Smith Barney
INVESTMENT FUNDS INC.
388 Greenwich Street
New York, New York 10013
(212) 723-9218
STATEMENT OF ADDITIONAL INFORMATION
NOVEMBER 7, 1994
This Statement of Additional Information expands upon and supplements the
information contained in the current Prospectuses of Smith Barney Invest-
ment Funds Inc. (the "Company"), dated November 7, 1994, as amended or
supplemented from time to time, and should be read in conjunction with the
Company's Prospectuses. The Company issues a Prospectus for each of the
investment funds offered by the Company (the "Funds"). The Company's Pro-
spectuses may be obtained from a Smith Barney Financial Consultant, or by
writing or calling the Company at the address or telephone number listed
above. This Statement of Additional Information, although not in itself a
prospectus, is incorporated by reference into the Prospectuses in its en-
tirety.
CONTENTS
For ease of reference, the same section headings are used in the Prospec-
tuses and this Statement of Additional Information, except where shown
below:
<TABLE>
<S>
<C>
Management of the Company (see in the Prospectuses "Management of
the Company and the Fund")
1
Investment Objectives and Management Policies
6
Purchase of Shares
24
Redemption of Shares
25
Distributor
26
Valuation of Shares
27
Exchange Privilege
28
Performance Data (See in the Prospectuses "Performance")
28
Taxes (See in the Prospectuses "Dividends, Distributions and Taxes")
32
Additional Information
36
Financial Statements
36
Appendix
A-1
</TABLE>
MANAGEMENT OF THE COMPANY
The executive officers of the Company are employees of certain of the or-
ganizations that provide services to the Company. These organizations are
the following:
<TABLE>
<CAPTION>
NAME SERVICE
<S> <C>
Smith Barney Inc.
("Smith Barney") Distributor
Smith Barney Mutual Funds Management Inc.
("SBMFM") Investment
Adviser and Administrator
The Boston Company Advisors, Inc.
("Boston Advisors") Sub-
Administrator
Boston Safe Deposit and Trust Company
("Boston Safe") Custodian
The Shareholder Services Group, Inc. ("TSSG"),
a subsidiary of First Data Corporation Transfer Agent
</TABLE>
These organizations and the functions they perform for the Company are
discussed in the Prospectuses and in this Statement of Additional Informa-
tion.
DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
The Directors and executive officers of the Company, together with infor-
mation as to their principal business occupations during the past five
years, are shown below. Each Director who is an "interested person" of the
Company, as defined in the Investment Company Act of 1940, as amended (the
"1940 Act"), is indicated by an asterisk.
Paul R. Ades, Director. Partner in the law firm of Murov & Ades. His ad-
dress is 272 South Wellwood Avenue, Lindenhurst, New York 11757.
Herbert Barg, Director. Private investor. His address is 273 Montgomery
Avenue, Bala Cynwyd, Pennsylvania 19004.
Alger B. Chapman, Director. Chairman and Chief Operating Officer of the
Chicago Board of Options Exchange. His address is Chicago Board of Options
Exchange, LaSalle at Van Buren, Chicago, Illinois 60605.
Dwight B. Crane, Director. Professor, Graduate School of Business Adminis-
tration, Harvard University. His address is Graduate School of Business
Administration, Harvard University, Boston, Massachusetts 02163.
Frank G. Hubbard, Corporate Vice President, Materials Management and Mar-
keting Services of Huls America, Inc. His address is 80 Centennial Avenue
P.O. Box 456, Piscataway, New Jersey 08855-0456.
Allan R. Johnson, Director. Retired; Former Chairman, Retail Division of
BATUS, Inc., and Chairman and Chief Executive Officer of Saks Fifth Ave-
nue, Inc. His address is 2 Sutton Place South, New York, New York 10022.
*Heath B. McLendon, Chairman of the Board. Executive Vice President of
Smith Barney and Chairman of Smith Barney Strategy Advisers Inc. ("SBSA");
prior to July 1993, Senior Executive Vice President of Shearson Lehman
Brothers Inc. ("Shearson Lehman Brothers"), Vice Chairman of Shearson
Asset Management, a Director of PanAgora Asset Management, Inc. and PanAg-
ora Asset Management Limited. His address is 388 Greenwich Street, New
York, New York 10013.
Ken Miller, Director. President of Young Stuff Apparel Group, Inc. His ad-
dress is 1407 Broadway, 6th Floor, New York, New York 10018.
John F. White, Director. President Emeritus of The Cooper Union for the
Advancement of Science and Art; Special Assistant to the President of the
Aspen Institute. His address is Crows Nest Road, Tuxedo Park, New York
10987.
Stephen J. Treadway, President. Executive Vice President and Director of
Smith Barney; Director and President of Mutual Management Corp. and
SBMFM, and Trustee of Corporate
Realty Income Trust I. His address is 388 Greenwich Street, New York, New
York 10013.
Richard P. Roelofs, Executive Vice President. Managing Director of Smith
Barney and President of SBSA; prior to July 1993, Senior Vice President of
Shearson Lehman Brothers and President of Shearson Lehman Investment
Strategy Advisors Inc. His address is 388 Greenwich Street, New York, New
York 10013.
James E. Conroy, First Vice President. Investment Officer of SBMFM; prior
to July 1993, Managing Director of Shearson Lehman Advisors. His address
is 388 Greenwich Street, New York, New York 10013.
Kenneth A. Egan, First Vice President. Investment Officer of SBMFM; prior
to July 1993, Managing Director of Shearson Lehman Advisors. His address
is 388 Greenwich Street, New York, New York 10013.
R. Jay Gerken, Investment Officer. Investment Officer of SBMFM; prior to
July 1993, Senior Vice President of Shearson Lehman Advisors. His address
is 388 Greenwich Street, New York, New York 10013.
George E. Mueller, Jr., Investment Officer. Investment Officer of SBMFM;
prior to July 1993, Managing Director of Shearson Lehman Advisors. His ad-
dress is 388 Greenwich Street, New York, New York 10013.
George V. Novello, Investment Officer. Investment Officer of SBMFM; prior
to July 1993, Managing Director of Shearson Lehman Advisors. Prior to Sep-
tember 1990, Mr. Novello was a Managing Director at McKinley-Allsopp where
he served as Head of Research. His address is 388 Greenwich Street, New
York, New York 10013.
Jeffrey L. Russell, Managing Director, Senior International Equity Portfo-
lio Manager, SBA; prior to 1990 Vice President of Drexel Burham, Lambert.
His address is 1345 Avenue of the Americas, New York, New York 10022.
Lewis E. Daidone, Treasurer. Managing Director of Smith Barney and Direc-
tor and Senior Vice President of SBMFM; prior to January, 1990, Senior
Vice President and Chief Financial Officer of Cortland Financial Group,
Inc. His address is 388 Greenwich Street, New York, New York 10013.
Christina T. Sydor, Secretary. Managing Director of Smith Barney and Sec-
retary of SBMFM. Her address is 388 Greenwich Street, New York, New York,
10013.
Each Director also serves as a director, trustee and/or individual general
partner of certain other mutual funds for which Smith Barney serves as
distributor. As of September 30, 1994, the Directors and officers of the
Company, as a group, owned less than 1.00% of the outstanding common stock
of the Company.
No officer, director or employee of Smith Barney or any parent or
sub-
sidiary of Smith Barney receives any compensation from the Company for
serving as an officer or Director of the Company. The Company pays each
Director who is not an officer or employee of Smith Barney or any of its
affiliates a fee of $14,000 per annum plus $3,000 per meeting attended and
reimburses travel and out-of-pocket expenses. For the fiscal year ended
December 31, 1993, such fees and expenses totalled approximately $147,980.
INVESTMENT ADVISER AND ADMINISTRATOR -- SBMFM
SBMFM serves as investment adviser to one or more of the Funds pursuant to
transfer of the investment advisory agreement effective November 7, 1994
from its affiliate, Mutual Management Corp. (Mutual Management Corp. and
SBMFM are both wholly owned subsidiaries of Smith Barney Holdings Inc.
("Holdings"). Holdings is in turn a wholly owned subsidiary of The
Travelers
Inc. ("Travelers"). The advisory agreements with the Funds (the
"Advisory Agreements")
were most recently approved by the Board of Directors, including a majority
of
the Directors who are not "interested persons" of the Company or the in-
vestment advisers (the "Independent Directors"), on August 5, 1993 and by
shareholders of the respective Funds with the exception of the European
Funds' Advisory Agreement on June 9, 1993. The Advisory Agreement for Eu-
ropean Fund was most recently approved by shareholders of European Fund on
May 10, 1994. Each of the investment advisers bears all expenses in con-
nection with the performance of its services and pays the salary of any
officer and employee who is employed by both it and the Company. The ser-
vices provided by the investment advisers under the Advisory Agreements
are described in the Prospectuses under "Management of the Company and the
Fund." SBMFM provides investment advisory and management services to in-
vestment companies affiliated with Smith Barney.
As compensation for investment advisory services rendered to
Investment Grade Bond Fund and Special Equities Fund, each Fund pays
SBMFM a fee computed daily and
paid monthly at the annual rates of 0.45% and 0.55%, respectively, of the
value of the Funds' average daily net assets.
As compensation for investment advisory services rendered to
Government Securities Fund, the Fund pays SBMFM a fee computed daily
and
paid monthly at the following annual rates of the Fund's average
daily net assets: 0.35% up to $2 billion; 0.30% on
the next $2 billion; 0.25% on the next $2 billion; 0.20% on the next $2
billion; and 0.15% on net assets thereafter.
As compensation for investment advisory services rendered to the
European Fund, the
Fund pays SBMFM a fee computed daily and paid monthly at the annual
rate of .70%
of the value of the Fund's average daily net asset.
For the fiscal years ended December 31, 1991, 1992 and 1993, the Funds ac-
crued approximate advisory fees as follows:
<TABLE>
<CAPTION>
FUND 1991 1992
1993
<S> <C> <C> <C>
Investment Grade Bond Fund $1,792,000 $1,879,000
$2,157,373
Government Securities Fund 4,771,000 3,926,000
3,357,123
Special Equities Fund 421,000 385,000
548,764
European Fund 203,000 189,000
195,586
</TABLE>
On February 8, 1994, the Company's Board of Directors determined to termi-
nate the Company's investment advisory agreement with LBGAM, at that time
an indirect wholly owned subsidiary of American Express Company, with re-
spect to European Fund, and to enter into an investment advisory agreement
with SBMFM. Such agreement, which was ratified by European Fund's share-
holders on May 10, 1994, provides for the provision of investment advisory
services by SBMFM to European Fund for the same fee as was paid to LBGAM.
SBMFM also serves as administrator to each Fund pursuant to a written
agreement dated May 4, 1994 (the "Administration Agreement"), which was
first approved by the Board of Directors, including a majority of the In-
dependent Directors, on May 4, 1994. The services provided by SBMFM
under the Administration Agreement are described in the Prospectus under
"Management of the Company and the Fund."
As compensation for administrative services rendered to each
Fund,
SBMFM receives a fee paid at the annual rate of .20% of
the value of its average daily net assets.
SUB-ADMINISTRATOR-BOSTON ADVISORS
Boston Advisors serves as sub-administrator to each Fund
pursuant to a written agreement (the "Sub-Administration Agreement")
dated May 4, 1994, which was first approved by the Company's
Board of Directors, including a majority of Directors who are not
"interested persons"
of the Company or Boston Advisors on May 4, 1994. Under the
Sub-Administration Agreement, Boston Advisors is paid a portion of the
administration
fee paid by the Company to SBMFM at a rate agreed upon from time to time
between
Boston Advisors and SBMFM. Boston Advisors is a wholly
owned subsidiary of The Boston Company, Inc. ("TBC"), a financial services
holding company, which is in turn an indirect wholly owned subsidiary of
Mellon Bank Corporation ("Mellon"). Prior to May 4, 1994, Boston
Advisors
served as the Company's sub-investment adviser and/or administrator.
Certain of the services provided to the Company by Boston Advi-
sors pursuant to the Sub-Administration Agreement are
described in the Prospectuses under "Management of the Company and the
Fund." In addition to those services, Boston Advisors pays the
salaries of all officers and employees who are employed by both it
and the Company, maintain office facilities for the Company, furnish the
Company with statistical and research data, clerical help and accounting,
data processing, bookkeeping, internal auditing and legal services and
certain other services required by the Company, prepares reports to the
Company's shareholders and prepares tax returns, reports to and filings
with the Securities and Exchange Commission (the "SEC") and state Blue Sky
authorities. Boston Advisors bears all expenses in connection
with the performance of its services.
For the fiscal years ended December 31, 1991, 1992 and 1993, the Funds
paid sub-investment advisory and/or administration fees as follows:
<TABLE>
<CAPTION>
FUND 1991 1992
1993
<S> <C> <C> <C>
Investment Grade Bond Fund $796,000 $835,000
$958,700
Government Securities Fund 2,726,000 2,243,000
1,918,367
Special Equities Fund 153,000 140,000
199,551
European Fund 60,000* 53,000
55,902
</TABLE>
[FN]
* For the fiscal year ended December 31, 1991, 100% of the sub-investment
advisory and administration fees were waived by Boston Advisors for the
European Fund.
The Company bears expenses incurred in its operation, including taxes, in-
terest, brokerage fees and commissions, if any; fees of Directors who are
not officers, directors, shareholders or employees of Smith Barney, SBMFM
or Boston Advisors; SEC fees and state Blue Sky qualification fees;
charges of custodians; transfer and dividend disbursing agent's fees; cer-
tain insurance premiums; outside auditing and legal expenses; costs of
maintenance of corporate existence; investor services (including allocated
telephone and personnel expenses); and costs of preparation and printing
of prospectuses for regulatory purposes and for distribution to existing
shareholders; shareholders' reports and corporate meetings.
SBMFM and Boston Advisors have agreed that if in any fiscal year the ag-
gregate expenses of a Fund (including fees paid pursuant to the Advisory,
Administration and Sub-Administration Agreements, but excluding interest,
taxes, brokerage fees paid pursuant to the each Fund's services and
distribution
plan and, with the prior written consent of the necessary
state securities commissions, extraordinary expenses) exceed the expense
limitation of any state having jurisdiction over the Fund, the investment
advisers, SBMFM and Boston Advisors will, to the extent required by law,
reduce their management fees for the Fund by the amount of such excess ex-
pense, such amount to be allocated between them in the proportion that
their respective fees bear to the aggregate of such fees paid by the Fund.
Such a fee reduction, if any, will be reconciled on a monthly basis. The
most restrictive state limitation applicable to the Company would require
SBMFM and Boston Advisors to reduce their fees in any year that such ex-
cess expenses exceed 2.5% of the first $30 million of average net assets,
2% of the next $70 million of average net assets and 1.5% of the remaining
average net assets. No fee reduction was required for the 1993, 1992 and
1991 fiscal years.
COUNSEL AND AUDITORS
Willkie Farr & Gallagher serves as counsel to the Company. The Directors
who are not "interested persons" of the Company have selected Stroock &
Stroock & Lavan as their legal counsel.
Coopers & Lybrand L.L.P., independent accountants, One Post Office Square,
Boston, Massachusetts 02109, serve as auditors of the Company and render
an opinion on the Company's financial statements annually.
INVESTMENT OBJECTIVES AND MANAGEMENT POLICIES
The Prospectuses discuss the investment objectives of each Fund and the
policies they employ to achieve such objectives. The following discussion
supplements the description of the Funds' investment objectives and man-
agement policies contained in the Prospectuses.
INVESTMENT GRADE BOND FUND
The investment objective of the Investment Grade Bond Fund is to provide
as high a level of current income as is consistent with prudent investment
management and preservation of capital. The Fund seeks to achieve its ob-
jective by investing in the following securities: corporate bonds which
are rated Aaa, Aa, A, or Baa by Moody's Investors Service, Inc.
("Moody's") or AAA, AA, A, or BBB by Standard & Poor's Corporation ("S&P")
(See Appendix for a description of these ratings); U.S. government securi-
ties (See below); commercial paper issued by domestic corporations rated
Prime-1 or Prime-2 by Moody's or A-1+, A-1 or A-2 by S&P or, if not rated
by Moody's or S&P, issued by a corporation having an outstanding debt
issue rated Aa or better by Moody's or AA or better by S&P (See Appendix);
negotiable bank certificates of deposit or bankers' acceptances issued by
domestic banks (but not their foreign branches) having together with
branches or subsidiaries, total assets in excess of $1 billion; high-
yielding common stocks (which may be purchased directly or acquired
through the exercise of warrants or the conversion of fixed-income securi-
ties); and Warrants.
The ratings of Moody's and S&P generally represent the opinions of those
organizations as to the quality of the securities that they rate. Such
ratings, however, are relative and subjective, are not absolute standards
of quality and do not evaluate the market risk of the securities. Although
the Fund's investment adviser uses these ratings as a criterion for the
selection of securities for the Fund, the Fund's investment adviser also
relies on its independent analysis to evaluate potential investments for
the Fund. The Fund's achievement of its investment objective may be more
dependent on the investment adviser's credit analysis of low-rated and un-
rated securities than would be the case for a portfolio of higher-rated
securities.
Subsequent to its purchase by the Fund, an issue of securities may cease
to be rated or its rating may be reduced below the minimum required for
purchase by the Fund. In addition, it is possible that Moody's and S&P
might not timely change their ratings of a particular issue to reflect
subsequent events. None of these events will require the sale of the secu-
rities by the Fund, although the investment adviser will consider these
events in determining whether the Fund should continue to hold the securi-
ties. To the extent that the ratings given by Moody's or S&P for securi-
ties may change as a result of changes in the rating systems or due to a
corporate reorganization of Moody's and/or S&P, the Fund will attempt to
use comparable ratings as standards for its investments in accordance with
the investment objective and policies of the Fund.
As a condition of its continuing registration in a state, the Investment
Grade Bond Fund has undertaken that its investments in warrants, valued at
the lower of cost or market, will not exceed 5% of the value of its net
assets. Included within that amount, but not to exceed 2% of the Fund's
net assets, may be warrants which are not listed on either the New York
Stock Exchange, Inc. (the "NYSE") or the American Stock Exchange. Warrants
acquired by the Fund in units or attached to securities will be deemed to
be without value for purposes of this restriction. These limits are not
fundamental policies of the Fund and may be changed by the Board of Direc-
tors without shareholder approval.
Investment Grade Bond Fund may enter into repurchase agreements, reverse
repurchase agreements and firm commitment agreements and may lend its
portfolio securities, in each case in accordance with the description of
those techniques (and subject to the same risks) set forth below. The Fund
may purchase American Depositary Receipts ("ADRs"), which are dollar-
denominated receipts issued generally by domestic banks and representing
the deposit with the bank of a security of a foreign issuer. ADRs are pub-
licly traded on exchanges or over-the-counter in the United States.
Investment Grade Bond Fund may also sell securities "short against the
box." While a short sale is the sale of a security the Fund does not own,
it is "against the box" if at all times when the short position is open,
the Fund owns an equal amount of the securities or securities convertible
into, or exchangeable without further consideration for, securities of the
same issue as the securities sold short. Short sales against the box are
used to defer recognition of capital gains or losses or to extend the
holding period of securities for certain federal income tax purposes.
It is the Fund's policy that at least 65% of its assets will be invested
in bonds, except during times when the investment adviser believes that
adoption of a temporary defensive position by investing more heavily in
cash or money market instruments (such as short-term U.S. government secu-
rities, commercial paper, and negotiable bank certificates of deposit) is
desirable due to prevailing market or economic conditions. This policy was
adopted in accordance with guidelines of the SEC which require that any
investment company whose name implies that it invests primarily in a par-
ticular type of security have a policy of investing at least 65% of its
total assets in that type of security under normal market conditions. This
policy may be changed without shareholder approval in the event the SEC
guidelines are modified.
Repurchase Agreements. The Fund may purchase securities and concurrently
enter into repurchase agreements with banks which are the issuers of in-
struments acceptable for purchase by the Fund and certain dealers on the
Federal Reserve Bank of New York's list of reporting dealers. Repurchase
agreements are contracts under which the buyer of a security simulta-
neously commits to resell the security to the seller at an agreed-upon
price and date. Under each repurchase agreement, the selling institution
will be required to maintain the value of the securities subject to the
repurchase agreement at not less than their repurchase price. Repurchase
agreements could involve certain risks in the event of default or insol-
vency of the other party, including possible delays or restrictions upon a
Fund's ability to dispose of the underlying securities, the risk of a pos-
sible decline in the value of the underlying securities during the period
in which the Fund seeks to assert its rights to them, the risk of incur-
ring expenses associated with asserting those rights and the risk of los-
ing all or part of the income from the repurchase agreement. SBMFM or Bos-
ton Advisors, acting under the supervision of the Company's Board of Di-
rectors, review on an ongoing basis the value of the collateral and the
creditworthiness of those banks and dealers with which the Fund enters
into repurchase agreements to evaluate potential risks. The Fund will not
enter into repurchase agreements that would cause more than 10% of its
total assets to be invested in "illiquid" securities.
Reverse Repurchase Agreements. A reverse repurchase agreement involves
the sale of a money market instrument held by the Fund coupled with an
agreement by the Fund to repurchase the instrument at a stated price, date
and interest payment. The Fund will use the proceeds of a reverse repur-
chase agreement to purchase other money market instruments which either
mature at a date simultaneous with or prior to the expiration of the re-
verse repurchase agreement or which are held under an agreement to resell
maturing as of that time.
The Fund will enter into a reverse repurchase agreement only when the in-
terest income to be earned from the investment of the proceeds of the
transaction is greater than the interest expense of the transaction. Under
the 1940 Act, reverse repurchase agreements may be considered to be bor-
rowings by the seller. The Fund may not enter into a reverse repurchase
agreement if, as a result, its current obligations under such agreements
would exceed one-third of the current market value of the Fund's total as-
sets (less all of its liabilities other than obligations under such agree-
ments).
The Fund may enter into reverse repurchase agreements with banks or
broker-dealers. Entry into such agreements with broker-dealers requires
the creation and maintenance of a segregated account with the Company's
custodian consisting of U.S. government securities or cash or cash equiva-
lents.
Firm Commitment Agreements. The Fund may enter into firm commitment
agreements (when-issued purchases) for the purchase of securities at an
agreed-upon price on a specified future date. Such agreements might be en-
tered into, for example, when a decline in the yield of securities of a
given issuer is anticipated and a more advantageous yield may be obtained
by committing currently to purchase securities to be issued later.
The Fund will not enter into such agreements for the purpose of investment
leverage. Liability for the purchase price, and all the rights and risks
of ownership of the securities, accrue to the Fund at the time it becomes
obligated to purchase such securities, although delivery and payment occur
at a later date. Accordingly, if the market price of the security should
decline, the effect of the agreement would be to obligate the Fund to pur-
chase the security at a price above the current market price on the date
of delivery and payment. During the time Investment Grade Bond Fund is ob-
ligated to purchase such securities, it will maintain in a segregated ac-
count with the Company's custodian, U.S. government securities or cash or
cash equivalents of an aggregate current value sufficient to make payment
for the securities.
Lending of Portfolio Securities. The Fund has the ability to lend securi-
ties from its portfolio to brokers, dealers and other financial organiza-
tions. Such loans, if and when made, may not exceed 20% of the Fund's
total assets taken at value. The Fund will not lend portfolio securities
to Smith Barney or its affiliates unless it has applied for and received
specific authority to do so from the SEC. Loans of portfolio securities
will be collateralized by cash, letters of credit or U.S. government secu-
rities which are maintained at all times in an amount at least 100% of the
current market value of the loaned securities.
In lending its securities, the Fund can increase its income by continuing
to receive interest on the loaned securities as well as by either invest-
ing the cash collateral in short-term instruments or obtaining yield in
the form of interest paid by the borrower when U.S. government securities
are used as collateral. Requirements of the SEC, which may be subject to
future modifications, currently provide that the following conditions must
be met whenever the Fund's portfolio securities are loaned: (a) the Fund
must receive at least 100% cash collateral or equivalent securities from
the borrower; (b) the borrower must increase such collateral whenever the
market value of the securities loaned rises above the level of such col-
lateral; (c) the Fund must be able to terminate the loan at any time; (d)
the Fund must receive reasonable interest on the loan, as well as an
amount equal to dividends, interest or other distributions on the loaned
securities, and any increase in market value; (e) the Fund may pay only
reasonable custodian fees in connection with the loan; and (f) voting
rights on the loaned securities may pass to the borrower; provided, how-
ever, that if a material event adversely affecting the investment in the
loaned securities occurs, the Board of Directors must terminate the loan
and regain the right to vote the securities. The risks in lending portfo-
lio securities, as with other extensions of secured credit, consist of
possible delay in receiving additional collateral or in the recovery of
the securities or possible loss of rights in the collateral should the
borrower fail financially. Loans will be made to firms deemed by the
Fund's investment adviser to be of good standing and will not be made un-
less, in the judgment of the Fund's investment adviser, the consideration
to be earned from such loans would justify the risk. From time to time,
the Fund may return a part of the interest earned from the investment of
collateral received for securities loaned to: (a) the borrower; and/or (b)
a third party, which is unaffiliated with the Fund or with Smith Barney
and, which is acting as a "finder."
GOVERNMENT SECURITIES FUND
The investment objective of Government Securities Fund is high current re-
turn. It seeks to achieve its objective by investing in U.S. government
securities and by writing covered call options and secured put options and
by purchasing put options on U.S. government securities. The Fund also may
purchase and sell interest rate futures contracts, and purchase and sell
put and call options on futures contracts, as a means of hedging against
changes in interest rates.
U.S. Government Securities. Direct obligations of the U.S. Treasury in-
clude a variety of securities, which differ in their interest rates, matu-
rities and dates of issuance. Treasury Bills have maturities of one year
or less; Treasury Notes have maturities of one to ten years and Treasury
Bonds generally have maturities of greater than ten years at the date of
issuance.
In addition to direct obligations of the United States Treasury, securi-
ties issued or guaranteed by the United States government, its agencies or
instrumentalities include securities issued or guaranteed by the Federal
Housing Administration, Farmers Home Administration, Export-Import Bank of
the United States, Small Business Administration, Government National
Mortgage Association ("GNMA"), General Services Administration, Central
Bank for Cooperatives, Federal Home Loan Mortgage Corporation, Federal In-
termediate Credit Banks, Federal Land Banks, Federal Maritime Administra-
tion, the Tennessee Valley Authority, District of Columbia Armory Board,
Student Loan Marketing Association, International Bank for Reconstruction
and Development, Resolution Trust Corporation and Federal National Mort-
gage Association ("FNMA"). The Fund will invest in obligations of an in-
strumentality to which the United States government is not obligated by
law to provide support only if the Fund's investment adviser determines
that the credit risk with respect to the instrumentality does not make its
securities unsuitable for investment by the Fund.
Some U.S. government securities are supported by the full faith and credit
of the United States Treasury; others are supported by the right of the
issuers to borrow from the United States Treasury; others, such as those
of FNMA, are supported by the discretionary authority of the United States
government to purchase the agency's obligations; still others, such as
those of the Student Loan Marketing Association, are supported only by the
credit of the instrumentality. No assurance can be given that the United
States government would provide financial support to a U.S. government-
sponsored instrumentality when it is not obligated to do so by law. The
Fund will invest in the securities of such U.S. government agencies and
instrumentalities only when it is satisfied that the credit risk is mini-
mal.
It is the Fund's policy that at least 65% of its total assets will be in-
vested in U.S. government securities, including options and futures con-
tracts thereon, except during times when the investment adviser believes
that adoption of a temporary defensive position by investing more heavily
in cash or money market instruments is desirable due to prevailing market
or economic conditions. This policy was adopted in accordance with guide-
lines of the SEC which require that any investment company whose name im-
plies that it invests primarily in a particular type of security have a
policy of investing at least 65% of its total assets in that type of secu-
rity under normal market conditions. This policy may be changed without
shareholder approval in the event that the SEC's guidelines are modified.
The Fund's current distribution return consists generally of interest in-
come from U.S. government securities, premiums from expired put and call
options written by the Fund, net gains from closing purchase and sale
transactions, and net gains from sales of portfolio securities pursuant to
options or otherwise.
Exchange Rate-Related U.S. Government Securities. Government Securities
Fund has the ability to invest up to 5% of its net assets in U.S. govern-
ment securities for which the principal repayment at maturity, while paid
in U.S. dollars, is determined by reference to the exchange rate between
the U.S. dollar and the currency of one or more foreign countries ("Ex-
change Rate-Related Securities"). The interest payable on these securities
is denominated in U.S. dollars, is not subject to foreign currency risk
and, in most cases, is paid at rates higher than most other U.S. govern-
ment securities in recognition of the foreign currency risk component of
Exchange Rate-Related Securities.
Exchange Rate-Related Securities are issued in a variety of forms, depend-
ing on the structure of the principal repayment formula. The principal re-
payment formula may be structured so that the securityholder will benefit
if a particular foreign currency to which the security is linked is stable
or appreciates against the U.S. dollar. In the alternative, the principal
repayment formula may be structured so that the securityholder benefits if
the U.S. dollar is stable or appreciates against the linked foreign cur-
rency. Finally, the principal repayment formula can be a function of more
than one currency and, therefore, be designed in either of the aforemen-
tioned forms or a combination of those forms.
Investments in Exchange Rate-Related Securities entail special risks.
There is the possibility of significant changes in rates of exchange be-
tween the U.S. dollar and any foreign currency to which an Exchange Rate-
Related Security is linked. If currency exchange rates do not move in the
direction or to the extent anticipated at the time of purchase of the se-
curity, the amount of principal repaid at maturity might be significantly
below the par value of the security, which might not be offset by the in-
terest earned by the Fund over the term of the security. The rate of ex-
change between the U.S. dollar and other currencies is determined by the
forces of supply and demand in the foreign exchange markets. These forces
are affected by the international balance of payments and other economic
and financial conditions, government intervention, speculation and other
factors. The imposition or modification of foreign exchange controls by
the United States or foreign governments or intervention by central banks
also could affect exchange rates. Finally, there is no assurance that suf-
ficient trading interest to create a liquid secondary market will exist
for particular Exchange Rate-Related Securities due to conditions in the
debt and foreign currency markets. Illiquidity in the forward foreign ex-
change market and the high volatility of the foreign exchange market may
from time to time combine to make it difficult to sell an Exchange Rate-
Related Security prior to maturity without incurring a significant price
loss.
Options Activities. Government Securities Fund may write (i.e., sell)
call options on U.S. government securities ("calls"). The Fund writes only
"covered" call options, which means that so long as the Fund is obligated
as the writer of a call option, it will own the underlying securities sub-
ject to the option, or, in the case of options on certain U.S. government
securities as described further below, it will maintain in a segregated
account with the Company's custodian, cash or cash equivalents or U.S.
government securities with a value sufficient to meet its obligations
under the call.
When the Fund writes a call, it receives a premium and gives the purchaser
the right to buy the underlying U.S. government security at any time dur-
ing the call period (usually between three and nine months, but not more
than fifteen months) at a fixed exercise price regardless of market price
changes during the call period. If the call is exercised, the Fund forgoes
any gain from an increase in the market price of the underlying security
over the exercise price.
The Fund may purchase a call on securities only to effect a "closing pur-
chase transaction," which is the purchase of a call covering the same un-
derlying security and having the same exercise price and expiration date
as the call previously written by the Fund on which it wishes to terminate
its obligation. Government Securities Fund also may purchase call options
on futures contracts, as described below. If the Fund is unable to effect
a closing purchase transaction, it will not be able to sell the underlying
security until the call previously written by the Fund expires (or until
the call is exercised and the Fund delivers the underlying security).
The Fund will realize a gain (or loss) on a closing purchase transaction
with respect to a call or put previously written by the Fund if the pre-
mium, plus commission costs, paid to purchase the call or put is less (or
greater) than the premium, less commission costs, received on the sale of
the call or put. A gain also will be realized if a call or put which the
Fund has written lapses unexercised, because the Fund would retain the
premium. See "Taxes."
Government Securities Fund also may write and purchase put options
("puts") on U.S. government securities. When the Fund writes a put, it re-
ceives a premium and gives the purchaser of the put the right to sell the
underlying U.S. government security to the Fund at the exercise price at
any time during the option period. When the Fund purchases a put, it pays
a premium in return for the right to sell the underlying U.S. government
security at the exercise price at any time during the option period. If
any put is not exercised or sold, it will become worthless on its expira-
tion date. The Fund will not purchase puts if more than 10% of its net as-
sets would be invested in premiums on puts.
The Fund may write puts only if they are "secured." A put is "secured" if
the Fund maintains cash, cash equivalents or U.S. government securities
with a value equal to the exercise price in a segregated account or holds
a put on the same underlying security at an equal or greater exercise
price. The aggregate value of the obligations underlying puts written by a
Fund will not exceed 50% of its net assets. The Fund also may write
"straddles," which are combinations of secured puts and covered calls on
the same underlying U.S. government security.
There can be no assurance that a liquid secondary market will exist at a
given time for any particular option. In this regard, trading in options
on U.S. government securities is relatively new, so that it is impossible
to predict to what extent liquid markets will develop or continue. The
Fund has undertaken with a state securities commission that it will limit
losses from all options transactions to 5% of its average net assets per
year, or cease options transactions until in compliance with the 5% limi-
tation, but there can be no absolute assurance that these limits can be
complied with.
The Company's custodian, or a securities depository acting for it, will
act as escrow agent as to the securities on which the Fund has written
puts or calls, or as to other securities acceptable for such escrow, so
that no margin deposit will be required of the Fund. Until the underlying
securities are released from escrow, they cannot be sold by the Fund.
SPECIAL CONSIDERATIONS RELATING TO OPTIONS ON CERTAIN U.S. GOVERNMENT SE-
CURITIES
Treasury Bonds and Notes. Because trading interest in U.S. Treasury bonds
and notes tends to center on the most recently auctioned issues, the ex-
changes will not continue indefinitely to introduce new expirations to re-
place expiring options on particular issues. The expirations introduced at
the commencement of options trading on a particular issue will be allowed
to run, with the possible addition of a limited number of new expirations
as the original expirations expire. Options trading on each issue of bonds
or notes will thus be phased out as new options are listed on more recent
issues, and a full range of expirations will not ordinarily be available
for every issue on which options are traded.
Treasury Bills. Because the deliverable U.S. Treasury bill changes from
week to week, writers of U.S. Treasury bill calls cannot provide in ad-
vance for their potential exercise settlement obligations by acquiring and
holding the underlying security. However, if the Fund holds a long posi-
tion in U.S. Treasury bills with a principal amount corresponding to the
contract size of the option, it may be hedged from a risk standpoint. In
addition, the Fund will maintain U.S. Treasury bills maturing no later
than those which would be deliverable in the event of the exercise of a
call option it has written in a segregated account with its custodian so
that it will be treated as being covered for margin purposes.
GNMA Certificates. GNMA Certificates are mortgage-backed securities rep-
resenting part ownership of a pool of mortgage loans. These loans are made
by private lenders and are either insured by the Federal Housing Adminis-
tration or guaranteed by the Veterans Administration. Once approved by
GNMA, the timely payment of interest and principal on each mortgage in a
"pool" of such mortgages is guaranteed by the full faith and credit of the
U.S. government. Unlike most debt securities, GNMA Certificates provide
for repayment of principal over the term of the loan rather than in a lump
sum at maturity. GNMA Certificates are called "pass-through" securities
because both interest and principal payments on the mortgages are passed
through to the holder.
Since the remaining principal balance of GNMA Certificates declines each
month as mortgage payments are made, the Fund as a writer of a GNMA call
may find that the GNMA Certificates it holds no longer have a sufficient
remaining principal balance to satisfy its delivery obligation in the
event of exercise of the call option it has written. Should this occur,
additional GNMA Certificates from the same pool (if obtainable) or re-
placement GNMA Certificates will have to be purchased in the cash market
to meet delivery obligations.
The Fund will either replace GNMA Certificates representing cover for call
options it has written or will maintain in a segregated account with its
custodian cash or cash equivalents or U.S. government securities having an
aggregate value equal to the market value of the GNMA Certificates under-
lying the call options it has written.
Other Risks. In the event of a shortage of the underlying securities de-
liverable on exercise of an option, the Options Clearing Corporation has
the authority to permit other, generally comparable securities to be de-
livered in fulfillment of option exercise obligations. If the Options
Clearing Corporation exercises its discretionary authority to allow such
other securities to be delivered it may also adjust the exercise prices of
the affected options by setting different prices at which otherwise ineli-
gible securities may be delivered. As an alternative to permitting such
substitute deliveries, the Options Clearing Corporation may impose special
exercise settlement procedures.
The hours of trading for options on U.S. government securities may not
conform to the hours during which the underlying securities are traded. To
the extent that the options markets close before the markets for the un-
derlying securities, significant price and rate movements can take place
in the underlying markets that cannot be reflected in the options markets.
Options are traded on exchanges on only a limited number of U.S. govern-
ment securities, and exchange regulations limit the maximum number of op-
tions which may be written or purchased by a single investor or a group of
investors acting in concert. The Company and other clients advised by af-
filiates of Smith Barney may be deemed to constitute a group for these
purposes. In light of these limits, the Board of Directors may determine
at any time to restrict or terminate the public offering of the Fund's
shares (including through exchanges from the other Funds).
Exchange markets in options on U.S. government securities are a relatively
new and untested concept. It is impossible to predict the amount of trad-
ing interest that may exist in such options, and there can be no assurance
that viable exchange markets will develop or continue.
Interest Rate Futures Transactions. The Fund may purchase and sell inter-
est rate futures contracts ("futures contracts") as a hedge against
changes in interest rates. A futures contract is an agreement between two
parties to buy and sell a security for a set price on a future date. Fu-
tures contracts are traded on designated "contracts markets" which,
through their clearing corporations, guarantee performance of the con-
tracts. Currently there are futures contracts based on securities such as
long-term U.S. Treasury bonds, U.S. Treasury notes, GNMA Certificates and
three-month U.S. Treasury bills.
Generally, if the market interest rates increase, the value of outstanding
debt securities declines (and vice versa). Entering into a futures con-
tract for the sale of securities has an effect similar to the actual sale
of securities, although sale of the futures contract might be accomplished
more easily and quickly. For example, if the Fund holds long-term U.S.
government securities and the investment adviser 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 securities de-
clined, 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. Similarly, entering into a futures contract
for the purchase of securities has an effect similar to actual purchase of
the underlying securities, but permits the continued holding of securities
other than the underlying securities. For example, if the investment ad-
viser expects long-term interest rates to decline, the Fund might enter
into futures contracts for the purchase of long-term securities, so that
it could 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. See "Taxes."
The Appendix contains additional information on the characteristics and
risks of interest rate futures contracts.
Options on Futures Contracts. Government Securities Fund also may pur-
chase and sell listed put and call options on futures contracts. An option
on a futures contract gives the purchaser the right, in return for the
premium paid, to assume a position in a futures contract (a long position
if the option is a call and a short position if the option is a put), at a
specified exercise price at any time during the option period. When an op-
tion on a futures contract is exercised, delivery of the futures position
is accompanied by cash representing the difference between the current
market price of the futures contract and the exercise price of the option.
The Fund may purchase put options on interest rate futures contracts in
lieu of, and for the same purpose as, sale of a futures contract. It also
may purchase such put options in order to hedge a long position in the un-
derlying futures contract in the same manner as it purchases "protective
puts" on securities. See "Options Activities."
The purchase of call options on interest rate futures contracts is in-
tended to serve the same purpose as the actual purchase of the futures
contract, and the Fund will set aside cash and cash equivalents sufficient
to purchase the amount of portfolio securities represented by the underly-
ing futures contracts. The Fund generally would purchase call options on
interest rate futures contracts in anticipation of a market advance when
it is not fully invested.
The Fund would write a call option on a futures contract in order to hedge
against a decline in the prices of the debt securities underlying the fu-
tures contracts. If the price of the futures contract at expiration is
below the exercise price, the Fund would retain the option premium, which
would offset, in part, any decline in the value of its portfolio securi-
ties.
The writing of a put option on a futures contract is similar to the pur-
chase of the futures contract, except that, if the market price declines,
the Fund would pay more than the market price for the underlying securi-
ties. The net cost to the Fund will be reduced, however, by the premium on
the sale of the put, less any transaction costs. See "Taxes."
Limitations on Transactions in Futures and Options on Futures. Government
Securities Fund will not engage in transactions in futures contracts or
related options for speculation but only as a hedge against changes in the
market values of debt securities held, or intended to be purchased by, the
Fund, and where the transactions are appropriate to reduction of the
Fund's risks. The Fund may not purchase futures contracts or related op-
tions if, immediately thereafter, more than 30% of the Fund's total assets
would be so invested. In purchasing and selling futures contracts and re-
lated options, the Fund will comply with rules and interpretations of the
Commodity Futures Trading Commissions ("CFTC"), under which the Fund is
excluded from regulation as a "commodity pool." In order to prevent lever-
age in connection with the purchase of futures contracts by the Fund, an
amount of cash, cash equivalents and/or U.S. government securities equal
to the market value of futures contracts purchased will be maintained in a
segregated account with the custodian (or broker).
The Fund's futures transactions will be entered into for traditional hedg-
ing purposes -- that is, futures contracts will be sold (or related put
options purchased) to protect against a decline in the price of securities
that the Fund owns, or futures contracts (or related call options) will be
purchased to protect the Fund against an increase in the price of securi-
ties it is committed to purchase. See Appendix, "Supplementary Description
of Interest Rate Futures Contracts and Related Options."
Leverage Through Borrowing. Government Securities Fund may borrow up to
25% of the value of its net assets on an unsecured basis from banks to in-
crease its holdings of portfolio securities or to acquire securities to be
placed in a segregated account with its custodian for various purposes
(e.g., to secure puts written by the Fund). The Fund is required to main-
tain continuous asset coverage of 300% with respect to such borrowings,
and to sell (within three days) sufficient portfolio holdings to restore
such coverage, if it should decline to less than 300% due to market fluc-
tuations or otherwise, even if disadvantageous from an investment stand-
point. Leveraging will exaggerate the effect of any increase or decrease
in the value of portfolio securities on the Fund's net asset value, and
money borrowed will be subject to interest costs (which may include com-
mitment fees and/or the cost of maintaining minimum average balances)
which may or may not exceed the interest and option premiums received from
the securities purchased with borrowed funds.
SPECIAL EQUITIES FUND
The investment objective of Special Equities Fund is long-term capital ap-
preciation. It seeks to achieve this objective by investing in common
stocks, or securities convertible into or exchangeable for common stocks
(such as convertible preferred stocks, convertible debentures or war-
rants), which the investment adviser believes to have superior apprecia-
tion potential.
The Fund invests primarily in equity securities of secondary companies
that have yet to reach a fully mature stage of earnings growth. These com-
panies may still be in the developmental stage or may be older companies
that appear to be entering a new stage of more rapid earnings progress due
to factors such as management change or development of new technology,
products or markets. A significant number of these companies may be in
technology areas and may have annual sales less than $300 million.
Some of the securities in which the Fund invests may not be listed on a
national securities exchange, but such securities will usually have an es-
tablished over-the-counter market. However, some of the securities in
which the Fund invests may have limited marketability, and the Fund may
invest up to 10% of its total assets in securities the disposition of
which would be subject to legal restrictions ("restricted securities"). It
may be difficult to sell restricted securities at a price which represents
the investment adviser's opinion of their fair value until they may be
sold publicly. The Fund ordinarily will acquire the right to have such se-
curities registered at the expense of the issuer within some specified pe-
riod of time. Where registration is required prior to sale, a considerable
period of time may elapse between a decision to sell the restricted secu-
rities and the time when the Fund could sell them, during which period the
price may change. The Fund may not invest in restricted securities of pub-
lic utilities.
The Fund may also acquire securities subject to contractual restrictions
on its right to resell them. These restrictions might prevent their sale
at a time when sale would otherwise be desirable. No restricted securities
and no securities for which there is no readily available market ("illiq-
uid securities") will be acquired if such acquisition would cause the ag-
gregate value of illiquid and restricted securities to exceed 10% of the
Fund's total assets. The Fund may not invest more than 5% of its total as-
sets in securities of issuers which, together with any predecessor, have
been in operation for less than three years.
Special Equities Fund also may invest in, or enter into repurchase agree-
ments with respect to, corporate bonds, U.S. government securities, com-
mercial paper, certificates of deposit or other money market securities
during periods when the investment adviser believes that adoption of a de-
fensive position is desirable due to prevailing market or economic condi-
tions. Special Equities Fund may lend its portfolio securities, in accor-
dance with the description set forth under "Investment Grade Bond Fund --
Lending of Portfolio Securities" above. Special Equities Fund's invest-
ments in warrants are subject to the same undertaking applicable to In-
vestment Grade Bond Fund, as described above. The limits contained in that
undertaking are not fundamental policies of the Fund and may be changed by
the Board of Directors without the vote of shareholders. Special Equities
Fund may also sell securities "short against the box," in accordance with
the description set forth above. The Fund may also purchase ADRs.
Investors should realize that the very nature of investing in smaller,
newer companies involves greater risk than is customarily associated with
investing in larger, more established companies. Smaller, newer companies
often have limited product lines, markets or financial resources, and they
may be dependent for management upon one of a few key persons. The securi-
ties of such companies may be subject to more abrupt or erratic market
movements than securities of larger, more established companies or than
the market averages in general. In accordance with its investment objec-
tive of long-term capital appreciation, securities purchased for Special
Equities Fund will not generally be traded for short-term profits, but
will be retained for their longer-term appreciation potential. This gen-
eral practice limits the Fund's ability to adopt a defensive position by
investing in money market instruments during periods of market downturn.
Accordingly, while in periods of market upturn the Fund may outperform the
market averages, in periods of downturn, it is likely to underperform the
market averages. Thus, investing in Special Equities Fund may involve
greater risk than investing in the other Funds.
EUROPEAN FUND
European Fund's investment objective is long-term capital appreciation,
which the Fund seeks to achieve by investing primarily in equity securi-
ties of issuers in its investment area.
Selecting Investments. In determining the appropriate distribution of in-
vestments among various countries and geographic regions for European
Fund, the investment adviser ordinarily considers the following factors:
prospects for relative economic growth among foreign countries; expected
levels of inflation; government policies influencing business conditions;
the outlook for currency relationships; and the range of the individual
investment opportunities available to international investors.
In analyzing companies for investment by the Fund, the investment adviser
ordinarily looks for one or more of the following characteristics: an
above-average earnings growth per share; high return on invested capital;
healthy balance sheet; sound financial and accounting policies and overall
financial strength; strong competitive advantages; effective research and
product development and marketing; efficient service; pricing flexibility;
strength of management; and general operating characteristics which will
enable the companies to compete successfully in their respective market-
place.
There may be times when, in the opinion of the Fund's investment adviser,
prevailing market, economic or political conditions warrant reducing the
proportion invested in equity securities from the primary investment areas
below 65% of the Fund's assets and increasing the proportion held in cash
or short-term obligations denominated in dollars or other currencies. A
portion of the Fund's assets will normally be held in dollars or short-
term interest-bearing dollar-denominated securities to provide for ongoing
expenses and redemptions.
Because European Fund will buy and sell securities denominated in curren-
cies other than the U.S. dollar, and receive interest, dividends and sale
proceeds in currencies other than the U.S. dollar, the Fund will engage in
foreign currency exchange transactions. These transactions will either be
on a spot (i.e., cash) basis at the spot rate prevailing in the foreign
currency exchange market, or the Fund will use forward contracts to pur-
chase or sell foreign currencies. A forward foreign currency exchange con-
tract will involve an obligation by the Fund to purchase or sell a spe-
cific amount of currency at a future date, which may be any fixed number
of days from the date of the contract upon which the parties agree, at a
price set at the time of the contract. These contracts are transferable in
the interbank market conducted directly between currency traders (usually
large commercial banks) and their customers. A forward contract generally
has no deposit requirement, and no commissions are charged at any stage
for trades. Neither spot transactions nor forward exchange contracts will
eliminate fluctuations in the prices of the Fund's securities or in for-
eign exchange rates, or prevent loss if the prices of such securities
should decline.
European Fund may enter into forward foreign exchange contracts in order
to hedge against risks arising from either specific transactions or aggre-
gate portfolio positions. When the Fund enters into a contract for the
purchase or sale of a security denominated in a foreign currency which the
Fund does not hold, it may desire to "lock in" the price of the security
on the basis of current or anticipated exchange rates. The Fund will then
enter into a forward contract for the purchase or sale of the amount of
foreign currency involved in the underlying securities transactions; in
this manner, the Fund will be better able to protect itself against a pos-
sible loss resulting from an adverse change in exchange rates during the
period between the date the securities are purchased or sold and the date
on which payment is made or received. In such cases, the Fund will retain
in a segregated account the full amount in the relevant currency needed to
cover this forward contract.
When the investment adviser believes that the currency of a particular
foreign country may suffer a substantial decline against the U.S. dollar
or another foreign currency, it may enter into a forward contract to sell
the amount of foreign currency approximating the value of some or all of
the Fund's securities denominated in such foreign currency. The precise
matching of the forward contract amounts and the value of the securities
involved will not generally be possible since the future value of such se-
curities in foreign currencies will change as a consequence of market
movements in the value of those securities between the date the forward
contract is entered into and the date it matures. The projection of short-
term currency market movements is extremely difficult, and the successful
execution of a short-term hedging strategy is highly uncertain. The Fund
generally will not attempt to hedge all of its portfolio positions and
will enter into such transactions only to the extent, if any, deemed ap-
propriate by the investment adviser. The Fund generally will not enter
into such forward contracts or maintain a net exposure to such contracts
when the consummation of the contracts would obligate the Fund to deliver
an amount of foreign currency in excess of the value of the Fund's securi-
ties or other assets denominated in that currency. Under normal circum-
stances, the Fund expects that any appreciation (depreciation) on such
forward exchange contracts will be approximately offset by the deprecia-
tion (appreciation) in translation of the underlying foreign investment
arising from fluctuations in foreign currency exchange rates.
Although the Fund values its assets daily in terms of U.S. dollars, the
Fund will not normally convert its holdings of foreign currencies into
U.S. dollars on a daily basis. The Fund will do so from time to time, and
investors should be aware of the costs of currency conversion. Although
foreign exchange dealers do not charge a fee for conversion, they do real-
ize a profit based on the difference (the "spread") between the prices at
which they are buying and selling various currencies. Thus, a dealer may
offer to sell a foreign currency to the Fund at one rate, while offering a
lesser rate of exchange should the Fund desire to sell that currency to
the dealer.
The Fund is not aware at this time of the existence of any investment or
exchange control regulations which might substantially impair its opera-
tions as described in the Prospectus and this Statement of Additional In-
formation. It should be noted, however, that this situation could change
at any time.
The Fund will recognize the unrealized appreciation or depreciation from
the fluctuation in a foreign currency forward contract as an increase or
decrease in the Fund's net assets on a daily basis, thereby providing an
appropriate measure of the Fund's financial position and changes in finan-
cial position.
The Fund may invest in yen-denominated bonds sold in Japan by non-Japanese
issuers ("Samurai Bonds") and may invest in dollar-denominated bonds sold
in the United States by non-U.S. issuers ("Yankee Bonds"). As compared
with the bonds issued in their countries of domicile, such bond issues
normally carry a higher interest rate but are less actively traded. It is
the policy of the Fund to invest in Samurai or Yankee Bond issues only
after taking into account considerations of quality and liquidity, as well
as yield. These bonds would be issued by Organization for European Cooper-
ation and Development ("OECD") governments or would have "AAA" ratings.
European Fund may invest in ADRs, European Depositary Receipts ("EDRs"),
which are designed for trading in European securities markets and are re-
ceipts issued in Europe which evidence a similar ownership arrangement to
ADRs, or securities convertible into securities of eligible European or
Far Eastern issuers. These convertible securities may not necessarily be
denominated in the same currency as the securities into which they may be
converted. Generally, ADRs, in registered form, are designed for use in
American securities markets, and EDRs, in bearer form, are designed for
use in European securities markets.
European Fund may lend its portfolio securities in accordance with the
guidelines set forth above. European Fund will invest no more than 10% of
the value of its net assets in warrants valued at the lower of cost or
market.
INVESTMENT RESTRICTIONS
The Funds' investment objectives and the investment restrictions set forth
below are fundamental policies of each Fund, i.e., they may not be changed
with respect to a Fund without a majority vote of the outstanding shares
of that Fund. (All other investment practices described in the Prospec-
tuses and the Statement of Additional Information may be changed by the
Board of Directors without the approval of shareholders.)
Unless otherwise indicated, all percentage limitations apply to each Fund
on an individual basis, and apply only at the time a transaction is en-
tered into. (Accordingly, if a percentage restriction is complied with at
the time of investment, a later increase or decrease in the percentage
which results from a relative change in values or from a change in the
Fund's net assets will not be considered a violation.)
Restrictions Applicable to All Funds. No Fund may:
1. Purchase the securities of any one issuer, other than the U.S. govern-
ment or its agencies or instrumentalities (and, for European Fund, govern-
ments, agencies or instrumentalities of any jurisdiction in the primary
investment area of the Fund and other OECD countries and the World Bank),
if immediately after such purchase more than 5% of the value of the total
assets of the Fund would be invested in securities of such issuer;
2. Invest in real estate, real estate mortgage loans, or interests in
oil, gas and/or mineral exploration or development programs, provided that
this limitation shall not prohibit the purchase of securities issued by
companies, including real estate investment trusts, which invest in real
estate or interests therein;
3. Purchase securities of any other investment company, except in connec-
tion with a merger, consolidation, reorganization, or acquisition or as-
sets. European Fund may, under certain circumstances, invest in securities
of other companies. See "Restrictions Applicable to European Fund." (For
purposes of this limitation, foreign banks or their agencies or subsidiar-
ies are not considered "investment companies");
4. Make investments in securities for the purpose of exercising control
over or management of the issuer;
5. Participate on a joint or a joint and several basis in any trading ac-
count in securities. (The "bunching" of orders of two or more Funds -- or
of one or more Funds and of other accounts -- for the sale or purchase of
portfolio securities shall not be considered participation in a joint se-
curities trading account);
6. Purchase the securities of any one issuer if, immediately after such
purchase, the Fund would own more than 10% of the outstanding voting secu-
rities of such issuer;
7. Purchase securities on margin, except such short-term credits as are
necessary for the clearance of transactions. (For this purpose, the de-
posit or payment by Government Securities Fund of initial or maintenance
margin in connection with futures contracts and related options is not
considered to be the purchase of a security on margin. Additionally, bor-
rowing by Government Securities Fund and European Fund to increase their
holdings of portfolio securities is not considered to be the purchase of
securities on margin);
8. Make loans, except that this restriction shall not prohibit (a) the
purchase and holding of a portion of an issue of publicly distributed debt
securities, (b) the lending of portfolio securities, or (c) entry into re-
purchase agreements;
9. Invest in securities of an issuer which, together with any predeces-
sor, has been in operation for less than three years if, as a result, more
than 5% of the total assets of the Fund would then be invested in such se-
curities (for purposes of this restriction, issuers include predecessors,
sponsors, controlling persons, general guarantors and originators of un-
derlying assets );
10. Purchase the securities of an issuer if, to the Company's knowledge,
one or more of the Directors or officers of the Company individually own
beneficially more than 1/2 of 1% of the outstanding securities of such is-
suer or together own beneficially more than 5% of such securities;
11. Purchase a security which is not readily marketable if, as a result,
more than 10% of the Fund's total assets would consist of such securities.
(For purposes of this limitation, restricted securities and repurchase
agreements having more than seven days remaining to maturity are consid-
ered not readily marketable);
12. Sell securities short, unless at all times when a short position is
open, it owns an equal amount of the securities or securities convertible
into, or exchangeable without payment of any further consideration for,
securities of the same issue as the securities sold short; or
13. Purchase the securities of issuers conducting their principal busi-
ness activities in the same industry, if immediately after such purchase
the value of its investments in such industry would exceed 25% of the
value of the total assets of the Fund, provided that (a) neither all util-
ity companies (including telephone companies), as a group, nor all banks,
savings and loan associations and savings banks, as a group, will be con-
sidered a single industry for purposes of this limitation, and (b) there
is no such limitation with respect to repurchase agreements or to invest-
ments in U.S. government securities or certificates of deposit or bankers'
acceptances issued by domestic institutions (but not their foreign
branches).
Restrictions Applicable to All Funds Except Government Securities Fund and
European Fund. The Funds may not:
1. Invest in commodities or commodity futures contracts;
2. Borrow amounts in excess of 5% of their total assets taken at cost or
at market value, whichever is lower, and then only from banks as a tempo-
rary measure for extraordinary or emergency purposes. A Fund may not mort-
gage, pledge or in any other manner transfer any of its assets as security
for any indebtedness. This restriction shall not prohibit entry into re-
verse repurchase agreements, provided that a Fund may not enter into a re-
verse repurchase agreement if, as a result, its current obligations under
such agreements would exceed one-third of the current market value of the
Fund's total assets (less its liabilities other than obligations under
such agreements); or
3. Write, purchase or sell puts, calls, straddles, spreads or any combi-
nations thereof.
Restrictions Applicable to All Funds Except Special Equities Fund and Eu-
ropean Fund. The Funds may not:
1. Purchase securities which may not be resold to the public without reg-
istration under the Securities Act of 1933, as amended (the "1933 Act");
or
2. Act as an underwriter of securities.
Restrictions Applicable to Special Equities Fund and European Fund. The
Funds may not act as an underwriter of securities, except that each Fund
may invest up to 10% of its total assets in securities which it may not be
free to resell without registration under the 1933 Act, in which registra-
tion the Fund may technically be deemed an underwriter for purposes of the
1933 Act.
Restrictions Applicable to Investment Grade Bond Fund Only. Investment
Grade Bond Fund may not purchase corporate bonds unless rated at the time
of purchase Baa or better by Moody's or BBB or better by S&P, or purchase
commercial paper unless issued by a U.S. corporation and rated at the time
of purchase Prime-1 or Prime-2 by Moody's or A-1 or A-2 by S&P (or, if not
rated, issued by a corporation having outstanding debt rated Aa or better
by Moody's or AA or better by S&P), although it may continue to hold a se-
curity if its quality rating is reduced by a rating service below those
specified.
Restrictions Applicable to European Fund Only. The Fund may invest in
shares of other investment companies to the extent permitted by the 1940
Act. With respect to certain countries (e.g., South Korea and Taiwan), in-
vestments by the Fund may only presently be made by acquiring shares of
other investment companies with local governmental approval to invest in
those countries. The 1940 Act provides that the Fund may purchase shares
in an investment company unless (a) such a purchase would cause the Fund
to own in aggregate more than 3% of the total outstanding voting stock of
the company, or (b) such a purchase would cause the Fund to have more than
5% of its assets invested in the company or more than 10% of its assets
invested in an aggregate of all such investment companies. (Investment
through a limited number of approved vehicles may also involve the payment
of substantial premiums above the value of such companies' portfolio secu-
rities. The yield of such securities will be reduced by operating expenses
of such companies including payments to the investment managers of those
investment companies. At such time as direct investment in these countries
is allowed, the Fund anticipates investing directly in these markets.)
BROKERAGE
In selecting brokers or dealers to execute securities transactions on be-
half of a Fund, the Fund's investment adviser seeks the best overall terms
available. In assessing the best overall terms available for any transac-
tion, each investment adviser will consider the factors that the invest-
ment adviser deems relevant, including the breadth of the market in the
security, the price of the security, the financial condition and execution
capability of the broker or dealer and the reasonableness of the commis-
sion, if any, for the specific transaction and on a continuing basis. In
addition, each investment advisory agreement between the Company and an
investment adviser authorizes the investment adviser, in selecting brokers
or dealers to execute a particular transaction and in evaluating the best
overall terms available, to consider the brokerage and research services
(as those terms are defined in Section 28(e) of the Securities Exchange
Act of 1934) provided to the Company, the other Funds and other accounts
over which the investment adviser or its affiliates exercise investment
discretion. The fees under the investment advisory agreements and the ad-
ministration agreement between the Company and the investment advisers and
administrator, respectively, are not reduced by reason of their receiving
such brokerage and research services. The Board of Directors periodically
will review the commissions paid by the Funds to determine if the commis-
sions paid over representative periods of time were reasonable in relation
to the benefits inuring to the Company. SEC rules require that commissions
paid to Smith Barney by a Fund on exchange transactions not exceed "usual
and customary brokerage commissions." The rules define "usual and custom-
ary" commissions to include amounts which are "reasonable and fair com-
pared to the commission, fee or other remuneration received or to be re-
ceived by other brokers in connection with comparable transactions involv-
ing similar securities being purchased or sold on a securities exchange
during a comparable period of time." The Board of Directors, particularly
those members who are not "interested persons" of the Company (as defined
in the 1940 Act), has adopted procedures for evaluating the reasonableness
of commissions paid to Smith Barney and reviews these procedures periodi-
cally. In addition, under rules adopted by the SEC, Smith Barney may di-
rectly execute transactions for a Fund on the floor of any national secu-
rities exchange, provided: (a) the Board of Directors has expressly autho-
rized Smith Barney to effect such transactions; and (b) Smith Barney
annually advises the Fund of the aggregate compensation it earned on such
transactions.
To the extent consistent with applicable provisions of the 1940 Act and
the rules and exemptions adopted by the SEC thereunder, the Board of Di-
rectors has determined that transactions for a Fund may be executed
through Smith Barney and other affiliated broker-dealers if, in the judg-
ment of the Fund's investment adviser, the use of such broker-dealer is
likely to result in price and execution at least as favorable as those of
other qualified broker-dealers, and if, in the transaction, such broker-
dealer charges the Fund a rate consistent with that charged to comparable
unaffiliated customers in similar transactions.
Portfolio securities are not purchased from or through Smith Barney or any
affiliated person (as defined in the 1940 Act) of Smith Barney where such
entities are acting as principal, except pursuant to the terms and condi-
tions of exemptive rules or orders promulgated by the SEC. Pursuant to
conditions set forth in rules of the SEC, the Company may purchase securi-
ties from an underwriting syndicate of which Smith Barney is a member (but
not from Smith Barney). Such conditions relate to the price and amount of
the securities purchased, the commission or spread paid, and the quality
of the issuer. The rules further require that such purchases take place in
accordance with procedures adopted and reviewed periodically by the Board
of Directors, particularly those Directors who are not interested persons
of the Company.
The Funds may use Smith Barney as a commodities broker in connection with
entering into futures contracts and commodity options. Smith Barney has
agreed to charge the Funds commodity commissions at rates comparable to
those charged by Smith Barney to its most favored clients for comparable
trades in comparable accounts.
The following table sets forth certain information regarding each Fund's
payment of brokerage commissions to Smith Barney:
<TABLE>
<CAPTION>
FISCAL YEAR GOVERNMENT SPECIAL
ENDED SECURITIES EQUITIES
EUROPEAN
DECEMBER 31, FUND FUND
FUND
<S> <C> <C> <C> <C>
Total Brokerage Commissions 1991 $196,809 $551,741
$139,159
1992 $238,425 $267,089
$143,776
1993 $717,340 --
$100,366
Commissions paid to 1991 $187,850 $74,657
$8,106
Smith Barney*
1992 $0 $56,498
$3,142
1993 $87,550 $16,614
$9,401
% of Total Brokerage 1993 12.2%** 11.9%
9.37%
Commissions paid to
Smith Barney*
% of Total Transactions 1993 .07%** 11.7%
10.56%
involving Commissions paid
to Smith Barney*
* Includes commissions paid to Shearson Lehman Brothers, the Company's
distributor prior to Smith Barney.
** The disproportional amount between the percentage of total brokerage
commissions paid to Smith Barney and the percentage of total transac-
tions involving commissions paid to Smith Barney for the Government Se-
curities Fund resulted from higher brokerage commissions for options
and futures transactions which were the only commission transactions
involving Smith Barney.
</TABLE>
PORTFOLIO TURNOVER
For reporting purposes, a Fund's portfolio turnover rate is calculated by
dividing the lesser of purchases or sales of portfolio securities for the
fiscal year by the monthly average of the value of the portfolio securi-
ties owned by the Fund during the fiscal year. In determining such portfo-
lio turnover, all securities whose maturities at the time of acquisition
were one year or less are excluded. A 100% portfolio turnover rate would
occur, for example, if all of the securities in the Fund's investment
portfolio (other than short-term money market securities) were replaced
once during the fiscal year.
Investment Grade Bond Fund will not normally engage in the trading of se-
curities for the purpose of realizing short-term profits, but it will ad-
just its portfolio as considered advisable in view of prevailing or antic-
ipated market conditions. Portfolio turnover will not be a limiting factor
should the Fund's investment adviser deem it advisable to purchase or sell
securities.
Special Equities Fund and European Fund invest for long-term capital ap-
preciation and will not generally trade for short-term profits. However,
each portfolio will be adjusted as deemed advisable by the investment ad-
viser, and portfolio turnover will not be a limiting factor should the
Fund's investment adviser deem it advisable to purchase or sell securi-
ties.
The options activities of Government Securities Fund may affect its port-
folio turnover rate and the amount of brokerage commissions paid by the
Fund. The exercise of calls written by the Fund may cause the Fund to sell
portfolio securities, thus increasing its turnover rate. The exercise of
puts also may cause the sale of securities and increase turnover; although
such exercise is within the Fund's control, holding a protective put might
cause the Fund to sell the underlying securities for reasons which would
not exist in the absence of the put. The Fund will pay a brokerage commis-
sion each time it buys or sells a security in connection with the exercise
of a put or call. Some commissions may be higher than those which would
apply to direct purchases or sales of portfolio securities. High portfolio
turnover involves correspondingly greater commission expenses and transac-
tion costs.
For the fiscal years ended December 31, 1992 and 1993, the portfolio turn-
over rates were as follows:
<TABLE>
<CAPTION>
FUND 1992 1993
<S> <C> <C>
Investment Grade Bond Fund 47% 65%
Government Securities Fund 426% 540%
Special Equities Fund 211% 112%
European Fund 108% 68%
</TABLE>
Increased portfolio turnover necessarily results in correspondingly
greater brokerage commissions which must be paid by the Fund. To the ex-
tent that portfolio trading results in realization of net short-term capi-
tal gains, shareholders will be taxed on such gains at ordinary income tax
rates (except shareholders who invest through IRAs and other retirement
plans which are not taxed currently on accumulations in their accounts).
The Funds' investment advisers manage a number of private investment ac-
counts on a discretionary basis. Neither investment adviser is bound by
the recommendations of the Smith Barney research department in managing
the Funds. Although investment decisions are made individually for each
client, at times decisions may be made to purchase or sell the same secu-
rities for one or more of the Funds and/or for one or more of the other
accounts managed by the investment adviser or fund manager. When two or
more such accounts simultaneously are engaged in the purchase or sale of
the same security, transactions are allocated in a manner considered equi-
table to each, with emphasis on purchasing or selling entire orders wher-
ever possible. In some cases, this procedure may adversely affect the
price paid or received by a Fund or the size of the position obtained or
disposed of by the Fund.
PURCHASE OF SHARES
VOLUME DISCOUNTS
The schedules of sales charges on Class A shares described in the Prospec-
tuses apply to purchases made by any "purchaser," which is defined to in-
clude the following: (a) an individual; (b) an individual's spouse and his
or her children purchasing shares for his or her own account; (c) a
trustee or other fiduciary purchasing shares for a single trust estate or
single fiduciary account; (d) a pension, profit-sharing or other employee
benefit plan qualified under Section 401(a) of the Internal Revenue Code
of 1986, as amended (the "Code"), and qualified employee benefit plans of
employers who are "affiliated persons" of each other within the meaning of
the 1940 Act; (e) tax-exempt organizations enumerated in Section 501(c)(3)
or (13) of the Code; and (f) a trustee or other professional fiduciary
(including a bank, or an investment adviser registered with the SEC under
the Investment Advisers Act of 1940, as amended) purchasing shares of a
Fund for one or more trust estates or fiduciary accounts. Purchasers who
wish to combine purchase orders to take advantage of volume discounts on
Class A shares should contact a Smith Barney Financial Consultant.
COMBINED RIGHT OF ACCUMULATION
Reduced sales charges, in accordance with the schedule in the Prospec-
tuses, apply to any purchase of Class A shares if the aggregate investment
in Class A shares of a Fund and in Class A shares of the other funds in
the Company and of other funds of the Smith Barney Mutual Funds that are
offered with a sales charge, including the purchase being made,
of any purchaser is $25,000 or more. The reduced sales charge is subject
to confirmation of the shareholder's holdings through a check of appropri-
ate records. Each Fund reserves the right to terminate or amend the com-
bined right of accumulation at any time after written notice to
shareholders. For further information regarding the rights of accumulation,
shareholders should contact a Smith Barney Financial Consultant.
DETERMINATION OF PUBLIC OFFERING PRICE
Each Fund offers its shares to the public on a continuous basis. The pub-
lic offering price for a Class A share of each Fund is equal to the
net
asset value per share at the time of purchase plus an initial sales charge
based on the aggregate amount of the investment. The public offering price
for a Class B share, Class C share and Class Y share (and Class A
share
purchases, including applicable rights of accumulation, equalling or ex-
ceeding $500,000, is equal to the net asset value per share at the time of
purchase and no sales charge is imposed at the time of purchase. A contin-
gent deferred sales charge ("CDSC"), however, is imposed on certain re-
demptions of Class B shares, Class C shares, and Class A shares when pur-
chased in amounts equalling or exceeding $500,000. The method of computa-
tion of the public offering price is shown in each Fund's financial
statements , incorporated by reference in their entirety into
this Statement of Additional Information.
REDEMPTION OF SHARES
The right of redemption may be suspended or the date of payment postponed
(a) for any period during which the NYSE is closed (other than for custom-
ary weekend and holiday closings), (b) when trading in markets a Fund nor-
mally utilizes is restricted, or an emergency exists, as determined by the
SEC, so that disposal of the Fund's investments or determination of net
asset value is not reasonably practicable or (c) for such other periods as
the SEC by order may permit for the protection of the Fund's shareholders.
DISTRIBUTIONS IN KIND
If the Board of Directors of the Company determines that it
would be detrimental to the best interests of the remaining
shareholders
to make a redemption payment wholly in cash, the Fund may pay, in
accordance with
SEC rules , any portion of a redemption in excess of the
lesser of $250,000 or 1% of the Fund's net assets by a distribution in
kind of portfolio securities in lieu of cash. Securities issued
as a distribution in kind may incur brokerage commissions
when
shareholders subsequently sell those securities.
AUTOMATIC CASH WITHDRAWAL PLAN
An automatic cash withdrawal plan (the "Withdrawal Plan") is available to
shareholders who own shares with a value of at least $10,000 ($5,000 for
retirement plan accounts) and who wish to receive specific amounts of cash
monthly or quarterly. Withdrawals of at least $100 may be made under the
Withdrawal Plan by redeeming as many shares of a Fund as may be necessary
to cover the stipulated withdrawal payment. Any applicable CDSC will not
be waived on amounts withdrawn by shareholders that exceed 1.00% per month
of the value of a shareholder's shares at the time the Withdrawal Plan
commences. (With respect to Withdrawal Plans in effect prior to November
7, 1994, any applicable CDSC waived on amounts withdrawn that do not ex-
ceed 2.00% per month of the shareholder's shares are subject to a CDSC.)
To the extent withdrawals exceed dividends, distributions and appreciation
of shareholder's investment in a Fund, there will be a reduction in the
value of the shareholder's investment and continued withdrawal payments
may reduce the shareholder's investment and ultimately exhaust it. With-
drawal payments should not be considered as income from investment in the
Fund. Furthermore, as it would not generally be advantageous to a share-
holder to make additional investments in the Fund at the same time that he
or she is participating in the Withdrawal Plan, purchases by such share-
holders in amounts of less than $5,000 will not ordinarily be permitted.
Shareholders who wish to participate in the Withdrawal Plan and who hold
their shares in certificate form must deposit their share certificates
with TSSG as agent for Withdrawal Plan members. All dividends and distri-
butions on shares in the Withdrawal Plan are automatically reinvested at
net asset value in additional shares of the Company. Effective November 7,
1994, Withdrawal Plans should be set up with any Smith Barney Financial
Consultant. A shareholder who purchases shares directly through TSSG may
continue to do so and applications for participation in the Withdrawal
Plan must be received by TSSG no later than the eighth day of the month to
be eligible for participation beginning with that month's withdrawal. For
additional information, shareholders should contact a Smith Barney Finan-
cial Consultant.
DISTRIBUTOR
Smith Barney serves as the Company's distributor on a best efforts basis
pursuant to a distribution agreement (the "Distribution Agreement") which
was most recently approved by the Company's Board of Directors on August
4, 1994. During the fiscal period from November 6, 1992 through December
31, 1992 and the fiscal year ended December 31, 1993, Shearson Lehman
Brothers and/or Smith Barney received $24,792 and $341,355, respectively,
in sales charges from the sale of Class A shares and did not reallow any
portion therof to dealers. During the fiscal years ended December 31, 1991
and 1992, Shearson Lehman Brothers received approximately $3,942,000 and
$1,320,000, respectively, representing the CDSC on redemptions of Class B
shares of the Funds. During the fiscal year ended December 31, 1993, Smith
Barney and Shearson Lehman Brothers received $699,139 and $871,809, re-
spectively, representing the CDSC on redemptions of Class B shares of the
Company.
When payment is made by the investor before the settlement date, unless
otherwise directed by the investor, the funds will be held as a free
credit balance in the investor's brokerage account, and Smith Barney may
benefit from the temporary use of the funds. The investor may designate
another use for the funds prior to settlement date, such as investment in
a money market fund (other than the Smith Barney Exchange Reserve Fund) of
the Smith Barney Mutual Funds. If the investor instructs Smith Barney to
invest the funds in a Smith Barney money market fund, the
amount of the investment will be included as part of the aver-
age daily net assets of both the Company and the money market fund, and
affiliates of Smith Barney that serve the funds in an investment
advisory
capacity will benefit from the fact that they are receiving fees from both
such investment companies for managing these assets computed on the basis
of their average daily net assets. The Company's Board of Directors has
been advised of the benefits to Smith Barney resulting from these settle-
ment procedures and will take such benefits into consideration when re-
viewing the Advisory, Administration and Distribution Agreements for con-
tinuance.
DISTRIBUTION ARRANGEMENTS
To compensate Smith Barney for the services it provides and for the ex-
pense it bears under the Distribution Agreement, the Company has adopted a
services and distribution plan (the "Plan") pursuant to Rule 12b-1 under
the 1940 Act. Under the Plan, each Fund pays Smith Barney a service fee,
accrued daily and paid monthly, calculated at the annual rate of 0.25% of
the value of each Fund's average daily net assets attributable to the
Class A, Class B and Class C shares (previously designated as Class D
shares). In addition, the Company pays Smith Barney a
distribution fee with respect to Class B and Class C shares
primarily intended to compensate Smith Barney for its
initial expense of paying Financial Consultants a commission upon sales of
those shares. Such shares distribution fees, which are accrued
daily and paid monthly, are calculated at the annual rate of 0.75% of the
value of average daily net assets attributable to the Class B and Class C
shares with respect to Special Equities Fund and European Fund, 0.50% of
the value of average daily net assets attributable to the Class B shares
and 0.45% of the value of average daily net assets attributable to Class C
shares, with respect to Government Securities Fund and Investment Grade
Bond Fund.
For the fiscal years ended December 31, 1991 and 1992 Shearson Lehman
Brothers, the Company's distributor prior to Smith Barney, received ap-
proximately $24,762,000 and $14,563,000, respectively, from the Funds in
distribution fees. During the fiscal year ended December 31, 1993, Smith
Barney and Shearson Lehman Brothers received $5,652,418 and $7,949,875,
respectively. During the fiscal year ended December 31, 1993, Shearson Le-
hman Brothers and Smith Barney incurred distribution expenses totalling
approximately $18,866,000, consisting of $11,059,000 for support services,
$7,479,000 to Financial Consultants, $50,000 for advertising expenses, and
$278,000 for printing and mailing expenses. No comparable information is
available for 1992 because that was the year that the variable pricing
system
was implemented.
Under its terms, the Plan continues from year to year, provided such con-
tinuance is approved annually by vote of the Board of Directors, including
a majority of the Independent Directors. The Plan may not be amended to
increase the amount to be spent for the services provided by Smith Barney
without shareholder approval, and all amendments of the Plan also must be
approved by the Directors in the manner described above. The Plan may be
terminated at any time, without penalty, by vote of a majority of the In-
dependent Directors or by a vote of a majority of the outstanding voting
securities of the Company (as defined in the 1940 Act) on not more than 30
days' written notice to any other party to the Plan. Pursuant to the Plan,
Smith Barney will provide the Board of Directors periodic reports of
amounts expended under the Plan and the purpose for which such expendi-
tures were made.
VALUATION OF SHARES
Each Class' net asset value per share is calculated on each day, Monday
through Friday, except days on which the NYSE is closed. The NYSE cur-
rently is scheduled to be closed on New Years's Day, Presidents' Day, Good
Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving and
Christmas, and on the preceding Friday or subsequent Monday when one of
these holidays falls on a Saturday or Sunday, respectively. Because of the
differences in distribution fees and Class-specific expenses, the per
share net asset value of each Class may differ. The following is a de-
scription of the procedures used by the Funds in valuing its assets.
Because of the need to obtain prices as of the close of trading on various
exchanges throughout the world, the calculation of the net asset value on
European Fund may not take place contemporaneously with the determination
of the prices of many of its respective portfolio securities used in such
calculation. A security which is listed or traded on more than one ex-
change is valued at the quotation on the exchange determined to be the
primary market for such security. All assets and liabilities initially ex-
pressed in foreign currency values will be converted into U.S. dollar val-
ues at the mean between the bid and offered quotations of such currencies
against U.S. dollars as last quoted by any recognized dealer. If such quo-
tations are not available, the rate of exchange will be determined in good
faith by the Board of Directors. In carrying out the Board of Director's
valuation policies, SBMFM, as administrator, or Boston Advisors, as sub-
administrator, may consult with an independent pricing service (the "Pric-
ing Service") retained by the Company.
Debt securities of U.S. issuers (other than U.S. government securities and
short-term investments) are valued by SBMFM, as administrator, or Boston
Advisors, as sub-administrator, after consultation with the Pricing Ser-
vice approved by the Board of Directors. When, in the judgment of the
Pricing Service, quoted bid prices for investments are readily available
and are representative of the bid side of the market, these investments
are valued at the mean between the quoted bid prices and asked prices. In-
vestments for which, in the judgment of the Pricing Service, there are no
readily obtainable market quotations are carried at fair value as deter-
mined by the Pricing Service. The procedures of the Pricing Service are
reviewed periodically by the officers of the Company under the general su-
pervision and responsibility of the Board of Directors.
EXCHANGE PRIVILEGE
Except as noted below, shareholders of any fund of the Smith Barney Mutual
Funds may exchange all or part of their shares for shares of the same
class of other funds of the Smith Barney Mutual Funds as listed in the
Prospectuses, on the basis of relative net asset value per share at the
time of exchange as follows:
A. Class A shares of any Fund or company purchased with a sales charge
may be exchanged for Class A shares of any of the other funds, and the
sales charge differential, if any, will be applied. Class A shares of any
fund may be exchanged without a sales charge for shares of the funds that
are offered without a sales charge. Class A shares of any fund purchased
without a sales charge may be exchanged for shares sold with a sales
charge, and the appropriate sales charge differential will be applied.
B. Class A shares of any fund acquired by a previous exchange of shares
purchased with a sales charge may be exchanged for Class A shares of any
of the other funds, and the sales charge differential, if any, will be ap-
plied.
C. Class B shares of any fund may be exchanged without a sales charge.
Class B shares of the Fund exchanged for Class B shares of another fund
will be subject to the higher applicable CDSC of the two funds and, for
purposes of calculating CDSC rates and conversion periods, will be deemed
to have been held since the date the shares being exchanged were deemed to
be purchased.
Dealers other than Smith Barney must notify TSSG of the investor's prior
ownership of Class A shares of Smith Barney High Income Fund and the ac-
count number in order to accomplish an exchange of shares of Smith Barney
High Income Fund under paragraph B above.
The exchange privilege enables shareholders to acquire shares of the same
Class in a fund with different investment objectives when they believe
that a shift between funds is an appropriate investment decision. This
privilege is available to shareholders residing in any state in
which the
fund shares being acquired may legally be sold. Prior to any exchange, the
shareholder should obtain and review a copy of the current prospectus of
each fund into which an exchange is being considered. Prospectuses may be
obtained from a Smith Barney Financial Consultant.
Upon receipt of proper instructions and all necessary supporting docu-
ments, shares submitted for exchange are redeemed at the then-current net
asset value and the proceeds are immediately invested at a price as de-
scribed above, in shares of the fund being acquired with such shares being
subject to any applicable CDSC. Smith Barney reserves the right to reject
any exchange request. The exchange privilege may be modified or terminated
at any time after written notice to shareholders.
PERFORMANCE DATA
From time to time, a Fund may quote its yield or total return in adver-
tisements or in reports and other communications to shareholders. The Fund
may include comparative performance information in advertising or market-
ing the Fund's shares. Such performance information may include the fol-
lowing industry and financial publications: Barron's, Business Week, CDA
Investment Technologies, Inc., Changing Times, Forbes, Fortune, Institu-
tional Investor, Investors Daily, Money, Morningstar Mutual Fund Values,
The New York Times, USA Today and The Wall Street Journal. To the extent
any advertisement or sales literature of a Fund describes the expenses or
performance of a Class, it will also disclose such information for the
other Classes.
YIELD
A Fund's 30-day yield figure described in the Prospectuses is calculated
according to a formula prescribed by the SEC. The formula can be expressed
as follows:
YIELD = 2[(abcd + 1)6 |m- 1]
Where: a = dividends and interest earned during the period.
b = expenses accrued for the period (net of reimburse-
ment).
c = the average daily number of shares outstanding dur-
ing the period that were entitled to receive
dividends.
d = the maximum offering price per share on the last day
of the period.
For the purpose of determining the interest earned (variable "a" in the
formula) on debt obligations that were purchased by the Fund at a discount
or premium, the formula generally calls for amortization of the discount
or premium; the amortization schedule will be adjusted monthly to reflect
changes in the market values of the debt obligations.
Investors should recognize that, in periods of declining interest rates, a
Fund's yield will tend to be somewhat higher than prevailing market rates,
and in periods of rising interest rates, the Fund's yield will tend to be
somewhat lower. In addition, when interest rates are falling, the inflow
of net new money to the Fund from the continuous sale of its shares will
likely be invested in portfolio instruments producing lower yields than
the balance of such Fund's investments, thereby reducing the current yield
of the Fund. In periods of rising interest rates, the opposite can be ex-
pected to occur.
The yields for the 30-day period ended December 31, 1993 for Class A,
Class B and Class C shares of Investment Grade Bond Fund were 6.50%, 6.29%
and 6.31%, respectively, and of Government Securities Fund were 3.65%,
3.38% and 3.33%, respectively.
AVERAGE ANNUAL TOTAL RETURN
A Class' "average annual total return" figures, as described and shown in
the Prospectuses, are computed according to a formula prescribed by the
SEC. The formula can be expressed as follows:
P(1+T)n = ERV
Where: P = a hypothetical initial payment of $1,000.
T = average annual total return.
n = number of years.
ERV = Ending Redeemable Value of a hypothetical $1,000
investment made at the beginning of a 1-, 5- or
10-year period at the end of the 1-, 5- or 10-year
period (or fractional portion thereof), assuming
reinvestment of all dividends and distributions.
A Class' total return figures calculated in accordance with the above for-
mula assume that the maximum applicable sales charge or maximum applicable
CDSC, as the case may be, has been deducted from the hypothetical $1,000
initial investment at the time of purchase or redemption, as applicable.
Class A's average annual total returns were as follows for the periods in-
dicated:
<TABLE>
<CAPTION>
YEAR ENDED
NOVEMBER 6, 1992*
NAME OF FUND JUNE 30, 1994 THROUGH JUNE 30,
1994
<S> <C> <C>
Investment Grade Bond Fund (9.40)% 3.20%
Government Securities Fund (5.53) 2.50
Special Equities Fund 7.97
10.00
European Fund 10.69 9.69
* The Funds commenced selling Class A shares on November 6, 1992.
</TABLE>
Class B's average annual total returns were as follows for the periods in-
dicated:
<TABLE>
<CAPTION>
TEN YEAR PERIOD OR
PERIOD FROM
COMMENCEMENT OF
YEAR ENDED FIVE YEARS ENDED
OPERATIONS THROUGH
NAME OF FUND JUNE 30, 1994 JUNE 30, 1994 JUNE 30, 1994
<S> <C> <C>
<C>
Investment Grade Bond Fund (9.49)% 8.37%
12.20%<F1>
Government Securities Fund (5.61) 7.58
9.17 <F2>
Special Equities Fund (8.60) 7.23
8.77 <F1>
European Fund 10.44 5.47
7.30 <F3>
<F1> Figures are for the ten-year period ended June 30, 1994.
<F2> Fund commenced operations on March 20, 1984.
<F3> Fund commenced operations on November 6, 1987.
</TABLE>
These average annual total return figures reflect the deduction of the ap-
plicable CDSC (maximum of 5.00% for Special Equities Fund and European
Fund and 4.50% for Investment Grade Bond Fund and Government Securities
Fund) that would have been deducted upon a redemption of shares at the end
of the periods indicated.
AGGREGATE TOTAL RETURN
A Class' aggregate total return figures, as described and shown in the
Prospectuses, represent the cumulative change in the value of an invest-
ment in the Class for the specified period and are computed by the follow-
ing formula:
AGGREGATE TOTAL RETURN = ERV-P
P
P
Where: P = a hypothetical initial payment of $10,000.
ERV = Ending Redeemable Value of a hypothetical $10,000
investment made at the beginning of a 1-, 5- or
10-year period (or fractional portion thereof) at
the end of the 1-, 5- or 10-year period (or frac-
tional portion thereof), assuming reinvestment of
all dividends and distributions.
Class A's aggregate total returns were as follows for the periods indi-
cated:
<TABLE>
<CAPTION>
PERIOD FROM
PERIOD FROM
ONE YEAR NOVEMBER 6, 1992* ONE YEAR
NOVEMBER 6, 1992
PERIOD ENDED THROUGH PERIOD ENDED
THROUGH
JUNE 30, 1994** JUNE 30, 1994** JUNE 30.
1994*** JUNE 30, 1994***
NAME OF FUND
<S> <C> <C> <C>
<C>
Investment Grade
Bond Fund (5.13)% 10.29% (9.40)%
5.33%
Government Secu-
rities Fund (1.08) 9.07 (5.53)
4.16
Special Equities
Fund (3.12) 23.06 (7.97)
16.91
European Fund 16.52 22.48 10.69
16.36
* The Funds commenced selling Class A shares on November 6, 1992.
** Figures do not include the effect of the maximum sales charge.
*** Figures include the effect of the maximum sales charge.
</TABLE>
Class B's aggregate total returns were as follows for the periods indi-
cated:
<TABLE>
<CAPTION>
TEN YEAR PERIOD
TEN YEAR PERIOD
OR PERIOD FROM
OR PERIOD FROM
COMMENCEMENT
COMMENCEMENT
ONE YEAR FIVE YEAR OF OPERATIONS ONE YEAR FIVE YEAR
OF OPERATIONS
PERIOD ENDED PERIOD ENDED THROUGH PERIOD ENDED PERIOD
ENDED THROUGH
JUNE 30, 1994* JUNE 30, 1994* JUNE 30, 1994* June 30, 1994** JUNE 30,
1994** JUNE 30, 1994**
NAME OF FUND
<S> <C> <C> <C> <C>
<C> <C>
Investment
Grade Bond
Fund (5.55)% 50.45% 216.07%<F1> (9.49)%
49.45% 216.07%<F1>
Government
Securi-
ties Fund (1.46) 45.12 140.40 <F2>
(5.61) 44.12 140.40 <F2>
Special
Equities
Fund (3.87) 42.79 131.79 <F1>
(8.60) 41.79 131.79 <F1>
European
Fund 15.44 31.52 59.76 <F3>
10.44 30.52 59.76 <F3>
* Figures do not include the effect of the CDSC (maximum 4.50% for In-
vestment Grade Bond Fund and Government Securities Fund and 5.00% for
the other Funds).
** Figures include the effect of the applicable CDSC, if any.
<F1> Figures are for the ten-year period ending June 30. 1994.
<F2> The Fund commenced operations on March 20, 1984.
<F3> The Fund commenced operations on November 6, 1987.
</TABLE>
It is important to note that the yield and total return figures set forth
above are based on historical earnings and are not intended to indicate
future performance.
Class C's (formerly Class D) aggregate total returns were as follows for
the period indicated:
<TABLE>
<CAPTION>
PERIOD FROM PERIOD FROM
ONE YEAR COMMENCMENT* ONE YEAR
COMMENCEMENT*
PERIOD ENDED THROUGH PERIOD ENDED
THROUGH
JUNE 30, 1994 JUNE 30, 1994 JUNE 30. 1994
JUNE 30, 1994
NAME OF FUND
<S> <C> <C> <C>
<C>
Investment Grade
Bond Fund (5.58)% (.71)% (6.45)% (.71)%
Government Secu-
rities Fund (1.49) 2.87 (2.41)
2.87
Special Equities
Fund N/A (23.97) N/A
(24.72)
European Fund ** ** **
**
* Investment Grade Bond Fund and Government Securities Fund commenced
selling Class C shares on January 29, 1993. Special Equities Fund
commenced selling Class C shares on October 18, 1993.
Class C shares are sold at net asset value without any sales charge or
CDSC.
** As of June 30, 1994, no publically offered Class C shares of the
Fund had been purchased, and therefore no meaningful performance
infor-
mation is available.
</TABLE>
A Class' performance will vary from time to time depending upon market
conditions, the composition of the Fund's investment portfolio and operat-
ing expenses and the expenses exclusively attributable to the Class. Con-
sequently, any given performance quotation should not be considered repre-
sentative of the Class' performance for any specified period in the fu-
ture. Because performance will vary, it may not provide a basis for
comparing an investment in the Class with certain bank deposits or other
investments that pay a fixed yield for a stated period of time. Investors
comparing the Class' performance with that of other mutual funds should
give consideration to the quality and maturity of the respective invest-
ment companies' portfolio securities.
TAXES
The following is a summary of certain Federal income tax
considerations
generally affecting the Company and its shareholders. The summary is not
intended as a substitute for individual tax planning, and investors are
urged to consult their tax advisors with specific reference to their own
Federal, state or local tax situations.
TAX STATUS OF THE FUNDS
Each Fund will be treated as a separate taxable entity for Federal tax
purposes.
The Company intends that each Fund qualify separately as a "regulated in-
vestment company" under the Code. A qualified Fund generally will not be
liable for Federal income taxes to the extent that its taxable net invest-
ment income and net realized capital gains are distributed to its share-
holders, provided that each Fund distributes at least 90% of its net in-
vestment income.
Each Fund intends to accrue dividend income for federal income tax pur-
poses in accordance with the rules applicable to regulated investment com-
panies. In some cases, these rules may have the effect of accelerating (in
comparison to other recipients of the dividend) the time at which the div-
idend is taken into account by a Fund as taxable income.
Certain options, futures contracts and forward contracts in which the
Funds may invest are "section 1256 contracts." Gains or losses on section
1256 contracts generally are considered 60% long-term and 40% short-term
capital gains or losses ("60/40"); however, foreign currency gains or
losses arising from certain section 1256 contracts may be treated as ordi-
nary income or loss. Also, section 1256 contracts held by a Fund at the
end of each taxable year are "marked-to-market" with the result that unre-
alized gains or losses are treated as though they were realized and the
resulting gain or loss is treated as 60/40 gain or loss as ordinary income
or loss, as the case may be. These contracts also may be marked-to-market
for purposes of the 4% excise tax under rules prescribed in the Code.
Many of the hedging transactions undertaken by the Funds will result in
"straddles" for Federal income tax purposes. Straddles are defined to in-
clude "offsetting positions" in actively traded personal property. It is
not entirely clear under what circumstances one investment made by a Fund
will be treated as offsetting another investment held by the Fund. In gen-
eral, positions are offsetting if there is a substantial diminution in the
risk of loss from holding one position by reason of holding one or more
other positions. The straddle rules may effect the character of gains (or
losses) realized on straddle positions. In addition, losses realized by a
Fund on straddle positions may be deferred under the straddle rules,
rather than being taken into account in calculating the taxable income for
the taxable year in which losses are realized. The hedging transactions
may also increase the amount of gains from assets held less than three
months. As a result, the 30% limit on gains from certain assets held less
than three months, which applies to regulated investment companies, may
restrict a Fund in the amount of hedging transactions which it may under-
take. In addition, hedging transactions may increase the amount of short-
term capital gain realized by a Fund which is taxed as ordinary income
when distributed to the shareholders. The Fund may make one or more of the
elections available under the Code which are applicable to straddles. If a
Fund makes any of the elections, the amount, character and timing of the
recognition of gain or losses from the affected straddle positions will be
determined under rules that vary according to the election(s) made. Be-
cause only a few regulations implementing the straddle rules have been
promulgated, the consequences of straddle transactions to a Fund are not
entirely clear.
Distributions of investment company taxable income generally are taxable
to shareholders as ordinary income. In view of each Fund's investment pol-
icy, it is expected that dividends from domestic corporations will consti-
tute a portion of the gross income of several of the Funds but not of oth-
ers. Therefore, it is expected that a portion of the income distributed by
the Special Equities Fund but not others (Investment Grade Bond Fund, Gov-
ernment Securities Fund and European Fund) may be eligible for the
dividends- received deduction for corporations.
Distributions of net realized capital gains designated by a Fund as capi-
tal gains dividends are taxable to shareholders as long-term capital gain,
regardless of the length of time the shares of a Fund have been held by a
shareholder. Distributions of capital gains, whether long or short-term,
are not eligible for the dividends-received deduction.
Dividends (including capital gain dividends) declared by a Fund in Octo-
ber, November or December of any calendar year to shareholders of record
on a date in such a month will be deemed to have been received by share-
holders on December 31 of that calendar year, provided that the dividend
is actually paid by the Fund during January of the following calendar
year.
All dividends are taxable to the shareholder whether reinvested in addi-
tional shares or received in cash. Shareholders receiving distributions in
the form of additional shares will have a cost basis for Federal income
tax purposes in each share received equal to the net asset value of a
share of the Fund on the reinvestment date. Shareholders will be notified
annually as to Federal tax status of distributions.
Under the Code, gains or losses attributable to fluctuations in currency
exchange rates which occur between the time a Fund accrues income or other
receivables or accrues expenses or other liabilities denominated in a for-
eign currency and the time a Fund actually collects such receivables or
pays such liabilities, generally are treated as ordinary income or ordi-
nary loss. Similarly, on disposition of debt securities denominated in a
foreign currency and on disposition of certain futures contracts, forward
contracts and options, gains or losses attributable to fluctuations in the
value of certain currency between the date of acquisition of the security
and the date of disposition also are treated as ordinary gain or loss.
These gains or losses, referred to under the Code as "section 988" gains
or losses, may increase or decrease the amount of a Fund's investment com-
pany taxable income to be distributed to its shareholders as ordinary in-
come.
It is expected that certain dividends and interest received by the Fund
will be subject to foreign withholding taxes. So long as more than 50% in
value of a Fund's total assets at the close of a given taxable year con-
sists of stocks or securities of foreign corporations, the Fund may elect
to treat any foreign taxes paid or accrued by it as paid by its sharehold-
ers. Each Fund will notify shareholders in writing each year whether it
makes the election and the amount of foreign taxes it has elected to have
treated as paid by the shareholders. If a Fund makes the election, share-
holders will be required to include as income their proportionate share of
the amount of foreign taxes paid or accrued by the Fund and generally will
be entitled to claim either a credit or deduction (as an itemized deduc-
tion) for their share of the taxes in computing their Federal income tax,
subject to limitations.
Generally, a credit for foreign taxes is subject to the limitation that it
may not exceed the shareholder's U.S. tax attributable to his or her total
foreign source taxable income. For this purpose, if the pass-through elec-
tion is made, the source of the electing Fund's income will flow through
to its shareholders. With respect to a Fund, gains from the sales of secu-
rities generally will be treated as derived from U.S. sources and certain
currency fluctuation gains, including fluctuation gains from foreign cur-
rency denominated debt securities, receivables and payables, will be
treated as ordinary income derived from U.S. sources. The limitation on
the foreign tax credit is applied separately to foreign source passive in-
come (as defined for purposes of the foreign tax credit), including the
foreign source passive income passed through by a Fund. Shareholders may
be unable to claim a credit for the full amount of their proportionate
share of the foreign tax paid or accrued by a Fund. A foreign tax credit
can be used to offset only 90% of the alternative minimum tax (as computed
under the Code for purposes of the limitation) imposed on corporations and
individuals. If a Fund is not eligible to make the election to "pass
through" to its shareholders its foreign taxes, the foreign taxes it pays
will reduce investment company taxable income and the distributions by
that Fund will be treated as United States source income.
The foregoing is only a general description of the foreign tax credit. Be-
cause application of the credit depends on the particular circumstances of
each shareholder, shareholders are advised to consult their own tax advi-
sors.
Distributions by a Fund reduces the net asset value of the Fund's shares.
Should a distribution reduce the net asset value below a shareholder's
cost basis, such distribution nevertheless generally would be taxable to
the shareholder as ordinary income or capital gains as described above,
even though, from an investment standpoint, it may constitute a partial
return of capital. In particular, investors should be careful to consider
the tax implications of buying shares just prior to a distribution. The
price of shares purchased at that time includes the amount of the forth-
coming distribution but the distribution generally would be taxable to
him.
Upon redemption, sale or exchange of his shares, a shareholder will real-
ize a taxable gain or loss depending upon his basis for his shares. Such
gain or loss will be treated as capital gain or loss if the shares are
capital assets in the shareholder's hands. Such gain or loss generally
will be long-term or short-term depending upon the shareholder's holding
period for the shares. However, a loss realized by a shareholder on the
sale of shares of a Fund with respect to which capital gain dividends have
been paid will, to the extent of such capital gain dividends, be treated
as long-term capital loss if such shares have been held by the shareholder
for six months or less. A gain realized on a redemption, sale or exchange
will not be affected by a reacquisition of shares. A loss realized on a
redemption, sale or exchange, however, will be disallowed to the extent
the shares disposed of are replaced (whether through reinvestment of dis-
tributions or otherwise) within a period of 61 days beginning 30 days be-
fore and ending 30 days after the shares are disposed of. In such a case,
the basis of the shares acquired will be adjusted to reflect the disal-
lowed loss.
For the purposes of computing the revised alternative minimum tax of 20%
for corporations, 75% of the excess of the adjusted current earnings (as
defined in the Code) over other alternative minimum taxable income is
treated as an adjustment item. Shareholders are advised to consult their
own tax advisors for details regarding the alternative minimum tax.
If a Fund purchases shares in certain foreign investment funds classified
under the Code as a "passive foreign investment company", the Fund may be
subject to Federal income tax on a portion of an "excess distribution" and
gain from the disposition of such shares, even though such income may have
to be distributed as a taxable dividend by the Fund to its shareholders.
In addition, gains on the disposition of shares in a passive foreign in-
vestment company generally are treated as ordinary income even though the
shares are capital assets in the hands of the Company. Certain interest
charges may be imposed on either the Fund or its shareholders in respect
of any taxes arising from such distributions or gains. A Fund may be eli-
gible to elect to include in its gross income its share of earnings of a
passive foreign investment company on a current basis. Generally the elec-
tion would eliminate the interest charge and the ordinary income treatment
on the disposition of stock, but such an election may have the effect of
accelerating the recognition of income and gains by the Fund compared to a
fund that did not make the election. In addition, another election may be
available that would involve marking to market a Fund's passive foreign
investment company shares at the end of each taxable year (and on certain
other dates prescribed in the Code), with the result that unrealized gains
are treated as though they were realized. If this election were made, tax
at the Fund level under the passive foreign investment company rules would
generally be eliminated, but the Fund could, in limited circumstances,
incur nondeductible interest charges. Each Fund's intention to qualify an-
nually as a regulated investment company may limit its elections with re-
spect to shares of passive foreign investment companies.
Because the application of the passive foreign investment company rules
may affect, among other things, the character of gains, the amount of gain
or loss and the timing of the recognition of income with respect to pas-
sive foreign investment company shares, as well as subject a Fund itself
to tax on certain income from such shares, the amount that must be dis-
tributed to shareholders, and which will be taxed to shareholders as ordi-
nary income or long-term capital gain, may be increased or decreased sub-
stantially as compared to a fund that did not invest in passive foreign
investment companies.
If a shareholder (a) incurs a sales charge in acquiring shares of the Com-
pany, (b) disposes of those shares within 90 days and (c) acquires shares
in a mutual fund for which the otherwise applicable sales charge is re-
duced by reason of a reinvestment right (i.e., exchange privilege), the
original sales charge increases the shareholder's tax basis in the origi-
nal shares only to the extent the otherwise applicable sales charge for
the second acquisition is not reduced. The portion of the original sales
charge that does not increase the shareholder's tax basis in the original
shares would be treated as incurred with respect to the second acquisition
and, as a general rule, would increase the shareholder's tax basis in the
newly acquired shares. Furthermore, the same rule also applies to a dispo-
sition of the newly acquired shares made within 90 days of the subsequent
acquisition. This provision prevents a shareholder from immediately de-
ducting the sales charge by shifting his or her investment in a family of
mutual funds.
Backup Withholding. If a shareholder fails to furnish a correct taxpayer
identification number, fails to fully report dividend or interest income,
or fails to certify that he or she has provided a correct taxpayer identi-
fication number and that he or she is not subject to such withholding,
then the shareholder may be subject to "backup withholding tax" with re-
spect to (a) any taxable dividends and distributions and (b) any proceeds
of any redemption of Company shares. An individual's taxpayer identifica-
tion number is his or her social security number. The backup withholding
tax is not an additional tax and may be credited against a shareholder's
regular federal income tax liability.
The foregoing discussion relates only to Federal income tax law as appli-
cable to U.S. persons. Distributions by the Funds also may be subject to
state, local and foreign taxes, and their treatment under state, local and
foreign income tax laws may differ from the federal income tax treatment.
The Government Securities Fund's dividends, to the extent they consist of
interest from obligations of the U.S. government and certain of its agen-
cies and instrumentalities, may be exempt from state and local income
taxes in some jurisdictions. The Company intends to advise shareholders of
the proportion of that Fund's dividends which are derived from such inter-
est. Shareholders should consult their tax advisors with respect to par-
ticular questions of Federal, state and local taxation.
ADDITIONAL INFORMATION
The Company was incorporated on September 29, 1981 under the name Hutton
Investment Series Inc. The Company's corporate name was changed on Decem-
ber 29, 1988, October 23, 1992 and October 14, 1994, to SLH Investment
Portfolios Inc., Shearson Lehman Investment Funds Inc. and Smith Barney
Investment Funds Inc., respectively.
Boston Safe, an indirect, wholly owned subsidiary of Mellon, is located at
One Boston Place, Boston, Massachusetts 02108, and serves as the custodian
of the Company. Under its custody agreement with the Company, Boston Safe
holds the Company's fund securities and keeps all necessary accounts and
records. For its services, Boston Safe receives a monthly fee based upon
the month-end market value of securities held in custody and also receives
securities transaction charges. Boston Safe is authorized to establish
separate accounts for foreign securities owned by the Company to be held
with foreign branches of other domestic banks as well as with certain for-
eign banks and securities depositories. The assets of the Company are held
under bank custodianship in compliance with the 1940 Act.
TSSG, a subsidiary of First Data Corporation, is located at Exchange
Place, Boston, Massachusetts 02109 and serves as the Company's transfer
agent. For these services, TSSG receives a monthly fee computed on the
basis of the number of shareholder accounts it maintains for the Company
during the month and is reimbursed for out-of-pocket expenses.
FINANCIAL STATEMENTS
The Annual and Semi-Annual Reports for each Fund for the fiscal year ended
December 31, 1993 and the semi-annual period ended June 30, 1994 accompany
this Statement of Additional Information and are incorporated herein by
reference in their entirety.
APPENDIX
CORPORATE BONDS AND COMMERCIAL PAPER RATINGS
Corporate Bonds. Bonds rated Aa by Moody's are judged by Moody's to be of
high-quality by all standards. Together with bonds rated Aaa (Moody's
highest rating) they comprise what are generally known as high-grade
bonds. Aa bonds are rated lower than Aaa bonds because margins of protec-
tion may not be as large as those of Aaa bonds, or fluctuation of protec-
tive elements may be of greater amplitude, or there may be other elements
present which make the long-term risks appear somewhat larger than those
applicable to Aaa securities. Bonds which are rated A by Moody's possess
many favorable investment attributes and are to be considered as upper
medium-grade obligations. Factors giving security to principal and inter-
est are considered adequate, but elements may be present which suggest a
susceptibility to impairment sometime in the future.
Moody's Baa rated bonds 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 pro-
tective elements may be lacking or may be characteristically unreliable
over any great length of time. Such bonds lack outstanding investment
characteristics and, in fact, have speculative characteristics as well.
Bonds rated AA by S&P are judged by S&P to be the high-grade obligations
and in the majority of instances differ only in small degree from issues
rated AAA (S&P highest rating). Bonds rated AAA are considered by S&P to
be the highest grade obligations and possess the ultimate degree of pro-
tection as to principal and interest. With AA bonds, as with AAA bonds,
prices move with the long-term money market. Bonds rated A by S&P 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.
Bonds rated BBB by S&P, or medium-grade category bonds, are borderline be-
tween definitely sound obligations and those where speculative elements
begin to predominate. These bonds have adequate asset coverage and nor-
mally are protected by satisfactory earnings. Their susceptibility to
changing conditions, particularly to depressions, necessitates constant
watching. These bonds generally are more responsive to business and trade
conditions than to interest rates. This group is the lowest which quali-
fies for commercial bank investment.
Commercial Paper. The Prime rating is the highest commercial paper rating
assigned by Moody's. Among the factors considered by Moody's in assigning
ratings are the following: (a) evaluation of the management of the issuer;
(b) economic evaluation of the issuer's industry or industries and an ap-
praisal of speculative-type risks which may be inherent in certain areas;
(c) evaluation of the issuer's products in relation to competition and
customer acceptance; (d) liquidity; (e) amount and quality of long-term
debt; (f) trend of earnings over a period of ten years; (g) financial
strength of a parent company and the relationships which exist with the
issuer; and (h) recognition by management of obligations which may be
present or may arise as a result of public interest questions and prepara-
tions to meet such obligations. Issuers within the Prime category may be
given ratings 1, 2 or 3, depending on the relative strengths of these fac-
tors.
Commercial paper rated A by S&P has the following characteristics: (a) li-
quidity ratios are adequate to meet cash requirements; (b) long-term se-
nior debt rating should be A or better, although in some cases BBB credits
may be allowed if other factors outweigh the BBB; (c) the issuer should
have access to at least two additional channels of borrowing; (d) basic
earnings and cash flow should have an upward trend with allowances made
for unusual circumstances; and (e) typically the issuer's industry should
be well established and the issuer should have a strong position within
its industry, and the reliability and quality of management should be un-
questioned. Issuers rated A are further referred to by use of number 1, 2
and 3 to denote relative strength within this highest classification.
SUPPLEMENTARY DESCRIPTION OF INTEREST RATE FUTURES CONTRACTS AND RELATED
OPTIONS
Characteristics of Futures Contracts. Currently, futures contracts can be
purchased and sold on such securities as U.S. Treasury bonds, U.S. Trea-
sury notes, GNMAs and U.S. Treasury bills. Unlike when the Fund purchases
or sells a security, no price is paid or received by the Fund upon the
purchase or sales of a futures contract. The Fund will initially be re-
quired to deposit with the custodian or the broker an amount of "initial
margin" of cash of U.S. Treasury bills. The nature of initial margin in
futures transactions is different from that of margin in security transac-
tions in that futures contract initial margin does not involve the borrow-
ing of funds by their customer to finance the transaction. Rather, the
initial margin is in the nature of a performance bond or good faith de-
posit on the contract which is returned to the Fund upon termination of
the futures contract, assuming all contractual obligations have been sat-
isfied. Subsequent payments, called maintenance margin, to and from the
broker, will be made on a daily basis as the price of the underlying debt
security fluctuates, making the long and short positions in the futures
contract more or less valuable, a process known as "marked-to-market." For
example, when the Fund has purchased a futures contract and the price of
the underlying debt security has risen, that position will have increased
in value and the Fund will receive from the broker a maintenance margin
payment equal to that increase in value. Conversely, when the Fund has
purchased a futures contract and the price of the underlying debt security
has declined, the position would be less valuable and the Fund would be
required to make a maintenance margin payment to the broker. At any time
prior to expiration of the futures contract, the Fund may elect to close
the position by taking an opposite position which will operate to termi-
nate the Fund's position in the futures contract. A final determination of
maintenance margin is then made, additional cash is required to be paid by
or released to the Fund, and the Fund realizes a loss or a gain.
While futures contracts based on debt securities do provide for the deliv-
ery and acceptance of securities, such deliveries and acceptances are very
seldom made. Generally, the futures contract is terminated by entering
into an offsetting transaction. An offsetting transaction for a futures
contract sale is effected by the Fund entering into a futures contract
purchase for the same aggregate amount of the specific type of financial
instrument and same delivery date. If the price in the sale exceeds the
price in the offsetting purchase, the Fund pays the difference and real-
izes the loss. Similarly, the closing out of a futures contract purchase
is effected by the Fund entering into a futures contract sale. If the off-
setting sale price exceeds the purchase price, the Fund realizes a gain,
and if the purchase price exceeds the offsetting price, the Fund realizes
a loss.
Risks of Transactions in Futures Contracts. There are several risks in
connection with the use of futures contracts by Government Securities Fund
as a hedging device. One risk arises because of the imperfect correlation
between movements in the price of the futures contracts and movements in
the price of the debt securities which are the subject of the hedge. The
price of the futures contract may move more than or less than the price of
the debt securities being hedged. If the price of the futures contract
moves less than the price of the securities which are the subject of the
hedge, the hedge will not be fully effective, but, if the price of the se-
curities being hedged has moved in an unfavorable direction, the Fund
would be in a better position than if it has not hedged at all. If the
price of the securities being hedged has moved in a favorable direction,
this advantage will be partially offset by the movement in the price of
the futures contract. If the price of the futures contracts moves more
than the price of the security, the Fund will experience either a loss or
a gain on the future which will not be completely offset by movements in
the prices of the debt securities which are the subject of the hedge. To
compensate for the imperfect correlation of movements in the price of debt
securities being hedged and movements in the prices of the futures con-
tracts, the Fund may buy or sell futures contracts in a greater dollar
amount than the dollar amount of the securities being hedged if the his-
torical volatility of the prices of such securities has been greater than
the historical volatility of the futures contracts. Conversely, the Fund
may buy or sell fewer futures contracts if the historical volatility of
the price of the securities being hedged is less than the historical vola-
tility of the futures contracts. It is also possible that, where the Fund
has sold futures to hedge its portfolio against decline in the market, the
market may advance and the value of securities held in the Fund's portfo-
lio may decline. If this occurred, the Fund would lose money on the fu-
tures contracts and also experience a decline in value in its portfolio
securities. However, while this could occur for a very brief period or to
a very small degree, over time the value of a diversified portfolio will
tend to move in the same direction as the futures contracts.
Where futures are purchased to hedge against a possible increase in prices
of securities before the Fund is able to invest its cash (or cash equiva-
lents) in U.S. government securities (or options) in an orderly fashion,
it is possible that the market may decline instead; if the Fund then con-
cludes not to invest in U.S. government securities or options at that time
because of concern as to possible further market decline or for other rea-
sons, the Fund will realize a loss on the futures contract that is not
offset by a reduction in the price of securities purchased.
In addition to the possibility that there may be an imperfect correlation,
or no correlation at all, between movements in the futures contracts and
the portion of the portfolio being hedged, the market prices of futures
contracts may be affected by certain factors. First, all participants in
the futures market are subject to margin deposit and maintenance require-
ments. Rather than meeting additional margin deposit requirements, inves-
tors may close futures contracts though offsetting transactions which
could distort the normal relationship between the debt securities and fu-
tures markets; second, from the point of view of speculators, the deposit
requirements in the futures market are less onerous than margin require-
ments in the securities market. Therefore, increased participation by
speculators in the futures market may also cause temporary price distor-
tions. Due to the possibility of price distortion in the futures market
and because of the imperfect correlation between movements in the debt se-
curities and movements in the prices of futures contracts, a correct fore-
cast of interest rate trends by the investment advisor may still not re-
sult in a successful hedging transaction over a very short time frame.
Positions in futures contracts may be closed out only on an exchange or
board of trade which provides a secondary market for such futures. Al-
though Government Securities Fund intends to purchase or sell futures only
on exchanges or boards of trade where there appears to be an active sec-
ondary market, there is no assurance that a liquid secondary market on an
exchange or board of trade will exist for any particular contract or at
any particular time. In such event, it may not be possible to close a fu-
tures position, and in the event of adverse price movements, the Fund
would continue to be required to make daily cash payments of variation
margin. However, in the event that the futures contracts have been used to
hedge portfolio securities, such securities will not be sold until the fu-
tures contracts can be terminated. In such circumstances, an increase in
the price of the securities, if any, may partially or completely offset
losses on the futures contracts. However, as described above, there is no
guarantee that the price of the securities will, in fact, correlate with
the price movements of the futures contracts and thus provide an offset to
losses on futures contracts.
Successful use of futures contracts by the Fund is also subject to the in-
vestment adviser's ability to predict correctly movements in the direction
of interest rates and other factors affecting markets of debt securities.
For example, if the Fund has hedged against the possibility of an increase
in interest rates which would adversely affect debt securities held in its
portfolio and prices of such securities increase instead, the Fund will
lose part or all of the benefit of the increased value of its securities
which it has hedged because it will have offsetting losses in its futures
positions. In addition, in such situations, if the Fund has insufficient
cash, it may have to sell securities to meet daily variation margin re-
quirements. Such sale of securities may be, but will not necessarily be,
at increased prices which reflect the rising market. The Fund may have to
sell securities at a time when it may be disadvantageous to do so.
Characteristics of Options on Futures Contracts. As with options on debt
securities, the holder of an option may terminate his position by selling
an option of the same series. There is no guarantee that such closing
transactions can be effected. The Fund will be required to deposit initial
margin and maintenance margin with respect to put and call options on fu-
tures contracts written by it pursuant to brokers' requirements similar to
those applicable to interest rate futures contracts described above, and,
in addition, net option premiums received will be included as initial mar-
gin deposits.
In addition to the risks which apply to all options transactions, there
are several special risks relating to options on futures contracts. Trad-
ing in such options commenced in October 1982. The ability to establish
and close out positions on such options will be subject to the development
and maintenance of a liquid secondary market. It is not certain that this
market will develop. The Fund will not purchase options on futures con-
tracts on any exchange unless and until, in the investment advisor's opin-
ion, the market for such options had developed sufficiently that the risks
in connection with options on futures contracts are not greater than the
risks in connection with futures contracts. Compared to the use of futures
contracts, the purchase of options on futures contracts involves less po-
tential risk to the Fund because the maximum amount of risk is the premium
paid for the options (plus transaction costs). However, there may be cir-
cumstances when the use of an option on a futures contract would result in
a loss to the Fund when the use of a futures contract would not, such as
when there is no movement in the prices of debt securities. Writing an op-
tion on a futures contract involves risks similar to those arising in the
sale of futures contracts, as described above.
Smith Barney
INVESTMENT FUNDS INC.
388 Greenwich Street
New York, New York 10013
Smith Barney
INVESTMENT FUNDS INC.
SMITH BARNEY INVESTMENT GRADE BOND FUND
SMITH BARNEY GOVERNMENT SECURITIES FUND
SMITH BARNEY SPECIAL EQUITIES FUND
SMITH BARNEY EUROPEAN FUND
STATEMENT OF
ADDITIONAL INFORMATION
NOVEMBER 7, 1994
