Somerset Exchange Fund
Semi-Annual Report
June 30, 1999
Past performance results shown in this report should not be
considered a representation of future performance. The Fund has
leveraged its portfolio by investing borrowed money to seek the
opportunity for a more broadly invested portfolio and potentially
higher investment returns. However, leveraging may exaggerate
changes in the net asset value of the Fund's shares and in the yield
on the Fund's portfolio. Leveraging also exposes Fund shareholders
to the risk of potential adverse tax consequences in the event of
default or adverse market action. Statements and other information
herein are as dated and are subject to change.
Printed on post-consumer recycled paper
Somerset Exchange Fund, June 30, 1999
DEAR SHAREHOLDER
US equity markets displayed mixed results during the first quarter
of 1999. The unmanaged Standard & Poor's (S&P) 500 Index, whose
performance was dominated by a relatively narrow group of large
growth companies, posted a total return of +4.98% for the March
quarter. However, other market indexes with performance based on a
broader spectrum of companies fared far worse. For example, the
unmanaged S&P MidCap Index had produced a total return of -6.38% and
the unmanaged S&P Small Cap Index posted a return of -9.00%. In this
quarter, the Somerset Exchange Fund's equity portfolio declined in
value from $117.6 million to $112.3 million, although solid gains
were made by stocks in the telecommunications, technology,
restaurants and pharmaceuticals sectors. Gainers and losers were
nearly evenly split during these three months. For the three months
ended March 31, 1999, the Fund had a total return of -4.38%.
During the second quarter of 1999, the Fund's net asset value per
share increased sharply, as mid cap and small cap stocks handily
outperformed the large cap sector. The Fund's net asset value per
share increased from $725.87 to $783.98 during this period,
resulting in a total return of +8.01%. For the same period, the S&P
500 Index had a total return of +7.05%; the S&P Mid-Cap had a total
return of 14.16%; and the S&P Small Cap Index returned +15.42%.
For the six-month period, the best-performing issues included RCN
Corporation (+89.8%), The Cerplex Group, Inc. (+88.2), Trans-
Financial Holdings, Inc. (+66.7%), Sunglass Hut International,
Inc. (+63.7%) and MedPartners, Inc. (+57.9%). MedPartners, Inc.,
formerly the Fund's largest individual holding, advanced 135% from a
low of $3.1875 on March 17, 1999 to its closing price of $7.50 on
June 30, 1999. Sunglass Hut continued the strong rebound that began
in the fourth quarter of 1998, and ended June at an all-time high of
$17.1875, an increase of 145.5% over its 1998 year-end price of $7.
While only 28 of the Fund's holdings had negative results for the
second quarter, among the worst-performing stocks were Parametric
Technology Corporation (-29.8%), Regis Corporation (-27.9%), Compaq
Computer Corporation (-25.3%), Pfizer Inc. (-21.4%) and Watson
Pharmaceuticals, Inc. (-20.5%). Watson remained the Fund's largest
holding, but experienced a decline of 41% off its all-time high of
$59.125 on February 2, 1999 to close the June quarter at $36.0625.
During this time, its weight in the portfolio was cut from almost
11% of the Fund to its current weight of 6.0%. Watson's decline,
coupled with the 29% advance of Motorola, Inc. during the second
quarter, pushed Motorola up to the second-largest Fund holding, at
5.65%. Aside from Watson and Motorola, the Fund's most heavily
weighted stocks at the end of June were MAXXAM Inc. (3.39%),
Pinnacle Systems, Inc. (3.32%), Abbott Laboratories (2.89%),
International Business Machines Corporation (2.76%), General
Electric Company (2.59%), Washington Mutual, Inc. (2.48%), Jacobs
Engineering Group Inc. (2.41%) and UST Inc. (2.41%). Collectively,
these ten stocks represented one-third of the Fund's equity
portfolio.
The Fund's total return for the first half of 1999 was +3.28%. Based
on the Fund's starting net asset value per share of $503.02 on July
11, 1996 (before deduction of offering costs), the Fund's total
return since inception through June 30, 1999 was +56.53%. At June
30, 1999, the Fund's net assets stood at $117.85 million, with its
common stock portfolio valued at $120.64 million.
Portfolio Matters
During the first half of 1999, several of the Fund's holdings were
the targets of acquisitions. Grand Casinos Inc. (61,300 shares) was
acquired in a stock-swap by Park Place Entertainment Corporation,
with each share of Grand Casinos converting into 1 share of Park
Place on January 4, 1999. This resulted in the Fund's new position
of 61,300 shares of Park Place. During the second quarter, two of
the Fund's positions were removed as a result of cash acquisitions.
Georgia-Pacific Corp. (not a Fund holding) acquired Unisource
Worldwide, Inc. for $12.00 per share and St. Johns Knits
International acquired St. Johns Knits, Inc. for $30.00 per share.
The Fund's holding of 5,000 shares of Unisource and 59,954 shares of
St. Johns Knits were sent back to the contributing shareholders
prior to the completion of these acquisitions. In addition, the
Fund's 7,500 shares of Ascend Communications, Inc. were converted
into 12,375 shares of Lucent Technologies Inc., which acquired the
former company via a stock-swap of 1.65 shares of Lucent for each
share of Ascend. The newly issued shares of Lucent combined with the
Fund's existing holdings of that company, resulting in its new total
of 23,003 shares.
Solectron Corporation split two-for-one on February 25, 1999,
increasing the Fund's shares from 19,500 to 39,000; Regis
Corporation split three-for-two on March 2, 1999, increasing the
Fund's shares from 20,000 to 30,000; and McDonald's Corporation
split two-for-one on March 8, 1999, increasing the Fund's shares
from 4,255 to 8,510. During the second quarter, AT&T Corp. split
three-for-two, increasing the Fund's shares from 8,200 to 12,300.
FDX Corporation split two-for-one, increasing the shares from 6,880
to 13,760. Intel Corporation split two-for-one, increasing the
Fund's shares from 8,000 to 16,000. International Business Machines
Corporation split two-for-one, increasing the Fund's shares from
13,000 to 26,000; Lucent Technologies Inc. split two-for-one, with
the Fund's 5,314 shares converting into 10,628 shares; Office Depot,
Inc. split three-for-two, with the Fund's 48,000 converting into
72,000 shares; and Pinnacle Systems, Inc. split two-for-one,
resulting in a position of 120,000 shares.
One of the Fund's primary sources of income is the quarterly
dividend paid by its two preferred stocks, Banesto Holdings 10.50%
(476,786 shares with a quarterly dividend of $0.65625 per share) and
Indosuez Holdings 10.375% (379,000 shares with a quarterly dividend
of $0.64844 per share). The Fund received its regular dividend
payments of $312,890.81 for Banesto on March 31, 1999 and June 30,
1999, and the $245,758 payment for Indosuez on April 1, 1999 and
July 1, 1999. The Fund also received $285,535 in common stock
dividends during the first quarter and $300,394.06 during the second
quarter. Between December 31, 1998 and March 31, 1999, the price of
the Banesto preferred stock decreased from $31.00 per share to
$28.25 per share, while the price of the Indosuez preferred shares
decreased from $26.00 per share to $25.00 per share. These declines
reflect the continuing weakness in the US bond market, as the yield
on the 30-year Treasury bond, which had been below 5.5% in early
April, broke through the 6% barrier by late June.
Somerset Exchange Fund, June 30, 1999
At the Fund's inception, we initiated two loans in order to purchase
the $24 million in preferred stock as well as pay the Fund's initial
expenses. We borrowed $25 million based upon the three-month London
Interbank Offered Rate (LIBOR), and $3 million was borrowed on the
one-year LIBOR rate. The $25 million loan has been rolled over
quarterly since inception. On January 14, 1999, the quarterly rate
was reset at 5.6313% (5.0313% plus 0.60% margin), a decrease of
0.3125% from the October 14, 1998 rate, and on April 14, 1999 was
reset again at 5.600% (5.0000% plus 0.60% margin), a decline of an
additional 0.0313%. The annual loan rate was reset on July 13 at
6.38125% (5.78125% plus 0.60% margin), a decrease of 0.25% from the
prior year's annual rate of 6.63125% (6.03125% plus 0.60% margin).
Of the original $3 million loan, $2 million had been retired after
the Fund's first year of existence, and an additional $500,000 of
this loan was repaid on the July 1999 reset, thereby reducing the
Fund's indebtedness to the $25,000,000 quarterly loan and the
remaining $500,000 annual loan.
Also at inception the Fund entered into a fixed-for-floating rate
swap agreement with Goldman Sachs Financial Products (GSFP) on a
notional amount of $24 million. The Fund pays a fixed rate of 6.89%
(annualized) on the agreement and receives payments based on the
prevailing three-month LIBOR rate. At the January 15, 1999 reset of
the swap, the rate the Fund received from GSFP decreased to 5.030%,
which represented a decrease of 0.318% from the prior rate of 5.348%
effective on October 15, 1998. At the April 15, 1999 reset, this
rate declined an additional 0.03% to 5.000%. Thus, the interest rate
swap is accomplishing its intended objective of insulating the Fund
from income-related (but not principal-related) changes in the
interest rate being charged on its borrowed funds.
In Conclusion
We thank you for your investment in Somerset Exchange Fund, and we
look forward to updating you in our next report to shareholders.
Sincerely,
(Terry K. Glenn)
Terry K. Glenn
President
(Eric S. Mitofsky)
Eric S. Mitofsky
Senior Vice President and Portfolio Manager
August 13, 1999
Somerset Exchange Fund, June 30, 1999
<TABLE>
SCHEDULE OF INVESTMENT
<CAPTION>
Common Stock Shares Value Percent of
Sectors Industries Investments Held (Note 1a) Net Assets
<S> <S> <S> <C> <C> <C>
Basic Materials Aluminum ++MAXXAM Inc. 64,000 $ 4,128,000 3.5%
Chemicals E.I. du Pont de Nemours and Company 40,000 2,732,500 2.3
Chemicals--Diverse ++Airgas, Inc. 24,000 294,000 0.3
Paper & Forest Products Longview Fibre Company 29,140 455,312 0.4
Capital Goods Electrical Equipment ++AFC Cable Systems, Inc. 25,000 882,812 0.8
General Electric Company 27,942 3,157,446 2.7
Honeywell Inc. 5,715 662,226 0.6
Engineering & ++Jacobs Engineering Group Inc. 77,250 2,935,500 2.5
Construction
Manufacturing Dover Corporation 13,800 483,000 0.4
Pollution Control World Fuel Services Corporation 69,000 1,017,750 0.9
Consumer Auto Parts Bandag, Incorporated (Class A) 6,200 174,375 0.2
Cyclicals
Entertainment ++Pinnacle Systems, Inc. 120,000 4,035,000 3.4
The Walt Disney Company 87,000 2,680,687 2.3
Hotel/Motel ++Harrah's Entertainment, Inc. 40,000 880,000 0.7
++Park Place Entertainment Corporation 61,300 593,844 0.5
Household Furniture Bassett Furniture Industries,
& Appliances Incorporated 12,000 267,000 0.2
Leggett & Platt, Incorporated 86,000 2,391,875 2.0
Leisure Time ++Lakes Gaming, Inc. 15,325 167,617 0.1
Office Equipment IKON Office Solutions, Inc. 10,000 150,000 0.1
& Supplies
Publishing--Newspaper The Times Mirror Company (Class A) 11,330 671,303 0.6
Restaurants Bob Evans Farms, Inc. 50,000 993,750 0.8
Darden Restaurants, Inc. 18,605 405,822 0.3
McDonald's Corporation 8,510 351,569 0.3
++Rainforest Cafe, Inc. 22,500 113,906 0.1
Retail--General Casey's General Stores, Inc. 30,000 450,000 0.4
Merchandise
Retail--Specialty Amplicon, Inc. 125,000 1,750,000 1.5
++Office Depot, Inc. 72,000 1,588,500 1.3
Regis Corporation 30,000 575,625 0.5
++Sunglass Hut International, Inc. 12,000 206,250 0.2
Specialized Services ++Catalina Marketing Corporation 23,000 2,116,000 1.8
++Modis Professional Services, Inc. 30,600 420,750 0.4
Service Corporation International 12,000 231,000 0.2
The ServiceMaster Company 82,518 1,547,213 1.3
Textiles--Apparel Russell Corporation 19,900 388,050 0.3
Manufacturing
Consumer Beverages--Soft Drink The Coca-Cola Company 13,800 862,500 0.7
Staples Panamerican Beverages, Inc. `A' (US
Registered Shares) 28,000 666,750 0.6
Foods ++Agribrands International, Inc. 600 23,737 0.0
Archer-Daniels-Midland Company 11,999 185,235 0.2
General Mills, Inc. 4,000 321,500 0.3
H.J. Heinz Company 16,200 812,025 0.7
Ralston-Ralston Purina Group 18,000 547,875 0.5
Household Products The Procter & Gamble Company 22,162 1,977,959 1.7
Retail--Food Chains Albertson's, Inc. 7,500 386,719 0.3
++Safeway Inc. 24,000 1,188,000 1.0
Smart & Final Inc. 60,000 630,000 0.5
Tobacco Philip Morris Companies Inc. 41,013 1,648,210 1.4
UST Inc. 100,000 2,925,000 2.5
Energy Oil--International Exxon Corporation 33,000 2,545,125 2.2
</TABLE>
Somerset Exchange Fund, June 30, 1999
<TABLE>
SCHEDULE OF INVESTMENT (continued)
<CAPTION>
Common Stock Shares Value Percent of
Sectors Industries Investments Held (Note 1a) Net Assets
<S> <S> <S> <C> <C> <C>
Healthcare Healthcare-- Abbott Laboratories 75,370 $ 3,429,335 2.9%
Diversified Johnson & Johnson 19,600 1,920,800 1.6
Warner-Lambert Company 16,500 1,144,688 1.0
Healthcare--Drugs Pfizer Inc. 20,400 2,238,900 1.9
++Watson Pharmaceuticals, Inc. 200,000 7,012,500 6.0
Healthcare--HMOs ++MedPartners, Inc. 175,000 1,323,437 1.1
++Mid Atlantic Medical Services, Inc. 21,240 209,745 0.2
Healthcare-- ++Apria Healthcare Group Inc. 39,060 664,020 0.6
Miscellaneous ++Concentra Managed Care, Inc. 36,145 535,398 0.5
++Exogen, Inc. 35,000 74,375 0.1
++HEALTHSOUTH Corporation 113,730 1,698,842 1.4
++HEARx, Ltd. 60,000 26,250 0.0
Hospital Management ++Tenet Healthcare Corporation 25,000 464,063 0.4
Medical Products ++St. Jude Medical, Inc. 50,000 1,781,250 1.5
Interest Rate Banks--Money Center The Chase Manhattan Corporation 10,000 866,250 0.7
Sensitive
Banks--Regional First Union Corporation 8,400 394,800 0.3
Northern Trust Corporation 18,900 1,833,300 1.6
PNC Bank Corp. 18,860 1,086,807 0.9
Wells Fargo Company 21,000 897,750 0.8
Financial-- Bank One Corporation 38,451 2,290,238 1.9
Miscellaneous Forest City Enterprises, Inc. (Class A) 66,000 1,848,000 1.6
MFN Financial Corporation 108 1,039 0.0
MFN Financial Corporation (Series A)
(Warrants) (a) 126 189 0.0
MFN Financial Corporation (Series B)
(Warrants) (a) 126 126 0.0
MFN Financial Corporation (Series C)
(Warrants) (a) 126 126 0.0
SLM Holding Corporation 14,385 659,013 0.6
Insurance--Brokers Marsh & McLennan Companies, Inc. 13,200 996,600 0.8
Insurance--Multiline American International Group, Inc. 11,283 1,320,816 1.1
Insurance--Property The Commerce Group, Inc. 50,000 1,218,750 1.0
Savings & Loan CCB Financial Corporation 13,286 702,497 0.6
Washington Mutual, Inc. 84,672 2,995,272 2.5
Miscellaneous Miscellaneous ++Imation Corp. 286 7,096 0.0
Minnesota Mining and Manufacturing
Company (3M) 2,860 248,641 0.2
Technology Computer Software ++Informix Corporation 13,273 113,235 0.1
++Parametric Technology Corporation 14,000 194,250 0.2
++Sungard Data Systems Inc. 16,200 558,900 0.5
Computer Systems ++3Com Corporation 6,000 160,125 0.1
++The Cerplex Group, Inc. 5,350 4,347 0.0
Compaq Computer Corporation 31,500 746,156 0.6
Hewlett-Packard Company 16,000 1,608,000 1.4
International Business Machines
Corporation 26,000 3,360,500 2.9
Electronics-- ++GenRad, Inc. 25,000 520,312 0.4
Instruments
Electronics-- Intel Corporation 16,000 952,000 0.8
Semiconductors Motorola, Inc. 31,500 2,984,625 2.5
++Solectron Corporation 39,000 2,600,813 2.2
Telecommunications AT&T Corp. 12,300 686,494 0.6
Lucent Technologies Inc. 23,003 1,551,265 1.3
++MCI WorldCom Inc. 19,269 1,657,134 1.4
++NCR Corporation 512 24,992 0.0
Telecommuni- Utilities-- ALLTEL Corporation 35,000 2,502,500 2.1
cations Telecommunications ++Commonwealth Telephone Enterprises,
Inc. (Class B) 23,333 950,820 0.8
++RCN Corporation 70,000 2,913,750 2.5
Telephone and Data Systems, Inc. 11,300 825,606 0.7
</TABLE>
Somerset Exchange Fund, June 30, 1999
<TABLE>
SCHEDULE OF INVESTMENT (concluded)
<CAPTION>
Common Stock Shares Held/ Value Percent of
Sectors Industries Investments Face Amount (Note 1a) Net Assets
<S> <S> <S> <C> <C> <C>
Transportation Truckers ++FDX Corporation 13,760 $ 746,480 0.6%
++TransFinancial Holdings, Inc. 34,221 171,105 0.1
Utilities Utilities--Electric ++Citizens Utilities Company (Class B) 26,637 296,337 0.3
Total Investments in Common Stock 120,639,976 102.4
Preferred Stock Banks--Foreign Banesto Holdings (10.50%, Series A)* 476,786 13,469,204 11.4
Indosuez Holdings (10.375%, Series A)* 379,000 9,475,000 8.0
Total Investments in Preferred Stock 22,944,204 19.4
Short-Term Commercial Paper** General Motors Acceptance Corp.,
Securities 5.63% due 7/01/1999 $798,000 797,875 0.7
Total Investments in Short-Term Securities 797,875 0.7
Total Investments, at Value 144,382,055 122.5
Interest Rate Swaps (454,560) (0.4)
Liabilities in Excess of Other Assets (26,082,286) (22.1)
------------ ------
Net Assets $117,845,209 100.0%
============ ======
(a)Warrants entitle the Fund to purchase a predetermined number of
shares of Common Stock and are non-income producing. The purchase
price and number of shares are subject to adjustment under certain
conditions until the expiration date.
++Non-income producing security.
*The security may be offered and sold to "qualified institutional
buyers" under Rule 144A of the Securities Act of 1933.
**Commercial Paper is traded on a discount basis; the interest rate
shown reflects the discount rate paid at the time of purchase by the
Fund.
See Notes to Financial Statements.
</TABLE>
Somerset Exchange Fund, June 30, 1999
<TABLE>
STATEMENT OF ASSETS AND LIABILITIES
<CAPTION>
As of June 30, 1999
<S> <S> <C> <C>
Assets: Investments, at value (cost--$99,592,353) (Note 1a) $144,382,055
Dividends receivable 624,738
Prepaid expenses and other assets 1,824
------------
Total assets 145,008,617
------------
Liabilities: Loans (Note 5) 26,000,000
Interest rate swaps, at value (Notes 1b & 3) 454,560
Payables:
Interest on loans (Note 5) $ 365,906
Investment adviser (Note 2) 174,420
Interest rate swap contracts (Notes 1b & 3) 93,133
Administrator (Note 2) 58,140 691,599
------------
Accrued expenses and other liabilities 17,249
------------
Total liabilities 27,163,408
------------
Net Assets: Net assets $117,845,209
============
Net Assets Capital stock $ 74,376,585
Consist of: Undistributed investment income--net 890,763
Accumulated realized capital losses on investments--net (1,757,281)
Unrealized appreciation on investments--net 44,335,142
------------
Net assets--Equivalent to $783.98 per share based on 150,317
shares of beneficial interest outstanding $117,845,209
============
See Notes to Financial Statements.
</TABLE>
Somerset Exchange Fund, June 30, 1999
<TABLE>
STATEMENT OF OPERATIONS
<CAPTION>
For the Six Months Ended June 30, 1999
<S> <S> <C> <C>
Investment Dividends (net of $18,432 foreign withholding tax) $ 1,703,227
Income (Note 1d): Discount earned 17,255
------------
Total income 1,720,482
------------
Expenses: Loan interest expense (Note 5) $ 741,030
Investment advisory fees (Note 2) 341,069
Interest rate swap expense (Notes 1b & 3) 217,720
Organization expenses (Note 1e) 154,506
Administrative fees (Note 2) 113,690
Professional fees 64,532
Trustees' fees and expenses 6,582
Borrowing costs (Note 5) 4,525
Printing and shareholder reports 1,087
Other 1,036
------------
Total expenses 1,645,777
------------
Investment income--net 74,705
------------
Realized & Realized loss on investments--net (1,015,822)
Unrealized Change in unrealized appreciation on investments--net 4,699,574
Gain (Loss) on ------------
Investments--Net Net Increase in Net Assets Resulting from Operations $ 3,758,457
(Notes 1b, ============
1d & 3):
See Notes to Financial Statements.
</TABLE>
<TABLE>
STATEMENTS OF CHANGES IN NET ASSETS
<CAPTION>
For the
Six Months For the
Ended Year Ended
June 30, December 31,
Increase (Decrease) in Net Assets: 1999 1998
<S> <S> <C> <C>
Operations: Investment income--net $ 74,705 $ 497,766
Realized loss on investments--net (1,015,822) (600,802)
Change in unrealized appreciation on investments--net 4,699,574 10,716,120
------------ ------------
Net increase in net assets resulting from operations 3,758,457 10,613,084
------------ ------------
Distributions to Investment income--net (248,253) (232,671)
Shareholders Realized gain on investments--net (7,257) --
(Note 1f): ------------ ------------
Net decrease in net assets resulting from distributions
to shareholders (255,510) (232,671)
------------ ------------
Beneficial In-kind redemption of beneficial interest (1,753,388) (580,451)
Interest ------------ ------------
Transactions
(Note 4):
Net Assets: Total increase in net assets 1,749,559 9,799,962
Beginning of period 116,095,650 106,295,688
------------ ------------
End of period* $117,845,209 $116,095,650
============ ============
<FN>
*Undistributed investment income--net $ 890,763 $ 1,064,311
============ ============
See Notes to Financial Statements.
</TABLE>
Somerset Exchange Fund, June 30, 1999
<TABLE>
STATEMENT OF CASH FLOWS
<CAPTION>
For the Six Months Ended June 30, 1999
<S> <S> <C>
Cash Provided Net increase in net assets resulting from operations $ 3,758,457
by Operating Adjustments to reconcile net increase in net assets resulting from
Activities: operations to net cash provided by operating activities:
Decrease in receivables 32,598
Decrease in other assets 154,506
Increase in payables 33,449
Realized and unrealized gain on investments--net (3,683,752)
Amortization of discount (17,192)
------------
Net cash provided by operating activities 278,066
------------
Cash Used for Proceeds from sales and maturities of short-term investments 88,287,000
Investing Purchases of short-term investments (88,310,113)
Activities: ------------
Net cash used for investing activities (23,113)
------------
Cash Used for Distributions paid to shareholders (255,510)
Financing ------------
Activities: Net cash used for financing activities (255,510)
------------
Cash: Net decrease in cash (557)
Cash at beginning of period 557
------------
Cash at end of period $ --
============
Cash Flow Cash paid for interest $ 731,693
Information: ============
Non-Cash In-kind redemption of beneficial interest $ 1,753,388
Financing ============
Activities:
See Notes to Financial Statements.
</TABLE>
Somerset Exchange Fund, June 30, 1999
<TABLE>
FINANCIAL HIGHLIGHTS
<CAPTION>
For the For the
Six Period
The following per share data and ratios have been derived Months For the July 11,
from information provided in the financial statements. Ended Year Ended 1996++ to
June 30, December 31, Dec. 31,
Increase (Decrease) in Net Asset Value: 1999 1998 1997 1996
<S> <S> <C> <C> <C> <C>
Per Share Net asset value, beginning of period $ 760.86 $ 692.47 $ 516.04 $ 503.02
Operating Capital charge resulting from issuance of shares -- -- -- (3.02)
Performance: -------- -------- -------- --------
Net asset value, beginning of period, net of
capital charges 760.86 692.47 516.04 500.00
-------- -------- -------- --------
Investment income--net .58 3.29 3.18 2.01
Realized and unrealized gain on investments--net
(including discount for restricted securities) 24.22 66.62 173.25 14.03
-------- -------- -------- --------
Total from investments operations 24.80 69.91 176.43 16.04
-------- -------- -------- --------
Less distributions:
Investment income--net (1.63) (1.52) -- --
Realized gain on investments--net (0.05) -- -- --
-------- -------- -------- --------
Total distributions (1.68) (1.52) -- --
-------- -------- -------- --------
Net asset value, end of period $ 783.98 $ 760.86 $ 692.47 $ 516.04
======== ======== ======== ========
Total Investment Based on net asset value per share 3.28%+++ 10.10% 34.19% 2.59%+++
Return: ======== ======== ======== ========
Based on net asset value, net of capital charge 3.28%+++ 10.10% 34.19% 3.21%+++
======== ======== ======== ========
Ratios to Average Expenses, excluding interest expense 1.21%* .94% .94% 1.05%*
Net Assets: ======== ======== ======== ========
Expenses 2.90%* 2.71% 3.13% 3.78%*
======== ======== ======== ========
Investment income--net .13%* .46% .53% .87%*
======== ======== ======== ========
Supplemental Net assets, end of period (in thousands) $117,845 $116,096 $106,296 $ 79,315
Data: ======== ======== ======== ========
Portfolio turnover .00% .00% .00% .00%
======== ======== ======== ========
Leverage: Amount of borrowings outstanding, end of
period (in thousands) $ 26,000 $ 26,000 $ 26,000 $ 28,000
======== ======== ======== ========
Average amount of borrowings outstanding during
the period (in thousands) $ 26,000 $ 26,000 $ 27,047 $ 28,000
======== ======== ======== ========
Average amount of borrowings per share during
the period $ 170.76 $ 169.72 $ 175.89 $ 182.17
======== ======== ======== ========
<FN>
++Commencement of operations.
+++Aggregate total investment return.
*Annualized.
See Notes to Financial Statements.
</TABLE>
Somerset Exchange Fund, June 30, 1999
NOTES TO FINANCIAL STATEMENTS
1. Significant Accounting Policies:
Somerset Exchange Fund (the "Fund") is a Delaware business trust
registered under the Investment Company Act of 1940 as a
diversified, closed-end management investment company. The Fund's
financial statements are prepared in accordance with generally
accepted accounting principles, which may require the use of
management accruals and estimates. These unaudited financial
statements reflect all adjustments which are, in the opinion of
management, necessary to a fair statement of the results for the
interim period presented. All such adjustments are of a normal
recurring nature. Investments in the Fund were made by investors
contributing publicly-traded equity securities in exchange for
shares of beneficial interest in the Fund. Shares of beneficial
interest are illiquid unless and until shareholders vote to convert
the Fund into an open-end investment company (or, if appropriate, an
interval fund, which is a closed-end investment company that makes
scheduled periodic repurchase offers, if at that time redemptions in
kind are permissible). No present market exists for the shares of
beneficial interest and none is expected to develop. The Fund is not
listed on an exchange or otherwise regularly traded. No provision is
made initially for the Fund to provide liquidity through cash tender
offers or other means that may be available to closed-end investment
companies. The following is a summary of significant accounting
policies followed by the Fund.
(a) Valuation of securities--Securities for which market quotations
are readily available, including listed options and futures
contracts, are valued at their current market values in the
principal market on which such securities are normally traded. The
value of equity securities that are listed on the New York or
American Stock Exchanges or listed on the NASDAQ National Market
System are at the closing sale prices or, lacking any closing price,
the closing bid price. Equity securities that are not listed on the
New York or American Stock Exchanges but that are listed on any
other securities exchange are valued as if listed on the New York
Stock Exchange, providing the close of trading coincides. If the
close of trading on such securities exchange does not coincide with
the close of trading on the New York Stock Exchange, the value is
based on the latest available price data at the time of
determination of net asset value. Unlisted readily marketable equity
securities are valued at the bid price in the over-the-counter
market. Short-term securities are valued at amortized cost, which
approximates market value.
Pursuant to procedures authorized by the Trustees of the Fund, the
preferred stock holdings are valued at fair value as determined by
Merrill Lynch Asset Management, L.P. ("MLAM") or its designee, after
consideration of all relevant factors, data and information, which
include information from various firms with knowledge of such
issues, and the prices of comparable preferred stock issues.
Unlisted options and interest rate and equity swaps are valued at
their fair values determined in good faith by or on behalf of the
Trustees of the Fund.
(b) Derivative financial instruments--The Fund engages in various
portfolio strategies to seek to increase its return by hedging its
portfolio against adverse movements in the debt and equity markets.
Losses may arise due to changes in the value of the contract or if
the counterparty does not perform under the contract.
* Options--The Fund is authorized to write call options and purchase
put options. When the Fund writes an option, an amount equal to the
premium received by the Fund is reflected as an asset and an
equivalent liability. The amount of the liability is subsequently
marked to market to reflect the current market value of the option
written.
When a security is purchased or sold through an exercise of an
option, the related premium paid (or received) is added to (or
deducted from) the basis of the security acquired or deducted from
(or added to) the proceeds of the security sold. When an option
expires (or the Fund enters into a closing transaction), the Fund
realizes a gain or loss on the option to the extent of the premium
received or paid (or gain or loss to the extent the cost of the
closing transaction exceeds the premium paid or received). The Fund
does not expect to sell securities contributed by shareholders upon
exercise of written call options and purchased put options.
Written and purchased options are non-income producing investments.
* Financial futures contracts--The Fund may purchase or sell
financial futures contracts as a hedge against adverse changes in
interest rates and the stock market. A futures contract is an
agreement between two parties to buy and sell a security,
respectively, for a set price on a future date. Upon entering into a
contract, the Fund deposits and maintains as collateral such initial
margin as required by the exchange on which the transaction is
effected. Pursuant to the contract, the Fund agrees to receive from
or pay to the broker an amount of cash equal to the daily
fluctuation in value of the contract. Such receipts or payments are
known as variation margin and are recorded by the Fund as unrealized
gains or losses. When the contract is closed, the Fund records a
realized gain or loss equal to the difference between the value of
the contract at the time it was opened and the value at the time it
was closed.
* Interest rate swaps--The Fund is authorized to enter into interest
rate swaps and purchase or sell interest rate caps and floors. In an
interest rate swap, the Fund exchanges with another party their
respective commitments to pay or receive interest on a specified
notional principal amount. The purchase of an interest rate cap (or
floor) entitles the purchaser, to the extent that a specified index
exceeds (or falls below) a predetermined interest rate, to receive
payments of interest equal to the difference between the index and
the predetermined rate on a notional principal amount from the party
selling such interest rate cap (or floor).
(c) Income taxes--The Fund is treated as a partnership for federal
income tax purposes. As a partnership for federal income tax
purposes, the Fund does not incur federal income tax liability.
Items of partnership income, gain, loss and deduction pass through
to the shareholders as partners in the Fund.
Somerset Exchange Fund, June 30, 1999
(d) Security transactions and investment income--Interest income
(including amortization of discount) is recognized on the accrual
basis. Dividend income is recorded on the ex-dividend date. Realized
gains and losses on security transactions are determined on the
identified cost basis.
(e) Organization expenses--In accordance with Statement of Position
98-5, unamortized organization expenses of $154,506 were expensed on
January 1, 1999. This is considered to be a change in accounting
principle and had no material impact on the operations of the Fund.
(f) Distributions--Distributions of cash from investment income are
made at least annually in such amounts as the Trustees of the Fund
determine. Distributions of cash from realized capital gains are
made at least annually in years in which such gains are realized in
such amounts as the Trustees of the Fund determine. The Fund may
retain such investment income and realized capital gains in the
early years. The Fund does not offer a dividend reinvestment plan.
2. Investment Advisory Agreement and
Transactions with Affiliates:
The Fund has entered into an Investment Advisory Agreement with
MLAM. The general partner of MLAM is Princeton Services, Inc.
("PSI"), an indirect wholly-owned subsidiary of Merrill Lynch & Co.,
Inc. ("ML & Co."), which is the limited partner.
MLAM is responsible for the management of the Fund's portfolio and
provides the necessary personnel, facilities, equipment and certain
other services necessary to the operation of the Fund. For such
services, the Fund pays a quarterly fee of 0.60%, on an annual
basis, of the Fund's average weekly net assets. For this purpose,
"average weekly net assets" means the average weekly value of the
total assets of the Fund minus the sum of (i) accrued liabilities of
the Fund, and (ii) any accrued and unpaid interest on outstanding
borrowings.
The Fund has also entered into an Administration Agreement with
MLAM whereby MLAM provides or arranges for the provision of
administrative services (other than investment advice and related
portfolio activities) necessary for the operation of the Fund. Such
services include maintaining books and records and providing or
arranging for the provision on custody and transfer agency services.
For such services, the Fund pays a quarterly fee of 0.20%, on an
annual basis, of the Fund's average weekly net assets as defined
above.
MLAM has entered into a Sub-Administration Agreement with United
States Trust Company of New York ("US Trust") whereby US Trust
agrees to provide information and advice relating to securities
valuation and portfolio activities. For such services, MLAM pays US
Trust a quarterly fee of 0.05%, on an annual basis, of the Fund's
average weekly net assets as defined above. US Trust is compensated
directly by MLAM out of the administration fee at no additional cost
to the Fund.
MLAM has entered into a Shareholder Servicing Agreement with US
Trust whereby US Trust will provide or arrange for the provision of
shareholder reporting services. For such services, MLAM pays to US
Trust a quarterly fee of 0.15%, on an annual basis, of the Fund's
average weekly net assets, as defined above, multiplied by the
percentage of such assets (excluding any assets attributable to
borrowings by the Fund) attributable to shareholders of the Fund who
purchased their shares through a US Trust affiliate. US Trust is
compensated directly by MLAM at no additional cost to the Fund.
Certain officers and/or trustees of the Fund are officers and/or
directors of MLAM, PSI, or US Trust.
3. Investments:
Net realized losses for the six months ended June 30, 1999 and net
unrealized gains (losses) as of June 30, 1999 were as follows:
Realized Unrealized
Losses Gains (Losses)
Long-term investments $(1,015,822) $44,789,702
Interest rate swaps -- (454,560)
----------- -----------
Total $(1,015,822) $44,335,142
=========== ===========
The Fund has entered into the following interest rate swaps as of
June 30, 1999:
Interest Received Interest Paid
Notional Current Current Expiration
Amount Rate Type Rate Type Date
$24,000,000 5.0% Variable* 6.89% Fixed 7/15/2001
[FN]
*3-month LIBOR at reset date.
As of June 30, 1999, net unrealized appreciation for Federal income
tax purposes aggregated $111,624,515, all of which related to
appreciated securities. The aggregate cost of investments at June
30, 1999 for Federal income tax purposes was $32,757,540.
4. Beneficial Interest Transactions:
Shares issued and outstanding decreased by approximately 2,267 and
919 for the six months ended June 30, 1999 and the year ended
December 31, 1998, respectively, as a result of in-kind redemptions.
5. Short-Term Borrowings:
On July 11, 1996, the Fund entered into a loan commitment in the
amount of $35,000,000 with Merrill Lynch International Bank Limited,
an indirect wholly-owned subsidiary of ML & Co. For this commitment,
the Fund pays .10% on any unused balance. For the six months ended
June 30, 1999, the average amount borrowed was $26,000,000 and the
daily weighted average interest rate was 5.75%. For the six months
ended June 30, 1999, facility and commitment fees aggregated
approximately $4,500.
Somerset Exchange Fund, June 30, 1999
THE BENEFITS AND RISKS OF LEVERAGING
Somerset Exchange Fund utilizes leverage through borrowings.
Investing borrowed money creates an opportunity for the Fund to be
more broadly invested and to earn higher investment returns.
However, investing borrowed money is a speculative technique that
creates risks, including the likelihood of greater net asset value
volatility. Interest rate fluctuations could negatively impact the
Fund's net asset value. In addition, if the income derived from
securities purchased with assets received from the borrowings is not
sufficient to cover the cost of leverage, the Fund's net income will
be less than if leverage had not been used. As prescribed by the
Investment Company Act of 1940, the Fund has specified asset
coverages of at least 300% with respect to any borrowing immediately
following any such borrowing. Loan agreements may contain other
requirements that could limit distributions or require the Fund to
dispose of portfolio investments on unfavorable terms if market
fluctuations or other factors reduce the required asset coverage to
less than the prescribed amount. In the event of a default, the
lender could elect to foreclose on any assets pledged as collateral
without regard to the tax or other consequences of such action on
either any shareholder who contributed a particular security or on
shareholders generally.
Somerset Exchange Fund, June 30, 1999
OFFICERS AND TRUSTEES
Individual Trustees
Terry K. Glenn
Jack B. Sunderland
Stephen B. Swensrud
J. Thomas Touchton
David Fann
Officers
Terry K. Glenn, President
Robert C. Doll, Senior Vice President
Eric S. Mitofsky, Senior Vice President and Portfolio Manager
Donald C. Burke, Vice President and Treasurer
Robert E. Putney, III, Secretary
Somerset Exchange Fund
800 Scudders Mill Road
Plainsboro, NJ 08536
Investment Adviser, Adviser Trustee and Administrator
Merrill Lynch Asset Management, L.P.
800 Scudders Mill Road
Plainsboro, NJ 08536
(609) 282-2800
Sub-Administrator
United States Trust Company of New York
114 West 47th Street
New York, NY 10036
Custodian
The Chase Manhattan Bank, N.A.
Mutual Funds Service Division
770 Broadway
New York, NY 10003-9598
Transfer Agent
Chase Global Funds Services Company
73 Tremont Street
Boston, MA 02108-3913
Placement Agent
Merrill Lynch & Co.
Selected Dealer
UST Financial Services Corp.
Legal Counsel
Brown & Wood LLP
Independent Auditors
Deloitte & Touche LLP
