Putnam
High Quality
Bond Fund
ANNUAL REPORT ON PERFORMANCE AND OUTLOOK
10-31-98
[LOGO: BOSTON * LONDON * TOKYO]
Fund highlights
* "If the current conditions of low inflation, falling interest rates, and
subdued economic growth persist, there remains, in Putnam's opinion, no
reason for bonds to lose their appeal."
-- Kevin Cronin, manager
Putnam High Quality Bond Fund
CONTENTS
4 Report from Putnam Management
9 Fund performance summary
15 Portfolio holdings
20 Financial statements
From the Chairman
[GRAPHIC OMITTED: PHOTO OF GEORGE PUTNAM]
[copyright] Karsh, Ottawa
Dear Shareholder:
The managers of Putnam High Quality Bond Fund, formerly known as Putnam
Federal Income Trust, faced their share of challenges during the fund's
just-concluded fiscal year. The 12 months ended October 31, 1998,
represented a period in which the U.S. fixed-income market ranged from
rally to retreat. Risk-averse investors first flocked to the safety the
market represented then just as suddenly fled in the aftermath of the
Russian bond default and the collapse of a large hedge fund. Your
managers' report, which follows, provides the details.
During the period, two new members of Putnam's Core Fixed-Income Group
were named to the fund's management team. Kevin M. Cronin is chief
investment officer of the group's Mortgage and Asset-Backed team. Before
joining Putnam in 1997, he was with MFS Investment Management and Liberty
Mutual Insurance Co. He has 10 years of investment experience. Krishna K.
Memani is leader of the group's High-Grade Corporate Bond team. He came to
Putnam earlier this year from Morgan Stanley and PricewaterhouseCoopers
and has 14 years of investment experience.
Respectfully yours,
/S/GEORGE PUTNAM
George Putnam
Chairman of the Trustees
December 16, 1998
Report from the Fund Managers
Kevin M. Cronin
Krishna K. Memani
James M. Prusko
Throughout Putnam High Quality Bond Fund's fiscal year, the 12 months
ended October 31, 1998, fixed-income markets were buoyed by low inflation,
global economic slowdown, and a worldwide flight to quality that pushed
prices of high-quality corporate and U.S. Treasury bonds sharply higher.
However, fixed-income investors' concerns, which had been building for
most of the period, were exacerbated late in the fiscal year by Russia's
foreign debt moratorium, its effect on highly leveraged hedge funds, and
the resulting selloff of non-Treasury bonds. The simmering worry finally
climaxed in October with the bond market's worst three-day performance
since 1965. The Treasury market benefited most from the hot summer rally
but because of the inverse relationship between bond yields and prices,
the yields on these securities dropped to their lowest levels since the
late 1960s.
Within this challenging environment, your fund's class A share total
return at net asset value was 6.66%. At public offering price, class A
shares returned 1.58%. For more performance information, including the
results of other share classes, please see pages 9 through 11.
* U.S. TREASURIES SOAR TO NEW HIGHS, THEN DROP TO NEW LOWS
The summer rally came amid marked weakness in every kind of investment
that carries risk: from stocks to high-yield and emerging-markets bonds.
As a result, the rally has been described as a flight to quality in which
investors scrambled to buy the one investment they perceived as both safe
and liquid: U.S. Treasury securities. This reappraisal of risk caused
heavy selling in many of the sectors your fund invests in, such as
mortgage-backed securities and investment-grade and high-yield corporate
bonds. However, a large part of the summer's Treasury rally was
attributable to short sellers -- investors and dealers who borrowed and
sold Treasury securities, hoping to profit from a fall in their value.
Toward the end of your fund's fiscal year, investors who had stayed on the
sidelines during the start of the Treasury rally spent weeks rushing to
buy Treasuries at any price in an effort to cut losses. Just as the
summer's Treasury rally was largely the result of unwinding or closing out
of long-held bets on Treasury securities, so too was October's dramatic
selloff. Many investors had borrowed yen to buy Treasuries in recent years
- -- a maneuver termed the yen-carry trade -- betting that the yen would
fall in price while the dollar-denominated Treasuries would rise. That
strategy worked wonders until October, when the yen rose substantially
against the dollar. This development, combined with the need to raise cash
- -- given losses elsewhere in their portfolios -- spurred many investors to
dump Treasuries, causing prices to plunge.
Your fund's strategy of overweighting mortgage-backed and corporate
securities versus Treasuries enabled the fund to deliver an attractive
level of income but detracted from total return performance. These sectors
underperformed Treasuries on a duration-adjusted basis following massive
liquidations of each by hedge funds. However, we believe the recent
volatility in the bond markets obscures robust fundamentals. The economy
is slowing, inflation is low, and the supply of bonds is shrinking --
conditions that should help keep bond prices high.
[GRAPHIC OMITTED: horizontal bar chart BOND MARKET PERFORMANCE BY SECTOR]
BOND MARKET PERFORMANCE BY SECTOR*
Comparison of total returns, 10/31/97-10/31/98
Lehman Brothers
Mortgage-Backed Securities Index 7.3%
Lehman Brothers
Corporate Bond Index 8.0%
Salomon Brothers
World Government Bond Index 12.6%
Lehman Brothers
Long-Term Treasury Bond Index 16.3%
Footnote reads:
* Past performance is not indicative of future results. These indexes
reflect the general performance of market sectors in which the fund
invests. The fund's performance will differ. The indexes may include bonds
different from those in the fund. It is not possible to invest directly in
an index.
* MORTGAGES OFFER LIMITED APPEAL DURING PERIOD
Mortgage-backed securities generally offer higher yields than Treasuries
in order to compensate investors for the risk that their principal may be
returned in full at some point prior to the securities' stated maturity.
When Treasuries are strong, however, mortgage-backed securities typically
suffer because of such prepayment concerns. As interest rates fall, many
homeowners refinance their mortgages, returning principal to investors. In
addition to disrupting an investor's income stream, this prepayment of
principal forces the investor to reinvest at lower prevailing rates.
Mortgage-backed securities performed well during the first half of the
year, and your fund benefited from its exposure to this sector. We began
the fiscal year with an increased focus on GNMA mortgage-backed securities
and commercial mortgage-backed security (CMBS) issues. CMBS issues
represent mortgages of office buildings, hotels, multifamily housing, and
industrial real estate. Unlike residential mortgages, CMBS issues have the
advantage of a measure of prepayment protection. For example, under the
terms of some loans, commercial mortgage owners are not allowed to prepay
for the first five years.
When interest rates started dropping rapidly, mortgages began to lag
comparable Treasuries because of fears of increased prepayments. On
September 29, in a long-anticipated move, the Federal Reserve Board
lowered the federal funds rate from 5.50% to 5.25% and then lowered it
again to 5.00% two weeks later to try to sustain economic growth in the
United States. (Shortly after the end of the fiscal year, the rate was
lowered again to 4.75%.) Anticipating the increase in prepayments, we
reduced the fund's position in GNMA mortgage-backed securities during the
period.
[GRAPHIC OMITTED: horizontal bar chart CHANGES IN PORTFOLIO COMPOSITION]
CHANGES IN PORTFOLIO COMPOSITION*
10/31/97 10/31/98
Mortgage-backed
securities 51.2% 43.6%
U.S. Treasury
securities 29.8% 25.0%
Foreign
bonds and notes 6.4% 2.1%
Corporate bonds 8.6% 13.8%
Collateralized
mortgage obligations 7.6% 12.9%
Short-term
investments 1.0% 6.0%
Footnote reads:
*Based on total net assets as of indicated date. Holdings will vary over
time.
* CREDIT CONTRACTION AFFECTS THE CORPORATE SECTOR
The strong performance of Treasuries contrasted sharply with performance
elsewhere in the U.S. bond markets. Just as investors shunned equity
markets during the second half of the period, so too did they turn sour on
credit risk. Consequently, the U.S. corporate bond market suffered
setbacks during the period. With U.S. companies relying heavily on bonds
rather than on bank loans to raise capital, investors feared the credit
contraction would feed into the economy through defaults and possible
bankruptcies. Many U.S. companies were hampered because they could not
draw on credit lines with commercial banks to fill the gap vacated by
jittery bond investors. Banks tend to mark down the value of loans much
more slowly than the market downgrades bonds. This means borrowers with
access to bank credit have an additional cushion against the worst effects
of a credit contraction.
Your fund's emphasis on corporate bonds detracted from performance as
investors penalized the lower-rated issuers within the investment-grade
sector regardless of industry. Our emphasis on nonmoney-center bank
financial issues as well as our de-emphasis of dollar-denominated bonds
issued in the U.S. by foreign banks -- which were among the stronger and
weaker performing sectors, respectively, within the investment-grade
corporate market -- could not overcome the negative impact of the fund's
BBB/Baa rating bias, the lowest tier of the investment-grade bonds.
* FUND'S FLEXIBLE STRATEGY SEEKS TO TAKE ADVANTAGE OF OPPORTUNITIES AHEAD
In Putnam's opinion, if the current conditions of low inflation, falling
interest rates, and subdued economic growth persist, there remains no
reason for bonds to lose their appeal. We believe the market's current
pricing of corporate holdings does not accurately reflect the strong
underlying credit fundamentals of these bonds. Unprecedented levels of
volatility in the fixed-income markets have also pushed mortgage-backed
security spreads to recent wide levels. As the credit markets stabilize,
we believe investors will begin to focus on the positive underlying credit
fundamentals and determine that the attractive yields now associated with
corporates and mortgage-backed securities offer an attractive opportunity.
Given our outlook, we will continue to seek out the higher yields
generally offered by mortgage-backed securities while attempting to limit
the fund's exposure to prepayment risk. In addition, we will continue to
seek income opportunities outside the government sector. With a flexible
investment strategy and an active management style, we believe the fund is
well positioned to take advantage of an anticipated recovery in these
markets.
The views expressed here are exclusively those of Putnam Management. They
are not meant as investment advice. Although the described holdings were
viewed favorably as of 10/31/98, there is no guarantee the fund will
continue to hold these securities in the future. While U.S. government
backing of individual securities does not insure your principal, which
will fluctuate with market conditions, it does guarantee that the fund's
government-backed holdings will make timely payments of interest and
principal.
Performance summary
This section provides information about your fund's performance, which
should always be considered in light of its investment strategy. Putnam
High Quality Bond Fund is designed for investors seeking high current
income with preservation of capital and long-term total return as
secondary objectives, primarily through U.S. government securities.
TOTAL RETURN FOR PERIODS ENDED 10/31/98
Class A Class B Class M
(inception date) (6/2/86) (6/6/94) (4/12/95)
NAV POP NAV CDSC NAV POP
- ------------------------------------------------------------------------------
1 year 6.66% 1.58% 5.84% 0.84% 6.42% 2.99%
- ------------------------------------------------------------------------------
5 years 33.71 27.38 28.68 26.75 32.13 27.87
Annual average 5.98 4.96 5.17 4.86 5.73 5.04
- ------------------------------------------------------------------------------
10 years 108.38 98.52 92.00 92.00 102.17 95.54
Annual average 7.62 7.10 6.74 6.74 7.29 6.94
- ------------------------------------------------------------------------------
Life of fund 135.43 124.29 111.74 111.74 125.79 118.41
Annual average 7.14 6.73 6.23 6.23 6.78 6.50
- ------------------------------------------------------------------------------
COMPARATIVE INDEX RETURNS FOR PERIODS ENDED 10/31/98
Lehman Brothers
Government Consumer
Bond Index Price Index
- ------------------------------------------------------------------------------
1 year 11.28% 1.36%
- ------------------------------------------------------------------------------
5 years 40.10 12.42
Annual average 6.98 2.37
- ------------------------------------------------------------------------------
10 years 137.83 36.27
Annual average 9.05 3.14
- ------------------------------------------------------------------------------
Life of fund 183.62 50.41
Annual average 8.76 3.34
- ------------------------------------------------------------------------------
Past performance is no assurance of future results. Returns for class A
and class M shares reflect the current maximum initial sales charges of
4.75% and 3.25% respectively. Class B share returns for the 1-, 5-, and
10-year (where available) and life-of-fund periods reflect the applicable
contingent deferred sales charge (CDSC), which is 5% in the first year,
declines to 1% in the sixth year, and is eliminated thereafter. Returns
shown for class B and class M shares for periods prior to their inception
are derived from the historical performance of class A shares, adjusted to
reflect both the initial sales charge or CDSC, if any, currently
applicable to each class and in the case of class B and class M shares,
the higher operating expenses applicable to such shares. All returns
assume reinvestment of distributions at NAV. Investment return and
principal value will fluctuate so that an investor's shares when redeemed
may be worth more or less than their original cost.
This performance information does not reflect any market volatility that
may have occurred since the date of the information. As a result, more
recent returns may be more or less than those shown.
[GRAPHIC OMITTED: worm chart GROWTH OF A $10,000 INVESTMENT]
GROWTH OF A $10,000 INVESTMENT
Cumulative total return of
a $10,000 investment since
10/31/88
Fund's class A Lehman Bros. Govt. Consumer Price
Date shares at POP Bond Index Index
10/31/88 9,527 10,000 10,000
10/31/89 10,514 11,203 10,449
10/31/90 11,087 11,868 11,106
10/31/91 12,738 13,600 11,431
10/31/92 13,726 15,005 11,797
10/31/93 14,847 16,976 12,121
10/31/94 14,173 16,217 12,438
10/31/95 16,436 18,712 12,787
10/31/96 17,168 19,669 13,170
10/31/97 18,612 21,372 13,444
10/31/98 $19,852 $23,783 $13,627
Footnote reads:
Past performance is no assurance of future results. At the end of the same
time period, a $10,000 investment in the fund's class B shares would have
been valued at $19,200 and no contingent deferred sales charges would
apply; a $10,000 investment in the fund's class M shares would have been
valued at $20,217 ($19,554 at public offering price). See first page of
performance section for performance calculation method.
PRICE AND DISTRIBUTION INFORMATION
12 months ended 10/31/98
Class A Class B Class M
- -----------------------------------------------------------------------------
Distributions (number) 12 12 12
- -----------------------------------------------------------------------------
Income $0.636 $0.565 $0.613
- -----------------------------------------------------------------------------
Capital gains -- -- --
- -----------------------------------------------------------------------------
Total $0.636 $0.565 $0.613
- -----------------------------------------------------------------------------
Share value: NAV POP NAV NAV POP
- -----------------------------------------------------------------------------
10/31/97 $10.19 $10.70 $10.15 $10.19 $10.53
- -----------------------------------------------------------------------------
10/31/98 10.21 10.72 10.16 10.21 10.55
- -----------------------------------------------------------------------------
Current return (end of period)
- -----------------------------------------------------------------------------
Current dividend rate1 6.23% 5.93% 5.67% 5.99% 5.80%
- -----------------------------------------------------------------------------
Current 30-day SEC yield2 5.61 5.34 4.89 5.36 5.18
- -----------------------------------------------------------------------------
1 Income portion of most recent distribution, annualized and divided by NAV
or POP at end of period.
2 Based on investment income, calculated using SEC guidelines.
TOTAL RETURN FOR PERIODS ENDED 9/30/98
(most recent calendar quarter)
Class A Class B Class M
(inception date) (6/2/86) (6/6/94) (4/12/95)
NAV POP NAV CDSC NAV POP
- ------------------------------------------------------------------------------
1 year 9.40% 4.26% 8.67% 3.67% 9.15% 5.61%
- ------------------------------------------------------------------------------
5 years 35.69 29.30 30.67 28.71 34.12 29.81
Annual average 6.29 5.27 5.50 5.18 6.05 5.36
- ------------------------------------------------------------------------------
10 years 115.57 105.24 98.78 98.78 109.13 102.34
Annual average 7.98 7.45 7.11 7.11 7.66 7.30
- ------------------------------------------------------------------------------
Life of fund 138.57 127.28 114.89 114.89 128.85 121.36
Annual average 7.31 6.89 6.40 6.40 6.95 6.66
- ------------------------------------------------------------------------------
Performance data represent past results, do not reflect future
performance, and will differ for each share class. Investment returns and
principal value will fluctuate so that an investor's shares, when sold,
may be worth more or less than their original cost. See first page of
performance section for performance calculation method.
TERMS AND DEFINITIONS
Total return shows how the value of the fund's shares changed over time,
assuming you held the shares through the entire period and reinvested all
distributions in the fund.
Class A shares are generally subject to an initial sales charge.
Class B shares may be subject to a sales charge upon redemption.
Class M shares have a lower initial sales charge and a higher 12b-1 fee
than class A shares and no sales charge on redemption.
Net asset value (NAV) is the value of all your fund's assets, minus any
liabilities, divided by the number of outstanding shares, not including
any initial or contingent deferred sales charge.
Public offering price (POP) is the price of a mutual fund share plus the
maximum sales charge levied at the time of purchase. POP performance
figures shown here assume the 4.75% maximum sales charge for class A
shares and 3.25% for class M shares.
Contingent deferred sales charge (CDSC) is a charge applied at the time of
the redemption of class B shares and assumes redemption at the end of the
period. Your fund's CDSC declines from a 5% maximum during the first year
to 1% during the sixth year. After the sixth year, the CDSC no longer
applies.
COMPARATIVE BENCHMARKS
Lehman Brothers Government Bond Index* is an unmanaged list of publicly
issued U.S. Treasury obligations and debt obligations of U.S. government
agencies (excluding mortgage-backed securities). The average quality of
bonds included in the index may be higher than the average quality of
those bonds in which the fund customarily invests.
Lehman Brothers Corporate Bond Index* is an unmanaged list of publicly
issued, fixed-rate non-convertible investment-grade domestic corporate
debt securities frequently used as a general measure of the performance of
fixed-income securities.
Lehman Brothers Long-Term Treasury Bond Index* is composed of all bonds
covered by the Lehman Brothers Treasury Bond Index with maturities of 10
years or greater.
Lehman Brothers Mortgage-Backed Securities Index* is an unmanaged list of
GNMA bonds.
Salomon Brothers World Government Bond Index* is a market-capitalization
weighted benchmark that tracks the performance of government-bond markets
in 14 countries.
Consumer Price Index (CPI) is a commonly used measure of inflation; it
does not represent an investment return.
*Securities indexes assume reinvestment of all distributions and interest
payments and do not take in account brokerage fees or taxes. Securities in
the fund do not match those in the indexes and performance of the fund
will differ. It is not possible to invest directly in an index.
PUTNAM GROWTH FUNDS
Asia Pacific Growth Fund
Capital Appreciation Fund [DBL. DAGGER]
Capital Opportunities Fund
Diversified Equity Trust
Europe Growth Fund
Global Growth Fund
Global Natural Resources Fund
Growth Opportunities Fund
Health Sciences Trust
International Growth Fund
International New Opportunities Fund
Investors Fund
New Opportunities Fund [DBL. DAGGER]
OTC & Emerging Growth Fund
Research Fund
Vista Fund
Voyager Fund
Voyager Fund II
PUTNAM GROWTH
AND INCOME FUNDS
Balanced Retirement Fund
Convertible Income-Growth Trust
Equity Income Fund
The George Putnam Fund of Boston
Global Growth and Income Fund
The Putnam Fund for Growth and Income
Growth and Income Fund II
International Growth and Income Fund
New Value Fund
Utilities Growth and Income Fund
PUTNAM INCOME FUNDS
American Government Income Fund
Diversified Income Trust
Global Governmental Income Trust
High Quality Bond Fund +
High Yield Advantage Fund [DBL. DAGGER]
High Yield Total Return Fund
High Yield Trust [DBL. DAGGER]
High Yield Trust II
Income Fund
Intermediate U.S. Government
Income Fund
Money Market Fund **
Preferred Income Fund
Strategic Income Fund *
U.S. Government Income Trust
PUTNAM TAX-FREE
INCOME FUNDS
Municipal Income Fund
Tax Exempt Income Fund
Tax Exempt Money Market Fund**
Tax-Free High Yield Fund
Tax-Free Insured Fund
State tax-free income funds [SECTION MARK]
Arizona, California, Florida, Massachusetts, Michigan, Minnesota,
New Jersey, New York, Ohio and Pennsylvania
State tax-free money market funds [SECTION MARK]
California, New York
LIFESTAGE SM FUNDS
Putnam Asset Allocation Funds-three investment portfolios that spread
your money across a variety of stocks, bonds, and money market
investments.
The three portfolios:
Asset Allocation: Balanced Portfolio
Asset Allocation: Conservative Portfolio
Asset Allocation: Growth Portfolio
*Formerly Putnam Diversified Income Trust II
+Formerly Putnam Federal Income Trust
[DBL. DAGGER] Closed to new investors. Some exceptions may apply.
Contact Putnam for details.
[SECTION MARK] Not available in all states.
**An investment in a money market fund is neither insured nor guaranteed
by the U.S. government. These funds are managed to maintain a price of
$1.00 per share, although there is no assurance that this price will
be maintained in the future.
Please call your financial advisor or Putnam at 1-800-225-1581 to obtain
a prospectus for any Putnam fund. It contains more complete information,
including charges and expenses. Please read it carefully before you
invest or send money.
Report of independent accountants
For the fiscal year ended October 31, 1998
To the Trustees and Shareholders of
Putnam High Quality Bond Fund
(formerly Putnam Federal Income Trust)
In our opinion, the accompanying statement of assets and liabilities,
including the portfolio of investments owned, and the related statements
of operations and of changes in net assets and the financial highlights
present fairly, in all material respects, the financial position of Putnam
High Quality Bond Fund (formerly Putnam Federal Income Trust) (the "fund")
at October 31, 1998, and the results of its operations, the changes in its
net assets and the financial highlights for the periods indicated, in
conformity with generally accepted accounting principles. These financial
statements and financial highlights (hereafter referred to as "financial
statements") are the responsibility of the fund's management; our
responsibility is to express an opinion on these financial statements
based on our audits. We conducted our audits of these financial statements
in accordance with generally accepted auditing standards which require
that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts
and disclosures in the financial statements, assessing the accounting
principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that
our audits, which included confirmation of investments owned at October
31, 1998 by correspondence with the custodian, provide a reasonable basis
for the opinion expressed above.
PricewaterhouseCoopers LLP
Boston, Massachusetts
December 10, 1998
<TABLE>
<CAPTION>
Portfolio of investments owned
October 31, 1998
U.S. GOVERNMENT AND AGENCY OBLIGATIONS (68.6%) (a)
PRINCIPAL AMOUNT VALUE
U.S. Government Agency Mortgage Obligations (43.6%)
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Fannie Mae Strip
$ 1,348,098 Zero %, 294-1 PO (Principal Only), February 1, 2028 $ 1,144,199
1,509,787 6 1/2s, 290 IO (Interest Only), December 1, 2024 292,521
Federal Home Loan Mortgage Corp.
1,817,746 7s, with due dates from October 1, 2025 to
November 1, 2027 1,853,520
8,182,236 5 1/2s, with due dates from March 1, 2011 to
April 1, 2011 8,090,186
Federal National Mortgage Association
1,039,500 7s, Dwarf, with due dates from January 1, 2011 to
May 1, 2011 1,060,935
9,478,976 6 1/2s, April 1, 2028 9,553,007
18,987,216 6 1/2s, Dwarf, with due dates from
December 1, 2008 to October 1, 2013 19,265,953
4,139,928 6 1/2s, Dwarf, with due dates from October 1, 2010 to
August 1, 2013 4,200,701
4,410,000 6 1/2s, TBA, November 15, 2028 4,444,442
3,976,376 6 1/2s, with due dates from July 1, 2028 to
August 1, 2028 4,007,431
7,286,407 6s, Dwarf, with due dates from July 1, 2013 to
September 1, 2013 7,315,990
Freddie Mac Strip
1,844,610 Ser. 194, IO 6 1/2s, 2028 402,356
188,344 Ser. 199, IO 6 1/2s, 2028 41,083
Government National Mortgage Association
2,580,000 9 1/2s, TBA, November 15, 2028 2,789,625
21,692,284 8s, with due dates from January 15, 2001 to
February 15, 2028 22,589,485
66,744,089 7s, with due dates from October 20, 2024 to
June 15, 2028 68,335,078
3,590,210 6 7/8s, May 20, 2024 3,626,112
2,088,697 6 1/2s, with due dates from April 15, 2028 to
June 15, 2028 2,111,527
4,049,389 6 1/2s, with due dates from March 15, 2028 to
May 15, 2028 4,093,648
--------------
165,217,799
U.S. Treasury Obligations (25.0%)
- --------------------------------------------------------------------------------------------------------------------------
U.S. Treasury Bonds
12,040,000 11 7/8s, November 15, 2003 (SEG) 15,990,565
11,900,000 11 5/8s, November 15, 2004 16,284,436
3,935,000 8 1/8s, August 15, 2019 5,262,433
7,988,000 7 1/2s, November 15, 2024 10,348,214
6,355,000 6 1/8s, November 15, 2027 7,151,345
19,671,000 5 1/2s, August 15, 2028 20,700,580
2,625,000 5 1/4s, August 15, 2003 2,739,030
U.S. Treasury Notes
2,830,000 5 7/8s, September 30, 2002 2,976,792
12,325,000 5 5/8s, May 15, 2008 13,285,980
--------------
94,739,375
--------------
Total U.S. Government and Agency Obligations
(cost $254,639,914) $ 259,957,174
CORPORATE BONDS AND NOTES (13.8%) (a)
PRINCIPAL AMOUNT VALUE
Automotive (0.1%)
- --------------------------------------------------------------------------------------------------------------------------
$ 430,000 Chrysler Corp. deb. Ser. B, 7.45s, 2097 $ 459,709
Broadcasting (0.2%)
- --------------------------------------------------------------------------------------------------------------------------
850,000 Viacom, Inc. sr. notes 7 3/4s, 2005 916,156
Chemicals (0.2%)
- --------------------------------------------------------------------------------------------------------------------------
820,000 Arco Chemical deb. 9.8s, 2020 786,765
Computer Services and Software (0.3%)
- --------------------------------------------------------------------------------------------------------------------------
1,320,000 Dell Computer Corp. deb. 7.1s, 2028 1,293,600
Entertainment (0.5%)
- --------------------------------------------------------------------------------------------------------------------------
1,685,000 Time Warner Entertainment sr. notes 8 3/8s, 2033 1,970,085
Insurance and Finance (4.8%)
- --------------------------------------------------------------------------------------------------------------------------
1,420,000 AT&T Capital Corp. notes 6.6s, 2005 1,395,420
1,700,000 Executive Risk Capital Trust company guaranty
Ser. B, 8.675s, 2027 1,684,190
540,000 Finova Capital Corp. notes 6 1/4s, 2002 538,726
1,865,000 First Financial Caribbean Corp. sr. notes 7.84s, 2006 1,976,732
559,000 Fleet Financial Group, Inc. sub. deb. 6 7/8s, 2028 563,282
1,675,000 Markel Capital Trust I company guaranty
Ser. B, 8.71s, 2046 1,664,515
1,750,000 Paine Webber Group, Inc. sr. notes 6.55s, 2008 1,694,840
1,700,000 Peoples Bank-Bridgeport sub. notes 7.2s, 2006 1,609,373
2,010,000 Salton Sea Funding Corp. company guaranty
Ser. E, 8.3s, 2011 2,251,924
1,795,000 St. Paul Bancorp sr. notes 7 1/8s, 2004 1,928,710
2,590,000 Wilmington Trust Corp. sub. notes 6 5/8s, 2008 2,704,841
--------------
18,012,553
Metals and Mining (0.2%)
- --------------------------------------------------------------------------------------------------------------------------
1,770,000 PT Alatief Freeport sr. notes 9 3/4s, 2001
(Netherlands) 885,000
Oil and Gas (3.0%)
- --------------------------------------------------------------------------------------------------------------------------
1,735,000 Coastal Corp. bonds 6.95s, 2028 1,664,108
1,600,000 Coastal Corp. deb. 6 1/2s, 2008 1,622,944
1,090,000 Enron Corp. notes 6.95s, 2028 1,054,542
550,000 Enron Corp. notes 6.4s, 2006 555,731
2,595,000 Global Marine Inc. notes 7s, 2028 2,408,990
1,885,000 Petro Geo-Services AS ADR notes
7 1/2s, 2007 (Norway) 1,979,193
1,920,000 Union Pacific Resources Group Inc. notes
6 3/4s, 2008 1,899,130
--------------
11,184,638
Publishing (0.7%)
- --------------------------------------------------------------------------------------------------------------------------
1,705,000 News America Holdings, Inc. deb. 7 3/4s, 2045 1,670,798
840,000 News America Holdings, Inc. deb. 7.7s, 2025 834,120
--------------
2,504,918
Real Estate (0.3%)
- --------------------------------------------------------------------------------------------------------------------------
1,235,000 OMEGA Healthcare Investors, Inc. notes 6.95s, 2007 (R) 1,107,066
Retail (0.4%)
- --------------------------------------------------------------------------------------------------------------------------
1,725,000 Neiman-Marcus Group, Inc. deb. 7 1/8s, 2028 1,508,099
Telecommunications (0.9%)
- --------------------------------------------------------------------------------------------------------------------------
1,345,000 AirTouch Communications notes 6.65s, 2008 1,407,623
1,555,000 TCI Communications, Inc. sr. notes 8.65s, 2004 1,780,973
--------------
3,188,596
Transportation (0.9%)
- --------------------------------------------------------------------------------------------------------------------------
1,645,000 Continental Airlines pass-through certificates
Ser. 97CI, 7.42s, 2007 1,672,044
1,430,000 Canadian Pacific Ltd. deb. 9.45s, 2021 (Canada) 1,826,124
--------------
3,498,168
Utilities (1.3%)
- --------------------------------------------------------------------------------------------------------------------------
1,070,000 Edison Mission Energy 144A company guaranty
7.33s, 2008 1,145,382
1,850,000 Teco Energy, Inc. notes 5.54s, 2001 1,858,695
1,720,000 Texas Utilities Electric Capital Trust V
company guaranty 8.175s, 2037 1,855,433
--------------
4,859,510
--------------
Total Corporate Bonds and Notes
(cost $53,492,407) $ 52,174,863
NON-AGENCY COLLATERALIZED MORTGAGE OBLIGATIONS (12.9%) (a)
PRINCIPAL AMOUNT VALUE
- --------------------------------------------------------------------------------------------------------------------------
$ 608,416 Amresco Commercial Mortgage Funding I
Ser. 97-C1, Class A1, 6.73s, 2029 $ 622,842
Chase Mortgage Finance Corp.
720,000 Ser. 1998-S2, Class A14, 6 3/4s, 2028 725,400
1,295,321 Ser. 1994-G, Class B3, 7s, 2025 1,171,860
816,125 Interest Strip Ser. 1993-3, Class B6, 7.46s, 2024 856,931
3,501,413 Interest Strip Ser. 1993-3, Class B7, 7.46s, 2024 3,676,483
1,003,890 CMC Securities Corp. III Ser. 1994-F, Class B2,
6 1/4s, 2014 952,127
Commercial Mortgage Acceptance Corp.
2,670,000 Ser. 98-MLI, Class A2, 6.03s, 2008 2,650,392
75,000 Ser. 97-ML1, Class A2, 6.53s, 2007 77,367
1,080,000 Ser. 97-ML1, Class A3, 6.57s, 2007 1,110,038
1,010,000 Ser. 97-ML1, Class D, 7.11s, 2030 1,010,000
Criimi Mae Commercial Mortgage Trust
3,280,000 Ser. 98-C1, Class A2, 7s, 2011 3,196,463
1,310,000 Ser. 98-C1, Class B, 7s, 2011 1,218,300
First Union-Lehman Brothers
Commercial Mortgage Co.
795,000 Ser. 97-C2, Class A3, 6.65s, 2008 821,552
1,160,000 Ser. 97-C2, Class D, 7.12s, 2012 1,118,177
1,270,000 Ser. 98-C2, Class D, 6.778s, 2013 1,185,366
30,079,026 Ser. 98-C2, Class IO, 0.816s, 2028 1,261,909
1,249,696 Green Tree Recreational Equipment & Cons.
Ser. 98-A, Class A1C, 6.18s, 2019 1,277,082
GMAC Commercial Mortgage Securities Inc.
1,775,377 Ser. 98-C1, Class A1, 6.44s, 2030 1,822,396
1,278,000 Ser. 98-C1, Class E, 7.153s, 2011 1,265,420
GS Mortgage Securities Corp. II
1,030,000 Ser. 98-GLII, Class A2, 6.562s, 2031 1,048,347
565,000 Ser. 98-GLII, Class D, 7.191s, 2031 529,688
2,467,868 Housing Securities Inc. Ser. 1993-J,
Class J2, 6.66s, 2009 2,592,033
159,000 Merrill Lynch Mortgage Investors, Inc. Ser. 98-C2,
Class D, 7.116s, 2030 157,658
Morgan Stanley Capital I
610,000 Ser. 96-WF1, Class A2, 7.218s, 2006 646,981
315,000 Ser. 98-XL1, Class E, 6.989s, 2030 317,658
Prudential Home Mortgage Securities
2,628,517 Ser. 1994-28, Class B2, 6.803s, 2001 2,520,912
4,281,597 Ser. 94-D, Class 3B, 6.312s, 2009 4,276,245
3,627,639 Ser. 93-31, Class B1, 6s, 2000 3,529,013
Residential Funding Mortgage Securities
884,586 Ser. 93-S17, Class M3, 7s, 2008 890,391
677,132 Ser. 93-S23, Class M3, 6 1/2s, 2008 675,228
750,000 Sears Mortgage Securities, Ser. 1993-7,
Class T-7, 7s, 2007 764,531
Securitized Asset Sales, Inc.
3,335,157 Ser. 93-J, Class 2B, 6.808s, 2023 3,199,666
1,799,497 Mtge. Pass Thru Certificates Ser. 1994-3,
Class B1, 6.11s, 1999 1,780,377
--------------
Total Non-Agency Collateralized
Mortgage Obligations (cost $46,344,789) $ 48,948,833
FOREIGN GOVERNMENT BONDS AND NOTES (2.1%) (a)
PRINCIPAL AMOUNT VALUE
- --------------------------------------------------------------------------------------------------------------------------
DEM 6,390,000 Germany (Federal Republic of) bonds
Ser. 98, 5 5/8s, 2028 $ 4,115,416
CAD 4,010,000 Ontario (Province of) sr. unsub. 5 1/2s, 2008 4,018,822
--------------
Total Foreign Government Bonds and Notes
(cost $7,615,741) $ 8,134,238
SHORT TERM INVESTMENTS (6.0%)
PRINCIPAL AMOUNT VALUE
- --------------------------------------------------------------------------------------------------------------------------
$10,000,000 Bank Of Nova Scotia, 5.08s, 11/18/98 $ 9,967,529
12,894,000 Interest in $750,000,000 joint tri-party repurchase
agreement dated October 30, 1998, with Goldmann
Sachs & Co. due November 2, 1998, with respect to
various U.S. Treasury obligations- maturity value
of $12,899,781 for an effective yield of 5.38% 12,897,854
--------------
Total Short Term Investments (cost $22,865,398) $ 22,865,383
- --------------------------------------------------------------------------------------------------------------------------
Total Investments (cost $384,958,249) (b) $ 392,080,491
- --------------------------------------------------------------------------------------------------------------------------
(a) Percentages indicated are based on net assets of $379,156,713.
(b) The aggregate identified cost on a tax basis is $385,052,086, resulting in gross unrealized appreciation and
depreciation of $11,066,760 and $4,038,355, respectively, or net unrealized appreciation of $7,028,405.
(SEG) A portion of this security was pledged and segregated with the custodian to cover margin requirements for
futures contracts at October 31, 1998.
(R) Real Estate Investment Trust.
144A after the name of a security represents those exempt from registration under Rule 144A of the Securities
Act of 1933. These securities may be resold in transactions exempt from registration, normally to qualified
institutional buyers.
TBA after the name of a security represents to be announced securities (Note 1).
ADR after the name of a foreign holding stands for American Depository Receipt, representing ownership of
foreign securities on deposit with a domestic custodian bank.
- -------------------------------------------------------------------------------
Forward Currency Contracts to Buy at October 31, 1998
Market Aggregate Face Delivery Unrealized
Value Value Date Appreciation
- -------------------------------------------------------------------------------
Deutschemarks $3,803,599 $3,646,093 12/16/98 $157,506
- -------------------------------------------------------------------------------
Forward Currency Contracts to Sell at October 31, 1998
Market Aggregate Face Delivery Unrealized
Value Value Date Depreciation
- -------------------------------------------------------------------------------
Deutschemarks $7,768,868 $7,442,886 12/16/98 $(325,982)
- -------------------------------------------------------------------------------
Futures Contracts Outstanding at October 31, 1998
Market Aggregate Face Delivery Unrealized
Value Value Date Appreciation
- -------------------------------------------------------------------------------
U.S. Treasury
Bonds 20yr (long) $3,093,750 $3,011,406 Dec 98 $82,344
- -------------------------------------------------------------------------------
TBA Sale Commitments Outstanding at October 31, 1998
(proceeds receivable $4,393,692)
Principal Settlement Market
Agency Amount Date Value
- -------------------------------------------------------------------------------
FNMA 6s
November 15, 2013 $4,410,000 11/17/98 $4,427,905
- -------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
</TABLE>
<TABLE>
<CAPTION>
Statement of assets and liabilities
October 31, 1998
<S> <C>
Assets
- -----------------------------------------------------------------------------------------------
Investments in securities, at value (identified cost $384,958,249) (Note 1) $392,080,491
- -----------------------------------------------------------------------------------------------
Cash 80,233
- -----------------------------------------------------------------------------------------------
Interest and other receivables 5,153,202
- -----------------------------------------------------------------------------------------------
Receivable for shares of the fund sold 934,538
- -----------------------------------------------------------------------------------------------
Receivable for securities sold 5,361,574
- -----------------------------------------------------------------------------------------------
Receivable for open forward currency contracts 157,506
- -----------------------------------------------------------------------------------------------
Total assets 403,767,544
Liabilities
- -----------------------------------------------------------------------------------------------
Payable for securities purchased 18,629,161
- -----------------------------------------------------------------------------------------------
Payable for variation margin 11,250
- -----------------------------------------------------------------------------------------------
Payable for shares of the fund repurchased 302,916
- -----------------------------------------------------------------------------------------------
Payable for compensation of Manager (Note 2) 607,473
- -----------------------------------------------------------------------------------------------
Payable for investor servicing and custodian fees (Note 2) 49,503
- -----------------------------------------------------------------------------------------------
Payable for compensation of Trustees (Note 2) 19,736
- -----------------------------------------------------------------------------------------------
Payable for administrative services (Note 2) 562
- -----------------------------------------------------------------------------------------------
Payable for distribution fees (Note 2) 102,978
- -----------------------------------------------------------------------------------------------
Payable for open forward currency contracts 325,982
- -----------------------------------------------------------------------------------------------
Payable for closed forward currency contracts 51,167
- -----------------------------------------------------------------------------------------------
TBA sales commitments, at value (proceeds receivable $4,393,692) 4,427,905
- -----------------------------------------------------------------------------------------------
Other accrued expenses 82,198
- -----------------------------------------------------------------------------------------------
Total liabilities 24,610,831
- -----------------------------------------------------------------------------------------------
Net assets $379,156,713
Represented by
- -----------------------------------------------------------------------------------------------
Paid-in capital (Notes 1 and 4) $425,338,764
- -----------------------------------------------------------------------------------------------
Undistributed net investment income (Note 1) 1,124,216
- -----------------------------------------------------------------------------------------------
Accumulated net realized loss on investments and
foreign currency transactions (Note 1) (54,268,018)
- -----------------------------------------------------------------------------------------------
Net unrealized appreciation of investments and
assets and liabilities in foreign currencies 6,961,751
- -----------------------------------------------------------------------------------------------
Total -- Representing net assets applicable to capital shares outstanding $379,156,713
Computation of net asset value and offering price
- -----------------------------------------------------------------------------------------------
Net asset value and redemption price per class A share
($339,681,613 divided by 33,283,344 shares) $10.21
- -----------------------------------------------------------------------------------------------
Offering price per class A share (100/95.25 of $10.21)* $10.72
- -----------------------------------------------------------------------------------------------
Net asset value and offering price per class B share
($34,679,487 divided by 3,411,973 shares)** $10.16
- -----------------------------------------------------------------------------------------------
Net asset value and redemption price per class M share
($4,795,613 divided by 469,804 shares) $10.21
- -----------------------------------------------------------------------------------------------
Offering price per class M share (100/96.75 of $10.21)* $10.55
- -----------------------------------------------------------------------------------------------
* On single retail sales of less than $50,000. On sales of $50,000 or more and on group
sales the offering price is reduced.
** Redemption price per share is equal to net asset value less any applicable contingent
deferred sales charge.
The accompanying notes are an integral part of these financial statements.
</TABLE>
<TABLE>
<CAPTION>
Statement of operations
Year ended October 31, 1998
<S> <C>
Interest income: $24,629,739
- -----------------------------------------------------------------------------------------------
Expenses:
- -----------------------------------------------------------------------------------------------
Compensation of Manager (Note 2) 2,294,672
- -----------------------------------------------------------------------------------------------
Investor servicing and custodian fees (Note 2) 682,170
- -----------------------------------------------------------------------------------------------
Compensation of Trustees (Note 2) 24,924
- -----------------------------------------------------------------------------------------------
Administrative services (Note 2) 6,717
- -----------------------------------------------------------------------------------------------
Distribution fees -- Class A (Note 2) 842,701
- -----------------------------------------------------------------------------------------------
Distribution fees -- Class B (Note 2) 175,723
- -----------------------------------------------------------------------------------------------
Distribution fees -- Class M (Note 2) 8,552
- -----------------------------------------------------------------------------------------------
Reports to shareholders 48,750
- -----------------------------------------------------------------------------------------------
Auditing 60,985
- -----------------------------------------------------------------------------------------------
Legal 6,197
- -----------------------------------------------------------------------------------------------
Registration fees 2,003
- -----------------------------------------------------------------------------------------------
Postage 70,252
- -----------------------------------------------------------------------------------------------
Other 111,298
- -----------------------------------------------------------------------------------------------
Total expenses 4,334,944
- -----------------------------------------------------------------------------------------------
Expense reduction (Note 2) (205,493)
- -----------------------------------------------------------------------------------------------
Net expenses 4,129,451
- -----------------------------------------------------------------------------------------------
Net investment income 20,500,288
- -----------------------------------------------------------------------------------------------
Net realized gain on investments (Notes 1 and 3) 7,572,944
- -----------------------------------------------------------------------------------------------
Net realized gain on futures contracts (Note 1) 535,843
- -----------------------------------------------------------------------------------------------
Net realized loss on foreign currency transactions (Note 1) (2,008,737)
- -----------------------------------------------------------------------------------------------
Net unrealized depreciation of assets and liabilities in
foreign currencies during the year (123,603)
- -----------------------------------------------------------------------------------------------
Net unrealized depreciation of investments, futures and
TBA sale commitments during the year (4,004,453)
- -----------------------------------------------------------------------------------------------
Net gain on investments 1,971,994
- -----------------------------------------------------------------------------------------------
Net increase in net assets resulting from operations $22,472,282
- -----------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
</TABLE>
<TABLE>
<CAPTION>
Statement of changes in net assets
Year ended October 31
-------------------------------
1998 1997
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Increase (decrease) in net assets
- ---------------------------------------------------------------------------------------------------------------
Operations:
- ---------------------------------------------------------------------------------------------------------------
Net investment income $ 20,500,288 $ 22,631,534
- ---------------------------------------------------------------------------------------------------------------
Net realized gain on investments and
foreign currency transactions 6,100,050 2,234,048
- ---------------------------------------------------------------------------------------------------------------
Net unrealized appreciation (depreciation) of
investments and assets and liabilities in foreign currencies (4,128,056) 4,533,459
- ---------------------------------------------------------------------------------------------------------------
Net increase in net assets resulting from operations 22,472,282 29,399,041
- ---------------------------------------------------------------------------------------------------------------
Distributions to shareholders:
- ---------------------------------------------------------------------------------------------------------------
From net investment income
Class A (21,024,224) (22,525,251)
- ---------------------------------------------------------------------------------------------------------------
Class B (965,458) (563,757)
- ---------------------------------------------------------------------------------------------------------------
Class M (102,689) (51,138)
- ---------------------------------------------------------------------------------------------------------------
Increase (decrease) from capital share transactions (Note 4) 19,314,068 (34,799,540)
- ---------------------------------------------------------------------------------------------------------------
Total increase (decrease) in net assets 19,693,979 (28,540,645)
Net assets
- ---------------------------------------------------------------------------------------------------------------
Beginning of year 359,462,734 388,003,379
- ---------------------------------------------------------------------------------------------------------------
End of year (including undistributed net investment
income of $1,124,216 and $3,549,160, respectively) $379,156,713 $359,462,734
- ---------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
</TABLE>
<TABLE>
<CAPTION>
Financial highlights
(For a share outstanding throughout the period)
CLASS A
- ------------------------------------------------------------------------------------------------------------------------------------
Per-share
operating performance Year ended October 31
- ------------------------------------------------------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net asset value,
beginning of period $10.19 $10.01 $10.17 $9.32 $10.47
- ------------------------------------------------------------------------------------------------------------------------------------
Investment operations
- ------------------------------------------------------------------------------------------------------------------------------------
Net investment income .59(b) .61(b) .61(b) .60 .61
- ------------------------------------------------------------------------------------------------------------------------------------
Net realized and unrealized
gain (loss) on investments .07 .20 (.18) .84 (1.07)
- ------------------------------------------------------------------------------------------------------------------------------------
Total from
investment operations .66 .81 .43 1.44 (.46)
- ------------------------------------------------------------------------------------------------------------------------------------
Less distributions:
- ------------------------------------------------------------------------------------------------------------------------------------
From net
investment income (.64) (.63) (.59) (.59) (.66)
- ------------------------------------------------------------------------------------------------------------------------------------
Return of capital -- -- -- -- (.03)
- ------------------------------------------------------------------------------------------------------------------------------------
Total distributions (.64) (.63) (.59) (.59) (.69)
- ------------------------------------------------------------------------------------------------------------------------------------
Net asset value,
end of period $10.21 $10.19 $10.01 $10.17 $9.32
- ------------------------------------------------------------------------------------------------------------------------------------
Ratios and supplemental data
- ------------------------------------------------------------------------------------------------------------------------------------
Total investment return
at net asset value (%)(a) 6.66 8.41 4.45 15.97 (4.54)
- ------------------------------------------------------------------------------------------------------------------------------------
Net assets, end of period
(in thousands) $339,682 $347,223 $379,929 $426,252 $449,480
- ------------------------------------------------------------------------------------------------------------------------------------
Ratio of expenses to
average net assets (%)(c) 1.18 1.15 1.16 1.12 1.06
- ------------------------------------------------------------------------------------------------------------------------------------
Ratio of net investment income
to average net assets (%) 5.79 6.15 6.12 6.22 6.91
- ------------------------------------------------------------------------------------------------------------------------------------
Portfolio turnover (%) 174.76 218.97 297.30 234.95 317.91
- ------------------------------------------------------------------------------------------------------------------------------------
+ Commencement of operations.
* Not annualized
(a) Total investment return assumes dividend reinvestment and does not reflect the effect of sales charges.
(b) Per share net investment income has been determined on the basis the weighted average number
of shares outstanding during the period.
(c) The ratio of expenses to average net assets for periods ended October 31, 1995 and thereafter,
includes amounts paid through expense offset arrangements. Prior period ratios
exclude these amounts. (Note 2).
</TABLE>
<TABLE>
<CAPTION>
Financial highlights
(For a share outstanding throughout the period)
CLASS B
- ------------------------------------------------------------------------------------------------------------------------------------
For the period
Per-share June 6, 1994+
operating performance Year ended October 31 to October 31
- ------------------------------------------------------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net asset value,
beginning of period $10.15 $9.98 $10.14 $9.30 $9.68
- ------------------------------------------------------------------------------------------------------------------------------------
Investment operations
- ------------------------------------------------------------------------------------------------------------------------------------
Net investment income .51(b) .52 .54(b) .52 .18
- ------------------------------------------------------------------------------------------------------------------------------------
Net realized and unrealized
gain (loss) on investments .07 .21 (.18) .84 (.32)
- ------------------------------------------------------------------------------------------------------------------------------------
Total from
investment operations .58 .73 .36 1.36 (.14)
- ------------------------------------------------------------------------------------------------------------------------------------
Less distributions:
- ------------------------------------------------------------------------------------------------------------------------------------
From net
investment income (.57) (.56) (.52) (.52) (.23)
- ------------------------------------------------------------------------------------------------------------------------------------
Return of capital -- -- -- -- (.01)
- ------------------------------------------------------------------------------------------------------------------------------------
Total distributions (.57) (.56) (.52) (.52) (.24)
- ------------------------------------------------------------------------------------------------------------------------------------
Net asset value,
end of period $10.16 $10.15 $9.98 $10.14 $9.30
- ------------------------------------------------------------------------------------------------------------------------------------
Ratios and supplemental data
- ------------------------------------------------------------------------------------------------------------------------------------
Total investment return
at net asset value (%)(a) 5.84 7.55 3.74 15.09 (1.42)*
- ------------------------------------------------------------------------------------------------------------------------------------
Net assets, end of period
(in thousands) $34,679 $11,311 $7,535 $1,835 $498
- ------------------------------------------------------------------------------------------------------------------------------------
Ratio of expenses to
average net assets (%)(c) 1.93 1.90 1.93 1.85 .72*
- ------------------------------------------------------------------------------------------------------------------------------------
Ratio of net investment income
to average net assets (%) 5.06 5.30 5.44 5.42 2.34*
- ------------------------------------------------------------------------------------------------------------------------------------
Portfolio turnover (%) 174.76 218.97 297.30 234.95 317.91
- ------------------------------------------------------------------------------------------------------------------------------------
+ Commencement of operations.
* Not annualized
(a) Total investment return assumes dividend reinvestment and does not reflect the effect of sales charges.
(b) Per share net investment income has been determined on the basis the weighted average number
of shares outstanding during the period.
(c) The ratio of expenses to average net assets for periods ended October 31, 1995 and thereafter,
includes amounts paid through expense offset arrangements. Prior period ratios
exclude these amounts. (Note 2).
</TABLE>
<TABLE>
<CAPTION>
Financial highlights
(For a share outstanding throughout the period)
CLASS M
- ------------------------------------------------------------------------------------------------------------------------------------
For the period
Per-share April 12, 1995+
operating performance Year ended October 31 to October 31
- ------------------------------------------------------------------------------------------------------------------------------------
1998 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net asset value,
beginning of period $10.19 $10.01 $10.17 $9.57
- ------------------------------------------------------------------------------------------------------------------------------------
Investment operations
- ------------------------------------------------------------------------------------------------------------------------------------
Net investment income .57(b) .57 .59(b) .29(b)
- ------------------------------------------------------------------------------------------------------------------------------------
Net realized and unrealized
gain (loss) on investments .06 .22 (.18) .60
- ------------------------------------------------------------------------------------------------------------------------------------
Total from
investment operations .63 .79 .41 .89
- ------------------------------------------------------------------------------------------------------------------------------------
Less distributions:
- ------------------------------------------------------------------------------------------------------------------------------------
From net
investment income (.61) (.61) (.57) (.29)
- ------------------------------------------------------------------------------------------------------------------------------------
Return of capital -- -- -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Total distributions (.61) (.61) (.57) (.29)
- ------------------------------------------------------------------------------------------------------------------------------------
Net asset value,
end of period $10.21 $10.19 $10.01 $10.17
- ------------------------------------------------------------------------------------------------------------------------------------
Ratios and supplemental data
- ------------------------------------------------------------------------------------------------------------------------------------
Total investment return
at net asset value (%)(a) 6.42 8.16 4.20 9.35*
- ------------------------------------------------------------------------------------------------------------------------------------
Net assets, end of period
(in thousands) $4,796 $929 $539 $186
- ------------------------------------------------------------------------------------------------------------------------------------
Ratio of expenses to
average net assets (%)(c) 1.43 1.40 1.43 .71*
- ------------------------------------------------------------------------------------------------------------------------------------
Ratio of net investment income
to average net assets (%) 5.54 5.81 5.90 3.15*
- ------------------------------------------------------------------------------------------------------------------------------------
Portfolio turnover (%) 174.76 218.97 297.30 234.95
- ------------------------------------------------------------------------------------------------------------------------------------
+ Commencement of operations.
* Not annualized
(a) Total investment return assumes dividend reinvestment and does not reflect the effect of sales charges.
(b) Per share net investment income has been determined on the basis the weighted average number
of shares outstanding during the period.
(c) The ratio of expenses to average net assets for periods ended October 31, 1995 and thereafter,
includes amounts paid through expense offset arrangements. Prior period ratios
exclude these amounts. (Note 2).
</TABLE>
Notes to financial statements
October 31, 1998
Note 1
Significant accounting policies
Putnam High Quality Bond Fund (formerly known as Putnam Federal Income
Trust) (the "fund") is registered under the Investment Company Act of
1940, as amended, as a diversified, open-end management investment
company. The fund seeks high current income, consistent with preservation
of capital, through investments primarily in U.S. government securities.
The fund offers class A, class B and class M shares. Class A shares are
sold with a maximum front-end sales charge of 4.75%. Class B shares, which
convert to class A shares after approximately eight years, do not pay a
front-end sales charge, but pay a higher ongoing distribution fee than
class A shares, and are subject to a contingent deferred sales charge, if
those shares are redeemed within six years of purchase. Class M shares are
sold with a maximum front-end sales charge of 3.25% and pay an ongoing
distribution fee that is lower than class B shares and higher than class A
shares.
Expenses of the fund are borne pro-rata by the holders of each class of
shares, except that each class bears expenses unique to that class
(including the distribution fees applicable to such class). Each class
votes as a class only with respect to its own distribution plan or other
matters on which a class vote is required by law or determined by the
Trustees. Shares of each class would receive their pro-rata share of the
net assets of the fund, if the fund were liquidated. In addition, the
Trustees declare separate dividends on each class of shares.
The following is a summary of significant accounting policies consistently
followed by the fund in the preparation of its financial statements. The
preparation of financial statements is in conformity with generally
accepted accounting principles and requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities. Actual results could differ from those estimates.
A) Security valuation Investments for which market quotations are readily
available are stated at market value, which is determined using the last
reported sale price, or, if no sales are reported -- as in the case of
some securities traded over-the-counter -- the last reported bid price.
Securities quoted in foreign currencies are translated into U.S. dollars
at the current exchange rate. Short-term investments having remaining
maturities of 60 days or less are stated at amortized cost, which
approximates market value, and other investments, are stated at fair value
following procedures approved by the Trustees. Market quotations are not
considered to be readily available for long-term corporate bonds and
notes; such investments are stated at fair value on the basis of
valuations furnished by a pricing service, approved by the Trustees, which
determines valuations for normal, institutional-size trading units of such
securities using methods based on market transactions for comparable
securities and various relationships between securities which are
generally recognized by institutional traders.
B) Joint trading account Pursuant to an exemptive order issued by the
Securities and Exchange Commission, the fund may transfer uninvested cash
balances into a joint trading account along with the cash of other
registered investment companies and certain other accounts managed by
Putnam Investment Management, Inc. ("Putnam Management"), the fund's
Manager, a wholly-owned subsidiary of Putnam Investments, Inc. These
balances may be invested in one or more repurchase agreements and/or
short-term money market instruments.
C) Repurchase agreements The fund, or any joint trading account, through
its custodian, receives delivery of the underlying securities, the market
value of which at the time of purchase is required to be in an amount at
least equal to the resale price, including accrued interest. Collateral
for certain tri-party repurchase agreements is held at the counterparty's
custodian in a segregated account for the benefit of the fund and the
counterparty. Putnam Management is responsible for determining that the
value of these underlying securities is at all times at least equal to the
resale price, including accrued interest.
D) Security transactions and related investment income Security
transactions are accounted for on the trade date (date the order to buy or
sell is executed). Interest income is recorded on the accrual basis.
Discounts on original issue discount bonds are accreted according to the
yield-to-maturity basis.
E) Foreign currency translation The accounting records of the fund are
maintained in U.S. dollars. The market value of foreign securities,
currency holdings, other assets and liabilities are recorded in the books
and records of the fund after translation to U.S. dollars based on the
exchange rates on that day. The cost of each security is determined using
historical exchange rates. Income and withholding taxes are translated at
prevailing exchange rates when accrued or incurred. The fund does not
isolate that portion of realized or unrealized gains or losses resulting
from changes in the foreign exchange rate on investments from fluctuations
arising from changes in the market prices of the securities. Such gains
and losses are included with the net realized and unrealized gain or loss
on investments. Net realized gains and losses on foreign currency
transactions represent net exchange gains or losses on closed forward
currency contracts, disposition of foreign currencies and the difference
between the amount of investment income and foreign withholding taxes
recorded on the fund's books and the U.S. dollar equivalent amounts
actually received or paid. Net unrealized appreciation and depreciation of
assets and liabilities in foreign currencies arise from changes in the
value of open forward currency contracts and assets and liabilities other
than investments at the period end, resulting from changes in the exchange
rate.
F) Forward currency contracts The fund may engage in forward currency
contracts, which are agreements between two parties to buy and sell
currencies at a set price on a future date, to protect against a decline
in value relative to the U.S. dollar of the currencies in which its
portfolio securities are denominated or quoted (or an increase in the
value of a currency in which securities a fund intends to buy are
denominated, when a fund holds cash reserves and short-term investments).
The U.S. dollar value of forward currency contracts is determined using
current forward currency exchange rates supplied by a quotation service.
The market value of the contract will fluctuate with changes in currency
exchange rates. The contract is "marked to market" daily and the change in
market value is recorded as an unrealized gain or loss. When the contract
is closed, the fund records a realized gain or loss equal to the
difference between the value of the contract at the time it was opened and
the value at the time it was closed. The fund could be exposed to risk if
the value of the currency changes unfavorably, if the counterparties to
the contracts are unable to meet the terms of their contracts or if the
fund is unable to enter into a closing position.
G) Futures and options contracts The fund may use futures and options
contracts to hedge against changes in the values of securities the fund
owns or expects to purchase. The fund may also write options on securities
it owns or in which it may invest to increase its current returns.
The potential risk to the fund is that the change in value of futures and
options contracts may not correspond to the change in value of the hedged
instruments. In addition, losses may arise from changes in the value of
the underlying instruments, if there is an illiquid secondary market for
the contracts, or if the counterparty to the contract is unable to
perform. When the contract is closed, the fund records a realized gain or
loss equal to the difference between the value of the contract at the time
it was opened and the value at the time it was closed. Realized gains and
losses on purchased options are included in realized gains and losses on
investment securities.
Futures contracts are valued at the quoted daily settlement prices
established by the exchange on which they trade. Exchange traded options
are valued at the last sale price, or if no sales are reported, the last
bid price for purchased options and the last ask price for written
options. Options traded over-the-counter are valued using prices supplied
by dealers.
H) TBA purchase commitments The fund may enter into "TBA" (to be
announced) purchase commitments to purchase securities for a fixed unit
price at a future date beyond customary settlement time. Although the unit
price has been established, the principal value has not been finalized.
However, the amount of the commitments will not fluctuate more than 1.0%
from the principal amount. The fund holds, and maintains until settlement
date, cash or high-grade debt obligations in an amount sufficient to meet
the purchase price, or the fund may enter into offsetting contracts for
the forward sale of other securities it owns. Income on the securities
will not be earned until settlement date. TBA purchase commitments may be
considered securities in themselves, and involve a risk of loss if the
value of the security to be purchased declines prior to the settlement
date, which risk is in addition to the risk of decline in the value of the
fund's other assets. Unsettled TBA purchase commitments are valued at the
current market value of the underlying securities, according to the
procedures described under "Security valuation" above.
Although the fund will generally enter into TBA purchase commitments with
the intention of acquiring securities for their portfolio or for delivery
pursuant to options contracts it has entered into, the fund may dispose of
a commitment prior to settlement if Putnam Management deems it appropriate
to do so.
I) TBA sale commitments The fund may enter into TBA sale commitments to
hedge its portfolio positions or to sell mortgage-backed securities it
owns under delayed delivery arrangements. Proceeds of TBA sale commitments
are not received until the contractual settlement date. During the time a
TBA sale commitment is outstanding, equivalent deliverable securities, or
an offsetting TBA purchase commitment deliverable on or before the sale
commitment date, are held as "cover" for the transaction.
Unsettled TBA sale commitments are valued at the current market value of
the underlying securities, generally according to the procedures described
under "Security valuation" above. The contract is "marked-to-market" daily
and the change in market value is recorded by the fund as an unrealized
gain or loss. If the TBA sale commitment is closed through the acquisition
of an offsetting purchase commitment, the fund realizes a gain or loss. If
the fund delivers securities under the commitment, the fund realizes a
gain or a loss from the sale of the securities based upon the unit price
established at the date the commitment was entered into.
J) Federal taxes It is the policy of the fund to distribute all of its
taxable income within the prescribed time and otherwise comply with the
provisions of the Internal Revenue Code applicable to regulated investment
companies. It is also the intention of the fund to distribute an amount
sufficient to avoid imposition of any excise tax under Section 4982 of the
Internal Revenue Code of 1986, as amended. Therefore, no provision has
been made for federal taxes on income, capital gains or unrealized
appreciation on securities held nor for excise tax on income and capital
gains.
At October 31, 1998, the fund had a capital loss carryover of
approximately $54,092,000 available to offset future capital gains, if
any, which will expire on October 31, 2002.
K) Distributions to shareholders Distributions to shareholders are
recorded by the fund on the ex-dividend date. At certain times, the fund
may pay distributions at a level rate even though, as a result of market
conditions or investment decisions, the fund may not achieve projected
investment results for a given period. The amount and character of income
and gains to be distributed are determined in accordance with income tax
regulations which may differ from generally accepted accounting
principles. These differences include temporary and permanent differences
of losses on wash sale transactions, foreign currency gains and losses,
the expiration of a capital loss carryover, unrealized gains and losses on
certain futures contracts, paydown gains and losses on mortgage-backed
securities, and market discount. Reclassifications are made to the fund's
capital accounts to reflect income and gains available for distribution
(or available capital loss carryovers) under income tax regulations. For
the year ended October 31, 1998, the fund reclassified $832,861 to
decrease undistributed net investment income and $8,275,268 to decrease
paid-in-capital, with a decrease to accumulated net realized losses of
$9,108,129. The calculation of net investment income per share in the
financial highlights table excludes these adjustments.
Note 2
Management fee, administrative
services and other transactions
Compensation of Putnam Management, for management and investment advisory
services is paid quarterly based on the average net assets of the fund.
Such fee is based on the following annual rates: 0.75% of the first $100
million of average net assets, 0.65% of the next $100 million, 0.55% of
the next $300 million, 0.45% of the next $500 million, and 0.40%
thereafter.
On April 2, 1998, the shareholders approved a proposal to increase fees
payable to Putnam Management under the fund's management contract.
Management fees will be paid thereafter at an annual rate of 0.65% of the
first $500 million of average net assets, 0.55% of the next $500 million,
0.50% of the next $500 million, 0.45% of the next $5 billion, 0.425% of
the next $5 billion, 0.405% of the next $5 billion, 0.39% of the next $5
billion, and 0.38% thereafter.
The fund reimburses Putnam Management an allocated amount for the
compensation and related expenses of certain officers of the fund and
their staff who provide administrative services to the fund. The aggregate
amount of all such reimbursements is determined annually by the Trustees.
Custodial functions for the fund's assets are provided by Putnam Fiduciary
Trust Company (PFTC), a subsidiary of Putnam Investments, Inc. Investor
servicing agent functions are provided by Putnam Investor Services, a
division of PFTC.
For the year ended October 31, 1998, fund expenses were reduced by
$205,493 under expense offset arrangements with PFTC. Investor servicing
and custodian fees reported in the Statement of operations exclude these
credits. The fund could have invested a portion of the assets utilized in
connection with the expense offset arrangements in an income producing
asset if it had not entered into such arrangements.
Each Trustee of the fund receives an annual Trustee fee, of which $600 has
been allocated to the fund, and an additional fee for each Trustee's
meeting attended. Trustees who are not interested persons of Putnam
Management and who serve on committees of the Trustees receive additional
fees for attendance at certain committee meetings.
The fund has adopted a Trustee Fee Deferral Plan (the "Deferral Plan")
which allows the Trustees to defer the receipt of all or a portion of
Trustees Fees payable on or after July 1, 1995. The deferred fees remain
in the fund and are invested in certain Putnam funds until distribution in
accordance with the Deferral Plan.
The fund has adopted an unfunded noncontributory defined benefit pension
plan (the "Pension Plan") covering all Trustees of the fund who have
served as Trustee for at least five years. Benefits under the Pension Plan
are equal to 50% of the Trustee's average total retainer and meeting fees
for the three years preceding retirement. Pension expense for the fund is
included in Compensation of trustees in the Statement of operations.
Accrued pension liability is included in Payable for compensation of
Trustees in the Statement of assets and liabilities.
The fund has adopted distribution plans (the "Plans") with respect to its
class A, class B and class M shares pursuant to Rule 12b-1 under the
Investment Company Act of 1940. The purpose of the Plans is to compensate
Putnam Mutual Funds Corp., a wholly-owned subsidiary of Putnam Investments
Inc., for services provided and expenses incurred by it in distributing
shares of the fund. The Plans provide for payments by the fund to Putnam
Mutual Funds Corp. at an annual rate up to 0.35%, 1.00% and 1.00% of the
average net assets attributable to class A, class B and class M shares,
respectively. The Trustees currently limit payment by the fund to an
annual rate of 0.25%, 1.00% and 0.50% of the average net assets
attributable to class A, class B and class M shares respectively.
For the year ended October 31, 1998, Putnam Mutual Funds Corp., acting as
underwriter received net commissions of $57,183 and $974 from the sale of
class A and class M shares, respectively and $33,218 in contingent
deferred sales charges from redemptions of class B shares. A deferred
sales charge of up to 1% is assessed on certain redemptions of class A
shares. For the year ended October 31, 1998, Putnam Mutual Funds Corp.,
acting as underwriter received $10,172 on class A redemptions.
Note 3
Purchases and sales of securities
During the year ended October 31, 1998, purchases and sales of investment
securities other than U.S. government obligations and short-term
investments aggregated $105,734,184 and $92,151,927, respectively.
Purchases and sales of U.S. government obligations aggregated $489,817,264
and $516,562,963, respectively. In determining the net gain or loss on
securities sold, the cost of securities has been determined on the
identified cost basis.
Note 4
Capital shares
At October 31, 1998, there was an unlimited number of shares of beneficial
interest authorized. Transactions in capital shares were as follows:
Year ended
October 31, 1998
- -----------------------------------------------------------------------------
Class A Shares Amount
- -----------------------------------------------------------------------------
Shares sold 10,101,109 $ 103,240,553
- -----------------------------------------------------------------------------
Shares issued in
connection with
reinvestment of
distributions 1,173,180 11,897,999
- -----------------------------------------------------------------------------
11,274,289 115,138,552
Shares
repurchased (12,061,669) (123,127,715)
- -----------------------------------------------------------------------------
Net decrease (787,380) $ (7,989,163)
- -----------------------------------------------------------------------------
Year ended
October 31, 1997
- -----------------------------------------------------------------------------
Class A Shares Amount
- -----------------------------------------------------------------------------
Shares sold 2,019,842 $ 20,161,173
- -----------------------------------------------------------------------------
Shares issued in
connection with
reinvestment of
distributions 1,231,792 12,262,877
- -----------------------------------------------------------------------------
3,251,634 32,424,050
Shares
repurchased (7,118,836) (71,151,211)
- -----------------------------------------------------------------------------
Net decrease (3,867,202) $(38,727,161)
- -----------------------------------------------------------------------------
Year ended
October 31, 1998
- -----------------------------------------------------------------------------
Class B Shares Amount
- -----------------------------------------------------------------------------
Shares sold 3,718,018 $37,872,403
- -----------------------------------------------------------------------------
Shares issued in
connection with
reinvestment of
distributions 78,440 793,085
- -----------------------------------------------------------------------------
3,796,458 38,665,488
Shares
repurchased (1,498,741) (15,236,683)
- -----------------------------------------------------------------------------
Net increase 2,297,717 $ 23,428,805
- -----------------------------------------------------------------------------
Year ended
October 31, 1997
- -----------------------------------------------------------------------------
Class B Shares Amount
- -----------------------------------------------------------------------------
Shares sold 1,308,316 $13,014,460
- -----------------------------------------------------------------------------
Shares issued in
connection with
reinvestment of
distributions 50,048 496,673
- -----------------------------------------------------------------------------
1,358,364 13,511,133
Shares
repurchased (998,805) (9,956,230)
- -----------------------------------------------------------------------------
Net increase 359,559 $ 3,554,903
- -----------------------------------------------------------------------------
Year ended
October 31, 1998
Class M Shares Amount
- -----------------------------------------------------------------------------
Shares sold 444,102 $4,541,443
- -----------------------------------------------------------------------------
Shares issued in
connection with
reinvestment of
distributions 8,636 87,792
- -----------------------------------------------------------------------------
452,738 4,629,235
Shares
repurchased (74,041) (754,809)
- -----------------------------------------------------------------------------
Net increase 378,697 $3,874,426
- -----------------------------------------------------------------------------
Year ended
October 31, 1997
- -----------------------------------------------------------------------------
Class M Shares Amount
- -----------------------------------------------------------------------------
Shares sold 112,345 $1,116,519
- -----------------------------------------------------------------------------
Shares issued in
connection with
reinvestment of
distributions 3,484 34,651
- -----------------------------------------------------------------------------
115,829 1,151,170
Shares
repurchased (78,575) (778,452)
- -----------------------------------------------------------------------------
Net increase 37,254 $ 372,718
- -----------------------------------------------------------------------------
WELCOME TO
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learn more about investing and retirement planning, and access market
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VISIT PUTNAM'S SITE ON THE WORLD WIDE WEB FOR:
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New features will be added to the site regularly.
So be sure to bookmark us at
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Federal tax information
(Unaudited)
The Form 1099 you receive in January 1999 will show the tax status of all
distributions paid to your account in calendar 1998.
Fund information
INVESTMENT MANAGER
Putnam Investment
Management, Inc.
One Post Office Square
Boston, MA 02109
MARKETING SERVICES
Putnam Mutual Funds Corp.
One Post Office Square
Boston, MA 02109
CUSTODIAN
Putnam Fiduciary Trust Company
LEGAL COUNSEL
Ropes & Gray
INDEPENDENT
ACCOUNTANTS
PricewaterhouseCoopers LLP
TRUSTEES
George Putnam, Chairman
William F. Pounds, Vice Chairman
John A. Hill, Vice Chairman
Jameson Adkins Baxter
Hans H. Estin
Ronald J. Jackson
Paul L. Joskow
Elizabeth T. Kennan
Lawrence J. Lasser
John H. Mullin III
Robert E. Patterson
Donald S. Perkins
George Putnam, III
A.J.C. Smith
W. Thomas Stephens
W. Nicholas Thorndike
OFFICERS
George Putnam
President
Charles E. Porter
Executive Vice President
Patricia C. Flaherty
Senior Vice President
John D. Hughes
Senior Vice President and Treasurer
Lawrence J. Lasser
Vice President
Gordon H. Silver
Vice President
Ian C. Ferguson
Vice President
Brett C. Browchuk
Vice President
Stephen Oristaglio
Vice President
Kevin M. Cronin
Vice President and Fund Manager
Krishna K. Memani
Vice President and Fund Manager
James M. Prusko
Vice President and Fund Manager
John R. Verani
Vice President
Beverly Marcus
Clerk and Assistant Treasurer
This report is for the information of shareholders of Putnam High Quality
Bond Fund. It may also be used as sales literature when preceded or
accompanied by the current prospectus, which gives details of sales
charges, investment objectives, and operating policies of the fund, and
the most recent copy of Putnam's Quarterly Performance Summary. For more
information or to request a prospectus, call toll free: 1-800-225-1581.
You can also learn more at Putnam Investments' website:
http://www.putnaminv.com.
Shares of mutual funds are not deposits or obligations of, or guaranteed
or endorsed by, any financial institution; are not insured by the Federal
Deposit Insurance Corporation (FDIC), the Federal Reserve Board, or any
other agency; and involve risk, including the possible loss of the
principal amount invested.
[LOGO OMITTED]
PUTNAM INVESTMENTS
The Putnam Funds
One Post Office Square
Boston, Massachusetts 02109
www.putnaminv.com
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