FIXED INCOME FUND
ANNUAL REPORT
IAI BOND FUND
NOVEMBER 30, 1998
[LOGO] IAI
MUTUAL FUNDS
<PAGE>
TABLE OF CONTENTS
IAI BOND FUND
ANNUAL REPORT
NOVEMBER 30, 1998
President's Letter...............................................2
Fund Managers' Review............................................4
Fund Portfolio...................................................6
Notes to Fund Portfolio.........................................11
Statement of Assets and Liabilities.............................12
Statement of Operations.........................................13
Statements of Changes in Net Assets.............................14
Financial Highlights............................................15
Notes to Financial Statements...................................16
Independent Auditors' Report....................................20
Federal Tax Information.........................................21
IAI Mutual Fund Family..........................................22
Adviser, Custodian, Legal Counsel,
Independent Auditors,
Directors........................................Inside Back Cover
<PAGE>
PRESIDENT'S LETTER
IAI BOND FUND
WHAT'S RIGHT WITH THIS MARKET
[PHOTO]
ROY C. GILLSON
PRESIDENT
The stock market has been on a roller coaster of late, and that naturally makes
people uneasy. But if you're a long-term investor, I would argue there are a lot
more good things influencing the market than bad things.
True, U.S. corporate earnings are flattening out, and that's putting a damper on
the stock market. When you buy a stock, you're buying a future stream of
dividends as well as a stronger company because most of the profits are being
reinvested. After double-digit growth during much of the 1990s, profits in 1998
are struggling. A major reason why profits are sluggish is the economic and
currency turmoil in Asia, which hurts U.S. companies doing business there.
Another reason for weak profit growth is the great job Corporate America has
done to become more efficient. After years of cost-cutting, there isn't much
cutting left to do. To enhance profits, companies must either boost prices or
sell more products and services. But with inflation at virtually zero, it's
tough to raise prices. So, profit growth must come through increased unit
volume.
And that's where the good news is likely to begin. Even with the dampening
effects of Asia, the U.S. economy is still basically healthy, making it possible
for U.S. corporations to sell more products and services here at home. True,
we're losing business in Asia, because the dollar is so strong compared to their
currencies. But what we're losing in Asia, we're gaining in Europe, as that
region of the world begins to enjoy U.S.-style prosperity. Europe will look even
stronger once the euro, the Continent's new single currency, begins to filter
through the economy.
Asia has helped keep inflation worries away, and that has kept interest rates
low. Recently, the 30-year Treasury bond yield reached its lowest level ever, as
global investors buy our securities for the greatest safety and liquidity.
Partly because of our low inflation environment, worldwide demand for U.S.
stocks and bonds continues to be strong.
Although 1998 was extremely volatile, the year turned out quite well, with the
Dow Jones Industrial Average up 18%. The Dow has more than doubled since 1995
and virtually tripled since the beginning of this decade. Where was the Dow in
1982? 800! Has the value of your house gone up by a factor of ten in fifteen
years? Probably not. The point is markets do not go up in a straight line, and
there is bound to be volatility. But if you're an investor for the long term,
you should be able to step back and see the good in this market.
2
<PAGE>
PRESIDENT'S LETTER
IAI BOND FUND
ECONOMIC OUTLOOK
A summary of economic outlook as provided by Larry Hill, IAI's Chief Fixed
Income Officer, follows.
Growth in the U.S. economy is likely to continue in the months ahead, but at a
slower pace. Over the last four quarters, the real economy expanded by 3.4%
while inflation, as measured over the most recent quarter, rose at an annualized
rate of only 0.8%. While the economy is likely to slow, it is hard to become too
negative on the outlook. There is little evidence of a recession on the horizon.
A modest slowdown is more likely, with real growth dropping to about 2.5% for
1999.
Some sectors of the economy are losing forward momentum. The manufacturing
sector is clearly showing signs of weakness. This sector is directly exposed to
the global glut of commodity goods. With weaker demands overseas, exports are
slowing while imports are rising. Corporate profits are being squeezed, which is
likely to reduce capital spending plans for 1999. These indicators all point to
moderately slower growth ahead.
Yet, growing evidence of economic deterioration--if this occurs--will prompt
further rate reduction. Having taken the first step to ease in three years, the
Fed is now sensitive to overseas conditions and the fluid economic environment.
If the economy appears to be stumbling, the Fed has plenty of room to drop rates
and will do so with little hesitation. Likewise, renewed turmoil in the markets
will also prompt Fed action. Thus our outlook for no recession is driven by our
confidence that the Fed can and will act if necessary.
Fed diligence is also a key ingredient for the markets. Subdued inflation and
the prospect of further cuts in short rates--if need be--will provide support
for bonds. Stock prices remain trapped in a tug-of-war between slowing earnings
and favorable liquidity. The stock market will be pulled up and down until one
force overcomes the other and sets the next trend.
Please read the Fund Managers' Review, which follows this letter, for a detailed
perspective on Fund 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/ Roy C. Gillson
Roy C. Gillson
President
3
<PAGE>
FUND MANAGERS' REVIEW
IAI BOND FUND
IAI BOND FUND
[PHOTO]
LARRY R. HILL, CFA
IAI BOND FUND CO-MANAGER
[PHOTO]
STEPHEN C. COLEMAN, CFA
IAI BOND FUND CO-MANAGER
WHAT IS THE FUND'S OBJECTIVE?
The IAI Bond Fund's objective is to provide a high level of current income
consistent with preservation of capital. This objective is pursued by investing
in a diversified portfolio of high quality bonds. The Fund invests primarily in
investment-grade bonds and other debt securities of similar high quality. 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.
HOW HAS THE FUND PERFORMED?
The IAI Bond Fund earned a return of 6.68% for the year ended November 30, 1998.
This compares with a return for the benchmark, the Lehman Brothers Aggregate
Bond Index, of 9.45%.
WERE THERE ANY SIGNIFICANT CHANGES?
During the year, there were no major changes to the investment strategy. The
interest rate sensitivity of the Fund remained longer than the benchmark and
sector weightings continued to emphasize mortgages and corporates.
CAN YOU POINT TO ANY SPECIFIC MARKET FACTORS THAT INFLUENCED THE FUND'S
PERFORMANCE?
The continuing flight-to-quality from less stable markets combined with the
increased premium on liquidity caused by forced sales at some hedge funds led to
a discontinuity within the bond market. Treasury yields declined significantly
during both August and September. At the same time however, the yields on
corporates and mortgages declined only modestly. This widening of interest rate
spreads accounted for the majority of the performance shortfall for the Fund
during the year because the Fund's portfolio is comprised of more
mortgage-backed securities and corporate bonds, and less Treasury securities,
relative to the benchmark.
WHAT IS YOUR OUTLOOK FOR THE FUND?
Markets will remain volatile until the excess leverage employed by foreign
businesses and hedge funds has been unwound. This process has been going on for
foreign businesses for some time but hedge fund liquidations were just beginning
at the end of September. The Federal Reserve Board (the Fed) is trying to
prevent isolated cases of credit contraction from becoming a general economic
contraction. They have already acted to maintain ample liquidity by reducing the
Fed Funds rate by one-half percentage point.
Corporate bonds, mortgages and asset-backed securities present tremendous
long-term value at current, near record yield spreads. While these sectors are
still under pressure from leveraged sellers, we are maintaining our overweight
positions which have the potential to earn exceptional returns over the longer
term. We remain diligent in evaluating the credit trends for corporate holdings
and the prepayment uncertainties for mortgage backed securities. The Fund is
well diversified for the current volatile environment, giving us the flexibility
to take advantage of buying opportunities as they arise.
4
<PAGE>
FUND MANAGERS' REVIEW
IAI BOND FUND
VALUE OF $10,000 INVESTMENT+
[PLOT POINTS CHART]
LEHMAN BROTHERS
IAI BOND FUND AGGREGATE BOND INDEX
12/01/88 10,000 10,000
11/30/89 11,600 11,436
11/30/90 12,173 12,302
11/30/91 13,913 14,075
11/30/92 15,219 15,322
11/30/93 17,352 16,991
11/30/94 16,495 16,471
11/30/95 19,042 19,377
11/30/96 20,346 20,552
11/30/97 22,003 22,104
11/30/98 23,474 24,191
AVERAGE ANNUAL RETURNS+
THROUGH 11/30/98
1 Year 5 Years 10 Years
- --------------------------------------------------------------------------------
IAI BOND FUND 6.68% 6.23% 8.91%
- --------------------------------------------------------------------------------
Lehman Brothers Aggregate Bond Index 9.45% 7.32% 9.24%
+ PAST PERFORMANCE IS NOT PREDICTIVE OF FUTURE PERFORMANCE.
SECTORS
% OF PORTFOLIO AS OF 11/30/98
[PIE CHART]
U.S. Government Agency Mortgage-Backed 41%
Corporate 38%
Preferred Stock 8%
U.S. Government & Government Agency 6%
Asset-Backed 3%
Short-Term 3%
Foreign Denominated 1%
EFFECTIVE MATURITY
% OF PORTFOLIO AS OF 11/30/98
[BAR CHART]
Years
- -----
0-3 15%
3-5 29%
5-10 37%
10-20 7%
20+ 12%
NOTE TO PRESIDENT'S LETTER & FUND MANAGERS' REVIEW
PERFORMANCE DATA FOR THE IAI BOND FUND INCLUDES CHANGES IN SHARE PRICE AND
REINVESTMENT OF 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 PRO SPECTUS. PLEASE READ THE FUND'S PROSPECTUS
CAREFULLY BEFORE INVESTING. ALL INDEXES CITED ARE UNMANAGED, AND ARE EITHER
TRADEMARKS, REGISTERED TRADEMARKS OR COPYRIGHTS OF THEIR RESPECTIVE SPONSORING
COMPANIES.
CREDIT RATING
% OF PORTFOLIO AS OF 11/30/98
U.S.
Government................48%
Aaa........................6%
Aa........................11%
A..........................8%
Baa.......................12%
Non-Investment
Grade.....................15%
5
<PAGE>
FUND PORTFOLIO
IAI BOND FUND
NOVEMBER 30, 1998
(PERCENTAGE FIGURES INDICATE PERCENTAGE OF TOTAL NET ASSETS)
<TABLE>
<CAPTION>
CORPORATE BONDS - 36.8%
Principal Market
Rate Maturity Amount Value (a)
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
FINANCIAL - 6.0%
Abbey National (YANKEE) (f) 6.70% 06/29/49 $ 800,000 $ 765,144
Arcadia Financial 11.50 03/15/07 425,000 318,750
GMAC 5.75 11/10/03 285,000 286,100
Merrill Lynch 6.88 11/15/18 385,000 395,588
MMI Capital Trust I Series B 7.63 12/15/27 1,000,000 932,580
Nationsbank 6.13 07/15/04 215,000 221,097
Toyota Motor Credit 5.63 11/13/03 140,000 141,204
-----------
3,060,463
- ----------------------------------------------------------------------------------------------------------------------
INDUSTRIAL - 28.4%
Albecca (e) 10.75 08/15/08 150,000 153,000
Alberta Province (YANKEE) (f) 4.88 10/29/03 375,000 368,711
Atlas Air (e) 9.38 11/15/06 125,000 125,625
Bell Sports (e) 11.00 08/15/08 100,000 102,000
Biovail (e) 10.88 11/15/05 100,000 101,500
Cendant 7.75 12/01/03 515,000 518,363
Chesapeake Energy 9.13 04/15/06 325,000 279,500
Clear Channel Communications 6.88 06/15/18 540,000 531,187
Coca-Cola Bottling 7.20 07/01/09 500,000 520,800
CSC Holdings Series M (PIK BOND) (h) 11.13 04/01/08 4,111 (j) 464,566
Day International Group 9.50 03/15/08 300,000 291,000
Entex Information Services (k) 12.50 08/01/06 950,000 570,000
Grove Worldwide 9.25 05/01/08 150,000 150,375
Loewen Group International Series 3 7.50 04/15/01 125,000 111,250
Loewen Group International Series 3 7.75 10/15/01 200,000 178,000
Loewen Group International Series 4 8.25 10/15/03 500,000 435,000
Lubrizol 5.88 12/01/08 175,000 173,915
NE Restaurant (e) 10.75 07/15/08 250,000 256,875
Petro-Canada (YANKEE) (f) 7.00 11/15/28 420,000 422,100
Queen Sand Resources (e) 12.50 07/01/08 1,050,000 850,500
Radio Unica (STEP BOND) (e) (i) 10.36 08/01/06 1,300,000 676,000
Raytheon 6.15 11/01/08 305,000 308,779
Revlon Consumer Products 8.63 02/01/08 300,000 296,250
</TABLE>
SEE ACCOMPANYING NOTES TO FUND PORTFOLIO ON PAGE 11
6
<PAGE>
FUND PORTFOLIO
IAI BOND FUND
NOVEMBER 30, 1998
<TABLE>
<CAPTION>
CORPORATE BONDS (CONT.)
Principal Market
Rate Maturity Amount Value (a)
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Saks 7.25% 12/01/04 $ 250,000 $ 250,708
Sonic Automotive (e) 11.00 08/01/08 675,000 654,750
Styling Technology 10.88 07/01/08 75,000 70,125
Susa Partnership 7.45 07/01/18 275,000 254,716
Time Warner (e) 6.10 12/30/01 1,000,000 1,010,460
Transamerica Capital III 7.63 11/15/37 1,750,000 1,849,243
True Temper Sports (e) 10.88 12/01/08 125,000 126,875
Union Pacific (MEDIUM-TERM NOTE) 6.79 11/09/07 525,000 539,831
Union Pacific Resources 7.05 05/15/18 680,000 644,735
Williams Companies 6.50 08/01/06 570,000 580,870
Windmere-Durable 10.00 07/31/08 800,000 750,000
-----------
14,617,609
- ----------------------------------------------------------------------------------------------------------------------
UTILITIES - 2.4%
AT&T Capital (MEDIUM-TERM NOTE) 7.50 11/15/00 375,000 378,615
Global Crossing (PIK BOND) (e) (h) 10.50 12/01/08 1,250 (j) 125,000
KN Energy 7.25 03/01/28 350,000 346,811
Sprint Capital 6.88 11/15/28 385,000 399,796
-----------
1,250,222
======================================================================================================================
TOTAL INVESTMENTS IN CORPORATE BONDS
(COST: $19,439,429) ...................................................................................... $18,928,294
======================================================================================================================
U.S. GOVERNMENT & GOVERNMENT AGENCY OBLIGATIONS - 5.8%
Principal Market
Rate Maturity Amount Value (a)
- ----------------------------------------------------------------------------------------------------------------------
U.S. TREASURY BONDS - 2.4%
12.38% 05/15/04 $ 310,000 $ 421,650
9.25 02/15/16 545,000 791,525
-----------
1,213,175
- ----------------------------------------------------------------------------------------------------------------------
U.S. TREASURY STRIPS - 2.8%
U.S. Treasury STRIP (ZERO COUPON) 5.54 (g) 02/15/19 2,705,000 898,385
5.54 (g) 11/15/21 1,915,000 549,892
-----------
1,448,277
- ----------------------------------------------------------------------------------------------------------------------
U.S. GOVERNMENT AGENCY OBLIGATIONS - 0.6%
Federal Home Loan Mortgage Corporation 5.13 09/15/03 315,000 315,934
======================================================================================================================
TOTAL INVESTMENTS IN U.S. GOVERNMENT & GOVERNMENT AGENCY OBLIGATIONS
(COST: $2,850,369) ....................................................................................... $ 2,977,386
======================================================================================================================
</TABLE>
SEE ACCOMPANYING NOTES TO FUND PORTFOLIO ON PAGE 11
7
<PAGE>
FUND PORTFOLIO
IAI BOND FUND
NOVEMBER 30, 1998
<TABLE>
<CAPTION>
U.S. GOVERNMENT AGENCY MORTGAGE-BACKED SECURITIES - 40.6%
Principal Market
Rate Maturity Amount Value (a)
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
FEDERAL HOME LOAN MORTGAGE CORPORATION GOLD - 6.6%
6.00% 04/01/11 $ 911,913 $ 915,898
6.50 04/01/13 425,329 431,574
6.50 05/01/13 638,207 647,576
6.00 12/01/13 535,000 (b) 536,000
6.50 12/01/28 870,000 (b) 876,525
-----------
3,407,573
- ----------------------------------------------------------------------------------------------------------------------
FEDERAL NATIONAL MORTGAGE ASSOCIATION - 17.1%
6.11 08/01/08 1,128,221 1,150,335
5.81 10/01/08 529,603 529,127
9.00 06/01/17 764,933 811,304
7.50 01/01/28 877,893 902,027
6.50 04/01/28 326,394 328,536
7.50 04/01/28 488,296 501,568
7.00 05/01/28 819,099 835,987
7.00 08/01/28 1,628,908 1,662,496
6.00 10/01/28 1,099,923 1,085,481
6.50 11/01/28 949,550 955,779
-----------
8,762,640
- ----------------------------------------------------------------------------------------------------------------------
FEDERAL NATIONAL MORTGAGE ASSOCIATION DWARF - 5.6%
6.50 01/01/13 345,153 350,113
6.50 03/01/13 1,237,772 1,255,559
6.00 11/01/13 1,287,950 1,289,560
-----------
2,895,232
- ----------------------------------------------------------------------------------------------------------------------
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION - 10.7%
9.00 11/15/17 213,763 221,656
8.00 12/15/23 732,870 764,713
7.00 10/15/26 1,184,417 1,212,914
7.50 12/15/27 1,313,991 1,356,696
7.00 03/15/28 770,337 788,632
7.50 05/15/28 534,213 552,077
7.00 06/15/28 339,941 348,014
-----------
5,474,096
- ----------------------------------------------------------------------------------------------------------------------
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION MIDGET - 0.6%
7.00 01/15/08 311,249 319,709
======================================================================================================================
TOTAL INVESTMENTS IN U.S. GOVERNMENT AGENCY MORTGAGE-BACKED SECURITIES
(COST: $20,703,166)....................................................................................... $20,859,250
======================================================================================================================
</TABLE>
SEE ACCOMPANYING NOTES TO FUND PORTFOLIO ON PAGE 11
8
<PAGE>
FUND PORTFOLIO
IAI BOND FUND
NOVEMBER 30, 1998
<TABLE>
<CAPTION>
ASSET-BACKED SECURITIES - 3.1%
Principal Market
Rate Maturity Amount Value (a)
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
HOME EQUITY - 3.1%
EQCC Home Equity Loan Trust 98-2 A6F 6.16% 04/15/08 $ 560,000 $ 561,176
Money Store Home Equity Trust 98-B AF4 6.12 06/15/21 265,000 265,083
Residential Asset Securities 98-KS2 AI3 6.24 07/25/29 760,000 757,173
-----------
1,583,432
======================================================================================================================
TOTAL INVESTMENTS IN ASSET-BACKED SECURITIES
(COST: $1,585,242) ....................................................................................... $ 1,583,432
======================================================================================================================
FOREIGN DENOMINATED BONDS - 1.2%
Principal Market
Rate Maturity Amount Value (a)
- ----------------------------------------------------------------------------------------------------------------------
CORPORATE - 1.2%
Colt Telcom Group (GERMAN DEUTSCHEMARK) 7.63% 07/31/08 1,050,000 $ 619,455
======================================================================================================================
TOTAL INVESTMENTS IN FOREIGN DENOMINATED BONDS
(COST: $591,599) ......................................................................................... $ 619,455
======================================================================================================================
NON-CONVERTIBLE PREFERRED STOCK - 7.8%
Market
Rate Quantity Value (a)
- ----------------------------------------------------------------------------------------------------------------------
FINANCIAL - 7.8%
SI Financing Trust I 2.38% 150,000 $ 3,993,750
======================================================================================================================
TOTAL INVESTMENTS IN NON-CONVERTIBLE PREFERRED STOCK
(COST: $3,810,937) ....................................................................................... $ 3,993,750
======================================================================================================================
TOTAL INVESTMENTS IN LONG-TERM SECURITIES
(COST: $48,980,742) ...................................................................................... $48,961,567
======================================================================================================================
</TABLE>
SEE ACCOMPANYING NOTES TO FUND PORTFOLIO ON PAGE 11
9
<PAGE>
FUND PORTFOLIO
IAI BOND FUND
NOVEMBER 30, 1998
<TABLE>
<CAPTION>
SHORT-TERM SECURITIES - 2.9%
Principal Market
Rate Maturity Amount Value (a)
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. TREASURY BILL - 0.2%
4.05% 04/22/99 $ 100,000 (c) $ 98,253
- ----------------------------------------------------------------------------------------------------------------------
COMMERCIAL PAPER - 2.7%
Associates (FINANCIAL) 5.15 12/09/98 865,000 864,010
General Electric (UTILITIES) 5.12 12/14/98 535,000 534,011
-----------
1,398,021
======================================================================================================================
TOTAL INVESTMENTS IN SHORT-TERM SECURITIES
(COST: $1,496,477) ....................................................................................... $ 1,496,274
======================================================================================================================
TOTAL INVESTMENTS IN SECURITIES
(COST: $50,477,219) (L) .................................................................................. $50,457,841
======================================================================================================================
OTHER ASSETS AND LIABILITIES (NET) - 1.8%
........................................................................................................ $ 900,846
======================================================================================================================
TOTAL NET ASSETS
........................................................................................................ $51,358,687
======================================================================================================================
</TABLE>
SEE ACCOMPANYING NOTES TO FUND PORTFOLIO ON PAGE 11
10
<PAGE>
NOTES TO FUND PORTFOLIOS
IAI BOND FUND
NOVEMBER 30, 1998
(a)
Market value of securities is determined as described in Note 1 to the financial
statements, under "Security Valuation."
(b)
Purchased on a when-issued basis. At November 30, 1998, the total cost of
securities purchased on a when-issued basis was $1,411,100.
(c)
Security is partially pledged to cover initial margin on open futures contracts
(see Note 5 to financial statements).
(d)
Foreign security cost and market values are stated in U.S. dollars. Principal
amounts are denominated in the foreign currency indicated parenthetically.
(e)
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. The market value
of such securities was $4,182,585 (8.1% of net assets) at November 30, 1998.
(f)
Yankee represents dollar-denominated bonds issued in the United States by
foreign banks and corporations.
(g)
Interest rate shown represents yield-to-maturity at date of purchase.
(h)
The interest rate shown for Payment-in-Kind bonds (PIK bonds) represents
effective yield at November 30, 1998. PIK--Payment-in-Kind income is generally
paid by issuing additional par or shares of the security rather than paying
cash.
(i)
A step bond is a security that remains zero-coupon until a predetermined date at
which time the stated coupon rate becomes payable at regular intervals. The
interest rate shown for step bonds represents the effective yield at November
30, 1998, based upon the estimated timing and amount of future interest and
principal payments.
(j)
Represents a preferred security. Quantity is disclosed in units. One unit
represents 100 par.
(k)
Represents security sold within terms of a private placement memorandum exempt
from registration under Section 144A of the Securities Act of 1933. This issue
was deemed illiquid at November 30, 1998, based on guidelines established by the
Board of Directors. The market value of this security was $570,000 (1.1% of net
assets) at November 30, 1998.
(l)
At November 30, 1998, 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 $ 50,509,999
=================
Gross unrealized appreciation $ 908,666
Gross unrealized depreciation (960,824)
-----------------
Net unrealized depreciation $ (52,158)
=================
11
<PAGE>
STATEMENT OF ASSETS AND LIABILITIES
IAI BOND FUND
NOVEMBER 30, 1998
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Investments in securities, at market
(Cost: $50,477,219) $50,457,841
Cash in bank on demand deposit 1,827,621
Receivable for Fund shares sold 50,028
Accrued interest and dividends receivable 531,825
Variation margin receivable 18,750
Other 24,179
-------------
TOTAL ASSETS 52,910,244
-------------
LIABILITIES
Payable for investment securities purchased 136,144
Payable for investment securities purchased on a when-issued basis 1,411,100
Unrealized depreciation on foreign currency contracts held, at value (Note 6) 4,313
-------------
TOTAL LIABILITIES 1,551,557
-------------
NET ASSETS APPLICABLE TO OUTSTANDING CAPITAL STOCK $51,358,687
=============
REPRESENTED BY:
Capital stock $ 53,883
Additional paid-in capital 51,835,289
Undistributed net investment income 241,063
Accumulated net realized losses on investments (720,828)
Unrealized appreciation or depreciation on:
Investment securities $ (46,522)
Other assets and liabilities denominated in foreign currency (4,198)
------------
(50,720)
-------------
TOTAL - REPRESENTING NET ASSETS APPLICABLE TO OUTSTANDING CAPITAL STOCK $51,358,687
=============
Shares of capital stock outstanding; authorized 10 billion shares
of $0.01 par value stock 5,388,261
-------------
NET ASSET VALUE PER SHARE OF OUTSTANDING CAPITAL STOCK $ 9.53
=============
</TABLE>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS ON PAGE 16
12
<PAGE>
STATEMENT OF OPERATIONS
IAI BOND FUND
YEAR ENDED NOVEMBER 30, 1998
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C>
NET INVESTMENT INCOME
INCOME:
Interest $ 3,753,912
Dividends 367,375
------------
TOTAL INCOME 4,121,287
------------
EXPENSES:
Management fees 651,900
Compensation of Directors 11,925
------------
TOTAL EXPENSES 663,825
Less fees reimbursed by Advisers (11,925)
------------
NET EXPENSES 651,900
------------
NET INVESTMENT INCOME 3,469,387
------------
NET REALIZED AND UNREALIZED GAINS (LOSSES)
Net realized gains (losses) on:
Investment securities $ 1,682,706
Futures contracts (449,521)
Foreign currency transactions (113,032)
------------
1,120,153
Net change in unrealized appreciation or depreciation on:
Investment securities $ (917,845)
Futures contracts 240,021
Other assets and liabilities denominated in foreign currency (4,528)
------------
(682,352)
------------
NET GAIN ON INVESTMENTS AND FOREIGN CURRENCY 437,801
------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $ 3,907,188
============
</TABLE>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS ON PAGE 16
13
<PAGE>
STATEMENTS OF CHANGES IN NET ASSETS
IAI BOND FUND
<TABLE>
<CAPTION>
Year ended Year ended
November 30, 1998 November 30, 1997
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C>
OPERATIONS
Net investment income $ 3,469,387 $ 4,237,216
Net realized gains 1,120,153 3,154,037
Net change in unrealized appreciation or depreciation (682,352) (1,905,812)
-------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS 3,907,188 5,485,441
-------------------------------------
DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income (3,563,967) (4,411,156)
-------------------------------------
TOTAL DISTRIBUTIONS (3,563,967) (4,411,156)
-------------------------------------
CAPITAL SHARE TRANSACTIONS
Net proceeds from sale of 2,928,073 and 2,139,386 shares 28,071,182 19,823,156
Net asset value of 357,698 and 454,281 shares issued to
shareholders in reinvestment of distributions 3,415,929 4,206,938
Cost of 5,126,967 and 4,677,133 shares redeemed (49,092,006) (43,287,269)
-------------------------------------
DECREASE IN NET ASSETS FROM CAPITAL SHARE TRANSACTIONS (17,604,895) (19,257,175)
-------------------------------------
TOTAL DECREASE IN NET ASSETS (17,261,674) (18,182,890)
NET ASSETS AT BEGINNING OF PERIOD 68,620,361 86,803,251
-------------------------------------
NET ASSETS AT END OF PERIOD $ 51,358,687 $ 68,620,361
=====================================
INCLUDING UNDISTRIBUTED NET INVESTMENT INCOME OF: $ 241,063 $ 376,711
=====================================
</TABLE>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS ON PAGE 16
14
<PAGE>
FINANCIAL HIGHLIGHTS
IAI 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>
Years ended
November 30, Period from Year ended
------------------------------------------------- April 1, 1994 to March 31,
1998 1997 1996 1995 November 30, 1994+ 1994
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
NET ASSET VALUE
Beginning of period $ 9.49 $ 9.32 $ 9.34 $ 8.65 $ 9.32 $ 10.42
--------------------------------------------------------------------------------
OPERATIONS
Net investment income 0.58 0.54 0.56 0.58 0.36 0.62
Net realized and unrealized gains (losses) 0.04 0.19 0.04 0.72 (0.55) (0.25)
--------------------------------------------------------------------------------
TOTAL FROM OPERATIONS 0.62 0.73 0.60 1.30 (0.19) 0.37
--------------------------------------------------------------------------------
DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income (0.58) (0.56) (0.62) (0.61) (0.35) (0.66)
Net realized gains -- -- -- -- (0.13) (0.81)
--------------------------------------------------------------------------------
TOTAL DISTRIBUTIONS (0.58) (0.56) (0.62) (0.61) (0.48) (1.47)
--------------------------------------------------------------------------------
NET ASSET VALUE
End of period $ 9.53 $ 9.49 $ 9.32 $ 9.34 $ 8.65 $ 9.32
================================================================================
Total investment return* 6.68% 8.15% 6.85% 15.46% (2.10%) 3.16%
Net assets at end of period (000's omitted) $51,359 $68,620 $86,803 $77,526 $80,622 $97,139
RATIOS
Expenses to average net assets 1.10% 1.10% 1.10% 1.09% 1.10%** 1.09%
Net investment income to
average net assets 5.85% 5.74% 6.20% 6.32% 6.03%** 5.63%
Portfolio turnover rate
(excluding short-term securities) 280.3% 482.2% 342.4% 424.7% 226.7% 333.1%
</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
+ REFLECTS FISCAL YEAR-END CHANGE FROM MARCH 31 TO NOVEMBER 30.
15
<PAGE>
NOTES TO FINANCIAL STATEMENTS
IAI BOND FUND
NOVEMBER 30, 1998
[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 Bond Fund
(Bond Fund) is a separate portfolio of IAI Investment Funds I, Inc. The Fund's
primary objective is to provide a high level of current income consistent with
capital preservation, through investments in a diversified portfolio of
primarily investment grade bonds and other debt securities of similar high
quality. This report covers only 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. Such valuations are obtained from pricing services or are
supplied by dealers.
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. Those 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 may occur 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, assets with a
market value equal to the amount of its purchase commitments.
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 risks 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, representing the
initial margin, 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
purchase 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.
16
<PAGE>
NOTES TO FINANCIAL STATEMENTS
IAI BOND FUND
NOVEMBER 30, 1998
[1] SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT.)
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 and are recorded in realized and unrealized appreciation or
depreciation on foreign currency transactions.
Exchange gains and 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 the net
realized and unrealized gain or loss from investments.
The Fund may enter into forward 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
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 may 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 character of distributions made during the year from net
investment income or net realized gains may also differ from its ultimate
characterization for tax purposes.
On the statement of assets and liabilities, as a result of permanent book-to-tax
differences, undistributed net investment income has been decreased by $41,068
and accumulated net realized losses have been decreased by $41,068.
For federal income tax purposes, the Fund has a capital loss carryover of
approximately $725,000 at November 30, 1998, 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 accrued daily. 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. Distributions
from net investment income are made monthly. Capital gains, if any, are
primarily distributed at the end of the calendar year. Additional capital gains
distributions as needed to comply with federal tax regulations are distributed
during the year.
17
<PAGE>
NOTES TO FINANCIAL STATEMENTS
IAI BOND FUND
NOVEMBER 30, 1998
[1] SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT.)
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 in the financial statements. Actual results could
differ from those estimates.
[2] COMMITMENTS AND CONTINGENCIES
INSURANCE
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 obligation as a
policyholder, the Fund is committed to make future capital contributions, if
requested by the Company.
LINE OF CREDIT
The Fund has available a $9,000,000 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 November 30, 1998, the
Fund paid $2,346, in interest on the line of credit at an average rate of 8.50%.
This interest is included in interest income on the Statement of Operations.
There were no borrowings outstanding at November 30, 1998.
[3] FEES AND EXPENSES
Under terms of each Fund's Management Agreement, Investment Advisers, Inc.
(Advisers) is required to pay for all expenses of the Fund, except certain costs
(primarily those incurred in the purchase and sale of assets, taxes, interest
and extraordinary expenses), in return for the Fund paying an all inclusive
management fee (unified fee) to Advisers. The fee is equal to an annual rate of
1.10% declining to 1.00% of average daily net assets. This fee is paid monthly.
The Management Agreement further provides that Advisers 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.
18
<PAGE>
NOTES TO FINANCIAL STATEMENTS
IAI BOND FUND
NOVEMBER 30, 1998
[4] PURCHASES AND SALES OF SECURITIES
For the year ended November 30, 1998, purchases of securities and sales
proceeds, other than investments in short-term securities, for the Fund
aggregated $155,897,179 and $170,932,930, respectively.
[5] OPEN FUTURES CONTRACTS
The financial futures contracts shown below were open as of November 30, 1998.
The market value of securities deposited to cover initial margin requirements
for the open positions at November 30, 1998 was $49,127. The unrealized
depreciation on these contracts is included in unrealized appreciation or
depreciation on investment securities.
<TABLE>
<CAPTION>
FUTURES
- ----------------------------------------------------------------------------------------------------
Number of Expiration Market Unrealized
Type Contracts Month Position Value Depreciation
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
U.S. Treasury Bond 15 December 1998 Long $1,947,656 $27,144
- ----------------------------------------------------------------------------------------------------
</TABLE>
[6] FOREIGN CURRENCY EXCHANGE CONTRACTS
At November 30, 1998, the Fund had entered into foreign currency exchange
contracts. The unrealized depreciation on those contracts at November 30, 1998,
is included in unrealized appreciation or depreciation on other assets and
liabilities denominated in foreign currency. The terms of the open contracts are
as follows:
<TABLE>
<CAPTION>
Exchange Unrealized
Date Currency to be Delivered Currency to be Received Depreciation
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
12/30/98 944,000 German Deutschemark 554,968 U.S. Dollar $4,313
- ----------------------------------------------------------------------------------------------------
</TABLE>
19
<PAGE>
INDEPENDENT AUDITORS' REPORT
IAI BOND FUND
THE BOARD OF DIRECTORS AND SHAREHOLDERS
IAI INVESTMENT FUNDS I, INC.:
We are required by federal tax regulations to provide shareholders with certain
information regarding dividend distributions paid during our fiscal year. The
figures provided are for informational purposes only and should not be used for
reporting to federal or state revenue agencies. You will receive all necessary
tax information on Form 1099-DIV, Dividends and Distributions, in January of
each year. We have audited the accompanying statement of assets and liabilities,
including the fund portfolio, of IAI Bond Fund (a portfolio within IAI
Investment Funds I, Inc.) as of November 30, 1998, and the related statement of
operations for the year then ended, the statements of changes in net assets for
each of the years in the two-year period then ended, and the financial
highlights for the periods presented on page 15 of the annual report. These
financial statements and the financial highlights are the responsibility of the
Fund's management. Our responsibility is to express an opinion on these
financial statements and the financial highlights based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and the 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. Investment securities held in custody are confirmed to us by the
custodian. As to securities purchased but not received, we request confirmations
from brokers and where replies are not received, we carry out other appropriate
auditing 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 the financial highlights referred
to above present fairly, in all material respects, the financial position of IAI
Bond Fund at November 30, 1998, and the results of its operations, the changes
in its net assets and the financial highlights for the periods stated in the
first paragraph above, in conformity with generally accepted accounting
principles.
KPMG Peat Marwick LLP
Minneapolis, Minnesota
January 8, 1999
20
<PAGE>
FEDERAL TAX INFORMATION
IAI BOND FUND
We are required by federal tax regulations to provide shareholders with certain
information regarding dividend distributions paid during our fiscal year. The
figures provided are for informational purposes only and should not be used for
reporting to federal or state revenue agencies. You will receive all necessary
tax information on Form 1099-DIV, Dividends and Distributions, in January of
each year.
TAX INFORMATION:
- --------------------------------------------------------------------------------
Payable Date Ordinary Income (A)
- --------------------------------------------------------------------------------
DECEMBER 1997 $ 0.0500
JANUARY 1998 0.0500
FEBRUARY 1998 0.0650
MARCH 1998 0.0750
APRIL 1998 0.0400
MAY 1998 0.0400
JUNE 1998 0.0500
JULY 1998 0.0450
AUGUST 1998 0.0400
SEPTEMBER 1998 0.0540
OCTOBER 1998 0.0400
NOVEMBER 1998 0.0300
================================================================================
$ 0.5790
(A) INCLUDES DISTRIBUTIONS OF SHORT-TERM CAPITAL GAINS, IF ANY, WHICH ARE
TAXABLE AS ORDINARY INCOME. 10.39% OF ORDINARY INCOME DISTRIBUTIONS QUALIFY FOR
DEDUCTION BY CORPORATIONS.
21
<PAGE>
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 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 growth companies
- ------------------------------------------------------------------------------------------------------------------------------------
IAI CAPITAL Capital Appreciation -- Common stocks of small- to medium-sized
APPRECIATION FUND 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
small-to medium-sized companies
- ------------------------------------------------------------------------------------------------------------------------------------
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 short-term instruments
+ INCOME]
- ------------------------------------------------------------------------------------------------------------------------------------
IAI BOND FUND Income Capital Preservation 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>
22
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<PAGE>
INVESTMENT ADVISER
AND MANAGER
Investment Advisers, Inc.
P.O. Box 357
Minneapolis, MN 55440-0357 USA
800.945.3863
612.376.2700
http://www.iaifunds.com
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
J. Peter Thompson
Charles H. Withers
<PAGE>
[LOGO] IAI
MUTUAL FUNDS
P.O. BOX 357, MINNEAPOLIS, MINNESOTA 55440-0357 USA FAX 612.376.2737
800.945.3863
612.376.2700
