Document/Exhibit Description Pages Size
1: 485BPOS Pvc All Prospectus 485B Filing 8-30-2004 307 1.66M
2: EX-99.A CHARTER Article Supplementary 10± 39K
5: EX-99.D ADVSR CONTR Amended & Restated Bernstein Sub-Advisory 8± 33K
Agmt
3: EX-99.D ADVSR CONTR Amended & Restated Management Agreement 10± 31K
6: EX-99.D ADVSR CONTR Amended & Restated Morgan Stanley 6± 23K
Sub-Advisory Agmt
7: EX-99.D ADVSR CONTR Amended & Restated Neuberger Berman 8± 31K
Sub-Advisory Agmt
8: EX-99.D ADVSR CONTR Amended & Restated Principal Global 5± 23K
Sub-Advisory Agmt
9: EX-99.D ADVSR CONTR Amended & Restated T Rowe Price 10± 40K
Sub-Advisory Agmt
4: EX-99.D ADVSR CONTR American Century Sub-Advisory Agreement 10± 38K
10: EX-99.E UNDR CONTR Amended & Restated Distribution Agreement 7± 28K
11: EX-99.J OTH OPINIONS Ernst & Young Consent 1 7K
12: EX-99.P CODE ETH American Century Code of Ethics 20± 67K
13: EX-99.P CODE ETH Emerald Code of Ethics 5± 24K
Registration No. 02-35570
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
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POST-EFFECTIVE AMENDMENT NO. 58 TO
FORM N-1A
REGISTRATION STATEMENT
under
THE SECURITIES ACT OF 1933
and
REGISTRATION STATEMENT
under
THE INVESTMENT COMPANY ACT OF 1940
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PRINCIPAL VARIABLE CONTRACTS FUND, INC.
(Exact name of Registrant as specified in Charter)
The Principal Financial Group
Des Moines, Iowa 50392
(Address of principal executive offices)
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Telephone Number (515) 248-3842
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MICHAEL D. ROUGHTON Copy to:
The Principal Financial Group John W. Blouch, Esq.
Des Moines, Iowa 50392 Dykema Gossett PLLC
Franklin Square
1300 I Street, N.W., Suite 300 West
Washington, DC 20005-3306
(Name and address of agent for service)
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It is proposed that this filing will become effective (check appropriate box)
___ immediately upon filing pursuant to paragraph (b)of Rule 485
_X_ on August 30, 2004 pursuant to paragraph (b) of Rule 485
___ 60 days after filing pursuant to paragraph (a)(1) of Rule 485
___ on (date) pursuant to paragraph (a)(1) of Rule 485
___ 75 days after filing pursuant to paragraph (a)(2) of Rule 485
___ on (date) pursuant to paragraph (a)(2) of Rule 485
If appropriate, check the following box:
This post-effective amendment designates a new effective date for
a previously filed post-effective amendment.
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PRINCIPAL VARIABLE CONTRACTS FUND, INC.
[Download Table]
ACCOUNTS OF THE FUND
--------------------
ASSET ALLOCATION ACCOUNT LIMITED TERM BOND ACCOUNT
BALANCED ACCOUNT MIDCAP ACCOUNT
BOND ACCOUNT MIDCAP GROWTH ACCOUNT
CAPITAL VALUE ACCOUNT MIDCAP VALUE ACCOUNT
EQUITY GROWTH ACCOUNT MONEY MARKET ACCOUNT
EQUITY INCOME ACCOUNT PRINCIPAL LIFETIME 2010 ACCOUNT
EQUITY VALUE ACCOUNT PRINCIPAL LIFETIME 2020 ACCOUNT
GOVERNMENT SECURITIES ACCOUNT PRINCIPAL LIFETIME 2030 ACCOUNT
GROWTH ACCOUNT PRINCIPAL LIFETIME 2040 ACCOUNT
INTERNATIONAL ACCOUNT PRINCIPAL LIFETIME 2050 ACCOUNT
INTERNATIONAL EMERGING MARKETS PRINCIPAL LIFETIME
ACCOUNT STRATEGIC INCOME ACCOUNT
INTERNATIONAL SMALLCAP ACCOUNT REAL ESTATE SECURITIES ACCOUNT
LARGECAP BLEND ACCOUNT SMALLCAP ACCOUNT
LARGECAP GROWTH ACCOUNT SMALLCAP GROWTH ACCOUNT
LARGECAP STOCK INDEX ACCOUNT SMALLCAP VALUE ACCOUNT
LARGECAP VALUE ACCOUNT
This Prospectus describes a mutual fund organized by Principal Life Insurance
Company/(R)/ ("Principal Life"). The Fund provides a choice of investment
objectives through the Accounts listed above.
The date of this Prospectus is August 30, 2004.
As with all mutual funds, neither the Securities and Exchange Commission ("SEC")
nor any State Securities Commission has approved or disapproved of these
securities or determined if this prospectus is accurate or complete. It is a
criminal offense to represent otherwise.
TABLE OF CONTENTS
ACCOUNT DESCRIPTIONS....................................................
Asset Allocation Account..............................................
Balanced Account......................................................
Bond Account..........................................................
Capital Value Account.................................................
Equity Growth Account.................................................
Equity Income Account .................................................
Equity Value Account..................................................
Government Securities Account.........................................
Growth Account........................................................
International Account.................................................
International Emerging Markets Account................................
International SmallCap Account........................................
LargeCap Blend Account................................................
LargeCap Growth Equity Account ........................................
LargeCap Stock Index Account..........................................
LargeCap Value Account ................................................
Limited Term Bond Account .............................................
MidCap Account ........................................................
MidCap Growth Account .................................................
MidCap Value Account..................................................
Money Market Account..................................................
Principal LifeTime 2010 Account .......................................
Principal LifeTime 2020 Account.......................................
Principal LifeTime 2030 Account.......................................
Principal LifeTime 2040 Account.......................................
Principal LifeTime 2050 Account.......................................
Principal LifeTime Strategic Income Account...........................
Real Estate Securities Account ........................................
SmallCap Account......................................................
SmallCap Growth Account...............................................
SmallCap Value Account................................................
CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS.........................
PRICING OF ACCOUNT SHARES...............................................
DIVIDENDS AND DISTRIBUTIONS.............................................
MANAGEMENT, ORGANIZATION AND CAPITAL STRUCTURE..........................
The Manager...........................................................
The Sub-Advisors......................................................
Duties of the Manager and Sub-Advisors................................
Fees Paid to the Manager..............................................
MANAGERS' COMMENTS......................................................
GENERAL INFORMATION ABOUT AN ACCOUNT....................................
Eligible Purchasers...................................................
Shareholder Rights....................................................
Non-Cumulative Voting.................................................
Purchase of Account Shares............................................
Sale of Account Shares................................................
Restricted Transfers..................................................
Financial Statements..................................................
FINANCIAL HIGHLIGHTS....................................................
ADDITIONAL INFORMATION..................................................
ACCOUNT DESCRIPTIONS
The Principal Variable Contracts Fund (the "Fund") is made up of Accounts. Each
Account has its own investment objective. Principal Management Corporation*, the
"Manager" of the Fund, has selected a Sub-Advisor for certain Accounts based on
the Sub-Advisor's experience with the investment strategy for which it was
selected. The Manager seeks to provide a wide range of investment approaches
through the Fund.
The Sub-Advisors are:
.. Alliance Capital Management L.P. through its Bernstein Investment Research and
Management unit ("Bernstein")
.. American Century Investment Management, Inc. ("American Century")
.. Emerald Advisors, Inc. ("Emerald")
.. Grantham, Mayo, Van Otterloo & Co. LLC ("GMO")
.. J.P. Morgan Investment Management Inc. ("Morgan")
.. Morgan Stanley Investment Management Inc. doing business as Morgan Stanley
Asset Management ("MSAM")
.. Neuberger Berman Management Inc. ("Neuberger Berman")
.. Principal Global Investors, LLC ("Principal")*
.. T. Rowe Price Associates, Inc. ("T. Rowe Price")
.. The Dreyfus Corporation ("Dreyfus")
.. UBS Global Asset Management (Americas) Inc. ("UBS Global AM")
* Principal, Principal Management Corporation, Princor Financial Services
Corporation ("Princor") and Principal Life are members of the Principal
Financial Group/(R)/.
In the description for each Account, there is important information about the
Account's:
MAIN STRATEGIES AND RISKS
These sections summarize how each Account intends to achieve its investment
objective. The Account's primary investment strategy (including the type or
types of securities in which the Account invests) is discussed. In addition,
there is a discussion of any policy of the Account to concentrate in securities
of issuers in a particular industry or group of industries.
A description of the main risks is included with the discussion of each Account.
A full discussion of risks appears later in the Prospectus under the caption
"Certain Investment Strategies and Related Risks."
Each Account is designed to be a portion of an investor's portfolio. None of the
Accounts is intended to be a complete investment program. You should consider
the risks of each Account before making an investment and be prepared to
maintain the investment during periods of adverse market conditions.
INVESTMENT RESULTS
A bar chart and a table are included with each Account that has annual returns
for a full calendar year. They show the Account's annual returns and its
long-term performance. The chart shows how the Account's performance has varied
from year-to-year. The table compares the Account's performance over time to
that of:
.. a broad-based securities market index (An index measures the market price of a
specific group of securities in a particular market or securities in a market
sector. You cannot invest directly in an index. An index does not have an
investment advisor and does not pay any commissions or expenses. If an index
had expenses, its performance would be lower.); and
.. an average of mutual funds with a similar investment objective and management
style. The averages used are prepared by independent statistical services.
An Account's past performance is not necessarily an indication of how the
Account will perform in the future.
Call the Principal Variable Contracts Fund at 1-800-247-4123 to get the current
7-day yield for the Money Market
Account.
FEES AND EXPENSES
The annual operating expenses for each Account are deducted from that Account's
assets (stated as a percentage of Account assets) and are shown as of the end of
the most recent fiscal year. An Account's operating expenses are shown with each
Account. A discussion of the fees is found in the section of the Prospectus
titled "The Costs of Investing." The fees and expenses shown do not include the
effect of any separate account expenses or other contract
level expenses. If such charges were included, overall expenses would be higher
and would lower the Accountis
performance.
The examples are intended to help you compare the cost of investing in a
particular Account with the cost of investing in other mutual funds. The
examples assume you invest $10,000 in an Account for the time periods indicated.
The examples also assume that your investment has a 5% total return each year
and that the Account's operating expenses are the same as the expenses shown.
Although your actual costs may be higher or lower, based on these assumptions
your costs would be as shown.
NOTES:
.. No salesperson, dealer or other person is authorized to give information or
make representations about an Account other than those contained in this
Prospectus. Information or representations not contained in this Prospectus
may not be relied upon as having been made by the Principal Variable Contracts
Fund, an Account, the Manager or any Sub-Advisor.
.. Investments in these Accounts are not deposits of a bank and are not insured
or guaranteed by the Federal Deposit Insurance Corporation or any other
government agency.
ASSET ALLOCATION ACCOUNT
The Account seeks to generate a total investment return consistent with
preservation of capital.
MAIN STRATEGIES
The Account invests in a portfolio of securities that is broadly diversified by
asset class, global region, country, economic sector, and currency. The
Portfolio Manager makes the Account's broad asset allocation decisions and
delegates responsibility for selection specific individual securities to the
internal, active management teams of the Sub-Advisor, MSAM.
In deciding how to allocate the Account's assets, MSAM assesses three sets of
factors:
.. the relative value of the stock, bond and money markets in the various
regions, countries and economic sectors;
.. the long-term dynamic forces that are driving economies, economic sectors, and
companies; and
.. the short-term technical forces that are affecting market pricing.
Factors evaluated include growth rates in gross domestic product, inflation and
corporation earnings, labor market conditions, interest rate levels, sales
growth, return on equity, dividend yields, price to book ratios and currency
valuations.
From time-to-time, MSAM changes the Account's allocation of assets in various
ways, including by asset class, by global region, by country, by economic sector
and by currency, in order to keep the portfolio in alignment with global
investment outlook.
Allocation among asset classes is designed to lessen overall investment risk by
diversifying the Account's assets among different types of investments in
different markets. MSAM reallocates among asset classes and eliminates asset
classes for a period of time, when in its judgement the shift offers better
prospects of achieving the investment objective of the Account. Under normal
market conditions, abrupt reallocations among asset classes will not occur.
MSAM does not allocate a specific percentage of the Account's assets to a class.
Over time, it expects the asset mix to be within the following ranges:
.. 25% to 75% in equity securities;
.. 20% to 60% in fixed-income securities; and
.. 0% to 40% in money market instruments.
The Account may invest up to 100% of its assets in foreign securities.
Allowable instruments include individual securities (stocks (without regard to
the market capitalization of the issuing company) and bonds), equity and
interest rate futures, currency forward contracts, futures contracts, Exchange
Traded Funds, fixed-income TRAINS and listed options. The Account may purchase
securities issued as part of, or a short period after, companies' initial public
offerings and may at times dispose of those shares shortly after their
acquisition. MSAM may utilize currency contracts, currency or index futures or
other derivatives for hedging or other purposes, including modifying the
Account's exposure to various currency, equity or fixed-income markets.
MAIN RISKS
As with any security, the securities in which the Account invests have
associated risks. These include risks of:
STOCK MARKET VOLATILITY . The net asset value of the Account's shares is
effected by changes in the value of the securities it owns. The prices of equity
securities held by the Account may decline in response to certain events
including those directly involving issuers of these securities, adverse
conditions affecting the general economy, or overall market declines. In the
short term, stock prices can fluctuate dramatically in response to these
factors.
INTEREST RATE CHANGES . The value of fixed-income securities held by the Account
may be affected by factors such as changing interest rates, credit rating, and
effective maturities. When interest rates fall, the price of a bond rises and
when interest rates rise, the price declines.
CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater
credit risk and price fluctuations than higher quality and shorter maturity
bonds. Bonds held by the Account may be affected by unfavorable political,
economic, or governmental developments that could affect the repayment of
principal or the payment of interest.
HIGH YIELD SECURITIES . Fixed-income securities that are not investment grade
are commonly referred to as junk bonds or high yield securities. These
securities offer a higher yield than other, higher rated securities, but they
carry a greater degree of risk and are considered speculative by the major
credit rating agencies. (please see High Yield Securities in the section of the
Prospectus entitled CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS)
FOREIGN INVESTING . Foreign markets and currencies may not perform as well as
U.S. markets. Political and economic uncertainty in foreign countries, as well
as less public information about foreign investments may negatively impact the
Account's portfolio. Dividends and other income payable on foreign securities
may be subject to foreign taxes. Some investments may be made in currencies
other than the U.S. dollar that will fluctuate in value as a result of changes
in the currency exchange rate.
SMALL AND MEDIUM CAPITALIZATIONS . Companies with small capitalizations are
often companies with a limited operation history. Such companies may have been
created in response to cultural, economic, regulatory or technological
developments. Such developments can have significant impact or negative effect
on smaller capitalization companies securities which may be more volatile in
price than larger company securities, especially over the short-term.
HEDGING STRATEGIES . Use of forward foreign currency exchange contracts,
currency or index futures or other derivatives involves risks. The contracts may
increase the Account's volatility and, thus, could involve a significant risk.
If the Sub-Advisor's predictions are inaccurate, the averse consequences to the
Account (e.g., a reduction in the Account's net asset value) may leave the
Account in a worse position than if these strategies were not used.
INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in
IPOs exposes it to the additional risks associated with companies that have
little operating history as public companies, as well as to the risks inherent
in those sectors of the market where these new issuers operate. The market for
IPO issuers has been volatile and share prices of certain newly-public companies
have fluctuated in significant amounts over short periods of time. In addition,
the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at
times dispose of those shares shortly after their acquisition.
U.S. GOVERNMENT SPONSORED SECURITIES . The Account may invest in debt and
mortgage-backed securities issued by government-sponsored enterprises such as
the Federal Home Loan Mortgage Corporation, the Federal National Mortgage
Association and the Federal Home Loan Banks. Although the issuing agency,
instrumentality or corporation maybe chartered or sponsored by the United States
government, their securities are neither issued nor guaranteed by the United
States Treasury.
ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an
attempt to achieve its investment objective. The financial highlights table at
the end of this Prospectus shows the Account's turnover rate during recent
fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to
the Account buying and selling all of its securities two times during the course
of the year. A high turnover rate may increase the Account's trading costs and
may have an adverse impact on the Account's performance.
INVESTOR PROFILE
The Account may be an appropriate investment for investors seeking a moderate
risk approach towards long-term growth. As with all mutual funds, as the values
of the Account's assets rise or fall, the Account's share price changes. If
you sell your shares when their value is less than the price you paid, you will
lose money.
The Account's past performance is not necessarily an indication of how the
Account will perform in the future. The bar chart and tables provide some
indication of the risks of investing in the Account by showing changes in
performance from year to year and showing how the Account's average annual
returns compare with those of a broad measure of market performance. Annual
operating expenses do not include any separate account expenses, cost of
insurance or other contract level expenses. Total returns would be lower if such
expenses were included.
YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
[Download Table]
"1995"20.66
"1996"12.92
"1997"18.19
"1998"9.18
"1999"19.49
"2000"1.61
"2001"-3.92
"2002"-12.94
The Account's highest/lowest quarterly returns
"2003"21.61 during this
time period were:
HIGHEST Q2 '03 12.11%
LOWEST Q3 '02 -12.41%
LOGO
The year-to-date return as of June 30, 2004 is 1.86%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2003
[Download Table]
PAST 1
YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT*
ASSET ALLOCATION
ACCOUNT ..............
21.61 4.31 N/A 8.49
S&P 500 Index ........ 28.67 -0.57 11.06
Lehman Brothers
Aggregate Bond Index . 4.11 6.62 6.95
MSCI EAFE (Europe,
Australia, Far East)
Index-ND ............. 38.59 -0.05 4.47
Morningstar Moderate
Allocation Category... 20.06 2.48 8.15
* The Account's SEC effective date was June 1, 1994.
FEES AND EXPENSES AS A % OF AVERAGE DAILY NET ASSETS BASED ON THE ACCOUNT'S
LATEST FISCAL YEAR
(These fees and expenses do not include the effect of any sales charge, separate
account expenses or other contract level expenses which may be applied at the
variable life insurance or variable annuity product level. If such charges or
-
fees were included, overall expenses would be higher and would lower the
Account's performance.)
ACCOUNT OPERATING EXPENSES
[Download Table]
Management Fees................. 0.80
Other Expenses.................. 0.05
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TOTAL ACCOUNT OPERATING
EXPENSES 0.85
EXAMPLES
The Examples assume that you invest $10,000 in the Account for the time periods
indicated and then redeem all of your shares at the end of those periods. The
Examples also assume that your investment has a 5% return each year and that
the Account's operating expenses remain the same. If separate account expenses
and contract level expenses were included, expenses would be higher. Although
your actual costs may be higher or lower, based on these assumptions your cost
would be:
[Enlarge/Download Table]
NUMBER OF YEARS YOU OWN YOUR SHARES
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1 3 5 10
ASSET ALLOCATION
ACCOUNT $87 $271 $471 $1,049
BALANCED ACCOUNT
The Account seeks to generate a total return consisting of current income and
capital appreciation.
MAIN STRATEGIES
The Account seeks growth of capital and current income by investing primarily in
common stocks and corporate bonds. It may also invest in other equity
securities, government bonds and notes (obligations of the U.S. government or
its agencies or instrumentalities) and cash. Though the percentages in each
category are not fixed, common stocks generally represent 40% to 70% of the
Account's assets. The remainder of the Account's assets is invested in bonds and
cash.
In making its selection of common stocks, the Sub-Advisor, Principal, looks for
companies that have predictable earnings and which, based on growth prospects,
it believes are undervalued in the marketplace. Principal buys stocks with the
objective of long-term capital appreciation. From time to time, Principal
purchases stocks with the expectation of price appreciation over the short-term.
In response to changes in economic conditions, Principal may change the make-up
of the portfolio and emphasize different market sectors by buying and selling
the portfolio's stocks. The Account may invest up to 10% of its assets in
securities of foreign companies.
Fixed-income securities are purchased to generate income and for capital
appreciation purposes when Principal thinks that declining interest rates may
increase market value. Deep discount bonds (those which sell at a substantial
discount from their face amount) are also purchased to generate capital
appreciation. The Account may invest in bonds with speculative characteristics
but does not intend to invest more than 10% of its assets in securities rated
below BBB by Standard & Poor's Rating Service or Baa by Moody's Investors
Service, Inc. Fixed-income securities that are not investment grade are commonly
referred to as "junk bonds" or high yield securities.
MAIN RISKS
As with any security, the securities in which the Account invests have
associated risks. These include risks of:
STOCK MARKET VOLATILITY . The net asset value of the Account's shares is
effected by changes in the value of the securities it owns. The prices of equity
securities held by the Account may decline in response to certain events
including those directly involving issuers of these securities, adverse
conditions affecting the general economy, or overall market declines. In the
short term, stock prices can fluctuate dramatically in response to these
factors.
INTEREST RATE CHANGES . The value of fixed-income securities held by the Account
may be affected by factors such as changing interest rates, credit rating, and
effective maturities. When interest rates fall, the price of a bond rises and
when interest rates rise, the price declines.
CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater
credit risk and price fluctuations than higher quality and shorter maturity
bonds. Bonds held by the Account may be affected by unfavorable political,
economic, or governmental developments that could affect the repayment of
principal or the payment of interest.
HIGH YIELD SECURITIES . Fixed-income securities that are not investment grade
are commonly referred to as "junk bonds" or high yield securities. These
securities offer a higher yield than other, higher rated securities, but they
carry a greater degree of risk and are considered speculative by the major
credit rating agencies. (please see High Yield Securities in the section of the
Prospectus entitled CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS)
FOREIGN INVESTING . Foreign markets and currencies may not perform as well as
U.S. markets. Political and economic uncertainty in foreign countries, as well
as less public information about foreign investments may negatively impact the
Account's portfolio. Dividends and other income payable on foreign securities
may be subject to foreign taxes. Some investments may be made in currencies
other than the U.S. dollar that will fluctuate in value as a result of changes
in the currency exchange rate.
U.S. GOVERNMENT SPONSORED SECURITIES . The Account may invest in debt and
mortgage-backed securities issued by government-sponsored enterprises such as
the Federal Home Loan Mortgage Corporation, the Federal National Mortgage
Association and the Federal Home Loan Banks. Although the issuing agency,
instrumentality or corporation
maybe chartered or sponsored by the United States government, their securities
are neither issued nor guaranteed by the United States Treasury.
MORTGAGE-BACKED SECURITIES . Mortgage-backed securities are subject to
prepayment risk. When interest rates decline, significant unscheduled
prepayments may result. These prepayments must then be reinvested at lower
rates. Prepayments may also shorten the effective maturities of these
securities, especially during periods of declining interest rates. On the other
hand, during periods of rising interest rates, a reduction in prepayments may
increase the effective maturities of these securities, subjecting them to the
risk of decline in market value in response to rising interest rates. This may
increase the volatility of the Account.
Because the Account invests in both stocks and bonds, the Account may under
perform stock funds when stocks are in favor and under perform bond funds when
bonds are in favor. As with all mutual funds, as the values of the Account's
assets rise or fall, the Account's share price changes. If you sell your shares
when their value is less than the price you
paid, you will lose money.
INVESTOR PROFILE
The Account may be an appropriate investment for investors seeking current
income as well as long-term growth of capital.
The Account's past performance is not necessarily an indication of how the
Account will perform in the future. The bar chart and tables provide some
indication of the risks of investing in the Account by showing changes in
performance from year to year and showing how the Account's average annual
returns compare with those of a broad measure of market performance. Annual
operating expenses do not include any separate account expenses, cost of
insurance or other contract level expenses. Total returns would be lower if such
expenses were included.
YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
[Download Table]
"1994"-2.09
"1995"24.58
"1996"13.13
"1997"17.93
"1998"11.91
"1999"2.4
"2000"0.13
"2001"-6.96
"2002"-13.18
The Account's highest/lowest quarterly returns
"2003"18.82 during this
time period were:
HIGHEST Q2 '03 9.82%
LOWEST Q3 '02 -9.61%
LOGO
The year-to-date return as of June 30, 2004 is 2.22%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2003
[Download Table]
PAST 1
YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT*
BALANCED ACCOUNT .....
18.82 -0.32 6.01 8.44
60% S&P 500 Index/40%
Lehman Brothers
Aggregate Bond Index 18.47 2.65 9.74
Lehman Brothers
Aggregate Bond Index . 4.11 6.62 6.95
S&P 500 Index ........ 28.67 -0.57 11.06
Morningstar Moderate
Allocation Category... 20.06 2.48 8.15
* The Account's SEC effective date was December 18, 1987.
FEES AND EXPENSES AS A % OF AVERAGE DAILY NET ASSETS BASED ON THE ACCOUNT'S
LATEST FISCAL YEAR
(These fees and expenses do not include the effect of any sales charge, separate
account expenses or other contract level expenses which may be applied at the
variable life insurance or variable annuity product level. If such charges or
-
fees were included, overall expenses would be higher and would lower the
Account's performance.)
ACCOUNT OPERATING EXPENSES
[Download Table]
Management Fees................. 0.59
Other Expenses.................. 0.06
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TOTAL ACCOUNT OPERATING
EXPENSES 0.65
EXAMPLES
The Examples assume that you invest $10,000 in the Account for the time periods
indicated and then redeem all of your shares at the end of those periods. The
Examples also assume that your investment has a 5% return each year and that
the Account's operating expenses remain the same. If separate account expenses
and contract level expenses were included, expenses would be higher. Although
your actual costs may be higher or lower, based on these assumptions your cost
would be:
[Download Table]
NUMBER OF YEARS YOU OWN YOUR SHARES
----------------------------------------------------------------------------------
1 3 5 10
BALANCED ACCOUNT $66 $208 $362 $810
BOND ACCOUNT
The Account seeks to provide as high a level of income as is consistent with
preservation of capital and prudent
investment risk.
MAIN STRATEGIES
Under normal circumstances, the Account invests at least 80% of its assets in
intermediate maturity fixed-income or debt securities rated BBB or higher by
Standard & Poor's Rating Service ("S&P") or Baa or higher by Moody's Investors
Service, Inc. ("Moody's"). The Account considers the term "bond" to mean any
debt security. Under normal circumstances, the Account invests in:
.. securities issued or guaranteed by the U.S. government or its agencies or
instrumentalities;
.. mortgage-backed securities representing an interest in a pool of mortgage
loans;
.. debt securities and taxable municipal bonds rated, at the time of purchase, in
one of the top four categories by S&P or Moody's or, if not rated, in the
opinion of the Manager of comparable quality; and
.. securities issued or guaranteed by the governments of Canada (provincial or
federal government) or the United Kingdom payable in U.S. dollars.
The rest of the Account's assets may be invested in:
.. preferred and common stock that may be convertible (may be exchanged for a
fixed number of shares of common stock of the same issuer) or may be
non-convertible; or
.. securities rated less than the four highest grades of S&P or Moody's (i.e.
less than investment grade (commonly known as "junk bonds")) but not lower
than CCC- (S&P) or Caa (Moody's).
Under unusual market or economic conditions, the Account may invest up to 100%
of its assets in cash and cash equivalents.
During the fiscal year ended December 31, 2003, the average ratings of the
Account's assets, based on market value at each month-end, were as follows (all
ratings are by Moody's):
[Download Table]
59.31% in securities 16.70% in securities 0.24% in securities rated
rated Aaa rated Baa B
5.44% in securities rated 5.64% in securities rated 0.04% in securities rated
Aa Ba Ca
12.63% in securities
rated A
The above percentages for Aaa and Aa rated securities includes 0.26% and 0.22%,
respectively, of unrated securities which have been determined by the Manager to
be of comparable quality.
MAIN RISKS
As with any security, the securities in which the Account invests have
associated risks. These include risks of:
MUNICIPAL SECURITIES . Principal and interest payments of municipal securities
may not be guaranteed by the issuing body and may be payable only from monies
derived from a particular source. If the source does not perform as expected,
principal and income payments may not be made on time or at all. In addition,
the market for municipal securities is often thin and may be temporarily
affected by large purchases and sales, including those of the Account. General
conditions in the financial markets and the size of a particular offering may
also negatively affect the returns of a municipal security.
MORTGAGE-BACKED SECURITIES . Mortgage-backed securities are subject to
prepayment risk. When interest rates decline, significant unscheduled
prepayments may result. These prepayments must then be reinvested at lower
rates. Prepayments may also shorten the effective maturities of these
securities, especially during periods of declining interest rates. On the other
hand, during periods of rising interest rates, a reduction in prepayments may
increase the effective maturities of these securities, subjecting them to the
risk of decline in market value in response to rising interest rates. This may
increase the volatility of the Account.
U.S. GOVERNMENT SPONSORED SECURITIES . The Account may invest in debt and
mortgage-backed securities issued by government-sponsored enterprises such as
the Federal Home Loan Mortgage Corporation, the Federal National Mortgage
Association and the Federal Home Loan Banks. Although the issuing agency,
instrumentality or corporation
maybe chartered or sponsored by the United States government, their securities
are neither issued nor guaranteed by the United States Treasury.
PORTFOLIO DURATION. . The average portfolio duration of the Account normally
varies within a three- to six-year time frame based on the Manager's forecast
for interest rates. Duration is a measure of the expected life of a fixed-income
security that is used to determine the sensitivity of a security's price to
changes in interest rates. For example, if the portfolio duration of the Account
is three years, a change of 1% in the market's yield results in a change of
approximately 3% in the value of the Account's securities. The longer a
security's duration, the more sensitive it is to changes in interest rates. An
Account with a longer average portfolio duration will be more sensitive to
changes in interest rates than an Account with a shorter average portfolio
duration .
INTEREST RATE CHANGES . The value of fixed-income securities held by the Account
may be affected by factors such as changing interest rates. When interest rates
rise, the value of fixed-income securities will generally fall. Conversely, a
drop in interest rates will generally cause an increase in the value of
fixed-income securities. Some fixed-income investments give the issuer the
option to call, or redeem, its securities before their maturity date. If an
issuer calls its security during a time of declining interest rates, the Account
may have to reinvest the proceeds in securities with lower rates. In addition,
the Account's appreciation may be limited by issuer call options having more
value during times of declining interest rates.
CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater
credit risk and price fluctuations than higher quality and shorter maturity
bonds. Bonds held by the Account may be affected by unfavorable political,
economic, or governmental developments that could affect the repayment of
principal or the payment of interest.
HIGH YIELD SECURITIES . Fixed-income securities that are not investment grade
are commonly referred to as junk bonds or high yield securities. These
securities offer a higher yield than other, higher rated securities, but they
carry a greater degree of risk and are considered speculative by the major
credit rating agencies. (please see High Yield Securities in the section of the
Prospectus entitled CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS)
As with all mutual funds, as the values of the Account's assets rise or fall,
the Account's share price changes. If you sell
your shares when their value is less than the price you paid, you will lose
money.
INVESTOR PROFILE
The Account may be an appropriate investment for investors seeking
diversification by investing in a fixed-income mutual fund.
The Account's past performance is not necessarily an indication of how the
Account will perform in the future. The bar chart and tables provide some
indication of the risks of investing in the Account by showing changes in
performance from year to year and showing how the Account's average annual
returns compare with those of a broad measure of market performance. Annual
operating expenses do not include any separate account expenses, cost of
insurance or other contract level expenses. Total returns would be lower if such
expenses were included.
YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
[Download Table]
"1994"-2.9
"1995 "22.17
"1996 "2.36
"1997 "10.6
"1998 "7.69
"1999"-2.59
"2000 "8.17
"2001 "8.12
"2002 "9.26
The Account's highest/lowest quarterly returns
"2003 "4.59 during this
time period were:
HIGHESTQ2 '958.25%
LOWEST Q1 '96-3.24%
LOGO
The year-to-date return as of June 30, 2004 is 0.29%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2003
[Download Table]
PAST 1
YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT*
BOND ACCOUNT .........
4.59 5.42 6.53 8.19
Lehman Brothers
Aggregate Bond Index . 4.11 6.62 6.95
Morningstar
Intermediate-Term Bond
Category ............. 4.92 5.67 6.08
* The Account's SEC effective date was December 18, 1987.
FEES AND EXPENSES AS A % OF AVERAGE DAILY NET ASSETS BASED ON THE ACCOUNT'S
LATEST FISCAL YEAR
(These fees and expenses do not include the effect of any sales charge, separate
account expenses or other contract level expenses which may be applied at the
variable life insurance or variable annuity product level. If such charges or
-
fees were included, overall expenses would be higher and would lower the
Account's performance.)
ACCOUNT OPERATING EXPENSES
[Download Table]
Management Fees................. 0.46
Other Expenses.................. 0.01
----
TOTAL ACCOUNT OPERATING
EXPENSES 0.47
EXAMPLES
The Examples assume that you invest $10,000 in the Account for the time periods
indicated and then redeem all of your shares at the end of those periods. The
Examples also assume that your investment has a 5% return each year and that
the Account's operating expenses remain the same. If separate account expenses
and contract level expenses were included, expenses would be higher. Although
your actual costs may be higher or lower, based on these assumptions your cost
would be:
[Download Table]
NUMBER OF YEARS YOU OWN YOUR SHARES
--------------------------------------------------------------------------------
1 3 5 10
BOND ACCOUNT $48 $151 $263 $591
CAPITAL VALUE ACCOUNT
The Account seeks to provide long-term capital appreciation and secondarily
growth of investment income.
MAIN STRATEGIES
The Account invests primarily in common stock and other equity securities of
large capitalization companies. Under normal market conditions, the Account
invests at least 80% of its assets in common stocks of companies with large
market capitalizations (those with market capitalizations similar to companies
in the Russell 1000 Value Index (as of June 30, 2004 this range was between
approximately $1.36 billion and $391.96 billion) at the time of purchase. Market
capitalization is defined as total current market value of a company's
outstanding common stock. Up to 20% of Account assets may be invested in foreign
securities.
The Account invests in stocks that, in the opinion of the Sub-Advisor,
Principal, are undervalued in the marketplace at the time of purchase. Value
stocks are often characterized by below average price/earnings ratios (P/E) and
above average dividend yields relative to the overall market. Securities for the
Account are selected by consideration of the quality and price of individual
issuers rather than forecasting stock market trends. The selection process
focuses on four key elements:
.. determination that a stock is selling below its fair market value;
.. early recognition of changes in a company's underlying fundamentals;
.. evaluation of the sustainability of fundamental changes; and
.. by monitoring a stock's behavior in the market, evaluation of the timeliness
of the investment.
Principal focuses on its stock selections on established companies that it
believes have a sustainable competitive advantage. Principal constructs a
portfolio that is "benchmark aware" in that it is sensitive to the sector
(companies with similar characteristics) and security weights of its benchmark.
However, the Account is actively managed and prepared to over- and/or
under-weight sectors and industries differently from the benchmark.
MAIN RISKS
The Account is subject to the risk that its principal market segment, large
capitalization value stocks, may underperform compared to other market segments
or to the equity markets as a whole. The value of the Account's securities may
fluctuate on a daily basis. As with all mutual funds, as the values of the
Account's assets rise or fall, the Account's
share price changes. If you sell your shares when their value is less than the
price you paid, you will lose money.
As with any security, the securities in which the Account invests have
associated risks. These include risks of:
STOCK MARKET VOLATILITY . The net asset value of the Account's shares is
effected by changes in the value of the securities it owns. The prices of equity
securities held by the Account may decline in response to certain events
including those directly involving issuers of these securities, adverse
conditions affecting the general economy, or overall market declines. In the
short term, stock prices can fluctuate dramatically in response to these
factors.
VALUE STOCKS . The Account's potential investment in value stocks carries the
risk that the market will not recognize a security's intrinsic value for a long
time or that a stock judged to be undervalued may actually be appropriately
priced.
FOREIGN INVESTING . Foreign markets and currencies may not perform as well as
U.S. markets. Political and economic uncertainty in foreign countries, as well
as less public information about foreign investments may negatively impact the
Account's portfolio. Dividends and other income payable on foreign securities
may be subject to foreign taxes. Some investments may be made in currencies
other than the U.S. dollar that will fluctuate in value as a result of changes
in the currency exchange rate.
ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an
attempt to achieve its investment objective. The financial highlights table at
the end of this Prospectus shows the Account's turnover rate during recent
fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to
the Account buying and selling all of its securities two times during the course
of the year. A high turnover rate may increase the Account's trading costs and
may have an adverse impact on the Account's performance. The portfolio turnover
rate for the Account for the six month period ended June 30, 2004 was 175%
(computed on an annualized basis).
INVESTOR PROFILE
The Account may be an appropriate investment for investors seeking long-term
growth of capital and willing to accept the risks of investing in common stocks,
but who prefer investing in companies that appear to be considered undervalued
relative to similar companies.
The Account's past performance is not necessarily an indication of how the
Account will perform in the future. The bar chart and tables provide some
indication of the risks of investing in the Account by showing changes in
performance from year to year and showing how the Account's average annual
returns compare with those of a broad measure of market performance. Annual
operating expenses do not include any separate account expenses, cost of
insurance or other contract level expenses. Total returns would be lower if such
expenses were included.
YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
[Download Table]
"1994"0.49
"1995"31.91
"1996"23.5
"1997"28.53
"1998"13.58
"1999"-4.29
"2000"2.16
"2001"-8.05
"2002"-13.66
The Account's highest/lowest quarterly returns
"2003"25.49 during this
time period were:
HIGHEST Q2 '03 15.52%
LOWEST Q3 '02 -15.10%
LOGO
The year-to-date return as of June 30, 2004 is 3.39%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2003
[Download Table]
PAST 1
YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT*
CAPITAL VALUE ACCOUNT
25.49 -0.52 8.82 12.06
Russell 1000 Value
Index................. 30.03 3.57 11.87
Morningstar Large
Value Category........ 28.40 2.53 9.85
* The Account's SEC effective date was May 13, 1970.
FEES AND EXPENSES AS A % OF AVERAGE DAILY NET ASSETS BASED ON THE ACCOUNT'S
LATEST FISCAL YEAR
(These fees and expenses do not include the effect of any sales charge, separate
account expenses or other contract level expenses which may be applied at the
variable life insurance or variable annuity product level. If such charges or
-
fees were included, overall expenses would be higher and would lower the
Account's performance.)
ACCOUNT OPERATING EXPENSES
[Download Table]
Management Fees................. 0.60
Other Expenses.................. 0.01
----
TOTAL ACCOUNT OPERATING
EXPENSES 0.61
EXAMPLES
The Examples assume that you invest $10,000 in the Account for the time periods
indicated and then redeem all of your shares at the end of those periods. The
Examples also assume that your investment has a 5% return each year and that
the Account's operating expenses remain the same. If separate account expenses
and contract level expenses were included, expenses would be higher. Although
your actual costs may be higher or lower, based on these assumptions your cost
would be:
[Enlarge/Download Table]
NUMBER OF YEARS YOU OWN YOUR SHARES
---------------------------------------------------------------------------------------
1 3 5 10
CAPITAL VALUE ACCOUNT $62 $195 $340 $762
EQUITY GROWTH ACCOUNT
The Account seeks to provide long-term capital appreciation by investing
primarily in equity securities.
MAIN STRATEGIES
The Account seeks to maximize long-term capital appreciation by investing
primarily in growth-oriented equity securities of U.S. and, to a limited extent,
foreign companies that exhibit strong growth and free cash flow potential. These
companies are generally characterized as "growth" companies. Under normal market
conditions, the Account invests at least 80% of its assets in equity securities
of companies in the Russell 1000 Growth Index (as of June 30, 2004, this range
was between approximately $1.36 billion and $341.9 billion) at the time of
purchase. The Account's investments in foreign companies will be limited to 25%
of its assets and to securities listed on U.S. exchanges or traded in U.S.
markets. The Account may also purchase futures and options, in keeping with
Account objectives.
The Sub-Advisor, T. Rowe Price, generally looks for companies with an
above-average rate of earnings and cash flow growth and a lucrative niche in the
economy that gives then the ability to sustain earnings momentum even during
times of slow economic growth. As a growth investor, T. Rowe Price believes that
when a company increases its earnings faster than both inflation and the overall
economy, the market will eventually reward it with a higher stock price.
In pursuing its investment objective, the Sub-Advisor has the discretion to
purchase some securities that do not meet its normal investment criteria, as
described above, when it perceives an unusual opportunity for gain. These
special situations might arise when the Sub-Advisor believes a security could
increase in value for a variety of reasons, including a change in management, an
extraordinary corporate event, or a temporary imbalance in the supply of or
demand for the securities.
The Account may sell securities for a variety of reasons, such as to secure
gains, limit losses, or redeploy assets into more promising opportunities.
MAIN RISKS
The Account is subject to the risk that its principal market segment, large
capitalization growth-oriented stocks, may underperform compared to other market
segments or to the equity markets as a whole. The value of the Account's
securities may fluctuate on a daily basis. As with all mutual funds, as the
values of the Account's assets rise or fall, the
Account's share price changes. If you sell your shares when their value is less
than the price you paid, you will lose
money.
As with any security, the securities in which the Account invests have
associated risks. These include risks of:
STOCK MARKET VOLATILITY . The net asset value of the Account's shares is
effected by changes in the value of the securities it owns. The prices of equity
securities held by the Account may decline in response to certain events
including those directly involving issuers of these securities, adverse
conditions affecting the general economy, or overall market declines. In the
short term, stock prices can fluctuate dramatically in response to these
factors.
GROWTH STOCKS . Because growth securities typically do not make dividend
payments to shareholders, investment returns are based on capital appreciation
making returns more dependent on market increases and decreases. Growth stocks
may therefore be more volatile than non-growth stocks to market changes.
FOREIGN INVESTING . Foreign markets and currencies may not perform as well as
U.S. markets. Political and economic uncertainty in foreign countries, as well
as less public information about foreign investments may negatively impact the
Account's portfolio. Dividends and other income payable on foreign securities
may be subject to foreign taxes. Some investments may be made in currencies
other than the U.S. dollar that will fluctuate in value as a result of changes
in the currency exchange rate.
INVESTOR PROFILE
The Account may be an appropriate investment for investors seeking long-term
growth of capital and willing to accept the risks of investing in common stocks
that may have greater risks than stocks of companies with lower potential for
earnings growth.
T. Rowe Price became the Sub-Advisor to the Account on August 24, 2004.
The Account's past performance is not necessarily an indication of how the
Account will perform in the future. The bar chart and tables provide some
indication of the risks of investing in the Account by showing changes in
performance from year to year and showing how the Account's average annual
returns compare with those of a broad measure of market performance. Annual
operating expenses do not include any separate account expenses, cost of
insurance or other contract level expenses. Total returns would be lower if such
expenses were included.
YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
[Download Table]
"1995"44.19
"1996"28.05
"1997"30.86
"1998"18.95
"1999"39.5
"2000"-11.71
"2001"-14.86
"2002"-27.72
The Account's highest/lowest quarterly returns
"2003"25.95 during this
time period were:
HIGHESTQ4 '9822.68%
LOWEST Q1 '01-18.25%
LOGO
The year-to-date return as of June 30, 2004 is 2.58%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2003
[Download Table]
PAST 1
YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT*
EQUITY GROWTH ACCOUNT
25.95 -0.92 N/A 11.40
Russell 1000 Growth
Index................. 29.76 -5.11 9.21
Morningstar Large
Growth Category....... 28.55 -3.20 7.96
* The Account's SEC effective date was June 1, 1994.
FEES AND EXPENSES AS A % OF AVERAGE DAILY NET ASSETS BASED ON THE ACCOUNT'S
LATEST FISCAL YEAR
(These fees and expenses do not include the effect of any sales charge, separate
account expenses or other contract level expenses which may be applied at the
variable life insurance or variable annuity product level. If such charges or
-
fees were included, overall expenses would be higher and would lower the
Account's performance.)
ACCOUNT OPERATING EXPENSES
[Download Table]
Management Fees................. 0.76
Other Expenses.................. 0.01
----
TOTAL ACCOUNT OPERATING
EXPENSES 0.77
EXAMPLES
The Examples assume that you invest $10,000 in the Account for the time periods
indicated and then redeem all of your shares at the end of those periods. The
Examples also assume that your investment has a 5% return each year and that
the Account's operating expenses remain the same. If separate account expenses
and contract level expenses were included, expenses would be higher. Although
your actual costs may be higher or lower, based on these assumptions your cost
would be:
[Enlarge/Download Table]
NUMBER OF YEARS YOU OWN YOUR SHARES
---------------------------------------------------------------------------------------
1 3 5 10
EQUITY GROWTH ACCOUNT $79 $246 $428 $954
EQUITY INCOME ACCOUNT
The Account seeks to achieve high current income and long-term growth of income
and capital.
MAIN STRATEGIES
The Account seeks to achieve its objective by investing primarily in equity
securities, preferred securities, real estate investment trusts (REITs) and
convertible securities. In selecting securities, the Sub-Advisor, Principal,
places an emphasis on securities with potentially high dividend yields. Under
normal market conditions, the Account invests at least 80% of its assets in
equity securities. In addition, under normal market conditions, at least 25% of
the assets of the Account are invested in securities of companies in the
utilities industry with no policy to concentrate its assets in any segment of
the utilities industry. The Account may invest up to 20% of its assets in
securities of foreign companies.
When determining how to invest the Account's assets in equity securities,
Principal seeks stocks that it believes are undervalued in the marketplace at
the time of purchase. Securities for the Account are selected by consideration
of the quality and price of individual issuers rather than forecasting stock
market trends. The selection process focuses on:
.. the determination that a stock is selling below its fair market value;
.. an early recognition of changes in a company's underlying fundamentals;
.. an evaluation of the sustainability of fundamental changes; and
.. monitoring a stock's behavior in the market.
In selecting preferred securities for the Account, Principal focuses on the
financial services industry (i.e., banking, insurance and commercial finance).
For a security to be considered for the Account, Principal will assess the
credit risk within the context of the yield available on the preferred security.
The sub-advisor also may consider whether the companies' securities have a
favorable income-paying history and whether income payments are expected to
continue to increase.
REITs are corporations or business trusts that are permitted to eliminate
corporate level federal income taxes by meeting certain requirements of the
Internal Revenue Code. In selecting REITs for the Account, Principal focuses on
equity REITs which primarily own property and generate revenue from rental
income. Principal seeks to diversify the Account's REIT holdings by property
types (e.g. apartment REITs, mall REITs, office and industrial REITs).
MAIN RISKS
As with any security, the securities in which the Account invests have
associated risks. These include risks of:
STOCK MARKET VOLATILITY . The net asset value of the Account's shares is
effected by changes in the value of the securities it owns. The prices of equity
securities held by the Account may decline in response to certain events
including those directly involving issuers of these securities, adverse
conditions affecting the general economy, or overall market declines. In the
short term, stock prices can fluctuate dramatically in response to these
factors.
VALUE STOCKS . The Account's potential investment in value stocks carries the
risk that the market will not recognize a security's intrinsic value for a long
time or that a stock judged to be undervalued may actually be appropriately
priced.
INTEREST RATE CHANGES . Changes in interest rates may adversely affect the value
of an investor's securities. When interest rates rise, the value of preferred
securities will generally fall. Conversely, a drop in interest rates will
generally cause an increase in the value of preferred securities. Some
investments give the issuer the option to call, or redeem, its securities before
their maturity date. If an issuer calls its security during a time of declining
interest rates, the Account may have to reinvest the proceeds in securities with
lower rates. In addition, the Account's appreciation may be limited by issuer
call options having more value during times of declining interest rates.
PREPAYMENT OR CALL RISK . Some investments give the issuer the option to call,
or redeem, its securities before their maturity date. If an issuer calls its
security during a time of declining interest rates, the Account may have to
reinvest the proceeds in securities with lower rates. In addition, the Account's
appreciation may be limited by issuer call options having more value during
times of declining interest rates.
SECTOR RISK . Because the Account invests at least 25% of its assets in utility
securities, the Account is also subject to sector risk; that is, the possibility
that the utilities sector may under perform other sectors or the market as a
whole. As Principal allocates more of the Account's portfolio holdings to the
utilities sector, the Account's performance will be more susceptible to any
economic, business or other developments that generally affect that sector. The
share price of the Account may fluctuate more widely than the value of shares of
a fund that invests in a broader range of industries.
FOREIGN INVESTING . Foreign markets and currencies may not perform as well as
U.S. markets. Political and economic uncertainty in foreign countries, as well
as less public information about foreign investments may negatively impact the
Account's portfolio. Dividends and other income payable on foreign securities
may be subject to foreign taxes. Some investments may be made in currencies
other than the U.S. dollar that will fluctuate in value as a result of changes
in the currency exchange rate.
EQUITY REITS . Equity REITs are affected by the changes in the value of the
properties owned by the trust. In addition, they:
.. may not be diversified with regard to the types of tenants (thus subject to
business developments of the tenant(s));
.. may not be diversified with regard to the geographic locations of the
properties (thus subject to regional economic developments); and
.. are subject to cash flow dependency of its tenants.
ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an
attempt to achieve its investment objective. The financial highlights table at
the end of this Prospectus shows the Account's turnover rate during recent
fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to
the Account buying and selling all of its securities two times during the course
of the year. A high turnover rate may increase the Account's trading costs and
may have an adverse impact on the Account's performance. The portfolio turnover
rate for the Account for the six month period ended June 30, 2004 was 172%
(computed on an annualized basis).
The value of the Account's securities may fluctuate on a daily basis. As with
all mutual funds, as the values of the
Account's assets rise or fall, the Account's share price changes. If you sell
your shares when their value is less than the
price you paid, you will lose money.
INVESTOR PROFILE
The Account may be an appropriate investment for investors who seek dividends to
generate income or to be reinvested for growth and accept fluctuations in the
value of investments.
The Account's past performance is not necessarily an indication of how the
Account will perform in the future. The bar chart and tables provide some
indication of the risks of investing in the Account by showing changes in
performance from year to year and showing how the Account's average annual
returns compare with those of a broad measure of market performance. Annual
operating expenses do not include any separate account expenses, cost of
insurance or other contract level expenses. Total returns would be lower if such
expenses were included.
YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
[Download Table]
"1999"2.29
"2000"19.18
"2001"-27.7
"2002"-12.61
The Account's highest/lowest quarterly returns
"2003"13.83 during this
time period were:
HIGHESTQ3 '0018.18%
LOWEST Q3 '01-16.65%
LOGO
The year-to-date return as of June 30, 2004 is 1.13%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2003
[Enlarge/Download Table]
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT*
EQUITY INCOME ACCOUNT ........
13.83 -2.60 N/A 0.20
Lehman Brothers Aggregate Bond
Index/(1)/.................... 4.11 6.62 6.95
S&P 500 Index ................ 28.67 -0.57 11.06
S&P Utilities Index .......... 26.26 -2.19 5.61
Morningstar Moderate
Allocation Category........... 20.06 2.48 8.15
* The Account's SEC effective date was May 1, 1998.
///(1)/
The index against which the Account measures its performance is now a 50/50 blend of the S&P 500 Index and the Lehman Brothers
Aggregate Bond Index. The Manager and portfolio manager believe this index better represents the universe of investment
choices open to the Account given that the Account seeks to achieve high current income and long-term growth of income and
capital by investing in a broadly diversified mix of investments that includes value-oriented common stocks as well as lesser
proportions of preferred securities and real estate investment trusts (REITs). The previous index, the S&P Utilities Index,
which is also shown, is less appropriate because it is made up solely of utility stocks, while the Account's strategy is to
invest only slightly more than 25% of its assets in utilities stocks.
FEES AND EXPENSES AS A % OF AVERAGE DAILY NET ASSETS BASED ON THE ACCOUNT'S
LATEST FISCAL YEAR
(These fees and expenses do not include the effect of any sales charge, separate
account expenses or other contract level expenses which may be applied at the
variable life insurance or variable annuity product level. If such charges or
-
fees were included, overall expenses would be higher and would lower the
Account's performance.)
ACCOUNT OPERATING EXPENSES
[Download Table]
Management Fees................. 0.60
Other Expenses.................. 0.01
----
TOTAL ACCOUNT OPERATING
EXPENSES 0.61
EXAMPLES
The Examples assume that you invest $10,000 in the Account for the time periods
indicated and then redeem all of your shares at the end of those periods. The
Examples also assume that your investment has a 5% return each year and that
the Account's operating expenses remain the same.
If separate account expenses and contract level expenses were included,
expenses would be higher. Although your actual costs may be higher or lower,
based on these assumptions your cost would be:
[Enlarge/Download Table]
NUMBER OF YEARS YOU OWN YOUR SHARES
--------------------------------------------------------------------------------------------------------------
1 3 5 10
EQUITY INCOME ACCOUNT $62 $195 $340 $762
EQUITY VALUE ACCOUNT
The Account seeks long-term growth of capital.
MAIN STRATEGIES
The Account invests primarily in common stocks and other equity securities of
large capitalization companies. Under normal market conditions, the Account
invests at least 80% of its net assets in securities of companies with market
capitalizations similar to companies in the Russell 1000 Index (as of June 30,
2004, this range was between approximately $1.36 billion and $341.96 billion) at
the time of purchase. Market capitalization is defined as total current market
value of a company's outstanding common stock. The Account may invest up to 25%
of its assets in securities of foreign companies.
The Sub-Advisor, American Century, uses a value investment strategy that looks
for companies that are temporarily out of favor in the market. The Sub-Advisor
attempts to purchase the stocks of these undervalued companies and hold the
stocks until they have returned to favor in the market and their stock price has
gone up.
Companies may be undervalued due to market declines, poor economic conditions,
actual or anticipated bad news regarding the issuer or its industry, or because
they have been overlooked by the market. To identify these companies, the
Sub-Advisor looks for companies with earnings, cash flows and/or assets that may
not be reflected accurately in the companies' stock prices or may be outside the
companies' historical ranges. The Sub-Advisor also may consider whether the
companies' securities have a favorable income-paying history and whether income
payments are expected to continue or increase. When the Sub-Advisor believes it
is prudent, the Account may invest a portion of its assets in convertible debt
securities, equity-equivalent securities, foreign securities, debt securities of
companies, debt obligations of governments and their agencies, non-leveraged
futures contracts and other similar securities. Futures contracts, a type of
derivative security, can help the Account's cash assets remain liquid while
performing more like stocks. The Account has a policy governing futures
contracts and similar derivative securities to help manage the risk of these
types of investments. For example, the Sub-Advisor cannot invest in a derivative
security if it would be possible for the Account to lose more money than it
invested. In the event of exceptional market or economic conditions, the Account
may, as a temporary defensive measure, invest all or a substantial portion of
its assets in cash or short-term debt securities. To the extent the Account
assumes a defensive position, it will not be pursuing its objective of capital
growth.
MAIN RISKS
As with any security, the securities in which the Account invests have
associated risks. These include risks of:
STOCK MARKET VOLATILITY . The net asset value of the Account's shares is
effected by changes in the value of the securities it owns. The prices of equity
securities held by the Account may decline in response to certain events
including those directly involving issuers of these securities, adverse
conditions affecting the general economy, or overall market declines. In the
short term, stock prices can fluctuate dramatically in response to these
factors.
VALUE STOCKS . The Account's potential investment in value stocks carries the
risk that the market will not recognize a security's intrinsic value for a long
time or that a stock judged to be undervalued may actually be appropriately
priced.
INTEREST RATE CHANGES . The value of fixed-income securities held by the Account
may be affected by factors such as changing interest rates, credit rating, and
effective maturities. When interest rates fall, the price of a bond rises and
when interest rates rise, the price declines.
CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater
credit risk and price fluctuations than higher quality and shorter maturity
bonds. Bonds held by the Account may be affected by unfavorable political,
economic, or governmental developments that could affect the repayment of
principal or the payment of interest.
FOREIGN INVESTING . Foreign markets and currencies may not perform as well as
U.S. markets. Political and economic uncertainty in foreign countries, as well
as less public information about foreign investments may negatively impact the
Account's portfolio. Dividends and other income payable on foreign securities
may be subject to foreign taxes. Some
investments may be made in currencies other than the U.S. dollar that will
fluctuate in value as a result of changes in the currency exchange rate.
HEDGING STRATEGIES . Use of forward foreign currency exchange contracts,
currency or index futures or other derivatives involves risks. The contracts may
increase the Account's volatility and, thus, could involve a significant risk.
If the Sub-Advisor's predictions are inaccurate, the averse consequences to the
Account(e.g., a reduction in the Account's net asset value) may leave the
Account in a worse position than if these strategies were not used.
INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in
IPOs exposes it to the additional risks associated with companies that have
little operating history as public companies, as well as to the risks inherent
in those sectors of the market where these new issuers operate. The market for
IPO issuers has been volatile and share prices of certain newly-public companies
have fluctuated in significant amounts over short periods of time. In addition,
the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at
times dispose of those shares shortly after their acquisition.
ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an
attempt to achieve its investment objective. A high turnover rate may increase
the Account's trading costs and may have an adverse impact on the Account's
performance.
As with all mutual funds, as the values of the Account's assets rise or fall,
the Account's share price changes. If you sell
your shares when their value is less than the price you paid, you will lose
money.
INVESTOR PROFILE
The Account may be an appropriate investment for investors seeking long-term
growth of capital and willing to accept the risks of investing in common stocks
but prefer investing in companies that appear to be considered undervalued
relative to similar companies.
As the inception date of the Account is August 30, 2004, historical performance
data is not available.
FEES AND EXPENSES (ESTIMATED) AS A % OF AVERAGE DAILY NET ASSETS
(These fees and expenses do not include the effect of any sales charge, separate
account expenses or other contract level expenses which may be applied at the
variable life insurance or variable annuity product level. If such charges or
-
fees were included, overall expenses would be higher and would lower the
Account's performance.)
ACCOUNT OPERATING EXPENSES
[Enlarge/Download Table]
Management Fees.................. 0.85
Other Expenses................... 0.12
----
TOTAL ACCOUNT OPERATING EXPENSES 0.97
The Manager has voluntarily agreed to reimburse operating expenses so that the total Account operating expenses will not be
greater than 1.10% through April 30, 2005. The Manager may not continue this arrangement after May 1, 2005.
EXAMPLES
The Examples assume that you invest $10,000 in the Account for the time periods
indicated and then redeem all of your shares at the end of those periods. The
Examples also assume that your investment has a 5% return each year and that
the Account's operating expenses remain the same. If separate account expenses
and contract level expenses were included, expenses would be higher. Although
your actual costs may be higher or lower, based on these assumptions your cost
would be:
[Download Table]
NUMBER OF YEARS YOU OWN YOUR SHARES
----------------------------------------------------------------------------------
1 3 5 10
EQUITY VALUE ACCOUNT $99 $309 $536 $1,190
GOVERNMENT SECURITIES ACCOUNT
The Account seeks a high level of current income, liquidity and safety of
principal.
MAIN STRATEGIES
The Account seeks to achieve its investment objective by investing primarily (at
least 80% of its assets) in securities that are issued by the U.S. Government,
its agencies or instrumentalities. The Account may invest in mortgage-backed
securities representing an interest in a pool of mortgage loans. These
securities are rated AAA by Standard & Poor's Corporation or Aaa by Moody's
Investor Services, Inc. or, if unrated, determined by the Sub-Advisor,
Principal, to be of equivalent quality.
The Account relies on the professional judgment of Principal to make decisions
about the Account's portfolio securities. The basic investment philosophy of
Principal is to seek undervalued securities that represent good long-term
investment opportunities. Securities may be sold when Principal believes they no
longer represent good long-term value.
The Account may also hold cash and cash equivalents. The size of the Account's
cash position depends on various factors, including market conditions and
purchases and redemptions of Account shares. A large cash position could impact
the ability of the Account to achieve its objective but it also would reduce the
Account's exposure in the event of a market downturn and provide liquidity to
make additional investments or to meet redemptions.
MAIN RISKS
As with any security, the securities in which the Account invests have
associated risks. These include risks of:
U.S. GOVERNMENT SECURITIES . U.S. Government securities do not involve the
degree of credit risk associated with investments in lower quality fixed-income
securities. As a result, the yields available from U.S. Government securities
are generally lower than the yields available from many other fixed-income
securities. Like other fixed-income securities, the values of U.S. Government
securities change as interest rates fluctuate. Fluctuations in the value of the
Account's securities do not affect interest income on securities already held by
the Account, but are reflected in the Account's price per share. Since the
magnitude of these fluctuations generally is greater at times when the Account's
average maturity is longer, under certain market conditions the Account may
invest in short-term investments yielding lower current income rather than
investing in higher yielding longer term securities.
INTEREST RATE CHANGES . The value of fixed-income securities held by the Account
may be affected by factors such as changing interest rates. When interest rates
rise, the value of fixed-income securities will generally fall. Conversely, a
drop in interest rates will generally cause an increase in the value of
fixed-income securities. Some fixed-income investments give the issuer the
option to call, or redeem, its securities before their maturity date. If an
issuer calls its security during a time of declining interest rates, the Account
may have to reinvest the proceeds in securities with lower rates. In addition,
the Account's appreciation may be limited by issuer call options having more
value during times of declining interest rates.
CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater
credit risk and price fluctuations than higher quality and shorter maturity
bonds. Bonds held by the Account may be affected by unfavorable political,
economic, or governmental developments that could affect the repayment of
principal or the payment of interest.
U.S. GOVERNMENT SPONSORED SECURITIES . The Account may invest in debt and
mortgage-backed securities issued by government-sponsored enterprises such as
the Federal Home Loan Mortgage Corporation, the Federal National Mortgage
Association and the Federal Home Loan Banks. Although the issuing agency,
instrumentality or corporation maybe chartered or sponsored by the United States
government, their securities are neither issued nor guaranteed by the United
States Treasury.
MORTGAGE-BACKED SECURITIES . Mortgage-backed securities are subject to
prepayment risk. Prepayments, unscheduled principal payments, may result from
voluntary prepayment, refinancing or foreclosure of the underlying mortgage.
When interest rates decline, significant unscheduled prepayments may result.
These prepayments must then be reinvested at lower rates. Prepayments may also
shorten the effective maturities of these securities, especially
during periods of declining interest rates. On the other hand, during periods of
rising interest rates, a reduction in prepayments may increase the effective
maturities of these securities, subjecting them to the risk of decline in market
value in response to rising interest rates and potentially increasing the
volatility of the Account.
In addition, prepayments may cause losses on securities purchased at a premium
(dollar amount by which the price of the bond exceeds its face value). At times,
mortgage-backed securities may have higher than market interest rates and are
purchased at a premium. Unscheduled prepayments are made at par and cause the
Account to experience a loss of some or all of the premium.
INVESTOR PROFILE
The Account may be an appropriate investment for investors seeking
diversification by investing in a fixed-income mutual fund.
The Account's past performance is not necessarily an indication of how the
Account will perform in the future. The bar chart and tables provide some
indication of the risks of investing in the Account by showing changes in
performance from year to year and showing how the Account's average annual
returns compare with those of a broad measure of market performance. Annual
operating expenses do not include any separate account expenses, cost of
insurance or other contract level expenses. Total returns would be lower if such
expenses were included.
YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
[Download Table]
"1994"-4.53
"1995"19.07
"1996"3.35
"1997"10.39
"1998"8.27
"1999"-0.29
"2000"11.4
"2001"7.61
"2002"8.8
The Account's highest/lowest quarterly returns
"2003"1.84 during this
time period were:
HIGHESTQ2 '956.17%
LOWEST Q1 '94-3.94%
LOGO
The year-to-date return as of June 30, 2004 is 0.36%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2003
[Enlarge/Download Table]
PAST 1 YEAR
PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT*
GOVERNMENT SECURITIES ACCOUNT ....
1.84 5.78 6.40 7.85
Lehman Brothers
Government/Mortgage Index/(1)/.... 2.73 6.34 6.76
Lehman Brothers Mortgage Backed
Securities Index.................. 3.05 6.55 6.89
Morningstar Intermediate
Government Category............... 2.15 5.51 5.81
* The Account's SEC effective date was April 9, 1987.
///(1)/
The Account has changed its index to the Lehman Brothers Government Mortgage Index. The manager and the sub-advisor believe
that this index better represents the type and composition of bonds that are invested in the portfolio. The Account will
retain its mortgage bias, which was representative of the Lehman Brothers Mortgage Back Securities Index, however the new index
also incorporates the government bonds in which the portfolio invests.
FEES AND EXPENSES AS A % OF AVERAGE DAILY NET ASSETS BASED ON THE ACCOUNT'S
LATEST FISCAL YEAR
(These fees and expenses do not include the effect of any sales charge, separate
account expenses or other contract level expenses which may be applied at the
variable life insurance or variable annuity product level. If such charges or
-
fees were included, overall expenses would be higher and would lower the
Account's performance.)
ACCOUNT OPERATING EXPENSES
[Download Table]
Management Fees................. 0.43
Other Expenses.................. 0.01
----
TOTAL ACCOUNT OPERATING
EXPENSES 0.44
EXAMPLES
The Examples assume that you invest $10,000 in the Account for the time periods
indicated and then redeem all of your shares at the end of those periods. The
Examples also assume that your investment has a 5% return each year and that
the Account's operating expenses remain the same. If separate account expenses
and contract level expenses were included, expenses would be higher. Although
your actual costs may be higher or lower, based on these assumptions your cost
would be:
[Enlarge/Download Table]
NUMBER OF YEARS YOU OWN YOUR SHARES
-------------------------------------------------------------------------------------------------
1 3 5 10
GOVERNMENT SECURITIES
ACCOUNT $45 $141 $246 $555
GROWTH ACCOUNT
The Account seeks long-term growth of capital through the purchase primarily of
common stocks, but the Account may
invest in other securities.
MAIN STRATEGIES
The Account invests primarily in common stocks and other equity securities of
large capitalization companies with strong earnings growth potential. Under
normal market conditions, the Account invests at least 80% of its assets in
common stocks of companies with large market capitalizations (those with market
capitalizations similar to companies in the Russell 1000 Growth Index (as of
June 30, 2004 this range was between approximately $1.36 billion and $341.96
billion)) at the time of purchase. Market capitalization is defined as total
current market value of a company's outstanding common stock.
The Sub-Advisor, Principal, uses a bottom-up approach (focusing on individual
stock selection rather than forecasting stock market trends) in its selection of
individual securities that it believes have an above average potential for
earnings growth. Selection is based on fundamental analysis of a company
relative to other companies with the focus being on Principal's assessment of
current and future sales growth and operating margins. Companies meeting these
criteria typically have progressed beyond the development stage and are focused
on growing the business. Up to 10% of Account assets may be invested in foreign
securities.
Principal places strong emphasis on companies it believes are guided by high
quality management teams with a proven ability to execute. In addition, the
Account attempts to identify and emphasize those companies that are market
leaders possessing the ability to control pricing and margins in their
respective industries. Principal constructs a portfolio that is "benchmark
aware" in that it is sensitive to the sector (companies with similar
characteristics) and security weightings of its benchmark. However, the Account
is actively managed and prepared to over- and/or under-weight sectors and
industries differently from the benchmark.
MAIN RISKS
The Account is subject to the risk that its principal market segment, large
capitalization growth-oriented stocks, may underperform compared to other market
segments or to the equity markets as a whole. The value of the Account's
securities may fluctuate on a daily basis. As with all mutual funds, as the
values of the Account's assets rise or fall, the
Account's share price changes. If you sell your shares when their value is less
than the price you paid, you will lose
money.
As with any security, the securities in which the Account invests have
associated risks. These include risks of:
STOCK MARKET VOLATILITY . The net asset value of the Account's shares is
effected by changes in the value of the securities it owns. The prices of equity
securities held by the Account may decline in response to certain events
including those directly involving issuers of these securities, adverse
conditions affecting the general economy, or overall market declines. In the
short term, stock prices can fluctuate dramatically in response to these
factors.
GROWTH STOCKS . Because growth securities typically do not make dividend
payments to shareholders, investment returns are based on capital appreciation
making returns more dependent on market increases and decreases. Growth stocks
may therefore be more volatile than non-growth stocks to market changes.
FOREIGN INVESTING . Foreign markets and currencies may not perform as well as
U.S. markets. Political and economic uncertainty in foreign countries, as well
as less public information about foreign investments may negatively impact the
Account's portfolio. Dividends and other income payable on foreign securities
may be subject to foreign taxes. Some investments may be made in currencies
other than the U.S. dollar that will fluctuate in value as a result of changes
in the currency exchange rate.
INVESTOR PROFILE
The Account may be an appropriate investment for investors seeking long-term
growth of capital and willing to accept the risks of investing in common stocks
that may have greater risks than stocks of companies with lower potential for
earnings growth.
The Account's past performance is not necessarily an indication of how the
Account will perform in the future. The bar chart and tables provide some
indication of the risks of investing in the Account by showing changes in
performance from year to year and showing how the Account's average annual
returns compare with those of a broad measure of market performance. Annual
operating expenses do not include any separate account expenses, cost of
insurance or other contract level expenses. Total returns would be lower if such
expenses were included.
YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
[Download Table]
"1995"25.62
"1996"12.51
"1997"26.96
"1998"21.36
"1999"16.44
"2000"-10.15
"2001"-25.5
"2002"-29.07
The Account's highest/lowest quarterly returns
"2003"26.46 during this
time period were:
HIGHESTQ4 '9821.35%
LOWEST Q1 '01-23.55%
LOGO
The year-to-date return as of June 30, 2004 is 3.70%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2003
[Download Table]
PAST 1
YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT*
GROWTH ACCOUNT .......
26.46 -6.91 N/A 5.02
Russell 1000 Growth
Index................. 29.76 -5.11 9.21
Morningstar Large
Growth Category....... 28.55 -3.20 7.96
* The Account's SEC effective date was May 2, 1994.
FEES AND EXPENSES AS A % OF AVERAGE DAILY NET ASSETS BASED ON THE ACCOUNT'S
LATEST FISCAL YEAR
(These fees and expenses do not include the effect of any sales charge, separate
account expenses or other contract level expenses which may be applied at the
variable life insurance or variable annuity product level. If such charges or
-
fees were included, overall expenses would be higher and would lower the
Account's performance.)
ACCOUNT OPERATING EXPENSES
[Download Table]
Management Fees................. 0.60
Other Expenses.................. 0.01
----
TOTAL ACCOUNT OPERATING
EXPENSES 0.61
EXAMPLES
The Examples assume that you invest $10,000 in the Account for the time periods
indicated and then redeem all of your shares at the end of those periods. The
Examples also assume that your investment has a 5% return each year and that
the Account's operating expenses remain the same. If separate account expenses
and contract level expenses were included, expenses would be higher. Although
your actual costs may be higher or lower, based on these assumptions your cost
would be:
[Download Table]
NUMBER OF YEARS YOU OWN YOUR SHARES
---------------------------------------------------------------------------------
1 3 5 10
GROWTH ACCOUNT $62 $195 $340 $762
INTERNATIONAL ACCOUNT
The Account seeks long-term growth of capital by investing in a portfolio of
equity securities of companies established
outside of the U.S.
MAIN STRATEGIES
The Account invests in a portfolio of equity securities of companies domiciled
in any of the nations of the world. The Account invests in securities of:
.. companies with their principal place of business or principal office outside
the U.S.;
.. companies for which the principal securities trading market is outside the
U.S.; and
.. companies, regardless of where their securities are traded, that derive 50% or
more of their total revenue from goods or services produced or sales made
outside the U.S.
The Account has no limitation on the percentage of assets that are invested in
any one country or denominated in any one currency. However, under normal market
conditions, the Account intends to have at least 80% of its assets invested in
companies in at least three different countries. One of those countries may be
the U.S. though currently the Account does not intend to invest in equity
securities of U.S. companies.
Investments may be made anywhere in the world. Primary consideration is given to
securities of corporations of Western Europe, North America and Australasia
(Australia, Japan and Far East Asia). Changes in investments are made as
prospects change for particular countries, industries or companies.
In choosing investments for the Account, the Sub-Advisor, Principal, pays
particular attention to the long-term earnings prospects of the various
companies under consideration. Principal then weighs those prospects relative to
the price of the security.
MAIN RISKS
As with any security, the securities in which the Account invests have
associated risks. These include risks of:
STOCK MARKET VOLATILITY . The net asset value of the Account's shares is
effected by changes in the value of the securities it owns. The prices of equity
securities held by the Account may decline in response to certain events
including those directly involving issuers of these securities, adverse
conditions affecting the general economy, or overall market declines. In the
short term, stock prices can fluctuate dramatically in response to these
factors. As with
all mutual funds, as the values of the Account's assets rise or fall, the
Account's share price changes. If you sell your
shares when their value is less than the price you paid, you will lose money.
FOREIGN INVESTING . Foreign markets and currencies may not perform as well as
U.S. markets. Political and economic uncertainty in foreign countries, as well
as less public information about foreign investments may negatively impact the
Account's portfolio. Dividends and other income payable on foreign securities
may be subject to foreign taxes. Some investments may be made in currencies
other than the U.S. dollar that will fluctuate in value as a result of changes
in the currency exchange rate. Emerging market countries and companies doing
business in emerging market countries may not have the same rage of
opportunities as more developed countries companies in more developed countries.
FOREIGN EXCHANGE CONTRACTS . Because foreign securities generally are
denominated in foreign currencies, the value of the net assets of the Account as
measured in U.S. dollars will be affected by changes in exchange rates. To
protect against future uncertainties in foreign currency exchange rates, the
Account is authorized to enter into certain foreign currency exchange
transactions. In addition, the Account's foreign investments may be less liquid
and their price more volatile than comparable investments in U.S. securities.
Settlement periods may be longer for foreign securities and portfolio liquidity
may be affected.
SMALL AND MEDIUM CAPITALIZATIONS . Companies with small capitalizations are
often companies with a limited operation history. Such companies may have been
created in response to cultural, economic, regulatory or technological
developments. Such developments can have significant impact or negative effect
on smaller capitalization companies securities which may be more volatile in
price than larger company securities, especially over the short-term.
ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an
attempt to achieve its investment objective. The financial highlights table at
the end of this Prospectus shows the Account's turnover rate during recent
fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to
the Account buying and selling all of its securities two times during the course
of the year. A high turnover rate may increase the Account's trading costs and
may have an adverse impact on the Account's performance. The portfolio turnover
rate for the Account for the six month period ended June 30, 2004was 190%
(computed on an annualized basis).
INVESTOR PROFILE
The Account may be an appropriate investment for investors seeking long-term
growth of capital in markets outside of the U.S. who are able to assume the
increased risks of higher price volatility and currency fluctuations associated
with investments in international stocks which trade in non-U.S. currencies.
The Account's past performance is not necessarily an indication of how the
Account will perform in the future. The bar chart and tables provide some
indication of the risks of investing in the Account by showing changes in
performance from year to year and showing how the Account's average annual
returns compare with those of a broad measure of market performance. Annual
operating expenses do not include any separate account expenses, cost of
insurance or other contract level expenses. Total returns would be lower if such
expenses were included.
YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
[Download Table]
"1995 "14.17
"1996 "25.09
"1997 "12.24
"1998"9.98
"1999 "25.93
"2000"-8.34
"2001"-24.27
"2002"-16.07
The Account's highest/lowest quarterly returns
"2003 "32.33 during this
time period were:
HIGHEST Q2 '03 17.25%
LOWEST Q3 '02 -18.68%
LOGO
The year-to-date return as of June 30, 2004 is 2.81%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2003
[Download Table]
PAST 1
YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT*
INTERNATIONAL ACCOUNT
32.33 -0.59 N/A 5.34
MSCI EAFE (Europe,
Australia, Far East)
Index-ND.............. 38.59 -0.05 4.47
Morningstar Foreign
Small Mid Growth
Category ............. 33.32 0.49 4.65
* The Account's SEC effective date was May 2, 1994.
FEES AND EXPENSES AS A % OF AVERAGE DAILY NET ASSETS BASED ON THE ACCOUNT'S
LATEST FISCAL YEAR
(These fees and expenses do not include the effect of any sales charge, separate
account expenses or other contract level expenses which may be applied at the
variable life insurance or variable annuity product level. If such charges or
-
fees were included, overall expenses would be higher and would lower the
Account's performance.)
ACCOUNT OPERATING EXPENSES
[Download Table]
Management Fees................. 0.85
Other Expenses.................. 0.08
----
TOTAL ACCOUNT OPERATING
EXPENSES 0.93
EXAMPLES
The Examples assume that you invest $10,000 in the Account for the time periods
indicated and then redeem all of your shares at the end of those periods. The
Examples also assume that your investment has a 5% return each year and that
the Account's operating expenses remain the same. If separate account expenses
and contract level expenses were included, expenses would be higher. Although
your actual costs may be higher or lower, based on these assumptions your cost
would be:
[Enlarge/Download Table]
NUMBER OF YEARS YOU OWN YOUR SHARES
-----------------------------------------------------------------------------------------
1 3 5 10
INTERNATIONAL ACCOUNT $95 $296 $515 $1,143
INTERNATIONAL EMERGING MARKETS ACCOUNT
The Account seeks long-term growth of capital by investing primarily in equity
securities of issuers in emerging market
countries.
MAIN STRATEGIES
The Account seeks to achieve its objective by investing in common stocks of
companies in emerging market countries. For this Account, the term "emerging
market country" means any country which is considered to be an emerging country
by the international financial community (including the International Bank for
Reconstruction and Development (also known as the World Bank) and the
International Financial Corporation). These countries generally include every
nation in the world except the United States, Canada, Japan, Australia, New
Zealand and most nations located in Western Europe. Investing in many emerging
market countries is not feasible or may involve unacceptable political risk.
Principal, the Sub-Advisor, focuses on those emerging market countries that it
believes have strongly developing economies and markets which are becoming more
sophisticated.
Under normal conditions, at least 80% of the Account's assets are invested in
emerging market country equity securities. The Account invests in securities of:
.. companies with their principal place of business or principal office in
emerging market countries;
.. companies for which the principal securities trading market is an emerging
market country; or
.. companies, regardless of where their securities are traded, that derive 50% or
more of their total revenue from either goods or services produced in emerging
market countries or sales made in emerging market countries.
MAIN RISKS
As with any security, the securities in which the Account invests have
associated risks. These include risks of:
STOCK MARKET VOLATILITY . The net asset value of the Account's shares is
effected by changes in the value of the securities it owns. The prices of equity
securities held by the Account may decline in response to certain events
including those directly involving issuers of these securities, adverse
conditions affecting the general economy, or overall market declines. In the
short term, stock prices can fluctuate dramatically in response to these
factors. As with
all mutual funds, as the values of the Account's assets rise or fall, the
Account's share price changes. If you sell your
shares when their value is less than the price you paid, you will lose money.
FOREIGN INVESTING . Foreign markets and currencies may not perform as well as
U.S. markets. Political and economic uncertainty in foreign countries, as well
as less public information about foreign investments may negatively impact the
Account's portfolio. Dividends and other income payable on foreign securities
may be subject to foreign taxes. Some investments may be made in currencies
other than the U.S. dollar that will fluctuate in value as a result of changes
in the currency exchange rate.
EMERGING MARKET COUNTRIES . Investments in emerging market countries involve
special risks. Certain emerging market countries have historically experienced,
and may continue to experience, certain economic problems. These may include:
high rates of inflation, high interest rates, exchange rate fluctuations, large
amounts of debt, balance of payments and trade difficulties, and extreme poverty
and unemployment.
FOREIGN EXCHANGE CONTRACTS . Because foreign securities generally are
denominated in foreign currencies, the value of the net assets of the Account as
measured in U.S. dollars will be affected by changes in exchange rates. To
protect against future uncertainties in foreign currency exchange rates, the
Account is authorized to enter into certain foreign currency exchange
transactions. In addition, the Account's foreign investments may be less liquid
and their price more volatile than comparable investments in U.S. securities.
Settlement periods may be longer for foreign securities and portfolio liquidity
may be affected.
SMALL AND MEDIUM CAPITALIZATIONS . Companies with small capitalizations are
often companies with a limited operation history. Such companies may have been
created in response to cultural, economic, regulatory or technological
developments. Such developments can have significant impact or negative effect
on smaller capitalization companies securities which may be more volatile in
price than larger company securities, especially over the short-term.
INVESTOR PROFILE
The Account may be an appropriate investment for investors seeking long-term
growth of capital in securities of emerging market countries who are able to
assume the increased risks of higher price volatility and currency fluctuations
associated with investments in international stocks which trade in non-U.S.
currencies.
The Account's past performance is not necessarily an indication of how the
Account will perform in the future. The bar chart and tables provide some
indication of the risks of investing in the Account by showing changes in
performance from year to year and showing how the Account's average annual
returns compare with those of a broad measure of market performance. Annual
operating expenses do not include any separate account expenses, cost of
insurance or other contract level expenses. Total returns would be lower if such
expenses were included.
YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
[Download Table]
"2001"-4.24
"2002"-7.63
"2003"57.2 The Account's highest/lowest quarterly returns
during this
time period were:
HIGHESTQ4 '0126.63%
LOGO LOWEST Q3 '01-23.90%
The year-to-date return as of June 30, 2004 is -4.12%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2003
[Download Table]
PAST 1
YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT*
INTERNATIONAL EMERGING
MARKETS ACCOUNT....... 57.20 N/A N/A 8.72
MSCI Emerging Markets
Free Index-ID......... 51.59 8.17 -1.95
Morningstar
Diversified Emerging
Markets Category...... 55.30 11.12 1.00
* The Account's SEC effective date was October 24, 2000.
FEES AND EXPENSES AS A % OF AVERAGE DAILY NET ASSETS BASED ON THE ACCOUNT'S
LATEST FISCAL YEAR
(These fees and expenses do not include the effect of any sales charge, separate
account expenses or other contract level expenses which may be applied at the
variable life insurance or variable annuity product level. If such charges or
-
fees were included, overall expenses would be higher and would lower the
Account's performance.)
ACCOUNT OPERATING EXPENSES
[Download Table]
Management Fees................. 1.25
Other Expenses.................. 0.59
----
TOTAL ACCOUNT OPERATING
EXPENSES 1.84
EXAMPLES
The Examples assume that you invest $10,000 in the Account for the time periods
indicated and then redeem all of your shares at the end of those periods. The
Examples also assume that your investment has a 5% return each year and that
the Account's operating expenses remain the same. If separate account expenses
and contract level expenses were included, expenses would be higher. Although
your actual costs may be higher or lower, based on these assumptions your cost
would be:
[Enlarge/Download Table]
NUMBER OF YEARS YOU OWN YOUR SHARES
----------------------------------------------------------------------------------------
1 3 5 10
INTERNATIONAL EMERGING MARKETS ACCOUNT $187 $579 $995 $2,159
INTERNATIONAL SMALLCAP ACCOUNT
The Account seeks long-term growth of capital by investing in a portfolio of
equity securities of companies established
outside of the U.S.
MAIN STRATEGIES
The Account invests primarily in equity securities of non-U.S. companies with
comparatively smaller market capitalizations. Under normal market conditions,
the Account invests at least 80% of its assets in securities of companies
similar in size to companies included in the Citigroup Extended Market Index
(EMI) World ex US (as of June 30, 2004 this range was between approximately $79
million and $13 billion). Market capitalization is defined as total current
market value of a company's outstanding common stock.
The Account invests in securities of:
.. companies with their principal place of business or principal office outside
the U.S.;
.. companies for which the principal securities trading market is outside the
U.S.; and
.. companies, regardless of where their securities are traded, that derive 50% or
more of their total revenue from goods or services produced or sales made
outside the U.S.
The Sub-Advisor, Principal, diversifies the Account's investments
geographically. There is no limitation on the percentage of assets that may be
invested in one country or denominated in any one currency. However, under
normal market circumstances, the Account intends to invest at least 65% of its
assets in securities of companies of at least three countries.
MAIN RISKS
As with any security, the securities in which the Account invests have
associated risks. These include risks of:
STOCK MARKET VOLATILITY . The net asset value of the Account's shares is
effected by changes in the value of the securities it owns. The prices of equity
securities held by the Account may decline in response to certain events
including those directly involving issuers of these securities, adverse
conditions affecting the general economy, or overall market declines. In the
short term, stock prices can fluctuate dramatically in response to these
factors. As with
all mutual funds, as the values of the Account's assets rise or fall, the
Account's share price changes. If you sell your
shares when their value is less than the price you paid, you will lose money.
FOREIGN INVESTING . Foreign markets and currencies may not perform as well as
U.S. markets. Political and economic uncertainty in foreign countries, as well
as less public information about foreign investments may negatively impact the
Account's portfolio. Dividends and other income payable on foreign securities
may be subject to foreign taxes. Some investments may be made in currencies
other than the U.S. dollar that will fluctuate in value as a result of changes
in the currency exchange rate. Emerging market countries and companies doing
business in emerging market countries may not have the same rage of
opportunities as more developed countries companies in more developed countries.
FOREIGN EXCHANGE CONTRACTS . Because foreign securities generally are
denominated in foreign currencies, the value of the net assets of the Account as
measured in U.S. dollars will be affected by changes in exchange rates. To
protect against future uncertainties in foreign currency exchange rates, the
Account is authorized to enter into certain foreign currency exchange
transactions. In addition, the Account's foreign investments may be less liquid
and their price more volatile than comparable investments in U.S. securities.
Settlement periods may be longer for foreign securities and portfolio liquidity
may be affected.
SMALL AND MEDIUM CAPITALIZATIONS . Companies with small capitalizations are
often companies with a limited operation history. Such companies may have been
created in response to cultural, economic, regulatory or technological
developments. Such developments can have significant impact or negative effect
on smaller capitalization companies securities which may be more volatile in
price than larger company securities, especially over the short-term.
INVESTOR PROFILE
The Account may be an appropriate investment for investors seeking long-term
growth of capital in smaller companies outside of the U.S. who are able to
assume the increased risks of higher price volatility and currency fluctuations
associated with investments in international stocks which trade in non-U.S.
currencies.
The Account's past performance is not necessarily an indication of how the
Account will perform in the future. The bar chart and tables provide some
indication of the risks of investing in the Account by showing changes in
performance from year to year and showing how the Account's average annual
returns compare with those of a broad measure of market performance. Annual
operating expenses do not include any separate account expenses, cost of
insurance or other contract level expenses. Total returns would be lower if such
expenses were included.
YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
[Download Table]
"1999"93.81
"2000"-11.5
"2001"-21.85
"2002"-16.2
The Account's highest/lowest quarterly returns
"2003"54.15 during this
time period were:
HIGHESTQ4 '9936.59%
LOWEST Q3 '01-21.49%
LOGO
The year-to-date return as of June 30, 2004 is 10.43%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2003
[Enlarge/Download Table]
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT*
INTERNATIONAL SMALLCAP ACCOUNT ...........
54.15 11.61 N/A 8.06
Citigroup Extended Market Index (EMI)
World ex US/(1)/ ......................... 53.73 5.88 5.17
MSCI EAFE Small Cap Index ................ 57.76 5.48 N/A
Morningstar Foreign Small Mid Growth
Category ................................. 33.32 0.49 4.65
* The Account's SEC effective date was May 1, 1998.
///(1)/
This index is now the benchmark against which the Account measures its performance. The new Index contains significantly more
securities than the old. Thus the Manager and portfolio manager believe it better represents the universe of investment choices
open to the Account under its investment philosophy. The index formerly used is also shown.
FEES AND EXPENSES AS A % OF AVERAGE DAILY NET ASSETS BASED ON THE ACCOUNT'S
LATEST FISCAL YEAR
(These fees and expenses do not include the effect of any sales charge, separate
account expenses or other contract level expenses which may be applied at the
variable life insurance or variable annuity product level. If such charges or
-
fees were included, overall expenses would be higher and would lower the
Account's performance.)
ACCOUNT OPERATING EXPENSES
[Download Table]
Management Fees................. 1.20
Other Expenses.................. 0.13
----
TOTAL ACCOUNT OPERATING
EXPENSES 1.33
EXAMPLES
The Examples assume that you invest $10,000 in the Account for the time periods
indicated and then redeem all of your shares at the end of those periods. The
Examples also assume that your investment has a 5% return each year and that
the Account's operating expenses remain the same. If separate account expenses
and contract level expenses were included, expenses would be higher. Although
your actual costs may be higher or lower, based on these assumptions your cost
would be:
[Download Table]
NUMBER OF YEARS YOU OWN YOUR SHARES
----------------------------------------------------------------------------------
1 3 5 10
INTERNATIONAL SMALLCAP
ACCOUNT $135 $421 $729 $1,601
LARGECAP BLEND ACCOUNT
The Account seeks long-term growth of capital.
MAIN STRATEGIES
The Account pursues its investment objective by investing primarily in equity
securities of U.S. companies. Under normal market conditions, the Account
invests at least 80% of its assets in common stocks of companies with large
market capitalizations (those with market capitalizations within the range of
companies in the S&P 500 Index (as of June 30, 2004 this range was between
approximately $887 million and $342 billion)) at the time of purchase. Market
capitalization is defined as total current market value of a company's
outstanding common stock.
The Account's Sub-Advisor, T. Rowe Price, uses a disciplined portfolio
construction process whereby it weights each sector approximately the same as
the Standard & Poor's 500 Stock Index ("S&P 500 Index"). Individual holdings
within each sector, and their weights within the portfolio, can vary
substantially from the S&P 500 Index.
A team of equity analysts is directly responsible for selecting stocks for the
Account. Analysts select stocks from the industries they cover based on rigorous
fundamental analysis that assesses the quality of the business franchise,
earnings growth potential for the company, and stock valuation. The Account
seeks to take full advantage of the analysts' focused expertise in their
industries. A team of portfolio managers supervises the analysts and has the
responsibility for the overall structure of the Account. They oversee the
quantitative analysis that helps the analysts manage their industry-specific
portfolios.
Companies with similar characteristics may be grouped together in broad
categories called sectors. In determining the amount to invest in a security, T.
Rowe Price limits the Account's exposure to each business sector that comprises
the S&P 500 Index.
In pursuing its investment objective, the Account's management has the
discretion to purchase some securities that do not meet its normal investment
criteria, as described above, when it perceives an unusual opportunity for gain.
These special situations might arise when T. Rowe Price believes a security
could increase in value for a variety of reasons, including a change in
management, an extraordinary corporate event, or a temporary imbalance in the
supply of or demand for the securities.
The Account will generally remain fully invested (less than 5% cash reserves)
and will be sector neutral when compared to the S&P 500 Index. While the
majority of assets will be invested in large-capitalization U.S. common stocks,
small- and mid-capitalization and foreign stocks (up to 25% of assets) may also
be purchased in keeping with Account objectives. Futures and options may be
employed from time to time to manage flows of cash into and out of the Account.
Securities may be sold for a variety of reasons, such as to secure gains, limit
losses, or redeploy assets into more promising opportunities.
MAIN RISKS
The Account is subject to the risk that its principal market segment, large
capitalization stocks, may underperform compared to other market segments or to
the equity markets as a whole. The value of the Account's equity securities may
fluctuate on a daily basis. As with all mutual funds, as the values of the
Account's assets rise or fall, the Account's
share price changes. If you sell your shares when their value is less than the
price you paid, you will lose money.
As with any security, the securities in which the Account invests have
associated risks. These include risks of:
STOCK MARKET VOLATILITY . The net asset value of the Account's shares is
effected by changes in the value of the securities it owns. The prices of equity
securities held by the Account may decline in response to certain events
including those directly involving issuers of these securities, adverse
conditions affecting the general economy, or overall market declines. In the
short term, stock prices can fluctuate dramatically in response to these
factors.
GROWTH STOCKS . Because growth securities typically do not make dividend
payments to shareholders, investment returns are based on capital appreciation
making returns mare dependent on market increases and decreases. Growth stocks
may therefore be more volatile than non-growth stocks to market changes.
VALUE STOCKS . The Account's potential investment in value stocks carries the
risk that the market will not recognize a security's intrinsic value for a long
time or that a stock judged to be undervalued may actually be appropriately
priced.
SECTOR RISK . The Sub-Advisor may group companies with similar characteristics
into broad categories called sectors. Therefore, the Account is also subject to
sector risk; that is, the possibility that a certain sector may underperform
other sectors or the market as a whole. As the Sub-Advisor allocates more of the
Account's portfolio holdings to a particular sector, the Account's performance
will be more susceptible to any economic, business or other developments that
generally affect that sector.
FOREIGN INVESTING . Foreign markets and currencies may not perform as well as
U.S. markets. Political and economic uncertainty in foreign countries, as well
as less public information about foreign investments may negatively impact the
Account's portfolio. Dividends and other income payable on foreign securities
may be subject to foreign taxes. Some investments may be made in currencies
other than the U.S. dollar that will fluctuate in value as a result of changes
in the currency exchange rate.
SMALL AND MEDIUM CAPITALIZATIONS . Companies with small capitalizations are
often companies with a limited operation history. Such companies may have been
created in response to cultural, economic, regulatory or technological
developments. Such developments can have significant impact or negative effect
on smaller capitalization companies securities which may be more volatile in
price than larger company securities, especially over the short-term.
INVESTOR PROFILE
The Account may be an appropriate investment for investors seeking long-term
growth of capital and willing to accept the risks of investing in an
aggressively managed portfolio of common stocks, but who prefer investing in
larger, established companies.
T. Rowe Price became the Sub-Advisor to the Account effective March 9, 2004.
The Account's past performance is not necessarily an indication of how the
Account will perform in the future. The bar chart and tables provide some
indication of the risks of investing in the Account by showing changes in
performance from year to year and showing how the Account's average annual
returns compare with those of a broad measure of market performance. Annual
operating expenses do not include any separate account expenses, cost of
insurance or other contract level expenses. Total returns would be lower if such
expenses were included.
YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
[Download Table]
"2003"23.76
LOGO
The Account's highest/lowest quarterly returns
during this
time period were:
HIGHEST Q2 '03 14.07%
LOWEST Q3 '02 -5.51%
The year-to-date return as of June 30, 2004 is 2.95%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2003
[Download Table]
PAST 1
YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT*
LARGECAP BLEND ACCOUNT 23.76 N/A N/A 2.74
S&P 500 Index ........ 28.67 -0.57 11.06
Morningstar Large
Blend Category........ 26.72 -0.43 9.24
* The Account's SEC effective date was May 1, 2002.
FEES AND EXPENSES (ESTIMATED) AS A % OF AVERAGE DAILY NET ASSETS
(These fees and expenses do not include the effect of any sales charge, separate
account expenses or other contract level expenses which may be applied at the
variable life insurance or variable annuity product level. If such charges or
-
fees were included, overall expenses would be higher and would lower the
Account's performance.)
ACCOUNT OPERATING EXPENSES
[Download Table]
Management Fees.................. 0.75
Other Expenses................... 0.08
----
TOTAL ACCOUNT OPERATING EXPENSES 0.83
EXAMPLES
The Examples assume that you invest $10,000 in the Account for the time periods
indicated and then redeem all of your shares at the end of those periods. The
Examples also assume that your investment has a 5% return each year and that
the Account's operating expenses remain the same. If separate account expenses
and contract level expenses were included, expenses would be higher. Although
your actual costs may be higher or lower, based on these assumptions your cost
would be:
[Download Table]
NUMBER OF YEARS YOU OWN YOUR SHARES
----------------------------------------------------------------------------------
1 3 5 10
LARGECAP BLEND ACCOUNT $85 $265 $460 $1,025
LARGECAP GROWTH EQUITY ACCOUNT
The Account seeks to achieve long-term growth of capital.
MAIN STRATEGIES
The Account invests primarily in common stock of U.S. companies, with a focus on
growth stocks. Growth stocks are issued by companies that the Sub-Advisor, GMO,
believes are fast-growing and whose earning are believed to likely increase over
time. Growth in earnings may lead to an increase in the price of the stock. The
Sub-Advisor invests mainly in large companies, although investments can be made
in companies of any size
Under normal market conditions, the Account invests at least 80% of its assets
in equity securities of companies with large market capitalizations. The Fund
typically makes equity investments in companies chosen from among the 1,000 U.S.
exchange-listed companies with the largest market capitalization. Market
capitalization is defined as total current market value of a company's
outstanding common stock. In addition, the Account may invest up to 25% of its
assets in foreign securities, including American Depository Receipts (ADRs), at
the time of purchase.
When deciding whether to buy or sell stocks for the Account, GMO considers,
among other factors, a company's valuation, financial strength, competitive
position in its industry, projected future earnings, cash flows and dividends.
In addition to the main investment strategies described above, GMO may make
other investments, such as investments in preferred stocks, convertible
securities and debt instruments. These investments may be subject to other risks
as described later in this prospectus and/or the Statement of Additional
Information.
MAIN RISKS
The Account is subject to the risk that its principal market segment, large
capitalization growth-oriented stocks, may underperform compared to other market
segments or to the equity markets as a whole. The value of the Account's
securities may fluctuate on a daily basis. As with all mutual funds, as the
values of the Account's assets rise or fall, the
Account's share price changes. If you sell your shares when their value is less
than the price you paid, you will lose
money.
As with any security, the securities in which the Account invests have
associated risks. These include risks of:
STOCK MARKET VOLATILITY . The net asset value of the Account's shares is
effected by changes in the value of the securities it owns. The prices of equity
securities held by the Account may decline in response to certain events
including those directly involving issuers of these securities, adverse
conditions affecting the general economy, or overall market declines. In the
short term, stock prices can fluctuate dramatically in response to these
factors.
GROWTH STOCKS . Because growth securities typically do not make dividend
payments to shareholders, investment returns are based on capital appreciation
making returns mare dependent on market increases and decreases. Growth stocks
may therefore be more volatile than non-growth stocks to market changes.
FOREIGN INVESTING . Foreign markets and currencies may not perform as well as
U.S. markets. Political and economic uncertainty in foreign countries, as well
as less public information about foreign investments may negatively impact the
Account's portfolio. Dividends and other income payable on foreign securities
may be subject to foreign taxes. Some investments may be made in currencies
other than the U.S. dollar that will fluctuate in value as a result of changes
in the currency exchange rate.
INTEREST RATE CHANGES . Changes in interest rates may adversely affect the value
of an investor's securities. When interest rates rise, the value of preferred
securities will generally fall. Conversely, a drop in interest rates will
generally cause an increase in the value of preferred securities. Some
investments give the issuer the option to call, or redeem, its securities before
their maturity date. If an issuer calls its security during a time of declining
interest rates, the Account may have to reinvest the proceeds in securities with
lower rates. In addition, the Account's appreciation may be limited by issuer
call options having more value during times of declining interest rates.
ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an
attempt to achieve its investment objective. The financial highlights table at
the end of this Prospectus shows the Account's turnover rate during recent
fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to
the Account buying and selling all of its securities two times during the course
of the year. A high turnover rate may increase the Account's trading costs and
may have an adverse impact on the Account's performance.The portfolio turnover
rate for the Account for the six month period ended June 30, 2004 was 178%
(computed on an annualized basis).
INVESTOR PROFILE
The Account may be an appropriate investment for investors who are seeking
long-term growth and are willing to accept the potential for short-term,
volatile fluctuations in the value of their investment. This Account is designed
as a long-term investment with growth potential.
GMO became the Sub-Advisor to the Account on March 31, 2004.
The Account's past performance is not necessarily an indication of how the
Account will perform in the future. The bar chart and tables provide some
indication of the risks of investing in the Account by showing changes in
performance from year to year and showing how the Account's average annual
returns compare with those of a broad measure of market performance. Annual
operating expenses do not include any separate account expenses, cost of
insurance or other contract level expenses. Total returns would be lower if such
expenses were included.
YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
[Download Table]
"2001"-30.08
"2002"-33.27
"2003"23.14 The Account's highest/lowest quarterly returns
during this
time period were:
HIGHESTQ4 '0112.16%
LOGO LOWEST Q3 '01-21.14%
The year-to-date return as of June 30, 2004 is 0.89%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2003
[Download Table]
PAST 1
YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT*
LARGECAP GROWTH EQUITY
ACCOUNT ..............
23.14 N/A N/A -22.33
Russell 1000 Growth
Index................. 29.76 -5.11 9.21
Morningstar Large
Growth Category....... 28.55 -3.20 7.96
* The Account's SEC effective date was October 24, 2000.
FEES AND EXPENSES AS A % OF AVERAGE DAILY NET ASSETS BASED ON THE ACCOUNT'S
LATEST FISCAL YEAR
(These fees and expenses do not include the effect of any sales charge, separate
account expenses or other contract level expenses which may be applied at the
variable life insurance or variable annuity product level. If such charges or
-
fees were included, overall expenses would be higher and would lower the
Account's performance.)
ACCOUNT OPERATING EXPENSES
[Download Table]
Management Fees................. 1.00
Other Expenses.................. 0.19
----
TOTAL ACCOUNT OPERATING
EXPENSES 1.19
EXAMPLES
The Examples assume that you invest $10,000 in the Account for the time periods
indicated and then redeem all of your shares at the end of those periods. The
Examples also assume that your investment has a 5% return each year and that
the Account's operating expenses remain the same. If separate account expenses
and contract level expenses were included, expenses would be higher. Although
your actual costs may be higher or lower, based on these assumptions your cost
would be:
[Download Table]
NUMBER OF YEARS YOU OWN YOUR SHARES
----------------------------------------------------------------------------------
1 3 5 10
LARGECAP GROWTH EQUITY ACCOUNT $121 $378 $654 $1,443
LARGECAP STOCK INDEX ACCOUNT
The Account seeks long-term growth of capital.
MAIN STRATEGIES
Under normal market conditions, the Account invests at least 80% of its assets
in common stocks of companies that compose the Standard & Poor's ("S&P") 500
Index. The Sub-Advisor, Principal, attempts to mirror the investment performance
of the Index by allocating the Account's assets in approximately the same
weightings as the S&P 500. The S&P 500 is an unmanaged index of 500 common
stocks chosen to reflect the industries of the U.S. economy and is often
considered a proxy for the stock market in general. Each stock is weighted by
its market capitalization which means larger companies have greater
representation in the Index than smaller ones. As of June 30, 2004, the market
capitalization range of the Index was between approximately $887 million and
$342 billion. Over the long-term, Principal seeks a very close correlation
between performance of the Account, before expenses, and that of the S&P 500. It
is unlikely that a perfect correlation of 1.00 will be achieved.
The Account uses an indexing strategy and is not managed according to
traditional methods of "active" investment management. Active management would
include buying and selling securities based on economic, financial and
investment judgement. Instead, the Account uses a passive investment approach.
Rather than judging the merits of a particular stock in selecting investments,
Principal focuses on tracking the S&P 500. Principal may also use stock index
futures as a substitute for the sale or purchase of securities. It does not
attempt to manage market volatility, use defensive strategies or reduce the
effect of any long-term periods of poor stock performance.
The correlation between Account and Index performance may be affected by the
Account's expenses, changes in securities markets, changes in the composition of
the Index and the timing of purchases and sales of Account shares. The Account
may invest in futures and options, which could carry additional risks such as
losses due to unanticipated market price movements and could also reduce the
opportunity for gain.
Because of the difficulty and expense of executing relatively small stock
trades, the Account may not always be invested in the less heavily weighted S&P
500 stocks. At times, the Account's portfolio may be weighted differently from
the S&P 500, particularly if the Account has a small level of assets to invest.
In addition, the Account's ability to match the performance of the S&P 500 is
affected to some degree by the size and timing of cash flows into and out of the
Account. The Account is managed to attempt to minimize such effects.
Principal reserves the right to omit or remove any of the S&P 500 stocks from
the Account if it determines that the stock is not sufficiently liquid. In
addition, a stock might be excluded or removed from the Account if extraordinary
events or financial conditions lead Principal to believe that it should not be a
part of the Account's assets.
MAIN RISKS
The Account is subject to the risk that its principal market segment, large
capitalization stocks, may underperform compared to other market segments or to
the equity markets as a whole. The value of the Account's equity securities may
fluctuate on a daily basis. As with all mutual funds, as the values of the
Account's assets rise or fall, the Account's
share price changes. If you sell your shares when their value is less than the
price you paid, you will lose money.
As with any security, the securities in which the Account invests have
associated risks. These include risks of:
STOCK MARKET VOLATILITY . The net asset value of the Account's shares is
effected by changes in the value of the securities it owns. The prices of equity
securities held by the Account may decline in response to certain events
including those directly involving issuers of these securities, adverse
conditions affecting the general economy, or overall market declines. In the
short term, stock prices can fluctuate dramatically in response to these
factors.
GROWTH STOCKS . Because growth securities typically do not make dividend
payments to shareholders, investment returns are based on capital appreciation
making returns more dependent on market increases and decreases. Growth stocks
may therefore be more volatile than non-growth stocks to market changes.
VALUE STOCKS . The Account's potential investment in value stocks carries the
risk that the market will not recognize a security's intrinsic value for a long
time or that a stock judged to be undervalued may actually be appropriately
priced.
INVESTOR PROFILE
The Account may be an appropriate investment for investors seeking long-term
growth of capital, willing to accept the potential for volatile fluctuations in
the value of investments and preferring a passive, rather than active,
management style.
NOTE: "Standard & Poor's 500"and "S&P 500/(R)/" are trademarks of The
McGraw-Hill Companies, Inc. and have been licensed by the Manager. The
Account is not sponsored, endorsed, sold or promoted by Standard and Poor's
and Standard & Poor's makes no representation regarding the advisability of
investing in the Account.
The Account's past performance is not necessarily an indication of how the
Account will perform in the future. The bar chart and tables provide some
indication of the risks of investing in the Account by showing changes in
performance from year to year and showing how the Account's average annual
returns compare with those of a broad measure of market performance. Annual
operating expenses do not include any separate account expenses, cost of
insurance or other contract level expenses. Total returns would be lower if such
expenses were included.
YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
[Download Table]
"2000"-9.67
"2001"-12.1
"2002"-22.44
The Account's highest/lowest quarterly returns
"2003"28.32 during this
time period were:
HIGHEST Q2 '03 15.28%
LOWEST Q3 '02 -17.27%
LOGO
The year-to-date return as of June 30, 2004 is 3.10%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2003
[Download Table]
PAST 1
YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT*
LARGECAP STOCK INDEX
ACCOUNT ..............
28.32 N/A N/A -3.16
S&P 500 Index ........ 28.67 -0.57 11.06
Morningstar Large
Blend Category....... 26.72 -0.43 9.24
* The Account's SEC effective date was May 3, 1999.
FEES AND EXPENSES AS A % OF AVERAGE DAILY NET ASSETS BASED ON THE ACCOUNT'S
LATEST FISCAL YEAR
(These fees and expenses do not include the effect of any sales charge, separate
account expenses or other contract level expenses which may be applied at the
variable life insurance or variable annuity product level. If such charges or
-
fees were included, overall expenses would be higher and would lower the
Account's performance.)
ACCOUNT OPERATING EXPENSES
[Enlarge/Download Table]
Management Fees................. 0.35
Other Expenses.................. 0.04
----
TOTAL ACCOUNT OPERATING EXPENSES 0.39*
*The Manager has voluntarily agreed to reimburse operating expenses so that the total Account operating expenses will not be
greater than 0.40% through April 30, 2005. The Manager may not continue this arrangement after May 1, 2005.
EXAMPLES
The Examples assume that you invest $10,000 in the Account for the time periods
indicated and then redeem all of your shares at the end of those periods. The
Examples also assume that your investment has a 5% return each year and that
the Account's operating expenses remain the same. If separate account expenses
and contract level expenses were included, expenses would be higher. Although
your actual costs may be higher or lower, based on these assumptions your cost
would be:
[Download Table]
NUMBER OF YEARS YOU OWN YOUR SHARES
--------------------------------------------------------------------------------
1 3 5 10
LARGECAP STOCK INDEX
ACCOUNT $40 $125 $219 $493
LARGECAP VALUE ACCOUNT
The Account seeks long-term growth of capital.
MAIN STRATEGIES
The Account invests primarily in undervalued equity securities of companies
among the 750 largest by market capitalization that the Sub-Advisor, Bernstein,
believes offer above-average potential for growth in future earnings. Under
normal market conditions, the Account generally invests at least 80% of its
assets in companies with large market capitalizations (those with market
capitalizations similar to companies in the Russell 1000 Value Index (as of June
30, 2004, this range was between approximately $1.36 billion and $34.96
billion)) at the time of purchase. Market capitalization is defined as total
current market value of a company's outstanding common stock. The Account may
invest up to 25% of its assets in securities of foreign companies.
Bernstein employs an investment strategy, generally described as "value"
investing, that involves seeking securities that:
.. exhibit low financial ratios (particularly stock price-to-book value
(liquidation value), but also stock price-to-earnings and stock price-to-cash
flow);
.. can be acquired for less than what Bernstein believes is the issuer's
intrinsic value; or
.. whose price appears attractive relative to the value of the dividends expected
to be paid by the issuer in the future.
Value oriented investing entails a strong "sell discipline" in that it generally
requires the sale of securities that have reached their intrinsic value or a
target financial ratio. Value oriented investments may include securities of
companies in cyclical industries during periods when such securities appear to
Bernstein to have strong potential for capital appreciation or securities of
"special situation" companies. A special situation company is one that Bernstein
believes has potential for significant future earnings growth but has not
performed well in the recent past. These situations include companies with
management changes, corporate or asset restructuring or significantly
undervalued assets. For Bernstein, identifying special situation companies and
establishing an issuer's intrinsic value involves fundamental research about
such companies and issuers.
MAIN RISKS
The Account is subject to the risk that its principal market segment, large
capitalization value stocks, may underperform compared to other market segments
or to the equity markets as a whole. The value of the Account's securities may
fluctuate on a daily basis. As with all mutual funds, as the values of the
Account's assets rise or fall, the Account's
share price changes. If you sell your shares when their value is less than the
price you paid, you will lose money.
As with any security, the securities in which the Account invests have
associated risks. These include risks of:
STOCK MARKET VOLATILITY . The net asset value of the Account's shares is
effected by changes in the value of the securities it owns. The prices of equity
securities held by the Account may decline in response to certain events
including those directly involving issuers of these securities, adverse
conditions affecting the general economy, or overall market declines. In the
short term, stock prices can fluctuate dramatically in response to these
factors.
VALUE STOCKS . The Account's potential investment in value stocks carries the
risk that the market will not recognize a security's intrinsic value for a long
time or that a stock judged to be undervalued may actually be appropriately
priced.
FOREIGN INVESTING . Foreign markets and currencies may not perform as well as
U.S. markets. Political and economic uncertainty in foreign countries, as well
as less public information about foreign investments may negatively impact the
Account's portfolio. Dividends and other income payable on foreign securities
may be subject to foreign taxes. Some investments may be made in currencies
other than the U.S. dollar that will fluctuate in value as a result of changes
in the currency exchange rate.
INVESTOR PROFILE
The Account may be an appropriate investment for investors seeking long-term
growth of capital and willing to accept the risks of investing in common stocks
but prefer investing in companies that appear to be considered undervalued
relative to similar companies.
The Account's past performance is not necessarily an indication of how the
Account will perform in the future. The bar chart and tables provide some
indication of the risks of investing in the Account by showing changes in
performance from year to year and showing how the Account's average annual
returns compare with those of a broad measure of market performance. Annual
operating expenses do not include any separate account expenses, cost of
insurance or other contract level expenses. Total returns would be lower if such
expenses were included.
YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
[Download Table]
"2003"28.05
LOGO
The Account's highest/lowest quarterly returns
during this
time period were:
HIGHEST Q2 '03 16.19%
LOWEST Q3 '02 -18.55%
The year-to-date return as of June 30, 2004 is 3.53%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2003
[Download Table]
PAST 1
YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT*
LARGECAP VALUE ACCOUNT 28.05 N/A N/A 5.77
Russell 1000 Value
Index................. 30.03 3.57 11.87
Morningstar Large
Value Category........ 28.40 2.53 9.85
* The Account's SEC effective date was May 1, 2002.
FEES AND EXPENSES (ESTIMATED) AS A % OF AVERAGE DAILY NET ASSETS
(These fees and expenses do not include the effect of any sales charge, separate
account expenses or other contract level expenses which may be applied at the
variable life insurance or variable annuity product level. If such charges or
-
fees were included, overall expenses would be higher and would lower the
Account's performance.)
ACCOUNT OPERATING EXPENSES
[Download Table]
Management Fees................. 0.75
Other Expenses.................. 0.04
----
TOTAL ACCOUNT OPERATING EXPENSES 0.79
EXAMPLES
The Examples assume that you invest $10,000 in the Account for the time periods
indicated and then redeem all of your shares at the end of those periods. The
Examples also assume that your investment has a 5% return each year and that
the Account's operating expenses remain the same. If separate account expenses
and contract level expenses were included, expenses would be higher. Although
your actual costs may be higher or lower, based on these assumptions your cost
would be:
[Download Table]
NUMBER OF YEARS YOU OWN YOUR SHARES
--------------------------------------------------------------------------------
1 3 5 10
LARGECAP VALUE ACCOUNT $81 $252 $439 $978
LIMITED TERM BOND ACCOUNT
The Account seeks to provide current income.
MAIN STRATEGIES
The Account invests primarily in high quality, short-term fixed-income
securities. The Account considers the term "bond" to mean any debt security.
Under normal circumstances, it invests at least 80% of its assets in:
.. securities issued or guaranteed by the U.S. government or its agencies or
instrumentalities;
.. debt securities of U.S. issuers rated in the three highest grades by Standard
& Poor's Rating Service or Moody's Investors Service, Inc. or, if unrated, in
the opinion of the Sub-Advisor, Principal, of comparable quality; and
.. mortgage-backed securities representing an interest in a pool of mortgage
loans.
The rest of the Account's assets may be invested in a variety of financial
instruments, including securities in the fourth highest rating category or their
equivalent. Securities in the fourth highest category are "investment grade."
While they are considered to have adequate capacity to pay interest and repay
principal, they do have speculative characteristics. Changes in economic and
other conditions are more likely to affect the ability of the issuer to make
principal and interest payments than is the case with issuers of higher rated
securities.
Under normal circumstances, the Account maintains a dollar-weighted average
maturity of not more than five years. In determining the average maturity of the
Account's assets, the maturity date of callable or prepayable securities may be
adjusted to reflect Principal's judgment regarding the likelihood of the
security being called or prepaid.
Under unusual market or economic conditions, the Account may invest up to 100%
of its assets in cash and cash equivalents.
MAIN RISKS
As with any security, the securities in which the Account invests have
associated risks. These include risks of:
INTEREST RATE CHANGES . The value of fixed-income securities held by the Account
may be affected by factors such as changing interest rates. When interest rates
rise, the value of fixed-income securities will generally fall. Conversely, a
drop in interest rates will generally cause an increase in the value of
fixed-income securities. Some fixed-income investments give the issuer the
option to call, or redeem, its securities before their maturity date. If an
issuer calls its security during a time of declining interest rates, the Account
may have to reinvest the proceeds in securities with lower rates. In addition,
the Account's appreciation may be limited by issuer call options having more
value during times of declining interest rates.
CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater
credit risk and price fluctuations than higher quality and shorter maturity
bonds. Bonds held by the Account may be affected by unfavorable political,
economic, or governmental developments that could affect the repayment of
principal or the payment of interest.
PORTFOLIO DURATION. . The average portfolio duration of the Account normally is
less than three years and is based on Principal's forecast for interest rates.
Duration is a measure of the expected life of a fixed-income security that is
used to determine the sensitivity of a security's price to changes in interest
rates. For example, if the portfolio duration of the Account is three years, a
change of 1% in the Account's yield results in a change of approximately 3% in
the value of the Account's securities. The longer a security's duration, the
more sensitive it is to changes in interest rates. An Account with a longer
average portfolio duration will be more sensitive to changes in interest rates
than an Account with a shorter average portfolio duration.
U.S. GOVERNMENT SPONSORED SECURITIES . The Account may invest in debt and
mortgage-backed securities issued by government-sponsored enterprises such as
the Federal Home Loan Mortgage Corporation, the Federal National Mortgage
Association and the Federal Home Loan Banks. Although the issuing agency,
instrumentality or corporation maybe chartered or sponsored by the United States
government, their securities are neither issued nor guaranteed by the United
States Treasury.
MORTGAGE-BACKED SECURITIES . Mortgage-backed securities are subject to
prepayment risk. When interest rates decline, significant unscheduled
prepayments may result. These prepayments must then be reinvested at lower
rates. Prepayments may also shorten the effective maturities of these
securities, especially during periods of declining interest rates. On the other
hand, during periods of rising interest rates, a reduction in prepayments may
increase the effective maturities of these securities, subjecting them to the
risk of decline in market value in response to rising interest rates. This may
increase the volatility of the Account.
As with all mutual funds, as the values of the Account's assets rise or fall,
the Account's share price changes. If you sell
your shares when their value is less than the price you paid, you will lose
money.
INVESTOR PROFILE
The Account may be an appropriate investment for investors seeking
diversification by investing in a fixed-income mutual fund.
As the inception date of the Account is May 1, 2003, only limited historical
performance data is available. Annual operating expenses do not include any
separate account expenses, cost of insurance or other contract level expenses.
Total returns would be lower if such expenses were included.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2003
[Download Table]
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT*
LIMITED TERM BOND
ACCOUNT............... N/A N/A N/A 0.78
Lehman Brothers Mutual
Fund 1-5 Gov't./Credit
Index................. 3.35 6.26 6.24
Morningstar Short-Term
Bond Category......... 2.39 5.07 5.28
* The Account's SEC effective date was May 1, 2003.
FEES AND EXPENSES (ESTIMATED) AS A % OF AVERAGE DAILY NET ASSETS
(These fees and expenses do not include the effect of any sales charge, separate
account expenses or other contract level expenses which may be applied at the
variable life insurance or variable annuity product level. If such charges or
-
fees were included, overall expenses would be higher and would lower the
Account's performance.)
ACCOUNT OPERATING EXPENSES
[Download Table]
Management Fees.................. 0.50
Other Expenses................... 0.07
----
TOTAL ACCOUNT OPERATING EXPENSES 0.57
EXAMPLES
The Examples assume that you invest $10,000 in the Account for the time periods
indicated and then redeem all of your shares at the end of those periods. The
Examples also assume that your investment has a 5% return each year and that
the Account's operating expenses remain the same. If separate account expenses
and contract level expenses were included, expenses would be higher. Although
your actual costs may be higher or lower, based on these assumptions your cost
would be:
[Download Table]
NUMBER OF YEARS YOU OWN YOUR SHARES
--------------------------------------------------------------------------------
1 3 5 10
LIMITED TERM BOND
ACCOUNT $58 $183 $318 $714
MIDCAP ACCOUNT
The Account seeks to achieve capital appreciation by investing primarily in
securities of emerging and other growth-
oriented companies.
MAIN STRATEGIES
The Account invests primarily in common stocks and other equity securities of
medium capitalization companies. Under normal market conditions, the Account
invests at least 80% of its assets in common stocks of companies with medium
market capitalizations (those with market capitalizations similar to companies
in the Russell MidCap Index (as of June 30, 2004, this range was between
approximately $529 million and $13.68 billion)) at the time of purchase. Market
capitalization is defined as total current market value of a company's
outstanding common stock.
In selecting securities for investment, the Sub-Advisor, Principal, looks at
stocks with value and/or growth characteristics and constructs an investment
portfolio that has a "blend" of stocks with these characteristics. In managing
the assets of the Account, Principal does not have a policy of preferring one of
these categories to the other. The value orientation emphasizes buying stocks at
less than their inherent value and avoiding stocks whose price has been
artificially built up. The growth orientation emphasizes buying stocks of
companies whose potential for growth of capital and earnings is expected to be
above average.
Principal considers the quality and price of individual issuers rather than
forecasting stock market trends in its selection of individual securities.
Selection is based on fundamental analysis of a company relative to other
companies with the focus being on Principal's estimation of forward-looking
rates of return. Up to 10% of Account assets may be invested in foreign
securities.
Principal focuses its stock selections on established companies that it believes
have a sustainable competitive advantage. Principal constructs a portfolio that
is "benchmark aware" in that it is sensitive to the sector (companies with
similar characteristics) and security weightings of its benchmark. However, the
Account is actively managed and prepared to over- and/or under-weight sectors
and industries differently from the benchmark.
The Account may purchase securities issued as part of, or a short period after,
companies' initial public offerings and may at times dispose of those shares
shortly after their acquisition.
MAIN RISKS
The Account is subject to the risk that its principal market segment, medium
capitalization stocks, may underperform compared to other market segments or to
the equity markets as a whole. Because different types of stocks tend to shift
in and out of favor depending on market and economic conditions, the Account's
performance may sometimes be lower or higher than that of other types of funds.
The value of the Account's equity securities may fluctuate on a daily basis. As
with all mutual funds, as the values of the Account's assets rise or fall, the
Account's share price changes. If
you sell your shares when their value is less than the price you paid, you will
lose money.
As with any security, the securities in which the Account invests have
associated risks. These include risks of:
STOCK MARKET VOLATILITY . The net asset value of the Account's shares is
effected by changes in the value of the securities it owns. The prices of equity
securities held by the Account may decline in response to certain events
including those directly involving issuers of these securities, adverse
conditions affecting the general economy, or overall market declines. In the
short term, stock prices can fluctuate dramatically in response to these
factors.
SMALL AND MEDIUM CAPITALIZATIONS . Companies with small capitalizations are
often companies with a limited operation history. Such companies may have been
created in response to cultural, economic, regulatory or technological
developments. Such developments can have significant impact or negative effect
on smaller capitalization companies securities which may be more volatile in
price than larger company securities, especially over the short-term.
FOREIGN INVESTING . Foreign markets and currencies may not perform as well as
U.S. markets. Political and economic uncertainty in foreign countries, as well
as less public information about foreign investments may negatively impact the
Account's portfolio. Dividends and other income payable on foreign securities
may be subject to foreign taxes. Some investments may be made in currencies
other than the U.S. dollar that will fluctuate in value as a result of changes
in the currency exchange rate. Emerging market countries and companies doing
business in emerging market countries may not have the same rage of
opportunities as more developed countries companies in more developed countries.
INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in
IPOs exposes it to the additional risks associated with companies that have
little operating history as public companies, as well as to the risks inherent
in those sectors of the market where these new issuers operate. The market for
IPO issuers has been volatile and share prices of certain newly-public companies
have fluctuated in significant amounts over short periods of time. In addition,
the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at
times dispose of those shares shortly after their acquisition.
INVESTOR PROFILE
The Account may be an appropriate investment for investors seeking long-term
growth of capital and willing to accept the potential for short-term
fluctuations in the value of investments.
The Account's past performance is not necessarily an indication of how the
Account will perform in the future. The bar chart and tables provide some
indication of the risks of investing in the Account by showing changes in
performance from year to year and showing how the Account's average annual
returns compare with those of a broad measure of market performance. Annual
operating expenses do not include any separate account expenses, cost of
insurance or other contract level expenses. Total returns would be lower if such
expenses were included.
YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
[Download Table]
"1994"0.78
"1995"29.01
"1996"21.11
"1997"22.75
"1998"3.69
"1999"13.04
"2000"14.59
"2001"-3.71
"2002"-8.75
The Account's highest/lowest quarterly returns
"2003"32.81 during this
time period were:
HIGHESTQ4 '9923.31%
LOWEST Q3 '98-20.01%
LOGO
The year-to-date return as of June 30, 2004 is 6.26%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2003
[Download Table]
PAST 1
YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT*
MIDCAP ACCOUNT .......
32.81 8.61 11.72 14.20
Russell Midcap Index . 40.08 7.24 12.18
Morningstar Mid-Cap
Blend Category........ 36.42 7.78 11.48
* The Account's SEC effective date was December 18, 1987.
FEES AND EXPENSES AS A % OF AVERAGE DAILY NET ASSETS BASED ON THE ACCOUNT'S
LATEST FISCAL YEAR
(These fees and expenses do not include the effect of any sales charge, separate
account expenses or other contract level expenses which may be applied at the
variable life insurance or variable annuity product level. If such charges or
-
fees were included, overall expenses would be higher and would lower the
Account's performance.)
ACCOUNT OPERATING EXPENSES
[Download Table]
Management Fees................. 0.60
Other Expenses.................. 0.01
----
TOTAL ACCOUNT OPERATING
EXPENSES 0.61
EXAMPLES
The Examples assume that you invest $10,000 in the Account for the time periods
indicated and then redeem all of your shares at the end of those periods. The
Examples also assume that your investment has a 5% return each year and that
the Account's operating expenses remain the same. If separate account expenses
and contract level expenses were included, expenses would be higher. Although
your actual costs may be higher or lower, based on these assumptions your cost
would be:
[Download Table]
NUMBER OF YEARS YOU OWN YOUR SHARES
---------------------------------------------------------------------------------
1 3 5 10
MIDCAP ACCOUNT $62 $195 $340 $762
MIDCAP GROWTH ACCOUNT
The Account seeks long-term growth of capital.
MAIN STRATEGIES
Under normal market conditions, the Account invests at least 80% of its assets
in common stocks of companies with medium market capitalization (those with
market capitalizations similar to companies in the Russell Midcap Growth Index
(as of June 30, 2004, this range was between approximately $529 million and
$13.42 billion)) at the time of purchase. In the view of the Sub-Advisor,
Dreyfus, many medium-sized companies:
.. are in fast growing industries;
.. offer superior earnings growth potential; and
.. are characterized by strong balance sheets and high returns on equity.
The Account may also hold investments in large and small capitalization
companies, including emerging and cyclical growth companies. The Account may
invest up to 10% of its net assets in securities of foreign companies, including
securities of issuers in emerging countries and securities quoted in foreign
currencies.
Dreyfus uses valuation models designed to identify common stocks of companies
that have demonstrated consistent earnings momentum and delivered superior
results relative to market analyst expectations. Other considerations include
profit margins, growth in cash flow and other standard balance sheet measures.
The securities held are generally characterized by strong earnings momentum
measures and higher expected earnings per share growth.
The valuation model incorporates information about the relevant criteria as of
the most recent period for which data are available. Once ranked, the securities
are categorized under the headings "buy," "sell" or "hold." The decision to buy,
sell or hold is made by Dreyfus based primarily on output of the valuation
model. However, that decision may be modified due to subsequently available or
other specific relevant information about the security. In addition, Dreyfus
manages risk by diversifying across companies and industries, limiting the
potential adverse impact from any one stock or industry.
The Account may purchase securities issued as part of, or a short period after,
companies' initial public offerings and may at times dispose of those shares
shortly after their acquisition.
MAIN RISKS
As with any security, the securities in which the Account invests have
associated risks. These include risks of:
STOCK MARKET VOLATILITY . The net asset value of the Account's shares is
effected by changes in the value of the securities it owns. The prices of equity
securities held by the Account may decline in response to certain events
including those directly involving issuers of these securities, adverse
conditions affecting the general economy, or overall market declines. In the
short term, stock prices can fluctuate dramatically in response to these
factors. As with
all mutual funds, as the values of the Account's assets rise or fall, the
Account's share price changes. If you sell your
shares when their value is less than the price you paid, you will lose money.
SMALL AND MEDIUM CAPITALIZATIONS . Companies with small capitalizations are
often companies with a limited operation history. Such companies may have been
created in response to cultural, economic, regulatory or technological
developments. Such developments can have significant impact or negative effect
on smaller capitalization companies securities which may be more volatile in
price than larger company securities, especially over the short-term.
GROWTH STOCKS . Because growth securities typically do not make dividend
payments to shareholders, investment returns are based on capital appreciation
making returns more dependent on market increases and decreases. Growth stocks
may therefore be more volatile than non-growth stocks to market changes.
FOREIGN INVESTING . Foreign markets and currencies may not perform as well as
U.S. markets. Political and economic uncertainty in foreign countries, as well
as less public information about foreign investments may negatively impact the
Account's portfolio. Dividends and other income payable on foreign securities
may be subject to foreign taxes. Some investments may be made in currencies
other than the U.S. dollar that will fluctuate in value as a result of changes
in
the currency exchange rate. Emerging market countries and companies doing
business in emerging market countries may not have the same range of
opportunities as more developed countries companies in more developed countries.
EMERGING MARKET COUNTRIES . Investments in emerging market countries involve
special risks. Certain emerging market countries have historically experienced,
and may continue to experience, certain economic problems. These may include:
high rates of inflation, high interest rates, exchange rate fluctuations, large
amounts of debt, balance of payments and trade difficulties, and extreme poverty
and unemployment.
FOREIGN EXCHANGE CONTRACTS . Because foreign securities generally are
denominated in foreign currencies, the value of the net assets of the Account as
measured in U.S. dollars will be affected by changes in exchange rates. To
protect against future uncertainties in foreign currency exchange rates, the
Account is authorized to enter into certain foreign currency exchange
transactions. In addition, the Account's foreign investments may be less liquid
and their price more volatile than comparable investments in U.S. securities.
Settlement periods may be longer for foreign securities and portfolio liquidity
may be affected.
INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in
IPOs exposes it to the additional risks associated with companies that have
little operating history as public companies, as well as to the risks inherent
in those sectors of the market where these new issuers operate. The market for
IPO issuers has been volatile and share prices of certain newly-public companies
have fluctuated in significant amounts over short periods of time. In addition,
the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at
times dispose of those shares shortly after their acquisition.
INVESTOR PROFILE
The Account may be an appropriate investment for investors seeking long-term
growth and willing to accept the potential for short-term fluctuations in the
value of their investments.
The Account's past performance is not necessarily an indication of how the
Account will perform in the future. The bar chart and tables provide some
indication of the risks of investing in the Account by showing changes in
performance from year to year and showing how the Account's average annual
returns compare with those of a broad measure of market performance. Annual
operating expenses do not include any separate account expenses, cost of
insurance or other contract level expenses. Total returns would be lower if such
expenses were included.
YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
[Download Table]
"1999 "10.67
"2000"8.1
"2001"-16.92
"2002"-26.27
The Account's highest/lowest quarterly returns
"2003 "40.58 during this
time period were:
HIGHESTQ4 '0124.12%
LOWEST Q3 '01-25.25%
LOGO
The year-to-date return as of June 30, 2004 is 3.07%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2003
[Download Table]
PAST 1
YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT*
MIDCAP GROWTH ACCOUNT
40.58 0.60 N/A -0.08
Russell Midcap Growth
Index................. 42.72 2.01 9.41
Morningstar Mid-Cap
Growth Category....... 36.09 2.61 8.38
* The Account's SEC effective date was May 1, 1998.
FEES AND EXPENSES AS A % OF AVERAGE DAILY NET ASSETS BASED ON THE ACCOUNT'S
LATEST FISCAL YEAR
(These fees and expenses do not include the effect of any sales charge, separate
account expenses or other contract level expenses which may be applied at the
variable life insurance or variable annuity product level. If such charges or
-
fees were included, overall expenses would be higher and would lower the
Account's performance.)
ACCOUNT OPERATING EXPENSES
[Download Table]
Management Fees................. 0.90
Other Expenses.................. 0.04
----
TOTAL ACCOUNT OPERATING
EXPENSES 0.94
EXAMPLES
The Examples assume that you invest $10,000 in the Account for the time periods
indicated and then redeem all of your shares at the end of those periods. The
Examples also assume that your investment has a 5% return each year and that
the Account's operating expenses remain the same. If separate account expenses
and contract level expenses were included, expenses would be higher. Although
your actual costs may be higher or lower, based on these assumptions your cost
would be:
[Enlarge/Download Table]
NUMBER OF YEARS YOU OWN YOUR SHARES
-----------------------------------------------------------------------------------------
1 3 5 10
MIDCAP GROWTH ACCOUNT $96 $300 $520 $1,155
MIDCAP VALUE ACCOUNT
The Account seeks long-term growth of capital by investing primarily in equity
securities of companies with value
characteristics and market capitalizations in the $1 billion to $10 billion
range.
MAIN STRATEGIES
The Account invests primarily in common stocks of medium capitalization
companies. Under normal market conditions, the Account invests at least 80% of
its assets in common stocks of companies with a medium market capitalization
(those with market capitalizations similar to companies in the Russell Midcap
Value Index (as of June 30, 2004, this range was between approximately $529
million and $13.68 billion)) at the time of purchase. Market capitalization is
defined as total current market value of a company's outstanding common stock.
Companies may range from the well-established and well known to the new and
unseasoned. The Account may invest up to 10% of its assets in securities of
foreign companies.
The stocks are selected using a value oriented investment approach by Neuberger
Berman, the Sub-Advisor. Neuberger Berman identifies value stocks in several
ways. Factors it considers in identifying value stocks may include:
.. strong fundamentals, such as a company's financial, operational and
competitive positions;
.. consistent cash flow; and
.. a sound earnings record through all phases of the market cycle.
Neuberger Berman may also look for other characteristics in a company, such as a
strong position relative to competitors, a high level of stock ownership among
management, and a recent sharp decline in stock price that appears to be the
result of a short-term market overreaction to negative news. Neuberger Berman
believes that, over time, securities that are undervalued are more likely to
appreciate in price and are subject to less risk of price decline than
securities whose market prices have already reached their perceived economic
value.
The Account may purchase securities issued as part of, or a short period after,
companies' initial public offerings and may at times dispose of those shares
shortly after their acquisition.
This approach also involves selling portfolio securities when Neuberger Berman
believes they have reached their potential, when the securities fail to perform
as expected or when other opportunities appear more attractive.
MAIN RISKS
As with any security, the securities in which the Account invests have
associated risks. These include risks of:
STOCK MARKET VOLATILITY . The net asset value of the Account's shares is
effected by changes in the value of the securities it owns. The prices of equity
securities held by the Account may decline in response to certain events
including those directly involving issuers of these securities, adverse
conditions affecting the general economy, or overall market declines. In the
short term, stock prices can fluctuate dramatically in response to these
factors. As with
all mutual funds, as the values of the Account's assets rise or fall, the
Account's share price changes. If you sell your
shares when their value is less than the price you paid, you will lose money.
SMALL AND MEDIUM CAPITALIZATIONS . Companies with small capitalizations are
often companies with a limited operation history. Such companies may have been
created in response to cultural, economic, regulatory or technological
developments. Such developments can have significant impact or negative effect
on smaller capitalization companies securities which may be more volatile in
price than larger company securities, especially over the short-term.
VALUE STOCKS . The Account's potential investment in value stocks carries the
risk that the market will not recognize a security's intrinsic value for a long
time or that a stock judged to be undervalued may actually be appropriately
priced.
FOREIGN INVESTING . Foreign markets and currencies may not perform as well as
U.S. markets. Political and economic uncertainty in foreign countries, as well
as less public information about foreign investments may negatively impact the
Account's portfolio. Dividends and other income payable on foreign securities
may be subject to foreign taxes. Some investments may be made in currencies
other than the U.S. dollar that will fluctuate in value as a result of changes
in
the currency exchange rate. Emerging market countries and companies doing
business in emerging market countries may not have the same rage of
opportunities as more developed countries companies in more developed countries.
INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in
IPOs exposes it to the additional risks associated with companies that have
little operating history as public companies, as well as to the risks inherent
in those sectors of the market where these new issuers operate. The market for
IPO issuers has been volatile and share prices of certain newly-public companies
have fluctuated in significant amounts over short periods of time. In addition,
the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at
times dispose of those shares shortly after their acquisition.
INVESTOR PROFILE
The Account may be an appropriate investment for investors seeking long-term
growth and willing to accept short-term fluctuations in the value of
investments.
The Account's past performance is not necessarily an indication of how the
Account will perform in the future. The bar chart and tables provide some
indication of the risks of investing in the Account by showing changes in
performance from year to year and showing how the Account's average annual
returns compare with those of a broad measure of market performance. Annual
operating expenses do not include any separate account expenses, cost of
insurance or other contract level expenses. Total returns would be lower if such
expenses were included.
YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
[Download Table]
"2000"31.03
"2001"-2.58
"2002"-9.96
The Account's highest/lowest quarterly returns
"2003"36.49 during this
time period were:
HIGHEST Q4 '99 23.54%
LOWEST Q3 '02 -14.54%
LOGO
The year-to-date return as of June 30, 2004 is 7.96%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2003
[Download Table]
PAST 1
YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT*
MIDCAP VALUE ACCOUNT .
36.49 N/A N/A 12.46
Russell Midcap Value
Index................. 38.06 8.73 13.04
Morningstar Mid-Cap
Value Category........ 34.38 9.11 11.67
* The Account's SEC effective date was May 3, 1999.
FEES AND EXPENSES AS A % OF AVERAGE DAILY NET ASSETS BASED ON THE ACCOUNT'S
LATEST FISCAL YEAR
(These fees and expenses do not include the effect of any sales charge, separate
account expenses or other contract level expenses which may be applied at the
variable life insurance or variable annuity product level. If such charges or
-
fees were included, overall expenses would be higher and would lower the
Account's performance.)
ACCOUNT OPERATING EXPENSES
[Download Table]
Management Fees................. 1.05
Other Expenses.................. 0.03
----
TOTAL ACCOUNT OPERATING
EXPENSES 1.08
EXAMPLES
The Examples assume that you invest $10,000 in the Account for the time periods
indicated and then redeem all of your shares at the end of those periods. The
Examples also assume that your investment has a 5% return each year and that
the Account's operating expenses remain the same. If separate account expenses
and contract level expenses were included, expenses would be higher. Although
your actual costs may be higher or lower, based on these assumptions your cost
would be:
[Enlarge/Download Table]
NUMBER OF YEARS YOU OWN YOUR SHARES
----------------------------------------------------------------------------------------
1 3 5 10
MIDCAP VALUE ACCOUNT $110 $343 $595 $1,317
MONEY MARKET ACCOUNT
The Account has an investment objective of as high a level of current income
available from investments in short-term
securities as is consistent with preservation of principal and maintenance of
liquidity.
MAIN STRATEGIES
The Account invests its assets in a portfolio of high quality, short-term money
market instruments. The investments are U.S. dollar denominated securities which
the Manager believes present minimal credit risks. At the time the Account
purchases each security, it is an "eligible security" as defined in the
regulations issued under the Investment Company Act of 1940, as amended.
The Account maintains a dollar weighted average portfolio maturity of 90 days or
less. It intends to hold its investments until maturity. However, the Account
may sell a security before it matures:
.. to take advantage of market variations;
.. to generate cash to cover sales of Account shares by its shareholders; or
.. upon revised credit opinions of the security's issuer.
The sale of a security by the Account before maturity may not be in the best
interest of the Account. The sale of portfolio securities is usually a taxable
event. The Account does have an ability to borrow money to cover the sale of
Account shares.
It is the policy of the Account to be as fully invested as possible to maximize
current income. Securities in which the Account invests include:
.. securities issued or guaranteed by the U.S. government, including treasury
bills, notes and bonds;
.. securities issued or guaranteed by agencies or instrumentalities of the U.S.
government. These are backed either by the full faith and credit of the U.S.
government or by the credit of the particular agency or instrumentality;
.. bank obligations including:
. certificates of deposit which generally are negotiable certificates against
funds deposited in a commercial bank; or
. bankers acceptances which are time drafts drawn on a commercial bank,
usually in connection with international commercial transactions.
.. commercial paper which is short-term promissory notes issued by U.S. or
foreign corporations primarily to finance short-term credit needs;
.. corporate debt consisting of notes, bonds or debentures which at the time of
purchase by the Account has 397 days or less remaining to maturity;
.. repurchase agreements under which securities are purchased with an agreement
by the seller to repurchase the security at the same price plus interest at a
specified rate. Generally these have a short maturity (less than a week) but
may also have a longer maturity; and
.. taxable municipal obligations which are short-term obligations issued or
guaranteed by state and municipal issuers which generate taxable income.
Among the certificates of deposit typically held by the Account are Eurodollar
and Yankee obligations which are issued in U.S. dollars by foreign banks and
foreign branches of U.S. banks. Before the Manager selects a Eurodollar or
Yankee obligation, however, the foreign issuer undergoes the same credit-quality
analysis and tests of financial strength as an issuer of domestic securities.
MAIN RISKS
As with all mutual funds, the value of the Account's assets may rise or fall.
Although the Account seeks to preserve the value of an investment at $1.00 per
share, it is possible to lose money by investing in the Account. An investment
in the Account is not insured or guaranteed by the Federal Deposit Insurance
Corporation or any other government agency.
As with any security, the securities in which the Account invests have
associated risks. These include risks of:
CREDIT RISK . Credit risk pertains to the issuer's ability to make scheduled
principal or interest payments. This may reduce the Account's stream of income
and decrease the Account's yield.
INTEREST RATE RISK . The value of the Account's shares is directly impacted by
trends in interest rates. If interest rates rise, the value of debt securities
generally will fall.
REPURCHASE AGREEMENTS . The Account may invest in repurchase agreements with
commercial banks, brokers and dealers considered by the Manager to be
creditworthly. Default or insolvency of the other party is a potential risk to
the Account.
U.S. GOVERNMENT SPONSORED SECURITIES . The Account may invest in securities
issued by government-sponsored enterprises. Although the issuing agency,
instrumentality or corporation maybe chartered or sponsored by the United States
government, their securities are neither issued nor guaranteed by the United
States Treasury.
EURODOLLAR AND YANKEE OBLIGATIONS . Eurodollar and Yankee obligations have risks
similar to U.S. money market instruments, such as income risk and credit risk.
Other risks of Eurodollar and Yankee obligations include the possibilities that:
a foreign government will not let U.S. dollar-denominated assets leave the
country; the banks that issue Eurodollar obligations may not be subject to the
same regulations as U.S. banks; and adverse political or economic developments
will affect investments in a foreign country.
INVESTOR PROFILE
The Account may be an appropriate investment for investors seeking monthly
dividends without incurring much principal risk.
The Account's past performance is not necessarily an indication of how the
Account will perform in the future. The bar chart and tables provide some
indication of the risks of investing in the Account by showing changes in
performance from year to year and showing how the Account's average annual
returns compare with those of a broad measure of market performance. Annual
operating expenses do not include any separate account expenses, cost of
insurance or other contract level expenses. Total returns would be lower if such
expenses were included.
YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
[Download Table]
"1994"3.76
"1995"5.59
"1996"5.07
"1997"5.04
"1998"5.2
"1999"4.84
"2000"6.07
"2001"3.92
"2002"1.42
"2003"0.74
TO OBTAIN THE ACCOUNT'S CURRENT YIELD INFORMATION,
PLEASE CALL 1-800-247-4123
LOGO
The year-to-date return as of June 30, 2004 is 0.30%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2003
[Download Table]
PAST 1
YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT*
MONEY MARKET ACCOUNT .
0.74 3.38 4.17 3.28
* The Account's SEC effective date was March 18, 1983.
FEES AND EXPENSES AS A % OF AVERAGE DAILY NET ASSETS BASED ON THE ACCOUNT'S
LATEST FISCAL YEAR
(These fees and expenses do not include the effect of any sales charge, separate
account expenses or other contract level expenses which may be applied at the
variable life insurance or variable annuity product level. If such charges or
-
fees were included, overall expenses would be higher and would lower the
Account's performance.)
ACCOUNT OPERATING EXPENSES
[Download Table]
Management Fees................. 0.48
Other Expenses.................. 0.01
----
TOTAL ACCOUNT OPERATING
EXPENSES 0.49
EXAMPLES
The Examples assume that you invest $10,000 in the Account for the time periods
indicated and then redeem all of your shares at the end of those periods. The
Examples also assume that your investment has a 5% return each year and that
the Account's operating expenses remain the same. If separate account expenses
and contract level expenses were included, expenses would be higher. Although
your actual costs may be higher or lower, based on these assumptions your cost
would be:
[Enlarge/Download Table]
NUMBER OF YEARS YOU OWN YOUR SHARES
--------------------------------------------------------------------------------------
1 3 5 10
MONEY MARKET ACCOUNT $50 $157 $274 $616
PRINCIPAL LIFETIME 2010 ACCOUNT
The Account seeks a total return consisting of long-term growth of capital and
current income.
MAIN STRATEGIES
To pursue its goal, the Account invests in shares of other Principal Variable
Contracts Fund Accounts (the "underlying funds"). The underlying funds are
intended to give the Account broad exposure to the domestic and foreign equity
and fixed-income markets.
Over time, shifts in the allocations to the underlying funds will be designed to
accommodate investors progressing from asset accumulation years to
income-generation years; shifts in the underlying fund allocations may also
occur when market forces change allocations in ways the Sub-Advisor, Principal,
considers likely to help the Account achieve its investment objective.
In deciding how to allocation the Account's assets among the underlying funds at
any time, Principal considers long-term asset class returns, volatility
assumptions and the Account's target time horizon. There are no minimum or
maximum percentages in which the Account must invest in any underlying fund. As
the Account is weighted toward underlying funds that invest in fixed-income
securities (see table below), the Account is more subject to the risk of
interest rate changes and credit risk than to the risks associated with a stock
funds. At any time, Principal may add or substitute underlying funds in which
the Account invests.
Principal intends to gradually shift the Account's allocation among the
underlying funds so that within five to ten years after the year 2010, the
Account's underlying fund allocation matches the underlying fund allocation of
the Principal LifeTime Strategic Income Account, an Account that invests
primarily in fixed-income securities. At that time, the Account may be combined
with the Principal LifeTime Strategic Income Account. The Board of Directors
would need to determine at the time of the proposed combination that the
combining of the Accounts is in the best interests of the Accounts'
shareholders. If the Board determines that the proposed combination is
appropriate, it will seek: 1) an order of substitution from the Securities and
Exchange Commission; 2) submit the issue to a vote of the shareholders; 3) or a
combination of both 1 and 2.
MAIN RISKS
The Account's investments are concentrated in the underlying funds and, as a
result, the Account's performance is directly related to their performance. The
Account's ability to meet its investment objective depends on the ability of the
underlying funds to achieve their investment objectives. Consequently, the
Account is subject to the particular risks of the underlying funds in the
proportions in which the Account invests in them.
As with any security, the securities in which the underlying funds invest have
associated risks. These include risks of:
INTEREST RATE CHANGES . The value of fixed-income securities held by the Account
may be affected by factors such as changing interest rates, credit rating, and
effective maturities. When interest rates fall, the price of a bond rises and
when interest rates rise, the price declines.
CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater
credit risk and price fluctuations than higher quality and shorter maturity
bonds. Bonds held by the Account may be affected by unfavorable political,
economic, or governmental developments that could affect the repayment of
principal or the payment of interest.
HIGH YIELD SECURITIES . Fixed-income securities that are not investment grade
are commonly referred to as junk bonds or high yield securities. These
securities offer a higher yield than other, higher rated securities, but they
carry a greater degree of risk and are considered speculative by the major
credit rating agencies. (please see High Yield Securities in the section of the
Prospectus entitled CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS).
U.S. GOVERNMENT SPONSORED SECURITIES . The Account may invest in debt and
mortgage-backed securities issued by government-sponsored enterprises such as
the Federal Home Loan Mortgage Corporation, the Federal National Mortgage
Association and the Federal Home Loan Banks. Although the issuing agency,
instrumentality or corporation
maybe chartered or sponsored by the United States government, their securities
are neither issued nor guaranteed by the United States Treasury.
STOCK MARKET VOLATILITY . The net asset value of the Account's shares is
effected by changes in the value of the securities it owns. The prices of equity
securities held by the Account may decline in response to certain events
including those directly involving issuers of these securities, adverse
conditions affecting the general economy, or overall market declines. In the
short term, stock prices can fluctuate dramatically in response to these
factors.
FOREIGN INVESTING . Foreign markets and currencies may not perform as well as
U.S. markets. Political and economic uncertainty in foreign countries, as well
as less public information about foreign investments may negatively impact the
Account's portfolio. Dividends and other income payable on foreign securities
may be subject to foreign taxes. Some investments may be made in currencies
other than the U.S. dollar that will fluctuate in value as a result of changes
in the currency exchange rate.
SMALL AND MEDIUM CAPITALIZATIONS . Companies with small capitalizations are
often companies with a limited operation history. Such companies may have been
created in response to cultural, economic, regulatory or technological
developments. Such developments can have significant impact or negative effect
on smaller capitalization companies securities which may be more volatile in
price than larger company securities, especially over the short-term.
HEDGING STRATEGIES . Use of forward foreign currency exchange contracts,
currency or index futures or other derivatives involves risks. The contracts may
increase the Account's volatility and, thus, could involve a significant risk.
If the Sub-Advisor's predictions are inaccurate, the averse consequences to the
Account(e.g., a reduction in the Account's net asset value) may leave the
Account in a worse position than if these strategies were not used.
INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in
IPOs exposes it to the additional risks associated with companies that have
little operating history as public companies, as well as to the risks inherent
in those sectors of the market where these new issuers operate. The market for
IPO issuers has been volatile and share prices of certain newly-public companies
have fluctuated in significant amounts over short periods of time. In addition,
the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at
times dispose of those shares shortly after their acquisition.
The Account's broad diversification is designed to cushion severe losses in any
one investment sector and moderate the Account's overall price swings. However,
the Account's share prices will fluctuate as the prices of the underlying funds
rise or fall with changing market conditions. As with all mutual funds, as the
values of the Account's assets rise or
fall, the Account's share price changes. If you sell your shares when their
value is less than the price you paid, you will lose money.
INVESTOR PROFILE
The Account may be an appropriate investment for investors expecting to retire
around the year 2010 or fund a cashflow need in the year 2010.
UNDERLYING FUND ALLOCATION
Principal anticipates initially allocating Account assets among the underlying
funds as follows:
[Download Table]
Bond 30.2% LargeCap Value 7.9%
Capital Value 4.3 LargeCap Stock Index 12.7
Equity Growth 4.4 Money Market 9.4
Equity Income 7.0 Real Estate Securities 9.4
Growth 4.4 SmallCap 3.7
International 6.6
Based on this allocation, the weighted average of the total account operating
expenses of the underlying funds is 0.61%. The combined total expenses for the
Account may be higher or lower depending on the allocation of its assets among
the underlying funds.
As the inception date of the Account is August 30, 2004, historical performance
data is not available.
FEES AND EXPENSES (ESTIMATED) AS A % OF AVERAGE DAILY NET ASSETS
(These fees and expenses do not include the effect of any sales charge, separate
account expenses or other contract level expenses which may be applied at the
variable life insurance or variable annuity product level. If such charges or
-
fees were included, overall expenses would be higher and would lower the
Account's performance.)
ACCOUNT OPERATING EXPENSES
[Download Table]
Management Fees.................. 0.12
Other Expenses................... 0.10
----
TOTAL ACCOUNT OPERATING EXPENSES 0.22
The Manager has voluntarily agreed to reimburse operating expenses so that
the total Account operating expenses will not be greater than 0.16% through
April 30, 2005. The Manager may not continue this arrangement after May 1,
2005. The Account as a shareholder in the underlying funds, indirectly
bears its pro rata share of the operating expenses incurred by each
underlying fund. As of December 31, 2003, the operating expenses of the
underlying funds ranged from 0.39% to 1.84%. The Account's investment
return is net of the underlying funds' operating expenses.
EXAMPLES
The Examples assume that you invest $10,000 in the Account for the time periods
indicated and then redeem all of your shares at the end of those periods. The
Examples also assume that your investment has a 5% return each year and that
the Account's operating expenses remain the same. If the operating expenses of
the underlying funds, separate account expenses and contract level expenses
were included, expenses would be higher. Although your actual costs may be
higher or lower, based on these assumptions your cost would be:
[Enlarge/Download Table]
NUMBER OF YEARS YOU OWN YOUR SHARES
---------------------------------------------------------------------------------------------------------------------------
1 3 5 10
PRINCIPAL LIFETIME 2010 ACCOUNT $23 $72 $125 $284
PRINCIPAL LIFETIME 2020 ACCOUNT
The Account seeks a total return consisting of long-term growth of capital and
current income.
MAIN STRATEGIES
To pursue its goal, the Account invests in shares of other Principal Variable
Contracts Fund Accounts (the "underlying funds"). The underlying funds are
intended to give the Account broad exposure to the domestic and foreign equity
and fixed-income markets.
Over time, shifts in the allocations to the underlying funds will be designed to
accommodate investors progressing from asset accumulation years to
income-generation years; shifts in the underlying fund allocations may also
occur when market forces change allocations in ways the Sub-Advisor, Principal,
considers likely to help the Account achieve its investment objective.
In deciding how to allocation the Account's assets among the underlying funds at
any time, Principal considers long-term asset class returns, volatility
assumptions and the Account's target time horizon. There are no minimum or
maximum percentages in which the Account must invest in any underlying fund. As
the Account is weighted toward underlying funds that invest in equity securities
(see table below), the Account is more subject to the risks associated with
stock funds than to the risk of interest rate changes and credit risk. At any
time, Principal may add or substitute underlying funds in which the Account
invests.
Principal intends to gradually shift the Account's allocation among the
underlying funds so that within five to ten years after the year 2020, the
Account's underlying fund allocation matches the underlying fund allocation of
the Principal LifeTime Strategic Income Account, an Account that invests
primarily in fixed-income securities. At that time, the Account may be combined
with the Principal LifeTime Strategic Income Account. The Board of Directors
would need to determine at the time of the proposed combination that the
combining of the Accounts is in the best interests of the Accounts'
shareholders. If the Board determines that the proposed combination is
appropriate, it will seek: 1) an order of substitution from the Securities and
Exchange Commission; 2) submit the issue to a vote of the shareholders; 3) or a
combination of both 1 and 2.
MAIN RISKS
The Account's investments are concentrated in the underlying funds and, as a
result, the Account's performance is directly related to their performance. The
Account's ability to meet its investment objective depends on the ability of the
underlying funds to achieve their investment objectives. Consequently, the
Account is subject to the particular risks of the underlying funds in the
proportions in which the Account invests in them. As with all mutual funds, as
the values of
the Account's assets rise or fall, the Account's share price changes. If you
sell your shares when their value is less than
the price you paid, you will lose money.
As with any security, the securities in which the underlying funds invest have
associated risks. These include risks of:
STOCK MARKET VOLATILITY . The net asset value of the Account's shares is
effected by changes in the value of the securities it owns. The prices of equity
securities held by the Account may decline in response to certain events
including those directly involving issuers of these securities, adverse
conditions affecting the general economy, or overall market declines. In the
short term, stock prices can fluctuate dramatically in response to these
factors.
SMALL AND MEDIUM CAPITALIZATIONS . Companies with small capitalizations are
often companies with a limited operation history. Such companies may have been
created in response to cultural, economic, regulatory or technological
developments. Such developments can have significant impact or negative effect
on smaller capitalization companies securities which may be more volatile in
price than larger company securities, especially over the short-term.
FOREIGN INVESTING . Foreign markets and currencies may not perform as well as
U.S. markets. Political and economic uncertainty in foreign countries, as well
as less public information about foreign investments may negatively impact the
Account's portfolio. Dividends and other income payable on foreign securities
may be subject to foreign taxes. Some
investments may be made in currencies other than the U.S. dollar that will
fluctuate in value as a result of changes in the currency exchange rate.
HEDGING STRATEGIES . Use of forward foreign currency exchange contracts,
currency or index futures or other derivatives involves risks. The contracts may
increase the Account's volatility and, thus, could involve a significant risk.
If the Sub-Advisor's predictions are inaccurate, the averse consequences to the
Account(e.g., a reduction in the Account's net asset value) may leave the
Account in a worse position than if these strategies were not used.
INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in
IPOs exposes it to the additional risks associated with companies that have
little operating history as public companies, as well as to the risks inherent
in those sectors of the market where these new issuers operate. The market for
IPO issuers has been volatile and share prices of certain newly-public companies
have fluctuated in significant amounts over short periods of time. In addition,
the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at
times dispose of those shares shortly after their acquisition.
INTEREST RATE CHANGES . The value of fixed-income securities held by the Account
may be affected by factors such as changing interest rates, credit rating, and
effective maturities. When interest rates fall, the price of a bond rises and
when interest rates rise, the price declines.
CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater
credit risk and price fluctuations than higher quality and shorter maturity
bonds. Bonds held by the Account may be affected by unfavorable political,
economic, or governmental developments that could affect the repayment of
principal or the payment of interest.
HIGH YIELD SECURITIES . Fixed-income securities that are not investment grade
are commonly referred to as junk bonds or high yield securities. These
securities offer a higher yield than other, higher rated securities, but they
carry a greater degree of risk and are considered speculative by the major
credit rating agencies. (please see High Yield Securities in the section of the
Prospectus entitled CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS)
U.S. GOVERNMENT SPONSORED SECURITIES . The Account may invest in debt and
mortgage-backed securities issued by government-sponsored enterprises such as
the Federal Home Loan Mortgage Corporation, the Federal National Mortgage
Association and the Federal Home Loan Banks. Although the issuing agency,
instrumentality or corporation maybe chartered or sponsored by the United States
government, their securities are neither issued nor guaranteed by the United
States Treasury.
INVESTOR PROFILE
The Fund may be an appropriate investment for investors expecting to retire
around the year 2020 or fund a cashflow need in the year 2020.
UNDERLYING FUND ALLOCATION
Principal anticipates initially allocating Account assets among the underlying
funds as follows:
[Download Table]
Bond 29.3% LargeCap Value 10.2%
Capital Value 5.5 LargeCap Stock Index 14.9
Equity Growth 5.7 Real Estate Securities 9.0
Equity Income 6.7 SmallCap 1.7
Growth 5.7 SmallCap Growth 1.5
International 8.3 SmallCap Value 1.5
Based on this allocation, the weighted average of the total account operating
expenses of the underlying funds is 0.64%. The combined total expenses for the
Account may be higher or lower depending on the allocation of its assets among
the underlying funds.
As the inception date of the Account is August 30, 2004, historical performance
data is not available.
FEES AND EXPENSES (ESTIMATED) AS A % OF AVERAGE DAILY NET ASSETS
(These fees and expenses do not include the effect of any sales charge, separate
account expenses or other contract level expenses which may be applied at the
variable life insurance or variable annuity product level. If such charges or
-
fees were included, overall expenses would be higher and would lower the
Account's performance.)
ACCOUNT OPERATING EXPENSES
[Download Table]
Management Fees.................. 0.12
Other Expenses................... 0.07
----
TOTAL ACCOUNT OPERATING EXPENSES 0.19
The Manager has voluntarily agreed to reimburse operating expenses so that
the total Account operating expenses will not be greater than 0.13% through
April 30, 2005. The Manager may not continue this arrangement after May 1,
2005. The Account as a shareholder in the underlying funds, indirectly
bears its pro rata share of the operating expenses incurred by each
underlying fund. As of December 31, 2003, the operating expenses of the
underlying funds ranged from 0.39% to 1.84%. The Account's investment
return is net of the underlying funds' operating expenses.
EXAMPLES
The Examples assume that you invest $10,000 in the Account for the time periods
indicated and then redeem all of your shares at the end of those periods. The
Examples also assume that your investment has a 5% return each year and that
the Account's operating expenses remain the same. If the operating expenses of
the underlying funds, separate account expenses and contract level expenses
were included, expenses would be higher. Although your actual costs may be
higher or lower, based on these assumptions your cost would be:
[Enlarge/Download Table]
NUMBER OF YEARS YOU OWN YOUR SHARES
---------------------------------------------------------------------------------------------------------------------------
1 3 5 10
PRINCIPAL LIFETIME 2020 ACCOUNT $20 $62 $109 $246
PRINCIPAL LIFETIME 2030 ACCOUNT
The Account seeks a total return consisting of long-term growth of capital and
current income.
MAIN STRATEGIES
To pursue its goal, the Account invests in shares of other Principal Variable
Contracts Fund Accounts (the "underlying funds"). The underlying funds are
intended to give the Account broad exposure to the domestic and foreign equity
and fixed-income markets.
Over time, shifts in the allocations to the underlying funds will be designed to
accommodate investors progressing from asset accumulation years to
income-generation years; shifts in the underlying fund allocations may also
occur when market forces change allocations in ways the Sub-Advisor, Principal,
considers likely to help the Account achieve its investment objective.
In deciding how to allocation the Account's assets among the underlying funds at
any time, Principal considers long-term asset class returns, volatility
assumptions and the Account's target time horizon. There are no minimum or
maximum percentages in which the Account must invest in any underlying fund. As
the Account is weighted toward underlying funds that invest in equity securities
(see table below), the Account is more subject to the risks associated with
stock funds than to the risk of interest rate changes and credit risk. At any
time, Principal may add or substitute underlying funds in which the Account
invests.
Principal intends to gradually shift the Account's allocation among the
underlying funds so that within five to ten years after the year 2030, the
Account's underlying fund allocation matches the underlying fund allocation of
the Principal LifeTime Strategic Income Account, an Account that invests
primarily in fixed-income securities. At that time, the Account may be combined
with the Principal LifeTime Strategic Income Account. The Board of Directors
would need to determine at the time of the proposed combination that the
combining of the Accounts is in the best interests of the Accounts'
shareholders. If the Board determines that the proposed combination is
appropriate, it will seek: 1) an order of substitution from the Securities and
Exchange Commission; 2) submit the issue to a vote of the shareholders; 3) or a
combination of both 1 and 2.
MAIN RISKS
The Account's investments are concentrated in the underlying funds and, as a
result, the Account's performance is directly related to their performance. The
Account's ability to meet its investment objective depends on the ability of the
underlying funds to achieve their investment objectives. Consequently, the
Account is subject to the particular risks of the underlying funds in the
proportions in which the Account invests in them. As with all mutual funds, as
the values of
the Account's assets rise or fall, the Account's share price changes. If you
sell your shares when their value is less than
the price you paid, you will lose money.
As with any security, the securities in which the underlying funds invest have
associated risks. These include risks of:
STOCK MARKET VOLATILITY . The net asset value of the Account's shares is
effected by changes in the value of the securities it owns. The prices of equity
securities held by the Account may decline in response to certain events
including those directly involving issuers of these securities, adverse
conditions affecting the general economy, or overall market declines. In the
short term, stock prices can fluctuate dramatically in response to these
factors.
SMALL AND MEDIUM CAPITALIZATIONS . Companies with small capitalizations are
often companies with a limited operation history. Such companies may have been
created in response to cultural, economic, regulatory or technological
developments. Such developments can have significant impact or negative effect
on smaller capitalization companies securities which may be more volatile in
price than larger company securities, especially over the short-term.
FOREIGN INVESTING . Foreign markets and currencies may not perform as well as
U.S. markets. Political and economic uncertainty in foreign countries, as well
as less public information about foreign investments may negatively impact the
Account's portfolio. Dividends and other income payable on foreign securities
may be subject to foreign taxes. Some
investments may be made in currencies other than the U.S. dollar that will
fluctuate in value as a result of changes in the currency exchange rate.
HEDGING STRATEGIES . Use of forward foreign currency exchange contracts,
currency or index futures or other derivatives involves risks. The contracts may
increase the Account's volatility and, thus, could involve a significant risk.
If the Sub-Advisor's predictions are inaccurate, the averse consequences to the
Account(e.g., a reduction in the Account's net asset value) may leave the
Account in a worse position than if these strategies were not used.
INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in
IPOs exposes it to the additional risks associated with companies that have
little operating history as public companies, as well as to the risks inherent
in those sectors of the market where these new issuers operate. The market for
IPO issuers has been volatile and share prices of certain newly-public companies
have fluctuated in significant amounts over short periods of time. In addition,
the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at
times dispose of those shares shortly after their acquisition.
INTEREST RATE CHANGES . The value of fixed-income securities held by the Account
may be affected by factors such as changing interest rates, credit rating, and
effective maturities. When interest rates fall, the price of a bond rises and
when interest rates rise, the price declines.
CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater
credit risk and price fluctuations than higher quality and shorter maturity
bonds. Bonds held by the Account may be affected by unfavorable political,
economic, or governmental developments that could affect the repayment of
principal or the payment of interest.
HIGH YIELD SECURITIES . Fixed-income securities that are not investment grade
are commonly referred to as junk bonds or high yield securities. These
securities offer a higher yield than other, higher rated securities, but they
carry a greater degree of risk and are considered speculative by the major
credit rating agencies. (please see High Yield Securities in the section of the
Prospectus entitled CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS)
U.S. GOVERNMENT SPONSORED SECURITIES . The Account may invest in debt and
mortgage-backed securities issued by government-sponsored enterprises such as
the Federal Home Loan Mortgage Corporation, the Federal National Mortgage
Association and the Federal Home Loan Banks. Although the issuing agency,
instrumentality or corporation maybe chartered or sponsored by the United States
government, their securities are neither issued nor guaranteed by the United
States Treasury.
INVESTOR PROFILE
The Fund may be an appropriate investment for investors expecting to retire
around the year 2030 or fund a cashflow need in the year 2030.
UNDERLYING FUND ALLOCATION
Principal anticipates initially allocating Account assets among the underlying
funds as follows:
[Download Table]
Bond 22.1% LargeCap Value 12.4%
Capital Value 6.7 LargeCap Stock Index 17.6
Equity Growth 6.9 Real Estate Securities 6.8
Equity Income 5.1 SmallCap 1.8
Growth 6.9 SmallCap Growth 1.9
International 9.9 SmallCap Value 1.9
Based on this allocation, the weighted average of the total account operating
expenses of the underlying funds is 0.65%. The combined total expenses for the
Account may be higher or lower depending on the allocation of its assets among
the underlying funds.
As the inception date of the Account is August 30, 2004, historical performance
data is not available.
FEES AND EXPENSES (ESTIMATED) AS A % OF AVERAGE DAILY NET ASSETS
(These fees and expenses do not include the effect of any sales charge, separate
account expenses or other contract level expenses which may be applied at the
variable life insurance or variable annuity product level. If such charges or
-
fees were included, overall expenses would be higher and would lower the
Account's performance.)
ACCOUNT OPERATING EXPENSES
[Download Table]
Management Fees.................. 0.12
Other Expenses................... 0.07
----
TOTAL ACCOUNT OPERATING EXPENSES 0.19
The Manager has voluntarily agreed to reimburse operating expenses so that
the total Account operating expenses will not be greater than 0.16% through
April 30, 2005. The Manager may not continue this arrangement after May 1,
2005. The Account as a shareholder in the underlying funds, indirectly
bears its pro rata share of the operating expenses incurred by each
underlying fund. As of December 31, 2003, the operating expenses of the
underlying funds ranged from 0.39% to 1.84%. The Account's investment
return is net of the underlying funds' operating expenses.
EXAMPLES
The Examples assume that you invest $10,000 in the Account for the time periods
indicated and then redeem all of your shares at the end of those periods. The
Examples also assume that your investment has a 5% return each year and that
the Account's operating expenses remain the same. If the operating expenses of
the underlying funds, separate account expenses and contract level expenses
were included, expenses would be higher. Although your actual costs may be
higher or lower, based on these assumptions your cost would be:
[Enlarge/Download Table]
NUMBER OF YEARS YOU OWN YOUR SHARES
---------------------------------------------------------------------------------------------------------------------------
1 3 5 10
PRINCIPAL LIFETIME 2030 ACCOUNT $20 $62 $109 $246
PRINCIPAL LIFETIME 2040 ACCOUNT
The Account seeks a total return consisting of long-term growth of capital and
current income.
MAIN STRATEGIES
To pursue its goal, the Account invests in shares of other Principal Variable
Contracts Fund Accounts (the "underlying funds"). The underlying funds are
intended to give the Account broad exposure to the domestic and foreign equity
and fixed-income markets.
Over time, shifts in the allocations to the underlying funds will be designed to
accommodate investors progressing from asset accumulation years to
income-generation years; shifts in the underlying fund allocations may also
occur when market forces change allocations in ways the Sub-Advisor, Principal,
considers likely to help the Account achieve its investment objective.
In deciding how to allocation the Account's assets among the underlying funds at
any time, Principal considers long-term asset class returns, volatility
assumptions and the Account's target time horizon. There are no minimum or
maximum percentages in which the Account must invest in any underlying fund. As
the Account is heavily weighted toward underlying funds that invest in equity
securities (see table below), the Account is subject to the risks associated
with stock funds. The Account also invests to a limited degree in underlying
funds that invest in fixed-income securities. At any time, Principal may add or
substitute underlying funds in which the Account invests.
Principal intends to gradually shift the Account's allocation among the
underlying funds so that within five to ten years after the year 2040, the
Account's underlying fund allocation matches the underlying fund allocation of
the Principal LifeTime Strategic Income Account, an Account that invests
primarily in fixed-income securities. At that time, the Account may be combined
with the Principal LifeTime Strategic Income Account. The Board of Directors
would need to determine at the time of the proposed combination that the
combining of the Accounts is in the best interests of the Accounts'
shareholders. If the Board determines that the proposed combination is
appropriate, it will seek: 1) an order of substitution from the Securities and
Exchange Commission; 2) submit the issue to a vote of the shareholders; 3) or a
combination of both 1 and 2.
MAIN RISKS
The Account's investments are concentrated in the underlying funds and, as a
result, the Account's performance is directly related to their performance. The
Account's ability to meet its investment objective depends on the ability of the
underlying funds to achieve their investment objectives. Consequently, the
Account is subject to the particular risks of the underlying funds in the
proportions in which the Account invests in them. As with all mutual funds, as
the values of
the Account's assets rise or fall, the Account's share price changes. If you
sell your shares when their value is less than
the price you paid, you will lose money.
As with any security, the securities in which the underlying funds invest have
associated risks. These include risks of:
STOCK MARKET VOLATILITY . The net asset value of the Account's shares is
effected by changes in the value of the securities it owns. The prices of equity
securities held by the Account may decline in response to certain events
including those directly involving issuers of these securities, adverse
conditions affecting the general economy, or overall market declines. In the
short term, stock prices can fluctuate dramatically in response to these
factors.
SMALL AND MEDIUM CAPITALIZATIONS . Companies with small capitalizations are
often companies with a limited operation history. Such companies may have been
created in response to cultural, economic, regulatory or technological
developments. Such developments can have significant impact or negative effect
on smaller capitalization companies securities which may be more volatile in
price than larger company securities, especially over the short-term.
FOREIGN INVESTING . Foreign markets and currencies may not perform as well as
U.S. markets. Political and economic uncertainty in foreign countries, as well
as less public information about foreign investments may negatively impact the
Account's portfolio. Dividends and other income payable on foreign securities
may be subject to foreign taxes. Some
investments may be made in currencies other than the U.S. dollar that will
fluctuate in value as a result of changes in the currency exchange rate.
HEDGING STRATEGIES . Use of forward foreign currency exchange contracts,
currency or index futures or other derivatives involves risks. The contracts may
increase the Account's volatility and, thus, could involve a significant risk.
If the Sub-Advisor's predictions are inaccurate, the averse consequences to the
Account(e.g., a reduction in the Account's net asset value) may leave the
Account in a worse position than if these strategies were not used.
INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in
IPOs exposes it to the additional risks associated with companies that have
little operating history as public companies, as well as to the risks inherent
in those sectors of the market where these new issuers operate. The market for
IPO issuers has been volatile and share prices of certain newly-public companies
have fluctuated in significant amounts over short periods of time. In addition,
the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at
times dispose of those shares shortly after their acquisition.
FIXED-INCOME RISKS
.. Interest rate changes. The value of fixed-income securities held by the
Account may be affected by factors such as changing interest rates, credit
rating, and effective maturities. When interest rates fall, the price of a
bond rises and when interest rates rise, the price declines.
.. Credit risk. Lower quality and longer maturity bonds will be subject to
greater credit risk and price fluctuations than higher quality and shorter
maturity bonds. Bonds held by the Account may be affected by unfavorable
political, economic, or governmental developments that could affect the
repayment of principal or the payment of interest.
.. High yield securities. Fixed-income securities that are not investment grade
are commonly referred to as junk bonds or high yield securities. These
securities offer a higher yield than other, higher rated securities, but they
carry a greater degree of risk and are considered speculative by the major
credit rating agencies. (please see High Yield Securities in the section of
the Prospectus entitled CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS)
.. U.S. Government Sponsored Securities. The Account may invest in debt and
mortgage-backed securities issued by government-sponsored enterprises such as
the Federal Home Loan Mortgage Corporation, the Federal National Mortgage
Association and the Federal Home Loan Banks. Although the issuing agency,
instrumentality or corporation maybe chartered or sponsored by the United
States government, their securities are neither issued nor guaranteed by the
United States Treasury.
INVESTOR PROFILE
The Fund may be an appropriate investment for investors expecting to retire
around the year 2040 or fund a cashflow need in the year 2040.
UNDERLYING FUND ALLOCATION
Principal anticipates initially allocating Account assets among the underlying
funds as follows:
[Download Table]
Bond 16.1% LargeCap Value 14.6%
Capital Value 7.9 LargeCap Stock Index 20.0
Equity Growth 8.2 Real Estate Securities 3.8
Equity Income 3.1 SmallCap 2.2
Growth 8.2 SmallCap Growth 2.2
International 11.5 SmallCap Value 2.2
Based on this allocation, the weighted average of the total account operating
expenses of the underlying funds is 0.66%. The combined total expenses for the
Account may be higher or lower depending on the allocation of its assets among
the underlying funds.
As the inception date of the Account is August 30, 2004, historical performance
data is not available.
FEES AND EXPENSES (ESTIMATED) AS A % OF AVERAGE DAILY NET ASSETS
(These fees and expenses do not include the effect of any sales charge, separate
account expenses or other contract level expenses which may be applied at the
variable life insurance or variable annuity product level. If such charges or
-
fees were included, overall expenses would be higher and would lower the
Account's performance.)
ACCOUNT OPERATING EXPENSES
[Download Table]
Management Fees.................. 0.12
Other Expenses................... 0.23
----
TOTAL ACCOUNT OPERATING EXPENSES 0.35
The Manager has voluntarily agreed to reimburse operating expenses so that
the total Account operating expenses will not be greater than 0.14% through
April 30, 2005. The Manager may not continue this arrangement after May 1,
2005. The Account as a shareholder in the underlying funds, indirectly
bears its pro rata share of the operating expenses incurred by each
underlying fund. As of December 31, 2003, the operating expenses of the
underlying funds ranged from 0.39% to 1.84%. The Account's investment
return is net of the underlying funds' operating expenses.
EXAMPLES
The Examples assume that you invest $10,000 in the Account for the time periods
indicated and then redeem all of your shares at the end of those periods. The
Examples also assume that your investment has a 5% return each year and that
the Account's operating expenses remain the same. If the operating expenses of
the underlying funds, separate account expenses and contract level expenses
were included, expenses would be higher. Although your actual costs may be
higher or lower, based on these assumptions your cost would be:
[Enlarge/Download Table]
NUMBER OF YEARS YOU OWN YOUR SHARES
---------------------------------------------------------------------------------------------------------------------------
1 3 5 10
PRINCIPAL LIFETIME 2040 ACCOUNT $36 $113 $198 $446
PRINCIPAL LIFETIME 2050 ACCOUNT
The Account seeks a total return consisting of long-term growth of capital and
current income.
MAIN STRATEGIES
To pursue its goal, the Account invests in shares of other Principal Variable
Contracts Fund Accounts (the "underlying funds"). The underlying funds are
intended to give the Account broad exposure to the domestic and foreign equity
and fixed-income markets. At any time, the Sub-Advisor, Principal, may add or
substitute underlying funds in which the Account invests.
Over time, shifts in the allocations to the underlying funds will be designed to
accommodate investors progressing from asset accumulation years to
income-generation years; shifts in the underlying fund allocations may also
occur when market forces change allocations in ways the Sub-Advisor, Principal,
considers likely to help the Account achieve its investment objective.
In deciding how to allocation the Account's assets among the underlying funds at
any time, Principal considers long-term asset class returns, volatility
assumptions and the Account's target time horizon. There are no minimum or
maximum percentages in which the Account must invest in any underlying fund. As
the Account primarily invests in underlying funds that invest in equity
securities (see table below), the primarily risks of the Account are those
associated with stock funds. The Account also invests in fixed-income underlying
funds. At any time, Principal may add or substitute underlying funds in which
the Account invests.
Principal intends to gradually shift the Account's allocation among the
underlying funds so that within five to ten years after the year 2050, the
Account's underlying fund allocation matches the underlying fund allocation of
the Principal LifeTime Strategic Income Account, an Account that invests
primarily in fixed-income securities. At that time, the Account may be combined
with the Principal LifeTime Strategic Income Account. The Board of Directors
would need to determine at the time of the proposed combination that the
combining of the Accounts is in the best interests of the Accounts'
shareholders. If the Board determines that the proposed combination is
appropriate, it will seek: 1) an order of substitution from the Securities and
Exchange Commission; 2) submit the issue to a vote of the shareholders; 3) or a
combination of both 1 and 2.
MAIN RISKS
The Account's investments are concentrated in the underlying funds and, as a
result, the Account's performance is directly related to their performance. The
Account's ability to meet its investment objective depends on the ability of the
underlying funds to achieve their investment objectives. Consequently, the
Account is subject to the particular risks of the underlying funds in the
proportions in which the Account invests in them. As with all mutual funds, as
the values of
the Account's assets rise or fall, the Account's share price changes. If you
sell your shares when their value is less than
the price you paid, you will lose money.
As with any security, the securities in which the underlying funds invest have
associated risks. These include risks of:
STOCK MARKET VOLATILITY . The net asset value of the Account's shares is
effected by changes in the value of the securities it owns. The prices of equity
securities held by the Account may decline in response to certain events
including those directly involving issuers of these securities, adverse
conditions affecting the general economy, or overall market declines. In the
short term, stock prices can fluctuate dramatically in response to these
factors.
SMALL AND MEDIUM CAPITALIZATIONS . Companies with small capitalizations are
often companies with a limited operation history. Such companies may have been
created in response to cultural, economic, regulatory or technological
developments. Such developments can have significant impact or negative effect
on smaller capitalization companies securities which may be more volatile in
price than larger company securities, especially over the short-term.
FOREIGN INVESTING . Foreign markets and currencies may not perform as well as
U.S. markets. Political and economic uncertainty in foreign countries, as well
as less public information about foreign investments may negatively impact the
Account's portfolio. Dividends and other income payable on foreign securities
may be subject to foreign taxes. Some
investments may be made in currencies other than the U.S. dollar that will
fluctuate in value as a result of changes in the currency exchange rate.
HEDGING STRATEGIES . Use of forward foreign currency exchange contracts,
currency or index futures or other derivatives involves risks. The contracts may
increase the Account's volatility and, thus, could involve a significant risk.
If the Sub-Advisor's predictions are inaccurate, the averse consequences to the
Account(e.g., a reduction in the Account's net asset value) may leave the
Account in a worse position than if these strategies were not used.
INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in
IPOs exposes it to the additional risks associated with companies that have
little operating history as public companies, as well as to the risks inherent
in those sectors of the market where these new issuers operate. The market for
IPO issuers has been volatile and share prices of certain newly-public companies
have fluctuated in significant amounts over short periods of time. In addition,
the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at
times dispose of those shares shortly after their acquisition.
FIXED-INCOME RISKS
.. Interest rate changes. The value of fixed-income securities held by the
Account may be affected by factors such as changing interest rates, credit
rating, and effective maturities. When interest rates fall, the price of a
bond rises and when interest rates rise, the price declines.
.. Credit risk. Lower quality and longer maturity bonds will be subject to
greater credit risk and price fluctuations than higher quality and shorter
maturity bonds. Bonds held by the Account may be affected by unfavorable
political, economic, or governmental developments that could affect the
repayment of principal or the payment of interest.
.. High yield securities. Fixed-income securities that are not investment grade
are commonly referred to as junk bonds or high yield securities. These
securities offer a higher yield than other, higher rated securities, but they
carry a greater degree of risk and are considered speculative by the major
credit rating agencies. (please see High Yield Securities in the section of
the Prospectus entitled CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS)
.. U.S. Government Sponsored Securities. The Account may invest in debt and
mortgage-backed securities issued by government-sponsored enterprises such as
the Federal Home Loan Mortgage Corporation, the Federal National Mortgage
Association and the Federal Home Loan Banks. Although the issuing agency,
instrumentality or corporation maybe chartered or sponsored by the United
States government, their securities are neither issued nor guaranteed by the
United States Treasury.
INVESTOR PROFILE
The Fund may be an appropriate investment for investors expecting to retire
around the year 2050 or fund a cashflow need in the year 2050.
UNDERLYING FUND ALLOCATION
Principal anticipates initially allocating Account assets among the underlying
funds as follows:
[Download Table]
Bond 7.8% LargeCap Value 16.9%
Capital Value 9.2 LargeCap Stock Index 22.3
Equity Growth 9.5 Real Estate Securities 2.4
Equity Income 1.8 SmallCap 2.4
Growth 9.5 SmallCap Growth 2.5
International 13.2 SmallCap Value 2.5
Based on this allocation, the weighted average of the total account operating
expenses of the underlying funds is 0.68%. The combined total expenses for the
Account may be higher or lower depending on the allocation of its assets among
the underlying funds.
As the inception date of the Account is August 30, 2004, historical performance
data is not available.
FEES AND EXPENSES (ESTIMATED) AS A % OF AVERAGE DAILY NET ASSETS
(These fees and expenses do not include the effect of any sales charge, separate
account expenses or other contract level expenses which may be applied at the
variable life insurance or variable annuity product level. If such charges or
-
fees were included, overall expenses would be higher and would lower the
Account's performance.)
ACCOUNT OPERATING EXPENSES
[Download Table]
Management Fees.................. 0.12
Other Expenses................... 0.42
----
TOTAL ACCOUNT OPERATING EXPENSES 0.54
The Manager has voluntarily agreed to reimburse operating expenses so that
the total Account operating expenses will not be greater than 0.13% through
April 30, 2005. The Manager may not continue this arrangement after May 1,
2005. The Account as a shareholder in the underlying funds, indirectly
bears its pro rata share of the operating expenses incurred by each
underlying fund. As of December 31, 2003, the operating expenses of the
underlying funds ranged from 0.39% to 1.84%. The Account's investment
return is net of the underlying funds' operating expenses.
EXAMPLES
The Examples assume that you invest $10,000 in the Account for the time periods
indicated and then redeem all of your shares at the end of those periods. The
Examples also assume that your investment has a 5% return each year and that
the Account's operating expenses remain the same. If the operating expenses of
the underlying funds, separate account expenses and contract level expenses
were included, expenses would be higher. Although your actual costs may be
higher or lower, based on these assumptions your cost would be:
[Enlarge/Download Table]
NUMBER OF YEARS YOU OWN YOUR SHARES
---------------------------------------------------------------------------------------------------------------------------
1 3 5 10
PRINCIPAL LIFETIME 2050 ACCOUNT $55 $174 $303 $680
PRINCIPAL LIFETIME STRATEGIC INCOME ACCOUNT
The Account seeks high current income.
MAIN STRATEGIES
To pursue its goal, the Account invests in shares of other Principal Variable
Contracts Fund Accounts (the "underlying funds"). The underlying funds are
intended to give the Account moderate exposure to the domestic and foreign
equity and fixed-income markets. At any time, the Sub-Advisor, Principal, may
add or substitute underlying funds in which the Account invests.
In deciding how to allocate the Account's assets among the underlying funds at
any time, Principal considers long-term asset class returns and volatility
assumptions.As the Account invests primarily in underlying funds that invest in
fixed-income securities (see table below), the Account is subject to the risk of
interest rate changes and credit risks associated with fixed-income securities.
The Account may also invest in underlying funds which invest primarily in equity
securities.
MAIN RISKS
The Account's investments are concentrated in the underlying funds and, as a
result, the Account's performance is directly related to their performance. The
Account's ability to meet its investment objective depends on the ability of the
underlying funds to achieve their investment objectives. Consequently, the
Account is subject to the particular risks of the underlying funds in the
proportions in which the Account invests in them. As with all mutual funds, as
the values of
the Account's assets rise or fall, the Account's share price changes. If you
sell your shares when their value is less than
the price you paid, you will lose money.
As with any security, the securities in which the underlying funds invest have
associated risks. These include risks of:
INTEREST RATE CHANGES . The value of fixed-income securities held by the Account
may be affected by factors such as changing interest rates, credit rating, and
effective maturities. When interest rates fall, the price of a bond rises and
when interest rates rise, the price declines.
CREDIT RISK . Lower quality and longer maturity bonds will be subject to greater
credit risk and price fluctuations than higher quality and shorter maturity
bonds. Bonds held by the Account may be affected by unfavorable political,
economic, or governmental developments that could affect the repayment of
principal or the payment of interest.
HIGH YIELD SECURITIES . Fixed-income securities that are not investment grade
are commonly referred to as junk bonds or high yield securities. These
securities offer a higher yield than other, higher rated securities, but they
carry a greater degree of risk and are considered speculative by the major
credit rating agencies. (please see High Yield Securities in the section of the
Prospectus entitled CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS).
U.S. GOVERNMENT SPONSORED SECURITIES . The Account may invest in debt and
mortgage-backed securities issued by government-sponsored enterprises such as
the Federal Home Loan Mortgage Corporation, the Federal National Mortgage
Association and the Federal Home Loan Banks. Although the issuing agency,
instrumentality or corporation maybe chartered or sponsored by the United States
government, their securities are neither issued nor guaranteed by the United
States Treasury.
EQUITY SECURITY RISKS
.. Stock market volatility. The net asset value of the underlying fund shares is
effected by changes in the value of the securities it owns. The prices of
equity securities may decline in response to certain events including those
directly involving issuers of these securities, adverse conditions affecting
the general economy, or overall market declines. In the short term, stock
prices can fluctuate dramatically in response to these factors.
.. Foreign investing.Foreign markets and currencies may not perform as well as
U.S. markets. Political and economic uncertainty in foreign countries may
negatively impact the portfolio. Some investments may be made in currencies
other than the U.S. dollar that will fluctuate in value as a result of changes
in the currency exchange rate.
.. Small and Medium Capitalizations. Companies with small capitalizations are
often companies with a limited operation history. Smaller capitalization
companies securities may be more volatile in price than larger company
securities, especially over the short-term.
.. Hedging strategies. Use of forward foreign currency exchange contracts,
currency or index futures or other derivatives involves risks.
.. Initial Public Offerings ("IPOs"). Purchase of shares issued in IPOs exposes
an underlying fund to the additional risks associated with companies that have
little operating history as public companies, as well as to the risks inherent
in those sectors of the market where these new issuers operate.
INVESTOR PROFILE
The Fund may be an appropriate investment for investors in retirement.
UNDERLYING FUND ALLOCATION
Principal anticipates initially allocating Account assets among the underlying
funds as follows:
[Download Table]
Bond 31.0% LargeCap Value 5.5%
Capital Value 3.0 LargeCap Stock Index 10.5
Equity Growth 3.1 Money Market 19.3
Equity Income 7.2 Real Estate Securities 9.5
Growth 3.1 SmallCap 2.8
International 5.0
Based on this allocation, the weighted average of the total account operating
expenses of the underlying funds is 0.59%. The combined total expenses for the
Account may be higher or lower depending on the allocation of its assets among
the underlying funds.
As the inception date of the Account is August 30, 2004, historical performance
data is not available.
FEES AND EXPENSES (ESTIMATED) AS A % OF AVERAGE DAILY NET ASSETS
(These fees and expenses do not include the effect of any sales charge, separate
account expenses or other contract level expenses which may be applied at the
variable life insurance or variable annuity product level. If such charges or
-
fees were included, overall expenses would be higher and would lower the
Account's performance.)
ACCOUNT OPERATING EXPENSES
[Download Table]
Management Fees.................. 0.12
Other Expenses................... 0.26
----
TOTAL ACCOUNT OPERATING EXPENSES 0.38
The Manager has voluntarily agreed to reimburse operating expenses so that
the total Account operating expenses will not be greater than 0.14% through
April 30, 2005. The Manager may not continue this arrangement after May 1,
2005. The Account as a shareholder in the underlying funds, indirectly
bears its pro rata share of the operating expenses incurred by each
underlying fund. As of December 31, 2003, the operating expenses of the
underlying funds ranged from 0.39% to 1.84%. The Account's investment
return is net of the underlying funds' operating expenses.
EXAMPLES
The Examples assume that you invest $10,000 in the Account for the time periods
indicated and then redeem all of your shares at the end of those periods. The
Examples also assume that your investment has a 5% return each year and that
the Account's operating expenses remain the same. If the operating expenses of
the underlying funds, separate account expenses and contract level expenses
were included, expenses would be higher. Although your actual costs may be
higher or lower, based on these assumptions your cost would be:
[Enlarge/Download Table]
NUMBER OF YEARS YOU OWN YOUR SHARES
-----------------------------------------------------------------------------------------------------------------------
1 3 5 10
PRINCIPAL LIFETIME STRATEGIC INCOME ACCOUNT $39 $123 $215 $484
REAL ESTATE SECURITIES ACCOUNT
The Account seeks to generate a total return by investing primarily in equity
securities of companies principally
engaged in the real estate industry.
MAIN STRATEGIES
Under normal market conditions, the Account invests at least 80% of its net
assets in equity securities of companies principally engaged in the real estate
industry. For purposes of the Account's investment policies, a real estate
company has at least 50% of its assets, income or profits derived from products
or services related to the real estate industry. Real estate companies include
real estate investment trusts and companies with substantial real estate
holdings such as paper, lumber, hotel and entertainment companies. Companies
whose products and services relate to the real estate industry include building
supply manufacturers, mortgage lenders and mortgage servicing companies.
Real estate investment trusts ("REITs") are corporations or business trusts that
are permitted to eliminate corporate level federal income taxes by meeting
certain requirements of the Internal Revenue Code. REITs are characterized as:
.. equity REITs, which primarily own property and generate revenue from rental
income;
.. mortgage REITs, which invest in real estate mortgages; and
.. hybrid REITs, which combine the characteristics of both equity and mortgage
REITs.
In selecting securities for the Account, the Manager focuses on equity REITs.
The Account may invest up to 25% of its assets in securities of foreign real
estate companies.
MAIN RISKS
As with any security, the securities in which the Account invests have
associated risks. These include risks of:
STOCK MARKET VOLATILITY . The net asset value of the Account's shares is
effected by changes in the value of the securities it owns. The prices of equity
securities held by the Account may decline in response to certain events
including those directly involving issuers of these securities, adverse
conditions affecting the general economy, or overall market declines. In the
short term, stock prices can fluctuate dramatically in response to these
factors. As with
all mutual funds, as the values of the Account's assets rise or fall, the
Account's share price changes. If you sell your
shares when their value is less than the price you paid, you will lose money.
SECTOR RISK . Because the Account invests at least 80% of its net assets in
securities of companies principally engaged in the real estate industry, the
Account is also subject to sector risk; that is, the possibility that the real
estate sector may underperform other sectors or the market as a whole. As
Principal allocates more of the Account's portfolio holdings to the real estate
sector, the Account's performance will be more susceptible to any economic,
business or other developments that generally affect that sector. The share
price of the Account may fluctuate more widely than the value of shares of a
fund that invests in a broader range of industries.
Securities of real estate companies are subject to securities market risks as
well as risks similar to those of direct ownership of real estate. These
include:
.. declines in the value of real estate
.. risks related to general and local economic conditions
.. dependency on management skills
.. heavy cash flow dependency
.. possible lack of available mortgage funds
.. overbuilding
.. extended vacancies in properties
.. increases in property taxes and operating expenses
.. changes in zoning laws
.. expenses incurred in the cleanup of environmental problems
.. casualty or condemnation losses
.. changes in interest rates
In addition to the risks listed above, equity REITs are affected by the changes
in the value of the properties owned by the trust. Mortgage REITs are affected
by the quality of the credit extended. Both equity and mortgage REITs:
.. may not be diversified with regard to the types of tenants (thus subject to
business developments of the tenant(s));
.. may not be diversified with regard to the geographic locations of the
properties (thus subject to regional economic developments); and
.. are subject to cash flow dependency of its tenants.
FOREIGN INVESTING . Foreign markets and currencies may not perform as well as
U.S. markets. Political and economic uncertainty in foreign countries, as well
as less public information about foreign investments may negatively impact the
Account's portfolio. Dividends and other income payable on foreign securities
may be subject to foreign taxes. Some investments may be made in currencies
other than the U.S. dollar that will fluctuate in value as a result of changes
in the currency exchange rate.
INVESTOR PROFILE
The Account may be an appropriate investment for investors who seek a total
return, want to invest in companies engaged in the real estate industry and
accept the potential for volatile fluctuations in the value of investments.
The Account's past performance is not necessarily an indication of how the
Account will perform in the future. The bar chart and tables provide some
indication of the risks of investing in the Account by showing changes in
performance from year to year and showing how the Account's average annual
returns compare with those of a broad measure of market performance. Annual
operating expenses do not include any separate account expenses, cost of
insurance or other contract level expenses. Total returns would be lower if such
expenses were included.
YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
[Download Table]
"1999"-4.48
"2000 "30.97
"2001 "8.75
"2002 "7.72
The Account's highest/lowest quarterly returns
"2003 "38.91 during this
time period were:
HIGHESTQ2 '0011.51%
LOWEST Q3 '99-8.40%
LOGO
The year-to-date return as of June 30, 2004 is 5.26%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2003
[Download Table]
PAST 1
YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT*
REAL ESTATE SECURITIES
ACCOUNT ..............
38.91 15.28 N/A 12.01
Morgan Stanley REIT
Index................. 36.74 14.12 N/A
Morningstar Specialty
- Real Estate Category 36.89 14.04 11.32
* The Account's SEC effective date was May 1, 1998.
FEES AND EXPENSES AS A % OF AVERAGE DAILY NET ASSETS BASED ON THE ACCOUNT'S
LATEST FISCAL YEAR
(These fees and expenses do not include the effect of any sales charge, separate
account expenses or other contract level expenses which may be applied at the
variable life insurance or variable annuity product level. If such charges or
-
fees were included, overall expenses would be higher and would lower the
Account's performance.)
ACCOUNT OPERATING EXPENSES
[Download Table]
Management Fees................. 0.90
Other Expenses.................. 0.02
----
TOTAL ACCOUNT OPERATING
EXPENSES 0.92
EXAMPLES
The Examples assume that you invest $10,000 in the Account for the time periods
indicated and then redeem all of your shares at the end of those periods. The
Examples also assume that your investment has a 5% return each year and that
the Account's operating expenses remain the same. If separate account expenses
and contract level expenses were included, expenses would be higher. Although
your actual costs may be higher or lower, based on these assumptions your cost
would be:
[Enlarge/Download Table]
NUMBER OF YEARS YOU OWN YOUR SHARES
------------------------------------------------------------------------------------------
1 3 5 10
REAL ESTATE SECURITIES ACCOUNT $94 $293 $509 $1,131
SMALLCAP ACCOUNT
The Account seeks long-term growth of capitalby investing primarily in equity
securities of companies with
comparatively small market capitalizations.
MAIN STRATEGIES
The Account invests primarily in common stocks of small capitalization
companies. Under normal market conditions, the Account invests at least 80% of
its assets in common stocks of companies with small market capitalizations
(those with market capitalizations similar to companies in the Russell 2000
Index (as of June 30, 2004, this range was between approximately $117 million
and $1.92 billion)) at the time of purchase. Market capitalization is defined as
total current market value of a company's outstanding common stock. The Account
may invest up to 20% of its assets in securities of foreign companies.
In selecting securities for investment, the Sub-Advisor, Principal, looks at
stocks with value and/or growth characteristics and constructs an investment
portfolio that has a "blend" of stocks with these characteristics. In managing
the assets of the Account, Principal does not have a policy of preferring one of
these categories to the other. The value orientation emphasizes buying stocks at
less than their investment value and avoiding stocks whose price has been
artificially built up. The growth orientation emphasizes buying stocks of
companies whose potential for growth of capital and earnings is expected to be
above average. Selection is based on fundamental analysis of the company
relative to other companies with the focus being on Principal's estimation of
forward-looking rates of return.
Principal may purchase securities issued as part of, or a short period after,
companies' initial public offerings ("IPOs"), and may at times dispose of those
shares shortly after their acquisition.
MAIN RISKS
The Account's share price may fluctuate more than that of funds primarily
invested in stocks of mid-sized and large companies and may underperform as
compared to the securities of larger companies. As with all mutual funds, as the
values of the Account's assets rise or fall, the Account's share price changes.
If you sell your shares when their value is
less than the price you paid, you will lose money.
As with any security, the securities in which the Account invests have
associated risks. These include risks of:
STOCK MARKET VOLATILITY . The net asset value of the Account's shares is
effected by changes in the value of the securities it owns. The prices of equity
securities held by the Account may decline in response to certain events
including those directly involving issuers of these securities, adverse
conditions affecting the general economy, or overall market declines. In the
short term, stock prices can fluctuate dramatically in response to these
factors.
SMALL AND MEDIUM CAPITALIZATIONS . Companies with small capitalizations are
often companies with a limited operation history. Such companies may have been
created in response to cultural, economic, regulatory or technological
developments. Such developments can have significant impact or negative effect
on smaller capitalization companies securities which may be more volatile in
price than larger company securities, especially over the short-term.
GROWTH STOCKS . Because growth securities typically do not make dividend
payments to shareholders, investment returns are based on capital appreciation
making returns more dependent on market increases and decreases. Growth stocks
may therefore be more volatile than non-growth stocks to market changes.
VALUE STOCKS . The Account's potential investment in value stocks carries the
risk that the market will not recognize a security's intrinsic value for a long
time or that a stock judged to be undervalued may actually be appropriately
priced.
FOREIGN INVESTING . Foreign markets and currencies may not perform as well as
U.S. markets. Political and economic uncertainty in foreign countries, as well
as less public information about foreign investments may negatively impact the
Account's portfolio. Dividends and other income payable on foreign securities
may be subject to foreign taxes. Some investments may be made in currencies
other than the U.S. dollar that will fluctuate in value as a result of changes
in
the currency exchange rate. Emerging market countries and companies doing
business in emerging market countries may not have the same rage of
opportunities as more developed countries companies in more developed countries.
INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in
IPOs exposes it to the additional risks associated with companies that have
little operating history as public companies, as well as to the risks inherent
in those sectors of the market where these new issuers operate. The market for
IPO issuers has been volatile and share prices of certain newly-public companies
have fluctuated in significant amounts over short periods of time. In addition,
the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at
times dispose of those shares shortly after their acquisition.
ACTIVE PORTFOLIO TRADING . The Account may actively trade securities in an
attempt to achieve its investment objective. The financial highlights table at
the end of this Prospectus shows the Account's turnover rate during recent
fiscal years. A portfolio turnover rate of 200%, for example, is equivalent to
the Account buying and selling all of its securities two times during the course
of the year. A high turnover rate may increase the Account's trading costs and
may have an adverse impact on the Account's performance. The portfolio turnover
rate for the Account for the six month period ended June 30, 2004 was 223%
(computed on an annualized basis).
INVESTOR PROFILE
The Account may be an appropriate investment for investors seeking long-term
growth of capital and willing to accept the potential for volatile fluctuations
in the value of investments.
The Account's past performance is not necessarily an indication of how the
Account will perform in the future. The bar chart and tables provide some
indication of the risks of investing in the Account by showing changes in
performance from year to year and showing how the Account's average annual
returns compare with those of a broad measure of market performance. Annual
operating expenses do not include any separate account expenses, cost of
insurance or other contract level expenses. Total returns would be lower if such
expenses were included.
YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
[Download Table]
"1999 "43.58
"2000"-11.73
"2001 "2.55
"2002"-27.33
The Account's highest/lowest quarterly returns
"2003 "36.82 during this
time period were:
HIGHESTQ2 '9926.75%
LOWEST Q3 '01-25.61%
LOGO
The year-to-date return as of June 30, 2004 is 7.15%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2003
[Download Table]
PAST 1
YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT*
SMALLCAP ACCOUNT .....
36.82 5.26 N/A 0.48
Russell 2000 Index ... 47.25 7.13 9.48
Morningstar Small
Blend Category........ 42.77 10.83 10.76
* The Account's SEC effective date was May 1, 1998.
FEES AND EXPENSES AS A % OF AVERAGE DAILY NET ASSETS BASED ON THE ACCOUNT'S
LATEST FISCAL YEAR
(These fees and expenses do not include the effect of any sales charge, separate
account expenses or other contract level expenses which may be applied at the
variable life insurance or variable annuity product level. If such charges or
-
fees were included, overall expenses would be higher and would lower the
Account's performance.)
ACCOUNT OPERATING EXPENSES
[Download Table]
Management Fees................. 0.85
Other Expenses.................. 0.10
----
TOTAL ACCOUNT OPERATING
EXPENSES 0.95
EXAMPLES
The Examples assume that you invest $10,000 in the Account for the time periods
indicated and then redeem all of your shares at the end of those periods. The
Examples also assume that your investment has a 5% return each year and that
the Account's operating expenses remain the same. If separate account expenses
and contract level expenses were included, expenses would be higher. Although
your actual costs may be higher or lower, based on these assumptions your cost
would be:
[Download Table]
NUMBER OF YEARS YOU OWN YOUR SHARES
------------------------------------------------------------------------------------
1 3 5 10
SMALLCAP ACCOUNT $97 $303 $525 $1,166
SMALLCAP GROWTH ACCOUNT
The Account seeks long-term growth of capital.
The Manager has selected UBS Global AM and Emerald as Sub-Advisors to the
Account.
MAIN STRATEGIES
The Account pursues its investment objective by investing primarily in equity
securities. Under normal market conditions, the Account invests at least 80% of
its assets in equity securities of companies with small market capitalizations
(those with market capitalizations equal to or smaller than the greater of 1)
$2.5 billion or 2) the highest market capitalization of the companies in the
Russell 2000 Growth Index at the time of purchase (as of June 30, 2004, this
range was between approximately $70 million and $1.95 billion)). Market
capitalization is defined as total current market value of a company's
outstanding common stock. The Account may invest up to 25% of its assets in
securities of foreign companies.
UBS Global AM seeks to invest in companies that possess dominant market
positions or franchises, a major technical edge, or a unique competitive
advantage. To this end, UBS Global AM considers earnings revision trends,
positive stock price momentum and sales acceleration when selecting securities.
The Account may also invest in securities of emerging growth companies which are
companies that UBS Global AM expects to experience above average earnings or
cash flow growth or meaningful changes in underlying asset values. Investments
in equity securities may include common stock and preferred stock.
Utilizing fundamental analysis, Emerald seeks to invest in the common stock of
companies with distinct competitive advantages, strong management teams,
leadership positions, high revenue and earnings growth rates versus peers,
differentiated growth drivers and limited sell-side research.
MAIN RISKS
The Account's share price may fluctuate more than that of funds primarily
invested in stocks of mid-sized and large companies and may underperform as
compared to the securities of larger companies. As with any security, the
securities in which the Account invests have associated risks. These include
risks of:
STOCK MARKET VOLATILITY . The net asset value of the Account's shares is
effected by changes in the value of the securities it owns. The prices of equity
securities held by the Account may decline in response to certain events
including those directly involving issuers of these securities, adverse
conditions affecting the general economy, or overall market declines. In the
short term, stock prices can fluctuate dramatically in response to these
factors.
SMALL AND MEDIUM CAPITALIZATIONS . Companies with small capitalizations are
often companies with a limited operation history. Such companies may have been
created in response to cultural, economic, regulatory or technological
developments. Such developments can have significant impact or negative effect
on smaller capitalization companies securities which may be more volatile in
price than larger company securities, especially over the short-term.
GROWTH STOCKS . Because growth securities typically do not make dividend
payments to shareholders, investment returns are based on capital appreciation
making returns more dependent on market increases and decreases. Growth stocks
may therefore be more volatile than non-growth stocks to market changes.
SECTOR RISK . UBS Global AM may group companies with similar characteristics
into broad categories called sectors. Therefore, the Account is also subject to
sector risk; that is, the possibility that a certain sector may underperform
other sectors or the market as a whole. As UBS Global AM allocates more of the
Account's portfolio holdings to a particular sector, the Account's performance
will be more susceptible to any economic, business or other developments that
generally affect that sector.
FOREIGN INVESTING . Foreign markets and currencies may not perform as well as
U.S. markets. Political and economic uncertainty in foreign countries, as well
as less public information about foreign investments may negatively impact the
Account's portfolio. Dividends and other income payable on foreign securities
may be subject to foreign taxes. Some investments may be made in currencies
other than the U.S. dollar that will fluctuate in value as a result of changes
in the currency exchange rate. Emerging market countries and companies doing
business in emerging market countries may not have the same rage of
opportunities as more developed countries companies in more developed countries
..
INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in
IPOs exposes it to the additional risks associated with companies that have
little operating history as public companies, as well as to the risks inherent
in those sectors of the market where these new issuers operate. The market for
IPO issuers has been volatile and share prices of certain newly-public companies
have fluctuated in significant amounts over short periods of time. In addition,
the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at
times dispose of those shares shortly after their acquisition.
INVESTOR PROFILE
The Account may be an appropriate investment for investors seeking long-term
growth of capital and willing to accept the risks of investing in common stocks
that may have greater risks than stocks of companies with lower potential for
earnings growth.
UBS Global AM became the Sub-Advisor to the Account on October 1, 2002. On
August 24, 2004, Emerald also became Sub-Advisor to the Account.
The Account's past performance is not necessarily an indication of how the
Account will perform in the future. The bar chart and tables provide some
indication of the risks of investing in the Account by showing changes in
performance from year to year and showing how the Account's average annual
returns compare with those of a broad measure of market performance. Annual
operating expenses do not include any separate account expenses, cost of
insurance or other contract level expenses. Total returns would be lower if such
expenses were included.
YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
[Download Table]
"1999 "95.69
"2000"-13.91
"2001"-32.01
"2002"-45.85
The Account's highest/lowest quarterly returns
"2003 "45.64 during this
time period were:
HIGHESTQ4 '9959.52%
LOWEST Q3 '01-37.66%
LOGO
The year-to-date return as of June 30, 2004 is 0.00%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2003
[Download Table]
PAST 1
YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT*
SMALLCAP GROWTH
ACCOUNT ..............
45.64 -2.01 N/A -1.27
Russell 2000 Growth
Index................. 48.53 0.85 5.43
Morningstar Small
Growth Category....... 45.00 6.20 8.58
* The Account's SEC effective date was May 1, 1998.
FEES AND EXPENSES AS A % OF AVERAGE DAILY NET ASSETS BASED ON THE ACCOUNT'S
LATEST FISCAL YEAR
(These fees and expenses do not include the effect of any sales charge, separate
account expenses or other contract level expenses which may be applied at the
variable life insurance or variable annuity product level. If such charges or
-
fees were included, overall expenses would be higher and would lower the
Account's performance.)
ACCOUNT OPERATING EXPENSES
[Download Table]
Management Fees................. 1.00
Other Expenses.................. 0.02
----
TOTAL ACCOUNT OPERATING
EXPENSES 1.02
EXAMPLES
The Examples assume that you invest $10,000 in the Account for the time periods
indicated and then redeem all of your shares at the end of those periods. The
Examples also assume that your investment has a 5% return each year and that
the Account's operating expenses remain the same. If separate account expenses
and contract level expenses were included, expenses would be higher. Although
your actual costs may be higher or lower, based on these assumptions your cost
would be:
[Download Table]
NUMBER OF YEARS YOU OWN YOUR SHARES
----------------------------------------------------------------------------------
1 3 5 10
SMALLCAP GROWTH
ACCOUNT $104 $325 $563 $1,248
SMALLCAP VALUE ACCOUNT
The Account seeks long-term growth of capital.
MAIN STRATEGIES
The Account invests primarily in a diversified group of equity securities of
small U.S. companies with small market capitalizations (those with market
capitalizations similar to companies in the Russell 2000 Value Index (as of June
30, 2004, this range was between approximately $110 million and $1.95 billion))
at the time of purchase. Under normal market conditions, the Account invests at
least 80% of its assets in equity securities of such companies. Emphasis is
given to those companies that exhibit value characteristics. Value securities
generally have above average dividend yield and below average price to earnings
(P/E) ratios. Up to 10%% of the Account's assets may be invested in foreign
securities.
The Sub-Advisor, Morgan, uses quantitative and fundamental research, systematic
stock valuation and a disciplined portfolio construction process. It seeks to
enhance returns and reduce the volatility in the value of the Account relative
to that of the U.S. small company value universe, represented by the Russell
2000/(R)/ Value Index. Morgan continuously screens the small company universe to
identify for further analysis those companies that exhibit favorable factor
rankings. Such factors include Morgan's dividend discount model rankings,
price-to-cashflow, earnings revisions, as well as positive price momentum.
Morgan ranks these companies within economic sectors according to their relative
attractiveness. Morgan then selects for purchase the companies it feels to be
most attractive within each economic sector.
Under normal market conditions, the Account will have sector weightings
comparable to that of the U.S. small company value universe though it may under
or over-weight selected economic sectors. In addition, as a company moves out of
the market capitalization range of the small company universe, it generally
becomes a candidate for sale by the Account.
The Account may also purchase securities issued as part of, or a short period
after, companies' initial public offerings ("IPOs"), and may at times dispose of
those shares shortly after their acquisition.
Since the Account has a long-term investment perspective, it does not intend to
respond to short-term market fluctuations or to acquire securities for the
purpose of short-term trading.
MAIN RISKS
The Account's share price may fluctuate more than that of funds primarily
invested in stocks of mid-sized and large companies and may underperform as
compared to the securities of larger companies. As with all mutual funds, as the
values of the Account's assets rise or fall, the Account's share price changes.
If you sell your shares when their value is
less than the price you paid, you will lose money.
As with any security, the securities in which the Account invests have
associated risks. These include risks of:
STOCK MARKET VOLATILITY . The net asset value of the Account's shares is
effected by changes in the value of the securities it owns. The prices of equity
securities held by the Account may decline in response to certain events
including those directly involving issuers of these securities, adverse
conditions affecting the general economy, or overall market declines. In the
short term, stock prices can fluctuate dramatically in response to these
factors.
SMALL AND MEDIUM CAPITALIZATIONS . Companies with small capitalizations are
often companies with a limited operation history. Such companies may have been
created in response to cultural, economic, regulatory or technological
developments. Such developments can have significant impact or negative effect
on smaller capitalization companies securities which may be more volatile in
price than larger company securities, especially over the short-term.
VALUE STOCKS . The Account's potential investment in value stocks carries the
risk that the market will not recognize a security's intrinsic value for a long
time or that a stock judged to be undervalued may actually be appropriately
priced.
FOREIGN INVESTING . Foreign markets and currencies may not perform as well as
U.S. markets. Political and economic uncertainty in foreign countries, as well
as less public information about foreign investments may negatively impact the
Account's portfolio. Dividends and other income payable on foreign securities
may be subject to foreign taxes. Some investments may be made in currencies
other than the U.S. dollar that will fluctuate in value as a result of changes
in the currency exchange rate. Emerging market countries and companies doing
business in emerging market countries may not have the same rage of
opportunities as more developed countries companies in more developed countries.
INITIAL PUBLIC OFFERINGS ("IPOS") . The Account's purchase of shares issued in
IPOs exposes it to the additional risks associated with companies that have
little operating history as public companies, as well as to the risks inherent
in those sectors of the market where these new issuers operate. The market for
IPO issuers has been volatile and share prices of certain newly-public companies
have fluctuated in significant amounts over short periods of time. In addition,
the Sub-Advisor cannot guarantee continued access to IPO offerings, and may at
times dispose of those shares shortly after their acquisition.
INVESTOR PROFILE
The Account may be an appropriate investment for investors seeking long-term
growth and willing to accept volatile fluctuations in the value of their
investment. The Account is not designed for investors seeking income or
conservation of capital.
The Account's past performance is not necessarily an indication of how the
Account will perform in the future. The bar chart and tables provide some
indication of the risks of investing in the Account by showing changes in
performance from year to year and showing how the Account's average annual
returns compare with those of a broad measure of market performance. Annual
operating expenses do not include any separate account expenses, cost of
insurance or other contract level expenses. Total returns would be lower if such
expenses were included.
YEAR-BY-YEAR TOTAL RETURN (%) AS OF DECEMBER 31 EACH YEAR
[Download Table]
"1999 "21.45
"2000 "23.87
"2001"6.25
"2002"-8.86
The Account's highest/lowest quarterly returns
"2003 "50.61 during this
time period were:
HIGHEST Q2 '03 23.76%
LOWEST Q3 '98-19.14%
LOGO
The year-to-date return as of June 30, 2004 is 8.21%.
AVERAGE ANNUAL TOTAL RETURNS (%) FOR THE PERIOD ENDED DECEMBER 31, 2003
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PAST 1
YEAR PAST 5 YEARS PAST 10 YEARS LIFE OF ACCOUNT*
SMALLCAP VALUE ACCOUNT 50.61 17.02 N/A 11.61
Russell 2000 Value
Index................. 46.02 12.28 12.70
Morningstar Small
Value Category........ 42.71 12.86 12.80
* The Account's SEC effective date was May 1, 1998.
FEES AND EXPENSES AS A % OF AVERAGE DAILY NET ASSETS BASED ON THE ACCOUNT'S
LATEST FISCAL YEAR
(These fees and expenses do not include the effect of any sales charge, separate
account expenses or other contract level expenses which may be applied at the
variable life insurance or variable annuity product level. If such charges or
-
fees were included, overall expenses would be higher and would lower the
Account's performance.)
ACCOUNT OPERATING EXPENSES
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Management Fees................. 1.10
Other Expenses.................. 0.08
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TOTAL ACCOUNT OPERATING
EXPENSES 1.18
EXAMPLES
The Examples assume that you invest $10,000 in the Account for the time periods
indicated and then redeem all of your shares at the end of those periods. The
Examples also assume that your investment has a 5% return each year and that
the Account's operating expenses remain the same. If separate account expenses
and contract level expenses were included, expenses would be higher. Although
your actual costs may be higher or lower, based on these assumptions your cost
would be:
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NUMBER OF YEARS YOU OWN YOUR SHARES
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1 3 5 10
SMALLCAP VALUE ACCOUNT $120 $375 $649 $1,432
CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS
The information in this section does not directly apply to the Principal
LifeTime Accounts. It does apply to the
underlying funds in which the LifeTime Accounts invest.The Statement of
Additional Information (SAI) contains additional information about investment
strategies and their related risks.
SECURITIES AND INVESTMENT PRACTICES
MARKET VOLATILITY . Equity securities include common stocks, preferred stocks,
convertible securities, depositary receipts, rights and warrants. Common stocks,
the most familiar type, represent an equity (ownership) interest in a
corporation. The value of a company's stock may fall as a result of factors
directly relating to that company, such as decisions made by its management or
lower demand for the company's products or services. A stock's value may also
fall because of factors affecting not just the company, but also companies in
the same industry or in a number of different industries, such as increases in
production costs. The value of a company's stock may also be affected by changes
in financial markets that are relatively unrelated to the company or its
industry, such as changes in interest rates or currency exchange rates. In
addition, a company's stock generally pays dividends only after the company
invests in its own business and makes required payments to holders of its bonds
and other debt. For this reason, the value of a company's stock will usually
react more strongly than its bonds and other debt to actual or perceived changes
in the company's financial condition or prospects. Stocks of smaller companies
may be more vulnerable to adverse developments than those of larger companies.
Fixed-income securities include bonds and other debt instruments that are used
by issuers to borrow money from investors. The issuer generally pays the
investor a fixed, variable or floating rate of interest. The amount borrowed
must be repaid at maturity. Some debt securities, such as zero coupon bonds, do
not pay current interest, but are sold at a discount from their face values.
INTEREST RATE CHANGES . Fixed-income securities are sensitive to changes in
interest rates. In general, fixed-income security prices rise when interest
rates fall and fall when interest rates rise. Longer term bonds and zero coupon
bonds are generally more sensitive to interest rate changes.
CREDIT RISK . Fixed-income security prices are also affected by the credit
quality of the issuer. Investment grade debt securities are medium and high
quality securities. Some bonds, such as lower grade or "junk" bonds, may have
speculative characteristics and may be particularly sensitive to economic
conditions and the financial condition of the issuers.
REPURCHASE AGREEMENTS AND LOANED SECURITIES
Although not a principal investment strategy, each of the Accounts may invest a
portion of its assets in repurchase agreements. Repurchase agreements typically
involve the purchase of debt securities from a financial institution such as a
bank, savings and loan association or broker-dealer. A repurchase agreement
provides that the Account sells back to the seller and that the seller
repurchases the underlying securities at a specified price on a specific date.
Repurchase agreements may be viewed as loans by an Account collateralized by the
underlying securities. This arrangement results in a fixed rate of return that
is not subject to market fluctuation while the Account holds the security. In
the event of a default or bankruptcy by a selling financial institution, the
affected Account bears a risk of loss. To minimize such risks, the Account
enters into repurchase agreements only with large, well-capitalized and
well-established financial institutions. In addition, the value of the
securities collateralizing the repurchase agreement is, and during the entire
term of the repurchase agreement remains, at least equal to the repurchase
price, including accrued interest.
Each of the Accounts may lend its portfolio securities to unaffiliated
broker-dealers and other unaffiliated qualified financial institutions.
CURRENCY CONTRACTS
The Asset Allocation and Equity Growth Accounts may enter into currency
contracts, currency futures contracts and
options, and options on currencies for hedging and other purposes. The other
Accounts (except Government Securities
and Money Market) may each enter into forward currency contracts, currency
futures contracts and options, and options on currencies for hedging purposes
and not as a principal investment strategy. A forward currency contract involves
a privately negotiated obligation to purchase or sell a specific currency at a
future date at a price set in the contract. An Account will not hedge currency
exposure to an extent greater than the aggregate market value of the securities
held or to be purchased by the Account (denominated or generally quoted or
currently convertible into the currency).
Hedging is a technique used in an attempt to reduce risk. If an Account's
Sub-Advisor hedges market conditions incorrectly or employs a strategy that does
not correlate well with the Account's investment, these techniques could result
in a loss. These techniques may increase the volatility of an Account and may
involve a small investment of cash relative to the magnitude of the risk
assumed. In addition, these techniques could result in a loss if the other party
to the transaction does not perform as promised. There is also a risk of
government action through exchange controls that would restrict the ability of
the Account to deliver or receive currency.
FORWARD COMMITMENTS
Although not a principal investment strategy, each of the Accounts may enter
into forward commitment agreements. These agreements call for the Account to
purchase or sell a security on a future date at a fixed price. Each of these
Accounts may also enter into contracts to sell its investments either on demand
or at a specific interval.
WARRANTS
Each of the Accounts (except Government Securities and Money Market) may invest
up to 5% of its assets in warrants though none of the Accounts use such
investments as a principal investment strategy. A warrant is a certificate
granting its owner the right to purchase securities from the issuer at a
specified price, normally higher than the current market price.
HIGH YIELD SECURITIES
The Asset Allocation, Balanced, Bond and MidCap Value Accounts may invest in
debt securities rated lower than BBB by S&P or Baa by Moody's or, if not rated,
determined to be of equivalent quality by the Manager or the Sub-Advisor. Such
securities are sometimes referred to as high yield or "junk bonds" and are
considered speculative.
Investment in high yield bonds involves special risks in addition to the risks
associated with investment in highly rated debt securities. High yield bonds may
be regarded as predominantly speculative with respect to the issuer's continuing
ability to meet principal and interest payments. Moreover, such securities may,
under certain circumstances, be less liquid than higher rated debt securities.
Analysis of the creditworthiness of issuers of high yield securities may be more
complex than for issuers of higher quality debt securities. The ability of an
Account to achieve its investment objective may, to the extent of its investment
in high yield bonds, be more dependent on such credit analysis than would be the
case if the Account were investing in higher quality bonds.
High yield bonds may be more susceptible to real or perceived adverse economic
and competitive industry conditions than higher-grade bonds. The prices of high
yield bonds have been found to be less sensitive to interest rate changes than
more highly rated investments, but more sensitive to adverse economic downturns
or individual corporate developments. If the issuer of high yield bonds
defaults, an Account may incur additional expenses to seek recovery.
The secondary market on which high yield bonds are traded may be less liquid
than the market for higher-grade bonds. Less liquidity in the secondary trading
market could adversely affect the price at which an Account could sell a high
yield bond and could adversely affect and cause large fluctuations in the daily
price of the Account's shares. Adverse publicity and investor perceptions,
whether or not based on fundamental analysis, may decrease the value and
liquidity of high yield bonds, especially in a thinly traded market.
The use of credit ratings for evaluating high yield bonds also involves certain
risks. For example, credit ratings evaluate the safety of principal and interest
payments, not the market value risk of high yield bonds. Also, credit rating
agencies may fail to change credit ratings in a timely manner to reflect
subsequent events. If a credit rating agency changes the
rating of a portfolio security held by an Account, the Account may retain the
security if the Manager or Sub-Advisor thinks it is in the best interest of
shareholders.
INITIAL PUBLIC OFFERINGS ("IPOS")
The Accounts (except Bond, Government Securities, Limited Term Bond and Money
Market) may invest in IPOs. An IPO is a company's first offering of stock to the
public. IPO risk is that the market value of IPO shares will fluctuate
considerably due to factors such as the absence of a prior public market,
unseasoned trading, the small number of shares available for trading and limited
information about the issuer. The purchase of IPO shares may involve high
transaction costs. IPO shares are subject to market risk and liquidity risk. In
addition, the market for IPO shares can be speculative and/or inactive for
extended periods of time. The limited number of shares available for trading in
some IPOs may make it more difficult for an Account to buy or sell significant
amounts of shares without an unfavorable impact on prevailing prices. Investors
in IPO shares can be affected by substantial dilution in the value of their
shares by sales of additional shares and by concentration of control in existing
management and principal shareholders.
When an Account's assets base is small, a significant portion of the Account's
performance could be attributable to investments in IPOs because such
investments would have a magnified impact on the Account. As the Account's
assets grow, the effect of the Account's investments in IPOs on the Account's
performance probably will decline, which could reduce the Account's performance.
Because of the price volatility of IPO shares, an Account may choose to hold IPO
shares for a very short period of time. This may increase the turnover of the
Account's portfolio and lead to increased expenses to the Account, such as
commissions and transaction costs. By selling IPO shares, the Account may
realize taxable gains it will subsequently distribute to shareholders.
DERIVATIVES
To the extent permitted by its investment objectives and policies, each of the
Accounts (except Money Market) may invest in securities that are commonly
referred to as derivative securities. Generally, a derivative is a financial
arrangement, the value of which is derived from, or based on, a traditional
security, asset, or market index. Certain derivative securities are described
more accurately as index/structured securities. Index/structured securities are
derivative securities whose value or performance is linked to other equity
securities (such as depositary receipts), currencies, interest rates, indices or
other financial indicators (reference indices).
Some derivatives, such as mortgage-related and other asset-backed securities,
are in many respects like any other investment, although they may be more
volatile or less liquid than more traditional debt securities.
There are many different types of derivatives and many different ways to use
them. Futures and options are commonly used for traditional hedging purposes to
attempt to protect an Account from exposure to changing interest rates,
securities prices, or currency exchange rates and for cash management purposes
as a low-cost method of gaining exposure to a particular securities market
without investing directly in those securities. The Accounts may enter into put
or call options, future contracts, options on futures contracts and
over-the-counter swap contracts (e.g., interest rate swaps, total return swaps
and credit default swaps) for both hedging and non-hedging purposes.
Generally, no Account may invest in a derivative security unless the reference
index or the instrument to which it relates is an eligible investment for the
Account. For example, a security whose underlying value is linked to the price
of oil would not be a permissible investment because the Accounts may not invest
in oil leases or futures. However, an Account may be permitted to purchase and
sell financial futures contracts, options on such contracts, swaps and
securities backed by physical commodities even if the Account is not allowed to
invest in the underlying commodities or commodity contracts.
The return on a derivative security may increase or decrease, depending upon
changes in the reference index or instrument to which it relates. The risks
associated with derivative investments include:
.. the risk that the underlying security, interest rate, market index or other
financial asset will not move in the direction the Manager or Sub-Advisor
anticipated;
.. the possibility that there may be no liquid secondary market which may make it
difficult or impossible to close out a position when desired;
.. the risk that adverse price movements in an instrument can result in a loss
substantially greater than an Account's initial investment; and
.. the counterparty may fail to perform its obligations.
CONVERTIBLE SECURITIES
Convertible securities are fixed-income securities that an Account (except Bond,
Limited Term Bond and Money
Market) has the right to exchange for equity securities at a specified
conversion price. The option allows the Account to realize additional returns if
the market price of the equity securities exceeds the conversion price. For
example, the Account may hold fixed-income securities that are convertible into
shares of common stock at a conversion price of $10 per share. If the market
value of the shares of common stock reached $12, the Account could realize an
additional $2 per share by converting its fixed-income securities.
Convertible securities have lower yields than comparable fixed-income
securities. In addition, at the time a convertible security is issued the
conversion price exceeds the market value of the underlying equity securities.
Thus, convertible securities may provide lower returns than non-convertible
fixed-income securities or equity securities depending upon changes in the price
of the underlying equity securities. However, convertible securities permit the
Account to realize some of the potential appreciation of the underlying equity
securities with less risk of losing its initial investment.
The Accounts treat convertible securities as both fixed-income and equity
securities for purposes of investment policies and limitations because of their
unique characteristics. The Accounts may invest in convertible securities
without regard to their ratings.
FOREIGN INVESTING
As a principal investment strategy, the Asset Allocation, International,
International Emerging Markets and
International SmallCap Accounts may invest Account assets in securities of
foreign companies. The other Accounts (except Government Securities and Money
Market) may invest in securities of foreign companies but not as a principal
investment strategy. For the purpose of this restriction, foreign companies are:
.. companies with their principal place of business or principal office outside
the U.S.; and
.. companies for which the principal securities trading market is outside the
U.S.
Foreign companies may not be subject to the same uniform accounting, auditing
and financial reporting practices as are required of U.S. companies. In
addition, there may be less publicly available information about a foreign
company than about a U.S. company. Securities of many foreign companies are less
liquid and more volatile than securities of comparable U.S. companies.
Commissions on foreign securities exchanges may be generally higher than those
on U.S. exchanges, although each Account seeks the most favorable net results on
its portfolio transactions.
Foreign markets also have different clearance and settlement procedures than
those in U.S. markets. In certain markets there have been times when settlements
have been unable to keep pace with the volume of securities transactions, making
it difficult to conduct these transactions. Delays in settlement could result in
temporary periods when a portion of Account assets is not invested and earning
no return. If an Account is unable to make intended security purchases due to
settlement problems, the Account may miss attractive investment opportunities.
In addition, an Account may incur a loss as a result of a decline in the value
of its portfolio if it is unable to sell a security.
With respect to certain foreign countries, there is the possibility of
expropriation or confiscatory taxation, political or social instability, or
diplomatic developments that could affect an Account's investments in those
countries. In addition, an Account may also suffer losses due to
nationalization, expropriation or differing accounting practices and treatments.
Investments in foreign securities are subject to laws of the foreign country
that may limit the amount and types of foreign investments. Changes of
governments or of economic or monetary policies, in the U.S. or abroad, changes
in dealings between nations, currency convertibility or exchange rates could
result in investment losses for an Account. Finally, even though certain
currencies may be convertible into U.S. dollars, the conversion rates may be
artificial relative to the actual market values and may be unfavorable to
Account investors.
Foreign securities are often traded with less frequency and volume, and
therefore may have greater price volatility, than is the case with many U.S.
securities. Brokerage commissions, custodial services, and other costs relating
to investment in foreign countries are generally more expensive than in the U.S.
Though the Accounts intend to acquire the securities of foreign issuers where
there are public trading markets, economic or political turmoil in a country in
which an Account has a significant portion of its assets or deterioration of the
relationship between the U.S. and a
foreign country may negatively impact the liquidity of an Account's portfolio.
An Account may have difficulty meeting a large number of redemption requests.
Furthermore, there may be difficulties in obtaining or enforcing judgments
against foreign issuers.
An Account may choose to invest in a foreign company by purchasing depositary
receipts. Depositary receipts are certificates of ownership of shares in a
foreign-based issuer held by a bank or other financial institution. They are
alternatives to purchasing the underlying security but are subject to the
foreign securities to which they relate.
Investments in companies of developing countries may be subject to higher risks
than investments in companies in more developed countries. These risks include:
.. increased social, political and economic instability;
.. a smaller market for these securities and low or nonexistent volume of trading
that results in a lack of liquidity and in greater price volatility;
.. lack of publicly available information, including reports of payments of
dividends or interest on outstanding securities;
.. foreign government policies that may restrict opportunities, including
restrictions on investment in issuers or industries deemed sensitive to
national interests;
.. relatively new capital market structure or market-oriented economy;
.. the possibility that recent favorable economic developments may be slowed or
reversed by unanticipated political or social events in these countries;
.. restrictions that may make it difficult or impossible for the Account to vote
proxies, exercise shareholder rights, pursue legal remedies, and obtain
judgments in foreign courts; and
.. possible losses through the holding of securities in domestic and foreign
custodial banks and depositories.
In addition, many developing countries have experienced substantial, and in some
periods, extremely high rates of inflation for many years. Inflation and rapid
fluctuations in inflation rates have had and may continue to have negative
effects on the economies and securities markets of those countries.
Repatriation of investment income, capital and proceeds of sales by foreign
investors may require governmental registration and/or approval in some
developing countries. An Account could be adversely affected by delays in or a
refusal to grant any required governmental registration or approval for
repatriation.
Further, the economies of developing countries generally are heavily dependent
upon international trade and, accordingly, have been and may continue to be
adversely affected by trade barriers, exchange controls, managed adjustments in
relative currency values and other protectionist measures imposed or negotiated
by the countries with which they trade.
SMALL AND MEDIUM CAPITALIZATION COMPANIES
The Accounts (except Bond, Government Securities, Limited Term Bond and Money
Market) may invest in securities of companies with small- or mid-sized market
capitalizations. The Capital Value, Equity Value, LargeCap Blend,
LargeCap Growth, LargeCap Stock Index and LargeCap Value Accounts may hold
securities of small and medium capitalization companies but not as a principal
investment strategy. Market capitalization is defined as total current market
value of a company's outstanding common stock. Investments in companies with
smaller market capitalizations may involve greater risks and price volatility
(wide, rapid fluctuations) than investments in larger, more mature companies.
Small companies may be less significant within their industries and may be at a
competitive disadvantage relative to their larger competitors. While smaller
companies may be subject to these additional risks, they may also realize more
substantial growth than larger or more established companies.
Smaller companies may be less mature than larger companies. At this earlier
stage of development, the companies may have limited product lines, reduced
market liquidity for their shares, limited financial resources or less depth in
management than larger or more established companies. Unseasoned issuers are
companies with a record of less than three years continuous operation, including
the operation of predecessors and parents. Unseasoned issuers by their nature
have only a limited operating history that can be used for evaluating the
company's growth prospects. As a result, investment decisions for these
securities may place a greater emphasis on current or planned product lines and
the reputation and experience of the company's management and less emphasis on
fundamental valuation factors than would be the case for more mature growth
companies.
TEMPORARY DEFENSIVE MEASURES
From time to time, as part of its investment strategy, each Account (other that
the Money Market Account which may invest in high-quality money market
securities at any time) may invest without limit in cash and cash equivalents
for temporary defensive purposes in response to adverse market, economic or
political conditions. To the extent that the Account is in a defensive position,
it may lose the benefit of upswings and limit its ability to meet its investment
objective. For this purpose, cash equivalents include: bank notes, bank
certificates of deposit, bankers' acceptances, repurchase agreements, commercial
paper, and commercial paper master notes which are floating rate debt
instruments without a fixed maturity. In addition, an Account may purchase U.S.
government securities, preferred stocks and debt securities, whether or not
convertible into or carrying rights for common stock.
LIFETIME ACCOUNTS
The performance and risks of each LifeTime Account directly corresponds to the
performance and risks of the underlying funds in which the Account invests. By
investing in many underlying funds, the LifeTime Accounts have partial exposure
to the risks of many different areas of the market. The more a LifeTime Account
allocates to stock funds, the greater the expected risk.
For Accounts that are farthest from their stated retirement dates, allocations
to stocks are relatively high so that investors may benefit from their long-term
growth potential, while allocations to fixed-income securities are relatively
low. This approach is designed to help investors accumulate the assets needed
during their retirement years. Principal intends to gradually shift each
Lifetime Account's (except the Lifetime Strategic Income Account) allocation
among the underlying funds so that within five to ten years after the stated
retirement date, the Account's underlying fund allocation matches the underlying
fund allocation of the Principal LifeTime Strategic Income Account.
If you are considering investing in a LifeTime Account, you should take into
account your estimated retirement date and risk tolerance. In general, each
LifeTime Account is managed with the assumption that the investor will invest in
a LifeTime Account whose stated date is closest to the date the shareholder
retires. Choosing an Account targeting an earlier date represents a more
conservative choice; targeting an Account with a later date represents a more
aggressive choice. It is important to note that the retirement year of the
Account you select should not necessarily represent the specific year you intend
to start drawing retirement assets. It should be a guide only. Generally, the
potential for higher returns over time is accompanied by the higher risk of a
decline in the value of your principal. Investors should realize that the
LifeTime Accounts are not a complete solution to their retirement needs.
Investors must weigh many factors when considering when to retire, what their
retirement needs will be, and what sources of income they may have.
Each LifeTime Account indirectly bears its pro-rata share of the expenses of the
underlying funds as well as directly incurring expenses. Therefore, investment
in a LifeTime Account is more costly than investing directly in the underlying
funds.
PORTFOLIO TURNOVER
"Portfolio Turnover" is the term used in the industry for measuring the amount
of trading that occurs in an Account's portfolio during the year. For example, a
100% turnover rate means that on average every security in the portfolio has
been replaced once during the year.
Accounts with high turnover rates (more than 100%) often have higher transaction
costs (which are paid by the Account) and may have an adverse impact on the
Account's performance. No turnover rate can be calculated for the Money Market
Account because of the short maturities of the securities in which it invests.
No turnover rate is calculated for the Equity Value, Principal LifeTime 2010,
Principal LifeTime 2020, Principal LifeTime 2030, Principal
LifeTime 2040, Principal LifeTime 2050 and Principal LifeTime Strategic Income
Accounts as they have been in existence for less than six months. Turnover
rates for each of the other Accounts may be found in the Account's Financial
Highlights table.
Please consider all the factors when you compare the turnover rates of different
funds. A fund with consistently higher total returns and higher turnover rates
than another fund may actually be achieving better performance precisely because
the managers are active traders. You should also be aware that the "total
return" line in the Financial Highlights section already includes portfolio
turnover costs.
PRICING OF ACCOUNT SHARES
Each Account's shares are bought and sold at the current share price. The share
price of each Account is calculated each day the New York Stock Exchange
("NYSE") is open (shares are not priced on the days on which the NYSE is closed
for trading). The share price is determined at the close of business of the NYSE
(normally 3:00 p.m. Central time). When an order to buy or sell shares is
received, the share price used to fill the order is the next price calculated
after the order is received.
For all Accounts, except the Money Market Account, the share price is calculated
by:
.. taking the current market value of the total assets of the Account
.. subtracting liabilities of the Account
.. dividing the remainder by the total number of shares owned by the Account.
The securities of the Money Market Account are valued at amortized cost. The
calculation procedure is described in the SAI. The Money Market Account reserves
the right to determine a share price more than once each day.
NOTES:
.. If current market values are not readily available for a security owned by an
Account, its fair value is determined using a policy adopted by the Directors.
.. An Account's securities may be traded on foreign securities markets that
generally complete trading at various times during the day prior to the close
of the NYSE. The values of foreign securities used in computing share price
are determined at the time the foreign market closes. Occasionally, events
affecting the value of foreign securities occur when the foreign market is
closed and the NYSE is open. The NAV of an Account investing in foreign
securities may change on days when shareholders are unable to purchase or
redeem shares. If the Sub-Advisor believes that the market value is materially
affected, the share price will be calculated using the policy adopted by the
Fund.
.. Certain securities issued by companies in emerging market countries may have
more than one quoted valuation at any point in time. These may be referred to
as local price and premium price. The premium price is often a negotiated
price that may not consistently represent a price at which a specific
transaction can be effected. The Fund has a policy to value such securities at
a price at which the Sub-Advisor expects the securities may be sold.
DIVIDENDS AND DISTRIBUTIONS
The issuer of an equity security held by an Account may make a dividend payment.
When an Account receives a dividend, it increases the net asset value of a share
of the Account.
An Account accrues interest daily on its fixed-income securities in anticipation
of an interest payment from the issuer of the security. This accrual increases
the net asset value of an Account.
The Money Market Account (or any other Account holding commercial paper)
amortizes the discount on commercial paper it owns on a daily basis. This
increases the net asset value of the Account.
NOTE: As the net asset value of a share of an Account increases, the unit value
of the corresponding division also reflects an increase. The number of
units you own in the Account are not increased.
MANAGEMENT, ORGANIZATION AND CAPITAL STRUCTURE
THE MANAGER
Principal Management Corporation serves as the manager for the Fund. In its
handling of the business affairs of the Fund, the Manager provides clerical,
recordkeeping and bookkeeping services, and keeps the required financial and
accounting records. In addition, the Manager is responsible for the portfolio
management function for certain Accounts.
MANAGER: The Manager is an indirect subsidiary of Principal Financial Services,
Inc. and has managed mutual funds since 1969. As of December 31, 2003,
the mutual funds it manages had assets of approximately $7.8 billion.
The Manager's address is Principal Financial Group, Des Moines, Iowa
50392-2080.
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DAY-TO-DAY
ACCOUNT ACCOUNT MANAGEMENT
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Bond William C.Armstrong
Larry Post
Timothy R. Warrick
Money Market Michael R. Johnson
Tracy Reeg
Alice Robertson
Real Estate Securities Kelly D. Rush
WILLIAM C. ARMSTRONG, CFA . Mr. Armstrong leads the multi-sector/core portfolio
management group for a member company of the Principal Financial Group. Mr.
Armstrong has been with the Principal Financial Group since 1992. He earned his
Master's degree from the University of Iowa and his Bachelor's degree from
Kearney State College. He has earned the right to use the Chartered Financial
Analyst designation
MICHAEL R. JOHNSON . Mr. Johnson directs securities trading for Principal. He
joined the Principal Financial Group in 1982 and took his current position in
1994. His responsibilities include managing the fixed-income trading operation
for Principal and several short-term money market accounts. Mr. Johnson earned
his Bachelor's degree in Finance from Iowa State University.
LAWRENCE A. POST . Mr. Post joined Principal in 2003 with over 30 years of
investment experience. Prior to founding the Post Advisory Group in 1992, he
founded the high yield bond department at Smith Barney, and subsequently served
as director of high yield research at Salomon Brothers and co-director of
research and senior trader at Drexel Burnham Lambert. Mr. Post received an MBA
in Business Administration from the University of Pennsylvania's Wharton School
of Business and a Bachelor's degree from Lehigh University.
TRACY REEG. . Ms. Reeg is a portfolio manager at Principal specializing in the
management and research areas for the short-term money market portfolios. She
joined the firm in 1993. Ms. Reeg received a Bachelor's degree in Finance from
the University of Northern Iowa. She is a member of the Life Office Management
Association (LOMA) and is a Fellow of the Life Management Institute (FLMI).
ALICE ROBERTSON . Ms. Robertson is a trader for Principal on the corporate
fixed-income trading desk. She joined the Principal Financial Group in 1990 as a
credit analyst and moved to her current position in 1993. Previously, Ms.
Robertson was an assistant vice president/commercial paper analyst with Duff &
Phelps Credit Company. Ms. Robertson earned her Master's degree in Finance and
Marketing from DePaul University and her Bachelor's degree in Economics from
Northwestern University.
KELLY D. RUSH, CFA . Mr. Rush directs the Real Estate Investment Trust (REIT)
activity for Principal - REI. Mr. Rush joined the Principal Financial Group in
1987 and has been dedicated to public real estate investments since 1995. His
experience includes the structuring of public real estate transactions that
included commercial mortgage loans and the
issuance of unsecured bonds. He received his Master's degree and Bachelor's
degree in Finance from the University of Iowa. He has earned the right to use
the Chartered Financial Analyst designation.
TIMOTHY R. WARRICK, CFA . Mr. Warrick is a co-portfolio manager at Principal
with responsibility for the U.S. multi-sector product with focus on the
management of U.S. credit instruments. His prior responsibilities with the firm
include portfolio management for multiple asset class portfolios, product
development and fixed income credit analyst duties. He joined Principal in 1990.
In 1996, Mr. Warrick joined ReliaStar Investment Research, Inc. and was
responsible for multiple asset classes, including corporate bonds and leveraged
bank loans. He rejoined Principal in 1998 as a portfolio manager. He received an
MBA in Finance from Drake University and a Bachelor's degree in Accounting and
Economics from Simpson College. He holds the Chartered Financial Analyst
designation and is a member of the Association for Investment Management and
Research (AIMR).
THE SUB-ADVISORS
The Manager has signed contracts with various Sub-Advisors. Under the
Sub-Advisory agreements, the Sub-Advisor agrees to assume the obligations of the
Manager to provide investment advisory service for a specific Account. For these
services, the Sub-Advisor is paid a fee by the Manager.
SUB-ADVISOR: American Century Investment Management, Inc. ("American Century")
was founded in 1958. Its office is located in the American Century
Tower at 4500 Main Street, Kansas City, MO 64111. As of December 31,
2003, American Century managed over $87.4 billion in assets.
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Equity Value Brendan Healy, CFA
Mark Mallon, CFA
Charles A. Ritter, CFA
BRENDAN HEALY, CFA . Mr. Healy, Portfolio Manager, has been a member of the team
that manages Large Company Value since he joined American Century in April 2000
and has been a Portfolio Manager since February 2004. Before joining American
Century, he spent six years with USAA Investment Management Company as an Equity
Analyst. He has a bachelor's degree in mechanical engineering from the
University of Arizona and an MBA from the University of Texas-Austin. He is a
CFA charterholder.
MARK MALLON, CFA . Mark Mallon, CFA. Mr. Mallon, Chief Investment Officer and
Executive Vice President, has been a member of the team that manages Large
Company Value since its inception in July 1999. He joined American Century in
April 1997. Before joining American Century, he spent 19 years at Federated
Investors, most recently serviced as President and Portfolio Manager of
Federated Investment Counseling. Mr. Mallon has a bachelor of arts from
Westminster College and an MBA from Cornell University.
CHARLES A. RITTER, CFA . Mr. Ritter, Vice President and Senior Portfolio
Manager, has been a member of the team that manages Large Company Value since
its inception in July 1999. He joined American Century in December 1998. Before
joining American Century, he spent 15 years with Federated Investors, most
recently serving as a Vice President and Portfolio Manager for the company. He
has a bachelor's degree in mathematics and a master's degree in economics from
Carnegie Mellon University. He also has a MBA from the University of Chicago.
SUB-ADVISOR: Alliance Capital Management L.P. ("Alliance") through its Bernstein
Investment Research and Management unit ("Bernstein"). As of December
31, 2003, Alliance managed $474.6 billion in assets.
Bernstein is located at 767 Fifth Avenue, New York, NY 10153 and
Alliance is located at 1345 Avenue of the Americas, New York, NY 10105.
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LargeCap Value Marilyn G. Fedak
John D. Phillips, Jr.
MARILYN G. FEDAK, CFA . Ms. Fedak was named executive vice president and chief
investment officer for U.S. Value Equities of Alliance Capital in 2000. She
became chief investment office for U.S. Value Equities and chairman of the
Bernstein U.S. Equity Investment Policy Group at Sanford C. Bernstein & Co.,
Inc. in 1993. She had previously served as a senior portfolio manager since
joining the firm in 1984. From 1972 to 1983, she was a portfolio manager and
research analyst at Morgan Guaranty Trust Company. She earned a BA from Smith
College in 1968 and an MBA from Harvard University in 1972. She has earned the
right to use the Chartered Financial Analyst designation.
JOHN D. PHILLIPS, JR., CFA . Mr. Phillips, Senior Portfolio Manager - U.S. Value
Equities, is a member of the Investment Policy Group, and member of the Research
Review Committee. He joined the firm in 1994. From 1992 to 1993, he was chairman
of the Investment Committee and chief equity officer at Investment Advisers,
Inc. in Minneapolis. From 1972 to 1992, he was at State Street Research and
Management Co. in Boston, where he progressed from investment research analyst
to vice chairman of the Equity Investment Committee. He earned a BA from
Hamilton College and an MBA from Harvard University. He has earned the right to
use the Chartered Financial Analyst designation.
SUB-ADVISOR: The Dreyfus Corporation ("Dreyfus"), 200 Park Avenue, New York, NY
10166, was formed in 1947. Dreyfus is a wholly owned subsidiary of
Mellon Bank, N.A., which is a wholly owned subsidiary of Mellon
Financial Corporation. As of December 31, 2003, Dreyfus managed 201
portfolios with approximately $167 billion in investment company
assets.
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MidCap Growth William C. Jurik
John O'Toole
WILLIAM C. JURIK, CFA . Mr. Jurik is a portfolio manager of The Dreyfus
Corporation and Vice President of Mellon Equity Associates LLP (an affiliate of
The Dreyfus Corporation). He joined Mellon Equity in 1999 after having spent the
previous 6 years with Mellon Financial Corporation. Mr. Jurik has earned an MBA
and a BS in Chemical Engineering from Carnegie Mellon University. He is a member
of the Association for Investment Management and Research and the Pittsburgh
Society of Financial Analysts. He is a Chartered Financial Analyst.
JOHN O'TOOLE, CFA . Portfolio Manager of The Dreyfus Corporation and Senior Vice
President of Mellon Equity Associates LLP (an affiliate of The Dreyfus
Corporation) since 1990. Mr. O'Toole holds an MBA in Finance from the University
of Chicago and a BA in Economics from the University of Pennsylvania. He is a
member of the Association for Investment Management and Research, and the
Pittsburgh Society of Financial Analysts. He is a Chartered Financial Analyst.
SUB-ADVISOR: Emerald Advisers, Inc. ("Emerald") is a subsidiary of Emerald Asset
Management which is owned by eleven inside shareholders and one outside
minority shareholder. Emerald provides professional investment advisory
services to institutional investors, high net worth individuals and the
general public. Emerald's offices are located at 1703 Oregon Pike Road,
Suite 101, Lancaster, Pennsylvania 17601.
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SmallCap Growth Kenneth G. Mertz
Stacey L. Sears
KENNETH G. MERTZ II, C.F.A. . Mr. Mertz joined Emerald in 1992 and serves as
President of Emerald Advisers, Inc.; Trustee, Vice President and Chief
Investment Officer of the Emerald Mutual Funds; and a Partner of the Emerald
Organization (1992 - Present). Formerly he served as Chief Investment Officer,
Pennsylvania State Employees' Retirement System (1985-1992). Mr. Mertz graduated
from Millersville University with a BA in Economics.
STACEY L. SEARS . Ms. Sears joined Emerald in 1991 and serves as Senior Vice
President and Portfolio Manager of Emerald Advisers, Inc. and a Partner in the
Emerald Organization. She is co-manager of the Emerald Growth Fund and a member
of the Portfolio Management team. Additionally, Ms. Sears maintains research
coverage of retail, apparel, consumer goods and interactive television
companies. Ms. Sears received a BS in Business Administration from Millersville
University and an MBA from Villanova University.
SUB-ADVISOR: Grantham, Mayo, Van Otterloo & Co. LLC ("GMO") is a privately held
global investment management firm servicing clients in the corporate,
public, endowment and foundation marketplace located at 40 Rowes Wharf,
Boston, MA 02110. As of December 31, 2003, GMO managed more than $54
billion in client assets.
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LargeCap Growth Equity Chuck Joyce
Donna Murphy
Robert Soucy
CHUCK JOYCE . Mr. Joyce is involved in equity analysis and portfolio management
for the U.S. quantitative equity portfolios. Prior to joining GMO, he worked for
IBM and the U.S. Semiconductor Consortium, Sematech. Mr. Joyce earned a BS from
Cornell University and an MBA in Finance from the MIT Sloan School of
Management.
DONNA MURPHY . Ms. Murphy is on GMO's U.S. equity quantitative investment team
with a special focus on product management. Prior to joining GMO, she was a
partner and co-head of product management for INVESCO within its structured
products group. Previously, Ms. Murphy held senior positions with Nicholas
Applegate, UBS and the DAIS Group/Templeton. She earned an BA in Chemistry and
Biology from Elon College and an MBA from the University of North Carolina.
ROBERT SOUCY . Mr. Soucy is the Director of U.S. equity management and is
responsible for all U.S. quantitative equities portfolio management at GMO.
Prior to joining GMO, he served as a research engineer with Scientific Systems,
Inc. Mr. Soucy earned his BS from the University of Massachusetts at Amherst.
SUB-ADVISOR: J.P. Morgan Investment Management Inc. ("Morgan"), 522 Fifth
Avenue, New York, NY 10036 is a wholly-owned subsidiary of J.P. Morgan
Chase & Co. ("J.P. Morgan") a bank holding company. J.P. Morgan,
through Morgan and its other subsidiaries, offers a wide range of
services to governmental, institutional, corporate and individual
customers and acts as investment advisor to individual and
institutional clients. As of December 31, 2003, J.P. Morgan and its
subsidiaries had total combined assets under management of
approximately $559 billion.
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SmallCap Value Christopher T. Blum
CHRISTOPHER T. BLUM, CFA . Vice President of Morgan. Mr. Blum is a portfolio
manager in the U.S. Small Cap Equity Group. He rejoined the firm in 2001.
Previously, he spent two years as a research analyst responsible for the
valuation and acquisition of private equity assets at Pomona Capital. Prior to
that, Mr. Blum spent over three years with J.P. Morgan where he focused on
structured small-cap core and small-cap value accounts. He earned his BBA in
Finance at the Bernard M. Baruch School for Business and is a holder of the CFA
designation.
SUB-ADVISOR: Morgan Stanley Investment Management Inc., which does business in
certain instances (including in its role as sub-advisor to Asset
Allocation) as Morgan Stanley Asset Management ("MSAM"), with principal
offices at 1221 Avenue of the Americas, New York, NY 10020, provides a
broad range of portfolio management services to customers in the U.S.
and abroad. As of December 31, 2003, Morgan Stanley Asset Management,
together with its affiliated asset management companies, had
approximately $421 billion in asset under management with approximately
$174 billion in institutional assets.
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Asset Allocation Francine J. Bovich
FRANCINE J. BOVICH . Ms. Bovich is Managing Director of Morgan Stanley and
Morgan Stanley & Co. Incorporated since 1997. Principal 1993-1996. Ms. Bovich
holds a BA in Economics from Connecticut College, and an MBA in Finance from New
York University.
SUB-ADVISOR: Neuberger Berman Management, Inc. ("Neuberger Berman") is an
affiliate of Neuberger Berman, LLC. Neuberger Berman, LLC is located at
605 Third Avenue, 2nd Floor, New York, NY 10158-0180. Together with
Neuberger Berman, the firms manage more than $70.5 billion in total
assets (as of December 31, 2003) and continue an asset management
history that began in 1939. Neuberger Berman Management, Inc. is an
indirect, wholly owned subsidiary of Lehman Brothers Holdings, Inc.
Lehman Brothers is located at 745 Seventh Avenue, New York, NY 10019.
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MidCap Value Andrew Wellington
ANDREW WELLINGTON . Portfolio Manager, Neuberger Berman, since 2001. Mr.
Wellington earned a BS from the University of Pennsylvania, Wharton School of
Business. He has 12 years of industry experience.
SUB-ADVISOR: Principal Global Investors, LLC ("Principal") is an indirectly
wholly-owned subsidiary of Principal Life Insurance Company and an
affiliate of the Manager. Principal has been active in retirement plan
investing since 1941 and has sub-advised mutual fund assets since 1969.
Principal manages equity, fixed-income and real estate investments
primarily for institutional investors, including Principal Life. As of
December 31, 2003, Principal, together with its affiliated asset
management companies, had approximately $118.5 billion in asset under
management. Principal Global Investor's headquarters
address is 801 Grand Avenue, Des Moines, Iowa 50392 and has other
primary asset management offices in New York, London, Sydney and
Singapore.
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Balanced Paul A. Dow
Dirk Laschanzky
Capital Value John Pihlblad
Equity Income Rollin Woltjen
Government Securities Mark Karstrom
Martin J. Schafer
Growth Mary Sunderland
International Paul H. Blankenhagen
Juliet Cohn
International Emerging Markets Michael A. Marusiak
Michael L. Reynal
International SmallCap Brian W. Pattinson
LargeCap Stock Index Dirk Laschanzky
Limited Term Bond Martin J. Schafer
MidCap K. William Nolin
Principal LifeTime 2010 Dirk Laschanzky
Principal LifeTime 2020 Dirk Laschanzky
Principal LifeTime 2030 Dirk Laschanzky
Principal LifeTime 2040 Dirk Laschanzky
Principal LifeTime 2050 Dirk Laschanzky
Principal LifeTime Strategic Income Dirk Laschanzky
SmallCap Todd Sanders
PAUL H. BLANKENHAGEN, CFA . Mr. Blankenhagen is a portfolio manager at Principal
Global Investors. He is responsible for developing portfolio strategy and
leading the ongoing management of core international equity portfolios including
developed markets portfolios and broad market portfolios. Mr. Blankenhagen is
also active in research with an emphasis on the banking and media industries. He
joined the firm in 1992 and has been a member of the international equity team
since 1995. He was named a portfolio manager in 2000. Mr. Blankenhagen received
a Master's degree from Drake University and a Bachelor's degree in Finance from
Iowa State University. He holds the Chartered Financial Analyst designation, and
is a member of the Association for Investment Management and Research (AIMR) and
the Iowa Society of Financial Analysts.
JULIET COHN . Ms. Cohn is a portfolio manager at Principal Global Investors.
Prior to joining the firm in 2003, she served as a director and senior portfolio
manager at Allianz Dresdner Asset Management, managing both retail and
institutional European accounts. Prior to that, she was a fund manager at London
firms Capel Cure Myers and Robert Fleming. She earned a bachelor's degree in
Mathematics from Trinity College Cambridge England.
PAUL A. DOW, CFA . Mr. Dow is managing director of US equities for Principal
Global Investors. He joined the firm in January 2002, with over 28 years of
prior experience in institutional asset management, including over 17 years
direct experience in the management of institutional equity portfolios. Most
recently Mr. Dow spent over a decade with First American Asset Management, and
its predecessor Piper Capital Management, where he held various positions
including, head of equities, chief investment officer, president and chief
executive. He received a Bachelor's degree
from Southwest Missouri State University. He holds the Chartered Financial
Analyst designation and is a member of the Association for Investment Management
and Research (AIMR).
MARK KARSTROM. . Mr. Karstrom is a portfolio manager at Principal with
responsibility for mortgage-backed securities. Prior to joining Principal in
2001, Mr. Karstrom was a portfolio manager for Scudder Kemper Investments. He
received a BA in Economics from the University of Denver. He is a member of the
Association for Investment Management and Research (AIMR) and a Level II
candidate for the Chartered Financial Analyst Designation.
DIRK LASCHANZKY, CFA . As a portfolio manager at Principal, Mr. Laschanzky is
responsible for asset allocation and provides advice to clients concerning their
portfolios across all asset classes. Prior to joining Principal in 1997, he was
a portfolio manager and analyst for over seven years at AMR Investment Services
where he managed short-term money market funds and was responsible for American
Airlines' pension plan investment management. He also served as a financial
analyst for American Airlines. He received an MBA and BA, both in Finance, from
the University of Iowa. He has earned the right to use the Chartered Financial
Analyst designation.
MICHAEL A. MARUSIAK . Mr. Marusiak joined Principal in 2000, specializing in the
international emerging markets sector. Prior to joining Principal, he was an
analyst on Trust Company of the West's global fund management team. He also
worked with SBC Warburg of London as a research analyst responsible for Eastern
Europe, the Middle East and Africa. He earned an MIA in International Finance
from the Columbia University School of International and Public Affairs and a BA
in Business Administration and Finance from Simon Fraser University of Burnaby,
British Columbia.
K. WILLIAM NOLIN, CFA . Mr. Nolin has managed the domestic mid-cap equity
portfolios since 1999. His expertise is grounded in the telecommunications,
media & entertainment, lodging and consumer non-durables sectors. Mr. Nolin
joined the Principal Financial Group in 1993 as an investment credit analyst. He
earned his MBA from the Yale School of Management and his Bachelor's degree in
Finance from the University of Iowa. He has earned the right to use the
Chartered Financial Analyst designation.
BRIAN W. PATTINSON, CFA . Mr. Pattinson is a portfolio manager at Principal. He
performs international security analysis and strategy development for the firm's
core international equity research effort and also specializes in the
information technology and telecommunication sectors. He joined Principal in
1994. Mr. Pattinson earned his MBA and Bachelor's degree in Finance from the
University of Iowa. He has earned the right to use the Chartered Financial
Analyst designation.
JOHN PIHLBLAD, CFA . Mr. Pihlblad is director of quantitative portfolio
management for Principal. He has over 24 years experience in creating and
managing quantitative investment systems. Prior to joining Principal in 2000,
Mr. Pihlblad was a partner and co-founder of GlobeFlex Capital in San Diego
where he was responsible for the development and implementation of the
investment process for both domestic and international products. He received his
BA from Westminster College. He has earned the right to use the Chartered
Financial Analyst designation.
MICHAEL L. REYNAL . Mr. Reynal joined Principal in 2001, specializing in
emerging markets portfolios. Prior to joining Principal, he was responsible for
equity investments in Latin America, the Mediterranean and the Balkans while at
Wafra Investment Advisory Group, Inc. in New York. He also spent four years with
Paribas Capital Markets in New York as the head of the equity trading desk, and
three years with Barclays do Zoete Weed in London, focusing on Latin American
equity trading. Mr. Reynal received an MBA from the Amos Tuck School at
Dartmouth College in New Hampshire, a BA/MA in History from Christ's College at
Cambridge University in England and a BA in History from Middlebury College in
Vermont.
TODD SANDERS, CFA . Mr. Sanders is an equity analyst for Principal focused on
quantitative research. He joined the firm in 1998. Previously, he was an
investment analyst for NISA Investment Advisors and in credit analysis/risk
management with the U.S. Central Credit Union. He received an MBA in Finance
from Washington University and a Bachelor's degree in Finance/Economics from the
University of Missouri-Columbia. He is a member of the International Association
of Financial Engineers (IAFE), the Global Association of Risk Professionals
(GARP) and the Association of Investment Management and Research (AIMR). He has
earned the right to use the Chartered Financial Analyst designation.
MARTIN J. SCHAFER . Mr. Schafer is a portfolio manager for Principal
specializing in managing mortgage-backed securities and high quality short,
intermediate and long duration portfolios. Mr. Schafer joined the firm in 1977.
In the early 1980s, he developed the firm's secondary mortgage marketing
operation and in 1984, he assumed portfolio management responsibility for its
residential mortgage portfolio. He began managing mutual fund assets in 1985 and
institutional portfolios in 1992. Mr. Schafer holds a Bachelor's degree in
Accounting and Finance from the University of Iowa.
MARY SUNDERLAND, CFA . Prior to joining Principal in 1999, Ms. Sunderland
managed growth and technology portfolios for Skandia Asset Management for 10
years. Ms. Sunderland holds an MBA in Finance from Columbia University Graduate
School of Business and an undergraduate degree from Northwestern University. She
has earned the right to use the Chartered Financial Analyst designation.
ROLLIN C. WOLTJEN . Since 2000, Mr. Woltjen has been executive director of
equities for Principal Global Investors, overseeing the management of domestic,
international and emerging markets equity. He brings over 25 years of
experience in the investment management and consulting industry to the firm.
Previously, he was president of DeMarche Associates, Inc., an institutional
consulting and investment research firm. He received a Bachelor's degree from
Rider College in Trenton, NJ. He is an associate member of the Association for
Investment Management and Research (AIMR).
SUB-ADVISOR: T. Rowe Price Associates, Inc. ("T. Rowe Price"), a wholly-owned
subsidiary of T. Rowe Price Group, Inc., a financial services holding
company, has over 67 years of investment management experience.
Together with its affiliates, T. Rowe Price had approximately $190.0
billion in assets under management as of December 31, 2003. T. Rowe
Price is located at 100 East Pratt Street, Baltimore, MD 21202
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Equity Growth Robert W. Sharps
LargeCap Blend William J. Stromberg
Richard T. Whitney
M. Christine Wojciechowski
ROBERT W. SHARPS, CFA . Mr. Sharps is a Vice President of T. Rowe Price Group,
Inc., and T. Rowe Price Associates, Inc. He is also a Portfolio Manager with the
Large-Cap Growth Strategy Team in the Equity Division. Prior to joining the firm
in 1997, Mr. Sharps was a Senior Consultant at KPMG Peat Marwick. He earned a
BS, summa cum laude, in Accounting from Towson University and an MBA in Finance
from the Wharton School, University of Pennsylvania. He has also earned the
Chartered Financial Analyst and Certified Public Accountant accreditations.
WILLIAM J. STROMBERG, CFA . Mr. Stromberg is a Vice President of T. Rowe Price
Group, Inc., and T. Rowe Price Associates, Inc., Director of Global Equity
Research, and a member of the Equity Steering Committee. Prior to joining the
firm in 1987, he was employed as a Systems Engineer for the Westinghouse Defense
and Electronics Center. He earned a BA from Johns Hopkins University and an MBA
from Tuck School of Business at Dartmouth College. He has earned the right to
use the Chartered Financial Analyst designation.
RICHARD T. WHITNEY, CFA . Mr. Whitney is a Vice President of T. Rowe Price
Group, Inc. and T. Rowe Price, and a Portfolio Manager in the Systematic Equity
Group. Prior to joining the firm in 1985, Mr. Whitney was employed by the
Chicago Board of Trade and IBM. He earned a BS and an MEE in Electrical
Engineering from Rice University and an MBA from the University of Chicago. He
has earned the right to use the Chartered Financial Analyst designation.
M. CHRISTINE WOJCIECHOWSKI, CFA . Ms. Wojciechowski is a Vice President of T.
Rowe Price and a Quantitative Analyst in the Systematic Equity Group. She joined
the firm in 1984 as a Fund Accountant and began trading for the Taxable Bond
Division in 1988. Ms. Wojciechowski earned a BBA from Loyola College and an MBA
from the same institution. She has earned the right to use the Chartered
Financial Analyst designation.
SUB-ADVISOR: UBS Global Asset Management (Americas) Inc., a Delaware corporation
located at 1 North Wacker, Chicago, IL 60606 ("UBS Global AM"), is a
registered investment advisor. UBS Global AM, a subsidiary of UBS AG,
is a member of the UBS Global Asset Management business group (the
"Group") of UBS AG. As of March 31, 2004, UBS Global AM managed
approximately $53.8 billion in assets and the Group managed
approximately $475.0 billion in assets.
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SmallCap Growth Investment decisions for the
Fund are made by investment
management teams at UBS Global
AM, including Paul A. Graham,
Jr. and David N. Wabnik. No
member of the investment
management team is primarily
responsible for making
recommendations for portfolio
purchases.
PAUL A. GRAHAM, JR., CFA . Mr. Graham joined UBS Global AM in 1994 and has had
portfolio management responsibilities since 1994. Mr. Graham is Executive
Director, Co-Head of U.S. Small Cap Growth Equity. For eight years prior to
joining the firm, he served as a small cap portfolio manager and research
analyst at Value Line Asset Management. Mr. Graham received his BA from
Dartmouth College. He has earned the right to use the Chartered Financial
Analyst designation and is a member of the New York Society of Security
Analysts.
DAVID N. WABNIK . Mr. Wabnik joined UBS Global AM in 1995 and has been a
portfolio manager since 1995. Mr. Wabnik is Executive Director, Co-Head of U.S.
SmallCap Growth Equity. For four years prior to joining the firm, he served as a
small cap portfolio manager/senior research analyst at Value Line Asset
Management. Mr. Wabnik received his BS from Binghamton University and his MBA
from Columbia Business School. He has completed the Certified Financial Analyst
Level I exams.
DUTIES OF THE MANAGER AND SUB-ADVISOR
The Manager or Sub-Advisor provides the Directors of the Fund with a recommended
investment program. The program must be consistent with the Account's investment
objective and policies. Within the scope of the approved investment program, the
Manager or Sub-Advisor advises the Account on its investment policy and
determines which securities are bought or sold, and in what amounts.
FEES PAID TO THE MANAGER
The Manager is paid a fee by each Account for its services, which includes any
fee paid to the Sub-Advisor. The fee paid by each Account (as a percentage of
the average daily net assets) for the fiscal year ended December 31, 2003 was:
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Asset Allocation 0.80% LargeCap Growth Equity 1.00%
Balanced 0.59% LargeCap Stock Index 0.35%
Bond 0.46% LargeCap Value 0.75%
Capital Value 0.60% Limited Term Bond 0.50%
Equity Growth 0.76% MidCap 0.60%
Equity Income 0.60% MidCap Growth 0.90%
Government Securities 0.43% MidCap Value 1.05%
Growth 0.60% Money Market 0.48%
International 0.85% Real Estate Securities 0.90%
International Emerging SmallCap
Markets 1.25% 0.85%
International SmallCap 1.20% SmallCap Growth 1.00%
LargeCap Blend 0.75% SmallCap Value 1.10%
The Fund also entered into an agreement with the Manager for the Equity Value,
Principal LifeTime 2010, Principal LifeTime 2020, Principal LifeTime 2030,
Principal LifeTime 2040, Principal LifeTime 2050, Principal LifeTime Strategic
Income Accounts which were added to the Fund as of August 30, 2004. Under that
agreement, the Fund will pay the Manager 0.85% for the Equity Value Account and
0.1225% for each of the Principal LifeTime Accounts (an annual rate calculated
as a percentage of the average daily net assets).
The Fund and the Manager, under an order received from the SEC, may enter into
and materially amend agreements with Sub-Advisors without obtaining shareholder
approval. For any Account that is relying on that order, the Manager may:
.. hire one or more Sub-Advisors;
.. change Sub-Advisors; and
.. reallocate management fees between itself and Sub-Advisors.
The Manager will continue to have the ultimate responsibility for the investment
performance of these Accounts due to its responsibility to oversee Sub-Advisors
and recommend their hiring, termination and replacement. No Account will rely on
the order until it receives approval from its shareholders or, in the case of a
new Account, the Account's sole initial shareholder before the Account is
available to the public, and the Fund states in its prospectus that it intends
to rely on the order. The Manager will not enter into an agreement with an
affiliated Sub-Advisor for an Account that is relying on the order without that
agreement, including the compensation to be paid under it, being similarly
approved.
The Asset Allocation, Equity Growth, Equity Value, LargeCap Blend, LargeCap
Growth Equity, LargeCap Value, MidCap Growth, MidCap Value, SmallCap Growth and
SmallCap Value Accounts have received the necessary shareholder approval and
intend to rely on the order.
MANAGERS' COMMENTS
Principal Management Corporation and its Sub-Advisors are staffed with
investment professionals who manage each individual Account. Comments by these
individuals in the following paragraphs summarize in capsule form the general
strategy and results of each Account for 2003. The accompanying graphs display
results for the past 10 years or the life of the Account, whichever is shorter.
Average annual total return figures provided for each Account in the graphs
The various indices included in the following graphs are unmanaged and do not
reflect any commissions or fees which would be incurred by an investor
purchasing the securities included in the index. Investors cannot invest
directly into these or any indices.
ASSET ALLOCATION ACCOUNT
Market Environment
World financial markets ended the year with one of the best
performances in three years despite a turbulent first half marked by
geopolitical fears, economic uncertainties and the threat of SARS. Equity
markets staged an impressive rally during the second half on a wave of investor
enthusiasm following the end of the Iraq war and massive liquidity stimulus. The
rally was further supported by evidence of a synchronized global recovery, as
stronger demand emerged in Asia and Europe. Even news of Wall Street scandals in
the fourth quarter, which in prior years would have sent markets reeling, could
not deflate investor enthusiasm. In a reversal of fortune, the three-year bond
rally came to an end when bond and equity returns decoupled in the third
quarter. The 10-Year Treasury yield rose to 4.3% by year-end from a historic low
of 3.1% in June as the specter of deflation faded. Defying most analysts'
forecasts of single-digit equity returns for 2003, the S&P 500 Index rose 28.7%,
MSCI EAFE Index rose 38.6%, while the Lehman Aggregate Index returned 4.1% for
the year.
GROWTH OF $10,000
Total Returns of the Account
as of December 31, 2003
1 Year 5 Year Life of Fund
21.61% 4.31% 8.49%*
* Since inception 6/1/94
[Enlarge/Download Table]
Morgan Stanley
Capital
International
EAFE (Europe,
Australia and Lehman Brothers Morningstar Moderate Asset
Far East) Index Bond Index S&P 500 Index Allocation Category Allocation Account
10 10 10 10 10
"1994" 10.048 10.051 10.204 10.007 10.052
"1995" 11.174 11.907 14.039 12.584 12.128
"1996" 11.85 12.339 17.262 14.357 13.696
"1997" 12.061 13.53 23.021 17.135 16.187
"1998" 14.473 14.706 29.599 19.395 17.673
"1999" 18.375 14.585 35.827 21.426 21.117
"2000" 15.771 16.281 32.563 21.795 21.457
"2001" 12.363 17.655 28.695 20.751 20.616
"2002" 10.392 19.466 22.351 18.373 17.948
"2003" 14.402 20.264 28.764 22.059 21.827
LOGO
Performance
For the year ended December 31, 2003, the Variable Asset Allocation Fund ( net
of fees) returned 20.1%, which outperformed the Morningstar Moderate Allocation
Median of 17.7%, and ranked in the top 26th percentile for the year. The Fund
outperformed the financial benchmark (45% S&P 500, 15% MSCI EAFE, 40% Lehman
Aggregate Index) return of 19.8% for the same time period.
Strategy Review
The Fund's asset allocation decision was one of the largest contributors to
performance. We entered the fiscal year with a significant overweight to
equities and underweight to bonds, based on attractive valuations and oversold
sentiment. Overall, our constructive stance on equities was favorable for the
year, as equities outperformed.
Within our overweight to equities we preferred the non-US to the US, which added
to results. The portfolio's non-US exposure, particularly to Asia and Emerging
Markets contributed strongly to results, as these regions outperformed the US in
the second half. These regions benefited from excess liquidity and improved
global growth.
Our active currency decision to underweight the US dollar and overweight
non-dollar currencies was highly favorable. Our bearish stance on the dollar was
based on deteriorating fundamentals of a massive US current account deficit and
negative real short-term interest rates. During the year we established our US
dollar underweight by adding to the Euro, Japanese Yen, Canadian Dollar, and
more recently, the Chinese Renminbi.
Within fixed income, exposure to High Yield added significantly to returns. High
yield bonds delivered stellar returns, highlighting investors' increased risk
appetite and stronger economic growth.
U.S. Sector selection detracted from results. In the second half we preferred
cyclicals to defensive sectors, which was not rewarded as cyclicals remained the
market leaders.
Market Outlook
The U.S. economic recovery appears to have broadened to the overall global
economy with positive economic news stemming from Europe and Asia. In the U.S.,
economic activity has been strong highlighted by double-digit capex growth,
inventory liquidation and strong export growth. Even the labor market, the
Achilles' heel of the U.S. economy, showed tentative signs of improvement. The
strength of the recovery is remarkable given lingering structural issues of twin
deficits, low levels of capacity utilization and a declining dollar. This
dramatic economic turnaround appears to validate the massive liquidity stimulus
provided to markets earlier in the year. Despite the surge in growth, monetary
policy remains accommodative as inflation has been kept at bay. Although the
U.K. and Australia have tightened policy recently, the U.S. Federal Reserve
remains reluctant to shift from an easing policy stance until the recovery is
sustainable.
The current environment of strong growth accompanied by high liquidity
historically has proven supportive for the economy, corporate profits and
equities. While the Fed typically tightens monetary policy following such robust
periods of growth, we believe a longer reprieve will be granted in this cycle
given remaining uncertainties, particularly the weak labor market. With both
valuations and economic dynamics favoring equities relative to bonds, we remain
overweight equities and underweight bonds relative to the benchmark. We continue
to search for areas outside the U.S. that offer favorable valuations and are
more attractively priced for a moderate growth environment. We prefer Europe
ex-UK, Japan, Hong Kong, and the Emerging Markets. Within U.S. sectors we have
reduced exposure to higher beta sectors in favor of groups that offer more
stable growth supported by high free cash flows, solid return on equity, strong
sales growth, and relatively cheap valuations.
BOND ACCOUNT
While U.S. interest rates ended 2003 very close to where they started the year
(based on the 10-year Treasury bond), there were sharp fluctuations in between.
The constant for the year was a patient Federal Reserve (Fed), which has been
willing to drive short-term rates to very low levels and keep them there.
Consequently, the upward rate pressure of more rapid growth was largely
nullified, as the Fed anchored short-term rates, and the 10-year Treasury rate
ended the year at 4.26%. Given monetary and fiscal stimulus, corporate credit
conditions became very favorable during the year, producing excellent corporate
bond returns.
GROWTH OF $10,000
Total Returns of the Account
as of December 31, 2003
1 Year 5 Year 10 Year Life of Fund
4.59% 5.42% 6.53% 8.19%*
* Since inception 12/18/87
[Download Table]
Morningstar
Lehman Brothers Intermediate-Term
Aggregate Bond Index Bond Category Bond Account
10 10 10
"1994" 9.708 9.627 9.71
"1995" 11.501 11.297 11.862
"1996" 11.918 11.67 12.142
"1997" 13.068 12.692 13.429
"1998" 14.204 13.634 14.461
"1999" 14.088 13.468 14.086
"2000" 15.726 14.741 15.237
"2001" 17.053 15.826 16.474
"2002" 18.803 17.073 17.999
"2003" 19.574 17.913 18.825
LOGO
Corporate bonds performed well, as companies continued to repair their balance
sheets and realized significant earnings growth. This, in conjunction with
moderate corporate bond supply, kept the demand for corporate bonds high. Risk
premiums declined during the quarter, driven by low interest rates and an
improving economy. This caused riskier sectors within fixed income to
consistently outperform, and reversed the flight to quality trend that occurred
in 2002.
The Bond Account outperformed the Lehman Aggregate Index during the year with a
return of 4.59% vs. 4.10%. Sector allocation during the year was appropriate,
with overweighted positions vs. the index to some of the best performing fixed
income sectors. One of the major drivers of performance during the year was an
increased allocation to below-investment grade corporate bonds. These bonds,
which are not a component of the Lehman Aggregate Index, posted the best
performance among all fixed income sectors. For the year, this asset class
posted a 26.42% excess return over similar duration U.S. Treasuries. Duration is
a measure of bond price sensitivity to changes in interest rates. Another key
driver of performance during the year was an overweighted position to investment
grade corporate bonds. Investment grade credit was the second-best sector in
fixed income, posting a 5.27% excess return. Underweighted positions to U.S.
Treasuries and agencies also enhanced performance, as these sectors were two of
the worst performers in the index.
Our 2004 sector recommendations are based on a sustainable economic recovery in
which gross domestic product (GDP) growth will be approximately 4.5% in 2004.
The market continues to focus on job creation and the recent improvement in
non-farm payroll growth has made investors more confident that the economic
rebound will continue. In addition, earnings announcements have generally
exceeded expectations, and companies have continued to improve their financial
condition by paying down and extending debt maturities. This fundamental
improvement, combined with the technically-driven search for yield, led to
significant outperformance by the riskier, spread sectors throughout 2003. Our
outlook is for this to continue in early 2004. The fund continues to be
overweighted in investment grade corporate bonds and has a 10% weighting to
below investment grade corporate bonds. U.S. Treasuries and agencies remain
underweighted, as these securities offer less relative value in an environment
of low interest rates and improving economic conditions. The fund is currently
neutral duration to the index.
BALANCED ACCOUNT
The major domestic stock market indexes had a positive year during 2003,
reversing some of the negative performance over the past few years. The S&P 500
Index advanced 28.69% during the year, while the Russell 2000 Index,
representing small-cap companies, was up 47.25%. Higher corporate earnings and
positive economic news drove this equity market advance. The economy appears
positioned for continuing growth with low inflation.
GROWTH OF $10,000
Total Returns of the Account
as of December 31, 2003
1 Year 5 Year 10 Year Life of Fund
18.82% -0.32% 6.01% 8.44%*
* Since inception 12/18/87
[Download Table]
Lehman Brothers Morningstar Moderate
S&P 500 Index Aggregate Bond Index Allocation Category Balanced Account
10 10 10 10
"1994" 10.132 9.708 9.772 9.791
"1995" 13.94 11.501 12.288 12.198
"1996" 17.141 11.918 14.019 13.8
"1997" 22.859 13.068 16.732 16.274
"1998" 29.391 14.204 18.939 18.213
"1999" 35.575 14.088 20.922 18.65
"2000" 32.334 15.726 21.282 18.674
"2001" 28.493 17.053 20.263 17.374
"2002" 22.193 18.803 17.941 15.084
"2003" 28.56 19.574 21.54 17.923
LOGO
Small-cap companies tended to outperform large-cap companies during the year, as
investors sought more aggressive opportunities to add to their equity returns.
Value and growth companies both advanced nearly equally during the year, but
value companies did have a slight advantage in total return. Our asset
allocation has benefited from a positive position in value equities vs. growth
during the year. The exposure to small-cap companies was also a positive to
overall returns.
During 2003, the balanced portfolio outperformed the benchmark 60% S&P 500/40%
Lehman Aggregate Index. The portfolio's return was 18.82%, while the benchmark
advanced 18.47% for the trailing 12 months. The outperformance was driven by the
asset allocation positions to overweight equities relative to fixed income,
which provided only a small positive return during the year. In addition to
positive performance from small-cap exposure, there was also positive
performance from international equity exposure in the account.
The underlying equity portfolios tended to underperform their respective indexes
during the year, but positive performance from asset allocation offset the
equity underperformance. The fixed income portfolios were underweighted during
the year, which was a positive since the equity markets provided returns well
above the 4.10% return of the Lehman Aggregate Bond Index during 2003. The
portfolio continues to be well positioned for the new year, with an overweighted
position in equities and exposure to small-cap and international equity markets.
CAPITAL VALUE ACCOUNT
The Capital Value Account underperformed both the Morningstar peer group and the
Russell 1000 Value Index for the year ended December 31, 2003. The portfolio
returned 25.49%, trailing the index by -4.54%. The focus on improving
fundamentals and confirmation of those improvements hurt our returns, as
companies with low valuations and poor fundamentals continued their strong
relative performance.
GROWTH OF $10,000
Total Returns of the Account
as of December 31, 2003
1 Year 5 Year 10 Year Life of Fund
25.49% -0.52% 8.82% 12.06%*
* Since inception 5/13/70
[Download Table]
Russell 1000 Morningstar Large Capital
Value Index Value Category Value Account
10 10 10
"1994" 9.802 9.919 10.049
"1995" 13.562 13.121 13.255
"1996" 16.497 15.849 16.37
"1997" 22.301 20.13 21.041
"1998" 25.787 22.767 23.898
"1999" 27.682 24.276 22.873
"2000" 29.625 25.604 23.367
"2001" 27.969 24.229 21.486
"2002" 23.628 19.645 18.551
"2003" 30.723 25.224 23.28
LOGO
During 2003, the stock market posted its first annual gain in four years. The
economy established a solid footing, job creation began to take hold, investment
expanded and confidence grew. A majority of the portfolio's underperformance for
the 12 months stemmed from stock selection. Information technology, health care,
and utilities were the best-performing sectors for the period. The consumer
discretionary, financials, and materials sectors were negative contributors to
performance. Many companies in these sectors have experienced significant price
rebounds in anticipation of potential earnings rebounds, which have not
materialized. Large holdings with strong performance for the year included
Countrywide Financial Corp, Lennar, and Edison International. Companies that
hurt our performance this past year included Liberty Media, Lockheed Martin, and
Sprint.
The economic momentum from third quarter's 8.2% annual rate of real economic
growth carried over into the fourth quarter with only a small drop off. Consumer
spending growth moderated somewhat but the dip was more than compensated for by
renewed investment and industrial vigor. Job losses waned and the long-awaited
pickup in employment got underway. Purchasing manager surveys hit their highest
levels in 20 years, boding well for future growth. Chinese and U.S. growth are
fueling a synchronized global expansion. During 2003, the stock market posted
its first annual gain in four years. Looking forward, the U.S. economic future
looks bright, suggesting the recession is over and a recovery is on.
In managing equity portfolios, our investment philosophy is based on the belief
that superior stock selection is the key to consistent and repeatable
outperformance. To identify these stocks, we focus on finding companies with 1)
improving business fundamentals, 2) rising investor expectations, and 3)
attractive relative valuation.
Our equity portfolio construction process reflects an active, bottom-up
management style, in which security selection drives excess returns relative to
the designated index. This process is maintained while neutralizing unintended
risks.
EQUITY GROWTH ACCOUNT
In 2003 a number of positive stimuli moved the market forward. The war in Iraq
removed a significant geopolitical concern that had hung over the market for
some time. The Bush Administration's passage of tax cuts for income, capital
gains, and dividends served to make equity investing more appealing. Low
interest rates spurred record mortgage refinancing, robust home purchasing
activity, debt restructuring, and balance sheet de-leveraging. Corporate
earnings recovered after declines in 2001 and 2002, with results topping
expectations for the first three quarters of 2003. Manufacturing activity, as
reported by the Institute for Supply Management, rose to 66.2 as of December
month-end. The advance resulted from an expansion in new orders and a boost in
production, both of which point to industrial growth. The University of
Michigan's survey of consumer sentiment increased to a level of 92.6 during the
year, suggesting that consumers are gaining confidence in the recovery, but are
still waiting for labor market improvement. 2003 will also be remembered for the
weak U.S. dollar and as a period during which cheaper, more speculative stocks
rallied. Small-cap stocks performed best for the year, followed by mid- and
large-caps. Growth outpaced value in small and mid cap stocks, but styles were
even in large caps. Against this backdrop, the S&P 500 returned 28.68% and the
Lipper Large Cap Growth peer group returned 29.96%.
GROWTH OF $10,000
Total Returns of the Account
as of December 31, 2003
1 Year 5 Year Life of Fund
25.95% -0.92% 11.40%*
* Since inception 6/1/94
[Download Table]
Russell 1000 Morningstar Large Equity Growth
Growth Index Growth Category Account
10 10 10
"1994" 10.191 10.114 10.259
"1995" 14.04 13.378 14.792
"1996" 17.192 15.913 18.941
"1997" 22.84 19.891 24.784
"1998" 29.011 26.566 29.481
"1999" 35.077 37.118 41.126
"2000" 32.341 31.888 36.31
"2001" 28.315 24.353 30.914
"2002" 22.185 17.6 22.345
"2003" 28.818 22.625 28.144
LOGO
During 2003, across the market cap spectrum, smaller cap and lower quality, more
speculative stocks exceeded larger, higher quality names. Our emphasis on the
larger, higher quality names we favor had an opportunity cost to our
performance.
While sector allocations added to relative return, stock selection was a
detractor. Stock selection was weakest in the consumer discretionary sector. An
overweight in the sector was a modest positive. The portfolio was hampered by
weak performance from a number of retailers, including Wal-Mart, one of the
fund's 10 largest positions. Wal-Mart suffered from negative publicity and
increased scrutiny surrounding its labor practices. In the third quarter, we
established a substantial position in media stocks, some of which performed well
through year-end, while others lagged. We believe these stocks are poised for
strong performance as the economy recovers, particularly since 2004 has both a
Presidential election and the Olympics.
Favorable stock selection in the healthcare sector was unfortunately
overshadowed by the negative effect of our sector overweight. Health care did
not advance as strongly as other economically sensitive sectors. Among our
largest holdings in the healthcare sector, Pfizer and Johnson & Johnson both had
a negative effect on relative results. Johnson & Johnson, a company with
relatively stable earnings from its broad mix of drugs and consumer products,
initially benefited from the approval of its innovative stent to treat coronary
artery disease; however, later in the year, the company declined on negative
publicity about a number of deaths allegedly linked to the stent as well as
concerns about competitive threats and their ability to produce supply to meet
demand. We reduced our position in Johnson & Johnson in April. We reduced the
portfolio's holdings of Pfizer in the third quarter, based on concerns about
increased competition for Lipitor and Viagra, as well as our belief that
near-term growth for Pfizer stems from synergies related to the Pharmacia
acquisition and not new products. On the positive side, Pfizer maintains a
healthy cash flow and no patent expirations.
Stock selection among consumer staples stocks also fell short of the index
sector; an overweight in the sector detracted from relative results as well
since staples lagged the broad market. Positions in several beverage and food
companies, as well as a household products manufacturer were largely responsible
for underperformance in this sector. Top 10 holding Procter and Gamble was a
significant detractor. We had added to our holdings of Procter and Gamble in the
first quarter of the year, anticipating a positive impact from its acquisition
of Wella, a German hair care company. Although Procter & Gamble was one of the
stronger stocks within the consumer staples sector, its return lagged the
broader market. In the fourth quarter, Procter & Gamble announced earnings that
beat expectations as the company benefited from sales of its over-the-counter
heartburn medicine Prilosec.
In the financial services group, lagging stock performance was compounded by the
impact of a meaningful sector underweight. Among the portfolio's largest
financial positions, Citigroup was a strong positive contributor, while American
International Group's return was less than half that of the index sector.
Following a strong run in financials, we took profits in several names over the
course of the third quarter, including Citigroup. We subsequently added
incrementally to our Citigroup holdings, taking advantage of a price decline in
August. Late in the year, Citigroup benefited from positive market reaction to
its proposed acquisition of a Washington Mutual unit expected to broaden
Citigroup's consumer lending presence and extend its geographic reach. AIG
declined sharply in February following its announcement of a substantial charge
to cover higher-than-expected claims by U.S. businesses for costs of sick
workers and jury settlements. Through the remainder of the year, the stock's
price vacillated within a relatively narrow range before gaining some momentum
in the fourth quarter.
The fund's position in the industrial sector also detracted from relative
performance, due to both weak performance of individual holdings and the effect
of a sector underweight. While top 10 holding General Electric added to relative
results, its contribution was not enough to offset losses in a number of other
industrial stocks, particularly defense contractors. In the first quarter, we
reduced our position in General Electric, taking advantage of the stock's
strength. We subsequently increased our holdings of General Electric in August
due to our belief that the company can successfully remake itself into a high
growth, service-oriented business. In November, GE management indicated that
after limited to modest profit growth in 2004 they anticipated double-digit
profit growth in 2005.
The portfolio's energy position had a moderate negative effect on relative
results, due mainly to lagging stock performance. An underweight in the strong
performing materials sector also detracted from relative performance.
An overweight in the information technology sector was the largest positive
contributor to relative results for the year. This was augmented by strong stock
selection. Among the portfolio's largest technology positions, Cisco and Intel
were significant positive contributors. Semi-conductor company Intel more than
doubled in price, while communications equipment provider Cisco's gain was in
the high double digits. Both companies benefited from accelerating economic
momentum, strong earnings reports, and an improved outlook for corporate
spending. A large overweight in Microsoft detracted from relative results.
Despite Microsoft's weak showing this year, the company's prospects remain
favorable with substantial cash available for acquisitions or dividends and
expected earnings growth of 10% annually over the next five years. Microsoft
paid its first dividend in 2003 and is expected to double the small initial
payout in 2004. The fund generally benefited from its semi-conductor position as
the semi-conductor industry advanced amid the improved economic environment.
During the third quarter, we cut back on our semi-conductor allocation following
the group's strong performance. However, we remained overweight in the industry.
A meaningful underweight in telecommunications stocks also added to relative
return. Although telecommunications stocks were among the leaders in the early
stages of the 2003 rally, telecommunications finished the year as the worst
performing index sector.
As we enter the second year of the recovery, we are encouraged by signs of
continued economic strength globally. Corporate profits hit an all-time high in
the third quarter and negative earnings pre-announcements have been muted, which
bodes well for the fourth quarter earnings season. As well, the flow of money
into growth mutual funds has outpaced the flow into non-growth funds for the
last four months. We continue to position the portfolio for recovery and
emphasize high quality growth companies. It is our hope that quality will be
rewarded in the coming year as investors rotate away from the more speculative
stocks that drove the market in the early stages of the recovery.
GROWTH ACCOUNT
For the full year 2003, the portfolio rose 26.46% lagging the 29.75% rise of the
Russell 1000 Growth Index. The portfolio's bias toward high quality growth
stocks hurt performance in 2003. During the year, value stocks slightly
outperformed growth stocks and low-quality stocks surged. The portfolio's
quality bias was most affected in the second quarter, when low-quality stocks
with weak balance sheets and deteriorating fundamentals surged as short sellers
covered their positions. Although high-quality stocks continued to lag for the
remainder of the year, the portfolio performed well after that period. As the
economic recovery stabilizes we expect high-quality stocks to recover.
GROWTH OF $10,000
Total Returns of the Account
as of December 31, 2003
1 Year 5 Year Life of Fund
26.46% -6.91% 5.02%*
* Since inception 5/2/94
[Download Table]
Russell Midcap Morningstar Large Growth
Growth Index Growth Category Account
10 10 10
"1994" 10.107 10.132 10.542
"1995" 13.541 13.402 13.243
"1996" 15.908 15.942 14.9
"1997" 19.494 19.928 18.917
"1998" 22.976 26.616 22.957
"1999" 34.76 37.188 26.729
"2000" 30.679 31.948 24.016
"2001" 24.494 24.399 17.892
"2002" 20.528 17.633 12.691
"2003" 29.298 22.667 16.049
LOGO
Despite the low quality surge, the portfolio benefited from solid stock
selection in the technology sector, where more cyclical technology exposure
helped performance. The portfolio benefited from large positions in 3M, Cisco,
Linear Technology and Symantec as the market embraced economically sensitive
stocks. Performance was held back by large positions in Johnson & Johnson and
Medtronic, as the market shunned defensive health care holdings.
We expect the economy to continue to strengthen over the next six to 12 months,
which should boost corporate profits and stock returns. The fund continues to
maintain positions in companies with the highest quality long-term growth
potential. We think the low quality rally is unsustainable and expect investors
will return to higher quality stocks over the next six to 12 months.
GOVERNMENT SECURITIES ACCOUNT
The Government Securities Account returned 0.26% in the fourth quarter, which
was identical to the Lehman Government/Mortgage Index. For the year, the account
gained 1.84% vs. 2.73% for the Lehman Gov't/Mortgage Index. This performance
reflects the account's higher weighting to mortgage securities whose performance
was negatively impacted by high mortgage refinancing and prepayment on higher
coupon mortgage securities.
GROWTH OF $10,000
Total Returns of the Account
as of December 31, 2003
1 Year 5 Year 10 Year Life of Fund
1.84% 5.78% 6.40% 7.85%*
* Since inception 4/9/87
[Download Table]
Morningstar
Lehman Brothers Lehman Brothers Intermediate Government
Mortgage-Backed Government/ Government Securities
Bond Index Mortgage Index Category Account
10 10 10 10
"1994" 9.839 9.724 9.598 9.547
"1995" 11.492 11.456 11.174 11.368
"1996" 12.107 11.878 11.487 11.749
"1997" 13.256 13.011 12.458 12.969
"1998" 14.179 14.146 13.386 14.042
"1999" 14.443 14.07 13.193 14.001
"2000" 16.055 15.799 14.613 15.597
"2001" 17.375 17.017 15.613 16.784
"2002" 18.895 18.729 17.029 18.261
"2003" 19.475 19.24 17.395 18.597
LOGO
For 2003, the account benefited from its weighting in agency nonmortgage bonds,
which performed well during the extreme volatility of 2003. The account
performance was hurt by the position in 6.0% mortgages, which were refinanced at
par ($100) and performed poorly with a shorter duration than the Lehman
Government Mortgage Index. Declining mortgage rates produced a record level of
mortgage refinancing and this diminished the performance of all premium 6.0% and
6.5% mortgages during the period. The account purchased discount mortgages
(mortgages priced under $100) in an effort to avoid prepayments and to improve
performance in the bond market rally.
In the fourth quarter, the bond market reacted to further signs of a
strengthening economy and anticipation of a less accommodating Federal Reserve
(Fed) making their first move towards higher interest rates. During this period
intermediate-term interest rates rose 0.30% to 0.50%. This interest rate rise
and shorter portfolio duration, combined with slower principal repayments and a
lower mortgage risk premium, caused the account to perform in line with the
Government Mortgage Index.
INTERNATIONAL SMALLCAP ACCOUNT
After three consecutive years of declines, global equity markets bounced back in
2003. The Citigroup Extended Market Index (EMI) World ex US was up 53.73% for
the year. International small companies extended their outperformance over
large companies in 2003 and the Citigroup EMI Index outperformed the MSCI EAFE
Index by 15.14%.
GROWTH OF $10,000
Total Returns of the Account
as of December 31, 2003
1 Year 5 Year Life of Fund
54.15% 11.61% 8.06%*
* Since inception 5/1/98
[Download Table]
Morgan Stanley
Capital
International Citigroup Morningstar
EAFE (Europe, Extended Foreign
Australia Market Index Small/Mid International
and Far East) (EMI) Growth SmallCap
SmallCap Index ex US Market Category Account
10 10 10 10
"1998" 10 9.496 9.542 8.963
"1999" 11.973 11.729 17.6 17.371
"2000" 11.068 10.517 14.884 15.373
"2001" 9.683 8.867 11.226 12.014
"2002" 8.926 8.221 9.452 10.068
"2003" 14.402 12.638 14.563 15.52
LOGO
Canada was the strongest region this year, with the Citigroup EMI Canada Index
up 65.93%. The Asia Pacific ex Japan markets were also very strong, and the
Citigroup EMI Asia Pacific ex Japan Index was up 65.34%. Japan and Europe were
the lowest performing regions, with the Citigroup EMI Japan and Citigroup EMI
Europe Indexes up 49.48% and 52.20%, respectively.
Currency movements had a significant impact on returns again in 2003. The U.S.
dollar weakened relative to all major foreign currencies this year, increasing
the reported U.S. dollar returns of foreign markets. For the entire year, a
depreciating U.S. dollar added approximately 15.0% to the Citigroup EMI Index
return.
The telecommunications sector led international small-cap markets in 2003,
increasing over 100%. Other outperforming sectors included information
technology, industrials and materials. The utilities sector was the worst
performing international small-cap sector, rising just over 35%. Other
underperforming sectors included consumer staples, health care, financials and
consumer discretionary.
The International SmallCap Account increased by 54.15% in 2003, outperforming
the Citigroup EMI Index by 0.42%. The largest contributor to this outperformance
was strong stock selection in the industrials, materials, financials, consumer
discretionary and telecommunication services sectors. Poor stock selection in
the information technology and energy sectors detracted from performance for the
year.
From a regional perspective, strong stock selection in Japan and Europe was the
biggest contributor to performance in 2003. Poor stock selection in Australia
and Canada were the biggest detractors from performance.
We believe market fundamentals remain quite strong. Growth is increasing in most
of the world's major economies, corporate profitability is improving and
interest rates look to remain low. Over the last quarter of 2003, our investment
approach worked well as companies with high levels of positive business
fundamentals tended to outperform. We expect this trend to continue into 2004.
We remain focused on identifying attractively valued companies that are
exhibiting positive fundamental business improvements..
INTERNATIONAL EMERGING MARKETS ACCOUNT
Emerging market equity performance for the year provided a good reflection of
the themes that dominated much of 2003: U.S. dollar weakness, commodity price
strength, the resilient price of oil, and the emergence of a synchronized global
economic recovery. The emerging markets equity portfolio returned 57.2%,
outperforming the MSCI Emerging Markets Free Index (EMF), which rose 56.2% for
the year. The portfolio also outperformed the MSCI Europe, Australasia and the
Far East Index (EAFE), which returned 38.5%. In addition, the portfolio
outperformed the Standard & Poor's 500 Index at 28.6%, and the NASDAQ at 50.0%.
Latin America was the best-performing region, with a return of 72.3%, followed
by Eastern Europe, the Middle East and Africa (EEMEA) at 56.4%. Asia returned
50.6% for the year.
GROWTH OF $10,000
Total Returns of the Account
as of December 31, 2003
1 Year Life of Fund
57.20% 8.72%*
* Since inception 10/24/00
[Download Table]
Morgan Stanley Morningstar
Capital Diversified International
International Emerging Emerging
EMF (Emerging Markets Markets
Markets Free) Index Category Account
10 10 10
"2000" 8.668 9.33 9.386
"2001" 8.452 8.982 8.988
"2002" 7.945 8.452 8.302
"2003" 12.416 13.126 13.051
LOGO
Stock selection accounted for the bulk of outperformance on both a sector and
country basis. The portfolio outperformed significantly in the information
technology and consumer discretionary sectors. The portfolio benefited during
the year from good stock selection, especially in South Africa and South Korea.
Recent interest rate cuts in Brazil will continue and we have noted early signs
of real wage increases. This should spark a long-awaited pick up in consumer
spending. Further positive political news is expected, as fiscal and pension
reform grind though the congressional process. Mexico is more of a question
mark, with reasonable growth, a weaker currency outlook, and a lame duck
presidency. In Argentina, the economic recovery from the crisis of 2001-2002
gathers steam, and we have recently been adding to positions in that country.
The Russian market will dominate EEMEA for the foreseeable future. The central
European markets continue to be driven by convergence with Europe. The South
African market is still dominated by the performance of the rand. In the short
term, the rand will be supported by the weaker U.S. dollar, stronger
commodities, and high gold prices. Longer term the rand is becoming overvalued.
The fund will remain aggressively positioned in Asia. The strong economic
rebound, high liquidity environment and weak U.S. dollar point to strong equity
returns for 2004 in the region. In Southeast Asia, we are excited about
Indonesia's prospects in an environment of lower interest rates and higher
commodity prices. In Malaysia, we have a positive outlook on Prime Minister
Abdullah Badawi's new administration, but are cautious on the market due to high
valuations. Korea should benefit from continued strength in global trade.
Taiwan's close links to mainland China provide a good stimulus for the local
economy, which continues to perform well. Chinese momentum, both economically
and in the equity market, keeps building.
Emerging markets offer an inexpensive and higher growth alternative to developed
markets. We will continue to buy undervalued stocks with clear growth outlooks.
INTERNATIONAL ACCOUNT
Global equity markets rebounded strongly in 2003. The Morgan Stanley Capital
International Europe, Australasia, Far East Index (MSCI EAFE) rose 38.59%.
Appreciation of foreign currencies, relative to the dollar, contributed 15.22%,
or almost 40% of the index gain. Driven by economic recovery, the materials,
industrial, and information technology sectors were the strongest performers.
The financial sector also rose significantly. Sectors that are not economically
sensitive, such as consumer staples and health care, underperformed the market.
Poor quality companies experienced some of the greatest gains. Small-cap
companies and emerging markets outperformed the MSCI EAFE Index.
GROWTH OF $10,000
Total Returns of the Account
as of December 31, 2003
1 Year 5 Year Life of Fund
32.33% -0.59% 5.34%*
* Since inception date 5/2/94
[Download Table]
Morgan Stanley
Capital Morningstar
International Foreign
EAFE (Europe, LargeCap
Australia and Blend International
Far East) Index Category Account
10 10 10
"1994" 10.048 9.783 9.663
"1995" 11.174 10.836 11.032
"1996" 11.85 12.177 13.8
"1997" 12.061 12.886 15.489
"1998" 14.473 14.619 17.035
"1999" 18.375 20.287 21.452
"2000" 15.771 17.049 19.663
"2001" 12.363 13.344 14.891
"2002" 10.392 11.096 12.498
"2003" 14.402 14.793 16.539
LOGO
The international account returned 32.33% for the year, underperforming the
index. The underperformance was driven by poor stock selection in the financial
and materials sectors. Greater exposure to currencies that failed to appreciate,
relative to the dollar, as much as the euro also hurt performance. The
international account did not invest in poor quality companies, some near
bankruptcy, which significantly appreciated during the year. The fund benefited
from strong stock selection in the telecommunication services sector.
We strongly believe in our bottom-up, borderless investment approach. We have
developed a more robust quantitative screening platform that was fully
incorporated into our investment process in 2003. We expect this will enhance
stock selection going forward.
LARGECAP BLEND ACCOUNT
The market moved steadily higher throughout the fiscal year, after hitting a
three-year low on October 9th of 2002. Leadership in this new bull market was
predominately provided by those sectors and stocks which are more cyclically
oriented and leveraged to an economic rebound. Strong monetary and fiscal
stimulus (including one of the largest tax cuts in U.S. history) provided
liquidity and additional discretionary income, increasing consumption and demand
for equities. These catalysts simultaneously lifted both the economy and stock
market from their doldrums.
GROWTH OF $10,000
Total Returns of the Account
as of December 31, 2003
1 Year Life of Fund
23.76% 2.74%*
* Since inception 05/01/02
[Download Table]
Morningstar
S&P 500 Large Blend LargeCap
Index Category Blend Account
10 10 10
"2002" 8.269 8.215 8.453
"2003" 10.641 10.41 10.461
Optimism and rising expectations for an accelerating economy were supported by a
preponderance of positive and improving macroeconomic data. The service sector
has been in recovery for several months, and even manufacturing-in decline for
35 consecutive months through June - began to expand again in July. On the
consumer side, retail sales have been consistently strong. The economic data has
been reinforced by few negative earnings preannouncements or surprises by
companies which have right-sized their cost structures to a more normal demand
environment. As economists steadily increased their calendar 2003 growth
estimates throughout the year, resolution of the official war with Iraq,
combined with an increased corporate and consumer confidence, encouraged
investors to be more accepting of risk.
As would be expected in a cyclical bull market, the preponderance of equities
across all levels of capitalization rose, with both Growth and Value styles
benefiting from the year-long rebound. Value stocks outperformed Growth stocks,
returning 31.8% and 25.7%, respectively. Leadership was provided by those names
generally of smaller size, with higher financial and operating leverage, lower
quality and higher beta.
During the twelve-month period ended December 31, 2003, the Partners Variable
Contracts, Inc. Large Cap Blend Account returned 23.76%, trailing the S&P500
Index which gained 28.68%. After two strong years of performance, we are
disappointed that we did not fully participate. In a market driven predominately
by a single factor (i.e momentum) our fundamental, valuation driven approach was
disadvantaged. Our incremental approach based upon screens and fundamentals,
employing a balanced risk/reward methodology, did not fare well in a market
where returns were asymmetrically skewed toward higher risk.
Stock selection (generally, less cyclical) was the primary factor for
underperformance versus the benchmark. Specifically, while stock selection was
strong/neutral within Consumer Staples and Materials, it was offset by
lackluster performance within Information Technology, Consumer Discretionary and
Financials. In this rising market, performance was held back by having any cash,
in addition to being underweight Financials and Information Technology.
Alternatively, being overweight Utilities and Industrials benefited the
portfolio. Although we were correct in calling for a better/positive year in
2003, we did not fully appreciate the benefit of the extreme monetary and fiscal
stimulus. We were correctly positioned to benefit from an improving
corporate/industrial economy, yet underestimated the benefit of an improving
consumer-driven economy.
You may recall we started making moves within the portfolio toward riskier names
in the third quarter of 2002. We reduced exposure in Health Care, Utilities and
Energy, putting proceeds into opportunities within Financials, Information
Technology and Telecommunication Services. These moves, which continued
consistently throughout the year, proved to be correct. Our process driven,
incremental approach, prevented us from participating fully in the rally.
However, our approach is disciplined and deliberate with a focus on risk/reward,
and we believe this has served us well over time.
We continue to be positive toward the overall market, though more cautious than
last year at this time. We remain positive because even though expectations have
risen over the past year, they still remain reasonable. More importantly, our
analysts' discounted cash flow models, in aggregate, indicate the majority of
stocks are trading at/near fair value, allowing for some room for the market to
trade higher provided companies continue to meet/beat expectations, as we
expect. While many risks remain, there are two additional factors which could
help lift the economy for a second year in a row. First, an increasing supply of
oil that ultimately will come from Iraq and non-OPEC members, could potentially
lower the price of energy. Second, we have yet to see businesses increase their
historically low inventory levels in response to the strengthening economy. We
do not believe the potential for increased production, coupled with a recovery
in the labor markets is factored into stocks.
We continue to be market/overweight Information Technology and Industrials with
a bias toward corporate cyclicals. In addition, our overweight within Energy and
Telecommunication Services are deep value, contrarian plays. At the end of the
fiscal year, the portfolio held 51% of assets in Value stocks, with the
remaining 49% in Growth stocks.
LARGECAP GROWTH EQUITY ACCOUNT
As the U.S. economy staged a dramatic recovery in 2003, global equity markets
shook off daunting geopolitical concerns and rallied heartily. The Account
participated in the market's exuberant advance, gaining 24.4%, but trailed the
Russell 1000 Growth Index, which returned 29.8%. Especially noteworthy for the
year was the sharp appreciation in the stock prices of lower quality, higher
volatility, smaller capitalization companies. The portfolio was concentrated in
higher quality names whose gains lagged somewhat by comparison.
GROWTH OF $10,000
Total Returns of the Account
as of December 31, 2003
1 Year Life of Fund
23.14% -22.33%*
* Since inception 10/24/00
[Download Table]
Russell Morningstar LargeCap
1000 Large Growth
Growth Growth Equity
Index Category Account
10 10 10
"2000" 8.257 8.789 7.78
"2001" 6.585 6.712 5.44
"2002" 4.749 4.851 3.63
"2003" 6.162 6.236 4.47
LOGO
A beneficial overweight to technology was offset by unfavorable stock selection
in the sector, notably in the electronics industry, where underweighting Texas
Instruments and Motorola detracted, offsetting the benefit of an overweight
position in Intel.
Within the retail area of consumer cyclicals, beneficial positions in Advance
Auto Parts and Best Buy were offset by holding laggards Kohl's, Wal-Mart, and
TJX. In addition, not owning Internet survivors Yahoo! and eBay, in commercial
services, negated adept stock selection in lodging/tourism (Royal Caribbean) and
homebuilding (D.H. Horton, Lennar).
In health care, pharmaceuticals (Pfizer) and medical technology (Zimmer) had the
largest negative impacts. The biotechnology area also detracted, primarily due
to an overweight position in sluggish Amgen and an underweight position in
Genentech, which soared during the second quarter on the promise of its new
blockbuster colorectal drug, Avastin.
The basic materials sector contributed most to relative performance, primarily
due to holding Freeport McMoran, in the metals area, which rose over 150% in
2003 as copper and gold prices breached five-year highs. Underweighting the
sluggish consumer staples sector also helped, as did an overweight to Career
Education, in schools/education.
As the new year unfolds, the portfolio is positioned to take advantage of
continued growth in the U.S. economy. The technology commitment has increased
from a moderate underweight a year ago to the portfolio's largest overweight as
we enter 2004, concentrated on the electronics, computers, and communications
equipment industries. Financials are also overweight, focused on two
high-quality credit card companies in consumer finance (MBNA and Capital One).
The consumer cyclicals sector is also overweight, with all of that emphasis in
the retail area. The consumer staples sector is de-emphasized, especially so in
the lower-growth beverage, food, and consumer goods areas.
LARGECAP VALUE ACCOUNT
Market Overview & Performance
After dropping more than -40% over the prior three years, the S&P 500 gained
nearly +29% in 2003, including more than +12% in the fourth quarter. Mounting
evidence that the economy and corporate profits were improving drove the rally.
After nearly three years of value leadership, returns for the growth and value
indexes were almost identical during the year.
GROWTH OF $10,000
Total Returns of the Account
as of December 31, 2003
1 Year Life of Fund
28.05% 5.77%*
* Since inception 05/01/02
[Download Table]
Morningstar
Russell 1000 Large Value LargeCap
Value Index Category Value Account
10 10 10
"2002" 8.404 8.222 8.576
"2003" 10.928 10.557 10.982
During the period your portfolio had strong absolute returns, rising +28.5%, and
performed about in line with the market, measured by the S&P 500 (+28.7%) but
underperformed the Russell 1000 Value benchmark (+30%).
Stock selection in the consumer growth sector had the largest negative impact on
performance. Several of our pharmaceutical firms, including Schering Plough,
Wyeth and Pfizer underperformed due to investor concerns about weak product
pipelines, patent expirations and pricing pressures. On top of these industry
pressures, Wyeth was dragged down by news that it had added reserves to its
"fen-phen" (diet drug) settlement trust. Though our positions in these stocks
hurt performance, we continue to view them as attractive value opportunities and
are confident in the long-term outlook due to continuing growth in
prescriptions, both as the population ages and as new pharmaceuticals are under
development.
In this environment, cyclical stocks led the market up, with the portfolio's
technology stocks particularly strong on signs of a revival in capital spending.
Nortel Networks, Corning, Sanmina and Avaya rose an astounding +163%, +215%,
+181% and +428%, respectively, from very depressed levels. As the strong economy
prompted more people towards home ownership, our homebuilders outperformed;
Centex, Pulte and KB Home rose +118%, +96% and +70%.
Outlook
The increasingly positive economic environment, coupled with outperformance by
value during 2000-2002, have reduced the attractiveness of US equities and
narrowed the value opportunity to below our long-term average. The big value
themes we saw in recent years have largely been realized; this generated our
very strong premiums in 2000, 2001 and 2002. Without the return potential in new
themes to justify concentration, we have reduced portfolio risk; the wide
dispersion of the opportunity has led us to significantly reduce our sector
weights relative to the index. Yet, we continue to believe that we can
outperform by using our research-based stock selection as we did in other
periods of spread compression.
LIMITED TERM BOND ACCOUNT
The Limited Term Bond Account underperformed the Lehman Mutual Fund 1-5 year
Government/Credit Index since inception on May 1, 2003. The fund returned 0.78%
compared to 1.68% for the index since the fund's inception.* The account's
mortgage-backed securities (MBS) holdings experienced the most volatile period
since the refinancing/prepayment wave of 1993 and 1994. Performance was enhanced
by broad corporate diversification and overweighted sector allocation to
asset-backed securities (ABS), commercial mortgage-backed securities (CMBS) and
agencies. The tremendous growth of the fund adversely affected fund performance.
Two key factors caused the U.S. economy to be lackluster in late 2002 and early
2003. First, the uncertainties surrounding the possibility of war in Iraq
affected business decisions. This, coupled with the lingering concerns created
by corporate governance scandals, stalled business investment in the first
quarter of 2003. Fortunately, a vibrant housing market lifted construction
activity and refinancing provided extra support to consumer spending.
Both interest rates and stock prices began to rise by June. Economic activity
picked up and then accelerated further the summer of 2003, as tax cuts boosted
household disposable income. Investors, as well as businesses, started to take
more risks. Third quarter 2003 produced an increase of 8.2% in real gross
domestic product (GDP), the broadest measure of U.S. output. This was the
fastest quarterly rate of growth in nearly 20 years. This pace of growth is
unsustainable, but sets the stage for reasonable growth in 2004. The strength of
the economy during 2004 will depend on the strength of the U.S. labor market,
which is just starting to grow.
By employing a disciplined investment process and by focusing on sector and
security selection, we expect to reward our clients with favorable results over
a reasonable period of time. We have ample opportunity to enhance fund returns,
and to provide a well-diversified portfolio by exploiting expertise in a variety
of market sectors.
*Fund returns are after expenses, which do not apply to the index.
MIDCAP ACCOUNT
There has been no change in portfolio strategy in the past year. Our focus is on
purchasing high-quality businesses with competitive advantages and paying a
reasonable price for them. We also focus on minimizing business risk when
selecting companies for the portfolio. We believe this strategy will result in
superior returns, over time, while moderating volatility.
GROWTH OF $10,000
Total Returns of the Account
as of December 31, 2003
1 Year 5 Year 10 Year Life of Fund
32.81% 8.61% 11.72% 14.20%*
* Since inception 12/18/87
[Download Table]
Morningstar
Russell Mid-Cap
Midcap Blend MidCap
Index Category Account
10 10 10
"1994" 9.791 9.839 10.078
"1995" 13.164 12.664 13.002
"1996" 15.665 15.253 15.747
"1997" 20.209 19.287 19.329
"1998" 22.248 20.593 20.042
"1999" 26.304 24.444 22.655
"2000" 28.474 25.268 25.96
"2001" 26.871 24.015 24.997
"2002" 22.521 19.913 22.81
"2003" 31.547 27.165 30.294
LOGO
The account underperformed the Russell MidCap Index for the year, posting a
32.81% return, compared to a 40.01% return for the index. Low-quality companies
without earnings outperformed high-quality companies in the past year. Our focus
on high-quality companies and our underweighting in companies without earnings
were the main contributors to our underperformance. The primary contributors to
the underperformance during the year were the technology and consumer
discretionary sectors.
The strategy of the portfolio is evident in the characteristics of the portfolio
vs. the index. Two key measures of the quality of a business are return on
equity (ROE) and net margin (net income/sales). The higher these ratios are, the
more profitable the company. The companies in the portfolio have an ROE of 17%
vs. 14% for the index. Net margin is also higher for the companies in the
portfolio, at 12% vs. 9% for the index. One measure of reasonable valuation is
the price/earnings ratio (P/E). The high quality companies in the portfolio have
a P/E of 26 and are less expensive than the index companies' P/E of 32. We
believe that superior businesses that are selling at reasonable valuations are a
great combination.
MIDCAP GROWTH ACCOUNT
Market Commentary:
The year 2003 was a welcome relief to equity investors. A quick end to formal
hostilities in Iraq, healthier economic data, and an accommodative Federal
Reserve were all instrumental in driving equity markets to post impressive
positive returns during the year. As geopolitical risks diminished with the end
of major conflict in Iraq, investors increased their focus on a number of
positive economic influences. An improving economy translating into better
corporate earnings and growth prospects drove strong equity performance,
especially from the most economically sensitive sectors of the market. A
historically low interest rate environment in the U.S. continued to drive demand
for mortgage refinancing, providing consumers with the opportunity to improve
their personal balance sheets. Political momentum for stimulating the economy
with tax relief, including preferential tax treatment of stock dividends, also
provided investors reason to cheer.
GROWTH OF $10,000
Total Returns of the Account
as of December 31, 2003
1 Year 5 Year Life of Fund
40.58% 0.60% -0.08%*
* Since inception 5/1/98
[Download Table]
Russell Midcap Morningstar Mid-Cap MidCap Growth
Growth Index Growth Category Account
10 10 10
"1998" 10.328 10.258 9.66
"1999" 15.625 16.813 10.691
"2000" 13.791 15.653 11.557
"2001" 11.011 12.322 9.602
"2002" 7.994 8.93 7.08
"2003" 11.409 12.153 9.953
LOGO
Impressive double-digit returns were witnessed across all capitalization and
style strata. All major U.S. domestic equity indices this year have experienced
double digit increases, and we believe near-term opportunities have not
disappeared in spite of the recent market rise. A more confident consumer armed
with better buying power can continue to buoy demand for discretionary goods,
and the early signs of cyclical improvement in the demand for large capital
goods will help spur new capital investment across varied industry groups.
Our equity investment process is designed to recognize current market
leadership, and then to build portfolios that have exposures to those types of
characteristics, so that our client portfolios will participate in any market
rally. We remain optimistic about the current equity market. We are focused on
seeking out investments with solid fundamental underpinnings which also have the
potential for sustainable growth. Such investments will serve our clients well,
and ensure the success of this mandate.
Performance Review:
For 2003, the Fund finished with a 18th percentile ranking. Over this time
period, the fund posted a return of 38.87% which underperformed the Russell
Midcap Growth Index return of 42.71% but easily beat the median manager return
of 33.37%.
The portfolio benefited from strong stock selection in the Health Care and
Producer Goods sectors. Holding Health Care names such as Humana Inc., Express
Scripts Inc. and Caremark Rx Inc. contributed to strong absolute returns. These
holdings had good valuations and were viewed as companies that could help rein
in escalating health care costs. Each of the stocks were up over 35% for the
year. In the Producer Goods sector, holdings such as Monsanto Co. and Precision
Castparts Corp. were up over 50% as earnings for these cyclical companies
improved as the economy strengthened.
The portfolio was hurt by poor stock selection in the Services and Consumer
Cyclicals sectors. Holding names such as Jones Apparel Group Inc. and
Pharmaceutical Product Development Inc. was costly as both companies reduced
earnings forecasts and were down for the year.
Market Outlook:
We expect to see a continued improvement in the economy into 2004, fueled in
large part by capital spending and ongoing improvements in consumer confidence.
In this environment, we believe a long-term, focused investment strategy will be
rewarded and that fairly valued companies with earnings growth prospects will
likely benefit.
We continue to search for firms with positive earnings dynamics and reasonable
valuations while staying true to our midcap growth mandate. We also continue to
dedicate significant assets to researching and identifying ways to improve our
stock selection methodology. This is an ongoing process. Through research,
superior stock selection and risk controlled portfolio construction, our goal is
to provide consistent outperformance relative to a benchmark.
MONEY MARKET ACCOUNT
During 2003, the Federal Reserve (Fed) implemented one rate cut of 0.25% on June
25, which lowered the fed funds target rate from 1.25% to 1.00%. This is the
lowest level since 1958. The war in Iraq dominated the focus of the market
during the first part of 2003. The Fed even suspended its bias in March due to
the uncertainty surrounding the war. As the outcome of the war became certain,
investors' focus shifted to the anticipated date when the Fed would begin
raising rates. However, by the end of the year the Fed had become less of a
factor in the market as it made it clear short rates would be kept low for a
"considerable period."
During 2003, money funds had a second year of outflows and registered a 9%
decline in total industry assets. This is the largest outflow since 1983.
Outstanding commercial paper (short-term obligations) also fell for a third
straight year. Commercial paper declined $83 billion in 2003, $110 billion in
2002, and $161 billion in 2001.
The industry average maturity over the course of 2003 was in the area of 51-59
days. The portfolio actively monitors the industry average in order to keep both
the yield and maturity within the range of our typical competitors. Holdings of
maturities in the nine- to 13-month time frame helped the yield remain
competitive vs. our peer group. We continue to invest in high quality securities
that are actively monitored by our fixed income analytical staff.
Investments in the money market account are neither insured nor guaranteed by
the U.S. government. While the portfolio strives to maintain a $1.00 per share
net asset value, it is possible to lose money in money market securities.
MIDCAP VALUE ACCOUNT
Performance
The Principal Investors Fund-Partners Mid Cap Value Fund (PIF-MCV) produced a
solid total return in 2003 but fell slightly shy of the Russell Midcap Value
Index (RMCV).
GROWTH OF $10,000
Total Returns of the Account
as of December 31, 2003
1 Year Life of Fund
36.49% 12.46%*
* Since inception date 5/3/99
[Download Table]
Russell Morningstar
Midcap Mid-Cap MidCap
Value Value Value
Index Category Account
10 10 10
"1999" 9.232 10.023 11.024
"2000" 11.003 11.709 14.445
"2001" 11.26 12.458 14.072
"2002" 10.173 10.85 12.67
"2003" 14.045 14.58 17.293
LOGO
On an absolute basis, PIF-MCV's holdings in Consumer Discretionary and
Financials made the largest contribution to portfolio total return. The positive
impacts of portfolio holdings within Health Care, Energy, Industrials and
Information Technology (IT) were also sizable.
On a relative basis, strong stock selection in Consumer Discretionary and Energy
was beneficial, while lower (albeit solid) returns in Health Care and Financials
led to underperformance of the index.
We continue to be significantly overweight the Health Care and Energy sectors
and substantially underweight Information Technology and Utilities. This is not
due to our outlook on the sectors themselves, but is a result of our bottom-up
stock selection process. We believe our holdings within Health Care and Energy
remain very attractive on a fundamental and valuation basis. The fundamentals of
the companies we own in both sectors are, in our opinion, more favorable now,
going into 2004, than they were going into 2003. Even if commodity prices end up
being weaker than expected, we have confidence that our holdings would still be
able to meet our earnings expectations, given their solid balance sheets and low
operating and financing costs that would protect margins. In addition, their low
valuation multiples would likely provide a cushion against stock price
pressures. As for our underweight allocation to Information Technology, we have
simply been unable to find many quality companies at valuations not already
reflecting highly optimistic economic and earnings growth assumptions.
Investment Strategy and Outlook
We have a neutral view on the stock market; i.e., we believe 2004 is likely to
be a year of normal, single-digit returns. After a strong 2003, we believe
investors' positive expectations are already being reflected in many equity
valuations, and see little remaining that could carry the market significantly
higher. We do, however, believe that there is ample opportunity for select
stocks in 2004: those companies trading at valuations below what they are worth.
While we don't know when the valuation gaps will close, we are confident that
they will. We are therefore more bullish on our value-oriented portfolio than on
the equity market as a whole. While projections of earnings may not come to
pass, we note that our portfolio trades at a 22% discount to the RMCV based on
2004 earnings expectations, and is 32% cheaper than mid-caps overall on the same
basis (as represented in the Russell MidCap). In addition, our portfolio has a
higher return on equity (a measure of profitability and how effectively
companies use shareholders' money) and higher historical & projected earnings
growth rates than the RMCV. This is representative of our high quality
discipline, and of our affinity for growth but our discipline of under-paying
for it.
We can't predict what the economy or the market will do in 2004. This is
irrelevant given that we run the portfolio on a bottom-up basis. What we do to
reduce risk is pay low prices for what we believe are strong, well-run
businesses possessing the ability to act/react to favorable and unfavorable
economic conditions and events. We also try to ensure that there is enough
upside potential to justify the investment risks we take. In all, we are pleased
with the portfolio of companies we own going into the New Year.
REAL ESTATE ACCOUNT
Real estate stocks have outperformed the S&P 500 for the past four years. The
Real Estate Account's 38.9% return for 2003 exceeded the S&P 500 Index's 28.4%
return by 10.5%. The account also outperformed its benchmark, the Morgan Stanley
REIT Index, which had an annual return of 36.7%. Security selection and property
type allocation both positively contributed to outperformance in 2003, with
security selection being the predominant factor. Security selection involving
hotel, retail, and office owners was especially strong. The account also
materially benefited from its overweighted position in regional mall owners and
its underweighted position in hotel owners.
GROWTH OF $10,000
Total Returns of the Account
as of December 31, 2003
1 Year 5 Year Life of Fund
38.91% 15.28% 12.01%*
* Since inception 5/1/98
[Download Table]
Morgan Morningstar
Stanley Specialty-Real Real Estate
REIT Index Estate Category Account
10 10 10
"1998" 8.577 8.592 9.344
"1999" 8.187 8.304 8.925
"2000" 10.382 10.449 11.689
"2001" 11.714 11.382 12.712
"2002" 12.14 11.849 13.693
"2003" 16.6 16.22 19.021
LOGO
Mid-year purchases of Host Marriott and Hilton Hotels stocks proved to be quite
profitable for the account. The stocks of both hotel owners experienced robust
gains during the account's holding period, as they reflected improving
fundamental conditions. The account also materially benefited from not holding
two hotel companies that experienced negative returns, FelCor Lodging and
Meristar Hospitality.
Several retail property owners held by the fund made significant contributions
to the account's outperformance. These companies included Chelsea Property
Group, General Growth, Developer's Diversified, and CBL & Associates. Each of
these stocks experienced extraordinary returns at 72.7%, 68.3%, 62.1% and 49.4%,
respectively.
Brookfield Properties was the account's top office holding. Brookfield's strong
creditworthy tenant base and below average level of lease expirations served it
well, as office conditions were weak. Not holding office owner Crescent Real
Estate also contributed to superior results. With an approximate 1% benchmark
weighting, not owning it was helpful as its' 13.4% return significantly lagged
the office average of 29.4%.
The extraordinary returns of real estate stocks in 2003 reflected investors'
continued appetite for yield-oriented investment alternatives. The run-up in
prices was somewhat surprising given the generally weak real estate conditions
that existed. At some point, real estate conditions will need to improve to
support stock valuation levels following the 2003 price increases. Real estate
is a lagging cyclical business. Thus, it is reasonable to assume the U.S.
economic recovery that is underway will eventually provide the necessary
stimulus for improving real estate conditions.
SMALLCAP ACCOUNT
The Small Cap Account is built on the philosophy that superior stock selection
is the key to consistent outperformance. Superior stock selection is achieved by
a combination of systematically evaluating company fundamentals and in-depth
original research. Within this philosophical framework, we focus on four
critical drivers of stock performance: improving business fundamentals,
sustainable competitive advantages, rising investor expectations, and attractive
relative valuation. To leverage our stock selection skills as the primary
drivers of performance, we seek to maximize information advantages and
neutralize unintended portfolio risks.
GROWTH OF $10,000
Total Returns of the Account
as of December 31, 2003
1 Year 5 Year Life of Fund
36.82% 5.26% 0.48%*
* Since inception 5/1/98
[Download Table]
Morningstar
Russell Small Blend SmallCap
2000 Index Category Account
10 10 10
"1998" 8.768 8.609 7.949
"1999" 10.632 10.174 11.413
"2000" 10.311 11.48 10.074
"2001" 10.568 12.445 10.331
"2002" 8.404 10.433 7.508
"2003" 12.375 14.895 10.272
LOGO
Our process reflects a bottom-up style and draws upon both growth and value
disciplines. In analyzing growth companies, we focus on identifying businesses
that possess competitive advantages. These attributes are critical success
factors that provide a higher level of confidence in the sustainability of
growth. Among value-oriented opportunities, we seek quality companies with sound
long-term business models that are currently out of favor based on short-term
macro or company specific challenges. Identifying a catalyst for change is the
most important factor when analyzing a value company.
The portfolio underperformed the Russell 2000 Index by 10.43%, returning 36.82%
vs. 47.25% for the index. Stock selection from within the information
technology, telecommunications services, and health care sectors was the primary
culprit behind the full year's performance. However, the fund benefited from
stock selection within the consumer discretionary and financial sectors. The
fund's underperformance was due to our focus on stocks with improving and
sustainable business fundamentals that trade at a discount to their potential
valuation and demonstrate market confirmation of these improvements. However, we
continue to believe that over the long term, stocks with these characteristics
should provide superior returns.
SMALLCAP GROWTH ACCOUNT
Market Review
Small cap stocks got off to a poor start in early 2003 because investors were
frightened by the prospect of a war against Iraq and by concerns about the war's
effect on the U.S. economy. The end of major fighting in Iraq and strengthening
economic prospects helped lift stocks out of their multi-year bear market in the
spring. Not surprisingly, the past year witnessed a sharp recovery by market
segments that had been hit hardest in the prior three-year period. Based on
analysis of the Russell 2000 Growth Index, small cap information technology and
telecommunications stocks surged more than 60% in 2003. More conservative
sectors, such as consumer staples (+27.0%) and financials (+36.4%), reported
comparatively modest gains. Despite investors' clear preference for more
aggressive stocks in 2003, there was no strong style bias during the year. Small
cap growth stocks as measured by the Russell 2000 Growth Index (+ 48.5%) only
slightly outpaced small cap value stocks (+46.0%) as measured by the Russell
2000 Value Index.
GROWTH OF $10,000
Total Returns of the Account
as of December 31, 2003
1 Year 5 Year Life of Fund
45.64% -2.01% -1.27%*
* Since inception 5/1/98
[Download Table]
Morningstar SmallCap
Russell 2000 Small Growth Growth
Growth Index Category Account
10 10 10
"1998" 8.965 9.341 10.296
"1999" 12.828 15.081 20.148
"2000" 9.951 14.22 17.345
"2001" 9.033 12.937 11.793
"2002" 6.301 9.26 6.386
"2003" 9.36 13.427 9.301
LOGO
Performance Overview
In the fiscal year ended December 31, 2003, the Principal Variable Contracts
Small Cap Growth Fund slightly underperformed its benchmark, with a 45.6% gain
vs. a 48.5% surge for the Russell 2000 Growth Index. The Portfolio's best
holdings in 2003 tended to be in the Industrials, Consumer Discretionary, and
Financial sectors. The three biggest contributors to performance were Career
Education, Foundry Networks, and Chico's FAS. Career Education specializes in
post-secondary education for workers looking to develop career skills. School
enrollments sharply exceeded expectations, and the company's on-line educational
initiative has been a huge success. Foundry Networks enjoyed excellent success
selling networking gear, particularly to the government. Chico's FAS is a
women's apparel retailer that enjoyed better than expected sales due to
excellent merchandising.
We held an average of 3% frictional cash in the Portfolio during the year, which
hurt returns in a sharply rising market. Underperforming stocks included
Verisity, Emcor Group, and Copart. Verisity suffered from a longer than expected
slowdown in its semiconductor design markets. Emcor suffered several shortfalls
in earnings due to a weak contracting market. Copart experienced problems due to
a sharp slowdown in its growth rate due to saturation of its salvage auto
auction markets.
Looking Ahead
After such a vigorous small stock performance in 2003, many have questioned
whether the current rally has gotten ahead of underlying fundamentals. Although
a note of caution is in order, we note that past periods of strong small cap
returns have tended to carry on longer than most investors expect. Since the
late 1970s, small cap stocks have appreciated more than 40% in a calendar year
on only two other occasions (1979 and 1991) besides 2003. For instance, after
the 43.1% return in 1979, small cap stocks surged ahead again in 1980 with a
38.6% gain. Similarly, following the 1991 bull market of 46.1%, the Russell 2000
chalked up another 18.4% return in 1992. Although we expect a cooling off in the
markets in the months ahead, we would not be surprised to see another solid year
of equity gains as the economy continues to strengthen.
In this kind of environment, we suspect both large and small cap stocks will
perform reasonably well. Small cap earnings growth is again expected to outpace
the large cap increase in the year ahead, as it has in 13 of the past 14
quarters. We believe that relative valuations, meanwhile, no longer strongly
support small caps versus large caps, though small caps are by no means
overvalued relative to historical experience. This valuation parity is
surprising, given that small caps have outperformed large caps in each of the
last five years. Historically, small cap rallies have tended to continue on
until relative valuations move to extremes, so we believe that we still could
see another couple of years of outperformance in the small cap arena. In 2003,
the small caps that performed best were high-beta, more speculative issues,
especially those that were losing money. We believe the small cap recovery will
continue to broaden out over the course of 2004 and favor the types of
higher-quality companies that currently comprise the Principal Variable
Contracts Small Cap Growth Portfolio.
NOTE:Portfolios are actively managed and their compositions differ over time.
The views expressed are those of UBS Global Asset Management (its asset
management firms and individual portfolio managers) as of December 31,
2003. The views are subject to change based on market conditions; they are
not intended to predict or guarantee the future performance of the markets,
any individual security or market segment or any UBS advisory account or
mutual fund. For complete information about a mutual fund, including risks,
charges, and expenses, investors should read the prospectus carefully
before investing.
LARGECAP STOCK INDEX ACCOUNT
The LargeCap Stock Index Account seeks investment results that correspond to the
performance of the S&P 500 Index. The percentage of total assets of the account
allocated to each of the 500 stocks closely follows the weightings of each of
the stocks in the S&P 500 Index.
GROWTH OF $10,000
Total Returns of the Account
as of December 31, 2003
1 Year Life of Fund
28.32% -3.16%*
* Since inception date 5/3/99
[Download Table]
Morningstar LargeCap
S&P 500 Large Blend Stock Index
Index Category Account
10 10 10
"1999" 10.94 11.153 10.893
"2000" 9.943 10.376 9.84
"2001" 8.762 8.957 8.649
"2002" 6.825 6.985 6.708
"2003" 8.783 8.851 8.608
LOGO
The portfolio trailed the S&P 500 Index during 2003, with a return of 28.32%
vs.28.67% for the Index. The account performed within our expectations and the
difference in returns was mainly due to expenses.
The equity market provided strong positive returns during the year, as economic
reports improved and corporate earnings moved upward. Positive economic activity
and improving corporate earnings, along with the Federal Reserve (Fed) holding
interest rates at low levels resulted in positive stock market performance. All
sectors within the S&P 500 Index posted positive returns during the year. The
information technology and financial sector were the top performers, with the
telecommunication services and consumer staple sectors providing the lowest, yet
still positive, returns.
The outlook for equity market performance remains positive for 2004. A
strengthening economy with improved consumer confidence is providing an improved
outlook. Low inflation and a further drop in unemployment levels will be
important in sustaining the recovery and continuing the advance in the equity
markets.
SMALLCAP VALUE ACCOUNT
The performance of the Portfolio was affected by a couple of factors worth
mentioning. Exposure to mortgage-related companies, which benefited from
historically low interest rates, contributed to the Portfolio's strong
performance in the Finance sector. Investments in nursing homes paid off due to
increased reimbursement from Medicare patients. Beyond these contributors,
holding stocks in the Portfolio that were acquired during the fourth quarter
(such as Esperion, Allegiant Bancorp and Unisource) notably aided performance.
On the other hand, although our technology investments were generally up
significantly during the year, a number of holdings underperformed relative to
other technology companies. This was due primarily to the fact that lower
quality (non-earners) and micro-cap stocks significantly outperformed higher
quality small cap companies. An underweight in steel-related concerns resulted
in underperformance in the Basic Materials sector. Finally, fraud at Friedman's
Jewelers added to our overall underperformance in the Retail sector.
GROWTH OF $10,000
Total Returns of the Account
as of December 31, 2003
1 Year 5 Year Life of Fund
50.61% 17.02% 11.61%*
* Since inception 5/1/98
[Download Table]
Morningstar SmallCap
Russell 2000 Small Value Value
Value Index Category Account
10 10 10
"1998" 8.54 8.441 8.494
"1999" 8.413 8.82 10.316
"2000" 10.334 10.318 12.778
"2001" 11.783 12.104 13.577
"2002" 10.437 10.863 12.374
"2003" 15.241 15.503 18.636
LOGO
UTILITIES ACCOUNT
In 2003 the utilities industry rebounded, with the S&P Utilities Index gaining
26.26%. The account underperformed the index by -12.43% and its peers by -5.78%,
with a return of 13.83%. Performance was negatively affected by weaker returns
from the account's hybrid preferreds, which typically have a low correlation
with the risk/return characteristics of common stock, an asset class broadly
held by the peer group.
GROWTH OF $10,000
Total Returns of the Account
as of December 31, 2003
1 Year 5 Year Life of Fund
13.83% -2.60% 0.20%*
* Since inception 5/1/98
[Download Table]
S&P S&P
Utilities 500 Russell 3000 Morningstar Specialty- Utilities
Index Index Value Index Utilities Category Account
10 10 10 10 10
"1998" 11.089 11.079 10.195 10.973 11.536
"1999" 10.104 13.41 10.873 12.766 11.8
"2000" 16.134 12.188 11.747 13.679 14.063
"2001" 11.224 10.74 11.238 10.753 10.168
"2002" 7.86 8.365 9.532 8.194 8.886
"2003" 9.924 10.765 12.493 10.015 10.115
LOGO
The industry gained some stability during the year, underscored by a "back to
basics" strategy, adopted by many utilities, which reduced leverage and disposed
of non-core assets. The result was a stronger balance sheet and improved
financial flexibility. Notwithstanding ongoing rating erosion and fundamental
issues, the utility sector still proved to be one of the best performers in
2003. Overall improvement for the year resulted from lower financial risk, a
drop in capital spending, which helped to create more positive free cash flow,
and diminished investor concern relative to earlier Enron-like events.
Specifically, the Blackout of 2003, which effectively cut power to 50 million
customers in the northeast United States and eastern Canada for 24 hours in
August, has increased the importance of a comprehensive energy bill to address
transmission congestion and the repeal of the Public Utility Holding Co Act
(PUHCA). Also, successful efforts are needed by the Federal Energy Regulatory
Commission (FERC) to establish workable and viable regional transmission
organizations in the United States. Given the upcoming presidential election, it
is uncertain whether energy legislation will be drafted anytime soon. A repeal
of PUHCA could occur however, potentially leading to a broader role of financial
players in the utility sector.
Last year, the sector was supported by strong technicals, including significant
spread compression, despite being challenged by a variety of concerns such as
high oil and gas prices, deregulation, and infrastructure developments. Going
into 2004, conservative management teams should continue to avoid higher-risk,
non-regulated businesses and focus instead on rate cases and constructive
regulatory relationships. The rating agencies still appear to be locked in a
"catch-up" mode, continuing to downgrade utilities that probably should have had
lower ratings several years ago. However, the downgrade pace has slowed and this
should continue into 2004, given the industry's improving balance sheet and
stable electric operations, as well as signs of a strengthening economy.
The telecommunications industry reflected a much-improved capital structure,
strong free cash flow and the introduction of new technologies. Overall weak
demand, revenue pressures, an uncertain regulatory environment, fragile consumer
confidence, and stiff competition in long distance, wireless, and voice/data
services could nevertheless lead to a few opportunities going into 2004.
President Bush's dividend tax relief package could help prompt stronger investor
demand for common and preferred securities paying attractive dividends,
especially in the income-oriented utility and telecommunication sectors. In many
ways, conditions in 2003 created a "perfect storm" for the hybrid preferred
market. Historically low short-term rates, an accommodative Federal Reserve
(Fed) policy, a steep yield curve, signs of a strengthening economy, tightening
corporate bond spreads, positive legislative developments, and improving credit
quality encouraged strong institutional and individual demand for preferreds.
reflect all expenses of the Account and assume all distributions are reinvested
at net asset value. Past performance is not predictive of future performance.
Returns and net asset values fluctuate. Shares are redeemable at current net
asset value, which may be more or less than original cost.
The various indices included in the following graphs are unmanaged and do not
reflect any commissions or fees which would be incurred by an investor
purchasing the securities included in the index. Investors cannot invest
directly into these or any indices.
IMPORTANT NOTES
DOW JONES UTILITIES INDEX WITH INCOME is a price-weighted average of 15 utility
companies that are listed on the New York Stock Exchange and are involved in the
production of electrical energy.
LEHMAN BROTHERS AGGREGATE BOND INDEX represents securities that are U.S.
domestic, taxable, and dollar denominated. The index covers the U.S. investment
grade fixed rate bond market, with index components for
government and corporate securities, mortgage pass-through securities, and
asset-backed securities. These major sectors are subdivided into more specific
indices that are calculated and reported on a regular basis.
LEHMAN BROTHERS HIGH YIELD COMPOSITE BOND INDEX is an unmanaged index of all
publicly issued fixed, dollar-denominated, SEC-registered corporate debt rated
Ba1 or lower with at least $100 million outstanding and one year or more to
maturity.
LEHMAN BROTHERS MORTGAGE BACKED SECURITIES INDEX is composed of all fixed-rate,
securitized mortgage pools by GNMA, FNMA, and the FHLMC, including GNMA
Graduated Payment Mortgages. The minimum principal amount required for inclusion
is $50 million. Total return comprises price appreciation/depreciation and
income as a percentage of the original investment. Indices are rebalanced
monthly by market capitalization.
MORGAN STANLEY CAPITAL INTERNATIONAL (MSCI) EAFE (EUROPE, AUSTRALIA AND FAR
EAST) INDEX is a stock index designed to measure the investment returns of
developed economies outside of North America.
MORGAN STANLEY CAPITAL INTERNATIONAL (MSCI) EAFE (EUROPE, AUSTRALIA AND FAR
EAST) SMALLCAP INDEX is a stock index designed to measure the investment returns
small cap companies of developed economies outside of North America.
MORGAN STANLEY REIT INDEX is a total-return index comprised of the most actively
traded real estate investment trusts, and is designed to be a measure of real
estate equity performance.
MORNINGSTAR CONSERVATIVE ALLOCATION CATEGORY consists of domestic funds with
20-50% invested in equities and 50-80% invested in fixed income and cash.
MORNINGSTAR MODERATE ALLOCATION CATEGORY consists of domestic funds with 50-70%
invested in equities and the remainder invested in fixed income and cash.
MORNINGSTAR FOREIGN LARGE BLEND CATEGORY consists of funds that seek capital
appreciation by investing in a variety of large international stocks. Large-cap
foreign stocks have market capitalizations greater than $5 billion. The blend
style is assigned to funds where neither growth nor value characteristics
predominate.
MORNINGSTAR HIGH YIELD CATEGORY consists of High-Yield bond funds which
concentrate on lower-quality bonds. These funds generally offer high yields than
other types of funds - but they are also more vulnerable to economic and credit
risk.
MORNINGSTAR INTERMEDIATE GOVERNMENT CATEGORY consists of intermediate-term
government funds that devote at least 90% of their bond holdings to government
issues. These funds have, on average, durations between 3.5 and six years.
MORNINGSTAR INTERMEDIATE-TERM BOND CATEGORY consists of intermediate-term bond
funds that have average durations that are greater than 3.5 years and less than
six years. Most of the funds rotate among a variety of sectors in the bond
market, based upon which appear to offer better values.
MORNINGSTAR LARGE BLEND CATEGORY consists of large-cap blend funds that focus on
big companies that are fairly representative of the overall stock market in both
size and price. They tend to invest across the spectrum of U.S. industries and
owing to their broad exposure, the funds' returns are often similar to the S&P
500 Index.
MORNINGSTAR LARGE GROWTH CATEGORY consists of large-cap growth funds that invest
in big companies that are projected to grow faster than the overall stock
market. Most of these funds focus on either companies in rapidly expanding
industries with a high percentage of sales coming from foreign markets.
MORNINGSTAR LARGE VALUE CATEGORY consists of large-cap value funds that focus on
big companies that are less expensive than the market as a whole. They often
come from the utilities, energy, financial, and cyclical sectors, and many pay
dividends. They also generally have more-stable stock prices.
MORNINGSTAR MID-CAP BLEND CATEGORY consists of mid-cap blend funds that
typically invest in stocks of various sizes and mixed characteristics, giving it
a middle-of-the road profile. Most shy away from high-priced growth stocks, but
aren't so price-conscious that they land in value territory.
MORNINGSTAR MID-CAP GROWTH CATEGORY consists of mid-cap growth funds that
typically focus directly on mid-size companies though some invest in stocks of
all sizes. Mid-cap growth funds target firms that are projected to grow faster
than the overall market, therefore commanding relatively higher prices. Many of
these stocks are found in the volatile technology, health-care, and services
sectors.
MORNINGSTAR MID-CAP VALUE CATEGORY consists of mid-cap value funds that buy
stocks mainly of medium-size companies that are cheap relative to their earnings
potential.
MORNINGSTAR SMALL BLEND CATEGORY consists of small-cap blend funds that favor
firms at the smaller end of the market-capitalization range, and are flexible in
the types of small caps they buy. They own everything from fairly cheap,
out-of-favor stocks to somewhat expensive growth stocks. They thus provide
exposure both to traditional value sectors, such as financials and cyclicals,
and to growth sectors like technology and health care.
MORNINGSTAR SMALL GROWTH CATEGORY consists of small-cap growth funds that focus
on stocks at the lower end of the market-capitalization range. These funds tend
to favor companies in up-and-coming industries or young firms in their early
growth stages and tend to be volatile.
MORNINGSTAR SMALL VALUE CATEGORY consists of small-cap value funds that invest
in less-popular companies at the smaller end of the size range and may focus on
finding temporarily depressed stocks of companies working through business
problems.
MORNINGSTAR SPECIALTY - REAL ESTATE CATEGORY consists of specialty real-estate
funds that invest primarily in real-estate investment trusts (REITs) of various
types. The performance of these funds is less connected to the overall market
than most other types of stock funds.
MORNINGSTAR SPECIALTY - UTILITIES CATEGORY consists of specialty-utilities funds
that invest in phone, power, gas, and water companies. These types of companies
have historically been conservative investments that pay sturdy dividends. These
funds tend to provide relatively little capital appreciation, and more in the
way of yield. These funds are sensitive to interest rates and industry changes.
RUSSELL 1000 GROWTH INDEX is an index that measures the performance of those
Russell 1000 companies with higher price-to-book ratios and higher forecasted
growth values.
RUSSELL 1000 VALUE INDEX is an index that measures the performance of those
Russell 1000 companies with lower price to book ratios and lower forecasted
growth values.
RUSSELL 2000 GROWTH INDEX measures the performance of those Russell 2000
companies with higher price-to-book ratios and higher forecasted growth values.
RUSSELL 2000 INDEX measures the performance of the 2,000 smallest companies in
the Russell 3000 Index.
RUSSELL 2000 VALUE INDEX measures the performance of those Russell 2000
companies with lower price-to-book ratios and lower forecasted growth values.
RUSSELL 3000 VALUE INDEX measures the performance of those Russell 3000 Index
companies with lower price-to-book ratios and lower forecasted growth values.
The stocks in this index are also members of either the Russell 1000 Value or
the Russell 2000 Value indexes.
RUSSELL MIDCAP GROWTH INDEX is an unmanaged market-capitalization-weighted index
that measures the performance of those companies in the Russell MidCap Index
with higher price-to-book ratios and higher forecasted growth values.
RUSSELL MIDCAP VALUE INDEX is an unmanaged market-capitalization-weighted index
that measures the performance of those Russell Midcap companies with lower
price-to-book value ratios and lower forecasted growth values.
S&P 500 INDEX is a market capitalization-weighted index of 500 widely held
stocks often used as a proxy for the stock market. It measures the movement of
the largest issues. Standard & Poor's chooses the member companies for the 500
based on market size, liquidity and industry group representation. Included are
the stocks of industrial, financial, utility and transportation companies.
S&P/BARRA 500 VALUE INDEX is a market capitalization-weighted index of the
stocks in the S&P 500 Index having the highest book to price ratios. The index
consists of approximately half of the S&P 500 on a market capitalization basis.
S&P MIDCAP 400 INDEX includes approximately 10% of the capitalization of U.S.
equity securities. These are comprised of stocks in the middle capitalization
range. Any mid-sized stocks already included in the S&P 500 are excluded from
this index.
S&P SMALLCAP 600 INDEX consists of 600 domestic stocks chosen for market size,
liquidity and industry group representation. It is a market weighted index
(stock price x shares outstanding), with each stock affecting the index in
proportion to its market value.
S&P UTILITIES INDEX is comprised of the utility stocks within the S&P 500 Index.
GENERAL INFORMATION ABOUT AN ACCOUNT
ELIGIBLE PURCHASERS
Only certain eligible purchasers may buy shares of the Accounts. Eligible
purchasers are limited to 1) separate accounts of Principal Life or of other
insurance companies, 2) Principal Life or any of its subsidiaries or affiliates,
3) trustees of other managers of any qualified profit sharing, incentive or
bonus plan established by Principal Life or any of its subsidiaries or
affiliates for employees of such company, subsidiary or affiliate. Such trustees
or managers may buy Account shares only in their capacities as trustees or
managers and not for their personal accounts. The Board of Directors of the Fund
reserves the right to broaden or limit the designation of eligible purchaser.
Each Account serves as the underlying investment vehicle for variable annuity
contracts and variable life insurance policies that are funded through separate
accounts established by Principal Life. It is possible that in the future, it
may not be advantageous for variable life insurance separate accounts and
variable annuity separate accounts to invest in the Accounts at the same time.
Although neither Principal Life nor the Fund currently foresees any such
disadvantage, the Fund's Board of Directors monitors events in order to identify
any material conflicts between such policy owners and contract holders. Material
conflict could result from, for example, 1) changes in state insurance laws, 2)
changes in Federal income tax law, 3) changes in the investment management of an
Account, or 4) differences in voting instructions between those given by policy
owners and those given by contract holders. Should it be necessary, the Board
would determine what action, if any, should be taken. Such action could include
the sale of Account shares by one or more of the separate accounts which could
have adverse consequences.
SHAREHOLDER RIGHTS
The following information applies to each Account of the Principal Variable
Contracts Fund, Inc. Each Account share is eligible to vote, either in person or
by proxy, at all shareholder meetings for that Account. This includes the right
to vote on the election of directors, selection of independent auditors and
other matters submitted to meetings of shareholders of the Account. Each share
has equal rights with every other share of the Account as to dividends,
earnings, voting, assets and redemption. Shares are fully paid, non-assessable
and have no preemptive or conversion rights. Shares of an Account are issued as
full or fractional shares. Each fractional share has proportionately the same
rights including voting as are provided for a full share. Shareholders of the
Fund may remove any director with or without cause by the vote of a majority of
the votes entitled to be case at a meeting of all Account shareholders.
The bylaws of the Fund provide that the Board of Directors of the Fund may
increase or decrease the aggregate number of shares that the Fund has the
authority to issue, without a shareholder vote.
The bylaws of the Fund also provide that the Fund does not need to hold an
annual meeting of shareholders unless one of the following is required to be
acted upon by shareholders under the Investment Company Act of 1940: election of
directors; approval of an investment advisory agreement; ratification of the
selection of independent auditors; and approval of the distribution agreement.
The Fund intends to hold shareholder meetings only when required by law and at
such other times when the Board of Directors deems it to be appropriate.
Shareholder inquiries should be directed to: Principal Variable Contracts Fund,
Inc., Principal Financial Group, Des Moines, Iowa 50392-2080.
NON-CUMULATIVE VOTING
The Fund's shares have non-cumulative voting rights. This means that the holders
of more than 50% of the shares voting for the election of directors of the Fund
can elect 100% of the directors if they choose to do so. In such event, the
holders of the remaining shares voting for the election of directors will not be
able to elect any directors.
Principal Life votes each Account's shares allocated to each of its separate
accounts registered under the Investment Company Act of 1940 and attributable to
variable annuity contracts or variable life insurance policies participating in
the separate accounts. The shares are voted in accordance with instructions
received from contract holders, policy owners, participants and annuitants.
Other shares of each Account held by each separate account, including shares for
which no timely voting instructions are received, are voted in proportion to the
instructions that are received with respect to contracts or policies
participating that separate account. Shares of each of the Accounts held in the
general account of Principal Life or in the unregistered separate accounts are
voted in proportion to the instructions that are
received with respect to contracts and policies participating in its registered
and unregistered separate accounts. If Principal Life determines, under
applicable law, that an Account's shares held in one or more separate accounts
or in its general account need not be voted according to the instructions that
are received, it may vote those Account shares in its own right.
PURCHASE OF ACCOUNT SHARES
Shares are purchased from Princor Financial Services Corporation, the Fund's
principal underwriter. There are no sales charges on shares of the Accounts,
however, your variable contract may impose a charge. There are no restrictions
on amounts to be invested in shares of the Accounts.
Shareholder accounts for each Account are maintained under an open account
system. Under this system, an account is opened and maintained for each
investor. Each investment is confirmed by sending the investor a statement of
account showing the current purchase and the total number of shares owned. The
statement of account is treated by each Account as evidence of ownership of
Account shares. Share certificates are not issued.
SALE OF ACCOUNT SHARES
This section applies to eligible purchasers other than the separate accounts of
Principal Life and its subsidiaries.
Each Account sells its shares upon request. There is no charge for the sale. A
shareholder sends a written request to the Account requesting the sale of any
part or all of the shares. The letter must be signed exactly as the account is
registered. If payment is to be made to the registered shareholder or joint
shareholder, the Account does not require a signature guarantee. If payment is
to be made to another party, the shareholder's signature(s) must be guaranteed
by a commercial bank, trust company, credit union, savings and loan association,
national securities exchange member or brokerage firm. Shares are redeemed at
the net asset value per share next computed after the request is received by the
Account in proper and complete form.
Sales proceeds are generally sent within three business days after the request
is received in proper form. However, the right to sell shares may be suspended
during any period when 1) trading on the NYSE is restricted as determined by the
SEC or when the NYSE is closed for other than weekends and holidays, or 2) an
emergency exists, as determined by the SEC, as a result of which a) disposal by
a fund of securities owned by it is not reasonably practicable, b) it is not
reasonably practicable for a fund to fairly determine the value of its net
assets, or c) the SEC permits suspension for the protection of security holders.
If payments are delayed and the instruction is not canceled by the shareholder's
written instruction, the amount of the transaction is determined as of the first
valuation date following the expiration of the permitted delay. The transaction
occurs within five days thereafter.
In addition, payments on surrenders attributable to a premium payment made by
check may be delayed up to 15 days. This permits payment to be collected on the
check.
RESTRICTED TRANSFERS
Shares of each of the Accounts may be transferred to an eligible purchaser.
However, if an Account is requested to transfer shares to other than an eligible
purchaser, the Account has the right, at its election, to purchase the shares at
the net asset value next calculated after the receipt of the transfer request.
However, the Account must give written notification to the transferee(s) of the
shares of the election to buy the shares within seven days of the request.
Settlement for the shares shall be made within the seven-day period.
FINANCIAL STATEMENTS
You will receive an annual financial statement for the Fund, audited by the
Fund's independent auditors, Ernst & Young LLP. That report is a part of this
prospectus. You will also receive a semiannual financial statement that is
unaudited.
FINANCIAL HIGHLIGHTS
The following financial highlights are derived from financial statements that
were audited by Ernst & Young LLP., except for the financial highlights for the
six months ended June 30, 2004 which are unaudited.
FINANCIAL HIGHLIGHTS
PRINCIPAL VARIABLE CONTRACTS FUND, INC.
-------------------------------------------------------------------------------
SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR
ENDED DECEMBER 31 (EXCEPT AS NOTED):
[Download Table]
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
ASSET ALLOCATION ACCOUNT
------------------------
Net Asset Value,
Beginning of Period.. $9.82 $11.28 $12.02 $13.23 $12.30
Income from Investment
Operations:
Net Investment Income
(Operating Loss).... 0.15 0.20 0.24 0.35 0.35
Net Realized and
Unrealized Gain
(Loss) on
Investments......... 1.92 (1.66) (0.71) (0.17) 2.00
---- ----- ----- ----- ----
Total From Investment
Operations 2.07 (1.46) (0.47) 0.18 2.35
Less Dividends and
Distributions:
Dividends from Net
Investment Income... (0.19) -- (0.24) (0.34) (0.35)
Distributions from
Realized Gains...... -- -- (0.03) (1.05) (1.07)
---- ----- ----- -----
Total Dividends and
Distributions (0.19) -- (0.27) (1.39) (1.42)
---- ----- ----- ----- -----
Net Asset Value, End
of Period............ $11.70 $9.82 $11.28 $12.02 $13.23
====== ===== ====== ====== ======
Total Return.......... 21.61% (12.94)% (3.92)% 1.61% 19.49%
Ratio/Supplemental
Data:
Net Assets, End of
Period (in
thousands).......... $98,006 $82,409 $101,904 $94,905 $89,711
Ratio of Expenses to
Average Net Assets.. 0.85% 0.84% 0.85% 0.84% 0.85%
Ratio of Net
Investment Income to
Average Net Assets.. 1.49% 1.79% 2.23% 2.67% 2.50%
Portfolio Turnover
Rate................ 186.0% 255.3% 182.4% 67.8% 86.7%
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
BALANCED ACCOUNT
----------------
Net Asset Value,
Beginning of Period.. $11.56 $13.73 $15.43 $15.41 $16.25
Income from Investment
Operations:
Net Investment Income
(Operating Loss).... 0.27 0.34 0.40/(b)/ 0.45 0.56
Net Realized and
Unrealized Gain
(Loss) on
Investments......... 1.83 (2.11) (1.42)/(b)/ (0.43) (0.19)
---- ----- ----- ----- -----
Total From Investment
Operations 2.10 (1.77) (1.02) 0.02 0.37
Less Dividends and
Distributions:
Dividends from Net
Investment Income... (0.35) (0.40) (0.47) -- (0.57)
Distributions from
Realized Gains...... -- -- (0.21) -- (0.64)
---- ----- -----
Total Dividends and
Distributions (0.35) (0.40) (0.68) -- (1.21)
---- ----- ----- ----- -----
Net Asset Value, End
of Period............ $13.31 $11.56 $13.73 $15.43 $15.41
====== ====== ====== ====== ======
Total Return.......... 18.82% (13.18)% (6.96)% 0.13% 2.40%
Ratio/Supplemental
Data:
Net Assets, End of
Period (in
thousands).......... $124,735 $110,545 $144,214 $167,595 $209,747
Ratio of Expenses to
Average Net Assets.. 0.65% 0.61% 0.61% 0.60% 0.58%
Ratio of Gross
Expenses to Average
Net Assets /(a)/ ... 0.65% 0.62% -- -- --
Ratio of Net
Investment Income to
Average Net Assets.. 2.23% 2.52% 2.73%/(b)/ 2.74% 3.36%
Portfolio Turnover
Rate................ 114.3% 87.8% 114.3% 62.6% 21.7%
/(a) /Expense ratio without fees paid indirectly.
/(b) /Effective January 1, 2001, the Fund adopted the provisions of the AICPA
Audit and Accounting Guide for Investment Companies. The effect of this
change for the year ended December 31, 2001 was to decrease net investment
income per share by $.01, increase net realized and unrealized gains/losses
per share by $.01, and decrease the ratio of net investment income to average
net assets by .08%. Financial highlights for prior periods have not been
restated to reflect this change in presentation.
See accompanying notes.
160
FINANCIAL HIGHLIGHTS
PRINCIPAL VARIABLE CONTRACTS FUND, INC.
-------------------------------------------------------------------------------
SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR
ENDED DECEMBER 31 (EXCEPT AS NOTED):
[Download Table]
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
BOND ACCOUNT
------------
Net Asset Value,
Beginning of Period.. $12.32 $11.84 $11.78 $10.89 $12.02
Income from Investment
Operations:
Net Investment Income
(Operating Loss).... 0.52 0.51 0.56/(b)/ 0.85 0.81
Net Realized and
Unrealized Gain
(Loss) on
Investments......... 0.02 0.54 0.35/(b)/ 0.04 (1.12)
---- ---- ---- ---- -----
Total From Investment
Operations 0.54 1.05 0.91 0.89 (0.31)
Less Dividends and
Distributions:
Dividends from Net
Investment Income... (0.55) (0.57) (0.85) -- (0.82)
---- ----- ----- ----- -----
Total Dividends and
Distributions (0.55) (0.57) (0.85) -- (0.82)
---- ----- ----- ----- -----
Net Asset Value, End
of Period............ $12.31 $12.32 $11.84 $11.78 $10.89
====== ====== ====== ====== ======
Total Return.......... 4.59% 9.26% 8.12% 8.17% (2.59)%
Ratio/Supplemental
Data:
Net Assets, End of
Period (in
thousands).......... $263,435 $232,839 $166,658 $116,216 $125,067
Ratio of Expenses to
Average Net Assets.. 0.47% 0.49% 0.50% 0.51% 0.50%
Ratio of Net
Investment Income to
Average Net Assets.. 4.32% 5.02% 5.73%/(b)/ 7.47% 6.78%
Portfolio Turnover
Rate................ 82.1% 63.3% 146.1% 81.5% 40.1%
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
CAPITAL VALUE ACCOUNT
---------------------
Net Asset Value,
Beginning of Period.. $23.60 $27.78 $30.72 $30.74 $37.19
Income from Investment
Operations:
Net Investment Income
(Operating Loss).... 0.38 0.39 0.34 0.50 0.78
Net Realized and
Unrealized Gain
(Loss) on
Investments......... 5.63 (4.18) (2.80) 0.13 (2.41)
---- ----- ----- ---- -----
Total From Investment
Operations 6.01 (3.79) (2.46) 0.63 (1.63)
Less Dividends and
Distributions:
Dividends from Net
Investment Income... (0.38) (0.39) (0.34) (0.50) (0.80)
Distributions from
Realized Gains...... -- -- (0.14) (0.15) (4.02)
---- ----- ----- -----
Total Dividends and
Distributions (0.38) (0.39) (0.48) (0.65) (4.82)
----- ----- ----- ----- -----
Net Asset Value, End
of Period............ $29.23 $23.60 $27.78 $30.72 $30.74
====== ====== ====== ====== ======
Total Return.......... 25.49% (13.66)% (8.05)% 2.16% (4.29)%
Ratio/Supplemental
Data:
Net Assets, End of
Period (in
thousands).......... $248,253 $206,541 $254,484 $283,325 $367,927
Ratio of Expenses to
Average Net Assets.. 0.61% 0.61% 0.61% 0.60% 0.43%
Ratio of Gross
Expenses to Average
Net Assets /(a)/ ... 0.61% 0.61% -- -- --
Ratio of Net
Investment Income to
Average Net Assets.. 1.47% 1.45% 1.20% 1.54% 2.05%
Portfolio Turnover
Rate................ 125.7% 142.6% 91.7% 141.8% 43.4%
/(a) /Expense ratio without fees paid indirectly.
/(b) /Effective January 1, 2001, the Fund adopted the provisions of the AICPA
Audit and Accounting Guide for Investment Companies. The effect of this
change for the year ended December 31, 2001 was to decrease net investment
income per share by $.01, increase net realized and unrealized gains/losses
per share by $.01, and decrease the ratio of net investment income to average
net assets by .08%. Financial highlights for prior periods have not been
restated to reflect this change in presentation.
See accompanying notes.
161
FINANCIAL HIGHLIGHTS
PRINCIPAL VARIABLE CONTRACTS FUND, INC.
-------------------------------------------------------------------------------
SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR
ENDED DECEMBER 31 (EXCEPT AS NOTED):
[Download Table]
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
EQUITY GROWTH ACCOUNT
---------------------
Net Asset Value,
Beginning of Period.. $11.74 $16.29 $20.37 $23.89 $18.33
Income from Investment
Operations:
Net Investment Income
(Operating Loss).... 0.06 0.03 0.01 0.02 (0.01)
Net Realized and
Unrealized Gain
(Loss) on
Investments......... 2.99 (4.54) (2.82) (2.73) 7.17
---- ----- ----- ----- ----
Total From Investment
Operations 3.05 (4.51) (2.81) (2.71) 7.16
Less Dividends and
Distributions:
Dividends from Net
Investment Income... (0.06) (0.04) (0.02) -- --
Distributions from
Realized Gains...... -- -- (1.25) (0.81) (1.60)
---- ----- ----- -----
Total Dividends and
Distributions (0.06) (0.04) (1.27) (0.81) (1.60)
----- ----- ----- ----- -----
Net Asset Value, End
of Period............ $14.73 $11.74 $16.29 $20.37 $23.89
====== ====== ====== ====== ======
Total Return.......... 25.95% (27.72)% (14.86)% (11.71)% 39.50%
Ratio/Supplemental
Data:
Net Assets, End of
Period (in
thousands).......... $272,831 $219,044 $334,401 $383,139 $379,062
Ratio of Expenses to
Average Net Assets.. 0.74% 0.77% 0.75% 0.73% 0.77%
Ratio of Gross
Expenses to Average
Net Assets /(a)/ ... 0.77% -- -- -- --
Ratio of Net
Investment Income to
Average Net Assets.. 0.47% 0.19% 0.06% 0.08% (0.08)%
Portfolio Turnover
Rate................ 130.9% 138.8% 88.8% 69.1% 89.6%
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
GOVERNMENT SECURITIES ACCOUNT
-----------------------------
Net Asset Value,
Beginning of Period.. $12.00 $11.58 $11.43 $10.26 $11.01
Income from Investment
Operations:
Net Investment Income
(Operating Loss).... 0.45 0.43 0.51 0.69 0.71
Net Realized and
Unrealized Gain
(Loss) on
Investments......... (0.24) 0.55 0.32 0.48 (0.74)
----- ---- ---- ---- -----
Total From Investment
Operations 0.21 0.98 0.83 1.17 (0.03)
Less Dividends and
Distributions:
Dividends from Net
Investment Income... (0.44) (0.52) (0.68) -- (0.72)
Distributions from
Realized Gains...... -- (0.04) -- -- --
---- -----
Total Dividends and
Distributions (0.44) (0.56) (0.68) -- (0.72)
---- ----- ----- ----- -----
Net Asset Value, End
of Period............ $11.77 $12.00 $11.58 $11.43 $10.26
====== ====== ====== ====== ======
Total Return.......... 1.84% 8.80% 7.61% 11.40% (0.29)%
Ratio/Supplemental
Data:
Net Assets, End of
Period (in
thousands).......... $368,564 $342,001 $193,254 $127,038 $137,787
Ratio of Expenses to
Average Net Assets.. 0.44% 0.47% 0.49% 0.51% 0.50%
Ratio of Net
Investment Income to
Average Net Assets.. 3.83% 4.87% 5.63% 6.33% 6.16%
Portfolio Turnover
Rate................ 110.4% 33.8% 45.9% 4.3% 19.7%
/(a) /Expense ratio without fees paid indirectly.
See accompanying notes.
162
FINANCIAL HIGHLIGHTS
PRINCIPAL VARIABLE CONTRACTS FUND, INC.
-------------------------------------------------------------------------------
SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR
ENDED DECEMBER 31 (EXCEPT AS NOTED):
[Download Table]
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
GROWTH ACCOUNT
--------------
Net Asset Value,
Beginning of Period.. $8.68 $12.24 $16.43 $23.56 $20.46
Income from Investment
Operations:
Net Investment Income
(Operating Loss).... 0.03 0.02 -- (0.02) 0.14
Net Realized and
Unrealized Gain
(Loss) on
Investments......... 2.26 (3.58) (4.19) (2.29) 3.20
---- ----- ----- ----- ----
Total From Investment
Operations 2.29 (3.56) (4.19) (2.31) 3.34
Less Dividends and
Distributions:
Dividends from Net
Investment Income... (0.02) -- -- -- (0.14)
Distributions from
Realized Gains...... -- -- -- (4.82) (0.10)
---- ----- -----
Total Dividends and
Distributions (0.02) -- -- (4.82) (0.24)
---- ----- ----- -----
Net Asset Value, End
of Period............ $10.95 $8.68 $12.24 $16.43 $23.56
====== ===== ====== ====== ======
Total Return.......... 26.46% (29.07)% (25.50)% (10.15)% 16.44%
Ratio/Supplemental
Data:
Net Assets, End of
Period (in
thousands).......... $141,107 $124,079 $209,879 $294,762 $345,882
Ratio of Expenses to
Average Net Assets.. 0.61% 0.61% 0.61% 0.60% 0.45%
Ratio of Gross
Expenses to Average
Net Assets /(a)/ ... 0.61% 0.61% -- -- --
Ratio of Net
Investment Income to
Average Net Assets.. 0.35% 0.18% 0.02% (0.13)% 0.67%
Portfolio Turnover
Rate................ 40.8% 27.3% 39.0% 83.5% 65.7%
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
INTERNATIONAL ACCOUNT
---------------------
Net Asset Value,
Beginning of Period.. $8.78 $10.51 $13.90 $15.95 $14.51
Income from Investment
Operations:
Net Investment Income
(Operating Loss).... 0.13 0.10 0.09 0.10 0.48
Net Realized and
Unrealized Gain
(Loss) on
Investments......... 2.67 (1.78) (3.46) (1.48) 3.14
---- ----- ----- ----- ----
Total From Investment
Operations 2.80 (1.68) (3.37) (1.38) 3.62
Less Dividends and
Distributions:
Dividends from Net
Investment Income... (0.10) (0.05) (0.02) (0.08) (0.47)
Distributions from
Realized Gains...... -- -- -- (0.59) (1.71)
---- ----- -----
Total Dividends and
Distributions (0.10) (0.05) (0.02) (0.67) (2.18)
----- ----- ----- ----- -----
Net Asset Value, End
of Period............ $11.48 $8.78 $10.51 $13.90 $15.95
====== ===== ====== ====== ======
Total Return.......... 32.33% (16.07)% (24.27)% (8.34)% 25.93%
Ratio/Supplemental
Data:
Net Assets, End of
Period (in
thousands).......... $167,726 $119,222 $145,848 $190,440 $197,235
Ratio of Expenses to
Average Net Assets.. 0.92% 0.92% 0.92% 0.90% 0.78%
Ratio of Gross
Expenses to Average
Net Assets /(a)/ ... 0.93% 0.93% -- -- --
Ratio of Net
Investment Income to
Average Net Assets.. 1.33% 1.03% 0.78% 0.81% 3.11%
Portfolio Turnover
Rate................ 111.5% 82.2% 84.3% 99.9% 65.5%
/(a) /Expense ratio without fees paid indirectly.
See accompanying notes.
163
FINANCIAL HIGHLIGHTS
PRINCIPAL VARIABLE CONTRACTS FUND, INC.
-------------------------------------------------------------------------------
SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR
ENDED DECEMBER 31 (EXCEPT AS NOTED):
[Download Table]
2003 2002 2001 2000/(D)/
---- ---- ---- ----
INTERNATIONAL EMERGING MARKETS ACCOUNT
--------------------------------------
Net Asset Value,
Beginning of Period.. $8.24 $8.93 $9.37 $10.00
Income from Investment
Operations:
Net Investment Income
(Operating Loss).... 0.11 0.02 0.08 0.02
Net Realized and
Unrealized Gain
(Loss) on
Investments......... 4.60 (0.70) (0.48) (0.63)
---- ----- ----- -----
Total From Investment
Operations 4.71 (0.68) (0.40) (0.61)
Less Dividends and
Distributions:
Dividends from Net
Investment Income... (0.08) -- (0.04) (0.02)
Tax Return of Capital
Distributions /(a)/. (0.01) (0.01) -- --
---- ----- -----
Total Dividends and
Distributions (0.09) (0.01) (0.04) (0.02)
----- ----- ----- -----
Net Asset Value, End
of Period............ $12.86 $8.24 $8.93 $9.37
====== ===== ===== =====
Total Return.......... 57.20% (7.63)% (4.24)% (6.14)%/(e)/
Ratio/Supplemental
Data:
Net Assets, End of
Period (in
thousands).......... $23,972 $10,835 $6,964 $4,883
Ratio of Expenses to
Average Net Assets.. 1.71% 1.60% 1.35% 1.34%/(f)/
Ratio of Gross
Expenses to Average
Net Assets /(b)/ ... 1.84% 2.26% 2.33% 1.65%/(f)/
Ratio of Net
Investment Income to
Average Net Assets.. 1.16% 0.39% 0.97% 1.06%/(f)/
Portfolio Turnover
Rate................ 112.4% 147.7% 137.4% 44.0%/(f)/
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
INTERNATIONAL SMALLCAP ACCOUNT
------------------------------
Net Asset Value,
Beginning of Period.. $9.06 $10.84 $13.87 $16.66 $9.00
Income from Investment
Operations:
Net Investment Income
(Operating Loss).... 0.10 0.08 0.04 (0.04) (0.02)
Net Realized and
Unrealized Gain
(Loss) on
Investments......... 4.72 (1.83) (3.07) (1.89) 8.41
---- ----- ----- ----- ----
Total From Investment
Operations 4.82 (1.75) (3.03) (1.93) 8.39
Less Dividends and
Distributions:
Dividends from Net
Investment Income... (0.15) (0.03) -- -- --
Distributions from
Realized Gains...... -- -- -- (0.86) (0.73)
---- ----- -----
Total Dividends and
Distributions (0.15) (0.03) -- (0.86) (0.73)
---- ----- ----- ----- -----
Net Asset Value, End
of Period............ $13.73 $9.06 $10.84 $13.87 $16.66
====== ===== ====== ====== ======
Total Return.......... 54.15% (16.20)% (21.85)% (11.50)% 93.81%
Ratio/Supplemental
Data:
Net Assets, End of
Period (in
thousands).......... $66,242 $38,912 $43,674 $50,023 $40,040
Ratio of Expenses to
Average Net Assets.. 1.33% 1.31% 1.41% 1.44% 1.32%
Ratio of Gross
Expenses to Average
Net Assets /(c)/ ... 1.33% 1.32% -- -- --
Ratio of Net
Investment Income to
Average Net Assets.. 1.00% 0.77% 0.32% (0.26)% (0.28)%
Portfolio Turnover
Rate................ 128.9% 73.6% 123.8% 292.7% 241.2%
/(a) /See "Distributions to Shareholders" in Notes to Financial Statements.
/(b) /Expense ratio without fees paid indirectly and the Manager's voluntary
expense limit. The expense limit was increased on May 1, 2002 and May 1, 2003.
/(c) /Expense ratio without fees paid indirectly.
/(d) /Period from October 24, 2000, date shares first offered, through December
31, 2000.
/(e) /Total return amounts have not been annualized.
/(f) /Computed on an annualized basis.
See accompanying notes.
164
FINANCIAL HIGHLIGHTS
PRINCIPAL VARIABLE CONTRACTS FUND, INC.
-------------------------------------------------------------------------------
SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR
ENDED DECEMBER 31 (EXCEPT AS NOTED):
[Download Table]
2003 2002/(C)/
---- ----
LARGECAP BLEND ACCOUNT
----------------------
Net Asset Value,
Beginning of Period.. $8.43 $10.00
Income from Investment
Operations:
Net Investment Income
(Operating Loss).... 0.10 0.02
Net Realized and
Unrealized Gain
(Loss) on
Investments......... 1.90 (1.57)
---- -----
Total From Investment
Operations 2.00 (1.55)
Less Dividends and
Distributions:
Dividends from Net
Investment Income... (0.06) (0.02)
----- -----
Total Dividends and
Distributions (0.06) (0.02)
----- -----
Net Asset Value, End
of Period............ $10.37 $8.43
====== =====
Total Return.......... 23.76% (15.47)%/(d)/
Ratio/Supplemental
Data:
Net Assets, End of
Period (in
thousands).......... $54,632 $13,927
Ratio of Expenses to
Average Net Assets.. 0.80% 1.00%/(e)/
Ratio of Gross
Expenses to Average
Net Assets /(a)/ ... 0.83% 1.10%/(e)/
Ratio of Net
Investment Income to
Average Net Assets.. 1.08% 0.86%/(e)/
Portfolio Turnover
Rate................ 56.2% 49.1%/(e)/
2003 2002 2001 2000/(F)/
---- ---- ---- ----
LARGECAP GROWTH EQUITY ACCOUNT
------------------------------
Net Asset Value,
Beginning of Period.. $3.63 $5.44 $7.78 $10.00
Income from Investment
Operations:
Net Investment Income
(Operating Loss).... -- (0.02) (0.03) --
Net Realized and
Unrealized Gain
(Loss) on
Investments......... 0.84 (1.79) (2.31) (2.22)
---- ----- ----- -----
Total From Investment
Operations 0.84 (1.81) (2.34) (2.22)
---- ----- ----- -----
Net Asset Value, End
of Period............ $4.47 $3.63 $5.44 $7.78
===== ===== ===== =====
Total Return.......... 23.14% (33.27)% (30.08)% (22.22)%/(d)/
Ratio/Supplemental
Data:
Net Assets, End of
Period (in
thousands).......... $24,677 $5,572 $5,172 $4,233
Ratio of Expenses to
Average Net Assets.. 1.16% 1.05% 1.10% 1.04%/(e)/
Ratio of Gross
Expenses to Average
Net Assets /(b)/ ... 1.19% 1.09% 1.11% 1.35%/(e)/
Ratio of Net
Investment Income to
Average Net Assets.. (0.13)% (0.49)% (0.62)% (0.22)%/(e)/
Portfolio Turnover
Rate................ 51.1% 183.8% 121.2% 217.6%/(e)/
/(a)/ Expense ratio without fees paid indirectly and the Manager's voluntary
expense limit.
/(b) /Expense ratio without fees paid indirectly and the Manager's voluntary
expense limit. The expense limit ceased on May 1, 2002.
/(c) /Period from May 1, 2002, date operations commenced, through December 31,
2002.
/(d) /Total return amounts have not been annualized./ /
/(e) /Computed on an annualized basis.
/(f) /Period from October 24, 2000, date shares first offered, through December
31, 2000.
See accompanying notes.
165
FINANCIAL HIGHLIGHTS
PRINCIPAL VARIABLE CONTRACTS FUND, INC.
-------------------------------------------------------------------------------
SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR
ENDED DECEMBER 31 (EXCEPT AS NOTED):
[Enlarge/Download Table]
2003 2002 2001 2000 1999/(F)/
---- ---- ---- ---- ----
LARGECAP STOCK INDEX ACCOUNT
----------------------------
Net Asset Value,
Beginning of Period.. $6.35 $8.29 $9.52 $10.71 $9.83
Income from Investment
Operations:
Net Investment Income
(Operating Loss).... 0.10 0.08 0.08 0.10 0.06
Net Realized and
Unrealized Gain
(Loss) on
Investments......... 1.70 (1.94) (1.23) (1.14) 0.97
---- ----- ----- ----- ----
Total From Investment
Operations 1.80 (1.86) (1.15) (1.04) 1.03
Less Dividends and
Distributions:
Dividends from Net
Investment Income... (0.09) (0.08) (0.08) (0.10) (0.07)
Distributions from
Realized Gains...... -- -- -- (0.05) (0.08)
----- ----- -----
Total Dividends and
Distributions (0.09) (0.08) (0.08) (0.15) (0.15)
----- ----- ----- ----- -----
Net Asset Value, End
of Period............ $8.06 $6.35 $8.29 $9.52 $10.71
===== ===== ===== ===== ======
Total Return.......... 28.32% (22.44)% (12.10)% (9.67)% 8.93%/(d)/
Ratio/Supplemental
Data:
Net Assets, End of
Period (in
thousands).......... $118,638 $72,949 $73,881 $59,626 $46,088
Ratio of Expenses to
Average Net Assets.. 0.39% 0.39% 0.40% 0.40% 0.40%/(e)/
Ratio of Gross
Expenses to Average
Net Assets /(a)/ ... 0.39% 0.39% 0.41% 0.46% 0.49%/(e)/
Ratio of Net
Investment Income to
Average Net Assets.. 1.42% 1.22% 1.05% 1.01% 1.41%/(e)/
Portfolio Turnover
Rate................ 15.7% 15.1% 10.8% 11.0% 3.8%/(e)/
2003 2002/(C)/
---- ----
LARGECAP VALUE ACCOUNT
----------------------
Net Asset Value,
Beginning of Period.. $8.52 $10.00
Income from Investment
Operations:
Net Investment Income
(Operating Loss).... 0.16 0.06
Net Realized and
Unrealized Gain
(Loss) on
Investments......... 2.23 (1.48)
---- -----
Total From Investment
Operations 2.39 (1.42)
Less Dividends and
Distributions:
Dividends from Net
Investment Income... (0.11) (0.06)
----- -----
Total Dividends and
Distributions (0.11) (0.06)
----- -----
Net Asset Value, End
of Period............ $10.80 $8.52
====== =====
Total Return.......... 28.05% (14.24)%/(d)/
Ratio/Supplemental
Data:
Net Assets, End of
Period (in
thousands).......... $47,221 $13,186
Ratio of Expenses to
Average Net Assets.. 0.74% 0.96%/(e)/
Ratio of Gross
Expenses to Average
Net Assets /(b)/ ... 0.79% 1.00%/(e)/
Ratio of Net
Investment Income to
Average Net Assets.. 1.77% 1.79%/(e)/
Portfolio Turnover
Rate................ 17.1% 5.9%/(e)/
/(a) /Expense ratio without the Manager's voluntary expense limit.
/(b) /Expense ratio without fees paid indirectly and the Manager's voluntary
expense limit.
/(c) /Period from May 1, 2002, date operations commenced, through December 31,
2002.
/(d) /Total return amounts have not been annualized.
/(e) /Computed on an annualized basis.
/(f) /Period from May 1, 1999, date shares first offered, through December 31,
1999. LargeCap Stock Index Account recognized $.01 net investment income per
share and incurred an unrealized loss of $.18 per share from April 22, 1999
through April 30, 1999.
See accompanying notes.
166
FINANCIAL HIGHLIGHTS
PRINCIPAL VARIABLE CONTRACTS FUND, INC.
-------------------------------------------------------------------------------
SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR
ENDED DECEMBER 31 (EXCEPT AS NOTED):
[Download Table]
2003/(C)/
----
LIMITED TERM BOND ACCOUNT
-------------------------
Net Asset Value,
Beginning of Period.. $10.00
Income from Investment
Operations:
Net Investment Income
(Operating Loss).... 0.13
Net Realized and
Unrealized Gain
(Loss) on
Investments......... (0.05)
-----
Total From Investment
Operations 0.08
Less Dividends and
Distributions:
Dividends from Net
Investment Income... (0.09)
-----
Total Dividends and
Distributions (0.09)
-----
Net Asset Value, End
of Period............ $9.99
=====
Total Return.......... 0.78%/(d)/
Ratio/Supplemental
Data:
Net Assets, End of
Period (in
thousands).......... $20,552
Ratio of Expenses to
Average Net Assets.. 0.57%/(e)/
Ratio of Gross
Expenses to Average
Net Assets /(a)/ ... 0.57%/(e)/
Ratio of Net
Investment Income to
Average Net Assets.. 2.15%/(e)/
Portfolio Turnover
Rate................ 5.0%/(e)/
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
MIDCAP ACCOUNT
--------------
Net Asset Value,
Beginning of Period.. $28.54 $32.09 $34.47 $36.90 $34.37
Income from Investment
Operations:
Net Investment Income
(Operating Loss).... 0.35 0.30 0.24 0.10 0.12
Net Realized and
Unrealized Gain
(Loss) on
Investments......... 9.01 (3.08) (1.50) 4.76 4.20
---- ----- ----- ---- ----
Total From Investment
Operations 9.36 (2.78) (1.26) 4.86 4.32
Less Dividends and
Distributions:
Dividends from Net
Investment Income... (0.34) (0.30) (0.24) (0.10) (0.12)
Distributions from
Realized Gains...... -- (0.47) (0.88) (7.19) (1.67)
---- ----- ----- ----- -----
Total Dividends and
Distributions (0.34) (0.77) (1.12) (7.29) (1.79)
----- ----- ----- ----- -----
Net Asset Value, End
of Period............ $37.56 $28.54 $32.09 $34.47 $36.90
====== ====== ====== ====== ======
Total Return.......... 32.81% (8.75)% (3.71)% 14.59% 13.04%
Ratio/Supplemental
Data:
Net Assets, End of
Period (in
thousands).......... $334,204 $248,986 $278,707 $286,681 $262,350
Ratio of Expenses to
Average Net Assets.. 0.61% 0.62% 0.62% 0.62% 0.61%
Ratio of Gross
Expenses to Average
Net Assets /(b)/ ... 0.61% 0.62% -- -- --
Ratio of Net
Investment Income to
Average Net Assets.. 1.09% 0.98% 0.77% 0.28% 0.32%
Portfolio Turnover
Rate................ 44.9% 67.9% 73.6% 139.6% 79.6%
/(a) /Expense ratio without the Manager's voluntary expense limit.
/(b) /Expense ratio without fees paid indirectly.
/(c) /Period from May 1, 2003, date operations commenced, through December 31,
2003.
/(d) /Total return amounts have not been annualized.
/(e) /Computed on an annualized basis.
See accompanying notes.
167
FINANCIAL HIGHLIGHTS
PRINCIPAL VARIABLE CONTRACTS FUND, INC.
-------------------------------------------------------------------------------
SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR
ENDED DECEMBER 31 (EXCEPT AS NOTED):
[Download Table]
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
MIDCAP GROWTH ACCOUNT
---------------------
Net Asset Value,
Beginning of Period.. $6.26 $8.49 $10.46 $10.66 $9.65
Income from Investment
Operations:
Net Investment Income
(Operating Loss).... (0.03) (0.04) (0.05) 0.02 0.02
Net Realized and
Unrealized Gain
(Loss) on
Investments......... 2.57 (2.19) (1.68) 0.77 1.01
---- ----- ----- ---- ----
Total From Investment
Operations 2.54 (2.23) (1.73) 0.79 1.03
Less Dividends and
Distributions:
Dividends from Net
Investment Income... -- -- -- (0.02) (0.02)
Distributions from
Realized Gains...... -- -- (0.24) (0.97) --
---- ----- -----
Total Dividends and
Distributions -- -- (0.24) (0.99) (0.02)
---- ----- ----- -----
Net Asset Value, End
of Period............ $8.80 $6.26 $8.49 $10.46 $10.66
===== ===== ===== ====== ======
Total Return.......... 40.58% (26.27)% (16.92)% 8.10% 10.67%
Ratio/Supplemental
Data:
Net Assets, End of
Period (in
thousands).......... $54,288 $21,934 $27,838 $25,924 $14,264
Ratio of Expenses to
Average Net Assets.. 0.91% 0.91% 0.97% 0.96% 0.96%
Ratio of Gross
Expenses to Average
Net Assets /(a)/ ... 0.94% 0.92% -- 1.01% 1.09%
Ratio of Net
Investment Income to
Average Net Assets.. (0.39)% (0.55)% (0.66)% 0.27% 0.26%
Portfolio Turnover
Rate................ 67.5% 43.1% 55.2% 161.9% 74.1%
2003 2002 2001 2000 1999/(B)/
---- ---- ---- ---- ----
MIDCAP VALUE ACCOUNT
--------------------
Net Asset Value,
Beginning of Period.. $10.48 $11.68 $12.57 $11.11 $10.09
Income from Investment
Operations:
Net Investment Income
(Operating Loss).... 0.01 -- 0.01 -- 0.02
Net Realized and
Unrealized Gain
(Loss) on
Investments......... 3.81 (1.16) (0.35) 3.12 1.24
---- ----- ----- ---- ----
Total From Investment
Operations 3.82 (1.16) (0.34) 3.12 1.26
Less Dividends and
Distributions:
Dividends from Net
Investment Income... (0.01) -- (0.01) -- (0.02)
Distributions from
Realized Gains...... (0.16) (0.04) (0.54) (1.66) (0.22)
----- ----- ----- ----- -----
Total Dividends and
Distributions (0.17) (0.04) (0.55) (1.66) (0.24)
----- ----- ----- ----- -----
Net Asset Value, End
of Period............ $14.13 $10.48 $11.68 $12.57 $11.11
====== ====== ====== ====== ======
Total Return.......... 36.49% (9.96)% (2.58)% 31.05% 10.24%/(c)/
Ratio/Supplemental
Data:
Net Assets, End of
Period (in
thousands).......... $52,054 $24,766 $11,778 $7,739 $5,756
Ratio of Expenses to
Average Net Assets.. 1.05% 1.04% 1.36% 1.20% 1.19%/(d)/
Ratio of Gross
Expenses to Average
Net Assets /(a)/ ... 1.08% 1.10% -- 1.29% 1.26%/(d)/
Ratio of Net
Investment Income to
Average Net Assets.. 0.11% 0.03% 0.12% 0.02% 0.30%/(d)/
Portfolio Turnover
Rate................ 55.5% 75.3% 208.8% 233.2% 154.0%/(d)/
/(a) /Expense ratio without fees paid indirectly and the Manager's voluntary
expense limit. The expense limit ceased on January 1, 2001.
/(b) /Period from May 1, 1999, date shares first offered, through December 31,
1999. MidCap Value Account incurred an unrealized gain of $.09 per share from
April 22, 1999 through April 30, 1999.
/(c) /Total return amounts have not been annualized.
/(d) /Computed on an annualized basis.
See accompanying notes.
168
FINANCIAL HIGHLIGHTS
PRINCIPAL VARIABLE CONTRACTS FUND, INC.
-------------------------------------------------------------------------------
SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR
ENDED DECEMBER 31 (EXCEPT AS NOTED):
[Download Table]
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
MONEY MARKET ACCOUNT
--------------------
Net Asset Value,
Beginning of Period.. $1.000 $1.000 $1.000 $1.000 $1.000
Income from Investment
Operations:
Net Investment Income
(Operating Loss).... 0.007 0.014 0.039 0.059 0.048
----- ----- ----- ----- -----
Total From Investment
Operations 0.007 0.014 0.039 0.059 0.048
Less Dividends and
Distributions:
Dividends from Net
Investment Income... (0.007) (0.014) (0.039) (0.059) (0.048)
------ ------ ------ ------ ------
Total Dividends and
Distributions (0.007) (0.014) (0.039) (0.059) (0.048)
------ ------ ------ ------ ------
Net Asset Value, End
of Period............ $1.000 $1.000 $1.000 $1.000 $1.000
====== ====== ====== ====== ======
Total Return.......... 0.74% 1.42% 3.92% 6.07% 4.84%
Ratio/Supplemental
Data:
Net Assets, End of
Period (in
thousands).......... $151,545 $201,455 $180,923 $114,710 $120,924
Ratio of Expenses to
Average Net Assets.. 0.49% 0.49% 0.50% 0.52% 0.52%
Ratio of Net
Investment Income to
Average Net Assets.. 0.74% 1.40% 3.70% 5.88% 4.79%
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
REAL ESTATE ACCOUNT
-------------------
Net Asset Value,
Beginning of Period.. $11.24 $10.77 $10.29 $8.20 $9.07
Income from Investment
Operations:
Net Investment Income
(Operating Loss).... 0.49 0.35 0.42 0.44 0.43
Net Realized and
Unrealized Gain
(Loss) on
Investments......... 3.87 0.48 0.47 2.09 (0.85)
---- ---- ---- ---- -----
Total From Investment
Operations 4.36 0.83 0.89 2.53 (0.42)
Less Dividends and
Distributions:
Dividends from Net
Investment Income... (0.42) (0.35) (0.41) (0.44) (0.45)
Distributions from
Realized Gains...... (0.28) (0.01) -- -- --
---- ----- -----
Total Dividends and
Distributions (0.70) (0.36) (0.41) (0.44) (0.45)
----- ----- ----- ----- -----
Net Asset Value, End
of Period............ $14.90 $11.24 $10.77 $10.29 $8.20
====== ====== ====== ====== =====
Total Return.......... 38.91% 7.72% 8.75% 30.97% (4.48)%
Ratio/Supplemental
Data:
Net Assets, End of
Period (in
thousands).......... $93,018 $46,358 $22,457 $17,261 $10,560
Ratio of Expenses to
Average Net Assets.. 0.91% 0.92% 0.92% 0.99% 0.99%
Ratio of Gross
Expenses to Average
Net Assets /(a)/ ... 0.92% -- -- -- --
Ratio of Net
Investment Income to
Average Net Assets.. 3.83% 3.99% 4.55% 5.29% 4.92%
Portfolio Turnover
Rate................ 53.9% 54.4% 92.4% 44.7% 101.9%
/(a) /Expense ratio without fees paid indirectly.
See accompanying notes.
169
FINANCIAL HIGHLIGHTS
PRINCIPAL VARIABLE CONTRACTS FUND, INC.
-------------------------------------------------------------------------------
SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR
ENDED DECEMBER 31 (EXCEPT AS NOTED):
[Download Table]
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
SMALLCAP ACCOUNT
----------------
Net Asset Value,
Beginning of Period.. $5.83 $8.03 $7.83 $10.74 $8.21
Income from Investment
Operations:
Net Investment Income
(Operating Loss).... 0.01 0.01 -- 0.03 --
Net Realized and
Unrealized Gain
(Loss) on
Investments......... 2.14 (2.20) 0.20 (1.24) 3.52
---- ----- ---- ----- ----
Total From Investment
Operations 2.15 (2.19) 0.20 (1.21) 3.52
Less Dividends and
Distributions:
Dividends from Net
Investment Income... (0.01) (0.01) -- (0.02) --
Distributions from
Realized Gains...... -- -- -- (1.68) (0.99)
---- ----- -----
Total Dividends and
Distributions (0.01) (0.01) -- (1.70) (0.99)
---- ----- ----- ----- -----
Net Asset Value, End
of Period............ $7.97 $5.83 $8.03 $7.83 $10.74
===== ===== ===== ===== ======
Total Return.......... 36.82% (27.33)% 2.55% (11.73)% 43.58%
Ratio/Supplemental
Data:
Net Assets, End of
Period (in
thousands).......... $65,285 $32,201 $36,493 $30,006 $26,110
Ratio of Expenses to
Average Net Assets.. 0.95% 0.97% 1.00% 0.90% 0.91%
Ratio of Gross
Expenses to Average
Net Assets /(a)/ ... 0.95% 0.97% -- -- --
Ratio of Net
Investment Income to
Average Net Assets.. 0.09% 0.12% (0.06)% 0.28% 0.05%
Portfolio Turnover
Rate................ 162.9% 215.5% 154.5% 135.4% 111.1%
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
SMALLCAP GROWTH ACCOUNT
-----------------------
Net Asset Value,
Beginning of Period.. $5.74 $10.60 $15.59 $19.56 $10.10
Income from Investment
Operations:
Net Investment Income
(Operating Loss).... (0.04) (0.05) (0.10) (0.08) (0.05)
Net Realized and
Unrealized Gain
(Loss) on
Investments......... 2.66 (4.81) (4.89) (2.67) 9.70
---- ----- ----- ----- ----
Total From Investment
Operations 2.62 (4.86) (4.99) (2.75) 9.65
Less Dividends and
Distributions:
Distributions from
Realized Gains...... -- -- -- (1.22) (0.19)
---- ----- -----
Total Dividends and
Distributions -- -- -- (1.22) (0.19)
---- ----- -----
Net Asset Value, End
of Period............ $8.36 $5.74 $10.60 $15.59 $19.56
===== ===== ====== ====== ======
Total Return.......... 45.64% (45.85)% (32.01)% (13.91)% 95.69%
Ratio/Supplemental
Data:
Net Assets, End of
Period (in
thousands).......... $55,628 $32,754 $55,966 $68,421 $39,675
Ratio of Expenses to
Average Net Assets.. 0.99% 0.95% 1.05% 1.02% 1.05%
Ratio of Gross
Expenses to Average
Net Assets /(b)/ ... 1.02% 1.06% -- 1.02% 1.07%
Ratio of Net
Investment Income to
Average Net Assets.. (0.64)% (0.68)% (0.92)% (0.49)% (0.61)%
Portfolio Turnover
Rate................ 54.1% 287.9% 152.2% 90.8% 98.0%
/(a) /Expense ratio without fees paid indirectly.
/(b) /Expense ratio without fees paid indirectly and the Manager's voluntary
expense limit. The expense limit ceased on January 1, 2001.
See accompanying notes.
170
FINANCIAL HIGHLIGHTS
PRINCIPAL VARIABLE CONTRACTS FUND, INC.
-------------------------------------------------------------------------------
SELECTED DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR
ENDED DECEMBER 31 (EXCEPT AS NOTED):
[Download Table]
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
SMALLCAP VALUE ACCOUNT
----------------------
Net Asset Value,
Beginning of Period.. $10.30 $11.37 $11.26 $10.06 $8.34
Income from Investment
Operations:
Net Investment Income
(Operating Loss).... 0.06 0.06 0.09 0.13 0.06
Net Realized and
Unrealized Gain
(Loss) on
Investments......... 5.14 (1.07) 0.60 2.17 1.72
---- ----- ---- ---- ----
Total From Investment
Operations 5.20 (1.01) 0.69 2.30 1.78
Less Dividends and
Distributions:
Dividends from Net
Investment Income... (0.05) (0.06) (0.09) (0.12) (0.06)
Distributions from
Realized Gains...... (0.41) -- (0.49) (0.98) --
---- ----- ----- -----
Total Dividends and
Distributions (0.46) (0.06) (0.58) (1.10) (0.06)
----- ----- ----- ----- -----
Net Asset Value, End
of Period............ $15.04 $10.30 $11.37 $11.26 $10.06
====== ====== ====== ====== ======
Total Return.......... 50.61% (8.86)% 6.25% 23.87% 21.45%
Ratio/Supplemental
Data:
Net Assets, End of
Period (in
thousands).......... $82,135 $44,217 $30,888 $17,358 $11,080
Ratio of Expenses to
Average Net Assets.. 1.16% 1.28% 1.24% 1.16% 1.16%
Ratio of Gross
Expenses to Average
Net Assets /(a)/ ... 1.18% 1.29% -- 1.34% 1.44%
Ratio of Net
Investment Income to
Average Net Assets.. 0.50% 0.68% 0.95% 1.31% 0.82%
Portfolio Turnover
Rate................ 54.0% 77.4% 67.8% 133.0% 89.7%
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
UTILITIES ACCOUNT
-----------------
Net Asset Value,
Beginning of Period.. $7.26 $8.73 $12.43 $10.90 $10.93
Income from Investment
Operations:
Net Investment Income
(Operating Loss).... 0.34 0.37 0.25 0.24 0.23
Net Realized and
Unrealized Gain
(Loss) on
Investments......... 0.66 (1.47) (3.70) 1.81 0.02
---- ----- ----- ---- ----
Total From Investment
Operations 1.00 (1.10) (3.45) 2.05 0.25
Less Dividends and
Distributions:
Dividends from Net
Investment Income... (0.33) (0.37) (0.25) (0.24) (0.23)
Distributions from
Realized Gains...... -- -- -- (0.28) (0.05)
---- ----- -----
Total Dividends and
Distributions (0.33) (0.37) (0.25) (0.52) (0.28)
----- ----- ----- ----- -----
Net Asset Value, End
of Period............ $7.93 $7.26 $8.73 $12.43 $10.90
===== ===== ===== ====== ======
Total Return.......... 13.83% (12.61)% (27.70)% 19.18% 2.29%
Ratio/Supplemental
Data:
Net Assets, End of
Period (in
thousands).......... $30,255 $25,079 $33,802 $43,725 $30,684
Ratio of Expenses to
Average Net Assets.. 0.61% 0.62% 0.62% 0.63% 0.64%
Ratio of Net
Investment Income to
Average Net Assets.. 4.54% 4.40% 2.22% 2.32% 2.52%
Portfolio Turnover
Rate................ 22.5% 66.4% 104.2% 146.7% 23.0%
/(a) /Expense ratio without fees paid indirectly and the Manager's voluntary
expense limit. The expense limit ceased on January 1, 2001.
See accompanying notes.
171
REPORT OF INDEPENDENT AUDITORS
[Download Table]
The Board of Directors and
Shareholders
Principal Variable Contracts Fund,
Inc.
We have audited the accompanying statements of assets and liabilities, including
the schedules of investments, of Principal Variable Contracts Fund, Inc.
(comprised of the Asset Allocation, Balanced, Bond, Capital Value, Equity
Growth, Government Securities, Growth, International, International Emerging
Markets, International SmallCap, LargeCap Blend, LargeCap Growth Equity,
LargeCap Stock Index, LargeCap Value, Limited Term Bond, MidCap, MidCap Growth,
MidCap Value, Money Market, Real Estate, SmallCap, SmallCap Growth, SmallCap
Value and Utilities Accounts) as of December 31, 2003, and the related
statements of operations, statements of changes in net assets and financial
highlights for each of the periods indicated therein. These financial statements
and financial highlights are the responsibility of management of Principal
Variable Contracts Fund, Inc. 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 auditing standards generally accepted
in the United States. 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, 2003, by correspondence with the custodians and
brokers. As to certain securities relating to uncompleted transactions, we
performed other audit procedures. 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 each
of the respective accounts constituting Principal Variable Contracts Fund, Inc.
at December 31, 2003, and the results of their operations, the changes in their
net assets and their financial highlights for each of the periods indicated
therein, in conformity with accounting principles generally accepted in the
United States.
Des Moines, Iowa
January 23, 2004
172
FUND DIRECTORS
Under Maryland law, a Board of Directors oversees the Fund. The Directors have
financial or other relevant experience and meet several times during the year to
review contracts, Fund activities and the quality of services provided to the
Fund. Each director also has the same position with Principal Investors Fund,
Inc. and Principal Mutual Funds that are also sponsored by Principal Life
Insurance Company. Each director holds office for an indefinite term. Directors
considered to be "interested persons" are defined in the Investment Company Act
of 1940, as amended. The interested persons shown below are considered to be
interested because of a current or former affiliation with the Manager or
Principal Life Insurance Company.
THE FOLLOWING DIRECTORS ARE CONSIDERED NOT TO BE "INTERESTED PERSONS" AS DEFINED
IN THE 1940 ACT .
[Enlarge/Download Table]
NUMBER OF
PORTFOLIOS IN
FUND OTHER
COMPLEX DIRECTORSHIPS
NAME, POSITION HELD WITH THE FUND, PRINCIPAL OCCUPATION(S) OVERSEEN BY HELD BY
ADDRESS, AND DATE OF BIRTH DURING PAST 5 YEARS DIRECTOR DIRECTOR*
---------------------------------- ----------------------- ------------- -------------
[Download Table]
92 None
James D. Davis
Director since 1974 Attorney. Vice
Member Audit and President, Deere and
Nominating Committee Company, Retired.
4940 Center Court,
Bettendorf, Iowa
03/22/34
[Download Table]
92 None
Pamela A. Ferguson
Director since 1993 Professor of
Member Audit and Mathematics, Grinnell
Nominating Committee College since 1998.
4112 River Oaks Prior thereto,
Drive, Des Moines, President, Grinnell
Iowa College.
05/05/43
[Download Table]
92 None
Richard W. Gilbert
Director since 1985 President, Gilbert
Member Audit and Communications, Inc.
Nominating Committee since 1993. Prior
5040 Arbor Lane, thereto, President
#302, Northfield, and Publisher,
Illinois. Pioneer Press.
05/08/40
[Download Table]
92 None
William C. Kimball Chairman and CEO,
Director since 1999 Medicap Pharmacies,
Member Audit and Inc. since 1998.
Nominating Committee Prior thereto,
4350 Westown Parkway, President and CEO.
Suite 400
West Des Moines, Iowa
11/28/47
[Download Table]
92 None
Barbara A. Lukavsky
Director since 1987 President and CEO,
Member Audit and Barbican Enterprises,
Nominating Committee Inc. since 1997.
Member Executive President and CEO, Lu
Committee San ELITE USA, L.C.
13731 Bay Hill Court, 1985-1998.
Clive, Iowa
09/10/40
* Directorships of any company registered pursuant to Section 12 of the
Securities Exchange Act or subject to the requirements of Section 15(d) of
the Securities Exchange Act or any other mutual fund.
THE FOLLOWING DIRECTORS ARE CONSIDERED TO BE "INTERESTED PERSONS" AS DEFINED IN
THE 1940 ACT, AS AMENDED, BECAUSE OF CURRENT OR FORMER AFFILIATION WITH THE
MANAGER OR PRINCIPAL LIFE. .
[Download Table]
Director, Principal
Management
Corporation and
Princor Financial
Services Corporation
("Princor") since None
John E. Aschenbrenner 1998. President,
Director since 1998 Insurance and
08/16/49 Financial Services,
Principal Life since
2003. Executive Vice
President, 2000-2003.
Prior thereto, Senior
Vice President.
[Download Table]
Director and
President, Princor
Ralph C. Eucher and Principal
Director and Management
President since 1999 Corporation, since None
Member Executive 1999. Senior Vice
Committee President, Principal
06/14/52 Life, since 2002.
Prior thereto, Vice
President.
[Download Table]
Chairman and
Director, Princor and None
Larry D. Zimpleman Principal Management
Director and Chairman Corporation since
of the Board since 2002. President,
December 2001 Retirement and
Member Executive Investor Services,
Committee Principal Life since
09/07/51 2003. Executive Vice
President, 2001-2003.
Prior thereto, Senior
Vice President.
173
The Audit and Nominating Committee considers management's recommendation of
independent auditors for the Fund and oversees the activities of the independent
auditors as well as the internal auditors. The committee also receives reports
about accounting and financial matters affecting the Fund. In addition, the
committee selects and nominates all candidates who are not "interested persons"
of the Fund for election to the Board.
The Executive Committee is selected by the Board. It may exercise all the powers
of the Board, with certain exceptions, when the Board is not in session. The
Committee must report its actions to the Board.
Additional information about the Fund is available in the Prospectus and
Statement of Additional Information both dated May 1, 2003. These documents may
be obtained free of charge by writing or telephoning Princor Financial Services
Corporation, P.O. Box 10423, Des Moines, IA 50306. Telephone 1-800-247-4123.
PROXY VOTING POLICIES
A description of the policies and procedures the Fund uses to determine how to
vote proxies relating to portfolio securities may be obtained free of charge by
telephoning Princor Financial Services Corporation at 1-800-247-4123 or at
www.sec.gov.
174
ADDITIONAL INFORMATION
Additional information about the Fund is available in the Statement of
Additional Information dated, August 30, 2004, and which is part of this
prospectus. Additional information about the Fund's investments is available in
the Fund's annual and semiannual reports to shareholders.The Statement of
Additional Information, annual and semiannual reports can be obtained free of
charge by writing or telephoning Princor Financial Services Corporation, P.O.
Box 10423, Des Moines, IA 50306. To request other information about the
Accounts, and to make shareholder inquires, telephone 1-800-247-4123.
Information about the Fund (including the Statement of Additional Information)
can be reviewed and copied at the Commission's Public Reference Room in
Washington, D.C. Information on the operation of the Public Reference Room may
be obtained by calling the Commission at 1-202-942-8090. Reports and other
information about the Fund are available on the EDGAR Database on the
Commission's internet site at http://www.sec.gov. Copies of this information may
be obtained, upon payment of a duplicating fee, by electronic request at the
following E-mail address: publicinfo@sec.gov, or by writing the Commission's
Public Reference Section, Washington, D.C. 20549-0102.The U.S. government does
not insure or guarantee an investment in any of the Accounts. There can be no
assurance that the Money Market Account will be able to maintain a stable share
price of $1.00 per share.
Shares of the Accounts are not deposits or obligations of, or guaranteed or
endorsed by, any financial institution, nor are shares of the Accounts federally
insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board,
or any other agency.
Principal Variable Contracts Fund, Inc. SEC File 811-01944
PRINCIPAL VARIABLE CONTRACTS FUND, INC.
STATEMENT OF ADDITIONAL INFORMATION
dated August 30, 2004
This Statement of Additional Information (SAI) is not a prospectus. It contains
information in addition to the information in the Fund's prospectuses. The
Fund's prospectuses, dated August 30, 2004, which we may amend from time to
time, contain the basic information you should know before investing in the
Fund. You should read this SAI together with the Fund's prospectus.
The audited financial statements and auditor's report in the Fund's Annual
Report to Shareholders, for the fiscal year ended December 31, 2003, are
incorporated by reference (are legally a part of this SAI).
For a free copy of the current prospectus or annual report, call 1-800-247-4123
or write:
Principal Variable Contracts Fund, Inc.
Principal Financial Group
Des Moines IA 50392-2080
TABLE OF CONTENTS
Fund History............................................................
Description of the Fund's Investments and Risks.........................
Management..............................................................
Control Persons and Principal Holders of Securities.....................
Investment Advisory and Other Services..................................
Cost of Manager's Services..............................................
Brokerage Allocation and Other Practices................................
Purchase, Redemption, and Pricing of Shares.............................
Calculation of Performance Data.........................................
Tax Status..............................................................
General Information.....................................................
Financial Statements....................................................
Appendix A..............................................................
FUND HISTORY
The Principal Variable Contracts Fund is a registered, open-end management
investment company, commonly called a mutual fund. It was organized on May 27,
1997 as a Maryland corporation. The Articles of Incorporation have been amended
as follows:
.. February 13, 1998 to add the International SmallCap; MidCap Growth, Real
Estate; SmallCap; SmallCap Growth; SmallCap Value and Utilities Accounts;
.. February 1, 1999 to add the MidCap Value and Stock Index 500 Accounts;
.. July 27, 2000 to add the International Emerging Markets, LargeCap Growth
Equity and MidCap Growth Equity Accounts and change the name of the Stock
Index 500 Account to the LargeCap Stock Index Account;
.. April 6, 2001 to change the name of the Aggressive Growth Account to the
Equity Growth Account;
.. January 29, 2002 to add the LargeCap Blend and LargeCap Value Accounts; and
.. February 4, 2003 to add the Limited Term Bond Account.
.. February 12, 2004 to change the name of the Real Estate Account to Real Estate
Securities Account and the Utilities Account to the Equity Income Account.
.. June 21, 2004 to add the Equity Value, Principal LifeTime 2010, Principal
LifeTime 2020, Principal LifeTime 2030, Principal LifeTime 2040, Principal
LifeTime 2050 and Principal LifeTime Strategic Income Accounts.
Principal Management Corporation is the Manager of the Fund.
DESCRIPTION OF THE FUND'S INVESTMENTS AND RISKS
FUND POLICIES
The investment objectives, principal investment policies and the main risks of
each Account are described in the Prospectus. This Statement of Additional
Information ("SAI") contains supplemental information about those policies and
risks and the types of securities the Manager or Sub-Advisor can select for each
Account. Additional information is also provided about the strategies that the
Account may use to try to achieve its objective.
The composition of each Account and the techniques and strategies that the
Manager or Sub-Advisor may use in selecting securities will vary over time. An
Account is not required to use all of the investment techniques and strategies
available to it in seeking its goals.
Unless otherwise indicated, with the exception of the percentage limitations on
borrowing, the restrictions apply at the time transactions are entered into.
Accordingly, any later increase or decrease beyond the specified limitation,
resulting from market fluctuations or in a rating by a rating service, does not
require elimination of any security from the portfolio.
Except as described below as "Fundamental Restrictions," the investment policies
described in this SAI and the prospectuses are not fundamental and may be
changed by the Board of Directors without shareholder approval. The Fundamental
Restrictions may not be changed without a vote of a majority of the outstanding
voting securities of the affected Account. The Investment Company Act of 1940,
as amended ("1940 Act") provides that "a vote of a majority of the outstanding
voting securities" of an Account means the affirmative vote of the lesser of 1)
more than 50% of the outstanding shares, or 2) 67% or more of the shares present
at a meeting if more than 50% of the outstanding Account shares are represented
at the meeting in person or by proxy. Each share has one vote, with fractional
shares voting proportionately.
FUND INVESTMENT LIMITATIONS
Asset Allocation Account, Balanced Account, Equity Growth Account, Growth
Account, International Account and MidCap Account
Fundamental Restrictions
------------------------
Each of the following numbered restrictions for the above-listed Accounts is a
matter of fundamental policy and may not be changed without shareholder
approval. Each may not:
1) Issue any senior securities as defined in the 1940 Act. Purchasing and
selling securities and futures contracts and options thereon and borrowing
money in accordance with restrictions described below do not involve the
issuance of a senior security.
2) Purchase or retain in its portfolio securities of any issuer if those
officers or directors of the Account or the Manager owning beneficially more
than one-half of 1% (0.5%) of the securities of the issuer together own
beneficially more than 5% of such securities.
3) Invest in commodities or commodity contracts, but it may purchase and sell
financial futures contracts and options on such contracts.
4) Invest in real estate, although it may invest in securities that are secured
by real estate and securities of issuers that invest or deal in real estate.
5) Borrow money, except for temporary or emergency purposes, in an amount not
to exceed 5% of the value of the Account's total assets at the time of the
borrowing. The Balanced Account may borrow only from banks.
6) Make loans, except that the Account may a) purchase and hold debt
obligations in accordance with its investment objective and policies, b) enter
into repurchase agreements, and c) lend its portfolio securities without
limitation against collateral (consisting of cash or securities issued or
guaranteed by the U.S. Government or its agencies or instrumentalities) equal
at all times to not less than 100% of the value of the securities loaned.
7) Invest more than 5% of its total assets in the securities of any one issuer
(other than obligations issued or guaranteed by the U.S. Government or its
agencies or instrumentalities) or purchase more than 10% of the outstanding
voting securities of any one issuer, except that this limitation shall apply
only with respect to 75% of the total assets of each Account.
8) Act as an underwriter of securities, except to the extent the Account may be
deemed to be an underwriter in connection with the sale of securities held in
its portfolio.
9) Concentrate its investments in any particular industry or industries, except
that the Account may invest not more than 25% of the value of its total assets
in a single industry.
10) Sell securities short (except where the Account holds or has the right to
obtain at no added cost a long position in the securities sold that equals or
exceeds the securities sold short) or purchase any securities on margin,
except it may obtain such short-term credits as are necessary for the
clearance of transactions. The deposit or payment of margin in connection with
transactions in options and financial futures contracts is not considered the
purchase of securities on margin.
11) Invest in interests in oil, gas or other mineral exploration or development
programs, although the Account may invest in securities of issuers that invest
in or sponsor such programs.
Non-Fundamental Restrictions
----------------------------
Each of these Accounts has also adopted the following restrictions that are not
fundamental policies and may be changed without shareholder approval. It is
contrary to each Account's present policy to:
1) Invest more than 15% of its total assets in securities not readily
marketable and in repurchase agreements maturing in more than seven days. The
value of any options purchased in the Over-the-Counter market, including all
covered spread options and the assets used as cover for any options written in
the Over-the-Counter market are included as part of this 15% limitation.
2) Purchase warrants in excess of 5% of its total assets, of which 2% may be
invested in warrants that are not listed on the New York or American Stock
Exchange. The 2% limitation for the International Account does not apply to
warrants listed on the Toronto Stock Exchange or the Chicago Board Options
Exchange.
3) Purchase securities of any issuer having less than three years' continuous
operation (including operations of any predecessors) if such purchase would
cause the value of the Account's investments in all such issuers to exceed 5%
of the value of its total assets.
4) Pledge, mortgage or hypothecate its assets, except to secure permitted
borrowings. The deposit of underlying securities and other assets in escrow
and other collateral arrangements in connection with transactions in put and
call options, futures contracts, options on futures contracts and
over-the-counter swap contracts are not deemed to be pledges or other
encumbrances.
5) Invest in companies for the purpose of exercising control or management.
6) Invest more than 10% (25% for the Equity Growth Account) of its total assets
in securities of foreign issuers. This restriction does not pertain to the
International Account or the Asset Allocation Account.
7) Invest in arbitrage transactions.
8) The Account may not invest more than five (5) percent of its assets in real
estate limited partnerships.
9) Acquire securities of other investment companies in reliance on Section
12(d)(1)(F) or (G) of the 1940 Act.
The Equity Growth and MidCap Accounts have each adopted the non-fundamental
restriction which requires it, under normal circumstances, to invest at least
80% of its net assets in the type of securities, industry or geographic region
(as described in the prospectus) as suggested by the name of the Account. The
Account will provide 60-days notice to shareholders prior to implementing a
change in this policy for the Account.
Capital Value Account
Fundamental Restrictions
------------------------
Each of the following numbered restrictions for the above-listed Account is a
matter of fundamental policy and may not be changed without shareholder
approval. Each may not:
1) Concentrate its investments in any one industry. No more than 25% of the
value of its total assets will be invested in any one industry.
2) Invest more than 5% of its total assets in the securities of any one issuer
(other than obligations issued or guaranteed by the U.S. Government or its
agencies or instrumentalities) or purchase more than 10% of the outstanding
voting securities of any one issuer, except that these limitations shall apply
only with respect to 75% of the Account's total assets.
3) Underwrite securities of other issuers, except that the Account may acquire
portfolio securities under circumstances where if sold the Account might be
deemed an underwriter for purposes of the Securities Act of 1933.
4) Purchase securities of any company with a record of less than three years'
continuous operation (including that of predecessors) if the purchase would
cause the value of the Account's aggregate investments in all such companies
to exceed 5% of the Account's total assets.
5) Engage in the purchase and sale of illiquid interests in real estate. For
this purpose, readily marketable interests in real estate investment trusts
are not interests in real estate.
6) Invest in commodities or commodity contracts, but it may purchase and sell
financial futures contracts and options on such contracts.
7) Purchase or retain in its portfolio securities of any issuer if those
officers and directors of the Fund or the Manager owning beneficially more
than one-half of one percent (0.5%) of the securities of the issuer together
own beneficially more than 5% of such securities.
8) Purchase securities on margin, except it may obtain such short-term credits
as are necessary for the clearance of transactions. The deposit or payment of
margin in connection with transactions in options and financial futures
contracts is not considered the purchase of securities on margin.
9) Invest in companies for the purpose of exercising control or management.
10) Invest more than 5% of its assets at the time of purchase in rights and
warrants (other than those that have been acquired in units or attached to
other securities).
11) Invest more than 20% of its total assets in securities of foreign issuers.
12) Sell securities short (except where the Account holds or has the right to
obtain at no added cost a long position in the securities sold that equals or
exceeds the securities sold short).
In addition:
13) The Account may not make loans, except that the Account may a) purchase and
hold debt obligations in accordance with its investment objective and
policies, b) enter into repurchase agreements, and c) lend its portfolio
securities without limitation against collateral (consisting of cash or
securities issued or guaranteed by the U.S. Government or its agencies or
instrumentalities) equal at all times to not less than 100% of the value of
the securities loaned.
14) The Account does not propose to borrow money except for temporary or
emergency purposes from banks in an amount not to exceed the lesser of a) 5%
of the value of the Account's assets, less liabilities other than such
borrowings, or b) 10% of the Account's assets taken at cost at the time such
borrowing is made. The Account may not pledge, mortgage, or hypothecate its
assets (at value) to an extent greater than 15% of the gross assets taken at
cost. The deposit of underlying securities and other assets in escrow and
other collateral arrangements in connection with transactions in put and call
options, futures contracts and options on futures contracts are not deemed to
be pledges or other encumbrances.
15) It is contrary to the Account's present policy to purchase warrants in
excess of 5% of its total assets of which 2% may be invested in warrants that
are not listed on the New York or American Stock Exchange.
Non-Fundamental Restrictions
----------------------------
The Account has also adopted the following restrictions that are not fundamental
policies and may be changed without shareholder approval. It is contrary to the
Account's present policy to:
1) Acquire securities of other investment companies in reliance on Section
12(d)(1)(F) or (G) of the 1940 Act.
2) Invest more than 15% of its total assets in securities not readily
marketable and in repurchase agreement maturing in more than seven days.
3) The Account may not invest more than five (5) percent of its assets in real
estate limited partnerships.
Equity Income Account, International SmallCap Account, MidCap Growth Account,
Real Estate Securities Account, SmallCap Account, SmallCap Growth Account and
SmallCap Value Account
Fundamental Restrictions
------------------------
Each of the following numbered restrictions for the above-listed Accounts is a
matter of fundamental policy and may not be changed without shareholder
approval. Each may not:
1) Issue any senior securities as defined in the 1940 Act, as amended.
Purchasing and selling securities and futures contracts and options thereon
and borrowing money in accordance with restrictions described below do not
involve the issuance of a senior security.
2) Invest in physical commodities or commodity contracts (other than foreign
currencies), but it may purchase and sell financial futures contracts and
options on such contracts.
3) Invest in real estate, although it may invest in securities that are secured
by real estate and securities of issuers that invest or deal in real estate.
4) Borrow money, except it may a) borrow from banks (as defined in the 1940
Act, as amended) or other financial institutions or through reverse repurchase
agreements in amounts up to 33/1//3% of its total assets (including the amount
borrowed); b) to the extent permitted by applicable law, borrow up to an
additional 5% of its total assets for temporary purposes; c) obtain such
short-term credits as may be necessary for the clearance of purchases and
sales of portfolio securities, and d) purchase securities on margin to the
extent permitted by applicable law. Make loans, except that the Account may a)
purchase and hold debt obligations in accordance with its investment objective
and policies, b) enter into repurchase agreements, and c) lend its portfolio
securities without limitation against collateral (consisting of cash or
securities issued or guaranteed by the U.S. Government or its agencies or
instrumentalities) equal at all times to not less than 100% of the value of
the securities loaned.
5) Invest more than 5% of its total assets in the securities of any one issuer
(other than obligations issued or guaranteed by the U.S. Government or its
agencies or instrumentalities) or purchase more than 10% of the outstanding
voting securities of any one issuer, except that this limitation shall apply
only with respect to 75% of the total assets of each Account.
6) Act as an underwriter of securities, except to the extent the Account may be
deemed to be an underwriter in connection with the sale of securities held in
its portfolio.
7) Concentrate its investments in any particular industry, except that the
Account may invest not more than 25% of the value of its total assets in a
single industry.
However, the Real Estate Securities Account may not invest less than 25% of
its total assets in securities of companies in the real estate industry, and
the Equity Income Account may not invest less than 25% of its total assets in
securities of companies in the public utilities industry except that each may,
for temporary defensive purposes, place all of its assets in cash, cash
equivalents, bank certificates of deposit, bankers acceptances, repurchase
agreements, commercial paper, commercial paper master notes, U.S. government
securities, and preferred stocks and debt securities, whether or not
convertible into or carrying rights for common stock.
8) Sell securities short (except where the Account holds or has the right to
obtain at no added cost a long position in the securities sold that equals or
exceeds the securities sold short) or purchase any securities on margin,
except to the extent permitted by applicable law and except that the Account
may obtain such short-term credits as are necessary for the clearance of
transactions. The deposit or payment of margin in connection with transactions
in options and financial futures contracts is not considered the purchase of
securities on margin.
Non-Fundamental Restrictions
----------------------------
Each of these Accounts has also adopted the following restrictions that are not
fundamental policies and may be changed without shareholder approval. It is
contrary to each Account's present policy to:
1) Invest more than 15% of its total assets in illiquid securities and in
repurchase agreements maturing in more than seven days.
2) Pledge, mortgage or hypothecate its assets, except to secure permitted
borrowings. The deposit of underlying securities and other assets in escrow
and other collateral arrangements in connection with transactions in put and
call options, futures contracts, options on futures contracts, and
over-the-counter swap contracts are not deemed to be pledges or other
encumbrances.
3) Invest in companies for the purpose of exercising control or management.
4) Invest more than 25% (20% for each of the Equity Income and SmallCap
Accounts, 10% for each of the MidCap Growth and SmallCap Value Accounts) of
its total assets in securities of foreign issuers. This restriction does not
apply to the International SmallCap Account.
5) The Account may not invest more than five (5) percent of its assets in real
estate limited partnerships. This restriction does not apply to the Real
Estate Securities Account.
6) Acquire securities of other investment companies in reliance on Section
12(d)(1)(F) or (G) of the 1940 Act.
Each Account has also adopted the non-fundamental restriction which requires it,
under normal circumstances, to invest at least 80% of its net assets in the type
of securities, industry or geographic region (as described in the prospectus) as
suggested by the name of the Account. The Account will provide 60-days notice to
shareholders prior to implementing a change in this policy for the Account.
International Emerging Markets Account, LargeCap Blend Account, LargeCap Growth
Equity Account, LargeCap Stock Index Account, LargeCap Value Account and MidCap
Value Account
Fundamental Restrictions
------------------------
Each of the following numbered restrictions for the above-listed Accounts is a
matter of fundamental policy and may not be changed without shareholder
approval. Each may not:
1) Issue any senior securities as defined in the 1940 Act, as amended.
Purchasing and selling securities and futures contracts and options thereon
and borrowing money in accordance with restrictions described below do not
involve the issuance of a senior security.
2) Invest in physical commodities or commodity contracts (other than foreign
currencies), but it may purchase and sell financial futures contracts and
options on such contracts, swaps and securities backed by physical
commodities.
3) Invest in real estate, although it may invest in securities that are secured
by real estate and securities of issuers that invest or deal in real estate.
4) Borrow money, except it may a) borrow from banks (as defined in the 1940
Act, as amended) or other financial institutions or through reverse repurchase
agreements in amounts up to 33/1//3% of its total assets (including the amount
borrowed); b) to the extent permitted by applicable law, borrow up to an
additional 5% of its total assets for temporary purposes; c) obtain such
short-term credits as may be necessary for the clearance of purchases and
sales of portfolio securities, and d) purchase securities on margin to the
extent permitted by applicable law.
5) Make loans, except that the Account may a) purchase and hold debt
obligations in accordance with its investment objective and policies, b) enter
into repurchase agreements, and c) lend its portfolio securities without
limitation against collateral (consisting of cash or securities issued or
guaranteed by the U.S. Government or its agencies or instrumentalities) equal
at all times to not less than 100% of the value of the securities loaned. This
limit does not apply to purchases of debt securities or commercial paper.
6) Invest more than 5% of its total assets in the securities of any one issuer
(other than obligations issued or guaranteed by the U.S. Government or its
agencies or instrumentalities) or purchase more than 10% of the outstanding
voting securities of any one issuer, except that this limitation shall apply
only with respect to 75% of the total assets of each Account.
7) Act as an underwriter of securities, except to the extent the Account may be
deemed to be an underwriter in connection with the sale of securities held in
its portfolio.
8) Concentrate its investments in any particular industry, except that the
Account may invest not more than 25% of the value of its total assets in a
single industry, provided that, when the Account has adopted a temporary
defensive posture, there shall be no limitation on the purchase of obligations
issued or guaranteed by the U.S. Government, its agencies or
instrumentalities. This restriction applies to the LargeCap Stock Index
Account except to the extent that the Standard & Poor's 500 Index also is so
concentrated.
9) Sell securities short (except where the Account holds or has the right to
obtain at no added cost a long position in the securities sold that equals or
exceeds the securities sold short) or purchase any securities on margin,
except to the extent permitted by applicable law and except that the Account
may obtain such short-term credits as are necessary for the clearance of
transactions. The deposit or payment of margin in connection with transactions
in options and financial futures contracts is not considered the purchase of
securities on margin.
Non-Fundamental Restrictions
----------------------------
Each of these Accounts has also adopted the following restrictions that are not
fundamental policies and may be changed without shareholder approval. It is
contrary to each Account's present policy to:
1) Invest more than 15% of its total assets in illiquid securities and in
repurchase agreements maturing in more than seven days.
2) Pledge, mortgage or hypothecate its assets, except to secure permitted
borrowings. The deposit of underlying securities and other assets in escrow
and other collateral arrangements in connection with transactions in put and
call options, futures contracts, options on futures contracts, and
over-the-counter swap contracts are not deemed to be pledges or other
encumbrances.
3) Invest in companies for the purpose of exercising control or management.
4) Invest more than 25% (10% for the LargeCap Stock Index and MidCap Value
Accounts) of its total assets in securities of foreign issuers. This
restriction does not apply to the International Emerging Markets Account.
5) The Account may not invest more than five (5) percent of its assets in real
estate limited partnerships.
6) Acquire securities of other investment companies in reliance on Section
12(d)(1)(F) or (G) of the 1940 Act.
Each Account, except International Emerging Markets, has also adopted the
non-fundamental restriction which requires it, under normal circumstances, to
invest at least 80% of its net assets in the type of securities, industry or
geographic region (as described in the prospectus) as suggested by the name of
the Account. The Account will provide 60-days notice to shareholders prior to
implementing a change in this policy for the Account.
Bond Account and Limited Term Bond Account
Fundamental Restrictions
------------------------
Each of the following numbered restrictions for the above-listed Accounts is a
matter of fundamental policy and may not be changed without shareholder
approval. Each may not:
1) Issue any senior securities as defined in the 1940 Act. Purchasing and
selling securities and futures contracts and options thereon and borrowing
money in accordance with restrictions described below do not involve the
issuance of a senior security.
2) Purchase or retain in its portfolio securities of any issuer if those
officers or directors of the Account or the Manager owning beneficially more
than one-half of 1% (0.5%) of the securities of the issuer together own
beneficially more than 5% of such securities.
3) Invest in commodities or commodity contracts, but it may purchase and sell
financial futures contracts and options on such contracts.
4) Invest in real estate, although it may invest in securities which are
secured by real estate and securities of issuers which invest or deal in real
estate.
5) Borrow money, except for temporary or emergency purposes, in an amount not
to exceed 5% of the value of the Account's total assets at the time of the
borrowing. The Bond Account may borrow only from banks.
6) Make loans, except that the Account may a) purchase and hold debt
obligations in accordance with its investment objective and policies, b) enter
into repurchase agreements, and c) lend its portfolio securities without
limitation against collateral (consisting of cash or securities issued or
guaranteed by the U.S. Government or its agencies or instrumentalities) equal
at all times to not less than 100% of the value of the securities loaned.
7) Invest more than 5% of its total assets in the securities of any one issuer
(other than obligations issued or guaranteed by the U.S. Government or its
agencies or instrumentalities) or purchase more than 10% of the outstanding
voting securities of any one issuer, except that these limitations shall apply
only with respect to 75% of the total assets of each Account.
8) Act as an underwriter of securities, except to the extent the Account may be
deemed to be an underwriter in connection with the sale of securities held in
its portfolio.
9) Concentrate its investments in any particular industry or industries, except
that the Bond Account may invest not more than 25% of the value of its total
assets in a single industry.
10) Sell securities short (except where the Account holds or has the right to
obtain at no added cost a long position in the securities sold that equals or
exceeds the securities sold short) or purchase any securities on margin,
except it may obtain such short-term credits as are necessary for the
clearance of transactions. The deposit or payment of margin in connection with
transactions in options and financial futures contracts is not considered the
purchase of securities on margin.
11) Invest in interests in oil, gas or other mineral exploration or development
programs, although the Account may invest in securities of issuers which
invest in or sponsor such programs.
Non-Fundamental Restrictions
----------------------------
Each of these Accounts has also adopted the following restrictions that are not
fundamental policies and may be changed without shareholder approval. It is
contrary to each Account's present policy to:
1) Invest more than 15% of its total assets in securities not readily
marketable and in repurchase agreements maturing in more than seven days. The
value of any options purchased in the Over-the-Counter market, including all
covered spread options and the assets used as cover for any options written in
the Over-the-Counter market are included as part of this 15% limitation.
2) Purchase warrants in excess of 5% of its total assets, of which 2% may be
invested in warrants that are not listed on the New York or American Stock
Exchange.
3) Purchase securities of any issuer having less than three years' continuous
operation (including operations of any predecessors) if such purchase would
cause the value of the Account's investments in all such issuers to exceed 5%
of the value of its total assets.
4) Acquire securities of other investment companies in reliance on Section
12(d)(1)(F) or (G) of the 1940 Act.
5) Pledge, mortgage or hypothecate its assets, except to secure permitted
borrowings. The deposit of underlying securities and other assets in escrow
and other collateral arrangements in connection with transactions in put and
call options, futures contracts, options on futures contracts and
over-the-counter swap contracts are not deemed to be pledges or other
encumbrances.
6) Invest in companies for the purpose of exercising control or management.
7) Invest more than 20% of its total assets in securities of foreign issuers.
8) Invest in arbitrage transactions.
9) The Account may not invest more than five (5) percent of its assets in real
estate limited partnerships.
Each Account has also adopted the non-fundamental restriction which requires it,
under normal circumstances, to invest at least 80% of its net assets in the type
of securities, industry or geographic region (as described in the prospectus) as
suggested by the name of the Account. The Account will provide 60-days notice to
shareholders prior to implementing a change in this policy for the Account.
Government Securities Account
Fundamental Restrictions
------------------------
Each of the following numbered restrictions for the above-listed Account is a
matter of fundamental policy and may not be changed without shareholder
approval. The Account may not:
1) Issue any senior securities as defined in the Act except insofar as the
Account may be deemed to have issued a senior security by reason of a)
purchasing any securities on a standby, when-issued or delayed delivery basis;
or b) borrowing money in accordance with restrictions described below.
2) Purchase any securities other than obligations issued or guaranteed by the
U.S. Government or its agencies or instrumentalities, except that the Account
may maintain reasonable amounts in cash or commercial paper or purchase
short-term debt securities not issued or guaranteed by the U.S. Government or
its agencies or instrumentalities for daily cash management purposes or
pending selection of particular long-term investments.
3) Act as an underwriter of securities, except to the extent the Account may be
deemed to be an underwriter in connection with the sale of GNMA certificates
held in its portfolio.
4) Engage in the purchase and sale of interests in real estate, including
interests in real estate investment trusts (although it will invest in
securities secured by real estate or interests therein, such as
mortgage-backed securities) or invest in commodities or commodity contracts,
oil and gas interests, or mineral exploration or development programs.
5) Purchase or retain in its portfolio securities of any issuer if those
officers and directors of the Fund or the Manager owning beneficially more
than one-half of 1% (0.5%) of the securities of the issuer together own
beneficially more than 5% of such securities.
6) Sell securities short or purchase any securities on margin, except it may
obtain such short-term credits as are necessary for the clearance of
transactions. The deposit or payment of margin in connection with transactions
in options and financial futures contracts is not considered the purchase of
securities on margin.
7) Invest in companies for the purpose of exercising control or management.
8) Make loans, except that the Account may purchase or hold debt obligations in
accordance with the investment restrictions set forth in paragraph (2) and may
enter into repurchase agreements for such securities, and may lend its
portfolio securities without limitation against collateral consisting of cash,
or securities issued or guaranteed by the U.S. Government or its agencies or
instrumentalities, which is equal at all times to 100% of the value of the
securities loaned.
9) Borrow money, except for temporary or emergency purposes, in an amount not
to exceed 5% of the value of the Account's total assets at the time of the
borrowing.
10) Enter into repurchase agreements maturing in more than seven days if, as a
result thereof, more than 10% of the value of the Account's total assets would
be invested in such repurchase agreements and other assets without readily
available market quotations.
11) Invest more than 5% of its total assets in the purchase of covered spread
options and the purchase of put and call options on securities, securities
indices and financial futures contracts.
12) Invest more than 5% of its assets in initial margin and premiums on
financial futures contracts and options on such contracts.
Non-Fundamental Restrictions
----------------------------
The Account has also adopted the following restrictions that are not fundamental
policies and may be changed without shareholder approval. It is contrary to the
Account's present policy to:
1) Pledge, mortgage or hypothecate its assets, except to secure permitted
borrowings. The deposit of underlying securities and other assets in escrow
and other collateral arrangements in connection with transactions in put and
call options, futures contracts, options on futures contracts and
over-the-counter swap contracts are not deemed to be pledges or other
encumbrances.
2) Acquire securities of other investment companies in reliance on Section
12(d)(1)(F) or (G) of the 1940 Act.
The Account has also adopted the non-fundamental restriction which requires it,
under normal circumstances, to invest at least 80% of its net assets in the type
of securities, industry or geographic region (as described in the prospectus) as
suggested by the name of the Account. The Account will provide 60-days notice to
shareholders prior to implementing a change in this policy for the Account.
Money Market Account
Fundamental Restrictions
------------------------
Each of the following numbered restrictions for the above-listed Account is a
matter of fundamental policy and may not be changed without shareholder
approval. The Account may not:
1) Concentrate its investments in any one industry. No more than 25% of the
value of its total assets will be invested in securities of issuers having
their principal activities in any one industry, other than securities issued
or guaranteed by the U.S. Government or its agencies or instrumentalities, or
obligations of domestic branches of U.S. banks and savings institutions. (See
"Bank Obligations").
2) Purchase the securities of any issuer if the purchase will cause more than
5% of the value of its total assets to be invested in the securities of any
one issuer (except securities issued or guaranteed by the U.S. Government, its
agencies or instrumentalities).
3) Purchase the securities of any issuer if the purchase will cause more than
10% of the outstanding voting securities of the issuer to be held by the
Account (other than securities issued or guaranteed by the U.S. Government,
its agencies or instrumentalities).
4) Invest a greater percentage of its total assets in securities not readily
marketable than is allowed by federal securities rules or interpretations.
5) Act as an underwriter except to the extent that, in connection with the
disposition of portfolio securities, it may be deemed to be an underwriter
under the federal securities laws.
6) Purchase securities of any company with a record of less than 3 years
continuous operation (including that of predecessors) if the purchase would
cause the value of the Account's aggregate investments in all such companies
to exceed 5% of the value of the Account's total assets.
7) Engage in the purchase and sale of illiquid interests in real estate,
including interests in real estate investment trusts (although it may invest
in securities secured by real estate or interests therein) or invest in
commodities or commodity contracts, oil and gas interests, or mineral
exploration or development programs.
8) Purchase or retain in its portfolio securities of any issuer if those
officers and directors of the Fund or the Manager owning beneficially more
than one-half of 1% (0.5%) of the securities of the issuer together own
beneficially more than 5% of such securities.
9) Purchase securities on margin, except it may obtain such short-term credits
as are necessary for the clearance of transactions. The Account will not issue
or acquire put and call options, straddles or spreads or any combination
thereof.
10) Invest in companies for the purpose of exercising control or management.
11) Make loans, except that the Account may a) purchase and hold debt
obligations in accordance with its investment objective and policies, b) enter
into repurchase agreements, and c) lend its portfolio securities without
limitation against collateral (consisting of cash or securities issued or
guaranteed by the U.S. Government or its agencies or instrumentalities) equal
at all times to not less than 100% of the value of the securities loaned.
12) Borrow money, except from banks for temporary or emergency purposes,
including the meeting of redemption requests which might otherwise require the
untimely disposition of securities, in an amount not to exceed the lesser of
a) 5% of the value of the Account's assets, or b) 10% of the value of the
Account's net assets taken at cost at the time such borrowing is made. The
Account will not issue senior securities except in connection with such
borrowings. The Account may not pledge, mortgage, or hypothecate its assets
(at value) to an extent greater than 10% of the net assets.
13) Invest in uncertificated time deposits maturing in more than seven days;
uncertificated time deposits maturing from two business days through seven
calendar days may not exceed 10% of the value of the Account's total assets.
14) Enter into repurchase agreements maturing in more than seven days if, as a
result thereof, more than 10% of the value of the Account's total assets would
be invested in such repurchase agreements and other assets (excluding time
deposits) without readily available market quotations.
Non-Fundamental Restrictions
----------------------------
15) The Account has adopted the following restrictions that are not fundamental
policies and may be changed without shareholder approval. It is contrary to
the Account's present policy to: acquire securities of other investment
companies in reliance on Section 12(d)(1)(F) or (G) of the 1940 Act, and the
Account may purchase securities of closed-end companies in the open market
where no underwriter or dealer's commission or profit, other than a customary
broker's commission, is involved.
The Account has also adopted the non-fundamental restriction which requires it,
under normal circumstances, to invest at least 80% of its net assets in the type
of securities, industry or geographic region (as described in the prospectus) as
suggested by the name of the Account. The Account will provide 60-days notice to
shareholders prior to implementing a change in this policy for the Account.
Principal LifeTime 2010, Principal LifeTime 2020, Principal LifeTime 2030,
Principal LifeTime 2040, Principal LifeTime 2050 and Principal LifeTime
Strategic Income Accounts
FUNDAMENTAL RESTRICTIONS
Each of the following numbered restrictions for the above-listed Accounts is a
matter of fundamental policy and may not be changed without shareholder
approval. Each may not:
1) Issue senior securities as defined in the 1940 Act. Purchasing and selling
securities and futures contracts and options thereon and borrowing money in
accordance with restrictions described below do not involve the issuance of a
senior security.
2) Purchase or sell commodities or commodities contracts except that the
Account may invest in underlying funds that may purchase or write interest
rate, currency and stock and bond index futures contracts and related options
thereon.
3) Purchase or sell real estate or interests therein, although the Account may
purchase underlying funds which purchase securities of issuers that engage in
real estate operations and securities secured by real estate or interests
therein.
4) Borrow money, except that it may a) borrow from banks (as defined in the
1940 Act) or other financial institutions in amounts up to 33 1/3% of its
total assets (including the amount borrowed) and b) to the extent permitted by
applicable law, borrow up to an additional 5% of its total assets for
temporary purposes.
5) Make loans, except that the Account may a) purchase underlying funds which
purchase and hold debt obligations; and b) enter into repurchase agreements.
This limit does not apply to purchases of debt securities or commercial paper
by the Account or an underlying fund. For the purpose of this restriction,
lending of fund securities by the underlying funds are not deemed to be loans.
6) Act as an underwriter of securities, except to the extent that the Account
or an underlying fund may be deemed to be an underwriter in connection with
the sale of securities held in its portfolio.
7) Invest 25% or more of the value of its total assets in securities of
issuers in any one industry except that the Account will concentrate its
investments in the mutual fund industry. This restriction does not apply to
the Account's investments in the mutual fund industry by virtue of its
investments in the underlying funds. This restriction also does not apply to
obligations issued or guaranteed by the U.S. government, its agencies or
instrumentalities.
8) Sell securities short.
Each Account may invest in underlying funds which may sell securities short when
the underlying fund holds or has the right to obtain at no added cost a long
position in the securities sold that equals or exceeds the securities sold
short.
NON-FUNDAMENTAL RESTRICTIONS
Each of these Accounts has also adopted the following restrictions that are not
fundamental policies and may be changed without shareholder approval. It is
contrary to each Account's present policy to:
1) Pledge, mortgage or hypothecate its assets, except to secure permitted
borrowings. For the purpose of this restriction, collateral arrangements with
respect to the writing of options by the underlying funds and collateral
arrangements with respect to initial or variation margin for futures by the
underlying funds are not deemed to be pledges of assets.
2) Invest in companies for the purpose of exercising control or management.
Equity Value Account
FUNDAMENTAL RESTRICTIONS
Each of the following numbered restrictions for the above-listed Account is a
matter of fundamental policy and may not be changed without shareholder
approval. Each may not:
1) Issue any senior securities as defined in the 1940 Act. Purchasing and
selling securities and futures contracts and options thereon and borrowing
money in accordance with restrictions described below do not involve the
issuance of a senior security.
2) Invest in physical commodities or commodity contracts (other than foreign
currencies), but it may purchase and sell financial futures contracts, options
on such contracts, swaps and securities backed by physical commodities.
3) Invest in real estate, although it may invest in securities that are secured
by real estate and securities of issuers that invest or deal in real estate.
4) Borrow money, except that it may a) borrow from banks (as defined in the
1940 Act) or other financial institutions or through reverse repurchase
agreements in amounts up to 33 1/3% of its total assets (including the amount
borrowed); b) to the extent permitted by applicable law, borrow up to an
additional 5% of its total assets for temporary purposes; c) obtain short-term
credits as may be necessary for the clearance of purchases and sales of
portfolio securities; and d) purchase securities on margin to the extent
permitted by applicable law (the deposit or payment of margin in connection
with transactions in options and financial futures contracts is not considered
purchase of securities on margin).
5) Make loans, except that the Account may a) purchase and hold debt
obligations in accordance with its investment objectives and policies; b)
enter into repurchase agreements; and c) lend its portfolio securities without
limitation against collateral (consisting of cash or liquid assets) equal at
all times to not less than 100% of the value of the securities loaned. This
limit does not apply to purchases of debt securities or commercial paper.
6) Invest more than 5% of its total assets in the securities of any one issuer
(other than obligations issued or guaranteed by the U.S. government or its
agencies or instrumentalities) or purchase more than 10% of the outstanding
voting securities of any one issuer, except that this limitation shall apply
only with respect to 75% of the total assets of the Account.
7) Act as an underwriter of securities, except to the extent that the Account
may be deemed to be an underwriter in connection with the sale of securities
held in its portfolio.
8) Concentrate its investments in any particular industry, except that the
Account may invest up to 25% of the value of its total assets in a single
industry, provided that, when the Account has adopted a temporary defensive
posture, there shall be no limitation on the purchase of obligations issued or
guaranteed by the U.S. government or its agencies or instrumentalities.
9) Sell securities short (except where the Account holds or has the right to
obtain at no added cost a long position in the securities sold that equals or
exceeds the securities sold short).
NON-FUNDAMENTAL RESTRICTIONS
The Account has also adopted the following restrictions that are not fundamental
policies and may be changed without shareholder approval. It is contrary to the
Account's present policy to:
1) Invest more than 15% of its net assets in illiquid securities and in
repurchase agreements maturing in more than seven days except to the extent
permitted by applicable law.
2) Pledge, mortgage or hypothecate its assets, except to secure permitted
borrowings. The deposit of underlying securities and other assets in escrow
and other collateral arrangements in connection with transactions in put or
call options, futures contracts, options on futures contracts and
over-the-counter swap contracts are not deemed to be pledges or other
encumbrances.
3) Invest in companies for the purpose of exercising control or management.
4) Invest more than 25% of its assets in foreign securities.
5) Invest more than 5% of its total assets in real estate limited partnership
interests.
6) Acquire securities of other investment companies in reliance on Section
12(d)(1)(F) or (G) of the 1940 Act.
The Account has also adopted the non-fundamental restriction which requires it,
under normal circumstances, to invest at least 80% of its net assets in the type
of securities, industry or geographic region (as described in the prospectus) as
suggested by the name of the Account. The Account will provide 60-days notice to
shareholders prior to implementing a change in this policy for the Account.
SECURITY SELECTION
Equity Value
------------
American Century's value team looks for stocks of companies that they believe
are undervalued at the time of purchase. The managers use a value investment
strategy that looks for companies that are temporarily out of favor in the
market. The managers attempt to purchase the stocks of these undervalued
companies and hold them until they have returned to favor in the market and
their stock prices have gone up.
Asset Allocation
----------------
Morgan Stanley Asset Management ("MSAM") focuses on companies with consistent or
rising earnings growth records, potential for strong free cash flow and
compelling business strategies. MSAM continually and rigorously studies company
developments, including business strategy, management focus and financial
results, to identify
companies with earnings growth and business momentum. In its selection of
securities for Asset Allocation, MSAM considers valuation to be of secondary
importance and viewed in the context of prospects for sustainable earnings
growth and the potential for positive earnings surprises in relation to
consensus expectations.
LargeCap Growth Equity
--------------------------
When Grantham, Mayo, Van Otterloo & Co. LLC ("GMO") places a trade for the same
security or futures contract for more than one account, it is normal practice
that such trades will be placed as a block.
.. Execution of orders for clients who designate the use of particular brokers
generally can not participate in block trades, and should generally be delayed
until the execution of non-broker designated orders has been completed.
.. Execution of orders for any client who prohibits participation in block trades
should generally be delayed until the execution of any block trade for the
security.
Multiple Trades in the Same Security or Futures Contract
.. Intra-Day: When a security or futures contract is traded in more than one lot
during a day, either all accounts trading shall participate in each lot, or an
average price shall be obtained that is applicable to all accounts.
.. Multi-Day: When a security or futures contract is traded across multiple days,
all accounts trading shall participate on each day, unless the record clearly
demonstrates that the trading decisions were made independently.
The intended basis of allocation for a trade should be recorded prior to placing
the order. When this is not practicable, the intended allocation will be
recorded immediately thereafter.
LargeCap Stock Index
------------------------
Principal Global Investors, LLC ("Principal") allocates Account assets in
approximately the same weightings as the relevant index. Principal may omit or
remove any stock from the Account if it determines that the stock is not
sufficiently liquid. In addition, Principal may exclude or remove a stock from
the Account if extraordinary events or financial conditions lead it to believe
that such stock should not be a part of the Account's assets. Account assets may
be invested in futures and options.
MidCap Growth
-------------
The Dreyfus Corporation ("Dreyfus") uses valuation models designed to identify
common stocks of companies that have demonstrated consistent earnings momentum
and delivered superior results relative to market analyst expectations. Other
considerations include profit margins, growth in cash flow and other standard
balance sheet measures. The securities held are generally characterized by
strong earnings growth momentum measures and higher expected earnings per share
growth. Once such common stocks are identified, Dreyfus constructs a portfolio
that in the aggregate breakdown and risk profile resembles the Russell Midcap
Growth Index, but is weighted toward the most attractive stocks. The valuation
model incorporates information about the relevant criteria as of the most recent
period for which data are available. Once ranked, the securities are categorized
under the headings "buy", "sell" or "hold." The decision to buy, sell or hold is
made by Dreyfus based primarily on output of the valuation model. However, that
decision may be modified due to subsequently available or other specific
relevant information about the security.
SmallCap Value
------------------
J.P. Morgan Investment Management Inc. ("Morgan") uses fundamental research,
systematic stock valuation and a disciplined portfolio construction process.
Morgan seeks to enhance returns and reduce the volatility in the value of the
Account relative to that of the U.S. small company value universe. Morgan
continuously screens the small company universe to identify for further analysis
those companies that exhibit favorable characteristics. Such characteristics
include significant and predictable cash flow and high quality management. Based
on fundamental research and using a dividend discount model. Morgan ranks these
companies within economic sectors according to their relative values. Morgan
then selects for purchase the companies it feels to be most attractive within
each economic sector.
Selections of equity securities for the other Accounts (except the MidCap Value
-------------------------------------------------------------------------------
Account).
-------------
Such selections are made based on an approach described broadly as
"company-by-company" fundamental analysis. Three basic steps are involved in
this analysis.
.. First is the continuing study of basic economic factors in an effort to
conclude what the future general economic climate is likely to be over the
next one to two years.
.. Second, given some conviction as to the likely economic climate, the Manager
or Sub-Advisor attempts to identify the prospects for the major industrial,
commercial and financial segments of the economy. By looking at such factors
as demand for products, capacity to produce, operating costs, pricing
structure, marketing techniques, adequacy of raw materials and components,
domestic and foreign competition, and research productivity, the Manager or
Sub-Advisor evaluates the prospects for each industry for the near and
intermediate term.
.. Finally, determinations are made regarding earnings prospects for individual
companies within each industry by considering the same types of factors
described above. These earnings prospects are evaluated in relation to the
current price of the securities of each company.
MidCap Value
----------------
Neuberger Berman Management Inc. ("Neuberger Berman"), Sub-Advisor for the
MidCap Value Account primarily uses a bottom-up approach although a limited
top-down analysis will be used as well.
INVESTMENT STRATEGIES AND RISKS
Restricted Securities
---------------------
Generally, restricted securities are not readily marketable because they are
subject to legal or contractual restrictions upon resale. They are sold only in
a public offering with an effective registration statement or in a transaction
that is exempt from the registration requirements of the Securities Act of 1933.
When registration is required, an Account 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 Account may be permitted to sell a
security. If adverse market conditions were to develop during such a period, the
Account might obtain a less favorable price than existed when it decided to
sell. Restricted securities and other securities not readily marketable are
priced at fair value as determined in good faith by or under the direction of
the Directors.
Each of the Accounts (except the Government Securities and Money Market
Accounts) has adopted investment restrictions that limit its investments in
restricted securities or other illiquid securities to 15%of its net assets. The
Directors have adopted procedures to determine the liquidity of Rule 4(2)
short-term paper and of restricted securities under Rule 144A. Securities
determined to be liquid under these procedures are excluded from the preceding
investment restriction.
Foreign Securities
------------------
Foreign companies may not be subject to the same uniform accounting, auditing
and financial reporting practices as are required of U.S. companies. In
addition, there may be less publicly available information about a foreign
company than about a U.S. company. Securities of many foreign companies are less
liquid and more volatile than securities of comparable U.S. companies.
Commissions on foreign securities exchanges may be generally higher than those
on U.S. exchanges, although each Account seeks the most favorable net results on
its portfolio transactions.
Foreign markets also have different clearance and settlement procedures than
those in U.S. markets. In certain markets there have been times when settlements
have been unable to keep pace with the volume of securities transactions, making
it difficult to conduct these transactions. Delays in settlement could result in
temporary periods when a portion of a Fund's assets is not invested and are
earning no return. If an Account is unable to make intended security purchases
due to settlement problems, the Account may miss attractive investment
opportunities. In addition, an Account may incur a loss as a result of a decline
in the value of its portfolio if it is unable to sell a security.
With respect to certain foreign countries, there is the possibility of
expropriation or confiscatory taxation, political or social instability, or
diplomatic developments that could affect an Account's investments in those
countries. In addition, an Account may also suffer losses due to
nationalization, expropriation or differing accounting practices and treatments.
Investments in foreign securities are subject to laws of the foreign country
that may limit the amount and types of foreign investments. Changes of
governments or of economic or monetary policies, in the U.S. or abroad, changes
in dealings between nations, currency convertibility or exchange rates could
result in investment losses for an Account. Finally, even though certain
currencies may be convertible into U.S. dollars, the conversion rates may be
artificial relative to the actual market values and may be unfavorable to a
Fund's investors.
Foreign securities are often traded with less frequency and volume, and
therefore may have greater price volatility, than is the case with many U.S.
securities. Brokerage commissions, custodial services, and other costs relating
to investment in foreign countries are generally more expensive than in the U.S.
Though the Accounts intend to acquire the securities of foreign issuers where
there are public trading markets, economic or political turmoil in a country in
which an Account has a significant portion of its assets or deterioration of the
relationship between the U.S. and a foreign country may negatively impact the
liquidity of an Account's portfolio. The Account may have difficulty meeting a
large number of redemption requests. Furthermore, there may be difficulties in
obtaining or enforcing judgments against foreign issuers.
Investments in companies of developing countries may be subject to higher risks
than investments in companies in more developed countries. These risks include:
.. increased social, political and economic instability;
.. a smaller market for these securities and low or nonexistent volume of trading
that results in a lack of liquidity and in greater price volatility;
.. lack of publicly available information, including reports of payments of
dividends or interest on outstanding securities;
.. foreign government policies that may restrict opportunities, including
restrictions on investment in issuers or industries deemed sensitive to
national interests;
.. relatively new capital market structure or market-oriented economy;
.. the possibility that recent favorable economic developments may be slowed or
reversed by unanticipated political or social events in these countries;
.. restrictions that may make it difficult or impossible for the fund to vote
proxies, exercise shareholder rights, pursue legal remedies, and obtain
judgments in foreign courts; and
.. possible losses through the holding of securities in domestic and foreign
custodial banks and depositories.
In addition, many developing countries have experienced substantial, and in some
periods, extremely high rates of inflation for many years. Inflation and rapid
fluctuations in inflation rates have had and may continue to have negative
effects on the economies and securities markets of those countries.
Repatriation of investment income, capital and proceeds of sales by foreign
investors may require governmental registration and/or approval in some
developing countries. An Account could be adversely affected by delays in or a
refusal to grant any required governmental registration or approval for
repatriation.
Further, the economies of developing countries generally are heavily dependent
upon international trade and, accordingly, have been and may continue to be
adversely affected by trade barriers, exchange controls, managed adjustments in
relative currency values and other protectionist measures imposed or negotiated
by the countries with which they trade.
Depositary Receipts
-------------------
Depositary Receipts are generally subject to the same sort of risks as direct
investments in a foreign country, such as, currency risk, political and economic
risk, and market risk, because their values depend on the performance of a
foreign security denominated in its home currency.
The Accounts that may invest in foreign securities may invest in:
.. American Depositary Receipts ("ADRs") - receipts issued by an American bank or
trust company evidencing ownership of underlying securities issued by a
foreign issuer. They are designed for use in U.S. securities markets.
.. European Depositary Receipts ("EDRs") and Global Depositary Receipts ("GDRs")
- receipts typically issued by a foreign financial institution to evidence an
arrangement similar to that of ADRs.
Depositary Receipts may be issued by sponsored or unsponsored programs. In
sponsored programs, an issuer has made arrangements to have its securities
traded in the form of Depositary Receipts. In unsponsored programs, the issuer
may not be directly involved in the creation of the program. Although regulatory
requirements with respect to sponsored and unsponsored programs are generally
similar, in some cases it may be easier to obtain financial
information from an issuer that has participated in the creation of a sponsored
program. Accordingly, there may be less information available regarding issuers
of securities of underlying unsponsored programs, and there may not be a
correlation between the availability of such information and the market value of
the Depositary Receipts.
Securities of Smaller Companies
-------------------------------
The Accounts may invest in securities of companies with small- or mid-sized
market capitalizations. Market capitalization is defined as total current market
value of a company's outstanding common stock. Investments in companies with
smaller market capitalizations may involve greater risks and price volatility
(wide, rapid fluctuations) than investments in larger, more mature companies.
Smaller companies may be less mature than older companies. At this earlier stage
of development, the companies may have limited product lines, reduced market
liquidity for their shares, limited financial resources or less depth in
management than larger or more established companies. Small companies also may
be less significant factors within their industries and may be at a competitive
disadvantage relative to their larger competitors. While smaller companies may
be subject to these additional risks, they may also realize more substantial
growth than larger or more established companies. Small company stocks may
decline in price as large company stocks rise, or rise in price while larger
company stocks decline. Investors should therefore expect the net asset value of
the Account that invests a substantial portion of its assets in small company
stocks may be more volatile than the shares of an Account that invests solely in
larger company stocks.
Unseasoned Issuers
------------------
The Accounts may invest in the securities of unseasoned issuers. Unseasoned
issuers are companies with a record of less than three years continuous
operation, including the operation of predecessors and parents. Unseasoned
issuers by their nature have only a limited operating history that can be used
for evaluating the companies' growth prospects. As a result, investment
decisions for these securities may place a greater emphasis on current or
planned product lines and the reputation and experience of the company's
management and less emphasis on fundamental valuation factors than would be the
case for more mature growth companies. In addition, many unseasoned issuers also
may be small companies and involve the risks and price volatility associated
with smaller companies.
Spread Transactions, Options on Securities and Securities Indices, and Futures
------------------------------------------------------------------------------
Contracts and Options on Futures Contracts
------------------------------------------
The Accounts may each engage in the practices described under this heading.
.. Spread Transactions. Each Account may purchase covered spread options. Such
covered spread options are not presently exchange listed or traded. The
purchase of a spread option gives the Account the right to put, or sell, a
security that it owns at a fixed dollar spread or fixed yield spread in
relationship to another security that the Account does not own, but which is
used as a benchmark. The risk to the Account in purchasing covered spread
options is the cost of the premium paid for the spread option and any
transaction costs. In addition, there is no assurance that closing
transactions will be available. The purchase of spread options can be used to
protect each Account against adverse changes in prevailing credit quality
spreads, i.e., the yield spread between high quality and lower quality
securities. The security covering the spread option is maintained in a
segregated account by each Account's custodian. The Accounts do not consider a
security covered by a spread option to be "pledged" as that term is used in
the Account's policy limiting the pledging or mortgaging of assets.
.. Options on Securities and Securities Indices. Each Account may write (sell)
and purchase call and put options on securities in which it invests and on
securities indices based on securities in which the Account invests. The
Accounts may write call and put options to generate additional revenue, and
may write and purchase call and put options in seeking to hedge against a
decline in the value of securities owned or an increase in the price of
securities which the Account plans to purchase.
. Writing Covered Call and Put Options. When an Account writes a call option,
it gives the purchaser of the option the right to buy a specific security at
a specified price at any time before the option expires. When an Account
writes a put option, it gives the purchaser of the option the right to sell
to the Account a specific security at a specified price at any time before
the option expires. In both situations, the Account receives a premium from
the purchaser of the option.
The premium received by an Account reflects, among other factors, the
current market price of the underlying security, the relationship of the
exercise price to the market price, the time period until the expiration of
the option and interest rates. The premium generates additional income for
the Account if the option expires unexercised or is closed out at a profit.
By writing a call, an Account limits its opportunity to profit from any
increase in the market value of the underlying security above the exercise
price of the option, but it retains the risk of loss if the price of the
security should decline. By writing a put, an Account assumes the risk that
it may have to purchase the underlying security at a price that may be
higher than its market value at time of exercise.
The Accounts write only covered options and comply with applicable
regulatory and exchange cover requirements. The Accounts usually own the
underlying security covered by any outstanding call option. With respect to
an outstanding put option, each Account deposits and maintains with its
custodian cash or other liquid assets with a value at least equal to the
exercise price of the option.
Once an Account has written an option, it may terminate its obligation
before the option is exercised. The Account executes a closing transaction
by purchasing an option of the same series as the option previously written.
The Account has a gain or loss depending on whether the premium received
when the option was written exceeds the closing purchase price plus related
transaction costs.
. Purchasing Call and Put Options. When an Account purchases a call option, it
receives, in return for the premium it pays, the right to buy from the
writer of the option the underlying security at a specified price at any
time before the option expires. An Account purchases call options in
anticipation of an increase in the market value of securities that it
intends ultimately to buy. During the life of the call option, the Account
is able to buy the underlying security at the exercise price regardless of
any increase in the market price of the underlying security. In order for a
call option to result in a gain, the market price of the underlying security
must exceed the sum of the exercise price, the premium paid and transaction
costs.
When an Account purchases a put option, it receives, in return for the
premium it pays, the right to sell to the writer of the option the
underlying security at a specified price at any time before the option
expires. An Account purchases put options in anticipation of a decline in
the market value of the underlying security. During the life of the put
option, the Account is able to sell the underlying security at the exercise
price regardless of any decline in the market price of the underlying
security. In order for a put option to result in a gain, the market price of
the underlying security must decline, during the option period, below the
exercise price enough to cover the premium and transaction costs.
Once an Account purchases an option, it may close out its position by
selling an option of the same series as the option previously purchased. The
Account has a gain or loss depending on whether the closing sale price
exceeds the initial purchase price plus related transaction costs.
. Options on Securities Indices. Each Account may purchase and sell put and
call options on any securities index based on securities in which the
Account may invest. Securities index options are designed to reflect price
fluctuations in a group of securities or segment of the securities market
rather than price fluctuations in a single security. Options on securities
indices are similar to options on securities, except that the exercise of
securities index options requires cash payments and does not involve the
actual purchase or sale of securities. The Accounts engage in transactions
in put and call options on securities indices for the same purposes as they
engage in transactions in options on securities. When an Account writes call
options on securities indices, it holds in its portfolio underlying
securities which, in the judgment of the Manager or Sub-Advisor, correlate
closely with the securities index and which have a value at least equal to
the aggregate amount of the securities index options.
. Risks Associated with Option Transactions. An option position may be closed
out only on an exchange that provides a secondary market for an option of
the same series. The Accounts generally purchase or write only those options
for which there appears to be an active secondary market. However, there is
no assurance that a liquid secondary market on an exchange exists for any
particular option, or at any particular time. If an Account is unable to
effect closing sale transactions in options it has purchased, it has to
exercise its options in order to realize any profit and may incur
transaction costs upon the purchase or sale of underlying securities. If
an Account is unable to effect a closing purchase transaction for a covered
option that it has written, it is not able to sell the underlying
securities, or dispose of the assets held in a segregated account, until the
option expires or is exercised. An Account's ability to terminate option
positions established in the over-the-counter market may be more limited
than for exchange-traded options and may also involve the risk that
broker-dealers participating in such transactions might fail to meet their
obligations.
.. Futures Contracts and Options on Futures Contracts. Each Account may purchase
and sell financial futures contracts and options on those contracts. Financial
futures contracts are commodities contracts based on financial instruments
such as U.S. Treasury bonds or bills or on securities indices such as the S&P
500 Index. Futures contracts, options on futures contracts and the commodity
exchanges on which they are traded are regulated by the Commodity Futures
Trading Commission ("CFTC"). Each Fund may enter into futures contracts and
related options transactions both for hedging and non-hedging purposes.
Through the purchase and sale of futures contracts and related options, an
Account seeks primarily to hedge against a decline in the value of securities
owned by the Account or an increase in the price of securities that the
Account plans to purchase. Each Account
may also purchase and sell futures contracts and related options to maintain
cash reserves while simulating full
investment in securities and to keep substantially all of its assets exposed
to the market.
. Futures Contracts. When an Account sells a futures contract based on a
financial instrument, the Account is obligated to deliver that kind of
instrument at a specified future time for a specified price. When an Account
purchases that kind of contract, it is obligated to take delivery of the
instrument at a specified time and to pay the specified price. In most
instances, these contracts are closed out by entering into an offsetting
transaction before the settlement date. The Account realizes a gain or loss
depending on whether the price of an offsetting purchase plus transaction
costs are less or more than the price of the initial sale or on whether the
price of an offsetting sale is more or less than the price of the initial
purchase plus transaction costs. Although the Accounts usually liquidate
futures contracts on financial instruments in this manner, they may make or
take delivery of the underlying securities when it appears economically
advantageous to do so.
A futures contract based on a securities index provides for the purchase or
sale of a group of securities at a specified future time for a specified
price. These contracts do not require actual delivery of securities but
result in a cash settlement. The amount of the settlement is based on the
difference in value of the index between the time the contract was entered
into and the time it is liquidated (at its expiration or earlier if it is
closed out by entering into an offsetting transaction).
When a futures contract is purchased or sold a brokerage commission is paid.
Unlike the purchase or sale of a security or option, no price or premium is
paid or received. Instead, an amount of cash or other liquid assets
(generally about 5% of the contract amount) is deposited by the Account with
its custodian for the benefit of the futures commission merchant through
which the Account engages in the transaction. This amount is known as
"initial margin." It does not involve the borrowing of funds by the Account
to finance the transaction. It instead represents a "good faith" deposit
assuring the performance of both the purchaser and the seller under the
futures contract. It is returned to the Account upon termination of the
futures contract if all the Account's contractual obligations have been
satisfied.
Subsequent payments to and from the broker, known as "variation margin," are
required to be made on a daily basis as the price of the futures contract
fluctuates, a process known as "marking to market." The fluctuations make
the long or short positions in the futures contract more or less valuable.
If the position is closed out by taking an opposite position prior to the
settlement date of the futures contract, a final determination of variation
margin is made. Any additional cash is required to be paid to or released by
the broker and the Account realizes a loss or gain.
In using futures contracts, the Account seeks primarily to establish more
certainly than would otherwise be possible the effective price of or rate of
return on portfolio securities or securities that the Account proposes to
acquire. An Account, for example, sells futures contracts in anticipation of
a rise in interest rates that would cause a decline in the value of its debt
investments. When this kind of hedging is successful, the futures contract
increases in value when the Account's debt securities decline in value and
thereby keep the Account's net asset value from declining as much as it
otherwise would. An Account also sells futures contracts on
securities indices in anticipation of or during a stock market decline in an
endeavor to offset a decrease in the market value of its equity investments.
When an Account is not fully invested and anticipates an increase in the
cost of securities it intends to purchase, it may purchase financial futures
contracts. When increases in the prices of equities are expected, an Account
purchases futures contracts on securities indices in order to gain rapid
market exposure that may partially or entirely offset increases in the cost
of the equity securities it intends to purchase.
. Options on Futures Contracts. The Accounts may also purchase and write call
and put options on futures contracts. A call option on a futures contract
gives the purchaser the right, in return for the premium paid, to purchase a
futures contract (assume a long position) at a specified exercise price at
any time before the option expires. A put option gives the purchaser the
right, in return for the premium paid, to sell a futures contract (assume a
short position), for a specified exercise price, at any time before the
option expires.
Upon the exercise of a call, the writer of the option is obligated to sell
the futures contract (to deliver a long position to the option holder) at
the option exercise price, which will presumably be lower than the current
market price of the contract in the futures market. Upon exercise of a put,
the writer of the option is obligated to purchase the futures contract
(deliver a short position to the option holder) at the option exercise
price, which will presumably be higher than the current market price of the
contract in the futures market. However, as with the trading of futures,
most options are closed out prior to their expiration by the purchase or
sale of an offsetting option at a market price that reflects an increase or
a decrease from the premium originally paid. Options on futures can be used
to hedge substantially the same risks addressed by the direct purchase or
sale of the underlying futures contracts. For example, if an Account
anticipates a rise in interest rates and a decline in the market value of
the debt securities in its portfolio, it might purchase put options or write
call options on futures contracts instead of selling futures contracts.
If an Account purchases an option on a futures contract, it may obtain
benefits similar to those that would result if it held the futures position
itself. But in contrast to a futures transaction, the purchase of an option
involves the payment of a premium in addition to transaction costs. In the
event of an adverse market movement, however, the Account is not subject to
a risk of loss on the option transaction beyond the price of the premium it
paid plus its transaction costs.
When an Account writes an option on a futures contract, the premium paid by
the purchaser is deposited with the Account's custodian. The Account must
maintain with its custodian all or a portion of the initial margin
requirement on the underlying futures contract. It assumes a risk of adverse
movement in the price of the underlying futures contract comparable to that
involved in holding a futures position. Subsequent payments to and from the
broker, similar to variation margin payments, are made as the premium and
the initial margin requirements are marked to market daily. The premium may
partially offset an unfavorable change in the value of portfolio securities,
if the option is not exercised, or it may reduce the amount of any loss
incurred by the Account if the option is exercised.
. Risks Associated with Futures Transactions. There are a number of risks
associated with transactions in futures contracts and related options. An
Account's successful use of futures contracts is subject to the ability of
the Manager or Sub-Advisor to predict correctly the factors affecting the
market values of the Account's portfolio securities. For example, if an
Account is hedged against the possibility of an increase in interest rates
which would adversely affect debt securities held by the Account and the
prices of those debt securities instead increases, the Account loses part or
all of the benefit of the increased value of its securities it hedged
because it has offsetting losses in its futures positions. Other risks
include imperfect correlation between price movements in the financial
instrument or securities index underlying the futures contract, on the one
hand, and the price movements of either the futures contract itself or the
securities held by the Account, on the other hand. If the prices do not move
in the same direction or to the same extent, the transaction may result in
trading losses.
Prior to exercise or expiration, a position in futures may be terminated
only by entering into a closing purchase or sale transaction. This requires
a secondary market on the relevant contract market. The Account enters into
a futures contract or related option only if there appears to be a liquid
secondary market. There can be no
assurance, however, that such a liquid secondary market exists for any
particular futures contract or related option at any specific time. Thus, it
may not be possible to close out a futures position once it has been
established. Under such circumstances, the Account continues to be required
to make daily cash payments of variation margin in the event of adverse
price movements. In such situations, if the Account has insufficient cash,
it may be required to sell portfolio securities to meet daily variation
margin requirements at a time when it may be disadvantageous to do so. In
addition, the Account may be required to perform under the terms of the
futures contracts it holds. The inability to close out futures positions
also could have an adverse impact on the Account's ability effectively to
hedge its portfolio.
Most United States futures exchanges limit the amount of fluctuation
permitted in futures contract prices during a single trading day. This daily
limit establishes the maximum amount that the price of a futures contract
may vary either up or down from the previous day's settlement price at the
end of a trading session. Once the daily limit has been reached in a
particular type of contract, no more trades may be made on that day at a
price beyond that limit. The daily limit governs only price movements during
a particular trading day and therefore does not limit potential losses
because the limit may prevent the liquidation of unfavorable positions.
Futures contract prices have occasionally moved to the daily limit for
several consecutive trading days with little or no trading, thereby
preventing prompt liquidation of futures positions and subjecting some
futures traders to substantial losses.
. Limitations on the Use of Futures and Options on Futures Contracts. Each
Account intends to come within an exclusion from the definition of
"commodity pool operator" provided by CFTC regulations.
Each Account may enter into futures contracts and related options
transactions, primarily for hedging purposes and for other appropriate risk
management purposes, and to modify the Account's exposure to various
currency, equity, or fixed-income markets. Each Account (other than Asset
Allocation and Equity Growth) may engage in speculative futures trading.
When using futures contracts and options on futures contracts for hedging or
risk management purposes, each Account determines that the price
fluctuations in the contracts and options are substantially related to price
fluctuations in securities held by the Account or which it expects to
purchase. In pursuing traditional hedging activities, each Account may sell
futures contracts or acquire puts to protect against a decline in the price
of securities that the Account owns. Each Account may purchase futures
contracts or calls on futures contracts to protect the Account against an
increase in the price of securities the Account intends to purchase before
it is in a position to do so.
When an Account purchases a futures contract, or purchases a call option on
a futures contract, it segregates fund assets, which must be liquid and
marked to the market daily, in a segregated account. The amount so
segregated plus the amount of initial margin held for the account of its
broker equals the market value of the futures contract.
Forward Foreign Currency Exchange Contracts
-------------------------------------------
The Accounts (except the Government Securities and Money Market) may, but are
not obligated to, enter into forward foreign currency exchange contracts under
various circumstances. The Accounts (other than Asset Allocation and Equity
Growth) will enter into forward foreign currency exchange contracts only for the
purpose of "hedging", that is limiting the risks associated with changes in the
relative rates of exchange between the U.S. dollar and foreign currencies in
which securities owned by an Account are denominated or exposed. They do not
enter into such forward contracts for non-hedging purposes. The Asset Allocation
and Equity Growth Accounts each may engage in speculative forward foreign
currency exchange contracts. Currency transactions include forward currency
contracts, exchange listed or over-the-counter options on currencies. A forward
currency contract involves a privately negotiated obligation to purchase or sell
a specific currency at a specified future date at a price set at the time of the
contract.
The typical use of a forward contract is to "lock in" the price of a security in
U.S. dollars or some other foreign currency which an Account is holding in its
portfolio. By entering into a forward contract for the purchase or sale, for a
fixed amount of dollars or other currency, of the amount of foreign currency
involved in the underlying security transactions, an Account may be able to
protect itself against a possible loss resulting from an adverse change in the
relationship
between the U.S. dollar or other currency which is being used for the security
purchase and the foreign currency in which the security is denominated in or
exposed to during the period between the date on which the security is purchased
or sold and the date on which payment is made or received.
The Sub-Advisor also may from time to time utilize forward contracts for other
purposes. For example, they may be used to hedge a foreign security held in the
portfolio or a security which pays out principal tied to an exchange rate
between the U.S. dollar and a foreign currency, against a decline in value of
the applicable foreign currency. They also may be used to lock in the current
exchange rate of the currency in which those securities anticipated to be
purchased are denominated in or exposed to. At times, an Account may enter into
"cross-currency" hedging transactions involving currencies other than those in
which securities are held or proposed to be purchased are denominated.
An Account segregates assets consisting of foreign securities denominated in or
exposed to the currency for which the Account has entered into forward contracts
under the second circumstance, as set forth above, for the term of the forward
contract. It should be noted that the use of forward foreign currency exchange
contracts does not eliminate fluctuations in the underlying prices of the
securities. It simply establishes a rate of exchange between the currencies that
can be achieved at some future point in time. Additionally, although such
contracts tend to minimize the risk of loss due to a decline in the value of the
hedged currency, they also tend to limit any potential gain that might result if
the value of the currency increases.
Currency hedging involves some of the same risks and considerations as other
transactions with similar instruments. Currency transactions can result in
losses to an Account if the currency being hedged fluctuates in value to a
degree or in a direction that is not anticipated. Further, the risk exists that
the perceived linkage between various currencies may not be present or may not
be present during the particular time that an Account is engaging in proxy
hedging. Currency transactions are also 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 adversely affected by
government exchange controls, limitations or restrictions on repatriation of
currency, and manipulations or exchange restrictions imposed by governments.
These forms of governmental actions can result in losses to an Account if it is
unable to deliver or receive currency or monies in settlement of obligations.
They could also cause hedges the Account has entered into to be rendered
useless, resulting in full currency exposure as well as incurring transaction
costs. Currency exchange rates may also fluctuate based on factors extrinsic to
a country's economy. Buyers and sellers of currency futures contracts are
subject to the same risks that apply to the use of futures contracts generally.
Further, settlement of a currency futures contract for the purchase of most
currencies must occur at a bank based in the issuing nation. The ability to
establish and close out positions on trading options on currency futures
contracts is subject to the maintenance of a liquid market that may not always
be available.
Repurchase and Reverse Repurchase Agreements, Mortgage Dollar Rolls and
-----------------------------------------------------------------------
Sale-Buybacks
-------------
The Accounts may invest in repurchase and reverse repurchase agreements. In a
repurchase agreement, an Account purchases a security and simultaneously commits
to resell that security to the seller at an agreed upon price on an agreed upon
date within a number of days (usually not more than seven) from the date of
purchase. The resale price consists of the purchase price plus an amount that is
unrelated to the coupon rate or maturity of the purchased security. A repurchase
agreement involves the obligation of the seller to pay the agreed upon price,
which obligation is in effect secured by the value (at least equal to the amount
of the agreed upon resale price and marked-to-market daily) of the underlying
security or "collateral." A risk associated with repurchase agreements is the
failure of the seller to repurchase the securities as agreed, which may cause an
Account to suffer a loss if the market value of such securities declines before
they can be liquidated on the open market. In the event of bankruptcy or
insolvency of the seller, an Account may encounter delays and incur costs in
liquidating the underlying security. Repurchase agreements that mature in more
than seven days are subject to the 15% limit on illiquid investments. While it
is not possible to eliminate all risks from these transactions, it is the policy
of the Account to limit repurchase agreements to those parties whose
creditworthiness has been reviewed and found satisfactory by the Manager or
Sub-Advisor.
An Account may use reverse repurchase agreements, mortgage dollar roles, and
economically similar transactions to obtain cash to satisfy unusually heavy
redemption requests or for other temporary or emergency purposes without the
necessity of selling portfolio securities, or to earn additional income on
portfolio securities, such as Treasury bills or notes. In a reverse repurchase
agreement, an Account sells a portfolio security to another party, such as a
bank or
broker-dealer, in return for cash and agrees to repurchase the instrument at a
particular price and time. While a reverse repurchase agreement is outstanding,
an Account will maintain cash and appropriate liquid assets to cover its
obligation under the agreement. The Account will enter into reverse repurchase
agreements only with parties that the Manager or Sub-Advisor deems creditworthy.
Using reverse repurchase agreements to earn additional income involves the risk
that the interest earned on the invested proceeds is less than the expense of
the reverse repurchase agreement transaction. This technique may also have a
leveraging effect on the Account, although the Account's intent to segregate
assets in the amount of the reverse repurchase agreement minimizes this effect.
A "mortgage dollar roll" is similar to a reverse repurchase agreement in certain
respects. In a "dollar roll" transaction an Account sells a mortgage-related
security, such as a security issued by GNMA, to a dealer and simultaneously
agrees to repurchase a similar security (but not the same security) in the
future at a pre-determined price. A dollar roll can be viewed, like a reverse
repurchase agreement, as a collateralized borrowing in which an Account pledges
a mortgage-related security to a dealer to obtain cash. Unlike in the case of
reverse repurchase agreements, the dealer with which an Account enters into a
dollar roll transaction is not obligated to return the same securities as those
originally sold by the Account, but only securities which are "substantially
identical." To be considered "substantially identical," the securities returned
to an Account generally must: (1) be collateralized by the same types of
underlying mortgages; (2) be issued by the same agency and be part of the same
program; (3) have a similar original stated maturity; (4) have identical net
coupon rates; (5) have similar market yields (and therefore price); and (6)
satisfy "good delivery" requirements, meaning that the aggregate principal
amounts of the securities delivered and received back must be within 2.5% of the
initial amount delivered.
An Account's obligations under a dollar roll agreement must be covered by
segregated liquid assets equal in value to the securities subject to repurchase
by the Account. As with reverse repurchase agreements, to the extent that
positions in dollar roll agreements are not covered by segregated liquid assets
at least equal to the amount of any forward purchase commitment, such
transactions would be subject to the Account's restrictions on borrowings.
Furthermore, because dollar roll transactions may be for terms ranging between
one and six months, dollar roll transactions may be deemed "illiquid" and
subject to a Fund's overall limitations on investments in illiquid securities.
An Account also may effect simultaneous purchase and sale transactions that are
known as "sale-buybacks." A sale-buyback is similar to a reverse repurchase
agreement, except that in a sale-buyback, the counterparty who purchases the
security is entitled to receive any principal or interest payments make on the
underlying security pending settlement of the Account's repurchase of the
underlying security. An Account's obligations under a sale-buyback typically
would be offset by liquid assets equal in value to the amount of the Account's
forward commitment to repurchase the subject security.
Swap Agreements and Options on Swap Agreements
----------------------------------------------
Each Account (except Money Market Account) may engage in swap transactions,
including, but not limited to, swap agreements on interest rates, security or
commodity indexes, specific securities and commodities, and credit and
event-linked swaps, to the extent permitted by its investment restrictions. To
the extent an Account may invest in foreign currency-denominated securities, it
may also invest in currency exchange rate swap agreements. An Account may also
enter into options on swap agreements ("swap options").
An Account may enter into swap transactions for any legal purpose consistent
with its investment objective and policies, such as for the purpose of
attempting to obtain or preserve a particular return or spread at a lower cost
than obtaining a return or spread through purchases and/or sales of instruments
in other markets, to protect against currency fluctuations, as a duration
management technique, to protect against any increase in the price of securities
an Account anticipates purchasing at a later date, or to gain exposure to
certain markets in the most economical way possible.
Swap agreements are two party contracts entered into primarily by institutional
investors for periods ranging from a few weeks to more than one year. In a
standard "swap" transaction, two parties agree to exchange the returns (or
differentials in rates of return) earned or realized on particular predetermined
investments or instruments, which may be adjusted for an interest factor. The
gross returns to be exchanged or "swapped" between the parties are generally
calculated with respect to a "notional amount," i.e., the return on or increase
in value of a particular dollar amount invested at a particular interest rate,
in a particular foreign currency, or in a "basket" of securities or commodities
representing a particular index. Forms of swap agreements include interest rate
caps, under which, in return for a premium, one party agrees to make payments to
the other to the extent that interest rates exceed a specified rate, or "cap";
interest rate floors, under which, in return for a premium, one party agrees to
make payments to the other to the extent that interest rates fall below a
specified rate, or "floor"; and interest rate collars, under which a party sells
a cap and purchases a floor or vice versa in an attempt to protect itself
against interest rate movements exceeding given minimum or maximum levels.
Consistent with an Account's investment objectives and general investment
polices, certain of the Accounts may invest in commodity swap agreements. For
example, an investment in a commodity swap agreement may involve the exchange of
floating-rate interest payments for the total return on a commodity index. In a
total return commodity swap, an Account will receive the price appreciation of a
commodity index, a portion of the index, or a single commodity in exchange for
paying an agreed-upon fee. If the commodity swap is for one period, an Account
may pay a fixed fee, established at the outset of the swap. However, if the term
of the commodity swap is for more than one period, with interim swap payments,
an Account may pay an adjustable or floating fee. With a "floating" rate, the
fee may be pegged to a base rate, such as the London Interbank Offered Rate, and
is adjusted each period. Therefore, if interest rates increase over the term of
the swap contract, an Account may be required to pay a higher fee at each swap
reset date.
An Account may enter into credit default swap agreements. The "buyer" in a
credit default contract is obligated to pay the "seller" a periodic stream of
payments over the term of the contract provided that no event of default on an
underlying reference obligation has occurred. If an event of default occurs, the
seller must pay the buyer the full notional value, or "par value," of the
reference obligation in exchange for the reference obligation. An Account may be
either the buyer or seller in a credit default swap transaction. If an Account
is a buyer and no event of default occurs, the Account will lose its investment
and recover nothing. However, if an event of default occurs, the Account (if the
buyer) will receive the full notional value of the reference obligation that may
have little or no value. As a seller, an Account receives a fixed rate of income
throughout the term of the contract, which typically is between six months and
three years, provided that there is no default event. If an event of default
occurs, the seller must pay the buyer the full notional value of the reference
obligation. Credit default swap transactions involve greater risks than if an
Account had invested in the reference obligation directly.
A swap option is a contract that gives a counterparty the right (but not the
obligation) in return for payment of a premium, to enter into a new swap
agreement or to shorten, extend, cancel or otherwise modify an existing swap
agreement, at some designated future time on specified terms. Each Account
(except Money Market Account) may write (sell) and purchase put and call swap
options. Most swap agreements entered into by the Accounts would calculate the
obligations of the parties to the agreement on a "net basis." Consequently, an
Account's current obligations (or rights) under a swap agreement will generally
be equal only to the net amount to be paid or received under the agreement based
on the relative values of the positions held by each party to the agreement (the
"net amount"). An Account's current obligations under a swap agreement will be
accrued daily (offset against any amounts owed to the Account) and any accrued
but unpaid net amounts owed to a swap counterparty will be covered by the
segregation of assets determined to be liquid by the Manager or Sub-Advisor in
accordance with procedures established by the Board of Directors, to avoid any
potential leveraging of the Account's portfolio. Obligations under swap
agreements so covered will not be construed to be "senior securities" for
purposes of the Account's investment restriction concerning senior securities.
Each Account will not enter into a swap agreement with any single party if the
net amount owed or to be received under existing contracts with that party would
exceed 5% of the Account's total assets.
Whether an Account's use of swap agreements or swap options will be successful
in furthering its investment objective of total return will depend on the
ability of the Account's Manager or Sub-Advisor to predict correctly whether
certain types of investments are likely to produce greater returns than other
investments. Because they are two party contracts and because they may have
terms of greater than seven days, swap agreements may be considered to be
illiquid. Moreover, an Account bears the risk of loss of the amount expected to
be received under a swap agreement in the event of the default or bankruptcy of
a swap agreement counterparty. The Accounts will enter into swap agreements only
with counterparties that present minimal credit risks, as determined by the
Account's Manager or Sub-Advisor. Certain restrictions imposed on the Accounts
by the Internal Revenue Code may limit the Accounts' ability to use swap
agreements. The swaps market is a relatively new market and is largely
unregulated. It is possible that developments in the swaps market, including
potential government regulation, could adversely affect an Account's ability to
terminate existing swap agreements or to realize amounts to be received under
such agreements.
Depending on the terms of the particular option agreement, an Account will
generally incur a greater degree of risk when it writes a swap option than it
will incur when it purchases a swap option. When an Account purchases a swap
option, it risks losing only the amount of the premium it has paid should it
decide to let the option expire unexercised. However, when an Account writes a
swap option, upon exercise of the option the Account will become obligated
according to the terms of the underlying agreement.
Liquidity. Some swap markets have 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, these swap
markets have become relatively liquid.
The liquidity of swap agreements will be determined by the Manager or
Sub-Advisor based on various factors, including:
. the frequency of trades and quotations,
. the number of dealers and prospective purchasers in the marketplace,
. dealer undertakings to make a market,
. the nature of the security (including any demand or tender features, and
. the nature of the marketplace for trades (including the ability to assign or
offset a portfolio's rights and obligations relating to the investment).
Such determination will govern whether a swap will be deemed to be within the
15% restriction on investments in illiquid securities.
For purposes of applying the Accounts' investment policies and restrictions (as
stated in the Prospectuses and this SAI) swap agreements are generally valued by
the Accounts at market value. In the case of a credit default swap sold by an
Account (i.e., where the Account is selling credit default protection), however,
the Account will value the swap at its notional amount. The manner in which the
Accounts value certain securities or other instruments for purposes of applying
investment policies and restrictions may differ from the manner in which those
investments are valued by other types of investors.
High-Yield/High-Risk Bonds
--------------------------
The Asset Allocation, Balanced, Bond, and MidCap Value Accounts each may invest
a portion of its assets in bonds that are rated below investment grade (i.e.,
bonds rated BB or lower by Standard & Poor's Ratings Services or Ba or lower by
Moody's Investors Service, Inc.). Lower rated bonds involve a higher degree of
credit risk, which is the risk that the issuer will not make interest or
principal payments when due. In the event of an unanticipated default, an
Account would experience a reduction in its income and could expect a decline in
the market value of the bonds so affected. The Asset Allocation, Balanced and
Bond Accounts may also invest in unrated bonds of foreign and domestic issuers.
Unrated bonds, while not necessarily of lower quality than rated bonds, may not
have as broad a market. Because of the size and perceived demand of the issue,
among other factors, certain municipalities may not incur the expense of
obtaining a rating. The Manager or Sub-Advisor will analyze the creditworthiness
of the issuer, as well as any financial institution or other party responsible
for payments on the bond, in determining whether to purchase unrated bonds.
Unrated bonds will be included in the limitation each Account has with regard to
high yield bonds unless the Manager or Sub-Advisor deems such securities to be
the equivalent of investment grade bonds.
Mortgage- and Asset-Backed Securities
-------------------------------------
The yield characteristics of the mortgage- and asset-backed securities in which
the Asset Allocation, Balanced, Bond
and Government Securities Accounts may invest differ from those of traditional
debt securities. Among the major differences are that the interest and principal
payments are made more frequently on mortgage- and asset-backed securities
(usually monthly) and that principal may be prepaid at any time because the
underlying mortgage loans or other assets generally may be prepaid at any time.
As a result, if the Account purchases those securities at a premium, a
prepayment rate that is faster than expected will reduce their yield, while a
prepayment rate that is slower than expected will have the opposite effect of
increasing yield. If the Account purchases these securities at a discount,
faster than expected prepayments will increase their yield, while slower than
expected prepayments will reduce their yield. Amounts available for reinvestment
by the Account are likely to be greater during a period of declining interest
rates and, as a result, are likely to be reinvested at lower interest rates than
during a period of rising interest rates.
In general, the prepayment rate for mortgage-backed securities decreases as
interest rates rise and increases as interest rates fall. However, rising
interest rates will tend to decrease the value of these securities. In addition,
an increase in interest rates may affect the volatility of these securities by
effectively changing a security that was considered a short-term security at the
time of purchase into a long-term security. Long-term securities generally
fluctuate more widely in response to changes in interest rates than short- or
medium-term securities.
The market for privately issued mortgage- and asset-backed securities is smaller
and less liquid than the market for U.S. government mortgage-backed securities.
A collateralized mortgage obligation ("CMO") may be structured in a manner that
provides a wide variety of investment characteristics (yield, effective maturity
and interest rate sensitivity). As market conditions change, and especially
during periods of rapid market interest rate changes, the ability of a CMO to
provide the anticipated investment characteristics may be greatly diminished.
Increased market volatility and/or reduced liquidity may result.
Real Estate Investment Trusts
-----------------------------
Equity real estate investment trusts own real estate properties, while mortgage
real estate investment trusts make construction, development and long-term
mortgage loans. Their value may be affected by changes in the underlying
property of the trusts, the creditworthiness of the issuer, property taxes,
interest rates, and tax and regulatory requirements, such as those relating to
the environment. Both types of trusts are dependent upon management skill, are
not diversified, and are subject to heavy cash flow dependency, defaults by
borrowers, self-liquidation, and the possibility of failing to qualify for
tax-free status of income under the Internal Revenue Code and failing to
maintain exemption from the 1940 Act.
Zero-coupon securities
----------------------
The Accounts may invest in zero-coupon securities. Zero-coupon securities are
"stripped" U.S. Treasury notes and bonds. They usually trade at a substantial
discount from their face (par) value. Zero-coupon securities are subject to
greater market value fluctuations in response to changing interest rates than
debt obligations of comparable maturities that make distributions of interest in
cash.
Securities Lending
------------------
All Accounts may lend their portfolio securities. None of the Accounts will lend
its portfolio securities if as a result the aggregate of such loans made by the
Account would exceed the limits established by the 1940 Act. Portfolio
securities may be lent to unaffiliated broker-dealers and other unaffiliated
qualified financial institutions provided that such loans are callable at any
time on not more than five business days' notice and that cash or other liquid
assets equal to at least 100% of the market value of the securities loaned,
determined daily, is deposited by the borrower with the Account and is
maintained each business day. While such securities are on loan, the borrower
pays the Account any income accruing thereon. The Account may invest any cash
collateral, thereby earning additional income, and may receive an agreed-upon
fee from the borrower. Borrowed securities must be returned when the loan
terminates. Any gain or loss in the market value of the borrowed securities that
occurs during the term of the loan belongs to the Account and its shareholders.
An Account pays reasonable administrative, custodial and other fees in
connection with such loans and may pay a negotiated portion of the interest
earned on the cash or government securities pledged as collateral to the
borrower or placing broker. An Account does not normally retain voting rights
attendant to securities it has lent, but it may call a loan of securities in
anticipation of an important vote.
When-Issued and Delayed Delivery Securities
-------------------------------------------
Each of the Accounts may from time to time purchase securities on a when-issued
basis and may purchase or sell securities on a delayed delivery basis. The price
of such a transaction is fixed at the time of the commitment, but delivery and
payment take place on a later settlement date, which may be a month or more
after the date of the commitment. No interest accrues to the purchaser during
this period. The securities are subject to market fluctuations that involve the
risk for the purchaser that yields available in the market at the time of
delivery are higher than those obtained in the transaction. Each Account only
purchases securities on a when-issued or delayed delivery basis with the
intention of acquiring the securities. However, an Account may sell the
securities before the settlement date, if such action is deemed advisable. At
the time an Account commits to purchase securities on a when-issued or delayed
delivery basis, it records the transaction and reflects the value of the
securities in determining its net asset value. Each Account also segregates
Account assets, which must be liquid and marked to the market daily, equal in
value to the Account's commitments for when-issued or delayed delivery
securities. Segregation of assets may be accomplished
by placement in a segregated account on the books of the Account's custodian, by
notation on the books of the Account's custodian that the assets in question are
"segregated", or by designation of the Account's records that such assets are
segregated. The availability of liquid assets for this purpose and the effect of
asset segregation on an Account's ability to meet its current obligations, to
honor requests for redemption and to have its investment portfolio managed
properly limit the extent to which the Account may engage in forward commitment
agreements. Except as may be imposed by these factors, there is no limit on the
percent of an Account's total assets that may be committed to transactions in
such agreements.
Money Market Instruments/Temporary Defensive Position
-----------------------------------------------------
The Money Market Account invests all of its available assets in money market
instruments maturing in 397 days or less. In addition, each Account may make
money market investments (cash equivalents), without limit, pending other
investment or settlement, for liquidity or in adverse market conditions.
Following are descriptions of the types of money market instruments that the
Accounts may purchase:
.. U.S. Government Securities - Securities issued or guaranteed by the U.S.
government, including treasury bills, notes and bonds.
.. U.S. Government Agency Securities - Obligations issued or guaranteed by
agencies or instrumentalities of the U.S. government.
. U.S. agency obligations include, but are not limited to, the Bank for
Cooperatives, Federal Home Loan Banks and Federal Intermediate Credit Banks.
. U.S. instrumentality obligations include, but are not limited to, the
Export-Import Bank, Federal Home Loan Mortgage Corporation and Federal
National Mortgage Association.
Some obligations issued or guaranteed by U.S. government agencies and
instrumentalities are supported by the full faith and credit of the U.S.
Treasury. Others, such as those issued by the Federal National Mortgage
Association, are supported by discretionary authority of the U.S. government
to purchase certain obligations of the agency or instrumentality. Still
others, such as those issued by the Student Loan Marketing Association, are
supported only by the credit of the agency or instrumentality.
.. Bank Obligations - Certificates of deposit, time deposits and bankers'
acceptances of U.S. commercial banks having total assets of at least one
billion dollars and overseas branches of U.S. commercial banks and foreign
banks, which in the opinion of the Manager or Sub-Advisor, are of comparable
quality. However, each such bank with its branches has total assets of at
least five billion dollars, and certificates, including time deposits of
domestic savings and loan associations having at least one billion dollars in
assets that are insured by the Federal Savings and Loan Insurance Corporation.
The Account may acquire obligations of U.S. banks that are not members of the
Federal Reserve System or of the Federal Deposit Insurance Corporation.
Obligations of foreign banks and obligations of overseas branches of U.S.
banks are subject to somewhat different regulations and risks than those of
U.S. domestic banks. For example, an issuing bank may be able to maintain that
the liability for an investment is solely that of the overseas branch which
could expose an Account to a greater risk of loss. In addition, obligations of
foreign banks or of overseas branches of U.S. banks may be affected by
governmental action in the country of domicile of the branch or parent bank.
Examples of adverse foreign governmental actions include the imposition of
currency controls, the imposition of withholding taxes on interest income
payable on such obligations, interest limitations, seizure or nationalization
of assets, or the declaration of a moratorium. Deposits in foreign banks or
foreign branches of U.S. banks are not covered by the Federal Deposit
Insurance Corporation. An Account only buys short-term instruments where the
risks of adverse governmental action are believed by the Manager or
Sub-Advisor to be minimal. An Account considers these factors, along with
other appropriate factors, in making an investment decision to acquire such
obligations. It only acquires those which, in the opinion of management, are
of an investment quality comparable to other debt securities bought by the
Account. An Account may invest in certificates of deposit of selected banks
having less than one billion dollars of assets providing the certificates do
not exceed the level of insurance (currently $100,000) provided by the
applicable government agency.
A certificate of deposit is issued against funds deposited in a bank or
savings and loan association for a definite period of time, at a specified
rate of return. Normally they are negotiable. However, an Account occasionally
may invest in certificates of deposit which are not negotiable. Such
certificates may provide for interest penalties in the event of withdrawal
prior to their maturity. A bankers' acceptance is a short-term credit
instrument issued by corporations to finance the import, export, transfer or
storage of goods. They are termed "accepted" when a bank guarantees their
payment at maturity and reflect the obligation of both the bank and drawer to
pay the face amount of the instrument at maturity.
.. Commercial Paper - Short-term promissory notes issued by U.S. or foreign
corporations.
.. Short-term Corporate Debt - Corporate notes, bonds and debentures that at the
time of purchase have 397 days or less remaining to maturity.
.. Repurchase Agreements - Instruments under which securities are purchased from
a bank or securities dealer with an agreement by the seller to repurchase the
securities at the same price plus interest at a specified rate.
.. Taxable Municipal Obligations - Short-term obligations issued or guaranteed by
state and municipal issuers which generate taxable income.
The ratings of nationally recognized statistical rating organization (NRSRO),
such as Moody's Investor Services, Inc. ("Moody's") and Standard & Poor's
("S&P"), which are described in Appendix A, represent their opinions as to the
quality of the money market instruments which they undertake to rate. It should
be emphasized, however, that ratings are general and are not absolute standards
of quality. These ratings, including ratings of NRSROs other than Moody's and
S&P, are the initial criteria for selection of portfolio investments, but the
Manager or Sub-Advisor further evaluates these securities.
INDUSTRY CONCENTRATIONS
Each of the Accounts, except the Equity Income and Real Estate Securities
Accounts, may not concentrate (invest more than 25% of its assets) its
investments in any particular industry. The Equity Income Account may hold more
than 25% of its assets in securities of companies in the utilities industry. The
Real Estate Securities Account may hold more than 25% of its assets in
securities of companies in the real estate industry. The LargeCap Stock Index
Account may concentrate its investments in a particular industry only to the
extent that the S&P 500 Index is concentrated. For purposes of applying the
LargeCap Growth Equity and SmallCap Growth Accounts' industry concentration
restrictions, the Accounts use the industry groups used in the Data Monitor
Portfolio Monitoring System of William O'Neill & Co., Incorporated. The LargeCap
Growth Account uses Bloomberg L.P. industry classifications. The Equity Value
Account uses the industry groups of Morgan Stanley Capital International -
Global Industry Classification Standard. The other Accounts use industry
classifications based on the "Directory of Companies Filing Annual Reports with
the Securities and Exchange Commission."
PORTFOLIO TURNOVER
Portfolio turnover is a measure of how frequently a portfolio's securities are
bought and sold. The portfolio turnover rate is generally calculated as the
dollar value of the lesser of a portfolio's purchases or sales of shares of
securities during a given year, divided by the monthly average value of the
portfolio securities during that year (excluding securities whose maturity or
expiration at the time of acquisition were less than one year). For example, a
portfolio reporting a 100% portfolio turnover rate would have purchased and sold
securities worth as much as the monthly average value of its portfolio
securities during the year.
It is not possible to predict future turnover rates with accuracy. Many variable
factors are outside the control of a portfolio manager. The investment outlook
for the securities in which a portfolio may invest may change as a result of
unexpected developments in securities markets, economic or monetary policies, or
political relationships. High market volatility may result in a portfolio
manager using a more active trading strategy than might otherwise be employed.
Each portfolio manager considers the economic effects of portfolio turnover but
generally does not treat the portfolio turnover rate as a limiting factor in
making investment decisions.
Sale of shares by investors may require the liquidation of portfolio securities
to meet cash flow needs. In addition, changes in a particular portfolio's
holdings may be made whenever the portfolio manager considers that a security is
no longer appropriate for the portfolio or that another security represents a
relatively greater opportunity. Such changes may be made without regard to the
length of time that a security has been held.
Higher portfolio turnover rates generally increase transaction costs that are
expenses of the portfolio. Active trading may generate short-term gains (losses)
for taxable shareholders.
MANAGEMENT
BOARD OF DIRECTORS
Under Maryland law, a Board of Directors oversees the Fund. The Directors have
financial or other relevant experience and meet several times during the year to
review contracts, Fund activities and the quality of services provided to the
Fund. Other than serving as Directors, most of the Board members have no
affiliation with the Fund or service providers. Each Director serves until a
successor is duly qualified and elected.
MANAGEMENT INFORMATION
The name, tenure in office, address and date of birth of the officers and Board
members are shown below. Each person also has the same position (including
committee memberships, if any) with the Principal Investors Fund, Inc. and the
Principal Mutual Funds which are also sponsored by Principal Life. Unless an
address is shown, the mailing address for the Directors and Officers is the
Principal Financial Group, Des Moines, Iowa 50392.
The following directors are considered not to be "interested persons" as defined
--------------------------------------------------------------------------------
in the 1940 Act.
----------------
[Enlarge/Download Table]
NUMBER
OF
PORTFOLIOS
IN FUND OTHER
COMPLEX DIRECTORSHIPS
OVERSEEN HELD
POSITION(S) HELD WITH LENGTH OF PRINCIPAL OCCUPATION(S) BY BY
NAME, ADDRESS AND AGE FUND TIME SERVED DURING PAST 5 YEARS DIRECTOR DIRECTOR
--------------------- --------------------- ----------- ----------------------- ---------- -------------
James D. Davis Director Since 1997 Attorney. Vice President, Deere and 95 None
4940 Center Court Member Audit and Company, Retired.
Bettendorf, Iowa Nominating Committee
03/22/34
Richard W. Gilbert Director Since 1997 President, Gilbert Communications, None
5040 Arbor Lane, #302 Member Audit and Inc. since 1993.
Northfield, Illinois Nominating Committee
05/08/40
Mark A. Grimmett Director Since 2004 Executive Vice President and CFO,
6310 Deerfield Avenue Member Audit and Merle Norman Cosmetics, Inc., since None
San Gabriel, Nominating Committee 2000. Prior thereto, Vice President
California and CFO.
04/03/60
William C. Kimball Director Since 1999 Chairman and CEO, Medicap Pharmacies, Casey's General
3094 104th Member Audit and Inc. Retired. Stores, Inc.
Urbandale, Iowa Nominating Committee
11/28/1947
Barbara A. Lukavsky Director Since 1997 President and CEO, Barbican
13731 Bay Hill Court Member Audit and Enterprises, Inc. since 1997. None
Clive, Iowa Nominating Committee
09/10/40 Member Executive
Committee
The following directors are considered to be "interested persons" as defined in
-------------------------------------------------------------------------------
the 1940 Act because of an affiliation with the Manager and Principal Life.
---------------------------------------------------------------------------
[Enlarge/Download Table]
John E. Aschenbrenner Director Since 1998 Director, Principal 95
08/16/49 Management
Corporation and
Princor Financial
Services Corporation
("Princor") since
1998. President,
Insurance and None
Financial Services
since 2003. Executive
Vice President,
Principal Life
Insurance Company
2000-2003; Prior
thereto, Senior Vice
President, 1996-2000.
Ralph C. Eucher Director and President Since 1999 Director and 95
06/14/52 Member Executive President, Princor
Committee and Principal
Management
Corporation since
1999. Senior Vice
President, Principal
Life Insurance
Company since 2002. None
Vice President,
1999-2002. Prior
thereto, Second Vice
President, Principal
Life Insurance
Company.
Larry D. Zimpleman Director Since 2001 Chairman and 95
09/07/51 Chairman of the Board Director, Princor and
Member Executive Principal Management
Committee Corporation since
2001. President,
Retirement and
Investor Services
since 2003. Executive
Vice President, None
Principal Life
2001-2003. Senior
Vice
President,1999-2001.
Prior thereto, Vice
President,1998-1999.
The Audit and Nominating Committee selects the independent auditors for the Fund
and oversees the activities of the independent auditors as well as the internal
auditors. The committee also receives reports about accounting and financial
matters affecting the Fund. In addition, the committee selects and nominate all
candidates who are not "interest persons" of the Fund for election to the Board.
During the year ended December 31, 2003, the committee met twice.
The Executive Committee is selected by the Board. It may exercise all the powers
of the Board, with certain exceptions, when the Board is not in session. The
Committee must report its actions to the Board. During the year ended December
31, 2003, the committee met once.
Officers (other than Directors)
-------------------------------
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Craig L. Bassett Treasurer Since 1997 Second Vice President
03/12/52 and Treasurer,
Principal Life
Insurance Company since
1998. Director -
Treasury 1996-1998.
Prior thereto,
Associate Treasurer.
Michael J. Beer Executive Vice Since 1997 Executive Vice
01/09/61 President President and Chief
Principal Accounting Operating Officer,
Officer Princor Financial
Services Corporation
and Principal
Management Corporation
since 1999. Vice
President and Chief
Operating Officer,
1998-1999. Prior
thereto, Vice President
and Financial Officer.
Jill R. Brown Vice President Since 2003 Vice President and
08/17/67 Chief Financial Chief Financial
Officer Officer, Princor since
2003. Assistant
Financial Controller
Principal Financial
Group, 1999-2003. Prior
thereto, Senior
Accounting Leader
Principal Financial
Group.
Arthur S. Filean Senior Vice President Since 1997 Senior Vice President,
11/04/38 and Secretary Princor and Principal
Management Corporation,
since 2000. Vice
President, Princor,
1990-2000. Vice
President, Principal
Management Corporation,
1996-2000.
Ernest H. Gillum Vice President Since 1997 Vice President -
06/01/55 Assistant Secretary Product Development,
Princor and Principal
Management Corporation,
since 2000. Vice
President - Compliance
and Product
Development, Princor
and Principal
Management Corporation,
1998-2000. Prior
thereto, Assistant Vice
President, Registered
Products, 1995-1998.
Jane E. Karli Assistant Treasurer Since 1997 Assistant Treasurer,
04/01/57 Principal Life
Insurance Company since
1998. Prior thereto
Senior Accounting and
Custody Administrator.
Patrick A. Kirchner Assistant Counsel Since 2002 Counsel, Principal Life
12/11/60 Insurance Company since
2000. Attorney,
1999-2000. Prior
thereto, Attorney,
MidAmerican Energy
Company
Thomas J. Loftus Assistant Counsel Since 2002 Counsel, Principal Life
07/03/53 Insurance Company since
2002. Counsel, Merrill
Lynch Insurance Group
2000-2001. Prior
thereto Counsel, The
Prudential Insurance
Company of America.
Sarah J. Pitts Assistant Counsel Since 2000 Counsel, Principal Life
12/31/45 Insurance Company since
1997.
Layne A. Rasmussen Controller Since 1997 Controller - Mutual
10/30/58 Funds, Principal
Management Corporation
since 1995.
Michael D. Roughton Counsel Since 1997 Vice President and
07/10/51 Senior Securities
Counsel, Principal Life
Insurance Company,
since 1999. Counsel
1994-1999. Counsel,
Principal Global
Investors, LLC, Princor
and Principal
Management Corporation.
Jean B. Schustek Assistant Vice Since 1997 Assistant Vice
02/17/52 President President - Registered
Assistant Secretary Products, Principal
Management Corporation
and Princor Financial
Services Corporation
since 2000. Prior
thereto, Compliance
Officer - Registered
Products.
CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES
The following tables set forth the aggregate dollar range of mutual funds within
the fund complex which were beneficially owned by the Directors as of December
31, 2003. Mr. Grimmett was elected to the Board of Directors on March 8, 2004
and therefore is not included in the tables below. As of December 31, 2003, none
of the Directors own any shares of the Principal Variable Contracts Fund, Inc.
(all of which are owned by the Principal Life Insurance Company). Only the
Directors who are "interested persons" are eligible to participate in an
employee benefit program which invests in the Principal Investors Fund, Inc.
[Enlarge/Download Table]
DIRECTORS NOT CONSIDERED TO BE "INTERESTED PERSONS"
--------------------------------------------------------------
JAMES D. RICHARD W. WILLIAM C. BARBARA A.
PRINCIPAL MUTUAL FUND DAVIS GILBERT KIMBALL LUKAVSKY
--------------------- ----- ------- ------- --------
Balanced B B A A
Bond C D B E
Capital Value B C A A
Cash Management E B A D
Equity Income D B A A
Government Securities Income B B B A
Growth D D A A
International B C B E
International Emerging Markets C A B A
International SmallCap C A B A
LargeCap Stock Index A A B A
Limited Term Bond A A A E
MidCap E D B A
Partners Blue Chip D B A A
Partners Equity Growth A A B A
Partners LargeCap Blend A A B A
Partners LargeCap Value A A B A
Partners MidCap Growth A A A A
Partners SmallCap Growth A A A A
Real Estate Securities A A B A
SmallCap A A B A
Tax-Exempt Bond B A A A
TOTAL FUND COMPLEX E E C E
[Enlarge/Download Table]
DIRECTORS CONSIDERED TO BE "INTERESTED PERSONS"
-----------------------------------------------------------------
JOHN E. RALPH C. LARRY D.
PRINCIPAL MUTUAL FUND ASCHENBRENNER EUCHER ZIMPLEMAN
--------------------- ------------- ------ ---------
Balanced B A A
Bond B A A
Capital Value C A A
Cash Management B A A
Equity Income B C A
Government Securities
Income A C A
Growth C C A
International C A A
International Emerging
Markets A A A
International SmallCap C A A
LargeCap Stock Index A A A
Limited Term Bond C A A
MidCap C C A
Partners Blue Chip C A A
Partners Equity Growth C C A
Partners LargeCap
Blend A D A
Partners LargeCap
Value A D A
Partners MidCap Growth B A A
Partners SmallCap
Growth A A A
Real Estate Securities B A A
SmallCap A A A
Tax-Exempt Bond A C A
PRINCIPAL INVESTORS FUND (THROUGH PARTICIPATION IN AN EMPLOYEE
BENEFIT PLAN)
Bond & Mortgage
Securities B B C
Government Securities D A A
International I D A C
International Emerging
Markets B A A
LargeCap Growth C A A
LargeCap S&P 500 Index B C A
MidCap Blend B B C
Money Market B A A
Partners LargeCap
Blend I B A A
Partners LargeCap
Growth I C A A
Partners LargeCap
Value B C C
Partners MidCap Growth C A A
Principal LifeTime
Strategic Income B A A
Real Estate Securities C A A
SmallCap S&P 600 Index B A A
TOTAL FUND COMPLEX E E E
A None
B $1 - $10,000
C $10,001 - $50,000
D $50,001 - $100,000
E over $100,000
The Directors also serve as Directors for each of the 24 investment companies
(with a total of 95 portfolios as of June 1, 2004) sponsored by Principal Life
Insurance Company ("Principal Life"). Each Director who is also not an
"interested person" as defined in the 1940 Act received compensation for service
as a member of the Board of all such companies based on a schedule that takes
into account an annual retainer amount, the number of meetings attended and the
assets of the Account for which the meetings are held. These fees and expenses
are divided among the
The Directors also serve as Directors for each of the 24 investment companies
(with a total of 95 portfolios as of June 1, 2004) sponsored by Principal Life
Insurance Company ("Principal Life"). Each Director who is also not an
"interested person" as defined in the 1940 Act received compensation for service
as a member of the Board of all such companies based on a schedule that takes
into account an annual retainer amount, the number of meetings attended and the
assets of the Account for which the meetings are held. These fees and expenses
are divided among the
Accounts: Asset Allocation
Sub-Advisor: Morgan Stanley Investment Management Inc., which does business in
certain instances (including in its role as sub-advisor to Asset
Allocation) as Morgan Stanley Asset Management ("MSAM"), with principal
offices at 1221 Avenue of the Americas, New York, NY 10020, provides a
broad range of portfolio management services to customers in the U.S.
and abroad. As of December 31, 2003, Morgan Stanley Asset Management,
together with its affiliated asset management companies, had
approximately $421 billion in asset under management with approximately
$174 billion in institutional assets.
Accounts: MidCap Value
Sub-Advisor: Neuberger Berman Management, Inc. ("Neuberger Berman") is an
affiliate of Neuberger Berman, LLC. Neuberger Berman, LLC is located at
605 Third Avenue, 2nd Floor, New York, NY 10158-0180. Together with
Neuberger Berman, the firms manage more than $70.5 billion in total
assets (as of December 31, 2003) and continue an asset management
history that began in 1939. Neuberger Berman Management, Inc. is an
indirect, wholly owned subsidiary of Lehman Brothers Holdings, Inc.
Lehman Brothers is located at 745 Seventh Avenue, New York, NY 10019.
Accounts: Balanced, Capital Value, Government Securities, Equity Income, Growth,
International, International Emerging Markets, International SmallCap,
LargeCap Stock Index, Limited Term Bond, MidCap, Principal LifeTime
2010, Principal LifeTime 2020, Principal LifeTime 2030, Principal
LifeTime 2040, Principal LifeTime 2050, Principal LifeTime Strategic
Income, and SmallCap.
Sub-Advisor: Principal Global Investors, LLC ("Principal") is an indirectly
wholly-owned subsidiary of Principal Life Insurance Company and an
affiliate of the Manager. Principal has been active in retirement plan
investing since 1941 and has sub-advised mutual fund assets since 1969.
Principal manages equity, fixed-income and real estate investments
primarily for institutional investors, including Principal Life. As of
December 31, 2003, Principal, together with its affiliated asset
management companies, had approximately $118.5 billion in asset under
management. Principal Global Investor's headquarters address is 801
Grand Avenue, Des Moines, Iowa 50392 and has other primary asset
management offices in New York, London, Sydney and Singapore.
Accounts: Equity Growth and LargeCap Blend
Sub-Advisor: T. Rowe Price Associates, Inc. ("T. Rowe Price"), a wholly-owned
subsidiary of T. Rowe Price Group, Inc., a financial services holding
company, has over 67 years of investment management experience.
Together with its affiliates, T. Rowe Price had approximately $190.0
billion in assets under management as of December 31, 2003. T. Rowe
Price is located at 100 East Pratt Street, Baltimore, MD 21202
Accounts: SmallCap Growth
Sub-Advisor: UBS Global Asset Management (Americas) Inc., a Delaware corporation
located at 1 North Wacker, Chicago, IL 60606 ("UBS Global AM"), is a
registered investment advisor. UBS Global AM, a subsidiary of UBS AG,
is a member of the UBS Global Asset Management business group (the
"Group") of UBS AG. As of March 31, 2004, UBS Global AM managed
approximately $53.8 billion in assets and the Group managed
approximately $475.0 billion in assets.
Each of the persons affiliated with the Fund who is also an affiliated person of
the Manager or Principal is named below, together with the capacities in which
such person is affiliated:
[Enlarge/Download Table]
NAME OFFICE HELD WITH THE FUND OFFICE HELD WITH THE MANAGER/PRINCIPAL
---- ------------------------- --------------------------------------
John E. Aschenbrenner Director Director (Manager)
Craig L. Bassett Treasurer Treasurer (Manager)
Michael J. Beer Executive Vice President and Principal Executive Vice President and Chief Operating Officer
Accounting Officer (Manager)
Jill R. Brown Vice President and Chief Financial Officer Vice President and Chief Financial Officer (Manager)
Ralph C. Eucher Director and President Director and President (Manager)
Arthur S. Filean Senior Vice President and Secretary Senior Vice President (Manager)
Ernest H. Gillum Vice President and Assistant Secretary Vice President (Manager)
Layne A. Rasmussen Controller Controller - Mutual Funds (Manager)
Michael D. Roughton Counsel Counsel (Manager; Principal)
Assistant Vice President and Assistant
Jean B. Schustek Secretary Assistant Vice President - Registered Products (Manager)
Larry D. Zimpleman Director and Chairman of the Board Director and Chairman of the Board (Manager)
CODES OF ETHICS
The Fund, the Manager, each of the Sub-Advisors and Princor (as principal
underwriter of the Fund) have adopted Codes of Ethics ("Codes") under Rule 17j-1
of the 1940 Act. These Codes are designed to prevent persons with access to
information regarding the portfolio trading activity of an Account from using
that information for their personal benefit. In certain circumstances, personal
securities trading is permitted in accordance with procedures established by the
Codes. The Boards of Directors of the Manager, the Fund, Princor and each of the
Sub-Advisors periodically review their respective Codes. The Codes are on file
with, and available from, the SEC.
PROXY VOTING POLICIES
The Board of Directors has delegated responsibility for decisions regarding
proxy voting for securities held by each Account to that Account's Sub-Advisor.
The Sub-Advisor will vote such proxies in accordance with its proxy policies and
procedures, which have been reviewed by the Board of Directors, and which are
found in Appendix B.
Any material changes to the proxy policies and procedures will be submitted to
the Board of Directors for approval.
COST OF MANAGER'S SERVICES
For providing the investment advisory services, and specified other services,
the Manager, under the terms of the Management Agreement for the Fund, is
entitled to receive a fee computed and accrued daily and payable monthly, at the
following annual rates:
[Enlarge/Download Table]
NET ASSET VALUE OF ACCOUNT
-------------------------------------------------------------
FIRST NEXT NEXT NEXT
ACCOUNT $250 MILLION $250 MILLION $250 MILLION $250 MILLION THEREAFTER
------- ------------- ------------ ------------ ------------ ---
Capital Value and
Growth 0.60% 0.55% 0.50% 0.45% 0.40%
LargeCap Blend and
LargeCap Value 0.75 0.70 0.65 0.60 0.55
Equity Value and
International 0.85 0.80 0.75 0.70 0.65
International
Emerging Markets 1.25 1.20 1.15 1.10 1.05
MidCap Value 1.05 1.00 0.95 0.90 0.85
[Download Table]
OVERALL
FEE
----
LargeCap Growth
Equity 1.00%
LargeCap Stock Index 0.35
Principal LifeTime
2010 0.1225
Principal LifeTime
2020 0.1225
Principal LifeTime
2030 0.1225
Principal LifeTime
2040 0.1225
Principal LifeTime
2050 0.1225
Principal LifeTime
Strategic Income 0.1225
[Enlarge/Download Table]
FIRST NEXT NEXT NEXT OVER
$100 MILLION $100 MILLION $100 MILLION $100 MILLION $400 MILLION
------------- ------------ ------------ ------------ ------------
Asset Allocation and
Equity Growth 0.80% 0.75% 0.70% 0.65% 0.60%
Balanced and Equity
Income 0.60 0.55 0.50 0.45 0.40
International
SmallCap 1.20 1.15 1.10 1.05 1.00
SmallCap Growth 1.00 0.95 0.90 0.85 0.80
MidCap 0.65 0.60 0.55 0.50 0.45
MidCap Growth and
Real Estate
Securities 0.90 0.85 0.80 0.75 0.70
SmallCap 0.85 0.80 0.75 0.70 0.65
SmallCap Value 1.10 1.05 1.00 0.95 0.90
All Other 0.50 0.45 0.40 0.35 0.30
There is no assurance that the net assets of any Account will reach sufficient
amounts to be able to take advantage of the rate decreases. The net assets of
each Account and the rate of the fee for each Account for investment management
services as provided in the Management Agreement were as follows:
[Download Table]
NET ASSETS AS OF MANAGEMENT FEE
ACCOUNT DECEMBER 31, 2003 FOR PERIODS ENDED DECEMBER 31, 2003
------- ----------------- -----------------------------------
Asset Allocation $ 98,005,896 0.80%
Balanced 124,734,804 0.59
Bond 263,434,669 0.46
Capital Value 248,252,616 0.60
Equity Growth 272,830,823 0.76
Equity Income 30,255,143 0.60
Government Securities 368,563,674 0.43
Growth 141,107,205 0.60
International 167,725,999 0.85
International
Emerging Markets 23,971,665 1.25
International
SmallCap 66,241,909 1.20
LargeCap Blend 54,631,845 0.75
LargeCap Growth
Equity 24,676,880 1.00
LargeCap Stock Index 118,637,926 0.35
LargeCap Value 47,220,625 0.75
Limited Term Bond 20,552,229 0.50
MidCap 334,203,986 0.60
MidCap Growth 54,287,754 0.90
MidCap Value 52,053,984 1.05
Money Market 151,544,989 0.48
Real Estate
Securities 93,017,853 0.90
SmallCap 65,285,232 0.85
SmallCap Growth 55,627,807 1.00
SmallCap Value 82,135,413 1.10
Except for certain Fund expenses set out below, the Manager is responsible for
expenses, administrative duties and services including the following: expenses
incurred in connection with the registration of the Fund and Fund shares with
the SEC; office space, facilities and costs of keeping the books of the Fund;
compensation of all personnel who are officers and any directors who are also
affiliated with the Manager; fees for auditors and legal counsel; preparing and
printing Fund prospectuses; administration of shareholder accounts, including
issuance, maintenance of open account system, dividend disbursement, reports to
shareholders and redemptions. However, some of all of these expenses may be
assumed by Principal Life and some or all of the administrative duties and
services may be delegated by the Manager to Principal Life or affiliate thereof.
Each Account pays for certain corporate expenses incurred in its operation.
Among such expenses, the Account pays brokerage commissions on portfolio
transactions, transfer taxes and other charges and fees attributable to
investment transactions, any other local, state or federal taxes, fees and
expenses of all directors of the Fund who are not persons affiliated with the
Manager, interest, fees for Custodian of the Account, and the cost of meetings
of shareholders.
Sub-Advisory Agreement
----------------------
For providing the investment advisory services, and specified other services,
the Sub-Advisor, under the terms of the Sub-Advisory Agreement for the Account,
is entitled to receive a fee computed and accrued daily and payable monthly, at
the following annual rates:
[Download Table]
NET ASSET VALUE OF ACCOUNT
-------------------------------------------------------------------
FIRST NEXT NEXT NEXT
ACCOUNT $100 MILLION $150 MILLION $250 MILLION $250 MILLION THEREAFTER
------- ------------- ------------ ------------ ------------ ----------
MidCap Value 0.50% 0.475% 0.45% 0.425% 0.40%
[Download Table]
FIRST NEXT NEXT OVER
ACCOUNT $40 MILLION $160 MILLION $100 MILLION $300 MILLION
------- ------------ ------------ ------------ ------------
Asset Allocation 0.45% 0.30% 0.25% 0.20%
[Download Table]
FIRST NEXT NEXT NEXT OVER
ACCOUNT $50 MILLION $200 MILLION $350 MILLION $400 MILLION $1 BILLION
------- ------------ ------------ ------------ ------------ ----------
LargeCap Blend 0.40% 0.35% 0.30% 0.275% 0.275% on
all assets
[Download Table]
FIRST NEXT NEXT OVER
ACCOUNT $250 MILLION $2500 MILLION $500 MILLION $1 BILLION
------- ------------- ------------- ------------ ----------
LargeCap Growth 0.41% 0.33% 0.25% 0.20% on
Equity all assets
[Download Table]
FIRST NEXT OVER
ACCOUNT $250 MILLION $250 MILLION $500 MILLION
------- ------------- ------------ ------------
Equity Growth 0.40% 0.375% 0.35%
The Sub-Advisory Fees on all assets through the period ending July 31, 2005 is 0.35%
[Download Table]
FIRST NEXT NEXT OVER
ACCOUNT $200 MILLION $300 MILLION $250 MILLION $750 MILLION
------- ------------- ------------ ------------ ------------
Equity Value 0.40% 0.35% 0.30% 0.28%
[Download Table]
FIRST NEXT OVER
ACCOUNT $50 MILLION $250 MILLION $300 MILLION
------- ------------ ------------ ------------
SmallCap Growth
- UBS 0.60% 0.55% 0.45%
[Download Table]
FIRST NEXT NEXT OVER
ACCOUNT $10 MILLION $40 MILLION $150 MILLION $200 MILLION
------- ------------ ----------- ------------ ------------
SmallCap Growth -
Emerald 0.75% 0.60% 0.50% 0.45%
[Download Table]
FIRST NEXT OVER
ACCOUNT $50 MILLION $250 MILLION $300 MILLION
------- ------------ ------------ ------------
SmallCap Value 0.60% 0.55% 0.50%
[Download Table]
FIRST OVER
ACCOUNT $50 MILLION $50 MILLION
------- ------------ -----------
MidCap Growth 0.40% 0.35%
[Download Table]
ACCOUNT OVERALL FEE
------- -----------
Balanced
(equity securities
portion) 0.086%
Balanced
(fixed-income
portion) 0.10
Capital Value 0.10
Equity Income 0.70
Government Securities 0.10
Growth 0.07
International 0.11
International
Emerging Markets 0.50
International
SmallCap 0.50
Limited Term Bond 0.10
MidCap 0.10
LargeCap Stock Index 0.015
Principal LifeTime
2010 0.0425
Principal LifeTime
2020 0.0425
Principal LifeTime
2030 0.0425
Principal LifeTime
2040 0.0425
Principal LifeTime
2050 0.0425
Principal LifeTime
Strategic Income 0.0425
SmallCap 0.25
[Enlarge/Download Table]
NET ASSET VALUE OF ACCOUNT
-------------------------------------------------------------------------------------------
FIRST NEXT NEXT NEXT NEXT NEXT NEXT
ACCOUNT $10 MILLION $15 MILLION $25 MILLION $50 MILLION $50 MILLION $50 MILLION $200 MILLION
------- ------------ ----------- ----------- ----------- ----------- ----------- ------------
LargeCap Value 0.60% 0.50% 0.40% 0.30% 0.25% 0.225% 0.20%
Fees paid for investment management services during the periods indicated were
as follows:
[Download Table]
MANAGEMENT FEES FOR PERIODS ENDED DECEMBER 31,
ACCOUNT 2003 2002 2001
------- ---- ---- ----
Asset Allocation $ 684,764 $ 742,230 $ 769,651
Balanced 670,500 746,208 864,481
Bond 1,164,438 929,868 671,822
Capital Value 1,307,704 1,396,713 1,532,333
Equity Growth 1,798,319 2,039,756 2,493,622
Equity Income 159,295 167,214 256,850
Government Securities 1,633,416 1,166,975 749,046
Growth 773,354 971,214 1,346,524
International 1,113,831 1,116,629 1,308,061
International Emerging Markets 185,777* 120,464* 70,968*
International SmallCap 566,727 511,381 537,250
LargeCap Blend 225,306 35,303*
LargeCap Growth Equity 77,701 56,562 42,440*
LargeCap Stock Index 306,803 259,068 223,887*
LargeCap Value 196,493 36,992
Limited Term Bond 38,467
MidCap 1,654,689 1,616,053 1,625,044
MidCap Growth 275,040 218,745 228,686
MidCap Value 369,527 196,057 91,178
Money Market 858,412 883,421 711,218
Real Estate Securities 588,499 313,424 184,424
SmallCap 347,933 288,410 278,725
SmallCap Growth 414,201 418,449 572,638
SmallCap Value 637,097 446,550 258,967
* before waiver
Fees paid for Sub-Advisory services during the periods indicated were as
follows:
[Download Table]
SUB-ADVISOR FEES FOR PERIODS ENDED DECEMBER 31,
-----------------
ACCOUNT 2003 2002 2001
------- ---- ---- ----
Asset Allocation $316,910 $338,364 $347,126
Balanced 102,307 117,141 113,086
Capital Value 215,037 236,571 179,607
Equity Growth 749,065 831,921 979,841
Equity Income 18,310 19,909 30,423
Government Securities 377,766 244,986 91,332
Growth 89,509 116,607 158,469
International 140,055 146,890 170,797
International
Emerging Markets 69,527 46,999 35,287
International
SmallCap 225,589 215,541 273,587
LargeCap Blend 108,749 16,524
LargeCap Growth
Equity 34,989 27,779 21,117
LargeCap Stock Index 12,633 11,130 17,335
LargeCap Value 136,201 29,415
Limited Term Bond 0
MidCap 267,108 269,737 254,382
MidCap Growth 122,357 97,151 101,104
MidCap Value 176,123 93,492 43,260
SmallCap 98,871 86,311 77,298
SmallCap Growth 234,954 216,791 284,304
SmallCap Value 342,873 243,766 140,900
For the periods ended December 31, the Manager waived a portion of its fee from
the following:
[Download Table]
ACCOUNT 2003 2002 2001
------- ---- ---- ----
International Emerging Markets $12,743 $59,127 $55,689
LargeCap Blend 1,966
LargeCap Growth Equity 404
LargeCap Stock Index 3,662
The Manager intends to continue the waivers and, if necessary, pay expenses
normally payable by the Accounts through April 30, 2004 in an amount that will
maintain total operating expenses as follows:
[Download Table]
ACCOUNT
-------
International Emerging
Markets 2.00%
LargeCap Blend 1.00
LargeCap Stock Index 0.40
LargeCap Value 1.00
The expense limits in place through the period ended April 30, 2003 maintained
operating expenses (expressed as a percentage of average net assets attributable
to an Account on an annualized basis) which did not exceed the following
percentages:
[Download Table]
ACCOUNT
-------
International Emerging
Markets 1.75%
LargeCap Blend 1.00
LargeCap Stock Index 0.40
LargeCap Value 1.00
The Management Agreement and the Investment Service Agreement, under which
Principal Life (or its subsidiaries), has agreed to furnish certain personnel,
services and facilities required by the Manager to enable it to fulfill its
responsibilities for the Accounts, were last approved by the Fund's Board of
Directors on September 8, 2003. The Management Agreement was last approved by
shareholders on November 2, 1999. The Sub-Advisory Agreement for the Limited
Term Bond Account was approved by the Fund's Board of Directors on March 10,
2003. The Sub-Advisory Agreements for the other Accounts were approved by the
Fund's Board of Directors on September 8, 2003.
The agreements provide for continuation in effect from year to year only so long
as such continuation is specifically approved at least annually either by the
Board of Directors or by vote of a majority of the outstanding voting securities
of an Account of the Fund. In either event, continuation shall be approved by
vote of a majority of the independent Directors.
The objective of the annual review of each of these contracts by the Board of
Directors is to determine whether, in light of all pertinent factors, the
Directors, and specifically the Directors who are not "interested persons", are
satisfied in the aggregate with the services provided by the Manager and each
Sub-Advisor or other party, and whether the Directors believe it is in the best
interests of the Fund's shareholders to continue receiving such services. The
Directors concluded that the fees paid by each Account to the Manager and each
Sub-Advisor or other party, reflected a reasonable relationship to the services
rendered and would have been the product of arm's length bargaining. The
Directors also concluded that it was in the best interests of each Account's
shareholders to continue to receive such services. The Directors reached this
conclusion based upon a review of all pertinent factors including, but not
limited to, each Account's management fees and operating expenses relative to a
peer group consisting of unaffiliated mutual funds; a review of all
non-investment services such as transfer agency services and shareholder
administrative services provided by to the Fund by the Manager without charge,
corporate accounting and general administration
services provided without charge by the Manager and regulatory services
(including initial and all subsequent regulatory filings with the SEC, and the
preparation and printing of prospectuses), also provided without charge to the
Fund by the Manager; review of the investment advisory services provided by the
Manager and Sub-Advisor to each Account; investment performance and the quality
of services provided; the financial and managerial strength of the Manager and
Sub-Advisor, including their affiliation with substantial financial services
companies; the Manager's sub-advisor selection and monitoring process; and the
soft dollar arrangements by which brokers provide research to the Manager and
Sub-Advisors for some of the Accounts in return for brokerage allocation. Based
upon their review, the Directors determined that each Account was paying a
competitive fee for the services provided by the Manager and Sub-Advisors and
that the Manager and Sub-Advisors were doing an appropriate job of fulfilling
their contractual obligations for each Account.
The Agreements may be terminated at any time on 60 days written notice to the
applicable Sub-Advisor either by vote of the Board of Directors of the Fund or
by a vote of a majority of the outstanding securities of the applicable Account
and by the Manager, the respective Sub-Advisor, or Principal Life, as the case
may be, on 60 days written notice to the Fund and/or applicable Sub-Advisor. The
Agreements will automatically terminate in the event of their assignment.
Custodian
---------
The custodian for the International, International Emerging Markets and
International SmallCap Accounts is J.P.Morgan Chase Bank., 4 Chase Metro Tech
Center, 18th Floor, Brooklyn, NY 11245. The custodian for the other Accounts is
Bank of New York, 100 Church Street, 10th Floor, New York, NY 10286. The
custodians perform no managerial or policymaking functions for the Fund or the
Accounts.
BROKERAGE ALLOCATION AND OTHER PRACTICES
BROKERAGE ON PURCHASES AND SALES OF SECURITIES
In distributing brokerage business arising out of the placement of orders for
the purchase and sale of securities for any Account, the objective of the
Account's Manager or Sub-Advisor is to obtain the best overall terms. In
pursuing this objective, the Manager or Sub-Advisor considers all matters it
deems relevant, including the breadth of the market in the security, the price
of the security, the financial condition and executing capability of the broker
or dealer, confidentiality, including trade anonymity, and the reasonableness of
the commission, if any (for the specific transaction and on a continuing basis).
This may mean in some instances that the Manager or Sub-Advisor will pay a
broker commissions that are in excess of the amount of commissions another
broker might have charged for executing the same transaction when the Manager or
Sub-Advisor believes that such commissions are reasonable in light of a) the
size and difficulty of the transaction b) the quality of the execution provided
and c) the level of commissions paid relative to commissions paid by other
institutional investors. (Such factors are viewed both in terms of that
particular transaction and in terms of all transactions that broker executes for
accounts over which the Manager
or Sub-Advisor exercises investment discretion. The Manager or Sub-Advisor may
purchase securities in the over-the-counter market, utilizing the services of
principal market makers unless better terms can be obtained by purchases through
brokers or dealers, and may purchase securities listed on the NYSE from
non-Exchange members in transactions off the Exchange.)
The Manager or Sub-Advisor may give consideration in the allocation of business
to services performed by a broker (e.g., the furnishing of statistical data and
research generally consisting of, but not limited to, information of the
following types: analyses and reports concerning issuers, industries, economic
factors and trends, portfolio strategy and performance of client accounts). If
any such allocation is made, the primary criteria used will be to obtain the
best overall terms for such transactions. The Manager or Sub-Advisor may also
pay additional commission amounts for research services. Such statistical data
and research information received from brokers or dealers as described above may
be useful in varying degrees and the Manager or Sub-Advisor may use it in
servicing some or all of the accounts it manages. However, in the opinion of the
Manager or Sub-Advisor, the value thereof is not determinable and it is not
expected that the expenses will be significantly reduced since the receipt of
such statistical data and research information is only supplementary to the
research efforts of Manager or Sub-Advisor. The Manager or Sub-Advisor allocated
portfolio transactions for the Accounts indicated in the following table to
certain brokers during the most recent fiscal year due to research services
provided by such brokers. The table also indicates the commissions paid to such
brokers as a result of these portfolio transactions.
[Download Table]
ACCOUNT COMMISSIONS PAID
------- ----------------
Asset Allocation 4,269
Balanced 73,584
Capital Value 404,297
Equity Growth 2,283
Growth 63,931
International 94,815
International Emerging Markets 12,569
International SmallCap 16,518
LargeCap Blend 11,991
LargeCap Growth Equity 3,755
LargeCap Value 54
MidCap 106,291
MidCap Growth 875
MidCap Value 694
Real Estate Securities 19,449
SmallCap 48,040
SmallCap Growth 6,937
Subject to the rules promulgated by the SEC, as well as other regulatory
requirements, the Board has approved procedures whereby an Account may purchase
securities that are offered in underwritings in which an affiliate of a
Sub-Advisor, or the Manager, participates. These procedures prohibit an Account
from directly or indirectly benefiting a Sub-Advisor affiliate or a Manager
affiliate in connection with such underwritings. In addition, for underwritings
where a Sub-Advisor affiliate or a Manager participates as a principal
underwriter, certain restrictions may apply that could, among other things,
limit the amount of securities that the Account could purchase in the
underwritings. The Manager
or Sub-Advisor shall determine the amounts and proportions of orders allocated
to the Sub-Advisor or affiliate. The Directors of the Fund will receive
quarterly reports on these transactions.
The Board has approved procedures that permit a Fund to effect a purchase or
sale transaction between the Account and any other affiliated mutual fund or
between the Account and affiliated persons of the Account under limited
circumstances prescribed by SEC rules. Any such transaction must be effected
without any payment other than a cash payment for the securities, for which a
market quotation is readily available, at the current market price; no brokerage
commission or, fee (except for customary transfer fees), or other remuneration
may be paid in connection with the transaction. The Board receives quarterly
reports of all such transactions.
Purchases and sales of debt securities and money market instruments usually are
principal transactions; portfolio securities are normally purchased directly
from the issuer or from an underwriter or marketmakers for the securities. Such
transactions are usually conducted on a net basis with the Account paying no
brokerage commissions. Purchases from underwriters include a commission or
concession paid by the issuer to the underwriter, and the purchases from dealers
serving as marketmakers include the spread between the bid and asked prices.
The Board has approved procedures whereby an Account may participate in a
commission recapture program. Commission recapture is a form of institutional
discount brokerage that returns commission dollars directly to a Account. It
provides a way to gain control over the commission expenses incurred by an
Account's Manager and/or Sub-Advisor, which can be significant over time and
thereby reduces expenses, improves cash flow and conserves assets. An Account
can derive commission recapture dollars from both equity trading commissions and
fixed-income (commission equivalent) spreads. The Accountsparticipate in a
program through a relationship with Frank Russell Securities, Inc.om time to
time, the Board reviews whether participation in the recapture program is in the
best interest of the Accounts.
The following table shows the brokerage commissions paid during the periods
indicated. In each year, 100% of the commissions paid by each Account went to
broker-dealers that provided research, statistical or other factual information.
[Download Table]
TOTAL BROKERAGE COMMISSIONS PAID
FOR PERIODS ENDED DECEMBER 31
-----------------------------
ACCOUNT 2003 2002 2001
------- ---- ---- ----
Asset Allocation 137,183 $ 126,621 $ 67,015
Balanced 303,483 271,415 161,473
Capital Value 1,004,105 1,127,656 594,729
Equity Growth 901,138 1,118,481 561,704
Equity Income 16,250 63,049 85,357
Growth 148,663 178,189 162,561
International 702,806 509,661 577,040
International Emerging Markets 139,853 117,597 55,126
International SmallCap 311,164 167,477 313,988
LargeCap Blend 61,404 15,394/(//1//)/
LargeCap Growth Equity 25,798 21,960 6,052
LargeCap Stock Index 17,972 21,117 17,935
LargeCap Value 62,968 24,658/(//1//)/
MidCap 405,297 563,439 433,078
MidCap Growth 69,231 31,721 19,563
MidCap Value 87,313 61,374 48,210
Real Estate Securities 141,989 106,929 77,976
SmallCap 331,111 326,624 112,509
SmallCap Growth 68,630 504,866 101,435
SmallCap Value 131,174 128,916 95,099
/(//1//) /Period from May 1, 2002 (date operations commenced) through December
31, 2002.
.. Certain broker-dealers are considered to be affiliates of the Fund.
Archipelago, LLC and Spear, Leeds & Kellogg are affiliates of Goldman Sachs &
Co. Goldman Sachs Asset Management is a sub-advisor for the Principal Partners
Blue Chip Fund, Inc. and two funds of the Principal Investors Fund, Inc.
.. JP Morgan Chase is an affliated broker of American Century which serves as
sub-advisor to the Equity Value Account of Principal Variable Contracts Fund
and one fund in the Principal Investors Fund.
.. Chase Securities, J.P. Morgan/Chase, Fleming Martin Ltd., and Robert Fleming
Inc. are affiliates of J.P.Morgan Securities J.P.Morgan Investment Management
Inc. is a sub-advisor for the SmallCap Value Account and a fund of Principal
Investors Fund, Inc.
.. Neuberger Berman Management Inc. and Lehman Brothers are affiliates of
Neuberger Berman LLC. Neuberger Berman Management Inc. is a sub-advisor for
the MidCap Value Account and a fund of the Principal Investors Fund, Inc.
.. Morgan Stanley DW, Inc. is affiliated with Morgan Stanley Asset Management,
which acts as sub-advisor to the Asset Allocation Account, the Equity Growth
Account, a fund in the Principal Investors Fund, Inc. and the Principal
Partners Equity Growth Fund, Inc.
.. Advest, Inc. and Sanford C. Bernstein & Co., LLC are affiliates of Alliance
Capital Management L.P., which through its Bernstein Investment Research &
Management Unit sub-advises the LargeCap Value Account, a fund in the
Principal Investors Fund, Inc. and the Principal Partners LargeCap Value Fund,
Inc. Alliance Capital Management LP sub-advises a fund in the Principal
Investors Fund, Inc.
.. Spectrum Asset Management, Inc. is an affiliate of the Principal Global
Investors which serves as sub-advisor for several of the Principal Mutual
Funds.
.. UBS PaineWebber and UBS Warburg are affliates of UBS Global AM which serves as
sub-advisor to the SmallCap Growth Account of Principal Variable Contracts
Fund, one fund in the Principal Investors Fund and the Partners SmallCap
Growth Fund.
Brokerage commissions paid to affiliates during the periods ending December 31
were as follows:
[Download Table]
COMMISSIONS PAID TO ARCHIPELAGO LLC
-----------------------------------
TOTAL DOLLAR AS PERCENT OF PERCENT OF DOLLAR AMOUNT OF
AMOUNT TOTAL COMMISSIONS COMMISSIONABLE TRANSACTION S
ACCOUNT ------ ----------------- ----------------------------
-------
SmallCap Growth
2002 4,762 0.94 1.88
SmallCap Value
2003 124 0.09 0.17
[Download Table]
COMMISSIONS PAID TO CHASE SECURITIES
------------------------------------
TOTAL DOLLAR AS PERCENT OF PERCENT OF DOLLAR AMOUNT OF
AMOUNT TOTAL COMMISSIONS COMMISSIONABLE TRANSACTION S
ACCOUNT ------ ----------------- ----------------------------
-------
Asset Allocation
2002 15 0.01 0.02
Equity Growth
2002 215 0.02 0.03
[Download Table]
COMMISSIONS PAID TO FLEMING MARTIN, INC.
----------------------------------------
TOTAL DOLLAR AS PERCENT OF PERCENT OF DOLLAR AMOUNT OF
AMOUNT TOTAL COMMISSIONS COMMISSIONABLE TRANSACTION S
ACCOUNT ------ ----------------- ----------------------------
-------
MidCap Value
2003 240 0.27 0.08
2002 798 1.30 1.22
[Download Table]
COMMISSIONS PAID TO ADVEST, INC.
--------------------------------
TOTAL DOLLAR AS PERCENT OF PERCENT OF DOLLAR AMOUNT OF
AMOUNT TOTAL COMMISSIONS COMMISSIONABLE TRANSACTION S
ACCOUNT ------ ----------------- ----------------------------
-------
Asset Allocation
2003 25 0.02 0.01
Equity Growth
2003 505 0.06 0.05
[Download Table]
COMMISSIONS PAID TO JP MORGAN/CHASE
-----------------------------------
TOTAL DOLLAR AS PERCENT OF PERCENT OF DOLLAR AMOUNT OF
AMOUNT TOTAL COMMISSIONS COMMISSIONABLE TRANSACTION S
ACCOUNT ------ ----------------- ----------------------------
-------
Equity Growth
2002 426 0.04 0.06
LargeCap Blend
2002 6 0.04 0.02
[Enlarge/Download Table]
COMMISSIONS PAID TO GOLDMAN SACHS & CO.
---------------------------------------
TOTAL DOLLAR AS PERCENT OF PERCENT OF DOLLAR AMOUNT OF
AMOUNT TOTAL COMMISSIONS COMMISSIONABLE TRANSACTION S
ACCOUNT ------ ----------------- ----------------------------
-------
Asset Allocation
2003 5,626 4.10 4.98
2002 9,421 7.44 14.84
2001 4,413 6.58 5.88
2000 4,056 8.09 8.34
Balanced
2003 11,377 3.75 2.73
2002 13,471 4.96 4.25
2000 8,058 5.40 3.05
Capital Value
2003 42,501 4.23 2.68
2002 77,273 6.85 6.25
2001 10,070 1.69 1.47
2000 68,717 6.97 7.28
Equity Growth
2003 41,345 4.59 4.23
2002 94,111 8.41 7.54
2001 39,992 7.12 7.31
2000 62,592 14.55 12.86
Equity Income
2002 2,940 4.66 2.32
2001 2,710 3.17 2.53
2000 7,679 9.45 6.97
Growth
2003 7,310 4.92 4.77
2002 3,935 2.21 2.60
2001 420 0.26 0.23
2000 17,004 5.17 6.55
International
2003 37,111 5.28 4.89
2002 37,725 7.40 7.14
2001 43,192 7.49 7.32
2000 69,826 7.12 6.99
International
Emerging Markets
2003 364 0.26 0.27
2002 1,461 1.24 1.95
2001 2,247 4.08 4.11
2000 255 2.36 2.16
International
SmallCap
2003 12,270 3.94 3.69
2002 5,054 3.02 3.10
2001 2,633 0.84 0.91
2000 13,042 1.54 1.83
LargeCap Blend
2003 1,889 3.08 1.61
2002 537 3.49 1.38
LargeCap Growth
Equity
2003 532 2.06 1.42
2002 569 2.59 2.17
2001 323 5.33 4.18
LargeCap Stock Index
2001 23 0.12 0.04
LargeCap Value
2003 1,789 2.84 3.08
2002 44 0.18 0.03
MidCap
2003 13,810 3.41 3.42
2002 55,229 9.80 7.41
2001 13,793 3.18 3.27
2000 51,068 10.53 7.06
MidCap Growth
2003 4,884 7.05 12.47
2002 130 0.41 0.15
2000 1,305 2.63 1.81
MidCap Value
2003 227 0.25 0.32
2002 1,044 1.70 1.54
2001 445 0.92 0.84
2000 875 2.19 2.08
Real Estate
Securities
2003 2,904 2.04 1.61
2002 1,884 1.76 1.81
2001 1,958 2.51 1.08
SmallCap
2003 19,199 5.80 5.51
2002 11,733 3.59 2.76
2001 2,696 2.40 2.93
2000 5,579 3.43 4.16
SmallCap Growth
2003 250 0.36 0.31
2002 18,655 3.69 3.51
2001 1,567 1.55 1.40
SmallCap Value
2003 6,607 5.04 5.71
2002 4,085 3.17 2.45
2001 3,142 3.30 4.02
2000 296 0.89 0.66
[Download Table]
COMMISSIONS PAID TO J. P. MORGAN SECURITIES
-------------------------------------------
TOTAL DOLLAR AS PERCENT OF PERCENT OF DOLLAR AMOUNT OF
AMOUNT TOTAL COMMISSIONS COMMISSIONABLE TRANSACTION S
ACCOUNT ------ ----------------- ----------------------------
-------
Asset Allocation
2003 2,405 1.75 1.26
2002 2,806 2.22 1.74
2001 2,025 3.02 2.63
2000 1,787 3.57 3.43
Balanced
2003 3,971 1.31 0.85
2002 10,022 3.69 3.11
2000 2,762 1.85 2.22
Capital Value
2003 6,904 0.69 0.70
2002 56,035 4.97 3.86
2001 9,891 1.66 1.79
2000 59,147 6.00 6.78
Equity Growth
2003 28,396 3.15 3.40
2002 34,433 3.08 2.80
2001 25,450 4.53 3.79
2000 32,160 7.48 5.72
Equity Income
2002 592 0.94 0.71
2001 2,998 3.51 3.75
2000 1,805 2.22 3.09
Growth
2003 2,240 1.51 0.71
2002 2,812 1.58 1.68
2001 1,830 1.13 1.18
2000 5,705 1.74 2.29
International
2003 28,759 4.09 3.53
2002 19,178 3.76 2.70
2001 21,541 3.73 3.10
2000 29,882 3.05 3.29
International
Emerging Markets
2003 19,086 13.65 9.40
2002 12,291 10.45 7.83
2001 5,615 10.19 9.03
2000 194 1.80 1.37
International
SmallCap
2003 3,107 1.00 0.96
2002 2,591 1.55 0.95
2001 3,103 0.99 0.69
2000 1,183 0.14 0.15
LargeCap Blend
2003 1,190 1.94 0.91
2002 122 0.79 0.50
LargeCap Growth
Equity
2003 256 0.99 0.68
2002 704 3.21 2.24
2001 130 2.15 1.48
LargeCap Value
2003 132 0.21 0.03
MidCap
2003 8,446 2.08 1.58
2002 29,229 5.19 4.57
2001 15,031 3.47 3.50
2000 23,780 4.90 3.65
MidCap Growth
2001 2,694 13.77 10.34
MidCap Value
2003 1,341 1.54 1.43
2002 1,172 1.91 1.76
2001 600 1.24 1.36
2000 1,040 2.61 3.21
Real Estate
Securities
2003 5,210 3.67 3.05
2002 4,110 3.84 1.67
2001 4,455 5.71 4.81
2000 492 1.67 1.09
SmallCap
2003 2,695 0.81 1.00
2002 9,123 2.79 1.75
2001 1,920 1.71 1.90
2000 1,530 0.94 0.90
SmallCap Growth
2003 635 0.93 0.69
2002 23,927 4.74 3.29
2001 2,209 2.18 2.70
[Enlarge/Download Table]
COMMISSIONS PAID TO MORGAN STANLEY DW INC.
------------------------------------------
TOTAL DOLLAR AS PERCENT OF PERCENT OF DOLLAR AMOUNT OF
AMOUNT TOTAL COMMISSIONS COMMISSIONABLE TRANSACTION S
ACCOUNT ------ ----------------- ----------------------------
-------
Asset Allocation
2002 1,744 1.38 1.58
2001 1,249 1.86 1.96
Balanced
2002 67,135 24.74 27.66
2000 5,711 3.83 4.00
Capital Value
2002 66,971 5.94 6.07
2001 8,984 1.51 1.75
2000 25,913 2.63 3.05
Equity Growth
2002 13,624 1.22 1.46
2001 6,558 1.17 1.49
2000 2,930 0.68 0.88
Equity Income
2002 2,075 3.29 1.89
2001 2,055 2.41 2.61
2000 5,163 6.36 5.15
Growth
2002 9,443 5.30 5.73
2001 1,160 0.71 1.52
2000 4,750 1.45 1.58
International
2002 51,533 10.11 9.80
2001 1,533 0.27 0.42
2000 78,873 8.04 9.47
International
Emerging Markets
2002 16,016 13.62 15.58
2001 185 0.34 0.39
International
SmallCap
2002 5,236 3.13 3.23
2000 17,765 2.09 2.82
LargeCap Blend
2002 400 2.60 2.23
LargeCap Growth
Equity
2002 963 4.38 3.99
2001 175 2.89 2.31
2000 95 3.73 1.85
LargeCap Stock Index
2002 165 0.78 8.81
2001 156 0.83 0.31
LargeCap Value
2002 175 0.71 0.14
MidCap
2002 18,265 3.24 5.97
2001 16,829 3.89 5.07
2000 21,343 4.40 4.48
MidCap Growth
2002 5,209 16.42 14.70
2001 5,198 26.57 36.18
2000 2,897 5.84 5.91
MidCap Value
2001 20 0.04 0.09
2000 535 1.34 1.36
Real Estate
Securities
2002 7,655 7.16 4.42
2001 3,885 4.98 5.60
2000 1,855 6.31 6.12
SmallCap
2002 74,769 22.89 29.18
2001 2,681 2.38 2.22
2000 3,070 1.89 2.26
SmallCap Growth
2002 16,112 3.19 2.86
2001 2,982 2.94 3.06
2000 1,347 3.17 1.70
SmallCap Value
2002 3,704 2.87 2.88
2001 1,574 1.65 1.48
2000 13,929 41.80 45.06
[Download Table]
COMMISSIONS PAID TO NEUBERGER BERMAN
------------------------------------
TOTAL DOLLAR AS PERCENT OF PERCENT OF DOLLAR AMOUNT OF
AMOUNT TOTAL COMMISSIONS COMMISSIONABLE TRANSACTION S
ACCOUNT ------ ----------------- ----------------------------
-------
Asset Allocation
2003 515 0.38 0.29
2002 256 0.20 0.28
2001 200 0.30 0.39
2000 155 0.31 0.35
Equity Growth
2003 1,440 0.16 0.17
2002 4,353 0.39 0.57
2001 2,290 0.41 0.63
2000 2,640 0.61 0.52
MidCap Value
2003 43,708 50.06 47.69
2002 25,893 42.19 40.97
2001 31,258 64.84 65.29
2000 15,061 37.77 41.03
[Download Table]
COMMISSIONS PAID TO PUTNAM
--------------------------
TOTAL DOLLAR AS PERCENT OF PERCENT OF DOLLAR AMOUNT OF
AMOUNT TOTAL COMMISSIONS COMMISSIONABLE TRANSACTION S
ACCOUNT ------ ----------------- ----------------------------
-------
Asset Allocation
2003 185 0.13 0.13
SmallCap Growth
2002 411 0.08 0.09
SmallCap Value
2002 84 0.07 0.19
[Enlarge/Download Table]
COMMISSIONS PAID TO SANFORD C. BERNSTEIN
----------------------------------------
TOTAL DOLLAR AS PERCENT OF PERCENT OF DOLLAR AMOUNT OF
AMOUNT TOTAL COMMISSIONS COMMISSIONABLE TRANSACTION S
ACCOUNT ------ ----------------- ----------------------------
-------
Asset Allocation
2003 3,646 2.66 1.93
2002 3,277 2.59 2.37
Balanced
2003 8,693 2.86 3.32
2002 8,390 3.09 2.17
Capital Value
2003 20,011 1.99 2.59
2002 65,876 5.84 4.11
Equity Growth
2003 15,950 1.77 1.80
2002 24,144 2.16 2.28
Equity Income
2003 935 0.66 0.56
2002 315 0.29 0.37
Growth
2003 5,288 3.56 2.48
2002 1,550 0.87 1.14
International
2002 4,640 0.91 0.99
International
Emerging Markets
2002 10 0.01 0.02
LargeCap Blend
2002 10 0.06 0.04
LargeCap Growth
Equity
2003 123 0..48 0.42
2002 43 0.20 0.11
LargeCap Stock Index
2003 35 0.20 0.26
LargeCap Value
2003 38,590 61.28 67.61
2002 17,442 70.74 72.42
MidCap
2003 11,216 2.77 3.55
2002 21,537 3.82 4.71
MidCap Value
2003 1,805 2.07 1.73
2002 1,960 3.19 3.08
SmallCap
2003 19,669 5.94 9.69
2002 6,798 2.08 1.79
SmallCap Growth
2003 785 1.14 0.82
2002 2,893 0.57 0.55
SmallCap Value
2003 4,666 3.56 3.36
2002 488 0.38 0.45
[Download Table]
COMMISSIONS PAID TO SPEAR, LEEDS & KELLOGG
------------------------------------------
TOTAL DOLLAR AS PERCENT OF PERCENT OF DOLLAR AMOUNT OF
AMOUNT TOTAL COMMISSIONS COMMISSIONABLE TRANSACTION S
ACCOUNT ------ ----------------- ----------------------------
-------
MidCap Growth
2002 6 0.02 0.15
SmallCap Value
2002 2,015 1.56 1.00
[Download Table]
COMMISSIONS PAID TO SPECTRUM ASSET MANAGEMENT
---------------------------------------------
TOTAL DOLLAR AS PERCENT OF PERCENT OF DOLLAR AMOUNT OF
AMOUNT TOTAL COMMISSIONS COMMISSIONABLE TRANSACTION S
ACCOUNT ------ ----------------- ----------------------------
-------
Equity Income
2003 16,250 100.00 100.00
2002 43,247 68.59 75.79
[Download Table]
COMMISSIONS PAID TO UBS PAINEWEBBER INC.
----------------------------------------
TOTAL DOLLAR AS PERCENT OF PERCENT OF DOLLAR AMOUNT OF
AMOUNT TOTAL COMMISSIONS COMMISSIONABLE TRANSACTION S
ACCOUNT ------ ----------------- ----------------------------
-------
LargeCap Growth
Equity
2003 125 0.48 0.26
2002 635 2.89 6.67
SmallCap Growth
2003 936 1.36 1.33
2002 47 0.01 0.01
SmallCap Value
2003 297 0.23 0.19
2002 183 0.14 0.18
[Enlarge/Download Table]
COMMISSIONS PAID TO UBS WARBURG LLC
-----------------------------------
TOTAL DOLLAR AS PERCENT OF PERCENT OF DOLLAR AMOUNT OF
AMOUNT TOTAL COMMISSIONS COMMISSIONABLE TRANSACTION S
ACCOUNT ------ ----------------- ----------------------------
-------
Asset Allocation
2003 46,382 33.81 39.17
2002 10,563 8.34 12.07
Balanced
2003 33,899 11.17 15.37
2002 7,553 2.78 2.54
Capital Value
2003 87,090 8.67 10.86
2002 39,112 3.47 2.73
Equity Growth
2003 57,221 6.35 6.01
2002 69,081 6.18 4.72
Growth
2003 5,564 3.74 3.50
2002 5,068 2.84 1.43
International
2003 86,477 12.30 13.09
2002 50,324 9.87 10.37
International
Emerging Markets
2003 14,588 10.43 12.65
2002 12,090 10.28 10.16
International
SmallCap
2003 38,541 12.39 12.46
2002 27,356 16.33 16.66
LargeCap Blend
2003 805 1.31 1.08
LargeCap Growth
Equity
2003 258 1.00 1.43
LargeCap Stock Index
2003 101 0.56 0.73
MidCap
2003 30,964 7.64 9.11
2002 15,656 2.78 2.41
MidCap Value
2003 1,782 2.04 2.38
2002 820 1.34 1.90
Real Estate
Securities
2003 5,801 4.09 3.36
2002 2,521 2.36 1.74
SmallCap
2002 6,559 2.01 2.00
SmallCap Growth
2002 12,990 2.57 2.03
SmallCap Value
2002 5,276 4.09 1.96
[Enlarge/Download Table]
COMMISSIONS PAID TO LEHMAN BROTHERS
-----------------------------------
TOTAL DOLLAR AS PERCENT OF PERCENT OF DOLLAR AMOUNT OF
AMOUNT TOTAL COMMISSIONS COMMISSIONABLE TRANSACTION S
ACCOUNT ------ ----------------- ----------------------------
-------
Asset Allocation
2003 15,593 11.37 10.85
Balanced
2003 15,580 5.13 4.85
Capital Value
2003 70,924 7.06 8.09
Equity Growth
2003 45,924 5.10 5.00
Growth
2003 21,698 14.60 13.90
International
2003 31,035 4.42 4.56
International
Emerging Markets
2003 406 0.29 0.38
International
SmallCap
2003 7,078 2.27 2.52
LargeCap Blend
2003 12,113 19.73 40.33
LargeCap Growth
Equity
2003 334 1.29 1.10
LargeCap Stock Index
2003 12,646 70.37 62.21
LargeCap Value
2003 785 1.25 0.98
MidCap
2003 31,625 7.80 5.94
MidCap Growth
2003 420 0.61 0.23
MidCap Value
2003 1,741 1.99 2.65
Real Estate
Securities
2003 19,839 13.97 10.73
SmallCap
2003 18,379 5.55 3.72
SmallCap Growth
2003 1,345 1.96 1.57
SmallCap Value
2003 2,586 1.97 1.79
ORDER ALLOCATION
The Manager acts as investment advisor for each of the funds sponsored by
Principal Life. The Manager or Sub-
Advisor places orders to trade portfolio securities for each of the Accounts.
The following describes the process used by the Manager or Sub-Advisor in
allocating securities among its clients and/or accounts it manages.
Asset Allocation
----------------
Transactions for each portfolio account advised by MSAM generally are completed
independently. MSAM, however, may purchase or sell the same securities or
instruments for a number of portfolio accounts, including portfolios of its
affiliates, simultaneously. These accounts will include pooled vehicles,
including partnerships and investment companies for which MSAM and related
persons of MSAM act as investment manager and administrator, and in which MSAM,
its officers, employees and its related persons have a financial interest, and
accounts of pension plans covering employees of MSAM and its affiliates
("Proprietary Accounts"). When possible, orders for the same security are
combined or "batched" to facilitate best execution and to reduce brokerage
commissions or other costs. MSAM effects batched transactions in a manner
designed to ensure that no participating portfolio, including any Proprietary
Account, is favored over any other portfolio. Specifically, each portfolio
(including the Equity Growth Account) that participates in a batched transaction
will participate at the average share price for all of MSAM's transactions in
that security on that business day, with respect to that batched order.
Securities purchased or sold in a batched transaction are allocated pro-rata,
when possible, to the participating portfolio accounts in proportion to the size
of the order placed for each account. MSAM may, however, increase or decrease
the amount of securities allocated to each account if necessary to avoid holding
odd-lot or small numbers of shares for particular portfolios. Additionally, if
MSAM is unable to fully execute a batched transaction and MSAM determines that
it would be impractical to allocate a small number of securities among the
accounts participating in the transaction on a pro-rata basis, MSAM may allocate
such securities in a manner determined in good faith to be a fair allocation.
Balanced, Capital Value, Equity Income, Growth, International, International
----------------------------------------------------------------------------
Emerging Markets, International SmallCap, LargeCap Stock Index, MidCap, Real
----------------------------------------------------------------------------
Estate Securities and SmallCap
------------------------------
If, in carrying out the investment objectives of the Accounts, occasions arise
when purchases or sales of the same equity securities are to be made for two or
more of the Accounts at the same time (or, in the case of accounts managed by a
Sub-Advisor, for two or more Accounts and any other accounts managed by the
Sub-Advisor), the Manager or Sub-Advisor may submit the orders to purchase or,
whenever possible, to sell, to a broker/dealer for execution on an aggregate or
"bunched" basis (including orders for accounts in which Registrant, its
affiliates and/or its personnel have beneficial interests). The Manager (or, in
the case of accounts managed by a Sub-Advisor, the Sub-Advisor) may create
several aggregate or "bunched" orders relating to a single security at different
times during the same day. On such occasions, the Manager (or, in the case of
accounts managed by a Sub-Advisor, the Sub-Advisor) shall compose, before
entering an aggregated order, a written Allocation Statement as to how the order
will be allocated among the various accounts. Securities purchased or proceeds
of sales received on each trading day with respect to each such aggregate or
"bunched" order shall be allocated to the various Accounts (or, in the case of a
Sub-Advisor, the various Accounts and other client accounts) whose individual
orders for purchase or sale make up the aggregate or "bunched" order by filling
each Account's (or, in the case of a Sub-Advisor, each Account's or other client
account's) order in accordance with the Allocation Statement. If the order is
partially filled, it shall be allocated pro-rata based on the Allocation
Statement. Securities purchased for funds (or, in the case of a Sub-Advisor,
Accounts and other client accounts) participating in an aggregate or "bunched"
order will be placed into those Accounts and, where applicable, other client
accounts at a price equal to the average of the prices achieved in the course of
filling that aggregate or "bunched" order.
If purchases or sales of the same debt securities are to be made for two or more
of the Accounts at the same time, the securities will be purchased or sold
proportionately in accordance with the amount of such security sought to be
purchased or sold at that time for each Account.
The Manager or Sub-Advisor expects aggregation or "bunching" of orders, on
average, to reduce slightly the cost of execution. The Manager or Sub-Advisor
will not aggregate a client's order if, in a particular instance, it believes
that aggregation will increase the client's cost of execution. In some cases,
aggregation or "bunching" of orders may increase the price a client pays or
receives for a security or reduce the amount of securities purchased or sold for
a client account.
The Manager or Sub-Advisor may enter aggregated orders for shares issued in an
initial public offering (IPO). In determining whether to enter an order for an
IPO for any client account, the Manager or Sub-Advisor considers the account's
investment style, investment restrictions, risk profile, asset composition and
cash level. Accordingly, it is unlikely that every client account will
participate in every available IPO order. Partially filled orders for IPOs will
be allocated to participating accounts in accordance with the procedures set out
above. Often, however, the amount of shares designated by an underwriter for
clients of the Manager or Sub-Advisor are insufficient to provide a meaningful
allocation to each participating account. In such cases, the Manager or
Sub-Advisor will employ an allocation system it feels treats all participating
accounts fairly and equitably over time.
Equity Growth and LargeCap Blend - T. Rowe Price
-----------------------------------------------------
T. Rowe Price has developed written trade allocation guidelines for its Equity,
Municipal and Taxable Fixed Income Trading Desks. Generally, when the amount of
securities available in a public offering (such as IPOs) or the secondary
markets is insufficient to satisfy the volume or price requirements for the
participating client portfolios, the guidelines require a pro rata allocation
based upon the relative size of the participating client portfolios or the
relative size of the participating client's order depending upon the market
involved. In allocating trades made on a combined basis, the trading desk seeks
to achieve the same net unit price of the securities for each participating
client. Because a pro rata allocation may not always adequately accommodate all
facts and circumstances, the guidelines provide for exceptions to allocate
trades on an adjusted, pro rata basis. For example, adjustments may be made: (i)
to recognize the efforts of a portfolio manager in negotiating a transaction or
a private placement; (ii) to eliminate de minimis positions; (iii) to give
priority to accounts with specialized investment policies and objectives; and
(iv) to reallocate in light of a participating portfolio's characteristics
(e.g., available cash, industry or issuer concentration, duration, credit
exposure).
Equity Value
----------------
American Century Investments has a written policy for the aggregation of
portfolio transactions in order to minimize the risk that any portfolio could be
systematically advantaged or disadvantaged in connection with such aggregation
and to ensure that all clients are treated fairly in the aggregation and
allocation of portfolio transactions. IPO allocations are calculated on a pro
rata basis by client order size, set by the indication of the largest portfolio
by asset size. The policy contemplates that IPO allocations may be subject to
adjustment for round lot size, minimum order size, suitability or fundamental
restrictions. In any case, American Century's trading desk seeks to achieve the
same net price and an equitable allocation for all participating portfolios.
LargeCap Growth Equity
--------------------------
ALLOCATION - IPOS AND OTHER LIMITED OPPORTUNITY SECURITIES . Two important
characteristics:
.. Because of the particularly limited nature of such offerings, each investment
area / trading desk must be particularly diligent to ensure that these
opportunities are allocated equitably among accounts eligible to participate.
While account-specific trading is permitted for normal securities, it is
generally expected that a trading desk will give consideration to all of its
eligible accounts when it allocates an IPO or other limited opportunity.
.. If more than one GMO trading desk will participate in the opportunity, the
trade must be allocated and executed on a coordinated basis.
PRINCIPLES OF LIMITED OPPORTUNITY ALLOCATIONS . GMO recognizes that each of the
trading desks maintains its own relationships with brokers, dealers and other
market participants, and that firms that have contacts with more than one of
GMO's trading desks may view the groups as one or independently. GMO requires
that trading desks deal honestly with their trading partners, making clear when
statements or policies are specific to the desk or are meant to apply to GMO
generally.
GMO recognizes that its trading desks sometimes participate in IPOs and other
limited opportunities with different holding period strategies. GMO believes
that both short and long holding period strategies can be legitimately pursued.
GMO must promote a responsible and credible reputation in the investment
community by providing only accurate and non-misleading information. In
particular, if a trading desk provides information as to holding intention to
the underwriter of a stock, the desk should be careful to speak only for itself
if other areas of GMO may participate on a different basis.
ALLOCATION STANDARDS .
1) Each Investment Area is responsible for determining which of its accounts
are appropriate for participation in IPOs and other limited opportunities.
2) Trading Desks are responsible for discovery and process management of their
own IPOs and other limited opportunities. Only trading desks that have
independently identified and selected an IPO or other opportunity may
participate. Trading desks generally shall not participate in such
opportunities because of the research or recommendation of another investment
area of the firm.
3) Participation in the IPO or other opportunity must be consistent with the
guidelines and other compliance limitations applicable to the account, and the
strategy must otherwise be consistent with the account's investment objective
and strategy.
4) Each trading desk must determine an intended allocation among its own
eligible accounts.
5) Before submitting a subscription, a trading desk must determine if other
trading desks are independently interested in participating. A reasonable time
(considering the circumstances) should be allowed for other trading desks to
determine target subscription amounts for each of that desk's accounts that
will participate.
6) All accounts identified for participation shall be included in a
consolidated subscription across trading desks. The intended allocation shall
be pro-rata to each account's target.
7) Deviations from the consolidated subscription approach will be permitted
only after consultation with Compliance.
LargeCap Value
--------------
In carrying out the investment objectives of the Account, occasions arise when
purchases or sales of the same equity securities are to be made for the Account
and any other account managed by Bernstein. Bernstein's allocation and
executions policies are designed to assist it in providing clients with money
management on an individual basis. In circumstances where other units of
Alliance are placing orders for the same securities as Bernstein, order
executions are not coordinated. Prior to determining which accounts should
participate in a potential purchase or sale of blocks of securities during a
trading day, in addition to prevailing market conditions, Bernstein considers:
1) for purchases: a) whether the security is appropriate for all accounts or a
certain category of accounts; b) whether the security is appropriate for all
accounts, though in varying percentages for each account; or c) whether the
security is appropriate for a certain category of accounts, and 2) for sales: a)
whether the security should not be owned by any of its client accounts; b)
whether the security should be owned in lesser percentages for each account or a
certain category of accounts; or c) whether Bernstein intends to liquidate a
position for tax purposes for those clients requiring a gain or loss. Where
Bernstein determines to sell a security regardless of tax considerations, both
taxable and tax-exempt accounts are eligible for sale contemporaneously. In
those situations where tax gains influence the sale, securities in the
tax-exempt accounts will usually be placed for sale first, as additional time is
needed to consider the tax implications for each taxable account. Conversely,
when tax losses influence the sale, Bernstein may prioritize taxable clients
first as the loss has a specific impact in a given year. When orders are
generated, the decision as to which accounts should participate, and in what
amount, is based on the type of security, the present or desired structure of
the portfolio, the nature of the account's goals and tolerance for risk, the tax
status, and the permitted investment techniques. As a result, Bernstein may have
different price limits at which it would desire to purchase or sell a security
for different accounts. Bernstein's portfolio-information system, portfolio
reports and quality control reports permit it to consider and weigh these
factors as appropriate.
Upon execution of an order, the appropriate amounts and prices are recorded for
each account. Bernstein's Trading and Technical Group records the specific
accounts that may participate in a proposed execution of U.S. equity orders. The
pending orders on these accounts are then used as a basis for the allocations of
executed orders. U.S. equity orders for accounts for which Bernstein's
affiliated broker-dealer, Sanford C. Bernstein & Co., LLC ("SCB LLC") executes
transactions and accounts that utilize other brokers are executed on a
proportional basis. Among the accounts that direct brokerage to firms other than
SCB LLC, the priority of the orders is generally determined on a random basis.
This procedure may vary depending on factors such as purchase or sale
opportunities among brokers selected by the clients, the size of the order and
timing considerations.
Where SCB LLC executes transactions, at any particular time, all outstanding
equity orders for investment management accounts for the same security at the
same limit are treated equally. When such executions occur at different prices
during the day, participating clients get the average price of all eligible
executions in that security during the day. If all the orders for the same
security have the same limit, or if all the executions satisfy the most
restrictive limit, then all the executions are price-averaged for allocation to
the orders. Otherwise, the orders are grouped according to limit. For each
group, portions of each execution are chosen such that the average price of
executions chosen for each group meets its limit, does not exceed the quantity
ordered and comes closer to proportional allocation than any other distribution.
If the amount that SCB LLC has been able to execute in the desired price range
is not sufficient to fill all the orders, the total amount executed is allocated
to the accounts on a mechanical basis as described below.
Accounts are generally divided into two categories: 1) those with equity equal
to or greater than $5 million (including relationships with combined equity
equal or greater than $5 million), and 2) those with equity less than $5
million. Accounts or account relationships falling into the first category will
receive the appropriate partial allocation rounded to the nearest 100 shares if
the result of the partial allocation is 1,000 shares or more. In any account or
account relationship in this category where, as a result of the partial
allocation, the account or account relationship would receive less than1,000
shares, those accounts or account relationships are then chosen on a random
basis to receive, if selected, the lesser of 1,000 shares or the number of
shares remaining to be filled. Transactions for accounts or account
relationships with equity of less than $5 million will be allocated on an
all-or-nothing basis by random selection. This category of accounts and account
relationships will receive roughly the percentage of the execution to which it
is entitled as a whole (e.g. if this group represents 30% of the entire order,
then approximately 30% of the shares executed will be allocated to the group).
However, if there are shares remaining that would result in a partial allocation
to an account with equity of less than $5 million, these shares will be
allocated, if possible, to accounts with
equity greater than $5 million if there are partials that have not been
completed. To the extent that there are none, these shares will be allocated to
one account with equity of less than $5 million, resulting in a partial
allocation. While a defined relationship of accounts will generally be treated
as a single trading entity from the standpoint of allocation, account-specific
factors, such as differences in risk tolerance, tax considerations or permitted
investment techniques, may make treatment of the relationship as an entity
inappropriate.
For equity accounts, allocation may also be based on the following additional
factors: 1) whether or not a client has an existing partial position in that
particular security; 2) the tax status of the account, e.g. time constraints
involved in reviewing tax consequences or effecting tax strategies; 3) the
account's risk/reward goals; and 4) time constraints involved in reviewing
guidelines which may prohibit certain allocations.
IPOs generally do not fall within the investment objectives of Bernstein's
clients in its value services.
SmallCap Growth
---------------
UBS Global AM will attempt to equitably allocate portfolio transactions among
the Account and others whenever concurrent decisions are made to purchase or
sell securities by the Account and another. Allocations between the Account and
others are pro rated based on account size, relative to the outstanding order
book for a given stock as of 3:00 pm Central time each day. In some cases, this
procedure could have an adverse effect on the Account. In the opinion of the
Sub-Advisor, however, the results of such procedures will, on the whole, be in
the interest of each of its clients.
If the purchase or sale of securities consistent with the investment objectives
of the Accounts or one or more of the other clients for which Berger, Dreyfus,
J.P. Morgan Investment or Neuberger Berman acts as investment sub-advisor or
advisor is to be made at the same time, the securities are purchased or sold
proportionately in accordance with the amount of such security sought to be
purchased or sold at that time for each Account or client.
OFFERING PRICE
For all Accounts except the Money Market Account
------------------------------------------------
As stated in the Prospectuses, the NAVof the Accounts (except Money Market
Account) is determined once each day on which the NYSE is open, at the close of
its regular trading session (normally 4:00 p.m., New York time, Monday through
Friday). As stated in the Prospectus, the NAV of Account shares is not
determined on days the NYSE is closed (generally, New Year's Day, Martin Luther
King Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor
Day, Thanksgiving and Christmas).
The share pricefor each Account is determined by dividing the value of
securities in the Account's investment portfolioby the number of Account shares
outstanding. In determining NAV, securities listed on an Exchange, the NASDAQ
National Market and foreign markets are valued at the closing prices on such
markets, or if such price is lacking for the trading period immediately
preceding the time of determination, such securities are valued at their current
bid price. Municipal securities held by the Accounts are traded primarily in the
over-the-counter market. Valuations of such securities are furnished by one or
more pricing services employed by the Accounts and are based upon appraisals
obtained by a pricing service, in reliance upon information concerning market
transactions and quotations from recognized municipal securities dealers. Other
securities that are traded on the over-the-counter market are valued at their
closing bid prices. Foreign securities and currencies are converted to U.S.
dollars using the exchange rate in effect at the close of the London Exchange
(generally 11 a.m. Eastern Time). Each Account will determine the market value
of individual securities held by it, by using prices provided by one or more
professional pricing services which may provide market prices to other funds,
or, as needed, by obtaining market quotations from independent broker-dealers.
Short-term securities maturing within 60 days are valued on an amortized cost
basis. Securities for which quotations are not readily available, and other
assets, are valued at fair value determined in good faith under procedures
established by and under the supervision of the Directors.
Trading in securities on foreign securities exchanges and over-the-counter
markets is normally completed well before the close of business on each business
day in New York (i.e., a day on which the NYSE is open). In addition, foreign
securities trading generally or in a particular country or countries may not
take place on all business days in New York. Furthermore, trading may take place
in various foreign markets on days which are not business days in New York and
on which an Account's NAV is not calculated. An Account calculates its NAVper
share, and therefore effects sales,
redemptions and repurchases of its shares, as of the close of the NYSE once on
each day on which the NYSE is open. Such calculation may not take place
contemporaneously with the determination of the prices of the foreign portfolio
securities used in such calculation.
Certain securities issued by companies in emerging market countries may have
more than one quoted valuation at any point in time, sometimes referred to as a
"local" price and a "premium" price. The premium price is often a negotiated
price which may not consistently represent a price at which a specific
transaction can be effected. It is the policy of the Accounts to value such
securities at prices at which it is expected those shares may be sold, and the
Manager or any Sub-Advisor is authorized to make such determinations subject to
the oversight of the Board as may from time to time be necessary.
Money Market Account
--------------------
The share priceof shares of the Money Market Account is determined at the same
time and on the same days as the Accounts as described above. The share price is
computed by dividing the total value of the Account's securities and other
assets, less liabilities, by the number of Account shares outstanding.
All securities held by the Money Market Account are valued on an amortized cost
basis. Under this method of valuation, a security is initially valued at cost;
thereafter, the Account assumes a constant proportionate amortization in value
until maturity of any discount or premium, regardless of the impact of
fluctuating interest rates on the market value of the security. While this
method provides certainty in valuation, it may result in periods during which
value, as determined by amortized cost, is higher or lower than the price that
would be received upon sale of the security.
Use of the amortized cost valuation method by the Money Market Account requires
the Account to maintain a dollar weighted average maturity of 90 days or less
and to purchase only obligations that have remaining maturities of 397 days or
less or have a variable or floating rate of interest. In addition, the Account
invests only in obligations determined by the Directors to be of high quality
with minimal credit risks.
The Directors have established procedures for the Money Market Account designed
to stabilize, to the extent reasonably possible, the Account's price per share
as computed for the purpose of sales and redemptions at $1.00. Such procedures
include a directive to the Manager to test price the portfolio or specific
securities on a weekly basis using a mark-to-market method of valuation to
determine possible deviations in the net asset value from $1.00 per share. If
such deviation exceeds 1/2 of 1%, the Directors promptly consider what action,
if any, will be initiated. In the event the Directors determine that a deviation
exists which may result in material dilution or other unfair results to
shareholders, they take such corrective action as they regard as appropriate,
including: sale of portfolio instruments prior to maturity; the withholding of
dividends; redemptions of shares in kind; the establishment of a net asset value
per share based upon available market quotations; or splitting, combining or
otherwise recapitalizing outstanding shares. The Account may also reduce the
number of shares outstanding by redeeming proportionately from shareholders,
without the payment of any monetary compensation, such number of full and
fractional shares as is necessary to maintain the net asset value at $1.00 per
share.
CALCULATION OF PERFORMANCE DATA
FOR ALL ACCOUNTS EXCEPT THE MONEY MARKET ACCOUNT
An Account's performance will vary from time to time depending upon market
conditions, the composition of its portfolio, and its operating expenses.
Consequently, any given performance quotation should not be considered
representative of an Account's performance for any specified period in the
future. In addition, because performance will fluctuate, it may not provide a
basis for comparing an investment in an Account with certain bank deposits or
other investments that pay a fixed yield or return for a stated period of time.
In addition, the calculations of total return and
yield for the Accounts do not include any separate account expenses or contract
level expenses.
Comparative performance information may be used from time to time in advertising
the Accounts, including appropriate market indices including the benchmarks
shown in the prospectus for the Account or data from Lipper, Inc., Ibbotson
Associates, Morningstar Inc., the Dow Jones Industrial Average and other
industry publications.
From time to time, the Account may, in addition to any other permissible
information, include the following types of information in advertisements,
supplemental sales literature and reports to shareholders: 1) discussions of
general economic or financial principles (such as the effects of compounding and
the benefits of dollar-cost averaging); 2) discussions of general economic
trends; 3) presentations of statistical data to supplement such discussions; 4)
descriptions of past or anticipated portfolio holdings for one or more of the
Accounts; 5) descriptions of investment strategies for one or more of the
Accounts; 6) descriptions or comparisons of various savings and investment
products (including, but not limited to, qualified retirement plans and
individual stocks and bonds), which may or may not include the Accounts; 7)
comparisons of investment products (including the Accounts) with relevant
markets or industry indices or other appropriate benchmarks; 8) discussions of
fund rankings or ratings by recognized rating organizations; and 9) discussions
of various statistical methods quantifying the Account's volatility relative to
its benchmark or to past performance, including risk adjusted measures. The
Account may also include calculations, such as hypothetical compounding
examples, which describe hypothetical investment results in such communications.
Such performance examples will be based on an express set of assumptions and are
not indicative of the performance of any of the Accounts.
Money Market Account Yield
--------------------------
The Money Market Account may advertise its yield and its effective yield. Yield
is computed by determining the net change, exclusive of capital changes, in the
value of a hypothetical pre-existing account having a balance of one share at
the beginning of the period, subtracting a hypothetical charge reflecting
deductions from shareholder accounts, and dividing the difference by the value
of the account at the beginning of the base period to obtain the base period
return, and then multiplying the base period return by (365/7) with the
resulting yield figure carried to at least the nearest hundredth of one percent.
As of December 31, 2003, the Money Market Account's yield was 0.63%. Because
realized capital gains or losses in an Account's portfolio are not included in
the calculation, the Account's net investment income per share for yield
purposes may be different from the net investment income per share for dividend
purposes, that includes net short-term realized gains or losses on the Account's
portfolio.
Effective yield is computed by determining the net change, exclusive of capital
changes, in the value of a hypothetical pre-existing account having a balance of
one share at the beginning of the period, subtracting a hypothetical charge
reflecting deductions from shareholder accounts, and dividing the difference by
the value of the account at the beginning of the base period to obtain the base
period return, and then compounding the base period return by adding 1, raising
the sum to a power equal to 365 divided by 7, and subtracting 1 from the result.
The resulting effective yield figure is carried to at least the nearest
hundredth of one percent. As of December 31, 2003, the Money Market
Account's effective yield was 0.63%.
The yield quoted at any time for the Money Market Account represents the amount
that was earned during a specific, recent seven-day period and is a function of
the quality, types and length of maturity of instruments in the Account's
portfolio and the Account's operating expenses. The length of maturity for the
portfolio is the average dollar weighted maturity of the portfolio. This means
that the portfolio has an average maturity of a stated number of days for its
issues. The calculation is weighted by the relative value of each investment.
The yield for the Money Market Account fluctuates daily as the income earned on
the investments of the Account fluctuates. Accordingly, there is no assurance
that the yield quoted on any given occasion will remain in effect for any period
of time. There is no guarantee that the net asset value or any stated rate of
return will remain constant. A shareholder's investment in the Account is not
insured. Investors comparing results of the Money Market Account with investment
results and yields from other sources such as banks or savings and loan
associations should understand these distinctions. Historical and comparative
yield information may, from time to time, be presented by the Account.
Total Return for all other Accounts
-----------------------------------
When advertising total return figures, each of the other Accounts will include
its average annual total return for each of the one, five and ten year periods
(or if shorter, the period during which its corresponding predecessor fund's
registration statement has been in effect) that end on the last day of the most
recent calendar quarter. Average annual total return is computed by calculating
the average annual compounded rate of return over the stated period that would
equate an initial $1,000 investment to the ending redeemable value assuming the
reinvestment of all dividends and capital gains distributions at net asset
value. In its advertising, an Account may also include average annual total
return for some other period or cumulative total return for a specified period.
Cumulative total return is computed by dividing the ending redeemable value
(assuming the reinvestment of all dividends and capital gains distributions at
net asset value) by the initial investment.
This table shows the average annual total return as of December 31, 2003 for the
Accounts for the periods indicated
[Download Table]
1-YEAR 5-YEAR 10-YEAR
ACCOUNT ------ ------ -------
-------
Asset Allocation 21.61% 4.31% 8.49%/(1)/
Balanced 18.82 -0.32 6.01
Bond 4.59 5.42 6.53
Capital Value 25.49 -0.52 8.82
Equity Growth 25.95 -0.92 11.40/(1)/
Equity Income 13.83 -2.60 0.20/(2)/
Government Securities 1.84 5.78 6.40
Growth 26.46 -6.91 5.02/(//3//)/
International 32.33 -0.59 5.34/(//3//)/
International Emerging Markets 57.20 8.72/(//4//)/
International SmallCap 54.15 11.61 8.06/(//2//)/
LargeCap Blend 23.76 2.74/(//5//)/
LargeCap Growth Equity 23.14 -22.33/(4)/
LargeCap Stock Index 28.32 -3.16/(//6//)/
LargeCap Value 28.05 5.77/(//5//)/
Limited Term Bond 0.78/(//7//)/
MidCap 32.81 8.61 11.72
MidCap Growth 40.58 0.60 -0.08/(//2//)/
MidCap Value 36.49 12.46/(//6//)/
Real Estate Securities 38.91 15.28 12.01/(2)/
SmallCap 36.82 5.26 0.48/(2)/
SmallCap Growth 45.64 -2.01 -1.27/(2)/
SmallCap Value 50.61 17.02 11.61/(2)/
/ //(1)/ Period beginning June 1, 1994 and ending December 31, 2003.
/ //(2)/ Period beginning May 1, 1998 and ending December 31, 2003.
/ //(//3//)/ Period beginning May 1, 1994 and ending December 31, 2003.
/ //(//4//)/ Period beginning October 24, 2000 and ending December 31, 2003.
/ //(5)/ Period beginning May 1, 2002 and ending December 31, 2003.
/ //(//6//)/ Period beginning May 3, 1999 and ending December 31, 2003.
/ //(//7//)/ Period beginning May 1, 2003 and ending December 31, 2003.
Principal Underwriter
---------------------
Princor Financial Services Corporation ("Princor") is the principal underwriter
of the Fund and offers shares of each Account on a continuous basis. As
principal underwriter, Princor is paid for the distribution of the Fund. For the
last three fiscal years, Princor has received and returned the following
commissions:
[Download Table]
2003 2002 2001
---- ---- ----
$30,520,667 $39,948,115 $32,133,629
Princor may, from time to time, at its expense or as an expense for which it may
be compensated under a distribution plan, if applicable, pay a bonus or other
consideration or incentive to dealers who sell a minimum dollar amount of the
shares of the Fund during a specific period of time. In some instances, these
incentives may be offered only to certain dealers who have sold or may sell
significant amounts of shares. The total amount of such additional bonus
payments or other consideration shall not exceed 0.25% of the public offering
price of the shares sold. Any such bonus or incentive program will not change
the price paid by investors for the purchase of the Fund's shares or the amount
that any particular Account receives as the proceeds from such sales. Dealers
may not use sales of the Fund's shares to qualify for any incentives to the
extent that such incentives may be prohibited by the laws of any state.
TAX STATUS
It is the policy of each Account to distribute substantially all net investment
income and net realized gains. Through such distributions, and by satisfying
certain other requirements, the Fund intends to qualify for the tax treatment
accorded to regulated investment companies under the applicable provisions of
the Internal Revenue Code. This means that in each year in which the Fund so
qualifies, it is exempt from federal income tax upon the amount so distributed
to investors. If an Account fails to qualify as a regulated investment company,
it will be liable for taxes, significantly reducing its distributions to
shareholders and eliminating shareholders' ability to treat distributions of the
Account in the manner they were received by the Account.
For federal income tax purposes, capital gains and losses on futures contracts
or options thereon, index options or options traded on qualified exchanges are
generally treated at 60% long-term and 40% short-term. In addition, an Account
must recognize any unrealized gains and losses on such positions held at the end
of the fiscal year. An Account may elect out of such tax treatment, however, for
a futures or options position that is part of an "identified mixed straddle"
such as a put option purchased by the Account with respect to a portfolio
security. Gains and losses on figures and options included in an identified
mixed straddle will be considered 100% short-term and unrealized gain or loss on
such positions will not be realized at year end. The straddle provisions of the
Code may require the deferral of realized losses to the extent that the Account
has unrealized gains in certain offsetting positions at the end of the fiscal
year, and may also require recharacterization of all or a part of losses on
certain offsetting positions from short-term to long-term, as well as adjustment
of the holding periods of straddle positions.
The 1986 Tax Reform Act imposes an excise tax on mutual funds that fail to
distribute net investment income and capital gains by the end of the calendar
year in accordance with the provisions of the Act. The Fund intends to comply
with the Act's requirements and to avoid this excise tax.
GENERAL INFORMATION
LargeCap Stock Index Account only
---------------------------------
The Account is not sponsored, endorsed, sold or promoted by Standard & Poor's, a
division of The McGraw-Hill Companies, Inc. ("S&P"). S&P makes no representation
or warranty, express or implied, to Account shareholders or any member of the
public regarding the advisability of investing in securities generally or in the
Account particularly or the ability of the S&P 500 Index to track general stock
market performance. S&P's only relationship to Principal Life Insurance Company
and the Manager is the licensing of certain trademarks and trade names of S&P
and the S&P 500 Index which is determined, composed and calculated by S&P
without regard to Principal Life Insurance Company, the Manager or the Account.
S&P has no obligation to take the needs of Principal Life Insurance Company, the
Manager or Account shareholders into consideration in determining, composing or
calculating the S&P 500 Index. S&P is not responsible for and has not
participated in the determination of the prices of the Account or the timing of
the issuance or sale of the Account or in the determination or calculation of
the equation by which the Account is to be converted into cash. S&P has no
obligation or liability in connection with the administration, marketing or
trading of the Account.
S&P DOES NOT GUARANTEE THE ACCURACY AND/OR THE COMPLETENESS OF THE S&P 500 INDEX
OR ANY DATA CONTAINED THEREIN AND S&P SHALL HAVE NO LIABILITY FOR ANY ERRORS,
OMISSIONS OR INTERRUPTIONS THEREIN. S&P MAKES NO WARRANTY, EXPRESS OR IMPLIED,
AS TO RESULTS TO BE OBTAINED BY PRINCIPAL LIFE INSURANCE COMPANY, THE MANAGER,
Account SHAREHOLDERS OR ANY OTHER PERSON OR ENTITY FROM THE USE OF THE S&P 500
INDEX OR ANY DATA INCLUDED THEREIN. S&P MAKES NO EXPRESS OR IMPLIES WARRANTIES,
AND EXPRESSLY DISCLAIMS ALL WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A
PARTICULAR PURPOSE OR USE WITH RESPECT TO THE S&P 500 INDEX OR ANY DATA INCLUDED
THEREIN. WITHOUT LIMITING ANY OF THE FOREGOING, IN NO EVENT SHALL S&P HAVE ANY
LIABILITY FOR ANY SPECIAL, PUNITIVE, INDIRECT OR CONSEQUENTIAL DAMAGES
(INCLUDING LOST PROFITS), EVEN IF NOTIFIED OF THE POSSIBILITY OF SUCH DAMAGES.
FINANCIAL STATEMENTS
The financial statements for the Fund appear in the Annual Report to
Shareholders and are legally a part of this Statement of Additional Information.
Reports on those statements from the Fund's independent auditors, Ernst & Young
LLP, are included in the Annual Report. The Annual Reports are furnished,
without charge, to investors who request copies.
APPENDIX A
Description of Bond Ratings:
Moody's Investors Service, Inc. Bond Ratings
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, i.e.,
they are neither highly protected nor poorly secured. Interest payments and
principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any
great length of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as well.
Ba: Bonds which are rated Ba are judged to have speculative elements; their
future cannot be considered as well-assured. Often the protection of
interest and principal payments may be very moderate and thereby not well
safeguarded during 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.
CONDITIONAL RATING: Bonds for which the security depends upon the completion of
some act or the fulfillment of some condition are rated conditionally. These
bonds secured by a) earnings of projects under construction, b) earnings of
projects unseasoned in operation experience, c) rentals which begin when
facilities are completed, or d) payments to which some other limiting condition
attaches. Parenthetical rating denotes probable credit stature upon completion
of construction or elimination of basis of condition.
RATING REFINEMENTS: Moody's may apply numerical modifiers, 1, 2 and 3 in each
generic rating classification from Aa through B in its bond rating system. The
modifier 1 indicates that the security ranks in the higher end of its generic
rating category; the modifier 2 indicates a mid-range ranking; and a modifier 3
indicates that the issue ranks in the lower end of its generic rating category.
SHORT-TERM NOTES: The four ratings of Moody's for short-term notes are MIG 1,
MIG 2, MIG 3 and MIG 4; MIG 1 denotes "best quality, enjoying strong protection
from established cash flows"; MIG 2 denotes "high quality" with "ample margins
of protection"; MIG 3 notes are of "favorable quality...but lacking the
undeniable strength of the preceding grades"; MIG 4 notes are of "adequate
quality, carrying specific risk for having protection...and not distinctly or
predominantly speculative."
Description of Moody's Commercial Paper Ratings
Moody's Commercial Paper ratings are opinions of the ability to 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.
Description of Standard & Poor's Corporation's Debt Ratings:
A Standard & Poor's 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 Standard & Poor's from other sources Standard & Poor's considers reliable.
Standard & Poor's 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:
I. 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;
II. Nature of and provisions of the obligation;
III. 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 creditor's rights.
AAA: Debt rated "AAA" has the highest rating assigned by Standard & Poor's.
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 they are 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 exhibits 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 for debt in higher-rated categories.
BB, B, CCC, CC: Debt rated "BB", "B", "CCC" and "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: The rating "C" 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 "AA" 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 bonds 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 his own judgment with respect to such likelihood and risk.
NR: Indicates that no rating has been requested, that there is insufficient
information on which to base a rating or that Standard & Poor's does not rate
a particular type of obligation as a matter of policy.
Standard & Poor's, Commercial Paper Ratings
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. Ratings are applicable to
both taxable and tax-exempt commercial paper. The four categories are as
follows:
A: Issues assigned the highest rating are regarded as having the greatest
capacity for timely payment. Issues in this category are delineated with
the numbers 1, 2 and 3 to indicate the relative degree of safety.
A-1: This designation indicates that the degree of safety regarding timely
payment is either overwhelming or very strong. Issues that possess
overwhelming safety characteristics will be given a "+" designation.
A-2: Capacity for timely payment on issues with this designation is strong.
However, the relative degree of safety is not as high as for issues
designated "A-1".
A-3: Issues carrying this designation have a satisfactory capacity for timely
payment. They are, however, somewhat more vulnerable to the adverse effects
of changes in circumstances than obligations carrying the highest
designations.
B: 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.
C: This rating is assigned to short-term debt obligations with a doubtful
capacity for payment.
D: This rating indicates that the issue is either in default or is expected to
be in default upon maturity.
The Commercial Paper Rating is not a recommendation to purchase or sell a
security. The ratings are based on current information furnished to Standard &
Poor's by the issuer and obtained by Standard & Poor's from other sources it
considers reliable. The ratings may be changed, suspended, or withdrawn as a
result of changes in or unavailability of, such information.
Standard & Poor's rates notes with a maturity of less than three years as
follows:
SP-1: A very strong, or strong, capacity to pay principal and interest. Issues
that possess overwhelming safety characteristics will be given a "+"
designation.
SP-2: A satisfactory capacity to pay principal and interest.
SP-3: A speculative capacity to pay principal and interest.
APPENDIX B
PROXY VOTING POLICIES
The Proxy voting policies applicable to each Account follow.
JULY 2003
ALLIANCE CAPITAL MANAGEMENT L.P.
STATEMENT OF POLICIES AND PROCEDURES FOR
VOTING PROXIES ON BEHALF OF DISCRETIONARY CLIENT ACCOUNTS
---------------------------------------------------------
INTRODUCTION
As a registered investment adviser, Alliance Capital Management L.P. ("Alliance
Capital", "we" or "us") has a fiduciary duty to act solely in the best interests
of our clients. As part of this duty, we recognize that we must vote client
securities in a timely manner and make voting decisions that are in the best
interests of our clients.
This statement is intended to comply with Rule 206(4)-6 of the Investment
Advisers Act of 1940. It sets forth our policies and procedures for voting
proxies for our discretionary investment advisory clients, including investment
companies registered under the Investment Company Act of 1940. This statement is
applicable to Alliance Capital's growth and value investment groups investing on
behalf of clients in both US and global securities.
PROXY POLICIES
This statement is designed to be responsive to the wide range of subjects that
can have a significant effect on the investment value of the securities held in
our clients' accounts. These policies are not exhaustive due to the variety of
proxy voting issues that we may be required to consider. Alliance Capital
reserves the right to depart from these guidelines in order to avoid voting
decisions that we believe may be contrary to our clients' best interests. In
reviewing proxy issues, we will apply the following general policies:
ELECTIONS OF DIRECTORS: . Unless there is a proxy fight for seats on the Board
or we determine that there are other compelling reasons for withholding votes
for directors, we will vote in favor of the management proposed slate of
directors. That said, we believe that directors have a duty to respond to
shareholder actions that have received significant shareholder support. We may
withhold votes for directors that fail to act on key issues such as failure to
implement proposals to declassify boards, failure to implement a majority vote
requirement, failure to submit a rights plan to a shareholder vote and failure
to act on tender offers where a majority of shareholders have tendered their
shares. In addition, we will withhold votes for directors who fail to attend at
least seventy-five percent of board meetings within a given year without a
reasonable excuse. Finally, we may withhold votes for directors of non-U.S.
issuers where there is insufficient information about the nominees disclosed in
the proxy statement.
APPOINTMENT OF AUDITORS: . Alliance Capital believes that the company remains in
the best position to choose the auditors and will generally support management's
recommendation. However, we recognize that there may be inherent conflicts when
a company's independent auditor performs substantial non-audit related services
for the company. Therefore, we may vote against the appointment of auditors if
the fees for non-audit related services are disproportionate to the total audit
fees paid by the company or there are other reasons to question the independence
of the company's auditors.
CHANGES IN CAPITAL STRUCTURE: . Changes in a company's charter, articles of
incorporation or by-laws are often technical and administrative in nature.
Absent a compelling reason to the contrary, Alliance Capital will cast its votes
in accordance with the company's management on such proposals. However, we will
review and analyze on a case-by-case basis any non-routine proposals that are
likely to affect the structure and operation of the company or have a material
economic effect on the company. For example, we will generally support proposals
to increase authorized common stock when it is necessary to implement a stock
split, aid in a restructuring or acquisition or provide a sufficient number of
shares for an employee savings plan, stock option or executive compensation
plan. However, a satisfactory explanation of a company's intentions must be
disclosed in the proxy statement for proposals requesting an increase of greater
than one hundred percent of the shares outstanding. We will oppose increases in
authorized common stock where there is evidence that the shares will be used to
implement a poison pill or another form of anti-takeover device, or if the
issuance of new shares could excessively dilute the value of the outstanding
shares upon issuance.
CORPORATE RESTRUCTURINGS, MERGERS AND ACQUISITIONS: . Alliance Capital believes
proxy votes dealing with corporate reorganizations are an extension of the
investment decision. Accordingly, we will analyze such proposals on a
case-by-case basis, weighing heavily the views of the research analysts that
cover the company and the investment professionals managing the portfolios in
which the stock is held.
PROPOSALS AFFECTING SHAREHOLDER RIGHTS: . Alliance Capital believes that certain
fundamental rights of shareholders must be protected. We will generally vote in
favor of proposals that give shareholders a greater voice in the affairs of the
company and oppose any measure that seeks to limit those rights. However, when
analyzing such proposals we will weigh the financial impact of the proposal
against the impairment of shareholder rights.
CORPORATE GOVERNANCE: . Alliance Capital recognizes the importance of good
corporate governance in ensuring that management and the board of directors
fulfill their obligations to the shareholders. We favor proposals promoting
transparency and accountability within a company. For example, we will vote for
proposals providing for equal access to proxies, a majority of independent
directors on key committees, and separating the positions of chairman and chief
executive officer.
ANTI-TAKEOVER MEASURES: . Alliance Capital believes that measures that impede
takeovers or entrench management not only infringe on the rights of shareholders
but may also have a detrimental effect on the value of the company. We will
generally oppose proposals, regardless of whether they are advanced by
management or shareholders, the purpose or effect of which is to entrench
management or dilute shareholder ownership. Conversely, we support proposals
that would restrict or otherwise eliminate anti-takeover measures that have
already been adopted by corporate issuers. For example, we will support
shareholder proposals that seek to require the company to submit a shareholder
rights plan to a shareholder vote. We will evaluate, on a case-by-case basis,
proposals to completely redeem or eliminate such plans. Furthermore, we will
generally oppose proposals put forward by management (including blank check
preferred stock, classified boards and supermajority vote requirements) that
appear to be intended as management entrenchment mechanisms.
EXECUTIVE COMPENSATION: . Alliance Capital believes that company management and
the compensation committee of the board of directors should, within reason, be
given latitude to determine the types and mix of compensation and benefit awards
offered. Whether proposed by a shareholder or management, we will review
proposals relating to executive compensation plans on a case-by-case basis to
ensure that the long-term interests of management and shareholders are properly
aligned. We will analyze the proposed plans to ensure that shareholder equity
will not be excessively diluted, the option exercise price is not below market
price on the date of grant and an acceptable number of employees are eligible to
participate in such programs. We will generally oppose plans that permit
repricing of underwater stock options without shareholder approval. Other
factors such as the company's performance and industry practice will generally
be factored into our analysis. We will support proposals to submit severance
packages triggered by a change in control to a shareholder vote and proposals
that seek additional disclosure of executive compensation. Finally, we will
support shareholder proposals requiring companies to expense stock options
because we view them as a large corporate expense.
SOCIAL AND CORPORATE RESPONSIBILITY: . Alliance Capital will review and analyze
on a case-by-case basis proposals relating to social, political and
environmental issues to determine whether they will have a financial impact on
shareholder value. We will vote against proposals that are unduly burdensome or
result in unnecessary and excessive costs to the company. We may abstain from
voting on social proposals that do not have a readily determinable financial
impact on shareholder value.
PROXY VOTING PROCEDURES
PROXY VOTING COMMITTEES
Our growth and value investment groups have formed separate proxy voting
committees to establish general proxy policies for Alliance Capital and consider
specific proxy voting matters as necessary. These committees periodically review
new types of corporate governance issues, evaluate proposals not covered by
these policies and recommend how we should generally vote on such issues. In
addition, the committees, in conjunction with the analyst that covers the
company, contact management and interested shareholder groups as necessary to
discuss proxy issues.
Members of the committees include senior investment personnel and
representatives of the Corporate Legal Department. The committees may also
evaluate proxies where we face a potential conflict of interest (as discussed
below). Finally, the committees monitor adherence to guidelines, industry trends
and review the policies contained in this statement from time to time.
CONFLICTS OF INTEREST
Alliance Capital recognizes that there may be a potential conflict of interest
when we vote a proxy solicited by an issuer whose retirement plan we manage,
whose retirement plan we administer, or with whom we have another business or
personal relationship that may affect how we vote on the issuer's proxy. We
believe that centralized management of proxy voting, oversight by the proxy
voting committees and adherence to these policies ensures that proxies are voted
with only our clients' best interests in mind. That said, we have implemented
additional procedures to ensure that our votes are not the product of a conflict
of interests, including: (i) requiring anyone involved in the decision making
process to disclose to the chairman of the appropriate proxy committee any
potential conflict that they are aware of and any contact that they have had
with any interested party regarding a proxy vote; (ii) prohibiting employees
involved in the decision making process or vote administration from revealing
how we intend to vote on a proposal in order to reduce any attempted influence
from interested parties; and (iii) where a material conflict of interests
exists, reviewing our proposed vote by applying a series of objective tests and,
where necessary, considering the views of a third party research service to
ensure that our voting decision is consistent with our clients' best interests.
For example, if our proposed vote is consistent with our stated proxy voting
policy, no further review is necessary. If our proposed vote is contrary to our
stated proxy voting policy but is also contrary to management's recommendation,
no further review is necessary. If our proposed vote is contrary to our stated
proxy voting policy or is not covered by our policy, is consistent with
management's recommendation, and is also consistent with the views of an
independent source, no further review is necessary. If our proposed vote is
contrary to our stated proxy voting policy or is not covered by our policy, is
consistent with management's recommendation and is contrary to the views of an
independent source, the proposal is reviewed by the appropriate proxy committee
for final determination.
PROXIES OF CERTAIN NON-US ISSUERS
Proxy voting in certain countries requires "share blocking." Shareholders
wishing to vote their proxies must deposit their shares shortly before the date
of the meeting (usually one-week) with a designated depositary. During this
blocking period, shares that will be voted at the meeting cannot be sold until
the meeting has taken place and the shares are returned to the clients'
custodian banks. Alliance Capital may determine that the value of exercising the
vote does not outweigh the detriment of not being able to transact in the shares
during this period. Accordingly, if share blocking is required we may abstain
from voting those shares. In such a situation we would have determined that the
cost of voting exceeds the expected benefit to the client.
PROXY VOTING RECORDS
Clients may obtain information about how we voted proxies on their behalf by
contacting their Alliance Capital administrative representative. Alternatively,
clients may make a written request for proxy voting information to: Mark R.
Manley, Senior Vice President & Assistant General Counsel, Alliance Capital
Management L.P., 1345 Avenue of the Americas, New York, NY 10105.
AMERICAN CENTURY INVESTMENT MANAGEMENT, INC.
PROXY VOTING POLICIES
American Century Investment Management, Inc. ("ACIM") is the investment manager
for the American Century family of funds and for a number of separately managed
accounts. As such, it has been delegated the authority to vote proxies with
respect to investments held in the accounts it manages. The following is a
statement of the proxy voting policies that have been adopted by the Board of
Directors of ACIM.
I. GENERAL PRINCIPLES:
In voting proxies, ACIM is guided by general fiduciary principles. It must act
prudently, solely in the interest of the beneficial owners of the accounts it
manages, and for the exclusive purpose of providing benefits to such persons.
ACIM will attempt to consider all factors of its vote that could affect the
value of the investment. It will not subordinate the interests of the
beneficial owners in the value or their investments to unrelated objectives. In
short, ACIM will vote proxies in the manner that it believes will do the most to
maximize shareholder value.
II. SPECIFIC PROXY MATTERS:
A. ROUTINE MATTERS.
-------------------
1. ELECTION OF DIRECTORS. . In general, ACIM will vote in favor of management's
director nominees if they are running unopposed. ACIM believes that management
is in the best possible position to evaluate the qualifications of directors and
the needs and dynamics of a particular board. Qualitative performance
information about nominees is generally not available to us from sources other
than the company and we must rely on the company's current management to solicit
proxies for qualified individuals. ACIM of course maintains the ability to vote
against any candidate whom it feels is not qualified, but the exercise of this
right will probably be rare. When management's nominees are opposed in a proxy
contest, ACIM will evaluate which nominees' publicly-announced management
policies and goals are most likely to maximize shareholder value, as well as the
past performance of the incumbents.
2. RATIFICATION OF SELECTION OF AUDITORS. . ACIM will generally rely on the
judgment of management in selecting the independent auditors who will provide
the best service to the company. ACIM will examine the recommendation of
management in more depth if the proxy statement discloses (as required by law) a
change in auditors based upon a fundamental disagreement in policy.
3. STOCK OPTION PLAN PROPOSALS. . ACIM will conduct a case-by-case analysis of
each stock option plan or amendment, and generally approve management's
recommendations with respect to adoption of or amendments to a company's
incentive stock option plans, provided that the total number of shares reserved
under all of a company's plans is reasonable and not excessively dilutive. ACIM
recognizes that stock options can be useful in attracting and maintaining
desirable employees.
As a rule of thumb, ACIM will generally approve stock option plans or amendments
thereto if the total number of shares reserved for issuance under all of the
company's incentive plans does not exceed 10% of the number of outstanding
shares. In the event more than 10% of the company's outstanding shares are
reserved for issuance upon exercise of options, ACIM will make a case-by-case
determination concerning the option proposals. Factors that will be considered
in the determination include the company's overall capitalization and the
maturity of the company and its industry; for example, technology companies
often use options broadly throughout its employee base which may justify
somewhat greater dilution.
Amendments which are proposed in order to bring a company's plan within
applicable legal requirements will be reviewed by ACIM's legal counsel;
amendments to executive bonus plans to comply with IRS Section 162(m) disclosure
requirements, for example, are generally approved.
ACIM will generally vote against the adoption of plan amendments which provide
for immediate vesting of all options in the event of a change of control of the
company (see "Anti-Takeover Proposals" below), and which reset outstanding
options at a lower strike price unless accompanied by a corresponding and
proportionate reduction in the number of shares designated. ACIM will generally
oppose adoption of stock option plans that explicitly or historically permit
repricing of stock options, regardless of the number of shares reserved for
issuance, since their effect is impossible to evaluate.
B. ANTI-TAKEOVER PROPOSALS.
---------------------------
In general, ACIM will vote against any proposal, whether made by management or
shareholders, which ACIM believes would materially contribute to preventing a
potential acquisition or takeover. In most cases an acquisition or takeover of
a particular company will increase share value. The adoption of anti-takeover
measures may prevent or frustrate a bid from being made, may prevent
consummation of the acquisition, and may have a negative effect on share price
when no acquisition proposal is pending. The items below discuss specific
anti-takeover proposals.
1. CUMULATIVE VOTING. . ACIM will vote in favor of any proposal to adopt
cumulative voting and will vote against any proposal to eliminate cumulative
voting that is already in place. Cumulative voting gives minority shareholders
a stronger voice in the company and a greater chance for representation on the
board. ACIM believes that the elimination of cumulative voting constitutes an
anti-takeover measure.
2. STAGGERED BOARD. . If a company has a "staggered board," its directors are
elected for terms of more than one year and only a segment of the board stands
for election in any year. Therefore, a potential acquiror cannot replace the
entire board in one year even if it controls a majority of the votes. Although
staggered boards may provide some degree of continuity and stability of
leadership and direction to the board of directors, ACIM believes that staggered
boards are primarily an anti-takeover device and will vote against them. ACIM
does not, however, vote against the re-election of staggered boards.
3. "BLANK CHECK" PREFERRED STOCK. . Blank check preferred stock gives the board
of directors the ability to issue preferred stock, without further shareholder
approval, with such rights, preferences, privileges and restrictions as may be
set by the board. In response to a hostile take-over attempt, the board could
issue such stock to a friendly party or "white knight" and could establish
conversion or other rights in the preferred stock which would dilute the common
stock and make an acquisition impossible or less attractive. The argument in
favor of blank check preferred stock is that it gives the board flexibility in
pursuing financing, acquisitions or other proper corporate purposes without
incurring the time or expense of a shareholder vote. Generally, ACIM will vote
against blank check preferred stock. However, ACIM may vote in favor of blank
check preferred if the proxy statement discloses that such stock will be used
for a specific, proper corporate objective.
4. ELIMINATION OF PREEMPTIVE RIGHTS. . When a company grants preemptive rights,
existing shareholders are given an opportunity to maintain their proportional
ownership when new shares are issued. A proposal to eliminate preemptive rights
is a request from management to revoke that right.
While preemptive rights will protect the shareholder from having its equity
diluted, it may also decrease a company's ability to raise capital through stock
offerings or use stock for acquisitions or other proper corporate purposes.
Preemptive rights may therefore result in a lower market value for the company's
stock. In the long term, shareholders could be adversely affected by preemptive
rights. ACIM generally votes against proposals to grant preemptive rights, and
for proposals to eliminate preemptive rights.
5. NON-TARGETED SHARE REPURCHASE. . A non-targeted share repurchase is
generally used by company management to prevent the value of stock held by
existing shareholders from deteriorating. A non-targeted share repurchase may
reflect management's belief in the favorable business prospects of the company.
ACIM finds no disadvantageous effects of a non-targeted share repurchase, as
opposed to preemptive rights, and will generally vote for the approval of a
non-targeted share repurchase subject to analysis of the company's financial
condition.
6. INCREASE IN AUTHORIZED COMMON STOCK. . The issuance of new common stock can
also be viewed as an anti-takeover measure, although its effect on shareholder
value would appear to be less significant than the adoption of blank check
preferred. ACIM will evaluate the amount of the proposed increase and the
purpose or purposes for which the increase is sought. If the increase is not
excessive and is sought for proper corporate purposes, the increase will be
approved. Proper corporate purposes might include, for example, the creation of
additional stock to accommodate a stock split or stock dividend, additional
stock required for a proposed acquisition, or additional stock required to be
reserved upon exercise of employee stock option plans or employee stock purchase
plans. Generally, ACIM will vote in favor of an increase in authorized common
stock of up to 100%; increases in excess of 100% are evaluated on a case-by-case
basis, and will be voted affirmatively if management has provided sound
justification for the increase.
7. "SUPERMAJORITY" VOTING PROVISIONS. . A "supermajority" voting provision is a
provision placed in a company's charter documents which would require a
"supermajority" (ranging from 66 to 90%) of shareholders to approve any type of
acquisition of the company. ACIM believes that the supermajority provision is a
standard anti-takeover measure and will vote against it. The supermajority
provision makes an acquisition more time-consuming and expensive for the
acquiror. It is often proposed in conjunction with other anti-takeover
measures.
8. "FAIR PRICE" AMENDMENTS. . This is another type of charter amendment that
would require an offeror to pay a "fair" and uniform price to all shareholders
in an acquisition. In general, fair price amendments are designed to protect
shareholders from coercive, two-tier tender offers in which some shareholders
may be merged out on disadvantageous terms. Fair price amendments also have an
anti-takeover impact, although their adoption is generally believed to have less
of a negative effect on stock price than other anti-takeover measures. ACIM
will carefully examine all fair price proposals. In general, ACIM will vote
against fair price proposals unless it can be determined from the proposed
operation of the fair price proposal that it is likely that share price will not
be negatively affected and the proposal will not have the effect of discouraging
acquisition proposals.
9. LIMITING THE RIGHT TO CALL SPECIAL SHAREHOLDER MEETINGS. . The incorporation
statutes of many states allow minority shareholders at a certain threshold level
of ownership (frequently 10%) to call a special meeting of shareholders. This
right can be eliminated (or the threshold increased) by amendment to the
company's charter documents. ACIM believes that the right to call a special
shareholder meeting is significant for minority shareholders; the elimination of
such right will be viewed as an anti-takeover measure and will be voted opposed.
10. POISON PILLS OR "SHAREHOLDERS RIGHTS" PLANS. . Many companies have now
adopted some version of a poison pill or "shareholder rights" plan. Poison pill
plans generally provide for the issuance of additional equity securities or
rights to purchase equity securities upon the occurrence of certain hostile
events, such as the acquisition of a large block of stock.
The basic argument against poison pills is that they depress share value,
discourage offers for the company and serve to "entrench" management. The basic
argument in favor of poison pills is that they give management more time and
leverage to deal with a takeover bid and, as a result, shareholders receive a
better price. ACIM believes that the potential benefits of a poison pill plan
are outweighed by the potential detriments. ACIM will continue to join with
most institutional investors in voting against all forms of poison pills.
11. GOLDEN PARACHUTES. . Golden parachute arrangements provide substantial
compensation to executives who are terminated as a result of a takeover or
change in control of their company. The existence of such plans in reasonable
amounts probably has only a slight anti-takeover effect. In voting, ACIM will
evaluate the specifics of the plan presented.
12. REINCORPORATION . Reincorporation in a new state is often proposed as one
part of a package of anti-takeover measures. Several states now provide some
type of legislation which discourage takeovers. Management believes that
Delaware in particular is beneficial as a corporate domicile because of the
well-developed body of statutes and case law dealing with corporate
acquisitions.
We will examine reincorporation proposals on a case-by-case basis. If ACIM
believes that the reincorporation will result in greater protection from
takeovers, the reincorporation proposal will be opposed. When reincorporation
is proposed for a legitimate business purpose, ACIM will vote affirmatively.
13. CONFIDENTIAL VOTING. . Companies that have not previously adopted a
"confidential voting" policy allow management to view the results of shareholder
votes. This gives management the opportunity to contact those shareholders
voting against management in an effort to change their votes.
Proponents of secret ballots argue that confidential voting enables shareholders
to vote on all issues on the basis of merit without pressure from management to
influence their decision. Opponents argue that confidential voting is more
expensive and unnecessary; also, holding shares in a nominee name, maintains
shareholders' confidentiality. ACIM
believes that the only way to insure anonymity of votes is through confidential
voting, and that the benefits of confidential voting outweigh the incremental
additional cost of administering a confidential voting system. Therefore, we
will vote in favor of any proposal to adopt confidential voting.
14. OPTING IN OR OUT OF STATE TAKEOVER LAWS. . State takeover laws typically
are designed to make it more difficult to acquire a corporation organized in
that state. ACIM believes that the decision of whether or not to accept or
reject offers of merger or acquisition should be made by the shareholders,
without unreasonably restrictive state laws that may impose ownership thresholds
or waiting periods on potential acquirors. Therefore, ACIM will generally vote
in favor of opting out of restrictive state takeover laws.
C. OTHER MATTERS.
-----------------
1. SHAREHOLDER PROPOSALS INVOLVING SOCIAL, MORAL OR ETHICAL MATTERS. . ACIM
will generally vote management's recommendation on issues that primarily involve
social, moral or ethical matters, such as the MacBride Principles pertaining to
operations in Northern Ireland. While the resolution of such issues may have an
effect on shareholder value, the precise economic effect of such proposals, and
individual shareholder's preferences regarding issues is often unclear. Where
this is the case, ACIM believes it is impossible to vote in a manner that would
accurately reflect the views of the beneficial owners of the funds that ACIM
manages, and therefore will rely on management's assessment of the economic
effect of such proposals.
Shareholders may also introduce social, moral or ethical proposals which are the
subject of existing law or regulation. Examples of such proposals would include
a proposal to require disclosure of a company's contributions to political
actions committees or a proposal to require a company to adopt a non-smoking
workplace policy. ACIM believes that such proposals are better addressed
outside the corporate arena, and will vote with management's recommendation; in
addition, ACIM will generally vote against any proposal which would require a
company to adopt practices or procedures which go beyond the requirements of
existing, directly applicable law.
2. ANTI-GREENMAIL PROPOSALS. . "Anti-greenmail" proposals generally limit the
right of a corporation, without a shareholder vote, to pay a premium or buy out
a 5% or greater shareholder. Management often argues that they should not be
restricted from negotiating a deal to buy out a significant shareholder at a
premium if they believe it is in the best interest of the company.
Institutional shareholders generally believe that all shareholders should be
able to vote on such a significant use of corporate assets. ACIM believes that
any repurchase by the company at a premium price of a large block of stock
should be subject to a shareholder vote. Accordingly, it will vote in favor of
anti-greenmail proposals.
3. INDEMNIFICATION. . ACIM will generally vote in favor of a corporation's
proposal to indemnify its officers and directors in accordance with applicable
state law. Indemnification arrangements are often necessary in order to attract
and retain qualified directors. The adoption of such proposals appears to have
little effect on share value.
4. NON-STOCK INCENTIVE PLANS. . Management may propose a variety of cash-based
incentive or bonus plans to stimulate employee performance. In general, the
cash or other corporate assets required for most incentive plans is not
material, and ACIM will vote in favor of such proposals, particularly when the
proposal is recommended in order to comply with IRS Rule 162(m) regarding salary
disclosure requirements. Case-by-case determinations will be made of the
appropriate shareholder value transferred by proposed plans.
5. DIRECTOR TENURE. . These proposals ask that age and term restrictions be
placed on the board of directors. ACIM believes that these types of
restrictions are not necessarily in the best interests of shareholders and
therefore will vote against such proposals, unless they have been recommended by
management.
6. DIRECTORS' STOCK OPTIONS PLANS. . ACIM believes that stock options are an
appropriate form of compensation for directors, and ACIM will vote for director
stock option plans which are reasonable and do not result in excessive
shareholder dilution. Analysis of such proposals will be made on a case-by-case
basis, and will take into account total board compensation.
7. DIRECTOR SHARE OWNERSHIP. . ACIM will vote against shareholder proposals
which would require directors to hold a minimum number of the company's shares
to serve on the Board of Directors, in the belief that such ownership should be
at the discretion of Board members.
The voting policies expressed above are of course subject to modification in
certain circumstances and will be reexamined from time to time. With respect to
matters that do not fit in the categories stated above, ACIM will exercise its
best judgment as a fiduciary to vote in the manner which will most enhance
shareholder value.
Case-by-case determinations will be made by ACIM staff, which is overseen by the
General Counsel of ACIM, in consultation with equity managers. Electronic
records will be kept of all votes made.
ACIM requests all recipients of these Proxy Voting Policies to maintain their
confidentiality and not to disclose ACIM's general or specific voting policies
to proxy solicitation firms or to others.
6/1/89
Revised 12/05/91
Revised 2/15/97
Revised 8/1/99
MELLON FINANCIAL CORPORATION
PROXY VOTING POLICY
(Approved 04/19/02)
GENERAL STATEMENT OF PRINCIPLES
1) Stock Ownership Rights as Assets - We, the members of the Mellon Financial
Corporation ("Mellon") Proxy Voting Committee, recognize that rights inherent
in stock ownership, including the right to vote proxies, are assets, just as
the economic investment represented by the shares themselves is an asset. We
will manage such ancillary ownership rights with the same level of care,
skill, prudence, and diligence as we manage the economic investment. With
regard to voting proxies of foreign companies, we weigh the cost of voting
the shares against the benefit of voting the shares to determine whether or
not to vote.
2) Exclusive Benefit of Beneficiaries - We recognize that stock ownership
rights must be exercised for the exclusive benefit of pension and other
employee benefit plan participants, shareholders of investment companies
managed by the investment advisory subsidiaries of Mellon (the
"Subsidiaries") or other beneficiaries of fiduciary accounts for whom the
stock is held. In voting proxies, we will act solely in the best financial
and economic interest of the applicable client.
3) Long-Term Perspective - We believe our goal in managing financial assets
is to protect capital and enhance long-term value. We recognize that
management of a publicly-held company may need protection from the market's
frequent focus on short-term considerations, so as to be able to concentrate
on such long-term goals as productivity and development of competitive
products and services.
4) Limited Role of Shareholders - We believe that a shareholder's role in the
governance of a publicly-held company is generally limited to monitoring the
performance of the company and its managers and voting on matters which
properly come to a shareholder vote. We will monitor actions which limit
shareholder control and could affect shareholder values.
5) Anti-takeover Proposals - We will tend to oppose proposals that seem
designed to insulate management unnecessarily from the wishes of a majority
of the shareholders and that would lead to a determination of a company's
future by a minority of its shareholders. We will generally support
proposals that seem to have as their primary purpose providing management
with temporary or short-term insulation from outside influences so as to
enable them to bargain effectively with potential suitors and otherwise
achieve identified long-term goals to the extent such proposals are discrete
and not bundled with other proposals.
6)" Social" Issues - On questions of social responsibility where economic
performance does not appear to be an issue we will attempt to ensure that
management reasonably responds to the social issues. Responsiveness will be
measured by management's efforts to address the particular social issue
including, where appropriate, assessment of the implications of the proposal
to the ongoing operations of the company. We will pay particular attention to
repeat issues where management has failed in the intervening period to take
actions previously committed.
7)Proxy Voting Process - We review every proxy we receive. Every voting
proposal is categorized and analyzed in accordance with our written
guidelines in effect from time to time. Our guidelines are updated
periodically so as to reflect new issues and any changes in our policies on
specific issues. Items that can be categorized will be voted in accordance
with any applicable guidelines. Proposals that cannot be categorized under
the guidelines will be referred to us for discussion and vote. Additionally,
we may review any proposal where we have identified a particular company,
particular industry or particular issue for special scrutiny. We will also
consider specific
interests and issues raised by a Subsidiary to the Committee, which interests
and issues may require that a vote for an account managed by a Subsidiary be
cast differently from the collective vote in order to reflect action taken in
the best interests of such account's beneficial owners.
8)Securities Lending - We balance the economic benefits of engaging in
lending securities against the inability to vote on proxy proposals to
determine whether to recall shares, unless a plan fiduciary retains the right
to direct us to recall shares.
9)
Recordkeeping - We keep the following records for each voting proposal for
six years:
. Record of date of receipt of proxy materials.
. Record of number of shares held as of record date and of any necessary
efforts to reconcile differences as to number of shares held between proxy
materials and internal records (including efforts to obtain missing
proxies).
. With respect to each matter submitted for a vote, record of either (a) in
the case of matters subject to a guideline for voting, references to the
guideline and evidence that the matter was voted in accordance with the
guideline, or if not voted in accordance with the guideline, the specific
facts and reasons why not so voted, or (b) in the case of matters not
subject to a guideline, a record of how the matter was voted and the
justification for voting that way.
. For all matters submitted for a vote, a record of management's
recommendation for the vote.
. Record of when the proxy was returned and the method of delivery.
. Proof that records are retained for six years.
10) Disclosure - We will furnish a copy of this General Statement of
Principles to any authorized representative requesting it who in the judgment
of the Proxy Policy Committee has an interest in an account for whom shares
are voted, including without limitation named fiduciaries of employee benefit
plans, co-trustees, employee benefit, and other trust beneficiaries, and
shareholders of investment companies managed by the Subsidiaries. We
recognize that the applicable trust or account document, the applicable
client agreement, the Employee Retirement Income Security Act of 1974 (ERISA)
and certain laws may require disclosure of other information relating to
proxy voting in certain circumstances. This information will only be
disclosed to those who have an interest in the account for which shares are
voted, and after the vote is recorded.
GRANTHAM, MAYO, VAN OTTERLOO & CO. LLC
GMO AUSTRALASIA LLC
(TOGETHER "GMO")
PROXY VOTING POLICIES AND PROCEDURES
I. Introduction and General Principles
---------------------------------------
GMO provides investment advisory services primarily to institutional, including
both ERISA and non-ERISA clients, and commercial clients. GMO understands that
proxy voting is an integral aspect of security ownership. Accordingly, in cases
where GMO has been delegated authority to vote proxies, that function must be
conducted with the same degree of prudence and loyalty accorded any fiduciary or
other obligation of an investment manager.
This policy permits clients of GMO to: (1) delegate to GMO the responsibility
and authority to vote proxies on their behalf according to GMO's proxy voting
polices and guidelines; (2) delegate to GMO the responsibility and authority to
vote proxies on their behalf according to the particular client's own proxy
voting policies and guidelines; or (3) elect to vote proxies themselves. In
instances where clients elect to vote their own proxies, GMO shall not be
responsible for voting proxies on behalf of such clients.
GMO believes that the following policies and procedures are reasonably designed
to ensure that proxy matters are conducted in the best interest of its clients,
in accordance with GMO's fiduciary duties, applicable rules under the Investment
Advisers Act of 1940 and fiduciary standards and responsibilities for ERISA
clients set out in the Department of Labor interpretations.
II. Proxy Voting Guidelines
----------------------------
GMO has engaged Institutional Shareholder Services, Inc. ("ISS") as its proxy
voting agent to:
(1) research and make voting recommendations or, for matters for which GMO has
so delegated, to make the voting determinations;
(2) ensure that proxies are voted and submitted in a timely manner;
(3) handle other administrative functions of proxy voting;
(4) maintain records of proxy statements received in connection with proxy votes
and provide copies of such proxy statements promptly upon request;
(5) maintain records of votes cast; and
(6) provide recommendations with respect to proxy voting matters in general.
Proxies will be voted in accordance with the voting recommendations contained in
the applicable domestic or global ISS Proxy Voting Manual, as in effect from
time to time. Copies of the current domestic and global ISS proxy voting
guidelines are attached to these Voting Policies and Procedures as Exhibit A.
GMO reserves the right to amend any of ISS's guidelines in the future. If any
such changes are made an amended Proxy Voting Policies and Procedures will be
made available for clients.
Except in instances where a GMO client retains voting authority, GMO will
instruct custodians of client accounts to forward all proxy statements and
materials received in respect of client accounts to ISS.
III. Proxy Voting Procedures
-----------------------------
GMO has a Corporate Actions Group with responsibility for administering the
proxy voting process, including:
1. Implementing and updating the applicable domestic and global ISS proxy voting
guidelines;
2. Overseeing the proxy voting process; and
3. Providing periodic reports to GMO's Compliance Department and clients as
requested.
There may be circumstances under which a portfolio manager or other GMO
investment professional ("GMO Investment Professional") believes that it is in
the best interest of a client or clients to vote proxies in a manner
inconsistent with the recommendation of ISS. In such an event, the GMO
Investment Professional will inform GMO's Corporate Actions Group of its
decision to vote such proxy in a manner inconsistent with the recommendation of
ISS. GMO's Corporate Actions Group will report to GMO's Compliance Department
no less than quarterly any instance where a GMO Investment Professional has
decided to vote a proxy on behalf of a client in that manner.
IV. Conflicts of Interest
--------------------------
As ISS will vote proxies in accordance with the proxy voting guidelines
described in Section II, GMO believes that this process is reasonably designed
to address conflicts of interest that may arise between GMO and a client as to
how proxies are voted.
In instances where GMO has the responsibility and authority to vote proxies on
behalf of its clients for shares of GMO Trust, a registered mutual fund for
which GMO serves as the investment adviser, there may be instances where a
conflict of interest exists. Accordingly, GMO will (i) vote such proxies in the
best interests of its clients with respect to routine matters, including proxies
relating to the election of Trustees; and (ii) with respect to matters where a
conflict of interest exists between GMO and GMO Trust, such as proxies relating
to a new or amended investment management contract between GMO Trust and GMO, or
a re-organization of a series of GMO Trust, GMO will either (a) vote such
proxies in the same proportion as the votes cast with respect to that proxy, or
(b) seek instructions from its clients.
In addition, if GMO is aware that one of the following conditions exists with
respect to a proxy, GMO shall consider such event a potential material conflict
of interest:
1. GMO has a business relationship or potential relationship with the issuer;
2. GMO has a business relationship with the proponent of the proxy proposal; or
3. GMO members, employees or consultants have a personal or other business
relationship with the participants in the proxy contest, such as corporate
directors or director candidates.
In the event of a potential material conflict of interest, GMO will (i) vote
such proxy according to the specific recommendation of ISS; (ii) abstain; or
(iii) request that the client votes such proxy. All such instances shall be
reported to GMO's Compliance Department at least quarterly.
V. Recordkeeping
-----------------
GMO will maintain records relating to the implementation of these proxy voting
policies and procedures, including:
(1) a copy of these policies and procedures which shall be made available to
clients, upon request;
(2) a record of each vote cast (which ISS maintains on GMO's behalf); and
(3) each written client request for proxy records and GMO's written response to
any client request for such records.
Such proxy voting records shall be maintained for a period of five years.
VI.Reporting
------------
GMO's Compliance Department will provide GMO's Conflict of Interest Committee
with periodic reports that include a summary of instances where GMO has (i)
voted proxies in a manner inconsistent with the recommendation of ISS, (ii)
voted proxies in circumstances in which a material conflict of interest may
exist as set forth in Section IV, and (iii) voted proxies of shares of GMO Trust
on behalf of its clients.
VII. Disclosure
----------------
Except as otherwise required by law, GMO has a general policy of not disclosing
to any issuer or third party how GMO or its voting delegate voted a client's
proxy.
GLOBAL PROXY VOTING MANUAL
FINANCIAL RESULTS/DIRECTOR AND AUDITOR REPORTS
ISS GENERAL RECOMMENDATION & POLICY
Vote FOR approval of financial statements and director and auditor reports,
unless:
. there are concerns about the accounts presented or audit procedures used; or
. the company is not responsive to shareholder questions about specific items
that should be publicly disclosed.
DISCUSSION
Most companies around the world submit these reports to shareholders for
approval, and this is one of the first items on most agendas. The official
financial statements and director and auditor reports are valuable documents
when evaluating a company's annual performance. The director report usually
includes a review of the company's performance during the year, justification of
dividend levels and profits or losses, special events such as acquisitions or
disposals, and future plans for the company.
The auditor report discloses any irregularities or problems with the company's
finances. While a qualified report by itself is not sufficient reason to oppose
this resolution, it raises cautionary flags of which shareholders should be
aware. Most auditor reports are unqualified, meaning that in the auditor's
opinion, the company's financial statements are made in accordance with
generally accepted accounting principles.
When evaluating a company's financial statements, ISS looks at debt/equity
levels on the balance sheet, historical sales and earnings performance, dividend
history and payout ratios, and the company's performance within its own country
and relative to similar companies in its industry. Unless there are major
concerns about the accuracy of the financial statements or the director or
auditor reports, ISS recommends approval of this item.
APPOINTMENT OF AUDITORS AND AUDITOR COMPENSATION
ISS GENERAL RECOMMENDATION & POLICY
Vote FOR the reelection of auditors and proposals authorizing the board to fix
auditor fees, unless:
. there are serious concerns about the accounts presented or the audit
procedures used;
. the auditors are being changed without explanation; or
. nonaudit-related fees are substantial or are routinely in excess of standard
annual audit fees.
Vote AGAINST the appointment of external auditors if they have previously served
the company in an executive capacity or can otherwise be considered affiliated
with the company.
ABSTAIN if a company changes its auditor and fails to provide shareholders with
an explanation for the change.
DISCUSSION
Most major companies around the world use one of the major international
auditing firms to conduct their audits. As such, concerns about the quality and
objectivity of the audit are minimal, and the reappointment of the auditor is
usually a routine matter. Audit fees tend to be highly competitive and vary
little between companies. However, if a company proposes a new auditor or an
auditor resigns and does not seek reelection, companies should offer an
explanation to shareholders. If shareholders request an explanation for a change
in auditor and the company or retiring auditor fails to provide one, ISS
recommends a vote against the election of a new auditor. If an explanation is
otherwise unavailable, ISS recommends that shareholders abstain on this item.
Many countries also require the appointment of censors, or special auditors who
ensure that the board and management are in compliance with the company's
articles. The censors' role is purely advisory in nature. Proposals to appoint
censors are routine, as the censors usually act as a secondary auditor for
special audit requirements.
The practice of auditors providing nonaudit services to companies is
problematic. While large auditors may have effective internal barriers to ensure
that there are no conflicts of interest, an auditor's ability to remain
objective becomes questionable when fees paid to the auditor for nonaudit
services such as management consulting, general bookkeeping, and special
situation audits exceed the standard annual audit fees. While some compensation
for nonaudit services is customary, the importance of maintaining the
independence of the auditor is paramount. If fees from nonaudit services become
significant without any clear safeguards against conflicts of interest, ISS
recommends opposing the auditor's reappointment.
APPOINTMENT OF INTERNAL STATUTORY AUDITORS
ISS GENERAL RECOMMENDATION & POLICY
Vote FOR the appointment or reelection of statutory auditors, unless:
. there are serious concerns about the statutory reports presented or the
audit procedures used;
. questions exist concerning any of the statutory auditors being appointed; or
. the auditors have previously served the company in an executive capacity or
can otherwise be considered affiliated with the company.
DISCUSSION
The appointment of internal statutory auditors is a routine request for
companies in Latin America, Italy, Spain, Portugal, Japan, Korea, and Russia.
The statutory auditing board is usually composed of three to five members,
including a group chairman and two alternate members, all of whom are expected
to be independent. In addition to the regular duty of verifying corporate
accounts, the auditor board is responsible for supervising management and
ensuring compliance with the law and articles of association. The auditors must
perform an audit of the accounts every three months and present to shareholders
a report on the balance sheet at the AGM. For most countries, the auditors are
elected annually and may seek reelection. ISS recommends supporting the
appointment of statutory auditors unless there are serious concerns about the
reports presented or questions about an auditor's qualifications.
ALLOCATION OF INCOME
ISS GENERAL RECOMMENDATION & POLICY
Vote FOR approval of the allocation of income, unless:
. the dividend payout ratio has been consistently below 30 percent without
adequate explanation; or
. the payout is excessive given the company's financial position.
DISCUSSION
Many countries require shareholders to approve the allocation of income
generated during the year. These proposals usually, but not always, contain an
allocation to dividends. When determining the acceptability of this proposal,
ISS focuses primarily on the payout ratio. Payouts of less than 30 percent or
more than 100 percent are a trigger for further analysis. The minimum level of
30 percent is based on a review of international practice. Payouts of more than
100 percent are a signal that the company is dipping into reserves to make the
payment.
Further analysis of payout ratios should include the following: an examination
of historical payouts to determine if there is a long-term pattern of low
payouts; exceptional events that may have artificially modified earnings for the
year; the condition of a company's balance sheet; comparisons with similar
companies both domestically and internationally; and the classification of the
company as growth or mature.
Justifications for extreme payouts must be reviewed carefully. If the company
has an adequate explanation for a certain payout, ISS supports the income
allocation as proposed. However, if a company has a pattern of low payouts,
fails to adequately justify the retention of capital, and is not experiencing
above-average growth, ISS recommends opposing the proposal. A vote against the
payout is also recommended if a company appears to be maintaining an excessive
payout that may affect its long-term health.
STOCK (SCRIP) DIVIDEND ALTERNATIVE
ISS GENERAL RECOMMENDATION & POLICY
Vote FOR most stock (scrip) dividend proposals.
Vote AGAINST proposals that do not allow for a cash option unless management
demonstrates that the cash option is harmful to shareholder value.
DISCUSSION
Stock (scrip) dividend alternatives, whereby shareholders are offered the option
of receiving their dividend payment in the form of fully paid ordinary shares,
are common proposals worldwide. While dividend payments in the form of shares in
lieu of cash do not immediately add to shareholder value, they allow companies
to retain cash and to strengthen the position and commitment of long-term
shareholders. ISS opposes stock dividend proposals that do not allow a cash
option unless management shows that the cash outflow is detrimental to the
company's health and to long-term shareholder value.
AMENDMENTS TO ARTICLES OF ASSOCIATION
ISS GENERAL RECOMMENDATION & POLICY
Vote amendments to the articles of association on a CASE-BY-CASE basis.
DISCUSSION
Requests to amend a company's articles of association are usually motivated by
changes in the company's legal and regulatory environment, although evolution of
general business practice can also prompt amendments to articles. Such proposals
are especially common whenever stock exchange listing rules are revised, new
legislation is passed, or a court case exposes the need to close loopholes.
Amendments to articles range from minor spelling changes to the adoption of an
entirely new set of articles. While the majority of such requests are of a
technical and administrative nature, minor changes in wording can have a
significant impact on corporate governance. As such, ISS carefully scrutinizes
any changes to a company's articles.
From a company's perspective, it is often more efficient to adopt a new set of
articles than to introduce numerous amendments. However, bundling changes that
treat different provisions of the articles into one voting item prevents
shareholders from separating items of concern from routine changes. By leaving a
shareholder with an all-or-nothing choice, bundling allows companies to include
negative provisions along with positive or neutral changes.
When reviewing new or revised articles, ISS classifies each change according to
its potential impact on shareholder value and then weighs the package as a
whole. The presence of one strongly negative change may warrant a recommendation
against the resolution. In assigning these classifications, ISS is not concerned
with the nature of the article being amended, but rather focuses on whether the
proposed change improves or worsens the existing provision.
The final criterion on which ISS bases its decision is whether failure to pass a
resolution would cause an immediate loss of shareholder value. In such cases,
ISS supports even a bundled resolution that includes negative changes.
CHANGE IN COMPANY FISCAL TERM
ISS GENERAL RECOMMENDATION & POLICY
Vote FOR resolutions to change a company's fiscal term unless a company's
motivation for the change is to postpone its AGM.
DISCUSSION
Companies routinely seek shareholder approval to change their fiscal year end.
This is a decision best left to management. ISS opposes this resolution only if
the company is changing its year end to postpone its AGM. Most countries require
companies to hold their AGM within a certain period of time after the close of
the fiscal year. If a company is embroiled in a controversy, it might seek
approval to amend its fiscal year end at an EGM to avoid controversial issues at
an AGM. ISS opposes the change in year end in these cases.
LOWER DISCLOSURE THRESHOLD FOR STOCK OWNERSHIP
ISS GENERAL RECOMMENDATION & POLICY
Vote AGAINST resolutions to lower the stock ownership disclosure threshold below
five percent unless specific reasons exist to implement a lower threshold.
DISCUSSION
ISS's recommended level for ownership disclosure is five percent. A level below
that does not add substantially to shareholders' interests and is often only a
pretext for an antitakeover defense. A lower level also requires a greater
number of shareholders to disclose their ownership, causing a greater burden to
shareholders and to the company. Positions of more than five percent are
significant, however, and this is the standard that the U.S. SEC uses.
In certain cases, shareholders may want to know of smaller positions-at a
troubled company likely to be put in play, for example. ISS examines these
companies to determine if these lower thresholds would benefit shareholders.
AMEND QUORUM REQUIREMENTS
ISS GENERAL RECOMMENDATION & POLICY
Vote proposals to amend quorum requirements for shareholder meetings on a
CASE-BY-CASE basis.
DISCUSSION
Quorum requirements differ widely by market. In the United States, for instance,
a quorum of a majority of the outstanding shares is the norm. In many global
markets, however, the percentage of shares represented at meetings is not as
high as in the United States. Indeed, many companies incorporated in markets
outside the United States have difficulty attaining a quorum.
Proposals to amend the quorum requirement are evaluated on a case-by-case basis
based on market norms, the company's reasons for the change, and the company's
ownership structure. With respect to the latter, companies that have a
substantial shareholder or shareholder group should set their quorum requirement
well above the percentage of shares owned by such shareholder or shareholder
group. Quorum requirements are intended to ensure that a broad range of
shareholders is represented at meetings. Setting a quorum requirement that is
too low, whether in absolute terms or relative to the holdings of a large
shareholder, undermines this purpose. A low quorum requirement is of particular
concern in markets where resolutions are decided on the basis of either shares
present and entitled to vote at a meeting or votes cast at the meeting; in such
cases, once a quorum is attained the shares present, regardless of whether they
are representative of the entire body of shareholders, will be able to decide
the matters under consideration at the meeting.
TRANSACT OTHER BUSINESS
ISS GENERAL RECOMMENDATION & POLICY
Vote AGAINST other business when it appears as a voting item.
DISCUSSION
This item provides a forum for questions and any other resolutions that may be
brought up at the meeting. In most countries the item is a formality and does
not require a shareholder vote, but companies in certain countries include other
business as a voting item. Because shareholders who vote by proxy cannot know
what issues will be raised under this item, ISS cannot recommend that
shareholders approve this request when asked for a vote. While ISS recognizes
that in most cases this item is a formality or includes discussion that will
have no impact on shareholders, shareholders cannot risk the negative
consequences of voting in advance on an item for which information has not been
disclosed.
DIRECTOR ELECTIONS
ISS GENERAL RECOMMENDATION & POLICY
Vote FOR management nominees in the election of directors, unless:
. there are clear concerns about the past performance of the company or the
board; or
. the board fails to meet minimum corporate governance standards.
Vote FOR individual nominees unless there are specific concerns about the
individual, such as criminal wrongdoing or breach of fiduciary responsibilities.
Vote AGAINST shareholder nominees unless they demonstrate a clear ability to
contribute positively to board deliberations.
Vote AGAINST individual directors if they cannot provide an explanation for
repeated absences at board meetings (in countries where this information is
disclosed)
DISCUSSION
ISS considers director elections to be one of the most important voting
decisions that shareholders make, especially because shareholders are only given
the opportunity to review their companies' operations once a year at the AGM.
Thus, if detailed information on boards or nominees is available, analysis to
the highest degree possible is warranted. Directors function as the
representatives of shareholders throughout the year and are therefore a crucial
avenue of ongoing influence on management.
Levels of disclosure regarding directors vary widely. In some countries, such as
the United Kingdom, Canada, and Australia, companies publish detailed
information such as director biographies, share ownership, and related
information that aids shareholders in determining the level of director
independence. In many other countries, the only information available on
directors is their names, while still other countries disclose no information at
all. In cases where detailed information about directors is not available, it
would be counterproductive to vote against directors on the basis of a lack of
information. Opposition to specific nominees or boards should be supported by
specific problems or concerns.
While ISS supports the annual election of directors, boards in many countries
are divided into two or more classes that are elected on a staggered basis. This
system of classified boards is common across the world. Only Canadian companies
routinely elect the entire board on an annual basis, but even in Canada
companies may classify their board if an appropriate amendment is made to the
articles. In certain countries, executive directors may be appointed for terms
of up to five years, and a company's articles may give executive directors
protected board seats under which they are not subject to shareholder election.
ISS opposes protected board seats and preferential treatment of executive
directors.
When reviewing director election proposals, ISS examines board composition,
company performance, and any negative views or information on either the company
or individual directors. ISS determines the number of executive, independent,
and affiliated directors on the board, the existence and composition of board
committees, and the independence of the chairman. An affiliated director is
defined as one who represents a major shareholder; has significant commercial
contacts with the company as a legal counsel, auditor, or consultant; has held
executive positions within the company in the past; or is related to the
founding family, another board member, or a top executive. In cases where board
composition is of concern, the company's general health and its recent financial
performance may play a part in the evaluation of directors. Individual director
information is also considered, including share ownership among director
nominees.
ISS also takes into account the attendance records of directors when such
information is provided to shareholders, using a benchmark attendance rate of 75
percent of board meetings. If an individual director fails to attend at least 75
percent of board meetings for two or more consecutive years, ISS makes further
inquiries to the company regarding the absences. ISS recommends withholding
votes against the director unless the company has provided a reasonable
explanation for the absences. International companies tend to have directors who
reside in other countries on their boards, making attendance difficult. While
ISS understands the difficulties imposed on such directors, failing to attend
meetings prevents directors from fulfilling their fiduciary obligations and
adequately representing shareholder interests. Other business obligations and
conflicting travel schedules are not acceptable reasons for consistently poor
attendance records. ISS supports the use of teleconferencing and
videoconferencing to cope with the increasing time and travel demands faced by
directors in global business.
Statements of corporate governance practices are also helpful in reviewing
director election proposals, but only in a few countries are these routinely
included as part of the annual report, usually as a listing requirement of the
major stock exchange. These reports are required in Australia, Canada, South
Africa, and the United Kingdom.
For shareholder nominees, ISS places the persuasive burden on the nominee or the
proposing shareholder to prove that they are better suited to serve on the board
than management's nominees. Serious consideration of shareholder nominees will
be given only if there are clear and compelling reasons for the nominee to join
the board. These nominees must also demonstrate a clear ability to contribute
positively to board deliberations; some nominees may have hidden or narrow
agendas and may unnecessarily contribute to divisiveness among directors.
DIRECTOR COMPENSATION
ISS GENERAL RECOMMENDATION & POLICY
Vote FOR proposals to award cash fees to nonexecutive directors unless the
amounts are excessive relative to other companies in the country or industry.
Vote nonexecutive director compensation proposals that include both cash and
share-based components on a CASE-BY-CASE basis.
Vote proposals that bundle compensation for both nonexecutive and executive
directors into a single resolution on a CASE-BY-CASE basis.
Vote AGAINST proposals to introduce retirement benefits for nonexecutive
directors.
DISCUSSION
Proposals seeking shareholder approval for nonexecutive directors' fees are not
controversial in most countries. ISS generally supports resolutions regarding
directors' fees unless they are excessive relative to fees paid by other
companies in the same country or industry. In evaluating such proposals, ISS
focuses on the fees paid to each nonexecutive or, if such detailed information
is not available, on the aggregate amount payable to all of the nonexecutives.
Where available, ISS will also take into consideration evidence of past abuses,
both by the company and those, if any, characteristic of the market.
Companies in many markets provide their nonexecutives an option to receive all
or a portion of their cash fees in the form of company shares. We approve these
measures as the exchange is on a 'dollar-for-dollar' basis, that is, as long as
a director receives shares having a cash value equal to that of the foregone
fees, with the share price used for such calculation being determined on a
reasonable date. While there is some dilution associated with such payments,
such dilution is minimal, and in any event, increasing directors' share
ownership is likely to align the interests of the directors with those of
shareholders.
However, we will not support such arrangements if the exchange is not
dollar-for-dollar; such exchanges put shareholders at a disadvantage by
providing directors the opportunity to receive shares at discount, and the
interests of directors who have acquired shares at a discount are likely to be
less closely aligned with those of other shareholders. Some companies provide
their nonexecutive directors the opportunity to exchange all or a portion of
their cash fees for stock options; we would evaluate such grants in accordance
with our stock option guidelines.
As is already common in the United States, companies in some global markets have
begun to provide their nonexecutives with stock options as a separate element of
their remuneration. In such countries, proposals seeking approval for the
remuneration of nonexecutive directors cannot be evaluated without detailed
information regarding the proposed remuneration, which could include options,
and in some cases, discounted options. Remuneration proposals that include
option grants must be evaluated in accordance with the guidelines for stock
options. Likewise, remuneration proposals that could include option grants-by
virtue of their being proposed by a company in a market where option grants to
nonemployee directors are common-must also be evaluated in accordance with the
guidelines for stock options.
Some countries require shareholder approval for the remuneration of executive as
well as nonexecutive directors. Companies in such markets occasionally bundle
nonexecutive and executive remuneration proposals into a single resolution.
While ISS generally believes that executive compensation is the purview of the
board, when proposed executive compensation is gratuitous or otherwise excessive
in light of market norms or there is past evidence of abuse, ISS will recommend
a vote against such resolutions. In reviewing such proposals, our analysis
focuses, among other things, on the amount of the proposed compensation relative
to market norms but also relative to the company's financial performance. For
example, absent performance criteria and appropriate limits, it would be
inappropriate to approve a resolution entitling an executive to a bonus equal to
a substantial portion of a company's profits.
Retirement benefits for nonexecutive directors are inappropriate, as they
increase the directors' financial reliance on the company and could call into
question the objectivity of their decision-making. In addition, most directors
have served as senior executives of other companies, and adequate retirement
benefits should be provided through these
companies. The only caveat to this policy would be for professional nonexecutive
directors such as those found in the United Kingdom. However, requests for such
benefits in the United Kingdom are rare, and the appropriateness of using
shareholder funds in this manner is questionable.
DISCHARGE OF BOARD AND MANAGEMENT
ISS GENERAL RECOMMENDATION & POLICY
Vote FOR discharge of the board and management, unless:
. there are serious questions about actions of the board or management for the
year in question; or
. legal action is being taken against the board by other shareholders.
DISCUSSION
The annual formal discharge of board and management represents shareholder
approval of actions taken during the year. Discharge is a tacit vote of
confidence in the company's management and policies. It does not necessarily
eliminate the possibility of future shareholder action, although it does make
such action more difficult to pursue. Meeting agendas normally list proposals to
discharge both the board and management as one agenda item.
This is a routine item in many countries. Discharge is generally granted unless
a shareholder states a specific reason for withholding discharge and plans to
undertake legal action. Withholding discharge is a serious matter and is
advisable only when a shareholder has concrete evidence of negligence or abuse
on the part of the board or management, has plans to take legal action, or has
knowledge of other shareholders' plans to take legal action.
If evidence suggests that one or more board or management members are
responsible for problems such as fraud or grave mismanagement, shareholders can
withhold discharge from these individuals and pursue further legal action. Poor
performance that can be directly linked to flagrant error or neglect on the part
of the board or management, or board actions that are detrimental to
shareholders' interests, may also constitute grounds for voting against
discharge.
If shareholders approve discharge of the board and management, they will face a
greater challenge if they subsequently decide to pursue legal action against
these parties. Shareholders would be required to prove that management or the
board did not supply correct and complete information regarding the matter in
question.
DIRECTOR, OFFICER, AND AUDITOR INDEMNIFICATION AND LIABILITY PROVISIONS
ISS GENERAL RECOMMENDATION & POLICY
Vote proposals seeking indemnification and liability protection for directors
and officers on a CASE-BY-CASE basis.
Vote AGAINST proposals to indemnify auditors.
DISCUSSION
The scope of directors' and officers' indemnification and liability provisions
varies by market. Within reason, ISS seeks to respect the indemnification and
liability protections applicable in each market, but some markets allow
companies to provide indemnification and liability protection that we deem
excessive. In general, ISS believes that officers and directors should only be
eligible for indemnification and liability protection if they have acted in good
faith on company business and were found innocent of any civil or criminal
charges for duties performed on behalf of the company. Providing indemnification
and liability protection beyond such levels would effectively absolve officers
and directors of their duties to shareholders. ISS recognizes that limiting a
company's ability to provide liability and indemnification protection may limit
its ability to attract and retain qualified directors and executives and that
indemnification provisions afford directors and officers protection to take
risks and maximize shareholder wealth. However, ISS also believes that providing
liability and indemnification protection in excess of that outlined above could
unfairly prejudice shareholders in holding officers and directors accountable
and that the level of protection allowed under our guidelines represents a
reasonable compromise.
When evaluating indemnification and liability provisions in more developed
markets that enumerate the duty of loyalty and the duty of care, ISS also takes
into account the liability and indemnification provisions contained in ISS's
U.S. Proxy Voting Guidelines.
Although ISS supports indemnifying directors and officers, ISS opposes providing
these protections to auditors. These payments call into question the objectivity
of the auditor in carrying out the audit, as the fees paid on its behalf could
be greater than the audit fees alone. Eliminating concerns about being sued for
carelessness could also lead to a decrease in the quality of the audit. Given
the substantial settlements against auditors in recent years for poor audit
practices, the cost of such insurance to the company and its shareholders is
unwarranted.
BOARD STRUCTURE
ISS GENERAL RECOMMENDATION & POLICY
Vote FOR proposals to fix board size.
Vote AGAINST the introduction of classified boards and mandatory retirement ages
for directors.
Vote AGAINST proposals to alter board structure or size in the context of a
fight for control of the company or the board.
DISCUSSION
Resolutions relating to board structures range from fixing the number of
directors or establishing a minimum or maximum number of directors to
introducing classified boards and director term limits.
BOARD SIZE
Proposals to fix board size are common and are routinely approved. Proposals to
establish a range of board size are also frequent; a range of two or three open
slots relative to the existing board size is reasonable, as it gives the company
some flexibility to attract potentially valuable board members during the year.
Latitude beyond this range is inappropriate, however, because companies can use
this freedom to hinder unwanted influence from potential acquirers or large
shareholders.
ADOPT CLASSIFIED BOARD
ISS prefers that all directors stand for reelection every year. All directors
should be accountable to shareholders on an annual basis, as the ability to
elect directors is the single most important use of the shareholder franchise.
While classified boards are the norm in most countries, some companies have
chosen to place their directors up for annual election. ISS supports initiatives
to declassify boards and opposes proposals to classify previously unstaggered
boards. Classifying the board makes it more difficult to effect a change of
control through a proxy contest; because only a minority of the directors are
elected each year, a dissident shareholder would be unable to win control of the
board in a single election.
INTRODUCTION OF MANDATORY AGE OF RETIREMENT
ISS believes that age should not be the sole factor in determining a director's
value to a company. Rather, each director's performance should be evaluated on
the basis of their individual contribution and experience.
ALTERING BOARD SIZE
Companies may attempt to increase board size in order to add related or
like-minded directors to the board. Conversely, establishing a minimum number of
directors could make it easier to remove independent directors from the board.
ISS considers these proposals on a case-by-case basis.
All proposals to alter board size during a proxy fight or other possible
contests for control should be opposed. Allowing directors to alter the terms of
a contest while it is underway is not in shareholders' interests, as this tactic
could be used to thwart a takeover that is in shareholders' interests.
TWO-TIERED BOARDS
Companies in many countries have a two-tiered board structure, comprising a
supervisory board of nonexecutive directors and a management board with
executive directors. The supervisory board oversees the actions of the
management board, while the management board is responsible for the company's
daily operations. Companies with two-tiered boards elect members to the
supervisory board only; management board members are appointed by the
supervisory board. In Austria, Brazil, the Czech Republic, Germany, Peru,
Poland, Portugal, and Russia, two-tiered boards are the norm. They are also
permitted by company law in France and Spain.
CAPITAL SYSTEMS
Companies have one of two main types of capital systems: authorized and
conditional. Both systems provide companies with the means to finance business
activities, but they are considerably different in structure. Which system is
used by a company is determined by the economic and legal structure of the
market in which it operates.
AUTHORIZED CAPITAL SYSTEM
The authorized capital system sets a limit in a company's articles on the total
number of shares that can be issued by the company's board. The system allows
companies to issue shares from this preapproved limit, although in many markets
shareholder approval must be obtained prior to an issuance. Companies also
request shareholder approval for increases in authorization when the amount of
shares contained in the articles is inadequate for issuance authorities. ISS
reviews proposals for such increases based on the following criteria: the
history of issuance requests; the size of the request; the purpose of the
issuance (general or specific) associated with the increase in authorization;
and the status of preemptive rights (see pol.19 and pol.21).
CONDITIONAL CAPITAL SYSTEM
Under the conditional capital system, companies seek authorizations for pools of
capital with fixed periods of availability. For example, if a company seeks to
establish a pool of capital for general issuance purposes, it requests the
creation of a certain number of shares with or without preemptive rights,
issuable piecemeal at the discretion of the board for a fixed period of time.
Shares unissued after the fixed time period lapse. This type of authority would
be used to carry out a general rights issue or small issuances without
preemptive rights.
Requests for a specific issuance authority are tied to a specific transaction or
purpose, such as an acquisition or the servicing of convertible securities. Such
authorities cannot be used for any purpose other than that specified in the
authorization. In this case, a company requests the creation of a certain number
of shares with or without preemptive rights, issuable as needed for the specific
purpose requested. This pool of conditional capital also carries a fixed
expiration date.
In reviewing these proposals, ISS takes into consideration the existence of
pools of capital from previous years. Because most capital authorizations are
for several years, new requests may be made on top of the existing pool of
capital. While most requests contain a provision to eliminate earlier pools and
replace them with the current request, this is not always the case. Thus, if
existing pools of capital are being left in place, the aggregate potential
dilution amount from all capital should be considered.
SHARE ISSUANCE REQUESTS
ISS GENERAL RECOMMENDATION & POLICY
General Issuances:
Vote FOR issuance requests with preemptive rights to a maximum of 100 percent
over currently issued capital.
Vote FOR issuance requests without preemptive rights to a maximum of 20 percent
of currently issued capital.
Specific Issuances:
Vote on a CASE-BY-CASE basis on all requests, with or without preemptive rights.
GENERAL ISSUANCES
General issuance requests under both authorized and conditional capital systems
allow companies to issue shares to raise funds for general financing purposes.
Approval of such requests gives companies sufficient flexibility to carry out
ordinary business activities without having to bear the expense of calling
shareholder meetings for every issuance.
Issuances can be carried out with or without preemptive rights. Preemptive
rights permit shareholders to share proportionately in any new issuances of
stock. These rights guarantee existing shareholders the first opportunity to
purchase shares of new issuances of stock in the class they own in an amount
equal to the percentage of the class they already own. Corporate law in many
countries recognizes preemptive rights and requires shareholder approval for the
disapplication of such rights.
ISS believes that the ability to double share capital through a rights issue
(with preemptive rights) provides the company with sufficient financing to meet
most contingencies. Rights issues for general capital needs of more than 100
percent of outstanding capital warrant shareholder approval. Issuance
authorities of more than 100 percent can lead to excessive cash calls on
shareholders, requiring them to provide the funds necessary to maintain their
relative positions in the company or to accept substantial dilution.
In some cases, companies may need the ability to raise funds for routine
business contingencies without the expense of carrying out a rights issue. Such
contingencies could include the servicing of option plans, small acquisitions,
or payment for services. When companies make issuance requests without
preemptive rights, shareholders suffer dilution as a result of such issuances.
Therefore, authorizations should be limited to a fixed number of shares or a
percentage of capital at the time of issuance. While conventions regarding this
type of authority vary widely among countries, ISS routinely approves issuance
requests without preemptive rights for up to 20 percent of a company's
outstanding capital.
Stock exchange listing rules also play a factor in determining the acceptability
of share issuance requests. In some markets, companies may ask for the authority
to issue all of their authorized but unissued share capital, yet the country's
stock exchange prevents a company from issuing more than ten percent of the
company's share capital in any one year without seeking additional shareholder
approval. Another example is global companies that are listed on NASDAQ or the
New York Stock Exchange (NYSE). Generally speaking, companies listed on NASDAQ
and the NYSE must seek shareholder approval for any issuance of shares or of
securities convertible into shares in excess of 20 percent of the company's
outstanding shares at the time of issuance. If stock exchange listing
requirements include adequate safeguards with respect to share issuances, ISS
will approve the request unless there are specific concerns with the company.
SPECIFIC ISSUANCES
Specific issuance requests should be judged on their individual merits. For
example, a company may request the issuance of shares for an acquisition in the
form of a rights issue to raise funds for a cash payment, or else a company
could request an issuance without preemptive rights for use in a share-based
acquisition or issuance to a third party. Such a request could be of any size,
and ISS recommends approval as long as the proposal is sound. A more routine
request would be an authority to issue shares without preemptive rights for
issuance as needed upon conversion of convertible securities or to service a
share option plan. These shares can only be used for the purpose defined in the
resolution.
INCREASES IN AUTHORIZED CAPITAL
ISS GENERAL RECOMMENDATION & POLICY
Vote FOR nonspecific proposals to increase authorized capital up to 100 percent
over the current authorization unless the increase would leave the company with
less than 30 percent of its new authorization outstanding.
Vote FOR specific proposals to increase authorized capital to any amount,
unless:
. the specific purpose of the increase (such as a share-based acquisition or
merger) does not meet ISS guidelines for the purpose being proposed; or
. the increase would leave the company with less than 30 percent of its new
authorization outstanding after adjusting for all proposed issuances.
Vote AGAINST proposals to adopt unlimited capital authorizations.
DISCUSSION
Increases in authorized capital are requested both for general financing
flexibility and to provide for a specific purpose. Companies need an adequate
buffer of unissued capital in order to take advantage of opportunities during
the year, thus they often request increases in authorized capital for no
specific purpose other than to retain this flexibility. ISS believes that
approving such requests is reasonable.
An increase of 100 percent over the existing authorization gives the company
sufficient flexibility in any given year, but requiring that at least 30 percent
of the new authorization be outstanding also limits the company's ability to
abuse this privilege. If a company wishes to issue shares for any unforeseen
reason during the year that would double (or possibly triple) outstanding share
capital, an EGM to seek shareholder approval is justified.
Another important consideration is the status of preemptive rights. Not all
countries recognize shareholders' preemptive rights, and excessive
authorizations could lead to substantial dilution for existing shareholders.
When preemptive rights are not guaranteed, companies do not need shareholder
approval for share issuances as long as the issuance does not result in an
increase above the authorized capital limit.
For specific requests, increases in capital up to any size may be justified if
the purpose of the new authorization is in shareholders' interests. Such
increases may be needed to fund a variety of corporate activities, thus each
proposal must be reviewed on its individual merits. However, the same concerns
with dilution exist if the outstanding capital is still less than 30 percent of
the new authorization after all issuances take place.
ISS recommends that shareholders vote against proposals seeking to increase
authorized capital to an unlimited number of shares. ISS does not believe that
companies need unlimited financial flexibility to transact ordinary business
because such an arrangement precludes management from periodically consulting
shareholders for new capital. Unlimited authorizations may also be used as
antitakeover devices, and they have the potential for substantial voting and
earnings dilution. As such, they are not in shareholders' best interests.
PREFERRED STOCK
ISS GENERAL RECOMMENDATION & POLICY
Vote FOR the creation of a new class of preferred stock or for issuances of
preferred stock up to 50 percent of issued capital unless the terms of the
preferred stock would adversely affect the rights of existing shareholders.
Vote FOR the creation/issuance of convertible preferred stock as long as the
maximum number of common shares that could be issued upon conversion meets ISS's
guidelines on equity issuance requests.
Vote AGAINST the creation of a new class of preference shares that would carry
superior voting rights to the common shares.
Vote AGAINST the creation of blank check preferred stock unless the board
clearly states that the authorization will not be used to thwart a takeover bid.
Vote proposals to increase blank check preferred authorizations on a
CASE-BY-CASE basis.
DISCUSSION
Preferred stock is an equity security, but also has certain features that liken
it to debt instruments, such as fixed dividend payments, seniority of claims
relative to regular common stock, and (in most cases) no voting rights except on
matters that affect the seniority of preferred stock as a class. Preferred stock
usually ranks senior to a company's ordinary shares with respect to dividends
and the distribution of assets or winding up of the company. Preferred stock can
be an effective means of raising capital without increasing debt levels,
especially if a company has recently concluded a series of acquisitions.
In determining the acceptability of proposals relating to preferred stock, ISS
examines the rights and terms of the proposed shares, including their
designation, conditions, restrictions, and limitations. ISS prefers that the
terms of preferred stock be set out at the time of the issuance or authorization
request. Also important is the company's justification for issuing or
authorizing preferred stock. Whether or not the preferred shares carry voting
rights is also considered, especially if the preferred stock will feature
superior voting rights to the common shares. While ISS believes that preferred
shares are a valid form of financing, we also believe that the creation or
issuance of preference shares should be limited to 50 percent of a company's
share capital. ISS will also oppose cases where there has been evidence of
management abuse of a past issuance authority.
VOTING PREFERRED STOCK
In some markets, preferred stock carries voting rights. Such preference shares
may carry voting rights equal to the voting rights of the common shares or may
carry multiple voting rights. In such cases, ISS's guidelines on capital
structure are applied. ISS supports a one share, one vote policy and opposes
measures that seek to establish dual-class capital structures. However, if a
company already has a preference share authorization with different voting
rights than the common shares, ISS will approve additional issuances of the
preference shares, as long as issuances of these preferred shares are limited
and do not adversely affect the rights of common shareholders.
CONVERTIBLE PREFERRED STOCK
Companies may also seek approval for the creation or issuance of preferred stock
that is convertible into common stock. If the shares are convertible into common
shares, ISS evaluates the conversion ratio and calculates the maximum number of
shares that could be issued upon conversion to determine the potential amount of
dilution that could result for common shareholders as a result of the proposal.
ISS's equity issuance guidelines are then applied to determine whether the level
of dilution is in shareholder's best interests.
BLANK CHECK PREFERRED STOCK
Companies may also seek shareholder approval for blank check preferred stock,
which refers to blanket authorities to issue preferred stock under which the
directors are allowed to set the size, terms, and recipient of such shares at
the time of issuance. Blank check preferred stock can be used for legitimate
corporate purposes such as raising capital or making acquisitions. By not
establishing the terms of preferred stock at the time the class of stock is
created, companies maintain the flexibility to tailor their preferred stock
offerings to prevailing market conditions. However, blank check preferred stock
can also be used as an entrenchment device. The ability to issue a block of
preferred stock with multiple voting or conversion rights to a friendly investor
is a powerful takeover defense.
ISS supports blank check preferred stock proposals as long as the proposal
states that the shares will not be issued as a takeover defense. ISS also
considers, on a case-by-case basis, proposals to increase authorizations of
blank check preferred stock when shareholders have already approved the class of
stock and the company has a history of issuing such stock for legitimate
financing purposes. Theoretically, companies with authorized blank check
preferred stock can use these shares for antitakeover purposes as long as there
are a few shares remaining, as they are free to set voting or conversion terms
with each issue. Therefore, an increase in authorization may have little effect
on the usage of this stock. In cases where a company has issued preferred stock
from its authorization for legitimate financing purposes, there is no reason to
object to an increase.
REDUCTION OF CAPITAL
ISS GENERAL RECOMMENDATION & POLICY
Vote FOR proposals to reduce capital for routine accounting purposes unless the
terms are unfavorable to shareholders.
Vote proposals to reduce capital in connection with corporate restructuring on a
CASE-BY-CASE basis.
DISCUSSION
Proposals to reduce capital can cover a variety of corporate actions, ranging
from routine accounting measures to reductions pertaining to a significant
corporate restructuring in the face of bankruptcy. In addition, proposals to
reduce capital can vary significantly from market to market as a result of local
laws and accounting standards. Some examples of capital reduction proposals
found overseas include:
REDUCTION IN STATED CAPITAL
One example of this type of proposal asks shareholders to allow the board to
reduce the company's deficit and create a contributed surplus by effecting a
reduction in the state capital of the company's common shares. A company may
take this action if its net assets are in danger of falling below the aggregate
of its liabilities and its stated capital. Should that situation occur, under
some corporate law statutes the company would be prohibited from paying
dividends on its shares. ISS usually supports such proposals as they are
considered to be routine accounting measures. This type of proposal is seen
often in Canada.
REDUCTION IN CONNECTION WITH CANCELLATION OF REPURCHASED SHARES
A company may also seek a reduction in capital corresponding to the cancellation
of shares repurchased in connection with an earlier buyback authorization. The
amount of equity that may be cancelled is usually limited to ten percent by
national law. This type of proposal is seen most often in Scandanavia, Japan,
Spain, and some Latin America markets and is considered a routine accounting
measure.
REDUCTION IN CONNECTION WITH DIVIDEND PAYMENTS
If a board determines growth in income to be insufficient to enable the payment
of a dividend, it may propose to lower the par value of the company's shares and
pay the difference in par value back to the shareholders, effecting a
corresponding reduction in capital. Such reduction is normally effected
proportionately against all outstanding capital, and therefore does not involve
any material change relative to shareholder value. Thus, ISS generally
recommends that shareholders vote for these proposals, which are most often seen
in Switzerland, Spain, and some Latin American markets.
REDUCTION IN CONNECTION WITH REPAYMENT AND CANCELLATION OF DEFERRED SHARES AND
PREFERENCE SHARES
Companies may also seek approval for the reduction of share capital pursuant to
a repayment and cancellation of deferred shares or preference shares. Deferred
shares may be created as bonus shares by a company capitalizing credit from a
share premium account pursuant to a reorganization plan, for example, to return
excess capital back to shareholders. The company then repurchases the bonus
shares in exchange for cash equal to their nominal value and cancels them
through a capital reduction. Companies that have preference shares outstanding
may also request to cancel and repay these shares which may no longer be
required for the carrying out of their financial objectives and may accrue
administration costs which have become disproportionate to the benefits of
maintaining such shares. Preference shares also carry certain rights that
restrict the flexibility of conducting certain corporate actions, in particular
share repurchases, which is another reason why companies propose to cancel such
shares. In either case, ISS supports such reductions as they simplify capital
structure and save on administration costs and remove certain restrictions
associated with preference shares. This type of proposal is commonly seen in the
United Kingdom.
REDUCTION IN CONNECTION WITH RESTRUCTURING
As noted above, some proposals to reduce capital are made in connection with a
significant corporate restructuring. ISS generally supports such proposals
because opposition could lead to insolvency, which is not in shareholders'
interests. Evaluation of this type of proposal should take a realistic approach
to the company's situation and the future prospects for shareholders.
CAPITAL STRUCTURES
ISS GENERAL RECOMMENDATION & POLICY
Vote FOR resolutions that seek to maintain or convert to a one share, one vote
capital structure.
Vote AGAINST requests for the creation or continuation of dual class capital
structures or the creation of new or additional supervoting shares.
DISCUSSION
A key decision for any business is determining its capital structure. When timed
correctly, sophisticated capital management-finding the right mix of equity,
long-term debt, and short-term financing-can enhance shareholder returns. This
process involves coordination of important issues, including dividend policy,
tax and interest rates, types of assets, opportunities for growth, ability to
finance new projects internally, and cost of obtaining additional capital.
These decisions are best left to a company's board and senior management, who
should be given the latitude to determine the company's capital structure.
However, shareholders should be aware that many financing decisions could have
an adverse effect on shareholder returns. For example, additional equity
financing may reduce an existing shareholder's ownership interest and can dilute
the value of the investment. Some capital requests can be used as takeover
defenses; in response to this situation, company laws establish limits on
management's authority to issue new capital and often require shareholder
approval for significant changes in management's existing authorizations.
ISS supports a one share, one vote policy and opposes mechanisms that skew
voting rights. Shareholders' voting rights should accrue in accordance with
their equity capital commitment to the company. Dual class capital structures
entrench certain shareholders and management, insulating them from possible
takeovers or other external influence or action. The interests of parties with
voting control may not be the same as those of shareholders constituting a
majority of the company's capital. Additionally, research and market experience
have shown that companies with dual class capital structures or other
antitakeover mechanisms consistently trade at a discount to similar companies
without such structures.
When companies with dual class capital structures seek shareholder approval for
the creation of new shares, ISS opposes the creation of additional supervoting
shares because this perpetuates the dual class structure. If companies are
seeking to increase ordinary or subordinate share capital, ISS reviews such
requests on a case-by-case basis. If the shares are needed for a specific
purpose, ISS recommends approval as long as the proposal meets the issuance
guidelines for specific requests. Refusing such requests could cause an
immediate loss of shareholder value by not allowing the company to carry out its
ordinary business. However, ISS opposes general share creation requests on the
grounds that they would perpetuate unequal voting structures. If shareholders
routinely approve the creation of ordinary or subordinate voting shares, the
company has no incentive to reform its capital structure. By not approving such
requests, shareholders can send a signal of dissatisfaction to management.
DEBT ISSUANCE REQUESTS
ISS GENERAL RECOMMENDATION & POLICY
Vote nonconvertible debt issuance requests on a CASE-BY-CASE basis, with or
without preemptive rights.
Vote FOR the creation/issuance of convertible debt instruments as long as the
maximum number of common shares that could be issued upon conversion meets ISS's
guidelines on equity issuance requests.
Vote FOR proposals to restructure existing debt arrangements unless the terms of
the restructuring would adversely affect the rights of shareholders.
DISCUSSION
Debt issuance is a popular financing strategy in world markets. Companies
routinely issue bonds directly to shareholders in order to raise funds while
enjoying low borrowing costs, although bonds are also often issued without
preemptive rights. The issuance of unsecured debt can often include warrants,
which are detached at the time of bond issuance. Warrants are usually attached
to a debt issuance in order to enhance the marketability of the accompanying
fixed income security. Debt instruments are often issued with the right to
convert into equity securities. Convertible bonds give holders the choice of
becoming shareholders, thereby increasing the shareholder base and liquidity of
the company's stock, or selling their newly converted shares on the open market.
In addition, many companies issue debt denominated in currencies other than that
of their home market.
When evaluating a debt issuance request, ISS determines the type of debt
instrument being issued, the characteristics of the instrument (including
whether or not it is convertible into common stock), the intended recipient of
the issuance, and the company's justification for the issuance.
In the case of convertible debt, ISS evaluates the conversion ratio and
calculates the maximum number of shares that could be issued upon conversion to
determine the potential amount of dilution that could result from the proposal.
ISS's equity issuance guidelines are then applied to determine whether the level
of dilution is in shareholders' best interests.
In the case of nonconvertible debt, ISS takes into account the size and purpose
of the increase, and the board's use of past authorizations including examining
whether there has been a history of abuse of the authorities. ISS looks at the
company's current financial situation, specifically examining its current
debt-to-equity ratio, or gearing level. A high gearing level may incline markets
and financial analysts to downgrade the company's bond rating, increasing its
investment risk factor in the process. ISS also considers other factors such as
the company's growth over the past five years relative to earnings or market
capitalization, recent corporate events that might affect the company's bottom
line (such as the acquisition of a major competitor or the release of a
revolutionary product), and the normal debt levels in the company's industry and
country of origin. Although all of these considerations are factored into ISS's
analysis of debt issuance proposals, ISS generally believes that such financing
concerns are best decided by management. ISS will, however, issue vote
recommendations against such proposals in cases where there has been evidence of
management abuse of an authority, where the proposal is not in line with market
practices, or extreme cases where shareholders' rights could be negatively
affected.
Companies may also seek shareholder approval to restructure existing debt
arrangements. ISS generally supports restructuring proposals, particularly if
the company is in danger of default. However, ISS will oppose restructuring
proposals in which common shareholders are being treated unfairly.
PLEDGING OF ASSETS FOR DEBT
ISS GENERAL RECOMMENDATION & POLICY
Vote proposals to approve the pledging of assets for debt on a CASE-BY-CASE
basis.
DISCUSSION
In certain countries, shareholder approval is required when a company needs to
secure a debt issuance with its assets. In many cases, this is a routine request
and is a formality under the relevant law. When reviewing such proposals, ISS
takes into account the terms of the proposed debt issuance and the company's
overall debt level. If both of these factors are acceptable, ISS recommends
supporting these requests.
INCREASE IN BORROWING POWERS
ISS GENERAL RECOMMENDATION & POLICY
Vote proposals to approve increases in a company's borrowing powers on a
CASE-BY-CASE basis.
DISCUSSION
In some countries, companies are required to seek shareholder approval for
increases in their aggregate borrowing power authorities. The aggregate limit on
the board's ability to borrow money is often fixed in a company's articles, and
shareholder approval to change this limit is therefore legally required. ISS
believes that a company's financing needs are best determined by the board, and
modest increases in borrowing powers are necessary to allow the company to take
advantage of new acquisition opportunities or to complete development and
restructuring projects. ISS's analysis of borrowing power increase requests take
into account management's stated need for the increase, the size of the
increase, and the company's current gearing level. Large increases in borrowing
powers can sometimes result in dangerously high debt-to-equity ratios that could
harm shareholder value. If an increase is excessive without sufficient
justification and if a company already has exceptionally high gearing compared
to its industry, ISS recommends opposing the request.
SHARE REPURCHASE PLANS
ISS GENERAL RECOMMENDATION & POLICY
Vote FOR share repurchase plans, unless:
. clear evidence of past abuse of the authority is available; or
. the plan contains no safeguards against selective buybacks.
DISCUSSION
Proposals regarding share repurchase plans are routine in most countries, and
such plans are usually sufficiently regulated by local laws or listing
requirements to protect shareholder interests.
ISS looks for the following conditions in share repurchase plans: limitations on
a company's ability to use the plan to repurchase shares from third parties at a
premium; limitations on the exercise of the authority to thwart takeover
threats; and a requirement that repurchases be made at arm's length through
independent third parties and that selective repurchases require shareholder
approval.
Some shareholders object to companies repurchasing shares, preferring to see
extra cash invested in new businesses or paid out as dividends. ISS believes
that when timed correctly, stock repurchases are a legitimate use of corporate
funds and can add to long-term shareholder returns.
REISSUANCE OF SHARES REPURCHASED
ISS GENERAL RECOMMENDATION & POLICY
Vote FOR requests to reissue any repurchased shares unless there is clear
evidence of abuse of this authority in the past.
DISCUSSION
ISS generally believes that properly timed repurchases of company shares can
enhance shareholder value and improve general shareholder returns. With good
timing and proper safeguards, the same returns and improvements in shareholder
value can be generated through the reissuance of the shares repurchased. In most
countries, the text of this general mandate provides sufficient shareholder
protection to make this item routine. When reviewing such proposals, ISS takes
into account the country's legal framework for such reissuances and the
company's history of reissuing shares under the authority.
CAPITALIZATION OF RESERVES FOR BONUS ISSUES/INCREASE IN PAR VALUE
ISS GENERAL RECOMMENDATION & POLICY
Vote FOR requests to capitalize reserves for bonus issues of shares or to
increase par value.
DISCUSSION
Companies routinely carry out bonus issues of shares or increases in par value
to existing shareholders, usually through the capitalization of reserves from
either the share premium reserve or the retained earnings account.
Capitalization of these reserves-transferring them into the share capital
account-usually requires shareholder approval. These issuances essentially
function as dividends.
When companies increase par value or capitalize reserves and distribute new
fully paid shares to shareholders free of charge through a bonus issue, there is
no cost to shareholders to maintain their stakes and no risk of dilution. This
procedure transfers wealth to shareholders and does not significantly impact
share value. The only impact on shareholders is that by increasing the number of
shares on issue, the company could increase liquidity, enhance marketability,
and ultimately expand its shareholder base.
REORGANIZATIONS/RESTRUCTURINGS
ISS GENERAL RECOMMENDATION & POLICY
Vote reorganizations and restructurings on a CASE-BY-CASE basis.
DISCUSSION
Requests to approve corporate reorganizations or restructurings range from the
routine shuffling of subsidiaries within a group to major rescue programs for
ailing companies. ISS usually approves such resolutions unless there are clear
conflicts of interest among the various parties, shareholders' rights are being
negatively affected, or certain groups or shareholders appear to be getting a
better deal at the expense of general shareholders.
In the case of routine reorganizations of assets or subsidiaries within a group,
ISS's primary focus with the proposed changes is to ensure that shareholder
value is being preserved. This includes the effect of the reorganization on the
control of group assets, the final ownership structure, the relative voting
power of existing shareholders if the share capital is being adjusted, and the
expected benefits arising from the changes.
In the case of a distress restructuring of a company or group, shareholders'
options are far more limited; often, they have no choice but to approve the
restructuring or lose everything. In such cases, ISS first determines the
company's degree of distress by determining whether or not the company still has
a positive net asset value-that is, if realizable assets are greater than
liabilities. Although rare, liquidation should be considered an option in these
situations.
In most cases, however, the company has a negative asset value, meaning that
shareholders would have nothing left after a liquidation. ISS seeks to ensure
that the degree of dilution proposed is consistent with the claims of outside
parties and is commensurate with the relative commitments of other company
stakeholders. Existing shareholders usually must accept the transfer of majority
control over the company to outside secured creditors. Ultimately, ownership of
a small percentage of something is worth more than majority ownership of
nothing.
MERGERS AND ACQUISITIONS
ISS GENERAL RECOMMENDATION & POLICY
Vote FOR mergers and acquisitions, unless:
. the impact on earnings or voting rights for one class of shareholders is
disproportionate to the relative contributions of the group; or
. the company's structure following the acquisition or merger does not reflect
good corporate governance.
Vote AGAINST if the companies do not provide sufficient information upon request
to make an informed voting decision.
ABSTAIN if there is insufficient information available to make an informed
voting decision.
DISCUSSION
When evaluating the merits of a proposed acquisition, merger, or takeover offer,
ISS focuses on the impact of the proposal on shareholder value, both in the
immediate and long term. The primary concern is to determine whether or not the
proposal is beneficial to shareholders' existing and future earnings stream and
to ensure that the impact on voting rights is not disproportionate to that
benefit. Although ISS examines these proposals primarily from a corporate
governance perspective, a variety of other factors are considered, including the
financial terms of the transaction and the strategic rationale for the proposal.
In the case of an acquisition, ISS examines the level of voting or earnings
dilution and the logic of the proposed purchase if large share issuances are
required. The method of financing is also important, as various methods can
result in different valuations than originally perceived. ISS also checks for an
independent valuation of the terms, particularly if the target of the
acquisition is not a publicly traded entity or asset and precise market
valuations are not readily available. ISS also considers the control premium in
the transaction. Control premiums on acquisitions vary widely depending on the
industry, the time period, and the country. For publicly traded entities or
assets, ISS looks at the price of the acquisition relative to the average market
price prior to any announcement, as well as the historical price trends for 60
days prior. For nonpublicly traded entities or assets, an independent financial
evaluation becomes even more important.
In the case of mergers, ISS examines whether or not the merger makes commercial
or strategic sense for the company. ISS also considers the method of effecting
the merger and the ultimate impact on shareholders of the proposed financial and
corporate governance structure. While historical relative valuations based on
market prices are useful in the financial evaluation process, the often
complicated financial details of such proposals make an independent fairness
opinion of extreme importance. The proposed board structure, share capital
structure, relative share ownership, and any takeover defenses of the new
company are all important factors for consideration in this evaluation process.
Obviously, levels of disclosure regarding merger and acquisition proposals will
vary greatly from market to market. In more developed markets, shareholders are
often provided with detailed financial and governance information as well as an
independent fairness opinion and in some cases, a formal valuation report. When
evaluating proposals in these markets, ISS relies primarily on the documents and
information provided by the company and its advisors. However, in
many emerging markets, detailed information regarding mergers and acquisistions
can be scarce. In these markets, ISS must rely more heavily on secondary
sources, including local shareholder associations, market reaction to the
proposed transaction, and news reports.
If the details of a given proposal are unclear or not available and a fairness
opinion (in markets where they are regularly provided) is also not available,
ISS recommends either abstaining on or voting against the proposal. Abstention
would most likely be the result of a lack of information about the proposal. If
a company is uncooperative in providing information about the proposal or is
evasive when responding to questions, ISS recommends voting against it.
MANDATORY TAKEOVER BID WAIVERS
ISS GENERAL RECOMMENDATION & POLICY
Vote proposals to waive mandatory takeover bid requirements on a CASE-BY-CASE
basis.
DISCUSSION
Many countries impose a bid threshold that forces any shareholder whose stake
exceeds the limit to tender a public bid to all the other owners to purchase the
remaining shares. The thresholds are imposed either by national law, stock
exchange rules, or a company's articles of association. This mandatory takeover
bid rule prohibits a shareholder from owning a large stake in the company and
having a dominating voice in the decision making without being required to
purchase the remainder of the shares. Without such a requirement, the other
shareholders, although potentially holding a substantial percentage of the
company's shares, would be left with relatively little say in decisions.
Mandatory bid requirements also seek to prevent 'creeping acquisitions' and to
ensure that shareholders, other than the controlling shareholder, receive a
control premium when control of the company shifts to the large shareholder.
ISS opposes proposals to exempt a large shareholder from the obligation to bid.
The requirement that a takeover bid should be launched when a substantial amount
of shares have been acquired prevents the entrenchment of the controlling
shareholder and protects minority owners.
ISS does make an exception to the mandatory takeover bid rule when the event
prompting the takeover bid is a repurchase by the company of its own shares.
When a company repurchases its own shares, the relative stake of a large
shareholder increases even though the number of shares held by the large
shareholder has not changed. In certain markets, notably the United Kingdom and
Ireland, the mandatory bid rules require a large shareholder to make a takeover
bid if its stake in the company is increased on a relative basis as a result of
a share repurchase by the company. Companies in these markets may seek a waiver
from the takeover bid requirement applicable to their large shareholder. Under
certain circumstances, ISS will support such a waiver, namely, if the share
repurchase would not push the large shareholder's stake in the company above 50
percent.
REINCORPORATION PROPOSALS
ISS GENERAL RECOMMENDATION & POLICY
Vote reincorporation proposals on a CASE-BY-CASE basis.
DISCUSSION
Reincorporation proposals are most commonly seen in Canada, where companies may
register under one of the provincial business statutes. However, companies in
other countries may also seek shareholder approval to reincorporate in a U.S.
state or another country. Many companies, including U.S. companies, choose to
reincorporate in places such as Bermuda, the Cayman Islands, or the British
Virgin Islands for tax purposes.
When examining a reincorporation proposal, ISS first examines the reasons for
the move. Sometimes a reincorporation proposal is part of a restructuring effort
or merger agreement that contributes significantly to a company's growth,
financial health, and competitive position more than the anticipated negative
consequences of incorporating in another province or country. Some
reincorporations allow firms to realize lower taxes or incorporation fees. In
addition, there may be advantages to incorporating in the province in which the
company conducts the bulk of its business.
Companies often adopt a new charter or bylaws with increased protection for
management upon reincorporation. For instance, many reincorporation proposals
are bundled with the ratification of a new charter that increases the company's
capital stock or imposes a classified board. When such changes to the charter
include the addition of negative corporate governance provisions, the impact of
these new provisions on shareholders must be balanced against the anticipated
benefits of the reincorporation.
ISS believes that reincorporations to countries, states, or provinces with less
stringent disclosure requirements or corporate governance provisions are often
management attempts to lessen accountability to shareholders. In such cases, ISS
recommends voting against the proposal. The expenses involved in a change of
domicile relating to legal and administrative fees, plus the greater
entrenchment such a reincorporation could provide management, would likely harm
shareholders' interests. In cases where companies propose to move to a more
protective province or country and supply reasonable financial reasons for doing
so, the benefits of the reincorporation must be weighed against the costs of
possible management entrenchment.
EXPANSION OF BUSINESS ACTIVITIES
ISS GENERAL RECOMMENDATION & POLICY
Vote FOR resolutions to expand business activities unless the new business takes
the company into risky areas.
DISCUSSION
Companies are usually required by law to include in their articles of
association or memorandum of association specific business purposes in the form
of an objects clause. Because most countries require shareholder approval before
articles can be amended, any change to the company's objects clause requires
shareholder approval. Countries often seek shareholder approval to amend the
objects clause to expand business lines.
Expanding business lines is a decision usually best left to management, but
there are some instances where ISS withholds support for such changes. If a
company has performed poorly for several years and seeks business expansion into
a risky enterprise, ISS would require further clarification from management
regarding the purpose of the expansion. If the company does not provide a
satisfactory business plan, ISS recommends that shareholders vote against the
proposal.
EXPANSION OF BUSINESS ACTIVITIES
ISS GENERAL RECOMMENDATION & POLICY
Vote FOR resolutions to expand business activities unless the new business takes
the company into risky areas.
DISCUSSION
Companies are usually required by law to include in their articles of
association or memorandum of association specific business purposes in the form
of an objects clause. Because most countries require shareholder approval before
articles can be amended, any change to the company's objects clause requires
shareholder approval. Countries often seek shareholder approval to amend the
objects clause to expand business lines.
Expanding business lines is a decision usually best left to management, but
there are some instances where ISS withholds support for such changes. If a
company has performed poorly for several years and seeks business expansion into
a risky enterprise, ISS would require further clarification from management
regarding the purpose of the expansion. If the company does not provide a
satisfactory business plan, ISS recommends that shareholders vote against the
proposal.
RELATED-PARTY TRANSACTIONS
ISS GENERAL RECOMMENDATION & POLICY
Vote related-party transactions on a CASE-BY-CASE basis.
DISCUSSION
Shareholders are often asked to approve commercial transactions between related
parties. A transaction between a parent company and its subsidiary, or a
company's dealings with entities that employ the company's directors, are
usually classified as related party transactions and are subject to company law
or stock exchange listing requirements that mandate shareholder approval.
Shareholder approval of these transactions is meant to protect shareholders
against insider trading abuses.
In most cases, both the rationale and terms of such transactions are reasonable.
ISS looks for evidence of an evaluation of the transaction by an independent
body, but this is not always available. Unless the agreement requests a
strategic move outside the company's charter or contains unfavorable terms, ISS
recommends that shareholders support the proposal.
COMPENSATION PLANS
ISS GENERAL RECOMMENDATION & POLICY
Vote compensation plans on a CASE-BY-CASE basis.
DISCUSSION
Disclosure on compensation in most countries is not as extensive as U.S.
disclosure. However, compensation plans are becoming more common on meeting
agendas of foreign companies, and the structures of these plans are of vital
interest to shareholders. When given the opportunity to review these structures,
ISS supports plans that motivate participants to focus on long-term shareholder
value and returns, encourage employee stock ownership, and more closely align
employee interests with those of shareholders.
For many years, ISS has employed a complex methodology for evaluating
compensation proposals in the United States, but this has only been possible
because of the extensive disclosure provided in U.S. proxy circulars. This
degree of disclosure is a reflection of strict regulatory requirements, investor
concern and activity, and corporate governance sophistication. Compensation is
not a topical issue in most non-U.S. markets, therefore the degree of
information available to evaluate such proposals is usually limited to basic
details. For this reason, ISS uses a simpler methodology for evaluating most
non-U.S. compensation proposals, but with the same goal of maximizing
shareholder value.
Beyond the problems presented by limited disclosure, local conditions and
traditions in particular countries also hinder the creation of a comprehensive
compensation evaluation procedure. Standard market practice in one country may
be illegal activity in another. Some countries establish numerical limits on the
number of shares available under their plans, while others have percentage
limits that apply over a specific length of time. Holding all global companies
to the strict standards of the United States, for example, could result in
recommendations against almost every compensation plan in many countries.
Conversely, making too many allowances for local practices may only encourage
poor governance standards over the long term.
ISS reviews three main types of compensation plans: stock option plans,
incentive plans, and share purchase plans. Also included in this section are
grants outside of plans. With the exception of the United Kingdom, where ISS
uses a compensation valuation model to evaluate the cost of stock-based
compensation plans, ISS analyzes plans in all other global markets by
calculating the dilution under a company's share plans and by analyzing plan
features.
STOCK OPTION PLANS
Stock option plans grant participants an option to buy company shares at a set
price (the exercise price). Shares are usually granted at market prices and may
be exercised when the company's share price reaches the exercise price.
Participants may then purchase the promised shares at the strike price and may
later sell the shares after their purchase (or after a defined holding period
when the shares may not be sold).
When evaluating stock option plans, ISS's first hurdle is obtaining information
regarding the key terms of the plan. Ideally, we would like to see the full text
of the plan, or a summary of the plan's key terms, with information on the
plan's dilution, exercise price/presence of discounts, administration and
participation, types of awards used, vesting provisions, and performance
criteria. However, in many markets, especially where companies are only
beginning to introduce stock-based compensation, information on key plan terms
can be quite limited. ISS generally supports
efforts to more closely align executive pay with shareholder interests, and
generally encourages companies to improve their compensation disclosure
practices. However, until disclosure standards improve in these markets, ISS
believes that it would be counterproductive to oppose all plans in a given
country on this basis. Still, some basic parameters are necessary in order for
ISS to consider supporting a compensation plan. At a minimum, ISS requires
information on the maximum potential dilution of a plan and information
concerning the exercise price. If a plan meets our guidelines on these two
points, ISS will support the plan. For markets where certain plan information is
regularly disclosed, and a company has failed to provide this information to
shareholders, ISS will vote against the plan on the basis of substandard
disclosure.
Among the criteria that ISS examines in evaluating stock option plans are the
following, generally organized from criteria of greater importance to criteria
of lesser importance:
SHARES RESERVED FOR ISSUANCE OF OPTIONS UNDER THE PLAN
The maximum number of shares ISS approves under a plan depends on the
classification of a company's stage of development as growth or mature. Growth
companies are usually smaller, in new industries requiring significant research
and development, and have restricted cash flows. A company in an established
industry but expanding rapidly, or a mature company that is experiencing an
extended period of rapid expansion, may also be classified as growth. Mature
companies are characterized by stable sales and revenue growth, production
efficiencies resulting from volume gains, and strong cash flow resulting from
developed products in the payoff stage.
For mature companies, shares available under stock option plans should be no
more than five percent of the issued capital at the time of approval under all
plans. For growth companies, shares available should be no more than ten percent
of the issued capital at the time of approval under all plans. However, ISS will
support plans at mature companies with dilution levels of up to ten percent if
the plan includes other positive features, such as challenging performance
criteria or premium-priced options. These features partially offset dilution
concerns, as their inclusion reduces the likelihood that options will become
exercisable unless there is a clear improvement in shareholder value.
For all companies, an absolute number of shares fixed at the time of approval is
ideal, but many countries do not include such a limit. In these cases, revolving
limits (a certain percentage of issued shares at any one time) of five percent
or ten percent are common. The practice of setting a percentage of shares
issuable over a certain number of years before or after the plan is adopted
appears to be a compromise between these first two methods. ISS prefers plans
where the limits are sufficiently spread out, e.g., five percent in five years,
ten percent in ten years. Revolving limits of ten percent in ten years should
also include 'flow-rate' restrictions that further limit the plan's dilution,
such as a cap of 'three percent in three years,' '2.5 percent in five years,' or
'one percent in one year.'
EXERCISE PRICE
ISS prefers that options be priced at not less than 100 percent of the shares'
fair market value on the date of grant. Usually this is taken as the closing
price of the company's shares on the day prior to the date of grant. Some
countries determine fair market value as an average of the trading price for the
five days prior to the date of grant. This is a common and acceptable practice.
Some emerging market countries use a 30-day average or longer to determine fair
market value; these resolutions must be reviewed on a case-by-case basis,
although provisions of longer than 30 days increase the possibility of
discounted options.
DISCOUNTED OPTIONS, RESTRICTED STOCK, AND STOCK GRANTS
Many countries allow for options to be granted at a discount to market prices.
ISS evaluates restricted stock, which is essentially a deeply discounted option
often with mandatory vesting provisions, in the same manner as a discounted
option. Restricted stock, which is generally offered at a 100-percent discount
and vests in three to five years, is most often seen in the United States, but
it is becoming increasingly popular in other jurisdictions. Stock grants are
another type of discounted award in which company shares may be granted outright
to recipients with no payment required for the receipt of shares. In the absence
of performance criteria (see below), ISS opposes grants of discounted options,
including restricted stock. Absent performance criteria or vesting provisions,
holders of discounted options or restricted stock have an incentive to cash in
their grants for an immediate return rather than hold on to their options for
future gains, thereby reducing or eliminating the incentive value of such
awards. ISS generally opposes stock grants as their incentive value is dubious.
In very rare cases, ISS may consider supporting a plan that includes discounted
options, including restricted stock, if the company has attached challenging
performance criteria to the options, including price hurdles. Performance-based
vesting provisions require tangible improvements in the company's financial
performance or share price before the discounted options or restricted shares
can be exercised. Performance criteria are evaluated by reference to both the
company's country of incorporation and industry. Recipients of discounted
options and restricted shares are required to tender less consideration, if any,
to exercise their awards than recipients of market-priced options are required
to tender; as a result, the former type of awards are more costly to
shareholders from an economic perspective. However, the higher performance
threshold imposed by suitably challenging performance criteria may mitigate the
higher economic costs.
In general, ISS does not believe that vesting provisions, however stringent,
sufficiently mitigate the excessive cost of discounted awards, but with respect
to the use of restricted stock in U.S.-style stock option plans seen in global
markets, ISS recognizes that restricted stock is a common feature of these
plans, that often these awards represent only a small portion (usually
significantly below one percent) of a company's outstanding share capital, and
that performance criteria are not common in U.S.-style plans. As a result, ISS
believes that it would be counterproductive to oppose all such plans solely on
the inclusion of restricted stock. However, ISS would only approve of plans that
set out strict limits on such grants, include stringent vesting provisions, and
that meet our guidelines in all other aspects.
PLAN ADMINISTRATION
ISS opposes allowing the administering committee to grant options to itself due
to the potential for abuse and conflicts of interest. Administration of plans
should be in the hands of directors who are unable to participate in the plan.
Plans administered by the full board should not allow voting by executive
directors; plans administered by remuneration committees should be composed
entirely of independent directors. Plans that allow nonexecutive directors to
participate should not give them any discretion on individual grants; instead,
an automatic system of grants should be introduced with fixed annual grants at
market prices on a fixed date. Alternatively, ISS approves of separate
nonexecutive director option plans with independent administration if the number
of shares reserved for such plans is limited. Shares reserved for director
plans, when combined with shares reserved for all of the company's stock option
plans should not exceed ISS's aggregate dilution limits. In addition, shares
reserved over the life of such a plan should not exceed one percent of a
company's outstanding share capital for mature companies and 1.6 percent for
growth-oriented companies for a five-year plan. Shares reserved for nonexecutive
director option grants in any one year should not exceed 0.2 percent for mature
companies and 0.3 percent for growth companies.
ELIGIBILITY AND PARTICIPATION
ISS prefers separate plans for employees, directors, and nonexecutive directors,
but most plans include all or some combination of these categories of
participants. Other global plans distinguish between full-time and part-time
employees or establish a set length of service to the company (usually one year)
before options may be granted. Most plans allow the administrating committee to
select plan participants.
PERFORMANCE CRITERIA AND VESTING PROVISIONS
Performance criteria and vesting provisions are important considerations when
evaluating a compensation plan, and the existence of long vesting provisions and
realistic performance criteria may compensate for minor shortcomings in a plan.
If a plan falls just beyond one of the above guidelines but has both performance
criteria and vesting provisions, support may be justified. The ultimate goal of
share option plans is to tie executive and employee remuneration to company
performance and to give key employees and executives incentive to stay with the
firm. We favor the inclusion of performance targets and graduated vesting
schedules because awards that are contingent upon sustained and measurable
improvements are more likely to fulfill their purpose of truly providing
incentive. However, if a plan meets all other aspects of ISS's guidelines, these
two criteria are not mandatory, unless the inclusion of such provisions are
standard in the company's country of incorporation and a company has failed to
include them.
OTHER FEATURES SPECIFIC TO OPTION PLANS
ISSUE TERMS
Some countries require optionees to pay a nominal fee (often equivalent to
$0.01) for every option received. This is common and acceptable, although many
companies that once enforced this provision are now deleting it from the rules
of their plans.
OPTION REPRICING
Some plans include specific provisions allowing for the repricing of options at
the board's discretion. ISS opposes plans that include option repricing when the
exercise price is reduced in response to a dropping share price. Repricing
outstanding options reduces the incentive that options provide to raise the
share price for shareholders.
FINANCIAL ASSISTANCE
Some plans offer participants loans to pay the full exercise price on their
options. If loans are part of a company's option plan, ISS prefers that loans be
made to employees as part of a broad-based, company-wide plan to encourage
ownership rather than being given only to executive directors. ISS also prefers
loans with interest set at market rates that must be paid back in full over a
reasonable length of time. The absence of these features does not necessary
warrant a recommendation against an option plan, but they are taken into
consideration in ISS's analysis of the plan.
PLANS FOR INTERNATIONAL EMPLOYEES
Many overseas companies introduce separate plans or delegate a special section
of their option plan to deal with tax considerations raised by having a large
number of employees working in other countries. Many of these plans contain
provisions that deal directly with particular U.S. tax code provisions on stock
options. ISS applies the same criteria to these plans as to country-specific
plans.
STOCK APPRECIATION RIGHTS
Stock appreciation rights (SARs) allow participants to receive the difference
between the exercise price and the market price at the date of exercise. Many
companies use SARs in lieu of regular options. While SARs do not result in the
dilution associated with large option exercises, there is little difference
between a SAR and a regular option from a shareholder perspective because the
financial cost to the company is the same. However, SARs do not encourage stock
ownership by participants because they involve no purchase or sale of company
stock. ISS reviews SARs in the context of the option plan under which they are
issued.
PHANTOM STOCK OPTION PLANS
Phantom stock options offer participants cash bonuses based on the increase in
share price during a set period of time. Phantom plans are distinct from SARs in
that they often form their own separate plan. Some companies will create a
phantom stock option plan to award employees who reside in countries that do not
allow stock-based compensation. Participants are designated a set number of
hypothetical (phantom) shares, on which the award is based. While ISS prefers
compensation plans that encourage employee ownership, SARs and phantom options
are an effective way to provide incentive.
SUPEROPTIONS
Superoptions exceed the limits in a particular country for the value of options
granted to any one individual, although they are usually tied to significantly
more restrictive vesting provisions and performance criteria. U.K. superoptions,
for example, exceed the Association of British Insurers' recommended limit that
options represent no more than four times a participant's salary, yet the
stricter performance criteria and longer vesting periods usually mitigate
excessive grants. Additionally, dilution resulting from superoptions has
historically been fairly moderate. Superoptions appear most often in advanced
markets with developed stock option plans.
DIVIDENDS UNDER OPTION AND DIVIDEND EQUIVALENT PAYMENT PROVISIONS
Most holders of stock options do not receive dividend payments. However, some
option plans allow participants to receive dividends or dividend equivalent
payments prior to the exercise of options. ISS believes that any economic
benefit derived from option plans should occur at the time of exercise.
USING REPURCHASED SHARES IN SHARE COMPENSATION PLANS
In many countries, companies use shares purchased on the market for use in their
compensation plans. In some cases, using repurchased shares is more efficient
than issuing new shares to participants on exercise. ISS also recognizes the
benefits to existing shareholders when repurchased shares are used to fund
option grants, as dilution to their interests is minimized. However, although
there is no cost to shareholders in terms of dilution of their voting interests,
buybacks still represent a very real cost to the company and shareholders. As a
result, if a company wants to use repurchased shares in its compensation plans,
ISS expects some kind of limitation on the number that can be used.
If a plan includes a specified limit on the total number of shares that could be
used and repurchased shares would count toward that limit, ISS recommends that
shareholders support the plan as long as it meets all other guidelines. However,
if repurchased shares would not count toward the plan's limit on newly issued
shares but would operate as an additional pool of shares, then ISS looks for an
additional limitation, either an aggregate numerical limit, a percentage limit,
or limitations on individual awards.
INCENTIVE PLANS
Share incentive plans tie key employees' compensation more directly to company
performance. Though most popular in the United Kingdom, incentive plans are
becoming increasingly popular across the globe. Incentive plans provide
participants with free grants of company shares (or, less frequently, cash
grants) in proportion with prearranged performance criteria-often earnings per
share measured against inflation or total shareholder return. These indicators
are frequently compared with those of other firms in the company's industry or
stock market index, creating a benchmark and a further determinant of the number
of shares granted to a particular participant. Proponents of incentive plans
note that they offer shareholders the potential for less dilution and that they
more directly encourage participants to focus on long-term company performance
through strict performance criteria tied to more than just share price
movements.
Most incentive plans are organized with strict vesting provisions, where
participants may not receive the share awards until after a period of three
years or more. Many plans also grant a percentage of the total amount reserved
for each participant on a sliding scale measured against performance criteria.
Performance criteria targets that have been satisfied only to a certain point
may represent disbursement of 25 percent of the shares or cash to a participant,
while 100-percent satisfaction may represent the full allotment of the grant.
From a shareholder perspective, this graduated system of performance criteria is
a major advance.
Evaluation of incentive plans is similar to that of option plans in that
acceptable dilution and impartial administration and eligibility remain key
factors for a positive recommendation. Insufficient performance criteria or
abbreviated vesting provisions are deciding factors as well.
EMPLOYEE STOCK PURCHASE PLANS AND SAVINGS-RELATED SHARE OPTION SCHEMES
Employee stock purchase plans and savings-related share option schemes
(together, ESPPs) provide employees an opportunity to purchase stock in their
company, often at a discount to market prices. Plans may operate via monthly
deductions from employees' paychecks, gathered and held for safekeeping by a
trust or bank, and used to purchase company stock on behalf of the employee.
ESPPs can lead to greater commitment from employees, provide performance
incentives, and provide all employees the opportunity to share in the company's
growth.
ESPPs differ from stock option plans in that in an ESPP, all eligible
participants have the option to participate in the plan and may choose how much
they wish to contribute to the plan, whereas in a stock option plan, the
administering committee chooses who actually participates in the plan, that is,
receives options under the plan. ISS recommends approval for many of these plans
because they encourage wide share ownership in the company among employees. When
analyzing ESPPs for global companies, ISS considers the following factors:
ELIGIBILITY
This is an important factor when considering ESPPs proposed by global companies.
For a plan to qualify as an ESPP, all full-time employees who have been with the
company for a reasonable amount of time (some plans also allow for participation
by part-time employees) must be eligible to participate in the plan, and more
important, eligible participants must have the ability to determine whether they
will participate and to what extent they will participate, subject to certain
limits, as discussed below.
DILUTION
Many markets, such as the United States, Canada, Ireland, and certain tax haven
markets, differentiate between shares reserved for ESPPs and shares reserved for
stock option plans. In these markets it is our practice to have separate
dilution limits (a) for shares reserved for ESPPs, and (b) shares reserved for
stock option plans. Other markets, notably the United Kingdom, do not reserve
separate pools of shares for ESPPs and option plans, therefore we cannot make
such distinctions.
For those markets that reserve a separate pool of shares for ESPPs, ISS policy
is to exclude such shares from our dilution calculations for stock option plans.
However, ISS policy provides that no more than five percent of a company's
shares may be reserved for ESPPs at any given time, with such five percent being
over and above the company's limit (either five or ten percent) reserved for
option plans. Accordingly, a company could have up to ten percent of its shares
reserved for option plans and five percent of its shares reserved for ESPPs at
any given time. Alternatively, ISS would consider a higher dilution limit for
ESPPs if the company in question sufficiently limited dilution under its option
plans.
For those markets that reserve a common pool of shares for ESPPs and stock
option plans, ISS policy is to evaluate the dilution under the common pool of
shares in accordance with the dilution limitations applicable to stock option
plans.
OFFERING PERIOD AND OFFERING PRICE
The offering period, also known as the purchase period, is the time period over
which a participant's contributions are accumulated for the purchase of shares
under the plan. The offering price is the company's share price taken on a
specific date, less the applicable discount, at which a participant's
accumulated payroll deductions are used to purchase shares. Both the offering
period and the offering price are country- and plan-specific. For example, ESPPs
that are intended to comply with Section 423 of the U.S. Internal Revenue Code
(Section 423 Plans) and therefore qualify for favorable tax treatment may not
have an offering period in excess of 27 months. Section 423 Plans, however,
almost always provide for an 'either/or' offering price, which provides
participants the right to purchase shares at the lesser of the fair market value
of that company's shares, less the applicable discount, as of either the first
or last day of the offering period. In contrast, plans in the United Kingdom and
Ireland generally have a three-, five-, or even seven-year offering period, and
the offering price is the fair market value on the date an employee commences
participation in the plan.
ISS's assessment of a plan takes into account the length of the offering period
and the date on which the offering price is determined. If the plan has an
'either/or' feature, a shorter offering period is in the interests of
shareholders because such provisions reduce the market risk associated with the
plan. The maximum offering period for plans with such a feature is 27 months. In
contrast, if the offering price is based on the price of the company's shares on
the date plan participation commences, then a longer offering period is
generally in the interests of shareholders, as it should more effectively focus
the efforts of plan participants on increasing shareholder value. In these
cases, the minimum offering period is three years.
DISCOUNTS
These are generally country-specific, e.g. the maximum discount under a Section
423 Plan is 15 percent. In the United Kingdom the maximum discount is 20
percent, and in Ireland it is 25 percent. The amount of the discount is often
obscured because some plans do not provide for a discount per se, but rather
provide that participants will receive matching shares. This practice is common
in Canada. For instance, a plan may stipulate that for every two shares a
participant purchases under a plan, the company will provide one 'matching
share' to the participant; in effect the participant receives three shares for
the price of two, which is mathematically equivalent to a 33-percent discount.
If a plan employs matching shares, the analyst must simply calculate the imputed
discount using the maximum match.
In reviewing discounts, ISS takes into consideration the offering period and
offering price. Because plans with 'either/ or' provisions reduce the market
risk associated with plan purchases, we believe the maximum discount available
under such plans should be 15 percent. However, ISS guidelines allow for greater
discounts, up to 25 percent, for plans in which the offering price is based on
the company's share price on the date participation commences.
LIMITS ON THE NUMBER OR VALUE OF SHARES PURCHASEABLE (PARTICIPATION LIMITS)
ESPPs must specify a limit on the number or value of shares each participant is
eligible to purchase, for Section 423 Plans it is US$25,000 per year, in the
United Kingdom and Ireland it is GBP 3,000 and IRP 3,000, respectively. Because
the shares are discounted, there must be some limit on the ability of eligible
employees to participate to prevent excessive dilution. This also limits the
ability of executives to buy, via the plan, large amounts of discounted shares.
Ideally, there should be a plan feature prohibiting employees who are large
shareholders (five percent in Section 423 Plans) from participating.
LOAN TERMS
Some plans offer participants loans to pay for the shares. If loans are part of
a share purchase plan, ISS prefers that loans be made to employees as part of a
broad-based, company-wide plan to encourage ownership rather than being given
only to executive directors. ISS also prefers loans with interest set at market
rates that must be paid back in full over a reasonable length of time. The
absence of these features does not necessarily warrant a recommendation against
a share purchase plan, but they are taken into consideration in ISS's analysis
of the plan.
GRANTS OUTSIDE OF PLANS
Resolutions asking shareholders to approve specific grants of shares or cash
outside of established plans are problematic. Some companies prefer not to adopt
formal share plans, instead asking shareholders to approve yearly grants to
specific employees. ISS prefers that companies make such grants in the context
of an established plan.
ISS's primary concern with grants outside of plans is the level of dilution they
afford. The number of shares issued as part of the grants, when combined with
the number of shares reserved for the company's other share plans, must fall
within acceptable dilution limits. Vesting provisions and performance criteria
are also important and are evaluated on the same basis as if the grants were
part of a formal plan.
ANTITAKEOVER MECHANISMS
ISS GENERAL RECOMMENDATION & POLICY
Vote AGAINST all antitakeover proposals unless they are structured in such a way
that they give shareholders the ultimate decision on any proposal or offer.
DISCUSSION
Common antitakeover mechanisms include staggered boards, supervoting shares,
poison pills, unlimited authorized capital authorizations (including blank check
preferred stock), and golden shares. Some of these restrictions are aimed solely
at limiting share ownership by foreign or unwanted minority shareholders, and
others are designed to preclude an unwanted takeover of the target company by
any party. ISS opposes all forms of such mechanisms, as they limit shareholder
value by eliminating the takeover or control premium for the company. As owners
of the company, shareholders should be given the opportunity to decide on the
merits of takeover offers.
RENEW PARTIAL TAKEOVER PROVISION (AUSTRALIA)
Australian law allows companies to introduce into their articles a provision to
protect shareholders from partial takeover offers, to be renewed by shareholders
every three years. If a partial takeover of the company is announced, directors
are required to convene a shareholder meeting at least 15 days before the
closing of the offer to seek approval of the offer. If shareholders reject the
resolution, the offer is considered withdrawn under company law and the company
can refuse to register the shares tendered to the offer. ISS approves of
consulting shareholders on takeover offers, and this article provides protection
for minority shareholders by giving them ultimate decision-making authority
based on their own interests, not the interests of directors or outside parties.
ISS supports the adoption of this proposal in almost all cases.
GOLDEN SHARES
Recently privatized companies around the world often include in their share
structure a golden share held by their respective governments. These shares
often carry special voting rights or the power of automatic veto over specific
proposals. Golden shares are most common among former state-owned companies or
politically sensitive industries such as utilities, railways, and airlines.
While the introduction of golden shares is not a desirable governance practice,
ISS recognizes the political importance certain companies hold for governments
and treats the introduction or amendment of government shares on a case-by-case
basis.
POISON PILLS (CANADA)
Otherwise known as shareholder rights plans, poison pills are seen primarily in
the Canadian market. Unlike in the United States, Canadian securities
legislation requires shareholder approval of all poison pills. Companies
generally state that they seek to adopt or renew pills in order to protect
shareholders against unfair, abusive, or coercive takeover strategies and to
give the target company's board time to pursue alternatives to a hostile
takeover bid.
Theoretically, the board will refuse to redeem the pill in the face of an unfair
offer in order to force a bidder to negotiate for a better offer, at which point
it will redeem the pill. Some pills have operated this way and have resulted in
better terms for target companies.
Nonetheless, ISS guidelines generally do not support the adoption of poison
pills on the grounds that they serve to entrench management. Improperly
structured rights plans have been used by boards to ward off offers beneficial
to shareholders. Current owners should decide who will own the company, with
advice and negotiation from the board and management. When considering the
merits of a poison pill, ISS also examines what other antitakeover devices the
company has and the company's treatment of shareholders in past situations.
Canadian poison pills often have a sunset provision, requiring shareholder
confirmation of the plan. Most pills have either a five-year sunset provision or
a ten-year sunset provision with a requirement that shareholders confirm the
continuation of the plan in five years. ISS guidelines support a three-year
sunset provision, which affords shareholders the ability to reconsider the plan
in light of changing market conditions and to review management's use of the
plan. Canadian pills also typically include a permitted bid clause, under which
the takeover bid must be made on equal terms to all holders of the company's
voting shares; the company must extend the expiration of the bid, usually by 60
or 90 days following the date of the bid. Management sets the terms of the
permitted bid clause, and therefore it influences the level of protection that
will be provided to shareholders.
ISS determines whether the permitted bid feature offers shareholders adequate
powers relative to the board in the event of a bid not being approved by the
board. Allowing shareholders the right to override the board as a means of
balancing power is crucial, but the specifics of the permitted bid clause are
usually insufficient. Under the clause, the pill may be triggered by a
shareholder not intent on a complete acquisition, but who merely wishes to
purchase a significant stake in the company. This gives the board power to deny
shareholders the benefit of a large, semi-controlling shareholder and precludes
partial bids that may be in shareholders' interests.
Despite the inclusion of sunset provisions and permitted bid clauses, the
balance of power in Canadian pills generally favors the board over shareholders.
Under the terms of most pills, the board has either the right or discretion to
do the following:
. redeem or trigger the pill;
. amend the pill if shareholder approval is obtained prior to the separation
date;
. amend the exercise price of the rights;
. alter the separation date;
. decide which parties are acting in concert to determine the level of
beneficial ownership that could be used to trigger the pill; and
. waive the pill's triggering with respect to one bidder and not others,
allowing the board to favor one bid over another.
This does not mean that all pills are detrimental. Companies may continue to
amend their pills (the permitted bid clause in particular) and may develop a
pill that offers shareholders adequate power.
DEPOSITARY RECEIPTS AND PRIORITY SHARES (THE NETHERLANDS)
Depositary receipts are an especially common antitakeover defense among large
Dutch companies. Ordinary voting shares are first issued to a company-friendly
trust or foundation. The trust or foundation in turn issues depositary receipts,
similar to banks in the United States issuing ADRs except that the foundation
retains the voting rights of the issued security. The depositary receipts carry
only the financial rights attached to the shares (i.e., dividends). In this
manner, the company gains access to capital while retaining control over voting
rights.
Priority shares, established in a company's articles, may be awarded with
certain powers of control over the rest of the company. In practice, priority
shares are held by members of the supervisory board, company-friendly trusts or
foundations, or other friendly parties. Depending on the articles, priority
shareholders may determine the size of the management or supervisory boards or
may propose amendments to articles and the dissolution of the company. ISS
recommends voting against the introduction of depositary receipts and priority
shares.
SUPERMAJORITY VOTE REQUIREMENTS
Supermajority vote requirements violate the principle that a simple majority of
voting shares should be all that is necessary to effect change regarding a
company and its corporate governance provisions. Requiring more than this may
permit management to entrench themselves by blocking provisions that are in the
best interest of shareholders. However, in many world markets, supermajority
vote requirements for special resolutions or EGMs are the norm, either
two-thirds or three-fourths of shares voting at the meeting (either in person or
by proxy). When reviewing proposals to introduce supermajority vote
requirements, ISS takes into account market norms, the company's reasons for the
change, and the company's ownership structure.
SHAREHOLDER PROPOSALS
ISS GENERAL RECOMMENDATION & POLICY
Vote all shareholder proposals on a CASE-BY-CASE basis.
Vote FOR proposals that would improve the company's corporate governance or
business profile at a reasonable cost.
Vote AGAINST proposals that limit the company's business activities or
capabilities or result in significant costs being incurred with little or no
benefit.
DISCUSSION
ISS reviews all shareholder proposals to ascertain whether the proposal is
beneficial or detrimental to shareholder value. Most resolutions fall into three
basic categories: corporate governance, social, and environmental. While
shareholder proposals in most countries are not as prevalent as they are in the
United States, they are becoming more common, and standards for reviewing the
various types of proposals are necessary.
CORPORATE GOVERNANCE PROPOSALS
Corporate governance-related proposals must be evaluated carefully because any
changes can dramatically affect shareholder value. Support for such proposals
must be measured against the likely impact that approval would have on the
company's operations. If a measure would improve disclosure of company
activities in nonstrategic areas and at minimal costs, ISS supports the
proposal. If a proposal seeks to improve the company's corporate governance
structure, such as adopting board committees, eliminating staggered board
structures, or cancelling antitakeover instruments, approval is also warranted.
However, if acceptance of a proposal is likely to lead to a disruption in board
or management operations and to cause the company to incur significant costs
without clear benefit, ISS recommends opposing the proposal.
SOCIAL AND ENVIRONMENTAL PROPOSALS
In evaluating social and environmental proposals, ISS first determines whether
or not the issue in question should be addressed on a company-specific basis.
Many social and environmental issues are beyond the scope of any one company and
are more properly the province of government and broader regulatory action. If
this is the case, ISS recommends voting against the proposal.
Most proposals of this type require shareholders to apply subjective criteria in
making their voting decision. While broader issues are of concern to everyone,
institutional shareholders acting as representatives of their beneficiaries are
required to consider only the ultimate interests of their direct beneficiaries.
Relating the interests of their beneficiaries to the greater good can be a
difficult process and a matter for individual determination. For this reason,
ISS focuses on the financial aspects of social and environmental proposals. If a
proposal would have a negative impact on the company's financial position or
adversely affect important operations, ISS recommends opposing the resolution.
Conversely, if a proposal would have a clear and beneficial impact on the
company's finances or operations, ISS recommends supporting the proposal.
JPMORGAN FLEMING
ASSET MANAGEMENT
GLOBAL PROXY VOTING
PROCEDURES AND GUIDELINES
2003 EDITION
NOVEMBER 17, 2003
Table of Contents- Global
Part I: JPMorgan Fleming Asset Management Global Proxy-Voting Procedures
A.
Objective................................................................. 3
B. Proxy
Committee................................................................... 3
C. The Proxy Voting
Process.................................................... 3- 4
D. Material Conflicts of
Interest................................................... 4- 5
E. Escalation of Material Conflicts of
Interest...................................... 5
F.
Recordkeeping.............................................................. 5
Exhibit
A......................................................................... 6
Part II: JPMorgan Fleming Asset Management Global Proxy-Voting Guidelines
A. North
America.................................................................. 8-20
Table of
Contents..............................................................9-10
Guidelines..............................................................11-20
B. Europe, Middle East, Africa, Central America and South America....... 21-31
Table of
Contents..................................................................22
Guidelines...............................................................23-31
C. Asia
(ex-Japan)................................................................
32-33
D.
Japan.................................................................. 34-35
Part I: JP Morgan Fleming Asset Management Proxy Voting Procedures
A. Objective
As an investment adviser within JPMorgan Fleming Asset Management, each of the
entities listed on Exhibit A attached hereto (each referred to individually as
a "JPMFAM Entity" and collectively as "JPMFAM") may be granted by its clients
the authority to vote the proxies of the securities held in client portfolios.
In such cases, JPMFAM's objective is to vote proxies in the best interests of
its clients. To further that objective, JPMFAM adopted these Procedures. 1
These Procedures incorporate detailed guidelines for voting proxies on
specific types of issues (the "Guidelines"). The Guidelines have been
developed and approved by the relevant ProxyCommittee (as defined below) with
the objective of encouraging corporate action that enhancesshareholder value.
Because proxy proposals and individual company facts and circumstances
mayvary, JPMFAM may not always vote proxies in accordance with the Guidelines.
B. Proxy Committee
To oversee the proxy-voting process on an on-going basis, a Proxy Committee
will be establishedfor each global location where proxy-voting decisions are
made. Each Proxy Committee will becomposed of a Proxy Administrator (as
defined below) and senior officers from among theInvestment, Legal, Compliance
and Risk Management Departments. The primary functions of eachProxy
Committee are to periodically review general proxy-voting matters; review and
approve theGuidelines annually; and provide advice and recommendations on
general proxy-voting matters aswell as on specific voting issues to be
implemented by the relevant JPMFAM Entity. The ProxyCommittee may delegate
certain of its responsibilities to subgroups composed of Proxy
Committeemembers. The Proxy Committee meets at least semi-annually, or more
frequently as circumstances dictate.
C. The Proxy Voting Process
JPMFAM investment professionals monitor the corporate actions of the companies
held in their clients' portfolios. To assist JPMFAM investment professionals
with public companies' proxy voting proposals, a JPMFAM Entity may, but shall
not be obligated to, retain the services of an independent proxy voting
service ("Independent Voting Service"). The Independent Voting Service is
assigned responsibility for various functions, which may include one or more
of the following: coordinating with client custodians to ensure that all proxy
materials are processed in a timely fashion; providing JPMFAM with a
comprehensive analysis of each proxy proposal and providing JPMFAM with
recommendations on how to vote each proxy proposal based on the Guidelines or,
where no Guideline exists or where the Guidelines require a case-by-case
analysis, on the Independent Voting Service's analysis; and executing the
voting of the proxies in accordance with Guidelines and its recommendation,
except when a recommendation is overridden by JPMFAM, as described below. If
those functions are not assigned to an Independent Voting Service, they are
performed or coordinated by a Proxy Administrator (as defined below).
Situations often arise in which more than one JPMFAM client invests in the
same company or in which a single client may invest in the same company but in
multiple accounts. In those situations, two or more clients, or one client
with different accounts, may be invested in strategies having different
investment objectives, investment styles, or portfolio managers. As a result,
JPMFAM may cast different votes on behalf of different clients or on behalf of
the same client with different accounts.
_______________________
1. The JPMorgan Value Opportunities Fund votes proxies in accordance
with its own voting policies and not the policies of JPMFAM. The
JPMorgan Multi-Manager Funds vote proxies in accordance with the
voting policies of each of the Managers, as applicable, and not the
policies of JPMFAM, except, to the extent, the JPMFAM policies apply
to the JPMorgan Multi-Manager Small Cap Value Fund.
C. The Proxy Voting Process - Continued
Each JPMFAM Entity appoints a JPMFAM professional to act as a proxy
administrator ("Proxy Administrator") for each global location of such entity
where proxy-voting decisions are made. The Proxy Administrators are charged
with oversight of these Procedures and the entire proxy-voting process. Their
duties, in the event an Independent Voting Service is retained, include the
following: evaluating the quality of services provided by the Independent
Voting Service; escalating proposals identified by the Independent Voting
Service as non-routine, but for which a Guideline exists (including, but not
limited to, compensation plans, anti-takeover proposals, reincorporation,
mergers, acquisitions and proxy-voting contests) to the attention of the
appropriate investment professionals and confirming the Independent Voting
Service's recommendation with the appropriate JPMFAM investment professional
(documentation of those confirmations will be retained by the appropriate
Proxy Administrator); escalating proposals identified by the Independent
Voting Service as not being covered by the Guidelines (including proposals
requiring a case-by-case determination under the Guidelines) to the
appropriate investment professional and obtaining a recommendation with
respect thereto; reviewing recommendations of JPMFAM investment professionals
with respect to proposals not covered by the Guidelines (including proposals
requiring a case-by-case determination under the Guidelines) or to override
the Guidelines (collectively, "Overrides"); referring investment
considerations regarding Overrides to the Proxy Committee, if necessary;
determining, in the case of Overrides, whether a material conflict, as
described below, exists; escalating material conflicts to the Proxy Committee;
and maintaining the records required by these Procedures.
In the event investment professionals are charged with recommending how to
vote the proxies, theProxy Administrator's duties include the following:
reviewing recommendations of investmentprofessionals with respect to
Overrides; referring investment considerations regarding such Overridesto the
Proxy Committee, if necessary; determining, in the case of such Overrides,
whether a materialconflict, as described below, exists; escalating material
conflicts to the Proxy Committee; andmaintaining the records required by these
Procedures.
In the event a JPMFAM investment professional makes a recommendation in
connection with an Override, the investment professional must provide the
appropriate Proxy Administrator with a written certification ("Certification")
which shall contain an analysis supporting his or her recommendation and a
certification that he or she (A) received no communication in regard to the
proxy that would violate either the J.P. Morgan Chase ("JPMC") Safeguard
Policy (as defined below) or written policy on information barriers, or
received any communication in connection with the proxy solicitation or
otherwise that would suggest the existence of an actual or potential conflict
between JPMFAM'S interests and that of its clients and (B) was not aware of
any personal or other relationship that could present an actual or potential
conflict of interest with the clients' interests.
D. Material Conflicts of Interest
The U.S. Investment Advisers Act of 1940 requires that the proxy-voting
procedures adopted andimplemented by a U.S. investment adviser include
procedures that address material conflicts ofinterest that may arise between
the investment adviser's interests and those of its clients. To addresssuch
material potential conflicts of interest, JPMFAM relies on certain policies
and procedures. Inorder to maintain the integrity and independence of
JPMFAM's investment processes and decisions,including proxy-voting decisions,
and to protect JPMFAM's decisions from influences that could leadto a vote
other than in its clients' best interests, JPMC (including JPMFAM) adopted a
SafeguardPolicy, and established formal informational barriers designed to
restrict the flow of information fromJPMC's securities, lending, investment
banking and other divisions to JPMFAM investment professionals. The
information barriers include, where appropriate: computer firewalls;
theestablishment of separate legal entities; and the physical separation of
employees from separatebusiness divisions. Material conflicts of interest are
further avoided by voting in accordance withJPMFAM's predetermined Guidelines.
When an Override occurs, any potential material conflict ofinterest that may
exist is analyzed in the process outlined in these Procedures.
D. Material Conflicts of Interest - Continued
Examples of such material conflicts of interest that could arise include
circumstances in which: (i) management of a JPMFAM investment management
client or prospective client, distributor or prospective distributor of its
investment management products, or critical vendor, is soliciting proxies and
failure to vote in favor of management may harm JPMFAM's relationship with
such company and materially impact JPMFAM's business; or (ii) a personal
relationship between a JPMFAM officer and management of a company or other
proponent of a proxy proposal could impact JPMFAM's voting decision.
E. Escalation of Material Conflicts of Interest
When an Override occurs, the investment professional must complete the
Certification and the Proxy Administrator will review the circumstances
surrounding such Certification. When a potential material conflict of
interest has been identified, the Proxy Administrator, in consultation with a
subgroup of the Proxy Committee, will evaluate the potential conflict and
determine whether an actual material conflict of interest exists. That
subgroup shall include a Proxy Committee member from the Investment Department
and one or more Proxy Committee members from the Legal, Compliance or Risk
Management Departments. In the event that the Proxy Administrator and the
subgroup of the Proxy Committee determine that an actual material conflict of
interest exists, they shall make a recommendation on how the relevant JPMFAM
Entity shall vote the proxy. Sales and marketing professionals will be
precluded from participating in the decision-making process.
Depending upon the nature of the material conflict of interest, JPMFAM, in the
course of addressingthe material conflict, may elect to take one or more of
the following measures, or other appropriateaction:
. removing certain JPMFAM personnel from the proxy voting process;
. "walling off" personnel with knowledge of the material conflict to ensure
that such personnel do not influence the relevant proxy vote;
. voting in accordance with the applicable Guidelines, if any, if the
application of the Guidelines would objectively result in the casting of a
proxy vote in a predetermined manner; or
. deferring the vote to the Independent Voting Service, if any, which will
vote in accordance with its own recommendation.
The resolution of all potential and actual material conflict issues will be
documented in order todemonstrate that JPMFAM acted in the best interests of
its clients.
F. Recordkeeping
JPMFAM is required to maintain in an easily accessible place for seven (7)
years all records relating to the proxy voting process. Those records include
the following:
. a copy of the JPMFAM Proxy Voting Procedures and Guidelines;
. a copy of each proxy statement received on behalf of JPMFAM clients;
. a record of each vote cast on behalf of JPMFAM client holdings;
. a copy of all documents created by JPMFAM personnel that were material to
making a decision on the voting of client securities or that memorialize the
basis of the decision; and
. a copy of each written request by a client for information on how JPMFAM
voted proxies on behalf of the client, as well as a copy of any written
response by JPMFAM to any request by a JPMFAM client for information on how
JPMFAM voted proxies on behalf of our client.
. It should be noted that JPMFAM reserves the right to use the services of the
Independent Voting Service to maintain certain required records in
accordance with all applicable regulations.
EXHIBIT A
J.P. Morgan Investment Management, Inc.
J.P. Morgan Fleming Asset Management (London) Limited
J.P. Morgan Fleming Asset Management (UK) Limited
JF International Management Inc.
JF Asset Management Limited
JF Asset Management (Singapore) Limited
Part II: Proxy Voting Guidelines
JPMFAM is a global asset management organization with the capabilities to invest
in securities of issuers located around the globe. Because the regulatory
framework and the business cultures and practices vary from region to region,
our proxy voting guidelines have been customized for each region to take into
account such variations.
JMPFAM currently has four sets of proxy voting guidelines covering the regions
of (1) North America, (2) Europe, Middle East, Africa, Central America and South
America (3) Asia (ex-Japan) and (4) Japan, respectively. Notwithstanding the
variations among the guidelines, all of these guidelines have been designed with
the uniform objective of encouraging corporate action that enhances shareholder
value. As a general rule, in voting proxies of a particular security, each
JPMFAM Entity will apply the guidelines of the region in which the issuer of
such security is organized.
Part II.A: North America Proxy Voting Guidelines
Part II.A: North America Guidelines Table of Contents
1. Uncontested Director Elections 11
2. Proxy Contests 11
a. Election of Directors11
b. Reimburse Proxy Solicitation Expenses11
3. Ratification of Auditors 11
4. Proxy Contest Defenses 12-13
a. Board Structure: Staggered vs. Annual Elections12
b. Shareholder Ability to Remove Directors12
c. Cumulative Voting12
d. Shareholder Ability to Call Special Meeting13
e. Shareholder Ability to Act by Written Consent13
f. Shareholder Ability to Alter the Size of the Board13
5. Tender Offer Defenses 13-14
a.Poison Pills13
b.Fair Price Provisions13
c.Greenmail13
d.Unequal Voting Rights13
e.Supermajority Shareholder Vote Requirement to Amend Charter or Bylaws13
f.Supermajority Shareholder Vote Requirement to Approve Mergers14
6. Miscellaneous Board Provisions 14
a.Separate Chairman and CEO Positions14
b.Lead Directors and Executive Sessions14
c.Majority of Independent Directors14
d.Stock Ownership Requirements14
e.Term of Office14
f.Director and Officer Indemnification and Liability Protection14
g.Board Size14
7. Miscellaneous Governance Provisions 15
a.Independent Nominating Committee15
b.Confidential Voting15
c.Equal Access15
d.Bundled Proposals15
e.Charitable Contributions15
f.Date/Location of Meeting15
g.Include Nonmanagement Employees on Board15
h.Adjourn Meeting if Votes are Insufficient15
i.Other Business15
j.Disclosure of Shareholder Proponents15
8. Capital Structure 15-16
a. Common Stock Authorization15
b. Stock Distributions: Splits and Dividends16
c. Reverse Stock Splits16
d. Blank Check Preferred Authorization16
e. Shareholder Proposals Regarding Blank Check Preferred Stock16
f. Adjustments to Par Value of Common Stock16
g. Restructurings/Recapitalizations16
h. Share Repurchase Programs16
i. Targeted Share Placements16
Part II.A: North America Guidelines Table of Contents
9. Executive and Director Compensation 17-18
a. Stock-based Incentive Plans17
b. Approval of Cash or Cash-and-Stock Bonus Plans17
c. Shareholder Proposals to Limit Executive and Director Pay17
d. Golden and Tin Parachutes17
e. 401(k) Employee Benefit Plans17
f. Employee Stock Purchase Plans17
g. Option Expensing18
h. Options Repricing18
i. Stock Holding Periods18
10. Incorporation 18
a. Reincorporation Outside of the United States18
b. Voting on State Takeover Statutes18
c. Voting on Reincorporation Proposals18
11. Mergers and Corporate Restructurings 18-19
a. Mergers and Acquisitions18
b. Nonfinancial Effects of a Merger or Acquisition18
c. Corporate Restructuring18
d. Spin-offs18
e. Asset Sales18
f. Liquidations18
g. Appraisal Rights19
h. Changing Corporate Name19
12. Social and Environmental Issues 19-20
a. Energy and Environment19
b. Northern Ireland19
c. Military Business19
d. International Labor Organization Code of Conduct19
e. Promote Human Rights in China, Nigeria, and Burma19
f. World Debt Crisis19
g. Equal Employment Opportunity and Discrimination19
h. Animal Rights19
i. Product Integrity and Marketing19
j. Human Resources Issues20
k. Link Executive Pay with Social and/or Environmental Criteria20
13. Foreign Proxies 20
14. Pre-Solicitation Contact 20
Part II.A: North America Guidelines
1. Uncontested Director Elections
Votes on director nominees should be made on a case-by-case (for) basis. Votes
generally will be WITHHELD from directors who:
1) attend less than 75 percent of the board and committee meetings without a
valid excuse for the absences; or
2) implement or renew a dead-hand or modified dead-hand poison pill; or
3) are inside or affiliated outside directors and sit on the audit,
compensation, or nominating committees; or
4) ignore a shareholder proposal that is approved by a i) majority of the
shares outstanding, or ii) majority of the votes cast for two consecutive
years; or
5) are inside or affiliated outside directors and the full board serves as the
audit, compensation, or nominating committee or the company does not have one
of these committees.
Special attention will be paid to companies that display a chronic lack of
shareholder accountability.
2. Proxy Contests
2a. Election of Directors
Votes in a contested election of directors must be evaluated on a case-by-case
basis, considering the following factors: long-term financial performance of
the subject company relative to its industry; management's track record;
background to the proxy contest; qualifications of director nominees (both
slates); evaluation of what each side is offering shareholders as well as the
likelihood that the proposed objectives and goals can be met; and stock
ownership positions.
2b. Reimburse Proxy Solicitation Expenses
Decisions to provide full reimbursement for dissidents waging a proxy contest
should be made on a case-by-case basis.
3. Ratification of Auditors
Vote for proposals to ratify auditors, unless an auditor has a financial
interest in or association with the company, and is therefore not independent;
or there is reason to believe that the independent auditor has rendered an
opinion that is neither accurate nor indicative of the company's financial
position.
Generally vote against auditor ratification and withhold votes from Audit
Committee members if non-audit fees exceed audit fees.
Generally vote for shareholder proposals asking for audit firm rotation unless
the rotation period is so short (less than five years) that it would be unduly
burdensome to the company.
4. Proxy Contest Defenses
4a. Board Structure: Staggered vs. Annual Elections
Proposals regarding classified boards will be voted on a case-by-case basis.
Classified boardsnormally will be Suppported if the company's governing
documents contain each of the following provisions:
1) Majority of board composed of independent directors,
2) Nominating committee composed solely of independent directors,
3) Do not require more than a two-thirds shareholders' vote to remove a
director, revise any bylaw or revise any classified board provision,
4) Confidential voting (however, there may be a provision for suspending
confidential voting during proxy contests),
5) Ability of shareholders to call special meeting or to act by written
consent with 90 days' notice,
6) Absence of superior voting rights for one or more classes of stock,
7) Board does not have the sole right to change the size of the board beyond a
stated range that has been approved by shareholders, and
8) Absence of shareholder rights plan that can only be removed by the
incumbent directors (dead-hand poison pill).
4b. Shareholder Ability to Remove Directors
Vote against proposals that provide that directors may be removed only for
cause.
Vote for proposals to restore shareholder ability to remove directors with or
without cause.
Vote against proposals that provide that only continuing directors may elect
replacements to fill board vacancies.
Vote for proposals that permit shareholders to elect directors to fill board
vacancies.
4c. Cumulative Voting
Cumulative voting proposals will be voted on a case-by-case basis. If there
are other safeguards to ensure that shareholders have reasonable access and
input into the process of nominating and electing directors, cumulative voting
is not essential. Generally, a company's governing documents must contain the
following provisions for us to vote against restoring or providing for
cumulative voting:
1) Annually elected board,
2) Majority of board composed of independent directors,
3) Nominating committee composed solely of independent directors,
4) Confidential voting (however, there may be a provision for suspending
confidential voting during proxy contests),
5) Ability of shareholders to call special meeting or to act by written
consent with 90 days' notice,
6) Absence of superior voting rights for one or more classes of stock,
7) Board does not have the sole right to change the size of the board beyond a
stated range that has been approved by shareholders, and
8) Absence of shareholder rights plan that can only be removed by the
incumbent directors (dead- hand poison pill).
4d. Shareholder Ability to Call Special Meeting
Vote against proposals to restrict or prohibit shareholder ability to call
special meetings. The ability to call special meetings enables shareholders to
remove directors or initiate a shareholder resolution without having to wait
for the next scheduled meeting.
Vote for proposals that remove restrictions on the right of shareholders to
act independently of management.
4e. Shareholder Ability to Act by Written Consent
We generally vote for proposals to restrict or prohibit shareholder ability to
take action by written consent. The requirement that all shareholders be given
notice of a shareholders' meeting and matters to be discussed therein seems a
reasonable protection of minority shareholder rights.
We generally vote against proposals to allow or facilitate shareholder action
by written consent.
4f. Shareholder Ability to Alter the Size of the Board
Vote for proposals that seek to fix the size of the board.
Vote against proposals that give management the ability to alter the size of
the board without shareholder approval.
5. Tender Offer Defenses
5a. Poison Pills
Vote for shareholder proposals that ask a company to submit its poison pill
for shareholderratification.
Review on a case-by-case basis shareholder proposals to redeem a company's
poison pill. Studies indicate that companies with a rights plan secure higher
premiums in hostile takeoversituations.
Review on a case-by-case basis management proposals to ratify a poison pill.
We generally lookfor shareholder friendly features including a two- to
three-year sunset provision, a permitted bidprovision, a 20 percent or higher
flip-in provision, and the absence of dead-hand features.
5b. Fair Price Provisions
Vote proposals to adopt fair price provisions on a case-by-case basis,
evaluating factors such as the vote required to approve the proposed
acquisition, the vote required to repeal the fair price provision, and the
mechanism for determining the fair price.
Generally, vote against fair price provisions with shareholder vote
requirements greater than a majority of disinterested shares.
5c. Greenmail
Vote for proposals to adopt antigreenmail charter or bylaw amendments or
otherwise restrict a company's ability to make greenmail payments.
5d. Unequal Voting Rights
Generally, vote against dual-class recapitalizations as they offer an
effective way for a firm to thwart hostile takeovers by concentrating voting
power in the hands of management or other insiders.
Vote for dual-class recapitalizations when the structure is designed to
protect economic interests of investors.
5e. Supermajority Shareholder Vote Requirement to Amend Charter or Bylaws
Vote against management proposals to require a supermajority shareholder vote
to approve charter and bylaw amendments. Supermajority provisions violate the
principle that a simple majority of voting shares should be all that is
necessary to effect change regarding a company.Vote for shareholder proposals
to lower supermajority shareholder vote requirements for charter and bylaw
amendments.
5f. Supermajority Shareholder Vote Requirement to Approve Mergers
Vote against management proposals to require a supermajority shareholder vote
to approve mergers and other significant business combinations. Supermajority
provisions violate the principle that a simple majority of voting shares
should be all that is necessary to effect change regarding a company.
Vote for shareholder proposals to lower supermajority shareholder vote
requirements for mergers and other significant business combinations.
6. Miscellaneous Board Provisions
6a. Separate Chairman and CEO Positions
We will generally vote for proposals looking to separate the CEO and Chairman
roles.
6b. Lead Directors and Executive Sessions
In cases where the CEO and Chairman roles are combined, we will vote for the
appointment of a "lead" (non-insider) director and for regular "executive"
sessions (board meetings taking place without the CEO/Chairman present).
6c. Majority of Independent Directors
We generally vote for proposals that call for the board to be composed of a
majority of independent directors. We believe that a majority of independent
directors can be an important factor in facilitating objective decision making
and enhancing accountability to shareholders.
Vote for shareholder proposals requesting that the board's audit,
compensation, and/or nominating committees include independent directors
exclusively.
Generally vote for shareholder proposals asking for a 2/3 independent board.
6d. Stock Ownership Requirements
Vote for shareholder proposals requiring directors to own a minimum amount of
company stock in order to qualify as a director or to remain on the board, so
long as such minimum amount is not excessive or unreasonable.
6e. Term of Office
Vote against shareholder proposals to limit the tenure of outside directors.
Term limits pose artificial and arbitrary impositions on the board and could
harm shareholder interests by forcing experienced and knowledgeable directors
off the board.
6f. Director and Officer Indemnification and Liability Protection
Proposals concerning director and officer indemnification and liability
protection should be evaluated on a case-by-case basis.
Vote against proposals to limit or eliminate director and officer liability
for monetary damages for violating the duty of care.
Vote against indemnification proposals that would expand coverage beyond legal
expenses to acts, such as negligence, that are more serious violations of
fiduciary obligations than mere carelessness.
Vote for proposals that provide such expanded coverage in cases when a
director's or officer's legal defense was unsuccessful only if: (1) the
director was found to have acted in good faith and in a manner that he
reasonably believed was in the company's best interests, and (2) the
director's legal expenses would be covered.
6g. Board Size
Vote for proposals to limit the size of the board to 15 members.
7. Miscellaneous Governance Provisions
7a. Independent Nominating Committee
Vote for the creation of an independent nominating committee.
7b. Confidential Voting
Vote for shareholder proposals requesting that companies adopt confidential
voting, use independent tabulators, and use independent inspectors of election
as long as the proposals include clauses for proxy contests as follows: In the
case of a contested election, management should be permitted to request that
the dissident group honor its confidential voting policy. If the dissidents
agree, the policy remains in place. If the dissidents do not agree, the
confidential voting policy is waived.
Vote for management proposals to adopt confidential voting.
7c. Equal Access
Vote for shareholder proposals that would give significant company
shareholders equal access to management's proxy material in order to evaluate
and propose voting recommendations on proxy proposals and director nominees
and to nominate their own candidates to the board.
7d. Bundled Proposals
Review on a case-by-case basis bundled or "conditioned" proxy proposals. In
the case of items that are conditioned upon each other, examine the benefits
and costs of the packaged items. In instances where the joint effect of the
conditioned items is not in shareholders' best interests, vote against the
proposals. If the combined effect is positive, support such proposals.
7e. Charitable Contributions
Vote against shareholder proposals regarding charitable contributions. In the
absence of bad faith, self-dealing, or gross negligence, management should
determine which contributions are in the best interests of the company.
7f. Date/Location of Meeting
Vote against shareholder proposals to change the date or location of the
shareholders' meeting.No one site will meet the needs of all shareholders.
7g. Include Nonmanagement Employees on Board
Vote against shareholder proposals to include nonmanagement employees on the
board. Constituency representation on the board is not supported, rather
decisions are based on director qualifications.
7h. Adjourn Meeting if Votes are Insufficient
Vote for proposals to adjourn the meeting when votes are insufficient.
Management has additional opportunities to present shareholders with
information about its proposals.
7i. Other Business
Vote for proposals allowing shareholders to bring up "other matters" at
shareholder meetings.
7j. Disclosure of Shareholder Proponents
Vote for shareholder proposals requesting that companies disclose the names of
shareholder
proponents. Shareholders may wish to contact the proponents of a shareholder
proposal for
additional information.
8. Capital Structure
8a. Common Stock Authorization
Review proposals to increase the number of shares of common stock authorized
for issue on a case-by-case basis.
Vote against proposals to increase the number of authorized shares of a class
of stock that has superior voting rights in companies that have dual-class
capital structure.
8b. Stock Distributions: Splits and Dividends
Vote for management proposals to increase common share authorization for a
stock split, provided that the increase in authorized shares would not result
in an excessive number of shares available for issuance given a company's
industry and performance as measured by total shareholder returns.
8c. Reverse Stock Splits
Vote for management proposals to implement a reverse stock split that also
reduces the number of authorized common shares to a level where the number of
shares available for issuance is not excessive given a company's industry and
performance in terms of shareholder returns.
Vote case-by-case on proposals to implement a reverse stock split that does
not proportionately reduce the number of shares authorized for issue.
8d. Blank Check Preferred Authorization
Vote against proposals authorizing the creation of new classes of preferred
stock with unspecified voting, conversion, dividend distribution, and other
rights ("blank check" preferred stock).
Vote for proposals to create "blank check" preferred stock in cases when the
company expressly states that the stock will not be used as a takeover device.
Vote for proposals to authorize preferred stock in cases when the company
specifies voting, dividend, conversion, and other rights of such stock and the
terms of the preferred stock appear reasonable.
Vote case-by-case on proposals to increase the number of blank check preferred
shares after analyzing the number of preferred shares available for issue
given a company's industry and performance as measured by total shareholder
returns.
8e. Shareholder Proposals Regarding Blank Check Preferred Stock
Vote for shareholder proposals to have blank check preferred stock placements,
other than those shares issued for the purpose of raising capital or making
acquisitions in the normal course of business, submitted for shareholder
ratification.
8f. Adjustments to Par Value of Common Stock
Vote for management proposals to reduce the par value of common stock. The
purpose of par value is to establish the maximum responsibility of a
shareholder in the event that a company becomes insolvent.
8g. Restructurings/Recapitalizations
Review proposals to increase common and/or preferred shares and to issue
shares as part of a debt restructuring plan on a case-by-case basis. Consider
the following issues:
Dilution-How much will ownership interest of existing shareholders be reduced,
and how extreme will dilution to any future earnings be?
Change in Control-Will the transaction result in a change in control of the
company?
Bankruptcy-Generally, approve proposals that facilitate debt restructurings
unless there are clear signs of self-dealing or other abuses.
8h. Share Repurchase Programs
Vote for management proposals to institute open-market share repurchase plans
in which all shareholders may participate on equal terms.
8i. Targeted Share Placements
These shareholder proposals ask companies to seek stockholder approval before
placing 10% or more of their voting stock with a single investor. The
proposals are in reaction to the placement by various companies of a large
block of their voting stock in an ESOP, parent capital fund or with a single
friendly investor, with the aim of protecting themselves against a hostile
tender offer. These proposals are voted on a case by case basis after
reviewing the individual situation of the company receiving the proposal.
9. Executive and Director Compensation
9a. Stock-based Incentive Plans
Votes with respect to compensation plans should be determined on a
case-by-case basis. The analysis of compensation plans focuses primarily on
the transfer of shareholder wealth (the dollar cost of pay plans to
shareholders). Other matters included in our analysis are the amount of the
company's outstanding stock to be reserved for the award of stock options,
whether the exercise price of an option is less than the stock's fair market
value at the date of the grant of the options, and whether the plan provides
for the exchange of outstanding options for new ones at lower exercise prices.
Every award type is valued. An estimated dollar cost for the proposed plan and
all continuing plans is derived. This cost, dilution to shareholders' equity,
will also be expressed as a percentage figure for the transfer of shareholder
wealth and will be considered along with dilution tovoting power.
Once the cost of the plan is estimated, it is compared to a company-specific
dilution cap. The allowable cap is industry-specific, market cap-based, and
pegged to the average amount paid by companies performing in the top quartile
of their peer groupings. To determine allowable caps, companies are
categorized according to standard industry code (SIC) groups. Top quartile
performers for each group are identified on the basis of five-year total
shareholder returns. Industry-specific cap equations are developed using
regression analysis to determine those variables that have the strongest
correlation to shareholder value transfer. Industry equations are used to
determine a company-specific allowable cap; this is accomplished by plugging
company specific data into the appropriate industry equation to reflect size,
performance, and levels of cash compensation.
Votes are primarily determined by this quantitative analysis. If the proposed
plan cost is above the allowable cap, an against vote is indicated. If the
proposed cost is below the allowable cap, a vote for the plan is indicated
unless the plan violates the repricing guidelines. If the company has a
history of repricing options or has the express ability to reprice underwater
stock options without first securing shareholder approval under the proposed
plan, the plan receives an against vote-even in cases where the plan cost is
considered acceptable based on the quantitative analysis.
9b. Approval of Cash or Cash-and-Stock Bonus Plans
Vote for cash or cash-and-stock bonus plans to exempt the compensation from
limits on deductibility under the provisions of Section 162(m) of the Internal
Revenue Code.
9c. Shareholder Proposals to Limit Executive and Director Pay
Generally, vote for shareholder proposals that seek additional disclosure of
executive and director pay information.
Review on a case-by-case basis all other shareholder proposals that seek to
limit executive and director pay.
Review on a case-by-case basis shareholder proposals for performance pay such
as indexed or premium priced options if a company has a history of oversized
awards and one-, two- and three-year returns below its peer group.
9d. Golden and Tin Parachutes
Review on a case-by-case basis all proposals to ratify or cancel golden or tin
parachutes. Favor golden parachutes that limit payouts to two times base
salary, plus guaranteed retirement and other benefits.
9e. 401(k) Employee Benefit Plans
Vote for proposals to implement a 401(k) savings plan for employees.
9f. Employee Stock Purchase Plans
Vote for employee stock purchase plans with an offering period of 27 months or
less when voting power dilution is ten percent or less.
Vote against employee stock purchase plans with an offering period of greater
than 27 months or voting power dilution of greater than ten percent.
9g. Option Expensing
Within the context of common industry practice, generally vote for shareholder
proposals to expense fixed-price options.
9h. Option Repricing
In most cases, we take a negative view of option repricings and will,
therefore, generally vote against such proposals. We do, however, consider the
granting of new options to be an acceptable alternative and will generally
support such proposals.
9i. Stock Holding Periods
Generally vote against all proposals requiring executives to hold the stock
received upon option exercise for a specific period of time.
10. Incorporation
10a. Reincorporation outside of the United States
Generally speaking, we will vote against companies looking to reincorporate
outside of the U.S.
10b. Voting on State Takeover Statutes
Review on a case-by-case basis proposals to opt in or out of state takeover
statutes (including control share acquisition statutes, control share cash-out
statutes, freezeout provisions, fair price provisions, stakeholder laws,
poison pill endorsements, severance pay and labor contract provisions,
antigreenmail provisions, and disgorgement provisions).
10c. Voting on Reincorporation Proposals
Proposals to change a company's state of incorporation should be examined on a
case-by-case basis. Review management's rationale for the proposal, changes to
the charter/bylaws, and differences in the state laws governing the companies.
11. Mergers and Corporate Restructurings
11a. Mergers and Acquisitions
Votes on mergers and acquisitions should be considered on a case-by-case
basis, taking into account factors including the following: anticipated
financial and operating benefits; offer price (cost vs. premium); prospects of
the combined companies; how the deal was negotiated; and changes in corporate
governance and their impact on shareholder rights.
11b. Nonfinancial Effects of a Merger or Acquisition
Some companies have proposed a charter provision which specifies that the
board of directors may examine the nonfinancial effect of a merger or
acquisition on the company. This provision would allow the board to evaluate
the impact a proposed change in control would have on employees, host
communities, suppliers and/or others. We generally vote against proposals to
adopt such charter provisions. We feel it is the directors' fiduciary duty to
base decisions solely on the financial interests of the shareholders.
11c. Corporate Restructuring
Votes on corporate restructuring proposals, including minority squeezeouts,
leveraged buyouts, Spin-offs, liquidations, and asset sales, should be
considered on a case-by-case basis.
11d. Spin-offs
Votes on spin-offs should be considered on a case-by-case basis depending on
the tax and regulatory advantages, planned use of sale proceeds, market focus,
and managerial incentives.
11e. Asset Sales
Votes on asset sales should be made on a case-by-case basis after considering
the impact on the balance sheet/ working capital, value received for the
asset, and potential elimination of diseconomies.
11f. Liquidations
Votes on liquidations should be made on a case-by-case basis after reviewing
management's efforts to pursue other alternatives, appraisal value of assets,
and the compensation plan for executives managing the liquidation.
11g. Appraisal Rights
Vote for proposals to restore, or provide shareholders with, rights of
appraisal. Rights of appraisal provide shareholders who are not satisfied with
the terms of certain corporate transactions the right to demand a judicial
review in order to determine a fair value for their shares.
11h. Changing Corporate Name
Vote for changing the corporate name.
12. Social and Environmental Issues
12a. Energy and Environment
Vote case-by-case on proposals that request companies to subscribe to the
CERES Principles.
Vote case-by-case on disclosure reports that seek additional information.
12b. Northern Ireland
Vote case-by-case on proposals pertaining to the MacBride Principles.
Vote case-by-case on disclosure reports that seek additional information about
progress being made toward eliminating employment discrimination.
12c. Military Business
Vote case-by-case on defense issue proposals.
Vote case-by-case on disclosure reports that seek additional information on
military-related operations.
12d. International Labor Organization Code of Conduct
Vote case-by-case on proposals to endorse international labor organization
code of conducts.
Vote case-by-case on disclosure reports that seek additional information on
company activities in this area.
12e. Promote Human Rights in China, Nigeria, and Burma
Vote case-by-case on proposals to promote human rights in countries such as
China, Nigeria, and Burma.
Vote case-by-case on disclosure reports that seek additional information on
company activities regarding human rights.
12f. World Debt Crisis
Vote case-by-case on proposals dealing with third world debt.
Vote case-by-case on disclosure reports regarding company activities with
respect to third world debt.
12g. Equal Employment Opportunity and Discrimination
Vote case-by-case on proposals regarding equal employment opportunities and
discrimination.
Vote case-by-case on disclosure reports that seek additional information about
affirmative action efforts, particularly when it appears that companies have
been unresponsive to shareholder requests.
12h. Animal Rights
Vote case-by-case on proposals that deal with animal rights.
12i. Product Integrity and Marketing
Vote case-by-case on proposals that ask companies to end their production of
legal, but socially questionable, products.
Vote case-by-case on disclosure reports that seek additional information
regarding product integrity and marketing issues.
12j. Human Resources Issues
Vote case-by-case on proposals regarding human resources issues.
Vote case-by-case on disclosure reports that seek additional information
regarding human resources issues.
12k. Link Executive Pay with Social and/or Environmental Criteria
Vote case-by-case on proposals to link executive pay with the attainment of
certain social and/or environmental criteria.
Vote case-by-case on disclosure reports that seek additional information
regarding this issue.
13. Foreign Proxies
Responsibility for voting non-U.S. proxies rests with our Proxy Voting
Committee located in London. The Proxy Committee is composed of senior
analysts and portfolio managers and officers of the Legal and Compliance
Department. It is chaired by a Managing Director of the Firm. A copy of our
policy for voting international proxies can be provided upon request.
14. Pre-Solicitation Contact
From time to time, companies will seek to contact analysts, portfolio managers
and others in advance of the formal proxy solicitation to solicit support for
certain contemplated proposals. Such contact can potentially result in the
recipient receiving material non-public information and result in the
imposition of trading restrictions. Accordingly, pre-solicitation contact
should occur only under very limited circumstances and only in accordance with
the terms set forth herein.
What is material non-public information?
The definition of material non-public information is highly subjective. The
general test however, is whether or not such information would reasonably
affect an investor's decision to buy, sell or hold securities, or whether it
would be likely to have a significant
market impact. Examples of such information include, but are not limited to:
. a pending acquisition or sale of a substantial business;
. financial results that are better or worse than recent trends would lead one
to expect;
. major management changes;
. an increase or decrease in dividends;
. calls or redemptions or other purchases of its securities by the company;
. a stock split, dividend or other recapitalization; or
. financial projections prepared by the Company or the Company's
representatives.
What is pre-solicitation contact?
Pre-solicitation contact is any communication, whether oral or written, formal
or informal, with the Company or a representative of the Company regarding
proxy proposals prior to publication of the official proxy solicitation
materials. This contact can range from simply polling investors as to their
reaction to a broad topic, e.g., "How do you feel about dual classes of
stock?", to very specific inquiries, e.g., "Here's a term sheet for our
restructuring. Will you vote to approve this?"
Determining the appropriateness of the contact is a factual inquiry which must
be determined on a case-by-case basis. For instance, it might be acceptable
for us to provide companies with our general approach to certain issues.
Promising our vote, however, is prohibited under all circumstances. Likewise,
discussion of our proxy guidelines, in whole or in part, with a company or
others is prohibited. In the event that you are contacted in advance of the
publication of proxy solicitation materials, please notify the
Legal/Compliance Department immediately. The Company or its representative
should be instructed that all further contact should be with the
Legal/Compliance Department.
It is also critical to keep in mind that as a fiduciary, we exercise our
proxies solely in the best interests of our clients. Outside influences,
including those from within J.P. Morgan Chase should not interfere in any way
in our decision making process. Any calls of this nature should be referred to
the Legal/Compliance Department for response.
Part III.B: Europe, Middle East, Africa, Central America andSouth America Proxy
Voting Guidelines
Part III.B: Europe, Middle East, Africa, Central America andSouth America
Guidelines Table of Contents
1. Reports & Accounts 23
2. Dividends 23
3. Auditors 23
a. Auditor Independence23
b. Auditor Remuneration23
4. Boards 23-24
a. Chairman & CEO23
b. Board Structure24
c. Board Size24
d. Board Independence24
e. Board Committees24
5. Directors 25
a. Directors' Contracts25
b. Executive Director's Remuneration25
c. Directors' Liability25
d. Directors over 7025
6. Non-Executive Directors 26
a. Role of Non-Executive Directors26
b. Director Independence26
c. Non-Executive Director's Remuneration26
d. Multiple Directorships26
7. Issue of Capital 26-27
a. Issue of Equity26
b. Issue of Debt27
c. Share Repurchase Programmes27
8. Mergers/Acquisitions 27
9. Voting Rights 27
10. Share Options/Long-Term Incentive Plans (L-TIPs) 27-28
a. Share Options27
b. Long-Term Incentive Plans (L-TIPs)28
11. Others 28-29
a. Poison Pills28
b. Composite Resolutions28
c. Social/Environmental Issues28
d. Charitable Issues29
e. Political Issues29
12. Shareholder Activism and Company Engagement 29-30
a. Activism Statement29
b. Activism Policy29-30
13. Socially Responsible Investment ("SRI") 31
a. SRI Statement31
b. SRI Policy31
Part III.B: Europe, Middle East, Africa, Central America andSouth America
Guidelines
1. Reports & Accounts
Reports and accounts should be both detailed and transparent, and should be
submitted toshareholders for approval. They should meet accepted reporting
standards, and company accountsshould employ Generally Accepted Accounting
Practices (GAAP). Reports should meet with the spiritas well as the letter of
reporting standards, including the most recent recommendations of
theInternational Accounting Standards Board (IASB).
For UK companies, a statement of compliance with the Combined Code should be
made, or reasonsgiven for non-compliance. The reports and accounts should
include a detailed report on executiveremuneration, and best practice demands
that this should also be submitted to shareholders forapproval.
Legal disclosure varies from market to market. If, in our opinion, a company's
standards of disclosure(whilst meeting minimum legal requirements) are
insufficient, we will inform company management ofour concerns, and either
abstain or vote against the approval of the annual report, depending on
thecircumstances. Similar consideration would relate to the use of
inappropriate accounting methods.
2. Dividends
Proposals for the payment of dividends should be presented to shareholders for
approval, and shouldbe fully disclosed in advance of the meeting.
We will vote against dividend proposals if the earnings and cash cover are
inadequate and we feel that payment of the proposed dividend would prejudice
the solvency or future prospects of the company.
3. Auditors
3a. Auditor Independence
Auditors must provide an independent and objective check on the way in which
the financialstatements have been prepared and presented.
JPMF will vote against the appointment or reappointment of auditors who are
not perceived as beingindependent. The length of time both the audit company
and the audit partner have served intheircapacity with a given company will be
taken into account when determining independence.
3b. Auditor Remuneration
Companies should be encouraged to distinguish clearly between audit and
non-audit fees. Auditcommittees should keep under review the non-audit fees
paid to the auditor, both in relation to thesize of the total audit fee and in
relation to the company's total expenditure on consultancy, and thereshould be
a mechanism in place to ensure that consultancy work is put out to competitive
tender.
We would oppose non-audit fees consistently exceeding audit fees, where no
explanation was givento shareholders. Audit fees should never be excessive.
See Audit Committee.
4. Boards
4a. Chairman & CEO
The Combined Code states that there should be a clear division of
responsibilities at the head of acompany, such that no one individual has
unfettered powers of decision. JPMF believes that the rolesof Chairman and
Chief Executive Officer should normally be separate. JPMF will generally
voteagainst combined posts.
4b. Board Structure
JPMF is in favour of unitary boards of the type found in the UK, as opposed to
tiered board structures.We agree with the Combined Code, which finds that
unitary boards offer flexibility while, with a tieredstructure, there is a
risk of upper tier directors becoming remote from the business, while lower
tierdirectors become deprived of contact with outsiders of wider experience.
No director should beexcluded from the requirement to submit him/herself for
reelection on a regular basis.
JPMF will generally vote to encourage the gradual phasing-out of tiered board
structures, in favour ofunitary boards. However, tiered boards are still very
prevalent in markets outside the UK and localmarket practice will always be
taken into account.
4c. Board Size
Boards with more than 20 directors are deemed excessively large, and JPMF will
exercise its votingpowers in favour of reducing large boards wherever
possible.
4d. Board Independence
JPMF believes that a strong independent element to a board is essential to the
effective running of acompany. The Combined Code states that the calibre and
number of non-executive directors on aboard should be such that their views
will carry significant weight in the board's decisions. We agreewith the ICGN,
and the findings of the Higgs Review, that the majority of a board of
directors shouldbe independent, especially if the company has a joint
Chairman/CEO. However, as a minimum, allboards should require at least three
non-executive directors, unless the company is of such a sizethat sustaining
such a number would be an excessive burden.
JPMF will use its voting powers to encourage appropriate levels of board
independence, taking intoaccount local market practice.
See Non Executive Directors.
4e. Board Committees
Where appropriate, boards should delegate key oversight functions to
independent committees. The Chairman and members of any Committee should be
clearly identified in the annual report.
(i)Nomination Committee -
There should be a formal nomination process for the appointment of Directors
with bothexecutive and non-executive representation on the Nomination
Committee.
(ii)Remuneration Committee -
Boards should appoint remuneration committees consisting exclusively of
independentnon-executive directors, with no personal financial interest in
relation to the matters to bedecided, other than their fees and their
shareholdings. Non-executive directors should haveno potential conflicts of
interest arising from cross directorships and no day-to-dayinvolvement in
the running of the business. We would oppose the reelection of any
nonexecutive director who, in our view, had failed to exercise sound
judgement onremuneration issues.
(iii)Audit Committee
An Audit Committee should be established consisting solely of non-executive
directors,who should be independent of management. The Committee should
include at least oneperson with appropriate financial qualifications but
they should all undergo appropriatetraining that provides and maintains a
reasonable degree of up-to-date financial literacyand there should be
written terms of reference which deal clearly with their authority
andduties. Formal arrangements should be in place for the Committee to hold
regular meetingswith external auditors, without executive or staff presence,
and they should have an explicitright of unrestricted access to company
documents and information. The Committee shouldhave the authority to engage
independent advisers where appropriate and also shouldhave responsibility
for selecting and recommending to the board, the external auditors to beput
forward for appointment by the shareholders in general meeting. The
Committee shouldmonitor and review the scope and results of internal audit
work on a regular basis. The Committee should be able to give additional
assurance about the quality and reliability offinancial information used by
the board and public financial statements by the company.
5. Directors
5a. Directors' Contracts
JPMF believes that there is a strong case for directors' contracts being of
one year's duration or less.This is in line with the findings of recent UK
government committees as well as the view of the NAPFand ABI. However, JPMF
always examines these issues on a case-by-case basis and we are awarethat
there will occasionally be a case for contracts of a longer duration in
exceptional circumstances,in order to secure personnel of the required
calibre.
Generally, we encourage contracts of one year or less and vote accordingly.
Unless the remunerationcommittee gives a clearly-argued reason for contracts
in excess of one year, we will vote against thereelection of any director who
has such a contract, as well as consider the reelection of any directorwho is
a member of the remuneration committee.
Directors' contracts increasingly contain special provisions whereby
additional payment becomes duein the event of a change of control. We agree
with the view of the NAPF and ABI that such terms areinappropriate and should
be discouraged and, under normal circumstances, we will use our votingpower
accordingly.
Market practice globally regarding the length of directors' service contracts
varies enormously, andJPMF is cognisant that it would be inappropriate to
enforce UK standards in some other markets. Tothis end, JPMF investment takes
into account local market practice when making judgements in thisarea.
5b. Executive Directors' Remuneration
Executive remuneration is and will remain a contentious issue, particularly
the overall quantum of remuneration. However, company policy in this area
cannot be prescribed by any code or formula to cater for all circumstances and
must depend on responsible and well-informed judgement on the part of
remuneration committees. Any remuneration policy should be transparent and
fully disclosed to shareholders in the Annual Report.
JPMF will generally vote against shareholder proposals to restrict arbitrarily
the compensation ofexecutives or other employees. We feel that the specific
amounts and types of employeecompensation are within the ordinary business
responsibilities of the board and the companymanagement. However, the
remuneration of executive directors should be determined byindependent
remuneration committees and fully disclosed to shareholders. Any stock option
plans orlong-term incentive plans should meet our guidelines for such plans
set forth herein.
We strongly believe that directors should be encouraged to hold meaningful
amounts of company stock, equivalent to at least one year's salary, in order
to align fully their interests with the interests of shareholders.
See Stock Options and Long-Term Incentive Plans (L-TIPs).
5c. Directors' Liability
In certain markets, this proposal asks shareholders to give blanket discharge
from responsibility for alldecisions made during the previous financial year.
Depending on the market, this resolution may ormay not be legally binding, and
may not release the board from its legal responsibility.
JPMF will usually vote against discharging the board from responsibility in
cases of pending litigation, or if there is evidence of wrongdoing for which
the board must be held accountable.
5d. Directors over 70
Whilst special requirements for directors over 70 have their roots in company
legislation (in the UK)as well as various corporate governance guidelines,
JPMF considers that a similar standard of careshould be applied to the
selection of a director over 70 as would be applied to that of any
otherdirector, although we would expect to see such a director offer him or
herself for reelection eachyear.
6. Non-Executive Directors
6a. Role of Non-Executive Directors
As stated earlier in these guidelines, JPMF believes that a strong independent
element to a board isessential to the effective running of a company. We will
use our voting power to ensure that a healthyindependent element to the board
is preserved at all times and to oppose the reelection of non-executive
directors whom we no longer consider to be independent.
In determining our vote, we will always consider independence issues on a
case-by-case basis, taking into account any exceptional individual
circumstances, together with local markets' differing attitudes to director
independence.
In order to help assess their contribution to the company, the time spent by
each non-executivedirector should be disclosed to shareholders, as well as
their attendance at board and committeemeetings.
Audit and remuneration committees should be composed exclusively of
independent directors.
6b.Director Independence
We agree with the ICGN that a director will generally be deemed to be
independent if he or she has no significant financial, familial or other ties
with the company which might pose a conflict, and has not been employed in an
executive capacity by the company for at least the previous ten years.
A non-executive director who has served more than three terms (or ten years)
in the same capacitycan no longer be deemed to be independent.
6c. Non-Executive Director's Remuneration
JPMF strongly believes that non-executive directors should be paid, at least
in part, in shares of the company wherever possible, in order to align their
interests with the interests of shareholders. Performance criteria, however,
should never be attached. Non-executive directors should not be awarded
options.
6d. Multiple Directorships
In order to be able to devote sufficient time to his or her duties, we would
not normally expect a non-executive to hold more than five significant
directorships at any one time. For executives, only oneadditional
non-executive post would normally be considered appropriate without further
explanation.
7. Issue of Capital
7a. Issue of Equity
In most countries, company law requires that shareholder approval be obtained
in order to increase the authorised share capital of the company. Proposals
for equity issues will also specify whether pre-emptive rights are to be
retained or suppressed or partially suppressed for the issue. As a general
rule, JPMF believes that any new issue of equity should first be offered to
existing shareholders on a preemptive basis.
JPMF will vote in favour of increases in capital which enhance a company's
long-term prospects. Wewill also vote in favour of the partial suspension of
preemptive rights if they are for purely technicalreasons (e.g., rights offers
which may not be legally offered to shareholders in certain jurisdictions).
JPMF will vote against increases in capital which would allow the company to
adopt "poison pill"takeover defence tactics, or where the increase in
authorised capital would dilute shareholder value inthe long term.
7b. Issue of Debt
Reasons for increased bank borrowing powers are many and varied, including
allowing normal growth of the company, the financing of acquisitions, and
allowing increased financial leverage. Management may also attempt to borrow
as part of a takeover defence.
JPMF will vote in favour of proposals which will enhance a company's long-term
prospects. We willvote against an increase in bank borrowing powers which
would result in the company reaching anunacceptable level of financial
leverage, where such borrowing is expressly intended as part of atakeover
defence, or where there is a material reduction in shareholder value.
7c. Share Repurchase Programmes
Boards may instigate share repurchase or stock buy-back programs for a number
of reasons. JPMF will vote in favour of such programmes where the repurchase
would be in the best interests of shareholders, and where the company is not
thought to be able to use the cash in a more useful way.
We will vote against such programmes when shareholders' interests could be
better served bydeployment of the cash for alternative uses, or where the
repurchase is a defensive manoeuvre or anattempt to entrench management.
8. Mergers/Acquisitions
Mergers and acquisitions are always reviewed on a case-by-case basis by the
investment analyst inconjunction with portfolio managers and, in exceptional
circumstances , the Committee. Individualcircumstances will always apply.
However, as a general rule, JPMF will favour mergers andacquisitions where the
proposed acquisition price represents fair value, where shareholders
cannotrealise greater value though other means, and where all shareholders
receive fair and equaltreatment under the merger/acquisition terms.
9. Voting Rights
JPMF believes in the fundamental principle of "one share, one vote."
Accordingly, we will vote tophase out dual voting rights or classes of share
with restricted voting rights, and will oppose attemptsto introduce new ones.
We are opposed to mechanisms that skew voting rights, such as
cumulativevoting; directors should represent all shareholders equally, and
voting rights should accrue inaccordance with the shareholder's equity capital
commitment to the company.
Similarly, we will generally oppose amendments to require supermajority (i.e.,
more than 51%) votesto approve mergers, consolidations or sales of assets or
other business combinations.
10. Share Options/Long-Term Incentive Plans (L-TIPs)
10a.Share Options
Share option schemes should be clearly explained and fully disclosed to both
shareholders andparticipants, and put to shareholders for approval. Each
director's share options should be detailed,including exercise prices, expiry
dates and the market price of the shares at the date of exercise.They should
take into account maximum levels of dilution, as set out in ABI, NAPF and
similarguidelines. Full details of any performance criteria should be
included. Share options should never beissued at a discount, and there should
be no award for below-median performance. In general, JPMFwill vote in favour
of option schemes, the exercise of which requires that challenging performance
criteria be met.
Best practice requires that share options be fully expensed, so that
shareholders can assess theirtrue cost to the company. The assumptions and
methodology behind the expensing calculationshould also be explained to
shareholders.
We will generally vote against the cancellation and reissue, retesting or
repricing, of underwateroptions.
10b.Long-Term Incentive Plans (L-TIPs)
A Long-Term Incentive Plan ("L-TIP") can be defined as any arrangement, other
than deferredbonuses and retirement benefit plans, which require one or more
conditions in respect of serviceand/or performance to be satisfied over more
than one financial year.
JPMF, in agreement with the stipulations of the Combined Code, feels that the
performance-related elements of any L-TIP should be designed to give
directors keen incentives to perform at the highest levels, and that grants
under such schemes should be subject to performance criteria which are
challenging and which reflect the company's objectives.
Ideally, the L-TIP should use a methodology such as total shareholder return
("TSR"), coupled with afinancial underpin such as growth in earnings per share
("EPS"). Performance should bebenchmarked against an appropriate comparator
group of companies and a graph of recentperformance should be included. Awards
should increase on a straight-line basis, with a maximumaward only vesting for
the very highest performance. As with share option schemes, there should beno
award for below-median performance. Any beneficiary should be encouraged to
retain anyresultant shares for a suitable time.
In all markets JPMF will vote in favour of schemes with keen incentives and
challenging performancecriteria, which are fully disclosed to shareholders in
advance, and vote against payments which areexcessive or performance criteria
which are undemanding. We would expect remunerationcommittees to explain why
criteria are considered to be challenging and how they align the interestsof
shareholders with the interests of the recipients.
11. Others
11a. Poison Pills
Poison pills, or shareholder rights plans, are designed to give shareholders
of a target company theright to purchase shares of the acquiring company, the
target company, or both at a substantialdiscount from market value. These
rights are exercisable once a predefined "triggering event" occurs, generally
a hostile takeover offer or an outsider's acquisition of a certain percentage
of stock.Corporations may or may not be able to adopt poison pills without
shareholder approval, dependingon the market.
JPMF reviews such proposals on a case-by-case basis; however we will generally
vote against suchproposals and support proposals aimed at revoking existing
plans.
In reaching its voting position, the Committee has reviewed and continues to
review current takeoverevents. However, it has concluded that there is no
clear evidence that poison pills deter takeoveroffers or defeat takeover
attempts, and are in fact sometimes used as tools to entrench management.
11b. Composite Resolutions
Agenda items at shareholder meetings should be presented in such a way that
they can be votedupon clearly, distinctly and unambiguously. We normally
oppose deliberately vague, composite or"bundled" resolutions, depending on the
context.
11c. Social/Environmental Issues
The Committee reviews shareholder proposals concerning social and
environmental issues. Innormal circumstances, the consideration of social
issues in investment decisions is the duty ofdirectors; nevertheless, from
time to time, a company's response to the circumstances of a particularsocial
or environmental issue may have economic consequences, either directly or
indirectly. In thesecases, the economic effects are considered in determining
our vote.
Where management is proposing changes with a social, environmental or ethical
dimension, theseproposals should be in line with JPMF's SRI policy.
See Socially Responsible Investment (SRI).
11d. Charitable Issues
Charitable donations are generally acceptable, provided they are within
reasonable limits and fullydisclosed to shareholders.
11e. Political Issues
JPMF does not normally support the use of shareholder funds for political
donations, and wouldrequire the fullest explanation as to why this would be
beneficial to shareholders.
12. Shareholder Activism and Company Engagement
12a. Activism Statement
The Myners Review identified "shareholder activism" as an important part of
the responsibilities of UKpension fund trustees and their investment managers
and recommended that managers address theissue as follows:
. ensure managers have an explicit strategy on activism
. monitor the performance of investee companies
. intervene where necessary
. evaluate the impact of engagement activity
. report back to clients
This approach was endorsed by the Institutional Shareholders' Committee
("ISC") in their response toMyners. Curiously, neither activism nor
intervention is defined in the Myners Report and they areinterpreted
differently by different investors. At one extreme are those who deliberately
set out toinvest in underperforming companies with the aim of encouraging
change. Such investors wouldexpect to be involved in detailed discussions
about management and policy and would expect to havesignificant influence on
both. As effective insiders they are unlikely to be active traders of
theirposition and will take a long-term view of the investment, regardless of
market
conditions. At the otherextreme are those who regard activism as the simple
process of voting their shareholding, with littleor no regard for a company's
governance policy or standards. They would argue that their clients'interests
are best served by selling shares in underperforming companies. JPMF's
approach is setout below.
12b. Activism Policy
(i) Explicit Strategy -
A clearly articulated policy has existed at JPMF for many years. Our primary
aim is toprotect our clients' interests. Thus, where appropriate, we will
engage with companies inwhich client assets are invested if they fail to
meet our requirements with regard tocorporate governance and/or performance.
The approach involves active discussion withcompany management and, if
necessary,participation in action groups, but not direct involvement in
management.
Our strategy is explicitly based on the US Department of Labor's
recommendations whichare commended by Myners and which have been cited in
every edition of our Voting Policyand Guidelines.
(ii) Monitor Performance -
At JPMF, whilst we do seek to build a good understanding of the businesses
in which we invest, we do not see ourselves in any way as management
consultants. Our responsibility is to achieve our clients' investment
objectives and, provided a company's potential is undiminished and it offers
satisfactory prospective returns, we believe that we are most likely to meet
these objectives retaining our holdings, meeting management, when
appropriate and by considered voting at company meetings. In addition we
increasingly find that we are consulted by companies on remuneration policy
proposals. Of course, there are times when it is in the best interests of
our clients to sell holdings in companies which we expect to perform badly
and we absolutely reserve the right to do so.
(iii)Intervene Where Necessary -
As we have an active approach to proxy voting we do, in that sense,
intervene frequently incompany affairs and this causes us to vote against or
abstain on resolutions at company meetings.
Whenever we believe that it may be appropriate to vote against management,
we speakwith the company in order to ensure that they are fully informed of
the reasons for thepolicy to which we are opposed and to give management an
opportunity to amend thatpolicy. The evidence is that by consistently
seeking compliance with best practice we do,over time, influence company
behaviour. On occasion, this has been best achieved by registering
disapproval and abstaining whilst making it clear to management that
unlesspolicy changes within a year we shall vote against management in the
following year. Inthis context we have found "vocal abstention" as a very
potent form of activism.
JPMF does not intervene directly in the management of companies. However,
where a company has failed to meet our expectations in terms of revenue or
profits growth and it is not clear what action is being taken to remedy the
situation but we believe that the potential of the company still justifies
retention in our clients' portfolios, we arrange to meet with senior
management. On such occasions we expect management to explain what is being
done to bring the business back on track, but if possible we try to avoid
being made insiders as this constrains our ability to deal in the stock. In
the small capitalisation end of the market, more aggressive intervention is
more common, but still infrequent, as we may hold a significant percentage
of a company's equity. In such circumstances we will frequently raise our
concerns first with the company's brokers or advisers.
(iv) Evaluate Impact
Noon to our knowledge has so far been able to measure directly and
explicitly the benefits of good corporate governance. However, we remain
convinced that a strong governance culture leads ultimately to a better
business with above average growth and a better stock market rating. There
is some evidence from the emerging markets that better governance leads to
more effective capital markets and until recently investors' confidence in
the Anglo-Saxon markets was supported by a belief in their strong governance
culture.
As investors we scrutinise companies' governance policies as a part of our
investment research and take comfort from good governance. Thus, one measure
of success is the extent to which our investment strategy achieves our
clients' investment objectives. Where we have pushed for change, either in
governance policies or in business strategy, we measure success by the
extent that change is forthcoming and whether our clients benefit as a
result.
We are actively involved in a number of working parties and investor groups
and our aim is to be at the forefront of developments in this area.
(v) Reporting
Reports detailing our engagement activity are available to clients on a
quarterly basis.
13. Socially Responsible Investment ("SRI")
13a. SRI Statement
From 3rd July 2000, trustees of occupational pension schemes in the UK have
been required todisclose their policy on socially responsible investment in
their Statement of Investment Principles.
JPMF has had experience in tailoring portfolios to meet individual ethical
requirements for over fifty years. We believe that we operate to the highest
standards and that our SRI screens will meet or exceed the requirements of
most clients. For pension fund clients, who are not permitted to exclude
specific areas of investment from their portfolios, we have developed a number
of strategies to positively target companies with superior social, ethical and
environmental credentials.
For institutional clients such as charitable foundations and endowments, where
the legal framework for ethical and socially responsible investing is less
restrictive, JPMF has substantial experience over a long period of time of
managing ethically-constrained portfolios. This service is client-preference
led and flexible, and forms part of our charitable sector specialist
investment services.
For clients who have not specified individual social or environmental criteria
in their guidelines, these issues are still taken into account by analysts and
portfolio managers as part of the overall stock selection process, and certain
engagement activity is still undertaken by JPMF on their behalf. This is
detailed in the following section.
13b. SRI Policy
Where JPMF engages with companies on broader social, environmental and
sustainability issues, we have adopted a positive engagement approach. Thus,
specific assets or types of assets are not excluded on purely social,
environmental or ethical criteria (unless specifically requested by clients).
Rather, analysts take such issues into account as part of the mainstream
analytical process. Where appropriate, JPMF will also engage with company
management on specific issues at company one-to-one meetings. This engagement
activity is then reported to clients at regular intervals.
Where social or environmental issues are the subject of a proxy vote, JPMF
will consider the issue on a case-by-case basis, keeping in mind at all times
the best economic interests of our clients. Increasingly, shareholder
proposals are being used by activist groups to target companies as a means of
promoting single-issue agendas. In
these instances, it is important to differentiate between constructive
resolutions, intended to bring about genuine social or environmental
improvement, and hostile proposals intended to limit management power, which
may in fact ultimately destroy shareholder value.
In formulating our SRI policy, we have endeavoured not to discriminate against
individual companies or sectors purely on the grounds of the particular
business sector in which they are involved. Thus a company in an extractive
industry or the defence industry will not be automatically marked down because
their sector is perceived as "unfriendly." Similarly, a company in a
low-impact industry such as financial services will still be expected to have
in place detailed policies and rigorous oversight of its environmental impact.
JPMF is committed to improving standards of corporate social responsibility
among all of the companies in which it invests its clients' assets as part of
an inclusive positive engagement strategy.
The current focus of this engagement process is on UK companies. However,
social and environmental issues are taken into account for overseas companies
on a wider basis where appropriate as described previously. It is anticipated
that our SRI program will continue to expand both in terms of scope and market
coverage as client demand and availability of suitable resources dictate.
Part IV: Asia Ex-Japan Proxy Voting Guidelines
1. The client is the beneficial owner of all securities in a portfolio. As such
the client is entitled to all benefits of ownership including the exercise of
votes in the event of corporate actions.
2. In the absence of specific client instructions, the investment manager is the
party responsible for exercising the voting of proxies.
3. JFAM, as investment managers, recognise that proxies have an economic value;
the voting of proxies therefore represents a responsibility on JFAM as
fiduciaries.
4. The sole criterion for determining how to vote a proxy is always what is in
the best interest of the client.
5. For routine proxies (e.g., in respect of voting at AGMs) the house position
is neither to vote in favour or against. For EGMs, however, where specific
issues are put to a shareholder vote, these issues are analysed by the
respective Country Specialist concerned. A decision is then made based on
his/her judgement.
6. Where proxy issues concern corporate governance, takeover defense measures,
compensation plans, capital structure changes and so forth, JFAM pays
particular attention to management's arguments for promoting the prospective
change. The sole criterion in determining our voting stance is whether such
changes will be to the economic benefit of the beneficial owners of the
shares.
7. Corporate governance procedures differ among the countries. Proxy materials
are generally mailed by the issuer to the subcustodian which holds the
securities for the client in the country where the portfolio company is
organised, but there may not be sufficient time for such materials to be
transmitted to the investment manager in time for a vote to be cast. Many
proxy statements are in foreign languages. In some countries proxy statements
are not mailed at all. Voting is highly impractical (if not impossible) in
locations where the deadline for voting is two to four days after the initial
announcement that a vote is to be solicited or where voting is restricted to
the beneficial owner. In short, because of the time constraints and local
customs involved, it is not always possible for an investment manager to
receive and review all proxy materials in connection with each item submitted
for vote. The cost of voting is also an issue that we will consider in light
of the expected benefit of the vote.
Part V: Japan Proxy Voting Guidelines
1. Number of Directors
To ensure a swift management decision-making process, the appropriate number
of directors shouldbe 20 or less.
2. Release of Directors from Legal Liability
Vote against actions releasing a director from legal liability.
3. Director's Tenure
Director's tenure should be equal to/less than 1 year.
4. Director's Remuneration
Remuneration of directors should generally be determined by an independent
committee.
5. Audit fees
Audit fees must be at an appropriate level.
6. Capital Increase
Capital increases will be judged on a case-by-case basis depending on its
purpose. Vote againstcapital increases if the purpose is to defend against a
takeover.
7. Borrowing of Funds
Vote against abrupt increases in borrowing of funds if the purpose is to
defend against a takeover.
8. Share Repurchase Programs
Vote in favor of share repurchase programs if it leads to an increase in the
value of the company's shares.
9. Payout ratio
As a general rule, vote against any proposal for appropriation of profits
which involves a payout ratio of less than 50% (after taking into account
other forms of payouts to shareholders such as share repurchase programs) if
the capital ratio is equal to or greater than 50% and there is no further need
to increase the level of retained earnings.
10. Mergers/Acquisitions
Mergers and acquisitions must only be consummated at a price representing fair
value.
11. Stock Options
Stock option programs should generally be publicly disclosed. Programs which
result in increases in remuneration despite declines in corporate earnings
(such as through a downward adjustment of the exercise price) is generally not
acceptable.
12. Political Contributions
Do not approve any use of corporate funds for political activities.
13. Environmental/Social Issues
Do not take into account environmental/social issues that do not affect the
economic value of the company.
MORGAN STANLEY INVESTMENT MANAGEMENT
PROXY VOTING POLICY AND PROCEDURES
I. POLICY STATEMENT
Introduction - Morgan Stanley Investment Management's ("MSIM") policies and
------------
procedures for voting proxies with respect to securities held in the accounts of
clients applies to those MSIM entities that provide discretionary Investment
Management services and for which a MSIM entity has the authority to vote their
proxies. The policies and procedures and general guidelines in this section will
be reviewed and, as necessary, updated periodically to address new or revised
proxy voting issues. The MSIM entities covered by these policies and procedures
currently include the following: Morgan Stanley Investment Advisors Inc., Morgan
Stanley Alternative Investment Partners, L.P., Morgan Stanley AIP GP LP, Morgan
Stanley Investment Management Inc., Morgan Stanley Investment Group Inc., Morgan
Stanley Investment Management Limited, Morgan Stanley Investment Management
Company, Morgan Stanley Asset & Investment Trust Management Co., Limited, Morgan
Stanley Investment Management Private Limited, Morgan Stanley Investments LP,
Van Kampen Investment Advisory Corp., Van Kampen Asset Management Inc., and Van
Kampen Advisors Inc. (each a "MSIM Affiliate" and collectively referred to as
the "MSIM Affiliates").
Each MSIM Affiliate will vote proxies as part of its authority to manage,
acquire and dispose of account assets. With respect to the MSIM registered
management investment companies (Van Kampen, Institutional and Advisor
Funds)(collectively referred to as the "MSIM Funds"), each MSIM Fund will vote
proxies pursuant to authority granted under its applicable investment advisory
agreement or, in the absence of such authority, as authorized by its Board of
Directors or Trustees. A MSIM Affiliate will not vote proxies if the "named
fiduciary" for an ERISA account has reserved the authority for itself, or in the
case of an account not governed by ERISA, the Investment Management Agreement
does not authorize the MSIM Affiliate to vote proxies. MSIM Affiliates will, in
a prudent and diligent manner, vote proxies in the best interests of clients,
including beneficiaries of and participants in a client's benefit plan(s) for
which we manage assets, consistent with the objective of maximizing long-term
investment returns ("Client Proxy Standard"). In certain situations, a client or
its fiduciary may provide a MSIM Affiliate with a statement of proxy voting
policy. In these situations, the MSIM Affiliate will comply with the client's
policy unless to do so it would be inconsistent with applicable laws or
regulations or the MSIM Affiliate's fiduciary responsibility.
Proxy Research Services - To assist the MSIM Affiliates in their responsibility
-----------------------
for voting proxies and the overall global proxy voting process, Institutional
Shareholder Services ("ISS") and the Investor Responsibility Research Center
("IRRC") have been retained as experts in the proxy voting and corporate
governance area. ISS and IRRC are independent advisers that specialize in
providing a variety of fiduciary-level proxy-related services to institutional
investment managers, plan sponsors, custodians, consultants, and other
institutional investors. The services provided to MSIM Affiliates include
in-depth research, global issuer analysis, and voting recommendations. In
addition to research, ISS provides vote execution, reporting, and recordkeeping.
MSIM's Proxy Review Committee (see Section IV.A. below) will carefully monitor
and supervise the services provided by the proxy research services.
Voting Proxies for certain Non-US Companies - While the proxy voting process is
well established in the United States and other developed markets with a number
of tools and services available to assist an investment manager, voting proxies
of non-US companies located in certain jurisdictions, particularly emerging
markets, may involve a number of problems that may restrict or prevent a MSIM
Affiliate's ability to vote such proxies. These problems include, but are not
limited to: (i) proxy statements and ballots being written in a language other
than English; (ii) untimely and/or inadequate notice of shareholder meetings;
(iii) restrictions on the ability of holders outside the issuer's jurisdiction
of organization to exercise votes; (iv) requirements to vote proxies in person,
(v) the imposition of restrictions on the sale of the securities for a period of
time in proximity to the shareholder meeting; and (vi) requirements to provide
local agents with power of attorney to facilitate the MSIM Affiliate's voting
instructions. As a result, clients' non-U.S. proxies will be voted on a best
efforts basis only, consistent with the Client Proxy Standard. ISS has been
retained to provide assistance to the MSIM Affiliates in connection with voting
their clients' non-US proxies.
II. GENERAL PROXY VOTING GUIDELINES
To ensure consistency in voting proxies on behalf of its clients, MSIM
Affiliates will follow (subject to any exception set forth herein) these Proxy
Voting Policies and Procedures, including the guidelines set forth below. These
guidelines address a broad range of issues, including board size and
composition, executive compensation, anti-takeover proposals, capital structure
proposals and social responsibility issues and are meant to be general voting
parameters on issues that arise most frequently. The MSIM Affiliates, however,
may vote in a manner that is contrary to the following general guidelines,
pursuant to the procedures set forth in Section IV. below, provided the vote is
consistent with the Client Proxy Standard.
III. GUIDELINES
A) Management Proposals
When voting on routine ballot items the following proposals are generally
voted in support of management, subject to the review and approval of the
Proxy Review Committee, as appropriate.
. Selection or ratification of auditors.
. Approval of financial statements, director and auditor reports.
. Election of Directors.
. Limiting Directors' liability and broadening indemnification of Directors.
. Requirement that a certain percentage (up to 66 2/3%) of its Board's
members be comprised of independent and unaffiliated Directors.
. Requirement that members of the company's compensation, nominating and
audit committees be comprised of independent or unaffiliated Directors.
. Recommendations to set retirement ages or require specific levels of stock
ownership by Directors.
. General updating/corrective amendments to the charter.
. Elimination of cumulative voting.
. Elimination of preemptive rights.
. Provisions for confidential voting and independent tabulation of voting
results.
. Proposals related to the conduct of the annual meeting except those
proposals that relate to the "transaction of such other business which may
come before the meeting."
The following non-routine proposals, which potentially may have a
substantive financial or best interest impact on a shareholder, are
generally voted in support of management, subject to the review and approval
of the Proxy Review Committee, as appropriate.
Capitalization changes
----------------------
. Capitalization changes that eliminate other classes of stock and voting
rights.
. Proposals to increase the authorization of existing classes of common
stock (or securities convertible into common stock) if: (i) a clear and
legitimate business purpose is stated; (ii) the number of shares requested
is reasonable in relation to the purpose for which authorization is
requested; and (iii) the authorization does not exceed 100% of shares
currently authorized and at least 30% of the new authorization will be
outstanding.
. Proposals to create a new class of preferred stock or for issuances of
preferred stock up to 50% of issued capital.
. Proposals for share repurchase plans.
. Proposals to reduce the number of authorized shares of common or preferred
stock, or to eliminate classes of preferred stock.
. Proposals to effect stock splits.
. Proposals to effect reverse stock splits if management proportionately
reduces the authorized share amount set forth in the corporate charter.
Reverse stock splits that do not adjust proportionately to the authorized
share amount will generally be approved if the resulting increase in
authorized shares coincides with the proxy guidelines set forth above for
common stock increases.
Compensation
------------
. Director fees, provided the amounts are not excessive relative to other
companies in the country or industry.
. Employee stock purchase plans that permit discounts up to 15%, but only
for grants that are part of a broad based employee plan, including all
non-executive employees.
. Establishment of Employee Stock Option Plans and other employee ownership
plans.
Anti-Takeover Matters
---------------------
. Modify or rescind existing supermajority vote requirements to amend the
charters or bylaws.
. Adoption of anti-greenmail provisions provided that the proposal: (i)
defines greenmail; (ii) prohibits buyback offers to large block holders
not made to all shareholders or not approved by disinterested
shareholders; and (iii) contains no anti-takeover measures or other
provisions restricting the rights of shareholders.
The following non-routine proposals, which potentially may have a
substantive financial or best interest impact on the shareholder, are
generally voted against (notwithstanding management support), subject to the
review and approval of the Proxy Review Committee, as appropriate.
. Capitalization changes that add classes of stock that which substantially
dilute the voting interests of existing shareholders.
. Proposals to increase the authorized number of shares of existing classes
of stock that carry preemptive rights or supervoting rights.
. Creation of "blank check" preferred stock.
. Changes in capitalization by 100% or more.
. Compensation proposals that allow for discounted stock options that have
not been offered to employees in general.
. Amendments to bylaws that would require a supermajority shareholder vote
to pass or repeal certain provisions.
. Proposals to indemnify auditors.
The following types of non-routine proposals, which potentially may have a
potential financial or best interest impact on an issuer, are voted as
determined by the Proxy Review Committee.
Corporate Transactions
----------------------
. Mergers, acquisitions and other special corporate transactions (i.e.,
takeovers, spin-offs, sales of assets, reorganizations, restructurings and
recapitalizations) will be examined on a case-by-case basis. In all cases,
ISS and IRRC research and analysis will be used along with MSIM
Affiliates' research and analysis, based on, among other things, MSIM
internal company-specific knowledge.
. Change-in-control provisions in non-salary compensation plans, employment
contracts, and severance agreements that benefit management and would be
costly to shareholders if triggered.
. Shareholders rights plans that allow appropriate offers to shareholders to
be blocked by the board or trigger provisions that prevent legitimate
offers from proceeding.
. Executive/Director stock option plans. Generally, stock option plans
should meet the following criteria:
(i) Whether the stock option plan is incentive based;
(ii) For mature companies, should be no more than 5% of the issued capital
at the time of approval;
(iii) For growth companies, should be no more than 10% of the issued
capital at the time of approval.
Anti-Takeover Provisions
------------------------
. . Proposals requiring shareholder ratification of poison pills.
. . Anti-takeover and related provisions that serve to prevent the majority
of shareholders from exercising their rights or effectively deter the
appropriate tender offers and other offers.
B) SHAREHOLDER PROPOSALS
The following shareholder proposals are generally supported, subject to the
review and approval of the Proxy Review Committee, as appropriate:
. Requiring auditors to attend the annual meeting of shareholders.
. Requirement that members of the company's compensation, nominating and
audit committees be comprised of independent or unaffiliated Directors.
. Requirement that a certain percentage of its Board's members be comprised
of independent and unaffiliated Directors.
. Confidential voting.
. Reduction or elimination of supermajority vote requirements.
The following shareholder proposals will be voted as determined by the Proxy
Review Committee.
. Proposals that limit tenure of directors.
. Proposals to limit golden parachutes.
. Proposals requiring directors to own large amounts of stock to be eligible
for election.
. Restoring cumulative voting in the election of directors.
. Proposals that request or require disclosure of executive compensation in
addition to the disclosure required by the Securities and Exchange
Commission ("SEC") regulations.
. Proposals that limit retirement benefits or executive compensation.
. Requiring shareholder approval for bylaw or charter amendments.
. Requiring shareholder approval for shareholder rights plan or poison pill.
. Requiring shareholder approval of golden parachutes.
. Elimination of certain anti-takeover related provisions.
. Prohibit payment of greenmail.
The following shareholder proposals are generally not supported, subject to
the review and approval of the Committee, as appropriate.
. Requirements that the issuer prepare reports that are costly to provide or
that would require duplicative efforts or expenditures that are of a
non-business nature or would provide no pertinent information from the
perspective of institutional shareholders.
. Restrictions related to social, political or special interest issues that
impact the ability of the company to do business or be competitive and
that have a significant financial or best interest impact to the
shareholders.
. Proposals that require inappropriate endorsements or corporate actions.
IV. ADMINISTRATION OF PROXY POLICIES AND PROCEDURES
A) Proxy Review Committee
The MSIM Proxy Review Committee ("Committee") is responsible for creating
and implementing MSIM's Proxy Voting Policy and Procedures and, in this
regard, has expressly adopted them. Following are some of the functions and
responsibilities of the Committee.
a) The Committee, which will consist of members designated by MSIM's Chief
Investment Officer, is responsible for establishing MSIM's proxy voting
policies and guidelines and determining how MSIM will vote proxies on an
ongoing basis.
b) The Committee will periodically review and have the authority to amend as
necessary MSIM's proxy voting policies and guidelines (as expressed in
these Proxy Voting Policy and Procedures) and establish and direct voting
positions consistent with the Client Proxy Standard.
c) The Committee will meet at least monthly to (among other matters): (1)
address any outstanding issues relating to MSIM's Proxy Voting Policy and
Procedures; and (2) generally review proposals at upcoming shareholder
meetings of MSIM portfolio companies in accordance with this Policy and
Procedures including, as appropriate, the voting results of prior
shareholder meetings of the same issuer where a similar proposal was
presented to shareholders. The Committee, or its designee, will timely
communicate to ISS MSIM's Proxy Voting Policy and Procedures (and any
amendments to them and/or any additional guidelines or procedures it may
adopt).
d) The Committee will meet on an ad hoc basis to (among other matters): (1)
authorize "split voting" (i.e., allowing certain shares of the same issuer
that are the subject of the same proxy solicitation and held by one or
more MSIM portfolios to be voted differently than other shares) and/or
"override voting" (i.e., voting all MSIM portfolio shares in a manner
contrary to the Procedures); (2) review and approve upcoming votes, as
appropriate, for matters for which specific direction has been provided in
Sections I, II, and III above; and (3) determine how to vote matters for
which specific direction has not been provided in Sections I, II and III
above. Split votes will generally not be approved within a single Global
Investor Group team. The Committee may take into account ISS
recommendations and the research provided by IRRC as well as any other
relevant information they may request or receive.
e) In addition to the procedures discussed above, if the Committee
determines that an issue raises a potential material conflict of interest,
or gives rise to the appearance of a potential material conflict of
interest, the
Committee will designate a special committee to review, and recommend a
course of action with respect to, the conflict(s) in question ("Special
Committee"). The Special Committee may request the assistance of the Law
and Compliance Departments and will have sole discretion to cast a vote.
In addition to the research provided by ISS and IRRC, the Special
Committee may request analysis from MSIM Affiliate investment
professionals and outside sources to the extent it deems appropriate.
f) The Committee and the Special Committee, or their designee(s), will
document in writing all of their decisions and actions, which
documentation will be maintained by the Committee and the Special
Committee, or their designee(s) for a period of at least 6 years. To the
extent these decisions relate to a security held by a MSIM U.S. registered
investment company, the Committee and Special Committee, or their
designee(s), will report their decisions to each applicable Board of
Trustees/Directors of those investment companies at each Board's next
regularly Scheduled Board meeting. The report will contain information
concerning decisions made by the Committee and Special Committee during
the most recently ended calendar quarter immediately preceding the Board
meeting.
g) The Committee and Special Committee, or their designee(s), will timely
communicate to applicable PMs, the Compliance Departments and, as
necessary to ISS, decisions of the Committee and Special Committee so
that, among other things, ISS will vote proxies consistent with their
decisions.
CO/PROCEDURES/PROXY FINAL 5/30/03
NEUBERGER BERMAN, LLC
PROXY POLICY
I. INTRODUCTION
Neuberger Berman, LLC ("NB") is generally responsible for voting the proxies of
its ERISA accounts.
This precept is based on the views of the Department of Labor ("DOL") set forth
in an advisory letter known as the "Avon letter".
The DOL maintains that proxy voting is an integral aspect of investment
management. Accordingly, proxy voting must be conducted with the same degree of
prudence and loyalty accorded any other fiduciary obligation of an investment
manager. Accordingly, NB, as a fiduciary, must vote ERISA account proxies
exclusively for the benefit of the plan's participants or beneficiaries.*
NB has created a Proxy Committee** to formulate a policy on the manner in which
NB will vote ERISA Account proxies.
In formulating a proxy policy, the Proxy Committee believes that many
propositions to be voted upon will fit into categories and, presumptively, such
propositions should be voted on in a predetermined manner to meet the DOL
requirements outlined above.
Such proxy policy is based on the following positions taken by the proxy
committee:
(i) management is generally most qualified to determine how to vote on board
of director composition, selection of auditor, compensation, corporate law
compliance and social issues; and
(ii) measures that are likely to entrench management or deter takeovers
generally depress market value on both a long and short term and should not be
supported.
II. FLEXIBILITY OF THE POLICY DIRECTIVES
The NB policy of specific voting directives as set forth in Section IV below are
not intended to be rigid. Based on the particular factual situation or the
investment goals of a particular ERISA account, circumstances may arise where
adherence to a preset proxy policy will not advance the best interests of plan
beneficiaries. Proxies may be voted contrary to the specific directives
contained herein if (i) approved by a majority of the members of the proxy
committee and (ii) such approval is based on the DOL precepts and rules set
forth above.
A request to deviate from a specific directive can be made by the money manager
of the ERISA account, a member of the NB Executive Committee or a member of the
Proxy Committee.
The Proxy Committee will maintain appropriate records of its actions approving
deviations from the directive, citing reasons therefor.
III. AMENDMENT OF DIRECTIVES
The Proxy Committee will meet periodically to review the voting directives.
Directives are subject to amendment by vote of a majority of the Proxy Committee
members.
IV. THE VOTING DIRECTIVES
1) Director Slate. Vote FOR the management slate. This is based on the view
that (i) management is in a good position to determine the credibility of the
nominees and (ii) director selection alone generally does not materially
affect a company's market value. However, if director states are proposed in
the context of proxy fights, the NB research analyst covering the company is
to analyze competing slates and determine in accordance with the DOL precepts
whether NB should vote for the management or stockholder slate. Director
selections in proxy fights can materially affect a company's value, since
management may be more interested in remaining in place than serving
stockholders' best interests.
2) Increase "Blank Check" Authorized Preferred Stock.Vote AGAINST increases in
"blank check preferred stock" (i.e., preferred stock all or many of whose
rights, preferences and designations, (e.g.; dividend and voting rights) can
be established by the Board of Directors acting alone) on the grounds that the
Board of Directors can readily issue such stock in conjunction with "poison
pill" devices or otherwise fashion such stock into takeover deterrents or
weapons. Vote FOR the authorization of preferred stock whose rights,
designations and preferences are pre-established where such stock is being
authorized to achieve a specific and legitimate corporate purpose.
3) Classified or "Staggered Board. Vote AGAINST proposals to classify or
stagger boards. The periodic, as opposed to yearly, election of directors can
be used to entrench management and make a corporation less attractive as a
takeover candidate. To illustrate: a typical classified board consists of
three equal or nearly equal classes of directors where only one class is up
for election each year. Each director on a classified board serves a three
year term, as opposed to a one year term served by directors that are not
subject to a staggered arrangement.
4) Cumulative Voting. Under cumulative voting minority shareholders
dissatisfied with entrenched management can achieve board representation.
Under cumulative voting, each stockholder is permitted to cast a number of
votes equal to the number of shares he owns multiplied by the number of
directors to be elected. The stockholder may cast these votes among any or all
the nominees for director in any manner he wishes. The stockholder, for
example, can concentrate all his votes for the election of just one director.
If there is evidence that the Company is attempting to entrench the Board, or if
the Company has significant anti-takeover devices already in place, we will vote
FOR cumulative voting. If not, and if we are pleased with the current structure
of the Board, we will vote AGAINST such proposals. Consequently, our decision
will be made on a case by case basis.
5) Restrictions on Stockholders to Act by Written Consent. Vote AGAINST
restrictions on use of stockholder written consents in lieu of a stockholder
meeting. Use of written consents is an inexpensive method often not requiring
compliance with the proxy rules employed by stockholders to pass resolutions
that might be challenged by entrenched management in a stockholders meeting.
Written consents have been used as takeover mechanisms to quickly expel
entrenched management.
6) Restrictions on Stockholders to Call Meetings. Vote AGAINST restrictions on
stockholders to call meetings. Any limitation on stockholders to act can
strengthen entrenched management's hand in a takeover or other corporate
challenge and thus can both render the corporation a less attractive takeover
candidate and bestow to management a decided advantage in a takeover.
7) Confidential Voting. Vote FOR confidential voting which permits
stockholders, particularly large institutional stockholders, to vote without
identification.
8) Super-Voting Stock Characteristics. Vote AGAINST super-voting stock. This
device gives entrenched management or other insiders excessive voting
dominance or power through stock where each share can carry ten or more times
the number of votes of the stock issued to the public. Under current S.E.C.
regulations, a corporation with a class of issued super-voting stock is
generally ineligible for trading on NASDAQ or a national stock exchange.
9) "Capping" the Number for Directors. Vote AGAINST "capping" the board.
Entrenched management can use this device to limit the number of directors to
its own friendly directors, thus making it more difficult for outside
stockholders to add their own representatives to the board.
10) Supermajority Provisions. Vote AGAINST. These provisions increase the
difficulty of amending charter and By-Law provisions, thereby securing the
continuation of such provisions presumably supported by entrenched management.
A supermajority provision provides that amendment to the charter and/or
By-Laws or any provision thereof requires a vote of more than the holders of a
majority of stock (e.g., 66-2/3% of all votes).
11) Fair Price Provisions Vote AGAINST fair price provisions. Such provisions
tend to make takeovers, particularly tender offers, more expensive by
requiring that stockholders tendering their shares in the "back end" of a
tender offer receive consideration whose value is equal to that given to
stockholders who tender their shares in the "front end." Certain states such
as Delaware have built fair price provisions into their corporate law, which
provisions apply to all public companies except for those that expressly "opt
out" of the requirement. Thus vote FOR any proposal to "opt out" of a fair
price statute, which would most likely take the form of a stockholder
proposal.
12) Stock Option Plans and other Stock and Deferred Compensation Arrangements.
Vote FOR management-sponsored compensation plans for rank and file employees
that do not alone or in conjunction with other plans result in reserving over
20% of the Company's total issued and outstanding stock. Management is
generally in the best position to establish means of compensating its rank and
file employees. Also vote FOR compensation plans whose participants include
officers and directors, provided that such plans (alone or in conjunction with
already existing plans) either (i) are not structured so as to enable a
control block of stock (over 10%) to be issued to such officers and directors
or (ii) do not provide such officers and directors with either excessive
payments of automatic cash-outs through stock appreciation rights or other
vehicles (golden parachutes) parachutes in the event of a takeover.
Vote AGAINST any plan under which insiders can acquire control blocks of stock
or receive excessive compensation or takeover cash-outs. Such plans can either
have the effect of entrenching management or transferring excessive amounts of
corporate assets out of the corporation (and thus not in the best interest of
stockholders).
13) Director Liability Limitation Proposals. Vote FOR proposals limiting
director liability on the grounds that such proposals are necessary to attract
board nominees of quality in a litigious corporate environment where director
and officer liability insurance is often quite expensive.
14) Environmental Issues, Discrimination Issues, Health Issues and other
"Social Proposals". Neuberger Berman, LLC appreciates the importance of
proposals relating to social issues and believes that economic, political,
social, environmental and similar concerns can significantly affect both
corporate and industry-wide performance and the community in general.
Accordingly, Neuberger Berman, LLC will review and vote on such
social-oriented proposals in accordance with its legal responsibilities and
its voting procedures described in Part II of this Policy
("Flexibility of the Policy Directives"). In such review, Neuberger Berman,
LLC will seriously consider management's recommendations on the grounds that
management is often most qualified to determine how social proposals will
impact on a particular corporation's business and stockholders.
15) Selection of Auditor. Vote as recommended by management. Proposals on
selection of an auditor generally do not materially impact on a corporation's
market value, and management is generally most qualified to make this
determination.
16) Adjustments in Charter or By-laws to Conform to Corporate Law Changes.
Generally vote as recommended by management on technical adjustments to
corporate documents stemming from ongoing changes in corporate and securities
law. Such technical adjustments generally do not materially impact on the
corporation's market value. Moreover, management and corporate counsel are
most qualified to monitor the propriety of these changes for compliance
purposes.
17) Change in Par Value of Authorized Stock. Generally vote FOR these proposals
on the grounds that changes in par value are routine matters not likely to
impact materially on corporate market value and that management is most
qualified to determine this type of matter. Vote AGAINST those proposals,
however, that call for (i) reduction of par value that would decrease the
value of a security held by NB or clients (e.g., reduction in par value where
the security is redeemable at par), (ii) increase in par value that will
materially reduce the corporation's paid in or excess capital that otherwise
could be used for legitimate purposes, e.g., reinvestments, payment of
dividends, etc. or (iii) reduction in par value of a class of securities whose
issuance can be used for anti-takeover purposes, because such a reduction in
par value of a class of securities whose issuance can be used for
anti-takeover purposes, because such a reduction will permit the corporation
to issue these securities for a lower price, thus enhancing management's
ability to defend against takeovers.
V. FREQUENT PROPOSITIONS WITH NO DIRECTIVE
There are proposals that frequently arise that will require Proxy Committee
action because such propositions and the context in which they arise are not
susceptible of a presumptive vote as in Section IV. Examples are listed below.
1) Increases in Common Stock. Vote FOR increases in authorized common stock
that are necessary to achieve legitimate corporate purposes because authorized
common stock constitutes an important vehicle for raising capital and, vote
AGAINST increases in authorized common stock that are unnecessary, excessive
or likely to be used to deter or fight takeovers or unnecessarily dilute
current stockholders.
2) Dividend Rights Plans, Poison Pills and Similar Devices. The Proxy Committee
believes that the impact of dividend rights plans, poison pills and similar
devices on corporate governance and shareholders' values substantially varies
depending upon numerous factors, including but not limited to the following:
the specific terms of the plan or device, the prior performance of Management,
the extent to which anti-takeover and Management entrenchment devices are in
place, the extent to which Management's decisions both in general and in
particular with regard to mergers, acquisitions and the like, are subject to
shareholder and Board of Director review, the medium and long term business
plans of the Company, the relationship of stock price to unrealized values,
and the extent to which the corporation is presently perceived as a merger
candidate. Accordingly, the Proxy Committee will evaluate and vote on matters
regarding these types of plans or devices on a case-by-case basis, taking such
of the foregoing and such other factors into account as it deems appropriate
in the particular circumstances then pertaining.
3) Merger Consolidation Reorganization Recapitalization Sale of Assets. Voting
on non-routine corporate transactions such as mergers, consolidations,
reorganizations, tender offers and large asset sales should be voted as
determined based on analysis of the transaction by the appropriate research
analysts or portfolio managers. The vote on these transactions should be the
result of reasoned and formulated investment decisions.
4) Anti-Greenmail Proposals. Anti-greenmail proposals prohibit management from
buying out at a premium a stockholder that management views as disruptive (or
potentially disruptive). Vote FOR anti-greenmail proposals that are designed
primarily to serve legitimate corporate purposes such as requiring equal
treatment among
stockholders and preventing corporate waste. Vote AGAINST such proposals
designed primarily to deter potential raiders from making large investments in
the subject corporation as a first step in a takeover (a raider may not want
to commit large sums up front if he has no opportunity to receive a premium if
he decides to withdraw).
5) Standoff Proposals. "Standoff proposals" typically prohibit a corporation
from engaging in material transactions (mergers, asset purchases, etc.) with a
"substantial stockholder" (often defined as a stockholder who acquires over
10% or 15% of the outstanding stock for a period of time, e.g. 5 years) unless
the transaction is consented to by the board of directors or a supermajority
of stockholders. Vote FOR those standoff provisions designed to prevent the
corporation from being forced to engage in transactions with disruptive
stockholders and vote AGAINST those proposals designed to prevent legitimate
raiders from effecting transactions with the corporation in connection with
takeovers.
6) Stockholder Proposals on Corporate Matters. Often stockholder proposals
attempt to overturn anti-takeover arrangements that have been in place over
time (e.g., staggered boards, supermajority provisions). Some of these
arrangements will have served the corporation well, others poorly. Thus,
voting on any of these proposals should be on a case-by-case basis. Other
stockholder proposals relate to procedural issues or issues that do not
directly affect the corporation's business (e.g., calling a stockholders'
meeting by a rocket company to discuss rocket safety). Vote for these
proposals as recommended by management because management is often in the best
position to determine these procedural or collateral issues.
7) Reincorporation Into Delaware or Other State with "Pro-Management" Corporate
Laws. Vote AGAINST such proposals for reincorporation into Delaware or other
pro-management states (e.g., New York and Nevada) if the proposed state is
considered "pro-management" because its corporation or similar laws contains a
variety of provisions that limit stockholder rights in favor of management.
"Pro-management" laws often have the effect of entrenching management and
deterring takeovers. While many reincorporation proposals may have such
objectives, there are occasions when we should vote FOR if the Proxy Committee
believes that the purpose of the reincorporation is to secure certain benefits
such as laws permitting limitations on directors' and officers' liability
which enhances a corporation's ability to secure quality management.
VI. OTHER PROPOSALS AND DEVIATIONS FROM VOTING DIRECTIVES
Periodically proposals will appear in proxy material that do not fit any of the
descriptions set forth in Section IV or that the Proxy Committee will not want
to vote as discussed above. Such proposals will be dealt with by the Proxy
Committee as described in Section II of this proxy policy.
VII. RECORD OF VOTING
In each case, the Proxy Committee should maintain internal records on how and
why NB voted the proxies.
Original Guidelines: 05/31/91
Revised 04/19/00 Re: Cumulative Voting.
Revised 11/05/02 Re: South African issue
PRINCIPAL GLOBAL INVESTORS, LLC
PRINCIPAL CAPITAL GLOBAL INVESTORS LIMITED
PRINCIPAL REAL ESTATE INVESTORS, LLC
SPECTRUM ASSET MANAGEMENT, INC.
PRINCIPAL MANAGEMENT CORPORATION
(THE ADVISERS)
STOCK PROXY VOTING POLICY
FOR ALL CLIENT ACCOUNTS
GENERAL POLICY
--------------
1) Each of the Advisers is registered with the Securities and Exchange
Commission and acts as investment manager for various types of client accounts
(e.g. employee benefit plans, governmental plans, mutual funds, insurance
company separate accounts, corporate pension plans, endowments, foundations,
high net worth individuals). When delegated the authority by a client, each
Adviser will vote client-owned shares under its management. The Advisers'
policy concerning proxy voting of client-owned shares is:To vote shares of
common stock in the long-term economic best interest of the clients.
2) To act solely in the interest of clients in providing for ultimate long-term
stockholder value.To act without undue influence from individuals or groups
who may have an economic interest in the outcome of a proxy vote.
PROCESS
-------
For the purpose of timely and consistent application of the above general
policy, the Advisers classify proxy vote issues into three broad categories:
Routine Administrative Items, Special Interest Issues, and Issues Having the
Potential for Significant Economic Impact. Once it has analyzed and identified
each issue as belonging in a particular category, each Adviser will cast the
client's vote(s) in accordance with the philosophy and decision guidelines
developed for that category. New and unfamiliar issues are constantly appearing
in the proxy voting process. As new issues arise, the Advisers will make every
effort to classify them among the following three categories. If the Advisers
believe it would be informative to do so, they may revise this document to
reflect how they evaluate such issues.
Occasions may arise in which an Adviser is required to vote a proxy while having
a conflict between its interest or the interest of an affiliated person of the
Adviser and its clients. To protect clients against a breach of its duty to
them, on any occasion when a proxy vote presents a conflict of interest, the
Adviser will obtain the review of the General Counsel of Principal Financial
Group, Inc. before casting such vote in a manner that is contrary to both (1)
its pre-determined policy, and (2) the recommendation of Institutional
Shareholder Services, Inc.
Due to timing delays, logistical hurdles and high costs associated with
procuring and voting international proxies, each Adviser has elected to approach
international proxy voting on the basis of achieving "best efforts at a
reasonable cost."
CATEGORY I: ROUTINE ADMINISTRATIVE ITEMS
----------------------------
Philosophy: The Advisers are willing to defer to management on matters of a
----------
routine administrative nature. The Advisers feel management is best suited to
make those decisions which are essential to the ongoing operation of the company
and which do not have a major economic impact on the corporation and its
shareholders. Examples of issues on which the Advisers will normally defer to
management's recommendation include:selection of auditorsincreasing the
authorized number of common shares election of unopposed independent directors
CATEGORY II: SPECIAL INTEREST ISSUES
-----------------------
Philosophy: While there are many social, political, environmental and other
----------
special interest issues that are worthy of public attention, the Advisers do not
believe the corporate proxy process is the appropriate arena in which to achieve
gains in these areas. In recent history, proxy issues of this sort have included
such matters as sales to the military, doing business in South Africa, and
environmental responsibility. The Advisers' primary responsibility in voting
proxies is to provide for the greatest long-term value for clients. The Advisers
are opposed to proposals which involve an economic cost to the corporation, or
which restrict the freedom of management to operate in the best interest of the
corporation and its shareholders. However, in general the Advisers will abstain
from voting on shareholder social, political and environmental proposals because
their long-term impact on share value cannot be calculated with any reasonable
degree of confidence.
CATEGORY III: ISSUES HAVING THE POTENTIAL FOR SIGNIFICANT ECONOMIC IMPACT
-----------------------------------------------------------
Philosophy: The Advisers are not willing to defer to management on proposals
----------
which have the potential for major economic impact on the corporation and the
value of its shares. The Advisers believe such issues should be carefully
analyzed and decided by the owners of the corporation. Presented below are
examples of issues which we believe have the potential for significant economic
impact on shareholder value.
1) Classification of Board of Directors. Rather than electing all directors
---------------------------------------
annually, these provisions stagger a board, generally into three annual
classes, and call for only one-third to be elected each year. Staggered boards
may help to ensure leadership continuity, but they also serve as defensive
mechanisms. Classifying the board makes it more difficult to change control of
a company through a proxy contest involving election of directors. In general,
the Advisers vote on a case-by-case basis on proposals for staggered boards,
but generally favor annual elections of all directors.
2) Cumulative Voting of Directors. Most corporations provide that shareholders
------------------------------
are entitled to cast one vote for each director for each share owned - the one
share, one vote standard. The process of cumulative voting, on the other hand,
permits shareholders to distribute the total number of votes they have in any
manner they wish when electing directors. Shareholders may possibly elect a
minority representative to a corporate board by this process, ensuring
representation for all sizes of shareholders. Outside shareholder involvement
can encourage management to maximize share value. The Advisers generally
support cumulative voting of directors.
3) Prevention of Greenmail. These proposals seek to prevent the practice of
-----------------------
"greenmail", or targeted share repurchases by management of company stock from
individuals or groups seeking control of the company. Since only the hostile
party receives payment, usually at a substantial premium over the market value
of its shares, the practice discriminates against all other shareholders. By
making greenmail payments, management transfers significant sums of corporate
cash to one entity, most often for the primary purpose of saving their jobs.
Shareholders are left with an asset-depleted and often less competitive
company. The Advisers think that if a corporation offers to buy back its
stock, the offer should be made to all shareholders, not just to a select
group or individual. The Advisers are opposed to greenmail and will support
greenmail prevention proposals.
4) Supermajority Provisions. These corporate charter amendments generally
------------------------
require that a very high percentage of share votes (70-85%) be cast
affirmatively to approve a merger, unless the board of directors has approved
it in advance. These provisions have the potential to give management veto
power over merging with another company, even though a majority of
shareholders favor the merger. In most cases the Advisers believe requiring
supermajority approval of mergers places too much veto power in the hands of
management and other minority shareholders, at the expense of the majority
shareholders, and therefore oppose such provisions.
5) Defensive Strategies. These proposals will be analyzed on a case-by-case
-----------------------
basis to determine the effect on shareholder value. A decision will be based
on whether the proposal enhances long-term economic value.
6) Business Combinations or Restructuring. These proposals will be analyzed on
-----------------------------------------
a case-by-case basis to determine the effect on shareholder value. A decision
will be based on whether the proposal enhances long-term economic value.
7) Executive and Director Compensation. These proposals will be analyzed on a
-----------------------------------
case-by-case basis to determine the effect on shareholder value. A decision
will be based on whether the proposal enhances long-term economic value.
Policy Established August, 1988Revised May, 2003
PRINCIPAL GLOBAL INVESTORS, LLC
PRINCIPAL CAPITAL GLOBAL INVESTORS LIMITED
PRINCIPAL REAL ESTATE INVESTORS, LLC
SPECTRUM ASSET MANAGEMENT, INC.
PRINCIPAL MANAGEMENT CORPORATION
PROXY VOTING REPORT
DETAILED PROXY VOTING GUIDELINES
I. THE BOARD OF DIRECTORS
A) VOTING ON DIRECTOR NOMINEES IN UNCONTESTED ELECTIONS
Votes on director nominees are made on a CASE-BY-CASE basis, examining the
following factors:
. long-term corporate performance record relative to a market index;
. composition of board and key board committees;
. nominee's attendance at meetings (past two years);
. nominee's investment in the company;
. whether a retired CEO sits on the board; and
. whether the chairman is also serving as CEO.
In cases of significant votes and when information is readily available, we
also review:
. corporate governance provisions and takeover activity;
. board decisions regarding executive pay;
. director compensation;
. number of other board seats held by nominee; and
. interlocking directorships.
B) CHAIRMAN AND CEO ARE THE SAME PERSON
We vote on a CASE-BY-CASE basis on shareholder proposals that would require
the positions of chairman and CEO to be held by different persons.
C) MAJORITY OF INDEPENDENT DIRECTORS
Shareholder proposals that request that the board be comprised of a majority
of independent directors are evaluated on a CASE-BY-CASE basis.
We vote FOR shareholder proposals that request that the board audit,
compensation and/or nominating committees include independent directors
exclusively.
D) STOCK OWNERSHIP REQUIREMENTS
We generally vote AGAINST shareholder proposals requiring directors to own a
minimum amount of company stock in order to qualify as a director, or to
remain on the board.
E) TERM OF OFFICE
We vote AGAINST shareholder proposals to limit the tenure of outside
directors.
F) DIRECTOR AND OFFICER INDEMNIFICATION AND LIABILITY PROTECTION
Proposals concerning director and officer indemnification and liability
protection are evaluated on a CASE-BY-CASE basis.
Proposals to limit or eliminate entirely director and officer liability for
monetary damages for violating the duty of care are evaluated on a
CASE-BY-CASE basis.
Indemnification proposals that would expand coverage beyond just legal
expenses to acts, such as negligence, that are more serious violations of
fiduciary obligations than mere carelessness are evaluated on a CASE-BY-CASE
basis.
We vote FOR only those proposals that provide such expanded coverage in
cases when a director's or officer's legal defense was unsuccessful if: (1)
the director was found to have acted in good faith and in a manner that he
reasonably believed was in the best interests of the company, and (2) only
if the director's legal expenses would be covered.
G) CHARITABLE CONTRIBUTIONS
We vote AGAINST shareholder proposals to eliminate, direct or otherwise
restrict charitable contributions.
II. PROXY CONTESTS
A) VOTING FOR DIRECTOR NOMINEES IN CONTESTED ELECTIONS
Votes in a contested election of directors are evaluated on a CASE-BY-CASE
basis, considering the following factors:
. long-term financial performance of the target company relative to its
industry;
. management's track record;
. background to the proxy contest;
. qualifications of director nominees (both slates);
. evaluation of what each side is offering shareholders as well as the
likelihood that the proposed objectives and goals can be met; and
. stock ownership positions.
B) REIMBURSE PROXY SOLICITATION EXPENSES
Decisions to provide full reimbursement for dissidents waging a proxy
contest are made on a CASE-BY-CASE basis.
III. AUDITORS
RATIFYING AUDITORS
We vote FOR proposals to ratify auditors, unless: an auditor has a financial
interest in or association with the company, and is therefore not independent;
or fees for non-audit services are excessive; or there is reason to believe that
the independent auditor has rendered an opinion which is neither accurate nor
indicative of the company's financial position.
We vote CASE-BY-CASE on shareholder proposals asking companies to prohibit their
auditors from engaging in non-audit services (or capping the level of non-audit
services).
We vote CASE-BY-CASE on shareholder proposals asking for audit firm rotation.
IV. PROXY CONTEST DEFENSES
A) BOARD STRUCTURE: STAGGERED VS. ANNUAL ELECTIONS
We consider proposals to classify the board on a CASE-BY-CASE basis.
We consider proposals to repeal classified boards and to elect all directors
annually on a CASE-BY-CASE basis.
B) SHAREHOLDER ABILITY TO REMOVE DIRECTORS
We vote AGAINST proposals that provide that directors may be removed only
for cause.
We vote FOR proposals to restore shareholder ability to remove directors
with or without cause.
We vote AGAINST proposals that provide that only continuing directors may
elect replacements to fill board vacancies.
We vote FOR proposals that permit shareholders to elect directors to fill
board vacancies.
C) CUMULATIVE VOTING
We vote AGAINST proposals to eliminate cumulative voting.
We vote FOR proposals to permit cumulative voting.
D) SHAREHOLDER ABILITY TO CALL SPECIAL MEETINGS
We vote AGAINST proposals to restrict or prohibit shareholder ability to
call special meetings.
We vote FOR proposals that remove restrictions on the right of shareholders
to act independently of management.
E) SHAREHOLDER ABILITY TO ACT BY WRITTEN CONSENT
We vote AGAINST proposals to restrict or prohibit shareholder ability to
take action by written consent.
We vote FOR proposals to allow or make easier shareholder action by written
consent.
F) SHAREHOLDER ABILITY TO ALTER THE SIZE OF THE BOARD
We vote FOR proposals that seek to fix the size of the board.
We vote AGAINST proposals that give management the ability to alter the size
of the board without shareholder approval.
V. TENDER OFFER DEFENSES
A) POISON PILLS
We vote FOR shareholder proposals that ask a company to submit its poison
pill for shareholder ratification.
We review on a CASE-BY-CASE basis shareholder proposals to redeem a
company's poison pill.
We review on a CASE-BY-CASE basis management proposals to ratify a poison
pill.
B) FAIR PRICE PROVISIONS
We vote CASE-BY-CASE on fair price proposals, taking into consideration
whether the shareholder vote requirement embedded in the provision is no
more than a majority of disinterested shares.
We vote FOR shareholder proposals to lower the shareholder vote requirement
in existing fair price provisions.
C) GREENMAIL
We vote FOR proposals to adopt anti-greenmail charter or bylaw amendments or
otherwise restrict a company's ability to make greenmail payments.
We review on a CASE-BY-CASE basis anti-greenmail proposals when they are
bundled with other charter or bylaw amendments.
D) PALE GREENMAIL
We review on a case-by-case basis restructuring plans that involve the
payment of pale greenmail.
E) UNEQUAL VOTING RIGHTS
We vote AGAINST dual class exchange offers.
We vote AGAINST dual class recapitalizations.
F) SUPERMAJORITY SHAREHOLDER VOTE REQUIREMENT TO AMEND THE CHARTER OR BYLAWS
We vote AGAINST management proposals to require a supermajority shareholder
vote to approve charter and bylaw amendments.
We vote FOR shareholder proposals to lower supermajority shareholder vote
requirements for charter and bylaw amendments.
G) SUPERMAJORITY SHAREHOLDER VOTE REQUIREMENT TO APPROVE MERGERS
We vote AGAINST management proposals to require a supermajority shareholder
vote to approve mergers and other significant business combinations.
We vote FOR shareholder proposals to lower supermajority shareholder vote
requirements for mergers and other significant business combinations.
H) WHITE SQUIRE PLACEMENTS
We vote for shareholder proposals to require approval of blank check
preferred stock issues for other than general corporate purposes.
VI. MISCELLANEOUS GOVERNANCE PROVISIONS
A) CONFIDENTIAL VOTING
We vote FOR shareholder proposals that request corporations to adopt
confidential voting, use independent tabulators and use independent
inspectors of election as long as the proposals include clauses for proxy
contests as follows: In the case of a contested election, management is
permitted to request that the dissident group honor its confidential voting
policy. If the dissidents agree, the policy remains in place. If the
dissidents do not agree, the confidential voting policy is waived.
We vote FOR management proposals to adopt confidential voting.
B) EQUAL ACCESS
Shareholder proposals that would allow significant company shareholders
equal access to management's proxy material in order to evaluate and propose
voting recommendations on proxy proposals and director nominees, and in
order to nominate their own candidates to the board are evaluated on a
CASE-BY-CASE basis.
C) BUNDLED PROPOSALS
We review on a CASE-BY-CASE basis bundled or "conditioned" proxy proposals.
In the case of items that are conditioned upon each other, we examine the
benefits and costs of the packaged items. In instances when the joint effect
of the conditioned items is not in shareholders' best interests, we vote
against the proposals. If the combined effect is positive, we support such
proposals.
D) SHAREHOLDER ADVISORY COMMITTEES
We review on a CASE-BY-CASE basis proposals to establish a shareholder
advisory committee.
VII. CAPITAL STRUCTURE
A) COMMON STOCK AUTHORIZATION
We review on a case-by-case basis proposals to increase the number of shares
of common stock authorized for issue.
We vote against proposed common stock authorizations that increase the
existing authorization by more than 100 percent unless a clear need for the
excess shares is presented by the company.
B) STOCK DISTRIBUTIONS: SPLITS AND DIVIDENDS
We vote FOR management proposals to increase common share authorization for
a stock split, provided that the split does not result in an increase of
authorized but unissued shares of more than 100% after giving effect to the
shares needed for the split.
C) REVERSE STOCK SPLITS
We vote FOR management proposals to implement a reverse stock split,
provided that the reverse split does not result in an increase of authorized
but unissued shares of more than 100% after giving effect to the shares
needed for the reverse split.
D) BLANK CHECK PREFERRED AUTHORIZATION
We vote FOR proposals to create blank check preferred stock in cases when
the company expressly states that the stock will not be used as a takeover
defense or carry superior voting rights.
We review on a CASE-BY-CASE basis proposals that would authorize the
creation of new classes of preferred stock with unspecified voting,
conversion, dividend and distribution, and other rights.
We review on a CASE-BY-CASE basis proposals to increase the number of
authorized blank check preferred shares.
E) SHAREHOLDER PROPOSALS REGARDING BLANK CHECK PREFERRED STOCK
We vote FOR shareholder proposals to have blank check preferred stock
placements, other than those shares issued for the purpose of raising
capital or making acquisitions in the normal course of business, submitted
for shareholder ratification.
F) ADJUST PAR VALUE OF COMMON STOCK
We vote FOR management proposals to reduce the par value of common stock.
G) PREEMPTIVE RIGHTS
We review on a CASE-BY-CASE basis proposals to create or abolish preemptive
rights. In evaluating proposals on preemptive rights, we look at the size of
a company and the characteristics of its shareholder base.
H) DEBT RESTRUCTURINGS
We review on a CASE-BY-CASE basis proposals to increase common and/or
preferred shares and to issue shares as part of a debt restructuring plan.
We consider the following issues:
. Dilution -- How much will ownership interest of existing shareholders be
reduced, and how extreme will dilution to any future earnings be?
. Change in Control -- Will the transaction result in a change in control of
the company?
. Bankruptcy -- Is the threat of bankruptcy, which would result in severe
losses in shareholder value, the main factor driving the debt
restructuring?
Generally, we approve proposals that facilitate debt restructurings unless
there are clear signs of self-dealing or other abuses.
I) SHARE REPURCHASE PROGRAMS
We vote FOR management proposals to institute open-market share repurchase
plans in which all shareholders may participate on equal terms.
VIII. EXECUTIVE AND DIRECTOR COMPENSATION
In general, we vote on a CASE-BY-CASE basis on executive and director
compensation plans, with the view that viable compensation programs reward the
creation of stockholder wealth by having a high payout sensitivity to
increases in shareholder value.
In evaluating a pay plan, we measure its dilutive effect both on shareholder
wealth and on voting power. We value equity-based compensation along with the
cash components of pay. We estimate the present value of all short- and
long-term incentives, derivative awards, and cash/bonus compensation -- which
enables us to assign a dollar value to the amount of potential shareholder
wealth transfer.
Our vote is based, in part, on a comparison of company-specific adjusted
allowable dilution cap and a weighted average estimate of shareholder wealth
transfer and voting power dilution. Administrative features are also factored
into our vote. For example, our policy is that the plan should be administered
by a committee of disinterested persons; insiders should not serve on
compensation committees.
Other factors, such as repricing underwater stock options without shareholder
approval, would cause us to vote against a plan. Additionally, in some cases
we would vote against a plan deemed unnecessary.
A) OBRA-RELATED COMPENSATION PROPOSALS
. AMENDMENTS THAT PLACE A CAP ON ANNUAL GRANT OR AMEND ADMINISTRATIVE
FEATURES
Vote FOR plans that simply amend shareholder-approved plans to include
administrative features or place a cap on the annual grants any one
participant may receive to comply with the provisions of Section 162(m) of
OBRA.
. AMENDMENTS TO ADDED PERFORMANCE-BASED GOALS
Vote FOR amendments to add performance goals to existing compensation
plans to comply with the provisions of Section 162(m) of OBRA.
. AMENDMENTS TO INCREASE SHARES AND RETAIN TAX DEDUCTIONS UNDER OBRA
Votes on amendments to existing plans to increase shares reserved and to
qualify the plan for favorable tax treatment under the provisions of
Section 162(m) should be evaluated on a CASE-BY-CASE basis.
. APPROVAL OF CASH OR CASH-AND-STOCK BONUS PLANS
Vote FOR cash or cash-and-stock bonus plans to exempt the compensation
from taxes under the provisions of Section 162(m) of OBRA.
B) SHAREHOLDER PROPOSALS TO LIMIT EXECUTIVE AND DIRECTOR PAY
We review on a CASE-BY-CASE basis all shareholder proposals that seek
additional disclosure of executive and director pay information.
We review on a CASE-BY-CASE basis all other shareholder proposals that seek
to limit executive and director pay.
C) GOLDEN AND TIN PARACHUTES
We vote FOR shareholder proposals to have golden and tin parachutes
submitted for shareholder ratification.
We review on a CASE-BY-CASE basis all proposals to ratify or cancel golden
or tin parachutes.
D) EMPLOYEE STOCK OWNERSHIP PLANS (ESOPS)
We vote FOR proposals that request shareholder approval in order to
implement an ESOP or to increase authorized shares for existing ESOPs,
except in cases when the number of shares allocated to the ESOP is
"excessive" (i.e., generally greater than five percent of outstanding
shares).
E) 401(K) EMPLOYEE BENEFIT PLANS
We vote FOR proposals to implement a 401(k) savings plan for employees.
IX. STATE OF INCORPORATION
A) VOTING ON STATE TAKEOVER STATUTES
We review on a CASE-BY-CASE basis proposals to opt in or out of state
takeover statutes (including control share acquisition statutes, control
share cash-out statutes, freezeout provisions, fair price provisions,
stakeholder laws, poison pill endorsements, severance pay and labor contract
provisions, anti-greenmail provisions, and disgorgement provisions).
B) VOTING ON REINCORPORATION PROPOSALS
Proposals to change a company's state of incorporation are examined on a
CASE-BY-CASE basis.
X. MERGERS AND CORPORATE RESTRUCTURINGS
A) MERGERS AND ACQUISITIONS
Votes on mergers and acquisitions are considered on a CASE-BY-CASE basis,
taking into account at least the following:
. anticipated financial and operating benefits;
. offer price (cost vs. premium);
. prospects of the combined companies;
. how the deal was negotiated; and
. changes in corporate governance and their impact on shareholder rights.
B) CORPORATE RESTRUCTURING
Votes on corporate restructuring proposals, including minority squeezeouts,
leveraged buyouts, spin-offs, liquidations, and asset sales are considered
on a CASE-BY-CASE basis.
C) SPIN-OFFS
Votes on spin-offs are considered on a CASE-BY-CASE basis depending on the
tax and regulatory advantages, planned use of sale proceeds, market focus,
and managerial incentives.
D) ASSET SALES
Votes on asset sales are made on a CASE-BY-CASE basis after considering the
impact on the balance sheet/ working capital, value received for the asset,
and potential elimination of diseconomies.
E) LIQUIDATIONS
Votes on liquidations are made on a CASE-BY-CASE basis after reviewing
management's efforts to pursue other alternatives, appraisal value of
assets, and the compensation plan for executives managing the liquidation.
F) APPRAISAL RIGHTS
We vote for proposals to restore, or provide shareholders with, rights of
appraisal.
G) CHANGING CORPORATE NAME
We vote for changing the corporate name.
XI. MUTUAL FUND PROXIES
A) ELECTION OF TRUSTEES
We vote on trustee nominees on a case-by-case basis.
B) INVESTMENT ADVISORY AGREEMENT
We vote on investment advisory agreements on a case-by-case basis.
C) FUNDAMENTAL INVESTMENT RESTRICTIONS
We vote on amendments to a fund's fundamental investment restrictions on a
case-by-case basis.
D) DISTRIBUTION AGREEMENTS
We vote on distribution agreements on a case-by-case basis.
XII. SOCIAL AND ENVIRONMENTAL ISSUES
In general we abstain from voting on shareholder social and environmental
proposals, on the basis that their impact on share value can rarely be
anticipated with any high degree of confidence.
In most cases, however, we vote for disclosure reports that seek additional
information, particularly when it appears companies have not adequately
addressed shareholders' social and environmental concerns.
In determining our vote on shareholder social and environmental proposals, we
also analyze the following factors:
.. whether adoption of the proposal would have either a positive or negative
impact on the company's short-term or long-term share value;
.. the percentage of sales, assets and earnings affected;
.. the degree to which the company's stated position on the issues could affect
its reputation or sales, or leave it vulnerable to boycott or selective
purchasing;
.. whether the issues presented should be dealt with through government or
company-specific action;
.. whether the company has already responded in some appropriate manner to the
request embodied in a proposal;
.. whether the company's analysis and voting recommendation to shareholders is
persuasive;
.. what other companies have done in response to the issue;
.. whether the proposal itself is well framed and reasonable;
.. whether implementation of the proposal would achieve the objectives sought in
the proposal; and
.. whether the subject of the proposal is best left to the discretion of the
board.
Among the social and environmental issues to which we apply this analysis are
the following:
.. Energy and Environment
.. South Africa
.. Northern Ireland
.. Military Business
.. Maquiladora Standards and International Operations Policies
.. World Debt Crisis
.. Equal Employment Opportunity and Discrimination
.. Animal Rights
.. Product Integrity and Marketing
.. Human Resources Issues
T. ROWE PRICE ASSOCIATES, INC AND T. ROWE PRICE INTERNATIONAL, INC
PROXY VOTING POLICIES AND PROCEDURES
RESPONSIBILITY TO VOTE PROXIES
As an investment adviser to its clients, T. Rowe Price analyzes the proxy
statements of issuers whose stock is owned by the investment companies that it
sponsors and for which it serves as investment adviser.
PROXY ADMINISTRATION
The T. Rowe Price Proxy Committee develops positions on all major corporate
issues, creates guidelines, and oversees the voting process. The Proxy Committee
composed of portfolio managers, investment operations managers, and internal
legal counsel, analyzes proxy policies based on whether they would adversely
affect shareholders` interests and make a company less attractive to own. In
evaluating proxy policies each year, the Proxy Committee relies upon our own
fundamental research, independent research provided by third parties, and
information presented by company managements and shareholder groups.
Once the Proxy Committee establishes its recommendations, they are distributed
to the firm's portfolio managers as voting guidelines. Ultimately, the fund's
portfolio manager is responsible for deciding and voting on the proxy proposals
of companies in his or her fund. When portfolio managers cast votes that are
counter to the Proxy Committee's guidelines, they are required to document their
reasons in writing to the Proxy Committee. Annually, the Proxy Committee reviews
T. Rowe Price's proxy voting process, policies, and voting records.
T. Rowe Price has retained Institutional Shareholder Services, an expert in the
proxy voting and corporate governance area, to provide proxy advisory and voting
services. These services include in-depth research, analysis, and voting
recommendations as well as vote execution, reporting, auditing, and consulting
assistance for the handling of proxy voting responsibility and corporate
governance-related efforts. While the Proxy Committee relies upon ISS research
in establishing T. Rowe Price's voting guidelines-many of which are consistent
with ISS positions-T. Rowe Price may deviate from ISS recommendations on general
policy issues or specific proxy proposals.
FIDUCIARY CONSIDERATIONS
T. Rowe Price's decisions with respect to proxy issues are made in light of the
anticipated impact of the issue on the desirability of investing in the
portfolio company. Proxies are voted solely in the interests of fund
shareholders. Practicalities involved with international investing may make it
impossible at times, and at other times disadvantageous, to vote proxies in
every instance.
CONSIDERATION GIVEN MANAGEMENT RECOMMENDATIONS
When determining whether to invest in a particular company, one of the key
factors T. Rowe Price considers is the quality and depth of its management. As a
result, T. Rowe Price believes that recommendations of management on most issues
should be given weight in determining how proxy issues should be voted.
T. ROWE PRICE VOTING POLICIES
Specific voting guidelines have been established by the Proxy Committee for
recurring issues that appear on proxies. The following is a summary of the more
significant T. Rowe Price policies:
ELECTION OF DIRECTORS
T. Rowe Price generally supports slates with a majority of independent directors
and nominating committees chaired by an independent board member. T. Rowe Price
withholds votes for inside directors serving on compensation and audit
committees and for directors who miss more than one-fourth of the scheduled
board meetings.
EXECUTIVE COMPENSATION
The goal of T. Rowe Price is to assure that a company's equity-based
compensation plan is aligned with shareholders` long-term interests. While it
evaluates most plans on a case-by-case basis, T. Rowe Price generally opposes
compensation packages that provide what it views as excessive awards to a few
senior executives or that contain excessively dilutive stock option plans. T.
Rowe Price bases its review on criteria such as the costs associated with the
plan, plan features, dilution to shareholders and comparability to plans in the
company's peer group. T. Rowe Price generally opposes plans that give a company
the ability to reprice options.
ANTI-TAKEOVER AND CORPORATE GOVERNANCE ISSUES
T. Rowe Price generally opposes anti-takeover measures and other proposals
designed to limit the ability of shareholders to act on possible transactions.
When voting on corporate governance proposals, T. Rowe Price will consider the
dilutive impact to shareholders and the effect on shareholder rights.
SOCIAL AND CORPORATE RESPONSIBILITY ISSUES
T. Rowe Price generally votes with a company's management on social issues
unless they have substantial economic implications for the company's business
and operations that have not been adequately addressed by management.
MONITORING AND RESOLVING CONFLICTS OF INTEREST
The Proxy Committee is also responsible for monitoring and resolving possible
material conflicts between the interests of T. Rowe Price and those of its
clients with respect to proxy voting. Since T. Rowe Price's voting guidelines
are predetermined by the Proxy Committee using recommendations from ISS, an
independent third party, application of the T. Rowe Price guidelines by fund
portfolio managers to vote fund proxies should in most instances adequately
address any possible conflicts of interest. However, for proxy votes
inconsistent with T. Rowe Price guidelines, the Proxy Committee reviews all such
proxy votes in order to determine whether the portfolio manager's voting
rationale appears reasonable. The Proxy Committee also assesses whether any
business or other relationships between T. Rowe Price and a portfolio company
could have influenced an inconsistent vote on that company's proxy. Issues
raising possible conflicts of interest are referred to designated members of the
Proxy Committee for immediate resolution.
UBS GLOBAL ASSET MANAGEMENT
CORPORATE GOVERNANCE
PHILOSOPHY
VOTING GUIDELINES
AND
POLICY
DRAFT 7.0
8 April 2003
A.Table of Contents
I. Voting and Corporate Governance Policy...............................1
A. General Corporate Governance Benchmarks............................. 1
B. Proxy Voting Guidelines - Macro Rationales.......................... 3
C. Proxy Voting Disclosure Guidelines.................................. 6
D. Proxy Voting Conflict Guidelines.................................... 7
II. Voting and Corporate Governance Procedures..........................9
A. Global Corporate Governance Committee............................... 9
B. Proxy Voting - Process.............................................. 10
C. Taking Action with a Company's Board................................11
D. Procedures for Contacting the Media ................................. 12
E. Recordkeeping.......................................................13
Appendices: Local Voting Policies:
- UK / London......................................................... 14
- AU / Sydney.......................................................... 16
- CH / Zurich.......................................................... 18
- JP / Tokyo........................................................... 19
- CA / Toronto......................................................... 20
- US / Chicago......................................................... 21
I. VOTING AND CORPORATE GOVERNANCE POLICY
Our philosophy, guidelines and policy are based on our active investment style
and structure whereby we have detailed knowledge of the investments we make on
behalf of our clients and therefore are in a position to judge what is in the
best interest of our clients as shareholders. We believe voting rights have
economic value and must be treated accordingly. Proxy votes that impact the
economic value of client investments involve the exercise of fiduciary
responsibility. Thus, we expect board members of companies we have invested in
(the "company" or "companies") to act in the service of the shareholders, view
themselves as stewards of the financial assets of the company, exercise good
judgment and practice diligent oversight with the management of the company.
Underlying our voting and corporate governance policies we have three
fundamental objectives:
1) We seek to act in the best financial interests of our clients to protect and
enhance the long-term value of their investments.
2) In order to do this effectively, we aim to utilize the full weight of our
clients' shareholdings in making our views felt. For this reason, we seek full
voting discretion from our clients where applicable.
3) As investors, we have a strong commercial interest in ensuring that the
companies in which we invest are successful. We actively pursue this interest
by promoting best practice in the boardroom.
UBS Global Asset Management believes that good governance practices are an
essential element in the stewardship of a corporation. Good corporate governance
should, in the long term, lead toward both better corporate performance and
improved shareholder value. In acting on behalf of our clients, our objective is
to seek to maximize the value of client investments. To achieve this objective,
we have implemented this policy, which we believe is reasonably designed to
guide our exercise of voting rights and the taking of other appropriate actions,
within our ability, and to support and encourage sound corporate governance
practice.
A. GENERAL CORPORATE GOVERNANCE BENCHMARKS
PRINCIPLE 1: INDEPENDENCE OF BOARD FROM COMPANY MANAGEMENT
GUIDELINES:
.. Board exercises judgment independently of management.
.. Separate Chairman and Chief Executive.
.. Board has access to senior management members.
.. Board is comprised of a significant number of independent outsiders.
.. Outside directors meet independently.
.. CEO performance standards are in place.
.. CEO performance is reviewed annually by the full board.
.. CEO succession plan is in place.
.. Board involvement in ratifying major strategic initiatives.
.. Compensation, audit and nominating committees are led by a majority of outside
directors.
PRINCIPLE 2: QUALITY OF BOARD MEMBERSHIP
GUIDELINES:
.. Board determines necessary board member skills, knowledge and experience.
.. Board conducts the screening and selection process for new directors.
.. Directors whose present job responsibilities change are reviewed as to the
appropriateness of continued directorship.
.. Directors are reviewed every 3-5 years to determine appropriateness of
continued directorship.
.. Board meets regularly (at least four times annually).
PRINCIPLE 3: APPROPRIATE MANAGEMENT OF CHANGE IN CONTROL
GUIDELINES:
.. Protocols should ensure that all bid approaches and material proposals by
management are brought forward for board consideration.
.. Any contracts or structures which impose financial constraints on changes in
control should require prior shareholder approval.
.. Employment contracts should not entrench management.
.. Management should not receive substantial rewards when employment contracts
are terminated for performance reasons.
PRINCIPLE 4: REMUNERATION POLICIES ARE ALIGNED WITH SHAREHOLDER INTERESTS
GUIDELINES:
.. Executive remuneration should be commensurate with responsibilities and
performance.
.. Incentive schemes should align management with shareholder objectives.
.. Employment policies should encourage significant shareholding by management
and board members.
.. Incentive rewards should be proportionate to the successful achievement of
pre-determined financial targets.
.. Long-term incentives should be linked to transparent long-term performance
criteria.
.. Dilution of shareholders' interests by share issuance arising from egregious
employee share schemes and management incentives should be limited by
shareholder resolution.
PRINCIPLE 5: AUDITORS ARE INDEPENDENT
GUIDELINES:
.. Auditors are approved by shareholders at the annual meeting.
.. Audit, consulting and other fees to the auditor are explicitly disclosed.
.. The Audit Committee should affirm the integrity of the audit has not been
compromised by other services provided by the auditor firm.
.. Periodic (every 5 years) tender of the audit firm or audit partner.
B. PROXY VOTING GUIDELINES - MACRO RATIONALES
UBS Global Asset Management will evaluate issues that may have an impact on the
economic value of client investments during the time period which it expects to
hold the investment. While there is no absolute set of rules that determine
appropriate governance under all circumstances and no set of rules will
guarantee ethical behavior, there are certain benchmarks, which, if substantial
progress is made toward, give evidence of good corporate governance. Generally,
we will exercise voting rights on behalf of clients in accordance with this
policy. However, we may take actions not consistent with this policy when we
believe it necessary to act prudently considering the prevailing circumstances,
consistent with our obligation to maximize the value of client investments and
for the exclusive purpose of benefiting its clients.
Where a client has given specific direction as to how to exercise voting rights
on its behalf, we will, to the extent possible, vote in accordance with a
client's direction. Where we have determined that the voting of a particular
proxy is of limited benefit to clients or where the costs of voting a proxy
outweigh the benefit to clients, we may abstain or choose not to vote. Among
others, such costs may include the cost of translating a proxy, a requirement to
vote in
person at a shareholders meeting or if the process of voting restricts our
ability to sell for a period of time (an opportunity cost). For holdings managed
pursuant to quantitative, index or index-like strategies, we may delegate the
authority to exercise voting rights for such strategies to an independent proxy
voting and research service with the direction that the votes be exercised in
accordance with this Policy.
GENERAL GUIDELINES
1) When our view of the issuer's management is favorable, we generally support
current management initiatives. When our view is that changes to the
management structure would probably increase shareholder value, we may not
support existing management proposals.
2) If management's performance has been questionable we may abstain or vote
against specific proxy proposals.
3) Where there is a clear conflict between management and shareholder
interests, even in those cases where management has been doing a good job, we
may elect to vote against management.
4) In general, we oppose proposals, which in our view, act to entrench
management.
5) In some instances, even though we strongly support management, there are
some corporate governance issues that, in spite of management objections, we
believe should be subject to shareholder approval.
BOARD OF DIRECTORS & AUDITORS
6) Although we wish to encourage directors to own shares, we acknowledge that
the accumulation of a significant shareholding may need to be phased-in over a
period of years in that qualified board members with insufficient liquid funds
could otherwise be steered away from board duty.
7) Unless our objection to management's recommendation is strenuous, if we
believe auditors to be competent and professional, we support continuity in
the appointed auditing firm subject to regular review.
8) We generally vote for proposals that seek to fix the size of the board
and/or require shareholder approval to alter the size of the board; that allow
shareholders to remove directors with or without cause and/or allow
shareholders to elect directors and fill board vacancies; that permit
shareholders to act by written consent; and that limit the bias present when
proxy solicitation and contest defense expenses are reimbursed for incumbents
but not for dissidents unless they are successful.
9) We generally oppose proposals to limit or restrict shareholder ability to
call special meetings.
COMPENSATION
10) We will not try to micro-manage compensation schemes, however, we believe
remuneration should not be excessive, and we will not support compensation
plans that are poorly structured or otherwise egregious.
11) Senior management compensation should be set by independent directors
according to industry standards, taking advice from benefits consultants where
appropriate.
12) ll senior management and board compensation should be disclosed within
annual financial statements, including the value of fringe benefits, company
pension contributions, deferred compensation and any company loans.We may vote
against a compensation or incentive program if it is not adequately tied to a
company's fundamental financial performance, is vague, is not in line with
market practices, allows for option re-pricing, does not have adequate
performance hurdles or is highly dilutive.
13) Where company and management's performance has been poor, we may object to
the issuance of additional shares for option purposes or the re-pricing of
options such that management is rewarded for poor performance or further
entrenches its position.
14) Given the increased level of responsibility and oversight required of
directors, it is reasonable to expect that compensation should increase
commensurably. We consider that there should be an appropriate balance between
fixed and variable elements of compensation and between short and long term
incentives.
GOVERNANCE PROVISIONS
15) We believe that votes at company meetings should be determined on the basis
of one share one vote. We will vote against cumulative voting proposals.
16) We believe that "poison pill" proposals, which dilute an issuer's stock
when triggered by particular events such as take over bids or buy-outs should
be voted on by the shareholders and will support attempts to bring them before
the shareholders.
17) Any substantial new share issuance should require prior shareholder
approval.
18) We believe proposals that authorize the issuance of new stock without
defined terms or conditions and are intended to thwart a take-over or restrict
effective control by shareholders should be discouraged.
19) We will support directives to increase the independence of the board of
directors when we believe that the measures will improve shareholder value.
20) Staggered boards, where directors are elected to overlapping terms, can
provide some continuity of oversight. Therefore, we generally do not oppose
management's recommendation to implement a staggered board, unless we object
to management's handling of a company, or are concerned about the independence
of the Board.
21) We generally support the regular re-election of directors on a rotational
basis.
CAPITAL STRUCTURE AND CORPORATE RESTRUCTURING
22) It is difficult to direct where a company should incorporate, however, in
instances where a move is motivated solely to entrench management or restrict
effective corporate governance, we will vote accordingly.
23) In general we will oppose management initiatives to create dual classes of
stock, which serves to insulate company management from shareholder opinion
and action. We support shareholder proposals to eliminate dual class schemes.
MERGERS, TENDER OFFERS & PROXY CONTESTS
24) Based on our analysis and research we will support proposals that increase
shareholder value and vote against proposals that do not.
SOCIAL, ENVIRONMENTAL, POLITICAL & CULTURAL
25) Depending on the situation, we do not typically vote to prohibit a company
from doing business anywhere in the world.
26) There are occasional issues, we support, that encourage management to make
changes or adopt more constructive policies with respect to social,
environmental, political and other special interest issues, but in many cases
we believe that the shareholder proposal may be too binding or restrict
management's ability to find an optimal solution. While we wish to remain
sensitive to these issues, we believe there are better ways to resolve them
than through a proxy proposal. We prefer to address these issues through
engagement. Our primary responsibility in voting proxies is to provide for the
greatest long-term shareholder value and we are therefore generally opposed to
special interest proposals that involve an economic cost to the company or
that restrict the freedom of management to operate in the best interest of the
company and its shareholders.
ADMINISTRATIVE & OPERATIONS
27) Occasionally, stockholder proposals, such as asking for reports and
donations to the poor, are presented in a way that appear to be honest
attempts at bringing up a worthwhile issue. Nevertheless, judgment must be
exercised with care, as we do not expect our shareholder companies to be
charitable institutions.
28) We are sympathetic to shareholders who are long-term holders of a company's
stock, who desire to make concise statements about the long-term operations of
the company in the proxy statement. However, because regulatory agencies do
not require such actions, we may abstain unless we believe there are
compelling reasons to vote for or against.
C. PROXY VOTING DISCLOSURE GUIDELINES
.. Upon request or as required by law or regulation, UBS Global Asset Management
will disclose to a client or other fiduciaries, the manner in which we
exercised voting rights on behalf of the client.
.. Upon request, we will inform a client of our intended vote provided the
request does not raise a conflict issue due to the client's relationship with
the company that has issued the proxy (See Proxy Voting Conflict Guidelines
below). Note, however, in some cases, because of the controversial nature of a
particular proxy, our intended vote may not be available until a few days
before the deadline. We will make every effort to communicate with our clients
effectively on these issues.
.. Other than as described herein, we will not disclose our voting intentions or
make public statements to any third party (except electronically to our proxy
vote processor or regulatory agencies) including but not limited to proxy
solicitors, non-clients, the media, or other UBS divisions.
.. Any employee, officer or director of UBS Global Asset Management receiving an
inquiry directly from a company will notify the appropriate industry analyst,
proxy voting delegate and Legal and Compliance Department.
.. Proxy solicitors and company agents will not be provided with either our votes
or the number of shares we own in a particular company.
.. In response to a proxy solicitor or company agent, we will acknowledge receipt
of the proxy materials, inform them of our intent to vote or that we have
voted, but not the result of the vote itself.
.. We will inform the company (not their agent) where we have decided to vote
against any material resolution at their company.
..
The Local and Global Chief Investment Officer must approve exceptions to this
disclosure policy.
Nothing in this policy should be interpreted as to prevent dialogue with the
company and its advisers by the industry analyst, proxy voting delegate or other
appropriate senior investment personnel when a company approaches us to discuss
governance issues or resolutions they wish to include in their proxy statement.
D. PROXY VOTING CONFLICT GUIDELINES
.. In addition to the Proxy Voting Disclosure Guidelines above, UBS Global Asset
Management has implemented the following guidelines to address conflicts of
interests that arise in connection with our exercise of voting rights on
behalf of clients:
.. No personnel in UBS Global Asset Management's marketing, sales or business
development departments shall participate in or have influence over how any
specific voting rights are exercised.
.. UBS Global Asset Management has instituted information barriers designed to
separate UBS Global Asset Management from its affiliates engaged in banking
and investment banking activities. These information barriers are intended to
prevent us from gaining access to inside information that our banking and
investment banking affiliates may have acquired or developed in connection
with their business activities and vice versa. None of our personnel may
disclose information regarding our voting intentions to any banking or
investment banking affiliate. Any of our personnel involved in the proxy
voting process who are contacted by such an affiliate regarding the manner in
which we intend to vote on a specific issue, must terminate the contact and
notify the Legal and Compliance Department immediately.
.. Where UBS Global Asset Management is aware of a conflict of interest in
voting a particular proxy as a result of an existing or prospective client or
business relationship or otherwise, the appropriate Local Corporate
Governance Committee will be notified of the conflict and the full Local
Corporate Governance Committee will determine how such proxy should be voted.
If such Committee decides to vote other than in accordance with this Policy,
the Committee shall prepare and maintain a written rationale for its vote.
(Note: For purposes of this policy, for an entity to be considered a
prospective client, there must be a reasonable likelihood it will engage us
to manage assets within a reasonable period of time.)
II. VOTING AND CORPORATE GOVERNANCE PROCEDURES
A. GLOBAL CORPORATE GOVERNANCE COMMITTEE
Members:
--------
.. Global CIO (Chair) and Local CIOs or their equivalents from each office
(Chicago, London, Zurich, Tokyo, Toronto & Sydney) or their appointed
delegates
.. Representative from Operations
.. Global Head of Legal & Compliance will act as counsel to the Committee
Responsibilities:
-----------------
.. To review, approve and oversee the implementation of this Policy.
.. Keep abreast of and share trends in corporate governance and update this
policy as necessary.
.. To provide a forum for discussing corporate governance issues between regions.
.. Coordinate with the Communications group on all corporate or other
communication related to global proxy issues.
.. Consult with Analysts, Research Directors and others regarding issues relevant
to portfolio companies.
.. Engage and oversee any independent proxy voting services being used.
.. Oversee the activities of the Local Corporate Governance Committees.
Meetings:
---------
Meetings will be held at least quarterly.
LOCAL CORPORATE GOVERNANCE COMMITTEES
Each office or region as applicable will set up a Local Corporate Governance
Committee to discuss local corporate governance issues and to review proxies
where we are aware of conflicts of interests including but not limited to those
arising from:
.. Relationships with clients and potential clients
.. Banking and investment banking divisions within UBS
.. Media sensitive votes
The Local Corporate Governance Committees will set their own agendas and
schedule, but should meet at least twice a year on a formal basis.
Members:
--------
.. Local CIO or equivalent (chair) from each office (Chicago, London, Zurich,
Tokyo, Toronto & Sydney) or their appointed delegates
.. Personnel from the Equity group
.. Operations group representative
.. A Legal & Compliance group representative will act as counsel to the Committee
Responsibilities:
.. Keep abreast of and share trends in corporate governance and update local
policy as necessary.
.. Provide a forum for discussing corporate governance issues within a region.
.. Oversee the proxy voting process.
.. Coordinate with the Communications group all corporate or other communication
related to local proxy issues.
.. Consult with Analysts, Research Directors and others regarding issues relevant
to portfolio companies.
.. Interpret this Policy into the local context.
.. Propose additional Macro Rationales at the global and local levels.
.. Review and resolve conflicts of interest.
B. PROXY VOTING - PROCESS
The Global Corporate Governance Committee, under the chairmanship of the Global
CIO, is responsible for our corporate governance policy and proxy voting
process.
Given the magnitude of the effort, availability of resources and local customs
certain functions and responsibilities may be delegated to the Local Corporate
Governance Committees or others for the efficient processing of the votes. The
Legal & Compliance groups will regularly be brought into the decision making
process on complex issues and on issues involving conflicts of interests.
In order to facilitate the process, proxy issues and portfolios are categorized
into and assigned an approval escalation level. Details are listed below:
.. Proxies are divided into 2 categories:
. Active - Companies held in an actively managed portfolio
. Passive - Companies held in an index, index-like or quantitative portfolio
1)Active
. ISSUES ON PROXIES ARE DIVIDED INTO THREE CATEGORIES:
.Sensitive - Requires Analyst, Research Director and Global Chief
Investment Officer approval for a vote against management, regardless of
guidelines and policy. Requires Analyst, Research Director and Local
Chief Investment Officer approval for a vote for management.
.Ordinary - May be voted by a delegate of the Equity group according to
our general guidelines and macro rationales regardless of whether for or
against management.
.Directed - Votes may be effected by a delegate according to specific
written client guidelines.
. Votes on proxy issues where we are aware of a conflict of interest
require approval of the full Local Corporate Governance Committee as more
fully described above in Section I.C. Proxy Voting Conflict Guidelines.
SENSITIVE ISSUES
2)
Sensitive issues are those where we are concerned at the overall governance
regime of the company such that we intend to take action to remove board
members, support new board candidates not recommended by the existing board
or any other controversial issues. Any votes to be made in a manner
inconsistent with this Policy, and any votes on matters not covered in this
Policy are also considered sensitive.Passive
Where we manage portfolios pursuant to quantitative, index or index-like
strategies, we may delegate the authority to exercise voting rights for
holdings managed pursuant to such strategies to an independent proxy
voting and research service with the direction that the votes be exercised
in accordance with this Policy. If such holdings are also held in an
actively-managed strategy, we will exercise the voting rights for the
passive holdings according to the active strategy.
BALLOT RECONCILIATION
UBS Global Asset Management's proxy voting personnel will take necessary steps
to determine that we are receiving ballots for all accounts over which we have
voting authority.
C. PROCEDURES FOR TAKING ACTION WITH A COMPANY'S BOARD
.Where we suspect poor corporate governance may negatively impact the
long-term value of the issuer (including loss of confidence in senior
management), we will attempt to gather further information from the company
and standard information sources.
.
Pursuing direct contact with a company's external board or internal company
management board members regarding their board responsibilities requires
the involvement of the Local Chief Investment Officer.
.If action is considered necessary, we will attempt to arrange an informal
meeting with one or more outside directors to gather additional information
and learn more about the company's corporate governance practices. The
intent of the meeting with outside directors is not to gain private or
inside information but to communicate our concerns. If we initiate the
meeting, the Global Chief Investment Officer will be informed before any
meeting is scheduled.
.
If it is determined that appropriate corporate governance practices are not
presently nor likely to be put in place, then it may be necessary to:
. withdraw our support for the common stock;
. communicate with the entire board;
. reflect our positions in our proxy vote opportunities; or
. contact other shareholders regarding our concerns.
.When we initiate a formal communication to the board it will include the
following:
.
A statement of our belief in the importance of good corporate governance;
.A listing of areas of deficient governance we believe to exist at the
company;
.A statement that the maintenance of our continued corporate support will
be predicated on addressing any deficiencies; and
.A request for a response as to what actions the board feels is necessary
to address our concerns.
D. PROCEDURES FOR CONTACTING THE MEDIA
It is our policy not to make comments to the media on any issues relating to
proxy issues of any individual company. Tasked with managing the assets of
clients, we are honor-bound to work in their best interests.
Requests from the media for general information relating to this Policy,
comments on Corporate Governance issues relating to a specific security or
general, non-specific issues related to Corporate Governance, must be directed
to the Regional/Global CIO and the Regional Head of Legal & Compliance or the
Business Group General Counsel.
The Regional/Global CIO and the Head of Legal & Compliance or the Business Group
General Counsel will determine if there is to be an exception to this policy.
All communication with the media must be coordinated with the Communications
Group in accordance with appropriate media policy.
E. RECORDKEEPING
UBS Global Asset Management will maintain records of proxies voted. Such records
include copies of:
.. Our policies and procedures;
.. Proxy statements received;
.. Votes cast per client;
.. Number of shares voted;
.. Communications received and internal documents created that were material to
the voting decision;
.. A list of all proxies where it was determined a conflict existed and any
written rationale created or approved by the Local Corporate Governance
Committee supporting its voting decision; and
.. Client requests for proxy voting records and our Policy, as well as our
response.
LOCAL POLICY - UK / LONDON
[Download Table]
DIRECTORS' Greenbury - Invited to
REMUNERATION approve all new long term
AND/OR PENSION incentive schemesGreenbury -
ARRANGEMENTS Shares granted should not
vest, and options should not
be exercisable, in under
three yearsGreenbury - Total
awards potentially available
should not be
excessiveGreenbury - Subject
to challenging
criteriaGreenbury -
Consideration
should be given to criteria
which reflects the company's
performance relative to a
group of comparator
companies in some key
variables such as
TSRGreenbury -
re grant options
phasedGreenbury - Executive
options are not at a
discountABI -
Options should only be
granted over the capital of
the parent company.ABI - A
Scheme should not last more
than 10 yearsABI - All Each on its own merits
Schemes No more than 10%
of share capital should be
used in any rolling 10 year
periodABI - Executive
Schemes No more than 5% of
the issued Ordinary share
cap in any 10 year
period unless these Options
are Super-OptionsCombined
Code - Agrees with the
recommendations of the
Greenbury Code.
BASIC AUTHORITY FOR Companies Act - Section 80
DIRECTORS TO ALLOT provides authority for
ANY SHARES Directors to issue
sharesABI5 - New issues
should not exceed one third
of existing issued share
capital - taking account
amounts reserved for share For Management
schemes, warrants or
convertible shares
SHARE ALLOTMENT OTHER Companies Act - Section 89
THAN TO EXISTING imposes pre-emption (shares
SHAREHOLDERS must be first offered to
existing shareholders on a
pro-rata basis)Companies Act
- Section 95 allows
dis-application of S89 for
issues of shares for cash
(but not for assets)IPC -
Dis-application of S89
acceptable provided no more
than 5% of the issued For management if issue
capital on a non-pre-emptive meets IPC 5% guideline
basis in any one year and no
more than 7.5% in the
current and preceding 2
years
MARKET PURCHASE OF ABI7 -Authority under S166
ITS OWN SHARES BY must be renewed annually;
COMPANY increase in EPS a
pre-requisite; approval of
preference shareholders
necessary; 10% of issued
share capital is
appropriateCompanies Act -
Section 166 permits
buy-back, S162 must have
power for buy-back within For Management if
articles of assoc.Stock criteria is met.
Exchange Yellow book - up to
15% of issued share capital
within 12 months
permissible. Price must not
exceed 105% of market value.
SCRIP DIVIDEND
ALTERNATIVE No guidelines For Management
ENHANCED SCRIP
DIVIDEND No guidelines Each on its own merits
AMENDMENTS TO
ARTICLES OF No guidelines For Management
ASSOCIATION
SHAREHOLDER RESN. No guidelines For Management
POLITICAL DONATIONS For Management if the
Political Parties, Elections company issues a
and Referendums Act 2000 statement confirming
that the donation is
not to a political
party in the true
sense.Against if this
statement is not made
LOCAL POLICY - AUSTRALIA / SYDNEY
AUSTRALIAN MARKET CONVENTIONS AND "BEST PRACTICE"
Board Structure and Quality
---------------------------
Review allocation of work between Board and management (IFSA 9).
Board has majority of independent directors with appropriate skills (IFSA 2).
Chairman should be an independent director (IFSA 3) or a lead director to be
appointed.
The Board should appoint an audit committee, a remuneration committee and a
nomination committee (IFSA 4 and 5).
Generally constituted with a majority of independent directors
Audit committee comprises only non executive directors
Have access to employees and advisers of the company
Entitled to obtain independent professional advice at the company's expense
The Board should review its performance and the performance of individual
directors, the company and management regularly (IFSA 7)
Before accepting appointment, non-executive directors should be formally advised
of the reasons they have been asked to join the Board and given an outline of
what the Board expects of them (IFSA 6)
ASX listing rules require director election each year on a one third rotational
basis. Company Law sets retirement age at 72 years unless a 75% approval vote is
obtained.
Aust Law requires at least 3 directors with at least 2 residing in Australia.
Change of Control Procedures
----------------------------
Major corporate changes, which in substance or effect may impact shareholder
equity or erode ownership rights, should be submitted to a vote of shareholders
(IFSA 13).
Share repurchase of up to 10% in a 12 month period without shareholder approval.
Purchase from a single vendor requires 75% approval.
ASX listing rules require shareholder approval for any disposal or change in
control of a company's main undertaking.
Partial takeover provisions may be approved by shareholders but are renewable
every 3 years.
Auditors
--------
Fees from non-audit services by an audit firm must be disclosed (pending Aust
legislation).
Expanded role for the Financial Reporting Council to oversee audit independence
and auditing standards (pending legislation)
Compulsory audit partner rotation after 5 years but not rotation of audit firms
(pending legislation)
Mandatory audit committees for Top 500 companies (pending legislation).
Statement from audit committee that non-audit services are compatible with
independence (pending legislation).
Compensation
------------
The Board should review its performance and the performance of individual
directors, the company and management regularly (IFSA 7)
The Board should establish and disclose in the annual report a policy to
encourage non-executive directors to invest their own capital in the company or
to acquire shares from an allocation of a portion of their fees (IFSA 8).
The Board should disclose in the company's annual report its policies on and the
quantum and components of remuneration for all directors and each of the 5
highest paid executives (IFSA 10).
All equity participation compensation plans must be approved by shareholders in
a special resolution.
Option term maximum is 5 years
Share options must be "expensed" from middle of 2004 (pending legislation)
General Governance
------------------
Conduct of meetings - separate motions, form of proxy, adequate notification of
meeting, all voting by poll, results of voting disclosed (IFSA 11)
BEST PRACTICE FOR INVESTMENT MANAGERS
Encourage direct contact with companies including constructive communication
with both senior management and board members about performance, corporate
governance and other matters affecting shareholders' interests.
Vote on all material issues.
Written policy on exercising proxy votes and ensure consistently applied
Report proxy votes cast to clients and a positive statement that the investment
manager has complied with its obligation to exercise voting rights in the
client's interest only.
LOCAL POLICY - SWITZERLAND / ZURICH
Swiss law does not allow for UBS Global Asset Management Switzerland to vote
proxies. This function is managed by the securities operations group of UBS AG
(Zurich). The Swiss Code of Obligations allows UBS AG the custodian, the right
to vote in accordance with explicit instructions from its clients. In the case
where UBS AG has no explicit instructions, the Swiss Code of Obligations,
(Article #689), states that UBS AG must vote the proxy based upon general
instructions. In the absence of general instructions, the bank must vote in line
with the proposals presented by the board of directors.
LOCAL POLICY - JAPAN / TOKYO
No Local Policies at this time
LOCAL POLICY - CANADA / TORONTO
No Local policies at this time
LOCAL POLICY - UNITED STATES / CHICAGO
OUR GLOBAL POLICIES ARE OUR LOCAL POLICIES EXCEPT FOR THE FOLLOWING:
General:
--------
UBS Global Asset Management in the United States has adopted and implemented
policies and procedures, in accordance with SEC Rule 206(4)-6 under the Advisers
Act of 1940, that we believe are reasonably designed to ensure that proxies are
voted in the best interest of clients. Our authority to vote the proxies of our
clients is established by our advisory contracts or comparable documents, and
our proxy voting guidelines have been tailored to reflect these specific
contractual obligations. In addition to SEC requirements governing advisers, our
proxy voting policies reflect the long-standing fiduciary standards and
responsibilities for ERISA accounts set out in Department of Labor Bulletin
94-2, 29 C.F.R. 2509.94-2 (July 29, 1994). Further, with respect to our mutual
fund accounts, our proxy voting policies and procedures accommodate the SEC
disclosure requirements for proxy voting by registered investment companies.
I. B. Proxy Voting Guidelines - Macro Rationales
------------------------------------------------
For accounts subject to ERISA, we will exercise voting rights in accordance with
client directions unless we believe it imprudent to do so. Should we determine
it is imprudent to follow an ERISA client's direction, and the client confirms
such direction after being notified of our opinion, we will exercise the voting
right in the manner we deem prudent.
PART C. OTHER INFORMATION
[Enlarge/Download Table]
Item 23. Exhibits.
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(a) Amendment and Restatement of the Articles
of Incorporation (filed 10/24/2000)
(1) Articles Supplementary (filed 2/13/2002)
(2) Articles Supplementary (filed 2/26/2004)
(3) Articles Supplementary *
(b) By-laws (filed 12/31/03)
(c) Specimen Share Certificate N/A
(d) (1) Management Agreement (filed 10/23/97)
(2) First Amendment to Management Agreement (filed 2/12/98)
(3) Second Amendment to Management Agreement (filed 10/24/00)
(4) Third Amendment to Management Agreement (filed 10/24/00)
(5) Fourth Amendment to Management Agreement (filed 12/31/03)
(6) Amended & Restated Management Agreement (filed 12/31/03)
(7) Amended & Restated Management Agreement (filed 6/15/2004)
(8) Amended & Restated Management Agreement *
(9) Investment Service Agreement (filed 10/23/97)
(10) Amended & Restated Investment Service Agreement (filed 6/15/2004)
(11) Sub-Advisory Agreement - Invista (filed 10/23/97)
(12) First Amendment to Sub-Advisory Agrmt. (filed 2/12/98)
(13) Second Amendment to Sub-Advisory Agrmt. (filed 10/24/00)
(14) Third Amendment to Sub-Advisory Agrmt. (filed 10/24/00)
(15) Sub-Advisory Agreement - Morgan Stanley Asset Mgmt.
(filed 10/23/97)
(16) Sub-Advisory Agreement - Berger Assoc. (filed 4/13/98)
(17) Sub-Advisory Agreement - Dreyfus Corp. (filed 4/13/98)
(18) Sub-Advisory Agreement - Goldman Sachs (filed 4/13/98)
(19) Sub-Advisory Agreement - JP Morgan (filed 4/13/98)
(20) Sub-Advisory Agreement - Neuberger Berman (filed 4/21/99)
(21) Sub-Advisory Agreement - Janus Capital (filed 4/21/99)
(22) Sub-Advisory Agreement - Duncan-Hurst (filed 10/24/00)
(23) Sub-Advisory Agreement - Turner (filed 10/24/00)
(24) Sub-Advisory Agreement - Bernstein (filed 04/29/02)
(25) Sub-Advisory Agreement - Federated (filed 04/29/02)
(26) 6th Amdt. to Sub-Adv. Agreement w/Invista (filed 04/29/02)
(27) 2nd Amdt. to Sub-Adv. Agreement w/PCII (filed 04/29/02)
(28) Sub-Advisory Agreement - Putnam (filed 02/13/03)
(29) Amended & Restated Sub-Adv. - Federated (filed 2/26/04)
(30) Sub-Advisory Agreement - Neuberger Berman (filed 2/26/04)
(31) Amended & Restated Sub-Adv. - Dreyfus (filed 2/26/04)
(32) Sub-Advisory Agreement - Grantham, Mayo, Van Otterloo (filed 4/29/04)
(33) Sub-Advisory Agreement - T. Rowe Price (filed 6/15/2004)
(34) Amended & Restate Sub-Adv - PGI (filed 6/15/2004)
(35) Sub-Advisory Agreement - UBS (filed 6/15/2004)
(36) Amended & Restated Sub-Advisory Agreement - Bernstein *
(37) Amended & Restated Sub-Advisory Agreement - MSAM *
(38) Amended & Restated Sub-Advisory Agreement - PGI *
(39) Amended & Restated Sub-Advisory Agreement - Neuberger Berman *
(40) Amended & Restated Sub-Advisory Agreement - T. Rowe Price *
(41) Sub-Advisory Agreement - American Century *
(e) Distribution Agreement (filed 10/24/00)
(1) Amended & Restated Distribution Agreement *
(f) N/A
(g) Custodian Agreement
(1) Domestic Custody Agreement (filed 10/23/97)
(2) Global Custody Agreement (filed 10/23/97)
(h) Agreement and Plan of Reorganization and Liquidation
(filed 10/23/97)
(i) Legal Opinion (filed 10/24/00)
(j) Consent of Independent Auditors *
(k) Financial Statements included in this Registration
Statement:
(1) Part A:
None
(2) Part B:
None
(3) Annual Report to Shareholders filed under Rule
N-30D-1 on February 19, 2004**
(l) Initial Capital Agreements
(1-11) Initial Capital Agreements 1987 (filed 4/27/01)
(12-19) Initial Capital Agreements 1998 (filed 4/27/01)
(20-23) Initial Capital Agreements 1999 (filed 4/27/01)
(24-26) Initial Capital Agreements 2000 (filed 4/27/01)
(27) Initial Capital Agreements 2003 (filed 2/26/04)
(m) Rule 12b-1 Plan N/A
(o) Rule 18f-3 Plan N/A
(p) Code of Ethics
(1) PMC Code of Ethics (filed 12/31/03)
(2) Invista Code of Ethics (filed 4/26/00)
(3) Dreyfus Code of Ethics (filed 4/26/00)
(4) Goldman Code of Ethics (filed 4/26/00)
(5) JP Morgan Code of Ethics (filed 2/13/2002)
(6) Janus Code of Ethics (filed 4/26/00)
(7) MSDW Code of Ethics (filed 12/31/03)
(8) Neuberger Berman Code of Ethics (filed 6/15/2004)
(9) Berger Code of Ethics (filed 4/26/00)
(10) Duncan-Hurst Code of Ethics (filed 10/24/00)
(11) Turner Code of Ethics (filed 10/24/00)
(12) PCII Code of Ethics (filed 4/27/01)
(13) Bernstein Code of Ethics (filed 2/13/2002)
(14) Federated Code of Ethics (filed 2/13/2002)
(15) Sr. & Executive Officers Code of Ethics (Sarbanes)
(filed 12/31/03)
(16) Principal Global Investors (filed 12/31/03)
(17) Grantham, Mayo, Van Otterloo Code of Ethics (filed 4/29/04)
(18) T. Rowe Price Code of Ethics (filed 6/15/2004)
(19) UBS Code of Ethics (filed 6/15/2004)
(20) Emerald Code of Ethics *
(21) American Century Code of Ethics *
* Filed herein.
** To be filed by amendment.
*** Incorporated herein by reference.
Item 24. Persons Controlled by or Under Common Control with Registrant
Principal Financial Services, Inc. (an Iowa corporation) an
intermediate holding company organized pursuant to Section 512A.14 of
the Iowa Code.
Subsidiaries wholly-owned by Principal Financial Services, Inc.:
a. Princor Financial Services Corporation (an Iowa Corporation) a
corporation that acts as a registered broker-dealer and markets a
variety of mutual funds, unit investment trusts and limited
partnerships and serves as the principal underwriter and
distributor for the mutual funds organized by Principal Life
Insurance Company.
b. PFG DO Brasil LTDA (Brazil) a Brazilian holding company.
c. Principal International, Inc. an Iowa corporation engaged in
international business development.
d. Principal International Holding Company, LLC a Delaware limited
liability company that serves as a downstream holding company for
Principal Financial Services, Inc.
e. Principal Global Investors Holding Company, Inc. a Delaware
holding company.
f. ING/Principal Pensions Co., Ltd. (Japan) a Japan company who
engages in the management, investment and administration of
financial assets and any services incident thereto.
g. Principal Financial Group (Mauritius) Ltd. a Mauritius holding
company.
h. Principal Life Insurance Company (an Iowa corporation) a stock
life insurance company engaged in the business of insurance and
retirement services.
i. Principal Financial Services (Australia), Inc. an Iowa holding
company.
j. Principal International De Chile S.A. (Chile) a holding company.
k. Principal Financial Group Investments (Australia) Pty Limited a
holding company.
Subsidiary wholly-owned by Princor Financial Services Corporation:
a. Principal Management Corporation (an Iowa Corporation) a SEC
registered investment advisor providing investment management and
other services to the mutual funds organized by Principal Life
Insurance Company and distributed through Princor Financial
Services Corporation.
Subsidiary 42% owned by PFG DO Brasil LTDA:
a. BrasilPrev Seguros e Previdencia S.A.(Brazil) a pension fund
company.
Subsidiaries wholly-owned by Principal International, Inc.:
a. Zao Principal International (Russia) an inactive company.
b. Principal International Argentina, S.A. (Argentina) a holding
company that owns Argentina corporations offering annuities,
group and individual insurance policies. These companies
including Principal Life Compania de Securos de Vida S.A. and
Principal Retiro Compania de Securos de Retiro S.A.
c. Principal Asset Management Company (Asia) Limited (Hong Kong) an
asset management company.
d. Principal International (Asia) Limited (Hong Kong) a corporation
operating as a regional headquarters for Asia.
e. Principal Insurance Company (Hong Kong) Limited a company that
sells insurance and pension products.
f. Principal Trust Company (Asia) Limited (Hong Kong) an Asia Trust
company.
g. Principal Mexico Compania De Seguros S.A. De C.V. (Mexico) a life
insurance company.
h. Principal Pensiones, S.A. De C.V. (Mexico) a pension company.
i. Principal Afore, S.A. De C.V. (Mexico) a pension company.
j. Principal Mexico Servicios, S.A. De C.V. (Mexico) a company
established to be the employer of Mexico administration
employees.
k. Distribuidora Principal Mexico, S.A. De C.V. (Mexico) a Mexico
company established to be the employer of Mexico sales employees.
l. Principal Consulting (India) Private Limited a consulting
company.
Subsidiaries wholly-owned by Principal Global Investors Holding
Company, Inc.:
a. Principal Global Investors (Singapore) Limited a company engaged
in funds management services including the management of unit
trusts and investment advisory services.
b. Principal Global Investors (Europe) Limited a United Kingdom
company that engages in European representation and distribution
of the Principal Investments Funds.
c. Principal Global Investors (Ireland) Limited a company that
engages in funds management.
Subsidiary wholly-owned by Principal Financial Group (Mauritius) Ltd.:
a. Principal Asset Management Company Limited (India) an asset
management company.
b. Principal Trustee Company Limited (India) a trustee company for
mutual funds.
Subsidiaries wholly-owned by Principal Life Insurance Company:
a. InSource Group, LLC a Delaware limited liability company engaged
in marketing products for companies of the Principal Financial
Group.
b. Principal Global Investors, LLC a Delaware limited liability
company which is an SEC Registered Investment Advisor who
provides private mortgage, real estate and fixed-income
securities to institutional clients.
c. Principal Development Investors, LLC a Delaware limited liability
company engaged in acquiring and improving real property through
development and redevelopment.
d. Principal Net Lease Investors, LLC a Delaware limited liability
company which operates as a buyer and seller of net leased
investments.
e. Principal Holding Company an Iowa corporation that serves as a
downstream holding company for Principal Life Insurance Company.
f. Executive Benefit Services, Inc. a North Carolina marketing,
sales and administration of executive employee benefit services.
g. BCI Group, Inc. a Delaware limited liability company.
Principal Life Insurance Company sponsored the organization of the
following mutual funds, some of which it controls by virtue of owning
voting securities
Principal Balanced Fund, Inc.(a Maryland Corporation) 0.00% of
shares outstanding owned by Principal Life Insurance Company
(including subsidiaries and affiliates) on August 19, 2004.
Principal Bond Fund, Inc.(a Maryland Corporation) 0.00% of shares
outstanding owned by Principal Life Insurance Company (including
subsidiaries and affiliates) on August 19, 2004.
Principal Capital Value Fund, Inc. (a Maryland Corporation)
17.51% of outstanding shares owned by Principal Life Insurance
Company (including subsidiaries and affiliates)on August 19,
2004.
Principal Cash Management Fund, Inc. (a Maryland Corporation)
2.31% of outstanding shares owned by Principal Life Insurance
Company (including subsidiaries and affiliates) on August 19,
2004.
Principal Equity Income Fund, Inc. (f/k/a Principal Utilities
Fund, Inc.) (a Maryland Corporation) 0.00% of shares outstanding
owned by Principal Life Insurance Company (including subsidiaries
and affiliates) on August 19, 2004.
Principal Government Securities Income Fund, Inc. (a Maryland
Corporation) 0.00% of shares outstanding owned by Principal Life
Insurance Company (including subsidiaries and affiliates) on
August 19, 2004.
Principal Growth Fund, Inc. (a Maryland Corporation) 0.00% of
outstanding shares owned by Principal Life Insurance Company
(including subsidiaries and affiliates) on August 19, 2004.
Principal International Emerging Markets Fund, Inc. (a Maryland
Corporation) 26.51% of shares outstanding owned by Principal Life
Insurance Company (including subsidiaries and affiliates) on
August 19, 2004.
Principal International Fund, Inc. (a Maryland Corporation)
13.92% of shares outstanding owned by Principal Life Insurance
Company (including subsidiaries and affiliates) on August 19,
2004.
Principal International SmallCap Fund, Inc. (a Maryland
Corporation) 0.00% of shares outstanding owned by Principal Life
Insurance Company (including subsidiaries and affiliates) on
August 19, 2004.
Principal Limited Term Bond Fund, Inc. (a Maryland Corporation)
2.79% of shares outstanding owned by Principal Life Insurance
Company (including subsidiaries and affiliates) on August 19,
2004.
Principal LargeCap Stock Index Fund, Inc. (a Maryland
Corporation) 0.00% of shares outstanding owned by Principal
Life Insurance Company (including subsidiaries and affiliates) on
August 19, 2004.
Principal MidCap Fund, Inc. (a Maryland Corporation) 0.00% of
shares outstanding owned by Principal Life Insurance Company
(including subsidiaries and affiliates) on August 19, 2004
Principal Partners Blue Chip Fund, Inc.(a Maryland Corporation)
0.00% of shares outstanding owned by Principal Life Insurance
Company (including subsidiaries and affiliates) on August 19,
2004.
Principal Partners Equity Growth Fund, Inc.(a Maryland
Corporation) 0.00% of shares outstanding owned by Principal Life
Insurance Company (including subsidiaries and affiliates) on
August 19, 2004
Principal Partners LargeCap Blend Fund, Inc.(a Maryland
Corporation) 0.00% of shares outstanding owned by Principal
Life Insurance Company (including subsidiaries and affiliates) on
August 19, 2004
Principal Partners LargeCap Value Fund, Inc.(a Maryland
Corporation) 3.15% of shares outstanding owned by Principal
Life Insurance Company (including subsidiaries and affiliates) on
August 19, 2004
Principal Partners MidCap Growth Fund, Inc.(a Maryland
Corporation) 0.00% of shares outstanding owned by Principal
Life Insurance Company (including subsidiaries and affiliates) on
August 19, 2004
Principal Partners SmallCap Growth Fund, Inc.(a Maryland
Corporation) 14.52% of shares outstanding owned by Principal
Life Insurance Company (including subsidiaries and affiliates) on
August 19, 2004
Principal Real Estate Securities Fund, Inc. (a Maryland
Corporation) 0.00% of shares outstanding owned by Principal Life
Insurance Company (including subsidiaries and affiliates) on
August 19, 2004
Principal SmallCap Fund, Inc.(a Maryland Corporation) 0.00% of
shares outstanding owned by Principal Life Insurance Company
(including subsidiaries and affiliates) on August 19, 2004.
Principal Investors Fund, Inc.(a Maryland Corporation),
0.18% of shares outstanding of the Bond & Mortgage Securitites
Fund,
6.99% of shares outstanding of the Capital Preservation Fund,
0.01% of shares outstanding of the Governement Securities Fund,
0.03% of shares outstanding of the High Quality
Intermediate-Term Bond Fund,
0.13% of shares outstanding of the High Quality Long-Term Bond
Fund,
0.04% of shares outstanding of the High Quality Short-Term Bond
Fund,
22.87% of shares outstanding of the International Emerging
Markets Fund,
14.79% of shares outstanding of the International Fund I,
0.00% of shares outstanding of the International Fund II,
73.03% of shares outstanding of the LargeCap Blend Fund I,
21.12% of shares outstanding of the LargeCap Growth Fund,
0.00% of shares outstanding of the LargeCap S&P 500 Index Fund,
25.43% of shares outstanding of the LargeCap Value Fund,
0.03% of shares outstanding of the MidCap Blend Fund,
0.11% of shares outstanding of the MidCap Growth Fund,
0.02% of shares outstanding of the MidCap S&P 400 Index Fund,
0.00% of shares outstanding of the MidCap Value Fund,
0.00% of shares outstanding of the Money Market Fund,
6.29% of shares outstanding of the Partners International Fund,
0.00% of shares outstanding of the Partners LargeCap Blend Fund,
0.35% of shares outstanding of the Partners LargeCap Blend
Fund I,
52.88% of shares outstanding of the Partners LargeCap Growth
Fund,
0.00% of shares outstanding of the Partners LargeCap Growth Fund
I,
0.00% of shares outstanding of the Partners LargeCap Growth Fund
II,
0.00% of shares outstanding of the Partners LargeCap Value Fund,
99.98% of shares outstanding of the Partners LargeCap Value
Fund I,
0.04% of shares outstanding of the Partners MidCap Growth Fund,
3.31% of shares outstanding of the Partners MidCap Growth Fund I,
0.06% of shares outstanding of the Partners MidCap Value Fund,
1.79% of shares outstanding of the Partners MidCap Value Fund
I,
2.84% of shares outstanding of the Partners SmallCap Blend Fund,
0.00% of shares outstanding of the Partners SmallCap Growth Fund
I,
0.00% of shares outstanding of the Partners SmallCap Growth Fund
II,
99.98% of shares outstanding of the Partners SmallCap Growth Fund
III,
0.01% of shares outstanding of the Partners SmallCap Value Fund,
1.67% of shares outstanding of the Partners SmallCap Value Fund
I,
100.00% of shares outstanding of the Partners SmallCap Value Fund
II,
0.02% of shares outstanding of the Preferred Securities Fund,
0.00% of shares outstanding of the Principal LifeTime 2010 Fund,
0.00% of shares outstanding of the Principal LifeTime 2020 Fund,
0.00% of shares outstanding of the Principal LifeTime 2030 Fund,
0.01% of shares outstanding of the Principal LifeTime 2040 Fund,
0.02% of shares outstanding of the Principal LifeTime 2050 Fund,
0.02% of shares outstanding of the Principal LifeTime Strategic
Income Fund,
0.00% of shares outstanding of the Real Estate Securities Fund,
14.69% of shares outstanding of the SmallCap Blend Fund,
0.11% of shares outstanding of the SmallCap Growth Fund,
0.00% of shares outstanding of the SmallCap S&P 600 Index Fund,
0.20% of shares outstanding of the SmallCap Value Fund,
were owned by Principal Life Insurance Company (including
subsidiaries and affiliates) on August 19, 2004.
Principal Tax-Exempt Bond Fund, Inc. (a Maryland Corporation)
0.00% of shares outstanding owned by Principal Life Insurance
Company (including subsidiaries and affiliates) on August 19,
2004.
Principal Variable Contracts Fund, Inc. (a Maryland Corporation)
100% of shares outstanding of the following Accounts owned by
Principal Life Insurance Company and its Separate Accounts on
August 19, 2004: Asset Allocation, Balanced, Bond, Capital Value,
Equity Growth, Equity Income (f/k/a Utilities), Government
Securities, Growth, International, International Emerging
Markets, International SmallCap, LargeCap Blend, LargeCap Growth
Equity, LargeCap Stock Index, LargeCap Value, Limited Term Bond,
MidCap, MidCap Growth, MidCap Value, Money Market, Real Estate
Securities, SmallCap, SmallCap Growth and SmallCap Value.
Subsidiary wholly-owned by Principal Financial Services (Australia),
Inc.:
a. Principal Tactical Asset Management Pty, Limited an Australia
company that engages in management of futures positions.
b. Principal Global Investors (Australia) Service Company Pty Ltd an
Australia company established to be the employer of Australia
employees.
c. Principal Capital Global Investors Limited an Australia company
which is an SEC registered investment advisor which manages
international funds (non-Australian) residents.
d. Principal Financial Group Australia Pty Ltd. an Australia holding
company.
Subsidiaries wholly-owned by Principal International De Chile S.A.
(Chile):
a. Principal Tanner Administradora General De Fondos Mutuos S.A.
(Chile) a corporation organized for the administration of various
funds.
b. Principal Compania De Securos De Vida Chile S.A. (Chile) a life
insurance company.
Subsidiary wholly owned by Principal Financial Group Investments
(Australia) Pty Limited:
a. Principal Hotels Holdings Pty Limited an Australia holding
company.
Subsidiaries owned by Principal International Argentina, S.A.
(Argentina):
a. Principal Retiro Compania De Securos De Retiro, S.A. (Argentina)
an annuity company.
b. Principal Life Compania De Seguros, S.A. (Argentina) a life
insurance company.
Subsidiary owned by Principal International (Asia) Limited (Hong
Kong):
a. Principal Global Investors (Asia) Limited (Hong Kong) a company
that provides sale, marketing and client services support for
Principal Capital Management funds and institutional investors.
Subsidiary owned by Principal Afore, S.A. De C.V. (Mexico):
a. Principal Siefore, S.A. De C.V. (Mexico) an investment fund
company.
Subsidiaries wholly-owned by Principal Global Investors, LLC:
a. Principal Enterprise Capital, LLC a Delaware limited liability
company engaged in portfolio management on behalf of
institutional clients for structuring, underwriting and
management of entity-level investments in real estate operating
companies (REOCs).
b. Principal Commercial Acceptance, LLC a Delaware limited liability
company that provides private market bridge financing and other
secondary market opportunities.
c. Principal Real Estate Investors, LLC a Delaware limited liability
company which is an SEC Registered Investment Advisor that
provides real estate debt and equity portfolio management on
behalf of institutional clients.
d. Principal Commercial Funding, LLC a Delaware limited liability
company engaged in the structuring, warehousing, securitization
and sale of commercial mortgage-backed securities.
e. Principal Capital Futures Trading Advisors, LLC a Delaware
limited liability company which is a commodities trading advisor
registered with the CFTC.
f. Principal Global Investors Trust a Delaware business trust and
private investment company offering non-registered units,
initially, to tax-exempt entities.
g. Spectrum Asset Management, Inc. a Connecticut corporation
specializing in all aspects of the preferred market including
portfolio management, risk management and trading.
Subsidiaries wholly-owned by Principal Holding Company:
a. Principal Generation Plant, LLC a Delaware limited liability
company that sells excess power.
b. Principal Bank a federally-chartered direct delivery savings
bank, with FDIC insurance offering traditional banking services
and products to its customers including checking, money market
demand accounts, savings accounts and certificates of deposit as
well as traditional consumer loans, car loans and personal loans.
c. Patrician Associates, Inc. a California corporation that engages
in real estate joint venture transactions with developers.
d. Petula Associates, Ltd. an Iowa corporation that engages in real
estate joint venture transactions with developers.
e. Principal Development Associates, Inc. a California corporation
that engages in real estate joint venture transactions with
developers.
f. Principal Spectrum Associates, Inc. a California corporation
which engages in real estate joint venture transactions with
developers.
g. Principal FC, Ltd. an Iowa limited purpose investment
corporation.
h. Equity FC, Ltd. an Iowa general business corporation that engages
in investment transactions, including limited partnerships and
limited liability companies.
i. Principal Delaware Name Holding Company, Inc. a corporation which
currently is inactive.
j. Principal Asset Markets, Inc. an Iowa corporation which currently
is inactive.
k. Principal Residential Mortgage, Inc. an Iowa full service
mortgage banking company that makes and services a wide variety
of loan types on a nationwide basis.
l. Principal Portfolio Services, Inc. an Iowa corporation which
currently is inactive.
m. Healthrisk Resource Group, Inc. an Iowa general business
corporation engaged in providing managed are expertise and
administrative ser4vices to provider organizations involved in
risk-assuming contracts for health care services.
n. Preferred Product Network, Inc. a Delaware insurance broker which
markets selected products manufactured outside the Principal
Financial Group--formerly known as Principal Product Network,
Inc. and Principal Marketing Services, Inc.
o. Principal Health Care, Inc. an Iowa managed care company.
p. Dental-Net, Inc. an Arizona managed dental care services
organization.
q. Principal Financial Advisors, Inc. an Iowa corporation that acts
as an SEC Registered Investment Advisor offering retirement plan
asset allocation services to employers and plan members and cash
flow value assessments of commercial mortgages for institutional
clients.
r. Delaware Charter Guarantee & Trust Company (D/B/A Trustar
Retirement Services) a Delaware corporation that administers
individual and group retirement plans for stock brokerage firm
clients and mutual fund distributors.
s. Professional Pension, Inc. a Connecticut corporation engaged in
sales, marketing and administration of group insurance plans and
third-party administration for defined contribution plans. Does
business as Northeast Plan Administrators.
t. Principal Investors Corporation a New Jersey general business
corporation that holds investments.
Subsidiaries wholly-owned by Executive Benefit Services, Inc.:
a. Executive Broker Dealer Services, LLC a North Carolina limited
liability company anticipated to be a registered broker-dealer.
Subsidiaries wholly-owned by Principal Global Investors (Australia)
Service Company Pty Ltd.:
a. Principal Global Investors (Australia) Limited a company
established to hold the responsible entity license regarding
non-property business.
b. Principal Real Estate Investors (Australia) Limited an Australia
company established to hold the responsible entity license
regarding property business.
Subsidiary wholly-owned by Principal Financial Group Australia Pty
Ltd.:
a. Principal Investments (Australia) Limited a Delaware holding
company.
Subsidiary wholly-owned by Principal Compania De Seguros De Vida Chile
S.A. (Chile):
a. Principal Creditos Hipotecarios, S.A. (Chile) a residential
mortgage company.
Subsidiary wholly-owned by Principal Hotels Holdings Pty Limited:
a. Principal Hotels Australia Pty Limited an Australia holding
company.
Subsidiary wholly-owned by Petula Associates, Ltd.:
a. Petula Prolix Development Company an Iowa general business
corporation involved in joint real estate ventures.
Subsidiaries wholly-owned by Principal Residential Mortgage, Inc.:
a. Principal Wholesale Mortgage, Inc. an Iowa brokerage and servicer
of residential mortgages.
b. Principal Mortgage Reinsurance Company a Vermont mortgage
reinsurance company.
c. Principal Residential Mortgage Funding, LLC a Delaware limited
liability company which purchases and holds residential mortgage
loans.
d. Principal Residential Mortgage Servicing, LLC a Delaware limited
liability company which acquires mortgage servicing rights.
Subsidiary wholly-owned by Dental-Net, Inc.:
a. Employers Dental Services, Inc. an Arizona prepaid dental plan
organization.
Subsidiaries wholly-owned by Professional Pensions, Inc.:
a. Benefit Fiduciary Corporation a Rhode Island corporation which
serves as a corporate trustee for retirement trusts.
b. PPI Employee Benefits Corporation a Connecticut registered
broker-dealer, limited to the sale of open-end mutual funds and
variable insurance products.
c. Boston Insurance Trust, Inc. a Massachusetts corporation which
serves as a trustee and administrator of insurance trusts and
arrangements.
Subsidiary wholly-owned by Principal Investments (Australia) Limited:
a. Principal Australia (Holdings) Pty Ltd an Australia commercial
and investment banking and asset management company.
Subsidiary wholly-owned by Principal Hotels Australia Pty Limited:
a. Principal Hotel Limited an Australia corporation, which is the
hotel operating/managing company of the BT Hotel Group.
Item 25. Indemnification
Under Section 2-418 of the Maryland General Corporation Law, with respect
to any proceedings against a present or former director, officer, agent or
employee (a "corporate representative") of the Registrant, the Registrant may
indemnify the corporate representative against judgments, fines, penalties, and
amounts paid in settlement, and against expenses, including attorneys' fees, if
such expenses were actually incurred by the corporate representative in
connection with the proceeding, unless it is established that:
(i) The act or omission of the corporate representative was
material to the matter giving rise to the proceeding; and
1. Was committed in bad faith; or
2. Was the result of active and deliberate dishonesty; or
(ii) The corporate representative actually received an improper
personal benefit in money, property, or services; or
(iii) In the case of any criminal proceeding, the corporate
representative had reasonable cause to believe that the act or
omission was unlawful.
If a proceeding is brought by or on behalf of the Registrant, however, the
Registrant may not indemnify a corporate representative who has been adjudged to
be liable to the Registrant. Under the Registrant's Articles of Incorporation
and Bylaws, directors and officers of Registrant are entitled to indemnification
by the Registrant to the fullest extent permitted under Maryland law and the
Investment Company Act of 1940. Reference is made to Article VI, Section 7 of
the Registrant's Articles of Incorporation, Article 12 of Registrant's Bylaws
and Section 2-418 of the Maryland General Corporation Law.
The Registrant has agreed to indemnify, defend and hold the Distributor,
its officers and directors, and any person who controls the Distributor within
the meaning of Section 15 of the Securities Act of 1933, free and harmless from
and against any and all claims, demands, liabilities and expenses (including the
cost of investigating or defending such claims, demands or liabilities and any
counsel fees incurred in connection therewith) which the Distributor, its
officers, directors or any such controlling person may incur under the
Securities Act of 1933, or under common law or otherwise, arising out of or
based upon any untrue statement of a material fact contained in the Registrant's
registration statement or prospectus or arising out of or based upon any alleged
omission to state a material fact required to be stated in either thereof or
necessary to make the statements in either thereof not misleading, except
insofar as such claims, demands, liabilities or expenses arise out of or are
based upon any such untrue statement or omission made in conformity with
information furnished in writing by the Distributor to the Registrant for use in
the Registrant's registration statement or prospectus: provided, however, that
this indemnity agreement, to the extent that it might require indemnity of any
person who is also an officer or director of the Registrant or who controls the
Registrant within the meaning of Section 15 of the Securities Act of 1933, shall
not inure to the benefit of such officer, director or controlling person unless
a court of competent jurisdiction shall determine, or it shall have been
determined by controlling precedent that such result would not be against public
policy as expressed in the Securities Act of 1933, and further provided, that in
no event shall anything contained herein be so construed as to protect the
Distributor against any liability to the Registrant or to its security holders
to which the Distributor would otherwise be subject by reason of willful
misfeasance, bad faith, or gross negligence, in the performance of its duties,
or by reason of its reckless disregard of its obligations under this Agreement.
The Registrant's agreement to indemnify the Distributor, its officers and
directors and any such controlling person as aforesaid is expressly conditioned
upon the Registrant being promptly notified of any action brought against the
Distributor, its officers or directors, or any such controlling person, such
notification to be given by letter or telegram addressed to the Registrant.
Item 26. Business or Other Connection of Investment Adviser
A complete list of the officers and directors of the investment adviser,
Principal Management Corporation, are set out below. This list includes some of
the same people (designated by an *), who are serving as officers and directors
of the Registrant. For these people the information as set out in the Statement
of Additional Information (See Part B) under the caption "Directors and Officers
of the Fund" is incorporated by reference.
*John E. Aschenbrenner Principal See Part B
Director Financial Group
Patricia A. Barry Same Counsel
Assistant Corporate Principal Life Insurance
Secretary Company
*Craig L. Bassett Same See Part B
Treasurer
*Michael J. Beer Same See Part B
Executive Vice President
*Jill R. Brown Same See Part B
Vice President and
Chief Financial Officer
Timothy E. Dohlman Same Assistant Treasurer
Assistant Treasurer Principal Life Insurance
Company
*Ralph C. Eucher Same See Part B
President and Director
*Arthur S. Filean Same See Part B
Sr. Vice President
Michael P. Finnegan Same Second Vice President -
Senior Vice President - Investment Services
Investment Services Principal Life Insurance
Company
Paul N. Germain Same Vice President -
Vice President - Mutual Fund Operations
Mutual Fund Operations Princor Financial Services
Corporation
*Ernest H. Gillum Same See Part B
Vice President - Product
Development
Joyce N. Hoffman Same Senior Vice President and
Sr. Vice President and Corporate Secretary
Corporate Secretary Principal Life Insurance
Company
Jane E. Karli Same Assistant Treasurer
Assistant Treasurer Principal Life Insurance
Company
Deanna L. Mankle Same Assistant Treasurer
Assistant Treasurer Principal Life Insurance
Company
*Layne A. Rasmussen Same See Part B
Controller -
Mutual Funds
*Michael D. Roughton Same See Part B
Counsel
James F. Sager Same Vice President
Vice President Princor Financial Services
Corporation
Karen E. Shaff Same Senior Vice President &
Director General Counsel
Principal Life Insurance
Company
*Jean B. Schustek Same See Part B
Assistant Vice President -
Registered Products
*Larry D. Zimpleman Same See Part B
Chairman of the Board &
Director
Principal Management Corporation serves as investment adviser and dividend
disbursing and transfer agent for, Principal Balanced Fund, Inc., Principal Bond
Fund, Inc., Principal Capital Value Fund, Inc., Principal Cash Management Fund,
Inc., Principal Equity Income Fund, Inc., Principal Government Securities Income
Fund, Inc., Principal Growth Fund, Inc., Principal International Emerging
Markets Fund, Inc., Principal International Fund, Inc., Principal International
SmallCap Fund, Inc., Principal Investors Fund, Inc., Principal LargeCap Stock
Index Fund, Inc., Principal Limited Term Bond Fund, Inc., Principal MidCap Fund,
Inc., Principal Partners Blue Chip Fund, Inc., Principal Partners Equity Growth
Fund, Inc., Principal Partners LargeCap Blend Fund, Inc., Principal Partners
LargeCap Value Fund, Inc. Principal Partners MidCap Growth Fund, Inc., Principal
Partners SmallCap Growth Fund, Inc., Principal Real Estate Fund, Inc., Principal
SmallCap Fund, Inc., Principal Tax-Exempt Bond Fund, Inc., Principal Variable
Contracts Fund, Inc. - funds sponsored by Principal Life Insurance Company.
Item 27. Principal Underwriters
(a) Princor Financial Services Corporation, principal underwriter for
Registrant, acts as principal underwriter for, Principal Balanced Fund, Inc.,
Principal Bond Fund, Inc., Principal Capital Value Fund, Inc., Principal Cash
Management Fund, Inc., Principal Equity Income Fund, Inc., Principal Government
Securities Income Fund, Inc., Principal Growth Fund, Inc., Principal
International Emerging Markets Fund, Inc., Principal International Fund, Inc.,
Principal International SmallCap Fund, Inc., Principal Investors Fund, Inc.,
Principal LargeCap Stock Index Fund, Inc., Principal Limited Term Bond Fund,
Inc., Principal MidCap Fund, Inc., Principal Partners Blue Chip Fund, Inc.,
Principal Partners Equity Growth Fund, Inc., Principal Partners LargeCap Blend
Fund, Inc., Principal Partners LargeCap Value Fund, Inc. Principal Partners
MidCap Growth Fund, Inc., Principal Partners SmallCap Growth Fund, Inc.,
Principal Real Estate Fund, Inc., Principal SmallCap Fund, Inc., Principal
Tax-Exempt Bond Fund, Inc., Principal Variable Contracts Fund, Inc. and for
variable annuity contracts participating in Principal Life Insurance Company
Separate Account B, a registered unit investment trust, and for variable life
insurance contracts issued by Principal Life Insurance Company Variable Life
Separate Account, a registered unit investment trust.
(b) (1) (2)
Positions
and offices
Name and principal with principal
business address underwriter
Lindsay L. Amadeo Assistant Director -
The Principal Marketing Services
Financial Group
Des Moines, IA 50392
John E. Aschenbrenner Director
The Principal
Financial Group
Des Moines, IA 50392
Patricia A. Barry Assistant Corporate Secretary
The Principal
Financial Group
Des Moines, IA 50392
Craig L. Bassett Treasurer
The Principal
Financial Group
Des Moines, IA 50392
Michael J. Beer Executive Vice President
The Principal
Financial Group
Des Moines, IA 50392
David J. Brown Vice President
The Principal
Financial Group
Des Moines, IA 50392
Jill R. Brown Vice President and
The Principal Chief Financial Officer
Financial Group
Des Moines, IA 50392
P. Scott Cawley Product Marketing Officer
The Principal
Financial Group
Des Moines, IA 50392
Ralph C. Eucher Director and
The Principal President
Financial Group
Des Moines, IA 50392
Arthur S. Filean Senior Vice President
The Principal
Financial Group
Des Moines, IA 50392
Michael P. Finnegan Senior Vice President -
The Principal Investment Services
Financial Group
Des Moines, IA 50392
Paul N. Germain Vice President -
The Principal Mutual Fund Operations
Financial Group
Des Moines, IA 50392
Ernest H. Gillum Vice President -
The Principal Product Development
Financial Group
Des Moines, IA 50392
Susan R. Haupts Marketing Officer
The Principal
Financial Group
Des Moines, IA 50392
Joyce N. Hoffman Sr. Vice President and
The Principal Corporate Secretary
Financial Group
Des Moines, IA 50392
Peter R. Kornweiss Vice President
The Principal
Financial Group
Des Moines, IA 50392
Elise M. Pilkington Assistant Director -
The Principal Retirement Consulting
Financial Group
Des Moines, IA 50392
Martin R. Richardson Operations Officer -
The Principal Broker/Dealer Services
Financial Group
Des Moines, IA 50392
Michael D. Roughton Counsel
The Principal
Financial Group
Des Moines, IA 50392
James F. Sager Vice President
The Principal
Financial Group
Des Moines, IA 50392
Jean B. Schustek Assistant Vice President -
The Principal Registered Products
Financial Group
Des Moines, IA 5092
Kyle R. Selberg Vice President-Marketing
The Principal
Financial Group
Des Moines, IA 50392
Karen E. Shaff Director
The Principal
Financial Group
Des Moines, IA 50392
Minoo Spellerberg Assistant Vice President and
The Principal Compliance Officer
Financial Group
Des Moines, IA 50392
Jamie K. Stenger Assistant Director - Compliance
The Principal
Financial Group
Des Moines, IA 50392
Larry D. Zimpleman Chairman of the Board and
The Principal Director
Financial Group
Des Moines, IA 50392
(c) Inapplicable.
Item 28. Location of Accounts and Records
All accounts, books or other documents of the Registrant are located at the
offices of the Registrant and its Investment Adviser in the Principal Life
Insurance Company home office building, The Principal Financial Group, Des
Moines, Iowa 50392.
Item 29. Management Services
Inapplicable.
Item 30. Undertakings
Indemnification
Reference is made to Item 27 above, which discusses circumstances under
which directors and officers of the Registrant shall be indemnified by the
Registrant against certain liabilities and expenses incurred by them by reason
of being a director or officer of the Registrant.
Notwithstanding the provisions of Registrant's Articles of Incorporation
and Bylaws, the Registrant hereby makes the following undertaking:
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
Registrant, pursuant to the foregoing provisions or otherwise, the Registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Act and is,
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by the Registrant of expenses incurred
or paid by a director, officer or controlling person of the Registrant, in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person of the Registrant, in connection with
the securities being registered, the Registrant will, unless in the opinion of
its counsel the matter has been settled by controlling precedent, submit to a
court of appropriate jurisdiction the question whether such indemnification by
it is against public policy as expressed in the Act and will be governed by the
final adjudication of such issue
Shareholder Communications
Registrant hereby undertakes to call a meeting of shareholders for the
purpose of voting upon the question of removal of a director or directors when
requested in writing to do so by the holders of at least 10% of the Registrant's
outstanding shares of common stock and in connection with such meeting to comply
with the provisions of Section 16(c) of the Investment Company Act of 1940
relating to shareholder communications
Delivery of Annual Report to Shareholders
The registrant hereby undertakes to furnish each person to whom a
prospectus is delivered a copy of the registrant's latest annual report to
shareholders, upon request and without charge.
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the
Investment Company Act of 1940 the Registrant certifies that it meets all of the
requirements for effectiveness of this Registration Statement and has duly
caused this Amendment to the Registration Statement to be signed on its behalf
by the undersigned, thereunto duly authorized in the City of Des Moines and
State of Iowa, on the 27th day of August, 2004.
Principal Variable Contracts Fund, Inc.
(Registrant)
By /s/ R. C. Eucher
______________________________________
R. C. Eucher
President, Chief Executive
Officer and Director
Attest:
/s/ A. S. Filean
______________________________________
A. S. Filean
Senior Vice President and Secretary
Pursuant to the requirement of the Securities Act of 1933, this Amendment
to the Registration Statement has been signed below by the following persons in
the capacities and on the dates indicated.
Signature Title Date
/s/ R. C. Eucher
_____________________________ Director, President and August 27, 2004
R. C. Eucher Chief Executive Officer __________________
(Principal Executive
Officer)
(L. D. Zimpleman)*
_____________________________ Director and August 27, 2004
L. D. Zimpleman Chairman of the Board __________________
/s/ J. R. Brown
_____________________________ Vice President and August 27, 2004
J. R. Brown Chief Financial Officer __________________
(Principal Accounting
Officer)
(J. E. Aschenbrenner)*
_____________________________ Director August 27, 2004
J. E. Aschenbrenner __________________
(J. D. Davis)*
_____________________________ Director August 27, 2004
J. D. Davis __________________
(R. W. Gilbert)*
_____________________________ Director August 27, 2004
R. W. Gilbert __________________
(M. A. Grimmett)*
_____________________________ Director August 27, 2004
M. A. Grimmett __________________
(W. C. Kimball)*
_____________________________ Director August 27, 2004
W. C. Kimball __________________
(B. A. Lukavsky)*
_____________________________ Director August 27, 2004
B. A. Lukavsky __________________
*By /s/ R. C. Eucher
_____________________________________
R. C. Eucher
President and Director
Pursuant to Powers of Attorney
Previously Filed or Included
Dates Referenced Herein and Documents Incorporated by Reference
| Referenced-On Page |
|---|
| This ‘485BPOS’ Filing | | Date | | First | | Last | | | Other Filings |
|---|
| |  |
| | 7/31/05 | | 175 |
| | 5/1/05 | | 27 | | 86 |
| | 4/30/05 | | 27 | | 86 |
| Effective on: | | 8/30/04 | | 1 | | 136 |
| Filed on: | | 8/27/04 | | 307 |
| | 8/24/04 | | 21 | | 95 |
| | 8/19/04 | | 306 | | | | | N-CSRS |
| | 6/30/04 | | 9 | | 120 | | | N-30D, N-CSRS, N-PX, N-PX/A, NSAR-A |
| | 6/21/04 | | 138 |
| | 6/1/04 | | 170 | | 171 |
| | 4/30/04 | | 177 | | | | | 485BPOS |
| | 3/31/04 | | 47 | | 172 |
| | 3/9/04 | | 44 |
| | 3/8/04 | | 169 |
| | 2/19/04 | | 306 | | | | | N-30D |
| | 2/12/04 | | 138 |
| | 1/23/04 | | 132 |
| | 12/31/03 | | 9 | | 193 | | | 24F-2NT, 485APOS, N-30D, N-CSR, NSAR-B |
| | 11/17/03 | | 240 |
| | 9/8/03 | | 177 |
| | 5/1/03 | | 55 | | 193 | | | 485BPOS |
| | 4/30/03 | | 177 |
| | 3/10/03 | | 177 |
| | 2/4/03 | | 138 |
| | 12/31/02 | | 125 | | 180 | | | 24F-2NT, N-30D, NSAR-B |
| | 10/1/02 | | 95 |
| | 5/1/02 | | 44 | | 193 | | | 485BPOS |
| | 1/29/02 | | 138 |
| | 12/31/01 | | 120 | | 121 | | | 24F-2NT, N-30D, NSAR-B |
| | 4/6/01 | | 138 |
| | 1/1/01 | | 120 | | 131 |
| | 12/31/00 | | 124 | | 125 | | | 24F-2NT, N-30D, NSAR-B |
| | 10/24/00 | | 38 | | 193 | | | 485BPOS |
| | 7/27/00 | | 138 |
| | 12/31/99 | | 126 | | 128 | | | 24F-2NT, N-30D, NSAR-B |
| | 11/2/99 | | 177 | | | | | DEFS14A, PRES14A |
| | 5/3/99 | | 50 | | 193 |
| | 5/1/99 | | 126 | | 128 |
| | 4/30/99 | | 126 | | 128 |
| | 4/22/99 | | 126 | | 128 |
| | 2/1/99 | | 138 |
| | 5/1/98 | | 24 | | 193 |
| | 2/13/98 | | 138 | | | | | 485APOS |
| | 5/27/97 | | 138 |
| | 7/29/94 | | 305 |
| | 6/1/94 | | 9 | | 193 |
| | 5/2/94 | | 32 | | 35 |
| | 5/1/94 | | 193 |
| List all Filings |
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