PROSPECTUS SEPTEMBER 30, 1996
KEYSTONE SMALL COMPANY GROWTH FUND (S-4)
200 BERKELEY STREET, BOSTON, MASSACHUSETTS 02116-5034
CALL TOLL FREE 1-800-343-2898
Keystone Small Company Growth Fund (S-4) (the "Fund") is a mutual fund
whose goal is long-term growth of capital.
The Fund invests, under normal circumstances, at least 65% of its total
assets in equity securities of companies with small market capitalizations.
Your purchase payment is fully invested. There is no sales charge when
you buy the Fund's shares. The Fund may impose a deferred sales charge, which
declines from 4% to 1%, if you redeem your shares within four years of purchase.
The Fund has adopted a Distribution Plan pursuant to Rule 12b-1 under
the Investment Company Act of 1940 under which it bears some of the costs of
selling its shares to the public.
This prospectus sets forth concisely the information about the Fund
that you should know before investing. Please read it and retain it for future
reference.
Additional information about the Fund is contained in a statement of
additional information dated September 30, 1996, which has been filed with the
Securities and Exchange Commission and is incorporated by reference into this
prospectus. For a free copy, or for other information about the Fund, write to
the address or call the telephone number listed above.
Shares of the Fund are not deposits or obligations of, or guaranteed or
endorsed by, any bank, and shares are not federally insured by the Federal
Deposit Insurance Corporation, the Federal Reserve Board, or any other agency.
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.
Table of Contents
Page
Fee Table............................................................. 2
Financial Highlights.................................................. 3
The Fund.............................................................. 4
Investment Objective and Policies..................................... 4
Investment Restrictions............................................... 5
Risk Factors.......................................................... 5
Pricing Shares........................................................ 6
Dividends and Taxes .................................................. 7
Fund Management and Expenses.......................................... 7
How to Buy Shares..................................................... 9
Distribution Plan..................................................... 11
How to Redeem Shares.................................................. 13
Shareholder Services.................................................. 14
Performance Data...................................................... 16
Fund Shares........................................................... 16
Additional Information................................................ 16
Additional Investment Information..................................... (i)
<PAGE>
FEE TABLE
Keystone Small Company Growth Fund (S-4)
The purpose of the fee table is to assist investors in understanding
the costs and expenses that an investor in the Fund will bear directly or
indirectly. For more complete descriptions of the various costs and expenses,
see the following sections of this prospectus: "Fund Management and Expenses";
"How to Buy Shares"; "Distribution Plan"; and "Shareholder Services."
Shareholder Transaction Expenses
Deferred Sales Load[1]......................................... 4.00%
(as a percentage of the lesser of original purchase
price or redemption proceeds, as applicable)
Exchange Fee[2]................................................ $10.00
(per exchange)
Annual Fund Operating Expenses[3]
(as a percentage of average net assets)
Management Fee.................................................. 0.46%
12b-1 Fees[4]................................................... 1.00%
Other Expenses.................................................. 0.27%
----
Total Fund Operating Expenses................................... 1.73%
====
<TABLE>
<CAPTION>
Example[5] 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:........................................... $58.00 $74.00 $94.00 $204.00
You would pay the following expenses on
the same investment, assuming no
redemption:................................................... $18.00 $54.00 $94.00 $204.00
</TABLE>
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.
[1] The deferred sales charge declines from 4% to 1% of amounts redeemed
within four calendar years after purchase. No deferred sales charge is
imposed thereafter.
[2] There is no fee for exchange orders received by the Fund directly from
a shareholder over the Keystone Automated Response Line ("KARL"). (For
a description of KARL, see "Shareholder Services.")
[3] Expense ratios are for the Fund's fiscal year ended May 31, 1996. Total
Fund Operating Expenses include indirectly paid expenses.
[4] Long-term shareholders may pay more than the economic equivalent of the
maximum front-end sales charges permitted by rules adopted by the
National Association of Securities Dealers, Inc. ("NASD").
[5] The Securities and Exchange Commission requires use of a 5% annual
return figure for purposes of this example. Actual return for the Fund
may be greater or less than 5%.
<PAGE>
FINANCIAL HIGHLIGHTS
KEYSTONE SMALL COMPANY GROWTH FUND (S-4)
(For a share outstanding throughout the year)
The following table contains important financial information relating
to the Fund and has been audited by KPMG Peat Marwick LLP, the Fund's
independent auditors. The table appears in the Fund's Annual Report and should
be read in conjunction with the Fund's financial statements and related notes,
which also appear, together with the independent auditors' report, in the Fund's
Annual Report. The Fund's financial statements, related notes, and independent
auditors' report are included in the statement of additional information.
Additional information about the Fund's performance is contained in its Annual
Report, which will be made available upon request and without charge.
<TABLE>
<CAPTION>
Year Ended May 31,
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1996 1995 1994 1993(a) 1992(a) 1991(a) 1990(a) 1989(a) 1988 1987
---- ---- ---- ---- ---- ---- ---- ---- ---- ----
Net asset value $8.62 $7.64 $7.95 $7.61 $7.17 $6.24 $5.66 $4.48 $7.80 $7.60
beginning of year
Income from investment
operations
Net investment income (0.13) (0.07) (0.12) (0.12) (0.08) (0.04) 0.00 0.02 0.00 0.00
(loss)
Net realized and 2.87 1.68 0.63 1.82 0.98 1.17 0.63 1.20 (1.64) 1.11
unrealized gains
(losses) on
investments
Net commissions paid 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 (0.02)
on fund share sales (b)
Total from investment 2.74 1.61 0.51 1.70 0.90 1.13 0.63 1.22 (1.64) 1.09
operations
Less distributions from
Net investment income 0.00 0.00 0.00 0.00 0.00 0.00 (0.05) (0.01) 0.00 (0.01)
Net realized gains (1.01) (0.63) (0.82) (1.36) (0.46) (0.20) 0.00 (0.03) (1.68) (o.88)
Total distributions (1.01) (0.63) (0.82) (1.36) (0.46) (0.20) (0.05) (0.04) (1.68) (0.89)
Net asset value end of $10.35 $8.62 $7.64 $7.95 $7.61 $7.17 $6.24 $5.66 $4.48 $7.80
year
Total return (c) 33.03% 23.58% 6.84% 28.76% 13.45% 19.42% 11.24% 27.45% (22.39%) 16.24%
Ratios/supplemental data
Ratios to average net
assets:
Total expenses 1.73%(d) 1.78% 1.73% 2.04% 1.47% 1.48% 1.40% 1.27% 1.17% 0.81%
Net investment (loss) (1.34%) (1.10%) (1.49%) (1.68%) (1.09%) (0.68%) 0.02% 0.47% 0.03% 0.04%
Portfolio turnover rate 94% 38% 60% 78% 81% 73% 77% 57% 80% 74%
Average commission rate $0.0563 N/A N/A N/A N/A N/A N/A N/A N/A N/A
paid
Net assets end of year $2,005,803 $1,459,955 $1,005,595 $965,959 $702,442 $623,291 $537,912 $503,908 $442,020 $679,281
(thousands)
</TABLE>
(a) Calculation based on average shares outstanding.
(b) 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 Distribution
Plans be treated as operating expenses rather than as capital charges.
Accordingly, beginning with the fiscal year ended May 31, 1988, the
Fund's financial statements reflect 12b-1 Distribution Plan expenses
(i.e., shareholder service fees plus commissions paid net of deferred
sales charges received by the Fund) as a component of the net
investment income section of the financial highlights.
(c) Excluding applicable sales charges.
(d) "Ratio of total expenses to average net assets" for the year ended May
31, 1996 includes indirectly paid expenses. Excluding indirectly paid
expenses for the year ended May 31, 1996, the expense ratio would have
been 1.72%.
THE FUND
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 approximately twenty funds managed by Keystone
Management, Inc. ("Keystone Management"), the Fund's investment manager, and is
one of more than thirty funds managed or advised by Keystone Investment
Management Company ("Keystone"), the Fund's investment adviser. Keystone and
Keystone Management are, from time to time, also collectively referred to as
"Keystone."
INVESTMENT OBJECTIVE AND POLICIES
The Fund's investment objective is to provide shareholders with
long-term growth of capital.
The Fund's objective is fundamental and cannot be changed without the
approval of a majority of the Fund's outstanding shares (as defined in the
Investment Company Act of 1940 (the "1940 Act"), which means the lesser of (1)
67% of the shares represented at a meeting at which more than 50% of the
outstanding shares are represented or (2) more than 50% of the outstanding
shares).
Any investment involves risk, and there is no assurance that the Fund
will achieve its investment objective.
PRINCIPAL INVESTMENTS
The Fund invests, under normal circumstances, at least 65% of its total
assets in equity securities of companies with small market capitalizations. For
this purpose, companies with small market capitalizations are generally those
with market capitalization of less than $1 billion ("small cap") at the time of
the Fund's investment. Companies whose capitalization falls outside this range
after the purchase continue to be considered small cap for this purpose.
While the Fund focuses on small cap stocks, it may also invest in other
types of securities, including 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, and up to 25% of
its assets in foreign securities. The Fund does not currently intend to invest
more than 5% of its assets in foreign securities.
OTHER ELIGIBLE INVESTMENTS
While income is not an objective, securities appearing to offer
attractive possibilities for future growth of income may be included in the
portfolio whenever it seems possible to do so without conflicting with the
Fund's objective of capital growth.
When market conditions warrant, the Fund may invest up to 100% of its
assets for temporary or defensive purposes in money market instruments. Such
instruments, which must mature within one year of their purchase, consist of
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. When the Fund invests for defensive purposes, it seeks to limit the risk
of loss of principal and is not pursuing its investment objective.
The Fund intends to follow policies of the Securities and Exchange
Commission as they are adopted from time to time with respect to illiquid
securities, including, at this time, (1) treating as illiquid, securities that
may not be sold or disposed of in the ordinary course of business within seven
days at approximately the value at which the Fund has valued the investment on
its books and (2) limiting its holdings of such securities to 15% of net assets.
The Fund may invest in restricted securities, including securities
eligible for resale pursuant to Rule 144A under the Securities Act of 1933 (the
"1933 Act"). Generally, Rule 144A establishes a safe harbor from the
registration requirements of the 1933 Act for resales by large institutional
investors of securities not publicly traded in the U.S. The Fund may purchase
Rule 144A securities when such securities present an attractive investment
opportunity and otherwise meet the Fund's selection criteria. The Board of
Trustees has adopted guidelines and procedures pursuant to which Keystone
determines the liquidity of the Fund's Rule 144A securities. The Board monitors
Keystone's implementation of such guidelines and procedures.
At the present time, the Fund cannot accurately predict exactly how the
market for Rule 144A securities will develop. A Rule 144A security that was
readily marketable upon purchase may subsequently become illiquid. In such an
event the Board of Trustees will consider what action, if any, is appropriate.
The Fund may enter into repurchase and reverse repurchase agreements,
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. The Fund may also enter into currency and other
financial futures contracts and related options transactions for hedging
purposes and not for speculation. The Fund may employ new investment techniques
with respect to options or financial futures contracts and related options.
For further information about the types of investments and investment
techniques available to the Fund, and the associated risks, see the "Risk
Factors" and "Additional Investment Information" sections of this prospectus and
the statement of additional information.
INVESTMENT RESTRICTIONS
The Fund has adopted the fundamental restrictions summarized below,
which may not be changed without the approval of a 1940 Act majority of the
Fund's outstanding shares. These restrictions and certain other fundamental and
nonfundamental 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 the Fund's total assets may be invested
without regard to this limit; (2) invest in more than 10% of the outstanding
voting securities of any one issuer (other than U.S. government securities),
except that up to 25% of the Fund's total assets may be invested without regard
to this limit; (3) 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; or (4) invest more than 25% of its total assets in
issuers in any single industry (other than U.S. government securities).
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.
RISK FACTORS
Like any investment, your investment in the Fund involves an element of
risk. Before you buy shares of the Fund, you should carefully evaluate your
ability to assume the risks your investment in the Fund poses. You can lose
money by investing in the Fund. Your investment is not guaranteed. A decrease in
the value of the Fund's portfolio securities can result in a decrease in the
value of your investment.
The Fund seeks to provide long-term growth of capital by investing
principally in equity securities of companies with small market capitalizations.
The Fund is best suited to patient investors who can afford to maintain their
investment over a relatively long period of time and who are seeking a fund that
is aggressive and has the potential for high returns. The Fund involves a high
degree of risk and is not an appropriate investment for conservative investors
who are seeking preservation of capital and/or income.
Certain risks related to the Fund are discussed below. To the extent
not discussed in this section, specific risks attendant to individual securities
or investment practices are discussed in "Additional Investment Information" and
the statement of additional information.
Fund Risks. Investing in companies with small market capitalizations
involves greater risk than investing in larger companies. Their stock prices can
rise very quickly and drop dramatically in a short period of time. This
volatility results from a number of factors, including reliance by these
companies on limited product lines, markets, and financial and management
resources. These and other factors may make small cap companies more susceptible
to setbacks or downturns. These companies may experience higher rates of
bankruptcy or other failures than larger companies. They may be more likely to
be negatively affected by changes in management. In addition, the stock of small
cap companies may be thinly traded.
Moreover, a need for cash due to large liquidations from the Fund when
the prices of small cap stocks are declining could result in losses to the Fund.
Investing in the Fund involves the risk common to investing in any
security; that is, the value of the securities held by the Fund will fluctuate
in response to changes in economic conditions or public expectations about those
securities. The net asset value of the Fund's shares will change accordingly.
Other Considerations. The Fund, which normally invests at least 65% of
its assets in small cap stocks, does not, by itself, constitute a balanced
investment plan. The Fund may be appropriate as part of an overall investment
program. Investors may wish to consult their financial advisers when considering
what portion of their total assets to invest in small cap stocks.
PRICING SHARES
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 portfolio
securities do not affect the current net asset value of its shares. The Exchange
currently is closed on weekends, New Year's Day, Presidents' Day, Good Friday,
Memorial Day, Independence Day, Labor Day, Thanksgiving Day, and Christmas Day.
The net asset value per share is arrived at by determining the value of all of
the Fund's assets, subtracting all liabilities and dividing the result by the
number of shares outstanding.
Current values for the Fund's securities are generally determined as
follows:
(1) Securities traded on an established exchange are valued on the
basis of the last sales price. Securities traded in the over-the-counter market,
for which complete quotations are available, are valued at the mean of the bid
and the asked prices.
(2) 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 value.
(3) Short-term investments maturing in more than sixty days for which
market quotations are readily available are valued at current market value.
(4) Short-term investments maturing in more than sixty days when
purchased that are held on the sixtieth day prior to maturity are valued at
amortized cost (market value on the sixtieth day adjusted for amortization of
premium or accretion of discount), which, when combined with accrued interest,
approximates market value.
(5) 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.
DIVIDENDS AND TAXES
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.
The Fund generally will make distributions from its net investment
income to its shareholders and net capital gains, if any, at least annually.
If the Fund qualifies and if it distributes all of its net investment
income and net capital gains, if any, to shareholders, it will be relieved of
any federal income tax liability.
Distributions are payable in shares of the Fund or, at the
shareholder's option (which must be exercised before the record date for the
distribution), in cash. Fund distributions in the form of additional shares are
made at net asset value without the imposition of a sales charge.
Income dividends and net short-term gains distributions are taxable as
ordinary income. Net long-term gains dividends are taxable as capital gains
regardless of how long the Fund's shares are held, and regardless of whether
paid in shares or in cash. 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.
Any taxable dividend declared in October, November, or December to
shareholders of record in such month and paid by the following January 31 will
be includable in the taxable income of the shareholders as if paid on December
31 of the year in which the dividend was declared.
The Fund advises its shareholders annually as to the federal tax status
of all distributions made during the year.
FUND MANAGEMENT AND EXPENSES
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 (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. 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; and
(3) providing services to the Fund's shareholders in connection with federal and
state taxation and distributions of income and capital gains..
The Fund pays Keystone Management a fee for its services at the annual
rate set forth below:
Aggregate Net Asset Value
Management Fee Of the Shares 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.
INVESTMENT ADVISER
Keystone, located at 200 Berkeley Street, Boston, Massachusetts
02116-5034, has provided investment advisory and management services to
investment companies and private accounts since 1932. Keystone is a wholly-owned
subsidiary of Keystone Investments, Inc. ("Keystone Investments"), also located
at 200 Berkeley Street, Boston, Massachusetts 02116-5034.
Keystone Investments is a private corporation predominantly owned by
current and former members of management 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, Ralph J. Spuehler, Jr., and Rosemary
D. Van Antwerp. 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 equal to 85% of the management fee received by Keystone Management
under the Management Agreement.
For the fiscal year ended May 31, 1996, the Fund paid or accrued to
Keystone Management investment management and administrative services fees of
$8,473,139, which represented 0.46% of the Fund's average daily net assets. Of
such amount paid to Keystone Management, $7,202,168 was paid to Keystone for its
services to the Fund.
The Fund has adopted a Code of Ethics incorporating policies on
personal securities trading as recommended by the Investment Company Institute.
Keystone Investments has recently entered into an Agreement and Plan of
Acquisition and Merger with First Union Corporation ("First Union"), pursuant to
which Keystone Investments is to be merged with and into a subsidiary of First
Union National Bank of North Carolina ("FUNB-NC") (the "Merger"). The surviving
corporation will be known as Keystone Investments, Inc. FUNB-NC is a
wholly-owned subsidiary of First Union. Subject to a number of conditions being
met, it is currently anticipated that the Merger will take place on or around
December 23, 1996. Thereafter, Keystone Investments, Inc. is expected to be a
subsidiary of FUNB-NC.
If consummated, the proposed Merger will be deemed to cause an
assignment, within the meaning of the 1940 Act, of the Advisory Agremeent and
the Management Agreement. Consequently, the completion of the transaction is
contingent upon, among other things, the approval of the Fund's shareholders of
a new investment advisory agreement between the Fund and Keystone (the "New
Advisory Agreement"). The Fund's Trustees have approved the terms of the New
Advisory Agreement, subject to the approval of shareholders and the completion
of the Merger, and have called a special meeting of shareholders to obtain their
approval of the New Advisory Agreement. The meeting is expected to be held in
December 1996. The proposed New Advisory Agreement has terms, including the fees
payable thereunder, that are substantially identical to those in the current
agreements.
PORTFOLIO MANAGER
Donald C. Dates has been the Fund's portfolio manager since 1996. Mr.
Dates is a Keystone Senior Vice President and has more than 35 years of
investment experience.
FUND EXPENSES
The Fund will pay all of its expenses. In addition to the investment
advisory and management fees discussed above, the principal expenses that the
Fund is expected to pay include, but are not limited to, expenses of its
transfer agent, its custodian and its independent auditors; expenses under its
Distribution Plan; fees of its Trustees who are not interested persons (as
defined in the 1940 Act) (the "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 May 31, 1996, the Fund
paid 1.73% of its average net assets in expenses.
For the fiscal year ended May 31, 1996, the Fund paid or accrued
$3,683,215 to Keystone Investor Resource Center, Inc. ("KIRC"), the Fund's
transfer and dividend disbursing agent, for transfer agent fees. KIRC is a
wholly-owned subsidiary of Keystone. During the same year, the Fund paid or
accrued $20,669 to Keystone Investments for the cost of certain accounting and
printing services.
SECURITIES TRANSACTIONS
Under policies established by the Board of Trustees, Keystone selects
broker-dealers to execute transactions subject to the receipt of best execution.
When selecting broker-dealers to execute portfolio transactions for the Fund,
Keystone may consider the number of shares of the Fund sold by such
broker-dealers. In addition, broker-dealers executing portfolio transactions
may, from time to time, be affiliated with the Fund, Keystone Management,
Keystone, the Fund's principal underwriter, or their affiliates.
The Fund may pay higher commissions to broker-dealers that provide
research services. Keystone may use these services in advising the Fund as well
as in advising its other clients.
PORTFOLIO TURNOVER
The Fund's portfolio turnover rates for the fiscal years ended May 31,
1995 and 1996 were 38% and 94%, respectively. For further information about
brokerage and distributions, see the statement of additional information.
HOW TO BUY SHARES
You may purchase shares of the Fund from any broker-dealer that has a
selling agreement with Keystone Investment Distributors Company (the "Principal
Underwriter"), the Fund's principal underwriter. The Principal Underwriter, a
wholly-owned subsidiary of Keystone, is located at 200 Berkeley Street, Boston,
Massachusetts 02116-5034.
In addition, you may 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. You may also 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 Fund shares in any amount may be made by check, by
wiring Federal funds, direct deposit or by 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.
In addition to an assignment of the Fund's Management Agreement and
Advisory Agreement, the Merger, if consummated, will also be deemed to cause an
assignment, as defined by the 1940 Act, of the Principal Underwriting Agreement
between the Fund and the Principal Underwriter. As a result, the Fund's Trustees
have approved the following agreements, subject to the Merger's completion: (i)
a principal underwriting agreement with Evergreen Funds Distributor, Inc.
("EFD") and the Fund; (ii) a marketing support agreement between the Principal
Underwriter and EFD with respect to the Fund; and (iii) a subadministration
agreement between Keystone and EFD with respect to the Fund. EFD is a
wholly-owned subsidiary of Furman Selz LLC. It is currently anticipated that on
or about January 2, 1997, Furman Selz LLC will transfer EFD, and its related
services, to BISYS Group, Inc. ("BISYS") (the "Transfer"). The Fund's Trustees
have also approved, subject to completion of the Transfer, (i) a principal
underwriting agreement with EFD and the Fund; (ii) a maketing support agreement
between the Principal Underwriter and EFD with respect to the Fund; and (iii) a
subadministration agreement between Keystone and BISYS with respect to the Fund.
The terms of such agreements will be substantially identical to the terms of the
agreements to be executed upon completion of the Merger.
CONTINGENT DEFERRED SALES CHARGE
With certain exceptions, when shares are redeemed within four calendar
years after their purchase, a deferred sales charge may be imposed at rates
ranging from a maximum of 4% of amounts redeemed during the same calendar year
of purchase to 1% of amounts redeemed during the third calendar year after the
year of purchase. No deferred sales charge is imposed on amounts redeemed
thereafter or on shares purchased through reinvestment of dividends. If imposed,
the deferred sales charge is deducted from the redemption proceeds otherwise
payable to the shareholder. To the extent permitted by the NASD, the deferred
sales charge is paid to the Principal Underwriter.
The contingent deferred sales charge is a declining percentage of the
lesser of (1) the net asset value of the shares redeemed or (2) the total cost
of such shares. No 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.
Upon request for redemption, shares not subject to the contingent
deferred sales charge will be redeemed first. Thereafter, shares held the
longest will be the first to be redeemed. No deferred sales charge is payable on
permitted exchanges of shares between the funds in the Keystone Fund Family that
have adopted distribution plans pursuant to Rule 12b-1 under the 1940 Act. For
purposes of computing deferred sales charges, when shares of one fund are
exchanged for shares of another fund, the date of purchase of the shares being
acquired by exchange is deemed to be the date the shares being tendered for
exchange were originally purchased.
WAIVER OF DEFERRED SALES CHARGE
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 Employment Retirement Income Security Act of 1974 ("ERISA"); (3)
automatic withdrawals from ERISA plans if the shareholder is at least 59 1/2
years old; (4) involuntary redemptions of accounts having an aggregate net asset
value of less than $1,000; (5) automatic withdrawals under a Systematic Income
Plan of up to 1% 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.
Shares also may be sold, to the extent permitted by applicable law, at
net asset value without the payment of commissions or the imposition of a
deferred sales charge to (1) certain Directors, Trustees, officers, and
employees of the Fund, Keystone Management, Keystone, the Principal Underwriter,
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. For more details see the
statement of additional information.
In addition, purchases of Fund shares made for the benefit of a Chilean
insurance company, mutual fund, or retirement plan through broker-dealers or
others having a selling agreement with the Principal Underwriter in the amount
of $1,000,000 or more (each such purchase, a "Special Chilean Purchase") will
not be subject to a contingent deferred sales charge.
DISTRIBUTION PLAN
The Fund bears some of the costs of selling its shares under a
Distribution Plan adopted pursuant to Rule 12b-1 under the 1940 Act. The Fund's
Distribution Plan provides that the Fund may expend up to 0.3125% quarterly
(approximately 1.25% annually) of the average daily net asset value of its
shares to pay distribution costs for sales of its shares and to pay shareholder
service fees. The NASD limits the amount that a fund may pay annually in
distribution costs for the sale of its shares and shareholder service fees. The
NASD limits annual expenditures to 1% of the aggregate average daily net asset
value of its shares, of which 0.75% may be used to pay such distribution costs
and 0.25% may be used to pay shareholder service fees. The NASD also limits the
aggregate amount that the Fund may pay for such distribution costs to 6.25% of
gross share sales since the inception of the Fund's Distribution Plan, plus
interest at the prime rate plus 1% on such amounts (less any deferred sales
charges paid by shareholders to the Principal Underwriter) remaining unpaid from
time to time.
Payments under the Distribution Plan are currently made to the
Principal Underwriter (which may reallow all or part to others, such as
broker-dealers) (1) as commissions for Fund shares sold and (2) as shareholder
service fees in respect of shares maintained by the recipients and 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 broker-dealers or others a commission equal to 4% of the price paid
for each Fund share sold. In addition, the Principal Underwriter generally
reallows to broker-dealers or others a shareholder service fee at a rate of
0.25% per annum of the net asset value of shares maintained by such recipients
and outstanding on the books of the Fund for specified periods. See also
"Arrangements with Broker-Dealers and Others" below.
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 broker-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 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. 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.
The Fund's unreimbursed distribution expenses at May 31, 1996, were
$3,165,670 (0.17% of net assets on May 31, 1996).
For the year ended May 31, 1996, the Fund paid $18,458,861 (1.00% of
the Fund's average daily net asset value during the year) under its Distribution
Plan. During the year ended May 31, 1996, the Principal Underwriter made
payments of commissions on new sales to dealers and others of $21,624,531.
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. 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 outstanding amounts. 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 a 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 broker-dealers or to selected broker-dealers who have sold or
are expected to sell significant amounts of shares. Additional compensation may
also include financial assistance to broker-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.
With respect to Special Chilean Purchases only, in lieu of any other
commission, including the 4% commission generally reallowed to broker-dealers,
the Principal Underwriter will pay broker-dealers or others commissions for such
purchases as described below:
(1) Commissions will be based on (a) the investor's cumulative
purchases during the one-year period beginning with the date of the initial
Special Chilean Purchase and (b) the investor's cumulative purchases during each
subsequent one-year period beginning with the first Special Chilean Purchase
following the end of the prior period.
(2) Commissions will be paid at the following rate: 1.00% of the
investment amount up to $2,999,999; plus 0.50% of the investment amount between
$3,000,000 and $4,999,999; plus 0.25% of the investment amount over $4,999,999.
(3) Depending on the respective arrangements made with a recipient, the
Principal Underwriter may pay such commissions either in full at the time of the
Special Chilean Purchase or in installments. If a commission is paid in full, a
prorated portion of such commission will be returned to the Principal
Underwriter should any shares upon which the payment of the commission was based
be redeemed within a specified period from the date of the Special Chilean
Purchase.
The Principal Underwriter may, at its own expense, pay concessions in
addition to those described above to broker-dealers that 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, depending on the
broker-dealer's satisfaction of the required conditions, may be periodic and may
be up to 0.25% of the value of shares sold by such broker-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
broker-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.
HOW TO REDEEM SHARES
You may redeem Fund shares cash at the redemption value upon written
order by the shareholder(s) to the Fund, c/o KIRC, Box 2121, Boston,
Massachusetts 02106-2121, and presentation to the Fund of a properly endorsed
share certificate, if certificates have been issued. Your signature(s) on the
written order and certificates must be guaranteed, as described below.
You may also redeem your shares through your broker-dealer. The
Principal Underwriter, acting as agent for the Fund, stands ready to repurchase
Fund shares upon orders from broker-dealers and will calculate the net asset
value on the same terms as those orders for the purchase of shares received from
broker-dealers and described under "How to Buy Shares." If the Principal
Underwriter has received proper documentation, it will pay the redemption
proceeds, less any applicable deferred sales charge, to the broker-dealers
placing the order within seven days thereafter. The Principal Underwriter
charges no fee for this service. Your broker-dealer, however, may charge a
service fee.
The redemption value equals the net asset value adjusted for fractions
of a cent and may be more or less than your 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.
For your protection, signatures on certificates, stock powers and all
written orders or authorizations must be guaranteed by a U.S. stock exchange
member, or bank or other persons eligible to guarantee signatures under the
Securities Exchange Act of 1934 and KIRC's policies. The Fund and KIRC may not
only waive this requirement, but may also require additional documents in
certain cases. Currently, the requirement for a signature guarantee has been
waived on redemptions of $50,000 or less when the account address of record has
been the same for a minimum period of 30 days. The Fund and KIRC reserve the
right to withdraw this waiver at any time.
If the Fund receives a redemption or repurchase order, but the
shareholder has not clearly indicated the amount of money or number of shares
involved, the Fund cannot execute the order. In such cases, the Fund will
request the missing information from the shareholder and process the order the
day it receives such information.
TELEPHONE REDEMPTIONS
Under ordinary circumstances you may redeem up to $50,000 from your
account by calling toll free 1-800-343-2898. You must complete the Telephone
Redemptions section of the application to enjoy telephone redemption privileges.
In order to insure that instructions received by KIRC are genuine when
you initiate a telephone transaction, you will be asked to verify certain
criteria specific to your account. At the conclusion of the transaction, you
will be given a transaction number confirming your request, and written
confirmation of your transaction will be mailed the next business day. Your
telephone instructions will be recorded. Redemptions by telephone are allowed
only if the address and bank account of record have been the same for a minimum
period of 30 days.
If you cannot reach the Fund by telephone, you should follow the
procedures for redeeming by mail or through a broker-dealer as set forth above.
SMALL ACCOUNTS
Because of the high cost of maintaining small accounts, the Fund
reserves the right to redeem your account if its value falls below $1,000, the
current minimum investment level, as a result of your redemptions (but not as a
result of market action). You will be notified in writing and allowed 60 days to
increase the value of your account to the minimum investment level. No
contingent deferred sales charges are applied to such redemptions.
GENERAL
The Fund reserves the right at any time to terminate, suspend, or
change the terms of any redemption method described in this prospectus, except
redemption by mail, and to impose fees.
Except as otherwise noted, neither the Fund, KIRC, nor the Principal
Underwriter assumes responsibility for the authenticity of any instructions
received by any of them from a shareholder in writing, over the Keystone
Automated Response Line ("KARL") or by telephone. KIRC will employ reasonable
procedures to confirm that instructions received over KARL or by telephone are
genuine. Neither the Fund, KIRC, nor the Principal Underwriter will be liable
when following instructions received over KARL or by telephone that KIRC
reasonably believes to be genuine.
The Fund may temporarily suspend the right to redeem its shares when
(1) the Exchange is closed, other than customary weekend and holiday closings;
(2) trading on the Exchange is restricted; (3) the Fund cannot dispose of its
investments or fairly determine their value; or (4) the Securities and Exchange
Commission so orders.
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 funds in the Keystone Fund
Family, on the basis of their respective net asset values, by calling toll free
1-800-343-2898 or by writing KIRC at P.O. 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 any fund
in the Keystone Fund Family, other than Keystone Precious Metals Holdings, Inc.
("KPMH"). In order to exchange Fund shares for shares of KPMH, a shareholder
must have held Fund shares for a period of at least six months. You may exchange
your shares for another Keystone fund for a $10 fee by calling or writing to
Keystone. The exchange fee is waived for individual investors who make an
exchange using KARL. If the shares being tendered for exchange have been held
for less than four years and are still subject to a deferred sales charge, such
charge will carry over to the shares being acquired in the exchange transaction.
The Fund reserves the right to terminate this exchange offer or to change its
terms, including the right to change the service charge for any exchange.
Orders to exchange shares of the Fund for shares of Keystone Liquid
Trust ("KLT") will be executed by redeeming the shares of the Fund and
purchasing shares of KLT at the net asset value of KLT shares determined after
the proceeds from such redemption become available, which may be up to seven
days after such redemption. In all other cases, orders for exchanges received by
the Fund prior to 4:00 p.m. (eastern time) 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.
(eastern time) on any business day will be executed at the respective net asset
values determined at the close of the next business day.
An excessive number of exchanges may be disadvantageous to the Fund.
Therefore, the Fund, in addition to its right to reject any exchange, reserves
the right to terminate the exchange privilege of any shareholder who makes more
than five exchanges of shares of the funds in a year or three in a calendar
quarter.
An exchange order must comply with the requirements for a redemption or
repurchase order and must specify the dollar value or number of shares to be
exchanged. Exchanges are subject to the minimum initial purchase requirements of
the fund being acquired. An exchange constitutes a sale for federal income tax
purposes.
The exchange privilege is available only in states where shares of the
fund being acquired may legally be sold.
RETIREMENT PLANS
The Fund has various retirement plans available to investors, including
Individual Retirement Accounts (IRAs); Rollover IRAs; Simplified Employee
Pension Plans (SEPs); Salary Reduction Plans (SARSEPs); Tax Sheltered Annuity
Plans (TSAs); 403(b)(7) Plans; 401(k) Plans; Keogh Plans; Corporate
Profit-Sharing Plans; and Money Purchase Pension Plans. For details, including
fees and application forms, call KIRC toll free at 1-800-247-4075 or write to
KIRC at P.O. Box 2121, Boston, Massachusetts 02106-2121.
AUTOMATIC INVESTMENT PLAN
With a Keystone Automatic Investment Plan, you can automatically
transfer as little as $100 per month or quarter from your bank account or KLT to
the Keystone fund of your choice. Your bank account will be debited for each
transfer. You will receive confirmation with your next account statement.
To establish or terminate an Automatic Investment Plan or to change the
amount or schedule of your automatic investments, you may write to or call
Keystone. Please include your account numbers. Termination of an Automatic
Investment Plan may take up to 30 days.
SYSTEMATIC INCOME PLAN
Under a Systematic Income 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 Systematic Income
Plan was 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.
PERFORMANCE DATA
From time to time, the Fund may advertise "total return" and "current
yield." Both figures are based on historical earnings. Past performance should
not be considered representative of results for any future period of time. Total
return refers to the Fund's average annual compounded rates of return over
specified periods determined by comparing the initial amount invested to the
ending redeemable value of that amount. The resulting equation assumes
reinvestment of all dividends and distributions and deduction of all recurring
charges, if any, applicable to all shareholder accounts. The deduction of the
contingent deferred sales charge is reflected in the applicable years. The
exchange fee is not included in the calculation.
Current yield quotations represent the yield on an investment for a
stated 30-day period computed by dividing net investment income earned per share
during the base period by the maximum offering price per share on the last day
of the base period. The Fund presently does not intend to advertise current
yield.
The Fund may also 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.
FUND SHARES
The Fund currently issues one class of shares, which participate
equally in dividends and distributions and have equal voting, liquidation and
other rights. When issued and paid for, the shares will be fully paid and
nonassessable by the Fund. Shares may be exchanged as explained under
"Shareholder Services," but will have no other preference, conversion, exchange
or preemptive rights. Shareholders are entitled to one vote for each full share
owned and fractional votes for fractional shares. Shares are redeemable,
transferable, and freely assignable as collateral. The Fund may establish
additional classes or series of shares.
The Fund does not have annual meetings. The Fund will have special
meetings from time to time as required under its Trust Agreement and under the
1940 Act. As provided in the Fund's 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 holders of 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.
ADDITIONAL INFORMATION
KIRC, located at 200 Berkeley Street, Boston, Massachusetts 02116-5034,
is a wholly-owned subsidiary of Keystone and serves as the Fund's transfer agent
and dividend disbursing agent.
When the Fund determines from its records that more than one account in
the Fund is registered in the name of a shareholder or shareholders having the
same address, upon written notice to those shareholders, the Fund intends, when
an annual report or semi-annual report of the Fund is required to be furnished,
to mail one copy of such report to that address.
Except as otherwise stated in this prospectus or required by law, the
Fund reserves the right to change the terms of the offer stated in this
prospectus without shareholder approval, including the right to impose or change
fees for services provided.
ADDITIONAL INVESTMENT INFORMATION
The Fund may manage 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 permit the Fund
to demand payment of principal and accrued interest at any time (on not more
than seven days notice) and to resell the note at any time to a third party.
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, at the time of investment, 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 intends
only 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 such as U.S. government securities or other high grade debt securities
having a value not less than the repurchase price (including accrued interest)
and will subsequently monitor the account to ensure such value is maintained.
Reverse repurchase agreements involve the risk that the market value of the
securities that the Fund is obligated to repurchase may decline below the
repurchase price. 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. 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.
FOREIGN SECURITIES
The Fund may invest up to 25% of its assets in securities principally
traded in securities markets outside the United States. At this time, the Fund
does not currently intend to invest more than 5% of its assets in foreign
securities. While investment in foreign securities is intended to reduce risk by
providing further diversification, such investments involve sovereign risk in
addition to the credit and market risks normally associated with domestic
securities. Foreign investments may be affected favorably or unfavorably by
changes in currency rates and exchange control regulations. There may be less
publicly available information about a foreign company than about a U.S.
company, and foreign companies may not be subject to accounting, auditing and
financial reporting standards and requirements comparable to those applicable to
U.S. companies. Securities of some foreign companies are less liquid or more
volatile than securities of U.S. companies, and foreign brokerage commissions
and custodian fees are generally higher than in the United States. Investments
in foreign securities may also be subject to other risks different than those
affecting U.S. investments, including local political or economic developments,
expropriation or nationalization of assets, imposition of withholding taxes on
dividend or interest payments and currency blockage (which would prevent cash
from being brought back to the United States).
In addition, investing in securities of foreign issuers generally
involves more risk than investing in securities of domestic issuers for the
following reasons: (1) there may be less public information available about
foreign companies than is available about U.S. companies; (2) foreign companies
are not generally subject to the uniform accounting, auditing and financial
reporting standards and practices applicable to U.S. companies; (3) foreign
stock markets have less volume than the U.S. market, and the securities of some
foreign companies are much less liquid and much more volatile than the
securities of comparable U.S. companies; (4) foreign securities transactions may
involve higher brokerage commissions; (5) there may be less government
regulation of stock markets, brokers, listed companies and banks in foreign
countries than in the U.S.; (6) the Fund may incur fees on currency exchanges
when it changes investments from one country to another; (7) the Fund's foreign
investments could be affected by expropriation, confiscatory taxation,
nationalization, establishment of currency exchange controls, political or
social instability or diplomatic developments; (8) fluctuations in foreign
exchange rates will affect the value of the Fund's investments, the value of
dividends and interest earned, gains and losses realized on the sale of
securities, net investment income and unrealized appreciation or depreciation of
investments; and (9) interest and dividends on foreign securities may be subject
to withholding taxes in a foreign country that could result in a reduction of
net investment income available for distribution.
Investing in securities of issuers in emerging market countries
involves exposure to economic systems that are generally less mature and
political systems that are generally less stable than those of developed
countries. In addition, investing in companies in emerging market countries may
also involve exposure to national policies that may restrict investment by
foreigners and undeveloped legal systems governing private and foreign
investments and private property. The typically small size of the markets for
securities issued by companies in emerging markets countries and the possibility
of a low or nonexistent volume of trading in those securities may also result in
a lack of liquidity and in price volatility of those securities. Furthermore,
investing in securities of companies in the formerly communist countries of
Eastern Europe and the People's Republic of China involves additional risks to
those associated with investments in companies in non-formerly communist
emerging markets countries. Specifically, those countries could convert back to
a single economic system, and the claims of property owners prior to the
expropriation by the communist regime could be settled in favor of the former
property owners, in which case the Fund could lose its entire investment in
those countries. These risks are carefully considered by Keystone prior to the
purchase of these securities.
"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 consistent with
its investment objective 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 and dealers pursuant to
agreements requiring that the loans be continuously secured by cash or
securities of the U.S. government, its agencies or instrumentalities, or any
combination of cash and such securities, as collateral equal at all times in
value to at least the market value of the securities loaned. Such securities
loans will not be made with respect to the Fund if, as a result, the aggregate
of all outstanding securities loans exceeds 15% of the value of the Fund's total
assets taken at their current value. The Fund continues to receive interest or
dividends on the securities loaned and simultaneously earns interest on the
investment of the cash loan collateral in U.S. Treasury notes, certificates of
deposit, other high-grade, short-term obligations or interest bearing cash
equivalents. Although voting rights attendant to securities loaned pass to the
borrower, such loans may be called at any time and will be called so that the
securities may be voted by the Fund if, in the opinion of the Fund, a material
event affecting the investment is to occur. There may be risks of delay in
receiving additional collateral or in recovering the securities loaned or even
loss of rights in the collateral should the borrower of the securities fail
financially. Loans may only be made to borrowers deemed to be of good standing,
under standards approved by the Board of Trustees, when the income to be earned
from the loan justifies the attendant risks.
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. 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 objective 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 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 U.S. 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>
STATEMENT OF ADDITIONAL INFORMATION
KEYSTONE SMALL COMPANY GROWTH FUND (S-4)
September 30, 1996
This statement of additional information is not a prospectus, but relates
to, and should be read in conjunction with, the prospectus of Keystone Small
Company Growth Fund (S-4)(the "Fund") dated September 30, 1996. A copy of the
prospectus may be obtained from Keystone Investment Distributors Company (the
"Principal Underwriter"), the Fund's principal underwriter, located at 200
Berkeley Street, Boston, Massachusetts, 02116-5034, or your broker-dealer.
TABLE OF CONTENTS
Page
Investment Objective and Policies 2
Investment Restrictions 2
Valuation of Securities 5
Distributions and Taxes 6
Sales Charges 7
Distribution Plan 9
The Trust Agreement 12
Investment Manager and Investment Advisor 14
Trustees and Officers 19
Principal Underwriter 23
Brokerage 25
Standardized Total Return
and Yield Quotations 27
Additional Information 28
Appendix A-1
Financial Statements F-1
Independent Auditors' Report F-13
INVESTMENT OBJECTIVE AND POLICIES
The Fund is an open-end, diversified management investment company commonly
known as a mutual fund. The Fund's investment objective is to provide
shareholders with long-term growth of capital. It is the Fund's policy to invest
its assets as fully as practicable.
Certain information about the Fund is contained in its prospectus. This
statement of additional information provides additional information about the
Fund that may be of interest to some investors.
INVESTMENT RESTRICTIONS
FUNDAMENTAL INVESTMENT RESTRICTIONS
The Fund has adopted the fundamental investment restrictions set forth
below, which may not be changed without a vote of the majority of the Fund's
outstanding voting shares (as defined in the Investment Company Act of 1940 (the
"1940 Act")). Unless otherwise stated, all references to Fund assets are in
terms of current market value.
The Fund may not do any of the following:
(1) with respect to 75% of its total assets, invest more than 5% of the
value of its total assets, determined at market or other fair value at the time
of purchase, in the securities of any one issuer, or invest in more than 10% of
the outstanding voting securities of any one issuer, all as determined
immediately after such investment; provided that these limitations do not apply
to investments in securities issued or guaranteed by the United States ("U.S.")
government or its agencies or instrumentalities;
(2) invest more than 5% of the value of its total assets in companies which
have been in operation for less than three years;
(3) borrow money, except that the Fund may (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;
(4) underwrite securities, except that the Fund may purchase securities
from issuers thereof or others and dispose of such securities in a manner
consistent with its other investment policies; in the disposition of restricted
securities the Fund may be deemed to be an underwriter, as defined in the
Securities Act of 1933 (the "1933 Act");
(5) purchase or sell real estate or interests in real estate, except that
it may purchase and sell securities secured by real estate and securities of
companies which invest in real estate, or purchase or sell commodities or
commodity contracts, except that the Fund may engage in currency or other
financial futures contracts and related options transactions;
(6) invest for the primary purpose of exercising control over, or
management of, any issuer;
(7) make margin purchases or short sales of securities;
(8) 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;
(9) invest more than 25% of its total assets in the securities of issuers
in any single industry, other than securities issued or guaranteed by the U.S.
Government, its agencies or instrumentalities; and
(10) purchase the securities of any other investment company except in the
open market and at customary brokerage rates and in no event more than 3% of the
voting securities of any investment company.
If a percentage limit is satisfied at the time of investment or borrowing,
a later increase or decrease resulting from a change in the value of a security
or a decrease in Fund assets is not a violation of the limit.
The Fund has no current intention of attempting to increase its net income
by borrowing and intends to repay any borrowings made in accordance with the
fourth investment restriction enumerated above before it makes any additional
investments.
NON-FUNDAMENTAL INVESTMENT RESTRICTIONS
Although not fundamental restrictions or policies requiring a shareholders'
vote to change, the Fund has agreed, so long as a state authority requires and
shares of the Fund are registered for sale in that state, that it 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; and (2) 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.
VALUATION OF SECURITIES
Current value for the Fund's portfolio securities is determined in the
following manner:
(1) Securities traded on an established exchange are valued on the basis of
the last sales price on the exchange where the securities are primarily traded
prior to the time of the valuation;
(2) 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;
(3) 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;
(4) Short-term investments maturing in more than sixty days are valued at
market value;
(5) Short-term investments maturing in more than sixty days when purchased
that are held on the sixtieth day prior to maturity are valued at amortized cost
(market value on the sixtieth day adjusted for amortization of premium or
accretion of discount), which, when combined with accrued interest, approximates
market; and
(6) The Fund's Board of Trustees values the following securities at prices
it deems in good faith to be fair: (a) securities, including restricted
securities, for which complete quotations are not readily available; (b) listed
securities if, in the Board's opinion, the last sales price does not reflect a
current market value or if no sale occurred; and (c) other assets.
DISTRIBUTIONS AND TAXES
The Fund distributes to its shareholders dividends from net investment
income and net realized capital gains, if any, annually in shares or, at the
option of the shareholder, in cash. (Distributions of ordinary income may be
eligible in whole or in part for the corporate 70% dividends received
deduction.) Shareholders who have not opted, prior to the record date for any
distribution, to receive cash will have the number of distributed shares
determined on the basis of the Fund's net asset value per share computed at the
end of the day on the record date after adjustment for the distribution. Net
asset value is used in computing the number of shares in both gains and income
distribution reinvestments. 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.
Distributed long-term capital gains are taxable as such to the shareholder
regardless of the period of time Fund shares have been held by the shareholder.
However, if such shares are held less than six months and redeemed at a loss,
the shareholder will recognize a long-term capital loss on such shares to the
extent of the long-term capital gain distribution received in connection with
such shares. If the net asset value of the Fund's shares is reduced below a
shareholder's cost by a capital gains distribution, such distribution, to the
extent of the reduction, would be a return of investment though taxable as
stated above. Since distributions of capital gains depend upon profits actually
realized from the sale of securities by the Fund, they may or may not occur. The
foregoing comments relating to the taxation of dividends and distributions paid
on the Fund's shares relate solely to federal income taxation. Such dividends
and distributions may also be subject to state and local taxes.
When the Fund makes a distribution, it intends to distribute only the
Fund's net capital gains and such income as has been predetermined to the best
of the Fund's ability to be taxable as ordinary income. Shareholders of the Fund
will be advised annually of the federal income tax status of distributions.
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.
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 1996 and on a given date in 1997 the value of the investor's
account has grown through investment performance and reinvestment of
distributions to $12,000. On such date in 1997, 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.
Upon request for redemption, shares not subject to the contingent deferred
sales charge will be redeemed first. Thereafter, shares held the longest will be
the first to be redeemed. There is no contingent deferred sales charge on
permitted exchanges of shares between the funds in the Keystone Fund Family that
have adopted distribution plans pursuant to Rule 12b-1 under the 1940 Act. When
shares of one such fund have been exchanged for shares of another such fund, the
calendar year of the purchase, for purposes of any future deferred sales charge,
is deemed 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) Directors, Trustees, officers,
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 contingent deferred sales charge is imposed on a redemption of shares of
the Fund purchased by a bank or trust company in a single account in the name of
such bank or trust company as trustee if the initial investment in shares of the
Fund, any other fund in the Keystone Fund Family, and/or any Keystone America
Fund, is at least $500,000 and any commission paid by the Fund and such other
funds at the time of such purchase is not more than 1% of the amount invested.
In addition, no contingent deferred sales charge is imposed on a redemption
of shares of the Fund in the event of (1) death or disability of the
shareholder; (2) a lump-sum distribution from a 401(k) plan or other benefit
plan qualified under the Employee Retirement Income Security Act of 1974
("ERISA"); (3) automatic withdrawals from ERISA plans if the shareholder is at
least 591/2 years old; (4) involuntary redemptions of an account having an
aggregate net asset value of less than $1,000; (5) automatic withdrawals under a
Systematic Income Plan of up to 1% 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.
DISTRIBUTION PLAN
Rule 12b-1 under the 1940 Act permits investment companies, such as the
Fund, to use their assets to bear the expenses of distributing their shares if
they comply with various conditions, including the 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 the average daily net asset
value of its shares to pay distribution costs for sales of its shares and to pay
shareholder service fees. The National Association of Securities Dealers, Inc.
("NASD") limits such annual expenditures to 1.0%, of which 0.75% may be used to
pay such distribution costs and 0.25% may be used to pay shareholder service
fees. The NASD also limits the aggregate amount that the Fund may pay for such
distribution costs to 6.25% of gross share sales since the inception of the
Fund's Distribution Plan plus interest at the prime rate plus 1% 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 broker-dealers)
(1) as commissions for Fund shares sold and (2) as shareholder service fees in
respect of shares maintained by the recipients and 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 broker-dealers 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 and 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 pay 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 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. If the Fund's
disinterested trustees (as defined in the 1940 Act) (the "Independent Trustees")
authorize such payments, the effect will be to extend the period of time during
which the Fund incurs the maximum amount of costs allowed by the Distribution
Plan. If the Distribution Plan is terminated, the Principal Underwriter will ask
the Independent Trustees to take whatever action they deem appropriate under the
circumstances with respect to payment of such amounts.
The total amounts paid by the Fund under the foregoing arrangements may not
exceed the maximum Distribution Plan limit specified above, and the amounts and
purposes of expenditures under the Distribution Plan must be reported to the
Fund's Independent Trustees quarterly. The Fund's Independent Trustees may
require or approve changes in the implementation or operation of the
Distribution Plan and may require that total expenditures by the Fund under the
Distribution Plan be kept within limits lower than the maximum amount permitted
by the Distribution Plan as stated above. If such costs are not limited by the
Independent Trustees, such costs could, for some period of time, be higher than
such costs permitted by most other plans presently adopted by other investment
companies.
The Distribution Plan may be terminated at any time by vote of the
Independent Trustees or by vote of a majority of the outstanding voting
securities of the Fund.
Any change in the Distribution Plan that would materially increase the
distribution expenses of the Fund provided for in the Distribution Plan requires
shareholder approval. Otherwise, the Distribution Plan may be amended by 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.
The amount paid by the Fund under its Distribution Plan for the fiscal year
ended May 31, 1996 was $18,458,861 (1.00% of the Fund's average daily net asset
value during the year). During the same year, the Principal Underwriter paid
commissions on new sales to broker-dealers and others in the amount of
$21,624,531.
Whether any expenditure under the Distribution Plan is subject to a state
expense limit will depend upon the nature of the expenditure and the terms of
the state law, regulation or order imposing the limit. A portion of the Fund's
Distribution Plan expenses may be includable in the Fund's total operating
expenses for purposes of determining compliance with state expense limits.
The Independent Trustees of the Fund have determined that the sales of the
Fund's shares resulting from payments under the Distribution Plan have benefited
the Fund.
THE TRUST AGREEMENT
TRUST AGREEMENT
The Fund is a Pennsylvania common law trust established under a Trust
Agreement dated July 15, 1935, as restated and amended (the "Trust Agreement").
The Trust Agreement restructured the Fund so that its operation would be
substantially similar to that of most other mutual funds. The Trust Agreement
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 Trust Agreement
is on file 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 Trust Agreement.
DESCRIPTION OF SHARES
The Trust Agreement authorizes the issuance of an unlimited number of
shares of beneficial interest and the creation of additional series and/or
classes of series of Fund shares. Each share represents an equal proportionate
interest in the Fund with each other share of that class. Upon liquidation,
shares are entitled to a pro rata share in the net assets of their class of Fund
shares. Shareholders shall have no preemptive or conversion rights. Shares are
transferable. The Fund currently intends to issue only one class of shares.
SHAREHOLDER LIABILITY
Pursuant to court decisions or other theories of law, shareholders of a
Pennsylvania common law trust could possibly be held personally liable for the
obligations of the trust. The possibility of Fund shareholders incurring
financial loss under such circumstances appears to be remote, however, because
the Trust Agreement (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 Trust Agreement, 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 Trust
Agreement that adversely affects any class of shares without the approval of a
majority of the shares of that class. There shall be no cumulative voting in the
election of Trustees.
After a meeting as described above, no further meetings of shareholders for
the purpose of electing Trustees will be held, unless required by law, or until
such time as less than a majority of the Trustees holding office have been
elected by shareholders, at which time, the Trustees then in office will call a
shareholders' meeting for the election of Trustees.
Except as set forth above, the Trustees shall continue to hold office
indefinitely unless otherwise required by law and may appoint successor
Trustees. A Trustee may cease to hold office or may be removed from office (as
the case may be) (1) at any time by a two-thirds vote of the remaining Trustees;
(2) when such Trustee becomes mentally or physically incapacitated; or (3) at a
special meeting of shareholders by a two-thirds vote of the outstanding shares.
Any Trustee may voluntarily resign from office.
LIMITATION OF TRUSTEES' LIABILITY
The Trust Agreement 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 Trust Agreement 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.
INVESTMENT MANAGER AND INVESTMENT ADVISOR
INVESTMENT MANAGER
Subject to the general supervision of the Fund's Board of Trustees,
Keystone Management, located at 200 Berkeley Street, Boston, Massachusetts
02116-5034, serves as investment manager to the Fund and is responsible for the
overall management of the Fund's business and affairs. Keystone Management,
organized in 1989, is a wholly-owned subsidiary of Keystone. Its directors and
principal executive officers have been affiliated with Keystone, a seasoned
investment adviser, for a number of years. Keystone Management also serves as
investment manager to each of the other funds in the Keystone Fund Family and to
certain other funds in the Keystone Investments Family of Funds.
Except as otherwise noted below, pursuant to an Investment Management
Agreement with the Fund (the "Management Agreement"), 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 and all necessary office facilities,
equipment, and personnel in connection with its services under the Management
Agreement. The Management Agreement also stipulates that Keystone Management
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 provisions 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.
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 (the "Code"),
(b) tax treatment of the Fund's portfolio investments, (c) tax treatment of
special corporate actions (such as reorganizations), (d) state tax matters
affecting the Fund, and (e) the Fund's distributions of income and capital
gains; (2) preparing the Fund's federal and state tax returns; and (3) providing
services to the Fund's shareholders in connection with federal and state
taxation and distributions of income and capital gains.
The Fund pays Keystone Management a fee for its services at the annual rate
set forth below:
Aggregate Net Asset Value
Annual Management Fee of the shares 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 payable daily. For
additional discussion of fees paid to Keystone Management, see "Investment
Adviser" below.
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 the Fund's average net assets;
2.0% of the next $70 million of the Fund's average net assets; and
1.5% of the Fund's 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 state, Keystone
Management has agreed to reimburse the Fund annually for certain operating
expenses incurred by the Fund in excess of certain percentages of the Fund's
average daily net assets. Keystone Management is not required, however, to make
such reimbursements to the extent 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 continues in effect only if approved at least
annually by the Fund's Board of Trustees or by a vote of a majority of the
outstanding shares, and such renewal has been approved by the vote of a majority
of the Independent Trustees cast in person at a meeting called for the purpose
of voting on such approval. The Management Agreement may be terminated, without
penalty, on 60 days' written notice by the Fund's Board of Trustees or by a vote
of a majority of outstanding shares. The Management Agreement will terminate
automatically upon its "assignment," as that term is defined in the 1940 Act.
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 its rights,
duties, and obligations under the Management Agreement.
INVESTMENT ADVISOR
Pursuant to the Management Agreement, Keystone Management has entered into
an Investment Advisory Agreement with Keystone (the "Advisory Agreement"), under
which Keystone Management has delegated all of its investment management
functions, except for certain administrative and management services, to
Keystone. As a result, subject to the supervision of the Fund's Board of
Trustees, Keystone performs services on behalf of the Fund that are
substantially similar to those described above with respect to Keystone
Management.
Keystone 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. Both Keystone and
Keystone Investments are located at 200 Berkeley Street, Boston, Massachusetts
02116-5034.
Keystone Investments is a private corporation predominantly owned by
current and former members of management 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, Ralph J. Spuehler, Jr., and Rosemary
D. Van Antwerp. 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 equal to 85% of the management fee received by Keystone Management
under the Management Agreement.
For the fiscal year ended May 31, 1996, the Fund paid or accrued to
Keystone Management investment management and administrative services fees of
$8,473,139, which represented 0.46% of the Fund's average daily net asset value
during the period. Of such amount paid to Keystone Management, $7,202,168 was
paid to Keystone for its services to the Fund.
For the fiscal year ended May 31, 1995, the Fund paid or accrued to
Keystone Management investment management and administrative services fees of
$6,037,504, which represented 0.50% of the Fund's average daily net assets. Of
such amount paid to Keystone Management, $5,131,878 was paid to Keystone for
investment advisory services to the Fund.
For the fiscal year ended May 31, 1994, the Fund paid or accrued to
Keystone Management investment management and administrative services fees of
$5,433,201, which represented 0.52% of the Fund's average daily net assets. Of
such amount paid to Keystone Management, $4,618,221 was paid to Keystone for
investment advisory services to the Fund.
MERGER WITH FIRST UNION
Keystone Investments has recently entered into an Agreement and Plan of
Acquisition and Merger with First Union Corporation ("First Union"), pursuant to
which Keystone Investments will be merged with and into a subsidiary of First
Union National Bank of North Carolina ("FUNB-NC")(the "Merger"). The surviving
corporation will be known as Keystone Investments, Inc. FUNB-NC is a
wholly-owned subsidiary of First Union. Subject to a number of conditions being
met, it is currently anticipated that the Merger will take place on or around
December 23, 1996. Thereafter, Keystone Investments, Inc. is expected to be a
subsidiary of FUNB-NC.
If consummated, the proposed Merger will be deemed to cause an assignment,
within the meaning of the 1940 Act, of both the Management Agreement and the
Advisory Agreement. Consequently, the completion of the Merger is contingent
upon, among other things, the approval of the Fund's shareholders of a new
investment advisory agreement between the Fund and Keystone ("the "New Advisory
Agreement"). The Fund's Trustees have approved the terms of the New Advisory
Agreement, subject to the approval of shareholders and the completion of the
Merger, and have called a special meeting of shareholders to obtain their
approval of the New Advisory Agreement. The meeting is expected to be held in
December 1996. The proposed New Advisory Agreement has terms, including fees
payable thereunder, that are substantially identical to those in the current
agreements.
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 and Chief Executive Officer of
Keystone Investments, Keystone, Keystone Management, Inc. ("Keystone
Management") and Keystone Software, Inc. ("Keystone Software"); President,
Chief Executive Officer and Trustee or Director of all other funds in the
Keystone Investments Family of Funds; Chairman of the Board and Director of
Keystone Institutional Company, Inc. ("Keystone Institutional")and Keystone
Fixed Income Advisors ("KFIA"); Director and President of Keystone Asset
Corporation, Keystone Capital Corporation and Keystone Trust Company;
Director of the Principal Underwriter, KIRC, and Fiduciary Investment
Company, Inc. ("FICO"); Director of Boston Children's Services Association;
Trustee of Anatolia College, Middlesex School, and Middlebury College;
Member, Board of Governors, New England Medical Center; former Director and
President of Hartwell Keystone Advisers, Inc. ("Hartwell Keystone"); former
Director and Vice President, Robert Van Partners, Inc.; 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; Pro fessor, Finance Department,
George Washington University; President, Amling & Company (investment
advice); and former Member, Board of Advisers, Credito Emilano (banking).
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.; and former Managing Director, Seaward Management
Corporation (investment advice).
*GEORGE S. BISSELL: Chairman of the Board and Trustee of the Fund; Chairman of
the Board and Trustee or Director of all other funds in the Keystone
Investments Family of Funds; Director of Keystone Investments; Chairman of
the Board and Trustee of Anatolia College; Trustee of University Hospital
(and Chairman of its Investment Committee); former Director and Chairman of
the Board of Hartwell Keystone; and former Chairman of the Board and Chief
Executive Officer of Keystone Investments.
EDWIND. CAMPBELL: Trustee of the Fund; Trustee or Director of all other funds
in the Keystone Investments Family of Funds; Principal, Padanaram
Associates, Inc.; and former Executive Director, Coalition of Essential
Schools, Brown University.
CHARLES F. CHAPIN: Trustee of the Fund; Trustee or Director of all other funds
in the Keystone Investments Family of Funds; and former Director, Peoples
Bank (Charlotte, NC).
K. DUN GIFFORD: Trustee of the Fund; Trustee or Director of all other funds in
the Keystone Investments Family of Funds; Trustee, Treasurer, and Chairman
of the Finance Committee, Cambridge College; Chairman Emeritus and
Director, American Institute of Food and Wine; Chairman and President,
Oldways Preservation and Exchange Trust (education); Former Chairman of the
Board, Director, and Executive Vice President, The London Harness Company;
former Managing Partner, Roscommon Capital Corp.; former Chief Executive
Officer, Gifford Gifts of Fine Foods; former Chairman, Gifford, Drescher &
Associates (environmental consulting); and former Director, Keystone
Investments and Keystone.
LEROY KEITH, JR.: Trustee of the Fund; Trustee or Director of all other funds in
the Keystone Investments Family of Funds; Chairman of the Board and Chief
Executive Officer, Carson Products Company; 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.
F. RAY KEYSER, JR.: Trustee of the Fund; Trustee or Director of all other
funds in the Keystone Investments Family of Funds; Chairman and Of Counsel,
Keyser, Crowley, Meub, Layden, Kulig & Sullivan P.C.; Member, Governor's
(VT) Council of Economic Advisers; Chairman of the Board and Director,
Central Vermont Public Service Corporation and Lahey Hitchcock Clinic; Di
rector, Vermont Yankee Nuclear Power Corporation, Grand Trunk Corporation,
Grand Trunk Western Railroad, Union Mutual Fire Insurance Company, New
England Guaranty Insurance Company, Inc., and the Investment Company
Institute; former Director and President, Associated Industries of Vermont;
former Director of Keystone, Central Vermont Railway, Inc., S.K.I. Ltd.,
and Arrow Financial Corp.; and former Director and Chairman of the Board,
Hitchcock Clinic, Proctor Bank, and Green Mountain Bank.
DAVID M. RICHARDSON: Trustee of the Fund; Trustee or Director of all other funds
in the Keystone Investments Family of Funds; Vice Chair and former
Executive Vice President, DHR Interna tional, 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. (insurance agency); Executive Consultant, Drake Beam Morin, Inc.
(executive outplacement); Director of Connecticut Natural Gas Corpora tion,
Hartford Hospital, Old State House Association, Middlesex Mutual Assurance
Company, and Enhance Financial Services, Inc.; Chairman, Board of Trustees,
Hartford Graduate Center; Trustee, Greater Hartford YMCA; former Director,
Vice Chairman and Chief Investment Officer, The Travelers Corpora tion;
former Trustee, Kingswood-Oxford School; and former Managing Director and
Consultant, 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.; Adjunct Professor of Law and
former Associate Dean, St. John's University School of Law; Adjunct
Professor of Law, Touro College School of Law; and former President, Nassau
County Bar Association.
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, and Keystone Trust Company; Treasurer of
Keystone Institutional and FICO; Treasurer and Director of Keystone
Management and Keystone Software; Vice President and Treasurer of KFIA;
Director of KIRC; former Treasurer and Director of Hartwell Keystone; and
former Treasurer of Robert Van Partners, Inc.
JAMES R. McCALL: Senior Vice President of the Fund; Senior Vice President of all
other funds in the Keystone Investments Family of Funds; and President of
Keystone.
J. KEVIN KENELY: Treasurer of the Fund; Treasurer of all other funds in the
Keystone Investments Family of Funds; Vice President and former Controller
of Keystone Investments, Keystone, the Principal Underwriter, FICO, and
Keystone Software; and former Controller of Keystone Asset Corporation and
Keystone Capital Corporation.
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; 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; and former Senior Vice
President and Secretary of Hartwell Keystone and Robert Van Partners, Inc.
DONALD C. DATES: Vice President of the Fund; Vice President of certain other
funds in the Keystone Investments Family of Funds; and Senior Vice
President of Keystone.
* 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 a Director of Keystone
Investments. Mr. Bissell is a Director of Keystone Investments.
During the fiscal year ended May 31, 1996, no Trustee affiliated with
Keystone or any officer received any direct remuneration from the Fund. Annual
retainers and meeting fees paid by all funds in the Keystone Investments Family
of Funds (which includes over 30 mutual funds) for the calendar year ended
December 31, 1995, totaled approximately $450,716. On August 30, 1996, the
Fund's Trustees and officers beneficially owned less than 1.0% of the Fund's
then outstanding shares.
The address of all the Fund's Trustees and officers and the address of the
Fund is 200 Berkeley Street, Boston, Massachusetts 02116-5034.
PRINCIPAL UNDERWRITER
The Fund has entered into a Principal Underwriting Agreement with the
Principal Underwriter (the "Underwriting Agreement"). The Principal Underwriter
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 Fund's 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, 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 annually (i) by a vote of a majority
of the Fund's Independent Trustees cast in person at a meeting called for that
purpose and (ii) 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 provide to
selected dealers promotional materials and selling aids, including, but not
limited to, personal computers, related software, and Fund data files.
The amount paid by the Fund to the Principal Underwriter for the fiscal
year ended May 31, 1996 was $18,458,861 (1.00% of the Fund's average daily net
asset value during the year). During that same year, the Principal Underwriter
made payments of commissions on new sales to dealers and others of $21,624,531.
The amount paid by the Fund to the Principal Underwriter for the fiscal
year ended May 31, 1995 was $11,894,985 (1.00% of the Fund's average daily net
asset value during the year). During that same year, the Principal Underwriter
made payments of commissions on new sales to dealers and others of $9,885,207.
The amount paid by the Fund to the Principal Underwriter for the fiscal
year ended May 31, 1994 was $9,772,223 (0.93% of the Fund's average daily net
asset value during the year). During that same year, the Principal Underwriter
made payments of commissions on new sales to dealers and others of $7,941,233.
Nomura Securities Co., Ltd. ("Nomura"), located at 1-9-1 Nihonbashi Tohri,
Chuo-ku, Tokyo, Japan, acts as an underwriter of the Fund's shares offered for
sale in Japan. Kokusai Securities Co., Ltd. ("Kokusai"), located at Shinjuku
Nomura Building, 26-2 Hishishinjuku 1-Chrone, Shinjuku, Japan, acts as a
co-underwriter of the Fund's shares offered for sale in Japan. For the fiscal
year ended May 31, 1996, Nomura and Kokusai received service fees in the amounts
of $97,894 and $516,864, respectively. For the fiscal year ended May 31, 1995,
Nomura and Kokusai received service fees in the amounts of $71,026 and $371,638,
respectively. For the fiscal year ended May 31, 1994, Nomura and Kokusai
received service fees in the amounts of $44,030 and $283,767, respectively.
In addition to an assignment of the Fund's Management Agreement and
Advisory Agreement, the Merger, if consummated, will also be deemed to cause an
assignment, as defined by the 1940 Act, of the Underwriting Agreement. As a
result, the Fund's Trustees have approved the following agreements, subject to
the Merger's completion: (i) a principal underwriting agreement with Evergreen
Funds Distributor, Inc. ("EFD") and the Fund; (ii) a marketing support agreement
between the Principal Underwriter and EFD with respect to the Fund; and (iii) a
subadministration agreement between Keystone and EFD with respect to the Fund.
EFD is a wholly-owned subsidiary of Furman Selz LLC. It is currently anticipated
that on or about January 2, 1997, Furman Selz LLC will transfer EFD, and its
related services, to BISYS Group, Inc. ("BISYS") (the "Transfer"). The Fund's
Trustees have also approved, subject to completion of the Transfer, (i) a
principal underwriting agreement with EFD and the Fund; (ii) a marketing support
agreement between the Principal Underwriter and EFD with respect to the Fund;
and (iii) a subadministration agreement between Keystone and BISYS with respect
to the Fund. The terms of such agreements will be substantially identical to the
terms of the agreements to be executed upon completion of the Merger.
BROKERAGE
It is Keystone's policy, in effecting transactions for the Fund 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
broker's 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
direct purchase from an issuer of certain securities for the Fund's portfolio
thereby taking 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 consider
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 that is
equitable to each fund or account. Although, in some cases, this system could
have a detrimental effect on the price or volume of the Fund's securities, the
Fund believes that in other cases its ability to participate in volume
transactions will produce better executions.
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.
During the fiscal years ended May 31, 1996, 1995, and 1994, the Fund paid
$2,853,950, $1,445,066, and $1,426,939, respectively, in brokerage fees. Of the
$1,445,066 paid in brokerage fees during fiscal 1995, $371,638 was paid to
Kokusai and $71,026 was paid to Nomura.
STANDARDIZED TOTAL RETURN AND YIELD QUOTATIONS
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 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 one, five and ten year
periods ended May 31, 1996 were 30.03% (including contingent deferred sales
charge), 156.56%, and 291.83%, respectively. The compounded average annual rates
of return for the one, five, and ten year periods ended May 31, 1996 were 30.03%
(including contingent deferred sales charge), 20.74% and 14.63%, 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 presently does not
intend to advertise current yield.
ADDITIONAL INFORMATION
State Street Bank and Trust Company, located at 225 Franklin Street,
Boston, Massachusetts 02110, is custodian of all securities and cash of the Fund
(the "Custodian"). The Custodian may hold securities of some foreign issuers
outside the United States. The Custodian performs no investment management
functions for the Fund, but, in addition to its custodial services, is
responsible for accounting and related recordkeeping on behalf of the Fund.
KPMG Peat Marwick LLP, located at 99 High Street, Boston, Massachusetts
02110, Certified Public Accountants, are the independent auditors for the Fund.
KIRC, located at 200 Berkeley Street, Boston, Massachusetts 02116-5034, is
a wholly-owned subsidiary of Keystone and acts as transfer agent and dividend
disbursing agent for the Fund.
As of August 30, 1996, Merrill Lynch Pierce Fenner & Smith, Attn: Book
Entry, 4800 Deer Lake Dr. E 3rd Floor, Jacksonville, FL 32246-6484, owned of
record 12.147% of the Fund's outstanding shares.
As of August 30, 1996, Rofe & Co., c/o State Street Bank & Trust Company,
Sub Account Kokusai Securities Co., Ltd., P.O. Box 5061, Boston, MA 02206-0001
owned of record 8.937% of the Fund's outstanding shares.
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.
If conditions arise that would make it undesirable for the Fund to pay for
all redemptions in cash, the Fund may authorize payment to be made in portfolio
securities or other property. The Fund has obligated itself, however, under the
1940 Act to redeem for cash all shares presented for redemption by any one
shareholder up to the lesser of $250,000 or 1% of the Fund's net assets in any
90-day period. Securities delivered in payment of redemptions would be valued at
the same value assigned to them in computing the net asset value per share and
would, to the extent permitted by law, be readily marketable. Shareholders
receiving such securities would incur brokerage costs upon the securities' sale.
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. 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 its registration statement filed with the
Securities and Exchange Commission, which may be obtained from the Commission's
principal office in Washington, D.C. upon payment of the fee prescribed by the
rules and regulations promulgated by the Commission.
<PAGE>
APPENDIX
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 considerable bearing on relative quality.
S&P rankings, however, do not reflect all of the factors, tangible or
intangible, that bear on stock quality.
Growth and stability of earnings and dividends are deemed key elements in
establishing S&P earnings and dividend rankings for common stocks, which
capsulize the nature of this record in a single symbol.
S&P has established a computerized scoring system based on per share
earnings and dividend records of the most recent ten years, a period deemed long
enough to measure a company's performance under varying economic conditions. S&P
measures growth, stability within the trend line and cyclicity. The ranking
system also makes allowances for company size, since large companies have
certain inherent advantages over small ones. From these, scores for earnings and
dividends are determined.
The final score for each stock is measured against a scoring matrix
determined by analysis of the scores of a large and repre sentative 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 perfor mance of earnings and
dividends, and relative current standing.
MOODY'S COMMON STOCK RANKINGS
Moody's presents a concise statement of the important char acteristics 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 anal ysis of each company's
financial strength, stability of earnings and record of dividend payments. Other
considerations include conserva tiveness of capitalization, depth and caliber of
management, accounting practices, technological capabilities and industry posi
tion. 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 pre ference 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.
CORPORATE BOND RATINGS
S&P CORPORATE BOND RATINGS
An S&P corporate bond rating is a current assessment of the
creditworthiness of an obligor, including obligors outside the United States,
with respect to a specific obligation. This assess ment may take into
consideration obligors such as guarantors, insurers, or lessees. Ratings of
foreign obligors do not take into account currency exchange and related
uncertainties. The ratings are based on current information furnished by the
issuer or obtained by S&P from other sources it considers reliable.
The ratings are based, in varying degrees, on the following considerations:
a. Likelihood of default - capacity and willingness of the obligor as to
the timely payment of interest and repayment of principal in accordance with the
terms of the obligation;
b. Nature of and provisions of the obligation; and
c. Protection afforded by and relative position of the obligation in the
event of bankruptcy, reorganization or other arrangement under the laws of
bankruptcy and other laws affecting creditors' rights.
PLUS (+) OR MINUS (-): To provide more detailed indications of credit
quality, ratings from "AA" to "A" may be modified by the addition of a plus or
minus sign to show relative standing within the major rating categories.
Bond ratings are as follows:
1. AAA - Debt rated AAA has the highest rating assigned by S&P. Capacity to
pay interest and repay principal is extremely strong.
2. AA - Debt rated AA has a very strong capacity to pay interest and repay
principal and differs from the higher rated issues only in small degree.
3. A - Debt rated A has a strong capacity to pay interest and repay
principal although it is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than debt in higher rated
categories.
4. BBB - Debt rated BBB is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher rated categories.
5. BB, B, CCC, CC and C - Debt rated BB, B, CCC, CC and C is regarded, on
balance, as predominantly speculative with respect to capacity to pay interest
and repay principal in accordance with the terms of the obligation. BB indicates
the lowest degree of speculation and C the highest degree of speculation. While
such debt will likely have some quality and protective characteristics, these
are outweighed by large uncertainties or major risk exposures to adverse
conditions.
MOODY'S CORPORATE BOND RATINGS
Moody's ratings are as follows:
1. Aaa - Bonds which are rated Aaa are judged to be of the best quality.
They carry the smallest degree of investment risk and are generally referred to
as "gilt-edge." Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized are
most unlikely to impair the fundamentally strong position of such issues.
2. Aa - Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known as
high grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in Aaa securities or fluctuation of protective
elements may be of greater amplitude or there may be other elements present
which make the long term risks appear somewhat larger than in Aaa securities.
3. A - Bonds which are rated A possess many favorable investment attributes
and are to be considered as upper medium grade obligations. Factors giving
security to principal and interest are considered adequate but elements may be
present which suggest a susceptibility to impairment sometime in the future.
4. Baa - Bonds which are rated Baa are considered as medium grade
obligations, i.e., they are neither highly protected nor poorly secured.
Interest payments and principal security appear adequate for the present but
certain protective elements may be lacking or may be characteristically
unreliable over any great length of time. Such bonds lack outstanding investment
charac teristics and in fact have speculative characteristics as well.
5. Ba - Bonds which are rated Ba are judged to have specu lative elements.
Their future cannot be considered as well assured. Often the protection of
interest and principal payments may be very moderate and thereby not well
safeguarded during both good and bad times over the future. Uncertainty of
position characterizes bonds in this class.
6. B - Bonds which are rated B generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or of
maintenance of other terms of the contract over any long period of time may be
small.
Moody's applies numerical modifiers 1, 2 and 3 in each generic rating
classification from Aa through B in its corporate bond rating system. The
modifier 1 indicates that the security ranks in the higher end of its generic
rating category; the modifier 2 indicates a mid-range ranking; and the modifier
3 indicates that the issue ranks in the lower end of its generic rating
category.
MONEY MARKET INSTRUMENTS
The Fund's investments in commercial paper are limited to those rated A-1
by Standard & Poor's Corporation, Prime-1 by Moody's Investors Service, Inc. or
F-1 by Fitch Investors Service, Inc. These ratings and other money market
instruments are described as follows:
COMMERCIAL PAPER RATINGS
Commercial paper rated A-1 by Standard & Poor's has the following
characteristics: Liquidity ratios are adequate to meet cash requirements. The
issuer's long-term senior debt is rated "A" or better, although in some cases
"BBB" credits may be allowed. The issuer has access to at least two additional
channels of borrowing. Basic earnings and cash flow have an upward trend with
allowance made for unusual circumstances. Typically, the issuer's industry is
well established and the issuer has a strong position within the industry.
The rating Prime-1 is the highest commercial paper rating assigned by
Moody's. Among the factors considered by Moody's in assigning ratings are the
following: (1) evaluation of the manage ment 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 pro ducts 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 Administra tion, 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 instrumental-ities in which the United States Government, its
agencies or instrumentalities participate, such as the World Bank, the Asian
Development Bank or the Inter-American Development Bank, or issues insured by
the Federal Deposit Insurance Corporation.
OPTIONS TRANSACTIONS
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 returns.
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 (OCC),a
clearing corporation which assumes responsi bility 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 secu rity with the same exercise price and
expiration date. (The Fund may, under certain circumstances, also be able to
transfer a pre viously 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 pur chasing 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 pos sible
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 under lying securities until the option expires or it
delivers the under lying 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 his torical levels.
This would result in higher transaction costs, in cluding brokerage commissions.
The Fund will pay brokerage commis sions 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 secu rities 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 port folio securities, with the risk that a potential loss may be in
creased 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 quali fies 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 pur poses 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 doing so, 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 or other financial futures contracts for the hedging purposes and in
connection with the hedging strategies described above.
Although techniques other than sales and purchases of futures contracts and
related options transactions could be used to reduce the Fund's exposure to
interest rate and/or market fluctuations, the Fund may be able to hedge its
exposure more effectively and perhaps at a lower cost through using futures
contracts and related options transactions. While the Fund does not intend to
take delivery of the instruments underlying futures contracts it holds, the Fund
does not intend to engage in such futures contracts for speculation.
FUTURES CONTRACTS
Futures contracts are transactions in the commodities markets rather than
in the securities markets. A futures contract creates an obligation by the
seller to deliver to the buyer the commodity specified in the contract at a
specified future time for a specified price. The futures contract creates an
obligation by the buyer to accept delivery from the seller of the commodity
specified at the specified future time for the specified price. In contrast, a
spot transaction creates an immediate obligation for the seller to deliver and
the buyer to accept delivery of and pay for an identified commodity. In general,
futures contracts involve transactions in fungible goods such as wheat, coffee
and soybeans. However, in the last decade an increasing number of futures
contracts have been developed which specify currencies, financial instruments or
financially based indexes as the underlying commodity.
U.S. futures contracts are traded only on national futures exchanges and
are standardized as to maturity date and underlying financial instrument. The
principal financial futures exchanges in the United States are The Board of
Trade of the City of Chicago, the Chicago Mercantile Exchange, the International
Monetary Market (a division of the Chicago Mercantile Exchange), the New York
Futures Exchange and the Kansas City Board of Trade. Each exchange guarantees
performance under contract provisions through a clearing corporation, a
nonprofit organization managed by the exchange membership, which is also
responsible for handling daily accounting of deposits or withdrawals of margin.
A futures commission merchant (Broker) effects each transaction in connection
with futures contracts for a commission. Futures exchanges and trading are
regulated under the Commodity Exchange Act by the Commodity Futures Trading
Commission (CFTC) and National Futures Association (NFA).
INTEREST RATE FUTURES CONTRACTS
The sale of an interest rate futures contract creates an obligation by the
Fund, as seller, to deliver the type of financial instrument specified in the
contract at a specified future time for a specified price. The purchase of an
interest rate futures contract creates an obligation by the Fund, as purchaser,
to accept delivery of the type of financial instrument specified at a specified
future time for a specified price. The specific securities delivered or
accepted, respectively, at settlement date, are not determined until at or near
that date. The determination is in accordance with the rules of the exchange on
which the futures contract sale or purchase was made.
Currently, interest rate futures contracts can be purchased or sold on
90-day U.S. Treasury bills, U.S. Treasury bonds, U.S. Treasury notes with
maturities between 6 1/2 and 10 years, Government National Mortgage Association
(GNMA) certificates, 90-day domestic bank certificates of deposit, 90-day
commercial paper, and 90-day Eurodollar certificates of deposit. It is expected
that futures contracts trading in additional financial instruments will be
authorized. The standard contract size is $100,000 for futures contracts in U.S.
Treasury bonds, U.S. Treasury notes and GNMA certificates, and $1,000,000 for
the other designated contracts. While U.S. Treasury bonds, U.S. Treasury bills
and U.S. Treasury notes are backed by the full faith and credit of the U.S.
government and GNMA certificates are guaranteed by a U.S. government agency, the
futures contracts in U.S. government securities are not obligations of the U.S.
Treasury.
INDEX BASED FUTURES CONTRACTS
a. Stock Index Futures Contracts
A stock index assigns relative values to the common stocks included in the
index. The index fluctuates with changes in the market values of the common
stocks so included. A stock index futures contract is a bilateral agreement by
which two parties agree to take or make delivery of an amount of cash equal to a
specified dollar amount times the difference between the closing value of the
stock index on the expiration date of the contract and the price at which the
futures contract is originally made. No physical delivery of the underlying
stocks in the index is made.
Currently, stock index futures contracts can be purchased or sold on the
Standard and Poor's Corporation (S&P) Index of 500 Stocks, the S&P Index of 100
Stocks, the New York Stock Exchange Composite Index, the Value Line Index and
the Major Market Index. It is expected that futures contracts trading in
additional stock indices will be authorized. The standard contract size is $500
times the value of the index.
The Fund does not believe that differences between existing stock indices
will create any differences in the price movements of the stock index futures
contracts in relation to the movements in such indices. However, such
differences in the indices may result in differences in correlation of the
futures with movements in the value of the securities being hedged.
b. Other Index Based Futures Contracts
It is expected that bond index and other financially based index futures
contracts will be developed in the future. It is anticipated that such index
based futures contracts will be structured in the same way as stock index
futures contracts but will be measured by changes in interest rates, related
indexes or other measures, such as the consumer price index. In the event that
such futures contracts are developed the Fund will sell interest rate index and
other index based futures contracts to hedge against changes which are expected
to affect the Fund's portfolio.
The purchase or sale of a futures contract differs from the purchase or
sale of a security, in that no price or premium is paid or received. Instead, to
initiate trading an amount of cash, cash equivalents, money market instruments,
or U.S. Treasury bills equal to approximately 1 1/2% (up to 5%) of the contract
amount must be deposited by the Fund with the Broker. This amount is known as
initial margin. The nature of initial margin in futures transactions is
different from that of margin in security transactions. Futures contract margin
does not involve the borrowing of funds by the customer to finance the
transactions. Rather, the initial margin is in the nature of a performance bond
or good faith deposit on the contract which is returned to the Fund upon
termination of the futures contract assuming all contractual obligations have
been satisfied. The margin required for a particular futures contract is set by
the exchange on which the contract is traded, and may be significantly modified
from time to time by the exchange during the term of the contract.
Subsequent payments, called variation margin, to the Broker and from the
Broker, are made on a daily basis as the value of the underlying instrument or
index fluctuates, making the long and short positions in the futures contract
more or less valuable, a process known as mark-to-market. For example, when the
Fund has purchased a futures contract and the price of the underlying financial
instrument or index has risen, that position will have increased in value and
the Fund will receive from the Broker a variation margin payment equal to that
increase in value. Conversely, where the Fund has purchased a futures contract
and the price of the underlying financial instrument or index has declined, the
position would be less valuable and the Fund would be required to make a
variation margin payment to the Broker. At any time prior to expiration of the
futures contract, the Fund may elect to close the position. A final
determination of variation margin is then made, additional cash is required to
be paid to or released by the Broker, and the Fund realizes a loss or gain.
The Fund intends to enter into arrangements with its custodian and with
Brokers to enable its initial margin and any variation margin to be held in a
segregated account by its custodian on behalf of the Broker.
Although interest rate futures contracts by their terms call for actual
delivery or acceptance of financial instruments and index based futures
contracts call for the delivery of cash equal to the difference between the
closing value of the index on the expiration date of the contract and the price
at which the futures contract is originally made, in most cases such futures
contracts are closed out before the settlement date without the making or taking
of delivery. Closing out a futures contract sale is effected by an offsetting
transaction in which the Fund enters into a futures contract purchase for the
same aggregate amount of the specific type of financial instrument or index and
same delivery date. If the price in the sale exceeds the price in the offsetting
purchase, the Fund is paid the difference and thus realizes a gain. If the
offsetting purchase price exceeds the sale price, the Fund pays the difference
and realizes a loss. Similarly, the closing out of a futures contract purchase
is effected by an offsetting transaction in which the Fund enters into a futures
contract sale. If the offsetting sale price exceeds the purchase price, the Fund
realizes a gain. If the purchase price exceeds the offsetting sale price the
Fund realizes a loss. The amount of the Fund's gain or loss on any transaction
is reduced or increased, respectively, by the amount of any transaction costs
incurred by the Fund.
As an example of an offsetting transaction, the contractual obligations
arising from the sale of one contract of September U.S. Treasury bills on an
exchange may be fulfilled at any time before delivery of the contract is
required (i.e. on a specified date in September, the "delivery month") by the
purchase of one contract of September U.S. Treasury bills on the same exchange.
In such instance the difference between the price at which the futures contract
was sold and the price paid for the offsetting purchase after allowance for
transaction costs, represents the profit or loss to the Fund.
There can be no assurance, however, that the Fund will be able to enter
into an offsetting transaction with respect to a particular contract at a
particular time. If the Fund is not able to enter into an offsetting
transaction, the Fund will continue to be required to maintain the margin
deposits on the contract and to complete the contract according to its terms.
OPTIONS ON CURRENCY AND OTHER FINANCIAL FUTURES
The Fund intends to purchase call and put options on currency and other
financial futures contracts and sell such options to terminate an existing
position. Options on currency or other financial futures contracts are similar
to options on stocks except that an option on a currency 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
currency or other instruments making up a financial futures index, 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 or 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 currency or other financial
futures contracts is analagous to the purchase of protec tive puts on individual
stocks, where an absolute level of protec tion is sought below which no
additional economic loss would be incurred by the Fund. Put options may be
purchased to hedge a port folio 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, 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 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 herein.
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.
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 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 rates or exchange control regulations between foreign
currencies and the dollar. Changes in foreign currency exchange rates also may
affect the value of dividends and interest earned, gains and losses realized on
the sale of securities and net investment income and gains, if any, to be
distributed to shareholders by the Fund.
CURRENCY FUTURES CONTRACTS
Currency futures contracts are bilateral agreements under which two parties
agree to take or make delivery of a specified amount of a currency at a
specified future time for a specified price. Trading of currency futures
contracts in the United States is regulated under the Commodity Exchange Act by
the Commodity Futures Trading Commission (CFTC) and National Futures Association
(NFA). Currently the only national futures exchange on which currency futures
are traded is the International Monetary Market of the Chicago Mercantile
Exchange. Foreign currency futures trading is conducted in the same manner and
subject to the same regulations as trading in interest rate and index based
futures. The Fund intends to engage in currency futures contracts 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 contracts are similar to those described above for forward
foreign currency exchange contracts.
Currently, currency futures contracts for the British Pound Sterling,
Canadian Dollar, Dutch Guilder, Deutsche Mark, Japanese Yen, Mexican Peso, Swiss
Franc, and French Franc can be purchased or sold for U.S. dollars through the
International Monetary Market. It is expected that futures contracts trading in
additional currencies will be authorized. The standard contract sizes are
L125,000 for the Pound, 125,000 for the Guilder, Mark, French Francs 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, French 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,
purchase of a call option may be less risky than the ownership of the foreign
currency or the foreign securities. The Fund would purchase a call option on a
foreign currency to hedge against an increase in the foreign currency or a
foreign market advance when the Fund is not fully invested.
The Fund may employ new investment techniques involving forward foreign
currency exchange contracts, foreign currency futures contracts and options on
foreign currencies in order to take advantage of new techniques in these areas
which may be developed from time to time and which are consistent with the
Fund's investment objective. The Fund believes that no additional techniques
have been identified for employment by the Fund in the foreseeable future other
than those described above.
CURRENCY TRADING RISKS
Currency exchange trading may involve significant risks. The four major
types of risk the Fund faces are exchange rate risk, interest rate risk, credit
risk and country risk.
EXCHANGE RATE RISK
Exchange rate risk results from the movement up and down of foreign
currency values in response to shifting market supply and demand. When the Fund
buys or sells a foreign currency, an exposure called an open position is
created. Until the time that position can be "covered" by selling or buying an
equivalent amount of the same currency, the Fund is exposed to the risk that the
exchange rate might move against it. Since exchange rate changes can readily
move in one direction, a position carried overnight or over a number of days
involves greater risk than one carried a few minutes or hours. Techniques such
as foreign currency forward and futures contracts and options on foreign
currency are intended to be used by the Fund to reduce exchange rate risk.
MATURITY GAPS AND INTEREST RATE RISK
Interest rate risk arises whenever there are mismatches or gaps in the
maturity structure of the Fund's foreign exchange currency holdings, which is
the total of its outstanding spot and forward or futures contracts.
Foreign currency transactions often involve borrowing short term and
lending longer term to benefit from the normal tendency of interest rates to be
higher for longer maturities. However in foreign exchange trading, while the
maturity pattern of interest rates for one currency is important, it is the
differential between interest rates for two currencies that is decisive.
CREDIT RISK
Whenever the Fund enters into a foreign exchange contract, it faces a risk,
however small, that the counterparty will not perform under the contract. As a
result there is a credit risk, although no extension of "credit" is intended. To
limit credit risk, the Fund intends to evaluate the creditworthiness of each
other party. The Fund does not intend to trade more than 5% of its net assets
under foreign exchange contracts with one party.
Credit risk exists because the Fund's counterparty may be unable or
unwilling to fulfill its contractual obligations as a result of bankruptcy or
insolvency or when foreign exchange controls prohibit payment. In any foreign
exchange transaction, each party agrees to deliver a certain amount of currency
to the other on a particular date. In establishing its hedges 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 difference between the
U.S. and foreign nations. If the Fund sells small 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
payments 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 liberal-izations 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.
ADDITIONAL INFORMATION REGARDING DERIVATIVE INSTRUMENTS
Derivatives have been variously defined to include forwards, futures,
options, mortgage-backed securities, other asset-backed securities and
structured securities, such as interest rate swaps, equity swaps, index swaps,
currency swaps and caps and floors. These basic vehicles can also be combined to
create more complex products, called hybrid derivatives. Options, fututes and
forwards are discussed elsewhere in the Fund's prospectus and statement of
additional information. The following discussion addresses mortgage backed and
other asset-backed securities, structured securities and other instruments.
COLLATERALIZED MORTGAGE OBLIGATIONS
The Fund, if allowed, may also invest in fixed rate and adjustable rate
collateralized mortgage obligations ("CMOs"), including CMOs with rates that
move inversely to market rates that are issued by and guaranteed as to principal
and interest by the U.S. government, its agencies or instrumentalities. The
principal governmental issuer of CMOs is FNMA. In addition, FHLMC issues a
significant number of CMOs. The Fund, if permitted to invest in CMOs, will not
invest in CMOs that are issued by private issuers. CMOs are debt obligations
collateralized by Mortgage Securities in which the payment of the principal and
interest is supported by the credit of, or guaranteed by, the U.S. government or
an agency or instrumentality of the U.S. government. The secondary market for
CMOs is actively traded.
CMOs are structured by redirecting the total payment of principal and
interest on the underlying Mortgage Securities used as collateral to create
classes with different interest rates, maturities and payment schedules. Instead
of interest and principal payments on the underlying Mortgage Securities being
passed through or paid pro rata to each holder (e.g., the Fund), each class of a
CMO is paid from and secured by a separate priority payment of the cash flow
generated by the pledged Mortgage Securities.
Most CMO issues have at least four classes. Classes with an earlier
maturity receive priority on payments to assure the early maturity. After the
first class is redeemed, excess cash flow not necessary to pay interest on the
remaining classes is directed to the repayment of the next maturing class until
that class is fully redeemed. This process continues until all classes of the
CMO issue have been paid in full. Among the CMO classes available are floating
(adjustable) rate classes, which have characteristics similar to ARMS, and
inverse floating rate classes whose coupons vary inversely with the rate of some
market index. The Fund, if allowed to purchase CMOs, may purchase any class of
CMO other than the residual (final) class.
INTEREST-RATE SWAP CONTRACTS
Interest rate swaps are over-the-counter ("OTC") agreements between parties
and counterparties to make periodic payments to each other for a stated time,
generally entered into for the purpose of changing the nature or amount of
interest being received on debt securities held by one or both parties. The
calculation of these payments is based on an agreed-upon amount called the
"notional amount." The notional amount is not typically exchanged in swaps
(except in currency swaps). The periodic payments may be fixed or floating.
Floating payments change (positively or inversely) with fluctuations in interest
or currency rates or equity or commodity prices, depending on the swap
contract's terms.
Swaps may be used to hedge against adverse changes in interest rates, for
instance. Thus, if permitted by its investment policies, the Fund may have a
portfolio of debt instruments (ARM's, for instance) the floating interest rates
of which adjust frequently because they are tied positively to changes in market
interest rates. The Fund would then be exposed to interest rate risk because a
decline in interest rates would reduce the interest receipts on its portfolio.
If the investment adviser believed interest rates would decline, the Fund, if
permitted by its investment policies, could enter into an interest rate swap
with another financial institution to hedge the interest rate risk. In the swap
contract, the Fund would agree to make payments based on a floating interest
rate in exchange for receiving payments based on a fixed interest rate.
Thereafter, if interest rates declined, the Fund's fixed rate receipts on the
swap would offset the reduction in its portfolio receipts. If interest rates
rose, the higher rates the Fund could obtain from new portfolio investments
(assuming sale of existing investments) would offset the higher rates it paid
under the swap agreement.
EQUITY SWAP CONTRACTS
The counterparty to an equity swap contract would typically be a bank,
investment banking firm or broker/dealer. For example, the counterparty would
generally agree to pay the Fund the amount, if any, by which the notional amount
of the equity swap contract would have increased in value if such notional
amount had been invested in the stocks comprising the S&P 500 Index in
proportion to the composition of the Index, plus the dividends that would have
been received on those stocks. The Fund would agree to pay to the counterparty a
floating rate of interest (typically the London Inter Bank Offered Rate) on the
notional amount of the equity swap contract plus the amount, if any, by which
that notional amount would have decreased in value had it been invested in such
index stocks. Therefore, the return to the Fund on any equity swap contract
should be the gain or loss on the notional amount plus dividends on the stocks
comprising the S&P 500 Index less the interest paid by the Fund on the notional
amount. If permitted by its investment policies, the Fund will only enter into
equity swap contracts on a net basis, i.e., the two parties' obligations are
netted out, with the Fund paying or receiving, as the case may be, only the net
amount of any payments. Payments under equity swap contracts may be made at the
conclusion of the contract or periodically during its term.
If permitted by its investment policies, the Fund may also from time to
time enter into the opposite side of equity swap contracts (i.e., where the Fund
is obligated to pay the increase (net of interest) or received the decrease
(plus interest) on the contract) to reduce the amount of the Fund's equity
market exposure consistent with the Fund's investment objective(s) and policies.
These positions are sometimes referred to as "reverse equity swap contracts."
Equity swap contracts will not be used to leverage the Fund. Since the SEC
considers equity swap contracts and reverse equity swap contracts to be illiquid
securities, the Fund will not invest in equity swap contracts or reverse equity
swap contracts if the total value of such investments together with that of all
other illiquid securities that the Fund owns would exceed the Fund's limitations
on investments in illiquid securities.
The Fund does not believe that its obligations under equity swap contracts
or reverse equity swap contracts are senior securities and, accordingly, the
Fund will not treat them as being subject to its borrowing restrictions.
However, the net amount of the excess, if any, of the Fund's obligations over
its respective entitlement with respect to each equity swap contract and each
reverse equity swap contract will be accrued on a daily basis and an amount of
cash, U. S. Government Securities or other liquid high quality debt securities
having an aggregate market value at lease equal to the accrued excess will be
maintained in a segregated account by the Fund's Custodian.
CURRENCY SWAPS, INDEX SWAPS AND CAPS AND FLOORS
A currency swap is an agreement to exchange cash flows on a notional amount
of two or more currencies based on the relative value differential among them.
An index swap is an agreement to swap cash flows on a notional amount based on
changes in the values of reference indices. The purchase of an interest rate cap
entitles the purchaser, to the extent that a specified index exceeds an
agree-upon interest rate, to receive payments of interest on a notional
principal amount from the party selling such interest rate cap. The purchase of
an interest rate floor entitles the purchaser to receive payments of interest on
a notional principal amount from the party selling such interest rate floor. If
permitted by the Fund's investment policies, the investment adviser expects to
enter into these types of transactions on behalf of the Fund primarily to
preserve a return or spread on a particular investment or portion of its
portfolio or to protect against any increase in the price of securities the Fund
anticipates purchasing at a later date rather than for speculative purposes.
Accordingly, if permitted by the Fund's investment policies, the Fund intends to
use these transactions as hedges and not as speculative investments and will not
sell interest rate caps or floors unless it owns securities or other instruments
providing the income stream the Fund may be obligated to pay. Caps and floors
require segregation of assets with a value equal to the Fund's net obligation,
if any.
SPECIAL RISKS OF SWAPS, CAPS AND FLOORS
As with futures, options, forward contracts, and mortgage backed and other
asset-backed securities, the use of swap, cap and floor contracts exposes the
Fund to additional investment risk and transaction costs. These risks include
operational risk, market risk and credit risk.
Operational risk includes, among others, the risks that the investment
adviser will incorrectly analyze market conditions or will not employ
appropriate strategies and monitoring with respect to these instruments or will
be forced to defer closing out certain hedged positions to avoid adverse tax
consequences.
Market risk includes, among others, the risks of imperfect correlations
between the expected values of the contracts, or their underlying bases, and
movements in the prices of the securities or currencies being hedged, and the
possible absence of a liquid secondary market for any particular instrument at
any time. The swap market has grown substantially in recent years with a large
number of banks and investment banking firms acting both as principals and as
agents utilizing standardized swap documentation. As a result, the swap market
has become relatively more illiquid. Nevertheless, a secondary market for swaps
is never assured, and caps and floors, which are more recent innovations for
which standardized documentation has not yet been fully developed, are much less
liquid than swaps.
Credit risk is primarily the risk that counterparties may be financially
unable to fulfill their contracts on a timely basis, if at all. If there is a
default by the counterparty to any such contract, the Fund will be limited to
contractual remedies pursuant to the agreements related to the transaction.
There is no assurance that contract counterparties will be able to meet contract
obligations or that, in the event of default, the Fund will succeed in pursuing
contractual remedies. The Fund thus assumes the risk that it may be delayed in
or prevented from obtaining payments owed to it pursuant to such contracts. The
Fund will closely monitor the credit of swap counterparties in order to minimize
this risk. The Fund will not enter into any equity swap contract or reverse
equity swap contract unless, at the time of entering into such transaction, the
unsecured senior debt of the counterparty is rated at least A by Moody's or S&P.
<PAGE>
- ---------------------------------------
Keystone Small Company Growth Fund (S-4)
SCHEDULE OF INVESTMENTS--May 31, 1996
Market
Shares Value
- ----------------------------------- ---------- -----------------
COMMON STOCKS (98.2%) (d)
AEROSPACE (0.4%)
Rohr Industries, Inc. 419,500 $ 8,861,938
- ----------------------------------- -------- ---------------
ADVERTISING & PUBLISHING (1.5%)
Clear Channel Communications, Inc. 340,000 27,625,000
Outdoor Systems, Inc. 42,800 1,380,300
- ----------------------------------- -------- ---------------
29,005,300
- ----------------------------------- -------- ---------------
AIR TRANSPORTATION (0.6%)
America West Airlines, Inc. 300,000 6,112,500
Atlantic Southeast Airlines, Inc.
(e) 250,000 6,640,625
- ----------------------------------- -------- ---------------
12,753,125
- ----------------------------------- -------- ---------------
AMUSEMENTS (4.1%)
Harrah's Entertainment, Inc. 500,000 16,812,500
Hospitality Franchise Systems, Inc. 400,000 24,950,000
Hollywood Casino Corp., Class A 1,000,000 4,937,500
La Quinta Inns, Inc. (e) 300,000 9,450,000
Players International, Inc. 395,000 3,845,078
Promus Hotel Corp. 450,000 12,375,000
Station Casinos, Inc. 650,000 10,196,875
- ----------------------------------- -------- ---------------
82,566,953
- ----------------------------------- -------- ---------------
AUTOMOTIVE (1.0%)
Gentex Corp. 300,000 13,500,000
Tower Automotive, Inc. 307,500 7,380,000
- ----------------------------------- -------- ---------------
20,880,000
- ----------------------------------- -------- ---------------
BUILDING MATERIALS (3.1%)
Amre, Inc. (b) 940,300 25,153,025
Champion Enterprises, Inc. 292,000 11,826,000
Oakwood Homes Corp. (e) 500,000 24,250,000
- ----------------------------------- -------- ---------------
61,229,025
- ----------------------------------- -------- ---------------
BUSINESS SERVICES (2.7%)
Alternative Resources Corp. 216,000 8,370,000
Safeguard Scientifics, Inc. 250,000 22,031,250
Security Dynamics Technologies,
Inc. 213,400 19,072,625
Vincam Group, Inc. 152,000 4,294,000
- ----------------------------------- -------- ---------------
53,767,875
- ----------------------------------- -------- ---------------
CAPITAL GOODS (1.9%)
AGCO Corp. (e) 800,000 24,100,000
Cognex Corp. 740,500 13,236,437
- ----------------------------------- -------- ---------------
37,336,437
- ----------------------------------- -------- ---------------
CHEMICALS (0.5%)
OM Group, Inc. (e) 249,300 $ 10,034,325
- ----------------------------------- -------- ---------------
CONSUMER GOODS (2.2%)
Blyth Industries, Inc. 400,000 18,400,000
DeVry, Inc. Del 467,000 18,563,250
USA Detergents, Inc. 167,400 6,633,225
- ----------------------------------- -------- ---------------
43,596,475
- ----------------------------------- -------- ---------------
DRUGS (6.3%)
Agouron Pharmaceuticals, Inc. 200,000 8,550,000
Amylin Pharmaceuticals, Inc. 1,000,000 12,187,500
Autoimmune, Inc. 23,400 234,000
Cephalon, Inc. 200,000 5,425,000
Cytyc Corp. (e) 200,000 6,350,000
Cytotherapeutics 340,000 4,165,000
Gilead Sciences, Inc. 858,100 29,818,975
Human Genome Sciences, Inc. 253,500 9,316,125
Idexx Laboratories, Inc. 300,000 13,012,500
Magainin Pharmaceutical, Inc. 600,000 6,750,000
Matrix Pharmaceuticals, Inc. 188,000 4,136,000
Neurogen Corp. 390,000 11,261,250
Oncogene Science, Inc. 255,000 2,964,375
Sequus Pharmaceuticals, Inc. 564,800 12,072,600
- ----------------------------------- -------- ---------------
126,243,325
- ----------------------------------- -------- ---------------
ELECTRONICS PRODUCTS (7.5%)
Analog Devices, Inc. 600,000 16,575,000
BMC Industries, Inc. (e) 50,000 1,487,500
Gemstar International Group Ltd. 304,200 10,114,650
Kemet Corp. 379,600 8,541,000
Linear Technology Corp. (e) 320,000 11,000,000
Maxim Integrated Products, Inc. 586,000 19,960,625
Merix Corp. (b) 345,000 10,759,688
Microchip Technology, Inc. 450,000 11,671,875
SDL, Inc. (b) 450,000 19,293,750
Sheldahl Co. 5,000 128,438
Sipex Corp. 255,300 4,563,488
Solectron Corp. 300,000 13,012,500
Trimble Navigation Ltd. 244,900 5,877,600
Xilinx, Inc. 500,000 17,312,500
- ----------------------------------- -------- ---------------
150,298,614
- ----------------------------------- -------- ---------------
<PAGE>
- ---------------------------------------
SCHEDULE OF INVESTMENTS---May 31, 1996
Market
Shares Value
- ----------------------------------- ---------- -----------------
FINANCE (6.4%)
Astoria Financial Corp. (e) 106,500 $ 5,917,406
BISYS Group, Inc. 500,000 18,281,250
BostonFed Bancorp, Inc. (e) 300,000 3,675,000
Chronicle 2001 Mutual Fund 1,653,374 714,469
CMAC Investment Corp. (e) 300,000 16,350,000
First Empire State Corp. (e) 25,000 5,900,000
Jayhawk Acceptance Corp. 300,000 4,218,750
Long Islands Bancorp, Inc. (e) 500,000 14,093,750
Queen's County Bancorp (e) 145,000 6,923,750
RAC Financial Group, Inc. 427,300 12,445,113
Standard Federal Bankcorporation,
Inc. (e) 500,000 19,687,500
TCF Financial Corp. (e) 600,000 20,550,000
- ----------------------------------- -------- ---------------
128,756,988
- ----------------------------------- -------- ---------------
HEALTH CARE SERVICES (10.7%)
Biopsys Med, Inc. 97,900 2,435,263
CNS, Inc. 300,000 6,581,250
Emeritus Corp. 500,000 10,125,000
Express Scripts, Inc., Class A 310,000 15,500,000
Health Management Associates, Inc.,
Class A 499,400 17,229,317
Heartport, Inc. 207,100 8,025,125
Heartstream, Inc. 390,300 5,659,350
Iridex Corp. 190,000 3,087,500
i-STAT Corp. 86,000 1,752,250
Lifecore Biomedical, Inc. 510,700 9,128,762
MedCath, Inc. 268,700 10,177,012
Novoste Corp. 65,000 905,938
Occusystems, Inc. 400,000 13,400,000
Optical Sensors, Inc. 226,600 2,761,688
Parexel International Corp. 203,500 10,989,000
Perclose, Inc. 250,000 5,625,000
PhyMatrix Corp. 600,000 14,812,500
Physician Reliance Network, Inc. 405,000 21,110,625
Sibia Neurosciences, Inc. 135,000 1,350,000
Target Therapeutics, Inc. 200,000 9,825,000
Thermo Cardiosystems, Inc. 600,000 30,600,000
Total Renal Care Hldgs., Inc. 295,000 12,168,750
Urologix, Inc. 100,000 1,487,500
- ----------------------------------- -------- ---------------
214,736,830
- ----------------------------------- -------- ---------------
INSURANCE (1.2%)
Blanch (E.W.) Hldgs., Inc. (e) 120,100 $ 2,552,124
Capital Re Corp. (e) 136,100 4,967,650
HCC Insurance Hldgs., Inc. 790,250 17,089,156
- ----------------------------------- -------- ---------------
24,608,930
- ----------------------------------- -------- ---------------
METALS & MINING (0.2%)
RMI Titanium Co. 220,000 4,427,500
- ----------------------------------- -------- ---------------
MISCELLANEOUS (0.6%)
Polymer Group, Inc. 461,000 8,874,250
Strategic Distribution, Inc. 350,000 2,909,375
- ----------------------------------- -------- ---------------
11,783,625
- ----------------------------------- -------- ---------------
NATURAL GAS (0.6%)
Nuevo Energy Co. 400,000 12,400,000
- ----------------------------------- -------- ---------------
OFFICE & BUSINESS EQUIPMENT (2.5%)
EMC Corp. 1,750,000 38,718,750
Natural Microsystems Corp. 200,000 7,500,000
Read Rite Corp. 171,900 3,953,700
- ----------------------------------- -------- ---------------
50,172,450
- ----------------------------------- -------- ---------------
OIL (0.4%)
Triton Energy Corp. 152,000 7,296,000
- ----------------------------------- -------- ---------------
OIL SERVICES (3.4%)
BJ Services Co. 260,800 8,802,000
Carbo Ceramics, Inc. 147,800 3,528,725
Dual Drilling Co. 11,400 218,025
Ensco International, Inc. 867,900 26,362,462
Falcon Drilling, Inc. 300,000 7,218,750
Global Industries, Inc. 272,800 8,525,000
Newpark Resources, Inc. 370,545 13,432,256
- ----------------------------------- -------- ---------------
68,087,218
- ----------------------------------- -------- ---------------
RESTAURANTS (2.1%)
Apple South, Inc. (d) 400,000 10,000,000
Applebee's International, Inc. (e) 400,000 11,275,000
HomeTown Buffet, Inc. 174,400 2,605,100
Lone Star Steakhouse & Saloon 150,000 6,037,500
Outback Steakhouse, Inc. 300,000 11,381,250
- ----------------------------------- -------- ---------------
41,298,850
- ----------------------------------- -------- ---------------
<PAGE>
- ---------------------------------------
Keystone Small Company Growth Fund (S-4)
SCHEDULE OF INVESTMENTS-May 31, 1996
Market
Shares Value
- ----------------------------------- ---------- -----------------
RETAIL (9.0%)
CDW Computer Centers, Inc. 204,600 $ 16,751,625
Corporate Express, Inc. 500,000 21,000,000
Global Directmail Corp. 300,000 13,462,500
Kohl's Corp. 314,000 10,401,250
Mens Wearhouse, Inc. 317,500 10,596,563
Nautica Enterprises, Inc. 486,000 12,150,000
Office Max, Inc. 575,000 15,021,875
O'Reilly Automotive, Inc. 166,600 6,455,750
PETsMART, Inc. 400,000 17,700,000
Saks Hldgs., Inc. 210,200 6,831,500
Sports Authority, Inc. 500,000 14,875,000
Sunglass Hut International, Inc. 600,000 16,612,500
Tiffany & Co. (e) 160,000 12,140,000
West Marine, Inc. 93,800 6,683,250
- ----------------------------------- -------- ---------------
180,681,813
- ----------------------------------- -------- ---------------
SERVICES (4.6%)
Equity Corporation International 387,400 11,379,875
G & K Services, Class A (e) 216,300 6,516,037
GTS Duratek, Inc. 300,000 5,175,000
Insituform Technologies, Inc.,
Class A 232,800 2,226,150
Molten Metal Technology, Inc. 466,100 14,099,525
Peak Technologies Group, Inc. 400,000 9,650,000
Sanifill, Inc. 266,000 11,936,750
Thermedics, Inc. 600,000 18,000,000
U.S. Filter Corp. 400,000 13,950,000
- ----------------------------------- -------- ---------------
92,933,337
- ----------------------------------- -------- ---------------
SOFTWARE SERVICES (15.6%)
America Online, Inc. 400,000 22,625,000
Arbor Software Corp. 177,000 10,797,000
BDM International, Inc. 402,000 17,788,500
BMC Software, Inc. 500,000 31,562,500
CBT Group Publishers, Ltd. 140,000 6,510,000
CMG Information Services, Inc. 441,100 10,420,987
Cambridge Technology Partners Mgmt. 183,000 13,953,750
Desktop Data, Inc. 250,000 8,312,500
Edify Corp. 97,000 4,098,250
Epic Design Technology, Inc. 500,000 14,937,500
Geoworks, Inc. 500,000 17,625,000
I2 Technologies, Inc. 189,000 7,560,000
INSO Corp. 300,000 16,800,000
Integrated Systems, Inc., Class A 40,000 1,340,000
Intuit, Inc. 205,000 10,660,000
McAfee Associates, Inc. 450,000 16,762,500
Mechanical Dynamics, Inc. 150,000 2,671,875
MetaTools, Inc. 278,600 8,810,725
National Data Corp. (e) 337,000 12,721,750
Nova Corp. 17,800 676,400
Parametric Technology Corp. (c) 400,000 18,275,000
Project Software & Development,
Inc. 323,500 12,576,063
Raptor Systems, Inc. 96,500 2,985,469
Synopsys, Inc. 500,000 22,312,500
System Software Associates, Inc.
(e) 277,500 4,578,750
Verity, Inc. 260,400 10,057,950
Wind River Systems, Inc. 168,750 5,378,906
Wonderware Corp. 28,500 570,000
- ----------------------------------- -------- ---------------
313,368,875
- ----------------------------------- -------- ---------------
TELECOMMUNICATIONS (7.6%)
Allen Group, Inc. (e) 146,000 4,015,000
Brooks Fiber Properties, Inc. 306,100 10,292,612
CAI Wireless Systems, Inc. 277,500 2,965,781
Cidco, Inc. 400,000 15,800,000
Heartland Wireless Communications,
Inc. 700,000 18,681,250
Netmanage, Inc. 700,000 11,856,250
P-Com, Inc. 600,000 18,000,000
Premisys Communications, Inc. 231,200 13,207,300
Proxim, Inc. 132,500 5,482,188
Spectrian Corp. 374,400 7,254,000
Tel-Save Hldgs., Inc. 613,500 13,343,625
Westell Technologies, Inc., Class A 87,000 6,666,375
Winstar Communications, Inc. 800,000 25,000,000
- ----------------------------------- -------- ---------------
152,564,381
- ----------------------------------- -------- ---------------
TRANSPORTATION (1.5%)
Landstar System, Inc. 312,500 9,140,625
Railtex, Inc. 454,100 11,068,688
Swift Transportation Co., Inc. 500,000 9,187,500
- ----------------------------------- -------- ---------------
29,396,813
- ----------------------------------- -------- ---------------
TOTAL COMMON STOCKS
(Cost--$1,367,076,131) 1,969,087,002
- ----------------------------------- -------- ---------------
<PAGE>
- ---------------------------------------
SCHEDULE OF INVESTMENTS--May 31, 1996
<TABLE>
<CAPTION>
Par Market
Value Value
- --------------------------------------------------------- ---------- --------------
<S> <C> <C>
FIXED INCOME (0.4%)
INDUSTRIAL BONDS & NOTES (0.4%)
AMUSEMENTS (0.4%)
Hemmeter Enterprises, Inc., Sr. PIK Note (c)(e)(g)
12.00%, 2000 $16,642,763 $ 7,655,671
- --------------------------------------------------------- -------- ------------
TOTAL FIXED INCOME
(Cost--$17,775,758) 7,655,671
- --------------------------------------------------------- -------- ------------
Maturity
Value
- --------------------------------------------------------- -------- ------------
SHORT-TERM INVESTMENTS (0.7%)
Investments in repurchase agreements, in a joint trading
account purchased 5/31/96, 5.3354%, maturing 06/01/96 14,769,564 14,763,000
- --------------------------------------------------------- -------- ------------
TOTAL SHORT-TERM INVESTMENTS
(Cost--$14,763,000)(e)(f) 14,763,000
- ----------------------------------------------------------------------- ------------
Market
Shares Value
- --------------------------------------------------------- -------- ------------
WARRANTS/RIGHTS (0.0%)
AMUSEMENTS (0.0%)
Hemmeter Enterprises, Inc. (c), expiration date of
12/15/99 292,400 292
Hemmeter Enterprises, Inc. (c), expiration date of
12/15/99 78,750 79
- --------------------------------------------------------- -------- ------------
TOTAL WARRANTS/RIGHTS (Cost--$1,866,383) 371
- --------------------------------------------------------- -------- ------------
TOTAL INVESTMENTS
(Cost $1,401,481,272) (a) 1,991,506,044
- --------------------------------------------------------- -------- ------------
FOREIGN CURRENCY HOLDINGS
(Cost $5,863) (0.0%) 5,781
- ----------------------------------------------------------------------- ------------
OTHER ASSETS AND LIABILITIES--NET (0.7%) 14,290,752
- --------------------------------------------------------- -------- ------------
NET ASSETS (100%) $2,005,802,577
- --------------------------------------------------------- -------- ------------
</TABLE>
<PAGE>
- ---------------------------------------
Keystone Small Company Growth Fund (S-4)
SCHEDULE OF INVESTMENTS-May 31,1996
(a) The cost of investments and foreign currency holdings for federal income
tax purposes amounted to $1,402,485,793. Gross unrealized appreciation and
depreciation on investments, based on identified tax cost, at May 31,
1996, are as follows:
Gross unrealized appreciation $632,810,492
Gross unrealized depreciation (43,784,460)
-----------
Net unrealized appreciation $589,026,032
===========
(b) Affiliated issuers are those in which the Fund's holdings of an issuer
represent 5% or more of the outstanding voting securities of the issuer.
The Fund has never owned enough of the outstanding voting securities of
any issuer to have control (as defined in the Investment Company Act of
1940) of that issuer.
(c) All or a portion of these securities are restricted (i.e., securities
which may not be publicly sold without registration under the Federal
Securities Act of 1933) which are valued using market quotations where
readily available. In the absence of market quotations, the securities are
valued based upon their fair value determined under procedures approved by
the Board of Trustees. The Fund may make investments in an amount up to
15% of the value of the Fund's net assets in such securities. On the date
of acquisition there was no market quotation on similar securities and the
above securities were valued at acquisition cost. At May 31, 1996, the
fair value of these restricted securities was $8,212,790, (0.41% of net
assets). The Fund will not pay the costs of disposition of the above
restricted securities other than ordinary brokerage fees, if any.
(d) All securities unless otherwise indicated with a (e) are
non-income-producing.
(e) Income-producing security.
(f) The repurchase agreements are fully collateralized by U.S. government
and/or agency obligations based on market prices on May 31, 1996.
(g) Each unit is comprised of $1,000 par Senior Secured PIK note and 15
warrants.
See Notes to Financial Statements.
<PAGE>
- ---------------------------------------
FINANCIAL HIGHLIGHTS
(For a share outstanding throughout the year)
<TABLE>
<CAPTION>
Year Ended May 31,
1996 1995 1994 1993(a) 1992(a) 1991(a)
- ------------------------------- -------- -------- --------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Net asset value beginning of
year $8.62 $7.64 $7.95 $7.61 $7.17 $6.24
- ------------------------------- ------- ------- ------- ------- ------- -------
Income from investment operations
Net investment income (loss) (0.13) (0.07) (0.12) (0.12) (0.08) (0.04)
Net realized and unrealized
gains (losses) on investments 2.87 1.68 0.63 1.82 0.98 1.17
Net commission paid on fund
share sales (b) 0.00 0.00 0.00 0.00 0.00 0.00
- ------------------------------- ------- ------- ------- ------- ------- -------
Total from investment
operations 2.74 1.61 0.51 1.70 0.90 1.13
- ------------------------------- ------- ------- ------- ------- ------- -------
Less distributions from
Net investment income 0.00 0.00 0.00 0.00 0.00 0.00
Net realized gains (1.01) (0.63) (0.82) (1.36) (0.46) (0.20)
- ------------------------------- ------- ------- ------- ------- ------- -------
Total distributions (1.01) (0.63) (0.82) (1.36) (0.46) (0.20)
- ------------------------------- ------- ------- ------- ------- ------- -------
Net asset value end of year $10.35 $8.62 $7.64 $7.95 $7.61 $7.17
- ------------------------------- ------- ------- ------- ------- ------- -------
Total return (c) 33.03% 23.58% 6.84% 28.76% 13.45% 19.42%
Ratios/supplemental data
Ratios to average net assets:
Total expenses 1.73%(d) 1.78% 1.73% 2.04% 1.47% 1.48%
Net investment (loss) (1.34%) (1.10%) (1.49%) (1.68%) (1.09%) (0.68%)
Portfolio turnover rate 94% 38% 60% 78% 81% 73%
Average commission rate paid $0.0563 N/A N/A N/A N/A N/A
- ------------------------------- ------- ------- ------- ------- ------- -------
Net assets end of year
(thousands) $2,005,803 $1,459,955 $1,005,595 $965,959 $702,442 $623,291
- ------------------------------- ------- ------- ------- ------- ------- -------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
1990(a) 1989(a) 1988 1987
- ------------------------------- -------- -------- --------- --------
<S> <C> <C> <C> <C>
Net asset value beginning of
year $ 5.66 $ 4.48 $ 7.80 $ 7.60
- ------------------------------- ------- ------- ------- -------
Income from investment
operations
Net investment income (loss) 0.00 0.02 0.00 0.00
Net realized and unrealized
gains (losses) on investments 0.63 1.20 (1.64) 1.11
Net commission paid on fund
share sales (b) 0.00 0.00 0.00 (0.02)
- ------------------------------- ------- ------- ------- -------
Total from investment
operations 0.63 1.22 (1.64) 1.09
- ------------------------------- ------- ------- ------- -------
Less distributions from
Net investment income (0.05) (0.01) 0.00 (0.01)
Net realized gains 0.00 (0.03) (1.68) (0.88)
- ------------------------------- ------- ------- ------- -------
Total distributions (0.05) (0.04) (1.68) (0.89)
- ------------------------------- ------- ------- ------- -------
Net asset value end of year $ 6.24 $ 5.66 $ 4.48 $ 7.80
- ------------------------------- ------- ------- ------- -------
Total return (c) 11.24% 27.45% (22.39%) 16.24%
Ratios/supplemental data
Ratios to average net assets:
Total expenses 1.40% 1.27% 1.17% 0.81%
Net investment (loss) 0.02% 0.47% 0.03% 0.04%
Portfolio turnover rate 77% 57% 80% 74%
Average commission rate paid N/A N/A N/A N/A
- ------------------------------- ------- ------- ------- -------
Net assets end of year
(thousands) $537,912 $503,908 $442,020 $679,281
- ------------------------------- ------- ------- ------- -------
</TABLE>
(a) Calculation based on average shares outstanding.
(b) Prior to June 30, 1987, net commissions paid on new sales of shares under
the Fund's Rule 12b-1 Distribution Plan had been treated for both financial
statement and tax purposes as capital charges. On June 11, 1987, the
Securities and Exchange Commission adopted a Rule which required for
financial statements for periods ended on or after June 30, 1987, that net
commissions paid under Rule 12b-1 Distribution Plans be treated as operating
expenses rather than as capital charges. Accordingly, beginning with the
fiscal year ended May 31, 1988, the Fund's financial statements reflect
12b-1 Distribution Plan expenses (i.e., shareholder service fees plus
commissions paid net of deferred sales charges received by the Fund) as a
component of the net investment income section of the financial highlights.
(c) Excluding applicable sales charges.
(d) "Ratio of total expenses to average net assets" for the year ended May 31,
1996 includes indirectly paid expenses. Excluding indirectly paid expenses
for the year ended May 31, 1996, the expense ratio would have been 1.72%.
See Notes to Financial Statements.
<PAGE>
- ---------------------------------------
Keystone Small Company Growth Fund (S-4)
STATEMENT OF ASSETS AND LIABILITIES
May 31, 1996
Assets (Note 1)
Investments at market value:
(identified cost--$1,401,481,272) $1,991,506,044
Foreign currency holdings: (identified cost--$5,863) 5,781
- ----------------------------------------------------- -----------
Total investments and foreign currency holdings 1,991,511,825
Cash 715
Receivable for:
Investments sold 23,564,465
Fund shares sold 10,403,168
Interest and dividends 107,434
Prepaid expenses 101,398
Other assets 151,154
- ----------------------------------------------------- -----------
Total assets 2,025,840,159
- ----------------------------------------------------- -----------
Liabilities (Note 4)
Payable for:
Investments purchased 16,857,162
Fund shares redeemed 2,974,701
Other accrued expenses and liabilities 205,719
- ----------------------------------------------------- -----------
Total liabilities 20,037,582
- ----------------------------------------------------- -----------
Net assets $2,005,802,577
- ----------------------------------------------------- -----------
Net assets represented by (Notes 1 and 2)
Paid-in capital $1,220,629,744
Accumulated distributions in excess on net
investment income (7,483)
Accumulated net realized gains on investment
transactions and foreign currency related
transactions 195,155,626
Net unrealized appreciation on investments and
foreign currency holdings 590,024,690
- ----------------------------------------------------- -----------
Total net assets applicable to outstanding shares
of beneficial interest ($10.35 a share on
193,826,852 shares outstanding) $2,005,802,577
- ----------------------------------------------------- -----------
STATEMENT OF OPERATIONS
Year Ended May 31, 1996
Investment income (Note 1)
Dividends (less foreign withholding
tax of $9,355) $ 3,276,217
Interest 3,732,102
- -------------------------------------- -------- -----------
Total income 7,008,319
- -------------------------------------- -------- -----------
Expenses (Notes 2 and 4)
Management fee $ 8,473,139
Transfer agent fees 3,683,215
Accounting, auditing and legal 82,553
Custodian fees 614,103
Printing 79,328
Trustees' fees and expenses 46,542
Distribution Plan expenses 18,458,861
Registration fees 175,282
Miscellaneous expenses 95,483
- -------------------------------------- -------- -----------
Total expenses 31,708,506
Less: Expenses paid indirectly (Note
4) (221,745)
- -------------------------------------- -------- -----------
Net expenses 31,486,761
- -------------------------------------- -------- -----------
Net investment loss (24,478,442)
- -------------------------------------- -------- -----------
Net realized and unrealized gain
(loss) on investments and foreign
currency related transactions (Notes
1 and 3)
Net realized gain (loss) on:
Investments 389,813,838
Foreign currency related
transactions (59,334)
- -------------------------------------- -------- -----------
Net realized gain on investments and
foreign currency related transactions 389,754,504
- ---------------------------------------------------- -----------
Net change in unrealized appreciation
on investments 127,581,090
- -------------------------------------- -------- -----------
Net gain on investment and foreign
currency related transactions 517,335,594
- -------------------------------------- -------- -----------
Net increase in net assets resulting
from operations $492,857,152
- -------------------------------------- -------- -----------
See Notes to Financial Statements.
<PAGE>
- ---------------------------------------
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
Year Ended Year Ended
May 31, 1996 May 31, 1995
==================================================================== ============ ==============
<S> <C> <C>
Operations:
Net investment loss $ (24,478,442) $ (13,214,945)
Net realized gain on investments and foreign currency related
transactions 389,754,504 82,349,681
Net change in unrealized appreciation or depreciation on investments 127,581,090 207,499,070
- -------------------------------------------------------------------- ---------- ------------
Net increase in net assets resulting from operations 492,857,152 276,633,806
- -------------------------------------------------------------------- ---------- ------------
Distributions to shareholders from net realized gains on investment
transactions (Notes 1 and 5) (173,760,139) (85,473,776)
- -------------------------------------------------------------------- ---------- ------------
Capital share transactions (Note 2)
Proceeds from shares sold 1,354,600,987 776,843,226
Payments for shares redeemed (1,267,570,849) (582,622,286)
Net asset value of shares issued in reinvestment of distributions
from capital gains 139,720,568 68,978,844
- -------------------------------------------------------------------- ---------- ------------
Net increase in net assets resulting from capital share
transactions 226,750,706 263,199,784
- -------------------------------------------------------------------- ---------- ------------
Total increase in net assets 545,847,719 454,359,814
Net assets:
Beginning of year 1,459,954,858 1,005,595,044
- -------------------------------------------------------------------- ---------- ------------
End of year [including undistributed net investment income
(accumulated distributions in excess of net investment income) as
follows: 1996--($7,483) and 1995--$7,480,848] (Note 1) $ 2,005,802,577 $1,459,954,858
==================================================================== ========== ============
</TABLE>
See Notes to Financial Statements.
<PAGE>
- ---------------------------------------
Keystone Small Company Growth Fund (S-4)
NOTES TO FINANCIAL STATEMENTS
(1.) Significant Accounting Policies
Keystone Small Company Growth Fund (S-4), (the "Fund"), is an open-end
diversified management investment company. The Fund was created under
Pennsylvania law as a common law trust. Keystone Management, Inc. ("KMI") is the
Fund's investment manager and Keystone Investment Management Company
("KEYSTONE") is the Fund's investment adviser. The Fund's investment objective
is long-term growth of capital.
Keystone is a wholly-owned subsidiary of Keystone Investments, Inc. ("KII"), a
Delaware corporation. KII is a private corporation predominately owned by
current and former members of management of Keystone and its affiliates. KMI is
a wholly-owned subsidiary 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 which
require management to make estimates and assumptions that affect amounts
reported herein. Although actual results could differ from these estimates, any
such differences are expected to be immaterial relative to the net assets of the
Fund.
A. Investments are usually valued at the closing sales price, or, in the absence
of sales and for over-the-counter securities, the mean of bid and asked
quotations. Management values the following securities at prices it deems in
good faith to be fair under the direction of the Board of Trustees: (a)
securities (including restricted securities) for which complete quotations are
not readily available and (b) listed securities if, in the opinion of
management, the last sales price does not reflect a current value or if no sale
occurred.
Short-term investments maturing in sixty days or less are valued at amortized
cost (original purchase cost as adjusted for amortization of premium or
accretion of discount) which when combined with accrued interest approximates
market. Short-term investments maturing in more than sixty days for which market
quotations are readily available are valued at current market value. Short-term
investments maturing in more than sixty days when purchased which are held on
the sixtieth day prior to maturity are valued at amortized cost (market value on
the sixtieth day adjusted for amortization of premium or accretion of discount)
which when combined with accrued interest approximates market.
Market quotations are not considered to be readily available for long-term
corporate bonds and notes; such investments are stated at fair value on the
basis of valuations furnished by a pricing service, approved by the Trustees,
which determines valuations for normal institutional-size trading units of such
securities using methods based on market transactions for comparable securities
and various relationships between securities which are generally recognized by
institutional traders.
The Fund enters into currency and other financial futures contracts as a hedge
against changes in interest or currency exchange rates. A futures contract is an
agreement between two parties to buy and sell a specific amount of a commodity,
security, financial instrument, or, in the case of a stock index, cash at a set
price on a future date. Upon entering into a futures contract, the Fund is
required to deposit with a broker an amount ("initial margin") equal to a
certain percentage of the purchase price indicated in the futures contract.
Subsequent payments ("variation margin") are made or received by the Fund each
day, as the value of the underlying instrument or index fluctuates, and are
recorded for book purposes as unrealized gains or
<PAGE>
- ---------------------------------------
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.
Investments denominated in a foreign currency are adjusted daily to reflect
changes in exchange rates. Foreign currency amounts are translated into United
States dollars as follows: market value of investments, assets and liabilities
at the daily rate of exchange, purchases and sales of 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 or depreciation of investments. In addition to market
risk, the Fund is subject to the credit risk that the other party will not be
able to complete the obligations of the contract.
B. Securities transactions are accounted for no later than one business day
after the trade date. Realized gains and losses are recorded on the identified
cost basis. Interest income is recorded on the accrual basis and dividend income
is recorded on the ex-dividend date. 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 is relieved of any federal income tax
liability by distributing all of its net taxable investment income and net
taxable capital gains, if any, to its shareholders. The Fund intends to avoid
excise tax liability by making the required distributions under the Internal
Revenue Code.
D. When the Fund enters into a repurchase agreement (a purchase of securities
whereby the seller agrees to repurchase the securities at a mutually agreed upon
date and price) the repurchase price of the securities will generally equal the
amount paid by the Fund plus a negotiated interest amount. The seller under the
repurchase agreement will be required to provide securities ("collateral") to
the Fund whose value will be maintained at an amount not less than the
repurchase price, and which generally will be maintained at 101% of the
repurchase price. The Fund monitors the value of collateral on a daily basis,
and if the value of collateral falls below required levels, the Fund intends to
seek additional collateral from the seller or terminate the repurchase
agreement. If the seller defaults, the Fund would suffer a loss to the extent
that the proceeds from the sale of the underlying securities were less than the
repurchase price. Any such loss would be increased by any cost incurred on
disposing of such securities. If bankruptcy proceedings are commenced against
the seller under the repurchase agreement, the realization on the collateral may
be delayed or limited. Repurchase agreements entered into by the Fund will be
limited to transactions with dealers or domestic banks believed to present
minimal credit risks. The Fund will take constructive receipt of all securities
underlying repurchase agreements until such agreements expire.
Pursuant to an exemptive order issued by the Securities and Exchange
Commission, the Fund, along with certain other Keystone funds, may transfer
uninvested cash balances into a joint trading account. These balances are
invested in one or more repurchase agreements that are fully collateralized by
U.S. Treasury and/or Federal Agency obligations.
E. In connection with portfolio purchases and sales of securities denominated in
foreign currency, the Fund may enter into forward foreign currency exchange
contracts ("contracts"). Additionally, from time to time the Fund may enter into
contracts to hedge certain foreign currency assets. Contracts are
<PAGE>
- ---------------------------------------
Keystone Small Company Growth Fund (S-4)
recorded at market value and marked-to-market daily. Realized gains and losses
arising from such transactions are included in net realized gain (loss) on
foreign currency related transactions. The Fund is subject to the credit risk
that the other party will not complete the obligations of the contract.
F. The Fund intends to distribute its net investment income 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 income and net capital gains. The
significant differences between financial statement amounts available for
distribution and distributions made in accordance with income tax regulations
are primarily due to net operating losses generated by the Fund and
distributions paid through shareholder redemptions.
(2.) Capital Share Transactions
The Trust agreement authorizes the issuance of an unlimited number of shares
of beneficial interest with a par value of $1.00. Transactions in shares of the
Fund were as follows:
Year Ended Year Ended
May 31, 1996 May 31, 1995
===================== ============ =============
Sales 141,592,081 102,978,570
Redemptions (131,599,635) (75,737,013)
Reinvestment of
distributions from
realized capital
gains 14,560,340 10,332,058
- --------------------- ---------- -----------
Net increase 24,552,786 37,573,615
===================== ========== ===========
The Fund bears some of the costs of selling its shares under a Distribution
Plan adopted pursuant to Rule 12b-1 under the Investment Company Act of 1940.
Under the Distribution Plan, the Fund pays Keystone Investment Distributors
Company ("KIDCO"), the principal underwriter and a wholly- owned subsidiary of
Keystone, amounts which in total may not exceed the Distribution Plan maximum.
The Fund's shares are offered for sale at net asset value without any initial
sales charge. In connection with the Distribution Plan, and subject to the
limitations discussed below, KIDCO generally re-allows to broker-dealers or
others commissions, equal to 4.00% of the price paid to the Fund for each sale
of Fund shares as well as a shareholder service fee at a rate of 0.25% per annum
of the net asset value of shares maintained by such recipients and outstanding
on the books of the Fund for specified periods.
The Distribution Plan provides that the Fund may expend up to 0.3125%
quarterly (approximately 1.25% annually) of the Fund's average daily net assets
to pay distribution costs for sale of its shares and to pay shareholder service
fees. Rules adopted by the National Association of Securities Dealers, Inc.
("NASD") limit the annual expenditures that the Fund may incur under the
Distribution Plan to 1.00% of the Fund's average daily net asset value, of which
0.75% may be used to pay such distribution costs and 0.25% may be used to pay
shareholder service fees. NASD rules also limit the aggregate amount which the
Fund may pay for such distribution costs to 6.25% of gross share sales since the
inception of the Fund's Distribution Plan, plus interest at the prime rate plus
1.00% per annum on unpaid amounts thereof (less any contingent deferred sales
charges paid by the shareholders to KIDCO) remaining unpaid from time to time.
Contingent deferred sales charges applicable to shares of the Fund are to the
extent permitted by the NASD Rule, paid to KIDCO.
KIDCO intends, but is not obligated, to continue to pay or accrue distribution
costs and services which
<PAGE>
- ---------------------------------------
exceed current maximum annual payments it is permitted to receive from the Fund.
KIDCO intends to seek full payment of such amounts from the Fund (together with
annual interest thereon at the prime rate plus 1.00%) at such time in the future
as, and to the extent that, payment thereof by the Fund would be within
permitted limits. Unreimbursed expense in respect of fiscal year end was
$3,165,670 at fiscal year end.
The amount paid by the Fund under its Distribution Plan for the year ended May
31, 1996 was $18,458,861 (1.00% of the Fund's average daily net asset value
during the year). During the year ended May 31, 1996, KIDCO made payments of
commissions on new sales to dealers and others of $21,624,531.
(3.) Securities Transactions
Cost of purchases and proceeds from sales of investment securities excluding
short-term securities during the year ended May 31, 1996 were $1,720,676,250 and
$1,686,968,962, respectively.
(4.) Investment Management and Transactions With Affiliates
Under the terms of the Investment Management Agreement between KMI and the Fund,
KMI provides investment management and administrative services to the Fund. In
return, KMI is paid a management fee computed and paid daily. The management fee
is calculated by applying percentage rates, which start at 0.70% and decline as
net assets increase, to 0.35% per annum, to the net asset value of the Fund. KMI
has entered into an Investment Advisory Agreement with Keystone under which
Keystone provides investment advisory and management services to the Fund and
receives for its services an annual fee representing 85% of the management fee
received by KMI.
During the year ended May 31, 1996, the Fund paid or accrued to KMI investment
management and administrative services fees of $8,473,139 which represented
0.46% of the Fund's average daily net asset value during the period. Of such
amount paid to KMI, $7,202,168 was paid to Keystone for its services to the
Fund.
During the year ended May 31, 1996, the Fund paid or accrued to KII and KIRC
$20,669 for certain accounting and printing services, and $3,683,215 for
transfer agent fees, respectively.
The Fund has entered into an expense offset arrangement with its custodian. For
the year ended May 31, 1996 the Fund paid or accrued total custody fees in the
amount of $614,103 and received a credit of $221,745 pursuant to the expense
offset arrangement resulting in a net custody expense of $392,358. The assets
deposited with the custodian under the expense offset arrangement could have
been invested in income-producing assets.
(5.) Distributions to Shareholders
A distribution of $1.02 per share was declared on June 17, 1996 from the taxable
net long-term capital gains realized during the fiscal year ended May 31, 1996.
This declaration was payable by July 5, 1996 to shareholders of record June 25,
1996. This distribution is not reflected in the accompanying financial
statements.
(6.) Other
Shareholders will receive upon request a list of securities in the Fund's
portfolio as of the end of a fiscal quarter of the Fund.
<PAGE>
- ---------------------------------------
Keystone Small Company Growth Fund (S-4)
INDEPENDENT AUDITORS' REPORT
The Trustees and Shareholders
Keystone Small Company Growth Fund (S-4)
We have audited the accompanying statement of assets and liabilities of Keystone
Small Company Growth Fund (S-4), including the schedule of investments as of May
31, 1996, and the related statement of operations for the year then ended, the
statements of changes in net assets for each of the years in the two-year period
then ended, and the financial highlights for each of the years in the ten-year
period then ended. These financial statements and financial highlights are the
responsibility of the Fund's management. Our responsibility is to express an
opinion on these financial statements and financial highlights based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned as of May
31, 1996 by correspondence with the custodian and brokers. An audit also
includes assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of
Keystone Small Company Growth Fund (S-4) as of May 31, 1996, the results of its
operations for the year then ended, the changes in its net assets for each of
the years in the two-year period then ended, and the financial highlights for
each of the years in the ten-year period then ended in conformity with generally
accepted accounting principles.
KPMG Peat Marwick LLP
Boston, Massachusetts
June 28, 1996
