Smith Barney
INCOME FUNDS
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 Prospectuses of Smith Barney Income
Funds (the "Trust"), relating to eight investment funds offered by the
Trust (the "Funds"), each dated November 7, 1994, as amended or supple-
mented from time to time, and should be read in conjunction with the Pro-
spectuses. The Prospectuses may be obtained from any Smith Barney Finan-
cial Consultant or by writing or calling the Trust at the address or tele-
phone number set forth above. This Statement of Additional Information,
although not in itself a prospectus, is incorporated by reference into the
Prospectuses in its entirety.
CONTENTS
For ease of reference, the same section headings are used in both the Pro-
spectuses and this Statement of Additional Information, except where shown
below:
<TABLE>
<CAPTION>
<S>
<C>
Management of the Trust and the Funds 2
Investment Objectives and Management Policies 7
Purchase of Shares 27
Redemption of Shares 28
Distributor 29
Valuation of Shares 32
Exchange Privilege 33
Performance Data (See in the Prospectuses "Performance") 34
Taxes (See in the Prospectuses "Dividends, Distributions and Taxes") 39
Additional Information 43
Financial Statements 43
Appendix A-1
</TABLE>
MANAGEMENT OF THE TRUST AND THE FUND
The executive officers of the Trust are employees of certain of the orga-
nizations that provide services to the Trust. These organizations are the
following:
<TABLE>
<CAPTION>
NAME SERVICE
<S> <C>
Smith Barney Inc. Distributor
("Smith Barney")
Smith Barney Mutual Funds Management Inc. Investment adviser to
Convertible,
("SBMFM") High Income, Diversified
Strategic
Income, Tax- Exempt Income,
Utilities and Exchange
Reserve Funds
Smith Barney Strategy Advisers Inc. Investment adviser to
Premium Total
("Strategy Advisers") Return Fund
Smith Barney Global Capital Management Inc. Investment adviser to Global
Bond
("Global Capital Management") Fund and sub-investment
adviser to
Diversified Strategic Income
Fund
SBMFM Administrator
The Boston Company Advisors, Inc. Sub-Administrator
("Boston Advisors")
Boston Safe Deposit and Trust Company Custodian
("Boston Safe")
The Shareholder Services Group, Inc.
("TSSG"), a subsidiary of First Data
Corporation Transfer Agent
</TABLE>
These organizations and the functions they perform for the Trust are dis-
cussed in the Prospectuses and in this Statement of Additional Informa-
tion.
TRUSTEES AND EXECUTIVE OFFICERS OF THE TRUST
The Trustees and executive officers of the Trust, together with informa-
tion as to their principal business occupations during the past five
years, are shown below. The executive officers of the Trust are employees
of organizations that provide services to the Funds. Each Trustee who is
an "interested person" of the Trust, as defined in the Investment Company
Act of 1940, as amended (the "1940 Act"), is indicated by an asterisk.
Lee Abraham, Trustee. Retired; formerly Chairman and Chief Executive Of-
ficer of Associated Merchandising Corporation, a major retail merchandis-
ing and sourcing organization. His address is 1440 Broadway, Suite 1001,
New York, New York 10018.
Antoinette C. Bentley, Trustee. Retired; formerly Senior Vice President
and Associate General Counsel of Crum and Forster, Inc., an insurance
holding company. Her address is 24 Fowler Road, Far Hills, New Jersey
07931.
Allan J. Bloostein, Trustee. Consultant; formerly Vice Chairman of the
Board of and Consultant to The May Department Stores Company; Director of
Crystal Brands, Inc., Melville Corp. and R.G. Barry Corp. His address is
Anderson Road, Sherman, Connecticut 06784.
Richard E. Hanson, Jr., Trustee. Headmaster, The Peck School, Morristown,
NJ; prior to July 1, 1994, Headmaster, Lawrence Country Day School-
Woodmere Academy, Woodmere, New York; prior to July 1, 1990, Headmaster of
Woodmere Academy. His address is 247 South Street, Morristown, New Jersey
07960.
*Heath B. McLendon, Chairman of the Board and Investment Officer. Execu-
tive Vice President of Smith Barney and Chairman of the Board 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.
Madelon DeVoe Talley, Trustee. Author; Governor at Large of the National
Association of Securities Dealers, Inc. Her address is 876 Park Avenue,
New York, New York 10021.
Stephen J. Treadway, President. Executive Vice President and Director of
Smith Barney; Director and President of Mutual Management Corp. and
SBMFM and Trustee of Corporate Re-
alty Income Trust I. His address is 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 and Vice President
of Shearson Lehman Investment Strategy Advisors Inc., an investment advi-
sory affiliate of Shearson Lehman Brothers. His address is 388 Greenwich
Street, New York, New York 10013.
John C. Bianchi, Vice President and Investment Officer. Managing Director
of SBMFM; prior to July 1993, Managing Director of Shearson Lehman Advi-
sors. His address is 388 Greenwich Street, New York, New York 10013.
James E. Conroy, Vice President and Investment Officer. Managing Director
of SBMFM; prior to July 1993, Managing Director of Shearson Lehman Advi-
sors. His address is 388 Greenwich Street, New York, New York 10013.
Victor S. Filatov, Investment Officer. International Strategist and Presi-
dent of Global Capital Management; prior to November 1993, Business Coor-
dinator and Head of European Fixed Income Research of J.P. Morgan Securi-
ties Inc. His address is 10 Piccadilly, London, W1V 9LA, England.
John B. Fullerton, Sr., Investment Administrator. Vice President of Boston
Advisors; Senior Vice President of The Boston Company Institutional Inves-
tors, Inc. His address is 100 Drake's Landing Road, Greenbrae, California
94904.
Jack S. Levande, Vice President and Investment Officer. Managing Director
of SBMFM; prior to July 1993, Managing Director of Shearson Lehman Advi-
sors. His address is 388 Greenwich Street, New York, New York 10013.
Karen Mahoney-Malcomson, Investment Officer. Vice President of SBMFM;
prior to July 1993, Vice President of Shearson Lehman Advisors. Her ad-
dress is 388 Greenwich Street, New York, New York 10013.
Lawrence T. McDermott, Vice President and Investment Officer. Managing Di-
rector of SBMFM; prior to July 1993, Managing Director of Shearson Lehman
Advisors. His address is 388 Greenwich Street, New York, New York 10013.
Evelyn R. Robertson, Investment Officer. Vice President and Portfolio Man-
ager of SBMFM; prior to July 1993, Vice President of Shearson Lehman Advi-
sors. Her address is 388 Greenwich Street, New York, New York 10013.
Harry Rosenbluth, Investment Administrator. Vice President of Boston Advi-
sors; Senior Vice President of The Boston Company Institutional Investors,
Inc. His address is 100 Drake's Landing Road, Greenbrae, California 94904.
Phyllis M. Zahorodny, Vice President and Investment Officer. Managing Di-
rector of SBMFM; prior to July 1993, Managing Director of Shearson Lehman
Advisors. Her address is 388 Greenwich Street, New York, New York 10013.
Patricia Zuch, Investment Administrator. Vice President of Boston Advi-
sors. Her address is 100 Drake's Landing Road, Greenbrae, California
94904.
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, New York 10013.
Christina T. Sydor, Secretary. Managing Director of Smith Barney; General
Counsel and Secretary of SBMFM. Her address is 388 Greenwich Street, New
York, New York 10013.
Each Trustee also serves as a director, trustee and/or general partner of
certain other mutual funds for which Smith Barney serves as distributor.
Global Capital Management, SBMFM and Strategy Advisers (the "Advisers")
are "affiliated persons" of the Trust as defined in the 1940 Act by virtue
of their positions as investment advisers to the Funds. As of October 31,
1994, the Trustees and officers of the Funds, as a group, owned less than
1% of the outstanding shares of beneficial interest of each Fund.
No officer, director or employee of Smith Barney or any parent or
subsidiary
receives any compensation from the Trust for serving as an of-
ficer or Trustee of the Trust. The Trust pays each Trustee who is not an
officer, director or employee of Smith Barney or any of their affiliates a
fee of $10,000 per annum plus $1,500 per meeting attended and reimburses
them for travel and out-of-pocket expenses. For the fiscal year ended July
31, 1994, such fees and expenses totalled $115,411.
INVESTMENT ADVISERS, SUB-INVESTMENT ADVISER, ADMINISTRATOR, AND
SUB-ADMINISTRATOR
Each Adviser serves as investment adviser to one or more Funds pursuant to
a separate written agreement with the relevant Fund (an ''Advisory Agree-
ment''). SBMFM serves as investment adviser to its relevant Funds 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'')). Strategy Advisers is a wholly owned subsidiary of Hold-
ings and Global Capital Management is an indirect wholly owned subsidiary
of Holdings. Holdings is a wholly owned subsidiary of The Travelers
Inc. The Advisory Agreements were most recently approved by the Board of
Trustees, including a majority of the Trustees who are not ''interested
persons'' of the Trust or the Advisers (''Independent Trustees''), on Au-
gust 10, 1994, with the exception of Premium Total Return Fund and Global
Bond Fund, which were approved on April 4, 1994 and January 20,1994, re-
spectively. SBMFM also serves as administrator to each Fund pursuant to a
separate written agreement dated May 4, 1994 (the ''Administration Agree-
ment'') which was most recently approved by the Board of Trustees, includ-
ing a majority of the Independent Trustees, on August 10, 1994. Global
Capital Management also serves as sub-investment adviser to Diversified
Strategic Income Fund, pursuant to a written agreement dated March 21,
1994 which was approved by the Fund's Board of Trustees, including a ma-
jority of the Independent Trustees, on January 20, 1994 and by the Fund's
shareholders on April 29, 1994. Prior to March 21, 1994, Lehman Brothers
Global Asset Management Limited (''LBGAM'') acted in the capacity as the
Fund's sub-investment adviser.
Boston Advisors serves as sub-administrator to the Funds
pursuant to a written agreement (the "Sub-Administration Agreement")
dated May 4, 1994,
which was most recently approved by the Trust's Board of Trustees, includ-
ing the Independent Trustees, on May 4, 1994. Prior to that date, Boston
Advisors served as administrator to the Funds, and prior to April 4, 1994,
also served as investment advisor to Premium Total Return Fund.
Boston Advisors is a wholly owned subsidiary of The Boston Company, Inc.
("TBC"), a financial services hold-
ing company, which is in turn an indirect wholly owned subsidiary of Mel-
lon Bank Corporation ("Mellon").
Certain of the services provided to the Trust by the Advisers, Global Cap-
ital Management, SBMFM and Boston Advisors are described in the
Prospectuses
under "Management of the Trust and the Fund." Each Adviser, SBMFM, as ad-
ministrator, and Boston Advisors, as sub-administrator, pay the salaries
of all officers and employees who are employed by both it and the Trust,
and maintain office facilities for the Trust. In addition to those ser-
vices, Boston Advisors pays the salaries of all officers and employees who
are employed by both it and the Trust, maintains office facilities for the
Trust, furnishes the Trust with statistical and research data, clerical
help and accounting, data processing, bookkeeping, internal auditing and
legal services and certain other services required by the Trust, prepares
reports to the Funds' shareholders and prepares tax returns, reports to
and filings with the Securities and Exchange Commission (the "SEC") and
state Blue Sky authorities. The Advisers, Global Capital Management,
SBMFM and Boston Advisors bear all expenses in connection with the
performance of
their services.
For the fiscal years ended July 31, 1992, 1993 and 1994, the Funds paid
investment advisory fees to their respective Advisers as follows:
<TABLE>
<CAPTION>
FUND 1992 1993 1994
<S> <C> <C> <C>
Premium Total Return Fund $ 2,776,638 $4,803,717 $8,506,930
Tax-Exempt Income Fund 2,884,333 3,978,637 4,561,779
Convertible Fund 305,154 329,323 425,505
Global Bond Fund 301,528 356,324 466,389
High Income Fund 1,313,890 2,659,448 3,771,643
Diversified Strategic Income Fund 3,346,434 6,226,342
8,761,857
Utilities Fund 4,272,080 10,317,792 10,896,883
Exchange Reserve Fund 970,662 612,812 622,203
</TABLE>
For the fiscal years ended July 31, 1992, 1993 and 1994, the Funds paid
administrative fees to Boston Advisors or SBMFM as follows:
<TABLE>
<CAPTION>
BOSTON ADVISORS
SBMFM
FOR THE FISCAL FOR
THE FISCAL
PERIOD FROM
PERIOD FROM
8/1/93 THROUGH
5/4/94 THROUGH
FUND 1992 1993 5/3/94
7/31/94
<S> <C> <C> <C> <C>
Premium Total Return Fund $ 1,009,687 $1,746,806 $2,639,140
$454,284
Tax-Exempt Income Fund 1,442,166 1,989,319 1,971,064
309,826
Convertible Fund 122,062 131,729 145,717
24,485
Global Bond Fund 100,509 118,434 134,269
21,556
High Income Fund 525,556 1,063,779 1,297,678
210,979
Diversified Strategic
Income Fund 1,912,279 3,557,910 4,289,630
717,145
Utilities Fund 1,898,703 4,584,796 4,256,098
586,961
Exchange Reserve Fund 647,081 408,842 341,472
73,330
</TABLE>
For the fiscal years ended July 31, 1992, 1993 and the period ended March
20, 1994, Diversified Strategic Income Fund paid LBGAM $956,195,
$1,778,955 and $1,562,892, respectively, in sub- investment advisory fees.
For the period from March 21, 1994 through July 31, 1994, Diversified
Strategic Income Fund paid Global Capital Management $940,496 in sub-
investment advisory fees.
Each Adviser, SBMFM, as administrator, and Boston Advisors, as sub-
administrator, have agreed that if in any fiscal year the aggregate
expenses of the Fund that it serves (including fees
payable pursuant to its Advisory Agreement and Administration Agreement,
but excluding interest, taxes, brokerage, distribution and service fees
and, if permitted by the relevant state securities commission, extraordi-
nary expenses) exceed the expense limitation of any state having jurisdic-
tion over the Fund, the Adviser, SBMFM and Boston Advisors </R<will, to
the extent required by state law, reduce their fees by the amount of such
excess expenses, such
amount to be allocated between them in the proportion that their respec-
tive fees bear to the aggregate of the fees paid by the Fund. Such fee re-
duction, if any, will be estimated and reconciled on a monthly basis. The
most restrictive state expense limitation applicable to any Fund is 2.5%
of the first $30 million of the Fund's average daily net assets, 2% of the
next $70 million of the average daily net assets and 1.5% of the remaining
average daily net assets of each Fund. No such fee reduction was required
for the fiscal years ended July 31, 1992, 1993 and 1994.
The Fund bears expenses incurred in its operation, including: taxes,
interest, brokerage fees and commissions, if any; fees of Trustees 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 custodians; transfer and dividend disbursing agent 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 preparing 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 Trustees of the Trust.
COUNSEL AND AUDITORS
Willkie Farr & Gallagher serves as legal counsel to the Trust. The Trust-
ees who are not "interested persons" of the Fund have selected Stroock &
Stroock & Lavan as their legal counsel.
KPMG Peat Marwick LLP, independent accountants, 345 Park Avenue, New York,
New York 10154. serve as auditors of the Trust and will render an opinion
on the Trust's financial statements annually. Prior to October 20, 1994,
Coopers & Lybrand L.L.P., independent accountants, served as auditors of
the Trust and rendered an opinion on the Trust's financial statements for
the fiscal year ended July 31, 1994.
In the interest of economy and convenience, certificates representing
shares in the Trust are not physically issued except upon specific request
made by a shareholder to TSSG. TSSG maintains a record of each sharehold-
er's ownership of Trust shares. Shares do not have cumulative voting
rights, which means that holders of more than 50% of the shares voting for
the election of Trustees can elect all of the Trustees. Shares are trans-
ferable but have no preemptive or subscription rights. Shareholders gener-
ally vote by Fund, except with respect to the election of Trustees and the
selection of independent public accountants.
Massachusetts law provides that, under certain circumstances, shareholders
could be held personally liable for the obligations of the Trust. However,
the Trust Agreement disclaims shareholder liability for acts or obliga-
tions of the Trust and requires that notice of such disclaimer be given in
each agreement, obligation or instrument entered into or executed by the
Trust or a Trustee. The Trust Agreement provides for indemnification from
the Trust's property for all losses and expenses of any shareholder held
personally liable for the obligations of the Trust. Thus, the risk of a
shareholder's incurring financial loss on account of shareholder liability
is limited to circumstances in which the Trust would be unable to meet its
obligations, a possibility that the Trust's management believes is remote.
Upon payment of any liability incurred by the Trust, the shareholder pay-
ing the liability will be entitled to reimbursement from the general as-
sets of the Trust. The Trustees intend to conduct the operations of the
Trust in such a way so as to avoid, as far as possible, ultimate liability
of the shareholders for liabilities of the Trust.
INVESTMENT OBJECTIVES AND MANAGEMENT POLICIES
The Prospectuses discuss the investment objectives of the Funds and the
policies to be employed to achieve those objectives. This section contains
supplemental information concerning the types of securities and other in-
struments in which the Funds may invest, the investment policies and port-
folio strategies that the Funds may utilize and certain risks attendant to
such investments, policies and strategies.
U.S. Government Securities (All Funds). United States government securi-
ties include debt obligations of varying maturities issued or guaranteed
by the United States government or its agencies or instrumentalities
("U.S. government securities"). U.S. government securities include not
only direct obligations of the United States Treasury, but also securities
issued or guaranteed by the Federal Housing Administration, Farmers Home
Administration, Export-Import Bank of the United States, Small Business
Administration, Government National Mortgage Association ("GNMA"), General
Services Administration, Central Bank for Cooperatives, Federal Intermedi-
ate Credit Banks, Federal Land Banks, Federal National Mortgage Associa-
tion ("FNMA"), Maritime Administration, Tennessee Valley Authority, Dis-
trict of Columbia Armory Board, Student Loan Marketing Association, Inter-
national Bank for Reconstruction and Development and Resolution Trust
Corporation. Certain U.S. government securities, such as those issued or
guaranteed by GNMA, FNMA and Federal Home Loan Mortgage Corporation
("FHLMC"), are mortgage-related securities. Because the United States gov-
ernment is not obligated by law to provide support to an instrumentality
that it sponsors, a Fund will invest in obligations issued by such an in-
strumentality only if its Adviser determines that the credit risk with re-
spect to the instrumentality does not make its securities unsuitable for
investment by the Fund.
Bank Obligations (All Funds). Domestic commercial banks organized under
Federal law are supervised and examined by the Comptroller of the Currency
and are required to be members of the Federal Reserve System and to be in-
sured by the Federal Deposit Insurance Corporation (the "FDIC"). Domestic
banks organized under state law are supervised and examined by state bank-
ing authorities but are members of the Federal Reserve System only if they
elect to join. Most state banks are insured by the FDIC (although such in-
surance may not be of material benefit to a Fund, depending upon the prin-
cipal amount of certificates of deposit ("CDs") of each held by the Fund)
and are subject to Federal examination and to a substantial body of Fed-
eral law and regulation. As a result of Federal and state laws and regula-
tions, domestic branches of domestic banks are, among other things, gener-
ally required to maintain specified levels of reserves, and are subject to
other supervision and regulation designed to promote financial soundness.
Obligations of foreign branches of U.S. banks, such as CDs and time depos-
its ("TDs"), may be general obligations of the parent bank in addition to
the issuing branch, or may be limited by the terms of a specific obliga-
tion and governmental regulation. Obligations of foreign branches of U.S.
banks and foreign banks are subject to different risks than are those of
U.S. banks or U.S. branches of foreign banks. These risks include foreign
economic and political developments, foreign governmental restrictions
that may adversely affect payment of principal and interest on the obliga-
tions, foreign exchange controls and foreign withholding and other taxes
on interest income. Foreign branches of U.S. banks are not necessarily
subject to the same or similar regulatory requirements that apply to U.S.
banks, such as mandatory reserve requirements, loan limitations and ac-
counting, auditing and financial recordkeeping requirements. In addition,
less information may be publicly available about a foreign branch of a
U.S. bank than about a U.S. bank. CDs issued by wholly owned Canadian sub-
sidiaries of U.S. banks are guaranteed as to repayment of principal and
interest, but not as to sovereign risk, by the U.S. parent bank.
Obligations of U.S. branches of foreign banks may be general obligations
of the parent bank in addition to the issuing branch, or may be limited by
the terms of a specific obligation and by Federal and state regulation as
well as governmental action in the country in which the foreign bank has
its head office. A U.S. branch of a foreign bank with assets in excess of
$1 billion may or may not be subject to reserve requirements imposed by
the Federal Reserve System or by the state in which the branch is located
if the branch is licensed in that state. In addition, branches licensed by
the Comptroller of the Currency and branches licensed by certain states
("State Branches") may or may not be required to: (a) pledge to the regu-
lator by depositing assets with a designated bank within the state, an
amount of its assets equal to 5% of its total liabilities; and (b) main-
tain assets within the state in an amount equal to a specified percentage
of the aggregate amount of liabilities of the foreign bank payable at or
through all of its agencies or branches within the state. The deposits of
State Branches may not necessarily be insured by the FDIC. In addition,
there may be less publicly available information about a U.S. branch of a
foreign bank than about a U.S. bank.
In view of the foregoing factors associated with the purchase of CDs and
TDs issued by foreign banks and foreign branches of U.S. banks, a Fund's
Adviser will carefully evaluate such investments on a case-by-case basis.
Exchange Reserve Fund may purchase a CD issued by a bank, savings and loan
association or other banking institution with less than $1 billion in as-
sets (a "Small Issuer CD") so long as the issuer is a member of the FDIC
or Office of Thrift Supervision and is insured by the Savings Association
Insurance Fund ("SAIF") and so long as the principal amount of the Small
Issuer CD is fully insured and is no more than $100,000. Exchange Reserve
Fund will at any one time hold only one Small Issuer CD from any one
issuer.
Savings and loan associations whose CDs may be purchased by the Funds are
members of the Federal Home Loan Bank and are insured by the SAIF. As a
result, such savings and loan associations are subject to regulation and
examination.
When-Issued Securities and Delayed-Delivery Transactions (Global Bond,
High Income, Premium Total Return, Diversified Strategic Income and Tax-
Exempt Income Funds). To secure an advantageous price or yield, these
Funds may purchase certain securities on a when-issued basis or purchase
or sell securities for delayed delivery. A Fund will enter into such
transactions for the purpose of acquiring portfolio securities and not for
the purpose of leverage. Delivery of the securities in such cases occurs
beyond the normal settlement periods, but no payment or delivery is made
by a Fund prior to the reciprocal delivery or payment by the other party
to the transaction. In entering into a when-issued or delayed- delivery
transaction, a Fund will rely on the other party to consummate the trans-
action and may be disadvantaged if the other party fails to do so.
U.S. government securities and Municipal Securities (as defined below)
normally are subject to changes in value based upon changes, real or an-
ticipated, in the level of interest rates and, although to a lesser extent
in the case of U.S. government securities, the public's perception of the
creditworthiness of the issuers. In general, U.S. government securities
and Municipal Securities tend to appreciate when interest rates decline
and depreciate when interest rates rise. Purchasing these securities on a
when-issued or delayed-delivery 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. Simi-
larly, the sale of U.S. government securities for delayed delivery can in-
volve the risk that the prices available in the market when the delivery
is made may actually be higher than those obtained in the transaction it-
self.
In the case of the purchase by a Fund of securities on a when-issued or
delayed-delivery basis, a segregated account in the name of the Fund con-
sisting of cash or liquid debt securities equal to the amount of the when-
issued or delayed-delivery commitments will be established at Boston Safe.
For the purpose of determining the adequacy of the securities in the ac-
counts, the deposited securities will be valued at market or fair value.
If the market or fair value of the securities declines, additional cash or
securities will be placed in the account daily so that the value of the
account will equal the amount of such commitments by the Fund involved. On
the settlement date, a Fund will meet its obligations from then-available
cash flow, the sale of securities held in the segregated account, the sale
of other securities or, although it would not normally expect to do so,
from the sale of the securities purchased on a when-issued or delayed-
delivery basis (which may have a value greater or less than the Fund's
payment obligations).
Lending of Portfolio Securities (Premium Total Return, Utilities, Convert-
ible, Global Bond, High Income and Diversified Strategic Income Fund-
s). These Funds have the ability to lend portfolio securities to brokers,
dealers and other financial organizations. Such loans, if and when made,
may not exceed 20% (33 1/3 % in the case of Diversified Strategic Income
Fund) of a Fund's total assets taken at value. A Fund will not lend port-
folio securities to Smith Barney unless it has applied for and received
specific authority to do so from the SEC. Loans of portfolio securities
will be collateralized by cash, letters of credit or U.S. government secu-
rities which are maintained at all times in an amount at least equal to
the current market value of the loaned securities. From time to time, a
Fund may pay a part of the interest earned from the investment of collat-
eral received for securities loaned to the borrower and/or a third party
which is unaffiliated with the Fund and is acting as a "finder."
By lending its securities, a Fund can increase its income by continuing to
receive interest on the loaned securities as well as by either investing
the cash collateral in short-term instruments or obtaining yield in the
form of interest paid by the borrower when U.S. government securities are
used as collateral. A Fund will comply with the following conditions when-
ever its portfolio securities are loaned: (a) the Fund must receive at
least 100% cash collateral or equivalent securities from the borrower; (b)
the borrower must increase such collateral whenever the market value of
the securities loaned rises above the level of such collateral; (c) the
Fund must be able to terminate the loan at any time; (d) the Fund must re-
ceive reasonable interest on the loan, as well as any dividends, interest
or other distributions on the loaned securities, and any increase in mar-
ket value; (e) the Fund may pay only reasonable custodian fees in connec-
tion with the loan; and (f) voting rights on the loaned securities may
pass to the borrower; provided, however, that if a material event ad-
versely affecting the investment in the loaned securities occurs, the
Trust's Board of Trustees must terminate the loan and regain the right to
vote the securities. The risks in lending portfolio securities, as with
other extensions of secured credit, consist of a possible delay in receiv-
ing additional collateral or in the recovery of the securities or possible
loss of rights in the collateral should the borrower fail financially.
Loans will be made to firms deemed by each Fund's Adviser to be of good
standing and will not be made unless, in the judgment of the Adviser, the
consideration to be earned from such loans would justify the risk.
Options on Securities (Premium Total Return, Convertible, Global Bond, Di-
versified Strategic Income and High Income Funds). These Funds may engage
in transactions in options on securities, which, depending on the Fund,
may include the writing of covered put options and covered call options,
the purchase of put and call options and the entry into closing transac-
tions.
The principal reason for writing covered call options on securities is to
attempt to realize, through the receipt of premiums, a greater return than
would be realized on the securities alone. Diversified Strategic Income
Fund, however, may engage in option transactions only to hedge against ad-
verse price movements in the securities that it holds or may wish to pur-
chase and the currencies in which certain portfolio securities may be de-
nominated. In return for a premium, the writer of a covered call option
forfeits the right to any appreciation in the value of the underlying se-
curity above the strike price for the life of the option (or until a clos-
ing purchase transaction can be effected). Nevertheless, the call writer
retains the risk of a decline in the price of the underlying security.
Similarly, the principal reason for writing covered put options is to re-
alize income in the form of premiums. The writer of a covered put option
accepts the risk of a decline in the price of the underlying security. The
size of the premiums that a Fund may receive may be adversely affected as
new or existing institutions, including other investment companies, engage
in or increase their option-writing activities.
Options written by a Fund normally will have expiration dates between one
and nine months from the date written. The exercise price of the options
may be below, equal to or above the market values of the underlying secu-
rities at the times the options are written. In the case of call options,
these exercise prices are referred to as "in-the-money," "at-the-money"
and "out-of-the-money," respectively. A Fund with option-writing authority
may write (a) in-the-money call options when its Adviser expects that the
price of the underlying security will remain flat or decline moderately
during the option period, (b) at-the-money call options when its Adviser
expects that the price of the underlying security will remain flat or ad-
vance moderately during the option period and (c) out-of-the-money call
options when its Adviser expects that the price of the underlying security
may increase but not above a price equal to the sum of the exercise price
plus the premiums received from writing the call option. In any of the
preceding situations, if the market price of the underlying security de-
clines and the security is sold at this lower price, the amount of any re-
alized loss will be offset wholly or in part by the premium received. Out-
of-the-money, at-the-money and in-the-money put options (the reverse of
call options as to the relation of exercise price to market price) may be
utilized in the same market environments that such call options are used
in equivalent transactions.
So long as the obligation of a Fund as the writer of an option continues,
the Fund may be assigned an exercise notice by the broker-dealer through
which the option was sold, requiring the Fund to deliver, in the case of a
call, or take delivery of, in the case of a put, the underlying security
against payment of the exercise price. This obligation terminates when the
option expires or the Fund effects a closing purchase transaction. A Fund
can no longer effect a closing purchase transaction with respect to an op-
tion once it has been assigned an exercise notice. To secure its obliga-
tion to deliver the underlying security when it writes a call option, or
to pay for the underlying security when it writes a put option, a Fund
will be required to deposit in escrow the underlying security or other as-
sets in accordance with the rules of the Options Clearing Corporation (the
"Clearing Corporation") or similar foreign clearing corporation and of the
securities exchange on which the option is written.
The Global Bond and Diversified Strategic Income Funds may purchase and
sell put, call and other types of option securities that are traded on do-
mestic or foreign exchanges or the over-the-counter market including, but
not limited to, "spread" options, "knock-out" options, "knock-in" options
and "average rate" or "look-back" options.
"Spread" options are dependent upon the difference between the price of
two securities or futures contracts, "Knock-out" options are cancelled if
the price of the underlying asset reaches a trigger level prior to expira-
tion, "Knock-in" options only have value if the price of the underlying
asset reaches a trigger level and, "average rate" or "look-back" options
are options where at expiration, the option's strike price is set based on
either the average, maximum or minimum price of the asset over the period
of the option.
The Global Bond and Diversified Strategic Income Funds may utilize up to
15% of their assets to purchase options and may do so at or about the same
time that they purchase the underlying security or at a later time. In
purchasing options on securities, the Funds will trade only with counter-
parties of high status in terms of credit quality and commitment to the
market.
An option position may be closed out only where there exists a secondary
market for an option of the same series on a recognized securities ex-
change or in the over-the-counter market. In light of this fact and cur-
rent trading conditions, the Funds expect to purchase only call or put op-
tions issued by the Clearing Corporation. The Funds with option-writing
authority expect to write options only on U.S. securities exchanges, ex-
cept that the Global Bond and Diversified Strategic Income Funds also may
write options on foreign exchanges and in the over-the-counter market.
A Fund may realize a profit or loss upon entering into a closing transac-
tion. In cases in which a Fund has written an option, it will realize a
profit if the cost of the closing purchase transaction is less than the
premium received upon writing the original option and will incur a loss if
the cost of the closing purchase transaction exceeds the premium received
upon writing the original option. Similarly, when a Fund has purchased an
option and engages in a closing sale transaction, whether the Fund real-
izes a profit or loss will depend upon whether the amount received in the
closing sale transaction is more or less than the premium that the Fund
initially paid for the original option plus the related transaction costs.
Although a Fund generally will purchase or write only those options for
which its Adviser believes there is an active secondary market so as to
facilitate closing transactions, there is no assurance that sufficient
trading interest to create a liquid secondary market on a securities ex-
change will exist for any particular option or at any particular time, and
for some options no such secondary market may exist. A liquid secondary
market in an option may cease to exist for a variety of reasons. In the
past, for example, higher than anticipated trading activity or order flow,
or other unforeseen events, have at times rendered inadequate certain of
the facilities of the Clearing Corporation and U.S. and foreign securities
exchanges and resulted in the institution of special procedures, such as
trading rotations, restrictions on certain types of orders or trading
halts or suspensions in one or more options. There can be no assurance
that similar events, or events that may otherwise interfere with the
timely execution of customers' orders, will not recur. In such event, it
might not be possible to effect closing transactions in particular op-
tions. If as a covered call option writer a Fund is unable to effect clos-
ing purchase transaction in a secondary market, it will not be able to
sell the underlying security until the option expires or it delivers the
underlying security upon exercise.
Securities exchanges generally have established limitations governing the
maximum number of calls and puts of each class which may be held or writ-
ten, or exercised within certain time periods, by an investor or group of
investors acting in concert (regardless of whether the options are written
on the same or different securities exchanges or are held, written or ex-
ercised in one or more accounts or through one or more brokers). It is
possible that the Funds with authority to engage in options transactions
and other clients of their respective Advisers and certain of their affil-
iates may be considered to be such a group. A securities exchange may
order the liquidation of positions found to be in violation of these lim-
its and it may impose certain other sanctions.
In the case of options written by a Fund that are deemed covered by virtue
of the Fund's holding convertible or exchangeable preferred stock or debt
securities, the time required to convert or exchange and obtain physical
delivery of the underlying common stocks with respect to which the Fund
has written options may exceed the time within which the Fund must make
delivery in accordance with an exercise notice. In these instances, a Fund
may purchase or borrow temporarily the underlying securities for purposes
of physical delivery. By so doing, the Fund will not bear any market risk
because the Fund will have the absolute right to receive from the issuer
of the underlying security an equal number of shares to replace the bor-
rowed stock, but the Fund may incur additional transaction costs or inter-
est expenses in connection with any such purchase or borrowing.
Additional risks exist with respect to certain of the U.S. government se-
curities for which a Fund may write covered call options. If a Fund writes
covered call options on mortgage-backed securities, the securities that it
holds as cover may, because of scheduled amortization or unscheduled pre-
payments, cease to be sufficient cover. The Fund will compensate for the
decline in the value of the cover by purchasing an appropriate additional
amount of those securities.
Stock Index Options (Premium Total Return and Utilities Funds). The Pre-
mium Total Return and Utilities Funds may purchase and write put and call
options on U.S. stock indexes listed on U.S. exchanges for the purpose of
hedging its portfolio. A stock index fluctuates with changes in the market
values of the stocks included in the index. Some stock index options are
based on a broad market index such as the NYSE Composite Index or a nar-
rower market index such as the Standard & Poor's 100. Indexes also are
based on an industry or market segment such as the AMEX Oil and Gas Index
or the Computer and Business Equipment Index.
Options on stock indexes are similar to options on stock except that (a)
the expiration cycles of stock index options are monthly, while those of
stock options currently are quarterly, and (b) the delivery requirements
are different. Instead of giving the right to take or make delivery of
stock at a specified price, an option on a stock index gives the holder
the right to receive a cash "exercise settlement amount" equal to (a) the
amount, if any, by which the fixed exercise price of the option exceeds
(in the case of a put) or is less than (in the case of a call) the closing
value of the underlying index on the date of exercise, multiplied by (b) a
fixed "index multiplier." Receipt of this cash amount will depend upon the
closing level of the stock index upon which the option is based being
greater than, in the case of a call, or less than, in the case of a put,
the exercise price of the option. The amount of cash received will be
equal to such difference between the closing price of the index and the
exercise price of the option expressed in dollars times a specified multi-
ple. The writer of the option is obligated, in return for the premium re-
ceived, to make delivery of this amount. The writer may offset its posi-
tion in stock index options prior to expiration by entering into a closing
transaction on an exchange or it may let the option expire unexercised.
The effectiveness of purchasing or writing stock index options as a hedg-
ing technique will depend upon the extent to which price movements in the
portion of a securities portfolio being hedged correlate with price move-
ments of the stock index selected. Because the value of an index option
depends upon movements in the level of the index rather than the price of
a particular stock, whether the Premium Total Return and Utilities Funds
will realize a gain or loss from the purchase or writing of options on an
index depends upon movements in the level of stock prices in the stock
market generally or, in the case of certain indexes, in an industry or
market segment, rather than movements in the price of a particular stock.
Accordingly, successful use by a Fund of options on stock indexes will be
subject to its Adviser's ability to predict correctly movements in the di-
rection of the stock market generally or of a particular industry. This
requires different skills and techniques than predicting changes in the
prices of individual stocks.
The Premium Total Return and Utilities Funds will engage in stock index
options transactions only when determined by their respective Advisers to
be consistent with the Funds' efforts to control risk. There can be no as-
surance that such judgment will be accurate or that the use of these port-
folio strategies will be successful. When a Fund writes an option on a
stock index, the Fund will establish a segregated account with Boston Safe
in an amount equal to the market value of the option and will maintain the
account while the option is open.
Mortgage-Related Securities (Diversified Strategic Income Fund). The av-
erage maturity of pass- through pools of mortgage-related securities var-
ies with the maturities of the underlying mortgage instruments. In addi-
tion, a pool's stated maturity may be shortened by unscheduled payments on
the underlying mortgages. Factors affecting mortgage prepayments include
the level of interest rates, general economic and social conditions, the
location of the mortgaged property and age of the mortgage. Because pre-
payment rates of individual pools vary widely, it is not possible to accu-
rately predict the average life of a particular pool. Common practice is
to assume that prepayments will result in an average life ranging from 2
to 10 years for pools of fixed-rate 30-year mortgages. Pools of mortgages
with other maturities or different characteristics will have varying aver-
age life assumptions.
Mortgage-related securities may be classified as private, governmental or
government-related, depending on the issuer or guarantor. Private
mortgage-related securities represent pass-through pools consisting prin-
cipally of conventional residential mortgage loans created by non-
governmental issuers, such as commercial banks, savings and loan associa-
tions and private mortgage insurance companies. Governmental mortgage- re-
lated securities are backed by the full faith and credit of the United
States. GNMA, the principal guarantor of such securities, is a wholly
owned United States government corporation within the Department of Hous-
ing and Urban Development. Government-related mortgage-related securities
are not backed by the full faith and credit of the United States govern-
ment. Issuers of such securities include FNMA and FHLMC. FNMA is a
government-sponsored corporation owned entirely by private stockholders,
which is subject to general regulation by the Secretary of Housing and
Urban Development. Pass-through securities issued by FNMA are guaranteed
as to timely payment of principal and interest by FNMA. FHLMC is a corpo-
rate instrumentality of the United States, the stock of which is owned by
the Federal Home Loan Banks. Participation certificates representing in-
terests in mortgages from FHLMC's national portfolio are guaranteed as to
the timely payment of interest and ultimate collection of principal by
FHLMC.
Private, U.S. governmental or government-related entities create mortgage
loan pools offering pass- through investments in addition to those de-
scribed above. The mortgages underlying these securities may be alterna-
tive mortgage instruments, that is, mortgage instruments whose principal
or interest payments may vary or whose terms to maturity may be shorter
than previously customary. As new types of mortgage-related securities are
developed and offered to investors, Diversified Strategic Income Fund,
consistent with its investment objective and policies, will consider mak-
ing investments in such new types of securities.
Currency Transactions (Global Bond, Diversified Strategic Income and High
Income Funds). The Funds' dealings in forward currency exchange transac-
tions will be limited to hedging involving either specific transactions or
portfolio positions. Transaction hedging is the purchase or sale of for-
ward currency contracts with respect to specific receivables or payables
of the Fund generally arising in connection with the purchase or sale of
its securities. Position hedging, generally, is the sale of forward cur-
rency contracts with respect to portfolio security positions denominated
or quoted in the currency. A Fund may not position hedge with respect to a
particular currency to an extent greater than the aggregate market value
at any time of the security or securities held in its portfolio denomi-
nated or quoted in or currently convertible (such as through exercise of
an option or consummation of a forward currency contract) into that par-
ticular currency, except that Global Bond Fund may utilize forward cur-
rency contracts denominated in the European Currency Unit to hedge portfo-
lio security positions when a security or securities are denominated in
currencies of member countries in the European Monetary System. If a Fund
enters into a transaction hedging or position hedging transaction, it will
cover the transaction through one or more of the following methods: (a)
ownership of the underlying currency or an option to purchase such cur-
rency; (b) ownership of an option to enter into an offsetting forward cur-
rency contract; (c) entering into a forward contract to purchase currency
being sold or to sell currency being purchased, provided that such cover-
ing contract is itself covered by any one of these methods unless the cov-
ering contract closes out the first contract; or (d) depositing into a
segregated account with the custodian or a sub-custodian of the Fund cash
or readily marketable securities in an amount equal to the value of the
Fund's total assets committed to the consummation of the forward currency
contract and not otherwise covered. In the case of transaction hedging,
any securities placed in the account must be liquid debt securities. In
any case, if the value of the securities placed in the segregated account
declines, additional cash or securities will be placed in the account so
that the value of the account will equal the above amount. Hedging trans-
actions may be made from any foreign currency into dollars or into other
appropriate currencies.
At or before the maturity of a forward contract, a Fund either may sell a
portfolio security and make delivery of the currency, or retain the secu-
rity and offset its contractual obligation to deliver the currency by pur-
chasing a second contract pursuant to which the relevant Fund will obtain,
on the same maturity date, the same amount of the currency which it is ob-
ligated to deliver. If a Fund retains the portfolio security and engages
in an offsetting transaction, the Fund, at the time of execution of the
offsetting transaction, will incur a gain or loss to the extent movement
has occurred in forward contract prices. Should forward prices decline
during the period between a Fund's entering into a forward contract for
the sale of a currency and the date that it enters into an offsetting con-
tract for the purchase of the currency, the Fund will realize a gain to
the extent that the price of the currency it has agreed to sell exceeds
the price of the currency it has agreed to purchase. Should forward prices
increase, the Fund will suffer a loss to the extent the price of the cur-
rency it has agreed to purchase exceeds the price of the currency it has
agreed to sell.
The cost to a Fund of engaging in currency transactions varies with fac-
tors such as the currency involved, the length of the contract period and
the market conditions then prevailing. Because transactions in currency
exchange are usually conducted on a principal basis, no fees or commis-
sions are involved. The use of forward currency contracts does not elimi-
nate fluctuations in the underlying prices of the securities, but it does
establish a rate of exchange that can be achieved in the future. In addi-
tion, although forward currency contracts limit the risk of loss due to a
decline in the value of the hedged currency, at the same time, they limit
any potential gain that might result should the value of the currency in-
crease.
If a devaluation is generally anticipated, the Global Bond, Diversified
Strategic Income and High Income Funds may not be able to contract to sell
the currency at a price above the devaluation level they anticipate.
Foreign Currency Options (Global Bond, Diversified Strategic Income and
High Income Funds) With the exception of High Income Fund which may only
purchase put and call options on foreign currencies, these Funds may pur-
chase or write put and call options on foreign currencies for the purpose
of hedging against changes in future currency exchange rates. Foreign cur-
rency options generally have three, six and nine month expiration cycles.
Put options convey the right to sell the underlying currency at a price
which is anticipated to be higher than the spot price of the currency at
the time the option expires. Call options convey the right to buy the un-
derlying currency at a price which is expected to be lower than the spot
price of the currency at the time that the option expires.
The Fund may use foreign currency options under the same circumstances
that it could use forward currency exchange transactions. A decline in the
dollar value of a foreign currency in which a Fund's securities are denom-
inated, for example, will reduce the dollar value of the securities, even
if their value in the foreign currency remains constant. In order to pro-
tect against such diminutions in the value of securities that it holds,
the Fund may purchase put options on the foreign currency. If the value of
the currency does decline, the Fund will have the right to sell the cur-
rency for a fixed amount in dollars and will thereby offset, in whole or
in part, the adverse effect on its securities that otherwise would have
resulted. Conversely, if a rise in the dollar value of a currency in which
securities to be acquired are denominated is projected, thereby poten-
tially increasing the cost of the securities, the Fund may purchase call
options on the particular currency. The purchase of these options could
offset, at least partially, the effects of the adverse movements in ex-
change rates. The benefit to the Fund derived from purchases of foreign
currency options, like the benefit derived from other types of options,
will be reduced by the amount of the premium and related transaction
costs. In addition, if currency exchange rates do not move in the direc-
tion or to the extent anticipated, the Fund could sustain losses on trans-
actions in foreign currency options that would require it to forego a por-
tion or all of the benefits of advantageous changes in the rates.
Foreign Government Securities (Diversified Strategic Income and Global
Bond Funds). Among the foreign government securities in which these Funds
may invest are those issued by countries with developing economies, which
are countries in the initial stages of their industrialization cycles. In-
vesting in securities of countries with developing economies involves ex-
posure to economic structures that are generally less diverse and less ma-
ture, and to political systems that can be expected to have less stabil-
ity, than those of developed countries. The markets of countries with
developing economies historically have been more volatile than markets of
the more mature economies of developed countries, but often have provided
higher rates of return to investors.
Municipal Securities (Tax-Exempt Income Fund). Municipal securities gen-
erally 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 gen-
eral operating expenses and extensions of loans to public institutions and
facilities ("Municipal Securities"). Private activity bonds that are is-
sued by or on behalf of public authorities to finance privately operated
facilities are considered to be Municipal Securities 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.
Municipal bonds may be issued to finance life care facilities. Life care
facilities are an alternative form of long-term housing for the elderly
which offer residents the independence of condominium life style and, if
needed, the comprehensive care of nursing home services. Bonds to finance
these facilities have been issued by various state industrial development
authorities. Because the bonds are secured only by the revenues of each
facility and not by state or local government tax payments, they are sub-
ject to a wide variety of risks, including a drop in occupancy levels, the
difficulty of maintaining adequate financial reserves to secure estimated
actuarial liabilities, the possibility of regulatory cost restrictions ap-
plied to health care delivery and competition from alternative health care
or conventional housing facilities.
Municipal leases are Municipal Securities that may take the form of a
lease or an installment purchase contract issued by state and local gov-
ernmental authorities to obtain funds to acquire a wide variety of equip-
ment and facilities such as fire and sanitation vehicles, computer equip-
ment and other capital assets. These obligations have evolved to make it
possible for state and local government authorities to acquire property
and equipment without meeting constitutional and statutory requirements
for the issuance of debt. Thus, municipal leases have special risks not
normally associated with municipal bonds. These obligations frequently
contain "non-appropriation" clauses providing that the governmental issuer
of the obligation has no obligation to make future payments under the
lease or contract unless money is appropriated for such purposes by the
legislative body on a yearly or other periodic basis. In addition to the
"non-appropriation" risk, municipal leases represent a type of financing
that has not yet developed the depth of marketability associated with mu-
nicipal bonds; moreover, although the obligations will be secured by the
leased equipment, the disposition of the equipment in the event of fore-
closure might prove to be difficult. In order to limit the risks, Tax-
Exempt Income Fund proposes to purchase either (a) municipal leases rated
in the four highest categories by Moody's Investors Service, Inc.
("Moody's") or Standard & Poor's Corporation ("S&P") or (b) unrated munic-
ipal leases purchased principally from domestic banks or other responsible
third parties which enter into an agreement with the Fund providing the
seller will either remarket or repurchase the municipal lease within a
short period after demand by the Fund.
Temporary Investments (Tax-Exempt Income Fund). When the Tax-Exempt In-
come Fund is maintaining a defensive position, the Fund may invest in
short-term investments ("Temporary Investments") consisting of: (a) the
following tax-exempt securities: (i) tax-exempt notes of municipal issuers
having, at the time of purchase, a rating of MIG 1 through MIG 4 by
Moody's or rated SP-1 or SP-2 by S&P or, if not rated, of issuers having
an issue of outstanding Municipal Securities rated within the four highest
grades by Moody's or S&P; (ii) tax-exempt commercial paper having, at the
time of purchase, a rating not lower than A-2 by S&P or Prime-2 by
Moody's; and (iii) variable rate demand notes rated at the time of pur-
chase within the two highest ratings by any major rating service or deter-
mined to be of comparable quality to instruments with such rating; and (b)
the following taxable securities: (i) U.S. government securities, includ-
ing repurchase agreements with respect to such securities; (ii) other debt
securities rated within the four highest grades by Moody's or S&P; (iii)
commercial paper rated in the highest grade by either of these rating ser-
vices; and (iv) certificates of deposit of domestic banks with assets of
$1 billion or more. Among the tax-exempt notes in which the Fund may in-
vest are Tax Anticipation Notes, Bond Anticipation Notes and Revenue An-
ticipation Notes which are issued in anticipation of receipt of tax funds,
proceeds of bond placements or other revenues, respectively. At no time
will more than 20% of the Fund's total assets be invested in Temporary In-
vestments unless the Fund has adopted a defensive investment policy in an-
ticipation of a market decline. The Fund intends, however, to purchase
tax-exempt Temporary Investments pending the investment of the proceeds of
the sale of shares of the Fund and of its portfolio securities, or in
order to have highly liquid securities available to meet anticipated re-
demptions.
Investing in Utilities (Utilities Fund). Each of the risks referred to in
Utilities Fund's Prospectus could adversely affect the ability and incli-
nation of public utilities to declare or pay dividends and the ability of
holders of common stock to realize any value from the assets of the issuer
upon liquidation or bankruptcy. Moreover, price disparities within se-
lected utility groups and discrepancies in relation to averages and indi-
ces have occurred frequently for reasons not directly related to the gen-
eral movements or price trends of utility common stocks. Causes of these
discrepancies include changes in the overall demand for and supply of var-
ious securities (including the potentially depressing effect of new stock
offerings), and changes in investment objectives, market expectations or
cash requirements of other purchasers and sellers of securities.
Ratings as Investment Criteria (All Funds). In general, the ratings of
nationally recognized statistical rating organizations ("NRSROs") repre-
sent the opinions of these agencies as to the quality of securities that
they rate. Such ratings, however, are relative and subjective, and are not
absolute standards of quality and do not evaluate the market value risk of
the securities. These ratings will be used by the Funds as initial crite-
ria for the selection of portfolio securities, but the Funds also will
rely upon the independent advice of their respective Advisers 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. The Appendix to this Statement of Additional Information
contains further information concerning the rating categories of NRSROs
and their significance.
Subsequent to its purchase by a Fund, an issue of securities may cease to
be rated or its rating may be reduced below the minimum required for pur-
chase by the Fund. In addition, it is possible that an NRSRO might not
change its rating of a particular issue to reflect subsequent events. None
of these events will require sale of such securities by a Fund, but the
Fund's Adviser will consider such events in its determination of whether
the Fund should continue to hold the securities. In addition, to the ex-
tent that the ratings change as a result of changes in such organizations
or their rating systems, or due to a corporate reorganization, a Fund will
attempt to use comparable ratings as standards for its investments in ac-
cordance with its investment objective and policies.
Futures Activities (High Income, Utilities and Tax-Exempt Income Fund-
s). These Funds may enter into futures contracts and/or options on fu-
tures contracts that are traded on a United States exchange or board of
trade. These investments may be made by a Fund solely for the purpose of
hedging against the effects of changes in the value of its portfolio secu-
rities due to anticipated changes in interest rates, currency values
and/or market conditions, and not for purposes of speculation. In the case
of Tax-Exempt Income Fund, investments in futures contracts will be made
only in unusual circumstances, such as when the Fund's Adviser anticipates
an extreme change in interest rates or market conditions. See "Taxes"
below.
Futures Contracts. The purpose of the acquisition or sale of a futures
contract by a Fund is to mitigate the effects of fluctuations in interest
rates or currency or market values, depending on the type of contract, on
securities or their values without actually buying or selling the securi-
ties. For example, if Tax-Exempt Income Fund owns long-term bonds and tax-
exempt rates are expected to increase, the Fund might enter into a short
position in municipal bond index futures contracts. Such a sale would have
much the same effect as the Fund's selling some of the long-term bonds in
its portfolio. If tax-exempt rates increase as anticipated, the value of
certain long-term Municipal Securities in the Fund would decline, but the
value of the Fund's futures contracts would increase at approximately the
same rate, thereby keeping the net asset value of the Fund from declining
as much as it otherwise would have. Of course, because the value of port-
folio securities will far exceed the value of the futures contracts sold
by a Fund, an increase in the value of the futures contracts could only
mitigate -- but not totally offset -- the decline in the value of the
Fund.
The Global Bond and Diversified Strategic Income Funds may enter into fu-
tures contracts or related options on futures contracts that are traded on
a domestic or foreign exchange or in the over-the-counter market. These
investments may be made solely for the purpose of hedging against changes
in the value of its portfolio securities due to anticipated changes in in-
terest rates, currency values and/or market conditions when the transac-
tions are economically appropriate to the reduction of risks inherent in
the management of the Fund and not for purposes of speculation. The abil-
ity of the Funds to trade in futures contracts may be limited by the re-
quirements of the Internal Revenue Code of 1986 as amended (the "Code"),
applicable to a regulated investment company.
No consideration is paid or received by a Fund upon entering into a fu-
tures contract. Initially, a Fund will be required to deposit with its
custodian an amount of cash or cash equivalents equal to approximately 1%
to 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, known as initial mar-
gin, is in the nature of a performance bond or good faith deposit on the
contract and is returned to a Fund upon termination of the futures con-
tract, assuming that all contactual obligations have been satisfied. Sub-
sequent payments, known as variation margin, to and from the broker, will
be made daily as the price of the securities, currency or index underlying
the futures contract 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 expiration of a futures contract, a Fund
may elect to close the position by taking an opposite position, which will
operate to terminate the Fund's existing position in the contract.
Several risks are associated with the use of futures contracts as a hedg-
ing device. Successful use of futures contracts by a Fund is subject to
the ability of its Adviser to predict correctly movements in interest
rates, stock or bond indices or foreign currency values. These predictions
involve skills and techniques that may be different from those involved in
the management of the portfolio being hedged. In addition, there can be no
assurance that there will be a correlation between movements in the price
of the underlying securities, currency or index and movements in the price
of the securities which are the subject of the hedge. A decision of
whether, when and how to hedge involves the exercise of skill and judg-
ment, and even a well-conceived hedge may be unsuccessful to some degree
because of market behavior or unexpected trends in interest rates or cur-
rency values.
Although the Funds with authority to engage in futures activity intend to
enter into futures contracts only if there is an active market for such
contracts, there is no assurance that an active market will exist for the
contracts at any particular time. Most futures exchanges and boards of
trade limit the amount of fluctuation permitted in futures contract prices
during a single trading day. Once the daily limit has been reached in a
particular contract, no trades may be made that day at a price beyond that
limit. 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, and in the
event of adverse price movements, a Fund would be required to make daily
cash payments of variation margin, and 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 the securities being hedged will, in
fact, correlate with the price movements in a futures contract and thus
provide an offset to losses on the futures contract.
If a Fund has hedged against the possibility of a change in interest rates
or currency or market values adversely affecting the value of securities
held in its portfolio and rates or currency or market values move in a di-
rection opposite to that which the Fund has anticipated, the Fund will
lose part or all of the benefit of the increased value of securities which
it has hedged because it will have offsetting losses in its futures posi-
tions. In addition, in such situations, if the Fund had insufficient cash,
it may have to sell securities to meet daily variation margin requirements
at a time when it may be disadvantageous to do so. These sales of securi-
ties may, but will not necessarily, be at increased prices which reflect
the change in interest rates or currency values, as the case may be.
Options on Futures Contracts. An option on an interest rate futures con-
tract, as contrasted with the direct investment in such a contract, gives
the purchaser the right, in return for the premium paid, to assume a posi-
tion in the underlying interest rate futures contract at a specified exer-
cise price at any time prior to the expiration date of the option. An op-
tion on a foreign currency futures contract, as contrasted with the direct
investment in such a contract, gives the purchaser the right, but not the
obligation, to assume a long or short position in the relevant underlying
future currency at a predetermined exercise price at a time in the future.
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 margin ac-
count, which represents the amount by which the market price of the fu-
tures 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 for loss related to the purchase of an option on 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 a Fund in-
vesting in the options.
Several risks are associated with options on futures contracts. The abil-
ity to establish and close out positions on such options will be subject
to the existence of a liquid market. In addition, the purchase of put or
call options on interest rate and foreign currency futures will be based
upon predictions by a Fund's Adviser as to anticipated trends in interest
rates and currency values, as the case may be, which could prove to be in-
correct. Even if the expectations of an Adviser are correct, there may be
an imperfect correlation between the change in the value of the options
and of the portfolio securities or the currencies being hedged.
Foreign Investments. Investors should recognize that investing in foreign
companies involves certain considerations which are not typically associ-
ated with investing in U.S. issuers. Since the Fund will be investing in
securities denominated in currencies other than the U.S. dollar, and since
the Fund may temporarily hold funds in bank deposits or other money market
investments denominated in foreign currencies, the Fund may be affected
favorably or unfavorably by exchange control regulations or changes in the
exchange rate between such currencies and the dollar. A change in the
value of a foreign currency relative to the U.S. dollar will result in a
corresponding change in the dollar value of the Fund's assets denominated
in that foreign currency. Changes in foreign currency exchange rates may
also affect the value of dividends and interest earned, gains and losses
realized on the sale of securities and net investment income and gain, if
any, to be distributed to shareholders by the Fund.
The rate of exchange between the U.S. dollar and other currencies is de-
termined by the forces of supply and demand in the foreign exchange mar-
kets. Changes in the exchange rate may result over time from the interac-
tion of many factors directly or indirectly affecting economic conditions
and political developments in other countries. Of particular importance
are rates of inflation, interest rate levels, the balance of payments and
the extent of government surpluses or deficits in the Unites States and
the particular foreign country, all of which are in turn sensitive to the
monetary, fiscal and trade policies pursued by the governments of the
United States and other foreign countries important to international trade
and finance. Governmental intervention may also play a significant role.
National governments rarely voluntarily allow their currencies to float
freely in response to economic forces. Sovereign governments use a variety
of techniques, such as intervention by a country's central bank or imposi-
tion of regulatory controls or taxes, to affect the exchange rates of
their currencies.
Many of the securities held by the Fund will not be registered with, nor
the issuers thereof be subject to reporting requirements of, the SEC. Ac-
cordingly, there may be less publicly available information about the se-
curities and about the foreign company or government issuing them than is
available about a domestic company or government entity. Foreign issuers
are generally not subject to uniform financial reporting standards, prac-
tices and requirements comparable to those applicable to U.S. issuers. In
addition, with respect to some foreign countries, there is the possibility
of expropriation or confiscatory taxation, limitations on the removal of
funds or other assets of the Fund, political or social instability, or do-
mestic developments which could affect U.S. investments in those coun-
tries. Moreover, individual foreign economies may differ favorably or un-
favorably from the U.S. economy in such respects as growth of gross na-
tional product, rate of inflation, capital reinvestment, resource self-
sufficiency and balance of payments positions. The Fund may invest in
securities of foreign governments (or agencies or instrumentalities
thereof), and many, if not all, of the foregoing considerations apply to
such investments as well.
Securities of some foreign companies are less liquid and their prices are
more volatile than securities of comparable domestic companies. Certain
foreign countries are known to experience long delays between the trade
and settlement dates of securities purchased or sold. Due to the increased
exposure to the Fund of market and foreign exchange fluctuations brought
about by such delays, and due to the corresponding negative impact on Fund
liquidity, the Fund will avoid investing in countries which are known to
experience settlement delays which may expose the Fund to unreasonable
risk of loss.
The interest payable on the Fund's foreign securities may be subject to
foreign withholding taxes, and while investors may be able to claim some
credit or deductions for such taxes with respect to their allocated shares
of such foreign tax payments, the general effect of these taxes will be to
reduce the Fund's income. Additionally, the operating expenses of the Fund
can be expected to be higher than that of an investment company investing
exclusively in U.S. securities, since the expenses of the Fund, such as
custodial costs, valuation costs and communication costs, as well as the
rate of the investment advisory fees, though similar to such expenses of
some other international funds, are higher than those costs incurred by
other investment companies.
Short Sales (Utilities Fund). Utilities Fund may from time to time sell
securities short, but the value of securities sold short will not exceed
5% of the value of the Fund's assets. In addition, the Fund may not (a)
sell short the securities of a single issuer to the extent of more than 2%
of the value of the Fund's net assets and (b) sell short the securities of
any class of an issuer to the extent of more than 2% of the outstanding
securities of the class at the time of the transaction. A short sale is a
transaction in which the Fund sells securities that it does not own (but
has borrowed) in anticipation of a decline in the market price of the se-
curities.
When the Fund makes a short sale, the proceeds it receives from the sale
are retained by a broker until the Fund replaces the borrowed securities.
To deliver the securities to the buyer, the Fund must arrange through a
broker to borrow the securities and, in so doing, the Fund becomes obli-
gated to replace the securities borrowed at their market price at the time
of replacement, whatever that price may be. The Fund may have to pay a
premium to borrow the securities and must pay any dividends or interest
payable on the securities until they are replaced.
The Fund's obligation to replace the securities borrowed in connection
with a short sale will be secured by collateral deposited with the broker
that consists of cash or U.S. government securities. In addition, the Fund
will place in a segregated account with its custodian an amount of cash or
U.S. government securities equal to the difference, if any, between (a)
the market value of the securities sold at the time they were sold short
and (b) any cash or U.S. government securities deposited as collateral
with the broker in connection with the short sale (not including the pro-
ceeds of the short sale). Until it replaces the borrowed securities, the
Fund will maintain the segregated account daily at a level so that the
amount deposited in the account plus the amount deposited with the broker
(not including the proceeds from the short sale) (a) will equal the cur-
rent market value of the securities sold short and (b) will not be less
than the market value of the securities at the time they were sold short.
Short Sales Against the Box (Premium Total Return, Convertible and Utili-
ties Funds). These Funds may enter into a short sale of common stock such
that when the short position is open the Fund involved owns an equal
amount of preferred stocks or debt securities, convertible or exchange-
able, without payment of further consideration, into an equal number of
shares of the common stock sold short. This kind of short sale, which is
described as "against the box," will be entered into by a Fund for the
purpose of receiving a portion of the interest earned by the executing
broker from the proceeds of the sale. The proceeds of the sale will be
held by the broker until the settlement date when the Fund delivers the
convertible securities to close out its short position. Although prior to
delivery a Fund will have to pay an amount equal to any dividends paid on
the common stock sold short, the Fund will receive the dividends from the
preferred stock or interest from the debt securities convertible into the
stock sold short, plus a portion of the interest earned from the proceeds
of the short sale. The Funds will deposit, in a segregated account with
their custodian, convertible preferred stock or convertible debt securi-
ties in connection with short sales against the box.
INVESTMENT RESTRICTIONS
The investment restrictions numbered 1 through 14 below (other than re-
striction number 10 as applied to Utilities Fund) have been adopted by the
Trust with respect to the Funds as fundamental policies. Under the 1940
Act, a fundamental policy may not be changed without the vote of a major-
ity of the outstanding voting securities of a Fund, as defined in the 1940
Act. Majority is defined in the 1940 Act as the lesser of (a) 67% or more
of the shares present at a shareholder meeting, if the holders of more
than 50% of the outstanding shares of the Trust are present or represented
by proxy, or (b) more than 50% of the outstanding shares. Investment re-
strictions 15 through 20, and number 10 as applied to Utilities Fund, may
be changed by vote of a majority of the Board of Trustees at any time.
The investment policies adopted by the Trust prohibit a Fund from:
1. Purchasing the securities of any issuer (other than U.S. government
securities) if as a result more than 5% of the value of the Fund's total
assets would be invested in the securities of the issuer, except that up
to 25% of the value of the Fund's total assets may be invested without re-
gard to this 5% limitation.
2. Purchasing (a) more than 10% of the voting securities of any one is-
suer, (b) more than 10% of the securities of any class of any one issuer
or (c) more than 10% of the outstanding debt securities of any one issuer,
except that limitation (c) does not apply to the Exchange Reserve and Di-
versified Strategic Income Funds and limitations (b) and (c) do not apply
to the Utilities Fund; provided that this limitation shall not apply to
investment in U.S. government securities.
3. Purchasing securities on margin, except that the Fund may obtain any
short-term credits necessary for the clearance of purchases and sales of
securities. For purposes of this restriction, the deposit or payment of
initial or variation margin in connection with futures contracts or re-
lated options will not be deemed to be a purchase of securities on margin
by any Fund permitted to engage in transactions in futures contracts or
related options.
4. Making short sales of securities or maintaining a short position ex-
cept that (a) the Premium Total Return, Utilities and Convertible Funds
may engage in such activities if, at all times when a short position is
open, the relevant Fund owns an equal amount of the securities convertible
into or exchangeable, without payment of any further consideration, for
securities of the same issuer as, and at least equal in amount to, the se-
curities sold short, and if, with respect to the Premium Total Return and
Convertible Funds, not more than 10% of the relevant Fund's net assets
(taken at current value) is held as collateral for such sales at any one
time and (b) Utilities Fund may make short sales or maintain a short posi-
tion to the extent of 5% of its net assets.
5. Borrowing money, except that (a) the Fund may borrow from banks for
temporary or emergency (not leveraging) purposes, including the meeting of
redemption requests that might otherwise require the untimely disposition
of securities, in an amount not exceeding 10% (20% for Utilities Fund) of
the value of the Fund's total assets (including the amount borrowed) val-
ued at market less liabilities (not including the amount borrowed) at the
time the borrowing is made, (b) Diversified Strategic Income Fund may
enter into reverse repurchase agreements and forward roll transactions and
(c) one or more Funds may enter into futures contracts. Except for Diver-
sified Strategic Income Fund, whenever borrowings described in (a) exceed
5% of the value of a Fund's total assets, the Fund will not make any addi-
tional investments. Immediately after any borrowing (including reverse re-
purchase agreements and forward roll transactions), Diversified Strategic
Income Fund will maintain an asset coverage of at least 300% with respect
to all its borrowings.
6. Pledging, hypothecating, mortgaging or otherwise encumbering more than
10% of the value of the Fund's total assets. For purposes of this restric-
tion, (a) the deposit of assets in escrow in connection with the writing
of covered put or call options and the purchase of securities on a when-
issued or delayed-delivery basis and (b) collateral arrangements with re-
spect to (i) the purchase and sale of stock options, options on foreign
currencies and options on stock indexes and (ii) initial or variation mar-
gin for futures contracts, will not be deemed to be pledges of a Fund's
assets.
7. Underwriting the securities of other issuers, except insofar as the
Fund may be deemed an underwriter under the Securities Act of 1933, as
amended, by virtue of disposing of portfolio securities.
8. Purchasing or selling real estate or interests in real estate, except
that the Fund may purchase and sell securities that are secured by real
estate and may purchase securities issued by companies that invest or deal
in real estate.
9. Investing in commodities, except that (a) the Global Bond, High In-
come, Diversified Strategic Income, Utilities and Tax-Exempt Income Funds
may invest in futures contracts and options on futures contracts as de-
scribed in their Prospectuses and (b) upon 60 days' notice given to its
shareholders, the Premium Total Return and Convertible Funds may engage in
hedging transactions involving futures contracts and related options, in-
cluding stock index futures contracts and financial futures contracts.
10. Investing in oil, gas or other mineral exploration or development
programs, except that the Premium Total Return, Convertible, Diversified
Strategic Income, Global Bond, Utilities and High Income Funds may invest
in the securities of companies that invest in or sponsor those programs.
11. Making loans to others, except through the purchase of qualified debt
obligations, the entry into repurchase agreements and, with respect to
Funds other than the Exchange Reserve Fund, loans of portfolio securities
consistent with the Fund's investment objective.
12. Investing in securities of other investment companies registered or
required to be registered under the 1940 Act, except as they may be ac-
quired as part of a merger, consolidation, reorganization, acquisition of
assets or an offer of exchange.
13. Purchasing any securities which would cause more than 25% of the
value of the Fund's total assets at the time of purchase to be invested in
the securities of issuers conducting their principal business activities
in the same industry, except that Exchange Reserve Fund and Utilities Fund
will invest in excess of 25% of their respective assets in the securities
of companies within the banking industry and utility industry, respec-
tively; provided that there shall be no limit on the purchase of (a) U.S.
government securities or (b) for Funds other than the Exchange Reserve and
Utilities Funds, Municipal Securities issued by governments or political
subdivisions of governments.
14. Writing or selling puts, calls, straddles, spreads or combinations
thereof, except, with respect to Funds other than Exchange Reserve Fund,
as permitted under the Fund's investment objective and policies.
15. Purchasing restricted securities, illiquid securities (such as repur-
chase agreements with maturities in excess of seven days and, in the case
of Exchange Reserve Fund, time deposits maturing from two business days
through seven calendar days) or other securities that are not readily mar-
ketable if more than 10% or, in the case of the High Income, Global Bond
and Diversified Strategic Income Funds, 15% of the total assets of the
Fund would be invested in such securities.
16. Purchasing any security if as a result the Fund would then have more
than 5% of its total assets invested in securities of companies (including
predecessors) that have been in continuous operation for fewer than three
years; provided that in the case of private activity bonds purchased for
Tax-Exempt Income Fund, this restriction shall apply to the entity supply-
ing the revenues from which the issue is to be paid.
17. Making investments for the purpose of exercising control or manage-
ment.
18. Purchasing or retaining securities of any company if, to the knowl-
edge of the Trust, any of the Trust's officers or Trustees or any officer
or director of an Adviser individually owns more than 1/2 of 1% of the
outstanding securities of such company and together they own beneficially
more than 5% of the securities.
19. Investing in warrants (except as permitted under a Fund's investment
objective and policies or other than warrants acquired by the Fund as part
of a unit or attached to securities at the time of purchase) if, as a re-
sult, the investments (valued at the lower of cost or market) would exceed
5% of the value of the Fund's net assets of which not more than 2% of the
Fund's net assets may be invested in warrants not listed on a recognized
United States or foreign stock exchange to the extent permitted by appli-
cable state securities laws.
20. With respect to Utilities Fund only, purchasing in excess of 5% of
the voting securities of a public utility or public utility holding com-
pany, so as to become a public utility holding company as defined in the
Public Utility Holding Company Act of 1935, as amended.
The Trust has adopted two additional investment restrictions applicable to
Exchange Reserve Fund, the first of which is a fundamental policy, which
prohibit Exchange Reserve Fund from:
1. Investing in common stocks, preferred stocks, warrants, other equity
securities, corporate bonds or debentures, state bonds, municipal bonds or
industrial revenue bonds.
2. Investing more than 10% of its assets in variable rate master demand
notes providing for settlement upon more than seven days' notice by the
Fund.
For purposes of the investment restrictions described above, the issuer of
a Municipal Security is deemed to be the entity (public or private) ulti-
mately responsible for the payment of the principal of and interest on the
security. For purposes of investment restriction number 13, private activ-
ity bonds (other than those issued for charitable, educational and certain
other purposes), the payment of principal and interest on which is the ul-
timate responsibility of companies within the same industry, are grouped
together as an industry. The Trust may make commitments more restrictive
than the restrictions listed above with respect to a Fund so as to permit
the sale of shares of the Fund in certain states. Should the Trust deter-
mine that any such commitment is no longer in the best interests of the
Fund and its shareholders, the Trust will revoke the commitment by termi-
nating the sale of shares of the Fund in the state involved. The percent-
age limitations contained in the restrictions listed above apply at the
time of purchases of securities.
PORTFOLIO TURNOVER
The Funds do not intend to seek profits through short-term trading. Never-
theless, the Funds will not consider portfolio turnover rate a limiting
factor in making investment decisions.
Under certain market conditions, a Fund authorized to engage in transac-
tions in options may experience increased portfolio turnover as a result
of its investment strategies. For instance, the exercise of a substantial
number of options written by a Fund (due to appreciation of the underlying
security in the case of call options on securities or depreciation of the
underlying security in the case of put options on securities) could result
in a turnover rate in excess of 100%. A portfolio turnover rate of 100%
also would occur, for example, if all of a Fund's securities that are in-
cluded in the computation of turnover were replaced once during a period
of one year. A Fund's turnover rate is calculated by dividing the lesser
of purchases or sales of its portfolio securities for the year by the
monthly average value of the portfolio securities. Securities or options
with remaining maturities of one year or less on the date of acquisition
are excluded from the calculation.
Certain other practices which may be employed by a Fund also could result
in high portfolio turnover. For example, portfolio 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 of comparable qual-
ity purchased at approximately the same time to take advantage of what a
Fund's Adviser 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 securities.
For the fiscal years ended July 31, 1993 and 1994, the portfolio turnover
rates were as follows:
<TABLE>
<CAPTION>
FUND 1993 1994
<S> <C> <C>
Premium Total Return Fund 55% 34%
Tax-Exempt Income Fund 34% 39%
Convertible Fund 95% 54%
High Income Fund 95% 98%
Global Bond Fund 216% 257%
Diversified Strategic Income Fund 116% 93%
Utilities Fund 37% 28%
</TABLE>
For regulatory purposes the turnover rate of Exchange Reserve Fund is
zero.
PORTFOLIO TRANSACTIONS
Most of the purchases and sales of securities for a Fund, whether trans-
acted on a securities exchange or over-the-counter, will be effected in
the primary trading market for the securities, except for Eurobonds which
are principally traded over-the-counter. The primary trading market for a
given security is generally located in the country in which the issuer has
its principal office. Decisions to buy and sell securities for a Fund are
made by its Adviser, which also is responsible for placing these transac-
tions, subject to the overall review of the Trust's Trustees. With respect
to Diversified Strategic Income Fund, decisions to buy and sell domestic
securities for the Fund are made by SBMFM, which is also responsible for
placing these transactions; the responsibility to make investment deci-
sions with respect to foreign securities and to place these transactions
rests with Global Capital Management. Although investment decisions for
each Fund are made independently from those of the other accounts managed
by its Adviser, investments of the type that the Fund may make also may be
made by those other accounts. When a Fund and one or more other accounts
managed by its Adviser 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 believed by the Adviser to be equitable to each.
In some cases, this procedure may adversely affect the price paid or re-
ceived by a Fund or the size of the position obtained or disposed of by
the Fund.
Transactions on domestic stock exchanges and some foreign stock exchanges
involve the payment of negotiated brokerage commissions. On exchanges on
which commissions are negotiated, the cost of transactions may vary among
different brokers. Commissions generally are fixed on most foreign ex-
changes. There is generally no stated commission in the case of securities
traded in U.S. or foreign over-the-counter markets, but the prices of
those securities include undisclosed commissions or mark-ups. The cost of
securities purchased from underwriters includes an underwriting commission
or concession, and the prices at which securities are purchased from and
sold to dealers include a dealer's mark-up or mark-down. U.S. government
securities generally are purchased from underwriters or dealers, although
certain newly issued U.S. government securities may be purchased directly
from the United States Treasury or from the issuing agency or instrumen-
tality. The following table sets forth certain information regarding each
Fund's payment of brokerage commissions:
<TABLE>
<CAPTION>
PREMIUM
DIVERSIFIED
TOTAL CONVERT- HIGH
STRATEGIC
FISCAL RETURN IBLE INCOME UTILITIES
INCOME
YEAR FUND FUND FUND FUND
FUND
<S> <C> <C> <C> <C> <C>
<C>
Total Brokerage
Commissions 1992 $ 762,101 $51,993 $11,296 $
562,710 --
1992* -- -- -- $
774,306 --
1993 $1,933,587 $75,836 $17,225
$1,810,481 $ 19,446
1994 $1,767,577 $60,818 $96,670
$2,006,028 $106,421
Commissions paid to
Shearson Lehman
Brothers or Smith
Barney 1992 $ 283,190 $ 2,700 $ 22,419 $
28,848 --
1992* -- -- -- $
51,828 --
1993 $ 355,027 -- -- $
97,740 --
1994 $ 280,686 -- -- $
174,858 --
% of Total Brokerage
Commissions paid to
Smith Barney 1994 15.88% -- --
8.70% --
% of Total Transac-
tions involving
Commissions paid to
Smith Barney 1994 14.92% -- --
8.10% --
* Periods disclosed for Utilities Fund are for fiscal year ended February
29, 1992 and the period from March 1, 1992 through July 31, 1992.
</TABLE>
In selecting brokers or dealers to execute securities transactions on be-
half of a Fund, the Fund's Adviser seeks the best overall terms available.
In assessing the best overall terms available for any transaction, each
Adviser will consider the factors that it deems relevant, including the
breadth of the market in the security, the price of the security, the fi-
nancial condition and execution capability of the broker or dealer and the
reasonableness of the commission, if any, for the specific transaction and
on a continuing basis. In addition, each Advisory Agreement between the
Trust and an Adviser authorizes the Adviser, in selecting brokers or deal-
ers to execute a particular transaction and in evaluating the best overall
terms available, to consider the brokerage and research services (as those
terms are defined in Section 28(e) of the Securities Exchange Act of 1934)
provided to the Trust, the other Funds and/or other accounts over which
the Adviser or its affiliates exercise investment discretion. The fees
under the Advisory Agreements and the Sub-Advisory and/or Administration
Agreements are not reduced by reason of their receiving such brokerage and
research services. Further, Smith Barney will not participate in commis-
sions brokerage given by the Fund to other brokers or dealers and will not
receive any reciprocal brokerage business resulting therefrom. The Trust's
Board of Trustees periodically will review the commissions paid by the
Funds to determine if the commissions paid over representative periods of
time were reasonable in relation to the benefits inuring to the Trust.
To the extent consistent with applicable provisions of the 1940 Act and
the rules and exemptions adopted by the SEC thereunder, the Trust's Board
of Trustees has determined that transactions for a Fund may be executed
through Smith Barney and other affiliated broker-dealers if, in the judg-
ment of the Fund's Adviser, the use of such broker-dealer is likely to re-
sult in price and execution at least as favorable as those of other quali-
fied broker-dealers, and if, in the transaction, such broker-dealer
charges the Fund a rate consistent with that charged to comparable unaf-
filiated customers in similar transactions. In addition, under rules re-
cently adopted by the SEC, Smith Barney may directly execute such transac-
tions for the Funds on the floor of any national securities exchange, pro-
vided (a) the Trust's Board of Trustees has expressly authorized Smith
Barney to effect such transactions, and (b) Smith Barney annually advises
the Trust of the aggregate compensation it earned on such transactions.
Over-the-counter purchases and sales are transacted directly with princi-
pal market makers except in those cases in which better prices and execu-
tions may be obtained elsewhere.
The Funds will not purchase any security, including U.S. government secu-
rities or Municipal Securities, during the existence of any underwriting
or selling group relating thereto of which Smith Barney is a member, ex-
cept to the extent permitted by the SEC.
The Funds may use Smith Barney as a commodities broker in connection with
entering into futures contracts and options on futures contracts. Smith
Barney has agreed to charge the Funds commodity commissions at rates com-
parable to those charged by Smith Barney to its most favored clients for
comparable trades in comparable accounts.
PURCHASE OF SHARES
VOLUME DISCOUNTS
The schedule of sales charges on Class A shares described in the Prospec-
tuses applies to purchases made by any "purchaser," which is defined to in-
clude 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 Code and qualified em-
ployee 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; (f) any other orga-
nized group of persons, provided that the organization has been in exist-
ence for at least six months and was organized for a purpose other than
the purchase of investment company securities at a discount; or (g) a
trustee or other professional fiduciary (including a bank, or an invest-
ment adviser registered with the SEC under the Investment Advisers Act of
1940) purchasing shares of the Fund for one or more trust estates or fidu-
ciary accounts. Purchasers who wish to combine purchase orders to take ad-
vantage of volume discounts on Class A shares should contact a
Smith
Barney Financial Consultant.
COMBINED RIGHT OF ACCUMULATION
Reduced sales charges, in accordance with the schedules in the Prospec-
tuses, apply to any purchase of Class A shares if the aggregate investment
in Class A shares of the relevant 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" (as
defined above) 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 Trust reserves the right to terminate or amend the combined
right of accumulation at any time after written notice to
shareholders. For fur-
ther information regarding the rights of accumulation, shareholders should
contact a Smith Barney Financial Consultant.
DETERMINATION OF PUBLIC OFFERING PRICES
The Trust offers shares of the Funds to the public on a continuous basis.
The public offering price for a Class A, Class Y and Class Z 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 ac-
cumulation, 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"), how-
ever, is imposed on certain redemptions of Class B and Class C shares and
of
Class A shares when purchased in amounts exceeding $500,000. The method of
computation of the public offering price is shown in the Funds' financial
statements incorporated by reference in their entirety into this Statement
of Additional Information.
REDEMPTION OF SHARES
Detailed information on how to redeem shares of a Fund is included in its
Prospectus. The right of redemption of shares of a Fund may be suspended
or the date of payment postponed (a) for any periods during which the New
York Stock Exchange, Inc. (the "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 exists, as determined by
the SEC, so that disposal of the Fund's investments or determination of
its net asset value is not reasonably practicable or (c) for such other
periods as the SEC by order may permit for the protection of the Fund's
shareholders.
Distributions in Kind. If the Board of Trustees of the Trust determines
that
it would be detrimental to the best interests of the remaining sharehold-
ers to make a redemption payment wholly in cash, the Trust may
pay, in accordance with SEC rules, any portion of a redemption in excess
of the lesser of $250,000 or 1% of the Fund's net assets by distribution
in kind of portfolio securities in lieu of cash. Securities is-
sued 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 of a Fund
with a value of at least $10,000 ($5,000 for retirement plan accounts) and
who wish to receive specific amounts of cash monthly or quarterly. With-
drawals of at least $100 may be made under the Withdrawal Plan by redeem-
ing 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 re-
spect to Withdrawal Plans in effect prior to November 7, 1994, any appli-
cable CDSC will be waived on amounts withdrawn that do not exceed 2.00%
per month of the value of a shareholder's shares at the time the With-
drawal Plan commences). To the extent that 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 in-
come from investment in a Fund. Furthermore, as it generally would not be
advantageous to a shareholder to make additional investments in a Fund at
the same time he or she is participating in the Withdrawal Plan with
respect to that Fund, purchases by such shareholders of additional shares
in the Fund in amounts less than $5,000 will not ordinarily be permitted.
Shareholders who wish to participate in the Withdrawal Plan and who hold
their shares in certificate form must deposit their share certificates of
the Fund from which withdrawals will be made with TSSG, as agent for With-
drawal Plan members. All dividends and distributions on shares in the
Withdrawal Plan are reinvested automatically at net asset value in addi-
tional shares of the Fund involved. Effective November 7, 1994, Withdrawal
Plans should be set up with a Smith Barney Financial Consultant.
All ap-
plications for participation in the Withdrawal Plan must be received by
TSSG as Plan Agent no later than the eighth day of each month to be eligi-
ble for participation beginning with that month's withdrawal. For addi-
tional information regarding the Withdrawal Plan, contact your Smith Bar-
ney Financial Consultant.
DISTRIBUTOR
Smith Barney serves as the Trust's distributor on a best efforts basis
pursuant to a distribution agreement (the "Distribution Agreement").
When payment is made by the investor before the settlement date, unless
otherwise directed 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 Smith Barney money market fund (other than Smith Barney
Exchange Reserve Fund) of the Smith Barney Mutual Funds. If the investor
instructs Smith Barney to
invest the funds in a Smith Barney money market fund, the amount of
the investment will
be included as part of the average daily net assets of both the relevant
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 man-
aging these assets computed on the basis of their average daily net as-
sets. The Trust's Board of Trustees has been advised of the benefits to
Smith Barney resulting from these settlement procedures and will take such
benefits into consideration when reviewing the Advisory, Administration
and Distribution Agreements for continuance.
DISTRIBUTION ARRANGEMENTS
Shares of the Trust are distributed on a best efforts basis by Smith Bar-
ney as exclusive sales agent of the Trust pursuant to the Distribution
Agreement. To compensate Smith Barney for the services it provides and for
the expense it bears under the Distribution Agreement, the Trust has
adopted a services and distribution plan (the "Plan") pursuant to Rule
12b-1 under the 1940 Act. Under the Plan, each Fund pays Smith Barney a
service fee, accrued daily and paid monthly, calculated at the annual rate
of .25% (.15% in the case of Tax-Exempt Income Fund) 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 Financial Consultants a commission upon sales of those
respective
shares. The Class B and Class C distribution fees, accrued daily and paid
monthly, are calculated at the annual rate of .50% of the value of a
Fund's average daily net assets attributable to the shares of the respec-
tive Class.
During the fiscal years ended July 31, 1992 and 1993, Shearson Lehman
Brothers, the Funds' distributor prior to Smith Barney, received
$35,428,596 and $48,427,224, respectively, in the aggregate from the Trust
under the Plan. For the fiscal year ended July 31, 1994, Smith Barney re-
ceived $61,280,961, in the aggregate from the Trust under the Plan. For
the same period, Smith Barney incurred distribution expenses totaling ap-
proximately $105,372,000, consisting of approximately $732,000 for adver-
tising, $814,000 for printing and mailing of Prospectuses, $44,025,000 for
support services, $45,777,000 to Smith Barney Financial Consultants, and
$14,024,000 in accruals for interest on the excess of Smith Barney ex-
penses incurred in distributing the Trust's shares over the sum of the
distribution fees and CDSC received by Smith Barney from the Trust.
The following expenses were incurred during the periods indicated:
SALES CHARGES (paid to Smith Barney or Shearson Lehman Brothers, its pre-
decessor).
<TABLE>
<CAPTION>
CLASS A
FOR PERIOD
FROM 11/6/92 FISCAL YEAR
NAME OF FUND THROUGH 7/31/93 ENDED 7/31/94
<S> <C> <C>
Premium Total Return $399,065 $546,635
Tax-Exempt Income 103,757 176,786
Convertible 13,105 14,561
High Income 324,552 507,890
Global Bond 12,570 13,847
Diversified Strategic Income 629,705 818,088
Utilities 572,895 364,556
</TABLE>
CDSC (paid to Smith Barney or Shearson Lehman Brothers, its predecessor).
<TABLE>
<CAPTION>
CLASS B
FISCAL YEAR FISCAL YEAR FISCAL
YEAR
NAME OF FUND ENDED 7/31/92 ENDED 7/31/93 ENDED
7/31/94
<S> <C> <C> <C>
Premium Total Return $330,726 $492,148
$2,133,023
Tax-Exempt Income 883,630 713,191
1,570,424
Convertible 126,725 107,519
87,160
High Income 560,013 562,214
743,718
Global Bond 79,361 48,463
109,733
Diversified Strategic Income 2,485,544 4,531,241
5,301,256
Utilities 2,001,692 2,489,562
8,429,876
</TABLE>
SERVICE FEES
<TABLE>
<CAPTION>
CLASS A
FOR PERIOD
FROM 11/6/92 FISCAL YEAR
NAME OF FUND THROUGH 7/31/93 ENDED 7/31/94
<S> <C> <C>
Premium Total Return $32,902 $138,713
Tax-Exempt Income 5,963 26,737
Convertible 1,212 5,556
High Income 401,688 593,011
Global Bond 2,302 10,579
Diversified Strategic Income 38,096 169,673
Utilities 46,507 125,227
</TABLE>
<TABLE>
<CAPTION>
CLASS B
FISCAL YEAR FISCAL YEAR
NAME OF FUND ENDED 7/31/93 ENDED 7/31/94
<S> <C> <C>
Premium Total Return $1,760,462 $3,725,474
Tax-Exempt Income 1,125,371 1,683,930
Convertible 124,907 207,197
High Income 673,903 1,238,239
Global Bond 108,768 183,065
Diversified Strategic Income 2,303,022 6,054,604
Utilities 4,480,226 5,877,824
</TABLE>
<TABLE>
<CAPTION>
CLASS C
(FORMERLY DESIGNATED AS CLASS D)
FOR PERIOD
FROM 11/6/92 FISCAL YEAR
NAME OF FUND THROUGH 7/31/93 ENDED
7/31/94
<S> <C> <C>
Premium Total Return $137 $2,600
Tax-Exempt Income -- --
Convertible -- --
High Income -- --
Global Bond 12 48
Diversified Strategic Income 4 980
Utilities 112 2,828
</TABLE>
DISTRIBUTION FEES
<TABLE>
<CAPTION>
CLASS B
FISCAL YEAR FISCAL YEAR FISCAL
YEAR
NAME OF FUND ENDED 7/31/92 ENDED 7/31/93 ENDED
7/31/94
<S> <C> <C> <C>
Premium Total Return $3,786,350 $4,691,152
$7,450,948
Tax-Exempt Income 5,408,124 5,554,513
5,613,101
Convertible 457,731 365,443
414,394
High Income 1,970,780 1,998,175
2,476,479
Global Bond 376,910 330,220
365,230
Diversified Strategic Income 7,171,314 10,875,236
12,109,208
Utilities 4,556,871 12,484,195
11,755,647
</TABLE>
<TABLE>
<CAPTION>
CLASS C
(FORMERLY DESIGNATED AS CLASS D)
FOR PERIOD
FROM 11/6/92 FISCAL YEAR
NAME OF FUND THROUGH 7/31/93 ENDED
7/31/94
<S> <C> <C>
Premium Total Return $274 $5,199
Tax-Exempt Income -- --
Convertible -- --
High Income -- --
Global Bond 24 96
Diversified Strategic Income 8 1,960
Utilities 225 5,656
</TABLE>
Under its terms, the Plan continues from year to year, provided such con-
tinuance is approved annually by vote of the Trust's Board of Trustees,
including a majority of the Independent Trustees who have no direct or in-
direct financial interest in the operation of the Plan. The Plan may not
be amended to increase the amount to be spent for the services provided by
Smith Barney without shareholder approval, and all amendments of the Plan
also must be approved by the Trustees in the manner described above. The
Plan may be terminated with respect to a Class at any time, without pen-
alty, by vote of a majority of the Independent Trustees or, with respect
to any Fund, 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 Trust's Board of Trustees with periodic reports of
amounts expended under the Plan and the purpose for which such expendi-
tures were made.
VALUATION OF SHARES
Each Class' net asset value per share is calculated on each day, Monday
through Friday, except days on which the NYSE is closed. The NYSE cur-
rently is scheduled to be closed on New Year's Day, President's 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 de-
scription of procedures used by a Fund in valuing its assets.
Because of the need to obtain prices as of the close of trading on various
exchanges throughout the world, the calculation of the net asset value of
Funds investing in foreign securities may not take place contemporaneously
with the determination of the prices of many of their respective portfolio
securities used in such calculation. A security which is listed or traded
on more than one exchange is valued at the quotation on the exchange de-
termined to be the primary market for such security. All assets and lia-
bilities initially expressed in foreign currency values will be converted
into U.S. dollar values at the mean between the bid and offered quotations
of such currencies against U.S. dollars as last quoted by any recognized
dealer. If such quotations are not available, the rate of exchange will be
determined in good faith by the Trust's Board of Trustees. In carrying out
the Board's valuation policies, SBMFM, as administrator, may consult with
an independent pricing service (the "Pricing Service") retained by the
Trust.
Debt securities of United States issuers (other than U.S. government secu-
rities and short-term investments), including Municipal Securities held by
Tax-Exempt Income Fund, are valued by SBMFM, as administrator, after con-
sultation with the Pricing Service approved by the Trust's Board of Trust-
ees. When, in the judgment of the Pricing Service, quoted bid prices for
investments are readily available and are representative of the bid side
of the market, these investments are valued at the mean between the quoted
bid prices and asked prices. Investments for which, in the judgment of the
Pricing Service, there are no readily obtainable market quotations are
carried at fair value as determined by the Pricing Service. The procedures
of the Pricing Service are reviewed periodically by the officers of the
Trust under the general supervision and responsibility of the Board of
Trustees.
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 of 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 ex-
changed 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 ap-
plied.
C. Class B shares of any fund may be exchanged without a sales charge.
Class B shares of a Fund exchanged for Class B shares of another fund will
be subject to the higher applicable CDSC of the two funds and, for pur-
poses of calculating CDSC rates and conversion periods, will be deemed to
have been held since the date the shares being exchanged were deemed to be
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 ac-
count number in order to accomplish an exchange of shares of 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 docu-
ments, shares submitted for exchange are redeemed at the then-current net
asset value and, subject to any applicable CDSC, the proceeds are
immediately
invested, at a price as described above, in shares of the fund being ac-
quired. 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 Trust may quote yield or total return of the Funds
in advertisements or in reports and other communications to shareholders.
The Fund may include comparative performance information in 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, Insti-
tutional 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 Trust describes the expenses
or performance of Class A, Class B, Class C or Class Y, it will also dis-
close such information for the other Classes.
YIELD
Exchange Reserve Fund. The current yield for the Fund is computed by (a)
determining the net change in the value of a hypothetical pre-existing ac-
count in the Fund having a balance of one share at the beginning of a
seven-calendar-day period for which yield is to be quoted, (b) dividing
the net change by the value of the account at the beginning of period to
obtain the base period return and (c) annualizing the results (i.e., mul-
tiplying the base period return by 365/7). The net change in the value of
the account reflects the value of additional shares purchased with divi-
dends declared on the original share and any such additional shares, but
does not include realized gains and losses or unrealized appreciation and
depreciation. In addition, the Fund may calculate a compound effective an-
nualized yield by adding 1 to the base period return (calculated as de-
scribed above), raising the sum to a power equal to 365/7 and subtracting
1.
For the seven-day period ended July 31, 1994, the annualized yield was
3.09%, and the compound effective yield was 3.13%. As of July 31, 1994,
the Fund's average portfolio maturity was 32 days.
Other Funds. The 30-day yield figure of a Fund other than Exchange Re-
serve Fund is calculated according to a formula prescribed by the SEC. The
formula can be expressed as follows:
YIELD =2 [ ( a-bcd +1)6--1]
Where: a = dividends and interest earned during the period.
b = expenses accrued for the period (net of waiver and reimburse-
ment).
c = the average daily number of shares outstanding during the pe-
riod that were entitled to receive dividends.
d = the maximum offering price per share on the last day of the
period.
For the purpose of determining the interest earned (variable "a" in the
formula) on debt obligations that were purchased by a 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 Class A yields for the 30-day period ended July 31, 1994 for the High
Income, Diversified Strategic Income, Global Bond and Utilities Funds were
9.70%, 8.02%, 4.73% and 6.26%, respectively.
The Class B yields for the 30-day period ended July 31, 1994 for the High
Income, Diversified Strategic Income, Global Bond and Utilities Funds were
9.66%, 7.91%, 4.53% and 6.13%, respectively.
The Class C yields for the 30-day period ended July 31, 1994 for the High
Income, Diversified Strategic Income, Global Bond and Utilities Funds were
11.32%, 7.85%, 4.63% and 6.21%, respectively.
The Class A and Class B yield for Tax-Exempt Income Fund for the 30-day
period ended July 31, 1994, was 5.32% and 5.07%, respectively, and the
equivalent taxable yield for that period was 7.39%, and 7.04%, respec-
tively, assuming payment of Federal income taxes at a rate of 28%.
Investors should recognize that, in periods of declining interest rates, a
Fund's yield will tend to be somewhat higher than prevailing market rates,
and in periods of rising interest rates the Fund's yield 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 such Fund's investments, thereby reducing the current yield
of the Fund. In periods of rising interest rates, the opposite can be ex-
pected to occur.
AVERAGE ANNUAL TOTAL RETURN
The "average annual total return" figures for each Fund, other than Ex-
change Reserve Fund, are computed according to a formula prescribed by the
SEC. The formula can be expressed as follows:
P (1+T)n = ERV
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 the 1-, 5- or 10-year period at
the end of the 1-, 5- or 10-year period (or fractional por-
tion thereof), assuming reinvestment of all dividends and
distributions.
The average annual total returns (with fees waived and without sales
charge) of the Fund's Class A shares were as follows for the periods indi-
cated:
Class A Shares:
<TABLE>
<CAPTION>
PER ANNUM FOR
THE PERIOD FROM
ONE YEAR COMMENCEMENT OF
PERIOD ENDED OPERATIONS*
THROUGH
NAME OF FUND 7/31/94 7/31/94
<S> <C> <C>
Premium Total Return 8.65% 11.01%
Tax-Exempt Income 1.14 6.48
Convertible 1.99 8.37
High Income 2.11 10.97
Global Bond (0.67) 3.97
Diversified Strategic Income 1.16 5.97
Utilities (8.99) 3.69
* The Fund commenced selling Class A shares on November 6, 1992.
</TABLE>
The average annual total returns (with fees waived and without CDSC) of
the Fund's Class B shares were as follows for the periods indicated:
Class B Shares:
<TABLE>
<CAPTION>
PER ANNUM PER
ANNUM FOR
FOR THE THE
PERIOD FROM
ONE YEAR FIVE YEAR
COMMENCEMENT OF
PERIOD ENDED PERIOD ENDED OPERATIONS
THROUGH
NAME OF FUND 7/31/94 7/31/94
7/31/94
<S> <C> <C> <C>
Premium Total Return<F1> 8.12% 11.42%
12.49%
Tax-Exempt Income<F1><F6> 0.60 6.86
8.76
Convertible<F2> 1.50 6.82
7.76
High Income<F2><F6> 1.60 8.20
8.49
Global Bond<F3><F6> (1.19) 7.47
8.39
Diversified Strategic Income<F4><F6> 0.66 --
8.92
Utilities<F5> (9.52) 7.63
9.36
<F1> Fund commenced operations on September 16, 1985.
<F2> Fund commenced operations on September 2, 1986.
<F3> Fund commenced operations on October 27, 1986.
<F4> Fund commenced operations on December 28, 1989.
<F5> Fund commenced operations on March 28, 1988.
<F6> Prior to November 6, 1992 the maximum CDSC imposed on redemptions was
5.00%.
</TABLE>
The average annual total returns (with fees waived) of the Fund's Class C
shares were as follows for the periods indicated:
Class C Shares:
<TABLE>
<CAPTION>
PER ANNUM FOR
THE PERIOD FROM
ONE YEAR COMMENCEMENT OF
PERIOD ENDED OPERATIONS THROUGH
NAME OF FUND 7/31/94 7/31/94
<S> <C> <C>
Premium Total Return* 8.12% 9.33%
Tax-Exempt Income -- --
Convertible -- --
High Income -- --
Global Bond* (1.19) 3.29
Diversified Strategic Income** 0.66 2.98
Utilities*** (9.52) (1.49)
* The Fund commenced selling Class C shares (previously designated as
Class D shares) on November 6, 1992.
** The Fund commenced selling Class C shares (previously designated as
Class D shares) on March 19, 1993.
*** The Fund commenced selling Class C shares (previously designated as
Class D shares) on February 4, 1993.
</TABLE>
A Class' total return figures calculated in accordance with the above for-
mula assume that the maximum sales charge or maximum applicable CDSC, as
the case may be, has been deducted for the hypothetical $1,000 initial in-
vestment at the time of purchase.
AGGREGATE TOTAL RETURN
The aggregate total return figures for each Fund, other than Exchange Re-
serve Fund, 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
Where: P = a hypothetical initial payment of $10,000.
ERV = Ending Redeemable Value of a hypothetical $10,000 invest-
ment made at the beginning of the 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 distributions.
The aggregate total returns (with fees waived) of the Class B shares of
the Funds indicated were as follows for the periods indicated:
<TABLE>
<CAPTION>
NO LOAD
LOAD
ONE YEAR FIVE YEAR PERIOD FROM ONE YEAR
FIVE YEAR PERIOD FROM
PERIOD PERIOD COMMENCEMENT PERIOD
PERIOD COMMENCEMENT
ENDED ENDED OF OPERATIONS ENDED
ENDED OF OPERATIONS
JULY 31, JULY 31, THROUGH JULY 31,
JULY 31, THROUGH
NAME OF FUND 1994* 1994* JULY 31, 1994* 1994**
1994** JULY 31, 1994**
<S> <C> <C> <C> <C>
<C> <C>
Premium Total
Return<F1> 8.12% 71.75% 184.18% 3.12%
70.75% 184.18%
Tax-Exempt
Income<F1><F6> 0.60 39.36 110.72 (3.66)
38.36 110.72
Convertible<F2> 1.50 39.07 80.61 (3.35)
38.07 80.61
High Income<F2><F6> 1.60 48.28 90.58 (2.59)
47.45 90.58
Global Bond<F3><F6> (1.19) 43.34 86.85 (5.32)
42.43 86.85
Diversified Strategic
Income<F4><F6> 0.66 -- 48.02 (3.49)
- -- 47.05
Utilities<F5> (9.52) 44.46 76.38 (13.68)
43.47 76.38
* Figures do not include the effect of the maximum sales charge or maxi-
mum applicable CDSC. If they had been included, it would have the ef-
fect of lowering the returns shown.
** Figures include the effect of the maximum sales charge or maximum ap-
plicable CDSC.
<F1> Fund commenced operations on September 16, 1985.
<F2> Fund commenced operations on September 2, 1986.
<F3> Fund commenced operations on October 27, 1986.
<F4> Fund commenced operations on December 28, 1989.
<F5> Fund commenced operations on March 28, 1988.
<F6> Prior to November 6, 1992 the maximum CDSC imposed on redemptions was
5%.
</TABLE>
The aggregate total returns (with fees waived) of the Class A and Class C
shares of the Funds indicated were as follows for the periods indicated:
<TABLE>
<CAPTION>
NO LOAD LOAD NO LOAD
LOAD
PERIOD FROM
PERIOD FROM
ONE YEAR ONE YEAR NOVEMBER 6,
1992 NOVEMBER 6, 1992
PERIOD ENDED PERIOD ENDED THROUGH
THROUGH
NAME OF FUND JULY 31, 1994* JULY 31, 1994** JULY 31, 1994*
JULY 31, 1994**
<S> <C> <C> <C>
<C>
Premium Total Return
Class A 8.65% 3.22% 19.85%
13.86%
Class C 8.12 7.12 10.94
10.94
Tax-Exempt Income
Class A 1.14 (2.91) 11.49
7.03
Class C -- -- --
- --
Convertible
Class A 1.99 (3.11) 14.87
9.13
Class C -- -- --
- --
High Income
Class A 2.11 (2.48) 19.77
14.38
Class C -- -- --
- --
Global Bond
Class A (0.67) (5.14) 6.98%
2.17%
Class C (1.19) (2.10) 4.93
4.93
Diversified Strategic
Income
Class A 1.16 (3.39) 10.57
5.60
Class C+ 0.66 (0.27) 4.09
4.09
Utilities
Class A 8.99 (13.54) 6.48
1.16
Class C++ (9.52) (10.35) (2.21)
(2.21)
* Figures do not include the effect of the maximum sales charge or maxi-
mum applicable CDSC.
** Figures include the effect of the maximum sales charge or maximum ap-
plicable CDSC.
+ The Fund commenced selling Class C shares (previously designated as
Class D shares) on March 19, 1993.
++ The Fund commenced selling Class C shares (previously designated as
Class D shares) on February 4, 1993.
</TABLE>
It is important to note that the yield and total return figures set forth
above are based on historical earnings and are not intended to indicate
future performance.
A Class' performance will vary from time to time depending upon market
conditions, the composition of the relevant Fund's portfolio and operating
expenses and the expenses exclusively attributable to that Class. Conse-
quently, any given performance quotation should not be considered repre-
sentative of the Class' performance for any specified period in the fu-
ture. Because performance will vary, it may not provide a basis for com-
paring 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
company's portfolio securities.
TAXES
The following is a summary of certain Federal income tax
considerations
that may affect the Trust and its shareholders. This summary is
not in-
tended 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 any Fund of the Trust.
TAX STATUS OF THE FUNDS
Each Fund will be treated as a separate taxable entity for Federal income
tax purposes.
Each Fund has qualified and the Trust intends that each Fund continue to
qualify separately each year as a "regulated investment company" under the
Code. A qualified Fund will not be liable for Federal income taxes to the
extent its taxable net investment income and net realized capital gains
are distributed to its shareholders, provided that each Fund distributes
at least 90% of its net investment income. One of the several requirements
for qualification is that a Fund receive at least 90% of its gross income
each year from dividends, interest, payments with respect to securities
loans and gains from the sale or other disposition of equity or debt secu-
rities or foreign currencies, or other income (including but not limited
to gains from options, futures, or forward contracts) derived with respect
to the Fund's investment in such stock, securities, or currencies. The
Trust does not expect any Fund to have difficulty meeting this test.
To qualify as a regulated investment company, a Fund also must earn less
than 30% of its gross income from the disposition of securities held for
less than three months. The 30% test will limit the extent to which a Fund
may sell securities held for less than three months; effect short sales of
securities held for less than three months; write options which expire in
less than three months; and effect closing transactions with respect to
call or put options that have been written or purchased within the preced-
ing three months. (If a Fund purchases a put option for the purpose of
hedging an underlying portfolio security, the acquisition of the option is
treated as a short sale of the underlying security unless the option and
the security are acquired on the same date.) Finally, as discussed below,
this requirement also may limit investments by certain Funds in options on
stock indexes, options on nonconvertible debt securities, futures con-
tracts and options on futures contracts, and foreign currencies (or op-
tions, futures or forward contracts on foreign currencies) but only to the
extent that such foreign currencies are not directly related to the
Trust's principal business of investing in securities.
TAXATION OF INVESTMENT BY THE FUNDS
Gains or losses on sales of securities by a Fund generally will be long-
term capital gains or losses if the Fund has held the securities for more
than one year. Gains or losses on sales of securities held for not more
than one year generally will be short-term. If a Fund acquires a debt se-
curity at a substantial discount, a portion of any gain upon sale or re-
demption will be taxed as ordinary income, rather than capital gain, to
the extent that it reflects accrued market discount.
Options and Futures Transactions. The tax consequences of options trans-
actions entered into by a Fund will vary depending on the nature of the
underlying security, whether the option is written or purchased, and
whether the "straddle" rules, discussed separately below, apply to the
transaction. When a Fund writes a call or put option on an equity or con-
vertible debt security, it will receive a premium that will, subject to
the straddle rules, be treated as follows for tax purposes. If the option
expires unexercised, or if the Fund enters into a closing purchase trans-
action, the Fund will realize a gain (or loss if the cost of the closing
purchase transaction exceeds the amount of the premium) without regard to
any unrealized gain or loss on the underlying security. Any such gain or
loss will be a short-term capital gain or loss, except that any loss on a
"qualified" covered call stock option that is not treated as a part of a
straddle may be treated as long-term capital loss. If a call option writ-
ten by a Fund is exercised, the Fund will recognize a capital gain or loss
from the sale of the underlying security, and will treat the premium as
additional sales proceeds. Whether the gain or loss will be long-term or
short-term will depend on the holding period of the underlying security.
If a put option written by a Fund is exercised, the amount of the premium
will reduce the tax basis of the security that the Fund then purchases.
If a put or call option that a Fund has purchased on an equity or convert-
ible debt security expires unexercised, the Fund will realize capital loss
equal to the cost of the option. If the Fund enters into a closing sale
transaction with respect to the option, it will realize a capital gain or
loss (depending on whether the proceeds from the closing transaction are
greater or less than the cost of the option). The gain or loss will be
short-term or long-term, depending on the Fund's holding period in the op-
tion. If the Fund exercises such a put option, it will realize a short-
term capital gain or loss (long-term if the Fund holds the underlying se-
curity for more than one year before it purchases the put) from the sale
of the underlying security measured by the sales proceeds decreased by the
premium paid. If the Fund exercises such a call option, the premium paid
for the option will be added to the tax basis of the security purchased.
One or more Funds may invest in section 1256 contracts, and the Code im-
poses a special "mark-to-market" system for taxing these contracts. These
contracts generally include options on nonconvertible debt securities (in-
cluding United States government securities), options on stock indexes,
futures contracts, options on futures contracts and certain foreign cur-
rency contracts. Options on foreign currency, futures contracts on foreign
currency and options on foreign currency futures will qualify as "section
1256" contracts if the options or futures are traded on or subject to the
rules of a qualified board or exchange. Generally, most of the foreign
currency options and foreign currency futures and related options in which
certain Funds may invest will qualify as section 1256 contracts. In gen-
eral, gain or loss on section 1256 contracts will be taken into account
for tax purposes when actually realized (by a closing transaction, by ex-
ercise, by taking delivery or by other termination). In addition, any sec-
tion 1256 contracts held at the end of a taxable year will be treated as
sold at their year-end fair market value (that is, marked to the market),
and the resulting gain or loss will be recognized for tax purposes. Pro-
vided that section 1256 contracts are held as capital assets and are not
part of a straddle, both the realized and the unrealized year-end gain or
loss from these investment positions (including premiums on options that
expire unexercised) will be treated as 60% long-term and 40% short-term
capital gain or loss, regardless of the period of time particular posi-
tions actually are held by a Fund.
A portion of the mark-to-market gain on instruments held for less than
three months at the close of a Fund's taxable year may represent a gain on
securities held for less than three months for purposes of the 30% test
discussed above. Accordingly, a Fund may have to restrict its fourth-
quarter transactions in section 1256 contracts.
Straddles. While the mark-to-market system is limited to section 1256
contracts, the Code contains other rules applicable to transactions which
create positions which offset positions in section 1256 or other invest-
ment contracts. Those rules, applicable to "straddle" transactions, are
intended to eliminate any special tax advantages for such transactions.
"Straddles" are defined to include "offsetting positions" in actively-
traded personal property. Under current law, it is not clear under what
circumstances one investment made by a Fund, such as an option or futures
contract, would be treated as "offsetting" another investment also held by
the Fund, such as the underlying security (or vice versa) and, therefore,
whether the Fund would be treated as having entered into a straddle. In
general, investment positions may be "offsetting" if there is a substan-
tial diminution in the risk of loss from holding one position by reason of
holding one or more other positions (although certain "qualified" covered
call stock options written by a Fund may be treated as not creating a
straddle). Also, the forward currency contracts entered into by a Fund may
result in the creation of "straddles" for Federal income tax purposes.
If two (or more) positions constitute a straddle, a realized loss from one
position (including a mark-to-market loss) must be deferred to the extent
of unrecognized gain in an offsetting position. Also, the holding period
rules described above may be modified to recharacterize long-term gain as
short-term gain, or to recharacterize short-term loss as long-term loss,
in connection with certain straddle transactions. Furthermore, interest
and other carrying charges allocable to personal property that is part of
a straddle must be capitalized. In addition, "wash sale" rules apply to
straddle transactions to prevent the recognition of loss from the sale of
a position at a loss where a new offsetting position is or has been ac-
quired within a prescribed period. To the extent that the straddle rules
apply to positions established by a Fund, losses realized by the Fund may
be either deferred or recharacterized as long-term losses, and long-term
gains realized by the Fund may be converted to short-term gains.
If a Fund chooses to identify particular offsetting positions as being
components of a straddle, a realized loss will be recognized, but only
upon the liquidation of all of the components of the identified straddle.
Special rules apply to the treatment of "mixed" straddles (that is, strad-
dles consisting of a section 1256 contract and an offsetting position that
is not a section 1256 contract). If a Fund makes certain elections, the
section 1256 contract components of such straddles will not be subject to
the "60%/40%" mark-to-market rules. If any such election is made, the
amount, the nature (as long-or short-term) and the timing of the recogni-
tion of the Fund's gains or losses from the affected straddle positions
will be determined under rules that will vary according to the type of
election made.
Section 988. Foreign currency gain or loss from transactions in (a) bank
forward contracts not traded in the interbank market and (b) futures con-
tracts traded on a foreign exchange may be treated as ordinary income or
loss under Code section 988. A Fund may elect to have section 988 apply to
section 1256 contracts. Pursuant to that election, foreign currency gain
or loss from these transactions would be treated entirely as ordinary in-
come or loss when realized. A Fund will make the election necessary to
gain such treatment if the election is otherwise in the best interests of
the Fund.
TAXATION OF THE TRUST'S SHAREHOLDERS
Dividends paid by a Fund from investment income and distributions of
short-term capital gains will be taxable to shareholders as ordinary in-
come for Federal income tax purposes, whether received in cash or rein-
vested in additional shares. Distributions of long-term capital gains will
be taxable to shareholders as long-term capital gain, whether paid in cash
or reinvested in additional shares, and regardless of the length of time
that the shareholder has held his or her shares of the Fund.
Dividends of investment income (but not capital gains) from any Fund gen-
erally will qualify for the Federal dividends-received deduction for do-
mestic corporate shareholders to the extent that such dividends do not ex-
ceed the aggregate amount of dividends received by the Fund from domestic
corporations. If securities held by a Fund are considered to be "debt-
financed" (generally, acquired with borrowed funds), are held by the Fund
for less than 46 days (91 days in the case of certain preferred stock), or
are subject to certain forms of hedges or short sales, the portion of the
dividends paid by the Fund which corresponds to the dividends paid with
respect to such securities will not be eligible for the corporate
dividends-received deduction.
If a shareholder (a) incurs a sales charge in acquiring or redeeming Fund
shares and (b) disposes of those shares and acquires within 90 days after
the original acquisition, or (c) acquires within 90 days of the redemp-
tion, shares in a mutual fund for which the otherwise applicable sales
charge is reduced by reason of a reinvestment right (i.e., exchange privi-
lege), the original sales charge increases the shareholder's tax basis in
the original shares only to the extent the otherwise applicable sales
charge for the second acquisition is not reduced. The portion of the orig-
inal sales charge that does not increase the shareholder's tax basis in
the original shares would be treated as incurred with respect to the sec-
ond acquisition and, as a general rule, would 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 share-
holder from immediately deducting the sales charge by shifting his or her
investment in a family of mutual funds.
Capital Gains Distribution. As a general rule, a shareholder who redeems
or exchanges his or her shares will recognize long-term capital gain or
loss if the shares have been held for more than one year, and will recog-
nize short-term capital gain or loss if the shares have been held for one
year or less. However, if a shareholder receives a distribution taxable as
long-term capital gain with respect to shares of a Fund and redeems or ex-
changes the shares before he or she has held them for more than six
months, any loss on such redemption or exchange that is less than or equal
to the amount of the distribution will be treated as a long-term capital
loss.
Backup Withholding. If a shareholder fails to furnish a correct taxpayer
identification number, fails to fully report dividend or interest income,
or fails to certify that he or she has provided a correct taxpayer identi-
fication number and that he or she is not subject to such withholding,
then the shareholder may be subject to a 31% "backup withholding tax" with
respect to (a) any taxable dividends and distributions and (b) any pro-
ceeds of any redemption of Trust shares. An individual's taxpayer identi-
fication number is his or her social security number. The backup withhold-
ing tax is not an additional tax and may be credited against a sharehold-
er's regular Federal income tax liability.
Tax-Exempt Income Fund Because Tax-Exempt Income Fund will distribute
exempt-interest dividends, interest on indebtedness incurred by sharehold-
ers, directly or indirectly, to purchase or carry shares of the Fund will
not be deductible for Federal income tax purposes. If a shareholder re-
deems or exchanges shares of the Fund with respect to which he receives an
exempt-interest dividend before holding the shares for more than six
months, no loss will be allowed on the redemption or exchange to the ex-
tent of the dividend received. Also, that portion of any dividend from the
Fund which represents income from private activity bonds other than those
issued for charitable, educational and certain other purposes held by the
Fund may not retain its tax-exempt status in the hands of a shareholder
who is a "substantial user" of a facility financed by such bonds or a per-
son "related" to a substantial user. Investors should consult their own
tax advisors to see whether they may be substantial users or related per-
sons with respect to a facility financed by bonds in which the Fund may
invest. Moreover, investors receiving social security or certain other re-
tirement benefits should be aware that tax-exempt interest received from
the Fund may under certain circumstances cause up to one-half of such re-
tirement benefits to be subject to tax. If the Fund receives taxable in-
vestment income, it will designate as taxable the same percentage of each
dividend as the actual taxable income bears to the total investment income
earned during the period for which the dividend is paid. The percentage of
each dividend designated as taxable, if any, may, therefore, vary. Divi-
dends derived from interest from Municipal Securities which are exempt
from Federal tax also may be exempt from personal income taxes in the
state where the issuer is located, but in most cases will not be exempt
under the tax laws of other states or local authorities. Annual statements
will set forth the amount of interest from Municipal Securities earned by
the Fund in each state or possession in which issuers of portfolio securi-
ties are located.
ADDITIONAL INFORMATION
The Trust was organized as an unincorporated business trust under the laws
of the Commonwealth of Massachusetts pursuant to a Master Trust Agreement
dated March 12, 1985, as amended from time to time, and on November 5,
1992 the Trust filed an Amended and Restated Master Trust Agreement (the
"Trust Agreement"). The Trust commenced business as an investment company
on September 16, 1985, under the name Shearson Lehman Special Portfolios.
On February 21, 1986, December 6, 1988, August 27, 1990, November 5, 1992,
July 30, 1993 and October 14, 1994, the Trust changed its name to Shearson
Lehman Special Income Portfolios, SLH Income Portfolios, Shearson Lehman
Brothers Income Portfolios, Shearson Lehman Brothers Income Funds, Smith
Barney Shearson Income Funds and Smith Barney Income Funds, 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 Trust. Under its custodian agreement with the Trust, Boston Safe is
authorized to establish separate accounts for foreign securities owned by
the Trust to be held with foreign branches of other U.S. banks as well as
with certain foreign banks and securities depositaries. For its custody
services to the Trust, Boston Safe receives monthly fees based upon the
month-end aggregate net asset value of the Trust, plus certain charges for
securities transactions including out-of-pocket expenses, and costs of any
foreign and domestic sub-custodians. The assets of the Trust are held
under bank custodianship in compliance with the 1940 Act.
TSSG is located at Exchange Place, Boston, Massachusetts 02109, and serves
as the Trust's transfer agent. Under the transfer agency agreement, TSSG
maintains the shareholder account records for the Trust, handles certain
communications between shareholders and the Trust and distributes divi-
dends and distributions payable by each Fund. For these services TSSG re-
ceives from each Fund a monthly fee computed on the basis of the number of
shareholder accounts maintained during the year for each Fund and is reim-
bursed for certain out-of-pocket expenses.
FINANCIAL STATEMENTS
The Funds' Annual Reports for the fiscal year ended July 31, 1994, accom-
pany this Statement of Additional Information and are incorporated herein
by reference in their entirety.
APPENDIX
Description of Ratings
DESCRIPTION OF S&P CORPORATE BOND RATINGS
AAA
Bonds rated AAA have the highest rating assigned by S&P to a debt obliga-
tion. Capacity to pay interest and repay principal is extremely strong.
AA
Bonds rated AA have a very strong capacity to pay interest and repay prin-
cipal and differ from the highest rated issues only in small degree.
A
Bonds rated A have a strong capacity to pay interest and repay principal
although they are somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than bonds in higher
rated categories.
BBB
Bonds rated BBB are regarded as having an adequate capacity to pay inter-
est and repay principal. Whereas they normally exhibit adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal
for bonds in this category than for bonds in higher rated categories.
BB, B AND CCC
Bonds rated BB and B are regarded, on balance, as predominantly specula-
tive with respect to capacity to pay interest and repay principal in ac-
cordance with the terms of the obligation. BB represents a lower degree of
speculation than B and CCC, the highest degrees 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.
DESCRIPTION OF MOODY'S CORPORATE BOND RATINGS
Aaa
Bonds which are rated Aaa are judged to be 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 exceptionally
stable margin and principal is secure. While the various protective ele-
ments are likely to change, such changes as can be visualized are most un-
likely to impair the fundamentally strong position of such issues.
Aa
Bonds which are rated Aa are judged to be of high quality by all stan-
dards. Together with the Aaa group they comprise what are generally known
as high grade bonds. They are rated lower than the best bonds because mar-
gins of protection may not be as large as in Aaa securities, or fluctua-
tion 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 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 fu-
ture.
Baa
Bonds which are rated Baa are considered as medium grade obligations,
i.e., they are neither highly protected nor poorly secured. Interest pay-
ments 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 in-
terest and principal payments may be very moderate and thereby not well
safeguarded during both good and bad times over the future. Uncertainty of
position characterizes bonds in this class.
B
Bonds which are rated B generally lack characteristics of desirable in-
vestments. 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 de-
fault or present elements of danger may exist with respect to principal or
interest.
Moody's applies the numerical modifier 1, 2 and 3 to each generic rating
classification from Aa through B. The modifier 1 indicates that the secu-
rity 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.
DESCRIPTION OF S&P MUNICIPAL BOND RATINGS
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. Qual-
ity of management appears superior.
Revenue Bonds -- Debt service coverage has been, and is expected to re-
main, 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 cov-
enant, earnings test for issuance of additional bonds, debt service re-
serve requirements) are rigorous. There is evidence of superior manage-
ment.
AA
High Grade -- The investment characteristics of 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 although the bonds are somewhat more susceptible to
the adverse affects of changes in circumstances and economic conditions
than bonds in higher rated categories. This rating describes the third
strongest capacity for payment of debt service. Regarding municipal bonds,
the ratings differ 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 expen-
ditures, or in quality of management. Under certain adverse 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. Sta-
bility of the pledged revenues could show some variations because of in-
creased 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. Bonds
in this group are regarded as having an adequate capacity to pay interest
and repay principal. Whereas they normally exhibit adequate protection pa-
rameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal
for bonds in this category than for bonds in higher rated categories.
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 funda-
mental weakness, whereas the former shows only one deficiency among the
factors considered.
Revenue Bonds -- Debt coverage is only fair. Stability of the pledged rev-
enues 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 includes the lowest de-
gree 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 cat-
egories, except in the AAA-Prime Grade category.
DESCRIPTION OF S&P MUNICIPAL NOTE RATINGS
Municipal notes with maturities of three years or less are usually given
note ratings (designated SP-1, -2 or -3) 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 de-
termined to possess overwhelming safety characteristics are given the des-
ignation of SP-1+. Notes rated SP-2 have satisfactory capacity to pay
principal and interest.
DESCRIPTION OF MOODY'S MUNICIPAL BOND RATINGS
Aaa
Bonds which are rated Aaa are judged to be 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 excep-
tionally stable margin and principal is secure. While the various protec-
tive elements are likely to change, 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 stan-
dards. Together with the Aaa group they comprise what are generally known
as high grade bonds. They are rated lower than the best bonds because mar-
gins of protection may not be as large as in Aaa securities, or fluctua-
tion 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 se-
curity 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 pay-
ments 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 in-
terest and principal payments may be very moderate and thereby not well
safeguarded during both good and bad times over the future. Uncertainty of
position characterize 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 which are rated Caa are of poor standing. Such issues may be in de-
fault or there may be present elements of danger with respect to principal
or interest.
Ca
Bonds which are rated Ca represent obligations which are speculative in a
high degree. Such issues are often in default or have other marked short-
comings.
C
Bonds which 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.
Moody's applies the numerical modifiers 1, 2 and 3 in each generic rating
classification from Aa through B. The modifier 1 indicates that the secu-
rity ranks in the higher end of its generic ratings 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 ratings category.
DESCRIPTION OF MOODY'S MUNICIPAL NOTE RATINGS
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 recognizes the differences between short- and long-term credit
risk. Loans bearing the designation MIG 1/VMIG 1 are the best quality, en-
joying strong protection from established cash flows of funds for their
servicing or from established and broad-based access to the market for re-
financing, or both. Loans bearing the designation MIG 2/VMIG 2 are of high
quality, with margins of protection ample, although not as large as the
preceding group. Loans bearing the designation MIG 3/VMIG 3 are of favor-
able quality, with all security elements accounted for but lacking the un-
deniable strength of the preceding grades. Market access for refinancing,
in particular, is likely to be less well established. Loans bearing the
designation MIG 4/VMIG 4 are of adequate quality. Protection commonly re-
garded as required of an investment security is present and although not
distinctly or predominantly speculative, there is specific risk.
DESCRIPTION OF COMMERCIAL PAPER RATINGS
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 strength combined with strong liquidity char-
acteristics (typically, such issuers or guarantors would display credit
quality characteristics which would warrant a senior bond rating of A- or
higher) or the direct credit support of an issuer or guarantor that pos-
sesses above average long-term fundamental operating and financing capa-
bilities combined with ongoing excellent liquidity characteristics. Paper
rated A-1 must have 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 bor-
rowing; 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.
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) eco-
nomic 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 cus-
tomer 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 parent company and the relationships which exist with the issue; 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.
Short-term obligations, including commercial paper, rated A-1+ by IBCA
Limited or its affiliate IBCA Inc. are obligations supported by the high-
est capacity for timely repayment. Obligations rated A-1 have a very
strong capacity for timely repayment. Obligations rated A-2 have a strong
capacity for timely repayment, although such capacity may be susceptible
to adverse changes in business, economic and financial conditions.
Thomson BankWatch employs the rating "TBW-1" as its highest category,
which indicates that the degree of safety regarding timely repayment of
principal and interest is very strong. "TBW-2" is its second highest rat-
ing category. While the degree of safety regarding timely repayment of
principal and interest is strong, the relative degree of safety is not as
high as for issues rated "TBW-1."
Fitch Investors Services, Inc. employs the rating F-1+ to indicate issues
regarded as having the strongest degree of assurance of timely payment.
The rating F-1 reflects an assurance of timely payment only slightly less
in degree than issues rated F-1+, while the rating F-2 indicated a satis-
factory degree of assurance of timely payment although the margin of
safety is not as great as indicated by the F-1+ and F-1 categories.
Duff & Phelps Inc. employs the designation of Duff 1 with respect to top
grade commercial paper and bank money instruments. Duff 1+ indicated the
highest certainty of timely payment: short-term liquidity is clearly out-
standing and safety is just below risk-free U.S. Treasury short-term obli-
gations. Duff 1- indicates high certainty of timely payment. Duff 2 indi-
cates good certainty of timely payment: liquidity factors and company fun-
damentals are sound.
Various NRSROs utilize rankings within ratings categories indicated by a +
or -. The Funds, in accordance with industry practice, recognize such rat-
ings within categories as gradations, viewing for example S&P's rating of
A-1+ and A-1 as being in S&P's highest rating category.
SMITH BARNEY
INCOME FUNDS
388 Greenwich Street
New York, New York 10013
Smith Barney
INCOME FUNDS
PREMIUM TOTAL RETURN FUND
CONVERTIBLE FUND
GLOBAL BOND FUND
HIGH INCOME FUND
DIVERSIFIED STRATEGIC INCOME FUND
TAX-EXEMPT INCOME FUND
UTILITIES FUND
EXCHANGE RESERVE FUND
STATEMENT OF
ADDITIONAL INFORMATION
NOVEMBER 7, 1994
