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PROSPECTUS DECEMBER 29, 1994
Supplemented May 1, 1995
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KEYSTONE GROWTH AND INCOME FUND (S-1)
200 Berkeley Street, Boston, Massachusetts 02116-5034
Call toll free 1-800-343-2898
Keystone Growth and Income Fund (S-1) (the "Fund") (formerly named Keystone
Custodian Fund, Series S-1) is a mutual fund whose goal is the best possible
growth of capital and long-term growth of income.
The Fund invests, under normal circumstances, principally in common stocks
of generally accepted investment quality selected primarily from or similar to
those found in the Standard & Poor's 500 Index, usually with established records
of dividend payments. However, the Fund may purchase securities that are not
currently paying dividends, but show potential capital growth or future income.
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 (the "Distribution Plan") pursuant
to Rule 12b-1 under the Investment Company Act of 1940 (the "1940 Act") 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 December 29,1994, as supplemented May 1, 1995,
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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<TABLE>
<CAPTION>
<S> <C> <C> <C>
Page Page
Fee Table .......................................... 2 How to Buy Shares .............................. 9
Financial Highlights ............................... 3 Distribution Plan .............................. 10
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 .................................... 15
Pricing Shares ..................................... 6 Additional Information ......................... 16
Dividends and Taxes ................................ 7 Additional Investment Information .............. (i)
Fund Management and Expenses ....................... 7
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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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</TABLE>
<PAGE>
FEE TABLE
KEYSTONE GROWTH AND INCOME FUND (S-1)
The purpose of this 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."
<TABLE>
<S> <C>
SHAREHOLDER TRANSACTION EXPENSES
Contingent Deferred Sales Charge<F1> .......................................................... 4.00%
(as a percentage of the lesser of total cost or net asset value of shares redeemed).
Exchange Fee<F2> .............................................................................. $10.00
(per exchange)
ANNUAL FUND OPERATING EXPENSES<F3>
(as a percentage of average net assets)
Management Fee ................................................................................ 0.67%
12b-1 Fees (4) ................................................................................ 0.96%
Other Expenses ................................................................................ 0.44%
-----
Total Fund Operating Expenses ................................................................. 2.07%
=====
<CAPTION>
EXAMPLE<F5> 1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
<S> <C> <C> <C> <C>
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 ................ $61.00 $85.00 $111.00 $240.00
You would pay the following expenses on the same
investment, assuming no redemption ...................... $21.00 $65.00 $111.00 $240.00
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.
- ---------
<FN>
<F1>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.
<F2>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".)
<F3>Expense ratios are for the Fund's fiscal year ended August 31, 1994.
<F4>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").
<F5>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%.
</TABLE>
<PAGE>
FINANCIAL HIGHLIGHTS
KEYSTONE GROWTH AND INCOME FUND (S-1)
(For a share outstanding throughout the period)
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.
<TABLE>
Year Ended August 31,
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1994 1993 1992 1991 1990 1989 1988 1987 1986 1985
---- ---- ---- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
NET ASSET VALUE,
BEGINNING OF YEAR $25.42 $23.17 $25.12 $22.97 $24.82 $18.93 $27.23 $25.49 $20.34 $19.85
Income From Investment
Operations
Investment income -- net 0.16 0.11 0.15 0.19 0.22 0.32 0.46 0.18 0.46 0.55
Net gains (losses) on
securities ............. (0.35) 3.11 (0.11) 4.72 (1.29) 6.16 (6.77) 6.50 6.34 1.80
Net commissions paid on
fund share sales<F1> ... -0- -0- -0- -0- -0- -0- -0- -0- (0.23) (0.17)
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Total from investment
operations ........... (0.19) 3.22 0.04 4.91 (1.07) 6.48 (6.31) 6.68 6.57 2.18
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Less distributions from:
Investment income -- net (0.23) (0.11) (0.15) (0.26) (0.65) (0.59) (0.46) (0.42) (0.48) (0.57)
In excess of investment
income -- net<F2> .... (0.05) (0.17) (0.17) (0.25) (0.09) -0- -0- -0- -0- -0-
Realized gains on
investments -- net ... (1.74) (0.69) (1.67) (2.25) (0.04) -0- (1.53) (4.52) (0.94) (1.12)
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Total distributions . (2.02) (0.97) (1.99) (2.76) (0.78) (0.59) (1.99) (4.94) (1.42) (1.69)
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
NET ASSET VALUE, END OF
YEAR ................. $23.21 $25.42 $23.17 $25.12 $22.97 $24.82 $18.93 $27.23 $25.49 $20.34
====== ====== ====== ====== ====== ====== ====== ====== ====== ======
TOTAL RETURN<F4> ...... (0.72)% 14.31% 0.38% 24.82% (4.56)% 34.99% (24.55%) 34.80% 34.53% 11.95%
RATIOS/SUPPLEMENTAL DATA
Ratios to average net assets:
Operating and management
expenses ........... 2.07% 2.28% 2.08% 2.33% 2.35% 2.05% 1.77% 2.21% 1.12% 1.13%
Investment income --
net ................ 0.67% 0.47% 0.61% 0.93% 1.36% 2.16% 2.28% 0.88% 2.04% 2.82%
Portfolio turnover
rate<F3> ............. 73% 96% 95% 64% 47% 44% 82% 71% 106% 106%
Net assets, End of year
(thousands) ........... $208,532 $234,688 $204,004 $176,985 $154,124 $187,696 $195,375 $261,804 $117,625 $85,413
<FN>
<F1>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 the periods ended on or after June 30, 1987, that net
commissions paid under Rule 12b-1 be treated as operating expenses rather than capital charges. Accordingly, beginning with
the year ended August 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.
<F2>Effective September 1, 1993, the Fund adopted Statement of Position 93-2: "Determination, Disclosure and Financial Statement
Presentation of Income, Capital Gain and Return of Capital Distributions by Investment Companies." As a result, distribution
amounts exceeding book basis net investment income (or tax basis net income on a temporary basis) are presented as
"Distributions in excess of investment income -- net". Similarly, capital gain distributions in excess of book basis capital
gains (or tax basis capital gains on a temporary basis) are presented as "Distributions in excess of realized capital gains."
<F3>Portfolio turnover rate for periods ended on or after July 31, 1985 includes certain U.S. Government obligations.
<F4>Without contingent deferred sales charge.
</TABLE>
<PAGE>
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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 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 the best
possible growth of capital and long-term growth of income. The Fund will invest,
under normal circumstances, principally in common stocks of generally accepted
investment quality selected primarily from or similar to those found in the
Standard & Poor's 500 Index ("S&P 500"), usually with established records of
dividend payments. However, the Fund may purchase securities that are not
currently paying dividends, but show potential capital growth or future income.
In addition, the Fund will invest in quality companies with medium market
capitalizations that are smaller than those of companies typically found in the
S&P 500. For this purpose, companies with medium capitalizations are generally
those whose market capitalization falls within the capitalization range of the
Standard & Poor's MidCap 400 Index ("S&P MidCap 400") at the time of the Fund's
investment. As of February 1995, the S&P MidCap 400 included companies with a
median market capitalization of approximately $1 billion.
In pursuing its objective, the Fund may invest up to 25% of its assets in
foreign securities issued by issuers located in developed countries as well as
emerging markets 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, from time to time, by the International Bank for Reconstruction
and Development ("World Bank").
The Fund may also invest in other types of securities, including other common
stocks, debt securities convertible into common stocks or having common stock
characteristics and rights and warrants to purchase common stocks. In addition
to its other investment options, the Fund may invest in limited partnerships,
including master limited partnerships.
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 such securities 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, 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 the
holders of a majority (as defined in the 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 of the Fund's outstanding
shares. These restrictions and certain other 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 (other than U.S. government securities)
except that up to 25% of its total assets may be invested without regard to this
limit; (2) borrow money, except that the Fund may 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 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 net assets; and (3)
invest more than 25% of its total assets in securities of issuers in the same
industry.
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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Investing in the Fund involves the risk common to investing in any security,
i.e., net asset value will fluctuate in response to changes in economic
conditions and the market's perception of the underlying portfolio securities of
the Fund.
By itself, the Fund does not constitute a balanced investment plan. The Fund
stresses providing the best possible growth of capital and long-term growth of
income by investing principally in a diversified group of common stocks of
generally accepted investment quality. The yield of the Fund's portfolio
securities will fluctuate with changing market conditions. The Fund makes most
sense for those investors who can afford to ride out changes in the stock market
because it invests a substantial portion of its assets in common stocks.
Investing in medium capitalization stocks may involve greater risk than
investing in large capitalization stocks, since they can be subject to more
abrupt or erratic movements. However, they tend to involve less risk than stocks
of small capitalization companies, which may have more limited product lines,
markets or financial resources.
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
less liquid and 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 exchanges, 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 exchange controls,
political or social instability or diplomatic developments; (8) foreign
governments may withhold income on investments; and (9) 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.
Past performance should not be considered representative of results for any
future period of time. Moreover, should many shareholders change from this Fund
to some other investment at about the same time, the Fund might have to sell
portfolio securities at a time when it would be disadvantageous to do so and at
a lower price that if such securities were held to maturity.
For additional information regarding the Fund's investments in Rule 144A
securities, see "Investment Objective and Policies". For further information
about the types of investments and investment techniques available to the Fund,
including the associated risks, see "Additional Investment Information" and the
statement of additional information.
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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 is currently
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 money market instruments it purchases as follows:
short-term investments purchased with maturities of 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; and 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 and reflects fair value as determined by the Fund's 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 Fund's 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 when 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 such
distributions would be (1) declared in October, November, or December to
shareholders of record in such a month, (2) paid by the following January 31 and
(3) includable in the taxable income of shareholders for the year in which such
distributions were declared. If the Fund qualifies and if it distributes
substantially 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 by the 15th day of
January, April, July and October each year and net capital gains, if any, at
least annually.
The Fund makes distributions in additional shares of the Fund or, at the
shareholder's election (which must be made before the record date for the
distribution), in cash. Distributions are reinvested at net asset value without
any sales charge. Income dividends and net short-term gains distributions are
taxable as ordinary income and net long-term gains distributions are taxable as
capital gains regardless of how long the shareholder has held the Fund's shares.
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 Internal Revenue 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 currently pays Keystone Management a fee for its services at the
annual rate set below.
AGGREGATE NET ASSET VALUE
MANAGEMENT OF THE SHARES
FEE OF THE FUND
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.
During the fiscal year ended August 31, 1994, the Fund paid or accrued to
Keystone Management investment management and administrative services fees of
$1,453,310, which represented 0.67% of the Fund's average net assets. Of such
amount paid to Keystone Management, $1,235,313 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"), 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 Management Agreement.
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 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 ("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
August 31, 1994, the Fund paid 2.07% of its average net assets in expenses.
During the year ended August 31, 1994, the Fund paid or accrued to Keystone
Investor Resource Center, Inc. ("KIRC"), the Fund's transfer and dividend
disbursing agent, and Keystone Investments, $22,577 for the cost of certain
accounting services and $744,581 for transfer agent fees. KIRC is a wholly-owned
subsidiary of Keystone.
PORTFOLIO MANAGER
Judith A. Warners is a Keystone Vice President and Portfolio Manager. Ms.
Warners has been the Fund's Portfolio Manager since January 1995 and has more
than fourteen years' experience in equity management.
SECURITIES TRANSACTIONS
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 follow a policy of considering as a
factor the number of shares of the Fund sold by such broker-dealers. In
addition, broker-dealers may from time to time be affiliated with the Fund,
Keystone Management, Keystone, the Fund's principal underwriter or their
affiliates.
PORTFOLIO TURNOVER
The Fund's portfolio turnover rate for the fiscal years ended August 31, 1994
and 1993 were 73% and 96%, 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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Shares of the Fund may be purchased from any broker-dealer that has a selling
agreement with the Fund's principal underwriter, Keystone Investment
Distributors Company ("Principal Underwriter") (formerly named Keystone
Distributors, Inc.). 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 KIRC, 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 investments 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 contingent deferred sales charge may be imposed at rates
ranging from a maximum of 4% of amounts redeemed during the same calendar year
of purchase to 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 or on shares purchased through reinvestment of dividends. If
imposed, the contingent 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 deferred sales charge attributable to shares
purchased after January 1, 1992 is, to the extent permitted by a new rule
adopted by the NASD, paid to the Principal Underwriter. For the fiscal year
ended August 31, 1994, the Fund recovered $31,173 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 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 Keystone funds 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 purchase of the
shares of the fund exchanged into, 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; or (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 an initial
sales charge or 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) 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 its Distribution
Plan adopted on June 1, 1983 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 such annual expenditures to 1%, 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 charges 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) (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 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 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
Under-writer in excess of the Distribution Plan limitation, the Principal
Underwriter intends to seek full payment of such amounts 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 August 31, 1994, the Fund recovered $31,173 in
deferred sales charges. During the year, the Fund paid the Principal Underwriter
$2,114,143 (0.97% of the Fund's average daily net asset value during the year).
The amount paid by the Fund under its Distribution Plan, net of deferred sales
charges, was $2,082,970 (0.96% of the Fund's average daily net asset value
during the year). During the year, the Principal Underwriter retained $1,101,385
and paid commissions on new sales and shareholder service fees to dealers and
others of $1,012,758. During the year, the Principal Underwriter received
$203,083 in deferred sales charges, reducing the total advances to $503,872
(0.24% of the Fund's net asset value as of August 31, 1994).
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 .25% of the value of shares sold by such
dealer.
The Principal Underwriter also 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 Fund's Board of Trustees 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 either 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 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 also may 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. 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 where 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 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 electronic
funds transfer ("EFT") to your previously designated bank account as you direct.
If you do not specify how you wish your redemption 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 has fallen 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 writing or 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 seven funds in the Keystone Fund
Family, Keystone Precious Metals Holdings, Inc. ("KPMH"), Keystone International
Fund Inc. ("KIF"), Keystone Tax Exempt Trust ("KTET"), Keystone Liquid Trust
("KLT") or Keystone Tax Free Fund ("KTFF") 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 named funds, other than KPMH, KTET or
KTFF, after 15 days provided good payment for the purchase of Fund shares has
been collected. In order to exchange Fund shares for shares of KPMH, KTET or
KTFF, a shareholder must have held Fund shares for a period of 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 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 pension and profit-sharing plans available to investors,
including Individual Retirement Accounts ("IRAs"); Rollover IRAs; Simplified
Employee Pension Plans ("SEPs"); Tax Sheltered Annuity Plans ("TSAs"); 401(k)
Plans; Keogh Plans; Corporate Profit-Sharing Plans, Pension and Target Benefit
Plans; Money Purchase Pension Plans; and Salary-Reduction 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, 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 and Ibbotson Associates
or other industry publications.
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FUND SHARES
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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. There are no sinking fund provisions. 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. As previously mentioned, KIRC 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
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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. Examples of governmental actions would be the
imposition of currency controls, interest limitations, withholding taxes,
seizure of assets or the declaration of a moratorium. 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 purchased by the Fund must 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 are 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 will invest in them only
if the issuer meets the criteria established for commercial paper.
REPURCHASE AGREEMENTS
The Fund may enter into repurchase agreements with member banks of the Federal
Reserve System having at least $1 billion in assets, primary dealers in U.S.
government securities or other financial institutions believed by Keystone to be
credit-worthy. Such persons must be registered as U.S. government securities
dealers with an appropriate regulatory organization. Under such agreements, the
bank, primary dealer or other financial institution agrees, upon entering into
the contract, to repurchase the security at a mutually agreed upon date and
price, thereby determining the yield during the term of the agreement. This
results in a fixed rate of return insulated from market fluctuations during such
period. Under a repurchase agreement, the seller must maintain the value of the
securities subject to the agreement at not less than the repurchase price, such
value being determined on a daily basis by marking the underlying securities to
their market value. Although the securities subject to the repurchase agreement
might bear maturities exceeding a year, the Fund only intends to enter into
repurchase agreements that provide for settlement within a year and usually
within seven days. Securities subject to repurchase agreements will be held by
the Fund's custodian or in the Federal Reserve book entry system. The Fund does
not bear the risk of a decline in the value of the underlying security unless
the seller defaults under its repurchase obligation. In the event of a
bankruptcy or other default of a seller of a repurchase agreement, the Fund
could experience both delays in liquidating the underlying securities and
losses, including (1) possible declines in the value of the underlying
securities during the period while the Fund seeks to enforce its rights thereto;
(2) possible subnormal levels of income and lack of access to income during this
period; and (3) expenses of enforcing its rights. The Board of Trustees has
established procedures to evaluate the creditworthiness of each party with whom
the Fund enters into repurchase agreements by setting guidelines and standards
of review for Keystone and monitoring Keystone's actions with regard to
repurchase agreements.
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 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 Securities and Exchange Commission
has taken the position that reverse repurchase agreements are subject to the
percentage limit on borrowings imposed under the 1940 Act.
FOREIGN SECURITIES
The Fund may invest up to 25% of its assets in securities principally traded
in securities markets outside the U.S. 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, particularly emerging market country companies, 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 U.S.).
"WHEN ISSUED" SECURITIES
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. No payment or delivery is made by the Fund however,
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 for purposes
which are consistent with its investment objectives and policies and not for the
purpose of investment leverage. The Fund currently does not intend to invest
more than 5% of its assets in when issued or delayed delivery transactions.
LOANS OF SECURITIES TO BROKER-DEALERS
The Fund may lend securities to brokers or 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.
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 that 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. The Fund does not expect, however, 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
securities 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 are generally
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 Securities and Exchange Commission 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 policies on illiquid securities.
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 securities,
currency 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 Fund's 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 establish
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 related 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 accurately predict 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.
Although the Fund does not currently intend to do so, the Fund may also purchase
and sell options related to foreign currencies. The Fund does not intend to
enter into foreign currency transactions for speculation or leverage.
<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
[Keystone Logo] KEYSTONE
INVESTMENTS
Keystone Investment Distributors Company
200 Berkeley Street
Boston, Massachusetts 02116-5034
S1-P Sup. 5/95
22M [recycle logo]
KEYSTONE
Photo: Montage of Stock Certificates plus % sign.
GROWTH AND INCOME
FUND (S-1)
[Keystone Logo]
PROSPECTUS AND
APPLICATION
STATEMENT OF ADDITIONAL INFORMATION
KEYSTONE GROWTH AND INCOME FUND (S-1)
December 29, 1994
Supplemented May 1, 1995
This statement of additional information is not a prospectus, but
relates to, and should be read in conjunction with, the prospectus of Keystone
Growth and Income Fund (S-1) (the "Fund") (formerly named Keystone Custodian
Fund, Series S-1) dated December 29, 1994, as supplemented May 1, 1995. A copy
of the prospectus may be obtained from Keystone Investment Distributors Company,
the Fund's principal underwriter ("the Principal Underwriter"), 200 Berkeley
Street, Boston, Massachusetts 02116-5034 or your broker-dealer.
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TABLE OF CONTENTS
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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
The Trust Agreement 10
Investment Manager 12
Investment Adviser 14
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-12
<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 the best possible
growth of capital and long-term growth of income by investing 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 any of the following:
(1) invest more than 5% of its total assets, computed at market value,
in the securities of any one issuer, other than securities issued or guaranteed
by the United States ("U.S.") Government, its agencies or instrumentalities;
(2) invest in more than 10% of the outstanding voting securities of any
one issuer, other than securities issued or guaranteed by the U.S. Government,
its agencies or instrumentalities;
(3) invest more than 5% of the value of its total assets in companies
which have been in operation for less than three years;
(4) borrow money, except that the Fund may (a) 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 (b) enter into reverse
repurchase agreements (bank borrowings and reverse repurchase agreements, in
aggregate, shall not exceed 10% of the value of the Fund's net assets);
(5) 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");
(6) 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;
(7) invest for the primary purpose of exercising control over or
management of any issuer;
(8) make margin purchases or short sales of securities;
(9) make loans, except that the Fund may purchase money market
securities, enter into repurchase agreements, buy publicly and privately
distributed debt securities and lend limited amounts of its portfolio securities
to broker-dealers; all such investments must be consistent with the Fund's
investment objective and policies;
(10) invest more than 25% of its total assets in the securities of
issuers in any single industry, other than securities issued by banks and
savings and loan associations or securities issued or guaranteed by the U.S.
Government, its agencies or instrumentalities; and
(11) 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.
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.
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 its net
assets.
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.
Although not fundamental restrictions or policies requiring a
shareholders' vote to change, the Fund has undertaken to a state securities
authority that, so long as the state authority requires and shares of the Fund
are registered for sale in that state, the Fund will (1) 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; (2) not invest in real estate limited
partnership interests; and (3) not invest in oil, gas or other mineral leases.
Additional restrictions adopted by the Fund, which may be changed by
the Fund's Board of Trustees, stipulate 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.
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:
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 the 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. Short-term
investments that are purchased with maturities of 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 current market value. Short-term investments maturing in more than
sixty days when purchased 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 and reflects fair value as determined by the Board of
Trustees.
The Board of Trustees values the following securities at prices it
deems in good faith to be fair: (1) securities, including restricted securities,
for which complete quotations are not readily available; (2) 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 (3) other assets.
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DISTRIBUTIONS AND TAXES
- -------------------------------------------------------------------------------
The Fund ordinarily distributes its net capital gains in shares of the
Fund or, at the option of the shareholder, in cash. All shareholders may
reinvest dividends without being subject to a contingent deferred sales charge
when shares so purchased are redeemed. Shareholders who have opted prior to the
record date to receive shares with regard to capital gains and/or income
distributions will have the number of such shares determined on the basis of the
share value computed at the end of the day on the record date after adjustment
for the distribution. Net asset value is used in computing the appropriate
number of shares in a capital gains distribution and in an income distribution
reinvestment. Account statements and/or checks as appropriate will be mailed to
shareholders by the 15th of the appropriate month. 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.
The Fund's income distributions may be eligible, in whole or in part,
for the corporate 70% dividends received deduction. Distributed long-term
capital gains are taxable as such to the shareholder whether received in cash or
in additional Fund shares and regardless of the period of time Fund shares have
been held by the shareholder. Distributions designated by the Fund as capital
gains dividends are not eligible for the corporate dividends received deduction.
If the net asset value of shares was reduced below a shareholder's cost by
distribution of gains realized on sales of securities, 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 securities
profits actually realized, 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 its
net capital gains and such income as has been predetermined, to the best of the
Fund's ability, to be taxable as ordinary income. Fund shareholders will be
advised annually of the 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. 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 deferred sales charge
attributable to shares purchased after January 1, 1992 is, to the extent
permitted by a rule adopted by the National Association of Securities Dealers,
Inc. ("NASD"), is paid to the Principal Underwriter. For the fiscal year ended
August 31, 1994, the Fund recovered $31,173 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 illustrates the operation of the contingent
deferred sales charge. Assume that an investor makes a purchase payment of
$10,000 during the calendar year 1994 and on a given date in 1995 the value of
the investor's account has grown through investment performance and reinvestment
of distributions to $12,000. On such date in 1995, 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 proceeds (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 Keystone funds 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 such 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 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), 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 a
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.
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DISTRIBUTION PLAN
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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 selling 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 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%,
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)
(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 specific periods. Amounts paid or accrued to the Principal Underwriter under
(1) and (2) in the aggregate may not exceed the 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 amounts from the Fund (together
with interest 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 ("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 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 votes of the majority of both (1) the Funds 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.
For the fiscal year ended August 31, 1994, the Fund paid the Principal
Underwriter $2,114,143 under the Distribution Plan. For said year, the Principal
Underwriter retained $1,101,385 and paid commissions on new sales and service
fees to dealers and others in the amount of $1,012,758.
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.
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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THE TRUST AGREEMENT
- -------------------------------------------------------------------------------
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
"Restatement of Trust"). The Restatement of Trust restructured the Fund so that
its operation would be substantially similar to that of most other mutual funds.
The Restatement 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 Restatement 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 Restatement
of Trust.
DESCRIPTION OF SHARES
The Restatement 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 personally liable for the
obligations of the Fund. The possibility of Fund shareholders incurring
financial loss under such circumstances appears to be remote, however, because
the Restatement 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 Restatement 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 Restatement 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
unless and 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 Restatement 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 Restatement 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 and 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 shareholders' 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, will provide 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, (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.
<PAGE>
The Fund currently pays Keystone Management a fee for its services at
the annual rate set forth below:
Annual 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 state annual 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 expenses, 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 particular
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, however, is not required
to make such reimbursements to the extent it 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 will continue 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, 200 Berkeley
Street, Boston, Massachusetts 02116-5034.
Keystone Investments is a corporation privately owned by current and
former members of Keystone management and certain employees 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 Investment 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 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 August 31, 1992, the Fund paid or accrued to
Keystone Management investment management and administrative services fees of
$1,246,687, which represented 0.68% of the Fund's average net assets. Of such
amount paid to Keystone Management, $1,059,684 was paid to Keystone for its
services to the Fund.
During the year ended August 31, 1993, the Fund paid or accrued to
Keystone Management investment management and administrative services fees of
$1,510,047, which represented 0.66% of the Fund's average net assets. Of such
amount paid to Keystone Management, $1,283,540 was paid to Keystone for its
services to the Fund.
For the fiscal year ended August 31, 1994, the Fund paid or accrued to
Keystone Management investment management and administrative services fees of
$1,453,310, which represented 0.67% of the Fund's average net assets. Of such
amount paid to Keystone Management, $1,235,313 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"); President,
Chief Executive Officer and Trustee or Director of all 30 Funds in the
Keystone Investments Family of Funds; Director and Chairman of the Board,
Chief Executive Officer and Vice Chairman 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, Chairman of the Board, Chief Executive Officer
and President of Keystone Management, Inc. ("Keystone Management"),
Keystone Software Inc. ("Keystone Software"); Director and President of
Hartwell Keystone Advisers, Inc. ("Hartwell Keystone"), 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 and Vice President of
Robert Van Partners, Inc.; 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.
FREDERICK AMLING: Trustee of the Fund; Trustee or Director of all other funds in
the Keystone Investments Family of 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
funds in the Keystone Investments Family of 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 funds in the Keystone Investments Family of Funds; Director and
Chairman of the Board of Hartwell Keystone; 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 Group; and former Chief Executive Officer of
the Fund.
EDWIN D. CAMPBELL: Trustee of the Fund; Trustee or Director of all other funds
in the Keystone Investments Family of 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 funds
in the Keystone Investments Family of 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 funds in
the Keystone Investments Family of 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 funds in
the Keystone Investments Family of 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 Investments and Keystone.
F. RAY KEYSER, JR.: Trustee of the Fund; Trustee or Director of all other
funds in the Keystone Investments Family of 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 funds
in the Keystone Investments Family of 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 funds in
the Keystone Investments Family of 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 funds in
the Keystone Investments Family of Funds; Partner, Farrell, Fritz,
Caemmerer, Cleary, Barnosky & Armentano, P.C.; 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 funds in the Keystone Investments Family of 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, Robert Van Partners, Inc., and FICO; Treasurer and Director
of Keystone Management, Keystone Software, Inc., and Hartwell Keystone;
Vice President and Treasurer of KFIA; and Director of KIRC.
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.
KEVIN J. MORRISSEY: Treasurer of the Fund; Treasurer of all other funds in
the Keystone Investments Family of Funds; Vice President of Keystone
Investments; Assistant Treasurer of FICO and Keystone; and former Vice
President and Treasurer of KIRC.
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
Family of 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; Senior Vice
President and Secretary of Hartwell Keystone and Robert Van Partners, Inc.;
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.
* 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.
For the fiscal year ended August 31, 1994, none of the Directors and
officers of Keystone received any direct remuneration from the Fund. During the
same period the nonaffiliated Trustees received $24,528 in retainers and fees.
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
August 31, 1994, totalled approximately $585,930. On November 30, 1994, 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 is 200 Berkeley
Street, Boston, Massachusetts 02116-5034.
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PRINCIPAL UNDERWRITER
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Pursuant to a Principal Underwriting Agreement (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. 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.
During the fiscal years ended August 31, 1992, 1993 and 1994, the
Principal Underwriter earned commissions of $492,437, $881,464 and $203,083,
respectively, after allowing commissions and service fees of $2,341,323,
$2,151,834 and $1,012,758, 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 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 the 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
which 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.
During the fiscal years ended August 31, 1992, 1993 and 1994, the Fund
paid approximately $808,373, $830,929 and $345,941 respectively, in brokerage
fees. Of the $345,941 paid in brokerage fees for fiscal year 1994, $11,674 was
paid to Kokusai Securities, Inc.
In no instance are portfolio securities 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.
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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 returns of the Fund for the five and ten year
periods ending August 31, 1994 was 35.70% and 180.58%, respectively. The
compounded average annual rates of return for the one, five and ten year periods
ended August 31, 1994 were (3.46)% (including contingent deferred sales charge),
6.30% and 10.87%, 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
- -------------------------------------------------------------------------------
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 U.S. 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, One Boston Place, Boston, Massachusetts 02108,
Certified Public Accountants, are the Fund's independent auditors.
KIRC, located at 101 Main Street, Cambridge, Massachusetts 02142-1519,
is a wholly-owned subsidiary of Keystone, and acts as transfer agent and
dividend disbursing agent for the Fund.
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.
As of November 30, 1994, Merrill Lynch Pierce Fenner & Smith, Attn:
Book Entry, 4800 Deer Lake Dr., E 3rd FL, Jacksonville, FL 32246-6484 owned of
record 5.013% of the Fund's outstanding shares.
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 & Poor's 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 consid-erable 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 pershare
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 cyclicality. 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 Investors Service, Inc. ("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.
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CORPORATE BOND RATINGS
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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 *I903*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.
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LIMITED PARTNERSHIPS
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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.
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MONEY MARKET INSTRUMENTS
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The Fund's investments in commercial paper are limited to those rated
A-1 by S&P, Prime-1 by Moody's 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 S&P 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 InterAmerican 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 U.S. banks, including their branches abroad, which are members
of the Federal Reserve System or the Federal Deposit Insurance Corporation, and
of U.S. branches of foreign banks, each of which have total deposits at the time
of purchase in excess of $1 billion 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. Athough 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.
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OPTIONS TRANSACTIONS
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The Fund is authorized to write (i.e., sell) covered call options and
to purchase call options to close out covered call options previously written. A
call option obligates a writer to sell, and gives a purchaser the right to buy,
the underlying security at the stated exercise price at any time until the
stated expiration date.
The Fund will only write call options which are covered, which means
that the Fund will own the underlying security (or other securities, such as
convertible securities, which are acceptable for escrow) when it writes the call
option and until the Fund's obligation to sell the underlying security is
extinguished by exercise or expiration of the call option or the purchase of a
call option covering the same underlying security and having the same exercise
price and expiration date. The Fund will receive a premium for writing a call
option, but will give up, until the expiration date, the opportunity to profit
from an increase in the underlying security's price above the exercise price.
The Fund will retain the risk of loss from a decrease in the price of the
underlying security. The writing of covered call options is a conservative
investment technique believed to involve relatively little risk (in contrast to
the writing of naked options which the Fund will not do) but capable of
enhancing the Fund's total return.
The premium received by the Fund for writing a covered call option will
be recorded as a liability in the Fund's statement of assets and liabilities.
This liability will be adjusted daily to the option's current market value,
which will be the latest sale price at the time as of which the net asset value
per share of the Fund is computed (the close of the New York Stock Exchange),
or, in the absence of such sale, at the latest bid quotation. The liability will
be extinguished upon expiration of the option, the purchase of an identical
option in a closing transaction or delivery of the underlying security upon
exercise of the option.
Many options are traded on registered securities exchanges. Options
traded on such exchanges are issued by the Options Clearing Corporation, a
clearing corporation which assumes responsibility for the completion of options
transactions.
The Fund will purchase call options only to close out a covered call
option it has written. When it appears that a covered call option written by the
Fund is likely to be exercised, the Fund may consider it appropriate to avoid
having to sell the underlying security. Or, the Fund may wish to extinguish a
covered call option which it has written in order to be free to sell the
underlying security to realize a profit on the previously written call option or
to write another covered call option on the underlying security. In all such
instances, the Fund can close out the previously written call option by
purchasing a call option on the same underlying security with the same exercise
price and expiration date. (The Fund may, under certain circumstances, also be
able to transfer a previously written call option.) The Fund will realize a
short-term capital gain if the amount paid to purchase the call option plus
transaction costs is less than the premium received for writing the covered call
option. The Fund will realize a short-term capital loss if the amount paid to
purchase the call option plus transaction costs is greater than the premium
received for writing the covered call option.
A previously written call option can be closed out by purchasing an
identical call option only in a secondary market for the call option. 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.
If a substantial number of the call options written by the Fund are
exercised, the Fund's rate of portfolio turnover may exceed historical levels.
This would result in higher transaction costs, including brokerage commissions.
The Fund will pay brokerage commissions in connection with the writing of
covered call options and the purchase of call options to close out previously
written options. Such brokerage commissions are normally higher than those
applicable to purchases and sales of portfolio securities.
In the past the Fund has qualified for, and elected to receive, the
special tax treatment afforded regulated investment companies under Subchapter M
of the Internal Revenue Code. Although the Fund intends to continue to qualify
for such tax treatment, in order to do so it must, among other things, derive
less than 30% of its gross income from gains from the sale or other disposition
of securities held for less than three months. Because of this, the Fund may be
restricted in the writing of call options where the underlying securities have
been held less than three months, in the writing of covered call options which
expire in less than three months, and in effecting closing purchases with
respect to options which were written less than three months earlier. As a
result, the Fund may elect to forego otherwise favorable investment
opportunities and may elect to avoid or delay effecting closing purchases or
selling portfolio securities, with the risk that a potential loss may be
increased or a potential gain may be reduced or turned into a loss.
Under the Internal Revenue Code of 1954, as amended, gain or loss
attributable to a closing transaction and premiums received by the Fund for
writing a covered call option which is not exercised may constitute short-term
capital gain or loss. Under provisions of the Tax Reform Act of 1986, effective
for taxable years beginning after October 22, 1986, a gain on an option
transaction which qualifies as a "designated hedge" transaction under Treasury
regulations may be offset by realized or unrealized losses on such designated
transaction. The netting of gain against such losses could result in a reduction
in gross income from options transactions for purposes of the 30 percent test.
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 market or 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 equivalent 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
currency and other financial 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 determinaion 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
indexes 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. Tresury 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 CONTRACTS
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 on 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 commodity futures contracts
is analagous 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 or 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 AND 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 the90% 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 rate 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 rate 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 only for
hedging purposes, and not for speculation. The Fund may enter into 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 ontracts 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
and French francs 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 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
analagous 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 echange 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 a 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 recently 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 control 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 trader 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 buyer 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; Philadephia 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 published 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
Chicago 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 underlyng 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 chanqes 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 stock index 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>
SCHEDULE OF INVESTMENTS--August 31, 1994
<TABLE>
<CAPTION>
Number Market
of Shares Value
<S> <C> <C>
COMMON STOCKS (89.9%)
ADVERTISING AND PUBLISHING (2.8%)
Capital Cities/ABC, Inc. 45,000 $ 3,774,375
Dun & Bradstreet Corp. 17,300 996,913
Time Warner, Inc. 30,000 1,143,750
5,915,038
AEROSPACE (1.8%)
Boeing Co. 40,000 1,820,000
Rockwell International Corp. 20,000 722,500
United Technologies Corp. 19,170 1,219,691
3,762,191
AMUSEMENTS (1.7%)
Disney (Walt) Co. (The) 63,700 2,619,663
Hilton Hotels Corp. 15,000 883,125
3,502,788
AUTOMOTIVE (1.7%)
Ford Motor Co. 76,200 2,228,850
General Motors Corp. 24,810 1,246,703
3,475,553
CAPITAL GOODS (8.8%)
Caterpillar, Inc. 32,020 3,698,310
Deere & Co. 18,000 1,336,500
Emerson Electric Co. 13,500 838,687
Fluor Corp. 35,000 1,855,000
Foster Wheeler Corp. 65,000 2,648,750
General Electric Co. 158,200 7,870,450
18,247,697
CHEMICALS (6.8%)
Dow Chemical Co. 23,300 1,750,413
DuPont (E.I) de Nemours & Co. 59,700 3,611,850
Monsanto Co. 47,500 3,924,687
PPG Industries, Inc. 30,000 1,248,750
Rohm and Haas Co. 25,000 1,556,250
Union Carbide Corp. 60,000 2,062,500
14,154,450
CONSUMER GOODS (3.1%)
Eastman Kodak Co. 40,000 $ 1,990,000
Gillette Co. 30,000 2,171,250
Maytag Corp. 75,000 1,368,750
Procter & Gamble Co. 16,500 1,004,438
6,534,438
DIVERSIFIED COMPANIES (3.3%)
Allied-Signal, Inc. 40,000 1,495,000
ITT Corp. 10,900 893,800
Minnesota Mining & Mfg. Co. 37,200 2,050,650
Tenneco, Inc. 27,100 1,334,675
TRW, Inc. 14,000 1,050,000
6,824,125
DRUGS (7.7%)
American Home Products Corp. 45,000 2,671,875
Columbia/HCA Healthcare Corp. 60,000 2,550,000
Community Psychiatric Centers 110,200 1,542,800
Genentech, Inc. (a) 45,000 2,311,875
Johnson & Johnson 75,000 3,759,375
Merck & Co., Inc. 35,500 1,211,437
Pharmacia (a) 120,000 2,025,000
16,072,362
ELECTRONICS PRODUCTS (3.0%)
Intel Corp. 30,000 1,968,750
Motorola, Inc. 58,800 3,175,200
Texas Instruments, Inc. 14,200 1,105,825
6,249,775
FINANCE (8.0%)
American Express Co. 32,000 900,000
Banc One Corp. 127,000 4,413,250
Bankers Trust New York Corp. 35,000 2,576,875
Chase Manhattan Corp. 85,000 3,208,750
Federal National Mortgage Association 26,240 2,332,080
Morgan (J.P.) & Co., Inc. 50,200 3,306,925
16,737,880
</TABLE>
See Notes to Schedule of Investments. (continued on next page)
<PAGE>
Keystone S-1 Blue Chip Stock Fund
(Keystone Custodian Fund, Series S-1)
SCHEDULE OF INVESTMENTS--August 31, 1994
<TABLE>
<CAPTION>
Number Market
of Shares Value
<S> <C> <C>
FOODS (2.4%)
Coca-Cola Co. 63,000 $ 2,898,000
CPC International, Inc. 40,600 2,172,100
5,070,100
INSURANCE (0.9%)
American International Group, Inc. 20,250 1,903,500
METALS AND MINING (0.6%)
Aluminum Co. of America 15,000 1,260,000
NATURAL GAS (1.6%)
Anadarko Petroleum Corp. 50,000 2,343,750
Sonat, Inc. 30,000 915,000
3,258,750
OFFICE AND BUSINESS EQUIPMENT (3.0%)
Hewlett-Packard Co. 26,990 2,425,726
International Business Machines, Inc. 35,000 2,401,875
Xerox Corp. 14,000 1,499,750
6,327,351
OIL (12.9%)
Amoco Corp. 67,120 3,884,570
Atlantic Richfield Co. 12,300 1,317,638
Chevron Corp. 62,400 2,644,200
Exxon Corp. 70,000 4,165,000
Mobil Corp. 52,100 4,389,425
Royal Dutch Petroleum Corp. 52,500 5,912,812
Unocal Corp. 163,000 4,665,875
26,979,520
OIL SERVICES (2.1%)
Halliburton Co. 54,400 1,645,600
Schlumberger, Ltd. 48,805 2,781,885
4,427,485
PAPER AND PACKAGING (1.3%)
Georgia-Pacific Corp. 10,040 746,725
International Paper Co. 15,500 1,195,437
Weyerhaeuser Co. 17,300 793,638
2,735,800
RESTAURANTS (0.9%)
McDonald's Corp. 66,572 $ 1,880,659
RETAIL (4.5%)
J.C. Penney Co., Inc. 62,000 3,262,750
Wal-Mart Stores, Inc. 245,000 6,033,125
9,295,875
SERVICES (1.0%)
Browning-Ferris Industries, Inc. 65,000 2,055,625
TELECOMMUNICATIONS (6.7%)
Airtouch Communications (a) 58,500 1,652,625
American Telephone & Telegraph Co. 80,200 4,390,950
Bell South Corp. 44,000 2,612,500
GTE Corp. 61,400 1,949,450
Pacific Telesis Group 58,500 1,930,500
Sprint Corp. 35,000 1,386,875
13,922,900
TRANSPORTATION (1.9%)
CSX Corp. 52,000 4,017,000
UTILITIES (1.4%)
American Electric Power, Inc. 18,800 592,200
Central & South West Corp. 21,000 472,500
Consolidated Edison Co. of New York, Inc. 20,000 547,500
Dominion Resources, Inc. 15,700 590,712
Duke Power Co. 17,000 658,750
Texas Utilities Co. 5 168
2,861,830
TOTAL COMMON STOCKS
(Cost--$161,246,735) 187,472,692
CONVERTIBLE PREFERRED STOCK (0.5%)
TRANSPORTATION (0.5%)
Burlington Northern, Inc., Series A
(Cost--$810,000) 16,200 992,250
</TABLE>
See Notes to Schedule of Investments
<PAGE>
SCHEDULE OF INVESTMENTS--August 31, 1994
<TABLE>
<CAPTION>
Maturity Par Market
Rate Date Value Value
<S> <C> <C> <C> <C>
CONVERTIBLE BOND (0.77%)
BUILDING MATERIALS (0.7%)
Empresas ICA Sociedad Controladora, S.A. de C.V.
Conv. (Subord.) Deb.
(Cost $1,400,000) 5.000% 03/15/04 $ 1,400,000 $ 1,463,000
SHORT TERM INVESTMENTS (7.6%)
CERTIFICATE OF DEPOSIT (0.0%)
State Street Bank & Trust Co.
(Cost $23,400) 3.250 10/31/94 23,400 23,400
Maturity
Value
REPURCHASE AGREEMENT (7.6%)
Sanwa Bank, purchased 8/31/94 (Collateralized by
$12,000,000 FNMA #190699, 7.0%, 3/01/2009 and
$5,425,000 GNMA #8348, 6.0%, 12/20/23) (Cost
$15,927,000) 4.850 09/01/94 $15,929,146 15,927,000
TOTAL SHORT TERM INVESTMENTS (Cost--$15,950,400) 15,950,400
TOTAL INVESTMENTS (Cost--$179,407,135)(b) 205,878,342
OTHER ASSETS AND LIABILITIES--net (1.3%) 2,653,803
Net Assets (100%) $208,532,145
</TABLE>
NOTES TO SCHEDULE OF INVESTMENTS
(a) Non-income-producing security.
(b) The cost of investments for federal tax purposes amounted to
$179,495,945.
Gross unrealized appreciation and depreciation of investments based on
identified cost, at August 31, 1994 are as follows:
Gross unrealized appreciation................................. $27,995,860
Gross unrealized depreciation ............................... (1,613,463)
Net unrealized appreciation .................................. $26,382,397
See Notes to Financial Statements.
<PAGE>
Keystone S-1 Blue Chip Stock Fund
(Keystone Custodian Fund, Series S-1)
FINANCIAL HIGHLIGHTS
(For a share outstanding throughout the year)
<TABLE>
<CAPTION>
Year Ended August 31,
1994 1993 1992 1991 1990 1989 1988 1987 1986 1985
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net asset value:
Beginning of year $25.42 $23.17 $25.12 $22.97 $24.82 $18.93 $27.23 $25.49 $20.34 $19.85
Income from investment operations
Investment income--net 0.16 0.11 0.15 0.19 0.22 0.32 0.46 0.18 0.46 0.55
Net gains (losses) on securities (0.35) 3.11 (0.11) 4.72 (1.29) 6.16 (6.77) 6.50 6.34 1.80
Net commissions paid on fund share
sales (a) -0- -0- -0- -0- -0- -0- -0- -0- (0.23) (0.17)
Total from investment operations (0.19) 3.22 0.04 4.91 (1.07) 6.48 (6.31) 6.68 6.57 2.18
Less distributions from:
Investment income--net (0.23) (0.11) (0.15) (0.26) (0.65) (0.59) (0.46) (0.42) (0.48) (0.57)
In excess of investment
income--net (b) (0.05) (0.17) (0.17) (0.25) (0.09) -0- -0- -0- -0- -0-
Realized gains on investments--net (1.74) (0.69) (1.67) (2.25) (0.04) -0- (1.53) (4.52) (0.94) (1.12)
Total distributions (2.02) (0.97) (1.99) (2.76) (0.78) (0.59) (1.99) (4.94) (1.42) (1.69)
Net asset value:
End of year $23.21 $25.42 $23.17 $25.12 $22.97 $24.82 $18.93 $27.23 $25.49 $20.34
Total return (d) (0.72%) 14.31 0.38% 24.82% (4.56%) 34.99% (24.55%) 34.80% 34.53% 11.95%
Ratios/supplemental data
Ratios to average net assets:
Operating and management expenses 2.07% 2.28% 2.08% 2.33% 2.35% 2.05% 1.77% 2.21% 1.12% 1.13%
Investment income--net 0.67% 0.47% 0.61% 0.93% 1.36% 2.16% 2.28% 0.88% 2.04% 2.82%
Portfolio turnover rate (c) 73% 96% 95% 64% 47% 44% 82% 71% 106% 106
Net assets, end of year
(thousands) $208,532 $234,688 $204,004 $176,985 $154,124 $187,696 $195,375 $261,804 $117,625 $85,413
</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 the periods ended on or after June 30, 1987, that
net commissions paid under Rule 12b-1 be treated as operating expenses rather
than capital charges. Accordingly, beginning with the year ended August 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 net investment
income.
(b) Effective September 1, 1993, the Fund adopted Statement of Position 93-2:
"Determination, Disclosure, and Financial Statement Presentation of Income
Capital Gain and Return of Capital Distributions by Investment Companies". As
a result, distribution amounts exceeding book basis net investment income (or
tax basis net income on a temporary basis) are presented as "Distributions in
excess of investment income--net". Similarly, capital gain distributions in
excess of book basis capital gains (or tax basis capital gains on a temporary
basis) are presented as "Distributions in excess of realized capital gains".
(c) Portfolio turnover rate for periods ended on or after July 31, 1985
includes certain U.S. Government obligations.
(d) Without contingent deferred sales charge (CDSC).
See Notes to Financial Statements.
<PAGE>
STATEMENT OF ASSETS AND LIABILITIES
<TABLE>
<CAPTION>
August 31, 1994
<S> <C>
Assets:
Investments at market value
(identified cost--$179,407,135)(Note 1) $205,878,342
Cash 87
Receivable for:
Investments sold 2,777,316
Fund shares sold 259,163
Dividends and interest 776,372
Prepaid expenses 2,337
Other assets 19,493
Total assets 209,713,110
Liabilities:
Payable for:
Investments purchased 756,325
Fund shares redeemed 367,775
Other accrued expenses 56,865
Total liabilities 1,180,965
Net assets $208,532,145
Net assets represented by: (Note 1)
Paid-in capital $170,518,152
Undistributed investment income--net 1,181,883
Accumulated realized gains (losses) on investment
transactions--net 10,360,903
Net unrealized appreciation on investments 26,471,207
Total net assets applicable to outstanding shares
of beneficial interest ($23.21 a share on
8,985,634 shares outstanding) (Note 2) $208,532,145
</TABLE>
STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
Year Ended August 31, 1994
<S> <C> <C>
Investment income: (Note 1)
Dividends (net of withholding
taxes of $18,931) $ 5,207,773
Interest 771,628
Total income 5,979,401
Expenses (Notes 2 and 4):
Management fee $ 1,453,310
Transfer Agent fees 744,581
Accounting, auditing and legal 48,216
Custodian fees 75,795
Printing 24,066
Trustees' fees and expenses 24,528
Distribution Plan expenses 2,082,970
Registration fees 24,328
Miscellaneous expenses 35,694
Total expenses 4,513,488
Investment income--net (Note 1) 1,465,913
Realized and unrealized gain
(loss) on investments (Note 3):
Realized gain on investments sold:
Proceeds from sales 173,500,034
Cost of investments sold 158,588,318
Realized gain on
investments--net 14,911,716
Unrealized appreciation
(depreciation) on investments--net:
Beginning of year 44,735,792
End of year 26,471,207
Increase (decrease) in unrealized
appreciation or depreciation--net (18,264,585)
Net loss on investments (3,352,869)
Net decrease in net assets
resulting from operations ($ 1,886,956)
</TABLE>
See Notes to Financial Statements.
<PAGE>
Keystone S-1 Blue Chip Stock Fund
(Keystone Custodian Fund, Series S-1)
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
Year Ended August 31,
1994 1993
<S> <C> <C>
Operations:
Investment income--net (Note 1) $ 1,465,913 $ 1,057,831
Realized gain on investments--net (Note 3) 14,911,716 11,684,505
Increase (decrease) in unrealized appreciation or depreciation--net (18,264,585) 17,714,546
Net increase (decrease) in net assets resulting from operations (1,886,956) 30,456,882
Net equalization charges and credits (Note 1) -0- 125
Distributions to shareholders from (Notes 1 and 5):
Investment income--net (2,132,697) (1,156,506)
In excess of investment income--net (427,099) (1,489,580)
Realized gain on investments--net (15,848,242) (6,615,883)
Total distributions to shareholders (18,408,038) (9,261,969)
Capital share transactions (Note 2):
Proceeds from shares sold 28,162,081 55,774,097
Payments for shares redeemed (49,724,383) (54,117,758)
Net asset value of shares issued in reinvestment of distributions from:
Investment income--net and in excess of investment income--net 2,022,738 2,098,432
Realized gains on investments--net 13,678,937 5,734,149
Net increase (decrease) in net assets resulting from capital share
transactions (5,860,627) 9,488,920
Total increase (decrease) in net assets (26,155,621) 30,683,958
Net assets:
Beginning of year 234,687,766 204,003,808
End of year [including undistributed investment income--net as follows:
August 31, 1994--$1,181,883 and August 31, 1993--$666,785] (Note 1) $208,532,145 $234,687,766
</TABLE>
See Notes to Financial Statements.
<PAGE>
NOTES TO FINANCIAL STATEMENTS
(1.) Significant Accounting Policies
Keystone Custodian Fund, Series S-1 Blue Chip Stock Fund (the "Fund") is a
common law trust for which Keystone Management, Inc. ("KMI") is the
Investment Manager and 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 Group, Inc. ("KGI"), a
Delaware corporation. KGI is privately owned by an investor group consisting
of members of current management of Keystone. 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: (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. Short-term 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.
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.
<PAGE>
Keystone S-1 Blue Chip Stock Fund
(Keystone Custodian Fund, Series S-1)
Foreign currency amounts are translated into United States dollars as
follows: market value of investments, assets and liabilities at the daily
rate of exchange, purchase and sales of investment, 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 on 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 original issue 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 excise tax liability by making the required
distributions under the Internal Revenue Code.
D. For the year ended August 31, 1993, the Fund used the accounting practice
known as equalization by which a portion of the proceeds from the sales and
the cost of redemptions of capital shares (equivalent on a per share basis to
the amount of undistributed net investment income on the date of the
transactions) was credited or charged to undistributed net investment income.
As a result, undistributed net investment income per share was not affected
by sales or redemptions of shares. Effective September 1, 1993, the Fund
discontinued equalization accounting.
E. 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 the 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.
<PAGE>
F. The Fund distributes net investment income to shareholders quarterly and
net capital gains, if any, annually. Distributions are determined in
accordance with income tax regulations. Distributions from taxable net
investment income and net capital gains can exceed book basis net investment
income and net capital gains. Effective September 1, 1993, the Fund adopted
Statement of Position 93-2: Determination, Disclosure and Financial Statement
Presentation of Income, Capital Gain and Return of Capital Distributions by
Investment Companies. As a result of this statement, the Fund changed the
Financial statement classification of distributions to shareholders to better
disclose the differences between financial statement amounts and
distributions determined in accordance with income tax regulation.
Accordingly, the following reclassifications have been made as of August 31,
1993: a decrease in paid-in capital of $10,194,744 and increases in
undistributed investment income--net and accumulated realized gains (losses)
on investment transactions of $666,785 and $9,527,959, respectively, to
reflect adoption of the statement. Differences between book basis investment
income--net available for distribution and tax basis investment income--net
available for distribution are primarily attributable to differences in the
treatment of 12b-1 Distribution Plan charges.
(2.) Capital Share Transactions
The Fund's agreement authorizes the issuance of an unlimited number of shares
of beneficial interest with a par value of $1.00. Transactions in shares of
the Fund were as follows:
<TABLE>
<CAPTION>
Year Ended August 31
1994 1993
<S> <C> <C>
Shares sold 1,188,692 2,360,300
Shares redeemed (2,108,660) (2,267,254)
Shares issued in
reinvestment of
distributions from:
investment income--net
and in excess of
investment income--net 86,169 88,250
Realized gains--net 587,079 247,695
Net increase
(decrease) (246,720) 428,991
</TABLE>
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 Distributors, Inc.
("KDI"), the principal underwriter and a wholly-owned subsidiary of Keystone,
amounts which in total may not exceed the Distribution Plan maximum.
In connection with the Distribution Plan and subject to the limitations
discussed below, Fund shares are offered for sale at net asset value without
any initial sales charge. From the amounts received by KDI in connection with
the Distribution Plan, and subject to the limitations discussed below, KDI
generally pays brokers or others a commission equal to 4% 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 4.0%, applied to the lesser of the net
asset value of shares redeemed or the total cost of such shares.
Since July 8, 1992, contingent deferred sales charges applicable to shares of
the Fund issued after January 1, 1992 have, to the extent permitted by NASD
rule, been paid to KDI rather than to the Fund.
<PAGE>
Keystone S-1 Blue Chip Stock Fund
(Keystone Custodian Fund, Series S-1)
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% of
which 0.75% may be used to pay such distribution expenses and 0.25% may be
used to pay shareholder service fees. The new 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 12b-1 Distribution
Plan, plus interest at the prime rate plus 1% on unpaid amounts thereof (less
any contingent deferred sales charges paid by the shareholders to KDI).
The Fund has operated its Distribution Plan in accordance with both the Plan
and the NASD Rule since July 8, 1992, except that until July 7, 1993, maximum
annual payments with respect to Net Asset Value as represented by shares sold
prior to January 1, 1992 remained at the then current rate of 0.3125%
quarterly (approximately 1.25% annually).
KDI intends, but is not obligated, to continue to pay or accrue distribution
charges which exceed current annual payments permitted to be received by KDI
from the Fund. KDI 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. KDI currently intends to seek payment
of interest only on such charges paid or accrued by KDI since January 1,
1992.
During the year ended August 31, 1994, the Fund recovered $31,173 in deferred
sales charges. During the year, the Fund paid KDI $2,114,143 under the
Distribution Plan under which $654,483 represented repayments of amounts
("advances") paid by KDI during the year or in previous years in excess of
amounts received by KDI under the Distribution Plan. The amount paid by the
Fund under its Distribution Plan, net of deferred sales charges, was
$2,082,970 (.96% of the Fund's average daily net asset value during the
year). During the year, KDI retained $1,101,385 and paid commissions on new
sales and shareholder service fees to dealers and others of $1,012,758.
During the year, KDI received $203,083 in deferred sales charges, reducing
the total advances to $503,872 (.24% of the Fund's daily net asset value on
August 31, 1994).
(3.) Securities Transactions
For the year ended August 31, 1994, purchases and sales of investment
securities were as follows:
<TABLE>
<CAPTION>
Cost of Proceeds
Purchases From Sales
<S> <C> <C>
Portfolio securities $ 149,368,444 $ 173,500,034
Short-term investments 3,356,908,583 3,354,601,582
$3,506,277,027 $3,528,101,616
</TABLE>
<PAGE>
(4.) Investment Management and Transactions with Affiliates
Under the terms of the Investment Management Agreement between KMI and the
Fund, dated December 29, 1989, 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 calculated by applying
percentage rates, starting at 0.70% and declining 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, dated December 30, 1989, 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 August 31, 1994, the
Fund paid or accrued to KMI investment management and administrative services
fees of $1,453,310 which represented 0.67% of the Fund's average daily net
asset value during the year. Of such amount paid to KMI, $1,235,313 was paid
to Keystone for its services to the Fund.
During the year ended August 31, 1994, the Fund paid or accrued to KIRC and
KGI $22,577 as reimbursement for certain accounting services and $744,581 for
transfer agent fees.
(5.) Distributions to Shareholders
A distribution of net investment income of $0.07 per share was declared
payable by October 6, 1994 to shareholders of record September 23, 1994. This
distribution is not reflected in the accompanying financial statements.
<PAGE>
Keystone S-1 Blue Chip Stock Fund
(Keystone Custodian Fund, Series S-1)
INDEPENDENT AUDITORS' REPORT
The Trustees and Shareholders
Keystone Custodian Fund, Series S-1
We have audited the accompanying statement of assets and liabilities of
Keystone Custodian Fund, Series S-1, including the schedule of investments,
as of August 31, 1994 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 August 31, 1994 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 Custodian Fund, Series S-1, as of August 31, 1994, 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
October 7, 1994
