- -------------------
Kleinwort
Benson
Australian
Income Fund, Inc.
- -------------------
Report to Shareholders
- --------------------------------------------------------------------------------
Report Highlights
o Positive Australian bond market performance offset by currency weakness
over the quarter.
o Australian underlying inflation remained low, at 1.4% for 1997.
o A$ rebounded to US$0.685 at January 31, 1997 after falling below US$0.64
earlier in the month.
- --------------------------------------------------------------------------------
To Our Shareholders,
During the three months ended January 31, 1998, the total value of the
Fund decreased slightly, with the positive Australian bond market performance
outweighed by a decline in the Australian and New Zealand currencies against the
US dollar. The Australian dollar was undermined by falling gold and other
commodity prices, and by the fall in the value of the currencies of its major
trading partners in Southeast Asia. The New Zealand dollar also suffered the
effects of financial troubles in the region, compounded by increasing concerns
over the New Zealand current account deficit. At January 31, 1998, the Fund's
closing market price was $8.00, a discount of 11.60% to its net asset value of
$9.05.
For the quarter ended January 31, 1998, the Fund's total return on net
asset value (with distributions reinvested) was -1.86%. The Fund's return on a
market value basis (also with distributions reinvested) was slightly better at
- -0.42%, reflecting a narrowing of the discount to net asset value. A further
analysis of the Fund's performance since inception is provided on page three of
this report.
At the Fund's December Board Meeting, the monthly dividend rate was
reduced to US$0.05 per share, effective with the dividend payable on February
15, 1998. This change reflected a combination of the reduction in yields on
Australian and New Zealand debt securities, as a result of the gradual fall in
inflation over recent years, and the recent weakness in the Australian and New
Zealand currencies. The Fund's current yield of 7.5% (based on the Fund's stock
price at January 31, 1998 and the current monthly dividend rate) remains
superior to comparably rated US cash and bond investments.
- ------------------------
MARKET SUMMARY
- ------------------------
The recent developments in the Australian and New Zealand economies and
foreign exchange and debt markets are detailed in the Economic Review. In
summary, the Australian economy continued to provide evidence of robust domestic
economic activity, with unemployment finally beginning to fall in response to
this strength. However, inflation remained benign and there were concerns over
the effect on Australia of slower growth in the Asian region. Against this
background, short-term interest rates were left unchanged, with the Reserve Bank
of Australia satisfied that inflation was likely to remain in their target range
in the medium-term. In New Zealand, the economy remained subdued, with consumer
confidence low, and inflation continued to decline. The Reserve Bank of New
Zealand raised short-term interest rates over the period to counteract the drop
in the trade-weighted New Zealand dollar.
<PAGE>
- -------------------
Kleinwort
Benson
Australian
Income Fund, Inc.
- -------------------
The Australian bond market was underpinned by continued low inflation and
expectations that lower levels of activity in Southeast Asia would restrict
future inflationary pressures. In addition, the US Treasury market set a
positive background for global bond markets. The New Zealand bond market
suffered early in the period under review from current account concerns, but
rallied into the year end on evidence of continued slow domestic activity and
expectations of slower global growth.
On behalf of the Board of Directors,
/s/ Sir Robert Cotton
Sir Robert Cotton
Chairman
/s/ David M. Felder
David M. Felder
President
February 13, 1998
- --------------------------------------------------------------------------------
PORTFOLIO SUMMARY
At January 31, 1998, the average maturity of the portfolio was 4.8 years, with
an average duration of 3.7 years and a current yield to maturity of 5.8%.
Securities rated AAA comprised 81% of the portfolio with the remaining 19% in AA
rated securities.
- --------------------------------------------------------------------------------
2
<PAGE>
- -------------------
Kleinwort
Benson
Australian
Income Fund, Inc.
- -------------------
Performance from Inception through January 31, 1998
(Unaudited)
Growth of a Hypothetical $10,000 Investment
[LINE CHART OMITTED]
Since its inception in 1986, the Fund has achieved an average annualized return
on market value of 10.31%, on the basis noted below. On a net asset value basis,
which measures the performance of the Fund's underlying portfolio, the average
return has been 12.01%. Both the market and net asset value performance measures
have outpaced the Salomon Brothers US Government Bond Index which has averaged
8.27%. The Salomon Brothers Australian Government Bond Index has averaged 14.14%
since the Fund's inception, with the difference between the Fund's net asset
value performance and that of the index primarily attributable to the Fund's
operating and foreign tax expenses, which neither index is subject to. After
adjusting for these expenses, which have averaged 2.23% since inception, the
Fund has also outperformed the Australian index.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------
Annualized 3 10 Since
Performance Months* 1 Year 3 Years 5 Years Years Inception+
- --------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Fund Market Value(1) -0.42% -0.47% 6.72% 7.46% 9.76% 10.31%
- --------------------------------------------------------------------------------------------------------
Fund Net Asset Value(2) -1.86% -0.58% 9.00% 9.21% 10.63% 12.01%
- --------------------------------------------------------------------------------------------------------
Salomon Brothers US Gov't Bond Index(3) 3.17% 11.15% 9.89% 7.20% 8.69% 8.27%
- --------------------------------------------------------------------------------------------------------
Salomon Brothers Australian Gov't Bond Index(4) -1.20% 2.24% 11.75% 10.77% 12.52% 14.14%
- --------------------------------------------------------------------------------------------------------
</TABLE>
* Not Annualized.
+ Fund commenced operations November 28, 1986.
(1) Based on market value per share, adjusted for rights offerings, and
assumes reinvestment of all distributions at reinvestment plan
prices.
(2) Based on net asset value per share, adjusted for rights offerings,
and assumes reinvestment of all distributions at the ex-dividend
date net asset value. This measures the performance of the
underlying Fund portfolio and may not be indicative of returns to
investors.
(3)(4) The Salomon Brothers US and Australian Government Bond Indices
are US$ based unmanaged indices.
Please remember that past performance may not be indicative of
future results.
3
<PAGE>
- -------------------
Kleinwort
Benson
Australian
Income Fund, Inc.
- -------------------
Economic Review
- ----------------------
ECONOMIC REVIEW
- ----------------------
During the fourth quarter of 1997, the United States economy exhibited
strong domestic activity, continuing the trend set earlier in the year. However,
the most significant influence on US economic sentiment was the impact of the
deepening crisis in Asia. European economies continued to recover, but
confidence remained low and unemployment stubbornly high. In Japan, growth
remained sluggish and there were renewed concerns over the financial system,
compounded by exposure to the Asian turmoil. The US bond market was supported by
a combination of stable official interest rates and strong growth with low
inflation. Additionally, the initial direct impact of "safe haven" buying of US
Treasury bonds by fearful equity investors was confirmed by increased asset
allocation flows into bonds. European bond markets also rallied against a
background of low inflation and slack labor markets. Japanese bond yields
remained at historical lows with the economy showing few signs of recovery.
Australia
Australian economic growth was stronger than expected over the third
quarter of 1997, with GDP(A), the average growth measure, rising 1.5% over the
quarter, to be 3.6% higher than in September 1996. Domestic final demand was up
a robust 5.9% in the year to September 1997, although an increased proportion of
this demand was met by imports. There was strong growth in the communications
and property areas and, despite a slower quarter, business investment was up
over 15% on year ago levels. The only particularly weak area of the economy was
the agricultural sector where activity fell back from last year's spectacular
crop. The price deflators released with the GDP data were again consistent with
the low levels of inflation reported in the CPI releases. The GDP figures also
revealed encouraging gains in productivity.
The growth in retail sales seen throughout 1997 did moderate late in the
year, but activity remained at reasonably strong levels. Sales were up 4.2% in
the year to December 1997, a marked acceleration from the 1%-3% increases
reported in the first half of the year. December sales were disappointing in
seasonally adjusted terms, falling 0.8%, but caution is advised when
interpreting Christmas figures given that sales were about 27% higher in
unadjusted terms. Anecdotal evidence has suggested that the trend in retail
spending remains positive. Consumer sentiment remained surprisingly robust over
the period given events in Asia, and the Westpac consumer sentiment index rose
in January 1998 to its highest level since the end of 1996. The improvement was
driven by more positive future expectations, low interest rates and an improving
employment situation.
The Australian labor market began to respond to the stronger domestic
activity over the period. The rate of unemployment, which had hovered around
8.7% over the first half of 1997, declined to 8.2% in January 1998. Total
employment increased by 67,200 over the period under review, and with the number
of part-time jobs declining, full-time employment
4
<PAGE>
- -------------------
Kleinwort
Benson
Australian
Income Fund, Inc.
- -------------------
Economic Review
growth was strong. Leading indicators, such as the ANZ job advertisement series,
were consistent with meaningful employment growth, but did turn downwards in
January. The growth in employment was led by the two largest states, Victoria
and New South Wales.
Australian December quarter CPI was released slightly below market
expectations, and continued to confirm the benign price environment. Headline
CPI fell 0.2% in the year to December, after declining 0.3% in the year to
September 1997. The underlying inflation rate, which excludes the influence of
lower interest rates, was 1.4%, down from 1.5% in the previous quarter. The
weakness of the Australian dollar against the US dollar did not feed into higher
import prices because the currency was little changed in trade-weighted terms.
Indeed, despite a rise in the cost of importing cars, falling dealer margins led
to a sharp decline in car prices, highlighting ongoing competition in the
domestic goods markets.
The concerns of the Reserve Bank of Australia over the level of wage
settlements were moderated by the release of average earnings figures for the
quarter to November 1997 at levels well below market expectations. Average
weekly ordinary time earnings rose 0.4% over the quarter, to be up 3.7% over the
year. This represented a decline from the 4.4% pace observed over the year to
August 1997 and leaves wage inflation below the Reserve Bank's 4.5% "level of
concern". The wage data has been volatile in recent quarters, but the average
rate over the last four quarters has been an acceptable 3.6%. The drop in wage
inflation is consistent with the change in labor market composition. Wage rises
in the expanding full-time sector have been slower than those in the contracting
part-time sector for some time.
The release of the Australian current account data for the September
quarter of 1997 revealed a deterioration from the June quarter, and it seems
likely that the trend improvement in the current account has now been reversed.
In addition, it should be noted that the June balance was bolstered by the
export of a frigate to New Zealand and by Reserve Bank gold exports. The
September figures did not reflect the recent weakness in Asia but did pick up a
drop in rural exports as a result of lower crop yields.
New Zealand
New Zealand GDP for the September quarter of 1997 was reported at 0.5%,
leading to growth of 2.3% over the year to September. Growth in the year to June
1997 was 2.7%, and the September quarter figures highlight the ongoing weakness
of the economy, despite upwards revisions to the previous quarter's data.
Consumption remained flat and investment actually declined, but inventories
increased and there was a slightly stronger contribution from the government
sector. In addition, there was a boost to growth from net exports due to imports
declining by more than exports over the quarter. More recent data suggested that
activity remained slow in the final quarter of 1997, with trend retail sales
declining in November. Anecdotal evidence suggested that Christmas sales were
reasonably robust, but are
5
<PAGE>
- -------------------
Kleinwort
Benson
Australian
Income Fund, Inc.
- -------------------
Economic Review
unlikely to lead to positive sales growth over the December quarter as a whole.
The labor market did show some tightening over the final quarter of 1997. The
rate of unemployment declined from 6.8% to 6.7% on the back of employment growth
of 0.4%, with job gains broadly based.
The subdued level of domestic activity and the relatively tight monetary
conditions combined to keep New Zealand inflation on a downwards trajectory. CPI
ex-credit services, the new inflation measure targeted by the Reserve Bank of
New Zealand, was up 0.5% in the December quarter, in line with market
expectations. Annual inflation fell from 1.8% in the year to September 1997 to
1.6% in the year to December, well within the RBNZ's target range. The housing
sector continued to make the most significant positive contribution to the CPI,
largely as a result of increases in local property tax rates and construction
costs. Tradeable goods inflation was reasonably subdued, countering fears that
the lower level of the trade-weighted New Zealand dollar would feed into higher
import prices. However, the currency weakness continued into early 1998 and may
yet affect domestic price levels.
The New Zealand current account deficit again became a focus for
international investors over the period under review. The September quarter
deficit was slightly lower than market expectations, but did reveal a
deterioration to NZ$2.2 billion and the annual deficit rose to 6.4% of GDP. The
visible balance remained in surplus with the problems concentrated in the
invisible balance. In particular, cash transfers into New Zealand by migrants
fell, and the outflow of investment income remained strong.
Debt Markets
The continued low inflation environment and the global uncertainties
created by the Asian financial crisis allowed the Reserve Bank of Australia to
keep short-term interest rates unchanged over the period under review. The
Australian bond market improved over the period, with ten year yields falling
from 6.1% in early November to 5.9% at the end of January, having reached a low
of 5.65% at the start of 1998. Bond prices fell in November on concerns about
stronger domestic activity, before rallying strongly with lower global yields as
money was switched from nervous equity markets into bonds. The yield premium on
Australian bonds over their US counterparts increased from 20 to 40 basis
points.
New Zealand short-term interest rates were dictated by the level of the
trade-weighted currency rate over the period. The decline in the currency was
felt by the Reserve Bank of New Zealand to have loosened monetary conditions to
an inappropriate level, and short rates increased accordingly. This affected
longer term interest rates adversely, and the New Zealand bond market declined
over November and early December. The yield on ten year New Zealand government
bonds rose from 6.65% at the beginning of November to 7.4% in mid-December. In
addition to higher short rates, bonds were hampered by concerns over the level
of the current account deficit. The New Zealand bond market rallied over
6
<PAGE>
- -------------------
Kleinwort
Benson
Australian
Income Fund, Inc.
- -------------------
Economic Review
the remainder of the period, in line with global bond markets, and yields ended
January at 6.8%.
Australian and New Zealand Dollars
The Australian dollar fell sharply against the US dollar from November
into early January, from US$0.71 to below US$0.64. The currency was little
changed in trade-weighted terms but declined along with the currencies of its
Asian trading partners against the US dollar. In addition, the prices of
commodities, in particular gold, which are vital exports from Australia, fell in
response to lower expected global growth in the wake of the Asian financial
crisis. Gold prices were undermined by a perceived lack of demand from central
banks, and indeed the Reserve Bank of Australia has been a regular seller of the
metal in recent years. The Australian dollar did rally in the month of January
as these negative forces were reversed to some extent. Commodity prices rose and
there was some stabilization of the Asian crisis. The Yen received support from
hopes of a fiscal stimulus package in Japan, and given that Japan is a major
market for Australian exports, the Australian dollar rose above US$0.685 at the
end of January.
The New Zealand dollar fell in line with the Australian dollar into
January, with sentiment dampened by many of the factors discussed above. The New
Zealand economy is not subject to the same exposure to commodities as the
Australian market, but the New Zealand currency also suffered from concerns over
the level of the current account deficit. The New Zealand currency fell against
the US dollar from US$0.63 to US$0.59, having reached a low of US$0.56 at the
turn of the year. It also fell in trade-weighted terms over the period.
7
<PAGE>
- -------------------
Kleinwort
Benson
Australian
Income Fund, Inc.
- -------------------
Portfolio of Investments and Cash on Deposit
January 31, 1998
(Unaudited)
<TABLE>
<CAPTION>
Long-Term Investments -- 96.2%
Principal Amount Value (US$)
- ---------------- ----------
<S> <C> <C> <C>
Australian Government and Semi-Government Bonds -- 64.7%
Eurobonds -- 44.6%
A$2,000,000 State Bank of South Australia 9.50% due 10/15/02 ................. $ 1,560,400
5,000,000 Australian Industrial Development Corp. 9.25% due 2/17/03 .................. 3,895,070
1,300,000 State Bank of New South Wales 9.25% due 2/18/03 .................. 1,009,911
3,300,000 Export Finance & Insurance Corp. 9% due 3/26/03 ..................... 2,549,709
16,450,000 Queensland Treasury Corp. 8% due 5/14/03 ..................... 12,407,726
2,750,000 State Bank of South Australia 10.50% due 6/23/03 ................. 2,257,744
2,500,000 Australian Industrial Development Corp. 8.75% due 7/20/04 .................. 1,941,589
22,400,000 Queensland Treasury Corp. 6.5% due 6/14/05 ................... 15,819,002
2,200,000 Treasury Corp. of Victoria 9% due 6/27/05 ..................... 1,759,568
1,000,000 Commonwealth Bank of Australia 9% due 8/15/05 ..................... 797,782
6,000,000 New South Wales Treasury Corp. 6.5% due 5/1/06 .................... 4,218,520
------------
48,217,021
------------
Domestic Bonds -- 20.1%
A$6,500,000 Western Australia Treasury Corp. 12.5% due 4/1/98 ................... 4,545,024
10,000,000 Commonwealth Government Bond 12% due 11/15/01 ................... 8,389,634
4,000,000 Victorian Public Finance Authority 12.5% due 10/15/03 ................. 3,614,104
6,000,000 Commonwealth Government Bond 10% due 2/15/06 .................... 5,204,457
-----------
21,753,219
-----------
Total Australian Government and Semi-Government Bonds -- (Cost $65,794,522) ................... 69,970,240
-----------
Australian Eurobonds -- 17.3%
A$5,800,000 Toyota Motor Credit Corp. 10.75% due 3/6/98 .................. 4,001,054
2,500,000 Unilever Australia Ltd. 12% due 4/8/98 ..................... 1,736,279
3,500,000 DSL Finance N.V. 10.25% due 4/7/00 .................. 2,623,389
6,000,000 Morgan Guaranty Trust Co. 8% due 4/18/01 ..................... 4,366,988
2,000,000 Bayerische Vereinsbank AG 8.75% due 5/17/01 .................. 1,484,589
4,000,000 National Australia Bank 7% due 7/23/04 ..................... 2,864,715
2,000,000 Bayerische Vereinsbank AG 10.25% due 10/28/04 ................ 1,664,656
-----------
Total Australian Eurobonds -- (Cost $19,710,408) .................................... 18,741,670
-----------
New Zealand Eurobonds -- 10.0%
NZ$5,000,000 Province of Alberta 8.00% due 10/30/98 ................. 2,919,900
2,500,000 General Electric Capital Corp. 8.75% due 5/21/99 .................. 1,471,381
4,000,000 European Investment Bank 8.50% due 5/30/01 .................. 2,387,407
7,000,000 Federal National Mortgage Association 7.25% due 6/20/02 .................. 4,089,052
-----------
Total New Zealand Eurobonds -- (Cost $12,054,335) .................................... 10,867,740
-----------
New Zealand Goverment Bond -- 4.2%
NZ$ 7,000,000 New Zealand Goverment Bond 10% due 3/15/02--(Cost $5,242,415) ................... 4,534,840
-----------
Total Long-Term Investments -- (Cost $102,801,680) .................................... 104,114,490
-----------
Cash on Deposit -- 1.2%
A$ 1,808,851 Brown Brothers Harriman & Co., upon demand at 3.6875% ........................... 1,239,877
US$ 38,335 Brown Brothers Harriman & Co., upon demand at 4.50% ............................. 38,835
-----------
Total Cash on Deposit-- (Cost $1,232,128) .................................... 1,278,712
-----------
Total Portfolio of Investments and Cash on Deposit -- 97.4% (Cost $104,033,808) ................ 105,393,202
Other Assets less Liabilities -- 2.6% .................................... 2,765,340
-----------
Net Assets-- 100.0% .................................... $108,158,542
===========
</TABLE>
8
<PAGE>
- -------------------
Kleinwort
Benson
Australian
Income Fund, Inc.
- -------------------
Financial Summary
for the Three Months ended January 31, 1998
(Unaudited)
<TABLE>
<CAPTION>
Net Asset Value
Total Net Assets Per Share
---------------- ---------
<S> <C> <C>
Beginning of period, November 1, 1997 ..................... $ 113,639,028 $ 9.51
------------- --------
Net investment income* ................................ 1,817,835 0.15
Net realized gain on:
Investment transactions* ............................ 619,666 0.05
Foreign currency transactions** ..................... (1,025,900) (0.09)
Change in unrealized appreciation on:
Investments* ........................................ (1,469,311) (0.12)
Foreign currency denominated assets
and liabilities** ................................. (2,159,178) (0.18)
------------- --------
Net decrease in net assets resulting from operations .. (2,216,888) (0.19)
------------- --------
Dividends paid from net investment income ............. (1,912,733) (0.16)
Distributions paid from net realized capital gains .... (1,350,865) (0.11)
------------- --------
Net decrease in net assets resulting from distributions
to shareholders ..................................... (3,263,598) (0.27)
------------- --------
Net decrease in net asset value ....................... (5,480,486) (0.46)
------------- --------
End of period, January 31, 1998 ........................... $ 108,158,542 $ 9.05
============= ========
</TABLE>
** Net increase in net assets before net foreign currency loss and dividends
and distributions paid to shareholders was $968,190, equal to $0.08 per
share.
** Net realized and unrealized foreign currency loss was ($3,185,078), equal
to ($0.27) per share.
The financial statements contained in this report were not audited and,
accordingly, no opinion is expressed on them.
9
<PAGE>
- -------------------
Kleinwort
Benson
Australian
Income Fund, Inc.
- -------------------
Dividend Reinvestment and Cash Purchase Plan
Tax Information (Unaudited)
Dividend Reinvestment and Cash Purchase Plan
The Fund offers to shareholders a Dividend Reinvestment Plan which
provides participants with a prompt and simple way to reinvest their income
dividends and capital gain distributions in additional Fund shares. If you
choose to participate in the Plan, your income dividends and capital gain
distributions will automatically be reinvested in Fund shares at the lower of
market price or net asset value, at up to a 5% discount from market price, on
valuation date. The Plan also includes a Cash Purchase option which provides
Reinvestment Plan participants with the opportunity to make additional cash
investments in Fund shares directly through the Plan Agent.
The Plan is entirely voluntary and, subject to the terms and conditions of
the Plan, you may join or withdraw at any time. A brochure with more
information, including the full terms and conditions, and an application is
available from the Plan Agent, Boston EquiServe, telephone (800) 730-6001.
If you wish to participate and your shares are registered in your name,
simply complete and return the application form. If your shares are held in the
name of a brokerage firm, bank or other nominee, your shares may need to be
re-registered in your own name in order for you to participate. Please consult
your broker to determine what needs to be done to arrange for you to join the
Plan.
Tax Information
In accordance with United States Federal income tax regulations, a summary
for the calendar year ended December 31, 1997, of the dividends and
distributions paid for Federal income tax purposes on a per share basis is
provided below.
Distributions to Shareholders:
- ------------------------------
Dividends ...................... $ 0.73300
Long-Term Capital Gains* ....... 0.14000
Foreign Taxes (Australia) ...... 0.02877
--------
Total Distributions ............ $ 0.90177
========
Distributions by Source:
- ------------------------
Ordinary Income, Foreign Source:
Australia .................... $ 0.71052
New Zealand .................. 0.05107
--------
Total Foreign Source ......... 0.76159
Ordinary Income, U.S. Source ... 0.00018
--------
Total Ordinary Income .......... 0.76177
Long-Term Capital Gains* ....... 0.14000
--------
Total Distributions ............ $ 0.90177
========
* Of which $0.11950 will be taxed at a maximum Federal income tax rate of
20%.
For 1997 the Fund has elected to treat the foreign taxes paid by it as
having been paid proportionately by its shareholders. These foreign taxes have
been allocated and reported according to above schedule.
Shareholders can generally use this foreign tax amount, which is reported
in Box 3 on Form 1099-DIV, to claim either a tax credit or an itemized deduction
on their U.S. Federal tax return. IRS Form 1116 should be used to apply for a
tax credit while for a deduction the amount of foreign taxes paid should be
included on IRS Schedule A.
If you require further tax information please consult your tax advisor.
Please note that if you report for Federal income tax purposes on a
calendar year basis, amounts which should be included in your 1997 return should
be based on the Form 1099-DIV provided to you in January 1998.
10
