<PAGE>
- --------------------------------------------------------------------------------
SEMIANNUAL REPORT
- --------------------------------------------------------------------------------
[Logo](R)
NEW ENGLAND FUNDS(R)
Where The Best Minds Meet(R)
- --------------------------------------------------------------------------------
New England Adjustable Rate U.S. Government Fund
[Graphic Omitted]
- ---------------------
JUNE 30, 1998
- ---------------------
<PAGE>
August 1998
- --------------------------------------------------------------------------------
[Photo of Henry L.P. Schmelzer
Dear Shareholder:
Investors had reason for comfort during the first half of 1998.
After stunning gains in each of the last three years, the stock market behaved
more like its customary self: Major market indicators moved up for a time, slid
back and were once again in recovery mode at the end of the period. This pattern
largely reflected investors' responses to fast-changing events in Asia.
Unpredictable markets call to mind the long-term experience of millions of
mutual fund investors; those of us who held firm to our plans as markets entered
difficult periods were often rewarded as markets recovered. The longer you stay
invested the less interim ups and downs -- here or overseas -- should concern
you.
News from the Far East drove bond market sentiment as well. In the United
States, faltering Asian economies meant lower prices on many imported goods,
putting pressure on prices and corporate earnings. With slower growth now a real
possibility and with little immediate evidence of inflation, the Federal Reserve
Board left short-term interest rates unchanged, while long-term rates fell to
record lows in mid-June.
In the pages that follow, you can read about how your Fund's management dealt
with the disruptions in the Pacific region and their impact on our domestic
economy. But beyond Asia's present problems, and notwithstanding the inevitable
ebb and flow of our own business cycle, there are reasons to be optimistic about
investment prospects over the next several years. For example, vast,
under-served populations in China and elsewhere represent huge potential demand
for consumer goods. Here in the United States, there is the prospect of a
demography-driven spending wave, as millions of baby-boomers enter their peak
consumption years. Events may turn out differently -- volatility will always be
part of investing -- but as much as the markets may waver, the watchwords for
many long-term investors are constant: diversify and persist.
While you are thinking about your investments, take a few minutes to review your
portfolio. It's possible that three years of strong market gains have tilted
your holdings disproportionately toward aggressive stock funds. If so, you and
your financial representative can adjust the balance easily using some of New
England Funds' more conservative equity or bond funds to reallocate your assets
in line with your long-term goals and comfort level. Once you are satisfied with
your portfolio's balance, be sure to stay in touch with your financial
professional, invest regularly and don't try to guess what the market will do
next.
Thank you for your continued support of New England Funds.
Sincerely,
/s/ Henry L.P. Schmelzer
Henry L.P. Schmelzer
President
PREPARING FOR THE YEAR 2000
- --------------------------------------------------------------------------------
New England Funds continues to work to provide high quality service as we move
into the new century. Since last year we have devoted significant resources to
identifying, analyzing and resolving computer issues related to Year 2000. As a
further measure, we have focused on year-end 1998 as a target for preparedness
by vendor and service agency systems that we rely on for support. We expect
major systems to be ready before the end of the year, with a year of quality
assurance to follow.
<PAGE>
- --------------------------------------------------------------------------------
NEW ENGLAND ADJUSTABLE RATE U.S. GOVERNMENT FUND
- --------------------------------------------------------------------------------
INVESTMENT RESULTS THROUGH JUNE 30, 1998
- --------------------------------------------------------------------------------
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.
GROWTH OF A $10,000 INVESTMENT IN CLASS A SHARES
[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:]
December 1991 through June 1998
Compared to Lehman Adjustable Rate Mortgage (ARM) Index(4)
and the Cost of Living(5)
With
Net Maximum Cost
Asset Sales Lehman of
Value(1) Charge(2) Arm(4) Living(5)
-------- ------- ------ ---------
12/31/91 $10,000 $ 9,900 $10,000 $10,000
6/92 $10,282 $10,179 $10,355 $10,167
6/93 $10,789 $10,681 $11,028 $10,472
6/94 $10,936 $10,826 $11,112 $10,733
6/95 $11,588 $11,473 $12,041 $11,059
6/96 $12,243 $12,121 $12,801 $11,363
6/97 $13,034 $12,904 $13,817 $11,625
6/98 $13,724 $13,586 $14,750 $11,806
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 vary 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 -- 6/30/98
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
CLASS A (Inception 10/18/91) 6 MONTHS 1 YEAR 5 YEARS SINCE INCEPTION
Net Asset Value(1) 2.20% 5.28% 4.93% 5.03%
With Max. Sales Charge(2) 1.23 4.30 4.71 4.86
Lehman ARM Index(4) 3.01 6.75 5.99 N/A
Lipper ARM Average(6) 2.22 5.10 4.87 4.80
(calculated from 10/31/91)
- --------------------------------------------------------------------------------
CLASS B (Inception 9/13/93) 6 MONTHS 1 YEAR SINCE INCEPTION
Net Asset Value(1) 1.94% 4.50% 4.15%
With CDSC(3) -3.03 -0.48 3.80
Lehman ARM Index(4) 3.01 6.75 6.07
(calculated from 9/30/93)
Lipper ARM Average(6) 2.22 5.10 4.81
(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>
- --------------------------------------------------------------------------------
NEW ENGLAND ADJUSTABLE RATE U.S. GOVERNMENT FUND
- --------------------------------------------------------------------------------
QUESTIONS & ANSWERS WITH YOUR PORTFOLIO MANAGER
- --------------------------------------------------------------------------------
- --------------------------
[Photo of Scott Nicholson]
- --------------------------
Scott Nicholson
Back Bay Advisors, L.P.
Q. How did New England Adjustable Rate U.S. Government Fund perform over the
past six months?
For the six-month period ending June 30, 1998, the Fund's Class A shares
generated a total return of 2.20%, including a $0.05 per share drop in net asset
value to $7.34 and the reinvestment of $0.21 per share in dividend
distributions.
Q. What was the investment environment for adjustable rate mortgage securities
(ARMS)?
The environment was challenging for ARMS investors. Whereas declining rates are
positive for most bonds, they are negative for ARMS because they encourage
mortgage holders to refinance into lower-rate mortgages. In the current
environment, many mortgage holders have chosen to prepay their loans and
refinance out of ARMS into fixed-rate mortgages so that they can secure a low
interest rate for the life of the mortgage.
Q. How did you manage the Fund to minimize the effect of these conditions?
We reduced the Fund's exposure to ARMS to about two-thirds of assets, keeping it
close to the minimum required by the prospectus. We opted instead to increase
our holdings of callable agency securities and U.S. Treasuries with high coupons
(stated fixed rates of interest) and short maturities. These securities
decreased the Fund's exposure to prepayments and still provided an attractive
stream of income. Additionally, we purchased floating rate securities issued by
the Small Business Administration. The coupon of these securities is pegged to
an index, the prime rate, and rises and falls with changes in that index. We
believe floating rate bonds added value to the Fund because of their attractive
yield and tie to the prime rate. The prime rate increases quickly in a rising
interest rate environment and falls slowly when interest rates decline. This
type of response to interest rate changes protects and enhances the Fund's
income.
PORTFOLIO MIX -- 6/30/98
-----------------------------------------
ARMS 68%
U.S. Gov't. Agency Securities 18%
U.S. Treasuries 12%
Cash Equivalents 2%
Portfolio holdings are subject to change.
-----------------------------------------
Q. What is your outlook for ARMS?
We anticipate a continuation of many of the trends witnessed over the past six
months, including economic strength in the United States, low inflation and
concerns about economic problems in Asia. We believe the Federal Reserve Board
will act cautiously, keeping interest rates low while it evaluates the extent to
which the Asian situation reduces both U.S. economic activity and inflationary
pressures. However, as long as interest rates remain low, we expect high
prepayment rates to dampen returns in the ARMS market.
On the positive side, we believe a limited supply of ARMS should act as a
support to prices. Supply has declined as older ARMS with higher coupons have
been paid off. Further, new issuance is minimal because many consumers opt for
fixed-rate mortgages, given the low level of interest rates. In this
environment, we will seek those investments that provide attractive yields and
price stability while minimizing the Fund's exposure to prepayment risk.
Portfolio commentary reflects the conditions and actions taken during the
reporting period, which are subject to change. A shift in opinion may result in
strategic and other portfolio changes.
<PAGE>
<TABLE>
- -------------------------------------------------------------------------------------------------------------
PORTFOLIO COMPOSITION
- -------------------------------------------------------------------------------------------------------------
Investments as of June 30, 1998
(unaudited)
BONDS AND NOTES--96.5% OF TOTAL NET ASSETS
<CAPTION>
FACE
AMOUNT DESCRIPTION VALUE (a)
- -------------------------------------------------------------------------------------------------------------
GOVERNMENT AGENCIES (c)--84.5%
<S> <C>
$ 5,000,000 Federal Home Loan Mortgage Corp., 6.000%, 6/15/01 .............. $ 4,990,600
4,398,800 Federal Home Loan Mortgage Corp., 6.382%, 10/15/23, (e) ........ 4,448,286
1,423,473 Federal Home Loan Mortgage Corp., 6.784%, 11/01/35 ............. 1,464,626
1,278,883 Federal Home Loan Mortgage Corp., 7.146%, 4/01/22, (d) ......... 1,301,468
3,253,328 Federal Home Loan Mortgage Corp., 7.273%, 1/01/25 .............. 3,335,182
4,012,307 Federal Home Loan Mortgage Corp., 7.334%, 1/01/20, (d) ......... 4,155,265
971,648 Federal Home Loan Mortgage Corp., 7.430%, 6/01/22, (d) ......... 997,454
959,009 Federal Home Loan Mortgage Corp., 7.544%, 6/01/22, (d) ......... 995,126
2,470,677 Federal Home Loan Mortgage Corp., 7.551%, 5/01/19, (d) ......... 2,576,076
1,922,576 Federal Home Loan Mortgage Corp., 7.563%, 5/01/23, (d) ......... 1,978,446
2,576,503 Federal Home Loan Mortgage Corp., 7.594%, 2/01/22 .............. 2,659,827
2,366,311 Federal Home Loan Mortgage Corp., 7.622%, 5/01/23, (d) ......... 2,436,922
986,470 Federal Home Loan Mortgage Corp., 7.625%, 10/01/21, (d) ........ 1,016,991
2,120,254 Federal Home Loan Mortgage Corp., 7.631%, 7/01/26, (d) ......... 2,165,309
1,647,522 Federal Home Loan Mortgage Corp., 7.652%, 1/01/23, (d) ......... 1,708,793
3,180,815 Federal Home Loan Mortgage Corp., 7.677%, 1/01/19, (d) ......... 3,331,395
1,850,586 Federal Home Loan Mortgage Corp., 7.754%, 12/01/22, (d) ........ 1,876,901
1,412,478 Federal Home Loan Mortgage Corp., 7.766%, 3/01/25, (d) ......... 1,442,493
3,879,395 Federal Home Loan Mortgage Corp., 7.784%, 4/01/25, (d) ......... 4,038,218
766,185 Federal Home Loan Mortgage Corp., 7.842%, 12/01/25 ............. 778,635
3,010,596 Federal Home Loan Mortgage Corp., 7.869%, 4/01/29, (d) ......... 3,093,869
2,134,815 Federal Home Loan Mortgage Corp., 7.871%, 10/01/23, (d) ........ 2,183,852
663,851 Federal Home Loan Mortgage Corp., 7.875%, 8/01/22, (d) ......... 682,525
676,630 Federal Home Loan Mortgage Corp., 7.930%, 9/01/22, (d) ......... 699,675
1,428,748 Federal Home Loan Mortgage Corp., 7.974%, 7/01/25, (d) ......... 1,467,152
3,311,188 Federal Home Loan Mortgage Corp., 7.984%, 9/01/23, (d) ......... 3,394,498
1,353,731 Federal Home Loan Mortgage Corp., 8.000%, 8/01/24, (d) ......... 1,374,037
1,499,625 Federal Home Loan Mortgage Corp., 8.059%, 9/01/23, (d) ......... 1,535,241
421,920 Federal National Mortgage Association, 5.917%, 9/01/23, (d) .... 420,338
5,000,000 Federal National Mortgage Association, 6.100%, 10/06/00 ........ 5,015,600
4,217,627 Federal National Mortgage Association, 6.321%, 6/01/27 ......... 4,259,804
2,000,000 Federal National Mortgage Association, 6.330%, 3/10/03 ......... 1,995,620
1,706,026 Federal National Mortgage Association, 6.464%, 7/01/19, (d) .... 1,718,548
5,000,000 Federal National Mortgage Association, 6.540%, 9/08/00 ......... 5,006,250
2,737,019 Federal National Mortgage Association, 6.597%, 7/01/27 ......... 2,799,040
373,439 Federal National Mortgage Association, 6.676%, 6/01/19, (d) .... 377,465
1,135,578 Federal National Mortgage Association, 6.771%, 1/01/20, (d) .... 1,152,964
3,192,709 Federal National Mortgage Association, 6.958%, 4/01/26 ......... 3,274,027
1,072,720 Federal National Mortgage Association, 7.405%, 5/01/22, (d) .... 1,108,260
1,451,504 Federal National Mortgage Association, 7.418%, 4/01/23, (d) .... 1,492,553
2,353,345 Federal National Mortgage Association, 7.460%, 7/01/24, (d) .... 2,407,025
383,010 Federal National Mortgage Association, 7.501%, 5/01/20, (d) .... 396,894
253,752 Federal National Mortgage Association, 7.505%, 8/01/17, (d) .... 259,223
2,739,145 Federal National Mortgage Association, 7.584%, 4/01/24, (d) .... 2,820,881
2,184,319 Federal National Mortgage Association, 7.617%, 9/01/25, (d) .... 2,239,277
1,122,168 Federal National Mortgage Association, 7.621%, 5/01/25, (d) .... 1,146,541
2,048,749 Federal National Mortgage Association, 7.641%, 11/01/20, (d) ... 2,123,651
1,574,351 Federal National Mortgage Association, 7.665%, 11/01/25, (d) ... 1,607,317
7,966,490 Federal National Mortgage Association, 7.750%, with various
maturities to 6/01/22(d)(c) .................................. 8,316,116
1,065,795 Federal National Mortgage Association, 7.789%, 7/01/17, (d) .... 1,110,921
569,392 Federal National Mortgage Association, 7.851%, 7/01/23, (d) .... 578,200
1,796,090 Federal National Mortgage Association, 7.978%, 1/01/24, (d) .... 1,890,098
3,146,129 Government National Mortgage Association, 6.875%, 2/20/23 ...... 3,219,875
8,592,105 Government National Mortgage Association, 7.000%, with various
maturities to 8/20/25(c) ..................................... 8,792,129
15,219,159 Government National Mortgage Association, 7.375%, with various
maturities to 6/20/23(c)(d) .................................... 15,570,468
6,453,230 Small Business Administration Guaranteed Loan, 6.000%, 1/25/23 . 6,469,363
5,242,966 Small Business Administration Pool Certificates,
6.000%, 6/25/23 ................................................ 5,256,073
------------
154,953,383
------------
U.S. GOVERNMENT--12.0%
15,000,000 United States Treasury Notes, 7.500%, 11/15/01 ................. 15,888,300
6,000,000 United States Treasury Notes, 8.875%, 2/15/99 .................. 6,121,860
------------
22,010,160
------------
Total Bonds and Notes (Identified Cost $176,741,217) ........... 176,963,543
------------
SHORT TERM INVESTMENT--1.7%
FACE
AMOUNT DESCRIPTION VALUE (a)
- ------------------------------------------------------------------------------------------------------------
$ 3,000,000 Repurchase Agreement with State Street Corp. dated 6/30/98
at 5.000% to be repurchased at $3,000,416 on 7/01/98,
collateralized by 2,655,000 U.S. Treasury Bond, 8.375%,
due 8/15/08, valued at $3,063,206. ........................... $ 3,000,000
------------
Total Short Term Investment (Identified Cost $3,000,000) ....... 3,000,000
------------
Total Investments--98.2% (Identified Cost $179,741,217)(b) ..... 179,963,543
Other assets less liabilities ................................. 3,371,740
------------
Total Net Assets--100% ......................................... $183,335,283
============
(a) See Note 1a of Notes to Financial Statements.
(b) Federal Tax Information: At June 30, 1998 the net unrealized appreciation on
investments based on cost for federal income tax purposes of $179,741,217 was
as follows:
Aggregate gross unrealized appreciation for all investments in which there is
an excess value over tax cost ................................................ $ 695,050
Aggregate gross unrealized depreciation for all investments in which there is
an excess of tax cost over value ............................................. (472,724)
------------
Net unrealized appreciation .................................................. $ 222,326
============
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 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 June 30, 1998.
(e) Collateralized mortgage obligation.
See accompanying notes to financial statements.
</TABLE>
<PAGE>
<TABLE>
- ---------------------------------------------------------------------------------------------------
STATEMENT OF ASSETS & LIABILITIES
- ---------------------------------------------------------------------------------------------------
June 30, 1998
(unaudited)
ASSETS
<S> <C> <C>
Investments at value (Identified cost $179,741,217) ...... $179,963,543
Fund shares sold ....................................... 18,881
Securities sold ........................................ 137,912
Dividends and interest ................................. 4,139,106
Prepaid registration expense ............................. 7,000
------------
184,266,442
LIABILITIES
Due to custodian bank .................................. $ 38,056
Fund shares redeemed ................................... 325,459
Dividends declared ..................................... 377,863
Management fees ........................................ 132,283
Deferred trustees' fees ................................ 11,182
Accounting and administrative .......................... 4,218
Other .................................................. 42,098
-------- 931,159
------------
NET ASSETS ............................................... $183,335,283
============
Net Assets consist of:
Capital paid in ...................................... $198,708,562
Undistributed net investment income .................. 426,845
Accumulated net realized losses ...................... (16,022,450)
Unrealized appreciation on investments ............... 222,326
------------
NET ASSETS ............................................... $183,335,283
============
Computation of net asset value and offering price:
Net asset value and redemption price of Class A shares
($180,334,693 divided by 24,574,391 shares of beneficial
interest) ................................................ $7.34
=====
OFFERING PRICE PER SHARE (100/99 OF $7.34) ................. $7.41*
=====
Net asset value and offering price of Class B shares
($3,000,590 divided by 409,031 shares of beneficial
interest) ................................................ $7.34**
=====
*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 charge.
See accompanying notes to financial statements.
</TABLE>
<PAGE>
<TABLE>
- ---------------------------------------------------------------------------------------------------
STATEMENT OF OPERATIONS
- ---------------------------------------------------------------------------------------------------
Six months Ended June 30, 1998
(unaudited)
<S> <C> <C>
INVESTMENT INCOME
Interest ................................................... $6,891,720
Expenses
Management fees .......................................... $ 558,847
Service fees - Class A ................................... 252,417
Service and distribution fees - Class B .................. 14,677
Trustees' fees and expenses .............................. 7,812
Accounting and administrative ............................ 21,604
Custodian ................................................ 46,390
Transfer agent ........................................... 69,042
Audit and tax services ................................... 15,285
Legal .................................................... 2,232
Printing ................................................. 13,576
Registration ............................................. 20,060
Miscellaneous ............................................ 4,240
----------
Total expenses ............................................. 1,026,182
Less expenses waived by the investment adviser and
subadviser ............................................... (298,132) 728,050
---------- ----------
Net investment income ...................................... 6,163,670
REALIZED AND UNREALIZED LOSS ON INVESTMENTS
Realized loss on investments - net ........................... (915,785)
Unrealized depreciation on Investments - net ................. (907,087)
----------
Net loss on investment transactions .......................... (1,822,872)
----------
NET INCREASE IN NET ASSETS FROM OPERATIONS ................... $4,340,798
==========
See accompanying notes to financial statements.
</TABLE>
<PAGE>
- --------------------------------------------------------------------------------
STATEMENT OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
(unaudited)
<TABLE>
<CAPTION>
SIX MONTHS
YEAR ENDED ENDED
DECEMBER 31, JUNE 30,
1997 1998
------------ --------
FROM OPERATIONS
<S> <C> <C>
Net investment income ................................... $ 14,116,845 $ 6,163,670
Net realized loss on investments ........................ (2,347,087) (915,785)
Unrealized appreciation (depreciation) on investments ... 1,792,855 (907,087)
------------- ------------
Increase in net assets from operations ......... 13,562,613 4,340,798
------------- ------------
FROM DISTRIBUTIONS TO SHAREHOLDERS
Net investment income
Class A ............................................... (12,791,602) (5,651,383)
Class B ............................................... (142,367) (71,249)
------------- ------------
(12,933,969) (5,722,632)
------------- ------------
DECREASE IN NET ASSETS DERIVED FROM CAPITAL SHARE
TRANSACTIONS ........................................... (26,369,546) (15,171,383)
------------- ------------
Total decrease in net assets .............. (25,740,902) (16,553,217)
NET ASSETS
Beginning of the period ................................. 225,629,402 199,888,500
------------- ------------
End of the period .................... $ 199,888,500 $183,335,283
UNDISTRIBUTED (DISTRIBUTIONS IN EXCESS OF) NET INVESTMENT INCOME
End of the period ....................................... $ (14,193) $ 426,845
============= ============
See accompanying notes to financial statements.
</TABLE>
<PAGE>
- --------------------------------------------------------------------------------
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
(unaudited)
<TABLE>
<CAPTION>
CLASS A
------------------------------------------------------------------------------------------------
SIX MONTHS
YEAR ENDED DECEMBER 31, ENDED
--------------------------------------------------------------------------- JUNE 30,
1993 1994 1995 1996 1997 1998
----- ----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of
Period ........................ $ 7.46 $ 7.45 $ 7.20 $ 7.37 $ 7.37 $ 7.39
----- ----- ----- ----- ----- -----
Income From Investment Operations
Net Investment Income ........... 0.33 0.37 0.47 0.43 0.47(d) 0.23
Net Realized and Unrealized
Gain (Loss) on Investments .... (0.03) (0.31) 0.14 (0.01) (0.02) (0.07)
----- ----- ----- ----- ----- -----
Total From Investment
Operations .................... 0.30 0.06 0.61 0.42 0.45 0.16
----- ----- ----- ----- ----- -----
Less Distributions
Distributions From Net
Investment Income ............. (0.31) (0.31) (0.44) (0.42) (0.43) (0.21)
----- ----- ----- ----- ----- -----
Total Distributions ............. (0.31) (0.31) (0.44) (0.42) (0.43) (0.21)
----- ----- ----- ----- ----- -----
Net Asset Value, End of
Period ........................ $ 7.45 $ 7.20 $ 7.37 $ 7.37 $ 7.39 $ 7.34
====== ====== ====== ====== ====== ======
Total Return (%) (c) ............ 4.0 0.8 8.6 5.8 6.2 2.2
Ratio of Operating Expenses
to Average Net Assets (%)
(a) ........................... 0.60 0.60 0.66 0.70 0.70 0.70(b)
Ratio of Net Investment
Income to Average Net
Assets (%) .................... 4.39 4.85 6.29 6.39 6.27 6.03(b)
Portfolio Turnover Rate (%) ..... 54 17 73 54 49 91(b)
Net Assets, End of Period
(000) ......................... $734,251 $489,637 $331,112 $222,809 $196,928 $180,335
(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 0.99(b)
(b) Computed on an annualized basis.
(c) A sales charge is not reflected in total return calculations. Periods less
than one year are not annualized.
(d) Per share net investment income does not reflect the period's
reclassification of permanent differences between book and tax basis net
investment income. See Note 1d to the financial statements.
See accompanying notes to financial statements.
</TABLE>
<PAGE>
- --------------------------------------------------------------------------------
FINANCIAL HIGHLIGHTS - continued
- --------------------------------------------------------------------------------
(unaudited)
<TABLE>
<CAPTION>
CLASS B
------------------------------------------------------------------------------------------------
SEPTEMBER 13(a) SIX MONTHS
THROUGH YEAR ENDED DECEMBER 31, ENDED
DECEMBER 31, ---------------------------------------------------------- JUNE 30,
1993 1994 1995 1996 1997 1998
-------------- ------ ------ ------ ------ ----
<S> <C> <C> <C> <C> <C> <C>
Net Asset Value,
Beginning of Period ............ $ 7.52 $ 7.45 $ 7.20 $ 7.37 $ 7.36 $ 7.38
------ ------ ------ ------ ------ ------
Income From Investment
Operations
Net Investment Income ............ 0.08 0.29 0.41 0.37 0.41(e) 0.21
Net Realized and
Unrealized Gain (Loss)
on Investments ................. (0.08) (0.29) 0.14 (0.02) (0.02) (0.07)
------ ------ ------ ------ ------ ------
Total From Investment
Operations ..................... 0.00 0.00 0.55 0.35 0.39 0.14
------ ------ ------ ------ ------ ------
Less Distributions
Distributions From Net
Investment Income .............. (0.07) (0.25) (0.38) (0.36) (0.37) (0.18)
------ ------ ------ ------ ------ ------
Total Distributions .............. (0.07) (0.25) (0.38) (0.36) (0.37) (0.18)
------ ------ ------ ------ ------ ------
Net Asset Value, End of
Period ......................... $ 7.45 $ 7.20 $ 7.37 $ 7.36 $ 7.38 $ 7.34
====== ====== ====== ====== ====== ======
Total Return (%) (d) ............. 0.0 0.1 7.8 4.9 5.4 1.9
Ratio of Operating
Expenses to Average
Net Assets (%) (b) ............. 1.35(c) 1.35 1.41 1.45 1.45 1.45(c)
Ratio of Net Investment
Income to Average Net
Assets (%) ..................... 3.50(c) 4.10 5.54 5.64 5.52 5.28(c)
Portfolio Turnover Rate
(%) ............................ 54(c) 17 73 54 49 91(c)
Net Assets, End of
Period (000) ................... $855 $2,056 $2,368 $2,821 $2,961 $3,001
(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(c) 1.63 1.65 1.69 1.73 1.74(c)
(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 period's
reclassification of permanent differences between book and tax basis net
investment income. See Note 1d to the financial statements.
</TABLE>
<PAGE>
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
June 30, 1998
(unaudited)
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 Fund seeks a high level of current income consistent with low
volatility of principal. The Fund intends to pursue its objective by investing
only in securities issued or guaranteed by the U.S. Government, its agencies
or instrumentalities. 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. 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, 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 and 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, including interest. The 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. For the six months ended June 30, 1998
purchases and sales of securities (excluding short-term investments) were as
follows:
PURCHASES SALES
--------- -----
U.S. GOVERNMENT U.S. GOVERNMENT
--------------- ---------------
$88,818,917 $101,672,436
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 Nvest Companies, L.P.
("Nvest"), 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 six months ended June 30, 1998 are as follows:
FEES EARNED(a)
--------------
$279,424 NEFM
$279,423 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 Nvest
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 six months ended June 30, 1998
these expenses amounted to $21,604 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 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 six
months ended June 30, 1998, the Fund paid New England Funds $252,417 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 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 six months ended June 30, 1998, the Fund paid New England
Funds $3,669 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 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 six months
ended June 30, 1998, the Fund paid New England Funds $11,008 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 six months
ended June 30, 1998 amounted to $29,698.
D. TRANSFER AGENT FEES. New England Funds Service Corporation ("NEFSCO") is
the transfer and shareholder servicing agent to the Fund. For the six months
ended June 30, 1998, the Fund paid NEFSCO $45,470 as compensation for its
services in that capacity. For the six months ended June 30, 1998, the Fund
received $2,193 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, NEFSCO, Nvest or their affiliates, other than
registered investment companies. Each other trustee is compensated by the Fund
as follows:
Annual Retainer $1,143
Meeting Fee 159/meeting
Annual Committee Member Retainer 171
Annual Committee Chairman Retainer 114
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 January 1, 1993 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. As a result of the Fund's expenses exceeding the
applicable voluntary expense limitation during the six months ended June 30,
1998, Back Bay Advisors reduced its management fee of $279,423 by $149,066 and
NEFM reduced its management fee of $279,424 by $149,066.
5. CAPITAL SHARES. At June 30, 1998 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 SIX MONTHS ENDED
DECEMBER 31, 1997 JUNE 30, 1998
----------------------------- ----------------------------
CLASS A SHARES AMOUNT SHARES AMOUNT
- -------- ----------- ------------- ---------- ------------
<S> <C> <C> <C> <C>
Shares sold ...................... 10,184,271 $ 75,205,511 5,290,237 $ 39,011,068
Shares issued in connection with the
reinvestment of:
Distributions from net
investment income .............. 901,119 6,657,982 395,800 2,915,744
----------- ------------- ---------- ------------
11,085,390 81,863,493 5,686,037 41,926,812
Shares repurchased ............... (14,678,342) (108,373,107) (7,770,485) (57,157,669)
----------- ------------- ---------- ------------
Net decrease ..................... (3,592,952) $ (26,509,614) (2,084,448) $(15,230,857)
----------- ------------- ---------- ------------
<CAPTION>
YEAR ENDED SIX MONTHS ENDED
DECEMBER 31, 1997 JUNE 30, 1998
----------------------------- ----------------------------
CLASS B SHARES AMOUNT SHARES AMOUNT
- -------- ----------- ------------- ---------- ------------
<S> <C> <C> <C> <C>
Shares sold ...................... 104,271 $ 777,704 61,050 $ 450,191
Shares issued in connection with the
reinvestment of:
Distributions from net
investment income .............. 17,276 127,549 8,940 65,852
----------- ------------- ---------- ------------
121,547 905,253 69,990 516,043
Shares repurchased ............... (103,688) (765,185) (61,922) (456,569)
----------- ------------- ---------- ------------
Net increase ..................... 17,859 140,068 8,068 59,474
----------- ------------- ---------- ------------
Decrease derived from capital
shares transactions (3,575,093) $ (26,369,546) (2,076,380) $(15,171,383)
========== ============= ========== ============
</TABLE>
<PAGE>
GLOSSARY FOR MUTUAL FUND INVESTORS
- -------------------------------------------------------------------------------
TOTAL RETURN - The change in value of a mutual fund investment over a specific
time period, assuming all earnings are reinvested in additional shares of the
fund. Expressed as a percentage.
INCOME DISTRIBUTIONS - Payments to shareholders resulting from the net interest
or dividend income earned by a fund's portfolio.
CAPITAL GAINS DISTRIBUTIONS - Payments to shareholders of profits earned from
selling securities in a fund's portfolio. Capital gains distributions are
usually paid once a year.
YIELD - The rate at which a fund pays income. Yield calculations for 30-day
periods are standardized among mutual funds, based on a formula developed by
the Securities and Exchange Commission.
MATURITY - Refers to the period of time before principal repayment on a bond is
due. A bond fund's "average maturity" refers to the weighted average of the
maturities of all the individual bonds in the potfolio.
DURATION - A measure, stated in years, of a bond's sensitivity to interest
rates. Duration is a means to directly compare the volatility of different
instruments. As a general rule, for every 1% move in interest rates, a bond is
expected to fluctuate in value as indicated by its duration. For example, if
interest rates fall by 1%, a bond with a duration of 4 years should rise in
value 4%. Conversely, the bond should decline 4% if interest rates rise 1%.
TREASURIES - Negotiable debt obligations of the U.S. government, secured by its
full faith and credit. The income from Treasury securities is exempt from state
and local income taxes but not from federal income taxes. There are three types
of Treasuries: Bills (maturity of 3-12 months), Notes (maturity of 1-10 years)
and Bonds (maturity of 10-30 years).
MUNICIPAL BOND - A debt security issued by a state or municipality to finance
public expenditures. Interest payments are exempt from federal taxes and, in
most cases, from state and local income taxes. The two main types are general
obligation (GO) bonds, which are backed by the full faith and credit and taxing
powers of the municipality; and revenue bonds, supported by the revenues from a
municipal enterprise, such as airports and toll bridges.
<PAGE>
- --------------------------------------------------------------------------------
SAVING FOR RETIREMENT
- --------------------------------------------------------------------------------
AN EARLY START CAN MAKE A BIG DIFFERENCE
With today's lengthening life spans, you may be retired for 20 years or more
after you complete your working career. Living these retirement years the way
you've dreamed of will require considerable financial resources. while it's
never too late to start a retirement savings program, it's certainly never too
early: The sooner you begin, the longer the time your money has to grow.
The chart below illustrates this point dramatically. One investor starts at age
30, saves for just 10 years, then leaves the investment to grow. The second
investor starts 10 years later but saves much longer -- for 25 years, in fact.
Can you guess which investor accumulates the greater retirement nest egg? For
the answer, look at the chart.
- --------------------------------------------------------------------------------
AN EARLY START CAN MAKE A BIG DIFFERENCE
- --------------------------------------------------------------------------------
[A chart in the form of a line graph appears here, comparing the growth of
investments made for 10 years by an investor who begins investing at age 30 to
the growth of investments made for twenty-five years by an investor who begins
investing at age 40. A hypothetical appreciation of 10% is assumed. The data
points from the graph are as follows:]
Investor A - Begins investing at age 30 for 10 years:
Age Growth of Investments
30 $2,000
35 $15,431
40 $35,062
45 $90,943
55 $146,464
60 $235,882
65 $379,890
Investor B - Begins investing at age 40 for 25 years:
Age Growth of Investments
40 $2,000
45 $15,431
50 $37,062
55 $71,899
60 $128,005
65 $216,364
Assumes 10% hypothetical appreciation. For illustrative purposes only and not
indicative of future performance of any New England Fund.
Investor A invested $20,000, less than half of Investor B's commitment -- and
for less than half the time. Yet Investor A wound up with a much greater
retirement nest egg. The reason? It's all thanks to an early start.
New England Funds has prepared a number of informative retirement planning
guides. Call your financial representative or New England Funds today, and ask
for the guide that best fits your personal needs.
<PAGE>
- --------------------------------------------------------------------------------
NEW ENGLAND FUNDS
- --------------------------------------------------------------------------------
STOCK FUNDS
Bullseye Fund
Star Small Cap Fund
Growth Fund
Star Advisers Fund
Capital Growth Fund
Growth Opportunities Fund
Value Fund
Equity Income Fund
Balanced Fund
INTERNATIONAL STOCK FUNDS
International Equity Fund
Star Worldwide Fund
BOND FUNDS
High Income Fund
Strategic Income Fund
Bond Income Fund
Government Securities Fund
Limited Term U.S. Government Fund
Adjustable Rate U.S. Government Fund
TAX EXEMPT FUNDS
Municipal Income Fund
Massachusetts Tax Free Income Fund
Tax Free Income Fund of New York
Intermediate Term Tax Free Fund of California
MONEY MARKET FUNDS
Cash Management Trust, Money Market Series
Tax Exempt Money Market Trust
To learn more, and for a free prospectus,
contact your financial representative.
VISIT OUR WORLD WIDE WEB SITE AT WWW.MUTUALFUNDS.COM
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.
New England Funds, L.P., and other firms selling shares of New England Funds
are members of the National Association of Securities Dealers, Inc.
(NASD). As a service to investors, the NASD has asked that we inform you
of the availability of a brochure on its Public Disclosure Program.
The program provides access to information about
securities firms and their representatives. Investors may obtain
a copy by contacting the NASD at 1-800-289-9999 or by
visiting their web site at www.NASDR.com.
<PAGE>
------------------
[LOGO](R) Bulk Rate
NEW ENGLAND FUNDS(R) U.S. Postage
Where The Best Minds Meet(R) Paid
Brockton, MA
Permit No. 770
------------------
---------------------
399 Boylston Street
Boston, Massachusetts
02116
---------------------
[Dalbar Logo]
- -----------------------
1995 o 1996 o 1997
AR58-0698
[Recycle Logo] Printed on Recycled Paper
