PAGE 1
- ------------------------------------
Keystone Diversified Bond Fund (B-2)
Seeks generous income and capital preservation from a broad spectrum of
bonds.
Dear Shareholder:
We are writing to report to you on the activities of Keystone Diversified
Bond Fund (B-2) for the six-month period which ended February 29, 1996.
Performance
Your Fund returned 3.30% for the six-month period and 9.77% for the
twelve-month period. The Lehman Aggregate Bond Index, a broad-based index of
corporate, government and mortgage-backed securities, returned 4.12% for the
six-month period and 12.24% for the twelve-month period. These returns
included both income and changes in prices. We believe this positive
performance was the result of your Fund's flexible investment style as well
as the bond market's favorable performance during the six-month period.
Bond investors faced two different environments over the six month period.
In September 1995, the bond market was building momentum that was driven by a
positive outlook for slow U.S. economic growth and low inflation, and by
interest rate cuts in Japan. Cash was plentiful in the global markets and
poured in to the U.S. bond market. With such strong demand, yields fell close
to historically low levels.
The market's focus changed towards the end of 1995, however. Interest rates
began to climb, causing bond prices to decline. In the U.S., budget gridlock,
uncertainty about the upcoming election year and the unwinding of large
leveraged transactions by some bond market participants all contributed to a
new environment.
In February 1996, bond prices declined as a result of comments from Federal
Reserve Board Chairman Alan Greenspan who expected a moderate growth and
stable inflation environment. Mr. Greenspan's testimony and subsequent
economic reports tend to support the view that the economy is not as weak as
was previously thought; that short-term interest rates may not need to be
reduced; and that long-term rates may have bottomed for this cycle.
We think that interest rates may continue to drift a bit higher over the
near term, as investors wait for a clearer picture of the economy. Longer
term, however, we expect to see a continuation of a low inflation and
moderate economic growth environment. We believe this should result in an
improving climate for bonds over the coming months.
The flexible investment approach that we employed with Keystone Diversified
Bond Fund (B-2), played a key role in your Fund's performance during the
six-month period. Your Fund was largely invested in domestic fixed income
securities, which included primarily corporate bonds, mortgage-backed
securities, and U.S. government and agency issues. The high yield bond
component of the Fund stood at 32% of portfolio assets at the end of the
period.
During the six-month period, we continued to upgrade the credit quality of
the high yield portion of your Fund. On February 29, 1996, investments in the
top two credit categories of the high yield sector accounted for 71% of our
high yield holdings, versus 47% on August 31, 1995. The Fund's average
maturity stood at thirteen years at the end of the period.
Further, we reduced holdings in U.S. government and corporate bonds and
added selected foreign government bonds of Canada, Germany and Spain. These
countries have stable governments, good economic fundamentals and liquid
securities markets. We believed these bonds would offer attractive total
returns and consistent performance.
--continued--
<PAGE>
PAGE 2
- ------------------------------------
Keystone Diversified Bond Fund (B-2)
Our outlook
We believe the environment continues to be attractive for income-oriented
investors. "Real" interest rates, or the rate received by investors after
inflation is subtracted, have been historically high. From that standpoint,
we think bonds have provided good values. We also expect that the state of
the economy will again become investors' primary focus, while the bond market
may be influenced by some temporary factors including election year rhetoric.
We look for slow to moderate growth, with continued low inflation.
We believe your Fund's diversification and flexibility should provide the
opportunity for relatively attractive income and returns. Combined with our
careful credit analysis, we think that your Fund's ability to be flexible
should be valuable as market conditions change.
Thank you for your continued support of Keystone Diversified Bond Fund
(B-2). If you have any questions or comments about your Keystone investment,
we encourage you to write to us.
Sincerely,
/s/ Albert H. Elfner, III
Albert H. Elfner, III
Chairman and President
Keystone Investments, Inc.
/s/George S. Bissell
George S. Bissell
Chairman of the Board
Keystone Funds
April 1996
{Photo of Albert H. Elfner, III]
Albert H. Elfner, III
[Photo of George S. Bissell]
George S. Bissell
Keystone Introduces Investment Insight Line for Shareholders
Now you can keep up-to-date on your fund's current strategy and outlook by
calling Keystone Investment Insight Line. You can hear senior portfolio
manager Chris Conkey discuss his latest strategy for Keystone's high grade
bond funds. You can also listen to Keystone's overall market outlook from
James McCall, chief investment officer. The service is available 24 hours a
day, seven days a week and updated at least monthly.
Keystone Investment Insight Line 1-800-346-3858, Press 2
Keystone Fixed-Income Update Press 3
<PAGE>
PAGE 3
- ------------------------------------
A Discussion With
Your Fund Manager
[Photo of Christopher P. Conkey]
Christopher P. Conkey is senior portfolio manager of your Fund and
leads Keystone's high grade bond team. A Chartered Financial
Analyst, Mr. Conkey has 12 years of experience managing fixed-income
investments. He holds a BA in economics from Clark University and
an MBA in finance from Boston University.
Your Fund's investment team is comprised of senior high grade
portfolio manager Barbara McCue, high yield portfolio man-
ager Kristine Cloyes and international portfolio manager
Gilman Gunn, who evaluate credit quality and the economic
environment in selecting bonds for your Fund.
Q What factors shaped the bond market over the last six months?
A The market environment can be broken down into two time frames during this
period. Between September and November 1995, momentum towards lower rates was
building. This was prompted by an outlook for slow economic growth and low
inflation here in the U.S., as well as interest rate cuts overseas. Investors
were able to borrow at very low rates in Japan and reinvest globally at
higher rates. "Cheap money" flooded the global markets and poured heavily
into the U.S. bond market, driving bond prices higher. Also, the U.S. dollar
was appreciating, investors benefitted in two ways.
Hedge fund investors were active in this environment. Hedge funds are
unregulated investment entities that can make investments with borrowed
money. They are "momentum players," and can have a significant effect on
short-term movements in the bond market.
Q What happened to cause the bond market to change course?
A At the end of 1995, investors began to focus on the budget gridlock in
Washington, speculation about the upcoming election year and the possibility
of a stronger economy. Many investors still believed that the positive
fundamentals for bonds--a slow growth economy and declining interest
rates--remained intact. But, positive sentiment took a back seat to the
budget, politics and the economy. Momentum faded and with it, hedge funds
began to "unwind" trades. Hedge fund selling put downward pressure on U.S.
bond prices and contributed to what was beginning to be an uncertain
environment for bond investors.
Shortly thereafter, Federal Reserve Board Chairman Alan Greenspan commented
that the economy appeared to be growing at a moderate rate with stable
inflation. Many investors had anticipated a recession, and viewed his
statement negatively, resulting in bond price declines. We believe that much
of this price volatility can be attributed to short-term factors. While
interest rates may drift a bit higher initially, we are looking for interest
rates to trade in a narrow range over the longer term.
Fund Profile
Objective: Seeks generous income and capital preservation from a broad
spectrum of bonds.
Commencement of investment operations: September 11, 1935
Average maturity: 13 years
Average quality: A
Net assets: $659 million
Newspaper listing: "DivrB2"
<PAGE>
PAGE 4
- ------------------------------------
Keystone Diversified Bond Fund (B-2)
[Pie Chart of Asset Allocations]
Asset Allocation
as of February 29, 1996
Corporate bonds (Industrial bonds & notes) (52.5%)
U.S. government obligations (13.0%)
Mortgage-backed securities (11.9%)
Mortgage pass-through securities (3.1%)
Foreign bonds (U.S. $) (3.7%)
Foreign bonds (non-U.S. $) (10.7%)
Other(1) (5.1%)
(as a percent of net assets)
{end Pie Chart]
Q What strategies did you employ during this period?
A At the end of the period, your Fund was largely invested in domestic fixed
income securities, which included corporate bonds, mortgage-backed
securities, and U.S. government and agency obligations. The high yield
component of the Fund stood at 32% of net assets. We also established a
position in non-dollar foreign government bonds, which comprised 10.7% of net
assets at the end of the period. To limit the effects of currency
fluctuations, we hedged a portion of this investment into U.S. dollars.
We significantly upgraded the credit quality of the Fund's high yield
component. The health of the corporate borrower is particularly critical
during a slow growth economy and so we think it made sense to be conservative
in taking on credit risk. Currently, 71% of the high yield portion of the
Fund is ranked within that sector's top two credit categories, which reflect
a BB rating by either one or more of the rating agencies, Moody's and
Standard & Poor's. That was an increase from 47% on August 31, 1996. We also
have reduced our holdings of smaller market capitalization securities, which
should further improve trading liquidity.
(1) Includes other assets and liabilities, common stocks and warrants, and a
repurchase agreement.
A second strategy was to take advantage of an opportunity presented in the
global markets. We built a position in government bonds of Canada, Germany
and Spain. These countries have stable governments, good economic
fundamentals and liquid securities markets. Further, these markets offered
high "real" or inflation-adjusted, interest rates. These transactions were
partially protected from currency changes through hedging into U.S. dollars.
At the end of the period, the Fund's average maturity stood at approximately
thirteen years, which was a little bit longer than our competitive group. We
believed this was appropriate for our interest rate outlook for the six-month
period.
Q Are bonds a good investment at the present time?
A We consider bonds to be attractive based on "real", or inflation-adjusted
interest rates. For example, if a bond yields 6-1/2% and inflation is running
at 3%, the "real" yield earned by an investor is 3-1/2%. This is high by
historical standards.
Q What do you think will happen over the next six months?
A We continue to expect moderate economic growth and low inflation, with
interest rates trading within a narrow range. Uncertainty about the direction
of the economy, as well as other short-term factors, may cause some
volatility in bond prices over the near term.
As we've said, the lack of significant inflation continues to be a
positive influence on bonds. In addition, corporations have been successful
in managing inventories and controlling costs. The quality of earnings is
high and there is little wage pressure--a primary contributor to higher
inflation. Longer term, though, we expect to see a positive environment for
bonds, with interest rates trading close to current levels.
<PAGE>
PAGE 5
- ------------------------------------
[Pie chart of Portfolio Quarterly Summary]
Portfolio Quarterly Summary
as of February 29, 1996
S&P rating (2)
AAA (13.5%)
AA (19.0%)
A (8.0%)
BBB (7.4%)
BB (10.1%)
B (21.6%)
Not Rated (0.7%)
Other(3) (4.6%)
U.S. government and agency (15.1%)
Average portfolio quality: A
(percentage of portfolio net assets)
[end Pie Chart]
Q What other factors do you see affecting bonds?
A In the near term, we expect hedge fund activity to put some more downward
pressure on bond prices. We've seen this happen before, and usually it is a
short run phenomenon. In addition, election year rhetoric will probably add
some uncertainty, as will the budget discussions in Washington. As far as
we're concerned, the bottom line on the budget is that government spending is
declining. We believe this should be less of a drain on private savings and
should be favorable for bond prices over the long term.
Q Will Keystone Diversified Bond Fund's (B-2) flexible investment approach
be a benefit in this environment?
A We think so. The Fund's flexibility enables us to take advantage of
opportunities in a variety of market sectors. We believe that prudent
allocation in various markets should help to protect and maximize your Fund's
income and total returns over the long term.
[diamond]
This column is intended to answer
questions about your Fund. If you have a question
you would like answered, please write to:
Keystone Investment Distributors Company
Attn: Shareholder Communications, 22nd Floor
200 Berkeley Street, Boston, Massachusetts 02116-5034.
(2) Where Standard & Poor's (S&P) ratings were not available, we have used
ratings from Moody's Investor Service, Inc., Fitch Investor's Service,
Inc. or ratings assigned by another nationally recognized statistical
rating organization.
(3) Includes short-term obligations.
<PAGE>
PAGE 6
- ------------------------------------
Keystone Diversified Bond Fund (B-2)
Your Fund's Performance
[Mountain chart]
Growth of an investment in
Keystone Diversified Bond Fund (B-2)
Initial Reinvested
Investment Distributions
2/86 10000 10000
10025 11131
2/88 9270 11385
8857 12022
2/90 8043 12129
7481 12676
2/92 7943 14823
8207 16666
2/94 8291 18215
7437 17578
2/96 7481 19296
A $10,000 investment in Keystone Diversified Bond Fund (B-2)
made on February 28, 1986 with all distributions reinvested was worth
$19,296 on February 29, 1996. Past performance is no guarantee of
future results.
[end of Mountain chart]
The one-year return reflects the deduction of the 3% contingent deferred
sales charge for those investors who sold Fund shares after one calendar
year. Investors who retained their fund investment received the one-year
return reported in the second column of the table.
Six-Month Performance as of February 29, 1996
==============================================
Total return* 3.30%
Net asset value 8/31/95 $15.09
2/29/96 $15.06
Dividends $ 0.53
Capital gains None
* Before deduction of contingent deferred sales charge (CDSC).
Historical Record as of February 29, 1996
==========================================
If you If you did
Cumulative total return redeemed not redeem
1-year 6.77% 9.77%
5-year 52.23% 52.23%
10-year 92.96% 92.96%
Average annual total return
1-year 6.77% 9.77%
5-year 8.77% 8.77%
10-year 6.79% 6.79%
The investment return and principal value will fluctuate so that your
shares, when redeemed, may be worth more or less than the original cost.
You may exchange your shares to another Keystone fund for a $10 fee by
contacting Keystone directly. The exchange fee is waived for individual
investors who make an exchange using Keystone's Automated Response Line
(KARL). The Fund reserves the right to change or terminate the exchange
offer.
<PAGE>
PAGE 7
- ------------------------------------
SCHEDULE OF INVESTMENTS--February 29, 1996
(Unaudited)
<TABLE>
<CAPTION>
Interest Maturity Par Market
Rate Date Value Value
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
FIXED INCOME (94.9%)
INDUSTRIAL BONDS & NOTES (52.5%)
ADVERTISING & PUBLISHING (1.8%)
EZ Communications Sr. Notes (Subord.) 9.750% 2005 $ 4,000,000 $ 4,020,000
Hollinger International Sr. Notes (Subord.) 9.250 2006 5,000,000 5,037,500
K III Communications Corp. (b) Sr. Notes 8.500 2006 3,000,000 2,970,000
- -----------------------------------------------------------------------------------------------------------------
12,027,500
- -----------------------------------------------------------------------------------------------------------------
AMUSEMENTS (1.6%)
Boyd Gaming Corp. Sr. Notes (Subord.) 10.750 2003 4,000,000 4,230,000
Grand Casino, Inc. Gtd. 1st Mtge. Notes 10.125 2003 2,500,000 2,693,750
Six Flags Theme Parks, Inc.
(Effective Yield 11.123%) (c) Sr. Disc. Notes 0.000 2005 4,250,000 3,570,000
- -----------------------------------------------------------------------------------------------------------------
10,493,750
- -----------------------------------------------------------------------------------------------------------------
BROADCASTING (0.8%)
Sinclair Broadcast Group, Inc. Sr. Notes (Subord.) 10.000 2005 5,000,000 5,075,000
- -----------------------------------------------------------------------------------------------------------------
BUILDING MATERIALS (1.6%)
HMH Properties, Inc. Sr. Secd. Notes 9.500 2005 5,000,000 5,100,000
Schuller International Group, Inc. Sr. Notes 10.875 2004 5,000,000 5,600,000
- -----------------------------------------------------------------------------------------------------------------
10,700,000
- -----------------------------------------------------------------------------------------------------------------
CABLE (1.5%)
Comcast Corp. Sr. (Subord.) Deb. 10.625 2012 5,000,000 5,700,000
Fundy Cable Ltd. Sr. Secd. Second
Priority Note 11.000 2005 1,175,000 1,227,875
Rogers Cable Systems Ltd. Sr. (Subord.) Gtd. Deb. 11.000 2015 3,000,000 3,345,000
- -----------------------------------------------------------------------------------------------------------------
10,272,875
- -----------------------------------------------------------------------------------------------------------------
CAPITAL GOODS (0.8%)
Sherrit, Inc. Deb. 10.500 2014 3,000,000 3,375,000
Tenneco, Inc. Notes 10.375 2000 1,705,000 1,976,112
- -----------------------------------------------------------------------------------------------------------------
5,351,112
- -----------------------------------------------------------------------------------------------------------------
CHEMICALS (1.4%)
Arcadian Partners LP Sr. Notes, Series B 10.750 2005 5,000,000 5,500,000
GI Holdings, Inc. (b) Sr. Disc. Notes 10.000 1998 2,275,000 1,831,375
GI Holdings, Inc. (b) Sr. Notes 10.000 2006 2,166,000 2,239,103
- -----------------------------------------------------------------------------------------------------------------
9,570,478
- -----------------------------------------------------------------------------------------------------------------
CONSUMER GOODS (2.6%)
Bayer Corp. Notes 7.125 2015 9,000,000 8,980,920
Coty, Inc. Sr. Notes (Subord.) 10.250 2005 2,500,000 2,662,500
Revlon Consumer Products Corp. Sr. Notes (Subord.) 10.500 2000 5,000,000 5,200,000
- -----------------------------------------------------------------------------------------------------------------
16,843,420
</TABLE>
<PAGE>
PAGE 8
- ------------------------------------
Keystone Diversified Bond Fund (B-2)
SCHEDULE OF INVESTMENTS--February 29, 1996
(Unaudited)
<TABLE>
<CAPTION>
Interest Maturity Par Market
Rate Date Value Value
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
DIVERSIFIED COMPANIES (3.9%)
General Electric Capital Corp. Gtd. Notes 8.750% 2007 $ 10,750,000 $ 11,308,355
Grand Metropolitan Investment Corp. Gtd. Sr. Notes 7.450 2035 9,000,000 9,603,990
Jordan Industries, Inc. Sr. Notes 10.375 2003 5,000,000 4,525,000
- -----------------------------------------------------------------------------------------------------------------
25,437,345
- -----------------------------------------------------------------------------------------------------------------
FINANCE (12.9%)
American General Financial Corp. Sr. Notes 8.125 2009 4,250,000 4,649,755
American Life Holding Co. Sr. Notes (Subord.) 11.250 2004 4,000,000 4,280,000
APP International Finance Co. B. V. Gtd. Secd. Sr. Notes 11.750 2005 3,000,000 2,940,000
Banc One Corp. Subord. Deb. 7.750 2025 10,000,000 10,520,500
Comerica, Inc. Subord. Notes 7.250 2007 5,000,000 5,167,100
Commercial Credit Group, Inc. Notes 10.000 2009 5,000,000 6,262,950
Donaldson Lufkin & Jenrette, Inc. Medium Term Notes 5.625 2016 9,500,000 9,427,040
European Investment Bank Deb. 9.125 2002 6,750,000 7,731,585
Golden West Financial Corp. Subord. Notes 6.700 2002 4,450,000 4,466,777
Lehman Brothers Hldgs., Inc. Medium Term Notes 6.125 2001 4,500,000 4,433,400
Marine Midland Asset Backed 8.000 2024 4,192,483 4,167,590
Merita Bank Ltd. Subord. Notes 6.500 2006 2,500,000 2,413,125
Morgan Stanley Inc. Coml. Mtge. Certificates 6.475 2027 4,993,360 5,032,370
Paine Webber Group Inc. Medium Term Notes 6.730 2004 9,385,000 9,028,370
Tembec Finance Corp. Sr. Notes 9.875 2005 5,000,000 4,750,000
- -----------------------------------------------------------------------------------------------------------------
85,270,562
- -----------------------------------------------------------------------------------------------------------------
FOODS (1.2%)
Cott Corp., Quebec Sr. Notes 9.375 2005 3,500,000 3,570,000
TLC Beatrice International Holdings
Inc. Sr. Secd. Notes 11.500 2005 4,600,000 4,623,000
- -----------------------------------------------------------------------------------------------------------------
8,193,000
- -----------------------------------------------------------------------------------------------------------------
HEALTHCARE (1.0%)
Dynacare Inc. Sr. Notes 10.750 2006 1,600,000 1,648,000
Quorum Health Group Inc. Sr. Notes (Subord.) 8.750 2005 1,175,000 1,222,000
Tenet Healthcare Corp. Sr. Notes 8.625 2003 3,450,000 3,605,250
- -----------------------------------------------------------------------------------------------------------------
6,475,250
- -----------------------------------------------------------------------------------------------------------------
INSURANCE (4.9%)
CCP Insurance Sr. Notes 10.500 2004 5,000,000 5,625,000
Chartwell Re Holdings Sr. Notes 10.250 2004 4,000,000 4,280,000
MBIA, Inc. Deb. 9.375 2011 15,000,000 17,897,850
Reliance Group Holdings, Inc. Sr. Deb. (Subord.) 9.750 2003 4,000,000 4,150,000
- -----------------------------------------------------------------------------------------------------------------
31,952,850
- -----------------------------------------------------------------------------------------------------------------
METALS AND MINING (0.5%)
Koppers Industries, Inc. Sr. Notes 8.500 2004 3,500,000 3,465,000
</TABLE>
(continued on next page)
<PAGE>
PAGE 9
- ------------------------------------
SCHEDULE OF INVESTMENTS--February 29, 1996
(Unaudited)
<TABLE>
<CAPTION>
Interest Maturity Par Market
Rate Date Value Value
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
- -----------------------------------------------------------------------------------------------------------------
MUNICIPALS (0.8%)
Los Angeles, California Fire Safety
Improvements
Assessment Dist. #1 8.480% 2015 $ 5,000,000 $ 5,331,250
- -----------------------------------------------------------------------------------------------------------------
NATURAL GAS (0.8%)
TransTexas Gas Corp. Sr. Secd. Notes 11.500 2002 5,000,000 5,075,000
- -----------------------------------------------------------------------------------------------------------------
OFFICE & BUSINESS EQUIPMENT (0.4%)
Specialty Equipment Companies, Inc. Sr. Notes (Subord.) 11.375 2003 2,500,000 2,612,500
- -----------------------------------------------------------------------------------------------------------------
OIL (0.9%)
Plains Resources, Inc. Sr. Notes (Subord.) 12.000 1999 2,000,000 2,110,000
Stena AB Sr. Notes 10.500 2005 3,500,000 3,587,500
- -----------------------------------------------------------------------------------------------------------------
5,697,500
- -----------------------------------------------------------------------------------------------------------------
PAPER & PACKAGING (1.4%)
Owens Illinois, Inc. Deb. 11.000 2003 3,500,000 3,920,000
Rainy River Forest Products, Inc. Sr. Secd. Notes 11.000 2001 5,000,000 5,500,000
- -----------------------------------------------------------------------------------------------------------------
9,420,000
- -----------------------------------------------------------------------------------------------------------------
RETAIL (1.9%)
Big 5 Holdings, Inc. (f) Sr. Notes (Subord.) 13.625 2002 1,000,000 740,000
Cole National Group, Inc. Sr. Notes 11.250 2001 4,000,000 4,020,000
Sears Roebuck Corp. Medium Term Notes 6.340 2000 7,890,000 7,901,993
- -----------------------------------------------------------------------------------------------------------------
12,661,993
- -----------------------------------------------------------------------------------------------------------------
SERVICES (0.8%)
Comcast Cellular Corp. (Effective
Yield 11.732%)(c) Sr. Part. Notes 0.000 2000 3,380,000 2,501,200
Community Health Systems, Inc. Sr. Deb. (Subord.) 10.250 2003 2,500,000 2,700,000
- -----------------------------------------------------------------------------------------------------------------
5,201,200
- -----------------------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS (4.7%)
Adelphia Communications Corp. Sr. Notes 12.500 2002 2,000,000 2,095,000
American Media Operations Corp. Sr. Notes (Subord.) 11.625 2004 4,000,000 4,150,000
Bell Cablemedia PLC (Effective
Yield 10.640%) (c) Sr. Disc. Notes 0.000 2005 4,675,000 3,015,375
Mobile Telecommunications Sr. Disc. Notes
Technology (Subord.) 13.500 2002 5,000,000 5,400,000
Pagemart, Inc. (Effective Yield Unit (Sr. Disc.
12.250%) (c) Notes/Wts.) 0.000 2003 3,050,000 2,314,188
Paxson Communications Corp. Sr. Notes (Subord.) 11.625 2002 3,000,000 3,135,000
Telewest PLC (Effective Yield
9.825%) (c) Sr. Disc. Deb. 0.000 2007 8,500,000 5,142,500
Videotron Group Ltd. Voting Conv. Deb.
(Subord.) 10.625 2005 5,000,000 5,450,000
- -----------------------------------------------------------------------------------------------------------------
30,702,063
- -----------------------------------------------------------------------------------------------------------------
TRANSPORTATION (1.2%)
Eletson Holdings, Inc. 1st Mtge. Notes 9.250 2003 3,999,500 3,999,500
Gearbulk Holding Ltd. Sr. Notes 11.250 2004 3,500,000 3,823,750
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
PAGE 10
- ------------------------------------
Keystone Diversified Bond Fund (B-2)
SCHEDULE OF INVESTMENTS--February 29, 1996
(Unaudited)
<TABLE>
<CAPTION>
Interest Maturity Par Market
Rate Date Value Value
- ----------------------------------- -------------------- ---- ------ ---------- -------
<S> <C> <C> <C> <C> <C>
UTILITIES (3.1%) 7,823,250
Chugach Electric Association, Inc. 1st Mtge. Bds. 9.140% 2022 $13,150,000 $ 14,658,305
El Paso Electric Co. 1st Mtge. Bds. 9.400 2011 4,350,000 4,447,875
Montana Power Co. 1st Mtge. Bds. 7.700 1999 1,375,000 1,431,444
- -----------------------------------------------------------------------------------------------------------------
20,537,624
- -----------------------------------------------------------------------------------------------------------------
TOTAL INDUSTRIAL BONDS & NOTES (Cost--$339,829,829) 346,190,522
- -----------------------------------------------------------------------------------------------------------------
FOREIGN BONDS (U.S. DOLLARS) (3.7%)
Fomento Economico Mexico Euro-Dollar 9.500 1997 1,750,000 1,736,875
Gulf Canada Resources Ltd. Sr. Notes (Subord.) 9.625 2005 4,500,000 4,792,500
Indah Kiat International Finance Gtd. Sr. Secd.
Co. B. V. Notes 11.875 2002 3,000,000 3,135,000
Ispat Mexicana S.A. Sr. Unsecd. Deb. 10.375 2001 5,000,000 4,637,500
Republic of Argentina Sr. Notes 8.375 2003 5,500,000 4,592,500
Wharf International Capital 1994 Ltd. Gtd. Notes 8.875 2004 5,500,000 5,718,130
- -----------------------------------------------------------------------------------------------------------------
TOTAL FOREIGN BONDS (U.S. DOLLARS) (Cost--$22,243,452) 24,612,505
- -----------------------------------------------------------------------------------------------------------------
FOREIGN BONDS (NON U.S. DOLLARS) (10.7%)
Commonwealth of Canada Deb. 8.750 2005 43,400,000 34,181,574
Canadian Dollars
Federal Republic of Germany Deb. 6.875 2005 22,250,000 15,607,689
German Marks
Kingdom of Spain Deb. 10.150 2006 2,450,000,000 20,377,237
Spanish Pesetas
- -----------------------------------------------------------------------------------------------------------------
TOTAL FOREIGN BONDS (NON U.S. DOLLARS) (Cost--$72,380,168) 70,166,500
- -----------------------------------------------------------------------------------------------------------------
COLLATERALIZED MORTGAGE OBLIGATIONS (11.9%)
Collateralized Mortgage Investors
Trust (Est. Mat. 1996) (a) Series 6 Class D 8.800 2006 $ 3,975,800 $ 4,012,138
Criimi Mae Financial Corp. (Est.
Mat. 2001) (a) Series 1 Class A 7.000 2033 3,492,371 3,436,711
Debartolo Capital Partnership (Est.
Mat. 2000) (a) Commercial Mtge. Class B 7.610 2004 9,000,000 9,407,813
FHA Pool #02043143 (Est. Mat. 1999) (a) Blair House Project 9.125 2034 3,284,180 3,545,240
FHA Pool #02043143 (Est. Mat. 1999) (a) Blair House Project 10.250 2034 2,508,755 2,625,379
FHLMC (Est. Mat. 2010 ) (a) Series G8 Class SB 9.600 2023 191,912 143,934
FHLMC (Est. Mat. 1999) (a) Series 1666 5.360 2024 6,873,008 4,965,748
FHLMC REMIC Trust (Est. Mat. 2005)(a) Series 47, Class A 5.000 2022 5,000,000 4,414,063
FNMA REMIC Trust (Est. Mat. 1998) (a) Series 1993 038 Class L 5.000 2022 5,000,000 4,213,050
Green Tree Financial Corp. (Est.
Mat. 1998) (a) Series 1994 A Class A 6.900 2004 2,875,055 2,893,024
Green Tree Financial Corp. (Est.
Mat. 1997) (a) Series 1994 B Class A 7.850 2004 3,093,219 3,141,535
Merrill Lynch Mortgage Investors,
Inc. (Est. Mat. 1999) (a) Series 1992 D Class B 8.500 2017 1,674,344 1,739,057
The Money Store Home Equity Trust
(Est. Mat. 1997) (a) Series 1995 A Class A 7.925 2014 5,210,000 5,338,791
</TABLE>
(continued on next page)
<PAGE>
PAGE 11
- ------------------------------------
SCHEDULE OF INVESTMENTS--February 29, 1996
(Unaudited)
<TABLE>
<CAPTION>
Interest Maturity Par Market
Rate Date Value Value
- ----------------------------------- -------------------- ---- ------ ---------- -------
<S> <C> <C> <C> <C> <C>
COLLATERALIZED MORTGAGE OBLIGATIONS (Continued)
Paine Webber Mortgage Acceptance
Corp. IV (Est. Mat. 1997 ) (a) Series 1993 5 Class A3 6.875% 2008 $ 4,652,249 $ 4,658,065
Residential Funding Mortgage
Securities I (Est. Mat. 1997) (a) Series 1994 S15 Class A1 7.750 2024 6,499,791 6,587,083
U.S. Home Equity Loan (Est. Mat.
1997) (a) Series 1991-2 Class B 9.125 2021 4,569,000 4,684,641
Volvo Car Finance Grantor Trust
(Effective Yield 6.62%) (Est.
Mat. 1996) (a) (c) Series 1993-2 Class A 0.000 1997 1,406,687 1,343,386
Zale Funding Trust (Est. Mat. 1999)(a) Series 1994-1 Class A2 7.325 2003 11,000,000 11,312,813
- -----------------------------------------------------------------------------------------------------------------
TOTAL COLLATERALIZED MORTGAGE OBLIGATIONS (Cost--$77,794,427) 78,462,471
- -----------------------------------------------------------------------------------------------------------------
MORTGAGE PASS-THROUGH CERTIFICATES (3.1%)
FHLMC Pool #W00056 Gold Pool 7.500 2010 5,205,498 5,321,008
Resolution Trust Corp., Mortgage
Pass-Through Series 1995 Class 2C 7.500 2028 7,250,000 7,152,578
Structured Asset Securites Corp. Series 1996 Class B 6.303 2028 8,393,750 8,219,318
- -----------------------------------------------------------------------------------------------------------------
TOTAL MORTGAGE PASS-THROUGH CERTIFICATES (Cost--$20,860,338) 20,692,904
- -----------------------------------------------------------------------------------------------------------------
UNITED STATES GOVERNMENT ISSUES (13.0%)
U.S. Treasury Notes 6.500 2005 3,750,000 3,837,900
U.S. Treasury Notes 6.750 2000 10,700,000 11,106,279
U.S. Treasury Bonds 6.000 2026 27,570,000 25,829,506
U.S. Treasury Bonds 7.625 2025 25,000,000 28,300,750
U.S. Treasury Bonds 7.875 2021 14,690,000 16,863,679
- -----------------------------------------------------------------------------------------------------------------
TOTAL UNITED STATES GOVERNMENT ISSUES (Cost--$87,521,352) 85,938,114
- -----------------------------------------------------------------------------------------------------------------
TOTAL FIXED INCOME (COST--$620,629,566) 626,063,016
- -----------------------------------------------------------------------------------------------------------------
COMMON STOCKS & WARRANTS (0.3%)
Hollywood Casino Corp. (d) 485,765 1,943,060
Pagemart, Inc., wts. (b) (d) 14,030 56,120
PM Holdings Corp. (d) 1,618 2
Reliance Group Holdings, Inc. wts.
(d) 67,904 135,808
- -----------------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS & WARRANTS (Cost $134,096) 2,134,990
- -----------------------------------------------------------------------------------------------------------------
Maturity
Value
- ----------------------------------- -------------------- ---- ------ ----------- -------
REPURCHASE AGREEMENT (0.8%)
Keystone Joint Repurchase Agreement (Investments in
repurchase agreements, in a joint trading account,
purchased 2/29/96) (Cost $4,759,000) (e) 5.415 3/1/96 $ 4,759,716 4,759,000
- -----------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS (Cost--$625,522,662) 632,957,006
- -----------------------------------------------------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES--NET (4.0%) 26,454,597
- -----------------------------------------------------------------------------------------------------------------
NET ASSETS (100%) $659,411,603
- -----------------------------------------------------------------------------------------------------------------
<PAGE>
PAGE 12
- ------------------------------------
Keystone Diversified Bond Fund (B-2)
SCHEDULE OF INVESTMENTS--February 29, 1996
(a) The estimated maturity of a Collateralized Mortgage Obligation ("CMO") is based on current and projected
prepayment rates. Changes in interest rates can cause the estimated maturity to differ from the listed date.
(b) Securities that may be resold to "qualified institutional buyers" under rule 144a or securities offered
pursuant to Section 4(2) of the Securities Act of 1933, as amended. These securities have been determined to
be liquid under guidelines established by the Board of Trustees.
(c) Effective yield (calculated at date of purchase) is the yield at which the bond accretes on an annual basis
until maturity date.
(d) Non-income producing security.
(e) The repurchase agreements are fully collateralized by U.S. government and/or agency obligations based on
market prices at February 29, 1996.
(f) Illiquid securities which may not be sold or disposed of in the ordinary course of business within seven
days at approximately the current market value. The combined value of such securities at February 29, 1996
was $740,000 (0.1% of the Fund's net assets at February 29, 1996).
</TABLE>
Legend of Portfolio Abbreviations:
FHA--Federal Housing Administration
FHLMC--Federal Home Loan Mortgage Corporation
FNMA--Federal National Mortgage Association
REMIC--Real Estate Mortgage Investment Conduit
SCHEDULE OF FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS
FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS TO SELL
<TABLE>
<CAPTION>
EXCHANGE U.S. VALUE AT IN EXCHANGE NET UNREALIZED
DATE FEBRUARY 29, 1996 FOR U.S. $ APPRECIATION
- -----------------------------------------------------------------------------------------------------------
CONTRACTS TO DELIVER
-----------------------------------------------------------
<S> <C> <C> <C> <C> <C>
4/11/96 48,895,000 Canadian Dollars $35,773,339 $35,640,535 $132,804
3/05/96 24,600,000 German Marks 17,101,147 16,736,800 364,347
4/12/96 2,600,000,000 Spanish Pesetas 21,266,154 20,921,175 344,979
------------
Net Unrealized Appreciation on Forward Foreign Currency Exchange Contracts $842,130
============
</TABLE>
(continued on next page)
See Notes to Financial Statements.
<PAGE>
PAGE 13
- ------------------------------------
FINANCIAL HIGHLIGHTS
(For a share outstanding throughout each period)
<TABLE>
<CAPTION>
Six Months
Ended Year Ended August 31,
February 29, 1996 1995 1994 1993 1992 1991
================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
(Unaudited)
Net asset value beginning of period $15.09 $15.28 $17.06 $16.44 $15.37 $15.51
- -----------------------------------------------------------------------------------------------------------------
Income from investment operations
Net investment income 0.47 1.06 1.06 1.28 1.33 1.33
Net realized and unrealized gain
(loss) on investments 0.03 0.11 (1.62) 0.70 1.14 0.17
- -----------------------------------------------------------------------------------------------------------------
Total from investment operations 0.50 1.17 (0.56) 1.98 2.47 1.50
- -----------------------------------------------------------------------------------------------------------------
Less distributions from:
Net investment income (0.53) (1.06) (1.22) (1.28) (1.33) (1.63)
In excess of net investment income 0 (0.22) 0 (0.08) (0.07) (0.01)
Tax basis return of capital 0 (0.08) 0 0 0 0
- -----------------------------------------------------------------------------------------------------------------
Total distributions (0.53) (1.36) (1.22) (1.36) (1.40) (1.64)
- -----------------------------------------------------------------------------------------------------------------
Net asset value end of period $15.06 $15.09 $15.28 $17.06 $16.44 $15.37
================================================================================================================
Total return (a) 3.30% 8.13% (3.53%) 12.73% 16.88% 10.58%
Ratios/supplemental data
Ratios to average net assets:
Total expenses 1.81%(b)(c) 1.81% 1.75% 1.89% 1.99% 1.94%
Net investment income 7.05%(c) 7.05% 6.48% 7.73% 8.29% 8.74%
Portfolio turnover rate 116% 178% 200% 133% 117% 101%
- -----------------------------------------------------------------------------------------------------------------
Net assets end of period (thousands) $659,412 $734,837 $814,245 $1,004,393 $902,339 $814,528
=================================================================================================================
</TABLE>
(a) Excluding applicable sales charges.
(b) The annualized expense ratio includes indirectly paid expenses for the
six months ended February 29, 1996. Excluding indirectly paid expenses,
the expense ratio would have been 1.79%.
(c) Annualized
See Notes to Financial Statements.
<PAGE>
PAGE 14
- ------------------------------------
Keystone Diversified Bond Fund (B-2)
STATEMENT OF ASSETS AND LIABILITIES
February 29, 1996 (Unaudited)
<TABLE>
<CAPTION>
=======================================================================
Assets (Note 1)
<S> <C>
Investments at market value (identified
cost--$625,522,662) $ 632,957,006
Cash 838
Receivable for:
Investments sold 17,295,800
Fund shares sold 401,912
Interest 10,641,600
Net unrealized appreciation on forward foreign
currency exchange contracts 842,130
Other assets 144,368
- -----------------------------------------------------------------------
Total assets 662,283,654
- -----------------------------------------------------------------------
Liabilities (Notes 1 and 4)
Payable for:
Fund shares redeemed 1,158,776
Distributions to shareholders 1,548,554
Due to related parties 9,930
Other accrued expenses 154,791
- -----------------------------------------------------------------------
Total liabilities 2,872,051
- -----------------------------------------------------------------------
Net assets $ 659,411,603
=======================================================================
Net assets represented by (Note 1)
Paid-in capital $ 822,388,039
Accumulated distributions in excess of net
investment income (4,432,440)
Accumulated net realized loss on investments (166,806,186)
Net unrealized appreciation on investments and
foreign currency related transactions 8,262,190
- -----------------------------------------------------------------------
Total net assets $ 659,411,603
=======================================================================
Net Asset Value Per Share (Note 2)
Net asset value of $659,411,603 / 43,798,430 shares
outstanding $ 15.06
=======================================================================
</TABLE>
<TABLE>
<CAPTION>
<S> <C> <C>
========================================================================================
Investment income (Note 1)
Interest $28,995,321
- ----------------------------------------------------------------------------------------
Expenses (Notes 2 and 4)
Management fee $ 1,851,900
Transfer agent fees 759,972
Accounting, auditing and legal 30,913
Custodian fees 165,986
Trustees' fees and expenses 22,406
Distribution Plan expenses 3,611,183
Other 59,265
- ----------------------------------------------------------------------------------------
Total expenses 6,501,625
Less: Expenses paid indirectly (Note 4) (53,084)
- ----------------------------------------------------------------------------------------
Net expenses 6,448,541
- ----------------------------------------------------------------------------------------
Net investment income 22,546,780
- ----------------------------------------------------------------------------------------
Net realized and unrealized gain on
investments and forward foreign
currency related transactions
(Notes 1 and 3)
Net realized gain on investments 2,756,094
Net change in unrealized appreciation
(depreciation) on:
Investments (1,478,560)
Forward foreign currency related transactions 827,846
- ----------------------------------------------------------------------------------------
Net change in unrealized appreciation
(depreciation) on investments and forward
foreign currency related transactions (650,714)
- ----------------------------------------------------------------------------------------
Net realized and unrealized gain on investments and
forward foreign currency related transactions 2,105,380
- ----------------------------------------------------------------------------------------
Net increase in net assets resulting from
operations $24,652,160
========================================================================================
</TABLE>
See Notes to Financial Statements.
<PAGE>
PAGE 15
- ------------------------------------
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
Six Months Ended Year Ended
February 29, 1996 August 31, 1995
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C>
(Unaudited)
Operations (Notes 1 and 3)
Net investment income $ 22,546,780 $ 53,360,595
Net realized gain (loss) on investments 2,756,094 (25,270,677)
Net change in unrealized appreciation (depreciation) on investments
and forward foreign currency exchange contracts (650,714) 29,299,264
- --------------------------------------------------------------------------------------------------------------
Net increase in net assets resulting from operations 24,652,160 57,389,182
- --------------------------------------------------------------------------------------------------------------
Distributions to shareholders from (Note 1)
Net investment income (24,741,271) (53,360,595)
In excess of net investment income 0 (11,593,245)
Tax basis return of capital 0 (3,726,265)
- --------------------------------------------------------------------------------------------------------------
Total distributions to shareholders (24,741,271) (68,680,105)
- --------------------------------------------------------------------------------------------------------------
Capital share transactions (Note 2)
Proceeds from shares sold 56,741,088 115,263,649
Payments for shares redeemed (146,368,990) (222,230,419)
Net asset value of shares issued in reinvestment of dividends and
distributions 14,291,336 38,850,254
- --------------------------------------------------------------------------------------------------------------
Net decrease in net assets resulting from capital share transactions (75,336,566) (68,116,516)
- --------------------------------------------------------------------------------------------------------------
Total decrease in net assets (75,425,677) (79,407,439)
Net assets:
Beginning of period 734,837,280 814,244,719
- --------------------------------------------------------------------------------------------------------------
End of period [Including accumulated distributions in excess of net
investment income as follows: 1996--($4,432,440) and
1995--($2,237,949)] (Note 1) $ 659,411,603 $ 734,837,280
- --------------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
<PAGE>
PAGE 16
- ------------------------------------
Keystone Diversified Bond Fund (B-2)
NOTES TO FINANCIAL STATEMENTS (Unaudited)
(1.) Significant Accounting Policies
Keystone Diversified Bond Fund (B-2) (formerly Keystone Custodian Fund,
Series B-2) (the "Fund") is a common law trust for which Keystone Management,
Inc. ("KMI") is the Investment Manager and Keystone Investment Management
Company (formerly Keystone Custodian Funds, Inc.) ("Keystone") is the
Investment Adviser. The Fund is registered under the Investment Company Act
of 1940, as amended (the "1940 Act"), as a diversified, open-end investment
company. The Fund seeks generous income and capital preservation from a broad
spectrum of bonds.
Keystone is a wholly-owned subsidiary of Keystone Investments Inc. (formerly
Keystone Group, Inc.) ("KII"), a Delaware corporation. KII is privately owned
by an investor group consisting predominantly of members of current and
former management of Keystone and its affiliates. Keystone Investor Resource
Center, Inc. ("KIRC"), a wholly-owned subsidiary of Keystone, is the Fund's
transfer and dividend disbursing agent.
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
which requires management to make estimates and assumptions that affect
amounts reported herein. Although actual results could differ from these
estimates, any such differences are expected to be immaterial to the net
assets of the Fund.
A. Investments are usually valued at the closing sales price or, in the
absence of sales and for over-the- counter securities, the mean of bid and
asked quotations. Management values the following securities at prices it
deems in good faith to be fair: (a) securities (including restricted
securities) for which complete quotations are not readily available and (b)
listed securities if, in the opinion of management, the last sales price does
not reflect a current value or if no sale occurred. Short-term investments
maturing in sixty days or less are valued at amortized cost (original
purchase cost as adjusted for amortization of premium or accretion of
discount), which, when combined with accrued interest, approximates market.
Short-term investments maturing in more than sixty days for which market
quotations are readily available are valued at current market value.
Short-term investments maturing in more than sixty days when purchased which
are held on the sixtieth day prior to maturity are valued at amortized cost
(market value on the sixtieth day adjusted for amortization of premium or
accretion of discount), which, when combined with accrued interest,
approximates market. Investments denominated in a foreign currency are
adjusted daily to reflect changes in exchange rates. Market quotations are
not considered to be readily available for long-term corporate bonds and
notes; such investments are stated at fair value on the basis of valuations
furnished by a pricing service, approved by the Trustees, which determines
valuations for normal institutional-size trading units of such securities
using methods based on market transactions for comparable securities and
various relationships between securities which are generally recognized by
institutional traders.
B. When the Fund enters into a repurchase agreement (a purchase of securities
whereby the seller agrees to repurchase the securities at a mutually agreed
upon date and price) the repurchase price of the securities will generally
equal the amount paid by the Fund plus a negotiated interest amount. The
seller under the repurchase agreement will be required to provide securities
("collateral") to the Fund whose value will be maintained at an amount not
less than the repurchase price, and which generally will be maintained at
101% of the repurchase price. The Fund monitors the value of the collateral
on a daily basis, and if the value of the collateral falls below required
levels, the Fund intends to seek additional
<PAGE>
PAGE 17
- ------------------------------------
collateral from the seller or terminate the repurchase agreement. If the
seller defaults, the Fund would suffer a loss to the extent that the proceeds
from the sale of the underlying securities were less than the repurchase
price. Any such loss would be increased by any cost incurred on disposing of
such securities. If bankruptcy proceedings are commenced against the seller
under the repurchase agreement, the realization on the collateral may be
delayed or limited. Repurchase agreements entered into by the Fund will be
limited to transactions with dealers or domestic banks believed to present
minimal credit risks, and the Fund will take constructive receipt of all
securities underlying repurchase agreements until such agreements expire.
Pursuant to an exemptive order issued by the Securities and Exchange
Commission, the Fund, along with certain other Keystone funds, may transfer
uninvested cash balances into a joint trading account. These balances are
invested in one or more repurchase agreements that are fully collateralized
by U.S. Treasury and/or Federal Agency obligations.
C. The Fund enters into currency and other financial futures contracts as a
hedge against changes in interest or currency rates. A futures contract is an
agreement between two parties to buy and sell a specific amount of a
commodity, security, financial instrument, or, in the case of a stock index,
cash at a set price on a future date. Upon entering into a futures contract
the Fund is required to deposit with a broker an amount ("initial margin")
equal to a certain percentage of the purchase price indicated in the futures
contract. Subsequent payments ("variation margin") are made or received by
the Fund each day, as the value of the underlying instrument or index
fluctuates, and are recorded for book purposes as unrealized gains or losses
by the Fund. For federal tax purposes, any futures contracts which remain
open at fiscal year-end are marked-to-market and the resultant net gain or
loss is included in federal taxable income. In addition to market risk, the
Fund is subject to the credit risk that the other party will not be able to
complete the obligations of the contract.
Foreign currency amounts are translated into United States dollars as
follows: market value of investments, assets and liabilities at the daily
rate of exchange, purchases and sales of investments, income and expenses at
the rate of exchange prevailing on the respective dates of such transactions.
Net unrealized foreign exchange gains/losses are a component of unrealized
appreciation/depreciation on investments.
D. In connection with portfolio purchases and sales denominated in a foreign
currency, the Fund may enter into forward foreign currency exchange contracts
("contracts") to hedge certain foreign currency assets. Contracts are
recorded at the forward rate and are marked-to-market daily. Realized gains
and losses arising from such transactions are included in net realized gain
(loss) on foreign currency related transactions. The Fund is subject to the
credit risk that the other party will not complete the obligations of the
contract.
E. Securities transactions are accounted for on the day after trade date.
Realized gains and losses are computed on the identified cost basis. Interest
income is recorded on the accrual basis. All discounts are amortized for both
financial reporting and federal income tax purposes.
F. The Fund distributes net investment income to shareholders monthly and net
capital gains, if any, annually. Distributions to shareholders are recorded
at the close of business on the ex-dividend date. Distributions are
determined from taxable net investment income and net capital gains and can
differ from book basis net investment income and net capital gains. The
significant differences between financial statement amounts available for
distribution and distributions made in accordance with income tax regulations
are
<PAGE>
PAGE 18
- ------------------------------------
Keystone Diversified Bond Fund (B-2)
primarily due to the different treatment of 12b-1 expenses prior to April
1995 and net operating losses.Keystone Diversified Bond Fund (B-2)
G. The Fund has qualified, and intends to qualify in the future, as a
regulated investment company under the Internal Revenue Code of 1986, as
amended ("Internal Revenue Code"). Thus, the Fund is relieved of any federal
income tax liability by distributing all of its net taxable investment income
and net taxable capital gains, if any, to its shareholders. The Fund intends
to avoid any excise tax liability by making the required distributions under
the Internal Revenue Code.
(2.) Capital Share Transactions
The Trust agreement authorizes the issuance of an unlimited number of shares
of beneficial interest with a par value of $1.00. Transactions in shares of
the Fund were as follows:
<TABLE>
<CAPTION>
Six Months Ended Year Ended
February 29, 1996 August 31, 1995
- ---------------- ------------------ -------------------
<S> <C> <C>
Sales 3,719,224 7,685,412
Redemptions (9,572,269) (14,886,517)
Reinvestment of
dividends and
distributions 941,417 2,612,246
- ---------------- ---------------- ------------------
Net decrease (4,911,628) (4,588,859)
- ---------------- ---------------- ------------------
</TABLE>
The Fund bears some of the costs of selling its shares under a Distribution
Plan adopted pursuant to Rule 12b-1 under the 1940 Act. Under the
Distribution Plan, the Fund pays Keystone Investment Distributors Company
(formerly Keystone Distributors, Inc.) ("KIDC"), the principal underwriter
and a wholly-owned subsidiary of Keystone, amounts which in total may not
exceed the Distribution Plan maximum.
In connection with the Distribution Plan and subject to the limitations
discussed below, Fund shares are offered for sale at net asset value without
any initial sales charge. From the amounts received by KIDC in connection
with the Distribution Plan, and subject to the limitations discussed below,
KIDC generally pays dealers or others a commission equal to 4.00% of the
price paid to the Fund for each sale of a Fund share as well as a shareholder
service fee at a rate of 0.25% per annum of the net asset value of shares
sold by such brokers or others and maintained on the books of the Fund for
specified periods.
To the extent Fund shares are redeemed within four calendar years of
original issuance, the Fund may be eligible to receive a deferred sales
charge from the investor as partial reimbursement for sales commissions
previously paid on those shares. This charge is based on declining rates,
which begin at 4.00%, applied to the lesser of the net asset value of shares
redeemed or the total cost of such shares.
The Distribution Plan provides that the Fund may incur certain expenses
which may not exceed a maximum amount equal to 0.3125% of the Fund's average
daily net assets for any calendar quarter (approximately 1.25% annually)
occurring after the inception of the Distribution Plan. Rules adopted by the
National Association of Securities Dealers, Inc. ("NASD") limit the annual
expenditures that the Fund may incur under the Distribution Plan to 1% of
which 0.75% may be used to pay such distribution expenses and 0.25% may be
used to pay shareholder service fees. NASD rules also will limit the
aggregate amount which the Fund may pay for such distribution costs to 6.25%
of gross share sales since the inception of the Fund's 12b-1 Distribution
Plan, plus interest at the prime rate plus 1.00% on unpaid amounts thereof
(less any contingent deferred sales charges paid by the shareholders to
KIDC).
KIDC intends, but is not obligated, to continue to pay or accrue
distribution charges that exceed current annual payments permitted to be
received by KIDC from the Fund. KIDC intends to seek full payment of
<PAGE>
PAGE 19
- ------------------------------------
such charges from the Fund (together with annual interest thereon at the
prime rate plus one percent) at such time in the future as, and to the extent
that, payment thereof by the Fund would be within permitted limits. KIDC
currently intends to seek payment of interest only on such charges paid or
accrued by KIDC subsequent to January 1, 1992.
Commencing on July 8, 1992, contingent deferred sales charges applicable to
shares of the Fund issued after January 1, 1992 have, to the extent permitted
by a NASD rule, been paid to KIDC rather than to the Fund.
During the six months ended February 29, 1996, the Fund paid $3,611,183
under its Distribution Plan, all of which was paid to KIDC. During the six
months ended February 29, 1996, KIDC received $2,965,898 after payments of
commissions on new sales to dealers and others of $645,285. Under a NASD
rule, the maximum uncollected amount for which KIDC may seek payment from the
Fund under its Distribution Plan is $19,916,072 (3.02% of the Fund's net
assets at February 29, 1996).
(3.) Securities Transactions
As of August 31, 1995, the Fund had a capital loss carryover for federal
income tax purposes of approximately $149,889,000 which expires as follows:
1998--$38,243,000; 1999--$85,002,000; and 2003--$26,644,000.
Cost of purchases and proceeds from sales of investment securities excluding
short-term securities during the six months ended February 29, 1996 were
$804,305,009 and $889,622,740 respectively.
(4.) Investment Management Agreement and Other Transactions
Under the terms of the Investment Management Agreement between KMI and the
Fund, KMI provides investment management and administrative services to the
Fund. In return, KMI is paid a management fee computed and paid daily at a
rate of 2.0% of the Fund's gross investment income plus an amount determined
by applying percentage rates, that start at 0.50% and decline, as net assets
increase to 0.25% per annum, to the net asset value of the Fund.
KMI has entered into an Investment Advisory Agreement with Keystone, under
which Keystone provides investment advisory and management services to the
Fund and receives for its services an annual fee representing 85% of the
management fee received by KMI.
During the six months ended February 29, 1996, the Fund paid or accrued to
KMI investment management fees of $1,851,900 which represented 0.51% of the
Fund's average net assets on an annualized basis. Of such amount paid to KMI,
$1,574,115 was paid to Keystone for its services to the Fund.
During the six months ended February 29, 1996, the Fund paid or accrued
$10,458 to KII for certain accounting services and $759,972 to KIRC for
transfer agent fees.
The Fund has entered into an expense offset arrangement with its custodian.
For the six months ended February 29, 1996 the Fund paid custody fees in the
amount of $112,902 and received a credit of $53,084 pursuant to the expense
offset arrangement resulting in a total expense of $165,986. The assets
deposited with the custodian under the expense offset arrangement could have
been invested in income- producing assets.
Certain officers and/or Directors of Keystone are also officers and/or
Trustees of the Fund. Officers of Keystone and affliated Trustees received no
compensation directly from the Fund.
(5.) Distributions to Shareholders
A distribution of net investment income of $0.085 per share was declared
payable on April 4, 1996 to shareholders of record March 25, 1996. This
distribution is not reflected in the accompanying financial statements.
<PAGE>
[back cover]
KEYSTONE
FAMILY OF FUNDS
[diamond]
Balanced Fund (K-1)
Diversified Bond Fund (B-2)
Growth and Income Fund (S-1)
High Income Bond Fund (B-4)
International Fund Inc.
Liquid Trust
Mid-Cap Growth Fund (S-3)
Precious Metals Holdings, Inc.
Quality Bond Fund (B-1)
Small Company Growth Fund (S-4)
Strategic Growth Fund (K-2)
Tax Free Fund
This report was prepared primarily for the information of the Fund's
shareholders. It is authorized for distribution if preceded or accompanied
by the Fund's current prospectus. The prospectus contains important
information about the Fund including fees and expenses. Read it carefully
before you invest or send money. For a free prospectus on other Keystone
funds, contact your financial adviser or call Keystone.
[Keystone logo] KEYSTONE
INVESTMENTS
P.O. Box 2121
Boston, Massachusetts 02106-2121
DBF-SAR-4/96
37.6M
[recycle logo]
<PAGE>
KEYSTONE
[picture of family in woods]
DIVERSIFIED
BOND FUND (B-2)
[Keystone logo]
SEMIANNUAL REPORT
FEBRUARY 29, 1996
