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KEYSTONE STRATEGIC GROWTH FUND (K-2)
PART A
PROSPECTUS
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PROSPECTUS JANUARY 24, 1996
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KEYSTONE STRATEGIC GROWTH FUND (K-2)
200 BERKELEY STREET, BOSTON, MASSACHUSETTS 02116-5034
CALL TOLL FREE 1-800-343-2898
Keystone Strategic Growth Fund (K-2) (the "Fund") (formerly named Keystone
Custodian Fund, Series K-2) is a mutual fund whose goal is growth of capital.
The Fund invests principally in a diversified group of common stocks, but
also debt securities.
Your purchase payment is fully invested. There is no sales charge when you
buy the Fund's shares. The Fund may impose, however, a deferred sales charge,
which declines from 4% to 1%, if you redeem your shares within four years of
purchase.
The Fund has adopted a Distribution Plan pursuant to Rule 12b-1 under the
Investment Company Act of 1940 under which it bears some of the costs of selling
its shares to the public.
This prospectus sets forth concisely the information about the Fund that you
should know before investing. Please read it and retain it for future reference.
Additional information about the Fund is contained in a statement of
additional information dated January 24, 1996, which has been filed with the
Securities and Exchange Commission and is incorporated by reference into this
prospectus. For a free copy, or for other information about the Fund, write to
the address or call the telephone number listed above.
SHARES OF THE FUND ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR
ENDORSED BY, ANY BANK, AND SHARES ARE NOT FEDERALLY INSURED BY THE FEDERAL
DEPOSIT INSURANCE CORPORATION, THE FEDERAL RESERVE BOARD, OR ANY OTHER AGENCY.
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TABLE OF CONTENTS
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Fee Table .......................................... 2 How to Buy Shares .............................. 9
Financial Highlights ............................... 3 Distribution Plan .............................. 11
The Fund ........................................... 4 How to Redeem Shares ........................... 12
Investment Objective and Policies .................. 4 Shareholder Services ........................... 14
Investment Restrictions ............................ 5 Performance Data ............................... 15
Risk Factors ....................................... 5 Fund Shares .................................... 16
Pricing Shares ..................................... 6 Additional Information ......................... 16
Dividends and Taxes ................................ 7 Additional Investment Information .............. (i)
Fund Management and Expenses ....................... 8
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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
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FEE TABLE
KEYSTONE STRATEGIC GROWTH FUND (K-2)
The purpose of the fee table is to assist investors in understanding the
costs and expenses that an investor in the Fund will bear directly or
indirectly. For more complete descriptions of the various costs and expenses,
see the following sections of this prospectus: "Fund Management and Expenses";
"How to Buy Shares"; "Distribution Plan"; and "Shareholder Services."
SHAREHOLDER TRANSACTION EXPENSES
Contingent Deferred Sales Charge(1) .................... 4.00%
(as a percentage of the lesser of total cost or
net asset value of shares redeemed)
Exchange Fee(2) ........................................ $10.00
(per exchange)
ANNUAL FUND OPERATING EXPENSES(3)
(as a percentage of average net assets)
Management Fee .......................................... 0.61%
12b-1 Fees(4) ........................................... 1.00%
Other Expenses .......................................... 0.40%
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Total Fund Operating Expenses ........................... 2.01%
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EXAMPLE(5) 1 YEAR 3 YEARS 5 YEARS 10 YEARS
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You would pay the following expenses on a $1,000
investment, assuming (1) 5% annual return and (2)
redemption at the end of each period ................. $60 $83 $108 $234
You would pay the following expenses on the same
investment, assuming no redemption ................... $20 $63 $108 $234
AMOUNTS SHOWN IN THE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST
OR FUTURE EXPENSES; ACTUAL EXPENSES MAY BE GREATER OR LESS THAN THOSE SHOWN.
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1 The deferred sales charge declines from 4% to 1% of amounts redeemed within
four calendar years after purchase. No deferred sales charge is imposed
thereafter.
2 There is no fee for exchange orders received by the Fund directly from a
shareholder over the Keystone Automated Response Line ("KARL"). (For a
description of KARL, see "Shareholder Services".)
3 Expense ratios are for the Fund's fiscal year ended October 31, 1995.
4 Long-term shareholders may pay more than the economic equivalent of the
maximum front-end sales charges permitted by rules adopted by the National
Association of Securities Dealers, Inc. ("NASD").
5 The Securities and Exchange Commission requires use of a 5% annual return
figure for purposes of this example. Actual return for the Fund may be
greater or less than 5%.
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FINANCIAL HIGHLIGHTS
KEYSTONE STRATEGIC GROWTH FUND (K-2)
(For a share outstanding throughout the year)
The following table contains important financial information relating to
the Fund and has been audited by KPMG Peat Marwick LLP, the Fund's independent
auditors. The table appears in the Fund's Annual Report and should be read in
conjunction with the Fund's financial statements and related notes, which also
appear, together with the independent auditors' report, in the Fund's Annual
Report. The Fund's financial statements, related notes, and independent
auditors' report are included in the statement of additional information.
Additional information about the Fund's performance is contained in its Annual
Report, which will be made available upon request and without charge.
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YEAR ENDED OCTOBER 31,
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1995 1994 1993 1992 1991 1990 1989 1988 1987 1986
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NET ASSET VALUE BEGINNING OF
YEAR ......................... $7.54 $9.00 $7.60 $8.18 $6.52 $7.67 $6.53 $7.55 $9.13 $7.47
----- ----- ----- ----- ----- ----- ----- ----- ----- -----
Income from investment operations:
Net nvestment income (loss) ... (0.02) 0.00 (0.06) (0.01) 0.08 0.08 0.16 0.18 0.02 0.14
Net gains (losses) on
investments and foreign
currency related
transactions ................. 1.13 0.23 1.89 0.42 2.24 (0.80) 1.21 0.19 0.04 2.15
Net commissions paid on fund
share sales (a) .............. -0- -0- -0- -0- -0- -0- -0- -0- -0- (0.08)
----- ----- ----- ----- ----- ----- ----- ----- ----- -----
Total from investment
operations ................... 1.11 0.23 1.83 0.41 2.32 (0.72) 1.37 0.37 0.06 2.21
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Less distributions from:
Net investment income ......... -0- -0- -0- (0.01) (0.16) (0.18) (0.18) (0.14) (0.13) (0.11)
In excess of net investment -0- -0- (0.03) (0.05) -0- -0- -0- -0- -0- -0-
Net realized gains on
investments and foreign
currency related
transactions ................ (0.60) (1.66) (0.40) (0.93) (0.50) (0.25) (0.05) (1.25) (1.51) (0.44)
In excess of net realized
gains on investments and
foreign currency related
transactions .................. -0- (0.03) -0- -0- -0- -0- -0- -0- -0- -0-
----- ----- ----- ----- ----- ----- ----- ----- ----- -----
Total distributions ........... (0.60) (1.69) (0.43) (0.99) (0.66) (0.43) (0.23) (1.39) (1.64) (0.55)
----- ----- ----- ----- ----- ----- ----- ----- ----- -----
NET ASSET VALUE END OF YEAR ... $8.05 $7.54 $9.00 $7.60 $8.18 $6.52 $7.67 $6.53 $7.55 $9.13
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TOTAL RETURN (B) .............. 15.05% 3.55% 24.97% 6.38% 38.77% (10.05%) 21.74% 7.73% 0.15% 31.38%
RATIOS/SUPPLEMENTAL DATA
Ratios to average net assets:
Total expenses (c) ............ 2.01% 1.73% 1.83% 1.58% 1.52% 1.65% 1.59% 1.69% 2.12% 0.98%
Net investment income (loss) .. (0.25%) (0.17%) (0.57%) (0.15%) 0.99% 1.64% 2.06% 2.14% 0.23% 1.63%
Portfolio turnover rate ....... 140% 68% 65% 62% 86% 30% 40% 89% 104% 104%
Net assets end of year
(thousands) .................. $491,610 $416,684 $403,693 $321,794 $339,359 $234,060 $329,994 $328,205 $298,748 $303,994
(a) Prior to June 30, 1987, net commissions paid on new sales of shares under
the Fund's Rule 12b-1 Distribution Plan had been treated for both
financial statement and tax purposes as capital charges. On June 11, 1987,
the Securities and Exchange Commission adopted a Rule which required for
financial statements for periods ended on or after June 30, 1987, that net
commissions paid under Rule 12b-1 Distribution Plans be treated as
operating expenses rather than as capital charges. Accordingly, beginning
with the fiscal year ended October 31, 1987, the Fund's financial
statements reflect 12b-1 Distribution Plan expenses (i.e., shareholder
service fees plus commissions paid net of deferred sales charges received
by the Fund) as a component of the net investment income section of the
financial highlights.
(b) Excluding contingent deferred sales charge (CDSC).
(c) The annualized expense ratio for the year ended October 31, 1995 includes
indirectly paid expenses. Excluding indireclty paid expenses, the
annualized expense ratio would have been 2.00%.
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THE FUND
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The Fund is an open-end, diversified management investment company, commonly
known as a mutual fund. The Fund was created under Pennsylvania law as a
common law trust and has been offering its shares continuously since September
11, 1935. The Fund is one of twenty funds managed by Keystone Management, Inc.
("Keystone Management"), the Fund's investment manager, and is one of more
than thirty funds managed or advised by Keystone Investment Management Company
("Keystone") (formerly named Keystone Custodian Funds, Inc.), the Fund's
investment adviser. Keystone and Keystone Management are, from time to time,
also collectively referred to as "Keystone."
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INVESTMENT OBJECTIVE AND POLICIES
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The Fund's investment objective is to provide shareholders with growth of
capital. In pursuing this objective, the Fund invests in common stocks, debt
securities, including debt securities convertible or exchangeable for
preferred or common stock, and rights and warrants to purchase such stocks and
securities that it considers to be consistent with an investment objective of
capital growth. When appropriate, the Fund increases the quality of its
investments to resist downward market movements. In addition to its other
investment options, the Fund may invest in limited partnerships, including
master limited partnerships, and in foreign securities issued by issuers
located in developed countries as well as emerging market countries, including
certain formerly communist countries. For this purpose, countries with
emerging markets are generally those where the per capita income is in the low
to middle ranges, as determined by the International Bank for Reconstruction
and Development ("World Bank").
When market conditions warrant, the Fund may adopt a defensive position to
preserve shareholders' capital by investing in money market instruments. Such
instruments, which must mature within one year of their purchase, include
United States ("U.S.") government securities; instruments, including
certificates of deposit, demand and time deposits and bankers acceptances, of
banks that are members of the Federal Deposit Insurance Corporation and have
at least $1 billion in assets as of the date of their most recently published
financial statements, including U.S. branches of foreign banks and foreign
branches of U.S. banks; and prime commercial paper, including master demand
notes.
The Fund intends to follow policies of the Securities and Exchange
Commission as they are adopted from time to time with respect to illiquid
securities, including at this time (1) treating as illiquid securities that
may not be sold or disposed of in the ordinary course of business within seven
days at approximately the value at which the Fund has valued the investment on
its books and (2) limiting its holdings of such securities to 15% of net
assets.
The Fund may invest in restricted securities, including securities eligible
for resale pursuant to Rule 144A under the Securities Act of 1933 (the "1933
Act"). Generally, Rule 144A establishes a safe harbor from the registration
requirements of the 1933 Act for resales by large institutional investors of
securities not publicly traded in the U.S. The Fund may purchase Rule 144A
securities when such securities present an attractive investment opportunity
and otherwise meet the Fund's selection criteria. The Board of Trustees has
adopted guidelines and procedures pursuant to which Keystone determines the
liquidity of the Fund's Rule 144A securities. The Board monitors Keystone's
implementation of such guidelines and procedures.
At the present time, the Fund cannot accurately predict exactly how the
market for Rule 144A securities will develop. A Rule 144A security that was
readily marketable upon purchase may subsequently become illiquid. In such an
event, the Board of Trustees will consider what action, if any, is
appropriate.
The Fund may enter into repurchase and reverse repurchase agreements, invest
in master demand notes, lend portfolio securities, purchase and sell
securities and currencies on a when issued and delayed delivery basis and
purchase or sell securities on a forward commitment basis, write covered call
and put options and purchase call and put options to close out existing
positions and may employ new investment techniques with respect to such
options. The Fund may also enter into currency and other financial futures
contracts and related options transactions for hedging purposes and not for
speculation, and may employ new investment techniques with respect to such
futures contracts and related options.
For further information about the types of investments and investment
techniques available to the Fund, and the risks associated therewith, see the
"Risk Factors" and "Additional Investment Information" sections of this
prospectus and the statement of additional information.
Of course, there can be no assurance that the Fund will achieve its
investment objective since there is uncertainty in every investment.
The investment objective of the Fund cannot be changed without a vote of a
majority (as defined in the Investment Company Act of 1940 ("1940 Act")) of
the Fund's outstanding shares.
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INVESTMENT RESTRICTIONS
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The Fund has adopted the fundamental restrictions set forth below, which may
not be changed without the approval of a majority (as defined in the 1940 Act)
of the Fund's outstanding shares. These restrictions and certain other
fundamental and non-fundamental restrictions are set forth in the statement of
additional information.
The Fund may not do the following: (1) invest more than 5% of its total assets
in the securities of any one issuer; and (2) borrow money, (a) except from banks
for temporary or emergency purposes in aggregate amounts up to 10% of the value
of the Fund's net assets, or (b) enter into reverse repurchase agreements
provided that bank borrowings and reverse repurchase agreements, in aggregate,
shall not exceed 10% of the value of the Fund's assets.
In addition, the Fund may, notwithstanding any other investment policy or
restriction, invest all of its assets in the securities of a single open-end
management investment company with substantially the same fundamental
investment objectives, policies and restrictions as the Fund. The Fund does
not currently intend to implement this policy and would do so only if the
Trustees were to determine such action to be in the best interest of the Fund
and its shareholders. In the event of such implementation, the Fund will
comply with such requirements as to written notice to shareholders as are then
in effect.
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RISK FACTORS
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Like any investment, your investment in the Fund involves some degree of
risk. Before you buy shares of the Fund, you should carefully evaluate your
ability to assume the risks your investment in the Fund poses. You can lose
money by investing in
the Fund. Your investment is not guaranteed. A decrease in the value of the
Fund's portfolio securities can result in a decrease in the value of your
investment.
The Fund seeks to provide growth of capital by investing principally in a
diversified group of common stocks, but also debt securities and rights and
warrants.
The Fund is best suited to patient investors who can afford to maintain
their investment over a relatively long period of time, and who are seeking a
fund which is relatively aggressive and has the potential for significant
returns. The Fund involves risk and is not an appropriate investment for
conservative investors who are seeking preservation of capital and/or income.
Certain risks related to the Fund are discussed below. To the extent not
discussed in this section, specific risks attendant to individual securities
or investment practices are discussed in "Additional Investment Information".
FUND RISKS. Investing in the Fund involves the risk common to investing in
any security, that is that the value of the securities held by the Fund will
fluctuate in response to changes in economic conditions or public expectations
about those securities. The net asset value of the Fund's shares will change
accordingly.
FOREIGN RISK. Investing in securities of foreign issuers generally involves
greater risk than investing in securities of domestic issuers for the following
reasons: (1) there may be less public information available about foreign
companies than is available about U.S. companies; (2) foreign companies are not
generally subject to the uniform accounting, auditing and financial reporting
standards and practices applicable to U.S. companies; (3) foreign stock markets
have less volume than the U.S. market, and the securities of some foreign
companies are much less liquid and much more volatile than the securities of
comparable U.S. companies; (4) foreign securities transactions may involve
higher brokerage commissions; (5) there may be less government regulation of
stock markets, brokers, listed companies and banks in foreign countries than in
the U.S.; (6) the Fund may incur fees on currency exchanges when it changes
investments from one country to another; (7) the Fund's foreign investments
could be affected by expropriation, confiscatory taxation, nationalization,
establishment of currency exchange controls, political or social instability or
diplomatic developments; (8) fluctuations in foreign exchange rates will affect
the value of the Fund's investments, the value of dividends and interest earned,
gains and losses realized on the sale of securities, net investment income and
unrealized appreciation or depreciation of investments; and (9) interest and
dividends on foreign securities may be subject to withholding taxes in a foreign
country that could result in a reduction of net investment income available for
distribution.
Investing in securities of issuers in emerging market countries involves
exposure to economic systems that are generally less mature and political
systems that are generally less stable than, those of developed countries. In
addition, investing in companies in emerging market countries may also involve
exposure to national policies that may restrict investment by foreigners and
undeveloped legal systems governing private and foreign investments and private
property. The typically small size of the markets for securities issued by
companies in emerging markets countries and the possibility of a low or
nonexistent volume of trading in those securities may also result in a lack of
liquidity and in price volatility of those securities. Furthermore, investing in
securities of companies in the formerly communist countries of Eastern Europe
and the People's Republic of China involve additional risks to those associated
with investments in companies in non-formerly communist emerging markets
countries. Specifically, those countries could convert back to a single economic
system, and the claims of property owners prior to the expropriation by the
communist regime could be settled in favor of the former property owners, in
which case the Fund could lose its entire investment in those countries. These
risks are carefully considered by Keystone prior to the purchase of these
securities.
OTHER CONSIDERATIONS. The Fund does not, by itself, constitute a balanced
investment plan. The Fund may be appropriate as part of an overall investment
program. Investors may wish to consult their financial advisers when
considering what portion of their total assets to invest in equity and debt
securities.
Past performance should not be considered representative of results for any
future period of time.
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PRICING SHARES
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The net asset value of a Fund share is computed each day on which the New
York Stock Exchange (the "Exchange") is open as of the close of trading on the
Exchange (currently 4:00 p.m. eastern time for the purpose of pricing Fund
shares) except on days when changes in the value of the Fund's securities do
not affect the current net asset value of its shares. The Exchange currently
is closed on weekends, New Year's Day, Presidents' Day, Good Friday, Memorial
Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day. The net
asset value per share is arrived at by determining the value of all of the
Fund's assets, subtracting all liabilities and dividing the result by the
number of shares outstanding.
The Fund values the short-term investments it purchases as follows: short-
term investments that are purchased with maturities of sixty days or less are
valued at amortized cost (original purchase price 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; and short-term investments maturing in more than sixty
days when purchased that 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; in any case reflecting fair value as
determined by the Board of Trustees. All other investments are valued at
market value or, where market quotations are not readily available, at fair
value as determined in good faith by the Board of Trustees.
The Fund believes that reliable market quotations are generally not readily
available for purposes of valuing fixed income securities. As a result,
depending on the particular securities owned by the Fund, it is likely that
most of the valuations for such securities will be based upon their fair value
determined under procedures approved by the Board of Trustees. The Board of
Trustees has authorized the use of a pricing service to determine the fair
value of the Fund's fixed income securities and certain other securities.
Securities for which market quotations are readily available are valued on a
consistent basis at that price quoted which, in the opinion of the Board of
Trustees or the person designated by the Board of Trustees to make the
determination, most nearly represents the market value of the particular
security. Any securities for which market quotations are not readily available
or other assets are valued on a consistent basis at fair value as determined
in good faith using methods prescribed by the Board of Trustees.
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DIVIDENDS AND TAXES
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The Fund has qualified and intends to qualify in the future as a regulated
investment company under the Internal Revenue Code (the "Code"). The Fund
qualifies if, among other things, it distributes to its shareholders at least
90% of its net investment income for its fiscal year. The Fund also intends to
make timely distributions, if necessary, sufficient in amount to avoid the
nondeductible 4% excise tax imposed on a regulated investment company to the
extent that it fails to distribute, with respect to each calendar year, at
least 98% of its ordinary income for such calendar year and 98% of its net
capital gains for the one-year period ending on October 31 of such calendar
year. Any taxable dividend declared in October, November, or December to
shareholders of record in such a month, and paid by the following January 31,
will be includable in the taxable income of shareholders as if paid on
December 31 of the year in which the dividend was declared. If the Fund
qualifies and if it distributes all of its net investment income and net
capital gains, if any, to shareholders, it will be relieved of any federal
income tax liability. The Fund will make distributions from its net investment
income to its shareholders by the 15th day of December following each fiscal
year and net capital gains, if any, at least annually.
Distributions are payable in shares of the Fund or, at the shareholder's
option (which must be exercised before the record date for the distribution),
in cash. Fund distributions in the form of additional shares are made at net
asset value without the imposition of a sales charge. Income dividends and net
short-term gains distributions are taxable as ordinary income, and net long-
term gains are taxable as capital gains regardless of how long the Fund's
shares are held. If Fund shares held for less than six months are sold at a
loss, however, such loss will be treated for tax purposes as a long-term
capital loss to the extent of any long-term capital gains dividends received.
Dividends and distributions may also be subject to state and local taxes. The
Fund advises its shareholders annually as to the federal tax status of all
distributions made during the year.
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FUND MANAGEMENT AND EXPENSES
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FUND MANAGEMENT
Subject to the general supervision of the Fund's Board of Trustees, Keystone
Management located at 200 Berkeley Street, Boston, Massachusetts 02116-5034,
serves as investment manager to the Fund and is responsible for the overall
management of the Fund's business and affairs.
INVESTMENT MANAGER
Keystone Management, organized in 1989, is a wholly-owned subsidiary of
Keystone. Its directors and principal executive officers have been affiliated
with Keystone, a seasoned investment adviser, for a number of years. Keystone
Management also serves as investment manager to each of the other funds in the
Keystone Fund Family and certain other funds in the Keystone Investments
Family of Funds.
Pursuant to its Investment Management Agreement with the Fund, Keystone
Management has delegated its investment management functions, except for
certain administrative and management services, to Keystone and has entered
into an Investment Advisory Agreement with Keystone under which Keystone
provides investment advisory and management services to the Fund. Services
performed by Keystone Management include (1) performing research and planning
with respect to (a) the Fund's qualification as a regulated investment company
under Subchapter M of the Code, (b) tax treatment of the Fund's portfolio
investments, (c) tax treatment of special corporate actions (such as
reorganizations), (d) state tax matters affecting the Fund, and (e) the Fund's
distributions of income and capital gains; (2) preparing the Fund's federal
and state tax returns; (3) providing services to the Fund's shareholders in
connection with federal and state taxation and distributions of income and
capital gains; and (4) storing documents relating to the Fund's activities.
The Fund pays Keystone Management a fee for its services at the annual rate
set forth below:
AGGREGATE NET ASSET VALUE
MANAGEMENT OF THE SHARES
FEE OF THE FUND
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0.70% of the first $ 100,000,000, plus
0.65% of the next $ 100,000,000, plus
0.60% of the next $ 100,000,000, plus
0.55% of the next $ 100,000,000, plus
0.50% of the next $ 100,000,000, plus
0.45% of the next $ 500,000,000, plus
0.40% of the next $ 500,000,000, plus
0.35% of amounts over $1,500,000,000
computed as of the close of business each business day and payable daily.
During the fiscal year ended October 31, 1995, the Fund paid or accrued to
Keystone Management investment management and administration service fees of
$2,799,544, which represented 0.61% of the Fund's average daily net assets. Of
such amount paid to Keystone Management, $2,379,612 was paid to Keystone for
its services to the Fund.
INVESTMENT ADVISER
Keystone, the Fund's investment adviser, located at 200 Berkeley Street,
Boston, Massachusetts 02116-5034, has provided investment advisory and
management services to investment companies and private accounts since it was
organized in 1932. Keystone is a wholly-owned subsidiary of Keystone
Investments, Inc. ("Keystone Investments") (formerly named Keystone Group,
Inc.), located at 200 Berkeley Street, Boston, Massachusetts 02116-5034.
Keystone Investments is a corporation privately owned by current and former
members of management and certain employees of Keystone and its affiliates.
The shares of Keystone Investments common stock beneficially owned by
management are held in a number of voting trusts, the trustees of which are
George S. Bissell, Albert H. Elfner, III, Edward F. Godfrey and Ralph J.
Spuehler, Jr. Keystone Investments provides accounting, bookkeeping, legal,
personnel and general corporate services to Keystone Management, Keystone,
their affiliates and the Keystone Investments Family of Funds.
Pursuant to the Advisory Agreement, Keystone receives for its services an
annual fee representing 85% of the management fee received by Keystone
Management under its Investment Management Agreement with the Fund.
The Fund has adopted a Code of Ethics incorporating policies on personal
securities trading as recommended by the Investment Company Institute.
FUND EXPENSES
The Fund will pay all of its expenses. In addition to the investment
advisory and management fees discussed above, the principal expenses that the
Fund is expected to pay include, but are not limited to, expenses of its
transfer agent, its custodian and its independent auditors; expenses under its
Distribution Plan; fees of its Independent Trustees; expenses of shareholders'
and Trustees' meetings; fees payable to government agencies, including
registration and qualification fees of the Fund and its shares under federal
and state securities laws; expenses of preparing, printing and mailing Fund
prospectuses, notices, reports and proxy material; and certain extraordinary
expenses. In addition to such expenses, the Fund pays its brokerage
commissions, interest charges and taxes. For the fiscal year ended October 31,
1995, the Fund paid 2.01% of its average net assets in expenses.
During the fiscal year ended October 31, 1995, the Fund paid or accrued to
Keystone Investor Resource Center, Inc. ("KIRC"), the Fund's transfer and
dividend disbursing agent, and Keystone Investments, $24,342 for the cost of
certain accounting services and $1,296,268 for shareholder services. KIRC is a
wholly-owned subsidiary of Keystone.
PORTFOLIO MANAGER
Maureen E. Cullinane has been the Fund's Portfolio Manager since 1995. Ms.
Cullinane is a Keystone Senior Vice President and Senior Portfolio Manager and
has more than 20 years' of investment experience.
SECURITIES TRANSACTIONS
Under policies established by the Fund's Board of Trustees, Keystone selects
broker-dealers to execute transactions subject to the receipt of best
execution. When selecting broker-dealers to execute portfolio transactions for
the Fund, Keystone may consider the number of shares of the Fund sold by such
broker-dealers. In addition, broker-dealers executing portfolio transactions
may, from time to time, be affiliated with the Fund, Keystone Management,
Keystone, the Fund's principal underwriter or their affiliates. The Fund may
pay higher commissions to broker-dealers that provide research services.
Keystone may use these services in advising the Fund as well as in advising
its other clients.
PORTFOLIO TURNOVER
The Fund's portfolio turnover rates for the fiscal years ended October 31,
1994 and 1995 were 68% and 140%, respectively. High portfolio turnover may
involve correspondingly greater brokerage commissions and other transaction
costs, which would be borne directly by the Fund, as well as additional
realized gains and/or losses to shareholders. For further information about
brokerage and distributions, see the statement of additional information.
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HOW TO BUY SHARES
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You may purchase shares of the Fund from any broker-dealer that has a
selling agreement with Keystone Investment Distributors Company (formerly
named Keystone Distributors, Inc.), (the "Principal Underwriter"), the Fund's
principal underwriter. The Principal Underwriter, a wholly-owned subsidiary of
Keystone, is located at 200 Berkeley Street, Boston, Massachusetts 02116-5034.
In addition, you may open an account for the purchase of shares of the Fund
by mailing to the Fund, c/o Keystone Investment Resource Center, Inc., P.O.
Box 2121, Boston, Massachusetts 02106-2121, a completed account application
and a check payable to the Fund, or you may telephone 1-800-343-2898 to obtain
the number of an account to which you can wire or electronically transfer
funds and then send in a completed account application. Subsequent investment
in any amount may be made by check, by wiring federal funds or by an
electronic funds transfer ("EFT").
The Fund's shares are sold at the net asset value per share next computed
after the Fund receives the purchase order. The initial purchase must be at
least $1,000 except for purchases by participants in certain retirement plans
for which the minimum is waived. There is no minimum for subsequent purchases.
Purchase payments are fully invested at net asset value. There are no sales
charges on purchases of Fund shares at the time of purchase.
CONTINGENT DEFERRED SALES CHARGE
With certain exceptions, when shares are redeemed within four calendar years
after their purchase, a deferred sales charge may be imposed at rates ranging
from a maximum of 4% of amounts redeemed during the calendar year of purchase
to 1% of amounts redeemed during the third calendar year after the year of
purchase. No deferred sales charge is imposed on amounts redeemed thereafter
or on shares purchased through reinvestment of dividends. If imposed, the
deferred sales charge is deducted from the redemption proceeds otherwise
payable to the shareholder. Prior to July 8, 1992, the Fund retained the
deferred sales charge. Since July 8, 1992, the deferred sales charge
attributable to shares purchased prior to January 1, 1992 has been retained by
the Fund, and the contingent deferred sales charge attributable to shares
purchased after January 1, 1992 is, to the extent permitted by a rule adopted
by the NASD, paid to the Principal Underwriter.
The contingent deferred sales charge is a declining percentage of the lesser
of (1) the net asset value of the shares redeemed or (2) the total cost of
such shares. No contingent deferred sales charge is imposed when a shareholder
redeems amounts derived from (1) increases in the value of his account above
the total cost of such shares due to increases in the net asset value per
share of the Fund; (2) certain shares with respect to which the Fund did not
pay a commission on issuance, including shares acquired through reinvestment
of dividend income and capital gains distributions; or (3) shares held in all
or part of more than four consecutive calendar years.
In determining whether a contingent deferred sales charge is payable and, if
so, the percentage charge applicable, it is assumed that shares held the
longest are the first to be redeemed. No deferred sales charge is payable on
permitted exchanges of shares between the Funds in the Keystone Fund Family
that have adopted distribution plans pursuant to Rule 12b-1 under the 1940
Act. When shares of one such fund have been exchanged for shares of another
such fund, for purposes of any future contingent deferred sales charge, the
calendar year of the exchange is assumed to be the year shares tendered for
exchange were originally purchased.
In addition, no contingent deferred sales charge is imposed on a redemption
of shares of the Fund in the event of (1) death or disability of the
shareholder; (2) a lump-sum distribution from 401(k) plan or other benefit
plan qualified under the Employee Retirement Income Security Act of 1974
("ERISA"); (3) automatic withdrawals from ERISA plans if the shareholder is at
least 59 1/2 years old; (4) involuntary redemptions of accounts having an
aggregate net asset value of less than $1,000; (5) automatic withdrawals under
an automatic withdrawal plan of up to 1 1/2% per month of the shareholder's
initial account balance; (6) withdrawals consisting of loan proceeds to a
retirement plan participant; (7) financial hardship withdrawals made by a
retirement plan participant; or (8) withdrawals consisting of returns of
excess contributions or excess deferral amounts made to a retirement plan
participant.
WAIVER OF DEFERRED SALES CHARGE
Shares also may be sold, to the extent permitted by applicable law, at net
asset value without the payment of commissions or the imposition of a deferred
sales charge to (1) certain officers, Directors, Trustees and employees of the
Fund, Keystone Management, Keystone and certain of their affiliates; (2)
registered representatives of firms with dealer agreements with the Principal
Underwriter; and (3) to a bank or trust company acting as trustee for a single
account.
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DISTRIBUTION PLAN
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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. The Fund's
Distribution Plan provides that the Fund may expend up to 0.3125% quarterly
(approximately 1.25% annually) of average daily net asset value of its shares
to pay distribution costs for sales of its shares and to pay shareholder
service fees. A NASD rule limits the amount that a Fund may pay annually in
distribution costs for the sale of its shares and shareholder service fees.
The rule limits such annual expenditures to 1% of the aggregate average daily
net asset value of its shares, of which 0.75% may be used to pay such
distribution costs and 0.25% may be used to pay shareholder service fees. The
NASD rule also limits 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 Distribution Plan, plus interest at the prime rate plus 1% per annum on
such amounts (less any contingent deferred sales charges paid by shareholders
to the Principal Underwriter), remaining unpaid from time to time.
Payments under the Distribution Plan are currently made to the Principal
Underwriter, (which may reallow all or part to others, such as dealers) (1) as
commissions for Fund shares sold and (2) as shareholder service fees in
respect of shares maintained by the recipients outstanding on the Fund's books
for specified periods. Amounts paid or accrued to the Principal Underwriter
under (1) and (2) in the aggregate may not exceed the annual limitations
referred to above. The Principal Underwriter generally reallows to brokers or
others a commission equal to 4% of the price paid for each Fund share sold. In
addition, the Principal Underwriter generally reallows to brokers or others a
shareholder service fee at a rate of 0.25% per annum of the net asset value of
shares maintained by such recipients outstanding on the books of the Fund for
specified periods.
If the Fund is unable to pay the Principal Underwriter a commission on a new
sale because the annual maximum (0.75% of average daily net assets) has been
reached, the Principal Underwriter intends, but is not obligated, to continue
to accept new orders for the purchase of Fund shares and to pay or accrue
commissions and service fees to dealers in excess of the amount it currently
receives from the Fund. While the Fund is under no contractual obligation to
reimburse the Principal Underwriter for advances made by the Principal
Underwriter in excess of the Distribution Plan limitation, the Principal
Underwriter intends to seek full payment of such charges from the Fund
(together with interest at the rate of prime 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. The Principal Underwriter currently intends to seek
payment of interest only on such charges paid or accrued by the Principal
Underwriter subsequent to January 1, 1992. If the Fund's Independent Trustees
authorize such payments, the effect will be to extend the period of time
during which the Fund incurs the maximum amount of costs allowed by the
Distribution Plan. If the Distribution Plan is terminated, the Principal
Underwriter will ask the Independent Trustees to take whatever action they
deem appropriate under the circumstances with respect to payment of such
amounts.
During the fiscal year ended October 31, 1995, the Fund recovered $3,720 in
deferred sales charges. During the year, the Fund paid the Principal
Underwriter under the Distribution Plan $4,584,433. The amount paid by the
Fund under its Distribution Plan, net of deferred sales charges recovered by
the Fund, was $4,580,713 (1.0% of the Fund's average daily net asset value
during the year). During the year, the Principal Underwriter also received
$484,167 in deferred sales charges. Unpaid distribution costs at October 31,
1995 were $1,629,795 (0.33% of the Fund's net assets.)
The amounts and purposes of expenditures under the Distribution Plan must be
reported to the Independent Trustees quarterly. The Independent Trustees may
require or approve changes in the operation of the Distribution Plan and may
require that total expenditures by the Fund under the Distribution Plan be
kept within limits lower than the maximum amount permitted by the Distribution
Plan as stated above. If such costs are not limited by the Independent
Trustees, such costs could, for some period of time, be higher than such costs
permitted by most other plans presently adopted by other investment companies.
The Distribution Plan may be terminated at any time by vote of the
Independent Trustees or by vote of a majority of the outstanding voting shares
of the Fund. Any change in the Distribution Plan that would materially
increase the distribution expenses of the Fund provided for in the
Distribution Plan requires shareholder approval. Otherwise, the Distribution
Plan may be amended by votes of the majority of both (1) the Fund's Trustees
and (2) the Independent Trustees cast in person at a meeting called for the
purpose of voting on such amendment.
While the Distribution Plan is in effect, the Fund is required to commit the
selection and nomination of candidates for Independent Trustees to the
discretion of the Independent Trustees.
Whether any expenditure under the Distribution Plan is subject to a state
expense limit depends upon the nature of the expenditure and the terms of the
state law, regulation or order imposing the limit. A portion of the Fund's
Distribution Plan expenses may be includable in the Fund's total operating
expenses for purposes of determining compliance with state expense limits.
ARRANGEMENTS WITH BROKER-DEALERS AND OTHERS
Upon written notice to dealers, the Principal Underwriter, at its own
expense, may periodically sponsor programs that offer additional compensation
in connection with sales of Fund shares. Participation in such programs may be
available to all dealers or to selected dealers who have sold or are expected
to sell significant amounts of shares. Additional compensation may also
include financial assistance to dealers in connection with preapproved
seminars, conferences and advertising. No such programs or additional
compensation will be offered to the extent they are prohibited by the laws of
any state or any self-regulatory agency, such as the NASD.
The Principal Underwriter may, at its own expense, pay concessions in
addition to those described above to dealers which satisfy certain criteria
established from time to time by the Principal Underwriter. These conditions
relate to increasing sales of shares of the Keystone funds over specified
periods and certain other factors. Such payments may, depending on the
dealer's satisfaction of the required conditions, be up to 0.25% of the value
of shares sold by such dealer.
The Principal Underwriter may pay banks and other financial services firms
that facilitate transactions in shares of the Fund for their clients a
transaction fee up to the level of the payments made allowable to dealers for
the sale of such shares, as described above.
The Glass-Steagall Act currently limits the ability of a depository
institution (such as a commercial bank or a savings and loan association) to
become an underwriter or distributor of securities. In the event the Glass-
Steagall Act is deemed to prohibit depository institutions from accepting
payments under the arrangement described above, or should Congress relax
current restrictions on depository institutions, the Board of Directors will
consider what action, if any, is appropriate.
In addition, state securities laws on this issue may differ from the
interpretations of federal law expressed herein and banks and financial
institutions may be required to register as dealers pursuant to state law.
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HOW TO REDEEM SHARES
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Fund shares may be redeemed for cash at the redemption value upon written
order by the shareholder(s) to the Fund, c/o Keystone Investor Resource
Center, Inc., Box 2121, Boston, Massachusetts 02106-2121, and presentation to
the Fund of a properly endorsed share certificate, if certificates have been
issued. The signature(s) of the shareholder(s) on the written order and
certificates must be guaranteed. The redemption value is the net asset value
adjusted for fractions of a cent and may be more or less than the
shareholder's cost depending upon changes in the value of the Fund's portfolio
securities between purchase and redemption. The Fund may impose a deferred
sales charge at the time of redemption of certain shares as explained in "How
to Buy Shares." If imposed, the Fund deducts the deferred sales charge from
the redemption proceeds otherwise payable to the shareholder.
REDEMPTION OF SHARES IN GENERAL
At various times, the Fund may be requested to redeem shares for which it
has not yet received good payment. In such a case, the Fund will mail the
redemption proceeds upon clearance of the purchase check, which may take up to
15 days or more. Any delay may be avoided by purchasing shares with a
certified check drawn on a U.S. bank or by bank wire of funds. Although the
mailing of a redemption check may be delayed, the redemption value will be
determined and the redemption processed in the ordinary course of business
upon receipt of proper documentation. In such a case, after the redemption and
prior to the release of the proceeds, no appreciation or depreciation will
occur in the value of the redeemed shares, and no interest will be paid on the
redemption proceeds. If the mailing of a redemption check has been delayed,
the check will be mailed promptly after good payment has been collected.
The Fund computes the redemption value at the close of the Exchange at the
end of the day on which it has received all proper documentation from the
shareholder. Payment of the amount due on redemption, less any applicable
deferred sales charge, will be made within seven days thereafter except as
discussed herein.
Shareholders may also redeem their shares through their broker-dealers. The
Principal Underwriter, acting as agent for the Fund, stands ready to
repurchase Fund shares upon orders from dealers as follows: redemption
requests received by broker-dealers prior to that day's close of trading on
the Exchange and transmitted to the Fund prior to its close of business that
day will receive the net asset value per share computed at the close of
trading on the Exchange on the same day. Redemption requests received by
broker-dealers after that day's close of trading on the Exchange and
transmitted to the Fund prior to the close of business on the next business
day will receive the next business day's net asset value price. Assuming it
has received proper documentation, the Principal Underwriter will pay the
redemption proceeds, less any applicable deferred sales charge, to the dealer
placing the order within seven days thereafter, assuming it has received
proper documentation. The Principal Underwriter charges no fees for this
service, but the shareholder's broker-dealer may do so.
For the protection of shareholders, SIGNATURES ON CERTIFICATES, STOCK POWERS
AND ALL WRITTEN ORDERS OR AUTHORIZATIONS MUST BE GUARANTEED BY A U.S. STOCK
EXCHANGE MEMBER, A BANK OR OTHER PERSONS ELIGIBLE TO GUARANTEE SIGNATURES
UNDER THE SECURITIES EXCHANGE ACT OF 1934 AND KIRC'S POLICIES. The Fund and
KIRC may waive this requirement, but may also require additional documents in
certain cases. Currently, the requirement for a signature guarantee has been
waived on redemptions of $50,000 or less when the account address of record
has been the same for a minimum period of 30 days. The Fund and KIRC reserve
the right to withdraw this waiver at any time.
If the Fund receives a redemption or repurchase order, but the shareholder
has not clearly indicated the amount of money or number of shares involved,
the Fund cannot execute the order. In such cases, the Fund will request the
missing information from the shareholder and process the order the day it
receives such information.
TELEPHONE
Under ordinary circumstances you may redeem up to $50,000 from your account
by telephone by calling toll free 1-800-343-2898. To engage in telephone
transactions generally, you must complete the appropriate sections of the
Fund's application.
In order to insure that instructions received by KIRC are genuine when you
initiate a telephone transaction, you will be asked to verify certain criteria
specific to your account. At the conclusion of the transaction, you will be
given a transaction number confirming your request, and written confirmation
of your transaction will be mailed the next business day. Your telephone
instructions will be recorded. Redemptions by telephone are allowed only if
the address and bank account of record have been the same for a minimum period
of 30 days.
If the redemption proceeds are less than $2,500, they will be mailed by
check. If they are $2,500 or more, they will be mailed, wired or sent by EFT
to your previously designated bank account as you direct. If you do not
specify how you wish your redemptions proceeds to be sent, they will be mailed
by check.
If you cannot reach the Fund by telephone, you should follow the procedures
for redeeming by mail or through a broker as set forth above.
SMALL ACCOUNTS
Because of the high cost of maintaining small accounts, the Fund reserves
the right to redeem your account if its value falls below $1,000, the current
minimum investment level, as a result of your redemptions (but not as a result
of market action). You will be notified in writing and allowed 60 days to
increase the value of your account to the minimum investment level. No
contingent deferred sales charges are applied to such redemptions.
GENERAL
The Fund reserves the right at any time to terminate, suspend or change the
terms of any redemption method described in this prospectus, except redemption
by mail, and to impose fees.
Except as otherwise noted, neither the Fund, KIRC nor the Principal
Underwriter assumes responsibility for the authenticity of any instructions
received by any of them from a shareholder in writing, over the Keystone
Automated Response Line ("KARL") or by telephone. KIRC will employ reasonable
procedures to confirm that instructions received over KARL or by telephone are
genuine. Neither the Fund, KIRC nor the Principal Underwriter will be liable
when following instructions received over KARL or by telephone that KIRC
reasonably believes to be genuine.
The Fund may temporarily suspend the right to redeem its shares when (1) the
Exchange is closed, other than customary weekend and holiday closings; (2)
trading on the Exchange is restricted; (3) the Fund cannot dispose of its
investments or fairly determine their value; or (4) the Securities and
Exchange Commission, for the protection of shareholders, so orders.
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SHAREHOLDER SERVICES
- ------------------------------------------------------------------------------
Details on all shareholder services may be obtained from KIRC by calling toll
free 1-800-343-2898.
KEYSTONE AUTOMATED RESPONSE LINE
KARL offers shareholders specific fund account information and price and
yield quotations as well as the ability to effect account transactions,
including investments, exchanges and redemptions. Shareholders may access KARL
by dialing toll free 1-800-346-3858 on any touch-tone telephone, 24 hours a
day, seven days a week.
EXCHANGES
A shareholder who has obtained the appropriate prospectus may exchange
shares of the Fund for shares of any of the other funds in the Keystone Fund
Family, on the basis of their respective net asset values by calling toll free
1-800-343-2898 or by writing KIRC at Box 2121, Boston, Massachusetts 02106-
2121 (See "How to Redeem Shares" for additional information with respect to
telephone transactions.)
Fund shares purchased by check may be exchanged for shares of the funds in
the Keystone Fund Family, other than Keystone Precious Metals Holdings, Inc.
("KPMH"), Keystone Tax Exempt Trust ("KTET") or Keystone Tax Free Fund
("KTFF"). In order to exchange Fund shares for shares of KPMH, KTET or KTFF, a
shareholder must have held Fund shares for a period of at least six months.
You may exchange your shares for another Keystone fund for a $10 fee by
calling or writing to Keystone. The exchange fee is waived for individual
investors who make an exchange using KARL. If the shares being tendered for
exchange have been held for less than four years and are still subject to a
deferred sales charge, such charge will carry over to the shares being
acquired in the exchange transaction. The Fund reserves the right to terminate
this exchange offer or to change its terms, including the right to change the
service charge for any exchange.
Orders to exchange shares of the Fund for shares of Keystone Liquid Trust
("KLT") will be executed by redeeming the shares of the Fund and purchasing
shares of KLT at the net asset value of KLT shares determined after the
proceeds from such redemption become available, which may be up to seven days
after such redemption. In all other cases, orders for exchanges received by
the Fund prior to 4:00 p.m. on any day the funds are open for business will be
executed at the respective net asset values determined as of the close of
business that day. Orders for exchanges received after 4:00 p.m. on any
business day will be executed at the respective net asset values determined at
the close of the next business day.
An excessive number of exchanges may be disadvantageous to the Fund.
Therefore, the Fund, in addition to its right to reject any exchange, reserves
the right to terminate the exchange privilege of any shareholder who makes
more than five exchanges of shares of the funds in a year or three in a
calendar quarter.
An exchange order must comply with the requirements for a redemption or
repurchase order and must specify the dollar value or number of shares to be
exchanged. Exchanges are subject to the minimum initial purchase requirements
of the fund being acquired. An exchange constitutes a sale for federal income
tax purposes.
The exchange privilege is available only in states where shares of the fund
being acquired may legally be sold.
RETIREMENT PLANS
The Fund has various retirement plans available to investors, including
Individual Retirement Accounts ("IRAs"); Rollover IRA's; Simplified Employee
Pension Plans ("SEPs"); Tax Sheltered Annuity Plans ("TSAs"); 403(b) Plans;
401(k) Plans; Keogh Plans; Corporate Profit-Sharing Plans; and Money Purchase
Pension Plans. For details, including fees and application forms, call KIRC
toll free at 1-800-247-4075 or write to KIRC at P.O. Box 2121, Boston,
Massachusetts 02106-2121.
AUTOMATIC INVESTMENT PLAN
Shareholders may take advantage of investing on an automatic basis by
establishing an automatic investment plan. Funds are drawn on a shareholder's
checking account monthly and used to purchase Fund shares.
AUTOMATIC WITHDRAWAL PLAN
Under an Automatic Withdrawal Plan, shareholders may arrange for regular
monthly or quarterly fixed withdrawal payments. Each payment must be at least
$100 and may be as much as 1% per month or 3% per quarter of the total net
asset value of the Fund shares in the shareholder's account when the Automatic
Withdrawal Plan is opened. Fixed withdrawal payments are not subject to a
deferred sales charge. Excessive withdrawals may decrease or deplete the value
of a shareholder's account.
OTHER SERVICES
Under certain circumstances, shareholders may, within 30 days after a
redemption, reinstate their accounts at current net asset value.
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PERFORMANCE DATA
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From time to time, the Fund may advertise "total return" and "current
yield." BOTH FIGURES ARE BASED ON HISTORICAL EARNINGS AND ARE NOT INTENDED TO
INDICATE FUTURE PERFORMANCE. Total return refers to the Fund's average annual
compounded rates of return over specified periods determined by comparing the
initial amount invested to the ending redeemable value of that amount. The
resulting equation assumes reinvestment of all dividends and distributions and
deduction of all recurring charges, if any, applicable to all shareholder
accounts. The deduction of the contingent deferred sales charge is reflected
in the applicable years. The exchange fee is not included in the calculation.
Current yield quotations represent the yield on an investment for a stated
30-day period computed by dividing net investment income earned per share
during the base period by the maximum offering price per share on the last day
of the base period. The Fund presently does not intend to advertise current
yield.
The Fund may include comparative performance information when advertising or
marketing the Fund's shares, such as data from Lipper Analytical Services,
Inc., Morningstar, Inc., Standard & Poor's Corporation, Ibbotson Associates or
other industry publications.
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FUND SHARES
- ------------------------------------------------------------------------------
The Fund currently issues one class of shares, which participate equally in
dividends and distributions and have equal voting, liquidation and other
rights. When issued and paid for, the shares will be fully paid and
nonassessable by the Fund. Shares may be exchanged as explained under
"Shareholder Services," but will have no other preference, conversion,
exchange or preemptive rights. Shareholders are entitled to one vote for each
full share owned and fractional votes for fractional shares. Shares are
redeemable, transferable and freely assignable as collateral. The Fund may
establish additional classes or series of shares.
The Fund does not have annual meetings. The Fund will have special meetings,
from time to time, as required under its Restatement of Trust Agreement and
under the 1940 Act. As provided in the Fund's Restatement of Trust Agreement,
shareholders have the right to remove Trustees by an affirmative vote of two-
thirds of the outstanding shares. A special meeting of the shareholders will
be held when 10% of the outstanding shares request a meeting for the purpose
of removing a Trustee. The Fund is prepared to assist shareholders in
communications with one another for the purpose of convening such a meeting as
prescribed by Section 16(c) of the 1940 Act.
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ADDITIONAL INFORMATION
- ------------------------------------------------------------------------------
KIRC, located at 101 Main Street, Cambridge, Massachusetts 02142-1519, is a
wholly-owned subsidiary of Keystone and serves as the Fund's transfer agent
and dividend disbursing agent.
When the Fund determines from its records that more than one account in the
Fund is registered in the name of a shareholder or shareholders having the
same address, upon written notice to those shareholders, the Fund intends,
when an annual report or semi-annual report of the Fund is required to be
furnished, to mail one copy of such report to that address.
Except as otherwise stated in this prospectus or required by law, the Fund
reserves the right to change the terms of the offer stated in this prospectus
without shareholder approval, including the right to impose or change fees for
services provided.
<PAGE>
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ADDITIONAL INVESTMENT INFORMATION
- ------------------------------------------------------------------------------
The Fund may engage in the following investment practices to the extent
described in the prospectus and the statement of additional information.
OBLIGATIONS OF FOREIGN BRANCHES OF UNITED STATES BANKS
The obligations of foreign branches of U.S. banks may be general obligations
of the parent bank in addition to the issuing branch, or may be limited by the
terms of a specific obligation and by government regulation. Payment of
interest and principal upon these obligations may also be affected by
governmental action in the country of domicile of the branch (generally
referred to as sovereign risk). In addition, evidences of ownership of such
securities may be held outside the U.S. and the Fund may be subject to the
risks associated with the holding of such property overseas. Various
provisions of federal law governing domestic branches do not apply to foreign
branches of domestic banks.
OBLIGATIONS OF UNITED STATES BRANCHES OF FOREIGN BANKS
Obligations of U.S. branches of foreign banks may be general obligations of
the parent bank in addition to the issuing branch, or may be limited by the
terms of a specific obligation and by federal and state regulation as well as
by governmental action in the country in which the foreign bank has its head
office. In addition, there may be less publicly available information about a
U.S. branch of a foreign bank than about a domestic bank.
MASTER DEMAND NOTES
Master demand notes are unsecured obligations that permit the investment of
fluctuating amounts by the Fund at varying rates of interest pursuant to
direct arrangements between the Fund, as lender, and the issuer as borrower.
Master demand notes may permit daily fluctuations in the interest rate and
daily changes in the amounts borrowed. The Fund has the right to increase the
amount under the note at any time up to the full amount provided by the note
agreement, or to decrease the amount. The borrower may repay up to the full
amount of the note without penalty. Notes acquired by the Fund permit the Fund
to demand payment of principal and accrued interest at any time (on not more
than seven days' notice). Notes acquired by the Fund may have maturities of
more than one year, provided that (1) the Fund is entitled to payment of
principal and accrued interest upon not more than seven days notice, and (2)
the rate of interest on such notes is adjusted automatically at periodic
intervals which normally will not exceed 31 days, but may extend up to one
year. The notes will be deemed to have a maturity equal to the longer of the
period remaining to the next interest rate adjustment or the demand notice
period. Because these types of notes are direct lending arrangements between
the lender and borrower, such instruments are not normally traded and there is
no secondary market for these notes, although they are redeemable and thus
repayable by the borrower at face value plus accrued interest at any time.
Accordingly, the Fund's right to redeem is dependent on the ability of the
borrower to pay principal and interest on demand. In connection with master
demand note arrangements, Keystone considers, under standards established by
the Board of Trustees, earning power, cash flow and other liquidity ratios of
the borrower and will monitor the ability of the borrower to pay principal and
interest on demand. These notes are not typically rated by credit rating
agencies. Unless rated, the Fund may invest in them only if at the time of an
investment the issuer meets the criteria established for commercial paper.
REPURCHASE AGREEMENTS
The Fund may enter into repurchase agreements; i.e., the Fund purchases a
security subject to the Fund's obligation to resell and the seller's
obligation to repurchase that security at an agreed upon price and date, such
date usually being not more than seven days from the date of purchase. The
resale price is based on the purchase price plus an agreed upon current market
rate of interest that (for purposes of the transaction) is generally unrelated
to the coupon rate or maturity of the purchased security. A repurchase
agreement imposes an obligation on the seller to pay the agreed upon price,
which obligation is in effect secured by the value of the underlying security.
The value of the underlying security is at least equal to the amount of the
agreed upon resale price and marked to market daily to cover such amount. The
Fund may enter into such agreements only with respect to U.S. government and
foreign government securities, which may be denominated in U.S. or foreign
currencies. The Fund may enter into such repurchase agreements with foreign
banks and securities dealers approved in advance by the Fund's Trustees.
Whether a repurchase agreement is the purchase and sale of a security or a
collateralized loan has not been definitively established. This might become
an issue in the event of the bankruptcy of the other party to the transaction.
It does not presently appear possible to eliminate all risks involved in
repurchase agreements. These risks include the possibility of an increase in
the market value of the underlying securities or inability of the repurchaser
to perform its obligation to repurchase coupled with an uncovered decline in
the market value of the collateral, including the underlying securities, as
well as delay and costs to the Fund in connection with enforcement or
bankruptcy proceedings. Therefore, it is the policy of the Fund to enter into
repurchase agreements only with large, well-capitalized banks that are members
of the Federal Reserve System and with primary dealers in U.S. government
securities (as designated by the Federal Reserve Board) whose creditworthiness
has been reviewed and found satisfactory by the Fund's advisers.
REVERSE REPURCHASE AGREEMENTS
Under a reverse repurchase agreement, the Fund would sell securities and
agree to repurchase them at a mutually agreed upon date and price. The Fund
intends to enter into reverse repurchase agreements to avoid otherwise having
to sell securities during unfavorable market conditions in order to meet
redemptions. At the time the Fund enters into a reverse repurchase agreement,
it will establish a segregated account with the Fund's custodian containing
liquid assets such as U.S. government securities or other high grade debt
securities having a value not less than the repurchase price (including
accrued interest) and will subsequently monitor the account to ensure such
value is maintained. Reverse repurchase agreements involve the risk that the
market value of the securities that the Fund is obligated to repurchase may
decline below the repurchase price. Borrowing and reverse repurchase
agreements magnify the potential for gain or loss on the portfolio securities
of the Fund and, therefore, increase the possibility of fluctuation in the
Fund's net asset value. Such practices may constitute leveraging. In the event
the buyer of securities under a reverse repurchase agreement files for
bankruptcy or becomes insolvent, such buyer or its trustee or receiver may
receive an extension of time to determine whether to enforce the Fund's
obligation to repurchase the securities and the Fund's use of the proceeds of
the reverse repurchase agreement may effectively be restricted pending such
determination. The staff of the SEC has taken the position that the Investment
Company Act of 1940 treats reverse repurchase agreements as being included in
the percentage limit on borrowings imposed on a Fund.
FOREIGN SECURITIES
The Fund may invest in securities principally traded in securities markets
outside the United States. While investment in foreign securities is intended
to reduce risk by providing further diversification, such investments involve
sovereign risk in addition to the credit and market risks normally associated
with domestic securities. Foreign investments may be affected favorably or
unfavorably by changes in currency rates and exchange control regulations.
There may be less publicly available information about a foreign company than
about a U.S. company, and foreign companies may not be subject to accounting,
auditing and financial reporting standards and requirements comparable to
those applicable to U.S. companies. Securities of some foreign companies are
less liquid or more volatile than securities of U.S. companies, and foreign
brokerage commissions and custodian fees are generally higher than in the
United States. Investments in foreign securities may also be subject to other
risks different from those affecting U.S. investments, including local
political or economic developments, expropriation or nationalization of
assets, imposition of withholding taxes on dividend or interest payments and
currency blockage (which would prevent cash from being brought back to the
United States). These risks are carefully considered by Keystone prior to the
purchase of these securities.
"WHEN ISSUED" TRANSACTIONS
The Fund may also purchase and sell securities and currencies on a when
issued and delayed delivery basis. When issued or delayed delivery
transactions arise when securities or currencies are purchased or sold by the
Fund with payment and delivery taking place in the future in order to secure
what is considered to be an advantageous price and yield to the Fund at the
time of entering into the transaction. When the Fund engages in when issued
and delayed delivery transactions, the Fund relies on the buyer or seller, as
the case may be, to consummate the sale. Failure to do so may result in the
Fund missing the opportunity to obtain a price or yield considered to be
advantageous. When issued and delayed delivery transactions may be expected to
occur a month or more before delivery is due. However, no payment or delivery
is made by the Fund until it receives payment or delivery from the other party
to the transaction. A separate account of liquid assets equal to the value of
such purchase commitments will be maintained until payment is made. When
issued and delayed delivery agreements are subject to risks from changes in
value based upon changes in the level of interest rates, currency rates and
other market factors, both before and after delivery. The Fund does not accrue
any income on such securities or currencies prior to their delivery. To the
extent the Fund engages in when issued and delayed delivery transactions, it
will do so consistent with its investment objective and policies and not for
the purpose of investment leverage.
DERIVATIVES
The Fund may use derivatives in furtherance of its investment objective.
Derivatives are financial contracts whose value depends on, or is derived
from, the value of an underlying asset, reference rate or index. These assets,
rates, and indices may include bonds, stocks, mortgages, commodities, interest
rates, currency exchange rates, bond indices and stock indices. Derivatives
can be used to earn income or protect against risk, or both. For example, one
party with unwanted risk may agree to pass that risk to another party who is
willing to accept the risk, the second party being motivated, for example, by
the desire either to earn income in the form of a fee or premium from the
first party, or to reduce its own unwanted risk by attempting to pass all or
part of that risk to the first party.
Derivatives can be used by investors such as the Fund to earn income and
enhance returns, to hedge or adjust the risk profile of the portfolio, and
either in place of more traditional direct investments or to obtain exposure
to otherwise inaccessible markets. The Fund is permitted to use derivatives
for one or more of these purposes, although the Fund generally uses
derivatives primarily as direct investments in order to enhance yields and
broaden portfolio diversification. Each of these uses entails greater risk
than if derivatives were used solely for hedging purposes. The Fund uses
futures contracts and related options for hedging purposes. Derivatives are a
valuable tool which, when used properly, can provide significant benefit to
Fund shareholders. Keystone is not an aggressive user of derivatives with
respect to the Fund. However, the Fund may take positions in those derivatives
that are within its investment policies if, in Keystone's judgement, this
represents an effective response to current or anticipated market conditions.
Keystone's use of derivatives is subject to continuous risk assessment and
control from the standpoint of the Fund's investment objectives and policies.
Derivatives may be (1) standardized, exchange-traded contracts or (2)
customized, privately negotiated contracts. Exchange-traded derivatives tend
to be more liquid and subject to less credit risk than those that are
privately negotiated.
There are four principal types of derivative instruments -- options,
futures, forwards and swaps -- from which virtually any type of derivative
transaction can be created. Further information regarding options and futures,
is provided later in this section and is provided in the Fund's statement of
additional information. The Fund does not presently engage in the use of
swaps.
While the judicious use of derivatives by experienced investment managers
such as Keystone can be beneficial, derivatives also involve risks different
from, and, in certain cases, greater than, the risks presented by more
traditional investments. Following is a general discussion of important risk
factors and issues concerning the use of derivatives that investors should
understand before investing in the Fund.
* Market Risk -- This is the general risk attendant to all investments that
the value of a particular investment will decline or otherwise change in a
way detrimental to the Fund's interest.
* Management Risk -- Derivative products are highly specialized instruments
that require investment techniques and risk analyses different from those
associated with stocks and bonds. The use of a derivative requires an
understanding not only of the underlying instrument, but also of the
derivative itself, without the benefit of observing the performance of the
derivative under all possible market conditions. In particular, the use and
complexity of derivatives require the maintenance of adequate controls to
monitor the transactions entered into, the ability to assess the risk that a
derivative adds to the Fund's portfolio and the ability to forecast price,
interest rate or currency exchange rate movements correctly.
* Credit Risk -- This is the risk that a loss may be sustained by the Fund as
a result of the failure of a another party to a derivative (usually referred
to as a "counterparty") to comply with the terms of the derivative contract.
The credit risk for exchange traded derivatives is generally less than for
privately negotiated derivatives, since the clearing house, which is the
issuer or counterparty to each exchange-traded derivative, provides a
guarantee of performance. This guarantee is supported by a daily payment
system (i.e., margin requirements) operated by the clearing house in order
to reduce overall credit risk. For privately negotiated derivatives, there
is no similar clearing agency guarantee. Therefore, the Fund considers the
creditworthiness of each counterparty to a privately negotiated derivative
in evaluating potential credit risk.
* Liquidity Risk -- Liquidity risk exists when a particular instrument is
difficult to purchase or sell. If a derivative transaction is particularly
large or if the relevant market is illiquid (as is the case with many
privately negotiated derivatives), it may not be possible to initiate a
transaction or liquidate a position at an advantageous price.
* Leverage Risk -- Since many derivatives have a leverage component, adverse
changes in the value or level of the underlying asset, rate or index can
result in a loss substantially greater than the amount invested in the
derivative itself. In the case of swaps, the risk of loss generally is
related to a notional principal amount, even if the parties have not made
any initial investment. Certain derivatives have the potential for unlimited
loss, regardless of the size of the initial investment.
* Other Risks -- Other risks in using derivatives include the risk of
mispricing or improper valuation and the inability of derivatives to
correlate perfectly with underlying assets, rates and indices. Many
derivatives, in particular privately negotiated derivatives, are complex and
often valued subjectively. Improper valuations can result in increased cash
payment requirements to counterparties or a loss of value to a Fund.
Derivatives do not always perfectly or even highly correlate or track the
value of the assets, rates or indices they are designed to closely track.
Consequently, the Fund's use of derivatives may not always be an effective
means of, and sometimes could be counterproductive to, furthering the Fund's
investment objective.
OPTIONS TRANSACTIONS
WRITING COVERED OPTIONS. The Fund may write (i.e., sell) covered call and
put options. By writing a call option, the Fund becomes obligated during the
term of the option to deliver the securities underlying the option upon
payment of the exercise price. By writing a put option, the Fund becomes
obligated during the term of the option to purchase the securities underlying
the option at the exercise price if the option is exercised. The Fund also may
write straddles (combinations of covered puts and calls on the same underlying
security).
The Fund may only write "covered" options. This means that so long as the
Fund is obligated as the writer of a call option, it will own the underlying
securities subject to the option or, in the case of call options on U.S.
Treasury bills, the Fund might own substantially similar U.S. Treasury bills.
If the Fund has written options against all of its securities which are
available for writing options, the Fund may be unable to write additional
options unless it sells a portion of its portfolio holdings to obtain new
securities against which it can write options. If this were to occur, higher
portfolio turnover and correspondingly greater brokerage commissions and other
transaction costs may result. However, the Fund does not expect that this will
occur.
The Fund will be considered "covered" with respect to a put option it writes
if, so long as it is obligated as the writer of the put option, it deposits
and maintains with its custodian in a segregated account liquid assets having
a value equal to or greater than the exercise price of the option.
The principal reason for writing call or put options is to obtain, through a
receipt of premiums, a greater current return than would be realized on the
underlying securities alone. The Fund receives a premium from writing a call
or put option, which it retains whether or not the option is exercised. By
writing a call option, the Fund might lose the potential for gain on the
underlying security while the option is open, and by writing a put option the
Fund might become obligated to purchase the underlying security for more than
its current market price upon exercise.
PURCHASING OPTIONS. The Fund may purchase put or call options, including
purchasing put or call options for the purpose of offsetting previously
written put or call options of the same series.
If the Fund is unable to effect a closing purchase transaction with respect
to covered options it has written, the Fund will not be able to sell the
underlying security or dispose of assets held in a segregated account until
the options expire or are exercised.
An option position may be closed out only in a secondary market for an
option of the same series. Although the Fund generally will write only those
options for which there appears to be an active secondary market, there is no
assurance that a liquid secondary market will exist for any particular option
at any particular time, and for some options no secondary market may exist. In
such event, it might not be possible to effect a closing transaction in a
particular option.
Options on some securities are relatively new, and it is impossible to
predict the amount of trading interest that will exist in such options. There
can be no assurance that viable markets will develop or continue. The failure
of such markets to develop or continue could significantly impair the Fund's
ability to use such options to achieve its investment objective.
OPTIONS TRADING MARKETS. Options in which the Fund will trade generally are
listed on national securities exchanges. Exchanges on which such options
currently are traded include the Chicago Board Options Exchange and the New
York, American, Pacific and Philadelphia Stock Exchanges. Options on some
securities may not be listed on any Exchange, but traded in the over-the-
counter market. Options traded in the over-the-counter market involve the
additional risk that securities dealers participating in such transactions
could fail to meet their obligations to the Fund. The use of options traded in
the over-the-counter market may be subject to limitations imposed by certain
state securities authorities. In addition to the limits on its use of options
discussed herein, the Fund is subject to the investment restrictions described
in this prospectus and in the statement of additional information.
The staff of the SEC is of the view that the premiums that the Fund pays for
the purchase of unlisted options, and the value of securities used to cover
unlisted options written by the Fund, are considered to be invested in
illiquid securities or assets for the purpose of calculating whether the Fund
is in compliance with its investment restriction relating to illiquid
investments.
FUTURES TRANSACTIONS
The Fund may enter into currency and other financial futures contracts and
write options on such contracts. The Fund intends to enter into such contracts
and related options for hedging purposes. The Fund will enter into futures on
securities or currencies or index-based futures contracts in order to hedge
against changes in interest or exchange rates or securities prices. A futures
contract on securities or currencies is an agreement to buy or sell securities
or currencies at a specified price during a designated month. A futures
contract on a securities index does not involve the actual delivery of
securities, but merely requires the payment of a cash settlement based on
changes in the securities index. The Fund does not make payment or deliver
securities upon entering into a futures contract. Instead, it puts down a
margin deposit, which is adjusted to reflect changes in the value of the
contract and which continues until the contract is terminated.
The Fund may sell or purchase futures contracts. When a futures contract is
sold by the Fund, the value of the contract will tend to rise when the value
of the underlying securities or currencies declines and to fall when the value
of such securities or currencies increases. Thus, the Fund sells futures
contracts in order to offset a possible decline in the value of its securities
or currencies. If a futures contract is purchased by the Fund, the value of
the contract will tend to rise when the value of the underlying securities or
currencies increases and to fall when the value of such securities or
currencies declines. The Fund intends to purchase futures contracts in order
to fix what is believed by Keystone to be a favorable price and rate of return
for securities or favorable exchange rate for currencies the Fund intends to
purchase.
The Fund also intends to purchase put and call options on futures contracts
for hedging purposes. A put option purchased by the Fund would give it the
right to assume a position as the seller of a futures contract. A call option
purchased by the Fund would give it the right to assume a position as the
purchaser of a futures contract. The purchase of an option on a futures
contract requires the Fund to pay a premium. In exchange for the premium, the
Fund becomes entitled to exercise the benefits, if any, provided by the
futures contract, but is not required to take any action under the contract.
If the option cannot be exercised profitably before it expires, the Fund's
loss will be limited to the amount of the premium and any transaction costs.
The Fund may enter into closing purchase and sale transactions in order to
terminate a futures contract and may sell put and call options for the purpose
of closing out its options positions. The Fund's ability to enter into closing
transactions depends on the development and maintenance of a liquid secondary
market. There is no assurance that a liquid secondary market will exist for
any particular contract or at any particular time. As a result, there can be
no assurance that the Fund will be able to enter into an offsetting
transaction with respect to a particular contract at a particular time. If the
Fund is not able to enter into an offsetting transaction, the Fund will
continue to be required to maintain the margin deposits on the contract and to
complete the contract according to its terms, in which case it would continue
to bear market risk on the transaction.
Although futures and options transactions are intended to enable the Fund to
manage market, interest rate or exchange rate risk, unanticipated changes in
interest rates, exchange rates or market prices could result in poorer
performance than if it had not entered into these transactions. Even if
Keystone correctly predicts interest or exchange rate movements, a hedge could
be unsuccessful if changes in the value of the Fund's futures position did not
correspond to changes in the value of its investments. This lack of
correlation between the Fund's futures and securities or currencies positions
may be caused by differences between the futures and securities or currencies
markets or by differences between the securities or currencies underlying the
Fund's futures position and the securities or currencies held by or to be
purchased for the Fund. Keystone will attempt to minimize these risks through
careful selection and monitoring of the Fund's futures and options positions.
The Fund does not intend to use futures transactions for speculation or
leverage. The Fund has the ability to write options on futures, but intends to
write such options only to close out options purchased by the Fund. The Fund
will not change these policies without supplementing the information in its
prospectus and statement of additional information.
FOREIGN CURRENCY TRANSACTIONS
As discussed above, the Fund may invest in securities of foreign issuers.
When the Fund invests in foreign securities they usually will be denominated
in foreign currencies, and the Fund temporarily may hold funds in foreign
currencies. Thus, the value of Fund shares will be affected by changes in
exchange rates.
As one way of managing exchange rate risk, in addition to entering into
currency futures contracts, the Fund may enter into forward currency exchange
contracts (agreements to purchase or sell currencies at a specified price and
date). The exchange rate for the transaction (the amount of currency the Fund
will deliver or receive when the contract is completed) is fixed when the Fund
enters into the contract. The Fund usually will enter into these contracts to
stabilize the U.S. dollar value of a security it has agreed to buy or sell.
The Fund intends to use these contracts to hedge the U.S. dollar value of a
security it already owns, particularly if the Fund expects a decrease in the
value of the currency in which the foreign security is denominated. Although
the Fund will attempt to benefit from using forward contracts, the success of
its hedging strategy will depend on Keystone's ability to predict accurately
the future exchange rates between foreign currencies and the U.S. dollar. The
value of the Fund's investments denominated in foreign currencies will depend
on the relative strength of those currencies and the U.S. dollar, and the Fund
may be affected favorably or unfavorably by changes in the exchange rates or
exchange control regulations between foreign currencies and the dollar.
Changes in foreign currency exchange rates also may affect the value of
dividends and interest earned, gains and losses realized on the sale of
securities and net investment income and gains, if any, to be distributed to
shareholders by the Fund. The Fund may also purchase and sell options related
to foreign currencies in connection with hedging strategies.
LOANS OF SECURITIES TO BROKER-DEALERS
The Fund may lend securities to brokers and dealers pursuant to agreements
requiring that the loans be continuously secured by cash or securities of the
U.S. government, its agencies or instrumentalities, or any combination of cash
and such securities, as collateral equal at all times in value to at least the
market value of the securities loaned. Such securities loans will not be made
with respect to the Fund if as a result the aggregate of all outstanding
securities loans exceeds 15% of the value of the Fund's total assets taken at
their current value. The Fund continues to receive interest or dividends on
the securities loaned and simultaneously earns interest on the investment of
the cash loan collateral in U.S. Treasury notes, certificates of deposit,
other high-grade, short-term obligations or interest bearing cash equivalents.
Although voting rights attendant to securities loaned pass to the borrower,
such loans may be called at any time and will be called so that the securities
may be voted by the Fund if, in the opinion of the Fund, a material event
affecting the investment is to occur. There may be risks of delay in receiving
additional collateral or in recovering the securities loaned or even loss of
rights in the collateral should the borrower of the securities fail
financially. Loans may only be made to borrowers deemed to be of good
standing, under standards approved by the Board of Trustees, when the income
to be earned from the loan justifies the attendant risks.
<PAGE>
KEYSTONE
FUND FAMILY
Quality Bond Fund (B-1)
Diversified Bond Fund (B-2)
High Income Bond Fund (B-4)
Balanced Fund (K-1)
Strategic Growth Fund (K-2)
Growth and Income Fund (S-1)
Mid-Cap Growth Fund (S-3)
Small Company Growth Fund (S-4)
International Fund
Precious Metals Holdings
Tax Free Fund
Tax Exempt Trust
Liquid Trust
[LOGO] KEYSTONE
INVESTMENTS
Keystone Investment Distributors Company
200 Berkeley Street
Boston, Massachusetts 02116-5034
[recycle symbol]
KEYSTONE
Photo:
Adult & child
walking on
beach
STRATEGIC
GROWTH FUND (K-2)
[LOGO]
PROSPECTUS AND
APPLICATION
<PAGE>
KEYSTONE STRATEGIC GROWTH FUND (K-2)
PART B
STATEMENT OF ADDITIONAL INFORMATION
<PAGE>
STATEMENT OF ADDITIONAL INFORMATION
KEYSTONE STRATEGIC GROWTH FUND (K-2)
(FORMERLY NAMED KEYSTONE CUSTODIAN FUND, SERIES K-2)
JANUARY 24, 1996
This statement of additional information is not a prospectus but
relates to, and should be read in conjunction with, the prospectus of Keystone
Strategic Growth Fund (K-2) (formerly named Keystone Custodian Fund, Series K-2)
(the "Fund") dated January 24, 1996. A copy of the prospectus may be obtained
from Keystone Investment Distributors Company (the "Principal Underwriter"), the
Fund's principal underwriter, located at 200 Berkeley Street, Boston,
Massachusetts 02116-5034 or your broker-dealer.
TABLE OF CONTENTS
Page
The Fund's Objective and Policies 2
Investment Restrictions 2
Valuation of Securities 4
Distributions and Taxes 5
Sales Charges 6
Distribution Plan 8
Redemptions in Kind 10
The Trust Agreement 10
Investment Manager 12
Investment Adviser 15
Trustees and Officers 16
Principal Underwriter 20
Brokerage 21
Standardized Total Return
and Yield Quotations 23
Additional Information 23
Appendix A-1
Financial Statements F-1
Independent Auditors' Report F-11
<PAGE>
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THE FUND'S OBJECTIVE AND POLICIES
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The Fund is an open-end, diversified management investment company. The
Fund's investment objective is to provide shareholders with growth of capital.
It is the Fund's policy to invest its assets as fully as practicable.
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INVESTMENT RESTRICTIONS
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None of the restrictions enumerated in this paragraph may be changed
without a vote of the holders of a majority (as defined in the Investment
Company Act of 1940 (the "1940 Act")) of the Fund's outstanding shares. The Fund
shall not do the following:
(1) invest more than 5% of its total assets, computed at
market value, in the securities of any one issuer;
(2) invest more than 5% of the value of its total assets in companies
which have been in operation for less than three years;
(3) borrow money, except that the Fund may (1) borrow money from banks
for temporary or emergency purposes in aggregate amounts up to 10% of the value
of the Fund's net assets (computed at cost), or (2) enter into reverse
repurchase agreements provided that bank borrowings and reverse repurchase
agreements, in aggregate, shall not exceed 10% of the value of the Fund's
assets;
(4) underwrite securities, except that the Fund may purchase securities
from issuers thereof or others and dispose of such securities in a manner
consistent with its other investment policies; in the disposition of restricted
securities the Fund may be deemed to be an underwriter, as defined in the
Securities Act of 1933 (the 1933 Act);
(5) purchase or sell real estate or interests in real estate, except
that it may purchase and sell securities secured by real estate and securities
of companies which invest in real estate, and will not purchase or sell
commodities or commodity contracts, except that the Fund may engage in currency
or other financial futures contracts and related options transactions;
(6) invest in a company for the purpose of control or
management;
(7) make margin purchases or short sales of securities;
(8) make loans, except that the Fund may buy publicly and privately
distributed debt securities, provided that such securities purchases are
consistent with its investment objectives and policies, and except that the Fund
may lend limited amounts of its portfolio securities to broker-dealers;
(9) invest more than 25% of its assets in the securities of
issuers in any single industry; and
(10) purchase the securities of any other investment company except in
the open market and at customary brokerage rates and in no event more than 3% of
the voting securities of any investment company.
If a percentage limit is satisfied at the time of investment or
borrowing, a later increase or decrease resulting from a change in the value of
a security or a decrease in Fund assets is not a violation of the limit.
The Fund has no current intention of attempting to increase its net
income by borrowing and intends to repay any borrowings made in accordance with
the fourth investment restriction enumerated above before it makes any
additional investments.
Additional restrictions adopted by the Fund, which may be changed by
the Board of Trustees, provide that the Fund may not purchase or retain
securities of an issuer if, to the knowledge of the Fund, any officer, Trustee
or Director of the Fund, Keystone Management, Inc. ("Keystone Management") or
Keystone Investment Management Company ("Keystone"), each owning beneficially
more than 1/2 of 1% of the securities of such issuer, own, in the aggregate,
more than 5% of the securities of such issuer, or such persons or management
personnel of the Fund, Keystone Management or Keystone have a substantial
beneficial interest in the securities of such issuer. Portfolio securities of
the Fund may not be purchased from or sold or loaned to Keystone Management,
Keystone or any affiliate thereof or any of their Directors, officers or
employees.
Although not fundamental restrictions or policies requiring a
shareholders vote to change, the Fund has undertaken, so long as a state
authority requires and shares of the Fund are registered for sale in that state,
(1) to not to invest more than 5% of its total assets in securities of
unseasoned issuers, including their predecessors that have been in operation for
less than three years, and in equity securities of issuers that are not readily
marketable, (2) to not invest in interests in oil, gas, or other mineral leases,
exploration or development programs, (3) to limit its purchase of warrants to 5%
of net assets, of which 2% may be warrants not listed on the New York or
American Stock Exchanges (warrants acquired by the Fund in units or attached to
securities will be deemed to be without value with regard to this restriction),
and (4) not invest in real estate limited partnership interests.
In order to permit the sale of Fund shares in certain states, the Fund
may make commitments more restrictive than the investment restrictions described
above. Should the Fund determine that any such commitment is no longer in the
best interests of the Fund, it will revoke the commitment by terminating sales
of its shares in the state involved.
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VALUATION OF SECURITIES
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Current value for the Fund's portfolio securities is determined in the
following manner:
(1) Securities traded on an established exchange are valued on the
basis of the last sales price on the exchange where the securities are primarily
traded prior to the time of valuation. Securities traded in the over-the-counter
market, for which complete quotations are readily available, are valued at the
mean of the bid and asked prices at the time of valuation;
(2) Short-term investments maturing 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 are
valued at market. Short-term investments maturing in more than sixty days when
purchased that 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. In any case, such valuation reflects fair value as
determined by the Fund's Board of Trustees; and
(3) The Fund's Board of Trustees 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; (b) listed
securities if in the Fund's opinion the last sales price does not reflect a
current market value or if no sale occurred; and (c) other assets.
The Fund believes that reliable market quotations generally are not
readily available for purposes of valuing fixed income securities. As a result,
depending on the particular securities owned by the Fund, it is likely that most
of the valuations for such securities will be based upon their fair value
determined under procedures approved by the Board of Trustees. The Board of
Trustees has authorized the use of a pricing service to determine the fair value
of its fixed income securities and certain other securities. Securities for
which market quotations are readily available are valued on a consistent basis
at that price quoted that, in the opinion of the Board of Trustees or the person
designated by the Board of Trustees to make the determination, most nearly
represents the market value of the particular security. Any securities for which
market quotations are not readily available or other assets are valued on a
consistent basis at fair value as determined in good faith using methods
prescribed by the Board of Trustees.
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DISTRIBUTIONS AND TAXES
- --------------------------------------------------------------------------------
The Fund distributes to its shareholders dividends from net investment
income and net realized long-term and short-term capital gains annually in
shares or, at the option of the shareholder, in cash. (Distributions of ordinary
income maybe eligible in whole or in part for the corporate 70% dividend
received deduction.) Shareholders who have not opted, prior to the record date
for any distribution, to receive cash will have the number of distributed shares
determined on the basis of the Fund's net asset value per share computed at the
end of the day on the record date after adjustment for the distribution. Net
asset value is used in computing the number of shares in both gains and income
distribution reinvestments. Unless the Fund receives instructions to the
contrary from a shareholder before the record date, it will assume that the
shareholder wishes to receive that distribution and future gains and income
distributions in shares. Instructions continue in effect until changed in
writing.
Distributed long-term capital gains are taxable as such to the
shareholder regardless of the period of time Fund shares have been held by the
shareholder. However, if such shares are held less than six months and redeemed
at a loss, the shareholder will recognize a long-term capital loss on such
shares to the extent of the long-term capital gain distribution received in
connection with such shares. If the net asset value of the Fund's shares is
reduced below a shareholder's cost by a capital gains distribution, such
distribution, to the extent of the reduction, would be a return of investment
though taxable as stated above. Since distributions of capital gains depend upon
profits actually realized from the sale of securities by the Fund, they may or
may not occur. The foregoing comments relating to the taxation of dividends and
distributions paid on the Fund's shares relate solely to federal income
taxation. Such dividends and distributions may also be subject to state and
local taxes.
When the Fund makes a distribution, it intends to distribute only
Fund's net capital gains and such income as has been predetermined to the best
of the Fund's ability to be taxable as ordinary income. Shareholders of the Fund
will be advised annually of the federal income tax status of distributions.
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SALES CHARGES
- --------------------------------------------------------------------------------
In order to reimburse the Fund for certain expenses relating to the
sale of its shares (see "Distribution Plan"), a deferred sales charge may be
imposed at the time of redemption of certain Fund shares within four calendar
years after their purchase. If imposed, the deferred sales charge is deducted
from the redemption proceeds otherwise payable to the shareholder. For the
fiscal year ended October 31, 1995, the Fund recovered $3,720 in deferred sales
charges.
The contingent deferred sales charge is a declining percentage of the
lesser of (1) the net asset value of the shares redeemed, or (2) the total cost
of such shares. No contingent deferred sales charge is imposed when the
shareholder redeems amounts derived from (1) increases in the value of his
account above the total cost of such shares due to increases in the net asset
value per share of the Fund; (2) certain shares with respect to which the Fund
did not pay a commission on issuance, including shares acquired through
reinvestment of dividend income and capital gains distributions; or (3) shares
held in all or part of more than four consecutive calendar years.
Subject to the limitations stated above, the contingent deferred sales
charge is imposed according to the following schedule: 4% of amounts redeemed
during the calendar year of purchase; 3% of amounts redeemed during the calendar
year after the year of purchase; 2% of amounts redeemed during the second
calendar year after the year of purchase; and 1% of amounts redeemed during the
third calendar year after the year of purchase. No contingent deferred sales
charge is imposed on amounts redeemed thereafter.
The following example will illustrate the operation of the contingent
deferred sales charge. Assume that an investor makes a purchase payment of
$10,000 during the calendar year 1995 and on a given date in 1996, the value of
the investor's account has grown through investment performance and reinvestment
of distributions to $12,000. On such date in 1996, the investor could redeem up
to $2,000 ($12,000 minus $10,000) without incurring a deferred sales charge. If,
on such date, the investor should redeem $3,000, a deferred sales charge would
be imposed on $1,000 of the redemption (the amount by which the investor's
account was reduced by the redemption below the amount of the initial purchase
payment). The charge would be imposed at the rate of 3% (because the redemption
is made during the calendar year after the calendar year of purchase) and would
total $30.
In determining whether a contingent deferred sales charge is payable
and, if so, the percentage charge applicable, it is assumed that shares held the
longest are the first to be redeemed. There is no contingent deferred sales
charge on exchanges of shares between Funds in the Keystone Fund Family that
have adopted distribution plans pursuant to Rule 12b-1 under the 1940 Act.
Moreover, when shares of one such fund have been exchanged for shares of another
such fund, the calendar year of the exchange, for purposes of any future
deferred sales charge, is assumed to be the year shares tendered for exchange
were originally purchased.
Shares also may be sold, to the extent permitted by applicable law,
regulations, interpretations or exemptions, at net asset value without the
imposition of a deferred sales charge to: (1) officers, Directors, Trustees,
full-time employees and sales representatives of the Fund, Keystone Management,
Keystone, Keystone Investments, Inc. ("Keystone Investments"), Harbor Capital
Management Company, Inc., their subsidiaries and the Principal Underwriter who
have been such for not less than ninety days; and (2) the pension and profit
sharing plans established by said companies, their subsidiaries and affiliates,
for the benefit of their officers, Directors, Trustees full-time employees and
sales representatives, provided, however, that all such sales are made upon the
written assurance of the purchaser that the purchase is made for investment
purposes and that the securities will not be resold except through redemption by
the Fund.
No contingent deferred sales charge is imposed on a redemption of
shares of the Fund purchased by a bank or trust company in a single account in
the name of such bank or trust company as trustee if the initial investment in
shares of the Fund, any other fund in the Keystone Fund Family (as hereinafter
defined), Keystone Precious Metals Holdings, Inc., Keystone International Fund
Inc., Keystone Tax Exempt Trust, Keystone Tax Free Fund, Keystone Liquid Trust
and/or any Keystone America Fund (as hereinafter defined) and is at least
$500,000 and any commission paid by the Fund and such other funds at the time of
such purchase is not more than 1% of the amount invested.
In addition, no contingent deferred sales charge is imposed on a
redemption of shares of the Fund in the event of (1) death or disability of the
shareholder; (2) a lump-sum distribution from a 401(k) plan or other benefit
plan qualified under the Employee Retirement Income Security Act of 1974
("ERISA"); (3) automatic withdrawals from ERISA plans if the shareholder is at
least 591/2 years old; (4) involuntary redemptions of accounts having an
aggregate net asset value of less than $1,000; (5) automatic withdrawals under
an automatic withdrawal plan of up to 11/2% per month of the shareholder's
initial account balance; (6) withdrawals consisting of loan proceeds to a
retirement plan participant; (7) financial hardship withdrawals made by a
retirement plan participant; or (8) withdrawals consisting of returns of excess
contributions or excess deferral amounts made to a retirement plan participant.
REDEMPTION OF SHARES
The Fund has obligated itself under the 1940 Act to redeem for cash all
shares presented for redemption by any one shareholder up to the lesser of
$250,000 or 1% of the Fund's assets in any 90 day period.
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DISTRIBUTION PLAN
- --------------------------------------------------------------------------------
Rule 12b-1 under the 1940 Act permits investment companies such as the
Fund, to use their assets to bear expenses of distributing their shares if
they comply with various conditions, including adoption of a distribution plan
containing certain provisions set forth in Rule 12b-1. The Fund bears some of
the costs of putting its shares under a Distribution Plan adopted on June 1,
1983 pursuant to Rule 12b-1 (the "Distribution Plan").
The Fund's Distribution Plan provides that the Fund may expend up to
0.3125% quarterly (approximately 1.25% annually) of the average daily net asset
value of its shares to pay distribution costs for sales of its shares and to pay
shareholder service fees. The NASD rule limits such annual expenditures to 1.0%,
of which 0.75% may be used to pay such distribution costs and 0.25% may be used
to pay shareholder service fees. The aggregate amount that the Fund may pay for
such distribution costs is limited to 6.25% of gross share sales since the
inception of the Fund's Distribution Plan plus interest at the prime rate plus
1% on unpaid amounts thereof (less any contingent deferred sales charge paid by
shareholders to the Principal Underwriter).
Payments under the Distribution Plan are currently made to the
Principal Underwriter (which may reallow all or part to others, such as dealers)
as (1) commissions for Fund shares sold and (2) shareholder service fees in
respect of shares maintained by the recipients outstanding on the Fund's books
for specific periods. Amounts paid or accrued to the Principal Underwriter under
(1) and (2) in the aggregate may not exceed the annual limitation referred to
above. The Principal Underwriter generally reallows to brokers or others a
commission equal to 4% of the price paid for each Fund share sold as well as a
shareholder service fee at a rate of 0.25% per annum of the net asset value of
shares maintained by such recipients outstanding on the books of the Fund for
specified periods.
If the Fund is unable to pay the Principal Underwriter a commission on
a new sale because the annual maximum (0.75% of average daily net assets) has
been reached, the Principal Underwriter intends, but is not obligated, to
continue to accept new orders for the purchase of Fund shares and to pay
commissions and service fees to dealers in excess of the amount it currently
receives from the Fund. While the Fund is under no contractual obligation to
reimburse the Principal Underwriter for advances made by the Principal
Underwriter in excess of the Distribution Plan limitation, the Principal
Underwriter intends to seek full payment of such charges from the Fund (together
with interest 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. The Principal Underwriter currently intends to seek payment of
interest only on such charges paid or accrued by the Principal Underwriter
subsequent to January 1, 1992. If the Fund's Trustees who are not interested
persons of the Fund as defined in the 1940 Act ("Independent Trustees")
authorize such payments, the effect will be to extend the period of time during
which the Fund incurs the maximum amount of costs allowed by the Distribution
Plan. If the Distribution Plan is terminated, the Principal Underwriter will ask
the Independent Trustees to take whatever action they deem appropriate under the
circumstances with respect to payment of such amounts.
The total amounts paid by the Fund under the foregoing arrangements may
not exceed the maximum Distribution Plan limit specified above, and the amounts
and purposes of expenditures under the Distribution Plan must be reported to the
Fund's Independent Trustees quarterly. The Fund's Independent Trustees may
require or approve changes in the implementation or operation of the
Distribution Plan and may require that total expenditures by the Fund under the
Distribution Plan be kept within limits lower than the maximum amount permitted
by the Distribution Plan as stated above. If such costs are not limited by the
Independent Trustees, such costs could, for some period of time, be higher than
such costs permitted by most other plans presently adopted by other investment
companies.
The Distribution Plan may be terminated at any time by vote of the
Independent Trustees, or by vote of a majority of the outstanding voting
securities of the Fund. Any change in the Distribution Plan that would
materially increase the distribution expenses of the Fund provided for in the
Distribution Plan requires shareholder approval. Otherwise, the Distribution
Plan may be amended by the majority of both (1) the Fund's Trustees and (2) the
Independent Trustees cast in person at a meeting called for the purpose of
voting on such amendment.
While the Distribution Plan is in effect, the Fund is required to
commit the selection and nomination of candidates for Independent Trustees to
the discretion of the Independent Trustees.
During the fiscal year ended October 31, 1995, the Fund paid the
Principal Underwriter $4,584,433 under the Distribution Plan. For said year, the
Principal Underwriter received $217,959 after payments of commissions on new
sales and shareholder service fees to dealers and others in the amount of
$4,366,474.
Whether any expenditure under the Distribution Plan is subject to a
state expense limit will depend upon the nature of the expenditure and the terms
of the state law, regulation or order imposing the limit. A portion of the
Fund's Distribution Plan expenses may be includable in the Fund's total
operating expenses for purposes of determining compliance with state expense
limits.
The Independent Trustees of the Fund have determined that the sales of
the Fund's shares resulting from payments under the Distribution Plan have
benefited the Fund.
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REDEMPTIONS IN KIND
- --------------------------------------------------------------------------------
If conditions arise that would make it undesirable for the Fund to pay
for all redemptions in cash, the Board of Trustees may authorize payment to be
made in portfolio securities or other Fund property. The Fund has obligated
itself, however, under the 1940 Act to redeem for cash all shares presented for
redemption by any one shareholder in any 90-day period up to the lesser of
$250,000, or 1% of the Fund's net assets. Securities delivered in payment of
redemptions would be valued at the same value assigned to them in computing the
net asset value per share. Shareholders receiving such securities would incur
brokerage costs when these securities are sold.
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THE TRUST AGREEMENT
- --------------------------------------------------------------------------------
The Fund is a Pennsylvania common law trust established under a Trust
Agreement dated July 15, 1935, as amended and restated on December 19, 1989 (the
"Declaration of Trust"). The Declaration of Trust restructured the Fund so that
its operation would be substantially similar to that of most other mutual funds.
The Declaration of Trust provides for a Board of Trustees and enables the Fund
to enter into an agreement with an investment manager and/or adviser to provide
the Fund with investment advisory, management and administrative services. A
copy of the Declaration of Trust is filed as an exhibit to the Fund's
Registration Statement of which this statement of additional information is a
part. This summary is qualified in its entirety by reference to the Declaration
of Trust.
DESCRIPTION OF SHARES
The Declaration of Trust authorizes the issuance of an unlimited number
of shares of beneficial interest and the creation of additional series and/or
classes of series of Fund shares. Each share represents an equal proportionate
interest in the Fund with each other share of that class. Upon liquidation,
shares are entitled to a pro rata share in the net assets of their class of Fund
shares. Shareholders shall have no preemptive or conversion rights. Shares are
transferable. The Fund currently intends to issue only one class of shares.
SHAREHOLDER LIABILITY
Pursuant to court decisions or other theories of law, shareholders of a
Pennsylvania common law trust could possibly be held personally liable for the
obligations of the Trust. The possibility of Fund shareholders incurring
financial loss under such circumstances appears to be remote, however, because
the Declaration of Trust (1) contains an express disclaimer of shareholder
liability for obligations of the Fund; (2) requires that notice of such
disclaimer be given in each agreement, obligation or instrument entered into or
executed by the Fund or the Trustees; and (3) provides for indemnification out
of Fund property for any shareholder held personally liable for the obligations
of the Fund.
VOTING RIGHTS
Under the terms of the Declaration of Trust, the Fund does not hold
annual meetings. At meetings called for the initial election of Trustees or to
consider other matters, shares are entitled to one vote per share. Shares
generally vote together as one class on all matters. No amendment may be made to
the Declaration of Trust that adversely affects any class of shares without the
approval of a majority of the shares of that class. There shall be no cumulative
voting in the election of Trustees.
After a meeting as described above, no further meetings of shareholders
for the purpose of electing Trustees will be held, unless required by law, or
until such time as less than a majority of the Trustees holding office have been
elected by shareholders, at which time the Trustees then in office will call a
shareholders' meeting for the election of Trustees.
Except as set forth above, the Trustees shall continue to hold office
indefinitely unless otherwise required by law and may appoint successor
Trustees. A Trustee may cease to hold office or may be removed from office (as
the case may be) (1) at any time by a two-thirds vote of the remaining Trustees;
(2) when such Trustee becomes mentally or physically incapacitated; or (3) at a
special meeting of shareholders by a two-thirds vote of the outstanding shares.
Any Trustee may voluntarily resign from office.
LIMITATION OF TRUSTEES' LIABILITY
The Declaration of Trust provides that a Trustee shall be liable only
for his own willful defaults and, if reasonable care has been exercised in the
selection of officers, agents, employees or investment advisers, shall not be
liable for any neglect or wrongdoing of any such person; provided, however, that
nothing in the Declaration of Trust shall protect a Trustee against any
liability for his willful misfeasance, bad faith, gross negligence or reckless
disregard of his duties.
The Trustees have absolute and exclusive control over the management
and disposition of all assets of the Fund and may perform such acts as in their
sole judgment and discretion are necessary and proper for conducting the
business and affairs of the Fund or promoting the interests of the Fund and the
shareholders.
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INVESTMENT MANAGER
- --------------------------------------------------------------------------------
Subject to the general supervision of the Fund's Board of Trustees,
Keystone Management, located at 200 Berkeley Street, Boston, Massachusetts
02116-5034 serves as investment manager to the Fund and is responsible for the
overall management of the Fund's business and affairs. Keystone Management,
organized in 1989, is a wholly-owned subsidiary of Keystone. Its directors and
principal executive officers have been affiliated with Keystone, a seasoned
investment adviser, for a number of years. Keystone Management also serves as
investment manager to each of the other funds in the Keystone Fund Family and to
certain other funds in the Keystone Investments Family of Funds.
Except as otherwise noted below, pursuant to an Investment Management
Agreement with the Fund (the "Management Agreement") and subject to the
supervision of the Fund's Board of Trustees, Keystone Management manages and
administers the operation of the Fund and manages the investment and
reinvestment of the Fund's assets in conformity with the Fund's investment
objectives and restrictions. The Management Agreement stipulates that Keystone
Management shall provide office space, all necessary office facilities,
equipment and personnel in connection with its services under the Management
Agreement and shall pay or reimburse the Fund for the compensation of Fund
officers and Trustees who are affiliated with the investment manager as well as
pay all expenses of Keystone Management incurred in connection with the
provision of its services. All charges and expenses, other than those
specifically referred to as being borne by Keystone Management, will be paid by
the Fund, including, but not limited to, custodian charges and expenses;
bookkeeping and auditors' charges and expenses; transfer agent charges and
expenses; fees of Independent Trustees; brokerage commissions, brokers' fees and
expenses; issue and transfer taxes; costs and expenses under the Distribution
Plan; taxes and trust fees payable to governmental agencies; the cost of share
certificates; fees and expenses of the registration and qualification of the
Fund and its shares with the Securities and Exchange Commission (sometimes
referred to herein as the "SEC" or the "Commission") or under state or other
securities laws; expenses of preparing, printing and mailing prospectuses,
statements of additional information, notices, reports and proxy materials to
shareholders of the Fund; expenses of shareholder's and Trustees' meetings;
charges and expenses of legal counsel for the Fund and for the Trustees of the
Fund on matters relating to the Fund; charges and expenses of filing annual and
other reports with the SEC and other authorities; and all extraordinary charges
and expenses of the Fund.
The Management Agreement permits Keystone Management to enter into an
agreement with Keystone or another investment adviser under which Keystone or
such other investment adviser, as investment adviser, provides substantially all
the services to be provided by Keystone Management under the Management
Agreement. The Management Agreement also permits Keystone Management to delegate
to Keystone or another investment adviser substantially all of the investment
manager's rights, duties and obligations under the Management Agreement.
Services performed by Keystone Management include (1) performing
research and planning with respect to (a) the Fund's qualification as a
regulated investment company under Subchapter M of the Internal Revenue Code of
1986, as amended (the "Code"),
(b) tax treatment of the Fund's portfolio investments, (c) tax treatment of
special corporate actions (such as reorganizations), (d) state tax matters
affecting the Fund, and (e) the Fund's distributions of income and capital
gains; (2) preparing the Fund's federal and state tax returns; (3) providing
services to the Fund's shareholders in connection with federal and state
taxation and distributions of income and capital gains; and (4) storing
documents relating to the Fund's activities.
The Fund pays Keystone Management a fee for its services at the annual
rate set forth below:
Aggregate Net Asset
Management Value of the Shares
Fee of the Fund
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0.70% of the first $ 100,000,000, plus
0.65% of the next $ 100,000,000, plus
0.60% of the next $ 100,000,000, plus
0.55% of the next $ 100,000,000, plus
0.50% of the next $ 100,000,000, plus
0.45% of the next $ 500,000,000, plus
0.40% of the next $ 500,000,000, plus
0.35% of amounts over $1,500,000,000.
computed as of the close of business each business day and paid
daily.
The Fund is subject to certain annual state expense limitations, the
most restrictive of which is as follows:
2.5% of the first $30 million of Fund average net assets; 2.0% of the
next $70 million of Fund average net assets; and 1.5% of Fund average
net assets over $100 million.
Capital charges and certain expenses, including a portion of the Fund's
Distribution Plan fees, are not included in the calculation of the state expense
limitation. This limitation may be modified or eliminated in the future.
As a continuing condition of registration of shares in a state,
Keystone Management has agreed to reimburse the Fund annually for certain
operating expenses incurred by the Fund in excess of certain percentages of the
Fund's average daily net assets. Keystone Management is not required, however,
to make such reimbursements to the extent such reimbursements would result in
the Fund's inability to qualify as a regulated investment company under
provisions of the Internal Revenue Code. This condition may be modified or
eliminated in the future.
The Management Agreement continues in effect only if approved at least
annually by the Fund's Board of Trustees or by a vote of a majority of the
outstanding shares, and such renewal has been approved by the vote of a majority
of the Independent Trustees cast in person at a meeting called for the purpose
of voting on such approval. The Management Agreement may be terminated, without
penalty, on 60 days' written notice by the Fund's Board of Trustees or by a vote
of a majority of outstanding shares. The Management Agreement will terminate
automatically upon its "assignment" as that term is defined in the 1940 Act.
For additional discussion of fees paid to Keystone Management, see
"Investment Adviser" below.
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INVESTMENT ADVISER
- --------------------------------------------------------------------------------
Pursuant to the Management Agreement, Keystone Management has delegated
its investment management functions, except for certain administrative and
management services to Keystone and has entered into an Investment Advisory
Agreement with Keystone (the "Advisory Agreement") under which Keystone provides
investment advisory and management services to the Fund.
Keystone, located at 200 Berkeley Street, Boston, Massachusetts
02116-5034, has provided investment advisory and management services to
investment companies and private accounts since it was organized in 1932.
Keystone is a wholly-owned subsidiary of Keystone Investments, Inc. ("Keystone
Investments"), located at 200 Berkeley Street, Boston, Massachusetts 02116-5034.
Keystone Investments is a corporation privately owned by current and
former members of management and certain employees of Keystone and its
affiliates. The shares of Keystone Investments common stock beneficially owned
by management are held in a number of voting trusts, the trustees of which are
George S. Bissell, Albert H. Elfner, III, Edward F. Godfrey and Ralph J.
Spuehler, Jr. Keystone Investments provides accounting, bookkeeping, legal,
personnel and general corporate services to Keystone Management, Keystone, their
affiliates and the Keystone Investments Family of Funds.
Pursuant to the Advisory Agreement, Keystone receives for its services
an annual fee representing 85% of the management fee received by Keystone
Management under the Management Agreement.
Pursuant to the Advisory Agreement and subject to the supervision of
the Fund's Board of Trustees, Keystone manages and administers the Fund's
operation and manages the investment and reinvestment of the Fund's assets in
conformity with the Fund's investment objectives and restrictions. The Advisory
Agreement stipulates that Keystone shall provide office space, all necessary
office facilities, equipment and personnel in connection with its services under
the Advisory Agreement and shall pay or reimburse the Fund for the compensation
of Fund officers and Trustees of the Fund who are affiliated with the investment
adviser as well as pay all expenses of Keystone incurred in connection with the
provision of its services. All charges and expenses other than those
specifically referred to as being borne by Keystone will be paid by the Fund,
including, but not limited to, custodian charges and expenses; bookkeeping and
auditors' charges and expenses; transfer agent charges and expenses; fees of
Independent Trustees; brokerage commissions, brokers' fees and expenses; issue
and transfer taxes; costs and expenses under the Distribution Plan; taxes and
trust fees payable to governmental agencies; the cost of share certificates,
fees and expenses of the registration and qualification of the Fund and its
shares with the SEC or under state or other securities laws; expenses of
preparing, printing and mailing prospectuses, statements of additional
information, notices, reports and proxy materials to shareholders of the Fund;
expenses of shareholder's and Trustees' meetings; charges and expenses of legal
counsel for the Fund and for the Trustees of the Fund on matters relating to the
Fund; charges and expenses of filing annual and other reports with the SEC and
other authorities; and all extraordinary charges and expenses of the Fund.
During the year ended October 31, 1993, the Fund paid or accrued to
Keystone Management investment management and administrative services fees of
$2,312,269, which represented 0.63% of the Fund's average net assets. Of such
amount paid to Keystone Management, $1,965,429 was paid to Keystone for its
services to the Fund.
During the year ended October 31, 1994, the Fund paid or accrued to
Keystone Management investment management and administrative service fees of
$2,440,144 which represents 0.62% of the Fund's then average net assets. Of such
amount paid to Keystone Management, $2,074,122 was paid to Keystone for its
services to the Fund.
During the year ended October 31, 1995, the Fund paid or accrued to
Keystone Management investment management and administrative service fees of
$2,799,544 which represents 0.61% of the Fund's then average net assets. Of such
amount paid to Keystone Management, $2,379,612 was paid to Keystone for its
services to the Fund.
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TRUSTEES AND OFFICERS
- --------------------------------------------------------------------------------
Trustees and Officers of the Fund, their principal occupations and some
of their affiliations over the last five years are as follows:
*ALBERT H. ELFNER, III: President, Chief Executive Officer and Trustee of the
Fund; Chairman of the Board, President, Director and Chief Executive
Officer of Keystone Investments, Inc. ("Keystone Investments"),
Keystone Management, Inc. ("Keystone Management") and Keystone Software
Inc. ("Keystone Software"); President, Chief Executive Officer and
Trustee or Director of all 30 Funds in the Keystone Investments Funds;
Chairman of the Board, Director and Chief Executive Officer of Keystone
Investment Management Company ("Keystone"); Chairman of the Board and
Director of Keystone Institutional Company, Inc. ("Keystone
Institutional") (formerly named Keystone Investment Management
Corporation) and Keystone Fixed Income Advisors ("KFIA"); Director and
President of Keystone Asset Corporation, Keystone Capital Corporation,
and Keystone Trust Company; Director of Keystone Investment
Distributors Company (the "Principal Underwriter"), Keystone Investor
Resource Center, Inc. ("KIRC"), and Fiduciary Investment Company, Inc.
("FICO"); Director of Boston Children's Services Association; Trustee
of Anatolia College, Middlesex School, and Middlebury College; Member,
Board of Governors, New England Medical Center and former Trustee of
Neworld Bank; former Director and President of Hartwell Keystone
Advisers, Inc. ("Hartwell Keystone"); and former Director and Vice
President of Robert Van Partners, Inc.;
FREDERICK AMLING: Trustee of the Fund; Trustee or Director of all other Keystone
Investments Funds; Professor, Finance Department, George Washington
University; President, Amling & Company (investment advice); Member,
Board of Advisers, Credito Emilano (banking); and former Economics and
Financial Consultant, Riggs National Bank.
CHARLES A. AUSTIN III: Trustee of the Fund; Trustee or Director of all other
Keystone Investments Funds; Investment Counselor to Appleton Partners,
Inc.; former Managing Director, Seaward Management Corporation
(investment advice) and former Director, Executive Vice President and
Treasurer, State Street Research & Management Company (investment
advice).
*GEORGE S. BISSELL: Chairman of the Board and Trustee of the Fund; Director of
Keystone Investments; Chairman of the Board and Trustee or Director of
all other Keystone Investments Funds,; Chairman of the Board and
Trustee of Anatolia College; Trustee of University Hospital (and
Chairman of its Investment Committee); former Chairman of the Board and
Chief Executive Officer of Keystone Investments; former Chief Executive
Officer of the Fund; and former Director and Chairman of the Board of
Hartwell Keystone.
EDWIN D. CAMPBELL: Trustee of the Fund; Trustee or Director of all other
Keystone Investments Funds; Executive Director, Coalition of Essential
Schools, Brown University; Director and former Executive Vice
President, National Alliance of Business; former Vice President,
Educational Testing Services; and former Dean, School of Business,
Adelphi University.
CHARLES F. CHAPIN: Trustee of the Fund; Trustee or Director of all other
Keystone Investments Funds; former Group Vice President, Textron Corp.;
and former Director, Peoples Bank (Charlotte, N.C).
LEROY KEITH, JR.: Trustee of the Fund; Trustee or Director of all other Keystone
Investments Funds; Director of Phoenix Total Return Fund and Equifax,
Inc.; Trustee of Phoenix Series Fund, Phoenix Multi-Portfolio Fund and
The Phoenix Big Edge Series Fund; and former President, Morehouse
College.
K. DUN GIFFORD: Trustee of the Fund; Trustee or Director of all other Keystone
Investments Funds; Chairman of the Board, Director and Executive Vice
President, The London Harness Company; Managing Partner, Roscommon
Capital Corp.; Trustee, Cambridge College; Chairman Emeritus and
Director, American Institute of Food and Wine; Chief Executive Officer,
Gifford Gifts of Fine Foods; Chairman, Gifford, Drescher & Associates
(environmental consulting); President, Oldways Preservation and
Exchange Trust (education); and former Director, Keystone Group and
Keystone.
F. RAY KEYSER, JR.: Trustee of the Fund; Trustee or Director of all other
Keystone Investments Funds; Of Counsel, Keyser, Crowley & Meub, P.C.;
Member, Governor's (VT) Council of Economic Advisers; Chairman of the
Board and Director, Central Vermont Public Service Corporation and
Hitchcock Clinic; Director, Vermont Yankee Nuclear Power Corporation,
Vermont Electric Power Company, Inc., Grand Trunk Corporation, Central
Vermont Railway, Inc., S.K.I. Ltd., Sherburne Corporation, Union Mutual
Fire Insurance Company, New England Guaranty Insurance Company, Inc.
and the Investment Company Institute; former Governor of Vermont;
former Director and President, Associated Industries of Vermont; former
Chairman and President, Vermont Marble Company; former Director of
Keystone; and former Director and Chairman of the Board, Green Mountain
Bank.
DAVID M. RICHARDSON: Trustee of the Fund; Trustee or Director of all other
Keystone Investments Funds; Executive Vice President, DHR
International, Inc. (executive recruitment); former Senior Vice
President, Boyden International Inc. (executive recruitment); and
Director, Commerce and Industry Association of New Jersey, 411
International, Inc. and J & M Cumming Paper Co.
RICHARD J. SHIMA: Trustee of the Fund; Trustee or Director of all other Keystone
Investments Funds; Chairman, Environmental Warranty, Inc., and
Consultant, Drake Beam Morin, Inc. (executive outplacement); Director
of Connecticut Natural Gas Corporation, Trust Company of Connecticut,
Hartford Hospital, Old State House Association and Enhanced Financial
Services, Inc.; Member, Georgetown College Board of Advisors; Chairman,
Board of Trustees, Hartford Graduate Center; Trustee, Kingswood-Oxford
School and Greater Hartford YMCA; former Director, Executive Vice
President and Vice Chairman of The Travelers Corporation; and former
Managing Director of Russell Miller, Inc.
ANDREW J. SIMONS: Trustee of the Fund; Trustee or Director of all other Keystone
Investments Funds; Partner, Farrell, Fritz, Caemmerer, Cleary, Barnosky
& Armentano, P.C.; former President, Nassau County Bar Association;
former Associate Dean and Professor of Law, St. John's University
School of Law.
EDWARD F. GODFREY: Senior Vice President of the Fund; Senior Vice President of
all other Keystone Investments Funds; Director, Senior Vice President,
Chief Financial Officer and Treasurer of Keystone Investments, the
Principal Underwriter, Keystone Asset Corporation, Keystone Capital
Corporation, Keystone Trust Company; Treasurer of Keystone
Institutional, and FICO; Treasurer and Director of Keystone Management
and Keystone Software, Inc.; Vice President and Treasurer of KFIA; and
Director of KIRC; former Treasurer of Hartwell Keystone and Robert Van
Partners, Inc.,
JAMES R. McCALL: Senior Vice President of the Fund; Senior Vice President of all
other funds in the Keystone Investments Family of Funds; and President
of Keystone.
J. KEVIN KENELY: Treasurer of the Fund; Treasurer of all other Keystone
Investments Funds; Vice President of Keystone Investments, Assistant
Treasurer of FICO and Keystone; and former Vice President and
Controller of Keystone Investments and certain of its affiliated
operating companies.
ROSEMARY D. VAN ANTWERP: Senior Vice President and Secretary of the Fund; Senior
Vice President and Secretary of all other funds in the Keystone
Investments Funds; Senior Vice President, General Counsel and Secretary
of Keystone; Senior Vice President, General Counsel, Secretary and
Director of the Principal Underwriter, Keystone Management and Keystone
Software; Senior Vice President and General Counsel of Keystone
Institutional; Senior Vice President, General Counsel and Director of
FICO and KIRC; Vice President and Secretary of KFIA; Senior Vice
President, General Counsel and Secretary of Keystone Investments,
Keystone Asset Corporation, Keystone Capital Corporation and Keystone
Trust Company; former Senior Vice President and Secretary of Hartwell
Keystone and Robert Van Partners, Inc.
* This Trustee may be considered an "interested person" within the meaning of
the 1940 Act.
Mr. Elfner and Mr. Bissell are "interested persons" by virtue of their
positions as officers and/or Directors of Keystone Investments and several of
its affiliates including Keystone, the Principal Underwriter and KIRC. Mr.
Elfner and Mr. Bissell own shares of Keystone Investments. Mr. Elfner is
Chairman of the Board, Chief Executive Officer and Director of Keystone
Investments. Mr. Bissell is a Director of Keystone Investments.
During the fiscal year ended October 31, 1995, no Trustee affiliated
with Keystone or any officer received any direct remuneration from the Fund.
During the same period, the unaffiliated Trustees received approximately $36,448
in retainers and fees from the Fund. Annual retainers and meeting fees paid by
all funds in the Keystone Investments Family of Funds (which includes 30 mutual
funds) for the fiscal year ended October 31, 1995, totalled approximately
$462,686. On December 31, 1995, the Fund's Trustees and officers beneficially
owned less than 1% of the Fund's then outstanding shares.
The address of all the Fund's Trustees and officers and the address of
the Fund is 200 Berkeley Street, Boston, Massachusetts 02116-5034.
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PRINCIPAL UNDERWRITER
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Pursuant to a Principal Underwriting Agreement with the Fund (the
"Underwriting Agreement"), Keystone Investment Distributors Company acts as the
Fund's principal underwriter. The Principal Underwriter, located at 200 Berkeley
Street, Boston, Massachusetts 02116-5034, is a Delaware corporation wholly-owned
by Keystone. The Principal Underwriter, as agent has agreed to use its best
efforts to find purchasers for the shares. The Principal Underwriter may retain
and employ representatives to promote distribution of the shares and may obtain
orders from brokers, dealers and others, acting as principals, for sales of
shares to them. No such representative, dealer or broker shall have any
authority to act as agent for the Fund. The Underwriting Agreement provides that
the Principal Underwriter will bear the expense of preparing, printing and
distributing advertising and sales literature and prospectuses used by it. In
its capacity as Principal Underwriter, the Principal Underwriter may receive
payments from the Fund pursuant to the Fund's Distribution Plan.
The Underwriting Agreement provides that it will remain in effect as
long as its terms and continuance are approved by a majority of the Fund's
Independent Trustees at least annually at a meeting called for that purpose, and
if its continuance is approved annually by vote of a majority of Trustees, or by
vote of a majority of the outstanding shares.
The Underwriting Agreement may be terminated, without penalty, on 60
days' written notice by the Board of Trustees or by a vote of a majority of
outstanding shares. The Underwriting Agreement will terminate automatically upon
its "assignment" as that term is defined in the 1940 Act.
From time to time, if, in the Principal Underwriter's judgment, it
could benefit the sales of Fund shares, the Principal Underwriter may use its
discretion in providing to selected dealers promotional materials and selling
aids, including, but not limited to, personal computers, related software and
Fund data files.
For the fiscal years ended October 31, 1993, 1994 and 1995, the
Principal Underwriter earned commissions of $945,478, 1,070,098 and $217,959,
respectively, after allowing commissions and service fees of $2,160,697,
$2,918,769 and $4,366,474, respectively, to retail dealers under the
Distribution Plan.
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BROKERAGE
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It is the policy of the Fund, in effecting transactions in portfolio
securities, to seek best execution of orders at the most favorable prices. The
determination of what may constitute best execution and price in the execution
of a securities transaction by a broker involves a number of considerations
including, without limitation, the overall direct net economic result to the
Fund, involving both price paid or received and any commissions and other costs
paid, the efficiency with which the transaction is effected, the ability to
effect the transaction at all where a large block is involved, the availability
of the broker to stand ready to execute potentially difficult transactions in
the future and the financial strength and stability of the broker. Such
considerations are judgmental and are weighed by management in determining the
overall reasonableness of brokerage commissions paid.
Subject to the foregoing, a factor in the selection of brokers is the
receipt of research services, such as analyses and reports concerning issuers,
industries, securities, economic factors and trends and other statistical and
factual information. Any such research and other statistical and factual
information provided by brokers to the Fund, Keystone Management or Keystone is
considered to be in addition to and not in lieu of services required to be
performed by Keystone Management under the Management Agreement or Keystone
under the Advisory Agreement. The cost, value and specific application of such
information are indeterminable and cannot be practically allocated among the
Fund and other clients of Keystone Management or Keystone who may indirectly
benefit from the availability of such information. Similarly, the Fund may
indirectly benefit from information made available as a result of transactions
effected for such other clients. Under the Management Agreement and Advisory
Agreement, Keystone Management and Keystone are permitted to pay higher
brokerage commissions for brokerage and research services in accordance with
Section 28(e) of the Securities Exchange Act of 1934. In the event Keystone
Management and Keystone do follow such a practice, they will do so on a basis
that is fair and equitable to the Fund.
The Fund expects that purchases and sales of securities usually will be
effected through brokerage transactions for which commissions are payable.
Purchases from underwriters will include the underwriting commission or
concession, and purchases from dealers serving as market makers will include a
dealer's mark up or reflect a dealer's mark down. Where transactions are made in
the over-the-counter market, the Fund will deal with primary market makers
unless more favorable prices are otherwise obtainable.
The Fund may participate, if and when practicable, in group bidding for
the purchase directly from an issuer of certain securities for the Fund's
portfolio in order to take advantage of the lower purchase price available to
members of such a group.
Neither Keystone Management, Keystone nor the Fund intend to place
securities transactions with any particular broker-dealer or group thereof. The
Fund's Board of Trustees, however, has determined that the Fund may follow a
policy of considering sales of shares as a factor in the selection of
broker-dealers to execute portfolio transactions, subject to the requirements of
best execution, including best price, described above.
The policy of the Fund with respect to brokerage is and will be
reviewed by the Fund's Board of Trustees from time to time. Because of the
possibility of further regulatory developments affecting the securities
exchanges and brokerage practices generally, the foregoing practices may be
changed, modified or eliminated.
Investment decisions for the Fund are made independently by Keystone
Management or Keystone from those of the other funds and investment accounts
managed by Keystone Management or Keystone. It may frequently develop that the
same investment decision is made for more than one fund. Simultaneous
transactions are inevitable when the same security is suitable for the
investment objective of more than one account. When two or more funds or
accounts are engaged in the purchase or sale of the same security, the
transactions are allocated as to amount in accordance with a formula which is
equitable to each fund or account. It is recognized that in some cases this
system could have a detrimental effect on the price or volume of the security as
far as the Fund is concerned. In other cases, however, it is believed that the
ability of the Fund to participate in volume transactions will produce better
executions for the Fund.
In no instance will portfolio securities be purchased from or sold to
Keystone Management, Keystone, the Principal Underwriter or any of their
affiliated persons, as defined in the 1940 Act and rules and regulations issued
thereunder.
During the fiscal years ended October 31, 1993, 1994 and 1995, the Fund
paid $619,768, $404,419 and $874,000, respectively, in brokerage commissions. Of
the $874,000 paid in brokerage fees during fiscal 1995, $38,184 was paid to
Kokuksai and $11,738 was paid to Nomura.
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STANDARDIZED TOTAL RETURN AND YIELD QUOTATIONS
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Total return quotations for the Fund as they may appear from time to
time in advertisements are calculated by finding the average annual compounded
rates of return over the one, five and ten year periods on a hypothetical $1,000
investment that would equate the initial amount invested to the ending
redeemable value. To the initial investment all dividends and distributions are
added and all recurring fees charged to all shareholder accounts are deducted.
The ending redeemable value assumes a complete redemption at the end of the
one, five or ten year periods.
The cumulative total return of the Fund for the one, five and ten year
periods ending October 31, 1995 was 12.05% (including applicable sales charge),
119,79% and 241.17%, respectively. The compounded average annual rate of return
for the five and ten year periods ended October 31, 1995 were 17.06% and 13.06%,
respectively.
Current yield quotations as they may appear from time to time in
advertisements will consist of a quotation based on a 30-day period ended on the
date of the most recent balance sheet of the Fund, computed by dividing the net
investment income per share earned during the period by the maximum offering
price per share on the last day of the base period. The Fund does not presently
intend to advertise current yield.
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ADDITIONAL INFORMATION
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State Street Bank and Trust Company, 225 Franklin Street, Boston,
Massachusetts 02110, is custodian of all securities and cash of the Fund (the
"Custodian"). The Custodian may hold securities of some foreign issuers outside
the United States. The Custodian performs no investment management functions for
the Fund, but, in addition to its custodial services is responsible for
accounting and related recordkeeping on behalf of the Fund.
KPMG Peat Marwick LLP, 99 High Street, Boston,
Massachusetts 02110, Certified Public Accountants, are the independent
auditors for the Fund.
KIRC, 101 Main Street, Cambridge, Massachusetts 02142-1519, a
wholly-owned subsidiary of Keystone, acts as transfer agent and dividend
disbursing Agent for the Fund.
To the best of the Fund's knowledge, no shareholders of record owned 5%
or more of the Fund's outstanding shares on December 31, 1995.
Except as otherwise stated in its prospectus or required by law, the
Fund reserves the right to change the terms of the offer stated in its
prospectus without shareholder approval, including the right to impose or change
fees for services provided.
No dealer, salesman or other person is authorized to give any
information or to make any representation not contained in the Fund's
prospectus, this statement of additional information or in supplemental sales
literature issued by the Fund or the Principal Underwriter, and no person is
entitled to rely on any information or representation not contained therein.
The Fund's prospectus and this statement of additional information omit
certain information contained in the registration statement filed with the
Securities and Exchange Commission, which may be obtained from the Securities
and Exchange Commission's principal office in Washington, D.C. upon payment of
the fee prescribed by the rules and regulations promulgated by the Securities
and Exchange Commission.
<PAGE>
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APPENDIX
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COMMON AND PREFERRED STOCK RATINGS
S&P'S EARNINGS AND DIVIDEND RANKINGS FOR COMMON STOCKS
Because the investment process involves assessment of various factors,
such as product and industry position, corporate resources and financial policy,
with results that make some common stocks more highly esteemed than others,
Standard & Poors' Corporation ("S&P") believes that earnings and dividend
performance is the end result of the interplay of these factors and that, over
the long run, the record of this performance has a considerable bearing on
relative quality. S&P rankings, however, do not reflect all of the factors,
tangible or intangible, that bear on stock quality.
Growth and stability of earnings and dividends are deemed key elements
in establishing S&P earnings and dividend rankings for common stocks, which
capsulize the nature of this record in a single symbol.
S&P has established a computerized scoring system based on per share
earnings and dividend records of the most recent ten years, a period deemed long
enough to measure a company's performance under varying economic conditions. S&P
measures growth, stability within the trend line and cyclicity. The ranking
system also makes allowances for company size, since large companies have
certain inherent advantages over small ones. From these scores for earnings and
dividends are determined.
The final score for each stock is measured against a scoring matrix
determined by analysis of the scores of a large and representative sample which
is reviewed and sometimes modified with the following ladder of rankings:
A+ Highest B+ Average C Lowest
A High B Below Average D In Reorganization
A- Above Average B- Lower
S&P believes its rankings are not a forecast of future market price
performance but are basically an appraisal of past performance of earnings and
dividends and relative current standing.
MOODY'S COMMON STOCK RANKINGS
Moody's presents a concise statement of the important characteristics
of a company and an evaluation of the grade (quality) of its common stock. Data
presented includes: (a) capsule stock information which reveals short and
long-term growth and yield afforded by the indicated dividend, based on a recent
price; (b) a long-term price chart which shows patterns of monthly stock price
movements and monthly trading volumes; (c) a breakdown of a company's capital
account which aids in determining the degree of conservatism or financial
leverage in a company's balance sheet; (d) interim earnings for the current year
to date, plus three previous years; (e) dividend information; (f) company
background; (g) recent corporate developments; (h) prospects for a company in
the immediate future and the next few years; and (i) a ten year comparative
statistical analysis.
This information provides investors with information on what a company
does, how it has performed in the past, how it is performing currently and what
its future performance prospects appear to be.
These characteristics are then evaluated and result in a grading, or
indication of quality. The grade is based on an analysis of each company's
financial strength, stability of earnings and record of dividend payments. Other
considerations include conservativeness of capitalization, depth and caliber of
management, accounting practices, technological capabilities and industry
position. Evaluation is represented by the following grades:
(1) High Grade
(2) Investment Grade
(3) Medium Grade
(4) Speculative Grade
MOODY'S PREFERRED STOCK RATINGS
Preferred stock ratings and their definitions are as follows:
1. aaa: An issue which is rated aaa is considered to be a top-quality
preferred stock. This rating indicates good asset protection and the least risk
of dividend impairment within the universe of preferred stocks.
2. aa: An issue which is rated aa is considered a high-grade preferred
stock. This rating indicates that there is a reasonable assurance that earnings
and asset protection will remain relatively well maintained in the foreseeable
future.
3. a: An issue which is rated a is considered to be an upper- medium
grade preferred stock. While risks are judged to be somewhat greater then in the
aaa and aa classification, earnings and asset protection are, nevertheless,
expected to be maintained at adequate levels.
4. baa: An issue which is rated baa is considered to be a medium-grade
preferred stock, neither highly protected nor poorly secured. Earnings and asset
protection appear adequate at present but may be questionable over any great
length of time.
5. ba: An issue which is rated ba is considered to have speculative
elements and its future cannot be considered well assured. Earnings and asset
protection may be very moderate and not well-safeguarded during adverse periods.
Uncertainty of position characterizes preferred stocks in this class.
6. b: An issue which is rated b generally lacks the characteristics of
a desirable investment. Assurance of dividend payments and maintenance of other
terms of the issue over any long period of time may be small.
7. caa: An issue which is rated caa is likely to be in arrears on
dividend payments. This rating designation does not purport to indicate the
future status of payments.
8. ca: An issue which is rated ca is speculative in a high degree and
is likely to be in arrears on dividends with little likelihood of eventual
payments.
9. c: This is the lowest rated class of preferred or preference stock.
Issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
Moody's applies numerical modifiers 1, 2 and 3 in each rating
classification: the modifier 1 indicates that the security ranks in the higher
end of its generic rating category, the modifier 2 indicates a mid-range ranking
and the modifier 3 indicates that the issue ranks in the lower end of its
generic rating category.
LIMITED PARTNERSHIPS
The Fund may invest in limited and master limited partnerships. A
limited partnership is a partnership consisting of one or more general partners,
jointly and severally responsible as ordinary partners, and by whom the business
is conducted, and one or more limited partners who contribute cash as capital to
the partnership and who generally are not liable for the debts of the
partnership beyond the amounts contributed. Limited partners are not involved in
the day-to-day management of the partnership. They receive income, capital gains
and other tax benefits associated with the partnership project in accordance
with terms established in the partnership agreement. Typical limited
partnerships are in real estate, oil and gas and equipment leasing, but they
also finance movies, research and development and other projects.
For an organization classified as a partnership under the Internal
Revenue Code, each item of income, gain, loss, deduction and credit is not taxed
at the partnership level but flows through to the holder of the partnership
unit. This allows the partnership to avoid taxation and to pass through income
to the holder of the partnership unit at lower individual rates.
A master limited partnership is a publicly traded limited partnership.
The partnership units are registered with the Securities and Exchange Commission
and are freely exchanged on a securities exchange or in the over-the-counter
market.
CORPORATE BOND RATINGS
S&P CORPORATE BOND RATINGS
An S&P corporate bond rating is a current assessment of the
creditworthiness of an obligor, including obligors outside the United States,
with respect to a specific obligation. This assessment may take into
consideration obligors such as guarantors, insurers, or lessees. Ratings of
foreign obligors do not take into account currency exchange and related
uncertainties. The ratings are based on current information furnished by the
issuer or obtained by S&P from other sources it considers reliable.
The ratings are based, in varying degrees, on the following
considerations:
a. Likelihood of default - capacity and willingness of the obligor as
to the timely payment of interest and repayment of principal in accordance with
the terms of the obligation;
b. Nature of and provisions of the obligation; and
c. Protection afforded by and relative position of the obligation in
the event of bankruptcy, reorganization or other arrangement under the laws of
bankruptcy and other laws affecting creditors' rights.
PLUS (+) OR MINUS (-): To provide more detailed indications of credit
quality, ratings from AA to A may be modified by the addition of a plus or minus
sign to show relative standing within the major rating categories.
Bond ratings are as follows:
1. AAA - Debt rated AAA has the highest rating assigned by S&P.
Capacity to pay interest and repay principal is extremely strong.
2. AA - Debt rated AA has a very strong capacity to pay interest and
repay principal and differs from the higher rated issues only in small degree.
3. A - Debt rated A has a strong capacity to pay interest and repay
principal although it is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than debt in higher rated
categories.
4. BBB - Debt rated BBB is regarded as having an adequate capacity to
pay interest and repay principal. Whereas it normally exhibits adequate
protection parameters, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity to pay interest and repay principal
for debt in this category than in higher rated categories.
5. BB, B, CCC, CC AND C - Debt rated BB, B, CCC, CC and C is regarded,
on balance, as predominantly speculative with respect to capacity to pay
interest and repay principal in accordance with the terms of the obligation. BB
indicates the lowest degree of speculation and C the highest degree of
speculation. While such debt will likely have some quality and protective
characteristics, these are outweighed by large uncertainties or major risk
exposures to adverse conditions.
MOODY'S CORPORATE BOND RATINGS
Moody's ratings are as follows:
1. Aaa - Bonds which are rated Aaa are judged to be of the best
quality. They carry the smallest degree of investment risk and are generally
referred to as "gilt-edge." Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized are
most unlikely to impair the fundamentally strong position of such issues.
2. Aa - Bonds which are rated Aa are judged to be of high quality by
all standards. Together with the Aaa group they comprise what are generally
known as high grade bonds. They are rated lower than the best bonds because
margins of protection may not be as large as in Aaa securities or fluctuation of
protective elements may be of greater amplitude or there may be other elements
present which make the long term risks appear somewhat larger than in Aaa
securities.
3. A - Bonds which are rated A possess many favorable investment
attributes and are to be considered as upper medium grade obligations. Factors
giving security to principal and interest are considered adequate but elements
may be present which suggest a susceptibility to impairment sometime in the
future.
4. Baa - Bonds which are rated Baa are considered as medium grade
obligations, i.e., they are neither highly protected nor poorly secured.
Interest payments and principal security appear adequate for the present but
certain protective elements may be lacking or may be characteristically
unreliable over any great length of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as well.
5. Ba - Bonds which are rated Ba are judged to have speculative
elements. Their future cannot be considered as well assured. Often the
protection of interest and principal payments may be very moderate and thereby
not well safeguarded during both good and bad times over the future. Uncertainty
of position characterizes bonds in this class.
6. B - Bonds which are rated B generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or of
maintenance of other terms of the contract over any long period of time may be
small.
Moody's applies numerical modifiers, 1, 2 and 3 in each generic rating
classification from Aa through B in its corporate bond rating system. The
modifier 1 indicates that the security ranks in the higher end of its generic
rating category; the modifier 2 indicates a mid-range ranking; and the modifier
3 indicates that the issue ranks in the lower end of its generic rating
category.
MONEY MARKET INSTRUMENTS
The Fund's investments in commercial paper are limited to those rated
A-1 by Standard & Poor's Corporation, PRIME-1 by Moody's Investors Service, Inc.
or F-1 by Fitch Investors Service, Inc. These ratings and other money market
instruments are described as follows:
COMMERCIAL PAPER RATINGS
Commercial paper rated A-1 by Standard & Poor's has the following
characteristics: Liquidity ratios are adequate to meet cash requirements. The
issuer's long-term senior debt is rated A or better, although in some cases BBB
credits may be allowed. The issuer has access to at least two additional
channels of borrowing. Basic earnings and cash flow have an upward trend with
allowance made for unusual circumstances. Typically, the issuer's industry is
well established and the issuer has a strong position within the industry.
The rating PRIME-1 is the highest commercial paper rating assigned by
Moody's. Among the factors considered by Moody's in assigning ratings are the
following: (1) evaluation of the management of the issuer; (2) economic
evaluation of the issuer's industry or industries and an appraisal of
speculative-type risks which may be inherent in certain areas; (3) evaluation of
the issuer's products in relation to competition and customer acceptance; (4)
liquidity; (5) amount and quality of long-term debt; (6) trend of earnings over
a period of ten years; (7) financial strength of a parent company and the
relationships which exist with the issuer; and (8) recognition by the management
of obligations which may be present or may arise as a result of public
preparations to meet such obligations. Relative strength or weakness of the
above factors determines how the issuer's commercial paper is rated within
various categories.
The rating F-1 is the highest rating assigned by Fitch. Among the
factors considered by Fitch in assigning this rating are: (1) the issuer's
liquidity; (2) its standing in the industry; (3) the size of its debt; (4) its
ability to service its debt; (5) its profitability; (6) its return on equity;
(7) its alternative sources of financing; and (8) its ability to access the
capital markets. Analysis of the relative strength or weakness of these factors
and others determines whether an issuer's commercial paper is rated F-1.
UNITED STATES GOVERNMENT SECURITIES
Securities issued or guaranteed by the United States Government include
a variety of Treasury securities that differ only in their interest rates,
maturities and dates of issuance. Treasury bills have maturities of one year or
less. Treasury notes have maturities of one to ten years and Treasury bonds
generally have maturities of greater than ten years at the date of issuance.
Securities issued or guaranteed by the United States Government or its
agencies or instrumentalities include direct obligations of the United States
Treasury and securities issued or guaranteed by the Federal Housing
Administration, Farmers Home Administration, Export-Import Bank of the United
States, Small Business Administration, Government National Mortgage Association,
General Services Administration, Central Bank for Cooperatives, Federal Home
Loan Banks, Federal Loan Mortgage Corporation, Federal Intermediate Credit
Banks, Federal Land Banks, Maritime Administration, The Tennessee Valley
Authority, District of Columbia Armory Board and Federal National Mortgage
Association.
Some obligations of United States Government agencies and
instrumentalities, such as Treasury bills and Government National Mortgage
Association pass-through certificates, are supported by the full faith and
credit of the United States; others, such as securities of Federal Home Loan
Banks, by the right of the issuer to borrow from the Treasury; still others,
such as bonds issued by the Federal National Mortgage Association, a private
corporation, are supported only by the credit of the instrumentality. Because
the United States Government is not obligated by law to provide support to an
instrumentality it sponsors, the Fund will invest in the securities issued by
such an instrumentality only when Keystone determines that the credit risk with
respect to the instrumentality does not make its securities unsuitable
investments. United States Government securities will not include international
agencies or instrumentalities in which the United States Government, its
agencies or instrumentalities participate, such as the World Bank, the Asian
Development Bank or the Inter-American Development Bank, or issues insured by
the Federal Deposit Insurance Corporation.
CERTIFICATES OF DEPOSIT
Certificates of deposit are receipts issued by a bank in exchange for
the deposit of funds. The issuer agrees to pay the amount deposited plus
interest to the bearer of the receipt on the date specified on the certificate.
The certificate usually can be traded in the secondary market prior to maturity.
Certificates of deposit will be limited to U.S. dollar-denominated
certificates of United States banks, including their branches abroad, and of
U.S. branches of foreign banks which are members of the Federal Reserve System
or the Federal Deposit Insurance Corporation and have at least $1 billion in
deposits as of the date of their most recently published financial statements.
The Fund will not acquire time deposits or obligations issued by the
International Bank for Reconstruction and Development, the Asian Development
Bank or the Inter-American Development Bank. Additionally, the Fund does not
currently intend to purchase such foreign securities (except to the extent that
certificates of deposit of foreign branches of U.S. banks may be deemed foreign
securities) or purchase certificates of deposit, bankers' acceptances or other
similar obligations issued by foreign banks.
BANKERS' ACCEPTANCES
Bankers' acceptances typically arise from short-term credit
arrangements designed to enable businesses to obtain funds to finance commercial
transactions. Generally, an acceptance is a time draft drawn on a bank by an
exporter or an importer to obtain a stated amount of funds to pay for specific
merchandise. The draft is then "accepted" by the bank that, in effect,
unconditionally guarantees to pay the face value of the instrument on its
maturity date. The acceptance may then be held by the accepting bank as an
earning asset or it may be sold in the secondary market at the going rate of
discount for a specific maturity. Although maturities for acceptances can be as
long as 270 days, most acceptances have maturities of six months or less.
Bankers' acceptances acquired by the Fund must have been accepted by U.S.
commercial banks, including foreign branches of U.S. commercial banks, having
total deposits at the time of purchase in excess of $1 billion and must be
payable in U.S. dollars.
OPTIONS TRANSACTIONS
WRITING COVERED OPTIONS
The Fund writes only covered options. Options written by the Fund will
normally have expiration dates of not more than nine months from the date
written. The exercise price of the options may be below, equal to, or above the
current market values of the underlying securities at the times the options are
written.
Unless the option has been exercised, the Fund may close out an option
it has written by effecting a closing purchase transaction, whereby it purchases
an option covering the same underlying security and having the same exercise
price and expiration date ("of the same series") as the one it has written. If
the Fund desires to sell a particular security on which it has written a call
option, it will effect a closing purchase transaction prior to or concurrently
with the sale of the security. If the Fund is able to enter into a closing
purchase transaction, the Fund will realize a profit (or loss) from such
transaction if the cost of such transaction is less (or more) than the premium
received from the writing of the option.
An option position may be closed out only in a secondary market for an
option of the same series. Although the Fund will generally write only those
options for which there appears to be an active secondary market, there is no
assurance that a liquid secondary market will exist for any particular option at
any particular time, and for some options no secondary market may exist. In such
event it might not be possible to effect a closing transaction in a particular
option. If the Fund as a covered call option writer is unable to effect a
closing purchase transaction, it will not be able to sell the underlying
securities until the option expires or it delivers the underlying securities
upon exercise.
Because the Fund intends to qualify as a regulated investment company
under the Internal Revenue Code, the extent to which the Fund may write covered
call options and enter into so-called "straddle" transactions involving put and
call options may be limited.
Many options are traded on registered securities exchanges.
Options traded on such exchanges are issued by the Options
Clearing Corporation (OCC), a clearing corporation which assumes responsibility
for the completion of options transactions.
PURCHASING PUT AND CALL OPTIONS
The Fund can close out a put or call option it has written by entering
into a closing purchase transaction; for example, the Fund may close out a put
or call option it has written by buying an option identical to the one it has
written. If, however, a secondary market does not exist at a time the Fund
wishes to effect a closing sale transaction, the Fund will have to exercise the
option to realize any profit. If a covered call option writer cannot effect a
closing transaction, it cannot sell the underlying security until the option
expires or is exercised. In addition, in a transaction in which the Fund does
not own the security underlying a put option it has purchased, the Fund would be
required, in the absence of a secondary market, to purchase the underlying
security before it could exercise the option thereby incurring additional
transaction costs.
OPTION WRITING AND RELATED RISKS
The Fund may write covered call and put options. A call option gives
the purchaser of the option the right to buy, and the writer the obligation to
sell, the underlying security at the exercise price during the option period.
Conversely, a put option gives the purchaser the right to sell, and the writer
the obligation to buy, the underlying security at the exercise price during the
option period.
So long as the obligation of the writer continues, the writer may be
assigned an exercise notice by the broker-dealer through whom the option was
sold. The exercise notice would require the writer to deliver, in the case of a
call, or take delivery of, in the case of a put, the underlying security against
payment of the exercise price. This obligation terminates upon expiration of the
option, or at such earlier time as the writer effects a closing purchase
transaction by purchasing an option of the same series as the one previously
sold. Once an option has been exercised, the writer may not execute a closing
purchase transaction. For options traded on national securities exchanges
(Exchanges), to secure the obligation to deliver the underlying security in the
case of a call option, the writer of the option is required to deposit in escrow
the underlying security or other assets in accordance with the rules of the OCC,
an institution created to interpose itself between buyers and sellers of
options. Technically, the OCC assumes the order side of every purchase and sale
transaction on an Exchange, and by doing so, gives its guarantee to the
transaction.
The principal reason for writing options on a securities portfolio is
to attempt to realize, through the receipt of premiums, a greater return than
would be realized on the underlying securities alone. In return for the premium,
the covered call option writer has given up the opportunity for profit from a
price increase in the underlying security above the exercise price so long as
the option remains open, but retains the risk of loss should the price of the
security decline. Conversely, the put option writer gains a profit, in the form
of a premium, so long as the price of the underlying security remains above the
exercise price, but assumes an obligation to purchase the underlying security
from the buyer of the put option at the exercise price, even though the price of
the security may fall below the exercise price, at any time during the option
period. If an option expires, the writer realizes a gain in the amount of the
premium. Such a gain may, in the case of a covered call option, be offset by a
decline in the market value of the underlying security during the option period.
If a call option is exercised, the writer realizes a gain or loss from the sale
of the underlying security. If a put option is exercised, the writer must
fulfill his obligation to purchase the underlying security at the exercise
price, which will usually exceed the then market value of the underlying
security. In addition, the premium paid for the put effectively increases the
cost of the underlying security, thus reducing the yield otherwise available
from such securities.
Because the Fund can write only covered options, it may at times be
unable to write additional options unless it sells a portion of its portfolio
holdings to obtain new securities against which it can write options. This may
result in higher portfolio turnover and correspondingly greater brokerage
commissions and other transaction costs.
To the extent that a secondary market is available the covered option
writer may close out options it has written prior to the assignment of an
exercise notice by purchasing, in a closing purchase transaction, an option of
the same series as the option previously written. If the cost of such a closing
purchase, plus transaction costs, is greater than the premium received upon
writing the original option, the writer will incur a loss in the transaction.
OPTIONS TRADING MARKETS
Options which the Fund will trade are generally listed on Exchanges.
Exchanges on which such options currently are traded are the Chicago Board
Options Exchange and the American, New York, Pacific, and Philadelphia Stock
Exchanges. Options on some securities may not be listed on any Exchange but
traded in the over-the-counter market. Options traded in the over-the-counter
market involve the additional risk that securities dealers participating in such
transactions would fail to meet their obligations to the Fund. The use of
options traded in the over-the-counter market may be subject to limitations
imposed by certain state securities authorities. In addition to the limits on
its use of options discussed herein, the Fund is subject to the investment
restrictions described in the prospectus and the statement of additional
information.
The staff of the Commission currently is of the view that the premiums
which the Fund pays for the purchase of unlisted options, and the value of
securities used to cover unlisted options written by the Fund are considered to
be invested in illiquid securities or assets for the purpose of calculating
whether the Fund is in compliance with its fundamental investment restriction
prohibiting it from investing more than 10% of its total assets (taken at
current value) in any combination of illiquid assets and securities.
SPECIAL CONSIDERATIONS APPLICABLE TO OPTIONS
On Treasury Bonds and Notes. Because trading interest in U.S. Treasury
bonds and notes tends to center on the most recently auctioned issues, new
series of options with expirations to replace expiring options on particular
issues will not be introduced indefinitely. Instead, the expirations introduced
at the commencement of options trading on a particular issue will be allowed to
run their course, with the possible addition of a limited number of new
expirations as the original ones expire. Options trading on each series of bonds
or notes will thus be phased out as new options are listed on the more recent
issues, and a full range of expiration dates will not ordinarily be available
for every series on which options are traded.
ON TREASURY BILLS. Because the deliverable U.S. Treasury bill changes
from week to week, writers of U.S. Treasury bill call options cannot provide in
advance for their potential exercise settlement obligations by acquiring and
holding the underlying security. However, if the Fund holds a long position in
U.S. Treasury bills with a principal amount corresponding to the option contract
size, the Fund may be hedged from a risk standpoint. In addition, the Fund will
maintain in a segregated account with its Custodian liquid assets maturing no
later than those which would be deliverable in the event of an assignment of an
exercise notice to ensure that it can meet its open option obligations.
ON GNMA CERTIFICATES. Options on GNMA certificates are not currently
traded on any Exchange. However, the Fund may purchase and write such options in
the over the counter market or, should they commence trading, on any Exchange.
Since the remaining principal balance of GNMA certificates declines
each month as a result of mortgage payments, the Fund, as a writer of a covered
GNMA call holding GNMA certificates as "cover" to satisfy its delivery
obligation in the event of assignment of an exercise notice, may find that its
GNMA certificates no longer have a sufficient remaining principal balance for
this purpose. Should this occur, the Fund will enter into a closing purchase
transaction or will purchase additional GNMA certificates from the same pool (if
obtainable) or replacement GNMA certificates in the cash market in order to
remain covered.
A GNMA certificate held by the Fund to cover an option position in any
but the nearest expiration month may cease to present cover for the option in
the event of a decline in the GNMA coupon rate at which new pools are originated
under the FHA/VA loan ceiling in effect at any given time. Should this occur,
the Fund will no longer be covered, and the Fund will either enter into a
closing purchase transaction or replace the GNMA certificate with a certificate
which represents cover. When the Fund closes its position or replaces the GNMA
certificate, it may realize an unanticipated loss and incur transaction costs.
RISKS PERTAINING TO THE SECONDARY MARKET. An option position may be
closed out only in a secondary market for an option of the same series. Although
the Fund will generally purchase or write only those options for which there
appears to be an active secondary market, there is no assurance that a liquid
secondary market will exist for any particular option at any particular time,
and for some options no secondary market may exist. In such event, it might not
be possible to effect closing transactions in particular options, with the
result that the Fund would have to exercise its options in order to realize any
profit and might incur transaction costs in connection therewith. If the Fund as
a covered call option writer is unable to effect a closing purchase transaction
in a secondary market, it will not be able to sell the underlying security until
the option expires or it delivers the underlying security upon exercise.
Reasons for the absence of a liquid secondary market include the
following: (i) insufficient trading interest in certain options; (ii)
restrictions imposed on transactions (iii) trading halts, suspensions or other
restrictions imposed with respect to particular classes or series of options or
underlying securities; (iv) interruption of the normal operations on an Exchange
or by a broker; (v) inadequacy of the facilities of an Exchange, the OCC or a
broker to handle current trading volume; or (vi) a decision by one or more
Exchanges or a broker to discontinue the trading of options (or a particular
class or series of options), in which event the secondary market in that class
or series of options would cease to exist, although outstanding options that had
been issued as a result of trades would generally continue to be exercisable in
accordance with their terms.
The hours of trading for options on U.S. government securities may not
conform to the hours during which the underlying securities are traded. To the
extent that the option markets close before the markets for the underlying
securities, significant price and rate movements can take place in the
underlying markets that cannot be reflected in the option markets.
FUTURES CONTRACTS AND RELATED OPTIONS TRANSACTIONS
The Fund intends to enter into currency and other financial futures
contracts as a hedge against changes in prevailing levels of interest or
currency exchange rates to seek relative stability of principal and to establish
more definitely the effective return on securities held or intended to be
acquired by the Fund or as a hedge against changes in the prices of securities
or currencies held by the Fund or to be acquired by the Fund. The Fund's hedging
may include sales of futures as an offset against the effect of expected
increases in interest or currency exchange rates or securities prices and
purchases of futures as an offset against the effect of expected declines in
interest or currency exchange rates.
For example, when the Fund anticipates a significant marketor market
sector advance, it will purchase a stock index futures contract as a hedge
against not participating in such advance at a time when the Fund is not fully
invested. The purchase of a futures contract serves as a temporary substitute
for the purchase of individual securities which may then be purchased in an
orderly fashion. As such purchases are made, an quivalent amount of index based
futures contracts would be terminated by offsetting sales. In contrast, the Fund
would sell stock index futures contracts in anticipation of or in a general
market or market sector decline that may adversely affect the market value of
the Fund's portfolio. To the extent that the Fund's portfolio changes in value
in correlation with a given index, the sale of futures contracts on that index
would substantially reduce the risk to the portfolio of a market decline or
change in interest rates, and, by so doing, provide an alternative to the
liquidation of the Fund's securities positions and the resulting transaction
costs.
The Fund intends to engage in options transactions which are related to
commodity futures contracts for hedging purposes and in connection with the
hedging strategies described above.
Although techniques other than sales and purchases of futures contracts
and related options transactions could be used to reduce the Fund's exposure to
interest rate and/or market fluctuations, the Fund may be able to hedge its
exposure more effectively and perhaps at a lower cost through using futures
contracts and related options transactions. While the Fund does not intend to
take delivery of the instruments underlying futures contracts it holds, the Fund
does not intend to engage in such futures contracts for speculation.
FUTURES CONTRACTS
Futures contracts are transactions in the commodities markets rather
than in the securities markets. A futures contract creates an obligation by the
seller to deliver to the buyer the commodity specified in the contract at a
specified future time for a specified price. The futures contract creates an
obligation by the buyer to accept delivery from the seller of the commodity
specified at the specified future time for the specified price. In contrast, a
spot transaction creates an immediate obligation for the seller to deliver and
the buyer to accept delivery of and pay for an identified commodity. In general,
futures contracts involve transactions in fungible goods such as wheat, coffee
and soybeans. However, in the last decade an increasing number of futures
contracts have been developed which specify currencies, financial instruments or
financially based indexes as the underlying commodity.
U.S. futures contracts are traded only on national futures exchanges
and are standardized as to maturity date and underlying financial instrument.
The principal financial futures exchanges in the United States are The Board of
Trade of the City of Chicago, the Chicago Mercantile Exchange, the International
Monetary Market (a division of the Chicago Mercantile Exchange), the New York
Futures Exchange and the Kansas City Board of Trade. Each exchange guarantees
performance under contract provisions through a clearing corporation, a
nonprofit organization managed by the exchange membership, which is also
responsible for handling daily accounting of deposits or withdrawals of margin.
A futures commission merchant (Broker) effects each transaction in connection
with futures contracts for a commission. Futures exchanges and trading are
regulated under the Commodity Exchange Act by the Commodity Futures Trading
Commission (CFTC) and National Futures Association (NFA).
INTEREST RATE FUTURES CONTRACTS
The sale of an interest rate futures contract creates an obligation by
the Fund, as seller, to deliver the type of financial instrument specified in
the contract at a specified future time for a specified price. The purchase of
an interest rate futures contract creates an obligation by the Fund, as
purchaser, to accept delivery of the type of financial instrument specified at a
specified future time for a specified price. The specific securities delivered
or accepted, respectively, at settlement date, are not determined until at or
near that date. The determination is in accordance with the rules of the
exchange on which the futures contract sale or purchase was made.
Currently interest rate futures contracts can be purchased or sold on
90-day U.S. Treasury bills, U.S. Treasury bonds, U.S. Treasury notes with
maturities between 6 1/2 and 10 years, Government National Mortgage Association
(GNMA) certificates, 90- day domestic bank certificates of deposit, 90-day
commercial paper, and 90-day Eurodollar certificates of deposit. It is expected
that futures contracts trading in additional financial instruments will be
authorized. The standard contract size is $100,000 for futures contracts in U.S.
Treasury bonds, U.S. Treasury notes and GNMA certificates, and $1,000,000 for
the other designated contracts. While U.S. Treasury bonds, U.S. Treasury bills
and U.S. Treasury notes are backed by the full faith and credit of the U.S.
government and GNMA certificates are guaranteed by a U.S. government agency, the
futures contracts in U.S. government securities are not obligations of the U.S.
Treasury.
INDEX BASED FUTURES CONTRACTS
STOCK INDEX FUTURES CONTRACTS
A stock index assigns relative values to the common stocks included in
the index. The index fluctuates with changes in the market values of the common
stocks so included. A stock index futures contract is a bilateral agreement by
which two parties agree to take or make delivery of an amount of cash equal to a
specified dollar amount times the difference between the closing value of the
stock index on the expiration date of the contract and the price at which the
futures contract is originally made. No physical delivery of the underlying
stocks in the index is made.
Currently stock index futures contracts can be purchased or sold on the
Standard and Poor's Corporation (S&P) Index of 500 Stocks, the S&P Index of 100
Stocks, the New York Stock Exchange Composite Index, the Value Line Index and
the Major Market Index. It is expected that futures contracts trading in
additional stock indices will be authorized. The standard contract size is $500
times the value of the index.
The Fund does not believe that differences between existing stock
indices will create any differences in the price movements of the stock index
futures contracts in relation to the movements in such indices. However, such
differences in the indices may result in differences in correlation of the
futures with movements in the value of the securities being hedged.
OTHER INDEX BASED FUTURES CONTRACTS
It is expected that bond index and other financially based index
futures contracts will be developed in the future. It is anticipated that such
index based futures contracts will be structured in the same way as stock index
futures contracts but will be measured by changes in interest rates, related
indexes or other measures, such as the consumer price index. In the event that
such futures contracts are developed the Fund will sell interest rate index and
other index based futures contracts to hedge against changes which are expected
to affect the Fund's portfolio.
The purchase or sale of a futures contract differs from the purchase or
sale of a security, in that no price or premium is paid or received. Instead, to
initiate trading an amount of cash, cash equivalents, money market instruments,
or U.S. Treasury bills equal to approximately 1 1/2% (up to 5%) of the contract
amount must be deposited by the Fund with the Broker. This amount is known as
initial margin. The nature of initial margin in futures transactions is
different from that of margin in security transactions. Futures contract margin
does not involve the borrowing of funds by the customer to finance the
transactions.
Rather, the initial margin is in the nature of a performance bond or
good faith deposit on the contract which is returned to the Fund upon
termination of the futures contract assuming all contractual obligations have
been satisfied. The margin required for a particular futures contract is set by
the exchange on which the contract is traded, and may be significantly modified
from time to time by the exchange during the term of the contract.
Subsequent payments, called variation margin, to the Broker and from
the Broker, are made on a daily basis as the value of the underlying instrument
or index fluctuates making the long and short positions in the futures contract
more or less valuable, a process known as mark-to-market. For example, when the
Fund has purchased a futures contract and the price of the underlying financial
instrument or index has risen, that position will have increased in value and
the Fund will receive from the Broker a variation margin payment equal to that
increase in value. Conversely, where the Fund has purchased a futures contract
and the price of the underlying financial instrument or index has declined, the
position would be less valuable and the Fund would be required to make a
variation margin payment to the Broker. At any time prior to expiration of the
futures contract, the Fund may elect to close the position. A final
determination of variation margin is then made, additional cash is required to
be paid to or released by the Broker, and the Fund realizes a loss or gain.
The Fund intends to enter into arrangements with its custodian and with
Brokers to enable its initial margin and any variation margin to be held in a
segregated account by its custodian on behalf of the Broker.
Although interest rate futures contracts by their terms call for actual
delivery or acceptance of financial instruments, and index based futures
contracts call for the delivery of cash equal to the difference between the
closing value of the index on the expiration date of the contract and the price
at which the futures contract is originally made, in most cases such futures
contracts are closed out before the settlement date without the making or taking
of delivery. Closing out a futures contract sale is effected by an offsetting
transaction in which the Fund enters into a futures contract purchase for the
same aggregate amount of the specific type of financial instrument or index and
same delivery date. If the price in the sale exceeds the price in the offsetting
purchase, the Fund is paid the difference and thus realizes a gain. If the
offsetting purchase price exceeds the sale price, the Fund pays the difference
and realizes a loss. Similarly, the closing out of a futures contract purchase
is effected by an offsetting transaction in which the Fund enters into a futures
contract sale. If the offsetting sale price exceeds the purchase price, the Fund
realizes a gain. If the purchase price exceeds the offsetting sale price the
Fund realizes a loss. The amount of the Fund's gain or loss on any transaction
is reduced or increased, respectively, by the amount of any transaction costs
incurred by the Fund.
As an example of an offsetting transaction, the contractual obligations
arising from the sale of one contract of September U.S. Treasury bills on an
exchange may be fulfilled at any time before delivery of the contract is
required (i.e., on a specified date in September, the "delivery month") by the
purchase of one contract of September U.S. Treasury bills on the same exchange.
In such instance the difference between the price at which the futures contract
was sold and the price paid for the offsetting purchase after allowance for
transaction costs represents the profit or loss to the Fund.
There can be no assurance, however, that the Fund will be able to enter
into an offsetting transaction with respect to a particular contract at a
particular time. If the Fund is not able to enter into an offsetting
transaction, the Fund will continue to be required to maintain the margin
deposits on the contract and to complete the contract according to its terms.
OPTIONS ON CURRENCY AND OTHER FINANCIAL FUTURES
The Fund intends to purchase call and put options on currency and other
financial futures contracts and sell such options to terminate an existing
position. Options on currency and other financial futures contracts are similar
to options on stocks except that an option on a currency or other financial
futures contract gives the purchaser the right, in return for the premium paid,
to assume a position in a futures contract (a long position if the option is a
call and a short position if the option is a put) rather than to purchase or
sell stock, currency or other financial instruments at a specified exercise
price at any time during the period of the option. Upon exercise of the option,
the delivery of the futures position by the writer of the option to the holder
of the option will be accompanied by delivery of the accumulated balance in the
writer's futures margin account. This amount represents the amount by which the
market price of the futures contract at exercise exceeds, in the case of a call,
or is less than, in the case of a put, the exercise price of the option on the
futures contract. If an option is exercised the last trading day prior to the
expiration date of the option, the settlement will be made entirely in cash
equal to the difference between the exercise price of the option and value of
the futures contract.
The Fund intends to use options on currency and other financial futures
contracts in connection with hedging strategies. In the future the Fund may use
such options for other purposes.
PURCHASE OF PUT OPTIONS ON FUTURES CONTRACTS
The purchase of protective put options on a currency or other financial
futures contracts is analogous to the purchase of protective puts on individual
stocks, where an absolute level of protection is sought below which no
additional economic loss would be incurred by the Fund. Put options may be
purchased to hedge a portfolio of stocks or debt instruments or a position in
the futures contract upon which the put option is based.
PURCHASE OF CALL OPTIONS ON FUTURES CONTRACTS
The purchase of a call option on a currency or other financial futures
contract represents a means of obtaining temporary exposure to market
appreciation at limited risk. It is analogous to the purchase of a call option
on an individual stock which can be used as a substitute for a position in the
stock itself. Depending on the pricing of the option compared to either the
futures contract upon which it is based, or upon the price of the underlying
financial instrument or index itself, the purchase of a call option may be less
risky than the ownership of the interest rate or index based futures contract or
the underlying securities. Call options on currency and other financial futures
contracts may be purchased to hedge against an interest rate increase or a
market advance when the Fund is not fully invested.
USE OF NEW INVESTMENT TECHNIQUES INVOLVING CURRENCY OR OTHER
FINANCIAL FUTURES CONTRACTS OR RELATED OPTIONS
The Fund may employ new investment techniques involving currency and
other financial futures contracts and related options. The Fund intends to take
advantage of new techniques in these areas which may be developed from time to
time and which are consistent with the Fund's investment objective. The Fund
believes that no additional techniques have been identified for employment by
the Fund in the foreseeable future other than those described above.
LIMITATIONS ON PURCHASE AND SALE OF FUTURES CONTRACTS AND
RELATED OPTIONS ON SUCH FUTURES CONTRACTS
The Fund will not enter into a futures contract if, as a result
thereof, more than 5% of the Fund's total assets (taken at market value at the
time of entering into the contract) would be committed to margin deposits on
such futures contracts.
The Fund intends that its futures contracts and related options
transactions will be entered into for traditional hedging purposes. That is,
futures contracts will be sold to protect against a decline in the price of
securities that the Fund owns or futures contracts will be purchased to protect
the Fund against an increase in the price of securities it intends to purchase.
The Fund does not intend to enter into futures contracts for speculation.
In instances involving the purchase of futures contracts by the Fund,
an amount of cash and cash equivalents equal to the market value of the futures
contracts will be deposited in a segregated account with the Fund's Custodian
and/or in a margin account with a Broker to collateralize the position and
thereby insure that the use of such futures is unleveraged.
FEDERAL INCOME TAX TREATMENT
For federal income tax purposes, the Fund is required to recognize as
income for each taxable year its net unrealized gains and losses on futures
contracts as of the end of the year as well as those actually realized during
the year. Any gain or loss recognized with respect to a futures contract is
considered to be 60% long term and 40% short term, without regard to the holding
period of the contract. In the case of a futures transaction classified as a
"mixed straddle," the recognition of losses may be deferred to a later taxable
year. The federal income tax treatment of gains or losses from transactions in
options on futures is unclear.
In order for the Fund to continue to qualify for federal income tax
treatment as a regulated investment company, at least 90% of its gross income
for a taxable year must be derived from qualifying income. Any net gain realized
from the closing out of futures contracts, for purposes of the 90% requirement,
will be qualifying income. In addition, gains realized on the sale or other
disposition of securities held for less than three months must be limited to
less than 30% of the Fund's annual gross income. The 1986 Tax Act added a
provision which effectively treats both positions in certain hedging
transactions as a single transaction for the purpose of the 30% requirement. The
provision provides that, in the case of any "designated hedge," increases and
decreases in the value of positions of the hedge are to be netted for the
purposes of the 30% requirement. However, in certain situations, in order to
avoid realizing a gain within a three month period, the Fund may be required to
defer the closing out of a contract beyond the time when it would otherwise be
advantageous to do so.
RISKS OF FUTURES CONTRACTS
Currency and other financial futures contracts prices are volatile and
are influenced, among other things, by changes in stock prices, market
conditions, prevailing interest rates and anticipation of future stock prices,
market movements or interest rate changes, all of which in turn are affected by
economic conditions, such as government fiscal and monetary policies and
actions, and national and international political and economic events.
At best, the correlation between changes in prices of futures contracts
and of the securities being hedged can be only approximate. The degree of
imperfection of correlation depends upon circumstances, such as variations in
speculative market demand for futures contracts and for securities, including
technical influences in futures contracts trading; differences between the
securities being hedged and the financial instruments and indexes underlying the
standard futures contracts available for trading, in such respects as interest
rate levels, maturities and creditworthiness of issuers, or identities of
securities comprising the index and those in the Fund's portfolio. A decision of
whether, when and how to hedge involves the exercise of skill and judgment, and
even a well-conceived hedge may be unsuccessful to some degree because of market
behavior or unexpected interest rate trends.
Because of the low margin deposits required, futures trading involves
an extremely high degree of leverage. As a result, a relatively small price
movement in a futures contract may result in immediate and substantial loss, as
well as gain, to the investor. For example, if at the time of purchase, 10% of
the value of the futures contract is deposited as margin, a 10% decrease in the
value of the futures contract would result in a total loss of the margin
deposit, before any deduction for the transaction costs, if the account were
then closed out, and a 15% decrease would result in a loss equal to 150% of the
original margin deposit. Thus, a purchase or sale of a futures contract may
result in losses in excess of the amount invested in the futures contract.
However, the Fund would presumably have sustained comparable losses if, instead
of entering into the futures contract, it had invested in the underlying
financial instrument. Furthermore, in order to be certain that the Fund has
sufficient assets to satisfy its obligations under a futures contract, the Fund
will establish a segregated account in connection with its futures contracts
which will hold cash or cash equivalents equal in value to the current value of
the underlying instruments or indices less the margins on deposit.
Most U.S. futures exchanges limit the amount of fluctuation permitted
in futures contract prices during a single trading day. The daily limit
establishes the maximum amount that the price of a futures contract may vary
either up or down from the previous day's settlement price at the end of a
trading session. Once the daily limit has been reached in a particular type of
contract, no trades may be made on that day at a price beyond that limit. The
daily limit governs only price movement during a particular trading day and
therefore does not limit potential losses because the limit may prevent the
liquidation of unfavorable positions. Futures contract prices have occasionally
moved to the daily limit for several consecutive trading days with little or no
trading, thereby preventing prompt liquidation of futures positions and
subjecting some futures traders to substantial losses.
RISKS OF OPTIONS ON FUTURES CONTRACTS
In addition to the risks described above for currency and other
financial futures contracts, there are several special risks relating to options
on futures contracts. The ability to establish and close out positions on such
options will be subject to the development and maintenance of a liquid secondary
market. There is no assurance that a liquid secondary market will exist for any
particular contract or at any particular time. The Fund will not purchase
options on any futures contract unless and until it believes that the market for
such options has developed sufficiently that the risks in connection with such
options are not greater than the risks in connection with the futures contracts.
Compared to the use of futures contracts, the purchase of options on such
futures involves less potential risk to the Fund because the maximum amount at
risk is the premium paid for the options (plus transaction costs). However,
there may be circumstances when the use of an option on a futures contract would
result in a loss to the Fund, even though the use of a futures contract would
not, such as when there is no movement in the level of the futures contract.
FOREIGN CURRENCY TRANSACTIONS
The Fund may invest in securities of foreign issuers. When the Fund
invests in foreign securities they usually will be denominated in foreign
currencies and the Fund temporarily may hold funds in foreign currencies. Thus,
the Fund's share value will be affected by changes in exchange rates.
FORWARD CURRENCY CONTRACTS
As one way of managing exchange rate risk, the Fund may engage in
forward currency exchange contracts (agreements to purchase or sell currencies
at a specified price and date). Under the contract, the exchange rate for the
transaction (the amount of currency the Fund will deliver or receive when the
contract is completed) is fixed when the Fund enters into the contract. The Fund
usually will enter into these contracts to stabilize the U.S. dollar value of a
security it has agreed to buy or sell. The Fund also may use these contracts to
hedge the U.S. dollar value of a security it already owns, particularly if the
Fund expects a decrease in the value of the currency in which the foreign
security is denominated. Although the Fund will attempt to benefit from using
forward contracts, the success of its hedging strategy will depend on Keystone's
ability to predict accurately the future exchange rates between foreign
currencies and the U.S. dollar. The value of the Fund's investments denominated
in foreign currencies will depend on the relative strength of those currencies
and the U.S. dollar, and the Fund may be affected favorably or unfavorably by
changes in the exchange rates or exchange control regulations between foreign
currencies and the dollar. Changes in foreign currency exchange rates also may
affect the value of dividends and interest earned, gains and losses realized on
the sale of securities and net investment income and gains, if any, to be
distributed to shareholders by the Fund.
CURRENCY FUTURES CONTRACTS
Currency futures contracts are bilateral agreements under which two
parties agree to take or make delivery of a specified amount of a currency at a
specified future time for a specified price. Trading of currency futures
contracts in the United States is regulated under the Commodity Exchange Act by
the Commodity Futures Trading Commission (CFTC) and National Futures Association
(NFA). Currently the only national futures exchange on which currency futures
are traded is the International Monetary Market of the Chicago Mercantile
Exchange. Foreign currency futures trading is conducted in the same manner and
subject to the same regulations as trading in interest rate and index based
futures. The Fund intends to engage in currency futures contracts for hedging
purposes, and not for speculation. The Fund may engage in currency futures
contracts for other purposes if authorized to do so by the Board. The hedging
strategies which will be used by the Fund in connection with foreign currency
futures contracts are similar to those described above for forward foreign
currency exchange contracts.
Currently currency futures contracts for the British Pound Sterling,
Canadian Dollar, Dutch Guilder, Deutsche Mark, Japanese Yen, Mexican Peso, Swiss
Franc and French Franc can be purchased or sold for U.S. dollars through the
International Monetary Market. It is expected that futures contracts trading in
additional currencies will be authorized. The standard contract sizes are
L125,000 for the Pound, 125,000 for the Guilder, Mark and French and Swiss
Francs, C$100,000 for the Canadian Dollar, Y12,500,000 for the Yen, and
1,000,000 for the Peso. In contrast to Forward Currency Exchange Contracts which
can be traded at any time, only four value dates per year are available, the
third Wednesday of March, June, September and December.
FOREIGN CURRENCY OPTIONS TRANSACTIONS
Foreign currency options (as opposed to futures) are traded in a
variety of currencies in both the United States and Europe. On the Philadelphia
Stock Exchange, for example, contracts for half the size of the corresponding
futures contracts on the Chicago Board Options Exchange are traded with up to
nine months maturity in Marks, Sterling, Yen, Swiss francs and Canadian dollars.
Options can be exercised at any time during the contract life and require a
deposit subject to normal margin requirements. Since a futures contract must be
exercised, the Fund must continually make up the margin balance. As a result, a
wrong price move could result in the Fund losing more than the original
investment as it cannot walk away from the futures contract as it can an option
contract.
The Fund will purchase call and put options and sell such options to
terminate an existing position. Options on foreign currency are similar to
options on stocks except that an option on an interest rate and/or index based
futures contract gives the purchaser the right, in return for the premium paid,
to purchase or sell foreign currency, rather than to purchase or sell stock, at
a specified exercise price at any time during the period of the option.
The Fund intends to use foreign currency option transactions in
connection with hedging strategies.
PURCHASE OF PUT OPTIONS ON FOREIGN CURRENCIES
The purchase of protective put options on a foreign currency is
analogous to the purchase of protective puts on individual stocks, where an
absolute level of protection is sought below which no additional economic loss
would be incurred by the Fund. Put options may be purchased to hedge a portfolio
of foreign stocks or foreign debt instruments or a position in the foreign
currency upon which the put option is based.
PURCHASE OF CALL OPTIONS ON FOREIGN CURRENCIES
The purchase of a call option on foreign currency represents a means of
obtaining temporary exposure to market appreciation at limited risk. It is
analogous to the purchase of a call option on an individual stock which can be
used as a substitute for a position in the stock itself. Depending on the
pricing of the option compared to either the foreign currency upon which it is
based, or upon the price of the foreign stock or foreign debt instruments, the
purchase of a call option may be less risky than the ownership of the foreign
currency or the foreign securities. The Fund would purchase a call option on a
foreign currency to hedge against an increase in the foreign currency or a
foreign market advance when the Fund is not fully invested.
The Fund may employ new investment techniques involving forward foreign
currency exchange contracts, foreign currency futures contracts and options on
foreign currencies in order to take advantage of new techniques in these areas
which may be developed from time to time and which are consistent with the
Fund's investment objective. The Fund believes that no additional techniques
have been identified for employment by the Fund in the foreseeable future other
than those described above.
CURRENCY TRADING RISKS
Currency exchange trading may involve significant risks. The four major
types of risk the Fund faces are exchange rate risk, interest rate risk, credit
risk and country risk.
EXCHANGE RATE RISK
Exchange rate risk results from the movement up and down of foreign
currency values in response to shifting market supply and demand. When the Fund
buys or sells a foreign currency, an exposure called an open position is
created. Until the time that position can be "covered" by selling or buying an
equivalent amount of the same currency, the Fund is exposed to the risk that the
exchange rate might move against it. Since exchange rate changes can readily
move in one direction, a position carried overnight or over a number of days
involves greater risk than one carried a few minutes or hours. Techniques such
as foreign currency forward and futures contracts and options on foreign
currency are intended to be used by the Fund to reduce exchange rate risk.
MATURITY GAPS AND INTEREST RATE RISK
Interest rate risk arises whenever there are mismatches or gaps in the
maturity structure of the Fund's foreign exchange currency holdings, which is
the total of its outstanding spot and forward or futures contracts.
Foreign currency transactions often involve borrowing short term and
lending longer term to benefit from the normal tendency of interest rates to be
higher for longer maturities. However in foreign exchange trading, while the
maturity pattern of interest rates for one currency is important, it is the
differential between interest rates for two currencies that is decisive.
CREDIT RISK
Whenever the Fund enters into a foreign exchange contract, it faces a
risk, however small, that the counterparty will not perform under the contract.
As a result there is a credit risk, although no extension of "credit" is
intended. To limit credit risk, the Fund intends to evaluate the
creditworthiness of each other party. The Fund does not intend to trade more
than 5% of its net assets under foreign exchange contracts with one party.
Credit risk exists because the Fund's counterparty may be unable or
unwilling to fulfill its contractual obligations as a result of bankruptcy or
insolvency or when foreign exchange controls prohibit payment. In any foreign
exchange transaction, each party agrees to deliver a certain amount of currency
to the other on a particular date. In establishing its hedges the Fund relies on
each contract being completed. If the contract is not performed, then the Fund's
hedge is eliminated, and the Fund is exposed to any changes in exchange rates
since the contract was originated. To put itself in the same position it would
have been in had the contract been performed, the Fund must arrange a new
transaction. However, the new transaction may have to be arranged at an adverse
exchange rate. The trustee for a bankrupt company may elect to perform those
contracts which are advantageous to the company but disclaim those contracts
which are disadvantageous, resulting in losses to the Fund.
Another form of credit risk stems from the time zone differences
between the U.S. and foreign nations. If the Fund sells sterling it generally
must pay pounds to a counterparty earlier in the day than it will be credited
with dollars in New York. In the intervening hours, the buyer can go into
bankruptcy or can be declared insolvent. Thus, the dollars may never be credited
to the Fund.
COUNTRY RISK
At one time or another, virtually every country has interfered with
international transactions in its currency. Interference has taken the form of
regulation of the local exchange market, restrictions on foreign investment by
residents or limits on inflows of investment funds from abroad. Governments take
such measures for example to improve control over the domestic banking system or
to influence the pattern of receipts and payments between residents and
foreigners. In those cases, restrictions on the exchange market or on
international transactions are intended to affect the level or movement of the
exchange rate. Occasionally a serious foreign exchange shortage may lead to
payment interruptions or debt servicing delays, as well as interference in the
exchange market. It has become increasingly difficult to distinguish foreign
exchange or credit risk from country risk.
Changes in regulations or restrictions usually do have an important
exchange market impact. Most disruptive are changes in rules which interfere
with the normal payments mechanism. If government regulations change and a
counterparty is either forbidden to perform or is required to do something
extra, then the Fund might be left with an unintended open position or an
unintended maturity mismatch. Dealing with such unintended long or short
positions could result in unanticipated costs to the Fund.
Other changes in official regulations influence international
investment transactions. If one of the factors affecting the buying or selling
of a currency changes, the exchange rate is likely to respond. Changes in such
controls often are unpredictable and can create a significant exchange rate
response.
Many major countries have moved toward liberalization of exchange and
payments restrictions in recent years or accepted the principle that
restrictions should be relaxed. A few industrial countries have moved in the
other direction. Important liberalizations were carried out by Switzerland, the
United Kingdom and Japan. They dismantled mechanisms for restricting either
foreign exchange inflows (Switzerland), outflows (Britain) or elements of both
(Japan). By contrast, France and Mexico have tightened foreign exchange
controls.
Overall, many exchange markets are still heavily restricted. Several
countries limit access to the forward market to companies financing documented
export or import transactions in an effort to insulate the market from purely
speculative activities. Some of these countries permit local traders to enter
into forward contracts with residents but prohibit certain forward transactions
with nonresidents. By comparison, other countries have strict controls on
exchange transactions by residents, but permit free exchange transactions
between local traders and non-residents. A few countries have established tiered
markets, funneling commercial transactions through one market and financial
transactions through another. Outside the major industrial countries, relatively
free foreign exchange markets are rare and controls on foreign currency
transactions are extensive.
Another aspect of country risk has to do with the possibility that the
Fund may be dealing with a foreign trder whose home country is facing a payments
problem. Even though the foreign trader intends to perform on its foreign
exchange contracts, the contracts are tied to other external liabilities the
country has incurred. As a result performance may be delayed, and can result in
unanticipated cost to the Fund. This aspect of country risk is a major element
in the Fund's credit judgment as to with whom it will deal and in what amounts.
<PAGE>
EXHIBIT A
GLOSSARY OF TERMS
CLASS OF OPTIONS. Options covering the same underlying security.
CLEARING CORPORATION. The Options Clearing Corporation, Trans Canada
Options, Inc., The European Options Clearing Corporation B.V., or the London
Options Clearing House.
CLOSING PURCHASE TRANSACTION. A transaction in which an investor who is
obligated as a writer of an option or seller of a futures contract terminates
his obligation by purchasing on an Exchange an option of the same series as the
option previously written or futures contract identical to the futures contract
previously sold, as the case may be. (Such a purchase does not result in the
ownership of an option or futures contract.)
CLOSING SALE TRANSACTION. A transaction in which an investor who is the
holder or buyer of an outstanding option or futures contract liquidates his
position as a holder or seller by selling an option of the same series as the
option previously purchased or futures contract identical to the futures
contract previously purchased. (Such sale does not result in the investor
assuming the obligations of a writer or seller.)
COVERED CALL OPTION WRITER. A writer of a call option who, so long as
he remains obligated as a writer, owns the shares of the underlying security or
holds on a share for share basis a call on the same security where the exercise
price of the call held is equal to or less than the exercise price of the call
written, or, if greater than the exercise price of the call written, the
difference is maintained by the writer in cash, U.S. Treasury bills or other
high grade, short term obligations in a segregated account with the writer's
broker or custodian.
COVERED PUT OPTION WRITER. A writer of a put option who, so long as he
remains obligated as a writer, has deposited Treasury bills with a value equal
to or greater than the exercise price with a securities depository and has
pledged them to the Options Clearing Corporation for the account of the
broker-dealer carrying the writer's position or holds on a share for share basis
a put on the same security as the put written where the exercise price of the
put held is equal to or greater than the exercise price of the put written, or,
if less than the exercise price of the put written, the difference is maintained
by the writer in cash, U.S. Treasury bills or other high grade, short term
obligations in a segregated account with the writer's broker or custodian.
SECURITIES EXCHANGE. A securities exchange on which call and put
options are traded. The U.S. Exchanges are as follows: The Chicago Board Options
Exchange; American Stock Exchange; New York Stock Exchange; Philadelphia Stock
Exchange; and Pacific Stock Exchange. The foreign securities exchanges in Canada
are the Toronto Stock Exchange and the Montreal Stock Exchange; in the
Netherlands, the European Options Exchange; and in the United Kingdom, the Stock
Exchange (London).
Those issuers whose common stocks have been approved by the Exchanges
as underlying securities for options transactions are listed in various
financial publications.
COMMODITIES EXCHANGE. A commodities exchange on which futures contracts
are traded which is regulated by exchange rules that have been approved by the
Commodity Futures Trading Commission. The U.S. exchanges are as follows: The
Board of Trade of the City of Chicago, Chicago Mercantile Exchange,
International Monetary Market (a division of the Chicago Mercantile Exchange),
the Kansas City Board of Trade and the New York Futures Exchange.
EXERCISE PRICE. The price per unit at which the holder of a call option
may purchase the underlying security upon exercise or the holder of a put option
may sell the underlying security upon exercise.
EXPIRATION DATE. The latest date when an option may be
exercised or a futures contract must be completed according to
its terms.
HEDGING. An action taken by an investor to neutralize an investment
risk by taking an investment position which will move in the opposite direction
as the risk being hedged so that a loss (or gain) on one will tend to be offset
by a gain (or loss) on the other.
OPTION. Unless the context otherwise requires, the term "option" means
either a call or put option issued by a Clearing Corporation, as defined above.
A call option gives a holder the right to buy from such Clearing Corporation the
number of shares of the underlying security covered by the option at the stated
exercise price by the filing of an exercise notice prior to the expiration time
of the option. A put option gives a holder the right to sell to a Clearing
Corporation the number of shares of the underlying security covered by the put
at the stated exercise price by the filing of an exercise notice prior to the
expiration time of the option. The Fund will sell ("write") and purchase puts
only on U.S. Exchanges.
OPTION PERIOD. The time during which an option may be exercised,
generally from the date the option is written through its expiration date.
PREMIUM. The price of an option agreed upon between the buyer and
writer or their agents in a transaction on the floor of an Exchange.
SERIES OF OPTIONS. Options covering the same underlying security and
having the same exercise price and expiration date.
STOCK INDEX. A stock index assigns relative values to the common stocks
included in the index, and the index fluctuates with changes in the market
values of the common stocks so included.
INDEX BASED FUTURES CONTRACT. An index based futures contract is a
bilateral agreement pursuant to which a party agrees to buy or deliver at
settlement an amount of cash equal to $500 times the difference between the
closing value of an index on the expiration date and the price at which the
futures contract is originally struck. Index based futures are traded on
Commodities Exchanges. Currently index based futures contracts can be purchased
or sold with respect to the Standard & Poor's Corporation (S&P) 500 Stock Index
and S&P 100 Stock Index on the Chicago Mercantile Exchange, the New York Stock
Exchange Composite Index on the New York Futures Exchange and the Value Line
Stock Index and Major Market Index on the Kansas City Board of Trade.
UNDERLYING SECURITY. The security subject to being purchased upon the
exercise of a call option or subject to being sold upon the exercise of a put
option.
<PAGE>
Page 9
SCHEDULE OF INVESTMENTS--October 31, 1995
Market
Shares Value
----------------------------------------------------------------------------
COMMON STOCKS (96.1%)
[bullet] BRAZIL
Telecommunications (0.8%)
Telecomunicacoes Brasileiras S/A 100,000 $ 4,000,000
----------------------------------------------------------------------------
[bullet] GERMANY
Finance (0.8%)
Deutsche Bank AG (d) 89,000 4,025,739
----------------------------------------------------------------------------
[bullet] HONG KONG
Telecommunications (0.7%)
Hong Kong Telecommunications Limited 2,000,000 3,492,117
----------------------------------------------------------------------------
[bullet] NETHERLANDS
Advertising & Publishing (1.0%)
Wolters Kluwer N.V. (d) 56,719 5,162,155
----------------------------------------------------------------------------
[bullet] SWEDEN
Pharmaceutical (1.2%)
Pharmacia AB 165,000 5,739,692
----------------------------------------------------------------------------
[bullet] TAIWAN
Advertising & Publishing (0.6%)
Taiwan Semiconductor (c), (d) 486,000 1,512,728
United Microelectronics Corp., Ltd. (c), (d) 576,000 1,408,678
----------------------------------------------------------------------------
2,921,406
----------------------------------------------------------------------------
Finance (0.1%)
Chronicle 2001 Mutual Fund (d) 1,653,374 628,585
----------------------------------------------------------------------------
[bullet] TOTAL TAIWAN 3,549,991
----------------------------------------------------------------------------
[bullet] UNITED KINGDOM
Advertising & Publishing (0.7%)
International Cabletel, Inc. (c), (d) 133,333 3,566,658
----------------------------------------------------------------------------
[bullet] UNITED STATES
Advertising & Publishing (1.8%)
Infinity Broadcasting, Corp.,
Class A (d) 280,000 9,100,000
----------------------------------------------------------------------------
Aerospace (1.5%)
Boeing Co. 110,000 7,218,750
----------------------------------------------------------------------------
Amusement (1.9%)
HFS, Inc. (d) 150,000 9,187,500
----------------------------------------------------------------------------
Automotive (2.6%)
Lear Seating Corp. (d) 250,000 $ 6,937,500
Volvo AB, Class B, ADR 265,000 5,995,625
----------------------------------------------------------------------------
12,933,125
----------------------------------------------------------------------------
Capital Goods (5.0%)
AGCO Corporation 7,450,875
166,500
Caterpillar, Inc. 7,857,500
140,000
General Electric Co. 145,000 9,171,250
----------------------------------------------------------------------------
24,479,625
----------------------------------------------------------------------------
Chemicals (2.5%)
Potash Corp. of Saskatchewan, Inc. 175,000 12,184,375
----------------------------------------------------------------------------
Consumer Goods (4.5%)
CUC International, Inc. (b), (d) 12,381,900
357,600
Gillette Co. 200,000 9,675,000
----------------------------------------------------------------------------
22,056,900
----------------------------------------------------------------------------
Drugs (10.2%)
Amgen, Inc. (d) 75,000 3,604,688
Medaphis Corp. 88,600 2,813,050
Merck & Company, Inc. 115,000 6,612,500
Pharmacia AB, ADR 85,000 2,964,375
SmithKline Beecham plc, ADR 300,000 15,562,500
Warner Lambert Company 220,000 18,727,500
----------------------------------------------------------------------------
50,284,613
----------------------------------------------------------------------------
Electronics Products (5.9%)
Analog Devices, Inc. (d) 175,000 6,321,875
KLA Instruments Corporation (d) 161,800 6,957,400
Maxim Integrated Products, Inc. (d) 55,200 4,122,750
Microchip Technology, Inc. (d) 130,000 5,151,250
Solectron Corporation (d) 160,000 6,440,000
----------------------------------------------------------------------------
28,993,275
----------------------------------------------------------------------------
Finance (14.4%)
Allmerica Financial Corporation (d) 133,100 3,344,138
Bankamerica Corporation 180,000 10,350,000
Bank of Boston Corporation 250,000 11,125,000
Fleet Financial Group, Inc. 195,000 7,556,250
Golden West Financial Corporation 132,500 6,641,562
Greenpoint Financial Corporation 281,900 7,646,537
MBIA, Inc. 145,900 10,158,288
Merrill Lynch & Co., Inc. 97,500 5,411,250
Norwest Corporation 282,400 8,330,800
----------------------------------------------------------------------------
70,563,825
----------------------------------------------------------------------------
See Notes to Schedule of Investments. (Continued on next page)
<PAGE>
Page 10
Keystone Strategic Growth Fund (K-2)
(formerly Keystone Custodian Fund, Series K-2)
Market
Shares Value
- ----------------------------------------------------------------------------
United States -- (cont'd)
Foods (3.1%)
Pioneer Hi-Bred International, Inc. 155,700 $ 7,726,612
Sara Lee Corporation 250,000 7,343,750
----------------------------------------------------------------------------
15,070,362
----------------------------------------------------------------------------
Health Care Services (3.4%)
Boston Scientific Corp. 230,000 9,688,750
Pacificare Health Systems, Inc. (d) 94,300 6,872,113
----------------------------------------------------------------------------
16,560,863
----------------------------------------------------------------------------
Natural Gas (2.6%)
Anadarko Petroleum Corporation 190,000 8,241,250
Louisiana Land & Exploration Company 130,000 4,598,750
----------------------------------------------------------------------------
12,840,000
----------------------------------------------------------------------------
Office Products (1.3%)
EMC Corp. (d) 422,300 6,545,650
----------------------------------------------------------------------------
Oil Services (2.6%)
ENSCO International, Inc. (d) 375,000 6,328,125
Schlumberger, Ltd. 100,437 6,252,203
----------------------------------------------------------------------------
12,580,328
----------------------------------------------------------------------------
Restaurants (1.0%)
Apple South, Inc. 250,000 5,187,500
----------------------------------------------------------------------------
Retail (2.5%)
Barnes & Noble, Inc. (d) 200,000 7,300,000
General Nutrition, Inc. (d) 200,000 4,950,000
----------------------------------------------------------------------------
12,250,000
----------------------------------------------------------------------------
Services (4.5%)
Molten Metal Technology, Inc. (d) 82,500 $ 3,196,875
Thermo Electron Corporation (d) 300,000 13,800,000
U. S. Filter Corp. (d) 222,000 5,161,500
----------------------------------------------------------------------------
22,158,375
----------------------------------------------------------------------------
Software Services (10.1%)
Adobe Systems, Inc. 80,000 4,570,000
America Online, Inc. (d) 125,000 10,007,813
BMC Software, Inc. (d) 175,000 6,256,250
Microsoft Corp. (d) 130,000 13,008,125
Parametric Technology
Corporation (d) 238,700 15,948,144
----------------------------------------------------------------------------
49,790,332
----------------------------------------------------------------------------
Telecommunications (8.8%)
Cabletron Systems, Inc. (d) 100,000 7,862,500
Cisco Systems, Inc. (d) 150,000 11,634,375
Motorola, Inc. 110,000 7,218,750
Netmanage, Inc. (d) 400,000 8,175,000
Winstar Communications, Inc. (d) 490,000 8,146,250
----------------------------------------------------------------------------
43,036,875
----------------------------------------------------------------------------
TOTAL COMMON STOCKS
(Cost--$389,581,779) 472,558,625
----------------------------------------------------------------------------
<TABLE>
<CAPTION>
Interest Maturity Maturity Market
Rate Date Value Value
<S> <C> <C> <C> <C>
- ---------------------------------------------------------------------------------------------------------------
SHORT-TERM INVESTMENTS (2.6%)
Repurchase Agreement (2.6%) (b)
Goldman Sachs Group LP (collateralized by $12,975,195
FNMA, 6.394%, due 10/01/32 (Cost $12,846,000) 5.90% 11/01/95 $12,848,105 12,846,000
- ---------------------------------------------------------------------------------------------------------------
TOTAL SHORT-TERM INVESTMENTS (Cost--$12,846,000) 12,846,000
- ---------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS (Cost $402,427,779)(a) 485,404,625
- ---------------------------------------------------------------------------------------------------------------
FOREIGN CURRENCY HOLDINGS (Cost $303,840) (0.1%) (c) 294,164
OTHER ASSETS AND LIABILITIES--NET (1.2%) 5,911,029
- ---------------------------------------------------------------------------------------------------------------
NET ASSETS (100%) $491,609,818
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Schedule of Investments.
<PAGE>
Page 11
SCHEDULE OF INVESTMENTS--October 31, 1995
NOTES TO SCHEDULE OF INVESTMENTS:
(a) The cost of investments for federal income tax purposes is identical.
Gross unrealized appreciation and depreciation on investments, based
identified tax cost, at October 31, 1995 are as follows:
Gross unrealized appreciation $86,129,747
Gross unrealized depreciation (3,162,577)
--------------
$82,967,170
--------------
(b) The repurchase agreements are fully collateralized by U.S. government and/or
agency obligations based on market prices at October 31, 1995.
(c) Investments denominated in the local currency and/or foreign currency
holdings of certain foreign countries are considered illiquid due to current
foreign exchange restrictions of these foreign markets.
(d) Non-income-producing security.
See Notes to Financial Statements.
<PAGE>
Page 12
Keystone Strategic Growth Fund (K-2)
(formerly Keystone Custodian Fund, Series K-2)
FINANCIAL HIGHLIGHTS
(For a share outstanding throughout the year)
<TABLE>
<CAPTION>
Year Ended October 31,
-----------------------------------------------------
<S> <C> <C> <C> <C> <C>
1995 1994 1993 1992 1991
----------------------------------------------------------------------------------------------------------
Net asset value
beginning of year $ 7.54 $ 9.00 $ 7.60 $ 8.18 $ 6.52
----------------------------------------------------------------------------------------------------------
Income from investment operations:
Net investment income (loss) (0.02) 0.00 (0.06) (0.01) 0.08
Net gains (losses) on investments and foreign
currency related transactions 1.13 0.23 1.89 0.42 2.24
Net commissions paid on fund share sales (a) 0 0 0 0 0
----------------------------------------------------------------------------------------------------------
Total from investment operations 1.11 0.23 1.83 0.41 2.32
----------------------------------------------------------------------------------------------------------
Less distributions from:
Net investment income 0 0 0 (0.01) (0.16)
In excess of net investment income 0 0 (0.03) (0.05) 0
Net realized gains on investments and foreign
currency related transactions (0.60) (1.66) (0.40) (0.93) (0.50)
In excess of net realized gains on investments
and foreign currency related transactions 0 (0.03) 0 0 0
----------------------------------------------------------------------------------------------------------
Total distributions (0.60) (1.69) (0.43) (0.99) (0.66)
----------------------------------------------------------------------------------------------------------
Net asset value end of year $ 8.05 $ 7.54 $ 9.00 $ 7.60 $ 8.18
----------------------------------------------------------------------------------------------------------
Total return (b) 15.05% 3.55% 24.97% 6.38% 38.77%
Ratios/supplemental data
Ratios to average net assets:
Total expenses (c) 2.01% 1.73% 1.83% 1.58% 1.52%
Net investment income (loss) (0.25%) (0.17%) (0.57%) (0.15%) 0.99%
Portfolio turnover rate 140% 68% 65% 62% 86%
----------------------------------------------------------------------------------------------------------
Net assets end of year (thousands) $491,610 $416,684 $403,693 $321,794 $339,359
----------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
1990 1989 1988 1987 1986
<S> <C> <C> <C> <C> <C>
Net asset value
beginning of year $ 7.67 $ 6.53 $ 7.55 $ 9.13 $ 7.47
----------------------------------------------------------------------------------------------------------
Income from investment operations:
Net investment income (loss) 0.08 0.16 0.18 0.02 0.14
Net gains (losses) on investments and foreign
currency related transactions (0.80) 1.21 0.19 0.04 2.15
Net commissions paid on fund share sales (a) 0 0 0 0 (0.08)
----------------------------------------------------------------------------------------------------------
Total from investment operations (0.72) 1.37 0.37 0.06 2.21
----------------------------------------------------------------------------------------------------------
Less distributions from:
Net investment income (0.18) (0.18) (0.14) (0.13) (0.11)
In excess of net investment income 0 0 0 0 0
Net realized gains on investments and foreign
currency related transactions (0.25) (0.05) (1.25) (1.51) (0.44)
In excess of net realized gains on investments
and foreign currency related transactions 0 0 0 0 0
----------------------------------------------------------------------------------------------------------
Total distributions (0.43) (0.23) (1.39) (1.64) (0.55)
----------------------------------------------------------------------------------------------------------
Net asset value end of year $ 6.52 $ 7.67 $ 6.53 $ 7.55 $ 9.13
----------------------------------------------------------------------------------------------------------
Total return (b) (10.05%) 21.74% 7.73% 0.15% 31.38%
Ratios/supplemental data
Ratios to average net assets:
Total expenses (c) 1.65% 1.59% 1.69% 2.12% 0.98%
Net investment income (loss) 1.64% 2.06% 2.14% 0.23% 1.63%
Portfolio turnover rate 30% 40% 89% 104% 104%
----------------------------------------------------------------------------------------------------------
Net assets end of year (thousands) $234,060 $329,994 $328,205 $298,748 $303,994
----------------------------------------------------------------------------------------------------------
</TABLE>
(a) Prior to June 30, 1987, net commissions paid on new sales of shares under
the Fund's Rule 12b-1 Distribution Plan had been treated for both
financial statement and tax purposes as capital charges. On June 11,
1987, the Securities and Exchange Commission adopted a Rule which
required for financial statements for periods ended on or after June 30,
1987, that net commissions paid under Rule 12b-1 Distribution Plans be
treated as operating expenses rather than as capital charges.
Accordingly, beginning with fiscal year ended October 31, 1987, the
Fund's financial statements reflect 12b-1 Distribution Plan expenses
(i.e., shareholder service fees plus commissions paid net of deferred
sales charges received by the Fund) as a component of the net investment
income section of the financial highlights.
(b) Excluding contingent deferred sales charge (CDSC).
(c) The annualized expense ratio for the year ended October 31, 1995 includes
indirectly paid expenses. Excluding indirectly paid expenses, the
annualized expense ratio would have been 2.00%.
See Notes to Financial Statements.
<PAGE>
Page 13
STATEMENT OF ASSETS AND LIABILITIES
October 31, 1995
- ------------------------------------------------------------------------------
Assets:
Investments at market value (Note 1):
Long-term investments (identified cost
$402,427,779) $485,404,625
Foreign currency holdings (identified cost--
$303,840) 294,164
-----------------------------------------------------------------------------
Total investments and foreign currency
holdings (identified cost $402,731,619) 485,698,789
-----------------------------------------------------------------------------
Cash 322
Receivable for:
Investments sold 10,173,539
Fund shares sold 591,233
Dividends and Interest 170,580
Refundable foreign tax withheld 111,375
Prepaid expenses 36,616
-----------------------------------------------------------------------------
Total assets 496,782,454
-----------------------------------------------------------------------------
Liabilities:
Payable for:
Investments purchased 4,835,273
Fund shares redeemed 203,395
Other accrued expenses 133,968
-----------------------------------------------------------------------------
Total liabilities 5,172,636
-----------------------------------------------------------------------------
Net assets $491,609,818
-----------------------------------------------------------------------------
Net assets represented by (Notes 1 and 3):
Paid-in capital $382,083,937
Undistributed net investment income (Note 1) 478,981
Accumulated net realized gains (losses) on
investment and foreign currency related
transactions 26,065,648
Net unrealized appreciation (depreciation) on
investments, foreign currency holdings and
other assets and liabilities 82,981,252
-----------------------------------------------------------------------------
Total net assets applicable to outstanding
shares of beneficial interest ($8.05 a share on
61,095,706 shares outstanding) (Note 2) $491,609,818
-----------------------------------------------------------------------------
STATEMENT OF OPERATIONS
Year Ended October 31, 1995
- ------------------------------------------------------------------------------
Investment income (Note 1):
Dividends (Net of foreign withholding
taxes of $103,171) $ 5,532,697
Interest 2,420,655
-----------------------------------------------------------------------------
Total income 7,953,352
-----------------------------------------------------------------------------
Expenses (Notes 2 and 4):
Management fee $ 2,779,544
Transfer agent fees 1,296,268
Accounting, auditing and legal 64,639
Custodian fees 312,724
Printing 32,342
Trustees' fees and expenses 36,448
Distribution Plan expenses 4,580,713
Registration fees 39,106
Miscellaneous expenses 29,443
-----------------------------------------------------------------------------
Total expenses 9,171,227
Less: Expenses paid indirectly (Note 4) (64,847)
-----------------------------------------------------------------------------
Net expenses 9,106,380
-----------------------------------------------------------------------------
Net investment loss (1,153,028)
-----------------------------------------------------------------------------
Net realized and unrealized gain (loss) on
investments and foreign currency related
transactions (Notes 1 and 3):
Net realized gain (loss) on:
Investments 60,648,086
Foreign currency related transactions (193,244)
-----------------------------------------------------------------------------
Net realized gain on investments and foreign
currency related transactions (Notes 1 and 3) 60,454,842
-----------------------------------------------------------------------------
Net change in unrealized appreciation
(depreciation) on:
Investments and foreign currency holdings 8,411,692
Foreign currency related transactions 575,497
-----------------------------------------------------------------------------
Net change in unrealized appreciation or
depreciation 8,987,189
-----------------------------------------------------------------------------
Net gain (loss) on investments and foreign
currency related transactions 69,442,031
-----------------------------------------------------------------------------
Net increase in net assets resulting
from operations $68,289,003
-----------------------------------------------------------------------------
See Notes to Financial Statements.
<PAGE>
Page 14
Keystone Strategic Growth Fund (K-2)
(formerly Keystone Custodian Fund, Series K-2)
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
Year Ended October 31,
1995 1994
<S> <C> <C>
- -------------------------------------------------------------------------------------------
Operations:
Net investment loss (Note 1) $ (1,153,028) $ (649,697)
Net realized gain on investments and foreign
currency related transactions (Notes 1 and 3) 60,454,842 43,691,185
Net change in unrealized appreciation or
depreciation 8,987,189 (29,782,781)
- -------------------------------------------------------------------------------------------
Net increase in net assets resulting from
operations 68,289,003 13,258,707
- -------------------------------------------------------------------------------------------
Distributions to shareholders from (Note 1):
Net realized gain on investments and foreign
currency related transactions (34,582,438) (76,453,390)
In excess of net realized gain on investments and
foreign currency related transactions 0 (1,460,646)
- -------------------------------------------------------------------------------------------
Total distributions to shareholders (34,582,438) (77,914,036)
- -------------------------------------------------------------------------------------------
Capital share transactions (Note 2):
Proceeds from shares sold 101,411,115 80,583,329
Payments for shares redeemed (91,086,308) (72,254,270)
Net asset value of shares issued in reinvestment of
dividends and distributions 30,894,379 69,316,863
- -------------------------------------------------------------------------------------------
Net increase in net assets resulting from
capital share transactions 41,219,186 77,645,922
- -------------------------------------------------------------------------------------------
Total increase in net assets 74,925,751 12,990,593
- -------------------------------------------------------------------------------------------
Net assets:
Beginning of year 416,684,067 403,693,474
- -------------------------------------------------------------------------------------------
End of year [including undistributed investment
income as follows: October, 1995--$478,981 and
October, 1994--$571,945] $491,609,818 $416,684,067
- -------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
<PAGE>
Page 15
NOTES TO FINANCIAL STATEMENTS
(1.) Significant Accounting Policies
Keystone Strategic Growth Fund (K-2) (formerly Keystone Custodian Fund,
Series K-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 a diversified open-end investment company.
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 of current and former members
of management of Keystone and its affiliates. Keystone Investor Resource
Center, Inc. ("KIRC"), a wholly-owned subsidiary of Keystone, is the Fund's
transfer 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.
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 under the direction of the Board of Trustees:
(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.
The Fund enters into currency and other financial futures contracts as a
hedge against changes in interest or current exchange 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.
<PAGE>
Page 16
Keystone Strategic Growth Fund (K-2)
(formerly Keystone Custodian Fund, Series K-2)
Foreign currency amounts are translated into United States dollars as
follows: market value of investments, assets and liabilities at the daily
rates 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 of investments.
B. Securities transactions are accounted for no later than one business
day after the trade date. Realized gains and losses are recorded on the
identified cost basis. Interest income is recorded on the accrual basis and
dividend income is recorded on the ex-dividend date. All discounts are
amortized for both financial reporting and federal income tax purposes.
Distributions to shareholders are recorded at the close of business on the
ex-dividend date.
C. 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 expects to be 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.
D. 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
collateral on a daily basis, and if the value of collateral falls below
required levels, the Fund intends to seek additional 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.
E. The Fund may enter into forward foreign currency exchange contracts
("contracts") to settle portfolio purchases and sales of securities
denominated in a foreign currency and to hedge certain currency assets.
Contracts are recorded at market value 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.
F. The Fund distributes net investment income and net capital gains, if
any, annually. Distributions are determined in accordance with income tax
regulations. The significant differences between financial statement amounts
available for distribution and distributions made in accordance with income
tax regulations are
<PAGE>
Page 17
primarily due to the differing treatment of 12b-1 expenses prior to
April 1995 and foreign currency gains and losses.
(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:
Year Ended October 31,
1995 1994
-----------------------------------------------------------------------------
Shares sold 13,738,533 10,107,902
Shares redeemed (11,918,556) (8,857,902)
Shares issued in reinvestment of
dividends and distributions 3,996,685 9,186,809
-----------------------------------------------------------------------------
Net increase 5,816,662 10,436,809
-----------------------------------------------------------------------------
The Fund bears some of the costs of selling its shares under a
Distribution Plan adopted pursuant to Rule 12b-1 under the Investment Company
Act of 1940. Under the Distribution Plan, the Fund pays Keystone Investment
Distributors Company (formerly Keystone Distributors, Inc.) ("KIDC"), the
Fund's 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 brokers or others a commission equal to 4.00% of the
price paid to the Fund for each sale of Fund shares 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 remaining outstanding on the books of the
Fund for specified periods.
To the extent Fund shares purchased prior to January 1, 1992 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. A rule of the
National Association of Securities Dealers, Inc. ("NASD Rule") limits the
annual expenditures which the Fund may incur under the Distribution Plan to
1.00% of which 0.75% may be used to pay such distribution expenses and 0.25%
may be used to pay shareholder service fees. The NASD Rule also limits 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 Distribution Plan,
plus interest at the prime rate plus 1.0% 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 which exceed current annual payments permitted to be
received by KIDC from the Fund. KIDC intends to seek full payment of 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
<PAGE>
Page 18
Keystone Strategic Growth Fund (K-2)
(formerly Keystone Custodian Fund, Series K-2)
after January 1, 1992 have, to the extent permitted by
the NASD Rule, been paid to KIDC rather than to
the Fund.
During the year ended October 31, 1995, the Fund paid KIDC $4,584,433
under its Distribution Plan. The amount paid by the Fund under its
Distribution Plan, net of deferred sales charges, was $4,580,713 (1.0% of the
Fund's average daily net asset value during the year). During the year ended
October 31, 1995, KIDC received $1,287,663 after payments of commissions on
new sales to dealers and others of $4,366,474.
Under a rule of the NASD, the maximum unreimbursed amounts for which KIDC
may seek payment from the Fund under its Distribution Plan is $1,629,795
(0.33% of the Fund's net asset value as of October 31, 1995).
(3.) Securities Transactions
Purchases and sales of investment securities (including proceeds received at
maturity) for the year ended October 31, 1995, were as follows:
Cost of Purchases Proceeds from Sales
- ------------------------------------------------------------------
Portfolio securities $ 624,915,709 $ 577,244,985
Short-term investments 8,858,314,839 8,908,567,839
- ------------------------------------------------------------------
$9,483,230,548 $9,485,812,824
- ------------------------------------------------------------------
(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. The
management fee is determined by applying percentage rates, that start at
0.70% and declines as net assets increase, to 0.35% 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 year
ended October 31, 1995, the Fund paid or accrued to KMI investment management
and administrative services fees of $2,799,544 which represented 0.61% of the
Fund's average net assets. Of such amount paid to KMI, $2,379,612 was paid to
Keystone for its services to the Fund.
During the year ended October 31, 1995, the Fund paid or accrued $24,342
to KII for certain accounting services and $1,296,268 to KIRC for transfer
agent services.
The Fund has entered into an expense offset arrangement with its
custodian. For the year ended October 31, 1995, the Fund paid custody fees in
the amount of $247,877 and received a credit of $64,847 pursuant to the
expense offset arrangement, resulting in a total expense of $312,724. The
assets deposited with the custodian under the expense offset arrangement
could have been invested in income-producing assets.
FEDERAL TAX STATUS--FISCAL 1995 DISTRIBUTIONS (Unaudited)
For the fiscal year ended October 31, 1995 a capital gain distribution of
$0.60 per share was paid, all of which is considered long term. The
distribution is taxable to shareholders in the year in which received by them
or credited to their accounts.
In January 1996, we will send you complete information on the
distributions paid during the calendar year to help you in completing your
federal tax return.
<PAGE>
Page 19
INDEPENDENT AUDITORS' REPORT
The Trustees and Shareholders
Keystone Strategic Growth Fund (K-2)
We have audited the accompanying statement of assets and liabilities of
Keystone Strategic Growth Fund (K-2) (formerly Keystone Custodian Fund,
Series K-2), including the schedule of investments, as of October 31, 1995,
and the related statement of operations for the year then ended, the
statements of changes in net assets for each of the years in the two-year
period then ended, and the financial highlights for each of the years in the
ten-year period then ended. These financial statements and financial
highlights are the responsibility of the Fund's management. Our
responsibility is to express an opinion on these financial statements and
financial highlights based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements and
financial highlights are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures
in the financial statements. Our procedures included confirmation of
securities owned as of October 31, 1995 by correspondence with the custodian
and brokers. An audit includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of
Keystone Strategic Growth Fund (K-2) as of October 31, 1995, the results of
its operations for the year then ended, the changes in its net assets for
each of the years in the two-year period then ended, and the financial
highlights for each of the years in the ten-year period then ended in
conformity with generally accepted accounting principles.
KPMG Peat Marwick LLP
Boston, Massachusetts
December 8, 1995
