amount, if any, by which the option is "in-the-money" (i.e., where the value of the underlying instrument exceeds, in the case of a call option, or is less than, in the case of a put option, the exercise price of the option) at the time the option is exercised. Frequently, rather than taking or making delivery of the underlying instrument through the process of exercising the option, listed options are closed by entering into offsetting purchase or sale transactions that do not result in ownership of the new option. A Portfolio's ability to close out its position as a purchaser or seller of an OCC or exchange listed put or call option is dependent, in part, upon the liquidity of the option market. Among the possible reasons for the absence of a liquid option market on an exchange are: (i) insufficient trading interest in certain options; (ii) restrictions on transactions imposed by an exchange; (iii) trading halts, suspensions or other restrictions imposed with respect to particular classes or series of options or underlying securities including reaching daily price limits; (iv) interruption of the normal operations of the OCC or an exchange; (v) inadequacy of the facilities of an exchange or OCC to handle current trading volume; or (vi) a decision by one or more exchanges to discontinue the trading of options (or a particular class or series of options), in which event the relevant market for that option on that exchange would cease to exist, although outstanding options on that exchange would generally continue to be exercisable in accordance with their terms. The hours of trading for listed options may not coincide with the hours during which the underlying financial instruments are traded. To the extent that the option markets close before the markets for the underlying financial instruments, significant price and rate movements can take place in the underlying markets that cannot be reflected in the option markets. OTC options are purchased from or sold to securities dealers, financial institutions or other parties ("Counterparties") through direct bilateral agreement with the Counterparty. In contrast to exchange listed options, which generally have standardized terms and performance mechanics, all the terms of an OTC option, including such terms as method of settlement, term, exercise price, premium, guarantees and security, are set by negotiation of the parties. A Portfolio will only sell OTC options (other than OTC currency options) that are subject to a buy-back provision permitting the Portfolio to require the Counterparty to sell the option back to the Portfolio at a formula price within seven days. The Portfolios expect generally to enter into OTC options that have cash settlement provisions, although they are not required to do so. Unless the parties provide for it, there is no central clearing or guaranty function in an OTC option. As a result, if the Counterparty fails to make or take delivery of the security, currency or other instrument underlying an OTC option it has entered into with a Portfolio or fails to make a cash settlement payment due in accordance with the terms of that option, the Portfolio will lose any premium it paid for the option as well as any anticipated benefit of the transaction. Accordingly, the Sub-Adviser must assess the creditworthiness of each such Counterparty or any guarantor or credit enhancement of the Counterparty's credit to determine the likelihood that the terms of the OTC option will be satisfied. A Portfolio will engage in OTC option transactions only with United States government securities dealers recognized by the Federal Reserve Bank of New York as "primary dealers", or broker dealers, domestic or foreign banks or other financial institutions which have received (or the guarantors of the obligation of which have received) a short-term credit rating of "A-1" from Standard & Poor's Corporation or "P-1" from Moody's Investors Service, Inc. or an equivalent rating from any other nationally recognized statistical rating organization ("NRSRO"). If a Portfolio sells a call option, the premium that it receives may serve as a partial hedge, to the extent of the option premium, against a decrease in the value of the underlying securities or instruments in its portfolio or will increase a Portfolio's income. The sale of put options can also provide income. A Portfolio may purchase and sell call options on securities, including U.S. Treasury and agency securities, municipal obligations, mortgage-backed securities, corporate debt securities, equity securities (including convertible securities) and Eurodollar instruments that are traded on U.S. and foreign securities exchanges and in the over-the-counter markets and or securities indices, currencies and futures contracts. All calls sold by a Portfolio must be "covered" (i.e., the Portfolio must own the securities or futures contract subject to the call) or must meet the asset segregation requirements described below as long as the call is outstanding. Even though a Portfolio will receive the option premium to help protect it against loss, a call sold by a Portfolio exposes the Portfolio during the term of the option to possible loss of opportunity to realize appreciation in the market price of the underlying security or instrument and may require the Portfolio to hold a security or instrument which it might otherwise have sold. In selling calls on securities not owned by the Portfolio, the Portfolio may be required to acquire the underlying security at a disadvantageous price in order to satisfy its obligations with respect to the call. A Portfolio may purchase and sell put options on securities including U.S. Treasury and agency securities, mortgage-backed securities, municipal obligations, corporate debt securities, equity securities (including convertible securities) and Eurodollar instruments (whether or not it holds the above securities in its portfolio) and on securities indices, currencies and futures contracts other than futures on individual corporate debt and individual equity securities. A Portfolio will not sell put options if, as a result, more than 50% of the Portfolio's assets would be required to be segregated to cover its potential obligations under such put options other than those with respect to futures and options thereon. In selling put options, there is a risk that a Portfolio may be required to buy the underlying security at a disadvantageous price above the market price. General Characteristics of Futures. Certain Portfolios of the Trust may enter into financial futures contracts or purchase or sell put and call options on such futures as a hedge against anticipated interest rate, currency, equity or income market changes, for duration management and for risk management purposes. Futures are generally bought and sold on the commodities exchanges where they are listed with payment of initial and variation margin as described below. The purchase of a futures contract creates a firm obligation by a Portfolio, as purchaser, to take delivery from the seller of the specific type of financial instrument called for in the contract at a specific future time for a specified price (or, with respect to index futures and Eurodollar instruments, the net cash amount). The sale of a futures contract creates a firm obligation by the Portfolio, as seller, to deliver to the buyer the specific type of financial instrument called for in the contract at a specific future time for a specified price (or, with respect to index futures and Eurodollar instruments, the net cash amount). Options on futures contracts are similar to options on securities except that 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 and obligates the seller to deliver such option. The Portfolio's use of financial futures and options thereon will in all cases be consistent with applicable regulatory requirements and, in particular, with the rules and regulations of the Commodity Futures Trading Commission. Typically, maintaining a futures contract or selling an option thereon requires the Portfolio to deposit with a financial intermediary, as security for its obligations, an amount of cash or other specified assets (initial margin) which initially is typically 1% to 10% of the face amount of the contract (but may be higher in some circumstances). Additional cash or assets (variation margin) may be required to be deposited thereafter on a daily basis as the mark to market value of the contract fluctuates. The purchase of options on financial futures involves payment of a premium for the option without any further obligation on the part of the Portfolio. If the Portfolio exercises an option on a futures contract it will be obligated to post initial margin (and potential subsequent variation margin) for the resulting futures position just as it would for any position. Futures contracts and options thereon are generally settled by entering into an offsetting transaction but there can be no assurance that the position can be offset prior to settlement at an advantageous price nor that delivery will occur. A Portfolio will not enter into a futures contract or related option (except for closing transactions) for other than bona fide hedging purposes if, immediately thereafter, the sum of the amount of its initial margin and premiums on open futures contracts and options thereon would exceed 5% of the Portfolio's total assets (taken at current value); however, in the case of an option that is in-the-money at the time of the purchase, the in-the-money amount may be excluded in calculating the 5% limitation. The segregation requirements with respect to futures contracts and options thereon are described below. Options on Securities Indices and Other Financial Indices. A Portfolio also may purchase and sell call and put options on securities indices and other financial indices and in so doing can achieve many of the same objectives it would achieve through the sale or purchase of options on individual securities or other instruments. Options on securities indices and other financial indices are similar to options on a security or other instrument except that, rather than settling by physical delivery of the underlying instrument, they settle by cash settlement, i.e., an option on an index gives the holder the right to receive, upon exercise of the option, an amount of cash if the closing level of the index upon which the option is based exceeds, in the case of a call, or is less than, in the case of a put, the exercise price of the option (except if, in the case of an OTC option, physical delivery is specified). This amount of cash is equal to the excess of the closing price of the index over the exercise price of the option, which also may be multiplied by a formula value. The seller of the option is obligated, in return for the premium received, to make delivery of this amount. The gain or loss on an option on an index depends on price movements in the instruments making up the market, market segment, industry or other composite on which the underlying index is based, rather than price movements in individual securities, as is the case with respect to options on securities. Currency Transactions. Certain Portfolios of the Trust may engage in currency transactions with Counterparties in order to hedge the value of portfolio holdings denominated in particular currencies against fluctuations in relative value. Currency transactions include forward currency contracts, exchange listed currency futures, exchange listed and OTC options on currencies, and currency swaps. A forward currency contract involves a privately negotiated obligation to purchase or sell (with delivery generally required) 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. A currency swap is an agreement to exchange cash flows based on the notional difference among two or more currencies and operates similarly to an interest rate swap, which is described below. A Portfolio may enter into currency transactions with Counterparties which have received (or the guarantors of the obligations of such Counterparties have received) a credit rating of A-1 or P-1 by S&P or Moody's, respectively, or that have an equivalent rating from an NRSRO or (except for OTC currency options) are determined to be of equivalent credit quality by the Sub-Adviser. Dealings by the Portfolios in forward currency contracts and other currency transactions such as futures, options, options on futures and swaps will be limited to hedging involving either specific transactions or portfolio positions. Transaction hedging is entering into a currency transaction with respect to specific assets or liabilities of the Portfolio, which will generally arise in connection with the purchase or sale of its portfolio securities or the receipt of income therefrom. Position hedging is entering into a currency transaction with respect to portfolio security positions denominated or generally quoted in that currency. A Portfolio will not enter into a transaction to hedge currency exposure to an extent greater, after netting all transactions intended to wholly or partially offset other transactions, than the aggregate market value (at the time of entering into the transaction) of the securities held in its portfolio that are denominated or generally quoted in or currently convertible into such currency other than with respect to cross hedging and proxy hedging as described below. A Portfolio may cross-hedge currencies by entering into transactions to purchase or sell one or more currencies that are expected to decline in value relative to other currencies to which the Portfolio has or in which the Portfolio expects to have portfolio exposure. To reduce the effect of currency fluctuations on the value of existing or anticipated holdings of portfolio securities, a Portfolio may also engage in proxy hedging. Proxy hedging is often used when the currency to which the Portfolio's portfolio is exposed is difficult to hedge or to hedge against the dollar. Proxy hedging entails entering into a forward contract to sell a currency whose changes in value are generally considered to be linked to a currency or currencies in which some or all of the Portfolio's portfolio securities are or are expected to be denominated, and to buy U.S. dollars. For example, if the Sub-Adviser considers the Austrian schilling as being linked to the German deutschemark (the "D-mark") and the Trust holds securities denominated in schillings and the Sub-Adviser believes that the value of schillings will decline against the U.S. dollar, the Sub-Adviser may enter into a contract to sell D-marks and buy dollars. Currency hedging involves some of the same risks and considerations as other transactions with similar instruments. Currency transactions can result in losses to a Portfolio if the currency being hedged fluctuates in value to a degree or in a direction that is not anticipated. Further, there is the risk that the perceived linkage between various currencies may not be present or may not be present during the particular time that the Portfolio is engaging in proxy hedging. If a Portfolio enters into a currency hedging transaction, the Portfolio will comply with the asset segregation requirements described below. Risks of Currency Transactions. Currency transactions are subject to risks different from those of other portfolio transactions. Because currency control is of great importance to the issuing governments and influences economic planning and policy, purchases and sales of currency and related instruments can be negatively affected by government exchange controls, blockages, and manipulations or exchange restrictions imposed by governments. These can result in losses to a Portfolio if it is unable to deliver or receive currency or funds in settlement of obligations and could also cause hedges it has entered into to be rendered useless, resulting in full currency exposure as well as incurring transaction costs. Buyers and sellers of currency futures are subject to the same risks that apply to the use of futures generally. Further, settlement of a currency futures contract for the purchase of most currencies must occur at a bank based in the issuing nation. Trading options on currency futures is relatively new, and the ability to establish and close out positions on such options is subject to the maintenance of a liquid market which may not always be available. Currency exchange rates may fluctuate based on factors extrinsic to that country's economy. Combined Transactions. Certain Portfolios of the Trust may enter into multiple transactions, including multiple options transactions, multiple futures transactions, multiple currency transactions (including forward currency contracts), multiple interest rate transactions and any combination of futures, options, currency and interest rate transactions ("component" transactions), instead of a single Strategic Transaction, as part of a single or combined strategy when, in the opinion of the Sub-Adviser, it is in the best interest of the Portfolio to do so. A combined transaction will usually contain elements of risk that are present in each of its component transactions. Although combined transactions are normally entered into based on the Sub-Adviser's judgment that the combined strategies will reduce risk or otherwise more effectively achieve the desired portfolio management goal, it is possible that the combination will instead increase such risks or hinder achievement of the portfolio management objective. SWAPS, CAPS, FLOORS AND COLLARS. Among the Strategic Transactions into which certain Portfolios may enter are interest rate, currency and index swaps and the purchase or sale of related caps, floors and collars. The Portfolios expect to enter into these transactions primarily to preserve a return or spread on a particular investment or portion of their portfolios, to protect against currency fluctuations, as a duration management technique or to protect against any increase in the price of securities the Portfolio anticipates purchasing at a later date. The Portfolios intend to use these transactions as hedges and not as speculative investments and will not sell interest rate caps or floors where they do not own securities or other instruments providing the income stream the Portfolios may be obligated to pay. Interest rate swaps involve the exchange by the Portfolio with another party of their respective commitments to pay or receive interest, e.g., an exchange of floating rate payments for fixed rate payments with respect to a notional amount of principal. A currency swap is an agreement to exchange cashflows on a notional amount of two or more currencies based on the relative value differential among them. 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. A Portfolio will usually enter into swaps on a net basis, i.e., the two payment streams are netted out in a cash settlement on the payment date or dates specified in the instrument, with the Portfolio receiving or paying, as the case may be, only the net amount of the two payments. Inasmuch as these swaps, caps, floors and collars are entered into for good faith hedging purposes, the Sub-Adviser and the Portfolio believe such obligations do not constitute senior securities under the 1940 Act and, accordingly, will not treat them as being subject to its borrowing restrictions. A Portfolio will not enter into any swap, cap, floor or collar transaction unless, at the time of entering into such transaction, the unsecured long-term debt of the Counterparty, combined with any credit enhancements, is rated at least "A" by S&P or Moody's or has an equivalent equity rating from an NRSRO or is determined to be of equivalent credit quality by the Sub-Adviser. If there is a default by the Counterparty, the Portfolio may have contractual remedies pursuant to the agreements related to the transaction. The swap market has grown substantially in recent years with a large number of banks and investment banking firms acting both as principals and agents utilizing standardized swap documentation. As a result, the swap market has become relatively liquid. Caps, floors and collars are more recent innovations for which standardized documentation has not yet been fully developed and, accordingly, they are less liquid than swaps. EURODOLLAR INSTRUMENTS. Certain Portfolios of the Trust may make investments in Eurodollar instruments. Eurodollar instruments are U.S. dollar-denominated futures contracts or options thereon which are linked to the London Interbank Offered Rate ("LIBOR"), although foreign currency-denominated instruments are available from time to time. Eurodollar futures contracts enable purchasers to obtain a fixed rate for the lending of funds and sellers to obtain a fixed rate for borrowings. A Portfolio might use Eurodollar futures contracts and options thereon to hedge against changes in LIBOR, to which many interest rate swaps and income instruments are linked.
RISKS OF STRATEGIC TRANSACTIONS OUTSIDE THE UNITED STATES. When conducted
outside the United States, Strategic Transactions may not be regulated as
rigorously as in the United States, may not involve a clearing mechanism and
related guarantee, and are subject to the risk of governmental actions affecting
trading in, or the prices of, foreign securities, currencies and other
instruments. The value of such positions also could be adversely affected by:
USE OF SEGREGATED AND OTHER SPECIAL ACCOUNTS. Many Strategic Transactions, in addition to other requirements, require that the Portfolio segregate liquid high-grade assets with its custodian to the extent Portfolio obligations are not otherwise "covered" through ownership of the underlying security, financial instrument or currency. In general, either the full amount of any obligation by the Portfolio to pay or deliver securities or assets must be covered at all times by the securities, instruments or currency required to be delivered, or, subject to any regulatory restrictions, an amount of cash or liquid high-grade debt securities at least equal to the current amount of the obligation must be segregated with the custodian. The segregated assets cannot be sold or transferred unless equivalent assets are substituted in their place or it is no longer necessary to segregate them. For example, a call option written by a Portfolio will require the Portfolio to hold the securities subject to the call (or securities convertible into the needed securities without additional consideration) or to segregate liquid high-grade debt securities sufficient to purchase and deliver the securities if the call is exercised. A call option sold by a Portfolio on an index will require the Portfolio to own portfolio securities which correlate with the index or to segregate liquid high-grade assets equal to the excess of the index value over the exercise price on a current basis. A put option written by a Portfolio requires the Portfolio to segregate liquid, high-grade assets equal to the exercise price. Except when a Portfolio enters into a forward contract for the purchase or sale of a security denominated in a particular currency, which requires no segregation, a currency contract which obligates the Portfolio to buy or sell currency will generally require the Portfolio to hold an amount of that currency or liquid securities denominated in that currency equal to the Portfolio's obligations or to segregate liquid high-grade assets equal to the amount of the Portfolio's obligation. OTC options entered into by a Portfolio, including those on securities, currencies, financial instruments or indices and OCC issued and exchange listed index options, will generally provide for cash settlement. As a result, when a Portfolio sells these instruments it will only segregate an amount of assets equal to its accrued net obligations, as there is no requirement for payment or delivery of amounts in excess of the net amount. These amounts will equal 100% of the exercise price in the case of a non cash-settled put, the same as an OCC guaranteed listed option sold by the Portfolio, or the in-the-money amount plus any sell-back formula amount in the case of a cash-settled put or call. In addition, when the Portfolio sells a call option on an index at a time when the in-the-money amount exceeds the exercise price, the Portfolio will segregate, until the option expires or is closed out, cash or cash equivalents equal in value to such excess. OCC issued and exchange listed options sold by the Portfolio other than those above generally settle with physical delivery or with an election of either physical delivery or cash settlement, and the Portfolio will segregate an amount of assets equal to the full value of the option. OTC options settling with physical delivery, or with an election of either physical delivery or cash settlement, will be treated the same as other options settling with physical delivery. In the case of a futures contract or an option thereon, the Portfolio must deposit initial margin and possible daily variation margin in addition to segregating assets sufficient to meet its obligation to purchase or provide securities or currencies, or to pay the amount owed at the expiration of an index-based futures contract. Such assets may consist of cash, cash equivalents, liquid debt securities or other acceptable assets. With respect to swaps, a Portfolio will accrue the net amount of the excess, if any, of its obligations over its entitlements with respect to each swap on a daily basis and will segregate an amount of cash or liquid high-grade securities having a value equal to the accrued excess. Caps, floors and collars require segregation of assets with a value equal to a Portfolio's net obligation, if any. Strategic Transactions may be covered by other means when consistent with applicable regulatory policies. A Portfolio may also enter into offsetting transactions so that its combined position, coupled with any segregated assets, equals its net outstanding obligation in related options and Strategic Transactions. For example, a Portfolio 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 Portfolio. Moreover, instead of segregating assets if the Portfolio held a futures or forward contract, it could purchase a put option on the same futures or forward contract with a strike price as high or higher than the price of the contract held. Other Strategic Transactions may also be offset in combinations. If the offsetting transaction terminates at the time of or after the primary transaction, no segregation is required. However, if it terminates prior to such time, assets equal to any remaining obligation would need to be segregated. The Trust's activities involving Strategic Transactions may be limited by the requirements of Subchapter M of the Internal Revenue Code for qualification as a regulated investment company. See "Tax Status" in the Prospectus. INVESTMENT LIMITATIONS The Trust has adopted the following restrictions and policies relating to the investment of assets of the Portfolios and their activities. These are fundamental policies and may not be changed without the approval of the holders of a majority of the outstanding voting shares of each Portfolio affected (which for this purpose and under the Investment Company Act of 1940 means the lesser of (i) 67% of the shares represented at a meeting at which more than 50% of the outstanding shares are present or represented by proxy and (ii) more than 50% of the outstanding shares). A change in policy affecting only one Portfolio may be effected with the approval of a majority of the outstanding shares of such Portfolio. Where an investment restriction or policy restricts it to a specified percentage of its total assets in any type of instrument, that percentage is measured at the time of purchase. Except as noted hereunder, there will be no violation of any investment policy or restriction 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, in the securities rating of the investment or any other change. QUALITY BOND PORTFOLIO The Quality Bond Portfolio of the Trust may not: 1. Borrow money, except from banks for extraordinary or emergency purposes and then only in amounts up to 30% of the value of the Portfolio's total assets, taken at cost at the time of such borrowing and except in connection with reverse repurchase agreements permitted by Investment Restriction No. 8. Mortgage, pledge, or hypothecate any assets except in connection with any such borrowing in amounts up to 30% of the value of the Portfolio's net assets at the time of such borrowing. The Portfolio will not purchase securities while borrowings (including reverse repurchase agreements) exceed 5% of the Portfolio's total assets. This borrowing provision facilitates the orderly sale of portfolio securities, for example, in the event of abnormally heavy redemption requests. This provision is not for investment purposes. Collateral arrangements for premium and margin payments in connection with the Portfolio's's hedging activities are not deemed to be a pledge of assets; 2. Purchase the securities or other obligations of any one issuer if, immediately after such purchase, more than 5% of the value of the Portfolio's total assets would be invested in securities or other obligations of any one such issuer. This limitation shall not apply to securities issued or guaranteed by the U.S. Government, its agencies or instrumentalities or to permitted investments of up to 25% of the Portfolio's total assets; 3. Purchase the securities of an issuer if, immediately after such purchase, the Portfolio owns more than 10% of the outstanding voting securities of such issuer. This limitation shall not apply to permitted investments of up to 25% of the Portfolio's total assets; 4. Purchase securities or other obligations of issuers conducting their principal business activity in the same industry if, immediately after such purchase the value of its investments in such industry would exceed 25% of the value of the Portfolio's total assets. For purposes of industry concentration, there is no percentage limitation with respect to investments in U.S. Government securities; 5. Make loans, except through the purchase or holding of debt obligations (including privately placed securities) or the entering into of repurchase agreements, or loans of portfolio securities in accordance with the Portfolio's investment objective and policies; 6. Purchase or sell puts, calls, straddles, spreads, or any combination thereof, real estate, commodities, commodity contracts, except for the Portfolio's interest in hedging activities as described under "Investment Objectives and Policies"; or interests in oil, gas, or mineral exploration or development programs. However, the Portfolio may purchase debt obligations secured by interests in real estate or issued by companies which invest in real estate or interests therein including real estate investment trusts; 7. Purchase securities on margin, make short sales of securities, or maintain a short position in securities, except in the course of the Portfolio's hedging activities, unless at all times when a short position is open the Portfolio owns an equal amount of such securities, provided that this restriction shall not be deemed to be applicable to the purchase or sale of when-issued securities or delayed delivery securities; 8. Issue any senior security, except as appropriate to evidence indebtedness which constitutes a senior security and which the Portfolio is permitted to incur pursuant to Investment Restriction No. 1 and except that the Portfolio may enter into reverse repurchase agreements, provided that the aggregate of senior securities, including reverse repurchase agreement, shall not exceed one-third of the market value of the Portfolio's total assets, less liabilities other than obligations created by reverse repurchase agreements. The Portfolio's arrangements in connection with its hedging activities as described in "Investment Objectives and Policies" shall not be considered senior securities for purposes hereof; 9. Acquire securities of other investment companies, except as permitted by the 1940 Act; or 10. Act as an underwriter of securities. SELECT EQUITY, LARGE CAP STOCK AND SMALL CAP STOCK PORTFOLIOS Each of the Select Equity, Large Cap Stock and Small Cap Stock Portfolios may not: 1. Purchase the securities or other obligations of issuers conducting their principal business activity in the same industry if, immediately after such purchase the value of its investments in such industry would exceed 25% of the value of the Portfolio's total assets. For purposes of industry concentration, there is no percentage limitation with respect to investments in U.S. Government securities; 2. Borrow money, except from banks for extraordinary or emergency purposes and then only in amounts not to exceed 10% of the value of the Portfolio's total assets, taken at cost, at the time of such borrowing. Mortgage, pledge, or hypothecate any assets except in connection with any such borrowing and in amounts not to exceed 10% of the value of the Portfolio's net assets at the time of such borrowing. The Portfolio will not purchase securities while borrowings exceed 5% of the Portfolio's total assets. This borrowing provision is included to facilitate the orderly sale of portfolio securities, for example, in the event of abnormally heavy redemption requests, and is not for investment purposes. Collateral arrangements for premium and margin payments in connection with the Portfolio's hedging activities are not deemed to be a pledge of assets; 3. Purchase the securities or other obligations of any one issuer if, immediately after such purchase, more than 5% of the value of the Portfolio's total assets would be invested in securities or other obligations of any one such issuer. This limitation shall not apply to issues of the U.S. Government, its agencies or instrumentalities and to permitted investments of up to 25% of the Portfolio's total assets; 4. Purchase the securities of an issuer if, immediately after such purchase, the Portfolio owns more than 10% of the outstanding voting securities of such issuer; 5. Make loans, except through the purchase or holding of debt obligations (including privately placed securities), or the entering into of repurchase agreements, or loans of portfolio securities in accordance with the Portfolio's investment objective and policies (see "Investment Objectives and Policies"); 6. Purchase or sell puts, calls, straddles, spreads, or any combination thereof, real estate, commodities, or commodity contracts, except for the Portfolio's interest in hedging activities as described under "Investment Objectives and Policies"; or interests in oil, gas, or mineral exploration or development programs. However, the Portfolio may purchase securities or commercial paper issued by companies which invest in real estate or interests therein, including real estate investment trusts; 7. Purchase securities on margin, make short sales of securities, or maintain a short position, except in the course of the Portfolio's hedging activities, provided that this restriction shall not be deemed to be applicable to the purchase or sale of when-issued securities or delayed delivery securities; 8. Acquire securities of other investment companies, except as permitted by the 1940 Act; 9. Act as an underwriter of securities; 10. Issue any senior security, except as appropriate to evidence indebtedness which the Portfolio is permitted to incur pursuant to Investment Restriction No. 2. The Portfolio's arrangements in connection with its hedging activities as described in "Investment Objectives and Policies" shall not be considered senior securities for purposes hereof; or 11. Purchase any equity security if, as a result, the Portfolio would then have more than 5% of its total assets invested in securities of companies (including predecessors) that have been in continuous operation for fewer than three years. INTERNATIONAL EQUITY PORTFOLIO The International Equity Portfolio may not: 1. Borrow money, except from banks for extraordinary or emergency purposes and then only in amounts up to 30% of the value of the Portfolio's net assets at the time of borrowing, and except in connection with reverse repurchase agreements and then only in amounts up to 33 1/3% of the value of the Portfolio's net assets; or purchase securities while borrowings, including reverse repurchase agreements, exceed 5% of the Portfolio's total assets. The Portfolio will not mortgage, pledge, or hypothecate any assets except in connection with any such borrowing and in amounts not to exceed 30% of the value of the Portfolio's net assets at the time of such borrowing; 2. Purchase the securities or other obligations of any one issuer if, immediately after such purchase, more than 5% of the value of the Portfolio's total assets would be invested in securities or other obligations of any one such issuer. This limitation shall not apply to securities issued or guaranteed by the U.S. Government, its agencies or instrumentalities or to permitted investments of up to 25% of the Portfolio's total assets; 3. Purchase the securities of an issuer if, immediately after such purchase, the Portfolio owns more than 10% of the outstanding voting securities of such issuer. This limitation shall not apply to permitted investments of up to 25% of the Portfolio's total assets; 4. Purchase the securities or other obligations of issuers conducting their principal business activity in the same industry if, immediately after such purchase, the value of its investments in such industry would exceed 25% of the value of the Portfolio's total assets. For purposes of industry concentration, there is no percentage limitation with respect to investments in U.S. Government securities; 5. Make loans, except through the purchase or holding of debt obligations (including restricted securities), or the entering into of repurchase agreements, or loans of portfolio securities in accordance with the Portfolio's investment objective and policies, see "Investment Practices" in the Prospectus and "Investment Objectives and Policies" in this Statement of Additional Information; 6. Purchase or sell puts, calls, straddles, spreads, or any combination thereof, real property, including limited partnership interests, commodities, or commodity contracts, except for the Portfolio's interests in hedging and foreign exchange activities as described under "Investment Practices" in the Prospectus; or interests in oil, gas, mineral or other exploration or development programs or leases. However, the Portfolio may purchase securities or commercial paper issued by companies that invest in real estate or interests therein including real estate investment trusts; 7. Purchase securities on margin, make short sales of securities, or maintain a short position in securities, except to obtain such short-term credit as necessary for the clearance of purchases and sales of securities, provided that this restriction shall not be deemed to apply to the purchase or sale of when-issued securities or delayed delivery securities; 8. Acquire securities of other investment companies, except as permitted by the 1940 Act; 9. Act as an underwriter of securities, except insofar as the Portfolio may be deemed to be an underwriter under the 1933 Act by virtue of disposing of portfolio securities; or 10. Issue any senior security, except as appropriate to evidence indebtedness which the Portfolio is permitted to incur pursuant to Investment Restriction No. 1. The Portfolio's arrangements in connection with its hedging activities as described in "Investment Practices" in the Prospectus shall not be considered senior securities for purposes hereof. EMERGING MARKETS EQUITY PORTFOLIO The Emerging Markets Equity Portfolio may not: 1. Purchase any security if, as a result, more than 25% of the value of the Portfolio's total assets would be invested in securities of issuers having their principal business activities in the same industry. This limitation shall not apply to obligations issued or guaranteed by the U.S. Government, its agencies or instrumentalities; 2. Borrow money, except that the Portfolio may (i) borrow money from banks for temporary or emergency purposes (not for leveraging purposes) and (ii) enter into reverse repurchase agreements for any purpose; provided that (i) and (ii) in total do not exceed 33 1/3% of the value of the Portfolio's total assets (including the amount borrowed)less liabilities (other than borrowings). If at any time any borrowings come to exceed 33 1/3% of the value of the Portfolio's total assets, the Portfolio will reduce its borrowings within three business days to the extent necessary to comply with the 33 1/3% limitation; 3. With respect to 75% of its total assets, purchase any security if, as a result, (a) more than 5% of the value of the Portfolio's total assets would be invested in securities or other obligations of any one issuer; or (b) the Portfolio would hold more than 10% of the outstanding voting securities of that issuer. This limitation shall not apply to Government securities (as defined in the 1940 Act); 4. Make loans to other persons, except through the purchase of debt obligations, loans of portfolio securities, and participation in repurchase agreements; 5. Purchase or sell physical commodities or contracts thereon, unless acquired as a result of the ownership of securities or instruments, but the Portfolio may purchase or sell futures contracts or options (including options on futures contracts, but excluding options or futures contracts on physical commodities) and may enter into foreign currency forward contracts; 6. Purchase or sell real estate, but the Portfolio may purchase or sell securities that are secured by real estate or issued by companies (including real estate investment trusts) that invest or deal in real estate; 7. Underwrite securities of other issuers, except to the extent the Portfolio, in disposing of portfolio securities, may be deemed an underwriter within the meaning of the 1933 Act; and 8. Issue senior securities, except as permitted under the 1940 Act or any rule, order or interpretation thereunder. BOND DEBENTURE PORTFOLIO The Bond Debenture Portfolio of the Trust may not: 1. Sell short or buy on margin, although it may obtain short-term credit as needed to clear purchases of securities; 2. Buy or sell put or call options, although it may buy, hold or sell warrants acquired with debt securities; 3. Borrow in excess of 5% of the Portfolio's gross assets taken at cost or market value whichever is lower at the time of borrowing, and then only as a temporary measure for extraordinary or emergency purposes; 4. Act as an underwriter of securities issued by others, except where it may be deemed to be an underwriter by selling a portfolio security requiring registration under the Securities Act of 1933; 5. Invest knowingly more than 15% of its gross assets in illiquid securities; 6. Make loans, except for (a) time or demand deposits with banks, (b) purchasing commercial paper or publicly-offered debt securities at original issue or otherwise, (c) short-term repurchase agreements with sellers of securities the Portfolio has bought and (d) loans of portfolio securities to registered broker-dealers if 100% secured by cash or cash equivalents, made in full compliance with applicable regulations and which, in management's opinion, do not expose the Portfolio to significant risks or impair its qualification for pass-through tax treatment under the Internal Revenue Code; 7. Pledge, mortgage, or hypothecate its assets; 8. Buy or sell real estate (including limited partnership interests but excluding securities of companies, such as real estate investment trusts, which deal in real estate or interests therein) or oil, gas or other mineral leases, or commodities, or commodity contracts although it may buy securities of companies that deal in such interests (however, the Portfolio may hold and sell any of the aforementioned or any other property acquired through ownership of other securities, although the Portfolio may not purchase securities for the purpose of acquiring those interests); 9. Buy securities issued by any other open-end investment company (except pursuant to a plan of merger, consolidation or acquisition of assets), although it may invest up to 5% of its gross assets, taken at market value at the time of investment, in closed-end investment companies, provided such purchase is made in the open market and does not involve the payment of a fee or commission greater than the customary broker's commission; 10. Invest more than 5% of its gross assets, taken at market value at the time of investment in securities of companies with less than three years' continuous operation, including predecessor companies; 11. With respect to 75% of its gross assets, buy the securities of any issuer if the purchase causes it (a) to have more than 5% of its gross assets invested in the securities of such issuer (except obligations of the United States, its agencies or instrumentalities) or (b) to own more than 10% of the outstanding voting securities of such issuer; 12. Hold securities of any issuer, any of whose officers, directors or security holders is an officer, director or partner of the Adviser or Sub-Adviser or an officer or director of the Portfolio, if after the purchase of the securities of such issuer, one or more of such persons owns beneficially more than 1/2 of 1% of the securities of such issuer and such persons together own beneficially more than 5% of such securities; 13. Concentrate its investments in a particular industry, though, if it is deemed appropriate to its investment objective, up to 25% of the market value of its gross assets at the time of investment may be invested in any one industry classification used for investment purposes; 14. Buy from or sell to any of the Trust's directors, employees, or the Investment Adviser or Sub-Adviser or any of its officers, directors, partners or employees, any securities other than shares of the Portfolio's common stock; or 15. Invest more than 10% of the market value of its gross assets at the time of investment in debt securities which are in default as to interest or principal. With respect to investment restriction 5. above, securities subject to legal or contractual restrictions on resale, which are determined by the Board of Trustees, or by the Sub-Adviser pursuant to delegated authority, to be liquid are considered liquid securities. GROWTH & INCOME EQUITY, BALANCED AND EQUITY INCOME PORTFOLIOS The Growth & Income Equity, Balanced and Equity Income Portfolios of the Trust may not: 1. Purchase securities of any one issuer (other than obligations issued or guaranteed by the U.S. Government, its agencies or instrumentalities), if, immediately after and as a result of such investments, more than 5% of the Portfolio's total assets would be invested in the securities of such issuer, or more than 10% of the issuer's outstanding voting securities would be owned by the Portfolio or the Trust, except that up to 25% of the Portfolio's total assets may be invested without regard to such limitations. 2. Purchase any securities which would cause 25% or more of the Portfolio's total assets at the time of purchase to be invested in the securities of one or more issuers conducting their principal business activities in the same industry, provided that, however, (a) with respect to each Portfolio, (i) there is no limitation with respect to obligations issued or guaranteed by the U.S. Government, its agencies or instrumentalities, and repurchase agreements secured by obligations of the U.S. Government or its agencies or instrumentalities, and with respect to the Equity Income Portfolio only, securities issued by domestic banks, thrifts or savings institutions; (ii) wholly-owned finance companies will be considered to be in the industries of their parents if their activities are primarily related to financing the activities of their parents; and (iii) utilities will be divided according to their services (for example, gas, gas transmission, electric and gas, electric, and telephone will each be considered a separate industry). 3. Borrow money or issue senior securities, except that the Portfolio may borrow from banks and enter into reverse repurchase agreements for temporary defensive purposes in amounts not in excess of 10% of the Portfolio's total assets at the time of such borrowing; or mortgage, pledge, or hypothecate any assets, except in connection with any such borrowing and in amounts not in excess of the lesser of the dollar amounts borrowed or 10% of the Portfolio's total assets at the time of such borrowing; or purchase securities while its borrowings exceed 5% of its total assets. A Portfolio's transactions in futures and related options (including the margin posted by a Portfolio in connection with such transactions), and securities held in escrow or separate accounts in connection with a Portfolio's investment practices described in this Statement of Additional Information are not subject to this limitation. 4. Make loans, except that each Portfolio may purchase or hold debt instruments, lend portfolio securities, enter into repurchase agreements and make other investments in accordance with its investment objective and policies. 5. Purchase securities on margin, make short sales of securities or maintain a short position, except that (a) this investment limitation shall not apply to a Portfolio's transactions in options, and futures contracts and related options, and (b) a Portfolio may obtain short-term credits as may be necessary for the clearance of purchases and sales of portfolio securities. 6. Make investments for the purpose of exercising control or management. 7. Purchase or sell real estate, provided that each Portfolio may invest in securities secured by real estate or interests therein or issued by companies or investment trusts which invest in real estate or interests therein. 8. Act as an underwriter of securities within the meaning of the Securities Act of 1933 except insofar as a Portfolio might be deemed to be an underwriter upon disposition of portfolio securities acquired within the limitation on purchases of restricted securities and except to the extent that the purchase of obligations directly from the issuer thereof in accordance with a Portfolio's investment objective, policies and limitations may be deemed to be underwriting. 9. Purchase or sell commodity contracts, or invest in oil, gas or mineral exploration or development programs, except that each of the Balanced Portfolio and the Equity Income Portfolio may, to the extent appropriate to its investment objective, purchase publicly traded securities of companies engaging in whole or in part in such activities and may invest in futures contracts and related options in accordance with their respective investment activities and policies. 10. Act as an underwriter of securities within the meaning of the Securities Act of 1933 except insofar as a Portfolio might be deemed to be an underwriter upon disposition of portfolio securities acquired within the limitation on purchases of restricted securities and except to the extent that the purchase of obligations directly from the issuer thereof in accordance with a Portfolio's investment objective, policies and limitations may be deemed to be underwriting. LORD ABBETT GROWTH AND INCOME PORTFOLIO The Lord Abbett Growth and Income Portfolio may not: 1. sell short securities or buy securities or evidences of interests therein on margin, although it may obtain short-term credit necessary for the clearance of purchases of securities; 2. buy or sell put or call options, although it may buy, hold or sell rights or warrants, write covered call options and enter into closing purchase transactions as discussed below; 3. borrow money which is in excess of one-third of the value of its total assets taken at market value (including the amount borrowed) and then only from banks as a temporary measure for extraordinary or emergency purposes (borrowings beyond 5% of such total assets may not be used for investment leverage to purchase securities but solely to meet redemption requests where the liquidation of the Portfolio's investment is deemed to be inconvenient or disadvantageous); 4. lend money or securities to any person except that it may enter into short-term repurchase agreements with sellers of securities it has purchased, and it may lend its portfolio securities to registered broker-dealers where the loan is 100% secured by cash or its equivalent as long as it complies with regulatory requirements and the Portfolio deems such loans not to expose the Portfolio to significant risk (investment in repurchase agreements exceeding 7 days and in other illiquid investments is limited to a maximum of 5% of a Portfolio's assets); 5. pledge, mortgage or hypothecate its assets; however, this provision does not apply to permitted borrowing mentioned above or to the grant of escrow receipts or the entry into other similar escrow arrangements arising out of the writing of covered call options; 6. buy or sell real estate including limited partnership interests therein (except securities of companies, such as real estate investment trusts, that deal in real estate or interests therein), or oil, gas or other mineral leases, commodities or commodity contracts in the ordinary course of its business, except such interests and other property acquired as a result of owning other securities, though securities will not be purchased in order to acquire any of these interests; 7. invest more than 5% of its gross assets, taken at market value at the time of investment, in companies (including their predecessors) with less than three years' continuous operation; 8. buy securities if the purchase would then cause a Portfolio to have more than (i) 5% of its gross assets, at market value at the time of purchase, invested in securities of any one issuer, except securities issued or guaranteed by the U.S. Government, its agencies or instrumentalities, or (ii) 25% of its gross assets, at market value at the time of purchase, invested in securities issued or guaranteed by a foreign government, its agencies or instrumentalities; 9. buy voting securities if the purchase would then cause a Portfolio to own more than 10% of the outstanding voting stock of any one issuer; 10. own securities in a company when any of its officers, directors or security holders is an officer or Trustee of the Trust or an officer, director or partner of the investment adviser or sub-adviser, if after the purchase any of such persons owns beneficially more than 1/2 of 1% of such securities and such persons together own more than 5% of such securities; 11. concentrate its investments in any particular industry, but if deemed appropriate for attainment of its investment objective, up to 25% of its gross assets (at market value at the time of investment) may be invested in any one industry classification used for investment purposes; or 12. buy securities from or sell them to the Trust's officers, directors, or employees, or to the investment adviser or sub-adviser or to their partners, directors and employees. LARGE CAP RESEARCH, DEVELOPING GROWTH AND MID-CAP VALUE PORTFOLIOS The Large Cap Research, Developing Growth and Mid-Cap Value Portfolios may not: 1. borrow money, except that (i) the Portfolio may borrow from banks (as defined in the Investment Company Act of 1940, as amended (the "1940 Act")) in amounts up to 33 1/3% of its total assets (including the amount borrowed), (ii) the Portfolio may borrow up to an additional 5% of its total assets for temporary purposes, (iii) the Portfolio may obtain such short-term credit as may be necessary for the clearance of purchases and sales of portfolio securities and (iv) the Portfolio may purchase securities on margin to the extent permitted by applicable law; 2. pledge its assets (other than to secure borrowings, or to the extent permitted by the Portfolio's investment policies as permitted by applicable law); 3. engage in the underwriting of securities, except pursuant to a merger or acquisition or to the extent that, in connection with the disposition of its portfolio securities, it may be deemed to be an underwriter under federal securities laws; 4. make loans to other persons, except that the acquisition of bonds, debentures or other corporate debt securities and investment in government obligations, commercial paper, pass-through instruments, certificates of deposit, bankers acceptances, repurchase agreements or any similar instruments shall not be subject to this limitation, and except further that the Portfolio may lend its portfolio securities, provided that the lending of portfolio securities may be made only in accordance with applicable law; 5. buy or sell real estate (except that the Portfolio may invest in securities directly or indirectly secured by real estate or interests therein or issued by companies which invest in real estate or interests therein) or commodities or commodity contracts (except to the extent the Portfolio may do so in accordance with applicable law and without registering as a commodity pool operator under the Commodity Exchange Act, as, for example, with futures contracts); 6. with respect to 75% of the gross assets of the Portfolio, buy securities of one issuer representing more than (i) 5% of the Portfolio's gross assets, except securities issued or guaranteed by the U.S. Government, its agencies or instrumentalities or (ii) 10% of the voting securities of such issuer; 7. invest more than 25% of its assets, taken at market value, in the securities of issuers in any particular industry (excluding securities of the U.S. Government, its agencies and instrumentalities); or 8. issue senior securities to the extent such issuance would violate applicable laws. RIGGS STOCK, RIGGS SMALL COMPANY STOCK AND RIGGS U.S. GOVERNMENT SECURITIES PORTFOLIOS 1. The Portfolios will not issue senior securities except that a Portfolio may borrow money directly or through reverse repurchase agreements in amounts up to one-third of the value of its total assets, including the amount borrowed; and except to the extent that a Portfolio may enter into futures contracts. The Portfolios will not borrow money or engage in reverse repurchase agreements for investment leverage, but rather as a temporary, extraordinary, or emergency measure or to facilitate management of the Portfolio by enabling a Portfolio to meet redemption requests when the liquidation of portfolio securities is deemed to be inconvenient or disadvantageous. A Portfolio will not purchase any securities while any borrowings in excess of 5% of its total assets are outstanding. During the period any reverse repurchase agreements are outstanding, a Portfolio will restrict the purchase of portfolio securities to money market instruments maturing on or before the expiration date of the reverse repurchase agreements, but only to the extent necessary to assure completion of the reverse repurchase agreements. 2. The Portfolios will not sell any securities short or purchase any securities on margin, but may obtain such short-term credits as are necessary for clearance of purchases and sales of securities. The deposit or payment by a Portfolio of initial or variation margin in connection with futures contracts or related options transactions is not considered the purchase of a security on margin. 3. The Portfolios will not mortgage, pledge, or hypothecate any assets, except to secure permitted borrowings. In these cases the Portfolios may pledge assets having a value of 15% of assets taken at cost. For purposes of this restriction, (a) the deposit of assets in escrow in connection with the writing of covered put or call options and the purchase of securities on a when-issued basis; and (b) collateral arrangements with respect to (i) the purchase and sale of stock options and (ii) initial or variation margin for futures contracts will not be deemed to be pledges of a Portfolio's assets. Margin deposits for the purchase and sale of futures contracts and related options are not deemed to be a pledge. 4. The Portfolios will not lend any of their respective assets except portfolio securities up to one-third of the value of total assets. This shall not prevent a Portfolio from purchasing or holding U.S. government obligations, money market instruments, variable amount demand master notes, bonds, debentures, notes, certificates of indebtedness, or other debt securities, entering into repurchase agreements, or engaging in other transactions where permitted by a Portfolio's investment objective, policies, and limitations or the Trust's Declaration of Trust. 5. The Portfolios will not invest more than 10% of their respective net assets in securities subject to restrictions on resale under the Securities Act of 1933, except for commercial paper issued under Section 4(2) of the Securities Act of 1933 and certain other restricted securities which meet the criteria for liquidity as established by the Board of Trustees. 6. The Portfolios will not invest in commodities, except to the extent that they may engage in transactions involving futures contracts or options on futures contracts. 7. The Portfolios will not purchase or sell real estate, including limited partnership interests, although they may invest in securities of issuers whose business involves the purchase or sale of real estate or in securities which are secured by real estate or interests in real estate. 8. With respect to 75% of the value of its respective total assets, each Portfolio will not purchase securities issued by any one issuer (other than cash, cash items or securities issued or guaranteed by the government of the United States or its agencies or instrumentalities and repurchase agreements collateralized by such securities), if as a result more than 5% of the value of its total assets would be invested in the securities of that issuer. No Portfolio will acquire more than 10% of the outstanding voting securities of any one issuer. 9. A Portfolio will not invest 25% or more of the value of its respective total assets in any one industry (other than securities issued by the U.S. government, its agencies, or instrumentalities or repurchase agreements collateralized by these securities). 10. A Portfolio will not underwrite any issue of securities, except as a Portfolio may be deemed to be an underwriter under the Securities Act of 1933 in connection with the sale of securities in accordance with its investment objective, policies, and limitations. Except with respect to the Portfolios' policy of borrowing money, if a percentage limitation is adhered to at the time of investment, a later increase or decrease in percentage resulting from any change in value or net assets will not result in a violation of such restriction. For purposes of their policies and limitations, the Portfolios consider certificates of deposit and demand and time deposits issued by a U.S. branch of a domestic bank or savings association having capital, surplus, and undivided profits in excess of $100,000,000 at the time of investment to be "cash items." NON-FUNDAMENTAL INVESTMENT LIMITATIONS The investment limitations described below are not fundamental policies of the Portfolios described and may be changed by the Trustees without shareholder approval. NON-FUNDAMENTAL INVESTMENT LIMITATIONS - QUALITY BOND PORTFOLIO, SELECT EQUITY PORTFOLIO, LARGE CAP STOCK PORTFOLIO, SMALL CAP STOCK PORTFOLIO AND INTERNATIONAL EQUITY PORTFOLIO These non-fundamental investment policies require that each such Portfolio may not: (i) Acquire any illiquid securities, such as repurchase agreements with more than seven days to maturity or fixed time deposits with a duration of over seven calendar days, if as a result thereof, more than 15% of the market value of the Portfolio's total assets would be in investments that are illiquid; (ii) Purchase any security if, as a result, the Portfolio would then have more than 5% of its total assets invested in securities of companies (including predecessors) that have been in continuous operation for fewer than three years; (iii) Invest in warrants (other than warrants acquired by the Portfolio as part of a unit or attached to securities at the time of purchase) if, as a result, the investments (valued at the lower of cost or market) would exceed 5% of the value of the Portfolio's net assets or if, as a result, more than 2% of the Portfolio's net assets would be invested in warrants not listed on a recognized U.S. or foreign stock exchange, to the extent permitted by applicable state securities laws; or (iv) Purchase or retain securities of any issuer if, to the knowledge of the Portfolio, any of the Portfolio's officers or Trustees or any officer of the Advisor individually owns more than 1/2 of 1% of the issuer's outstanding securities and such persons owning more than 1/2 of 1% of such securities together beneficially own more than 5% of such securities, all taken at market. NON-FUNDAMENTAL INVESTMENT LIMITATIONS - EMERGING MARKETS EQUITY PORTFOLIO The Portfolio may not: (i) Acquire securities of other investment companies, except as permitted by the 1940 Act or any rule, order or interpretation thereunder, or in connection with a merger, consolidation, reorganization, acquisition of assets or an offer of exchange; (ii) Acquire any illiquid securities, such as repurchase agreements with more than seven days to maturity or fixed time deposits with a duration of over seven calendar days, if as a result thereof, more than 15% of the market value of the Portfolio's net assets would be in investments that are illiquid; (iii) Sell any security short, unless it owns or has the right to obtain securities equivalent in kind and amount to the securities sold or unless it covers such short sales as required by the current rules or positions of the SEC or its staff. Transactions in futures contracts and options shall not constitute selling securities short; or (iv) Purchase securities on margin, but the Portfolio may obtain such short term credits as may be necessary for the clearance of transactions. NON-FUNDAMENTAL INVESTMENT LIMITATIONS - LARGE CAP RESEARCH, DEVELOPING GROWTH AND MID-CAP VALUE PORTFOLIOS Each Portfolio may not: 1. borrow in excess of 5% of its gross assets taken at cost or market value, whichever is lower at the time of borrowing, and then only as a temporary measure for extraordinary or emergency purposes; 2. make short sales of securities or maintain a short position except to the extent permitted by applicable law; 3. invest knowingly more than 15% of its net assets (at the time of investment) in illiquid securities, except for securities qualifying for resale under Rule 144A of the Securities Act of 1933, deemed to be liquid by the Board of Trustees; 4. invest in the securities of other investment companies as defined in the 1940 Act except as permitted by applicable law; 5. invest in securities of issuers which, with their predecessors, have a record of less than three years' continuous operations, if more than 5% of the Portfolio's total assets would be invested in such securities (this restriction shall not apply to mortgaged-backed securities, asset-backed securities or obligations issued or guaranteed by the U.S. Government, its agencies or instrumentalities); 6. hold securities of any issuer if more than 1/2 of 1% of the securities of such issuer are owned beneficially by one or more officers or Trustees of the Trust or by one or more partners or members of the Trust's underwriter or investment adviser if these owners in the aggregate own beneficially more than 5% of the securities of such issuer; 7. invest in warrants if, at the time of the acquisition, its investment in warrants, value at the lower of cost or market, would exceed 5% of the Portfolio's total assets (included within such limitation, but not to exceed 2% of the Portfolio's total assets, are warrants which are not listed on the New York or American Stock Exchange or a major foreign exchange); 8. invest in real estate limited partnership interests or interests in oil, gas or other mineral leases, or exploration or other development programs, except that the Portfolio may invest in securities issued by companies that engage in oil, gas or other mineral exploration or other development activities; 9. write, purchase or sell puts, calls, straddles, spreads or combinations thereof, except to the extent permitted in the Portfolio's prospectus and statement of additional information, as they may be amended from time to time; or 10. buy from or sell to any of its officers, Trustees, employees, or its investment adviser or any of its officers, directors, partners or employees, any securities other than shares of the Portfolio's common stock. NON-FUNDAMENTAL INVESTMENT LIMITATIONS - RIGGS STOCK, RIGGS SMALL COMPANY STOCK AND RIGGS U.S. GOVERNMENT SECURITIES PORTFOLIOS 1. The Portfolios will not invest more than 15% of the value of their respective net assets in illiquid securities, including repurchase agreements providing for settlement more than seven days after notice, over-the-counter options and certain restricted securities not determined by the Trustees to be liquid. 2. Unless permitted by order of the Securities and Exchange Commission, the Portfolios will limit their respective investment in other investment companies to no more than 3% of the total outstanding voting stock of any investment company, and will not invest more than 5% of their respective total assets in any one investment company, or invest more than 10% of their respective total assets in investment companies in general. The Portfolios will purchase securities of closed-end investment companies only in open market transactions involving only customary broker's commissions. However, these limitations are not applicable if the securities are acquired in a merger, consolidation, reorganization, or acquisition of assets. 3. A Portfolio will not enter into transactions for the purpose of engaging in arbitrage. 4. A Portfolio will not purchase securities of a company for the purpose of exercising control or management. 5. The Riggs U.S. Government Securities Portfolio will not invest in warrants. The Riggs Stock and Riggs Small Company Stock Portfolios may not invest more than 5% of their respective net assets in warrants, including those acquired in units or attached to other securities. For purposes of this investment restriction, warrants will be valued at the lower of cost or market, except that warrants acquired by the Portfolios in units with or attached to securities may be deemed to be without value. DESCRIPTION OF SECURITIES RATINGS A description of the securities ratings is contained in the Appendix to the Statement of Additional Information. MANAGEMENT OF THE TRUST Responsibilities of Trustees The Board of Trustees of the Trust provides broad supervision over the affairs of the Trust and the Portfolios. In carrying out their duties, the Trustees follow the provisions of the Investment Company Act of 1940, the General Laws of the Commonwealth of Massachusetts governing business trusts, the Declaration of Trust of the Trust and its Bylaws. The Trustees approve contracts with the investment adviser, custodians and other service providers on behalf of the Portfolios. The Trustees also set broad policies for the management of the assets of each Portfolio, including the pricing of securities owned by the Portfolios and the policies governing investments by the Portfolios.
COMMITTEES The Board has established two committees. The committees, their members and the responsibilities of the committees are as follows: PRICING COMMITTEE. The Pricing Committee has the responsibility of overseeing the determination of the net asset value of the Portfolios and the calculation of the value of any debt instrument, share of stock, or other Portfolio security or asset. The members are as follows: Drew Ahrens William Flory Terri Tanaka AUDIT COMMITTEE. The Audit Committee makes recommendations to the Board concerning the selection of the Trust's independent auditors and reviews with such auditors the scope and results of the Trust's annual audit. The members are as follows: Stephen M. Alderman Theodore A. Myers Deborah A. Vohasek R. Kevin Williams COMPENSATION OF MANAGEMENT Each Trustee of the Trust who is not an interested person of the Trust or Adviser or Sub-Adviser receives an annual fee of $10,000 and an additional fee of $1,000 for each Trustees' meeting attended. In addition, disinterested Trustees who are members of any Board committees will receive a separate $1,000 fee for attendance of any committee meeting that is held on a day on which no Board meeting is held. The table below describes the compensation paid by the Trust during the past fiscal year to each of the Trustees who is a not an interested person of the Trust. None of the officers and no Trustee who is an interested person of the Trust received compensation from the Trust during the past fiscal year.
SUBSTANTIAL SHAREHOLDERS Shares of the Trust are issued and redeemed in connection with investments in and payments under certain variable annuity contracts and variable life insurance policies ("Variable Contracts") issued by Cova Financial Services Life Insurance Company and/or its affiliated insurance companies. On March 31, 2000, Cova Variable Annuity Account One, Cova Variable Life Account One and Cova Variable Life Account Eight, separate accounts of Cova Financial Services Life Insurance Company; Cova Variable Annuity Account Five and Cova Variable Life Account Five, separate accounts of Cova Financial Life Insurance Company; and First Cova Variable Annuity Account One, a separate account of First Cova Life Insurance Company, together were known to the Board of Trustees and the management of the Trust to own of record 99.71% of the Trust's shares. OWNERSHIP BY CERTAIN BENEFICIAL OWNERS Cova Life has advised the Trust that as of March 31, 2000, there were no persons owning Variable Contracts which would entitle them to instruct Cova Life with respect to more than 5% of the voting securities of the Trust. CUSTODIAN Investors Bank & Trust Company ("IBT"), 200 Clarendon Street, Boston, Massachusetts 02116, is the custodian of the Trust and has custody of all securities and cash of the Trust. The custodian, among other things, attends to the collection of principal and income, and payment for and collection of proceeds of securities bought and sold by the Trust. IBT also provides fund administration and accounting services to the Trust and is the Trust's transfer agent. DIVIDENDS All dividends are distributed to the separate accounts and will be automatically reinvested in Trust shares. Dividends and distributions made by the Portfolios are taxable, if at all, to Cova Life; they are not taxable to Variable Contract owners. TAX STATUS It is the intention of the Trust to qualify as a "regulated investment company" under Sub-chapter M of the Internal Revenue Code. If the Trust so qualifies and distributes each year to its shareholders at least 90% of its net investment income in each year, it will not be required to pay federal income taxes on any income distributed to shareholders. Each Portfolio of the Trust distributes all of its net income and gains to its shareholders (the separate accounts). Each Portfolio is treated as a separate entity for Federal income tax purposes and, therefore, the investments and results of the Portfolio are determined separately for purposes of determining whether the Trust qualifies as a "regulated investment company" and for purposes of determining net ordinary income (or loss) and net realized capital gains (or losses). Some of the Trust's investment practices are subject to special provisions of the Code that, among other things, may defer the use of certain losses of the Trust and affect the holding period of the securities held by the Trust and the character of the gains or losses realized by the Trust. These provisions may also require the Trust to mark-to-market some of the positions in its portfolio (i.e., treat them as if they were closed out), which may cause the Trust to recognize income without receiving cash with which to make distributions in amounts necessary to satisfy the 90% distribution requirement and the distribution requirements for avoiding income and excise taxes. The Trust will monitor its transactions and may make certain tax elections in order to mitigate the effect of these rules and prevent disqualification of the Trust as a regulated investment company. Investments of the Trust in securities issued at a discount or providing for deferred interest or payment of interest in kind are subject to special tax rules that will affect the amount, timing and character of distributions to shareholders. For example, with respect to securities issued at a discount, the Trust will be required to accrue as income each year a portion of the discount and to distribute such income each year in order to maintain its qualification as a regulated investment company and to avoid income and excise taxes. In order to generate sufficient cash to make distributions necessary to satisfy the 90% distribution requirement and to avoid income and excise taxes, the Trust may have to dispose of securities that it would otherwise have continued to hold. NET ASSET VALUES Portfolio shares are sold and redeemed at a price equal to the share's net asset value. The net asset value of a Portfolio is determined by calculating the total value of the Portfolio's assets, deducting its total liabilities, and dividing the result by the number of shares outstanding. The net asset value for each Portfolio is computed once daily as of the close of the New York Stock Exchange, Monday through Friday, except on customary business holidays, or except on any day on which no purchase or redemption orders are received, or there is not a sufficient degree of trading in the Portfolio's investments so that the Portfolio's net asset value per share might be materially affected. The Trust reserves the right to calculate the net asset value and to adjust the public offering price based thereon more frequently than once a day if deemed desirable. Securities that are listed on a securities exchange are valued at their closing sales price on the day of the valuation. Price valuations for listed securities are based on market quotations where the security is primarily traded or, if not available, are valued at the mean of the bid and asked prices on any valuation date. Unlisted securities in a Portfolio are primarily valued based on their latest quoted bid price or, if not available, are valued by a method determined by the Trustees to accurately reflect fair value. Money market instruments maturing in 60 days or less are valued on the basis of amortized cost, which means that securities are valued at their acquisition cost to reflect a constant amortization rate to maturity of any premium or discount, rather than at current market value. PERFORMANCE DATA As required by regulations of the Securities and Exchange Commission, the annualized total return of the Portfolios for a period is computed by assuming a hypothetical initial payment of $1,000. It is then assumed that all of the dividends and distributions by the Portfolio over the period are reinvested. It is then assumed that at the end of the period, the entire amount is redeemed. The annualized total return is then calculated by determining the annual rate required for the initial payment to grow to the amount which would have been received upon redemption. Quotations of average annual total return for a Portfolio will be expressed in terms of the average annual compounded rate of return of a hypothetical investment in a Portfolio over a period of one, five and ten years (or, if less, up to the life of a Portfolio, calculated pursuant to the formula: (n) P (1 + T) = ERV Where:
at the beginning of the 1, 5, or 10 year period at the end of the 1, 5, or 10 year period (or fractional portion thereof) From time to time, the investment adviser may reduce its compensation or assume expenses in respect of the operations of a Portfolio in order to reduce the Portfolio's expenses. Any such waiver or assumption would increase a Portfolio's yield and total return during the period of the waiver or assumption. Advertisements and other sales literature for the Portfolios may quote total returns which are calculated for periods other than the 1-, 5- and 10-year periods required by the Rules of the Securities and Exchange Commission or may quote returns that do not reflect the deduction of all expenses incurred by a Portfolio. The investment adviser may use these returns in advertising if the investment adviser believes the nonstandard returns are useful. Nonstandard returns are always accompanied by total returns calculated as required by Rules of the Securities and Exchange Commission, which require performance to be calculated for 1-, 5- and 10-year periods with the deduction of all expenses and the assumption that all dividends and distributions are reinvested. In addition, Portfolio performance may be advertised relative to certain indices and benchmark investments. The composition of the investment in such indices are the characteristics of such benchmark investments are not identical to, and in some cases are very different from, those of a Portfolio. These indices and averages are generally unmanaged and the items included in the calculations of such indices and averages may be different from those of the equations used by the Trust to calculate a Portfolio's performance figures. A Portfolio's investment results will vary from time to time depending upon market conditions, the composition of its investment portfolio and its operating expenses. The effective yield and total return for a Portfolio should be distinguished from the rate of return of a corresponding division of Cova Life's separate account, which rate will reflect the deduction of additional charges, including mortality and expense risk charges, and will therefore be lower. Accordingly, performance figures for a Portfolio will only be advertised if comparable performance figures for the corresponding division of the separate account are included in the advertisements. Contract owners should consult the Contract prospectus for further information. Each Portfolio's results also should be considered relative to the risks associated with its investment objectives and policies. LEGAL COUNSEL AND INDEPENDENT AUDITORS Blazzard, Grodd & Hasenauer, P.C., Westport, Connecticut is counsel to the Trust and passes upon the legality of the Trust's shares. The independent auditors for the Trust are KPMG LLP, 99 High Street, Boston, Massachusetts 02110. INVESTMENT ADVISORY AGREEMENT Cova Investment Advisory Corporation (the "Investment Adviser"), One Tower Lane, Suite 3000, Oakbrook Terrace, Illinois 60181-4644 is an Illinois corporation which was incorporated on August 31, 1993 under the name Oakbrook Investment Advisory Corporation and which is registered with the Securities and Exchange Commission as an investment adviser under the Investment Advisers Act of 1940. The Investment Adviser commenced providing investment advisory services to all Portfolios of the Trust as of May 1, 1996 pursuant to an Investment Advisory Agreement dated April 1, 1996, as amended ("Investment Advisory Agreement"). Prior to this date, Van Kampen American Capital Investment Advisory Corp. had acted as the investment adviser to all Portfolios of the Trust. The Investment Advisory Agreement was most recently approved by the Board of Trustees on November 12, 1999. The Investment Advisory Agreement was most recently approved by the shareholders of each of the Portfolios of the Trust at a Special Meeting of Shareholders held on January 6, 2000. As described in the Prospectus, the Investment Adviser has retained Sub-Advisers to assist it in managing the Portfolios. The Sub-Advisory Agreements between the Investment Adviser and each of the Sub-Advisers were approved most recently by the Board of Trustees on November 12, 1999 and by the shareholders of each of the Portfolios of the Trust at a Special Meeting of Shareholders held on January 6, 2000. Under the terms of the Investment Advisory Agreement, the Investment Adviser is obligated to (i) manage the investment and reinvestment of the assets of each Portfolio of the Trust in accordance with each Portfolio's investment objective and policies and limitations, or (ii) in the event that the Investment Adviser shall retain a sub-adviser or sub-advisers, to supervise and implement the investment activities of any Portfolio for which any such sub-adviser has been retained, including responsibility for overall management and administrative support including managing, providing for and compensating any sub-advisers; and to administer the Trust's affairs. The Investment Advisory Agreement further provides that the Investment Adviser agrees, among other things, to administer the business affairs of each Portfolio, to furnish offices and necessary facilities and equipment to each Portfolio, to provide administrative services for each Portfolio, to render periodic reports to the Board of Trustees of the Trust with respect to each Portfolio, and to permit any of its officers or employees, or those of any sub-adviser to serve without compensation as trustees or officers of the Portfolio if elected to such positions. The Investment Advisory Agreement provides that the Investment Adviser will not be liable for any error in judgment or of law, or for any loss suffered by the Trust in connection with the matters to which the agreement relates, except a loss resulting from willful misfeasance, bad faith, or gross negligence on the part of the Investment Adviser in the performance of its obligations and duties, or by reason of its reckless disregard of its obligations and duties under the Agreement. The Investment Adviser's activities are subject to the review and supervision of the Trust's Trustees to whom the Investment Adviser renders periodic reports of the Trust's investment activities. The Investment Advisory Agreement may be terminated without penalty upon 60 days written notice by either party and will automatically terminate in the event of assignment. COMPENSATION. The Investment Adviser receives a fee from the Trust for its services as investment adviser as described in the Prospectus. The Investment Adviser calculates the fee each day that the New York Stock Exchange is open for business based on the net asset value determined for that day. The fee accrues daily and is paid monthly. The Investment Adviser received the following fees from each Portfolio during the past three fiscal years.
The Investment Adviser received no advisory fee with respect to the Emerging Markets Equity Portfolio or the Riggs Small Company Stock Portfolio through December 31, 1999 in that these Portfolios had not yet commenced investment operations as of that date. EXPENSES OF THE TRUST Although each Portfolio must bear the expenses directly attributable to it, the Portfolios are expected to experience cost savings over the aggregate amount that would be payable if each Portfolio were a separate fund, because they have the same Trustees, accountants, attorneys and other general and administrative expenses. Any expenses which are not directly attributable to a specific Portfolio are allocated on the basis of the net assets of the respective Portfolios. For the year ended December 31, 1999, the expenses, taking into account the waivers and expense assumptions, borne by the Bond Debenture Portfolio amounted to $1,371,690 or .85% of its average net assets on an annualized basis; the net expenses borne by the Quality Bond Portfolio amounted to $600,321 or .64% of its average net assets on an annualized basis; the net expenses borne by the International Equity Portfolio amounted to $1,253,973 or 1.10% of its average net assets on an annualized basis; the net expenses borne by the Select Equity Portfolio amounted to $1,737,044 or .77% of its average net assets on an annualized basis; the net expenses borne by the Large Cap Stock Portfolio amounted to $1,704,505 or .75% of its average net assets on an annualized basis; the net expenses borne by the Small Cap Stock Portfolio amounted to $847,429 or 1.05% of its average net assets on an annualized basis; the net expenses borne by the Balanced Portfolio amounted to $80,904 or 1.10% of its average net assets on an annualized basis; the net expenses borne by the Equity Income Portfolio amounted to $68,615 or 1.10% of its average net assets on an annualized basis; the net expenses borne by the Growth & Income Equity Portfolio amounted to $144,592 or 1.10% of its average net assets on an annualized basis; the net expenses borne by the Mid-Cap Value Portfolio amounted to $308,331 or 1.25% of its average net assets on an annualized basis; the net expenses borne by the Large Cap Research Portfolio amounted to $301,679 or 1.25% of its average net assets on an annualized basis; the net expenses borne by the Developing Growth Portfolio amounted to $259,188 or 1.15% of its average net assets on an annualized basis;; the net expenses borne by the Lord Abbett Growth and Income Portfolio amounted to $5,736,259 or .70% of its average net assets on an annualized basis; the net expenses borne by the Riggs Stock Portfolio amounted to $255 or 1.05% of its average net assets on an annualized basis; and the net expenses borne by the Riggs U.S. Government Securities Portfolio amounted to $417 or .85% of its average net assets on an annualized basis. Cova Life and/or the Adviser and/or the Sub-Adviser(s) may at their discretion, but are not obligated to, assume all or any portion of Trust expenses. For the year ended December 31, 1999, Cova Life and the Adviser together assumed expenses of $59,975, with respect to the Quality Bond Portfolio; $55,853, with respect to the International Equity Portfolio; $21,437 with respect to the Bond Debenture Portfolio; $412, with respect to the Select Equity Portfolio; $21,826, with respect to the Large Cap Stock Portfolio; $32,598, with respect to the Small Cap Stock Portfolio; $70,427 with respect to the Balanced Portfolio; $70,417 with respect to the Equity Income Portfolio; $64,401 with respect to the Growth & Income Equity Portfolio; $39,659 with respect to the Mid-Cap Value Portfolio; $31,960 with respect to the Large Cap Research Portfolio; $42,877 with respect to the Developing Growth Portfolio; $23,044 with respect to the Riggs Stock Portfolio; and $24,025 with respect to the Riggs U.S. Government Securities Portfolio. CODE OF ETHICS To mitigate the possibility that a Portfolio will be adversely affected by personal trading of employees, the Trust, the Adviser and the Sub-Advisers have adopted Codes of Ethics under Rule 17j-1 of the 1940 Act. These Codes contain policies restricting securities trading in personal accounts of the portfolio managers and others who normally come into possession of information on portfolio transactions. These Codes comply, in all material respects, with the recommendations of the Investment Company Institute. Employees subject to the Codes of Ethics may invest in securities for their own investment accounts, including securities that may be purchased or held by the Trust. SUB-ADVISERS APPOINTMENT. The Investment Adviser has entered into agreements with registered investment advisers to carry out the management of the assets of the Portfolios based on the investment objectives and policies of the Portfolios. The Sub-Advisers are responsible for deciding which securities to purchase and sell for the Portfolios and for placing trades for those securities. The prospectus provides more information about the Sub-Advisers. COMPENSATION. The Investment Adviser pays the Sub-Advisers fees for their services, as described in the Prospectus, out of the compensation the Investment Adviser receives from each Portfolio. INVESTMENT DECISIONS Investment decisions for the Trust and for the other investment advisory clients of the Sub-Advisers are made with a view to achieving their respective investment objectives and after consideration of such factors as their current holdings, availability of cash for investment, and the size of their investments generally. Frequently, a particular security may be bought or sold for only one client or in different amounts and at different times for more than one but less than all clients. Likewise, a particular security may be bought for one or more clients when one or more other clients are selling the security. In addition, purchases or sales of the same security may be made for two or more clients of a Sub-Adviser on the same day. In such event, such transactions will be allocated among the clients in a manner believed by the Sub-Adviser to be equitable to each. In some cases, this procedure could have an adverse effect on the price or amount of the securities purchased or sold by the Trust. Purchase and sale orders for the Trust may be combined with those of other clients of a Sub-Adviser in the interest of achieving the most favorable net results for the Trust. PORTFOLIO TRANSACTIONS Transactions on U.S. stock exchanges and other agency transactions involve the payment by the Trust of negotiated brokerage commissions. Such commissions vary among different brokers. Also, a particular broker may charge different commissions according to such factors as the difficulty and size of the transaction. Transactions in foreign securities often involve the payment of fixed brokerage commissions, which are generally higher than those in the United States. There is generally no stated commission in the case of securities traded in the over-the-counter markets, but the price paid by the Trust usually includes an undisclosed dealer commission or mark-up. In underwritten offerings, the price paid by the Trust includes a disclosed, fixed commission or discount retained by the underwriter or dealer. It is currently intended that the Sub-Advisers will place all orders for the purchase and sale of portfolio securities for the Trust and buy and sell securities for the Trust through a substantial number of brokers and dealers. In so doing, the Sub-Advisers will use their best efforts to obtain for the Trust the best price and execution available. In seeking the best price and execution, the Sub-Advisers, having in mind the Trust's best interests, will consider all factors they deem relevant, including, by way of illustration, price, the size of the transaction, the nature of the market for the security, the amount of the commission, the timing of the transaction taking into account market prices and trends, the reputation, experience, and financial stability of the broker-dealer involved, and the quality of service rendered by the broker-dealer in other transactions. It has for many years been a common practice in the investment advisory business for advisers of investment companies and other institutional investors to receive research, statistical, and quotation services from broker-dealers who execute portfolio transactions for the clients of such advisers. Consistent with this practice, the Sub-Advisers may receive research, statistical, and quotation services from any broker-dealers with whom they place the Trust's portfolio transactions. These services, which in some cases may also be purchased for cash, include such matters as general economic and security market reviews, industry and company reviews, evaluations of securities, and recommendations as to the purchase and sale of securities. Some of these services may be of value to the Sub-Advisers and/or their affiliates in advising various other clients (including the Trust), although not all of these services are necessarily useful and of value in managing the Trust. The management fees paid by the Trust are not reduced because the Sub-Advisers and/or their affiliates may receive such services. As permitted by Section 28(e) of the Securities Exchange Act of 1934, a Sub-Adviser may cause a Portfolio to pay a broker-dealer who provides brokerage and research services to the Sub-Adviser an amount of disclosed commission for effecting a securities transaction for the Portfolio in excess of the commission which another broker-dealer would have charged for effecting that transaction provided that the Sub-Adviser determines in good faith that such commission was reasonable in relation to the value of the brokerage and research services provided by such broker-dealer viewed in terms of that particular transaction or in terms of all of the accounts over which investment discretion is so exercised. A Sub-Adviser's authority to cause a Portfolio to pay any such greater commissions is also subject to such policies as the Adviser or the Trustees may adopt from time to time. COMMISSIONS PAID BY THE PORTFOLIOS. The following are the aggregate amounts of commissions paid by each of the Portfolios for brokerage during the past three fiscal years:
FINANCIAL STATEMENTS The Financial Statements and notes thereto for the year ended December 31, 1999 and the independent auditors' report thereon appear in the Trust's Annual Report for the year ended December 31, 1999, which is incorporated by reference into this Statement of Additional Information. The Trust delivers a copy of the Annual Report to investors. In addition, the Trust will furnish, without charge, additional copies of such Annual Report and copies of the Statement of Additional Information to investors which may be obtained without charge by calling the Life Company at (800) 831-LIFE. APPENDIX - DESCRIPTION OF CORPORATE BOND RATINGS STANDARD & POOR'S CORPORATION. A brief description of the applicable Standard & Poor's Corporation ("S&P") rating symbols and their meanings (as published by S&P) follows: An S&P corporate or municipal debt rating is a current assessment of the creditworthiness of an obligor with respect to a specific obligation. This assessment may take into consideration obligors such as guarantors, insurers, or lessees. The debt rating is not a recommendation to purchase, sell, or hold a security, inasmuch as it does not comment as to market price or suitability for a particular investor. The ratings are based on current information furnished by the issuer or obtained by S&P from other sources it considers reliable. S&P does not perform an audit in connection with any rating and may, on occasion, rely on unaudited financial information. The ratings may be changed, suspended, or withdrawn as a result of changes in, or unavailability of, such information, or for other circumstances. The ratings are based, in varying degrees, on the following considerations: 1. Likelihood of default - capacity and willingness of the obligor as to the timely payment of interest and repayment of principal in accordance with the terms of the obligation; 2. Nature of and provisions of the obligation; 3. Protection afforded by, and relative position of, the obligation in the event of bankruptcy, reorganization, or other arrangement under the laws of bankruptcy and other laws affecting creditors' rights. LONG-TERM CORPORATE BONDS. AAA - Debt rated 'AAA' has the highest rating assigned by S&P. 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 highest rated issues only in small degree. A - Debt rated 'A' has a strong capacity to pay interest and repay principal although it is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than debt in higher rated categories. BBB - Debt rated 'BBB' is regarded as having an adequate capacity to pay interest and repay principal. Whereas it normally adequate protection parameters, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity to pay interest and repay principal for debt in this category than in higher rated categories. BB, B, CCC, CC - Debt rated 'BB', 'B', 'CCC', or 'CC' is regarded, on balance, as predominantly speculative with respect to capacity to pay interest and repay principal in accordance with the terms of the obligation. 'BB' indicates the lowest degree of speculation and 'CC' the highest degree of speculation. While such debt will likely have some quality and protective characteristics, these are outweighed by large uncertainties or major risk exposures to adverse conditions. C - This rating is reserved for income bonds on which no interest is being paid. D - Debt rated 'D' is in default, and payment of interest and/or repayment of principal is in arrears. PLUS (+) OR MINUS (-): The ratings from 'A' to 'B' may be modified by the addition of a plus or minus sign to show relative standing within the major rating categories. PROVISIONAL RATINGS: The letter "p" indicates that the rating is provisional. A provisional rating assumes the successful completion of the project being financed by the debt being rated and indicates that payment of debt service requirements is largely or entirely dependent upon the successful and timely completion of the project. This rating, however, while addressing credit quality subsequent to completion of the project, makes no comment on the likelihood of, or the risk of default upon failure of, such completion. The investor should exercise judgment with respect to such likelihood and risk. L - The letter 'L' indicates that the rating pertains to the principal amount of those bonds where the underlying deposit collateral is fully insured by the Federal Deposit Insurance Corp. [DAGGER] - Continuance of the rating is contingent upon S&P's receipt of closing documentation confirming investments and cash flow. * - Continuance of the rating is contingent upon S&P's receipt of an executed copy of the escrow agreement. NR - Indicates no rating has been requested, that there is insufficient information on which to base a rating, or that S&P does not rate a particular type of obligation as a matter of policy. MOODY'S INVESTORS SERVICE, INC. A brief description of the applicable Moody's Investors Service, Inc. rating symbols and their meanings (as published by Moody's Investors Service, Inc.) follows: LONG-TERM CORPORATE BONDS. Aaa - Bonds which are rated Aaa are judged to be of the best quality. They carry the smallest degree of investment risk and are generally referred to as "gilt edge". Interest payments are protected by a large or by an exceptionally stable margin and principal is secure. While the various protective elements are likely to change, such changes as can be visualized are most unlikely to impair the fundamentally strong position of such issues. Aa - Bonds which are rated Aa are judged to be of high quality by all standards. Together with the Aaa group they comprise what are generally known as high grade bonds. They are rated lower than the best bonds because margins of protection may not be as large as in Aaa securities or fluctuation of protective elements may be of greater amplitude or there may be other elements present which make the long term risks appear somewhat larger than in Aaa securities. A - Bonds which are rated A possess many favorable investment attributes and are to be considered as upper medium grade obligations. Factors giving security to principal and interest are considered adequate but elements may be present which suggest a susceptibility to impairment sometime in the future.
Baa - Bonds which are rated Baa are considered as medium grade obligations,
Ba - Bonds which are rated Ba are judged to have speculative elements; their future cannot be considered as well assured. Often the protection of interest and principal payments may be very moderate and thereby not well safeguarded during both good and bad times over the future. Uncertainty of position characterizes bonds in this class. B - Bonds which are rated B generally lack characteristics of the desirable investment. Assurance of interest and principal payments or of maintenance of other terms of the contract over any long period of time may be small. Caa - Bonds which are rated Caa are of poor standing. Such issues may be in default or there may be present elements of danger with respect to principal or interest. Ca - Bonds which are rated Ca represent obligations which are speculative in a high degree. Such issues are often in default or have other marked shortcomings. C - Bonds which are rated C are the lowest rated class of bonds and issues so rated can be regarded as having extremely poor prospects of ever attaining any real investment standing. NOTE: Those bonds in the Aa, A, Baa, Ba and B groups which Moody's believes possess the strongest investment attributes are designated by the symbols Aa 1, A 1, Baa 1, Ba 1 and B 1. COMMERCIAL PAPER RATINGS COMMERCIAL PAPER A Standard & Poor's commercial paper rating is a current assessment of the likelihood of timely payment of debt having an original maturity of no more than 365 days. Ratings are graded into four categories, ranging from "A" for the highest quality obligations to "D" for the lowest. The four categories are as follows:
repay punctually promissory obligations not having an original maturity in excess of nine months. Moody's employs the following three designations, all judged to be investment grade, to indicate the relative repayment capacity of rated issuers: Issuers rated Prime-1 (or related supporting institutions) have a superior capacity for repayment of short-term promissory obligations. Issuers rated Prime-2 (or related supporting institutions) have a strong capacity for repayment of short-term promissory obligations. Issuers rated Prime-3 (or related supporting institutions) have an acceptable capacity for repayment of short-term promissory obligations. Issuers rated Not Prime do not fall within any of the Prime rating categories. The three rating categories of Duff & Phelps for investment grade commercial paper and short-term debt are "D-1," "D-2" and "D-3." Duff & Phelps employs three designations, "D-1+." "D-1" and "D-1-," within the highest rating category. The following summarizes the rating categories used by Duff & Phelps for commercial paper: "D-1+" - Debt possesses highest certainty of timely payment. Short-term liquidity, including internal operating factors and/or access to alternative sources of funds, is outstanding, and safety is just below risk-free U.S. Treasury short-term obligations. "D-1" - Debt possesses very high certainty of timely payment. Liquidity factors are excellent and supported by good fundamental protection factors. Risk factors are minor. "D-1-" - Debt possesses high certainty of timely payment. Liquidity factors are strong and supported by good fundamental protection factors. Risk factors are very small. "D-2" - Debt possesses good certainty of timely payment. Liquidity factors and company fundamentals are sound. Although ongoing funding needs may enlarge total financing requirements, access to capital markets is good. Risk factors are small. "D-3" - Debt possesses satisfactory liquidity, and other protection factors qualify issue as investment grade. Risk factors are larger and subject to more variation. Nevertheless, timely payment is expected. "D-4" - Debt possesses speculative investment characteristics. Liquidity is not sufficient to ensure against disruption in debt service. Operating factors and market access may be subject to a high degree of variation. "D-5" - Issuer has failed to meet scheduled principal and/or interest payments. Fitch short-term ratings apply to debt obligations that are payable on demand or have original maturities of up to three years. The following summarizes the rating categories used by Fitch for short-term obligations: "F-1+" - Securities possess exceptionally strong credit quality. Issues assigned this rating are regarded as having the strongest degree of assurance for timely payment. "F-1" - Securities possess very strong credit quality. Issues assigned this rating reflect an assurance of timely payment only slightly less in degree than issues rated "F-1+." "F-2" - Securities possess good credit quality. Issues assigned this rating have a satisfactory degree of assurance for timely payment, but the margin of safety is not as great as the "F-1+" and "F-1" categories. "F-3" - Securities possess fair credit quality. Issues assigned this rating have characteristics suggesting that the degree of assurance for timely payment is adequate; however, near-term adverse changes could cause these securities to be rated below investment grade. "F-S" - Securities possess weak credit quality. Issues assigned this rating have characteristics suggesting a minimal degree of assurance for timely payment and are vulnerable to near-term adverse changes in financial and economic conditions. "D" - Securities are in actual or imminent payment default. Fitch may also use the symbol "LOC" with its short-term ratings to indicate that the rating is based upon a letter of credit issued by a commercial bank. Thomson BankWatch short-term ratings assess the likelihood of an untimely or incomplete payment of principal or interest of unsubordinated instruments having a maturity of one year or less which are issued by United States commercial banks, thrifts and non-bank banks; non-United States banks; and broker-dealers. The following summarizes the ratings used by Thomson BankWatch: "TBW-1" - This designation represents Thomson BankWatch's highest rating category and indicates a very high degree of likelihood that principal and interest will be paid on a timely basis. "TBW-2" - This designation indicates that while the degree of safety regarding timely payment of principal and interest is strong, the relative degree of safety is not as high as for issues rated "TBW-1." "TBW-3" - This designation represents the lowest investment grade category and indicates that while the debt is more susceptible to adverse developments (both internal and external) than obligations with higher ratings, capacity to service principal and interest in a timely fashion is considered adequate. "TBW-4" - This designation indicates that the debt is regarded as non-investment grade and therefore speculative. IBCA assesses the investment quality of unsecured debt with an original maturity of less than one year which is issued by bank holding companies and their principal bank subsidiaries. The following summarizes the rating categories used by IBCA for short-term debt ratings: "A1+" - Obligations supported by the highest capacity for timely repayment. "A1" - Obligations are supported by a strong capacity for timely repayment. "A2" - Obligations are supported by a satisfactory capacity for timely repayment, although such capacity may be susceptible to adverse changes in business, economic or financial conditions. "A3" - Obligations are supported by a satisfactory capacity for timely repayment. Such capacity is more susceptible to adverse changes in business, economic or financial conditions than for obligations in higher categories. "B" - Obligations for which the capacity for timely repayment is susceptible to adverse changes in business, economic or financial conditions. "C" - Obligations for which there is an inadequate capacity to ensure timely repayment. "D" - Obligations which have a high risk of default or which are currently in default. VARIABLE RATE DEMAND BOND RATINGS Standard & Poor's assigns "dual" ratings to all long-term debt issues that have as part of their provisions a variable rate demand or double feature. The first rating addresses the likelihood of repayment of principal and interest as due, and the second rating addresses only the demand feature. The long-term debt rating symbols are used for bonds to denote the long-term maturity and the commercial paper rating symbols are used to denote the put option (for example, 'AAA/A-1') or if the nominal maturity is short, a rating of 'SP-1+/AAA' is assigned. NOTES A Standard & Poor's note rating reflects the liquidity concerns and market access risks unique to notes. Notes due in 3 years or less will likely receive a note rating. Notes maturing beyond 3 years will most likely receive a long-term debt rating. The following criteria will be used in making that assignment: - - Amortization schedule (the longer the final maturity relative to other maturities the more likely it will be treated as a note). - - Source of payment (the more dependent the issue is on the market for its refinancing, the more likely it will be treated as a note). Note rating symbols are as follows: SP-1 Very strong or strong capacity to pay principal and interest. Those issues determined to possess overwhelming safety characteristics will be given a plus (+) designation. SP-2 Satisfactory capacity to pay principal and interest. SP-3 Speculative capacity to pay principal and interest. PREFERRED STOCK RATINGS (STANDARD & POOR'S) AAA This is the highest rating that may be assigned by Standard & Poor's to a preferred stock issue and indicates an extremely strong capacity to pay the preferred stock obligations. AA A preferred stock issue rated 'AA' also qualifies as a high-quality fixed income security. The capacity to pay preferred stock obligations is very strong, although not as overwhelming as for issues rated 'AAA'. A An issue rated 'A' is backed by a sound capacity to pay the preferred stock obligations, although it is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions. BBB An issue rated 'BBB' is regarded as backed by an adequate capacity to pay the preferred stock obligations. Whereas it normally exhibits adequate protection parameters, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity to make payments for a preferred stock in this category than for issues in the 'A' category. BB Preferred stock rated 'BB', 'B' and 'CCC' is regarded, on balance, as B Predominantly speculative with respect to the issuer's capacity to pay CCC preferred stock obligations. 'BB' indicates the lowest degree of speculation and 'CCC' the highest degree of speculation. While such issues will likely have some quality and protective characteristics, these are outweighed by large uncertainties or major risk exposures to adverse conditions. CC The rating 'CC' is reserved for a preferred stock issue in arrears on dividends or sinking fund payments, but that is currently paying. C A preferred stock rated 'C' is a non-paying issue. D A preferred stock rated 'D' is a non-paying issue with the issuer in default on debt instruments. PLUS (+) OR MINUS (-): To provide more detailed indications of preferred stock quality, the 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. NR This indicates that no rating has been requested, that there is insufficient information on which to base a rating, or that S&P does not rate a particular type of obligation as a matter of policy. A preferred stock rating is not a recommendation to purchase, sell, or hold a security inasmuch as it does not comment as to market price or suitability for a particular investor. The ratings are based on current information furnished to S&P by the issuer or obtained by S&P from other sources it considers reliable. S&P does not perform an audit in connection with any rating and may, on occasion, rely on unaudited financial information. The ratings may be changed, suspended, or withdrawn as a result of changes in, or unavailability of, such information, or based on other circumstances. MOODY'S INVESTORS SERVICE, INC. - A brief description of the applicable Moody's Investors Service, Inc. rating symbols with respect to preferred stock and their meanings (as published by Moody's Investors Service, Inc.) follows: PREFERRED STOCK RATINGS (MOODY'S) Preferred stock rating symbols and their definitions are as follows: aaa: An issue which is rated 'aaa' is considered to be a top-quality preferred stock. This rating indicates good asset protection and the least risk of dividend impairment within the universe of preferred stocks. aa: An issue which is rated 'aa' is considered a high-grade preferred stock. This rating indicates that there is a reasonable assurance the earnings and asset protection will remain relatively well maintained in the foreseeable future. a: An issue which is rated 'a' is considered to be an upper-medium preferred stock. While risks are judged to be somewhat greater than in the 'aaa' and 'aa' classifications, earnings and asset protection are, nevertheless, expected to be maintained at adequate levels. baa: An issue which is rated 'baa' is considered to be a medium grade preferred stock, neither highly protected nor poorly secured. Earnings and asset protection appear adequate at present but may be questionable over any great length of time. ba: An issue which is rated 'ba' is considered to have speculative elements and its future cannot be considered well assured. Earnings and asset protection may be very moderate and not well safeguarded during adverse periods. Uncertainty of position characterizes preferred stocks in this class. b: An issue which is rated 'b' generally lacks the characteristics of a desirable investment. Assurance of dividend payments and maintenance of other terms of the issue over any long period of time may be small. caa: An issue which is rated 'caa' is likely to be in arrears on dividend payments. This rating designation does not purport to indicate the future status of payments. ca: An issue which is rated 'ca' is speculative in a high degree and is likely to be in arrears on dividends with little likelihood of eventual payment. c: This is the lowest rated class of preferred or preference stock. Issues so rated can be regarded as having extremely poor prospects of ever attaining any real investment standing. NOTE: Beginning May 3, 1982, Moody's began applying numerical modifiers 1, 2 and 3 in each rating classification from "aa" through "b" in its preferred stock rating system. The modifier 1 indicates that the security ranks in the higher end of its generic rating category; the modifier 2 indicates a mid-range ranking; and the modifier 3 indicates that the issue ranks in the lower end of its generic rating category. SECURITY FIRST TRUST
T. ROWE PRICE GROWTH AND INCOME SERIES
BLACKROCK EQUITY SERIES BLACKROCK U.S. GOVERNMENT INCOME SERIES 11365 West Olympic Boulevard Los Angeles, California 90064 (310) 312-6100 STATEMENT OF ADDITIONAL INFORMATION This Statement of Additional Information is not a prospectus but should be read in conjunction with the Prospectus of Security First Trust (the "Trust"), dated November 30, 2000, which may be obtained by writing to Security First Trust, 11365 West Olympic Boulevard, Los Angeles, California 90064, Attention: Customer Services or by telephoning (310) 312- 6100 or (800) 283-4536. The date of this Statement of Additional Information is November 30, 2000. STATEMENT OF ADDITIONAL INFORMATION TABLE OF CONTENTS
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THE TRUST GENERAL INFORMATION ABOUT THE TRUST Security First Trust (the "Trust") is registered with the Securities and Exchange Commission under the Investment Company Act of 1940, as amended ("1940 Act") as a diversified, open-end investment management company. The Trust was established on February 11, 1987, pursuant to a Declaration of Trust under the laws of the Commonwealth of Massachusetts as a voluntary association known as a "Massachusetts business trust." It operates as a "series company" as that term is used in Rule 18f-2 under the 1940 Act with four series of shares. The assets received by the Trust from the issue or sale of the shares of a Series and all income, earnings, profits and proceeds attributable to them, subject only to the rights of creditors, are specifically allocated to that Series and are required to be segregated on the books of account of the Trust. The assets of a Series are also required to be charged with all of the expenses attributable to that Series. Any general expenses of the Trust not readily identifiable as belonging to a particular Series shall be allocated by or under the direction of the Board of Trustees in such manner as the Board determines to be fair and equitable. Each share of a Series represents an equal proportionate interest in that Series with each other share of that Series and is entitled to such dividends and distributions out of the income belonging to that Series as are declared by the Board of Trustees. Upon the liquidation of a Series, its shareholders are entitled to share pro rata in the net assets belonging to that Series available for distribution. The Declaration of Trust provides that no annual or regular meetings of shareholders are required. In addition, after the Trustees were initially elected by shareholders, the Trustees became a self-perpetuating body. Thus, there will ordinarily be no shareholder meetings unless otherwise required by the 1940 Act. The 1940 Act specifically requires that a shareholder meeting be held for the purpose of electing Trustees if at any time less than a majority of the Trustees has been elected by the shareholders of the Trust. The shareholders also have the power to remove a Trustee by the affirmative vote of the holders of not less than two-thirds of the shares of the Trust outstanding and entitled to vote either by a declaration in writing filed with the custodian or by votes cast in person or by proxy at a meeting called for the purpose of removal. The Trustees will promptly call such a meeting when requested to do so by the record holders of not less than 10 percent of the outstanding shares. Ten or more shareholders who have been shareholders for at least six months preceding the date of application and who hold in the aggregate either shares having a net asset value of at least $100,000 or at least 1 percent of the outstanding shares, whichever is less, may apply in writing to the Trustees stating that they wish to communicate with other shareholders to obtain signatures in order to request a meeting to remove a Trustee. This application must be accompanied by the proposed communication and form of the request that they wish to transmit. The Trustees will, within five business days after receipt of such application, either afford to the applicants access to a list of the names and addresses of all shareholders or inform such applicants as to the approximate number of shareholders of record and the approximate cost of mailing to them the proposed communication and form of request. Shares of each Series vote separately as a class on any matter submitted to shareholders except as to voting for Trustees and as otherwise required by the 1940 Act, in which cases the shareholders of all of the Series vote together as one class. In the event that the Trustees determine that a matter affects only the interest of one or more Series, then only the shareholders of the affected Series will be entitled to vote on the matter.
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INVESTMENT POLICIES AND RESTRICTIONS Certain of the investment policies and restrictions of the Series described below are fundamental policies that may not be changed without the approval of at least a majority of the outstanding shares of a Series or of 67% of the shares of a Series represented at a meeting of shareholders at which the holders of 50% or more of the outstanding shares of the Series are represented. Investment policies or restrictions which are not fundamental may be changed without the approval of shareholders. T. ROWE PRICE GROWTH AND INCOME SERIES
The following investment policies of the T. Rowe Price Growth and Income
Series are fundamental. While the purchase of equity securities will generally
be limited to seasoned and readily marketable securities of issuers listed on
national securities exchanges, the T. Rowe Price Growth and Income Series may
invest in securities not listed on a national exchange but generally such
securities will have well-established over-the-counter markets. The fixed income
debt instruments in which this Series may invest include: (1) marketable
straight debt securities rated at the time of purchase within the four highest
grades assigned by Moody's (Aaa, Aa, A or Baa) or by Standard & Poor's (AAA, AA,
A or BBB); (2) securities issued or guaranteed by the United States government
or its agencies or instrumentalities; (3) marketable securities issued or
guaranteed by the Dominion of Canada, any Province of Canada, or any
instrumentality or political subdivision thereof; (4) bank obligations such as
certificates of deposit and bankers' acceptances having investment quality and
which in the opinion of the Board of Trustees are comparable with debt
securities which may be purchased by the Series as described in (1) above;
INVESTMENT RESTRICTIONS FOR THE T. ROWE PRICE GROWTH AND INCOME SERIES As matters of fundamental investment policy, the T. Rowe Price Growth and Income Series may not: (1) purchase any security if, as a result of such purchase, more than 5% of the value of a Series' total assets would be invested in the securities of a single issuer, except securities issued or guaranteed by the United States Government or its agencies or instrumentalities; (2) purchase any security if, as a result of such purchase, more than 10% of the outstanding securities of any class of any issuer would be held by a Series (for this purpose, all indebtedness of any issuer shall be deemed a single class), except securities issued or guaranteed by the United States Government or any of its agencies or instrumentalities; (3) purchase any security if, as a result of such purchase, 25% or more of the value of a Series' total assets would be invested in the securities of issuers having their principal business activities in the same industry, except this limitation does not apply to securities issued or guaranteed by the United States Government or any of its agencies or instrumentalities, or to certificates of deposit or bankers, acceptances; (4) purchase any security if, as a result of such purchase, more than 5% of the value of a Series' total assets would be invested in the securities of issuers which at the time of purchase had been in operation for less than three years, except obligations issued or guaranteed by the United States Government or any of its agencies or instrumentalities (for this purpose, the period of operation of any issuer shall include the period of operation of any predecessor issuer or unconditional guarantor of such issuer); (5) purchase securities with legal or
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contractual restrictions on resale ("restricted securities") (excluding
repurchase agreements), except debt securities in private placements within the
limits imposed in restriction (11) below pertaining to loans; (6) purchase or
sell real estate, except that the Series may invest in the securities of
companies whose business involves the purchase or sale of real estate, (7)
purchase securities of other investment companies, except in connection with a
merger, consolidation, acquisition or organization; (8) purchase or sell
commodities or commodity contracts; (9) purchase participations or other direct
interests in oil, gas, or other mineral exploration or development programs;
NEUBERGER BERMAN BOND SERIES The following investment policies of the Neuberger Berman Bond Series (the "Bond Series") are not fundamental. Under normal circumstances, the Bond Series will invest not less than 65% of its total assets in fixed- income debt instruments, including debt securities issued in private placements. The Series may also invest in residential and commercial real estate mortgages secured by first liens and up to 10% of the value of its total assets in common and preferred stocks. U.S. dollar denominated foreign fixed income debt securities and Canadian government securities may also be purchased. The Series may enter into financial futures contracts or options on financial futures contracts for hedging and non-hedging purposes where such is deemed in the interest of shareholders. The percentage of the Series' assets which may be invested in common and preferred stocks, as opposed to investments in fixed-income instruments, can be expected to vary from time to time in light of changes in business and market conditions, fiscal and monetary policies and underlying security values and shall be limited to securities listed on a national securities exchange or regularly traded on a national or regional basis.
The fixed income debt instruments in which the Bond Series may invest
include: (1) marketable convertible and non-convertible debt securities rated at
the time of purchase within the four highest grades assigned by Moody's (Aaa,
Aa, A or Baa) or by Standard & Poor's (AAA, AA, A or BBB) or comparable unrated
securities; (2) marketable convertible and non-convertible debt securities rated
at the time of purchase within the grades Ba or B assigned by Moody's or grades
BB or B assigned by Standard & Poor's or comparable unrated securities, limited
to a maximum of 20% of the value of the Series total net assets; (3) securities
issued or guaranteed by the United States government or its agencies or
instrumentalities; (4) U.S. dollar denominated marketable foreign securities;
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INVESTMENT RESTRICTIONS FOR THE BOND SERIES
The Bond Series has certain fundamental policies which may not be
changed without shareholder approval. As matters of fundamental investment
policy, the Bond Series may not: (1) purchase any security if, as a result of
such purchase, more than 5% of the value of the Series' total assets would be
invested in the securities of a single issuer, except securities issued or
guaranteed by the United States Government or its agencies or instrumentalities;
The following investment restrictions are not fundamental to the Bond Series. The Bond Series may not: (1) invest more than 5% of its total assets in the securities of companies with less than 3 years of continuous operation unless such securities are guaranteed by the United States, Canada or a foreign government; (2) purchase securities of open-end investment companies and may not purchase the shares of closed-end investment companies except in the open market at normal rates; (3) purchase securities on margin or make short sales unless fully covered; (4) invest more than 15% of its total assets in securities with legal or contractual restrictions on resale ("restricted securities") or otherwise illiquid securities (excluding repurchase agreements maturing in less than 7 days); (5) invest more than 5% of its total assets in puts, calls, straddles, spreads or any combination thereof (excluding options on financial futures contracts); (6) enter into a futures contract or purchase an option on a futures contract for non-hedging purposes if the initial margin deposit and premium would exceed 5% of its total assets; (7) purchase real estate or real estate limited partnerships unless acquired as a result of ownership of securities, except that it may invest in the securities of companies that own or deal in real estate; (8) purchase any securities which would cause more than 2% of the value of the Series' total assets at the time of such purchase to be invested in warrants which are not listed on the New York Stock Exchange or the American Stock Exchange, or more than 5% of the value of total assets to be invested in warrants whether or not so listed, such warrants in each case to be valued at the lesser of cost or market but assigning no value to warrants acquired by the Series in units with or attached to debt securities: (9) invest more than 20% of its total assets in high-yield, high-risk bonds (see discussion below on Certain Risk Factors Relating to High-Yield Bonds); or (10) invest more than 10% of total assets in U.S. dollar denominated foreign securities which are not publicly traded in the United States (see Risks and Considerations Applicable to Investment Securities of Foreign Issuers below).
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CERTAIN RISK FACTORS RELATING TO THE BOND SERIES INVESTMENTS HIGH YIELD BONDS. As noted above, the Bond Series may invest up to 20% of its assets in high-yield, high-risk bonds. These bonds present certain risks not normally found in the lower yield investment grade bonds: SENSITIVITY TO INTEREST RATE AND ECONOMIC CHANGES. High-yield bonds are very sensitive to adverse economic changes and corporate developments. During an economic downturn or substantial period of rising interest rates, highly leveraged issuers may experience financial stress that would adversely affect their ability to service their principal and interest payment obligations, to meet projected business goals, and to obtain additional financing. If the issue of a bond defaulted on its obligations to pay interest or principal or entered into bankruptcy proceeding, the Bond Series may incur losses or expenses in seeking recovery of amounts owed to it. In addition, periods of economic uncertainty and changes can be expected to result in increased volatility of market prices of high-yield bonds and the Bond Series' net asset value. PAYMENT EXPECTATIONS. High-yield bonds may contain redemption or call provisions. If an issuer exercised these provisions in a declining interest rate market, the Bond Series would have to replace the security with a lower yielding security, resulting in a decreased return for investors. Conversely, a high- yield bond's value will decrease in a rising interest rate market, as will the value of the Bond Series' assets. If the Bond Series experiences unexpected net redemptions, this may force it to sell high-yield bonds without regard to their investment merits, thereby decreasing the asset base upon which their expenses can be spread and possibly reducing the Bond Series' rate of return. LIQUIDITY AND VALUATION. There may be little trading in the secondary market for particular bonds, which may affect adversely the Bond Series' ability to value accurately or dispose of such bonds. Adverse publicity and investor perceptions, whether or not based on fundamental analysis, may decrease the values and liquidity of high-yield bonds, especially in a thin market. ILLIQUID SECURITIES. The Bond Series may invest up to 15% of its net assets in restricted or illiquid securities. The term "illiquid securities" for this purpose means securities that the Series may not be able to dispose of within seven days in the ordinary course of business at approximately the amount at which the Bond Series has valued the securities. Illiquid restricted securities may be sold only in privately negotiated transactions or in public offerings with respect to which a registration statement is in effect under the Securities Act of 1933. However, not all restricted securities are illiquid. In recent years a large institutional market has developed for certain securities that are not registered under the 1933 Act, including private placements, repurchase agreements, commercial paper, foreign securities and corporate bonds and notes. These instruments are often restricted securities because the securities are sold in transactions not requiring registration. Institutional investors generally will not seek to sell these instruments to the general public, but instead will often depend either on an efficient institutional market in which such unregistered securities can be readily resold or on an issuer's ability to honor a demand for repayment. Therefore, the fact that there are contractual or legal restrictions on resale to the general public or certain institutions is not dispositive of the liquidity of such investments. The Board of Trustees is responsible for establishing policies and procedures for investments in restricted securities and other illiquid securities, and the Board will monitor compliance with these policies and procedures by investment advisers to the Series. RISKS AND CONSIDERATIONS APPLICABLE TO INVESTMENT IN SECURITIES OF FOREIGN ISSUERS. Elements of risk and opportunity which must be recognized and evaluated by the Investment Adviser when investment in foreign issuers are made for the Bond Series include trade imbalances and related economic policies; expropriation or confiscatory taxation; limitation on the removal of funds or other assets, political or social instability; the diverse structure and liquidity of securities markets in various countries and regions; policies of
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governments with respect to possible nationalization of their industries; and other specific local political and economic considerations. Foreign companies and foreign investment practices are generally not subject to uniform accounting, auditing and financial reporting standards and practices or regulatory requirements comparable to those of U.S. companies. There may be less information publicly available about foreign companies. Additional costs may also be incurred in connection with the Bond Series' investment activities in the area of foreign securities. Foreign brokerage commissions are generally higher than in the United States. Administrative difficulties (such as the applicability of foreign laws to foreign custodians in various circumstances including bankruptcy, ability to recover lost assets, expropriation, nationalization, record access, etc.) may be associated with the maintenance of assets in foreign jurisdictions. BLACKROCK EQUITY SERIES The BlackRock Equity Series (the "Equity Series") invests primarily in the securities of high quality companies, including common stocks, preferred stocks, corporate bonds, notes, warrants and convertible securities. Convertible Securities - Convertible securities are fixed income securities which may be exchanged or converted into a predetermined number of the issuer's underlying common stock at the option of the holder during a specified time period. Convertible securities may take the form of convertible preferred stock, convertible bonds or debentures, units consisting of "usable" bonds and warrants or a combination of the features of several of these securities. The investment characteristics of each convertible security vary widely, which allows convertible securities to be employed for different investment objectives. The Equity Series will exchange or convert the convertible securities held in its portfolio into shares of the underlying common stock in instances in which, in the sub-adviser's opinion, the investment characteristics of the underlying common shares will assist the Series in achieving its investment objectives. Otherwise, the Series may hold or trade convertible securities. In selecting convertible securities for the Series, the sub-adviser evaluates the investment characteristics of the convertible security as a fixed income instrument, and the investment potential of the underlying equity security for capital appreciation. In evaluating these matters with respect to a particular convertible security, the sub-adviser considers numerous factors, including the economic and political outlook, the value of the security relative to other investment alternatives, trends in the determinants of the issuer's profits, and the issuer's management capability and practices. WARRANTS - Warrants are basically options to purchase common stock at a specific price (usually at a premium above the market value of the optioned common stock at issuance) valid for a specific period of time. Warrants may have a life ranging from less than a year to twenty years or may be perpetual. However, most warrants have expiration dates after which they are worthless. In addition, if the market price of the common stocks does not exceed the warrant's exercise price during the life of the warrant, the warrant will expire as worthless. Warrants have no voting rights, pay no dividends, and have no rights with respect to the assets of the corporation issuing them. The percentage increase or decrease in the market price of the warrant may tend to be great than the percentage increase or decrease in the market price of the optioned common stock. FUTURES AND OPTIONS TRANSACTIONS - As a means of reducing fluctuations in the net asset value of the Equity Series, the Series may attempt to hedge all or a portion of its portfolio by buying and selling financial futures contracts buying put options on portfolio securities and listed put options on futures contracts, and writing call options on futures contracts. The Equity Series may also write covered call options on portfolio securities to attempt to increase its current income. The Series will maintain its positions in securities, option rights, and segregated cash subject to puts and calls until the options are exercised, closed, or have expired. An option position on financial futures contracts may be closed out only on an exchange which provides a secondary market for options of the same series.
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FINANCIAL FUTURES CONTRACTS - A futures contract is a firm commitment by two parties; the seller who agrees to make delivery of the specific type of security called for in the contract ("going short") and the buyer who agrees to take delivery of the security ("going long") at a certain time in the future. Financial futures contracts call for the delivery of shares of common stocks represented in a particular index. PUT OPTIONS ON FINANCIAL FUTURES CONTRACTS - The Series may purchase listed put options on financial futures contracts. Unlike entering directly into a futures contract, which requires the purchaser to buy a financial instrument on a set date at a specified price, the purchase of a put option on a futures contract entitles (but does not obligate) its purchaser to decide on or before a future date whether to assume a short position at the specified price. Generally, if the hedged portfolio securities decrease in value during the term of a put option, the related futures contracts will also decrease in value while the put option will increase in value. In such an event, the Series will normally close out its option by selling an identical option. If the hedge is successful, the proceeds received by the Series upon the sale of the second option will be large enough to offset the decrease in value of the hedged securities. Alternatively, the Series may exercise its put option to close out the position. To do so, it would simultaneously enter into a futures contract of the type underlying the option (for a price less than the strike price of the option) and exercise the option. The Series would then deliver the futures contract in return for payment of the strike price. If the Series neither closes out nor exercises an option, the option will expire on the date provided in the option contract, and the premium paid for the contract will be lost. Call Options on Financial Futures Contracts - In addition to purchasing put options on futures, the Equity Series may write listed call options on futures contracts to hedge its portfolio. When the Series writes a call option on a futures contract, it is undertaking the obligation of assuming a short futures position (selling a futures contract) at the fixed strike price at any time during the life of the option if the option is exercised. If stock prices fall, causing the prices of futures to go down, the Series' obligation under a call option on a future (to sell a futures contract) costs less to fulfill, causing the value of the Series' call option position to increase. In other words, as the underlying futures price goes down below the strike price, the buyer of the option has no reason to exercise the call, so that the Series keeps the premium received for the option. This premium can substantially offset the drop in value of the Series' fixed income or indexed portfolio which is occurring as interest rates rise. Prior to the expiration of a call written by the Series, or exercise of it by the buyer, the Series may close out the option by buying an identical option. If the hedge is successful, the cost of the second option will be less than the premium received by the Series for the initial option. The net premium income of the Series will then substantially offset the decrease in value of the hedged securities. The Series will not maintain open positions in futures contracts it has sold or call options it has written on futures contracts if, in the aggregate, the value of the open positions (marked to market) exceeds the current market value of its securities portfolio plus or minus the unrealized gain or loss on those open positions, adjusted for the correlation of volatility between the hedged securities and the futures contracts. If this limitation is exceeded at any time, the Series will take prompt action to close out a sufficient number of open contracts to bring its open futures and options positions within this limitation. RISKS - When the Equity Series uses financial futures and options on financial futures as hedging devices, there is a risk that the process of the securities subject to the futures contracts may not correlate perfectly with the prices of the securities in the Series' portfolio. This may cause the future contract and any related options to react differently than the portfolio securities to market changes. In addition, the Series' sub-adviser could be incorrect in its expectations about the direction or extent of market factors such as stock price movements. In these events, the Series may lose money on the futures contract or option.
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It is not certain that a secondary market for positions in futures contracts or for options will exist at all times. Although the sub-adviser will consider liquidity before entering into options transactions, there is no assurance that a liquid secondary market on an exchange or otherwise will exist for any particular futures contract or option at any particular time. The Series' ability to establish and close out futures and options positions depends on this secondary market. "MARGIN" IN FUTURES TRANSACTIONS - Unlike the purchase or sale of a security, the Series does not pay or receive money upon the purchase or sale of a futures contract. Rather, the Equity Series is required to deposit an amount of "initial margin" in cash or U.S. Treasury bills with its custodian (or the broker, if legally permitted). The nature of initial margin in futures transactions is different from that of margin in securities transactions in that futures contract initial margin does not involve the borrowing of funds by the Series to finance the transactions. Initial margin is in the nature of a performance bond or good faith deposit on the contract which is returned to the Series upon termination of the futures contract, assuming all contractual obligations have been satisfied. A futures contract held by the Series is valued daily at the official settlement price of the exchange on which it is traded. Each day the Series pays or received cash, called "variation margin," equal to the daily change in value of the futures contract. This process is known as "marking to market". Variation margin does not represent a borrowing or loan by the Series but is instead settlement between the Series and the broker of the amount one would owe the other if the futures contract expired. In computing its daily net asset value, the Series will mark to market its open futures positions. The Series is also required to deposit and maintain margin when it writes call options on futures contracts. PURCHASING PUT OPTIONS ON PORTFOLIO SECURITIES - The Series may purchase put options on portfolio securities to protect against price movements in particular securities in its portfolio. A put option gives the Series, in return for a premium, the right to sell the underlying security to the writer (seller) at a specified price during the term of the option. WRITING COVERED CALL OPTIONS ON PORTFOLIO SECURITIES - The Series may also write covered call options to generate income. As a writer of a call option, the Series has the obligation upon exercise of the option during the option period to deliver the underlying security upon payment of the exercise price. The Series may only sell call options either on securities held in its portfolio or on securities which it has the right to obtain without payment of further consideration (or has segregated cash in the amount of any additional consideration). OVER-THE-COUNTER OPTIONS - The Series may purchase and write over-the-counter options on portfolio securities in negotiated transactions with the buyers or writers of the options for those options on portfolio securities held by the Series and not traded on an exchange. Over-the-counter options are two party contracts with prices and terms negotiated between buyer and seller. In contrast, exchange-traded options are third party contracts with standardized strike prices and expiration dates and are purchased from a clearing corporation. Exchange-traded options generally have a continuous liquid market while over-the-counter options may not. U.S. GOVERNMENT OBLIGATIONS - The types of U.S. government obligations in which the Series may invest are described below under "U.S. Government Income Series". COMMERCIAL PAPER - The Series may invest in commercial paper rated at least A-1 by Standard & Poor's Corporation, or Prime-1 by Moody's Investors Service, Inc., or F-1 by Fitch Investors Service, Inc., and money market instruments (including commercial paper) which are unrated but of comparable
10
quality, including Canadian Commercial Paper ("CCPs") and Europaper. In the case where commercial paper, CCPs or Europaper has received different ratings from different rating services, such commercial paper, CCPs or Europaper is an acceptable investment so long as at least one rating is one of the preceding high quality ratings and provided the sub-adviser has determined that such investment presents minimal credit risks. BANK INSTRUMENTS - The Series may invest in the instruments of banks and savings and loans whose deposits are insured by the Bank Insurance Fund ("BIF"), both of which are administered by the Federal Deposit Insurance Corporation ("FDIC"), or the Savings Association Insurance Fund ("SAIF"), which is administered by the FDIC, such as certificates of deposit, demand and time deposits, savings shares, and bankers' acceptances (which are not necessarily guaranteed by SIF or SAIF). In addition to domestic bank obligations such as certificates of deposit, demand and time deposits, savings shares, and bankers' acceptance, the Series may invest in: o Eurodollar Certificates of Deposit ("ECDs") issued by foreign branches of U.S. or foreign banks; o Eurodollar Time Deposits ("ETDs"), which are U.S. dollar-denominated deposits in foreign branches of U.S. or foreign banks; o Canadian Time Deposits, which are U.S. dollar-denominated deposits issued by branches of major Canadian banks located in the United States; and o Yankee Certificates of Deposit ("Yankee CDs"), which are U.S. dollar-denominated certificates of deposits issued by U.S. branches of foreign banks and held in the United States. INVESTMENT RISKS ECDs, ETDs, Yankee CDs, and Europaper are subject to different risks than domestic obligations of domestic banks or corporations. Examples of these risks include international economic and political developments, foreign governmental restrictions that may adversely affect the payment of principal or interest, foreign withholding or other taxes on interest income, difficulties in obtaining or enforcing a judgment against the issuing entity, and the possible impact of interruptions in the flow of international currency transactions. Different risks may also exist for ECDs, ETDs, and Yankee CDs because the banks issuing these instruments, or their domestic or foreign branches, are not necessarily subject to the same regulatory requirements that apply to domestic banks, such as reserve requirements, loan limitations, examinations, accounting, auditing, record keeping, and the public availability of information. These factors will be carefully considered by the Equity Series' sub-adviser in selecting investments for the Series. WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS - These transactions are arrangements in which the Equity Series purchases securities with payment and delivery scheduled for a future time. The Series engages in when-issued and delayed delivery transactions only for the purpose of acquiring portfolio securities consistent with the Series' investment objective and policies, not for investment leverage. In when-issued and delayed delivery transactions, the Series relies on the seller to complete the transaction. The seller's failure to complete the transaction may cause the Series to miss a price or yield considered to be advantageous. These transactions are made to secure what is considered to be an advantageous price or yield for the Series. Settlement dates may be a month or more after entering into these transactions, and the market values of the securities purchased may vary from the purchase prices. No fees or other expenses, other than normal transaction costs, are incurred. However, liquid assets of the Series sufficient to make payment for the securities to be purchased are segregated on the Series' records at the trade date. These securities are marked to market daily and maintained until the transaction is settled.
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RESTRICTED AND ILLIQUID SECURITIES - The Series intends to invest in restricted securities. Restricted securities are any securities in which the Series may otherwise invest pursuant to its investment objective and policies but which are subject to restriction on resale under federal securities law. However, the Series will limit investments in illiquid securities, including certain restricted securities not determined by the Trustees to be liquid, non-negotiable time deposits, and repurchase agreements providing for settlement in more than seven days after notice, to 10% of its net assets. The Series may invest in commercial paper issued in reliance on the exemption from registration afforded by Section 4(2) of the Securities Act of 1933. Section 4(2) commercial paper is restricted as to disposition under federal securities law and is generally sold to institutional investors, such as the Series, who agree that they are purchasing the paper for investment purposes and not with a view to public distribution. Any resale by the purchaser must be in an exempt transaction. Section 4(2) commercial paper is normally resold to other institutional investors like the Series through or with the assistance of the issuer or investment dealers who make a market in Section 4(2) commercial paper, thus providing liquidity. The Series believes that Section 4(2) commercial paper and possibly certain other restricted securities which meet the criteria for liquidity established by the Board of Trustees are liquid. The Series intends, therefore, to treat the restricted securities which meet the criteria for liquidity established by the Trustees, including Section 4(2) commercial paper, as determined by the sub-adviser, as liquid and not subject to the investment limitation applicable to illiquid securities. In addition, because such Section 4(2) commercial paper is liquid, the Series intends to not subject such paper to the limitation applicable to restricted securities. The Board of Trustees is responsible for establishing policies and procedures for investments in restricted securities and other illiquid securities, and the Board will monitor compliance with these policies and procedures by investment advisers to the Series. REPURCHASE AGREEMENTS - The Series or its custodian will take possession of the securities subject to repurchase agreements, and these securities will be marked to market daily. In the event that a defaulting seller filed for bankruptcy or became insolvent, disposition of such securities by the Series might be delayed pending court action. The Series believes that under the regular procedures normally in effect for custody of the Series' portfolio securities subject to repurchase agreements, a court of competent jurisdiction would rule in favor of the Series and allow retention or disposition of such securities. The Series will only enter into repurchase agreements with banks and other recognized financial institutions such as broker/dealers which are deemed by the sub-adviser to be creditworthy pursuant to guidelines established by the Trustees. REVERSE REPURCHASE AGREEMENTS - The Series may also enter into reverse repurchase agreements. These transactions are similar to borrowing cash. In a reverse repurchase agreement, the Series transfers possession of a portfolio instrument to another person, such as a financial institution, broker, or dealer, in return for a percentage of the instrument's market value in cash, and agrees that on a stipulated date in the future the Series will repurchase the portfolio instrument by remitting the original consideration plus interest at an agreed upon rate. The use of reverse repurchase agreements may enable the Series to avoid selling portfolio instruments at a time when a sale may be deemed to be disadvantageous, but the ability to enter into reverse repurchase agreements does not ensure that the Series will be able to avoid selling portfolio instruments at a disadvantageous time. When effecting reverse repurchase agreements, liquid assets of the Series, in a dollar amount sufficient to make payment for the obligations to be purchased, are segregated on the Series' records at the trade date. These securities are marked to market daily and maintained until the transaction is settled.
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LENDING OF PORTFOLIO SECURITIES - The collateral received when the Equity Series lends portfolio securities must be valued daily and, should the market value of the loaned securities increase, the borrower must furnish additional collateral to the Series. During the time portfolio securities are on loan, the borrower pays the Series any dividends or interest paid on such securities. Loans are subject to termination at the option of the Series or the borrower. The Series may pay a negotiated portion of the interest earned on the cash or equivalent collateral to the borrower or placing broker. The Series does not have the right to vote securities on loan, but would terminate the loan and regain the right to vote if that were considered important with respect to the investment. BLACKROCK U.S. GOVERNMENT INCOME SERIES The BlackRock U.S. Government Income Series (the "Government Income Series") invests primarily in securities which are guaranteed as to payment of principal and interest by the U.S. government or its instrumentalities. U.S. GOVERNMENT OBLIGATIONS - The types of U.S. government obligations in which the Series may invest generally include direct obligations of the U.S. Treasury (such as U.S. Treasury bills, notes, and bonds) and obligations issued or guaranteed by U.S. government agencies or instrumentalities. These securities are backed by: (1) the full faith and credit of the U.S. Treasury; (2) the issuer's right to borrow from the U.S. Treasury; (3) the discretionary authority of the U.S. government to purchase certain obligations of agencies or instrumentalities; or (4) the credit of the agency or instrumentality issuing the obligations. Examples of agencies and instrumentalities which may not always receive financial support from the U.S. government are: Federal Land Banks; Central Bank for Cooperatives; Federal Intermediate Credit Banks; Federal Home Loan Banks; Farmers Home Association; and Federal National Mortgage Association. COLLATERALIZED MORTGAGE OBLIGATIONS (CMOs) - Privately issued CMOs generally represent an ownership Interest in federal agency mortgage pass-through securities such as those issued by the Government National Mortgage Association. The terms and characteristics of the mortgage instruments may vary among pass-through mortgage loan pools. The market for such CMOs has expanded considerably since its inception. The size of the primary issuance market and the active participation in the secondary market by securities dealers and other investors make government-related pools highly liquid. ADJUSTABLE RATE MORTGAGE SECURITIES (ARMS) - Like other U.S. government securities, the market value of ARMS will generally vary inversely with changes in market interest rates. Thus, the market value of ARMS generally declines when interest rates rise and generally rises when interest rates decline. While ARMS generally entail less risk of a decline during periods of rapidly rising rates, ARMS may also have less potential for capital appreciation than other similar investments (e.g., investments with comparable maturities) because as interest rates decline, the likelihood increases that mortgages will be prepaid. Furthermore, if ARMS are purchased at a premium, mortgage foreclosures and unscheduled principal payments result in some loss of a holder's principal investment to the extent of the premium paid. Conversely, if ARMS are purchased at a discount, both a scheduled payment of principal and an unscheduled prepayment of principal would increase current and total returns. WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS - These transactions are arrangements in which the U.S. Government Income Series purchases securities with payment and delivery scheduled for a future time. The Series engages in when-issued and delayed delivery transactions only for the purpose of acquiring portfolio securities consistent with the Series' investment objective and policies, not for investment leverage. In when-issued and delayed delivery transactions, the Series relies on the seller to complete the transaction. The seller's failure to complete the transaction may cause the Series to miss a price or yield considered to be advantageous.
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These transactions are made to secure what is considered to be an advantageous price or yield for the Series. Settlement dates may be a month or more after entering into these transactions, and the market values of the securities purchased may vary from the purchase prices. No fees or other expenses, other than normal transaction costs, are incurred. However, liquid assets of the Series sufficient to make payment for the securities to be purchased are segregated on the Series' records at the trade date. These securities are marked to market daily and maintained until the transaction is settled. REPURCHASE AGREEMENTS - The Series or its custodian will take possession of the securities subject to repurchase agreements, and these securities will be marked to market daily. In the event that a defaulting seller filed for bankruptcy or became insolvent, disposition of such securities by the Series might be delayed pending court action. The Series believes that under the regular procedures normally in effect for custody of the Series' portfolio securities subject to repurchase agreements, a court of competent jurisdiction would rule in favor of the Series and allow retention or disposition of such securities. The Series will only enter into repurchase agreements with banks and other recognized financial institutions such as broker/dealers which are deemed by the sub-adviser to be creditworthy pursuant to guidelines established by the Trustees. REVERSE REPURCHASE AGREEMENTS - The Series may also enter into reverse repurchase agreements. These transactions are similar to borrowing cash. In a reverse repurchase agreement, the Series transfers possession of a portfolio instrument to another person, such as a financial institution, broker, or dealer, in return for a percentage of the instrument's market value in cash, and agrees that on a stipulated date in the future the Series will repurchase the portfolio instrument by remitting the original consideration plus interest at an agreed upon rate. The use of reverse repurchase agreements may enable the Series to avoid selling portfolio instruments at a time when a sale may be deemed to be disadvantageous, but the ability to enter into reverse repurchase agreements does not ensure that the Series will be able to avoid selling portfolio instruments at a disadvantageous time. When effecting reverse repurchase agreements, liquid assets of the Series, in a dollar amount sufficient to make payment for the obligations to be purchased, are segregated on the Series' records at the trade date. These securities are marked to market daily and maintained until the transaction is settled. LENDING OF PORTFOLIO SECURITIES - The collateral received when the U.S. Government Income Series lends portfolio securities must be valued daily and, should the market value of the loaned securities increase, the borrower must furnish additional collateral to the Series. During the time portfolio securities are on loan, the borrower pays the Series any dividends or interest paid on such securities. Loans are subject to termination at the option of the Series or the borrower. The Series may pay reasonable administrative and custodial fees in connection with a loan and may pay a negotiated portion of the interest earned on the cash or equivalent collateral to the borrower or placing broker. The Series does not have the right to vote securities on loan, but would terminate the loan and regain the right to vote if that were considered important with respect to the investment. INVESTMENT RESTRICTIONS FOR THE EQUITY SERIES AND U.S. GOVERNMENT INCOME SERIES The investment restrictions of the Series described below are fundamental policies that may not be changed without the approval of at least a majority of the outstanding shares of a Series or of 67% of the shares of a Series represented at a meeting of shareholders at which the holders of 50% or more of the outstanding shares of the Series are represented. As a matter of fundamental policy, neither Series may: (1) issue senior securities except that the Series may borrow money directly or through reverse repurchase agreements in amounts up to one-third of the value of its net assets, including the amount borrowed (the Series will not borrow money or engage in reverse repurchase agreements for investment leverage, but rather as a temporary, extraordinary, or emergency measure or to facilitate management of the portfolio by enabling the Series to meet redemption requests when the
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liquidation of portfolio securities is deemed to be inconvenient or
disadvantageous. The Series will not purchase any securities while any
borrowings in excess of 5% of its total assets are outstanding. During the
period any reverse repurchase agreements are outstanding, the Series will
restrict the purchase of portfolio securities to money market instruments
maturing on or before the expiration date of the reverse repurchase agreements,
but only to the extent necessary to assure completion of the reverse repurchase
agreements); (2) purchase any securities on margin, but may obtain such
short-term credits as are necessary for clearance of purchases and sales of
securities (the deposit or payment by the Series of initial or variation margin
in connection with financial futures contracts or related options transactions
is not considered the purchase of a security on margin); (3) mortgage, pledge,
or hypothecate any assets, except to secure permitted borrowings (in those
cases, it may pledge assets having a value of 15% of its assets taken at cost.
Margin deposits for the purchase and sale of financial futures contracts and
related options are not deemed to be a pledge); (4) lend any of its assets
except portfolio securities up to one-third of the value of its total assets
(this shall not prevent the Series from purchasing or holding bonds, debentures,
notes, certificates of indebtedness, or other debt securities, entering into
repurchase agreements, or engaging in other transactions where permitted by the
Series' investment objective, policy, and limitations or Declaration of Trust);
The above limitations cannot be changed without shareholder approval. The following limitations for the Equity and U.S. Government Income Series, however, may be changed by the Trustees without shareholder approval. Shareholders will be notified before any material change in these limitation becomes effective. Under these limitations, neither Series securities, including repurchase agreements providing for settlement in more than seven days after notice and certain restricted securities determined by the Trustees not to be liquid; (2) invest in other investment companies to the extent of more than 3% of the total outstanding voting stock of any investment company, invest more than 5% of its total assets in any one investment company, or invest more than 10% of its total assets in investment companies in general (a Series will purchase securities of closed-end investment companies only in open market transactions involving only customary broker's commissions. However, these limitations are not applicable if the securities are acquired in a merger, consolidation, reorganization or acquisition of assets); (3) invest more than 5% of the value of its total assets in securities of issuers which have records of less than three years of continuous operations, including the operation of any predecessor; (4) purchase or retain the securities of any issuer if the officers and Trustees of the Trust or its investment adviser, owning individually more than 1/2 of 1% of the issuer's securities, together own more than 5% of the issuer's securities; (5) purchase interests in oil, gas, or other mineral exploration or development programs or leases, although it may invest in the securities of issuers which invest in or sponsor such programs; (6) in the case of the Equity Series, purchase securities of a company for the purpose of exercising control or management; (7) invest more than 5% of its net assets in warrants, including those acquired in units or attached to other securities For purposes of this investment restriction, warrants will be valued at the lower of cost or market, except that warrants acquired by the Series in units with or
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attached to securities may be deemed to be without value); (8) enter into transactions for the purpose of engaging in arbitrage; (9) purchase put options on securities unless the securities are held in the Series' portfolio and not more than 5% of the value of the Series' total assets would be invested in premiums on open put option positions; (10) write call options on securities unless the securities are held in its portfolio or unless the Series is entitled to them in deliverable form without further payment or after segregating cash in the amount of any further payment, or (11) sell securities short unless (a) it owns, or has right to acquire, an equal amount of such securities, or (b) it has segregated an amount of its other assets equal to the lesser of the market value of the securities sold short or the amount required to acquire such securities. (The segregated amount will not exceed 10% of the Series' net assets. While in a short position, the Series will retain the securities, rights, or segregated assets). Except with respect to borrowing money, if a percentage limitation is adhered to at the time of investment, a later increase or decrease in percentage resulting from any change in value or net assets will not result in a violation of such restriction. REPURCHASE AGREEMENTS The T. Rowe Price Growth and Income Series and the Bond Series may invest in repurchase agreements. A repurchase agreement is an instrument through which an investor (such as a Series) purchases a security from a bank with an agreement by the seller to repurchase the security at the same price, plus interest at a specified rate. The underlying securities are limited to those which would otherwise qualify for investment by the Series. Repurchase agreements usually have a short duration, often less than one week. As a fundamental investment policy of the T. Rowe Price Growth and Income Series, the Series will not will enter into a repurchase agreement of a duration of more than seven business days if, as a result, more than 10% of the value of the Series' total assets would be so invested. As a non-fundamental policy of the Bond Series, the Series will not invest more than 10% of its assets in repurchase agreements maturing in more than seven days. Neither of the Series will enter into repurchase agreements with securities dealers unless the Series has been advised by legal counsel that such a transaction would not constitute a purchase of an interest in such a dealer under section 12(d)(3) of the Investment Company Act of 1940. INVESTMENT ADVISER AND OTHER SERVICES The following sets forth certain additional information concerning Met Investors Advisory Corp. ("Met Investors"), formerly known as Security First Investment Management Corporation ("Security Management"), the investment adviser for the Series; T. Rowe Price Associates, Inc. ("Price Associates"), the sub-adviser to Met Investors for the T. Rowe Price Growth and Income; Neuberger Berman, the sub-advisor to the Bond Series; and BlackRock Financial Management, Inc. ("BlackRock"), the sub-adviser to Security Management for the Equity Series and the U.S. Government Income Series. MET INVESTORS AND THE ADVISORY AGREEMENTS Met Investors serves as the investment adviser to the T. Rowe Price Growth and Income Series and the Bond Series, pursuant to a Master Investment Management and Advisory Agreement dated October 30, 1997 and serves as the investment adviser to the Equity Series and the U.S. Government Income Series pursuant to a Master Investment Management and Advisory Agreement dated March 27, 1998 ("the Advisory Agreements"). Met Investors was incorporated in Delaware on December 6, 1973 and is a wholly-owned subsidiary of Security First Group, Inc., also a Delaware corporation. Met Investors and Security First Group, Inc. maintain their principal places of business at 11365 West Olympic Boulevard, Los Angeles California 90064. The common stock of Security First Group is currently wholly owned by a subsidiary of Metropolitan Life Insurance Company, a New York life insurance company. Met Investors also acts as investment adviser to an affiliated insurance company, Security First Life Insurance Company.
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The Advisory Agreements provide that Met Investors is responsible for supervising and directing the investments of each of the Series in accordance with the investment objectives of each. Pursuant to the Advisory Agreements, Met Investors shall obtain and evaluate information relating to the economy, industries, business, securities markets, and particular issues of securities. In addition, Met Investors agrees to formulate and implement a continuing program for the management of each of the Series' assets, give investment advice and manage the investment and reinvestment of the Series' securities. Met Investors's obligations include the making and execution of investment decisions, and the placement of orders for the purchase and sale of securities with or through such brokers, dealers or issuers as Security Management may select. Met Investors is also authorized to enter into sub-advisory agreements with third parties for the provision of investment advice to Met Investors relating to each Series' portfolio of securities, investments, cash and other properties. Under the Advisory Agreements, the Trust will assume and pay legal and independent accounting and auditing expenses of the Trust, costs related to reports, notices and proxy material, compensation and expense of disinterested trustees, share issuance expenses, expenses of custodians, transfer agents and registrars, brokers' commissions, all taxes and fees payable to governmental agencies, expenses of shareholders' and trustees' meetings and interest expenses. Met Investors will be responsible for paying all expenses and charges not assumed by the Trust. The Advisory Agreements provide that Met Investors, its officers, directors and employees shall not be liable for any error of judgment, mistake of law, or loss suffered by the Trust, while rendering services under the Agreements, except for loss resulting from willful misfeasance, bad faith, gross negligence in the performance of their duties on behalf of the Trust or reckless disregard of their duties and obligations under the Agreements. For its services to the T. Rowe Price Growth and Income Series and Bond Series, Met Investors receives from the Trust fees computed by using an annual rate of .50% (1/2 of 1%) based on the average daily net assets of each of the Series. Such compensation is accrued daily and payable monthly. For its services to the Equity Series and U.S. Government Income Series, Security Management receives from the Trust fees computed by using an annual rate of 70% and .55%, respectively, of the average daily net assets of the respective Series. Such compensation is accrued daily and payable monthly. For the fiscal year ended July 31, 2000, management fees of $1,714,097 ($514,229 after payment of subadvisory fees) were paid by the T. Rowe Price Growth and Income Series to Met Investors. During the fiscal year ended July 31, 2000, management fees in the amount of $121,324 ($36,397 after payment of the subadvisory fee) were earned by Met Investors from the Bond Series. In regard to the U.S. Government Income Series, for the fiscal year ended July 31, 2000, Met Investors earned advisory fees of $178,490 ($48,679 after payment of subadvisory fees). In regard to the Equity Series, for the fiscal year ended July 31, 2000, Met Investors earned advisory fees of $418,770 ($89,739 after payment of subadvisory fees). Each Advisory Agreement provides that it will remain in effect for an initial term of two years from its initial effective date and will continue in effect from year to year thereafter as to each Series provided that such continuance is specifically approved at least annually by the Board of Trustees (at a meeting called for that purpose), or by vote of a majority of the outstanding shares of each Series. In either case, renewal of the Advisory Agreement must be approved by a majority of the Trust's independent Trustees. Each Advisory Agreement provides that it will terminate automatically if assigned and that it may be terminated as to a particular Series without penalty by either party upon 60 days' prior written notice to the other party, provided that termination by the Trust must be authorized by a resolution of a majority of the Board of Trustees or by a vote of a majority of the outstanding shares of the affected Series.
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PRICE ASSOCIATES AND THE PRICE SUB-ADVISORY AGREEMENT Price Associates serves as sub-adviser to Met Investors with respect to the T. Rowe Price Growth and Income Series pursuant to a Sub-Advisory Agreement (the "Price Sub-Advisory Agreement") dated October 30, 1997. Price Associates is a Maryland corporation which was incorporated in 1947, as the successor to the investment counseling business founded by the late Mr. T. Rowe Price in 1937. Its principal offices are located at 100 East Pratt Street, Baltimore, Maryland 21202. Price Associates and its subsidiaries serve as investment advisers to individual and institutional investors (including mutual funds) with total net assets under supervision of approximately $179.6 billion as of September 30, 2000. Price Associates is registered as an investment adviser under the Investment Advisers Act of 1940. Under the Price Sub-Advisory Agreement Price Associates provides investment management services to the T. Rowe Price Growth and Income Series. Price Associates has the discretion to purchase or sell securities on behalf of the Trust in accordance with the Trust's investment objectives or restrictions and to communicate with brokers, dealers, custodians or other parties on behalf of the Trust and to allocate brokerage or obtain research services. In performing these services, Price Associates must obtain and evaluate information relating to the economy, industries, business, securities markets and securities as it may deem necessary, and it must formulate and implement a continuing plan for performance of its services. The Price Sub-Advisory Agreement provides that Price Associates, its officers, directors and employees shall not be liable for any error of judgment, mistake of law, or loss suffered by the Trust, while rendering services under the Agreement, except for loss resulting from willful misfeasance, bad faith, gross negligence in the performance of their duties on behalf of the Trust or reckless disregard of their duties and obligations under the Price Sub-Advisory Agreement. For its services, Price Associates receives a fee from Security Management computed by using an annual rate of .35% based on the average daily net assets of the T. Rowe Price Growth and Income Series. Such compensation is accrued daily and payable monthly. For the fiscal year ended July 31, 2000, Price Associates received advisory fees from the T. Rowe Price Growth and Income Series of $1,199,868. For the fiscal year ended July 31, 2000, the ratios of total expenses to average net assets for this Series was .55%. The Price Sub-Advisory Agreement provides that it will remain in effect for an initial term of two years and will continue in effect from year to year thereafter as to each Series, provided that such continuance is specifically approved at least annually by the Board of Trustees (at a meeting called for that purpose), or by vote of a majority of the outstanding shares of each Series. In either case, renewal of the Price Sub-Advisory Agreement must be approved by a majority of the Trust's independent Trustees. The Price Sub-Advisory Agreement provides that it will terminate automatically if assigned and that it may be terminated without penalty by either party or by a Series of the Trust upon 60 days prior written notice to the other party, provided that termination by a Series of the Trust must be authorized by a resolution of a majority of the Board of Trustees or by a vote of a majority of the outstanding shares of the Series of the Trust. No single shareholder owns beneficially more than 10% of the stock of Price Associates. NEUBERGER BERMAN AND NEUBERGER BERMAN SUB-ADVISORY AGREEMENT Neuberger Berman was founded in 1939 to manage assets for high net worth individuals. It is an investment adviser registered as such with the Securities and Exchange Commission ("SEC") under the Investment Advisers Act of 1940. It is also registered with the SEC as a broker-dealer under the Securities Exchange Act of 1934, and is a member of the New York Stock Exchange. Its offices are located at 605 Third Avenue, New York, New York 10158. Currently, it provides
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investment management services to a wide variety of clients, including individuals, investment companies, pension and profit-sharing plans, trusts and charitable organizations, and has approximately $54.4 billion in assets under its management for clients as of December 31, 1999. Under the Neuberger Berman Sub-Advisory Agreement, dated October 30, 1997, Neuberger Berman provides investment management services to the Bond Series. Neuberger Berman has the discretion to purchase or sell securities on behalf of the Trust in accordance with the Trust's investment objectives or restrictions and to communicate with brokers, dealers, custodians or other parties on behalf of the Trust and to allocate brokerage or obtain research services. In performing these services, Neuberger Berman must obtain and evaluate information relating to the economy, industries, business, securities markets and securities as it may deem necessary, and it must formulate and implement a continuing plan for performance of its services. The Neuberger Berman Sub-Advisory Agreement provides that Neuberger Berman, its officers, directors and employees shall not be liable for any error of judgment, mistake of law, or loss suffered by the Trust, while rendering services under the Agreement, except for loss resulting from willful misfeasance, bad faith, gross negligence in the performance of their duties on behalf of the Trust or reckless disregard of their duties and obligations under the Neuberger Berman Sub-Advisory Agreement. For its services, Neuberger Berman receives a fee from Security Management computed by using an annual rate of .35% based on the average daily net assets of the Bond Series. Such compensation is accrued daily and payable monthly. Neuberger Berman began providing sub-advisory services to the Bond Series on July 15, 1997. In the fiscal year ended July 31, 2000, Neuberger Berman received advisory fees of $84,927. The Neuberger Berman Sub-Advisory Agreement provides that it will remain in effect for an initial term of two years and will continue in effect from year to year thereafter as to the Bond Series, provided that such continuance is specifically approved at least annually by the Board of Trustees (at a meeting called for that purpose), or by vote of a majority of the outstanding shares of each Series. In either case, renewal of the Neuberger Berman Sub-Advisory Agreement must be approved by a majority of the Trust's independent Trustees. The Neuberger Berman Sub-Advisory Agreement provides that it will terminate automatically if assigned and that it may be terminated without penalty by either party or by a Series of the Trust upon 60 days prior written notice to the other party, provided that termination by a Series of the Trust must be authorized by a resolution of a majority of the Board of Trustees or by a vote of a majority of the outstanding shares of the Series of the Trust. BLACKROCK AND THE BLACKROCK SUB-ADVISORY AGREEMENT BlackRock serves as sub-adviser to Met Investors with respect to the Equity Series and U.S. Government Income Series pursuant to sub-advisory agreements (the "BlackRock Sub-Advisory Agreements") dated March 27, 1998. BlackRock is a wholly-owned subsidiary of BlackRock, Inc., which is subsidiary of PNC Bank, N.A. The principal offices of BlackRock and BlackRock, Inc. are located at 345 Park Avenue, New York, New York 10154, with additional offices in Philadelphia, Wilmington, Edinburgh and Tokyo. BlackRock, Inc. is a fully integrated money management firm with global fixed income, equity and cash management capabilities. As of December 31, 1999, BlackRock, Inc. And its subsidiaries managed or administered approximately $165 billion in assets.
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As compensation for providing services under the BlackRock Sub-Advisory Agreements, BlackRock receives from Met Investors fees computed by using an annual rate of 0.55% based on average daily assets of the Equity Series and an annual rate of 0.40% based on the average daily net assets of the U.S. Government Income Series. These fees are accrued daily, and paid monthly. Under the BlackRock Sub-Advisory Agreements BlackRock provides investment management services to the Equity Series and U.S. Government Income Series. BlackRock has the discretion to purchase or sell securities on behalf of the Series in accordance with the Series' investment objectives or restrictions and to communicate with brokers, dealers, custodians or other parties on behalf of the Series and to allocate brokerage or obtain research services. In performing these services, BlackRock must obtain and evaluate information relating to the economy, industries, business, securities markets and securities as it may deem necessary, and it must formulate and implement a continuing plan for performance of its services. The BlackRock Sub-Advisory Agreements provide that BlackRock and its officers, directors and employees shall not be liable for any error of judgment, mistake of law, or loss suffered by the Trust, while rendering services under the BlackRock Sub-Advisory Agreements, except for loss resulting from willful misfeasance, bad faith, gross negligence in the performance of their duties on behalf of the Trust or reckless disregard of their duties and obligations. During the fiscal year ended July 31, 2000, BlackRock earned a sub-advisor fee of $329,031 from the Equity Series. During the same period, BlackRock earned a sub-advisor fee of $129,811 from the U.S. Government Income Series. The BlackRock Sub-Advisory Agreements provide that it will remain in effect for an initial term of two years and will continue in effect from year to year thereafter, provided that such continuance is specifically approved at least annually by the Board of Trustees (at a meeting called for that purpose), or by vote of a majority of the outstanding shares of the Series. In either case, renewal of the BlackRock Sub-Advisory Agreement must be approved by a majority of the Trust's independent Trustees. The BlackRock Sub-Advisory Agreement provides that it will terminate automatically if assigned and that it may be terminated without penalty by either party or by the relevant Series upon 60 days prior written notice to the other party, provided that termination by the Series must be authorized by a resolution of a majority of the Board of Trustees or by a vote of a majority of the outstanding shares of the Series. PRINCIPAL HOLDERS OF SECURITIES Security First Life Separate Account A, the depositor of which is the Security First Life Insurance Company, has entered into a participation agreement with the Trust for the purchase of Series shares at net asset value. As of July 31, 2000, Security First Life Separate Account A was the owner of 99.51% of the outstanding shares of Bond Series, 99.51% of the outstanding shares of the T. Rowe Price Growth & Income Series and 100% of the outstanding shares of the Equity Series and U.S. Government Income Series. The address of Security First Life Separate Account A, and the depositor, Security First Life Insurance Company, is 11365 West Olympic Boulevard, Los Angeles, California 90064.
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MANAGEMENT OF THE TRUST The Trustees are responsible for managing the Trust's business affairs and for exercising all the Trust's powers except those reserved for the shareholders. Information about each Trustee is provided below and includes each person's name, address, age, present position(s) held with the Trust, principal occupations for the past five years and positions held prior to the past five years, total compensation received as a Trustee from the Trust for its most recent fiscal year
Each disinterested Trustee receives a Trustee's fee of $7,000 per year, $1,000 for each Trustees' meeting attended and reimbursement of expenses. Ms. Eagle is also Senior Vice President, Finance of Met Investors. Mr. Pearson is also President of Met Investors. Mr. Turner is also Vice President, Taxation and Assistant Secretary of Met Investors. Ms. Finney is also Vice President, and Assistant Secretary of Met Investors. * Interested Trustee
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BROKERAGE Decisions with respect to the purchase and sale of portfolio securities on behalf of the Trust are made by Met Investors pursuant to the terms of the Advisory Agreement. However, pursuant to the terms of the Sub-Advisory Agreements, Price Associates, Neuberger Berman and BlackRock may allocate brokerage and principal business or obtain research services from organizations with which the Trust or Met Investors may be dealing. Met Investors is ultimately responsible for implementing these decisions, including the allocation of principal business and portfolio brokerage and the negotiation of commissions. In purchasing and selling the Series' portfolio securities, it is Met Investors's, Price Associates', Neuberger Berman's and BlackRock's policies to seek quality execution at the most favorable prices through responsible broker-dealers and, in the case of agency transactions, at competitive commission rates. However, under certain conditions and with the exception of the Bond Series advised by Neuberger Berman, a Series may pay higher brokerage commissions in return for brokerage and research services. In selecting broker-dealers to execute a Series' portfolio transactions, consideration will be given to such factors as the price of the security, the rate of commission, the size and difficulty of the order, the reliability integrity, financial condition, general execution and operational capabilities of competing broker-dealers, and brokerage and research services which they provide to Met Investors, Price Associates, Neuberger Berman, BlackRock or the Series. Met Investors, Price Associates or BlackRock may cause a Series to pay a broker-dealer who furnishes brokerage and/or research services a commission that is in excess of the commission another broker-dealer would have received for executing the transaction if it is determined that such commission is reasonable in relation to the value of the brokerage and/or research services which have been provided. This determination may be viewed in terms of either that particular transaction or the overall responsibilities of Security Management, Price Associates and BlackRock with respect to the accounts over which they exercise investment discretion. In some cases, research services are generated by third parties, but are provided to Met Investors, Price Associates, Neuberger Berman or BlackRock by or through broker-dealers. Price Associates, Neuberger Berman and BlackRock may effect principal transactions on behalf of a Series with a broker-dealer who furnishes brokerage and/or research services, designate any such broker-dealer to receive selling concessions, discounts or other allowances, or otherwise deal with any such broker-dealer in connection with the acquisition of securities in underwritings. Additionally, purchases and sales of fixed income securities are transacted with the issuer, the issuer's underwriter, or with a primary market maker acting as principal or agent. The Trust does not usually pay brokerage commissions for these purchases and sales, although the price of the securities generally includes compensation which is not disclosed separately. The prices the Trust pays to underwriters of newly-issued securities usually include a concession paid by the issuer to the underwriter. Transactions placed through dealers who are serving as primary market makers reflect the spread between the bid and asked prices. Met Investors, Price Associates, Neuberger Berman and BlackRock receive a wide range of research services from broker-dealers including information on securities markets, the economy, individual companies, statistical information, accounting and tax law interpretations, technical market action, pricing and appraisal services, and credit analysis. Research services are received primarily in the form of written reports, telephone contacts, personal meetings with security analysts, corporate and industry spokespersons, economists, academicians, government representatives, and access to various computer-generated data. Research services received from broker-dealers are supplemental to Met Investors's, Price Associates', Neuberger Berman's and BlackRock's own research efforts and, when utilized, are subject to internal analysis before being incorporated into the investment process.
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Each year Met Investors, Price Associates, Neuberger Berman and BlackRock assess the contribution of the brokerage and research services provided by broker-dealers and allocate a portion of the brokerage business of their clients on the basis of these assessments. In addition, broker-dealers sometimes suggest a level of business they would like to receive in return for the various brokerage and research services they provide. Actual brokerage received by any firm may be less than the suggested allocations, but can (and often does) exceed the suggestions because total brokerage is allocated on the basis of all the considerations described above. In no instance is a broker-dealer excluded from receiving business because it has not been identified as providing research services. Met Investors, Price Associates, Neuberger Berman and BlackRock cannot readily determine the extent to which commissions or net prices charged by broker-dealers reflect the value of their unsolicited research services. In some instances, Met Investors and/or Price Associates, and/or Neuberger Berman and/or BlackRock will receive research services they might otherwise have had to perform for themselves. The research services provided by broker-dealers can be useful to Met Investors, Price Associates, Neuberger Berman and BlackRock in serving their other clients, but they can also be useful in serving the Trust. Met Investors, Price Associates, Neuberger Berman and BlackRock do not allocate business to any broker- dealer on the basis of its efforts in promoting sales of shares of the Series. However, this does not mean that such broker-dealers will not receive business from the Trust. Some of Price Associates', Neuberger Berman's or BlackRock's other clients have investment objectives and programs similar to one or more of the Series. They may occasionally make recommendations to other clients which result in their purchasing or selling securities simultaneously with a Series. As a result, the demand for securities being purchased or the supply of securities being sold may increase, and this could have an adverse effect on the price of those securities. It is Price Associates', Neuberger Berman's and BlackRock's policy not to favor one client over another in making recommendations or in placing orders. If two or more clients are purchasing or selling a given security on the same day from or to the same broker-dealer, the advisor may average the price of the transactions and allocate the average among the clients participating in the transaction. Price Associates has established a general investment policy that it will ordinarily not make additional purchases of a common stock of a company for its clients (including the T. Rowe Price Funds) if, as a result of such purchases, 10% or more of the outstanding common stock of such company would be held by its clients in the aggregate. All brokerage commissions will be allocated by Price Associates, Neuberger Berman and BlackRock according to the foregoing policies. The T. Rowe Price Growth and Income Series paid brokerage commissions to securities dealers in connection with underwritings during the fiscal year ended July 31, 2000, of $162,871. The Equity Series paid brokerage commissions to securities dealers during that fiscal year of $97,806. The Bond Series and U.S. Government Income Series did not pay any brokerage commissions or discounts to securities dealers in that fiscal year. PORTFOLIO TURNOVER The portfolio turnover rate can be expected to be higher during periods of rapidly changing economic or market conditions than in a more stable period. Portfolio turnover may be defined as the ratio of the total dollar amount of the lesser of the purchase or sales of securities to the monthly average value of portfolio securities owned by the Trust. The portfolio turnover rate for the T. Rowe Price Growth and Income Series for the fiscal year ended July 31, 2000, was 16%. The portfolio turnover rate for the Bond Series for the fiscal year ended July 31, 2000, was 177%. The portfolio turnover rate during said period for the Equity Series was 83%. The portfolio turnover rate for the U.S. Government Income Series for said period was 159%. High portfolio turnover involved correspondingly greater brokerage commissions, to the extent such commissions are payable, and other transaction costs that are borne directly by the Series involved. Higher turnover rates reflect an increased rate of realization of gains and losses by the Series,
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which would normally affect the taxable income of the Series' shareholders. Where the shareholder is an insurance company separate account funding variable annuity contracts, qualified as such under the Internal Revenue Code ("Code"), however, the contract owners are not currently charged with such income or losses except to the extent provided under the Code (normally when distributions under the contracts are made). PRICING AND REDEMPTION OF SECURITIES BEING OFFERED DETERMINING NET ASSET VALUE The net asset value per share of each Series is determined by dividing the value of the Series' securities, plus any cash and other assets (including dividends and interest accrued and not collected), less all liabilities (including accrued expenses), by the number of shares outstanding. T. ROWE PRICE GROWTH AND INCOME AND BOND SERIES
Debt securities other than convertible securities and short-term
obligations are valued at prices obtained for the day of valuation from a bond
pricing service of a major dealer in bonds, when such prices are available.
However, when such prices are not available and where Met Investors deems it
appropriate to do so, an over-the-counter or exchange quotation may be used. The
market value of the Series' other portfolio securities is determined as follows:
EQUITY AND U.S. GOVERNMENT INCOME SERIES The market values of the Series' portfolio securities are determined as follows: o for equity securities, according to the last sale price on a national securities exchange, if available; o in the absence of recorded sales for listed equity securities, according to the mean between the last closing bid and asked prices; o for unlisted equity securities, the latest bid prices; o for bonds and other fixed income securities, as determined by an independent pricing service; o for short-term obligations, according to the mean between bid and asked prices as furnished by an independent pricing service or for short-term obligations with maturities of less than 60 days, at amortized cost; or o for all other securities, at fair value as determined in good faith by the Board of Trustees. The Series will value future contracts, options, put options on futures and financial futures at their market values established by the exchanges at the close of option trading on such exchanges unless the Board determines in good faith that another method of valuing option positions is necessary to appraise their fair value.
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REDEMPTION OF SHARES The Trust will redeem shares at the net asset value per share next to be determined after receipt of a duly executed request for redemption. Redemption of shares or payment may be suspended at times (i) when the New York Stock Exchange is closed other than customary weekends and holidays, (ii) when trading on said exchange is restricted, (iii) when an emergency (as determined by the Securities and Exchange Commission) exists, making disposal of portfolio securities or the valuation of net assets of the Series not reasonably practicable, or (iv) when the Securities and Exchange Commission has by order permitted such suspension for the protection of shareholders of the Trust. The Trust's redemption procedures will not be changed without prior notice to shareholders. TAXATION Under the Code, each of the Series is treated as a separate regulated investment company provided the qualification requirements of Subchapter M are otherwise met. As a regulated investment company, a Series will not be subject to federal income tax on net investment income and capital gains (short- and long-term), if any, that it distributes to its shareholders if at least 90% of its net investment income and net short-term capital gains for the taxable year is distributed.
In order to qualify as a regulated investment company under the Code, a
Series must, among other things, (a) derive at least 90% of its gross income
from dividends, interest, payments with respect to securities loans, gains from
the sale or other disposition of stocks or securities, or other income
In addition to the diversification requirements contained in the Trust's investment restrictions, the Trust is also subject to diversification requirements applicable to variable annuities under Section 817(h) of the Code. Under this section, a variable annuity will not receive the tax treatment afforded annuities if its underlying investments are not adequately diversified. Under applicable regulations, no more than 55% of total assets can be invested in one investment, 70% in two investments, 80% in three investments and 90% in four investments. Investments are generally defined as securities issued by any one issuer. U.S. Government agencies or instrumentalities are considered separate issuers. Unlike public shareholders, under the Code a life insurance company separate account will not incur any federal income tax liability on dividends and capital gains distributions received from a regulated investment company by a separate account funding variable annuity contracts as defined in section 817(d) of the Code. To the extent that there is in excess of $250,000 invested in a Series other than through variable contract premium payment, the Code imposes a 4% nondeductible excise tax on the undistributed income of such Series to the extent the Series does not distribute at least 98% of its net investment income and its net capital gains (both long- and short-term) for each taxable year by the end of such year. For purposes of the 4% excise tax, dividends and distributions will be treated as paid when actually distributed, except that dividends declared in December payable to shareholders of record on a specified date in December, and paid before February 1 of the following year, will be treated as having been (i) paid by the Series on the record date and (ii) received by each shareholder on such date. Net capital gains realized for the one year period ending on October 31 of each tax year are subject to distribution in this manner. Series which do not have in excess of $250,000 invested other than through variable contract premium payments are not subject to the above described 4% excise tax. Each Series will send written notices to its shareholders (Separate Accounts) regarding the tax status of all distributions made during each taxable year.
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BOND RATINGS MOODY'S INVESTORS SERVICE, INC. Bonds which are rated Aaa are judged to be of the best quality. They carry the smallest degree of investment risk and are generally referred to as "gilt edge." Interest payments are protected by a large or 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. Bonds which are rated Aa are judged to be of high quality by all standards. Together with the Aaa group they comprise what are generally known as high grade bonds. They are rated lower than the best bonds because margins of protection may not be as large as in Aaa securities or fluctuation of protective elements may be of greater amplitude, or there may be other elements present which make the long-term risks appear somewhat larger than in Aaa securities. Bonds which are rated A possess many favorable investment attributes and are to be considered as upper medium grade obligations. Factors giving security to principal and interest are considered adequate but elements may be present which suggest a susceptibility to impairment sometime in the future.
Bonds which are rated Baa are considered as medium grade obligations,
STANDARD & POOR'S CORPORATION Bonds rated AAA have the highest rating assigned by Standard & Poor's to a debt obligation. Capacity to pay interest and repay principal is extremely strong. Bonds rated AA have a very strong capacity to pay interest and repay principal, and differs from the higher-rated issues only in small degree. Bonds rated A have a strong capacity to pay interest and repay principal, although they are somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than bonds in higher-rated categories. Bonds rated BBB are regarded as having an adequate capacity to pay interest and repay principal. Whereas they normally exhibit adequate protection parameters, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity to pay interest and repay principal for bonds in this category than for bonds In higher- rated categories. FITCH INVESTORS SERVICE, INC. Fitch's investment grade bond ratings are summarized as follows: AAA - Bonds considered to be investment grade and of the highest credit quality. The obligor has an exceptionally strong ability to pay interest and repay principal, which is unlikely to be affected by reasonably foreseeable events; AA Bonds considered to be investment grade and of very high credit quality. The obligors' ability to pay interest and repay principal is very strong, although not quite as strong as bonds rated 'AAA'. Because bonds rated in the 'AAA' and 'AA' categories are not significantly vulnerable to foreseeable future developments, short-term debt of these issuers is generally rated 'F-1+'; A - Bonds considered to be investment grade and of high credit quality. The obligor's ability to pay interest and repay principal is considered to be strong, but may be more vulnerable to adverse changes in economic conditions and circumstances than bonds with higher ratings; BBB - Bonds considered to be investment grade and of
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satisfactory credit quality. The obligors' ability to pay interest and repay principal is considered to be adequate. Adverse changes in economic conditions and circumstances, however, are more likely to have adverse impact on these bonds, and therefore impair timely payment. The likelihood that the ratings of these bonds will fall below investment grade is higher than for bonds with higher ratings. Plus (+) Minus (-) - Plus and minus signs are used with a rating symbol to indicate the relative position of a credit within the rating category. Plus and minus signs, however, are not used in the 'AAA' category. COMMERCIAL PAPER RATINGS MOODY'S INVESTORS SERVICE, INC. Moody's employs the following three designations, all judged to be of investment grade, to indicate the relative repayment ability of rated issuers:
Issuers rated Prime-1 (or supporting institutions) have a superior
ability for repayment of senior short-term debt obligations. Prime-1 repayment
ability will often be evidenced by many of the following characteristics:
Issuers rated Prime-2 (or supporting institutions) have a strong ability for repayment of senior short-term debt 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, may 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 supporting institutions) have an acceptable ability for repayment of senior short- term obligations. The effect of industry characteristics and market compositions may be more pronounced. Variability in earnings and profitability may result in changes in the level of debt protection measurements and may require relatively high financial leverage. Adequate alternate liquidity is maintained. STANDARD & POOR'S CORPORATION A Standard & Poor's commercial paper rating is a current assessment of the likelihood of timely payment of debt considered short-term in the relevant market. Ratings are graded into several categories, ranging from "A-1" for the highest quality obligations to "D" for the lowest. Categories A-1, A-2 and A-3 are as follows: A-1--This highest category indicates that the degree of safety regarding timely payment is strong. Those issues determined to possess extremely strong safety characteristics are denoted with a plus (+) sign designation; A-2--Capacity for timely payments on issues with this designation is satisfactory. However, the relative degree of safety is not as high as for issues designated "A-1"; and A-3--Issues carrying this designation have adequate capacity for timely payment. They are, however, more vulnerable to the adverse effects of changes In circumstances than obligations carrying the higher designations. CUSTODIAN The Bank of New York (the "Custodian"), 1 Wall Street, New York, New York 10286, serves as the Trust's custodian. Pursuant to the terms of the Custodian Agreement executed with the Trust, the Trust will forward to the Custodian the proceeds of each purchase of Series shares. The Custodian will
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hold such proceeds and make disbursements therefrom in accordance with the terms of the Custodian Agreement. It will retain possession of the securities purchased with such proceeds and maintain appropriate records with respect to receipt and disbursements of money, receipt and release of securities, and all other transactions of the Custodian with respect to the securities and other assets of the Series. The Custodian Agreement provides that each of the Series shall pay to the Custodian compensation for its services, in accordance with the Custodian's regularly established rate schedule. Said compensation shall be computed on the basis of the Series' average daily net assets payable as of the end of each month. The Custodian Agreement may be terminated by either the Trust or the Custodian upon 60 days' written notice to the other party. Such termination shall not be in contravention of any applicable federal or state laws or regulations, or any provision of the Trust Declaration or By-Laws. INDEPENDENT AUDITORS The financial statements of Security First Trust at July 31, 1999, and July 31, 2000, and for the periods indicated in this report appearing in this Statement of Additional Information and Registration Statement have been audited by Deloitte & Touche LLP, independent auditors, as set forth in their report appearing elsewhere in the registration statement, and is included in reliance upon their report of such firm given upon their authority as experts in accounting and auditing. The consolidated financials statements and the related financial statements schedules of Security First Trust at July 31, 1998, 1997 and 1996 included elsewhere in the registration statement have been audited by Ernst & Young LLP, independent auditors, as stated in their reports appearing elsewhere in the registration statement, and are included in reliance upon the reports of such firm given upon their authority as experts in accounting and auditing. FEDERAL REGISTRATION OF SHARES The Trust's shares are registered for sale under the Securities Act of 1933. LEGAL COUNSEL Sullivan & Worcester LLP, whose address is 1025 Connecticut Avenue N.W., Washington, D.C. 20036, is legal counsel to the Trust.
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February 11, 2000 LETTER FROM THE PRESIDENT Dear contract holder: It has been more than a year now since the world began counting down the days to January 1, 2000 and the looming Y2K computer issue. The opinions of what might happen varied from those who passed Y2K off as nothing but media hysteria to those who truly believed we were facing a global Armageddon. Well, I am thankful to report that the New Year uneventfully came and passed, and the world celebrated the arrival of the year 2000 with much jubilation. We at Cova were especially glad to see the New Year come as we anxiously awaited the closing of the acquisition of the Cova companies by Metropolitan Life Insurance Company. As you are probably aware, Metropolitan announced their intention to purchase the Cova companies on August 26, 1999. The transaction was completed on January 6, 2000, and as I draft this letter, I am pleased to announce that Cova is now a MetLife company. For Cova, this transaction meant that we would be affiliated with the largest life insurance company in North America, with more than $400 billion in assets under management and more than $1.7 trillion of life insurance in force. For Cova and its contract holders, being affiliated with MetLife resulted in immediate benefits as Cova's ratings were quickly upgraded by the following rating agencies once the closing was announced:
With the deal now behind us, we enter into a planning stage to determine how we can capitalize on the synergies that exist between the Cova companies and MetLife. For MetLife, this means a partnership with a company characterized by award-winning service as well as by the value we bring to our contract holders. For Cova, this means access to a wealth of resources offered by MetLife. We look forward to a prosperous and enterprising future as a MetLife company--a future that will allow us to offer even greater value to you--our contract holders. Of course, it is to our contract holders that we provide this annual report of the fund managers in the Cova Series Trust. Also enclosed is the financial report for the General American Capital Company Money Market Fund. We thank you for placing your long-term retirement needs in the hands of Cova.
Sincerely,
[Cova logo] [GRAPHIC OMITTED]
Small Cap Stock Portfolio For the year ended 12/31/99
Managed by J.P. Morgan Investment Management
The Small Cap Stock Portfolio finished the year strong up 44.56%. The fund outperformed its benchmark, the Russell 2000 Index1 in the year ending December 31,1999. The broad small cap market narrowly edged past the S&P 500 for the year. The Russell 2000 Index was up 21.26% for the 12 months ending December 31, 1999, while the S&P 5002 returned 21.04% over the same period. Once again growth indices dominated by technology shares led the market, while value stocks lagged. The Russell 2000 Growth Index3 was up 43.09% for the 12 month period versus the Russell 2000 index +21.26% and the Russell 2000 Value Index4, -1.49%. The portfolio's outperformance can be attributed to stock selection and sector allocation. The decision to overweight in the technology sector allowed the portfolio to end the year well ahead of the benchmark. For the past twelve months, SDL Inc. (+1,000.3%), a company that manufactures semiconductor lasers and fiber optic products had the biggest impact on portfolio performance. The company rallied in-line with other tech infrastructure companies that enhance broadband capabilities. Orbital Sciences Corp. (-57.8%), a company that designs and manufactures space and information systems, was the largest detractor to performance over the past 12 months due to earnings shortfalls and accounting restatements. Though the portfolio went into year-end with significant overweighted positions in both technology and communications companies, over the month of December we began trimming these positions. We've shifted more assets into the consumer services and insurance sectors, which we believe are attractively valued, relative to their long-term earnings potential. The portfolio remains highly diversified and well positioned for a broadening in the market. On a valuation basis, our internal valuation tools, as well as current price-to-earnings ratios, are still near historical extremes in favor of small caps. Given both the prolonged underperformance of the small-cap market and relative valuation, we continue to believe small-cap stocks are undervalued relative to large-cap stocks. In addition we believe that the portfolio, which is highly diversified, is well positioned to absorb volatility. 1 The Russell 2000 Index is an unmanaged index consisting of the stocks of 2000 U.S.-based companies. The Index does not include fees or expenses and is not available for direct investment. 2 The S&P 500 Index is an unmanaged index consisting of stocks of 500 of the largest U.S.-based companies. The Index does not include fees or expenses and is not available for direct investment. 3 The Russell 2000 Growth Index is an unmanaged index and measures the performance of those Russell 2000 companies with higher price-to-book ratios and higher forecasted growth values. The index does not include fees or expenses and is not available for direct investment. 4 The Russell 2000 Value Index measures the performance of those Russell 2000 companies with lower price-to-book ratios and lower forecasted growth values. This index does not include fees or expenses and is not available for direct investment.
Marian U. Pardo
J.P. Morgan Investment Management Inc.
+Performance is shown from date of initial public offering, May 1, 1996. 1 "Average Annual Return" is calculated including reinvestment of all income dividends and capital gain distributions. Results represent past performance and do not indicate future results. The value of an investment in the Small Cap Stock Portfolio managed by J.P. Morgan Investment Management (JPMIM) and the return on the investment will fluctuate, and redemption proceeds may be higher or lower than an investor's original cost. Performance data is historical and includes changes in share price and reinvestment of dividends and capital gains. Performance numbers are net of all Portfolio operating expenses, but they do not include the administrative fee, the insurance risk charge, the annual contract maintenance charge or the 5% withdrawal charge imposed by the Cova variable annuity contract. If this performance information included the effect of the insurance charges, performance numbers would be lower. Graph prepared by Cova. The index returns in the graph above were generated by CDA Wiesenberger HySales software. Comparison line graphs chart the hypothetical growth of $10,000 over a given historical period of time. Although data are gathered from reliable sources, accuracy and completeness cannot be guaranteed.
Quality Bond Portfolio For the year ended 12/31/99
Managed by J.P. Morgan Investment Management
The Quality Bond Portfolio provided a total return of -1.54% for the year ending December 31, 1999. The Salomon Broad Investment Grade Index1 returned -0.84% for the same time period. Bond yields ended the year sharply higher as investors reassessed the strengthening economy and anticipated tighter monetary policy after the Y2K turn. Consumption continued to grow rapidly as third quarter final GDP at 5.7% was revised almost a full percentage point above the original estimate. The strong equity rally in December suggests the Fed's tightening action thus far will do little to stem economic growth. Low unemployment, firm wage laws, together with the unprecedented external deficit, imply the need to slow the economy to a more sustainable pace, even in the absence of any significant consumer price pressures. The Salomon BIG Index fell 0.2% for the quarter bringing the full year decline to -0.8%. Earlier in the year, the Portfolio was conservatively positioned in corporate bonds and held a heavy allocation to mortgage backed securities. In addition we maintained an overweight position in AAA rated agency debenture bonds. Towards the end of the year, the Portfolio's largest positions, vis-a-vis the major aggregate indexes, reflected our positive outlook on mortgages relative to U.S. Treasuries. The corporate sector outperformed Treasuries during the last quarter. This was primarily due to the abatement of Y2K fears in the market and the presence of buyers who had built up cash and were stretching for yield ahead of the first quarter. The Portfolio was modestly overweighted in the corporate sector and we remained comfortable with the overweight position in anticipation of a strong economic backdrop and light near-term supply. Following the late October Fed tightening and their move to neutral bias, Treasury yields fell by approximately 30 basis points. With the view that this move put yields below justifiable levels, we shifted the Portfolio's duration position early in November from neutral to a modest short position relative to the index. We maintained this duration position through the end of the year. With little sign of any material slowing in U.S. growth, aside from some moderation in the construction sector, the U.S. bond market lacked fundamental support at year-end. Strong business and consumer confidence, a robust equity market and very buoyant labor market suggest the need for additional Fed policy tightening. The market continues to discount an insufficient amount of tightening this year in order to slow the economy to an acceptable pace. As a result, we expect to continue to remain defensive in the first half of next year in terms of the Portfolio's duration positions as U.S.Treasury yields should continue to move higher. 1 The Salomon Brothers Broad Investment-Grade Bond Index (BIG) is a market-capitalized weighted index that includes fixed-rate Treasury, government sponsored, corporate (Baa3/BBB or better) and mortgage securities. The Index is not available for direct investment and does not reflect any expenses.
Harriet T. Huber
+Performance is shown from date of initial public offering, May 1, 1996. 1 "Average Annual Return" is calculated including reinvestment of all income dividends and capital gain distributions. Results represent past performance and do not indicate future results. The value of an investment in the Quality Bond Portfolio managed by J.P. Morgan Investment Management (JPMIM) and the return on the investment will fluctuate, and redemption proceeds may be higher or lower than an investor's original cost. Performance data is historical and includes changes in share price and reinvestment of dividends and capital gains. Performance numbers are net of all Portfolio operating expenses, but they do not include the administrative fee, the insurance risk charge, the annual contract maintenance charge or the 5% withdrawal charge imposed by the Cova variable annuity contract. If this performance information included the effect of the insurance charges, performance numbers would be lower. Graph prepared by Cova. The index returns in the graph above were generated by CDA Wiesenberger HySales software. Comparison line graphs chart the hypothetical growth of $10,000 over a given historical period of time. Although data are gathered from reliable sources, accuracy and completeness cannot be guaranteed.
Select Equity Portfolio For the year ended 12/31/99
Managed by J.P. Morgan Investment Management
The Select Equity Portfolio returned 9.71% for the year ended December 31,1999. Our investment approach, which selects stocks which are the most undervalued relative to their longer term earnings and cash flow prospects, proved less effective in a market fiercely driven by price momentum. The confluence of a strong economy, abundant liquidity, and high investor confidence going into the Year 2000 rollover fueled a stunning year-end rally. Stocks surged during the final quarter of 1999, leading the major indexes to close out the millennium at record highs. Still, despite outstanding performance in the broader market averages, 1999 was a turbulent year with significant dispersion in returns between sectors and investment styles. Once again, growth outperformed value, large-cap stocks outperformed small-cap stocks, and technology stocks, despite a difficult first half, delivered spectacular performance for the year. Internet obsession led the technology sector to jump 109% -- a stunning achievement, particularly following last year's gain of 78%. Technology now accounts for 30% of the market capitalization of the S&P 500 index.1 By contrast, six of the sixteen sectors we track actually lost value during 1999: consumer staples (-12.9%), utilities (-9.7%), transportation (-9.6%), drugs (-9.3%), health service (-7.8%), and consumer cyclical (-7.8%). Indeed, fully 49.5% of the stocks in the S&P 500 finished the year lower. This explains why an equal-weighted version of the index would have produced roughly one-half the index return, or 11.9%, for the year. Like the market, the sector performance within the fund showed both a wide distribution of individual returns and a narrow concentration of outperforming issues. Stock selection among technology issues was particularly beneficial. Sun Microsystems gained 262% while Internet optimism also propelled holdings in Cisco Systems (+131%) and EMC Corp (+116%). Improving semiconductor supply/demand characteristics, together with explosive growth in wireless communications, powered Texas Instruments shares 126% higher. Underweighting PC makers Dell and Compaq, which underperformed during the year, also contributed to results. On the other hand, stock picks in the multi-industry group performed poorly. Waste Management was the worst performer in the portfolio, losing 63% of its value as it restated earnings and lowered forecasts. Underweighting GE, whose 54% gain accounted for almost 10% of the rise in the S&P 500 index, also hurt results. The strength of high-profile equity indexes despite notable increases in bond yields and measured price inflation was arguably the defining feature of the financial market action in 1999. The Federal Reserve's active pursuit of a generous monetary policy on the eve of the calendar date change to 2000, coincident with high investor confidence, produced this result. Going forward, we believe the medium-term goal will be tighter, not easier, monetary conditions. Rising interest rates should curb euphoric consumer confidence and spending, and could dampen upside potential for U.S. stocks. Technology may be particularly vulnerable in this scenario, since stocks in this sector trade at 2.5 times the market multiple and currently claim over 80% of net domestic mutual fund inflows.
Peggy Adams
J.P. Morgan Investment Management Inc. 1 The S&P 500 Index is an unmanaged index consisting of stocks of 500 of the largest U.S.-based companies. The Index does not include fees or expenses and is not available for direct investment.
+Performance is shown from date of initial public offering, May 1, 1996. 1 "Average Annual Return" is calculated including reinvestment of all income dividends and capital gain distributions. Results represent past performance and do not indicate future results. The value of an investment in the Select Equity Portfolio managed by J.P. Morgan Investment Management (JPMIM) and the return on the investment will fluctuate, and redemption proceeds may be higher or lower than an investor's original cost. Performance data is historical and includes changes in share price and reinvestment of dividends and capital gains. Performance numbers are net of all Portfolio operating expenses, but they do not include the administrative fee, the insurance risk charge, the annual contract maintenance charge or the 5% withdrawal charge imposed by the Cova variable annuity contract. If this performance information included the effect of the insurance charges, performance numbers would be lower. Graph prepared by Cova. The index returns in the graph above were generated by CDA Wiesenberger HySales software. Comparison line graphs chart the hypothetical growth of $10,000 over a given historical period of time. Although data are gathered from reliable sources, accuracy and completeness cannot be guaranteed.
Large Cap Stock Portfolio For the year ended 12/31/99
Managed by J.P. Morgan Investment Management
The Large Cap Stock Portfolio returned 17.64% for the year ended December 31,1999. The S&P 5001 returned 21.04% during this period, posting record highs by climbing to a record 1,469.25 for the year. After a strong 1998 and first half of 1999, the third and fourth quarters were difficult ones for the Large Cap Stock Portfolio. In the second half of the year, the equity market reverted back to a very narrow group of outperforming stocks as investors sought out the companies with positive earnings and price momentum. During the latter half of the year, investors tended to focus on short-term earnings, projecting them forward indefinitely, which was a challenge to the performance of the portfolio. The investment strategy employed by the portfolio focuses on normalized earnings and intermediate growth rates, thus it tended to be challenged by the unprecedented market environment that we experienced during the latter part of the year. In addition, while the portfolio is well diversified and its risk controls are robust, during times of extreme internal market divergence, even modest exposures to common risk factors such as price momentum can result in out of scale performance results. Finally, our analysts depend on accurate financial data from the companies that they cover to set their earnings forecasts. Companies that look attractive to our analysts are overweighted in the portfolio and in some instances, less than candid disclosures by company management followed by divergent reported earnings resulted in a sharp correction in stock prices. In particular, underperformance in the second half of the year was led by Waste Management, which was overweighted and detracted from relative performance due to the accounting issues discussed above. Strong relative performance in the tech sector added to performance but was more than offset by challenges from the Services sector (primarily due to an overweight in Service Corp.) and Insurance (an underweight in AIG and an overweight in UnumProvident was pressed by the market's momentum buying in AIG). Additionally, difficulty with American Home Products and diet pill litigation also hurt performance. We remain confident in our investment process and risk controls, and expect that the historically wide spread between the most and least attractive names in our universe suggests opportunities ahead. 1 The S&P 500 Index is an unmanaged index consisting of stocks of 500 of the largest U.S.-based companies. The Index does not include fees or expenses and is not available for direct investment.
John M. Devlin, Jr.
+Performance is shown from date of initial public offering, May 1, 1996. 1 "Average Annual Return" is calculated including reinvestment of all income dividends and capital gain distributions. Results represent past performance and do not indicate future results. The value of an investment in the Large Cap Stock Portfolio managed by J.P. Morgan Investment Management (JPMIM) and the return on the investment will fluctuate, and redemption proceeds may be higher or lower than an investor's original cost. Performance data is historical and includes changes in share price and reinvestment of dividends and capital gains. Performance numbers are net of all Portfolio operating expenses, but they do not include the administrative fee, the insurance risk charge, the annual contract maintenance charge or the 5% withdrawal charge imposed by the Cova variable annuity contract. If this performance information included the effect of the insurance charges, performance numbers would be lower. Graph prepared by Cova. The index returns in the graph above were generated by CDA Wiesenberger HySales software. Comparison line graphs chart the hypothetical growth of $10,000 over a given historical period of time. Although data are gathered from reliable sources, accuracy and completeness cannot be guaranteed.
International Equity Portfolio For the year ended 12/31/99
Managed by J.P. Morgan Investment Management
The International Equity Portfolio returned 28.52% for the year-end December 31, 1999. The Portfolio outperformed the benchmark, MSCI EAFE Index1, which returned 27.30% for the same time period. This outperformance reflects added value from stock selection in all major regions: the United Kingdom, continental Europe, and particularly Japan. Japan was the best performer amongst the major markets, reflecting both the surprising strength of its economy as well as signs of corporate restructuring. Two of our Japanese holdings that performed quite well were Softbank, the technology company with Internet interests, and Sony, which has transformed itself from an audio-visual hardware manufacturer to an entertainment conglomerate with its PlayStation. Another holding, Mitsubishi Chemical has been increasingly proactive in managing costs and improving profitability. Amongst the smaller markets, Hong Kong and Singapore did particularly well, with the surprising strength of the Asia region's recovery driving the returns to levels that even outperformed Japan. Looking forward, the prospect of a further round of monetary policy tightening by central banks in the first quarter may dampen sentiment towards equities. However, the background of continuing global economic growth is supportive. In the UK we believe economic growth is set to continue, although the prospect of further interest rate increases is likely to prove to be a dampening effect. As for vulnerability in respect to Federal tightening, the Japanese central bank will maintain an easy monetary policy, but the market may pause after a strong 1999. Continental Europe continues to look attractive with low inflation and a strong improvement in corporate earnings. There is also still significant potential for corporate restructuring, and the expectation of a high level of mergers and acquisition and initial public offering activity. 1 The Morgan Stanley Capital International Europe, Australia and Far East Index is an unmanaged index and is an aggregate of 15 individual country indexes that collectively represent many of the major markets of the world. The Index does not include fees or expenses and is not available for direct investment.
Nigel Emmett
Portfolio Managers
+Performance is shown from date of initial public offering, May 1, 1996. 1 "Average Annual Return" is calculated including reinvestment of all income dividends and capital gain distributions. Results represent past performance and do not indicate future results. The value of an investment in the International Equity Portfolio managed by J.P. Morgan Investment Management (JPMIM) and the return on the investment will fluctuate, and redemption proceeds may be higher or lower than an investor's original cost. Performance data is historical and includes changes in share price and reinvestment of dividends and capital gains. Performance numbers are net of all Portfolio operating expenses, but they do not include the administrative fee, the insurance risk charge, the annual contract maintenance charge or the 5% withdrawal charge imposed by the Cova variable annuity contract. If this performance information included the effect of the insurance charges, performance numbers would be lower. Graph prepared by Cova. The index returns in the graph above were generated by CDA Wiesenberger HySales software. Comparison line graphs chart the hypothetical growth of $10,000 over a given historical period of time. Although data are gathered from reliable sources, accuracy and completeness cannot be guaranteed.
Bond Debenture Portfolio For the year ended 12/31/99
Managed by Lord, Abbett & Co.
Market Review 1999 was a difficult year for bond investors. Interest rates began to rise during the first and second quarter of 1999 on the heels of exceptional U.S. economic growth. Despite little hard evidence of increasing wages or rising basic materials costs, the strength of the U.S. economy sparked concerns about a surge in inflation. Given these conditions, the U.S. Federal Reserve Board increased its key, short-term interest rate three separate times in 1999. Throughout the year, inflationary fears continued to plague the bond market. Investors worried that continued growth in the U.S. economy and rising oil prices would spark inflation even though excess capacity in industrial materials, a competitive world economy, high productivity, and low unemployment were still prominent. This tug of war between continued U.S. economic growth and the fear of escalating inflation resulted in one of the flattest bond markets in recent years, and many bond prices ended the year in decline. The notion that additional interest rate increases may lie ahead merely added to the ills of the U.S. bond market. Portfolio Review Overall, high-yield bonds held up better than government bonds despite challenging market conditions and the fact that interest rates rose 200 basis points (2%) during the past 15 months. The Portfolio's focus on high-yield/lower-rated bonds enabled it to perform well when compared to traditional government or investment-grade bond portfolios. Throughout the year, over 65% of the Portfolio consisted of high-yield bonds in order to take advantage of the tremendous yield advantages over Treasuries. Convertible securities, which posted solid returns as the stock market advanced, helped boost the Portfolio's performance. We continued to find good value in the technology, drug, telecommunications and media sectors. We maintained our moderate exposure to mortgage-backed securities, investing mainly in new, higher coupon FNMA bonds that were acquired at discount prices. If inflation remains in check, we may increase our exposure to these mortgage securities in lieu of Treasuries. Outlook We believe that the economy is experiencing a return to the inflation levels we had before the global deflationary prices of 1998, rather than a new level of high inflation. We will continue to be watchful of the Fed in light of talks of a rate hike in early 2000. However, we feel that bonds represent excellent value given today's level of inflation, and will continue to be attractive if the inflation level remains in the area of 2-3%. While in the short term we do not anticipate a meaningful decline in interest rates, we remain encouraged by signs such as lower housing starts, low inflation, and a U.S. government budget surplus. Typically, these signs indicate that the U.S. economy is slowing -- a factor which would bode well for the bond markets.
Christopher J. Towle
+Performance is shown from date of initial public offering, May 1, 1996. 1 "Average Annual Return" is calculated including reinvestment of all income dividends and capital gain distributions. Results represent past performance and do not indicate future results. The value of an investment in the Bond Debenture Portfolio managed by Lord Abbett and the return on the investment will fluctuate, and redemption proceeds may be higher or lower than an investor's original cost. 2 The First Boston High Yield Index is representative of the lower rated debt (including straight-preferred stocks) investments in the portfolio; the Merrill Lynch All Convertible Index is representative of the equity-related securities in the portfolio; and Salomon Brothers Broad Investment High Grade Index is representative of the high-grade debt in the portfolio. The three indices chosen have elements of these three categories, but since there is no one index combining all three categories, these three separate indices may not be a valid comparison for the Portfolio. You may not directly invest in any of these indices. The indices do not reflect any expenses. Performance data is historical and includes changes in share price and reinvestment of dividends and capital gains. Performance numbers are net of all Portfolio operating expenses, but they do not include the administrative fee, the insurance risk charge, the annual contract maintenance charge or the 5% withdrawal charge imposed by the Cova variable annuity contract. If this performance information included the effect of the insurance charges, performance numbers would be lower. Graph prepared by Cova. The index returns in the graph above were generated by CDA Wiesenberger HySales software and Bloomberg. Comparison line graphs chart the hypothetical growth of $10,000 over a given historical period of time. Although data are gathered from reliable sources, accuracy and completeness cannot be guaranteed.
Mid-Cap Value Portfolio For the year ended 12/31/99
Managed by Lord, Abbett & Co.
Market Review After a tough start in early 1999, value investors were rewarded briefly in the second quarter as performance in the stock market broadened out after several quarters of very narrow leadership. The stocks of mid-sized companies handily outperformed the large-cap growth stocks that had dominated the attention of investors. Stocks then retreated during the third quarter as fears of rising interest rates and slower earnings growth dampened investors' enthusiasm. Market leadership again narrowed and only a few specific industries were able to post gains. Performance across various market indices was similar, unlike earlier in the year when large capitalization stocks were the dominant leaders. Once again, stocks snapped back in the final quarter of the year. However, only a narrow group of high performers continued to dominate the market as the stocks of technology and communication companies overwhelmed the performance of the broader indices. As evidence, the S&P Mid-Cap 400 BARRA Value Index (mid-sized companies whose stocks are considered "value" oriented) was up only 2.3% for 1999, while the S&P Mid-Cap 400 BARRA Growth Index (mid-sized companies whose stocks are considered "growth" oriented) advanced by 28.7%.1 Portfolio Review Technology stocks performed strongly throughout the year and, consistent with the overall market, the Portfolio benefited from its technology holdings. Investments in the electric utilities sector performed well as a result of a trend toward deregulation in the industry. Energy stocks were among the best performers during the third quarter, and the Portfolio benefited from its overweighting in this sector. Financial stocks were among the weakest performers. We consciously reduced the Portfolio's exposure to banks and other financial companies in 1998 and benefited in early 1999 from that decision. However, the few financial company stocks that we held (primarily insurance companies) provided positive contributions as fears of aggressive interest rate hikes by the Federal Reserve moderated and the prospect for insurance industry price hikes improved late in the year. Despite the bounce back in financials, we will probably remain underweighted in this group, as we see few catalysts to drive strong performance in this sector. Outlook With stocks of mid-sized companies selling at appealing discounts in comparison to large-company stocks and with many mid-sized companies displaying strong fundamentals and promising business developments, we believe the potential reward opportunities in the mid-cap value market are excellent. In our opinion, the greater risk now exists in stocks that have experienced the strongest recent performance; primarily large companies with strong expected earnings growth and technology companies. We feel these stocks have become very expensive relative to their fundamental business characteristics. We expect that a trend favoring value stocks will resume in 2000. We look forward to executing our research-driven, value-based investment strategy in such an environment.
Edward von der Linde
1The S&P Mid-Cap 400 Index consists of 400 domestic stocks chosen for market size, liquidity, and industry group representation. The S&P/BARRA Growth and Value Indexes are constructed by dividing the stocks in an index according to a single attribute: book-to-price ratio. This splits the index into two mutually exclusive groups designed to track two of the predominant investment styles in the U.S. equity market. The Value Index contains stocks with higher book-to-price ratios; conversely, the Growth Index includes stocks with lower book-to-price ratios. Indices cited are unmanaged, do not reflect the deduction of fees or expenses and are not available for direct investment.
+Index is shown from the first full month since Portfolio's inception. 1 "Average Annual Return" is calculated including reinvestment of all income dividends and capital gain distributions. Results represent past performance and do not indicate future results. The value of an investment in the Mid-Cap Value Portfolio managed by Lord Abbett and the return on the investment will fluctuate, and redemption proceeds may be higher or lower than an investor's original cost. 2 The Russell Midcap Index measures the performance of the 800 smallest securities in the Russell 1000 Index, which represent approximately 35% of the total market capitalization. The index does not reflect any expenses. Performance data is historical and includes changes in share price and reinvestment of dividends and capital gains. Performance numbers are net of all Portfolio operating expenses, but they do not include the administrative fee, the insurance risk charge, the annual contract maintenance charge or the 5% withdrawal charge imposed by the Cova variable annuity contract. If this performance information included the effect of the insurance charges, performance numbers would be lower. Graph prepared by Cova. The index returns in the graph above were generated by CDA Wiesenberger HySales software and Bloomberg. Comparison line graphs chart the hypothetical growth of $10,000 over a given historical period of time. Although data are gathered from reliable sources, accuracy and completeness cannot be guaranteed.
Large Cap Research Portfolio For the year ended 12/31/99
Managed by Lord, Abbett & Co.
Market Review The year was characterized by continued overall strength in both the equity market and the U.S. economy, but also by rising interest rates and continued global deflationary pressures. These factors combined to create an environment that, among large companies, favored a very select group of growth stocks with stable earnings growth. With the exception of a brief broadening of the market during the second quarter, investors stayed with names familiar to them, investing in companies that exhibited strong earnings and recent outstanding stock performance. Portfolio Review The Portfolio's performance was helped by our exposure to the technology sector. We are now beginning to pare back the Portfolio's allocation to technology stocks. The proceeds from those sales will most likely be used to increase our allocation to cyclical stocks such as paper, chemicals and electrical equipment, as well as other industrial stocks that tend to reflect the improving global economies. We also began focusing some attention on the property and casualty insurance sector, and will seek out companies in this market segment that display improving fundamentals. At the same time, we were generally underweighted in financial companies, which worked to the Portfolio's advantage since many of these stocks continued to struggle as interest rates increased. Our holdings in health care services hurt the Portfolio, as political issues and government influence hampered the performance of these companies. Furthermore, electric utilities stocks, which typically do not perform well in a rising interest rate environment, also underperformed. Outlook We anticipate that the global economy will maintain steady improvement. We continue to be encouraged by low inflation rates and minimal trade restrictions around the world. As we begin the New Year, we believe that global cyclicals, (paper, chemicals and electric equipment) are among the best values in the market. Many financial services companies currently display solid fundamentals and, save for an increase in short-term interest rates by the Federal Reserve, we will likely add to our exposure in this area. There are some signs that the U.S. economy may be moderating. As consumer debt levels climb, and mortgage refinancings, which reduce consumers' monthly mortgage payments, decrease, a slowdown in consumer spending is possible. Consequently, we remain moderately underweighted in consumer stocks, especially those that are highly sensitive to changes in economic activity.
Robert Morris
+Index is shown from first full month since Portfolio's inception. 1 "Average Annual Return" is calculated including reinvestment of all income dividends and capital gain distributions. Results represent past performance and do not indicate future results. The value of an investment in the Large Cap Research Portfolio managed by Lord Abbett and the return on the investment will fluctuate, and redemption proceeds may be higher or lower than an investor's original cost. Performance data is historical and includes changes in share price and reinvestment of dividends and capital gains. Performance numbers are net of all Portfolio operating expenses, but they do not include the administrative fee, the insurance risk charge, the annual contract maintenance charge or the 5% withdrawal charge imposed by the Cova variable annuity contract. If this performance information included the effect of the insurance charges, performance numbers would be lower. Graph prepared by Cova. The index returns for the graph above were generated by Cova from CDA Wiesenberger HySales software. Comparison line graphs chart the hypothetical growth of $10,000 over a given historical period of time. Although data are gathered from reliable sources, accuracy and completeness cannot be guaranteed.
Developing Growth Portfolio For the year ended 12/31/99
Managed by Lord, Abbett & Co.
Market Review The year was interesting for the stock markets. Many of the broad indexes (S&P 5001, Russell 20002, etc.) posted returns in excess of 20%. However, overall performance of these indexes was driven by a relatively narrow group of stocks. Stocks of technology and internet companies, which were subject to some volatility, influenced performance the most in the small-cap growth sector throughout the year. Portfolio Review Careful bottom-up stock selection contributed to the Portfolio's positive return throughout the year. The Portfolio's overall performance was most significantly affected by our overweighting in technology stocks, which benefited from rapid multiple expansion and strong earnings growth. In addition, the Portfolio was overweighted in the retail and leisure industries, where we uncovered several opportunities as a result of our ongoing, proprietary research. We reduced our exposure to the healthcare stocks as influence from Washington, D.C. and market speculation regarding possible government intervention, made 1999 a disappointing year for the healthcare sector. Many information technology (IT) services companies also experienced some difficulty surrounding Y2K spending. In addition, the Portfolio was underweighted in financial services stocks, because we did not believe this area offered the long-term earnings growth potential we sought. With the exception of a resurgence in energy stocks, we saw very few "themes" emerge during the third quarter. Our best investment returns were company-specific rather than sector-wide. For the remainder of the year, we continued our aggressive pursuit of companies with strong earnings and the potential for outstanding growth. The Portfolio's performance was positively impacted by companies in the technology outsourcing area that focus on helping corporate America implement and operate Internet businesses. Some of the smallest companies we owned posted earnings slightly below expectations, in some cases citing business slowdowns due to anticipated Y2K problems. The technology weighting in the Portfolio expanded solely as a function of the strong performance by companies in the technology universe in recent months. Outlook We are encouraged that the economy continues to exhibit steady growth, but remain watchful of consumer debt levels and interest rates, as well as overall consumer confidence. In the New Year, we believe that many small companies will experience solid earnings growth. Based on our belief that many small companies currently have attractive fundamentals and offer very good relative value versus large-company stocks, we expect small-cap stocks to deliver good relative performance in the future. The Portfolio management team continues to focus on companies with strong earnings potential and outstanding growth prospects across a diverse group of industries.
Stephen J. McGruder
1The S&P 500 Index is an unmanaged index consisting of stocks of 500 of the largest U.S.-based companies. The Index does not include fees or expenses and is not available for direct investment. 2The Russell 2000 Index is an unmanaged index consisting of the stocks of 2000 U.S.-based companies. The Index does not include fees or expenses and is not available for direct investment.
+Index is shown from the first full month since Portfolio's inception. 1 "Average Annual Return" is calculated including reinvestment of all income dividends and capital gain distributions. Results represent past performance and do not indicate future results. The value of an investment in the Developing Growth Portfolio managed by Lord Abbett and the return on the investment will fluctuate, and redemption proceeds may be higher or lower than an investor's original cost. 2 The Russell 2000 Index is an unmanaged index consisting of the stocks of 2000 U.S.-based companies. The Index does not include fees or expenses and is not available for direct investment. Performance data is historical and includes changes in share price and reinvestment of dividends and capital gains. Performance numbers are net of all Portfolio operating expenses, but they do not include the administrative fee, the insurance risk charge, the annual contract maintenance charge or the 5% withdrawal charge imposed by the Cova variable annuity contract. If this performance information included the effect of the insurance charges, performance numbers would be lower. Graph prepared by Cova. The index returns in the graph above were generated by CDA Wiesenberger HySales software and Bloomberg. Comparison line graphs chart the hypothetical growth of $10,000 over a given historical period of time. Although data are gathered from reliable sources, accuracy and completeness cannot be guaranteed.
Lord Abbett Growth and Income Portfolio For the year ended 12/31/99
Managed by Lord, Abbett & Co.
Market Review Since 1997, low interest rates and a deceleration in earnings drove the U.S. equity market. This environment favored a very select group of large-cap stocks that had stable earnings growth. Rather than venturing into unknown waters, investors stayed the course and continued to purchase names familiar to them, remaining with companies that exhibited strong earnings and/or good recent stock performance. The first quarter of 1999 saw a continuation of this trend, with large-cap growth stocks continuing to dominate the market. In the second quarter we saw a broadening of the market, where for the first time in many quarters value outperformed growth, and small- and mid-cap stocks outperformed large-cap issues. Towards the end of the year, the trend reversed once again, and growth stocks returned to favor. Global growth rates continued to surge throughout 1999, instilling inflationary concerns in many investors. The Federal Reserve Board responded by initiating a series of fall rate hikes that have normalized U.S. interest rates from their record lows last year. Portfolio Review In early 1999, we sold some of our holdings in non-cyclical stocks, such as technology, healthcare and pharmaceuticals, because they approached what we believed to be their full values. We then used the proceeds to build or add to positions in stocks of undervalued cyclical companies in the manufacturing and commodities industries. When cyclical stocks advanced in April, the Portfolio was well positioned to benefit from the upswing. Anticipating some improvement in the global economy, we made an early entry into the energy sector that paid off well in both the first half of the year and in the third quarter. Rising interest rates in the latter part of the year caused interest-rate-sensitive sectors such as electric utilities and financial services to underperform. However, technology stocks demonstrated tremendous relative strength despite their high valuations. Over the course of the year, the Portfolio remained underweighted in financial services companies in anticipation of rising interest rates, although we maintained a focus on property and casualty insurance companies, as this market segment continues to benefit from industry consolidation. We were well positioned to benefit from the leadership position of the technology sector, and many of our technology holdings posted strong gains. We also increased our exposure in basic materials industries, in anticipation of further global economic recovery in 2000 and beyond. Outlook We expect to see global economic growth continue throughout the coming year. In response, we are investing in companies that are likely to benefit from this recovery, such as those producing basic materials and capital goods. In the U.S., some signs are emerging that the economy may be moderating, which diminishes the risk of significant future U.S. interest rate hikes. As a result, we are reconsidering financial services stocks, many of which display solid fundamentals at attractive prices. We believe that any possibility of a future interest rate increase is already reflected in the low stock prices of these companies.
W. Thomas Hudson Jr.
+Index is shown from first full month since inception (1/8/99). 1 "Total Return" is calculated including reinvestment of all income dividends and capital gain distributions. Results represent past performance and do not indicate future results. The value of an investment in the LA Growth and Income Portfolio and the return on the investment both will fluctuate, and redemption proceeds may be higher or lower than an investor's original cost. 2 The S&P 500 Index is an unmanaged index generally considered to be representative of stock market activity. Performance data is historical and includes changes in share price and reinvestment of dividends and capital gains. Performance numbers are net of all Portfolio operating expenses, but they do not include the administrative fee, the insurance risk charge, the annual contract maintenance charge or the 5% withdrawal charge imposed by the Cova variable annuity contract. If this performance information included the effect of the insurance charges, performance numbers would be lower. Graph prepared by Cova. The index returns in the graph above were generated by Cova from CDA Wiesenberger HySales software. Comparison line graphs chart the hypothetical growth of $10,000 over a given historical period of time. Although data are gathered from reliable sources, accuracy and completeness cannot be guaranteed.
Balanced Portfolio For the year ended 12/31/99
Managed by Mississippi Valley Advisors
The stock market finished the year with a phenomenal surge and the S&P 5001 gained 21.04% for the year. While substantial, these gains were miniscule compared to the 85% increase in the NASDAQ Composite Index2. It was only the second time in the composite's history that it was able to rally more than 40%. Given that the S&P 500 has advanced for eight of those nine years, one could call for some caution looking forward. Most market strategists have some concern for the market in 2000. GDP, corporate profits, and inflation concerns will be major factors in the determination of the success of the stock market next year. The bond market ended the reporting period, and entire year, in negative territory. The bellwether 30-year bond ended the quarter down 4%, and ended the year down over 15%. With the last of three rate hikes in 1999 on November 16, the Fed felt confident that a 5.50% Fed funds rate would be a sufficient level to help balance the economy. Many bond-market strategists and economists are calling for three more rate hikes in the first six months of the year 2000. This summer's 6.28% high in the 30-year bond has been surpassed. Most likely the stock market will give us an additional clue as to the Fed's next rate hike. The prospect of declining economic growth and corporate profits suggests a defensive stock mix.
Peter Merzian
Mississippi Valley Advisors 1 The S&P 500 Index is an unmanaged index consisting of stocks of 500 of the largest U.S.-based companies. The Index does not include fees or expenses and is not available for direct investment. 2 The NASDAQ Composite Index is a market-value weighted index of all common stocks listed on NASDAQ.
+Index is shown from the first full month since Portfolio's inception. 1 "Average Annual Return" is calculated including reinvestment of all income dividends and capital gain distributions. Results represent past performance and do not indicate future results. The value of an investment in the Balanced Portfolio managed by Mississippi Valley Advisors (MVA) and the return on the investment will fluctuate, and redemption proceeds may be higher or lower than an investor's original cost. Performance data is historical and includes changes in share price and reinvestment of dividends and capital gains. Performance numbers are net of all Portfolio operating expenses, but they do not include the administrative fee, the insurance risk charge, the annual contract maintenance charge or the 5% withdrawal charge imposed by the Cova variable annuity contract. If this performance information included the effect of the insurance charges, performance numbers would be lower. Graph prepared by Cova. The index returns in the graph above were generated by CDA Wiesenberger HySales software. Comparison line graphs chart the hypothetical growth of $10,000 over a given historical period of time. Although data are gathered from reliable sources, accuracy and completeness cannot be guaranteed.
Equity Income Portfolio For the year ended 12/31/99
Managed by Mississippi Valley Advisors
The Equity Income Portfolio finished the year with a 2.51% return, compared to a 20.92% return of its benchmark Russell 1000 Index.1 Earlier in the year, the Portfolio benefited from continued strength in the U.S. economy, and improving economic trends worldwide helped focus investor attention back on cyclical stocks. In addition, higher interest rates during the period put pressure on some of the more overvalued higher multiple growth stocks, which in turn helped the valued segment of the market show improvement. The fourth quarter of 1999 proved to be a disappointing one for value investors. Rising interest rates once again took their toll on banks and utilities. Consumer product stocks turned in mixed performances, while pharmaceuticals lagged the overall market. Technology stocks turned in a strong performance, as did our industrial cyclical holdings, which were benefiting from a strong economy. Oil companies took a breather from their good showing during the first three-quarters of the year, as oil prices stopped going up. The normal catalysts for value stocks to do well (a strong economy, accelerating earnings growth and rising interest rates), have all taken place, but the market continues to focus on large cap growth, especially technology, and more specifically Internet related issues. How large the valuation gap can become is anyone's guess, but it would appear to be at a fairly extreme level at present. We continue to believe the value sector holds above average return potential over the next 12-24 months, especially with many worldwide economies strengthening and the U.S. economy continuing to maintain its solid growth.
Gregory A. Glidden
Mississippi Valley Advisors 1 The Russell 1000 Index consists of the largest 1000 companies in the Russell 3000 Index. The Index represents the universe of large capitalization stocks from which most active money managers typically select. The Index does not include fees or expenses and is not available for direct investment.
+Index is shown from the first full month since Portfolio's inception. 1 "Average Annual Return" is calculated including reinvestment of all income dividends and capital gain distributions. Results represent past performance and do not indicate future results. The value of an investment in the Equity Income Portfolio managed by Mississippi Valley Advisors (MVA) and the return on the investment will fluctuate, and redemption proceeds may be higher or lower than an investor's original cost. Performance data is historical and includes changes in share price and reinvestment of dividends and capital gains. Performance numbers are net of all Portfolio operating expenses, but they do not include the administrative fee, the insurance risk charge, the annual contract maintenance charge or the 5% withdrawal charge imposed by the Cova variable annuity contract. If this performance information included the effect of the insurance charges, performance numbers would be lower. Graph prepared by Cova. The index returns in the graph above were generated by CDA Wiesenberger HySales software. Comparison line graphs chart the hypothetical growth of $10,000 over a given historical period of time. Although data are gathered from reliable sources, accuracy and completeness cannot be guaranteed.
Growth & Income Equity Portfolio For the year ended 12/31/99
Managed by Mississippi Valley Advisors
The Growth & Income Equity Portfolio finished the year with a 16.17% return, compared to a 21.04% return of its benchmark S&P 500 Index.1 Over the year, the Portfolio benefited from continued improvement in the global economy, which had a direct impact on energy stocks and economically sensitive stocks. In the second quarter, value investing came into vogue and small caps became more interesting than large cap growth. The fourth quarter of 1999 staged a strong recovery following the seasonal weakness experienced in the third quarter. Despite a more stringent Federal Reserve policy and nine years of economic expansion, the equity market posted double-digit gains lead by the technology and telecom sectors. For the 5th year in a row, the equity market has had an upward bias despite the fact that it has become more pyramidal in nature in that as the market moves higher fewer stocks are participating. This is evidenced by the fact that 57% of the equities in the S&P 500 posted negative returns for the year. Equity purchases have focused on momentum and ignored value, thus while some sectors of the market are overvalued some sectors appear to be undervalued. Fears of inflation and global economic expansion have caused the recent back up in interest rates. This global recovery should benefit the industrial cyclical and capital goods sectors of the market. With stocks near record valuation levels, we continue to be cautious and focus on the most attractive relative values that would include specialty retailers, financials, industrial cyclical and selected technology stocks. Our portfolio remains well diversified and biased towards predictable growth.
Equity Committee
1 The S&P 500 Index is an unmanaged index consisting of stocks of 500 of the largest U.S.-based companies. The Index does not include fees or expenses and is not available for direct investment.
+Index is shown from the first full month since Portfolio's inception. 1 "Average Annual Return" is calculated including reinvestment of all income dividends and capital gain distributions. Results represent past performance and do not indicate future results. The value of an investment in the Growth and Income Equity Portfolio managed by Mississippi Valley Advisors (MVA) and the return on the investment will fluctuate, and redemption proceeds may be higher or lower than an investor's original cost. Performance data is historical and includes changes in share price and reinvestment of dividends and capital gains. Performance numbers are net of all Portfolio operating expenses, but they do not include the administrative fee, the insurance risk charge, the annual contract maintenance charge or the 5% withdrawal charge imposed by the Cova variable annuity contract. If this performance information included the effect of the insurance charges, performance numbers would be lower. Graph prepared by Cova. The index returns in the graph above were generated by CDA Wiesenberger HySales software. Comparison line graphs chart the hypothetical growth of $10,000 over a given historical period of time. Although data are gathered from reliable sources, accuracy and completeness cannot be guaranteed.
Riggs U.S. Government Securities Portfolio For the year ended 12/31/99
Managed by Riggs Bank N.A.
The fixed income markets experienced their second worst performance in 50 years during 1999. Only 1994 surpassed this year in generating negative rates of return. From a year, which began with expectations of a slowing economy, accompanied by declining rates, 1999 turned into a very powerful bear market. The continued residual from both the Russian default and the Long Term Capital rescue did not slow the U.S. economy in 1999. In fact GDP is expected to have grown in excess of 4.00% during the year. In addition, oil prices, which began the year by falling to their lowest level since April 1986, ended 1999 at $25.60 or more than double the low of $11.26 reached in February. The Federal Reserve took back its three twenty-five basis point easings of 1998 by tightening 25 basis points in June, August and November. Granted the easings of 1998 were attributable to the crisis surrounding Russia and Long Term Capital, the tightenings still weighed on the bond market. The resiliency of the U.S. economy to withstand the global problems and continue to expand at a 4.00% rate surprised most economists, and probably the Fed. Add the fact that unemployment reached its lowest level since January 1970 and you have a central bank concerned about inflationary pressures. The only reassuring factor limiting the Fed from tightening more rapidly was the continued rise in productivity and the tame core inflation rate. The fourth quarter's major highlight surrounded the Y2K issue. The Fed announced in December that it would have tightened or at least gone to a bias favoring tightening had it not been for the uncertainty surrounding any Y2K glitches. In addition, corporations, banks and individuals increased their liquidity to varying degrees into year-end 1999. Inventories and supplies were stockpiled "just in case". The bond market continued to deteriorate in the fourth quarter as the majority of economic indicators pointed toward continued strength instead of any weakening trend. This combined with the low unemployment rate led most bond participants to question the "new paradigm" of strong growth and low inflation. The result was that the yield curve flattened as rates rose in anticipation of future tightening in 2000. Following the end of the Y2K uncertainty, the Fed should respond by increasing interest rates in 2000. We believe the Fed will likely wish to get its restrictive monetary policy out of the way before the national conventions and presidential elections. Thus the Fed is likely to respond to any hint of inflation or continued strength in the economy by hiking rates. There are several caveats to our forecast. The first is that any substantial "meltdown" in the equity market would likely short circuit this bear market and force the Fed to end its tightening and even ease to restore confidence. The second is the dollar. The United States is running the highest trade deficit of the western industrialized nations. Any substantial decline in the dollar could cause a rise in inflationary expectations and rates, which would have a negative effect on equities.
John Lockhart
+Index is shown from the first full month since Portfolio's inception (11/3/99). 1 "Total Return" is calculated including reinvestment of all income dividends and capital gain distributions. Results represent past performance and do not indicate future results. The value of an investment in the U.S. Government Securities Portfolio managed by Riggs Bank N.A. and the return on the investment will fluctuate, and redemption proceeds may be higher or lower than an investor's original cost. Performance data is historical and includes changes in share price and reinvestment of dividends and capital gains. Performance numbers are net of all Portfolio operating expenses, but they do not include the administrative fee, the insurance risk charge, the annual contract maintenance charge or the 5% withdrawal charge imposed by the Cova variable annuity contract. If this performance information included the effect of the insurance charges, performance numbers would be lower. Graph prepared by Cova. The index returns in the graph above were generated by CDA Wiesenberger HySales software. Comparison line graphs chart the hypothetical growth of $10,000 over a given historical period of time. Although data are gathered from reliable sources, accuracy and completeness cannot be guaranteed.
Riggs Stock Portfolio For the year ended 12/31/99
Managed by Riggs Bank N.A.
The equity markets were immune to the travails of the fixed income markets. Higher productivity, the "new" economy (i.e. technology), the Internet and e-commerce were the buzzwords that kept the stock market floating in the ether of the new valuation metrics. The old economy (anything not technology) was susceptible to the rising trend of interest rates and the competition from the new. The new versus the old produced a dichotomy in the equity markets that led to the most narrow momentum driven market in history. Some interesting facts regarding the unusual stock market environment in the past year: o A select group1 of about 5% of the stocks in the S&P 5002 produced nearly 100% of the index's returns. o The median stock in the S&P 500 was up only 0.40%. o The technology sector at year-end constituted 30% of the market capitalization of the S&P 500 and accounted for roughly 70% of the return. Technology, up 109% in 1999, was by far the strongest sector. The strong returns of the past several years (over 20% for each of the past five years for the S&P 500) are unlikely to be repeated over the next several years. Keep in mind, however, that many stocks have not participated in the success of late and may benefit to a greater degree as money shifts from technology into different sectors of the market. Though technology spending will continue to be robust as the communications revolution takes hold, the rate of growth in several segments of technology will decelerate from the higher-than-trend growth rate over the last few years. This was partly a function of corporations rushing to prepare themselves for Y2K, as well as the need to offset higher wages with improving productivity. Further, through the downturn in world economies, larger companies have been able to maintain their earnings power by reducing input costs by taking advantage of lower commodity prices and by squeezing their suppliers. As the world economies begin to recover (their stock markets being a leading indicator), smaller companies may have a better chance of demonstrating an improving earnings trend relative to larger companies. In this respect, we believe there may be a broadening out of stock market returns to areas other than the technology sector. As this happens we are positioned to benefit in this diversified portfolio.
John Lockhart
1 Microsoft, Cisco, General Electric, Wal-Mart, Oracle Systems, Nortel Networks, Qualcomm, Sun Microsystems, Citigroup, Intel, America Online, EMC Corp, Home Depot, Lucent Technologies, Motorola, American Intl Group, Hewlett-Packard, Texas Instruments, Morgan Stanley Dean Witter, Dell Computer 2 The S&P 500 Index is an unmanaged index consisting of stocks of 500 of the largest U.S.-based companies. The Index does not include fees or expenses and is not available for direct investment.
+Index is shown from the first full month since Portfolio's inception (11/3/99). 1 "Total Return" is calculated including reinvestment of all income dividends and capital gain distributions. Results represent past performance and do not indicate future results. The value of an investment in the Stock Portfolio managed by Riggs Bank N.A. and the return on the investment will fluctuate, and redemption proceeds may be higher or lower than an investor's original cost. Performance data is historical and includes changes in share price and reinvestment of dividends and capital gains. Performance numbers are net of all Portfolio operating expenses, but they do not include the administrative fee, the insurance risk charge, the annual contract maintenance charge or the 5% withdrawal charge imposed by the Cova variable annuity contract. If this performance information included the effect of the insurance charges, performance numbers would be lower. Graph prepared by Cova. The index returns in the graph above were generated by CDA Wiesenberger HySales software. Comparison line graphs chart the hypothetical growth of $10,000 over a given historical period of time. Although data are gathered from reliable sources, accuracy and completeness cannot be guaranteed. REPORT OF INDEPENDENT AUDITORS
The Board of Trustees and Shareholders
We have audited the accompanying statements of assets and liabilities, including the portfolios of investments, of Small Cap Stock Portfolio, Quality Bond Portfolio, Select Equity Portfolio, Large Cap Stock Portfolio, International Equity Portfolio, Bond Debenture Portfolio, Mid-Cap Value Portfolio, Large Cap Research Portfolio, Developing Growth Portfolio, Lord Abbett Growth & Income Portfolio, Balanced Portfolio, Equity Income Portfolio, Growth & Income Equity Portfolio, Riggs U.S. Government Securities Portfolio, and Riggs Stock Portfolio, portfolios of Cova Series Trust (the Trust), as of December 31, 1999 and the related statements of operations for the year or periods then ended and changes in net assets for each of the years or periods in the two-year period then ended and the financial highlights for each of the years or periods in the four-year period then ended. These financial statements and financial highlights are the responsibility of the Trust's management. Our responsibility is to express an opinion on these financial statements and financial highlights based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and financial highlights are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Our procedures included confirmation of securities owned as of December 31, 1999 by correspondence with the custodian and brokers. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements and financial highlights referred to above present fairly, in all material respects, the financial position of Small Cap Stock Portfolio, Quality Bond Portfolio, Select Equity Portfolio, Large Cap Stock Portfolio, International Equity Portfolio, Bond Debenture Portfolio, Mid-Cap Value Portfolio, Large Cap Research Portfolio, Developing Growth Portfolio, Lord Abbett Growth & Income Portfolio, Balanced Portfolio, Equity Income Portfolio, Growth & Income Equity Portfolio, Riggs U.S. Government Securities Portfolio, and Riggs Stock Portfolio, as of December 31, 1999, the results of their operations for the year or periods then ended, changes in their net assets for each of the years or periods in the two-year period then ended and the financial highlights for each of the years or periods in the four-year period then ended in conformity with generally accepted accounting principles. [KPMG logo] [Graphic omitted]
Boston, Massachusetts
COVA SERIES TRUST
PORTFOLIO OF INVESTMENTS
Portfolio Footnotes: * Non-income producing security. REIT - Real Estate Investment Trust ADR - American Depositary Receipt
Cova Series Trust
PORTFOLIO OF INVESTMENTS
Cova Series Trust
PORTFOLIO OF INVESTMENTS
Cova Series Trust
PORTFOLIO OF INVESTMENTS
Cova Series Trust
PORTFOLIO OF INVESTMENTS
SMALL CAP STOCK PORTFOLIO For the Period ended 6/30/00
MANAGED BY J.P. MORGAN INVESTMENT MANAGEMENT Letter to Policyholders
MARKET REVIEW
PORTFOLIO REVIEW
OUTLOOK We believe that volatility will be a fixture in the small cap market, particularly in high growth sectors like technology, services, biotech and communications. We also expect to see the market broaden as more sectors of the economy achieve positive results. For this reason we believe that multi-sector exposure, which positions the Portfolio to participate in a broad market rally, remains the most prudent approach for this core strategy.
DENISE E. HIGGINS
1 The Russell 2000 Index is an unmanaged index consisting of the stocks of 2000 U.S.-based companies. The Index does not include fees or expenses and is not available for direct investment. 2 "Average Annual Return" is calculated including reinvestment of all income dividends and capital gain distributions. Results represent past performance and do not indicate future results. The value of an investment in the Small Cap Stock Portfolio managed by J.P. Morgan Investment Management (JPMIM) and the return on the investment will fluctuate, and redemption proceeds may be higher or lower than an investor's original cost. Performance data is historical and includes changes in share price and reinvestment of dividends and capital gains. Performance numbers are net of all Portfolio operating expenses, but they do not include any insurance charges imposed in connection with your variable insurance contract. If this performance information included the effects of these fees or charges, performance numbers would be lower.
QUALITY BOND PORTFOLIO For the Period ended 6/30/00
MANAGED BY J.P. MORGAN INVESTMENT MANAGEMENT Letter to Policyholders
MARKET REVIEW
However, growth and inflationary indicators for the remainder of 2000 were more mixed, suggesting that inflation (excluding the impact of recent increases in energy prices) is not accelerating sharply. As a result, the Fed did not change policy at their June meeting and market expectations of future Fed tightening moderated significantly as the 2000 ended.
PORTFOLIO REVIEW
government fiscal surplus in the second half of the year and related paydown of U.S. Treasuries, we maintained a modest long duration position mostly concentrated in the longer maturity sector of the yield curve. Additionally, we started the year off overweighting Treasuries by reducing allocations to investment grade corporate bonds and selling off the portfolio's agency notes. We maintained the portfolio's underweight position in investment grade corporate bonds during the period, but moved to a more neutral position near the end of the reporting period. We reduced the portfolio's exposure to Treasuries at the end of the period by adding to mortgage backed securities and residential mortgages. OUTLOOK We believe that global growth has peaked and that the likely path for the U.S. economy is for a "soft landing" slowdown, with GDP growth moving below 4% in the coming months. Inflation pressures will remain contained. Fed tightening of monetary policy is nearly done, with one final move of 25bps before year-end still likely. Interest rates will remain in a range roughly around current levels, with short rates responding to any further moves by the Fed.
HARRIET T. HUBER
Portfolio Managers
1 The Salomon Brothers Broad Investment-Grade Bond Index (BIG) is a market-capitalized weighted index that includes fixed-rate Treasury, government sponsored, corporate (Baa3/BBB or better) and mortgage securities. The index does not reflect any expenses. 2 "Average Annual Return" is calculated including reinvestment of all income dividends and capital gain distributions. Results represent past performance and do not indicate future results. The value of an investment in the Quality Bond Portfolio managed by J.P. Morgan Investment Management (JPMIM) and the return on the investment will fluctuate, and redemption proceeds may be higher or lower than an investor's original cost. Performance data is historical and includes changes in share price and reinvestment of dividends and capital gains. Performance numbers are net of all Portfolio operating expenses, but they do not include any insurance charges imposed in connection with your variable insurance contract. If this performance information included the effects of these fees or charges, performance numbers would be lower.
SELECT EQUITY PORTFOLIO For the Period ended 6/30/00
MANAGED BY J.P. MORGAN INVESTMENT MANAGEMENT Letter to Policyholders
MARKET REVIEW
PORTFOLIO REVIEW
Overall, the pharmaceuticals and capital markets sectors moved ahead as investors continued their rotation out of "new economy" stocks. As a consequence, the software and services, telecommunications and technology sectors fell. While the pharmaceuticals and capital markets sectors posted a positive return for the six month period, holdings such as Oracle and Microsoft pulled down performance as the latter was roiled with detailed announcements of Judge Jackson's ruling against the company in the lengthy anti-trust suit. Individual security selection contributed to the portfolio's overall performance. The portfolio ended the period with an overweight position in Intel which posted a positive total return for the six months ending June 30, 2000. OUTLOOK The strategy for the portfolio remains unchanged and we continue to be fully invested and largely sector neutral. We anticipate that another short-term rate rise is still possible for the second half of the year. The economy has been slowing, as share prices of more speculative equity were disproportionately impacted toward the end of the first quarter. We expect the slowdown to continue as evidenced by the recent cooling of the overheated rate of late 1999 and early 2000.
PEGGY ADAMS
1 The S&P 500 Index is an unmanaged index consisting of the stocks of 500 of the largest U.S.-based companies. The Index does not include fees or expenses and is not available for direct investment. 2 "Average Annual Return" is calculated including reinvestment of all income dividends and capital gain distributions. Results represent past performance and do not indicate future results. The value of an investment in the Select Equity Portfolio managed by J.P. Morgan Investment Management (JPMIM) and the return on the investment will fluctuate, and redemption proceeds may be higher or lower than an investor's original cost. Performance data is historical and includes changes in share price and reinvestment of dividends and capital gains. Performance numbers are net of all Portfolio operating expenses, but they do not include any insurance charges imposed in connection with your variable insurance contract. If this performance information included the effects of these fees or charges, performance numbers would be lower.
LARGE CAP STOCK PORTFOLIO For the Period ended 6/30/00
MANAGED BY J.P. MORGAN INVESTMENT MANAGEMENT Letter to Policyholders
MARKET REVIEW
PORTFOLIO REVIEW
Industrial cyclical and finance sectors were among the worst performers during the second quarter. The rising interest rate environment has led many financial services stocks to continue to underperform and resulted in a 15% decline for the sector in June. In Industrial cyclicals, Rohm & Haas and Honeywell had second quarter earnings disappointments. In the Insurance sector, earnings warnings deflated shares of Aon Corp earlier this year. OUTLOOK The strategy for the portfolio remains unchanged and we continue to be fully invested and sector neutral. We anticipate that another short-term rate rise is still possible for the second half of the year. The economy has been slowing, as share prices of more speculative equity were disproportionately impacted toward the end of the first quarter. We expect the slowdown to continue as evidenced by the recent cooling of the overheated rate of late 1999 and early 2000.
JOHN M. DEVLIN, JR.
1 The S&P 500 Index is an unmanaged index consisting of the stocks of 500 of the largest U.S.-based companies. The Index does not include fees or expenses and is not available for direct investment. 2 "Average Annual Return" is calculated including reinvestment of all income dividends and capital gain distributions. Results represent past performance and do not indicate future results. The value of an investment in the Large Cap Stock Portfolio managed by J.P. Morgan Investment Management (JPMIM) and the return on the investment will fluctuate, and redemption proceeds may be higher or lower than an investor's original cost. Performance data is historical and includes changes in share price and reinvestment of dividends and capital gains. Performance numbers are net of all Portfolio operating expenses, but they do not include any insurance charges imposed in connection with your variable insurance contract. If this performance information included the effects of these fees or charges, performance numbers would be lower.
INTERNATIONAL EQUITY PORTFOLIO For the Period ended 6/30/00
MANAGED BY J.P. MORGAN INVESTMENT MANAGEMENT Letter to Policyholders
MARKET REVIEW
PORTFOLIO REVIEW
OUTLOOK In general, the Fed's policy regarding inflation risk and the market's perception of the Fed's actions will continue to drive overall sentiment. Within the international equity market universe, we continue to favor the U.K. market. Short-term interest rates appear to be peaking, and sterling should fall modestly from its current overvalued levels. Both of these factors should be supportive of the markets. The Continental European markets do not look as attractively valued, but expectations of economic growth are being revised upwards. The equity markets could, however, be held back due to investor concerns over the valuation of the technology/telecom sectors. We are becoming more cautious about the Japanese market. Growth has picked up, but may not be enough to cope with a potential tightening of monetary policy. While the longer-term valuation remains reasonable, the shorter-term news flow could be difficult.
NIGEL EMMETT
1 The Morgan Stanley Capital International Europe, Australia and Far East Index is an unmanaged index and is an aggregate of 15 individual country indexes that collectively represent many of the major markets of the world. The Index does not include fees or expenses and is not available for direct investment. 2 "Average Annual Return" is calculated including reinvestment of all income dividends and capital gain distributions. Results represent past performance and do not indicate future results. The value of an investment in the International Equity Portfolio managed by J.P. Morgan Investment Management (JPMIM) and the return on the investment will fluctuate, and redemption proceeds may be higher or lower than an investor's original cost. Performance data is historical and includes changes in share price and reinvestment of dividends and capital gains. Performance numbers are net of all Portfolio operating expenses, but they do not include any insurance charges imposed in connection with your variable insurance contract. If this performance information included the effects of these fees or charges, performance numbers would be lower.
BOND DEBENTURE PORTFOLIO For the Period ended 6/30/00
MANAGED BY LORD, ABBETT & CO. Letter to Policyholders This period proved to be a very difficult credit environment, characterized by rising borrowing costs and reduced access to capital for many companies. Fragile market conditions, low issuances of new high yield bonds, and heavy outflows from high yield bond mutual funds resulted in lackluster performance and wider spreads. In fact, the yield spread, or difference, between lower-rated, high yield bonds and 10-year Treasury notes remained at historically wide levels for most of this reporting period, increasing to where high yield bonds (represented by the Merrill Lynch High Yield Master Index) were yielding roughly 5.65% more than Treasurys. We placed a higher degree of emphasis on better quality securities, increasing the portfolio's weighting of high-grade corporate/investment grade bonds overall. Since current coupon mortgage rates increased by nearly 60 basis points to more than 8%, we identified what we believe are compelling opportunities to capture attractive yield in the mortgage-backed securities market. We added to this asset class, thereby raising the overall credit quality of the portfolio. In addition, we increased the percentage of equity-related securities, primarily convertible bonds issued by technology and wireless-telecommunications companies. Finally, we reduced the number of companies represented in the portfolio by culling the portfolio of underperforming securities and increasing our exposure to the holdings that we favor, including certain oil and gas companies. If the Fed is successful in engineering a "soft landing" for the economy and in slowing consumer demand, we believe high yield securities are apt to provide good returns, and accordingly, we expect to increase our exposure to this asset class. We will continue to place emphasis on the securities issued by select wireless-telecommunications companies, as we anticipate strong growth and further consolidation in this industry sector. Likewise, we continue to favor securities associated with companies in oil and natural gas, since we believe oil and gas prices are likely to remain above historical averages throughout the remainder of the year. In general, we expect that the Fed's attempts to slow U.S. economic growth will continue to impact the market. As sufficient evidence of an economic slowdown becomes more apparent in the second half of this year, the Fed is likely to abandon its tightening posture.
CHRISTOPHER J. TOWLE
1 "Average Annual Return" is calculated including reinvestment of all income dividends and capital gain distributions. Results represent past performance and do not indicate future results. The value of an investment in the Bond Debenture Portfolio managed by Lord Abbett and the return on the investment will fluctuate, and redemption proceeds may be higher or lower than an investor's original cost. 2The First Boston High Yield Index is representative of lower rated debt, including straight-preferred stocks. 3The Salomon Brothers Broad Investment-Grade Bond Index (BIG) is a market-capitalized weighted index that includes fixed-rate Treasury, government sponsored, corporate (Baa3/BBB or better) and mortgage securities. The index does not reflect any expenses. 4The Merrill Lynch Convertible Index is representative of the equity-related securities. The three indices chosen have elements of these three categories, but since there is no one index combining all three categories, these three separate indices may not be a valid comparison for the Portfolio. These indices do not include fees or expenses and are not available for direct investment. Performance data is historical and includes changes in share price and reinvestment of dividends and capital gains. Performance numbers are net of all Portfolio operating expenses, but they do not include any insurance charges imposed in connection with your variable insurance contract. If this performance information included the effects of these fees or charges, performance numbers would be lower.
MID-CAP VALUE PORTFOLIO For the Period ended 6/30/00
MANAGED BY LORD, ABBETT & CO. Letter to Policyholders The strong performance of our mid-cap value funds relative to the S&P Mid-Cap 400 BARRA Value Index was driven by solid gains in our stocks of healthcare, energy and select consumer companies. In the energy sector, we benefited from our exposure to natural gas companies. With natural gas prices currently high during what is normally a seasonally weak period, increasing demand for natural gas from electric generators and a shrinking reserve base, we remain very optimistic on the outlook for natural gas. Additionally, our holdings in stocks of insurance companies helped performance in the financial services sector. We were able to sidestep the recent correction in the technology sector by investing selectively in stocks of medical technology companies that remained afloat based on their solid fundamentals, healthy profits and realistic profit projections. Nevertheless, we did have a few disappointments in the portfolio. In particular, while high oil prices benefited many of our energy holdings, they did not bode well for our holdings in the transportation sector, where companies found it difficult to pass on rising fuel costs. Additionally, a few retail and food company stocks in the consumer non-durables sector underperformed, holding down performance in that area. In many cases though, the problems were generally company specific and our broad diversification muted their impact on the portfolio. Momentum investing in technology appears to have fizzled out, and investors are turning to solid values with quantifiable earnings. We believe the trend toward fundamental investing will continue as more investors discover companies with exceptional values and strong business prospects, especially those presented by mid-cap stocks. Many mid-sized companies have shown promising business developments and many of these stocks are selling at appealing discounts when compared to stocks of large companies.
EDWARD VON DER LINDE
1 "Average Annual Return" is calculated including reinvestment of all income dividends and capital gain distributions. Results represent past performance and do not indicate future results. The value of an investment in the Mid-Cap Value Portfolio managed by Lord Abbett and the return on the investment will fluctuate, and redemption proceeds may be higher or lower than an investor's original cost. 2The S&P 400 Midcap Index consists of 400 domestic stocks of midsize companies in the U.S. market. The Index does not include fees and expenses and is not available for direct investment. Performance data is historical and includes changes in share price and reinvestment of dividends and capital gains. Performance numbers are net of all Portfolio operating expenses, but they do not include any insurance charges imposed in connection with your variable insurance contract. If this performance information included the effects of these fees or charges, performance numbers would be lower. Index return since inception is as of 8/22/97.
LARGE CAP RESEARCH PORTFOLIO For the Period ended 6/30/00
MANAGED BY LORD, ABBETT & CO. Letter to Policyholders Utility stocks, a lead indicator of a change in monetary policy, were the star performers of the large cap style in the second quarter. We selectively added to the sector in a defensive stance in preparation for a slowdown in the economy and because we believed the Fed was near the end of its recent round of tightenings. A development in the utilities sector involving the convergence of electric and gas power also benefited several of our holdings. Sector overweights in the high-performing healthcare and utilities sectors, together with an underweight in the weak-performing communications services sector, also added relative performance. At the onset of the second quarter, we had already begun to reduce the portfolio's exposure to many "new economy" stocks in the technology, telecommunications and media sectors due to high valuations and some concerns over inflated expectations on the sustainability of current business fundamentals. In exchange, we made select investments in undervalued "old economy" stocks in basic industries, utilities and financial services (especially insurance stocks) where we saw more intrinsic value. We maintained this weighting shift throughout the second quarter. Your overweight position in consumer cyclical stocks detracted from performance this quarter. General Motors Corp. and Federated Department Stores were two weaker performing stocks. The second quarter brought a shift in attitudes toward equity investing. Throughout 1999 and the opening months of this year investors were caught up in a price and earnings growth-driven "momentum market." They bought a company's stock simply because its price was going up and its earnings were growing at a faster rate than other companies. They all but ignored the sustainability of corporate earnings, valuations, and interest rates. But, toward the end of the first quarter, this pattern began to change. Investors in late March seemed to wake up to the risks of "momentum" investing. In April and May, equity markets experienced a considerable turnaround. Whereas the technology rich NASDAQ index had previously led the market, it fell by some 37 percent from its March peak to the end of May. By contrast, the broad S&P 500 Index fell only 10 percent, and the Dow Jones Industrial Average (DJIA) fell less than five percent. Uncertainty persisted throughout the quarter with respect to the ultimate economic and market impact of the Fed's initiatives. Investors reacted abruptly to economic and corporate earnings announcements. Focus on consumer-oriented factors, such as retail sales, housing, investor confidence and employment, signaled economic slowing from the extremely high levels of prior periods. Hope for a "soft landing" emerged. Momentum-oriented sectors, such as technology, returned to favor in June. Nevertheless, a renewed sensitivity to risk and wariness about fundamentals challenged many investors' decisions. The investing environment now seems suited to a moderately defensive strategy consistent with a slowdown in the economy, but not an absolute downturn. Investors' clear new preference for stable sectors suggests a renewed interest in earnings predictability, valuations, and financial strength -- qualities that are well suited to a slower growth environment. At the same time, concern over value has led investors to reconsider small and particularly medium capitalization issues which investors have neglected, at least relatively speaking. Signs of a slowdown in economic growth confirm the desirability of a cautious approach and a renewed attention to investment fundamentals and value.
ROBERT MORRIS
1 "Average Annual Return" is calculated including reinvestment of all income dividends and capital gain distributions. Results represent past performance and do not indicate future results. The value of an investment in the Large Cap Research Portfolio managed by Lord Abbett and the return on the investment will fluctuate, and redemption proceeds may be higher or lower than an investor's original cost. 2The S&P 500 Index is an unmanaged index consisting of the stocks of 500 of the largest U.S.-based companies. The Index does not include fees or expenses and is not available for direct investment. Performance data is historical and includes changes in share price and reinvestment of dividends and capital gains. Performance numbers are net of all Portfolio operating expenses, but they do not include any insurance charges imposed in connection with your variable insurance contract. If this performance information included the effects of these fees or charges, performance numbers would be lower. Index return since inception is as of 8/22/97.
Cova Series Trust
DEVELOPING GROWTH PORTFOLIO For the Period ended 6/30/00
Managed by Lord, Abbett & Co.
Letter to Policyholders Healthcare sector stocks, coupled with the decision to underweight this area versus the Russell 2000 Growth Index, impeded performance. Hooper Holmes, a provider of home-based medical exams for insurance applicants, lost significant value after warning that analyst expectations were overly optimistic due to the overall poor performance in the life insurance industry. Although this company has hurt performance lately, this holding had been extremely advantageous to the portfolio historically. Given our strong fundamental outlook for this company, we will add to our position on this present weakness. Strong performance was experienced by a top ten holding, Coherent, a provider of electro-optical systems and medical instruments. It is interesting to note that the stocks within this sector that contributed most favorably to the index's return were companies with market capitalizations ranging from $4-$11 billion. Our market cap constraints precluded us from investing in these particular companies. Stock selection within the Financials sector detracted from performance. S1 Corp., a provider of internet-based financial services, has been plagued by the area's extreme stock price movements. Although the price of the stock has declined significantly during this year, S1 was one of the largest contributors to performance during 1999. S1, having established strong alliances with global banking giants, is positioned uniquely within the area of internet based banking, continuing to make this holding a prudent investment. Technology holdings have also affected performance. Although under-weighting the sector relative to the benchmark proved to be advantageous, stock selection within this sector detracted from performance. Igate Capital, an information technology consulting firm, experienced difficulty during the quarter. Although the stock price has been down recently, we are adding to our position to take advantage of the temporary sell-off. However, some technology stocks did add value. Nvidia, a designer of graphics processors and software, contributed positively, having rapidly appreciated to one of your largest holdings. The company has been profitable supporting the computer gaming industry -- a large and rapidly growing segment within the tech sector. Your largest holding, Plantronics, a manufacturer of telephone headsets, was one of the largest contributors to performance during the quarter. Plantronics has been a major holding for several quarters and while it experienced significant performance difficulties in the third quarter of 1999, we continued to hold the stock as we believed that the company's fundamental outlook remained strong. Our ability not to be swayed by the market's fickle nature was ultimately rewarded. As we move into the second half of the year, we believe the volatility in the market is likely to continue in the short-term and liquidity and earnings shortfalls will continue to be concerns for small company investors. However, once the market begins to slow, we believe we will begin to see many smaller companies experience some double-digit growth. Regardless of market conditions, we will continue to execute our disciplined investment approach remaining focused on finding the highest quality companies possible for the portfolio.
STEPHEN J. MCGRUDER
1The Russell Growth 2000 Index is an unmanaged index and measures the performance of those Russell 2000 companies with higher price-to-book ratios and higher forecasted growth values. The Index does not include fees or expenses and is not available for direct investment. 2 "Average Annual Return" is calculated including reinvestment of all income dividends and capital gain distributions. Results represent past performance and do not indicate future results. The value of an investment in the Developing Growth Portfolio managed by Lord Abbett and the return on the investment will fluctuate, and redemption proceeds may be higher or lower than an investor's original cost. 3The Russell 2000 Index is an unmanaged index consisting of the stocks of 2000 U.S. -based companies. The Index does not include fees or expenses and is not available for direct investment. Performance data is historical and includes changes in share price and reinvestment of dividends and capital gains. Performance numbers are net of all Portfolio operating expenses, but they do not include any insurance charges imposed in connection with your variable insurance contract. If this performance information included the effects of these fees or charges, performance numbers would be lower. Index return since inception is as of 8/22/97.
LORD ABBETT GROWTH AND INCOME PORTFOLIO For the Period ended 6/30/00
Managed by Lord, Abbett & Co. Letter to Policyholders Utility stocks, a lead indicator of a change in monetary policy, were the star performers of the large cap style in the second quarter. We selectively added to the sector in a defensive stance in preparation for a slowdown in the economy and because we believed the Fed was near the end of its recent round of tightenings. A development in the utilities sector involving the convergence of electric and gas power also benefited several of our holdings. Throughout the quarter, our relatively large exposure to oil service companies paid off well, as rising oil prices helped boost the price of many of these stocks. Our careful stock picking and general overweighting in stocks of consumer non-cyclical companies, particularly healthcare companies, also significantly buoyed performance for the quarter. At the onset of the second quarter, we had already begun to reduce the portfolio's exposure to many "new economy" stocks in the technology, telecommunications and media sectors due to high valuations and some concerns over inflated expectations on the sustainability of current business fundamentals. In exchange, we made select investments in undervalued "old economy" stocks in basic industries, utilities and financial services (especially insurance stocks) where we saw more intrinsic value. We maintained this weighting shift throughout the second quarter. Our move to basic industries (paper, chemicals, and metals) proved to be a bit premature and worked against our performance for the quarter. However, if the U.S. economy slows later this year, we believe investors will begin to anticipate a more balanced global economic growth environment that should favor the performance of these stocks. Restructuring and consolidation of production capacity in many of these markets is also occurring and will ultimately aid pricing and profit margins. The second quarter brought a shift in attitudes toward equity investing. Throughout 1999 and the opening months of this year investors were caught up in a price and earnings growth-driven "momentum market." They bought a company's stock simply because its price was going up and its earnings were growing at a faster rate than other companies. They all but ignored the sustainability of corporate earnings, valuations, and interest rates. But, toward the end of the first quarter, this pattern began to change. Investors in late March seemed to wake up to the risks of "momentum" investing. In April and May, equity markets experienced a considerable turnaround. Whereas the technology rich NASDAQ index had previously led the market, it fell by some 37 percent from its March peak to the end of May. By contrast, the broad S&P 500 Index fell only 10 percent, and the Dow Jones Industrial Average (DJIA)fell less than five percent. Uncertainty persisted throughout the quarter with respect to the ultimate economic and market impact of the Fed's initiatives. Investors reacted abruptly to economic and corporate earnings announcements. Focus on consumer-oriented factors, such as retail sales, housing, investor confidence and employment, signaled economic slowing from the extremely high levels of prior periods. Hope for a "soft landing" emerged. Momentum-oriented sectors, such as technology, returned to favor in June. Nevertheless, a renewed sensitivity to risk and wariness about fundamentals challenged many investors' decisions. The investing environment now seems suited to a moderately defensive strategy consistent with a slowdown in the economy, but not an absolute downturn. Investors' clear new preference for stable sectors suggests a renewed interest in earnings predictability, valuations, and financial strength -- qualities that are well suited to a slower growth environment. At the same time, concern over value has led investors to reconsider small and particularly medium capitalization issues which investors have neglected, at least relatively speaking. Signs of a slowdown in economic growth confirm the desirability of a cautious approach and a renewed attention to investment fundamentals and value.
W. THOMAS HUDSON JR.
1 "Average Annual Return" is calculated including reinvestment of all income dividends and capital gain distributions. Results represent past performance and do not indicate future results. The value of an investment in the Lord Abbett Growth and Income Portfolio managed by Lord Abbett and the return on the investment will fluctuate, and redemption proceeds may be higher or lower than an investor's original cost. 2 The S&P 500 Index is an unmanaged index consisting of the stocks of 500 of the largest U.S.-based companies. The Index does not include fees or expenses and is not available for direct investment. Performance data is historical and includes changes in share price and reinvestment of dividends and capital gains. Performance numbers are net of all Portfolio operating expenses, but they do not include any insurance charges imposed in connection with your variable insurance contract. If this performance information included the effects of these fees or charges, performance numbers would be lower.
BALANCED PORTFOLIO For the Period ended 6/30/00
Managed by the Mississippi Valley Advisors
Division of FIRMCO
Letter to Policyholders Market volatility continued during the second quarter of 2000 culminating in an important change in market psychology. Investors appear to be returning to fundamental investment criteria in valuing securities -- criteria such as earnings and cash flow. A return to the basics bolstered the returns of your portfolio relative to the overall market during this period. The Standard & Poor's 500 fell -2.65% during the second quarter, bringing the six month return to -0.42%. The technology heavy NASDAQ decline was even more dramatic at -13.3% for the quarter after having fallen 29% from the end of March through the end of May. Smaller stocks continued to outperform larger companies as the Standard & Poor's SmallCap 600 rose +6.9%. Fixed income securities, as measured by the (Lehman Bros. Intermediate Government/Corporate or Lehman Brothers 7-year tax-exempt index) returned (3.2%/3.2%). Future market direction will likely be influenced by the Federal Reserve and the direction of interest rates. The Fed is currently "on hold pending further information on the strength of our economy. We believe the U.S. economy is incredibly resilient and it will likely require further interest rate moves to accomplish the Fed's goal. In this environment we will continue to focus our stock selection on those companies that are providing products or services that are in demand regardless of the level of rates." Currently the entire Treasury yield curve is trading below the Fed Funds rate of 6.5%; apparently the market is discounting an easing of credit at the next Fed meeting, which occurs on August 22. We believe that this is a very optimistic view and that rates on Treasuries are below a sustainable level given the strong economic environment that is present today.
BOB BERNSTEIN
Mississippi Valley Advisors Division of FIRMCO
1 The S&P 500 Index is an unmanaged index consisting of the stocks of 500 of the largest U.S.-based companies. The Index does not include fees or expenses and is not available for direct investment. 2 "Average Annual Return" is calculated including reinvestment of all income dividends and capital gain distributions. Results represent past performance and do not indicate future results. The value of an investment in the Balanced Portfolio managed by Mississippi Valley Advisors (MVA) and the return on the investment will fluctuate, and redemption proceeds may be higher or lower than an investor's original cost. 3 The Salomon Brothers Broad Investment-Grade Bond Index (BIG) is a market-capitalized weighted index that includes fixed-rate Treasury, government sponsored, corporate (Baa3/BBB or better) and mortgage securities. The index does not reflect any expenses. Performance data is historical and includes changes in share price and reinvestment of dividends and capital gains. Performance numbers are net of all Portfolio operating expenses, but they do not include any insurance charges imposed in connection with your variable insurance contract. If this performance information included the effects of these fees or charges, performance numbers would be lower.
EQUITY INCOME PORTFOLIO For the Period ended 6/30/00
MANAGED BY THE MISSISSIPPI VALLEY ADVISORS DIVISION OF FIRMCO Letter to Policyholders The Equity Income Portfolio seeks to provide an above average level of income consistent with long-term capital appreciation. We believe our strength is in stock selection, and will therefore typically maintain a well-diversified portfolio among numerous economic sectors. Early 2000 saw large cap growth stocks continue their outperformance, becoming even more expensive versus value stocks. Value stocks underperformed the S&P 500 until March when Fed rate increases began to scare the markets, driving investors toward value names. In this very concentrated market, we see above average returns in energy, selected electric utilities, and technology stocks. Retailers and industrial cyclicals remain the weakest sectors due in part to concern that the Federal Reserve will slow the economy. With short-term interest rates approaching 7%, stock prices will continue to be volatile over the summer months. However, volatility creates opportunities to buy top quality companies with proven management teams at attractive prices. As always, the Fund's focus is high quality companies with predictable sales, earnings and cash flow growth, strong balance sheets and innovative management. Ongoing market volatility should force investors to seek companies with strong underlying fundamentals rather than chase the hottest new internet story. We continue to believe the value sector holds well above average return potential over the next year or two, especially with many worldwide economies strengthening and the U.S. economy continuing to maintain its solid growth. Many value stocks are in the financial services industries, which should see good performance when the Fed completes its rate increases. Moreover, having been out of favor for nearly four years, value stocks truly deserve the name.
JOHN H. BLIXEN
Mississippi Valley Advisors Division of FIRMCO
1 "Average Annual Return" is calculated including reinvestment of all income dividends and capital gain distributions. Results represent past performance and do not indicate future results. The value of an investment in the Equity Income Portfolio managed by Mississippi Valley Advisors (MVA) and the return on the investment will fluctuate, and redemption proceeds may be higher or lower than an investor's original cost. 2 The Russell 1000 Index consists of the largest 1000 companies in the Russell 3000 Index. The Index represents the universe of large capitalization stocks from which most active money managers typically select. The Index does not include fees or expenses and is not available for direct investment. Performance data is historical and includes changes in share price and reinvestment of dividends and capital gains. Performance numbers are net of all Portfolio operating expenses, but they do not include any insurance charges imposed in connection with your variable insurance contract. If this performance information included the effects of these fees or charges, performance numbers would be lower.
GROWTH & INCOME EQUITY PORTFOLIO For the Period ended 6/30/00
MANAGED BY THE MISSISSIPPI VALLEY ADVISORS DIVISION OF FIRMCO Letter to Policyholders The Mercantile Growth and Income Fund posted a (1.72%) total return during the first six months of the year. This compares to a -0.42% return for the Standard & Poor's 500 Index and a -4.07% return for the Standard & Poor's Barra Value Index. Based on the Fund's profile, an appropriate benchmark is a fifty-fifty blend of these two indexes. Within the technology sector, we emphasized companies benefiting from accelerating unit growth in internet infrastructure and wireless communications. Specific holdings that contributed to the Fund's strong relative performance were Intel, the world leader in semiconductor chips; Nortel Networks, the leading provider of fiber optic technology for the telecommunications industry; and Nokia, the largest global producer of cellular phones. Strength in the Fund's holdings in the capital goods sector was paced by Millipore, a manufacturer of products used to analyze and purify liquids and gases. In the microelectronics segment, Millipore has been a beneficiary of a strong semi conductor capital equipment cycle while the company's biopharmaceutical segment should benefit from increased research and development activity in genomics and monclonal antibodies. With short-term interest rates approaching 7%, stock prices will continue to be volatile over the summer months. However, volatility creates opportunities to buy top quality companies with proven management teams at attractive prices. As always, the Growth and Income Fund's focus is high quality companies with predictable sales, earnings and cash flow growth, strong balance sheets and innovative management. Ongoing market volatility should force investors to seek companies with strong underlying fundamentals rather than chase the hottest new internet story. Investor rotation back to quality stocks should equate to even better relative performance for the Growth and Income Fund.
BOB BERNSTEIN
Mississippi Valley Advisors Division of FIRMCO
1 The S&P 500 Index is an unmanaged index consisting of the stocks of 500 of the largest U.S.-based companies. The Index does not include fees or expenses and is not available for direct investment. 2 "Average Annual Return" is calculated including reinvestment of all income dividends and capital gain distributions. Results represent past performance and do not indicate future results. The value of an investment in the Growth & Income Equity Portfolio managed by Mississippi Valley Advisors (MVA) and the return on the investment will fluctuate, and redemption proceeds may be higher or lower than an investor's original cost. Performance data is historical and includes changes in share price and reinvestment of dividends and capital gains. Performance numbers are net of all Portfolio operating expenses, but they do not include any insurance charges imposed in connection with your variable insurance contract. If this performance information included the effects of these fees or charges, performance numbers would be lower.
PORTFOLIO OF INVESTMENTS
See notes to financial statements
Cova Series Trust
PORTFOLIO OF INVESTMENTS - CONTINUED
See notes to financial statements
Cova Series Trust
PORTFOLIO OF INVESTMENTS - CONTINUED
See notes to financial statements
Cova Series Trust
PORTFOLIO OF INVESTMENTS - CONTINUED
PORTFOLIO FOOTNOTES: * Non-income producing security. (a) Represents investment of collateral received from securities lending transactions. ADR - American Depositary Receipt REIT - Real Estate Investment Trust See notes to financial statements Cova Series Trust Quality Bond Portfolio
PORTFOLIO OF INVESTMENTS
See notes to financial statements
Cova Series Trust
PORTFOLIO OF INVESTMENTS - CONTINUED
See notes to financial statements
Cova Series Trust
PORTFOLIO OF INVESTMENTS - CONTINUED
See notes to financial statements
Cova Series Trust
PORTFOLIO OF INVESTMENTS - CONTINUED
PORTFOLIO FOOTNOTES: (a) Securities that may be resold to "qualified institutional buyers" under Rule 144A or securities offered pursuant to Section 4(2) of the Securities Act of 1933, as amended. These securities have been determined to be liquid under guidelines established by the Board of Trustees. (b) Assets segregated for purchase for purchase price of delayed delivery or when-issued security. (c) Security purchased on a delayed or when-issued basis. (See note 1 to financial statements) (d) Held as collateral for open futures contracts. (e) Represents investment of collateral received from securities lending transactions. Yankee - U.S. Dollar denominated bonds issued by non-U.S. companies in the U.S. See notes to financial statements Cova Series Trust Select Equity Portfolio
PORTFOLIO OF INVESTMENTS
See notes to financial statements
Cova Series Trust
PORTFOLIO OF INVESTMENTS - CONTINUED
PORTFOLIO FOOTNOTES: * Non-income producing security. (a) Represents investment of collateral received from securities lending transactions. See notes to financial statements
Cova Series Trust Large Cap Stock Portfolio PORTFOLIO OF INVESTMENTS JUNE 30,
See notes to financial statements
Cova Series Trust
PORTFOLIO OF INVESTMENTS - CONTINUED
See notes to financial statements
Cova Series Trust
PORTFOLIO OF INVESTMENTS - CONTINUED
See notes to financial statements
Cova Series Trust
PORTFOLIO OF INVESTMENTS - CONTINUED
PORTFOLIO FOOTNOTES: * Non-income producing security. (a) Security purchased on a delayed or when-issued basis. (See note 1 to financial statements) (b) Assets segregated for purchase for purchase price of delayed delivery or when-issued security. (c) Held as collateral for open futures contracts. (d) Represents investment of collateral received from securities lending transactions. See notes to financial statements Cova Series Trust International Equity Portfolio
PORTFOLIO OF INVESTMENTS
See notes to financial statements
Cova Series Trust
See notes to financial statements
Cova Series Trust
See notes to financial statements
Cova Series Trust
PORTFOLIO FOOTNOTES: * Non-income producing security. (a) Securities that may be resold to "qualified institutional buyers" under Rule 144A or securities offered pursuant to Section 4(2) of the Securities Act of 1933, as amended. These securities have been determined to be liquid under guidelines established by the Board of Trustees. (b) Represents investment of collateral received from securities lending transactions. (c) Held as collateral for open futures contracts. ADR - American Depositary Receipt See notes to financial statements Cova Series Trust Bond Debenture Portfolio
PORTFOLIO OF INVESTMENTS
See notes to financial statements
Cova Series Trust
PORTFOLIO OF INVESTMENTS - CONTINUED
See notes to financial statements
Cova Series Trust
PORTFOLIO OF INVESTMENTS - CONTINUED
See notes to financial statements
Cova Series Trust
PORTFOLIO OF INVESTMENTS - CONTINUED
See notes to financial statements
Cova Series Trust
PORTFOLIO OF INVESTMENTS - CONTINUED
See notes to financial statements
Cova Series Trust
PORTFOLIO OF INVESTMENTS - CONTINUED
See notes to financial statements
Cova Series Trust
PORTFOLIO OF INVESTMENTS - CONTINUED
PORTFOLIO FOOTNOTES: (a) Securities that may be resold to "qualified institutional buyers" under Rule 144A or securities offered pursuant to Section 4(2) of the Securities Act of 1933, as amended. These securities have been determined to be liquid under guidelines established by the Board of Trustees. (b) Security is in Bankruptcy or is in default. * Non-income producing security. (c) Represents investment of collateral received from securities lending transactions. + Zero coupon bond ++ Security is a "step-up" bond where coupon increases or steps up at a predetermined date. Rates shown are current coupon and next coupon rate when security steps up. Yankee - U.S. Dollar denominated bonds issued by non-U.S. companies in the U.S. See notes to financial statements
Cova Series Trust
PORTFOLIO COMPOSITION BY CREDIT QUALITY (UNAUDITED)
JUNE 30, 2000 The following table summarizes the portfolio composition of long-term debt holdings at June 30, 2000, based upon quality ratings issued by Standard & Poor's. For securities not rated by Standard & Poor's, the Moody's rating is used.
See notes to financial statements Cova Series Trust Mid-Cap Value Portfolio
PORTFOLIO OF INVESTMENTS
PORTFOLIO FOOTNOTES: * Non-income producing security. (a) Represents investment of collateral received from securities lending transactions. REIT - Real Estate Investment Trust See notes to financial statements
Cova Series Trust Large Cap Research Portfolio PORTFOLIO OF INVESTMENTS JUNE 30,
See notes to financial statements
Cova Series Trust Large Cap Research Portfolio PORTFOLIO OF INVESTMENTS -
PORTFOLIO FOOTNOTES: * Non-income producing security. (a) Represents investment of collateral received from securities lending transactions. ADR - American Depositary Receipt See notes to financial statements Cova Series Trust Developing Growth Portfolio
PORTFOLIO OF INVESTMENTS
See notes to financial statements
Cova Series Trust
PORTFOLIO OF INVESTMENTS - CONTINUED
See notes to financial statements
Cova Series Trust
PORTFOLIO OF INVESTMENTS - CONTINUED
PORTFOLIO FOOTNOTES: * Non-income producing security. (a) Security is in Bankruptcy. (b) Represents investment of collateral received from securities lending transactions. ADR - American Depositary Receipt REIT - Real Estate Investment Trust See notes to financial statements Cova Series Trust Lord Abbett Growth and Income Portfolio
PORTFOLIO OF INVESTMENTS
See notes to financial statements Cova Series Trust Lord Abbett Growth and Income Portfolio
PORTFOLIO OF INVESTMENTS - CONTINUED
PORTFOLIO FOOTNOTES: * Non-income producing security. (a) Represents investment of collateral received from securities lending transactions. ADR - American Depositary Receipt See notes to financial statements
Cova Series Trust
PORTFOLIO OF INVESTMENTS
See notes to financial statements
Cova Series Trust
PORTFOLIO OF INVESTMENTS - CONTINUED
See notes to financial statements
Cova Series Trust
PORTFOLIO OF INVESTMENTS - CONTINUED
PORTFOLIO FOOTNOTES: * Non-income producing security. ADR - American Depositary Receipt See notes to financial statements Cova Series Trust Equity Income Portfolio
PORTFOLIO OF INVESTMENTS
See notes to financial statements
Cova Series Trust
PORTFOLIO OF INVESTMENTS - CONTINUED
PORTFOLIO FOOTNOTES: * Non-income producing security. REIT - Real Estate Investment Trust See notes to financial statements
Cova Series Trust Growth & Income Equity Portfolio PORTFOLIO OF INVESTMENTS JUNE
See notes to financial statements
Cova Series Trust Growth & Income Equity Portfolio PORTFOLIO OF INVESTMENTS -
(PERCENTAGE OF NET ASSETS)
PORTFOLIO FOOTNOTES: * Non-income producing security. ADR - American Depositary Receipt See notes to financial statements
COVA SERIES TRUST
See notes to financial statements
See notes to financial statements
COVA SERIES TRUST
See notes to financial statements
See notes to financial statements
COVA SERIES TRUST
See notes to financial statements.
See notes to financial statements.
COVA SERIES TRUST
See notes to financial statements
See notes to financial statements
COVA SERIES TRUST
See notes to financial statements
See notes to financial statements
COVA SERIES TRUST
* Fund commenced operations on January 8, 1999. See notes to financial statements
* Fund commenced operations on January 8, 1999. See notes to financial statements
COVA SERIES TRUST
See notes to financial statements
See notes to financial statements COVA SERIES TRUST
FINANCIAL HIGHLIGHTS
* Non-annualized ** Annualized + Less than $.0005 per share (1) Amount is less than 0.00% N/A Not Applicable See notes to financial statements
* Non-annualized ** Annualized + Less than $.0005 per share (1) Amount is less than 0.00% N/A Not Applicable See notes to financial statements COVA SERIES TRUST
FINANCIAL HIGHLIGHTS
* Non-annualized ** Annualized N/A Not Applicable See notes to financial statements
* Non-annualized ** Annualized N/A Not Applicable See notes to financial statements COVA SERIES TRUST
FINANCIAL HIGHLIGHTS
* Non-annualized ** Annualized N/A Not Applicable See notes to financial statements
* Non-annualized ** Annualized N/A Not Applicable See notes to financial statements COVA SERIES TRUST
FINANCIAL HIGHLIGHTS
* Non-annualized ** Annualized N/A Not Applicable See notes to financial statements
* Non-annualized ** Annualized N/A Not Applicable See notes to financial statements COVA SERIES TRUST
FINANCIAL HIGHLIGHTS
* Non-annualized ** Annualized N/A Not Applicable See notes to financial statements
* Non-annualized ** Annualized N/A Not Applicable See notes to financial statements COVA SERIES TRUST
FINANCIAL HIGHLIGHTS
* Non-annualized ** Annualized See notes to financial statements
* Non-annualized ** Annualized See notes to financial statements COVA SERIES TRUST Notes to Financial Statements (Unaudited) June 30, 2000 1. SIGNIFICANT ACCOUNTING POLICIES Cova Series Trust (the Trust) is registered as an open-end management investment company under the Investment Company Act of 1940, as amended (the 1940 Act). The Trust offers thirteen diversified portfolios (each, a Fund and collectively, the Funds) each of which operates as a distinct investment vehicle of the Trust. J.P. Morgan Investment Management Inc. manages the Small Cap Stock Portfolio, Quality Bond Portfolio, Select Equity Portfolio, Large Cap Stock Portfolio, and International Equity Portfolio. Lord, Abbett & Co. manages the Bond Debenture Portfolio, Mid-Cap Value Portfolio, Large Cap Research Portfolio, Developing Growth Portfolio, and Lord Abbett Growth and Income Portfolio. FIRSTAR Investment and Research Management Company, LLC, "FIRMCO", (formerly Mississippi Valley Advisors Inc.) manages the Balanced Portfolio, Equity Income Portfolio and Growth & Income Equity Portfolio. The Small Cap Stock Portfolio, Quality Bond Portfolio, Select Equity Portfolio, Large Cap Stock Portfolio, International Equity Portfolio and Bond Debenture Portfolio commenced operations on April 2, 1996. The Balanced Portfolio, Equity Income Portfolio and Growth & Income Equity Portfolio commenced operations on July 1, 1997. The Mid-Cap Value Portfolio, Large Cap Research Portfolio and Developing Growth Portfolio commenced operations on August 20, 1997. The Lord Abbett Growth and Income Portfolio commenced operations on January 8, 1999. The Riggs U.S. Government Securities Portfolio and Riggs Stock Portfolio, managed by Riggs Bank N.A., ceased operations on June 29, 2000. The preparation of financial statements in conformity with generally accepted accounting principles may require management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the reporting period. Actual results could differ from these estimates. The following is a summary of significant accounting policies consistently followed by the Trust in the preparation of its financial statements. A. SECURITY VALUATION - Investments in securities listed on a securities exchange are valued at their sale price as of the close of such securities exchange. If there was no sale on such day, the securities are valued at the mean between the most recently quoted bid and asked prices. Investments in securities not listed on a securities exchange are valued based on their last quoted bid price or, if not available, their fair value as determined in good faith by the Board of Trustees. Domestic fixed income investments are stated at values using the mean between the most recently quoted bid and asked prices. Foreign fixed income securities are valued at their sale price as of the close of the securities exchange on which the securities are listed. If such valuations are not available, estimates obtained from yield data relating to instruments or securities with similar characteristics in accordance with procedures established in good faith by the Board of Trustees are used. Short-term securities with remaining maturities of less than 60 days are valued at amortized cost, which approximates market value. Under the amortized cost method, investments are recorded at cost and any discount or premium is accreted or amortized, respectively, on a straight line basis to the maturity of the investment. Value on any given date equals original cost plus or minus accreted discount or amortized premium, respectively, to that date. Futures contracts and options are valued based upon their daily settlement prices. Forward currency exchange contracts are valued at forward rates and are marked-to-market daily. B. SECURITY TRANSACTIONS - Security transactions are recorded on a trade date basis. Realized gains and losses are determined on an identified cost basis. The Funds may purchase and sell securities on a "when issued" or "delayed delivery" basis, with settlement to occur at a later date. The value of the security so purchased is subject to market fluctuations during this period. The Funds segregate assets having an aggregate value at least equal to the amount of the when issued or delayed delivery purchase commitments until payment is made. C. INVESTMENT INCOME AND EXPENSES - Dividend income is recorded on the ex-dividend date, or in the case of some foreign securities, on the date thereafter when the Fund is made aware of the dividend. Interest income and expenses are recorded when earned or incurred, respectively. Foreign income and foreign capital gains realized on some foreign securities may be subject to foreign withholding taxes, which are accrued as applicable. D. FEDERAL INCOME TAXES - The Trust's policy is to comply with the requirements of Subchapter M of the Internal Revenue Code applicable to regulated investment companies and to distribute substantially all of its taxable income, including net realized gains, if any, to its shareholders. Accordingly, the Funds have not recorded a provision for federal income taxes. In addition, any Funds subject to federal excise tax regulations will distribute substantially all of their net investment income and net capital gains, if any, in each calendar year in order to avoid the payment of federal excise taxes. Distributions from net investment income and capital gains are determined in accordance with federal income tax regulations which may differ from generally accepted accounting principles. As a result, distributions from net investment income and net realized capital gains may differ from their ultimate characterization for federal income tax purposes due to timing differences. For the Large Cap Stock, Quality Bond and International Equity Portfolios, net realized gains and losses may differ for financial and tax reporting purposes primarily as a result of timing differences. E. DISTRIBUTION OF INCOME AND GAINS - The Funds annually declare, pay and automatically reinvest dividends from net investment income and distributions of any net realized capital gains.
COVA SERIES TRUST
1. SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
The primary risks associated with the use of these financial instruments for hedging purposes are the possibility of (a) an imperfect correlation between the change in market value of the hedged securities held by the Funds and the change in market value of these financial instruments, and (b) an illiquid market. As a result, the use of these financial instruments may involve, to a varying degree, elements of market risk in excess of the amount recognized in the Statement of Assets and Liabilities. The following are brief descriptions of derivative instruments the Funds may hold. A. FUTURES CONTRACTS - A futures contract is an agreement involving the delivery of a particular asset on a specified future date at an agreed upon price. These contracts are generally used to provide the return of an index without purchasing all of the securities underlying the index or as a temporary substitute for purchasing or selling specific securities. Upon entering into a futures contract, the Funds are required to make initial margin deposits with the broker or segregate liquid investments to satisfy the broker's margin requirements. Initial margin deposits are recorded as assets and held in a segregated account at the custodian. During the period the futures contract is open, changes in the value of the contract are recognized as unrealized gains or losses by "marking to market" the contract on a daily basis to reflect the value of the contract's settlement price at the end of each day's trading. Variation margin payments are made or received and recognized as assets due from or liabilities to the broker depending upon whether unrealized gains or losses, respectively, are incurred. When the contract is closed, the Fund records a realized gain or loss equal to the difference between the proceeds from (or cost of) the closing transaction and its basis in the contract. B. OPTIONS CONTRACTS - A purchased option contract gives the buyer the right, but not the obligation, to buy (call) or sell (put) an underlying item at a fixed exercise price during a specified period. These contracts are generally used by the Funds to provide the return of an index without purchasing all of the securities underlying the index or as a substitute for purchasing or selling specific securities. Purchases of put and call options are recorded as investments, the value of which are market-to-market daily. When a purchased option expires, the Fund will realize a loss equal to the premium paid. When the Fund enters into a closing sale transaction, the Fund will realize a gain or loss depending on whether the sales proceeds from the closing sale transaction are greater or less the cost of the option. When the Fund exercises a put option, it will realize a gain or loss from the sale of the underlying security and the proceeds from such sale will be decreased by the premium originally paid. When the Fund exercises a call option, the cost of the security which the Fund purchases upon exercise will be increased by the premium originally paid. The premium received for a written option is recorded as a liability. The liability is marked-to-market daily based on the option's quoted market price. When an option expires or the Fund enters into a closing purchase transaction, the Fund realizes a gain (or loss if the cost of the closing purchase transaction exceeds the premium received when the option was sold) without regard to any unrealized gain or loss on the underlying security and the liability related to such option is eliminated. When a written call option is exercised, the Fund realizes a gain or loss from the sale of the underlying security and the proceeds from such sale are increased by the premium originally received. If a written put option is exercised, the amount of the premium originally received will reduce the cost of the underlying security purchased. The risk associated with purchasing options is limited to the premium originally paid. The risk in writing a call option is that the Fund may forego the opportunity for profit if the market price of the underlying security increases and the option is exercised. The risk in writing a put option is that the Fund may incur a loss if the market price of the underlying security decreases and the option is exercised this loss can be greater than premium received. In addition, the Fund could be exposed to risks if the counterparties to the transactions are unable to meet the terms of the contracts. C. FORWARD FOREIGN CURRENCY CONTRACTS - The Quality Bond and International Equity Portfolios may enter into forward foreign currency contracts to hedge their portfolio holdings against future movements in certain foreign currency exchange rates. A forward currency contract is a commitment to purchase or sell a foreign currency at a future date at a set price. The forward currency contracts are valued at the forward rate and are marked-to-market daily. The change in market value is recorded by the Fund as an unrealized gain or loss. When the contract is closed, the Fund recognizes a realized gain or loss equal to the difference between the value of the contract at the time it was opened and the value at the time it was closed. The use of forward foreign currency contracts does not eliminate fluctuations in the underlying prices of the securities of the Fund, but it does establish a rate of exchange that can be achieved in the future. Although forward foreign currency contracts to sell limit the risk of loss due to a decline in the value of the currency holdings, they also limit any potential gain that might result should the value of the currency increase. In addition, the Fund could be exposed to risks if the counterparties to the contracts are unable to meet the terms of the contracts. G. SECURITY LENDING - The Funds may lend their securities to certain qualified brokers. The loans are collateralized at all times with cash or securities with a market value at least equal to the market value of the securities on loan. As with other extensions of credit, the Funds may bear the risk of delay in recovery or even loss of rights in the collateral should the borrower financially. The Funds receive compensation for lending their securities.
COVA SERIES TRUST
1. SIGNIFICANT ACCOUNTING POLICIES - CONTINUED H. FOREIGN CURRENCY TRANSLATION - Assets and liabilities denominated in foreign currencies are translated into U.S. dollars at the rate of exchange at the end of the period. Purchases and sales of securities are translated at the rates of exchange prevailing when such securities were acquired or sold. Income is translated at rates of exchange prevailing when interest is accrued or dividends are recorded. The Fund does not isolate that portion of operations resulting from changes in foreign exchange rates on investments from the fluctuations arising from changes in market prices of securities held. Such fluctuations are included with the net realized and unrealized gain or loss from investments. Reported net realized foreign exchange gains or losses arise from activity in forward foreign currency contracts, sales of foreign currencies, currency gains or losses realized between the trade and settlement dates on securities transactions, and the difference between the amounts of dividends, interest, and foreign withholding taxes recorded on the Fund's books, and the U.S. dollar equivalent of the amounts actually received or paid. Net unrealized foreign exchange gains and losses arise from changes in the value of assets and liabilities other than investments in securities at fiscal year end, from changes in the exchange rates of foreign currency held, and from changes in the contract value of forward foreign currency contracts. I. REPURCHASE AGREEMENTS - The Funds may enter into repurchase agreements with selected commercial banks and broker-dealers, under which the Fund acquires securities as collateral and agrees to resell the securities at an agreed upon time and at an agreed upon price. The Fund accrues interest for the difference between the amount it pays for the securities and the amount it receives upon resale. At the time the Fund enters into a repurchase agreement, the value of the collateral securities including accrued interest will be equal to or exceed the value of the repurchase agreement and, for repurchase agreements that mature in more than one day, the seller will agree that the value of the collateral securities including accrued interest will continue to be at least equal to the value of the repurchase agreement. J. REVERSE REPURCHASE AGREEMENTS - The Funds may enter into reverse repurchase agreements with selected commercial banks or broker-dealers. In a reverse repurchase agreement, the Fund sells securities as collateral and agrees to repurchase them at a mutually agreed upon date and price. This practice is the equivalent of borrowing using the securities as collateral and can create leverage. During the reverse repurchase agreement period, the Fund continues to receive principal and interest payments on these securities but pays interest to the counter-party based upon competitive market rates at the time of issuance. At the time the Fund enters into a reverse repurchase agreement, it will establish and maintain a segregated account with the custodian containing liquid assets having a value not less than the repurchase price (including accrued interest). If the counterparty to the transaction is rendered insolvent, the ultimate realization of the collateral securities to be repurchased by the Fund may be delayed or limited. 2. INVESTMENT ADVISORY AGREEMENT AND OTHER TRANSACTIONS WITH AFFILIATES The Trust has entered into an investment advisory agreement with Cova Investment Advisory Corporation (the "Adviser"), pursuant to which the Adviser manages the investment operations of the Trust's affairs. On January 6, 2000, the Adviser's ultimate parent company, General American Mutual Holding Company, was acquired by the Metropolitan Life Insurance Company. The Adviser has entered into sub-advisory agreements with J.P. Morgan Investment Management Inc., Lord, Abbett & Co., and FIRMCO (the "Sub-advisers") for investment advisory services in connection with the investment management of the Funds. The Adviser supervises the Sub-advisers and makes recommendations to the Board of Trustees with respect to the retention or renewal of the sub-advisory agreements. The Adviser pays the Sub-advisers and bears the cost of compensating officers of the Trust. Under the terms of the Funds' investment advisory agreement, the Funds pay the Adviser a monthly fee based upon annual rates applied to each of the Funds' average daily net assets as follows:
COVA SERIES TRUST
2. INVESTMENT ADVISORY AGREEMENT AND OTHER TRANSACTIONS WITH AFFILIATES - CONTINUED
The Trust has entered into a Custodian, Fund Accounting, and Transfer Agency Agreement with Investors Bank & Trust Company ("Investors Bank"). Cova Variable Annuity Account One and Five, Cova Variable Life Account One, Five, and Eight, and First Cova Variable Annuity Account One are separate investment accounts offered by Cova Financial Services Life Insurance Co. and its subsidiaries, Cova Financial Life Insurance Co. and First Cova Life Insurance Co. (collectively "Cova Life"). At June 30, 2000, Cova Life owned all shares of beneficial interest of each Fund except those listed below.
The Adviser has voluntarily reimbursed each of the Funds, exclusive of the Lord Abbett Growth and Income, Small Cap, Select Equity, and International Equity Portfolios, for their operating expenses, exclusive of brokerage, advisory, or other portfolio transaction expenses or expenses of litigation, indemnification, taxes, or other extraordinary expenses, to the extent that they exceeded an annual rate of .10% of the average daily net assets of the Quality Bond, Large Cap Stock, Bond Debenture, Balanced, Equity Income, and Growth & Income Equity Portfolios. The Adviser has voluntarily reimbursed the Mid-Cap Value, Large Cap Research, and Developing Growth Portfolios for their operating expenses, exclusive of brokerage, advisory, or other portfolio transaction expenses or expenses of litigation, indemnification, taxes, or other extraordinary expenses, to the extent that they exceeded an annual rate of .30% of the average daily net assets.
COVA SERIES TRUST
3. INVESTMENT TRANSACTIONS Aggregate cost of purchases and proceeds of sales of investment securities, excluding short-term securities, for the six months ended June 30, 2000 were as follows:
COVA SERIES TRUST
3. INVESTMENT TRANSACTIONS - CONTINUED At June 30, 2000, the cost of securities for federal income tax purposes and the unrealized appreciation (depreciation) of investments for federal income tax purposes for each Fund was as follows:
4. FUTURES CONTRACTS Transactions in futures contracts for the six months ended June 30, 2000, were as follows:
The futures contracts outstanding as of June 30, 2000 and the description and unrealized appreciation or depreciation were as follows:
COVA SERIES TRUST
4. FUTURES CONTRACTS - CONTINUED
5. FORWARD FOREIGN CURRENCY CONTRACTS Open forward foreign currency contracts for the International Equity Portfolio at June 30, 2000, were as follows: Forward Foreign Currency Contracts to Buy:
Forward Foreign Currency Contracts to Sell:
COVA SERIES TRUST
6. SECURITY LENDING As of June 30, 2000, certain Portfolios had loaned securities which were collateralized by short term investments. Each Portfolio receives transaction fees for providing services in connection with the securities lending program. The risks to the Portfolios of securities lending are that the borrower may not provide additional collateral when required or return the securities when due. The value of the securities on loan and the value of the related collateral were as follows:
7. PROXY VOTING RESULTS A special meeting of the Funds' shareholders was held on January 6, 2000, as adjourned from December 23, 1999. The results of votes taken among shareholders on proposals before them are reported below. PROPOSAL 1: To approve a New Investment Advisory Agreement between Cova Investment Advisory Corporation and Cova Series Trust, such New Investment Advisory Agreement to contain the same terms and conditions as the current Investment Advisory Agreement except for the dates of execution, effectiveness and termination.
COVA SERIES TRUST
7. PROXY VOTING RESULTS - CONTINUED PROPOSAL 2: To approve a New Sub-Advisory Agreement among Cova Investment Advisory Corporation, Cova Series Trust and J.P. Morgan Investment Management Inc., such New Sub-Advisory Agreement to contain the same terms and conditions as the current Sub-Advisory Agreement except for the dates of execution, effectiveness and termination.
PROPOSAL 3: To approve a New Sub-Advisory Agreement among Cova Investment Advisory Corporation, Cova Series Trust and Lord, Abbett & Co., such New Sub-Advisory Agreement to contain the same terms and conditions as the current Sub-Advisory Agreement except for the dates of execution, effectiveness and termination.
PROPOSAL 4: To approve a New Sub-Advisory Agreement among Cova Investment Advisory Corporation, Cova Series Trust and Mississippi Valley Advisors Inc., such New Sub-Advisory Agreement to contain the same terms and conditions as the current Sub-Advisory Agreement except for the dates of execution, effectiveness and termination.
PROPOSAL 5: To approve a New Sub-Advisory Agreement among Cova Investment Advisory Corporation, Cova Series Trust and Riggs Bank N.A., such New Sub-Advisory Agreement to contain the same terms and conditions as the current Sub-Advisory Agreement except for the dates of execution, effectiveness and termination.
Dear Contract Owner: The stock market soared, dove, then rose again during the six months ended July 31, 2000, creating significant volatility among various sectors and individual stocks. By the time the dust settled at the end of June, most major market indices were mixed for the six-month period. Bond prices, which move inversely to their yields, have risen in expectation of a slowing economy due to higher short-term interest rates. Treasury yields decreased in the first half of 2000. Over the course of the last six months, the yield of the thirty year Treasury has decreased by nearly 58 basis points. I encourage you to review the following report covering the past six months and to contact us if you have any questions. Respectfully submitted,
[SECURITY FIRST TRUST LOGO]
SECURITY FIRST TRUST:
EQUITY MARKET OVERVIEW There have been signs during the past few months that momentum may have begun to shift back toward quality companies with a history of earnings growth and relatively high dividend yields, and we regard this development -- if it continues --as a welcome return to reality in the equities market. The year began with a continuation of the pattern that characterized the stock market through most of last year. In the first quarter, the technology-heavy Nasdaq Composite led the way as the more aggressive market sectors provided the strongest performance. In April and May, those stocks experienced a sudden and sharp decline, and traditional value stocks provided better relative performance. In June, the market under-went another reversal in sentiment, with growth stocks rebounding from their spring decline. By the end of July, the Standard and Poors 500 rose slightly while the Nasdaq Composite suffered a modest loss. Within these indices, growth stocks generally fared better than value stocks, and smaller and mid-cap shares outperformed the largest-cap stocks. EQUITY MARKET OUTLOOK After the shakeout of the past six months, the market ended up treading water as investors digested a series of tightening moves by the Fed aimed at slowing the pace of economic growth. In earlier reports we discussed the de-linkage between stock prices and the earnings and dividend growth that normally support them, since share prices have risen at a faster pace in recent years. This gap began to close modestly during the recent period, with earnings and dividend growth moving ahead while stocks declined in value. Despite the improved performance of value stocks mentioned earlier, they remain very inexpensive relative to their growth stock siblings. If history is any guide, true value tends to reassert itself over time.
PORTFOLIO MANAGEMENT:
During the six-month period, the portfolio benefited from several successful investments and suffered from some that did not work out as well. Our holdings in the financial, consumer nondurables, and technology sectors were generally good performers, while business services, transportation, and basic materials were weaker overall.
GROWTH AND INCOME SERIES
Among our major holdings were BP Amoco, Citigroup, American Home Products, Abbott Laboratories, Disney, and Starwood Hotels & Resorts Worldwide.
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GROWTH & INCOME SERIES
15 LARGEST HOLDINGS
The strategy we followed during the period was to invest in good companies after the sell-off. Equity investors not only have high expectations for future returns, but also little tolerance for any disappointing news affecting their investments. As a result, the stocks of many quality companies with solid earnings histories suffered in the downdraft. In this climate, we capitalized on the significant price declines in several stocks to make new investments. Our experience suggests that investing in strong companies after they lose much of their value is often a rewarding move. This was our reason for purchases of Rockwell International, Gillette, Microsoft, America Online, Black & Decker, and Motorola. Rockwell is the classic value stock. Having fallen substantially in price, the stock sold for 10 times earnings and sported a dividend yield of 3% --an attractive valuation for a leading manufacturing company. Our other purchases share the common characteristics of recent price weakness, strong market position, and attractive valuations. Microsoft is a slightly unusual holding for us given our general reluctance to invest in technology stocks for valuation reasons. Nonetheless, after its highly publicized antitrust problems and stock price nosedive, we though it was an opportune time to initiate a small position. Most of the portfolio sales were of successful investments whose valuations reached unattractive levels as their share prices rose, which diminished their appeal for us. Included among our major sales were Baker Hughes and General Electric. The fund's holdings sell at a substantial discount to the overall market. Our historical approach has been to invest in companies selling at relatively low price/earnings ratios with attractive dividend yields and other compelling valuation characteristics. Compared with the broad market, at the end of June we had a portfolio of undervalued companies with good prospects over the next few years.
PORTFOLIO MANAGEMENT:
In this volatile market environment, the Security First Trust Equity Series portfolio underperformed the Standard and Poors 500 Index for the quarter. In particular, an overweight position in the technology sector and an underweight position in the consumer staples sector early in the second quarter hurt performance.
EQUITY SERIES
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Stock selection also detracted from performance among the larger positions in the portfolio while stock selection among the smaller positions in the portfolio contributed positively to performance. During the last few months, we bought Alcatel, Anheuser Busch, Ericsson and Mellon Financial Group. This group showed improving fundamentals and attractive growth prospects. We sold Fleet Boston Financial Corp. due to earnings uncertainty, sold Qualcomm because of deteriorating fundamentals and sold Warner-Lambert because it was fully valued. As of the end of June, the top ten holdings included Cisco Systems, General Electric, Intel and Microsoft.
EQUITY SERIES
15 LARGEST HOLDINGS
Going forward, the portfolio still maintains a value tilt with modes overweight positions in the capital goods, energy and financial sectors relative to the Standard and Poors 500 Index. Despite this value bias, the Portfolio holds many companies that should benefit from the market's emphasis on companies with strong earnings growth prospects.
SECURITY FIRST TRUST:
FIXED-INCOME MARKET OVERVIEW The U.S. economy finally slowed from its rapid pace in the second quarter as gains related to Y2K liquidity and preparations, bonus compensation payments, unseasonably warm weather and tax receipts began to dissipate. While the consumer continued to spend, it was clearly with less enthusiasm than the first quarter, as retail sales declined significantly in the second quarter. A slowdown in the manufacturing sector appeared as well, with the NAPM Purchasing Managers Index falling to its lowest level in 18 months. While the economy is surely slowing, inflation appears less clear. Secular trends such as improving technology and globalization of labor markets continue to put downward pressure on inflation. However, the sharp increase in oil and natural gas prices, along with an upward trending core CPI and Personal Consumption Expenditure deflator, suggest that cyclical inflationary pressures could continue to build even if the economy slows to a more sustainable pace. In March, the Federal Reserve raised both the overnight rate and the discount rate 0.25% to 6.0% and 5.5%, respectively. Despite the sell-off in the equity market in April, in May concerns about an overheating economy due to an increased shortage of labor and rising oil prices led the Federal Reserve to rise rates another 0.50% to 6.5% Treasury yields decreased in the first half of 2000. Over the course of the year so far, the yield of the 30-year Treasury has decreased by nearly 58 basis points (0.58%). The yield of the 10-Year Treasury posted a net decrease of 42 basis points (0.42%). We anticipate a continued flattening of the yield curve as a result of an active Federal Reserve and potential Treasury repurchases of long maturity debt. Mortgages posted positive returns during the first half of the year, but trailed the broader market, which was led by the strong rally in the Treasury market. As measured by the Lehman Brothers Mortgage Index, mortgages posted a 3.67% total return versus 3.99% for the Lehman Brothers Aggregate Index. Strength in the housing market has continued unabated, leading
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to more supply than expected, but in comparison to other spread sectors, mortgages benefited from greater liquidity and higher credit quality. On a relative valuation basis mortgages appear cheap, although uncertainty was increased in the market by Treasury Undersecretary Gensler's testimony concerning a bill seeking to end the quasi-governmental status of FNMA and FHLMC. GNMAs performed well during the first quarter as a Treasury substitute, since it is the only other asset class backed by the full faith and credit of the U.S. Government. FIXED-INCOME MARKET OUTLOOK While some imbalanced and potential inflationary pressures exist, data points to slower economic growth and restrained inflation. We believe that the Fed will refrain from tightening rates for the rest of the year.
PORTFOLIO MANAGEMENT:
We manage the Bond Series portfolio with the objective of earning superior total returns than broadly diversified investment quality bond portfolios that are measured against the Lehman Aggregate Index. We seek to meet this objective through a superior yield profile, diversification, capital appreciation and minimal capital loss. During the first half of the Series' fiscal year (August 1, 1999 - January 31, 2000), an extension of the bear market produced anemic returns (-14% at the portfolio level). However, in the second half (February 1, 2000 - July 31, 2000) a bond market rally produced much more robust returns (4.49% at the portfolio level). In addition, while reviewing those results one should bear in mind that for the last year, risk involving fixed income securities has simply not been rewarded. Treasury Bills -- the risk free asset class --have provided some of the highest returns and the under-performance of riskier asset classes is perhaps not surprising. The evolution of the portfolio structure over the last year has been a reduction to our commitment to the Treasury sector, an increase in commitment to the mortgage sector, reduced commitment to high yield and international issues and our conservative duration posture.
BOND SERIES
During the last year mortgage spreads returned to levels not seen in the last decade, and we took advantage of this by adding primarily GNMA securities that offer the full faith and credit of the United States Government combined with minimal prepayment risk. Offered the opportunity to add yield with no credit risk, we increased our commitment by over 50% during the course of the year. The high yield and international sectors suffered during the last year. High yield was buffeted by higher rates, a slowing economy and increasing downgrade and defaults. International markets suffered as the dollar continued to show strength versus all currencies except the yen. We responded by cutting our commitment. There are a number of high yield issuers that seem quite attractive. We have moved to issues with good visibility, larger size and access to the equity market. Internationally, we expect that the dollar's strength will wane in the coming months and present us with new opportunities. In the meantime caution is our watchword, and we will add to positions slowly.
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PORTFOLIO MANAGEMENT:
During the semi-annual period, the duration of the Portfolio remained long relative to its benchmark for most of the first quarter. The Portfolio ended the quarter with a duration of 5.75 versus 5.64 for the benchmark. We reduced residential mortgage positions during the quarter in favor of Treasuries/Agencies, although mortgages are our largest overweight position. The Portfolio's residential mortgage exposure in the quarter decreased from 45% to 40%. We added slightly to Treasuries/Agencies in the quarter, although our Treasury and agency allocation remains below the market weighting. The Portfolio's exposure to Treasuries/Agencies decreased from 97.4% to 91.5% for the quarter. We also had a slightly higher allocation to cash at the end of the quarter. Looking forward, we are structuring the Portfolio to take advantage of the intermediate-long part of the yield curve. Our yield curve structure in the Portfolio emphasizes the 10- to 20-year part of the curve over the front-end.
U.S. GOVERNMENT INCOME SERIES
PERFORMANCE OF SECURITY FIRST TRUST
The following are the average annual and total returns for each series for the period ending July 31, 2000, assuming an investment of $10,000 at the start of the period, and redemption at the end of the period, with dividends reinvested. These returns are based on past experience. Future values of shares will fluctuate so that their redemption values may be more or less than original cost.
(*) Funds were introduced as of May 1993.
(*) Funds were introduced as of May 1993. (1) Return is computed after deduction of all series expenses, but before deduction of actuarial risk charges and other fees of the variable annuity account. (2) From inception to July 1983, Security First Investment Management Corporation reimbursed the Growth and Income Series for expenses in excess of the maximum expense limitation, and these reimbursements were repaid from August 1983 to July 1986. Likewise, the Bond Series was reimbursed for excess expenses from inception to July 1985, and these reimbursements were repaid from August 1985 to July 1993. Reimbursement of expenses to a series increases average annual total returns while repayments of such reimbursements reduces these returns.
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The following graphs set forth the historical performance of each series as compared to a stated market index for the periods ended July 31: Comparison of Change in Value of $10,000 Investment in Security First Trust T. Rowe Price Growth and Income Series and Standard and Poors 500 Index Assuming Dividends and Distributions are Reinvested. [GRAPH]
The performance indicated here may not be indicative of future performance. Comparison of Change in Value of $10,000 Investment in Security First Trust Bond Series, Lehman Government Bonds Index, and the Lehman Aggregate Bond Index Assuming Dividends and Distributions are Reinvested. [GRAPH]
The performance indicated here may not be indicative of future performance. Comparison of Change in Value of $10,000 Investment in Security First Trust Equity Series and Standard and Poors 500 Index Assuming Dividends and Distributions are Reinvested. [GRAPH]
The performance indicated here may not be indicative of future performance.
Comparison of Change in Value of $10,000 Investment in Security First Trust U.S. Government Income Series and Lehman Government and Intermediate Index Assuming Dividends and Distributions are Reinvested. [GRAPH]
The performance indicated here may not be indicative of future performance.
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SECURITY FIRST TRUST T. ROWE
The graph and Per Share Data Table below illustrate the growth in per share value for the period ending July 31, 2000, of one share of the Security First Trust T. Rowe Price Growth and Income Series purchased on August 1, 1979, at a price of $5.07, assuming that dividends and capital gains were reinvested. The results shown should not be considered a representation of the income that may be earned by investing in the Series today. The value of variable annuities funded by shares in this Series will be reduced by any actuarial risk charges. [GROWTH AND INCOME SERIES GRAPH] PER SHARE DATA
SECURITY FIRST TRUST
The graph and Per Share Data Table below illustrate the growth in per share value for the period ending July 31, 2000, of one share of the Security First Trust Bond Series purchased on August 1, 1979, at a price of $3.12, assuming that dividends and capital gains were reinvested. The results shown should not be considered a representation of the income that may be earned by investing in the Series today. The value of variable annuities funded by shares in this Series will be reduced by any actuarial risk charges. [BOND SERIES GRAPH] PER SHARE DATA
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SECURITY FIRST TRUST
The Per Share Data Table below illustrates the growth in per share value for the period ending July 31, 2000, of one share of the Security First Trust Equity Series purchased on May 19, 1993, at a price of $5.00, assuming that dividends and capital gains were reinvested. The results shown should not be considered a representation of the income that may be earned by investing in the Series today. The value of variable annuities funded by shares in this Series will be reduced by any actuarial risk charges. PER SHARE DATA
+change from 5-19-93 to 12-31-93
SECURITY FIRST TRUST
The Per Share Data Table below illustrates the growth in per share value for the period ending July 31, 2000, of one share of the Security First Trust U.S. Government Income Series purchased on May 19, 1993, at a price of $5.00, assuming the dividends and capital gains were reinvested. The results shown should not be considered a representation of the income that may be earned by investing in the Series today. The value of variable annuities funded by shares in this Series will be reduced by any actuarial risk charges. PER SHARE DATA
+change from 5-19-93 to 12-31-93
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SECURITY FIRST TRUST
The accompanying notes are an integral part of these financial statements.
9
SECURITY FIRST TRUST
The accompanying notes are an integral part of these financial statements.
10
SECURITY FIRST TRUST
The accompanying notes are an integral part of these financial statements.
11
SECURITY FIRST TRUST
The accompanying notes are an integral part of these financial statements.
12
SECURITY FIRST TRUST SCHEDULE I
The accompanying notes are an integral part of these financial statements.
13
SECURITY FIRST TRUST SCHEDULE I
The accompanying notes are an integral part of these financial statements.
14
SECURITY FIRST TRUST SCHEDULE I
The accompanying notes are an integral part of these financial statements.
15
SECURITY FIRST TRUST SCHEDULE I
The accompanying notes are an integral part of these financial statements.
16
SECURITY FIRST TRUST SCHEDULE I
The accompanying notes are an integral part of these financial statements.
17
SECURITY FIRST TRUST SCHEDULE I
The accompanying notes are an integral part of these financial statements.
18
SECURITY FIRST TRUST SCHEDULE I
The accompanying notes are an integral part of these financial statements.
19
SECURITY FIRST TRUST SCHEDULE I
These accompanying notes are an integral part of these financial statements.
20
SECURITY FIRST TRUST SCHEDULE I
* Non-income producing
The accompanying notes are an integral part of these financial statements.
21
SECURITY FIRST TRUST SCHEDULE I
* Non-income producing
The accompanying notes are an integral part of these financial statements.
22
SECURITY FIRST TRUST SCHEDULE I
The accompanying notes are an integral part of these financial statements.
23
SECURITY FIRST TRUST SCHEDULE I
*Non-income producing
The accompanying notes are an integral part of these financial statements.
24
SECURITY FIRST TRUST SCHEDULE I
*Non-income producing
The accompanying notes are an integral part of these financial statements.
25
SECURITY FIRST TRUST SCHEDULE I
*Non-income producing
The accompanying notes are an integral part of these financial statements.
26
SECURITY FIRST TRUST SCHEDULE I
*Non-income producing
The accompanying notes are an integral part of these financial statements.
27
SECURITY FIRST TRUST SCHEDULE I
*Non-income producing
The accompanying notes are an integral part of these financial statements.
28
SECURITY FIRST TRUST SCHEDULE I
The accompanying notes are an integral part of these financial statements.
29
SECURITY FIRST TRUST SCHEDULE I
*Non-income producing
The accompanying notes are an integral part of these financial statements.
30
SECURITY FIRST TRUST SCHEDULE I
*Non-income producing
The accompanying notes are an integral part of these financial statements.
31
SECURITY FIRST TRUST SCHEDULE I
The accompanying notes are an integral part of these financial statements.
32
SECURITY FIRST TRUST SCHEDULE I
The accompanying notes are an integral part of these financial statements.
33
SECURITY FIRST TRUST SCHEDULE I
The accompanying notes are an integral part of these financial statements.
34
SECURITY FIRST TRUST SCHEDULE I
The accompanying notes are an integral part of these financial statements.
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SECURITY FIRST TRUST
NOTES TO FINANCIAL STATEMENTS JULY 31, 2000 NOTE A -- ORGANIZATION OF THE TRUST AND SIGNIFICANT ACCOUNTING POLICIES Security First Trust (the Trust) was established under Massachusetts law pursuant to a Declaration of Trust dated February 13, 1987, as an unincorporated business trust, a form of organization that is commonly called a Massachusetts Business Trust. The Trust is registered with the Securities and Exchange Commission as a diversified open-end management investment company (mutual fund) under the Investment Company Act of 1940 (1940 Act). On June 17, 1987, the shareowners of Security First Legal Reserve Fund, Inc. and Security First Variable Life Fund, Inc. (the Funds), each of which was a Maryland corporation registered as an investment company under the 1940 Act, approved Plans of Reorganization and Liquidation and on July 24, 1987, the Funds became Series of the Trust and their shareowners became shareowners of the Bond Series and the T. Rowe Price Growth and Income Series (the Growth and Income Series), respectively, in a tax-free exchange of shares. The Trust operates as a "series company," as that term is used in Rule 18f-2 under the 1940 Act. Financial information for periods prior to June 17, 1987, reflect the results of the respective funds. The Declaration of Trust permits the Trustees to issue an unlimited number of shares and to divide such shares into an unlimited number of series, all without shareowner approval. Pursuant to this authority, the Board of Trustees of Security First Trust established the Equity Series and the U.S. Government Income Series on July 11, 1993, which commenced operations May 19, 1993. The following is a summary of significant accounting policies followed by the Trust: FEDERAL INCOME TAXES -- Each series of the Trust has elected to qualify as a "Regulated Investment Company." No provision for federal income taxes is necessary because each series intends to maintain its qualification as a "Regulated Investment Company" under the Internal Revenue Code and distribute each year substantially all of its net income and realized capital gains to its shareowners. Income and gains to be distributed are determined annually as of December 31. As of 12/31/1999 the Bond Series and U.S. Government Income Series had capital loss carryforwards of $657,021 and $857,344, respectively. The loss carryforwards expire on 12/31/2009. PORTFOLIO VALUATION -- Investments are carried at market value. The market value of equity securities is determined as follows: securities traded on a national securities exchange are valued at the last sale price; securities not traded on a national securities exchange are valued at the bid price for such securities as reported by security dealers. Fixed maturities are valued at prices obtained from a major dealer in bonds. Short-term investments that have remaining maturities of more than 60 days and for which representative market quotations are readily available are valued at the most recent bid price or yield equivalent as quoted by a major broker-dealer in money market securities. Securities with remaining maturities of 60 days or less are valued at their amortized cost, which approximates market value due to the short duration to maturity. Securities and other assets for which such procedures are deemed not to reflect fair value, or for which representative quotes are not readily available, are valued at prices deemed best to reflect their fair value as determined in good faith by or under supervision of officers of the Trust in a manner specifically authorized by the Board of Directors and applied on a consistent basis.
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SECURITY FIRST TRUST
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE A--ORGANIZATION OF THE TRUST AND SIGNIFICANT ACCOUNTING POLICIES
CURRENCY TRANSLATION -- Assets and liabilities are translated into U.S. dollars at the prevailing exchange rate at the end of the reporting period. Purchases and sales of securities and income and expenses are translated into U.S. dollars at the prevailing exchange rate on the dates of such transactions. The effect of changes in foreign exchange rates on realized and unrealized security gains and losses is reflected as a component of such gains and losses. FOREIGN CURRENCY CONTRACTS -- The Trust may use foreign currency contracts to facilitate transactions in foreign securities and to manage the Trust's currency exposure. Contracts to buy and to sell foreign currency generally are used to minimize the effect of currency fluctuation on the portfolios. Also, a contract to buy or to sell can offset a previous contract. Losses may arise from changes in the value of the foreign currency or if the counterparties do not perform under the contractual terms. The U.S. dollar value of forward foreign currency contracts is determined using forward currency exchange rates supplied by The Wall Street Journal. Purchases and sales of forward foreign currency contracts having the same settlement date are offset, and any gain or loss is recognized on the date of offset; otherwise, the gain or loss is recognized on the settlement date. DIVIDENDS AND DISTRIBUTIONS -- Each series declares dividends annually. Net realized gains from security transactions, if any, are distributed annually. OTHER -- As is common in the industry, security transactions are accounted for no later than the day following the date the securities are purchased or sold. Dividend income is recorded on the ex-dividend date. Interest income is accrued daily. Net realized gain or loss on sale of investments is determined by the specific identification method. ESTIMATES -- Certain amounts reported in the accompanying financial statements are based on management's best estimates and judgements. Actual results could differ from those estimates. NOTE B -- REMUNERATION OF MANAGER AND OTHERS Bond Series and T. Rowe Price Growth and Income Series: Security First Investment Management Corporation (Security Management or Manager) serves as both investment adviser and manager, and is entitled by agreement to a monthly fee equal to 1/24 of 1% of the average daily net asset value of the Bond Series and Growth and Income Series (equivalent annually to .5%), less compensation payable to the Series' sub-advisers, Neuberger & Berman, LLC and T. Rowe Price Associates, respectively. However, to the extent that operating expenses (including management fees but excluding interest and taxes and certain extraordinary expenses) of each series exceed 2.5% of the first $30 million of each series' average daily net assets, 2.0% of the next $70 million of each series' average daily net assets, and 1.5% of each series' average daily net assets in excess of that amount, calculated on the basis of each series' fiscal year (the expense limitation), the agreement requires that Security Management waive its fee. In addition, for the year ended July 31, 2000, Security Management has also agreed to reimburse the Bond Series for any remaining expenses exceeding a limitation
SECURITY FIRST TRUST
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NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE B -- REMUNERATION OF MANAGER AND OTHERS (CONTINUED) equivalent annually to 1.5%. Security Management may elect on an annual basis to reimburse the Series for future excess expenses. If during the fiscal year repayments are made to the Manager and the series' expenses subsequently exceed the expense limitation, the Series shall recover such repayments from the Manager to the extent of the excess determined. Conversely, if during the fiscal year repayments are made by the Manager and the series' expenses subsequently are within the expense limitation, the Manager shall recover such repayments to the extent of the excess repaid. It is management's opinion that it is reasonably possible that actual operating expense may be less than the expense limitation; however, in accordance with the requirements of FASB Statement No. 5, no accrual has been made for the contingent obligation to repay Security Management for excess expense reimbursements since the conditions required for such accrual have not, in the opinion of management, been met. T. Rowe Price Associates provides investment advice and makes investment decisions for the Growth and Income Series, while Neuberger & Berman, LLC provides the same for the Bond Series. T. Rowe Price Associates and Neuberger & Berman, LLC are each paid an annual fee of .35% of the average daily net assets of the series for which they respectively provide investment advice less any compensation payable to Security Management acting as adviser on certain assets in which a series may invest. Equity Series and U.S. Government Income Series: Security Management serves as both investment adviser and manager, and is entitled by agreement to a monthly fee equal to 1/17 of 1% (equivalent annually to .7%) of the average daily net asset value of the Equity Series and 1/22 of 1% (equivalent annually to .55%) of the average daily net asset value of the U.S. Government Income Series, less compensation payable to the Series' sub-adviser, Blackrock, Inc. (Blackrock). However, to the extent that operating expenses (including management fees but excluding interest and taxes and certain extraordinary expenses) of each series exceed 2.5% of the first $30 million of each series' average daily net assets, 2.0% of the next $70 million of each series' average daily net assets and 1.5% of each series' average daily net assets in excess of that amount, calculated on the basis of each series' fiscal year (the expense limitation), the agreement requires that Security Management and Blackrock waive their fees. Blackrock provides investment advice and makes investment decisions for the U.S. Government Income Series and for the Equity Series. Blackrock is paid an annual fee of .40% of the average daily net assets of the U.S. Government Income Series and an annual fee of .55% of the average daily net assets of the Equity Series.
SECURITY FIRST TRUST
38
NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE C -- INVESTMENT SECURITIES TRANSACTIONS Purchases and sales of fixed maturities and equity securities for the year ended July 31, 2000 were as follows:
The cost of investments at July 31, 2000 was the same for both financial statement and federal income tax purposes. At July 31, 2000, the composition of unrealized appreciation and depreciation of investment securities was as follows:
39
SECURITY FIRST TRUST NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE D -- CAPITAL SHARE TRANSACTIONS Transactions in capital shares of the Trust were as follows:
40
SECURITY FIRST TRUST NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE E -- FINANCIAL HIGHLIGHTS The per share information for each respective series' capital stock outstanding throughout the period is as follows:
(1) Total return computed after deduction of all series expenses, but before
deduction of actuarial risk charges and other fees of the variable annuity
account.
41
SECURITY FIRST TRUST NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE E -- FINANCIAL HIGHLIGHTS (CONTINUED)
* The former investment adviser had agreed to waive a portion of its management and advisory fees. Absent this agreement, the ratio of expenses to average net assets and the ratio of net investment income to average net assets would have been .98% and .81% and 1.05% and 1.51% for 1998 and 1997 respectively. ** The former investment adviser had agreed to waive a portion of its management and advisory fees. Absent this agreement, the ratio of expenses to average net assets and the ratio of net investment income to average net assets would have been .90% and 5.27% and 1.04% and 5.34% for 1998 and 1997 respectively.
42
INDEPENDENT AUDITORS' REPORT To the Shareholders and the Board of Trustees of the Security First Trust: We have audited the accompanying statements of assets and liabilities, including the portfolio of investments, of the Security First Trust comprised of the Bond Series, the T. Rowe Price Growth and Income Series, the Equity Series, and the U.S. Government Income Series (collectively, the "Trust") as of July 31, 2000 and the related statements of operations for the year then ended and the statements of changes in net assets and the financial highlights for each of the two years in the period then ended. These financial statements and financial highlights are the responsibility of the Trust's management. Our responsibility is to express an opinion on these financial statements and financial highlights based on our audits. The financial highlights for the three years ended July 31, 1998, were audited by other auditors whose report, dated September 14, 1998, expressed an unqualified opinion on those financial highlights for each of the three years. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and financial highlights are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Our procedures included confirmation of securities owned as of July 31, 2000, by correspondence with the custodian and brokers. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements and financial highlights referred to above present fairly, in all material respects, the financial position of Security First Trust's Bond Series, T. Rowe Price Growth and Income Series, Equity Series, and U.S. Government Income Series as of July 31, 2000, the results of their operations for the year then ended, and the changes in their net assets and the financial highlights for each of the two years in the period then ended, in conformity with accounting principles generally accepted in the United States of America.
VARIABLE ANNUITIES OFFER CHOICES AND BENEFITS THAT REGULAR MUTUAL FUNDS CAN'T Tax-deferred retirement savings plans are among the best investments a person can make today for his or her future. As a vehicle for creating tax-favored retirement savings, variable annuities offer many advantages. A variable annuity offers the opportunity to invest in a diversified portfolio of securities similar to mutual funds. Taxes are deferred on all dividends and on all increases in portfolio value until you take your money out. At retirement, another significant advantage is that the variable annuity can provide you with income that is based on the performance of the fund or funds in which you participated. You may elect to receive monthly, quarterly or annual payments for a specified number of years, your lifetime, or the longer of your lifetime and the lifetime of your joint payee. See your policy for specific options available to you. The Security First Trust series offers you a choice of professionally managed options. You may invest in a Bond Series, Growth and Income Series, Equity Series, or U.S. Government Income Series, each with a varying degree of risk: SECURITY FIRST TRUST BOND SERIES is for conservative investors. The objective is to achieve the highest investment income over the long term consistent with the preservation of capital. SECURITY FIRST TRUST T. ROWE PRICE GROWTH AND INCOME SERIES is for individuals willing to accept a degree of risk. The fund's goal is growth of principal with a reasonable level of income primarily through investment in common stocks. SECURITY FIRST TRUST EQUITY SERIES also seeks to provide growth of capital and income through investment in common stocks of high quality companies. The fund is for individuals willing to accept a degree of risk. SECURITY FIRST TRUST U.S. GOVERNMENT INCOME SERIES is for conservative investors and seeks to provide current income through investment in a diversified portfolio limited primarily to U.S. government securities.
ANNUAL REPORT
SECURITY
BOARD OF TRUSTEES Jack R. Borsting Howard H. Kayton Katherine L. Hensley Lawrence E. Marcus
[SECURITY FIRST TRUST LOGO]
SFG 1768
Security First Trust Bond Series
Security First Trust T. Rowe Price Growth and Income Series Security First Trust Equity Series Security First Trust U.S. Government Income Series
COMBINED PRO FORMA PORTFOLIO OF INVESTMENTS
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