AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON APRIL 25, 1996.
FILE NO. 2-82710
ICA NO. 811-3032
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM N-1A
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 [X]
PRE-EFFECTIVE AMENDMENT NO. _____ [ ]
POST-EFFECTIVE AMENDMENT NO. 18 [X]
AND
REGISTRATION STATEMENT UNDER THE
INVESTMENT COMPANY ACT OF 1940 [X]
AMENDMENT NO. 16 [X]
FUNDAMENTAL FUNDS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN CHARTER)
90 WASHINGTON STREET
19TH FLOOR
NEW YORK, NEW YORK 10006
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE)
(212) 635-3000
(AREA CODE AND TELEPHONE NUMBER)
COPIES TO:
VINCENT J. MALANGA CARL FRISCHLING, ESQ.
90 WASHINGTON STREET KRAMER, LEVIN, NAFTALIS,
19TH FLOOR NESSEN, KAMIN & FRANKEL
NEW YORK, NEW YORK 10006 919 THIRD AVENUE
NEW YORK, NEW YORK 10022
- --------------------------------------------------------------------------------
(NAME AND ADDRESS OF AGENT FOR SERVICE)
IT IS PROPOSED THAT THIS FILING WILL BECOME EFFECTIVE:
|X| IMMEDIATELY UPON FILING PURSUANT TO |_| ON ( ) PURSUANT TO
PARAGRAPH (B) PARAGRAPH (B)
|_| 60 DAYS AFTER FILING PURSUANT TO |_| ON ( ) PURSUANT TO
PARAGRAPH (A)(1) PARAGRAPH (A)(1)
|_| 75 DAYS AFTER FILING PURSUANT TO |_| ON ( ) PURSUANT TO
PARAGRAPH (A)(2) OF PARAGRAPH (A)(2) RULE 485.
IF APPROPRIATE, CHECK THE FOLLOWING BOX:
|_| THIS POST-EFFECTIVE AMENDMENT DESIGNATES A NEW EFFECTIVE DATE FOR A
PREVIOUSLY FILED POST- EFFECTIVE AMENDMENT.
REGISTRANT HAS REGISTERED AN INDEFINITE NUMBER OF SHARES PURSUANT TO RULE 24F-2
AND ITS RULE 24F-2 NOTICE FOR ITS 1995 FISCAL YEAR WAS FILED ON FEBRUARY 23,
1996, IN ACCORDANCE WITH RULE 24F-2.
<PAGE>
NEW YORK MUNI FUND
REGISTRATION STATEMENT ON FORM N-1A
CROSS REFERENCE SHEET
Form N-1A
Item Number
- -----------
Part A Prospectus Caption
- ------ ------------------
1. Cover Page
2. Highlights; Fee Table
3. Financial Highlights
4. Investment Objective and Policies; Investment
Strategies; Special Risks; General
Information
5.(a) Management
(b) Management
(c) *
(d) General Information
(e) Management
(f) See statement of additional information under
Portfolio Transactions
6.(a) General Information
(b) *
(c) *
(d) *
(e) Cover Page; General Information
(f) Dividends and Tax Status
(g) Dividends and Tax Status
7.(a) *
(b) Determination of Net Asset Value
(c) Purchase of Shares - Exchange Privilege
(d) Purchase of Shares
(e) *
(f) Distribution Expenses
8. Redemption of Shares
9. *
Part B Statement Caption
- ------ -----------------
10. Cover Page
11. Table of Contents
12. *
13. Investment Objectives; Policies and
Restrictions; Additional Information Relating
to Municipal Obligations; Additional
Information Concerning New York Issuers
14. Management of the Fund
15. *
<PAGE>
16.(a) Management of the Fund
(b) Management of the Fund
(c) *
(d) *
(e) *
(f) Distribution Plan
(g) *
(h) Custodian and Independent Accountants
(i) *
17.(a) Portfolio Transactions
(b) Portfolio Transactions
(c) Portfolio Transactions
(d) *
(e) *
18. See prospectus under General Information
19.(a) See prospectus under Purchase of Shares
(b) See prospectus under Determination of Net
Asset Value
(c) *
20. Tax Matters
21. *
22. Calculation of Yield
23. Financial Statements
Part C Information required to be included in Part C is
- ------ set forth under the appropriate item, so
numbered, in Part C to this Registration
Statement
- ----------------------------
*Not Applicable
<PAGE>
NEW YORK MUNI FUND
90 Washington Street
New York, New York 10006
1-800-225-6864
New York Muni Fund, "New York's First Triple Tax-Free Mutual Fund", (the
"Fund") is a series of Fundamental Funds, Inc. (the "Company"), a Maryland
corporation. The Fund seeks to provide a high level of income that is excluded
from gross income for Federal income tax purposes and exempt from New York State
and New York City personal income taxes and is consistent with the preservation
of capital. Under normal market conditions, at least 80% of the Fund's assets
will be invested in securities that are free from Federal, New York State and
New York City income taxes. Of course, there can be no assurance that the Fund's
investment objective will be achieved.
The Fund intends to achieve its objective by investing substantially all
(and at least 80%) of its total assets in municipal obligations of New York
State, its political subdivisions, and its other duly constituted authorities
and corporations, that are rated within the four highest quality grades for
bonds as determined by Moody's Investors Service, Inc. ("Moody's"), Standard &
Poor's Corporation ("S&P"), Fitch Investors Service, Inc. ("Fitch") or Duff &
Phelps, Inc. ("Duff") or within the three highest quality grades for municipal
notes as determined by Moody's, S&P, Fitch or Duff or, if unrated, are judged by
Fund management to be of comparable quality. While municipal obligations in
these categories are generally deemed to have adequate to very strong protection
of principal and interest, municipal obligations rated within the lowest of
these categories have speculative characteristics as well.
This Prospectus provides you with the basic information you should know
before investing in the Fund. You should read it and keep it for future
reference. A Statement of Additional Information containing additional
information about the Fund has been filed with the Securities and Exchange
Commission. You may obtain a copy of the Statement without charge by writing to
the Fund at the address listed above, or by calling (800) 322-6864. Shareholder
inquiries may also be placed through this number.
<TABLE>
<CAPTION>
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TABLE OF CONTENTS
<S> <C>
Highlights .................................. 2 Purchase of Shares .......................... 17
Fee Table ................................... 3 Redemption of Shares ........................ 19
Financial Highlights ........................ 4 Determination of Net Asset Value ............ 22
Investment Objective and Policies ........... 5 Distribution Expenses ....................... 22
Investment Strategies ....................... 7 Management .................................. 23
Special Risks ............................... 13 Dividends and Tax Status .................... 25
Calculation of Yield and Performance Data ... 16 General Information ......................... 27
- ---------------------------------------------------------------------------------------------------------
</TABLE>
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
THE STATEMENT OF ADDITIONAL INFORMATION DATED APRIL 25, 1996 IS HEREBY
INCORPORATED BY REFERENCE INTO THIS PROSPECTUS.
PROSPECTUS DATED APRIL 25, 1996
<PAGE>
HIGHLIGHTS
What is New York Muni Fund?
New York Muni Fund is a non-diversified mutual fund which seeks to provide a
high level of income that is excluded from gross income for Federal income tax
purposes and exempt from New York State and New York City personal income taxes
and is consistent with the preservation of capital.
Management
New York Muni Fund, America's Oldest Triple Tax-Free Fund, is a member of
the Fundamental Family of Funds. Fundamental Portfolio Advisors, Inc. is the
Fund's investment manager.
Dr. Lance Brofman founded the New York Muni Fund in 1981. Dr. Brofman
received an M.B.A. and a Ph.D. in Economics and Finance from New York University
in 1978. He is currently the Chief Portfolio Strategist for the Fundamental
Family of Funds and is supervised by Dr. Vincent J. Malanga, the Chief Executive
Officer, President and Treasurer of the Fund. Investment Risks
To achieve its objective, the Fund invests primarily in municipal
obligations of New York issuers that are rated within the four highest quality
grades for bonds as determined by Moody's, S&P, Fitch or Duff or within the
three highest quality grades for municipal notes as determined by Moody's, S&P,
Fitch or Duff or, if unrated, are judged by Fund management to be of comparable
quality. While municipal obligations in these categories are generally deemed to
have adequate to very strong protection of principal and interest, municipal
obligations in the lowest of these categories have speculative characteristics
as well (see "Investment Objective and Policies" and "Special Risks").
In addition, the Fund may employ various investment strategies and
techniques which are designed to enhance income and liquidity or attempt to
hedge against market fluctuation and risk, such as buying and selling interest
rate futures contracts ("futures contracts"), using options to purchase or sell
such contracts, using options to purchase or sell debt securities, and writing
covered call options and cash-secured puts (see "Investment Strategies"). Such
strategies themselves involve certain additional risks (see "Special Risks").
Moreover, there are additional risk considerations associated with certain other
investment policies of, and strategies employed by, the Fund, such as those
relating to concentration of investments in New York issuers, investing in
variable and floating rate instruments, zero coupon bonds, pay-in-kind bonds,
lower quality municipal obligations, illiquid securities and borrowing for
investment (see "Investment Strategies" and "Special Risks").
Tax-Free Income
The interest earned by the Fund from municipal obligations that is paid as
exempt-interest dividends is not includable in your gross income for Federal
income tax purposes. Moreover, to the extent that dividends on shares of the
Fund are derived from interest received by the Fund on obligations of New York
and its political subdivisions, such dividends will also be exempt from a New
York shareholder's gross income for New York State and New York City personal
income tax purposes (see "Dividends and Tax Status"). You should recognize,
however, that the Fund's investment in municipal obligations of New York issuers
may involve inherent risks (see "Special Risks").
How to Buy and Sell Shares of the Fund?
Shares of the Fund may be purchased on a continuous basis without any sales
charge at the next determined net asset value per share (see "Purchase of
Shares" and "Determination of Net Asset Value"). Your purchase order becomes
effective immediately if it is received before 4:00 P.M. on any business day.
Shares are redeemable (may be sold) at your option without charge at the
next determined net asset value per share (see "Redemption of Shares"). The Fund
reserves the right, however, to liquidate an account with a value of less than
$100 on 60 days' notice.
Shareholder Services and Privileges
For your convenience, the Fund provides certain services and privileges
which we have suited to your particular needs, including the Automatic
Investment Program and the Exchange, Check Redemption, Telephone Redemption and
Expedited Redemption Privileges (see "Purchase of Shares" and "Redemption of
Shares").
2
<PAGE>
Monthly Dividends
The Fund declares dividends daily and pays them on a monthly basis,
eliminating the need for you to hold your shares until quarter-end to receive
dividend income. Dividends are automatically reinvested at net asset value in
additional Fund shares without any charge. You may elect, however, to receive
them in cash (see "Dividends and Tax Status"). Management and The Fundamental
Family of Funds
Fundamental Portfolio Advisors, Inc., 90 Washington Street, New York, New
York 10006, the Fund's investment manager (the "Manager") determines overall
investment strategy for the Fund and provides the Fund with all necessary office
facilities, equipment and personnel for managing the Fund's affairs and
investments (see "Management").
The Manager also acts as investment manager to several other mutual fund
portfolios in The Fundamental Family of Funds, including The California Muni
Fund, and the High-Yield Municipal Bond Series, the Tax-Free Money Market Series
and the Fundamental U.S. Government Strategic Income Fund Series of Fundamental
Fixed-Income Fund. Shares of such funds are exchangeable for shares of the Fund
(minimum $1,000 value) at the respective net asset values per share without any
charge and may be exchanged by telephone (see "Purchase of Shares").
FEE TABLE
Shareholder Transaction Expenses
- --------------------------------------------------------------------------------
Sales Load Imposed on Purchases .......................... None
Sales Load Imposed on Reinvested Dividends ............... None
Redemption Fees .......................................... None
Exchange Fees ............................................ None
Annual Fund Expenses (as a percentage of average net assets)
- --------------------------------------------------------------------------------
Management Fees .......................................... .49%
12b-1 Fees1 .............................................. .50%
Other Expenses:
Interest ............................................... 2.09%
Other .................................................. .56%
----
Total Fund Expenses ...................................... 3.64%
====
Example: You would pay the following expenses on a $1,000 investment,
assuming (1) 5% annual return and (2) redemption at the end of each time period:
1 year 3 years 5 years 10 years
$37 $111 $188 $390
The purpose of the foregoing table is to assist you in understanding the
various costs and expenses that you will bear directly and indirectly. (For more
complete descriptions of the various costs and expenses, see "Management",
"Distribution Expenses" and the Financial Statements included at the end of the
Fund's Statement of Additional Information.) The expenses and example appearing
in the preceding table have been restated to reflect current fees and operating
expenses. The example shown in the table should not be considered a
representation of past or future expenses, and actual expenses may be greater or
less than those shown.
- ------------
1As a result of distribution fees of .50% per annum of the Fund's average daily
net assets, a long-term shareholder may pay more than the economic equivalent
of the maximum front-end sales charges permitted by the Rules of the National
Association of Securities Dealers, Inc.
3
<PAGE>
FINANCIAL HIGHLIGHTS
The following selected per share data and ratios for each of the years in
the ten-year period ended December 31, 1995 has been audited by McGladrey &
Pullen, LLP, independent certified public accountants whose report on the
Financial Statements and the related notes appear at the end of the Fund's
Statement of Additional Information.
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1995 1994 1993 1992 1991 1990 1989 1988 1987 1986**
---- ---- ---- ---- ---- ---- ---- ---- ---- ----
PER SHARE OPERATING PERFORMANCE
(for a share outstanding throughout the period)
Net Asset Value, Beginning of year ...... $0.88 $1.18 $1.21 $1.14 $1.04 $1.12 $1.09 $1.05 $1.25 $1.19
----- ----- ----- ----- ----- ----- ----- ----- ----- -----
Income from investment operations:
Net investment income ................. .035 .056 .065 .061 .059 .069 .072 .074 .078 .085
Net realized and unrealized gain
(loss) on investments ............... .101 (.290) .082 .070 .100 (.080) .031 .040 (.167) .120
----- ----- ----- ----- ----- ----- ----- ----- ----- -----
Total from investment
operations .................... .136 (.234) .147 .131 .159 (.011) .103 .114 (.089) .205
----- ----- ----- ----- ----- ----- ----- ----- ----- -----
Less: Distributions:
Dividends from net investment income .. (.035) (.056) (.065) (.060) (.059) (.069) (.072) (.074) (.078) (.085)
Dividends from net realized gains ..... (.001) (.010) (.112) (.001) - - - - (.030) (.055)
----- ----- ----- ----- ----- ----- ----- ----- ----- -----
Total distributions (.036) (.066) (.177) (.061) (.059) (.069) (.072) (.074) (.108) (.140)
Net Asset Value, End of year $0.98 $0.88 $1.18 $1.21 $1.14 $1.04 $1.12 $1.09 $1.05 $1.25
===== ===== ===== ===== ===== ===== ===== ===== ===== =====
Total Return 15.67 (20.47%) 12.58% 11.83% 15.73% (.99%) 9.60% 11.22% (7.44%) 17.62%
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (000) .........$226,692 $212,665 $275,552 $196,516 $183,307 $182,282 $236,525 $230,356 $219,872 $260,271
Ratios to Average Net Assets:
Interest expenses ..................... 2.09% 1.59% .61% .19% .09% .17% .35% .55% .72% .34%
Operating expenses .................... 1.55% 1.62% 1.44% 1.50% 1.69% 1.48% 1.34% 1.19% 1.32% 1.14%
----- ----- ----- ----- ----- ----- ----- ----- ----- -----
Total expenses .................. 3.64% 3.21% 2.05% 1.69% 1.78% 1.65% 1.69% 1.74% 2.04% 1.48%
==== ==== ==== ==== ==== ==== ==== ==== ==== ====
Net investment income ........... 3.81% 5.34% 5.20% 5.16% 5.47% 6.43% 6.47% 6.94% 6.97% 6.91%
Portfolio turnover rate 347.50% 289.69% 404.05% 460.58% 365.12% 482.58% 386.48% 462.73% 548.50% 333.60%
BANK LOANS
Amount outstanding at end of period
(000 omitted) ......................... $64,575 $20,000 $20,873 $725 - $248 $9,758 - $1,660 $8,000
Average amount of bank loans
outstanding during the year
(000 omitted) ......................... $49,603 $54,479 $24,100 $5,194 $1,483* $4,767* $9,581* $11,500* 24,000* $10,000*
Average number of shares outstanding
during the year (000 omitted) ......... 191,692 206,323 184,664 161,404 167,206* 209,484* 211,210* 212,394*228,740* 180,195*
Average amount of debt per share
during the year ....................... .259 $ .264 $ .131 $ .032 $ .009 $ .023 $ .045 $ .054 $ .105 $.056
- --------
*Based on monthly averages.
**The Fund changed managers on October 1, 1986.
</TABLE>
4
<PAGE>
INVESTMENT OBJECTIVE AND POLICIES
The Fund's fundamental investment objective is to provide you with a high
level of income that is excluded from gross income for Federal income tax
purposes and exempt from New York State and New York City personal income taxes
and is consistent with the preservation of capital. Under normal market
conditions, at least 80% of the Fund's assets will be invested in securities
that are free from Federal, New York State and New York City income taxes.
The Fund attempts to achieve its objective by investing substantially all
(at least 80%) of its total assets in municipal obligations which are rated
within the four highest quality grades for bonds as determined by Moody's, S&P,
Fitch or Duff or within the three highest quality grades for municipal notes as
determined by Moody's, S&P, Fitch or Duff or, if unrated, are judged by Fund
management to be of comparable quality, and which are issued by the State of New
York, its political subdivisions, and its other duly constituted authorities and
corporations, the interest from which, in the opinion of counsel to the issuer,
is totally excluded from gross income for Federal income tax purposes, does not
constitute a preference item and, therefore, will not be subject to the Federal
alternative minimum tax on individuals and is exempt from New York State and New
York City personal income taxes. At least 65% of the value of the Fund's net
assets (except when maintaining a temporary defensive position) will be invested
in New York municipal obligations. There can be no assurance that the Fund's
objective will be achieved. The Fund's ability to achieve its objective is
subject to the continuing ability of the issuers of municipal obligations to
meet their principal and interest payments, and is further subject to
fluctuations in interest rates as well as other factors.
While the municipal obligations in which the Fund may invest are generally
deemed to have adequate to very strong protection of principal and interest,
those rated within the lowest of the quality grades described above are
considered medium-grade obligations which have speculative characteristics as
well. For example, obligations rated Baa by Moody's have been determined by
Moody's to be neither highly protected nor poorly secured, and although interest
payments and principal security appear adequate for the present, certain
protective elements may be lacking or may be characteristically unreliable over
any great length of time. Similarly, obligations rated BBB by S&P, Fitch or Duff
are regarded by S&P, Fitch and Duff as having adequate capacity to pay interest
and repay principal, and while such obligations normally exhibit adequate
protection parameters, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity to pay interest and repay principal
for obligations in this category than in higher rated categories.
Although the Fund intends to invest primarily in higher quality municipal
obligations as described above, up to 10% of its total assets may be invested in
municipal obligations rated lower than Baa by Moody's or BBB by S&P, Fitch or
Duff and as low as Caa by Moody's or CC by S&P, Fitch or Duff, or if unrated,
are judged by Fund management to be of comparable quality. Investments rated Ba
or lower by Moody's and BB or lower by S&P, Fitch or Duff normally provide
higher yields, but involve greater risk because of their speculative
characteristics and are commonly referred to as "junk bonds." (See "Special
Risks-Special Risk Factors Relating to Lower Rated Securities.")
It should be noted that ratings are general and not absolute standards of
quality or guarantees of the creditworthiness of an issuer. The ratings of
Moody's, S&P, Fitch and Duff represent their opinions as to the quality of the
municipal obligations which they undertake to rate. It should be emphasized,
however, that ratings are relative and subjective and, although ratings may be
useful in evaluating the safety of interest and principal payments, they do not
evaluate the market value risk of these bonds. Therefore, although these ratings
may be an initial criterion for selection of portfolio investments, the Manager
also will evaluate these securities and the ability of the issuers of such
securities to pay interest and principal. The Fund's ability to achieve its
investment objective may be more dependent on the Manager's credit analysis than
might be the case for a fund that invested in higher rated securities only. Once
the rating of a portfolio security or the quality determination ascribed by Fund
management to an unrated portfolio security has been downgraded, the Fund will
consider all circumstances deemed relevant in determining whether to continue to
hold the security, but in no event will the Fund retain such securities if it
would cause the Fund to have 20% of the value of its total assets invested in
securities rated lower than Baa by Moody's or BBB by S&P, Fitch or Duff, or if
unrated, are judged by Fund management to be of
5
<PAGE>
comparable quality. The purchase of unrated securities is subject to guidelines
that may be set for Fund management from time to time by the Fund's Board of
Directors. A description of the ratings of municipal obligations as determined
by Moody's, S&P, Fitch and Duff is included in the Statement of Additional
Information. (See the Appendix to this Prospectus for a summary of the Fund's
asset composition, based on the monthly weighted average of credit ratings of
its portfolio securities.)
The Fund invests in municipal obligations that have remaining maturities
ranging from short-term maturities (less than one year) to long-term maturities
(in excess of fifteen years). Depending on market conditions, the Fund attempts
to achieve a favorable tradeoff between longer maturities that have higher
income as opposed to shorter maturities with relatively less income. Because the
Fund may purchase bonds that mature in more than one year, invests in inverse
floating variable rate bonds, assumes some credit risk and does not have a
stable net asset value (the value of its shares fluctuates), it is not a money
market fund. The longer the maturity of a municipal obligation, the greater the
impact of fluctuating interest rates on the market value of the instrument. In
periods of rising interest rates, the market value of municipal obligations
generally declines in order to bring the current yield in line with prevailing
interest rates. Conversely, in periods of declining interest rates, the market
value of municipal obligations generally rises. Although fluctuating interest
rates affect the market value of all municipal obligations, short-term
obligations are generally less sensitive to such factors than long-term
obligations. During periods of rapidly rising interest rates, the Fund intends
to adopt various corrective measures (i.e., shortening the average length of
maturities of portfolio securities, raising the overall quality of portfolio
investments) in order to minimize the effect of such rates on per share net
asset value during such periods.
As a non-diversified investment company, the Fund could conceivably invest
all of its assets in one issuer. However, in order to qualify as a "regulated
investment company" for Federal income tax purposes, the Fund must comply with
the provisions of Subchapter M of the Internal Revenue Code of 1986, as amended
(the "Code"), which limit the aggregate value of all holdings (except U.S.
Government and cash items, as defined in the Code), each of which exceeds 5% of
the Fund's total assets, to an aggregate amount of 50% of such assets, and which
further limit the holdings of a single issuer (with the same exceptions) to 25%
of the Fund's total assets. Therefore, for our purposes, non-diversification
means that, with regard to the Fund's total assets, 50% of such assets may be
invested in as few as two single issuers. (These limits are measured at the end
of each quarter.) In the event of decline of creditworthiness or default on the
obligations of one or more such issuers exceeding 5%, an investment in the Fund
will involve greater risk than in a fund that has a policy of diversification.
Many of the Fund's portfolio securities will be obligations which are
related in such a way that an economic, business or political development or
change affecting one such security also would affect the other portfolio
securities (e.g., securities the interest on which is paid from revenues of
similar types of projects). As a result, the Fund's portfolio may be subject to
greater risk as compared to a portfolio composed of more varied obligations or
issuers. Furthermore, the relatively high degree of similarities among the
issuers of obligations in the Fund's portfolio may result in a greater degree of
fluctuation in the market value of the portfolio. To offset such fluctuations,
Fund management will attempt to adopt a temporary defensive posture during
periods of economic difficulty affecting either the economy as a whole or, more
specifically, individual issuers involved in the Fund's portfolio. Such practice
may include, among other modifications, reducing or eliminating holdings in
securities of issuers such as state and local governments which the Fund
believes may be adversely affected by changing economic conditions or political
events, shortening average maturity and/or upgrading the average quality of the
Fund's portfolio. These defensive measures may have the effect of reducing the
income to the Fund from the portfolio. Moreover, notwithstanding the imposition
of such measures, Fund management may not be able to foresee developments in the
economy sufficiently in advance to avoid significant declines in market value.
To the extent that the Fund is in a temporary defensive posture, the Fund's
objective may not be achieved.
Municipal Obligations
Municipal obligations include debt obligations of states, territories and
possessions of the United States and of any political subdivisions thereof, such
as counties, cities, towns, districts and authorities. Municipal obligations are
issued to raise funds for a variety of purposes, including construction of a
wide range of public facilities, refunding of outstanding obligations, obtaining
funds
6
<PAGE>
for general operating expenses, and lending to other public institutions and
facilities. In addition, certain types of qualified private activity bonds are
issued by, or on behalf of, public authorities to obtain funds for privately
operated facilities.
Also included within the definition of municipal obligations are short-term,
tax-exempt debt obligations, known as municipal notes, which are generally
issued in anticipation of receipt by the issuer of revenues from taxes, the
issuance of longer term bonds, or other sources. States, municipalities, and
other issuers of tax-exempt securities may also issue short-term debt, often for
general purposes, known as "municipal commercial paper." All of these
obligations (excluding those just referred to as "municipal commercial paper")
are included within the term "municipal obligations," as used in this
Prospectus, if their interest payments are excluded for Federal income tax
purposes.
Yields on municipal obligations depend on a variety of factors, including
the general condition of the money and municipal securities markets, the size of
a particular offering, the maturity of the obligation and the rating of the
issue. Unlike other types of securities, municipal obligations have
traditionally not been subject to regulation by, or registration with, the
Securities and Exchange Commission.
The two principal classifications of municipal obligations are general
obligation bonds and revenue bonds. General obligation bonds are secured by the
issuer's pledge of its full faith, credit and taxing power for the payment of
principal and interest. Revenue bonds are payable from only the revenues derived
from a particular facility or class of facilities or, in some cases, from the
proceeds of a special excise tax or other specific revenue source. Qualified
private activity bonds that are municipal obligations are, in most cases,
revenue bonds and do not generally constitute the pledge of the credit of the
issuer of such bonds. The credit quality of qualified private activity bonds is
usually related to the credit standing of the industrial user involved. The Fund
reserves the right to invest up to 20% of its total assets in qualified private
activity bonds, if such bonds meet the Fund's investment criteria.
There are also a variety of hybrid and special types of municipal
obligations, as well as numerous differences in the security of municipal
obligations, both within and between the two principal classifications described
above (see the Statement of Additional Information for more details).
Portfolio Transactions and Turnover
The Manager provides the Fund with investment advice and recommendations for
the purchase and sale of portfolio securities. All orders for the purchase and
sale of portfolio securities are placed by the Manager, subject to the general
control of the Fund's directors. The Manager may sell portfolio securities prior
to their maturity if market conditions and other considerations indicate, in the
opinion of the Manager, that such sale would be advisable. In addition, the
Manager may engage in short-term trading when it believes it is consistent with
the Fund's investment objective. Also, a security may be sold and another of
comparable quality may be simultaneously purchased to take advantage of what the
Manager believes to be a temporary disparity in the normal yield relationships
of two securities. The frequency of portfolio transactions-the Fund's turnover
rates-will vary from year to year depending upon market conditions. Because a
high turnover rate (over 100%) increases transaction costs and the possibility
of taxable short-term gains (see "Dividends and Tax Status"), the Manager weighs
the added costs of short-term investment against anticipated gains. The Fund's
portfolio turnover rate was approximately 290% for the year ended December 31,
1994, and was approximately 347% for the year ended December 31, 1995.
INVESTMENT STRATEGIES
In seeking to achieve its investment objective, the Fund utilizes various
investment strategies, including borrowing to purchase additional securities,
investing in participation interests, variable and floating rate instruments,
purchasing municipal obligations that are offered on a "when-issued" or "delayed
delivery" basis and, when deemed necessary in the opinion of Fund management,
making temporary investments in certain taxable obligations, as described below.
The Fund's fundamental investment restrictions
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also permit buying and selling of interest rate futures contracts ("futures
contracts"), using options to purchase or sell such contracts, using options to
purchase or sell debt securities, and writing covered call options and
cash-secured puts. Futures contracts and options are used by the Fund only as a
defensive measure (i.e., as a hedge and not for speculation) on the Manager's
advice. The use of options and futures contracts may benefit the Fund and its
shareholders by improving the Fund's liquidity and by helping to stabilize the
value of its net assets. In addition, the Fund's fundamental investment
restrictions have been recently amended to permit the Fund to enter into
repurchase agreement and reverse repurchase agreement transactions, to lend its
portfolio securities and to invest up to 15% of its net assets in illiquid
securities.
Each investment strategy is briefly described below with a short example of
how it can be used by the Fund.
Futures Contracts
A futures contract is an agreement between two parties to buy and sell a
security for a set price on a future date. Futures contracts are traded on
designated "contract markets" which, through their clearing corporations,
guarantee performance of the contracts. Presently, there are futures contracts
based on such debt securities as long-term U.S. Treasury Bonds, Treasury Notes,
Government National Mortgage Association modified pass-through mortgage-backed
securities, three-month U.S. Treasury Bills, and bank certificates of deposit.
Although most futures contracts call for actual delivery or acceptance of debt
securities, the contracts usually are closed out before the settlement date
without the making or taking of delivery. A futures contract sale is closed out
by effecting a futures contract purchase for the same aggregate amount of the
specific type of debt security and the same delivery date. If the sale price
exceeds the offsetting purchase price, the seller would be paid the difference
and would realize a gain. If the offsetting purchase price exceeds the sale
price, the seller would pay the difference and would realize a loss. Similarly,
a futures contract purchase is closed out by effecting a futures contract sale
for the same aggregate amount of the specific type of debt security and the same
delivery date. If the offsetting sale price exceeds the purchase price, the
purchaser would realize a gain, whereas if the purchase price exceeds the
offsetting sale price, the purchaser would realize a loss. There is no assurance
that the Fund will be able to enter into a closing transaction. In the unlikely
event that the Fund was unable to enter into a closing transaction of an open
futures or options position, the Fund could be forced to perform certain actions
as specified by the futures or options contract. This would depend on the type
of outstanding contract involved. The two types of methods by which futures and
options contracts are closed in the absence of offsetting trades are by index
value and by delivery.
Futures and options contracts in financial instruments such as municipal
bonds and LIBOR rates, settle by index value. That means that on the last
trading day of the contract, all outstanding contracts are automatically closed
out at the value of the index that day. The effect on the Fund would be exactly
the same as if a closing transaction had been effected at that price.
Futures and options in financial instruments such as Treasury bonds and
notes, if not closed out, will result in actual delivery of the securities in
question. The holder of a long futures contract or an option contract that was
exercised could be forced to purchase (take delivery of) a specified amount of
securities at a specified price. Likewise the entity that was short a futures
contract or option that did not enter into a closing transaction prior to
expiration, could be forced to deliver a specific amount of securities at a
specified price according to the terms of the futures or option contract.
The inability of the Fund to enter into a closing contract could result in
the Fund being forced to deliver or take delivery of a specific amount of
securities at a specific price. Disposing of or obtaining the specified
securities could involve considerable expense to the Fund and could affect the
Fund's net asset value.
When the futures contract is entered into, each party deposits with a broker
or in a segregated custodial account approximately 5% of the contract amount,
called the "initial margin." The segregated custodial account will be in an
amount equal to the total market value of the futures contract, less the initial
margin deposited therefor. Subsequent payments to and from the broker or
account, called "variation margin," will be made on a daily basis as the price
of the underlying debt security fluctuates making the long and short positions
of the futures contract more or less valuable, a process known as "mark to the
market."
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The purpose of a futures contract, in the case of a portfolio holding
long-term municipal debt securities, is to gain the benefit of changes in
interest rates without actually buying or selling long-term debt securities.
Generally, if market interest rates increase, the value of outstanding debt
securities declines (and vice versa). Entering into a futures contract for the
sale of debt securities has an effect similar to the actual sale of such
securities, although the sale of the futures contract might be accomplished more
easily and quickly given the greater liquidity in the futures market. For
example, if the Fund holds long-term debt securities and it anticipates a rise
in long-term interest rates, it could, in lieu of disposing of its portfolio
securities, enter into futures contracts for the sale of similar long-term
securities. If rates increased and the value of the Fund's portfolio securities
declined, the value of the Fund's futures contracts would increase, thereby
protecting the Fund by preventing net asset value from declining as much as it
otherwise would have declined. Similarly, entering into futures contracts for
the purchase of debt securities has an effect similar to the actual purchase of
the underlying securities, but permits the continued holding of securities other
than the underlying securities. For example, if the Fund expects long-term
interest rates to decline, it might enter into futures contracts for the
purchase of long-term securities in order to gain rapid market exposure that may
offset anticipated increases in the cost of securities it intends to purchase,
while continuing to hold higher-yield, short-term securities or waiting for the
long-term market to stabilize. The Board of Directors has adopted a percentage
restriction limiting the aggregate market value of the futures contracts the
Fund holds to an amount not to exceed 20% of the market value of its total
assets.
Options
An option gives the holder a right to buy or sell futures contracts, or
securities, in the future. The Fund will only buy options listed on national
securities exchanges except for agreements, sometimes called cash puts, which
may accompany the purchase of a new issue of bonds from a dealer. Unlike a
futures contract, which requires the parties to the contract to buy and sell a
security on a set date, an option on a futures contract, for example, merely
entitles its holder to decide on or before a future date whether to enter into
such a contract. If the holder decides not to enter into the contract, all that
is lost is the price, called the "premium," paid for the option. Further,
because the value of the option is fixed at the point of sale, there are no
daily cash payments to reflect the change in the value of the underlying
contract. However, since an option gives the buyer the right to enter into a
contract at a set price for a fixed period of time, its value does change daily,
and the change is reflected in the net asset value of the Fund.
In addition to options on futures contracts, there are options that give the
buyer the right to buy or sell actual debt securities, such as tax-exempt bonds.
Currently, the market for options on tax-exempt securities is very small. It is
anticipated that it will become substantially larger in the future. A put option
gives the buyer of the option the right to sell a designated security for a set
price, and a call option gives the buyer the right to buy a security for a set
price on or before a specified date. The "writer," or seller, of a call option,
for example, is required to sell the security described in the option to the
holder of the option, if the holder decides to buy such security. For
undertaking this obligation, the writer receives a premium, less the commission
charged by a broker, which the writer retains regardless of whether the option
is exercised. The Fund will only write call options on securities it holds in
its portfolio, (referred to as covered call writing) or will write "cash secured
puts," as defined below. The buyer of such a put pays the Fund a premium for the
option to sell to the Fund a specific bond at a specified price within a
specified period of time. The Fund will maintain adequate cash reserves to
purchase the underlying bond should the put option be exercised, by placing in a
segregated account, only liquid assets, such as cash, U.S. Government securities
or other appropriate high-grade debt obligations ("cash secured puts"). The Fund
retains the premium whether or not the option is exercised. However, the Fund
will be obligated to purchase the bond at the exercise price regardless of how
much the market value of the bond has declined below the exercise price. As a
covered call option writer, the Fund earns additional income from premiums, but
it risks losing any appreciation of the security covered by the option if
interest rates decline. Option writing can be used advantageously to generate
incremental income when the outlook is for relatively stable bond prices;
however, such income may be taxable. The aggregate market value of the options
on debt securities held or written by the Fund may not exceed 25% of the Fund's
total net assets. The risk involved in writing options (or selling futures) is
not limited to the value of the options, since the maximun potential loss to the
Fund is the cost of closing out the short options (or futures) positions which
theoretically has no limit. Participation in options transactions involves
certain risks (see "Special Risks").
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Investing in Other Investment Companies
The Fund may invest indirectly in municipal obligations by investing in
other investment companies. Such investments may involve the payment of premiums
above the net asset value of such issuers' portfolio securities, are subject to
limitations under the Investment Company Act of 1940 and are constrained by
market availability. As a shareholder in an investment company, the Fund would
bear its ratable share of that investment company's expenses, including its
advisory and administration fees. Fundamental Portfolio Advisors, Inc. has
agreed to waive its management (advisory) fees with respect to the portion of
the Fund's assets invested in shares of other open-end investment companies. The
Fund would continue to pay its own management fees and other expenses with
respect to its investments in shares of a closed-end investment company.
Repurchase Agreements
The Fund may enter into repurchase agreement transactions. Under a
repurchase agreement, the Fund acquires a debt instrument for a relatively short
period (usually not more than one week) subject to the obligation of the seller
to repurchase and the Fund to resell such debt instrument at a fixed price. The
resale price is in excess of the purchase price in that it reflects an
agreed-upon market interest rate effective for the period of time during which
the Fund's money is invested. The Fund's repurchase agreements will at all times
be fully collateralized in an amount at least equal to the purchase price
including accrued interest earned on the underlying securities. The instruments
held as collateral are valued daily, and as the value of instruments declines,
the Fund will require additional collateral. If the seller defaults and the
value of the collateral securing the repurchase agreement declines, the Fund may
incur a loss. Repurchase agreements are considered by the staff of the
Securities and Exchange Commission to be loans by the Fund.
Reverse Repurchase Agreements
The Fund may enter into reverse repurchase agreement transactions only in
amounts such that the total of the reverse repurchase agreements and all other
borrowings combined will not exceed 33-1/3% of the Fund's total assets at the
time it enters into a reverse repurchase agreement. Such transactions involve
the sale of securities held by the Fund, with an agreement that the Fund will
repurchase such securities at an agreed upon price and date. The Fund will
employ reverse repurchase agreements when necessary to meet unanticipated net
redemptions so as to avoid liquidating other portfolio investments during
unfavorable market conditions, or as a technique to enhance income. At the time
it enters into a reverse repurchase agreement, the Fund will place in a
segregated custodial account high-quality liquid debt securities having a dollar
value equal to the repurchase price. The Fund will utilize reverse repurchase
agreements when the interest income to be earned from portfolio investments is
greater than the interest expense incurred as a result of the reverse repurchase
transactions. Any reverse repurchase agreement entered into by the Fund
constitutes a borrowing, has leveraging effects and makes the Fund's net asset
value more volatile.
Lending of Portfolio Securities
In order to generate income, the Fund may lend its portfolio securities in
an amount up to 33-1/3% of total assets to broker-dealers, major banks or other
recognized domestic institutional borrowers of securities not affiliated with
the Manager. The borrower at all times during the loan must maintain cash or
cash equivalent collateral or provide to the Fund an irrevocable letter of
credit equal in value to at least 100% of the value of the securities loaned.
During the time portfolio securities are on loan, the borrower pays the Fund any
dividends or interest paid on such securities, and the Fund may invest the cash
collateral in high-grade, short-term, tax-exempt instruments and earn income, or
it may receive an agreed-upon amount of interest income from the borrower who
has delivered equivalent collateral or a letter of credit.
Temporary Investments
The Fund may from time to time invest a small portion of its total assets,
on a temporary basis, in high-grade fixed-income obligations, the interest on
which is subject to Federal, New York State and/or New York City income tax.
Such high-grade quality
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investments include obligations issued or guaranteed by the U.S. Government, its
agencies or instrumentalities, and obligations of domestic branches of U.S.
banks, including certificates of deposit and bankers' acceptances. A description
of high-grade municipal obligations is included in the Statement of Additional
Information.
Investments of this kind may be obtained by the Fund pending investment or
reinvestment in municipal obligations of the proceeds from the sale of Fund
shares or the sale by the Fund of portfolio securities. In addition, the Fund
may invest in highly liquid taxable obligations to avoid the necessity of
liquidating portfolio securities to meet redemptions by investors. Although
there are no specific limitations other than those imposed under the Code (see
"Dividends and Tax Status") on the portion of Fund assets that may be invested
in taxable obligations, it is anticipated that on a 12-month average, taxable
obligations will constitute less than 10% of the value of the Fund's portfolio.
Fund management also anticipates that a cash reserve will be maintained for
purposes of meeting the day-to-day operating expenses of the Fund as well as
redemptions of Fund shares. Such cash reserve may be maintained in either
interest or non-interest bearing form, at the discretion of the Fund's
directors. Furthermore, if maintained in interest-bearing form, it is
anticipated that all or part of such interest will be subject to Federal, New
York State and/or New York City income tax. However, it is expected that, on a
12-month average, such reserve will constitute less than 5% of the Fund's total
assets.
Illiquid Securities
The Fund will not invest more than 15% of its net assets (taken at market
value) in illiquid securities, including repurchase agreements with maturities
in excess of seven days.
The Fund may invest in securities that are subject to restrictions on resale
because they have not been registered under the Securities Act of 1933 (the
"1933 Act"). These securities are sometimes referred to as private placements.
Although securities which may be resold only to "qualified institutional buyers"
in accordance with the provisions of Rule 144A under the 1933 Act are
technically considered "restricted securities", the Fund may purchase Rule 144A
securities without regard to the limitation on investments in illiquid
securities described above, provided that a determination is made that such
securities have a readily available trading market. Fund management will
determine the liquidity of Rule 144A securities under the supervision of the
Fund's Board of Directors. The liquidity of Rule 144A securities will be
monitored by Fund management and, if as a result of changed conditions, it is
determined that a Rule 144A security is no longer liquid, the Fund's holding of
illiquid securities will be reviewed to determine what, if any, action is
required to assure that the Fund does not exceed its applicable percentage
limitation for investments in illiquid securities.
Fund management anticipates that the market for certain restricted
securities such as inverse floaters that are created in the secondary market
will expand further as a result of this relatively new regulation and the
development of automated systems for the trading, clearing and settlement of
unregistered securities, as more institutions and dealers invest in and make
markets in these securities.
In reaching liquidity decisions, Fund management will consider, inter alia,
the following factors: (1) the frequency of trades and quotes for the security;
(2) the number of dealers wanting to purchase or sell the security and the
number of other potential purchasers; (3) dealer undertakings to make a market
in the security and (4) the nature of the security and the nature of the
marketplace trades (e.g., the time needed to dispose of the security, the method
of soliciting offers and the mechanics of the transfer).
When-lssued Purchases
Municipal securities are frequently offered on a "when-issued" basis. When
so offered, the price and coupon rate are fixed at the time the commitment to
purchase is made, but delivery and payment for the when-issued securities take
place at a later date. Normally, the settlement date occurs between 15-45 days
from the date of purchase. During the period between purchase and settlement, no
interest accrues to the purchase. The price that the Fund would be required to
pay may be in excess of the market value
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of the security on the settlement date. While securities may be sold prior to
the settlement date, the Fund intends to purchase such securities for the
purpose of actually acquiring them unless a sale becomes desirable for
investment reasons. At the time the Fund makes a commitment to purchase a
municipal security on a when-issued basis, it will record the transaction and
reflect the value of the security in determining its net asset value. That value
may fluctuate from day to day in the same manner as values of other municipal
securities held by the Fund. The Fund will establish a segregated account with
its custodian bank in which it will maintain cash or high-grade liquid debt
securities determined daily to be equal in value to its commitments for
when-issued securities. Generally, both the when-issued securities and the
securities held in the segregated account will tend to experience appreciation
when interest rates decline and depreciation when interest rates increase.
Accordingly, the purchase of when-issued securities may increase the volatility
of the Fund's net asset value. The Fund may invest in when-issued securities
without limitation.
At such time as the Fund is required to pay for when-issued securities, it
will meet its obligation from then-available cash flow, sale of the securities
held in the separate account, sale of other securities, or (although it would
not normally expect to do so) from the sale of the when-issued securities
themselves (which may have a market value greater or less than the Fund's
payment obligation). Sale of securities to meet such obligations carries with it
a greater potential for the realization of capital gains, which are not excluded
from gross income for Federal, state or local income tax purposes.
Delayed-Delivery Transactions
The Fund may buy and sell securities on a "delayed-delivery" basis, with
payment and delivery taking place at a future date. The market value of
securities purchased in this way may change before the delivery date, which
could affect the market value of the Fund's assets, and could increase
fluctuations in the Fund's yield and net asset value. Ordinarily, the Fund will
not earn interest on the securities purchased until they are delivered.
Participation Interests, Variable and Floating Rate Instruments
The Fund may purchase participation interests from financial institutions.
These participation interests give the purchaser an undivided interest in one or
more underlying municipal obligations. The Fund may also invest in municipal
obligations which have variable interest rates that are readjusted periodically.
Such readjustment may be based either upon a predetermined standard, such as a
bank prime rate or the U.S. Treasury bill rate, or upon prevailing market
conditions. Many variable rate instruments are subject to redemption or
repurchase at par on demand by the Fund (usually upon no more than seven days'
notice). All variable rate instruments must meet the quality standards of the
Fund. The Manager will monitor the pricing, quality and liquidity of the
variable rate municipal obligations held by the Fund.
The Fund may purchase inverse floaters which are instruments whose interest
rates bear an inverse relationship to the interest rate on another security or
the value of an index. Changes in the interest rate on the other security or
index inversely affect the residual interest rate paid on the inverse floater,
with the result that the inverse floater's price will be considerably more
volatile than that of a fixed-rate bond. For example, a municipal issuer may
decide to issue two variable rate instruments instead of a single long-term,
fixed-rate bond. The interest rate on one instrument reflects short-term
interest rates. Typically, this component pays an interest rate that is reset
periodically through an auction process, while the interest rate on the other
instrument (the inverse floater) pays a current residual interest rate based on
the total difference between the total interest paid by the issuer on the
municipal obligation and the auction rate paid on the auction component. This
reflects the approximate rate the issuer would have paid on a fixed-rate bond,
multiplied by two, minus the interest rate paid on the short-term instrument.
Depending on market availability, the two portions may be recombined to form a
fixed-rate municipal bond. The market for inverse floaters is relatively new.
The Fund may purchase both the auction and the residual components.
The Fund may invest in municipal obligations that pay interest at a coupon
rate equal to a base rate, plus additional interest for a certain period of time
if short-term interest rates rise above a predetermined level or "cap". The
amount of such an additional interest payment typically is calculated under a
formula based on a short-term interest rate index multiplied by a designated
factor.
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The Fund may purchase various types of structured municipal bonds whose
interest rates fluctuate according to changes in other interest rates for some
period and then revert to a fixed rate. The relationship between the interest
rate on these bonds and the other interest rate or index may be direct or
inverse, or it may be based on the relationship between two other interest rates
such as the relationship between taxable and tax-exempt interest rates.
Borrowing For Investment and For Other Purposes
The Fund may borrow money from banks (including its custodian bank) or from
other lenders to the extent permitted under applicable law, for temporary or
emergency purposes, to meet redemptions or for purposes of leveraging and may
pledge its assets to secure such borrowings. Borrowing for investment increases
both investment opportunity and investment risk. Such borrowings in no way
affect the Federal or New York State tax status of the Fund or its dividends. If
the investment income on securities purchased with borrowed money exceeds the
interest paid on the borrowing, the net asset value of the Fund's shares will
rise faster than would otherwise be the case. On the other hand, if the
investment income fails to cover the Fund's costs, including the interest on
borrowings or if there are losses, the net asset value of the Fund's shares will
decrease faster than would otherwise be the case.
This is the speculative factor known as leverage.
The Investment Company Act of 1940 (the "1940 Act") requires the Fund to
maintain asset coverage of at least 300% for all such borrowings, and should
such asset coverage at any time fall below 300%, the Fund would be required to
reduce its borrowings within three days to the extent necessary to meet the
requirements of the 1940 Act. To reduce its borrowings, the Fund might be
required to sell securities at a time when it would be disadvantageous to do so.
In addition, because interest on money borrowed is a Fund expense that it
would not otherwise incur, the Fund may have less net investment income during
periods when its borrowings are substantial. The interest paid by the Fund on
borrowings may be more or less than the yield on the securities purchased with
borrowed funds, depending on prevailing market conditions.
The Fund's investment objective and its investment policies and strategies
with respect to futures, options, lending portfolio securities and borrowing
(described above) are fundamental policies that cannot be changed without the
approval of the holders of a majority of the Fund's outstanding shares. A more
detailed explanation of certain investment policies and the Fund's fundamental
investment restrictions is contained in the Statement of Additional Information.
As used in this Prospectus, the phrase majority of the Fund's outstanding
shares means the vote of the lesser of (1) 67% of the Fund's shares present at a
meeting of shareholders if the holders of more than 50% of the outstanding
shares are present in person or by proxy at such a meeting or (2) more than 50%
of the Fund's outstanding shares.
SPECIAL RISKS
Special Risk Factors Relating to Non-Diversification
The Fund's portfolio is non-diversified (see "Investment Objective and
Policies") and may have greater risk than a diversified portfolio.
Special Risk Factors Relating to Futures and Options
There are certain risks in investing in options and interest rate futures
contracts. With respect to the use of futures contracts, although the Fund
intends to purchase or sell futures contracts only if there is an active market
for such contracts, no assurance can be given that a liquid market will exist
for any particular contract at any particular time. Many futures exchanges and
boards of trade limit the amount of fluctuation permitted in futures contract
prices during a single trading day. Once the daily limit has been reached in a
particular contract, no trades may be made that day at a price beyond that
limit. Futures contract prices could move to the daily limit for several
consecutive trading days with little or no trading, thereby preventing prompt
liquidation of futures positions and potentially subjecting the Fund to
substantial losses. If it is not possible, or the Fund determines not to close a
futures position in
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anticipation of adverse price movements, the Fund will be required to make daily
cash payments of variation margin. In such circumstances, an increase in the
value of the portion of the portfolio being hedged, if any, may offset partially
or completely losses on the futures contract.
In addition, no assurance can be given that the price of the securities
being hedged will correlate with the price movements in a futures contract and
thus provide an offset to losses on the futures contract. However, the risk of
imperfect correlation generally tends to diminish as the maturity date of the
futures contract approaches.
The Manager could also be incorrect in its expectations about the direction
or degree of various interest rate movements in the time span within which the
movements take place. Predicting interest rate direction involves skills and
techniques different from those used in most investment strategies, and there is
no guarantee that such predictions will be accurate.
The risk the Fund assumes when it buys an option is the loss of the premium
paid for the option. In order to benefit from buying an option, the price of the
underlying security must change sufficiently to cover the premium paid, the
commissions paid, both in the acquisition of the option and in a closing
transaction, or the exercise of the option and subsequent sale of the underlying
security. (The Fund could enter into a closing transaction by purchasing an
option if it had previously sold one, or by selling an option if it had
previously bought one, with the same terms as the option previously acquired.)
Nevertheless, the price change in the underlying security does not assume a
profit, because prices in the options market may not reflect such a change.
The risk involved in writing options on futures contracts the Fund owns, or
on securities held in its portfolio, is that there could be an increase in the
market value of such contracts or securities. In such case, the option would be
exercised and the asset would be sold at a lower price than the cash market
price. To some extent, the risk of not realizing a gain could be reduced by
entering into a closing transaction. However, the cost of closing the option and
terminating the Fund's obligation might be more or less than the premium
received when it originally wrote the option. Further, the Fund might not be
able to close the option because of insufficient activity in the options market.
The risk involved in writing options (or selling futures) is not limited to the
value of the options, since the maximun potential loss to the Fund is the cost
of closing out the short options (or futures) positions which theoretically has
no limit.
Finally, in deciding whether to use futures contracts or options,
consideration must be given to brokerage commission costs, which are normally
higher than those associated with general securities transactions.
Special Risk Factors Relating to Lower Rated Municipal Bonds
You should carefully consider the relative risks of investing in the higher
yielding (and, therefore, higher risk) securities in which the Fund may invest.
These are bonds such as those rated Ba to Caa by Moody's or BB to CC by S&P,
Fitch or Duff or, if unrated, are judged by Fund management to be of comparable
quality. They generally are not meant for short-term investing and may be
subject to certain risks with respect to the issuing entity and to greater
market fluctuations than certain lower yielding, higher rated fixed-income
securities. Bonds rated Ba by Moody's are judged to have speculative elements;
their future cannot be considered as well assured and often the protection of
interest and principal payments may be very moderate. Bonds rated BB by S&P,
Fitch or Duff are regarded as having predominantly speculative characteristics
and, while such obligations have less near-term vulnerability to default than
other speculative grade debt, they face major ongoing uncertainties or exposure
to adverse business, financial or economic conditions which could lead to
inadequate capacity to meet timely interest and principal payments. Bonds rated
CC by S&P, Fitch or Duff are regarded as having the highest degree of
speculation; while such bonds may have some small degree of quality and
protective characteristics, these are outweighed by large uncertainties or major
risk exposures to adverse conditions. Bonds rated as low as Caa by Moody's may
be in default or may present elements of danger with respect to principal or
interest. The Fund will not purchase bonds in default.
Investments in bonds rated Ba or lower by Moody's and BB or lower by S&P,
Fitch or Duff, while generally providing greater income and opportunity for gain
than investments in higher rated bonds, usually entail greater risk of principal
and income (including the possibility of default or bankruptcy of the issuers of
such bonds), and may involve greater volatility of price (especially during
periods
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of economic uncertainty or change) than investments in higher rated bonds.
However, since yields may vary over time, no specific level of income can be
assured. These lower rated, high yielding securities generally tend to reflect
economic changes and short-term corporate and industry developments to a greater
extent than higher rated securities which react primarily to fluctuations in the
general level of interest rates. Lower rated securities will also be affected by
the market's perception of their credit quality (especially during times of
adverse publicity) and the outlook for economic growth. In the past, economic
downturns or an increase in interest rates have, under certain circumstances,
caused a higher incidence of default by the issuers of these securities and may
do so in the future, especially in the case of highly leveraged issuers. The
prices for these securities may be affected by legislative and regulatory
developments. For example, new Federal rules require that savings and loan
associations gradually reduce their holdings of high-yield securities. An effect
of such legislation may be to significantly depress the prices of outstanding
lower rated high yielding fixed-income securities. Factors adversely affecting
the market price and yield of these securities will adversely affect the Fund's
net asset value. In addition, the retail secondary market for these securities
may be less liquid than that of higher rated bonds; adverse conditions could
make it difficult at times for the Fund to sell certain securities or could
result in lower prices than those used in calculating the Fund's net asset
value. Therefore, judgment may at times play a greater role in valuing these
securities than in the case of investment grade fixed-income securities, and it
also may be more difficult during certain adverse market conditions to sell
these lower rated securities at their fair value to meet redemption requests or
to respond to changes in the market.
Special Risk Factors Relating to Zero Coupon Bonds
The Fund may invest in zero coupon bonds and pay-in-kind bonds (bonds which
pay interest through the issuance of additional bonds), which involve special
considerations. These securities may be subject to greater fluctuations in value
due to changes in interest rates than interest-bearing securities and thus may
be considered more speculative than comparably rated interest-bearing
securities. In addition, current Federal income tax law requires the holder of a
zero coupon security or of certain pay-in-kind bonds to accrue income with
respect to these securities prior to the receipt of cash payments. To maintain
its qualification as a regulated investment company and avoid liability for
Federal income taxes, the Fund may be required to distribute income accrued with
respect to these securities and may have to dispose of portfolio securities
under disadvantageous circumstances in order to generate cash to satisfy these
distribution requirements. Fund management anticipates that investments in zero
coupon securities and pay-in-kind bonds will not ordinarily exceed 25% of the
value of the Fund's total assets. (See "Additional Information Relating to Lower
Rated Securities" in the Statement of Additional Information.)
Special Risk Factors Relating to Variable and Floating Rate Instruments
Certain securities that may be purchased by the Fund, such as those with
interest rates that fluctuate directly or indirectly (inverse floaters) based on
multiples of a stated index, are designed to be highly sensitive to changes in
interest rates and can subject the holders thereof to extreme reductions of
yield and possibly loss of principal.
Special Risk Factors Relating to New York Issuers
You should carefully consider the special risks inherent in the Fund's
investment in municipal obligations of New York issuers. These risks result from
the financial condition of New York State and certain of its public bodies and
municipalities, including New York City. Beginning in early 1975, New York State
(the "State"), New York City (the "City") and other entities faced serious
financial difficulties which jeopardized the credit standing and impaired the
borrowing abilities of such entities and contributed to high interest rates on,
and lower market prices for, debt obligations issued by them. A recurrence of
such financial difficulties, as may be currently developing, or a failure of
certain financial recovery programs related thereto could result in defaults or
declines in the market values of various municipal obligations in which the Fund
may invest. If there should be a default or other financial crisis relating to
the State, the City, a State or City agency, or other municipality, the market
value and marketability of outstanding municipal obligations of New York issuers
in the Fund's portfolio and the interest income to the Fund could be adversely
affected. In addition, the effects of actual
15
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and proposed changes in Federal and State tax laws, as well as the significant
slowdown in the New York and regional economy, have added substantial
uncertainty to estimates of the State's tax revenues, which resulted in the
State's overestimate of General Fund tax receipts in the 1992 fiscal year by
$575 million. The 1992 fiscal year was the fourth consecutive year in which the
State incurred a cash-basis operating deficit in the General Fund and issued
deficit notes. The State's 1992-93 fiscal year, however, was characterized by
national and regional economies that performed better than projected in April
1992. National gross domestic product, State personal income, and employment and
unemployment in the State were estimated to have performed better than
originally projected in April 1992. After reflecting a 1992-93 year-end deposit
to the refund reserve account of $671 million, reported 1992-93 General Fund
receipts were $45 million higher than originally projected in April 1992. If not
for that year-end transaction, General Fund receipts would have been $716
million higher than originally projected. The State completed the 1994 fiscal
year with an operating surplus of $914 million. The State reported a General
Fund operating deficit of $1.426 billion for the 1995 fiscal year. There can be
no assurance that the State will not face substantial potential budget gaps in
future years. In 1990, Moody's and S&P lowered their ratings of the State's
general obligation debt from A-1 to A and AA- to A, respectively. In addition,
Moody's and S&P lowered their ratings of New York's short-term notes from MIG-1
to MIG-2 and from SP-1+ to SP-1, respectively. The rating changes reflected the
rating agencies' concerns about the State's financial condition, its heavy debt
load and economic uncertainties in the region. In February 1991, Moody's lowered
its rating on New York City's general obligation bonds from A to Baa1 and in
July 1995, S&P lowered its rating on such bonds from A\'96 to BBB+. On April 29,
1991, S&P downgraded the City's general obligation revenue anticipation notes
from SP-1 to SP-2, citing a budget impasse at the State level that would leave
the City at risk if the State was unable to forward promised State aid before
the end of the City's fiscal year June 30. On January 6, 1992, Moody's lowered
the ratings on certain appropriation-backed debt of New York State and its
agencies from A to Baa1. On January 13, 1992, S&P lowered from A to A\'96 the
ratings of New York State general obligation bonds. The ratings of various
agency debt, State moral obligations, contractual obligations, lease purchase
obligations and State guarantees also were lowered. A complete discussion of the
risks associated with investments in obligations of New York issuers is
contained in the Statement of Additional Information.
A number of pending court actions have been brought against or involve the
State, its agencies, or other municipal subdivisions of the State, which actions
relate to financing, the use of tax or other revenues for the payment of
obligations and claims that would require additional public expenditures.
Adverse decisions in such cases could require extraordinary appropriations or
expenditure reductions or both and might have a materially adverse effect on the
financial condition of the State and its agencies and municipal subdivisions.
Any such adverse effect could affect, to some extent, all municipal securities
issued by the State, its agencies, or municipal subdivisions.
To the extent that State agencies and local governments seek special State
assistance, the ability of the State to pay its obligations as they become due
or to obtain additional financing could be adversely affected, and the
marketability of notes and bonds issued by the State, its agencies, and other
governmental entities may be impaired.
CALCULATION OF YIELD AND PERFORMANCE DATA
The Fund may from time to time include yield information in advertisements
or information furnished to existing or proposed shareholders. The Fund's yield
is computed by dividing the Fund's net investment income per share during a base
period of 30 days, or one month, by the net asset value per share of the Fund on
the last day of such base period. The resulting 30-day yield is then annualized
pursuant to the bond equivalent annualization method described below. The Fund's
net investment income per share is determined by dividing the Fund's net
investment income during the base period by the average number of shares of the
Fund entitled to receive dividends during the base period. The Fund's 30-day
yield (computed as described above) is then annualized by a computation that
assumes the Fund's net investment income is earned and reinvested for a
six-month period at the same rate as during the 30-day base period and that the
resulting six-month income will again be generated over an additional period of
six months.
The Fund may also advertise from time to time its taxable equivalent yield.
The Fund's taxable equivalent yield is determined by dividing that portion of
the Fund's yield (calculated as described above) that is tax-exempt by one minus
the stated marginal Federal income tax rate and adding the product to that
portion, if any, of the Fund's yield that is not tax-exempt.
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The Fund may also furnish to existing or prospective shareholders
information concerning the average annual total return on an investment in the
Fund for a designated period of time. The average annual total return quotation
for a given period is computed by determining the average annual compounded rate
of return that would cause a hypothetical investment made on the first day of
the designated period (assuming all dividends and distributions are reinvested)
to equal the resulting net asset value of such hypothetical investment on the
last day of the designated period.
The yield and average annual total return quotations of the Fund do not take
into account any required payments for Federal or state income taxes.
The Fund's yield and average annual total return will vary from time to time
depending on market conditions, the composition of the Fund's portfolio, and the
Fund's operating expenses. These factors and possible differences in the methods
used in calculating yields and returns should be considered when comparing the
Fund's performance information to information published with respect to other
investment companies and other investment vehicles. Yields and return quotations
should also be considered relative to changes in the value of the Fund's shares
and the risks associated with the Fund's investment objective and policies. At
anytime in the future, yield and return quotations may be higher or lower than
past yields or return quotations, and there can be no assurance that any
historical yield or return quotation will continue in the future.
The Fund may also include comparative performance information in advertising
or marketing the Fund's shares. Such performance information may include data
from Lipper Analytical Services, Inc., and Morningstar, Inc., or other industry
publications.
For more information regarding the computation of yield or average annual
total return quotations, see the Statement of Additional Information.
PURCHASE OF SHARES
You may purchase shares directly from the Fund without a sales charge on any
day the New York Stock Exchange is open for business. The public offering price
for shares purchased is the net asset value per share of the Fund next
determined after a purchase order becomes effective. Orders for the purchase of
Fund shares become effective (i) immediately, if received prior to 4:00 P.M. New
York time on any business day. Shares being purchased will begin accruing
dividends on the day following the date of purchase and continue to earn
dividends until the date of redemption. Information regarding transmittal of
funds by bank wire and procurement of a Federal Reserve Draft may be obtained
from your bank. All payments (including checks from individual investors) must
be in U.S. dollars. If your check does not clear, Fundamental Shareholder
Services, Inc. will cancel your purchase and you could be liable for any losses
or fees incurred.
The minimum initial purchase is $1,000 and the minimum subsequent purchase
is $100. Subsequent investments are made in the same manner as an initial
purchase is made.
All shares purchased are confirmed to you and credited to your account at
the net asset value determined as described herein under the heading
"Determination of Net Asset Value." Share certificates are issued only on
written request by you to Fundamental Shareholder Services, Inc., Agent, Bowling
Green Station, P.O. Box 1013, New York, New York 10274-1013. There is no charge
for share certificates. Certificates are not issued for fractional shares.
Certificates will only be issued in amounts of 1,000 or more shares. The
issuance of certificates may be discontinued at any time without prior notice.
The Fund reserves the right to reject any purchase order. The Fund reserves the
right to limit the number of purchase order checks processed at any one time and
will notify investors prior to exercising this right. If this right is
exercised, the Fund will return checks immediately.
Although shares of the Fund may be purchased without a sales charge if you
purchase them directly from the Fund, you may be charged a fee for effecting
transactions in the Fund's shares through securities dealers, banks, or other
financial institutions.
The Fundamental Automatic Investment Program offers a simple way to maintain
a regular investment program. The Fund has waived the initial investment minimum
for you when you open a new account and invest $100 or more per month through
the
17
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Fundamental Automatic Investment Program. The Fundamental Automatic Investment
Program allows you to purchase shares (minimum of $50 per transaction) at
regular intervals. Investments are made by transferring funds directly from your
checking, or bank money market account. At your option investments can be made,
once a month on either the fifth or the twentieth day, or twice a month on both
days.
To establish a Fundamental Automatic Investment Program, or to add this
option to your existing account simply complete an authorization form, which can
be obtained by calling 1-800-322-6864. You may cancel this privilege or change
the amount you invest at any time. Initial Program setup and any modifications
may take up to ten days to take effect. There is currently no charge for this
service, and the Fund may terminate or modify this privilege at any time.
Methods of Payment
Payment by Wire: An expeditious method of investing in the Fund is through the
transmittal of Federal funds by bank wire to The Chase Manhattan Bank, N.A. (the
"Bank"). Federal funds transmitted by bank wire to the Bank and received by it
prior to 4:00 P.M. New York time are priced at the net asset value determined on
such day. Federal funds received after 4:00 P.M. New York time will be available
on the next business day. Funds other than Federal funds transmitted by bank
wire may or may not be converted into Federal funds on the day received by the
Bank depending upon the time the funds are received and the bank wiring the
funds. We encourage you to make payment by wire in Federal funds. The Fund will
not be responsible for delays in the wiring system.
To purchase shares by wiring funds, instruct a commercial bank to wire your
money to: The Chase Manhattan Bank, N.A., ABA#021000021, Credit to: United
States Trust Company of New York, A/C #920-1-073195, further credit to:
Fundamental Family of Funds, A/C #2073919. Instructions for new accounts should
specify the name, address, and social security number of each person in whose
name the shares are to be registered and the name of the Fund. If you are an
existing shareholder, you need only furnish your account number and the name of
the Fund. Failure to submit required information may delay investment.
Payment by Mail: Purchase orders for which remittance is to be made by check
may be submitted directly by mail to Fundamental Shareholder Services, Inc.,
Agent, P.O. Box 1013, Bowling Green Station, New York, New York 10274-1013.
Checks should be made payable to Fundamental Family of Funds.
When opening a new account, you must enclose a completed purchase
application. If you are an existing shareholder, you should enclose the
detachable stub from a monthly account statement you have received or otherwise
indicate your account number and the name of the Fund.
Personal Delivery: For personal delivery instructions, please call the Fund
at (800) 322-6864.
Exchange for Municipal Securities: If you own municipal obligations meeting
the criteria for investment by the Fund, you may exchange such securities for
shares of the Fund. All such exchanges are discretionary with the Fund. If you
desire to make such an exchange, you should contact the Fund prior to delivering
any securities in order to establish that the securities are acceptable for
exchange, to determine what transaction charges, if any, may be imposed and to
obtain delivery instructions for such securities. The value of the securities
being exchanged will be determined in the same manner that the value of the
Fund's portfolio securities is determined (see "Determination of Net Asset
Value"); the specific method of determining the value will be provided to you on
request. The Fund reserves the right to refuse any such exchange, even if the
securities offered by an investor meet the general investment criteria of the
Fund. A capital gain or loss for Federal income tax purposes may be realized by
the investor following the exchange. Maturing bonds or detached coupons
submitted within five (5) business days of the payment date are credited on the
payment date.
Exchange Privilege: For your convenience, the Exchange Privilege permits you
to purchase shares in any of the other funds for which Fundamental Portfolio
Advisors, Inc. acts as the investment manager in exchange for shares of the Fund
at respective net asset values per share. Exchange instructions must be given in
writing to Fundamental Shareholder Services, Inc., Agent, P.O. Box 1013, Bowling
Green Station, New York, New York 10274-1013, the Fund's transfer agent, and
must specify the number of shares of the Fund
18
<PAGE>
to be exchanged (such shares must have a current value of at least $1,000) and
the fund into which the exchange is being made. If you have previously
established a Telephone Exchange Privilege, you may telephone exchange
instructions by calling Fundamental Shareholder Services, Inc. However, there
are other considerations with respect to losses resulting from unauthorized
telephone transactions. For more detail, see "Redemption of Shares-Telephone
Redemption Privilege." Before any exchange, you must obtain, and should review,
a copy of the current prospectus of the fund into which your exchange is being
made. Prospectuses may be obtained by calling or writing the Fund.
The Exchange Privilege is only available in those states where such exchange
can legally be made and exchanges may only be made between accounts with
identical account registration and account numbers. Prior to effecting an
exchange, you should consider the investment policies of the fund in which you
are seeking to invest. Any exchange of shares is, in effect, a redemption of
shares in one fund and a purchase of the other fund. You may realize a capital
gain or loss for Federal income tax purposes in connection with an exchange. The
Exchange Privilege may be modified or terminated by the Fund at any time without
notice.
REDEMPTION OF SHARES
Shares of the Fund are redeemable at your option without charge at the next
determined net asset value following receipt by Fundamental Shareholder
Services, Inc. of a redemption request in proper order. To effect a redemption,
you may utilize the Check Redemption Privilege, the Telephone Redemption
Privilege, the Expedited Redemption Privilege, or the regular redemption
procedure. Due to the cost of maintaining an account, the Fund reserves the
right to redeem an account involuntarily, on not less than 60 days' written
notice, at any time an investor has reduced his or her account to less than
$100. During the 60-day period, a shareholder may increase his or her holdings
to $100 or more, and thereby avoid an involuntary redemption.
When redemption requests are received by Fundamental Shareholder Services,
Inc. by 4:00 P.M. New York time on any day during which the net asset value is
determined (see "Determination of Net Asset Value"), the redemption will be
effective on such day, and payment will be made on the next business day based
on the net asset value next determined after receipt of the redemption
instruction. If a redemption notice is received after 4:00 P.M. New York time,
the redemption will be effective on the next business day, and payment will be
made thereafter on the second business day. In the event you wish to liquidate
your holdings, you will be entitled to all dividends declared through the date
of redemption. At times, the Fund may be requested to redeem shares for which it
has not yet received good payment. The Fund may delay, or cause to be delayed,
the mailing of a redemption check until such time as it has assured itself that
good payment has been received from the purchase of such shares, which may take
up to 15 days from the purchase date. In the case of payment by check, the
determination of whether the check has been paid by the paying institution
generally takes up to seven days, but may take longer. You may avoid this delay
by purchasing shares by wire or by using a certified or official bank check
drawn on a U.S. bank. In the event of delays in payment of redemption proceeds,
the Fund will take all available steps to expedite collection of the investment
check. If shares were purchased by check, you may write checks against such
shares only after 15 days from the date the purchase was executed. Shareholders
who draw against shares purchased fewer than 15 days from the date of original
purchase, will be charged usual and customary bank fees. The Fund reserves the
right to suspend the right of redemption or postpone the day of payment (1)
during any period when the New York Stock Exchange is closed (other than
customary weekend and holiday closings), (2) when the trading markets normally
used by the Fund are restricted or an emergency exists as determined by the
Securities and Exchange Commission (the "Commission") as to make the disposal of
the Fund's investments or determination of its net asset value unreasonably
impracticable, or (3) for such other periods as the Commission by order may
permit to protect the Fund's shareholders.
You may realize a taxable capital gain or loss when shares are redeemed,
depending on their net asset value. On all redemption requests (including
redemption checks) for joint accounts, the signatures of all joint owners are
required unless shareholders have designated otherwise.
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Check Redemption Privilege
You may request that the Fund provide you with redemption checks ("Checks")
drawn on the Fund's account by either (i) completing the appropriate section of
the application order form or (ii) subsequent written request to the Fund. These
Checks will be sent only to the individuals in whose name the account is
registered and only to the address of record with the Fund. You may use the
Checks in any lawful manner and make them payable to the order of any person or
company in an amount of $100 or more. Dividends continue to be earned until the
Check clears the Fund account and is paid by Fundamental Shareholder Services,
Inc. The Fund may delay, or cause to be delayed, payment of redemption proceeds
until such time as it or Fundamental Shareholder Services, Inc. has assured
itself that good payment has been collected for the purchase of such shares. In
addition, the Fund reserves the right not to honor Check redemption requests
received by Fundamental Shareholder Services, Inc. within 15 days from the
purchase date if the shares to be redeemed have been purchased by check. You
will be subject to the same rules and regulations that the Bank applies to
checking accounts in general. There is currently no charge to you for the use of
the Checks, except that a fee may be imposed by Fundamental Shareholder
Services, Inc. if an investor requests that it stop payment of a Check or if it
cannot honor a Check due to insufficient funds or other valid reasons.
When a Check is presented for payment, Fundamental Shareholder Services,
Inc., as your agent, will cause the Fund to redeem a sufficient number of shares
in your account to cover the amount of the Check. Shares for which stock
certificates have been issued may not be redeemed by Check. Since the net asset
value of the Fund's shares changes daily, you should make certain that the total
value of your account is sufficient to cover the amount of your Check.
Otherwise, the Check will be returned marked insufficient funds. Checks may not
be used to close an account. The Check Redemption Privilege may be modified or
terminated by either the Fund or Fundamental Shareholder Services, Inc. upon 60
days' written notice to shareholders.
Telephone Redemption Privilege
You may direct redemptions of up to $150,000 worth of shares per day by
telephone either (i) by completing the appropriate section of the application
form or (ii) by later signature guaranteed* written request. Telephone calls may
be recorded. Fundamental Shareholder Services, Inc. will act on instructions
that it reasonably believes to be genuine. The proceeds of the redemption will
only be mailed to the address of record with the Fund, provided that your
account registration has not changed in the last 30 days. The Fund reserves the
right to refuse a telephone redemption and may limit the amount and frequency.
The Telephone Redemption Privilege may be modified or terminated at any time by
either the Fund or Fundamental Shareholder Services, Inc. Neither the Fund nor
its transfer agent will be liable for following instructions that they
reasonably believe to be genuine. It is the Fund's policy to provide that a
written confirmation statement of all telephone call transactions be mailed to
shareholders at their address of record within 3 business days after the
telephone call transaction. You should verify the accuracy of telephone call
transactions immediately upon receipt of your confirmation statement. As a
result of this policy, you will bear the risk of loss in the event of a
fraudulent telephone exchange or redemption transaction.
Expedited Redemption Privilege
Requests for expedited redemption may be made by letter or telephone for
amounts equal to or exceeding $5,000, if you have previously filed with
Fundamental Shareholder Services, Inc. a signed telephone authorization form
available from the Fund. If the request is for more than $5,000, proceeds of the
expedited redemption will be transferred by Federal Reserve wire to the
commercial bank specified in the authorization form or to a correspondent bank
if your bank is not a member of the Federal Reserve System. If the correspondent
bank fails to notify your bank immediately, there could be a delay in crediting
the funds to your bank account. Proceeds of less than $5,000 will be mailed to
your address. The Fund reserves the right to refuse an expedited redemption and
may limit the amount and frequency.
Jointly registered accounts may redeem only up to $250,000 by telephone
within any 30-day period. This procedure may be modified or terminated at any
time without prior notice by either the Fund or Fundamental Shareholder
Services, Inc. Any time funds are wired by the Bank, the proceeds of redemption
may be subject to the deduction of the Bank's usual and customary charges for
wiring funds.
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<PAGE>
Requests by letter should be addressed to Fundamental Shareholder Services,
Inc., Agent, P.O. Box 1013, Bowling Green Station, New York, New York
10274-1013.
In order to qualify to use the Expedited Redemption Privilege, you must
complete the appropriate portion of the new account application and your initial
payment for purchase of the Fund's shares must be drawn on, and redemption
proceeds paid to, the same bank and account as designated on the application.
In order to change the commercial bank or account designated to receive the
redemption proceeds, you must send a written request to Fundamental Shareholder
Services, Inc., Agent, P.O. Box 1013, Bowling Green Station, New York, New York
10274-1013. Such request must be signed by each shareholder with each signature
guaranteed by an eligible guarantor (see above).
- ------------
*A signature guarantee must be from an eligible guarantor institution approved
by Fundamental Shareholder Services, Inc. Signature guarantees in proper form
generally will be accepted from domestic banks, a member of a national
securities exchange, credit unions and savings associations, as well as from
participants in the Securities Transfer Agents Medallion Program ("STAMP"). If
you have any questions with respect to signature guarantees, please call the
transfer agent at (800) 322-6864.
Regular Redemption Procedure
You may redeem your shares by sending a written request, together with duly
endorsed stock certificates, if any, to Fundamental Shareholder Services, Inc.,
Agent, P.O. Box 1013, Bowling Green Station, New York, New York 10274-1013. All
certificates and all written requests for redemption must be endorsed by you.
For redemptions exceeding $50,000 (and for all written redemption requests,
regardless of amount, made within 30 days following any change in account
registration), your endorsement must be signature guaranteed, as described
above. Fundamental Shareholder Services, Inc. may, at its option, request
further documentation from corporations, executors, administrators, trustees or
guardians. If requested, redemption proceeds of more than $5,000 will be wired
into any member bank of the Federal Reserve System. However, such transaction
may be subject to a deduction of the Bank's usual and customary charges for
wiring funds. The Fund will accept other suitable verification arrangements for
foreign investors. Redemptions by mail will not become effective until all
documents in the form required have been received by Fundamental Shareholder
Services, Inc.
Requests for redemption subject to any special condition, or which specify
an effective date other than as provided herein, cannot be accepted and will be
returned to you.
How to Transfer Shares
Shares may be transferred from one person to another by sending to
Fundamental Shareholder Services, Inc. a written request for such transfer,
signed by the registered owner(s) exactly as the account is registered with each
signature guaranteed as described above, with (i) the name(s) of the new
registered owner(s), (ii) the social security number or taxpayer identification
number for the new registration, and (iii) the redemption option elected. If the
shares being transferred are represented by certificates in the possession of
the investor, such certificates, properly signed with signature guarantees, must
also be forwarded to Fundamental Shareholder Services, Inc. In addition,
Fundamental Shareholder Services, Inc. reserves the right to request any
additional documents that may be required for transfer by corporations,
executors, administrators, trustees, and guardians.
Reopening an Account
You may reopen an account with a minimum investment of $100 or more without
filing a new application form during the year in which your account was closed
or during the following calendar year, provided that the information on your
original form is still applicable. The Fund may require you to file a statement
that all information on the original account application form remains
applicable.
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<PAGE>
DETERMINATION OF NET ASSET VALUE
The net asset value per share is determined as of the close of trading on
the New York Stock Exchange (currently 4:00 P.M., New York time) on each day
that both the New York Stock Exchange and the Fund's custodian bank are open for
business and on any other day during which there is a sufficient degree of
trading in the Fund's portfolio securities that the Fund's net asset value might
be materially affected by changes in the value of its portfolio securities,
unless there have been no shares tendered for redemption or orders to purchase
shares received. The net asset value per share is computed by taking the value
of all assets of the Fund, subtracting the liabilities of the Fund, and dividing
by the number of outstanding shares. For purposes of determining net asset
value, expenses of the Fund are accrued daily and taken into account.
The Fund's portfolio securities are valued on the basis of prices provided
by an independent pricing service when, in the opinion of persons designated by
the Fund's trustees, such prices are believed to reflect the fair market value
of such securities. Prices of non-exchange traded portfolio securities provided
by independent pricing services are generally determined without regard to bid
or last sale prices but take into account institutional size trading in similar
groups of securities, yield, quality, coupon rate, maturity, type of issue,
trading characteristics and other market data. Securities traded or dealt in
upon a securities exchange and not subject to restrictions against resale as
well as options and futures contracts listed for trading on a securities
exchange or board of trade are valued at the last quoted sales price, or, in the
absence of a sale, at the mean of the last bid and asked prices. Options not
listed for trading on a securities exchange or board of trade for which
over-the-counter market quotations are readily available are valued at the mean
of the current bid and asked prices. Money market and short-term debt
instruments with a remaining maturity of 60 days or less will be valued on an
amortized cost basis. Municipal daily or weekly variable rate demand instruments
will be priced at par value plus accrued interest. Securities not priced in a
manner described above and other assets are valued by persons designated by the
Fund's trustees using methods which the trustees believe accurately reflects
fair value. The prices realized from the sale of these securities could be less
than those originally paid by the Fund or less than what may be considered the
fair value of such securities.
Included in the portfolio of the Fund in determining net asset value is the
value of all when-issued securities that the Fund has committed itself to
purchase. However, the Fund's ability to purchase such securities remains
constant (see "Investment Objective and Policies").
The Fund's most recent asset value can be obtained by calling
1-800-322-6864 7 days a week, 24 hours a day. To obtain more detailed
information on the Fund's net asset value, yield, performance and portfolio
composition you can call 1-800-322-6864 weekdays 9:00 AM-5:30 PM Eastern Time.
DlSTRlBUTlON EXPENSES
The Board of Directors and shareholders of the Fund have approved a plan of
distribution under Rule 12b-1 of the 1940 Act (the "Plan"). Pursuant to the
Plan, the Fund may pay certain promotional and advertising expenses and may
compensate certain registered securities dealers and financial institutions for
services provided in connection with processing orders for the purchase or
redemption of Fund shares, and for furnishing other shareholder services.
Payments by the Fund shall not, in the aggregate, in any fiscal year of the
Fund, exceed one-half of 1% of daily net assets of the Fund for expenses
incurred in distributing and promoting the Fund's shares. The Plan will make
payments only for expenses actually incurred by such dealers and financial
institutions. Under the Plan, unreimbursed covered distribution expenses may be
carried forward for three consecutive fiscal years (without interest or any type
of finance or service charges) in the event such expenses exceed on an
annualized basis the amount that may be paid under the Plan in any one fiscal
year. If the Plan is terminated in accordance with its terms, the obligation of
the Fund to make payments pursuant to the Plan, including any prior expenses
carried forward, will cease and the Fund will not be required to make any
payments for expenses incurred after the date the Plan terminates. The Fund may
enter into shareholder processing and service agreements ("Shareholder Service
Agreements") with any securities dealer who is registered under the Securities
Exchange Act of 1934 and is a member in good standing of the National
Association of Securities Dealers, Inc., and with banks and other financial
institutions that may wish to establish accounts or sub-accounts on behalf of
their customers
22
<PAGE>
("Shareholder Service Agents"). The Fund may pay such Shareholder Service Agents
for their services, and to cover expenses in connection with advertising, sales
literature and other promotional materials on behalf of the Fund, and the fees
payable therefor will be reviewed quarterly by the Fund's Board of Directors.
See "Distribution Plan" in the Statement of Additional Information for more
details.
The Board of Directors of the Fund, including a majority of the
disinterested directors who have no direct or indirect financial interest in the
operation of the Plan or any agreements relating thereto, authorized the Fund to
enter into an agreement with Fundamental Service Corporation, a Delaware
corporation, under the Plan. The agreement provides that the Fund may pay the
usual and customary agency's commission to Fundamental Service Corporation for
producing and placing Fund advertising in newspapers, magazines, or other
periodicals, on radio or television, or in direct marketing campaigns. In
addition to the foregoing, the Fund may pay Fundamental Service Corporation for
marketing research and promotional services specifically relating to the
distribution of Fund shares, including employment expenses and support services
of personnel primarily responsible for responding to inquiries from prospective
investors.
The Plan will continue from year to year if specifically approved annually
by the Board of Directors of the Fund and the affirmative vote of a majority of
the directors who are not interested persons of the Fund, and with no direct or
indirect financial interest in the Plan, by votes cast in person at a meeting
called for such purpose. The Plan may not be amended to increase the maximum
amount of payments by the Fund without shareholder approval, and all material
amendments to the provisions of the Plan must be approved by a vote of the Board
of Directors and the directors who have no direct or indirect interest in the
Plan, cast in person at a meeting called for the purpose of such vote.
The Plan provides that Fund management shall provide, and the independent
directors shall review, quarterly reports setting forth the amounts expended
pursuant to the Plan and the purpose for which the amounts were expended. It
further provides that while the Plan is in effect, the selection and nomination
of those directors of the Fund who are not interested persons of the Fund, is
committed to the discretion of the independent directors. During the year ended
December 31, 1995, the Fund paid $838,008 under the Plan, including $420,197
paid to Fundamental Service Corporation under the Plan.
The Glass-Steagall Act and other applicable laws, among other things,
generally prohibit Federally chartered or supervised banks from engaging in the
business of underwriting, selling, or distributing securities. Accordingly, the
Fund will engage banks as Shareholder Service Agents to perform only
administrative and shareholder servicing functions. While the matter is not free
from doubt, Fund management believes that such laws should not preclude a bank
from acting as a Shareholder Service Agent performing the above-referenced
administrative and shareholder servicing functions. However, judicial or
administrative decisions or interpretations of such laws, as well as changes in
either Federal or state statutes or regulations relating to the permissible
activities of banks or their subsidiaries or affiliates, could prevent a bank
from continuing to perform all or part of its servicing activities. If a bank
were prohibited from so acting, shareholder clients would be permitted to remain
as Fund shareholders and alternative means for continuing the servicing of such
shareholders would be sought. In such event, changes in the operation of the
Fund might occur, and shareholders serviced by such bank might no longer be able
to avail themselves of services then being provided by such a bank. It is not
expected that shareholders would suffer any adverse financial consequences as a
result of any of these occurrences.
MANAGEMENT
Fundamental Portfolio Advisors, Inc. (the "Manager"), which was organized in
1986, manages and advises five investment company portfolios. A Management
Agreement (the "Agreement"), between the Company, on behalf of the Fund, and the
Manager, was adopted by the Board of Directors of the Fund on October 3, 1990,
and was approved by shareholders on November 29, 1990.
The Agreement provides that the Manager shall, at its own expense, furnish
to the Fund office space in the offices of the Manager or in such other place as
may be agreed upon from time to time, and all necessary office facilities,
equipment and personnel for managing the affairs and investments and supervising
the keeping of the Fund's books and shall arrange, if desired by the Fund, for
23
<PAGE>
all directors and executive officers of the Manager's organization to serve as
officers or directors of the Fund. Under the terms of the Agreement, the Manager
assumes and shall pay or reimburse the Fund for: (1) the compensation (if any)
of the directors of the Fund who are affiliated with, or "interested persons"
of, the Manager and all officers of the Fund as such; and (2) all expenses not
specifically assumed by the Fund where such expenses are incurred by the Manager
or by the Fund in connection with the management of the investment and
reinvestment of the assets of the Fund, and the management of the affairs of the
Fund.
Under the terms of the Agreement, the following expenses, among others,
incurred in the operation of the Fund, will be borne by the Fund (1) charges and
expenses for determining from time to time the value of the net assets of the
Fund and the keeping of its books and records; (2) charges and expenses of
auditors; (3) charges and expenses of any custodian, transfer agent, plan agent,
dividend-disbursing agent, and registrar appointed by the Fund; (4) brokers'
commissions, and issue and transfer taxes, chargeable to the Fund in connection
with securities transactions to which the Fund is a party; (5) insurance
premiums, interest charges, dues and fees for membership in trade associations,
and all taxes and fees payable by the Fund to Federal, state, or other
governmental agencies; (6) the cost of share certificates representing shares of
the Fund; (7) fees and expenses involved in registering and maintaining
registrations of the Fund and of its shares with the Commission, including the
preparation of prospectuses for filing with the Commission and any application
for exemption whether or not relating to, or directed toward, the sale of the
Fund's shares; (8) all expenses of shareholders and directors meetings and of
preparing, printing, and distributing notices, proxy statements, and all reports
to shareholders and to governmental agencies; (9) charges and expenses of legal
counsel to the Fund; (10) compensation of those directors of the Fund as such
who are not affiliated with or "interested persons" of the Manager or the Fund
(other than as directors); (11) fees and expenses incurred pursuant to a plan
adopted pursuant to Rule 12b-1 under the 1940 Act; and (12) such nonrecurring or
extraordinary expenses as may arise, including litigation affecting the Fund and
any indemnification by the Fund of its directors, officers, employees, or agents
with respect thereto.
Pursuant to the Agreement, the Manager will provide the Fund with advice
and recommendations in the choice of investments and will execute the Fund's
security transactions. These services will be under the supervision of Dr.
Vincent J. Malanga, as director, president-treasurer, and chief executive
officer of the Fund. The Agreement provides that the Manager shall, subject to
the supervision of the Board of Directors of the Fund, generally attend, direct,
and manage the affairs of the Fund. In consideration for such services, the Fund
has agreed to pay the Manager an annual fee, accrued daily and paid monthly, at
the following rate on the average daily closing net asset value of the Fund:
Net Asset Value Annual Rate
- --------------------------------------------------------------------------------
For assets up to $100,000,000 50/100 of 1%
For assets in excess of S100,000,000 up to S200,000,000 48/100 ot 1%
For assets in excess of $200,000,000 up to $300,000,000 46/100 of 1%
For assets in excess of $300,000,000 up to $400,000,000 44/100 of 1%
For assets in excess of $400,000,000 up to $5OO,OOO,OOO 42/100 of 1%
For assets in excess of $500,000,000 40/100 of 1%
Under the Agreement, the Manager is required to reimburse to the Fund an
amount not exceeding the amount of fees payable to the Manager under the
Agreement for any fiscal year, if, and to the extent that the aggregate
operating expenses of the Fund for any fiscal year (including the fees payable
to the Manager, but excluding interest expenses, taxes, brokerage fees and
commissions, expenses paid pursuant to the Plan, and extraordinary expenses
beyond the control of the Manager) exceed, on an annual basis, 1.5% of the
average daily net assets of the Fund. During the year ended December 31, 1995,
the Manager received fees from the Fund in the amount of $885,389, which
represented .49% of the Fund's average net assets.
24
<PAGE>
The Agreement terminates upon assignment and may be terminated without
penalty on 60 days' written notice by a vote of the majority of the Fund's Board
of Directors or by the holders of a majority of the Fund's outstanding shares.
Unless earlier terminated as described above, the Agreement will continue in
effect from year to year if its continuance is approved at least annually (1) by
the Board of Directors of the Fund or the vote of the holders of a majority of
the outstanding shares of the Fund and (2) in either event, by a majority of the
directors of the Fund who are not parties to the Agreement or "interested
persons" of any such party, by votes cast in person at a meeting called for the
purpose of voting on such approval.
The Fund, its Manager and Fundamental Service Corporation have agreed, in an
assurance of discontinuance (the "assurance") entered into with the Department
of Law of the State of New York, to refrain from making certain statements about
the Fund's investment objectives in advertisements and sales materials and to
disclose more about the risks involved in certain of the Fund's investment
strategies, particularly with respect to certain investment strategies employed
by the Fund that may differ from or may result in an increased level of risk not
present in some other tax-exempt mutual funds.
In addition, the Fund has agreed to establish a portfolio review committee,
consisting of no less than three independent directors of the Fund, to oversee
the Fund's investment performance and strategies, internal controls and
procedures, Prospectus review and compliance with the investment policies stated
therein, and review of annual and semi-annual reports to shareholders (See
"Management of the Fund-Portfolio Review Committee" in the Statement of
Additional Information). The Fund has also agreed to submit new sales material
for certain specified time periods to the staff of the Department of Law (the
"staff") for prior review and to submit to the staff, copies of any shareholder
complaints and Fund filings with, or submissions to, the Commission or the
National Association of Securities Dealers, Inc.
The assurance also requires (i) that a portfolio composition report
portraying the Fund's (a) principal asset categories, (b) use of leverage, (c)
effective portfolio duration or sensitivity to interest rate risk and (d) credit
ratings of portfolio securities be included in the Fund's annual and semi-annual
reports to shareholders and that a portfolio composition report be delivered to
potential investors along with the Fund's Prospectus.
For further information concerning the management of the Fund, see the
Fund's Statement of Additional Information under the caption "Management of the
Fund."
Portfolio Brokerage
It is the Fund's policy to seek execution of its purchases and sales at the
most favorable prices through responsible broker-dealers and in agency
transactions, at competitive commission rates. The Fund's brokerage allocation
policy may permit the Fund to pay a broker-dealer which furnishes research
services a higher commission than that which might be charged by another
broker-dealer which does not furnish research services, provided that such
commission is deemed reasonable in relation to the value of the services
provided by such broker-dealer (see the Statement of Additional Information for
a complete discussion of the Fund's brokerage allocation policy). It is not the
Fund's practice to allocate principal business on the basis of sales of Fund
shares which may be made through brokers or dealers, although broker-dealers
effecting purchases of Fund shares for their customers may participate in
principal transactions or brokerage allocation. The Fund may, however, allocate
principal business or brokerage to obtain for the benefit of the Fund services
that the Fund would otherwise have to pay for directly.
The Fund's directors have authorized the Manager to effect portfolio
transactions on an agency basis with affiliated broker-dealers, subject to
quarterly determination of compliance by the board, including a majority of the
independent directors and have adopted certain procedures incorporating the
standards of Rule 17e-1 of the 1940 Act, which requires, among other things,
that the commissions paid to any affiliated broker-dealer must be "reasonable
and fair compared to the commission, fee, or other remuneration received, or to
be received, by other brokers in connection with comparable transactions
involving similar securities during a comparable period of time."
25
<PAGE>
DIVIDENDS AND TAX STATUS
Dividends and Distributions
The Fund declares all of its net investment income as a dividend, on a daily
basis, prior to calculating net asset value, on shares of record at the close of
business on the preceding day. Dividends are distributed monthly. Capital gains,
if any, will normally be distributed in December of each fiscal year of the
Fund. The amounts paid, and distribution dates thereof, are subject to
determination by the Fund's Board of Directors. All dividends paid and capital
gains distributed are paid in additional shares of the Fund's common stock,
which are credited to the shareholder's account. If you desire to receive such
distribution in cash, you must file an election with Fundamental Shareholder
Services, Inc., which election will remain in effect until Fundamental
Shareholder Services, Inc. is notified by you in writing to change the election,
at least ten (10) days prior to payment date. Distributions declared in the
months of October, November or December will be treated as received by
shareholders of record in such months as of December 31 even if they are not
paid until the following January. Certificates will not be issued for dividend
distributions.
Taxes
The Fund intends to qualify as a "regulated investment company" under
Subchapter M of the Code. If the Fund so qualifies, it will not pay any Federal
corporate income taxes on net investment taxable income or net realized capital
gains which are distributed to investors in a timely manner. If the Fund fails
to meet certain distribution requirements at the end of the calendar year, the
Fund will be subject to a 4% excise tax on a portion of its undistributed
taxable income. The Fund intends to make distributions in a timely manner and,
accordingly, does not expect to be subject to Federal income taxes or the 4%
excise tax.
Distributions by the Fund of its tax-exempt interest income (net of
expenses) are designated as exempt-interest dividends and shareholders should
exclude the interest from their gross income for Federal income tax purposes. It
is a policy of the Fund to maximize the percentage of distributions to
shareholders that are not subject to Federal income taxes. However, a small
portion of the Fund's net investment income may under certain circumstances be
taxable, and distributions thereof, as well as distributions of any capital
gains, are taxable to shareholders. Distributions by the Fund of any taxable net
investment income and of any net short-term capital gain over net long-term
capital loss are taxable to shareholders as ordinary income. Such distributions
constitute dividends for Federal income tax purposes but do not qualify for the
70% dividends-received deduction for corporations. Distributions of any net
capital gain are designated as capital gain dividends and are taxable as
long-term capital gains without regard to the length of time the shareholder has
held shares of the Fund. If a shareholder sells shares held for six months or
less at a loss, the loss will be disallowed to the extent of the exempt-interest
dividends received on the shares and (to the extent not disallowed) will be
treated as a long-term capital loss to the extent of any capital gain dividends
received on the shares.
Tax-exempt interest on specified private activity bonds issued after August
7, 1986 is treated as a tax preference item for purposes of the Federal
alternative minimum tax ("AMT"). Thus, corporate and individual shareholders may
incur an AMT liability as a result of receiving exempt-interest dividends from
the Fund to the extent such dividends are attributable to interest from such
private activity bonds. In addition, because all exempt-interest dividends are
included in a corporate shareholder's adjusted current earnings (which are used
in computing a separate preference item for corporations), corporate
shareholders may incur an AMT liability as a result of receiving any
exempt-interest dividends from the Fund. For a description of the AMT, see the
Fund's Statement of Additional Information under the caption "Tax Matters."
Although exempt-interest dividends are excludable from gross income for
Federal income tax purposes, shareholders are required to report the receipt of
exempt-interest dividends, together with other tax-exempt interest, on their
Federal income tax returns. In addition, exempt-interest dividends must be taken
into account in computing the portion, if any, of social security or railroad
retirement benefits that must be included in an individual shareholder's gross
income and subject to Federal income tax. Further, shareholders are denied a
deduction for interest on indebtedness incurred or continued to purchase or
carry shares of the Fund. Moreover, a shareholder who is (or is related to) a
"substantial user" of a facility financed by industrial development bonds held
by the Fund will likely be subject to tax on dividends paid by the Fund that are
derived from interest on such bonds.
26
<PAGE>
Distributions to shareholders will be treated in the manner described above
regardless of whether received in cash or reinvested in additional shares of the
Fund. In general, distributions by the Fund are taken into account by the
shareholders in the year in which they are made. However, certain distributions
made during January will be treated as having been paid by the Fund and received
by the shareholders on December 31 of the preceding year.
Under the backup withholding rules of the Code, certain shareholders may be
subject to 31% withholding of Federal income tax on ordinary income dividends,
capital gain dividends and redemption payments made by the Fund. To avoid this
backup withholding, a shareholder must provide the Fund with a correct taxpayer
indentification number (which for an individual is usually his or her social
security number) and/or certify that it is a corporation or otherwise exempt
from or not subject to backup withholding.
The exclusion from gross income for Federal income tax purposes of
exempt-interest dividends does not necessarily result in exclusion under the
income or other tax laws of any state or local taxing authority. However, to the
extent that exempt-interest dividends are derived from interest received by the
Fund on obligations of New York State, its political subdivisions or its duly
constituted authorities, they will be exempt from New York State and City
personal income taxes for a New York resident individual shareholder.
Exempt-interest dividends will not be excluded in determining New York State or
City franchise taxes applicable to corporations or financial institutions. You
are advised to consult with your tax advisors concerning the application of
state and local taxes to an investment in the Fund, which may differ from the
Federal income tax consequences heretofore described.
Statements regarding the tax status of distributions by the Fund will be
mailed annually by Fundamental Shareholder Services, Inc. In the event that a
distribution may not be wholly excludable from gross income for Federal income
tax purposes or exempt from New York State and City personal income taxes, the
statement will provide information about the tax-exempt percentage, which may
vary from distribution to distribution.
The foregoing discussion is for general information only. A prospective
shareholder should also review the more detailed discussion of Federal income
tax considerations in the Fund's Statement of Additional Information under the
caption "Tax Matters." In addition, each prospective shareholder should consult
with his or her own tax advisor as to the tax consequences of an investment in
the Fund.
GENERAL INFORMATION
The Company, which was incorporated under the laws of the State of New York
on January 30, 1980, and which was reorganized as a Maryland corporation on
December 31, 1990, is an open-end, non-diversified management investment
company. The Fund's fiscal year begins January 1 and ends December 31. On April
24, 1996, the Company changed its name from New York Muni Fund, Inc. to
Fundamental Funds, Inc.
Annual and semi-annual reports of the Fund, together with the list of
securities held by the Fund in its portfolio, are mailed to each shareholder.
The Company is authorized to issue 1,000,000,000 shares of common stock, par
value $.001 per share, of which 500,000,000 shares are designated "New York Muni
Fund Series" and the balance of which are unclassified. All shares of the Fund
are entitled to equal participation in dividends and distributions declared by
the Fund and in its net assets on liquidation remaining after satisfaction of
all outstanding liabilities. The Fund's shares are fully paid and non-assessable
when issued and have no preemptive rights. Holders of common stock are entitled
to one vote for each full share and to such fraction of a vote that corresponds
to any fractional shares. The Fund will not normally hold annual shareholders'
meetings. Shareholders may remove directors from office by a majority of votes
entitled to be cast at a meeting of shareholders. Shareholders holding 10% or
more of the Fund's outstanding stock may call a special meeting of shareholders.
The Code of Ethics of Fundamental Portfolio Advisors, Inc. and the Fund
prohibits all affiliated personnel from engaging in personal investment
activities which compete with or attempt to take advantage of the Fund's planned
portfolio transactions. The
27
<PAGE>
objective of the Code of Ethics of both the Fund and Fundamental Portfolio
Advisors, Inc. is that their operations be carried out for the exclusive benefit
of the Fund's shareholders. Both organizations maintain careful monitoring of
compliance with the Code of Ethics.
The custodian for the assets of the Fund is The Chase Manhattan Bank, N.A.
("Chase"). Fundamental Shareholder Services, Inc. performs all services in
connection with the transfer of the shares of the Fund. Shareholder inquiries
concerning the status of an account should be directed to Fundamental
Shareholder Services, Inc. by calling (800) 322-6864.
Litigation
The Company was named as a defendant in a class action lawsuit: Herzog v.
Malanga, New York Muni Fund, Inc., et al., United States District Court,
Southern District of New York. Also named as defendants in this action were the
Manager, Fundamental Service Corporation, and an officer of the Company.
The suit was filed in July of 1994 and alleged that the Fund invested in
certain financial instruments, primarily "derivatives," that were inconsistent
with the Fund's stated objectives as set forth in its prospectus. The suit
claimed that defendants are liable under Sections 11 and/or 12 of the Securities
Act of 1933 because there existed material misstatements or omissions in the
prospectus that rendered it misleading. This suit also alleged common law fraud
and claims that defendants are liable under Section 10(b) of the Securities and
Exchange Act of 1934 (and Rule 10b-5 promulgated thereunder) for making material
misstatements or omissions in connection with the purchase or sale of
securities.
By Stipulation of Settlement dated April 5, 1996, a settlement requiring
court approval was reached with the plaintiffs. If approved by the Court, the
settlement will require a payment of approximately $500,000 or more under
certain future circumstances by the Fund's investment adviser to the class
members as set forth in the Stipulation of Settlement. Under no circumstances
will the settlement result in any liability or cost to the Fund or its
shareholders. The settlement will, however, result in the dismissal of the
lawsuit and a release from liability issuing in favor of all defendants
including the Fund. The Stipulation of Settlement also expressly states that the
settlement does not constitute an admission of wrongdoing by the Fund or any of
the other defendants. By Class Action Settlement Notice Order entered by the
Court on April 15, 1996, the Court ordered, among other things, that a hearing
on the settlement will occur on July 17, 1996. If the settlement is not
successfully concluded, the Fund intends to contest the litigation vigorously.
This Prospectus omits certain information contained in the Fund's
Registration Statement, filed with the Securities and Exchange Commission.
Copies of the Registration Statement, including items omitted herein, may be
obtained from the Commission by paying the charges prescribed under its rules
and regulations. The Statement of Additional Information included in such
Registration Statement may be obtained without charge from the Fund.
28
<PAGE>
APPENDIX
For the fiscal year ended December 31, 1995, the Fund's asset composition,
based on the monthly weighted average of credit ratings of portfolio securities,
was as follows:
S&P or Percentage of Percentage of assets
Moody's assets rated by unrated but determined to
Rating rating agency be of comparable quality*
- ------ ------------- ------------------------
AAA or Aaa 31.05% 0%
AA or Aa 7.63% 0%
A 34.08% 0%
BBB or Baa 22.26% 0%
BB or Ba 0% 0%
B 0% 0%
Below B 0% 0%
- -----------
*4.98% of the Fund's assets was invested in unrated securities during the fiscal
year ended December 31, 1995. Unrated securities are not necessarily
lower-quality securities. Issuers of municipal securities frequently choose not
to incur the expense of obtaining a rating. Please refer to the Fund's Statement
of Additional Information for a more complete discussion of these ratings.
29
<PAGE>
NEW YORK MUNI FUND
90 Washington Street
New York NY 10006
1-800-225-6864
Transfer Agent
Fundamental Shareholder Services, Inc.
P.O. Box 1013
New York, NY 10274
1-800-322-6864
Counsel to the Fund
Kramer, Levin, Naftalis, Nessen
Kamin & Frankel
New York, New York
Independent Auditors
McGladrey & Pullen, LLP
New York, New York
No person has been authorized to give any information or to make any
representations other than those contained in this Prospectus and in the Funds
official sales literature in connection with the offer of the Funds shares, and,
if given or made, such other information or representations must not be relied
upon as having been authorized by the Fund. This Prospectus does not constitute
an offer in any State in which, or to any person to whom, such offering may not
lawfully be made.
NEW YORK MUNI FUND
Prospectus
April 25, 1996
NEW YORK MUNI FUND
FUNDAMENTAL
Family of Funds
<PAGE>
STATEMENT OF ADDITIONAL INFORMATION
NEW YORK MUNI FUND
P.O. Box 1013
Bowling Green Station
New York, New York 10274-1013
(800) 322-6864
NEW YORK MUNI FUND (the "Fund") is a series of Fundamental Funds, Inc.
(the "Company"), a Maryland corporation. The Fund seeks to provide a high level
of income that is excluded from gross income for Federal income tax purposes and
exempt from New York State and New York City personal income taxes and is
consistent with the preservation of capital. Of course, there can be no
assurance that this investment objective will be achieved. The Fund intends to
achieve its objective through investing primarily in municipal obligations of
New York State, its political subdivisions, and its other duly constituted
authorities and corporations, that are rated within the four highest quality
grades for bonds as determined by Moody's Investors Service, Inc. ("Moody's"),
Standard & Poor's Corporation ("S&P"), Fitch Investors Service, Inc. ("Fitch")
or Duff & Phelps, Inc. ("Duff") or within the three highest quality grades for
municipal notes as determined by Moody's, S&P, Fitch or Duff or, if unrated, are
judged by Fund management to be of comparable quality. While municipal
obligations in these categories are generally deemed to have adequate to very
strong protection of principal and interest, municipal obligations rated within
the lowest of these categories may have speculative characteristics as well.
This Statement of Additional Information provides certain detailed
information concerning the Fund. It is not a Prospectus and should be read in
conjunction with the Fund's current Prospectus, a copy of which may be obtained
by writing to Fundamental Service Corporation at the address listed above, or by
calling (800) 322-6864. Shareholder inquiries may also be placed through this
number.
THIS STATEMENT IS DATED APRIL 25, 1996 AND
SUPPLEMENTS THE FUND'S PROSPECTUS OF THE SAME DATE.
<PAGE>
TABLE OF CONTENTS
PAGE
----
INVESTMENT OBJECTIVE, POLICIES AND RESTRICTIONS 3
ADDITIONAL INFORMATION RELATING TO MUNICIPAL OBLIGATIONS 6
ADDITIONAL INFORMATION RELATING TO LOWER RATED SECURITIES 9
ADDITIONAL INFORMATION CONCERNING NEW YORK ISSUERS 11
MANAGEMENT OF THE FUND 26
DISTRIBUTION PLAN 31
CALCULATION OF YIELD 32
CUSTODIAN AND INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS 36
TAX MATTERS 36
PORTFOLIO TRANSACTIONS 43
FINANCIAL STATEMENTS 45
APPENDIX A-1
2
<PAGE>
INVESTMENT OBJECTIVE, POLICIES AND RESTRICTIONS
As stated in the Fund's Prospectus, the objective of the Fund is
to provide investors with a high level of income that is excluded from gross
income for Federal income tax purposes and exempt from New York State and New
York City personal income taxes and is consistent with the preservation of
capital. Of course, there can be no assurance that this objective will be
achieved. The Fund intends to attempt to achieve its objective by investing
substantially all, and at least 80%, of its total assets in debt obligations
which are rated within the four highest quality grades for bonds as determined
by Moody's, S&P, Fitch or Duff or within the three highest quality grades for
municipal notes as determined by Moody's, S&P, Fitch or Duff or, if unrated, are
judged by Fund management to be of comparable quality, and which are issued by
the State of New York, its political subdivisions, and its other duly
constituted authorities and corporations, the interest from which is, in the
opinion of counsel to the issuer, totally excluded from gross income for Federal
income tax purposes and exempt from New York State and New York City personal
income taxes.
The investment restrictions described below have been adopted by
the Fund as fundamental policies which cannot be changed without approval of a
majority of the outstanding shares of the Fund.
1. The Fund will not issue any senior security (as defined in
the 1940 Act), except that (a) the Fund may enter into commitments to purchase
securities in accordance with the Fund's investment program, including reverse
repurchase agreements, delayed delivery and when-issued securities, which may be
considered the issuance of senior securities; (b) the Fund may engage in
transactions that may result in the issuance of a senior security to the extent
permitted under applicable regulations, interpretations of the 1940 Act or an
exemptive order; (c) the Fund may engage in short sales of securities to the
extent permitted in its investment program and other restrictions; (d) the
purchase or sale of futures contracts and related options shall not be
considered to involve the issuance of senior securities; and (e) subject to
fundamental restrictions, the Fund may borrow money as authorized by the 1940
Act.
2. The Fund will not underwrite any issue of securities, except
to the extent that the purchase of municipal obligations directly from the
issuer, in accordance with the Fund's investment objective, policies and
restrictions, may be deemed to be an underwriting.
3. The Fund will not purchase or sell real estate. This
restriction shall not prevent the Fund from investing in municipal obligations
secured by real estate or interests therein.
4. The Fund will not invest in commodity contracts, except
that the Fund may, to the extent appropriate under its
3
<PAGE>
investment program, purchase securities of companies engaged in whole or in part
in such activities, may enter into transactions in financial and index futures
contracts and related options and may engage in transactions on a when-issued or
forward commitment basis.
5. The Fund will not invest in oil, gas or thermal mineral
exploration, or development programs.
6. The Fund will not make loans, except that, to the
extent appropriate under its investment program, the Fund may (a) purchase debt
instruments, including bonds, debentures, notes and municipal commercial paper;
(b) enter into repurchase transactions; and (c) lend portfolio securities
provided that the value of such loaned securities does not exceed one-third of
the Fund's total assets.
7. The Fund may borrow money from banks (including its
custodian bank) or from other lenders to the extent permitted under applicable
law, for temporary or emergency purposes, to meet redemptions or for purposes of
leveraging, but only if, immediately after such borrowing, the value of the
Fund's assets, including the amount borrowed, less its liabilities, is equal to
at least 300% of the amount borrowed, plus all outstanding borrowings. If at any
time the value of the Fund's assets fails to meet the 300% asset coverage
requirement, the Fund will, within three days (not including Sundays and
holidays), reduce its borrowings to the extent necessary to meet the 300% test.
The Fund may enter into certain futures contracts and options related thereto
and the Fund may enter into commitments to purchase securities in accordance
with the Fund's investment program, including delayed delivery and when-issued
securities and reverse repurchase agreements.
8. The Fund will not invest 25% or more of its total
assets in securities of issuers in any one industry; provided, however, that
such limitation shall not be applicable to municipal obligations other than
those municipal obligations backed only by the assets and revenues of
non-governmental users, nor shall it apply to municipal obligations issued or
guaranteed by the U.S. Government, its agencies or instrumentalities.
In addition to the foregoing, the Fund is subject to the
following non-fundamental restrictions:
1. The Fund will not purchase a qualified private activity
bond if as a result of such purchase more than 20% of the Fund's total assets,
determined at market value at the time of the proposed investment, would be
invested in qualified private activity bonds.
2. The Fund may purchase and sell futures contracts and
related options under the following conditions: (a) the then- current aggregate
futures market prices of financial instruments required to be delivered and
purchased under open futures contracts
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shall not exceed 20% of the fund's total assets, at market value; and (b) no
more than 5% of the assets, at market value at the time of entering into a
contract, shall be committed to margin deposits in relation to futures
contracts.
3. The Fund will not invest more than 15% of its net
assets in illiquid investments, including repurchase agreements maturing in more
than seven days, securities that are not readily marketable and restricted
securities not eligible for resale pursuant to Rule 144A under the Securities
Act of 1933.
4. The Fund will not make short sales of securities, other
than short sales "against the box", or purchase securities on margin except for
short-term credits necessary for clearance of portfolio transactions, provided
that this restriction will not be applied to limit the use of options, futures
contracts and related options, in the manner otherwise permitted by the
investment restrictions, policies and investment program of the Fund.
Since the Fund may invest in qualified private activity bonds,
its shares may not be an appropriate investment for "substantial users" of
facilities financed by industrial development bonds (as defined in Treasury
regulation section 1.103- 11), or "related persons" to such users (within the
meaning of Internal Revenue Code section 147(a)).
The Fund, together with any of its "affiliated persons" (as
described in the 1940 Act), may only purchase up to 3% of the total outstanding
securities of any underlying investment company. Accordingly, when the Fund or
such "affiliated persons" hold shares of any of the underlying investment
companies, the Fund's ability to invest fully in shares of those investment
companies is restricted, and Fundamental Portfolio Advisors, Inc. must then, in
some instances, select alternative investments that would not have been its
first preference.
The 1940 Act also provides that an underlying investment company
whose shares are purchased by the Fund will be obligated to redeem shares held
by the Fund and its affiliates only in an amount up to 1% of the underlying
investment company's outstanding securities during any period of less than 30
days. Shares held by the Fund and its affiliates in excess of 1% of an
underlying investment company's outstanding securities therefore will be
considered not readily marketable securities, which together with other such
illiquid securities may not exceed 15% of the Fund's net assets.
In certain circumstances, an underlying investment company may
determine to make payment of a redemption by the Fund wholly or partly by a
distribution in kind of securities from its portfolio, in lieu of cash, in
conformity with rules of the Securities and Exchange Commission. In such cases,
the Fund may hold securities distributed by an underlying investment company
until Fundamental
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Portfolio Advisors, Inc. determines that it is appropriate to dispose of such
securities.
There can be no assurance that funds for investing in municipal
obligations will be available for investment. The Fund does not intend to invest
in such funds unless, in the judgment of Fundamental Portfolio Advisors, Inc.,
the potential benefits of such investment justify the payment of any applicable
premium or sales charge.
Where relevant in this Statement of Additional Information, the
term "issuer" is defined as the entity which has either actually issued the
security or which is ultimately responsible for payment of the obligation. For
purposes of diversification of the Fund's investments, separate issues by the
same issuer will be considered as distinct or diverse investments provided that
such issues differ either with respect to collateral (i.e., the pledge of
specific revenue or taxes standing as security for the payment of the
obligation) or guarantor of ultimate payment.
ADDITIONAL INFORMATION RELATING TO MUNICIPAL OBLIGATIONS
MUNICIPAL BONDS
Municipal bonds are long-term debt obligations, generally with a
maturity at the time of issuance of greater than three years, of states and
their political subdivisions issued to obtain funds for various public purposes,
including construction of a wide range of public facilities, such as airports,
bridges, highways, housing, hospital, mass transportation, schools, streets and
water and sewer works. Other purposes for which municipal bonds may be issued
include refunding outstanding obligations; obtaining funds for general operating
expenses; or obtaining funds to lend to public or private institutions for
construction of such facilities as educational, hospital and housing facilities.
In addition, certain types of bonds may be issued by public authorities to
finance privately operated housing facilities, sports facilities, convention or
trade show facilities, and certain local facilities for water supply, gas,
electricity, or sewage or solid waste disposal. Other types of qualified private
activity bonds, the proceeds of which are used for the construction, equipment,
repair or improvement of privately operated industrial or commercial facilities,
may constitute municipal bonds, although current Federal tax laws place
substantial limitations on the size of such issues.
The two principal classifications of municipal bonds are general
obligation and revenue bonds. General obligation bonds are secured by the
issuer's pledge of faith, credit and taxing power for the payment of principal
and interest. Revenue bonds are payable from only revenues derived from a
particular facility or class of facilities or, in some cases, from the proceeds
of a
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special excise tax or other specific revenue sources such as from the user of
the facility being financed. Qualified private activity bonds are, in most
cases, revenue bonds and do not generally constitute the pledge of the credit or
taxing power of the issuer of such bonds. The payment of the principal and
interest on such bonds depends solely on the ability of the user of the
facilities financed by the bonds to meet its financial obligations and the
pledge, if any, of real and personal property so financed as security for such
payment.
MUNICIPAL NOTES
Municipal notes are short-term obligations, generally with a
maturity at the time of issuance of six months to three years. The principal
types of municipal notes include tax anticipation notes, bond anticipation
notes, revenue anticipation notes, and project notes. Tax anticipation notes are
sold to provide working capital to states and municipalities in anticipation of
collection of taxes. Bond anticipation notes are issued to provide funds
temporarily in anticipation of a bond sale. Revenue anticipation notes are sold
in expectation of receipt of other revenues, such as funds under the Federal
Revenue Sharing Program. Project notes are issued by local agencies in
connection with such programs as construction of low-income housing in order to
provide construction financing prior to permanent financing. Project notes are
guaranteed by the U.S. Department of Housing and Urban Development and
consequently are secured by the full faith and credit of the United States.
VARIABLE RATE INSTRUMENTS
Municipal bonds and notes are sometimes issued with a variable
interest rate ("variable rate instruments"). The interest rate on variable rate
instruments is usually tied to an objective standard, such as the 90-day
Treasury Bill rate or the prime rate of a bank involved in the financing. Prime
rates can change daily; the auction for 90-day Treasury Bill rates is held
weekly. In addition to having a variable interest rate, any such instruments are
subject to repayment of principal on demand by the Fund, usually in not more
than five business days. Both the variable rate feature and the principal
repayment on demand feature tend to reduce fluctuations in the price of variable
rate instruments; these instruments are generally of interest and sold to
institutional investors. Also available are participation interests in loans to
municipal issuers, which are similar except that these loan participations are
made available through a commercial bank that arranges the tax-exempt loan.
Participation interests are frequently backed by an irrevocable bank letter of
credit or a guarantee by a financial institution and give the Fund the right to
demand, on short notice (usually not more than seven days), payment of all or
any part of the principal amount and accrued interest. The Board of Directors
will determine that the participation interest in the municipal securities meets
the Fund's prescribed quality standards. The Fund's management has been
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instructed by the Board of Directors to monitor the pricing, quality and
liquidity of any variable rate demand instruments held, including participation
interests supported by letters of credit or guarantee, on the basis of published
financial information and reports of the rating agencies and other analytical
sources. The Fund's management will also monitor the creditworthiness of the
guarantor. Banks retain fees for their role in an amount equal to the excess of
the interest paid on the municipal securities over the negotiated yield at which
the participation interests were purchased. In the event that the participation
interest that the Fund acquires includes the right to demand payment of
principal and accrued interest from the issuer of the participation interest
pursuant to a letter of credit or other commitment, the maturity will be deemed
to be equal to the time remaining until the principal amount can be recovered
from the issuer through demand, although the stated maturity may be in excess of
one year. To the extent that variable rate instruments and loan participations
may lack liquidity (unless payable on demand or within seven days), they are
subject to the restriction on illiquid securities, described herein under the
caption "Investment Objective, Policies and Restrictions".
OTHER INFORMATION
A portion of the Fund's assets may be invested in qualified
hospital bonds. Such bonds are rated on the basis of feasibility studies that
project occupancy levels, revenues and expenses. The gross receipts and income
of hospitals are affected by many future events and conditions (including among
other things, demand for hospital services, the ability of the hospital to
provide such services, competition, actions by insurers and governmental
agencies, the cost and possible unavailability of malpractice insurance, and the
funding of medicare and medicaid programs), whose effects are often difficult to
predict. Changes or future developments in all of the foregoing areas may have
an adverse effect on the price or marketability of such bonds.
A part of the Fund's assets may be invested in obligations of
state and local housing authorities. Such obligations are not part of the
general obligations of the state or the municipality in question. To a large
extent, such obligations are generally supported by Federal housing subsidy
programs. Any weakness in such programs or their administration, or the failure
by a state or local housing authority to meet the qualifications required for
coverage under such programs, may result in a decrease or the elimination of
such Federal subsidies and could adversely affect payment of principal and
interest on housing authority bonds. These factors as well as general economic
factors affecting housing in general could cause a decrease in the value or
marketability of such bonds.
A portion of the Fund's assets may be invested in municipal
obligations that are moral obligation bonds issued by agencies and authorities
of the State of New York (i.e., issued
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pursuant to the municipality's good faith and credit to pay principal and
interest). Under the statutes applicable to such bonds, the State may be called
on to restore any deficits in capital reserve funds of such agencies or
authorities created with respect to the bonds. Any such restoration requires
appropriation by the state legislature for such purposes, and accordingly, the
statutes do not constitute legally enforceable obligations or debt of the State.
The agencies or authorities in question have no taxing power, and on a default
by such agencies or authorities, there are no guarantees that payments of
principal and interest will be met.
ADDITIONAL INFORMATION RELATING TO LOWER RATED SECURITIES
The lower quality securities in which the Fund may invest (i.e.,
those rated lower than Baa by Moody's or BBB by S&P, Fitch or Duff or determined
by Fund management to be a comparable quality if unrated) generally produce a
higher current yield than do securities of higher ratings. However, these
obligations are considered speculative because they involve greater price
volatility and risk than do higher rated securities and the yields on these
securities will tend to fluctuate over time. Although the market value of all
fixed-income securities varies as a result of changes in prevailing interest
rates (e.g., when interest rates rise, the market value of fixed-income
securities can be expected to decline), values of lower rated securities tend to
react differently than the values of higher rated securities. The prices of
lower rated securities are less sensitive to changes in interest rates than
higher rated securities. Conversely, lower rated securities also involve a
greater risk of default by the issuer in the payment of principal and income and
are more sensitive to economic downturns and recessions than higher rated
securities. The financial stress resulting from an economic downturn could have
a greater negative effect on the ability of issuers of lower rated securities to
service their principal and interest payments, to meet projected business goals
and to obtain additional financing than on more creditworthy issuers. In the
event of an issuer's default in payment of principal or interest on such
securities, or any other securities in the Fund's portfolio, the net asset value
of the Fund will be negatively affected. Moreover, as the market for lower rated
securities is a relatively new one which has not yet been tested through a
recession, a severe economic downturn might increase the number of defaults,
thereby adversely affecting the value of all outstanding lower rated municipal
bonds and disrupting the market for such securities. Securities purchased by the
Fund as part of an initial underwriting present an additional risk due to their
lack of market history. These risks are exacerbated with respect to securities
rated CCC or lower by S&P, Fitch or Duff or Caa or lower by Moody's. Unrated
securities generally carry the same risks as do lower rated securities.
The Fund may invest in lower rated securities that are
structured as zero coupon or pay-in-kind bonds. Such securities
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may be more speculative and subject to greater fluctuation in value due to
changes in interest rates than lower rated, income-bearing securities. In
addition, zero coupon and pay-in-kind securities are also subject to the risk
that in the event of a default, a fund may realize no return on its investment,
because these securities do not pay cash interest. Zero coupon, or deferred
interest, securities are debt obligations that do not entitle the holder to any
periodic payment of interest prior to maturity or a specified date when the
securities begin paying current interest (the "cash payment date") and therefore
are issued and traded at a discount from their face amounts or par value.
Pay-in-kind securities are securities that pay interest through the issuance of
additional securities. Holders of zero coupon securities are considered to
receive each year the portion of the original issue discount on such securities
that accrues that year and must include such amount in gross income, even though
the holders receive no cash payments during the year. Consequently, as a fund is
accruing original issue discount on these securities prior to the receipt of
cash payment, it is still subject to the requirement that it distribute
substantially all of its income to its shareholders in order to qualify as a
"regulated investment company" under applicable tax law. Therefore, such fund
may have to dispose of its portfolio securities under disadvantageous
circumstances or leverage itself by borrowing to generate the cash necessary to
satisfy its distribution requirements.
Lower rated securities are typically traded among a smaller
number of broker-dealers rather than in a broad secondary market. Purchasers of
lower rated securities tend to be institutions, rather than individuals, a
factor that further limits the secondary market. To the extent that no
established retail secondary market exists, many lower rated securities may not
be as liquid as Treasury and investment grade securities. The ability of the
Fund to sell lower rated securities will be adversely affected to the extent
that such securities are thinly traded or illiquid. Moreover, the ability of the
Fund to value lower rated securities becomes more difficult, and judgment plays
a greater role in valuation, as there is less reliable, objective data available
with respect to such securities that are thinly traded or illiquid.
Because investors may perceive that there are greater risks
associated with the medium to lower rated securities of the type in which the
Fund may invest, the yields and prices of such securities may tend to fluctuate
more than those for securities with a higher rating. Changes in perception of
issuers' creditworthiness tend to occur more frequently and in a more pronounced
manner in the lower quality segments of the fixed-income securities market than
do changes in higher quality segments of such market, resulting in greater yield
and price volatility.
The general legislative environment has included discussions and
legislative proposals relating to the tax treatment of high-yield securities.
Any or a combination of such proposals, if enacted into law, could negatively
affect the value of the
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high-yield securities in the Fund's portfolio. The likelihood of any such
legislation is uncertain.
Fund management believes that the risks of investing in such
high-yielding securities may be minimized through careful analysis of
prospective issuers. Although the opinion or ratings services such as Moody's,
S&P, Fitch and Duff is considered in selecting portfolio securities, they relate
to credit risk and evaluate the safety of the principal and the interest
payments of the security, not their market value risk. Additionally, credit
rating agencies may experience slight delays in updating ratings to reflect
current events. The Fund relies, primarily, on its own credit analysis, which
includes a study of the existing debt, capital structure, ability to service
debts and to pay dividends, and the current trend of earnings for any issuer
under consideration for the Fund's investment portfolio. This may suggest,
however, that the achievement of the Fund's investment objective is more
dependent on its proprietary credit analysis, than is otherwise the case for a
fund that invests in higher quality securities.
ADDITIONAL INFORMATION CONCERNING NEW YORK ISSUERS
The financial condition of New York State (the "State") and
certain of its public bodies (the "Agencies") and municipalities, particularly
New York City (the "City"), could affect the market values and marketability of
New York Municipal Obligations which may be held by the Fund. The following
information constitutes only a brief summary, does not purport to be a complete
description, and is based on information drawn from official statements relating
to securities offerings of the State, the City and the Municipal Assistance
Corporation for the City of New York ("MAC") available as of the date of this
Statement of Additional Information. While the Fund has not independently
verified such information, it has no reason to believe that such information is
not correct in all material respects.
A national recession commenced in mid-1990. The downturn
continued through the remainder of the 1990-91 fiscal year, and was followed by
a period of weak economic growth during the remainder of the 1991 calendar year.
For the calendar year 1992, the national economy continued to recover, although
at a rate below all post-war recoveries. The recession was more severe in the
State than in other parts of the nation, owing to a significant retrenchment in
the financial services industry, cutbacks in defense spending, and an overbuilt
real estate market. The State economy remained in recession until 1993, when
employment growth resumed. Since early 1993, the State has gained approximately
100,000 jobs. The State's economy expanded modestly during 1995. Although
industries that export goods and services abroad are expected to benefit from
the lower dollar, growth will be slowed by
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government cutbacks at all levels. On an average annual basis, employment growth
in 1995 was estimated to be about the same as 1994. Both personal income and
wages were estimated to have recorded moderate gains in 1995. Employment growth
is expected to slow significantly in 1996 as the pace of national economic
growth slackens, entire industries experience consolidations, and governmental
employment continues to shrink. Personal income is estimated to increase by 4.0%
in 1996.
The State's budget for the 1995-96 fiscal year was enacted by
the Legislature on June 7, 1995, more than two months after the start of the
fiscal year. Prior to adoption of the budget, the Legislature enacted
appropriations for disbursements considered to be necessary for State operations
and other purposes, including all necessary appropriations for debt service. The
State Financial Plan for 1995-96 fiscal year was formulated on June 20, 1995 and
is based on the State's budget as enacted by the Legislature and signed into law
by the Governor.
The 1995-96 budget was the first to be enacted in the
administration of the Governor, who assumed office on January 1. It was the
first budget in over half a century which proposed and, as enacted, projected an
absolute year-over-decline in General Fund disbursements. Spending for State
operations was projected to drop even more sharply, by 4.6%. Nominal spending
from all State funding sources (i.e., excluding Federal aid) was proposed to
increase by only 2.5% from the prior fiscal year, in contrast to the prior
decade when such spending growth averaged more than 6.0% annually.
In his Executive Budget, the Governor indicated that in the
1995-96 fiscal year, the State Financial Plan, based on then-current law
governing spending and revenues, would be out of balance by almost $4.7 billion,
as a result of the projected structural deficit resulting from the ongoing
disparity between sluggish growth in receipts, the effect of prior-year tax
changes, and the rapid acceleration of spending growth; the impact of unfunded
1994-95 initiatives, primarily for local aid programs; and the use of one-time
solutions, primarily surplus funds from the prior year, to fund recurring
spending in the 1994-95 budget. The Governor proposed additional tax cuts, to
spur economic growth and provide relief for low and middle income tax payers,
which were larger than those ultimately adopted, and which added $240 million to
the then projected imbalance or budget gap, bringing their total to
approximately $5 billion.
This gap was projected to be closed in the 1995-96 State
Financial Plan based on the enacted budget, through a series of actions, mainly
spending reductions and cost containment measures and certain reestimates that
were expected to be recurring, but also through the use of one-time solutions.
The General Fund was projected to be balanced on a cash basis
for the 1995-96 fiscal year. Total receipts and transfers
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from other funds were projected to be $33.110 billion, a decrease of $48 million
from total receipts in the prior fiscal year. Total General Fund disbursements
and transfers to other funds were projected to be $33.055 billion, a decrease of
$344 million from the total amount disbursed in the prior fiscal year.
The State Financial Plan was based upon forecasts of national
and State economic activity. Economic forecasts have frequently failed to
predict accurately the timing and magnitude of changes in the national and the
State economies. Many uncertainties exist in forecasts of both the national and
State economies, including consumer attitudes toward spending, Federal financial
and monetary policies, the availability of credit and the condition of the world
economy, which could have an adverse effect on the State. There can be no
assurance that the State economy will not experience worse-than-predicted
results , with corresponding material and adverse effects on the State's
projections of receipts and disbursements.
The State issued its second quarterly update to the cash-basis
1995-96 State Financial Plan (the "Mid-Year Update") on October 26, 1995.
Revisions have been made to estimates of both receipts and disbursements based
on: (1) updated economic forecasts for both the nation and the State, (2) an
analysis of actual receipts and disbursements through the first six months of
the fiscal year, and (3) an assessment of changing program requirements and cost
savings initiatives. The Mid-Year Update projects continued balance in the
State's 1995-96 Financial Plan,with estimated receipts reduced by a net $71
million and estimated disbursements reduced by a net $30 million. The resulting
General Fund balance decreases to $172 million in the Mid-Year Update,
reflecting the expected use of $41 million from the Contingency Reserve Fund for
payment of litigation and disallowance expenses.
On October 2, 1995, the State Comptroller released a report
entitled "Comptroller's Report on the Financial Condition of New York State
1995" in which he identified several risks to the State Financial Plan and
reaffirmed his estimate that the State faces a potential imbalance in receipts
and disbursements of at least $2.7 billion for the State's 1996-97 fiscal year
and at least $3.9 billion for the State's 1997-98 fiscal year.
There can be no assurance that the State will not face
substantial potential budget gaps in future years resulting from a significant
disparity between tax revenues projected from a lower recurring receipts base
and the spending required to maintain State programs at current levels. To
address any potential budgetary imbalance, the State may need to take
significant actions to align recurring receipts and disbursements in future
fiscal years.
On June 6, 1990, Moody's changed its ratings on all the State's
outstanding general obligation bonds from A1 to A. On March 26, 1990 and January
13, 1992, S&P changed its ratings on all
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of the State's outstanding general obligation bonds from AA- to A and from A to
A-, respectively. In February 1991, Moody's lowered its rating on the City's
general obligation bonds from A to Baa1 and in July 1995, S&P lowered its rating
on such bonds from A- to BBB+. Ratings reflect only the respective views of such
organizations, and their concerns about the financial condition of New York
State and City, the debt load of the State and City and any economic
uncertainties about the region. There is no assurance that a particular rating
will continue for any given period of time or that any such rating will not be
revised downward or withdrawn entirely if, in the judgment of the agency
originally establishing the rating, circumstances so warrant.
(1) The State, Agencies and Other Municipalities.
During the mid 1970's, some of the Agencies and municipalities (in particular,
the City) faced extraordinary financial difficulties, which affected the State's
own financial condition. These events, including a default on short-term notes
issued by the New York State Urban Development Corporation ("UDC") in February
1975, which default was cured shortly thereafter, and a continuation of the
financial difficulties of the City, created substantial investor resistance to
securities issued by the State and by some of its municipalities and Agencies.
For a time, in late 1975 and early 1976, these difficulties resulted in a
virtual closing of public credit markets for State and many State related
securities.
In response to the financial problems confronting it, the State
developed and implemented programs for its 1977 fiscal year that included the
adoption of a balanced budget on a cash basis (a deficit of $92 million that
actually resulted was financed by issuing notes that were paid during the first
quarter of the State's 1978 fiscal year). In addition, legislation was enacted
limiting the occurrence of additional so-called "moral obligation" and certain
other Agency debt, which legislation does not, however, apply to MAC debt.
State Financial Plan--GAAP-Basis Results--1995-96 Update. The
State issued its first update to the GAAP-basis Financial Plan for the State's
1995-96 fiscal year on September 1, 1995. The September GAAP-basis update
projected a General Fund operating surplus of $401 million. The prior projection
of the 1995-96 GAAPbasis State Financial Plan, issued in March 1995 as part of
the 1995-96 Executive Budget, projected an operating surplus in the General Fund
of $800 million. The change to the projection primarily reflects the impact of
legislative changes to the 1995-96 Executive Budget, as well as increases in
projected accruals for certain local assistance programs (primarily Medicaid).
Total revenues in the General Fund are projected at $31.871
billion, consisting of $29.625 billion in tax revenues and $2.246 billion in
miscellaneous revenue. Total expenditures in the General Fund are projected at
$32.444 billion, including $22.678 billion for grants to local governments,
$8.037 billion for State
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operations, $1.711 billion for general State charges, and $18 million for debt
service. Compared to the projections made in March, expenditures for grants to
local governments are substantially increased, primarily because of legislative
changes to the 1995-96 Executive Budget and increased projected accruals for
Medicaid.
For all governmental funds, the summary GAAP-basis Financial
Plan shows an excess of revenues and other financing sources over expenditures
and other financing uses of $359 million.
GAAP-Basis Results--1994-95 Fiscal Year. The State's Combined
Balance Sheet as of March 31, 1995 showed an accumulated deficit in its combined
governmental funds of $1.666 billion reflecting liabilities of $14.778 billion
and assets of $13.112 billion. This accumulated governmental funds deficit
includes a $3.308 billion accumulated deficit in the General Fund, as well as
accumulated surpluses in the special Revenue and Debt Service fund types of $877
million and $1.753 billion, respectively, and a $988 million accumulated deficit
in the Capital Projects fund type.
The State completed its 1994-95 fiscal year with a combined
Governmental Funds operating deficit of $1.791 billion, which included operating
deficits int he General Fund of $1.426 billion, in the Capital Projects Funds of
$366 million, and in the Debt Service Funds of $38 million. There is an
operating surplus in the Special Revenue Funds of $39 million.
GAAP-Basis Results--1993-94 Fiscal Year. The State reported a
General Fund operating surplus of $914 million for the 1993-94 fiscal year, as
compared to an operating surplus of $2.065 billion for the prior fiscal year.
The 1993-94 fiscal year surplus reflects several major factors, including the
cash basis surplus recorded in 1993-94, the use of $671 million of the 1992-93
surplus to fund operating expenses in 1993-94, net proceeds of $575 million in
bonds issued by the New York Local Government Assistance Corporation ("LGAC")
and the accumulation of a $265 million balance in the Contingency Reserve Fund
("CRF") . Revenues increased $543 million (1.7%) over prior fiscal year revenues
with the largest increase occurring in personal income taxes. Expenditures
increased $1.659 billion (5.6%) over the prior fiscal year, with the largest
increase occurring in State aid for social services programs.
The Special Revenue fund and Debt Service fund ended 1993- 94
with operating surpluses of $149 million and $23 million, respectively. The
Capital Projects fund ended with an operating deficit of $35 million.
GAAP-Basis Results--1992-93 Fiscal Year. The State completed its
1992-93 fiscal year with a GAAP-basis operating surplus of $2.065 billion in the
General Fund and an accumulated deficit of $2.551 billion. The Combined
Statement of Revenues,
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Expenditures and Changes in Fund Balances reported total revenues of $31.085
billion, total expenditures of $29.337 billion, and net other financing sources
and uses of $317 million. The surplus primarily reflects the 1992-93 cash-basis
surplus and the net proceeds of $881 million in bonds issued by LGAC.
The Special Revenue, Debt Service and Capital Projects fund
types ended the 1992-93 fiscal year with GAAP-basis operating surpluses of $131
million, $381 million, and $57 million, respectively.
State Financial Plan--Cash-Basis Results--General Fund. The
General Fund is the principal operating fund of the State and is used to account
for all financial transactions, except those required to be accounted for in
another fund. It is the State's largest fund and receives almost all State taxes
and other resources not dedicated to particular purposes. General Fund moneys
are also transferred to other funds, primarily to support certain capital
projects and debt service payments in other fund types.
The General Fund is projected to be balanced on a cash basis for
the 1995-96 fiscal year. Total receipts and transfers from other funds are
projected to be $33.110 billion, a decrease of $48 million from total receipts
in the prior fiscal year. Total General Fund disbursements and transfers to
other funds are projected to be $33.055 billion, a decrease of $344 million from
the total amount disbursed in the prior fiscal year.
New York State's financial operations have improved during
recent fiscal years. During the period 1989-90 through 1991-92, the State
incurred General Fund operating deficits that were closed with receipts from the
issuance of tax and revenue anticipation notes ("TRANs"). First, the national
recession, and then the lingering economic slowdown in the New York and regional
economy, resulted in repeated shortfalls in receipts and three budget deficits.
For its 1992-93, 1993-94 and 1994-95 fiscal years, the State recorded balanced
budgets on a cash basis, with substantial fund balances in 1992-93 and 1993-94,
and smaller fund balance in 1994-95, as described below.
New York State ended its 1994-95 fiscal year with the General
fund in balance. The closing fund balance of $158 million reflects $157 million
in the Tax Stabilization Reserve Fund and $1 million in the Contingency Reserve
Fund ("CRF"). The CRF was established in State Fiscal year 199394, funded partly
with surplus monies, to assist the State in financing the 1994-95 fiscal year
costs of extraordinary litigation known or anticipated at that time; the opening
fund balance in State fiscal year 1994-95 was $265 million. The $241 million
change in the fund balance reflects the use of $264 million in the CRF as
planned, as well as the required deposit of $23 million to the Tax Stabilization
Reserve Fund. In addition, $278 million was on deposit in the tax refund reserve
account, $250 million of which was deposited at the end of
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the State's 1994-95 fiscal year to continue the process of restructuring the
State's cash flow as part of the New York Local Government Assistance
Corporation ("LGAC") program.
Compared to the State Financial Plan for 1994-1995 as formulated
on June 16, 1994, reported receipts fell short of original projections by $1.163
billion, primarily in the categories of personal income and business taxes. of
this amount, the personal income tax accounts for $800 million, reflecting weak
estimated tax collections and lower withholding due to reduced wage and salary
growth, more severe reductions in brokerage industry bonuses than projected
earlier, and deferral of capital gains realizations in anticipation of potential
Federal tax changes. Business taxes fell short by $373 million, primarily
reflecting lower payments from banks as substantial overpayments of 1993
liability depressed net collections in the 1994-95 fiscal year. These shortfalls
were offset by better performance in the remaining taxes, particularly the user
taxes and fees, which exceeded projections by $210 million. Of this amount, $277
million was attributable to certain restatements for accounting treatment
purposes pertaining to the CRF and LGAC; these restatements had no impact on
balance in the General Fund.
Disbursements were also reduced from original projections by
$848 million. After adjusting for the net impact of restatements relating to the
CRF and LGAC which raised disbursements by $38 million, the variance is $886
million. Well over two-thirds of this variance is in the category of grants to
local governments, primarily reflecting the conservative nature of the original
estimates of projected costs for social services and other programs. Lower
education costs are attributable to the availability of $110 million in
additional lottery proceeds and the use of LGAC bond proceeds.
The spending reductions also reflect $188 million in actions
initiated in January 1995 by the Governor to reduce spending to avert a
potential gap in the 1994-95 State Financial Plan. These actions included
savings from a hiring freeze, halting the development of certain services, and
the suspension of nonessential capital projects. These actions, together with
$71 million in other measures comprised the Governor's $259 million gapclosing
plan, submitted to the Legislature in connection with the 1995-96 Executive
Budget.
The State ended its 1993-94 fiscal year with a balance of $1.140
billion in the tax refund reserve account, $265 million in the CRF and $134
million in its tax stabilization reserve fund. These fund balances were
primarily the result of an improving national economy, State employment growth,
tax collections that exceeded earlier projections and disbursements that were
below expectations.
Before the deposit of $1.140 billion in the tax refund reserve
account, General Fund receipts in 1993-94 exceeded those
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originally projected when the State Financial Plan for the year was formulated
on April 16, 1993 by $1.002 billion. Greater-thanexpected receipts in the
personal income tax, the bank tax, the corporation franchise tax and the estate
tax accounted for most of this variance, and more than offset
weaker-than-projected collections from the sales and use tax and miscellaneous
receipts. The higher receipts resulted, in part, because the New York economy
performed better than forecasted. Employment growth started in the first quarter
of the State's 1993-94 year, and although this lagged the national economic
recovery, the growth in New York began earlier than forecasted. The New York
economy exhibited signs of strength in the service sector, in construction, and
in trade.
Disbursements and transfer from the General Fund were $303
million below the level projected in April 1993, an amount that would have been
$423 million had the State not accelerated the payment of Medicaid billings,
which in the April 1993 State Financial Plan were planned to be deferred into
the 1994-95 fiscal year. Compared to the estimates included in the State
Financial Plan formulated in April 1993, disbursements were lower for Medicaid,
capital projects, and debt service (due to refundings).
In addition, $114 million of school and payments were funded
from the proceeds of LGAC bonds. Disbursements were higherthan-expected for
general support for public schools. The State also made the first of six
required payments to the State of Delaware related to the settlement of
Delaware's litigation against the State regarding the disposition of abandoned
property receipts.
During the 1993-94 fiscal year, the State also established and
funded the CRF as a way to assist the State in financing the cost of litigation
affecting the State. The CRF was initially funded with a transfer of $100
million attributable to the positive margin recorded in the 1992-93 fiscal year.
In addition, the State augmented this initial deposit with $132 million on debt
service savings attributable to the refinancing of State and public authority
bonds during 1993-94. A year-end transfer of $36 million was also made to the
CRF, which, after a disbursement for authorized fund purposes, brought the CRF
balance at the end of 1993-94 to $265 million. This amount was $165 million
higher than the amount originally targeted for this reserve fund.
The State ended the 1992-93 fiscal year with a balance on a cash
basis of $671 million in the General Fund that was deposited in the tax refund
reserve account and $67 million in the Tax Stabilization Fund.
After reflecting a 1992-93 year-end deposit to the refund
reserve account of $671 million, reported 1992-93 General Fund receipts were $45
million higher than originally projected in April 1992. If not for that year-end
transaction, which had the effect of reducing 1992-93 receipts by $671 million
and making
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those receipts available in 1993-94, General Fund receipts would have been $716
million higher than originally projected.
During its 1989-90, 1990-91 and 1991-92 fiscal years, the State
incurred cash-basis operating deficits in the General Fund of $775 million,
$1.081 billion and $575 million, respectively, prior to the issuance of
short-term TRANs, owing to lower-thanprojected receipts.
Cash-Basis Results--Other Governmental Funds. Activity in the
three other governmental funds has remained relatively stable over the last
three fiscal years, with Federally-funded programs comprising approximately
two-thirds of these funds. The most significant change in the structure of these
funds has been the redirection, beginning in the 1993-94 fiscal year, of a
portion of transportation-related revenues from the General Fund to two new
dedicated funds in the Special Revenue and Capital Projects Fund types. These
revenues totalling $676 million in the 1994-95 fiscal year were used to support
the capital programs of the Department of Transportation and the Metropolitan
Transportation Authority ("MTA").
The Special Revenue Funds account for State receipts from
specific sources that are legally restricted in use to specified purposes and
include all moneys received from the Federal government. Total receipts in
Special Revenue Funds are projected at $25.547 billion in the State's 1995-96
fiscal year. Disbursements from Special Revenue Funds are projected to be
$26.002 billion for the State's 1995-96 fiscal year.
The Capital Projects Funds are used to finance the acquisition
and construction of major capital facilities and to aid local government units
and Agencies in financing capital constructions. Federal grants for capital
projects, largely highway-related, are projected to account for 24% of the
$4.170 billion in total projected receipts in Capital Projects Funds in the
State's,1995-96 fiscal year. Total disbursements for capital projects are
projected to be $4.160 billion during the State's 1995-96 fiscal year.
The Debt Service Funds serve to fulfill State debt service on
long-term general obligation State debt and other State lease/purchase and
contractual obligation financing commitments. Total receipts in Debt Service
Funds are projected to reach $2.409 billion in the State's 1995-96 fiscal year.
Total disbursements from Debt Service Funds for debt service, lease/purchase and
contractual obligation financing commitments are projected to be $2.506 billion
for the 1995-96 fiscal year.
State Borrowing Plan. The State anticipates that its capital
programs will be financed, in part, through borrowings by the State and public
authorities in the 1995-96 fiscal year. The
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State expects to issue $248 million in general obligation bonds (including $70
million for purposes of redeeming outstanding BANs) and $186 million in general
obligation commercial paper . The Legislature has also authorized the issuance
of up to $33 million in COPs during the State's 1995-96 fiscal year for
equipment purchases and $14 million for capital purposes. The projection of the
State regarding its borrowings for the 1995-96 fiscal year may change , if
circumstances require.
In addition, the LGAC is authorized to provide net proceeds of
up to $529 million during the 1995-96 fiscal year to redeem notes sold in June
1995.
State Agencies. The fiscal stability of the State is related, at
least in part, to the fiscal stability of its localities and various of its
Agencies. Various Agencies have issued bonds secured, in part, by non-binding
statutory provisions for State appropriations to maintain various debt service
reserve funds established for such bonds (commonly referred to as "moral
obligation" provisions).
At September 30, 1994, there were 18 Agencies that had
outstanding debt of $100 million or more. The aggregate outstanding debt,
including refunding bonds, of these 18 Agencies was $70.3 billion as of
September 30, 1994. As of March 31, 1995, aggregate Agency debt outstanding as
State supported debt was $27.9 billion and as State-related was $36.1 billion.
Debt service on the outstanding Agency obligations normally is paid out of
revenues generated by the Agencies' projects or programs, but in recent years
the State has provided special financial assistance, in some cases on a
recurring basis, to certain Agencies for operating and other expenses and for
debt service pursuant to moral obligation indebtedness provisions or otherwise.
Additional assistance is expected to continue to be required in future years.
Several Agencies have experienced financial difficulties in the
past. Certain Agencies continue to experience financial difficulties requiring
financial assistance from the State. Failure of the State to appropriate
necessary amounts or to take other action to permit certain Agencies to meet
their obligations could result in a default by one or more of such Agencies. If
a default were to occur, it would likely have a significant effect on the
marketability of obligations of the State and the Agencies.
These Agencies are discussed below.
The New York State Housing Finance Agency ("HFA") provides
financing for multifamily housing, State University construction, hospital and
nursing home development, and other programs. In general, HFA depends upon
mortgagors in the housing programs it finances to generate sufficient funds from
rental income, subsidies and other payments to meet their respective mortgage
repayment obligations to HFA, which provide the principal source of funds for
the payment of debt service on HFA bonds, as well as to meet operating and
maintenance costs of the projects financed. From
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January 1, 1976 through March 31, 1987, the State was called upon to appropriate
a total of $162.8 million to make up deficiencies in the debt service reserve
funds of HFA pursuant to moral obligation provisions. The State has not been
called upon to make such payments since the 1986-87 fiscal year and no payments
are anticipated during the 1995-96 fiscal year.
UDC has experienced, and expects to continue to experience,
financial difficulties with the housing programs it had undertaken prior to
1975, because a substantial number of these housing program mortgagors are
unable to make full payments on their mortgage loans. Through a subsidiary, UDC
is currently attempting to increase its rate of collection by accelerating its
program of foreclosures and by entering into settlement agreements. UDC has
been, and will remain, dependent upon the State for appropriations to meet its
operating expenses. The State also has appropriated money to assist in the
curing of a default by UDC on notes which did not contain the State's moral
obligation provision.
The MTA oversees New York City's subway and bus lines by its
affiliates, the New York City Transit Authority and the Manhattan and Bronx
Surface Transit Operating Authority (collectively, the "TA"). Through MTA's
subsidiaries, the Long Island Rail Road Company, the Metro-North Commuter
Railroad Company and the Metropolitan Suburban Bus Authority, the MTA operates
certain commuter rail and bus lines in the New York metropolitan area. In
addition, the Staten Island Rapid Transit Authority, an MTA subsidiary, operates
a rapid transit line on Staten Island. Through its affiliated agency, the
Triborough Bridge and Tunnel Authority (the "TBTA"), the MTA operates certain
toll bridges and tunnels. Because fare revenues are not sufficient to finance
the mass transit portion of these operations, the MTA has depended and will
continue to depend for operating support upon a system of State, local
government and TBTA support and, to the extent available, Federal operating
assistance, including loans, grants and subsidies. If current revenue
projections are not realized and/or operating expenses exceed current
projections, the TA or commuter railroads may be required to seek additional
State assistance, raise fares or take other actions.
Over the past several years the State has enacted several
taxes--including a surcharge on the profits of banks, insurance corporations and
general business corporations doing business in the 12-county region (the
"Metropolitan Transportation Region") served by the MTA and a special .25%
regional sales and use tax-that provide additional revenues for mass transit
purposes, including assistance to the MTA. In addition, since 1987, State law
has required that the proceeds of .25% mortgage recording tax paid on certain
mortgages in the metropolitan Transportation Region be deposited in a special
MTA fund for operating or capital expenses. Further, in 1993, the State
dedicated a portion of certain additional State petroleum business tax receipts
to fund operating or capital assistance to the MTA. For the 1995-96
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State fiscal year, total State assistance to the MTA is estimated at
approximately $1.1 billion.
In 1981, the State Legislature authorized procedures for the
adoption, approval and amendment of a five-year plan for the capital program
designed to upgrade the performance of the MTA's transportation systems and to
supplement, replace and rehabilitate facilities and equipment, and also granted
certain additional bonding authorization therefor.
On April 5, 1993, the Legislature approved, and the Governor
subsequently signed into law, legislation authorizing a five-year $9.56 billion
capital plan for the MTA for 1992-1996. The MTA has received approval of the
1992-1996 Capital Program based on this legislation from the MTA Capital Program
Review Board (the "CPRB"), as State law requires. This is the third five-year
plan since the Legislature authorized procedures for the adoption, approval and
amendment of a five-year plan in 1981 for a capital program designed to upgrade
the performance of the MTA's transportation systems and to supplement, replace
and rehabilitate facilities and equipment. The MTA, the TBTA and the TA are
collectively authorized to issue an aggregate of $3.1 billion of bonds (net of
certain statutory exclusions) to finance a portion of the 1992-96 Capital
Program. The 1992-96 Capital Program was expected to be financed in significant
part through dedication of the State petroleum business tax receipts.
There can be no assurance that such governmental actions will be
taken, that sources currently identified will not be decreased or eliminated, or
that the 1992-1996 Capital Program will not be delayed or reduced. If the MTA
capital program is delayed or reduced because of funding shortfalls or other
factors, ridership and fare revenues may decline, which could, among other
things, impair the MTA's ability to meet its operating expenses without
additional State assistance.
The cities, towns, villages and school districts of the State
are political subdivisions of the State with the powers granted by the State
Constitution and statutes. As the sovereign, the State retains broad powers and
responsibilities with respect to the government, finances and welfare of these
political subdivisions, especially in education and social services. In recent
years the State has been called upon to provide added financial assistance to
certain localities.
Other Localities. Certain localities in addition to the City
could have financial problems leading to requests for additional
State-assistance during the State's 1995-96 fiscal year and thereafter. The
potential impact on the State of such actions by localities is not included in
the projections of the State receipts and disbursements in the State's 1995-96
fiscal year.
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Municipalities and school districts have engaged in substantial
short-term and long-term borrowings. In 1993, the total indebtedness of all
localities in the State, other than the City, was approximately $17.7 billion. A
small portion (approximately $105 million) of this indebtedness represented
borrowing to finance budgetary deficits and was issued pursuant to enabling
State legislation. State law requires the Comptroller to review and make
recommendations concerning the budgets of those local government units other
than the City authorized by State law to issue debt to finance deficits during
the period that such deficit financing is outstanding. Fifteen localities had
outstanding indebtedness for deficit financing at the close of their fiscal year
ending in 1993.
Certain proposed Federal expenditure reductions would reduce, or
in some cases eliminate, Federal funding of some local programs and accordingly
might impose substantial increased expenditure requirements on affected
localities to increase local revenues to sustain those expenditures. If the
State, the City or any of the Agencies were to suffer serious financial
difficulties jeopardizing their respective access to the public credit markets,
the marketability of notes and bonds issued by localities within the State could
be adversely affected. Localities also face anticipated and potential problems
resulting from certain pending litigation, judicial decisions and long-range
economic trends. The longer-range, potential problems of declining city
population, increasing expenditures and other economic trends could adversely
affect localities and require increasing State assistance in the future.
Because of significant fiscal difficulties experienced from time
to time by the City of Yonkers, a Financial Control Board was created by the
State in 1984 to oversee Yonkers' fiscal affairs. Future actions taken by the
Governor or the State Legislature to assist Yonkers in this crisis could result
in the allocation of State resources in amounts that cannot yet be determined.
Certain litigation pending against the State or its officers or
employees could have a substantial or long-term adverse effect on State
finances. Among the more significant of these litigations are those that
involve: (i) the validity and fairness of agreements and treaties by which
various Indian tribes transferred title to the State of approximately six
million acres of land in central New York; (ii) certain aspects of the State's
Medicaid rates and regulations, including reimbursements to providers of
mandatory and optional Medicaid services; (iii) contamination in the Love Canal
area of Niagara Falls; (iv) a challenge to the State's practice of reimbursing
certain Office of Mental Health patient-care expenses with clients' Social
Security benefits; (v) a challenge to the methods by which the State reimburses
localities for the administrative costs of food stamp programs; (vi) a challenge
to the State's possession of certain funds taken pursuant to the State's
Abandoned Property law; (vii)
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alleged responsibility of State officials to assist in remedying racial
segregation in the City of Yonkers; (viii) an action, in which the state is a
third party defendant, for injunctive or other appropriate relief, concerning
liability for the maintenance of stone groins constructed along certain areas of
Long Island's shoreline; (ix) actions challenging the constitutionality of
legislation enacted during the 1990 legislative session which changed the
actuarial funding methods for determining contributions to State employee
retirement systems; (x) an action against State and City officials alleging that
the present level of shelter allowance for public assistance recipients is
inadequate under statutory standards to maintain proper housing; (xi) an action
challenging legislation enacted in 1990 which had the effect of deferring
certain employer contributions to the State Teachers' Retirement System and
reducing State aid to school districts by a like amount; (xii) a challenge to
the constitutionality of financing programs of the Thruway Authority authorized
by Chapters 166 and 410 of the Laws of 1991 (described below in this Part);
(xiii) a challenge to the constitutionality of financing programs of the
Metropolitan Transportation Authority and the Thruway Authority authorized by
Chapter 56 of the Laws of 1993 (described below in this Part); (xiv) challenges
to the delay by the State Department of Social Services in making two one-week
Medicaid payments to the service providers; (xv) challenges by commercial
insurers, employee welfare benefit plans, and health maintenance organizations
to provisions of Section 2807-c of the Public Health Law which impose 13%, 11%
and 9% surcharges on inpatient hospital bills and a bad debt and charity care
allowance on all hospital bills paid by such entities; (xvi) challenges to the
promulgation of the State's proposed procedure to determine the eligibility for
and nature of home care services for Medicaid recipients; (xvii) a challenge to
State implementation of a program which reduces Medicaid benefits to certain
home-relief recipients; and (xviii) challenges to the rationality and
retroactive application of State regulations recelebrating nursing home Medicaid
rates.
Adverse developments or decisions in such cases could affect the
ability of the State to maintain a balanced 1995-96 State Financial Plan.
(2) New York City. In the mid- 1970s, the City had
large accumulated past deficits and until recently was not able to generate
sufficient tax and other ongoing revenues to cover expenses in each fiscal year.
However, the City's operating results for the fiscal year ending June 30, 1995
were balanced in accordance with GAAP, the thirteenth consecutive year in which
the City achieved balanced operating results in accordance with GAAP. The City's
ability to maintain balanced operating results in future years is subject to
numerous contingencies and future developments.
The City's economy, whose rate of growth slowed substantially
over the past three years, is currently in recession. During the 1990 and 1991
fiscal years, as a result of the slowing
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economy, the City has experienced significant shortfalls in almost all of its
major tax sources and increases in social services costs, and has been required
to take actions to close substantial budget gaps in order to maintain balanced
budgets in accordance with the Financial Plan.
In 1975, the City became unable to market its securities and
entered a period of extraordinary financial difficulties. In response to this
crisis, the State created MAC to provide financing assistance to the City and
also enacted the New York State Financial Emergency Act for the City of New York
(the "Emergency Act") which, among other things, created the Financial Control
Board (the "Control Board") to oversee the City's financial affairs and
facilitate its return to the public credit markets. The State also established
the Office of the State Deputy Comptroller ("OSDC") to assist the Control Board
in exercising its powers and responsibilities. On June 30, 1986, the Control
Board's powers of approval over the City Financial Plan were suspended pursuant
to the Emergency Act. However, the Control Board, MAC and OSDC continue to
exercise various monitoring functions relating to the City's financial
condition. The City prepares and operates under a four-year financial plan which
is submitted annually to the Control Board for review and which the City
periodically updates.
The City's independently audited operating results for each of
its fiscal years from 1981 through 1995 show a General Fund surplus reported in
accordance with GAAP. The City has eliminated the cumulative deficit in its net
General Fund position.
According to a recent OSDC economic report, the City's economy
was slow to recover from the recession and is expected to experience a weak
employment situation, and moderate wage and income growth, during the 1995-96
period. Also, Financial Plan reports of OSDC, the Control Board, and the City
Comptroller have variously indicated that many of the City's balanced budgets
have been accomplished, in part, through the use of non-recurring resource, tax
and fee increases, personnel reductions and additional State assistance; that
the City has not yet brought its long-term expenditures in line with recurring
revenues; that the City's proposed gap-closing programs, if implemented, would
narrow future budget gaps; that these programs tend to rely heavily on actions
outside the direct control of the City; and that the City is therefore likely to
continue to face futures projected budget gaps requiring the City to reduce
expenditures and/or increase revenues. According to the most recent staff
reports of OSDC, the Control Board and the City Comptroller during the four-year
period covered by the current Financial Plan, the City is relying on obtaining
substantial resources from initiatives needing approval and cooperation of its
municipal labor unions, Covered Organizations, and City Council, as well as the
State and Federal governments, among others, and there can be no assurance that
such approval can be obtained.
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The City requires certain amounts of financing for seasonal and
capital spending purposes. The City has issued $1.75 billion of notes for
seasonal financing purposes during the 1994 fiscal year. The City's capital
financing program projects long-term financing requirements of approximately $17
billion for the City's fiscal years 1995 through 1998 for the construction and
rehabilitation of the City's infrastructure and other fixed assets. The major
capital requirement include expenditures for the City's water supply system, and
waste disposal systems, roads, bridges, mass transit, schools and housing. In
addition, the City and the Municipal Water Finance Authority issued about $1.8
billion in refunding bonds in the 1994 fiscal year.
State Economic Trends. The State historically has been one of
the wealthiest states in the nation. For decades, however, the State has grown
more slowly than the nation as a whole, gradually eroding its relative economic
position. Statewide, urban centers have experienced significant changes
involving migration of the more affluent to the suburbs and an influx of
generally less affluent residents. Regionally, the older Northeast cities have
suffered because of the relative success that the South and the West have had in
attracting people and business. The City has also had to face greater
competition as other major cities have developed financial and business
capabilities which make them less dependent on the specialized services
traditionally available almost exclusively in the City.
During the 1982-83 recession, overall economic activity in the
State declined less than that of the nation as a whole. However, in the calendar
years 1984 through 1991, the State's rate of economic expansion was somewhat
slower than that of the nation. In the 1990-91 recession, the economy of the
State, and that of the rest of the Northeast, was more heavily damaged than that
of the nation as a whole and has been slower to recover. The total employment
growth rate in the State has been.below the national average since 1984. The
unemployment rate in the State dipped below the national rate in the second half
of 1981 and remained lower until 1991; since then, it has been higher. According
to data published by the U.S. Bureau of Economic Analysis, during the past ten
years, total personal income in the State rose slightly faster than the national
average only from 1986 through 1988.
MANAGEMENT OF THE FUND
DIRECTORS AND OFFICERS
Directors and officers of the Fund, together with information as
to their principal business occupations during the last five years, are shown
below. Each director who is considered to be an "interested person" of the Fund,
as defined in the 1940 Act, is indicated by as asterisk (*).
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James C. Armstrong: Director of the Fund. Mr. Armstrong is a
partner in Armstrong/Seltzer Communications Inc., a New York management,
consulting and public relations firm. He was formerly Executive Director, Global
Public Affairs Institute at New York University and Professor, Bell of
Pennsylvania Chair in Telecommunications, Temple University, and is a management
consultant. He was with American Telephone and Telegraph Company for 15 years.
His last position with AT&T was Director, Corporate Policy Analysis. Mr.
Armstrong previously held positions at the Institute for Defense Analysis, the
Office of the Postmaster General, and on the faculty of the University of
Maryland. He has been a consultant to government, academic and business
organizations, and has served on various government-industry task forces and
committees. Mr. Armstrong was an Officer in the United States Navy and holds a
Ph.D. in nuclear physics. Mr. Armstrong's address is 51 Mt. Pleasant Road,
Morristown, New Jersey 07960.
James A. Bowers: Director of the Fund. Mr. Bowers is a
consultant for Prototypes (formerly, Director of Finance and Administration),
the American Telephone and Telegraph Company, The RAND Corporation and CogniTech
Services Corporation. He was employed at AT&T for 23 years. His latest position
with AT&T was in the Treasury Department as District Manager-Securities and
Exchange Commission Reporting. Mr. Bowers holds Bachelor of Science and Master
of Arts degrees in Economics from Florida Atlantic University. Mr. Bowers'
address is 60 East Eighth Street, New York, N.Y. 10003.
Clark L. Bullock: Director of the Fund. Mr. Bullock is Chairman
of the Board of Shelter Rock Investors Services Corp., a privately-held, New
York-based investment company. Mr. Bullock received a Masters of Science degree
in Mathematical Economics from Purdue University in 1972 and a Bachelor of Arts
degree in International Relations from the University of Arizona. Mr. Bullock's
address is c/o Shelter Rock Investors, 150 Hopper Avenue, Waldwick, NJ 07463.
L. Greg Ferrone: Director of the Fund. Mr. Ferrone is a
consultant with IntraNet, Inc., a provider of computer systems to the domestic
and international banking industry. Previously he was the Director of Sales &
Marketing for RAV Communications Inc., Vice President/Regional Manager with
National Westminster Bank USA and an officer at Security Pacific Bank. Mr.
Ferrone received a Bachelor of Science degree from Rensselaer Polytechnic
Institute in 1972 and studied at the Stonier Graduate School of Banking. Mr.
Ferrone's address is 83 Ronald Court, Ramsey, New Jersey 07446.
*Vincent J. Malanga: Chairman of the Board, Chief Executive
Officer, President and Treasurer of the Fund, The California Muni Fund and
Fundamental Fixed Income Fund. Mr. Malanga is President, Treasurer and a
Director of Fundamental Portfolio Advisors, Inc., Executive Vice President,
Secretary and
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a Director of Fundamental Service Corporation, and President, LaSalle Economics
Inc., an economic consulting firm. Mr. Malanga is Vice President, Secretary and
a 50% shareholder of LaSalle Portfolio Management, Inc., the general partner of
both LPM Financial Futures Fund I, Limited Partnership and LPM Equities Fund
Limited Partnership. Prior thereto, he was a Vice President and Senior Economist
at A. Gary Shilling & Company, Inc., an economic consulting and brokerage firm.
He previously served as an Economist at White, Weld & Co. (an investment banking
and brokerage firm) and so served from 1976 to 1978. Prior thereto, Mr. Malanga,
who holds a Ph.D. in Economics from Fordham University, was an Economist at the
Federal Reserve Bank of New York. Mr. Malanga's address is 90 Washington Street,
19th Floor, New York, New York 10006.
David P. Wieder: Vice President of the Fund, Secretary of
Fundamental Portfolio Advisors, Inc., and President and a Director of
Fundamental Shareholder Services, Inc. Mr. Wieder holds a Bachelor of Science
degree in Economics from Cornell University. Mr. Wieder's address is 90
Washington Street, 19th Floor, New York, New York 10006.
Carole M. Laible: Secretary of the Fund. Treasurer and Secretary
of Fundamental Shareholder Services, Inc. She was formerly a General Service
Manager for McGladrey & Pullen. Ms. Laible receibved a Bachelor of Science
degree from St. John's University in 1985. Ms. Laible's address is 90 Washington
Street, 19th Floor, New York, New York 10006.
All of the Directors of the Fund are also Trustees of The
California Muni Fund and Fundamental Fixed-Income Fund. All of the officers of
the Fund hold similar offices with The California Muni Fund and Fundamental
Fixed-Income Fund.
For services and attendance at board meetings and meetings of
committees which are common to the Fund, Fundamental Fixed-Income Fund and The
California Muni Fund (other affiliated mutual funds for which the Fund's
investment manager acts as the investment adviser), each Director of the Fund
who is not affiliated with the Fund's investment manager is compensated at the
rate of $6,500 per quarter prorated among the three funds based on their
respective net assets at the end of each quarter. Each such Director is also
reimbursed by the three funds, on the same basis, for actual out-of-pocket
expenses relating to his attendance at meetings. For the fiscal year ended
December 31, 1995, Directors' fees totalling $73,332 were paid by the Fund to
the Directors as a group. As of the date of this Statement of Additional
Information, Directors and officers of the Fund as a group owned beneficially
less than 1% of the Fund's outstanding shares.
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COMPENSATION TABLE
(FOR EACH CURRENT BOARD MEMBER
RECEIVING COMPENSATION FROM
A FUNDAMENTAL FUND FOR THE
MOST RECENTLY COMPLETED FISCAL YEAR)
AGGREGATE COMPENSATION FROM FUND
AGGREGATE
COMPENSATION
PAID BY ALL
HIGH- U.S. FUNDS MANAGED
YIELD TAX- GOV'T BY
CALI- MUNI- FREE STRA- FUNDAMENTAL
FORNIA CIPAL MONEY TEGIC PORTFOLIO
NAME NY MUNI MUNI BOND MARKET INCOME ADVISORS, INC.
- ---- ------- ---- ---- ------ ------ --------------
James C. Armstrong $18,333 $1,376 $117 $4,518 $1,656 $26,000
James A. Bowers 18,333 1,376 117 4,518 1,656 26,000
Clark L. Bullock 18,333 1,376 117 4,518 1,656 26,000
L. Greg Ferrone 18,333 1,376 117 4,518 1,656 26,000
PORTFOLIO REVIEW COMMITTEE
Pursuant to the terms of an assurance of discontinuance (the
"assurance") entered into with the Department of Law of the State of New York,
the Fund has established and will maintain for a period of at least five years
from April 15, 1994, a Portfolio Review Committee of its Board of Directors,
consisting of no fewer than three independent directors. Messrs. James C.
Armstrong, James A. Bowers and Clark L. Bullock constitute the Portfolio Review
Committee's members.
The Portfolio Review Committee oversees the Fund's (i)
investment performance and strategies; (ii) the adequacy of internal controls
and procedures applicable to portfolio personnel and activity; (iii) the
amendment, as they may deem necessary in the exercise of their duties, of the
Fund's Prospectus; and (iv) compliance with investment policies stated in the
Fund's Prospectus, with such other policies as the Board of Directors may from
time to time establish, and with all applicable laws, rules and regulations. The
Portfolio Review Committee also reviews all annual and semi-annual reports prior
to their dissemination to shareholders.
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The Portfolio Review Committee is required to keep a record of
its meetings and has the authority to retain such expert (legal, financial or
accounting) assistance as the Committee in its sole discretion deems necessary
in the exercise of their duties. Fundamental Service Corporation has designated
a Compliance Officer who has day-to-day responsibility for the Fund's compliance
with applicable Federal and state laws, rules and regulations, the assurance
entered into with the Department of Law of the State of New York, and the rules,
policies and by-laws of the National Association of Securities Dealers, Inc.,
particularly as they pertain to sales materials. The Compliance Officer also
assists the work of the Portfolio Review Committee.
INVESTMENT MANAGEMENT
As discussed in the Fund's Prospectus, a Management Agreement
(the "Agreement") between the Company, on behalf of the Fund, and Fundamental
Portfolio Advisors, Inc. (the "Manager"), was adopted by the Board of Directors
of the Fund on October 3, 1990, and was approved by shareholders on November 29,
1990. Vincent J. Malanga, Chairman of the Board, Chief Executive Officer,
President and Treasurer of the Fund, and Dr. Lance M. Brofman, Chief Portfolio
Strategist of the Fund, each own approximately 48.5% of the outstanding shares
of the voting capital stock of the Manager.
The Manager has agreed that it will notify the Fund's Board of
Directors before engaging any new clients of material significance; that, if
requested, each Director will receive a weekly portfolio transaction statement
from the Manager in order to review all trades made by the Manager; and that if
at any time three or more Directors who are "non-interested persons" of the Fund
desire to purchase or sell any security for or of the Fund, the Manager, at the
direction of the "non-interested" Directors, will immediately purchase or sell
such security, as the case may be, at the expense and risk of the Fund.
TRANSFER AGENT
Fundamental Shareholder Services, Inc., P.O. Box 1013, Bowling
Green Station, New York, New York 10274-1013, an affiliate of Fundamental
Portfolio Advisors, Inc. and Fundamental Service Corporation, performs all
services in connection with the transfer of shares of the Fund, acts as its
dividend disbursing agent, and as administrator of the exchange, check
redemption, telephone redemption and expedited redemption privileges of the Fund
pursuant to a Transfer Agency and Service Agreement dated as of February 1,
1990. During the fiscal year ended December 31, 1995, fees paid to the Transfer
Agent by the Fund amounted to $375,225.
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<PAGE>
DISTRIBUTION PLAN
The Board of Directors and shareholders of the Fund have
approved a plan of distribution under Rule 12b-1 of the 1940 Act (the "Plan").
Pursuant to the Plan, the Fund may pay certain promotional and advertising
expenses and may compensate certain registered securities dealers and financial
institutions for services provided in connection with the processing of orders
for purchase or redemption of the shares of the Fund and furnishing other
shareholder services. Payments by the Fund shall not in the aggregate in any
fiscal year of the Fund exceed 1/2 of 1% of daily net assets of the Fund. The
Fund may enter into shareholder processing and service agreements (the
"Shareholder Service Agreements") with any securities dealer who is registered
under the Securities Exchange Act of 1934 and a member in good standing of the
National Association of Securities Dealers, Inc., and with banks and other
financial institutions, who may wish to establish accounts or sub-accounts on
behalf of their customers ("Shareholder Service Agents"). For processing
investor purchase and redemption orders, responding to inquiries from Fund
shareholders concerning the status of their accounts and operations of the Fund
and communicating with the Fund, the Fund may pay each such Shareholder Service
Agent to cover expenditures for advertising, sales literature and other
promotional materials on behalf of the Fund.
The fees payable to Shareholder Service Agents under Shareholder
Service Agreements will be negotiated by the Fund's management. The Fund's
management will report quarterly to the Board of Directors on the rate to be
paid under each such agreement and the amounts paid or payable under such
agreements. It will be based upon the management's analysis of (1) the
contribution that the Shareholder Service Agent makes to the Fund by increasing
Fund assets and reducing expense ratios; (2) the nature, quality and scope of
services being provided by the Shareholder Service Agent; (3) the cost to the
Fund if shareholder services were provided directly by the Fund or other
authorized persons; (4) the costs incurred by the Shareholder Servicing Agent in
connection with providing services to shareholders; and (5) the need to respond
to competitive offers of others which could result in assets being withdrawn
from the Fund and an increase in the expense ratio for the Fund.
The Board of Directors of the Fund, including a majority of the
"disinterested" Directors who have no direct or indirect financial interest in
the operation of the Plan or any agreements relating thereto, authorized the
Fund to enter into an agreement with Fundamental Service Corporation, a Delaware
corporation, under the Plan. The agreement provides that the Fund may pay the
usual and customary agency's commission to Fundamental Service Corporation for
producing and placing Fund advertising in newspapers, magazines or other
periodicals, on radio or television, or in direct marketing campaigns. In
addition to the foregoing, the Fund may pay Fundamental Service Corporation for
marketing research and promotional services specifically relating to the
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<PAGE>
distribution of Fund shares, including office space, facilities and equipment,
salaries, training and administrative expenses, computer systems and software,
communications, supplies, photocopying and similar types of expenses. The
following persons own of record 5% or more of the outstanding shares of voting
stock of Fundamental Service Corporation: Mr. Vincent J. Malanga (43.71%); Mr.
Thomas W. Buckingham (43.71%); and Dr. Lance M. Brofman (9.90%).
The Plan will continue in effect until December 31, 1996. The
Plan will continue in effect from year to year if specifically approved at least
annually by the Board of Directors and the affirmative vote of a majority of the
Directors who are not parties to any Shareholder Service Agreement or
"interested persons" of any such party by votes cast in person at a meeting
called for such purpose. In approving the Plan, the Directors determined, in the
exercise of their business judgment and in light of their fiduciary duties as
Directors of the Fund, that there was a reasonable likelihood that the Plan
would benefit the Fund and its shareholders. The Plan may only be renewed if the
Directors make a similar determination for each subsequent year. The Plan may
not be amended to increase the maximum amount of payments by the Fund to its
Shareholder Service Agents without shareholder approval, and all material
amendments to the provisions of the Plan must be approved by a vote of the Board
of Directors and of the Directors who have no direct or indirect interest in the
Plan, cast in person at a meeting called for the purpose of such vote.
The Plan provides that the Fund's management shall provide, and
that the independent Directors shall review, quarterly reports setting forth the
amounts expended pursuant to the Plan and the purpose for which the amounts were
expended. It further provides that while the Plan is in effect, the selection
and nomination of those Directors of the Fund who are not "interested persons"
of the Fund is committed to the discretion of the independent Directors.
During the year ended December 31, 1995, the Fund paid $885,389
for expenses incurred pursuant to the Plan, which amount was spent in the
distribution of the Fund's shares, including expenses for: advertising --
$336,448; printing and mailing of Prospectuses to other than current
shareholders -- $17,708; and sales, and shareholder servicing support services
and other distribution services, -- $531,233. Of the amount paid by the Fund
during last year, $420,197 was paid to Fundamental Service Corporation for
expenses incurred and services rendered by it pursuant to the Plan.
CALCULATION OF YIELD
The Fund's yield quotations and average annual total return
quotations as they may appear in the Prospectus, this Statement of Additional
Information or in advertising and sales
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<PAGE>
material, are calculated by standard methods prescribed by the
Securities and Exchange Commission.
The Fund's yield is computed by dividing the Fund's net
investment income per share during a base period of 30 days, or one month, by
the net asset value per share of the Fund on the last day of such base period in
accordance with the following formula:
a-b 6
Yield = 2[( ----------+1) -1]
cd
Where: a = dividends and interest earned during the period
b = expenses accrued for the eriod (net of
reimbursements)
c = the average daily number of shares outstanding during
the period that were entitled to receive dividends.
d = the maximum offering price per share on the last day
of the period.
For purposes of calculating interest earned on debt obligations as provided in
item "a" above:
1. The yield to maturity of each obligation held by the Fund is
computed based on the market value of the obligation (including actual accrued
interest, if any) at the close of business on the last day of each month, or,
with respect to obligations purchased during the month, the purchase price (plus
actual accrued interest, if any).
2. The yield to maturity of each obligation is then divided by
360 and the resulting quotient is multiplied by the market value of the
obligation (including actual accrued interest, if any) to determine the interest
income on the obligation for each day of the subsequent month that the
obligation is in the portfolio. For these purposes, it is assumed that each
month has 30 days.
3. Interest earned on all debt obligations during the 30-day or
one-month period is then totaled.
4. The maturity of an obligation with a call provision(s) is the
next call date on which the obligation reasonably may be expected to be called
or, if none, the maturity date.
5. In the case of a tax-exempt obligation issued without
original issue discount and having a current market discount, the
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<PAGE>
coupon rate of interest of the obligation is used in lieu of yield to maturity
to determine interest income earned on the obligation.
In the case of a tax-exempt obligation with original issue discount where the
discount based on the current market value of the obligation exceeds the then
remaining portion of original issue discount (i.e. market discount), the yield
to maturity used to determine interest income earned on the obligation is the
imputed rate based on the original issue discount calculation. In the case of a
tax-exempt obligation with original issue discount where the discount based on
the current market value of the obligation is less than the then remaining
portion of the original issue discount (market premium), the yield to maturity
used to determine interest income earned on the obligation is based on the
market value of the obligation.
With respect to the treatment of discount and premium on
mortgage or other receivables-backed obligations which are expected to be
subject to monthly payments of principal and interest ("pay downs"), the Fund
accounts for gain or loss attributable to actual monthly pay downs as an
increase or decrease to interest income during the period. In addition, the Fund
may elect (1) to amortize the discount or premium on a remaining security, based
on the cost of the security, to the weighted average maturity date, if such
information is available, or to the remaining term of the security, if the
weighted average maturity date is not available, or (2) not to amortize the
discount or premium on a remaining security.
For the purposes of computing yield, dividend income is
recognized by accruing 1/360 of the stated dividend rate of each obligation in
the Fund's portfolio each day that the obligation is in the portfolio. The Fund
does not use equalization accounting in the calculation of yield. Expenses
accrued during any base period, if any, pursuant to the Plan are included among
the expenses accrued during the base period. Any reimbursement accrued pursuant
to the Plan during a base period, if any, will reduce expenses accrued pursuant
to such plan, but only to the extent the reimbursement does not exceed the
accrued expenses for the base period.
The Fund's yield for the one-month period ended December 31,
1995 determined in accordance with the above formula was 3.71%.
Average annual total return quotations are computed by finding
the average annual compounded rates of return that would cause a hypothetical
investment made on the first day of a designated period (assuming all dividends
and distributions are reinvested) to equal the ending redeemable value of such
hypothetical investment on the last day of the designated period in accordance
with the following formula:
n
P(1+T) = ERV
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<PAGE>
Where: P = a hypothetical initial payment of $1000
T = average annual total return
n = number of years
ERV = ending redeemable value of a hypothetical $1000
payment made at the end of a designated period
(or fractional portion thereof)
For purposes of the above computation, it is assumed that all dividends and
distributions made by the Fund are reinvested at net asset value during the
designated period. The average annual total return quotation is determined to
the nearest 1/100 of 1%. The average annual total return for the year ended
December 31, 1995 was - 15.67%. For the five-year period ended December 31,
1995, the average annual total return was 6.04% and for the ten year period
ended December 31, 1995, the average annual total return was 5.82%.
In determining the average annual total return (calculated as
provided above), recurring fees, if any, that are charged to all shareholder
accounts are taken into consideration. For any account fees that vary with the
size of the account, the account fee used for purposes of the above computation
is assumed to be the fee that would be charged to the Fund's mean account size.
The Fund may also from time to time advertise its taxable
equivalent yield. The Fund's taxable equivalent yield is determined by dividing
that portion of the Fund's yield (calculated as described above) that is
tax-exempt by one minus the stated marginal Federal income tax rate and adding
the product to that portion, if any, of the yield of the Fund that is not
tax-exempt. The taxable equivalent yield of the Fund for the one-month period
ended December 31, 1995 was 6.98% for a taxpayer whose income was subject to the
then highest combined Federal, New York State and New York City income tax rate
of 46.88%.
The Fund's yield and average annual total return will vary from
time to time depending on market conditions, the composition of the Fund's
portfolio and operating expenses of the Fund. These factors and possible
differences in the methods used in calculating yields and returns should be
considered when comparing performance information regarding the Fund to
information published for other investment companies and other investment
vehicles. Yields and return quotations should also be considered relative to
changes in the value of the Fund's shares and the risks associated with the
Fund's investment objectives and policies. At any time in the future, yields and
return quotations may be higher or lower than past yields or return quotations
and there can be no assurance that any historical yield or return quotation will
continue in the future.
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<PAGE>
CUSTODIAN AND INDEPENDENT CERTIFIED
PUBLIC ACCOUNTANTS
The Chase Manhattan Bank, N.A. (the "Bank"), 114 West 47th
Street, New York, New York, acts as Custodian of the Fund's cash and securities.
The Bank also acts as bookkeeping agent for the Fund, and in that capacity,
monitors the Fund's accounting records and calculates its net asset value.
McGladrey & Pullen, LLP, 555 Fifth Avenue, New York, New York,
acts as independent certified public accountants for the Fund, performing an
annual audit of the Fund's financial statements and preparing its tax returns.
TAX MATTERS
The following is only a summary of certain additional tax
considerations generally affecting the Fund and its shareholders that are not
described in the Prospectus. No attempt is made to present a detailed
explanation of the tax treatment of the Fund or its shareholders, and the
discussions here and in the Prospectus are not intended as substitutes for
careful tax planning.
Qualification as a Regulated Investment Company
The Fund has elected to be taxed as a regulated investment
company under Subchapter M of the Internal Revenue Code of 1986, as amended (the
"Code"). As a regulated investment company, the Fund is not subject to federal
income tax on the portion of its net investment income (i.e., taxable interest,
dividends and other taxable ordinary income, net of expenses) and capital gain
net income (i.e., the excess of capital gains over capital losses) that it
distributes to shareholders, provided that it distributes at least 90% of its
investment company taxable income (i.e., net investment income and the excess of
net short-term capital gain over net long-term capital loss) and at least 90% of
its tax-exempt income (net of expenses allocable thereto) for the taxable year
(the "Distribution Requirement"), and satisfies certain other requirements of
the Code that are described below. Distributions by the Fund made during the
taxable year or, under specified circumstances, within twelve months after the
close of the taxable year, will be considered distributions of income and gains
of the taxable year and can therefore satisfy the Distribution Requirement.
In addition to satisfying the Distribution Requirement, a
regulated investment company must: (1) derive at least 90% of its gross income
from dividends, interest, certain payments with respect to securities loans,
gains from the sale or other disposition of stock or securities or foreign
currencies (to the extent such currency gains are directly related to the
regulated investment company's principal business of investing in stock or
securities) and other income (including but not limited to gains
36
<PAGE>
from options, futures or forward contracts) derived with respect to its business
of investing in such stock, securities or currencies (the "Income Requirement");
and (2) derive less than 30% of its gross income (exclusive of certain gains on
designated hedging transactions that are offset by realized or unrealized losses
on offsetting positions) from the sale or other disposition of stock, securities
or foreign currencies (or options, futures or forward contracts thereon) held
for less than three months (the "ShortShort Gain Test"). For purposes of these
calculations, gross income includes tax-exempt income. However, foreign currency
gains, including those derived from options, futures and forwards, will not in
any event be characterized as Short-Short Gain if they are directly related to
the regulated investment company's investments in stock or securities (or
options or futures thereon). Because of the Short-Short Gain Test, the Fund may
have to limit the sale of appreciated securities that it has held for less than
three months. However, the Short-Short Gain Test will not prevent the Fund from
disposing of investments at a loss, since the recognition of a loss before the
expiration of the three-month holding period is disregarded for this purpose.
Interest (including original issue discount) received by the Fund at maturity or
upon the disposition of a security held for less than three months will not be
treated as gross income derived from the sale or other disposition of such
security within the meaning of the Short-Short Gain Test. However, income that
is attributable to realized market appreciation will be treated as gross income
from the sale or other disposition of securities for this purpose.
In general, gain or loss recognized by the Fund on the
disposition of an asset will be a capital gain or loss. However, gain recognized
on the disposition of a debt obligation (including municipal obligations)
purchased by the Fund at a market discount (generally, at a price less than its
principal amount) will be treated as ordinary income to the extent of the
portion of the market discount which accrued during the period of time the Fund
held the debt obligation.
In general, for purposes of determining whether capital gain or
loss recognized by the Fund on the disposition of an asset is long-term or
short-term, the holding period of the asset may be affected if (1) the asset is
used to close a "short sale" (which includes for certain purposes the
acquisition of a put option) or is substantially identical to another asset so
used, (2) the asset is otherwise held by the Fund as part of a "straddle" (which
term generally excludes a situation where the asset is stock and the Fund grants
a qualified covered call option (which, among other things, must not be
deep-in-the-money) with respect thereto) or (3) the asset is stock and the Fund
grants an in-the-money qualified covered call option with respect thereto.
However, for purposes of the Short-Short Gain Test, the holding period of the
asset disposed of may be reduced only in the case of clause (1) above. In
addition, the Fund may be required to defer the recognition of a loss on the
disposition of an asset held as part of a straddle to the extent of any
unrecognized gain on the offsetting position.
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<PAGE>
Any gain recognized by the Fund on the lapse of, or any gain or
loss recognized by the Fund from a closing transaction with respect to, an
option written by the Fund will be treated as a short-term capital gain or loss.
For purposes of the Short-Short Gain Test, the holding period of an option
written by the Fund will commence on the date it is written and end on the date
it lapses or the date a closing transaction is entered into. Accordingly, the
Fund may be limited in its ability to write options which expire within three
months and to enter into closing transactions at a gain within three months of
the writing of options.
Transactions that may be engaged in by the Fund (such as
regulated futures contracts, certain foreign currency contracts, and options on
stock indexes and futures contracts) will be subject to special tax treatment as
"Section 1256 contracts." Section 1256 contracts are treated as if they are sold
for their fair market value on the last business day of the taxable year, even
though a taxpayer's obligations (or rights) under such contracts have not
terminated (by delivery, exercise, entering into a closing transaction or
otherwise) as of such date. Any gain or loss recognized as a consequence of the
year-end deemed disposition of Section 1256 contracts is taken into account for
the taxable year together with any other gain or loss that was previously
recognized upon the termination of Section 1256 contracts during that taxable
year. Any capital gain or loss for the taxable year with respect to Section 1256
contracts (including any capital gain or loss arising as a consequence of the
year-end deemed sale of such contracts) is generally treated as 60% long-term
capital gain or loss and 40% short-term capital gain or loss. The Fund, however,
may elect not to have this special tax treatment apply to Section 1256 contracts
that are part of a "mixed straddle" with other investments of the Fund that are
not Section 1256 contracts. The IRS has held in several private rulings (and
Treasury Regulations now provide) that gains arising from Section 1256 contracts
will be treated for purposes of the Short-Short Gain Test as being derived from
securities held for not less than three months if the gains arise as a result of
a constructive sale under Code Section 1256.
Treasury Regulations permit a regulated investment company, in
determining its investment company taxable income and net capital gain (i.e.,
the excess of net long-term capital gain over net short-term capital loss) for
any taxable year, to elect (unless it has made a taxable year election for
excise tax purposes as discussed below) to treat all or any part of any net
capital loss, any net long-term capital loss or any net foreign currency loss
incurred after October 31 as if it had been incurred in the succeeding year.
In addition to satisfying the requirements described above, the
Fund must satisfy an asset diversification test in order to qualify as a
regulated investment company. Under this test, at the close of each quarter of
the Fund's taxable year, at least 50% of the value of the Fund's assets must
consist of cash and cash items, U.S. Government securities, securities of other
regulated
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<PAGE>
investment companies, and securities of other issuers (as to which the Fund has
not invested more than 5% of the value of the Fund's total assets in securities
of such issuer and as to which the Fund does not hold more than 10% of the
outstanding voting securities of such issuer), and no more than 25% of the value
of its total assets may be invested in the securities of any one issuer (other
than U.S. Government securities and securities of other regulated investment
companies), or in two or more issuers which the Fund controls and which are
engaged in the same or similar trades or businesses. Generally, an option (call
or put) with respect to a security is treated as issued by the issuer of the
security, not the issuer of the option.
If for any taxable year the Fund does not qualify as a regulated
investment company, all of its taxable income (including its net capital gain)
will be subject to tax at regular corporate rates without any deduction for
distributions to shareholders, and such distributions will be taxable to the
shareholders as ordinary dividends to the extent of the Fund's current and
accumulated earnings and profits. Such distributions generally will be eligible
for the dividends-received deduction in the case of corporate shareholders.
Excise Tax on Regulated Investment Companies
A 4% non-deductible excise tax is imposed on a
regulated investment company that fails to distribute in each calendar year an
amount equal to 98% of ordinary taxable income for the calendar year and 98% of
capital gain net income for the one-year period ended on October 31 of such
calendar year (or, at the election of a regulated investment company having a
taxable year ending November 30 or December 31, for its taxable year (a "taxable
year election")). (Tax-exempt interest on municipal obligations is not subject
to the excise tax.) The balance of such income must be distributed during the
next calendar year. For the foregoing purposes, a regulated investment company
is treated as having distributed any amount on which it is subject to income tax
for any taxable year ending in such calendar year.
For purposes of the excise tax, a regulated investment company
shall: (1) reduce its capital gain net income (but not below its net capital
gain) by the amount of any net ordinary loss for the calendar year; and (2)
exclude foreign currency gains and losses incurred after October 31 of any year
(or after the end of its taxable year if it has made a taxable year election) in
determining the amount of ordinary taxable income for the current calendar year
(and, instead, include such gains and losses in determining ordinary taxable
income for the succeeding calendar year).
The Fund intends to make sufficient distributions or deemed
distributions of its ordinary taxable income and capital gain net income prior
to the end of each calendar year to avoid liability for the excise tax. However,
investors should note that
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<PAGE>
the Fund may in certain circumstances be required to liquidate portfolio
investments to make sufficient distributions to avoid excise tax liability.
Fund Distributions
The Fund anticipates distributing substantially all of its
investment company taxable income for each taxable year. Such distributions will
be taxable to shareholders as ordinary income and treated as dividends for
federal income tax purposes, but will not qualify for the 70% dividends-received
deduction for corporate shareholders.
The Fund may either retain or distribute to shareholders its net
capital gain for each taxable year. The Fund currently intends to distribute any
such amounts. Net capital gain that is distributed and designated as a capital
gain dividend, will be taxable to shareholders as long-term capital gain,
regardless of the length of time the shareholder has held his shares or whether
such gain was recognized by the Fund prior to the date on which the shareholder
acquired his shares.
The Fund intends to qualify to pay exempt-interest dividends by
satisfying the requirement that at the close of each quarter of the Fund's
taxable year at least 50% of the Fund's total assets consists of tax-exempt
municipal obligations. Distributions from the Fund will constitute
exempt-interest dividends to the extent of the Fund's tax-exempt interest income
(net of expenses and amortized bond premium). Exempt-interest dividends
distributed to shareholders of the Fund are excluded by them from gross income
for federal income tax purposes. However, shareholders required to file a
federal income tax return will be required to report the receipt of
exempt-interest dividends on their returns. Moreover, while exempt-interest
dividends are excluded from gross income for federal income tax purposes, they
may be subject to alternative minimum tax ("AMT") in certain circumstances and
may have other collateral tax consequences discussed below. Distributions by the
Fund of any investment company taxable income or of any net capital gain will be
taxable to shareholders as discussed above.
AMT is imposed in addition to, but only to the extent it
exceeds, the regular tax and is -- computed at a maximum marginal rate of 28%
for noncorporate taxpayers and 20% for corporate taxpayers -- on the excess of
the taxpayer's alternative minimum taxable income ("AMTI") over an exemption
amount. In addition, under the Superfund Amendments and Reauthorization Act of
1986, a tax is imposed for taxable years beginning after 1986 and before 1996 at
the rate of 0.12% on the excess of a corporate taxpayer's AMTI (determined
without regard to the deduction for this tax and the AMT net operating loss
deduction) over $2 million. Exemptinterest dividends derived from certain
"private activity" municipal obligations issued after August 7, 1986 will
generally constitute an item of tax preference includable in AMTI for both
corporate and noncorporate taxpayers. In addition, exempt-interest
40
<PAGE>
dividends derived from all municipal obligations, regardless of the date of
issue, must be included in adjusted current earnings, which are used in
computing an additional corporate preference item (i.e., 75% of the excess of a
corporate taxpayer's adjusted current earnings over its AMTI (determined without
regard to this item and the AMT net operating loss deduction)) includable in
AMTI.
Exempt-interest dividends must be taken into account in
computing the portion, if any, of social security or railroad retirement
benefits that must be included in an individual shareholder's gross income and
subject to federal income tax. Further, a shareholder of the Fund is denied a
deduction for interest on indebtedness incurred or continued to purchase or
carry shares of the Fund. Moreover, a shareholder who is (or is related to) a
"substantial user" of a facility financed by industrial development bonds held
by the Fund will likely be subject to tax on dividends paid by the Fund which
are derived from interest on such bonds. Receipt of exempt-interest dividends
may result in other collateral federal income tax consequences to certain
taxpayers, including financial institutions, property and casualty insurance
companies and foreign corporations engaged in a trade or business in the United
States. Prospective investors should consult their own tax advisers as to such
consequences.
Distributions by the Fund that do not constitute ordinary income
dividends, exempt-interest dividends or capital gain dividends will be treated
as a return of capital to the extent of (and in reduction of) the shareholder's
tax basis in his shares; any excess will be treated as gain from a sale of the
shares, as discussed below.
Distributions by the Fund will be treated in the manner
described above regardless of whether such distributions are paid in cash or
reinvested in additional shares of the Fund (or of another fund). Shareholders
receiving a distribution in the form of additional shares will be treated as
receiving a distribution in an amount equal to the fair market value of the
shares received, determined as of the reinvestment date. In addition, if the net
asset value at the time a shareholder purchases shares of the Fund reflects
undistributed income or gain, or unrealized appreciation in the value of assets
held by the Fund, a subsequent distribution of such amounts will be taxable to
the shareholder in the manner described above, although it economically
constitutes a return of capital.
Ordinarily, shareholders are required to take distributions by
the Fund into account in the year in which they are made. However, dividends
declared in October, November or December of any year and payable to
shareholders of record on a specified date in such a month will be deemed to
have been received by the shareholders (and made by the Fund) on December 31 of
such calendar year if such dividends are actually paid in January of the
following year. Shareholders will be advised annually as to the
41
<PAGE>
U.S. federal income tax consequences of distributions made (or deemed made) to
them during the year.
The Fund will be required in certain cases to withhold and remit
to the U.S. Treasury 31% of ordinary income and capital gain dividends, and the
proceeds of redemption of shares, paid to any shareholder who (1) has provided
either an incorrect tax identification number or no number at all, (2) is
subject to backup withholding by the IRS for failure to report the receipt of
interest or dividend income properly, or (3) has failed to certify to the Fund
that it is not subject to backup withholding or that it is a corporation or
other "exempt recipient."
Sale or Redemption of Shares
A shareholder will recognize gain or loss on the sale or
redemption of shares of the Fund in an amount equal to the difference between
the proceeds of the sale or redemption and the shareholder's adjusted tax basis
in the shares. All or a portion of any loss so recognized may be disallowed if
the shareholder purchases other shares of the Fund within 30 days before or
after the sale or redemption. In general, any gain or loss arising from (or
treated as arising from) the sale or redemption of shares of the Fund will be
considered capital gain or loss and will be long-term capital gain or loss if
the shares were held for longer than one year. However, any capital loss arising
from the sale or redemption of shares held for six months or less will be
disallowed to the extent of the amount of exempt-interest dividends received on
such shares and (to the extent not disallowed) will be treated as a long-term
capital loss to the extent of the amount of capital gain dividends received on
such shares. For this purpose, the special holding period rules of Code Section
246(c)(3) and (4) generally will apply in determining the holding period of
shares. Long-term capital gains of noncorporate taxpayers are currently taxed at
a maximum rate 11.6% lower than the maximum rate applicable to ordinary income.
Capital losses in any year are deductible only to the extent of capital gains
plus, in the case of noncorporate taxpayers, $3,000 of ordinary income.
Foreign Shareholders
Taxation of a shareholder who, as to the United States, is a
nonresident alien individual, foreign trust or estate, foreign corporation, or
foreign partnership ("foreign shareholder"), depends on whether the income from
the Fund is "effectively connected" with a U.S. trade or business carried on by
such shareholder.
If the income from the Fund is not effectively connected with a
U.S. trade or business of a foreign shareholder, ordinary income paid to the
shareholder will be subject to U.S. withholding tax at the rate of 30% (or lower
applicable treaty rate) on the gross amount of the dividend. Such a foreign
shareholder would generally be exempt from U.S. federal income tax on gains
realized
42
<PAGE>
on the sale of shares of the Fund, capital gain dividends and exempt-interest
dividends.
If the income from the Fund is effectively connected with a U.S.
trade or business of a foreign shareholder, then ordinary income and capital
gain dividends received in respect of, and any gains realized on, the sale of
shares of the Fund will be subject to U.S. federal income tax at the rates
applicable to U.S. citizens or domestic corporations.
In the case of a foreign noncorporate shareholder, the Fund may
be required to withhold U.S. federal income tax at a rate of 31% on
distributions that are otherwise exempt from withholding (or taxable at a
reduced treaty rate), unless the shareholder furnishes the Fund with proper
notification of its foreign status.
The tax consequences to a foreign shareholder entitled to claim
the benefits of an applicable tax treaty may be different from those described
herein. Foreign shareholders are urged to consult their own tax advisers with
respect to the particular tax consequences to them of an investment in the Fund,
including the applicability of foreign taxes.
Effect of Future Legislation; Local Tax Considerations
The foregoing general discussion of U.S. federal income tax
consequences is based on the Code and Treasury Regulations issued thereunder as
in effect on the date of this Statement. Future legislative or administrative
changes or court decisions may significantly change the conclusions expressed
herein, perhaps with retroactive effect.
Rules of state and local taxation of ordinary income dividends,
exempt-interest dividends and capital gain dividends from regulated investment
companies often differ from the rules for U.S. federal income taxation described
above. Shareholders are urged to consult their tax advisers as to the
consequences to them of federal, state and local tax rules with respect to an
investment in the Fund.
PORTFOLIO TRANSACTIONS
The Fund's management provides the Fund with investment advice
and recommendations for the purchase and sale of portfolio securities. Newly
issued securities are usually purchased from the issuer or an underwriter, at
prices including underwriting fees; other purchases and sales are usually placed
with those dealers from whom it appears that the best price or execution will be
obtained. All orders for the purchase and sale of portfolio securities are
placed by the Fund's management, subject to the general control of the Fund's
Directors. The Fund's management may sell portfolio securities prior to their
maturity if market conditions and other considerations indicate, in the opinion
of the
43
<PAGE>
Fund's management, that such sale would be advisable. In addition, the Fund's
management may engage in short-term trading when it believes it is consistent
with the Fund's investment objective. Also, a security may be sold and another
of comparable quality may be simultaneously purchased to take advantage of what
the Fund's management believes to be a temporary disparity in the normal yield
relationships of two securities. The frequency of portfolio transactions -- the
Fund's turnover rates -- will vary from year to year depending upon market
conditions. For the years ended December 31, 1994 and 1995, the Fund's annual
rate of portfolio turnover was approximately 290% and 348%, respectively.
Because a high turnover rate increases transaction costs and the possibility of
taxable short-term gains (see "Dividends and Tax Status" in the Fund's
Prospectus), the Fund's management weighs the added costs of short-term
investment against anticipated gains. The Fund's management is generally
responsible for the implementation, or supervision of the implementation, of
investment decisions, including the allocation of principal business and
portfolio brokerage, and the negotiation of commissions.
It is the Fund's policy to seek execution of its purchases and
sales at the most favorable prices through responsible broker-dealers and in
agency transactions, at competitive commission rates. When considering
broker-dealers, the Fund will take into account such factors as the price of the
security, the size and difficulty of the order, the rate of commission, if any,
the reliability, financial condition, integrity and general execution and
operational capabilities of competing broker-dealers, and the brokerage and
research services which they provide to the Fund's management.
The Board of Directors of the Fund is authorized to adopt a
brokerage allocation policy pursuant to the Securities Exchange Act of 1934
which would permit the Fund to pay a broker-dealer which furnishes research
services a higher commission than that which might be charged by another
broker-dealer which does not furnish research services, or which furnishes
research services deemed to be of a lesser value, provided that such commission
is deemed reasonable in relation to the value of the brokerage and research
services provided by the broker-dealer.
Section 28(e)(3) of the Securities Exchange Act of 1934 defines
"Brokerage and Research Services" as including, among other things, advice as to
the value of securities, the advisability of investing in, purchasing or selling
securities, the availability of securities or purchasers or sellers of
securities, furnishing analyses and reports concerning issuers, industries,
securities, economic factors and trends, portfolio strategy and performance of
accounts, and offering securities transactions and performing functions
incidental thereto (such as clearance and settlement).
It is not the Fund's practice to allocate principal business or
brokerage on the basis of sales of Fund shares which
44
<PAGE>
may be made through brokers or dealers, although broker-dealers effecting
purchases of Fund shares for their customers may participate in principal
transactions of brokerage allocation as described above.
FINANCIAL STATEMENTS
Audited financial statements of the Fund for the year ended
December 31, 1995 are attached hereto.
45
<PAGE>
APPENDIX
RATINGS OF MUNICIPAL BONDS
MOODY'S INVESTORS SERVICE, INC.
A brief description of the applicable Moody's Investors
Services, Inc. rating symbols and their meanings is as follows:
Aaa-Bonds which are Aaa are judged to be of the best quality.
They carry the smallest degree of investment risk and are generally referred to
as "gilt edge." Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized are
most unlikely to impair the fundamentally strong position of such issues.
Aa-Bonds which are rated Aa are judged to be of high quality by
all standards. Together with the Aaa group they comprise what are generally
known as high grade bonds. They are rated lower than the best bonds because
margins of protection may not be as large as in the Aaa securities or
fluctuation of protective elements may be of a greater amplitude or there may be
other elements present which make the long-term risk appear somewhat larger than
Aaa securities.
A-Bonds which are rated A possess many favorable investment
attributes and are to be considered as upper-medium grade obligations. Factors
giving security to principal and interest are considered adequate but elements
may be present which suggest a susceptibility to impairment sometime in the
future.
Baa-Bonds which are rated Baa are considered as medium grade
obligations, i.e., they are neither highly protected nor poorly secured.
Interest payments and principal security appear adequate for the present but
certain protective elements may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
Ba-Bonds which are rated Ba are judged to have speculative
elements; their future cannot be considered as well assured. Often the
protection of interest and principal payments may be very moderate and thereby
not well safeguarded during both good and bad times over the future. Uncertainty
of position characterizes bonds in this class.
B-Bonds which are rated B generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or of
maintenance of other terms of the contract over any long period of time may be
small.
A-1
<PAGE>
Caa-Bonds which are rated Caa are of poor standing. Such issues
may be in default or there may be present elements of danger with respect to
principal or interest.
Ca-Bonds which are rated Ca represent obligations which are
speculative in a high degree. Such issues are often in default or have other
marked shortcomings.
C-Bonds which are rated C are the lowest rated class of bonds,
and issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
Moody's applies numerical modifiers 1, 2 and 3 to show relative
standing within the major rating categories, except in the Aaa category. The
modifier 1 indicates a ranking for the security in the higher end of a rating
category; the modifier 2 indicates a mid-range ranking; and the modifier 3
indicates a ranking in the lower end of a rating category.
I. Con. (---)--Bonds for which the security depends upon the completion of some
act or the fulfillment of some condition are rated conditionally. These are
bonds secured by 1. earnings of projects under construction, 2. earnings of
projects unseasoned in operation experience, 3. rentals which begin when
facilities are completed, or 4. payments to which some other limiting condition
attaches. Parenthetical rating denotes probable credit stature upon completion
of construction or elimination of condition.
STANDARD & POOR'S CORPORATION
A brief description of the applicable S&P Corporation rating
symbols and their meanings is as follows:
AAA-This is the highest rating assigned by S&P to a debt
obligation and indicates an extremely strong capacity to pay principal and
interest.
AA-Bonds rated AA also qualify as high-quality debt obligations.
Capacity to repay principal and interest is very strong, and in the majority of
instances they differ from AAA issues in only small degrees.
A-Bonds rated A have a strong capacity to pay principal and
interest, although they are somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions.
BBB-Bonds rated BBB are regarded as having an adequate capacity
to pay principal and interest. Whereas they normally exhibit adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay principal and interest for bonds in
this category than for bonds in the A category.
A-2
<PAGE>
BB, B, CCC, CC-Bonds rated BB, B, CCC and CC are regarded, on
balance, as predominantly speculative with respect to capacity to pay interest
and repay principal in accordance with the terms of the obligation. BB indicates
the lowest degree of speculation and CC the highest degree of speculation. While
such bonds will likely have some quality and protective characteristics, these
are outweighed by large uncertainties or major risk exposures to adverse
conditions.
C-The rating C is reserved for income bonds on which no interest
is being paid.
D-Bonds rated D are in default, and payment of interest and/or
repayment of principal is in arrears.
Plus (+) or minus (-): The ratings from AA to BBB may be
modified by the addition of a plus or minus sign to show relative standing
within the major ratings categories.
Provisional Ratings: the letter "p" indicates that the rating is
provisional. A provisional rating assumes the successful completion of the
project being financed by the issuance of the bonds being rated and indicates
that payment of debt service requirements is largely or entirely dependent upon
the successful and timely completion of the project. This rating, however, while
addressing credit quality subsequent to completion of the project, makes no
comment on the likelihood of, or the risk of default upon failure of, such
completion. Accordingly, the investor should exercise his own judgment with
respect to such likelihood and risk.
FITCH
Ratings
A brief description of the applicable Fitch Investors Service,
Inc. rating symbols and their meanings is as follows:
AAA
Bonds rated AAA are considered to be investment grade and of the
highest credit quality. The obligor has an exceptionally strong ability to pay
interest and repay principal, which is unlikely to be affected by reasonably
foreseeable events.
AA
Bonds rated AA are considered to be investment grade and of the
very high credit quality. The obligor's ability to pay interest and repay
principal is very strong, although not quite as strong as bonds rated AAA.
Because bonds rated in the AAA and AA categories are not significantly
vulnerable to foreseeable future developments, short-term debt of these issuers
is generally rated F-1+.
A-3
<PAGE>
A
Bonds rated A are considered to be investment grade and of high
credit quality. The obligor's ability to pay interest and repay principal is
considered to be strong, but may be more vulnerable to adverse changes in
economic conditions and circumstances than bonds with higher ratings.
BBB
Bonds rated BBB are considered to be investment grade and of
satisfactory credit quality. The obligor's ability to pay interest and repay
principal is considered to be adequate. Adverse changes in economic conditions
and circumstances, however, are more likely to have an adverse impact on these
bonds and, therefore, impair timely payment. The likelihood that the ratings of
these bonds will fall below investment grade is higher than for bonds with
higher ratings.
BB
Bonds rated BB are considered speculative. The obligor's ability
to pay interest and repay principal may be affected over time by adverse
economic changes. However, business and financial alternatives can be identified
which could assist the obligor in satisfying its debt service requirements.
B
Bonds rated B are considered highly speculative. While bonds in
this class are currently meeting debt service requirements, the probability of
continued timely payment of principal and interest reflects the obligor's
limited margin of safety and the need for reasonable business and economic
activity throughout the life of the issue.
CCC
Bonds rated CCC have certain identifiable characteristics,
which, if not remedied, may lead to default. The ability to meet obligations
requires an advantageous business and economic environment.
CC
Bonds rated CC are minimally protected. Default in payment of
interest and/or principal seems probable over time.
C
Bonds rated C are in imminent default in payment of interest or
principal.
A-4
<PAGE>
DDD, DD AND D
Bonds rated DDD, DD and D are in actual or imminent default of
interest and/or principal payments. Such bonds are extremely speculative and
should be valued on the basis of their ultimate recovery value in liquidation or
reorganization of the obligor. DDD represents the highest potential for recovery
on these bonds and D represents the lowest potential for recovery.
Plus (+) and minus (-) signs are used with a rating symbol to
indicate the relative position of a credit within the rating category. Plus and
minus signs, however, are not used in the AAA Category covering 12-36 months or
the DDD, DD or D categories.
DUFF & PHELPS, INC.
RATING
SCALE DEFINITION
AAA Highest credit quality. The risk factors are negligible,
being only slightly more than for risk-free U.S. Treasury
debt.
AA+ High credit quality. Protection factors are strong.
AA- Risk is AA modest but may vary slightly from time to time
AA- because of economic conditions.
A+ Protection factors are average but adequate. However,
A risk factors are more variable and greater in periods of
A- economic stress.
BBB+ Below average protection factors but still considered
BBB sufficient for prudent investment. Considerable
BBB- variability in risk during economic cycles.
BB+ Below investment grade but deemed likely to meet
BB obligations when due. Present or prospective financial
BB- protection factors fluctuate according to industry
conditions or company fortunes. Overall quality may move
up or down frequently within this category.
B+ Below investment grade and possessing risk that
B obligations will not be met when due. Financial
B- protection factors will fluctuate widely according to
economic cycles, industry conditions and/or company fortunes.
Potential exists for frequent changes in the rating within this
category or into a higher or lower rating grade.
CCC Well below investment grade securities. Considerable
uncertainty exists as to timely payment of principal,
interest or preferred dividends. Protection factors are
narrow and risk can be substantial with unfavorable
A-5
<PAGE>
economic/industry conditions, and/or with unfavorable company
developments.
DD Defaulted debt obligations. Issuer failed to meet scheduled
principal and/or interest payments.
DP Preferred stock with dividend arrearages.
RATING
SCALE DEFINITION
HIGH GRADE
Duff 1+ Highest certainty of timely payment. Short-term liquidity,
including internal operating factors and/or access to alternative
sources of funds, is outstanding, and safety is just below
risk-free U.S. Treasury short-term obligations.
Duff 1 Very high certainty of timely payment. Liquidity factors are
excellent and supported by good fundamental protection factors.
Risk factors are minor.
Duff 1- High certainty of timely payment. Liquidity factors are strong
and supported by good fundamental protection factors. Risk factors
are very small.
GOOD GRADE
Duff 2 Good certainty of timely payment. Liquidity factors and company
fundamentals are sound. Although ongoing funding needs may enlarge
total financing requirements, access to capital markets is good.
Risk factors are small.
SATISFACTORY GRADE
Duff 3 Satisfactory liquidity and other protection factors qualify issues
as to investment grade. Risk factors are larger and subject to more
variation. Nevertheless, timely payment is expected.
NON-INVESTMENT GRADE
Duff 4 Speculative investment characteristics. Liquidity is not
sufficient to insure against disruption in debt service. Operating
factors and market access may be subject to a high degree of
variation.
DEFAULT
Issuer failed to meet scheduled principal and/or interest payments.
A-6
<PAGE>
RATINGS OF MUNICIPAL NOTES
MOODY'S INVESTORS SERVICE, INC.
A brief description of the applicable Moody's Investors Service,
Inc. rating symbols for municipal notes and their meanings is as follows:
MIG-1 - This is the highest rating assigned by Moody's to municipal
notes and designates noted judged to be of the best quality.
MIG-2 - This rating designates notes of a high quality by all
standards. However, the margins of protection, although ample, are not as large
as in the preceding group.
MIG-3 - This rating designates notes which are of a favorable
quality, with all security elements accounted for. However, such notes are
lacking the undeniable strength of notes in the preceding two groups. Market
access for refinancing, in particular, is likely to be less well established.
SHORT-TERM RATINGS
FITCH
Fitch's short-term ratings apply to debt obligations that are
payable on demand or have original maturities of up to three years, including
commercial paper, certificates of deposit, medium-term notes, and municipal and
investment notes.
Although the credit analysis is similar to Fitch's bond rating
analysis, the short-term rating places greater emphasis than bond ratings on the
existence of liquidity necessary to meet the issuer's obligations in a timely
manner.
F-1+
Exceptionally Strong Credit Quality. Issues assigned this
rating are regarded as having the strongest degree of assurance for
timely payment.
Very Strong Credit Quality. Issues assigned this rating reflect an
assurance of timely payment only slightly less in degree than issues rated F-1+.
F-1
Very Strong Credit Quality. Issues assigned this rating reflect an
assurance of timely payment only slightly less in degree than issues rated F-1+.
A-7
<PAGE>
F-2
Good Credit Quality. Issues carrying this rating have a
satisfactory degree of assurance for timely payments, but the margin of safety
is not as great as the F-1+ and F-1 categories.
SHORT-TERM MUNICIPAL LOANS
Moody's highest rating for short-term municipal loans is
MIG-1/VMIG-1. Moody's states that short-term municipal securities rated
MIG-1/VMIG-1 are of the best quality, enjoying strong protection from
established cash flows of funds for their servicing or from established and
broad-based access to the market for refinancing, or both. Loans bearing the
MIG-2/VMIG-2 designation are of high quality, with margins of protection ample
although not so large as in the MIG-1/VMIG-1 group.
S&P's highest rating for short-term municipal loans is SP-1. S&P
states that short-term municipal securities bearing the SP-1 designation have
very strong or strong capacity to pay principal and interest. Those issues rated
SP-1 which are determined to possess overwhelming safety characteristics will be
given a plus (+) designation. Issues rated SP-2 have satisfactory capacity to
pay principal and interest.
OTHER MUNICIPAL SECURITIES AND COMMERCIAL PAPER
"Prime-1" is the highest rating assigned by Moody's for other
short-term municipal securities and commercial paper, and "A- 1+" and "A-1" are
the two highest ratings for commercial paper assigned by S&P (S&P does not rate
short-term tax-free obligations). Moody's uses the numbers 1, 2 and 3 to denote
relative strength within its highest classification of "Prime", while S&P uses
the number 1+, 1, 2 and 3 to denote relative strength within its highest
classification of "A". Issuers rated "Prime" by Moody's have the following
characteristics: their short-term debt obligations carry the smallest degree of
investment risk, margins of support for current indebtedness are large or stable
with cash flow and asset protection well assured, current liquidity provides
ample coverage of near-term liabilities and unused alternative financing
arrangements are generally available. While protective elements may change over
the intermediate or longer term, such changes are most unlikely to impair the
fundamentally strong position of short-term obligations. Commercial paper
issuers rated "A" by S&P have the following characteristics: liquidity ratios
are better than industry average, long-term debt rating is A or better, the
issuer has access to at least two additional channels of borrowing, and basic
earnings and cash flow are in an upward trend. Typically, the issuer is a strong
company in a well-established industry and has superior management.
A-8
<PAGE>
(Left column)
NEW YORK MUNI FUND, INC.
STATEMENT OF ASSETS AND LIABILITIES
December 31, 1995
- --------------------------------------------------------------------------------
ASSETS
Cash............................................ $ 409,040
Investment in securities at value
(Note 4) (cost $277,479,404).................. 271,490,055
Receivables:
Interest...................................... 4,009,011
Investment securities sold.................... 2,013,478
Capital stock sold............................ 80,216,384
------------
Total assets.............................. 358,137,968
------------
LIABILITIES
Notes payable (Note 6).......................... 64,575,000
Payables:
Investment securities purchased............... 65,761,095
Capital stock redeemed........................ 199,009
Dividend declared............................. 89,475
Accrued expenses.............................. 821,758
------------
Total liabilities......................... 131,446,337
------------
NET ASSETS consisting of:
Accumulated net realized loss................... $(19,488,520)
Unrealized depreciation of securities........... (5,989,349)
Paid-in-capital applicable to 231,288,831
shares of $.01 par value capital stock........ 252,169,500
------------ ------------
$226,691,631
============
NET ASSET VALUE PER SHARE......................... $.98
====
(Right column)
STATEMENT OF OPERATIONS
For the Year ended December 31, 1995
- --------------------------------------------------------------------------------
INVESTMENT INCOME
Interest income................................. $ 13,442,670
EXPENSES (Notes 2 and 3)
Management fee.................................. $ 885,389
Custodian and accounting fees................... 218,290
Transfer agent fees............................. 375,225
Professional fees............................... 238,536
Directors' fees................................. 72,596
Printing and postage............................ 30,079
Interest........................................ 3,771,000
Distribution expenses........................... 838,008
Operating expenses on defaulted bonds........... 96,013
Other........................................... 43,850
----------
Total expenses............................ 6,568,986
------------
Net investment income..................... 6,873,684
------------
REALIZED AND UNREALIZED GAIN (LOSS)
ON INVESTMENTS
Net realized (loss) gain on:
Investments................................... 2,599,302
Futures contracts............................. (147,344)
Options written............................... (73,794)
----------
2,378,164
Net unrealized appreciation of investments...... 25,287,298
------------
Net gain on investments......................... 27,665,462
------------
NET INCREASE IN NET ASSETS FROM OPERATIONS........ $ 34,539,146
============
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Year Ended Year Ended
December 31, December 31,
------------ ------------
1995 1994
<S> <C> <C>
INCREASE (DECREASE) IN NET ASSETS FROM:
OPERATIONS
Net investment income............................................. $ 6,873,684 $ 11,648,285
Net realized gain (loss) on investments and futures contracts..... 2,451,958 (21,046,462)
Net realized (loss) on option contracts written................... (73,794) (96,873)
Unrealized appreciation (depreciation) on investments............. 25,287,298 (27,168,378)
------------ ------------
Net increase (decrease) in net assets from operations....... 34,539,146 (36,663,428)
DIVIDENDS PAID TO SHAREHOLDERS FROM:
Investment income................................................. (6,873,684) (11,649,104)
Net realized gain from investments................................ (112,509) (1,888,345)
CAPITAL SHARE TRANSACTIONS (Note 5)................................. (13,526,231) (12,686,075)
------------ ------------
Total increase (decrease)................................... 14,026,722 (62,886,952)
NET ASSETS:
Beginning of year................................................. 212,664,909 275,551,861
------------ ------------
End of year....................................................... $226,691,631 $212,664,909
============ ============
</TABLE>
See Notes to Financial Statements.
5
<PAGE>
NEW YORK MUNI FUND, INC.
STATEMENT OF CASH FLOWS
For the Year Ended December 31, 1995
- --------------------------------------------------------------------------------
Increase (Decrease) in Cash
Cash Flows From Operating Activities
Net increase to net assets from operations................... $ 34,539,146
Adjustments to reconcile net increase in net assets from
operations to net cash provided by operating activities:
Purchase of investment securities.......................... (880,868,531)
Proceeds on sale of securities............................. 920,163,169
Premiums paid to close options written..................... (197,468)
(Decrease) in interest receivable.......................... 424,294
Increase in accrued expenses............................... 42,616
Net accretion of discount on securities.................... (51,045)
Net realized gain (loss):
Investments.............................................. (2,869,205)
Options written.......................................... 73,794
Unrealized depreciation on securities and options written
for the period........................................... (25,287,298)
-------------
Net cash provided by operating activities.............. 45,969,472
-------------
Cash Flows From Financing Activities:*
Net proceeds from notes payable............................ 44,575,000
Proceeds on shares sold.................................... 2,994,410,794
Payment on shares repurchased.............................. (3,094,316,286)
Cash dividends paid........................................ (1,036,308)
-------------
Net cash used in financing activities.................. (56,366,800)
-------------
Net decrease in cash................................... (10,397,328)
Cash at beginning of year...................................... 10,806,368
-------------
Cash at end of year............................................ $ 409,040
=============
- ---------------
*Non-cash financing activities not included herein consist of reinvestment of
dividends of $6,361,886.
Cash payments for interest expense totaled $3,667,093.
See Notes to Financial Statements.
6
<PAGE>
NEW YORK MUNI FUND
STATEMENT OF INVESTMENTS
December 31, 1995
<TABLE>
<CAPTION>
Principal
Amount Issue000 Type0 Rating00 Value
------ -------- ----- -------- -----
<S> <C> <C> <C> <C>
$10,075,000 Battery Park City, HDA, RB, Series A, 5.25%, 11/01/17........................... FCLT AA $ 9,818,793
4,780,000++ Cayuga County, HIC, Auburn Memorial Hospital, Asset Guaranty
Insured, 6.00%, 1/01/21....................................................... FCLT AAA 4,958,294
2,000,000 City University, NY, COP, John Jay College, AMBAC Insured, 5.00%, 8/15/09....... FCLT AAA 1,940,280
3,045,000++ Franklin County, SWMA, Solid Waste System Project, RB, 6.25%, 6/01/15........... FCLT BBB 3,129,864
3,615,000++ Glen Cove, IDA, CFR, The Regency at Glen Cove Project, AMBAC
Insured, ETM, CAB, 10/15/19................................................... FCLT AAA 871,034
2,165,000++ Glen Cove, IDA, CFR, The Regency at Glen Cove Project, ETM, CAB, 10/15/19....... FCLT AAA 521,657
2,000,000++ Lyons, MCF, Initiatives Corporation Project, RB, 6.80%, 9/01/24................. FCLT BAA1 2,142,460
5,290,000++ New York City, ECF, MBIA lnsured, 5.50%, 10/01/08............................... FCSI AAA 5,448,435
5,925,000++ New York City, ECF, MBIA lnsured, 5.50%, 4/01/08................................ FCSI AAA 6,102,454
4,225,000++ New York City, GO, IFRN*, 17.36%, 10/01/03...................................... SRIB A- 6,899,805
18,330,000 New York City, GO, IFRN*, 3.725%, 8/01/12....................................... INLT A- 18,354,012
13,640,000++ New York City, GO, IFRN*, 3.725%, 8/01/14....................................... INLT A- 13,581,621
14,600,000 New York City, GO, IFRN*, 3.939%, 8/15/17....................................... INLT A- 13,939,058
6,680,000++ New York City, Health & Hospital Corp, RB, Series A, 6.00%, 2/15/05............. FCSI BBB- 6,707,388
25,315,000++ New York City, Health & Hospital Corp, RB, Series A, 6.30%, 2/15/20............. FCLT BBB 25,787,125
5,375,000 New York City, Health & Hospital Corp, RB, Series A, AMBAC Insured,
5.75%, 2/15/22................................................................ FCLT AAA 5,466,160
2,113,000++ New York City, IDA, Imclone Systems Inc Project, AMT, 10.75%, 6/15/96........... FCSI NR 2,103,217
2,200,000 New York City, IDA, Imclone Systems Inc Project, AMT, 11.25%, 5/01/04........... FCSI NR 2,407,416
8,500,000 New York City, IDA, SFR, Terminal One Group Association Project, AMT,
6.00%, 1/01/15................................................................ FCLT A 8,621,210
11,870,000++ New York City, IFRN*, 8/15/10................................................... INLT A- 11,964,960
2,000,000 New York State DAR, HNHRB, LOC Republic National Bank, 5.50%, 7/01/09........... FCSI AA 1,942,520
700,000 New York State DAR, HNHRB, LOC Republic National Bank, 5. 75%, 7/01/14.......... FCLT AA 685,951
4,500,000++ New York State DAR, NHRB, LOC Chemical Bank, 5.75%, 7/01/17..................... FCLT AA3 4,518,765
1,350,000 New York State DAR, NHRB, Our Lady of Consolation, Geriatric Care,
FHA Insured, 6.05%, 8/01/35................................................... FCLT AA 1,386,139
1,000,000 New York State DAR, NHRB, Wesley Gardens Corporation, FHA Insured,
6.125%, 8/01/35............................................................... FCLT AA 1,014,850
4,000,000 New York State DAR, RB, Court Facilities Lease 5.25%, 5/15/21................... FCLT BBB+ 3,749,600
4,760,000 New York State DAR, RB, Court Facilities Lease 5.50%, 5/15/23................... FCLT BBB+ 4,615,677
2,400,000 New York State DAR, RB, University of Rochester Strong Memorial Hospital,
MBIA Insured, 5.50%, 7/01/21.................................................. FCLT AAA 2,405,688
500,000 New York State Energy, RDA, Western New York Nuclear Service Center Project,
5.50%, 4/01/05................................................................ FCSI BAA1 496,735
3,500,000 New York State HFA, RB, Service Contract Obligation, 5.375%, 3/15/23............ FCLT BAA1 3,290,385
5,000,000 New York State MCFFA, Mental Health Services Facilities, FGIC Insured,
5.50%, 8/15/21................................................................ FCLT AAA 5,012,500
</TABLE>
7
<PAGE>
NEW YORK MUNI FUND
STATEMENT OF INVESTMENTS (continued)
December 31, 1995
<TABLE>
<CAPTION>
Principal
Amount Issue000 Type0 Rating00 Value
------ -------- ----- -------- -----
<S> <C> <C> <C> <C>
3,700,000 New York State Mortgage Agency, RB, AMT,6.10%, 4/01/26.......................... FCLT AA $ 3,728,157
25,000,000++ New York State Thruway Authority, Convertible, FGIC lnsured, IFRN*,
3.57%, 1/01/04................................................................ LRIB AAA 25,081,000
450,000 New York State Thruway Authority, General Revenue, MBIA Insured, 5.75%, 1/01/19. FCLT AAA 453,726
5,000,000 New York State Thruway Authority, Highway & Bridge Trust Fund, 5.80%, 4/01/09... FCSI A+ 5,163,400
1,500,000 New York State UDC, Correctional Capital Facilities, 5.75%, 1/01/13............. FCLT A 1,498,380
5,000,000 New York State UDC, Correctional Capital Facilities, FSA Insured, 5.25%, 1/01/21 FCLT AAA 4,993,050
5,500,000 New York State UDC, RB, Correctional Capital Facilities, FSA Insured,
5.375%, 1/01/25............................................................... FCLT AAA 5,444,120
6,445,000++ New York State, Housing of New York Corp, RB, Refunding, 5.50%, 11/01/20........ FCLT AA 6,324,672
1,120,000++ New York State, MCFFA, Central Suffolk Hospital Project, 6.125%, 11/01/16....... FCLT BBB 1,101,766
2,000,000++ New York State, MCFFA, Insured Mortgage Project, FHA Insured, 6.20%, 2/15/35.... FCLT AA+ 2,110,140
12,080,000++ New York State, MCFFA, Insured Mortgage Project, MBIA Insured, 5.90%, 8/15/33... FCLT AAA 12,500,505
1,000,000 New York State, MCFFA, Mercy Medical Center, LOC Natwest Bank, 5.875%, 11/01/15. FCLT AA- 1,030,820
1,750,000++ New York State, MCFFA, RB, 6.50%, 11/01/14...................................... FCLT BBB 1,843,065
4,020,000~++ Niagara County, IDA, Falls Street Faire Project, AMT, 10.00%, 9/01/06........... FCSI NR 1,599,638
9,805,000~++ Niagara County, IDA, Falls Street Faire Project, AMT, 10.00%, 9/01/06........... FCSI NR 3,901,606
5,870,000~++ Niagara Falls, URA, Old Falls Street Improvement Project, 11.00%, 5/01/99....... FCSI NR 2,896,023
4,350,000++ Onondaga County, IDA, Community General Hospital Project, 6.625%, 1/01/18....... FCLT BAA1 4,507,992
2,470,000++ Onondaga County, IDA, Resource Recovery Project, AMT, 7.00%, 5/01/15............ FCLT A- 2,590,388
3,400,000++ Onondaga County, IDA, Series A, Crouse Irving Project, LOC Fleet Bank,
7.90%, 1/01/17................................................................ FCLT A- 3,937,880
855,000 Puerto Rico Industrial, Tourist, Educational, Medical & Environmental
Control Facs, 6.25% Dr Pila Hospital Proj, FHA Insured, 8/01/32............... FCLT AAA 899,674
------------
Total Investments (cost $277,479,404**)................................ $271,490,055
============
<FN>
* Inverse Floating Rate Notes (IFRN) are instruments whose interest rates bear
an inverse relationship to the interest rate on another security or the value
of an index. Rates shown are at year end.
** Cost for Federal income tax purposes is $277,130,118.
~ The value of these non-income producing securities has been estimated in good
faith using procedures approved by the Fund's Board of Directors. See Note 4
to the financial statements.
++ Approximately $163,131,754 market value of securities are segregated in whole
or in part as collateral securing a line of credit.
</FN>
</TABLE>
8
<PAGE>
NEW YORK MUNI FUND
STATEMENT OF INVESTMENTS (continued)
December 31, 1995
Legend
0Type FCLT -Fixed Coupon Long Term
FCSI -Fixed Coupon Short or Intermediate Term
LRIB -Residual Interest Bond Long Term
SRIB -Residual Interest Bond Short or Intermediate Term
INLT -Indexed Inverse Floating Rate Bond Long Term
INSI -Indexed Inverse Floating Rate Bond Short or Intermediate Term
00Ratings If a security has a split rating the highest applicable rating is
used, including published ratings on identical credits for individual
securities not individually rated. Ratings are unaudited.
NR-Not Rated
000Issue AMBAC American Municipal Bond Assurance Corporation
AMT Alternative Minimum Tax
CAB Capital Appreciation Bond
CFR Civic Facility Revenue
COP Certificate of Participation
DAR Dormitory Authority Revenue
ECF Educational Construction Fund
ETM Escrowed to Maturity
FGIC Financial Guaranty Insurance Corporation
FHA Federal Housing Administration
FSA Financial Security Association
GO General Obligation
HDA Housing Development Authority
HIC Hospital Improvement Corporation
HFA Housing Finance Agency
HNHRB Hospital and Nursing Home Revenue Bonds
IDA Industrial Development Authority
MBIA Municipal Bond Insurance Assurance Corporation
MCF Medical Care Facilities
MCFFA Medical Care Facilities Finance Agency
NHRB Nursing Home Revenue Bonds
RB Revenue Bond
RDA Research and Development Authority
SFR Special Facilities Revenue
SWMA Solid Waste Management Authority
UDC Urban Development Corporation
URA Urban Renewal Authority
See Notes to Financial Statements.
9
<PAGE>
NEW YORK MUNI FUND
NOTES TO FINANCIAL STATEMENTS
December 31, 1995
- --------------------------------------------------------------------------------
1. Significant Accounting Policies
New York Muni Fund, Inc. (the Fund) is an open-end management investment
company registered under the Investment Company Act of 1940. The Fund seeks to
provide a high level of income that is excluded from gross income for Federal
income tax purposes and exempt from New York State and New York City personal
income taxes and is consistent with the preservation of capital. The following
is a summary of significant accounting policies followed in the preparation of
its financial statements:
Valuation of Securities-Investments are stated at value based on prices
provided by a pricing service when such prices are believed to reflect the
fair market value of such securities. Securities not priced in this manner
are at the mean of the last reported bid and asked prices provided by
principal market makers and recognized dealers in such securities. Other
assets and securities for which no quotations are readily available are
valued in good faith under methods approved by the Board of Directors.
Futures Contracts and Options Written on Future Contracts-Initial margin
deposits with respect to these contracts are maintained by the Fund's
custodian in segregated asset accounts. Subsequent changes in the daily
valuation of open contracts are recognized as unrealized gains or losses.
Variation margin payments are made or received as daily appreciation or
depreciation in the value of these contracts occurs. Realized gains or
losses are recorded when a contract is closed.
Options Written on Municipal Bonds-The Fund writes options on municipal
bonds. Premiums received for options written are recorded as a liability and
subsequently marked to market daily to reflect the current value of the
options written. If the written option expires unexercised, the premium
received is treated as realized gain. If the option is exercised, the
premium received is used to reduce the cost of the security purchased or
sold.
Federal Income Taxes-It is the Fund's policy to comply with the
requirements of the Internal Revenue Code applicable to "regulated
investment companies" and to distribute all of its taxable and tax exempt
income to its shareholders. Therefore, no provision for federal income tax
is required.
Distributions-The Fund declares dividends daily from its net investment
income and pays such dividends on the last business day of each month.
Distributions of net capital gains, if any, realized on sales of investments
are made annually, as declared by the Fund's Board of Directors.
Distributions are determined in accordance with income tax regulations.
Dividends are reinvested at the net asset value unless shareholders request
payment in cash.
General-Securities transactions are accounted for on a trade date basis.
Interest income is accrued as earned. Premiums and original issue discount
on securities purchased are amortized over the life of the respective
securities. Realized gains and losses from the sale of securities are
recorded on an identified cost basis. Net operating expenses incurred on
properties collateralizing defaulted bonds are charged to operating expenses
as incurred. Costs incurred to restructure defaulted bonds are charged to
realized losses as incurred.
Accounting 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 amounts of increases and
decreases in net assets from operations during the reporting period. Actual
results could differ from those estimates.
10
<PAGE>
NEW YORK MUNI FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1995
- --------------------------------------------------------------------------------
2. Investment Advisory Fees and Other Transactions with Affiliates
Under a Management Agreement, the Fund pays an investment management fee to
Fundamental Portfolio Advisors, Inc. (the Manager) equal to 0.5% of the Fund's
average daily net asset value up to $100 million and decreasing by .02% of each
$100 million increase in net assets down to 0.4% of net assets in excess of $500
million. The Manager is required to reimburse the Fund an amount not exceeding
the amount of fees payable to the Manager under the agreement for any fiscal
year, if, and to the extent that the aggregate operating expenses of the Fund
for any fiscal year including the fees payable to the Manager, but excluding
interest expenses, taxes, brokerage fees and commissions, expenses paid pursuant
to the Distribution Plan, and extraordinary expenses exceeds, on an annual
basis, 1.5% of the average daily net assets of the Fund. No such reimbursement
was required for the year ended December 31, 1995.
Pursuant to a Distribution Plan (the Plan) adopted pursuant to Rule 12b-1
promulgated under the Investment Company Act of 1940, the Fund may pay certain
promotional and advertising expenses and may compensate certain registered
securities dealers and financial institutions for services provided in
connection with the processing of orders for purchase or redemption of the
Fund's shares and furnishing other shareholder services. Payments by the Fund
shall not in the aggregate, in any fiscal year, exceed 0.5% of the average daily
net assets of the Fund.
Under a distribution agreement with Fundamental Service Corporation (FSC),
an affiliate of the Manager, amounts are paid under the Plan to compensate FSC
for the services it provides and the expenses it bears in distributing the
Fund's shares to investors. Any cumulative distribution expenses related to the
Fund incurred by FSC in excess of the annual maximum amount payable by the Fund
under the Plan may be carried forward for three years in anticipation of
reimbursement by the Fund on a "first in-first out" basis. If the Plan is
terminated or discontinued in accordance with its terms, the obligation of the
Fund to make payments to FSC will cease and the Fund will not be required to
make payments past the termination date. Amounts paid to FSC pursuant to the
agreement totaled $420,197 for the year ended December 31, 1995. The Fund
compensates Fundamental Shareholder Services, Inc., an affiliate of the manager,
for the services it provides under a Transfer Agent and Service Agreement.
Transfer agent fees for the year ended December 31, 1995 are set forth in the
statement of operations.
3. Directors' Fees
All of the Directors of the Fund are also directors or trustees of two other
affiliated mutual funds for which the Manager acts as investment adviser. For
services and attendance at board meetings and meetings of committees which are
common to each Fund, each Director who is not affiliated with the Manager is
compensated at the rate of $6,500 per quarter pro rated among the funds based on
their respective average net assets.
4. Complex Securities, Concentrations of Credit Risk, and Investment
Transactions
Inverse Floating Rate Notes (IFRN):
The Fund invests in variable rate securities commonly called "inverse
floaters". The interest rates on these securities have an inverse relationship
to the interest rate of other securities or the value of an index. Changes in
interest rate on the other security or index inversely affect the rate paid on
the inverse floater, and the inverse floater's price will be more volatile than
that of a fixed-rate bond. Certain interest rate movements and other market
factors can substantially affect the liquidity of IFRN's.
11
<PAGE>
NEW YORK MUNI FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1995
- --------------------------------------------------------------------------------
Futures Contracts and Options on Futures Contracts:
The Fund invests in futures contracts, consisting primarily of US Treasury
Bond Futures. A futures contract is an agreement between two parties to buy and
sell a security for a set price on a future date. Futures contracts are traded
on designated "contract markets" which through their clearing corporations,
guarantee performance of the contracts. In addition the Fund invests in options
on US Treasury Bond Futures which give the holder a right to buy or sell futures
contracts in the future. Unlike a futures contract which requires the parties to
the contract to buy and sell a security on a set date, an option on a futures
contract entitles its holder to decide before a future date whether to enter
into such a futures contract. Both types of contracts are marked to market daily
and changes in valuation will effect the net asset value of the Fund.
The Fund's principal investment objective in holding or issuing derivative
financial instruments is as a hedge against interest-rate fluctuations in its
municipal bond portfolio, and to enhance its total return. The Fund's principal
objective is to maximize the level of tax-exempt interest income while
maintaining acceptable levels of interest rate and liquidity risk. To achieve
this objective, the Fund uses a combination of derivative financial instruments
principally consisting of US Treasury Bond Futures and Options on US Treasury
Bond Futures. Typically the Fund sells treasury bond futures contracts or writes
treasury bond option contracts. These activities create off balance sheet risk
since the Fund may be unable to enter into an offsetting position and under the
terms of the contract must deliver the underlying security at a specified time
at a specified price. The cost to the Fund of acquiring the security to deliver
may be in excess of recorded amounts and result in a loss to the Fund. During
the year ended December 31, 1995, the Fund had daily average notional amounts
outstanding of approximately $6,300 and $904,100 of short positions on US
Treasury Bond Futures and options written on US Treasury Bond Futures,
respectively. Realized gains and losses from these transactions are stated
separately in the Statement of Operations.
The following table summarizes option contracts written by the Fund for the
year ended December 31, 1995.
Number of Premiums Realized
Contracts Received Cost Loss
--------- -------- ---- ----
Contracts outstanding December 31, 1994 100 $123,674
Options written........................ - - -
Contracts closed or expired............ 100 (123,674) $197,468 ($73,794)
--- --------
Contracts outstanding December 31, 1995 - $ 0
=== ========
Concentration of Credit Risk:
The Fund owns 100% of two Niagara Falls Industrial Development Agency bonds
("IDA Bonds") due to mature on September 1, 2006, and 98.3% of a Niagara Falls
New York Urban Renewal Agency 11% bond ("URA Bond") due to mature on May 1, 2009
which are in default. The IDA Bonds are secured by commercial retail and office
buildings known as the Falls Street Faire and Falls Street Station Projects
("Projects"). The URA Bond is secured by certain rental payments from the
Projects. There is uncertainty as to the timing of events and the subsequent
ability of the Projects to generate cash flows sufficient to service the IDA and
URA Bonds. These bonds are valued under methods determined by the Board of
Directors. In the aggregate these bonds are valued at $8,397,267 at December 31,
1995 (42.64% of their face value of $19,695,000). No interest income was accrued
on these bonds during the year ended December 31, 1995.
12
<PAGE>
NEW YORK MUNI FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1995
- --------------------------------------------------------------------------------
On October 6, 1992 the Fund entered into an agreement to restructure the
terms of the IDA bonds whereby the lessors of the Projects agreed to surrender
control of the Projects and waive any and all rights and interests of any kind
in the Projects. Legal, investment banking, and other restructuring costs
charged to realized loss totaled approximately $269,900 for year ended December
31, 1995 ($1,193,500 cumulatively from October 6, 1992 to December 31, 1995).
The Fund has retained an investment banker to assist them in finding the highest
and best use for the Projects. The Fund, through its investment banker, engaged
a manager to operate the Projects on its behalf, and the Fund is paying the net
operating expenses of the Projects. Net operating expenses related to the
Projects for the year ended December 31, 1995 are disclosed in the statement of
operations, and cumulatively from October 6, 1992 to December 31, 1995 totaled
approximately $372,000.
Other Investment Transactions:
During the year ended December 31, 1995, purchases and sales of investment
securities, other than short-term obligations, were $865,543,943 and
$878,083,183 respectively.
As of December 31, 1995 net unrealized depreciation of portfolio securities
on a federal income tax basis amounted to $5,640,063 composed of unrealized
appreciation of $8,244,445 and unrealized depreciation of $13,884,508.
5. Capital Stock
As of December 31, 1995 there were 500,000,000 shares of $.01 par value
capital stock authorized. Transactions in capital stock were as follows:
<TABLE>
<CAPTION>
Year Ended Year Ended
December 31, 1995 December 31, 1994
------------------------------- -------------------------------
Shares Amount Shares Amount
------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
Shares sold.................................. 3,269,945,429 $3,074,627,178 2,943,748,646 $3,005,186,891
Shares issued on reinvestment of dividends... 6,772,089 6,361,886 10,690,975 11,094,904
Shares redeemed.............................. (3,287,552,791) (3,094,515,295) 2,946,253,498) (3,028,967,870)
------------- -------------- ------------- --------------
Net increase (decrease)...................... (10,835,273) $ (13,526,231) 8,186,123 $ (12,686,075)
============= ============== ============= ==============
</TABLE>
6.Line of Credit
The Fund has line of credit agreements with banks collateralized by cash and
portfolio securities. Borrowings under these agreements bear interest linked to
the banks' prime rate.
13
<PAGE>
NEW YORK MUNI FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1995
- --------------------------------------------------------------------------------
7.Selected Financial Information
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------------------
1995 1994 1993 1992 1991
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE
(for a share outstanding throughout the year)
Net Asset Value, Beginning of Year......................... $0.88 $1.18 $1.21 $1.14 $1.04
----- ----- ----- ----- -----
Income from investment operations:
Net investment income...................................... .035 .056 .065 .061 .059
Net realized and unrealized gains (losses)
on investments........................................... .101 (.290) .082 .070 .100
----- ----- ----- ----- -----
Total from investment operations................... .136 (.234) .147 .131 .159
----- ----- ----- ----- -----
Less Distributions:
Dividends from net investment income....................... (.035) (.056) (.065) (.060) (.059)
Dividends from net realized gains.......................... (.001) (.010) (.112) (.001) -
----- ----- ----- ----- -----
Total distributions................................ (.036) (.066) (.177) (.061) (.059)
----- ----- ----- ----- -----
Net Asset Value, End of Year............................... $0.98 $0.88 $1.18 $1.21 $1.14
===== ===== ===== ===== =====
Total Return............................................... 15.67% (20.47%) 12.58% 11.83% 15.73%
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (000).............................. $226,692 $212,665 $275,552 $196,516 $183,307
Ratios to Average Net Assets:
Interest expense......................................... 2.09% 1.59% .61% .19% .09%
Operating expenses....................................... 1.55% 1.62% 1.44% 1.50% 1.69%
----- ----- ----- ----- -----
Total expenses..................................... 3.64% 3.21% 2.05% 1.69% 1.78%
===== ===== ===== ===== =====
Net investment income.............................. 3.81% 5.34% 5.20% 5.16% 5.47%
Portfolio turnover rate.................................... 347.50% 289.69% 404.05% 460.58% 365.12%
BANK LOANS
Amount outstanding at end of year (000 omitted)............ $ 64,575 $ 20,000 $ 20,873 $ 725 $ -
Average amount of bank loans outstanding during the year
(000 omitted)............................................ $ 49,603 $ 54,479 $ 24,100 $ 5,194 $ 1,483*
Average number of shares outstanding during the year
(000 omitted)............................................ 191,692 206,323 184,664 161,404 167,206*
Average amount of debt per share during the year........... $ .259 $ .264 $ .131 $ .032 $ .009
*Based on monthly average
</TABLE>
14
<PAGE>
NEW YORK MUNI FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1995
- --------------------------------------------------------------------------------
8. Contingencies
The Fund has been named as a defendant in a class action lawsuit alleging
that the Fund invested in certain derivative financial instruments that were
inconsistent with the Fund's stated investment objectives. The suit claims that
the defendants, which include the Fund's investment adviser, distributor, and
certain control persons, are liable for damages because there existed material
misstatements or omissions in the prospectuses that rendered them misleading.
Management has entered into negotiations with the plaintiffs who have
consented to a series of adjournments of all operative dates in the litigation.
These negotiations have resulted in a settlement in principle with the
plaintiffs that, if consummated, would require a payment of approximately
$500,000 or more under certain future circumstances by the Fund's investment
adviser and no liability or cost to the Fund or its shareholders. The
contemplated stipulation of settlement expressly states that the setttlement
does not constitute an admission of wrongdoing by the Fund or any of the other
defendants. The settlement remains subject to final documentation and agreement
by the parties and approval by the Court. If the settlement is not successfully
concluded, the Fund intends to contest the litigation vigorously. If this
litigation ever goes forward, it would involve significant complexities that
preclude a present determination of whether any liability to the Fund ultimately
would result and, if so, whether any such liability would be material to the
financial position of the Fund. Accordingly, and because the contemplated
settlement does not require any payment by the Fund, no amount has been accrued
in the financial statements with respect to this matter.
15
<PAGE>
INDEPENDENT AUDITOR'S REPORT
The Board of Directors and Shareholders
New York Muni Fund, Inc.
We have audited the accompanying statement of assets and liabilities, including
the statement of investments, of New York Muni Fund, Inc. as of December 31,
1995, and the related statements of operations and cash flows for the year then
ended, the statements of changes in net assets for each of the two years in the
period then ended, and selected financial information for each of the five years
in the period then ended. These financial statements and selected financial
information are the responsibility of the Fund's management. Our responsibility
is to express an opinion on these financial statements and selected financial
information 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 selected
financial information are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. Our procedures included confirmation of securities
owned as of December 31, 1995 by correspondence with the custodian and brokers.
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 selected financial information
referred to above present fairly, in all material respects, the financial
position of New York Muni Fund, Inc. as of December 31, 1995 and the results of
its operations, cash flows, changes in net assets, and selected financial
information for the periods indicated, in conformity with generally accepted
accounting principles.
As explained in Note 4, the financial statements include securities valued at
$8,397,267 (3.7% of net assets) whose values have been estimated by the Board
Directors in the absence of readily estimatable market values. We have reviewed
the procedures used by the Board of Directors in arriving at its estimate of
value of such securities and have inspected underlying documentation, and, in
the circumstances, we believe the procedures are reasonable and the
documentation appropriate. However, those estimated values may differ
significantly from the values that would have been used had a ready market for
the securities existed, and the differences could be material.
New York, New York
February 13, 1996
16
<PAGE>
(Left column)
NEW YORK MUNI FUND, INC.(r)
90 Washington Street
New York, NY 10006
1-800-322-6864
Independent Auditors
McGladrey & Pullen, LLP
New York, NY 10017
Attorney
Kramer, Levin, Naftalis,
Nessen, Kamin & Frankel
919 Third Avenue
New York, NY 10022
This report and the financial statements contained
herein are submitted for the general information of
the shareholders of theFund. The report is not
authorized for distribution to prospective investors
in the Fund unless preceded or accompanied by an
effective prospectus.
(Right Column)
NEW YORK MUNI FUND, INC.(r)
Annual Report
December 31, 1995
NEW YORK MUNI FUND
Triple
Tax-Free Investing
FUNDAMENTAL
Fundamental Family of Funds
<PAGE>
PART C. OTHER INFORMATION
ITEM 24. Financial Statements and Exhibits
(a) FINANCIAL STATEMENTS:
IN PART A:
(1) Financial Highlights
IN PART B:
(1) Auditor's Report
(2) Statements of Assets and Liabilities as of
December 31, 1995.
(3) Statements of Changes in Net Assets for the year
ended December 31, 1995.
(4) Statements of Operations for the year ended
December 31, 1995.
(5) Schedule of Investments as of December 31, 1995.
(b) EXHIBITS:
(1) (a) Articles of Incorporation*
(b) Articles of Amendment***
(2) By-Laws of Registrant*
(3) Inapplicable
(4) Form of Specimen Security*
(5) Form of Management Agreement with Fundamental
Portfolio Advisors, Inc.*
(6) Inapplicable
(7) Inapplicable
(8) Form of Custody Agreement with Registrant's
Custodian*
(9) Inapplicable
(10) (a) Opinion of Counsel*
(b) Consent of Counsel***
(c) Consent of McGladrey & Pullen***
(11) Inapplicable
(12) Inapplicable
(13) Inapplicable
(14) Inapplicable
(15) Form of Distribution Plan pursuant to Rule
12b-1 and related agreements*
(16) Schedule for Computation of Performance
Quotations (unaudited)**
- -----------------------------
* Filed on October 26, 1990 as an Exhibit to Post-Effective
Amendment No. 11 to the Registration Statement and
Incorporated herein by reference thereto.
** Filed on April 27, 1988 as Exhibit No. 16 to Post-Effective
Amendment No. 8 to the Registration Statement and incorporated
herein by reference thereto.
*** Filed as part of this document.
<PAGE>
ITEM 25. Persons Controlled by or under Common Control with Registrant
Registrant is not controlled by or under common control with any other
person.
ITEM 26. Number of Holders of securities
As of March 29, 1996, Registrant had 7,463 record holders of its
securities.
ITEM 27. Indemnification
Under the terms of the Registrant's Articles of Incorporation and
By-laws, the Registrant may indemnify any person who was or is a director,
officer or employee of the Registrant to the maximum extent permitted by law;
provided, however, that any such indemnification (unless ordered by a court)
shall be made by the Registrant only as authorized in the specific case upon a
determination that the indemnification of such persons is proper in the
circumstances. Such determination shall be made (i) by the directors, by a
majority vote of a quorum which consists of directors who are neither
"interested persons" of the Registrant, as defined in Section 2(a)(19) of the
Investment Company Act of 1940, nor parties to the proceeding, or (ii) if the
required quorum is not obtainable or, if a quorum of such directors so directs,
by independent legal counsel in a written opinion. No indemnification will be
provided by the Registrant to any director or officer of the Registrant for any
liability to the Registrant or shareholders to which he would otherwise be
subject by reason of willful misfeasance, bad faith, gross negligence or
reckless disregard of duty.
ITEM 28. Business and Other Connections of Investment Advisor
Fundamental Portfolio Advisors, Inc. is the investment advisor of
Registrant. For information as to the business, profession, vocation or
employment of a substantial nature of Fundamental Portfolio Advisory, Inc., its
directors and its officers, reference is made to Part I of this Registration
Statement and to Form ADV filed under the Investment Advisers Act of 1940 by
Fundamental Portfolio Advisors, Inc.
ITEM 29. Principal Underwriters
Registrant has no principal underwriter.
<PAGE>
ITEM 30. Location of Accounts and Records
The accounts, books and other documents required to be maintained by
Section 31(a) of the Investment Company Act of 1940 and the rules promulgated
thereunder are in the possession of Registrant, 90 Washington Street, 19th
Floor, New York, N.Y., Mutual Fund Service Company, 126 High Street, Boston, MA
02110, the Registrant's Accounting Agent and The Chase Manhattan Bank, N.A., 114
West 47th Street, New York, N.Y., the Registrant's Custodian.
ITEM 31. Management Services
Inapplicable.
ITEM 32. Undertakings.
(1) The Registrant undertakes to comply with Section 16(c) of the
Investment Company Act of 1940 as though such provisions of the Act were
applicable to the Registrant, except that the request referred to in the third
full paragraph thereof may only be made by shareholders who hold in the
aggregate at least 1 per centum of the outstanding shares of the Registrant,
regardless of the net asset value of the shares held by such requesting
shareholders.
(2) The Registrant undertakes to call a meeting of stockholders for
the purpose of voting upon the question of removal of one or more of the
Registrant's directors when requested in writing to do so by the holders of at
least 10% of the Registrant's outstanding shares of common stock and, in
connection with such meeting, to comply with the provisions of Section 16(c) of
the Investment Company Act of 1940 relating to shareholder communications.
(3) The Registrant undertakes to furnish each person to whom a
prospectus relating to its New York Muni Fund series is delivered, a copy of the
Fund's latest annual report to shareholders, upon request and without charge.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the
Investment Company Act of 1940, the Registrant certifies that it meets all of
the requirements for effectiveness of this Registration Statement pursuant to
Rule 485 (b) under the Securities Act of 1933 and has duly caused this
Registration Statement or Amendment to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of New York and State of New
York on the 24th day of April, 1995.
Registrant: FUNDAMENTAL FUNDS, INC.
By: /s/Vincent J. Malanga
Vincent J. Malanga, Chairman
and Chief Executive Officer
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement or Amendment has been signed below by the following
persons in the capacities and on the dates indicated.
SIGNATURES TITLE DATE
/s/Vincent J. Malanga Director, Principal April 24, 1995
- --------------------------- Executive Officer and
Vincent J. Malanga Principal Financial
and Accounting Officer
* James C. Armstrong Director April 24, 1995
- ------------------------
James C. Armstrong
* James A. Bowers Director April 24, 1995
- ------------------------
James A. Bowers
- ------------------------ Director
Clark L. Bullock
* L. Greg Ferrone Director April 24, 1995
- ------------------------
L. Gregg Ferrone
*By: /s/Jules Buchwald
-----------------
Jules Buchwald, Attorney-in-Fact,
pursuant to powers of attorney
dated April 24, 1991, previously
filed with the Securities and
Exchange Commission
KRAMER, LEVIN, NAFTALIS, NESSEN, KAMIN & FRANKEL
919 THIRD AVENUE
NEW YORK, NEW YORK 10022-3852
(212) 715-9100
ARTHUR H. AUFSES III RICHARD MARLIN SHERWIN KAMIN
THOMAS D. BALLIETT THOMAS E. MOLNER ARTHUR B. KRAMER
JAY G. BARIS THOMAS H. MORELAND MAURICE N. NESSEN
SAUL E. BURIAN ELLEN R. NADLER FOUNDING PARTNERS
BARRY MICHAEL CASS GARY P. NAFTALI COUNSEL
THOMAS E. CONSTANCE MICHAEL J. NASSA --------
MICHAEL J. DELL MICHAEL S. NELSON MARTIN BALSAM
KENNETH H. ECKSTEIN JAY A. NEVELOFF JOSHUA M. BERMAN
CHARLOTTE M. FISCHMAN MICHAEL S.OBERMAN JULES BUCHWALD
DAVID S. FRANKEL PAUL S. PEARLMAN RUDOLPH DE WINTER
MARVIN E. FRANKEL SUSAN J. PENRY-WILLIAMS MEYER EISENBERG
ALAN R. FRIEDMAN BRUCE RABB ARTHUR D. EMIL
CARL FRISCHLING ALLAN E. REZNICK MAXWELL M. RABB
MARK J. HEADLEY SCOTT S. ROSENBLUM JAMES SCHREIBER
ROBERT M. HELLER MICHELE D. ROSS COUNSEL
PHILIP S. KAUFMAN MAX J. SCHWARTZ -------
PETER S. KOLEVZON MARK B. SEGALL M. FRANCES BUCHINSKY
KENNETH P. KOPELMAN JUDITH SINGER DEBORA K. GROBMAN
MICHAEL PAUL KOROTKIN HOWARD A. SOBEL CHRISTIAN S. HERZECA
KEVIN B. LEBLANG STEVEN C. TODRYS PINCHAS MENDELSON
DAVID P. LEVIN JEFFREY S. TRACHTMAN LYNN R. SAIDENBERG
EZRA G. LEVIN D. GRANT VINGOE JONATHAN M. WAGNER
LARRY M. LOEB HAROLD P. WEINBERGER SPECIAL COUNSEL
MONICA C. LORD E. LISK WYCKOFF, JR. -------
FAX
(212) 715-8000
---
WRITER'S DIRECT NUMBER
(212)715-9100
-------------
April 24, 1996
New York Muni Fund
90 Washington Street
New York, New York 10006
Re: Registration No. 2-82710
------------------------
Gentlemen:
We hereby consent to the reference to our firm as counsel in
Post-Effective Amendment No. 18 to Registration Statement No. 2-82710.
Very truly yours,
/s/Kramer, Levin,DNaftalis,ENessen,
Kamin & Frankel COUNSEL
CONSENT OF INDEPENDENT AUDITORS
We consent to the use of our reports dated February 13, 1996
on the financial statements of New York Muni Fund, Inc., referred to therein in
Post-Effective Amendment No. 18 to the Registration Statement on Form N-1A, File
No. 2-82710, as filed with the Securities and Exchange Commission.
We also consent to the reference to our Firm in the prospectus
under the caption "Financial Highlights" and in the Statement of Additional
Information under the caption "Custodian and Independent Certified Public
Accountants."
/s/McGladrey & Pullen, LLP
New York, New York
April 24, 1996
NEW YORK MUNI FUND, INC.
ARTICLES OF AMENDMENT
NEW YORK MUNI FUND, INC., a Maryland corporation, registered as an
open-end company under the Investment Company Act of 1940, and having its
principal office in the State of Maryland in Baltimore City, Maryland
(hereinafter referred to as the "Corporation"), hereby certifies to the State
Department of Assessments and Taxation of Maryland (the "Department") that:
FIRST: The Corporation hereby amends its charter as currently
in effect, consisting of Articles of Incorporation filed with the
Department on or about May 21, 1990 (the "Articles of Incorporation"),
by changing the name of the Corporation from "NEW YORK MUNI FUND, INC."
to "FUNDAMENTAL FUNDS, INC."
SECOND: The foregoing amendment was authorized and approved by
a majority of the entire Board of Directors of the Corporation, without
action by the stockholders. The foregoing amendment is limited to a
change expressly permitted by Section 2-605 of the Maryland General
Corporation Law ("MGCL") to be made without action by the stockholders
and was approved under Section 2-605(a)(4) of the MGCL.
THIRD: The Corporation is registered as an open-
end company under the Investment Company Act of 1940.
FOURTH: The foregoing amendment does not increase the
authorized stock of the Corporation, and does not change the
preference, conversion or other rights, voting power, restrictions,
limitation as to dividends, qualifications or terms or conditions of
redemption of any class or series of authorized stock of the
Corporation.
<PAGE>
IN WITNESS WHEREOF, the Corporation has caused these Articles of
Amendment to be executed in its name and on its behalf by its undersigned
President and witnessed or attested to by its undersigned Secretary as of this
23rd day of April, 1996 and its undersigned President acknowledges that these
Articles of Amendment are the act and deed of the Corporation and, under
penalties of perjury, that the matters in fact set forth herein are true in all
material respects to the best of his knowledge, information and belief.
WITNESS/ATTEST: NEW YORK MUNI FUND, INC.
By:/s/Carole Laible By:/s/Vincent J. Malanga
--------------------- ------------------------------
Carole Laible, Secretary Vincent J. Malanga, President
<TABLE> <S> <C>
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<NAME> FUNDAMENTAL FUNDS, INC.
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