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PROSPECTUS JANUARY 21, 1998
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Smith Barney Total Return Bond Fund
388 Greenwich Street
New York, New York 10013
(800) 451-2010
Smith Barney Total Return Bond Fund (the "Fund") is a diversified bond fund
that seeks to maximize total return, consisting of capital appreciation and
income, by investing in a portfolio of fixed-income securities of varying
maturities.
The Fund is one of a number of funds, each having distinct investment
objectives and policies, making up the Smith Barney Income Funds (the "Trust").
The Trust is an open-end management investment company commonly referred to as a
mutual fund.
The initial subscription period for shares is scheduled to end on February
26, 1998 (the "Subscription Period"). After the expiration of the Subscription
Period or a limited continuous offering period, the Fund will suspend the
offering of shares to the public. A continuous offering of shares is expected to
commence on or about March 16, 1998. See "Purchase of Shares."
This Prospectus sets forth concisely certain information about the Fund and
the Trust, including sales charges, distribution and service fees and expenses,
that prospective investors will find helpful in making an investment decision.
Investors are encouraged to read this Prospectus carefully and retain it for
future reference. Shares of other investment funds offered by the Trust are
described in separate prospectuses that may be obtained by calling the Trust at
the telephone number set forth above or by contacting a Smith Barney Financial
Consultant.
Additional information about the Fund and the Trust is contained in a
Statement of Additional Information dated January 21, 1998, as amended or
supplemented from time to time, that is available upon request and without
charge by calling or writing the Trust at the telephone number or address set
forth above or by contacting a Smith Barney Financial Consultant. The Statement
of Additional Information has been filed with the Securities and Exchange
Commission (the "SEC") and is incorporated by reference into this Prospectus in
its entirety.
SMITH BARNEY INC.
Distributor
MUTUAL MANAGEMENT CORP.
Investment Manager
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
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TABLE OF CONTENTS
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PROSPECTUS SUMMARY 3
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INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES 9
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VALUATION OF SHARES 19
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DIVIDENDS, DISTRIBUTIONS AND TAXES 20
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PURCHASE OF SHARES 22
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EXCHANGE PRIVILEGE 33
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REDEMPTION OF SHARES 36
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MINIMUM ACCOUNT SIZE 39
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PERFORMANCE 39
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MANAGEMENT OF THE TRUST AND THE FUND 40
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DISTRIBUTOR 41
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ADDITIONAL INFORMATION 42
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NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS IN CONNECTION WITH THIS OFFERING OTHER THAN THOSE CONTAINED IN
THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE FUND OR THE
DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER BY THE FUND OR THE
DISTRIBUTOR TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY OF THE SECURITIES
OFFERED HEREBY IN ANY JURISDICTION TO ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE
SUCH AN OFFER OR SOLICITATION IN ANY SUCH JURISDICTION.
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2
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PROSPECTUS SUMMARY
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THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY DETAILED INFORMATION
APPEARING ELSEWHERE IN THIS PROSPECTUS AND IN THE STATEMENT OF ADDITIONAL
INFORMATION. CROSS REFERENCES IN THIS SUMMARY ARE TO HEADINGS IN THE PROSPECTUS.
SEE "TABLE OF CONTENTS."
INVESTMENT OBJECTIVE The Fund is an open-end, diversified, management
investment company whose investment objective is to maximize total return. The
Fund seeks to achieve its objective by investing in a professionally managed
portfolio consisting of fixed-income securities of varying maturities. The Fund
will invest primarily in the following types of securities: U.S. government
securities; corporate debt securities; mortgage-related securities; and taxable
municipal securities. The allocation and reallocation of the Fund's assets will
be undertaken by Mutual Management Corp. ("MMC"), formerly known as Smith Barney
Mutual Funds Management Inc., on the basis of its analysis of economic and
market conditions and the relative risks and opportunities of particular types
of fixed-income securities.
ALTERNATIVE PURCHASE ARRANGEMENTS The Fund offers several classes of shares
("Classes") to investors designed to provide them with the flexibility of
selecting an investment best suited to their needs. The general public is
offered three Classes of shares: Class A shares, Class B shares and Class C
shares, which differ principally in terms of sales charges and rates of expenses
to which they are subject. A fourth Class of shares, Class Y shares, is offered
only to investors meeting an initial investment minimum of $5,000,000. See
"Purchase of Shares" and "Redemption of Shares."
CLASS A SHARES. Class A shares are sold at net asset value plus an initial
sales charge of up to 4.50% and are subject to an annual service fee of 0.25% of
the average daily net assets of the Class. The initial sales charge may be
reduced or waived for certain purchases. Purchases of Class A shares of $500,000
or more will be made at net asset value with no initial sales charge but will be
subject to a contingent deferred sales charge ("CDSC") of 1.00% on redemptions
made within 12 months of purchase. See "Prospectus Summary -- Alternative
Purchase Arrangements -- Reduced or No Initial Sales Charge."
CLASS B SHARES. Class B shares are offered at net asset value subject to a
maximum CDSC of 4.50% of redemption proceeds, declining by 0.50% the first year
after purchase and by 1.00% each year thereafter to zero. This CDSC may be
waived for certain redemptions. Class B shares are subject to an annual service
fee of 0.25% and an annual distribution fee of 0.50% of the average daily net
assets of the Class. The Class B shares' distribution fee may cause that Class
to have higher expenses and pay lower dividends than Class A shares.
3
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PROSPECTUS SUMMARY (CONTINUED)
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CLASS B SHARES CONVERSION FEATURE. Class B shares will convert
automatically to Class A shares, based on relative net asset value, eight years
after the date of the original purchase. Upon conversion, these shares will no
longer be subject to an annual distribution fee. In addition, a certain portion
of Class B shares that have been acquired through the reinvestment of dividends
and distributions ("Class B Dividend Shares") will be converted at that time.
See "Purchase of Shares -- Deferred Sales Charge Alternatives."
CLASS C SHARES. Class C shares are sold at net asset value with no initial
sales charge. They are subject to an annual service fee of 0.25% and an annual
distribution fee of 0.45% of the average daily net assets of the Class, and
investors pay a CDSC of 1.00% if they redeem Class C shares within 12 months of
purchase. The CDSC may be waived for certain redemptions. The Class C shares'
distribution fee may cause that Class to have higher expenses and pay lower
dividends than Class A shares. Purchases of Fund shares, which when combined
with current holdings of Class C shares of the Fund equal or exceed $500,000 in
the aggregate, should be made in Class A shares at net asset value with no sales
charge, and will be subject to a CDSC of 1.00% on redemptions made within 12
months of purchase.
CLASS Y SHARES. Class Y shares are available only to investors meeting an
initial investment minimum of $5,000,000. Class Y shares are sold at net asset
value with no initial sales charge or CDSC. They are not subject to any service
or distribution fees.
In deciding which Class of Fund shares to purchase, investors should
consider the following factors, as well as any other relevant facts and
circumstances:
INTENDED HOLDING PERIOD. The decision as to which Class of shares is more
beneficial to an investor depends on the amount and intended duration of his or
her investment. Shareholders who are planning to establish a program of regular
investment may wish to consider Class A shares; as the investment accumulates
shareholders may qualify for reduced sales charges and the shares are subject to
lower ongoing expenses over the term of the investment. As an alternative, Class
B and Class C shares are sold without any initial sales charge so the entire
purchase price is immediately invested in the Fund. Any investment return on
these additional invested amounts may partially or wholly offset the higher
annual expenses of these Classes. Because the Fund's future return cannot be
predicted, however, there can be no assurance that this would be the case.
4
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PROSPECTUS SUMMARY (CONTINUED)
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Finally, investors should consider the effect of the CDSC period and any
conversion rights of the Classes in the context of their own investment time
frame. For example, while Class C shares have a shorter CDSC period than Class B
shares, they do not have a conversion feature and therefore are subject to an
ongoing distribution fee. Thus, Class B shares may be more attractive than Class
C shares to investors with longer-term investment outlooks.
REDUCED OR NO INITIAL SALES CHARGE. The initial sales charge on Class A
shares may be waived for certain eligible purchasers and the entire purchase
price would be immediately invested in the Fund. In addition, Class A share
purchases of $500,000 or more will be made at net asset value with no initial
sales charge but will be subject to a CDSC of 1.00% on redemptions made within
12 months of purchase. The $500,000 investment may be met by adding the purchase
to the net asset value of all Class A shares held in certain funds sponsored by
Smith Barney Inc. ("Smith Barney") listed under "Exchange Privilege." Class A
share purchases may also be eligible for a reduced initial sales charge. See
"Purchase of Shares." Because the ongoing expenses of Class A shares may be
lower than those for Class B and Class C shares, purchasers eligible to purchase
Class A shares at net asset value or at a reduced sales charge should consider
doing so.
Smith Barney Financial Consultants may receive different compensation for
selling the different Classes of shares. Investors should understand that the
purpose of the CDSC on the Class B and Class C shares is the same as that of the
initial sales charge on the Class A shares.
See "Purchase of Shares" and "Management of the Trust and the Fund" for a
complete description of the sales charges and service and distribution fees for
each Class of shares and "Valuation of Shares," "Dividends, Distributions and
Taxes" and "Exchange Privilege" for other differences between the Classes of
shares.
SMITH BARNEY 401(k) AND EXECCHOICE-TM- PROGRAMS Investors may be eligible to
participate in the Smith Barney 401(k) Program, which is generally designed to
assist plan sponsors in the creation and operation of retirement plans under
Section 401(a) of the Internal Revenue Code of 1986, as amended (the "Code"), as
well as other types of participant-directed, tax-qualified employee benefit
plans. Other investors may be eligible to participate in the Smith Barney
ExecChoice-TM- Program. Class A and Class C shares are available as investment
alternatives under both of these programs. See "Purchase of Shares -- Smith
Barney 401(k) and ExecChoice-TM- Program Programs."
5
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PROSPECTUS SUMMARY (CONTINUED)
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PURCHASE OF SHARES Shares may be purchased through the Fund's distributor,
Smith Barney, a broker that clears securities transactions through Smith Barney
on a fully disclosed basis (an "Introducing Broker") or an investment dealer in
the selling group during the continuous offering period.
The initial subscription period for shares is scheduled to end on February
26, 1998 (the "Subscription Period"). After the expiration of the Subscription
Period or a limited continuous offering period, the Fund will suspend the
offering of shares to the public. A continuous offering of shares is expected to
commence on or about March 16, 1998. See "Purchase of Shares."
INVESTMENT MINIMUMS Investors in Class A, Class B and Class C shares may open
an account by making an initial investment of at least $1,000 for each account.
Investors in Class Y shares may open an account for an initial investment of
$5,000,000. Subsequent investments of at least $50 may be made for all Classes.
The minimum initial investment requirement for Class A, Class B and Class C
shares and the subsequent investment requirement for all Classes through the
Systematic Investment Plan are described below. There is no minimum investment
requirement in Class A for unitholders who invest distributions from a unit
investment trust ("UIT") sponsored by Smith Barney. See "Purchase of Shares."
SYSTEMATIC INVESTMENT PLAN The Fund offers shareholders a Systematic Investment
Plan under which they may authorize the automatic placement of a purchase order
each month or quarter for Fund shares. The minimum initial investment
requirement for Class A, Class B and Class C shares and the subsequent
investment requirement for all Classes for shareholders purchasing shares
through the Systematic Investment Plan on a monthly basis is $25 and on a
quarterly basis is $50. See "Purchase of Shares."
REDEMPTION OF SHARES Shares may be redeemed on each day the New York Stock
Exchange, Inc. ("NYSE") is open for business. See "Purchase of Shares" and
"Redemption of Shares."
MANAGEMENT OF THE TRUST AND THE FUND MMC serves as the Fund's investment
manager. MMC is a wholly owned subsidiary of Salomon Smith Barney Holdings Inc.
("Holdings"), which, in turn, is a wholly owned subsidiary of Travelers Group
Inc. ("Travelers"), a diversified financial services holding company engaged,
through its subsidiaries, principally in four business segments: Investment
Services, Consumer Finance Services, Life Insurance Services and Property &
Casualty Insurance Services. See "Management of the Trust and the Fund."
6
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PROSPECTUS SUMMARY (CONTINUED)
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EXCHANGE PRIVILEGE Shares of a Class may be exchanged for shares of the same
class of certain other Smith Barney Mutual Funds at the respective net asset
values next determined. See "Exchange Privilege."
VALUATION OF SHARES Net asset value of the Fund for the prior day is generally
quoted daily in the financial section of most newspapers and is also available
from Smith Barney Financial Consultants. See "Valuation of Shares."
DIVIDENDS AND DISTRIBUTIONS Dividends from net investment are paid monthly and
distributions of net realized capital gains, if any, are paid annually. See
"Dividends, Distributions and Taxes."
REINVESTMENT OF DIVIDENDS Dividends and distributions paid on shares of any
Class will be reinvested automatically, unless otherwise specified by an
investor, in additional shares of the same Class at current net asset value.
Shares acquired by dividend and distribution reinvestments will not be subject
to any sales charge or CDSC. Class B shares acquired through dividend and
distribution reinvestments will become eligible for conversion to Class A shares
on a pro rata basis. See "Dividends, Distributions and Taxes."
RISK FACTORS AND SPECIAL CONSIDERATIONS There can be no assurance that the Fund
will achieve its investment objective. The market value of fixed-income
securities, which constitute a major part of the investments of the Fund, may
vary inversely in response to changes in prevailing interest rates. The Fund may
employ investment techniques which involve certain risks, including entering in
repurchase agreements and reverse repurchase agreements, entering into forward
roll transactions, purchasing or selling securities on a when-issued or
delayed-delivery basis, lending portfolio securities and entering into
transactions involving options and futures contracts. See "Investment Objective
and Management Policies -- Certain Investment Strategies."
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PROSPECTUS SUMMARY (CONTINUED)
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THE FUND'S EXPENSES THE FOLLOWING EXPENSE TABLE LISTS THE COSTS AND EXPENSES AN
INVESTOR WILL INCUR EITHER DIRECTLY OR INDIRECTLY AS A SHAREHOLDER OF THE FUND,
BASED UPON THE MAXIMUM SALES CHARGE OR MAXIMUM CDSC THAT MAY BE INCURRED AT THE
TIME OF PURCHASE OR REDEMPTION AND, UNLESS OTHERWISE NOTED, THE FUND'S OPERATING
EXPENSES FOR ITS MOST RECENT FISCAL YEAR:
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SMITH BARNEY TOTAL RETURN BOND FUND CLASS A CLASS B CLASS C CLASS Y
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SHAREHOLDER TRANSACTION EXPENSES
Maximum sales charge imposed on purchases (as
a percentage of offering price) 4.50% None None None
Maximum CDSC (as a percentage of original cost
or redemption proceeds, whichever is lower) None* 4.50% 1.00% None
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ANNUAL FUND OPERATING EXPENSES
(as a percentage of average net assets)
Management fees 0.65% 0.65% 0.65% 0.65%
12b-1 fees** 0.25 0.75 0.70 None
Other expenses*** 0.14 0.12 0.12 0.10
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TOTAL OPERATING EXPENSES 1.04% 1.52% 1.47% 0.75%
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* Purchases of Class A shares of $500,000 or more will be made at net asset
value with no sales charge, but will be subject to a CDSC of 1.00% on
redemptions made within 12 months of purchase.
** Upon conversion of Class B shares to Class A shares, such shares will no
longer be subject to a distribution fee. Class C shares do not have a
conversion feature and, therefore, are subject to an ongoing distribution
fee. As a result, long-term shareholders of Class C shares may pay more
than the economic equivalent of the maximum front-end sales charge
permitted by the National Association of Securities Dealers, Inc.
*** For Class A, B, C and Y shares, "Other Expenses" have been estimated
because no Class A, B, C or Y shares were outstanding during the fiscal
year ended July 31, 1997.
Class A shares of the Fund purchased through the Smith Barney AssetOne
Program will be subject to an annual asset-based fee, payable quarterly, in lieu
of the initial sales charge. The fee will vary to a maximum of 1.50%, depending
on the amount of assets held through the Program. For more information, please
call your Smith Barney Financial Consultant.
The sales charge and CDSC set forth in the above table are the maximum
charges imposed on purchases or redemptions of Fund shares and investors may
actually pay lower or no charges depending on the amount purchased and, in the
case of Class B, Class C and certain Class A shares, the length of time the
shares are held. See "Purchase of Shares" and "Redemption of Shares." Smith
Barney receives an annual 12b-1 service fee of 0.25% of the value of average
daily net assets of Class A shares. Smith Barney also receives, with respect to
Class B shares, an annual 12b-1 fee of 0.75% of the value of average daily net
assets of that Class, consisting of a 0.50% distribution fee and a 0.25% service
fee. With respect to Class C shares, Smith Barney receives an annual 12b-1 fee
8
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PROSPECTUS SUMMARY (CONTINUED)
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of 0.70% of the value of average daily net assets of the Class, consisting of a
0.45% distribution fee and a 0.25% service fee. "Other expenses" in the above
table include fees for shareholder services, custodial fees, legal and
accounting fees, printing costs and registration fees.
EXAMPLE THE FOLLOWING EXAMPLE IS INTENDED TO ASSIST AN INVESTOR IN
UNDERSTANDING THE VARIOUS COSTS THAT AN INVESTOR IN THE FUND WILL BEAR DIRECTLY
OR INDIRECTLY. THE EXAMPLE ASSUMES PAYMENT BY THE FUND OF OPERATING EXPENSES AT
THE LEVELS SET FORTH IN THE TABLE ABOVE. SEE "PURCHASE OF SHARES," "REDEMPTION
OF SHARES" AND "MANAGEMENT OF THE TRUST AND THE FUND."
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SMITH BARNEY TOTAL RETURN BOND FUND 1 YEAR 3 YEARS
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An investor would pay the following expenses on a
$1,000 investment, assuming (1) 5.00% annual
return and (2) redemption at the end of each time
period:
Class A $ 55 $ 77
Class B 60 78
Class C 25 46
Class Y 8 24
An investor would pay the following expenses on
the same investment, assuming the same annual
return and no redemption:
Class A 55 77
Class B 15 48
Class C 15 46
Class Y 8 24
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The example also provides a means for the investor to compare expense levels
of funds with different fee structures over varying investment periods. To
facilitate such comparison, all funds are required to utilize a 5.00% annual
return assumption. However, the Fund's actual return will vary and may be
greater or less than 5.00%. THIS EXAMPLE SHOULD NOT BE CONSIDERED A
REPRESENTATION OF PAST OR FUTURE EXPENSES AND ACTUAL EXPENSES MAY BE GREATER OR
LESS THAN THOSE SHOWN.
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES
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The Fund seeks to maximize total return, consisting of capital appreciation
and income, by investing in fixed-income securities. In attempting to achieve
its objective, the Fund allocates and reallocates its assets primarily among
various types of fixed-income securities selected by MMC. The types of
fixed-income securities among which the Fund's assets will be primarily
allocated are: obligations issued or guaranteed as to principal and interest by
the United States
9
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INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
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government ("U.S. government securities"); mortgage-related securities issued by
various governmental and non-governmental entities; domestic investment-grade
corporate debt securities; and taxable municipal securities.
The allocation and reallocation of the Fund's assets will be undertaken by
MMC on the basis of its analysis of economic and market conditions and the
relative risks and opportunities of particular types of fixed-income securities.
The average portfolio duration will vary based on MMC's forecast for interest
rates. At any given time, the Fund may be entirely or partially invested in a
particular type of fixed-income security. Under normal conditions, at least 65%
of the Fund's assets will be invested in fixed-income securities.
The "total return" sought by the Fund will consist of interest and dividends
from underlying securities, capital appreciation reflected in unrealized
increases in value of fund securities (realized by the shareholder only upon
selling shares), or realized from the purchase and sale of securities and the
use of futures and options. The change in market value of fixed-income
securities (and therefore their capital appreciation) is largely a function of
changes in the current level of interest rates.
The Fund's ability to achieve maximum total return is limited in certain
markets because the Fund can only invest in fixed-income securities.
CHARACTERISTICS AND RISKS OF SECURITIES AND INVESTMENT TECHNIQUES
The Fund will invest principally in the following securities:
U.S. GOVERNMENT SECURITIES
The U.S. government securities in which the Fund may invest include direct
obligations of the United States Treasury (such as Treasury Bills, Treasury
Notes and Treasury Bonds) and obligations issued by U.S. government agencies and
instrumentalities, including: securities supported by the full faith and credit
of the United States (such as Government National Mortgage Association ("GNMA")
certificates); securities supported by the right of the issuer to borrow from
the United States Treasury (such as securities of Federal Home Loan Banks); and
securities supported by the credit of the instrumentality (such as Federal
National Mortgage Association ("FNMA") and Federal Home Loan Mortgage
Corporation ("FHLMC") bonds). Treasury Bills have maturities of less than one
year, Treasury Notes have maturities of one to 10 years and Treasury Bonds
generally have maturities of greater than 10 years at the date of issuance.
Certain U.S. government securities, such as those issued or guaranteed by GNMA,
FNMA and FHLMC, are mortgage-related securities. U.S. government securities
generally do not involve the credit risks associated with
10
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INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
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other types of interest bearing securities, although, as a result, the yields
available from U.S. government securities are generally lower than the yields
available from interest-bearing corporate securities.
CORPORATE DEBT SECURITIES
Corporate debt securities include corporate bonds, debentures, notes and
other similar corporate debt securities. The Fund will purchase a corporate debt
security if MMC believes that the yield and, to a lesser extent, the potential
for capital appreciation of the security are sufficiently attractive in light of
the risks of ownership of the security. In determining whether the Fund should
invest in a particular debt security, MMC will consider factors such as the
price, coupon and yield to maturity of the security; the credit quality of the
issuer; the issuer's available cash flow and the related coverage ratios; the
property, if any, securing the obligation; and the terms of the debt security,
including the subordination, default, sinking fund and early redemption
provisions. MMC also will review the ratings, if any, assigned to the security
by Moody's Investors Service, Inc. ("Moody's"), Standard & Poor's Ratings Group
("S&P") or other nationally recognized statistical rating organizations
("NRSROs"). MMC's judgments as to credit quality of a debt security may differ,
however, from that suggested by the ratings published by a NRSRO.
MORTGAGE-RELATED SECURITIES
Mortgage-related securities in which the Fund may invest include mortgage
obligations collateralized by mortgage loans or mortgage pass-through
certificates. Under current market conditions, the Fund's holdings of mortgage-
related securities may be expected to consist primarily of securities issued or
guaranteed by GNMA, FNMA and FHLMC. The composition of the Fund's investments in
mortgage-related securities, however, will vary from time to time based upon a
determination of MMC on how best to achieve the Fund's investment objective,
taking into account factors such as the liquidity and yield of various
mortgage-related securities. Mortgage-related securities held by the Fund
generally will be rated no lower than Aa by Moody's or AA by S&P or, if not
rated, will be of equivalent investment quality as determined by MMC. MMC may
also consider the ratings, if any, assigned to mortgage-related securities by
NRSROs other than Moody's and S&P.
Mortgage-related securities provide a monthly payment consisting of interest
and principal payments. Additional payments may be made out of unscheduled
repayments of principal resulting from the sale, refinancing or foreclosure of
the underlying residential property, net of fees or costs that may be incurred.
Prepayments of principal on mortgage-related securities may tend to increase due
to refinancing of mortgages as interest rates decline. Mortgage pools created by
11
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INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
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private organizations generally offer a higher rate of interest than government
and government-related pools because no direct or indirect guarantees of payment
are applicable with respect to the former pools. Timely payment of interest and
principal in these pools, however, may be supported by various forms of private
insurance or guarantees, including individual loan, title, pool and hazard
insurance. There can be no assurance that the private insurers can meet their
obligation under the policies. Prompt payment of principal and interest on GNMA
mortgage pass-through certificates is backed by the full faith and credit of the
United States. FNMA-guaranteed mortgage pass-through certificates and FHLMC
participation certificates are solely the obligations of those entities but are
supported by the discretionary authority of the United States government to
purchase the agencies' obligations. Collateralized mortgage obligations are a
type of bond secured by an underlying pool of mortgages or mortgage pass-through
certificates structured to direct payments on underlying collateral to different
series or classes of the obligations.
To the extent that the Fund purchases mortgage-related securities at a
premium, mortgage foreclosures and prepayments of principal by mortgagors (which
may be made at any time without penalty) may result in some loss of the Fund's
principal investment to the extent of the premium paid. The Fund's yield may be
affected by reinvestment of prepayments at higher or lower rates than the
original investment. In addition, like other debt securities, the values of
mortgage-related securities, including government and government-related
mortgage pools, generally will fluctuate in response to market interest rates.
TAXABLE MUNICIPAL SECURITIES
The Fund will also 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
12
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INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
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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.
Further information about the Fund's investment policies, including a list
of those restrictions on the Fund's investment activities that cannot be changed
without shareholder approval, appears in the Statement of Additional
Information.
ADDITIONAL INVESTMENTS
ZERO COUPON SECURITIES. The Fund may also invest in zero coupon bonds. A
zero coupon bond pays no interest in cash to its holder during its life,
although interest is accrued during that period. Its value to an investor
consists of the difference between its face value at the time of maturity and
the price for which it was acquired, which is generally an amount significantly
less than its face value (sometimes referred to as a "deep discount" price).
Because such securities usually trade at a deep discount, they will be subject
to greater fluctuations of market value in response to changing interest rates
than debt obligation of comparable maturities which make periodic distribution
of interest. On the other hand, because there are not periodic interest payments
to be reinvested prior to maturity, zero coupon securities eliminate
reinvestment risk and lock in a rate of return to maturity.
ASSET-BACKED SECURITIES. An asset-backed security represents an interest in
a pool of assets such as receivables from credit card loans, automobile loans
and other trade receivables. Changes in the market's perception of the asset
backing the security, the creditworthiness of the servicing agent for the loan
pool, the originator of the loans, or the financial institution providing any
credit enhancement will all affect the value of an asset-backed security, as
will the exhaustion of any credit enhancement. The risks of investing in
asset-backed securities ultimately depend upon the payment of the consumer loans
by the individual borrowers. In its capacity as purchaser of an asset-backed
security, the Fund would generally have no recourse to the entity that
originated the loans in the event of default by the borrower. Additionally, in
the same manner as described above under "Mortgage-Related Securities" with
respect to prepayment of a pool of mortgage loans underlying mortgage-related
securities, the loans underlying asset-backed securities are subject to
prepayments, which may shorten the weighted average life of such securities and
may lower their return.
MEDIUM-, LOW- AND UNRATED SECURITIES. The Fund may invest up to 10% of its
assets in medium- or low-rated securities and unrated securities of comparable
quality. Generally, these securities offer a higher current yield than
13
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INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
- -------------------------------------------------------------------
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. A more detailed discussion of the risks
associated with medium, low- and unrated securities appears in the Statement of
Additional Information.
CERTAIN INVESTMENT STRATEGIES
In attempting to achieve its investment objective, the Fund may employ, the
following portfolio strategies:
WHEN-ISSUED SECURITIES AND DELAYED-DELIVERY TRANSACTIONS. In order to
secure yields or prices deemed advantageous at the time, the Fund may purchase
or sell securities offered on a when-issued or delayed-delivery basis. The Fund
will enter into a when-issued transaction for the purpose of acquiring
securities and not for the purpose of leverage. In such transactions, delivery
of the securities occurs beyond the normal settlement period but no payment or
delivery is made by the Fund prior to the actual delivery or payment by the
other party to the transaction. Due to fluctuations in the value of securities
purchased or sold on a when-issued or delayed-delivery basis, the yields
obtained on such securities may be higher or lower than the yields available in
the market on the dates when the investments are actually delivered to the
buyers. The Fund will establish a segregated account with the Fund's custodian
consisting of cash, U.S. government securities, debt securities of any grade or
equity securities having a value equal to or greater than the Fund's purchase
commitments, provided such securities have been determined by MMC to be liquid
and unencumbered and are marked to market daily pursuant to guidelines
established by the Trustees. Placing securities rather than cash in the
segregated account may have a leveraging effect on the Fund's net assets.
14
<PAGE>
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
- -------------------------------------------------------------------
FORWARD ROLL TRANSACTIONS. In order to enhance current income, the Fund may
enter into forward roll transactions with respect to mortgage-related securities
issued by GNMA, FNMA and FHLMC. In a forward roll transaction, the Fund sells a
mortgage security to a financial institution, such as a bank or broker-dealer,
and simultaneously agrees to repurchase a similar security from the institution
at a later date at an agreed-upon price. The mortgage securities repurchased
will bear the same interest rate as those sold, but generally will be
collateralized by different pools of mortgages with different prepayment
histories than those sold. During the period between the sale and repurchase,
the Fund will not be entitled to receive interest and principal payments on the
securities sold. Proceeds of the sale will be invested in short-term
instruments, particularly repurchase agreements, and the income from these
investments, together with any additional fee income received on the sale, will
generate income for the Fund exceeding the yield on the securities sold. Forward
roll transactions involve the risk that the market value of the securities sold
by the Fund may decline below the repurchase price of those securities. At the
time the Fund enters into forward roll transactions, it will establish a
segregated account with the Fund's custodian consisting of cash, U.S. government
securities, equity securities or debt securities of any grade having a value
equal to or greater than the repurchase price, provided such securities have
been determined by MMC to be liquid and unencumbered and are marked to market
daily pursuant to guidelines established by the Trustees.
MONEY MARKET INSTRUMENTS. Under normal market conditions, the Fund may hold
up to 20% of its total assets in cash or money market instruments, including
taxable money market instruments. In addition, when MMC believes that market
conditions warrant, the Fund may take a temporary defensive posture and invest
without limitation in short-term instruments. Securities eligible for short-term
investment by the Fund include: U.S. government securities; certain bank
obligations (including certificates of deposit, time deposits and bankers'
acceptances of domestic banks, domestic savings and loan associations and
similar institutions); commercial paper rated no lower than A-2 by S&P or
Prime-2 by Moody's or the equivalent from another NRSRO or, if unrated, of an
issuer having an outstanding unsecured debt issue then rated within the three
highest rating categories; and repurchase agreements as described below.
REPURCHASE AGREEMENTS. The Fund may engage repurchase agreement
transactions with certain member banks of the Federal Reserve System and with
certain dealers on the Federal Reserve Bank of New York's list of reporting
dealers. Under the terms of a typical repurchase agreement, the Fund would
acquire an underlying debt obligation for a relatively short period (usually not
more than one week) subject to an obligation of the seller to repurchase, and
the
15
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INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
- -------------------------------------------------------------------
Fund to resell, the obligation at an agreed-upon time and price, thereby
determining the yield during the Fund's holding period. This arrangement results
in a fixed rate of return that is not subject to market fluctuations during the
Fund's holding period. The value of the underlying securities will be at least
equal at all times to the total amount of the repurchase obligation, including
interest. Repurchase agreements could involve certain risks in the event of
default or insolvency of the other party, including possible delays or
restrictions upon the Fund's ability to dispose of the underlying securities,
the risk of a possible decline in the value of the underlying securities during
the period in which the Fund seeks to assert its rights to them, the risk of
incurring expenses associated with asserting those rights and the risk of losing
all or part of the income from the agreement. MMC, acting under the supervision
of the Board of Trustees, reviews on an ongoing basis the value of the
collateral and the creditworthiness of those banks and dealers with which the
Fund may enter into repurchase agreements to evaluate potential risks.
REVERSE REPURCHASE AGREEMENTS. The Fund may enter into reverse repurchase
agreement transactions with member banks of the Federal Reserve Bank of New
York's list of reporting dealers. A reverse repurchase agreement, which is
considered a borrowing by the Fund, involves a sale by the Fund of securities
that it holds concurrently with an agreement by the Fund to repurchase the same
securities at an agreed-upon time and price. The Fund typically will invest the
proceeds of a reverse repurchase agreement in money market instruments or
repurchase agreements maturing not later than the expiration of the reverse
repurchase agreement. This use of the proceeds is known as leverage. The Fund
will enter into a reverse repurchase agreement for leveraging purposes only when
the interest income to be earned from the investment of the proceeds is greater
than the interest expense of the transaction. The Fund also may use the proceeds
of reverse repurchase agreements to provide liquidity to meet redemption
requests when the sale of the Fund's securities is considered to be
disadvantageous.
FINANCIAL FUTURES AND OPTIONS TRANSACTIONS. When deemed advisable by MMC,
the 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.
16
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INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
- -------------------------------------------------------------------
In entering into a financial futures contract, the Fund will be required to
deposit with the broker through which it undertakes the transaction an amount of
cash or cash equivalents equal to approximately 5% of the contract amount. This
amount, which is known as "initial margin," is subject to change by the exchange
or board of trade on which the contract is traded, and members of the exchange
or board of trade may charge a higher amount. Initial margin is in the nature of
a performance bond or good faith deposit on the contract that is returned to the
Fund upon termination of the futures contract, assuming all contractual
obligations have been satisfied. In accordance with a process known as
"marking-to-market," subsequent payments called "variation margin," will be made
daily to and by the broker as the price of the securities underlying the futures
contract fluctuates, making the long and short positions in the futures contract
more or less valuable. At any time prior to the expiration of a futures
contract, the Fund may elect to close the position by taking an opposite
position, which will terminate the Fund's existing position in the contract.
A financial futures contract provides for the future sale by one party and
the purchase by the other party of a certain amount of specified property at a
specified price, date, time and place. Unlike a direct investment in a futures
contract, an option on a financial futures contract gives the purchaser the
right, in return for the premium paid, to assume a position in the financial
futures contract at a specified exercise price at any time prior to the
expiration date of the option. 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
loss related to the purchase of an option on financial futures contracts is
limited to the premium paid for the option, plus transaction costs. The value of
the option may change daily and that change would be reflected in the net asset
value of the Fund.
Regulations of the Commodity Futures Trading Commission applicable to the
Fund require that its transactions in financial futures contracts and options on
financial futures contracts be engaged in for bona fide hedging purposes, or if
the Fund enters into futures contracts for speculative purposes, that the
aggregate initial margin deposits and premiums paid by the Fund will not exceed
5% of the market value of its assets. In addition, the Fund will, with respect
to its purchases of financial futures contracts, establish a segregated account
consisting of cash or cash equivalents in an amount equal to the total market
value of the futures contracts, less the amount of initial margin on deposit for
the contracts.
17
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INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
- -------------------------------------------------------------------
Although the Fund intends to enter into financial futures contracts and
options on financial futures contracts traded on a domestic exchange or board of
trade only if an active market exists for those instruments, no assurance can be
given that an active market will exist for them at any particular time. If
closing a futures position in anticipation of adverse price movements is not
possible, the Fund would be required to make daily cash payments of variation
margin. In those circumstances, an increase in the value of the portion of the
Fund's investments being hedged, if any, may partially or completely offset
losses on the futures contract. No assurance can be given, however, that the
price of the securities being hedged will correlate with the price movements in
a futures contract, and thus provide an offset to losses on the futures contract
or option on the futures contract. In addition, due to the risk of an imperfect
correlation between securities held by the Fund that are the subject of a
hedging transaction and the futures or options used as a hedging device, the
hedge may not be fully effective because, for example, losses on the securities
held by the Fund may be in excess of gains on the futures contract or losses on
the futures contract may be in excess of gains on the securities held by the
Fund that were the subject of the hedge. In an effort to compensate for the
imperfect correlation of movements in the price of the securities being hedged
and movements in the price of futures contracts, the Fund may enter into
financial futures contracts or options on financial futures contracts in a
greater or lesser dollar amount than the dollar amount of the securities being
hedged if the historical volatility of the futures contract has been less or
greater than that of the securities. This "over hedging" or "under hedging" may
adversely affect the Fund's net investment results if market movements are not
as anticipated when the hedge is established.
If the Fund has hedged against the possibility of an increase in interest
rates adversely affecting the value of securities it holds and rates decrease
instead, the Fund will lose part or all of the benefit of the increased value of
securities that it has hedged because it will have offsetting losses in its
futures or options positions. In addition, in those situations, if the Fund has
insufficient cash, it may have to sell securities to meet daily variation margin
requirements on the futures contracts at a time when it may be disadvantageous
to do so. These sales of securities may, but will not necessarily, be at
increased prices that reflect the decline in interest rates.
LENDING OF PORTFOLIO SECURITIES. Consistent with applicable regulatory
requirements, the Fund may lend securities it holds to brokers, dealers and
other financial organizations. The Fund's loans of securities will be
collateralized by cash, letters of credit or government securities that are
maintained at all times in a segregated account with the Fund's custodian in an
amount at least equal to the current market value of the loaned securities. By
lending its portfolio securities, the Fund will seek to generate income by
continuing to receive
18
<PAGE>
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES (CONTINUED)
- -------------------------------------------------------------------
interest on the loaned securities, by investing the cash collateral in
short-term instruments or by obtaining yield in the form of interest paid by the
borrower when government securities are used as collateral. The risks in lending
portfolio securities, as with other extensions of secured credit, consist of
possible delays 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 MMC to be of good standing
and will not be made unless, in the judgment of MMC, the consideration to be
earned from such loans would justify the risk.
CERTAIN ADDITIONAL INVESTMENT GUIDELINES
Up to 15% of the assets of the Fund may be invested in securities with
contractual or other restrictions on resale and other instruments not readily
marketable, including (a) repurchase agreements with maturities greater than
seven days and (b) time deposits maturing from two business days through seven
calendar days. Not withstanding the foregoing, the Fund shall not invest more
that 10% of its net assets in securities that are restricted, excluding those
subject to Rule 144A under the Securities Act of 1933, as amended (the "1933
Act"). In addition, the Fund may invest up to 5% of its assets in the securities
of issuers which have been in continuous operation for less than three years.
The Fund may also borrow from banks for temporary or emergency purposes, but not
for investment purposes, in an amount up to 33 1/3% of its total assets, and may
pledge its assets to the same extent in connection with such borrowings.
Whenever these borrowings exceed 5% of the value of the Fund's total assets, the
Fund will not make any additional investments. Except for the limitation on
borrowing, the investment guidelines set forth in this paragraph may be changed
at any time without shareholder consent by vote of the Trust's Board of
Trustees. A complete list of investment restrictions that identifies additional
restrictions that cannot be changed without the approval of the majority of the
Fund's outstanding shares is contained in the Statement of Additional
Information.
VALUATION OF SHARES
- -------------------------------------------------------------------
The Fund's net asset value per share is determined as of the close of
regular trading on the NYSE, on each day that the NYSE is open, by dividing the
value of the Fund's net assets attributable to each Class by the total number of
shares of that Class outstanding.
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VALUATION OF SHARES (CONTINUED)
- -------------------------------------------------------------------
The Fund's net asset value per share is determined as of the close of
regular trading on the NYSE on each day that the NYSE is open, by dividing the
value of the Fund's net assets attributable to each Class by the total number of
shares of the Class outstanding.
Generally, the Fund's investments are valued at market value or, in the
absence of a market value with respect to any securities, at fair value as
determined by or under the direction of the Trust's Board of Trustees. Portfolio
securities that are traded primarily on a domestic stock exchange are valued at
the last sale price on that exchange or, if there were no sales during the day,
at the current quoted bid price. Over-the-counter securities are valued on the
basis of the bid price at the close of business on each day. Investments in U.S.
government securities (other than short-term securities) are valued at the
average of the quoted bid and asked prices in the over-the-counter market.
Short-term investments that mature in 60 days or less are valued at amortized
cost whenever the Trustees determine that amortized cost reflects fair value of
those investments. An option generally is valued at the last sale price or, in
the absence of the last sale price, the last offer price. The value of a futures
contract equals the unrealized gain or loss on the contract, which is determined
by marking the contract to the current settlement price for a like contract
acquired on the day on which the futures contract is being valued. A settlement
price may not be used if the market makes a limit move with respect to a
particular commodity or if the underlying securities market experiences
significant price fluctuations after the determination of the settlement price.
In such event, the futures contract will be valued at a fair market price to be
determined by or under the direction of the Board of Trustees. Further
information regarding the Trust's valuation policies with respect to the Fund is
contained in the Statement of Additional Information.
DIVIDENDS, DISTRIBUTIONS AND TAXES
- -------------------------------------------------------------------
DIVIDENDS AND DISTRIBUTIONS
The Fund will be treated separately from the Trust's other funds in
determining the amounts of dividends from investment income and distributions of
capital gains payable to shareholders.
If a shareholder does not otherwise instruct, dividends and capital gains
distributions will be reinvested automatically in additional shares of the same
Class at net asset value, subject to no sales charge or CDSC. In addition, in
order to avoid the application of a 4.00% nondeductible excise tax on certain
undistributed amounts of ordinary income and capital gains, the Fund may make
20
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DIVIDENDS, DISTRIBUTIONS AND TAXES (CONTINUED)
- -------------------------------------------------------------------
an additional distribution shortly before December 31 of each year of any
undistributed ordinary income or capital gains, and expects to make any other
distributions as are necessary to avoid the application of this tax.
If, for any full fiscal year, the Fund's total distributions exceed net
investment income and net realized capital gains, the excess distributions may
be treated as a taxable dividend or as a tax-free return of capital (up to the
amount of the shareholder's tax basis in his or her shares). The amount treated
as a tax-free return of capital will reduce a shareholder's adjusted basis in
his or her shares. Pursuant to the requirements of the Investment Company Act of
1940, as amended (the "1940 Act"), and other applicable laws, a notice will
accompany any distribution paid from sources other than net investment income.
In the event the Fund distributes amounts in excess of its net investment income
and net realized capital gains, such distributions may have the effect of
decreasing the Fund's total assets, which may increase the Fund's expense ratio.
The per share dividends on Class B shares and Class C shares may be lower
than the per share dividends on Class A and Class Y shares, principally as a
result of the distribution fee applicable with respect to Class B and Class C
shares. The per share dividends on Class A shares of the Fund may be lower than
the per share dividends on Class Y shares, principally as a result of the
service fee applicable to Class A shares. Distributions of capital gains, if
any, will be in the same amount for Class A, Class B, Class C and Class Y
shares.
TAXES
The Fund will be treated as a separate taxpayer with the result that, for
Federal income tax purposes, the amount of investment income and capital gains
earned by the Fund will be determined without regard to the earnings of the
other funds of the Trust. The Fund intends to qualify each year as a "regulated
investment company" under the Code. If the Fund qualifies as a regulated
investment company and meets certain distribution requirements, the Fund will
not be subject to Federal income tax on its net investment income and net
capital gains that it distributes to its shareholders.
Dividends paid by the Fund from investment income and distributions of
short-term capital gain will be taxable to shareholders as ordinary income for
Federal income tax purposes, whether received in cash or reinvested in
additional shares.
Furthermore, as a general rule, distributions of long-term capital gain 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
investor has held his or her shares of the Fund.
21
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DIVIDENDS, DISTRIBUTIONS AND TAXES (CONTINUED)
- -------------------------------------------------------------------
The Fund anticipates that most of its dividends will not qualify for the
Corporate Deduction. Each shareholder will receive a statement annually from the
Trust, which will set forth separately the aggregate dollar amount of dividends
and capital gains, including the portion of capital gains eligible for a reduced
maximum 20% tax rate, distributed to the shareholder by the Fund with respect to
the prior calendar year.
Shareholders are urged to consult their tax advisers regarding the
application of Federal, state and local tax laws to their specific situation
before investing in the Fund.
PURCHASE OF SHARES
- -------------------------------------------------------------------
GENERAL
The Fund currently offers four Classes of shares. Class A shares are sold to
investors with an initial sales charge and Class B and Class C shares are sold
without an initial sales charge but are subject to a CDSC payable upon certain
redemptions. Class Y shares are sold without an initial sales charge or a CDSC
and are available only to investors investing a minimum of $5,000,000 (except
for purchases of Class Y shares by Smith Barney Concert Allocation Series Inc.,
for which there is no minimum purchase amount). See "Prospectus Summary --
Alternative Purchase Arrangements" for a discussion of factors to consider in
selecting which Class of shares to purchase.
INITIAL SUBSCRIPTION PERIOD
Smith Barney, the Fund's distributor, will solicit subscriptions for shares
of the Fund during the Subscription Period. Subscriptions for shares must be
made through a brokerage account maintained with Smith Barney or an Introducing
Broker. Shares of the Fund subscribed for during the Subscription Period for
which Smith Barney accepts purchase orders will be issued and sold by the Fund
on the third business day after the end of the Subscription Period (the
"Purchase Date"). Also on the Purchase Date, shareholders of other funds of the
Smith Barney Mutual Funds will be able to exchange shares of such funds for
shares of the Fund. On the Purchase Date, Smith Barney will notify the Fund of
the aggregate number of shares for which it has received and accepted
subscriptions, and the Fund will issue shares for such subscriptions and
commence operations.
The Fund is offering its Class A shares to the public at a maximum purchase
price per share of $12.00, which equals the Class A share initial net asset
value per share of $11.46 plus the maximum sales charge set forth below
22
<PAGE>
PURCHASE OF SHARES (CONTINUED)
- -------------------------------------------------------------------
under "Continuous Offerings". The Fund is offering its Class B, Class C and
Class Y shares to the public at each Class' respective initial net asset value
per share of $11.46.
The Fund and Smith Barney may in their discretion determine to withdraw the
offering without notice for any reason before the end of the Subscription
Period. The Fund also reserves the right to refuse any order in whole or in
part.
CONTINUOUS OFFERINGS
Smith Barney will suspend the offering of shares to the public immediately
after the expiration of the Subscription Period or within three weeks
thereafter. During the three-week period, Smith Barney will commence a limited
continuous offering of shares to the public. Once Smith Barney suspends the
offering of shares to the public (the "Closing Period"), it is expected to do so
for 30 days. This period may be lengthened or shortened in the absolute
discretion of Smith Barney. During the Closing Period, the Fund will invest the
proceeds from its Subscription Period and its continuous offering, if any, and
existing shareholders may request redemptions, purchase additional shares and
exchange shares of the Fund for shares of certain other funds of the Smith
Barney Mutual Funds. See "Exchange Privilege." Immediately after the expiration
of the Closing Period, Smith Barney expects to commence a continuous offering of
shares of the Fund.
During the continuous offering, shares may be purchased through a brokerage
account maintained with Smith Barney. Shares may also be purchased through an
Introducing Broker or an investment dealer in the selling group. In addition,
certain investors, including qualified retirement plans and certain other
institutional investors, may purchase shares directly from the Fund through the
Fund's transfer agent, First Data Investor Services Group, Inc. ("First Data").
When purchasing shares of the Fund, investors must specify whether the purchase
is for Class A, Class B, Class C or Class Y shares. Smith Barney and other
broker-dealers may charge their customers an annual account maintenance fee in
connection with a brokerage account through which an investor purchases or holds
shares. Accounts held directly at First Data are not subject to a maintenance
fee.
Investors in Class A, Class B and Class C shares may open an account in the
Fund by making an initial investment of at least $1,000. Investors in Class Y
shares may open an account by making an initial investment of $5,000,000.
Subsequent investments of at least $50 may be made for all Classes. For
shareholders purchasing shares of the Fund through the Systematic Investment
Plan on a monthly basis, the minimum initial investment requirement for Class A,
Class B and Class C shares and the minimum subsequent investment requirement for
all Classes is $25. For shareholders purchasing shares of the
23
<PAGE>
PURCHASE OF SHARES (CONTINUED)
- -------------------------------------------------------------------
Fund through the Systematic Investment Plan on a quarterly basis, the minimum
initial investment requirement for Class A, Class B and Class C shares and the
subsequent investment requirement for all Classes is $50. There are no minimum
investment requirements for Class A shares for employees of Travelers and its
subsidiaries, including Smith Barney, unitholders who invest distributions from
a UIT sponsored by Smith Barney and Directors or Trustees of any of the Smith
Barney Mutual Funds and their spouses and children. The Fund reserves the right
to waive or change minimums, to decline any order to purchase its shares and to
suspend the offering of shares from time to time. Shares purchased will be held
in the shareholder's account by First Data. Share certificates are issued only
upon a shareholder's written request to the First Data.
The minimum initial investment requirement in the Fund for an account
established under the Uniform Gift to Minors Act is $250 and the minimum
subsequent investment requirement is $50.
Purchase orders received by the Fund or Smith Barney prior to the close of
regular trading on the NYSE, on any day the Fund calculates its net asset value
are priced according to the net asset value determined on that day (the "trade
date"). Orders received by dealers or Introducing Brokers prior to the close of
regular trading on the NYSE on any day the Fund calculates its net asset value
are priced according to the net asset value determined on that day, provided the
order is received by the Fund or Smith Barney prior to Smith Barney's close of
business. For shares purchased through Smith Barney or Introducing Brokers
purchasing through Smith Barney, payment for Fund shares is due on the third
business day after the trade date (the "settlement date"). In all other cases,
payment must be made with the purchase order.
SYSTEMATIC INVESTMENT PLAN
Shareholders may make additions to their accounts at any time by purchasing
shares through a service known as the Systematic Investment Plan. Under the
Systematic Investment Plan, Smith Barney or First Data is authorized through
pre-authorized transfers of at least $25 on a monthly basis, or at least $50 on
a quarterly basis, to charge the shareholder's account held with a bank or other
financial institution as indicated by the shareholder to provide systematic
additions to the shareholder's Fund account. A shareholder who has insufficient
funds to complete the transfer will be charged a fee of up to $25 by Smith
Barney or First Data. The Systematic Investment Plan also authorizes Smith
Barney to apply cash held in the shareholder's Smith Barney brokerage account or
redeem the shareholder's shares of a Smith Barney money market fund to make
additions to the account. Additional information is available from the Fund or a
Smith Barney Financial Consultant.
24
<PAGE>
PURCHASE OF SHARES (CONTINUED)
- -------------------------------------------------------------------
INITIAL SALES CHARGE ALTERNATIVE -- CLASS A SHARES
The sales charges applicable to purchases of Class A shares of the Fund are
as follows:
<TABLE>
<CAPTION>
DEALERS
SALES SALES REALLOWANCE
CHARGE AS % CHARGE AS % AS %
OF OFFERING OF AMOUNT OF OFFERING
AMOUNT OF INVESTMENT PRICE INVESTED PRICE
<S> <C> <C> <C>
- ----------------------------------------------------------------------------------------------
Less than $25,000 4.50% 4.71% 4.05%
$25,000 - $49,999 4.00 4.17 3.60
$50,000 - $99,999 3.50 3.63 3.15
$100,000 - $249,999 2.50 2.56 2.25
$250,000 - $499,999 1.50 1.52 1.35
$500,000 and over * * *
- ----------------------------------------------------------------------------------------------
</TABLE>
* Purchases of Class A shares of $500,000 or more will be made at net asset
value without any initial sales charge, but will be subject to a CDSC of
1.00% on redemptions made within 12 months of purchase. The CDSC on Class A
shares is payable to Smith Barney, which compensates Smith Barney Financial
Consultants and other dealers whose clients make purchases of $500,000 or
more. The CDSC is waived in the same circumstances in which the CDSC
applicable to Class B and Class C shares is waived. See "Deferred Sales
Charge Alternatives" and "Waivers of CDSC."
Members of the selling group may receive up to 90% of the sales charge and
may be deemed to be underwriters of the Fund as defined in the 1933 Act, as
amended.
The reduced sales charges shown above apply to the aggregate of purchases of
Class A shares of the Fund made at one time by "any person," which includes an
individual and his or her immediate family or a trustee or other fiduciary of a
single trust estate or single fiduciary account.
INITIAL SALES CHARGE WAIVERS
Purchases of Class A shares may be made at net asset value without a sales
charge in the following circumstances: (a) sales to (i) Board Members and
employees of Travelers and its subsidiaries and of any of the Smith Barney
Mutual Funds (including retired Board Members and employees; the immediate
families of such persons including the surviving spouse of a deceased Board
Member or employee and pension, profit-sharing or other benefit plans for such
persons and (ii) employees of members of the National Association of Securities
Dealers, Inc., provided such sales are made upon the assurance of the purchaser
that the purchase is made for investment purposes and that the securities will
not be resold except through redemption or repurchase; (b) offers of Class A
shares to any other investment company to effect the combination of such company
with the Fund by merger, acquisition of assets or otherwise; (c) purchases of
Class A shares by any client of a newly employed Smith Barney Financial
Consultant (for a period up to 90 days from the commencement of the Financial
25
<PAGE>
PURCHASE OF SHARES (CONTINUED)
- -------------------------------------------------------------------
Consultant's employment with Smith Barney), on the condition the purchase of
Class A shares is made with the proceeds of the redemption of shares of a mutual
fund which (i) was sponsored by the Financial Consultant's prior employer, (ii)
was sold to the client by the Financial Consultant and (iii) was subject to a
sales charge; (d) purchases by shareholders who have redeemed Class A shares in
the Fund (or Class A shares of another Smith Barney Mutual Fund offered with a
sales charge) and who wish to reinvest their redemption proceeds in the Fund,
provided the reinvestment is made within 60 calendar days of the redemption; (e)
purchases by accounts managed by registered investment advisory subsidiaries of
Travelers; (f) investments of distributions from a UIT sponsored by Smith
Barney; (g) direct rollovers by plan participants of distributions from a 401(k)
plan offered to employees of Travelers or its subsidiaries or a 401(k) plan
enrolled in the Smith Barney 401(k) Program (Note: subsequent investments will
be subject to the applicable sales charge); (h) purchases by separate accounts
used to fund certain unregistered variable annuity contracts; (i) purchases by
investors participating in a Smith Barney fee-based arrangement; and (j)
purchases of Class A shares of the Fund by Section 403(b) or Section 401(a) or
(k) accounts associated with Copeland Retirement Programs. In order to obtain
such discounts, the purchaser must provide sufficient information at the time of
purchase to permit verification that the purchase would qualify for the
elimination of the sales charge.
RIGHT OF ACCUMULATION
Class A shares of the Fund may be purchased by "any person" (as defined
above) at a reduced sales charge or at net asset value determined by aggregating
the dollar amount of the new purchase and the total net asset value of all Class
A shares of the Fund and of funds sponsored by Smith Barney which are offered
with a sales charge listed under "Exchange Privilege" then held by such person
and applying the sales charge applicable to such aggregate. In order to obtain
such discount, the purchaser must provide sufficient information at the time of
purchase to permit verification that the purchase qualifies for the reduced
sales charge. The right of accumulation is subject to modification or
discontinuance at any time with respect to all shares purchased thereafter.
GROUP PURCHASES
Upon completion of certain automated systems, a reduced sales charge or
purchase at net asset value will also be available to employees (and partners)
of the same employer purchasing as a group, provided each participant makes the
minimum initial investment required. The sales charge applicable to purchases by
each member of such a group will be determined by the table set forth above
under "Initial Sales Charge Alternative -- Class A Shares," and will be based
26
<PAGE>
PURCHASE OF SHARES (CONTINUED)
- -------------------------------------------------------------------
upon the aggregate sales of Class A shares of Smith Barney Mutual Funds offered
with a sales charge to, and share holdings of, all members of the group. To be
eligible for such reduced sales charges or to purchase at net asset value, all
purchases must be pursuant to an employer or partnership-sanctioned plan meeting
certain requirements. One such requirement is that the plan must be open to
specified partners or employees of the employer and its subsidiaries, if any.
Such plan may, but is not required to, provide for payroll deductions. Smith
Barney may also offer a reduced sales charge or net asset value purchase for
aggregating related fiduciary accounts under such conditions that Smith Barney
will realize economies of sales efforts and sales-related expenses. An
individual who is a member of a qualified group may also purchase Class A shares
at the reduced sales charge applicable to the group as a whole. The sales charge
is based upon the aggregate dollar value of Class A shares offered with a sales
charge that have been previously purchased and are still owned by the group,
plus the amount of the current purchase. A "qualified group" is one which (a)
has been in existence for more than six months, (b) has a purpose other than
acquiring Fund shares at a discount and (c) satisfies uniform criteria which
enable Smith Barney to realize economies of scale in its costs of distributing
shares. A qualified group must have more than 10 members, must be available to
arrange for group meetings between representatives of the Fund and the members,
and must agree to include sales and other materials related to the Fund in its
publications and mailings to members at no cost to Smith Barney. In order to
obtain such reduced sales charge or to purchase at net asset value, the
purchaser must provide sufficient information at the time of purchase to permit
verification that the purchase qualifies for the reduced sales charge. Approval
of group purchase reduced sales charge plans is subject to the discretion of
Smith Barney.
LETTER OF INTENT
CLASS A SHARES. A Letter of Intent for amounts of $50,000 or more provides
an opportunity for an investor to obtain a reduced sales charge by aggregating
investments over a 13-month period, provided that the investor refers to such
Letter when placing orders. For purposes of a Letter of Intent, the "Amount of
Investment" as referred to in the preceding sales charge table includes
purchases of all Class A shares of the Fund and other funds of the Smith Barney
Mutual Funds offered with a sales charge over the 13-month period based on the
total amount of intended purchases plus the value of all Class A shares
previously purchased and still owned. An alternative is to compute the 13-month
period starting up to 90 days before the date of execution of a Letter of
Intent. Each investment made during the period receives the reduced sales charge
applicable to the total amount of the investment goal. If the
27
<PAGE>
PURCHASE OF SHARES (CONTINUED)
- -------------------------------------------------------------------
goal is not achieved within the period, the investor must pay the difference
between the sales charges applicable to the purchases made and the charges
previously paid, or an appropriate number of escrowed shares will be redeemed.
Please contact a Smith Barney Financial Consultant or First Data to obtain a
Letter of Intent application.
CLASS Y SHARES. A Letter of Intent may also be used as a way for investors
to meet the minimum investment requirement for Class Y shares. Such investors
must make an initial minimum purchase of $1,000,000 in Class Y shares of the
Fund and agree to purchase a total of $5,000,000 of Class Y shares of the Fund
within six months from the date of the Letter. If a total investment of
$5,000,000 is not made within the six-month period, all Class Y shares purchased
to date will be transferred to Class A shares, where they will be subject to all
fees (including a service fee of 0.25%) and expenses applicable to the Fund's
Class A shares, which may include a CDSC of 1.00%. Please contact a Smith Barney
Financial Consultant or First Data for further information.
DEFERRED SALES CHARGE ALTERNATIVES
"CDSC Shares" are sold at net asset value next determined without an initial
sales charge so that the full amount of an investor's purchase payment may be
immediately invested in the Fund. A CDSC, however, may be imposed on certain
redemptions of these shares. "CDSC Shares" are: (a) Class B shares; (b) Class C
shares; and (c) Class A shares that were purchased without an initial sales
charge but subject to a CDSC.
Any applicable CDSC will be assessed on an amount equal to the lesser of the
original cost of the shares being redeemed or their net asset value at the time
of redemption. CDSC Shares redeemed will not be subject to a CDSC to the extent
that the value of such shares represents: (a) capital appreciation of Fund
assets; (b) reinvestment of dividends or capital gain distributions; (c) with
respect to Class B shares, shares redeemed more than five years after their
purchase; or (d) with respect to Class C shares and Class A shares that are CDSC
Shares, shares redeemed more than 12 months after their purchase.
Class C and Class A shares that are CDSC Shares are subject to a 1.00% CDSC
if redeemed within 12 months of purchase. In circumstances in which the CDSC is
imposed on Class B shares, the amount of the charge will depend on the number of
years since the shareholder made the purchase payment from which the amount is
being redeemed. Solely for purposes of determining the number of years since a
purchase payment, all purchase payments made during a
28
<PAGE>
PURCHASE OF SHARES (CONTINUED)
- -------------------------------------------------------------------
month will be aggregated and deemed to have been made on the last day of the
preceding Smith Barney statement month. The following table sets forth the rates
of the charge for redemptions of Class B shares by shareholders.
<TABLE>
<CAPTION>
YEAR SINCE PURCHASE
PAYMENT WAS MADE CDSC
<S> <C>
- ---------------------------------------
First 4.50%
Second 4.00
Third 3.00
Fourth 2.00
Fifth 1.00
Sixth and thereafter 0.00
- ---------------------------------------
</TABLE>
Class B shares will convert automatically to Class A shares eight years
after the date on which they were purchased and thereafter will no longer be
subject to any distribution fees. There will also be converted at that time such
proportion of Class B Dividend Shares owned by the shareholder as the total
number of his or her Class B shares converting at the time bears to the total
number of outstanding Class B shares (other than Class B Dividend Shares) owned
by the shareholder. See "Prospectus Summary -- Alternative Purchase Arrangements
- -- Class B Shares Conversion Feature."
The length of time that CDSC Shares acquired through an exchange have been
held will be calculated from the date that the shares exchanged were initially
acquired in one of the other Smith Barney Mutual Funds, and Fund shares being
redeemed will be considered to represent, as applicable, capital appreciation or
dividend and capital gain distribution reinvestments in such other funds. For
Federal income tax purposes, the amount of the CDSC will reduce the gain or
increase the loss, as the case may be, on the amount realized on redemption. The
amount of any CDSC will be paid to Smith Barney.
To provide an example, assume an investor purchased 100 Class B shares at
$10 per share for a cost of $1,000. Subsequently, the investor acquired five
additional shares through dividend reinvestment. During the fifteenth month
after the purchase, the investor decided to redeem $500 of his or her
investment. Assuming at the time of the redemption the net asset value had
appreciated to $12 per share, the value of the investor's shares would be $1,260
(105 shares at $12 per share). The CDSC would not be applied to the amount which
represents appreciation ($200) and the value of the reinvested dividend shares
($60). Therefore, $240 of the $500 redemption proceeds ($500 minus $260) would
be charged at a rate of 4.00% (the applicable rate for Class B shares) for a
total deferred sales charge of $9.60.
29
<PAGE>
PURCHASE OF SHARES (CONTINUED)
- -------------------------------------------------------------------
WAIVERS OF CDSC
The CDSC will be waived on: (a) exchanges (see "Exchange Privilege"); (b)
automatic cash withdrawals in amounts equal to or less than 1.00% per month of
the value of the shareholder's shares at the time the withdrawal plan commences
(see "Automatic Cash Withdrawal Plan"), provided, however, that automatic cash
withdrawals in amounts equal to or less than 2.00% per month of the value of the
shareholder's shares will be permitted for withdrawal plans that were
established prior to November 7, 1994; (c) redemptions of shares within 12
months following the death or disability of the shareholder; (d) involuntary
redemptions; and (e) redemptions of shares to effect a combination of the Fund
with any investment company by merger, acquisition of assets or otherwise. In
addition, a shareholder who has redeemed shares from other Smith Barney Mutual
Funds may, under certain circumstances, reinvest all or part of the redemption
proceeds within 60 days and receive pro rata credit for any CDSC imposed on the
prior redemption.
CDSC waivers will be granted subject to confirmation (by Smith Barney in the
case of shareholders who are also Smith Barney clients or by First Data in the
case of all other shareholders) of the shareholder's status or holdings, as the
case may be.
SMITH BARNEY 401(k) PROGRAM AND EXECCHOICE-TM- PROGRAMS
During the continuous offering period investors may be eligible to
participate in the Smith Barney 401(k) Program or the Smith Barney
ExecChoice-TM- Program. To the extent applicable, the same terms and conditions,
which are outlined below, are offered to all plans participating ("Participating
Plans") in these programs.
Each Fund offers to Participating Plans Class A and Class C shares as
investment alternatives under the Smith Barney 401(k) and ExecChoice-TM-
Programs. Class A and Class C shares acquired through the Participating Plans
are subject to the same service and/or distribution fees as the Class A and
Class C shares acquired by other investors; however, they are not subject to any
initial sales charge or CDSC. Once a Participating Plan has made an initial
investment in a Fund, all of its subsequent investments in the Fund must be in
the same Class of shares, except as otherwise described below.
CLASS A SHARES. Class A shares of a Fund are offered without any sales
charge or CDSC to any Participating Plan that purchases $1,000,000 or more of
Class A shares of one or more funds of the Smith Barney Mutual Funds.
30
<PAGE>
PURCHASE OF SHARES (CONTINUED)
- -------------------------------------------------------------------
CLASS C SHARES. Class C shares of a Fund are offered without any sales
charge or CDSC to any Participating Plan that purchases less than $1,000,000 of
Class C shares of one or more funds of the Smith Barney Mutual Funds.
401(k) AND EXECCHOICE-TM- PLANS OPENED ON OR AFTER JUNE 21, 1996. At the
end of the fifth year after the date the Participating Plan enrolled in the
Smith Barney 401(k) Program or the Smith Barney ExecChoice-TM- Program, if its
total Class C holdings in all non-money market Smith Barney Mutual Funds equal
at least $1,000,000, it will be offered the opportunity to exchange all of its
Class C shares for Class A shares of a Fund. For Participating Plans originally
established through a Smith Barney retail brokerage account, the five-year
period will be calculated from the date the retail brokerage account was opened.
Such Participating Plans will be notified of the pending exchange in writing
within 30 days after the fifth anniversary of the enrollment date and, unless
the exchange offer has been rejected in writing, the exchange will occur on or
about the 90th day after the fifth anniversary date. If the Participating Plan
does not qualify for the five-year exchange to Class A shares, a review of the
Participating Plan's holdings will be performed each quarter until either the
Participating Plan qualifies or the end of the eighth year.
401(k) PLANS OPENED PRIOR TO JUNE 21, 1996. In any year after the date a
Participating Plan enrolled in the Smith Barney 401(k) Program, if its total
Class C holdings in all non-money market Smith Barney Mutual Funds equal at
least $500,000 as of the calendar year-end, the Participating Plan will be
offered the opportunity to exchange all of its Class C shares for Class A shares
of a Fund. Such Plans will be notified in writing within 30 days after the last
business day of the calendar year and, unless the exchange offer has been
rejected in writing, the exchange will occur on or about the last business day
of the following March.
Any Participating Plan in the Smith Barney 401(k) or ExecChoice-TM- Programs
that has not previously qualified for an exchange into Class A shares will be
offered the opportunity to exchange all of its Class C shares for Class A shares
of a Fund, regardless of asset size, at the end of the eighth year after the
date the Participating Plan enrolled in the Smith Barney 401(k) or
ExecChoice-TM- Programs. Such Plans will be notified of the pending exchange in
writing approximately 60 days before the eighth anniversary of the enrollment
date and, unless the exchange has been rejected in writing, the exchange will
occur on or about the eighth anniversary date. Once an exchange has occurred, a
Participating Plan will not be eligible to acquire additional Class C shares of
the Fund but instead may acquire Class A shares of the Fund. Any Class C shares
not converted will continue to be subject to the distribution fee.
31
<PAGE>
PURCHASE OF SHARES (CONTINUED)
- -------------------------------------------------------------------
Participating Plans wishing to acquire shares of a Fund through the Smith
Barney 401(k) Program or the Smith Barney ExecChoice-TM- Program must purchase
such shares directly from First Data. For further information regarding these
Programs, investors should contact a Smith Barney Financial Consultant.
EXISTING 401(k) PLANS INVESTING IN CLASS B SHARES. Class B shares of the
Smith Barney Mutual Funds are not available for purchase by Participating Plans
opened on or after June 21, 1996, but may continue to be purchased by any
Participating Plan in the Smith Barney 401(k) Program opened prior to such date
and originally investing in such Class. Class B shares acquired are subject to a
CDSC of 3.00% of redemption proceeds, if the Participating Plan terminates
within eight years of the date the Participating Plan first enrolled in the
Smith Barney 401(k) Program.
At the end of the eighth year after the date the Participating Plan enrolled
in the Smith Barney 401(k) Program, the participating plan will be offered the
opportunity to exchange all of its Class B shares for Class A shares of the
Fund. Such Participating Plan will be notified of the pending exchange in
writing approximately 60 days before the eighth anniversary of the enrollment
date and, unless the exchange has been rejected in writing, the exchange will
occur on or about the eighth anniversary date. Once the exchange has occurred, a
Participating Plan will not be eligible to acquire additional Class B shares of
the Fund but instead may acquire Class A shares of the Fund. If the
Participating Plan elects not to exchange all of its Class B shares at that
time, each Class B share held by the Participating Plan will have the same
conversion feature as Class B shares held by other investors. See "Purchase of
Shares -- Deferred Sales Charge Alternatives."
No CDSC is imposed on redemptions of Class B shares to the extent the net
asset value of the shares redeemed does not exceed the current net asset value
of the shares purchased through reinvestment of dividends or capital gain
distributions, plus the current net asset value of Class B shares purchased more
than eight years prior to the redemption, plus increases in the net asset value
of the shareholder's Class B shares above the purchase payments made during the
preceding eight years. Whether or not the CDSC applies to the redemption by a
Participating Plan depends on the number of years since the Participating Plan
first became enrolled in the Smith Barney 401(k) Program, unlike the
applicability of the CDSC to redemptions by other shareholders, which depends on
the number of years since those shareholders made the purchase payment from
which the amount is being redeemed.
The CDSC will be waived on redemptions of Class B shares in connection with
lump-sum or other distributions made by a Participating Plan as a result of: (a)
the retirement of an employee in the Participating Plan; (b) the termination
32
<PAGE>
PURCHASE OF SHARES (CONTINUED)
- -------------------------------------------------------------------
of employment of an employee in the Participating Plan; (c) the death or
disability of an employee in the Participating Plan; (d) the attainment of age
59 1/2 by an employee in the Participating Plan; (e) hardship of an employee in
the Participating Plan to the extent permitted under Section 401(k) of the Code;
or (f) redemptions of shares in connection with a loan made by the Participating
Plan to an employee.
EXCHANGE PRIVILEGE
- -------------------------------------------------------------------
Except as otherwise noted below, shares of each Class may be exchanged at
the net asset value next determined for shares of the same Class in the
following Smith Barney Mutual Funds, to the extent shares are offered for sale
in the shareholder's state of residence. Exchanges of Class A, Class B and Class
C shares are subject to minimum investment requirements and all shares are
subject to the other requirements of the fund into which exchanges are made.
<TABLE>
<C> <S>
FUND NAME
GROWTH FUNDS
Smith Barney Aggressive Growth Fund Inc.
Smith Barney Appreciation Fund Inc.
Smith Barney Disciplined Small Cap Fund, Inc.
Smith Barney Fundamental Value Fund Inc.
Smith Barney Large Capitalization Growth Fund
Concert Peachtree Growth Fund
Smith Barney Managed Growth Fund
Smith Barney Natural Resources Fund Inc.
Smith Barney Special Equities Fund
GROWTH AND INCOME FUNDS
Concert Social Awareness Fund
Smith Barney Convertible Fund
Smith Barney Funds, Inc. -- Equity Income Portfolio
Smith Barney Growth and Income Fund
Smith Barney Premium Total Return Fund
Smith Barney Utilities Fund
</TABLE>
33
<PAGE>
EXCHANGE PRIVILEGE (CONTINUED)
- -------------------------------------------------------------------
<TABLE>
<C> <S>
TAXABLE FIXED-INCOME FUNDS
** Smith Barney Adjustable Rate Government Income Fund
Smith Barney Diversified Strategic Income Fund
++ Smith Barney Funds, Inc. -- Short-Term U.S. Treasury Securities
Portfolio
Smith Barney Funds, Inc. -- U.S. Government Securities Portfolio
Smith Barney Government Securities Fund
Smith Barney High Income Fund
Smith Barney Investment Grade Bond Fund
Smith Barney Managed Governments Fund Inc.
TAX-EXEMPT FUNDS
Smith Barney Arizona Municipals Fund Inc.
Smith Barney California Municipals Fund Inc.
* Smith Barney Intermediate Maturity California Municipals Fund
* Smith Barney Intermediate Maturity New York Municipals Fund
Smith Barney Managed Municipals Fund Inc.
Smith Barney Massachusetts Municipals Fund
Smith Barney Muni Funds -- Florida Portfolio
Smith Barney Muni Funds -- Georgia Portfolio
* Smith Barney Muni Funds -- Limited Term Portfolio
Smith Barney Muni Funds -- National Portfolio
Smith Barney Muni Funds -- New York Portfolio
Smith Barney Muni Funds -- Pennsylvania Portfolio
Smith Barney New Jersey Municipals Fund Inc.
Smith Barney Oregon Municipals Fund
Smith Barney Municipal High Income Fund
GLOBAL -- INTERNATIONAL FUNDS
Smith Barney World Funds, Inc. -- Emerging Markets Portfolio
Smith Barney World Funds, Inc. -- European Portfolio
Smith Barney World Funds, Inc. -- Global Government Bond Portfolio
Smith Barney World Funds, Inc. -- International Balanced Portfolio
Smith Barney World Funds, Inc. -- International Equity Portfolio
Smith Barney World Funds, Inc. -- Pacific Portfolio
Smith Barney Hansberger Global Small Cap Value Fund
Smith Barney Hansberger Global Value Fund
SMITH BARNEY CONCERT ALLOCATION SERIES INC.
Smith Barney Concert Allocation Series Inc. -- Balanced Portfolio
Smith Barney Concert Allocation Series Inc. -- Conservative Portfolio
Smith Barney Concert Allocation Series Inc. -- Growth Portfolio
Smith Barney Concert Allocation Series Inc. -- High Growth Portfolio
Smith Barney Concert Allocation Series Inc. -- Income Portfolio
</TABLE>
34
<PAGE>
EXCHANGE PRIVILEGE (CONTINUED)
- -------------------------------------------------------------------
<TABLE>
<C> <S>
MONEY MARKET FUNDS
Smith Barney Exchange Reserve Fund
++ Smith Barney Money Funds, Inc. -- Cash Portfolio
++ Smith Barney Money Funds, Inc. -- Government Portfolio
*** Smith Barney Money Funds, Inc. -- Retirement Portfolio
++ Smith Barney Municipal Money Market Fund, Inc.
++ Smith Barney Muni Funds -- California Money Market Portfolio
++ Smith Barney Muni Funds -- New York Money Market Portfolio
</TABLE>
- -------------------------------------------------------------------
* Available for exchange with Class A, Class C and Class Y shares of the
Fund.
** Available for exchange with Class A and Class B shares of the Fund.
*** Available for exchange with Class A shares of the Fund.
+ Available for exchange with Class B and Class C shares of the Fund.
++ Available for exchange with Class A and Class Y shares of the Fund. In
addition, shareholders who own Class C shares of the Fund through the Smith
Barney 401(k) or ExecChoice-TM- Programs may exchange those shares for
Class C shares of this Fund.
CLASS B EXCHANGES. In the event a Class B shareholder wishes to exchange
all or a portion of his or her shares for shares of any of the funds imposing a
higher CDSC than that imposed by the Fund, the exchanged Class B shares will be
subject to the higher applicable CDSC. Upon an exchange, the new Class B shares
will be deemed to have been purchased on the same date as the Class B shares of
the Fund that have been exchanged.
CLASS C EXCHANGES. Upon an exchange, the new Class C shares will be deemed
to have been purchased on the same date as the Class C shares of the Fund that
have been exchanged.
CLASS A AND CLASS Y EXCHANGES. Class A and Class Y shareholders of the Fund
who wish to exchange all or a portion of their shares for shares of the
respective Class in any of the funds identified above may do so without
imposition of any charge.
ADDITIONAL INFORMATION REGARDING THE EXCHANGE PRIVILEGE. Although the
exchange privilege is an important benefit, excessive exchange transactions can
be detrimental to the Fund's performance and its shareholders. The Fund may
determine that a pattern of frequent exchanges is excessive and contrary to the
best interests of its other shareholders. In this event, the Fund may, at its
discretion, decide to limit additional purchases and/or exchanges by a
shareholder. Upon such a determination, the Fund will provide notice in writing
or by telephone to the shareholder at least 15 days prior to suspending the
exchange privilege and during the 15-day period the shareholder will be required
to (a) redeem his or her shares in the Fund or (b) remain invested in the Fund
or exchange into any of the Smith Barney Mutual Funds ordinarily available,
which
35
<PAGE>
EXCHANGE PRIVILEGE (CONTINUED)
- -------------------------------------------------------------------
position the shareholder would be expected to maintain for a significant period
of time. All relevant factors will be considered in determining what constitutes
an abusive pattern of exchanges.
Certain shareholders may be able to exchange shares by telephone. See
"Redemption of Shares -- Telephone Redemption and Exchange Program." Exchanges
will be processed at the net asset value next determined. Redemption procedures
discussed below are also applicable for exchanging shares, and exchanges will be
made upon receipt of all supporting documents in proper form. If the account
registration of the shares of the fund being acquired is identical to the
registration of the shares of the fund exchanged, no signature guarantee is
required. A capital gain or loss for tax purposes will be realized upon the
exchange, depending upon the cost or other basis of shares redeemed. Before
exchanging shares, investors should read the current prospectus describing the
shares to be acquired. The Fund reserves the right to modify or discontinue
exchange privileges upon 60 days' prior notice to shareholders.
REDEMPTION OF SHARES
- -------------------------------------------------------------------
The Fund is required to redeem the shares of the Fund tendered to it, as
described below, at a redemption price equal to their net asset value per share
next determined after receipt of a written request in proper form at no charge
other than any applicable CDSC. Redemption requests received after the close of
regular trading on the NYSE are priced at the net asset value next determined.
If a shareholder holds shares in more than one Class, any request for
redemption must specify the Class being redeemed. In the event of a failure to
specify which Class, or if the investor owns fewer shares of the Class than
specified, the redemption request will be delayed until First Data receives
further instructions from Smith Barney, or if the shareholder's account is not
with Smith Barney, from the shareholder directly. The redemption proceeds will
be remitted on or before the third business day following receipt of proper
tender, except on any days on which the NYSE is closed or as permitted under the
1940 Act in extraordinary circumstances. Generally, if the redemption proceeds
are remitted to a Smith Barney brokerage account, these funds will not be
invested for the shareholder's benefit without specific instruction and Smith
Barney will benefit from the use of temporarily uninvested funds. Redemption
proceeds for shares purchased by check, other than a certified or official bank
check, will be remitted upon clearance of the check, which may take up to ten
days or more.
36
<PAGE>
REDEMPTION OF SHARES (CONTINUED)
- -------------------------------------------------------------------
Shares held by Smith Barney as custodian must be redeemed by submitting a
written request to a Smith Barney Financial Consultant. Shares other than those
held by Smith Barney as custodian may be redeemed through an investor's
Financial Consultant, Introducing Broker or a dealer in the selling group or by
submitting a written request for redemption to:
Smith Barney Total Return Bond Fund
Class A, B, C or Y (please specify)
c/o First Data Investor Services Group, Inc.
P.O. Box 5128
Westborough, Massachusetts 01581-5128
A written redemption request must (a) state the Class and number or dollar
amount of shares to be redeemed, (b) identify the shareholder's account number
and (c) be signed by each registered owner exactly as the shares are registered.
If the shares to be redeemed were issued in certificate form, the certificates
must be endorsed for transfer (or be accompanied by an endorsed stock power) and
must be submitted to First Data together with the redemption request. Any
signature required in connection with a written redemption request in excess of
$2,000, share certificate or stock power must be guaranteed by an eligible
guarantor institution such as a domestic bank, savings and loan institution,
domestic credit union, member bank of the Federal Reserve System or member firm
of a national securities exchange. Written redemption requests of $2,000 or less
do not require a signature guarantee unless more than one such redemption
request is made in any 10-day period. Redemption proceeds will be mailed to an
investor's address of record. First Data may require additional supporting
documents for redemptions made by corporations, executors, administrators,
trustees or guardians. A redemption request will not be deemed properly received
until First Data receives all required documents in proper form.
TELEPHONE REDEMPTION AND EXCHANGE PROGRAM
Shareholders who do not have a Smith Barney brokerage account may be
eligible to redeem and exchange Fund shares by telephone. To determine if a
shareholder is entitled to participate in this program, he or she should contact
First Data at (800) 451-2010. Once eligibility is confirmed, the shareholder
must complete and return a Telephone/Wire Authorization form, including a
signature guarantee, that will be provided by First Data upon request.
Alternatively, an investor may authorize telephone redemptions on the new
account application with a signature guarantee when making his or her initial
investment in the Fund.
REDEMPTIONS. Redemption requests of up to $10,000 of any class or classes
of the Fund's shares may be made by eligible shareholders by calling
37
<PAGE>
REDEMPTION OF SHARES (CONTINUED)
- -------------------------------------------------------------------
First Data at (800) 451-2010. Such requests may be made between 9:00 a.m. and
5:00 p.m. (New York City time) on any day the NYSE is open. Redemptions of
shares (i) by retirement plans or (ii) for which certificates have been issued
are not permitted under this program.
A shareholder will have the option of having the redemption proceeds mailed
to his or her address of record or wired to a bank account pre-designated by the
shareholder. Generally, redemption proceeds will be mailed or wired, as the case
may be, on the next business day following the redemption request. In order to
use the wire procedures, the bank receiving the proceeds must be a member of the
Federal Reserve System or have a correspondent relationship with a member bank.
The Fund reserves the right to charge shareholders a nominal fee for each wire
redemption. Such charges, if any, will be assessed against the shareholder's
account from which shares were redeemed. In order to change the bank account
designated to receive redemption proceeds, a shareholder must complete a new
Telephone/Wire Authorization Form and, for the protection of the shareholder's
assets, will be required to provide a signature guarantee and certain other
documentation.
EXCHANGES. Eligible shareholders may make exchanges by telephone if the
account registration of the fund being acquired is identical to the registration
of the shares of the fund exchanged. Such exchange requests may be made by
calling First Data at (800) 451-2010 between 9:00 a.m. and 5:00 p.m. (New York
City time) on any day on which the NYSE is open.
ADDITIONAL INFORMATION REGARDING TELEPHONE REDEMPTION AND EXCHANGE
PROGRAM. Neither the Fund nor its agents will be liable for following
instructions communicated by telephone reasonably believed to be genuine. The
Fund and its agents will employ procedures designed to verify the identity of
the caller and legitimacy of instructions (for example, a shareholder's name and
account number will be required and phone calls may be recorded). The Fund
reserves the right to suspend, modify or discontinue the telephone redemption
and exchange program or to impose a charge for this service at any time
following at least seven days' prior notice to shareholders.
AUTOMATIC CASH WITHDRAWAL PLAN
The Fund offers shareholders an automatic cash withdrawal plan, under which
shareholders who own shares with a value of at least $10,000 may elect to
receive cash payments of at least $50 monthly or quarterly. The withdrawal plan
will be carried over on exchanges between funds or Classes of the Fund. Any
applicable CDSC will not be waived on amounts withdrawn by a shareholder that
exceed 1.00% per month of the value of the shareholder's shares subject to the
CDSC at the time the withdrawal plan commences. With
38
<PAGE>
REDEMPTION OF SHARES (CONTINUED)
- -------------------------------------------------------------------
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 shareholder's shares subject to the CDSC. For further information regarding
the automatic cash withdrawal plan, shareholders should contact a Smith Barney
Financial Consultant.
MINIMUM ACCOUNT SIZE
- -------------------------------------------------------------------
The Fund reserves the right to involuntarily liquidate any shareholder's
account in the Fund if the aggregate net asset value of the shares held in the
Fund account is less than $500. If a shareholder has more than one account in
this Fund, each account must satisfy the minimum account size. The Fund,
however, will not redeem shares based solely on market reductions in net asset
value. Before the Fund exercises such right, shareholders will receive written
notice and will be permitted 60 days to bring accounts up to the minimum to
avoid involuntary liquidation.
PERFORMANCE
- -------------------------------------------------------------------
YIELD
From time to time, the Fund may advertise the 30-day "yield" and "equivalent
taxable yield" of each Class of shares. The yield refers to the income generated
by an investment in those shares over the 30-day period identified in the
advertisement and is computed by dividing the net investment income per share
earned by the Class during the period by the maximum public offering price per
share on the last day of the period. This income is "annualized" by assuming the
amount of income is generated each month over a one-year period and is
compounded semi-annually. The annualized income is then shown as a percentage of
the net asset value.
The equivalent taxable yield demonstrates the yield on a taxable investment
necessary to produce an after-tax yield equal to the Fund's tax-exempt yield for
each Class. It is calculated by increasing the yield shown for the Class to the
extent necessary to reflect the payment of taxes at specified tax rates. Thus,
the equivalent taxable yield always will exceed the Fund's yield. For more
information on equivalent taxable yields, refer to the table under "Dividends,
Distributions and Taxes."
TOTAL RETURN
From time to time the Fund may include its total return, average annual
total return and current dividend return in advertisements and/or other types of
39
<PAGE>
PERFORMANCE (CONTINUED)
- -------------------------------------------------------------------
sales literature. These figures are computed separately for Class A, Class B,
Class C and Class Y shares of the Fund. These figures are based on historical
earnings and are not intended to indicate future performance. Total return is
computed for a specified period of time assuming deduction of the maximum sales
charge, if any, from the initial amount invested and reinvestment of all income
dividends and capital gain distributions on the reinvestment dates at prices
calculated as stated in this Prospectus, then dividing the value of the
investment at the end of the period so calculated by the initial amount invested
and subtracting 100%. The standard average annual total return, as prescribed by
the SEC, is derived from this total return, which provides the ending redeemable
value. Such standard total return information may also be accompanied with
nonstandard total return information for differing periods computed in the same
manner but without annualizing the total return or taking sales charges into
account. The Fund calculates current dividend return for each Class by
annualizing the most recent monthly distribution and dividing by the net asset
value or the maximum public offering price (including sales charge) on the last
day of the period for which current dividend return is presented. The current
dividend return for each Class may vary from time to time depending on market
conditions, the composition of its investment portfolio and operating expenses.
These factors and possible differences in the methods used in calculating
current dividend return should be considered when comparing a Class' current
return to yields published for other investment companies and other investment
vehicles. The Fund may also include comparative performance information in
advertising or marketing its shares. Such performance information may include
data from Lipper Analytical Services, Inc. or similar independent services that
monitor the performance of mutual funds, or other financial publications.
MANAGEMENT OF THE TRUST AND THE FUND
- -------------------------------------------------------------------
BOARD OF TRUSTEES
Overall responsibility for management and supervision of the Fund rests with
the Trust's Board of Trustees. The Trustees approve all significant agreements
between the Trust and the companies that furnish services to the Trust and the
Fund, including agreements with the Fund's distributor, investment manager and
administrator, custodian and transfer agent. The day-to-day operations of the
Fund are delegated to the Fund's investment manager. The Statement of Additional
Information contains background information regarding each Trustee and executive
officer of the Trust.
40
<PAGE>
MANAGEMENT OF THE TRUST AND THE FUND (CONTINUED)
- -------------------------------------------------------------------
INVESTMENT MANAGER
MMC, located at 388 Greenwich Street, New York, New York 10013, serves as
the Fund's investment manager. MMC is a wholly owned subsidiary of Holdings. MMC
(through its predecessor entities) has been in the investment counseling
business since 1934 and is a registered investment adviser. MMC renders
investment advice to investment companies that had aggregate assets under
management as of September 30, 1997 in excess of $81 billion.
Subject to the supervision and direction of the Trust's Board of Trustees,
MMC manages the Fund's portfolio in accordance with the Fund's investment
objective and policies, makes investment decisions for the Fund, places orders
to purchase and sell securities and employs professional portfolio managers and
securities analysts who provide research services to the Fund. For investment
management services, the Fund pays MMC a monthly fee at the annual rate of 0.65%
of the value of the Fund's average daily net assets.
PORTFOLIO MANAGEMENT
Joseph P. Deane, an Investment Officer of MMC and a Vice President and
Investment Officer of the Fund, is responsible for managing the day-to-day
operations of the Fund, including making investment decisions.
DISTRIBUTOR
- -------------------------------------------------------------------
Smith Barney is located at 388 Greenwich Street, New York, New York 10013.
Smith Barney distributes shares of the Fund as principal underwriter and as such
conducts a continuous offering pursuant to a "best efforts" arrangement
requiring Smith Barney to take and pay for only such securities as may be sold
to the public. Pursuant to a plan of distribution adopted by the Fund under Rule
12b-1 under the 1940 Act (the "Plan"), Smith Barney is paid a service fee with
respect to Class A, Class B and Class C shares of the Fund at the annual rate of
0.25% of the average daily net assets of the respective Class. Smith Barney is
also paid a distribution fee with respect to Class B and Class C shares at the
annual rate of 0.50% and 0.45%, respectively, of the average daily net assets
attributable to those Classes. Class B shares which automatically convert to
Class A shares eight years after the date of original purchase will no longer be
subject to a distribution fee. The fees are used by Smith Barney to pay its
Financial Consultants for servicing shareholder accounts and, in the case of
Class B and Class C shares, to cover expenses primarily intended to result in
the sale of those shares. These expenses include: advertising expenses; the cost
of printing and mailing prospectuses to potential investors; payments to and
expenses of Smith Barney Financial Consultants and other persons who provide
41
<PAGE>
DISTRIBUTOR (CONTINUED)
- -------------------------------------------------------------------
support services in connection with the distribution of shares; interest and/or
carrying charges; and indirect and overhead costs of Smith Barney associated
with the sale of Fund shares, including lease, utility, communications and sales
promotion expenses.
The payments to Smith Barney Financial Consultants for selling shares of a
Class include a commission or fee paid by the investor or Smith Barney at the
time of sale and, with respect to Class A, Class B and Class C shares, a
continuing fee for servicing shareholder accounts for as long as a shareholder
remains a holder of that Class. Smith Barney Financial Consultants may receive
different levels of compensation for selling different Classes of shares.
Payments under the Plan are not tied exclusively to the distribution and
shareholder service expenses actually incurred by Smith Barney and the payments
may exceed distribution expenses actually incurred. The Fund's Board of Trustees
will evaluate the appropriateness of the Plan and its payment terms on a
continuing basis and in so doing will consider all relevant factors, including
expenses borne by Smith Barney, amounts received under the Plan and proceeds of
the CDSC.
ADDITIONAL INFORMATION
- -------------------------------------------------------------------
The Trust was organized on March 12, 1985, under the laws of the
Commonwealth of Massachusetts and is an entity commonly known as a
"Massachusetts business trust." The Trust offers shares of beneficial interest
of separate series having a $0.001 per share par value. When matters are
submitted for shareholder vote, shareholders of each Class will have one vote
for each full share owned and a proportionate, fractional vote for any
fractional share held of that Class. Shares of the Trust will be voted generally
on a Trust-wide basis on all matters, except matters affecting the interests of
one Fund or one Class of shares.
Each Class of Fund shares represents identical interests in the Fund's
investment portfolio. As such, they have the same rights, privileges and
preferences, except with respect to: (a) the designation of each Class; (b) the
effect of the respective sales charges for each Class; (c) the distribution
and/or service fees, if any, borne by each Class; (d) the expenses allocable
exclusively to each Class; (e) voting rights on matters exclusively affecting a
single Class; (f) the exchange privilege of each Class; and (g) the conversion
feature of the Class B shares. The Trust's Board of Trustees does not anticipate
that there will be any conflicts among the interests of the holders of the
different Classes. The Trustees, on an ongoing basis, will consider whether any
such conflict exists and, if so, take appropriate action.
42
<PAGE>
ADDITIONAL INFORMATION (CONTINUED)
- -------------------------------------------------------------------
The Trust does not hold annual shareholder meetings. There normally will be
no meetings of shareholders for the purpose of electing Trustees unless and
until such time as less than a majority of the Trustees holding office have been
elected by shareholders. The Trustees will call a meeting for any purpose upon
written request of shareholders holding at least 10% of the Trust's outstanding
shares and the Trust will assist shareholders in calling such a meeting as
required by the 1940 Act.
PNC Bank, National Association, located at 17th and Chestnut Streets,
Philadelphia, PA 19103, serves as custodian of the Trust's investments.
First Data, located at Exchange Place, Boston, Massachusetts 02109, serves
as the Trust's transfer agent.
The Fund sends its shareholders a semi-annual report and an audited annual
report, each of which includes a list of the investment securities held by the
Fund at the end of the reporting period. In an effort to reduce the Fund's
printing and mailing costs, the Trust plans to consolidate the mailing of the
Fund's semi-annual and annual reports by household. This consolidation means
that a Household having multiple accounts with the identical address of record
will receive a single copy of each report. Shareholders who do not want this
consolidation to apply to their accounts should contact their Smith Barney
Financial Consultants or the Transfer Agent.
43
Smith Barney
INCOME FUNDS
388 Greenwich Street
New York, New York 10013
(800) 451-2010
Statement of Additional Information November 28, 1997,
as amended on
January 21, 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 eight
investment funds offered by the Trust: 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
Premium Total Return Fund (the "Premium Total Return Fund"), Smith
Barney Municipal High Income Fund (the "Municipal High Income
Fund"), Smith Barney Total Return Bond Fund ("Total Return Bond
Fund") and Smith Barney Utilities Fund (the "Utilities Fund"),
each a "Fund" and together the "Funds," each dated November 28,
1997, (except for Total Return Bond Fund, which is dated January
21, 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 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 29
Redemption of Shares 30
Distributor 31
Valuation of Shares 34
Exchange Privilege 34
Performance Data (See in the Prospectuses
"Performance" or "Yield Information") 35
Taxes (See in the Prospectuses "Dividends,
Distributions and Taxes") 41
Additional Information 45
Voting Rights 46
Financial Statements 51
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:
<TABLE>
<CAPTION>
Name Service
<S> <C>
Smith Barney Inc. ("Smith Barney") Distributor
PFS Distributors ("PFS") Distributor to Exchange
Reserve Fund
Mutual Management Corp., formerly
known as Smith Barney Mutual
Funds Management Inc. ("MMC") Investment Adviser to the
Convertible Fund, Diversified
Strategic Income Fund, Exchange
Reserve Fund; High Income
Fund, Municipal High Income
Fund, Total Return Bond Fund
and Utilities Fund; Administrator
Smith Barney Strategy Advisers Inc.
("Strategy Advisers") Investment Adviser to Premium
Total Return Fund
Smith Barney Global Capital
Management Inc. ("Global Capital
Management") Sub-Investment Adviser to
Diversified Strategic Income Fund
Boston Partners Asset Management,
L.P. ("Boston Partners") Sub-Investment Adviser to Premium
Total Return Fund
PNC Bank, National Association
("PNC Bank") Custodian to Convertible Fund,
Exchange Reserve Fund, High
Income Fund, Premium Total Return
Fund, Municipal High Income Fund,
Total Return Bond Fund and Utilities
Fund
Chase Manhattan Bank ("Chase") Custodian to Diversified
Strategic Income Fund
First Data Investors Services Group, Inc.
("First Data") Transfer Agent
</TABLE>
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 70). 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 67). 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 56). 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 61). Managing Director of Smith Barney and Chairman of the
Board of Strategy Advisers; prior to July 1993, Senior Executive
Vice President of Shearson Lehman Brothers Inc. ("Shearson Lehman
Brothers"); Vice Chairman of Shearson Asset Management, a Director
of PanAgora Asset Management, Inc. and PanAgora Asset Management
Limited. His address is 388 Greenwich Street, New York, New York
10013.
John C. Bianchi, Vice President and Investment Officer (Age 42).
Managing Director of Smith Barney; prior to July 1993, Managing
Director of Shearson Lehman Advisors. His address is 388 Greenwich
Street, New York, New York 10013.
James E. Conroy, Vice President and Investment Officer (Age 46).
Managing Director of Smith Barney; prior to July 1993, Managing
Director of Shearson Lehman Advisors. His address is 388 Greenwich
Street, New York, New York 10013.
Joseph P. Deane, Vice President and Investment Officer (Age 50).
Managing Director of Smith Barney; prior to July 1993, Managind
Director of Shearson Lehman Advisors. Investment Officer of six
other Smith Barney Mutual Funds. His address is 388 Greenwich
Street, New York, New York 10013.
Victor Filatov, Vice President and Investment Officer (Age 45).
Managing Director of Smith Barney, President and Director of Smith
Barney Global Capital Management Inc.; prior to 1993, Vice
President of J.P. Morgan Securities Inc. Mr. Filatov is Vice
President and Investment Officer of four other Smith Barney Mutual
Funds. His address is 10 Piccadilly, London, WIV 9LA, UK.
Jack S. Levande, Vice President and Investment Officer (Age 51).
Managing Director of Smith Barney; prior to July 1993, Managing
Director of Shearson Lehman Advisors. His address is 388 Greenwich
Street, New York, New York 10013.
Lawrence T. McDermott, Vice President and Investment Officer (Age
49). Managing Director of Smith Barney; prior to July 1993,
Managing Director of Shearson Lehman Advisors. His address is 388
Greenwich Street, New York, New York 10013.
Mark E. Donovan, Investment Officer (Age 38). Equity Portfolio
Manager of Boston Partners and Chairman of the Equity Strategy
Committee; prior to 1995, Senior Vice President and Equity
Portfolio Manager of The Boston Company Advisors. His address is
One Financial Center, Boston, MA 02111.
Robert E. Swab, Investment Officer (Age 42). Vice President of
Smith Barney. His address is 388 Greenwich Street, New York, New
York 10013.
Phyllis M. Zahorodny, Vice President and Investment Officer (Age
39). Managing Director of Smith Barney; prior to July 1993,
Managing Director of Shearson Lehman Advisors. Her address is 388
Greenwich Street, New York, New York 10013.
Lewis E. Daidone, Senior Vice President and Treasurer (Age 40).
Managing Director and Chief Financial Officer of Smith Barney
Mutual Funds; Director and Senior Vice President of MMC. His
address is 388 Greenwich Street, New York, New York 10013.
Christina T. Sydor, Secretary (Age 46). Managing Director of Smith
Barney; General Counsel and Secretary of MMC. Her address is 388
Greenwich Street, New York, New York 10013.
Each Trustee also serves as a director, trustee and/or
general partner of certain other mutual funds for which Smith
Barney serves as distributor. Global Capital Management, MMC and
Strategy Advisers are "affiliated persons" of the Trust as defined
in the 1940 Act by virtue of their positions as investment
advisers to the Funds. As of October 31, 1997, the Trustees and
officers of the Funds, as a group, owned less than 1% of the
outstanding shares of beneficial interest of each Fund.
No officer, director or employee of Smith Barney or any
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 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, 1997, such travel and out-of-pocket expenses totaled $2,599.
For the fiscal year ended July 31, 1997 and the calendar
year ended December 31, 1996, the Trustees of the Trust were paid
the following compensation:
<TABLE>
<CAPTION>
Aggregate
Total Compensation
Aggregate Pension or from the Funds
Compensation Retirement and the Fund
from the Funds Benefits Complex for
for the Fiscal Accrued the Year ended
Year ended from the December
Trustee(*) July 31, 1997 the Funds 31, 1996
<S> <C> <C> <C>
Lee Abraham (9) $36,050 $0 44,550
Antoinette C. Bentley (9)+ 63,310 0 4,350
Allan J. Bloostein (15) 44,550 0 3,150
Richard E. Hanson, Jr. (9) 44,550 0 4,550
Heath B. McLendon (41) 0 0 0
Madelon DeVoe Talley (10)++ # 22,275 0 5,342
</TABLE>
* Number of directorships/trusteeships held with other Smith
Barney Mutual Funds.
+ Director deceased as of March 1997. Ms. Bentley's estate was
paid $38,960 in deferred compensation.
++ Director deceased as of July 1997.
# Ms. Talley deferred $22,275 of compensation from the Trust for
the fiscal year ended July 31, 1997.
Investment Advisers, Sub-Investment Advisers and Administrator
MMC and Strategy Advisors each serve 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 Smith
Barney Holdings Inc. ("Holdings"). Strategy Advisers is a wholly
owned subsidiary of MMC. Holdings is a wholly owned subsidiary of
Travelers Group Inc. The Advisory Agreements were most recently
approved by the Board of Trustees, including a majority of the
Trustees who are not "interested persons" of the Trust or the
Advisers ("Independent Trustees"), on August 6, 1997. 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 of Trustees, including a majority of the Independent
Trustees, on August 6, 1997. Boston Partners and Global Capital
Management each serve as a sub-investment adviser ("Sub-Investment
Adviser") to Premium Total Return Fund, pursuant to a written
agreement dated August 15, 1995 and 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 6, 1997.
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 pay the salaries of all officers and employees who
are employed by both it and the Trust, and maintain office
facilities for the Trust. In addition to those 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:
<TABLE>
<CAPTION>
Investment Advisory
Fee As a Percentage
Fund of Average Net Assets
<S> <C>
Convertible Fund 0.50%
Diversified Strategic Income Fund 0.45%
Exchange Reserve Fund 0.30%
High Income Fund 0.50%
Premium Total Return Fund 0.55%
Municipal High Income Fund 0.40%
Total Return Bond Fund 0.65%
Utilities Fund 0.45%
</TABLE>
For the periods below, the Funds paid investment advisory
fees to their respective Investment Advisers as follows:
<TABLE>
<CAPTION>
For the
Period
From
August
For the 1, 1996
Fiscal through
Year ended Dec-
July 31: cember
1995 1996 1997 31, 1996
<S> <C> <C> <C> <C>
Convertible Fund $415,666 $417,942 $489,663
Diversified Strategic
Income Fund 11,112,553 11,818,108 12,546,980
Exchange Reserve Fund 547,990 448,925 442,557
High Income Fund 3,706,659 4,506,352 5,646,405
Premium Total Return
Fund 10,627,086 13,381,076 -- $6,454,801
Municipal High Income
Fund 4,033,479 3,771,279 3,395,338
Total Return Bond Fund -- -- --
Utilities Fund 7,885,332 8,094,511 6,431,624
</TABLE>
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:
<TABLE>
<CAPTION>
For the
Period
from
For the August
Fiscal 1, 1996
Year ended through
July 31: December
1995 1996 1997 31, 1996
<S> <C> <C> <C> <C>
Convertible Fund $166,266 $167,177 $195,865
Diversified Strategic
Income Fund 4,938,912 5,252,493 5,576436
Exchange Reserve Fund 365,327 299,283 295,038
High Income Fund 1,482,663 1,802,541 2,258,562
Premium Total Return
Fund 3,930,566 2,299,990 -- $2,347,201
Municipal High Income
Fund 2,016,740 1,885,640 1,697,669
Total Return Bond Fund N/A N/A N/A
Utilities Fund 3,542,538 3,597,560 2,858,500
</TABLE>
For the fiscal years ended July 31, 1995, 1996 and 1997,
Diversified Strategic Income Fund paid Global Capital Management
sub-investment advisory fees of $1,234,728, $2,626,246 and
$2,788,218, 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, 1995, 1996 and 1997.
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 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, 1998.
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, Premium Total Return,
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, Premium Total Return, Total Return
Bond and Utilities 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 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, Premium Total Return,
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, Premium Total Return and Utilities 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 (Premium Total Return and Utilities
Funds). 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 Premium Total Return and Utilities
Funds will realize a gain or loss from the purchase or writing of
options on an index depends upon movements in the level of stock
prices in the stock market generally or, in the case of certain
indexes, in an industry or market segment, rather than movements
in the price of a particular stock. Accordingly, successful use by
a Fund of options on stock indexes will be subject to its
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 Premium Total Return and Utilities Funds 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 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 provide 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.
Investing in Utilities (Utilities Fund). Each of the risks
referred to in Utilities Fund's Prospectus could adversely affect
the ability and inclination of public utilities to declare or pay
dividends and the ability of holders of common stock to realize
any value from the assets of the issuer upon liquidation or
bankruptcy. Moreover, price disparities within selected utility
groups and discrepancies in relation to averages and indices have
occurred frequently for reasons not directly related to the
general movements or price trends of utility common stocks. These
discrepancies may caused by changes in the overall demand for, and
supply of, various securities (including the potentially
depressing effect of new stock offerings), and changes in
investment objectives, market expectations or cash requirements of
other purchasers and sellers of securities.
Futures Activities (Diversified Strategic Income, High
Income, Municipal High Income, Total Return Bond and Utilities
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 and Utilities 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 Utilities 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 (Utilities Fund). Utilities Fund may, from time
to time, sell securities short but the value of securities sold
short will not exceed 5% of the value of the Fund's assets. In
addition, the Fund may not (a) sell short the securities of a
single issuer to the extent of more than 2% of the value of the
Fund's net assets 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 (Premium Total Return,
Convertible and Utilities 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 14 below
(other than restriction 10 as applied to Utilities Fund) 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 15 through 20, and
restriction 10, as applied to Utilities Fund, may be changed by
vote of a majority of the Board of Trustees at any time.
The investment policies adopted by the Trust prohibit a Fund
from:
1. Purchasing the securities of any issuer (other than U.S.
government securities) if as a result more than 5% of the
value of the Fund's total assets would be invested in the
securities of the issuer, except that up to 25% of the
value of the Fund's total assets may be invested without
regard to this 5% limitation.
2. Purchasing (a) more than 10% of the voting securities of
any one issuer, (b) more than 10% of the securities of
any class of any one issuer or (c) more than 10% of the
outstanding debt securities of any one issuer, except
that limitation (c) does not apply to the Exchange
Reserve and Diversified Strategic Income Funds and
limitations (b) and (c) do not apply to the Utilities
Fund; provided that this limitation shall not apply to
investment in U.S. government securities.
3. Purchasing securities on margin, except that the Fund may
obtain any short-term credits necessary for the clearance
of purchases and sales of securities. For purposes of
this restriction, the deposit or payment of initial or
variation margin in connection with futures contracts or
related options will not be deemed to be a purchase of
securities on margin by any Fund permitted to engage in
transactions in futures contracts or related options.
4. Making short sales of securities or maintaining a short
position except that (a) the Premium Total Return,
Utilities and Convertible Funds may engage in such
activities if, at all times when a short position is
open, the relevant Fund owns an equal amount of the
securities convertible into or exchangeable, without
payment of any further consideration, for securities of
the same issuer as, and at least equal in amount to, the
securities sold short, and if, with respect to the
Premium Total Return and Convertible Funds, not more than
10% of the relevant Fund's net assets (taken at current
value) is held as collateral for such sales at any one
time and (b) Utilities Fund may make short sales or
maintain a short position to the extent of 5% of its net
assets.
5. Borrowing money, except that: (a) the Fund may borrow
from banks for temporary or emergency (not leveraging)
purposes, including the meeting of redemption requests
that might otherwise require the untimely disposition of
securities, in an amount not exceeding 10% (20% for
Utilities Fund) of the value of the Fund's total assets
(including the amount borrowed) valued at market less
liabilities (not including the amount borrowed) at the
time the borrowing is made; (b) Diversified Strategic
Income Fund may enter into reverse repurchase agreements
and forward roll transactions; and (c) one or more Funds
may enter into futures contracts. Except for Diversified
Strategic Income Fund, whenever borrowings described
under (a) above exceed 5% of the value of a Fund's total
assets, the Fund will not make any additional
investments. Immediately after any borrowing (including
reverse repurchase agreements and forward roll
transactions), Diversified Strategic Income Fund will
maintain an asset coverage of at least 300% with respect
to all its borrowings.
6. Pledging, hypothecating, mortgaging or otherwise
encumbering more than 10% of the value of the Fund's
total assets. For purposes of this restriction, (a) the
deposit of assets in escrow in connection with the
writing of covered put or call options and the purchase
of securities on a when-issued or delayed-delivery basis
and (b) collateral arrangements with respect to (i) the
purchase and sale of stock options, options on foreign
currencies and options on stock indexes and (ii) initial
or variation margin for futures contracts will not be
deemed to be pledges of a Fund's assets.
7. Underwriting the securities of other issuers, except
insofar as a Fund may be deemed an underwriter under the
Securities Act of 1933, as amended, (the "1933 Act") by
virtue of disposing of portfolio securities.
8. Purchasing or selling real estate or interests in real
estate, except that the Fund may purchase and sell
securities that are secured by real estate and may
purchase securities issued by companies that invest or
deal in real estate.
9. Investing in commodities, except that (a) the High
Income, Diversified Strategic Income, Utilities and
Municipal High Income Funds may invest in futures
contracts and options on futures contracts as described
in their Prospectuses and (b) upon 60 days' notice given
to its shareholders, the Premium Total Return and
Convertible Funds may engage in hedging transactions
involving futures contracts and related options,
including stock index futures contracts and financial
futures contracts.
10. Investing in oil, gas or other mineral exploration or
development programs, except that the Premium Total
Return, Convertible, Diversified Strategic Income,
Utilities and High Income Funds may invest in the
securities of companies that invest in or sponsor those
programs.
11. Making loans to others, except through purchasing
qualified debt obligations, entering into repurchase
agreements and, with respect to Funds other than the
Exchange Reserve Fund, lending portfolio securities
consistent with the Fund's investment objective.
12. Investing in securities of other investment companies
registered or required to be registered under the 1940
Act, except as they may be acquired as part of a merger,
consolidation, reorganization, acquisition of assets or
an offer of exchange.
13. Purchasing any securities which would cause more than
25% of the value of the Fund's total assets at the time
of purchase to be invested in the securities of issuers
conducting their principal business activities in the
same industry, except that Exchange Reserve Fund and
Utilities Fund will invest in excess of 25% of their
respective assets in the securities of companies within
the banking industry and utility industry, respectively;
provided that there shall be no limit on the purchase of
(a) U.S. government securities or (b) for Funds other
than the Exchange Reserve and Utilities Funds, Municipal
Securities issued by governments or political
subdivisions of governments.
14. Writing or selling puts, calls, straddles, spreads or
combinations thereof, except, with respect to Funds other
than Exchange Reserve Fund, as permitted under the Fund's
investment objective and policies.
15. 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
16. Purchasing any security if as a result the Fund would
then have more than 5% of its total assets invested in
securities of companies (including predecessors) that
have been in continuous operation for fewer than three
years; provided that, in the case of private activity
bonds purchased for Municipal High Income Fund, this
restriction shall apply to the entity supplying the
revenues from which the issue is to be paid.
17. Making investments for the purpose of exercising
control or management.
18. 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.
19. 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.
20. With respect to Utilities 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.
For purposes of the investment restrictions described above,
the issuer of a Municipal Security is deemed to be the entity
(public or private) ultimately responsible for the payment of the
principal of and interest on the security. For purposes of
investment restriction 13, private activity bonds (other than
those issued for charitable, educational and certain other
purposes), the payment of principal and interest on which is the
ultimate responsibility of companies within the same industry, are
grouped together as an industry. The Trust may make commitments
more restrictive than the restrictions listed above with respect
to a Fund so as to permit the sale of shares of the Fund in
certain states. Should the Trust determine that any such
commitment is no longer in the best interests of the Fund and its
shareholders, the Trust will revoke the commitment by terminating
the sale of shares of the Fund in the state involved. The
percentage limitations contained in the restrictions listed above
apply at the time of purchases of securities.
Portfolio Turnover
The Funds do not intend to seek profits through short-term
trading. 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, 1995, 1996 and 1997, the
portfolio turnover rates were as follows:
<TABLE>
<CAPTION>
For the Period
For the Fiscal from August 1,
Year Ended 1996 through
July 31 December 31,
1995 1996 1997 1996
<S> <C> <C> <C> <C>
Convertible Fund 48% 59% 57%
Diversified Strategic Income Fund 83 90 85
High Income Fund 60 72 78
Premium Total Return Fund 63 58 -- 30%
Municipal High Income Fund 38 44 51
Total Return Bond Fund -- -- --
Utilities Fund 36 58 45
</TABLE>
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
<TABLE>
<CAPTION>
Premium Diversified Total
Total High Strategic Return
Fiscal Return Convertible Income Utilities Income Bond
Year Fund Fund Fund Fund Fund Fund
<S> <C> <C> <C> <C> <C> <C>
1995 $3,517,469 $39,798 $97,439 $2,134,306 $0 --
1996 3,935,585 16,920 32,621 2,446,072 50,196 --
1996* 1,179,425 -- -- -- -- --
1997 -- 0 0 138,150 0 --
</TABLE>
Brokerage Commissions Paid to Smith Barney
<TABLE>
<CAPTION>
Premium Diversified Total
Total High Strategic Return
Fiscal Return Convertible Income Utilities Income Bond
Year Fund Fund Fund Fund Fund Fund
<S> <C> <C> <C> <C> <C> <C>
1995 $694,467 $600 $0 $162,924 $0 --
1996 628,778 0 0 91,818 0 --
1996* 209,905 -- -- -- -- --
1997 -- 0 0 138,150 0 --
</TABLE>
% of Total Brokerage Commissions Paid to Smith Barney
<TABLE>
<CAPTION>
Premium Diversified Total
Total High Strategic Return
Fiscal Return Convertible Income Utilities Income Bond
Year Fund Fund Fund Fund Fund Fund
<S> <C> <C> <C> <C> <C> <C>
1995 19.75% 1.51% 0% 7.63% 0% --
1996 15.98 0 0 3.75 0 --
1996* 17.80 -- -- -- -- --
1997 -- 0 0 6.60 0 --
</TABLE>
% of Total Dollar Amount of Transactions Involving Commissions
Paid to Smith Barney
<TABLE>
<CAPTION>
Premium Diversified Total
Total High Strategic Return
Fiscal Return Convertible Income Utilities Income Bond
Year Fund Fund Fund Fund Fund Fund
<S> <C> <C> <C> <C> <C> <C>
1995 20.02% 1.69% 0% 8.21% 0% --
1996 16.26 0 0 2.72 0 --
1996* 13.62 -- -- -- -- --
1997 -- 0 0 5.85 0 --
</TABLE>
* 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, 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 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, 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 Smith Barney to effect
such transactions, and (b) Smith Barney annually advises the Trust
of the aggregate compensation it earned on such transactions.
Over-the-counter purchases and sales are transacted directly with
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 Smith Barney is a member,
except to the extent permitted by the SEC.
The Funds may use Smith Barney as a commodities broker in
connection with entering into futures contracts and options on
futures contracts. Smith Barney has agreed to charge the Funds
commodity commissions at rates comparable to those charged by
Smith Barney to its most favored clients for comparable trades in
comparable accounts.
PURCHASE OF SHARES
Volume Discounts
The schedule of sales charges on Class A shares described in the
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 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 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 shares an initial sales charge
based on the aggregate amount of the investment. The public
offering price for a Class B and Class C share (and Class A share
purchases, including applicable rights of accumulation, equaling
or exceeding $500,000), is equal to the net asset value per share
at the time of purchase and no sales charge is imposed at the time
of purchase. A contingent deferred sales charge ("CDSC"), however,
is imposed on certain redemptions of Class B and Class C shares
and 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
Smith Barney Financial Consultant.
DISTRIBUTOR
Smith Barney serves as the Trust's distributor on a best
efforts basis pursuant to a distribution agreement (the
"Distribution Agreement").
PFS serves as one of the Trust's distributors with respect
to the Exchange Reserve Fund pursuant to a Distribution Agreement
dated November 20, 1995.
When payment is made by the investor before the settlement
date, unless otherwise directed by the investor, the funds will be
held as a free credit balance in the investor's brokerage account,
and Smith Barney may benefit from the temporary use of the funds.
The investor may designate another use for the funds prior to
settlement date, such as an investment in a money market fund
(other than the Exchange Reserve Fund) of the Smith Barney Mutual
Funds. If the investor instructs Smith Barney to invest the funds
in a Smith Barney money market fund, the amount of the investment
will be included as part of the average daily net assets of both
the relevant Fund and the Smith Barney money market fund, and
affiliates of Smith Barney that serve the funds in an investment
advisory or administrative capacity will benefit from the fact
they are receiving fees from both such investment companies for
managing these assets computed on the basis of their average daily
net assets. The Trust's Board of Trustees has been advised of the
benefits to Smith Barney resulting from these settlement
procedures and will take such benefits into consideration when
reviewing the Advisory, Administration and Distribution Agreements
for continuance.
For the fiscal year ended July 31, 1997, Smith Barney and/or
PFS incurred distribution expenses totaling approximately
$73,773,261, consisting of approximately $3,088,019 for
advertising, $770,603 for printing and mailing prospectuses,
$31,569,280 for support services and overhead expenses,
$36,763,766 to Smith Barney or PFS Financial Consultants and
$1,581,592 for accruals for interest on the excess of 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
Smith Barney and/or PFS.
Distribution Arrangements
Shares of the Trust are distributed on a best efforts basis
by Smith Barney as sales agent of the Trust pursuant to the
Distribution Agreement. To compensate Smith Barney for the
services it provides and for the expense it bears under the
Distribution Agreement, the Trust has adopted a services and
distribution plan (the "Plan") pursuant to Rule 12b-1 under the
1940 Act. Under the Plan, each Fund, except Exchange Reserve Fund,
pays 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 and Class C
shares. In addition, each Fund except the Exchange Reserve Fund,
pays Smith Barney, with respect to its Class B and Class C 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 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 C
shares' distribution fees, accrued daily and paid monthly, are
calculated at the annual rate of 0.50% for Class B shares and
0.45% for Class C shares (0.50% for Class C shares in the case of
Exchange Reserve Fund and 0.55% for Class C 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 fiscal years ended July 31, 1995, 1996 and 1997,
Smith Barney received $52,644,615, $57,460,253 and $,
respectively, in the aggregate from the Trust under the Plan.
The following expenses were incurred during the periods
indicated:
Sales Charges (paid to Smith Barney).
Class A
<TABLE>
<CAPTION>
For the Period
For the Fiscal from August 1,
Year Ended 1996 through
July 31: December 31,
1995 1996 1997 1996
<S> <C> <C> <C> <C>
Convertible Fund $8,900 $49,000 $19,000
Diversified Strategic
Income Fund 471,500 792,000 983,000
High Income Fund 457,100 593,000 726,000
Premium Total Return
Fund 594,400 968,000 -- $435,000
Municipal High Income
Fund 68,794 47,000 46,000
Total Return Bond Fund -- -- --
Utilities Fund 150,600 228,000 55,000
</TABLE>
CDSC (paid to Smith Barney)
Class B
<TABLE>
<CAPTION>
For the Period
For the Fiscal from August 1,
Year Ended 1996 through
July 31: December 31,
1995 1996 1997 1996
<S> <C> <C> <C> <C>
Convertible Fund $126,500 $95,000 $59,000
Diversified Strategic
Income Fund 6,000,000 4,015,000 2,858,000
Exchange Reserve Fund 1,429,000 765,000 618,000
High Income Fund 1,000,000 915,000 831,000
Premium Total Return
Fund 1,765,800 2,905,000 -- $1,009,000
Municipal High Income
Fund 1,649,382 929,000 525,000
Total Return Bond Fund -- -- --
Utilities Fund 4,738,800 3,393,000 2,514,000
</TABLE>
Service Fees and Distribution Fees
<TABLE>
<CAPTION>
For the Period
For the Fiscal from August 1,
Year Ended 1996 through
July 31: December 31,
1995 1996 1997 1996
<S> <C> <C> <C> <C>
Convertible Fund $468,685 $433,951 $413,173
Diversified Strategic
Income Fund 17,817,988 18,641,336 19,195,740
Exchange Reserve Fund 913,444 748,208 737,595
High Income Fund 4,029,911 4,893,170 5,818,152
Premium Total Return
Fund 12,565,954 15,646,147 -- $7,545,851
Municipal High Income
Fund 5,456,482 4,945,112 4,316,732
Total Return Bond Fund -- -- --
Utilities Fund 12,305,595 12,152,329 9,205,137
</TABLE>
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 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, 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 shares of any fund purchased with a sales charge
may be exchanged for Class A shares of any of the other
funds. Class A shares of any fund may be exchanged
without a sales charge for shares of the funds that are
offered without a sales charge. Class A shares of any
fund purchased without a sales charge may be exchanged
for shares sold with a sales charge.
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.
Dealers other than 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 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. 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 C 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, 1997, the annualized
yield was 4.51%, and the compound effective yield was 4.61%. As of
July 31, 1997, the Fund's average portfolio maturity was 47 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-bcd+1)6-1]
Where:
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 fees waived and
without sales charge) of the Fund's Class A shares were as follows
for the periods indicated:
<TABLE>
<CAPTION>
One- Five- Commencement
Year Year of
Fund Period Period Operations
<S> <C> <C> <C>
Convertible Fund 21.94% N/A 12.50%
Diversified Strategic
Income Fund 11.36 N/A 8.52
High Income Fund 13.31 N/A 11.90
Premium Total Return
Fund+ 20.67 N/A 14.69
Municipal High Income
Fund 10.39 N/A 7.23
Total Return Bond Fund -- -- --
Utilities Fund 15.48 N/A 9.25
</TABLE>
+ For the Premium Total Return Fund, figures are for the
period ended December 31, 1996. For all other Funds, figures
are for the period ended July 31, 1997.
The average annual total returns (with fees waived and
without CDSC) of the Fund's Class B shares were as follows for the
periods indicated:
<TABLE>
<CAPTION>
One- Five- Ten- Commencement
Year Year Year of
Fund Period Period Period Operations
<S> <C> <C> <C> <C>
Convertible Fund (1) 26.29% 11.28% 9.08% 9.44%
Diversified Strategic
Income Fund (2)(6) 10.89 7.26 N/A 9.16
High Income Fund(3)(6) 17.72 11.03 9.32 9.41
Premium Total Return
Fund+(4) 20.67 13.52 N/A 14.69
Municipal High Income
Fund(4)(6) 9.88 6.03 7.56 8.35
Total Return Bond Fund -- -- -- --
Utilities Fund(5) 14.80 7.87 N/A 10.21
</TABLE>
+ For the Premium Total Return Fund, figures are for the period
ended December 31, 1996. For all other Funds, figures are for
the period ended July 31, 1997.
(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%.
The average annual total returns (with fees waived) of the
Fund's Class C shares were as follows for the periods indicated:
<TABLE>
<CAPTION>
One- Five- Commencement
Year Year of
Fund Period Period Operations
<S> <C> <C> <C>
Convertible Fund(3) 26.37% N/A 16.40%
Diversified Strategic
Income Fund (5) 10.92 N/A 7.41
High Income Fund (4) 17.76 N/A 12.83
Premium Total Return
Fund+(1) 20.13 N/A 14.73
Municipal High Income
Fund(2) 9.78 N/A 10.70
Total Return Bond Fund -- -- --
Utilities Fund(6) 15.01 N/A 7.40
</TABLE>
+ For the Premium Total Return Fund, figures are for the period
ended December 31, 1996. For all other Funds, figures are for
the period ended July 31, 1997.
(1) The Fund commenced selling Class C shares (previously
designated as Class D shares) on June 1, 1993.
(2) The Fund commenced selling Class C shares (previously
designated as Class D shares) on November 17, 1994
(3) The Fund commenced selling Class C shares (previously
designated as Class D shares) on November 7, 1994
(4) The Fund commenced selling Class C shares (previously
designated as Class D shares) on August 24, 1994.
(5) The Fund commenced selling Class C shares (previously
designated as Class D shares) on March 19, 1993.
(6) The Fund commenced selling Class C shares (previously
designated as Class D shares) on February 4, 1993.
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.
Aggregate Total Return
The aggregate total return figures for each Fund, other than
Exchange Reserve Fund, represent the cumulative change in the
value of an investment in the Class for the specified period and
are computed by the following formula:
ERV - P
P
Where:
P = a hypothetical initial payment of $10,000.
ERV= Ending Redeemable Value of a hypothetical $10,000
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 aggregate total returns (with fees waived) of the Class
B shares of the Funds indicated were as follows for the periods
indicated:
No Load*
<TABLE>
<CAPTION>
One- Five- Ten- Commencement
Year Year Year of
Fund Period Period Period Operations
<S> <C> <C> <C> <C>
Convertible Fund(1) 26.29% 70.64% 138.43%167.86%
Diversified Strategic
Income Fund(2)(6) 10.89 41.99 N/A 94.63
High Income Fund(3)(6) 17.72 68.74 143.71 166.99
Premium Total Return
Fund+(4) 20.09 88.52 N/A 314.70
Municipal High Income
Fund(4)(6) 9.88 34.03 107.33 159.26
Total Return Bond
Fund (7) N/A N/A N/A N/A
Utilities Fund(5) 14.88 46.03 N/A 148.20
</TABLE>
Load**
<TABLE>
<CAPTION>
One- Five- Ten- Commencement
Year Year Year of
Fund Period Period Period Operations
<S> <C> <C> <C> <C>
Convertible Fund(1) 21.29% 69.64% 138.43%167.86%
Diversified Strategic
Income Fund(2)(6) 6.39 40.99 N/A 94.63
High Income Fund(3)(6) 13.22 67.74 143.71 166.99
Premium Total Return
Fund +(4) 15.09 87.52 N/A 314.16
Municipal High Income
Fund(4)(6) 5.38 33.03 107.33 159.26
Total Return Bond
Fund (7) N/A N/A N/A N/A
Utilities Fund(5) 9.88 45.03 N/A 148.20
</TABLE>
+ For the Premium Total Return Fund, figures are for the period
ended December 31, 1996. For all other Funds, figures are for
the period ended July 31, 1997.
* Figures do not include the effect of the maximum sales charge
or maximum applicable CDSC. If they had been included, it would
have the effect of lowering the returns shown.
** Figures include the effect of the maximum sales charge or
maximum applicable CDSC.
(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%.
(7) Fund commenced operations on January 21, 1998.
The aggregate total returns (with fees waived) of the Class A and
Class C shares of the Funds indicated were as follows for the periods
indicated:
No Load*
<TABLE>
<CAPTION>
One- Five- Commencement
Year Year of
Fund/Class Period Period Operations
<S> <C> <C> <C>
Convertible Fund
Class A (1) 26.94% N/A 72.83%
Class C (2) 26.37 N/A 51.42
Diversified Strategic Income Fund
Class A (1) 11.36 N/A 47.29
Class C (3) 10.92 N/A 36.68
High Income Fund
Class A (1) 18.31 N/A 70.25
Class C (4) 17.76 N/A 42.54
Premium Total Return Fund+
Class A (1) 20.67 N/A 76.73
Class C (5) 20.13 N/A 61.83
Municipal High Income Fund
Class A (1) 10.39 N/A 39.19
Class C (6) 15.01 N/A 31.62
Total Return Bond Fund (8)
Class A N/A N/A N/A
Class C N/A N/A N/A
Utilities Fund
Class A (1) 15.48 N/A 52.04
Class C (7) 15.01 N/A 37.77
</TABLE>
Load**
<TABLE>
<CAPTION>
One- Five- Commencement
Year Year of
Fund Period Period Operations
<S> <C> <C> <C>
Convertible Fund
Class A (1) 20.62 N/A 64.15
Class C (2) 25.37 N/A 51.42
Diversified Strategic Income Fund
Class A (1) 6.33 N/A 40.63
Class C (3) 9.92 N/A 36.68
High Income Fund
Class A (1) 12.96 N/A 62.58
Class C (4) 16.76 N/A 42.54
Premium Total Return Fund+
Class A (1) 14.64 N/A 67.87
Class C (5) 19.13 N/A 61.83
Municipal High Income Fund
Class A (1) 5.98 N/A 33.60
Class C (6) 8.78 N/A 31.62
Total Return Bond Fund (8)
Class A N/A N/A N/A
Class C N/A N/A N/A
Utilities Fund
Class A (1) 9.73 N/A 44.40
Class C (7) 14.01 N/A 37.77
</TABLE>
+ For the Premium Total Return Fund, figures are for the period
ended December 31, 1996. For all other Funds, figures are for
the period ended July 31, 1997.
* Figures do not include the effect of the maximum sales charge
or maximum applicable CDSC.
** Figures include the effect of the maximum sales charge or
maximum applicable CDSC.
(1) The Fund commenced selling Class A shares on November 6,
1992.
(2) The Fund commenced selling Class C shares (previously
designated as Class D shares) on November 7, 1994.
(3) The Fund commenced selling Class C shares (previously
designated as Class D shares) on March 19, 1993.
(4) The Fund commenced selling Class C shares (previously
designated as Class D shares) on August 24, 1994.
(5) The Fund commenced selling Class C shares (previously
designated as Class D shares) on June 1, 1993.
(6) The Fund commenced selling Class C shares (previously
designated as Class D shares) on November 17, 1994.
(7) The Fund commenced selling Class C shares (previously
designated as Class D shares) on February 4, 1993.
(8) The Fund commenced selling Class A and Class C shares on
January 21, 1998.
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.
To qualify as a regulated investment company, a Fund also
must earn less than 30% of its gross income from the disposition
of securities held for less than three months. The 30% test will
limit the extent to which a Fund may sell securities held for less
than three months; effect short sales of securities held for less
than three months; write options which expire in less than three
months; and effect closing transactions with respect to call or
put options that have been written or purchased within the
preceding three months. (If a Fund purchases a put option for the
purpose of hedging an underlying portfolio security, the
acquisition of the option is treated as a short sale of the
underlying security unless the option and the security are
acquired on the same date.) Finally, as discussed below, this
requirement also may limit investments by certain Funds in options
on stock indexes, options on non-convertible debt securities,
futures contracts and options on futures contracts, and foreign
currencies (or options, futures or forward contracts on foreign
currencies) but only to the extent that such foreign currencies
are not directly related to the Trust's principal business of
investing in securities.
Taxation of Investment by the Funds
Gains or losses on sales of securities by a Fund generally will be
long-term capital gains or losses if the Fund has held the
securities for more than one year. Gains or losses on sales of
securities held for not more than one year generally will be
short-term. If a Fund acquires a debt 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.
A portion of the mark-to-market gain on instruments held for
less than three months at the close of a Fund's taxable year may
represent a gain on securities held for less than three months for
purposes of the 30% test discussed above. Accordingly, a Fund may
have to restrict its fourth-quarter transactions in section 1256
contracts.
Straddles. While the mark-to-market system is limited to
section 1256 contracts, the Code contains other rules applicable
to transactions which create positions which offset positions in
section 1256 or other 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 C 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 October 31,
1997, the following shareholders beneficially owned 5% or more of
a class of shares of a Fund:
Convertible Fund Class C
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 6,131.730 (7.9325%) shares
Edith B. Cappel
1549 Rockledge Lane #1
Walnut Creek, CA 94595-2485
owned 5,067.523 (6.5557%) shares
Marsha L. Miller, Trustee
FBO Christopher Travis Hedenann Trust
u/a/d 1/5/88
P.O. Box 540303
Houston, TX 77254-0303
owned 3,973.850 (5.1409%) 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 1,897,887.672 (70.2272%) shares
Smith Barney Concert Series, Inc.
Conservative Portfolio
PNC Bank, NA
Attn: Beverly Timson
200 Stevens Drive Suite 440
Lester, PA 19113-1522
owned 512,122.585 (18.9499%) shares
Smith Barney Concert Series, Inc.
Income Portfolio
PNC Bank, NA
Attn: Beverly Timson
200 Stevens Drive Suite 440
Lester, PA 19113-1522
owned 143,872.407 (5.3236%) 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 6,706,119.974 (59.6145%) shares
Smith Barney Concert Series, Inc.
Conservative Portfolio
PNC Bank, NA
Attn: Beverly Timson
200 Stevens Drive Suite 440
Lester, PA 19113-1522
owned 2,384,904.133 (21.2007%) shares
Smith Barney Concert Series, Inc.
Income Portfolio
PNC Bank, NA
Attn: Beverly Timson
200 Stevens Drive Suite 440
Lester, PA 19113-1522
owned 1,356,386.933 (12.0576%) 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 2,534,451.818 (99.9949%) shares
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 4,926,349.245 (35.3241%) 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 3,982,698.793 (28.5577%) shares
CoreStates Bank NA
NDTA
Taxable Account
Attn: Charles Mercado/Joe Alteri
P.O. Box 7829
Philadelphia, PA 19101-7829
owned 1,834,560.768 (13.1546%) shares
CoreStates Bank NA
ANDTA
IRA Account
Attn: Charles Mercado/Joe Alteri
P.O. Box 7829
Philadelphia, PA 19101-7829
owned 1,029,694.691 (7.3833%) shares
Smith Barney Concert Series, Inc.
Income Portfolio
PNC Bank, NA
Attn: Beverly Timson
200 Stevens Drive Suite 440
Lester, PA 19113-1522
owned 943,794.447 (6.7674%) shares
Smith Barney Concert Series, Inc.
Conservative Portfolio
PNC Bank, NA
Attn: Beverly Timson
200 Stevens Drive Suite 440
Lester, PA 19113-1522
owned 808,272.816 (5.7956%) 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 (47.0815%) shares
Ennis D. Robertson
Smith Barney Inc. IRA Custodian
Carefree Country Club
9705 Lake Bess Road #253
Winter Haven, FL 33884-3225
owned 3,664.199 (40.8819%) shares
Michael A. Blum
Smith Barney Inc. Rollover Custodian
235 East 22nd Street, Apt. 101
New York, NY 10010-4637
owned 879.249 (9.8099%) shares
Premium Total Return 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 1,621,857.688 (76.3720%) shares
Smith Barney Concert Series, Inc.
Conservative Portfolio
PNC Bank, NA
Attn: Beverly Timson
200 Stevens Drive Suite 440
Lester, PA 19113-1522
owned 219,513.609 (10.3367%) 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 127,272.269 (5.9931%) shares
Smith Barney Concert Series, Inc.
Income Portfolio
PNC Bank, NA
Attn: Beverly Timson
200 Stevens Drive Suite 440
Lester, PA 19113-1522
owned 123,891.848 (5.8339%) shares
Municipal High Income Fund Class C
Margaret C. Glass
311 Louise Drive
Lafayette, LA 70506-3239
owned 5,452.029 (12.3651%) shares
Albert P. Brown
4248 Saratoga Avenue, K-384
Downers Grove, IL 60515-1973
owned 4,489.778 (10.1828%) shares
Joseph Giralano and Gloria Giralano, JTWRS
1435 Clinton Place
River Forest, IL 60305-1205
owned 4,188.661 (9.4998%) shares
John J. Madden and Deborah A. Madden, JTWRS
1920 Sandhill Road
Indianapolis, IN 46217-4659
owned 2,949.181 (6.6887%) shares
Deloa Oakes
3700 Taft
Boise, ID 83703-4876
owned 2,917.132 (6.6160%) shares
Daniel D. Dunsing and L. Mae Dunsing, TIC
Sub-Acount 1
P.O. Box 12
Sitka, AK 99835-0012
Utilities Fund Class Y
Smith Barney Concert Series, Inc.
Select Balanced Portfolio
PNC Bank, NA
Attn: Beverly Timson
200 Stevens Drive Suite 440
Lester, PA 19113-1522
owned 87,595.967 (74.5319%) shares
Smith Barney Concert Series, Inc.
Select Conservative Portfolio
PNC Bank, NA
Attn: Beverly Timson
200 Stevens Drive Suite 440
Lester, PA 19113-1522
owned 21,266.015 (18.0944%) shares
Smith Barney Concert Series, Inc.
Select Income Portfolio
PNC Bank, NA
Attn: Beverly Timson
200 Stevens Drive Suite 440
Lester, PA 19113-1522
owned 8,582.457 (7.3024%) shares
Utilities 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 739,802.184 (95.9836%) shares
FINANCIAL STATEMENTS
The Funds' Annual Reports for the fiscal year ended July 31, 1997
(except for the Premium Total Return Fund, whose Annual Report is
for the fiscal year ended December 31, 1996), 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 28, 1997, as amended on January
21, 1998
Convertible Fund
Diversified Strategic Income Fund
Exchange Reserve Fund
High Income Fund
Premium Total Return Fund
Municipal High Income Fund
Total Return Bond Fund
Utilities Fund
Smith Barney
Income Funds
388 Greenwich Street
New York, New York 10013 SMITH BARNEY
A Member of The Travelers Group
FD 01217 1/98
