[COVER]
[PHOTO OF SAILBOAT GLIDING THROUGH WATER]
- KEYSTONE STRATEGIC INCOME FUND
{KEYSTONE LOGO]
ANNUAL REPORT
JULY 31, 1996
KEYSTONE AMERICA
FAMILY OF FUNDS
[Filled in Diamond]
Balanced Fund II
California Insured Tax Free Fund
Capital Preservation and Income Fund
Florida Tax Free Fund
Fund for Total Return
Fund of the Americas
Global Opportunities Fund
Global Resources & Development Fund
Government Securities Fund
Hartwell Emerging Growth Fund, Inc.
Intermediate Term Bond Fund
Massachusetts Tax Free Fund
Missouri Tax Free Fund
New York Insured Tax Free Fund
Omega Fund
Pennsylvania Tax Free Fund
Small Company Growth Fund II
Strategic income Fund
Tax Free Income Fund
World Bond Fund
This report was prepared primarily for the information of the Fund's
shareholders. It is authorized for distribution if preceded or accompanied by
the Fund's current prospectus. The prospectus contains important information
about the Fund including fees and expenses. Read it carefully before you invest
or send money. For a free prospectus on other Keystone Funds, contact your
financial adviser or call Keystone.
{KEYSTONE LOGO]
KEYSTONE INVESTMENTS
P.O. Box 2121
Boston, Massachusetts 02106-2121
[RECYCLE LOGO]
SIF-R-9/96
16.4M
<PAGE>
Keystone Strategic Income Fund
Seeks generous income from a diversified portfolio of high yield,
foreign, and U.S. government or agency obligations.
Dear Shareholder:
We are pleased to report on the performance of Keystone Strategic Income Fund
for the twelve-month period which ended July 31, 1996. Following our letter
to you we have included a discussion with your Fund's manager.
Performance
Your Fund provided the following returns including price changes and
reinvested dividends for the twelve-month period ended July 31, 1996:
Class A shares returned 6.84%.
Class B shares returned 6.21%.
Class C shares returned 6.07%.
For the same twelve-month period, the Lehman Aggregate Bond Index--a broad
index of U.S. corporate, government and mortgage-backed securities--returned
5.53% and the Salomon World Government Bond Index--a U.S. dollar index of
foreign government bonds--returned 2.05%.
We were pleased with your Fund's improved results. They were achieved during
a period of generally declining bond prices which had an adverse impact on
the performance of many fixed income investments. While your Fund experienced
a slight price decline, shareholders benefitted from the Fund's diversified
asset strategy. This strategy is intended to provide attractive income and
returns with lower price volatility. Strength in the foreign markets and
demand for high yield bonds helped to offset price declines among U.S.
government and agency securities. We believe the differing performances of
the markets underscored the value of this type of asset allocation strategy.
The U.S. bond market experienced two different types of climates over the
past twelve months. Interest rates declined through much of 1995 resulting in
bond price increases. This was prompted by slower economic growth and
relatively low inflation. However, in early 1996 interest rates began to
rise. Reports of a strengthening economy stimulated concerns about higher
inflation rates. This news had a particularly negative effect on the prices
of U.S. government bonds whose performance is influenced to a great extent by
changes in interest rates.
Asset allocation
For much of the year, approximately 45% of net assets were invested in high
yield bonds, 35% in foreign bonds and 20% in U.S. government and agency
securities. The foreign sector primarily consisted of investments in Latin
America and Denmark, Sweden, Italy and Canada. Your Fund's Latin American
holdings were U.S. dollar-denominated and invested in large, well-established
corporations with solid cash flows. During the year, we recognized value in
the so-called "high yield" European countries of Denmark, Sweden and Italy.
We established positions in European bonds by shifting assets from Latin
America. The move also served to broaden the portfolio's diversification.
An increased emphasis on foreign bonds
Recently, we reduced the high yield portion by 10% and increased the foreign
bond and U.S. government and agency holdings each by 5%. As of July 31, 1996,
Strategic Income Fund was structured as follows: 25% in high grade bonds, 33%
in high yield bonds and 42% in foreign bonds. Approximately half of the
foreign investments were Latin American and half were in the government bonds
of Denmark, Sweden and Italy at the end of the period. We attempted to limit
our exposure to currency fluctuations by hedging approximately 25% of the
Fund's non-dollar foreign holdings into U.S. dollars.
-continued-
1
<PAGE>
Strategic Income Fund's flexibility enabled your management to find value in
the high yield sector and foreign bond markets. Lower interest rates over the
past year prompted many investors to attempt to maximize yield by investing
in high yield bonds. Demand for this sector supported high yield bond prices
when the U.S. government bond prices declined in the first half of 1996.
Attractive returns were also found in the foreign bond markets. We invested
in bonds issued by well-established Latin American corporations which
generated attractive income. Latin America's investment environment has
improved dramatically from the devaluation of the Mexican peso in 1994.
Industry privatization, dramatically lower inflation and improved fiscal
policies have resulted in a rebound in investor confidence and bond prices.
Our outlook
Looking ahead, we expect that the stronger economic growth we have seen over
the past few months should moderate in the fourth quarter. We anticipate a
slower economy in early 1997 with few inflationary pressures. This should
provide a stable backdrop for the fixed-income markets.
We will continue to seek value through careful research, analysis and sector
diversification. We are confident that this philosophy can build attractive
returns and above average income for the long-term fixed income investor.
We are pleased to inform you that Keystone has agreed to be acquired by
First Union Corporation. The acquisition is subject to a number of
conditions, including approvals of investment advisory agreements with
Keystone by fund shareholders. First Union is a financial services firm based
in Charlotte, North Carolina. It is the nation's sixth largest bank holding
company with assets of approximately $140 billion. First Union, through its
wholly-owned subsidiary Evergreen Asset Management Corp., manages more than
$16 billion in 36 mutual funds. Keystone will remain a separate entity after
its acquisition and will continue to provide investment advisory and
management services to the Fund. We believe First Union's acquisition of
Keystone should strengthen the investment management services we provide to
you.
Thank you for your continued support of Keystone Strategic Income Fund. We
encourage you to write to us with questions or comments about your
investment.
Sincerely,
/s/ Albert H. Elfner, III
Albert H. Elfner, III
Chairman and President
Keystone Investments, Inc.
[PHOTO - ALBERT H. ELFNER, III]
/s/ George S. Bissell
George S. Bissell
Chairman of the Board
Keystone Funds
[PHOTO - GEORGE S. BISSELL]
September 1996
2
<PAGE>
A Discussion With
Your Fund's Manager
[PHOTO - RICHARD CRYAN]
Richard Cryan is portfolio manager of the Fund and
heads Keystone's high yield bond team. Mr. Cryan has
more than 16 years of investment experience, and served
as president of Wasserstein Perella Asset Management
and also as a portfolio manager at Fidelity Investments.
Dick received his BS from the University of Colorado
and his MBA from Columbia University. In managing
the Fund, he is supported by Gilman Gunn, head of
Keystone's international bond group and Chris Conkey,
head of Keystone's domestic high grade bond group.
Q How do you manage the Fund?
A Our ongoing strategy in managing the Fund is to provide a premium yield
and consistent performance, with reduced price fluctuations. We seek this by
diversifying the portfolio into three asset classes: high yield corporate
bonds, foreign bonds, and U.S. government securities. Our own analysis has
shown that historically a blend of these asset classes can provide most of
the returns of a single asset class, with lower price volatility.
Q How do you determine the Fund's asset allocation?
A Asset allocation decisions are driven by our outlook for the risk and
reward potential in each market sector. This includes evaluation of the
current economic and business cycle and its effects on the asset class.
Within a sector, we seek investments that will limit volatility and maximize
the Fund's income. The Fund's asset allocations are actively managed and
reviewed on a regular basis. We attempt to maintain a high degree of
liquidity to accommodate asset shifts in the event there is a change in a
sector's risk/reward profile. Our allocations as of July 31, 1996 appear on
page four.
Q What was the environment like for bonds over the last twelve months?
A The U.S. bond market experienced two different kinds of climates during
the fiscal year. Interest rates declined as bond prices rose during the last
half of 1995. However, early in 1996 interest rates rose and bond prices fell
(see yield chart on page four). Reports showed the economy gaining strength
and investors becoming concerned about higher inflation rates. This news had
the greatest effect on long-term U.S. government and agency securities, but
also influenced the performance of the high yield and foreign bond markets.
Fund Profile
Objective: Seeks generous income from high yield, foreign, and
U.S. government or agency obligations.
Commencement of investment operations: April 14, 1987
Average maturity: 10 years
Net assets: $223 million
Newspaper listing: "StrInc"
3
<PAGE>
****************************[line chart]**************************************
The Benchmark 30-Year
U.S. Treasury Bond Yield
Date Yield
91 7.930
7.880
7.820
7.770
7.880
7.960
8.040
7.930
7.870
7.820
7.980
7.930
7.800
7.770
7.570
7.510
92 7.480
7.460
7.600
7.700
7.770
7.760
7.900
7.940
7.800
7.920
8.060
8.040
7.940
7.870
7.880
7.930
8.040
8.010
7.900
7.800
7.820
7.830
7.850
7.820
7.780
7.620
7.630
7.680
7.560
7.440
7.390
7.320
7.350
7.410
7.280
7.290
7.320
7.340
7.320
7.520
7.530
7.630
7.630
7.750
7.570
7.530
7.590
7.500
7.440
7.430
7.360
7.390
93 7.460
7.340
7.300
7.210
7.160
7.120
7.010
6.890
6.750
6.850
6.800
6.930
7.050
6.840
6.750
6.790
6.940
6.840
6.940
7.030
6.980
6.900
6.790
6.810
6.710
6.660
6.640
6.540
6.700
6.560
6.530
6.350
6.210
6.120
5.950
5.880
6.030
6.050
5.980
5.910
5.780
5.980
5.960
6.210
6.150
6.330
6.250
6.250
6.180
6.280
6.210
6.350
94 6.230
6.300
6.280
6.210
6.360
6.410
6.630
6.720
6.840
6.910
6.900
6.990
7.110
7.260
7.290
7.210
7.300
7.530
7.500
7.300
7.390
7.260
7.310
7.450
7.510
7.610
7.690
7.540
7.550
7.380
7.530
7.480
7.490
7.490
7.490
7.700
7.780
7.790
7.820
7.900
7.830
7.980
7.960
8.150
8.140
8.130
7.940
7.910
7.850
7.850
7.850
7.880
95 7.860
7.790
7.890
7.740
7.600
7.680
7.580
7.540
7.550
7.460
7.370
7.370
7.430
7.380
7.330
7.330
7.340
7.010
7.000
6.900
6.740
6.520
6.710
6.620
6.500
6.620
6.520
6.590
6.960
6.900
6.900
6.970
6.900
6.720
6.600
6.590
6.460
6.590
6.480
6.420
6.300
6.350
6.340
6.270
6.320
6.230
6.250
6.090
6.050
6.090
6.050
5.950
96 6.040
6.160
5.970
6.040
6.140
6.100
6.220
6.410
6.380
6.690
6.740
6.640
6.670
6.660
6.810
6.790
6.780
7.110
6.920
6.830
6.830
6.990
7.040
7.090
7.100
6.900
7.180
7.020
6.960
7.010
The release of stronger than expected U.S. growth statistics during the first
quarter of 1996 caused yields to rise and bond prices to fall.
Source: Fact Set
******************************************************************************
High yield bonds held their value better than any other domestic bond sector
during that time. The lower interest rates we have seen over the past year
caused many investors to "stretch for yield", creating strong demand for high
yield bonds. This demand supported the prices of high yield bonds when the
higher quality sectors incurred losses.
Q How about the foreign markets?
A Selected foreign markets performed well. The investment climate in Latin
America has turned around from what it had been several years ago. Valuations
have rebounded due to a number of positive trends that have taken place.
These included a reduced role of the government in managing the economy,
industry privatization and aggressive inflation-fighting policies. The Fund's
Latin American holdings provided the portfolio with attractive current
income.
In Europe, our holdings of Danish, Swedish and Italian bonds also were
strong performers, due to a favorable environment in these particular
countries. The economic environment in these countries has been relatively
stable, inflation has been low and deficit reduction policies have been in
place, despite a sluggish economic environment in many other European
countries. These government bonds appeared undervalued to us at the time of
purchase.
Asset Allocation
as of July 31, 1996
*********************[pie chart]***********************
High grade (includes U.S. government, agency
and mortgage-backed securities) 24.7%
Foreign bonds (non-U.S.$) 19.6%
Foreign bonds (U.S.$) 22.3%
High yield 31.6%
Other(1) 1.8%
*******************************************************
- -----------------------
1 Includes common and preferred stocks and warrants, repurchase agreements,
and other assets and liabilities.
4
<PAGE>
Top 10 Holdings
as of July 31, 1996
<TABLE>
<CAPTION>
<S> <C>
as of July 31, 1996 Percentage of
net assets
Kingdom of Sweden, 10.25%, 2003 6.9
Kingdom of Denmark, 8%, 2003 5.9
Federal Home Loan Mortgage Corp., 7.69%, 2022 5.4
Government National Mortgage Assoc., 6.5%, 2023 4.4
Republic of Italy, 9.5%, 2006 3.9
U.S. Treasury Bonds, 7.875%, 2021 3.9
Telecom Argentina, 8.375%, 2000 3.8
Government National Mortgage Assoc.,
6.50%, 2009 3.8
New Zealand Government, 8%, 2001 2.9
Telefonica de Argentina, 11.875%, 2004 2.8
</TABLE>
In New Zealand, conservative fiscal and monetary policies have resulted in
strong performance for government bonds. The government has been running
budget surpluses and paying down its debt. Further, the central bank's strict
monetary policy has kept inflation to a minimum.
Q How did Strategic Income Fund perform during the past year?
A We believe the Fund performed as it was designed. The last six months were
an unusually volatile period for U.S. interest rates, but the Fund
demonstrated good stability. The Fund's ability to diversify enabled it to
benefit from the positive performances in the foreign and high yield markets.
Further, the blend of assets helped to provide insulation from the decline
experienced by U.S. Treasury and agency securities.
Q You recently re-allocated 10% of the Fund's assets from high yield to
foreign and high grade bonds. Why?
A The risk/reward profile for high yield bonds has changed over the past few
months. Strength in that sector has driven yields to historically low levels
relative to U.S. Treasuries. We believed that the high yield market had had
good performance, with little further improvement expected over the short
term. Increasing the U.S. Treasury holdings in the high grade sector also
enhanced the Fund's liquidity. We built a larger position in the foreign
sector because we believed that selected markets were attractively valued. We
expected that a larger commitment to that sector would both improve
diversification and enhance overall performance.
Q What is your outlook for these market sectors over the next six months?
A We see positive factors in each of the sectors. Together, we look for them
to provide investors with above average income and attractive returns. We
share Federal Reserve Board Chairman Alan Greenspan's view that the economy
will grow slowly through the beginning of 1997 and that inflation will remain
low. That should provide a healthy climate for domestic fixed-income
securities.
Our outlook for high yield bonds is neutral. We expect to see their strength
relative to U.S. Treasuries subside, with those sectors resuming a
relationship that is closer to historical performance. We also anticipate a
solid performance from the foreign sector. Trends are in place that should
continue to strengthen the economic fundamentals of the respective countries.
We expect that the foreign sector will provide the portfolio with attractive
investment value and high current yield.
[DIAMOND-(filled in)]
This column is intended to answer questions about your Fund.
If you have a question you would like answered, please write to:
Keystone Investment Distributors Company
Attn: Shareholder Communications, 22nd Floor
200 Berkeley Street, Boston, Massachusetts 02116-5034.
5
<PAGE>
Your Fund's Performance
Growth of an investment in
Keystone Strategic Income Fund Class A
**************************[mountain chart]***********************************
In Thousands
Reinvested Distributions Initial Investment
4/87 9534 9534
9649 9735
7/88 9001 10172
8677 11084
7/90 6905 10131
5867 10195
7/92 6744 13118
7486 16290
7/94 7001 16593
6563 17090
7/96 6448 18259
Total Value: $18,259
*****************************************************************************
Twelve-Month Performance as of July 31, 1996
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Class A Class B Class C
Total returns* 6.84% 6.21% 6.07%
Net asset value 7/31/95 $6.89 $6.92 $6.92
7/31/96 $6.77 $6.81 $6.80
Dividends $0.57 $0.52 $0.52
Capital gains None None None
</TABLE>
* Before deduction of front-end or contingent deferred sales charge (CDSC).
Historical Record as of July 31, 1996
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Cumulative total returns Class A Class B Class C
1-year w/o sales charge 6.84% 6.21% 6.07%
1-year 1.76% 2.28% 6.07%
5-year 70.60% -- --
Life of Class 82.59% 25.14% 27.87%
Average Annual Returns
1-year w/o sales charge 6.84% 6.21% 6.07%
1-year 1.76% 2.28% 6.07%
5-year 11.27% -- --
Life of Class 6.69% 6.62% 7.28%
</TABLE>
Class A shares were introduced April 14, 1987. Performance is reported at the
current maximum front-end sales charge of 4.75%.
Class B shares were introduced on February 1, 1993. Shares purchased after
June 1, 1995 are subject to a contingent deferred sales charge (CDSC) that
declines from 5% to 1% over six years from the month purchased. Performance
assumes that shares were redeemed after the end of a one-year holding period
and reflects the deduction of a 4% CDSC.
Class C shares were introduced on February 1, 1993. Performance reflects the
return you would have received for holding shares for one year and redeeming
after the end of the period.
The investment return and principal value will fluctuate so that your
shares, when redeemed, may be worth more or less than the original cost.
Performance for each class will differ.
You may exchange your shares to another Keystone fund for a $10 fee by
contacting Keystone directly. The exchange fee is waived for individual
investors who make an exchange using Keystone's Automated Response Line
(KARL). The Fund reserves the right to change or terminate the exchange
offer.
6
<PAGE>
Growth of an Investment
*****************************[line chart]*************************************
Comparison of change in value of a $10,000 investment in Keystone Strategic
Income Fund Class A, the Lehman Aggregate Bond Index, and the Consumer Price
Index.
In Thousands April 14, 1987 through July 31, 1996
Class A Lehman Aggregate Consumer Price Index
Bond Index (LABI) (CPI)
4/87 9534 10000 10000
9735 9802 10152
7/88 10172 10544 10571
11084 12147 11097
7/90 10131 13004 11632
10195 14392 12150
7/92 13118 16520 12533
16290 18202 12881
7/94 16593 18219 13238
17090 20058 13604
7/96 18259 21166 14005
Average Annual Total Return
---------------------------
1 Year 5 Year Life of Class
Class A 1.76% 11.27% 6.69%
Class B 2.28% -- 6.62%
Class C 6.07% -- 7.28%
Past performance is no guarantee of future results. The performance of Class B
or Class C shares will be greater or less than the line shown based on
differences in loads and fees paid by the shareholder investing in the different
classes. Class B and Class C shares were introduced February 1, 1993. The
Consumer Price Index and Lehman Aggregate Bond Index are from March 31, 1987.
******************************************************************************
This chart graphically compares your Fund's total return performance to
certain investment indexes. It is the result of fund performance guidelines
issued by the Securities and Exchange Commission. The intent is to provide
investors with more information about their investment.
Components of the chart
The chart is composed of several lines that represent the accumulated value
of an initial $10,000 investment for the period indicated. The lines
illustrate a hypothetical investment in:
1. Keystone Strategic Income Fund
The Fund seeks generous income from high yield, foreign, and U.S. government
or agency obligations. The return is quoted after deducting sales charges (if
applicable), fund expenses, and transaction costs and assumes reinvestment of
all distributions.
2. Lehman Aggregate Bond Index (LABI)
The LABI is a broad-based, unmanaged fixed-income market index of U.S.
government, corporate, and mortgage-backed securities. It represents the
price change and coupon income of several thousand securities with various
maturities and qualities. Securities are selected and compiled by Lehman
Brothers, Inc. according to criteria that may be unrelated to your Fund's
investment objective. It would be difficult for most individual investors to
duplicate this index.
3. Consumer Price Index (CPI)
This index is a widely recognized measure of the cost of goods and services
produced in the U.S. The index contains factors such as prices of services,
housing, food, transportation and electricity which are compiled by the U.S.
Bureau of Labor Statistics. The CPI is generally considered a valuable
benchmark for investors who seek to outperform increases in the cost of
living.
These indexes do not include transaction costs associated with buying and
selling securities, and do not hold cash to meet redemptions. It would be
difficult for most individual investors to duplicate these indexes.
Understanding what the chart means
The chart demonstrates your Fund's performance in relation to a well known
investment index and to increases in the cost of living. It is important to
understand what the chart shows and does not show.
This illustration is useful because it charts Fund and index performance over
the same time frame and over a long period. Long-term performance is a more
reliable and useful measure of performance than measurements of short-term
returns or temporary swings in the market. Your financial adviser can help
you evaluate fund performance in conjunction with the other important
financial considerations such as safety, stability and consistency.
7
<PAGE>
Limitations of the chart
The chart, however, limits the evaluation of Fund performance in several
ways. Because the measurement is based on total returns over an extended
period of time, the comparison often favors those funds which emphasize
capital appreciation when the market is rising. Likewise, when the market is
declining, the comparison usually favors those funds which take less risk.
Performance can be distorted
Funds which are more conservative in their orientation and which place an
emphasis on capital preservation will tend to compare less favorably when the
market is rising. In addition, funds which have income as one of their
objectives also will tend to compare less favorably to relevant indexes.
Indexes may also reflect the performance of some securities which a fund may
be prohibited from buying. A bond fund, for example, may be limited to
investments in only high quality bonds, or a stock fund may only be able to
buy stocks that have been traded on a stock exchange for a minimum number of
years or stocks that have a certain market capitalization. Indexes usually do
not have the same investment restrictions as your Fund.
Indexes do not include the costs of investing
The comparison is further limited in its utility because the indexes do not
take into account any deductions for sales charges, transaction costs or
other fund expenses. Your Fund's performance figures do reflect such
deductions. Sales charges--whether up-front or deferred--pay for the cost of
the investment advice of your financial adviser. Transaction costs pay for
the costs of buying and selling securities for your Fund's portfolio. Fund
expenses pay for the costs of investment management and various shareholder
services. None of these costs are reflected in index total returns. The
comparison is not completely realistic because an index cannot be duplicated
by an investor--even an unmanaged index--without incurring some charges and
expenses.
One of several measures
The chart is one of several tools you can use to understand your investment.
It should be read in conjunction with the Fund's prospectus, and annual and
semiannual reports. Also, your financial adviser, who understands your
personal financial situation, can best explain the features of your Keystone
fund and how it applies to your financial needs.
Future returns may be different
Shareholders also should be mindful that the long-run performance of either
the Fund or the indexes is not representative of what shareholders should
expect to receive from their Fund investment in the future; it is presented
to illustrate only past performance and is not a guarantee of future returns.
8
<PAGE>
SCHEDULE OF INVESTMENTS--July 31, 1996
<TABLE>
<CAPTION>
Coupon Maturity Principal Market
Rate Date Amount Value
- ------------------------------------------- ---------------------- ------ ------- ----------- ------------
<S> <C> <C> <C> <C> <C>
FIXED INCOME (98.2%)
INDUSTRIAL BONDS & NOTES (31.6%)
AEROSPACE (0.5%)
Airplanes Pass Thru Trust Bond (Subord.) 10.875% 2019 $1,000,000 $1,040,000
- ------------------------------------------- ---------------------- ------ ------- ----------- ------------
BROADCASTING (2.6%)
Ackerly Communications Incorporated Sr. Notes 10.750 2003 775,000 802,125
EZ Communications, Incorporated Sr. Notes (Subord.) 9.750 2005 1,000,000 985,000
K-III Communications Corporation (f) Sr. Notes 8.500 2006 1,000,000 915,000
Park Broadcasting, Incorporated (f) Sr. Notes 11.750 2004 1,000,000 1,150,000
Paxson Communications Corporation Sr. Notes (Subord.) 11.625 2002 1,000,000 1,040,000
Sinclair Broadcast Group, Incorporated Sr. Notes (Subord.) 10.000 2005 1,000,000 982,500
- ------------------------------------------- ---------------------- ------ ------- ----------- ------------
5,874,625
- ------------------------------------------- ---------------------- ------ ------- ----------- ------------
CABLE/OTHER VIDEO DISTRIBUTION (3.5%)
Adelphia Communications Corporation Sr. Notes 12.500 2002 1,000,000 1,027,500
Cablevision Systems Corporation Sr. Deb. (Subord.) 10.500 2016 1,000,000 960,000
Comcast Corporation Sr. Deb. (Subord.) 10.625 2012 1,000,000 1,045,000
Diamond Cable Communications Company
(Eff. Yield 11.09%)(e) Sr. Disc. Notes 0.000 2005 1,000,000 595,000
Fundy Cable Limited Sr. Notes 11.000 2005 1,000,000 1,015,000
Marcus Cable Operating Company Sr. Disc. Notes
(Eff. Yield 10.54%)(e) (Subord.) 0.000 2004 1,000,000 720,000
Rogers Cablesystems Limited Sr. Notes 10.000 2005 1,000,000 995,000
Videotron Holdings, PLC
(Eff. Yield 11.00%)(e) Sr. Disc. Notes 0.000 2005 2,000,000 1,305,000
Videotron Group Limited Sr. Notes (Subord.) 10.250 2002 150,000 154,500
- ------------------------------------------- ---------------------- ------ ------- ----------- ------------
7,817,000
- ------------------------------------------- ---------------------- ------ ------- ----------- ------------
CHEMICALS (1.4%)
Rexene Corporation Sr. Notes 11.750 2004 1,000,000 1,092,500
Sifto Canada, Incorporated Sr. Notes 8.500 2000 1,000,000 970,000
Viridian, Incorporated Notes 9.750 2003 1,000,000 1,027,500
- ------------------------------------------- ---------------------- ------ ------- ----------- ------------
3,090,000
- ------------------------------------------- ---------------------- ------ ------- ----------- ------------
CONSUMER (1.2%)
Exide Corporation Sr. Notes 10.000 2005 1,500,000 1,470,000
International Semi-Tech Electronics,
Incorporated (Eff. Yield 11.98%)(e) Sr. Disc. Notes 0.000 2003 2,000,000 1,130,000
- ------------------------------------------- ---------------------- ------ ------- ----------- ------------
2,600,000
(continued on next page)
9
<PAGE>
- ------------------------------------------- ---------------------- ------ ------- ----------- ------------
DIVERSIFIED MEDIA (0.7%)
Lifestyle Brands Gtd. Deb. (Subord.) 10.000% 1997 $ 700,000 $ 700,000
Viacom, Incorporated Deb. (Subord.) 8.000 2006 1,000,000 915,000
- ------------------------------------------- ---------------------- ------ ------- ----------- ------------
1,615,000
- ------------------------------------------- ---------------------- ------ ------- ----------- ------------
ENERGY (2.8%)
Clark USA, Incorporated Sr. Notes 10.875 2005 1,000,000 1,007,500
Falcon Drilling Company Sr. Notes 8.875 2003 1,000,000 960,000
Ferrellgas Partners Limited Partnership (f) Sr. Notes 9.375 2006 775,000 747,875
Gulf Canada Resources Limited Sr. Notes (Subord.) 9.625 2005 1,000,000 1,007,500
Plains Resources, Incorporated (f) Sr. Notes (Subord.) 10.250 2006 500,000 495,000
TransTexas Gas Corporation Sr. Notes 11.500 2002 1,000,000 995,000
Vintage Petroleum, Incorporated Sr. Notes (Subord.) 9.000 2005 1,000,000 962,500
- ------------------------------------------- ---------------------- ------ ------- ----------- ------------
6,175,375
- ------------------------------------------- ---------------------- ------ ------- ----------- ------------
FINANCIAL (0.9%)
Conseco, Incorporated Sr. Notes 10.500 2004 1,000,000 1,137,000
Reliance Group Holdings, Incorporated Sr. Deb. (Subord.) 9.750 2003 1,000,000 990,000
- ------------------------------------------- ---------------------- ------ ------- ----------- ------------
2,127,000
- ------------------------------------------- ---------------------- ------ ------- ----------- ------------
FOODS/TOBACCO/BEVERAGES (2.6%)
American Rice, Incorporated Mtge. Notes 13.000 2002 500,000 460,000
Chiquita Brands International, Incorporated Sr. Notes 10.250 2006 500,000 497,500
Iowa Select Farms (8/2/94-$2,696,506)
(Eff. Yield 16.62%)(c)(e) Sr. Disc. Notes 0.000 2004 5,680,000 3,153,536
Specialty Foods Corporation Sr. Notes (Subord.) 11.250 2003 2,000,000 1,680,000
- ------------------------------------------- ---------------------- ------ ------- ----------- ------------
5,791,036
- ------------------------------------------- ---------------------- ------ ------- ----------- ------------
FOREST PRODUCTS/CONTAINERS (3.8%)
Buckeye Cellulose Corporation Sr. Notes (Subord.) 8.500 2005 1,000,000 952,500
Calmar, Incorporated Sr. Notes (Subord.) 11.500 2005 1,000,000 972,500
Container Corporation of America Sr. Notes 11.250 2004 1,000,000 1,040,000
Owens-Illinois, Incorporated Sr. Deb. 11.000 2003 1,000,000 1,077,500
Rainy River Forest Products, Incorporated Sr. Notes 10.750 2001 1,000,000 1,052,500
Riverwood International Corporation Gtd. Sr. Notes 10.250 2006 1,000,000 985,000
Tembec Finance Corporation Sr. Notes 9.875 2005 2,500,000 2,325,000
- ------------------------------------------- ---------------------- ------ ------- ----------- ------------
8,405,000
- ------------------------------------------- ---------------------- ------ ------- ----------- ------------
GAMING (2.9%)
Boyd Gaming Corporation Sr. Notes (Subord.) 10.750 2003 1,000,000 1,035,000
Colorado Gaming and Entertainment Company Sr. Secd. PIK Notes 12.000 2003 1,958,427 1,821,337
10
<PAGE>
Grand Palais Casino Incorporated (8/15/94-
$2,488,391)(b)(c)(d) Sr. Secd. PIK Notes 18.250% 1997 $2,488,391 $ 25
HMH Properties, Incorporated Sr. Secd. Notes 9.500 2005 1,500,000 1,440,000
Showboat, Incorporated Sr. Notes (Subord.) 13.000 2009 1,000,000 1,140,000
Starcraft Corporation (b)(c)(d) Notes (Subord.) 16.500 1998 750,000 15,000
Trump Atlantic City Associates 1st Mtge. Notes 11.250 2006 1,000,000 975,000
- ------------------------------------------- ---------------------- ------ ------- ----------- ------------
6,426,362
- ------------------------------------------- ---------------------- ------ ------- ----------- ------------
HEALTHCARE (0.4%)
Regency Health Services, Incorporated Sr. Notes (Subord.) 9.875 2002 1,000,000 970,000
- ------------------------------------------- ---------------------- ------ ------- ----------- ------------
HOUSING (0.9%)
Continental Homes Holding Corporation Sr. Notes 10.000 2006 1,000,000 950,000
Schuller International Group, Incorporated Sr. Notes 10.875 2004 1,000,000 1,080,000
- ------------------------------------------- ---------------------- ------ ------- ----------- ------------
2,030,000
- ------------------------------------------- ---------------------- ------ ------- ----------- ------------
MANUFACTURING (1.1%)
Alpine Group, Incorporated Sr. Notes 12.250 2003 1,000,000 1,020,000
Koppers Industries, Incorporated Sr. Notes 8.500 2004 1,550,000 1,476,375
- ------------------------------------------- ---------------------- ------ ------- ----------- ------------
2,496,375
- ------------------------------------------- ---------------------- ------ ------- ----------- ------------
METALS/MINERALS (1.3%)
AK Steel Corporation Sr. Notes 10.750 2004 750,000 811,875
GS Technologies Operations, Incorporated Sr. Notes 12.250 2005 1,000,000 1,027,500
Jorgensen Earle Sr. Notes 10.750 2000 1,000,000 990,000
- ------------------------------------------- ---------------------- ------ ------- ----------- ------------
2,829,375
- ------------------------------------------- ---------------------- ------ ------- ----------- ------------
RETAIL (1.3%)
Cole National Group, Incorporated Sr. Notes 11.250 2001 1,000,000 1,050,000
Finlay Fine Jewelry Corporation Sr. Notes 10.625 2003 1,000,000 987,500
Michaels Stores, Incorporated Sr. Notes 10.875 2006 1,000,000 990,000
- ------------------------------------------- ---------------------- ------ ------- ----------- ------------
3,027,500
- ------------------------------------------- ---------------------- ------ ------- ----------- ------------
TELECOMMUNICATIONS (1.1%)
Bell Cablemedia PLC (Eff. Yield 10.67%)(e) Sr. Disc. Notes 0.000 2005 2,000,000 1,240,000
Teleport Communications Group Sr. Notes 9.875 2006 1,200,000 1,152,000
- ------------------------------------------- ---------------------- ------ ------- ----------- ------------
2,392,000
- ------------------------------------------- ---------------------- ------ ------- ----------- ------------
TRANSPORTATION (0.9%)
Eletson Holdings, Incorporated 1st Pfd. Mtge. Notes 9.250 2003 1,000,000 955,000
Gearbulk Holding Limited Sr. Notes 11.250 2004 1,000,000 1,040,000
- ------------------------------------------- ---------------------- ------ ------- ----------- ------------
1,995,000
(continued on next page)
11
<PAGE>
- ------------------------------------------- ---------------------- ------ ------- ----------- ------------
WIRELESS COMMUNICATIONS (1.7%)
Centennial Cellular Corporation Sr. Notes 8.875% 2001 $ 1,000,000 $ 930,000
Mobile Telecommunication Technology Sr. Notes 13.500 2002 1,000,000 1,055,000
Rogers Cantel Sr. Deb. 9.375 2008 1,000,000 970,000
Vanguard Cellular Systems, Incorporated Deb. 9.375 2006 1,000,000 965,000
- ------------------------------------------- ---------------------- ------ ------- ----------- ------------
3,920,000
- ------------------------------------------- ---------------------- ------ ------- ----------- ------------
TOTAL INDUSTRIAL BONDS & NOTES (COST--$75,507,476) 70,621,648
- ------------------------------------------------------------------------------- ------- ----------- ------------
MORTGAGE-BACKED SECURITIES (18.7%)
FHLMC Participation Certificate Pool
#607352 7.694 2022 24,900,000 11,981,648
FNMA Grantor Trust 95-T5A 7.000 2035 1,500,000 1,202,013
FNMA Pool #322356 7.000 2025 4,602,585 4,372,687
FNMA Pool #324193 7.000 2025 6,261,500 5,833,333
GNMA Pool #354714 6.500 2023 11,613,669 9,796,589
GNMA Pool #780163 6.500 2009 10,000,000 8,509,694
- ------------------------------------------- ---------------------- ------ ------- ----------- ------------
TOTAL MORTGAGE-BACKED SECURITIES (COST--$42,392,278) 41,695,964
- --------------------------------------------------------------------- ------ ------- ----------- ------------
FOREIGN BONDS (U.S. DOLLARS) (22.3%)
Celulose Nipo Brasileiras Unsecd. Deb. 9.375 2003 3,750,000 3,726,563
Grupo Industrial Durango S.A. Notes 12.000 2001 2,500,000 2,521,875
Grupo Industrial Durango S.A. Notes 12.625 2003 400,000 403,500
Grupo Televisa S.A. (f) Sr. Notes 11.875 2006 2,900,000 2,936,250
Indah Kiat International Finance Co. Gtd. Sr. Secd. Notes 11.375 1999 2,000,000 2,100,000
Indah Kiat International Finance Co. Gtd. Sr. Secd. Notes 11.875 2002 3,000,000 3,210,000
Intermedia Capital Partners (f) Sr. Notes 11.250 2006 500,000 501,250
Ispat Mexicana S.A. Sr. Unsecd. Deb. 10.375 2001 2,000,000 1,940,000
Klabin Fabricadora Papel Unsecd. Deb. 11.000 1998 2,000,000 2,037,500
Klabin Fabricadora Papel Unsecd. Deb. 10.000 2001 5,000,000 4,950,000
Nuevo Energy Company Sr. Notes (Subord.) 9.500 2006 1,000,000 980,000
Telecom Argentina Unsecd. Deb. 8.375 2000 9,000,000 8,554,500
Telecom Argentina (f) Unsecd. Deb. 8.375 2000 1,440,000 1,375,200
Telecom Brasil Bonds 10.000 1997 4,852,000 4,949,040
Telefonica de Argentina Unsecd. Deb. 8.375 2000 1,000,000 962,500
Telefonica de Argentina Unsecd. Deb. 11.875 2004 6,000,000 6,360,000
Vencemos Financing (f) Unsecd. Deb. 9.250 1996 150,000 150,000
Yacimientos Petroliferos Fiscales S.A.
(YPF) Unsecd. Notes 8.000 2004 2,300,000 2,041,250
- ------------------------------------------- ---------------------- ------ ------- ----------- ------------
TOTAL FOREIGN BONDS (U.S. DOLLARS) (COST--$48,725,761) 49,699,428
- -------------------------------------------------------------------------------------------------------------------------
12
<PAGE>
- --------------------------------------------------------------------- ------ ------- ----------- ------------
FOREIGN BONDS (NON U.S. DOLLARS) (19.6%)
Denmark (Kingdom of) Deb. 8.000% 2003 70,500,000 $ 13,177,461
Danish Krone
Italy (Republic of) Deb. 9.500 2006 13,250,000,000 8,784,868
Italian Lira
New Zealand Government Deb. 8.000 2001 9,500,000 6,450,593
New Zealand Dollar
Sweden (Kingdom of) Deb. 10.250 2003 91,000,000 15,359,518
Swedish Krona
- ------------------------------------------- ---------------------- ------ ---------------------- ------------
TOTAL FOREIGN BONDS (NON U.S. DOLLARS) (COST--$40,175,830) 43,772,440
- ------------------------------------------------------------------------------- ------- ----------- ------------
U.S. GOVERNMENT ISSUES (6.0%)
U.S. Treasury Bonds (h) 7.875 2021 $7,998,000 8,709,102
U.S. Treasury Notes 6.250 1998 4,300,000 4,302,666
U.S. Treasury Notes 6.250 2000 500,000 495,155
- ------------------------------------------- ---------------------- ------ ------- ----------- ------------
TOTAL U.S. GOVERNMENT ISSUES (COST--$13,245,149) 13,506,923
- ------------------------------------------------------------------------------- ------- ----------- ------------
TOTAL FIXED INCOME (COST--$220,046,494) 219,296,403
- ------------------------------------------------------------------------------- ------- ----------- ------------
Shares
- ------------------------------------------- ---------------------- ------ ------- ----------- ------------
COMMON STOCKS/WARRANTS (0.7%)
Casino America, Incorporated (b) 110,614 753,558
Casino America, Incorporated, wts. (b) 19,582 19,582
Colorado Gaming and Entertainment Company (b) 195,842 636,487
Grand Palais Casinos, Inc., Series A, wts. (8/15/94-$727)(b)(c) 72,794 73
Grand Palais Casinos, Inc., Series B, wts. (8/15/94-$397)(b)(c) 39,706 40
Grand Palais Casinos, Inc., Series C, wts. (8/15/94-$3,507)(b)(c) 350,735 351
Grand Palais Casinos, Inc., Series D, wts. (8/15/94-$-0-)(b)(c) 160,136 160
Grand Palais Casinos, Inc., wts. (8/15/94-$57)(b)(c) 87,342 87
Iowa Select Farms, wts. (2/4/94-$955,122)(b)(c) 117,800 117,800
Nextel Communications Incorporated, wts. (b) 4,820 48
Pagemart, Inc., wts. (b)(f) 13,340 80,040
- ------------------------------------------------------------------------------- ------- ----------- ------------
TOTAL COMMON STOCKS/WARRANTS (COST--$3,231,103) 1,608,226
- ------------------------------------------------------------------------------- ------- ----------- ------------
PREFERRED STOCK (0.6%) (COST--$2,106,054)
Ampex Corp. (b)(c) 2,156 1,317,047
- ------------------------------------------- ---------------------- ------ ------- ----------- ------------
Coupon Maturity Maturity
Rate Date Value
- ------------------------------------------- ---------------------- ------ ------- ----------- ------------
REPURCHASE AGREEMENT (0.2%) (COST--$500,000)
Keystone Joint Repurchase Agreement (Investments in repurchase
agreements, in a joint trading account, dated 7/31/96) (g) 5.687% 08/01/96 $500,079 500,000
- --------------------------------------------------------------------- ------ ------- ----------- ------------
</TABLE>
(continued on next page)
13
<PAGE>
<TABLE>
<CAPTION>
Market
Value
- --------------------------------------------------------------------------------
<S> <C>
TOTAL INVESTMENTS (COST--$225,883,651)(A) $222,721,676
OTHER ASSETS AND LIABILITIES--NET (0.3%) 601,086
- --------------------------------------------------------------------------------
NET ASSETS (100.0%) $223,322,762
- --------------------------------------------------------------------------------
</TABLE>
(a) The cost of investments for federal income tax purposes is $226,402,398.
Gross unrealized appreciation and depreciation of investments, based on
idenified tax cost at July 31, 1996 are as follows:
<TABLE>
<CAPTION>
<S> <C>
Gross unrealized appreciation $ 6,433,451
Gross unrealized depreciation (10,114,173)
--------------
Net unrealized depreciation ($ 3,680,722)
==============
</TABLE>
(b) Non-income producing.
(c) All or a portion of these securities are either (1) restricted securities
(i.e., securities which may not be publicly sold without registration
under the Federal Securities Act of 1933) or (2) illiquid securities, and
are valued using market quotations where readily available. In the
absence of market quotations, the securities are valued based upon their
fair value determined under procedures approved by the Board of Trustees.
The Fund may make investments in an amount up to 15% of the value of the
Fund's net assets in such securities. The date of acquisition and cost
are set forth in parentheses after the title of each restricted security.
On the date of acquisition there were no market quotations on similar
securities and the above securities were valued at acquisition costs. At
July 31, 1996, the fair value of these restricted securities was
$3,272,072 (1.47% of the Fund's net assets).
(d) Securities which have defaulted on payment of interest and/or principal.
The Fund has stopped accruing income on these securities. At July 31,
1996, the market value of these securities was $15,025.
(e) Effective yield (calculated at the date of purchase) is the yield at
which the bond accretes on an annual basis until maturity date.
(f) Securities that may be resold to "qualified institutional buyers" under
Rule 144A or securities offered pursant to Section 4(2) of the Securities
Act of 1933, as amended. These securities have been determined to be
liquid under guidelines established by the Board of Trustees.
(g) The repurchase agreements are fully collateralized by U.S. government
and/or agency obligations based on market prices at July 31, 1996.
(h) $2,000,000 principal amount of this security is used as collateral for a
reverse repurchase agreement at July 31, 1996.
Legend of Portfolio Abbreviations:
FHLMC--Federal Home Loan Mortgage Corporation
FNMA--Federal National Mortgage Association
GNMA--Government National Mortgage Association
FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS
<TABLE>
<CAPTION>
U.S. $ Value at In Exchange Net Unrealized
Exchange July 31, 1996 for U.S. $ Appreciation/
Date (Depreciation)
- -------- --------- ------------ ----------- --------- --------------
<S> <C> <C> <C> <C> <C>
Forward Foreign Currency Exchange Contracts to Sell:
Contracts to Deliver
----------------------------------------
8/20/96 18,670,638 Danish Krone 3,282,480 3,159,000 ($123,480)
8/20/96 25,024,580 Swedish Krona 3,784,253 3,700,000 (84,253)
--------
Net Unrealized Depreciation on Forward Foreign Currency Exchange
Contracts ($207,733)
========
See Notes to Financial Statements.
</TABLE>
14
<PAGE>
FINANCIAL HIGHLIGHTS--CLASS A SHARES
(For a share outstanding throughout each year)
<TABLE>
<CAPTION>
Year Ended July 31,
1996 1995 1994(c) 1993 1992
- --------------------------------- -------- ------- -------- ------- ---------
<S> <C> <C> <C> <C> <C>
Net asset value beginning
of year $ 6.89 $ 7.35 $ 7.86 $ 7.02 $ 6.10
- ----------------------------- ------- ------ ------- ------ --------
Income from investment
operations:
Net investment income 0.54 0.64 0.61 0.69 0.78
Net realized and unrealized
gain (loss) on investments,
closed futures contracts and
forward foreign currency
related transactions (0.09) (0.45) (0.44) 0.89 0.89
- ----------------------------- ------- ------ ------- ------ --------
Total from investment
operations 0.45 0.19 0.17 1.58 1.67
- ----------------------------- ------- ------ ------- ------ --------
Less distributions from:
Net investment income (0.52) (0.60) (0.61) (0.72) (0.75)
In excess of investment
income 0 (0.03) (0.03) (0.02) 0
Tax basis return of capital (0.05) (0.02) (0.04) 0 0
Net realized gains on
investments 0 0 0 0 0
- ----------------------------- ------- ------ ------- ------ --------
Total distributions (0.57) (0.65) (0.68) (0.74) (0.75)
- ----------------------------- ------- ------ ------- ------ --------
Net asset value end
of year $6.77 $6.89 $7.35 $7.86 $7.02
- ----------------------------- ------- ------ ------- ------ --------
Total return (a) 6.84% 3.00% 1.86% 24.13% 28.73%
Ratios/supplemental data
Ratios to average net assets:
Total expenses 1.30%(d) 1.33% 1.32% 1.80% 2.09%
Total expenses excluding
reimbursement 1.30%(d) 1.33% 1.32% 1.80% 2.12%
Net investment income 8.05% 9.31% 7.79% 9.50% 11.73%
Portfolio turnover rate 101% 95% 92% 151% 95%
- ----------------------------- ------- ------ ------- ------ --------
Net assets end of year
(thousands) $68,118 $85,970 $105,181 $85,793 $70,459
- ----------------------------- ------- ------ ------- ------ --------
</TABLE>
<TABLE>
<CAPTION>
February 13,
1987
(Commencement
of Operations)
to
1991 1990 1989 1988 July 31, 1987
- ----------------------------- ------ ------ ------- ------- ---------------
<S> <C> <C> <C> <C> <C>
Net asset value beginning of
year $ 7.17 $ 9.02 $ 9.36 $ 10.04 $10.00
- ----------------------------- ------ ------ ------- ------- ---------------
Income from investment
operations:
Net investment income 0.89 1.03 1.10 1.05 0.22
Net realized and unrealized
gain (loss) on investments,
closed futures contracts and
forward foreign currency
related transactions (1.01) (1.79) (0.31) (0.65) 0.00
- ----------------------------- ------ ------ ------- ------- ---------------
Total from investment
operations (0.12) (0.76) 0.79 0.40 0.22
- ----------------------------- ------ ------ ------- ------- ---------------
Less distributions from:
Net investment income (0.89) (1.04) (1.11) (1.08) (0.18)
In excess of investment
income (0.06) (0.05) 0 0 0
Tax basis return of capital 0 0 0 0 0
Net realized gains on
investments 0 0 (0.02) 0 0
- ----------------------------- ------ ------ ------- ------- ---------------
Total distributions (0.95) (1.09) (1.13) (1.08) (0.18)
- ----------------------------- ------ ------ ------- ------- ---------------
Net asset value end
of year $ 6.10 $ 7.17 $ 9.02 $ 9.36 $10.04
- ----------------------------- ------ ------ ------- ------- ---------------
Total return (a) 0.54% (8.55%) 9.00% 4.49% 2.20%
Ratios/supplemental data
Ratios to average net assets:
Total expenses 2.00% 2.00% 1.81% 1.28% 1.00%(b)
Total expenses excluding
reimbursement 2.25% 2.01% 1.90% 2.08% 6.08%(b)
Net investment income 15.23% 12.91% 12.06% 10.98% 10.12%(b)
Portfolio turnover rate 82% 36% 73% 46% 13%
- ----------------------------- ------ ------ ------- ------- ---------------
Net assets end of year
(thousands) $70,246 $83,106 $138,499 $114,310 $8,191
- ----------------------------- ------ ------ ------- ------- ---------------
</TABLE>
(a) Excluding applicable sales charges.
(b) Annualized for the period from April 14, 1987 (Commencement of Investment
Operations) to July 31, 1987.
(c) Calculation based on average shares outstanding.
(d) Ratio of total expenses to average net assets for the year ended July 31,
1996 includes indirectly paid expenses. Excluding indirectly paid
expenses, the expense ratio would have been 1.28%.
See Notes to Financial Statements.
15
<PAGE>
FINANCIAL HIGHLIGHTS--CLASS B SHARES
(For a share outstanding throughout each year)
<TABLE>
<CAPTION>
Year Ended July 31,
February 1, 1993
(Date of Initial
Public Offering)
1996 1995 1994(c) to July 31, 1993
- ------------------------------------------------------ -------- -------- -------- -----------------
<S> <C> <C> <C> <C>
Net asset value beginning of year $ 6.92 $ 7.38 $ 7.89 $ 7.07
- ------------------------------------------------ ------- ------- ------- ---------------
Income from investment operations:
Net investment income 0.50 0.60 0.55 0.24
Net realized and unrealized gain (loss) on
investments, closed futures contracts and
forward foreign currency related transactions (0.09) (0.47) (0.44) 0.92
- ------------------------------------------------ ------- ------- ------- ---------------
Total from investment operations 0.41 0.13 0.11 1.16
- ------------------------------------------------ ------- ------- ------- ---------------
Less distributions from:
Net investment income (0.47) (0.55) (0.55) (0.24)
In excess of net investment income 0 (0.03) (0.03) (0.10)
Tax basis return of capital (0.05) (0.01) (0.04) 0
- ------------------------------------------------ ------- ------- ------- ---------------
Total distributions (0.52) (0.59) (0.62) (0.34)
- ------------------------------------------------ ------- ------- ------- ---------------
Net asset value end of year $ 6.81 $ 6.92 $ 7.38 $ 7.89
- ------------------------------------------------ ------- ------- ------- ---------------
Total return (a) 6.21% 2.12% 1.10% 16.75%
Ratios/supplemental data
Ratios to average net assets:
Total expenses 2.07%(d) 2.06% 2.07% 2.37%(b)
Net investment income 7.28% 8.58% 7.11% 7.18%(b)
Portfolio turnover rate 101% 95% 92% 151%
- ------------------------------------------------ ------- ------- ------- ---------------
Net assets end of year (thousands) $123,389 $149,091 $162,866 $35,415
- ------------------------------------------------------------------------------- --------------------
</TABLE>
(a) Excluding applicable sales charges
(b) Annualized
(c) Calculation based on average shares outstanding.
(d) Ratio of total expenses to average net assets for the year ended July 31,
1996 includes indirectly paid expenses. Excluding indirectly paid
expenses, the expense ratio would have been 2.05%.
See Notes to Financial Statements.
16
<PAGE>
FINANCIAL HIGHLIGHTS--CLASS C SHARES
(For a share outstanding throughout each year)
<TABLE>
<CAPTION>
February 1, 1993
(Date of Initial
Year Ended July 31, Public Offering)
1996 1995 1994(c) to July 31, 1993
- ------------------------------------------------ ------- ------ ------ ---------------
<S> <C> <C> <C> <C>
Net asset value beginning of year $6.92 $7.37 $7.88 $7.07
- ------------------------------------------------ ------- ------ ------ ---------------
Income from investment operations:
Net investment income 0.49 0.59 0.55 0.24
Net realized and unrealized gain (loss) on
investments, closed futures contracts and
forward foreign currency related transactions (0.09) (0.45) (0.44) 0.91
- ------------------------------------------------ ------- ------ ------ ---------------
Total from investment operations 0.40 0.14 0.11 1.15
- ------------------------------------------------ ------- ------ ------ ---------------
Less distributions from:
Net investment income (0.47) (0.55) (0.55) (0.24)
In excess of net investment income 0 (0.03) (0.03) (0.10)
Tax basis return of capital (0.05) (0.01) (0.04) 0
- ------------------------------------------------ ------- ------ ------ ---------------
Total distributions (0.52) (0.59) (0.62) (0.34)
- ------------------------------------------------ ------- ------ ------ ---------------
Net asset value end of year $6.80 $6.92 $7.37 $7.88
- ------------------------------------------------ ------- ------ ------ ---------------
Total return (a) 6.07% 2.27% 1.09% 16.61%
Ratios/supplemental data
Ratios to average net assets:
Total expenses 2.07%(d) 2.08% 2.07% 2.25%(b)
Net investment income 7.29% 8.56% 7.09% 7.35%(b)
Portfolio turnover rate 101% 95% 92% 151%
- ------------------------------------------------ ------- ------ ------ ---------------
Net assets end of year (thousands) $31,816 $46,221 $59,228 $19,706
- ------------------------------------------------ ------- ------ ------ ---------------
</TABLE>
(a) Excluding applicable sales charges
(b) Annualized
(c) Calculation based on average shares outstanding.
(d) Ratio of total expenses to average net assets for the year ended July 31,
1996 includes indirectly paid expenses. Excluding indirectly paid
expenses, the expense ratio would have been 2.05%.
See Notes to Financial Statements.
17
<PAGE>
STATEMENT OF ASSETS AND LIABILITIES
July 31, 1996
<TABLE>
<CAPTION>
Assets (Note 3)
<S> <C>
Investments at market value
(identified cost--$225,883,651) $222,721,676
Cash 145,431
Receivable for:
Investments sold 1,294,074
Fund shares sold 157,880
Interest 4,542,928
Prepaid expenses and other assets 168,577
- ---------------------------------------------------- -------------
Total assets 229,030,566
- ---------------------------------------------------- -------------
Liabilities (Notes 2, 3 and 5)
Payable for:
Investments purchased 2,073,892
Reverse repurchase agreement 2,237,856
Fund shares redeemed 352,972
Distributions to shareholders 656,991
Net unrealized depreciation on foreign currency
exchange contracts 207,733
Due to related parties 16,112
Other accrued expenses 162,248
- ---------------------------------------------------- -------------
Total liabilities 5,707,804
- ---------------------------------------------------- -------------
Net assets $223,322,762
- ---------------------------------------------------- -------------
Net assets represented by (Note 1)
Paid-in capital $297,544,782
Accumulated distributions in excess of net
investment income (1,169,996)
Accumulated net realized loss on investments,
closed futures contracts and foreign currency
related transactions (69,700,772)
Net unrealized depreciation on investments, foreign
currency exchange contracts and related
transactions (3,351,252)
- ---------------------------------------------------- -------------
Total net assets $223,322,762
- ---------------------------------------------------- -------------
Net Asset Value Per Share (Note 2)
Class A Shares
Net assets of $68,118,372 / 10,060,162 shares
outstanding $ 6.77
Offering price per share ($6.77 / 0.9525) (based
on a sales charge of 4.75% of the offering price
on July 31, 1996) $ 7.11
Class B Shares
Net assets of $123,388,688 / 18,132,004 shares
outstanding $ 6.81
Class C Shares
Net assets of $31,815,702 / 4,680,973 shares
outstanding $ 6.80
- ---------------------------------------------------- -------------
</TABLE>
STATEMENT OF OPERATIONS
Year Ended July 31, 1996
<TABLE>
<CAPTION>
Investment income (Note 1)
<S> <C> <C>
Interest (net of foreign withholding
taxes of $48,566) $23,880,913
Other income 133,017
- ------------------------------------- ---------- ------------
24,013,930
- ------------------------------------- ---------- ------------
Expenses (Notes 4 and 5)
Management fee $ 1,663,669
Transfer agent fees 655,455
Accounting, auditing and legal fees 79,228
Custodian fees 173,082
Trustees' fees and expenses 30,556
Distribution Plan expenses 1,972,005
Miscellaneous 140,311
- ------------------------------------- ---------- ------------
Total expenses 4,714,306
Less: Expenses paid indirectly
(Note 6) (37,066)
- ------------------------------------- ---------- ------------
Net expenses 4,677,240
- ------------------------------------- ---------- ------------
Net investment income 19,336,690
- ------------------------------------- ---------- ------------
Net realized and unrealized loss on
investments and foreign currency
related transactions
(Notes 1 and 3)
Net realized loss on:
Investments (2,858,545)
Foreign currency related
transactions (1,073,293)
- ------------------------------------- ---------- ------------
Net realized loss on investments and
foreign currency related
transactions (3,931,838)
- ------------------------------------- ---------- ------------
Net change in unrealized
appreciation (depreciation) on:
Investments (48,177)
Foreign currency related
transactions 295,422
- ------------------------------------- ---------- ------------
Net change in unrealized
appreciation on investments and
foreign currency related
transactions 247,245
- ------------------------------------- ---------- ------------
Net realized and unrealized loss on
investments and foreign currency
related transactions (3,684,593)
- ------------------------------------- ---------- ------------
Net increase in net assets resulting
from operations $15,652,097
- ------------------------------------- ---------- ------------
</TABLE>
See Notes to Financial Statements.
18
<PAGE>
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
Year Ended July 31,
1996 1995
- ------------------------------------------------------------------- ----------- -------------
<S> <C> <C>
Operations
Net investment income $ 19,336,690 $ 25,856,250
Net realized loss on investments, closed futures contracts
and foreign currency related transactions (3,931,838) (38,021,996)
Net change in unrealized appreciation on investments and foreign
currency related transactions 247,245 17,203,692
- ------------------------------------------------------------------- ----------- -------------
Net increase in net assets resulting from operations 15,652,097 5,037,946
- ------------------------------------------------------------------- ----------- -------------
Distributions to shareholders from (Note 1)
Net investment income:
Class A Shares (5,945,153) (8,015,693)
Class B Shares (9,706,657) (12,000,626)
Class C Shares (2,690,979) (3,983,775)
In excess of net investment income:
Class A Shares 0 (385,252)
Class B Shares 0 (576,777)
Class C Shares 0 (191,469)
Tax basis return of capital:
Class A Shares (564,217) (199,090)
Class B Shares (921,197) (298,065)
Class C Shares (255,384) (98,947)
- ------------------------------------------------------------------- ----------- -------------
Total distributions to shareholders (20,083,587) (25,749,694)
- ------------------------------------------------------------------- ----------- -------------
Capital share transactions (Note 2)
Proceeds from shares sold:
Class A Shares 5,908,665 10,254,533
Class B Shares 18,284,154 34,092,723
Class C Shares 3,935,676 12,856,402
Payment for shares redeemed:
Class A Shares (25,781,907) (27,229,543)
Class B Shares (46,918,273) (44,185,075)
Class C Shares (19,524,124) (24,956,159)
Net asset value of shares issued in reinvestment of dividends and
distributions:
Class A Shares 3,365,004 4,322,219
Class B Shares 5,354,257 6,821,317
Class C Shares 1,848,660 2,742,673
- ------------------------------------------------------------------- ----------- -------------
Net decrease in net assets resulting from capital share
transactions (53,527,888) (25,280,910)
- ------------------------------------------------------------------- ----------- -------------
Total decrease in net assets (57,959,378) (45,992,658)
- ------------------------------------------------------------------- ----------- -------------
Net assets
Beginning of year 281,282,140 327,274,798
- ------------------------------------------------------------------- ----------- -------------
End of year [including accumulated distributions in excess of
net investment income as follows: 1996--($1,169,996) and
1995--($1,023,303)](Note 1) $223,322,762 $281,282,140
- ------------------------------------------------------------------- ----------- -------------
</TABLE>
See Notes to Financial Statements.
19
<PAGE>
NOTES TO FINANCIAL STATEMENTS
(1.) Significant Accounting Policies
Keystone Strategic Income Fund (the "Fund") is a Massachusetts business
trust for which Keystone Management, Inc. ("KMI") is the Investment Manager
and Keystone Investment Management Company ("Keystone") is the Investment
Adviser. Keystone is a wholly-owned subsidiary of Keystone Investments, Inc.
("KII") and KMI is in turn a wholly-owned subsidiary of Keystone. The Fund is
registered under the Investment Company Act of 1940, as amended (the "1940
Act"), as a diversified, open-end investment company. The Fund offers several
classes of shares. The Fund's investment objective is to seek high current
income from high yield, foreign and U.S. Government or agency obligations.
The following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of its financial statements. The
policies are in conformity with generally accepted accounting principles,
which require management to make estimates and assumptions that affect
amounts reported herein. Although actual results could differ from these
estimates, any such differences are expected to be immaterial to the net
assets of the Fund.
A. Valuation of Securities
Investments are usually valued at the closing sales price, or in the absence
of sales and for over-the- counter securities, the mean of the bid and asked
prices as furnished by an independent pricing service.
U.S. Government obligations held by the Fund are valued at the mean between
the over-the-counter bid and asked prices. Listed corporate bonds, other
fixed income securities, mortgage and other asset-backed securities, and
other related securities are valued at prices provided by an independent
pricing service. In determining value for normal institutional-size
transactions, the pricing service uses methods based on market transactions
for comparable securities and various relationships between securities that
are generally recognized by institutional traders. Security valuations not
available from an independent pricing service (including restricted
securities) are valued at fair value as determined in good faith according to
procedures established by the Board of Trustees.
Short-term investments with remaining maturities of 60 days or less are
carried at amortized cost, which approximates market value. Short-term
securities with greater than 60 days to maturity are valued at market value.
B. Repurchase Agreements
Pursuant to an exemptive order issued by the Securities and Exchange
Commission, the Fund, along with certain other Keystone funds, may transfer
uninvested cash balances into a joint trading account. These balances are
invested in one or more repurchase agreements that are fully collateralized
by U.S. Treasury and/or Federal Agency obligations.
Securities pledged as collateral for repurchase agreements are held by the
custodian on the Fund's behalf. The Fund monitors the adequacy of the
collateral daily and will require the seller to provide additional collateral
in the event the market value of the securities pledged falls below the
carrying value of the repurchase agreement.
C. Reverse Repurchase Agreements
The Fund enters into reverse repurchase agreements with qualified
third-party broker-dealers. Interest on the value of reverse repurchase
agreements is based upon competitive market rates at the time of issuance. At
the time the Fund enters into a reverse repurchase agreement, it will
establish and maintain a segregated account with the custodian containing
liquid assets having a value not less than the repurchase price
20
<PAGE>
(including accrued interest). If the counterparty to the transaction is
rendered insolvent, the ultimate realization of the securities to be
repurchased by the Fund may be delayed or limited.
D. Foreign Currency
The books and records of the Fund are maintained in United States (U.S.)
dollars. Foreign currency amounts are translated into United States dollars
as follows: market value of investments, assets and liabilities at the daily
rate of exchange; purchases and sales of investments, income and expenses at
the rate of exchange prevailing on the respective dates of such transactions.
Net unrealized foreign exchange gain (loss) which result from changes in
foreign currency exchange rates is a component of net unrealized appreciation
(depreciation) on investments and foreign currency transactions. Net realized
foreign currency gains and losses resulting from changes in exchange rates
include foreign currency gains and losses between trade date and settlement
date on investment securities transactions, foreign currency transactions and
the difference between the amounts of interest and dividends recorded on the
books of the Fund and the amount actually received. The portion of foreign
currency gains and losses related to fluctuations in exchange rates between
the initial purchase trade date and subsequent sale trade date is included in
realized gain (loss) on foreign currency transactions.
E. Futures Contracts
In order to gain exposure to or protect against changes in security values,
the Fund may buy and sell futures contracts.
The initial margin deposited with a broker when entering into a futures
transaction is subsequently adjusted by daily payments or receipts as the
value of the contract changes. Such changes are recorded as unrealized gains
or losses. Realized gains or losses are recognized on closing the contract.
Risks of entering into futures contracts include (i) the possibility of an
illiquid market for the contract, (ii) the possibility that a change in the
value of the contract may not correlate with changes in the value of the
underlying instrument or index, (iii) the possibility that Keystone will not
accurately predict changes in exchange rates, interest rates or market
prices, and (iv) the credit risk that the other party will not fulfill the
obligations of the contract. Futures contracts also involve elements of
market risk in excess of the amount reflected in the statement of assets and
liabilities.
F. Forward Foreign Currency Exchange Contracts
The Fund may enter into forward foreign currency exchange contracts
("forward contracts") to settle portfolio purchases and sales of securities
denominated in a foreign currency and to hedge certain foreign currency
assets. Forward contracts are recorded at the forward rate and
marked-to-market daily. Realized gains and losses arising from such
transactions are included in net realized gain (loss) on foreign currency
related transactions. The Fund bears the risk of an unfavorable change in the
foreign currency exchange rate underlying the forward contract and is subject
to the credit risk that the other party will not fulfill the obligations of
the contract. Forward contracts involve elements of market risk in excess of
the amount reflected in the statement of assets and liabilities.
G. Security Transactions and Investment Income
Securities transactions are accounted for no later than one business day
after the trade date. Realized gains and losses are computed on the
identified cost basis. Interest income is recorded on the accrual basis and
includes amortization of discounts and premiums. Dividend income is recorded
on the ex-dividend date.
21
<PAGE>
H. Federal Income Taxes
The Fund has qualified and intends to qualify in the future as a regulated
investment company under the Internal Revenue Code of 1986, as amended (the
"Code"). Thus, the Fund is relieved of any federal income tax liability by
distributing all of its net taxable investment income and net taxable capital
gains, if any, to its shareholders. The Fund intends to avoid excise tax
liability by making the required distributions under the Code. Accordingly,
no provision for federal income taxes is required.
I. Distributions
The Fund distributes net investment income monthly and net capital gains, if
any, annually. Distributions to shareholders are recorded at the close of
business on the ex-dividend date.
Income and capital gains distributions to shareholders are determined in
accordance with income tax regulations, which may differ from generally
accepted accounting principles. These differences are primarily due to
differing treatment for paydown gains (losses) and foreign security
transactions for income tax purposes that have been recognized for financial
statement purposes.
J. Class Allocations
Class A shares are offered at a public offering price that includes a
maximum sales charge of 4.75% payable at the time of purchase. Class B shares
are sold subject to a contingent deferred sales charge payable upon
redemption which decreases depending on how long the shares have been held.
Class B shares purchased on or after June 1, 1995 that have been outstanding
for eight years will automatically convert to Class A shares. Class B shares
purchased prior to June 1, 1995 that have been outstanding for seven years
will automatically convert to Class A shares. Class C shares are sold subject
to a contingent deferred sales charge payable on shares redeemed within one
year of purchase.
Income, expenses (other than class specific expenses) and realized and
unrealized gains and losses are prorated among the classes based on the
relative net assets of each class. Currently, class specific expenses are
limited to expenses incurred under the Distribution Plan for each class.
(2.) Capital Share Transactions
The Fund's Declaration of Trust authorizes the issuance of an unlimited
number of shares of beneficial interest with no par value. Shares of
beneficial interest of the Fund are currently divided into Class A, Class B
and Class C. Transactions in shares of the Fund were as follows:
<TABLE>
<CAPTION>
Year ended July 31,
Class A 1996 1995
- --------------- ---------- ------------
<S> <C> <C>
Shares sold 862,737 1,476,748
Shares redeemed (3,779,494) (3,933,229)
Shares issued
in reinvestment
of dividends and
distributions 493,925 630,245
- --------------- ---------- ------------
Net decrease (2,422,832) (1,826,236)
- --------------- ---------- ------------
Class B
Shares sold 2,657,436 4,868,980
Shares redeemed (6,840,568) (6,393,919)
Shares issued
in reinvestment
of dividends and
distributions 781,880 989,682
- --------------- ---------- ------------
Net decrease (3,401,252) (535,257)
- --------------- ---------- ------------
Class C
Shares sold 573,201 1,847,558
Shares redeemed (2,845,554) (3,594,976)
Shares issued
in reinvestment
of dividends and
distributions 270,184 397,992
- --------------- ---------- ------------
Net decrease (2,002,169) (1,349,426)
- --------------- ---------- ------------
</TABLE>
22
<PAGE>
(3.) Securities Transactions
Cost of purchases and proceeds from sales of investment securities
(excluding short-term securities and U.S. government securities) for the year
ended July 31, 1996 were $251,943,715 and $304,655,949, respectively.
As of July 31, 1996, the Fund has a capital loss carryover for federal
income tax purposes of approximately $65,917,000 that expires as follows:
$1,843,000--1998, $11,547,000--1999, $12,167,000--2000, $5,288,000--2002 and
$35,072,000--2004.
The average daily balance of reverse repurchase agreements outstanding
during the year ended July 31, 1996 was approximately $1,621,500 at a
weighted average interest rate of 5.59%. The maximum amount of borrowing
during the year was $3,345,994 (including accrued interest). On July 31, 1996
the Fund had a reverse repurchase agreement outstanding in the amount of
$2,237,856 (including accrued interest at a rate of 5.73%) maturing on August
12, 1996.
(4.) Distribution Plans
The Fund bears some of the costs of selling its shares under Distribution
Plans adopted by its Class A, B and C shares pursuant to Rule 12b-1 under the
1940 Act. Under the Distribution Plans, the Fund pays its principal
underwriter, Keystone Investment Distributors Company ("KIDC"), a
wholly-owned subsidiary of Keystone, amounts that are calculated and paid
daily.
The Class A Distribution Plan provides for expenditures, which are currently
limited to 0.25% annually of the average net assets of the Class A shares, to
pay expenses related to the distribution of Class A shares. During the year
ended July 31, 1996, the Fund paid $181,536 to KIDC under the Class A
Distribution Plan.
Pursuant to the Fund's Class B and Class C Distribution Plans, the Fund pays
a distribution fee not to exceed 1.00% of the average daily net assets of
Class B and Class C shares, respectively. Of these amounts, 0.75% is used to
pay distribution expenses and 0.25% is used to pay service fees.
During the year ended July 31, 1996, under the Class B Distribution Plans,
the Fund paid or accrued $1,279,839 for Class B shares purchased before June
1, 1995 and $119,872 for Class B shares purchased on or after June 1, 1995.
The Fund paid $390,758 under the Class C Distribution Plan.
Each of the Distribution Plans may be terminated at any time by vote of the
Independent Trustees or by vote of a majority of the outstanding voting
shares of the respective class. However, after the termination of any
Distribution Plan, and subject to the discretion of the Independent Trustees,
payments to KIDC may continue as compensation for its services that had been
earned while the Distribution Plan was in effect.
KIDC intends, but is not obligated, to continue to pay distribution costs
that exceed the current annual payments from the Fund. KIDC intends to seek
full payment of such distribution costs from the Fund at such time in the
future as, and to the extent that, payment thereof by the Class B or Class C
shares would be within permitted limits.
At July 31, 1996 total unpaid distribution costs were $9,880,397 for Class B
shares purchased before June 1, 1995 and $911,527 for Class B shares
purchased on or after June 1, 1995. Unpaid distribution costs for Class C
were $4,739,883 at July 31, 1996.
Contingent deferred sales charges paid by redeeming shareholders are paid to
KIDC.
(5.) Investment Management Agreement and Other Affiliated Transactions
Under the terms of the Investment Management Agreement between KMI and the
Fund, KMI provides investment management and administrative services to
23
<PAGE>
the Fund. In return, KMI is paid a management fee, computed and paid daily,
at an annual rate of 2.00% of the Fund's gross investment income plus an
amount determined by applying percentage rates starting at 0.50% and
declining as net assets increase to 0.25% per annum, to the net asset value
of the Fund.
KMI has entered into an Investment Advisory Agreement with Keystone under
which Keystone provides investment advisory and management services to the
Fund. In return for its services, Keystone receives an annual fee equal to
85% of the management fee received by KMI.
During the year ended July 31, 1996, the Fund paid or accrued $24,365 to
Keystone for certain accounting services. The Fund paid or accrued $655,455
to Keystone Investor Resource Center, Inc., a wholly-owned subsidiary of
Keystone, for services rendered as the Fund's transfer and dividend
disbursing agent.
Certain officers and/or Directors of Keystone are also officers and/or
Trustees of the Fund. Officers of Keystone and affiliated Trustees receive no
compensation directly from the Fund.
(6.) Expense Offset Arrangement
The Fund has entered into an expense offset arrangement with its custodian.
For the year ended July 31, 1996, the Fund incurred total custody fees of
$173,082 and received a credit of $37,066 pursuant to this expense offset
arrangement, resulting in a net custody expense of $136,016. The assets
deposited with the custodian under this expense offset arrangement could have
been invested in income-producing assets.
(7.) Subsequent Distribution to Shareholders
Distributions from net investment income of $0.045 for Class A, $0.041 for
Class B and $0.041 for Class C were declared payable on September 6, 1996 to
shareholders of record on August 23, 1996. These distributions are not
reflected in the accompanying financial statements.
(8.) Subsequent Event
On September 6, 1996, Keystone Investments, Inc. entered into an Agreement
and Plan of Acquisition and Merger (the "Acquisition") with First Union
Corporation and First Union National Bank of North Carolina ("First Union")
whereby First Union would acquire all the assets and liabilities of Keystone
Investments, Inc. Subject to the receipt of the required regulatory and
shareholder approvals, the Acquisition is expected to take place in late
December 1996.
24
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Trustees and Shareholders
Keystone Strategic Income Fund
We have audited the accompanying statement of assets and liabilities of
Keystone Strategic Income Fund, including the schedule of investments, as of
July 31, 1996, and the related statement of operations for the year then
ended, the statements of changes in net assets for each of the years in the
two-year period then ended, and the financial highlights for each of the
years in the nine-year period then ended and the period from February 13,
1987 (commencement of operations) to July 31, 1987 for Class A shares and for
each of the years in the three-year period ended July 31, 1996 and the period
from February 1, 1993 (date of initial public offering) to July 31, 1993 for
Class B and Class C shares. These financial statements and financial
highlights are the responsibility of the Fund's management. Our
responsibility is to express an opinion on these financial statements and
financial highlights based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to
obtain reasonable assurance about whether the financial statements and
financial highlights are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures
in the financial statements. Our procedures included confirmation of
securities owned as of July 31, 1996 by correspondence with the custodian and
brokers. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of
Keystone Strategic Income Fund as of July 31, 1996, the results of its
operations for the year then ended, the changes in its net assets for each of
the years in the two-year period then ended, and the financial highlights for
each of the years or periods specified in the first paragraph above in
conformity with generally accepted accounting principles.
KPMG Peat Marwick LLP
Boston, Massachusetts
September 6, 1996
25
<PAGE>
FEDERAL TAX STATUS--FISCAL 1996 DISTRIBUTIONS
(Unaudited)
The per share distributions paid to you for fiscal 1996, whether taken in
shares or cash, are as follows:
<TABLE>
<CAPTION>
Income Return of
Dividends Capital
------------ --------------
<S> <C> <C>
CLASS A
SHARES 0.52 0.05
============ ==============
CLASS B
SHARES 0.47 0.05
============ ==============
CLASS C
SHARES 0.47 0.05
============ ==============
</TABLE>
In January 1997 complete information on calendar year 1996 distributions
will be forwarded to you to assist in completing your 1996 federal income tax
return.
26
<PAGE>
Keystone's Services
for Shareholders
KEYSTONE AUTOMATED RESPONSE LINE (KARL)--Receive up-to-date account
information on your balance, last transaction and recent Fund distribution.
You may also process transactions such as investments, redemptions and
exchanges using a touch-tone telephone as well as receive quotes on price,
yield, and total return of your Keystone Fund. Call toll-free,
1-800-346-3858.
EASY ACCESS TO INFORMATION ON YOUR ACCOUNT--Information about your Keystone
account is available 24 hours a day through KARL. To speak with a Shareholder
Services representative about your account, call toll-free 1-800-343-2898
between 8:00 A.M. and 6:00 P.M. Eastern time. Retirement Plan investors
should call 1-800-247-4075.
ADDITIONS TO YOUR ACCOUNT--You can buy additional shares for your account at
any time, with no minimum additional investment.
REINVESTMENT OF DISTRIBUTIONS--You can compound the return on your
investment by automatically reinvesting your Fund's distributions at net
asset value with no sales charge.
EXCHANGE PRIVILEGE--You may move your money among funds in the same Keystone
family quickly and easily for a nominal service fee. KARL gives you the added
ability to move your money any time of day, any day of the week. Keystone
offers a variety of funds with different investment objectives for your
changing investment needs.
ELECTRONIC FUNDS TRANSFER (EFT)-- Referred to as the "paper-less
transaction," EFT allows you to take advantage of a variety of preauthorized
account transactions, including automatic monthly investments and systematic
monthly or quarterly withdrawals. EFT is a quick, safe and accurate way to
move money between your bank account and your Keystone account.
CHECK WRITING--Shareholders of Keystone Liquid Trust may exercise the check
writing privilege to draw from their accounts.
EASY REDEMPTION--KARL makes redemption services available to you 24 hours a
day, every day of the year. The amount you receive may be more or less than
your original account value depending on the value of fund shares at time of
redemption.
RETIREMENT PLANS--Keystone offers a full range of retirement plans,
including IRA, SEP-IRA, profit sharing, money purchase, and defined
contribution plans. For more information, please call Retirement Plan
Services, toll-free at 1-800-247-4075.
Keystone is committed to providing you with quality, responsive account
service. We will do our best to assist you and your financial adviser in
carrying out your investment plans.
27
