Smith Barney
INCOME FUNDS
388 Greenwich Street
New York, New York 10013
(800) 451-2010
Statement of Additional Information
November 27, 1998, amended as of December 4, 1998
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 seven investment
funds offered by the Trust: Smith Barney Balanced Fund (the "Balanced
Fund") (formerly Smith Barney Utilities Fund), Smith Barney Convertible
Fund (the "Convertible Fund"), Smith Barney Diversified Strategic Income
Fund (the "Diversified Strategic Income Fund"), Smith Barney Exchange
Reserve Fund (the "Exchange Reserve Fund"), Smith Barney High Income
Fund (the "High Income Fund"), Smith Barney Municipal High Income Fund
(the "Municipal High Income Fund") and Smith Barney Total Return Bond
Fund ("Total Return Bond Fund"), each a "Fund" and together the "Funds,"
each dated November 27, 1998, (except for Premium Total Return Fund
which is dated April 29, 1998) as amended or supplemented from time to
time (the "Prospectuses"), and should be read in conjunction with the
Prospectuses. The Prospectuses may be obtained from any Salomon Smith
Barney Financial Consultant or by writing or calling the Trust at the
address or telephone number set forth above. This Statement of
Additional Information, although not in itself a prospectus, is
incorporated by reference into the Prospectuses in its entirety.
CONTENTS
For ease of reference, the same section headings are used in both
the Prospectuses and this Statement of Additional Information, except
where shown below:
Management of the Trust and the Funds 2
Investment Objectives and Management Policies. 7
Purchase of Shares 27
Redemption of Shares 28
Distributor.. 28
Valuation of Shares 31
Exchange Privilege 31
Performance Data (See in the Prospectuses "Performance" or "Yield
Information") 32
Taxes (See in the Prospectuses "Dividends, Distributions and Taxes") 37
Additional Information 41
Voting Rights 42
Financial Statements 47
Appendix A-1
MANAGEMENT OF THE TRUST AND THE FUNDS
The executive officers of the Trust are employees of certain of the
organizations that provide services to the Trust. These organizations
are the following:
Name
Service
CFBDS, Inc. ("CFBDS")
Distributor
Mutual Management Corp. ("MMC"),
(formerly known as Smith Barney
Mutual Funds Management Inc.)
Investment Adviser and Administrator
to the Convertible Fund, Diversified
Strategic Income Fund, Exchange
Reserve Fund, High Income Fund,
Municipal High Income Fund, Total
Return Bond Fund and Balanced Fund.
Smith Barney Global Capital
Management Inc. ("Global Capital
Management")
Sub-Investment Adviser to Diversified
Strategic Income Fund
PNC Bank, National Association
("PNC Bank")
Custodian to Convertible Fund,
Exchange Reserve Fund, High Income
Fund, Municipal High Income Fund,
Total Return Bond Fund and Balanced
Fund
Chase Manhattan Bank ("Chase")
Custodian to Diversified Strategic
Income Fund
First Data Investors Services
Group, Inc. ("First Data")
Transfer Agent
These organizations and the functions they perform for the Trust
are discussed in the Prospectuses and in this Statement of Additional
Information.
Trustees and Executive Officers of the Trust
The Trustees and executive officers of the Trust, together with
information 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 (Age 71). Retired; formerly Chairman and Chief
Executive Officer of Associated Merchandising Corporation, a major
retail merchandising and sourcing organization. His address is 106
Barnes Road, Stamford, Connecticut 06902.
Allan J. Bloostein, Trustee (Age 68). 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 27 West 67th Street, New York, New York 10023.
Richard E. Hanson, Jr., Trustee (Age 57). Head of School, The New
Atlanta Jewish Community High School, Atlanta Georgia; 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 58 Ivy Chase, Atlanta, GA 30342.
*Heath B. McLendon, Chairman of the Board and Investment Officer (Age
65). Managing Director of Salomon Smith Barney Inc. ("Salomon Smith
Barney") and Chairman of the Board of Smith Barney Strategy Advisers
Inc.; and President of MMC and Travelers Investment Adviser, Inc.
("TIA"). Mr. McLendon is Chairman or Co-Chairman of the Board and
Director of 58 investment companies associated with Salomon Smith Barney
Holdings Inc. His address is 388 Greenwich Street, New York, New York
10013.
John C. Bianchi, Vice President and Investment Officer (Age 43).
Managing Director of Salomon Smith Barney; Investment Officer of other
Smith Barney Mutual Funds. His address is 388 Greenwich Street, New
York, New York 10013.
James E. Conroy, Vice President and Investment Officer (Age 47).
Managing Director of Salomon Smith Barney. Investment Officer of other
Smith Barney Mutual Funds. His address is 388 Greenwich Street, New
York, New York 10013.
Joseph P. Deane, Vice President and Investment Officer (Age 51).
Managing Director of Salomon Smith Barney; Investment Officer of other
Smith Barney Mutual Funds. His address is 388 Greenwich Street, New
York, New York 10013.
Simon R. Hildreth, Vice President and Investment Officer (Age 46).
Managing Director of Salomon Smith Barney, member of the Investment
Policy of Smith Barney Global Capital Management Inc.; Mr. Hildreth is
Vice President and Investment Officer of other Smith Barney Mutual
Funds. Prior to 1994, a Director of Mercury Asset Management Ltd., a
fund manager located in the United Kingdom. His address is 10
Piccadilly, London, WIV 9LA, UK.
Charles P. Graves, III, Vice President and Investment Officer (Age 36).
Managing Director of Salomon Smith Barney. His address is 388 Greenwich
Street, New York, New York 10013.
Lawrence T. McDermott, Vice President and Investment Officer (Age 50).
Managing Director of Salomon Smith Barney. Investment Officer of other
Smith Barney Mutual Funds. His address is 388 Greenwich Street, New
York, New York 10013.
Robert E. Swab, Investment Officer (Age 43). Vice President of Salomon
Smith Barney. His address is 388 Greenwich Street, New York, New York
10013.
Phyllis M. Zahorodny, Vice President and Investment Officer (Age 40).
Managing Director of Salomon Smith Barney. Investment Officer of other
Smith Barney Mutual Funds.Her address is 388 Greenwich Street, New York,
New York 10013.
Lewis E. Daidone, Senior Vice President and Treasurer (Age 41).
Managing Director of Salomon Smith Barney; Director and Senior Vice
President of MMC and TIA. Mr. Daidone serves as Senior Vice President
and Treasurer or Executive Vice President and Treasurer of other
investment companies associated with Salomon Smith Barney. His address
is 388 Greenwich Street, New York, New York 10013.
Christina T. Sydor, Secretary (Age 47). Managing Director of Salomon
Smith Barney; General Counsel and Secretary of MMC and TIA. Ms. Sydor
serves as Secretary or Executive Vice President and General Counsel of
other investment companies associated with Salomon Smith Barney. 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 Smith Barney Mutual Funds. Global Capital
Management and MMC 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 November 6, 1998, 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 Salomon Smith Barney or any
Salomon Smith Barney parent or subsidiary receives any compensation from
the Trust for serving as an officer or Trustee of the Trust. The Trust
pays each Trustee who is not an officer, director or employee of Salomon
Smith Barney or any of its affiliates a fee of $17,000 per year plus
$3,250 per meeting attended, and reimburses them for travel and out-of-
pocket expenses. For the fiscal year ended July 31, 1998, such travel
and out-of-pocket expenses totaled $5,368.
For the fiscal year ended July 31, 1998 and the calendar year
ended December 31, 1997, the Trustees of the Trust were paid the
following compensation:
Trustee(*)
Aggregate
Compensation
from the Funds
for the Fiscal
Year ended
July 31, 1998
Total
Pension or
Retirement
Benefits
Accrued
from the
Funds
Aggregate
Compensation
from the Funds
and the Fund
Complex for the
Year ended
December 31,
1997
Number of
Funds for
Which Person
Served
Within Fund
Complex
Lee Abraham
$37,810
$0
$38,650
2
Allan J.
Bloostein
38,070
0
85,850
8
Richard E.
Hanson, Jr.
38,170
0
47,350
2
Heath B.
McLendon
0
0
0
58
Investment Advisers, Sub-Investment Advisers and Administrator
MMC serves as investment adviser ("Investment Adviser") to one or more
Funds pursuant to a separate written agreement with the relevant Fund
(an "Advisory Agreement"). MMC is a wholly owned subsidiary of Salomon
Salomon Smith Barney Holdings Inc. ("Holdings"). Holdings is a wholly
owned subsidiary of Citigroup Inc. ("Citigroup") 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 August 5 1998.
MMC also serves as administrator (the "Administrator") to each Fund
pursuant to a separate written agreement dated May 4, 1994 (the
"Administration Agreement") which was most recently approved by the
Board on August 5, 1998. Global Capital Management serves as a sub-
investment adviser ("Sub-Investment Adviser") to Diversified Strategic
Income Fund, pursuant to a written agreement dated March 21, 1994,
respectively. Both agreements were most recently approved by the Fund's
Board of Trustees, including a majority of the Independent Trustees, on
August 5, 1998.
Certain of the services provided to the Trust by the Investment
Advisers and the Sub-Investment Advisers are described in the
Prospectuses under "Management of the Trust and the Fund." Each
Investment Adviser, Sub-Investment Adviser, and the Administrator pays
the salaries of all officers and employees who are employed by both it
and the Trust, and maintains office facilities for the Trust. In
addition to those services, MMC 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 Investment Advisers and Sub-Investment Advisers bear
all expenses in connection with the performance of their services.
As compensation for investment advisory services, each Fund pays
its Investment Adviser a fee computed daily and paid monthly at the
following annual rates:
Fund
Investment Advisory
Fee As a Percentage
of Average Net
Assets
Convertible Fund
0.50%
Diversified Strategic Income Fund
0.45%
Exchange Reserve Fund
0.30%
High Income Fund
0.50%
Municipal High Income Fund
0.40%
Total Return Bond Fund
0.65%
Balanced Fund
0.45%
For the periods below, the Funds paid investment advisory fees to
their respective Investment Advisers as follows:
For the Fiscal Year Ended July 31:
Fund
1996
1997
1998
Convertible Fund
$417,942
$489,663
$665,663
Diversified Strategic
Income Fund
11,818,108
12,546,980
13,233,258
Exchange Reserve Fund
448,925
442,557
326,309
High Income Fund
4,506,352
5,646,405
7,363,535
Municipal High Income
Fund
3,771,279
3,395,338
3,103,442
Total Return Bond Fund(1)
N/A
N/A
378,792
Balanced Fund
8,094,511
6,431,624
5,097,517
____________________________
(1) Total Return Bond Fund waived $124,974 in management fees for the
fiscal year ended July 31, 1998. The administrative fees have
been included in the total for management fees.
As compensation for administrative services, each Fund pays the
Administrator a fee computed daily and paid monthly at the annual rate
of 0.20% of the Fund's average daily net assets. For the periods shown
below, the Funds paid administrative fees to MMC:
For the Fiscal Year Ended July 31:
Fund
1996
1997
1998
Convertible Fund
$167,177
$195,865
$266,265
Diversified Strategic
Income Fund
5,252,493
5,576,436
5,881,448
Exchange Reserve Fund
299,283
295,038
217,539
High Income Fund
1,802,541
2,258,562
2,945,414
Municipal High Income
Fund
1,885,640
1,697,669
1,551,721
Total Return Bond Fund*
N/A
N/A
N/A
Balanced Fund
3,597,560
2,858,500
2,265,563
___________________________
* The administrative fees have been included in the total for
management fees.
For the fiscal years ended July 31, 1996, 1997 and 1998,
Diversified Strategic Income Fund paid Global Capital Management sub-
investment advisory fees of $2,626,246, $2,788,218 and $2,940,724,
respectively.
Each Investment Adviser and MMC, as 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, extraordinary expenses) exceed the expense
limitation of any state having jurisdiction over the Fund, the
Investment Adviser and MMC 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 respective fees
bear to the aggregate of the fees paid by the Fund. Such fee reduction,
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 the Fund. No such fee reduction
was required for the fiscal years ended July 31, 1996, 1997 and 1998.
The Trust bears expenses incurred in its operations, including:
taxes, interest, brokerage fees and commissions, if any; fees of
Trustees who are not officers, directors, shareholders or employees of
Salomon Smith Barney or MMC; 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
Trustees who are not "interested persons" of the Fund have selected
Stroock & Stroock & Lavan, LLP as their legal counsel.
KPMG Peat Marwick LLP, 345 Park Avenue, New York, New York 10154
has been selected as the Trust's independent auditor to examine and
report on the Trust's financial statements and highlights for the fiscal
year ending July 31, 1999.
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 First Data. First Data
maintains a record of each shareholder'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 transferable but have no
preemptive or subscription rights. Shareholders generally 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 obligations 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 paying the liability will be
entitled to reimbursement from the general assets 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 instruments in which the Funds may invest, the
investment policies and portfolio 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
securities 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 Intermediate Credit Banks, Federal Land
Banks, Federal National Mortgage Association ("FNMA"), Maritime
Administration, Tennessee Valley Authority, District of Columbia Armory
Board, Student Loan Marketing Association, International 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 government is not
obligated by law to provide support to an instrumentality that it
sponsors, a Fund will invest in obligations issued by such an
instrumentality only if its Investment Adviser determines that the
credit risk with respect 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 insured by the Federal Deposit Insurance Corporation (the
"FDIC"). Domestic banks organized under state law are supervised and
examined by state banking 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 insurance may not be of material benefit to a
Fund, depending upon the principal amount of certificates of deposit
("CDs") of each held by the Fund) and are subject to Federal examination
and to a substantial body of Federal law and regulation. As a result of
Federal and state laws and regulations, domestic branches of domestic
banks are, among other things, generally 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 deposits ("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 obligation 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 obligations, 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 accounting, 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 subsidiaries 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 regulator by depositing assets with a
designated bank within the state, an amount of its assets equal to 5% of
its total liabilities; and (b) maintain 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 Investment Adviser will carefully evaluate such investments on
a case-by-case basis.
The 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 assets (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. The 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.
Ratings as Investment Criteria (All Funds). In general, the
ratings of nationally recognized statistical rating organizations
("NRSROs") represent 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 criteria for the selection of portfolio
securities, but the Funds also will rely upon the independent advice of
their respective Investment Advisers and/or Sub-Investment 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 purchase 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 Investment Adviser and/or Sub-
Investment Adviser will consider such events in its determination of
whether the Fund should continue to hold the securities. In addition, to
the extent that the ratings change as a result of changes in such
organizations or their rating systems, or due to a corporate
reorganization, a Fund will attempt to use comparable ratings as
standards for its investments in accordance with its investment
objective and policies.
When-Issued Securities and Delayed-Delivery Transactions
(Diversified Strategic Income, High Income, Total Return Bond and
Municipal High 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 transaction and may be disadvantaged if the other party
fails to do so.
U.S. government securities and Municipal Securities (as defined
below) are normally subject to changes in value based upon changes, real
or anticipated, 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. Similarly, the sale of U.S. government
securities for delayed delivery can involve the risk that the prices
available in the market when the delivery is made may actually be higher
than those obtained in the transaction itself.
In the case of the purchase of securities on a when-issued or
delayed-delivery basis by a Fund, the Fund will meet its obligations on
the settlement date 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 (Convertible, Diversified
Strategic Income, High Income, Total Return Bond and Balanced Funds).
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% of a Fund's total assets taken at value, except Total
Return Bond Fund, which may lend its portfolio securities to the fullest
extent allowed under the 1940 Act. A Fund will not lend portfolio
securities to Salomon 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 securities 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 collateral 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 whenever 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 receive reasonable
interest on the loan, as well as any dividends, interest or other
distributions on the loaned securities, and any increase in market
value; (e) the Fund may pay only reasonable custodian fees in connection
with the loan; and (f) voting rights on the loaned securities may pass
to the borrower; provided, however, that if a material event adversely
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 receiving
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 Investment Adviser to
be of good standing and will not be made unless, in the judgment of the
Investment Adviser, the consideration to be earned from such loans would
justify the risk.
Medium-, Low- and Unrated Securities (Convertible, Diversified
Strategic Income, High Income, Total Return Bond and Municipal High
Income Funds). The Fund may invest in medium- or low- rated securities
and unrated securities of comparable quality. Generally, these
securities offer a higher current yield than the yield offered by
higher-rated securities, but involve greater volatility of price and
risk of loss of income and principal, including the probability of
default by or bankruptcy of the issuers of such securities. Medium- and
low-rated and comparable unrated securities: (a) will likely have some
quality and protective characteristics that, in the judgment of the
rating organization, are outweighed by large uncertainties or major
risk exposures to adverse conditions and (b) are predominantly
speculative with respect to the issuer's capacity to pay interest and
repay principal in accordance with the terms of the obligation. Thus,
it is possible that these types of factors could, in certain instances,
reduce the value of securities held by the Fund with a commensurate
effect on the value of the Fund's shares. Therefore, an investment in
the Fund should not be considered as a complete investment program and
may not be appropriate for all investors.
While the market values of medium- and low-rated and comparable
unrated securities tend to react less to fluctuations in interest rate
levels than do those of higher-rated securities, the market values of
certain of these securities also tend to be more sensitive to
individual corporate developments and changes in economic conditions
than higher-rated securities. In addition, medium- and low-rated and
comparable unrated securities generally present a higher degree of
credit risk. Issuers of medium- and low-rated and comparable unrated
securities are often highly leveraged and may not have more traditional
methods of financing available to them so that their ability to service
their debt obligations during an economic downturn or during sustained
periods of rising interest rates may be impaired. The risk of loss due
to default by such issuers is significantly greater because medium- and
low-rated and comparable unrated securities generally are unsecured and
frequently are subordinated to the prior payment of senior
indebtedness. The Fund may incur additional expenses to the extent that
it is required to seek recovery upon a default in the payment of
principal or interest on its portfolio holdings. In addition, the
markets in which medium- and low-rated or comparable unrated securities
are traded generally are more limited than those in which higher- rated
securities are traded. The existence of limited markets for these
securities may restrict the availability of securities for the Fund to
purchase and also may have the effect of limiting the ability of the
Fund to: (a) obtain accurate market quotations for purposes of valuing
securities and calculating net asset value and (b) sell securities at
their fair value either to meet redemption requests or to respond to
changes in the economy or the financial markets. The market for medium-
and low-rated and comparable unrated securities is relatively new and
has not fully weathered a major economic recession. Any such recession,
however, could likely disrupt severely the market for such securities
and adversely affect the value of such securities. Any such economic
downturn also could adversely affect the ability of the issuers of such
securities to repay principal and pay interest thereon.
Fixed-income securities, including medium- and low-rated and
comparable unrated securities, frequently have call or buy-back
features that permit their issuers to call or repurchase the securities
from their holders, such as the Fund. If an issuer exercises these
rights during periods of declining interest rates, the Fund may have to
replace the security with a lower yielding security, resulting in a
decreased return to the Fund.
Securities that are rated Ba by Moody's or BB by S&P have
speculative characteristics with respect to capacity to pay interest
and repay principal. Securities that are rated B generally lack
characteristics of a desirable investment and assurance of interest and
principal payments over any long period of time may be small.
Securities that are rated Caa or CCC are of poor standing. These issues
may be in default or present elements of danger may exist with respect
to principal or interest.
In light of the risks described above, MMC, in evaluating the
creditworthiness of an issue, whether rated or unrated, will take
various factors into consideration, which may include, as applicable,
the issuer's financial resources, its sensitivity to economic
conditions and trends, the operating history of and the community
support for the facility financed by the issue, the ability of the
issuer's management and regulatory matters.
Options on Securities (Convertible, Diversified Strategic Income,
High Income, and Balanced 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 transactions.
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 adverse price movements in the
securities that it holds or may wish to purchase and the currencies in
which certain portfolio securities may be denominated. In return for a
premium, the writer of a covered call option forfeits the right to any
appreciation in the value of the underlying security above the strike
price for the life of the option (or until a closing 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 realize
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 securities 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 Investment 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 Investment Adviser expects that the
price of the underlying security will remain flat or advance moderately
during the option period and (c) out-of-the-money call options when its
Investment 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
declines and the security is sold at this lower price, the amount of any
realized 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 option once it has been assigned
an exercise notice. To secure its obligation 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 assets 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 Diversified Strategic Income Fund may purchase and sell put,
call and other types of option securities that are traded on domestic 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
canceled if the price of the underlying asset reaches a trigger level
prior to expiration. "Knock-in" options only have value if the price of
the underlying asset reaches a trigger level. "Average rate" or "Look-
back" options are options where the option's strike price at expiration
is set based on either the average, maximum or minimum price of the
asset over the period of the option.
The Diversified Strategic Income Fund may utilize up to 15% of its
assets to purchase options and may do so at or about the same time that
it purchases the underlying security or at a later time. In purchasing
options on securities, the Fund will trade only with counterparties 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 exchange or in the over-the-counter market. In light of this
fact and current trading conditions, the Fund expects to purchase only
call or put options issued by the Clearing Corporation. The Funds with
option-writing authority expect to write options only on U.S. securities
exchanges, except that the Diversified Strategic Income Fund 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
transaction. 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 realizes 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 Investment Adviser believes there is an active
secondary market, there is no assurance that sufficient trading interest
to create a liquid secondary market on a securities exchange 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. At times in the
past, for example, higher than anticipated trading activity or order
flow or other unforeseen events have rendered inadequate certain of the
facilities of the Clearing Corporation as well 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 options. If a Fund as a covered call option
writer is unable to effect a closing 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 that may be
held, written 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 exercised 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 Investment
Advisers and certain of their affiliates, may be considered to be such a
group. A securities exchange may order the liquidation of positions
found to be in violation of these limits and it may impose certain other
sanctions.
In the case of options 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 borrowed stock, but the Fund may incur additional
transaction costs or interest expenses in connection with any such
purchase or borrowing.
Additional risks exist with respect to certain of U.S. government
securities 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 prepayments, 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 (Balanced Fund). These Funds may purchase and
write put and call options on U.S. stock indexes listed on U.S.
exchanges for the purpose of hedging their portfolios. 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 New York Stock Exchange Composite Index or a narrower 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 are currently 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 multiple. The writer of the
option is obligated, in return for the premium received, to make
delivery of this amount. The writer may offset its position 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 hedging technique will depend upon the extent to which price movements
in the portion of a securities portfolio being hedged correlate with
price movements 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 Balanced Fund 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 Investment Adviser's ability to predict correctly
movements in the direction 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 Balanced Fund will engage in stock index options transactions
only when determined by their respective Investment Advisers to be
consistent with the Funds' efforts to control risk. There can be no
assurance that such judgment will be accurate or that the use of these
portfolio strategies will be successful. When a Fund writes an option on
a stock index, it will establish a segregated account in the name of the
Fund consisting of cash, equity securities or debt securities of any
grade in an amount equal to or greater than the market value of the
option, provided such securities are liquid and unencumbered and are
marked to market daily pursuant to guidelines established by the
Trustees.
Mortgage-Related Securities (Diversified Strategic Income,
Exchange Reserve and Total Return Bond Funds). The average maturity of
pass-through pools of mortgage-related securities varies with the
maturities of the underlying mortgage instruments. In addition, 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
prepayment rates of individual pools vary widely, it is not possible to
accurately 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 average 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 principally of conventional residential mortgage loans
created by non-governmental issuers, such as commercial banks, savings
and loan associations and private mortgage insurance companies.
Governmental mortgage-related 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 Housing and Urban Development. Government-
related mortgage-related securities are not backed by the full faith and
credit of the United States government. 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 corporate instrumentality of
the United States, the stock of which is owned by the Federal Home Loan
Banks. Participation certificates representing interests 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 described above. The mortgages underlying these securities may be
alternative 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 making investments in such new types of securities.
Currency Transactions (Diversified Strategic Income, Balanced
and High Income Funds). The Funds' dealings in forward currency exchange
transactions will be limited to hedging involving either specific
transactions or portfolio positions. Transaction hedging is the purchase
or sale of forward 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 currency 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 of the security at any time, or
securities held in its portfolio denominated or quoted in, or currently
convertible into (such as through exercise of an option or consummation
of a forward currency contract) that particular currency. 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
currency; (b) ownership of an option to enter into an offsetting forward
currency contract; (c) entering into a forward contract to purchase
currency being sold, or to sell currency being purchased, provided that
such covering contract is itself covered by any one of these methods
unless the covering 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 transactions 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 may either
sell a portfolio security and make delivery of the currency or retain
the security and offset its contractual obligation to deliver the
currency by purchasing 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 obligated 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 contract 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 currency 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 factors 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 commissions are involved. The use of forward currency contracts does
not eliminate fluctuations in the underlying prices of the securities,
but it does establish a rate of exchange that can be achieved in the
future. In addition, 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 increase.
If a devaluation is generally anticipated, the 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 (Diversified Strategic Income and High
Income Funds) The High Income Fund may only purchase put and call
options on foreign currencies, whereas the Diversified Strategic Income
Fund may purchase or write put and call options on foreign currencies
for the purpose of hedging against changes in future currency exchange
rates. Foreign currency 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 underlying 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 denominated, for example, will reduce the dollar value of
the securities even if their value in the foreign currency remains
constant. In order to protect 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 declines, the Fund will
have the right to sell the currency 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 potentially 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 exchange 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 direction or to the extent
anticipated, the Fund could sustain losses on transactions in foreign
currency options that would require it to forego a portion or all of the
benefits of advantageous changes in the rates.
Foreign Government Securities (Diversified Strategic Income Fund
and High Income Fund). Among the foreign government securities in which
the Fund may invest are those issued by countries with developing
economies, i.e., countries in the initial stages of their
industrialization cycles. Investing in securities of countries with
developing economies involves exposure to economic structures that are
generally less diverse and less mature, and to political systems that
can be expected to have less stability, 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.
Non-Taxable Municipal Securities (Municipal High Income Fund).
Non-taxable Municipal securities include debt obligations issued to fund
various public purposes, such as constructing public facilities,
refunding outstanding obligations, paying general operating expenses and
extending loans to public institutions and facilities. Private activity
bonds that are issued by or on behalf of public authorities to finance
privately operated facilities are considered to be Municipal Securities
if the interest paid thereon may be 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 subject 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 applied 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
governmental authorities to obtain funds to acquire a wide variety of
equipment and facilities such as fire and sanitation vehicles, computer
equipment and other capital assets. These obligations 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 municipal bonds; moreover, although the obligations will
be secured by the leased equipment, the disposition of the equipment in
the event of foreclosure might prove to be difficult. In order to limit
such risks, Municipal High 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 Ratings Group
("S&P") or (b) unrated municipal leases purchased principally from
domestic banks or other responsible third parties which enter into an
agreement with the Fund, which provides that the seller will either
remarket or repurchase the municipal lease within a short period after
demand by the Fund.
Taxable Municipal Securities. (Total Return Bond Fund). The Total
Return Bond Fund will invest in a diversified portfolio of taxable
long-term investment-grade securities issued by or on behalf of states
and municipal governments, U.S. territories and possessions of the
United States and their authorities, agencies, instrumentalities and
political subdivisions ("Taxable Municipal Obligations"). The Taxable
Municipal Obligations in which the Fund may invest are within the four
highest ratings of Moody's (Aaa, Aa, A, Baa) or S&P (AAA, AA, A, BBB).
Although securities rated in these categories are commonly referred to
as investment grade, they may have speculative characteristics. In
addition, changes in economic conditions or other circumstances are
more likely to lead to a weakened capacity to make principal and
interest payments than is the case with higher-grade securities.
Furthermore, the market for Taxable Municipal Obligations is relatively
small, which may result in a lack of liquidity and in price volatility
of those securities. Interest on Taxable Municipal Obligations is
includable in gross income for Federal income tax purposes and may be
subject to personal income taxes imposed by any state of the United
States or any political subdivision thereof, or by the District of
Columbia.
Temporary Investments (Municipal High Income Fund). When Municipal
High Income Fund is maintaining a defensive position it 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 a rating not lower than A-2 by S&P or Prime-2 by Moody's at the
time of purchase; and (iii) variable-rate demand notes rated within the
two highest ratings by any major rating service, or determined to be of
comparable quality to instruments with such rating, at the time of
purchase; and (b) the following taxable securities: (i) U.S. government
securities, including 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 services; and (iv) CDs of domestic banks
with assets of $1 billion or more. Among the tax-exempt notes in which
the Fund may invest are Tax Anticipation Notes, Bond Anticipation Notes
and Revenue Anticipation 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 Investments unless the Fund has adopted a
defensive investment policy in anticipation of a market decline. The
Fund, however, intends 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 redemptions.
Futures Activities (Diversified Strategic Income, High Income,
Municipal High Income, Total Return Bond and Balanced Funds). These
Funds may enter into futures contracts and/or options on futures
contracts that are traded on a U.S. exchange or board of trade. These
investments may be made by a Fund for the purpose of hedging against the
effects of changes in the value of its portfolio securities due to
anticipated changes in interest rates, currency values and/or market
conditions but not for purposes of speculation. In the case of Municipal
High Income Fund, investments in futures contracts will be made only in
unusual circumstances, such as when the Fund's Investment Adviser
anticipates an extreme change in interest rates or market conditions.
See "Taxes" below.
Futures Contracts (Convertible, Diversified Strategic Income,
Municipal High Income Total Return Bond Fund and Balanced Funds). The
Funds may acquire or sell a futures contract to mitigate the effect of
fluctuations in interest rates, currency values or market conditions
(depending on the type of contract) on portfolio securities without
actually buying or selling the securities. For example, if Municipal
High 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 portfolio 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, not totally offset, the decline
in the value of the Fund.
The Diversified Strategic Income Fund may enter into futures
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 for the purpose of hedging against changes in
the value of its portfolio securities but not for purposes of
speculation. The ability of the Fund to trade in futures contracts may
be limited by the requirements of the Internal Revenue Code of 1986 as
amended (the "Code"), applicable to a regulated investment company.
When deemed advisable by MMC, the Total Return Bond Fund may
enter into futures contracts or related options traded on a domestic
exchange or board of trade. Such investments, if any, by the Fund will
be made solely for the purpose of hedging against the effects of
changes in the value of the Fund's securities due to anticipated
changes in interest rates and market conditions, and when the
transactions are economically appropriate for the reduction of risks
inherent in the management of the Fund. The Fund may hedge up to 50%
of its assets using futures contracts or related options transactions.
No consideration is paid or received by a Fund upon entering into
a futures 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 margin, 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 contract, assuming that all contractual obligations have
been satisfied. Subsequent payments to and from the broker, known as
variation margin, 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 terminate the Fund's existing position
in the contract.
Several risks are associated with the use of futures contracts as
a hedging device. Successful use of futures contracts by a Fund is
subject to the ability of its Investment 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 judgment, and even a well-conceived
hedge may be unsuccessful to some degree because of market behavior or
unexpected trends in interest rates or currency 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 direction 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 positions. 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 securities 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 contract, as contrasted with the direct investment in such a
contract, gives the purchaser the right, in return for the premium paid,
to assume a position in the underlying interest rate futures contract at
a specified exercise price at any time prior to the expiration date of
the option. An option 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 account, which represents the
amount by which the market price of the futures contract exceeds, in the
case of a call, or is less than, in the case of a put, the exercise
price of the option on the futures contract. The potential 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 investing in
the option.
Several risks are associated with options on futures contracts.
The ability to establish and close out positions on such options will be
subject to the existence of a liquid market. In addition, the purchase
of put or call options on interest rate and foreign currency futures
will be based upon predictions by a Fund's Investment Adviser as to
anticipated trends in interest rates and currency values, as the case
may be, which could prove to be incorrect. Even if the expectations of
an Investment 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 (Convertible, Diversified Strategic Income,
High Income and Balanced Funds). Investors should recognize that
investing in foreign companies involves certain considerations which are
not typically associated 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 determined by the forces of supply and demand in the foreign exchange
markets. Changes in the exchange rate may result over time from the
interaction 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 these factors 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. Government 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 imposition 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. Accordingly, there may be less publicly available information
about the securities 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, practices 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 domestic developments which could
affect U.S. investments in those countries. Moreover, individual foreign
economies may differ favorably or unfavorably from the U.S. economy in
such respects as growth of gross national product, rate of inflation,
capital reinvestment, resource self-sufficiency and balance of payment
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 of the Fund to market and foreign exchange
fluctuations brought about by such delays, and 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 those
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.
The Fund may also purchase American Depository Receipts ("ADRs"),
European Depository Receipts ("EDRs") and Global Depository Receipts
("GDRs"), or other securities representing underlying shares of foreign
companies. ADRs are publicly traded on exchanges or over-the-counter in
the United States and are issued through "sponsored" or "unsponsored"
arrangements. In a sponsored ADR arrangement, the foreign issuer
assumes the obligation to pay some or all of the depository's
transaction fees, whereas under an unsponsored arrangement, the foreign
issuer assumes no obligation and the depository's transaction fees are
paid by the ADR holders. In addition, less information is available in
the United States about an unsponsored ADR than about a sponsored ADR,
and the financial information about a company may not be as reliable for
an unsponsored ADR as it is for a sponsored ADR. The Fund may invest in
ADRs through both sponsored and unsponsored arrangements.
Short Sales (Balanced Fund). Balanced 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 or (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 securities.
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 obligated 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, U.S. government securities,
equity securities or debt securities of any grade, providing such
securities have been determined by the Investment Adviser to be liquid
and unencumbered and are marked to market daily pursuant to guidelines
established by the Trustees. 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 the
market value of the securities at the time they were sold short and the
value of any assets deposited as collateral with the broker in
connection with the short sale (not including the proceeds of the short
sale). Until it replaces the borrowed securities, the Fund will maintain
the segregated account daily such that the amount deposited in the
account plus the amount deposited with the broker, not including the
proceeds from the short sale, will equal the current market value of
the securities sold short and will not be less than the market value of
the securities at the time they were sold short.
Short Sales Against the Box (Convertible and Balanced 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 exchangeable without
payment of further consideration into an equal number of shares of the
common stock sold short. A Fund will enter into this kind of short
sale,, described as "against the box," 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 a Fund will have to pay an
amount equal to any dividends paid on the common stock sold short prior
to delivery, it 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 securities in
connection with short sales against the box.
Investment Restrictions
The Trust has adopted investment restrictions 1 through 8 below as
fundamental policies with respect to the Funds, which, under the terms
of the 1940 Act, may not be changed without the vote of a majority of
the outstanding voting securities of a Fund. A "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 restrictions 9 through 16
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. Investing in a manner that would cause it to fail to be a
"diversified company" under the 1940 Act and the rules,
regulations and orders thereunder.
2. Investing in "senior securities" as defined in the 1940 Act and
the rules, regulations and orders thereunder except as
permitted under the 1940 Act and the rules, regulations and
orders thereunder.
3. Investing more than 25% of its total assets in securities, the
issuers of which conduct their principal business activities in
the same industry. For purposes of this limitation, securities
of the U.S. government (including its agencies and
instrumentalities) and securities of state or municipal
governments and their political subdivisions are not considered
to be issued by members of any industry.
4. Borrowing money, except that (a) the Fund may borrow from banks
for temporary or emergency (not leveraging) purposes, including
the meeting of redemption requests which might otherwise
require the untimely disposition of securities, and (b) the
Fund may to the extent consistent with its investment policies,
enter into reverse repurchase agreements, forward roll
transactions and similar investment strategies and techniques.
To the extent that it engages in transactions described in (a)
and (b), the Fund will be limited so that no more than 33-1/3%
of the value of its total assets (including the amount
borrowed), valued at the lesser of cost or market, less
liabilities (not including the amount borrowed) valued at the
time the borrowing is made, is derived from such transaction.
5. Purchasing securities on margin (except for such short-term
credits as are necessary for the clearance of purchases and
sales of portfolio securities) or sell any securities short
(except "against the box" and for the Balanced Fund which may
make short sales or maintain a short position to the extent of
5% of its net assets). For purposes of this restriction the
deposit or payment by the Fund of underlying securities and
other assets in escrow and collateral agreements with respect
to initial or maintenance margin in connection with futures
contracts and related options and options on securities,
indexes or similar items is not considered to be the purchase
of a security on margin.
6. Making Loans. This restriction does not apply to: (a) the
purchase of debt obligations in which the Fund may invest
consistent with its investment objective and policies; (b)
repurchase agreements; and (c) loans of its portfolio
securities, to the fullest extent permitted under the 1940 Act.
7. Underwriting securities issued by other persons, except to the
extent that the Fund may technically be deemed an underwriter
under the Securities Act of 1933, as amended, in disposing of
portfolio securities.
8. Purchasing or selling real estate, real estate mortgages,
commodities or commodity contracts, but this restriction shall
not prevent the Fund from (a) investing in securities of
issuers engaged in the real estate business or the business of
investing in real estate (including interests in limited
partnerships owning or otherwise engaging in the real estate
business or the business of investing in real estate) and
securities which are secured by real estate or interests
therein; (b) holding or selling real estate received in
connection with securities it holds or held; (c) trading in
futures contracts and options on futures contracts (including
options on currencies to the extent consistent with the Fund's
investment objective and policies); (d) investing in real
estate investment trust securities; or (e) investing in gold
bullion and coins or receipts for gold.
9. Investing in oil, gas or other mineral exploration or
development programs, except that the Convertible, Diversified
Strategic Income, Balanced and High Income Funds may invest in
the securities of companies that invest in or sponsor those
programs.
10. 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.
11. With respect to all Funds except the Exchange Reserve Fund,
purchasing restricted securities, illiquid securities (such as
repurchase agreements with maturities in excess of seven days
and, in the case of Exchange Reserve Fund, TDs maturing from
two business days through six months) or other securities that
are not readily marketable if more than 10% or, in the case of
the High Income and Diversified Strategic Income Funds, 15% of
the total assets of the Fund would be invested in such
securities. With respect to the Exchange Reserve Fund,
securities subject to Rule 144A of the 1933 Act (provided at
least two dealers make a market in such securities) and certain
privately issued commercial paper eligible for resale without
registration pursuant to Section 4(2) of the 1933 Act will not
be subject to this restriction
12 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 Municipal High
Income Fund, this restriction shall apply to the entity
supplying the revenues from which the issue is to be paid.
13. Making investments for the purpose of exercising control or
management.
14. Purchasing or retaining securities of any company if, to the
knowledge of the Trust, any of the Trust's officers or Trustees
or any officer or director of an Investment 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.
15. Investing in warrants other than those acquired by the Fund as
part of a unit or attached to securities at the time of
purchase (except as permitted under a Fund's investment
objective and policies) if, as a result, the investments
(valued at the lower of cost or market) would exceed 5% of the
value of the Fund's net assets. At no time may more than 2% of
the Fund's net assets be invested in warrants not listed on a
recognized U.S. or foreign stock exchange, to the extent
permitted by applicable state securities laws.
16. With respect to Balanced Fund, purchasing in excess of 5% of
the voting securities of a public utility or public utility
holding company, 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 the 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.
Portfolio Turnover
The Funds do not intend to seek profits through short-term
trading. Nevertheless, 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
transactions 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 if all of a Fund's
securities that are included in the computation of turnover were
replaced once during a one-year period. 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 quality purchased at approximately the same time to take
advantage of what a Fund's Investment 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, 1996, 1997 and 1998, the
portfolio turnover rates were as follows:
For the Fiscal Year Ended
July 31:
Fund
1996
1997
1998
Convertible Fund
59%
57%
49%
Diversified Strategic
Income Fund
90
85
128
High Income Fund
72
78
102
Municipal High Income
Fund
44
51
84
Total Return Bond Fund
N/A
N/A
0
Balanced Fund
58
45
110
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For regulatory purposes, the turnover rate of Exchange Reserve Fund is
zero.
Portfolio Transactions
Most of the purchases and sales of securities by a Fund, whether
transacted on a securities exchange or over the counter, will be made 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 Investment Adviser, who is also
responsible for placing these transactions subject to the overall review
of the Board of Trustees. With respect to Diversified Strategic Income
Fund, decisions to buy and sell domestic securities for the Fund are
made by MMC, which is also responsible for placing these transactions;
the responsibility to make investment decisions 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 Investment
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 Investment 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 Investment
Adviser to be equitable to each. In some cases this procedure may
adversely affect the price paid or received 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 exchanges. 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 instrumentality. The following
table sets forth certain information regarding each Fund's payment of
brokerage commissions:
Total Brokerage Commissions Paid
Fiscal
Year
Convertible Fund
High
Income
Fund
Balanced
Fund
Diversified
Strategic
Income Fund
Total
Return
Bond
Fund
1996
$16,920
$32,621
$2,446,072
$50,196
N/A
1996*
- --
- --
- --
- --
N/A
1997
- --
- --
138,150
- --
N/A
1998
23,753
34,725
2,187,80
5
20,200
- --
Brokerage Commissions Paid to Salomon Smith Barney
Fiscal
Year
Convertible Fund
High
Income
Fund
Balanced
Fund
Diversified
Strategic
Income Fund
Total
Return
Bond
Fund
1996
- --
- --
91,818
- --
N/A
1996*
- --
- --
- --
- --
N/A
1997
- --
- --
138,150
- --
N/A
1998
- --
- --
139,236
- --
- --
% of Total Brokerage Commissions Paid to Salomon Smith Barney
Fiscal
Year
Convertible Fund
High
Income
Fund
Balanced
Fund
Diversified
Strategic
Income Fund
Total
Return
Bond
Fund
1996
- --
- --
3.75%
- --
N/A
1996*
- --
- --
- --
- --
N/A
1997
- --
- --
6.60
- --
N/A
1998
- --
- --
6.36
- --
- --
% of Total Dollar Amount of Transactions Involving Commissions Paid to
Salomon Smith Barney
Fiscal
Year
Convertible Fund
High
Income
Fund
Balanced
Fund
Diversified
Strategic
Income Fund
Total
Return
Bond
Fund
1996
- --
- --
2.72%
- --
N/A
1996*
- --
- --
- --
- --
N/A
1997
- --
- --
5.85
- --
N/A
1998
- --
- --
6.54
- --
- --
* For the period from August 1, 1996 through December 31, 1996.
In selecting brokers or dealers to execute securities transactions
on behalf of a Fund, the Fund's Investment Adviser seeks the best
overall terms available. In assessing the best overall terms available
for any transaction, each Investment Adviser will consider the factors
that it deems relevant, including the breadth of the market in the
security, the price of the security, the financial 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
Investment Adviser authorizes the Investment Adviser, in selecting
brokers or dealers 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, as amended) provided to the Trust, the other Funds
and/or other accounts over which the Investment 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, Salomon Smith Barney will not participate in
commissions 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
Board of Trustees has determined that transactions for a Fund may be
executed through Salomon Smith Barney and other affiliated broker-
dealers if, in the judgment of the Fund's Investment Adviser, the use of
such broker-dealer is likely to result in price and execution at least
as favorable as those of other qualified broker-dealers, and if, in the
transaction, such broker-dealer charges the Fund a rate consistent with
that charged to comparable unaffiliated customers in similar
transactions. In addition, under rules recently adopted by the SEC,
Salomon Smith Barney may directly execute such transactions for the
Funds on the floor of any national securities exchange, provided (a) the
Trust's Board of Trustees has expressly authorized Salomon Smith Barney
to effect such transactions, and (b) Salomon 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 principal market makers except in those cases in which
better prices and executions may be obtained elsewhere. The Funds will
not purchase any security, including U.S. government securities or
Municipal Securities, during the existence of any underwriting or
selling group relating thereto of which Salomon Smith Barney is a
member, except to the extent permitted by the SEC.
The Funds may use Salomon Smith Barney as a commodities broker in
connection with entering into futures contracts and options on futures
contracts. Salomon Smith Barney has agreed to charge the Funds commodity
commissions at rates comparable to those charged by Salomon 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
Prospectuses applies to purchases made by any "purchaser", which is
defined to include the following: (a) an individual; (b) an individual's
spouse and his or her children purchasing shares for his or her own
account; (c) a trustee or other fiduciary purchasing shares for a single
trust estate or single fiduciary account; (d) a pension, profit-sharing
or other employee benefit plan qualified under Section 401(a) of the
Code and qualified employee benefit plans of employers who are
"affiliated persons" of each other within the meaning of the 1940 Act;
(e) tax-exempt organizations enumerated in Section 501(c)(3) or (13) of
the Code; (f) any other organized group of persons, provided that the
organization has been in existence 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 Investment Adviser registered with
the SEC under the Investment Advisers Act of 1940) purchasing shares of
the Fund for one or more trust estates or fiduciary accounts. Purchasers
who wish to combine purchase orders to take advantage of volume
discounts on Class A shares should contact a Salomon Smith Barney
Financial Consultant.
Combined Right of Accumulation
Reduced sales charges, in accordance with the schedules in the
Prospectuses, 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 further information regarding the rights of
accumulation, shareholders should contact a Salomon 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 a Fund is equal to the net asset value per share at the time of
purchase, plus for Class A and Class L shares an initial sales charge.
The public offering price for a Class B (and Class A share purchases,
including applicable rights of accumulation, equaling or exceeding
$500,000), is equal to the net asset value per share at the time of
purchase and no sales charge is imposed at the time of purchase. A
contingent deferred sales charge ("CDSC"), however, is imposed on
certain redemptions of Class B, Class L and Class O 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 shareholders of a Fund 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 issued as a distribution in kind may incur brokerage
commissions when shareholders subsequently sell those securities.
Automatic Cash Withdrawal Plan. An automatic cash withdrawal plan
(the "Withdrawal Plan") is available to shareholders who own shares 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. Withdrawals of at least $50 may be made under the Withdrawal
Plan by redeeming as many shares of the Fund as may be necessary to
cover the stipulated withdrawal payment. Any applicable CDSC will not be
waived on amounts withdrawn by shareholders that exceed 1.00% per month
of the value of a shareholder's shares at the time the Withdrawal Plan
commences. (With respect to Withdrawal Plans in effect prior to November
7, 1994, any applicable CDSC will be waived on amounts withdrawn that do
not exceed 2.00% per month of the value of a shareholder's shares at the
time the Withdrawal 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 income 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 First
Data, as agent for Withdrawal Plan members. All dividends and
distributions on shares in the Withdrawal Plan are reinvested
automatically at net asset value in additional shares of the Fund
involved. All applications for participation in the Withdrawal Plan must
be received by First Data as Plan Agent no later than the eighth day of
each month to be eligible for participation beginning with that month's
withdrawal. For additional information regarding the Withdrawal Plan,
contact your Salomon Smith Barney Financial Consultant.
DISTRIBUTOR
CFBDS 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 Salomon
Smith Barney may benefit from the temporary use of the funds. The
investor may designate another use for the funds prior to settlement
date, such as an investment in a money market fund (other than the
Exchange Reserve Fund) of the Smith Barney Mutual Funds. If the investor
instructs Salomon Smith Barney to invest the funds in a Salomon 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 Salomon Smith Barney money market fund, and affiliates of Salomon
Smith Barney that serve the funds in an investment advisory or
administrative capacity will benefit from the fact they are receiving
fees from both such investment companies for managing these assets
computed on the basis of their average daily net assets. The Trust's
Board of Trustees has been advised of the benefits to Salomon Smith
Barney resulting from these settlement procedures and will take such
benefits into consideration when reviewing the Advisory, Administration
and Distribution Agreements for continuance.
For the fiscal year ended July 31, 1998, Salomon Smith Barney
and/or PFS incurred distribution expenses for advertising, printing and
mailing prospectuses, support services and overhead expenses, to Salomon
Smith Barney or PFS Financial Consultants and for accruals for interest
on the excess of Salomon Smith Barney and/or PFS expenses incurred in
the distribution of the Fund's shares over the sum of the distribution
fees and CDSC received by Salomon Smith Barney and/or PFS are expressed
in the following table:
Fund Name
Financial
Consultant
Compensation
Branch
Expenses
Advertising
Expenses
Printing
Expenses
Interest
Expenses
Other
Expenses
Div.
Strat.
$12,436,072
$8,959,209
$966,299
$168,014
$412,185
$10,505,708
Balanced
90,235
3,559,360
195,177
66,243
(61,163)
3,759,617
High
Income
6,034,688
3,573,384
430,209
47,639
211,863
4,263,094
Muni High
603,894
1,333,426
133,180
38,047
825
1,505,478
Convertible
164,695
239,557
17,098
2,858
3,038
262,550
Ex.
Reserve
- --
146,365
--
9,149
(26,919)
128,594
Total
Return
6,229,612
1,010,375
138,608
612
117,941
1,267,536
Distribution Arrangements
Shares of the Trust are sold on a best efforts basis by CFBDS as
sales agent of the Trust pursuant to the Distribution Agreement. To
compensate Salomon 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, except Exchange
Reserve Fund, pays Salomon Smith Barney a service fee, accrued daily
and paid monthly, calculated at the annual rate of 0.25% (0.15% in the
case of Municipal High Income Fund) of the value of the Fund's average
daily net assets attributable to its Class A, Class B, Class L and
Class O shares. In addition, each Fund except the Exchange Reserve
Fund, pays Salomon Smith Barney, with respect to its Class B, Class L
and Class O shares, a distribution fee. The Exchange Reserve Fund pays
PFS a distribution fee with respect to its Class B shares. The
distribution fee is primarily intended to compensate Salomon Salomon
Smith Barney and/or PFS for its initial expense of paying Financial
Consultants a commission upon sales of those shares. The Class B and
Class L shares' distribution fees, accrued daily and paid monthly, are
calculated at the annual rate of 0.50% for Class B shares of each Fund
and 0.45% for Class L shares, except the Smith Barney Balanced Fund and
the Smith Barney Convertible Fund (0.50% for Class L shares in the case
of Exchange Reserve Fund and 0.55% for Class L shares in the case of
Municipal High Fund) of the value of a Fund's average daily net assets
attributable to the shares of the respective Class. For the Smith
Barney Convertible Fund and the Smith Barney Balanced Fund, Class L and
Class O shares' distribution fees, accrued daily and paid monthly, are
calculated at the annual rate of 0.75% for Class L shares and 0.45% for
Class O shares.
For the fiscal years ended July 31, 1998, Salomon Smith Barney
received $57,460,253, in the aggregate from the Trust under the Plan.
The following expenses were incurred during the periods indicated:
Initial Sales Charges (paid to Salomon Smith Barney).
Class A
For the Fiscal Year Ended July 31:
Fund
1996
1997
1998
Convertible Fund
$49,000
$19,000
$19,000
Diversified Strategic
Income Fund
792,000
983,000
1,344,000
High Income Fund
593,000
726,000
1,571,000
Municipal High Income
Fund
47,000
46,000
70,000
Total Return Bond Fund
N/A
N/A
1,146,000
Balanced Fund
228,000
55,000
68,000
Class L
For the Fiscal Year Ended July 31:
Fund
1996
1997
1998
Convertible Fund
N/A
N/A
$2,000
Diversified Strategic
Income Fund
N/A
N/A
78,000
High Income Fund
N/A
N/A
112,000
Municipal High Income
Fund
N/A
N/A
3,000
Total Return Bond Fund
N/A
N/A
21,000
Balanced Fund
N/A
N/A
4,000
CDSC (paid to Salomon Smith Barney)
Class A
For the Fiscal Year Ended July 31:
Fund
1998
Convertible Fund
N/A
Diversified Strategic Income Fund
23,000
Exchange Reserve Fund
N/A
High Income Fund
12,000
Municipal High Income Fund
N/A
Total Return Bond Fund
1,000
Balanced Fund
N/A
Class B
For the Fiscal Year Ended July 31:
Fund
1996
1997
1998
Convertible Fund
$95,000
$59,000
$50,000
Diversified Strategic Income Fund
4,015,000
2,858,000
2,494,000
Exchange Reserve Fund
765,000
618,000
349,000
High Income Fund
915,000
831,000
936,000
Municipal High Income Fund
929,000
525,000
231,000
Total Return Bond Fund
N/A
N/A
34,000
Balanced Fund
3,393,000
2,514,000
829,000
Class L
For the Fiscal Year Ended July 31:
Fund
1998
Convertible Fund
$0
Diversified Strategic Income Fund
35,000
Exchange Reserve Fund
N/A
High Income Fund
20,000
Municipal High Income Fund
0
Total Return Bond Fund
20,000
Balanced Fund
0
Class O
For the Fiscal Year Ended July 31:
Fund
1998
Balanced Fund
$1,000
Service Fees and Distribution Fees
For the Fiscal Year Ended July 31:
Fund
1996
1997
1998
Convertible Fund
$433,951
$413,173
$400,232
Diversified Strategic Income Fund
18,641,336
19,195,740
19,373,203
Exchange Reserve Fund
748,208
737,595
543,651
High Income Fund
4,893,170
5,818,152
7,255,916
Municipal High Income Fund
4,945,112
4,316,732
3,734,428
Total Return Bond Fund
N/A
N/A
329,050
Balanced Fund
12,152,329
9,205,137
7,016,893
Under its terms, the Plan continues from year to year, provided such
continuance is approved annually by vote of the Board of Trustees,
including a majority of the Independent Trustees who have no direct or
indirect 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 Salomon Smith Barney or PFS without shareholder approval,
and all amendments of the Plan 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 penalty, 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, Salomon Smith Barney and PFS will
provide the Board of Trustees with periodic reports of amounts expended
under the Plan and the purpose for which such expenditures 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
currently is scheduled to be closed on New Year's Day, Martin Luther
King Jr. Day, Presidents' Day, Good Friday, Memorial Day, Independence
Day, Labor Day, Thanksgiving and Christmas, and on the preceding Friday
or subsequent Monday when one of these holidays falls on a Saturday or
Sunday, respectively. Because of the differences in distribution fees
and Class-specific expenses, the per share net asset value of each Class
may differ. The following is a description of 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 determined to be the primary market for such
security. All assets and liabilities 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, MMC, 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 securities and short-term investments), including Municipal
Securities held by Municipal High Income Fund, are valued by MMC, as
administrator, after consultation with the Pricing Service approved by
the Trust's Board of Trustees. 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 of the Smith Barney Mutual
Funds may exchange all or part of their shares for shares of the same
Class of other 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 and Class Y shares may exchange all or a portion of
their shares of the respective Class without imposition of any
sales charge.
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.
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 purposes 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.
D. Class L and Class O Shares may be exchanged with Class L
shares of any of the other funds.
Dealers other than Salomon Smith Barney must notify First Data of the
investor's prior ownership of Class A shares of Smith Barney High Income
Fund and the account number in order to accomplish an exchange of shares
of 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 Salomon Smith Barney
Financial Consultant.
Upon receipt of proper instructions and all necessary supporting
documents, shares submitted for exchange are redeemed at the then-
current net asset value and, subject to any applicable CDSC, the
proceeds are immediately invested, at a price as described above, in
shares of the fund being acquired. Salomon 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 the Funds' yield or total return
in advertisements or in reports and other communications to
shareholders. The Trust may include comparative performance information
in advertising or marketing each Fund's shares. Such performance
information may include the following industry and financial
publications: Barron's, Business Week, CDA Investment Technologies,
Inc., Changing Times, Forbes, Fortune, Institutional Investor, Investors
Daily, Money, Morningstar Mutual Fund Values, The New York Times, USA
Today and The Wall Street Journal. To the extent any advertisement or
sales literature of a Fund describes the expenses or performance of
Class A, Class B, Class L, Class O or Class Y, it will also disclose
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
account 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 the
period to obtain the base period return and (c) annualizing the results
(i.e., multiplying the base period return by 365/7). The net change in
the value of the account reflects the value of additional shares
purchased with dividends 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 annualized yield by adding 1 to the base
period return (calculated as described above), raising the sum to a
power equal to 365/7 and subtracting 1.
For the seven-day period ended July 31, 1998, the annualized yield
was 4.31% and 4.29% for Class B and Class C shares, respectively. The
compound effective yield was 4.41% and 4.38% for Class B and Class C
shares, respectively. As of July 31, 1998, the Fund's average portfolio
maturity was 18 days.
Other Funds. The 30-day yield figure of a Fund other than Exchange
Reserve Fund is calculated according to a formula prescribed by the SEC.
The formula can be expressed as follows:
YIELD =2[(a-b+1)^6)-1]
Cd
regarding:
a = dividends and interest earned during the period.
b = expenses accrued for the period (net of waiver and
reimbursement).
c = the average daily number of shares outstanding during
the period that were entitled to receive dividends.
d = the maximum offering price per share on the last day of
the period.
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.
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 expected to occur.
Average Annual Total Return
The "average annual total return" figures for each Fund, other than
Exchange 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 portion thereof), assuming reinvestment
of all dividends and distributions.
The average annual total returns with sales charges of the Fund's
Class A shares were as follows for the periods indicated:
Fund*
One-Year
Period
Five-Year
Period
Since Inception
Convertible Fund
(3.13)%
8.25%
9.41%
Diversified Strategic
Income Fund
2.60
6.69
7.47
High Income Fund
3.92
8.57
10.47
Municipal High Income Fund
2.29
5.25
6.35
Total Return Bond Fund
N/A
N/A
(1.97)
Balanced Fund
10.85
7.58
9.53
*Each Fund, except Total Return Bond Fund, commenced selling Class
A shares on November 6, 1992. The Total Return Bond Fund commenced
operations on February 27, 1998.
The average annual total returns with CDSC (with fees waived) of
the Fund's Class B shares were as follows for the periods indicated:
Fund
One-Year
Period
Five-Year
Period
Ten-Year
Period
Since
Inception
Convertible Fund (1)
(3.03)%
8.70%
9.00%
8.76%
Diversified Strategic Income
Fund (2)(6)
2.46
7.05
N/A
8.90
High Income Fund(3)(6)
3.87
8.91
9.15
9.32
Municipal High Income
Fund(4)(6)
1.53
5.43
7.43
8.17
Total Return Bond Fund(7)
N/A
N/A
N/A
(2.02)
Balanced Fund(5)
11.17
8.00
10.94
10.78
(1) Fund commenced operations on September 9, 1986.
(2) Fund commenced operations on December 28, 1989.
(3) Fund commenced operations on September 2, 1986.
(4) Fund commenced operations on September 16, 1985.
(5) Fund commenced operations on March 28, 1988.
(6) Prior to November 6, 1992, the maximum CDSC imposed on redemptions
was 5.00%.
(7) Fund commenced operations on January 21, 1998.
The average annual total returns with sales charges (with fees
waived) of the Fund's Class L shares were as follows for the periods
indicated:
Fund
One-Year
Period
Five-Year
Period
Since Inception
Convertible Fund(3)
N/A
N/A
(2.69)%
Diversified Strategic
Income Fund (5)
5.04%
6.99%
7.16
High Income Fund (4)
6.31
N/A
11.40
Municipal High Income
Fund(2)
3.88
N/A
9.80
Total Return Bond Fund
N/A
N/A
0.44
Balanced Fund(6)
N/A
N/A
(4.19)
(1) The Fund commenced selling Class L shares (previously designated
as Class C shares) on June 1, 1993.
(2) The Fund commenced selling Class L shares (previously designated as
Class C shares) on November 17, 1994.
(3) The Fund commenced selling Class L shares on June 15, 1998.
(4) The Fund commenced selling Class L shares (previously designated as
Class C shares) on August 24, 1994.
(5) The Fund commenced selling Class L shares (previously designated as
Class C shares) on March 19, 1993.
(6) The Fund commenced selling Class L shares on June 15, 1998.
The average annual total returns with sales charges (with fees
waived) of the Fund's Class O shares were as follows for the periods
indicated:
Fund
One-Year
Period
Five-Year
Period
Since Inception
Convertible Fund(1)
0.62%
N/A
12.21%
Balanced Fund(2)
15.19
8.17
8.95
(1) The Fund commenced selling Class O shares (previously designated
as Class C shares) on November 7, 1994.
(2) The Fund commenced selling Class O shares (previously designated as
Class C shares) on February 4, 1993.
The average annual total returns (with fees waived) of the Fund's
Class Y shares were as follows for the periods indicated:
Fund
One-Year
Period
Five-Year
Period
Since Inception
Convertible Fund(1)
2.42%
N/A
11.09%
Diversified Strategic
Income Fund (2)
7.96
N/A
9.35
High Income Fund (3)
9.18
N/A
11.56
Balanced Fund(4)
16.67
N/A
12.22
(1) The Fund commenced selling Class Y shares on February 7, 1996.
(2) The Fund commenced selling Class Y shares on October 10, 1995.
(3) The Fund commenced selling Class Y shares on April 28, 1995.
(4) The Fund commenced selling Class Y shares on October 9, 1995.
The average annual total returns (with fees waived) of the Fund's
Class Z shares were as follows for the periods indicated:
Fund
One-Year
Period
Five-Year
Period
Since Inception
Diversified Strategic
Income Fund (1)
7.78%
8.05%
8.68%
High Income Fund (2)
9.33
9.88
11.65
Balanced Fund(3)
17.08
9.01
10.84
(1) The Fund commenced selling Class Z shares on November 6, 1992.
(2) The Fund commenced selling Class Z shares on November 6, 1992.
(3) The Fund commenced selling Class Z shares on November 6, 1992.
A Class' total return figures calculated in accordance with the
above formula assume that the maximum sales charge or maximum applicable
CDSC, as the case may be, has been deducted for the hypothetical $1,000
initial investment at the time of purchase.
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. Consequently, any given performance quotation should not be
considered representative of the Class' performance for any specified
period in the future. Because performance will vary, it may not provide
a basis for comparing an investment in the Class with certain bank
deposits or other investments that pay a fixed yield for a stated period
of time. Investors comparing a Class' performance with that of other
mutual funds should give consideration to the quality and maturity of
the respective investment 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
intended as a substitute for individual tax advice and investors are
urged to consult their own tax advisors as to the tax consequences of an
investment in 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 securities 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.
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 security at a substantial discount, a portion of any gain upon sale
or redemption 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
transactions 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
convertible 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 transaction, 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 written 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
convertible 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 option. 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 security 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 imposes a special "mark-to-market" system for taxing these
contracts. These contracts generally include options on non-convertible
debt securities (including United States government securities), options
on stock indexes, futures contracts, options on futures contracts and
certain foreign currency 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 general, gain or loss on section
1256 contracts will be taken into account for tax purposes when actually
realized (by a closing transaction, by exercise, by taking delivery or
by other termination). In addition, any section 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. Provided 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 positions
actually are held by a Fund.
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
investment 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 substantial 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 re-characterize
long-term gain as short-term gain, or to re-characterize 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 acquired 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 re-
characterized 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, straddles 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 recognition 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.
Constructive Sales. If a Fund effects a short sale of securities
at a time when it has an unrealized gain on the securities, it may be
required to recognize that gain as if it had actually sold the
securities (as a "constructive sale") at the time it effects the short
sale. However, such constructive sale treatment may not apply if the
Fund closes out the short sale with securities other than the
appreciated securities held at the time of the short sale and if certain
other conditions are satisfied. Uncertainty regarding the tax
consequences of effecting short sales may limit the extent to which a
Fund may effect short sales.
Section 988. Foreign currency gain or loss from transactions in
(a) bank forward contracts not traded in the interbank market and (b)
futures contracts traded on a foreign exchange may be treated as
ordinary income or loss under the 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 income 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
income for Federal income tax purposes, whether received in cash or
reinvested 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. A portion of long-term capital gains (including such gains
attributable to the 60% long-term gains portion of gains on Section 1256
contracts) may be designated as eligible for the 20% maximum capital
gains tax rate on gains realized by individuals from capital assets held
for more than 18 months.
Dividends of investment income (but not capital gains) from any
Fund generally will qualify for the Federal dividends-received deduction
for domestic corporate shareholders to the extent that such dividends do
not exceed 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 redemption, shares in a mutual fund for which the otherwise
applicable sales charge is reduced by reason of a reinvestment right
(i.e., exchange privilege), the original sales charge 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 original sales charge that does not increase
the shareholder's tax basis in the original shares would be treated as
incurred with respect to the second 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 shareholder 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 recognize 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 exchanges 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 identification 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 proceeds of any redemption of Trust shares. An
individual's taxpayer identification number is his or her social
security number. The backup withholding tax is not an additional tax and
may be credited against a shareholder's regular Federal income tax
liability.
Municipal High Income Fund. Because the Municipal High Income Fund
will distribute exempt-interest dividends, interest on indebtedness
incurred by shareholders, directly or indirectly, to purchase or carry
shares of the Fund will not be deductible for Federal income tax
purposes. If a shareholder redeems 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 extent 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 person
"related" to a substantial user. Investors should consult their own tax
advisors to see whether they may be substantial users or related persons
with respect to a facility financed by bonds in which the Fund may
invest. Moreover, investors receiving social security or certain other
retirement benefits should be aware that tax-exempt interest received
from the Fund may under certain circumstances cause up to one-half of
such retirement benefits to be subject to tax. If the Fund receives
taxable investment 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. Dividends 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 securities 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.
PNC Bank is located at 17th and Chestnut Streets, Philadelphia,
Pennsylvania 19103, and serves as the custodian for each of the Funds,
except Diversified Strategic Income Fund. Chase, located at Chase
MetroTech Center, Brooklyn, NY 11245, serves as the custodian for
Diversified Strategic Income Fund. Under their respective custodian
agreements with the respective Funds, each custodian is authorized to
establish separate accounts for foreign securities owned by the
appropriate Fund to be held with foreign branches of other U.S. banks as
well as with certain foreign banks and securities depositories. For its
custody services to the Trust, each custodian receives monthly fees
based upon the month-end aggregate net asset value of the appropriate
Fund, 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.
First Data is located at Exchange Place, Boston, Massachusetts
02109, and serves as the Trust's transfer agent. Under the transfer
agency agreement, First Data maintains the shareholder account records
for the Trust, handles certain communications between shareholders and
the Trust and distributes dividends and distributions payable by each
Fund. For these services First Data receives 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 reimbursed for certain
out-of-pocket expenses.
VOTING RIGHTS
The Trustees themselves have the power to alter the number and
the terms of office of the Trustees, and they may at any time lengthen
their own terms or make their terms of unlimited duration (subject to
certain removal procedures) and appoint their own successors, provided
that in accordance with the 1940 Act at any time at least a majority,
but in most instances at least two-thirds, of the Trustees have been
elected by the shareholders of the Fund. Shares do not have cumulative
voting rights and therefore the holders of more than 50% of the
outstanding shares of the Fund may elect all of the Trustees
irrespective of the votes of other shareholders. Class A, Class B,
Class O, Class L and Class Y shares of a Fund, if any, represent
interests in the assets of that Fund and have identical voting,
dividend, liquidation and other rights on the same terms and
conditions, except that each Class of shares has exclusive voting
rights with respect to provisions of the Fund's Rule 12b-1 distribution
plan which pertain to a particular class. For example, a change in
investment policy for a Fund would be voted upon only by shareholders
of the Fund involved. Additionally, approval of each Fund's Investment
Advisory Agreement is a matter to be determined separately by that
Fund. Approval of a proposal by the shareholders of one Fund is
effective as to that Fund whether or not enough votes are received from
the shareholders of the other Funds to approve the proposal as to those
Funds. As of November 6, 1998, the following shareholders beneficially
owned 5% or more of a class of shares of a Fund:
High Income Fund - Class Y
Smith Barney Concert Series, Inc.
Growth Portfolio
PNC Bank, NA
Attn: Beverly Timson
200 Stevens Drive Suite 440
Lester, PA 19113-1522
owned 6,702,935.779 (33.98%) shares
Smith Barney Concert Series, Inc.
High Growth Portfolio
PNC Bank, NA
Attn: Beverly Timson
200 Stevens Drive Suite 440
Lester, PA 19113-1522
owned 5,148,496.717 (26.10%) shares
Byrd & Co.
First Union National Bank
Taxable Account
Attn: Diane Pilegg
Mutual Funds DVD Proc. #PA4905
530 Walnut Street
Philadelphia, PA 19106-3620
Owned 2,271,447.367 (11.52%) shares
Smith Barney Concert Series, Inc.
Income Portfolio
PNC Bank, NA
Attn: Beverly Timson
200 Stevens Drive Suite 440
Lester, PA 19113-1522
owned 1,371,711.234 (6.95%) shares
Smith Barney Concert Series, Inc.
Conservative Portfolio
PNC Bank, NA
Attn: Beverly Timson
200 Stevens Drive Suite 440
Lester, PA 19113-1522
owned 1,230,335.484 (6.24%) shares
Byrd & Co.
First Union National Bank
Taxable Account
Attn: Diane Pilegg
Mutual Funds DVD Proc. #PA4905
530 Walnut Street
Philadelphia, PA 19106-3620
Owned 1,099,252.743 (5.57%) shares
High Income Fund- Class Z
Ennis D. Robertson
Carefree Country Club
9705 Lake Bess Road #253
Winter Haven, FL 33884-3225
owned 4,219.858 (45.75%) shares
Ennis D. Robertson
Smith Barney Inc. IRA Custodian
Carefree Country Club
9705 Lake Bess Road #253
Winter Haven, FL 33884-3225
owned 4,032.265 (43.71%) shares
Michael A. Blum
Smith Barney Inc. Rollover Custodian
235 East 22nd Street, Apt. 101
New York, NY 10010-4637
owned 967.568 (10.49%) shares
Municipal High Income Fund - Class L
Margaret C. Glass
311 Louise Drive
Lafayette, LA 70506-3239
owned 8,933.416 (6.90%) shares
Joann Donovan
Separate Property
5302 Yarwell Dr.
Houston, TX 77096
owned 8,210.854 (6.35%) shares
Avery Brighton
Mason Flinn Trustees
Larsen Flinn TR 12/16/76
852 Navesink River Road
Locust, NJ 07760
owned 7,143.188 (5.52%) shares
Avery Brighton
Larsen Flinn Trustees
Mason Flinn TR 12/16/76
852 Navesink River Road
Locust, NJ 07760
owned 7,143.188 (5.52%) shares
Mason Flinn
Larsen Flinn Trustees
Avery Flinn Family TR 12/16/76
852 Navesink River Road
Locust, NJ 07760
owned 7,143.188 (5.52%) shares
Terrance Winkler TTEE
FBO Terrance Winkler
UAD 5/29/87
C/o Insurance Brokers Ser. Inc.
20 N. Wacker Drive, 40th Floor
Chicago, Il 60606
Owned 6,904.292 (5.34%) shares
Katherine C. Ellis TTEE
UWD Robert J. Ellis
7580 Spalding Lane
Atlanta, GA 30350
Owned 6,802.927 (5.26%) shares
Balanced Fund- Class L
Roy G. Childers Sr.
Smith Barney Inc. IRA Custodian
559 Vaughan Drive
Satsuma, AL 36572-2861
Owned 23,843.047 (16.05%) shares
Dorothy M Burns
Smith Barney Inc. IRA custodian
21257 Westover Circle
Riverside, CA 92518-2922
Owned 15,916.06 (10.71%) shares
Balanced Fund Class Z
Citibank NA, Custodian
Smith Barney Shearson 401(k) Savings Plan
Smith Barney Account
Attn: Nancy Kronenberg
111 Wall Street FISD/20th Floor
New York, NY 10043
owned 877,093.853 (95.53%) shares
Convertible Fund - Class L
Harold Egon Gottschalk Jr.
And Barbara Gottschalk
Community Property
11603 Osage Trail
Lakeside, CA 92040
Owned 3,409.697 (15.32%) shares
Raymond Trudeau
Smith Barney Inc. IRA Custodian
99 Plummer Hill Road
Belmont, NH 03220-5811
Owned 2,906.239(13.06%) shares
James Kononuk
Smith Barney Inc. Rollover Cust.
130 K 6th Street
North Arlington, NJ 07031
Owned 2,783.765 (12.51%) shares
Harold A. Savage
Smith Barney Inc. IRA Custodian
2108 Ludwick Drive
Maryville, TN 37803
Owned 1,727.101 (7.76%) shares
Wilmer L. Keiser
Betty L. Keiser TTEES
The Keiser Family Trust
UAD 4/1/97
13060 Metcalf, Apt. 303
Overland Park, KS 66213
Owned 1,641.497(7.38%) shares
Rudolph B. and Helen E. Grom
UAD 5/11/92
Rudolph B. & Helen Grom Trust
13627 W. Pyracantha Dr.
Sun City West, AZ 85375
Owned 1,601.537 (7.20%) shares
George K. Stoltenberg
Smith Barney Inc. KEO PS Cust.
44 Church St.
Apt. 3
Burlington, VT 05401
Owned 1,372.171(6.17%) shares
Jay Burgess TRS
FBO Jay G. Burgess
UAD 7/23/85
3061 N. Southern Hills Ave.
Wadsworth, IL 60083
Owned 1,151.401 (5.17%)shares
Marjorie C. Gilmore
Smith Barney Inc. IRA Custodian
1055 West River Road
Grand Island, NY 14072
Owned 1,115.854(5.01%) shares
Convertible Fund - Class O
Norman O. Davis and Karen J. Davis, Trustees
Davis Trust 1995 u/a/d 10/18/95
5280 Via Ester
Yorba Linda, CA 92686-4530
owned 6,862.065 (8.74%) shares
C. Travis Hedemann
2115 Lexington
Houston, TX 77254-0303
owned 4,447.162 (5.66%) shares
Convertible Fund - Class Y
Smith Barney Concert Series, Inc.
Balanced Portfolio
PNC Bank, NA
Attn: Beverly Timson
200 Stevens Drive Suite 440
Lester, PA 19113-1522
owned 3,123,029.234 (61.01%) shares
Smith Barney Concert Series, Inc.
Conservative Portfolio
PNC Bank, NA
Attn: Beverly Timson
200 Stevens Drive Suite 440
Lester, PA 19113-1522
owned 863,496.605 (16.87%) shares
Smith Barney Concert Series, Inc.
Select Balanced Portfolio
PNC Bank, NA
Attn: Beverly Timson
200 Stevens Drive Suite 440
Lester, PA 19113-1522
owned 671,129.248 (13.11%) shares
Diversified Strategic Income Fund Class Y
Smith Barney Concert Series, Inc.
Balanced Portfolio
PNC Bank, NA
Attn: Beverly Timson
200 Stevens Drive Suite 440
Lester, PA 19113-1522
owned 9,225,586.838(52.88%) shares
Smith Barney Concert Series, Inc.
Conservative Portfolio
PNC Bank, NA
Attn: Beverly Timson
200 Stevens Drive Suite 440
Lester, PA 19113-1522
owned 3,302,383.059 (18.93%) shares
Smith Barney Concert Series, Inc.
Select Balanced Portfolio
PNC Bank, NA
Attn: Beverly Timson
200 Stevens Drive Suite 440
Lester, PA 19113-1522
owned 1,992,220.376 (11.42%) shares
Smith Barney Concert Series, Inc.
Income Portfolio
PNC Bank, NA
Attn: Beverly Timson
200 Stevens Drive Suite 440
Lester, PA 19113-1522
owned 1,833,945.945 (10.51%) shares
Diversified Strategic Income Fund Class Z
Citibank NA, Custodian
Smith Barney Shearson 401(k) Savings Plan
Smith Barney Account
Attn: Nancy Kronenberg
111 Wall Street FISD/20th Floor
New York, NY 10043
owned 2,631,963.692 (99.99%) shares
FINANCIAL STATEMENTS
The Funds' Annual Reports for the fiscal year ended July 31, 1998
(accompany 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
obligation. Capacity to pay interest and repay principal is extremely
strong.
AA
Bonds rated AA have a very strong capacity to pay interest and
repay principal 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
interest 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
speculative with respect to capacity to pay interest and repay principal
in accordance 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 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
standards. Together with the Aaa group they comprise what are generally
known as high grade bonds. They are rated lower than the best bonds
because margins of protection may not be as large as in Aaa securities,
or fluctuation of protective elements may be of greater amplitude or
there may be other elements present which make the long-term risks
appear somewhat larger than in Aaa securities.
A
Bonds which are rated A possess favorable investment attributes
and are to be considered as upper medium grade obligations. Factors
giving security to principal and interest are considered adequate but
elements may be present which suggest a susceptibility to impairment
sometime in the future.
Baa
Bonds which are rated Baa are considered as medium grade
obligations, i.e., they are neither highly protected nor poorly secured.
Interest payments and principal security appear adequate for the present
but certain protective elements may be lacking or may be
characteristically unreliable over any great length of time. Such bonds
lack outstanding investment characteristics and in fact have speculative
characteristics as well.
Ba
Bonds which are rated Ba are judged to have speculative elements;
their future cannot be considered as well assured. Often the protection
of interest and principal payments may be very moderate and 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 investments. Assurance of interest and principal payments or
of maintenance of other terms of the contract over any long period of
time may be small.
Caa
Bonds that are rated Caa are of poor standing. These issues may be
in default or present elements of danger may exist with respect to
principal or interest.
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 security ranks in the higher end of its generic rating category; the
modifier 2 indicates a mid-range ranking; and the modifier 3 indicates
that the issue ranks in the lower end of its generic rating category.
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. Quality of management appears superior.
Revenue Bonds -- Debt service coverage has been, and is expected
to remain, substantial. Stability of the pledged revenues is also
exceptionally strong due to the competitive position of the municipal
enterprise or to the nature of the revenues. Basic security provisions
(including rate covenant, earnings test for issuance of additional
bonds, debt service reserve requirements) are rigorous. There is
evidence of superior management.
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
expenditures, 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. Stability of the pledged revenues could show some
variations because of increased competition or economic influences on
revenues. Basic security provisions, while satisfactory, are less
stringent. Management performance appears adequate.
BBB
Medium Grade -- Of the investment grade ratings, this is the
lowest. Bonds in this group are regarded as having an adequate capacity
to pay interest 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.
General Obligation Bonds -- Under certain adverse conditions,
several of the above factors could contribute to a lesser capacity for
payment of debt service. The difference between A and BBB ratings is
that the latter shows more than one fundamental weakness, or one very
substantial fundamental weakness, whereas the former shows only one
deficiency among the factors considered.
Revenue Bonds -- Debt coverage is only fair. Stability of the
pledged revenues could show substantial variations, with the revenue
flow possibly being subject to erosion over time. Basic security
provisions are no more than adequate. Management performance could be
stronger.
BB, B, CCC and CC
Bonds rated BB, B, CCC and CC are regarded, on balance, as
predominately speculative with respect to capacity to pay interest and
repay principal in accordance with the terms of the obligation. BB
includes the lowest degree of speculation and CC the highest degree of
speculation. While such bonds will likely have some quality and
protective characteristics, these are outweighed by large uncertainties
or major risk exposures to adverse conditions.
C
The rating C is reserved for income bonds on which no interest is
being paid.
D
Bonds rated D are in default, and payment of interest and/or
repayment of principal is in arrears.
S&P's letter ratings may be modified by the addition of a plus or
a minus sign, which is used to show relative standing within the major
rating categories, except in the AAA-Prime Grade category.
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 determined to possess overwhelming safety characteristics are
given the designation 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
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be
visualized are most unlikely to impair the fundamentally strong position
of such issues.
Aa
Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally
known as high grade bonds. They are rated lower than the best bonds
because margins of protection may not be as large as in Aaa securities,
or fluctuation of protective elements may be of greater amplitude, or
there may be other elements present which make the long-term risks
appear somewhat larger than in Aaa securities.
A
Bonds which are rated A possess many favorable investment
attributes and are to be considered as upper medium grade obligations.
Factors giving security to principal and interest are considered
adequate, but elements may be present which suggest a susceptibility to
impairment sometime in the future.
Baa
Bonds which are rated Baa are considered as medium grade
obligations, i.e., they are neither highly protected nor poorly secured.
Interest payments and principal security appear adequate for the present
but certain protective elements may be lacking or may be
characteristically unreliable over any great length of time. Such bonds
lack outstanding investment characteristics and in fact have speculative
characteristics as well.
Ba
Bonds which are rated Ba are judged to have speculative elements;
their future cannot be considered as well assured. Often the protection
of interest and principal payments may be very moderate and 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 default 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 shortcomings.
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 security 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, enjoying strong protection from established cash flows
of funds for their servicing or from established and broad-based access
to the market for refinancing, 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 favorable quality, with all security
elements accounted for but lacking the undeniable 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 regarded 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 characteristics (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 possesses above average long-term fundamental operating
and financing capabilities 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 borrowing; basic earnings
and cash flow have an upward trend with allowance made for unusual
circumstances; typically, the issuer's industry is well established and
the issuer has a strong position within the industry; and the
reliability and quality of management are unquestioned.
The rating Prime-1 is the highest commercial paper rating assigned
by Moody's. Among the factors considered by Moody's in assigning ratings
are the following: (a) evaluation of the management of the issuer; (b)
economic evaluation of the issuer's industry or industries and an
appraisal of speculative-type risks which may be inherent in certain
areas; (c) evaluation of the issuer's products in relation to
competition and customer acceptance; (d) liquidity; (e) amount and
quality of long-term debt; (f) trend of earnings over a period of ten
years; (g) financial strength of parent company and the relationships
which exist with the issuer; and (h) recognition by the management of
obligations which may be present or may arise as a result of public
interest questions and preparations to meet such obligations.
Short-term obligations, including commercial paper, rated A-1+ by
IBCA Limited or its affiliate IBCA Inc. are obligations supported by the
highest 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 rating 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
indicates a satisfactory 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+
indicates the highest certainty of timely payment: short-term liquidity
is clearly outstanding and safety is just below risk-free U.S. Treasury
short-term obligations. Duff 1- indicates high certainty of timely
payment. Duff 2 indicates good certainty of timely payment: liquidity
factors and company fundamentals are sound.
Various NRSROs utilize rankings within ratings categories
indicated by a + or -. The Funds, in accordance with industry practice,
recognize such ratings 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
Statement of
Additional Information
November 27, 1998, as amended December 4, 1998
Convertible Fund
Diversified Strategic Income Fund
Exchange Reserve Fund
High Income Fund
Municipal High Income Fund
Total Return Bond Fund
Balanced Fund
Smith Barney
Income Funds
388 Greenwich Street
New York, New York 10013 SALOMON SMITH BARNEY
A Member of CitiGroup
FD 01217 11/98
