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KEYSTONE
FAMILY OF FUNDS
[DIAMOND]
Balanced Fund (K-1)
Diversified Bond Fund (B-2)
Growth and Income Fund (S-1)
High Income Bond Fund (B-4)
International Fund Inc.
Liquid Trust
Mid-Cap Growth Fund (S-3)
Precious Metals Holdings, Inc.
Quality Bond Fund (B-1)
Small Company Growth Fund (S-4)
Strategic Growth Fund (K-2)
Tax Free Fund
- -------------------------------------------------------------------------------
This report was prepared primarily for the information of the Fund's
shareholders. It is authorized for distribution if preceded or accompanied by
the Fund's current prospectus. The prospectus contains important information
about the Fund including fees and expenses. Read it carefully before you invest
or send money. For a free prospectus on other Keystone funds, contact your
financial adviser or call Keystone.
[KEYSTONE INVESTMENTS LOGO]
P.O. Box 2121
Boston, Massachusetts 02106-2121
K2-R-12/96
33.5M
<PAGE>
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KEYSTONE
[PHOTO OF MAN AND CHILD ON BEACH]
STRATEGIC
GROWTH FUND (K-2)
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[KEYSTONE LOGO]
ANNUAL REPORT
OCTOBER 31, 1996
<PAGE>
PAGE 1
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Keystone Strategic Growth Fund (K-2)
Seeks capital growth from a broad spectrum of domestic and foreign securities.
Dear Shareholder:
We would like to take this opportunity to report on the performance of
Keystone Strategic Growth Fund (K-2) for the twelve-month period which ended
October 31, 1996. Following our letter to you we have included a discussion
with your Fund's manager and complete financial information.
Performance
For the twelve-month period which ended October 31, 1996, your Fund returned
12.95%. For the same period, the Standard & Poor's 500 Index (S&P 500), a
broad-based index of large company stocks, returned 24.09%.
Your Fund's short-term results did not meet our expectations. While the
stock market indexes posted strong returns for the Fund's fiscal year, the
timing of some of our investments and individual stock selection could have
been better.
At the beginning of your Fund's fiscal year we anticipated slower economic
growth and no repeat of 1995's excellent market returns. With this in mind,
we attempted to reduce our exposure to stocks that we believed might be most
at risk in a slow growth environment. Our objective was to broaden your
Fund's diversification and emphasize stocks that would be less affected by
the expected slow growth environment. This strategy resulted in an emphasis
on companies with consistent earnings growth rates, rather than companies
with high growth rates.
In the first quarter of 1996 economic growth turned out to be much stronger
than many analysts had expected. Stocks of large, established companies
provided the best returns during the period. Strong corporate earnings,
relatively low interest rates and stronger-than-expected economic growth
propelled blue chip stock indexes to new highs, breaking previous records.
Price volatility increased during the fiscal period as investors attempted to
gauge the strength of the economy during the first half of 1996. In addition,
the smallest earnings disappointment often resulted in sharp stock price
declines. In this environment, our holdings of companies with consistent
growth rates did not benefit as much as higher growth rate companies.
As the fiscal year began, we cut back on overweighted sectors and in areas
that had provided good returns in 1995, such as technology. However, in some
cases these reductions occurred after corrections had occurred. While the
timing of these reductions were late, we believed that a smaller exposure to
technology stocks was a more appropriate long-term strategy, given the high
prices and higher relative volatility of technology stocks.
The strong performance of blue chip stocks continued into the spring of
1996. However, in April and May small company stocks provided some of the
best returns, as investors searched for companies with high earnings growth
rates at more attractive valuations than blue chip stocks. Your Fund
participated only modestly in the small company stock rally because we had
steadily increased our holdings of stocks with consistent earnings records,
primarily large company stocks.
We also increased the Fund's exposure to Japanese stocks during much of the
period, based on expectations for an improving economic environment in Japan.
These investments provided positive performance in local currency terms.
However, the weak yen and strong U.S. dollar hurt performance when converted
into U.S. dollars, despite hedging a portion of our investments to protect it
from currency changes.
(continued on next page)
<PAGE>
PAGE 2
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Keystone Strategic Growth Fund (K-2)
Our outlook
We expect the favorable economic fundamentals of 1996 to continue into 1997.
We believe that the economy should grow at a moderate rate, inflation should
remain under control, despite some wage pressures, which should allow
interest rates to remain relatively stable.
For investors with long-term goals, we continue to believe that stocks offer
the best potential returns. However, we are now in the sixth year of a stock
market rally--the longest since the end of World War II. While we have a
favorable outlook for 1997, history has shown that strong performance does
not persist indefinitely. Stocks periodically experience price declines. We
witnessed this type of "correction" in June and July, followed by a recovery.
With this in mind, we encourage you to keep the above average stock market
returns of the last few years in perspective.
Keystone acquired by First Union Corporation
On another note, we are pleased to inform you that Keystone has been acquired
by First Union Corporation. First Union is a financial services firm based in
Charlotte, North Carolina. It is the nation's sixth largest bank holding
company with assets of approximately $130 billion. First Union, through its
wholly-owned subsidiary Evergreen Asset Management Corp., together with
Keystone mutual funds, manages more than $30 billion in 70 mutual funds.
While Keystone will remain a separate entity and will continue to provide
investment advisory and management services to the Fund, services will be
provided under the 'Evergreen Keystone Funds' name. We believe First Union's
acquisition of Keystone strengthens the investment management services we
provide you.
Thank you for your continued support of Keystone Strategic Growth Fund
(K-2). If you have any questions or comments about your investments, we
encourage you to write to us.
Sincerely,
/s/ Albert H. Elfner, III
- -------------------------
Albert H. Elfner, III
Chairman
Keystone Investment Management Company
/s/ George S. Bissell
- -------------------------
George S. Bissell
Chairman of the Board
Keystone Funds
December 1996
[PHOTO OF ALBERT H. ELFNER, III]
Albert H. Elfner, III
[PHOTO OF GEORGE S. BISSELL]
George S. Bissell
<PAGE>
PAGE 3
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A Discussion With
Your Fund Manager
Maureen E. Cullinane is senior portfolio manager of your Fund and leads
Keystone's growth stock team. A Chartered Financial Analyst, Ms. Cullinane
has over 20 years of investment experience. She received BA and MA degrees
from Emmanuel College with post-graduate study at the Universite de Paris.
She holds an MBA from Boston University. Together with Margery C. Parker,
portfolio manager of Keystone Mid-Cap Growth Fund (S-3), the team focuses on
selecting companies with growing earnings.
Q What was the environment like during the twelve-month period?
A At the end of 1995, economic growth was moderate, inflation was contained,
and interest rates had declined. This had been a favorable environment for
stocks. At the beginning of 1996, the environment changed. While stock prices
rose, they fluctuated broadly as virtually every new economic statistic
triggered a debate over growth and inflation and whether or not the Federal
Reserve Board would raise interest rates. In June and July, stock prices
experienced steep declines. We believe this short-term correction helped
wring out the excesses in the market and brought stock prices to more
reasonable levels. During August, September and October, stocks generally
rose in value.
Q How did you manage the Fund during this period?
A Because of uncertainties in the market, we attempted to reduce risk by
focusing on consistency and diversification. In order to minimize the effects
of the market's gyrations on the portfolio, we invested in stable growth
companies. These are companies that tend to grow regardless of the state of
the economy. We emphasized companies that have had consistent earnings growth
rates of approximately 20%. On October 31, 1996, nearly 60% of the
portfolio's assets were invested in stable growth companies. We increased the
diversification of the portfolio, because we wanted the Fund to have broad
representation in a number of market sectors.
Q How did your focus on consistency and diversification change the
composition of the Fund?
A At the beginning of the period, finance companies accounted for the Fund's
largest industry weighting, and drug companies composed the Fund's second
largest industry. On October 31, 1996, these two industry sectors still
occupied the number one and two positions in the fund, however, the
percentage of assets in each category was reduced.
Twelve months ago, technology stocks (software services, telecommunications,
and electronics products companies) were among the Fund's top five industry
sectors. On October 31, 1996, there were fewer technology stocks in the
portfolio. Oil services, business services, and food companies were more
prominent in the portfolio
Fund Profile
Objective: Seeks capital growth from a broad spectrum of domestic and foreign
securities.
Number of stocks: 70
Commencement of investment operations: September 11, 1935
Net assets: $497 million
Newspaper Symbol: "StrGrK2"
<PAGE>
PAGE 4
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Keystone Strategic Growth Fund (K-2)
Your Fund Invests In . . .
(bullet) Companies with strong management teams, leading market positions and
solid balance sheets
(bullet) Stocks of any size in any industry: small-, mid-, and large-cap
(bullet) U.S. stocks and stocks of established foreign companies
and were among the Fund's top five industry sectors. We believed this more
diverse portfolio of growth stocks would benefit the Fund over the long term.
Q How do you decide which industries are most attractive?
A We take a "top-down" and "bottoms-up," approach. First we analyze trends
in the economy, and then look at how certain industries and companies may
benefit from those trends. In selecting stocks for the portfolio, we focus on
a company's fundamentals, that is, we assess its management, financials,
product line, and potential earnings growth.
Q Why were finance stocks a consistent theme in the portfolio throughout
the twelve months?
A On October 31, 1996, finance stocks accounted for 14.7% of the Fund's net
assets. We believe the stocks of finance companies benefitted from relatively
low interest rates and from consolidation in the industry. Strong
performers in this area included Bank of Boston and BankAmerica, two large
banks that have expanded their businesses by acquiring smaller banks. During
the last six months of the period, we broadened the Fund's financial holdings
to include Morgan Stanley, and Travelers Group. Travelers is the parent
company of Smith Barney, a brokerage firm. The addition of these two stocks
increased the Fund's exposure to firms that were benefitting from the
strength of the securities markets.
Q You reduced the drug position in the portfolio from 10.2% of net assets
on October 31, 1995 to 8.1% on October 31, 1996. Why?
A Even though we took profits in some of the companies that had performed in
line with our expectations, drug stocks were the Fund's second largest
industry weighting on October 31, 1996. Drug businesses benefitted from cost
efficiencies following restructurings and major acquisitions. We invested in
American Home Products, Johnson & Johnson, and Warner Lambert. We also owned
two foreign drug companies during the period--Rhone Poulenc Rorer and
Smithkline Beecham.
Q Energy companies composed a significant portion of portfolio assets. Why
were these companies attractive?
A Energy companies, which include oil services businesses, large oil
companies, and natural gas firms, accounted for 14.2% of net assets on
October 31, 1996. We believe that energy companies have benefitted from
restructuring efforts of the last several years, improved drilling and
exploration techniques, and an increase in demand.
In particular, oil services businesses, which support the drilling
activities of the industry by supplying
Top 5 Industries
as of October 31, 1996
Percentage of
Industry net assets
- -----------------------------------------
Finance 14.7
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Drugs 8.1
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Oil services 7.1
- -----------------------------------------
Business services 6.8
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Telecommunications 6.7
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<PAGE>
PAGE 5
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Diversification by
Market Capitalization
as of October 31, 1996
[TABULAR REPRESENTATION OF PIE CHART]
Large-cap(1) 70%
Small-cap stocks (U.S.) 5%
Mid-cap stocks (U.S.) 25%
(as a percentage of long-term portfolio assets)
A stock's market capitalization, or market cap, is its stock price multiplied
by the number of shares outstanding.
- -----------------
(1)Includes 15% of net assets invested in foreign stocks.
rigs, boats, pumping and seismology equipment, were among the best
performers. In the oil services area, we held ENSCO International,
Schlumberger, and Tidewater. We also invested in two large oil companies--
Exxon and Mobil. In the natural gas area, we invested in Anadarko, a company
that is exploring several new gas fields, and United Meridian, a company that
is conducting a drilling operation off the coast of Africa.
Q During the last six months of the period, you increased the retail
portion of the portfolio from 3% to 4.8% of net assets on October 31, 1996.
Why did retail stocks offer opportunity?
A Over the past year, unemployment declined, wages increased modestly, and
there were fewer headlines announcing layoffs at major corporations. We
believe these conditions helped boost consumer confidence. Historically,
heightened consumer confidence has been beneficial to the retail industry. In
the retail area, we invested in Loehmann's and Saks, two stores that market
to upscale consumers. We also invested in Abercrombie & Fitch, a store that
caters to older teens and young adults. In addition, we held Staples, a
leader in the discount office supply business.
Q You increased the foreign investments in the portfolio from 9% to 13.6%.
How did you manage the foreign component of the Fund?
A We were very selective in our approach to foreign markets. In Western
Europe, fiscal discipline and restructuring led to lower interest rates and
stronger corporate earnings. The rising U.S. dollar helped boost earnings of
large, multinational corporations that sell goods in the United States. In
Japan, the economic recovery was stalled by the weakness of the yen relative
to the U.S. dollar. Anticipating economic successes in Europe, we increased
the Fund's holdings there and reduced the Fund's weighting in Japan.
Q What is your outlook?
A We expect the environment for growth stocks to remain healthy. As we enter
1997, we expect economic growth to be moderate and inflation and interest
rates to remain relatively low. These factors, along with our expectations
for positive earnings, should favor growth stocks. However, we believe that
returns in 1997 may be less than those of 1996. We would not be surprised to
see some short-term pullback in stock prices in the months ahead. Should a
'correction' in the stock market occur, we would view it as a normal part of
the investing cycle, and use it as an opportunity to purchase more high
quality stocks at lower prices.
<PAGE>
PAGE 6
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Keystone Strategic Growth Fund (K-2)
Top 10 Holdings
as of October 31, 1996
Percentage of
Stock Industry net assets
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General Electric Capital goods 4.3
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ENSCO International Oil services 2.8
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USA Waste Services Business services 2.6
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Microsoft Software services 2.3
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Travelers Group Insurance 2.3
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Bank of Boston Finance 2.3
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Intel Electronic products 2.3
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Coca-Cola Foods 2.2
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HFS Amusements 2.2
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Tidewater Oil services 2.1
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[DIAMOND]
This column is intended to answer
questions about your Fund.
If you have a question you would like answered, please write to:
Evergreen Keystone Investment Services, Inc.
Attn: Shareholder Communications, 22nd Floor
200 Berkeley Street, Boston, Massachusetts 02116-5034.
<PAGE>
PAGE 7
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Your Fund's Performance
Growth of an investment in
Keystone Strategic Growth Fund (K-2)
In Thousands
[MOUNTAIN CHART]
Initial Reinvested
Investment Distributions
10/86 10000 10000
8269 10015
10/88 7152 10789
8401 13135
10/90 7141 11815
8959 16396
10/92 8324 17441
9858 21797
10/94 8258 22571
8817 25968
10/96 9507 29331
A $10,000 investment in Keystone Strategic Growth Fund (K-2) made on
October 31, 1986 with all distributions reinvested was worth $29,331 on
October 31, 1996. Past performance is no guarantee of future results.
Twelve-Month Performance as of October 31, 1996
=========================================================
Total return* 12.95%
Net asset value 10/31/95 $ 8.05
10/31/96 $ 8.68
Dividends $ 0.01
Capital gains $ 0.36
* Before deduction of contingent deferred sales charge (CDSC).
Historical Record as of October 31, 1996
=========================================================
If you If you did
Cumulative total return redeemed not redeem
1-year 9.95% 12.95%
5-year 78.89% 78.89%
10-year 193.31% 193.31%
Average annual total return
1-year 9.95% 12.95%
5-year 12.34% 12.34%
10-year 11.36% 11.36%
The "if you redeemed" returns reflect the deduction of the 3% CDSC for those
investors who bought and sold Fund shares after one calendar year. Investors
who retained their fund investment earned the returns reported in the second
column of the table.
The investment return and principal value will fluctuate so that your
shares, when redeemed, may be worth more or less than the original cost.
Shareholders may exchange shares for another Keystone fund by calling or
writing to Keystone directly, or through Keystone's Automated Response Line
(KARL). The Fund reserves the right to change or terminate the exchange
offer.
<PAGE>
PAGE 8
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Keystone Strategic Growth Fund (K-2)
Growth of an Investment
Comparison of change in value of a $10,000 investment
in Keystone Strategic Growth Fund (K-2), the Standard
& Poor's 500 Index and the Consumer Price Index.
In Thousands October 1986 through October 1996
Fund Average
Annual Total Return
- ----------------------------------
1 Year 5 Year 10 Year
9.95% 12.34% 11.36%
[LINE CHART]
Fund S&P CPI
10/86 10000 10000 10000
10015 10642 10453
10/88 10789 12192 10898
13135 15346 11387
10/90 11815 14184 12103
16396 18930 12457
10/92 17441 20816 12856
21797 23926 13209
10/94 22571 24852 13554
25968 31424 13935
10/96 29331 38993 14306
Past performance is no guarantee of future results. The one-year return
reflects the deduction of the Fund's 3% contingent deferred sales charge for
shares held for at least one year. The Consumer Price Index is through
September 30, 1996.
This chart graphically compares your Fund's total return performance to
certain investment indexes. It is the result of fund performance guidelines
issued by the Securities and Exchange Commission. The intent is to provide
investors with more information about their investment.
Components of the chart
The chart is composed of three lines that represent the accumulated value of
an initial $10,000 investment for the period indicated. The lines illustrate
a hypothetical investment in:
1. Keystone Strategic Growth Fund (K-2)
The Fund seeks capital growth from a broad spectrum of domestic and foreign
securities. The return is quoted after deducting sales charges (if
applicable), fund expenses and transaction costs and assumes reinvestment of
all distributions.
2. Standard & Poor's 500 Index (S&P 500)
The S&P 500 is a broad-based unmanaged index of common stock prices. It is
comprised of stocks of the largest U.S. companies. These stocks are selected
and compiled by Standard & Poor's Corporation according to criteria that may
be unrelated to your Fund's investment objective.
4. Consumer Price Index (CPI)
This index is a widely recognized measure of the cost of goods and services
produced in the U.S.. The index contains factors such as prices of services,
housing, food, transportation and electricity which are compiled by the U.S.
Bureau of Labor Statistics. The CPI is generally considered a valuable
benchmark for investors who seek to outperform increases in the cost of
living.
These indexes do not include transaction costs associated with buying and
selling securities, and do not hold cash to meet redemptions. It would be
difficult for most individual investors to duplicate these indexes.
Understanding what the chart means
The chart demonstrates your Fund's total return performance in relation to a
well known investment index and to increases in the cost of living. It is
important to understand what the chart shows and does not show.
This illustration is useful because it charts Fund and index performance
over the same time frame and over a long period. Long-term performance is a
more reliable and useful measure of performance than measurements of
short-term returns or temporary swings in the market. Your financial adviser
can help you evaluate fund performance in conjunction with the other
important financial considerations such as safety, stability and consistency.
<PAGE>
PAGE 9
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Limitations of the chart
The chart, however, limits the evaluation of Fund performance in several
ways. Because the measurement is based on total returns over an extended
period of time, the comparison often favors those funds which emphasize
capital appreciation when the market is rising. Likewise, when the market is
declining, the comparison usually favors those funds which take less risk.
Performance can be distorted
Funds which are more conservative in their orientation and which place an
emphasis on capital preservation will tend to compare less favorably when the
market is rising. In addition, funds which have income as one of their
objectives also will tend to compare less favorably to relevant indexes.
Indexes may also reflect the performance of some securities which a fund may
be prohibited from buying. A bond fund, for example, may be limited to
investments in only high quality bonds, or a stock fund may only be able to
buy stocks that have been traded on a stock exchange for a minimum number of
years or of a certain company size. Indexes usually do not have the same
investment restrictions as your Fund.
Indexes do not include costs of investing
The comparison is further limited in its utility because the index does not
take into account any deductions for sales charges, transaction costs or
other fund expenses. Your Fund's performance figures do reflect such
deductions. Sales charges--whether up-front or deferred--pay for the cost of
the investment advice of your financial adviser. Transaction costs pay for
the costs of buying and selling securities for your Fund's portfolio. Fund
expenses pay for the costs of investment management and various shareholder
services. None of these costs are reflected in index total returns. The
comparison is not completely realistic because an index cannot be duplicated
by an investor--even an unmanaged index--without incurring some charges and
expenses.
One of several measures
The chart is one of several tools you can use to understand your investment.
It should be read in conjunction with the Fund's prospectus, and annual and
semiannual reports. Also, your financial adviser, who understands your
personal financial situation, can best explain the features of your Keystone
fund and how it applies to your financial needs.
Future returns may be different
Shareholders also should be mindful that the long-run performance of either
the Fund or the indexes is not representative of what shareholders should
expect to receive from their Fund investment in the future; it is presented
to illustrate only past performance and is not a guarantee of future returns.
<PAGE>
PAGE 10
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Keystone Strategic Growth Fund (K-2)
Glossary of
Mutual Fund Terms
MUTUAL FUND--A company which combines the investment money of many people
whose financial goals are similar, and invests that money in a variety of
securities. A mutual fund allows the smaller investor the benefits of
diversification, professional management and constant supervision usually
available only to large investors.
PORTFOLIO MANAGER--An investment professional who is responsible for
managing a portfolio's assets prudently and making appropriate investment
decisions, such as which securities to buy, hold and sell, based on the
investment objectives of the portfolio.
STOCK--Equity or ownership interest in a corporation, which represents a
claim on the corporation's assets and earnings.
BOND--Security issued by a government or corporation to those from whom it
has borrowed money. A bond usually promises to pay interest income to the
bondholder at regular intervals and to repay the entire amount borrowed at
maturity date.
CONVERTIBLE SECURITY--A corporate security (usually preferred stock or
bonds) that is exchangeable for a set number of another security type
(usually common stocks) at a pre-stated price.
MONEY MARKET FUND--A mutual fund whose assets are invested in a diversified
portfolio of short-term securities, including commercial paper, bankers'
acceptances, certificates of deposit and other short-term instruments. The
fund pays income which can fluctuate daily. Liquidity and safety of principal
are primary objectives.
NET ASSET VALUE (NAV) PER SHARE--The value of one share of a mutual fund.
The NAV per share is determined by subtracting a fund's total liabilities
from its total assets, and dividing that amount by the number of fund shares
outstanding.
DIVIDEND--A per share distribution of the income earned from the fund's
portfolio holdings. When a dividend distribution is made, the fund's net
asset value drops by the amount of the distribution because the distribution
is no longer considered part of the fund's assets.
CAPITAL GAIN--The profit from the sale of securities, less any losses.
Capital gains are paid to fund shareholders on a per share basis. When a
capital gain distribution is made, the fund's net asset value drops by the
amount of the distribution because the distribution is no longer considered
part of the fund's assets.
YIELD--The annualized rate of income as measured against the current net
asset value of fund shares.
TOTAL RETURN--The change in value of a fund investment over a specified
period of time, taking into account the change in a fund's market price and
the reinvestment of all fund distributions.
SHORT-TERM--An investment with a maturity of one year or less.
LONG-TERM--An investment with a maturity of greater than one year.
AVERAGE MATURITY--The average number of days until the notes, drafts,
acceptances, bonds or other debt instruments in a portfolio become due and
payable.
OFFERING PRICE--The offering price of a share of a mutual fund is the price
at which the share is sold to the public.
<PAGE>
PAGE 11
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SCHEDULE OF INVESTMENTS--October 31, 1996
<TABLE>
<CAPTION>
Market
Shares Value
=============================================================================================
<S> <C> <C>
COMMON STOCKS (89.3%)
BRAZIL (1.0%)
Telecommunications (1.0%)
Telecomunicacoes Brasileiras S.A. ADR 65,000 $ 4,842,500
- ---------------------------------------------------------------------------------------------
GERMANY (0.5%)
Retail (0.5%)
Adidas AG 27,000 2,314,184
- ---------------------------------------------------------------------------------------------
JAPAN (2.2%)
Appliances and Furnishings (1.2%)
Sony Corp. 100,000 5,998,858
- ---------------------------------------------------------------------------------------------
Automotive (0.5%)
Fuji Heavy Industry 570,000 2,653,375
- ---------------------------------------------------------------------------------------------
Drugs (0.5%)
Taisho Pharmaceutical 130,000 2,580,475
- ---------------------------------------------------------------------------------------------
TOTAL JAPAN 11,232,708
- ---------------------------------------------------------------------------------------------
MEXICO (3.4%)
Advertising and Publishing (0.6%)
Grupo Televisa S.A. de C.V. ADR 120,000 3,150,000
- ---------------------------------------------------------------------------------------------
Auto Industry (0.9%)
Desc S.A. de C.V. ADR (c) 230,000 4,427,500
- ---------------------------------------------------------------------------------------------
Foods (1.1%)
PanAmerican Beverages, Inc. ADR 130,000 5,671,250
- ---------------------------------------------------------------------------------------------
Finance (0.8%)
Grupo Financiero Banamex 1,837,000 3,885,412
- ---------------------------------------------------------------------------------------------
TOTAL MEXICO 17,134,162
- ---------------------------------------------------------------------------------------------
NETHERLANDS (1.5%)
Advertising & Publishing (1.5%)
Wolters Kluwer N.V. (c) 56,719 7,290,867
- ---------------------------------------------------------------------------------------------
TAIWAN (0.2%)
Finance (0.2%)
Chronicle 2001 Mutual Fund (c) 1,653,374 748,041
- ---------------------------------------------------------------------------------------------
UNITED KINGDOM (2.6%)
Advertising and Publishing (1.2%)
Pearson PLC 500,000 6,168,620
- ---------------------------------------------------------------------------------------------
Business Services (1.4%)
Compass Group PLC 675,000 6,712,647
- ---------------------------------------------------------------------------------------------
TOTAL UNITED KINGDOM 12,881,267
- ---------------------------------------------------------------------------------------------
UNITED STATES (77.9%)
Aerospace (1.5%)
Boeing Co. 80,000 $ 7,630,000
- ---------------------------------------------------------------------------------------------
Amusement (2.2%)
HFS, Inc. (c) 149,000 10,914,250
- ---------------------------------------------------------------------------------------------
Automotive (0.5%)
Danaher Corp. 65,000 2,656,875
- ---------------------------------------------------------------------------------------------
Building (0.7%)
Fastenal Co. 75,000 3,478,125
- ---------------------------------------------------------------------------------------------
Business Services (5.4%)
Thermo Electron Corp. 240,000 8,760,000
USA Waste Services, Inc. (c) 400,000 12,800,000
U.S. Filter Corp. (c) 153,400 5,292,300
- ---------------------------------------------------------------------------------------------
26,852,300
- ---------------------------------------------------------------------------------------------
Capital Goods (4.3%)
General Electric Co. 220,000 21,285,000
- ---------------------------------------------------------------------------------------------
Chemicals (1.1%)
DuPont E. I. DeNemours and Co. 60,000 5,565,000
- ---------------------------------------------------------------------------------------------
Consumer Goods (2.4%)
CUC International, Inc. (c) 251,400 6,159,300
Procter & Gamble Co. 60,000 5,940,000
- ---------------------------------------------------------------------------------------------
12,099,300
- ---------------------------------------------------------------------------------------------
Drugs (7.6%)
Amercian Home Products Corp. 94,200 5,769,750
Gilead Sciences, Inc. (c) 151,300 3,508,269
Johnson & Johnson Co. 130,000 6,402,500
Rhone Poulenc Rorer Inc. 125,000 8,390,625
Smithkline Beecham P L C 100,000 6,262,500
Warner Lambert Co. 115,000 7,316,875
- ---------------------------------------------------------------------------------------------
37,650,519
- ---------------------------------------------------------------------------------------------
Electronics Products (3.4%)
Analog Devices, Inc. (c) 200,000 5,200,000
Intel Corp. 105,000 11,530,312
- ---------------------------------------------------------------------------------------------
16,730,312
- ---------------------------------------------------------------------------------------------
Finance (12.0%)
Bank of Boston Corp. 181,700 11,628,800
BankAmerica Corp. 68,900 6,304,350
Federal Home Loan Mortgage Corp. 90,000 9,090,000
Morgan Stanley Group Inc. 100,000 5,025,000
NationsBank Corp. 71,800 6,767,150
Norwest Corp. 212,400 9,319,050
<PAGE>
PAGE 12
- ------------------------------------
Keystone Strategic Growth Fund (K-2)
SCHEDULE OF INVESTMENTS--October 31, 1996
Market
Shares Value
=============================================================================================
United States -- (cont'd)
Finance -- (cont'd)
Travelers Group, Inc. 215,000 $ 11,663,750
- ---------------------------------------------------------------------------------------------
59,798,100
- ---------------------------------------------------------------------------------------------
Foods (5.2%)
Coca-Cola Co. 220,000 11,110,000
Flowers Industries, Inc. 357,600 8,358,900
Philip Morris Cos., Inc. 51,000 4,723,875
Richfood Holdings, Inc. 65,900 1,602,194
- ---------------------------------------------------------------------------------------------
25,794,969
- ---------------------------------------------------------------------------------------------
Insurance (1.2%)
American International Group, Inc. 55,000 5,974,375
- ---------------------------------------------------------------------------------------------
Metals & Mining (0.6%)
Aluminum Co. of America 50,000 2,931,250
- ---------------------------------------------------------------------------------------------
Natural Gas (3.8%)
Anadarko Petroleum Corp. 115,200 7,329,600
Noble Affiliates, Inc. 175,000 7,612,500
United Meridian Corp. (c) 87,100 4,104,587
- ---------------------------------------------------------------------------------------------
19,046,687
- ---------------------------------------------------------------------------------------------
Office Products (2.8%)
Compaq Computer Corp. (c) 80,000 5,570,000
EMC Corp. (c) 280,300 7,357,875
Synopsys, Inc. (c) 20,200 914,050
- ---------------------------------------------------------------------------------------------
13,841,925
- ---------------------------------------------------------------------------------------------
Oil (3.3%)
Exxon Corp. 95,000 8,419,375
Mobil Corp. 67,500 7,880,625
- ---------------------------------------------------------------------------------------------
16,300,000
- ---------------------------------------------------------------------------------------------
Oil Services (7.1%)
ENSCO International, Inc. (c) 325,000 14,056,250
Halliburton Co. 100,000 5,662,500
Schlumberger, Ltd. 50,437 4,999,568
Tidewater, Inc. 238,800 10,447,500
- ---------------------------------------------------------------------------------------------
35,165,818
- ---------------------------------------------------------------------------------------------
Retail (4.8%)
Abercrombie & Fitch Co. (c) 204,700 4,503,400
Federated Department Stores, Inc. (c) 100,000 3,300,000
Loehmann's Holdings, Inc. (c) 100,000 2,662,500
Saks Holdings, Inc. (c) 165,000 5,775,000
Staples, Inc. (c) 418,450 7,845,938
- ---------------------------------------------------------------------------------------------
24,086,838
- ---------------------------------------------------------------------------------------------
United States -- (cont'd)
Software Services (2.3%)
Microsoft Corp. (c) 85,000 $ 11,671,562
- ---------------------------------------------------------------------------------------------
Telecommunications (5.7%)
Cisco Systems, Inc. (c) 85,000 5,254,062
Teleport Communications Group (c) 189,800 4,673,825
3Com Corp. (c) 75,000 5,076,563
U.S. Robotics Corp. 120,000 7,552,500
Lucent Technologies, Inc. 116,800 5,489,600
- ---------------------------------------------------------------------------------------------
28,046,550
- ---------------------------------------------------------------------------------------------
TOTAL UNITED STATES 387,519,755
- ---------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS
(Cost--$369,300,279) 443,963,484
- ---------------------------------------------------------------------------------------------
PREFERRED STOCK (2.2%)
BRAZIL (2.2%)
Finance (1.7%)
Banco Bradesco S.A. 645,300,000 5,502,071
Banco Itau S.A. 6,441,000 2,789,804
- ---------------------------------------------------------------------------------------------
8,291,875
- ---------------------------------------------------------------------------------------------
Metals & Mining (0.5%)
Companhia Vale do Rio Doce Navegacao S.A. 115,000 2,384,174
- ---------------------------------------------------------------------------------------------
TOTAL BRAZIL 10,676,049
- ---------------------------------------------------------------------------------------------
TOTAL PREFERRED STOCK
(Cost--$9,558,296) 10,676,049
- ---------------------------------------------------------------------------------------------
Maturity
Value
=============================================================================================
REPURCHASE AGREEMENT (6.5%)
Investment in repurchase agreements in a joint trading
account, purchased 10/31/96, 5.565%, maturing 11/1/96
(Cost--$32,250,000) (a) $ 32,254,985 32,250,000
- ---------------------------------------------------------------------------------------------
TOTAL INVESTMENTS
(Cost--$411,108,575) (d) 486,889,533
- ---------------------------------------------------------------------------------------------
FOREIGN CURRENCY HOLDINGS
(Cost--$10,523) (0.0%) (b) 10,491
OTHER ASSETS AND LIABILITIES--NET (2.0%) 9,976,437
- ---------------------------------------------------------------------------------------------
NET ASSETS (100%) $496,876,461
- ---------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
PAGE 13
- ------------------------------------
(a) The repurchase agreement is fully collateralized by U.S. government
and/or agency obligations based on market prices at the date of the
portfolio.
(b) 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.
(c) Non-income producing security.
(d) The cost of investments for federal income tax purposes amounted to
$411,116,314.
Gross unrealized appreciation and depreciation of investments, based on
identified tax cost, at October 31, 1996 are as follows:
Gross unrealized appreciation $80,887,005
Gross unrealized depreciation (5,113,786)
-----------
Net unrealized appreciation $75,773,219
===========
Legend of Portfolio Abbreviations:
ADR--American Depository Receipt
FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS
<TABLE>
<CAPTION>
Net Unrealized
Exchange U.S. $ Value at In Exchange Appreciation/
Date October 31, 1996 for U.S. $ (Depreciation)
- -------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Forward Foreign Currency Exchange Contracts to Sell:
Contracts to Deliver
- ---------------------------------------
11/20/96 1,757,628 Pound Sterling $2,859,466 $2,720,000 ($139,466)
1/27/97 668,790,000 Japanese Yen 5,946,510 6,000,000 53,490
</TABLE>
See Notes to Financial Statments.
<PAGE>
PAGE 14
- ------------------------------------
Keystone Strategic Growth Fund (K-2)
FINANCIAL HIGHLIGHTS
(For a share outstanding throughout each year)See Notes to Financial
Statements.
<TABLE>
<CAPTION>
Year Ended October 31,
-----------------------------------------------------------
1996 1995 1994 1993 1992
==================================================================================================
<S> <C> <C> <C> <C> <C>
Net asset value
beginning of year $ 8.05 $ 7.54 $ 9.00 $ 7.60 $ 8.18
- --------------------------------------------------------------------------------------------------
Income from investment operations:
Net investment income (loss) (0.04) (0.02) 0 (0.06) (0.01)
Net realized and unrealized gain
(loss) on investments and foreign
currency related transactions 1.04 1.13 0.23 1.89 0.42
- --------------------------------------------------------------------------------------------------
Total from investment operations 1.00 1.11 0.23 1.83 0.41
- --------------------------------------------------------------------------------------------------
Less distributions from:
Net investment income (0.01) 0 0 0 (0.01)
In excess of net investment income 0 0 0 (0.03) (0.05)
Net realized gain on investments
and foreign currency related
transactions (0.36) (0.60) (1.66) (0.40) (0.93)
In excess of net realized gain on
investments and foreign currency
related transactions 0 0 (0.03) 0 0
- --------------------------------------------------------------------------------------------------
Total distributions (0.37) (0.60) (1.69) (0.43) (0.99)
- --------------------------------------------------------------------------------------------------
Net asset value end of year $ 8.68 $ 8.05 $ 7.54 $ 9.00 $ 7.60
==================================================================================================
Total return (a) 12.95% 15.05% 3.55% 24.97% 6.38%
Ratios/supplemental data
Ratios to average net assets:
Total expenses 1.91%(b) 2.01%(b) 1.73% 1.83% 1.58%
Net investment income (loss) (0.48%) (0.25%) (0.17%) (0.57%) (0.15%)
Portfolio turnover rate 156% 140% 68% 65% 62%
Average commission rate paid $ 0.0042 N/A N/A N/A N/A
- --------------------------------------------------------------------------------------------------
Net assets end of year (thousands) $496,876 $491,610 $416,684 $403,693 $321,794
==================================================================================================
</TABLE>
<TABLE>
<CAPTION>
1991 1990 1989 1988 1987
=================================================================================================
<S> <C> <C> <C> <C> <C>
Net asset value
beginning of year $ 6.52 $ 7.67 $ 6.53 $ 7.55 $ 9.13
------------------------------------------------------------------------------------------------
Income from investment operations:
Net investment income (loss) 0.08 0.08 0.16 0.18 0.02
Net realized and unrealized gain
(loss) on investments and foreign
currency related transactions 2.24 (0.80) 1.21 0.19 0.04
------------------------------------------------------------------------------------------------
Total from investment operations 2.32 (0.72) 1.37 0.37 0.06
------------------------------------------------------------------------------------------------
Less distributions from:
Net investment income (0.16) (0.18) (0.18) (0.14) (0.13)
In excess of net investment income 0 0 0 0 0
Net realized gain on investments
and foreign currency related
transactions (0.50) (0.25) (0.05) (1.25) (1.51)
In excess of net realized gain on
investments and foreign currency
related transactions 0 0 0 0 0
------------------------------------------------------------------------------------------------
Total distributions (0.66) (0.43) (0.23) (1.39) (1.64)
------------------------------------------------------------------------------------------------
Net asset value end of year $ 8.18 $ 6.52 $ 7.67 $ 6.53 $ 7.55
=================================================================================================
Total return (a) 38.77% (10.05%) 21.74% 7.73% 0.15%
Ratios/supplemental data
Ratios to average net assets:
Total expenses 1.52% 1.65% 1.59% 1.69% 2.12%
Net investment income (loss) 0.99% 1.64% 2.06% 2.14% 0.23%
Portfolio turnover rate 86% 30% 40% 89% 104%
Average commission rate paid N/A N/A N/A N/A N/A
------------------------------------------------------------------------------------------------
Net assets end of year (thousands) $339,359 $234,060 $329,994 $328,205 $298,748
=================================================================================================
</TABLE>
(a) Excluding applicable sales charges.
(b) Ratio of total expenses to average net assets includes indirectly paid
expenses. Excluding indirectly paid expenses, the expense ratio would have
been 1.90% and 2.00% for the years ended October 31, 1996 and 1995,
respectively.
See Notes to Financial Statements.
<PAGE>
PAGE 15
- ------------------------------------
STATEMENT OF ASSETS AND LIABILITIES
October 31, 1996
==================================================================
Assets
Investments at market value (identified cost--
$411,108,575) $486,889,533
Foreign currency holdings (identified cost--
$10,523) 10,491
Cash 11,459
Receivable for:
Investments sold 16,837,391
Unrealized appreciation on forward foreign
currency exchange contracts 53,490
Fund shares sold 19,663
Dividends and interest 464,949
Foreign tax reclaims 19,943
Prepaid expenses and other assets 40,500
- ------------------------------------------------------------------
Total assets 504,347,419
- ------------------------------------------------------------------
Liabilities
Payable for:
Investments purchased 6,995,054
Unrealized depreciation on forward foreign
currency exchange contracts 139,466
Fund shares redeemed 214,474
Foreign taxes to be withheld 17,860
Other accrued expenses 104,104
- ------------------------------------------------------------------
Total liabilities 7,470,958
- ------------------------------------------------------------------
Net assets $496,876,461
==================================================================
Net assets represented by (Note 3)
Paid-in capital $361,396,355
Undistributed net investment income 85,978
Accumulated net realized gain on investment and
foreign currency related transactions 59,696,846
Net unrealized appreciation (depreciation) on
investments and foreign currency related
transcations 75,697,282
- ------------------------------------------------------------------
Total net assets $496,876,461
- ------------------------------------------------------------------
Net asset value per share
Net assets of $496,876,461 / 57,242,129 shares
outstanding $ 8.68
- ------------------------------------------------------------------
STATEMENT OF OPERATIONS
Year Ended October 31, 1996
========================================================================
Investment income
Dividends (Net of foreign withholding
taxes of $103,251) $ 5,944,232
Interest 1,151,763
- ------------------------------------------------------------------------
Total income 7,095,995
- ------------------------------------------------------------------------
Expenses
Management fee $2,994,500
Transfer agent fees 1,227,881
Accounting, auditing and legal 70,044
Custodian fees 270,162
Printing 30,540
Trustees' fees and expenses 31,034
Distribution Plan expenses 4,845,352
Registration fees 57,858
Miscellaneous expenses 25,534
- ------------------------------------------------------------------------
Total expenses 9,552,905
Less: Expenses paid indirectly (Note 6) (44,293)
- ------------------------------------------------------------------------
Net expenses 9,508,612
- ------------------------------------------------------------------------
Net investment loss (2,412,617)
- ------------------------------------------------------------------------
Net realized and unrealized gain (loss) on
investments and foreign currency related
transactions (Note 3)
Net realized gain on investments and
foreign currency related transactions 70,337,618
- ------------------------------------------------------------------------
Net change in unrealized appreciation on
investments and foreign currency
related transactions (7,283,970)
- ------------------------------------------------------------------------
Net realized and unrealized gain on
investments and foreign currency
related transactions 63,053,648
- ------------------------------------------------------------------------
Net increase in net assets resulting
from operations $60,641,031
========================================================================
See Notes to Financial Statements.
<PAGE>
PAGE 16
- ------------------------------------
Keystone Strategic Growth Fund (K-2)
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
Year Ended October 31,
------------------------------
1996 1995
===========================================================================================================
<S> <C> <C>
Operations
Net investment loss ($ 2,412,617) ($ 1,153,028)
Net realized gain on investments and foreign currency related
transactions 70,337,618 60,454,842
Net change in unrealized appreciation on investments and foreign
currency transactions (7,283,970) 8,987,189
- -----------------------------------------------------------------------------------------------------------
Net increase in net assets resulting from operations 60,641,031 68,289,003
- -----------------------------------------------------------------------------------------------------------
Distributions to shareholders from
Net investment income (478,981) 0
Net realized gain on investments and foreign currency related
transactions (22,079,862) (34,582,438)
- -----------------------------------------------------------------------------------------------------------
Total distributions to shareholders (22,558,843) (34,582,438)
- -----------------------------------------------------------------------------------------------------------
Capital share transactions
Proceeds from shares sold 65,085,209 101,411,115
Payments for shares redeemed (118,085,204) (91,086,308)
Net asset value of shares issued in reinvestment of distributions 20,184,450 30,894,379
- -----------------------------------------------------------------------------------------------------------
Net increase (decrease) in net assets resulting from capital share
transactions (32,815,545) 41,219,186
- -----------------------------------------------------------------------------------------------------------
Total increase in net assets 5,266,643 74,925,751
- -----------------------------------------------------------------------------------------------------------
Net assets:
Beginning of period 491,609,818 416,684,067
- -----------------------------------------------------------------------------------------------------------
End of period [including undistributed net investment income as follows:
1996--$85,978 and 1995--$478,981] $ 496,876,461 $491,609,818
===========================================================================================================
</TABLE>
See Notes to Financial Statements.
<PAGE>
PAGE 17
- ------------------------------------
NOTES TO FINANCIAL STATEMENTS
(1.) Significant Accounting Policies
Keystone Strategic Growth Fund (K-2) (the "Fund") is a Pennsylvania common
law trust for which Keystone Management, Inc. ("KMI") is the Investment
Manager and Keystone Investment Management Company ("Keystone") is the
Investment Adviser. Keystone is a wholly owned subsidiary of Keystone
Investments, Inc. ("KII") and KMI is, in turn, a wholly-owned subsidiary of
Keystone. The Fund is registered under the Investment Company Act of 1940, as
amended (the "1940 Act"), as a diversified, open-end investment company. The
Fund's investment objective is to provide shareholders with growth of
capital.
The following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of its financial statements. The
policies are in conformity with generally accepted accounting principles,
which require management to make estimates and assumptions that affect
amounts reported herein. Although actual results could differ from these
estimates, any such differences are expected to be immaterial to the net
assets of the Fund.
A. Valuation of Securities
Investments are usually valued at the closing sales price, or, in the absence
of sales and for over-the- counter securities, the mean of the bid and asked
prices. Securities for which valuations are not available from an independent
pricing service (including restricted securities) are valued at fair value as
determined in good faith according to procedures established by the Board of
Trustees.
Short-term investments with remaining maturities of 60 days or less are
carried at amortized cost, which approximates market value. Short-term
securities with greater than 60 days to maturity are valued at market value.
B. Repurchase Agreements
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.
Securities pledged as collateral for repurchase agreements are held by the
custodian on the Fund's behalf. The Fund monitors the adequacy of the
collateral daily and will require the seller to provide additional collateral
in the event the market value of the securities pledged falls below the
carrying value of the repurchase agreement.
C. Foreign Currency
The books and records of the Fund are maintained in United States (U.S.)
dollars. Foreign currency amounts are translated into U.S. dollars as
follows: market value of investments, assets and liabilities at the daily
rate of exchange; purchases and sales of investments, income and expenses at
the rate of exchange prevailing on the respective dates of such transactions.
Net unrealized foreign exchange gain (loss) resulting from changes in foreign
currency exchange rates is a component of net unrealized appreciation
(depreciation) on investments and foreign currency related transactions. Net
realized foreign currency gains and losses resulting from changes in exchange
rates include foreign currency gains and losses between trade date and
settlement date on investment securities transactions, foreign currency
transactions and the difference between the amounts of interest and dividends
recorded on the books of the Fund and the amount actually received. The
portion of foreign currency gains and losses related to fluctuations in
exchange rates between the initial purchase trade date and subsequent
<PAGE>
PAGE 18
- ------------------------------------
Keystone Strategic Growth Fund (K-2)
sale trade date is included in realized gain (loss) on foreign currency
related transactions.
D. Forward Foreign Currency Exchange Contracts
The Fund may enter into forward foreign currency exchange contracts ("forward
contracts") to settle portfolio purchases and sales of securities denominated
in a foreign currency and to hedge certain foreign currency assets or
liabilities. Forward contracts are recorded at the forward rate and are
marked-to-market daily. Realized gains and losses arising from such
transactions are included in net realized gain (loss) on foreign currency
related transactions. The Fund bears the risk of an unfavorable change in the
foreign currency exchange rate underlying the forward contract and is subject
to the credit risk that the other party will not fulfill their obligations
under the contract. Forward contracts involve elements of market risk in
excess of the amount reflected in the statement of assets and liabilities.
E. Security Transactions and Investment Income
Securities transactions are accounted for no later than one business day
after the trade date. Realized gains and losses are computed on the
identified cost basis. Interest income is recorded on the accrual basis and
includes amortization of discounts and premiums. Dividend income is recorded
on the ex-dividend date.
F. Federal Income Taxes
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 (the
"Code"). Thus, the Fund is relieved of any federal income tax liability by
distributing all of its net taxable investment income and net taxable capital
gains, if any, to its shareholders. The Fund also intends to avoid excise tax
liability by making the required distributions under the Code. Accordingly,
no provision for federal income tax is required.
G. Distributions
The Fund distributes net investment income and net capital gains, if any, at
least annually. Distributions to shareholders are recorded at the close of
business on the ex-dividend date.
Income and capital gains distributions to shareholders are determined in
accordance with income tax regulations, which may differ from generally
accepted accounting principles. These differences are primarily due to the
differing treatment of foreign currency gains and losses and the
classification of short term capital gains for book and tax purposes.
(2.) Capital Share Transactions
The Fund's Restatement of 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,
-----------------------------
1996 1995
- -------------------------------------------------------------------
Shares sold 8,012,349 13,738,533
Shares redeemed (14,456,998) (11,918,556)
Shares issued in reinvestment of
distributions 2,591,072 3,996,685
- -------------------------------------------------------------------
Net increase/(decrease) (3,853,577) 5,816,662
===================================================================
(3.) Securities Transactions
Cost of purchases and proceeds from sales of investment securities (excluding
short-term securities and U.S. government securities) for the year ended
October 31, 1996, were $744,597,577 and $824,803,255, respectively.
(4.) Distribution Plan
The Fund bears some of the costs of selling its shares under a Distribution
Plan (the "Plan") adopted pursuant to Rule 12b-1 under the 1940 Act. Under
the
<PAGE>
PAGE 19
- ------------------------------------
Plan, the Fund pays its principal underwriter, Keystone Investment
Distributors Company ("KIDC"), a wholly-owned subsidiary of Keystone, amounts
that are calculated and paid daily.
Under the Plan, the Fund pays a distribution fee, which may not exceed 1.00%
of the Fund's average daily net assets. Of that amount, 0.75% is used to pay
distribution expenses and 0.25% may be used to pay service fees.
The 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.
However, after the termination of the Plan, at the discretion of the Board of
Trustees, payments to KIDC may continue as compensation for its services that
had been earned while the Plan was in effect.
KIDC intends, but is not obligated, to continue to pay distribution costs
that exceed the current annual payments from the Fund. KIDC intends to seek
full payment of such distribution costs from the Fund at such time in the
future as, and to the extent that, payment thereof by the Fund would be
within permitted limits.
Contingent deferred sales charges paid by redeeming shareholders may be paid
to KIDC.
(5.) Investment Management Agreement and Other Affiliated Transactions
Under the terms of the Investment Management Agreement between KMI and the
Fund, KMI provides investment management and administrative services to the
Fund. In return, KMI is paid a management fee, computed and paid daily, at an
amount determined by applying percentage rates starting at 0.70% and
declining as net assets increase to 0.35% per annum, to the average daily 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. In return for its services, Keystone receives an annual fee equal to
85% of the management fee received by KMI.
During the year ended October 31, 1996, the Fund paid or accrued $24,446 to
Keystone for certain accounting services. The Fund paid or accrued $1,227,881
to Keystone Investor Resource Center, Inc., a wholly-owned subsidiary of
Keystone, for services rendered as the Fund's transfer and dividend
disbursing agent.
Certain officers and/or Directors of Keystone are also officers and/or
Trustees of the Fund. Officers of Keystone and affiliated Trustees receive no
compensation directly from the Fund.
(6.) Expense Offset Arrangement
The Fund has entered into an expense offset arrangement with its custodian.
For the year ended October 31, 1996, the Fund incurred total custody fees of
$270,162 and received a credit of $44,293 pursuant to this expense offset
arrangement, resulting in a net custody expense of $225,869. The assets
deposited with the custodian under this expense offset arrangement could have
been invested in income-producing assets.
(7.) Distributions to Shareholders
A capital gain distribution of $1.04 per share was declared payable on
November 27, 1996 to shareholders of record November 25, 1996. The capital
gain distribution consists of $0.94 per share long-term and $0.10 per share
short-term. This distribution is not reflected in the accompanying financial
statements.
<PAGE>
PAGE 20
- ------------------------------------
Keystone Strategic Growth Fund (K-2)
(8.) Agreement and Plan of Acquisition
On September 6, 1996, KII entered into an Agreement and Plan of Acquisition
and Merger with First Union Corporation ("First Union"), First Union National
Bank of North Carolina ("FUNB-NC") and certain other parties pursuant to
which KII will be merged with and into a wholly-owned subsidiary of FUNB-NC.
Subject to the receipt of required regulatory and shareholder approvals, the
proposed merger is expected to take place in December 1996.
===============================================================================
FEDERAL TAX STATUS--FISCAL 1996 DISTRIBUTIONS (Unaudited)
For the fiscal year ended October 31, 1996 a capital gain distribution of
$0.36 per share and an income distribution of $0.01 per share was paid. Of
the capital gain distribution $0.19 is considered long term and $0.17 is
considered short term. The distribution is taxable to shareholders in the
year in which received by them or credited to their accounts.
In January 1997, 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 21
- ------------------------------------
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) including the schedule of investments,
as of October 31, 1996, 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, 1996 by correspondence with the custodian
and brokers. An audit also 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, 1996, 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
November 29, 1996
<PAGE>
PAGE 22
- ------------------------------------
Keystone Strategic Growth Fund (K-2)
Keystone's Services
for Shareholders
KEYSTONE AUTOMATED RESPONSE LINE (KARL)--Receive up-to-date account
information on your balance, last transaction and recent Fund distribution.
You may also process transactions such as investments, redemptions and
exchanges using a touch-tone telephone as well as receive quotes on price,
yield, and total return of your Keystone Fund. Call toll-free,
1-800-346-3858.
EASY ACCESS TO INFORMATION ON YOUR ACCOUNT--Information about your Keystone
account is available 24 hours a day through KARL. To speak with a Shareholder
Services representative about your account, call toll-free 1-800-343-2898
between 8:00 A.M. and 6:00 P.M. Eastern time. Retirement Plan investors
should call 1-800-247-4075.
ADDITIONS TO YOUR ACCOUNT--You can buy additional shares for your account at
any time, with no minimum additional investment.
REINVESTMENT OF DISTRIBUTIONS--You can compound the return on your
investment by automatically reinvesting your Fund's distributions at net
asset value with no sales charge.
EXCHANGE PRIVILEGE--You may move your money among funds in the same Keystone
family quickly and easily for a nominal service fee. KARL gives you the added
ability to move your money any time of day, any day of the week. Keystone
offers a variety of funds with different investment objectives for your
changing investment needs.
ELECTRONIC FUNDS TRANSFER (EFT)-- Referred to as the "paper-less
transaction," EFT allows you to take advantage of a variety of preauthorized
account transactions, including automatic monthly investments and systematic
monthly or quarterly withdrawals. EFT is a quick, safe and accurate way to
move money between your bank account and your Keystone account.
CHECK WRITING--Shareholders of Keystone Liquid Trust may exercise the check
writing privilege to draw from their accounts.
EASY REDEMPTION--KARL makes redemption services available to you 24 hours a
day, every day of the year. The amount you receive may be more or less than
your original account value depending on the value of fund shares at time of
redemption.
RETIREMENT PLANS--Keystone offers a full range of retirement plans,
including IRA, SEP-IRA, profit sharing, money purchase, and defined
contribution plans. For more information, please call Retirement Plan
Services, toll-free at 1-800-247-4075.
Keystone is committed to providing you with quality, responsive account
service. We will do our best to assist you and your financial adviser in
carrying out your investment plans.
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