As filed via EDGAR with the Securities and Exchange
Commission on May 1, 1998.
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. 20 [X]
and
REGISTRATION STATEMENT UNDER THE
INVESTMENT COMPANY ACT OF 1940 [X]
Amendment No. 18 [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 & Frankel
19th Floor 919 Third Avenue
New York, New York 10006 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.
<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. *
<PAGE>
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. *
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(R)
90 Washington Street
New York, New York 10006
1-800-225-6864
New York Muni Fund, "New York's Oldest 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 sets forth concisely the 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 OF CONTENTS
Highlights ............................................................. 2
Fee Table .............................................................. 3
Financial Highlights ................................................... 4
Investment Objective and Policies ...................................... 5
Investment Strategies .................................................. 8
Special Risks .......................................................... 13
Calculation of Yield and Performance Data .............................. 16
Purchase of Shares ..................................................... 17
Redemption of Shares ................................................... 19
Determination of Net Asset Value ....................................... 22
Distribution Expenses .................................................. 22
Management ............................................................. 24
Dividends and Tax Matters .............................................. 27
General Information .................................................... 29
- --------------------------------------------------------------------------------
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 MAY 1, 1998
IS HEREBY INCORPORATED BY REFERENCE INTO THIS PROSPECTUS.
PROSPECTUS DATED MAY 1, 1998
<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. There is no assurance,
however, that the Fund will achieve its stated objective. See "Investment
Objective and Policies".
Management
The Fund is a member of the Fundamental Family of Funds, a group of five
investment companies. Fundamental Portfolio Advisors, Inc. (the "Manager") is
the Fund's investment manager.
The Manager supervises and manages the Fund's investment portfolio and
directs the purchase and sales of its investment securities. The Manager
utilizes an investment committee to manage the assets of the Fund. See
"Management".
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 Matters"). 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 Matters").
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 Operating Expenses (as a percentage of average net assets)
- --------------------------------------------------------------------------------
Management Fees .................................... .49%
12b-1 Fees1 ........................................ .50%
Other Expenses:
Interest ........................................... 1.10%
Other .............................................. 1.65%
Total Fund Operating Expenses ...................... 3.74%
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
$38 $114 $193 $398
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, 1997 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,
----------------------------------------------------------------------------------------
1997 1996 1995 1994 1993 1992 1991 1990 1989 1988
---- ---- ---- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE
(for a share outstanding
throughout the period)
Net Asset Value, Beginning of year ........ $0.87 $0.98 $0.88 $1.18 $1.21 $1.14 $1.04 $1.12 $1.09 $1.05
----- ----- ----- ----- ----- ----- ----- ----- ----- -----
Income from investment operations:
Net investment income ................... .021 .035 .035 .056 .065 .061 .059 .069 .072 .074
Net realized and unrealized gain (loss)
on investments ........................ (.009) (.110) .101 (.290) .082 .070 .100 (.080) .031 .040
----- ----- ----- ----- ----- ----- ----- ----- ----- -----
Total from investment operations .... .012 (.075) .136 (.234) .147 .131 .159 (.011) .103 .114
----- ----- ----- ----- ----- ----- ----- ----- ----- -----
Less: Distributions:
Dividends from net investment income .... (.019) (.035) (.035) (.056) (.065) (.060) (.059) (.069) (.072) (.074)
Return of capital distributions ......... (.003) - - - - - - - - -
Dividends from net realized gains ....... - - (.001) (.010) (.112) (.001) - - - -
----- ----- ----- ----- ----- ----- ----- ----- ----- -----
Total distributions ................. (.022) (.035) (.036) (.066) (.177) (.061) (.059) (.069) (.072) (.074)
----- ----- ----- ----- ----- ----- ----- ----- ----- -----
Net Asset Value, End of year .............. $0.86 $0.87 $0.98 $0.88 $1.18 $1.21 $1.14 $1.04 $1.12 $1.09
===== ===== ===== ===== ===== ===== ===== ===== ===== =====
Total Return ........................ 1.46% (7.73%) 15.67% (20.47%) 12.58% 11.83% 15.73% (.99%) 9.60% 11.22%
RATIOS/SUPPLEMENTAL DATA
Net Assets,End of Period (000) ...........$134,595 $196,746 $226,692 $212,665 $275,552 $196,516 $183,307 $182,282 $236,525 $230,356
Ratios to Average Net Assets:
Interest expenses ....................... 1.10% 2.11% 2.09% 1.59% .61% .19% .09% .17% .35% .55%
Operating expenses ...................... 2.64% 1.66% 1.55% 1.62% 1.44% 1.50% 1.69% 1.48% 1.34% 1.19%
----- ----- ----- ----- ----- ----- ----- ----- ----- -----
Total expenses ...................... 3.74%+ 3.77% 3.64% 3.21% 2.05% 1.69% 1.78% 1.65% 1.69% 1.74%
===== ===== ===== ===== ===== ===== ===== ===== ===== =====
Net investment income ............... 2.23%+ 3.89% 3.81% 5.34% 5.20% 5.16% 5.47% 6.43% 6.47% 6.94%
Portfolio turnover rate ...................399.38% 347.44% 347.50% 289.69% 404.05% 460.58% 365.12% 482.58% 386.48% 462.73%
BANK LOANS
Amount outstanding at end of period
(000 omitted) ...........................$38,178 $1,200 $64,575 $20,000 $20,873 $725 - $248 $9,758 -
Average amount of bank loans
outstanding during the year
(000 omitted) ...........................$20,631 $49,448 $49,603 $54,479 $24,100 $5,194 $1,483* $4,767* $9,581* $11,500*
Average number of shares outstanding
during the year (000 omitted) ...........153,535 178,456 191,692 206,323 184,664 161,404 167,206* 209,484* 211,210* 212,394*
Average amount of debt per share during
the year ................................ $ .134 $ .277 $ .259 $ .264 $ .131 $ .032 $ .009 $ .023 $ .045 $ .054
<FN>
- ----------
**Based on monthly averages.
+These ratios are after expense reimbursement of .03% for the year ended December 31, 1997.
</FN>
</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's investment objective and its investment policies and strategies
with respect to futures, options, lending portfolio securities and borrowing
(described below) 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.
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
5
<PAGE>
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 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
6
<PAGE>
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 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 Matters"), the Manager
weighs the added costs of short-term investment against anticipated gains. The
Fund's portfolio turnover rate was approximately 347% for the year ended
December 31, 1996, and was approximately 399% for the year ended December 31,
1997.
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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 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. 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 is permitted 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 maximum 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 Matters") 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 Inverse 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 Fund may purchase both the auction and the
residual components. (See "Special Risk Factors Relating to Inverse Floating
Rate Instruments").
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.
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 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.
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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 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
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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 Inverse Floating Rate Instruments
Changes in interest rates inversely affect the rate paid on inverse floating
rate instruments ("inverse floaters"). The inverse floaters' price will be more
volatile than that of a fixed rate bond. Additionally, some inverse floaters
contain a "leverage factor" whereby the interest rate moves inversely by a
"factor" to the benchmark. For example, the rates on the inverse floating rate
note may move inversely at three times the benchmark rate. Certain interest rate
movements and other market factors can substantially affect the liquidity of
inverse floaters. These instruments are designed to be highly sensitive to
interest rate changes and may 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 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
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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.
Other Considerations
It is expected that a substantial portion of the assets of the Fund will be
derived from professional money managers and investors who intend to invest in
the Fund as part of an asset-allocation or market-timing investment strategy.
These investors are likely to redeem or exchange their Fund shares frequently to
take advantage of anticipated changes in market conditions. The strategies
employed by investors in the Fund may result in considerable assets moving in
and out of the Fund. Consequently, the Trust expects that the Fund will
generally experience significant portfolio turnover, which will likely cause
higher expenses and additional costs.
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
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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.
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
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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 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 Fisrstar Trust Company (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:
. 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 Family of Funds, c/o Firstar
Trust Company, P.O. Box 701, Milwaukee, WI 53201-0701. 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
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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 Family of Funds, c/o Firstar Trust Company, P.O. Box 701,
Milwaukee, WI 53201-0701, the Fund's transfer agent, and must specify the number
of shares of the Fund 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 Firstar Trust Company. 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 recognize 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 Firstar Trust Company 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 Firstar Trust Company 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),
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(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.
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 Firstar Trust Company. The Fund may
delay, or cause to be delayed, payment of redemption proceeds until such time as
it or Firstar Trust Company 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 Firstar Trust Company
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 Firstar
Trust Company 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, Firstar Trust Company, 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 Firstar Trust Company 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. Firstar Trust Company 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 Firstar Trust Company. 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 Firstar
Trust Company 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. Firstar Trust Company charges a $12 service fee for
each payment of redemption proceeds made by Federal wire. This fee will be
deducted from your account.
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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.
This privilege may be modified or terminated at any time without prior
notice by either the Fund or Firstar Trust Company. 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.
Requests by letter should be addressed to Fundamental Family of Funds, c/o
Firstar Trust Company, P.O. Box 701, Milwaukee, WI 53201-0701.
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 Family of
Funds, c/o Firstar Trust Company, P.O. Box 701, Milwaukee, WI 53201-0701. 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 Fundamental Family of Funds,
c/o Firstar Trust Company, P.O. Box 701, Milwaukee, WI 53201-0701. 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. Firstar Trust Company 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 Firstar Trust Company.
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 Firstar
Trust Company 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 Firstar Trust Company. In addition, Firstar Trust Company 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
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applicable. The Fund may require you to file a statement that all information on
the original account application form remains applicable.
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 value used by the Fund in computing the current price per share for the
purpose of purchase and redemption of Fund shares (the net asset value per
share) means an amount which reflects calculations to the nearest 1/10th of one
cent.
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.
The Fund's Board of Directors approved the continuance of the Fund's Plan
for a period of sixty days following the date of its expiration in contemplation
of a transaction pursuant to which Tocqueville Asset Management L.P. would
assume management of the assets of the Fund. Otherwise, the Plan would have
expired on April 1, 1998. See ("Management").
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
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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
("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, 1997, the Fund paid $647,839 under the Plan, including $307,200
paid to Fundamental Service Corporation under the Plan.
NASD Regulation, Inc. ("NASDR") entered into a Letter of Acceptance, Waiver
and Consent with Fundamental Service Corporation that imposed a total of
$125,000 in fines and other stipulated sanctions on Fundamental Service
Corporation and two of its officers for distributing advertising materials for
Fundamental U.S. Government Strategic Income Fund that NASDR deemed to be false
and misleading. Fundamental Service Corporation neither admitted nor denied the
allegations and filed a Mitigation Statement in response to the Letter of
Acceptance, Waiver and Consent.
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
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<PAGE>
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
Under the laws of the State of Maryland, the Board of Directors is
responsible for managing the business and affairs of the Fund. Acting pursuant
to an investment management agreement adopted by the Board of Directors of the
Fund on October 3, 1990 and approved by shareholders on November 29, 1990,
Fundamental Portfolio Advisors, Inc. (the "Manager") serves as the investment
manager of the Fund. Its principal place of business is 90 Washington Street,
New York, NY 10006. The Manager has been providing investment advisory services
to the Fundamental Family of Funds since it was founded in 1986.
The Fund's Board of Directors approved the continuance of the Fund's current
Management Agreement for a period of sixty days following the date of its
expiration in contemplation of the consummation of a transaction pursuant to
which Tocqueville Asset Management L.P. ("Tocqueville") would assume management
of the assets of the Fund. Otherwise, the Management Agreement would have
expired on April 1, 1998. Tocqueville is the investment adviser to the
Tocqueville Funds.
It is anticipated that shareholders of the Fund will be asked to consider
and approve an Agreement and Plan of Reorganization providing for the transfer
of the Fund's assets to a separate, newly-created Tocqueville Fund having the
same investment policies and objectives as those of the Fund at a special
meeting of shareholders scheduled to be held in late Spring. Subsequent to the
filing with the Securities and Exchange Commission of preliminary proxy
solicitation materials seeking shareholder approval of the Agreement and Plan of
Reorganization at the special meeting of shareholders, the Manager filed two
preliminary proxy statements with the Securities and Exchange Commission, one
opposing the transaction pursuant to which Tocqueville would assume management
of the assets of the Fund; the second, proposing to replace the two independent
Board Members of the Fundamental Funds and the election of six new nominees to
the Fund's Board (in addition to Vincent J. Malanga, a current Board Member).
Vincent J. Malanga is, and has been for more than the past five years,
Chairman of the Board, Chief Executive Officer, President and Treasurer of the
Fundamental Family of Funds. He is, and has been for more than the past five
years, President, Treasurer, and a Director of the Manager, Executive Vice
President, Secretary and a Director of Fundamental Service Corporation (the
Distributor for certain of the Fundamental Family of Funds) and President of
LaSalle Economics, Inc., an economic consulting firm, and a managing director of
LaSalle Portfolio Management, Inc., a commodity trading adviser.
Jane Tubis is, and has been for more than the past five years, a trading
assistant with the Manager.
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
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,
24
<PAGE>
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 of 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 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, 1996, the Manager received fees from
the Fund in the amount of $787,962, which represented .49% of the Fund's average
net assets.
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.
On September 30, 1997, the Securities and Exchange Commission (the
"Commission") instituted administrative proceedings against the Manager,
Fundamental Service Corporation, and Drs. Lance M. Brofman and Vincent J.
Malanga (the "Parties"). The Commission's Order instituting the proceedings
alleges, among other things, certain violations of the federal securities laws,
25
<PAGE>
including the antifraud provisions, for failing to disclose the risks associated
with investments in inverse floating rate notes made on behalf of the
Fundamental U.S. Government Strategic Income Fund (the "Government Fund") in
1993 and 1994, marketing the Government Fund in a way that was contrary to the
administration of the Government Fund, exceeding the Government Fund's portfolio
duration of three years or less as stated in its prospectus, and failing to
disclose the Manager's soft dollar practices to the Fundamental Fund Boards. A
hearing has been scheduled to determine whether the allegations against the
Parties are true, and if so, whether remedial action is appropriate. Counsel to
the Parties have indicated that the Parties intend to vigorously contest the
charges. The Manager has indicated that the institution of the proceedings
against the Parties has not adversely affected the ability of the Manager or
Fundamental Service Corporation to continue to perform the day-to-day affairs of
the Fundamental Funds.
The Manager and Fundamental Service Corporation (on behalf of certain of
their directors, officers, shareholders, employees and control persons) (the
"Indemnitees") received payments during the fiscal year ended December 31, 1997
from three of the Fundamental Funds for attorneys' fees incurred by them in
defending certain proceedings. The payments were as follows: Fundamental U.S.
Government Strategic Income Fund (approximately $232,500); New York Muni Fund
(approximately $50,000); and the California Muni Fund (approximately $4,000).
Upon learning of the payment, the independent Board Members of the Fundamental
Funds directed that the Indemnitees return all of the payments to the Funds or
place them in escrow pending their receipt of an opinion of an independent legal
counsel to the effect that the Indemnitees are entitled to receive them.
On April 30, 1998, the Indemnitees placed $106,863 into an escrow account
pending clarification of certain legal issues. The Manager and Fundamental
Service Corporation have asserted that they waived fees during the year ended
December 31, 1997 and that the amount placed in escrow should be net of any
reimbursements already made to the Funds in the form of fees forgone. Upon
learning that $106,863 was placed into an escrow account on behalf of the Funds,
the independent Board Members referred the Manager and Fundamental Service
Corporation to their prior directive and asked that the entire amount of all
payments received by such entities ($286,500) be placed into said escrow
account. For further information, see Notes to the December 31, 1997 Financial
Statements of Fundamental U.S. Government Strategic Income Fund, New York Muni
Fund and the California Muni Fund, attached to the Statement of Additional
Information.
To assist in the investment management of the Funds following the transfer
of portfolio management responsibilities from the Fund's former portfolio
manager to an investment committee, the Manager arranged for Mr. Christopher P.
Culp to join the investment committee responsible for the selection of specific
securities which the Fund may invest, hold, sell or exchange. Mr. Culp, a
portfolio co-manager affiliated with Tocqueville Asset Management L.P., joined
Dr. Vincent J. Malanga, a portfolio strategist affiliated with the Manager, and
Jane Tubis, a trading assistant affiliated with the Manager, as members of the
investment committee. Mr. Culp served on the Manager's investment committee on
an interim basis without compensation from February 18, 1997 until August 27,
1997, acting as the principal portfolio manager of the Fund. He did so in his
capacity as an employee of Fundamental, representing to the Boards that he was
working without salary or other compensation. At the same time, he continued to
be employed by Tocqueville Asset Management L.P.
Between April 17, 1997 and July 24, 1997, Mr. Culp engaged Tocqueville
Securities L.P. ("Tocqueville Securities"), an affiliate of Tocqueville, as
agent, to effect eight separate over-the-counter purchase transactions of
municipal obligations on behalf of the Fund. The Fund's Board has concluded that
the commissions paid to Tocqueville Securities in connection with these
transactions (a portion of which was paid to Mr. Culp) were not justified and
that the Fund bore unnecessary expenses as a result of the sale of its
securities to another party and the subsequent repurchase of them through
Tocqueville Securities. Based upon a report initiated by Tocqueville Securities
and prepared by the Fund's independent auditors, and upon the Board's own
analysis, the Board directed that the Manager terminate Mr. Culp's services as a
portfolio manager. At the Board's request and in order to reimburse the Fund for
all of its losses, Tocqueville Securities, on September 15, 1997, voluntarily
paid $260,000 to the Fund, an amount which significantly exceeds the total
commissions ($184,920.60) received by Tocqueville Securities in connection with
these transactions. The staff of the Commission and the Department of NASD
Regulation have been informed of these events by Tocqueville Securities.
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
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"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."
DIVIDENDS AND TAX MATTERS
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 Firstar Trust Company,
which election will remain in effect until Firstar Trust Company 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.
Tax Matters
The Fund intends to qualify as a regulated investment company by satisfying
the requirements under Subchapter M of the Code, including requirements with
respect to diversification of assets, distribution of income and sources of
income. It is the Fund's policy to
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distribute to shareholders all of its investment income (net of expenses) and
any capital gains (net of capital losses) in accordance with the timing
requirements imposed by the Code, so that the Fund will satisfy the distribution
requirement of Subchapter M and will not be subject to Federal income tax or the
4% excise tax.
If the Fund fails to satisfy any of the Code requirements for qualification
as a regulated investment company, it will be taxed at regular corporate tax
rates on all its taxable income (including capital gains) without any deduction
for distributions to shareholders, and distributions to shareholders will be
taxable as ordinary dividends (even if derived from the Fund's net long-term
capital gains) to the extent of the Fund s current and accumulated earnings and
profits.
The Fund intends to invest principally in tax-exempt municipal obligations
so that distributions by the Fund of its net tax-exempt interest income can be
designated as exempt-interest dividends, which are excludable from gross income
for Federal income tax purposes. However, 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, these
exempt-interest dividends may be subject to the Federal alternative minimum tax
and will be taken into account in determining the portion, if any, of Social
Security benefits received which must be included in gross income for Federal
income tax purposes. Further, interest or indebtedness incurred or continued to
purchase or carry shares of the Fund (which indebtedness likely need not be
directly traceable to the purchase or carrying of such shares) will not be
deductible for Federal income tax purposes. Finally, 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.
A small portion of the Fund's net investment income may under certain
circumstances betaxable, and distributions thereof, as well as distributions of
any net capital gain will be taxable to shareholders. Distributions by the Fund
of its taxable net investment income and the excess, if any, of its net
short-term capital gain over its net long-term capital loss are taxable to
shareholders as ordinary income. Such distributions are treated as dividends for
Federal income tax purposes but do not qualify for the 70% dividends-received
deduction for corporate shareholders. Distributions by the Fund of the excess,
if any, of its net long-term capital gain over its net short-term capital loss
are designated as capital gains dividends and are taxable to shareholders as
long-term capital gains, regardless of the length of time shareholders have held
their 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 is 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.
Distributions to shareholders will be treated in the same manner for Federal
income tax purposes 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.
Investors should carefully consider the tax implications of purchasing
shares just prior to the record date of any ordinary income dividend or capital
gain dividend. Those investors purchasing shares just prior to an ordinary
income or capital gain dividend will be taxed on the entire amount of the
dividend received, even though the net asset value per share on the date of such
purchase reflected the amount of such dividend and such dividend economically
constitutes a return of capital to such investors.
A shareholder will recognize gain or loss upon 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.
Any loss realized upon a taxable disposition of shares within six months from
the date of their purchase will be treated as a long-term capital loss to the
extent of any
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capital gain dividends received on such shares. All or a portion of any loss
realized upon a taxable disposition of shares of the Fund may be disallowed if
other shares of the Fund are purchased within 30 days before or after such
disposition.
If a shareholder is a non-resident alien or foreign entity shareholder,
ordinary income dividends paid to such shareholder generally will be subject to
United States withholding tax at a rate of 30% (or lower rate under an
applicable treaty). We urge non-United States shareholders to consult their own
tax adviser concerning the applicability of the United States withholding tax.
Under the backup withholding rules of the Code, certain shareholders may be
subject to 31% withholding of Federal income tax on ordinary income dividends
paid by the Fund. In order to avoid this backup withholding, a shareholder must
provide the Fund with a correct taxpayer identification number (which for most
individuals is his or her Social Security number) 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.
Statements regarding the tax status of distributions by the Fund will be
mailed annually by Firstar Trust Company. 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 of Federal income tax consequences is based on tax
laws and regulations in effect on the date of this Prospectus, and is subject to
change by legislative or administrative action. As the foregoing discussion is
for general information only, a prospective shareholder should also review the
more detailed discussion of Federal income tax considerations relevant to the
Fund that is contained in the Statement of Additional Information. In addition,
each prospective shareholder should consult with his own tax adviser as to the
tax consequences of investments in the Fund, including the application of state
and local taxes which may differ from the Federal income tax consequences
described above.
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.
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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 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 Firstar Trust Company. Firstar
Trust Company also 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 Firstar Trust Company by calling (800) 322-6864.
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.
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APPENDIX
For the fiscal year ended December 31, 1997, 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 5.96% 0%
AA or Aa 1.3% 0%
A 13.4% 0%
BBB or Baa 19.2% 0%
BB or Ba 0% 0%
B 0% 0%
Below B 0% 6.5%
- -----------
*6.5% of the Fund's assets was invested in unrated securities during the fiscal
year ended December 31, 1997. 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.
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(left column)
NEW YORK MUNI FUND(R)
90 Washington Street
New York NY 10006
1-800-225-6864
Transfer Agent
Firstar Trust Company
P.O. Box 701
Milwaukee, WI 53201-0701
1-800-322-6864
Counsel to the Fund
Kramer, Levin, Naftalis &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 Fund's official sales literature in
connection with the offer of the Fund's 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.
(right column)
NEW YORK MUNI FUND(R)
Prospectus
May 1, 1998
NEW YORK (logo) MUNI FUND
(logo) FUNDAMENTAL
Family of Funds
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STATEMENT OF ADDITIONAL INFORMATION
NEW YORK MUNI FUND
90 Washington Street
New York, New York 10006
(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 The Fund at the address listed above, or by calling (800)
322-6864. Shareholder inquiries may also be placed through this number.
THIS STATEMENT IS DATED MAY 1, 1998 AND
SUPPLEMENTS THE FUND'S PROSPECTUS OF THE SAME DATE.
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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.................................................. 41
DISTRIBUTION PLAN....................................................... 45
CALCULATION OF YIELD.................................................... 47
CUSTODIAN AND INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS.................. 50
TAX MATTERS............................................................. 58
PORTFOLIO TRANSACTIONS.................................................. 61
OTHER INFORMATION....................................................... 61
FINANCIAL STATEMENTS.................................................... 46
APPENDIX................................................................ A-1
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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.
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4. The Fund will not invest in commodity contracts, except that the
Fund may, to the extent appropriate under its 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.
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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 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 section 147(a)of the Internal Revenue Code of 1986, as amended (the
"Code")).
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.
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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 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
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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 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;
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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 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
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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 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
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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 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
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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 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 Fund will invest substantially all of its assets in New York
municipal securities. In addition, the specific New York municipal securities in
which the Fund will invest will change from time to time. The Fund is therefore
susceptible to political, economic, regulatory or other factors affecting
issuers of New York municipal securities. The following information constitutes
only a brief summary of a number of the complex factors which may
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affect issuers of New York municipal securities and does not purport to be a
complete or exhaustive description of all adverse conditions to which issuers of
New York municipal securities may be subject. Such information is derived from
official statements utilized in connection with the issuance of New York
municipal securities, as well as from other publicly available documents. Such
information has not been independently verified by the Fund, and the Fund
assumes no responsibility for the completeness or accuracy of such information.
Additionally, many factors, including national, economic, social and
environmental policies and conditions, which are not within the control of such
issuers, could have a material adverse impact on the financial condition of such
issuers. The Fund cannot predict whether or to what extent such factors or other
factors may affect the issuers of New York municipal securities, the market
value or marketability of such securities or the ability of the respective
issuers of such securities acquired by the Fund to pay interest on or principal
of such securities. The creditworthiness of obligations issued by local New York
issuers may be unrelated to the creditworthiness of obligations issued by the
State of New York, and there is no responsibility on the part of the State of
New York to make payments on such local obligations. There may be specific
factors that are applicable in connection with investment in the obligations of
particular issuers located within New York, and it is possible the Fund will
invest in obligations of particular issuers as to which such specific factors
are applicable. However, the information set forth below is intended only as a
general summary and not as a discussion of any specific factors that may affect
any particular issuer of New York municipal securities.
The Fund may invest in municipal securities issued by New York State
(the "State"), by its various public bodies (the "Agencies") and/or by other
entities located within the State, including the City of New York (the "City")
and political subdivisions thereof and/or their agencies.
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NEW YORK STATE. The State's current fiscal year commenced on April 1,
1996, and ends on March 31, 1997, and is referred to herein as the State's
1996-97 fiscal year. The State's budget for the 1996-97 fiscal year was enacted
by the Legislature on July 13, 1996, more than three 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 necessary appropriations for all State-supported
debt service. The State Financial Plan for the 1996-97 fiscal year was
formulated on July 25, 1996 and is based on the State's budget as enacted by the
Legislature and signed into law by the Governor, as well as actual results for
the first quarter of the current fiscal year. The 1996-97 State Financial Plan
will be updated in October and January.
1996-97 FISCAL YEAR STATE FINANCIAL PLAN. The 1996- 97 State Financial
Plan is projected to be balanced on a cash basis. As compared to the Governor's
proposed budget as revised on March 20, 1996, the State's adopted budget for
1996-97 increases General Fund spending by $842 million, primarily from
increases for education, special education and higher education ($563 million).
The balance represents funding increases to a variety of other programs,
including community projects and increased assistance to fiscally distressed
cities. Resources used to fund these additional expenditures include $540
million in increased revenues projected for 1996-97 based on higher-
than-projected tax collections during the first half of calendar 1996, $110
million in projected receipts from a new State tax amnesty program, and other
resources including certain non- recurring resources. The total amount of
non-recurring resources included in the 1996-97 State budget is projected by the
Division of Budget to be $1.3 billion, or 3.9 percent of total General Fund
receipts.
The economic and financial condition of the State may be affected by
various financial, social, economic and political factors. Those factors can be
very complex, may vary from fiscal year to fiscal year, and are frequently the
result of actions taken not only by the State and its agencies and
instrumentalities, but also by entities, such as the federal government, that
are not under the control of the State. In addition, the State Financial Plan is
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. The Division of Budget believes that
its projections of receipts and disbursements relating to the current State
Financial Plan, and the assumptions on which they are based, are reasonable.
Actual results, however, could differ materially and adversely from the
projections set forth in this Statement of Additional Information, and those
projections may be changed materially and adversely from time to time. There are
also risks
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and uncertainties concerning the future-year impact of actions taken in the
1996-97 budget.
The four government fund types that comprise the State Financial Plan
are the General Fund, the Special Revenue Funds, the Capital Projects Funds, and
the Debt Service Funds. This fund structure adheres to accounting standards of
the Governmental Accounting Standards Board. This section discusses first the
General Fund and then the other governmental funds. Receipts and disbursements
trends are presented in tabular form for each component of the General Fund.
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. In the State's 1996-97 fiscal year, the General Fund is expected to
account for approximately 47 percent of total Governmental Funds disbursements
and 71 percent of total State Funds disbursements. General Fund moneys are also
transferred to other funds, primarily to support certain capital projects and
debt service payments in other fund types. The following are the projected
shares of General Fund receipts and disbursements : Receipts: Personal Income
Tax - 51.55%, User Taxes and Fees - 29.51%, Business Taxes - 13.93%, Other Taxes
- - 2.86%, Miscellaneous - 7.16%; Disbursements: Local Assistance - 69.84%; State
Operations - 17.56%, Debt Service - 4.85%, General State Charges - 6.70%,
Capital/Other - 1.04%.
STATE FISCAL YEAR 1996-97. The General Fund is projected to be balanced
on a cash basis for the 1996-97 fiscal year. Total receipts and transfers from
other funds are projected to be $33.17 billion, an increase of $365 million from
the prior fiscal year. Total General Fund disbursements and transfers to other
funds are projected to be $33.12 billion, an increase of $444 million from the
total in the prior fiscal year.
PROJECTED GENERAL FUND RECEIPTS. The discussion below summarizes the
State's projections of General Fund tax revenues and other receipts for the
1996-97 fiscal year. Major statutory changes adopted with the 1996-97 budget
that affect 1996-97 include: tax reductions totaling $83 million, adoption of a
tax amnesty program expected to increase receipts by $110 million, and a variety
of measures increasing miscellaneous receipts by approximately $675 million.
THE PERSONAL INCOME TAX is imposed on the income of individuals,
estates and trusts and is based on federal definitions of income and deductions
with certain modifications. In 1995, the State enacted a tax-reduction program
designed to reduce receipts
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from the personal income tax by 20 percent over three years. Prior to 1995, the
tax had remained substantially unchanged since 1989 as a result of annual
deferrals of tax reductions originally enacted in 1987. The tax-reduction
program is estimated to reduce receipts by $2.3 billion in the 1996-97 fiscal
year, compared to what tax receipts would have been under the pre-1995 rate
structure. The maximum rate was reduced from the 7.875 percent in effect between
1989 and 1994 to 7.59375 percent for 1995, to 7.125 percent for 1996, and is
scheduled under current law to be reduced to 6.85 percent for 1997 and
thereafter. In addition to significant reductions in overall tax rates, the
program also includes increases in the standard deduction, widening tax brackets
to increase the income thresholds to which higher tax rates apply, and
modification of certain tax credits.
The projected yield of the tax for the 1996-97 fiscal year is $17.1
billion, an increase of $103 million from reported collections in the State's
1995-96 fiscal year. The increase reflects both the effects of the tax
reductions noted above and the fact that reported collections in the preceding
year were affected by net refund and tax refund reserve account transactions
that depressed collections in 1995-96 by $500 million. Without these statutory
and administrative changes, the yield of the tax would have grown by more than
$1 billion (nearly 7 percent), reflecting liability growth for the 1996 tax year
projected at approximately the same rate. The income base for the tax is
projected to rise approximately 5 percent for the 1996 tax year.
USER TAXES AND FEES are comprised of three-quarters of the State four
percent sales and use tax (the balance, one percent, flows to support Local
Government Assistance Corporation ("LGAC") debt service requirements),
cigarette, alcoholic beverage container, and auto rental taxes, and a portion of
the motor fuel excise levies. Also included in this category are receipts from
the motor vehicle registration fees and alcoholic beverage license fees.
Beginning in 1993-94, a portion of the motor fuel tax and motor vehicle
registration fees and all of the highway use tax are earmarked for dedicated
transportation funds.
Receipts in this category in the State's 1996-97 fiscal year are
expected to total $6.73 billion, an increase of $97 million from reported
1995-96 results. Underlying growth in the continuing sales tax base is forecast
to be 5 percent, accounting for the increase in the category as a whole.
Projected receipts in 1996-97 are adversely affected by the full-year effects of
reductions in the diesel motor fuel, container and beer taxes adopted in 1995 by
a temporary reduction of the sales tax on clothing enacted in 1996.
BUSINESS TAXES include franchise taxes based generally on net income of
general business, bank and insurance corporations, as
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well as gross-receipts-based taxes on utilities and gallonage-based petroleum
business taxes. Through 1993, these levies had been subject to a 15 percent
surcharge initially imposed in 1990. Beginning in 1994, the surcharge rate has
been phased out and, for most taxpayers, there will be no surcharge liability
for taxable periods ending in 1997 and thereafter.
Total business tax receipts in the State's 1996-97 fiscal year are
projected at $4.62 billion, a decline of $360 million from reported 1995-96
results. The decline results from the continuing effects of tax reductions
originally enacted in 1994 and 1995, valued at approximately $300 million more
in 1996-97 than in 1995- 96, and the previously scheduled diversion of petroleum
business and other tax receipts to dedicated transportation funds (valued at
approximately $130 million more in 1996-97 than in 1995-96). These factors
outweigh the modest growth projected in the bases of the continuing tax
structure. Tax reductions enacted in the preceding two years included, in
addition to a reduction in the surcharge rate, a lowering of the alternative
minimum tax rate and a variety of smaller changes to the tax on general business
corporations, as well as several changes to reduce the burden of the petroleum
business tax on selected industries.
OTHER TAXES include estate, gift and real estate transfer taxes, a tax
on gains from the sale or transfer of certain real estate where the total
consideration exceeds $1 million, a pari-mutuel tax and other minor levies.
Total receipts from this category in the State's 1996-97 fiscal year
are projected at $948 million, $151 million less than in the preceding year. The
estimates reflect pre-1996 legislation reducing the burden of the real property
gains tax and the estate tax as well as legislation enacted in 1996 repealing
the real property gains tax (valued at approximately $120 million more in
1996-97 than in 1995-96), and diversion of real estate transfer tax proceeds to
the Environmental Protection Fund (valued at approximately $44 million more in
1996-97 than in 1995-96).
MISCELLANEOUS RECEIPTS include investment income, abandoned property
receipts, medical provider assessments, receipts from public authorities, and
certain other license and fee revenues. Receipts in this category in the State's
1996-97 fiscal year are expected to total $2.1 billion, an increase of $683
million above the amount received in the prior State fiscal year. This includes
$481 million in surplus revenues from the Medical Malpractice Insurance
Association ("MMIA"), and other various non-recurring resources. MMIA is a
statutorily-created joint underwriting association of property/casualty
insurance companies authorized to write certain personal liability insurance in
the State which provides primary and excess medical malpractice insurance for
medical service providers in the State. It has been
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reported that certain health care providers are considering a challenge to the
State's right to these surplus revenues.
TRANSFER FROM OTHER FUNDS to the General Fund consist primarily of tax
revenues in excess of debt service requirements, particularly the one percent
sales tax used to support payments to LGAC. In the 1996-97 fiscal year, excess
sales tax revenues are projected to be $1.4 billion, $75 million more than in
the 1995-96 fiscal year. All other transfers are projected to decrease by $82
million, primarily reflecting the non-recurring transfer of $117 million from
the Mass Transportation Operating Assistance Fund to the Revenue Accumulation
Fund in 1995-96. As a result, total transfers are virtually unchanged
year-to-year.
PROJECTED GENERAL FUND DISBURSEMENTS. Grants to local governments is
the largest category of General Fund disbursements, and accounts for
approximately 70 percent of overall General Fund spending. Disbursements from
this category are projected to total $23.13 billion in the 1996-97 State
Financial Plan, an increase of $597 million (2.6 percent) from 1995-96 levels.
Of this amount, approximately $300 million is attributable to transactions which
were not accounted for in a comparable way in 1995-96, primarily $271 million in
spending related to the issuance of LGAC bonds. This category of the State
Financial Plan includes $11.27 billion in aid for elementary, secondary, and
higher education, accounting for 49 cents of every dollar spent in this
category. On a school year basis, formula-based elementary and secondary
education aid increases $217 million from 1995-96 levels. General Fund payments
for Medicaid are projected to be $5.29 billion, virtually unchanged from the
level of $5.34 billion in 1995-96 and down from $5.79 billion in 1994-95. This
slow growth is due primarily to continuation of cost containment measures
enacted in 1995-96, new reforms included in the 1996-97 adopted budget, and
forecasts for lower caseload based upon actual experience through May 1996.
Other social service spending is forecast to increase by only $7 million to
$3.17 billion in 1996-97, down from $3.34 billion in 1994-95.
Remaining disbursements primarily support community-based mental
hygiene programs, community and public health programs, local transportation
programs, and revenue sharing.
STATE OPERATIONS spending reflects the administrative costs of
operating the State's agencies, including the prison system, mental hygiene
institutions, the State University system ("SUNY"), the Legislature, and the
court system. Personal service costs account for approximately 76 percent of
this category in 1996-97. Since January 1995, the State's workforce has been
reduced by about 15,000 positions, with a decrease of 5,000 positions expected
in 1996-97. State employees will not receive a general salary increase this year
as part of the collective
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bargaining agreements recently negotiated for the 1995-96 through 1998-99 fiscal
years. Collective bargaining agreements have been ratified by employee
bargaining units representing most State employees subject to such agreements.
Negotiations are ongoing with the remaining units. For more information on the
State's workforce, see the section entitled "State Organization--State
Government Employment."
Disbursements for State operations are projected at $5.82 billion, a
decrease of $135 million or 2.3 percent. The lack of growth in this category
reflects the workforce reduction program for 1996-97 that will be accomplished
primarily through attrition, a continued hiring freeze and implementation of a
retirement incentive program. Most agencies will spend less in 1996-97 than in
1995-96; however, criminal justice spending will increase modestly to reflect
the impact of stricter sentencing laws.
GENERAL STATE CHARGES primarily reflect the costs of providing fringe
benefits for State employees, including contributions to pension systems, the
employer's share of social security contributions, employer contributions toward
the cost of health insurance, and the costs of providing worker's compensation
and unemployment insurance benefits. This category also reflects certain fixed
costs such as payments in lieu of taxes, and payments of judgments against the
State or its public officers. Disbursements in this category are projected to
total $2.22 billion in the 1996-97 State Financial Plan, an increase of $138
million from the 1995-96 levels. Fringe benefit costs in 1995-96 are depressed
by the one-time application of more than $100 million in reimbursements
traditionally budgeted in other categories of the Financial Plan. Pension costs
do not increase in 1996-97 assuming savings will be achieved as planned from the
refinancing of certain pension liabilities. Other fringe benefit costs
(including unemployment insurance) decline, due to workforce reductions
accomplished primarily through attrition and early retirements.
DEBT SERVICE paid from the General Fund for 1996-97 reflects only the
$10 million interest cost of the State's commercial paper program. No cost is
included for a TRAN borrowing, since none is expected to be undertaken. The
State's annual spring borrowing has been eliminated, as discussed in the section
entitled "Debt and Other Financing Activities--Local Government Assistance
Corporation." Debt service on long-term obligations is paid from Debt Service
Funds as described below.
TRANSFERS TO OTHER FUNDS from the General Fund are made primarily to
finance certain portions of State capital project spending and debt service on
long-term bonds, where these costs are not funded from other sources. Transfers
are projected to total $1.94 billion, a decrease of $161 million or 7.7 percent
from 1995- 96 levels. Transfers in support of capital projects decrease $210
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million due to the availability of non-recurring revenues which will be
deposited directly to the Capital Projects Funds in 1996-97 and the
reclassification of economic development programs from capital projects to
grants to local governments. Transfers in support of debt service increase $60
million reflecting prior year bond sales for prisons, housing programs, and
SUNY. All other transfers decrease $11 million from previous year levels.
CAPITAL PROJECTS paid directly from the General Fund represent
pay-as-you-go capital expenditures for certain youth and environmental projects.
This is a new Financial Plan category created as a part of the 1996-97 adopted
budget. Other pay-as-you-go capital expenditures are accounted for in the
Capital Projects Fund type.
The 1996-97 State Financial Plan includes actions that will have an
effect on the budget outlook for the State fiscal year 1996-97 and beyond. The
Division of the Budget estimates that the 1996-97 State Financial Plan contains
actions that provide non-recurring resources or savings totaling approximately
$1.3 billion. These include the use of $481 million in surplus funds available
from MMIA, $134 million in savings from a refinancing of certain pension
obligations, $88 million in projected savings from bond refundings, and $36
million in surplus fund transfers. The balance is composed of $314 million in
resources carried forward from the State's 1995-96 fiscal year and various other
actions, including that portion of the proposed tax amnesty program that is
projected to be non-recurring.
The State closed projected budget gaps of $5.0 billion and $3.9 billion
for its 1995-96 and 1996-97 fiscal years, respectively. The 1997-98 gap was
projected at $1.44 billion, based on the Governor's proposed budget of December
1995. As a result of changes made in the enacted budget, that gap is now
expected to be larger. However, the gap is not expected to be as large as those
faced in the prior two fiscal years. The Governor has indicated that he will
propose to close any potential imbalance primarily through General Fund
expenditure reductions and without increases in taxes or deferrals of scheduled
tax reductions.
The out-year projection will be impacted by a variety of factors.
Enacted tax reductions, which reduced receipts in the 1996-97 fiscal year by an
incremental $2.4 billion, are projected to reduce receipts in the 1997-98 fiscal
year by an additional increment of $2.1 billion. The use of up to $1.3 billion
of non-recurring resources in 1996-97, and the annualized costs of certain
program increases in the 1996-97 enacted budget, will both add additional
pressure in closing the 1997-98 gap.
Actions undertaken in the State's 1996-97 fiscal year, such as
workforce reductions, health care and education reforms,
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and strict controls on State agency spending, are expected to provide larger
recurring savings in 1997-98. Sustained growth in the State's economy and
continued declines in welfare caseload and Medicaid costs would produce
additional savings in the 1997-98 Financial Plan. Finally, future federal
reforms of welfare and/or Medicaid could potentially provide savings to the
State in the State fiscal year 1997-98. See "Special Considerations" below in
this section for a description of the risks and uncertainties associated with
the State Financial Plan process.
The 1996-97 opening fund balance of $287 million includes $237 million
which is reserved in the Tax Stabilization Reserve Fund ("TSRF"), $41 million
which is on deposit in the Contingency Reserve Fund ("CRF") (see the discussion
of this Fund under the heading "Prior Fiscal Years"), and $9 million in the
Revenue Accumulation Fund which has been drawn down for use in the 1996-97
fiscal year. The projected closing fund balance in the General Fund of $337
million reflects a balance of $252 million in the TSRF, following an additional
payment of $15 million during the year, and a balance of $85 million in the CRF.
In addition to the General Fund, the State Financial Plan includes
Special Revenue Funds, Capital Projects Funds and Debt Service Funds which are
discussed below. Amounts below do not include other sources and uses of funds
transferred to or from other fund types.
Special Revenue Funds are used to account for the proceeds of specific
revenue sources such as federal grants that are legally restricted, either by
the Legislature or outside parties, to expenditures for specified purposes.
Although activity in this fund type is expected to comprise approximately 43
percent of total government funds receipts in the 1996-97 fiscal year,
three-quarters of that activity relates to federally-funded programs.
Projected receipts in this fund type total $28.04 billion, an increase
of $2.43 billion (9.5 percent) over the prior year. Projected disbursements in
this fund type total $28.51 billion, an increase of $2.25 billion (8.6 percent)
over 1995-96 levels. Disbursements from federal funds, primarily the federal
share of Medicaid and other social services programs, are projected to total
$21.31 billion in the 1996-97 fiscal year. Remaining projected spending of $7.20
billion primarily reflects aid to SUNY supported by tuition and dormitory fees,
education aid funded from lottery receipts, operating aid payments to the
Metropolitan Transportation Authority funded from the proceeds of dedicated
transportation taxes, and costs of a variety of self-supporting programs which
deliver services financed by user fees.
Capital Projects Funds are used to account for the
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financial resources used for the acquisition, construction, or rehabilitation of
major State capital facilities and for capital assistance grants to certain
local governments or public authorities. This fund type consists of the Capital
Projects Fund, which is supported by tax receipts transferred from the General
Fund, and 37 other capital funds established to distinguish specific capital
construction purposes supported by other revenues. In the 1996-97 fiscal year,
activity in these funds is expected to comprise 6 percent of total governmental
receipts.
Total receipts in this fund type are projected at $3.58 billion.
Disbursements from this fund type are projected to be $3.85 billion, a decrease
of $120 million (3.1 percent) over prior-year levels, due in part to a
reclassification of economic development projects to the category of grants to
local governments in the General Fund. The Dedicated Highway and Bridge Trust
Fund is the single largest dedicated fund, comprising an estimated $920 million
(24 percent) of the activity in this fund type. Total spending for capital
projects will be financed through a combination of sources: federal grants (28
percent), public authority bond proceeds (34 percent), general obligation bond
proceeds (12 percent), and pay-as-you-go revenues (26 percent).
Debt Service Funds are used to account for the payment of principal of,
and interest on, long-term debt of the State and to meet communications under
lease-purchase and other contractual-obligation financing arrangements. (See the
section entitled "Debt and Other Financing Activities--Outstanding Debt of the
State and Certain Authorities" below.) This fund type is expected to comprise 4
percent of total government fund receipts and disbursements in the 1996-97
fiscal year. Receipts in these funds in excess of debt service requirements may
be transferred to the General Fund and Special Revenue Funds, pursuant to law.
The Debt Service fund type consists of the General Debt Service Fund,
which is supported primarily by tax receipts transferred from the General Fund,
and other funds established to accumulate moneys for the payment of debt
service. In the 1996-97 fiscal year, total disbursements in this fund type are
projected at $2.58 billion, an increase of $164 million or 6.8 percent. The
projected transfer from the General Fund of $1.59 billion is expected to finance
62 percent of these payments.
The remaining payments are expected to be financed by pledged revenues,
including $1.83 billion in taxes, $234 million in dedicated fees, and $2.35
billion in patient revenues, including transfers of federal and state
reimbursements and state dedicated taxes. After required impoundment for debt
service, $3.7 billion is expected to be transferred to the General Fund and
other funds in support of State operations. The largest transfer - $1.9 billion
- - is made to the Special Revenue Fund type in support of
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operations of the mental hygiene agencies. Another $1.4 billion in excess sales
taxes is expected to be transferred to the General Fund, following payment of
projected debt service on LGAC bonds.
SPECIAL CONSIDERATIONS. The economic and financial condition of the
State may be affected by various financial, social, economic and political
factors. These factors can be very complex, may vary from fiscal year to fiscal
year, and are frequently the result of actions taken not only by the State and
its agencies and instrumentalities, but also by entities, such as the federal
government, that are not under the control of the State. For example, various
proposals relating to federal tax and spending policies that are currently being
publicly discussed and debated could, if enacted, have a significant impact on
the State's financial condition in the current and future fiscal years. Because
of the uncertainty and unpredictability of the changes, their impact cannot, as
a practical matter, be included in the assumptions underlying the State's
projections at this time.
The State Financial Plan is based upon forecasts and national and State
economic activity developed through both internal analysis and review of State
and national economic forecasts prepared by commercial forecasting services and
other public and private forecasters. 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, the extent of
corporate and governmental restructuring, federal fiscal and monetary policies,
the level of interest rates, 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 results in the current fiscal year that are worse
than predicted, with corresponding material and adverse effects on the State's
projections of receipts and disbursements.
Projections of total State receipts in the State Financial Plan are
based on the State tax structure in effect during the fiscal year and on
assumptions relating to basic economic factors and their historical
relationships to State tax receipts. In preparing projections of State receipts,
economic forecasts relating to personal income, wages, consumption, profits and
employment have been particularly important. The projection of receipts from
most tax or revenue sources is generally made by estimating the change in yield
of such tax or revenue source caused by economic and other factors, rather than
by estimating the total yield of such tax or revenue source from its estimated
tax base. The forecasting methodology, however, ensures that State fiscal year
estimates for taxes that are based on computation of annual liability, such as
the business and personal income taxes, are consistent with estimates of total
liability under such taxes.
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Projections of total State disbursements are based on assumptions
relating to economic and demographic factors, levels of disbursements for
various services provided by local governments (where the cost is partially
reimbursed by the State), and the results of various administrative and
statutory mechanisms in controlling disbursements for State operations. Factors
that may affect the level of disbursements in the fiscal year include
uncertainties relating to the economy of the nation and the State, the policies
of the federal government, and changes in the demand for and use of State
services.
The Division of the Budget believes that its projections of receipts
and disbursements relating to the current State Financial Plan, and the
assumptions on which they are based, are reasonable. Actual results, however,
could differ materially and adversely form the projections set forth in this
Annual Information Statement. In the past, the State has taken management
actions and made use of internal sources to address potential State Financial
Plan shortfalls, and DOB believes it could take similar actions should variances
occur in its projections for the current fiscal year.
In recent years, State actions affecting the level of receipts and
disbursements, the relative strength of the State and regional economy, actions
of the federal government and other factors, have created structural budget gaps
for the State. These gaps resulted from a significant disparity between
recurring revenues and the costs of maintaining or increasing the level of
support for State programs. To address a potential imbalance in any given fiscal
year, the State would be required to take actions to increase receipts and/or
reduce disbursements as it enacts the budget for that year, and under the State
Constitution, the Governor is required to propose a balanced budget each year.
There can be no assurance, however, that the Legislature will enact the
Governor's proposals or that the State's actions will be sufficient to preserve
budgetary balance in a given fiscal year or to align recurring receipts and
disbursements in future fiscal year.
CASH-BASIS RESULTS FOR PRIOR FISCAL YEARS. The State reports its
financial results on two bases of accounting: the cash basis, showing receipts
and disbursements; and the modified accrual basis, prescribed by GAAP, showing
revenues and expenditures. These financial terms are described in the Glossary
of Financial Terms in Exhibit A to this Annual Information Statement.
GENERAL FUND 1993-94 THROUGH 1995-96. 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
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to other funds, primarily to support certain capital projects and debt service
payments in other fund types. A narrative description of cash-basis results in
the General Fund is presented below, followed by a tabular presentation of the
actual General Fund results for the prior three fiscal years. For a description
of the principal State taxes and fees, see Exhibit B to this Annual Information
Statement.
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"). A national recession, followed
by the lingering economic slowdown in the New York and regional economy,
resulted in repeated shortfalls in receipts and three budget deficits during
those years. During its last four fiscal years, however, the State has recorded
balanced budget on a cash basis, with positive fund balances as described below.
The State ended its 1995-96 fiscal year on March 31, 1996 with a
General Fund cash surplus. The Division of the Budget reported that revenues
exceeded projections by $270 million, while spending for social service programs
was lower than forecast by $120 million and all other spending was lower by $55
million. From the resulting benefit of $445 million, a $65 million voluntary
deposit was made into the TSRF, and $380 million was used to reduce 1996-97
Financial Plan liabilities by accelerating 1996-97 payments, deferring 1995-96
revenues, and making a deposit to the tax refund reserve account. (For more
information on the tax refund reserve account, see Table 5).
The General Fund closing fund balance was $287 million, an increase of
$129 million from 1994-95 levels. The $129 million change in fund balance is
attributable to the $65 million voluntary deposit to the TSRF, a $15 million
required deposit to the TSRF, a $40 million deposit to the CRF, and a $9 million
deposit to the Revenue Accumulation Fund. The closing fund balance includes $237
million on deposit in the TSRF, to be used in the event of any future General
Fund deficit as provided under the State Constitution and State Finance Law. In
addition, $41 million is on deposit in the CRF. The CRF was established in State
fiscal year 1993-94 to assist the State in financing the costs of extraordinary
litigation. The remaining $9 million reflects amounts on deposit in the Revenue
Accumulation Fund. This fund was created to hold certain tax receipts
temporarily before their deposit to other accounts. In addition, $678 million
was on deposit in the tax refund reserve account, of which $521 million was
necessary to complete the restructuring of the State's cash flow under the LGAC
program.
General Fund receipts totaled $32.81 billion, a decrease
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of 1.1 percent from 1994-95 levels. This decrease reflects the impact of tax
reductions enacted and effective in both 1994 and 1995. General Fund
disbursements totaled $32.68 billion for the 1995-96 fiscal year, a decrease of
2.2 percent from 1994-95 levels. Mid-year spending reductions, taken as part of
a management review undertaken in October at the direction of the Governor,
yielded savings from Medicaid utilization controls, office space consolidation,
overtime and contractual expense reductions, and statewide productivity
improvements achieved by State agencies. Together with decreased social services
spending, this management review accounts for the bulk of the decline in
spending.
The State ended its 1994-95 fiscal year with the General Fund in
balance. The $241 million decline in the fund balance reflects the planned use
of $264 million from the CRF, partially offset by the required deposit of $23
million to the TSRF. In addition, $278 million was on deposit in the tax refund
reserve account, $250 million of which was deposited to continue the process of
restructuring the State's cash flow as part of the LGAC program. The closing
fund balance of $158 million reflects $157 million in the TSRF and $1 million in
the CRF.
General Fund receipts totaled $33.16 billion, an increase of 2.9
percent from 1993-94 levels. General Fund disbursements totaled $33.40 billion
for the 1994-95 fiscal year, an increase of 4.7 percent from the previous fiscal
year. The increase in disbursements was primarily the result of one- time
litigation costs for the State, funded by the use of the CRF, offset by $188
million in spending reductions initiated in January 1995 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.
The State ended its 1993-94 fiscal year with a General Fund cash
surplus, primarily the result of an improving national economy, State employment
growth, tax collections that exceeded earlier projections and disbursements that
were below expectations. A deposit of $268 million was made to the CRF, with a
withdrawal during the year of $3 million, and a deposit of $67 million was made
to the TSRF. These three transactions result in the change balance of $332
million. In addition, a deposit of $1.14 billion was made to the tax refund
reserve account, of which $1.03 billion was available for budgetary purposes in
the 1994-95 fiscal year. (For more information on the personal income tax refund
reserve account, see Table 5.) The remaining $114 million was redeposited in the
tax refund reserve account at the end of the State's 1994- 95 fiscal year to
continue the process of restructuring the State's cash flow as part of the LGAC
program. The General Fund closing balance was $399 million, of which $265
million was on deposit in
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the CRF and $134 million in the TSRF. The CRF was initially funded with a
transfer of $100 million attributable to a positive margin recorded in the
1992-93 fiscal year.
General Fund receipts totaled $32.23 billion, an increase of 2.6
percent from 1992-93 levels. General Fund disbursements totaled $31.90 billion
for the 1993-94 fiscal year, 3.5 percent higher than the previous fiscal year.
Receipts were higher in part due to improved tax collections from renewed State
economic growth, although the State continued to lag behind the national
economic recovery. Disbursements were higher due in part to increased local
assistance costs for school aid and social services, accelerated payment of
certain Medicaid expenses, and the cost of an additional payroll for State
employees.
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 are used to support the capital programs of
the Department of Transportation and the Metropolitan Transportation Authority
("MTA").
In the Special Revenue Funds, disbursements increased from $22.72
billion to $26.26 billion over the last three years, primarily as a result of
increased costs for the federal share of Medicaid. Other activity reflected
dedication of taxes to a new fund for mass transportation, new lottery games,
and new fees for criminal justice programs.
Disbursements in the Capital Projects Funds grew from $3.10 billion to
$3.97 billion over the last three years, as spending for transportation and
mental hygiene programs increased, partially offset by declines for corrections
and environmental programs. The composition of this fund type's receipts also
changed as the dedicated transportation taxes began to be deposited, general
obligation bond proceeds declined substantially, federal grants remained stable,
and reimbursements from public authority bonds (primarily transportation
related) increased. The increase in the negative fund balance in 1994-95
resulted from delays in reimbursements caused by delays in the timing of public
authority bond sales.
Activity in the Debt Service Funds reflected increased use of bonds
during the three-year period for improvements to the State's capital facilities
and the continued implementation of the LGAC fiscal reform program. The
increases were moderated by the refunding savings achieved by the State over the
last several years
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using strict present value savings criteria. The growth in LGAC debt service was
offset by reduced short-term borrowing costs reflected in the General Fund.
GAAP-BASIS RESULTS FOR PRIOR FISCAL YEARS. The Comptroller prepares a
comprehensive annual financial report on the basis of generally accepted
accounting principles ("GAAP") for governments as promulgated by the
Governmental Accounting Standards Board. The report, generally released in July
each year, contains general purpose financial statements with a Combined Balance
Sheet and its Combined Statement of Revenues, Expenditures and Changes in Fund
Balances. These statements are audited by independent certified public
accountants.
The State completed its 1995-96 fiscal year with a combined
Governmental Funds operating surplus of $432 million, which included an
operating surplus in the General Fund of $380 million, in the Capital Projects
Funds of $276 million and in the Debt Service Funds of $185 million. There was
an operating deficit of $409 million in the Special Revenue Funds. The State's
Combined Balance Sheet as of March 31, 1996 showed an accumulated deficit in its
combined Governmental Funds of $1.23 billion, reflecting liabilities of $14.59
billion and assets of $13.35 billion. This accumulated Governmental Funds
deficit includes a $2.93 billion accumulated deficit in the General Fund and an
accumulated deficit of $712 million in the Capital Projects Fund type as
partially offset by accumulated surpluses of $468 million and $1.94 billion in
the Special Revenue and Debt Service fund types, respectively.
The State reported a General Fund operating surplus of $380 million for
the 1995-96 fiscal year, as compared to an operating deficit of $1.43 billion
for the prior fiscal year. The 1995-96 fiscal year surplus reflects several
major factors, including the cash-basis surplus and the benefit of $529 million
in LGAC bond proceeds which were used to fund various local assistance programs.
This was offset in part by a $437 million increase in tax refund liability
primarily resulting from the effects of ongoing tax reductions and (to a lesser
extent) changes in accrual measurement policies, and increases in various other
expenditure accruals.
Revenues increased $530 million (nearly 1.7 percent) over the prior
fiscal year with an increase in personal income taxes and miscellaneous revenues
offset by decreases in business and other taxes. Personal income taxes grew $715
million, an increase of 4.3 percent. The increase in personal income taxes was
caused by moderate employment and wage growth and the strong financial markets
during 1995. Business taxes declined $295 million or 5.8 percent, resulting
primarily from changes in the tax law that modified the distribution of taxes
between the General Fund and other fund types, and reduced business tax
liability.
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Miscellaneous revenues increased primarily because of an increase in receipts
from medical provider assessments.
Expenditures decreased $716 million (2.2 percent) from the prior fiscal
year with the largest decrease occurring in State aid for social services
program and State operations spending. Social services expenditures decreased
$739 million (7.5 percent) due mainly to implementation of cost containment
strategies by the State and local governments, and reduced caseloads. General
purpose and health and environment expenditures grew $139 million (20.2 percent)
and $121 million (33.3 percent), respectively. Health and environment spending
increased as a result of increases enacted with the 1995-96 Budget. In State
operations, personal service costs and fringe benefits declined $241 million
(3.8 percent) and $55 million (3.6 percent), respectively, due to staffing
reductions. The decline in non-personal service costs of $170 million (8.6
percent) was caused by a decline in the litigation accrual. Pension
contributions increased $103 million (66.4 percent) as a result of the return to
the aggregate cost method used to determine employer contributions.
Net other financing sources nearly tripled, increasing $561 million,
due primarily to an increase in bonds issued by LGAC, a transfer from the Mass
Transportation Operating Assistance Fund and transfers from public benefit
corporations.
An operating deficit of $409 million was reported for Special Revenue
Funds for the 1995-96 fiscal year which decreased the accumulated fund balance
to $468 million. Revenues increased $1.45 billion over the prior fiscal year
(5.8 percent) as a result of increases in federal grants and lottery revenues.
Expenditures increased $1.21 billion (5.4 percent) as a result of increased
costs for social services programs and an increase in the distribution of
lottery proceeds to school districts. Other financing uses increased $693
million (25.1 percent) primarily because of an increase in federal
reimbursements transferred to other funds.
Debt Service Funds ended the 1995-96 fiscal year with an operating
surplus of over $185 million and, as a result the accumulated fund balance,
increased to $1.94 billion. Revenues increased $10 million (0.5 percent) because
of increases in both dedicated taxes and mental hygiene patient fees. Debt
service expenditures increased $201 million (9.5 percent). Net other financing
sources increased threefold to $299 million, due primarily to increases in
patient reimbursement revenues.
An operating surplus of $276 million was reported in the Capital
Projects Funds for the State's 1995-96 fiscal year and, as a result, the
accumulated deficit fund balance in this fund type decreased to $712 million.
Revenues increased $260 million (14.9
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percent) primarily because a larger share of the petroleum business tax was
shifted from the General Fund to the Dedicated Highway and Bridge Trust Fund,
and by an increase in federal grant revenues for transportation and local waste
water treatment projects. Capital Projects Funds expenditures increased $194
million (5.7 percent) in State fiscal year 1995-96 because of increased
expenditures for education and health and environmental projects. Net other
financing sources increased by $577 million as a result of an increased in
proceeds from financing arrangements.
The State completed its 1994-95 fiscal year with a combined
Governmental Funds operating deficit of $1.79 billion, which included operating
deficits in the General Fund of $1.43 billion, in the Capital Projects Funds of
$366 million, and in the Debt Service Funds of $38 million. There was an
operating surplus in the Special Revenue Funds of $39 million.
The State reported a General Fund operating deficit of $1.43 billion
for the 1994-95 fiscal year, as compared to an operating surplus of $914 million
for the prior fiscal year. The 1994-95 fiscal year deficit was caused by several
factors, including the use of $1.03 billion of the 1993-94 cash-based surplus to
fund operating expenses in 1994-95, and the adoption of changes in accounting
methodologies by the State Comptroller. These factors were offset by net
proceeds of $315 million in bonds issued by LGAC.
Total revenues for 1994-95 were $31.46 billion. Revenues decreased by
$173 million over the prior fiscal year, a decrease of less than one percent.
Personal income taxes grew by $103 million, an increase of 0.6 percent.
Similarly, consumption and use taxes increased by $376 million or 6.0 percent.
The increase in personal income and sales taxes was due to modest growth in the
State's economy. Business taxes declined by $751 million or 12.8 percent from
the previous year. The decline in business taxes was caused primarily by a
decline in taxable earnings in the insurance, bank and petroleum industries and
the beginning of the phase-out of the corporate tax surcharges. Other revenues
and miscellaneous receipts showed modest increases.
Total 1994-95 expenditures were $33.08 billion, an increase of $2.08
billion, or 6.7 percent over the prior fiscal year. In Grants to Local
Governments, social service and education expenditures grew by $927 million
(10.3 percent) and $727 million (7.6 percent), collectively. Social services
spending increased in Medicaid and Income Maintenance, while education spending
grew as a result of increases enacted with the 1994-95 budget. General purpose
local assistance declined by $205 million (22.9 percent) as a result of prior
year spending reductions. Other local assistance spending showed modest
increases. In State Operations, personal service costs grew by $322 million (5.4
percent) while non-personal
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service declined by $70 million (3.4 percent). Pension contributions more than
doubled, increasing by $95 million, while other fringe benefit costs increased
by $151 million (10.9 percent). State Operations growth was primarily from labor
contracts that resulted in salary increases and retroactive payments.
Net other financing sources and uses declined from $282 million (as
restated) to $198 million, and $84 million (29.8 percent) decline from the
previous year, primarily because of a reduction in bonds issued by LGAC.
Special Revenue, Debt Services and Capital Projects Fund Types
An operating surplus of $39 million was reported for Special Revenue
Funds for the 1994-95 fiscal year which increased the accumulated fund balance
to $877 million. Revenues increased $1.62 billion over the prior fiscal year
(6.9 percent) as a result of increase in federal grants and lottery revenues.
Expenditures increased $1.89 billion (9.3 percent) as a result of increased
costs for social services programs and an increase in the distribution of
lottery proceeds to school districts. Other financing used declined $166 million
(5.7 percent) primarily because of a decline in federal reimbursements and
transferred to other funds.
Debt Service Funds ended the 1994-95 fiscal year with an operation
deficit of over $38 million and, as a result, the accumulated fund balance
declined to 41.75 billion. Revenues increased $145 million (7.1 percent) because
of increases in both dedicated taxes and mental hygiene patient fees. Debt
service expenditures increased $106 million (5.3 percent). Net other financing
uses increased $101 million, due primarily to a decrease in net operating
transfers of $158 million offset in part by a $57 million increase in proceeds
from other financing arrangements.
An operating deficit of $366 million was reported in the Capital
Projects Funds for the State's 1994-95 fiscal year and, as a result, the
accumulated deficit fund balance in this fund type increased to $988 million.
Revenues increased $256 million (17.3 percent) primarily because a larger share
of the petroleum business tax was shifted from the General Fund to the Dedicated
Highway and Bridge Trust fund, and by an increase in federal grant revenues for
transportation and local waste water treatment projects. Capital Projects Funds
expenditures increased $585 million (20.7 percent) in State fiscal year 1994-95
because of increased expenditures for transportation and correctional projects.
Net other financing sources (uses) declined by less than $2 million.
1994-95 FISCAL YEAR. The State reported a General Fund
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operating surplus of $914 million for the 1993-94 fiscal year, as compared to an
operating surplus of $2.07 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
LGAC and the accumulation of a $265 million balance in the CRF. Revenues
increased $543 million (1.7 percent) over prior fiscal year revenues with the
largest increase occurring in personal income taxes. Expenditures increased
$1.66 billion (5.6 percent) over the prior fiscal year, with the largest
increase occurring in State aid for social services programs. Other financing
sources declined more than 11 percent, with a net increase in operating
transfers from other funds more than offset by a decline in proceeds from
financing arrangements caused by lower LGAC bond sales.
GENERAL FUND. Personal income and business taxes increased by $847
million and $267 million, respectively, offset by reductions in consumption and
use taxes and miscellaneous revenues of $141 million and $318 million,
respectively. Personal income and business taxes increased primarily because the
economy performed at a higher level. General Fund revenues from consumption and
use taxes and fees declined primarily because revenues generated by both motor
fuel and highway and use taxes were earmarked instead for the Dedicated Highway
and Bridge Trust Fund which is reported in the Capital Projects Funds.
Miscellaneous revenues declined because certain receipts recorded in the prior
year were nonrecurring.
Expenditures for social services programs increased $1.05 billion
primarily due to increases in Medicaid and Income Maintenance. A $365 million
increase in departmental operations was caused primarily by the settlement of
outstanding labor contracts and unfavorable judicial decisions in previously
pending litigation.
Operating transfers from other funds increased, primarily reflecting
the receipt of $200 million from a prior-year claim settlement associated with
the federal government. In addition, transfers of excess sales tax receipts from
the Local Government Assistance Tax Fund increased by nearly $166 million as a
result of higher sales tax receipts in the Debt Service Funds. The increase in
operating transfers to other funds was caused by an increase in operating
subsidies provided to both the SUNY and the CUNY. Proceeds from financing
arrangements declined over $340 million, as a result of a decrease in the
issuance of LGAC bonds.
Special Revenue Funds ended with an operating surplus of $149 million
for the 1993-94 fiscal year and, as a result, the accumulated fund balance
increased to $837 million. Revenues
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increased $2.06 billion over the prior fiscal year primarily as a result of an
increase in federal grants to finance increased spending for social services
programs, and in petroleum gross receipt taxes. Expenditures increased by $1.57
billion primarily related to social services programs. Other financing use
increased by approximately $500 million, representing increases in federal
reimbursement for Medicaid patient services provided by various State health and
mental hygiene facilities.
Debt Service Funds ended with an operating surplus of $23 million for
the 1993-94 fiscal year, and as a result, the accumulated fund balance increased
to $1.79 billion. Revenues increased $34 million, primarily as a result of an
increase in dedicated taxes partially offset by a decrease in mental hygiene
patient fees. Debt service expenditures increased $31 million. Net other
financing sources decreased $361 million due to a net decline of $430 million in
proceeds from financing arrangements offset in part by a $70 million increase in
net operating transfers.
An operating deficit of $35 million was reported in the Capital
Projects Funds for the State's 1993-94 fiscal year, and, as a result, the
accumulated deficit fund balance increased to $622 million. Revenues increased
by $458 million which was primarily attributable to the shifting of certain tax
revenues from the General Fund to the Dedicated Highway and Bridge Trust Fund.
Capital Projects Funds expenditures increased by $61 million. Expenditures for
highway and bridge construction increased by approximately $223 million, but
this increase was offset in large part by a decrease of $160 million relating to
reductions in spending for water pollution control, hazardous waste programs and
various miscellaneous State aid programs. Net other financing sources (uses)
decreased $489 million primarily as a result of a reduction in general
obligation bond proceeds and a decrease in transfers from the General Fund.
ECONOMICS AND DEMOGRAPHICS. This section presents economic information
about the State which may be relevant in evaluating the future prospects of the
State. However, the demographic information and statistical data, which have
been obtained from the sources indicated, do not present all factors which may
have a bearing on the State's fiscal and economic affairs. Further, such
information requires economic and demographic analysis in order to assess the
import of the data presented. The data analysis may be interpreted differently,
according to the economist or other expert consulted.
The State Financial Plan is based upon a June 1996 projection by DOB of
national and State economic activity. The information in this section and in
tables 15 and 16 below summarize the economic outlook upon which projections of
receipts and certain
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disbursements were made for the 1996-97 fiscal year.
The national economy has resumed a more robust rate of growth after a
"soft landing" in 1995, with over 11 million jobs added nationally since early
1992. The State economy has continued to expand, but growth remains somewhat
slower than in the nation. Although the State has added approximately 240,000
jobs since late 1992, employment growth in the State has been hindered during
recent years by significant cutbacks in the computer and instrument
manufacturing, utility, defense, and banking industries. Government downsizing
has also moderated these job gains.
DOB forecasts that national economic growth will be quite strong in the
fist half of calendar 1996, but will moderate considerably as the year
progresses. The overall growth rate of the national economy during calendar year
1996 is expected to be just slightly below the "consensus" of a widely followed
survey of national economic forecasters. Growth in real Gross Domestic Product
during 1996 is projected to be moderate at 2.1 percent, with anticipated
declines in federal spending and net exports more than offset by increases in
consumption and investment. Inflation, as measured by the Consumer Price Index,
is projected to be contained at about 3 percent due to moderate wage growth and
foreign competition. Personal income and wages are projected to increase by
about 5 percent.
The forecast of the State's economy shows modest expansion during the
first half of calendar 1996, but some slowdown is projected during the second
half of the year. Although industries that export goods and services are
expected to continue to do well, growth is expected to be slowed by government
cutbacks at all levels and by tight fiscal constraints on health and social
services. On an average annual basis, employment growth in the State is expected
to be up slightly from the 1995 rate. Personal income is expected to record
moderate gains in 1996. Bonus payments in the securities industry are expected
to increase further from last year's record level.
The forecast for continued slow growth, and any resultant impact on the
State's 1996-97 Financial Plan, contains some uncertainties.
Stronger-than-expected gains in employment could lead to a significant
improvement in consumption spending. Investments could also remain robust.
Conversely, the prospect of a continuing deadlock on federal budget deficit
reduction or fears of excessively rapid economic growth could create upward
pressures on interest rates. In addition, the State economic forecast could
over- or underestimate the level of future bonus payments or inflation growth,
resulting in forecasted average wage growth that could differ significantly from
actual growth. Similarly, the State forecast could fail to correctly account for
expected declines in government and banking employment and the direction of
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employment change that is likely to accompany telecommunications deregulation.
THE NEW YORK ECONOMY. New York is the third most populous state in the
nation and has a relatively high level of personal wealth. The State's economy
is diverse, with a comparatively large share of the nation's finance, insurance,
transportation, communications and services employment, and a very small share
of the nation's farming and mining activity. The State's location and its
excellent air transport facilities and natural harbors have made it an important
link in international commerce. Travel and tourism constitute an important part
of the economy. Like the rest of the nation, New York has a declining proportion
of its workforce engaged in manufacturing, and an increasing proportion engaged
in service industries.
Services: The services sector which includes entertainment, personal
services, such as health care and auto repairs, and business-related services,
such as information processing, law and accounting, is the State's leading
economic sector. The services sector accounts for more than three of every ten
nonagricultural jobs in New York. New York's economy is somewhat more reliant
than the rest of the nation on this sector; this sector has added more jobs
(825,000) than has the State's economy as a whole (665,000) since 1980.
Manufacturing: Manufacturing employment continues to decline in
importance in New York, as in most other states, and New York's economy is less
reliant on this sector than is the nation. Manufacturing's share of total
employment declined from 20.1 to 12.0 percent between 1980 and 1995. The
principal manufacturing industries in recent years produced printing and
publishing materials, instruments and related products, machinery, apparel and
finished fabric products, electronic and other electric equipment, food and
related products, chemicals and allied products, and fabricated metal products.
Trade: Wholesale and retail trade is the second largest sector in terms
of nonagricultural jobs in New York but is considerably smaller when measured by
income share. Trade consists of wholesale businesses and retail businesses, such
as department stores and eating and drinking establishments.
Finance, Insurance and Real Estate: New York City is the nation's
leading center of banking and finance and, as a result, this is a far more
important sector in the State than in the nation as a whole. Although this
sector accounts for under one-tenth of all nonagricultural jobs in the State, it
contributes one-seventh of all nonfarm labor and proprietors' income.
Agriculture: Farming is an important part of the economy
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of large regions of the State, although it constitutes a very minor part of
total State output. Principal agricultural products of the State include milk
and dairy products, greenhouse and nursery products, apples and other fruits,
and fresh vegetables. New York ranks among the nation's leaders in the
production of these commodities.
Government: Federal, State and local government account for almost 18
percent of nonagricultural State employment and 16 percent of nonfarm labor
income.
The importance of the different sectors of the State's economy relative
to the national economy is shown in the following table, which compares
nonagricultural employment and income by industrial categories for the State and
the nation as a whole. Relative to the nation, the State has a smaller share of
manufacturing and construction and a larger share of service-related industries.
The State is likely to be less affected than the nation as a whole during an
economic recession that is concentrated in manufacturing and construction, but
likely to be more affected during a recession that is concentrated more in the
service-producing sector.
ECONOMIC AND DEMOGRAPHIC TRENDS. 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 1987 through 1995, the State's rate of economic
growth was somewhat slower than that of the nation. In particular, during the
1990-91 recession and post-recession period, 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 1987. 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 US 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.
The State's population has grown since 1930, except for a period of
decline during the 1970s and a virtual standstill the past two years.
State per capita personal income has historically been significantly
higher than the national average, although the ratio has varied substantially.
Because the City is a regional employment center for a multi-state region, state
personal income measured on a residence basis understates the relative
importance of the State to the national economy and the size of the base to
which State taxation applies.
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DEBT AND OTHER FINANCING ACTIVITIES
LEGAL CATEGORIES OF STATE DEBT AND OTHER FINANCINGS. State financing
activities include general obligation debt of the State and State-guaranteed
debt, to which the full faith and credit of the State has been pledged, as well
as lease-purchase and contractual-obligation financings, moral obligation
financings and other financings, through public authorities and municipalities,
where the State's legal obligation to make payments to those public authorities
and municipalities for their debt service is subject to annual appropriation by
the Legislature. These categories are described in the Glossary of Financial
Terms in Exhibit A to this Annual Information Statement and in more detail
below.
General Obligations and State-Guaranteed Financing. There are a number
of methods by which the State itself may incur debt. The State may issue general
obligation bonds. Under the State Constitution, the State may not, with limited
exceptions for emergencies, undertake long-term general obligation borrowing
(i.e., borrowing for more than one year) unless the borrowing is authorized in a
specific amount for a single work or purpose by the Legislature and approved by
the voters. There is no limitation on the amount of long-term general obligation
debt that may be so authorized and subsequently incurred by the State. With the
exception of general obligation housing bonds (which must be paid in equal
annual installments or installments that result in substantially level or
declining debt service payments, within 50 years after issuance, commencing no
more than three years after issuance), general obligation bonds must be paid in
equal annual installments or installments that result in substantially level or
declining debt service payments, within 40 years after issuance, beginning not
more than one year after issuance of such bonds.
The State may undertake short-term borrowings without voter approval
(i) in anticipation of the receipt of taxes and revenues, by issuing tax and
revenue anticipation notes ("TRANs"), and (ii) in anticipation of the receipt of
proceeds from the sale of duly authorized but unissued general obligation bonds,
by issuing bond anticipation notes ("BANs"). TRANs must mature within one year
from their dates of issuance and may not be refunded or refinanced beyond such
period. BANs may only be issued for the purposes and within the amounts for
which bonds may be issued pursuant to voter authorizations. Such BANs must be
paid from the proceeds of the sale of bonds in anticipation of which they were
issued or from other sources within two years of the date of issuance or, in the
case of BANs for housing purposes, within five years of the date of issuance.
Pursuant to specific constitutional authorization, the State may also
directly guarantee certain public authority obligations. The State Constitution
provides for the State
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guarantee of the repayment of certain borrowings for designated projects of the
New York State Thruway Authority, the Job Development Authority and the Port
Authority of New York and New Jersey. The State has never been called upon to
make any direct payments pursuant to such guarantees. The constitutional
provisions allowing a State guarantee of certain Port Authority of New York and
New Jersey debt stipulates that no such guaranteed debt may be outstanding after
December 31, 1996. State-guaranteed bonds issued by the Thruway Authority were
fully retired on July 1, 1995.
Payments of debt service on State general obligation and
State-guaranteed bonds and notes are legally enforceable obligations of the
State.
Lease-Purchases and Contractual-Obligation Financing. The State employs
additional long-term financing mechanisms, lease-purchase and contractual
obligation financings, which involve obligations of public authorities or
municipalities that are State-supported but not general obligations of the
State. Under these financing arrangements, certain public authorities and
municipalities have issued obligations to finance the construction and
rehabilitation of facilities or the acquisition and rehabilitation of equipment,
and expect to meet their debt service requirements through the receipt of rental
or other contractual payments made by the State. Although these financing
arrangements involve a contractual agreement by the State to make payments to a
public authority, municipality or other entity, the State's obligation to make
such payments is generally expressly made subject to appropriation by the
Legislature and the actual availability of money to the State for making the
payments. The State has also entered into a contractual-obligation financing
arrangement with LGAC to restructure the way the State makes certain local aid
payments (see "Local Government Assistance Corporation" below in this section).
The State also participates in the issuance of certificates of
participation ("COPs") in a pool of leases entered into by the State's Office of
General Services on behalf of several State departments and agencies interested
in acquiring operational equipment, or in certain cases, real property.
Legislation enacted in 1986 established restrictions upon and centralized State
control, through the Comptroller and the Director of the Budget, over the
issuance of COPs representing the State's contractual obligation, subject to
annual appropriation by the Legislature and availability of money, to make
installment or lease-purchase payments for the State's acquisition of such
equipment or real property.
The State has never defaulted on any of its general obligation
indebtedness or its obligations under lease-purchase or
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contractual-obligation financing arrangements and has never been called upon to
make any direct payments pursuant to its guarantees.
Moral Obligation and Other Financing. Moral obligation financing
generally involves the issuance of debt by a public authority to finance a
revenue-producing project or other activity. The debt is secured by project
revenues and includes statutory provisions requiring the State, subject to
appropriation by the Legislature, to make up any deficiencies which may occur in
the issuer's debt service reserve fund. There has never been a default on any
moral obligation debt of any public authority. The State does not intend to
increase statutory authorizations for moral obligation bond programs. From 1976
through 1987, the State was called upon to appropriate and make payments
totaling $162.8 million to make up deficiencies in the debt service reserve
funds of the Housing Finance Agency pursuant to moral obligation provisions. In
the same period, the State also expended additional funds to assist the Project
Finance Agency, the Urban Development Corporation ("UDC") and other public
authorities which had moral obligation debt outstanding. The State has not been
called upon to make any payments pursuant to any moral obligations since the
1986- 87 fiscal year and no such requirements are anticipated during the 1996-97
fiscal year.
In addition to the moral obligation financing arrangements described
above, State law provides for the creation of State municipal assistance
corporations, which are public authorities established to aid financially
troubled localities. The Municipal Assistance Corporation for the City of New
York ("NYC MAC") was created in 1975 to provide financing assistance to New York
City. To enable NYC MAC to pay debt service on its obligations, NYC MAC
receives, subject to annual appropriation by the Legislature, receipts from the
4 percent New York State sales tax for the benefit of New York City, the
State-imposed stock transfer tax and, subject to certain prior liens, certain
local assistance payments otherwise payable to New York City. The legislation
creating NYC MAC also includes a moral obligation provision. Under its enabling
legislation, NYC MAC's authority to issue moral obligation bonds and notes
(other than refunding bonds and notes) expired on December 31, 1984. In 1995,
the State created the Municipal Assistance Corporation for the City of Troy
("Troy MAC"). The bonds expected to be issued by Troy MAC would not be subject
to the State's moral obligation.
The State also provides for contingent contractual-obligation financing
for the Secured Hospital Program pursuant to legislation enacted in 1985. Under
this financing method, the State contracts to pay debt service, subject to
annual appropriations, on bonds formerly issued by the New York State Medical
Care Facilities Finance Agency ("MCFFA") and now issued by the Dormitory
Authority of the State of New York ("DASNY") in the
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event there are shortfalls of revenues from other sources. The State has never
been required to make any payments pursuant to this financing arrangement, nor
does it anticipate being required to do so during the 1996-97 fiscal year.
LOCAL GOVERNMENT ASSISTANCE CORPORATION. In 1990, as part of a State
fiscal reform program, legislation was enacted creating LGAC, a public benefit
corporation empowered to issue long-term obligations to fund certain payments to
local governments that had been traditionally funded through the State's annual
seasonal borrowing. The legislation authorized LGAC to issue its bonds and notes
in an amount to yield net proceeds not in excess of $4.7 billion (exclusive of
certain refunding bonds). Over a period of years, the issuance of these
long-term obligations, which are to be amortized over no more than 30 years, was
expected to eliminate the need for continued short-term seasonal borrowing. The
legislation also dedicated revenues equal to one-quarter of the four cent State
sales and use tax to pay debt service on these bonds. The legislation also
imposed a cap on the annual seasonal borrowing of the State at $4.7 billion,
less net proceeds of bonds issued by LGAC and bonds issued to provide for
capitalized interest, except in cases where the Governor and the legislative
leaders have certified the need for additional borrowing and provided a schedule
for reducing it to the cap. If borrowing above the cap is thus permitted in any
fiscal year, it is required by law to be reduced to the cap by the fourth fiscal
year after the limit was first exceeded. This provision capping the seasonal
borrowing was included as a covenant with LGAC's bondholders in the resolution
authorizing such bonds.
As of June 1995, LGAC had issued bonds and notes to provide net
proceeds of $4.7 billion, completing the program. The impact of LGAC's borrowing
is that the State has been able to meet its cash flow needs throughout the
fiscal year without relying on short-term seasonal borrowings. The 1996-97 State
Financial Plan includes no seasonal borrowing; this reflects the success of the
LGAC program in permitting the State to accelerate local aid payments from the
first quarter of the current fiscal year to the fourth quarter of the previous
fiscal year.
1996-97 BORROWING PLAN. The State anticipates that its capital programs
will be financed, in part, through borrowings by the State and public
authorities in the 1996-97 fiscal year. The State expects to issue $411 million
in general obligation bonds (including $153.6 million for purposes of redeeming
outstanding BANs) and $154 million in general obligation commercial paper. The
Legislature has also authorized the issuance of up to $101 million in COPs
during the State's 1996-97 fiscal year for equipment purchases. The projection
of the State regarding its borrowings for the 1996-97 fiscal year may change if
circumstances require.
- 39 -
<PAGE>
Borrowings by other public authorities pursuant to lease-purchase and
contractual-obligation financings for capital programs of the State are
projected to total $2.15 billion, including costs of issuances, reserve funds,
and other costs, net of anticipated refundings and other adjustments for 1996-97
capital projects. Included therein are borrowings by (i) DASNY for SUNY, The
City University of New York ("CUNY"), health facilities, and mental health
facilities; (ii) Thruway Authority for the Dedicated Highway and Bridge Trust
Fund and Consolidated Highway Improvement Program; (iii) UDC (doing business as
the Empire State Development Corporation) for prison and youth facilities; (iv)
the Housing Finance Agency ("HFA") for housing programs; and (v) borrowings by
the Environmental Facilities Corporation ("EFC") and other authorities. In
addition, the Legislature has authorized DASNY to refinance a $787 million
pension obligation of the State.
In the 1996 legislative session, the Legislature approved the
Governor's proposal to present to the voters in November 1996 a $1.75 billion
State general obligation bond referendum to finance various environmental
improvement and remediation projects. If the Clean Water, Clean Air Bond Act is
approved by the voters, the amount of general obligation bonds issued during the
1996-97 fiscal year may increase above the $411 million currently included in
the 1996-97 Borrowing Plan to finance a portion of this new program.
OUTSTANDING DEBT OF THE STATE AND CERTAIN AUTHORITIES. For purposes of
analyzing the financial condition of the State, debt of the State and of certain
public authorities may be classified as State-supported debt, which includes
general obligation debt of the State and lease-purchase and contractual
obligations of public authorities (and municipalities) where debt service is
paid from State appropriations (including dedicated-tax sources, and other
revenues such as patient charges and dormitory facilities rentals). In addition,
a broader classification, referred to as State-related debt, includes
State-supported debt, as well as certain types of contingent obligations,
including moral-obligation financing, certain contingent contractual-obligation
financing arrangements, and State-guaranteed debt described above, where debt
service is expected to be paid from other sources and State appropriations are
contingent in that they may be made and used only under certain circumstances.
STATE-SUPPORTED DEBT OUTSTANDING. General Obligation Bond Programs. The
first type of State-supported debt, general obligation debt, is currently
authorized for three programmatic categories: transportation, environmental and
housing. The State has issued bonds only if the first two categories in recent
years, with the size of the issues generally decreasing as existing
authorizations are diminished. The amount of general obligation bonds and BANs
issued in the 1993-94 through 1995-96 fiscal years (excluding bonds issued to
redeem BANs) were $388 million, $250
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<PAGE>
million and $333 million, respectively. Transportation-related bonds are issued
for State highway and bridge improvements, aviation, highway and mass
transportation projects and purposes, and rapid transit, rail, canal, port and
waterway programs and projects. Environmental bonds are issued to fund
environmentally-sensitive land acquisitions, air and water quality improvements,
municipal non-hazardous waste landfill closures and hazardous waste site cleanup
projects. As of March 31, 1996, the total amount of outstanding general
obligation debt was $5.05 billion, including $293.6 million in BANs.
The foregoing information as to certain New York risk factors is given
to investors in view of the Fund's policy of concentrating its investments in
New York Issuers. Such information constitutes only a brief summary and does not
purport to be a complete description. See Appendix A to this Statement of
Additional Information for a description of municipal securities ratings.
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 (*).
James C. Armstrong: Director of the Fund. Mr. Armstrong is a management
consultant. He was formerly a partner in Armstrong/Seltzer Communications Inc.,
a New York management, consulting and public relations firm. Earlier he served
as Executive Director, Global Public Affairs Institute at New York University
and Professor, Bell of Pennsylvania Chair in Telecommunications, Temple
University. 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 70 North Ravenwood Drive,
Cape May Court House, New Jersey 08210.
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
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<PAGE>
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 a
Director of Fundamental Service Corporation, and President, LaSalle Economics
Inc., an economic consulting firm. 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.
All of the Directors of the Fund are also Trustees of The California
Muni Fund and Fundamental Fixed-Income Fund. Dr. Vincent J. Malanga, an officer
of the Fund , holds 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. Some Directors received
additional compensation at a rate of $125 per hour for services related to
servicing on the Portfolio Review Committee. For the fiscal year ended December
31, 1997, Directors' fees totalling $______ were paid by the Fund to the
Directors and to former 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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<PAGE>
COMPENSATION TABLE
(FOR EACH CURRENT BOARD MEMBER
RECEIVING COMPENSATION FROM
A FUNDAMENTAL FUND FOR THE
MOST RECENTLY COMPLETED FISCAL YEAR)
AGGREGATE COMPENSATION FROM FUND
<TABLE>
<CAPTION>
AGGREGATE
COMPENSATION
PAID BY ALL
FUNDS MANAGED
BY
HIGH-YIELD TAX-FREE U.S. GOV'T FUNDAMENTAL
CALIFORNIA MUNICIPAL MONEY STRATEGIC PORTFOLIO
NAME NY MUNI MUNI BOND MARKET INCOME ADVISORS, INC.
<S> <C> <C> <C> <C> <C> <C>
JAMES C. ARMSTRONG $29,684 $3,044 $496 $2,919 $2,207 $38,350
L. GREG FERRONE $20,124 $2,064 $336 $1,979 $1,497 $26,000
</TABLE>
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. All of the Independent
Directors currently serve on the Portfolio Review Committee.
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.
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
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<PAGE>
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. The Board of Directors last approved the continuation of the Management
Agreement on March 25, 1998 for a period of sixty days following March 31, 1998.
Vincent J. Malanga, Chairman of the Board, Chief Executive Officer, President
and Treasurer of the Fund, and Dr. Lance M. Brofman, 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.
ADMINISTRATOR, TRANSFER AGENT,
CUSTODIAN AND ACCOUNTING AGENT
Firstar Trust Company, P.O. Box 701, Milwaukee, WI 53201- 0701
currently acts as Administrator, Transfer Agent, Custodian and Accounting Agent
of the Fund.
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, previously performed all
services in connection with the transfer of shares of the Fund, acted as its
dividend disbursing agent, and as administrator of the exchange, check
redemption, telephone redemption and expedited redemption privileges of the Fund
. During the fiscal year ended December 31, 1997, fees paid to Fundamental
Shareholder Services, Inc. by the Fund amounted to $260,717.
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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
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<PAGE>
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 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 for a period of sixty days
following March 31, 1998. 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, 1997, the Fund paid $647,839 for
expenses incurred pursuant to the Plan, which amount was spent in the
distribution of the Fund's shares, including expenses for: advertising --
$174,850; printing and mailing of Prospectuses to other than current
shareholders -- $9,687; and sales, and shareholder servicing support services
and other distribution services, -- $463,839. Of the amount paid by the Fund
during last year, $307,200 was paid to Fundamental Service Corporation for
expenses incurred and services rendered by it pursuant to the Plan.
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<PAGE>
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 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 period (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.
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<PAGE>
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 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, 1997
determined in accordance with the above formula was ------%.
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<PAGE>
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:
P(1 + T)^n = ERV
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, 1997 was - ____%. For the five-year period ended December 31, 1997,
the average annual total return was ____% and for the ten year period ended
December 31, 1997, the average annual total return was ____%.
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,
1997 was ____% for a taxpayer whose income was subject to the then highest
combined Federal, New York State and New York City income tax rate of _____%.
The Fund's yield and average annual total return will vary from time to
time depending on market conditions, the
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<PAGE>
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.
CUSTODIAN AND INDEPENDENT CERTIFIED
PUBLIC ACCOUNTANTS
Firstar Trust Company (the "Bank"), 615 East Michigan Street,
Milwaukee, WI, acts as Custodian of the Fund's cash and securities. The Bank
also acts as transfer agent and bookkeeping agent for the Fund, and, as
bookkeeping agent, 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 federal income
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 for
federal income tax purposes under Subchapter M of 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
- 50 -
<PAGE>
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 will therefore count toward satisfaction of the Distribution
Requirement.
If the Fund has a net capital loss (i.e., the excess of capital losses
over capital gains) for any year, the amount thereof may be carried forward up
to eight years and treated as a short-term capital loss which can be used to
offset capital gains in such years. As of December 31, 1997, the Fund has
capital loss carryforwards of $24,147,000 expiring through December 31, 2005.
Under Code Section 382, if the Fund has an "ownership change," the Fund's use of
its capital loss carryforwards in any year following the ownership change will
be limited to an amount equal to the net asset value of the Fund immediately
prior to the ownership change multiplied by the highest adjusted long-term
tax-exempt rate (which is published monthly by the Internal Revenue Service (the
"IRS")) in effect for any month in the 3-calendar- month period ending with the
calendar month in which the ownership change occurs (the rate for April 1998 is
5.04%). The Fund will use its best efforts to avoid having an ownership change.
However, because of circumstances which may be beyond the control of the Fund,
there can be no assurance that the Fund will not have, or has not already had,
an ownership change. If the Fund has or has had an ownership change, any capital
gain net income for any year following the ownership change in excess of the
annual limitation on the capital loss carryforwards will have to be distributed
by the Fund and will be taxable to shareholders as described under "Fund
Distributions" below.
In addition to satisfying the Distribution Requirement, a regulated
investment company must 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 from options, futures or forward contracts)
derived with respect to its business of investing in such stock, securities or
currencies (the "Income Requirement").
In general, gain or loss recognized by the Fund on the disposition of
an asset will be a capital gain or loss. In addition, gain will be recognized as
a result of certain constructive sales, including short sales "against the box."
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<PAGE>
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. 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. 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.
Further, the Code also treats as ordinary income a portion of the
capital gain attributable to a transaction where substantially all of the return
realized is attributable to the time value of a Fund's net investment in the
transaction and: (1) the transaction consists of the acquisition of property by
the Fund and a contemporaneous contract to sell substantially identical property
in the future; (2) the transaction is a straddle within the meaning of section
1092 of the Code; (3) the transaction is one that was marketed or sold to the
Fund on the basis that it would have the economic characteristics of a loan but
the interest-like return would be taxed as capital gain; or (4) the transaction
is described as a conversion transaction in the Treasury Regulations. The amount
of the gain recharacterized generally will not exceed the amount of the interest
that would have accrued on the net investment for the relevant period at a yield
equal to 120% of the federal long-term, mid-term, or short-term rate, depending
upon the type of instrument at issue, reduced by an amount equal to: (1) prior
inclusions of ordinary income items from the conversion transaction and (2) the
capital interest on acquisition indebtedness under Code section 263(g). Built-in
losses will be preserved where the Fund has a built-in loss with respect to
property that becomes a part of a conversion transaction. No authority exists
that indicates that the converted character of the income will not be passed
through to the Fund's shareholders.
- 52 -
<PAGE>
Certain 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
that year together with any other gain or loss that was previously recognized
upon the termination of Section 1256 contracts during the 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.
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 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
investment companies, and securities of other issuers (as to each of which the
Fund has not invested more than 5% of the value of the its total assets in
securities of such issuer and 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.
- 53 -
<PAGE>
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 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
- 54 -
<PAGE>
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 a 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 federal
income tax returns 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.
Exempt-interest dividends derived from certain "private activity" municipal
obligations issued after August 7, 1986 generally will constitute an item of tax
preference includable in AMTI for both corporate and noncorporate taxpayers. In
addition, exempt-interest 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.
- 55 -
<PAGE>
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 realized 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 realized but
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
provided such dividends are actually paid in January of the following year.
Shareholders will be advised annually as to the U.S. federal income tax
consequences of distributions made (or deemed made) 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 failed to
provide a correct taxpayer identification number , (2) is subject to backup
withholding for
- 56 -
<PAGE>
failure properly to report the receipt of interest or dividend income , or (3)
has failed to certify to the Fund that it is not subject to backup withholding
or that it is an "exempt recipient" (such as a corporation).
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. Long-term capital gain recognized by an individual
shareholder will be taxed at the lowest rates applicable to capital gains if the
holder has held such shares for more than 18 months at the time of the sale.
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. Capital losses in any year
are deductible only to the extent of capital gains plus, in the case of a
noncorporate taxpayer, $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 carried on by a foreign shareholder, ordinary income dividends
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 on the sale or redemption of shares of the Fund, capital gain
dividends and exempt-interest dividends
- 57 -
<PAGE>
and amounts retained by the Fund that are designated as undistributed capital
gains.
If the income from the Fund is effectively connected with a U.S. trade
or business carried on by 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. taxpayers.
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 subject to withholding 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 of Additional Information. 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 may differ from the rules for U.S. federal income taxation described
above. Shareholders are urged to consult their tax advisers as to the
consequences of these and other state and local tax rules affecting 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
- 58 -
<PAGE>
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 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, 1997 and
1996, the Fund's annual rate of portfolio turnover was approximately 399% and
347%, 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
- 59 -
<PAGE>
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 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.
The Fund pays LAS Investments, Inc.("LAS") commissions or fees for
effecting, or participating in the effectuation of (but not executing),
transactions in futures contracts and options thereon on behalf of the Fund
("Fund Futures and Options Transactions"). LAS is located at 190 South LaSalle
Street, Chicago, Illinois. Mr. Donald E. Newell is the chief executive officer
of LAS and the owner of all of its outstanding shares. Messrs. Malanga and
Newell are each executive officers and 50% shareholders of LaSalle Portfolio
Management, Inc. As a result of Mr. Newell's business relationship with Mr.
Malanga, certain procedures incorporating the standards of Rule 17e-1 of the
1940 Act govern the computation and review of all commissions paid and payable
to LAS. The procedures limit the commissions or fees received, or to be
received, by LAS for Fund Futures and Options Transactions to an amount which is
reasonable and fair compared to the commissions, fees or other remuneration
received by other introducing brokers in connection with comparable transactions
involving similar futures contracts or options on futures contracts, as the case
may be, being purchased or sold on a commodities exchange during a comparable
period of time. The Fund's independent Board Members determine no less
frequently than quarterly that all transactions with LAS during the quarter were
effected in compliance with such procedures.
Beginning in July 1990, all of the Fund's transactions in futures
contracts and related options were effected through Sierra Securities, Inc., a
broker-dealer located at 190 South LaSalle Street, Chicago, Illinois ("Sierra").
The total amount of commissions paid to Sierra as introducing broker on such
transactions for the Fund's account during the years 1990 through 1995 and
during January of 1996 was $11,298. The Manager has represented that during such
period, it believes that Mr. Donald Newell was a minority shareholder of Sierra.
As a result of Mr. Newell's business relationship with Mr. Malanga (see
discussion above), all of the futures and options transactions Sierra performed
on behalf of the Fund may have been subject to certain standards comparable to
those set forth in Rule 17e-1 of the 1940 Act (the "Rule"). On February 1, 1996,
the Manager commenced using
- 60 -
<PAGE>
LAS as its introducing broker for Fund transactions in futures contracts and
related options in place of Sierra. At a meeting held on May 2, 1996, the Fund's
Board of Directors, including a majority of the independent Directors, adopted
new standards and procedures for the Fund comparable to those set forth in the
Rule for transactions in futures contracts and related options through LAS, an
affiliated broker-dealer. See above discussion pertaining to LAS.
From January 1, 1990 to January 31, 1996, the Manager directed
syndicate designations in the aggregate dollar amount of $858,094 to Capital
Institutional Services, Inc. ("CIS") in connection with the Fundamental Funds'
bond purchases through underwriting syndicates. The Manager has represented that
CIS, a third-party research provider, at the Manager's direction, paid portions
of such syndicate designations to approximately 30 different firms that provided
research services used by the Manager in managing the Fundamental Funds,
including Capital Market Services, Inc. ("CMS"). Further, that CMS was paid by
CIS $115,000 for research provided to the Manager. The $115,000 dollar amount
paid by CIS to CMS for the following fiscal years of the Fund was: $35,000 in
1995; $55,000 in 1994; and $25,000 in 1993. The Manager has also represented
that it learned in 1996 that at all times during the years 1993, 1994 and 1995,
CMS was 100% owned by Mr. Donald E. Newell's wife. Mr. Vincent J. Malanga and
Mr. Donald E. Newell are each executive officers and 50% shareholders of LaSalle
Portfolio Management, Inc. In order to remove any appearance of impropriety
concerning all of the payments made by CIS to CMS in return for research the
Manager obtained from CMS, the Manager reimbursed Fundamental U. S. Government
Strategic Income Fund (the beneficiary of the research) $115,000 out of its own
resources.
OTHER INFORMATION
As of March 31, 1998, the Directors and Officers of the Fund as a group
beneficially owned less than 1% of the outstanding shares of the Fund. As of
such date, the following persons were known by Fund management to have owned
beneficially, directly or indirectly, 5% or more of the outstanding shares of
the Fund:
NAME & ADDRESS NUMBER OF SHARES PERCENTAGE OF
_______________ OWNED OUTSTANDING SHARES
Centre Reinsurance Limited 10,243,370.024 6.05%
1 Victoria Street
P.O. Box HM1788
Hamilton, Bermuda HMHX
FINANCIAL STATEMENTS
Audited financial statements of the Fund for the year ended December
31, 1997 are attached hereto.
- 61 -
<PAGE>
(CHART MATERIAL)
New York Muni Fund
Portfolio Composition
December 31, 1997
(unaudited)
BY TYPE
(15.8%) FCSI
(51.4%) FCLT
(20.9%) LRIB
(11.9%) INLT
BY RATING+
(4.6%) Non-income
producing bonds
(1.3%) AA
(59.6%) AAA
(19.2%) BBB
(1.9%) Not Rated
FIXED COUPON BONDS
FCLT -- Long (maturity > 15 years) (includes long zero coupons)
FCSI -- Short or Intermediate (maturity < 15 years) (includes zero coupon
bonds)
VARIABLE RATE BONDS
RIB(Residual Interest Bond) type inverse floaters. These are leveraged bonds
whose coupon varies inversely with rates on short term companion issues. The
inverse floater's price will be more volatile than that of a fixed coupon bond.
LRIB -- Long Term (maturity > 15 years)
IN (Index) based inverse floaters are bonds whose interest coupons vary
inversely with an index of short term interest rates and then revert to a fixed
rate mode. The inverse floater's price will be more volatile than that of a
fixed coupon bond.
INLT -- Long Term (maturity > 15 years)
+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.
2
<PAGE>
(CHART MATERIAL)
$22,786
Lehman
Brothers
Municipal
Bond Index*
$15,144
Fundamental
New York
Muni
Fund, Inc.
$13,926
Consumer
Price Index
- --------------------------------------------------------------------------------
New York Muni Fund
- --------------------------------------------------------------------------------
Average Annual Total Return
Ended on 12/31/97
- --------------------------------------------------------------------------------
1 Year 5 Year 10 Year
- --------------------------------------------------------------------------------
1.46% (0.62)% 4.24%
- --------------------------------------------------------------------------------
Thousands ($)
24 22 20 18 16 14 12 10
12/31/87 12/31/88 12/31/89 12/31/90 12/31/91 12/31/92 12/31/93 12/31/94
12/31/95 12/31/96 12/31/97
Past performance is not predictive of future performance.
The above illustration compares a $10,000 investment made in the New York Muni
Fund on 12/31/87 to a $10,000 investment made in the Lehman Brothers Municipal
Bond Index on that date. All dividends and capital gain distributions are
reinvested.
The Fund invests primarily in New York municipal securities and its performance
takes into account fees and expenses. Unlike the Fund, the Lehman Brothers
Municipal Bond Index is an unmanaged total return performance benchmark for the
long-term, investment-grade tax exempt bond market, calculated by using
municipal bonds selected to be representative of the market. The Index does not
take into account fees and expenses. Further information relating to Fund
performance, including expense reimbursements, if applic able, is contained in
the Fund's Prospectus and elsewhere in this report.
*Source:Lehman Brothers.
The Consumer Price Index is a commonly used measure of inflation; it does not
represent an investment return.
3
<PAGE>
(LEFT COLUMN)
NEW YORK MUNI FUND
STATEMENT OF ASSETS AND LIABILITIES
December 31, 1997
- --------------------------------------------------------------------------------
ASSETS
Investment in securities at value
(Note 4) (cost $127,411,133)..................... $122,737,274
Receivables:
Interest......................................... 1,484,267
Fund shares sold................................. 58,146,118
-----------
Total assets.............................. 182,367,659
-----------
LIABILITIES
Notes payable (Note 6)............................. 38,177,582
Payables:
Fund shares redeemed............................. 347,948
Investment securities purchased.................. 8,826,774
Dividend declared................................ 27,444
Due to advisor................................... 24,366
Accrued expenses................................. 368,138
-----------
Total liabilities................................. 47,772,252
-----------
NET ASSETS consisting of:
Distributions in excess of net
investment income................... $ (27,444)
Accumulated net realized loss ........ (24,284,760)
Unrealized depreciation of securities. (4,673,859)
Paid-in-capital applicable to
156,836,372 shares of $.01
par value capital stock............... 163,581,470
----------
$134,595,407
============
NET ASSET VALUE PER SHARE................ $.86
====
(RIGHT COLUMN)
STATEMENT OF OPERATIONS
Year ended December 31, 1997
- --------------------------------------------------------------------------------
INVESTMENT INCOME
Interest income............................... $ 7,756,494
EXPENSES (Notes 2 and 3)
Management fee............... $640,975
Custodian and accounting fees 327,214
Transfer agent fees.......... 450,401
Professional fees............ 1,050,450
Directors' fees.............. 102,427
Printing and postage......... 31,395
Interest..................... 1,431,511
Distribution expenses........ 647,839
Operating expenses on
defaulted bonds.............. 72,000
Other........................ 143,176
---------
4,897,388
Expenses reimbursed........ (40,700)
---------
Total expenses........................ 4,856,688
----------
Net investment income................. 2,899,806
----------
REALIZED AND UNREALIZED GAIN (LOSS)
ON INVESTMENTS
Net realized loss on investments (2,367,322)
Net unrealized appreciation of
investments.............. 5,608,133
---------
Net gain on investments ...................... 3,240,811
----------
NET INCREASE IN NET ASSETS
FROM OPERATIONS.................................. $6,140,617
==========
(FULL COLUMN)
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------
Year Ended Year Ended
December 31, December 31,
1997 1996
------------ ------------
<S> <C> <C>
INCREASE (DECREASE) IN NET ASSETS FROM
OPERATIONS
Net investment income...................................................... $ 2,899,806 $ 6,229,467
Net realized loss on investments........................................... (2,367,322) (2,404,362)
Unrealized appreciation (depreciation) on investments ..................... 5,608,133 (4,292,643)
----------- -----------
Net (decrease) increase in net assets from operations...................... 6,140,617 (467,538)
DISTRIBUTIONS:
Distributions from investment income....................................... (2,899,806) (6,229,467)
Distributions in excess of net investment income........................... (27,444) --
Return of capital distribution............................................. (551,666) --
Distributions from net realized gain from investments...................... (24,556) --
CAPITAL SHARE TRANSACTIONS (Note 5)........................................ (64,787,531) (23,248,833)
----------- -----------
Total decrease............................................................. (62,150,386) (29,945,838)
NET ASSETS:
Beginning of year.......................................................... 196,745,793 226,691,631
----------- -----------
End of year................................................................ $134,595,407 $196,745,793
=========== ===========
</TABLE>
See Notes to Financial Statements.
4
<PAGE>
NEW YORK MUNI FUND
STATEMENT OF CASH FLOWS
Year Ended December 31, 1997
<TABLE>
- ---------------------------------------------------------------------------------------------------------------------
<S> <C>
Increase (Decrease) in Cash
Cash Flows From Operating Activities
Net increase to net assets from operations .................................................. $ 6,140,617
Adjustments to reconcile net increase in net assets from operations
to net cash provided by operating activities:
Purchase of investment securities ......................................................... (1,574,433,817)
Proceeds on sale of securities ............................................................ 1,659,325,144
Decrease in interest receivable ........................................................... 2,324,155
Decrease in accrued expenses .............................................................. (391,142)
Net accretion of discount on securities ................................................... (111,800)
Net realized loss:
Investments ............................................................................. 2,367,322
Unrealized appreciation on securities .................................................... (5,608,133)
-------------
Net cash provided by operating activities ............................................. 89,612,346
-------------
Cash Flows From Financing Activities:*
Increase in notes payable ................................................................. 36,846,239
Proceeds on shares sold ................................................................... 2,222,770,042
Payment on shares repurchased ............................................................. (2,348,578,756)
Cash dividends paid ....................................................................... (649,871)
-------------
Net cash used in financing activities ................................................. (89,612,346)
-------------
Net decrease in cash .................................................................. 0
Cash at beginning of year ..................................................................... 0
-------------
Cash at end of year ........................................................................... $ 0
=============
<FN>
- --------------
*Non-cash financing activities not included herein consist of reinvestment of dividends of $3,233,013.
Cash payments for interest expense totaled $1,672,606.
</FN>
</TABLE>
See Notes to Financial Statements.
5
<PAGE>
NEW YORK MUNI FUND
STATEMENT OF INVESTMENTS
December 31, 1997
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------
Principal
Amount Issue ooo Type o Rating oo Value
-------- ----- ---- ----- -----
<C> <S> <C> <C> <C>
$ 1,000,000## Amherst NY Industrial Development Agency Lease Rev, SurfaceRink Complex,
LOC Keyhawk, 5.65%, 10/01/22............................................ FCLT A $ 1,015,360
1,000,000 Metropolitan Transit Authority NY Commuter Facilities Rev, Series C-1,
FGIC Insured 5.375%, 07/01/27........................................... FCLT AAA 1,011,120
300,000 Metropolitan Transit Authority NY Transportation Facilities Rev SVC Contract
Series 8 5.375%, 07/01/21............................................... FCLT A- 300,000
14,600,000x## New York Inverse Floating Rate Notes*...................................... INLT A- 14,618,104
500,000 New York NY Series B, 5.25%,0 8/01/15...................................... FCLT A- 495,445
5,290,000x## New York City, ECF, MBIA Insured, STEP** 3.75%, 04/01/08................... FCSI Aaa 5,402,042
5,925,000x## New York City, ECF, MBIA Insured, STEP** 3.75%, 10/01/08................... FCSI Aaa 6,046,463
2,200,000x## New York City, IDA, Imclone Systems Inc Project AMT 11.25%, 07/01/04....... FCSI NR 2,296,404
2,000,000 New York City, IDA, Brooklyn Navy Yard Cogen Partners AMT 5.75%, 10/01/36 . FCLT Baa3 2,017,800
6,700,000 New York City, MWFA, Water &Sewer Systems Rev Residual Int Tr Rcpts,
Series 29, FGIC Insured, 6.562%, 06/15/30............................... LRIB Aaa 6,497,258
1,030,000 New York City, IDA, Civic Facilities Rev, Anti-Defamation League Foundation
Ser A, MBIA Insured, 5.375%, 06/01/27.................................. FCLT Aaa 1,042,226
3,500,000## New York City, IDA, Special Facilities Rev, United Airlines Inc. Project,
AMT, 5.65%, 10/01/32.................................................... FCLT Baa3 3,538,605
4,970,000## New York State, DAR, City University Systems Series C 5.00%, 07/01/17 ..... FCLT Baa1 4,784,270
850,000 New York State, DAR, City University Series F, FGIC TCRS Insured,
5.00%, 07/01/20......................................................... FCLT Aaa 827,611
7,550,000## New York State, DAR, Court Facilities Lease Series A 5.25%, 05/15/21 ..... FCLT Baa1 7,419,838
1,000,000 New York State, DAR, Nursing Home FHA, Rosalind &Joseph Gurwin
Jewish Geriatric, AMBAC Insured 5.70%, 02/01/37......................... FCLT Aaa 1,023,890
1,650,000 New York State, DAR, St. Vincent DePaul Residence, LOC Allied Banks PLC,
5.30%, 07/01/18......................................................... FCLT Aa3 1,639,803
4,500,000## New York State, DAR, City University System Residual Int Tr Recpts 27,
MBIA Insured, Liquidity The Bank of New York, 8.22%, 07/01/24........... LRIB Aaa 4,949,055
13,460,000## New York State, DAR, City University System Residual Int Tr Recpts 28,
AMBAC Insured, Liquidity The Bank of New York, 7.63%, 07/01/25.......... LRIB Aaa 14,170,553
2,510,000 New York State, DAR, Vassar Brothers Hospital, FSA Insured 5.375%, 07/01/25 FCLT Aaa 2,525,462
5,000,000 New York State, DAR, Mental Health Services Facilities Improvement
Series D, FSA Insured, 5.125%, 08/15/27................................. FCLT AAA 4,909,950
7,500,000## New York State, DAR, FHA, St Barnabas Hospital AMBAC Insured
5.45%, 08/01/35......................................................... FCLT Aaa 7,565,700
750,000 New York State, DAR, FHA, Sara Neuman Nursing Home AMBAC Insured
5.45%, 08/01/27......................................................... FCLT Aaa 755,730
1,000,000 New York State, DAR, FHA, Sara Neuman Nursing Home AMBAC Insured
5.50%, 08/01/37......................................................... FCLT Aaa 1,009,340
42,000,000 New York State, DAR, FHA, Presbyterian Hospital Series A AMBAC Insured
0.00%, 08/15/36......................................................... FCLT Aaa 5,404,560
2,000,000 New York State, DAR, FHA, Highland Hospital Rochester Series A,
MBIA Insured, 5.45%, 08/01/37........................................... FCLT Aaa 2,008,680
1,000,000 New York State, EFC, Pollution Control Rev, Ref-St Wtr-Sub-Revolving Fund
Series E, MBIA Insd, 5.00%, 06/15/11.................................... FCLT Aaa 1,009,710
2,000,000 New York State, EFC, Pollution Control Rev, Ref-St Wtr-Sub-Revolving Fund
Series E, MBIA Insd, 5.00%, 06/15/12.................................... FCLT Aaa 2,016,160
</TABLE>
6
<PAGE>
NEW YORK MUNI FUND
STATEMENT OF INVESTMENTS (continued)
December 31, 1997
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------
Principal
Amount Issue ooo Type o Rating oo Value
-------- ----- ---- ----- -----
<C> <S> <C> <C> <C>
$ 4,040,000 New York State, HFA, Service Contract Obligation Rev Series C, 5.50%, 03/15/25. FCLT Baa1 $ 4,064,644
5,000,000## New York State, MCFFA, HFA, Rev, Presbyterian Hospital
MBIA-IBC Insured 5.375%, 02/15/25........................................... FCLT Aaa 5,045,500
9,805,000x# ## Niagara County NY, IDA Falls Street Faire Project AMT, 10.00% 09/01/06
(see Note 4 to Financial Statements)........................................ FCSI NR 3,509,700
5,870,000x# ## Niagara Falls NY, URA, Old Falls Street Improvement Project, 11.00% 05/01/09
(see Note 4 to Financial Statements).............................. ......... FCSI NR 2,101,167
1,760,000 Syracuse NY, IDA, Civic Facilities Rev, Crouse Health Hospital Project,
Series A 5.375%, 01/01/23................................................... FCLT BBB 1,715,124
------------
Total Investments (Cost $127,411,133 @)............................. $122,737,274
============
<FN>
* Inverse Floating Rate Notes (IFRN) are instruments whose interest rates bear an inverse relationship to the interest rate on
another security or value of an index. Rates shown are at December 31, 1997.
** Step Bonds (STEP) are instruments whose interest rate is fixed at an initial rate and then increases ("steps up") to another
fixed rate until maturity.
@ Cost for Federal income tax purposes is $127,989,424.
# The value of these non-income producing securities has been estimated by persons designated by the Fund's Board of Directors
using methods the Director's believe reflect fair value. See Note 4 to the financial statements.
## $82,462,761 market value of securities are segregated in whole or in part as collateral securing a line of credit.
x The Fund owns 100% of the security and therefore there is no trading in the security. See Note 4 to the financial
statements.
Legend
oType FCLT --Fixed Coupon Long Term
FCSI --Fixed Coupon Short or Intermediate Term
LRIB --Residual Interest Bond Long Term
INLT --Indexed Inverse Floating Rate Bond Long Term
ooRatings 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.
NR--Not Rated
ooolssue AMBAC American Municipal Bond Assurance Corporation
AMT Alternative Minimum Tax
CAB Capital Appreciation Bond
CFR Civic Facility Revenue
COP Certificates of Participation
DAR Dormitory Authority Revenue
ECF Educational Construction Fund
EFC Environmental Facilities Corp.
ETM Escrowed to Maturity
FGIC Financial Guaranty Insurance Corporation
FHA Federal Housing Administration
FSA Financial Security Association
GO General Obligation
HDA Housing Development Agency
HFA Housing Financing Agency
HIC Hospital Improvement Corporation
IDA Industrial Development Authority
ITEMECF Industrial, Tourist, Education, Medical and Environmental Control Facilities
LOC Letter of Credit
MBIA Municipal Bond Insurance Assurance Corporation
MCF Medical Care Facilities
MCFFA Medical Care Facilities Finance Agency
MTA Metropolitan Transit Authority
MWFA Municipal Water Finance Authority
NHRB Nursing Home Revenue Bond
RB Revenue Bond
RDA Research and Development Authority
SWMA Solid Waste Management Authority
URA Urban Renewal Authority
See Notes to Financial Statements.
</FN>
</TABLE>
7
<PAGE>
NEW YORK MUNI FUND
NOTES TO FINANCIAL STATEMENTS
December 31, 1997
- --------------------------------------------------------------------------------
1.Significant Accounting Policies
New York Muni Fund (the Fund) is a series of Fundamental Funds, Inc. (the
"Company"). The Company 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. The Fund
intends to achieve its objective by investing substantially all of its total
assets in municipal obligations of New York State, its political subdivisions
and its duly constituted authorities and corporations. The Fund employs leverage
in attempting to achieve this objective. The following is a summary of
significant accounting policies followed in the preparation of its financial
statements:
Valuation of Securities--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 directors, 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 directors using
methods which the directors believe reflect fair value.
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.
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. 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 loss 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.
8
<PAGE>
NEW YORK MUNI FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
2.Investment Advisory Fees and Other Transactions with Affiliates
Management Agreement
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 has voluntarily agreed 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, 1997 due to the
expense limitation. See Note 8.
SEC Administrative Action Against Manager
On September 30, 1997, the Securities & Exchange Commission announced that
it instituted public administrative and cease-and desist proceedings against the
Manager, the former portfolio manager of the Fund, the president of the Manager
and Fundamental Service Corporation (FSC). The proceeding arises from the
alleged failure of an affiliated mutual fund to disclose the risks of the
affiliated fund, and of the Manager's failure to disclose its soft dollar
arrangements to the Fund's Board of Directors. A hearing has been scheduled with
an admninistrative law judge to determine whether the allegations are true, and,
if so, what remedial action, if any, is appropriate.
Board's Termination of Portfolio Manager
Between April 17, 1997 and July 24, 1997, a representative of the Manager
engaged Tocqueville Securities L.P. ("Tocqueville Securities"), an affiliate of
Tocqueville (see Note 7), as agent, to effect eight separate over-the-counter
purchase transactions of municipal obligations on behalf of the Fund. The Fund's
Board has concluded that the commissions paid to Tocqueville Securities in
connection with these transactions (a portion of which was paid to the
representative) were not justified and that the Fund bore unnecessary expenses
as a result of the sale of its securities to another party and the subsequent
repurchase of them through Tocqueville Securities. Based upon a report initiated
by Tocqueville Securities and prepared by the Fund's independent auditors, and
upon the Board's own analysis, the Board directed that the Manager terminate the
representative's services as a portfolio manager. At the Board's request and in
order to reimburse the affiliated fund for all of its losses, Tocqueville
Securities, on September 15, 1997, voluntarily paid $260,000 to the Fund, an
amount which significantly exceeds the total commissions ($184,920.60) received
by Tocqueville Securities in connection with these transactions. $219,300 of the
proceeds from the reimbursement have been included in the realized gain on
investments and $40,700 have been included as an expense reimbursement in the
accompanying financial statements. The staff of the Securities and Exchange
Commission and the Department of NASD Regulation have been informed of these
events by Tocqueville Securities. See Note 7 regarding contemplated transaction
with the Tocqueville Trust.
Distribution Plan and Service Agreement
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 Service Agreement with 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 $307,200 for the year
ended December 31, 1997.
NASD Sanctions and Fines
On February 19, 1998, FSC and two of its executives, without admitting or
denying guilt, entered into an agreement with the National Association of
Securities Dealers, Inc. ("NASD") whereby they accepted fines totaling $125,000
and other stipulated sanctions as a result of the NASD's finding that they had
distributed advertising materials of an affiliated mutual fund which violated
NASD rules governing advertisements.
9
<PAGE>
NEW YORK MUNI FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
The Fund compensated Fundamental Shareholder Services, Inc. (FSSI), an
affiliate of the Manager, for the services it provided under a Transfer Agent
and Service Agreement which was terminated September 11, 1997. Transfer agent
fees paid to FSSI for the year ended December 31, 1997 amounted to $260,717.
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. The Directors also received additional
compensation for special services as requested by the Board. Additional
compensation totaled $40,923 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. Additionally, some of these securities contain a
"leverage factor"whereby the interest rate moves inversely by a "factor" to the
benchmark rate. For example, the rates on the inverse floating rate note may
move inversely at three times the benchmark rate. Certain interest rate
movements and other market factors can substantially affect the liquidity of
IFRN's.
Concentration of Credit Risk and Transactions in Defaulted Bonds:
The Fund owned 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.
The Fund, through its investment banker and manager, negotiated the sale of
the Falls Street Station project. The net proceeds received on the sale of
approximately $2,800,000 were accounted for as a pro rata recovery of principal
of each of the bonds. The remaining principal value of the Fall Street Station
IDA Bond of approximately $3,887,000 was charged to realized loss on
investments.
The remaining two securities are being valued under methods approved by the
Board of Directors. The aggregate value of these securities is $5,610,867 (35.8%
to their aggregate face value of $15,675,000). There is uncertainty as to the
timing of events and the subsequent ability of the Projects to generate cash
flows sufficient to provide repayment of the bonds. No interest income was
accrued on these bonds during the year ended December 31, 1997. Legal,
investment banking, and other restructuring costs charged to realized loss
totaled approximately $153,000 for the year ended December 31, 1997 ($1,640,000
cumulatively from October 6, 1992 to December 31, 1997). The Fund through its
investment banker, engaged a property manager to maintain the Projects on its
behalf, and the Fund is paying the net operating expenses of the Project. Net
operating expenses related to the Projects for the year ended December 31, 1997
are disclosed in the statement of operations, and cumulatively from October 6,
1992 to December 31, 1997 totaled approximately $684,629
Additionally, the Fund owns 100% of several securities as indicated in the
Statement of Investments. As a result of its ownership position there is no
active trading in these securities. Valuations of these securities are provided
by a pricing service and are believed by the Manager to reflect fair value. The
market value of securities owned 100% by the Fund was approximately $33,973,880
(25% of net assets) at December 31, 1997.
Other Investment Transactions:
During the year ended December 31, 1997, purchases and sales of investment
securities, other than short-term obligations, were $554,177,076 and
$647,162,806, respectively.
10
<PAGE>
NEW YORK MUNI FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
As of December 31, 1997 net unrealized depreciation of portfolio securities
on a federal income tax basis amounted to $5,252,150 composed of unrealized
appreciation of $4,320,774 and unrealized depreciation of $9,572,924.
The Fund has capital loss carryforwards available to offset future capital
gains as follows:
Amount Expiration
------ ----------
$18,503,000 December 31, 2002
3,430,000 December 31, 2004
2,214,000 December 31, 2005
-----------
$24,147,000
===========
5.Capital Stock
As of December 31, 1997 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, 1997 December 31, 1996
-------------------------- --------------------------
Shares Amount Shares Amount
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Shares sold......................... 2,692,167,470 $2,280,916,160 3,704,110,578 $3,314,430,819
Shares issued on reinvestment
of dividends........................ 3,788,810 3,223,013 5,501,544 4,939,206
Shares redeemed .................... (2,765,077,644) (2,348,926,704) (3,714,943,217) (3,342,618,858)
-------------- -------------- -------------- --------------
Net (decrease) ..................... (69,121,364) $ (64,787,531) (5,331,095) $ (23,248,833)
============== ============== ============== ==============
</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. Pursuant to these agreements $38,177,582 was
outstanding at December 31, 1997.
The maximum month end and the average borrowings outstanding during the year
ended December 31, 1997 were $82,500,000 and $20,630,505, respectively.
7. Agreement and Plan of Reorganization
On July 15, 1997 each of Fundamental's mutual funds (consisting of: New
York Muni Fund, The California Muni Fund, Fundamental Fixed Income Fund: Tax
Free Money Market Series, High Yield Municipal Bond Series, and Fundamental U.S.
Government Strategic Income Fund Series) have adopted, subject to shareholder
approval, an Agreement and Plan of Reorganization (the "Plan") under which each
fund (the "Fundamental Fund") will transfer all of its assets and liabilities to
a newly-created corresponding series of The Tocqueville Trust (the "Tocqueville
Fund") in exchange for shares of the Tocqueville Fund. Shareholders of each
Fundamental Fund will receive shares of the corresponding Tocqueville Fund equal
in value to their shares in the Fundamental Fund. Shareholders will not have to
pay a sales load upon receiving shares of the Tocqueville Fund.
The corresponding Tocqueville Fund will have investment objectives, polices
and restrictions substantially identical to those of the Fundamental Fund. The
Board of Trustees of the Tocqueville Funds is comprised of individuals other
than those who currently serve as Directors (Trustees) of the Fundamental Funds.
Tocqueville Asset Management L.P. is the investment adviser to the Tocqueville
Funds.
A majority of Fundamental's Board Members determined that the Plan would be
in the best interests of shareholders of the Fundamental Funds and recommended
that shareholders of each of the Fundamental Funds approve the Plan at a meeting
anticipated to be held in the Spring of 1998.
8. Subsequent Event
At its March 25, 1998 Board of Directors' meeting, the Board of the Fund
approved the continuation of the Management Agreement through May 30, 1998 in
contemplation of the consummation of the reorganization discussed in Note 7.
11
<PAGE>
NEW YORK MUNI FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
The Manager and FSC (on behalf of certain of their directors, officers,
shareholders, employees and control persons) (the "Indemnitees") received
payment during the fiscal year ended December 31, 1997 from the Fund in the
amount of approximately $50,230. Upon learning of the payments, the independent
Board Members of the Funds directed that the Indemnitees return all of the
payments to the Funds or place them in escrow pending their receipt of an
opinion of an inedpendent legal counsel to the effect that the Indemnitees are
entitled to receive them. The Declaration of Trust, Articles of Incorporation
and contracts that call for indemnification specify that no indemnification
shall be provided to a person who shall be found to have engaged in "disabling
conduct" as defined by applicable law. The Indemnities have undertaken to
reimburse the Fund for any indemnification expenses for which it is determined
that they were not entitled to as a result of "disabling conduct" net of any
reimbursements already made to the Fund in the form of fees forgone or other
similar payments.
FSC waived fees in the amount of $51,200 in 1998. The Manager and FSC have
asserted that they elected to forgo these fees because the Fund was paying legal
expenses pursuant to indemnification. The Fund has retained independent legal
counsel to determine whether the Indemnitees engaged in disabling conduct.
Pending clarification of the legal issues involved, the Independent Directors
have instructed the Manager to escrow the full amount incurred by the Fund of
approximately $50,230.
9. Selected Financial Information
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE
(for a share outstanding throughout the year)
Net Asset Value, Beginning of Year ....................... $0.87 $0.98 $0.88 $1.18 $1.21
----- ----- ----- ----- -----
Income from investment operations:
Net investment income .................................... .021 .035 .035 .056 .065
Net realized and unrealized gains (losses)
on investments ........................................... (.009) (.110) .101 (.290) .082
---- ----- ----- ----- -----
Total from investment operations ......................... .012 (.075) .136 (.234) .147
----- ----- ----- ----- -----
Less Distributions:
Dividends from net investment income ..................... (.019) (.035) (.035) (.056) (.065)
Return of capital distributions........................... (.003) -- -- -- --
Dividends from net realized gains ........................ -- -- (.001) (.010) (.112)
----- ----- ----- ----- -----
Total distributions ...................................... (.022) (.035) (.036) (.066) (.177)
----- ----- ----- ----- -----
Net Asset Value, End of Year ............................. $0.86 $0.87 $0.98 $0.88 $1.18
===== ===== ===== ===== =====
Total Return ............................................. 1.46% (7.73%) 15.67% (20.47%) 12.58%
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (000) ............................ $134,595 $196,746 $226,692 $212,665 $275,552
Ratios to Average Net Assets:
Interest expense ......................................... 1.10% 2.11% 2.09% 1.59% .61%
Operating expenses ....................................... 2.64% 1.66% 1.55% 1.62% 1.44%
----- ----- ----- ----- -----
Total expenses ........................................... 3.74%+ 3.77% 3.64% 3.21% 2.05%
===== ===== ===== ===== =====
Net investment income .................................... 2.23%+ 3.89% 3.81% 5.34% 5.20%
Portfolio turnover rate .................................. 399.38% 347.44% 347.50% 289.69% 404.05%
</TABLE>
12
<PAGE>
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
BANK LOANS
Amount outstanding at end of year (000 omitted) .......... $38,178 $1,200 $64,575 $20,000 $20,873
Average amount of bank loans outstanding during the year
(000 omitted) ............................................ $20,631 $49,448 $49,603 $54,479 $24,100
Average number of shares outstanding during the year
(000 omitted) ............................................ 153,535 178,456 191,692 206,323 184,664
Average amount of debt per share during the year ......... $ .134 $ .277 $ .259 $ .264 $ .131
<FN>
+These ratios are after expense reimbursement of .03% for the year ended December 31, 1997.
</FN>
</TABLE>
13
<PAGE>
INDEPENDENT AUDITOR'S REPORT
- --------------------------------------------------------------------------------
The Board of Directors and Shareholders
New York Muni Fund
We have audited the accompanying statement of assets and liabilities, including
the statement of investments, of New York Muni Fund as of December 31, 1997, 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, 1997 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 as of December 31, 1997 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.
See Notes 2 and 8 for information regarding regulatory proceedings and
transactions with affiliates.
S I G N A T U R E
New York, New York
March 2, 1998, except for Note 8 as to which the date is April 30, 1998.
14
<PAGE>
THE CALIFORNIA MUNI FUND
(LEFT COLUMN)
STATEMENT OF ASSETS AND LIABILITIES
December 31, 1997
- --------------------------------------------------------------------------------
ASSETS
Investment in securities
at value (cost $8,917,684) ................. $ 9,183,831
Interest receivable .......................... 252,201
Receivable for fund shares sold .............. 4,962,106
-----------
Total assets ..................... 14,398,138
-----------
LIABILITIES
Loans (Note 6) ............................... 503,018
Dividend Payable ............................. 10,223
Accrued expenses ............................. 52,893
-----------
Total liabilities ................ 566,134
-----------
NET ASSETS consisting of:
Accumulated net realized gain ... $ 220,789
Unrealized appreciation of
securities .................... 266,147
Paid-in-capital applicable to
1,672,917 shares of beneficial
interest (Note 4) ............. 13,345,068
---------- -----------
$13,832,004
===========
NET ASSET VALUE PER SHARE $8.27
=====
(RIGHT COLUMN)
STATEMENT OF OPERATIONS
Year Ended December 31, 1997
- --------------------------------------------------------------------------------
INVESTMENT INCOME
Interest income .................. $1,009,193
EXPENSES (Notes 2 and 3)
Management fee ................... $63,726
Custodian and accounting fees .... 60,460
Transfer agent fees .............. 38,033
Professional fees ................ 144,918
Printing and postage ............. 16,886
Interest ......................... 53,011
Distribution expenses ............ 44,731
Trustees' fees ................... 10,471
-------
Total expenses ...... 432,236
Less: Expenses reim-
bursed by manager . (3,296)
Net expenses ........ ------- 428,940
----------
Net investment income 580,253
----------
REALIZED AND UNREALIZED GAIN ON
INVESTMENTS
Net realized gain on investments . 493,308
Unrealized appreciation of
investments for the year ....... 374,518
----------
Net gain on investments 867,826
----------
NET INCREASE IN NET ASSETS FROM
OPERATIONS ......................... $1,448,079
==========
(FULL COLUMN)
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
Year Ended Year Ended
December 31, December 31,
1997 1996
------------ ------------
<S> <C> <C>
INCREASE (DECREASE) IN NET ASSETS FROM:
OPERATIONS
Net investment income ................................................ $ 580,253 $ 694,929
Net realized gain on investments ..................................... 493,308 100,733
Unrealized appreciation (depreciation) of investments for the year ... 374,518 (876,013)
----------- -----------
Net increase (decrease) in net assets from operations ............ 1,448,079 (80,351)
DIVIDENDS PAID TO SHAREHOLDERS FROM
Net investment income ................................................ (580,253) (694,929)
CAPITAL SHARE TRANSACTIONS (Note 4) .................................... (3,287,401) 4,404,527
----------- -----------
Total increase (decrease) .................................... (2,419,575) 3,629,247
NET ASSETS:
Beginning of year .................................................... 16,251,579 12,622,332
----------- -----------
End of year .......................................................... $13,832,004 $16,251,579
=========== ===========
</TABLE>
See Notes to Financial Statements.
18
<PAGE>
THE CALIFORNIA MUNI FUND
STATEMENT OF CASH FLOWS
Year Ended December 31, 1997
- --------------------------------------------------------------------------------
Increase (Decrease) in Cash
Cash Flows From Operating Activities
Net increase to net assets from operations ................... $ 1,448,079
Adjustments to reconcile net increase in net assets from
operations to net cash provided by operating activities:
Purchase of investment securities .......................... (128,371,610)
Proceeds on sale of securities ............................. 136,362,253
Increase in interest receivable ............................ (5,768)
Decrease in accrued expenses ............................... (81,857)
Net accretion of discount on securities .................... (135,229)
Net realized gain:
Investments .............................................. (493,308)
Unrealized appreciation on securities ........................ (374,518)
------------
Net cash provided by operating activities ............. 8,348,042
------------
Cash Flows From Financing Activities:*
Increase in notes payable .................................. 503,018
Proceeds on shares sold .................................... 251,745,912
Payment on shares repurchased .............................. (260,415,184)
Cash dividends paid ........................................ (195,278)
------------
Net cash used in financing activities ................. (8,361,532)
------------
Net decrease in cash .................................. (13,490)
Cash at beginning of year ...................................... 13,490
------------
Cash at end of year ............................................ $ 0
============
- -----------
*Non-cash financing activities not included herein consist of reinvestment of
dividends of $419,765.
Cash payments for interest expense totaled $57,087.
See Notes to Financial Statements.
19
<PAGE>
THE CALIFORNIA MUNI FUND
<TABLE>
<CAPTION>
STATEMENT OF INVESTMENTS
December 31, 1997
- ---------------------------------------------------------------------------------------------------------------------
Principal
Amount Issue ooo Type Rating Value
------ ----- ---- ------ -----
<C> <S> <C> <C> <C>
$ 100,000(DD) Arvin, Development Corporation, COP, RB, 8.75%, 9/01/18 ............. FCLT NR $ 24,505
200,000 Beverly Hills, PFA, RB, IFRN*, MBIA Insured, 7.32%, 6/01/15 ......... LRIB AAA 209,428
100,000 CSAC Finance Corp, COP, Sutter County Health Facilities Project,
7.80%, 1/01/21 .................................................... FCLT Baa1 102,158
70,000 California, HFA, Home Mortgage, RB, Series A, MBIA Insured,
5.70%, 8/01/10 .................................................... FCSI Aaa 74,163
300,000+ California Statewide Communities Development Authority, Cedars
Sinai Medical Project, COP, RB, IFRN*, 6.97%, 11/01/15 ............ LRIB A1 290,166
300,000 East Bay, Wastewater System Project, RB, Refunding, AMBAC
Insured, IFRN*, 6.87%, 6/01/20 .................................... LRIB AAA 312,108
220,000 Hawthorne, CRA, TAR, 6.75%, 9/01/24 ................................. FCLT Baa 240,933
170,000 Lake Elsinore, USD, Refunding, COP, 6.90%, 2/01/20 .................. FCLT BBB 187,299
10,000 Los Angeles, Home Mortgage, RB, 9.00%, 6/15/18 ...................... FCLT A 10,200
1,505,192 Los Angeles, HFA, MFH Project C, CAB, RB, 12.00%, 12/01/29 .......... FCLT NR 1,112,291
35,000 Modesto, Valley Oak Project, RB, 10.60%, 5/01/09 .................... FCSI NR 35,792
250,000 Northern California Power Agency, Multiple Capital Facilities, RB,
MBIA Insured, IFRN*, 8.76%, 8/01/25 ............................... LRIB AAA 293,040
250,000 Northern California Transmission Agency, CA-ORE Transmission
Project, RB, MBIA Insured, IFRN*, 6.81%, 4/29/24 .................. LRIB AAA 254,042
500,000 Orange County Airport, RB, Refunding, MBIA Insured, 5.625%,
7/01/12 ........................................................... FCLT Aaa 526,415
250,000+ Orange County, LTA, RB, IFRN*, 8.01%, 2/14/11 ....................... LRIB AA 297,597
250,000 Orange County, LTA, RB, IFRN*, 7.81%, 2/14/11 ....................... LRIB AAA 289,027
185,000 Panoche, Water District, COP, 7.50%, 12/01/08 ....................... FCSI BBB 199,776
250,000 Rancho, Water District Financing Authority, RB, Prerefunded @
104, AMBAC Insured, IFRN*, 8.82%, 8/17/21 ......................... LRIB AAA 301,443
250,000 Redding, Electric System, COP, Series A, FGIC Insured, IFRN*,
7.20%, 6/01/19 .................................................... LRIB AAA 264,078
175,000 Riverside, HFA, Riverside Apartment Project, RB, 7.87%, 11/01/19 .... FCLT BB- 178,896
500,000 San Bernardino, COP, Series B. MBIA Insured, IFRN*, 6.38%,
7/01/16 ........................................................... INLT AAA 531,045
900,000 San Bernardino, COP, Series PA38, MBIA Insured, IFRN*,
11.92%, 7/01/16, Rule 144A Security (restricted as to resale
except to qualified institutions) ................................. LRIB NR 1,021,995
200,000 San Diego Water Authority, COP, FGIC Insured, IFRN*, 7.09%,
4/22/09 ........................................................... LRIB AAA 240,624
1,440,000x San Jose, CRA, Series PA-38, TAB, MBIA Insured, IFRN*, 5.83%,
8/01/16, Rule 144A Security (restricted as to resale except to
qualified institutions) ........................................... LRIB AAA 1,471,306
</TABLE>
20
<PAGE>
THE CALIFORNIA MUNI FUND
<TABLE>
<CAPTION>
STATEMENT OF INVESTMENTS (continued)
December 31, 1997
- ---------------------------------------------------------------------------------------------------------------------
Principal
Amount Issue ooo Type Rating Value
------ ----- ---- ------ -----
<C> <S> <C> <C> <C>
$ 250,000 Southern California Public Power Authority, FGIC Isured, IFRN*,
6.62%, 7/01/17 .................................................... LRIB AAA $ 248,070
55,000 Tri City, HFA, FNMA/GNMA Collateralized, AMT, 6.45%, 12/01/28 ....... FCLT AAA 59,388
30,000 Tri City, HFA, FNMA/GNMA Collateralized, AMT, Series B, 6.30%,
12/01/28 .......................................................... FCLT AAA 32,358
250,000 Tri City, HFA, FNMA/GNMA Collateralized, AMT, Series E, 6.40%,
12/01/28 .......................................................... FCLT AAA 271,518
100,000 Upland, HFA, RB, 7.85%, 7/01/20 ..................................... FCLT BBB 104,170
-----------
Total Investments (Cost $8,917,684#) ........................ $ 9,183,831
===========
<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 December 31, 1997.
#Cost is the same for Federal income tax purposes.
xThe Fund owns 100% of the security and therefore there is no trading in the security.
(DD)Denotes non-income producing security: Security is in default.
+Segregated, in whole or part, a collateral securing a line of credit.
</FN>
</TABLE>
Legend
(LEFT COLUMN)
oType FCLT -Fixed Coupon Long Term
FCSI -Fixed Coupon Short or Intermediate Term
LRIB -Residual Interest Bond Long Term
INLT -Indexed Inverse Floating Rate Bond Long Term
ooRatings If a security has a split rating the highest applicable
rating is used, including published ratings on identicial
credits for individual securities not individually rated.
Ratings are unaudited.
NR -Not Rated
oooIssue AMBAC American Municipal Bond Assurance Corporation
AMT Alternative Minimum Tax
CAB Capital Appreciation Bond
CGIC Capital Guaranty Insurance Company
(RIGHT COLUMN)
COP Certificate of Participation
CRA California Redevelopment Agency
FGIC Financial Guaranty Insurance Corporation
FNMA Federal National Mortgage Association
FSA Financial Security Assurance, Inc.
GNMA Government National Mortgage Association
HFA Housing Finance Authority
LTA Local Transportation Authority
MBIA Municipal Bond Insurance Assurance Corporation
MFH Multi Family Housing
PFA Public Financing Authority
RB Revenue Bond
TAB Tax Allocation Bond
TAR Tax Allocation Refunding
USD Unified School District
See Notes to Financial Statements.
21
<PAGE>
THE CALIFORNIA MUNI FUND
NOTES TO FINANCIAL STATEMENTS
December 31, 1997
- --------------------------------------------------------------------------------
(LEFT COLUMN)
1. Significant Accounting Policies
The California Muni Fund (the Fund) was organized as a Massachusetts
business trust and is registered as an open end management investment company
under the Investment Company Act of 1940. The Fund's objective is to provide as
high a level of income that is excluded from gross income for Federal income tax
purposes and exempt from California personal income tax as is consistent with
the preservation of capital. The Fund employs leverage in attempting to achieve
its objective. The following is a summary of significant accounting policies
followed in the preparation of its financial statements:
Valuation of Securities-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. 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.
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.
(RIGHT COLUMN)
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 Trustees. 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.
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.
2. Investment Advisory Fees and Other Transactions With Affiliates
Management Agreement
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. See Note 8.
SEC Administrative Action Against the Manager
On September 30, 1997, the Securities & Exchange Commission announced that
it instituted public administrative and cease-and desist proceedings against the
Manager, the former portfolio manager of the Fund, the president of the Manager
and Fundamental Service Corporation (FSC). The proceeding arises from the
alleged failure of an affiliated mutual fund to disclose the risks of the
affiliated Fund, and of the Manager's failure to disclose its soft dollar
arrangements to the Fund's Board of Trustees. A hearing has been sched-
22
<PAGE>
THE CALIFORNIA MUNI FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
(LEFT COLUMN)
uled with an administrative law judge to determine whether the allegations are
true, and, if so, what remedial action, if any, is appropriate.
Board's Termination of Portfolio Manager
Between April 17, 1997 and July 24, 1997, a representative of the Manager
engaged Tocqueville Securities L.P. ("Tocqueville Securities"), an affiliate of
Tocqueville (see note 7), as agent, to effect eight separate over-the-counter
purchase transactions of municipal obligations on behalf of an affiliated fund.
The affiliated fund's Board has concluded that the commissions paid to
Tocqueville Securities in connection with these transactions (a portion of which
was paid to the representative) were not justified and that the affiliated fund
bore unnecessary expenses as a result of the sale of its securities to another
party and the subsequent repurchase of them through Tocqueville Securities.
Based upon a report initiated by Tocqueville Securities and prepared by the
Fund's independent auditors, and upon the Board's own analysis, the Board
directed that the Manager terminate its representative's services as a portfolio
manager. At the Board's request and in order to reimburse the affiliated fund
for all of its losses, Tocqueville Securities, on September 15, 1997,
voluntarily paid $260,000 to the affiliated fund, an amount which significantly
exceeds the total commissions ($184,920.60) received by Tocqueville Securities
in connection with these transactions. The staff of the Securities and Exchange
Commission and the Department of NASD Regulation have been informed of these
events by Tocqueville Securities. See Note 7 regarding contemplated transaction
with the Tocqueville Trust.
Distribution Plan and Service Agreement
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.
(RIGHT COLUMN)
Under a Service Agreement with 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. Distribution
fees for the year ended December 31, 1997 are set forth in the Statement of
Operations of which approximately $39,200 was paid by FSC.
NASD Sanctions and Fines
On February 19, 1998, FSC and two of its executives, without admitting or
denying guilt, entered into an agreement with the National Association of
Securities Dealers Inc. ("NASD") whereby they accepted fines totaling $125,000
and other stipulated sanctions as a result of the NASD's finding that they had
distributed advertising materials of an affiliated mutual fund which violated
NASD rules governing advertisements.
Affiliated Transfer Agent
The Fund compensated Fundamental Shareholder Services, Inc. (FSSI), an
affiliate of the Manager, for the services it provided under a Transfer Agent
and Service Agreement which terminated on September 11, 1997. Transfer agent
fees paid to FSSI for the year ended December 31, 1997 aggregated $28,066.
3. Trustees' Fees
All of the Trustees 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 Trustee 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. The Trustees also received additional
compensation for special services as requested by the Board. Additional
compensation totaled $40,923 pro rated among the funds based on their respective
average net assets.
4. Shares of Beneficial Interest
As of December 31, 1997 there were an unlimited number of shares of
beneficial interest (no par value) authorized and capital paid in amounted to
$13,345,068. Transactions in shares were as follows:
23
<PAGE>
THE CALIFORNIA MUNI FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
(LEFT COLUMN)
Year Ended Year Ended
December 31, 1997 December 31, 1996
----------------- -----------------
Shares Amount Shares Amount
------ ------ ------ ------
Shares sold 32,632,214 $256,708,018 29,177,580 $234,552,576
Shares issued
on
reinvest-
ment of
dividends 51,101 419,765 58,802 472,727
Shares
redeemed (33,097,092) (260,415,184) (28,566,533) (230,620,776)
----------- ------------ ----------- ------------
Net increase
(decrease) (413,777) (3,287,401) 669,849 $ 4,404,527
======== ========== ======= ============
5. Complex Securities and Investment
Transactions
Inverse Floating Rate Notes:
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.
Investment Transactions:
During the year ended December 31, 1997, the cost of purchases and proceeds
from sales of investment securities, other than short-term obligations, were
$9,050,450 and $13,516,911, respectively.
As of December 31, 1997 the net unrealized appreciation of portfolio
securities amounted to $266,147 composed of unrealized appreciation of $744,806
and unrealized depreciation of $478,659.
(RIGHT COLUMN)
6. Line of Credit
The Fund has a line of credit agreement with its custodian bank
collateralized by portfolio securities. Borrowings under this agreement bear
interest linked to the bank's prime rate. The maximum month end and the average
borrowings outstanding during the year ended December 1997, were $2,000,000 and
$664,000, respectively.
7. Agreement and Plan of Reorganization
On July 16, 1997 each of Fundamental's mutual funds (consisting of: New York
Muni Fund, The California Muni Fund, Fundamental Fixed Income Fund: Tax Free
Money Market Series, High Yield Municipal Bond Series, and Fundamental U.S.
Government Strategic Income Fund Series) have adopted, subject to shareholder
approval, an Agreement and Plan of Reorganization (the "Plan") under which each
fund (the "Fundamental Fund") will transfer all of its assets and liabilities to
a newly-created corresponding series of The Tocqueville Trust (the "Tocqueville
Fund") in exchange for shares of the Tocqueville Fund. Shareholders of each
Fundamental Fund will receive shares of the corresponding Tocqueville Fund equal
in value to their shares in the Fundamental Fund. Shareholders will not have to
pay a sales load upon receiving shares of the Tocqueville Fund.
The corresponding Tocqueville Fund will have investment objectives, polices
and restrictions substantially identical to those of the Fundamental Fund. The
Board of Trustees of the Tocqueville Funds is comprised of individuals other
than those who currently serve as Directors (Trustees) of the Fundamental Funds.
Tocqueville Asset Management L.P. is the investment adviser to the Tocqueville
Funds.
A majority of Fundamental's Board Members determined that the Plan would be
in the best interests of shareholders of the Fundamental Funds and recommended
that shareholders of each of the Fundamental Funds approve the Plan at a meeting
anticipated to be held in the Spring of 1998.
24
<PAGE>
THE CALIFORNIA MUNI FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
8. Subsequent Event
At its March 25, 1998 Board of Trustees' meeting, the Board of the Fund
approved the continuation of the Management Agreement through May 30, 1998 in
contemplation of the consummation of the reorganization discussed in Note 7.
The Manager and FSC (on behalf of certain of their directors, officers,
shareholders, employees and control persons) (the "Indemnitees") received
payment during the fiscal year ended December 31, 1997 from the Fund in the
amount of approximately $4,000. Upon learning of the payments, the independent
Board Members of the Funds directed that the Indemnitees return all of the
payments to the Funds or place them in escrow pending their receipt of an
opinion of an independent legal counsel to the effect that the Indemnitees are
entitled to receive them. The Declaration of Trust, Articles of Incorporation
and contracts that call for indemnification specify that no indemnification
shall be provided to a person who shall be found to have engaged in "disabling
conduct" as defined by applicable law. The Indemnities have undertaken to
reimburse the Fund for any indemnification expenses for which it is determined
that they were not entitled to as a result of "disabling conduct" net of any
reimbursements already made to the Fund in the form of fees forgone or other
similar payments. Pending clarification of the legal issues involved, the
Indemnitees have placed into an escrow account $4,000 as of April 30, 1998.
9. Selected Financial Information
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE
(for a share outstanding throughout the year)
Net Asset Value, Beginning of Year ......................... $ 7.79 $ 8.91 $ 7.10 $ 9.49 $ 8.81
------- ------- ------- ------- -------
Income from investment operations:
Net investment income ...................................... .376 .409 .419 .553 .563
Net realized and unrealized gains (losses)
on investments ........................................... .480 (1.120) 1.810 (2.390) .876
------- ------- ------- ------- -------
Total from investment operations .................... .856 (.711) 2.229 (1.837) 1.439
------- ------- ------- ------- -------
Less Distributions:
Dividends from net investment income ....................... (.376) (.409) (.419) (.553) (.563)
Dividends from net realized gains .......................... - - - - (.196)
------- ------- ------- ------- -------
Total distributions ........................................ (.376) (.409) (.419) (.553) (.759)
------- ------- ------- ------- -------
Net Asset Value, End of Year ............................... $ 8.27 $ 7.79 $ 8.91 $ 7.10 $ 9.49
======= ======= ======= ======= =======
Total Return ............................................... 11.33% (8.01%) 32.02% (19.89%) 16.80%
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (000) .............................. 13,832 16,252 12,622 10,558 16,280
Ratios to Average Net Assets:
Interest expense ......................................... .42 .45% .39% .98% .39%
Operating expenses ....................................... 2.95* 2.81% 2.81% 2.50% 1.77%*
------- ------- ------- ------- -------
Total expenses ...................................... 3.37* 3.26% 3.20% 3.48% 2.16%*
======= ======= ======= ======= =======
Net investment income ............................... 4.55%* 4.88% 5.02% 6.80% 6.04%*
Portfolio turnover rate .................................... 70.86% 89.83% 53.27% 15.88% 51.26%
BANK LOANS
Amount outstanding at end of year (000 omitted) ............ $ 275 $ 0 $ 0 $1,292 $3,714
Average amount of bank loans outstanding during the year
(000 omitted) ............................................ $ 664 $ 823 $ 642 $1,620 $ 958
Average number of shares outstanding during the year
(000 omitted) ............................................ 1,609 1,768 1,635 1,711 1,517
Average amount of debt per share during the year ........... $ .41 $ .47 $ .39 $ .95 $ .63
<FN>
*These ratios are after expense reimbursement of .03%, and .50% for the years ended December 31, 1997 and 1993.
</FN>
</TABLE>
25
<PAGE>
INDEPENDENT AUDITOR'S REPORT
The Board of Trustees and Shareholders
The California Muni Fund
We have audited the accompanying statement of assets and liabilities
including the statement of investments of The California Muni Fund as of
December 31, 1997 and the related statements of operations and cash flows for
the year then ended, statements of changes in net assets for each of the two
years in the period then ended, and the 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, 1997 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 The California Muni Fund as of December 31, 1997, the results of its
operations, cash flows, changes in its net assets, and selected financial
information for the periods indicated, in conformity with generally accepted
accounting principles.
See Notes 2 and 8 for information regarding regulatory proceedings and
transactions with affiliates.
S I G N A T U R E
New York, New York
March 2, 1998, except for Note 8 as to which the date is April 30, 1998.
26
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
TAX-FREE MONEY MARKET SERIES
(LEFT COLUMN)
STATEMENT OF ASSETS AND LIABILITIES
December 31, 1997
- --------------------------------------------------------------------------------
ASSETS
Cash ............................................ $ 1,776,944
Investment in securities at value
(cost $75,869,410) ............................ 75,869,410
Receivables:
Fund shares sold .............................. 135,853
Interest ...................................... 270,975
-----------
Total assets .......................... 78,053,182
-----------
LIABILITIES
Payables:
Investment securities purchased ............... 1,103,151
Fund shares redeemed .......................... 63,627,947
Dividends ..................................... 9,321
Due to advisor ................................ 10,866
Accrued expenses ................................ 38,729
-----------
Total liabilities ..................... 64,790,014
-----------
NET ASSETS equivalent to $1.00 per share on
13,270,069 shares of beneficial interest
outstanding (Note 4) ............................. $13,263,168
===========
(RIGHT COLUMN)
STATEMENT OF OPERATIONS
Year Ended December 31, 1997
- --------------------------------------------------------------------------------
INVESTMENT INCOME
Interest income ................... $1,729,572
EXPENSES (Notes 2 and 3)
Investment advisory fees ..........$245,844
Custodian and accounting fees ..... 41,002
Transfer agent fees ............... 84,687
Trustees' fees .................... 10,041
Professional fees ................. 88,996
Distribution fees ................. 245,844
Postage and printing .............. 22,506
Other ............................. 12,291
--------
Total expenses .......... 751,211
Less:
Expenses paid indirectly (Note 6) . (41,002)
Expenses reimbursed by Manager .... (5,982)
--------
Net expenses ............ 704,227
----------
NET INCREASE IN NET ASSETS FROM
OPERATIONS $1,025,345
----------
(FULL COLUMN)
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
Year Ended Year Ended
December 31, December 31,
1997 1996
------------ ------------
INCREASE (DECREASE) IN NET ASSETS FROM:
OPERATIONS
Net investment income .......................... $ 1,025,345 $ 1,161,235
----------- -----------
Net increase in net assets from operations. 1,025,345 1,161,235
DIVIDENDS PAID TO SHAREHOLDERS FROM
Investment income .............................. (1,025,345) (1,161,235)
CAPITAL SHARE TRANSACTIONS (Note 4) .............. 8,642,404 (6,629,783)
----------- -----------
Total (decrease) increase ................. 8,642,404 (6,629,783)
NET ASSETS
Beginning of year .............................. 4,620,764 11,250,547
----------- -----------
End of year .................................... $13,263,168 $ 4,620,764
=========== ===========
See Notes to Financial Statements.
27
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
TAX-FREE MONEY MARKET SERIES
<TABLE>
<CAPTION>
STATEMENT OF INVESTMENTS
December 31, 1997
- ------------------------------------------------------------------------------------------------------------
Principal
Amount Issue o Value
------ ----- -----
<C> <S> <C>
$2,700,000 Ascension Parish, LA, PCR, BASF Wyandote Corp, LOC Bank of Tokyo,
VRDN*, 5.10%, 12/01/15 ..................................................... $2,700,000
1,500,000 Burke County, GA, Development Authority, VRDN*, PCR, Georgia Power Co.
Vogtle Project 5th Series, 5.00%, 7/01/24 .................................. 1,500,000
4,000,000 Burke County, GA, Development Authority, VRDN*, PCR, Georgia Power Co.
Vogtle Project 4th Series, 5.00%, 9/01/25 .................................. 4,000,000
2,800,000 Columbia AL, IDB, PCR Alabama Power Co. Project, VRDN*, Series D, 5.00%,
10/01/22 ................................................................... 2,800,000
75,000 Cuyahoga County, OH, IDR, S & R Playhouse Realty, VRDN*, LOC Marine
Midland Bank, 3.85%, 12/01/09 .............................................. 75,000
200,000 Delaware County, PA, SWDF, Scott Paper Project, Kimberly-Clark Corp
Guaranty, VRDN*, 3.65%, 12/01/18 ............................................ 200,000
200,000 Fulton County, GA, PCR, General Motors Project, VRDN*, 3.90%, 4/01/10 ........ 200,000
200,000 Garfield County, OK, PCR, Oklahoma Gas & Electric Co. Project A, VRDN*,
3.75%, 1/01/25 ............................................................. 200,000
125,000 Genesee County, NY, IDR, Orcon Industries, AMT, LOC Fleet Bank, VRDN*,
4.50%,12/01/98 ............................................................. 125,000
300,000 Illinois Educational Facility Authority, RB, Art Institute of Chicago, Northern
Trust Liquidity, VRDN*, 3.85%, 3/01/27 ..................................... 300,000
300,000 Illinois HFAR, Franciscan Sisters Project, LOC Toronto Dominion Bank,
VRDN*, 3.65%, 9/01/15 ...................................................... 300,000
2,000,000 Illinois HFAR, Healthcorp Affiliates Project, LOC Raborbank Nederland,
VRDN*, 4.05%, 11/01/20 ..................................................... 2,000,000
2,855,000 Jackson County, Miss., PCR, Chevron Corp. Project, VRDN*, 5.00%,
12/01/16 ................................................................... 2,855,000
3,700,000 Los Angeles, CA, Regional Airports Improvement Corp, LOC Societe
Generale, VRDN*, 5.00%, 12/01/25 ........................................... 3,700,000
200,000 McIntosh, AL, PCR, Ciba Geigy Project, LOC Swiss Bank Corp. VRDN*,
3.65%, 12/01/03 ............................................................ 200,000
5,000,000 Midland County, MI, Economic Development Corp, Dow Chemical Project B,
AMT, VRDN*, 5.00%, 12/01/15 ................................................ 5,000,000
300,000 Missouri, PCR, Monsanto Project, VRDN*, 3.70%, 2/01/09 ....................... 300,000
200,000 Missouri, Third Street Building Project, SPA First Chicago, VRDN*, 3.90%,
8/01/99 .................................................................... 200,000
300,000 Montgomery, AL, Baptist Medical Center, Special Care Facilities Financing
Authority, Series H, AMBAC Insured, VRDN*, 3.70%, 12/01/30 ................. 300,000
200,000 Nebraska Higher Education Loan Program, SPA, SLMA, MBIA Insured,
VRDN*, 3.65%, 12/01/15 ..................................................... 200,000
</TABLE>
28
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
TAX-FREE MONEY MARKET SERIES
<TABLE>
<CAPTION>
STATEMENT OF INVESTMENTS (continued)
December 31, 1997
- ------------------------------------------------------------------------------------------------------------
Principal
Amount Issue o Value
------ ----- -----
<C> <S> <C>
$ 5,100,000 New York City, NY, GO, LOC Chase Manhattan Bank, VRDN*, 5.00%, 8/01/23 ...... $5,100,000
2,500,000 New York City, NY, GO, Landesbank Hessen Liquidity, VRDN*, 3.60%, 2/15/20 ... 2,500,000
4,000,000 New York City, NY, Municipal Water Finance Authority, Water & Sewer System
RB, TR Receipts Series 29, The Bank of New York Liquidity, VRDN*,
3.90%, 6/15/30 ............................................................ 4,000,000
40,000 New York City, NY, New PHA, 3.38%, 01/01/98 ................................. 39,740
10,700,000x New York State, DAR, TRS 27, 3.95%, 7/01/24, City University, Floating Rate
Trust Receipts 27, MBIA Insured, Liquidity The Bank of New York ........... 10,700,000
3,000,000 New York State Energy Research & Development Authority, PCR, New York,
State Electric & Gas Co., Series D, LOC Union Bank of Switzerland,
VRDN*, 5.00%, 10/01/29 .................................................... 3,000,000
2,100,000 New York State, Job Development Authority, St. Gtd., Special Purpose Series
A-1 thru A-25, LOC Sumitomo Bank, VRDN*, 5.25%, 3/01/07 ................... 2,100,000
5,200,000 Newport Beach CA, RB, Hoag Memorial Hospital Series B, SPA Bank of
America, 5.00%, 10/01/06 .................................................. 5,200,000
50,000 North Little Rock, AR, New PHA, FGIC Insured, 3.25%, 6/01/98 ................ 49,670
1,100,000 Orange County, CA, Water District Project B, COP, LOC National
Westminister VRDN*, 4.85%, 8/15/15 ........................................ 1,100,000
4,000,000 Princeton, IN, PCR, PSI Energy, Inc., Proj., LOC Morgan Guaranty, VRDN*,
5.10%, 4/01/22 ............................................................ 4,000,000
125,000 Scioto County, OH, HFR, VHA, Central Capital Project, AMBAC Insured,
VRDN*, 3.70%, 12/01/25 .................................................... 125,000
4,500,000 Sweetwater County, WY, PCR, Idaho Power Co. Project Series C, VRDN*,
5.10%, 7/15/26 ............................................................ 4,500,000
1,600,000 Uinta County, WY, PCR, Chevron Corp Project, VRDN*, 5.00%, 8/15/20 .......... 1,600,000
4,500,000 Valdez, AK, Marine Term Revenue, Exxon Pipeline Co. Project A, VRDN*,
5.00%, 12/01/33 ........................................................... 4,500,000
200,000 Wake County, NC, PCR, Carolina Power & Light Project, LOC Sumitomo
Bank, VRDN*, 4.15%, 10/01/15 .............................................. 200,000
-----------
Total Investments (Cost $75,869,410) ........................................ $75,869,410
===========
<FN>
*Variable Rate Demand Notes (VRDN) are instruments whose interest rate changes on a specific date and/or
whose interest rates vary with changes in a designated base rate.
**Cost is the same for Federal income tax purposes.
xThe Fund owns 100% of the security and therefore there is no trading in the security.
</FN>
</TABLE>
29
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
TAX-FREE MONEY MARKET SERIES
STATEMENT OF INVESTMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
Legend
Issue AMBAC American Municipal Bond Assurance Corporation
DAR Dormitory Authority Revenue
AMT Alternative Minimum Tax
GO General Obligation
ETM Escrowed to Maturity
HFAR Health Facilities Authority Revenue
HFR Hospital Facilities Revenue
IDB Industrial Development Board
IDR Industrial Development Revenue
LOC Letter of Credit
MBIA Municipal Bond Insurance Assurance Corporation
PCR Pollution Control Revenue
PHA Public Housing Authority
RB Revenue Bond
SLMA Student Loan Marketing Association
SPA Stand By Bond Purchase Agreement
SWDF Solid Waste Disposal Facility
TRANS Tax Revenue Anticipation Notes
TRS Trust Receipt Series
See Notes to Financial Statements.
30
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
TAX-FREE MONEY MARKET SERIES
NOTES TO FINANCIAL STATEMENTS
December 31, 1997
- --------------------------------------------------------------------------------
1. Significant Accounting Policies
Fundamental Fixed-Income Fund (the Fund) is an open-end management
investment company registered under the Investment Company Act of 1940. The Fund
acts as a series company currently issuing three classes of shares of beneficial
interest, the Tax-Free Money Market Series, the High-Yield Municipal Bond Series
and the Fundamental U.S. Government Strategic Income Fund Series. Each series is
considered a separate entity for financial reporting and tax purposes. The
Tax-Free Money Market Series (the Series) investment objective is to provide as
high a level of current income exempt from federal income tax as is consistent
with the preservaton of capital and liquidity. The following is a summary of
significant accounting policies followed in the preparation of the Series'
financial statements:
Valuation of Securities:
Investments are stated at amortized cost. Under this valuation method, a
portfolio instrument is valued at cost and any premium or discount is amortized
on a constant basis to the maturity of the instrument. Amortization of premium
is charged to income, and accretion of market discount is credited to unrealized
gains. The maturity of investments is deemed to be the longer of the period
required before the Fund is entitled to receive payment of the principal amount
or the period remaining until the next interest adjustment.
Federal Income Taxes:
It is the Series' 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 Series 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 are made annually, as declared by the Fund's Board of Trustees.
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. Realized gains and losses from the sale of
securities are recorded on an identified cost basis.
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.
31
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
TAX-FREE MONEY MARKET SERIES
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
2. Investment Advisory Fees and Other Transactions with Affiliates
Management Agreement
The Fund has a Management Agreement with Fundamental Portfolio Advisors,
Inc. (the Manager). Pursuant to the agreement, the Manager serves as investment
adviser to the Tax-Free Money Market Series and is responsible for the overall
management of the business affairs and assets of the Series subject to the
authority of the Fund's Board of Trustees. In consideration for the services
provided by the Manager, the Series will pay an annual management fee in an
amount equal to 0.5% of the Series' average daily net assets up to $100 million
and decreasing by .02% for each $100 million increase in net assets down to 0.4%
of net assets in excess of $500 million. See Note 8.
SEC Administrative Proceeding Against the Manager
On September 30, 1997, the Securities & Exchange Commission announced that
it instituted public administrative and cease-and desist proceedings against the
Manager, the former portfolio manager of the Fund, the president of the Manager
and Fundamental Service Corporation (FSC), the Fund's Distributor. The
proceeding arises from the alleged failure of an affiliated mutual fund to
disclose the risks of the affiliated series, and of the Manager's failure to
disclose its soft dollar arrangements to the Fund's Board of Trustees. A hearing
has been scheduled with an administrative law judge to determine whether the
allegations are true, and, if so, what remedial action, if any, is appropriate.
Board's Termination of Portfolio Manager
Between April 17, 1997 and July 24, 1997, a representative of the Manager
engaged Tocqueville Securities L.P. ("Tocqueville Securities") an affiliate of
Tocqueville, as agent, to effect eight separate over-the-counter purchase
transactions of municipal obligations on behalf of an affiliated fund. The
Fund's Board has concluded that the commissions paid to Tocqueville Securities
in connection with these transactions (a portion of which was paid to the
representative) were not justified and that the affiliated fund bore unnecessary
expenses as a result of the sale of its securities to another party and the
subsequent repurchase of them through Tocqueville Securities. Based upon a
report initiated by Tocqueville Securities and prepared by the Fund's
independent auditors, and upon the Board's own analysis, the Board directed that
the Manager terminate the representative's services as a portfolio manager. At
the Board's request and in order to reimburse the affiliated fund for all of its
losses, Tocqueville Securities, on September 15, 1997, voluntarily paid $260,000
to the affiliated fund, an amount which significantly exceeds the total
commissions ($184,920.60) received by Tocqueville Securities in connection with
these transactions. The staff of the Securities and Exchange Commission and the
Department of NASD Regulation have been informed of these events by Tocqueville
Securities. See Note 7 regarding contemplated transaction with the Tocqueville
Trust.
Plan of Distribution
The Fund has adopted a Plan of Distribution, pursuant to Rule 12b-1
promulgated under the Investment Company Act of 1940, under which the Series
pays to FSC, an affiliate of the Manager, a fee, which is accrued daily and paid
monthly, at an annual rate of 0.5% of the Series' average daily net assets. The
amounts paid under the plan compensate FSC for the services it provides and the
expenses it bears in distributing the Series' shares to investors. Distribution
fees for the year ended December 31, 1997 are set forth in the Statement of
Operations.
NASD Sanctions and Fines
On February 19, 1998, FSC and two of its executives, without admitting or
denying guilt, entered into an agreement with the National Association of
Securities Dealers Inc. ("NASD") whereby they accepted fines
32
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
TAX-FREE MONEY MARKET SERIES
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
totaling $125,000 and other stipulated sanctions as a result of the NASD's
finding that they had distributed advertising materials of an affiliated mutual
fund which violated NASD rules governing advertisements.
Affiliated Transfer Agent
The Fund compensated Fundamental Shareholder Services, Inc., (FSSI) an
affiliate of the Manager, for the services it provided under a Transfer Agent
and Service Agreement which was terminated on September 11, 1997. Transfer agent
fees paid by the Series to FSSI for the year ended December 31, 1997 amounted to
$17,745.
3. Trustees' Fees
All of the Trustees 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 Trustee 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. The Trustees also received additional
compensation for special services as requested by the Board. Additional
compensation totaled $40,923 pro rated among the funds based on their respective
average net assets.
4. Shares of Beneficial Interest
As of December 31, 1997 there were an unlimited number of shares of
beneficial interest (no par value) authorized and capital paid in amounted to
$13,270,069. Transactions in shares of beneficial interest, all at $1.00 per
share were as follows:
Year ended Year ended
December 31, December 31,
1997 1996
-------------- --------------
Shares sold ..............................$2,566,332,934 $3,547,580,681
Shares issued on reinvestment of dividends 1,048,578 1,042,865
Shares redeemed ..........................(2,558,739,108) (3,555,253,329)
-------------- ----------
Net (decrease) increase ..................$ 8,642,404 (6,629,783)
============== ==========
5. Line of Credit
The Fund has a line of credit agreement with its custodian bank
collateralized by cash and portfolio securities for $500,000. Borrowings under
this agreement bear interest linked to the bank's prime rate. The Series had no
borrowing under the line of credit agreement as of or during the year ended
December 31, 1997.
6. Expenses Paid Indirectly
The Fund has an arrangement with its custodian whereby credits earned on
cash balances maintained at the custodian are used to offset custody charges.
These credits amounted to approximately $41,000 for the year ended December 31,
1997.
7. Agreement and Plan of Reorganization
On July 16, 1997 each of Fundamental's mutual funds (consisting of: New York
Muni Fund, The California Muni Fund, Fundamental Fixed Income Fund: Tax Free
Money Market Series, High Yield Municipal Bond Series, and Fundamental U.S.
Government Strategic Income Fund Series) have adopted, subject to shareholder
approval, an Agreement and Plan of Reorganization (the "Plan") under which each
fund (the "Fundamental Fund") will transfer all of its assets and liabilities to
a newly-created corresponding series of The Tocqueville Trust (the "Tocqueville
Fund") in exchange for shares of the Tocqueville Fund. Shareholders of each
Fundamental Fund will receive shares of the corresponding Tocqueville Fund equal
in value to their shares in the Fundamental Fund. Shareholders will not have to
pay a sales load upon receiving shares of the Tocqueville Fund.
33
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
TAX-FREE MONEY MARKET SERIES
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
The corresponding Tocqueville Fund will have investment objectives, polices
and restrictions substantially identical to those of the Fundamental Fund. The
Board of Trustees of the Tocqueville Funds is comprised of individuals other
than those who currently serve as Directors (Trustees) of the Fundamental Funds.
Tocqueville Asset Management L.P. is the investment adviser to the Tocqueville
Funds.
A majority of Fundamentals' Board Members determined that the Plan would be
in the best interests of shareholders of the Fundamental Funds and recommended
that shareholders of each of the Fundamental Funds approve the Plan at a meeting
anticipated to be held in the Spring of 1998.
8. Subsequent Event
At its March 25, 1998 Board of Trustees' meeting, the Board of the Fund
approved the continuation of the Management Agreement and Distribution Agreement
through May 30, 1998 in contemplation of the consummation of the reorganization
discussed in Note 7.
9. Selected Financial Information
<TABLE>
<CAPTION>
Years Ended December 31,
--------------------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
PER SHARE DATA AND RATIOS
(for a share outstanding throughout the period)
Net Asset Value, Beginning of Year ........................ $1.00 $1.00 $1.00 $1.00 $1.00
Income from investment operations:
Net investment income ..................................... 0.022 0.023 0.026 0.017 0.014
Less Distributions:
Dividends from net investment income ...................... (0.022) (0.023) (0.026) (0.017) (0.014)
Net Asset Value, End of Period ............................ $1.00 $1.00 $1.00 $1.00 $1.00
Total Return .............................................. 2.19% 2.28% 2.60% 1.69% 1.62%
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (000 omitted) ..................... 13,263 4,621 11,251 9,004 5,830
Ratios to Average Net Assets
Expenses .............................................. 1.52%(D)(D) (D) 1.54% 1.53%(D)(D) 0.91%(D) .95%(D)
Net investment income ................................. 2.10% 2.04% 2.43% 1.55% 1.25%
BANK LOANS
Amount outstanding at end of period
(000 omitted) ........................................... $ - $ 218 $ - $ 451 $ 290
Average amount of bank loans outstanding during the period
(000 omitted) ........................................... $ - $ - $ 41 $ 53 $ 111
Average number of shares outstanding during the period
(000 omitted) ........................................... 48,801 56,876 44,432 56,267 25,786
Average amount of debt per share during the period ........ $ - $ - $ .001 $ .001 $ .004
<FN>
(D)These ratios are after expense reimbursement of .02%, .44% and .67%, for each of the years ended December 31, 1997, 1994 and
1993, respectively.
(D)(D)These ratios would have been 1.44%, 1.40% and 1.35% net of expense offsets of .08%, .14% and .18% for the years ended December
31, 1997, 1996 and 1995, respectively.
</FN>
</TABLE>
34
<PAGE>
INDEPENDENT AUDITOR'S REPORT
The Board of Trustees and Shareholders
Tax-Free Money Market Series of
Fundamental Fixed-lncome Fund
We have audited the accompanying statement of assets and liabilities,
including the statement of investments, of the Tax-Free Money Market Series of
Fundamental Fixed-lncome Fund as of December 31, 1997 and the related statement
of operations for the year then ended, the statement of changes in net assets
for each of the two years in the period then ended, and the 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, 1997 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 presenation. We believe that our audits provide a reasonable basis for
our opinion.
In our opinion, the financial statement and selected financial information
referred to above present fairly, in all material respects, the financial
position of the Tax-Free Money Market Series of Fundamental Fixed-Income Fund as
of December 31, 1997, and the results of its operations, changes in net assets,
and selected financial information for the periods indicated, in conformity with
generally accepted accounting principles.
See Note 2 for information regarding regulatory proceedings and transactions
with affiliates.
S I G N A T U R E
New York, New York
March 2, 1998, except for Note 8 as to which the date is March 25, 1998.
35
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
HIGH-YIELD MUNICIPAL BOND SERIES
(LEFT COLUMN)
STATEMENT OF ASSETS AND LIABILITIES
December 31, 1997
- --------------------------------------------------------------------------------
ASSETS
Investment in securities at value (Note 5)
(cost $2,739,553) ................................... $2,832,290
Interest receivable ................................... 40,346
Receivable for fund shares sold ....................... 463,520
----------
Total assets ............................. 3,336,156
----------
LIABILITIES
Payable for investments purchased ..................... 615,650
Accrued expenses ...................................... 11,735
Bank overdraft payable ................................ 452,313
Dividend payable ...................................... 1,233
Payable for fund shares redeemed ...................... 240
----------
Total liabilities ........................ 1,081,171
----------
NET ASSETS consisting of:
Accumulated net realized
loss .................................... $ (158,714)
Unrealized appreciation
of securities ........................... 92,737
Paid-in-capital applicable to
299,472 shares of
beneficial interest
(Note 4) ................................ 2,320,962
-----------
$2,254,985
==========
NET ASSET VALUE PER SHARE ............................... $ 7.53
==========
(RIGHT COLUMN)
STATEMENT OF OPERATIONS
Year Ended December 31, 1997
- --------------------------------------------------------------------------------
INVESTMENT INCOME
Interest income .................... $140,428
EXPENSES (Notes 2 and 3)
Investment advisory fees ........... $ 14,600
Custodian and accounting fees ...... 43,046
Transfer agent fees ................ 8,970
Trustee fees ....................... 2,413
Distribution fees .................. 9,125
Professional fees .................. 21,443
Postage and printing ............... 8,077
Other .............................. 3,583
--------
Total expenses .............. 111,257
Less: Expenses waived or reimbursed
by the manager and affiliates .... (64,243)
--------
Net expenses ................ 47,014
--------
Net investment income ....... 93,414
REALIZED AND UNREALIZED GAIN
(LOSS) ON INVESTMENTS
Net realized gain on investments ... 17,891
Change in unrealized appreciation of
investments for the year ........... 166,782
--------
Net gain on investments ..... 184,673
--------
NET INCREASE IN NET ASSETS FROM
OPERATIONS ......................... $278,087
========
(FULL COLUMN)
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
Years Ended December 31, 1997 and 1996
- --------------------------------------------------------------------------------------------------------
1997 1996
INCREASE (DECREASE) IN NET ASSETS FROM: ---- ----
<S> <C> <C>
OPERATIONS
Net investment income ................................................... $ 93,414 $ 108,670
Net realized gain on investments ........................................ 17,891 22,294
Unrealized (depreciation) appreciation of investments for the year ...... 166,782 (22,733)
--------- ---------
Net increase in net assets from operations ....................... 278,087 108,231
DIVIDENDS PAID TO SHAREHOLDERS FROM
Net investment income ................................................... (93,414) (108,670)
CAPITAL SHARE TRANSACTIONS (Note 4) ....................................... 212,100 401,216
--------- ---------
Total increase ................................................... 396,773 400,777
NET ASSETS:
Beginning of year ....................................................... 1,858,212 1,457,435
--------- ---------
End of year ............................................................. $2,254,985 $1,858,212
========== ==========
</TABLE>
See Notes to Financial Statements.
38
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
HIGH-YIELD MUNICIPAL BOND SERIES
<TABLE>
<CAPTION>
STATEMENT OF INVESTMENTS
December 31, 1997
- ------------------------------------------------------------------------------------------------------------
Principal
Amount Issue o Value
------ ----- -----
<C> <S> <C>
$ 40,000 Allegheny County, PA, IDA, AFR, USAir Inc., 8.88%, 3/01/21 ................................$ 40,782
40,000 Brookhaven, NY, IDA, CFR, Dowling College, 6.75%, 3/01/23 ................................. 42,730
250,000 Colorado Health Facilities Authority, RHR, Liberty Heights Project, ETM, CAB, 7/15/24 ..... 60,317
100,000 Corona, CA, COP, Vista Hospital Systems Inc. 8.38%, 7/01/11 ............................... 109,361
100,000 Escambia, FL, Housing Corporation, Royal Arms Project, Series B, 9.00%, 7/01/16 ........... 103,202
70,000 Florence County, SC, IDA, RB, Stone Container Corp., 7.38%, 2/01/07 ....................... 74,070
500,000 Foothill / Eastern TCA, Toll Road Revenue, CAB, 1/01/26 ................................... 106,500
25,000 Hildago County, TX, Health Services, Mission Hospital Inc Project, 6.88%, 8/15/26 ......... 26,567
50,000+ Illinois Development Financial Authority, Solid Waste Disposal, RB, Ford Heights Waste
Tire Project, 7.88%, 4/01/11 ............................................................ 10,582
45,000 Illinois Health Facilities Authority, Midwest Physician Group Ltd Project, RB, 8.13%,
11/15/19 ................................................................................ 48,833
35,000 Indianapolis, IN, RB, Robin Run Village Project, 7.63%, 10/01/22 .......................... 38,463
50,000 Joplin, MO, IDA, Hospital Facilities Revenue, Tri State Osteopathic, 8.25%, 12/15/14 ...... 53,674
50,000 Los Angeles, CA, Regional Airport, Continental Airlines, AMT, 9.25%, 8/01/24 .............. 59,104
630,000 Marengo County, AL, Port Authority Facilities, RB, CAB, Series A, 3/01/19 ................. 141,252
75,000 Maryland Economic Development Corporation, Nursing Facilities Mortgage RB,
Ravenwood Healthcare, Series A, 8.38%, 8/01/26 .......................................... 78,529
85,000 Montgomery County, TX, Health Facilities Development Corp., The Woodlands Medical
Center, 8.85%, 8/15/14 .................................................................. 93,171
100,000 New York City, NY, Municipal Water Finance Authority, Water & Sewer RB, TR Receipts
Series 29, 6.56%, 6/15/30 ............................................................... 96,974
100,000 New York State, DAR, City University System Residual Int Tr Recpts 27, MBIA Insured,
Liquidity The Bank of New York, 8.22%, 7/01/24 .......................................... 109,979
100,000 New York State, DAR, City University System Residual Int Tr Recpts 28, AMBAC Insured,
Liquidity The Bank of New York, 7.63%, 7/01/25 .......................................... 105,279
5,000,000 New York State, DAR, CAB, FHA Presbyterian Hospital Series A, AMBAC Insured,
8/15/36 ................................................................................. 643,400
100,000#x Niagara Falls, NY, URA, Old Falls Street Improvement Project, 11.00%, 5/01/09 ............. 35,795
50,000 Northeast, TX, Hospital Authority Revenue, Northeast Medical Center, 7.25%, 7/01/22 ....... 57,455
75,000 Perdido, FL, Housing Corporation, RB, Series B. 9.25%, 11/01/16 ........................... 75,787
30,000 Philadelphia, PA, HEHA, Graduate Health Systems Project, 7.25%, 7/01/18 ................... 31,468
60,000 Port Chester, NY, IDA, Nadal Industries Inc Project, 7.00%, 2/01/16 ....................... 61,876
75,000 San Antonio, TX, HFC, Multi Family Housing, RB, Agape Metro Housing Project, Series
A, 8.63%, 12/01/26 ...................................................................... 75,989
75,000 San Bernardino, CA, San Bernardino Community Hospital, RB, 7.88%, 12/01/19 ................ 77,531
100,000 San Bernardino County, CA, COP, Series PA-38, MBIA Insured, IFRN*, 11.92%, 7/01/16,
Rule 144A Security (restricted as to resale except to qualified institutions) ........... 113,555
</TABLE>
39
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
HIGH-YIELD MUNICIPAL BOND SERIES
<TABLE>
<CAPTION>
STATEMENT OF INVESTMENTS
December 31, 1997
- ------------------------------------------------------------------------------------------------------------
Principal
Amount Issue o Value
------ ----- -----
<C> <S> <C>
$ 35,000 San Joaquin Hills, CA, TCA, Toll Road Revenue, 7.00%, 1/01/30 ............................$ 40,033
60,000x San Jose, CA, Redevelopment Agency, Tax Allocation Bonds, IFRN*, MBIA Insured,
5.83%, 8/01/16, MBIA Insured, Rule 144A Security (restricted as to resale except to
qualified institutions) ................................................................ 61,304
150,000 Savannah, GA Economic Development Authority Revenue, ETM, CAB, 12/01/21 .................. 39,940
45,000 Schuylkill County, PA, IDA Resouce Recovery, Schuylkill Energy Res Inc. AMT, 6.50%,
1/01/10 ................................................................................ 46,040
15,000(D)# Troy, NY, IDA, Hudson River Project, 11.00%, 12/01/94 .................................... 6,150
75,000(D) (D)(D)Villages at Castle Rock, CO, Metropolitan District #4, 8.50%, 6/01/31 .................... 39,138
25,000 Wayne, MI, AFR, Northwest Airlines Inc. 6.75%, 12/01/15 .................................. 27,460
----------
Total Investments (Cost $2,739,553)** ....................................................$2,832,290
==========
<FN>
** Cost is approximately the same for income tax purposes.
* 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 December 31, 1997.
# The value of this non-income producing security has been estimated by persons designated by the Fund's Board of
Trustees using methods the Trustees believe reflect fair value. See note 5 to the financial statements.
+ Non-income producing security.
(D)(D) Security in default. Interest paid on cash flow basis. Rate shown as of December 31, 1997.
x The Fund or its affiliates owns 100% of the security and therefore there is no trading in the security.
</FN>
</TABLE>
Legend
o Issue AFR Airport Facilities Revenue
AMBAC American Municipal Bond Assurance Corporation
AMT Subject to Alternative Minimum Tax
CAB Capital Appreciation Bond
COP Certificate of Participation
CFR Civic Facility Revenue
DAR Dorm Authority Revenue
ETM Escrowed to Maturity
FHA Federal Housing Authority
HEHA Higher Education and Health Authority
HFC Housing Finance Corporation
IDA Industrial Development Authority
MBIA Municipal Bond Insurance Assurance Corporation
RB Revenue Bond
RHR Retirement Housing Revenue
TCA Transportation Corridor Agency
URA Urban Renewal Agency
See Notes to Financial Statements.
40
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
HIGH-YIELD MUNICIPAL BOND SERIES
NOTES TO FINANCIAL STATEMENTS
December 31, 1997
- --------------------------------------------------------------------------------
1. Significant Accounting Policies
Fundamental Fixed-Income Fund (the Fund) is an open-end management
investment company registered under the Investment Company Act of 1940. The Fund
operates as a series company currently issuing three classes of shares of
beneficial interest, the Tax-Free Money Market Series, the High-Yield Municipal
Bond Series and the Fundamental U.S. Government Strategic Income Fund Series
(the Series). Each series is considered a separate entity for financial
reporting and tax purposes. The High-Yield Municipal Bond Series (the Series)
seeks to provide a high level of current income exempt from federal income tax
through investment in a portfolio of lower quality municipal bonds, generally
referred to as "junk bonds." These bonds are considered speculative because they
involve greater price volatility and risk than higher rated bonds. The following
is a summary of significant accounting policies followed in the preparation of
the Series' financial statements:
Valuation of Securities: 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. 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.
Federal Income Taxes: It is the Series' 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 Series declares dividends daily from its net investment
income and pays such dividends on the last business day of each month.
Distributions of net capital gain, if any, realized on sales of investments are
anticipated to be made before the close of the Series' fiscal year, as declared
by the Board of Trustees. 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. Realized gain and loss from the sale of
securities are recorded on an identified cost basis. Original issue discounts
and premiums are amortized over the life of the respective securities. Premiums
are amortized and charged against interest income and original issue discounts
are accreted to interest income.
41
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
HIGH-YIELD MUNICIPAL BOND SERIES
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
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.
2. Investment Advisory Fees and Other Transactions with Affiliates
Management Agreement
The Fund has a Management Agreement with Fundamental Portfolio Advisors,
Inc. (the Manager). Pursuant to the agreement, the Manager serves as investment
adviser to the High-Yield Municipal Bond Series and is responsible for the
overall management of the business affairs and assets of the Series subject to
the authority of the Fund's Board of Trustees. In consideration for the services
provided by the Manager, the Series will pay an annual management fee in an
amount equal to 0.8% of the Series' average daily net assets up to $100 million
and decreasing by .02% for each $100 million increase in net assets down to 0.7%
of net assets in excess of $500 million. The Manager voluntarily waived fees and
reimbursed expenses of $49,643 for the year ended December 31, 1997. See Note 7.
SEC Administrative Action Against The Manager
On September 30, 1997, the Securities & Exchange Commission announced that
it instituted public administrative and cease-and desist proceedings against the
Manager, the former portfolio manager of the Fund, the president of the Manager
and Fundamental Service Corporation (FSC) the Funds distributor. The proceeding
arises from the alleged failure of an affiliated mutual fund to disclose the
risks of the Fund, and of the Manager's failure to disclose its soft dollar
arrangements to the Fund's Board of Trustees. A hearing has been scheduled to
determine whether the allegations are true, and, if so, what remedial action, if
any, is appropriate.
Board's Termination of Portfolio Manager
Between April 17, 1997 and July 24, 1997, a representative of the Manager
engaged Tocqueville Securities L.P. ("Tocqueville Securities") an affiliate of
Tocqueville, as agent, to effect eight separate over-the-counter purchase
transactions of municipal obligations on behalf of an affiliated fund. The
Fund's Board has concluded that the commissions paid to Tocqueville Securities
in connection with these transactions (a portion of which was paid to the
representative) were not justified and that the affiliated fund bore unnecessary
expenses as a result of the sale of its securities to another party and the
subsequent repurchase of them through Tocqueville Securities. Based upon a
report initiated by Tocqueville Securities and prepared by the Fund's
independent auditors, and upon the Board's own analysis, the Board directed that
the Manager terminate the representative's services as a portfolio manager. At
the Board's request and in order to reimburse the affiliated fund for all of its
losses, Tocqueville Securities, on September 15, 1997, voluntarily paid $260,000
to the affiliated fund, an amount which significantly exceeds the total
commissions ($184,920.60) received by Tocqueville Securities in connection with
these transactions. The staff of the Securities and Exchange Commission and the
Department of NASD Regulation have been informed of these events by Tocqueville
Securities. See note 7 regarding contemplated transaction with the Tocqueville
Trust.
42
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
HIGH-YIELD MUNICIPAL BOND SERIES
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
Plan of Distribution
The Fund has adopted a Plan of Distribution, pursuant to Rule 12b-1
promulgated under the Investment Company Act of 1940, under which the Series
pays to FSC, an affiliate of the Manager, a fee, which is accrued daily and paid
monthly, at an annual rate of 0.5% of the Series' average daily net assets.
Amounts paid under the plan are to compensate FSC for the services it provides
and the expenses it bears in distributing the Series' shares to investors. FSC
has waived all fees in the amount of $9,125 for the year ended December 31,
1997.
NASD Sanctions and Fines
On February 19, 1998, FSC and two of its executives, without admitting or
denying guilt, entered into an agreement with the National Association of
Securities Dealers, Inc. ("NASD") whereby they accepted fines totaling $125,000
and other stipulated sanctions as a result of the NASD's finding that they had
distributed advertising materials of an affiliated mutual fund which violated
NASD rules governing advertisements.
Affiliated Transfer Agent
The Fund compensated Fundamental Shareholder Services, Inc. (FSSI), an
affiliate of the Manager, for the services it provided under a Transfer Agent
and Service Agreement which was terminated on September 11, 1997. Transfer agent
fees paid by the Series to FSSI amounted to $5,012.
3. Trustees' Fees
All of the Trustees 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 Trustee 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. The Trustees also received additional
compensation for special services as requested by the Board. Additional
compensation totaled $40,923 pro rated among the funds based on their respective
average net assets.
4. Shares of Beneficial Interest
As of December 31, 1997, there were an unlimited number of shares of
beneficial interest (no par value) authorized and capital paid in amounted to
$2,320,962. Transactions in shares of beneficial interest were as follows:
<TABLE>
<CAPTION>
Year Ended Year Ended
December 31, 1997 December 31, 1996
----------------------- --------------------------
Shares Amount Shares Amount
--------- ---------- --------- -----------
<S> <C> <C> <C> <C>
Shares sold .................................... 2,941,324 20,530,136 1,912,593 $12,834,095
Shares issued on reinvestment of dividends ..... 11,426 79,995 11,925 80,347
Shares redeemed ................................ (2,924,097) (20,398,031) (1,859,933) (12,513,226)
---------- ----------- ---------- -----------
Net increase ................................... 28,653 $ 212,100 64,585 $ 401,216
========== =========== ========== ===========
</TABLE>
5. Investment Transactions
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
43
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
HIGH-YIELD MUNICIPAL BOND SERIES
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
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.
The Fund invests in lower rated or unrated ("junk") securities which are
more likely to react to developments affecting market risk and credit risk than
would higher rated securities which react primarily to interest rate
fluctuations. The Fund held securities in default with an aggregate value of
$91,665 at December 31, 1997 (4.1% of net assets). As indicated in the Statement
of Investments, the Troy, NY Industrial Revenue Bond, 11% due December 1, 2014
with a par value of $15,000 and a value of $6,150 at December 31, 1997 has been
estimated in good faith under methods determined by the Board of Trustees.
The Fund owns 1.7% of a Niagara Falls New York Urban Renewal Agency 11%
Bond ("URA Bond") due to mature on May 1, 2009 which has missed interest and
sinking fund payments. An affiliated investment company owns 98.3% of this bond
issue. The Fund was party to an agreement whereby certain related bonds owned by
an affiliate were to be subject to repayment under a debt assumption agreement.
The agreement allowed the affiliate to allocate a portion of the debt services
it receives to the URA Bond. In exchange the Fund forfeited certain rights it
had as holder of the URA bond. The debt assumption was not completed and the
timing and amount of debt service payments is uncertain. The value of this bond
is $35,795, and is valued at 35.80% of face value at December 31, 1997 under
methods determined by the Board of Trustees.
During the year ended December 31, 1997, the cost of purchases and proceeds
from sales of investment securities, other than short-term obligations, were
$2,982,245 and $2,610,195, respectively.
As of December 31, 1997 net unrealized appreciation of portfolio securities
amounted to $92,737, composed of unrealized appreciation of $225,341 and
unrealized depreciation of $132,604.
The Fund has capital loss carryforwards to offset future capital gains as
follows:
Amount Expiration
------- ----------
$23,500 12/31/1998
22,200 12/31/1999
20,500 12/31/2000
54,300 12/31/2002
40,000 12/31/2003
--------
$160,500
========
6. Agreement and Plan of Reorganization
On July 16, 1997 each of Fundamental's mutual funds (consisting of: New York
Muni Fund, The California Muni Fund, Fundamental Fixed Income Fund: Tax Free
Money Market Series, High Yield Municipal Bond Series, and Fundamental U.S.
Government Strategic Income Fund Series) have adopted, subject to shareholder
approval, an Agreement and Plan of Reorganization (the "Plan") under which each
fund (the "Fundamental Fund") will transfer all of its assets and liabilities to
a newly-created corresponding series of The Tocqueville Trust (the "Tocqueville
Fund") in exchange for shares of the Tocqueville Fund. Shareholders of each
Fundamental Fund will receive shares of the corresponding Tocqueville Fund equal
in value to their shares in the Fundamental Fund. Shareholders will not have to
pay a sales load upon receiving shares of the Tocqueville Fund.
44
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
HIGH-YIELD MUNICIPAL BOND SERIES
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
The corresponding Tocqueville Fund will have investment objectives, polices
and restrictions substantially identical to those of the Fundamental Fund. The
Board of Trustees of the Tocqueville Funds is comprised of individuals other
than those who currently serve as Directors (Trustees) of the Fundamental Funds.
Tocqueville Asset Management L.P. is the investment adviser to the Tocqueville
Funds.
A majority of Fundamental's Board members determined that the Plan would be
in the best interests of shareholders of the Fundamental Funds and recommended
that shareholders of each of the Fundamental Funds approve the Plan at a meeting
anticipated to be held in the Spring of 1998.
7. Subsequent Event
At its March 25, 1998 Board of Trustees' meeting, the Board of the Fund
approved the continuation of the Management Agreement and Distribution Agreement
through May 30, 1998 in contemplation of the consummation of the reorganization
discussed in Note 6.
8. Selected Financial Information
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------------
1997 1996 1995 1994 1993
PER SHARE OPERATING PERFORMANCE ---- ---- ---- ---- ----
(for a share outstanding throughout the period)
<S> <C> <C> <C> <C> <C>
Net asset value, beginning of period $6.86 $7.07 $5.92 $7.27 $7.30
----- ----- ----- ----- -----
Income from investment operations:
Net investment income 0.37 0.47 0.34 0.43 0.39
Net realized and unrealized gains (losses) on investments 0.67 (0.21) 1.15 1.35) (0.03)
----- ----- ----- ----- -----
Total from investment operations 1.04 0.26 1.49 (0.92) 0.36
----- ----- ----- ----- -----
Less distributions:
Dividends from net investment income (0.37) (0.47) (0.34) (0.43) (0.39)
----- ----- ----- ----- -----
Net asset value, end of period $7.53 $6.86 $7.07 $5.92 $7.27
===== ===== ===== ===== =====
Total Return 15.71% 4.05% 25.70% (12.92%) 5.11%
RATIOS/SUPPLEMENTAL DATA
Net assets, end of period (000 omitted) 2,255 1,858 1,457 979 1,087
Ratios to average net assets:
Expenses* 2.58% 2.49% 2.50% 2.50% 2.50%
Net investment income* 5.12% 6.85% 5.15% 6.70% 5.40%
Portfolio turnover rate 3.79% 139.26% 43.51% 75.31% 84.89%
BANK LOANS
Amount outstanding at end of period (000 omitted) $ - 228 379 $ - $ -
Average amount of bank loans outstanding during the period
(000 omitted) $ - $ - 61 $ - $ -
Average number of shares outstanding during the period
(000 omitted) 260 237 183 156 145
Average amount of debt per share during the period $ - $ - $0.33 $ - $ -
<FN>
**These ratios are after expense reimbursements of 3.52%, 4.59%, 6.22%, 6.20% and 5.76%, for each of the
years ended December 31, 1997, 1996, 1995, 1994 and 1993, respectively.
</FN>
</TABLE>
45
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
HIGH-YIELD MUNICIPAL BOND SERIES
INDEPENDENT AUDITOR'S REPORT
- --------------------------------------------------------------------------------
To the Board of Trustees and Shareholders
Fundamental Fixed-Income Fund
High-Yield Municipal Bond Series
We have audited the accompanying statement of assets and liabilities, including
the statement of investments, of Fundamental Fixed-Income Fund High-Yield
Municipal Bond Series as of December 31, 1997, and the related statements of
operations for the year then ended, the statement of changes in net assets for
each of the two years then ended and the 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 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 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, 1997 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 Fundamental Fixed-Income Fund High-Yield Municipal Bond Series as of
December 31, 1997, and the results of its operations, changes in net assets, and
selected financial information for the periods indicated, in conformity with
generally accepted accounting principles.
See Note 2 for information regarding regulatory proceedings and transactions
with affiliates.
New York, New York
March 2, 1998, except for Note 7 as to which the date is March 25, 1998.
46
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
(LEFT COLUMN)
STATEMENT OF ASSETS AND LIABILITIES
December 31, 1997
- --------------------------------------------------------------------------------
ASSETS
Investment in securities, at value
(cost $13,023,839) (Notes 5 and 6) $15,023,792
Receivables:
Interest 67,739
Fund shares sold ................ 4,001
-----------
Total assets ................ 15,095,532
-----------
LIABILITIES
Loans ............................. 225,907
Options written at value
(premiums received $18,801)
(Note 5) ........................ 10,625
Securities sold subject to
repurchase (Note 6) ............. 4,744,054
Payables:
Dividends declared .............. 11,104
Shares redeemed ................. 9,353
Variation margin ................ 41,563
Accrued expenses ................ 22,580
-----------
Total liabilities ........... 5,065,186
-----------
NET ASSETS consisting of:
Accumulated net realized loss ..... $(17,833,560)
Unrealized appreciation of
securities ...................... 1,999,953
Unrealized appreciation of
options written ................. 8,176
Unrealized depreciation of open
future contracts ................ (103,270)
Paid-in-capital applicable to
7,116,688 shares of beneficial
interest ........................ 25,959,047
-----------
$10,030,346
===========
NET ASSET VALUE PER SHARE $1.41
=====
(RIGHT COLUMN)
STATEMENT OF OPERATIONS
Year Ended December 31, 1997
- --------------------------------------------------------------------------------
INVESTMENT INCOME
Interest income, net of $315,574
of interest expense ...................... $1,812,306
EXPENSES (Notes 2, 3 and 6)
Investment advisory fees ................. $ 88,681
Custodian and accounting fees ............ 61,165
Transfer agent fees ...................... 71,081
Professional fees ........................ 563,154
Trustees' fees ........................... 5,458
Printing and postage ..................... 9,502
Interest on bank borrowing ............... 324,872
Distribution expenses .................... 29,560
Other .................................... 14,012
---------
Total expense ...................... 1,167,485
Less: Expenses waived or
reimbursed by the
manager and affiliates ........... (162,637)
---------
Net expenses ....................... 1,004,848
----------
Net investment income .............. 807,458
----------
REALIZED AND UNREALIZED GAIN
(LOSS) ON INVESTMENTS
Net realized gain (loss) on:
Investments ............................ 1,027,730
Future and options on futures .......... (956,715) 71,015
---------
Change in unrealized appreciation
(depreciation) of investments,
options and futures contracts
for the period:
Investments .......................... 66,558
Open option contracts
written ............................ (312)
Open futures contracts ............... (339,726) (273,480)
--------- ----------
Net loss on investments .................. (202,465)
----------
NET INCREASE IN NET ASSETS
FROM OPERATIONS .......................... $ 604,993
=========
<PAGE>
(FULL COLUMN)
<TABLE>
<CAPTION>
STATEMENTS OF CHANGES IN NET ASSETS
- ----------------------------------------------------------------------------------------------------------
Year Ended Year Ended
December December
31, 1997 31, 1996
-------- --------
INCREASE (DECREASE) IN NET ASSETS FROM:
OPERATIONS
<S> <C> <C>
Net investment income ...................................................... $ 807,458 $ 1,254,448
Net realized gain on investments ........................................... 71,015 433,173
Unrealized (depreciation) on investments, options and futures contracts .... (273,480) (1,070,217)
----------- -----------
Net increase in net assets from operations ........................ 604,993 617,404
DIVIDENDS PAID TO SHAREHOLDERS FROM
Investment income .......................................................... (807,458) (1,254,448)
CAPITAL SHARE TRANSACTIONS (Note 4) .......................................... (2,991,556) (1,332,818)
----------- -----------
Total decrease .................................................... (3,194,021) (1,969,862)
NET ASSETS
Beginning of year .......................................................... 13,224,367 15,194,229
----------- -----------
End of year ................................................................ $10,030,346 $13,224,367
=========== ===========
</TABLE>
See Notes to Financial Statements.
49
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
STATEMENT OF CASH FLOWS
<TABLE>
Year Ended December 31, 1997
- ---------------------------------------------------------------------------------------------
INCREASE (DECREASE) IN CASH
CASH FLOWS FROM OPERATING ACTIVITIES
<S> <C>
Net increase in net assets from operations ................................ $ 604,993
Adjustments to reconcile net increase in net assets from operations to
net cash provided by operating activities:
Purchase of investment securities ......................................... (2,228,044)
Proceeds on sale of securities ............................................ 8,312,593
Premiums received for options written ..................................... 633,904
Premiums paid to close options written .................................... (977,704)
Decrease in interest receivable ........................................... 28,925
Decrease in variation margin receivable ................................... 218,791
Decrease in accrued expenses .............................................. (93,909)
Net accretion of discount on securities ................................... (187,473)
Net realized (gain) loss:
Investments ............................................................. (1,027,730)
Options written ......................................................... 309,113
Unrealized appreciation on securities and options written for the period .. (66,246)
----------
Total adjustments ....................................................... 4,922,220
----------
Net cash provided by operating activities ............................... 5,527,213
----------
CASH FLOWS FROM FINANCING ACTIVITIES:*
Net repayments on sale of securities sold subject to repurchase ............. (1,617,934)
Net borrowings of note payable .............................................. (49,281)
Proceeds on shares sold ..................................................... 728,056
Payment on shares repurchased .............................................. (4,356,318)
Cash dividends paid ......................................................... (231,736)
----------
Net cash used in financing activities ................................... (5,527,213)
----------
Net increase in cash .................................................... 0
CASH AT BEGINNING OF YEAR .................................................. 0
----------
CASH AT END OF YEAR ......................................................... $ 0
==========
</TABLE>
*Non-cash financing activities not included herein consist of reinvestment of
dividends of $642,058. Cash payments for interest expense totaled $333,352 for
the period.
STATEMENT OF OPTIONS WRITTEN
<TABLE>
<CAPTION>
December 31, 1997
- ---------------------------------------------------------------------------------------------
Number of Expiration
Contracts++ Options Written Month Value
----------- --------------- ---------- -----
<C> <S> <C> <C>
40 U.S. Treasury Bonds, Call @ $123 ........... February 1998 $10,625
-------
$10,625
=======
</TABLE>
++Each contract represents $100,000 face value of U.S. Treasury Bond Futures.
See Notes to Financial Statements.
50
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
STATEMENT OF INVESTMENTS
December 31, 1997
- --------------------------------------------------------------------------------
Principal Interest Maturity
Amount Rate o Date Value
------ ------ ---- -----
United States Treasury Securities-49.03%
United States Treasury Bonds
85,000(2) 0.00% ZCS 11/15/03 $ 60,395
4,300,000(2) 0.00% PS 11/15/06 2,574,333
3,500,000(5) 9.00% 11/15/18 4,731,566
----------
(Cost $6,403,170) 7,366,294
----------
United States Agency Backed Securities-50.97%
Federal Home Loan Mortgage Corporation
843,718(1) 9.25% 08/15/23 928,005
285,124(1) 6.50% Z-Bond 12/15/23 261,907
750,000 13.59% IFRN 05/15/24 858,060
209,406(2) 15.30% IFRN 05/25/24 251,287
180,000 12.00% TTIB 03/15/27 180,079
FNMA-Federal National Mortgage Assoc.
356,450(4)(1) 15.50% TTIB 03/25/23 381,224
3,671,204(4)(1) 15.30% TTIB 03/25/23 4,185,686
490,760(4) 14.49% TTIB 05/25/23 544,900
----------
7,591,148
----------
FICO-Financing Corporation (U.S. Government Agency)
100,000 0.00% ZCS 11/02/12 39,284
100,000 0.00% ZCS 08/03/18 27,066
----------
(Cost $6,620,669) 66,350
----------
Total investments (Cost $13,023,839)(3) $15,023,792
----------
(1) Segregated for securities sold subject to repurchase (Note 6)
(2) Segregated, in whole or part, as initial margin for futures contracts
(Note 5)
(3) Cost is the same for Federal income tax purposes
(4) The Fund owns 100% of the security or tranche. See Note 5 to the financial
statements.
(5) Securities sold subject to repurchase (Note 6).
o Legend-IFRN: Inverse Floating Rate Notes 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 December
31, 1997.
TTIB: Two-Tiered Index Floating Rate Bonds are instruments with two
coupon levels. The "first tier" coupon is at a fixed rate,
effective as long as the underlying index is at or below the
strike level. At the strike level, the "second tier" coupon
resets the bond to an inverse floating rate note. See discussion
above. Coupons shown are at December 31, 1997.
ZCS: Zero Coupon Securities are instruments whose interest and
principal are paid at maturity.
Z Bond: A Z Bond is an instrument whose monthly interest coupon is paid
at a fixed rate in additional principal. Principal is paid at
maturity.
PS: Principal Stripped Bonds are instruments whose principle and
coupon have been separated and sold separately.
See Notes to Financial Statements.
51
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
NOTES TO FINANCIAL STATEMENTS
December 31, 1997
- --------------------------------------------------------------------------------
1. Significant Accounting Policies
Fundamental Fixed-Income Fund (the Fund) is an open-end management
investment company registered under the Investment Company Act of 1940. The Fund
operates as a series company currently issuing three classes of shares of
beneficial interest, the Tax-Free Money Market Series, the High-Yield Municipal
Bond Series and the Fundamental U.S. Government Strategic Income Fund Series
(the Series). The objective of the Series is to provide high current income with
minimum risk of principal and relative stability of net asset value. The Series
seeks to achieve its objective by investing primarily in U.S. Government
Obligations. U.S. Government Obligations consist of marketable securities issued
or guaranteed by the U.S. Government, its agencies or instrumentalities
(hereunder collectively referred to as "Government Securities"). The Series also
uses leverage in seeking to achieve its investment objective. Each series is
considered a separate entity for financial reporting and tax purposes.
Valuation of Securities-The Series 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 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. 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 reflect fair value.
Futures 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.
Repurchase Agreements-The Series may invest in repurchase agreements, which
are agreements pursuant to which securities are acquired from a third party with
the commitment that they will be repurchased by the seller at a fixed price on
an agreed upon date. The Series may enter into repurchase agreements with banks
or lenders meeting the creditworthiness standards established by the Board of
Trustees. The resale price reflects the purchase price plus an agreed upon
market rate of interest which is unrelated to the coupon rate or date of
maturity of the purchased security. The Series' repurchase agreements will at
all times be fully collateralized in an amount equal to the purchase price
including accrued interest earned on the underlying security.
52
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
Reverse Repurchase Agreements-The Series may enter into reverse
repurchase agreements with the same parties with whom it may enter into
repurchase agreements. Under a reverse repurchase agreement, the Series sells
securities and agrees to repurchase them at a mutually agreed upon date and
price. Under the Investment Company Act of 1940 reverse repurchase agreements
are generally regarded as a form of borrowing. At the time the Series enters
into a reverse repurchase agreement it will establish and maintain a segregated
account with its custodian containing securities from its portfolio having a
value not less than the repurchase price including accrued interest.
Federal Income Taxes-It is the Series' 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 Series declares dividends daily from its net
investment income and pays such dividends on the last business day of each
month. Distributions of net capital gain, if any, realized on sales of
investments are anticipated to be made before the close of the Series' fiscal
year, as declared by the Board of Trustees. 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. Realized gain and loss from the sale of
securities are recorded on an identified cost basis. Discounts and premiums are
amortized over the life of the respective securities. Premiums are charged
against interest income and discounts are accreted to interest income.
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.
2. Investment Advisory Fees and Other Transactions With Affiliates
Management Agreement
The Series has a Management Agreement with Fundamental Portfolio Advisors,
Inc. (the Manager). Pursuant to the agreement the Manager serves as investment
adviser to the Series and is responsible for the overall management of the
business affairs and assets of the Series subject to the authority of the Fund's
Board of Trustees. In consideration for the services provided by the Manager,
the Series will pay an annual management fee in an amount equal to .75% of the
Series' average daily net assets up to $500 million, .725% on the next $500
million, and .70% per annum on assets over $1 billion. The Manager waived fees
and reimbursed expenses of $133,077 for the year ended December 31, 1997. See
Note 8.
SEC Administrative Proceeding Against the Manager
On September 30, 1997, the Securities & Exchange Commission announced that
it instituted public administrative and cease-and desist proceedings against the
Manager, the former portfolio manager of the Fund, the president of the Manager
and Fundamental Service Corporation (FSC). The proceeding arises from the
53
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
alleged failure of the Fund to disclose the risks of the Fund, and of the
Manager's failure to disclose its soft dollar arrangements to the Fund's Board
of Trustees. A hearing has been scheduled with an administrative law judge to
determine whether the allegations are true, and, if so, what remedial action, if
any, is appropriate.
Board's Termination of Portfolio Manager
Between April 17, 1997 and July 24, 1997, a representative of the Manager
engaged Tocqueville Securities L.P. ("Tocqueville Securities") an affiliate of
Tocqueville, as agent, to effect eight separate over-the-counter purchase
transactions of municipal obligations on behalf of an affiliated fund. The
Fund's Board has concluded that the commissions paid to Tocqueville Securities
in connection with these transactions (a portion of which was paid to the
representative) were not justified and that the affiliated fund bore unnecessary
expenses as a result of the sale of its securities to another party and the
subsequent repurchase of them through Tocqueville Securities. Based upon a
report initiated by Tocqueville Securities and prepared by the Fund's
independent auditors, and upon the Board's own analysis, the Board directed that
the Manager terminate its representative's services as a portfolio manager. At
the Board's request and in order to reimburse the affiliated fund for all of its
losses, Tocqueville Securities, on September 15, 1997, voluntarily paid $260,000
to the affiliated fund, an amount which significantly exceeds the total
commissions ($184,920.60) received by Tocqueville Securities in connection with
these transactions. The staff of the Securities and Exchange Commission and the
Department of NASD Regulation have been informed of these events by Tocqueville
Securities. See note 7 regarding contemplated transaction with the Tocqueville
Trust.
Plan of Distribution
The Series has adopted a Distribution and Marketing Plan, pursuant to Rule
12b-1, promulgated under the Investment Company Act of 1940, under which the
Series pays to FSC, an affiliate of the Manager, a fee which is accrued daily
and paid monthly at an annual rate of 0.25% of the Series' average daily net
assets. Amounts paid under the plan are to compensate FSC for the services it
provides and the expenses it bears in distributing the Series' shares to
investors. The amount incurred by the Series pursuant to the agreement for the
year ended December 31, 1997 is set forth in the Statement of Operations. FSC
has waived fees in the amount of $29,560.
NASD Sanctions and Fines
On February 19, 1998, FSC and two of its executives, without admitting or
denying guilt, entered into an agreement with the National Association of
Securities Dealers, Inc. ("NASD") whereby they accepted fines totaling $125,000
and other stipulated sanctions as a result of the NASD's finding that they had
distributed advertising materials relating to the Fund which violated NASD rules
governing advertisements.
Affiliated Transfer Agent
The Series compensated Fundamental Shareholders Services, Inc. (FSSI), an
affiliate of the Manager, for services it provided under a Transfer Agent and
Service Agreement which was terminated on September 11, 1997. The amount paid by
the Series to FSSI for the year ended December 31, 1997 amounted to $57,038.
Commissions Paid to Affiliate
The Series effects a significant portion of its futures and options
transactions through LAS Investments, Inc. (LAS), an affiliated broker-dealer.
Commissions paid to LAS amounted to approximately $14,591 for the year ended
December 31, 1997.
54
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
3. Trustees' Fees
All of the Trustees 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 Trustee 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. The Trustees also received additional
compensation for special services as requested by the Board. Additional
compensation totaled $40,923 pro rated among the funds based on their respective
average net assets.
4. Shares of Beneficial Interest
As of December 31, 1997 there were an unlimited number of shares of
beneficial interest (no par value) authorized and capital paid-in amounted to
$25,959,047. Transactions in shares of beneficial interest were as follows:
<TABLE>
<CAPTION>
Year Ended Year Ended
December 31, 1997 December 31, 1996
----------------------- --------------------------
Shares Amount Shares Amount
--------- ---------- --------- -----------
<S> <C> <C> <C> <C>
Shares sold ................................... 521,491 $ 732,057 1,209,491 $1,721,466
Shares issued on reinvestment of dividends .... 457,380 642,058 605,897 860,888
Shares redeemed ............................... (3,119,211) (4,365,671) (2,749,791) (3,915,172)
---------- ----------- --------- -----------
Net decrease .................................. (2,140,340) ($2,991,556) (934,403) ($1,332,818)
========== =========== ========= ===========
</TABLE>
5. Complex Services, Off Balance Sheet Risks and Investment Transactions
Two-Tiered Index Floating Rate Bonds (TTIB):
The Fund invests in Two-Tiered Index Floating Rate Bonds. The term
two-tiered refers to the two coupon levels that the TTIB's coupon can reset to.
The "first tier" is the TTIB's fixed rate coupon, effective as long as the
underlying index is at or below the strike level. Above the strike, the TTIB
coupon resets to a formula similar to an inverse floating rate note. See
discussion of inverse floating rate notes below. Changes in interest rate on the
underlying security or index affect the rate paid on the TTIB, and the TTIB's
price will be more volatile than that of a fixed-rate bond.
Additionally the Fund owns 100% of several securities as indicated in the
Statement of Investments. As a result of its ownership position there is no
active market in these securities. Valuations of these securities are provided
by a pricing service and are believed by the Manager to reflect fair value. The
market value of securities owned 100% by the Fund was approximately $5,111,810
(or 50.96% of net assets) as of December 31, 1997.
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.
55
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
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 gives 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 affect the net asset value of the Fund.
The Fund's principal 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 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
deliver the 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. For the year ended December 31, 1997, the Fund
had daily average notional amounts outstanding of approximately $15,136,000 and
$5,737,561 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 Fund had the following open futures contracts at December 31, 1997.
Principal Expiration Unrealized
Type Amount Position Month Loss
---- ------ -------- ----- ----
U.S. Treasury Bond ............. $7,000,000 Short 3/98 ($103,270)
Portfolio securities with an aggregate value of approximately $1,389,306
have been segregated as initial margin as of December 31, 1997.
In addition, the following table summarizes option contracts written by the
Series for the year ended December 31, 1997:
Number of Premiums Realized
Contracts Received Cost Loss
--------- -------- ---- ----
Contracts outstanding
December 31, 1996 .............. 40 $53,488
Options written .................. 780 633,904
Contracts closed or expired ...... (780) (668,591) $977,704 ($309,113)
--- -------
Contracts outstanding
December 31, 1997 .............. 40 $ 18,801
=== ========
56
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
Other Investment Transactions
For the year ended December 31, 1997, the cost of purchases and proceeds
from sales of investment securities, other than short-term obligations, were
$2,228,044 and $7,702,650, respectively.
As of December 31, 1997, the Fund had no unrealized appreciation or
depreciation for tax purposes since it has elected to recognize market value
changes each day for tax purposes.
The Fund has capital loss carryforwards to offset future capital gains as
follows:
Amount Expiration
------ ----------
$15,000,500 12/31/2002
588,100 12/31/2004
202,500 12/31/2005
-----------
$15,791,100
===========
6. Borrowing
The Fund has a line of credit agreement with its custodian bank
collateralized by cash and portfolio securities to the extent of the amounts
borrowed. Borrowings under this agreement bear interest linked to the bank's
prime rate.
The Series enters into reverse repurchase agreements collateralized by
portfolio securities equal in value to the repurchase price. The reverse
repurchase agreement outstanding at December 31, 1997 bears an interest rate of
5.9%. Portfolio securities with an aggregate value of approximately $5,757,000
have been segregated for securities sold subject to repurchase as of December
31, 1997.
The maximum month-end and the average amount of borrowing outstanding under
these arrangements during the year ended December 31, 1997 were approximately
$6,329,000 and $5,967,000.
7. Agreement and Plan of Reorganization
On July 16, 1997 each of Fundamental's mutual funds (consisting of: New York
Muni Fund, The California Muni Fund, Fundamental Fixed Income Fund: Tax Free
Money Market Series, High Yield Municipal Bond Series, and Fundamental U.S.
Government Strategic Income Fund Series) have adopted, subject to shareholder
approval, an Agreement and Plan of Reorganization (the "Plan") under which each
fund (the "Fundamental Fund") will transfer all of its assets and liabilities to
a newly-created corresponding series of The Tocqueville Trust (the "Tocqueville
Fund") in exchange for shares of the Tocqueville Fund. Shareholders of each
Fundamental Fund will receive shares of the corresponding Tocqueville Fund equal
in value to their shares in the Fundamental Fund. Shareholders will not have to
pay a sales load upon receiving shares of the Tocqueville Fund.
The corresponding Tocqueville Fund will have investment objectives, polices
and restrictions substantially identical to those of the Fundamental Fund. The
Board of Trustees of the Tocqueville Funds is comprised of
57
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
individuals other than those who currently serve as Directors (Trustees) of the
Fundamental Funds. Tocqueville Asset Management L.P. is the investment adviser
to the Tocqueville Funds.
A majority of Fundamental's Board members determined that the Plan would be
in the best interests of shareholders of the Fundamental Funds and recommended
that shareholders of each of the Fundamental Funds approve the Plan at a meeting
anticipated to be held in the Spring of 1998.
8. Subsequent Event
At its March 25, 1998 Board of Trustees' meeting, the Board of the Fund
approved the continuation of the Management Agreement and Distribution Agreement
through May 30, 1998 in contemplation of the consummation of the reorganization
discussed in Note 7.
The Manager and FSC (on behalf of certain of their directors, officers,
shareholders, employees and control persons) (the "Indemnitees") received
payment during the fiscal year ended December 31, 1997 from the Fund in the
amount of approximately $232,500. Upon learning of the payments, the independent
Board Members of the Funds directed that the Indemnitees return all of the
payments to the Funds or place them in escrow pending their receipt of an
opinion of an inedpendent legal counsel to the effect that the Indemnitees are
entitled to receive them. The Declaration of Trust, Articles of Incorporation
and contracts that call for indemnification specify that no indemnification
shall be provided to a person who shall be found to have engaged in "disabling
conduct" as defined by applicable law. The Indemnities have undertaken to
reimburse the Fund for any indemnification expenses for which it is determined
that they were not entitled to as a result of "disabling conduct" net of any
reimbursements already made to the Fund in the form of fees forgone or other
similar payments.
The Manager and FSC waived fees in the amount of $96,077 and $29,560,
respectively for the year ended December 31, 1997. The Manager and FSC have
asserted that they elected to forgo these fees because the Fund was paying legal
expenses pursuant to indemnification. The Fund has retained independent legal
counsel to determine whether the Indemnitees engaged in disabling conduct.
Pending clarification of the legal issues involved, the Indemnitees have placed
into an escrow account $102,863 as of April 30, 1998. The independent trustees
have instructed the Manager to escrow the full amount incurred by the Fund of
approximately $232,500.
58
<PAGE>
9. Selected Financial Information
<TABLE>
<CAPTION>
Year Year Year Year Year
Ended Ended Ended Ended Ended
December 31, December 31, December 31, December 31, December 31,
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Per share operating performance
(for a share outstanding throughout the period)
<S> <C> <C> <C> <C> <C>
Net asset value, beginning of period .............. $ 1.43 $ 1.49 $ 1.37 $ 2.01 $ 2.02
------ ------ ------ ------ ------
Income from investment operations
Net investment income ............................. 0.10 0.13 0.08 0.14 0.16
Net realized and unrealized gain/(loss) on
investments ..................................... (0.02) (0.06) 0.12 (0.64) -
------ ------ ------ ------ ------
Total from investment operations ............ 0.08 0.07 0.20 (0.50) 0.16
------ ------ ------ ------ ------
Less distributions
Dividends from net investment income .............. (0.10) (0.13) (0.08) (0.14) (0.16)
Dividends from net realized gains ................. - - - - (0.01)
------ ------ ------ ------ ------
Net asset value, end of period .................... $ 1.41 $ 1.43 $ 1.49 $ 1.37 $ 2.01
====== ====== ====== ====== ======
Total return ...................................... 5.51% 5.02% 15.43% (25.57%) 8.14%
Ratios/supplemental data:
Net assets, end of period (000 omitted) ........... $10,030 13,224 15,194 19,020 63,182
Ratios to average net assets
Interest expense (a) ............................ 2.75% 2.61% 3.00% 2.01% 1.54%
Operating expenses .............................. 5.75% 3.41% 3.05% 2.16% 1.39%
------ ------ ------ ------ ------
Total expenses+ (a) ......................... 8.50% 6.02% 6.05% 4.17% 2.93%
====== ====== ====== ====== ======
Net investment income+ .......................... 6.83% 9.01% 5.91% 8.94% 7.85%
Portfolio turnover rate ........................... 12.55% 12.65% 114.36% 60.66% 90.59%
Borrowings
Amount outstanding at end of period
(000 omitted) ................................... $4,969 $6,610 $ 7,481 $ 9,674 $31,072
Average amount of debt outstanding during the
period (000 omitted) ............................ $5,967 $6,577 $ 7,790 $16,592 $28,756
Average number of shares outstanding during the
period (000 omitted) ............................ 8,433 9,764 11,571 21,436 28,922
Average amount of debt per share during the
period .......................................... $ .71 $ .67 $ .67 $ .77 $ .99
<FN>
+These ratios are after expense reimbursement of 1.37%, 2.02%, 1.0% and .13% for the years ended December 31,
1997, 1996, 1995 and 1993, respectively.
(a)The ratios for each of the years in the four year period ending December 31, 1996 have been reclassified to
conform with the 1997 presentations.
</FN>
</TABLE>
59
<PAGE>
INDEPENDENT AUDITOR'S REPORT
The Board of Trustees and Shareholders
Fundamental Fixed-Income Fund
Fundamental U.S. Government Strategic Income Fund Series
We have audited the accompanying statement of assets and liabilities
including the statement of investments and statement of options written, of the
Fundamental U.S. Government Strategic Income Fund Series of Fundamental
Fixed-lncome Fund as of December 31, 1997 and the related statements of
operations and cash flows for the year then ended, and the statement of changes
in net assets for the two years 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, 1997 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 the Fundamental U.S. Government Strategic Income Fund Series of
Fundamental Fixed-lncome Fund as of December 31, 1997, the results of its
operations, changes in its net assets, cash flows, and selected financial
information for the periods indicated, in conformity with generally accepted
accounting principles.
See Notes 2 and 8 for information regarding regulatory proceedings and
transactions with affiliates.
S I G N A T U R E
New York, New York
March 2, 1998, except for Note 8 as to which the date is April 30, 1998.
60
<PAGE>
(LEFT COLUMN)
FUNDAMENTAL
FAMILY OF FUNDS
90 Washington Street
New York NY 10006
1-800-322-6864
Independent Auditors
McGladrey & Pullen, LLP
New York, New York 10017
Legal Counsel
Kramer, Levin, Naftalis & Frankel
919 Third Avenue
New York, New York 10022
These reports and the financial statements contained
herein are submitted for the general information of
the shareholders of the Fund. These reports are not
authorized for distribution to prospective investors
in the Funds unless preceded or accompanied by an
effective prospectus.
(RIGHT COLUMN)
---------------------------
Annual Report
December 31, 1997
NEW YORK MUNI FUND
THE CALIFORNIA MUNI FUND
FUNDAMENTAL
FIXED-INCOME FUND
TAX-FREE
MONEY MARKET SERIES
HIGH-YIELD
MUNICIPAL MARKET SERIES
FUNDAMENTAL
U.S. GOVERNMENT
STRATEGIC INCOME FUND
F U N D A M E N T A L
Fundamental Family of Funds
---------------------------
<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
A-1
<PAGE>
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.
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.
A-2
<PAGE>
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.
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.
A-3
<PAGE>
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
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 charac teristics, which, if
not remedied, may lead to default. The ability to meet obligations requires an
advantageous business and
A-4
<PAGE>
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.
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 DEFINITION
SCALE
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
A-5
<PAGE>
may move up or down frequently within this category.
B+ Below investment grade and possessing risk that obliga-
B tions will not be met when due. Financial protection
B- 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 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 DEFINITION
SCALE
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
A-6
<PAGE>
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.
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.
A-7
<PAGE>
F-1+
Exceptionally Strong Credit Quality. Issues assigned this rating are
regarded as having the strongest degree of a ssurance 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+.
A-8
<PAGE>
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+.
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
A-9
<PAGE>
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-10
<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) Statement of Assets and Liabilities as of December 31,
1997.
(3) Statements of Changes in Net Assets for the years ended
December 31, 1997 and 1996
(4) Statement of Operations for the year ended December 31,
1997.
(5) Statement of Cash Flows for the year ended December 31,
1997.
(6) Schedule of Investments as of December 31, 1997.
(b) Exhibits:
(1) (a) Articles of Incorporation(1)
(b) Articles of Amendment (3)
(2) By-Laws of Registrant(1)
(3) Inapplicable
(4) Form of Specimen Security(1)
(5) Form of Management Agreement with Fundamental
Portfolio Advisors, Inc.(1)
(6) Inapplicable
(7) Inapplicable
(8) Form of Custody Agreement with Registrant's
Custodian(1)
(9) Inapplicable
(10) (a) Opinion of Counsel(1)
(11) (a) Consent of Counsel(4)
(b) Consent of McGladrey & Pullen(4)
(12) Inapplicable
(13) Inapplicable
(14) Inapplicable
(15) Form of Distribution Plan pursuant to Rule 12b-1
and related agreements(1)
(16) Schedule for Computation of Performance Quotations
(unaudited)(2)
(17) Financial Data Schedule (4)
- --------------------------------------------
(1) Filed on October 26, 1990 as an Exhibit to Post-Effective Amendment No.
11 to the Registration Statement and incorporated herein by reference
thereto.
(2) 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.
(3) Filed on April 25, 1996 as an Exhibit to Post-Effective Amendment No.
18 to the Registration Statements (accession number
0000922423-96-000189) and incorporated herein by reference thereto.
(4) 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 31, 1998, Registrant had 5,411 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.
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. and Firstar Trust Company, 615 East Michigan Street,
Milwaukee, WI 53202, the Registrant's Transfer Agent, Accounting Agent and
Custodian.
Item 31. Management Services
Inapplicable.
<PAGE>
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 30th day of April, 1998.
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.
<TABLE>
<CAPTION>
SIGNATURES TITLE DATE
- ---------- ----- ----
<S> <C> <C>
/s/Vincent J. Malanga Director, Principal Executive Officer and April 30, 1998
- -------------------------------
Vincent J. Malanga Principal Financial and Accounting Officer
* Director April 30, 1998
- --------------------------------
James C. Armstrong
* Director April 30, 1998
- --------------------------------
L. Gregg Ferrone
</TABLE>
*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
[LETTERHEAD OF KRAMER, LEVIN, NAFTALIS & FRANKEL]
April 30, 1998
Fundamental Funds, Inc.
90 Washington Street
New York, New York 10006
Re: New York Muni Fund
File No. 2-82710
----------------
Gentlemen:
We hereby consent to the reference to our firm as counsel in
Post-Effective Amendment No. 20 to Registration Statement No. 2-82710.
Very truly yours,
/s/ Kramer, Levin, Naftalis & Frankel
-------------------------------------
[LETTERHEAD OF MCGLADREY & PULLEN, LLP]
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
We consent to the use of our report dated March 2, 1998 (except for Note 8 as to
which the date is April 30, 1998) on the financial statements of Fundamental
Funds, Inc. New York Muni Fund referred to therein, in Post-Effective Amendment
No. 20 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 Statement of Additional
Information under the caption "Custodian and Independent Certified Public
Accountants." We also consent to the reference to our Firm in Part 1 of the
Prospectus under the caption "Financial Highlights."
/s/McGladrey & Pullen, LLP
--------------------------
McGladrey & Pullen, LLP
New York, New York
April 30, 1998
<TABLE> <S> <C>
<ARTICLE> 6
<CIK> 0000315811
<NAME> FUNDAMENTAL FUNDS, INC.
<SERIES>
<NUMBER> 1
<NAME> NEW YORK MUNI FUND SERIES
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<INVESTMENTS-AT-COST> 127,411
<INVESTMENTS-AT-VALUE> 122,738
<RECEIVABLES> 59,630
<ASSETS-OTHER> 0
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 182,368
<PAYABLE-FOR-SECURITIES> 8,827
<SENIOR-LONG-TERM-DEBT> 38,178
<OTHER-ITEMS-LIABILITIES> 768
<TOTAL-LIABILITIES> 47,773
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 163,581
<SHARES-COMMON-STOCK> 156,836
<SHARES-COMMON-PRIOR> 225,958
<ACCUMULATED-NII-CURRENT> 0
<OVERDISTRIBUTION-NII> (27)
<ACCUMULATED-NET-GAINS> (24,285)
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> (4,673)
<NET-ASSETS> 134,595
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 7,756
<OTHER-INCOME> 0
<EXPENSES-NET> 4,856
<NET-INVESTMENT-INCOME> 2,900
<REALIZED-GAINS-CURRENT> (2,367)
<APPREC-INCREASE-CURRENT> 5,608
<NET-CHANGE-FROM-OPS> 6,141
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> 2,900
<DISTRIBUTIONS-OF-GAINS> (25)
<DISTRIBUTIONS-OTHER> 579
<NUMBER-OF-SHARES-SOLD> 2,692,167
<NUMBER-OF-SHARES-REDEEMED> 2,765,078
<SHARES-REINVESTED> 3,789
<NET-CHANGE-IN-ASSETS> (62,150)
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> (21,893)
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 641
<INTEREST-EXPENSE> 1,432
<GROSS-EXPENSE> 4,897
<AVERAGE-NET-ASSETS> 129,960
<PER-SHARE-NAV-BEGIN> .87
<PER-SHARE-NII> 0.021
<PER-SHARE-GAIN-APPREC> (.009)
<PER-SHARE-DIVIDEND> 0.019
<PER-SHARE-DISTRIBUTIONS> 0
<RETURNS-OF-CAPITAL> 0.003
<PER-SHARE-NAV-END> .86
<EXPENSE-RATIO> 3.74
<AVG-DEBT-OUTSTANDING> 20,631
<AVG-DEBT-PER-SHARE> .134
</TABLE>
