<PAGE>
- --------------------------------------------------------------------------------
ANNUAL REPORT AND PERFORMANCE UPDATE
- --------------------------------------------------------------------------------
(Logo)
NEW ENGLAND FUNDS
Where The Best Minds Meet(TM)
- --------------------------------------------------------------------------------
New England
Adjustable Rate
U.S. Government Fund
[graphic omitted]
December 31, 1996
<PAGE>
FEBRUARY 1997
- --------------------------------------------------------------------------------
[Photo of Henry L.P. Schmelzer]
Dear New England Funds Shareholder,
Taken together, 1995 and 1996 constituted the sixth strongest back-to-back years
for the U.S. stock market since 1915, as measured by percentage gain in the Dow
Jones Industrial Average (according to Bloomberg Business News).
Most New England Funds portfolio managers believe that the forces behind this
rally -- low inflation, relatively stable interest rates and strong corporate
profits -- will persist, at least for a time. Nevertheless, bull markets can
suddenly turn quiet; they can decline modestly; or they can reverse course
sharply. No one can predict what is ahead, nor can anyone guarantee whether the
market's strength will extend even further in 1997 and beyond.
Maintain a Long-Term Perspective
Whatever the market's direction, you should be prepared to consider any
short-term trends in the broader context of your long-term personal goals,
including the accumulation of financial assets. One way to manage this important
process is by diversifying your investments. While U.S. stocks have historically
been the strongest performers, you may, depending on your financial goals and
needs, also benefit from investing in various types of bond funds, and by
participating in growing overseas markets.
Remember that each investment has its own unique risks. What's more, no strategy
can assure a profit or protect against a loss. However, one time-tested approach
is to invest regularly and stay invested -- in good times and bad -- to avoid
the pitfall of guessing what the market might do in the short run.
Our Multiple-Adviser Approach Sets Us Apart
Many financial representatives recommend New England Funds to their clients
because of our distinctive multiple-adviser approach. For each fund, we
hand-pick a specific subadviser or subadvisers with significant experience and
demonstrated skill in selecting investments that are in tune with that fund's
stated objective. We call it matching the talent to the task.
Finally, it may interest you to learn that you are part of a major national
trend. In 1996, nearly 37 million U.S. households owned mutual funds, according
to the Investment Company Institute, an industry trade organization. Mutual
funds are now a cornerstone of retirement, college and other investment plans
for millions of Americans.
New England Funds has grown with the industry and is now over $6 billion in
size. We thank you for helping us reach this important milestone, and look
forward to serving your investment needs well into the future.
Sincerely,
/s/ Henry L.P. Schmelzer
- ------------------------
Henry L.P. Schmelzer, President
For more information, including a prospectus for any New England Fund, please
contact your financial representative or call the Investor Services and
Marketing Group at 800-225-5478. Please read the prospectus carefully, including
the information on charges and expenses, before you invest.
<PAGE>
- --------------------------------------------------------------------------------
NEW ENGLAND ADJUSTABLE RATE U.S. GOVERNMENT FUND
- --------------------------------------------------------------------------------
AWARD WINNING SERVICE -- TWO YEARS RUNNING
- --------------------------------------------------------------------------------
- --------------------- For two years running we're proud to announce that
[Logo] DALBAR, an independent evaluator of mutual fund
QUALITY service, has awarded New England Funds its Quality
TESTED SERVICE Tested Service Seal for "providing the highest
1996 tier of service excellence in the mutual fund
- --------------------- industry." New England Funds is one of just three
DALBAR mutual fund companies to earn this distinction in
HONORS COMMITMENT TO: each of the last two years -- another reason why
INVESTORS we are becoming known as the mutual fund company
- --------------------- Where The Best Minds Meet(TM).
INVESTMENT RESULTS THROUGH DECEMBER 31, 1996
- --------------------------------------------------------------------------------
Putting Performance into Perspective
The graph comparing your Fund's performance to a benchmark index provides you
with a general sense of how your Fund performed. To put this information in
context, it may be helpful to understand the special differences between the
two. Your Fund's total return for the period shown appears with and without
sales charges and includes Fund expenses and management fees. A securities index
measures the performance of a theoretical portfolio. Unlike a fund, the index is
unmanaged; there are no expenses that affect the results. In addition, few
investors could purchase all of the securities necessary to match the index.
And, if they could, they would incur transaction costs and other expenses.
<PAGE>
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NEW ENGLAND ADJUSTABLE RATE U.S. GOVERNMENT FUND
- --------------------------------------------------------------------------------
[A chart in the form of a line graph appears here, illustrating the growth of a
$10,000 investment in the Fund compared to the Lehman Adjustable Rate Mortgage
Index and the Cost of Living since 12/31/91. The data points for this chart are
as follows:]
- --------------------------------------------------------------------------------
GROWTH OF A $10,000 INVESTMENT IN CLASS A SHARES
- --------------------------------------------------------------------------------
COMPARED TO LEHMAN ADJUSTABLE
RATE MORTGAGE INDEX (ARM)(4) AND THE COST OF LIVING(5)
DECEMBER 1991 THROUGH DECEMBER 1996
COST OF
DATE NAV(1) POP(2) LEHMAN ARM(4) LIVING(5)
- ---- -------- ------- ------------- ---------
12/31/91 $10,000 $9,900 $10,000 $10,000
12/31/92 $10,494 $10,389 $10,502 $10,290
12/31/93 $10,916 $10,807 $11,131 $10,573
12/31/94 $11,000 $10,890 $11,132 $10,856
12/31/95 $11,948 $11,829 $12,437 $11,140
12/31/96 $12,645 $12,518 $12,437 $11,510
This illustration represents past performance of Class A shares and cannot
predict future results. Investment return and principal value may vary,
resulting in a gain or loss on the sale of shares. Class B share performance
will be greater or less than that shown based on differences in inception date,
fees and sales charges. All index and Fund performance assumes reinvested
distributions.
<PAGE>
- --------------------------------------------------------------------------------
NEW ENGLAND ADJUSTABLE RATE U.S. GOVERNMENT FUND
- --------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS 12/31/96
- --------------------------------------------------------------------------------
CLASS A (Inception 10/18/91) 1 YEAR 3 YEARS 5 YEARS SINCE INCEPTION
NET ASSET VALUE(1) 5.83% 5.02% 4.80% 4.85%
WITH MAX. SALES CHARGE(2) 4.83 4.65 4.58 4.63
LIPPER ARM AVERAGE(6) 5.40 2.32 3.55 N/A
- --------------------------------------------------------------------------------
CLASS B (Inception 9/13/93) 1 YEAR 3 YEARS SINCE INCEPTION
NET ASSET VALUE(1) 4.90% 4.20% 3.80%
WITH CDSC(3) 0.90 3.28 3.25
LEHMAN ARM INDEX(4) 6.64 5.81 5.51
LIPPER ARM AVERAGE(6) 5.40 2.32 N/A
These returns represent past performance. Investment return and principal value
will fluctuate so that shares, upon redemption, may be worth more or less than
original cost.
NOTES TO CHARTS AND PERFORMANCE UPDATE
(1) Net Asset Value (NAV) performance assumes reinvestment of all distributions
and does not reflect the payment of a sales charge at the time of purchase.
(2) With Maximum Sales Charge performance assumes reinvestment of all
distributions and reflects the maximum sales charge of 1% at the time of
purchase of Class A shares.
(3) With Contingent Deferred Sales Charge (CDSC) performance assumes a maximum
4% sales charge is applied to a redemption of Class B shares. The sales
charge will decrease over time, declining to zero five years after the
purchase of shares.
(4) Lehman Adjustable Rate Mortgage Index (ARM) is an unmanaged index of
adjustable rate mortgages of short to intermediate maturities. The Index
performance has not been adjusted for ongoing management, distribution and
operating expenses and sales charges applicable to mutual fund investments.
(5) Cost of Living is based on the Consumer Price Index, a widely recognized
measure of the cost of goods and services in the United States, calculated
by the U.S. Bureau of Labor Statistics.
(6) Lipper Average is an average of the total return performance (calculated on
the basis of net asset value) of funds with similar investment objectives as
calculated by Lipper Analytical Services, an independent mutual fund ranking
service.
<PAGE>
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NEW ENGLAND ADJUSTABLE RATE U.S. GOVERNMENT FUND
- --------------------------------------------------------------------------------
QUESTIONS & ANSWERS WITH YOUR PORTFOLIO MANAGER
- --------------------------------------------------------------------------------
Q. How did New England Adjustable Rate U.S. Government Fund perform during
1996?
[Photo of Scott Nicholson
Back Bay Advisors, L.P.]
In a year that was particularly difficult for fixed income securities, New
England Adjustable Rate U.S. Government Fund provided a welcome shelter from
the storm. Although interest rates generally ended the year significantly
higher than their February lows, the Fund was able to maintain a stable
share price with only minor fluctuations during the period. For the year
ended December 31, 1996, your Fund generated a total return of 5.83% for
Class A shares, based on net asset value. This return reflects the
reinvestment of $0.42 per share in income distributions paid during the year
and a share price that began and ended the year at $7.37. By comparison, the
46 ARM (Adjustable Rate Mortgage) funds tracked by Lipper Analytical
Services produced an average total return of 5.4% while the Fund's
benchmark, the unmanaged Lehman ARM Index, returned 6.64%.
Q. How did you manage the Fund during the year?
Though the U.S. government and agency ARM securities (ARMS) in which your
Fund invests are among the most creditworthy investments available, like
other fixed-income investments, they are influenced by changes in interest
rates. In addition, ARM securities are subject to prepayment risk - the risk
that borrowers will prepay principal when homeowners take advantage of
favorable interest rates to refinance their debt. As prepayment expectations
shifted during the course of the year, the Fund adjusted its strategy,
focusing alternately on Treasury securities, which tend to perform better
during periods of declining interest rates, and ARMS, which typically
perform better when interest rates rise and the likelihood of prepayments
falls. Anticipating lower rates at the start of 1996, we maintained a lower
weighting of ARMS than usual - around 67%. Falling mortgage rates had raised
concerns that continued rapid mortgage prepayments would erode the Fund's
income stream while limiting price appreciation. As a result, we focused
more on U.S. Treasury securities, which do not carry prepayment risk.
However, as rates began to move up in the spring and early summer, we
shifted our focus back to ARMS in expectation that the higher mortgage rates
would slow down prepayment speeds.
The anticipated slowdown in refinancings did occur, allowing us to raise the
Fund's distribution rate from 5.625% to 5.75% in the month of August.
Subsequently, interest rates dropped somewhat from their early July highs,
raising again the specter of increasing ARM prepayment speeds. The fourth
quarter of 1996 was thus spent managing the portfolio's exposure to
prepayment risk, favoring slower prepaying Government National Mortgage
Association (GNMA) ARMS and ARMS with smaller premiums in their market
prices.
- --------------------------------------------------------------------------------
Portfolio Composition -- 12/31/96*
- --------------------------------------------------------------------------------
TOTAL ARM SECURITIES 81.1%
U.S. TREASURY NOTES 10.1%
COLLATERALIZED MORTGAGE OBLIGATIONS 2.1%
NET CASH/EQUIVALENT 0.9%
FHLB CALLABLE NOTES 4.3%
*Portfolio composition is based on total net assets and is subject to change.
Q. What's your investment strategy for the months ahead?
We will continue to heavily weight the portfolio in ARM securities - now
approximately 80% of the portfolio - reflecting our expectations for
moderate economic growth, low levels of inflation, and relatively stable
interest rates. Should our outlook for interest rates become more positive,
we would again work to lower the Fund's sensitivity to prepayment activity
by paring back holdings of ARMS in favor of Treasury securities. This
strategy would be consistent with our goal to provide our shareholders with
a competitive income stream while maintaining a stable share price.
<PAGE>
- --------------------------------------------------------------------------------
PORTFOLIO COMPOSITION
- --------------------------------------------------------------------------------
Investments as of December 31, 1996
<TABLE>
<CAPTION>
BONDS AND NOTES--97.6% OF TOTAL NET ASSETS
FACE
AMOUNT DESCRIPTION VALUE (a)
- ----------------------------------------------------------------------------------------------------------------
GOVERNMENT AGENCIES--87.5% (b)
<C> <S> <C>
$ 346,911 Federal Home Loan Mortgage Corp., 6.047%, 12/01/17, (d) ........................ $ 343,658
479,629 Federal Home Loan Mortgage Corp., 6.084%, 2/01/19, (d) ......................... 475,433
1,472,397 Federal Home Loan Mortgage Corp., 6.087%, 10/01/30, (d) ........................ 1,459,514
1,187,939 Federal Home Loan Mortgage Corp., 6.623%, 4/01/19, (d) ......................... 1,187,939
3,821,343 Federal Home Loan Mortgage Corp., 6.749%, 3/01/25, (d) ......................... 3,914,488
3,222,945 Federal Home Loan Mortgage Corp., 7.000%, 4/01/22, (d) ......................... 3,321,648
2,195,091 Federal Home Loan Mortgage Corp., 7.034%, 4/01/22, (d) ......................... 2,238,993
716,559 Federal Home Loan Mortgage Corp., 7.131%, 7/01/30, (d) ......................... 714,545
2,128,478 Federal Home Loan Mortgage Corp., 7.136%, 6/01/22, (d) ......................... 2,183,020
1,590,493 Federal Home Loan Mortgage Corp., 7.146%, 6/01/22, (d) ......................... 1,640,196
3,313,412 Federal Home Loan Mortgage Corp., 7.159%, 4/01/23, (d) ......................... 3,427,310
5,557,583 Federal Home Loan Mortgage Corp., 7.257%, 1/01/20, (d) ......................... 5,682,629
3,266,113 Federal Home Loan Mortgage Corp., 7.268%, 5/01/23, (d) ......................... 3,378,385
1,494,396 Federal Home Loan Mortgage Corp., 7.283%, 6/01/22, (d) ......................... 1,545,766
4,896,995 Federal Home Loan Mortgage Corp., 7.304%, 7/01/26, (d) ......................... 5,019,420
2,756,640 Federal Home Loan Mortgage Corp., 7.343%, 5/01/22, (d) ......................... 2,860,014
4,467,771 Federal Home Loan Mortgage Corp., 7.367%, 5/01/23, (d) ......................... 4,621,351
3,656,344 Federal Home Loan Mortgage Corp., 7.499%, 3/01/22, (d) ......................... 3,777,460
3,513,956 Federal Home Loan Mortgage Corp., 7.598%, 5/01/19, (d) ......................... 3,619,375
5,500,130 Federal Home Loan Mortgage Corp., 7.657%, 4/01/29, (d) ......................... 5,672,889
2,574,795 Federal Home Loan Mortgage Corp., 7.704%, 1/01/23, (d) ......................... 2,661,694
2,975,476 Federal Home Loan Mortgage Corp., 7.750%, with various maturities to 1/01/22(d) 3,063,179
5,768,396 Federal Home Loan Mortgage Corp., 7.789%, 4/01/25, (d) ......................... 5,977,500
3,805,624 Federal Home Loan Mortgage Corp., 7.810%, 1/01/19, (d) ......................... 3,929,307
2,327,070 Federal Home Loan Mortgage Corp., 7.841%, 8/01/22, (d) ......................... 2,405,609
3,723,827 Federal Home Loan Mortgage Corp., 7.868%, 7/01/25, (d) ......................... 3,861,143
1,626,098 Federal Home Loan Mortgage Corp., 7.875%, 7/01/22, (d) ......................... 1,686,061
3,239,663 Federal Home Loan Mortgage Corp., 7.880%, 12/01/22, (d) ........................ 3,338,878
1,173,220 Federal Home Loan Mortgage Corp., 7.905%, 9/01/22, (d) ......................... 1,208,416
6,108,797 Federal Home Loan Mortgage Corp., 7.912%, 9/01/23, (d) ......................... 6,286,318
4,304,485 Federal Home Loan Mortgage Corp., 7.928%, 10/01/23, (d) ........................ 4,460,523
3,019,423 Federal Home Loan Mortgage Corp., 7.994%, 9/01/23, (d) ......................... 3,128,877
1,170,299 Federal Home Loan Mortgage Corp., 8.000%, 8/01/22, (d) ......................... 1,204,676
3,048,112 Federal Home Loan Mortgage Corp., 8.125%, 8/01/24, (d) ......................... 3,133,840
4,689,674 Federal Home Loan Mortgage Pc Guaranteed, 6.105%, 10/15/23, (d) ................ 4,672,322
508,237 Federal National Mortgage Association, 5.839%, 9/01/23, (d) .................... 503,790
2,061,401 Federal National Mortgage Association, 6.329%, 7/01/19, (d) .................... 2,054,960
1,234,152 Federal National Mortgage Association, 6.500%, 6/01/17, (d) .................... 1,231,067
559,211 Federal National Mortgage Association, 6.585%, 6/01/19, (d) .................... 562,706
1,530,428 Federal National Mortgage Association, 6.796%, 1/01/20, (d) .................... 1,547,645
2,638,613 Federal National Mortgage Association, 7.219%, 4/01/23, (d) .................... 2,714,473
1,448,262 Federal National Mortgage Association, 7.237%, 5/01/22, (d) .................... 1,486,279
330,265 Federal National Mortgage Association, 7.304%, 8/01/17, (d) .................... 338,728
543,385 Federal National Mortgage Association, 7.370%, 5/01/20, (d) .................... 557,649
4,775,441 Federal National Mortgage Association, 7.459%, 7/01/24, (d) .................... 4,904,522
3,954,014 Federal National Mortgage Association, 7.461%, 11/01/25, (d) ................... 4,052,864
4,542,204 Federal National Mortgage Association, 7.481%, 9/01/25, (d) .................... 4,686,986
4,241,904 Federal National Mortgage Association, 7.509%, 6/01/22, (d) .................... 4,390,370
4,537,290 Federal National Mortgage Association, 7.520%, 4/01/24, (d) .................... 4,693,259
3,018,552 Federal National Mortgage Association, 7.591%, 11/01/20, (d) ................... 3,124,201
1,387,230 Federal National Mortgage Association, 7.658%, 7/01/17, (d) .................... 1,433,181
1,846,350 Federal National Mortgage Association, 7.692%, 7/01/23, (d) .................... 1,899,432
3,095,974 Federal National Mortgage Association, 7.813%, 1/01/24, (d) .................... 3,210,138
7,109,462 Federal National Mortgage Association, 7.875%, 10/01/18, (d) ................... 7,384,954
3,515,847 Federal National Mortgage Association, 7.987%, 10/01/23, (d) ................... 3,647,691
3,094,443 Federal National Mortgage Association, 8.153%, 11/01/22, (d) ................... 3,216,287
5,467,080 Government National Mortgage Association, 7.000%, 4/20/22, (d) ................. 5,579,839
25,644,917 Government National Mortgage Association, 7.125%, with various maturities
to 7/20/23, (d) ............................................................. 26,161,545
------------
197,484,942
------------
U.S. GOVERNMENT--10.1%
5,000,000 United States Treasury Notes, 6.250%, 6/30/98 .................................. 5,033,150
2,000,000 United States Treasury Notes, 7.375%, 11/15/97 ................................. 2,029,180
15,000,000 United States Treasury Notes, 9.000%, 5/15/98 .................................. 15,631,350
------------
22,693,680
------------
Total Bonds and Notes (Identified Cost $220,842,065) ........................... 220,178,622
------------
SHORT TERM INVESTMENTS--0.9%
FACE
AMOUNT DESCRIPTION VALUE (a)
- ----------------------------------------------------------------------------------------------------------------
$ 2,000,000 Repurchase agreement with Goldman Sachs Group L.P. dated 12/31/96 at 6.45% to be
repurchased at $2,000,717 on 01/02/97. Collateralized by $1,605,000 U.S.
Treasury Bonds 8.875% due 02/15/19 valued at $2,043,968 ..................... $ 2,000,000
------------
Total Short Term Investments (Identified Cost $2,000,000) ...................... 2,000,000
------------
Total Investments--98.5% (Identified Cost $222,842,065) (c) .................... 222,178,622
Other assets less liabilities ................................................ 3,450,780
------------
Total Net Assets--100% ......................................................... $225,629,402
============
(a) See Note 1a to the financial statements.
(b) The Fund's investments in mortgage backed securities of the Government
National Mortgage Association, Federal Home Loan Bank and Federal National
Mortgage Association are interests in separate pools of mortgages. All
separate investments in securities of these issues which have the same
coupon rate have been aggregated for the purpose of presentation in the
schedule of investments.
(c) Federal Tax Information: At December 31, 1996 the net unrealized depreciation on
investments based on cost for federal income tax purposes of $222,849,096 was as follows:
Aggregate gross unrealized appreciation for all investments in which there is an excess
value over tax cost ...................................................................... $ 699,860
Aggregate gross unrealized depreciation for all investments in which there is an excess of
tax cost over value ...................................................................... (1,370,334)
------------
Net unrealized depreciation .............................................................. $ (670,474)
============
As of December 31, 1996 the fund has a net tax basis capital loss carryforward as follows:
Expiring December 31, 2002 ............................................................... $ 5,625,994
December 31, 2003 ............................................................... 6,075,626
December 31, 2004 ............................................................... 2,134,629
(d) Variable rate mortgage backed securities. The interest rates change on these
instruments monthly based on changes in a designated base rate. The rates
shown were those in effect at December 31, 1996.
</TABLE>
See accompanying notes to financial statements.
<PAGE>
- --------------------------------------------------------------------------------
STATEMENT OF ASSETS & LIABILITIES
- --------------------------------------------------------------------------------
December 31, 1996
<TABLE>
<S> <C> <C>
ASSETS
Investments at value ....................................... $222,178,622
Cash ....................................................... 105,071
Receivable for:
Fund shares sold ......................................... 124,037
Securities sold .......................................... 83,367
Accrued interest ......................................... 4,219,920
Prepaid registration expense ............................... 7,000
------------
226,718,017
LIABILITIES
Payable for:
Fund shares redeemed ..................................... $408,336
Dividends declared ....................................... 408,186
Accrued expenses:
Management fees .......................................... 199,440
Deferred trustees' fees .................................. 6,835
Accounting and administrative ............................ 2,425
Other expenses ........................................... 63,393
--------
1,088,615
------------
NET ASSETS ................................................... $225,629,402
============
Net Assets consist of:
Capital paid in .......................................... $240,312,299
Undistributed net investment income ...................... 27,231
Accumulated net realized losses .......................... (14,046,685)
Unrealized depreciation on investments ................... (663,443)
------------
NET ASSETS ................................................... $225,629,402
============
Computation of net asset value and offering price:
Net asset value and redemption price of Class A shares
($222,808,891 divided by 30,251,790 shares of beneficial
interest) .................................................. $7.37
=====
Offering price per share (100/99 of $7.37) ................... $7.44*
=====
Net asset value and offering price of Class B shares ($2,820,511 divided by
383,105 shares of beneficial interest) ..................... $7.36**
=====
Identified cost of investments ............................... $222,842,065
============
*Based upon single purchases of less than $1,000,000. Reduced sales charges
apply for purchases in excess of this amount.
**Redemption price per share is equal to net asset value less any applicable
contingent deferred sales charges.
</TABLE>
See accompanying notes to financial statements.
<PAGE>
- --------------------------------------------------------------------------------
STATEMENT OF OPERATIONS
- --------------------------------------------------------------------------------
Year Ended December 31, 1996
<TABLE>
<S> <C> <C>
INVESTMENT INCOME
Interest ................................................. $20,738,164
Expenses
Management fees ........................................ $ 1,572,103
Service fees - Class A ................................. 724,984
Service and distribution fees - Class B ................ 25,756
Trustees' fees and expenses ............................ 23,342
Accounting and administrative .......................... 51,896
Custodian .............................................. 95,310
Transfer agent ......................................... 145,158
Audit and tax services ................................. 25,500
Legal .................................................. 24,372
Printing ............................................... 26,825
Registration ........................................... 34,409
Amortization of organization expenses .................. 11,242
Miscellaneous .......................................... 11,649
-----------
Total expenses ........................................... 2,772,546
Less expenses waived by the investment adviser and
subadviser ............................................. (705,267) 2,067,279
----------- -----------
Net investment income .................................... 18,670,885
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS
Realized loss on:
Investments - net ...................................... (3,076,747)
Unrealized appreciation on:
Investments - net ...................................... 568,620
-----------
Net loss on investment transactions ...................... (2,508,127)
------------
NET INCREASE IN NET ASSETS FROM OPERATIONS ................. $ 16,162,758
============
</TABLE>
See accompanying notes to financial statements.
<PAGE>
- --------------------------------------------------------------------------------
STATEMENT OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31,
1995 1996
------------ ------------
<S> <C> <C>
FROM OPERATIONS
Net investment income .................................... $ 26,292,012 $ 18,670,885
Net realized loss on investments ......................... (9,361,220) (3,076,747)
Unrealized appreciation on investments ................... 18,622,227 568,620
------------ ------------
Increase in net assets from operations ................... 35,553,019 16,162,758
------------ ------------
FROM DISTRIBUTIONS TO SHAREHOLDERS
Net investment income
Class A ................................................ (24,684,115) (16,446,055)
Class B ................................................ (112,561) (127,062)
------------ ------------
(24,796,676) (16,573,117)
------------ ------------
Decrease in net assets derived from capital share
transactions ........................................... (168,968,965) (107,440,637)
------------ ------------
Total decrease in net assets ............................. (158,212,622) (107,850,996)
NET ASSETS
Beginning of the year .................................... 491,693,020 333,480,398
------------ ------------
End of the year .......................................... $333,480,398 $225,629,402
============ ============
UNDISTRIBUTED (DISTRIBUTIONS IN EXCESS OF) NET INVESTMENT INCOME
Beginning of the year .................................... $ 313,893 $ (204,379)
============ ============
End of the year .......................................... $ (204,379) $ 27,231
============ ============
</TABLE>
See accompanying notes to financial statements.
<PAGE>
- --------------------------------------------------------------------------------
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS A
------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------
1992 1993 1994 1995 1996
------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Year .... $ 7.50 $ 7.46 $ 7.45 $ 7.20 $ 7.37
------ ------ ------ ------ ------
Income From Investment Operations
Net Investment Income ................. 0.42 0.33 0.37 0.47 0.43
Net Realized and Unrealized Gain (Loss)
on Investments ...................... (0.06) (0.03) (0.31) 0.14 (0.01)
------ ------ ------ ------ ------
Total From Investment Operations ...... 0.36 0.30 0.06 0.61 0.42
------ ------ ------ ------ ------
Less Distributions
Dividends From Net Investment Income .. (0.40) (0.31) (0.31) (0.44) (0.42)
------ ------ ------ ------ ------
Total Distributions ................... (0.40) (0.31) (0.31) (0.44) (0.42)
------ ------ ------ ------ ------
Net Asset Value, End of Year .......... $ 7.46 $ 7.45 $ 7.20 $ 7.37 $ 7.37
====== ====== ====== ====== ======
Total Return (%) (b) .................. 4.9 4.0 0.8 8.6 5.8
Ratio of Operating Expenses to
Average Net Assets (%) (a) .......... 0.57 0.60 0.60 0.66 0.70
Ratio of Net Investment Income to
Average Net Assets (%) .............. 5.39 4.39 4.85 6.29 6.39
Portfolio Turnover Rate (%) ........... 49 54 17 73 54
Net Assets, End of Year (000) ......... $294,687 $734,251 $489,637 $331,112 $222,809
(a) Commencing June 1, 1995 expenses were voluntarily limited to 0.70% of Class A average net assets. From May 1,
1995 through June 1, 1995 expenses were voluntarily limited to 0.65% of Class A average net assets. See Note
4. The ratio of operating expenses to average net assets without giving effect to this expense limitation
would have been 0.89% for the year ended December 31, 1995 and 0.94% for the year ended December 31, 1996.
From April 1, 1992 through May 1, 1995 expenses were voluntarily limited to 0.60% of Class A average net
assets. The ratio of operating expenses to average net assets without giving effect to this expense limitation
would have been 0.96%, 0.86% and 0.88% for the years ended December 31, 1992, 1993 and 1994, respectively.
From October 19, 1991 through March 31, 1992, expenses were voluntarily limited to 0.50% of average net
assets.
(b) A sales charge is not reflected in total return calculations.
</TABLE>
See accompanying notes to financial statements.
<PAGE>
- --------------------------------------------------------------------------------
FINANCIAL HIGHLIGHTS -- continued
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS B
-------------------------------------------------------
SEPTEMBER 13(a)
THROUGH YEAR ENDED DECEMBER 31,
DECEMBER 31, -----------------------------------
1993 1994 1995 1996
-------------- ------ ------ ------
<S> <C> <C> <C> <C>
Net Asset Value, Beginning of Period ......... $ 7.52 $ 7.45 $ 7.20 $ 7.37
------ ------ ------ ------
Income From Investment Operations
Net Investment Income ........................ 0.08 0.29 0.41 0.37
Net Realized and Unrealized Gain (Loss) on
Investments ................................ (0.08) (0.29) 0.14 (0.02)
------ ------ ------ ------
Total From Investment Operations ............. 0.00 0.00 0.55 0.35
------ ------ ------ ------
Less Distributions
Dividends From Net Investment Income ......... (0.07) (0.25) (0.38) (0.36)
------ ------ ------ ------
Total Distributions .......................... (0.07) (0.25) (0.38) (0.36)
------ ------ ------ ------
Net Asset Value, End of Period ............... $ 7.45 $ 7.20 $ 7.37 $ 7.36
====== ====== ====== ======
Total Return (%) (d) ......................... 0.0 0.1 7.8 4.9
Ratio of Operating Expenses to
Average Net Assets (%) (b) ................. 1.35(c) 1.35 1.41 1.45
Ratio of Net Investment Income to
Average Net Assets (%) ..................... 3.50(c) 4.10 5.54 5.64
Portfolio Turnover Rate (%) .................. 54(c) 17 73 54
Net Assets, End of Period (000) .............. $855 $2,056 $2,368 $2,821
(a) Commencement of operations.
(b) Commencing June 1, 1995 expenses were voluntarily limited to 1.45% of Class B average net assets. From May 1,
1995 through June 1, 1995 expenses were voluntarily limited to 1.40% of Class B average net assets. See Note
4. The ratio of operating expenses to average net assets without giving effect to this expense limitation
would have been 1.65% for the year ended December 31, 1995 and 1.69% for the year ended December 31, 1996.
From September 13, 1993 through May 1, 1995 expenses were voluntarily limited to 1.35% of Class B average net
assets. The ratio of operating expenses for Class B shares would have been 1.61% for the period ended December
31, 1993, 1.63% for the year ended December 31, 1994.
(c) Computed on an annualized basis.
(d) A contingent deferred sales charge is not reflected in total return calculations. Periods less than one year
are not annualized.
</TABLE>
See accompanying notes to financial statements.
<PAGE>
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
December 31, 1996
1. The Fund is a series of New England Funds Trust II, a Massachusetts business
trust (the "Trust"), and is registered under the Investment Company Act of 1940,
as amended (the "1940 Act"), as an open-end management investment company. The
Declaration of Trust permits the Trustees to issue an unlimited number of shares
of the Trust in multiple series (each series of shares a "Fund").
The Fund offers both Class A and Class B shares. The Fund commenced its public
offering of Class B shares on September 13, 1993. Class A shares are sold with a
maximum front end sales charge of 1.00%. Class B shares do not pay a front end
sales charge, but pay a higher ongoing distribution fee than Class A shares for
eight years (at which point they automatically convert to Class A shares), and
are subject to a contingent deferred sales charge if those shares are redeemed
within five years of purchase. Expenses of the Fund are borne pro-rata by the
holders of both classes of shares, except that each class bears expenses unique
to that class (including the Rule 12b-1 service and distribution fees applicable
to such class), and votes as a class only with respect to its own Rule 12b-1
Plan. Shares of each class would receive their pro-rata share of the net assets
of the Fund, if the Fund were liquidated. In addition, the Trustees approve
separate dividends on each class of shares.
The following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of its financial statements. The
policies are in conformity with generally accepted accounting principles for
investment companies.
The preparation of financial statements in accordance with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts and disclosures in the financial statements.
Actual results could differ from those estimates.
A. SECURITY VALUATION. The Fund's investment subadviser, Back Bay Advisors, L.P.
("Back Bay Advisors"), under the supervision of the Fund's trustees, determines
the value of the Fund's portfolio of securities, using valuations provided by a
pricing service selected by Back Bay Advisors and other information with respect
to transactions in securities, including quotations from securities dealers.
Valuations of securities and other assets owned by the Fund for which market
quotations are readily available are based on those quotations. Short-term
obligations that will mature in 60 days or less are stated at amortized cost,
which, when combined with accrued interest or discount earned, approximates
market value. All other securities and assets are valued at their fair value as
determined in good faith by Back Bay Advisors under the supervision of the
Fund's trustees.
B. SECURITY TRANSACTIONS AND RELATED INVESTMENT INCOME. Security transactions
are accounted for on the trade date (the date the buy or sell is executed).
Interest income is recorded on the accrual basis. Interest income is increased
by the accretion of discount. In determining net gain or loss on securities
sold, the cost of securities has been determined on the identified cost basis.
C. FEDERAL INCOME TAXES. The Fund intends to meet the requirements of the
Internal Revenue Code applicable to regulated investment companies, and to
distribute to its shareholders all of its income and any net realized capital
gains at least annually. Accordingly, no provision for federal income tax has
been made.
D. DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS. Dividends are declared daily
to shareholders of record at the time and are paid monthly.
The timing and characterization of certain income and capital gains
distributions are determined in accordance with federal tax regulations which
may differ from generally accepted accounting principles. These differences
relate primarily to differing treatments for income recognition for
mortgage-backed securities. Permanent book and tax basis differences relating to
shareholder distributions will result in reclassification to paid in capital.
E. REPURCHASE AGREEMENTS. The Fund, through its custodian, receives delivery of
the underlying securities collateralizing repurchase agreements. It is the
Fund's policy that the market value of the collateral be at least equal to 100%
of the repurchase price. Back Bay Advisors is responsible for determining that
the value of the collateral is at all times at least equal to the repurchase
price. Repurchase agreements could involve certain risks in the event of default
or insolvency of the other party including possible delays or restrictions upon
the Fund's ability to dispose of the underlying securities.
F. ORGANIZATION EXPENSE. Costs incurred in 1991 in connection with the Fund's
organization and initial registration, amounting to $57,650, were paid by the
Fund and are being amortized over 60 months beginning October 18, 1991. All
amounts are fully amortized as of December 31, 1996.
2. Purchase and Sales of Securities excluding short-term investments) for the
Fund for the year ended December 31, 1996 were as follows:
PURCHASES SALES
---------------------- -----------------
U.S. GOVERNMENT U.S. GOVERNMENT
---------------------- -----------------
$148,702,169 $228,526,956
3A. MANAGEMENT FEES AND OTHER TRANSACTIONS WITH AFFILIATES. The Fund pays
management fees to its investment adviser, New England Funds Management, L.P.
("NEFM") at the annual rate of 0.55% of the first $200 million of the Fund's
average daily net assets, 0.51% of the next $300 million and 0.47% of such
assets in excess of $500 million. NEFM pays the Fund's investment subadviser,
Back Bay Advisors at the rate of 0.275% of the first $200 million of the Fund's
average daily net assets, 0.255% of the next $300 million and 0.235% of such
assets in excess of $500 million. Certain officers and directors of NEFM are
also officers or trustees of the Fund. NEFM and Back Bay Advisors are wholly
owned subsidiaries of New England Investment Companies, L.P. ("NEIC"), which is
a subsidiary of Metropolitan Life Insurance Company ("MetLife"). Fees earned by
NEFM and Back Bay Advisors under the management agreement in effect during the
year ended December 31, 1996 are as follows:
FEES EARNED
-----------
$786,052(a) New England Funds Management, L.P.
$786,051(a) Back Bay Advisors, L.P.
(a) Before reduction pursuant to voluntary expense limitations. See Note 4.
B. ACCOUNTING AND ADMINISTRATIVE EXPENSE. New England Funds L.P. ("New England
Funds"), the Fund's distributor, is a wholly owned subsidiary of NEIC and
performs certain accounting and administrative services for the Fund. The Fund
reimburses New England Funds for all or part of New England Funds" expenses of
providing these services which include the following: (i) expenses for personnel
performing bookkeeping, accounting, internal auditing and financial reporting
functions and clerical functions relating to the Fund, (ii) expenses for
services required in connection with the preparation of registration statements
and prospectuses, shareholder reports and notices, proxy solicitation material
furnished to shareholders of the Fund or regulatory authorities and reports and
questionnaires for SEC compliance, and (iii) registration, filing and other fees
in connection with requirements of regulatory authorities. For the year ended
December 31, 1996 these expenses amounted to $51,896 and are shown separately in
the financial statements as accounting and administrative.
C. SERVICE AND DISTRIBUTION EXPENSE. Pursuant to Rule 12b-1 under the 1940 Act,
the Trust has adopted a Service Plan relating to the Fund's Class A shares (the
"Class A Plan") and a Service and Distribution Plan relating to the Fund's Class
B shares (the "Class B Plan").
Under the Class A Plan, the Fund pays New England Funds a monthly service fee at
the annual rate of up to 0.25% of the average daily net assets attributable to
the Fund's Class A shares, as reimbursement for expenses (including certain
payments to securities dealers, who may be affiliated with New England Funds)
incurred by New England Funds in providing personal services to investors in
Class A shares and/or the maintenance of shareholder accounts. For the year
ended December 31, 1996, the Fund paid New England Funds $724,984 in fees under
the Class A Plan. If the expenses of New England Funds that are otherwise
reimbursable under the Class A Plan incurred in any year exceed the amounts
payable by the Fund under the Class A Plan, the unreimbursed amount (together
with unreimbursed amounts from prior years) may be carried forward for
reimbursement in future years in which the Class A Plan remains in effect. The
amount of unreimbursed expenses carried forward into 1997 is $1,929,283.
Under the Class B Plan, the Fund pays New England Funds a monthly service fee at
the annual rate of up to 0.25% of the average daily net assets attributable to
the Fund's Class B shares, as compensation for services provided and expenses
(including certain payments to securities dealers, who may be affiliated with
New England Funds) incurred by New England Funds in providing personal services
to investors in Class B shares and/or the maintenance of shareholder accounts.
For the year ended December 31, 1996, the Fund paid New England Funds $6,439 in
service fees under the Class B Plan.
Also under the Class B Plan, the Fund pays New England Funds a monthly
distribution fee at the annual rate of up to 0.75% of the average daily net
assets attributable to the Fund's Class B shares, as compensation for services
provided and expenses (including certain payments to securities dealers, who may
be affiliated with New England Funds) incurred by New England Funds in
connection with the marketing or sale of Class B shares. For the year ended
December 31, 1996, the Fund paid New England Funds $19,317 in distribution fees
under the Class B Plan.
Commissions (including contingent deferred sales charges) on Fund shares paid to
New England Funds by investors in shares of the Fund during the year ended
December 31, 1996 amounted to $76,124.
D. TRANSFER AGENT FEES. New England Funds is the transfer and shareholder
servicing agent to the Fund. For the year ended December 31, 1996, the Fund
paid New England Funds $105,223 as compensation for its services in that
capacity.
E. TRUSTEES FEES AND EXPENSES. The Fund does not pay any compensation
directly to its officers or trustees who are directors, officers or employees
of NEFM, New England Funds, NEIC or their affiliates, other than registered
investment companies. Each other trustee is compensated by the Fund as
follows:
Annual Retainer $2,276
Meeting Fee $114/meeting
Committee Meeting Fee $68/meeting
Committee Chairman Retainer $156/year
A deferred compensation plan is available to the trustees on a voluntary basis.
Each participating trustee will receive an amount equal to the value that such
deferred compensation would have had, had it been invested in the Fund on the
normal payment date.
4. EXPENSE LIMITATIONS. Commencing June 1, 1995 and until further notice to the
Fund, Back Bay Advisors and NEFM have voluntarily agreed to reduce management
fees in order to limit the Fund's expenses to an annual rate of 0.70% of the
Fund's Class A average daily net assets and, 1.45% of Class B average daily net
assets. From May 1, 1995 through June 1, 1995 expenses were voluntarily limited
to 0.65% of Class A average net assets and 1.40% of Class B average net assets.
From April 1, 1992 through May 1, 1995 expenses were voluntarily limited to
0.60% of Class A average net assets and 1.35% of Class B average net assets.
Prior to April 1, 1992 the Fund's expenses were subject to a 0.50% voluntary
expense limitation agreed to by both Back Bay Advisors and New England Funds. As
a result of the Fund's expenses exceeding the applicable voluntary expense
limitation during the year ended December 31, 1996, Back Bay Advisors reduced
its management fee of $786,051 by $352,633 and NEFM reduced its management fee
of $786,052 by $352,634.
<PAGE>
5. CAPITAL SHARES. At December 31, 1996 there was an unlimited number of
shares of beneficial interest authorized, divided into two classes, Class A
and Class B capital stock. Transactions in capital shares were as follows:
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED
DECEMBER 31, 1995 DECEMBER 31, 1996
------------------------------- -------------------------------
CLASS A SHARES AMOUNT SHARES AMOUNT
- ------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Shares sold .................... 10,139,660 $ 74,377,759 9,423,564 $ 69,389,156
Shares issued in connection with
the reinvestment of:
Distributions from net
investment income .......... 1,309,593 9,615,221 1,009,552 7,430,124
----------- ------------- ----------- -------------
11,449,253 83,992,980 10,433,116 76,819,280
Shares repurchased ............. (34,512,776) (253,225,090) (25,080,230) (184,716,449)
----------- ------------- ----------- -------------
Net decrease ................... (23,063,523) $(169,232,110) (14,647,114) $(107,897,169)
----------- ------------- ----------- -------------
<CAPTION>
YEAR ENDED YEAR ENDED
DECEMBER 31, 1995 DECEMBER 31, 1996
------------------------------- -------------------------------
CLASS B SHARES AMOUNT SHARES AMOUNT
- ------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Shares sold .................... 127,300 $ 934,154 157,929 $ 1,162,842
Shares issued in connection with
the reinvestment of:
Distributions from net
investment income .......... 12,997 95,443 14,541 107,004
----------- ------------- ----------- -------------
140,297 1,029,597 172,470 1,269,846
Shares repurchased ............. (104,441) (766,452) (110,554) (813,314)
----------- ------------- ----------- -------------
Net increase ................... 35,856 263,145 61,916 456,532
----------- ------------- ----------- -------------
Decrease derived from capital
shares transactions .......... (23,027,667) $(168,968,965) (14,585,198) $(107,440,637)
=========== ============= =========== =============
</TABLE>
<PAGE>
- --------------------------------------------------------------------------------
REPORT OF INDEPENDENT ACCOUNTANTS
- --------------------------------------------------------------------------------
To the Board of Trustees of New England Funds Trust II and the Shareholders of
the NEW ENGLAND ADJUSTABLE RATE U.S. GOVERNMENT FUND
We have audited the accompanying statement of assets and liabilities, including
the schedule of portfolio investments, of New England Adjustable Rate U.S.
Government Fund as of December 31, 1996, and the related statement of operations
for the year then ended, and the statements of changes in net assets for each of
the two years in the period then ended, and financial highlights for each of the
periods indicated herein. These financial statements and financial highlights
are the responsibility of the Fund's management. Our responsibility is to
express an opinion on these financial statements and financial highlights based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned as of
December 31, 1996 by correspondence with the custodian and brokers. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of the
New England Adjustable Rate U.S. Government Fund as of December 31, 1996 the
results of its operations for the year then ended, the changes in its net assets
for each of the two years in the period then ended and the financial highlights
for each of the periods indicated herein, in conformity with generally accepted
accounting principles.
COOPERS & LYBRAND L.L.P.
Boston, Massachusetts
February 10, 1997
<PAGE>
--------------
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NEW ENGLAND FUNDS U.S. POSTAGE
Where The Best Minds Meet(TM) PAID
BROCKTON, MA
PERMIT NO. 770
--------------
---------------------
399 Boylston Street
Boston, Massachusetts
02116
---------------------
- --------------------- ---------------------
[Logo] [Logo]
QUALITY QUALITY
TESTED SERVICE TESTED SERVICE
1995 1996
- --------------------- ---------------------
DALBAR DALBAR
HONORS COMMITMENT TO: HONORS COMMITMENT TO:
INVESTORS INVESTORS
- --------------------- ---------------------
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