<PAGE>
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ANNUAL REPORT
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[LOGO]
NEW ENGLAND FUNDS(R)
Where The Best Minds Meet(R)
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New England
Adjustable Rate
U.S. Government Fund
[Graphic Omitted]
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December 31, 1997
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<PAGE>
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FEBRUARY 1998
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[Photo of Henry L.P. Schmelzer]
Dear Shareholder:
"Even in 1997 . . . investors saw some sharp, short-term drops, whether they
were invested in the United States or overseas, in bonds or stocks."
In 1997, many investors once again had reason to be pleased with the performance
of their mutual fund holdings. However, in times such as these, expectations
tend to grow along with prices. It pays to remind ourselves that no trend is
permanent, and we should keep our goals realistic and long-term needs in focus.
In the third straight year of outstanding returns, the Dow Jones Industrial
Average and the Standard & Poor's 500 Stock Index -- two widely followed
indicators of the performance of large-company stocks -- gained 24.9% and 33.3%
respectively. At the same time, smaller-company stocks, as measured by the
Russell 2000 Index, were up 22.4%. Meanwhile, bond investors also were rewarded
as declining interest rates and rising prices meant solid gains. The Lehman Long
Treasury Index, for example, posted a 15.1% return for the year. Results were
less favorable for international investors, especially those exposed to emerging
markets or the financial turmoil in Asia.
Gratifying though it has been, the markets' surge of the past few years obscures
the historic norm: Downturns and volatility also are regular features of
investing. Even in 1997, notwithstanding the impressive overall results,
investors saw some sharp, short-term drops, whether they were invested in the
United States or overseas, in bonds or stocks. Market fluctuations remind us of
some valuable lessons.
First, volatility is inevitable, and should not disrupt long-term programs
without sufficient evaluation. Those who sold in response to downturns --
October 1987 is an obvious example -- may have missed out on the subsequent
uptrend. Second, sound diversification can reduce risk. A useful exercise is to
review your asset allocation regularly with your financial representative.
Starting in 1998, you have one more reason to consult with your representative:
Newly expanded retirement options, including the new Roth IRA, could play an
important role in your retirement and tax planning for years to come. With this
in mind, New England Funds has introduced programs specially designed to help
you make the most of the newest retirement vehicles.
[Dalbar logo]
1995 o 1996 o 1997
In addition to offering quality mutual fund choices and tax-advantaged plans, we
focus on providing the highest quality customer service. This is why I am
pleased to report that we have received DALBAR's Mutual Fund Service Award for
"providing the highest tier of service excellence in the mutual fund industry."
New England Funds is one of just three mutual fund companies to receive this
award for the third consecutive year from DALBAR, an independent evaluator of
mutual fund service. We are continuing to work to provide even more effective
services. Two examples are: the Personal Access Line(TM) -- our enhanced
automated telephone account service (800-346-5984) -- and the account
information section of the New England Funds web site (www.mutualfunds.com).
Each provides convenient, 24-hour access to current information about your New
England Funds accounts.
All of us at New England Funds thank you for your continued support and look
forward to serving you in the years ahead.
Sincerely,
/s/ Henry L.P. Schmelzer
Henry L.P. Schmelzer
President
<PAGE>
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NEW ENGLAND ADJUSTABLE RATE U.S. GOVERNMENT FUND
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INVESTMENT RESULTS THROUGH DECEMBER 31, 1997
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Putting Performance in Perspective
The charts comparing your Fund's performance to a benchmark index provide 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.
[A chart in the form of a line graph appears here illustratng 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 for this chart are as follows:]
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GROWTH OF A $10,000 INVESTMENT IN CLASS A SHARES
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DECEMBER 1991 THROUGH DECEMBER 1997
Compared to Lehman Adjustable Rate Mortgage (ARM) Index(4)
and the Cost of Living(5)
Net With Maximum Lehman ARM(4) Cost
Asset Sales (index extablished of
Value(1) Charge(2) 12/31/91) Living(5)
- --------------------------------------------------------------------------------
12/31/91 $10,000 $ 9,900 $10,000 $10,000
1992 $10,494 $10,389 $10,502 $10,290
1993 $10,916 $10,807 $11,131 $10,573
1994 $11,000 $10,890 $11,132 $10,855
1995 $11,948 $11,829 $12,437 $11,131
1996 $12,645 $12,518 $13,263 $11,501
1997 $13,430 $13,296 $14,142 $11,711
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 and Class C 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>
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NEW ENGLAND ADJUSTABLE RATE U.S. GOVERNMENT FUND
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AVERAGE ANNUAL TOTAL RETURNS 12/31/97
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CLASS A (Inception 10/18/91) 1 YEAR 5 YEARS SINCE INCEPTION
Net Asset Value(1) 6.21% 5.06% 5.07%
With Max. Sales Charge(2) 5.21 4.83 4.89
Lehman ARM Index(4) 6.63 6.07 N/A
Lipper ARM Average(6) 6.07 4.90 4.82
(calculated from 10/31/91)
CLASS B (Inception 9/13/93) 1 YEAR 3 YEARS SINCE INCEPTION
Net Asset Value(1) 5.42% 6.03% 4.17%
With CDSC(3) 0.42 5.14 3.77
Lehman ARM Index(4) 6.63 8.27 5.94
(calculated from 9/30/93)
Lipper ARM Average(6) 6.07 6.75 4.83
(calculated from 9/30/93)
These returns represent past performance. Investment return and principal value
will fluctuate so that shares, upon redemption, may be worth more or less than
their original cost.
NOTES TO CHARTS
(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
5% sales charge is applied to a redemption of Class B shares. The sales
charge will decrease over time, declining to zero six years after the
purchase of shares.
(4) Lehman Adjustable Rate Mortgage (ARM) Index 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 Adjustable Rate Mortgage (ARM) 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
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QUESTIONS & ANSWERS WITH YOUR PORTFOLIO MANAGER
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Q. How did New England Adjustable Rate U.S. Government Fund perform over the
past 12 months?
[Photo of Scott Nicholson Back Bay Advisors, L.P.]
The Fund posted competitive returns while demon-strating a high degree of
share price stability. For the 12-month period ending December 31, 1997, New
England Adjustable Rate U.S. Government Fund's Class A shares generated a
total return of 6.21%, reflecting a $0.02 per share gain in net asset value
to $7.39 per share and the reinvestment of $0.426 per share in dividend
distributions. During the year, the Fund's Class A net asset value remained
very stable, fluctuating between $7.36 and $7.42. For the same period, Class
B shares produced a total return of 5.42%, based on net asset value.
Q. What was the environment like for adjustable rate mortgage securities
(ARMS)?
Favorable -- for most of 1997. But recently, condi-tions for ARMS have
deteriorated markedly. The combination of declining long-term interest rates
and a substantial flattening of the yield curve -- that is, a significant
decline in long-term rates compared to relatively stable short-term rates --
fostered a dramatic increase in ARMS prepayment activity. Prepayments occur
when owners of the underlying mortgages pay off their mortgages -- typically
to lower their borrowing costs -- and refinance at lower prevailing interest
rates. Rising levels of prepayments tend to lower the market value of ARMS.
In the first quarter of 1997, bond investors pushed up long-term interest
rates, concerned that strong economic growth might cause inflationary
pressures to escalate, eroding bond values. The Federal Reserve Board, in
fact, raised the federal funds rate -- the rate at which banks lend to each
other overnight -- by one-quarter of a percentage point in March. Yet the
rise was short-lived as both short- and long-term interest rates soon fell
below their levels at the start of 1997. Signs of slower economic growth, a
shrinking federal budget deficit, strong foreign demand for U.S. securities
and, most significantly, continued low inflation fueled the decline in rates.
The yield gap between long- and short-term bonds narrowed as yields on
longer-maturity bonds continued to drop sharply through the second half of
the year. While the decline in short-term rates was much less pronounced,
falling long-term rates caused mortgage prepayments to increase and prices of
existing ARMS to drop.
Q. How did you manage the Fund amidst these conditions?
As interest rates rose early in the year, I shortened the Fund's duration by
reducing its holdings in ARMS and increasing its positions in U.S. Treasuries
and cash. (Expressed in years, duration measures a portfolio's sensitivity to
interest rate changes.) A shorter duration enhanced the Fund's price
stability by reducing its sensitivity to changes in interest rates.
During the second half of the year, I concentrated on managing exposure to
prepayments while taking steps to capture additional income as a way to
offset the prepayment-related decline in the Fund's income earnings stream.
For example, I reduced holdings in ARMS somewhat while changing the
composition of the holdings to include older ARMS and GNMA (Government
National Mortgage Association) ARMS. These securities have demonstrated a
resiliency to prepayments during past periods of declining interest rates.
To boost income, I increased investments in U.S. agency callable notes, which
have typically offered higher coupons -- or fixed rates of interest -- than
U.S. Treasury securities with similar maturities. The yield advantage of
callable issues is intended to compensate investors for the possibility that
these issues can be called -- that is, redeemed -- before their maturity
dates. Finally, I moderately extended the average maturity of U.S. Treasury
note holdings to pursue price gains fostered by declining interest rates.
When interest rates decline, the prices of bonds with longer maturities tend
to rise more than those with shorter maturities.
As always, the Fund invests in the most creditworthy securities available and
continues to carry the highest Standard & Poor's rating for mutual funds --
AAAf.
Q. What is your outlook for ARMS?
We remain cautious; the recent interest rate pattern, characterized by
sharper declines in long-term rates than in short-term rates, could keep
prepayment activity at elevated levels. While prices of ARMS have dropped
significantly, they may have further to go before their values look better
than other securities with similar durations. On the other hand, the lack of
new supply is working in favor of ARMS. The popularity of fixed rate
mortgages, a consequence of falling interest rates, is curbing new issuance
of ARMS and thereby helping to support ARMS prices.
Looking ahead, the lingering effects of Asia's financial difficulties could
restrain economic growth in the United States. In the event of a substantial
slowdown, the Federal Reserve Board probably will lower short-term interest
rates. But, if the Asian influence proves negligible and the Federal Reserve
leaves interest rates unchanged, long-term interest rates could rise and
widen the gap between long-term and short-term interest rates. In either
case, however, the overall attractiveness of ARMS stands to improve.
<PAGE>
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PORTFOLIO COMPOSITION
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Investments as of December 31, 1997
BONDS AND NOTES--95.9% OF TOTAL NET ASSETS
<TABLE>
<CAPTION>
FACE
AMOUNT DESCRIPTION VALUE (a)
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GOVERNMENT AGENCIES (c)--81.1%
<C> <S> <C>
$ 5,000,000 Federal Farm Credit Bank Consolidated, 6.400%, 10/02/00 $ 4,996,100
1,694,213 Federal Home Loan Mortgage Corp., 6.592%, 11/01/35 (d) . 1,754,577
4,087,036 Federal Home Loan Mortgage Corp., 7.244%, 1/01/25, (d) . 4,215,410
1,655,627 Federal Home Loan Mortgage Corp., 7.303%, 4/01/22, (d) . 1,696,505
4,666,715 Federal Home Loan Mortgage Corp., 7.411%, 1/01/20, (d) . 4,848,997
1,273,924 Federal Home Loan Mortgage Corp., 7.625%, 10/01/21, (d) 1,328,868
2,309,005 Federal Home Loan Mortgage Corp., 7.661%, 3/01/25, (d) . 2,358,440
2,714,393 Federal Home Loan Mortgage Corp., 7.680%, 5/01/19, (d) . 2,821,693
2,037,412 Federal Home Loan Mortgage Corp., 7.701%, 1/01/23, (d) . 2,130,053
3,058,175 Federal Home Loan Mortgage Corp., 7.707%, 7/01/26, (d) . 3,134,629
6,864,678 Federal Home Loan Mortgage Corp., 7.725%, with various
maturities to 2/01/22, (d) ........................... 7,186,451
1,288,906 Federal Home Loan Mortgage Corp., 7.734%, 6/01/22, (d) . 1,344,290
4,549,128 Federal Home Loan Mortgage Corp., 7.839%, 4/01/25, (d) . 4,738,190
1,179,854 Federal Home Loan Mortgage Corp., 7.858%, 6/01/22, (d) . 1,225,939
3,268,323 Federal Home Loan Mortgage Corp., 7.875%, with various
maturities to 12/01/22, (d) .......................... 3,399,940
2,499,282 Federal Home Loan Mortgage Corp., 7.876%, 5/01/23, (d) . 2,606,677
2,947,010 Federal Home Loan Mortgage Corp., 7.932%, 10/01/23, (d) 3,040,961
837,093 Federal Home Loan Mortgage Corp., 7.959%, 9/01/22, (d) . 861,418
1,322,063 Federal Home Loan Mortgage Corp., 7.984%, 12/01/25, (d) 1,354,705
4,462,558 Federal Home Loan Mortgage Corp., 7.989%, 9/01/23, (d) . 4,633,385
3,974,274 Federal Home Loan Mortgage Corp., 7.990%, 4/01/29, (d) . 4,115,242
2,851,521 Federal Home Loan Mortgage Corp., 7.995%, 5/01/23, (d) . 2,939,747
1,729,582 Federal Home Loan Mortgage Corp., 8.000%, 8/01/24, (d) . 1,753,363
2,094,600 Federal Home Loan Mortgage Corp., 8.005%, 7/01/25, (d) . 2,148,934
2,116,019 Federal Home Loan Mortgage Corp., 8.057%, 9/01/23, (d) . 2,191,413
4,689,674 Federal Home Loan Mortgage Corp., 6.698%, 10/15/23,
(d)(e) ................................................ 4,718,984
450,469 Federal National Mortgage Association, 5.941%, 9/01/23,
(d) .................................................. 445,050
5,000,000 Federal National Mortgage Association, 6.100%, 10/06/00 5,004,700
1,860,839 Federal National Mortgage Association, 6.360%, 7/01/19,
(d) .................................................. 1,875,372
5,000,000 Federal National Mortgage Association, 6.540%, 9/08/00 . 5,009,350
458,770 Federal National Mortgage Association, 6.597%, 6/01/19,
(d) .................................................. 464,646
2,941,827 Federal National Mortgage Association, 6.602%, 7/01/27,
(d) .................................................. 2,992,838
1,289,764 Federal National Mortgage Association, 6.716%, 1/01/20,
(d) .................................................. 1,310,517
3,905,932 Federal National Mortgage Association, 7.000%, 4/01/26,
(d) .................................................. 3,999,908
423,575 Federal National Mortgage Association, 7.557%, 5/01/20,
(d) .................................................. 438,069
302,569 Federal National Mortgage Association, 7.600%, 8/01/17,
(d) .................................................. 313,159
2,092,714 Federal National Mortgage Association, 7.652%, 4/01/23,
(d) .................................................. 2,170,207
3,493,142 Federal National Mortgage Association, 7.659%, 7/01/24,
(d) .................................................. 3,624,694
1,194,448 Federal National Mortgage Association, 7.667%, 5/01/22,
(d) .................................................. 1,238,118
3,621,113 Federal National Mortgage Association, 7.700%, 4/01/24,
(d) .................................................. 3,768,782
2,469,251 Federal National Mortgage Association, 7.714%, 11/01/20,
(d) .................................................. 2,589,627
6,102,950 Federal National Mortgage Association, 7.750%, 10/01/18,
(d) .................................................. 6,435,743
2,310,308 Federal National Mortgage Association, 7.751%, 5/01/25,
(d) .................................................. 2,360,119
2,268,853 Federal National Mortgage Association, 7.797%, 11/01/25,
(d) .................................................. 2,313,164
2,993,074 Federal National Mortgage Association, 7.817%, 9/01/25,
(d) .................................................. 3,077,718
1,178,176 Federal National Mortgage Association, 7.850%, 7/01/17,
(d) .................................................. 1,228,802
3,166,068 Federal National Mortgage Association, 7.855%, 6/01/22,
(d) .................................................. 3,294,706
1,163,662 Federal National Mortgage Association, 7.956%, 7/01/23,
(d) .................................................. 1,194,569
2,176,140 Federal National Mortgage Association, 7.978%, 1/01/24,
(d) .................................................. 2,286,644
10,057,932 Government National Mortgage Association, 7.000%, with
various maturities to 8/20/25, (d) ................... 10,321,584
16,355,286 Government National Mortgage Association, 7.375%, with
various maturities to 6/20/23, (d) ................... 16,863,768
------------
162,166,765
------------
U.S. GOVERNMENT--14.8%
2,500,000 United States Treasury Note, 5.875%, 1/31/99 ........... 2,505,850
10,000,000 United States Treasury Note, 6.000%, 8/15/00 ........... 10,071,900
5,000,000 United States Treasury Note, 6.250%, 6/30/98 ........... 5,018,750
11,700,000 United States Treasury Note, 6.375%, 5/15/00 ........... 11,875,500
------------
29,472,000
------------
Total Bonds and Notes (Identified Cost $190,509,353) ... 191,638,765
------------
SHORT TERM INVESTMENT--2.1%
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4,200,000 Repurchase Agreement with Merrill Lynch & Co. dated 12/
31/97 at 6.50% to be repurchased at $4,201,517 on 1/
02/98. Collateralized by $4,185,000 U.S. Treasury Note
5.875% due 8/15/98 valued at $4,284,394 .............. 4,200,000
------------
Total Short Term Investment (Identified Cost $4,200,000) 4,200,000
------------
Total Investments--98.0% (Identified Cost
$194,709,353), (b) ................................... 195,838,765
Other assets less liabilities ......................... 4,049,735
------------
Total Net Assets--100% ................................. $199,888,500
============
(a) See Note 1a to the financial statements.
(b) Federal Tax Information: At December 31, 1997 the net unrealized
appreciation on investments based on cost for federal income tax
purposes of $194,709,353 was as follows:
Aggregate gross unrealized appreciation for all investments in
which there is an excess of value over tax cost ................... $ 1,435,961
Aggregate gross unrealized depreciation for all investments in
which there is an excess of tax cost over value ................... (306,549)
------------
Net unrealized appreciation ........................................ $ 1,129,412
============
At December 31, 1997 the Fund had a capital loss carryover of
approximately $14,291,537 of which $5,625,994 expires on December
31, 2002, $6,075,626 expires on December 31, 2003, $2,134,629
expires on December 31, 2004 and $455,288 expires on December 31,
2005. This may be available to offset future realized capital
gains, if any, to the extent provided by regulations.
(c) The Fund's investments in mortgage backed securities of the
Government National Mortgage Association, Federal Home Loan
Mortgage Corporation 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.
(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, 1997.
(e) Collateralized mortgage obligation.
</TABLE>
See accompanying notes to financial statements.
<PAGE>
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STATEMENT OF ASSETS & LIABILITIES
- --------------------------------------------------------------------------------
December 31, 1997
<TABLE>
<CAPTION>
<S> <C> <C>
ASSETS
Investments at value ....................................... $195,838,765
Cash ....................................................... 113,852
Receivable for:
Fund shares sold ......................................... 143,702
Securities sold .......................................... 157,354
Accrued interest ......................................... 5,039,566
Prepaid registration expense ............................... 7,000
------------
201,300,239
LIABILITIES
Payable for:
Fund shares redeemed ..................................... $989,456
Dividends declared ....................................... 163,012
Accrued expenses:
Management fees .......................................... 174,802
Deferred trustees' fees .................................. 9,979
Accounting and administrative ............................ 3,607
Other .................................................... 70,883
---------
1,411,739
------------
NET ASSETS ................................................... $199,888,500
============
Net Assets consist of:
Capital paid in .......................................... $213,879,946
Distributions in excess of net investment income ......... (14,193)
Accumulated net realized losses .......................... (15,106,665)
Unrealized appreciation on investments ................... 1,129,412
------------
NET ASSETS ................................................... $199,888,500
============
Computation of net asset value and offering price:
Net asset value and redemption price of Class A shares
($196,927,679 divided by 26,658,838 shares of beneficial
interest) ................................................ $7.39
=====
Offering price per share (100/99 OF $7.39) ................... $7.46*
=====
Net asset value and offering price of Class B shares
($2,960,821 divided by 400,964 shares of beneficial
interest) .................................................. $7.38**
=====
Identified cost of investments ............................... $194,709,353
============
* 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>
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STATEMENT OF OPERATIONS
- --------------------------------------------------------------------------------
Year Ended December 31, 1997
INVESTMENT INCOME
Interest ........................................ $15,716,868
Expenses
Management fees ............................... $1,230,235
Service fees - Class A ........................ 556,721
Service and distribution fees - Class B ....... 28,482
Trustees' fees and expenses ................... 21,605
Accounting and administrative ................. 44,817
Custodian ..................................... 100,855
Transfer agent ................................ 133,398
Audit and tax services ........................ 31,070
Legal ......................................... 10,779
Printing ...................................... 23,513
Registration .................................. 32,328
Miscellaneous ................................. 11,607
Total expenses .................................. 2,225,410
----------
Less fees waived by the investment adviser
and subadviser ............................... (625,387) 1,600,023
---------- -----------
Net investment income ........................... 14,116,845
REALIZED and UNREALIZED GAIN (LOSS) on INVESTMENTS
Realized loss on:
Investments - net ............................. (2,347,087)
Unrealized appreciation on:
Investments - net ............................. 1,792,855
----------
Net loss on investment transactions ............. (554,232)
-----------
NET INCREASE IN NET ASSETS FROM OPERATIONS ........ $13,562,613
===========
See accompanying notes to financial statements.
<PAGE>
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STATEMENT OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31,
1996 1997
------------ ------------
FROM OPERATIONS
Net investment income .................... $ 18,670,885 $ 14,116,845
Net realized loss on investments ......... (3,076,747) (2,347,087)
Unrealized appreciation on investments ... 568,620 1,792,855
------------ ------------
Increase in net assets from operations ... 16,162,758 13,562,613
------------ ------------
FROM DISTRIBUTIONS TO SHAREHOLDERS
Net investment income
Class A ................................ (16,446,055) (12,791,602)
Class B ................................ (127,062) (142,367)
------------ ------------
(16,573,117) (12,933,969)
------------ ------------
Decrease in net assets derived from
capital share transactions ............... (107,440,637) (26,369,546)
------------ ------------
Total decrease in net assets ............... (107,850,996) (25,740,902)
NET ASSETS
Beginning of the year .................... 333,480,398 225,629,402
------------ ------------
End of the year .......................... $225,629,402 $199,888,500
============ ============
UNDISTRIBUTED (DISTRIBUTIONS IN EXCESS
OF) NET INVESTMENT INCOME
Beginning of the year .................... $ (204,379) $ 27,231
============ ============
End of the year .......................... $ 27,231 $ (14,193)
============ ============
See accompanying notes to financial statements.
<PAGE>
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FINANCIAL HIGHLIGHTS
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<TABLE>
<CAPTION>
CLASS A
--------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------------
1993 1994 1995 1996 1997
------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Year ........ $ 7.46 $ 7.45 $ 7.20 $ 7.37 $ 7.37
------ ------ ------ ------ ------
Income From Investment Operations
Net Investment Income ..................... 0.33 0.37 0.47 0.43 0.47(c)
Net Realized and Unrealized Gain (Loss) on
Investments ............................. (0.03) (0.31) 0.14 (0.01) (0.02)
------ ------ ------ ------ ------
Total From Investment Operations .......... 0.30 0.06 0.61 0.42 0.45
------ ------ ------ ------ ------
Less Distributions
Distributions From Net Investment Income .. (0.31) (0.31) (0.44) (0.42) (0.43)
------ ------ ------ ------ ------
Total Distributions ....................... (0.31) (0.31) (0.44) (0.42) (0.43)
------ ------ ------ ------ ------
Net Asset Value, End of Year .............. $ 7.45 $ 7.20 $ 7.37 $ 7.37 $ 7.39
====== ====== ====== ====== ======
Total Return (%)(b) ....................... 4.0 0.8 8.6 5.8 6.2
Ratio of Operating Expenses to Average Net
Assets (%)(a) ........................... 0.60 0.60 0.66 0.70 0.70
Ratio of Net Investment Income to Average
Net Assets (%) .......................... 4.39 4.85 6.29 6.39 6.27
Portfolio Turnover Rate (%) ............... 54 17 73 54 49
Net Assets, End of Year (000) ............. $734,251 $489,637 $331,112 $222,809 $196,928
(a) The ratio of operating expenses to
average net assets without giving
effect to voluntary expense limitations
described in Note 4 to the Financial
Statements would have been (%) ........ 0.86 0.88 0.89 0.94 0.98
(b) A sales charge is not reflected in
total return calculations.
(c) Per share net investment income does
not reflect the periods
reclassification of permanent
differences between book and tax basis
net investment income. See note 1d to
the financial statements.
</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 1997
-------------- ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of
Period ....................... $ 7.52 $ 7.45 $ 7.20 $ 7.37 $ 7.36
------ ------ ------ ------ ------
Income From Investment
Operations
Net Investment Income .......... 0.08 0.29 0.41 0.37 0.41(e)
Net Realized and Unrealized Gain
(Loss) on Investments ........ (0.08) (0.29) 0.14 (0.02) (0.02)
------ ------ ------ ------ ------
Total From Investment Operations 0.00 0.00 0.55 0.35 0.39
------ ------ ------ ------ ------
Less Distributions
Distributions From Net
Investment Income ............ (0.07) (0.25) (0.38) (0.36) (0.37)
------ ------ ------ ------ ------
Total Distributions ............ (0.07) (0.25) (0.38) (0.36) (0.37)
------ ------ ------ ------ ------
Net Asset Value, End of Period . $ 7.45 $ 7.20 $ 7.37 $ 7.36 $ 7.38
====== ====== ====== ====== ======
Total Return (%)(d) ............ 0.0 0.1 7.8 4.9 5.4
Ratio of Operating Expenses to
Average Net Assets (%)(b) .... 1.35(c) 1.35 1.41 1.45 1.45
Ratio of Net Investment Income
to Average Net Assets (%) .... 3.50(c) 4.10 5.54 5.64 5.52
Portfolio Turnover Rate (%) .... 54(c) 17 73 54 49
Net Assets, End of Period (000) $855 $2,056 $2,368 $2,821 $2,961
(a) Commencement of operations.
(b) The ratio of operating
expenses to average net
assets without giving effect
to voluntary expense
limitations described in
Note 4 to the Financial
Statements would have been
(%) ........................ 1.61 1.63 1.65 1.69 1.73
(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.
(e) Per share net investment
income does not reflect the
periods reclassification of
permanent differences
between book and tax basis
net investment income. See
note 1d to the financial
statements.
</TABLE>
See accompanying notes to financial statements.
<PAGE>
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
December 31, 1997
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 A Shares on October 18, 1991 and 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 six years of purchase
(or five years if purchased before May 1, 1997). 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. Debt securities (other than short-term obligations with a
remaining maturity of less than sixty days) are valued on the basis of
valuations furnished by a pricing service, selected by the Fund's adviser as
authorized by the Board of Trustees, which service determines valuations for
normal, institutional-size trading units of such securities using market
information, transactions for comparable securities and various relationships
between securities which are generally recognized by institutional traders.
Short-term obligations with a remaining maturity of less than sixty days are
stated at amortized cost, which approximates value. All other securities and
assets are valued at their fair value as determined in good faith by the Fund's
adviser, New England Funds Management, L.P., and the subadviser, under the
supervision of the Fund's trustees.
B. SECURITY TRANSACTIONS AND RELATED 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. The Fund's subadviser 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.
2. PURCHASE AND SALES OF SECURITIES (excluding short-term investments) for the
Fund for the year ended December 31, 1997 were as follows:
PURCHASES SALES
--------------- ---------------
U.S. GOVERNMENT U.S. GOVERNMENT
--------------- ---------------
$116,297,994 $144,285,369
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 L.P. ("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, 1997 are as follows:
FEES EARNED(a)
- --------------
$615,118 New England Funds Management
$615,117 Back Bay Advisors
(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, financial reporting functions and clerical
functions relating to the Fund, and (ii) expenses for services required in
connection with the preparation of registration statements and prospectuses,
registration of shares in various states, shareholder reports and notices, proxy
solicitation material furnished to shareholders of the Fund or regulatory
authorities and reports and questionnaires for SEC compliance. For the year
ended December 31, 1997 these expenses amounted to $44,817 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, 1997, the Fund paid New England Funds $556,721 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 1998 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, 1997, the Fund paid New England Funds $7,121 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, 1997, the Fund paid New England Funds $21,361 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, 1997 amounted to $263,142.
D. TRANSFER AGENT FEES. New England Funds is the transfer and shareholder
servicing agent to the Fund. For the year ended December 31, 1997, the Fund paid
New England Funds $94,537 as compensation for its services in that capacity. For
the year ended December 31, 1997, the Fund received $4,432 in transfer agent
credits. The transfer agent expense in the Statement of Operations is net of
these credits.
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 $2,089
Meeting Fee $109/meeting
Committee Meeting Fee $65/meeting
Committee Chairman Retainer $95/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, 1997, Back Bay Advisors reduced
its management fee of $615,117 by $312,693 and NEFM reduced its management fee
of $615,118 by $312,694.
5. CAPITAL SHARES. At December 31, 1997 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, 1996 DECEMBER 31, 1997
--------------------------- --------------------------
CLASS A SHARES AMOUNT SHARES AMOUNT
- ------- ----------- ------------- ----------- ------------
<S> <C> <C> <C> <C>
Shares sold .................... 9,423,564 $ 69,389,156 10,184,271 $ 75,205,511
Shares issued in connection with
the reinvestment of:
Distributions from net
investment income ............ 1,009,552 7,430,124 901,119 6,657,982
----------- ------------- ----------- ------------
10,433,116 76,819,280 11,085,390 81,863,493
Shares repurchased ............. (25,080,230) (184,716,449) (14,678,342) (108,373,107)
----------- ------------- ----------- ------------
Net decrease ................... (14,647,114) $(107,897,169) (3,592,952) $(26,509,614)
----------- ------------- ----------- ------------
<CAPTION>
YEAR ENDED YEAR ENDED
DECEMBER 31, 1996 DECEMBER 31, 1997
--------------------------- --------------------------
CLASS B SHARES AMOUNT SHARES AMOUNT
----------- ------------- ----------- ------------
<S> <C> <C> <C> <C>
Shares sold .................... 157,929 $ 1,162,842 104,271 $ 777,704
Shares issued in connection with
the reinvestment of:
Distributions from net
investment income ............ 14,541 107,004 17,276 127,549
----------- ------------- ----------- ------------
172,470 1,269,846 121,547 905,253
Shares repurchased ............. (110,554) (813,314) (103,688) (765,185)
----------- ------------- ----------- ------------
Net increase ................... 61,916 456,532 17,859 140,068
----------- ------------- ----------- ------------
Decrease derived from capital
shares transactions .......... (14,585,198) $(107,440,637) (3,575,093) $(26,369,546)
=========== ============= ========== ============
</TABLE>
- -------------------------------------------------------------------------------
New England Funds, L.P., Distributor
399 Boylston Street
Boston, MA 02116
Toll Free 800-225-5478
This material is authorized for distribution to prospective investors when it is
preceded or accompanied by the Fund's current prospectus, which contains
information about distribution charges, management and other items of interest.
Investors are advised to read the prospectus carefully before investing.
<PAGE>
- -------------------------------------------------------------------------------
REPORT OF INDEPENDENT ACCOUNTANTS
- -------------------------------------------------------------------------------
To the Trustees of New England Funds Trust II and Shareholders of
NEW ENGLAND ADJUSTABLE RATE U.S. GOVERNMENT FUND
In our opinion, the accompanying statement of assets & liabilities, including
the portfolio composition, and the related statements of operations and of
changes in net assets and the financial highlights present fairly, in all
material respects, the financial position of New England Adjustable Rate U.S.
Government Fund ("the Fund"), a series of New England Funds Trust II, at
December 31, 1997, and the results of its operations, the changes in its net
assets and the financial highlights for the year then ended, in conformity
with generally accepted accounting principles. These financial statements and
the financial highlights (hereafter referred to as "financial statements") are
the responsibility of the Fund's management; our responsibility is to express
an opinion on these financial statements based on our audit. We conducted our
audit of these financial statements in accordance with generally accepted
auditing standards which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management,
and evaluating the overall financial statement presentation. We believe that
our audit, which included confirmation of securities owned at December 31,
1997 by correspondence with the custodian and brokers and the application of
alternative auditing procedures where confirmations from brokers were not
received, provides a reasonable basis for the opinion expressed above. The
statement of changes in net assets for the period ended December 31, 1996 and
the financial highlights for each of the periods then ended were audited by
other independent accountants whose report dated February 10, 1997 expressed
an unqualified opinion on those statements.
PRICE WATERHOUSE LLP
Boston, Massachusetts
February 12, 1998
<PAGE>
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- ----------------------
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02116
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