SEMI-ANNUAL REPORT
IAI INSTITUTIONAL
BOND FUND
MAY 31, 2000
(UNAUDITED)
[LOGO] IAI
MUTUAL FUNDS
<PAGE>
TABLE OF CONTENTS
IAI INSTITUTIONAL BOND FUND
SEMI-ANNUAL REPORT
MAY 31, 2000
(UNAUDITED)
Letter to Shareholders ...................... 2
Fund Manager's Review ....................... 4
Fund Portfolio .............................. 6
Notes to Fund Portfolio ..................... 8
Statement of Assets and Liabilities ......... 9
Statement of Operations ..................... 10
Statements of Changes in Net Assets ......... 11
Financial Highlights ........................ 12
Notes to Financial Statements ............... 13
Adviser, Custodian, Legal Counsel,
Independent Auditors,
Directors .................... Inside Back Cover
<PAGE>
LETTER TO SHAREHOLDERS
IAI INSTITUTIONAL BOND FUND
ECONOMIC OUTLOOK
A summary of economic outlook as provided by Larry Hill, IAI's Chief Fixed
Income Officer, follows.
Signs of a developing economic slowdown began to surface during the second
quarter. However, the length and depth of the slowdown are still open to debate.
In each of the last two years the economy paused in the second quarter, only to
reaccelerate in the last half of the year. It's still too early to tell if this
pattern will be repeated this year, but six interest rate increases by the Fed
in the last twelve months make a strong case for a longer lasting slowdown.
Nevertheless, the question remains: Is the Fed done?
Despite the record length of this economic expansion, the inflation outlook
continues to be mixed. Certainly the trend of inflation has been moving higher.
Gasoline prices have received a lot of recent attention and energy prices have
been driving the consumer price index up. However, price indices excluding
energy costs are still relatively well behaved. Likewise, commodity prices
(excluding energy) and the price of gold are moving sideways, giving no clear
signal about the future trend. Although this inflation news is better than what
might be expected, it is important to remember that inflation is a lagging
indicator. As such, the inflation rate may continue to rise even as the economy
cools. Thus, the threat of rising inflation does not immediately go away.
Instead, it presents a dilemma for the Fed and a risk for investors.
2
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<PAGE>
LETTER TO SHAREHOLDERS
IAI INSTITUTIONAL BOND FUND
ECONOMIC OUTLOOK (CONT.)
Some of the most convincing evidence of a slowdown comes from the labor markets.
Private sector payroll gains slowed in the second quarter. The headline reports
probably overstated the weakness because the unemployment rate remained near its
30-year low while some anecdotal evidence continued to point toward upward wage
pressure from a tight labor market. Yet, a softer trend seems to be developing.
New job creation is the engine that drives consumer confidence, income growth
and spending. Consumer spending is the engine that drives the U.S. economy.
Thus, a softer labor market is consistent with a slower economy. But again, the
dilemma: Can the Fed tighten to curb rising inflation if the labor markets look
soft - particularly in a presidential election year? Policy makers will see one
more month's employment data before their August meeting; that report will
likely help some Fed members make their decision.
Monetary policy during the last year has been extremely erratic. The Fed started
raising interest rates in June of last year, but chose to reverse its policy at
year-end in an attempt to forestall potential Y2K liquidity problems. Although
viewed as a temporary - but necessary - action, the amount of additional
liquidity provided by the Fed was overwhelming. By February, the Fed was
aggressively withdrawing the excess liquidity, pushing reserve growth into
record negative territory. These wide swings in policy probably explain the
unprecedented market volatility experienced during the last six months.
Clearly the Fed has increased short-term interest rates during the last year;
and the economy is beginning to feel the impact of this change. Yet, its just as
clear that monetary policy is not "tight" - at least not in comparison to the
way credit availability was strangled by the Fed at times in the 1980s. This
policy ambiguity - higher rates but adequate credit availability - is consistent
with the mixed data coming from the economy. The policy is also consistent with
the Fed's attempt to "fine tune" the economy onto a less inflationary path
without causing recession.
The markets responded favorably in May to signs of a slowing economy. Investors
viewed the data as a strong signal that the Fed might be done raising interest
rates. This shift in sentiment sparked the rally. Yet investor sentiment is
probably ahead of economic reality. The Fed is likely to nudge rates higher at
the August meeting and then hope they have done enough to achieve a soft
landing.
Please read the Fund Manager's 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.
3
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<PAGE>
FUND MANAGER'S REVIEW
IAI INSTITUTIONAL BOND FUND
IAI INSTITUTIONAL BOND FUND
FUND MANAGEMENT
LARRY R. HILL, CFA
HOW HAS THE FUND PERFORMED?
The Institutional Bond Fund had a return of 0.34% for the six months ended May
31, 2000. This compares with a return for the benchmark, the Lehman Aggregate
Bond Index, of 1.38% for the same time period. The peer group, Lipper A rated
Bond Funds, earned a return of 0.52%.
WERE THERE ANY SIGNIFICANT CHANGES?
We made several strategy changes before year-end 1999 to increase the liquidity
and improve the flexibility of the portfolio. Specifically, the mortgage-backed
and asset-backed sector allocations were eliminated while the corporate and high
yield sector allocations were greatly reduced. These holdings were replaced with
Treasury securities. In addition, the level of cash reserves and long maturities
were both increased while the exposure to the middle part of the yield curve was
reduced. This yield curve structure - commonly referred to as a barbell strategy
- positioned the portfolio to benefit from an inverted yield curve. The duration
strategy did not change appreciably during the period; at the end of November
the portfolio's duration was 5.15 years and at the end of May the duration was
5.21 years.
CAN YOU POINT TO ANY SPECIFIC MARKET FACTORS THAT INFLUENCED THE FUND'S
PERFORMANCE?
In the last six months the U.S. bond market has struggled to produce positive
returns. During this period the Fed has raised short-term interest rates by 1%,
the yield curve has inverted and credit spreads have widened rather
dramatically. This combination of events had a negative impact on the return
generated by both the market and the Fund.
In the IAI Institutional Bond Fund, the greatest negative return impact came
from wider credit spreads. For much of 1999, the Fund followed a strategy of
over weighting those sectors that provide more yield (i.e. investment grade
corporate bonds, high yield issues, mortgage-backed securities and asset-backed
securities) while under weighting Treasury issues. Over the long run this
strategy provides more yield and better value to the shareholders of the Fund.
However, during periods when credit spreads widen, this strategy underperforms
the market.
WHAT IS YOUR OUTLOOK FOR THE FUND?
Recent signs of an economic slowdown have helped reduce interest rates and
shrink credit spreads. With the developing slowdown, investors began to
anticipate the end to further rate increases by the Fed. This shift in sentiment
helped produce a rally in bonds. While economic growth is certainly slowing from
its recently unsustainable level, the depth and durability of the slowdown is
still debatable. At current yield levels, market expectations may be ahead of
the economic reality. Thus, we expect yields and credit spreads to remain in a
broad range until more data is available. Market and portfolio returns could
improve in this environment, but it is still too early to get overly bullish on
bonds. In the portfolio, we plan to maintain ample liquidity and flexibility.
4
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<PAGE>
FUND MANAGER'S REVIEW
IAI INSTITUTIONAL BOND FUND
VALUE OF $2,000,000 INVESTMENT+
[PLOT POINTS CHART]
IAI INSTITUTIONAL LEHMAN BROTHERS
BOND FUND AGGREGATE BOND INDEX
--------- --------------------
$2,000,000 $2,000,000
1,969,914 1,982,986
1,983,107 1,993,734
2,023,572 2,020,653
1,969,973 1,985,548
1,913,071 1,936,597
1,901,464 1,921,133
1,888,717 1,920,864
1,874,629 1,916,619
1,902,248 1,954,689
1,907,954 1,957,114
1,891,546 1,928,310
1,891,924 1,926,592
1,885,303 1,922,313
1,898,877 1,935,586
1,922,613 1,973,891
1,965,872 2,020,823
2,001,847 2,033,220
2,032,475 2,061,620
2,084,100 2,141,399
2,085,559 2,157,100
2,087,853 2,152,283
2,096,831 2,178,259
2,112,557 2,199,451
2,135,795 2,228,055
2,167,191 2,261,442
2,196,882 2,293,179
2,209,185 2,308,408
2,170,082 2,268,284
2,155,976 2,252,517
2,142,394 2,239,849
2,133,396 2,235,299
2,156,223 2,265,252
2,160,320 2,271,369
2,156,863 2,267,507
2,200,863 2,306,962
2,266,889 2,358,177
2,328,322 2,398,501
2,298,287 2,376,200
2,312,766 2,383,476
2,317,623 2,389,406
2,287,725 2,362,929
2,314,034 2,398,300
2,334,860 2,420,971
2,365,914 2,449,705
2,427,664 2,515,767
2,416,254 2,494,307
2,450,082 2,531,093
2,457,432 2,567,812
2,467,753 2,579,636
2,493,665 2,605,691
2,527,828 2,639,044
2,533,136 2,636,932
2,543,776 2,645,898
2,559,801 2,659,657
2,583,864 2,684,923
2,605,568 2,707,745
2,619,117 2,713,432
2,616,236 2,757,660
2,657,311 2,822,190
2,618,780 2,807,232
2,663,037 2,823,233
2,674,755 2,831,703
2,687,861 2,851,808
2,628,997 2,801,901
2,654,235 2,817,312
2,664,587 2,826,327
2,634,477 2,801,456
2,606,815 2,792,491
2,608,379 2,780,763
2,594,294 2,779,372
2,613,751 2,811,613
2,613,489 2,822,016
2,610,615 2,821,734
2,567,278 2,808,189
2,554,699 2,798,922
2,576,669 2,832,789
2,619,442 2,870,182
2,611,846 2,861,859
2,619,159 2,860,428
AVERAGE ANNUAL RETURNS+
THROUGH 5/31/00
Since
Inception
Six Months* 1 Year 5 Years 11/01/93
--------------------------------------------------------------------------------
IAI INSTITUTIONAL BOND FUND 0.34% (0.58)% 4.68% 4.18%
--------------------------------------------------------------------------------
Lehman Brothers Aggregate Bond Index 1.38% 2.11% 5.97% 5.59%
+ PAST PERFORMANCE IS NOT PREDICTIVE OF FUTURE PERFORMANCE.
* NOT ANNUALIZED.
SECTORS
% OF PORTFOLIO AS OF 5/31/00
[PIE CHART]
U.S. GOVERNMENT
AGENCY MORTGAGE-BACKED 14%
SHORT-TERM 29%
U.S. GOVERNMENT &
GOVERNMENT AGENCY 52%
CORPORATE 5%
EFFECTIVE MATURITY
% OF PORTFOLIO AS OF 5/31/00
[BAR CHART]
YEARS
-----
0-3 33%
3-5 37%
5-10 13%
10-20 2%
20+ 15%
NOTE TO FUND MANAGER'S 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 BOND PORTFOLIO AS OF 5/31/00
U.S.
Government ......... 94%
Aaa ................ 0%
Aa ................. 0%
A .................. 1%
Baa ................ 4%
Non-Investment
Grade .............. 1%
5
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<PAGE>
FUND PORTFOLIO
IAI INSTITUTIONAL BOND FUND
MAY 31, 2000
(UNAUDITED)
(PERCENTAGE FIGURES INDICATE PERCENTAGE OF TOTAL NET ASSETS)
<TABLE>
<CAPTION>
CORPORATE BONDS - 4.5%
Principal Market
Rate Maturity Amount Value (a)
--------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
BROADCASTING - 2.2%
Radio Unica (STEP BOND) (d) 16.61% 08/01/06 $50,000 $30,500
Time Warner 6.63 05/15/29 70,000 55,801
-------
86,301
--------------------------------------------------------------------------------------
FINANCIAL - 1.0%
Household Finance 5.88 02/01/09 45,000 38,183
--------------------------------------------------------------------------------------
INDUSTRIAL - 1.3%
Tyco International (YANKEE) (c) 6.88 01/15/29 65,000 52,610
======================================================================================
TOTAL INVESTMENTS IN CORPORATE BONDS
(COST $194,582)............................................................. $177,094
======================================================================================
<CAPTION>
U.S. GOVERNMENT & GOVERNMENT AGENCY OBLIGATIONS - 51.7%
Principal Market
Rate Maturity Amount Value (a)
--------------------------------------------------------------------------------------
FEDERAL HOME LOAN BANK BOND - 6.7%
5.13% 09/15/03 $280,000 $261,959
--------------------------------------------------------------------------------------
U.S. TREASURY BONDS - 25.5%
11.13 08/15/03 385,000 433,365
7.50 11/15/16 80,000 88,650
8.00 11/15/21 200,000 237,625
6.38 08/15/27 165,000 166,805
5.25 02/15/29 80,000 69,875
--------
996,320
--------------------------------------------------------------------------------------
U.S. TREASURY NOTES - 19.5%
4.63 12/31/00 125,000 123,555
6.50 05/15/05 210,000 209,344
6.50 08/15/05 200,000 199,187
7.00 07/15/06 50,000 51,047
6.63 05/15/07 180,000 180,900
--------
764,033
======================================================================================
TOTAL INVESTMENTS IN U.S. GOVERNMENT & GOVERNMENT AGENCY OBLIGATIONS
(COST $2,148,142)......................................................... $2,022,312
======================================================================================
</TABLE>
SEE ACCOMPANYING NOTES TO FUND PORTFOLIO.
6
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<PAGE>
FUND PORTFOLIO
IAI INSTITUTIONAL BOND FUND
MAY 31, 2000
(UNAUDITED)
(PERCENTAGE FIGURES INDICATE PERCENTAGE OF TOTAL NET ASSETS)
<TABLE>
<CAPTION>
U.S. GOVERNMENT AGENCY MORTGAGE-BACKED SECURITY - 13.5%
Principal Market
Rate Maturity Amount Value (a)
--------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
FANNIE MAE - 13.5%
7.13% 02/15/05 $535,000 $529,210
======================================================================================
TOTAL INVESTMENT IN U.S. GOVERNMENT AGENCY MORTGAGE-BACKED SECURITY
(COST $532,475)............................................................. $529,210
======================================================================================
TOTAL INVESTMENTS IN LONG-TERM SECURITIES
(COST $2,875,199)......................................................... $2,728,616
======================================================================================
<CAPTION>
SHORT-TERM SECURITIES - 29.1%
Principal Market
Rate Maturity Amount Value (a)
--------------------------------------------------------------------------------------
FREDDIE MAC DISCOUNT NOTE - 25.5%
5.94% 06/16/00 $1,000,000 $997,358
--------------------------------------------------------------------------------------
U.S. TREASURY BILL - 1.3%
5.86 10/19/00 50,000(b) 48,853
--------------------------------------------------------------------------------------
INVESTMENT COMPANY - 2.3%
Firstar Institutional Money Market Fund 6.04 90,890 90,890
======================================================================================
TOTAL INVESTMENTS IN SHORT-TERM SECURITIES
(COST $1,137,129)......................................................... $1,137,101
======================================================================================
TOTAL INVESTMENTS IN SECURITIES
(COST $4,012,328) (e)..................................................... $3,865,717
======================================================================================
OTHER ASSETS AND LIABILITIES (NET) - 1.2% ................................... $48,840
======================================================================================
TOTAL NET ASSETS ......................................................... $3,914,557
======================================================================================
</TABLE>
SEE ACCOMPANYING NOTES TO FUND PORTFOLIO.
7
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<PAGE>
NOTES TO FUND PORTFOLIO
IAI INSTITUTIONAL BOND FUND
MAY 31, 2000
(UNAUDITED)
(a)
Market value of securities is determined as described in Note 1 to the financial
statements, under "Security Valuation."
(b)
Security is pledged to cover initial margin on open futures contracts (see Note
5 to financial statements).
(c)
Yankee represents dollar-denominated bonds issued in the United States by
foreign banks and corporations.
(d)
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 May 31,
2000, based upon the estimated timing and amount of future interest and
principal payments.
(e)
At May 31, 2000, 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 .............................. $4,012,328
==========
Gross unrealized appreciation ..................................... $ 10,250
Gross unrealized depreciation ..................................... $ (156,861)
----------
Net unrealized depreciation ....................................... $ (146,611)
==========
8
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<PAGE>
STATEMENT OF ASSETS AND LIABILITIES
IAI INSTITUTIONAL BOND FUND
MAY 31, 2000
(UNAUDITED)
<TABLE>
<S> <C> <C>
--------------------------------------------------------------------------------------------
ASSETS
Investments in securities, at market (cost: $4,012,328) $ 3,865,717
Cash 216
Accrued interest receivable 45,102
Variation margin receivable (Note 5) 4,844
------------
TOTAL ASSETS 3,915,879
------------
LIABILITIES
Accrued management fee 1,322
------------
TOTAL LIABILITIES 1,322
------------
NET ASSETS $ 3,914,557
============
NET ASSETS REPRESENTED BY:
Paid in capital $ 8,296,029
Undistributed net investment income 5,310
Accumulated net realized losses on investments (4,245,290)
Unrealized appreciation or depreciation on:
Investment securities $ (146,611)
Futures contracts (Note 5) 5,119 (141,492)
---------- ------------
NET ASSETS $ 3,914,557
============
Shares of capital stock outstanding; authorized 10 billion
shares of $0.01 par value stock 481,774
------------
NET ASSET VALUE PER SHARE OF OUTSTANDING CAPITAL STOCK $ 8.13
============
</TABLE>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
9
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<PAGE>
STATEMENT OF OPERATIONS
IAI INSTITUTIONAL BOND FUND
SIX MONTHS ENDED MAY 31, 2000
(UNAUDITED)
<TABLE>
<S> <C> <C>
---------------------------------------------------------------------------------------------------------------------
NET INVESTMENT INCOME
INCOME:
Interest $ 237,049
Dividends 6,563
------------
TOTAL INCOME 243,612
------------
EXPENSES:
Management fees 16,714
Compensation of Directors 1,556
------------
TOTAL EXPENSES 18,270
Less fees reimbursed by Advisers (1,556)
------------
NET EXPENSES 16,714
------------
NET INVESTMENT INCOME 226,898
------------
NET REALIZED AND UNREALIZED GAINS (LOSSES)
Net realized gains (losses) on:
Investment securities $ (2,005,846)
Futures contracts (72,709)
Foreign currency transactions 9,621
------------
Net realized loss (2,068,934)
Net change in unrealized appreication or depreciation on:
Investment securities $ 1,675,759
Futures contracts 1,444
Other assets and liabilities denominated in foreign currency (6,201)
------------
Net unrealized gain 1,671,002
------------
NET LOSS ON INVESTMENTS, FUTURES CONTRACTS AND FOREIGN CURRENCY TRANSACTIONS (397,932)
------------
NET DECREASE IN NET ASSETS RESULTING FROM OPERATIONS $ (171,034)
============
</TABLE>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
10
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<PAGE>
STATEMENTS OF CHANGES IN NET ASSETS
IAI INSTITUTIONAL BOND FUND
<TABLE>
<CAPTION>
Six months ended
May 31, 2000 Year ended
(unaudited) November 30, 1999
----------------------------------------------------------------------------------------------------
<S> <C> <C>
OPERATIONS
Net investment income $ 226,898 $ 2,947,571
Net realized loss (2,068,934) (2,119,532)
Net change in unrealized appreciation or depreciation 1,671,002 (1,901,901)
------------- -------------
NET DECREASE IN NET ASSETS RESULTING FROM OPERATIONS (171,034) (1,073,862)
------------- -------------
DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income (289,621) (3,188,319)
Capital gains - (2,041,928)
------------- -------------
TOTAL DISTRIBUTIONS (289,621) (5,230,247)
------------- -------------
CAPITAL SHARE TRANSACTIONS
Net proceeds from sale of 2,822 and 544,202 shares 23,033 4,930,731
Net asset value of 34,858 and 586,919 shares issued in
reinvestment of distributions 288,084 5,223,622
Cost of 2,333,872 and 3,483,453 shares redeemed (19,125,474) (29,956,272)
------------- -------------
DECREASE IN NET ASSETS FROM CAPITAL SHARES TRANSACTIONS (18,814,357) (19,801,919)
------------- -------------
TOTAL DECREASE IN NET ASSETS (19,275,012) (26,106,028)
NET ASSETS AT BEGINNING OF PERIOD 23,189,569 49,295,597
------------- -------------
NET ASSETS AT END OF PERIOD $ 3,914,557 $ 23,189,569
============= =============
INCLUDING UNDISTRIBUTED NET INVESTMENT INCOME OF: $ 5,310 $ 79,317
============= =============
</TABLE>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
11
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<PAGE>
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 ARE AS FOLLOWS:
<TABLE>
<CAPTION>
Six months ended Years ended November 30,
May 31, 2000 -----------------------------------------------------------------
(unaudited) 1999 1998 1997 1996 1995
-------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
NET ASSET VALUE
Beginning of period $ 8.35 $ 9.61 $ 9.49 $ 9.54 $ 9.50 $ 8.85
-------- -------- -------- -------- -------- --------
OPERATIONS
Net investment income 0.28*** 0.64** 0.64 0.58 0.63 0.62
Net realized and unrealized
gains (losses) (0.25) (0.82) 0.09 (0.04) 0.04 0.66
-------- -------- -------- -------- -------- --------
TOTAL FROM OPERATIONS 0.03 (0.18) 0.73 0.54 0.67 1.28
-------- -------- -------- -------- -------- --------
DISTRIBUTIONS TO
SHAREHOLDERS
FROM:
Net investment income (0.25) (0.68) (0.61) (0.59) (0.63) (0.63)
Capital gains -- (0.40) -- -- -- --
-------- -------- -------- -------- -------- --------
TOTAL DISTRIBUTIONS (0.25) (1.08) (0.61) (0.59) (0.63) (0.63)
-------- -------- -------- -------- -------- --------
NET ASSET VALUE
End of period $ 8.13 $ 8.35 $ 9.61 $ 9.49 $ 9.54 $ 9.50
======== ======== ======== ======== ======== ========
Total investment return* 0.34% (1.97)% 7.92% 5.97% 7.44% 14.95%
Net assets at end of period
(000's omitted) $ 3,915 $ 23,190 $ 49,296 $108,367 $ 97,085 $101,429
RATIOS
Expenses to average daily net
assets 0.50%**** 0.50% 0.50% 0.50% 0.50% 0.50%
Net investment income to
average daily net assets 6.79%**** 7.06% 6.24% 6.19% 6.75% 6.76%
Portfolio turnover rate
(excluding short-term
securities) 137.6% 162.1% 333.3% 511.0% 323.0% 358.8%
</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.
**NET INVESTMENT INCOME PER SHARE IS CALCULATED USING THE ENDING BALANCE PRIOR
TO CONSIDERATION OF ADJUSTMENTS FOR PERMANENT BOOK AND TAX DIFFERENCES.
***NET INVESTMENT INCOME PER SHARE REPRESENTS NET INVESTMENT INCOME DIVIDED BY
THE AVERAGE SHARES OUTSTANDING THROUGHOUT THE YEAR.
****ANNUALIZED
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
12
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<PAGE>
NOTES TO FINANCIAL STATEMENTS
IAI INSTITUTIONAL BOND FUND
MAY 31, 2000
(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 (Institutional Bond Fund) is a separate portfolio of IAI
Investment Funds I, Inc. The Fund's primary investment objective is to provide
shareholders with a high level of total return derived from a combination of
capital appreciation and current income. The Fund pursues its objective by
investing primarily in a diversified portfolio of U.S. Government securities and
investment- and non-investment-grade bonds and other debt securities of similar
quality. This report covers only 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. Such valuations are obtained from pricing services or are
supplied by dealers.
Debt securities for which quotations are not readily available are valued 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. The 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 purchase
put or call option is adjusted by the amount of premium received or paid.
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
13
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<PAGE>
NOTES TO FINANCIAL STATEMENTS
IAI INSTITUTIONAL BOND FUND
MAY 31, 2000
(UNAUDITED)
[1] SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT.)
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 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.
The Fund may be subject to foreign taxes on income, gains on investments, or
currency repatriation. The Fund accrues such taxes as applicable.
For federal income tax purposes, the Fund has a capital loss carryover of
approximately $2,169,950, at November 30, 1999, which, if not offset by
subsequent capital gains, will expire in 2007. 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 the 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.
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.
14
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<PAGE>
NOTES TO FINANCIAL STATEMENTS
IAI INSTITUTIONAL BOND FUND
MAY 31, 2000
(UNAUDITED)
[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, together with other funds advised by Advisers, have an available joint
line of credit of $25,000,000 with Firstar Bank, N.A. at the prime interest rate
less 2%. To the extent funds are drawn against the line, securities are
segregated by the Fund. No compensating balances are required under the line of
credit, however, a commitment fee of .10% per annum on the commitment amount of
the line is payable quarterly in arrears. Advisers has agreed to pay the
commitment fee on behalf of the Fund. There were no borrowings outstanding for
the Fund at May 31, 2000.
[3] FEES AND EXPENSES
Under the terms of the 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 the Advisers. The fee is equal to an annual rate
of 0.50% 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.
[4] PURCHASE AND SALES OF SECURITIES
For the six months ended May 31, 2000, purchases of securities and sales
proceeds, other than investments in short-term securities, for the Fund were as
follows:
U.S. Government Other
--------------- -----------
Purchases $ 8,232,384 $ 342,968
Sales $16,522,522 $11,183,453
[5] OPEN FUTURES CONTRACTS
The financial futures contracts shown below were open as of May 31, 2000. The
market value of securities deposited to cover initial margin requirements for
the open positions at May 31, 2000 was $48,853. The unrealized appreciation on
this contract is included in unrealized appreciation on futures contracts.
FUTURES
Number
of Market Unrealized
Type Contracts Expiration Month Position Value Appreciation
--------------------------------------------------------------------------------
U.S. Treasury Bond 5 September 2000 Long $478,125 $5,119
15
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16
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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
Firstar Bank, N.A.
425 Walnut Street
Cincinnati, OH 45202
LEGAL COUNSEL
Dorsey & Whitney LLP
220 South Sixth Street
Minneapolis, MN 55402
INDEPENDENT AUDITORS
KPMG 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
c/o FIRSTAR MUTUAL FUND SERVICES, LLC, P.O. Box 701, Milwaukee,
Wisconsin 53201-0701 USA
800.945.3863
