<PAGE>
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ANNUAL REPORT
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[Logo](R)
NEW ENGLAND FUNDS(R)
Where The Best Minds Meet(R)
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New England
Massachusetts Tax Free
Income Fund
[graphic omitted]
Where
The Best
Minds
Meet(R)
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DECEMBER 31, 1998
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<PAGE>
FEBRUARY 1999
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[Photo of Bruce R. Speca]
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"Research indicates that saving for retirement is the number one goal for
investors. Yet, surprisingly often, investors behave like short-term traders
looking for a quick score."
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In September 1998, I became President of New England Funds. As an 18-year
veteran of the mutual fund industry, I was pleased and honored to accept this
important post. In my first message to you, I hope to present what I believe
you, our valued shareholders, really want to know and to offer it in a
straightforward manner.
How did my fund perform?
There's no question that long-term performance is the bottom line of your
investment program. With that in mind, please review the other sections of this
report. You'll see your fund's performance and commentary from your fund manager
that summarizes the fund's successes and shortcomings and the outlook for the
year ahead.
Our assessment of New England Funds' overall performance in 1998 is that we had
a solid, but not spectacular, year. While extremely pleased with both absolute
and relative returns in many of our stock and bond portfolios, we were
disappointed by the results of those equity funds that pursue a `value' rather
than a `growth' strategy. Value stocks were largely ignored in 1998, as
investors focused on very large, high visibility growth stocks (indeed, 45% of
the gain in the Standard & Poor's Composite Index of 500 Stocks (the "S&P 500")
- - a market value-weighted, unmanaged index of common stock prices for 500
selected stocks - came from just 10 stocks!) and select technology companies.
Much of the underperformance in value-oriented funds can be attributed to market
cycles, but we continue to pursue strategies to increase returns in these funds.
Can the stock market keep going up?
Like any winning streak, sooner or later the market will experience setbacks.
Does that mean 1999 will see the last burst of energy from the bull market? It's
easy to argue both sides of this question. Employment is high, inflation is low
and economic growth is continuing. But corporate profits may start to lag and
commodity prices, notably oil, are depressed around the world. The conclusion?
Economists, like weathermen and other forecasters, can only hope to be right
more often than they are wrong.
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NOT FDIC INSURED MAY LOSE VALUE NO BANK GUARANTEE
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<PAGE>
My Own Two Cents
All too often investors lament, "What I could have made if only . . ." instead
of "What I actually made." But experience has taught me that the more important
question is, "Did I stick with my investment program and make progress toward my
financial goals?"
Research indicates that saving for retirement is the number one goal for
investors. Yet, surprisingly often, investors behave like short-term traders
looking for a quick score.
The mutual fund industry has become extremely complex, with more funds, new
strategies and approaches to analyzing performance. What hasn't changed is your
financial representative's primary objective: to help you sort it all out and
increase your returns in line with your goals.
Your financial adviser can help you avoid being distracted by the daily noise
and avoid what I view as the most important risk that investors face. It's the
risk of not staying invested and possibly falling short of your long-term goals.
Your adviser will help you stick with your investment program during periods of
uncertainty.
One last thought: All of us at New England Funds appreciate the trust that you
and your representative have placed in us. We look forward to serving you in the
years ahead.
Sincerely,
/s/ Bruce R. Speca
Bruce R. Speca
President and CEO
PROGRESS ON THE Y2K FRONT
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New England Funds has been and continues to engage in initiatives aimed at
having our computer systems tested and ready to function capably for the Year
2000. We are insisting on the same standard from vendors whose systems must
interact reliably with ours as well as from the subadvisers to our funds. We are
monitoring their progress and pursuing assurances of their readiness. Our
systems are being tested on a four-digit format (2000, not 00) and updated as
needed to perform competently. Additionally, we are developing contingency plans
to diminish the possibility of inconvenience related to Year 2000. Stay informed
on our Year 2000 readiness by visiting our Web site at www.mutualfunds.com.
This material represents Year 2000 Readiness disclosure pursuant to the Year
2000 Information and Readiness Act.
<PAGE>
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NEW ENGLAND MASSACHUSETTS TAX FREE INCOME FUND
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INVESTMENT RESULTS THROUGH DECEMBER 31, 1998
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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 below 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 and does not have expenses that affect the results.
It is not possible to invest directly in an index. In addition, few investors
could purchase all of the securities necessary to match the index and would
incur transaction costs and other expenses even if they could.
GROWTH OF A $10,000 INVESTMENT IN CLASS A SHARES
[A chart appears here illustrating the growth of a $10,000 investment in the
Massachusetts Tax Free Fund's Class A shares since 12/31/88 compared to the
Lehman Municipal Index. The plot points for this chart are as follows.]
LEHMAN
NAV MSC MUNI
12/31/88 $10,000 $ 9,575 $10,000
89 $10,799 $10,340 $11,079
90 $11,361 $10,878 $11,887
91 $12,664 $12,125 $13,330
92 $13,812 $13,225 $14,504
93 $15,525 $14,865 $16,285
94 $14,373 $13,762 $15,443
95 $16,937 $16,217 $18,140
96 $17,486 $16,743 $18,945
97 $19,112 $18,300 $20,686
98 $20,049 $19,196 $22,026
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
differs from that shown based on differences in inception date, fees and sales
charges. All Index and Fund performance assumes reinvestment of distributions.
<PAGE>
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NEW ENGLAND MASSACHUSETTS TAX FREE INCOME FUND
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AVERAGE ANNUAL TOTAL RETURNS -- 12/31/98
<TABLE>
<CAPTION>
CLASS A (Inception 3/23/84) 1 YEAR 5 YEARS 10 YEARS
<S> <C> <C> <C>
Net Asset Value(1) 4.9% 5.3% 7.2%
With Max. Sales Charge(2) 0.4 4.3 6.7
- ----------------------------------------------------------------------------------------------------
CLASS B (Inception 9/13/93) 1 YEAR 5 YEARS SINCE INCEPTION
Net Asset Value(1) 4.2% 4.5% 4.4%
With CDSC(3) -0.7 4.2 4.2
- ----------------------------------------------------------------------------------------------------
<CAPTION>
SINCE FUND'S
CLASS B
COMPARATIVE PERFORMANCE 1 YEAR 5 YEARS 10 YEARS INCEPTION
<S> <C> <C> <C> <C>
Lehman Municipal Bond Index(4) 6.5% 6.2% 8.2% 6.2%
Lipper MA Municipal Debt Average(6) 5.4 5.3 7.6 5.3
Morningstar Muni Single State Long Avg.(5) 5.4 5.3 7.5 5.2
- ----------------------------------------------------------------------------------------------------
</TABLE>
These returns represent past performance. Investment return and principal value
will fluctuate so that shares, upon redemption, may be worth more or less than
original cost. All index and Fund performance assumes reinvestment of
distributions.
YIELDS AS OF 12/31/98
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Class A Class B
SEC Yield(7) 4.6% 4.1%
Taxable Equivalent Yield(8) 8.7 7.7
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This Fund waived certain fees and expenses during the period indicated and the
Fund's average annual total returns and yields would have been lower had these
not been waived.
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 4.25% 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 Municipal Bond Index is an unmanaged index of bonds issued by states,
municipalities and other governmental entities having maturities of more than
one year. The Index performance has not been adjusted for ongoing management,
distribution and operating expenses and sales charges applicable to mutual
fund investments. Class B since inception return is calculated from 9/30/93.
(5)Morningstar Muni Single State Long 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 Morningstar Inc., an
independent mutual fund ranking service. Class B since inception return is
calculated from 9/30/93.
(6)Lipper Massachusetts Municipal Debt 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 Inc., an independent
mutual fund ranking service. Class B since inception return is calculated
from 9/30/93.
(7)SEC Yield is based on the Fund's net investment income over a 30-day period
and is calculated in accordance with Securities and Exchange Commission
guidelines.
(8)Taxable equivalent yield is based on the maximum combined federal and
Massachusetts state income tax bracket of 46.85%. The alternative minimum tax
and some other federal and state taxes may apply, which are not reflected
here.
<PAGE>
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NEW ENGLAND MASSACHUSETTS TAX FREE INCOME FUND
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QUESTIONS & ANSWERS WITH YOUR PORTFOLIO MANAGER
[Photo of James Welch]
Back Bay Advisors, L.P.
Q. How did New England Massachusetts Tax Free Income Fund perform over the past
12 months?
New England Massachusetts Tax Free Income Fund delivered a total return of 4.9%
for Class A shares at net asset value for the 12 months ending December 31,
1998. This included a $0.11 per share loss to $17.02 and the reinvestment of
$0.93 per share in distributions. In addition to its strong total return, your
Fund continued to provide a high level of tax-free income during the year. On
December 31, 1998, the Fund's 30-day yield for Class A shares was 4.6%, which
translates into a taxable equivalent yield of 8.7%, based on the maximum
combined federal and Massachusetts state income tax rate of 46.85%.
Q. What was the investment environment for Massachusetts municipal bonds during
the period?
The environment was favorable at both the state and national levels, setting
the stage for Massachusetts municipal bonds to generate attractive returns. In
addition, as an asset class, municipal bonds paid out extremely attractive
income relative to taxable bonds in 1998. During the year, the yields paid by
municipal bonds were as high as 95% to 100% of the yields of equivalent taxable
bonds. This meant that on an after-tax basis, municipal bond investors received
more income than they would have received from taxable bonds of comparable
quality and maturity. Historically, municipal bond yields have averaged about
85% of equivalent taxable bond yields.
The nation's positive economic and interest rate environment supported municipal
bond prices during the year. Moderate-to-strong economic growth and continued
minimal inflation in the United States paved the way for low interest rates. The
Federal Reserve Board cut short-term interest rates three times in the fall of
1998 -- for a total of 0.75% -- to stimulate the economy, and as a result, the
domestic stock markets. The combination of a sound economy and low interest
rates improved the fiscal health and creditworthiness of many municipalities.
Economic strength helped generate higher tax revenues, increasing the cash flow
of many state and local governments. Further, low interest rates often allowed
municipalities to refinance existing debt at more attractive levels, thus
lowering their borrowing costs.
CREDIT QUALITY COMPOSITION - 12/31/98
[graphic omitted]
AAA 49.5%
AA 8.9%
A 25.4%
BBB 8.7%
Other 7.5%
Quality is based on ratings supplied by Standard & Poor's Ratings Group.
Portfolio holdings are subject to change.
AVERAGE PORTFOLIO QUALITY = AA AVERAGE MATURITY = 19.3 YEARS
Municipal bonds generally suffered from greater supply than demand, however.
Investors mainly directed cash to U.S. Treasury securities and the stock
markets. In the summer of 1998, investor concerns about the stability of global
economies and financial markets fueled a "flight-to-quality" characterized by
extraordinary demand for those securities considered to have the highest degree
of safety and liquidity. Typically, demand (both domestic and international) is
greatest for the most recently issued U.S. Treasury securities. As a result of
this demand, the prices of Treasury securities rose, driving down yields.
Increased demand also drove municipal bond prices up -- pushing yields lower --
but less dramatically than U.S. Treasuries. While they are tax advantaged, the
generally lower-yielding nature of municipal bonds appeals to a smaller investor
audience -- meaning less widespread demand and therefore less price pressure.
In Massachusetts, the economy continued to flourish in 1998. Primarily service
based, the Commonwealth's economy was less affected by a slowdown in
manufacturing than more industrial-dependent states. Housing prices rose and the
state's work force grew. In addition, the Massachusetts unemployment rate fell
to an 11-year low. This economic strength helped generate higher tax revenues,
increasing the cash flow -- and improving the financial health -- of state and
local governments in Massachusetts.
Tax-exempt bond issuance remained heavy in Massachusetts as the Commonwealth and
its authorities embarked upon sizable projects to improve the state's
infrastructure. Typically, increased supply limits price appreciation by feeding
demand, keeping prices steady and yields at attractive levels. Refinancings also
helped to boost supply, with municipalities replacing older, higher-cost debt
with bonds issued in 1998's lower interest rate environment.
Q. What strategies did you use in managing the Fund?
Throughout the year, we took advantage of the Commonwealth's healthy fiscal
position, emphasizing bonds whose interest payments were derived from general
state or municipal revenues, such as taxes. These included general obligation
bonds and state-guaranteed securities. These bonds differ from revenue bonds,
whose interest payments are derived from specific revenue streams, such as
highway tolls.
We also focused on quality, investing in higher-rated bonds for the entire
fiscal period, because bonds with lower ratings provided little yield advantage.
Our other strategies reflected the two different interest rate environments that
existed last year. In the first half of the year, we invested in zero-coupon
bonds and bonds with lower coupons, because we expected interest rates to fall
- -- these bonds tend to have greater price appreciation potential in a declining
interest rate environment. In the second half of the year, we shifted our
strategy to reflect a greater orientation toward income. At that point, interest
rates had declined significantly and we believed there was little room for
additional price improvement. As of December 31, 1998, the Fund's average
quality was "AA," average maturity was 19.3 years and duration stood at 7.2
years -- a positioning similar to that at mid-year.
Duration and average maturity are two measures of a bond's price sensitivity to
interest rate changes. In general, the longer a bond's duration or average
maturity, the greater potential for price appreciation when interest rates fall
and conversely, the greater the risk of price loss when interest rates rise.
During 1998 when interest rates generally fell, the portfolio's longer duration
and average maturity enhanced the Fund's total return.
We emphasized bonds in the 20-year maturity range to maximize yield. Bond
issuance was heavier for bonds with longer maturities. The increased supply of
these longer-maturity bonds kept yields attractive as issuers competed for
investors' dollars. We also believed that investing in those maturities
increased appreciation potential.
In the second half of the year, we reduced the Fund's investment in the health
care sector and emphasized general obligation bonds. This positioning helped
increase the Fund's potential to benefit from the favorable economic and fiscal
climate in the Commonwealth.
Q. What is your outlook for Massachusetts municipal bonds over the next few
months?
Our outlook for Massachusetts municipal bonds is positive for the coming months.
We anticipate the favorable investment environment in the United States --
including moderate economic growth accompanied by minimal inflation -- to
continue. We also think that ongoing concerns about global economies will help
keep interest rates low.
The events of the past year have reinforced the importance of quality, liquidity
and diversification in a well-rounded investor portfolio. In 1998, municipal
bonds generated solid returns and maintained a high degree of price stability.
Their merit is underscored considering the tax advantage they provide and the
attractive yield advantage they offer over U.S. Treasuries. With a favorable
outlook for the economy, interest rates and the fiscal health of Massachusetts
municipalities, we think the future could be bright for the tax-exempt sector.
A portion of income may be subject to state, federal and/or alternative minimum
tax. Capital gains, if any, are subject to capital gains tax. U.S. Treasury
bills and U.S. government bonds fluctuate in value, but they are guaranteed as
to the timely payment of interest and, if held to maturity, provide a guaranteed
return of principal. The opinions expressed are those of the portfolio manager
and are subject to change. The occurrence of forecasted events and predictions
is not certain and cannot be assured. See the Fund's prospectus for more
complete information.
<PAGE>
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PORTFOLIO COMPOSITION
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Investments as of December 31, 1998
TAX EXEMPT OBLIGATIONS--99.1% OF TOTAL NET ASSETS
<TABLE>
<CAPTION>
RATINGS (c)
(UNAUDITED)
-------------------------
FACE STANDARD
AMOUNT ISSUER MOODY'S & POOR'S VALUE (a)
- -------------------------------------------------------------------------------------------------
<C> <S> <C> <C> <C>
GUAM--4.9%
$1,500,000 Airport Authority Revenue Bond, Series B,
6.600%, 10/01/2010 ...................... -- BBB $ 1,647,720
4,000,000 Housing Corporation, Single Family
Mortgage, Series A,
5.750%, 9/01/2031, (FHLMC) ............. -- AAA 4,336,960
------------
5,984,680
------------
MASSACHUSETTS MUNICIPAL--4.4%
1,000,000 Haverhill, Series A, 7.000%, 6/15/2012,
(FGIC) .................................. Aaa AAA 1,123,320
1,500,000 Wholesale Electric, 6.750%, 7/01/2008 .... Baa2 BBB+ 1,621,815
2,500,000 Wholesale Electric, 6.750%, 7/01/2011 .... Baa2 BBB+ 2,692,125
------------
5,437,260
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MASSACHUSETTS STATE HEALTH & EDUCATION
FACILITY AUTHORITY--30.9%
2,450,000 Amherst College Series G, 5.375%,
11/01/2020 .............................. Aa1 AA+ 2,518,502
1,500,000 Beverly Hospital Ribs, 7.590%, 6/18/2020,
(MBIA) (d) ............................. Aaa AAA 1,705,455
3,000,000 Boston University Ribs, Series L,
9.436%, 10/01/2031, (MBIA) (d) ......... Aaa AAA 3,543,870
2,500,000 Brandeis University Series I, 4.750%,
10/01/2028, (MBIA) ..................... Aaa AAA 2,392,425
1,750,000 Charlton Memorial Hospital, Series B,
7.250%, 7/01/2013 ...................... A1 A 1,930,407
3,000,000 Dana Farber, Series G-1, 6.250%,
12/01/2022 .............................. A1 A 3,264,660
1,000,000 Faulkner Hospital, Series C, 6.000%,
7/01/2013 ............................... Baa1 -- 1,058,210
4,000,000 Harvard University Series N, 6.250%,
4/01/2020(e) ............................ Aaa AAA 4,742,880
2,400,000 Medical Center of Central Mass., Class A,
7.000%, 7/01/2012 ....................... A3 -- 2,633,280
1,000,000 New England Baptist Hospital, Series B,
7.300%, 7/01/2011 ....................... Baa1 AAA 1,104,270
1,220,000 New England Deaconess Hospital, Series D,
6.875%, 4/01/2022, (AMBAC) ............. Aaa AAA 1,358,690
1,190,000 New England Medical Center, Series F,
6.625%, 7/01/2025, (FGIC) ............... Aaa AAA 1,300,004
2,000,000 North Adams Regional Hospital, Series C,
6.750%, 7/01/2009 ....................... -- BBB- 2,182,220
4,340,000 Saints Memorial Medical Center, Series A,
6.000%, 10/01/2023 ...................... B1 -- 4,356,188
1,500,000 Valley Regional Health System, Series B,
Pre-refunded, 8.000%, 7/01/2018 ........ Aaa -- 1,628,850
1,000,000 Valley Regional Health System, Series C,
6.250%, 7/01/2011, (Connie Lee) ........ -- AAA 1,154,370
1,000,000 Wentworth Institute of Technology, Series
A, 7.400%, 4/01/2010, (AMBAC) .......... Aaa AAA 1,068,400
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37,942,681
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MASSACHUSETTS STATE HOUSING FINANCE
AGENCY--12.2%
555,000 Multifamily Residential Development, Series
A, 7.650%, 2/01/2028, (FNMA) ........... Aaa AAA 577,122
2,000,000 Residential Development, Series A, 6.900%,
11/15/2024, (FNMA) ...................... Aaa AAA 2,180,400
2,500,000 Residential Development, Series E, 6.250%,
11/15/2012, (FNMA) ...................... Aaa AAA 2,696,250
1,300,000 Residential Development, Series I, 6.900%,
11/15/2025, (FNMA) ...................... Aaa AAA 1,409,278
2,835,000 Single Family Mortgage, Series 13, 7.950%,
6/01/2023 .............................. Aa A+ 2,973,944
3,000,000 Single Family Mortgage, Series 21, 7.125%,
6/01/2025 .............................. Aa A+ 3,204,870
1,910,000 Single Family Mortgage, Series 32, 6.600%,
12/01/2026 ............................. Aa A+ 2,033,004
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15,074,868
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MASSACHUSETTS STATE INDUSTRIAL FINANCE
AGENCY--9.6%
2,000,000 FHA Briscoe House Assisted Living, 7.125%,
2/01/2036 .............................. -- AAA 2,311,040
1,500,000 New England Center For Children
Development, 5.875%, 11/01/2018 ........ Ba2 BB 1,543,740
5,000,000 Newton Group Property's Project, 8.000%,
9/01/2027 .............................. -- -- 5,579,550
2,500,000 Tufts University Series H, 4.750%, 2/15/
2028 (MBIA) ............................ Aaa AAA 2,393,475
------------
11,827,805
------------
MASSACHUSETTS STATE TURNPIKE AUTHORITY-- 5.1%
2,000,000 Capital Appreciation, Senior Series A,
5.000%, 1/01/2037, (MBIA) ............... Aaa AAA 1,946,920
10,000,000 Metropolitan Highway System, Capital
Appreciation Senior Series C,
Zero Coupon, 1/01/2016, (MBIA) .......... Aaa AAA 4,343,600
------------
6,290,520
------------
MASSACHUSETTS WATER RESOURCE AUTHORITY-- 5.7%
3,200,000 General Refunding, Series B, 5.000%,
3/01/2022, (MBIA) ...................... Aaa AAA 3,165,152
3,240,000 Series A, 6.500%, 7/15/2019 .............. A1 A 3,845,264
------------
7,010,416
------------
OTHER MASSACHUSETTS OBLIGATIONS--13.0%
2,000,000 Consolidated Loan, Series A, 7.625%,
6/01/2008 ............................... Aaa AA- 2,220,320
3,150,000 Massachusetts Development Finance Agency,
5.900%, 11/01/2018 ..................... Ba2 -- 3,149,685
1,040,000 Massachusetts Educational Loan Authority,
7.250%, 1/01/2009, (MBIA) .............. Aaa AAA 1,096,493
5,000,000 Massachusetts State Refunding, Series A,
6.500%, 11/01/2014, (AMBAC) ............ Aaa AAA 6,033,750
3,000,000 New England Educational Loan, Sub-Issue H,
6.900%, 11/01/2009 ..................... A3 -- 3,490,710
------------
15,990,958
------------
PUERTO RICO--10.5%
4,000,000 Aqueduct & Sewer Authority, 6.250%,
7/01/2013 ............................... Baa1 A 4,659,880
1,160,000 Aqueduct & Sewer Authority, 10.250%,
7/01/2009 ............................... Aaa AAA 1,581,532
2,000,000 Aqueduct & Sewer Authority, Refunding Bond,
6.250%, 7/01/2012 ...................... Baa1 A 2,335,480
4,125,000 Commonwealth Highway & Transportation,
Series Y, 5.500%, 7/01/2026 ............ Baa1 A 4,295,074
------------
12,871,966
------------
VIRGIN ISLANDS--2.8%
3,045,000 Public Financial Authority, Series A,
7.250%, 10/01/2018 ..................... -- AAA 3,477,573
------------
Total Tax Exempt Obligations (Identified
Cost $113,575,841) .............. 121,908,727
------------
OPTIONS--0.1%
- -------------------------------------------------------------------------------------------------
100 U.S. Treasury Bonds, 128 Call,
February 1999 ............................ 112,500
-----------
112,500
Total Options (Identified Cost $94,150) ... -----------
SHORT TERM INVESTMENT--0.2%
- ------------------------------------------------------------------------------------------------
204,000 Household Finance Corp., 5.000%,
1/04/1999 ................................ 203,915
-----------
Total Short Term Investment (Identified
Cost $203,915) ........................... 203,915
Total Investments--99.4% (Identified Cost -----------
$113,873,906) (b) ........................ 122,225,142
Other assets less liabilities ............ 710,752
-----------
Total Net Assets--100% ............ $122,935,894
============
<CAPTION>
WRITTEN OPTIONS
UNREALIZED
CONTRACTS DESCRIPTION DEPRECIATION
- --------------------------------------------------------------------------------
100 U.S. Treasury Bond Futures, 130 Call,
February 1999 ................................ $ (8,213)
==========
(a) See Note 1a of Notes to Financial Statements.
(b) Federal Tax Information: At December 31, 1998 the net unrealized
appreciation on investments based on cost of $113,885,376 for
federal income tax purposes was as follows:
Aggregate gross unrealized appreciation for all investments in
which there is an excess of value over tax cost .................. $8,342,244
Aggregate gross unrealized depreciation for all investments in
which there is an excess of tax cost over value .................. (2,478)
----------
Net unrealized appreciation ...................................... $8,339,766
==========
(c) The ratings shown are believed to be the most recent ratings
available at December 31, 1998. Securities are generally rated at
the time of issuance. The rating agencies may revise their ratings
from time to time. As a result there can be no assurance that the
same ratings would be assigned if the securities were rated at
December 31, 1998. The Fund's advisor independently evaluates the
Fund's portfolio securities and in making investment decisions
does not rely solely on the ratings of agencies.
(d) Inverse floating rate security.
(e) A portion of this security has been segregated as collateral in
connection with the Fund's derivative investments at December 31,
1998.
</TABLE>
Legend of Portfolio abbreviations:
AMBAC -- American Municipal Bond Assurance Corp.
Connie Lee -- College Construction Loan Insurance Association
FGIC -- Financial Guarantee Insurance Company
FHLMC -- Federal Home Loan Mortgage Corporation
FNMA -- Federal National Mortgage Association
MBIA -- Municipal Bond Investors Assurance Corp.
Rib -- Residual Interest Bond
<PAGE>
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STATEMENT OF ASSETS & LIABILITIES
- --------------------------------------------------------------------------------
December 31, 1998
<TABLE>
<CAPTION>
ASSETS
<S> <C> <C>
Investments at value (Identified cost $113,873,906) ...... $122,225,142
Cash ..................................................... 233
Receivable for:
Fund shares sold ....................................... 35,004
Securities sold ........................................ 957,258
Accrued interest ....................................... 2,010,831
------------
125,228,468
LIABILITIES
Payable for:
Securities purchased ................................... $1,948,310
Closed futures ......................................... 5,594
Written options - (proceeds of $38,662) ................ 46,875
Fund shares redeemed ................................... 49,555
Dividends declared ..................................... 83,782
Accrued expenses:
Management fees ........................................ 84,474
Deferred trustees' fees ................................ 11,824
Accounting and administrative .......................... 3,484
Other expenses ......................................... 58,676
----------
2,292,574
------------
NET ASSETS ................................................. $122,935,894
============
Net Assets consist of:
Capital paid in ........................................ $116,642,337
Undistributed net investment income .................... 3,547
Accumulated net realized gains (losses) ................ (2,053,013)
Unrealized appreciation (depreciation) on investments
and options .......................................... 8,343,023
------------
NET ASSETS ................................................. $122,935,894
============
Computation of net asset value and offering price:
Net asset value and redemption price of Class A shares
($113,909,915 divided by 6,693,020 shares of beneficial
interest) .............................................. $17.02
======
Offering price per share (100/95.75 of $17.02) ............. $17.78*
======
Net asset value and offering price of Class B shares
($9,025,979 divided by 531,414 shares of beneficial
interest) .............................................. $16.98**
======
* Based upon single purchases of less than $50,000.
Reduced sales charges apply for purchases in excess of this amount.
**Redemption price per share is equal to net asset value less any applicable
contingent deferred sales charges.
</TABLE>
See accompanying notes to financial statements
<PAGE>
- --------------------------------------------------------------------------------
STATEMENT OF OPERATIONS
- --------------------------------------------------------------------------------
Year Ended December 31, 1998
<TABLE>
<CAPTION>
INVESTMENT INCOME
<S> <C> <C>
Interest ................................................... $7,169,136
Expenses
Management fees .......................................... $ 704,088
Service and distribution fees - Class A .................. 394,314
Service and distribution fees - Class B .................. 81,564
Trustees' fees and expenses .............................. 10,242
Accounting and administrative ............................ 35,876
Custodian ................................................ 90,515
Transfer agent ........................................... 237,528
Audit and tax services ................................... 27,000
Legal .................................................... 5,239
Printing ................................................. 33,915
Registration ............................................. 15,010
Miscellaneous ............................................ 6,420
----------
Total expenses ............................................. 1,641,711
Less expenses waived by the investment adviser and
subadvisor ............................................... (380,516) 1,261,195
---------- ----------
Net investment income ...................................... 5,907,941
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS,
WRITTEN OPTIONS AND FUTURES CONTRACTS
Realized gain (loss) on:
Investments - net ........................................ 1,423,430
Futures contracts - net .................................. (806,544)
Written options contracts - net .......................... 14,594
----------
Total realized gain (loss) on investments, written options
and futures contracts .................................... 631,480
----------
UNREALIZED APPRECIATION (DEPRECIATION) ON:
Investments - net ........................................ (842,267)
Written options - net .................................... (20,313)
Futures contracts - net .................................. 92,543
----------
Total unrealized appreciation (depreciation) on investments,
written options and futures contracts .................... (770,037)
----------
Net gain (loss) on investment transactions ................. (138,557)
----------
NET INCREASE (DECREASE) IN NET ASSETS FROM OPERATIONS ........ $5,769,384
==========
See accompanying notes to financial statements
</TABLE>
<PAGE>
- --------------------------------------------------------------------------------
STATEMENT OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1997 1998
---- ----
FROM OPERATIONS
<S> <C> <C>
Net investment income ................................... $ 6,071,200 $ 5,907,941
Net realized gain (loss) on investments, written options
and futures contracts ................................. 275,884 631,480
Unrealized appreciation (depreciation) on investments,
written options and futures contracts ................. 4,160,896 (770,037)
------------ ------------
Increase (decrease) in net assets from operations ....... 10,507,980 5,769,384
------------ ------------
FROM DISTRIBUTIONS TO SHAREHOLDERS
Net investment income
Class A ............................................... (5,774,640) (5,592,703)
Class B ............................................... (314,984) (353,477)
Net realized gain on investments
Class A ............................................... 0 (546,044)
Class B ............................................... 0 (43,269)
------------ ------------
(6,089,624) (6,535,493)
------------ ------------
Increase (decrease) in net assets derived from capital
share transactions .................................... (3,526,289) 2,433,927
------------ ------------
Total increase (decrease) in net assets ................. 892,067 1,667,818
NET ASSETS
Beginning of the year ................................... 120,376,009 121,268,076
------------ ------------
End of the year ......................................... $121,268,076 $122,935,894
============ ============
UNDISTRIBUTED (DISTRIBUTIONS IN EXCESS OF)
NET INVESTMENT INCOME
End of the year ......................................... $ (41,118) $ 3,547
============ ============
</TABLE>
<PAGE>
- --------------------------------------------------------------------------------
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS A
-----------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------------------------
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Year ..... $17.27 $15.10 $16.85 $16.50 $17.13
------ ------ ------ ------ ------
Income From Investment Operations
Net Investment Income .................. 0.89 0.88 0.87 0.86 0.86
Net Realized and Unrealized Gain (Loss)
on Investments ....................... (2.15) 1.76 (0.35) 0.63 (0.04)
------ ------ ------ ------ ------
Total From Investment Operations ....... (1.26) 2.64 0.52 1.49 0.82
------ ------ ------ ------ ------
Less Distributions
Distributions From Net Investment
Income ............................... (0.89) (0.89) (0.87) (0.86) (0.85)
Distributions in Excess of Net
Investment Income .................... (0.02) 0.00 0.00 0.00 0.00
Distributions From Net Realized Gains .. 0.00 0.00 0.00 0.00 (0.08)
------ ------ ------ ------ ------
Total Distributions .................... (0.91) (0.89) (0.87) (0.86) (0.93)
------ ------ ------ ------ ------
Net Asset Value, End of Year ........... $15.10 $16.85 $16.50 $17.13 $17.02
====== ====== ====== ====== ======
Total Return (%) (b) ................... (7.4) 17.8 3.2 9.3 4.9
Ratio of Operating Expenses to Average
Net Assets (%) (a) ................... 0.85 0.85 0.90 1.00 1.00
Ratio of Net Investment Income to
Average Net Assets (%) ............... 5.63 5.46 5.31 5.17 4.93
Portfolio Turnover Rate (%) ............ 48 127 140 132 125
Net Assets, End of Year (000) .......... $107,565 $120,229 $112,934 $113,869 $113,910
(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 (%) ........................... 1.24 1.24 1.27 1.29 1.31
(b) A sales charge is not reflected in
total return calculations.
</TABLE>
See accompanying notes to financial statements
<PAGE>
<TABLE>
<CAPTION>
CLASS B
-----------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------------------------
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Year ..... $17.26 $15.08 $16.82 $16.47 $17.09
------ ------ ------ ------ ------
Income From Investment Operations
Net Investment Income .................. 0.77 0.78 0.75 0.76 0.74
Net Realized and Unrealized Gain (Loss)
on Investments ....................... (2.14) 1.74 (0.34) 0.62 (0.03)
------ ------ ------ ------ ------
Total From Investment Operations ....... (1.37) 2.52 0.41 1.38 0.71
------ ------ ------ ------ ------
Less Distributions
Distributions From Net Investment
Income ............................... (0.79) (0.78) (0.76) (0.76) (0.74)
Distributions in Excess of Net
Investment Income .................... (0.02) 0.00 0.00 0.00 0.00
Distributions From Net Realized Gains .. 0.00 0.00 0.00 0.00 (0.08)
------ ------ ------ ------ ------
Total Distributions .................... (0.81) (0.78) (0.76) (0.76) (0.82)
------ ------ ------ ------ ------
Net Asset Value, End of Year ........... $15.08 $16.82 $16.47 $17.09 $16.98
====== ====== ====== ====== ======
Total Return (%) (b) ................... (8.0) 17.0 2.6 8.6 4.2
Ratio of Operating Expenses to Average
Net Assets (%) (a) ................... 1.50 1.50 1.55 1.65 1.65
Ratio of Net Investment Income to
Average Net Assets (%) ............... 4.98 4.81 4.66 4.52 4.28
Portfolio Turnover Rate (%) ............ 48 127 140 132 125
Net Assets, End of Year (000) .......... $4,523 $6,697 $7,442 $7,399 $9,026
(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 (%) ........................... 1.89 1.89 1.92 1.94 1.96
(b) A contingent deferred sales charge
is not reflected in total return
calculations.
</TABLE>
See accompanying notes to financial statements
<PAGE>
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
December 31, 1998
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 exempt from federal
income tax and Massachusetts personal income tax. The Declaration of Trust
permits the trustees to issue an unlimited number of shares of the Trust in
multiple series (each such series of shares is 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 4.25%. 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 original issue discount. Interest income is reduced by the
amortization of premium. In determining net gain or loss on securities sold,
the cost of securities has been determined on the identified cost basis.
C. OPTIONS. The Fund uses options to hedge against changes in the values of
securities the Fund owns or expects to purchase. Writing puts and buying calls
tends to increase the Fund's exposure to the underlying instrument and writing
calls or buying puts tends to decrease the Fund's exposure to the underlying
instrument, or hedge other Fund investments.
For options purchased to hedge the Fund's investments, the potential risk to
the Fund is that the change in value of options contracts may not correspond
to the change in value of the hedged instruments. In addition, losses may
arise from changes in the value of the underlying instruments, if there is an
illiquid secondary market for the contracts, or if the counterparty is unable
to perform. The maximum loss for purchased options is limited to premium
initially paid for the option. For options written by the Fund, the maximum
loss is not limited to the premium initially received for the option.
Exchange traded options are valued at the last sale price, or if no sales are
reported, the last bid price for purchased options and the last ask price for
written options. Options traded over the counter are valued using prices
supplied by dealers.
D. INTEREST RATE FUTURES CONTRACTS. The Fund may purchase and sell interest
rate futures contracts to hedge against changes in the values of tax exempt
municipal securities the Fund owns or expects to purchase. An interest rate
futures contract is an agreement between two parties to buy and sell a
security for a set price (or to deliver an amount of cash) on a future date.
Upon entering into such a contract, the purchasing Fund is required to pledge
to the broker an amount of cash, U.S. Government securities or other high
quality debt securities equal to the minimum "initial margin" requirements of
the exchange. Pursuant to the contract, the Fund agrees to receive from or pay
to the broker an amount of cash equal to the daily fluctuation in value of the
contract. Such receipts or payments are known as "variation margin," and are
recorded by the Fund as unrealized gains or losses. When the contract is
closed, the Fund records a realized gain or loss equal to the difference
between the value of the contract at the time it was opened and the value at
the time it was closed.
The potential risk to the Fund is that the change in value of futures
contracts primarily corresponds with the value of underlying instruments which
may not correspond to the change in the value of the hedged instruments. In
addition, there is a risk that the Fund may not be able to close out its
futures positions due to an illiquid secondary market.
E. 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.
F. 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
are primarily due to differing treatments of market discount for book and tax
purposes. Permanent book and tax basis differences relating to shareholder
distributions will result in reclassification to paid in capital.
G. 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 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. PURCHASES AND SALES OF SECURITIES. For the year ended December 31, 1998
purchases and sales of securities (excluding short-term investments) were
$151,923,156 and $149,734,268, respectively.
Transactions in written options for the year ended December 31, 1998 are
summarized as follows:
WRITTEN OPTIONS
-------------------------------
NUMBER OF PREMIUMS
CONTRACTS RECEIVED
--------- --------
Open at December 31, 1997 (100) $ (63,663)
Contracts opened (1,950) (1,069,556)
Contracts closed 1,950 1,094,557
----- -----------
Open at December 31, 1998 (100) $ (38,662)
==== ===========
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 0.60% of the first $100 million of the Fund's
average daily net assets and 0.50% of such assets in excess of $100 million.
NEFM pays the Fund's investment subadviser, Back Bay Advisors L.P. ("Back Bay
Advisors"), at the rate of 0.30% of the first $100 million of the Fund's
average daily net assets and 0.25% of such assets in excess of $100 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"), formerly known as New England Investment Companies,
L.P., 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, 1998 are as follows:
FEES EARNED(a)
- --------------
$352,044 NEFM
$352,044 Back Bay Advisors
(a) Before reduction pursuant to voluntary expense limitations. See note 4.
The effective management fee for the year ended December 31, 1998 was 0.58%.
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, and 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, 1998 these
expenses amounted to $35,876 and are shown separately in the financial
statements as accounting and administrative.
C. SERVICE AND DISTRIBUTION FEES. Pursuant to Rule 12b-1 under the 1940 Act,
the Trust has adopted a Service and Distribution 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 Plans, 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 and Class B shares, as reimbursement 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 A and Class B shares and/or the
maintenance of shareholder accounts. For the year ended December 31, 1998, the
Fund paid New England Funds $281,620 and $20,391 in service fees for Class A
and Class B shares, respectively.
Also under the Plans, the Fund pays New England Funds monthly distribution
fees at the annual rate of 0.10% of the average daily net assets attributable
to the Fund's Class A shares and 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 A and Class B shares,
respectively. For the year ended December 31, 1998, the Fund paid New England
Funds $112,694 and $61,173 in distribution fees for Class A and Class B
shares, respectively.
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, 1998, amounted to $204,743.
D. TRANSFER AGENT FEES. New England Funds Service Corporation ("NEFSCO") is
the transfer and shareholder servicing agent to the Fund and Boston Financial
Data Services serves as a sub-transfer agent for the Fund. For the year ended
December 31, 1998, the Fund paid NEFSCO $168,188 as compensation for its
services in that capacity. For the year ended December 31, 1998, the Fund
received $2,574 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 $745
Meeting Fee 152/meeting
Annual Committee Member Retainer 112
Annual Committee Chairman Retainer 74
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. Effective September 1, 1996 until further notice to
the Fund, Back Bay Advisors and NEFM have voluntarily agreed to reduce their
management fees and, if necessary, to assume expenses of the Fund in order to
limit the Fund's expenses to an annual rate of 1.00% of the Fund's Class A
average daily net assets, and 1.65% of Class B average daily net assets. Prior
to this, effective May 1, 1991, Back Bay Advisors and NEFM had voluntarily
agreed to reduce their management fees and, if necessary, to assume expenses
of the Fund in order to limit the Fund's expenses to an annual rate of 0.85%
of the Fund's Class A average daily net assets and, effective September 13,
1993, 1.50% of Class B average daily net assets. As a result of the Fund's
expenses exceeding the applicable voluntary expense limitation during the year
ended December 31, 1998, Back Bay Advisors reduced its subadvisory fee of
$352,044 by $190,258 and NEFM reduced its advisory fee of $352,044 by
$190,258.
5. CONCENTRATION OF CREDIT. The Fund primarily invests in debt obligations
issued by the Commonwealth of Massachusetts and its political subdivisions,
agencies and public authorities to obtain funds for various public purposes.
The Fund is more susceptible to factors adversely affecting issuers of
Massachusetts municipal securities than is a comparable municipal bond fund
that is not so concentrated. Uncertain economic and fiscal conditions may
affect the ability of issuers of Massachusetts municipal securities to meet
their financial obligations. The Fund had the following industry
concentrations in excess of 10% on December 31, 1998 as a percentage of the
Fund's total net assets: College (19.0%), Housing (15.8%), Hospital (15.6),
and Water and Sewer (12.2). The Fund had (16.9%) of its total net assets
insured by Municipal Bond Investors Assurance Corporation (MBIA) at December
31, 1998.
6. CAPITAL SHARES. At December 31, 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 YEAR ENDED
DECEMBER 31, 1997 DECEMBER 31, 1998
--------------------------------- --------------------------------
CLASS A SHARES AMOUNT SHARES AMOUNT
- ------- -------------- ----------- -------------- ---------------
<S> <C> <C> <C> <C>
Shares sold .......................... 792,988 $13,125,655 1,003,641 $17,141,843
Shares issued in connection with
the reinvestment of:
Distributions from net investment
income ............................. 256,070 4,279,009 234,443 3,998,786
Distributions from net
realized gain ..................... 0 0 25,725 437,073
---------- ----------- ---------- -----------
1,049,058 17,404,664 1,263,809 21,577,702
Shares repurchased ................... (1,243,295) (20,634,447) (1,219,436) (20,828,010)
---------- ----------- ---------- -----------
Net increase (decrease) .............. (194,237) $(3,229,783) 44,373 $ 749,692
---------- ----------- ---------- -----------
<CAPTION>
YEAR ENDED YEAR ENDED
DECEMBER 31, 1997 DECEMBER 31, 1998
--------------------------------- ---------------------------------
CLASS B SHARES AMOUNT SHARES AMOUNT
- ---- -------------- --------------- -------------- ---------------
<S> <C> <C> <C> <C>
Shares sold .......................... 79,890 $ 1,325,027 139,399 $ 2,380,236
Shares issued in connection with
the reinvestment of:
Distributions from net investment
income ............................. 14,270 238,056 15,918 271,316
Distributions from net
realized gain ..................... 0 0 2,236 37,896
-------- ------------ ------- ------------
94,160 1,563,083 157,553 2,689,448
Shares repurchased ................... (113,037) (1,859,589) (58,973) (1,005,213)
-------- ------------ ------- ------------
Net increase (decrease) .............. (18,877) $ (296,506) 98,580 $ 1,684,235
-------- ------------ ------- ------------
Increase (decrease) derived from
capital shares transactions ........ (213,114) $(3,526,289) 142,953 $ 2,433,927
======== =========== ======= =============
</TABLE>
<PAGE>
- --------------------------------------------------------------------------------
REPORT OF INDEPENDENT ACCOUNTANTS
- --------------------------------------------------------------------------------
To the Trustees of New England Funds Trust II and the Shareholders of
NEW ENGLAND MASSACHUSETTS TAX FREE INCOME FUND
In our opinion, the accompanying statement of assets and 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 the New England Massachusetts
Tax Free Income Fund (the "Fund"), a series of New England Funds Trust II, at
December 31, 1998, and the results of its operations, the changes in its net
assets and the financial highlights for the periods indicated, in conformity
with generally accepted accounting principles. These financial statements and
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 audits. We conducted our
audits 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 audits, which included confirmation of securities at December 31, 1998 by
correspondence with the custodian and brokers, provide a reasonable basis for
the opinion expressed above.
PricewaterhouseCoopers LLP
Boston, Massachusetts
February 15, 1999
<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>
- --------------------------------------------------------------------------------
NEW ENGLAND FUNDS
- --------------------------------------------------------------------------------
LARGE-CAP EQUITY FUNDS
Capital Growth Fund
Growth Fund
Growth Opportunities Fund
Balanced Fund
Value Fund
ALL-CAP EQUITY FUNDS
Star Advisers Fund
Star Worldwide Fund
International Equity Fund
Bullseye Fund
Equity Income Fund
SMALL-CAP EQUITY FUNDS
Star Small Cap Fund
CORPORATE INCOME FUNDS
Short Term Corporate Income Fund
(formerly Adjustable Rate U.S. Government Fund)
Bond Income Fund
High Income Fund
Strategic Income Fund
GOVERNMENT INCOME FUNDS
Limited Term U.S. Government Fund
Government Securities Fund
TAX-FREE INCOME FUNDS
Municipal Income Fund
Intermediate Term Tax Free Fund of California
Tax Free Income Fund of New York
(formerly Intermediate Term Tax Free Fund of NY)
Massachusetts Tax Free Income Fund
MONEY MARKET FUNDS
Cash Management Trust
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
800-289-9999 or by visiting their Web site at
www.NASDR.com.
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399 Boylston Street
Boston, Massachusetts
02116
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MA56-1298
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