Putnam
High Income
Convertible
and Bond
Fund
ANNUAL REPORT
August 31, 1997
[LOGO: BOSTON * LONDON * TOKYO]
Fund highlights
* "Unlike most other convertible bond funds, whose main goal is
appreciation in the value of the bonds they purchase, your fund
seeks to provide a return that is derived primarily from interest
income. That said, we certainly do not object to appreciation when
it occurs -- and it frequently does."
-- Charles G. Pohl, manager
Putnam High Income Convertible and Bond Fund
* "The factors affecting bond performance are still the same:
inflation, the budget deficit and how the dollar is trading. And these
factors have recently been working in bonds' favor."
-- Money, September 1997
CONTENTS
4 Report from Putnam Management
8 Fund performance summary
12 Portfolio holdings
30 Financial statements
38 Results of July 10, 1997 shareholder meeting
From the Chairman
[GRAPHIC OMITTED: PHOTO OF GEORGE PUTNAM]
[copyright] Karsh, Ottawa
Dear Shareholder:
The sustained strength in high-yield bonds and the relative underperformance
of small and midsize company stocks during much of Putnam High Income
Convertible and Bond Fund's just-concluded fiscal year played right into the
hand of the fund's investment strategy. The fund invests primarily in
high-yielding convertibles issued by a wide variety of companies and in
lower-rated high-yield corporate bonds.
Because both types of securities are issued by small but promising companies
or companies that are temporarily out of favor, their convertibles can be
purchased at attractive valuations. Often these are companies with solid
fundamentals that have what your fund's managers believe are positive
attributes that will manifest themselves over time.
In the report that follows, Fund Managers Charles Pohl and Jennifer Leichter
discuss some of these investments and how they performed during fiscal 1997.
Then they look at prospects for fiscal 1998.
Respectfully yours,
/S/GEORGE PUTNAM
George Putnam
Chairman of the Trustees
October 15, 1997
Report from the Fund Managers
Charles G. Pohl, lead manager
Jennifer E. Leichter
The good times continue on in the high-yield bond markets and the stock
market, leading Putnam High Income Convertible and Bond Fund to produce an
outstanding return of 19.66% at net asset value and 14.29% at market price for
the 12 months ended August 31, 1997. This return can be compared with the
Merrill Lynch All-Convertible Index return of 21.92% and the First Boston High
Yield Bond Index return of 15.43%. Please see pages 8 and 9 for more
performance information.
* HIGH CURRENT INCOME REMAINS FUND'S PRIMARY GOAL
Your fund invests primarily in a unique type of convertible bond generally
issued by companies whose stocks have fallen a great deal. Because convertible
bond prices fall when the issuing company stock price drops, we typically see
a high yield associated with the convertible bond. This is the point at which
we step in, purchasing the company's bonds to take advantage of these
unusually high, often double-digit yields in order to meet our goal of
securing high current income for the fund. Therefore, unlike most other
convertible bond funds, whose main goal is appreciation in the value of the
bonds they purchase, your fund seeks to provide a return that is derived
primarily from interest income. That said, we certainly do not object to
appreciation when it occurs -- and it frequently does.
Interest-rate sensitive convertible bonds such as the ones in your fund tend
to lag the performance of their more equity-sensitive counterparts in a strong
stock market -- such as the one we've seen in the past three years.
Interest-rate sensitive convertible bonds differ from equity-sensitive
convertibles in that their performance depends largely upon the income they
generate. The more equity-sensitive bonds produce most of their return from
capital appreciation related to upward movement in the same company's stock
price. Nevertheless, the absolute returns from your fund have been unusually
attractive over the fiscal year.
* SECURITY SELECTION PLAYS KEY ROLE
Although the high-yield market in general has performed well this year, timely
security selection has played a key role in your fund's success. One example,
The Learning Company, has a large convertible bond which was well below its
issue price due to a dramatic decline in the underlying stock. Following a
number of contacts with the management, your fund began buying this bond with
a double-digit yield. Our view was that with the stock below $10 (down from
$40), the enterprise was undervalued. Additionally, Tribune Company owned a
large portion of the same convertible, which it accepted as consideration for
a division it sold to the company. Tribune recently transferred its stake in
the company to a group that includes Thomas H. Lee and Bain & Company. These
parties effectively swapped that portion of the the convertible for preferred
stock. Since that development, the stock of The Learning Company moved up
strongly, also lifting the convertible bond price. Shortly before the fiscal
year end, we sold these bonds at a substantial profit.
[GRAPHIC CHART OMITTED: TOP FIVE CONVERTIBLE HOLDINGS]
TOP FIVE CONVERTIBLE HOLDINGS*
Comcast Corp., 1.125%, 2007
Broadcasting
Exide Corp., 2.9%, 2005
Automotive
Softkey International, Inc., 5.5%, 2000
Computer
NovaCare, Inc., 5.5%, 2000
Health-care services
Mascotech, Inc. 4.5%, 2003
Automotive
[GRAPHIC CHART OMITTED: TOP FIVE CORPORATE HIGH-YIELD HOLDINGS]
TOP FIVE CORPORATE HIGH-YIELD HOLDINGS*
Transamerican Energy, stepped-coupon zeros, 2002
Oil and gas
NEXTEL Communications, Inc., stepped-coupon zeros, 2004
Cellular communications
Midland Funding Corp., 11.75%, 2005
Electric utilities
ICG Holdings, Inc., stepped-coupon zeros, 2005
Satellite services
Act III Theatres, Inc., 11.875%, 2003
Motion picture distribution
* These holdings represent a total of 14.5% of the fund's net assets as of
8/31/97. Portfolio holdings will vary over time.
* RETAIL AND HEALTH CARE OFFER GOOD PROSPECTS
Michaels, the arts and crafts store, is another example of the type of company
in which the fund invests. Michaels hired a new management team and CEO to
turn around the stores' sales. Their efforts boosted sales and enhanced the
company's profits and the convertible bonds in the portfolio responded
accordingly. Several other companies, Intevac and Boston Chicken, contributed
to the fund's strong returns. These companies experienced troubles, but
implemented measures to turn sales around and provided opportunities for the
fund.
Two securities in the health-care industry provided excellent performance
during this fiscal year: Healthsource, Inc. and Theratx, Inc. Both companies,
which were the takeover targets of much larger companies, demonstrate how
consolidation in the health-care industry has benefited your fund. After each
of these companies was acquired by a larger firm, the price of its bonds rose
substantially and we took profits accordingly.
We plan to add to our investments in the technology sector gradually,
especially when we can take advantage of extreme weaknesses in the market and
on a highly selective basis. During the fiscal year, when many of the
technology stocks that underlie the convertible market experienced weakness,
we made opportunistic investments, including new positions in National
Semiconductor and Cirrus Logic.
* STRONG ECONOMY HOLDS KEY TO HIGH-YIELD MARKET'S FUTURE
In general, the high-yield market continues to benefit from the strong economy
in two key ways. First, given the overall power of the economy, the credit
strength of many issuers has improved, making high-yield bonds a more
attractive investment. Second, cash continues to flow into this market, aided
by the newfound confidence of many previously more cautious investors. As
we've stated before, a well-balanced ratio between supply and demand can
enhance performance.
[GRAPHIC PIE CHART OMITTED: PORTFOLIO COMPOSITION (8/31/97)]
PORTFOLIO COMPOSITION (8/31/97)
Preferred stocks -- 3.3%
Corporate high-yield bonds -- 32.8%
Common stocks including warrants -- 0.9%
Convertible securities -- 57.4%
Other -- 5.6%
Footnote reads:
Based on total market value of assets. Composition will vary over time.
Given the positive economic background and the improvement in credit ratings
across the high-yield industry, we currently believe this market should
continue to perform well in the near term. The economy continues to expand,
inflation appears under control, and merger and acquisition activity is
proceeding at record levels. Earnings are solid across most industries and
demand for high-yield bonds remains robust. Ratings upgrades far outweigh
ratings downgrades, and defaults continue at extremely low levels.
Investors should keep in mind, however, that the economy is in its seventh
year of expansion and that history suggests that sooner or later growth will
need to be corralled in order to keep inflation at bay. Future action on
short-term interest rates by the Federal Reserve Board could affect the market
if the economy becomes too vigorous instead of chugging along at its present
comfortable rate. We will keep a watchful eye on such developments and
continue to use in-depth credit research to select good prospects while
constructing a diversified portfolio across many sectors.
The views expressed here are exclusively those of Putnam Management. They are
not meant as investment advice. Although the described holdings were viewed
favorably as of 8/31/97, there is no guarantee the fund will continue to hold
these securities in the future. The lower credit ratings of high-yield
corporate bonds reflect a greater possibility that adverse changes in an
issuer's business or financial condition, or in general economic conditions,
may impair the issuer's ability to pay principal and interest on its bonds.
International investing involves risks including political developments,
economic instability, and currency fluctuations.
Performance summary
Performance should always be considered in light of a fund's investment
strategy. Putnam High Income Convertible and Bond Fund is designed for
investors seeking high current income through an aggressive portfolio of
high-yielding convertible and debt securities with potential for capital
appreciation.
TOTAL RETURN FOR PERIODS ENDED 8/31/97
Merrill Lynch First Boston
Market All Convertible High-Yield
NAV price Index Index
- ------------------------------------------------------------------
1 year 19.66% 14.29% 21.92% 15.43%
- ------------------------------------------------------------------
5 years 92.92 88.27 97.86 72.66
Annual average 14.04 13.49 14.63 11.54
- ------------------------------------------------------------------
10 years 222.47 215.79 -- 202.03
Annual average 12.42 12.19 -- 11.69
- ------------------------------------------------------------------
Performance data represent past results and do not reflect future
performance. They do not take into account any adjustment for taxes
payable on reinvested distributions. Investment returns, net asset
value, and market price will fluctuate so that an investor's shares
when sold may be worth more or less than their original cost.
PRICE AND DISTRIBUTION INFORMATION
12 months ended 8/31/97
- -------------------------------------------------------------------
Distributions (number) 12
- -------------------------------------------------------------------
Income $0.852
- -------------------------------------------------------------------
Capital gains1
- -------------------------------------------------------------------
Long term 0.060
- -------------------------------------------------------------------
Short term --
- -------------------------------------------------------------------
Total $0.912
- -------------------------------------------------------------------
Share value NAV Market price
- -------------------------------------------------------------------
8/31/96 $9.48 $10.125
- -------------------------------------------------------------------
8/31/97 10.35 10.562
- -------------------------------------------------------------------
Current return NAV Market price
- -------------------------------------------------------------------
End of period
Current dividend rate2 8.23% 8.07%
- -------------------------------------------------------------------
1Capital gains, if any, are taxable for federal and, in most cases, state
tax purposes. For some investors, investment income may also be subject to
the federal alternative minimum tax. Investment income may be subject to
state and local taxes.
2Income portion of most recent distribution annualized and divided by NAV
or POP at end of period.
Performance data represent past results and do not reflect future
performance. They do not take into account any adjustment for taxes
payable on reinvested distributions. Investment returns, net asset value,
and market price will fluctuate so that an investor's shares when sold may
be worth more or less than their original cost.
TOTAL RETURN FOR PERIODS ENDED 9/30/97
(most recent calendar quarter)
Market
NAV price
- -------------------------------------------------------------------
1 year 19.45% 12.81%
- -------------------------------------------------------------------
5 years 94.03 84.99
Annual average 14.18 13.09
- -------------------------------------------------------------------
10 years 235.77 261.33
Annual average 12.88 13.71
- -------------------------------------------------------------------
Performance data represent past results and do not reflect future
performance. They do not take into account any adjustment for taxes
payable on reinvested distributions. Investment returns, net asset value
and market price will fluctuate so that an investor's shares when sold may
be worth more or less than their original cost.
TERMS AND DEFINITIONS
Total return shows how the value of the fund's shares changed over time,
assuming you held the shares through the entire period and reinvested all
distributions in the fund.
Net asset value (NAV) is the value of all your fund's assets, minus any
liabilities, divided by the number of outstanding common shares.
Market price is the current trading price of one share of the fund. Market
prices are set by transactions between buyers and sellers on the New York
Stock Exchange.
COMPARATIVE BENCHMARKS
Merrill Lynch All-Convertible Index* is an unmanaged list of convertible
securities commonly used as a measure of performance for the convertible
market.
First Boston High-Yield Bond Index* is a market-weighted index including
publicly traded bonds having a rating below BBB by Standard & Poor's
(registered trademark) and Moody's. The average quality of bonds
included in the index may be lower than the average quality of those
bonds in which the fund customarily invests.
* Securities indexes assume reinvestment of all distributions and interest
payments and do not take in account brokerage fees or taxes. Securities in
the fund do not match those in the indexes and performance of the fund
will differ. It is not possible to invest directly in an index.
Report of independent accountants
To the Trustees and Shareholders of
Putnam High Income Convertible and Bond Fund
In our opinion, the accompanying statement of assets and liabilities,
including the portfolio of investments owned, and the related statements of
operations and of changes in net assets and the financial highlights present
fairly, in all material respects, the financial position of Putnam High Income
Convertible and Bond Fund (the "fund") at August 31, 1997, and the results of
its operations, the changes in its net assets and the financial highlights for
the periods indicated, in conformity with generally accepted accounting
principles. These financial statements and financial highlights (hereafter
referred to as "financial statements") are the responsibility of the fund's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these financial
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits, which included
confirmation of investments owned at August 31, 1997 by correspondence with
the custodian and the application of alternative auditing procedures where
investments purchased were not yet received by the custodian, provide a
reasonable basis for the opinion expressed above.
Price Waterhouse LLP
Boston, Massachusetts
October 16, 1997
Portfolio of investments owned
August 31, 1997
<TABLE>
<CAPTION>
CONVERTIBLE BONDS AND NOTES (54.3%) *
PRINCIPAL AMOUNT VALUE
<S> <C> <C> <C>
Aerospace (1.1%)
- ------------------------------------------------------------------------------------------------------------
$1,495,000 UNC, Inc. cv. sub. deb. 7 1/2s, 2006 $ 1,487,525
Aerospace and Defense (2.4%)
- ------------------------------------------------------------------------------------------------------------
300,000 DRS Technologies, Inc. cv. sr. sub. deb. 9s, 2003 447,000
500,000 Hexcel Corp. cv. deb. 7s, 2011 499,375
2,450,000 Rohr Industries, Inc. cv. sub. deb. 7s, 2012 2,388,750
--------------
3,335,125
Automotive (4.4%)
- ------------------------------------------------------------------------------------------------------------
5,300,000 Exide Corp. 144A cv. sr. sub. notes 2.9s, 2005 3,365,500
3,000,000 Mascotech, Inc. cv. sub. deb. 4 1/2s, 2003 2,775,000
--------------
6,140,500
Banks (1.2%)
- ------------------------------------------------------------------------------------------------------------
1,395,000 Banamex 144A cv. jr. bonds 11s, 2003 (Bahamas) 1,496,138
108,000 Banco Nationale Mexico 144A cv. company
guaranty 7s, 1999 (Bahamas) 107,190
--------------
1,603,328
Broadcasting (2.8%)
- ------------------------------------------------------------------------------------------------------------
6,473,000 Comcast Corp. cv. notes 1 1/8s, 2007 3,891,891
Business Equipment and Services (2.7%)
- ------------------------------------------------------------------------------------------------------------
2,303,000 Corporate Express, Inc. cv. notes 4 1/2s, 2000 2,107,245
1,750,000 Corporate Express, Inc. 144A cv. notes 4 1/2s, 2000 1,603,438
--------------
3,710,683
Computer Equipment (1.4%)
- ------------------------------------------------------------------------------------------------------------
2,800,000 Maxtor Corp. cv. sub. deb. 5 3/4s, 2012 1,932,000
Computer Software (0.4%)
- ------------------------------------------------------------------------------------------------------------
500,000 MacNeal-Schwendler cv. sub. deb. 7 7/8s, 2004 520,000
Computers (3.1%)
- ------------------------------------------------------------------------------------------------------------
1,000,000 Safeguard Scientifics, Inc. 144A cv. sub. notes 6s, 2006 1,098,750
3,600,000 Softkey International, Inc. 144A cv. sr. notes
5 1/2s, 2000 3,240,000
--------------
4,338,750
Consumer Services (0.9%)
- ------------------------------------------------------------------------------------------------------------
220,000 Interact Systems, Inc. 144A units stepped-coupon
zero % (14s, 8/1/99), 2003 ++ 99,000
1,000,000 Protection One, Inc. cv. sr. sub. notes 6 3/4s, 2003 1,151,250
--------------
1,250,250
Electronics (2.4%)
- ------------------------------------------------------------------------------------------------------------
1,000,000 Cirrus Logic Inc. 144A cv. sub. notes 6s, 2003 953,750
2,500,000 HMT Technology Corp. 144A cv. sub. notes
5 3/4s, 2004 2,431,250
--------------
3,385,000
Entertainment (1.5%)
- ------------------------------------------------------------------------------------------------------------
3,500,000 Rogers Communications cv. deb. 2s, 2005 (Canada) 2,025,625
Environmental Control (2.4%)
- ------------------------------------------------------------------------------------------------------------
2,150,000 OHM Corp. cv. sub. deb. 8s, 2006 2,123,125
1,300,000 Weston (Roy F.), Inc. cv. deb. 7s, 2002 1,163,500
--------------
3,286,625
Food (2.0%)
- ------------------------------------------------------------------------------------------------------------
2,500,000 Chiquita Brands International, Inc. cv. sub. deb. 7s, 2001 2,362,500
400,000 Chiquita Brands International, Inc. 144A
cv. sub. deb 7s, 2001 378,000
--------------
2,740,500
Health Care Services (2.4%)
- ------------------------------------------------------------------------------------------------------------
3,150,000 NovaCare, Inc. cv. sub. deb. 5 1/2s, 2000 2,988,563
300,000 Quantum Health Resources, Inc. cv. sub. deb.
4 3/4s, 2000 275,250
--------------
3,263,813
Hospital Management and Medical Services (0.6%)
- ------------------------------------------------------------------------------------------------------------
1,000,000 PhyMatrix, Inc. cv. sub. deb. 6 3/4s, 2003 837,500
Office Equipment (1.6%)
- ------------------------------------------------------------------------------------------------------------
1,897,000 U.S. Office Products Co. 144A cv. sub. notes
5 1/2s, 2003 1,757,096
550,000 U.S. Office Products Co. cv. sub. notes 5 1/2s, 2003 503,250
--------------
2,260,346
Paper and Forest Products (1.1%)
- ------------------------------------------------------------------------------------------------------------
135,000 APP Global Finance (V) Ltd. 144A cv. sec. 2s, 2000
(United Kingdom) 129,600
1,500,000 Stone Container Corp. cv. sub. deb. 6 3/4s, 2007 1,350,000
--------------
1,479,600
Pharmaceuticals (1.6%)
- ------------------------------------------------------------------------------------------------------------
400,000 Pharmaceutical Marketing Services, Inc. cv. notes
6 1/4s, 2003 336,000
2,150,000 Pharmaceutical Marketing Services, Inc. 144A
cv. deb. 6 1/4s, 2003 1,892,000
--------------
2,228,000
Pipelines (0.9%)
- ------------------------------------------------------------------------------------------------------------
950,000 SFP Pipeline Holdings, Inc. var. rate exch. deb.
11.16s, 2010 [2 DBL. DAGGERS] 1,192,250
Publishing (1.7%)
- ------------------------------------------------------------------------------------------------------------
3,850,000 Hollinger, Inc. cv. Liquid Yield Option Notes (LYON)
zero %, 2013 1,472,625
850,000 Thomas Nelson, Inc. 144A cv. sub. notes 5 3/4s, 1999 836,188
--------------
2,308,813
REIT's (Real Estate Invesment Trust) (1.9%)
- ------------------------------------------------------------------------------------------------------------
850,000 Alexander Haagen Properties cv. sub. deb. Ser. A, (R)
7 1/2s, 2001 841,500
1,750,000 Malan Realty Investors cv. sub. notes 9 1/2s, 2004 (R) 1,767,500
--------------
2,609,000
Restaurants (1.1%)
- ------------------------------------------------------------------------------------------------------------
4,400,000 Boston Chicken, Inc. cv. notes LYON zero %, 2015 896,500
750,000 Boston Chicken, Inc. cv. sub. deb. 7 3/4s, 2004 641,250
--------------
1,537,750
Retail (5.1%)
- ------------------------------------------------------------------------------------------------------------
2,600,000 Baker (J.), Inc. cv. deb. 7s, 2002 2,314,000
2,550,000 Michaels Stores, Inc. cv. sub. notes 6 3/4s, 2003 2,403,375
3,050,000 Sunglass Hut International, Inc. 144A cv. sub. notes
5 1/4s, 2003 2,287,500
--------------
7,004,875
Semiconductors (3.7%)
- ------------------------------------------------------------------------------------------------------------
2,050,000 Integrated Device Technology, Inc. cv. sub. notes
5 1/2s, 2002 1,798,875
2,000,000 National Semiconductor 144A cv. deb. 6 1/2s, 2002 2,165,000
1,412,000 Richardson Electronics, Ltd. cv. sr. sub. deb. 8 1/4s, 2006 1,219,615
--------------
5,183,490
Telecommunications (1.5%)
- ------------------------------------------------------------------------------------------------------------
1,000,000 International CableTel, Inc. cv. sub. notes 7s, 2008 920,000
1,000,000 International CableTel Inc. 144A cv. deb. 7 1/4s, 2005 1,005,000
300,000 Winstar Communications, Inc. sr. disc. notes stepped-coupon
zero % (14s, 10/15/00), 2005 ++ 193,500
--------------
2,118,500
Telephone Services (0.5%)
- ------------------------------------------------------------------------------------------------------------
750,000 MIDCOM Communications, Inc. 144A cv. sub.
deb. 8 1/4s, 2003 630,000
Textiles (0.6%)
- ------------------------------------------------------------------------------------------------------------
1,000,000 Dixie Group, Inc. (The) cv. deb. 7s, 2012 890,000
Tobacco (1.4%)
- ------------------------------------------------------------------------------------------------------------
2,115,000 Standard Commercial Corp. cv. sub. deb. 7 1/4s, 2007 1,914,075
--------------
Total Convertible Bonds and Notes
(cost $65,983,216) $ 75,105,814
CORPORATE BONDS AND NOTES (32.7%) *
PRINCIPAL AMOUNT VALUE
Advertising (0.1%)
- ------------------------------------------------------------------------------------------------------------
$ 95,000 Lamar Advertising Co. sr. sub. notes 9 5/8s, 2006 $ 99,988
100,000 Outdoor Communications Inc. sr. sub. notes 9 1/4s, 2007 99,000
--------------
198,988
Aerospace and Defense (0.6%)
- ------------------------------------------------------------------------------------------------------------
500,000 BE Aerospace sr. sub. notes Ser. B, 9 7/8s, 2006 531,250
50,000 Howmet Corp. sr. sub. notes 10s, 2003 54,000
65,000 L-3 Communications Corp. 144A sr. sub. notes
10 3/8s, 2007 69,388
100,000 Sequa Corp. med. term notes 10s, 2001 103,425
70,000 Tracor, Inc. sr. sub. notes 8 1/2s, 2007 71,400
--------------
829,463
Agriculture (0.6%)
- ------------------------------------------------------------------------------------------------------------
585,000 PMI Holdings Corp. sub. disc. deb. stepped-coupon
Ser. B, zero % (11 1/2s, 9/1/00), 2005 ++ 450,450
388,165 Premium Standard Farms, Inc. sr. sec. notes
11s, 2003 [2 DBL. DAGGERS] 430,864
--------------
881,314
Apparel (0.2%)
- ------------------------------------------------------------------------------------------------------------
145,000 Sassco Fashions Ltd. sr. notes 12 3/4s, 2004 153,700
70,000 William Carter Holdings Co. 144A sr. sub. notes
12s, 2008 74,900
--------------
228,600
Automotive Parts (0.5%)
- ------------------------------------------------------------------------------------------------------------
95,000 A.P.S. Inc. company guaranty 11 7/8s, 2006 83,600
262,000 Aftermarket Technology Corp. sr. sub. notes 12s, 2004 290,820
100,000 Harvard Industries Inc. sr. notes 11 1/8s, 2005
(in default) + 42,000
$50,000 Hayes Wheels International, Inc. 144A sr. sub.
notes 9 1/8s, 2007 50,750
205,000 Lear Corp. sub. notes 9 1/2s, 2006 223,450
--------------
690,620
Banks (0.5%)
- ------------------------------------------------------------------------------------------------------------
70,000 Delta Financial Corp. sr. notes 9 1/2s, 2004 69,300
100,000 Dime Capital Trust I bank guaranty Ser. A, 9.33s, 2027 105,804
100,000 Greenpoint Capital Trust I 144A company guaranty
9.1s, 2027 103,500
25,000 Ocwen Capital Trust I company guaranty
10 7/8s, 2027 26,063
80,000 Ocwen Federal Bank sub. deb. 12s, 2005 88,600
50,000 Ocwen Financial Corp. notes 11 7/8s, 2003 55,750
75,000 Provident Capital Trust company guaranty 8.6s, 2026 75,255
45,000 Riggs Capital Trust 144A bonds 8 5/8s, 2026 45,230
65,000 Sovereign Capital Trust 144A company guaranty
9s, 2027 66,235
55,000 Webster Capital Trust I 144A bonds 9.36s, 2027 57,883
--------------
693,620
Broadcasting (2.2%)
- ------------------------------------------------------------------------------------------------------------
100,000 Argyle Television Corp. sr. sub. notes 9 3/4s, 2005 104,750
50,000 Azteca Holdings 144A sr. notes 11s, 2002 52,250
600,000 Benedek Communications Corp. sr. disc. notes stepped-
coupon zero % (13 1/4s, 5/15/01), 2006 ++ 384,000
90,000 Capstar Broadcasting 144A sr. sub. notes 9 1/4s, 2007 89,550
215,000 Capstar Broadcasting 144A sr. disc. notes stepped-
coupon zero % (12 3/4s, 2/1/02), 2009 ++ 141,900
75,000 Central European Media Enterprises Ltd. sr. notes
9 3/8s, 2004 75,188
40,000 Chancellor Radio Broadcasting Corp. sr. sub. notes
9 3/8s, 2004 41,400
10,220 Citadel Broadcasting Co. sr. notes 10 1/4s, 2007 10,910
80,000 Citadel Broadcasting Co. 144A sr. sub. notes
10 1/4s, 2007 85,400
250,000 Comcast UK Cable, Ltd. deb. stepped-coupon
zero % (11.2s, 11/15/00), 2007 (Bermuda) ++ 191,250
265,000 Commodore Media, Inc. sr. sub. notes stepped-
coupon 7 1/2s, (13 1/4s, 5/1/98), 2003 ++ 292,825
280,000 Fox/Liberty Networks LLC 144A sr. notes
8 7/8s, 2007 276,500
250,000 Heritage Media Services Corp. sr. sub. notes
8 3/4s, 2006 265,000
205,000 Jacor Communications, Co. 144A company guaranty
8 3/4s, 2007 206,025
45,000 Jacor Communications, Inc. company guaranty
9 3/4s, 2006 47,250
200,000 Paxson Communications Corp. sr. sub. notes
11 5/8s, 2002 219,000
110,000 Radio One Inc. 144A sr. sub. notes stepped-coupon
7s, (12s, 5/1/00), 2004 ++ 105,600
260,000 SFX Broadcasting, Inc. sr. sub. notes Ser. B,
10 3/4s, 2006 280,800
80,000 TCI Satellite Entertainment 144A sr. sub. notes
10 7/8s, 2007 82,400
35,000 TV Azteca Sa De Cv sr. notes Ser. B,
10 1/2s, 2007 (Mexico) 36,750
--------------
2,988,748
Building Products (0.6%)
- ------------------------------------------------------------------------------------------------------------
165,000 Cemex S.A. 144A bonds 12 3/4s, 2006 (Mexico) 195,938
150,000 Consumers International 144A sr. notes 10 1/4s, 2005 161,625
150,000 Johns Manville International Group sr. notes
10 7/8s, 2004 167,813
250,000 Nortek, Inc. sr. sub. notes 9 7/8s, 2004 252,500
50,000 Waxman Industries, Inc. sr. notes stepped-coupon
Ser. B, zero % (12 3/4s, 6/1/99), 2004 ++ 42,750
--------------
820,626
Building and Construction (1.1%)
- ------------------------------------------------------------------------------------------------------------
90,000 Atrium Companies Inc. sub. notes 10 1/2s, 2006 93,150
40,000 Continental Homes Holding Corp. sr. notes 10s, 2006 42,000
200,000 GS Superhighway Holdings 144A sr. notes
10 1/4s, 2007 200,500
500,000 NVR, Inc. sr. notes 11s, 2003 545,000
300,000 Presley Cos. sr. notes 12 1/2s, 2001 279,000
334,000 Terex Corp. sr. notes Ser. B, 13 1/4s, 2002 379,925
40,000 Webb (Del E.) Corp. sr. sub. notes 9 3/4s, 2008 40,800
--------------
1,580,375
Buses (0.2%)
- ------------------------------------------------------------------------------------------------------------
355,000 MCII Holding (USA) sec. notes stepped-coupon
zero % (12s, 11/15/98), 2002 ++ 322,163
Business Equipment and Services (0.3%)
- ------------------------------------------------------------------------------------------------------------
130,000 Coleman Escrow Corp. 144A 1st priority disc. notes
zero %, 2001 85,150
40,000 Coleman Escrow Corp. 144A 2nd priority sr. disc. notes
zero %, 2001 23,700
100,000 Corporate Express, Inc. sr. sub. notes Ser. B,
9 1/8s, 2004 100,000
50,000 Outsourcing Solutions, Inc. sr. sub. notes Ser. B,
11s, 2006 54,875
48,000 Pierce Leahy Corp. sr. sub. notes 11 1/8s, 2006 54,000
50,000 Williams Scotsman Inc. 144A sr.notes 9 7/8s, 2007 50,375
--------------
368,100
Cable Television (1.9%)
- ------------------------------------------------------------------------------------------------------------
660,530 Adelphia Communications Corp. sr. notes
9 1/2s, 2004 [2 DBL. DAGGERS] 639,063
70,000 Antenna TV S.A. 144A sr. notes 9s, (Greece) 67,900
200,000 Century Communications Corp. sr. notes 9 1/2s, 2005 208,000
215,000 Diamond Cable Communication Co. sr. disc. notes
stepped-coupon zero % (10 3/4s, 2/15/02), 2007
(United Kingdom) ++ 132,494
400,000 Diamond Cable Communication Co. sr. disc. notes
stepped-coupon zero % (11 3/4s, 12/15/00), 2005
(United Kingdom) ++ 285,500
360,961 Falcon Holdings Group, Inc. sr. sub. notes 11s, 2003 [2 DBL. DAGGERS] 379,009
80,000 Heartland Wireless Communications, Inc. sr. notes
Ser. B, 14s, 2004 35,200
100,000 Heartland Wireless Communications, Inc. sr. notes
13s, 2003 38,000
190,000 Marcus Cable Co. (L.P.) sr. sub. disc. notes stepped-
coupon zero % (13 1/2s, 8/1/99), 2004 ++ 168,625
210,000 NTL Inc. sr. notes Ser. B, 10s, 2007 (United Kingdom) 219,450
520,000 UIH Australia/Pacific, Inc. sr. disc. notes stepped-
coupon Ser. B, zero % (14s, 5/15/01), 2006
(Australia) ++ 343,200
--------------
2,516,441
Cellular Communications (1.6%)
- ------------------------------------------------------------------------------------------------------------
500,000 Comunicacion Cellular bonds stepped-coupon
zero % (13 1/8s, 11/15/00), 2003 (Colombia) ++ 382,500
250,000 Dial Call Communications, Inc. sr. disc. notes stepped-
coupon zero % (12 1/4s, 4/15/99), 2004 ++ 225,000
490,000 Intercel, Inc. sr. disc. notes stepped-coupon zero %
(12s, 5/1/01), 2006 ++ 313,600
325,000 Millicom International Cellular S.A. sr. disc. notes
stepped-coupon zero % (13 1/2s, 6/1/01), 2006
(Luxembourg) ++ 244,156
1,050,000 NEXTEL Communications, Inc. sr. disc. notes stepped-
coupon zero % (9 3/4s, 2/15/99), 2004 ++ 868,875
115,000 Pratama Datakom Asia BV 144A company guaranty
12 3/4s, 2005 (Indonesia) 111,550
--------------
2,145,681
Chemicals (1.2%)
- ------------------------------------------------------------------------------------------------------------
500,000 Acetex Corp. sr. notes 9 3/4s, 2003 (Canada) 511,250
240,000 Harris Chemical Corp. sr. sub. notes 10 3/4s, 2003 247,200
180,000 Huntsman Corp. 144A sr. sub. notes 9 1/2s, 2007 188,100
90,000 Huntsman Corp. 144A sr. sub. notes FRN 9.187s, 2007 92,700
250,000 ISP Holdings, Inc. sr. notes Ser. B, 9 3/4s, 2002 268,750
50,000 NL Industries, Inc. sr. notes 11 3/4s, 2003 54,875
40,000 Pioneer Americas Acquisition 144A sr. notes 9 1/4s, 2007 39,900
155,000 Polytama International notes 11 1/4s, 2007 (Netherlands) 147,250
105,000 Sovereign Specialty Chemical 144A sr. sub. notes
9 1/2s, 2007 105,000
75,000 Sterling Chemicals Holdings sr. disc. notes stepped-
coupon zero % (13 1/2s, 8/15/01), 2008 ++ 51,000
--------------
1,706,025
Computer Equipment (0.2%)
- ------------------------------------------------------------------------------------------------------------
300,000 Computervision Corp. sr. sub. notes 11 3/8s, 1999 263,250
Computer Services (0.2%)
- ------------------------------------------------------------------------------------------------------------
45,000 DecisionOne Corp. sr. sub. notes 9 3/4s, 2007 46,125
240,000 Unisys Corp. sr. notes 11 3/4s, 2004 265,200
--------------
311,325
Conglomerates (0.4%)
- ------------------------------------------------------------------------------------------------------------
600,000 MacAndrews & Forbes Holdings, Inc. sub. deb.
notes 13s, 1999 602,250
Consumer Durable Goods (0.2%)
- ------------------------------------------------------------------------------------------------------------
140,000 Icon Fitness Corp. sr. disc. notes stepped-coupon
Ser. B, zero % (14s, 11/15/01), 2006 ++ 75,600
200,000 Remington Products Co. LLC sr. sub. notes Ser. B, 11s, 2006 165,000
--------------
240,600
Consumer Non Durables (--%)
- ------------------------------------------------------------------------------------------------------------
30,000 Roller Bearing Co. 144A sr. sub. notes 9 5/8s, 2007 30,600
Consumer Services (0.4%)
- ------------------------------------------------------------------------------------------------------------
526,000 Coinmach Corp. sr. notes Ser. B, 11 3/4s, 2005 582,545
Containers (0.1%)
- ------------------------------------------------------------------------------------------------------------
110,000 Innova S De R.L. 144A sr. notes 12 7/8s,
2007 (Mexico) 116,270
40,000 Radnor Holdings Inc. sr.notes 10s, 2003 41,300
--------------
157,570
Cosmetics (0.3%)
- ------------------------------------------------------------------------------------------------------------
40,000 French Fragrances, Inc. sr. notes Ser. B., 10 3/8s, 2007 41,300
525,000 Revlon Worldwide Corp. sr. disc. notes Ser. B,
zero %, 2001 370,781
--------------
412,081
Electric Utilities (1.1%)
- ------------------------------------------------------------------------------------------------------------
100,000 Espirito Santo Centrais 144A sr. notes 10s, 2007 (Brazil) 102,500
281,000 First PV Funding deb. 10.15s, 2016 300,215
650,000 Midland Funding II Corp. deb. Ser. A, 11 3/4s, 2005 763,386
150,000 Midland Funding II Corp. deb. Ser. B, 13 1/4s, 2006 187,443
223,674 Northeast Utilities System notes Ser. A, 8.58s, 2006 221,519
--------------
1,575,063
Electrical Equipment (0.1%)
- ------------------------------------------------------------------------------------------------------------
100,000 Dobson Communications Corp. 11 3/4s, 2007 98,000
Electronic Components (0.2%)
- ------------------------------------------------------------------------------------------------------------
50,000 HCC Industries, Inc. 144A sr. sub. notes 10 3/4s, 2007 53,250
40,000 Therma-Wave Inc. 144A sr. notes 10 5/8s, 2004 42,900
105,000 Viasystems Inc. 144A sr. sub. notes 9 3/4s, 2007 108,150
25,000 Wavetek Corp. 144A sr. sub. notes 10 1/8s, 2007 25,750
--------------
230,050
Electronics (0.3%)
- ------------------------------------------------------------------------------------------------------------
55,000 Celestica International Ltd. sr. sub. notes
10 1/2s, 2006 (India) 59,125
545,000 International Semi-Tech. Corp. sr. secd. disc. notes
stepped-coupon zero % (11 1/2s, 8/15/00), 2003
(Canada) ++ 343,350
50,000 Moog, Inc. sr. sub. notes Ser. B, 10s, 2006 52,500
--------------
454,975
Energy-Related (0.3%)
- ------------------------------------------------------------------------------------------------------------
50,000 AES Corp. 144A sr. sub. notes 8 3/8s, 2007 49,625
40,000 Pacalta Resources Ltd. 144A sr. notes 10 3/4s,
2004 (Canada) 40,800
350,000 Panda Global Energy Co. 144A sr. notes
12 1/2s, 2004 339,500
--------------
429,925
Entertainment (0.4%)
- ------------------------------------------------------------------------------------------------------------
150,000 Affinity Group Holdings 144A sr. notes 11s, 2007 160,125
400,000 Premier Parks, Inc. sr. notes Ser. A, 12s, 2003 446,000
--------------
606,125
Environmental Control (0.2%)
- ------------------------------------------------------------------------------------------------------------
95,000 Allied Waste Industries, Inc. company guaranty
10 1/4s, 2006 103,550
175,000 Allied Waste Industries, Inc. 144A sr. disc. notes
stepped-coupon zero % (11.3s, 6/1/02), 2007 ++ 118,125
--------------
221,675
Finance (0.1%)
- ------------------------------------------------------------------------------------------------------------
145,000 Vicap SA. 144A company guaranty 10 1/4s, 2002 152,613
Financial Services (0.4%)
- ------------------------------------------------------------------------------------------------------------
165,000 Aames Financial Corp. sr. notes 9 1/8s, 2003 166,650
40,000 Colonial Capital II Ser. A company guaranty 8.92s, 2027 40,063
110,000 Contifinancial Corp. sr. notes 8 3/8s, 2003 113,300
45,000 Dollar Financial Group Inc. sr. notes Ser. A,
10 7/8s, 2006 48,150
75,000 Imperial Credit Capital Trust I 144A company
guaranty 10 1/4s, 2002 75,188
45,000 Imperial Credit Industries, Inc. sr. notes 9 7/8s, 2007 44,775
75,000 Intertek Finance PLC 144A sr. sub. notes 10 1/4s, 2006
(United Kingdom) 77,625
--------------
565,751
Food and Beverages (0.9%)
- ------------------------------------------------------------------------------------------------------------
120,000 Ameriserve Food Co. sr. sub. notes
10 1/8s, 2007 123,600
25,000 Aurora Foods Inc. 144A sr. sub notes Ser. C,
9 7/8s, 2007 25,375
125,000 Canandaigua Wine Co. sr. sub. notes Ser. C,
8 3/4s, 2003 126,250
30,000 Del Monte Corp. sr. sub. notes Ser. B, 12 1/4s, 2007 31,950
200,000 Doane Products Co. sr. notes 10 5/8s, 2006 212,000
115,000 Fleming Companies, Inc. 144A sr. sub. notes
10 1/2s, 2004 116,150
500,000 Mafco, Inc. sr. sub. notes 11 7/8s, 2002 532,500
35,000 Nebco Evans Holding Co. 144A sr. disc. notes stepped-
coupon zero % (12 3/8s, 7/15/02), 2007 ++ 21,000
60,000 Southern Foods Group 144A sr. sub. notes
9 7/8s, 2007 60,375
20,000 Windy Hill Pet Food Co. 144A sr. sub.notes
9 3/4s, 2007 20,400
--------------
1,269,600
Gaming (1.4%)
- ------------------------------------------------------------------------------------------------------------
100,000 Argosy Gaming Co. 1st mtge. 13 1/4s, 2004 100,000
70,000 Casino America, Inc. sr. notes 12 1/2s, 2003 73,500
192,786 Elsinore Corp. 144A exch. 1st mortgage 11 1/2s, 2000 185,075
125,000 Grand Casinos, Inc. 1st mtge. 10 1/8s, 2003 133,125
60,000 Harveys Casino Resorts sr. sub. notes 10 5/8s, 2006 64,950
350,000 Hollywood Casino Corp. sr. notes 12 3/4s, 2003 376,250
60,000 Isle of Capri Black Hawk LLC 144A 1st mortgage
13s, 2004 60,600
475,000 Lady Luck Gaming Corp. 1st mtge. 11 7/8s, 2001 475,000
125,000 Louisiana Casino Cruises Corp. sr. sub. deb.
11 1/2s, 1998 126,250
175,000 PRT Funding Corp. sr. notes 11 5/8s, 2004 141,313
243,000 Trump Castle notes 11 1/2s, 2000 243,000
--------------
1,979,063
Gas Utilities (0.1%)
- ------------------------------------------------------------------------------------------------------------
100,000 CMS Energy Corp. sr. notes 8 1/8s, 2002 101,688
Health and Fitness (0.2%)
- ------------------------------------------------------------------------------------------------------------
250,000 IHF Holdings, Inc. sr. disc. notes Ser. B, stepped-coupon
zero % (15.0s, 11/15/99), 2004 ++ 205,000
Hospital Management and Medical Services (0.7%)
- ------------------------------------------------------------------------------------------------------------
200,000 Merit Behavioral Care sr. sub. notes 11 1/2s, 2005 221,000
250,000 Paracelsus Healthcare Corp. sr. sub. notes 10s, 2006 254,375
500,000 Tenet Healthcare Corp. sr. sub. notes 10 1/8s, 2005 548,750
--------------
1,024,125
Insurance (0.2%)
- ------------------------------------------------------------------------------------------------------------
200,000 Reliance Group Holdings, Inc. sr. sub. deb. 9 3/4s, 2003 209,448
Lodging (0.1%)
- ------------------------------------------------------------------------------------------------------------
125,000 Prime Hospitality Corp. sub. notes 9 3/4s, 2007 132,500
Medical Supplies and Devices (0.5%)
- ------------------------------------------------------------------------------------------------------------
150,000 Dade International, Inc. sr. sub. notes Ser. B,
11 1/8s, 2006 168,938
150,000 Graphic Controls Corp. sr. sub. notes Ser. A, 12s, 2005 168,375
25,000 Leiner Health Products 144A sr. sub. notes
9 5/8s, 2007 25,875
250,000 Urohealth Systems, Inc. 144A sr. sub. notes
12 1/2s, 2004 241,250
125,000 Wright Medical Technology, Inc. 144A sr. notes, Ser. C,
11 3/4s, 2000 126,875
--------------
731,313
Metals and Mining (0.4%)
- ------------------------------------------------------------------------------------------------------------
35,000 Acindar Industria Argentina de Aceros S.A. bonds
11 1/4s, 2004 (Argentina) 37,100
85,000 Continental Global Group 144A sr. notes Ser. A,
11s, 2007 89,250
250,000 Ispat Mexicana, S.A. 144A deb. 10 3/8s, 2001 (Mexico) 267,500
70,000 Murrin Holdings 144A sr. notes 9 3/8s, 2007
(Australia) 70,700
75,000 Royal Oak Mines, Inc. sr. sub. notes Ser. B, 11s, 2006
(Canada) 67,500
--------------
532,050
Motion Picture Distribution (0.9%)
- ------------------------------------------------------------------------------------------------------------
600,000 Act III Theatres, Inc. sr. sub. notes 11 7/8s, 2003 642,000
140,000 AMC Entertainment, Inc. 144A sr. sub. notes
9 1/2s, 2009 140,700
235,500 Cinemark Mexico USA notes Ser. B, 13s, 2003
(Mexico) [2 DBL. DAGGERS] 235,500
15,700 Cinemark Mexico USA notes Ser. D, 13s, 2003
(Mexico) [2 DBL. DAGGERS] 15,700
170,000 Cinemark USA, Inc. notes 9 5/8s, 2008 171,700
--------------
1,205,600
Nursing Homes (0.2%)
- ------------------------------------------------------------------------------------------------------------
125,000 Genesis Eldercare 144A sr. sub. notes 9s, 2007 125,625
150,000 Sun Healthcare Group Inc. 144A sr. sub. notes
9 1/2s, 2007 153,750
--------------
279,375
Oil and Gas (1.9%)
- ------------------------------------------------------------------------------------------------------------
75,000 Abraxas Petroleum Corp. 144A sr. notes Ser. B,
11 1/2s, 2004 83,063
350,000 Chesapeake Energy Corp. sr. notes 10 1/2s, 2002 362,250
60,000 Cliffs Drilling Co. company guaranty Ser. B,
10 1/4s, 2003 64,200
30,000 Dailey Petroleum Services Corp. 144A company
guaranty 9 3/4s, 2007 30,525
50,000 DI Industries Inc. sr. notes 8 7/8s, 2007 49,500
50,000 Flores & Rucks, Inc. sr. sub. notes 9 3/4s, 2006 52,875
35,000 Kelley Oil & Gas Corp. sr. sub. notes Ser. B,
10 3/8s, 2006 36,313
60,000 Mesa Operating Co., company guaranty stepped-coupon
zero % (11 5/8s, 7/1/01), 2006 ++ 47,100
150,000 Ocean Energy, Inc. 144A sr. sub. notes 8 7/8s, 2007 151,875
80,000 Parker Drilling Corp. sr. notes Ser. B, 9 3/4s, 2006 84,800
20,000 Pogo Producing Co. 144A notes 8 3/4s, 2007 20,250
60,000 Pride Petroleum Services, Inc. sr. notes 9 3/8s, 2007 63,000
40,000 Texas Petrochemical Corp. sr. sub. notes 11 1/8s, 2006 42,800
1,150,000 Transamerican Energy 144A sr. disc. notes stepped-
coupon zero % (13s 6/15/00), 2002 ++ 871,125
455,000 Transamerican Energy 144A sr. notes 11 1/2s, 2002 441,350
197,000 TransTexas Gas Corp. sr. sub. notes 13 3/4s 2003 223,595
40,000 Wiser Oil Co. 144A sr. sub. notes 9 1/2s, 2007 38,700
--------------
2,663,321
Paging (0.8%)
- ------------------------------------------------------------------------------------------------------------
300,000 Metrocall, Inc. sr. sub. notes 10 3/8s, 2007 297,000
400,000 Mobile Telecommunications Tech. sr. notes
13 1/2s, 2002 437,000
500,000 Pagemart Nationwide, Inc. sr. disc. notes stepped-
coupon zero % (15s, 2/1/00), 2005 ++ 388,750
--------------
1,122,750
Paper and Forest Products (1.2%)
- ------------------------------------------------------------------------------------------------------------
100,000 APP International Finance Co. notes 11 3/4s, 2005
(Netherlands) 105,250
295,000 Florida Coast Paper LLC 1st mtge. Ser. B,
12 3/4s, 2003 318,600
250,000 Indah Kiat Financial Mauritius 144A 10s, 2007 (Indonesia) 238,750
190,000 PT Pabrik Kertas Tjiwi Kimia 144A company guaranty
10s, 2004 (Indonesia) 183,350
300,000 Repap New Brunswick sr. notes 10 5/8s, 2005
(Canada) 284,250
100,000 Riverwood International Corp. company guaranty
10 7/8s, 2008 95,250
100,000 Riverwood International Corp. 144A sr. notes
10 5/8s, 2007 101,000
100,000 Stone Container Corp. sr. notes 11 7/8s, 2016 109,000
145,000 Stone Container Corp. 144A company guaranty
11 1/2s, 2006 150,800
--------------
1,586,250
Pharmaceuticals and Biotechnology (0.1%)
- ------------------------------------------------------------------------------------------------------------
115,000 ICN Pharmaceuticals, Inc. 144a sr. notes 9 1/4s, 2005 117,588
Publishing (--%)
- ------------------------------------------------------------------------------------------------------------
40,000 Von Hoffman Press Inc. 144A sr. sub. notes
10 3/8s, 2007 42,000
REITs (0.1%)
- ------------------------------------------------------------------------------------------------------------
160,000 HMH Properties, Inc. 144A sr. notes 8 7/8s, 2007
(Canada) (R) 163,200
Railroads (0.2%)
- ------------------------------------------------------------------------------------------------------------
80,000 Hermes Europe Railtel 144a sr. notes 11 1/2s, 2007
(Netherlands) 84,200
30,000 TFM S.A. de CV. 144A company guaranty
10 1/4s, 2007 (Mexico) 31,200
160,000 TFM S.A. de CV. 144A company guaranty stepped-coupon
zero % (11 3/4s, 6/15/02), 2009 (Mexico) ++ 98,800
--------------
214,200
Restaurants (0.1%)
- ------------------------------------------------------------------------------------------------------------
100,000 FRD Acquisition Co. sr. notes Ser. B, 12 1/2s, 2004 107,000
Retail (0.8%)
- ------------------------------------------------------------------------------------------------------------
123,000 Guitar Center Management Co. sr. notes 11s, 2006 135,300
450,000 K mart Corp. med. term notes 7.85s, 2002 438,750
250,000 Mothers Work, Inc. sr. notes 12 5/8s, 2005 260,000
250,000 United Stationer Supply, Inc. sr. sub. notes
12 3/4s, 2005 283,750
--------------
1,117,800
Satellite Services (0.7%)
- ------------------------------------------------------------------------------------------------------------
145,000 Echostar DBS Corp. 144A company guaranty
12 1/2s, 2002 147,900
95,000 Esat Holdings Ltd. 144A sr. notes stepped-coupon
zero %, (12 1/2s, 2/1/02), 2007 ++ 59,850
890,000 ICG Holdings, Inc. sr. disc. notes stepped-coupon
zero % (13 1/2s, 9/15/00), 2005 ++ 683,075
--------------
890,825
Semiconductors (0.2%)
- ------------------------------------------------------------------------------------------------------------
64,122 Cirent Semiconductor sr. sub. notes 10.22s, 2002 65,324
68,050 Cirent Semiconductor 144A sr. sub. notes
10.14s, 2004 69,412
80,000 Fairchild Semiconductor Corp. sr. sub. notes
10 1/8s, 2007 85,400
90,000 Fairchild Semiconductor Corp. 144A sr. sub. notes
11.74s, 2008 94,050
--------------
314,186
Shipping (0.1%)
- ------------------------------------------------------------------------------------------------------------
95,000 Johnstown America Industries, Inc. 144A sr. sub. notes
11 3/4s, 2005 100,225
Steel (0.1%)
- ------------------------------------------------------------------------------------------------------------
85,000 AK Steel Corp. sr. notes 9 1/8s, 2006 89,463
90,000 Altos Hornos de Mexico 144A bonds 11 3/8s,
2002 (Mexico) 96,750
--------------
186,213
Supermarkets (0.5%)
- ------------------------------------------------------------------------------------------------------------
35,000 Marsh Supermarkets, Inc. 144A sr. sub. notes
8 7/8s, 2007 34,650
300,000 Ralphs Grocery Co. sr. notes 10.45s, 2004 327,000
275,000 Stater Brothers sr. notes 11s, 2001 301,813
--------------
663,463
Telecommunications (1.6%)
- ------------------------------------------------------------------------------------------------------------
80,000 America Communication Services, Inc. 144A sr. notes
13 3/4s, 2007 85,000
250,000 American Communication Services, Inc. sr. disc. notes
stepped-coupon zero % (12 3/4s, 4/1/01), 2006 ++ 148,125
45,000 Consorcio Ecuatoriano 144A notes 14s, 2002 (Ecuador) 48,431
100,000 GST Equipment Funding 144A sr. notes 13 1/4s, 2007 110,000
250,000 GST Telecommunication, Inc. company guaranty stepped-
coupon zero % (13 7/8s, 12/15/00), 2005 ++ 168,750
300,000 Hyperion Telecommunication Corp. sr. disc. notes stepped-
coupon Ser. B, zero % (13s, 4/15/01), 2003 ++ 189,750
180,000 Hyperion Telecommunication, Inc. 144A sr. notes
12 1/4s, 2004 184,500
100,000 International Cabletel Inc. sr. notes stepped-coupon
Ser. A, zero % (12 3/4s, 4/15/00), 2005 ++ 79,000
490,000 International Cabletel, Inc. sr. notes stepped-coupon
Ser. B, zero % (11 1/2s, 2/01/01), 2006 ++ 355,250
110,000 ITC Deltacom, Inc. 144A sr. notes 11s, 2007 116,050
160,000 McCaw International Ltd. 144A sr. disc. notes stepped-
coupon zero % (13s, 4/15/02), 2007 ++ 85,600
125,000 Orbcomm Global Capital Corp. sr. notes Ser. B,
14s, 2004 129,063
125,000 Teleport Communications Group Inc. sr. disc. notes
stepped-coupon zero % (11 1/8s, 7/1/01), 2007 ++ 93,125
600,000 Winstar Communications, Inc. 144A sr. disc. notes
stepped-coupon zero % (14s, 10/15/00), 2005 ++ 375,000
85,000 Winstar Equipment Corp. 144A company guaranty
12 1/2s, 2004 86,700
--------------
2,254,344
Telephone Services (0.9%)
- ------------------------------------------------------------------------------------------------------------
140,000 Brooks Fiber Properties, Inc. sr. notes 10s, 2007 147,700
105,000 Globo Communicacoes 144A company guaranty
10 1/2s, 2006 (Brazil) 109,725
255,000 Intermedia Communications, Inc. 144A sr. disc. notes
stepped-coupon zero % (11 1/4s, 7/15/02),
2007 ++ 160,650
170,000 McLeodusten, Inc. 144A sr. disc. notes stepped-coupon
zero % (10 1/2s, 3/1/02), 2007 ++ 111,775
250,000 Nextlink Communications sr. notes 12 1/2s, 2006 275,625
255,000 RSL Communications, Ltd. company guaranty
12 1/4s, 2006 267,750
100,000 Sprint Spectrum L.P. sr. notes 11s, 2006 111,000
--------------
1,184,225
Textiles (0.2%)
- ------------------------------------------------------------------------------------------------------------
40,000 Glenoit Corp. 144A sr. sub. notes 11s, 2007 42,500
100,000 Polymer Group, Inc. 144A sr. sub. notes 9s, 2007 100,000
160,000 Polysindo International Finance company guaranty
11 3/8s, 2006 (Indonesia) 175,200
--------------
317,700
Wireless Communications (1.1%)
- ------------------------------------------------------------------------------------------------------------
200,000 Advanced Radio Telecom Corp. sr. notes 14s, 2007 170,000
515,000 CellNet Data Systems, Inc. sr. disc. notes stepped-
coupon Ser. B, zero % (13s, 6/15/00), 2005 ++ 364,363
105,000 International Wireless Communications, Inc. sr. disc.
notes zero %, 2001 61,425
330,000 Iridium LLC/Capital Corp. 144A sr. notes 14s, 2005 351,450
175,000 Omnipoint Corp. sr. notes Ser. A, 11 5/8s, 2006 170,625
80,000 Omnipoint Corp. sr. notes 11 5/8s, 2006 78,000
250,000 Pricellular Wireless Corp. sr. disc. notes stepped-
coupon Ser. B, zero % (14s, 11/15/97), 2001 ++ 270,938
160,000 Wireless One, Inc. sr. notes 13s, 2003 84,800
--------------
1,551,601
--------------
Total Corporate Bonds and Notes
(cost $45,990,138) $ 45,171,815
PREFERRED STOCKS (3.2%) *
NUMBER OF SHARES VALUE
- ------------------------------------------------------------------------------------------------------------
2,232 Alliance Gaming Corp. Ser. B, $15.00 pfd. [2 DBL. DAGGERS] $ 228,780
2,000 AmeriKing, Inc. $3.25 pfd. [2 DBL. DAGGERS] 56,000
6,542 Cablevision Systems Corp. Ser. M, $11.125 dep. shs.
cum. pfd. [2 DBL. DAGGERS] 716,349
4,000 California Federal Bankcorp, Inc. Ser. B, $11.50 pfd. 450,000
3,500 California Federal Bancorp, Inc. Ser. B, $10.625
exch. pfd. 385,000
600 Capstar Broadcasting Inc. 144A $12.00 pfd. [2 DBL. DAGGERS] 63,000
1,270 Chancellor Radio Broadcasting 144A $12.00 pfd. 142,240
3,115 Chevy Chase Capital Corp. Ser. A, $5.19 pfd. 166,653
1,000 Citadel Broadcasting Co. 144A $13.25 pfd. [2 DBL. DAGGERS] 107,750
2,357 El Paso Electric Co. $11.40 pfd [2 DBL. DAGGERS] 260,449
4,700 Fitzgeralds Gaming Co. $3.75 pfd. 70,500
146 Intermedia Communication Ser. B, $13.50 pfd. [2 DBL. DAGGERS] 165,710
170 IXC Communications, Inc. 144A $12.50 pfd. [2 DBL. DAGGERS] 179,988
500 NEXTEL Communications Inc. 144A $13.00 pfd. [2 DBL. DAGGERS] 546,250
2,855 Nextlink Communications, Inc. Ser. $7.00
cum. pfd. 165,590
163 NTL Inc. Ser. B, $13.00 pfd. [2 DBL. DAGGERS] 183,375
250 Paxson Communications Corp. $12.50 pfd. [2 DBL. DAGGERS] 275,000
1,620 SFX Broadcasting, Inc. Ser. E, $12.625 pfd. [2 DBL. DAGGERS] 180,630
105 Spanish Broadcasting Systems 144A $14.25
cum. pfd. [2 DBL. DAGGERS] 114,975
1,010 Von Hoffman Corp. 144A $13.50 pfd. 28,886
--------------
Total Preferred Stocks (cost $4,180,685) $ 4,487,125
CONVERTIBLE PREFERRED STOCKS (2.7%) *
NUMBER OF SHARES VALUE
- ------------------------------------------------------------------------------------------------------------
17,364 Atlantic Richfield Co. $2.23 cv. pfd. $ 412,395
44,500 Oasis Residential, Inc. Ser. A, $2.25 cv. pfd. (R) 1,140,313
50,000 Vanstar Financial Trust Corp. 144A $3.375 cv. cum. pfd. 2,150,000
--------------
Total Convertible Preferred Stocks (cost $3,384,866) $ 3,702,708
UNITS (1.8%) *
NUMBER OF UNITS VALUE
- ------------------------------------------------------------------------------------------------------------
250 Australis Media, Ltd. units stepped-coupon zero %
(15 3/4s, 5/15/00), 2003 (Australia) ++ [2 DBL. DAGGERS] $ 201,867
30 Celcaribe S.A. 144A units stepped-coupon zero %
(13 1/2s,3/15/98), 2004 ++ 570,000
100 Colt Telecommunications Group PLC units
stepped-coupon zero % (12s, 12/15/01), 2006
(United Kingdom) ++ 67,000
195 Diva Systems Corp. 144A units stepped-coupon
zero % (13s, 5/15/01), 2006 ++ 169,155
375 Fitzgerald Gaming Co. units 13s, 2002 345,000
130 Fresenius Medical Care AG units Ser. D, 9s, 2006,
(Germany) 134,875
20 Hedstrom Holdings, Inc. units stepped-coupon zero %
(12s, 6/01/02), 2009 ++ 12,600
175 Iridium LLC/Capital Corp. units 13s, 2005 195,563
55 Paging Network Do Brasil 144A units 13 1/2s,
2005 (Brazil) 53,694
90 Real Time Data 144A units stepped-coupon zero %
(13 1/2s, 8/15/01), 2006 ++ 52,425
350 Signature Brands USA Inc. units 13s, 2002 376,250
80 Stone Container Corp. units sr. sub. 12 1/4s, 2002 82,400
600 XCL Ltd. units cum. pfd. zero %, 2006 52,200
210 XCL Ltd . sr. sec. notes units 13 1/2s, 2004 214,200
--------------
Total Units (cost $2,032,334) $ 2,527,229
COMMON STOCKS (0.8%) *
NUMBER OF SHARES VALUE
- ------------------------------------------------------------------------------------------------------------
4,047 Advanced Radio Telecom Corp. + $ 30,858
50 AmeriKing, Inc. + 2,500
8,120 CellNet Data Systems Inc. + 97,440
1,885 IFINT Diversified Holdings 144A + 18,850
14,351 Lady Luck Gaming Corp. (acquired 11/4/93,
cost $11,820) + 21,078
197 PMI Holdings Corp. 144A + 63,040
144 Premium Holdings (L.P.) 144A + 575
33,430 PSF Holdings LLC Class A + 885,895
3,750 Specialty Foods Acquisition Corp. + 937
2,000 Terex Corp. Rights expiration date 5/15/02 + 40,000
--------------
Total Common Stocks (cost $1,188,663) $ 1,161,173
FOREIGN GOVERNMENT BONDS AND NOTES (0.2%) * (cost $249,263)
PRINCIPAL AMOUNT VALUE
- ------------------------------------------------------------------------------------------------------------
USD 460,000 Bank of Foreign Economic Affairs of Russia
(Vnesheconombank) principal loan FRN
Libor plus 13/16, 2020 +##+++ $ 328,325
WARRANTS EXPIRATION
NUMBER OF WARRANTS DATE VALUE
- ------------------------------------------------------------------------------------------------------------
15,000 Becker Gaming Corp. 144A 11/15/00 $ 150
500 Comunicacion Cellular 144A (Colombia) 11/15/03 27,750
500 County Seat Holdings, Inc. 10/15/98 10
95 Esat Holdings 144A 2/1/07 1,900
200 Fitzgerald Gaming Co. 144A (acquired 7/26/96,
cost $--) [DBL. DAGGER] 3/15/99 20
250 Hyperion Telecommunication 4/15/01 7,500
1,617 Intelcom Group 9/15/05 23,447
220 Interact Systems Inc. 144A 8/1/03 55
250 Intermedia Communications 144A 6/1/00 12,750
105 International Wireless Communications
Holdings 144A 8/15/01 1
135 Louisiana Casino Cruises, Inc. 144A 12/1/98 6,750
160 McCaw International Ltd. 4/15/07 40
250 NEXTEL Communications, Inc. 4/25/99 3
2,665 Nextlink Communications, Inc. 144A 2/1/09 27
255 RSL Communications Ltd. 144A 11/15/06 12,750
1,490 SDW Hldgs Corp. 144A 12/15/06 19,370
105 Spanish Broadcasting Systems 144A 6/30/99 15,225
75 Sterling Chemicals Holdings 144A 8/15/08 2,625
2,700 UCC Investor Holding, Inc. (acquired 3/16/94,
cost $35,100) [DBL. DAGGER] 10/30/99 33,750
250 Urohealth Systems Inc. 144A 4/10/04 1,250
21 Wright Medical Technology, Inc. 144A 6/30/03 2,053
--------------
Total Warrants (cost $222,763) $ 167,426
SHORT-TERM INVESTMENTS (3.4%) * (cost $4,760,209)
PRINCIPAL AMOUNT VALUE
- ------------------------------------------------------------------------------------------------------------
$4,758,000 Interest in $500,000,000 joint repurchase agreement
dated August 29, 1997 with Morgan Stanley & Co. Inc.
due September 2,1997 with respect to various
U.S. Treasury obligations -- maturity value of
$4,760,945 for an effective yield of 5.57% $ 4,760,209
- ------------------------------------------------------------------------------------------------------------
Total Investments (cost $127,992,137) *** $137,411,824
- ------------------------------------------------------------------------------------------------------------
* Percentages indicated are based on net assets of $138,399,934.
*** The aggregate identified cost on a tax basis is $127,992,998,
resulting in gross unrealized appreciation and depreciation of
$15,055,248 and $5,636,422, respectively, or net unrealized appreciation
of $9,418,826.
+ Non-income-producing security.
++ The interest or dividend rate and date shown parenthetically
represent the new interest or dividend rate to be paid and the date the
fund will begin receiving interest or dividend income at this rate.
+++ A portion of the income will be received in additional
securities.
[DBL. DAGGER] Restricted, excluding 144A securities to public resale. The
total market value of restricted securities by the fund by August 31,
1997 was $33,770 or less than 0.1% of net assets.
[2 DBL. DAGGERS] Income may be received in cash or additional securities at the
discretion of the issuer.
## When-issued securities (Note 1).
(R) Real Estate Investment Trust.
144A after the name of a security represents those exempt from
registration under Rule 144A of the Securities Act of 1933. These
securities may be resold in transactions exempt from registration,
normally to qualified institutional buyers.
The rate shown on (FRN) are the current interest rates at August 31,
1997 which are subject to change based on the terms of the security.
The accompanying notes are an integral part of these financial statements.
</TABLE>
<TABLE>
<CAPTION>
Statement of assets and liabilities
August 31, 1997
<S> <C>
Assets
- ---------------------------------------------------------------------------------------------------
Investments in securities, at value
(identified cost $127,992,137) (Note 1) $137,411,824
- ---------------------------------------------------------------------------------------------------
Cash 29,614
- ---------------------------------------------------------------------------------------------------
Dividends and interest receivable 2,161,022
- ---------------------------------------------------------------------------------------------------
Receivable for securities sold 581,691
- ---------------------------------------------------------------------------------------------------
Total assets $140,184,151
Liabilities
- ---------------------------------------------------------------------------------------------------
Distributions payable to shareholders 946,149
- ---------------------------------------------------------------------------------------------------
Payable for securities purchased 491,536
- ---------------------------------------------------------------------------------------------------
Payable for compensation of Manager (Note 2) 259,085
- ---------------------------------------------------------------------------------------------------
Payable for investor servicing and custodian fees (Note 2) 11,829
- ---------------------------------------------------------------------------------------------------
Payable for compensation of Trustees (Note 2) 8,242
- ---------------------------------------------------------------------------------------------------
Payable for administrative services (Note 2) 1,188
- ---------------------------------------------------------------------------------------------------
Other accrued expenses 66,188
- ---------------------------------------------------------------------------------------------------
Total liabilities 1,784,217
- ---------------------------------------------------------------------------------------------------
Net assets $138,399,934
Represented by
- ---------------------------------------------------------------------------------------------------
Paid-in capital (Note 1) $124,861,954
- ---------------------------------------------------------------------------------------------------
Undistributed net investment income (Note 1) 633,021
- ---------------------------------------------------------------------------------------------------
Accumulated net realized gain on investment (Note 1) 3,485,272
- ---------------------------------------------------------------------------------------------------
Net unrealized appreciation of investments 9,419,687
- ---------------------------------------------------------------------------------------------------
Total -- Representing net assets applicable to
capital shares outstanding $138,399,934
Computation of net asset value
- ---------------------------------------------------------------------------------------------------
Net asset value per share ($138,399,934 divided by
13,377,770 shares) $ 10.35
- ---------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
</TABLE>
<TABLE>
<CAPTION>
Statement of operations
Year ended August 31, 1997
<S> <C>
Investment income:
- --------------------------------------------------------------------------------------------------
Interest $12,159,694
- --------------------------------------------------------------------------------------------------
Dividends 676,998
- --------------------------------------------------------------------------------------------------
Total investment income 12,836,692
Expenses:
- --------------------------------------------------------------------------------------------------
Compensation of Manager (Note 2) 986,002
- --------------------------------------------------------------------------------------------------
Investor servicing and custodian fees (Note 2) 196,687
- --------------------------------------------------------------------------------------------------
Compensation of Trustees (Note 2) 19,428
- --------------------------------------------------------------------------------------------------
Administrative services (Note 2) 7,281
- --------------------------------------------------------------------------------------------------
Reports to shareholders 24,207
- --------------------------------------------------------------------------------------------------
Registration fees 75
- --------------------------------------------------------------------------------------------------
Auditing 39,473
- --------------------------------------------------------------------------------------------------
Legal 17,684
- --------------------------------------------------------------------------------------------------
Postage 29,014
- --------------------------------------------------------------------------------------------------
Exchange listing fees 24,650
- --------------------------------------------------------------------------------------------------
Other 15,032
- --------------------------------------------------------------------------------------------------
Total expenses 1,359,533
- --------------------------------------------------------------------------------------------------
Expense reduction (Note 2) (86,072)
- --------------------------------------------------------------------------------------------------
Net expenses 1,273,461
- --------------------------------------------------------------------------------------------------
Net investment income 11,563,231
- --------------------------------------------------------------------------------------------------
Net realized gain on investments (Notes 1 and 3) 4,981,660
- --------------------------------------------------------------------------------------------------
Net unrealized appreciation of investments during the year 7,108,660
- --------------------------------------------------------------------------------------------------
Net gain on investments 12,090,320
- --------------------------------------------------------------------------------------------------
Net increase in net assets resulting from operations $23,653,551
- --------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
</TABLE>
<TABLE>
<CAPTION>
Statement of changes in net assets
Year ended August 31
--------------------------------
1997 1996
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Increase in net assets
- ----------------------------------------------------------------------------------------------------------------------
Operations:
- ----------------------------------------------------------------------------------------------------------------------
Net investment income $ 11,563,231 $ 11,598,744
- ----------------------------------------------------------------------------------------------------------------------
Net realized gain on investments 4,981,660 1,260,469
- ----------------------------------------------------------------------------------------------------------------------
Net unrealized appreciation
(depreciation) of investments 7,108,660 (1,728,563)
- ----------------------------------------------------------------------------------------------------------------------
Net increase in net assets resulting from operations 23,653,551 11,130,650
- ----------------------------------------------------------------------------------------------------------------------
Distributions to shareholders:
- ----------------------------------------------------------------------------------------------------------------------
From net investment income (11,357,565) (11,263,468)
- ----------------------------------------------------------------------------------------------------------------------
From net realized gain on investments (798,322) --
- ----------------------------------------------------------------------------------------------------------------------
Increase from capital share transactions 1,038,642 1,085,846
- ----------------------------------------------------------------------------------------------------------------------
Total increase in net assets 12,536,306 953,028
Net assets
- ----------------------------------------------------------------------------------------------------------------------
Beginning of year 125,863,628 124,910,600
- ----------------------------------------------------------------------------------------------------------------------
End of year (including undistributed net
investment income of $633,021 and
$490,442, respectively) $138,399,934 $125,863,628
Number of fund shares
- ----------------------------------------------------------------------------------------------------------------------
Shares outstanding at beginning of year 13,272,242 13,158,906
- ----------------------------------------------------------------------------------------------------------------------
Shares issued in connection with
reinvestment of distributions 105,528 113,336
- ----------------------------------------------------------------------------------------------------------------------
Shares outstanding at end of year 13,377,770 13,272,242
- ----------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
</TABLE>
<TABLE>
<CAPTION>
Financial highlights
(For a share outstanding throughout the period)
- ------------------------------------------------------------------------------------------------------------------------------------
Per-share
operating performance Year ended August 31
- ------------------------------------------------------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net asset value,
beginning of period $9.48 $9.49 $9.13 $9.52 $8.49
- ------------------------------------------------------------------------------------------------------------------------------------
Investment operations
- ------------------------------------------------------------------------------------------------------------------------------------
Net investment income .86 .88 .79 .78 .84
- ------------------------------------------------------------------------------------------------------------------------------------
Net realized and unrealized
gain (loss) on investments .92 (.04) .42 (.30) 1.05
- ------------------------------------------------------------------------------------------------------------------------------------
Total from
investment operations 1.78 .84 1.21 .48 1.89
- ------------------------------------------------------------------------------------------------------------------------------------
Less distributions:
- ------------------------------------------------------------------------------------------------------------------------------------
From net
investment income (.85) (.85) (.85) (.87) (.84)
- ------------------------------------------------------------------------------------------------------------------------------------
From net realized
gains on investments (.06) -- -- -- --
- ------------------------------------------------------------------------------------------------------------------------------------
In excess of net
investment income -- -- -- -- (.02)
- ------------------------------------------------------------------------------------------------------------------------------------
Total distributions (.91) (.85) (.85) (.87) (.86)
- ------------------------------------------------------------------------------------------------------------------------------------
Net asset value,
end of period $10.35 $9.48 $9.49 $9.13 $9.52
- ------------------------------------------------------------------------------------------------------------------------------------
Market price,
end of period $10.562 $10.125 $10.000 $9.750 $10.000
- ------------------------------------------------------------------------------------------------------------------------------------
Ratios and supplemental data
- ------------------------------------------------------------------------------------------------------------------------------------
Total investment return
at market price (%)(a) 14.29 10.63 12.60 6.84 23.78
- ------------------------------------------------------------------------------------------------------------------------------------
Net assets, end of period
(in thousands) $138,400 $125,864 $124,911 $118,988 $123,285
- ------------------------------------------------------------------------------------------------------------------------------------
Ratio of expenses to
average net assets (%)(b) 1.03 1.06 1.00 1.04 1.03
- ------------------------------------------------------------------------------------------------------------------------------------
Ratio of net investment income
to average net assets (%) 8.80 9.19 8.73 8.23 9.39
- ------------------------------------------------------------------------------------------------------------------------------------
Portfolio turnover (%) 58.88 56.82 61.19 52.10 71.63
- ------------------------------------------------------------------------------------------------------------------------------------
(a) Total investment return assumes dividend reinvestment and does not reflect the effect of sales charges.
(b) The ratio of expenses to average net assets for the period ended August 31, 1996 and thereafter
includes amounts paid through expense offset arrangements. Prior period ratios exclude
these amounts. (See Note 2).
</TABLE>
Notes to financial statements
August 31, 1997
Note 1
Significant accounting policies
Putnam High Income Convertible and Bond Fund (the "fund") is registered under
the Investment Company Act of 1940, as amended, as a diversified, closed-end
management investment company. The fund's primary investment objective is high
current income; its secondary objective is capital appreciation. The fund
invests in high-yielding convertible securities. The fund seeks to augment
current income by investing in non-convertible securities, lower-rated, or
non-rated debt securities, which are believed not to involve undue risk to
income or principal.
The following is a summary of significant accounting policies consistently
followed by the fund in the preparation of its financial statements. The
preparation of financial statements is in conformity with generally accepted
accounting principles and requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities. Actual
results could differ from those estimates.
A) Security valuation Investments for which market quotations are readily
available are stated at market value, which is determined using the last
reported sale price, or, if no sales are reported -- as in the case of some
securities traded over-the-counter -- the last reported bid price. Market
quotations are not considered to be readily available for certain long-term
corporate bonds and notes; such investments are stated at fair value on the
basis of valuations furnished by brokers or by a pricing service, approved by
the Trustees, which determine valuations for normal, institutional-size
trading units of such securities using methods based on market transactions
for comparable securities and various relationships between securities that
are generally recognized by institutional traders. Short-term investments
having remaining maturities of 60 days or less are stated at amortized cost,
which approximates market value, and other investments, including restricted
securities, are stated at fair value following procedures approved by the
Trustees.
B) Joint trading account Pursuant to an exemptive order issued by the
Securities and Exchange Commission, the fund may transfer uninvested cash
balances into a joint trading account along with the cash of other registered
investment companies and certain other accounts managed by Putnam Investment
Management, Inc. ("Putnam Management"), the fund's Manager, a wholly-owned
subsidiary of Putnam Investments, Inc.. These balances may be invested in one
or more repurchase agreements and/or short-term money market instruments.
C) Repurchase agreements The fund, or any joint trading account, through its
custodian, receives delivery of the underlying securities, the market value of
which at the time of purchase is required to be in an amount at least equal to
the resale price, including accrued interest. Putnam Management is responsible
for determining that the value of these underlying securities is at all times
at least equal to the resale price, including accrued interest.
D) Security transactions and related investment income Security transactions
are accounted for on the trade date (date the order to buy or sell is
executed). Interest income is recorded on the accrual basis. Dividend income
is recorded on the ex-dividend date. Discounts on zero coupon bonds, market
discount, original issue discounted bonds, stepped-coupon bonds and payment in
kind bonds are accreted according to the effective yield method.
Any premium resulting from the purchase of stepped-coupon securities in excess
of maturity value is amortized on a yield-to-maturity basis.
E) Federal taxes It is the policy of the fund to distribute all of its taxable
income within the prescribed time and otherwise comply with the provisions of
the Internal Revenue Code applicable to regulated investment companies. It is
also the intention of the fund to distribute an amount sufficient to avoid
imposition of any excise tax under Section 4982 of the Internal Revenue Code
of 1986, as amended. Therefore, no provision has been made for federal taxes
on income, capital gains or unrealized appreciation on securities held nor for
excise tax on income and capital gains.
F) Distributions to shareholders Distributions to shareholders are recorded by
the fund on the ex-dividend date. At certain times, the fund may pay
distributions at a level rate even though, as a result of market conditions or
investment decisions, the fund may not achieve projected investment results
for a given period. Capital gain distributions if any are recorded on the
ex-dividend date and paid at least annually. The amount and character of
income and gains to be distributed annually are determined in accordance with
income tax regulations which may differ from generally accepted accounting
principles. These differences include treatment of losses on wash sales
transactions, market discount and interest on payment-in-kind securities.
Reclassifications are made to the fund's capital accounts to reflect income
and gains available for distribution (or available capital loss carryovers)
under income tax regulations. For the year ended August 31, 1997, the fund
reclassified $63,087 to decrease undistributed net investment income and
$103,747 to increase paid-in-capital, with a decrease to accumulated net
realized gains and losses of $40,660. The calculation of net investment income
per share in the financial highlights table excludes these adjustments.
Note 2
Management fee, administrative services and other transactions
Compensation of Putnam Management, for management and investment advisory
services is paid quarterly based on the average net assets of the fund. Such
fee is based on the following annual rates: 0.75% of the first $500 million of
average weekly net assets, 0.65% of the next $500 million, 0.60% of the next
$500 million, and 0.55% of any amount over $1.5 billion.
The fund reimburses Putnam Management for the compensation and related
expenses of certain officers of the fund and their staff who provide
administrative services to the fund. The aggregate amount of all such
reimbursements is determined annually by the Trustees.
Custodial functions for the fund's assets are provided by Putnam Fiduciary
Trust Company (PFTC), a wholly-owned subsidiary of Putnam Investments, Inc.
Investor servicing agent functions are provided by Putnam Investor Services, a
division of PFTC.
For the year ended August 31, 1997, fund expenses were reduced by $86,072
under expense offset arrangements with PFTC. Investor servicing and custodian
fees reported in the Statement of operations exclude these credits. The fund
could have invested a portion of the assets utilized in connection with the
expense offset arrangements in an income producing asset if it had not entered
into such arrangements.
Trustees of the fund receive an annual Trustees fee of $650 and an additional
fee for each Trustee's meeting attended. Trustees who are not interested
persons of Putnam Management and who serve on committees of the Trustees
receive additional fees for attendance at certain committee meetings.
The fund has adopted a Trustee Fee Deferral Plan (the "Deferral Plan") which
allows the Trustees to defer the receipt of all or a portion of Trustees Fees
payable on or after July 1, 1995. The deferred fees remain in the fund and are
invested in certain Putnam funds until distribution in accordance with the
Deferral Plan.
The fund has adopted an unfunded noncontributory defined benefit pension plan
(the "Pension Plan") covering all Trustees of the fund who have served as
Trustee for at least five years. Benefits under the Pension Plan are equal to
50% of the Trustee's average total retainer and meeting fees for the three
years preceding retirement. Pension expense for the fund is included in
Compensation of trustees in the Statement of operations. Accrued pension
liability is included in Payable for compensation of Trustees in the Statement
of assets and liabilities.
Note 3
Purchase and sales of securities
During the year ended August 31, 1997, purchases and sales of investment
securities other than short-term investments aggregated $74,087,344 and
$76,028,552, respectively. There were no purchases and sales of U.S.
government obligations. In determining the net gain or loss on securities
sold, the cost of securities has been determined on the identified cost basis.
Federal tax information
(Unaudited)
The fund has designated 5.18% of the destributions from net investment income
as qualifying for the dividends received deduction for corporations.
The form 1099 you receive in January 1998 will show the tax status of all
distrbutions paid to your account in calendar 1997.
Pursuant to section 852 of the Internal Revenue Code, the fund hereby
designates $2,755,730, or if different, the amount necessary to offset net
capital gain earned by the fund as capital gain dividends for its taxable
year ended August 31,1997
Results of July 10, 1997 shareholder meeting
(Unaudited)
An annual meeting of shareholders of the fund was held on July 10, 1997. At
the meeting, each of the nominees for Trustees was elected, as follows:
Votes
Votes for withheld
Jameson Adkins Baxter 10,537,490 117,156
Hans H. Estin 10,533,538 121,108
John A. Hill 10,545,161 109,485
Ronald J. Jackson 10,543,761 110,885
Elizabeth T. Kennan 10,528,947 125,699
Lawrence J. Lasser 10,539,638 115,008
Robert E. Patterson 10,541,961 112,685
Donald S. Perkins 10,520,730 133,916
William F. Pounds 10,533,884 120,762
George Putnam 10,536,411 118,235
George Putnam, III 10,534,743 119,903
A.J.C. Smith 10,535,938 118,708
W. Nicholas Thorndike 10,540,334 114,312
A proposal to ratify the selection of Price Waterhouse LLP as auditors for the
fund was approved as follows: 10,503,810 votes for, and 58,078 votes against,
with 92,758 abstentions and broker non-votes.
Fund information
INVESTMENT MANAGER
Putnam Investment
Management, Inc.
One Post Office Square
Boston, MA 02109
MARKETING SERVICES
Putnam Mutual Funds Corp.
One Post Office Square
Boston, MA 02109
CUSTODIAN
Putnam Fiduciary Trust Company
LEGAL COUNSEL
Ropes & Gray
INDEPENDENT ACCOUNTANTS
Price Waterhouse LLP
TRUSTEES
George Putnam, Chairman
William F. Pounds, Vice Chairman
Jameson Adkins Baxter
Hans H. Estin
John A. Hill
Ronald J. Jackson
Elizabeth T. Kennan
Lawrence J. Lasser
Robert E. Patterson
Donald S. Perkins
George Putnam, III
A.J.C. Smith
W. Nicholas Thorndike
OFFICERS
George Putnam
President
Charles E. Porter
Executive Vice President
Patricia C. Flaherty
Senior Vice President
John D. Hughes
Senior Vice President and Treasurer
Lawrence J. Lasser
Vice President
Gordon H. Silver
Vice President
Gary N. Coburn
Vice President
William J. Curtin
Vice President
Jerome J. Jacobs
Vice President
Charles G. Pohl
Vice President and Fund Manager
Jennifer Leichter
Vice President and Fund Manager
William N. Shiebler
Vice President
John R. Verani
Vice President
Paul M. O'Neil
Vice President
Beverly Marcus
Clerk and Assistant Treasurer
Call 1-800-225-1581 weekdays from 9 a.m. to 5 p.m. Eastern Time for up-to-date
information about the fund's NAV.
[LOGO OMITTED]
PUTNAM INVESTMENTS
The Putnam Funds
One Post Office Square
Boston, Massachusetts 02109
- --------------------
Bulk Rate
U.S. Postage
PAID
Putnam
Investments
- --------------------
36572-061 10/97
