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 & on June 30, 1998
This Statement of Additional Information expands upon and
supplements the information contained in the current Prospectuses
of Smith Barney Income Funds (the "Trust"), relating to seven
investment funds offered by the Trust: Smith Barney Convertible
Fund (the "Convertible Fund"), Smith Barney Diversified Strategic
Income Fund (the "Diversified Strategic Income Fund"), Smith Barney
Exchange Reserve Fund (the "Exchange Reserve Fund"), Smith Barney
High Income Fund (the "High Income Fund"), Smith Barney Municipal
High Income Fund (the "Municipal High Income Fund"), 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 and Premium Total Return
Fund which is dated April 29, 1998) as amended or supplemented from
time to time (the "Prospectuses"), and should be read in
conjunction with the Prospectuses. The Prospectuses may be obtained
from any 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:
Name
Service
Smith Barney Inc. ("Smith Barney")
Distributor
PFS Distributors, Inc. ("PFS")
Distributor to Exchange Reserve Fund
Mutual Management Corp. ("MMC"),
formerly known as Smith Barney Mutual
Funds Management Inc.
Investment Adviser and Administrator
to the Convertible Fund, Diversified
Strategic Income Fund, Exchange
Reserve Fund, High Income Fund,
Municipal High Income Fund, Total
Return Bond Fund and Utilities Fund.
Smith Barney Global Capital Management
Inc. ("Global Capital Management")
Sub-Investment Adviser to Diversified
Strategic Income Fund
PNC Bank, National Association ("PNC
Bank")
Custodian to Convertible Fund,
Exchange Reserve Fund, High Income
Fund, Municipal High Income Fund,
Total Return Bond Fund and Utilities
Fund
Chase Manhattan Bank ("Chase")
Custodian to Diversified Strategic
Income Fund
First Data Investors Services Group,
Inc. ("First Data")
Transfer Agent
These organizations and the functions they perform for the
Trust are discussed in the Prospectuses and in this Statement of
Additional Information.
Trustees and Executive Officers of the Trust
The Trustees and executive officers of the Trust, together with
information as to their principal business occupations during the
past five years, are shown below. The executive officers of the
Trust are employees of organizations that provide services to the
Funds. Each Trustee who is an "interested person" of the Trust, as
defined in the Investment Company Act of 1940, as amended (the
"1940 Act"), is indicated by an asterisk.
Lee Abraham, Trustee (Age 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, Managing
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.
George Mueller, Vice President and Investment Officer (Age 57).
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.
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 and MMC are
"affiliated persons" of the Trust as defined in the 1940 Act by
virtue of their positions as investment advisers to the Funds. As
of 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:
Trustee(*)
Aggregate Compensation from the Funds
for the Fiscal Year ended July 31, 1997
Total Pension or Retirement Benefits
Accrued from the Funds
Aggregate Compensation from the Funds
and the Fund Complex for the Year ended
December 31, 1996
Lee Abraham (9)
$36,050
$0
$44,550
Antoinette C. Bentley (9)+
63,310
0
44,350
Allan J. Bloostein (15)
44,550
0
83,150
Richard E. Hanson, Jr. (9)
44,550
0
44,550
Heath B. McLendon (41)
0
0
0
Madelon DeVoe Talley (10)++ #
22,275
0
45,342
* 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 serves as investment adviser ("Investment Adviser") to one or
more Funds pursuant to a separate written agreement with the
relevant Fund (an "Advisory Agreement"). MMC is a wholly owned
subsidiary of Salomon Smith Barney Holdings Inc. ("Holdings").
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. Global Capital Management
serves as a sub-investment adviser ("Sub-Investment Adviser") to
Diversified Strategic Income Fund, pursuant to a written agreement
dated March 21, 1994, respectively. Both agreements were most
recently approved by the Fund's Board of Trustees, including a
majority of the Independent Trustees, on August 6, 1997. The
Agreement pertaining to Diversified Strategic Income Fund was most
recently approved by the Fund's Board of 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:
Fund
Investment Advisory
Fee As a Percentage
of Average Net Assets
Convertible Fund
0.50%
Diversified Strategic Income Fund
0.45%
Exchange Reserve Fund
0.30%
High Income Fund
0.50%
Municipal High Income Fund
0.40%
Total Return Bond Fund
0.65%
Utilities Fund
0.45%
For the periods below, the Funds paid investment advisory
fees to their respective Investment Advisers as follows:
For the Fiscal Year Ended July 31:
For the
Period from
August 1, 1996
through
December 31, 1996
Fund
1995
1996
1997
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
Municipal High Income
Fund
4,033,479
3,771,279
3,395,338
Total Return Bond Fund
N/A
N/A
N/A
Utilities Fund
7,885,332
8,094,511
6,431,624
As compensation for administrative services, each Fund pays
the Administrator a fee computed daily and paid monthly at the
annual rate of 0.20% of the Fund's average daily net assets. For
the periods shown below, the Funds paid administrative fees to MMC:
For the Fiscal Year Ended July 31:
For the
Period from
August 1, 1996
through December 31, 1996
Fund
1995
1996
1997
Convertible Fund
$166,266
$167,177
$195,865
Diversified Strategic
Income Fund
4,938,912
5,252,493
5,576,436
Exchange Reserve Fund
365,327
299,283
295,038
High Income Fund
1,482,663
1,802,541
2,258,562
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
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, Total Return Bond and
Municipal High Income Funds). To secure an advantageous price or
yield, these Funds may purchase certain securities on a when-issued
basis or purchase or sell securities for delayed delivery. A Fund
will enter into such transactions for the purpose of acquiring
portfolio securities and not for the purpose of leverage. Delivery
of the securities in such cases occurs beyond the normal settlement
periods, but no payment or delivery is made by a Fund prior to the
reciprocal delivery or payment by the other party to the
transaction. In entering into a when-issued or delayed-delivery
transaction, a Fund will rely on the other party to consummate the
transaction and may be disadvantaged if the other party fails to do
so.
U.S. government securities and Municipal Securities (as
defined below) are normally subject to changes in value based upon
changes, real or anticipated, in the level of interest rates and,
although to a lesser extent in the case of U.S. government
securities, the public's perception of the creditworthiness of the
issuers. In general, U.S. government securities and Municipal
Securities tend to appreciate when interest rates decline and
depreciate when interest rates rise. Purchasing these securities on
a when-issued or delayed-delivery basis, therefore, can involve the
risk that the yields available in the market when the delivery
takes place may actually be higher than those obtained in the
transaction itself. Similarly, the sale of U.S. government
securities for delayed delivery can involve the risk that the
prices available in the market when the delivery is made may
actually be higher than those obtained in the transaction itself.
In the case of the purchase of securities on a when-issued or
delayed-delivery basis by a Fund, the Fund will meet its
obligations on the settlement date from then-available cash flow,
the sale of securities held in the segregated account, the sale of
other securities or, although it would not normally expect to do
so, from the sale of the securities purchased on a when-issued or
delayed-delivery basis (which may have a value greater or less than
the Fund's payment obligations).
Lending of Portfolio Securities (Convertible, Diversified
Strategic Income, High Income, Total Return Bond and 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, Total Return Bond and
Municipal High Income Funds). The Fund may invest in medium- or
low- rated securities and unrated securities of comparable
quality. Generally, these securities offer a higher current yield
than the yield offered by higher-rated securities, but involve
greater volatility of price and risk of loss of income and
principal, including the probability of default by or bankruptcy
of the issuers of such securities. Medium- and low-rated and
comparable unrated securities: (a) will likely have some quality
and protective characteristics that, in the judgment of the
rating organization, are outweighed by large uncertainties or
major risk exposures to adverse conditions and (b) are
predominantly speculative with respect to the issuer's capacity
to pay interest and repay principal in accordance with the terms
of the obligation. Thus, it is possible that these types of
factors could, in certain instances, reduce the value of
securities held by the Fund with a commensurate effect on the
value of the Fund's shares. Therefore, an investment in the Fund
should not be considered as a complete investment program and may
not be appropriate for all investors.
While the market values of medium- and low-rated and
comparable unrated securities tend to react less to fluctuations
in interest rate levels than do those of higher-rated securities,
the market values of certain of these securities also tend to be
more sensitive to individual corporate developments and changes
in economic conditions than higher-rated securities. In addition,
medium- and low-rated and comparable unrated securities generally
present a higher degree of credit risk. Issuers of medium- and
low-rated and comparable unrated securities are often highly
leveraged and may not have more traditional methods of financing
available to them so that their ability to service their debt
obligations during an economic downturn or during sustained
periods of rising interest rates may be impaired. The risk of
loss due to default by such issuers is significantly greater
because medium- and low-rated and comparable unrated securities
generally are unsecured and frequently are subordinated to the
prior payment of senior indebtedness. The Fund may incur
additional expenses to the extent that it is required to seek
recovery upon a default in the payment of principal or interest
on its portfolio holdings. In addition, the markets in which
medium- and low-rated or comparable unrated securities are traded
generally are more limited than those in which higher- rated
securities are traded. The existence of limited markets for these
securities may restrict the availability of securities for the
Fund to purchase and also may have the effect of limiting the
ability of the Fund to: (a) obtain accurate market quotations for
purposes of valuing securities and calculating net asset value
and (b) sell securities at their fair value either to meet
redemption requests or to respond to changes in the economy or
the financial markets. The market for medium- and low-rated and
comparable unrated securities is relatively new and has not fully
weathered a major economic recession. Any such recession,
however, could likely disrupt severely the market for such
securities and adversely affect the value of such securities. Any
such economic downturn also could adversely affect the ability of
the issuers of such securities to repay principal and pay
interest thereon.
Fixed-income securities, including medium- and low-rated
and comparable unrated securities, frequently have call or buy-
back features that permit their issuers to call or repurchase the
securities from their holders, such as the Fund. If an issuer
exercises these rights during periods of declining interest
rates, the Fund may have to replace the security with a lower
yielding security, resulting in a decreased return to the Fund.
Securities that are rated Ba by Moody's or BB by S&P have
speculative characteristics with respect to capacity to pay
interest and repay principal. Securities that are rated B
generally lack characteristics of a desirable investment and
assurance of interest and principal payments over any long period
of time may be small. Securities that are rated Caa or CCC are of
poor standing. These issues may be in default or present elements
of danger may exist with respect to principal or interest.
In light of the risks described above, MMC, in evaluating
the creditworthiness of an issue, whether rated or unrated, will
take various factors into consideration, which may include, as
applicable, the issuer's financial resources, its sensitivity to
economic conditions and trends, the operating history of and the
community support for the facility financed by the issue, the
ability of the issuer's management and regulatory matters.
Options on Securities (Convertible, Diversified Strategic
Income, High Income, and 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 (Utilities Fund). These Funds may
purchase and write put and call options on U.S. stock indexes
listed on U.S. exchanges for the purpose of hedging their
portfolios. A stock index fluctuates with changes in the market
values of the stocks included in the index. Some stock index
options are based on a broad market index such as the New York
Stock Exchange Composite Index or a narrower market index such as
the Standard & Poor's 100. Indexes also are based on an industry or
market segment such as the AMEX Oil and Gas Index or the Computer
and Business Equipment Index.
Options on stock indexes are similar to options on stock
except that (a) the expiration cycles of stock index options are
monthly, while those of stock options are currently quarterly and
(b) the delivery requirements are different. Instead of giving the
right to take or make delivery of stock at a specified price, an
option on a stock index gives the holder the right to receive a
cash "exercise settlement amount" equal to (a) the amount, if any,
by which the fixed exercise price of the option exceeds (in the
case of a put) or is less than (in the case of a call) the closing
value of the underlying index on the date of exercise, multiplied
by (b) a fixed "index multiplier." Receipt of this cash amount will
depend upon the closing level of the stock index upon which the
option is based being greater than (in the case of a call) or less
than (in the case of a put) the exercise price of the option. The
amount of cash received will be equal to such difference between
the closing price of the index and the exercise price of the option
expressed in dollars times a specified multiple. The writer of the
option is obligated, in return for the premium received, to make
delivery of this amount. The writer may offset its position in
stock index options prior to expiration by entering into a closing
transaction on an exchange or it may let the option expire
unexercised.
The effectiveness of purchasing or writing stock index
options as a hedging technique will depend upon the extent to which
price movements in the portion of a securities portfolio being
hedged correlate with price movements of the stock index selected.
Because the value of an index option depends upon movements in the
level of the index rather than the price of a particular stock,
whether the Utilities Fund will realize a gain or loss from the
purchase or writing of options on an index depends upon movements
in the level of stock prices in the stock market generally or, in
the case of certain indexes, in an industry or market segment,
rather than movements in the price of a particular stock.
Accordingly, successful use by a Fund of options on stock indexes
will be subject to its Investment Adviser's ability to predict
correctly movements in the direction of the stock market generally
or of a particular industry. This requires different skills and
techniques than predicting changes in the prices of individual
stocks.
The Utilities Fund will engage in stock index options
transactions only when determined by their respective Investment
Advisers to be consistent with the Funds' efforts to control risk.
There can be no assurance that such judgment will be accurate or
that the use of these portfolio strategies will be successful. When
a Fund writes an option on a stock index, it will establish a
segregated account in the name of the Fund consisting of cash,
equity securities or debt securities of any grade in an amount
equal to or greater than the market value of the option, provided
such securities are liquid and unencumbered and are marked to
market daily pursuant to guidelines established by the Trustees.
Mortgage-Related Securities (Diversified Strategic Income,
Exchange Reserve and Total Return Bond Funds). The average maturity
of pass-through pools of mortgage-related securities varies with
the maturities of the underlying mortgage instruments. In addition,
a pool's stated maturity may be shortened by unscheduled payments
on the underlying mortgages. Factors affecting mortgage prepayments
include the level of interest rates, general economic and social
conditions, the location of the mortgaged property and age of the
mortgage. Because prepayment rates of individual pools vary widely,
it is not possible to accurately predict the average life of a
particular pool. Common practice is to assume that prepayments will
result in an average life ranging from 2 to 10 years for pools of
fixed-rate 30-year mortgages. Pools of mortgages with other
maturities or different characteristics will have varying average
life assumptions.
Mortgage-related securities may be classified as private,
governmental or government-related, depending on the issuer or
guarantor. Private mortgage-related securities represent pass-
through pools consisting principally of conventional residential
mortgage loans created by non-governmental issuers, such as
commercial banks, savings and loan associations and private
mortgage insurance companies. Governmental mortgage-related
securities are backed by the full faith and credit of the United
States. GNMA, the principal guarantor of such securities, is a
wholly owned United States government corporation within the
Department of Housing and Urban Development. Government-related
mortgage-related securities are not backed by the full faith and
credit of the United States government. Issuers of such securities
include FNMA and FHLMC. FNMA is a government-sponsored corporation
owned entirely by private stockholders, which is subject to general
regulation by the Secretary of Housing and Urban Development. Pass-
through securities issued by FNMA are guaranteed as to timely
payment of principal and interest by FNMA. FHLMC is a corporate
instrumentality of the United States, the stock of which is owned
by the Federal Home Loan Banks. Participation certificates
representing interests in mortgages from FHLMC's national portfolio
are guaranteed as to the timely payment of interest and ultimate
collection of principal by FHLMC.
Private, U.S. governmental or government-related entities
create mortgage loan pools offering pass-through investments in
addition to those described above. The mortgages underlying these
securities may be alternative mortgage instruments, that is,
mortgage instruments whose principal or interest payments may vary
or whose terms to maturity may be shorter than previously
customary. As new types of mortgage-related securities are
developed and offered to investors, Diversified Strategic Income
Fund, consistent with its investment objective and policies, will
consider making investments in such new types of securities.
Currency Transactions (Diversified Strategic Income 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 Total return Bond Fund 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 (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 8 below as
fundamental policies with respect to the Funds, which, under the
terms of the 1940 Act, may not be changed without the vote of a
majority of the outstanding voting securities of a Fund. A
"majority" is defined in the 1940 Act as the lesser of (a) 67% or
more of the shares present at a shareholder meeting, if the holders
of more than 50% of the outstanding shares of the Trust are present
or represented by proxy, or (b) more than 50% of the outstanding
shares. Investment restrictions 9 through 16 may be changed by vote
of a majority of the Board of Trustees at any time.
The investment policies adopted by the Trust prohibit a Fund
from:
1. Investing in a manner that would cause it to fail to be a
"diversified company" under the 1940 Act and the rules,
regulations and orders thereunder.
2. Investing in "senior securities" as defined in the 1940
Act and the rules, regulations and orders thereunder
except as permitted under the 1940 Act and the rules,
regulations and orders thereunder.
3. Investing more than 25% of its total assets in
securities, the issuers of which conduct their principal
business activities in the same industry. For purposes
of this limitation, securities of the U.S. government
(including its agencies and instrumentalities) and
securities of state or municipal governments and their
political subdivisions are not considered to be issued by
members of any industry.
4. Borrowing money, except that (a) the Fund may borrow from
banks for temporary or emergency (not leveraging)
purposes, including the meeting of redemption requests
which might otherwise require the untimely disposition of
securities, and (b) the Fund may to the extent consistent
with its investment policies, enter into reverse
repurchase agreements, forward roll transactions and
similar investment strategies and techniques. To the
extent that it engages in transactions described in (a)
and (b), the Fund will be limited so that no more than
33-1/3% of the value of its total assets (including the
amount borrowed), valued at the lesser of cost or market,
less liabilities (not including the amount borrowed)
valued at the time the borrowing is made, is derived from
such transaction.
5. Purchasing securities on margin (except for such short-
term credits as are necessary for the clearance of
purchases and sales of portfolio securities) or sell any
securities short (except "against the box" and for the
Utilities Fund which may make short sales or maintain a
short position to the extent of 5% of its net assets).
For purposes of this restriction the deposit or payment
by the Fund of underlying securities and other assets in
escrow and collateral agreements with respect to initial
or maintenance margin in connection with futures
contracts and related options and options on securities,
indexes or similar items is not considered to be the
purchase of a security on margin.
6. Making Loans. This restriction does not apply to: (a)
the purchase of debt obligations in which the Fund may
invest consistent with its investment objective and
policies; (b) repurchase agreements; and (c) loans of its
portfolio securities, to the fullest extent permitted
under the 1940 Act.
7. Underwriting securities issued by other persons, except
to the extent that the Fund may technically be deemed an
underwriter under the Securities Act of 1933, as amended,
in disposing of portfolio securities.
8. Purchasing or selling real estate, real estate mortgages,
commodities or commodity contracts, but this restriction
shall not prevent the Fund from (a) investing in
securities of issuers engaged in the real estate business
or the business of investing in real estate (including
interests in limited partnerships owning or otherwise
engaging in the real estate business or the business of
investing in real estate) and securities which are
secured by real estate or interests therein; (b) holding
or selling real estate received in connection with
securities it holds or held; (c) trading in futures
contracts and options on futures contracts (including
options on currencies to the extent consistent with the
Fund's investment objective and policies); (d) investing
in real estate investment trust securities; or (e)
investing in gold bullion and coins or receipts for gold.
9. Investing in oil, gas or other mineral exploration or
development programs, except that the Convertible,
Diversified Strategic Income, Utilities and High Income
Funds may invest in the securities of companies that
invest in or sponsor those programs.
10. Writing or selling puts, calls, straddles, spreads or
combinations thereof, except, with respect to Funds other
than Exchange Reserve Fund, as permitted under the Fund's
investment objective and policies.
11. With respect to all Funds except the Exchange Reserve
Fund, purchasing restricted securities, illiquid
securities (such as repurchase agreements with maturities
in excess of seven days and, in the case of Exchange
Reserve Fund, TDs maturing from two business days through
six months) or other securities that are not readily
marketable if more than 10% or, in the case of the High
Income and Diversified Strategic Income Funds, 15% of the
total assets of the Fund would be invested in such
securities. With respect to the Exchange Reserve Fund,
securities subject to Rule 144A of the 1933 Act (provided
at least two dealers make a market in such securities)
and certain privately issued commercial paper eligible
for resale without registration pursuant to Section 4(2)
of the 1933 Act will not be subject to this restriction
12 Purchasing any security if as a result the Fund would
then have more than 5% of its total assets invested in
securities of companies (including predecessors) that
have been in continuous operation for fewer than three
years; provided that, in the case of private activity
bonds purchased for Municipal High Income Fund, this
restriction shall apply to the entity supplying the
revenues from which the issue is to be paid.
13. Making investments for the purpose of exercising control
or management.
14. Purchasing or retaining securities of any company if, to
the knowledge of the Trust, any of the Trust's officers
or Trustees or any officer or director of an Investment
Adviser individually owns more than 1/2 of 1% of the
outstanding securities of such company and together they
own beneficially more than 5% of the securities.
15. Investing in warrants other than those acquired by the
Fund as part of a unit or attached to securities at the
time of purchase (except as permitted under a Fund's
investment objective and policies) if, as a result, the
investments (valued at the lower of cost or market) would
exceed 5% of the value of the Fund's net assets. At no
time may more than 2% of the Fund's net assets be
invested in warrants not listed on a recognized U.S. or
foreign stock exchange, to the extent permitted by
applicable state securities laws.
16. With respect to 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.
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:
For the Fiscal Year Ended
July 31:
Fund
1995
1996
1997
Convertible Fund
48%
59%
57%
Diversified Strategic
Income Fund
83
90
85
High Income Fund
60
72
78
Municipal High Income
Fund
38
44
51
Total Return Bond Fund
N/A
N/A
N/A
Utilities Fund
36
58
45
For regulatory purposes, the turnover rate of Exchange Reserve Fund
is zero.
Portfolio Transactions
Most of the purchases and sales of securities by a Fund, whether
transacted on a securities exchange or over the counter, will be
made in the primary trading market for the securities, except for
Eurobonds which are principally traded over the counter. The
primary trading market for a given security is generally located in
the country in which the issuer has its principal office. Decisions
to buy and sell securities for a Fund are made by its Investment
Adviser, who is also responsible for placing these transactions
subject to the overall review of the Board of Trustees. With
respect to Diversified Strategic Income Fund, decisions to buy and
sell domestic securities for the Fund are made by MMC, which is
also responsible for placing these transactions; the responsibility
to make investment decisions with respect to foreign securities and
to place these transactions rests with Global Capital Management.
Although investment decisions for each Fund are made independently
from those of the other accounts managed by its Investment Adviser,
investments of the type that the Fund may make also may be made by
those other accounts. When a Fund and one or more other accounts
managed by its Investment Adviser are prepared to invest in, or
desire to dispose of, the same security, available investments or
opportunities for sales will be allocated in a manner believed by
the Investment Adviser to be equitable to each. In some cases this
procedure may adversely affect the price paid or received by a
Fund, or the size of the position obtained or disposed of by the
Fund.
Transactions on domestic stock exchanges and some foreign
stock exchanges involve the payment of negotiated brokerage
commissions. On exchanges on which commissions are negotiated, the
cost of transactions may vary among different brokers. Commissions
generally are fixed on most foreign exchanges. There is generally
no stated commission in the case of securities traded in U.S. or
foreign over-the-counter markets, but the prices of those
securities include undisclosed commissions or mark-ups. The cost of
securities purchased from underwriters includes an underwriting
commission or concession, and the prices at which securities are
purchased from and sold to dealers include a dealer's mark-up or
mark-down. U.S. government securities generally are purchased from
underwriters or dealers, although certain newly issued U.S.
government securities may be purchased directly from the United
States Treasury or from the issuing agency or instrumentality. The
following table sets forth certain information regarding each
Fund's payment of brokerage commissions:
Total Brokerage Commissions Paid
Fiscal
Year
Convertible Fund
High Income Fund
Utilities Fund
Diversified Strategic
Income Fund
Total Return Bond Fund
1995
$39,798
$97,439
$2,134,3
06
- --
N/A
1996
16,920
32,621
2,446,07
2
50,196
N/A
1996*
- --
- --
- --
- --
N/A
1997
- --
- --
138,150
- --
N/A
Brokerage Commissions Paid to Smith Barney
Fiscal
Year
Convertible Fund
High Income Fund
Utilities Fund
Diversified Strategic
Income Fund
Total Return Bond Fund
1995
$600
- --
$162,924
- --
N/A
1996
- --
- --
91,818
- --
N/A
1996*
- --
- --
- --
- --
N/A
1997
- --
- --
138,150
- --
N/A
% of Total Brokerage Commissions Paid to Smith Barney
Fiscal Year
Convertible Fund
High Income Fund
Utilities Fund
Diversified Strategic
Income Fund
Total Return Bond Fund
1995
1.51%
0%
7.63%
- --
N/A
1996
- --
- --
3.75
- --
N/A
1996*
- --
- --
- --
- --
N/A
1997
- --
- --
100.0
0
- --
N/A
% of Total Dollar Amount of Transactions Involving Commissions
Paid to Smith Barney
Fiscal
Year
Convertible Fund
High Income Fund
Utilities Fund
Diversified Strategic
Income Fund
Total Return Bond Fund
1995
1.69%
- --
8.21%
- --
N/A
1996
- --
- --
2.72
- --
N/A
1996*
- --
- --
- --
- --
N/A
1997
- --
- --
5.85
- --
N/A
* 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 $73,773,261, consisting
of $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
For the Fiscal Year Ended July 31:
Fund
1995
1996
1997
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
Municipal High Income
Fund
68,794
47,000
46,000
Total Return Bond Fund
N/A
N/A
N/A
Utilities Fund
150,600
228,000
55,000
CDSC (paid to Smith Barney)
Class B
For the Fiscal Year Ended July 31:
Fund
1995
1996
1997
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
Municipal High Income
Fund
1,649,382
929,000
525,000
Total Return Bond Fund
N/A
N/A
N/A
Utilities Fund
4,738,800
3,393,000
2,514,000
Service Fees and Distribution Fees
For the Fiscal Year Ended July 31:
Fund
1995
1996
1997
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
Municipal High Income
Fund
5,456,482
4,945,112
4,316,732
Total Return Bond Fund
N/A
N/A
N/A
Utilities Fund
12,305,595
12,152,329
9,205,137
CDSC (paid to Smith Barney)
Class B
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 sales charges of the
Fund's Class A shares were as follows for the periods indicated:
Fund
One-Year Period
Five-Year Period
Commencement of
Operations
Convertible Fund
20.62%
N/A
11.06%
Diversified Strategic
Income Fund
6.33
N/A
7.48
High Income Fund
12.96
N/A
10.81
Municipal High Income Fund
5.99
N/A
6.31
Total Return Bond Fund
N/A
N/A
N/A
Utilities Fund
9.73
N/A
8.07
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:
Fund
One-Year Period
Five-Year Period
Ten-Year Period
Commencement
of Operations
Convertible Fund (1)
26.29%
11.28%
9.08%
9.44%
Diversified Strategic Income
Fund (2)(6)
10.89
7.26
N/A
9.17
High Income Fund(3)(6)
17.72
11.03
9.32
9.41
Municipal High Income
Fund(4)(6)
9.89
6.03
7.56
8.35
Total Return Bond Fund(7)
N/A
N/A
N/A
N/A
Utilities Fund(5)
14.88
7.87
N/A
10.21
(1) Fund commenced operations on September 9, 1986.
(2) Fund commenced operations on December 28, 1989.
(3) Fund commenced operations on September 2, 1986.
(4) Fund commenced operations on September 16, 1985.
(5) Fund commenced operations on March 28, 1988.
(6) Prior to November 6, 1992, the maximum CDSC imposed on
redemptions was 5.00%.
(7) Fund commenced operations on January 21, 1998.
The average annual total returns (with fees waived) of the
Fund's Class C shares were as follows for the periods indicated:
Fund
One-Year Period
Five-Year Period
Commencement of Operations
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
Municipal High Income
Fund(2)
9.79
N/A
10.70
Total Return Bond Fund
N/A
N/A
N/A
Utilities Fund(6)
15.01
N/A
7.40
(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*
Fund
One-Year Period
Five-Year Period
Ten-Year Period
Commencement
of Operations
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
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
Load**
Fund
One-Year Period
Five-Year Period
Ten-Year Period
Commencement
of Operations
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
Municipal High Income
Fund(4)(6)
5.39
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
.
* 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*
Fund/Class
One-Year Period
Five-Year Period
Commencement
of Operations
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)
17.77
N/A
42.54
Municipal High Income Fund
Class A (1)
10.40
N/A
39.19
Class C (6)
9.79
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
Load**
Fund/Class
One-Year Period
Five-Year Period
Commencement
of Operations
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)
16.77
N/A
42.54
Municipal High Income Fund
Class A (1)
5.98
N/A
33.60
Class C (6)
8.79
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
* 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
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
(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 & June 30, 1998
Convertible Fund
Diversified Strategic Income Fund
Exchange Reserve Fund
High Income 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 6/98
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