SMITH BARNEY
CALIFORNIA MUNICIPALS FUND INC.
388 Greenwich Street
New York, New York 10013 Fund 14, 198
Smith Barney
CALIFORNIA MUNICIPALS FUND INC.
STATEMENT OF
ADDITIONAL INFORMATION
NOVEMBER 7, 1994
[LOGO OF SMITH BARNEY APPEARS HERE]
Smith Barney
CALIFORNIA MUNICIPALS FUND INC.
388 Greenwich Street
New York, New York 10013
(212) 723-9218
STATEMENT OF ADDITIONAL INFORMATION
NOVEMBER 7, 1994
This Statement of Additional Information expands upon and supplements the
information contained in the current Prospectus of Smith Barney California
Municipals Fund Inc. (the "Fund") dated November 7, 1994, as amended or
supplemented from time to time, and should be read in conjunction with the
Fund's Prospectus. The Fund's Prospectus may be obtained from your Smith
Barney Financial Consultant or by writing or calling the Fund at the
address
or telephone number set forth above. This Statement of Additional
Information,
although not in itself a prospectus, is incorporated by reference into the
Prospectus in its entirety.
TABLE OF
CONTENTS
For ease of reference, the same section headings are used in both the
Prospectus and this Statement of Additional Information, except where shown
below:
<TABLE>
<S>
<C>
Management of the Fund..................................................
1
Investment Objective and Management Policies............................
5
Municipal Bonds (See in the Prospectus "California Municipal
Securities")...........................................................
12
Purchase of Shares......................................................
24
Redemption of Shares....................................................
25
Distributor.............................................................
26
Valuation of Shares.....................................................
27
Exchange Privilege......................................................
28
Performance Data (See in the Prospectus "The Fund's Performance").......
28
Taxes (See in the Prospectus "Dividends, Distributions and Taxes")......
32
Additional Information
.......................................................... 34
Financial Statements....................................................
35
Appendix................................................................
A-1
</TABLE>
MANAGEMENT OF THE FUND
The executive officers of the Fund are employees of certain of the
organizations that provide services to the Fund. These organizations are as
follows:
<TABLE>
<CAPTION>
NAME SERVICE
<S> <C>
Smith Barney Inc.
("Smith Barney")...................... Distributor
Smith Barney Mutual Funds Management
Inc.
("SBMFM")............................. Investment Adviser and
Administrator
The Boston Company Advisors, Inc.
("Boston Advisors")................... Sub-Administrator
Boston Safe Deposit and Trust Company
("Boston Safe")....................... Custodian
The Shareholder Services Group, Inc.
("TSSG"),
a subsidiary of First Data
Corporation........................... Transfer Agent
</TABLE>
These organizations and the functions they perform for the Fund are
discussed in the Prospectus and in this Statement of Additional
Information.
DIRECTORS AND EXECUTIVE OFFICERS OF THE FUND
The names of the Directors and executive officers of the Fund, together
with
information as to their principal business occupations during the past five
years, are set forth below. Each Director who is an "interested person" of
the
Fund, as defined in the Investment Company Act of 1940, as amended (the
"1940
Act"), is indicated by an asterisk.
Herbert Barg, Director. Private investor. His address is 273 Montgomery
Avenue, Bala Cynwyd, Pennsylvania 19004.
* Alfred J. Bianchetti, Director. Retired; formerly Senior Consultant to
Dean Witter Reynolds Inc. His address is 19 Circle End Drive, Ramsey, New
Jersey 17466.
Martin Brody, Director. Vice Chairman of the Board of Restaurant
Associates
Industries Corp.; a Director of Jaclyn, Inc. His address is HMK Associates,
Three ADP Boulevard, Roseland, New Jersey 07068.
Dwight B. Crane, Director. Professor, Graduate School of Business
Administration, Harvard University; a Director of Peer Review Analysis,
Inc.
His address is Graduate School of Business Administration, Harvard
University,
Boston, Massachusetts 02163.
James J. Crisona, Director . Attorney; formerly a Justice of the
Supreme Court of the State of New York. His address is 118 East 60th
Street,
New York, New York 10022.
Burt N. Dorsett, Director. Managing Partner of Dorsett McCabe
Management,
Inc., an investment counselling firm; Director of Research Corporation
Technologies Inc., a non-profit patent-clearing and licensing firm. His
address is 201 East 62nd Street, New York, New York 10021.
Robert A. Frankel, Director. Management Consultant; retired Vice
President
of The Reader's Digest Association, Inc. His address is 102 Grand Street,
Croton-on-Hudson, New York 10520.
Dr. Paul Hardin, Director. Chancellor of the University of North
Carolina
at Chapel Hill; a Director of The Summit Bancorporation. His address is
University of North Carolina, 103 S. Building, Chapel Hill, North Carolina
27599.
Elliot S. Jaffe, Director. Chairman of the Board and President of The
Dress
Barn, Inc. His address is 30 Dunnigan Drive, Suffern NY 10901.
Stephen E. Kaufman, Director. Attorney. His address is 277 Park Avenue,
New
York, New York 10172.
Joseph J. McCann, Director. Financial Consultant; formerly, Vice
President
of Ryan Homes, Inc. His address is 200 Oak Park Place, Pittsburgh,
Pennsylvania 15243.
* Heath B. McLendon, Chairman of the Board and Investment Officer.
Executive Vice President of Smith Barney and Chairman of Smith Barney
Strategy
Advisers Inc.; prior to July 1993, Senior Executive Vice President of
Shearson
Lehman Brothers Inc. ("Shearson Lehman Brothers"); Vice Chairman of
Shearson
Asset Management; a Director of PanAgora Asset Management, Inc. and
PanAgora
Asset Management Limited. His address is 388 Greenwich Street, New York,
New
York 10013.
Cornelius C. Rose, Jr., Director. President, Cornelius C. Rose
Associates,
Inc., financial consultants, and Chairman and Director of Performance
Learning
Systems, an educational consultant. His address is
P.O. Box 335,
Fair
Oaks, Enfield, New Hampshire 03748.
Stephen J. Treadway, President, Executive Vice President and Director of
Smith Barney; Director and President of Mutual Management Corp. and SBMFM;
Inc.; and Trustee of Corporate Realty Income Trust I. His address 388
Greenwich Street, New York, New York 10013 .
Richard P. Roelofs, Executive Vice President. Managing Director of Smith
Barney; President of Smith Barney Strategy Advisers Inc., prior to July
1993.
Senior Vice President of Shearson Lehman Brothers; Vice
2
President of Shearson Lehman Investment Strategy Advisors Inc. His address
is
388 Greenwich Street, New York, New York 10013.
Joseph P. Deane, Vice President and Investment Officer. Investment
Officer
of SBMFM; prior to July 1993, Managing Director of Shearson Lehman
Advisors.
His address is 388 Greenwich Street, New York, New York 10013.
David Fare, Investment Officer. Investment Officer of SBMFM; prior to
July
1993, Vice President of Shearson Lehman Advisors. His address is 388
Greenwich
Street, New York, New York 10013.
Lewis E. Daidone, Treasurer. Managing Director and Chief Financial
Officer
of Smith Barney; Director and Senior Vice President of SBMFM. His address
is
388 Greenwich Street, New York, NY 10013 .
Christina T. Sydor, Secretary. Managing Director of Smith Barney;
General
Counsel and Secretary of SBMFM. Her address is 388 Greenwich Street,
New York, NY 10013 .
Each Director also serves as a director, trustee and/or general
partner of certain other mutual funds for which Smith Barney
serves as distributor. As of October 31, 1994, the Directors and officers
of the Fund as a group owned less than 1.00% of the outstanding common
stock of the Fund.
No director, officer or employee of Smith Barney or parent or
subsidiary
receives compensation from the Fund for serving as an officer
or Director of the Fund. The Fund pays each Director who is not an officer,
director or employee of Smith Barney or any of its affiliates a fee of
$2,000
per annum plus $500 per meeting attended and reimburses them for travel and
out-of-pocket expenses. For the fiscal year ended February 28, 1994, such
fees
and expenses totalled $47,451.
INVESTMENT ADVISER AND ADMINISTRATOR--SBMFM
SBMFM serves as investment adviser to the Fund pursuant to a
transfer
of the investment advisory agreement effective November 7, 1994 from its
affiliate, Mutual Management Corp. (Mutual Management Corp. and SBMFM
are both wholly owned subsidiaries of Smith Barney Holdings Inc.
("Holdings").) Holdings is a wholly owned subsidiary of The Travelers Inc.
("Travelers"). The advisory agreement is</ R> dated July 30,
1993 (the "Advisory Agreement"),
and was first approved
by the Board of Directors, including a majority of those Directors who are
not
"interested persons" of the Fund or SBMFM, on April 7, 1993. The services
provided by SBMFM under the Advisory Agreement are described in the
Prospectus under "Management of the Fund. SBMFM pays the salary
of any officer and employee who is employed by both it and the Fund.
SBMFM bears all expenses in connection with the performance of its
services.
As compensation for investment advisory services, the Fund
pays SBMFM a fee computed daily and
paid monthly at the
following annual rates
of the Funds average daily net assets : 0.35%
up to $500 million; and
0.32%
in excess of
$500 million. For the 1992, 1993 and 1994 fiscal years, the Fund
incurred $1,226,008, $1,376,158 and $1,761,043, respectively, in
investment advisory fees.
3
SBMFM also serves as administrator to the Fund pursuant to a written
agreement dated April 20, 1994 (the "Administration Agreement")
, which was most recently approved on July 20, 1994 by
the Fund's Board of Directors, including a majority of Directors who are
not
"interested persons" of the Fund or SBMFM. The services provided by SBMFM
under the Administration Agreement are described in the Prospectus
under "Management of the Fund." SBMFM pays the salary of any officer and
employee who is employed by both it and the Fund and bears all expenses in
connection with the performance of its services.
As compensation for administrative services rendered to
the Fund, SBMFM receives a fee paid monthly at
the following annual rates of average daily net assets: 0.20% up to $500
million; 0.18% of the next $1 billion; and 0.16% in excess of $1.5 billion.
SUB-ADMINISTRATOR--BOSTON ADVISORS
Boston Advisors serves as sub-administrator to the
Fund pursuant to a written agreement (the "Sub-Administration
Agreement") dated April 20, 1994, which was most recently approved by
the Fund's Board of Directors, including a majority of Directors who are
not "interested persons" of the Fund or Boston Advisors, on July 20 ,
1994.
Under the Sub-Administration Agreement, Boston Advisors is paid
a portion of the administration fee paid by the Fund to SBMFM at a rate
agreed upon from time to time between Boston Advisors and SBMFM.
Boston Advisors is a wholly owned subsidiary of The Boston Company,
Inc. ("TBC"), a financial services holding company, which is in turn a
wholly owned subsidiary of Mellon Bank Corporation ("Mellon").
Prior to April 20, 1994, Boston Advisors served as the Funds
sub-investment adviser and/or administrator. For the 1992, 1993
and 1994 fiscal years, the Fund paid Boston Advisors, $700,576, $786,376
and $1,005,899, respectively, in sub-investment advisory and/or
administration fees.
Certain of the services provided to the Fund by Boston Advisors
pursuant to the Sub-Administration Agreement are described in the
Prospectus
under "Management of the Fund." In addition to those services,
Boston Advisors, maintains office facilities for the Fund,
furnishes the Fund with statistical and research data, clerical help
and accounting, data processing, bookkeeping, internal auditing and legal
services and certain other services required by the Fund, prepares
reports to the Fund's shareholders and prepares tax returns and
reports to and filings with the Securities and Exchange Commission
(the "SEC") and state Blue Sky authorities. Boston Advisors
pays the salaries of all officers and employees who are employed by both it
and the Fund and bears all expenses in connection with the performance
of its services.
The Fund bears expenses incurred in its operations, including: taxes,
interest, brokerage fees and commissions, if any; fees of Directors who are
not officers, directors, shareholders or employees of Smith Barney ,
SBMFM or Boston Advisors ; SEC fees and state Blue Sky qualification
fees; charges of custodian; transfer and dividend disbursing agent's fees;
certain insurance premiums; outside auditing and legal expenses; costs of
maintaining corporate existence; costs of investor services (including
allocated telephone and personnel expenses); costs of preparation and
printing of prospectuses for regulatory purposes and for distribution to
existing shareholders; costs of shareholders' reports and shareholder
meetings; and meetings of the officers or Board of Directors of
the Fund.
4
SBMFM and Boston Advisors have agreed that if in any fiscal year the
aggregate expenses of the Fund (including fees payable pursuant to the
Advisory Agreement, Administration Agreement and Sub-Administration
Agreement, but excluding interest, taxes, brokerage fees paid pursuant
to the Funds services and distribution plan, and, with the prior written
consent of the necessary state securities commissions, extraordinary
expenses)
exceed the expense limitation of any state having jurisdiction over the
Fund,
SBMFM and Boston Advisors will, to the extent required by state law, reduce
their fees by the amount of such excess expenses, such amount to be
allocated
among them in the proportion their respective fees bear to the aggregate of
such
fees paid by the Fund. Such fee reductions, if any, will be reconciled on a
monthly basis. The most restrictive state limitation currently applicable
to
the Fund would require a
SBMFM and Boston Advisors to reduce their
fees in any year that such expenses exceed 2.50% of the first $30
million
of average daily net assets, 2.00% of the next $70 million and 1.50%
of the
remaining average daily net assets. No fee reduction was required for the
1992,
1993 and 1994 fiscal years.
COUNSEL AND AUDITORS
Willkie Farr & Gallagher serves as legal counsel to the Fund. O'Melveny &
Myers acts as special California counsel for the Fund and has reviewed the
portions of the Prospectus and this Statement of Additional Information
concerning California taxes and the description of the special
considerations
relating to investments in California municipal securities. The Directors
who
are not "interested persons" of the Fund have selected Stroock & Stroock &
Lavan as their legal counsel.
KPMG Peat Marwick L.L.P independent accountants, 345 Park
Avenue, New York, New York 10154, serve as auditors of the Fund and
render an opinion on the Fund's financial statements annually. Prior
to October 19, 1994, Coopers & Lybrand L.L.P., independent auditors,
served as auditors of the Fund and rendered an opinion on the financial
statements for the fiscal year ended February 28, 1994.
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES
The Prospectus discusses the Fund's investment objective and the policies
it
employs to achieve that objective. The following discussion supplements the
description of the Fund's investment policies in the Prospectus. For
purposes
of this Statement of Additional Information, obligations of non-California
municipal issuers, the interest on which is excluded from gross income for
Federal income tax purposes, together with obligations of the State of
California, local governments in the State of California and certain other
municipal issuers such as the Commonwealth of Puerto Rico ("California
Municipal Securities"), are collectively referred to as "Municipal Bonds."
RATINGS AS INVESTMENT CRITERIA
In general, the ratings of Moody's Investors Service, Inc. ("Moody's") and
Standard & Poor's Corporation ("S&P") represent the opinions of those
agencies
as to the quality of the Municipal Bonds and short-term investments which
they
rate. It should be emphasized, however, that such ratings are relative and
subjective, are not absolute standards of quality and do not evaluate the
market risk of securities. These ratings will be used by the Fund as
initial
criteria for the selection of portfolio securities, but the Fund also will
rely upon the independent advice of SBMFM to evaluate potential
investments.
Among the factors that will be considered are the long-term ability of the
issuer to pay principal and interest and general economic trends. To the
extent the Fund invests in lower-rated and comparable unrated securities,
the
Fund's achievement of its investment objective may be more dependent on
SBMFMs' credit analysis of such securities than would be the case for a
portfolio consisting entirely of higher-rated securities. The Appendix
contains information concerning the ratings of Moody's and S&P and their
significance.
5
Subsequent to its purchase by the Fund, an issue of Municipal Bonds may
cease to be rated or its rating may be reduced below the rating given at
the
time the securities were acquired by the Fund. Neither event will require
the
sale of such Municipal Bonds by the Fund, but SBMFM will consider such
event
in its determination of whether the Fund should continue to hold the
Municipal
Bonds. In addition, to the extent that the ratings change as a result of
changes in such organizations or their rating systems or due to a corporate
restructuring of Moody's or S&P, the Fund will attempt to use comparable
ratings as standards for its investments in accordance with its investment
objective and policies.
The Fund generally may invest up to 25% of its total assets in
securities
rated below A, MIG3 or Prime-1 (P-1) by Moody's or A, SP-2 or A-3 by S&P,
or
in unrated securities of comparable quality. Such securities (a) will
likely
have some quality and protective characteristics that, in the judgment of
the
rating organization, are outweighed by large uncertainties or major risk
exposures to adverse conditions and (b) are predominantly speculative with
respect to the issuer's capacity to pay interest and repay principal in
accordance with the terms of the obligation.
Zero coupon securities involve special considerations. Zero coupon
securities are debt obligations which do not entitle the holder to any
periodic payments of interest prior to maturity of a specified cash payment
date when the securities begin paying current interest (the "cash payment
date") and therefore are issued and traded at a discount from their face
amounts or par values. The discount varies depending on the time remaining
until maturity or cash payment date, prevailing interest rates, liquidity
of
the security and the perceived credit quality of the issuer. The discount,
in
the absence of financial difficulties of the issuer, decreases as the final
maturity or cash payment date of the security approaches. The market prices
of
zero coupon securities generally are more volatile than the market prices
of
other debt securities that pay interest periodically and are likely to
respond
to changes in interest rates to a greater degree than do debt securities
having similar maturities and credit quality. The credit risk factors
pertaining to low-rated securities also apply to low-rated zero coupon
bonds.
Such zero coupon bonds carry an additional risk in that, unlike bonds which
pay interest throughout the period to maturity, the Fund will realize no
cash
until the cash payment date unless a portion of such securities is sold
and,
if the issuer defaults, the Fund may obtain no return at all on its
investment.
Current Federal income tax laws may require the holder of a zero coupon
security to accrue income with respect to that security prior to the
receipt
of cash payments. To maintain its qualification as a registered investment
company and avoid liability for Federal income taxes, the Fund may be
required
to distribute income accrued with respect to zero coupon securities and may
have to dispose of portfolio securities under disadvantageous circumstances
in
order to generate cash to satisfy these distribution requirements.
TEMPORARY INVESTMENTS
When the Fund is maintaining a defensive position, the Fund may invest in
short-term investments ("Temporary Investments") consisting of: (a) the
following tax-exempt securities: notes of municipal issuers having, at the
time of purchase, a rating within the three highest grades of Moody's or
S&P
or, if not rated, having an issue of outstanding Municipal Bonds rated
within
the three highest grades by Moody's or S&P; and (b) the following taxable
securities: obligations of the United States government, its agencies or
instrumentalities ("U.S. government securities"), repurchase agreements,
other
debt securities rated within the three highest grades by Moody's or S&P,
commercial paper rated in the highest grade by either of such rating
services,
and certificates of deposit of domestic banks with assets of $1 billion or
more. The Fund may invest
6
in Temporary Investments for defensive reasons in anticipation of a market
decline. At no time will more than 20% of the Fund's total assets be
invested
in Temporary Investments unless the Fund has adopted a defensive investment
policy. The Fund intends, however, to purchase tax-exempt Temporary
Investments pending the investment of the proceeds of the sale of portfolio
securities or shares of the Fund's common stock, or in order to have highly
liquid securities available to meet anticipated redemptions. Since
commencement of operations, the Fund has not found it necessary to purchase
taxable Temporary Investments.
Repurchase Agreements. The Fund may enter into repurchase agreements
with
banks which are the issuers of instruments acceptable for purchase by the
Fund
and with certain dealers on the Federal Reserve Bank of New York's list of
reporting dealers. A repurchase agreement is a contract under which the
buyer
of a security simultaneously commits to resell the security to the seller
at
an agreed-upon price on an agreed-upon date. Under the terms of a typical
repurchase agreement, the Fund would acquire an underlying debt obligation
for
a relatively short period of time (usually not more than seven days)
subject
to an obligation of the seller to repurchase, and the Fund to resell, the
obligation at an agreed-upon price and time, thereby determining the yield
during the Fund's holding period. This arrangement results in a fixed rate
of
return that is not subject to market fluctuations during the Fund's holding
period. Under each repurchase agreement, the selling institution will be
required to maintain the value of the securities subject to the repurchase
agreement at not less than their repurchase price. Repurchase agreements
could
involve certain risks in the event of default or insolvency of the other
party, including possible delays or restrictions upon the Fund's ability to
dispose of the underlying securities, the risk of a possible decline in the
value of the underlying securities during the period in which the Fund
seeks
to assert its rights to them, the risk of incurring expenses associated
with
asserting those rights and the risk of losing all or part of the income
from
the agreement. In evaluating these potential risks, SBMFM or Boston
Advisors,
acting under the supervision of the Fund's Board of Directors, reviews on
an
ongoing basis the value of the collateral and the creditworthiness of those
banks and dealers with which the Fund enters into repurchase agreements.
INVESTMENTS IN FINANCIAL FUTURES CONTRACTS AND OPTIONS ON FINANCIAL FUTURES
CONTRACTS
The Fund may invest in financial futures contracts and options on financial
futures contracts that are traded on a domestic exchange or board of trade.
Such investments may be made by the Fund solely for the purpose of hedging
against changes in the value of its portfolio securities due to anticipated
changes in interest rates and market conditions, and not for purposes of
speculation. Further, such investments will be made only in unusual
circumstances, such as when SBMFM anticipates an extreme change in interest
rates or market conditions.
Municipal Bond Index Futures Contracts. A municipal bond index futures
contract is an agreement pursuant to which two parties agree to take or
make
delivery of an amount of cash equal to a specific dollar amount multiplied
by
the difference between the value of the index at the close of the last
trading
day of the contract and the price at which the index contract was
originally
written. No physical delivery of the underlying municipal bonds in the
index
is made. Municipal bond index futures contracts based on an index of 40
tax-
exempt, long-term municipal bonds with an original issue size of at least
$50
million and a rating of A- or higher by S&P or A or higher by Moody's began
trading in mid-1985.
The purpose of the acquisition or sale of a municipal bond index futures
contract by the Fund, as the holder of long-term municipal securities, is
to
protect the Fund from fluctuations in interest rates on tax-exempt
securities
without actually buying or selling long-term municipal securities.
7
Unlike the purchase or sale of a Municipal Bond, no consideration is
paid
or received by the Fund upon the purchase or sale of a futures contract.
Initially, the Fund will be required to deposit with the broker an amount
of
cash or cash equivalents equal to approximately 10% of the contract amount
(this amount is subject to change by the board of trade on which the
contract
is traded and members of such board of trade may charge a higher amount).
This
amount is known as initial margin and 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 that all contractual
obligations
have been satisfied. Subsequent payments, known as variation margin, to and
from the broker, will be made on a daily basis as the price of the index
fluctuates, making the long and short positions in the futures contract
more
or less valuable, a process known as marking-to-market. At any time prior
to
the expiration of the contract, the Fund may elect to close the position by
taking an opposite position, which will operate to terminate the Fund's
existing position in the futures contract.
There are several risks in connection with the use of futures contracts
as
a hedging device. Successful use of futures contracts by the Fund is
subject
to SBMFM ability to predict correctly movements in the direction of
interest
rates. Such predictions involve skills and techniques which may be
different
from those involved in the management of a long-term municipal bond
portfolio.
In addition, there can be no assurance that there will be a correlation
between movements in the price of the municipal bond index and movements in
the price of the Municipal Bonds which are the subject of the hedge. The
degree of imperfection of correlation depends upon various circumstances,
such
as variations in speculative market demand for futures contracts and
municipal
securities, technical influences on futures trading, and differences
between
the municipal securities being hedged and the municipal securities
underlying
the futures contracts, in such respects as interest rate levels, maturities
and creditworthiness of issuers. A decision of whether, when and how to
hedge
involves the exercise of skill and judgment and even a well-conceived hedge
may be unsuccessful to some degree because of market behavior or unexpected
trends in interest rates.
Although the Fund intends to purchase or sell futures contracts only if
there is an active market for such contracts, there is no assurance that a
liquid market will exist for the contracts at any particular time. Most
domestic futures exchanges and boards of trade limit the amount of
fluctuation
permitted in futures contract prices during a single trading day. The daily
limit establishes the maximum amount the price of a futures contract may
vary
either up or down from the previous day's settlement price at the end of a
trading session. Once the daily limit has been reached in a particular
contract, no trades may be made that day at a price beyond that limit. The
daily limit governs only price movement during a particular trading day
and,
therefore, does not limit potential losses because the limit may prevent
the
liquidation of unfavorable positions. It is possible that futures contract
prices could move to the daily limit for several consecutive trading days
with
little or no trading, thereby preventing prompt liquidation of futures
positions and subjecting some futures traders to substantial losses. In
such
event, it will not be possible to close a futures position and, in the
event
of adverse price movements, the Fund would be required to make daily cash
payments of variation margin. In such circumstances, an increase in the
value
of the portion of the portfolio being hedged, if any, may partially or
completely offset losses on the futures contract. As described above,
however,
there is no guarantee that the price of Municipal Bonds will, in fact,
correlate with the price movements in the municipal bond index futures
contract and thus provide an offset to losses on a futures contract.
If the Fund has hedged against the possibility of an increase in
interest
rates adversely affecting the value of the Municipal Bonds held in its
portfolio and rates decrease instead, the Fund will lose part or all of the
8
benefit of the increased value of the Municipal Bonds it has hedged because
it
will have offsetting losses in its futures positions. In addition, in such
situations, if the Fund has insufficient cash, it may have to sell
securities
to meet daily variation margin requirements. Such sales of securities may,
but
will not necessarily, be at increased prices which reflect the decline in
interest rates. The Fund may have to sell securities at a time when it may
be
disadvantageous to do so.
When the Fund purchases municipal bond index futures contracts, an
amount
of cash and U.S. government securities or other high grade debt securities
equal to the market value of the futures contracts will be deposited in a
segregated account with the Fund's custodian (and/or such other persons as
appropriate) to collateralize the positions and thereby insure that the use
of
such futures contracts is not leveraged. In addition, the ability of the
Fund
to trade in municipal bond index futures contracts and options on interest
rate futures contracts may be materially limited by the requirements of the
Internal Revenue Code of 1986, as amended (the "Code"), applicable to a
regulated investment company. See "Taxes" below.
Options on Financial Futures Contracts. The Fund may purchase put and
call
options on futures contracts which are traded on a domestic exchange or
board
of trade as a hedge against changes in interest rates, and may enter into
closing transactions with respect to such options to terminate existing
positions. The Fund will sell put and call options on interest rate futures
contracts only as part of closing sale transactions to terminate its
options
positions. There is no guarantee that such closing transactions can be
effected.
Options on futures contracts, as contrasted with the direct investment
in
such contracts, gives the purchaser the right, in return for the premium
paid,
to assume a position in futures contracts at a specified exercise price at
any
time prior to the expiration date of the options. Upon exercise of an
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 contract margin account, which represents the amount
by
which the market price of the futures contract 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. The potential loss related to the purchase of an option
on
interest rate futures contracts is limited to the premium paid for the
option
(plus transaction costs). Because the value of the option is fixed at the
point of sale, there are no daily cash payments to reflect changes in the
value of the underlying contract; however, the value of the option does
change
daily and that change would be reflected in the net asset value of the
Fund.
There are several risks relating to options on futures contracts. The
ability to establish and close out positions on such options will be
subject
to the existence of a liquid market. In addition, the Fund's purchase of
put
or call options will be based upon predictions as to anticipated interest
rate
trends by SBMFM, which could prove to be inaccurate. Even if SBMFMs'
expectations are correct there may be an imperfect correlation between the
change in the value of the options and of the Fund's portfolio securities.
INVESTMENT RESTRICTIONS
The Fund has adopted the following investment restrictions for the
protection
of shareholders. Restrictions 1 through 7 below may not be changed without
the
approval of the holders of a majority of the outstanding shares of the
Fund,
defined as the lesser of (a) 67% of the Fund's shares present at a meeting
if
the holders of more than 50% of the outstanding shares are present in
person
or by proxy or (b) more than 50% of the Fund's outstanding shares. The
remaining restrictions may be changed by the Fund's Board of Directors at
any
time.
9
The Fund may not:
1.Issue senior securities as defined in the 1940 Act and any rules and
orders thereunder, except insofar as the Fund may be deemed to have
issued
senior securities by reason of: (a) borrowing money or purchasing
securities on a when-issued or delayed-delivery basis; (b) purchasing or
selling futures contracts and options on futures contracts and other
similar instruments; and (c) issuing separate classes of shares.
2.Invest more than 25% of its total assets in securities, the issuers of
which are in the same industry. For purposes of this limitation, U.S.
government securities and securities of state or municipal governments
and
their political subdivisions are not considered to be issued by members
of
any industry.
3.Borrow money, except that the Fund may borrow from banks for temporary
or emergency (not leveraging) purposes, including the meeting of
redemption
requests which might otherwise require the untimely disposition of
securities, in an amount not exceeding 10% of the value of the Fund's
total
assets (including the amount borrowed) valued at market less liabilities
(not including the amount borrowed) at the time the borrowing is made.
Whenever borrowings exceed 5% of the value of the Fund's total assets,
the
Fund will not make any additional investments.
4.Make loans. This restriction does not apply to: (a) the purchase of
debt
obligations in which the Fund may invest consistent with its investment
objective and policies; (b) repurchase agreements; and (c) loans of its
portfolio securities.
5.Engage in the business of underwriting securities issued by other
persons, except to the extent that the Fund may technically be deemed to
be
an underwriter under the Securities Act of 1933, as amended, in disposing
of portfolio securities.
6.Purchase or sell real estate, real estate mortgages, real estate
investment trust securities, commodities or commodity contracts, but this
shall not prevent the Fund from: (a) investing in securities of issuers
engaged in the real estate business and securities which are secured by
real estate or interests therein; (b) holding or selling real estate
received in connection with securities it holds; or (c) trading in
futures
contracts and options on futures contracts.
7.Purchase any securities on margin (except for such short-term credits
as
are necessary for the clearance of purchases and sales of portfolio
securities) or sell any securities short (except against the box). For
purposes of this restriction, the deposit or payment by the Fund of
initial
or maintenance margin in connection with futures contracts and related
options and options on securities is not considered to be the purchase of
a
security on margin.
8.Purchase or otherwise acquire any security if, as a result, more than
15% of its net assets would be invested in securities that are illiquid.
9.Purchase or sell oil and gas interests.
10.Invest more than 5% of the value of its total assets in the securities
of issuers having a record, including predecessors, of less than three
years of continuous operation, except U.S. government securities. For
purposes of this restriction, issuers include predecessors, sponsors,
controlling persons, general partners, guarantors and underlying assets.
10
11.Invest in companies for the purpose of exercising control.
12.Invest in securities of other investment companies, except as they may
be acquired as part of a merger, consolidation or acquisition of assets.
13.Engage in the purchase or sale of put, call, straddle or spread
options
or in the writing of such options, except that the Fund may purchase and
sell options on interest rate futures contracts.
Certain restrictions listed above permit the Fund to engage in
investment
practices that the Fund does not currently pursue. The Fund has no present
intention of altering its current investment practices as otherwise
described
in the Prospectus and this Statement of Additional Information and any
future
change in those practices would require Board approval and appropriate
notice
to shareholders. If a percentage restriction is complied with at the time
of
an investment, a later increase or decrease in the percentage of assets
resulting from a change in the values of portfolio securities or in the
amount
of the Fund's assets will not constitute a violation of such restriction.
In
order to permit the sale of the Fund's shares in certain states, the Fund
may
make commitments more restrictive than the restrictions described above.
Should the Fund determine that any such commitment is no longer in the best
interests of the Fund and its shareholders, it will revoke the commitment
by
terminating sales of its shares in the state involved.
PORTFOLIO TRANSACTIONS
Newly issued securities normally are purchased directly from the issuer or
from an underwriter acting as principal. Other purchases and sales usually
are
placed with those dealers from which it appears the best price or execution
will be obtained; those dealers may be acting as either agents or
principals.
The purchase price paid by the Fund to underwriters of newly issued
securities
usually includes a concession paid by the issuer to the underwriter, and
purchases of after-market securities from dealers normally are executed at
a
price between the bid and asked prices. The Fund paid no brokerage
commission
in 1992 and 1993 but for the fiscal year ended February 28, 1994, the Fund
paid $22,496 in brokerage commissions.
Allocation of transactions, including their frequency, to various
dealers
is determined by SBMFM in its best judgment and in a manner deemed fair and
reasonable to shareholders. The primary considerations are availability of
the
desired security and the prompt execution of orders in an effective manner
at
the most favorable prices. Subject to these considerations, dealers that
provide supplemental investment research and statistical or other services
to
SBMFM may receive orders for portfolio transactions by the Fund.
Information
so received enables Greenwich Street Advisors to supplement their own
research
and analysis with the views and information of other securities firms. Such
information may be useful to SBMFM in serving both the Fund and other
clients,
and, conversely, supplemental information obtained by the placement of
business of other clients may be useful to SBMFM in carrying out its
obligations to the Fund.
The Fund will not purchase Municipal Bonds during the existence of any
underwriting or selling group relating thereto of which Smith Barney is a
member, except to the extent permitted by the SEC. Under certain
circumstances, the Fund may be at a disadvantage because of this limitation
in
comparison with other investment companies which have a similar investment
objective but which are not subject to such limitation.
While investment decisions for the Fund are made independently from
those
of the other accounts managed by SBMFM, investments of the type the Fund
may
make also may be made by those other accounts. When the Fund and one or
more
other accounts managed by SBMFM are prepared to invest in, or desire to
dispose of, the same security, available investments or opportunities for
sales will be allocated in a manner
11
believed by SBMFM to be equitable to each. In some cases, this procedure
may
adversely affect the price paid or received by the Fund or the size of the
position obtained or disposed of by the Fund.
PORTFOLIO TURNOVER
The Fund's portfolio turnover rate (the lesser of purchases or sales of
portfolio securities during the year, excluding purchases or sales of
short-
term securities, divided by the monthly average value of portfolio
securities)
generally is not expected to exceed 100%, but the portfolio turnover rate
will
not be a limiting factor whenever the Fund deems it desirable to sell or
purchase securities. Securities may be sold in anticipation of a rise in
interest rates (market decline) or purchased in anticipation of a decline
in
interest rates (market rise) and later sold. In addition, a security may be
sold and another security of comparable quality may be purchased at
approximately the same time in order to take advantage of what the Fund
believes to be a temporary disparity in the normal yield relationship
between
the two securities. These yield disparities may occur for reasons not
directly
related to the investment quality of particular issues or the general
movement
of interest rates, such as changes in the overall demand for or supply of
various types of tax-exempt securities. For the 1993 and 1994 fiscal years,
the Fund's portfolio turnover rate was 72% and 76%, respectively.
MUNICIPAL BONDS
GENERAL INFORMATION
Municipal Bonds generally are understood to include debt obligations issued
to
obtain funds for various public purposes, including the construction of a
wide
range of public facilities, refunding of outstanding obligations, payment
of
general operating expenses and extensions of loans to public institutions
and
facilities. Private activity bonds that are issued by or on behalf of
public
authorities to finance various privately operated facilities are included
within the term Municipal Bonds if the interest paid thereon qualifies as
excluded from gross income (but not necessarily from alternative minimum
taxable income) for Federal income tax purposes in the opinion of bond
counsel
to the issuer.
The yield on Municipal Bonds is dependent upon a variety of factors,
including general economic and monetary conditions, general money market
conditions, general conditions of the Municipal Bond market, the financial
condition of the issuer, the size of a particular offering, the maturity of
the obligation offered and the rating of the issue.
Municipal Bonds also are subject to the provisions of bankruptcy,
insolvency and other laws affecting the rights and remedies of creditors,
such
as the Federal Bankruptcy Code, and laws, if any, that may be enacted by
Congress or state legislatures extending the time for payment of principal
or
interest, or both, or imposing other constraints upon enforcement of such
obligations or upon the ability of municipalities to levy taxes. There is
also
the possibility that, as a result of litigation or other conditions, the
power
or ability of any one or more issuers to pay, when due, the principal of
and
interest on its or their Municipal Bonds may be materially affected.
WHEN-ISSUED SECURITIES
The Fund may purchase Municipal Bonds on a "when-issued" basis (i.e., for
delivery beyond the normal settlement date at a stated price and yield).
The
payment obligation and the interest rate that will be received on the
Municipal Bonds purchased on a when-issued basis are each fixed at the time
the buyer enters into
12
the commitment. Although the Fund will purchase Municipal Bonds on a when-
issued basis only with the intention of actually acquiring the securities,
the
Fund may sell these securities before the settlement date if it is deemed
advisable as a matter of investment strategy.
Municipal Bonds are subject to changes in value based upon the public's
perception of the creditworthiness of the issuers and changes, real or
anticipated, in the level of interest rates. In general, Municipal Bonds
tend
to appreciate when interest rates decline and depreciate when interest
rates
rise. Purchasing Municipal Bonds on a when-issued basis, therefore, can
involve the risk that the yields available in the market when the delivery
takes place may actually be higher than those obtained in the transaction
itself. To account for this risk, a separate account of the Fund consisting
of
cash or liquid debt securities equal to the amount of the when-issued
commitments will be established at the Fund's custodian bank. For the
purpose
of determining the adequacy of the securities in the account, the deposited
securities will be valued at market or fair value. If the market or fair
value
of such securities declines, additional cash or securities will be placed
in
the account on a daily basis so the value of the account will equal the
amount
of such commitments by the Fund. Placing securities rather than cash in the
segregated account may have a leveraging effect on the Fund's net assets.
That
is, to the extent the Fund remains substantially fully invested in
securities
at the same time it has committed to purchase securities on a when-issued
basis, there will be greater fluctuations in its net assets than if it had
set
aside cash to satisfy its purchase commitments. Upon the settlement date of
the when-issued securities, the Fund will meet obligations from then-
available
cash flow, sale of securities held in the segregated account, sale of other
securities or, although it normally would not expect to do so, from the
sale
of the when-issued securities themselves (which may have a value greater or
less than the Fund's payment obligations). Sales of securities to meet such
obligations may involve the realization of capital gains, which are not
exempt
from Federal income taxes or California state personal income tax.
When the Fund engages in when-issued transactions, it relies on the
seller
to consummate the trade. Failure of the seller to do so may result in the
Fund's incurring a loss or missing an opportunity to obtain a price
considered
to be advantageous.
SPECIAL CONSIDERATIONS RELATING TO CALIFORNIA MUNICIPAL SECURITIES
Some of the significant financial considerations relating to the Fund's
investments in California Municipal Obligations are summarized below. This
summary information is derived principally from official statements and
prospectuses relating to securities offerings of the State of California
and
various local agencies in California, available as of the date of this
Statement of Additional Information and does not purport to be a complete
description of any of the considerations mentioned herein. The accuracy and
completeness of the information contained in such official statements has
not
been independently verified.
Economic Factors. The Governor's 1993-1994 Budget, introduced on January
8,
1993, proposed general fund expenditures of $37.3 billion, with projected
revenues of $39.9 billion. To balance the budget in the face of declining
revenues, the Governor proposed a series of revenue shifts from local
government, reliance on increased federal aid, and reductions in state
spending.
The Department of Finance of the State of California's May Revision of
General Fund Revenues and Expenditures (the "May Revision"), released on
May
20, 1993, projected the State would have an accumulated deficit of about
$2.75
billion by June 30, 1993 essentially unchanged from the prior year. The
Governor proposed to eliminate this deficit over an 18-month period. Unlike
previous years, the Governor's
13
Budget and May Revision did not calculate a "gap" to be closed, but rather
set
forth revenue and expenditure forecasts and proposals designed to produce a
balanced budget.
The 1993-1994 budget act (the "1993-94 Budget Act") was signed by the
Governor on June 30, 1993, along with implementing legislation. The
Governor
vetoed about $71 million in spending.
The 1993-94 Budget Act is predicated on general fund revenues and
transfers
estimated at $40.6 billion, $400 million below 1992-93 (and the second
consecutive year of actual decline). The principal reasons for declining
revenue are the continued weak economy and the expiration (or repeal) of
three
fiscal steps taken in 1991--a half cent temporary sales tax, a deferral of
operating loss carryforwards, and repeal by initiative of a sales tax on
candy
and snack foods.
The 1993-94 Budget Act also assumes special fund revenues of $11.9
billion,
an increase of 2.9% over 1992-93.
The 1993-94 Budget Act includes general fund expenditures of $38.5
billion
(a 6.3% reduction from projected 1992-93 expenditures of $41.1 billion), in
order to keep a balanced budget within the available revenues. The 1993-94
Budget Act also includes special fund expenditures of $12.1 billion, a 4.2%
increase. The 1993-94 Budget Act reflects the following major adjustments:
1. Changes in local government financing to shift about $2.6 billion
in
property taxes from cities, counties, special districts and redevelopment
agencies to school and community college districts, thereby reducing
general fund support by an equal amount. About $2.5 billion would be
permanent, reflecting termination of the State's "bailout" of local
governments following the property tax cuts of Proposition 13 in 1978
(See
"Constitutional, Legislative and Other Factors" below).
The property tax revenue losses for cities and counties are offset in
part by additional sales tax revenues and mandate relief. The temporary
0.5% sales tax was extended through December 31, 1993, for allocation to
counties for public safety programs. The voters approved Proposition 172
in
November 1993 and the 0.5% sales tax was extended permanently for public
safety purposes.
Legislation also has been enacted to eliminate state mandates in order
to provide local governments flexibility in making their programs
responsive to local needs. Legislation provides mandate relief for local
justice systems which affect county audit requirements, court reporter
fees, and court consolidation; health and welfare relief involving
advisory
boards, family planning, state audits and realignment maintenance
efforts;
and relief in areas such as county welfare department self-evaluations,
noise guidelines and recycling requirements.
2. The 1993-94 Budget Act projected K-12 Proposition 98 funding on a
cash basis at the same per-pupil level as 1992-93 by providing schools a
$609 million loan payable from future years' Proposition 98 funds.
3. The 1993-94 Budget Act assumed receipt of about $692 million of aid
to the State from the Federal government to offset health and welfare
costs
associated with foreign immigrants living in the State, which would
reduce
a like amount of general fund expenditures. About $411 million of this
amount was one-time funding. Congress ultimately appropriated only $450
million.
4. Reductions of $600 million in health and welfare programs, and $400
million in support for higher education (partly offset by fee increases
at
all three units of higher education) and various
14
miscellaneous cuts (totalling approximately $150 million) in State
government services in many agencies, up to 15%. The 1993-94 Budget Act
suspended the 4% automatic budget reduction "trigger", as was done in
1992-
93 so that cuts could be focused.
6. A 2-year suspension of the renters' tax credit ($390 million
expenditure reduction in 1993-94). A constitutional amendment will be
placed on the June 1994 ballot to restore the renters' tax credit after
1994-95.
7. Miscellaneous one-time items, including deferral of payment to the
Public Employees Retirement Fund ($339 million) and a change in
accounting
for debt service from accrual to cash basis, saving $107 million.
The 1993-94 Budget Act contains no general fund tax/revenue increases
other
than a two year suspension of the renters' tax credit.
Administration reports during the course of the 1993-94 Fiscal Year have
indicated that while economic recovery appears to have started in the
second
half of the fiscal year, recessionary conditions continued longer than has
been anticipated when the 1993-94 Budget Act was adopted. Overall, revenues
for the 1993-94 Fiscal Year were about $800 million lower than original
projections, and expenditures were about $780 million higher, primarily
because of higher health and welfare caseloads, lower property taxes which
require greater State support for K-14 education to make up the shortfall,
and
lower than anticipated federal government payments for immigration-related
costs. The reports in May and June, 1994, indicated that revenues in the
second half of the 1993-94 Fiscal Year have been very close to the
projections
made in the Governor's Budget of January 10, 1994, which is consistent with
a
slow turnaround in the economy.
The Department of Finance's July 1994 Bulletin, including the final June
receipts, reported that June revenues were $114 million (2.5 percent) above
projection, with final end-of-year results at $377 million (about 1
percent)
above the May Revision projections. Part of this result was due to end-of-
year
adjustments and reconciliations. Personal income tax and sales tax
continued
to track projections very well. The largest factor in the higher than
anticipated revenues was from bank and corporation taxes, which were $140
million (18.4 percent) above projection in June. While the higher June
receipts are reflected in the actual 1993-94 Fiscal Year cash flow results,
and help the starting cash balance for the 1994-95 Fiscal Year, the
Department
of Finance has not adjusted any of its revenue projections for the 1994-95
or
1995-96 Fiscal Years.
During the 1993-94 Fiscal Year, the State implemented the deficit
retirement plan, which was part of the 1993-94 Budget Act, by issuing $1.2
billion of revenue anticipation warrants in February 1994 maturing December
21, 1994. This borrowing reduced the cash deficit at the end of the 1993-94
Fiscal Year. Nevertheless, because of the $1.5 billion variance from the
original 1993-94 Budget Act assumptions, the General Fund ended the fiscal
year at June 30, 1994 carrying forward an accumulated deficit of
approximately
$2 billion.
Because of the revenue shortfall and the State's reduced internal
borrowable cash resources, in addition to the $1.2 billion of revenue
anticipation warrants issued as part of the deficit retirement plan, the
State
issued an additional $2.0 billion of revenue anticipation warrants,
maturing
July 26, 1994, which were needed to fund the State's obligations and
expenses
through the end of the 1993-94 Fiscal Year.
On January 17, 1994, a major earthquake measuring an estimated 6.8 on
the
Richter Scale struck Los Angeles. Significant property damage to private
and
public facilities occurred in a four-county area including
15
northern Los Angeles County, Ventura County, and parts of Orange and San
Bernardino Counties, which were declared as State and Federal disaster
areas
by January 18. Current estimates of total property damage (private and
public)
are in the range of $20 billion but these estimates still subject to
change.
Despite such damage, on the whole, the vast majority of structures in
the
areas, including large manufacturing and commercial buildings and all
modern
high-rise offices, survived the earthquake with minimal or no damage,
validating the cumulative effect of strict building codes and thorough
preparation for such an emergency by the State and local agencies.
State-owned facilities, including transportation corridors and
facilities
such as Interstate Highways 5 and 10 and State Highways 14, 118 and 210
sustained damage. Most of the major highways (Interstate 5 and 10) have now
been repaired. The campus of California State University at Northridge
(very
near the epicenter) suffered an estimated $350 million damage, resulting in
temporary closure of the campus. It has reopened using borrowed facilities
elsewhere in the area and many temporary structures. There was also some
damage to the University of California at Los Angeles and to an office
building in Van Nuys (now open after a temporary closure). Overall, except
for
the temporary road and bridge closures, and CSU-Northridge, the earthquake
did
not and is not expected to significantly affect State government
operations.
The State in conjunction with the Federal government is committed to
providing assistance to local governments, individuals and businesses
suffering damage as a result of the earthquake, as well as to provide for
the
repair and replacement of State-owned facilities. The Federal government
will
provide substantial earthquake assistance.
The President immediately allocated some available disaster funds, and
Congress has approved additional funds for a total of at least $9.5 billion
of
federal funds for earthquake relief, including assistance to homeowners and
small businesses, and costs for repair of damaged public facilities. The
Governor originally proposed that the State will have to pay about $1.9
billion for earthquake relief costs, including a 10% match to some of the
Federal funds, and costs for some programs not covered by the Federal aid.
The
Governor proposed to cover $1.05 billion of these costs from a general
obligation bond which was on the June 1994 ballot, but it was not approved
by
the voters. The Governor subsequently announced that the State's share for
transportation projects would come from existing Department of
Transportation
funds (thereby delaying other, non-earthquake related projects), that the
State's share for certain other costs (including local school building
repairs) would come from reallocating existing bond funds, and that a
proposed
program for homeowner and small business aid supplemental to federal aid
would
have to be abandoned. Some other costs will be borrowed from the federal
government in a manner similar to that used by the State of Florida after
Hurricane Andrew; pursuant to Senate Bill 2383, repayment will have to be
addressed in 1995-96 or beyond.
The 1994-95 Fiscal Year will represent the fourth consecutive year the
Governor and Legislature will be faced with a very difficult budget
environment to produce a balanced budget. Many program cuts and budgetary
adjustments have already been made in the last three years. The Governor's
Budget proposal, as updated in May and June, 1994, recognized that the
accumulated deficit could not be repaid in one year, and proposed a two-
year
solution. The budget proposal sets forth revenue and expenditure forecasts
and
revenue and expenditure proposals which result in operating surpluses for
the
budget for both 1994-95 and 1995-96, and lead to the elimination of the
accumulated budget deficit, estimated at about $2.0 billion at June 30,
1994,
by June 30, 1996.
16
The 1994-95 Budget Act, signed by the Governor on July 8, 1994, projects
revenues and transfers of $41.9 billion, $2.1 billion higher than revenues
in
1993-94. This reflects the Administration's forecast of an improving
economy.
Also included in this figure is a projected receipt of about $360 million
from
the Federal Government to reimburse the State's cost of incarcerating
undocumented immigrants. The State will not know how much the Federal
Government will actually provide until the Federal FY 1995 Budget is
completed. Completion of the Federal Budget is expected by October 1994.
The
Legislature took no action on a proposal in the January Governor's Budget
to
undertake an expansion of the transfer of certain programs to counties,
which
would also have transferred to counties 0.5% of the State's current sales
tax.
The Budget Act projects Special Fund revenues of $12.1 billion, a
decrease
of 2.4% from 1993-94 estimated revenues.
The 1994-95 Budget Act projects General Fund expenditures of $40.9
billion,
an increase of $1.6 billion over 1993-94. The Budget Act also projects
Special
Fund expenditures of $13.7 billion, a 5.4% increase over 1993-94 estimated
expenditures. The principal features of the Budget Act were the following:
1. Receipt of additional federal aid in 1994-95 of about $400 million
for costs of refugee assistance and medical care for undocumented
immigrants, thereby offsetting a similar General Fund cost. The State
will
not know how much of these funds it will receive until the Federal FY
1995
Budget is passed.
2. Reductions of approximately $1.1 billion in health and welfare
costs.
3. A General Fund increase of approximately $38 million in support for
the University of California and $65 million for California State
University. It is anticipated that student fees for both the U.C. and the
C.S.U. will increase up to 10%.
4. Proposition 98 funding for K-14 schools is increased by $526
million
from 1993-94 levels, representing an increase for enrollment growth and
inflation. Consistent with previous budget agreements, Proposition 98
funding provides approximately $4,217 per student for K-12 schools, equal
to the level in the past three years.
5. Legislation enacted with the Budget clarifies laws passed in 1992
and
1993 which require counties and other local agencies to transfer funds to
local school districts, thereby reducing State aid. Some counties had
implemented a method of making such transfers which provided less money
for
schools if there were redevelopment agency projects. The new legislation
bans this method of transfer. If all counties had implemented this
method,
General Fund aid to K-12 schools would have been $300 million higher in
each of the 1994-95 and 1995-96 Fiscal Years.
6. The 1994-95 Budget Act provides funding for anticipated growth in
the
State's prison inmate population, including provisions for implementing
recent legislation (the so-called "Three Strikes" law) which requires
mandatory life prison terms for certain third-time felony offenders.
7. Additional miscellaneous cuts ($500 million) and fund transfers
($255
million) totalling in the aggregate approximately $755 million.
The 1994-95 Budget Act contains no tax increases. Under legislation
enacted
for the 1993-94 Budget, the renters' tax credit was suspended for two years
(1993 and 1994). A ballot proposition to permanently restore the renters'
tax
credit after this year failed at the June, 1994 election. The Legislature
enacted a
17
further one-year suspension of the renters' tax credit, for 1995, saving
about
$390 million in the 1995-96 Fiscal Year.
The 1994-95 Budget assumes that the State will use a cash flow borrowing
program in 1994-95 which combines one-year notes and two-year warrants,
which
have now been issued. Issuance of warrants allows the State to defer
repayment
of approximately $1.0 billion of its accumulated budget deficit into the
1995-
96 Fiscal Year.
The State's cash flow management plan for the 1994-95 fiscal year
included
the issuance of $4.0 billion of revenue anticipation warrants on July 26,
1994, to mature on April 25, 1996, as part of a two-year plan to retire the
accumulated State budget deficit.
Because preparation of cash flow estimates for the 1995-96 Fiscal Year
is
necessarily more imprecise than for the current fiscal year and entails
greater risks of variance from assumptions, and because the Governor's two-
year budget plan assumes receipt of a large amount of federal aid in the
1995-
96 Fiscal Year for immigration-related costs which is uncertain, the
Legislature enacted a backup budget adjustment mechanism to mitigate
possible
deviations from projected revenues, expenditures or internal borrowable
resources which might reduce available cash resources during the two-year
plan, so as to assure repayment of the warrants.
Pursuant to Section 12467 of the California Government Code, enacted by
Chapter 135, Statutes of 1994 (the "Budget Adjustment Law"), the State
Controller will, on November 15, 1994, in conjunction with the Legislative
Analyst's Office, review the cash flow projections for the General Fund on
June 30, 1995 and compare them to the projections for the 1994-95 Fiscal
Year
included in the Official Statement dated July 20, 1994 for the 1994 Revenue
Anticipation Warrants, Series C and D. If the State Controller's report
identifies a decrease in the unused borrowable resources on June 30, 1995
of
more than $430,000,000, then the "1995 cash shortfall" shall be the amount
of
the difference that exceeds $430,000,000. On or before February 15, 1995,
legislation must be enacted providing for sufficient General Fund
expenditure
reductions, revenue increases, or both, to offset said 1995 cash shortfall.
If
such legislation is not enacted, within five days thereafter the Director
of
Finance must reduce all General Fund appropriations for the 1994-95 Fiscal
Year, except certain appropriations required by the State Constitution and
federal law (the "Required Appropriations"), by the percentage equal to the
ratio of said 1995 cash shortfall to total remaining General Fund
appropriations for the 1994-95 Fiscal Year, excluding the Required
Appropriations.
The Director of Finance is required to include updated cash-flow
statements
for the 1994-95 and 1995-96 Fiscal Years in the May revision to the 1995-96
Fiscal Year budget proposal. By June 1, 1995, the State Controller must
concur
with these updated statements or provide a revised estimate of the cash
condition of the General Fund for the 1994-95 and the 1995-96 Fiscal Years.
For the 1995-96 Fiscal Year, Chapter 135 prohibits any external borrowing
as
of June 30, 1996, thereby requiring the State to rely solely on internal
borrowable resources, expenditure reductions or revenue increases to
eliminate
any projected cash flow shortfall.
Commencing on October 15, 1995, the State Controller will, in
conjunction
with the Legislative Analyst's Office, review the estimated cash condition
of
the General Fund for the 1995-96 Fiscal Year. The "1996 cash shortfall"
shall
be the amount necessary to bring the balance of unused borrowable resources
on
June 30, 1996 to zero. On or before December 1, 1995, legislation must be
enacted providing for sufficient General Fund expenditure reductions,
revenue
increases, or both, to offset any such 1996 cash shortfall identified by
the
State Controller. If such legislation is not enacted, within five days
thereafter the Director of
18
Finance must reduce all General Fund appropriations for the 1995-96 Fiscal
Year, except the Required Appropriations, by the percentage equal to the
ratio
of said 1996 cash shortfall to total remaining General Fund appropriations
for
the 1995-96 Fiscal Year, excluding the Required Appropriations.
Constitutional, Legislative and Other Factors. Certain California
constitutional amendments, legislative measures, executive orders,
administrative regulations and voter initiatives could result in the
adverse
effects described below. The following information constitutes only a brief
summary, does not purport to be a complete description, and is based on
information drawn from official statements and prospectuses relating to
securities offerings of the State of California and various local agencies
in
California available as of the date of this Statement of Additional
Information.
Certain of the California Municipal Obligations in which the Fund may
invest may be obligations of issuers which rely in whole or in part on
California State revenues for payment of these obligations. Property tax
revenues and a portion of the State's general fund surplus are distributed
to
counties, cities and their various taxing entities and the State assumes
certain obligations theretofore paid out of local funds. Whether and to
what
extent a portion of the State's general fund will be distributed in the
future
to counties, cities and their various entities, is unclear.
In 1988, California enacted legislation providing for a water's-edge
combined reporting method if an election fee was paid and other conditions
met. On October 6, 1993, California Governor Pete Wilson signed Senate Bill
671 (Alquist) which modifies the unitary tax law by deleting the
requirements
that a taxpayer electing to determine its income on a water's-edge basis
pay a
fee and file a domestic disclosure spreadsheet and instead requiring an
annual
information return. Significantly, the Franchise Tax Board can no longer
disregard a taxpayer's election. The Franchise Tax Board is reported to
have
estimated state revenue losses from the Legislation as growing from $27
million in 1993-94 to $616 million in 1999-2000, but others, including
Assembly Speaker Willie Brown, disagree with that estimate and assert that
more revenue will be generated for California, rather than less, because of
an
anticipated increase in economic activity and additional revenue generated
by
the incentives in the Legislation.
Certain of the California Municipal Obligations may be obligations of
issuers who rely in whole or in part on ad valorem real property taxes as a
source of revenue. On June 6, 1978, California voters approved an amendment
to
the California Constitution known as Proposition 13, which added Article
XIIIA
to the California Constitution. The effect of Article XIIIA is to limit ad
valorem taxes on real property and to restrict the ability of taxing
entities
to increase real property tax revenues. On November 7, 1978, California
voters
approved Proposition 8, and on June 3, 1986, California voters approved
Proposition 46, both of which amended Article XIIIA.
Section 1 of Article XIIA limits the maximum ad valorem tax on real
property to 1% of full cash value (as defined in Section 2), to be
collected
by the counties and apportioned according to law; provided that the 1%
limitation does not apply to ad valorem taxes or special assessments to pay
the interest and redemption charges on (a) any indebtedness approved by the
voters prior to July 1, 1978, or (b) any bonded indebtedness for the
acquisition or improvement of real property approved on or after July 1,
1978,
by two-thirds of the votes cast by the voters voting on the proposition.
Section 2 of Article XIIIA defines "full cash value" to mean "the County
Assessor's valuation of real property as shown on the 1975/76 tax bill
under
"full cash value' or, thereafter, the appraised value of real property when
purchased, newly constructed, or a change in ownership has occurred after
the
1975 assessment." The full cash value may be adjusted annually to reflect
19
inflation at a rate not to exceed 2% per year, or reduction in the consumer
price index or comparable local data, or reduced in the event of declining
property value caused by damage, destruction or other factors. The
California
State Board of Equalization has adopted regulations, binding on county
assessors, interpreting the meaning of "change in ownership" and "new
construction" for purposes of determining full cash value of property under
Article XIIIA.
Legislation enacted by the California Legislature to implement Article
XIIIA (Statutes of 1978, Chapter 292, as amended) provides that
notwithstanding any other law, local agencies may not levy any ad valorem
property tax except to pay debt service on indebtedness approved by the
voters
prior to July 1, 1978, and that each county will levy the maximum tax
permitted by Article XIIIA of $4.00 per $100 assessed valuation (based on
the
former practice of using 25%, instead of 100%, of full cash value as the
assessed value for tax purposes). The legislation further provided that,
for
the 1978/79 fiscal year only, the tax levied by each county was to be
apportioned among all taxing agencies within the county in proportion to
their
average share of taxes levied in certain previous years. The apportionment
of
property taxes for fiscal years after 1978/79 has been revised pursuant to
Statutes of 1979, Chapter 282, which provides relief funds from State
moneys
beginning in fiscal year 1979/80 and is designed to provide a permanent
system
for sharing State taxes and budget funds with local agencies. Under Chapter
282, cities and counties receive more of the remaining property tax
revenues
collected under Proposition 13 instead of direct State aid. School
districts
receive a correspondingly reduced amount of property taxes, but receive
compensation directly from the State and are given additional relief.
Chapter
282 does not affect the derivation of the base levy ($4.00 per $100 of
assessed valuation) and the bonded debt tax rate.
On November 6, 1979, an initiative known as "Proposition 4" or the "Gann
Initiative" was approved by the California voters, which added Article
XIIIB
to the California Constitution. Under Article XIIIB, State and local
governmental entities have an annual "appropriations limit" and are not
allowed to spend certain monies called "appropriations subject to
limitation"
in an amount higher than the "appropriations limit." Article XIIIB does not
affect the appropriation of moneys which are excluded from the definition
of
"appropriations subject to limitation," including debt service on
indebtedness
existing or authorized as of January 1, 1979, or bonded indebtedness
subsequently approved by the voters. In general terms, the "appropriations
limit" is required to be based on certain 1978/79 expenditures, and is to
be
adjusted annually to reflect changes in consumer prices, population and
certain services provided by these entities. Article XIIIB also provides
that
if these entities' revenues in any year exceed the amounts permitted to be
spent, the excess is to be returned by revising tax rates or fee schedules
over the subsequent two years.
At the November 8, 1988 general election, California voters approved an
initiative known as Proposition 98. This initiative amends Article XIIIB to
require that (a) the California Legislature establish a prudent state
reserve
fund in an amount as it shall deem reasonable and necessary and (b)
revenues
in excess of amounts permitted to be spent and which would otherwise be
returned pursuant to Article XIIIB by revision of tax rates or fee
schedules,
be transferred and allocated (up to a maximum of 4%) to the State School
Fund
and be expended solely for purposes of instructional improvement and
accountability. No such transfer or allocation of funds will be required if
certain designated state officials determine that annual student
expenditures
and class size meet certain criteria as set forth in Proposition 98. Any
funds
allocated to the State School Fund shall cause the appropriation limits
established in Article XIIIB to be annually increased for any such
allocation
made in the prior year.
20
Proposition 98 also amends Article XVI to require that the State of
California provide a minimum level of funding for public schools and
community
colleges. Commencing with the 1988-89 fiscal year, state monies to support
school districts and community college districts shall equal or exceed the
lesser of (a) an amount equalling the percentage of state general revenue
bonds for school and community college districts in fiscal year 1986-87, or
(b) an amount equal to the prior year's state general fund proceeds of
taxes
appropriated under Article XIIIB plus allocated proceeds of local taxes,
after
adjustment under Article XIIIB. The initiative permits the enactment of
legislation, by a two-thirds vote, to suspend the minimum funding
requirement
for one year.
On June 30, 1989, the California Legislature enacted Senate
Constitutional
Amendment 1, a proposed modification of the California Constitution to
alter
the spending limit and the education funding provisions of Proposition 98.
Senate Constitutional Amendment 1, on the June 5, 1990 ballot as
Proposition
111, was approved by the voters and took effect on July 1, 1990. Among a
number of important provisions, Proposition 111 recalculates spending
limits
for the State and for local governments, allows greater annual increases in
the limits, allows the averaging of two years' tax revenues before
requiring
action regarding excess tax revenues, reduces the amount of the funding
guarantee in recession years for school districts and community college
districts (but with a floor of 40.9% of State general fund tax revenues),
removes the provision of Proposition 98 which included excess moneys
transferred to school districts and community college districts in the base
calculation for the next year, limits the amount of State tax revenue over
the
limit which would be transferred to school districts and community college
districts, and exempts increased gasoline taxes and truck weight fees from
the
State appropriations limit. Additionally, Proposition 111 exempts from the
State appropriations limit funding for capital outlays.
Article XIIIB, like Article XIIIA, may require further interpretation by
both the Legislature and the courts to determine its applicability to
specific
situations involving the State and local taxing authorities. Depending upon
the interpretation, Article XIIIB may limit significantly a governmental
entity's ability to budget sufficient funds to meet debt service on bonds
and
other obligations.
On November 4, 1986, California voters approved an initiative statute
known
as Proposition 62. This initiative (a) requires that any tax for general
governmental purposes imposed by local governments be approved by
resolution
or ordinance adopted by a two-thirds vote of the governmental entity's
legislative body and by a majority vote of the electorate of the
governmental
entity, (b) requires that any special tax (defined as taxes levied for
other
than general governmental purposes) imposed by a local governmental entity
be
approved by a two-thirds vote of the voters within that jurisdiction, (c)
restricts the use of revenues from a special tax to the purposes or for the
service for which the special tax was imposed, (d) prohibits the imposition
of
ad valorem taxes on real property by local governmental entities except as
permitted by Article XIIIA, (e) prohibits the imposition of transaction
taxes
and sales taxes on the sale of real property by local governments, (f)
requires that any tax imposed by a local government on or after August 1,
1985
be ratified by a majority vote of the electorate within two years of the
adoption of the initiative or be terminated by November 15, 1988, (g)
requires
that, in the event a local government fails to comply with the provisions
of
this measure, a reduction in the amount of property tax revenue allocated
to
such local government occurs in an amount equal to the revenues received by
such entity attributable to the tax levied in violation of the initiative,
and
(h) permits these provisions to be amended exclusively by the voters of the
State of California.
In September 1988, the California Court of Appeals in City of
Westminster
v. County of Orange 204 Cal. App. 3d 623, 215 Cal. Rptr. 511 (Cal. Ct. App.
1988), held that Proposition 62 is unconstitutional to
21
the extent that it requires a general tax by a general law city, enacted on
or
after August 1, 1985 and prior to the effective date of Proposition 62, to
be
subject to approval by a majority of voters. The Court held that the
California Constitution prohibits the imposition of a requirement that
local
tax measures be submitted to the electorate by either referendum or
initiative. It is not possible to predict the impact of this decision on
charter cities, on special taxes or on new taxes imposed after the
effective
date of Proposition 62.
On November 8, 1988, California voters approved Proposition 87.
Proposition
87 amended Article XVI, Section 16, of the California Constitution by
authorizing the California Legislature to prohibit redevelopment agencies
from
receiving any of the property tax revenue raised by increased property tax
rates levied to repay bonded indebtedness of local governments which is
approved by voters on or after January 1, 1989. It is not possible to
predict
whether the California Legislature will enact such a prohibition nor is it
possible to predict the impact of Proposition 87 on redevelopment agencies
and
their ability to make payments on outstanding debt obligations.
Certain California Municipal Obligations in which the Fund may invest
may
be obligations that are payable solely from the revenues of health care
institutions. Certain provisions under California law may adversely affect
such revenues and, consequently, payment on those California Municipal
Obligations.
The Federally sponsored Medicaid program for health care services to
eligible welfare beneficiaries in California is known as the Medi-Cal
program.
Historically, the Medi-Cal program has provided for a cost-based system of
reimbursement for inpatient care furnished to Medi-Cal beneficiaries by any
hospital wanting to participate in the Medi-Cal program, provided such
hospital met applicable requirements for participation. California law now
provides that the State of California shall selectively contract with
hospitals to provide acute inpatient services to Medi-Cal patients. Medi-
Cal
contracts currently apply only to acute inpatient services. Generally, such
selective contracting is made on a flat per diem payment basis for all
services to Medi-Cal beneficiaries, and generally such payment has not
increased in relation to inflation, costs or other factors. Other
reductions
or limitations may be imposed on payment for services rendered to Medi-Cal
beneficiaries in the future.
Under this approach, in most geographical areas of California, only
those
hospitals which enter into a Medi-Cal contract with the State of California
will be paid for non-emergency acute inpatient services rendered to Medi-
Cal
beneficiaries. The State may also terminate these contracts without notice
under certain circumstances and is obligated to make contractual payments
only
to the extent the California legislature appropriates adequate funding
therefor.
In February 1987, the Governor of the State of California announced that
payments to Medi-Cal providers for certain services (not including hospital
acute inpatient services) would be decreased by 10% through June 1987.
However, a federal district court issued a preliminary injunction
preventing
application of any cuts until a trial on the merits can be held. If the
injunction is deemed to have been granted improperly, the State of
California
would be entitled to recapture the payment differential for the intended
reduction period. It is not possible to predict at this time whether any
decreases will ultimately be implemented.
California enacted legislation in 1982 that authorizes private health
plans
and insurers to contract directly with hospitals for services to
beneficiaries
on negotiated terms. Some insurers have introduced plans known as
"preferred
provider organizations" ("PPOs"), which offer financial incentives for
subscribers who use only the hospitals which contract with the plan. Under
an
exclusive provider plan, which includes most
22
health maintenance organizations ("HMOs"), private payors limit coverage to
those services provided by selected hospitals. Discounts offered to HMOs
and
PPOs may result in payment to the contracting hospital of less than actual
cost and the volume of patients directed to a hospital under an HMO or PPO
contract may vary significantly from projections. Often, HMO or PPO
contracts
are enforceable for a stated term, regardless of provider losses or of
bankruptcy of the respective HMO or PPO. It is expected that failure to
execute and maintain such PPO and HMO contracts would reduce a hospital's
patient base or gross revenues. Conversely, participation may maintain or
increase the patient base, but may result in reduced payment and lower net
income to the contracting hospitals.
Such California Municipal Obligations may also be insured by the State
of
California pursuant to an insurance program implemented by the Office of
Statewide Health Planning and Development for health facility construction
loans. If a default occurs on insured California Municipal Obligations, the
State Treasurer will issue debentures payable out of a reserve fund
established under the insurance program or will pay principal and interest,
on
an unaccelerated basis from unappropriated State funds. At the request of
the
Office of Statewide Health Planning and Development, Arthur D. Little, Inc.
prepared a study in December 1983 to evaluate the adequacy of the reserve
fund
established under the insurance program and, based on certain formulations
and
assumptions found the reserve fund substantially underfunded. In September
of
1986, Arthur D. Little, Inc. prepared an update of the study and concluded
that an additional 10% reserve be established for "multi-level" facilities.
For the balance of the reserve fund, the update recommended maintaining the
current reserve calculation method. In March 1990, Arthur D. Little, Inc.
prepared a further review of the study and recommended that separate
reserves
continue to be established for "multi-level" facilities at a reserve level
consistent with those that would be required by an insurance company.
Certain California Municipal Obligations in the Fund may be obligations
which are secured in whole or in part by a mortgage or deed of trust on
real
property. California has five principal statutory provisions which limit
the
remedies of a creditor secured by a mortgage or deed of trust. Two limit
the
creditor's right to obtain a deficiency judgment, one limitation being
based
on the method of foreclosure and the other on the type of debt secured.
Under
the former, a deficiency judgment is barred when the foreclosure is
accomplished by means of a nonjudicial trustee's sale. Under the latter, a
deficiency judgment is barred when the foreclosed mortgage or deed of trust
secures certain purchase money obligations. Another California statute,
commonly known as the "one form of action" rule, requires creditors secured
by
real property to exhaust their real property security by foreclosure before
bringing a personal action against the debtor. The fourth statutory
provision
limits any deficiency judgment obtained by a creditor secured by real
property
following a judicial sale of such property to the excess of the outstanding
debt over the fair value of the property at the time of the sale, thus
preventing the creditor from obtaining a large deficiency judgment against
the
debtor as the result of low bids at a judicial sale. The fifth statutory
provision gives the debtor the right to redeem the real property from any
judicial foreclosure sale as to which a deficiency judgment may be ordered
against the debtor.
Upon the default of a mortgage or deed of trust with respect to
California
real property, the creditor's nonjudicial foreclosure rights under the
power
of sale contained in the mortgage or deed of trust are subject to the
constraints imposed by California law upon transfers of title to real
property
by private power of sale. During the three-month period beginning with the
filing of a formal notice of default, the debtor is entitled to reinstate
the
mortgage by making any overdue payments. Under standard loan servicing
procedures, the filing of the formal notice of default does not occur
unless
at least three full monthly payments have become
23
due and remain unpaid. The power of sale is exercised by posting and
publishing a notice of sale for at least 20 days after expiration of the
three-month reinstatement period. Therefore, the effective minimum period
for
foreclosing on a mortgage could be in excess of seven months after the
initial
default. Such time delays in collections could disrupt the flow of revenues
available to an issuer for the payment of debt service on the outstanding
obligations if such defaults occur with respect to a substantial number of
mortgages or deeds of trust securing an issuer's obligations.
In addition, a court could find that there is sufficient involvement of
the
issuer in the nonjudicial sale of property securing a mortgage for such
private sale to constitute "state action," and could hold that the private-
right-of-sale proceedings violate the due process requirements of the
Federal
or State Constitutions, consequently preventing an issuer from using the
nonjudicial foreclosure remedy described above.
Certain California Municipal Obligations in the Fund may be obligations
which finance the acquisition of single family home mortgages for low and
moderate income mortgagors. These obligations may be payable solely from
revenues derived from the home mortgages, and are subject to California's
statutory limitations described above applicable to obligations secured by
real property. Under California antideficiency legislation, there is no
personal recourse against a mortgagor of a single family residence
purchased
with the loan secured by the mortgage, regardless of whether the creditor
chooses judicial or nonjudicial foreclosure.
Under California law, mortgage loans secured by single-family owner-
occupied dwellings may be prepaid at any time. Prepayment charges on such
mortgage loans may be imposed only with respect to voluntary prepayments
made
during the first five years during the term of the mortgage loan, and
cannot
in any event exceed six months' advance interest on the amount prepaid in
excess of 20% of the original principal amount of the mortgage loan. This
limitation could affect the flow of revenues available to an issuer for
debt
service on the outstanding debt obligations which financed such home
mortgages.
Additional Considerations. With respect to Municipal Securities issued
by
the State of California and its political sub-divisions, (i.e., California
Municipal Obligations) the Fund cannot predict what legislation, if any,
may
be proposed in the California State Legislature as regards the California
State personal income tax status of interest on such obligations, or which
proposals, if any, might be enacted. Such proposals, if enacted, might
materially adversely affect the availability of California Municipal
Obligations for investment by the Fund and the value of the Fund's
portfolio.
In such an event, the Trustees would reevaluate the Fund's investment
objective and policies and consider changes in its structure or possible
dissolution.
PURCHASE OF SHARES
VOLUME DISCOUNTS
The schedule of sales charges on Class A shares described in the Prospectus
applies to purchases made by any "purchaser," which is defined to include
the
following: (a) an individual; (b) an individual's spouse and his or her
children purchasing shares for his or her own account; (c) a trustee or
other
fiduciary purchasing shares for a single trust estate or single fiduciary
account; (d) a pension, profit sharing or other employee benefit plan
qualified under Section 401(a) of the Internal Revenue Code of 1986, as
amended (the "Code" and qualified employee benefit plans of employers who
are
"affiliated persons" of each other within the meaning of the 1940 Act; (e)
tax-exempt organizations enumerated in Section 501(c)(3) or (13) of the
Code;
and (f) a trustee or other professional fiduciary (including a bank, or an
investment adviser registered with the SEC under the Investment Advisers
Act
of 1940, as amended) purchasing shares of the Fund for one or
24
more trust estates or fiduciary accounts. Purchasers who wish to combine
purchase orders to take advantage of volume discounts should contact a
Smith
Barney Financial Consultant.
COMBINED RIGHT OF ACCUMULATION
Reduced sales charges, in accordance with the schedule in the Prospectus,
apply to any purchase of Class A shares if the aggregate investment in
Class A
shares of the Fund and in Class A shares of other funds of the Smith Barney
Mutual Funds that are offered with a sales charge, including the
purchase being made, of any purchaser is $25,000 or more. The reduced sales
charge is subject to confirmation of the shareholder's holdings through a
check of appropriate records. The Fund reserves the right to terminate or
amend the combined right of accumulation at any time after written
notice to shareholders. For further information regarding the right of
accumulation, shareholders should contact a Smith Barney Financial
Consultant.
DETERMINATION OF PUBLIC OFFERING PRICE
The Fund offers its shares to the public on a continuous basis. The public
offering price for a Class A and Class Y share of the Fund is equal to the
net
asset value per share at the time of purchase, plus for Class A shares an
initial sales charge based on the aggregate amount of the investment. The
public offering price for a Class B and Class C share (and Class A share
purchases, including applicable rights of accumulation, equaling or
exceeding
$500,000), is equal to the net asset value per share at the time of
purchase
and no sales charge is imposed at the time of purchase. A contingent
deferred
sales charge ("CDSC"), however, is imposed on certain redemptions of Class
B
and Class C shares, and Class A shares when purchased in amounts exceeding
$500,000. The method of computation of the public offering price is shown
in
the Fund's financial statements, incorporated by reference
in their
entirety into this Statement of Additional Information.
REDEMPTION OF SHARES
The right of redemption may be suspended or the date of payment postponed
(a)
for any period during which the New York Stock Exchange, Inc. ("NYSE") is
closed (other than for customary weekend and holiday closings), (b) when
trading in the markets the Fund normally utilizes is restricted, or an
emergency, as determined by the SEC, so that disposal of the Fund's
investments or determination of net asset value is not reasonably
practicable
or (c) for such other periods as the SEC by order may permit for protection
of
the Fund's shareholders.
DISTRIBUTIONS IN KIND
If the Board of Directors of the Fund determines that
it would be detrimental to the best interests of the remaining shareholders
to make a redemption payment wholly in cash, the Fund may pay,
in accordance with SEC rules, any portion of a redemption in
excess of the lesser of $250,000 or 1.00% of the Fund's net assets by a
distribution in kind of portfolio securities in lieu of cash.
Securities
issued as a distribution in kind may incur brokerage
commissions when shareholders subsequently sell those
securities.
AUTOMATIC CASH WITHDRAWAL PLAN
An automatic cash withdrawal plan (the "Withdrawal Plan") is available to
shareholders who own shares with a value of at least $10,000 and who wish
to
receive specific amounts of cash monthly and quarterly.
25
Withdrawals of at least $100 may be made under the Withdrawal Plan by
redeeming as many shares of the Fund as may be necessary to cover the
stipulated withdrawal payment. Any applicable CDSC will not be waived on
amounts withdrawn by shareholders that exceed 1.00% per month of the
value of a shareholder's shares at the time the Withdrawal Plan commences.
(With respect to Withdrawal Plans in effect prior to November 7, 1994, any
applicable CDSC will be waived on amounts withdrawn that do not exceed
2.00% per month of the value of the shareholder's shares that are subject
to a
CDSC). To the extent withdrawals exceed dividends, distributions and
appreciation of a shareholder's investment in the Fund, there will be a
reduction in the value of the shareholder's investment, and continued
withdrawal payments may reduce the shareholder's investment
and ultimately exhaust it. Withdrawal payments should not be considered
as income from investment in the Fund. Furthermore, as it generally would
not be advantageous to a shareholder to make additional investments in the
Fund at the same time heor she is participating in the Withdrawal Plan,
purchases by such shareholder in amounts of less than $5,000 ordinarily
will
not be permitted.
Shareholders who wish to participate in the Withdrawal Plan and who hold
their shares in certificate form must deposit their share certificates with
TSSG as agent for Withdrawal Plan members. All dividends and distributions
on shares in the Withdrawal Plan are reinvested automatically at net asset
value in additional shares of the Fund. For additional information,
shareholders
should contact a Smith Barney Financial Consultant. Effective November
7,
1994, Withdrawal Plans should be set up with a Smith Barney
Financial Consultant. A shareholder who purchases shares directly
through TSSG may continue to do so and applications for participation in
the
Withdrawal Plan must be received by TSSG no later than the eighth day of
the
month to be eligible for participation beginning with that month's
withdrawal.
DISTRIBUTOR
Smith Barney serves as the Fund's distributor on a best efforts basis
pursuant
to a written agreement (the "Distribution Agreement"), which was most
recently
approved by the Fund's Board of Directors on July 20, 1994. For the 1992,
1993
and 1994 fiscal years, Smith Barney or its predecessor Shearson Lehman
Brothers received $1,638,252, $1,713,689 and $937,828, respectively, in
sales
charges for the sale of the Fund's Class A shares, and did not reallow any
portion thereof to dealers. For the period from November 6, 1992 through
February 28, 1993, and for the fiscal year ended February 28, 1994, Smith
Barney or Shearson Lehman Brothers received $9,030 and $75,150,
respectively,
representing CDSCs on redemption of the Fund's Class B shares.
When payment is made by the investor before settlement date, unless
otherwise noted by the investor, the funds will be held as a free credit
balance in the investor's brokerage account, and Smith Barney may benefit
from
the temporary use of the funds. The investor may designate another use for
the
funds prior to settlement date, such as an investment in a money market
fund
(other than the Smith Barney Exchange Reserve Fund) of the Smith Barney
Mutual Funds. If the investor instructs Smith Barney to invest the funds in
Smith Barney money market fund , the amount of the
investment will be included as part of the average daily net assets of both
the Fund and the money market fund, and affiliates of Smith Barney,
that serve the funds in an investment advisory or administrative
capacity, will benefit from the fact they are receiving
fees from both such investment companies for managing these assets
, computed on the basis of their average daily net assets. The Fund's
Board of Directors has been advised of the benefits to Smith Barney
resulting from these
26
settlement procedures and will take such benefits into consideration when
reviewing the Advisory, Administration and Distribution Agreements for
continuance.
For the fiscal years ended February 28, 1993 and 1994, Smith Barney
incurred
distribution expenses totaling approximately $530,000 and $1,911,000,
consisting of approximately $0 and $7,000 for advertising, $1,000
and $7,000 for printing and mailing of Prospectuses, $80,000 and
$541,000 for support services, $444,000 and $1,294,000 to Smith Barney
Financial Consultants, and $5,000 and $62,000, respectively, in accruals
for interest on the excess of Smith Barney expenses incurred in
distributing
the Funds shares over the sum of the distribution fees and CDSC received
by Smith Barney from the Fund. No comparable information is available
for 1992 because that was the year that the variable pricing system was
implemented.
DISTRIBUTION ARRANGEMENTS
To compensate Smith Barney for the services it provides and for the expense
it
bears under the Distribution Agreement, the Fund has adopted a services and
distribution plan (the "Plan") pursuant to Rule 12b-1 under the 1940 Act.
Under the Plan, the Fund pays Smith Barney a service fee, accrued daily and
paid monthly, calculated at the annual rate of 0.15% of the value of the
Fund's average daily net assets attributable to the Class A, Class B and
Class
C shares. In addition, the Fund pays Smith Barney a distribution
fee with respect to the Class B and Class C shares primarily
intended to compensate Smith Barney for its initial expense of paying its
Financial Consultants a commission upon sales of those shares. The
Class B distribution fee is calculated at the annual rate of 0.50% of the
value of the Fund's average net assets attributable to the shares of the
Class. The Class C distribution fee is calculated at the annual rate of
0.55%
of the value of the Fund's average net assets attributable to the shares of
the Class.
For the period from November 6, 1992 through February 28, 1993,
Class A and Class B shares incurred $187,628 and $8,827, respectively, in
service fees. For the same period, Class B shares incurred $29,426 in
distribution fees. For the fiscal year ended February 28, 1994, Class A and
Class B shares incurred $641,265 and $115,317, respectively in service
fees.
For the same period, Class B shares incurred $384,392 in distribution fees.
Under its terms, the Plan continues from year to year, provided such
continuance is approved annually by vote of the Fund's Board of Directors,
including a majority of the Directors who are not interested persons of the
Fund and who have no direct or indirect financial interest in the operation
of
the Plan or in the Distribution Agreement (the "Independent Directors").
The
Plan may not be amended to increase the amount of the service and
distribution
fees without shareholder approval, and all amendments of the Plan also must
be
approved by the Directors and Independent Directors in the manner described
above. The Plan may be terminated
with respect to a Class
at any
time , without
penalty, by vote of a majority of the Independent Directors or by vote of a
majority of the outstanding voting securities of the Class (as defined in
the
1940 Act). Pursuant to the Plan, Smith Barney will provide the Board of
Directors periodic reports of the amounts expended under the Plan and the
purpose for which such expenditures were made.
VALUATION OF SHARES
Each Class' net asset asset value per share is calculated on each day,
Monday
through Friday, except days on which the NYSE is closed. The NYSE currently
is
scheduled to be closed on New Year's Day, Presidents' Day, Good Friday,
Memorial Day, Independence Day, Labor Day, Thanksgiving and Christmas, and
on
the preceding Friday or subsequent Monday when one of these holidays falls
on
a Saturday or Sunday, respectively. Because of the differences in
distribution
fees and Class-specific expenses, the per share net asset value of each
Class
may differ. The following is a description of the procedures used by the
Fund
in valuing its assets.
The valuation of the Fund's assets is made by Boston Advisors after
consultation with an independent pricing service (the "Service") approved
by
the Fund's Board of Directors. When, in the judgment of the Service, quoted
bid prices for investments are readily available and representative of the
bid
side of the market, these investments are valued at the mean between the
quoted bid and asked prices. Investments for which, in the judgment of the
Service, there is no readily obtainable market quotation (which may
constitute
a majority of the portfolio securities) are carried at fair value as
determined by the Service. For the most part,
27
such investments are liquid and may be readily sold. The Service may employ
electronic data processing techniques and/or a matrix system to determine
valuations. The procedures of the Service are reviewed periodically by the
officers of the Fund under the general supervision and responsibility of
the
Board of Directors, which may replace any such Service at any time if it
determines it to be in the best interest of the Fund to do so.
EXCHANGE PRIVILEGE
Except as noted below, shareholders of any fund of the Smith Barney Mutual
Funds may exchange all or part of their shares for shares of the same Class
of
other funds in the Smith Barney Mutual Funds, to the extent such shares are
offered for sale in the shareholder's state of residence, on the basis of
relative net asset value per share at the time of exchange as follows:
A. Class A shares of any fund purchased with a sales charge may be
exchanged for Class A shares of any of the other funds, and the sales
charge differential, if any, will be applied. Class A shares of any
fund
may be exchanged without a sales charge for shares of the funds that
are
offered without a sales charge. Class A shares of any fund purchased
without a sales charge may be exchanged for shares sold with a sales
charge, and the appropriate sales charge differential will be applied.
B. Class A shares of any fund acquired by a previous exchange of shares
purchased with a sales charge may be exchanged for Class A shares of
any
of the other funds, and the sales charge differential, if any, will be
applied.
C. Class B shares of any fund may be exchanged without a sales charge.
Class B shares of the Fund exchanged for Class B shares of another
fund
will be subject to the higher applicable CDSC of the two funds and,
for
purposes of calculating CDSC rates and conversion periods, will be
deemed to have been held since the date the shares being exchanged
were
purchased.
Dealers other than Smith Barney must notify TSSG of the investor's prior
ownership of Class A shares of Smith Barney High Income Fund and the
account number in order to accomplish an exchange of shares of the Smith
Barney High Income Fund under paragraph B above.
The exchange privilege enables shareholders to acquire shares of the
same
Class in a fund with different investment objectives when they believe that
a
shift between funds is an appropriate investment decision. This
privilege
is available to shareholders residing in any state in which the Fund shares
being acquired may legally be sold. Prior to any exchange, the
shareholder should obtain and review a copy of the current prospectus of
each fund into which an exchange is being considered. Prospectuses may
be obtained from a Smith Barney Financial Consultant.
Upon receipt of proper instructions and all necessary supporting
documents,
shares submitted for exchange are redeemed at the then-current net asset
value
and, subject to any applicable CDSC, the proceeds immediately invested, at
a
price as described above, in shares of the fund being acquired. Smith
Barney
reserves the right to reject any exchange request. The exchange privilege
may
be modified or terminated at any time after written notice to shareholders.
PERFORMANCE DATA
From time to time, the Fund may quote yield or total return of a Class in
advertisements or in reports and other communications to shareholders. The
Fund may include comparative performance information in
28
advertising or marketing the Fund's shares. Such performance information
may
include the following industry and financial publications: Barron's,
Business
Week, CDA Investment Technologies, Inc., Changing Times, Forbes, Fortune,
Institutional Investor, Investors Daily, Money, Morningstar Mutual Fund
Values, The New York Times, USA Today and The Wall street Journal. To the
extent any advertisement or sales literature of the Fund describes the
expenses or performance of any Class, it will also disclose such
information
for the other Classes.
YIELD
A 30-day yield figure described below is calculated according to a formula
prescribed by the SEC. The formula can be expressed as follows:
YIELD = 2 [(a-b + 1)/6/ - 1]
---
cd
<TABLE>
<C> <C> <S>
Where: a = dividends and interest earned during the period
b = expenses accrued for the period (net of reimbursement).
c = the average daily number of shares outstanding during the
period that were entitled to receive dividends.
d = the maximum offering price per share on the last day of
the
period.
</TABLE>
For the purpose of determining the interest earned (variable "a" in the
formula) on debt obligations that were purchased by the Fund at a discount
or
premium, the formula generally calls for amortization of the discount or
premium; the amortization schedule will be adjusted monthly to reflect
changes
in the market values of the debt obligations.
The Fund's equivalent taxable 30-day yield for a Class of shares is
computed by dividing that portion of the Class' 30-day yield which is tax-
exempt by one minus a stated income tax rate and adding the product to that
portion, if any, of the Class' yield that is not tax-exempt.
The yield on municipal securities is dependent upon a variety of
factors,
including general economic and monetary conditions, conditions of the
municipal securities market, size of a particular offering, maturity of the
obligation offered and rating of the issue. Investors should recognize that
in
periods of declining interest rates the Fund's yield for each Class of
shares
will tend to be somewhat higher than prevailing market rates, and in
periods
of rising interest rates the Fund's yield for each Class of shares will
tend
to be somewhat lower. In addition, when interest rates are falling, the
inflow
of net new money to the Fund from the continuous sale of its shares will
likely be invested in portfolio instruments producing lower yields than the
balance of the Fund's portfolio, thereby reducing the current yield of the
Fund. In periods of rising interest rates, the opposite can be expected to
occur.
The Fund's yield for Class A and Class B shares for the 30-day period
ended
August 31 , 1994 was 5.04% and 4.74% , respectively. The
equivalent taxable
yield for the same period was 8.44% and 7.94% , respectively,
assuming the
payment of Federal income taxes at a rate of 31% and California income
taxes
at a rate of 9.30%.
29
AVERAGE ANNUAL TOTAL RETURN
"Average annual total return" figures, as described below, are computed
according to a formula prescribed by the SEC. The formula can be expressed
as
follows:
P(1 + T)/n/ = ERV
<TABLE>
<C> <C> <S>
Where: P = a hypothetical initial payment of $1,000.
T = average annual total return.
n = number of years.
ERV = Ending Redeemable Value of a hypothetical $1,000
investment
made at the beginning of a 1-, 5- or 10-year period at
the
end of a 1-, 5- or 10-year period (or fractional portion
thereof), assuming reinvestment of all dividends and
distri-
butions.
</TABLE>
The following total return figures assume that the maximum 4.00% sales
charge has been deducted from the investment at the time of purchase and
have
been restated to show the change in the maximum sales charge. The Fund's
average annual total returns for the Class A shares were as follows for the
periods indicated:
2.70% for the one-year period beginning on September 1, 1993 through
August 30, 1994.
7.17% per annum during the five-year period beginning on September 1,
1989 through August 30, 1994; and
9.32% per annum during the period from August 30, 1984 through August 30,
1994.
These Fund's average total return for Class B shares assuming the
maximum
applicable CDSC was for the periods indicated:
(3.34)% for the one-year period beginning on September 1, 1993 through
August 30, 1994.
5.36% per annum during the period from commencement (November 6, 1992)
through February 28, 1994.
The Fund's average total return for Class B shares without the CDSC was
as
follows for the periods indicated:
0.83% for the one year period beginning September 1, 1993 through August
30,
1994.
7.42% per annum during the period from commencement (November 6, 1992)
through August 30, 1994.
30
AGGREGATE TOTAL RETURN
Aggregate total return figures, as described below, represent the
cumulative
change in the value of an investment in the Class for the specified period
and
are computed by the following formula:
ERV-P
-----
P
<TABLE>
<C> <C> <S>
Where: P = a hypothetical initial payment of $10,000.
ERV = Ending Redeemable Value of a hypothetical $10,000
investment
made at the beginning of a 1-, 5- or 10-year period at
the
end of the 1-, 5- or 10-year period (or fractional
portion
thereof), assuming reinvestment of all dividends and
distri-
butions.
</TABLE>
The aggregate total returns for the Class A shares were as follows for
the
periods indicated:
1.36% for the one-year period beginning September 1, 1993 through August
30,
1994;
47.26% for the five-year period beginning September 1, 1989 through August
30,
1994; and
154.03% for the period from August 30, 1984 through August 30, 1994.
These aggregate total return figures do not assume that the maximum
4.00%
sales charge has been deducted from the investment at the time of purchase.
If
the sales charge had been deducted at the time of purchase, the aggregate
total return for its Class A shares for those same periods would have
been
(2.70)%, 41.37% and 143.87% respectively. The total return figures have
been restated to show the change in the maximum sales charge.
The aggregate total return for Class B shares for the periods indicated
were
as follows:
0.83% for the period from September 1, 1993 through August 30, 1994.
13.88% for the period from November 6, 1992 through August 30, 1994.
These figures do not assume that the maximum 4.50% CDSC assessed by the
Fund has been deducted from the investment at the time of purchase. If the
maximum CDSC had been deducted at the time of purchase, the Fund's a
ggregate total return for the same periods would have been (3.34)%
and 9.95%, respectively.
Performance will vary from time to time depending upon market
conditions,
the composition of the Fund's portfolio and operating expenses and the
expenses exclusively attributable to the Class. Consequently, any given
performance quotation should not be considered representative of the Class'
performance for any specified period in the future. Because the performance
will vary, it may not provide a basis for comparing an investment in the
Class
with certain bank deposits or other investments that pay a fixed yield for
a
stated period of time. Investors comparing a Class' performance with that
of
other mutual funds should give consideration to the quality and maturity of
the respective investment companies' portfolio securities.
It is important to note that the total return figures set forth above
are
based on historical earnings and are not intended to indicate future
performance. Each Class' net investment income changes in response to
fluctuation in interest rates and the expenses of the Fund.
31
TAXES
The following is a summary of selected Federal income tax considerations
that may affect the Fund and its shareholders. The summary is not intended
as
a substitute for individual tax advice and investors are urged to consult
their own tax advisors as to the tax consequences of an investment in the
Fund.
As described above and in the Prospectus, the Fund is designed to provide
investors with current income which is excluded from gross income for
Federal
income tax purposes and exempt from California state personal income taxes.
The Fund is not intended to constitute a balanced investment program and is
not designed for investors seeking capital gains or maximum tax-exempt
income
irrespective of fluctuations in principal. Investment in the Fund would not
be
suitable for tax-exempt institutions, qualified retirement plans, H.R. 10
plans and individual retirement accounts because such investors would not
gain
any additional tax benefit from the receipt of tax-exempt income.
The Fund has qualified and intends to continue to qualify each year as a
"regulated investment company" under the Code. Provided that the Fund (a)
qualifies as a regulated investment company and (b) distributes at least
90%
of its taxable net investment income and net realized short-term capital
gains
and 90% of its tax-exempt interest income (reduced by certain expenses),
the
Fund will not be liable for Federal and California state income or
franchise
taxes to the extent its taxable net investment income and its net realized
short-and long-term capital gains, if any, are distributed to its
shareholders. Any such taxes paid by the Fund would reduce the amount of
income and gains available for distribution to shareholders.
Because the Fund will distribute exempt-interest dividends, interest on
indebtedness incurred by a shareholder to purchase or carry Fund shares is
not
deductible for Federal and California state income tax purposes. If a
shareholder receives exempt-interest dividends with respect to any share
and
if such share is held by the shareholder for six months or less, then for
Federal and California state income tax purposes, any loss on the sale or
exchange of such share, to the extent of such exempt-interest dividend, may
be
disallowed. In addition, the Code may require a shareholder, if he or she
receives exempt-interest dividends, to treat as taxable income a portion of
certain otherwise non-taxable social security and railroad retirement
benefit
payments. Furthermore, that portion of any exempt-interest dividends paid
by
the Fund which represents income derived from private activity bonds held
by
the Fund may not retain its Federal tax-exempt status in the hands of a
shareholder who is a "substantial user" of a facility financed by such
bonds
or a "related person" thereof. Similar rules are applicable for California
state personal income tax purposes. Moreover, as noted in the Fund's
Prospectus, (a) some or all of the Fund's dividends and distributions may
be a
specific tax preference item, or a component of an adjustment item, for
purposes of the Federal individual and corporate alternative minimum taxes
and
(b) the receipt of the Fund's dividends and distributions may affect a
corporate shareholder's Federal "environmental" tax liability. In addition,
the receipt of Fund dividends and distributions may affect a foreign
corporate
shareholder's Federal "branch profits" tax liability and the Federal and
California state "excess net passive income" tax liability of a shareholder
of
a Subchapter S corporation. Shareholders should consult their own tax
advisors
as to whether they are (a) substantial users with respect to a facility or
related to such users within the meaning of the Code and (b) subject to a
Federal alternative minimum tax, the Federal environmental tax, the Federal
branch profits tax or the Federal and California state excess net passive
income tax.
As described above and in the Fund's Prospectus, the Fund may invest in
exchange-traded municipal bond index futures contracts and options on
interest
rates futures contracts. The Fund anticipates that these
32
investment activities will not prevent the Fund from qualifying as a
regulated
investment company. As a general rule, these investment activities will
increase or decrease the amount of long-and short-term capital gains or
losses
realized by the Fund and, accordingly, will affect the amount of capital
gains
distributed to the Fund's shareholders.
For Federal and California state income tax purposes, gain or loss on
the
futures contracts and options described above (collectively referred to
herein
as "section 1256 contracts") is taxed pursuant to a special "mark-to-market
system." Under the mark-to-market system, these instruments are treated as
if
sold at the Fund's fiscal year end for their fair market value. As a
result,
the Fund will be recognizing gains or losses before they are actually
realized. As a general rule, gain or loss on section 1256 contracts is
treated
as 60% long-term capital gain or loss and 40% short-term capital gain or
loss,
and accordingly, the mark-to-market system generally will affect the amount
of
capital gains or losses taxable to the Fund and the amount of distributions
taxable to a shareholder. Moreover, if the Fund invests in both section
1256
contracts and offsetting positions in such contracts which together
constitute
a straddle, then the Fund may be required to defer certain realized losses.
The Fund expects that its activities with respect to section 1256 contracts
and offsetting positions in such contracts will not cause it to be treated
as
recognizing a materially greater amount of capital gains than actually
realized and will permit it to use substantially all of the losses of the
Fund
for the fiscal years in which such losses actually occur.
While the Fund does not expect to realize a significant amount of net
long-
term capital gains, any such gains realized by the Fund will be distributed
annually as described in the Prospectus. Such distributions ("capital gain
dividends") will be taxable to shareholders as long-term capital gains,
regardless of how long they have held Fund shares, and will be designated
as
capital gain dividends in a written notice mailed to shareholders after the
close of the Fund's taxable year. If a shareholder receives a capital gain
dividend with respect to any share and if the share has been held by the
shareholder for six months or less, then any loss (to the extent not
disallowed pursuant to the other six-month rule described above relating to
exempt-interest dividends) on the sale or exchange of such share will be
treated as a long-term capital loss to the extent of the capital gain
dividend.
If a shareholder incurs a sales charge when acquiring shares of the
Fund,
disposes of those shares within 90 days and then acquires shares in a
mutual
fund for which the otherwise applicable sales charge is reduced by reason
of a
reinvestment right (i.e., exchange privilege), the original sales charge
will
not be taken into account when computing gain/loss on original shares to
the
extent the subsequent sales charge is reduced. Instead, it will be added to
the tax basis in the newly acquired shares. The portion of the original
sales
charge that does not increase the shareholder's tax basis in the original
shares will be treated as incurred with respect to the second acquisition
and,
as a general rule, will increase the shareholder's tax basis in the newly
acquired shares. Furthermore, the same rule also applies to a disposition
of
the newly acquired or redeemed shares made within 90 days of the second
acquisition. This provision prevents a shareholder from immediately
deducting
the sales charge by shifting his or her investment in a family of mutual
funds.
Each shareholder will receive after the close of the calendar year an
annual statement as to the Federal income tax and California state personal
income tax status of his or her dividends and distributions from the Fund
for
the prior calendar year. Dividends attributable to California Municipal
Securities and any other obligations which, when held by an individual, the
interest therefrom would be exempt from taxation by California, will be
exempt
from California state personal income taxation ("California exempt-interest
dividends"). Any dividends attributable to interest on municipal
obligations
that are not California Municipal
33
Securities generally will be taxable as ordinary dividends for California
state personal income tax purposes even if such dividends are excluded from
gross income for Federal income tax purposes. These statements also will
designate the amount of exempt-interest dividends that is a specific
preference item for purposes of the Federal individual and corporate
alternative minimum taxes. Each shareholder also will receive, if
appropriate,
various written notices after the close of the Fund's prior taxable year as
to
the Federal income tax status of his or her dividends and distributions
which
were received from the Fund during the Fund's prior taxable year.
Shareholders
should consult their tax advisors as to any other state and local taxes
that
may apply to these dividends and distributions. The dollar amount of
dividends
excluded or exempt from Federal income taxation or California state
personal
income taxation and the dollar amount subject to Federal income taxation or
California state personal income taxation, if any, will vary for each
shareholder depending upon the size and duration of each shareholder's
investment in the Fund. In the event the Fund earns taxable net investment
income, it intends to designate as taxable dividends the same percentage of
each day's dividend as its actual taxable net investment income bears to
its
total net investment income earned for the year.
Investors considering buying shares of the Fund just prior to a record
date
for a taxable dividend or capital gain distribution should be aware that,
regardless of whether the price of the Fund shares to be purchased reflects
the amount of the forthcoming dividend or distribution payment, any such
payment will be a taxable dividend or distribution payment.
If a shareholder fails to furnish the Fund with a correct taxpayer
identification number, fails to fully report dividend or interest income or
fails to certify to the Fund that he or she has provided a correct taxpayer
identification number and that he or she is not subject to "backup
withholding," then the shareholder may be subject to a 31% backup
withholding
tax with respect to (a) any taxable dividends and distributions and (b) the
proceeds of any redemption of Fund shares. An individual's taxpayer
identification number is his or her social security number. The backup
withholding tax is not an additional tax and may be credited against a
shareholder's regular Federal income tax liability.
The foregoing is only a summary of certain tax considerations generally
affecting the Fund and its shareholders, and is not intended as a
substitute
for careful tax planning. Further, it should be noted that, for California
state tax purposes, the portion of any Fund dividends constituting
California
exempt-interest dividends is exempt from income for California state
personal
income tax purposes only. Dividends (including California exempt-interest
dividends) paid to shareholders subject to California state franchise tax
or
California state corporate income tax may therefore be taxed as ordinary
dividends to such shareholders, notwithstanding that all or a portion of
such
dividends is exempt from California state personal income tax. Potential
shareholders in the Fund, including, in particular, corporate shareholders
which may be subject to either California franchise tax or California
corporate income tax, should consult their tax advisors with respect to (a)
the application of such corporate and franchise taxes to the receipt of
Fund
dividends and as to their own California state tax situation in general,
(b)
the application of other state and local taxes to the receipt of Fund
dividends and distributions and (c) their own specific tax situations.
ADDITIONAL INFORMATION
The Fund was incorporated on February 17, 1984 under the name Shearson
California Municipals Inc. On December 15, 1988, November 19, 1992, July
30,
1993 and October 14, 1994, the Fund changed its name to SLH California
Municipals Fund Inc. to Shearson Lehman Brothers California Municipals Fund
Inc. to
34
Smith Barney Shearson California Municipals Fund Inc. and Smith Barney
California Municipals Fund Inc., respectively.
Boston Safe, an indirect wholly owned subsidiary of Mellon, is located
at
One Boston Place, Boston, Massachusetts 02108, and serves as the custodian
of
the Fund. Under the custody agreement with the Fund, Boston Safe holds the
Fund's portfolio securities and keeps all necessary accounts and records.
For
its services, Boston Safe receives a monthly fee based upon the month-end
market value of securities held in custody and also receives certain
securities transaction charges. The assets of the Fund are held under bank
custodianship in compliance with the 1940 Act.
TSSG is located at Exchange Place, Boston, Massachusetts 02109, serves
as
the Fund's transfer agent. Under the transfer agency agreement, TSSG
maintains
the shareholder account records for the Fund, handles certain
communications
between shareholders and the Fund and distributes dividends and
distributions
payable by the Fund. For these services, TSSG receives a monthly fee
computed
on the basis of the number of shareholder accounts it maintains for the
Fund
during the month, and is reimbursed for certain out-of-pocket expenses.
FINANCIAL STATEMENTS
The Fund's Annual and Semi-Annual Reports for the fiscal year ended
February
28, 1994 and semi-annual period ended August 31, 1994 accompany this
Statement
of Additional Information and are incorporated herein by reference in their
entirety.
35
APPENDIX
Description of S&P and Moody's ratings:
S&P RATINGS FOR MUNICIPAL BONDS
S&P's Municipal Bond Ratings cover obligations of states and political
subdivisions. Ratings are assigned to general obligation and revenue bonds.
General obligation bonds are usually secured by all resources available to
the
municipality and the factors outlined in the rating definitions below are
weighed in determining the rating. Because revenue bonds in general are
payable from specifically pledged revenues, the essential element in the
security for a revenue bond is the quantity and quality of the pledged
revenues available to pay debt service.
Although an appraisal of most of the same factors that bear on the
quality
of general obligation bond credit is usually appropriate in the rating
analysis of a revenue bond, other factors are important, including
particularly, the competitive position of the municipal enterprise under
review and the basic security covenants. Although a rating reflects S&P's
judgment as to the issuer's capacity for the timely payment of debt
service,
in certain instances it may also reflect a mechanism or procedure for an
assured and prompt cure of a default, should one occur, i.e., an insurance
program, Federal or state guarantee or the automatic withholding and use of
state aid to pay the defaulted debt service.
AAA
Prime--These are obligations of the highest quality. They have the
strongest capacity for timely payment of debt service.
General Obligation Bonds--In a period of economic stress, the issuers
will
suffer the smallest declines in income and will be least susceptible to
autonomous decline. Debt burden is moderate. A strong revenue structure
appears more than adequate to meet future expenditure requirements. Quality
of
management appears superior.
Revenue Bonds--Debt service coverage has been, and is expected to
remain,
substantial. Stability of the pledged revenues is also exceptionally
strong,
due to the competitive position of the municipal enterprise or to the
nature
of the revenues. Basic security provisions (including rate covenant,
earnings
test for issuance of additional bonds and debt service reserve
requirements)
are rigorous. There is evidence of superior management.
AA
High Grade--The investment characteristics of general obligation and
revenue bonds in this group are only slightly less marked than those of the
prime quality issues. Bonds rated "AA" have the second strongest capacity
for
payment of debt service.
A
Good Grade--Principal and interest payments on bonds in this category
are
regarded as safe. This rating describes the third strongest capacity for
payment of debt service. It differs from the two higher ratings because:
General Obligation Bonds--There is some weakness, either in the local
economic base, in debt burden, in the balance between revenues and
expenditures, or in quality of management. Under certain adverse
A-1
circumstances, any one such weakness might impair the ability of the issuer
to
meet debt obligations at some future date.
Revenue Bonds--Debt service coverage is good, but not exceptional.
Stability of the pledged revenues could show some variations because of
increased competition or economic influences on revenues. Basic security
provisions, while satisfactory, are less stringent. Management performance
appears adequate.
BBB
Medium Grade--Of the investment grade ratings, this is the lowest.
General Obligation Bonds--Under certain adverse conditions, several of
the
above factors could contribute to a lesser capacity for payment of debt
service. The difference between "A" and "BBB" ratings is that the latter
shows
more than one fundamental weakness, or one very substantial fundamental
weakness, whereas the former shows only one deficiency among the factors
considered.
Revenue Bonds--Debt coverage is only fair. Stability of the pledged
revenues could show substantial variations, with the revenue flow possibly
being subject to erosion over time. Basic security provisions are no more
than
adequate. Management performance could be stronger.
BB, B, CCC AND CC
Bonds rated BB, B, CCC and CC are regarded, on balance, as predominately
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 CC the highest degree of speculation. While such bonds will
likely have some quality and protective characteristics, these are
outweighed
by large uncertainties or major risk exposures to adverse conditions.
C
The rating C is reserved for income bonds on which no interest is being
paid.
D
Bonds rated D are in default, and payment of interest and/or repayment of
principal is in arrears.
S&P's letter ratings may be modified by the addition of a plus or a
minus
sign, which is used to show relative standing within the major rating
categories, except in the AAA-Prime Grade category.
S&P RATINGS FOR MUNICIPAL NOTES
Municipal notes with maturities of three years or less are usually given
note
ratings (designated SP-1, -2 or -3) by S&P to distinguish more clearly the
credit quality of notes as compared to bonds. Notes rated SP-1 have a very
strong or strong capacity to pay principal and interest. Those issues
determined to possess overwhelming safety characteristics are given the
designation of SP-1+. Notes rated SP-2 have a satisfactory capacity to pay
principal and interest.
MOODY'S RATINGS FOR MUNICIPAL BONDS
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,
A-2
such changes as can be visualized are most unlikely to impair the
fundamentally strong position of such issues.
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.
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.
BAA
Bonds which are rated Baa are considered as medium grade obligations, i.e.,
they are neither highly protected nor poorly secured. Interest payments and
principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any
great
length of time. Such bonds lack outstanding investment characteristics and
in
fact have speculative characteristics as well.
BA
Bonds which are rated Ba are judged to have speculative elements; their
future
cannot be considered as well assured. Often the protection of interest and
principal payments may be very moderate and therefore not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
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.
CAA
Bonds that are rated Caa are of poor standing. These issues may be in
default
or present elements of danger may exist with respect to principal or
interest.
CA
Bonds that are rated Ca represent obligations which are speculative in a
high
degree. These issues are often in default or have other marked short-
comings.
C
Bonds that are rated C are the lowest rated class of bonds, and issues so
rated can be regarded as having extremely poor prospects of ever attaining
any
real investment standing.
A-3
Moody's applies the numerical modifiers 1, 2 and 3 in each generic
rating
classification from Aa through Baa. 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.
MOODY'S RATINGS FOR MUNICIPAL NOTES
Moody's ratings for state and municipal notes and other short-term loans
are
designated Moody's Investment Grade ("MIG") and for variable rate demand
obligations are designated Variable Moody's Investment Grade ("VMIG"). This
distinction is in recognition of the differences between short-term and
long-
term credit risk. Loans bearing the designation MIG 1 or VMIG 1 are of the
best quality, enjoying strong protection from established cash flows of
funds
for their servicing, from established and broad-based access to the market
for
refinancing or both. Loans bearing the designation MIG 2 or VMIG 2 are of
high
quality, with ample margins of protection although not as large as the
preceding group. Loans bearing the designation MIG 3 or VMIG 3 are of
favorable quality, with all security elements accounted for but lacking the
undeniable strength of the preceding grades. Liquidity and cash flow may be
tight and market access for refinancing is likely to be less well
established.
DESCRIPTION OF S&P A-1+ AND A-1 COMMERCIAL PAPER RATING
The rating A-1+ is the highest, and A-1 the second highest, commercial
paper
rating assigned by S&P. Paper rated A-1+ must have either the direct credit
support of an issuer or guarantor that possesses excellent long-term
operating
and financial strengths combined with strong liquidity characteristics
(typically, such issuers or guarantors would display credit quality
characteristics which would warrant a senior bond rating of "AA-" or
higher),
or the direct credit support of an issuer or guarantor that possesses
above-
average long-term fundamental operating and financing capabilities combined
with on-going excellent liquidity characteristics. Paper rated A-1 by S&P
has
the following characteristics: liquidity ratios are adequate to meet cash
requirements; long-term senior debt is rated "A" or better; 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; and the reliability and quality of
management are unquestioned.
DESCRIPTION OF MOODY'S PRIME-1 COMMERCIAL PAPER RATING
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: (a) evaluation of the management of the issuer; (b) economic
evaluation of the issuer's industry or industries and an appraisal of
speculative-type risks which may be inherent in certain areas; (c)
evaluation
of the issuer's products in relation to competition and customer
acceptance;
(d) liquidity; (e) amount and quality of long-term debt; (f) trend of
earnings
over a period of ten years; (g) financial strength of a parent company and
the
relationships which exist with the issuer; and (h) recognition by the
management of obligations which may be present or may arise as a result of
public interest questions and preparations to meet such obligations.
A-4
