Smith Barney
Investment Funds Inc.
388 Greenwich Street
New York, New York 10013
(212) 723-9218
Statement of Additional Information
April 30, 1997
As Amended April 6, 1998
This Statement of Additional Information
expands upon and supplements the information
contained in the current Prospectuses of Smith
Barney Investment Funds Inc. (the Company),
dated April 30, 1997, as amended or
supplemented from time to time, and should read
in conjunction with the Companys Prospectuses.
The Company issues a Prospectus for each of the
investment funds offered by the Company (the
Funds). The Companys Prospectuses 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 entirety.
CONTENTS
For ease of reference, the same section
headings are used in the Prospectuses and this
Statement of Additional Information, except
where shown below:
Management of the Company (see in the
Prospectuses Management of the Company and the
Fund) 1
Investment Objectives and Management
Policies.......................................
.............................. 5
Purchase of Shares 15
Redemption of Shares 16
Distributor 16
Valuation of Shares 19
Exchange Privilege 20
Performance Data (See in the Prospectus
Performance) 20
Taxes (See in the Prospectus Dividends,
Distributions and Taxes) 24
Additional Information 28
Financial Statements 28
Appendix A-1
MANAGEMENT OF THE COMPANY
The executive officers of the Company are
employees of certain of the organizations that
provide services to the Company. These
organizations are the following:
Name
Service
Smith Barney Inc. (Smith Barney)
Distributor
PFS Distributors, Inc.(PFS)
.....................................
Smith Barney Mutual Funds Management
Inc. (SBMFM)
Distributor (Growth Opportunity
Fund and Investment Grade Bond
Fund)
Investment Adviser and
Administrator
PNC Bank, National Association (PNC)
Custodian
First Data Investor Services Group, Inc.
(First Data) ......
Transfer Agent
These organizations and the functions they
perform for the Company are discussed in the
Prospectuses and in this Statement of
Additional Information.
Directors and Executive Officers of the Company
The names of the Directors and executive
officers of the Company, together with
information 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 (Age 56). Partner in
the law firm of Murov & Ades. His address is
272 South Wellwood Avenue, P.O. Box 504,
Lindenhurst, New York 11757.
Herbert Barg, Director (Age 73). Private
investor. His address is 273 Montgomery Avenue,
Bala Cynwyd, Pennsylvania 19004.
Alger B. Chapman, Director (Age 65). 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 (Age 59).
Professor, Graduate School of Business
Administration, Harvard University. His address
is Graduate School of Business Administration,
Harvard University, Boston, Massachusetts
02163.
Harvey Eisen, Senior Vice President and
Investment Officer. Vice President of
Investment Funds of Travelers Group Inc. His
address is 388 Greenwich Street, New York, NY
10013.
Frank G. Hubbard, Director (Age 61). Vice
President, S&S Industries; Former Corporate
Vice President, Materials Management and
Marketing Services of Huls America, Inc. His
address is 80 Centennial Avenue P.O. Box 456,
Piscataway, New Jersey 08855-0456.
Allan R. Johnson, Director Emeritus (Age 80).
Retired; Former Chairman, Retail Division of
BATUS, Inc., and Chairman and Chief Executive
Officer of Saks Fifth Avenue, Inc. His address
is 2 Sutton Place South, New York, New York
10022.
*Heath B. McLendon, Chairman of the Board
(Age 63). Managing Director of Smith Barney and
Chairman of the Board of Smith Barney Strategy
Advisers Inc.; 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
PanAgora Asset Management Limited. Mr.
McLendon is a director of 41 investment
companies associated with Smith Barney. His
address is 388 Greenwich Street, New York, New
York 10013.
Ken Miller, Director (Age 55). President of
Young Stuff Apparel Group, Inc. His address is
1411 Broadway, New York, New York 10018.
John F. White, Director (Age 79). 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.
Jessica M. Bibliowicz, President (Age 37).
Executive Vice President of Smith Barney; prior
to 1994, Director of Sales and Marketing for
Prudential Mutual Funds. Ms. Bibliowicz serves
as President of 40 investment companies
associated with Smith Barney. Her address is
388 Greenwich Street, New York, New York 10013.
James Conroy, Vice President and Investment
Officer. Managing Director of Smith Barney.
His address is 388 Greenwich Street, New York,
New York 10013.
Douglas H. Johnson, Vice President and
Investment Officer. Director of Mutual Fund
Division of Smith Barney. Prior to January
1995, Vice President of SafeCo Asset Management
Company. His address is 500 108th Avenue,
North E., Bellevue, Washington 98004.
George E. Mueller, Jr., Vice President and
Investment Officer. Managing Director of
SBMFM; prior to July 1993, Managing Director of
Shearson Lehman Advisors. His address is 388
Greenwich Street, New York, New York 10013.
George V. Novello, Vice President and
Investment Officer. Managing Director of
SBMFM; prior to July 1993, Managing Director of
Shearson Lehman Advisors. Prior to September
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.
Lewis E. Daidone, Senior Vice President and
Treasurer (Age 39). Director and Senior Vice
President of SBMFM. Mr. Daidone serves as
Senior Vice President and Treasurer of 41
investment companies associated with Smith
Barney. His address is 388 Greenwich Street,
New York, New York 10013.
Christina T. Sydor, Secretary (Age 46).
Managing Director of Smith Barney and Secretary
of SBMFM; General Counsel and Secretary of
SBMFM. Ms. Sydor serves as Secretary of 41
investment companies associated with Smith
Barney. Her address is 388 Greenwich Street,
New York, New York 10013.
Each Director also serves as a director,
trustee and/or general partner of certain other
mutual funds for which Smith Barney serves as
distributor. As of January 31, 1997, 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 subsidiary 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, director or employee of Smith Barney
or any of its affiliates a fee of $16,000 per
annum plus $2,500 per meeting attended and
reimburses travel and out-of-pocket expenses.
For the fiscal year ended December 31, 1996,
the Directors of the Company were paid the
following compensation:
Director
Aggregate
Compensation
from the Company
Aggregate
Compensation
from the Smith
Barney
Mutual Funds
Paul R. Ades (5)
$28,600.00
$52,475.00
Herbert Barg (20)
28,600.00
105,175.00
Alger B. Chapman (9)
26,000.00
76,775.00
Dwight B. Crane (26)
26,100.00
140,375.00
Frank G. Hubbard (5)
28,600.00
52,475.00
Heath McLendon (41)
N/A
N/A
Ken Miller (5)
26,100.00**
49,475.00
John F. White (5)
28,500.00**
52,375.00
Allan G. Johnson
(5)(*)
18,035.51
33,125.00
+ Number of funds for which director serves
within fund complex
* Director Emeritus
** Mr. Miller and Mr. White have deferred
$6,500 and $26,000, respectively, of
compensation from the Company in 1996.
Investment Adviser and Administrator - SBMFM
SBMFM serves as investment adviser to the Funds
pursuant to separate advisory agreements (the
Advisory Agreements). With respect to the
Investment Grade Bond Fund, Government
Securities Fund and Special Equities Fund, the
Advisory Agreements were transferred to SBMFM
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 a wholly owned
subsidiary of Travelers Group Inc. (Travelers).
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
investment advisers (the Independent
Directors), on July 25, 1996. SBMFM bears all
expenses in connection with the performance of
its services. The services provided by SBMFM
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
investment companies affiliated with Smith
Barney.
As compensation for investment advisory
services rendered to Investment Grade Bond
Fund, Special Equities Fund, Managed Growth
Fund and Growth Opportunity Fund, each Fund
pays SBMFM a fee computed daily and paid
monthly at the annual rates of 0.45%, 0.55%,
0.85% and 1.00%, respectively, of the value of
their 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 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.
For the fiscal years ended December 31, 1994,
1995 and 1996, the Funds accrued advisory fees
as follows:
Fund
1994
1995
1996
Investment Grade Bond Fund
$1,926,359
$2,067,222
$2,198,162
Government Securities Fund
2,578,209
2,287,647
1,979,639
Special Equities Fund
1,052,635
1,276,355
3,094,925
Managed Growth Fund
-
2,022,754
6,034,652
Growth Opportunity Fund
-
390,902
1,040,355
SBMFM also serves as administrator to
Investment Grade Bond Fund, Government
Securities Fund and Special Equities Fund
pursuant to a written agreement dated May 5,
1994 (the Administration Agreement), which was
first approved by the Board of Directors,
including a majority of the Independent
Directors, on May 5, 1994. The services
provided by SBMFM under the Administration
Agreement are described in the Prospectuses
under Management of the Company and the Fund.
SBMFM pays the salary of any officer and
employee who is employed by both it and the
Fund and bears all expenses in connection with
the performance of its services. Prior to May
5, 1994, The Boston Company Advisors (Boston
Advisors) served as the Companys sub-
investment adviser and/or administrator.
As compensation for administrative services
rendered to each of Investment Grade Bond Fund,
Government Securities Fund and Special Equities
Fund, SBMFM receives a fee computed daily and
paid monthly at the annual rate of 0.20 of the
value of the Funds average daily net assets.
For the fiscal years ended December 31, 1994,
1995 and 1996, these Funds paid administrative
fees to Boston Advisors or SBMFM as follows:
Boston
Advisors
SBMFM
Fund
For the
Fiscal
Period From
1/1/94
through
5/4/94
For the
Fiscal
Period From
5/5/94
through
12/31/94
For the
Fiscal
Year Ended
12/31/95
For the
Fiscal
Year Ended
12/31/96
Investment Grade Bond
Fund
$ 290,859
$ 565,300
$918,76
5
$ 976,938
Government Securities
Fund
500,505
972,757
1,307,2
22
1,131,222
Special Equities Fund
130,039
252,737
464,129
1,125,428
Counsel and Auditors
Willkie Farr & Gallagher L.L.P.serves as
counsel to the Company. The Directors who are
not interested persons of the Company have
selected Stroock & Stroock & Lavan LLP as their
legal counsel.
KPMG Peat Marwick LLP, 345 Park Avenue, New
York, New York 10154, has been selected as the
Funds independent auditor to examine and
report on the Funds financial statements and
highlights for the fiscal year ending December
31, 1997.
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 management policies contained in the
Prospectuses.
Repurchase Agreements. As described in the
applicable Prospectus, each Fund may enter into
repurchase agreements. A repurchase agreement
is a contract under which a Fund acquires a
security for a relatively short period (usually
not more than one week) subject to the
obligation of the seller to repurchase and the
Fund to resell such security at a fixed time and
price (representing the Funds cost plus
interest). It is each Funds present intention
to enter into repurchase agreements only upon
receipt of fully adequate collateral and only
with commercial banks (whether U.S. or foreign)
and registered broker-dealers. Repurchase
agreements may also be viewed as loans made by a
Fund which are collateralized primarily by the
securities subject to repurchase. A Fund bears
a risk of loss in the event that the other party
to a repurchase agreement defaults on its
obligations and the Fund is delayed or prevented
from exercising its rights to dispose of the
collateral securities. Pursuant to policies
established by the Board of Directors, SBMFM
monitors the creditworthiness of all issuers
with which each Fund enters into repurchase
agreements.
Reverse Repurchase Agreements. Each Fund may
enter into reverse repurchase agreements. A
reverse repurchase agreement involves the sale
of a money market instrument held by a Fund
coupled with an agreement by a Fund to
repurchase the instrument at a stated price,
date and interest payment. A Fund will use the
proceeds of a reverse repurchase agreement to
purchase other money market instruments which
either mature at a date simultaneous with or
prior to the expiration of the reverse
repurchase agreement or which are held under an
agreement to resell maturing as of that time.
A Fund will enter into a reverse repurchase
agreement only when the interest 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 borrowings by the seller. A
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 a
Funds total assets (less all of its liabilities
other than obligations under such agreements).
A 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 Companys custodian
consisting of U.S. government securities, cash
or cash equivalents.
Warrants. All Funds except the Government
Securities Fund may purchase warrants. A
warrant is a security that gives the holder the
right, but not the obligation, to subscribe for
newly created securities of the issuer at a
fixed price either at a certain date or during a
set period. The Investment Grade Bond Fund and
the Special Equities Fund will not invest in
warrants if, as a result of such investment,
the value of their investments in warrants,
valued at the lower of cost or market, exceeds
5% of the value of the Funds net assets.
Included in this 5% limitation, but not to
exceed 2% of the Funds net assets, may be
warrants which are not listed on either the New
York Stock Exchange (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 either Fund and may be changed by
the Board of Directors without shareholder
approval.
Short Sales Against the Box. Each Fund may sell
securities short against the box which means
that 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.
Firm Commitment Agreements and When-Issued
Purchases. The Government Securities Fund,
Investment Grade Bond Fund and Growth
Opportunity Fund may enter into firm commitment
agreements and purchase when-issued securities,
as described more fully in each Funds
Prospectus. Firm commitment agreements and when-
issued purchases involve the purchase of
securities at an agreed-upon price on a
specified future date. Such agreements might
be entered 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. 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 purchase the security
at a price above the current market price on
the date of delivery and payment. During the
time a Fund is obligated to purchase such
securities, it will maintain in a segregated
account with the Companys custodian, eligible
segregated assets (as defined in each Funds
Prospectus) equal to the aggregate current
value sufficient to make payment for the
securities. The Government Securities Fund and
Investment Grade Bond Fund will not enter into
such agreements for the purpose of investment
leverage
Lending Portfolio Securities. Each Fund has the
ability to lend securities from its portfolio
to brokers, dealers and other financial
organizations. Such loans, if and when made,
may not exceed 33 1/3% of a Funds total assets
taken at value. A Fund will not lend its
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 securities which are maintained
at all times in an amount at least equal to the
current market value of the loaned securities.
From time to time, a Fund may return a part of
the interest earned from the investment of
collateral received for securities loaned to
the borrower and/or a third party, which is
unaffiliated with the Fund or with Smith
Barney, and which is acting as a finder.
In lending its securities, a Fund can increase
its income by continuing to receive interest on
the loaned securities as well as by either
investing 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 further modifications, currently provide
that the following conditions must be met
whenever a Funds 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 collateral; (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, however, 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 portfolio 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 SBMFM to be of
good standing and will not be made unless, in
the judgment of SBMFM, the consideration to be
earned from such loans would justify the risk.
Government Securities. Direct obligations of
the United States Treasury include a variety of
securities, which differ in their interest
rates, maturities 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, securities issued or
guaranteed by the United States government, its
agencies or instrumentalities include
securities issued or guaranteed by the Federal
Housing Administration, Federal Financing Bank,
Export-Import Bank of the United States, Small
Business Administration, Government National
Mortgage Association (GNMA), General Services
Administration, Federal Home Loan Banks,
Federal Home Loan Mortgage Corporation, Federal
National Mortgage Association (FNMA), Federal
Maritime Administration, Tennessee Valley
Authority, Resolution Trust Corporation,
District of Columbia Armory Board, Student Loan
Marketing Association and various institutions
that previously were or currently are part of
the Farm Credit System (which has been
undergoing a reorganization since 1987).
Because the United States government is not
obligated by law to provide support to an
instrumentality that it sponsors, a Fund will
invest in obligations of an instrumentality to
which the United States government is not
obligated by law to provide support only if
SBMFM determines that the credit risk with
respect to the instrumentality does not make
its securities unsuitable for investment by a
Fund.
Exchange Rate-Related U.S. Government
Securities. The Government Securities Fund may
invest up to 5% of its net assets in U.S.
government 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
(Exchange Rate-Related Securities). The
interest payable on these securities is
denominated in U.S. dollars, is not subject to
foreign currency risks and, in most cases, is
paid at rates higher than most other U.S.
government 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, depending on the structure
of the principal repayment formula. The
principal repayment 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 currency. Finally,
the principal repayment formula can be a
function of more than one currency and,
therefore, be designed in either of the
aforementioned 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
between 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
security, the amount of principal repaid at
maturity might be significantly below the par
value of the security, which might not be
offset by the interest earned by the Fund over
the term of the security. The rate of exchange
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 sufficient 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
exchange 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.
Special Considerations Relating to Options on
Certain U.S. Government Securities
Treasury Bonds and Notes. Because
trading interest in U.S. Treasury bonds and
notes tends to center on the most recently
auctioned issues, the exchanges will not
continue indefinitely to introduce new
expirations to replace 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 advance for their potential exercise
settlement obligations by acquiring and holding
the underlying security. However, if the Fund
holds a long position 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 representing part
ownership of a pool of mortgage loans. These
loans are made by private lenders and are
either insured by the Federal Housing
Administration 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
options it has written. Should this occur,
additional GNMA Certificates from the same pool
(if obtainable) or replacement 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, cash
equivalents or U.S. government securities
having an aggregate value equal to the market
value of the GNMA Certificates underlying the
call options it has written.
Other Risks. In the event of a shortage
of the underlying securities deliverable on
exercise of an option, the Options Clearing
Corporation has the authority to permit other,
generally comparable securities to be delivered
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
ineligible 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
underlying 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. government securities,
and exchange regulations limit the maximum
number of options 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 affiliates 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 Funds 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 trading interest that may exist in
such options, and there can be no assurance
that viable exchange markets will develop or
continue.
Leverage Through Borrowing. The Government
Securities Fund may borrow up to 25% of the
value of its net assets on an unsecured basis
from banks to increase 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 maintain 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
fluctuations or otherwise, even if
disadvantageous from an investment standpoint.
Leveraging will exaggerate the effect of any
increase or decrease in the value of portfolio
securities on the Funds net asset value, and
money borrowed will be subject to interest
costs (which may include commitment 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 Risks Involving Investments in Smaller,
Newer Companies. The Special Equities Fund
invests primarily in equity securities of
secondary companies that have yet to reach a
fully mature stage of earnings growth. 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 established
over-the-counter market. 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 securities 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 objective of long-term capital
appreciation, securities purchased for the Fund
will not generally be traded for short-term
profits, but will be retained for their longer-
term appreciation potential. This general
practice limits the Funds 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 other Funds.
Investment Restrictions
The Funds investment objectives and investment
restrictions 1-7 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. Investment Restrictions 8
through 15 may be changed by the Board of
Directors without the approval of shareholders.
(All other investment practices described in
the Prospectuses 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 entered 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 Funds net
assets will not be considered a violation.)
Restrictions Applicable to All Funds. No Fund
may:
1. Invest in a manner that would cause
it to fail to be a diversified
company under the 1940 Act and the
rules, regulations and orders
thereunder.
2. Purchase or sell real estate, real
estate mortgages, commodities or
commodity contracts, but this restriction
shall not prevent the Fund from (a)
investing in securities of issuers
engaged in the real estate business or
the business of investing in real estate
(including interests in limited
partnerships owning or otherwise engaging
in the real estate business or the
business of investing in real estate) and
securities which are secured by real
estate or interests therein; (b) holding
or selling real estate received in
connection with securities it holds or
held; (c) trading in futures contracts
and options on futures contracts
(including options on currencies to the
extent consistent with the Funds
investment objective and policies); or
(d) investing in real estate investment
trust securities.
.. 3. Make loans. This restriction does
not apply to: (a) the purchase of debt
obligations in which the Fund may invest
consistent with its investment objectives
and policies; (b) repurchase agreements;
and (c) loans of its portfolio
securities, to the fullest extent
permitted under the 1940 Act.
.4. Invest more than 25% of its total
assets in securities, the issuers of
which conduct their principal business
activities in the same industry. For
purposes of this limitation, securities
of the U.S. government (including its
agencies and instrumentalities) and
securities of state or municipal
governments and their political
subdivisions are not considered to be
issued by members of any industry.
.
5. Issue senior securities as
defined in the 1940 Act and the rules,
regulations and orders thereunder, except
as permitted under the 1940 Act and the
rules, regulations and orders thereunder.
6. Borrow money, except that (a)
the Fund may borrow from banks for
temporary or emergency (not leveraging)
purposes, including the meeting of
redemption requests which might otherwise
require the untimely disposition of
securities, and (b) the Fund may, to the
extent consistent with its investment
policies, enter into reverse repurchase
agreements, forward roll transactions and
similar investment strategies and
techniques. To the extent that it
engages in transactions described in (a)
and (b), the Fund will be limited so that
no more than 33-l/3 of the value of its
total assets (including the amount
borrowed), valued at the lesser of cost
or market, less liabilities (not
including the amount borrowed) valued at
the time the borrowing is made, is
derived from such transactions.
7. Restriction Applicable to all
funds except Special Equities Fund,
Concert Peachtree Growth Fund and Managed
Growth Fund. The Funds may not: Act as
an underwriter of securities.
Restrictions Applicable to Special
Equities Fund. Special Equities Fund may
not act as an underwriter of securities,
except that the 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
registration the Fund may technically be
deemed an underwriter for purposes of the
1933 Act.
8. Invest in oil, gas or other
mineral exploration or development
programs
.
9. Purchase securities of any
other investment company, except in
connection with a merger, consolidation,
reorganization, or acquisition or assets.
(For purposes of this limitation, foreign
banks or their agencies or subsidiaries
are not considered investment companies)
(the Managed Growth Fund may purchase the
securities of closed-end investment
companies to the extent permitted by law);
10. Make investments in
securities for the purpose of exercising
control over or management of the issuer;
11. Purchase any securities on
margin (except for such short-term credits
as are necessary for the clearance of
purchases and sales of portfolio
securities) or sell any securities short
(except against the box). For purposes of
this restriction, the deposit or payment by
the Fund of underlying securities and other
assets in escrow and collateral agreements
with respect to initial or maintenance
margin in connection with futures contracts
and related options and options on
securities, indexes or similar items is not
considered to be the purchase of a security
on margin.
12. Invest in securities of an
issuer which, together with any
predecessor, 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 securities (for
purposes of this restriction, issuers
include predecessors, sponsors, controlling
persons, general guarantors and originators
of underlying assets);
13. Purchase or otherwise acquire
any security if, as a result, more than
15% of its net assets would be invested
in securities that are illiquid.
14. Purchase the securities of an
issuer if one or more of the Directors of
officers of the Company individually own
beneficially more than 1/2 of 1% of the
outstanding securities of such issuer or
together own benefically more than 5% of
such securities.
15. Restrictions Applicable to
all funds except Government Securities
Fund. The Funds may not: Write,
purchase or sell puts, calls, straddles,
spreads or any combinations thereof (the
Managed Growth Fund and the Concert
Peachtree Growth Fund each may write or
purchase puts, calls, straddles, spreads
and any combination thereof up to 5% of
their assets).
Brokerage
In selecting brokers or dealers to execute
securities transactions on behalf of a Fund,
SBMFM seeks the best overall terms available.
In assessing the best overall terms available
for any transaction, SBMFM will consider the
factors that it 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
commission, if any, for the specific
transaction and on a continuing basis. In
addition, each investment advisory agreement
authorizes SBMFM, 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 SBMFM or its affiliates
exercise investment discretion. The fees under
the investment advisory agreements and the
administration agreement between the Company
and SBMFM 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 commissions 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 customary commissions to
include amounts which are reasonable and fair
compared to the commission, fee or other
remuneration received or to be received by
other brokers in connection with comparable
transactions involving similar securities being
purchased or sold on a securities exchange
during a comparable period of time. The Board
of Directors, particularly the Independent
Directors 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 periodically. In addition, under
rules adopted by the SEC, Smith Barney may
directly execute transactions for a Fund on the
floor of any national securities exchange,
provided: (a) the Board of Directors has
expressly authorized 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 Directors has determined that
transactions for a Fund may be executed through
Smith Barney and other affiliated broker-
dealers if, in the judgment of SBMFM, 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 conditions of
exemptive rules or orders promulgated by the
SEC. Pursuant to conditions set forth in rules
of the SEC, the Company may purchase securities
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 Funds payment of
brokerage commissions to Smith Barney:
Fiscal
Year
Ended
December
31,
Special
Equities
Fund
Managed
Growth
Fund
Growth
Opportuni
ty
Fund
Total Brokerage
Commissions
1994
$217,269
N/A
N/A
1995
$56,735
$164,975
$201,706
1996
$378,451
$1,272,7
02
$716,937
Commissions paid to
Smith Barney
1994
$14,280
N/A
N/A
1995
$11,052
$140,970
$650
1996
$47,100
$166,656
$21,6
80
% of Total Brokerage
Commissions paid to
Smith Barney
1996
12.4%
13.1%
3.0%
% of Total
Transactions
Involving
Commissions paid
to Smith Barney
1996
7.3%
11.5%
3.0%
____________________
_
No commissions were paid by the Investment
Grade Bond Fund and Government Securities Fund.
Portfolio Turnover
For reporting purposes, a Funds 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
securities owned by the Fund during the fiscal
year. In determining such portfolio 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 Funds
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 securities for the
purpose of realizing short-term profits, but it
will adjust its portfolio as considered
advisable in view of prevailing or anticipated
market conditions. Portfolio turnover will not
be a limiting factor should SBMFM deem it
advisable to purchase or sell securities.
Special Equities Fund invests for long-term
capital appreciation and will not generally
trade for short-term profits. However, its
portfolio will be adjusted as deemed advisable
by SBMFM, and portfolio turnover will not be a
limiting factor should SBMFM deem it advisable
to purchase or sell securities.
The options activities of Government Securities
Fund may affect its portfolio 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 Funds 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 commission 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
transaction costs.
For the fiscal years ended December 31, 1995
and 1996, the portfolio turnover rates were as
follows:
Fund
1995
1996
Investment Grade Bond Fund
49%
48%
Government Securities Fund
294%
420%
Special Equities Fund
113%
118%
Managed Growth
Fund.................................
......................
6%
34%
Growth Opportunity
Fund.................................
..................
0%
183%
Increased portfolio turnover necessarily
results in correspondingly greater brokerage
commissions which must be paid by the Fund. To
the extent that portfolio trading results in
realization of net short-term capital gains,
shareholders will be taxed on such gains at
ordinary tax rates (except shareholders who
invest through IRAs and other retirement plans
which are not taxed currently on accumulations
in their accounts).
SBMFM manages a number of private investment
accounts on a discretionary basis and it is not
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 securities for one or more of the Funds
and/or for one or more of the other accounts
managed by SBMFM or the 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 equitable to each, with
emphasis on purchasing or selling entire orders
wherever possible. In some cases, this
procedure may adversely affect the price paid
or received by the 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 Prospectuses apply to
purchases made by any purchaser, which defined
to include the following: (a) an individual;
(b) an individuals 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
of 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 Prospectuses, apply to any
purchase of Class A shares if the aggregate
investment of any purchaser 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 is $25,000 or more. The reduced sales
charge is subject to confirmation of the
shareholders holdings through a check of
appropriate records. Each Fund reserves the
right to terminate or amend the combined right
of accumulation at any time after written
notice to shareholders. For further
information regarding the right 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 public offering price
for a Class A and Class Y share of each Fund is
equal to the net asset value per share at the
time of purchase plus, for Class A shares, an
initial sales charge based on the aggregate
amount of the investment. The public offering
price for a Class B share and Class C share,
and Class A share purchases, including
applicable right of accumulation, equaling or
exceeding $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 contingent deferred sales charge
(CDSC), however, is imposed on certain
redemptions of Class B shares, Class C shares,
and Class A shares when purchased in amounts
equaling or exceeding $500,000. The method of
computation of the public offering price is
shown in each Funds 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
customary weekend and holiday closings), (b)
when trading in markets a Fund normally
utilizes is restricted, or an emergency as
determined by the SEC exists, so that disposal
of the Funds 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
Funds 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 of
a Fund to make a redemption payment wholly in
cash, the Fund may pay, in accordance with the
SEC rules, any portion of a redemption in
excess of the lesser of $250,000 or 1% of the
Funds 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
$50 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
shareholders shares at the time the Withdrawal
Plan commences. To the extent withdrawals
exceed dividends, distributions and
appreciation of a shareholders investment in a
Fund, there will be a reduction in the value of
the shareholders investment and continued
withdrawal payments may reduce the shareholders
investment and ultimately exhaust it.
Withdrawal payments should not be considered as
income from investment in the Fund.
Furthermore, as it generally would not be
advantageous to a shareholder to make
additional investments in the Fund at the same
time that he or she is participating in the
Withdrawal Plan, purchases by such shareholders
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 First Data as agent for
Withdrawal Plan members. All dividends and
distributions on shares in the Withdrawal Plan
are automatically reinvested at net asset value
in additional shares of the Company.
Withdrawal Plans should be set up with a Smith
Barney Financial Consultant. A shareholder who
purchases shares directly through First Data
may continue to do so and applications for
participation in the Withdrawal Plan must be
received by First Data no later than the eighth
day of the month to be eligible for
participation beginning with that months
withdrawal. For additional information,
shareholders should contract a Smith Barney
Financial Consultant.
DISTRIBUTORS
Smith Barney serves as the Companys distributor
on a best efforts basis pursuant to a
distribution agreement (the Distribution
Agreement) which was most recently approved by
the Companys Board of Directors on July 25,
1996.
PFS serves as one of the Companys distributors
with respect to the Growth Opportunity Fund and
Investment Grade Bond Fund pursuant to a
Distribution Agreement which was most recently
approved by the Companys Board of Directors on
July 25, 1996.
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 investors 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 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 average 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 Companys Board of Directors has been
advised of the benefits to Smith Barney
resulting from these settlement procedures and
will take such benefits into consideration when
reviewing the Advisory, Administration and
Distribution Agreements for continuance.
For the fiscal year ended December 31, 1996,
Smith Barney incurred distribution expenses
totaling approximately $11,195,985, consisting
of approximately $834,786 for advertising,
$82,862 for printing and mailing of
Prospectuses, $6,683,975 for support services,
$14,110,451 to Smith Barney Financial
Consultants, and $850,755 in accruals for
interest on the excess of Smith Barney expenses
incurred in distributing the Funds shares over
the sum of the distribution fees and CDSC
received by Smith Barney from the Fund.
Distribution Arrangements
To compensate Smith Barney for the services it
provides and for the expense 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
and, with respect to the Class A and Class B
shares of Growth Opportunity Fund and
Investment Grade Bond Fund, PFS a service fee,
accrued daily and paid monthly, calculated at
the annual rate of 0.25% of the value of each
Funds average daily net assets attributable to
the Class A, Class B and Class C shares. In
addition, the Fund pays Smith Barney, and with
respect to the Class B shares of Growth
Opportunity Fund and Investment Grade Bond
Fund, PFS, a distribution fee with respect to
the Class B and Class C shares primarily
intended to compensate Smith Barney and/or PFS
for its initial expense of paying its Financial
Consultants and Registered Representatives,
respectively, 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, Managed Growth Fund
and Growth Opportunity Fund, and 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.
The following expenses were incurred during the
periods indicated:
Sales Charges paid to Smith Barney.
Class A
Name of Fund
Fiscal Year
Ended 12/31/94
Fiscal Year
Ended 12/31/95
Fiscal Year
Ended 12/31/96
Investment Grade Bond Fund
$ 114,571
$ 181,000
$ 182,000
Government Securities Fund
66,217
63,000
65,000
Special Equities Fund
186,104
347,000
1,800,000
Managed Growth
Fund.......................
........
-
5,400,000
1,700,000
Growth Opportunity
Fund.......................
....
-
18,000
18,000
CDSC paid to Smith Barney.
Class B
Name of Fund
Fiscal Year
Ended 12/31/94
Fiscal Year
Ended 12/31/95
Fiscal Year
Ended 12/31/96
Investment Grade Bond Fund
$ 556,007
$ 541,000
$422,000
Government Securities Fund
629,700
512,000
305,000
Special Equities Fund
288,013
379,000
658,000
Managed Growth
Fund.......................
........
-
174,000
1,112,000
Growth Opportunity
Fund.......................
...
-
-
3,000
Class C
Name of Fund
Fiscal Year
Ended 12/31/94
Fiscal Year
Ended 12/31/95
Fiscal Year
Ended 12/31/96
Investment Grade Bond Fund
-
$ 5,000
$1,000
Government Securities Fund
-
1,000
0
Special Equities Fund
-
1,000
22,000
Managed Growth
Fund.......................
........
-
10,000
27,000
Growth Opportunity
Fund.......................
....
-
-
1,000
Service Fees
Class A
Name of Fund
Fiscal Year
Ended 12/31/94
Fiscal Year
Ended 12/31/95
Fiscal Year
Ended 12/31/96
Investment Grade Bond Fund
$ 147,152
$ 505,094
$ 524,533
Government Securities Fund
334,848
1,212,522
1,026,748
Special Equities Fund
147,488
286,910
525,204
Managed Growth
Fund.......................
........
-
189,955
495,536
Growth Opportunity
Fund.......................
...
-
63,606
162,606
Class B
Name of Fund
Fiscal Year
Ended
12/31/94
Fiscal Year
Ended 12/31/95
Fiscal Year
Ended 12/31/96
Investment Grade Bond Fund
.
$ 922,038
$ 638,293
$ 662,187
Government Securities Fund .
1,505,763
419,433
340,572
Special Equities Fund .
329,007
283,978
696,750
Managed Growth
Fund.......................
........
-
351,874
1,024,802
Growth Opportunity
Fund.......................
...
-
34,096
96,931
Class C
(formerly designated as Class D)
Name of Fund
Fiscal Year
Ended
12/31/94
Fiscal Year
Ended 12/31/95
Fiscal Year
Ended 12/31/96
Investment Grade Bond Fund
$ 1,009
$ 5,068
$14,456
Government Securities Fund
967
2,078
3,050
Special Equities Fund
1,975
8,675
56,094
Managed Growth
Fund.......................
........
-
47,170
141,702
Growth Opportunity
Fund.......................
...
-
23
552
Distribution Fees
Class B
Name of Fund
Fiscal Year
Ended
12/31/94
Fiscal Year
Ended 12/31/95
Fiscal Year
Ended 12/31/96
Investment Grade Bond Fund
$ 1,844,077
$ 1,276,588
$ 1,324,350
Government Securities Fund
3,011,526
838,868
681,144
Special Equities Fund
987,022
851,933
2,090,250
Managed Growth
Fund.......................
........
-
1,055,621
3,074,405
Growth Opportunity
Fund.......................
....
-
102,289
290,792
Class C
(formerly designated as Class D)
Name of Fund
Fiscal Year
Ended
12/31/94
Fiscal Year
Ended 12/31/95
Fiscal Year
Ended 12/31/96
Investment Grade Bond Fund
$ 1,958
$ 9,124
$ 26,020
Government Securities Fund
1,893
3,741
5,491
Special Equities Fund
5,927
26,026
168,282
Managed Growth
Fund.......................
........
-
141,508
425,107
Growth Opportunity
Fund.......................
....
-
71
1,657
Under its terms, the Plan continues from year
to year, provided such continuance 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 or PFS
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
Independent Directors or by a vote of a
majority of the outstanding voting securities
of the Company (as defined in the 1940 Act).
Pursuant to the Plan, Smith Barney and PFS will
provide the Board of Directors periodic reports
of amounts expended under the Plan and the
purpose for which such expenditures 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 currently is scheduled to be closed on New
Years 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 description of the procedures used by the
Funds in valuing its assets.
A security which is listed or traded on more
than one exchange is valued at the quotation on
the exchange determined to be the primary
market for such security. All assets and
liabilities initially expressed in foreign
currency values will be converted into U.S.
dollar values 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 quotations are not available,
the rate of exchange will be determined in good
faith by the Board of Directors. In carrying
out the Board of Directors valuation policies,
SBMFM, as administrator, may consult with an
independent pricing service (the Pricing
Service) retained by the Company.
Debt securities of United States issuers (other
than U.S. government securities and short-term
investments) are valued by SBMFM, as
administrator, after consultation with the
Pricing Service 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.
Investments for which, in the judgment of the
Pricing Service, there are not readily
obtainable market quotations are carried at
fair value as determine by the Pricing Service.
The procedures of the Pricing Service are
reviewed periodically by the officers of the
Company under the general supervision 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, to the extent such shares are
offered for sale in the shareholders state of
residence and provided your Registered
Representative or your investment dealer is
authorized to distribute shares of the fund, on
the basis of relative net asset value per share
at the time of exchange. Class B shares of any
fund may be exchanged without a CDSC. 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 the
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.
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 or
Registered Representative of PFS Investments
Inc..
Upon receipt of proper instructions and all
necessary supporting documents, shares
submitted for exchange are redeemed at the
then-current net asset value and, subject to
any applicable CDSC, the proceeds are
immediately invested at a price as described
above, in shares of the fund being acquired.
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 advertisements or in reports
and other communications to shareholders. The
Fund may include comparative performance
information in advertising or marketing the
Funds shares. Such performance information may
include the following industry and financial
publications: Barrons, Business Week, CDA
Investment Technologies, Inc., Changing Times,
Forbes, Fortune, Institutional 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 Funds 30-day yield figure described below is
calculated according to a formula prescribed by
the SEC. The formula can be expressed as
follows:
YIELD = 2[(a-bcd + 1)6 - 1]
Where:
a =
dividends and interest earned during the period.
b =
expenses accrued for the period (net of
reimbursement).
c =
the average daily number of shares outstanding
during the period that were entitled to receive
dividends.
d =
the maximum offering price per share on the last day
of the period.
For the purpose of determining the interest
earned (variable a in the formula) on debt
obligations 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 Funds yield will
tend to be somewhat higher than prevailing
market rates, and in periods of rising interest
rates, the Funds 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 sales of its shares
will likely be invested in portfolio
instruments producing lower yields than the
balance of the Funds investments, thereby
reducing the current yield of the Fund. In
periods of rising interest rates, the opposite
can be expected to occur.
Average Annual Total Return
Average annual total return figures, as
described below, 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 formula 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 average annual total returns were as
follows for the periods indicated:
Name of Fund
Year Ended
December 31, 1996
Inception*
Through December 31,
1996
Investment Grade Bond Fund
(4.92)%
9.02%
Government Securities Fund
(2.62)%
5.15%
Special Equities Fund
(10.51)%
18.36%
Managed Growth Fund
10.54%
7.94%
Growth Opportunity Fund
8.28%
14.44%
__________________
* The Investment Grade Bond, Government
Securities and Special Equities Funds
commenced selling Class A shares on November
6, 1992. The Managed Growth Fund and Growth
Opportunity Fund Commenced Selling Class A
shares on June 30, 1995 and July 3, 1995,
respectively.
Performance calculations include the
historical return information related to the
Common Sense II Aggressive Opportunity Fund
of the Common Sense Trust (for the period
from May 3, 1994 through June 30, 1995.)
Class Bs average annual total returns were as
follows for the periods indicated:
Name of Fund
Year Ended
December 31,
1996
Five Year
Period Ended
December 31,
1996
Ten Year
Period Ended
December 31,
1996(1)
Inception
Through
December 31,
1996
Investment Grade Bond
Fund
(5.07)%
9.11%
8.83%
11.39%
Government Securities
Fund
(2.89)%
5.26%
6.50%
8.04%
Special Equities Fund
(11.03)%
15.31%
10.26%
10.55%
Managed Growth Fund
10.55%
N/A
N/A
8.30%
Growth Opportunity
Fund
8.12%
N/A
N/A
15.14%
__________________
(1) Class B shares automatically convert to
Class A shares eight years after date of
original purchase. Thus, a shareholders
actual return for the ten years ended
December 31, 1994 would be different than
that reflected above.
Performance calculations include the
historical return information related to the
Common Sense II Aggressive Opportunity Fund
of the Common Sense Trust (for the period
from May 3, 1994 through June 30, 1995.)
Class Cs average annual total returns were as
follows for the periods indicated:
Name of Fund
One Year
Period Ended
12/31/96
Inception
Through 12/31/96
Investment Grade Bond Fund (1)
(1.76)%
7.83%
Government Securities Fund (2)
0.52%
4.87%
Special Equities Fund (3)
(7.38)%
8.11%
Managed Growth Fund (4)
14.45%
10.83%
Growth Opportunity Fund (5)
.............
12.24%
15.98%
__________________
(1) The Fund commenced selling Class C shares
on February 26, 1993.
(2) The Fund commenced selling Class C shares
on February 4, 1993.
(3) The Fund commenced selling Class C shares
on October 18, 1993.
(4) The Fund commenced selling Class C shares
on June 30, 1995.
(5) The Fund commenced selling Class C shares
on July 3, 1995.
Aggregate Total Return
Aggregate total return figures, as described
below, represent the cumulative change in the
value of an investment in the Class of the
specified period and are computed by the
following formula:
AGGREGATE TOTAL RETURN =
ERV-P
P
Where:
P =
a hypothetical initial payment of $1,000.
ERV =
Ending Redeemable Value of a hypothetical
$10,000 investment made at the beginning of a
1-, 5- or 10-year period (a fractional portion
thereof) at the end of the 1-5- or 10- year
period (or fractional portion thereof),
assuming reinvestment of all dividends and
distributions.
Class As aggregate total returns were as
follows for the periods indicated:
Name of Fund
One Year
Period Ended
December 31,
1996**
Period from
Inception
through
December 31,
1996**
One Year
Period Ended
December 31,
1996***
Period from
Inception
through
December 31,
1996***
Investment Grade
Bond Fund
(0.47)%
49.96%
(4.92)%
43.21%
Government
Securities Fund
1.96%
29.01%
(2.62)%
23.21%
Special Equities
Fund
(5.81)%
111.55%
(10.51)%
101.02%
Managed Growth Fund
16.33%
18.12%
10.54%
12.22%
Growth Opportunity
Fund+
13.96%
50.83%
8.28%
43.31%
__________________
* The Investment Grade Bond Fund, Government
Securities Fund, and Special Equities Fund
commenced selling Class A shares on November
6, 1992. The Managed Growth Fund and Growth
Opportunity Fund commenced selling Class A
shares on June 30, 1995 and July 3, 1995,
respectively.
** Figures do not include the effect of the
maximum sales charge.
*** Figures include the effect of the maximum
sales charge.
+ Performance calculations include the
historical return information related to the
Common Sense II Aggressive Opportunity Fund
of the Common Sense Trust (for the period
from May 3, 1994 through June 30, 1995.
Class Bs aggregate total returns were as
follows for the periods indicated:
Name
of Fund
One
Year
Period
Ended
Dec.
31,
1996*
Five
Year
Period
Ended
Dec.
31,
1996*
Ten
Year
Period
Ended
Dec.
31,
1996*
Period
from
Incepti
on
through
Dec.
31,
1996*
One Year
Period
Ended
Dec. 31,
1996**
Five
Year
Period
Ended
Dec. 31,
1996**
Ten Year
Period
Ended
Dec. 31,
1996**(1)
Period
from
Inception
through
Dec. 31,
1996**
Investment
Grade
Bond Fund
(0.89)%
54.64%
133.15%
441.23%
(5.07)%
53.64%
133.15%
441.23%
Government
Securities
Fund
1.42%
30.23%
87.74%
168.75%
(2.89)%
29.23%
87.74%
168.75%
Special
Equities
Fund
(6.44)%
104.83%
165.64%
309.77%
(11.03)%
103.83%
165.64%
309.77%
Managed
Growth
Fund
15.55%
- -
- -
16.79%
10.55%
- -
- -
12.79%
Growth
Opportunity
Fund+
13.12%
- -
- -
48.68%
8.12%
- -
- -
45.07%
__________________
* Figures do not include the effect of the CDSC
(maximum 4.50% for Investment Grade Bond Fund
and Government Securities Fund and 5.00% for
the other Funds).
** Figures include the effect of the maximum
applicable CDSC, if any.
(1) Class B shares automatically convert to
Class A shares eight years after date of
original purchase. Thus, a shareholders
actual return for the ten years ended
December 31, 1995 would be different than
that reflected above.
+ Performance calculations include the
historical return information related to the
Common Sense II Aggressive Opportunity Fund
of the Common Sense Trust (for the period
from May 3, 1994 through June 30, 1995.
Class Cs aggregate total returns were as
follows for the periods indicated:
Name of Fund
One Year
Period Ended
Dec. 31,
1996**
Period from
Inception*
through
Dec.
31,1996**
One Year
Period Ended
Dec. 31,
1996***
Period from
Inception*
through
Dec. 31,
1996***
Investment Grade Bond
Fund
(0.83)%
33.62%
(1.76)%
33.62%
Government Securities
Fund
1.47%
20.41%
0.52%
20.41%
Special Equities Fund
(6.44)%
28.40%
(7.38)%
28.40%
Managed Growth Fund
15.45%
16.79%
14.45%
16.79%
Growth Opportunity Fund
13.24%
23.07%
12.24%
23.07%
__________________
* Investment Grade Bond Fund, Government
Securities Fund, Special Equities Fund,
Managed Growth Fund and Growth Opportunity
Fund commenced selling Class C shares on
February 26, 1993, February 4, 1993 October
18, 1993, June 30, 1995 and July 3, 1995,
respectively. Class C shares are sold at net
asset value without any sales charge or CDSC.
** Figures do not include the effect of the
CDSC.
*** Figures include the effect of the
applicable CDSC (1.00%)
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. A Class
performance will vary from time to time
depending upon market conditions, the
composition of the Funds investment portfolio
and operating expenses and the expenses
exclusively attributable to the Class.
Consequently, any given performance quotation
should not be considered representative of the
Class performance for any specified period in
the future. 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
investment companies portfolio securities.
TAXES
The following is a summary of certain Federal
income tax considerations that may affect the
Company and its shareholders. The summary is
not intended as a substitute for individual tax
advice, and investors are urged to consult
their tax advisors as to the tax consequences
of an investment in any Fund of the Company.
Tax Status of the Funds
Each Fund will be treated as a separate taxable
entity for Federal income tax purposes.
Each Fund has qualified and the Company intends
that each Fund will continue to qualify
separately each year as a regulated investment
company under the Code. A qualified Fund will
not be liable for Federal income taxes to the
extent that its taxable net investment income
and net realized capital gains are distributed
to its shareholders, provided that each Fund
distributes at least 90% of its net investment
income.
Each Fund intends to accrue dividend income for
Federal income tax purposes in accordance with
the rules applicable to regulated investment
companies. In some cases, these rules may have
the effect of accelerating (in comparison to
other recipients of the dividend) the time at
which the dividend 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
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 ordinary 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
unrealized 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
include 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 general,
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 affect 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 then three months,
which applies to regulated investment
companies, may restrict a Fund in the amount of
hedging transactions which it may undertake.
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
effected straddle positions will be determined
under rules that vary according to the
election(s) made.
Distributions of investment company taxable
income generally are taxable to shareholders as
ordinary income. In view of each Funds
investment policy, it is expected that
dividends from domestic corporations will
constitute a portion of the gross income of
several of the Funds but not of others.
Therefore, it is expected that a portion of the
income distributed by the Special Equities Fund
but not others (Investment Grade Bond Fund and
Government Securities Fund) may be eligible for
the dividends-received deduction for
corporations.
Distributions of net realized capital gains
designated by a Fund as capital 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 October, 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 shareholders 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 additional 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 the 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 foreign currency
and the time a Fund actually collects such
receivables or pays such liabilities, generally
are treated as ordinary income or ordinary
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 Funds
investment company taxable income to be
distributed to its shareholders as ordinary
income.
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 Funds total assets at
the close of a given taxable year consists 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
shareholders. 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, shareholders will be required to
include as income their proportionate share of
the amount of foreign taxes paid or accrued by
the Fund and generally be entitled to claim
either a credit or deduction (as an itemized
deduction) 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 shareholders United States tax
attributable to his or her total foreign source
taxable income. For this purpose, if the pass-
through election is made, the source of the
electing Funds income will flow through to its
shareholders. With respect to a Fund, gains
from the sales of securities generally will be
treated as derived from United States sources
and certain currency fluctuation gains,
including fluctuation gains from foreign
currency denominated debt securities,
receivables and payables, will be treated as
ordinary income derived from United States
sources. The limitation on the foreign tax
credit is applied separately to foreign source
passive income (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. Because application of
the credit depends on the particular
circumstances of each shareholder, shareholders
are advised to consult their own tax advisors.
Distributions by a Fund reduces the net asset
value of the Funds shares. Should a
distribution reduce the net asset value below a
shareholders 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
forthcoming distribution but the distribution
generally would be taxable to him.
Upon redemption, sale or exchange of his
shares, a shareholder will realize 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 shareholders hands. Such gain or
loss generally will be long-term or short-term
depending upon the shareholders 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 distributions
or otherwise) within a period of 61 days
beginning 30 days before 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 disallowed 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
investment 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 eligible to elect to
include in its gross income its share of
earnings of a passive foreign investment
company on a current basis. Generally the
election 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 Funds
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 Funds intention to
qualify annually as a regulated investment
company may limit its elections with respect 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 passive
foreign investment company shares, as well as
subject a Fund itself to tax on certain income
from such shares, the amount that must be
distributed to shareholders, and which will be
taxed to shareholders as ordinary income or
long-term capital gain, may be increased or
decreased substantially 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 Company, (b) disposes
of those shares within 90 days and (c) acquires
shares in a mutual fund for which the otherwise
applicable sales charge is reduced by reason of
a reinvestment right (i.e., exchange
privilege), the original sales charge increases
the shareholders tax basis in the original
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 shareholders 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 shareholders
tax basis in the newly acquired shares.
Furthermore, the same rule also applies to a
disposition of the newly acquired shares made
within 90 days of a subsequent acquisition.
This provision prevents a shareholder from
immediately deducting 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
identification number and that he or she is not
subject to such withholding, then the
shareholder may be subject to a 31% backup
withholding tax with respect to (a) any taxable
dividends and distributions and (b) any
proceeds of any redemption of Company shares.
An individuals taxpayer identification number
is his or her social security number. The
backup withholding tax is not an additional tax
and may be credited against a shareholders
regular federal income tax liability.
The foregoing discussion relates only to
Federal income tax law as applicable to United
States citizens. 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 Funds dividends, to the extent they
consist of interest from obligations of the
United States government and certain of its
agencies 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 Funds
dividends which are derived from such interest.
Shareholders should consult their tax advisors
with respect to particular questions of
Federal, state, local and foreign taxation.
ADDITIONAL INFORMATION
The Company was incorporated on September 29,
1981 under the name Hutton Investment Series
Inc. The Companys corporate name was changed
on December 29, 1988, July 30, 1993 and October
28, 1994, to SLH Investment Portfolios Inc.,
Smith Barney Shearson Investment Funds Inc.,
and Smith Barney Investment Funds, Inc.,
respectively.
PNC Bank, located at 17th and Chestnut Streets,
Philadelphia, Pennsylvania 19103, serves as the
custodian of the Company. Under its custody
agreement with the Company, PNC Bank holds the
Companys fund securities and keeps all
necessary accounts and records. For its
services, PNC Bank receives a monthly fee based
upon the month-end market value of securities
held in custody and also receives transaction
charges. PNC bank 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
foreign banks and securities depositories. The
assets of the Company are held under bank
custodianship in compliance with the 1940 Act.
First Data located at Exchange Place, Boston,
Massachusetts 02109, serves as the Companys
transfer agent. For these services, First Data
receives a monthly fee computed on the basis of
the number of shareholder accounts it maintains
with the Company during the month and is
reimbursed for out-of-pocket expenses.
FINANCIAL STATEMENTS
The Annual Reports for each Fund for the fiscal
year ended December 31, 1996 are incorporated
herein by reference in their entirety.
APPENDIX
BOND (AND NOTE) RATINGS
Moodys Investors Service, Inc. (Moodys)
Aaa - Bonds that are rated Aaa are
judged to be of the best quality. They carry
the smallest degree of investment risk and are
generally referred to as gilt edge. Interest
payments are protected by a large or by an
exceptionally stable margin and principal is
secure. While the various protective elements
are likely to change, such changes as can be
visualized are most unlikely to impair the
fundamentally strong position of such issues.
Aa - Bonds that are rated Aa are judged
to be of high quality by all standards.
Together with the Aaa group they comprise
what are generally known as high grade bonds.
They are rated lower than the best bonds because
margins of protection may not be as large as in
Aaa securities or fluctuation of protective
elements may be of greater amplitude or there
may be other elements present that make the long
term risks appear somewhat larger than in Aaa
securities.
A - Bonds that are rated A possess many
favorable investment attributes and are to be
considered as upper medium grade obligations.
Factors giving security to principal and
interest are considered adequate but elements
may be present that suggest a susceptibility to
impairment sometime in the future.
Baa - Bonds that are rated Baa are
considered as medium grade obligations, i.e.,
they are neither highly protected nor poorly
secured. Interest payments and principal
security appear adequate for the present but
certain protective elements may be 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.
Ba - Bonds that are rated Ba are judged to
have speculative elements; their future cannot
be considered as well assured. Often the
protection of interest and principal payments
may be very moderate and thereby not well
safeguarded during both good and bad times over
the future. Uncertainty of position
characterizes bonds in this class.
B - Bonds that are rated B generally lack
characteristics of desirable investments.
Assurance of interest and principal payments or
of maintenance of other terms of the contract
over any long period of time may be small.
Caa - Bonds that are rated Caa are of poor
standing. These issues may be in default or
present elements of danger may exist with
respect to principal or interest.
Ca - Bonds that are rated Ca represent
obligations which are speculative in a high
degree. Such issues are often in default or
have other marked short-comings.
C - Bonds that are rated C are the lowest
rated class of bonds, and issues so rated can be
regarded as having extremely poor prospects of
ever attaining any real investment standing.
Moodys applies the numerical modifiers 1,
2 and 3 in each generic rating classification
from Aa through B. The modifier 1 indicates
that the security ranks in the higher end of its
generic rating category; the modifier 2
indicates a mid-range ranking; and the modifier
3 indicates that the issue ranks in the lower
end of its generic rating category.
Standard & Poors Ratings Group (Standard &
Poors)
AAA - Debt rated AAA has the highest
rating assigned by Standard & Poors. Capacity
to pay interest and repay principal is extremely
strong.
AA - Debt rated AA has a very strong
capacity to pay interest and repay principal and
differs from the highest rated issues only in
small degree.
A - Debt rated A has a strong capacity
to pay interest and repay principal although it
is somewhat more susceptible to the adverse
effects of changes in circumstances and economic
conditions than debt in higher rated categories.
BBB - Debt rated BBB is regarded as
having an adequate capacity to pay interest and
repay principal. Whereas it normally exhibits
adequate protection parameters, adverse economic
conditions or changing circumstances are more
likely to lead to a weakened capacity to pay
interest and repay principal for debt in this
category than in higher rated categories.
BB, B and CCC - Bonds rated BB and B are
regarded, on balance, as predominantly
speculative with respect to capacity to pay
interest and repay principal in accordance with
the terms of the obligation. BB represents a
lower degree if speculation than B and CCC the
highest degree of speculation. While such bonds
will likely have some quality and protective
characteristics, these are outweighed by large
uncertainties or major risk exposures to adverse
conditions.
C - The rating C is reserved for income
bonds on which no interest is being paid.
D - Bonds rated D are in default, and
payment of interest and/or repayment of
principal is in arrears.
S&Ps letter ratings may be modified by
the addition of a plus or a minus sign, which is
used to show relative standing within the major
rating categories, except in the AAA category.
COMMERCIAL PAPER RATINGS
Moodys Investors Service, Inc.
Issuers rated Prime-1 (or related supporting
institutions) have a superior capacity for
repayment of short-term promissory obligations.
Prime-1 repayment capacity will normally be
evidenced by the following characteristics:
leading market positions in well-established
industries; high rates of return on funds
employed; conservative capitalization structures
with moderate reliance on debt and ample asset
protection; broad margins in earnings coverage
of fixed financial charges and high internal
cash generation; well-established access to a
range of financial markets and assured sources
of alternate liquidity.
Issuers rated Prime-2 (or related supporting
institutions) have a strong capacity for
repayment of short-term promissory obligations.
This will normally be evidenced by many of the
characteristics cited above but to a lesser
degree. Earnings trends and coverage ratios,
while sound, will be more subject to variation.
Capitalization characteristics, while still
appropriate, may be more affected by external
conditions. Ample alternate liquidity is
maintained.
Standard & Poors Ratings Group
A-1 - This designation indicates that the
degree of safety regarding timely payment is
either overwhelming or very strong. Those
issues determined to possess overwhelming safety
characteristics will be denoted with a plus (+)
sign designation.
A-2 - Capacity for timely payment on issues
with this designation is strong. However, the
relative degree of safety is not as high as for
issues designated A-1.
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. Treasury 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 required 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 transactions in
that futures contract initial margin does not
involve the borrowing of funds by their
customer to finance the transaction. Rather,
the initial margin is in the nature of a
performance bond or good faith deposit on the
contract which is returned to the Fund upon
termination of the futures contract, assuming
all contractual obligations have been
satisfied. 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 terminate the Funds 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 delivery 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
realizes the loss. Similarly, the closing out
of a futures contract purchase is effected by
the Fund entering into a futures contract sale.
If the offsetting 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 securities 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 contracts, the Fund may
buy or sell futures contracts in a greater
dollar amount of the securities being hedged if
the historical 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 volatility 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 Funds portfolio may decline. If
this occurred, the Fund would lose money on the
futures 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 equivalents) in U.S. government securities
(or options) in an orderly fashion, it is
possible that the market may decline instead;
if the Fund then concludes 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 reasons, 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
requirements. Rather than meeting additional
margin deposit requirements, investors may
close futures contracts though offsetting
transactions which could distort the normal
relationship between the debt securities and
futures markets; second, from the point of view
of speculators, the deposit requirements in the
futures market are less onerous than margin
requirements in the securities market.
Therefore, increased participation by
speculators in the futures market may also
cause temporary price distortions. Due to the
possibility of price distortion in the futures
market and because of the imperfect correlation
between movements in the debt securities and
movements in the prices of futures contracts, a
correct forecast of interest rate trends by the
investment advisor may still not result 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.
Although Government Securities Fund intends to
purchase or sell futures only on exchanges or
boards of trade where there appears to be an
active secondary 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
futures 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 futures 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 investment
advisers 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 requirements. 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 futures contracts described above,
and, in addition, net option premiums received
will be included as initial margin deposits.
In addition to the risks which apply to all
options transaction, there are several special
risks relating to options on futures contracts.
Trading 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 contracts on any
exchange unless and until, in the investment
advisors opinion, 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 potential risk
to the Fund because the maximum amount of risk
is the premium paid for the options (plus
transaction costs). However, there may be
circumstances 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 option
on a futures contract involves risks similar to
those arising in the sale of futures contracts,
as described above.
52
U:\legal\funds\sliv\1997\secdocs\stkr97 4/6/98 12:26 PM
STKR97.61 4/6/98 12:26 PM
