FIXED INCOME FUND
SEMI-ANNUAL REPORT
IAI INSTITUTIONAL BOND FUND
MAY 31, 1996
[LOGO] IAI
MUTUAL FUNDS
- OUTSIDE FRONT COVER -
BLANK
- INSIDE FRONT COVER -
TABLE OF CONTENTS
IAI INSTITUTIONAL BOND FUND
SEMI-ANNUAL REPORT
May 31, 1996
(unaudited)
Chairman's Letter 2
Fund Managers' Review 4
Fund Portfolio 6
Notes to Fund Portfolio 11
Statement of Assets and Liabilities 13
Statement of Operations 14
Statements of Changes in Net Assets 15
Financial Highlights 16
Notes to Financial Statements 17
Shareholder Update 21
IAI Mutual Fund Family 22
Adviser, Custodian, Legal Counsel,
Independent Auditors,
Directors Inside Back Cover
-1-
CHAIRMAN'S LETTER
IAI INSTITUTIONAL BOND FUND
INVESTING FOR INCOME
[PHOTO]
NOEL P. RAHN,
CHAIRMAN
Because of rising interest rates, the bond market has been volatile during the
past six months. But we think that the future looks promising for bonds.
Currently, the yield on the benchmark 30-year U.S. Treasury bond has risen above
7 percent. Corporate bonds and mortgage-backed securities offer even more. But
inflation is still just 3 percent. Historically, that's considered a very
healthy "real" return.
To be sure, inflation is not dead. The economy has accelerated rapidly since
last winter. The Gross Domestic Product advanced from less than one percent in
the fourth quarter of 1995 to nearly 4 percent by the second quarter of 1996.
The economy is fast approaching full capacity. Upward pressure on wages is
building. And, as you probably are aware, gasoline and food prices increased
sharply. If the economy continues to accelerate and inflation fears stay
kindled, then there will continue to be pressure on the bond market.
Keep in mind that your bond fund's total return is really the sum of two
parts--its income and its change in Net Asset Value (NAV). In a period of rising
interest rates, a bond fund's NAV usually falls. So if you're holding a bond
that pays 7 percent and interest rates rise to 8 percent, then the value of your
bond has diminished, at least temporarily. And the longer your bond's maturity,
the more the bond goes down in value. We've been managing our bond portfolios in
such a way as to minimize price declines when interest rates rise. But even
though your fund's net asset value goes down, the income paid to you may remain
constant or actually increase.
In contrast, when interest rates fall, your fund's NAV goes up. Since movements
in interest rates tend to be cyclical, so too will your fund's NAV. That's why
it's important not to sell just because of a fall in NAV.
Although the stock market gets all the attention of investors, bonds still have
an important place in the portfolios of a substantial segment of the investing
public, particularly those who are approaching retirement. And these days, bonds
are offering more income than they have in a long time.
-2-
Chairman's Letter
IAI Institutional Bond Fund
ECONOMIC OUTLOOK
Larry Hill, IAI's Chief Fixed Income Officer, provides his economic outlook
below.
Although we don't expect inflation to rise above 3% in 1996, we are more
concerned about rising prices in 1997. We are now in the sixth year of a modest,
but persistent expansion. A persistent expansion uses up economic capacity,
eventually putting upward pressure on prices. Monetary policy has been
accommodative over the last year, providing ample fuel for higher prices if the
economy runs out of adequate capacity. So far, the economy has not exceeded its
capacity ceiling. However, with a capacity utilization rate of 83% and an
unemployment rate of 5.3%, a modest growth acceleration could push these rates
over their limits. If the economy grows at a 3.5% rate instead of a 2.5% rate,
then there will be pressure on capacity and wages.
Another reason that we are concerned about inflation is that we have reached the
end of the trend toward corporate downsizing. Management techniques such as
just-in-time deliveries, reengineering, and layoffs have helped to make US
businesses the most competitive in the world. However, these practices have
created a business environment with very little cushion in the system to meet
unexpected increases in demand. As the economy grows, businesses eventually have
to hire more employees. If that becomes the case, the unemployment rate over the
next 12 months is going to go a lot lower, and there will be wage pressures--not
because of union demands, but because of supply and demand.
Economic growth in the second and third quarter should average about 3.5%. Much
of this will be inventory replenishment which should subside by the fourth
quarter. For the full year real GDP should expand by slightly under 3%.
Inflation will not be a problem this year, but as the expansion ages in 1997
higher prices are inevitable.
Please read the Fund Managers' Reviews, which follow this letter, for a detailed
perspective on the Fund's performance and our strategy going forward. We
appreciate your continued trust and confidence in IAI. If there is any way we
can serve you better, please let us know by calling our toll-free Investor
Services Hotline at 1-800-945-3863.
Sincerely,
/s/ Noel P. Rahn
Noel P. Rahn
Chairman
-3-
Fund Managers' Review
IAI Institutional Bond Fund
IAI INSTITUTIONAL BOND FUND
[PHOTO]
LARRY R. HILL, CFA
IAI INSTITUTIONAL BOND FUND CO-MANAGER
[PHOTO]
TIMOTHY A. PALMER, CFA
IAI INSTITUTIONAL BOND FUND CO-MANAGER
[PHOTO]
SCOTT A. BETTIN, CFA
IAI INSTITUTIONAL BOND FUND CO-MANAGER
FUND OBJECTIVE
The IAI Institutional Bond Fund's objective is to provide a high level of total
return derived from a combination of capital appreciation and current income.
This objective is pursued by investing in a diversified portfolio of high
quality bonds. The Fund invests in a variety of maturities and sectors which are
varied depending on relative values in the marketplace at a given point in time.
FUND POSITIONING FOR THE PAST SIX MONTHS
For the six months ended May 31, 1996, the IAI Institutional Bond Fund realized
a total return of (1.56%). In contrast, the Salomon Broad Investment Grade Bond
Index, an unmanaged benchmark, realized a total return of (1.17%).
In the beginning of 1996, a partial government shutdown combined with severe
winter weather depressed economic activity. On January 31, the Federal Reserve
Board lowered short-term interest rates from 5.50% to 5.25% in response to
recession fears. However, the economy regained most of its momentum by the end
of the first quarter, and bond prices sagged in response to this shift.
Intermediate and long-term interest rates began rising sharply. Between November
30, 1995 and May 31, 1996, the yield of ten-year Treasury notes rose from 6.13%
to 7.00%. During this period of steadily rising interest rates, market returns
were negative in four out of those six months.
Given this backdrop, our initial strategy was to maintain a benchmark neutral
duration with a position focused on an increasingly positively sloped yield
curve. As a result, we emphasized weightings in the middle part of the yield
curve. Toward the end of the quarter, we moved to a more neutral yield curve
strategy.
Over the past six months, we have biased the portfolio away from Treasuries and
toward corporate bonds, asset-backed issues and mortgage securities. Within the
corporate sector, we increased the weighting of investment grade holdings while
maintaining a maximum commitment to high yield issues.
In the Fund, we have used issue-specific strategies to enhance return. Such
strategies include an overweighting in insurance company surplus notes and
media/ telecommunications companies including Prudential Insurance and
Continental Cable. In addition, we have used strategies to add convexity such as
investing in 100-year bonds. Holdings include Columbia/HCA, the large hospital
management company and ABN-AMRO, the largest bank in the Netherlands. These
100-year bonds offer a substantial amount of additional yield and very positive
convexity with little additional risk.
OUTLOOK
After a sharp increase in interest rates, we believe that the bond market will
rally in the summer months before resuming a rising yield trend in the fall. The
yield curve is likely to steepen in the rally, but flatten later in the year as
investors anticipate tightening by the Federal Reserve Board.
Although yield spreads are not as attractive as they were earlier in the year,
investment grade as well as high yield corporate bonds will continue to offer
fair value based upon stable to improving credit quality. In addition, our
strategy will emphasize mortgage securities and well structured asset-backed
issues secured by credit card and automobile receivables. We will likely
underweight Treasuries.
The Fund's duration has been neutral with its benchmark during the six month
period. We believe that the bond market has improved in terms of value with
yields going above 7% and we may use some extension trades to take advantage of
shifts in momentum. Despite the cyclical risk we see for bonds during the next
six to twelve months, the secular trends remain favorable.
-4-
FUND MANAGERS' REVIEW
IAI INSTITUTIONAL BOND FUND
VALUE OF $2,000,000 INVESTMENT+
IAI INSTITUTIONAL BOND FUND SALOMON BROAD INVESTMENT
INCEPTION (11-01-93) GRADE BOND INDEX
11/01/93 $1,969,914 $1,983,200
11/30/93 $1,983,107 $1,994,306
11/30/94 $1,885,303 $1,922,902
11/30/95 $2,167,191 $2,265,744
5/31/96 $2,133,396 $2,239,127
AVERAGE ANNUAL RETURNS+
Through 5/31/96
<TABLE>
<CAPTION>
Since Inception*
Six Months* 1 Year 11/01/93
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C>
IAI Institutional Bond Fund (1.56%) 2.36% 2.54%
..........................................................................................
Salomon Broad Investment Grade Bond Index (1.17%) 4.37% 4.47%
</TABLE>
+ Past performance is not predictive of future performance
* Not annualized
SECTORS
% of Portfolio as of 5/31/96
[PIE CHARTS]
FOREIGN
DENOMINATED 3%
ASSET-BACKED 7%
U.S. GOVERNMENT
AGENCY
MORTGAGE-BACKED 29%
PREFERRED
STOCK 1%
U.S. GOVERNMENT &
GOVERNMENT AGENCY 16%
CORPORATE 36%
SHORT-TERM 8%
EFFECTIVE MATURITY
% of Portfolio as of 5/31/96
[BAR GRAPH]
YEARS
0-3 20%
3-5 5%
5-10 30%
10-20 28%
20+ 17%
NOTE TO CHAIRMAN'S LETTER & FUND MANAGERS' REVIEW
PERFORMANCE DATA FOR THE IAI INSTITUTIONAL BOND FUND INCLUDES CHANGES IN SHARE
PRICE AND REINVESTMENT OF ALL DIVIDENDS AND CAPITAL GAINS. PAST PERFORMANCE IS
NOT A GUARANTEE OF FUTURE RESULTS. THE FUND'S INVESTMENT RETURN, YIELD AND
PRINCIPAL MAY FLUCTUATE, SO THAT WHEN REDEEMED, SHARES MAY BE WORTH MORE OR LESS
THAN THE ORIGINAL COST. MORE COMPLETE INFORMATION ABOUT THE FUND, INCLUDING
CHARGES AND EXPENSES, IS AVAILABLE IN THE PROSPECTUS. PLEASE READ THE FUND'S
PROSPECTUS CAREFULLY BEFORE INVESTING. ALL INDICES CITED ARE UNMANAGED, AND ARE
EITHER TRADEMARKS, REGISTERED TRADEMARKS OR COPYRIGHTS OF THEIR RESPECTIVE
SPONSORING COMPANIES.
CREDIT RATING
% of Portfolio as of 5/31/96
U.S.
Government.........55%
Aaa.................6%
Aa..................5%
A..................11%
Baa.................9%
Non-Investment
Grade..............14%
-5-
FUND PORTFOLIO
IAI INSTITUTIONAL BOND FUND
<TABLE>
<CAPTION>
May 31, 1996
(percentage figures indicate percentage of total net assets)
(unaudited)
CORPORATE BONDS - 37.0%
Principal Market
Rate Maturity Amount Value (a)
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
ENERGY MINERALS - 6.3%
Ferrellgas Partners (f) 9.38% 06/15/06 $ 500,000 $ 488,750
Mitchell Energy 9.25 01/15/02 4,025,000 4,209,587
Triton Energy (step bond) 9.33 (c) 12/15/00 1,500,000 1,443,750
----------------
6,142,087
- ----------------------------------------------------------------------------------------------------------------
FINANCIAL - 10.7%
ABN-AMRO Bank 7.12 10/15/93 2,700,000 2,417,904
Continental 8.38 08/15/12 2,750,000 2,816,302
Nationwide Trust (f) 9.88 02/15/25 2,000,000 2,168,520
Prudential Insurance (f) 8.30 07/01/25 2,000,000 1,974,840
Salomon 6.75 02/15/03 1,250,000 1,184,562
----------------
10,562,128
- ----------------------------------------------------------------------------------------------------------------
INDUSTRIAL - 14.8%
360 Communications 7.50 03/01/06 115,000 108,168
Auburn Hills Trust 12.00 05/01/20 2,100,000 3,011,631
Columbia/HCA Healthcare 7.50 11/15/95 1,670,000 1,563,721
Continental Cablevision 8.88 09/15/05 1,000,000 1,045,000
Continental Cablevision 8.30 05/15/06 1,500,000 1,515,000
Dayton Hudson 10.00 01/01/11 2,290,000 2,679,643
Dimon 8.88 06/01/06 750,000 760,312
Federated Department Stores 8.50 06/15/03 1,500,000 1,500,000
HomeSide (f) 11.25 05/15/03 500,000 506,250
RJR Nabisco 8.00 07/15/01 1,000,000 987,430
Valassis Communication 9.55 12/01/03 900,000 904,486
----------------
14,581,641
- ----------------------------------------------------------------------------------------------------------------
UTILITIES - 3.5%
Commonwealth Edison 8.38 10/15/06 2,000,000 2,076,060
Long Island Lighting 7.85 05/15/99 1,350,000 1,337,243
----------------
3,413,303
- ----------------------------------------------------------------------------------------------------------------
YANKEE - 1.7%
Korea Electric Power (step bond) 7.23 (c) 04/01/96 2,350,000 320,564
Tenaga Nasional 7.50 01/15/96 1,500,000 1,346,685
----------------
1,667,249
================================================================================================================
TOTAL INVESTMENTS IN CORPORATE BONDS
(COST: $37,089,002) $ 36,366,408
================================================================================================================
</TABLE>
See accompanying Notes to Fund Portfolio
-6-
FUND PORTFOLIO
IAI INSTITUTIONAL BOND FUND
May 31, 1996
(unaudited)
<TABLE>
<CAPTION>
U.S. GOVERNMENT & GOVERNMENT AGENCY OBLIGATIONS - 16.5%
Principal Market
Rate Maturity Amount Value (a)
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. TREASURY NOTES - 10.0%
5.63% 10/31/97 $ 1,000,000 $ 994,060
7.88 04/15/98 1,420,000 1,460,825
6.00 05/31/98 2,500,000 2,488,675
5.13 11/30/98 3,210,000 3,119,702
7.12 09/30/99 280,000 284,945
5.75 10/31/00 1,590,000 1,537,578
--------------
9,885,785
- -----------------------------------------------------------------------------------------------------------------
U.S. TREASURY BOND - 3.4%
8.13 08/15/19 3,030,000 3,346,726
- -----------------------------------------------------------------------------------------------------------------
GOVERNMENT AGENCY OBLIGATION - 3.1%
Fico Strip 7.04 (b) 05/11/06 6,200,000 3,013,882
=================================================================================================================
TOTAL INVESTMENTS IN U.S. GOVERNMENT & GOVERNMENT AGENCY OBLIGATIONS
(COST: $16,511,550) $ 16,246,393
=================================================================================================================
U.S. GOVERNMENT AGENCY MORTGAGE-BACKED SECURITIES - 30.0%
PRINCIPAL MARKET
RATE MATURITY AMOUNT VALUE (A)
- -----------------------------------------------------------------------------------------------------------------
FEDERAL HOME LOAN MORTGAGE CORPORATION - 2.1%
10.50% 11/01/00 $ 1,454,951 $ 1,530,870
10.50 02/01/04 478,066 504,962
8.00 08/01/08 67,849 69,073
--------------
2,104,905
- -----------------------------------------------------------------------------------------------------------------
FEDERAL NATIONAL MORTGAGE ASSOCIATION - 4.7%
6.50 02/01/26 5,004,830 4,637,275
- -----------------------------------------------------------------------------------------------------------------
FEDERAL NATIONAL MORTGAGE ASSOCIATION DWARFS - 1.6%
6.00 05/01/11 1,633,500 1,531,407
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying Notes to Fund Portfolio
-7-
FUND PORTFOLIO
IAI INSTITUTIONAL BOND FUND
May 31, 1996
(unaudited)
<TABLE>
<CAPTION>
U.S. GOVERNMENT AGENCY MORTGAGE-BACKED SECURITIES (CONT.)
Principal Market
Rate Maturity Amount Value (a)
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION - 21.6%
8.00% 09/15/08 $ 564,300 $ 579,113
8.00 11/15/17 2,903,708 2,940,615
9.00 11/15/17 2,669,788 2,835,075
9.00 12/15/17 5,147,343 5,466,015
6.50 09/15/23 64,657 59,686
6.50 10/15/23 558,812 516,547
6.50 11/15/23 939,011 868,328
7.00 12/15/23 1,485,000 1,413,070
6.50 12/15/23 2,274,130 2,100,780
6.50 01/15/24 2,944,705 2,721,357
6.50 04/15/24 794,961 733,844
6.50 06/15/24 1,030,726 951,484
-----------------
21,185,914
=================================================================================================================
TOTAL INVESTMENTS IN U.S. GOVERNMENT AGENCY MORTGAGE-BACKED SECURITIES
(Cost: $29,660,956) $ 29,459,501
=================================================================================================================
ASSET-BACKED SECURITIES - 7.4%
Principal Market
Rate Maturity Amount Value (a)
- -----------------------------------------------------------------------------------------------------------------
AUTO LOAN RELATED - 2.9%
Chase Manhattan Grantor Trust 95-A A 6.00% 09/17/01 $ 939,674 $ 937,128
Daimler-Benz Auto Grantor Trust 95-A A 5.85 05/15/02 93,910 93,475
Ford Credit Grantor Trust 95-B A 5.90 10/15/00 1,816,315 1,804,310
-----------------
2,834,913
- -----------------------------------------------------------------------------------------------------------------
CREDIT CARD RELATED - 4.5%
Chemical Master Credit Card Trust I 96-3 A 7.09 02/15/09 2,900,000 2,856,500
Dayton Hudson Credit Card Master Trust 95-1 A 6.10 02/25/02 1,590,000 1,575,960
-----------------
4,432,460
=================================================================================================================
TOTAL INVESTMENTS IN ASSET-BACKED SECURITIES
(COST: $7,337,157) $ 7,267,373
=================================================================================================================
</TABLE>
See accompanying Notes to Fund Portfolio
- 8-
FUND PORTFOLIO
IAI INSTITUTIONAL BOND FUND
May 31, 1996
(unaudited)
<TABLE>
<CAPTION>
FOREIGN DENOMINATED BONDS - 2.8%
Principal Market
Rate Maturity Amount (e) Value (a)
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
SUPRA-NATIONAL BOND - 2.8%
International Bank for Reconstruction and
Development (Japanese yen) 4.75% 12/20/04 260,000,000 $ 2,710,397
==================================================================================================================
TOTAL INVESTMENTS IN FOREIGN DENOMINATED BONDS
(Cost: $3,008,176) $ 2,710,397
==================================================================================================================
NON-CONVERTIBLE PREFERRED STOCK - 1.1%
Market
Rate Quantity Value (a)
- ------------------------------------------------------------------------------------------------------------------
FINANCIAL - 0.1%
Grand Metro Delaware Series A 9.42% 4,380 $ 119,355
- ------------------------------------------------------------------------------------------------------------------
INDUSTRIAL - 1.0%
Cablevision Systems Series L (PIK) (f) 11.13 (c) 10,000 970,000
==================================================================================================================
TOTAL INVESTMENTS IN NON-CONVERTIBLE PREFERRED STOCK
(COST: $1,088,129) $ 1,089,355
==================================================================================================================
TOTAL INVESTMENTS IN LONG-TERM SECURITIES
(COST: $94,694,970) $ 93,139,427
==================================================================================================================
</TABLE>
See accompanying Notes to Fund Portfolio
-9-
FUND PORTFOLIO
IAI INSTITUTIONAL BOND FUND
May 31, 1996
(unaudited)
<TABLE>
<CAPTION>
SHORT-TERM SECURITIES - 7.7%
Principal Market
Rate Maturity Amount Value (a)
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U. S. GOVERNMENT AND GOVERNMENT AGENCY OBLIGATIONS - 7.7%
Federal Home Loan Corporation (discount notes) 5.21% 06/12/96 $ 1,000,000 $ 998,408
5.21 06/14/96 1,085,000 1,082,959
5.23 06/20/96 3,000,000 2,991,727
Federal Home Loan Association (discount note) 5.21 06/18/96 2,000,000 1,995,079
U. S. Treasury Bill 5.21 08/08/96 500,000 (d) 495,435
--------------
7,563,608
==================================================================================================================
TOTAL INVESTMENTS IN SHORT-TERM SECURITIES
(COST: $7,563,409) $ 7,563,608
==================================================================================================================
TOTAL INVESTMENTS IN SECURITIES
(COST: $102,258,379) (g) $ 100,703,035
==================================================================================================================
OTHER ASSETS & LIABILITIES (NET) - (2.5%)
$ (2,511,660)
==================================================================================================================
TOTAL NET ASSETS
$ 98,191,375
==================================================================================================================
</TABLE>
See accompanying Notes to Fund Portfolio
- 10-
NOTES TO FUND PORTFOLIO
IAI INSTITUTIONAL BOND FUND
May 31, 1996
(unaudited)
(a)
Market value of securities is determined as described in Note 1 to the financial
statements, under "Security Valuation."
(b)
Interest rate shown represents yield-to-maturity at date of purchase.
(c)
The interest rate shown for step bonds and payment-in-kind securities represents
effective yield at May 31, 1996, based upon the estimated timing and amount of
future interest and principal payments.
PIK - Payment-in-Kind income is generally paid by issuing additional par
or shares of the security rather than paying cash.
Step bond - Securities that remain zero-coupon until a predetermined date at
which time the stated coupon rate becomes payable at regular
intervals.
(d)
Security is partially pledged to cover initial margin on open futures contracts
(see Note 5 to the financial statements).
(e)
Foreign security cost and market values are stated in U.S. dollars. Principal
amounts are denominated in the foreign currency indicated parenthetically.
(f)
Represents security sold within terms of a private placement memorandum exempt
from registration under Section 144A of the Securities Act of 1933. These issues
may only be sold to other qualified institutional buyers, and are considered
liquid under guidelines established by the Board of Directors.
(g)
At May 31, 1996, the cost of securities for federal income tax purposes and the
aggregate gross unrealized appreciation and depreciation based on that cost were
as follows:
Cost for federal income tax purposes $ 102,258,379
=================
Gross unrealized appreciation $ 445,986
Gross unrealized depreciation (2,001,330)
-----------------
Net unrealized depreciation $ (1,555,344)
=================
-11-
(THIS PAGE INTENTIONALLY LEFT BLANK)
-12-
STATEMENT OF ASSETS AND LIABILITIES
IAI INSTITUTIONAL BOND FUND
May 31, 1996
(unaudited)
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C>
ASSETS
Investments in securities, at market
(Cost: $102,258,379) (see Fund Portfolio) $ 100,703,035
Cash denominated in foreign currency (Cost: $131) 131
Receivable for investment securities sold 6,316,944
Accrued interest receivable 1,127,603
Other 10,310
----------------
Total assets 108,158,023
================
LIABILITIES
Disbursements in excess of cash on demand deposit 21,856
Payable for investment securities purchased 9,905,342
Accrued management fee 39,450
----------------
Total liabilities 9,966,648
----------------
Net assets applicable to outstanding capital stock $ 98,191,375
================
REPRESENTED BY:
Capital stock $ 108,992
Additional paid-in capital 102,231,746
Undistributed net investment income 429,281
Accumulated net realized losses on investments (3,100,327)
Unrealized appreciation (depreciation) on:
Investment securities $ (1,477,219)
Other assets and liabilities denominated in foreign currency (1,098)
------------- (1,478,317)
----------------
Total - representing net assets applicable to outstanding capital stock $ 98,191,375
================
Shares of capital stock outstanding; authorized 10 billion shares
of $0.01 par value stock 10,899,201
Net asset value per share of outstanding capital stock $ 9.01
================
</TABLE>
See accompanying Notes to Financial Statements
- 13-
STATEMENT OF OPERATIONS
IAI INSTITUTIONAL BOND FUND
<TABLE>
<CAPTION>
Six months ended May 31, 1996
(unaudited)
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C>
NET INVESTMENT INCOME
Income:
Interest (net of foreign income taxes withheld of $6,242) $ 3,425,230
Dividends 95,118
-------------
Total income 3,520,348
-------------
Expenses:
Management fees 249,850
Compensation of Directors 1,396
-------------
Total expenses 251,246
Less fees waived by Advisers (1,396)
-------------
Net expenses 249,850
-------------
Net investment income 3,270,498
-------------
NET REALIZED AND UNREALIZED GAINS (LOSSES)
Net realized gains (losses) on:
Investment securities $ (545,479)
Foreign currency transactions 21,595
Futures contracts (215,287)
----------- (739,171)
Net change in unrealized appreciation or depreciation on:
Investment securities $(4,125,788)
Other assets and liabilities denominated in foreign currency 35,647
Futures contracts 78,125
----------- (4,012,016)
-------------
Net loss on investments and foreign currency (4,751,187)
-------------
Net decrease in net assets resulting from operations $ (1,480,689)
=============
</TABLE>
See accompanying Notes to Financial Statements
-14-
STATEMENTS OF CHANGES IN NET ASSETS
IAI INSTITUTIONAL BOND FUND
<TABLE>
<CAPTION>
Six months ended Year ended
May 31, 1996 November 30, 1995
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C>
OPERATIONS (unaudited)
Net investment income $ 3,270,498 $ 6,045,626
Net realized gains (losses) (739,171) 1,325,599
Net change in unrealized appreciation or depreciation (4,012,016) 4,993,096
--------------------------------------------
Net increase (decrease) in net assets resulting
from operations (1,480,689) 12,364,321
--------------------------------------------
DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income (3,741,896) (6,077,806)
--------------------------------------------
Total distributions (3,741,896) (6,077,806)
--------------------------------------------
CAPITAL SHARE TRANSACTIONS
Net proceeds from sale of 1,658,777 and 3,431,177 shares 15,310,712 31,579,054
Net asset value of 401,673 and 657,760 shares issued to
shareholders in reinvestment of distributions 3,741,896 6,059,953
Cost of 1,837,846 and 1,742,824 shares redeemed (17,067,560) (16,220,253)
--------------------------------------------
Increase in net assets from capital share transactions 1,985,048 21,418,754
--------------------------------------------
Total increase (decrease) in net assets (3,237,537) 27,705,269
Net assets at beginning of period 101,428,912 73,723,643
--------------------------------------------
Net assets at end of period $ 98,191,375 $ 101,428,912
(including undistributed net investment income ============================================
of $429,281 and $900,679)
</TABLE>
See accompanying Notes to Financial Statements
- 15-
FINANCIAL HIGHLIGHTS
IAI INSTITUTIONAL BOND FUND
Per share data for a share of capital stock outstanding
throughout each period and selected information for
each period indicated are as follows:
<TABLE>
<CAPTION>
Year ended Period from Period From
Six months ended November 30, April 1, 1994 to November 1, 1993***
May 31,1996 1995 November 30, 1994+ to March 31, 1994
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
NET ASSET VALUE (unaudited)
Beginning of period $ 9.50 $ 8.85 $ 9.36 $ 10.00
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OPERATIONS
Net investment income .30 .62 .38 .22
Net realized and unrealized losses (.44) .66 (.51) (.65)
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Total from operations (.14) 1.28 (.13) (.43)
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DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income (.35) (.63) (.38) (.21)
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Total distributions (.35) (.63) (.38) (.21)
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Net Asset Value
End of period $ 9.01 $ 9.50 $ 8.85 $ 9.36
===========================================================================
Total investment return* (1.56%) 14.95% (1.44%) (4.35%)
Net assets at end of period
(000's omitted) $ 98,191 $ 101,429 $ 73,724 $ 31,478
RATIOS
Expenses to average daily net assets 0.50%** 0.50% 0.50%** 0.50%**
Net investment income to average
daily net assets 6.56%** 6.76% 6.42%** 5.84%**
Portfolio turnover rate
(excluding short-term securities) 159.6% 358.8% 235.1% 127.1%
</TABLE>
* Total investment return is based on the change in net asset value of a
share during the period and assumes reinvestment of all distributions
at net asset value.
** Annualized
*** Commencement of operations
+ Reflects year-end change from March 31 to November 30.
-16-
NOTES TO FINANCIAL STATEMENTS
IAI INSTITUTIONAL BOND FUND
May 31, 1996
(unaudited)
[1] SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The IAI Mutual Funds are registered under the Investment Company Act of 1940 (as
amended) as diversified, open-end management investment companies. IAI
Institutional Bond Fund is a separate portfolio of IAI Investment Funds I, Inc.,
and commenced operations on November 1, 1993. The Fund's primary objective is to
provide a high level of current income consistent with capital preservation
through investment in primarily investment grade bonds and other debt securities
of similar high quality. This report covers only the IAI Institutional Bond Fund
(the Fund).
Significant accounting policies followed by the Fund are summarized below:
SECURITY VALUATION
Investments in securities traded on national or international securities
exchanges are valued at the last reported sales price at the close of each
business day. Securities traded on the over-the-counter market are valued at the
last reported sales price or if the last sales price is not available, the last
reported bid price is used.
Debt securities for which quotations are not readily available are valued
primarily using dealer-supplied valuations or at their fair value as determined
in good faith using consistently applied procedures under the general
supervision of the Board of Directors.
Short-term securities with maturities of 60 days or less from the date of
initial acquisition are valued at amortized cost. Short-term securities with
maturities greater than 60 days from the date of initial acquisition are
marked-to-market on a daily basis.
SECURITIES PURCHASED ON A WHEN-ISSUED BASIS
Delivery and payment for securities which have been purchased by the Fund on a
forward commitment or when-issued basis can take place a month or more after the
transaction date. During this period, such securities are subject to market
fluctuations and the Fund maintains, in a segregated account with its custodian,
assets with a market value equal to the amount of its purchase commitments.
The Fund may enter into transactions to sell its purchase commitments to third
parties at the current market values and concurrently acquire other purchase
commitments for similar securities at later dates, commonly referred to as
"dollar-rolls." As an inducement for the fund to "rollover" its purchase
commitments, the Fund receives negotiated fees. During the six months ended May
31, 1996, the Fund did not enter into any dollar-roll transactions.
FUTURES AND OPTIONS CONTRACTS
In order to increase exposure to and hedge against changes in the market the
Fund may buy and sell futures contracts and options. The risk of entering into
futures and option contracts include the possibility that changes in the value
of these contracts may not correlate with changes in the underlying security.
Futures contracts are valued at the settlement price of the exchange on which
they are traded. Upon entering into a futures contract, the Fund is required to
deposit either cash or securities into a segregated account, which represents
the initial
-17-
margin, which is equal to a certain percentage of the contract value. Subsequent
changes in the value of the contract, or variation margin, are recorded daily as
unrealized gains or losses. Variation margin is paid or received in cash daily
by the Fund. The Fund realizes a gain or loss when the contract is closed or
expires.
Options traded on an exchange are valued using the last sale price, and those
traded over-the-counter are valued using dealer-supplied valuations, resulting
in unrealized appreciation or depreciation being recorded. The Fund will realize
a gain or loss upon expiration or closing of the option transaction. When an
option is exercised, the proceeds on sales for a written call option, the
purchased cost for a written put option or the cost of a security for a
purchased put or call option is adjusted by the amount of premium received or
paid. The Fund is subject to credit risk that the other party will not complete
obligations of the contract.
FOREIGN CURRENCY TRANSLATIONS AND FOREIGN CURRENCY CONTRACTS
The Fund may invest in foreign securities. The market value of securities and
other assets and liabilities denominated in foreign currencies is translated
daily into U.S. dollars at the closing rate of exchange. Purchases and sales of
securities, income and expenses are translated at the exchange rate on the
transaction date. Exchange gains (losses) may also be realized between the trade
and settlement dates on security and foreign currency contract transactions.
The Fund does not isolate that portion of the results of operations resulting
from changes in foreign exchange rates on investments from the fluctuations
arising from changes in market prices of securities held. Such fluctuations are
included with net realized and unrealized gains (losses) from investments.
The Fund may enter into foreign currency exchange contracts for operational
purposes and to protect against adverse exchange rate fluctuations. The net U.S.
dollar value of foreign currency underlying all contractual commitments held by
the Fund and the resulting unrealized appreciation or depreciation are
determined using foreign currency exchange rates from an independent pricing
service. The Fund is subject to the credit risk that the other party will not
complete the obligations of the contract.
FEDERAL TAXES
Since it is the Fund's policy to comply with the provisions of the Internal
Revenue Code applicable to regulated investment companies and to distribute all
of its taxable income to its shareholders, no provision for income taxes is
required. In order to avoid the payment of any federal excise taxes, the Fund is
required to distribute substantially all of its net investment income and net
realized gains on a calendar year basis.
Net investment income and net realized gains differ for financial statement and
tax purposes primarily because of recognition of certain foreign currency gains
and losses as ordinary income and the deferral of "wash sale" losses for tax
purposes. The
-18-
character of distributions made during the year for net investment income or net
realized gains may also differ from its ultimate characterization for tax
purposes.
For federal income tax purposes, the Fund has a capital loss carryover of
approximately $2,361,000 at November 30, 1995 which, if not offset by subsequent
capital gains, will expire in 2002. It is unlikely the Board of Directors will
authorize a distribution of any net realized gains until the available capital
loss carryover is offset or expires.
SECURITY TRANSACTIONS AND INVESTMENT INCOME
The Fund records security transactions on trade date, the date the securities
are purchased or sold. Dividend income is recorded on the ex-dividend date.
Interest income is recorded on the accrual basis. The Fund amortizes discount
purchased on long-term bonds using the level yield method of amortization.
Security gains and losses are determined on the basis of identified cost, which
is the same basis used for federal income tax purposes.
DISTRIBUTIONS TO SHAREHOLDERS
Distributions to shareholders are recorded on the record date. Cash payments or
reinvestments in additional shares are made at the net asset value at the close
of business on the payable date. Distributions from net investment income are
made monthly. Capital gains, if any, are primarily distributed as of the end of
the calendar year. Additional capital gains distributions as needed to comply
with federal tax regulations are distributed during the year.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported results of operations during the reporting period. Actual results
could differ from those estimates.
[2] COMMITMENTS AND CONTINGENCIES
For purposes of obtaining certain types of insurance coverage for the Fund and
its officers and directors, the Fund is a policyholder in an industry-sponsored
mutual insurance company (the Company). In connection with its obligations as a
policyholder, the Fund has made payments to the Company which have been
capitalized. Also, the Fund is committed to make future capital contributions,
if requested by the Company.
The Fund has available a $14,978,144 line of credit with a bank at the prime
interest rate. To the extent funds are drawn against the line, securities are
held in a segregated account. No compensating balances or commitment fees are
required under the line of credit. During the year ended May 31, 1996, the Fund
paid $1,755 in interest on the line of credit at an average annual rate of
8.33%. Advances under the line of credit totalled $21,856 at May 31, 1996.
-19-
[3] FEES AND EXPENSES
Under the terms of a Management agreement, the Fund pays Investment Advisers,
Inc. (Advisers) a monthly management fee computed at an annual rate of .50% of
average daily net assets. The fee covers all of the Fund's operating expenses
other than interest, taxes, and other extraordinary expenses.
The Management agreement further provides that IAI will either reimburse the
Fund for the fees and expenses it pays to Directors who are not "interested
persons" of the Fund or reduce its fee by an equivalent amount.
[4] PURCHASES AND SALES OF SECURITIES
For the period ended May 31, 1996, purchases of securities and sales proceeds,
other than investments in short-term securities, for the Fund aggregated
$158,762,170 and $163,426,960, respectively.
[5] OPEN FUTURES CONTRACTS
The financial futures contracts shown below were open as of May 31, 1996. The
market value of securities deposited to cover initial margin requirements for
the open positions at May 31, 1996 was $346,805. The net unrealized appreciation
(depreciation) of $78,125 on these contracts is included in unrealized
appreciation (depreciation) on investment securities. 20
<TABLE>
<CAPTION>
IAI INSTITUTIONAL BOND FUND
- ------------------------------------------------------------------------------------------------------------------
Number Unrealized
of Expiration Market Appreciation
Type Contracts Month Position Value (Depreciation)
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
U.S. Treasury Note 40 June 1996 Short $ 4,260,000 $ 100,075
U.S. Treasury Bond 10 June 1996 Long $ 1,080,625 (21,950)
-------------
$ 78,125
=============
</TABLE>
-20-
SHAREHOLDER UPDATE
IAI INSTITUTIONAL BOND FUND
SPECIAL MEETING RESULTS
A special meeting of the Fund's shareholders was held on March 21, 1996. Each
matter voted upon at the meeting, as well as the number of votes cast for,
against or withheld, and the number of abstentions with respect to such matter,
are set forth below.
1. The Fund's shareholders re-elected the following directors:
- --------------------------------------------------------------------------
Shares Voted Shares Withheld
"For" Authority
- --------------------------------------------------------------------------
Madeline Betsch 7,101,848 --
W. William Hodgson 7,101,848 --
Richard E. Struthers 7,101,848 --
J. Peter Thompson 7,101,848 --
George R. Long 7,101,848 --
Noel P. Rahn 7,101,848 --
Charles H. Withers 7,101,848 --
2. The Fund's shareholders ratified the selection of KPMG Peat Marwick LLP as
the independent public accountants for the fiscal year. The following votes were
cast regarding the matter:
- -----------------------------------------------------------------------------
Shares Voted Shares Voted
"For" "Against" Abstentions
- -----------------------------------------------------------------------------
7,101,848 -- --
3. The Fund's shareholders ratified the Fund's Management Agreements. The
following votes were cast regarding the matter:
- -------------------------------------------------------------------------------
Shares Voted Shares Voted
"For" "Against" Abstentions
- -------------------------------------------------------------------------------
7,101,848 -- --
-21-
IAI MUTUAL FUND FAMILY
TO DIVERSIFY YOUR PORTFOLIO, PLEASE CONSIDER ALL OF THE MUTUAL FUNDS IN OUR FUND
FAMILY
<TABLE>
<CAPTION>
Secondary
IAI FUND Primary Objective Objective Portfolio Composition
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
IAI DEVELOPING Capital Appreciation -- Equity securities of companies in developing countries
COUNTRIES FUND
- ----------------------------------------------------------------------------------------------------------------------------
IAI INTERNATIONAL FUND Capital Appreciation Income Equity securities of non-u.s. companies
- ----------------------------------------------------------------------------------------------------------------------------
IAI EMERGING GROWTH FUND Capital Appreciation -- Common stocks of small to medium-sized emerging
(closed to new investors as of 2/1/96) growth companies
- ----------------------------------------------------------------------------------------------------------------------------
IAI CAPITAL APPRECIATION FUND Capital Appreciation -- Common stocks of small to medium-sized growth companies
- ----------------------------------------------------------------------------------------------------------------------------
IAI MIDCAP GROWTH FUND Capital Appreciation -- Common stocks of medium-sized growth companies
- ----------------------------------------------------------------------------------------------------------------------------
IAI REGIONAL FUND Capital Appreciation -- Common stocks of Upper Midwest companies
- ----------------------------------------------------------------------------------------------------------------------------
IAI GROWTH FUND Capital Appreciation -- Common stocks with potential for above-average
growth and appreciation
- ----------------------------------------------------------------------------------------------------------------------------
IAI VALUE FUND Capital Appreciation -- Common stocks which are considered to be undervalued
- ----------------------------------------------------------------------------------------------------------------------------
IAI GROWTH AND INCOME FUND Capital Appreciation Income Common stocks with potential for long-term appreciation,
and common stocks that are expected to
produce income
- ----------------------------------------------------------------------------------------------------------------------------
IAI BALANCED FUND Total Return Income Common stocks, investment grade bonds and
[Capital Appreciation + Income] short-term instruments
- ----------------------------------------------------------------------------------------------------------------------------
IAI BOND FUND Income Capital Investment grade bonds
Preservation
- ----------------------------------------------------------------------------------------------------------------------------
IAI GOVERNMENT FUND Income Capital U.S. Government securities
Preservation
- ----------------------------------------------------------------------------------------------------------------------------
IAI RESERVE FUND Stability/Liquidity Income The portfolio has a maximum average maturity of 25
months, investing primarily in investment grade bonds
- ----------------------------------------------------------------------------------------------------------------------------
IAI MONEY MARKET FUND Stability/Liquidity Income The portfolio's average dollar-weighted maturity is less
than 90 days, investing in high quality, money
market securities
- ----------------------------------------------------------------------------------------------------------------------------
</TABLE>
INVESTMENT ADVISER
AND MANAGER
Investment Advisers, Inc.
P.O. Box 357
Minneapolis, MN 55440-0357 USA
800.945.3863
612.376.2700
CUSTODIAN
Norwest Bank Minnesota, N.A.
Sixth and Marquette
Minneapolis, MN 55479
LEGAL COUNSEL
Dorsey & Whitney LLP
220 South Sixth Street
Minneapolis, MN 55402
INDEPENDENT AUDITORS
KPMG Peat Marwick LLP
4200 Norwest Center
Minneapolis, MN 55402
DIRECTORS
Madeline Betsch
W. William Hodgson
George R. Long
Noel P. Rahn
Richard E. Struthers
J. Peter Thompson
Charles H. Withers
-INSIDE BACK COVER-
[LOGO] IAI
MUTUAL FUNDS
3700 FIRST BANK PLACE, P.O. BOX 357, MINNEAPOLIS, MINNESOTA 55440-0357 USA
FAX 612.376.2737
800.945.3863
612.376.2700
-BACK COVER-
