ISI
Total Return
U.S. Treasury Fund Shares
- -----------------------------------------------------------------
Directors and Officers
Edward S. Hyman R. Alan Medaugh
Chairman President
Richard T. Hale Nancy Lazar
Vice Chairman Vice President
James J. Cunnane Carrie L. Butler
Director Vice President
John F. Kroeger Margaret M. Beeler
Director Assistant Vice President
Louis E. Levy Keith C. Reilly
Director Assistant Vice President
Eugene J. McDonald Amy M. Olmert
Director Secretary
Rebecca W. Rimel Joseph A. Finelli
Director Treasurer
Truman T. Semans Laurie D. Collidge
Director Assistant Secretary
Carl W. Vogt, Esq.
Director
Investment Objective
A mutual fund designed to provide a high level of total return with relative
stability of principal as well as the secondary objective of high current income
consistent with an investment in securities issued by the United States
Treasury.
Investment Advisor
ISI Inc.
717 Fifth Avenue
New York, NY 10022
(800) 955-7175
Shareholder Servicing Agent
Investment Company Capital Corp.
P.O. Box 419426
Kansas City, MO 64141-6426
(800) 882-8585
Distributor
ISI Group Inc.
717 Fifth Avenue
New York, NY10022
(800) 955-7175
ISI
INTERNATIONAL STRATEGY & INVESTMENT
ISI
TOTAL RETURN
U.S. TREASURY
FUND SHARES
(A Class of Total Return
U.S. Treasury Fund, Inc.)
[TREASURIES LOGO]
ANNUAL REPORT
October 31, 1997
<PAGE>
Investment Advisor's Report
We are pleased to report on the progress of your Fund for the fiscal year
ended October 31, 1997. In this year of volatile interest rates, the Fund
recorded a total return of 9.0%. From its inception on August 10, 1988 through
October 31, 1997, the Fund has posted a cumulative total return of 116.5%, which
translates into an average annual total return of 8.7%. These figures assume the
reinvestment of dividends and capital gains distributions and exclude the impact
of any sales charge.
Review of Bond Market During
Fiscal Year 1997
On balance, long-term Treasury rates fell during the fiscal year. The 12
months, however, were divided into two phases (please see chart, top right).
From October 1996 to mid-April 1997, rates generally rose because the economy
was experiencing surprisingly strong growth. This phase culminated when the
Federal Reserve raised the Federal Funds Rate from 5.25% to 5.50%. The economy
slowed after April and rates declined through early August. A burst of economic
growth caused rates to rise, but to levels well below their April peak. At that
point, the unfolding Pacific Rim financial crises pushed rates even lower,
closing the fiscal year at the lowest level of the year. For additional
information, please see our detailed Economic Outlook for 1998, which follows
this letter.
30-Year Treasury Yields
<Graph appears here--Need Plot Points>
Source: Bloomberg Inc.
Portfolio Management
The structure of the Fund remained generally long term throughout the
fiscal year. The Fund had a 10- to 14-year maturity range during the year. Our
active management moved within this maturity range as we anticipated changes in
the economy. For example, the portfolio's maturity was reduced early in the
fiscal year and was extended as the economy picked up again in the spring when
the Federal Reserve rate increase caused a slowdown. At fiscal year-end, the
portfolio's average maturity was the midpoint of the year range at 11.6 years.
1
<PAGE>
Performance Review
Treasury interest rates generally fell during the fiscal year, causing
longer maturity issues to outperform shorter-term issues (please see table
below).
Treasury Securities Performance Analysis
(October 31, 1996-October 31, 1997)
Maturity Capital Change Income Total Return
- -------------------------------------------------------
1-year 0.0% 5.4% +5.4%
- -------------------------------------------------------
3-year +0.4% 6.0% +6.4%
- -------------------------------------------------------
5-year 0.0% 6.1% +6.1%
- -------------------------------------------------------
10-year +2.5% 6.4% +8.9%
- -------------------------------------------------------
30-year +5.9% 6.7% +12.6%
- -------------------------------------------------------
The Fund's performance was helped by its relatively long 10- to 14-year
average maturity policy range. The Fund's annual total return was slightly
greater than that of a 10-year U.S. Treasury held for the period.
We would like to welcome our new investors to the Fund and thank those who
have been with us for some time. We appreciate your confidence.
Sincerely,
/s/ R. Alan Medaugh
- -------------------
R. Alan Medaugh
President
November 21, 1997
Economic Outlook for 1998
Overview
The Pacific Rim economies seem likely to be weaker in two months than they
are now. Japan's economy, which has slipped into recession in our view, is
likely to be no better by early 1998. Because U.S. retail sales are clearly
sensitive to stock market swings, we are likely to see "moderate" retail sales
at best over the next few months. We are forecasting just 2.5% real growth with
only 1.5% inflation, producing just 4% nominal (Gross Domestic Product) growth.
Stock market corrections around the world reflect a package of tightening
moves that started nine months ago with Japan's Value Added Tax hike and the
U.S. Federal Reserve tightening to 5.5% on its Federal Funds Rate. The Pacific
Rim countries lifted interest rates to defend their currencies and cut
government spending to get International Monetary Fund assistance. The
Bundesbank and the Bank of England both tightened recently. Germany announced a
government spending freeze. Brazil announced a fiscal package that is the
equivalent of a $180 billion tightening in the U.S. economy. Russia raised rates
from 21% to 28%. The Asian crises are clearly impacting the region's banking
system and are therefore likely to have a greater influence on world economic
activity than expected. Federal Reserve Board Chairman Greenspan ended his
testimony before Congress in mid-November by saying "and where required, provide
temporary financial assistance." Since this is the exact same phrase he ended
his testimony with before our $3 billion Indonesian assistance package, another
Pacific Rim bailout is probably in the works.
Based on early estimates, it is possible that on a seasonally adjusted
annual rate basis, the U.S. ran a budget surplus in October. At the same time,
odds are that our trade deficit will widen as exports slow and we see a flood of
Asian imports. To the extent foreign demand for Treasuries is related to our
trade deficit, a
2
<PAGE>
Economic Outlook for 1998 (continued)
demand/supply imbalance for Treasuries could develop, which could push up prices
on Treasury investments. Because of their importance, we have highlighted these
topics for greater analysis: the Pacific Rim Crises, Inflation and the U.S.
Budget Deficit. Please see ISI's Economic Forecast below.
ISI ECONOMIC FORECAST
97:1Q 97:2Q 97:3Q 97:4Q* 98:1Q* 98:2Q*
- -------------------------------------------------------------------------
Real GDP 4.9% 3.3% 3.5% 2.5% 2.5% 2.5%
- -------------------------------------------------------------------------
GDP Deflator** 2.4% 1.8% 1.4% 1.5% 1.5% 1.5%
- -------------------------------------------------------------------------
30-Year Bond Yields*** 7.1% 6.8% 6.4% 6.2% 6.0% 5.7%
- -------------------------------------------------------------------------
Fed Funds Rate*** 5.5% 5.5% 5.5% 5.5% 5.5% 5.5%
- -------------------------------------------------------------------------
*Estimated.
**A more accurate cost of living barometer than the CPI.
***End of quarter.
The Pacific Rim Crises
Thailand and Hong Kong have been at the center of the most recent series of
financial crises. The history of these events indicates that they often lower
Treasury bond yields (please see chart below). The positive influence on
financial assets comes about from this normal event cycle. The crisis surfaces
when the building pressure on the economic system causes a weak link to break.
At that point the problem is exposed and efforts are made to fix it.
<Graph appears here--Need Plot Points>
30-YEAR TREASURY YIELD
NOV. 10 6.14%
Source: ISI Inc.
After two rounds of the Pacific Rim crises, the U.S. economy is likely to
slow in the near term, cutting growth the next two quarters by roughly 0.5% from
our earlier forecast. The currency value of the U.S. dollar should be bolstered
by its status as a safe haven. Typically as events unfold, the Federal Reserve
lowers its Federal Funds Rate. This event sequence normally results in higher
prices for top quality assets such as U.S. Treasuries.
Inflation
Inflation has subsided around the industrial world. In the U.S., the recent
declines in "nominal" interest rates have been accompanied by a sizable fall in
inflation. The result is that despite falling interest rates, the "real" rates
have moved modestly higher (please see chart below).
REAL U.S. LONG BOND YIELD
SEP. 4.67%
<Graph appears here--Need Plot Points>
Source: ISI Inc.
The major forces behind the decline of inflation are:
o Global Competition
o Demographics
o Technology
o Reduced Government Spending
3
<PAGE>
Economic Outlook for 1998 (concluded)
The opening up of world trade has meant new plants can be built in low wage
areas and the products can be exported to high wage home markets. As a result,
pressure on U.S. real wages and a drive for corporate efficiency have marked the
last 10 years. The declining cost of technology has also been a major factor in
boosting capital spending and lowering the world inflation rate. Technology
represents a growing section of the overall economy, so the percentage of the
U.S. economy experiencing deflation has grown over the last 10 years. Baby
boomers have reached the age when people are seen beginning to save for
retirement. This change from consumption to savings is an important shift in the
economy. Finally, governments from the U.S. and Germany to Brazil and Thailand
have been cutting their spending. This has often been magnified by tax
increases. The result is less fiscal stimulus and lower inflation.
The U.S. Budget Deficit
A remarkable feature of the U.S. government's policy has been the virtual
elimination of the deficit. The swing since 1992 has been a very large $300
billion a year (please see chart, top right).
FEDERAL DEFICIT
12-Mo. Sum Sep.-$41.3
<Graph appears here--Need Plot Points>
Source: ISI Inc.
Despite tax cuts and a bit more spending next year, we think the budget
will register a surplus. This is a significant shift for the capital markets
freeing up massive amounts to finance the private economy. The results of
reduced Treasury borrowings should directly influence the level of rates, and
the freeing up of investment capital allows for greater productivity in the
private sector.
Tax Information for the Shareholder
None of the ordinary income distributions paid monthly by the Fund during
the year ended October 31, 1997, qualify for the dividends received deduction
for corporations.
4
<PAGE>
Additional Performance Information
The shareholder letter included in this report contains statistics designed
to help you evaluate the performance of your Fund's management. To further
assist in this evaluation, the Securities and Exchange Commission (SEC) requires
that we include, on an annual basis, a line graph comparing the Fund's
performance to that of an appropriate market index. This graph must measure the
growth of a $10,000 hypothetical investment from the Fund's inception on August
10, 1988 through the most recent fiscal year-end and must reflect the impact of
the Fund's total expenses and its currently effective 4.45% maximum sales
charge.
While the following chart is required by SEC rules, such comparisons are of
limited utility since the indices shown are not adjusted for sales charges and
ongoing management, distribution and operating expenses applicable to the Fund.
An investor who wished to replicate the total return of these indices would have
had to own the securities that they represent. Acquiring these securities would
require a considerable amount of money and would incur expenses that are not
reflected in the index results.
The SEC also requires that we report the Fund's total return, according to
a standardized formula, for various time periods through the end of the most
recent calendar quarter. The SECtotal return figures differ from those we
reported because the time periods may be different and because the
SECcalculation includes the impact of the currently effective 4.45% maximum
sales charge. These total returns correspond to those experienced by individual
shareholders only if their shares were purchased on the first day of each time
period and the maximum sales charge was paid. Any performance figures shown
are for the full period indicated. Since investment return and principal value
will fluctuate, an investor's shares may be worth more or less than their
original cost when redeemed.
- ---------------------------------------------------
AVERAGE ANNUAL TOTAL RETURN*
% Return with
Periods ended 9/30/97: Sales Charge
- ---------------------------------------------------
One Year 5.17%
- ---------------------------------------------------
Five Years 6.25%
- ---------------------------------------------------
Since Inception (8/10/88) 8.03%
- ---------------------------------------------------
CHANGE IN VALUE OF A $10,000 INVESTMENT*
August 10, 1988-October 31, 1997
[Graph appears here--see plot points below]
ISI Lehman Brothers Lehman Brothers
Total Return Intermediate Lehman Brothers Long-Term
U.S. Treasury Fund Treasury Index Treasury Index Treasury Index
8/88 $ 9,555 $10,000 $10,000 $10,000
10/88 9,852 10,313 10,407 10,685
10/89 11,021 11,388 11,676 12,493
10/90 11,178 12,266 12,345 12,592
10/91 12,954 13,889 14,140 14,876
10/92 14,116 15,268 15,608 16,593
10/93 16,564 16,685 17,659 20,526
10/94 15,534 16,400 16,871 18,143
10/95 18,344 18,329 19,464 23,016
10/96 18,975 19,359 20,449 23,810
10/97 20,682 20,766 22,210 26,815
*These figures assume the reinvestment of dividends and capital gains
distributions and include the Fund's 4.45% maximum sales charge. The Lehman
Brothers indices listed above are unmanaged. The Intermediate Index and the
Long-Term Index reflect the performance of U.S. Treasury securities in their
respective sectors. The Treasury Index is more of a general index in that it
reflects the performance of all public obligations and does not focus on any
one particular segment. Management is not aware of any single index that is
truly representative of the Fund since its active maturity management policy
allows the manager to adjust the weighted average maturity throughout each U.S.
Treasury sector. Currently, the Fund's weighted average maturity is
approximately 11.6 years. Past performance is not an indicator of future
results.
5
<PAGE>
Total Return U.S. Treasury Fund, Inc.
Statement of Net Assets October 31, 1997
<TABLE>
<CAPTION>
Maturity Par Value
Interest Rate Date (000) (Note A)
- ---------------------------------------------------------------------------------------------------
<S><C>
U.S. TREASURY BONDS - 71.7%
12.000% 8/15/13 $35,900 $ 52,537,424
11.750 11/15/14 36,000 53,184,384
7.500 11/15/16 37,000 42,255,147
8.875 8/15/17 1,000 1,300,000
9.000 11/15/18 14,750 19,513,793
8.875 2/15/19 10,000 13,085,940
8.750 8/15/20 22,250 29,025,815
------------
Total U.S. Treasury Bonds
(Cost $210,613,472) 210,902,503
------------
U.S. TREASURY NOTES - 5.2%
6.375 9/30/01 15,000 15,314,070
------------
Total U.S. Treasury Notes
(Cost $15,119,028) 15,314,070
------------
ZERO COUPON U.S. TREASURY BONDS (S.T.R.I.P.S.) - 9.8%
5.520* 8/15/98 30,000 28,735,290
------------
Total U.S. Treasury S.T.R.I.P.S.
(Cost $28,701,146) 28,735,290
------------
REPURCHASE AGREEMENTS - 12.6%
Goldman Sachs & Co., 5.60%
Dated 10/31/97, to be repurchased on 11/3/97,
collateralized by U.S. Treasury Bonds with a
market value of $37,782,559.
(Cost $37,041,000) 37,041 37,041,000
------------
Total Investments in Securities - 99.3%
(Cost $291,474,646)** 291,992,863
Other Assets in Excess of Liabilities, Net - 0.7% 2,148,610
------------
Net Assets - 100.0% $294,141,473
============
</TABLE>
6
<PAGE>
Total Return U.S. Treasury Fund, Inc.
Statement of Net Assets (concluded) October 31, 1997
<TABLE>
- ---------------------------------------------------------------------------------------------------
<S><C>
Net Asset Value and Redemption Price Per:
ISI Class Share
($171,074,149 / 17,036,448 shares outstanding) $10.04
======
Flag Investors Class A Share
($122,228,931 / 12,179,428 shares outstanding) $10.04
======
Flag Investors Class B Share
($838,393 / 83,601 shares outstanding) $10.03
======
Maximum Offering Price Per:
ISI Class Share
($10.04 / 0.9555) $10.51
======
Flag Investors Class A Share
($10.04 / 0.955) $10.51
======
Flag Investors Class B Share $10.03
======
- ---------------------------------------------------------------------------------------------------
</TABLE>
*Yield as of October 31, 1997.
**Also aggregate cost for federal tax purposes.
See Notes to Financial Statements.
7
<PAGE>
Total Return U.S. Treasury Fund, Inc.
Statement of Operations For the Year Ended October 31, 1997
<TABLE>
- ---------------------------------------------------------------------------------------------------
<S><C>
INVESTMENT INCOME (NOTE A):
Interest $19,868,979
-----------
EXPENSES:
Investment advisory fee (Note B) 848,963
Distribution fee (Note B) 769,292
Administration fee (Note B) 374,611
Transfer agent fee (Note B) 208,105
Accounting fee (Note B) 86,088
Printing and postage 63,992
Legal 44,942
Custodian fee (Note B) 41,752
Miscellaneous 29,139
Audit 23,999
Directors' fees 22,602
Registration fees 20,765
Insurance 11,731
-----------
Total expenses 2,545,981
-----------
Net investment income 17,322,998
-----------
REALIZED AND UNREALIZED GAIN/(LOSS) ON INVESTMENTS:
Net realized loss from security transactions (2,143,673)
Change in unrealized appreciation or depreciation of investments 10,567,788
-----------
Net gain on investments 8,424,115
-----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $25,747,113
===========
- ---------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
8
<PAGE>
Total Return U.S. Treasury Fund, Inc.
Statement of Changes in Net Assets
<TABLE>
<CAPTION>
For the Year Ended October 31,
-----------------------------------
1997 1996
- --------------------------------------------------------------------------------------------------
<S><C>
INCREASE/(DECREASE) IN NET ASSETS:
Operations:
Net investment income $ 17,322,998 $ 19,964,042
Net gain/(loss) from security transactions (2,143,673) 3,072,425
Change in unrealized appreciation
or depreciation on investments 10,567,788 (11,517,095)
------------ ------------
Net increase in net assets
resulting from operations 25,747,113 11,519,372
------------ ------------
DIVIDENDS TO SHAREHOLDERS FROM (NOTE A):
Net investment income and short-term gains:
ISI Class Shares (10,059,052) (13,146,313)
Flag Investors Class A Shares (7,246,184) (10,138,099)
Flag Investors Class B Shares (17,762) (685)
Tax return of capital distribution:
ISI Class Shares (1,433,152) --
Flag Investors Class A Shares (1,040,753) --
Flag Investors Class B Shares (2,606) --
Distributions in excess of net investment income:
ISI Class Shares (160,000) (723,712)
Flag Investors Class A Shares (116,192) (561,610)
Flag Investors Class B Shares (291) (8)
------------ ------------
Total distributions (20,075,992) (24,570,427)
------------ ------------
CAPITAL SHARE TRANSACTIONS (NOTE C):
Proceeds from sale of shares 15,601,057 29,511,549
Value of shares issued in reinvestment of dividends 12,541,599 14,241,221
Cost of shares repurchased (77,072,611) (64,122,099)
------------ ------------
Decrease in net assets derived
from capital share transactions (48,929,955) (20,369,329)
------------ ------------
Total decrease in net assets (43,258,834) (33,420,384)
NET ASSETS:
Beginning of year 337,400,307 370,820,691
------------ ------------
End of year $294,141,473 $337,400,307
============ ============
- --------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
9
<PAGE>
Total Return U.S. Treasury Fund, Inc.
Financial Highlights--ISI Class and Flag Investors Class A Shares
(For a share outstanding throughout each year)
<TABLE>
<CAPTION>
For the Year Ended October 31,
--------------------------------------------------
1997 1996 1995 1994 1993
- -----------------------------------------------------------------------------------------------------
<S><C>
Per Share Operating Performance:
Net asset value at beginning of year $ 9.83 $ 10.19 $ 9.22 $ 11.35 $ 10.47
-------- -------- -------- -------- --------
Income from Investment Operations:
Net investment income 0.55 0.56 0.57 0.51 0.62
Net realized and unrealized gain/(loss)
on investments 0.30 (0.23) 1.04 (1.16) 1.12
-------- -------- -------- -------- --------
Total from Investment Operations 0.85 0.33 1.61 (0.65) 1.74
Less Distributions (Note A):
Distributions from net investment income
and short-term gains (0.55) (0.65) (0.64) (1.15) (0.79)
Tax return of capital distribution (0.08) -- -- (0.05) --
Distributions in excess of net
investment income (0.01) (0.04) -- -- --
Distributions from net realized
long-term gains -- -- -- (0.28) (0.07)
-------- -------- -------- -------- --------
Total distributions (0.64) (0.69) (0.64) (1.48) (0.86)
-------- -------- -------- -------- --------
Net asset value at end of year $ 10.04 $ 9.83 $ 10.19 $ 9.22 $ 11.35
======== ======== ======== ======== ========
Total Return(1) 9.00% 3.44% 18.09% (6.22)% 17.33%
Ratios to Average Daily Net Assets:
Expenses 0.83% 0.81% 0.80% 0.77% 0.77%
Net investment income 5.62% 5.69% 5.94% 4.98% 5.21%
Supplemental Data:
Net assets at end of year (000):
ISI Class Shares $171,074 $193,486 $206,615 $200,309 $232,103
Flag Investors Class A Shares $122,229 $143,791 $164,206 $175,149 $224,790
Portfolio turnover rate 92% 199% 194% 68% 249%
- -----------------------------------------------------------------------------------------------------
</TABLE>
(1) Total return excludes the effect of sales charge.
See Notes to Financial Statements.
10
<PAGE>
Total Return U.S. Treasury Fund, Inc.
Financial Highlights--Flag Investors Class B Shares
(For a share outstanding throughout each period)
<TABLE>
<CAPTION>
For the For the Period
Year Ended June 20, 1996(1) through
October 31, 1997 October 31, 1996
- ------------------------------------------------------------------------------------------------------
<S><C>
Per Share Operating Performance:
Net asset value at beginning of period $ 9.85 $10.00
------ ------
Income from Investment Operations:
Net investment income 0.56 0.22
Net realized and unrealized gain/(loss) on investments 0.23 (0.15)
------ ------
Total from Investment Operations 0.79 0.07
Less Distributions (Note A):
Distributions from net investment income and
short-term gains (0.56) (0.22)
Tax return of capital distribution (0.04) --
Distributions in excess of net investment income (0.01) --
------ ------
Total distributions (0.61) (0.22)
------ ------
Net asset value at end of period $10.03 $ 9.85
====== ======
Total Return(2) 8.49% 6.37%
Ratios to Average Daily Net Assets:
Expenses 1.18% 1.40%(3)
Net investment income 5.24% 5.45%(3)
Supplemental Data:
Net assets at end of period (000) $ 838 $ 123
Portfolio turnover rate 92% 199%(3)
- ------------------------------------------------------------------------------------------------------
</TABLE>
(1) Commencement of operations.
(2) Total return excludes the effect of sales charge.
(3) Annualized.
See Notes to Financial Statements.
11
<PAGE>
Notes to Financial Statements
A. Significant Accounting Policies -- Total Return U.S. Treasury Fund, Inc.
(the "Fund"), which was organized as a Maryland Corporation on June 3, 1988
and commenced operations August 10, 1988, is registered under the
Investment Company Act of 1940 as a diversified, open-end investment
management company. It is designed to provide a high level of total return
with relative stability of principal as well as the secondary objective of
high current income consistent with an investment in securities issued by
the United States Treasury.
The Fund consists of three share classes: ISI Total Return U.S. Treasury
Fund Shares ("ISI Class") and Flag Investors Total Return U.S. Treasury
Fund Class A Shares ("Flag Investors Class A"), which both commenced August
10, 1988, and Flag Investors Total Return U.S. Treasury Fund Class B Shares
("Flag Investors Class B"), which commenced June 20, 1996.
The ISI Class Shares have a 4.45% maximum front-end sales charge, the Flag
Investors Class A Shares have a 4.50% maximum front-end sales charge and
the Flag Investors Class B Shares have a 2.00% maximum contingent deferred
sales charge. The classes each have different distribution fees.
When preparing the Fund's financial statements, management makes estimates
and assumptions to comply with generally accepted accounting principles.
These estimates affect 1) the assets and liabilities that we report at the
date of the financial statements; 2) the contingent assets and liabilities
that we disclose at the date of the financial statements; and 3) the
revenues and expenses that we report for the period. Our estimates could be
different from the actual results. Under certain circumstances, it is
necessary to reclassify prior year information in order to conform to the
current year's pre- sentation. The Fund's significant accounting policies
are:
Security Valuation -- The Fund values a portfolio security that is
primarily traded on a national exchange by using the last price reported
for the day by an independent pricing source. If there are no sales or the
security is not traded on a listed exchange, the Fund values the security
at the average of the last bid and asked prices in the over-the-counter
market. When a market quotation is unavailable, the Investment Advisor
determines a fair value using procedures that the Board of Directors
establishes and monitors. The Fund values short-term obligations with
maturities of 60 days or less at amortized cost.
Repurchase Agreements -- The Fund may enter into tri-party repurchase
agreements with broker-dealers and domestic banks. A repurchase agreement
is a short-term investment in which the Fund buys a debt security that the
broker agrees to repurchase at a set time and price. The third party, which
is the broker's custodial bank, holds the collateral in a separate account
until the repurchase agreement matures. The agreement ensures that the
collateral's market value, including any accrued interest, is sufficient if
the broker defaults. The Fund's access to the collateral may be delayed or
limited if the broker defaults and the value of the collateral declines or
if the broker enters into an insolvency proceeding.
Federal Income Taxes -- The Fund determines its distributions according to
income tax regulations, which may be different from generally accepted
accounting principles. As a result, the Fund occasionally makes
reclassifications within its capital accounts to reflect income and gains
that are available for distribution under income tax regulations.
The Fund is organized as a regulated investment company. As long as it
maintains this status and distributes to its shareholders substantially all
of its taxable net investment income and net realized capital gains, it
will be exempt
12
<PAGE>
Notes to Financial Statements (continued)
from most, if not all, federal income and excise taxes. As a result, the
Fund has made no provisions for federal income taxes.
Security Transactions, Investment Income, Distributions and Other -- The
Fund uses the trade date to account for security transactions and the
specific identification method for financial reporting and income tax
purposes to determine the cost of investments sold or redeemed. Interest
income is recorded on an accrual basis and includes the pro rata scientific
method for amortization of premiums and accretion of discounts when
appropriate. Income and common expenses are allocated to each class based
on its respective average net assets. Class specific expenses are charged
directly to each class. Dividends from net investment income are declared
daily and paid monthly. Distributions of capital gains are recorded on the
ex-dividend dates. Distributions in excess of net investment income are due
to differing tax treatments of dividends declared.
B. Investment Advisory Fees, Transactions with Affiliates and Other Fees --
International Strategy & Investment Inc. ("ISI") is the Fund's investment
advisor and Investment Company Capital Corp. ("ICC"), an indirect
subsidiary of Bankers Trust New York Corporation, is the Fund's
administrator. As compensation for its advisory services, the Fund pays ISI
an annual fee based on the Fund's average daily net assets. This fee is
calculated daily and paid monthly at the following annual rates: 0.20% of
the first $100 million, 0.18% of the next $100 million, 0.16% of the next
$100 million, 0.14% of the next $200 million and 0.12% of the amount over
$500 million. In addition, the Fund pays ISI 1.5% of the Fund's gross
income.
As compensation for its administrative services, the Fund pays ICC an
annual fee based on the Fund's average daily net assets. This fee is
calculated daily and paid monthly at the following annual rates: 0.10% of
the first $100 million, 0.09% of the next $100 million, 0.08% of the next
$100 million, 0.07% of the next $200 million and 0.06% of the amount over
$500 million. In addition, the Fund pays ICC 0.50% of the Fund's gross
income.
Certain officers and directors of the Fund are also officers or directors
of the Fund's investment advisor or administrator.
As compensation for its accounting services, the Fund pays ICC an annual
fee that is calculated daily and paid monthly from the Fund's average daily
net assets. The Fund paid ICC $86,088 for accounting services for the year
ended October 31, 1997.
As compensation for its transfer agent services, the Fund pays ICC a per
account fee that is calculated and paid monthly. The Fund paid ICC $208,105
for transfer agent services for the year ended October 31, 1997.
Effective September 22, 1997, Bankers Trust Company became the Fund's
custodian. Prior to September 22, 1997, PNC Bank served as the Fund's
custodian. From September 22, 1997 to October 31, 1997, the Fund accrued
$4,576 in custody expenses.
As compensation for providing distribution services for the ISI Class, the
Fund pays ISI Group Inc. ("ISI Group"), which is affiliated with ISI, an
annual fee that is calculated daily and paid monthly. This fee is paid at
an annual rate equal to 0.25% of the ISI Class' average daily net assets.
Prior to April 1, 1997, Armata Financial Corp. served as the distributor
for the ISI Class for the same compensation and on substantially the same
terms and conditions as ISI Group. As compensation for providing
distribution services for the Flag Investors classes, the Fund pays ICC
Distributors, Inc. ("ICC Distributors"), a member of the Forum Financial
Group of companies, an annual fee that is calculated daily and paid
monthly. This fee is paid at an annual rate equal to 0.25% of the Flag
Investors Class A Shares' average daily net assets and 0.60% (including a
0.25% shareholder servicing fee) of the Flag
13
<PAGE>
Notes to Financial Statements (continued)
Investors Class B Shares' average daily net assets. Prior to September 1,
1997, Alex. Brown & Sons Incorporated served as the distributor for the
Flag Investors classes for the same compensation and on substantially the
same terms and conditions as ICC Distributors. For the year ended October
31, 1997, distribution fees aggregated $769,292, of which $445,938 was
attributable to the ISI Class Shares, $321,332 was attributable to the Flag
Investors Class A Shares and $2,022 was attributable to the Flag Investors
Class B Shares.
The Fund's complex offers a retirement plan for eligible Directors. The
actuarially computed pension expense allocated to the Fund for the year
ended October 31, 1997 was $19,142, and the accrued liability was $55,193.
C. Capital Share Transactions -- The Fund is authorized to issue up to 100
million shares of $.001 par value capital stock (44 million ISI Class, 44
million Flag Investors Class A, 5 million Flag Investors Class B, 500,000
Flag Investors Class D and 6.5 million undesignated). Transactions in
shares of the Fund were as follows:
ISI Class Shares
---------------------------
For the Year Ended
October 31,
---------------------------
1997 1996
------------ ------------
Shares sold 1,028,342 2,043,599
Shares issued to share-
holders on reinvest-
ment of dividends 787,090 865,140
Shares redeemed (4,455,189) (3,510,096)
------------ ------------
Net decrease in shares
outstanding (2,639,757) (601,357)
============ ============
Proceeds from sale
of shares $ 10,021,751 $ 20,394,040
Value of reinvested
dividends 7,664,314 8,518,116
Cost of shares
redeemed (43,406,641) (34,725,846)
------------ ------------
Net decrease from
capital share
transactions $(25,720,576) $ (5,813,690)
============ ============
Flag Investors Class A Shares
-----------------------------
For the Year Ended
October 31,
-----------------------------
1997 1996
------------- -------------
Shares sold 490,187 914,108
Shares issued to share-
holders on reinvest-
ment of dividends 499,834 580,880
Shares redeemed (3,438,672) (2,986,509)
------------ ------------
Net decrease in shares
outstanding (2,448,651) (1,491,521)
============ ============
Proceeds from sale
of shares $ 4,746,207 $ 8,996,345
Value of reinvested
dividends 4,867,694 5,722,783
Cost of shares
redeemed (33,514,991) (29,396,253)
------------ ------------
Net decrease from
capital share
transactions $(23,901,090) $(14,677,125)
============ ============
Flag Investors Class B Shares
-----------------------------
For the Period
For the June 20, 1996*
Year Ended through
October 31, October 31,
1997 1996
----------- --------------
Shares sold 85,484 12,460
Shares issued to share-
holders on reinvest-
ment of dividends 982 34
Shares redeemed (15,359) --
--------- --------
Net increase in shares
outstanding 71,107 12,494
========= ========
Proceeds from sale
of shares $ 833,099 $121,164
Value of reinvested
dividends 9,591 322
Cost of shares
redeemed (150,979) --
--------- --------
Net increase from
capital share
transactions $ 691,711 $121,486
========= ========
- ---------
*Commencement of operations.
14
<PAGE>
Notes to Financial Statements
(concluded)
D. Investment Transactions -- Excluding short-term obligations, purchases of
investment securities aggregated $256,600,289 and sales of investment
securities aggregated $338,535,804 for the year ended October 31, 1997.
On October 31, 1997, aggregate gross unrealized appreciation for all
securities in which there is an excess of value over tax cost was
$2,251,650 and aggregate gross unrealized depreciation for all securities
in which there is an excess of tax cost over value was $1,733,433.
E. Net Assets -- On October 31, 1997, net assets consisted of:
Paid-in capital:
ISI Class Shares $174,608,782
Flag Investors Class A Shares 121,909,369
Flag Investors Class B Shares 810,591
Distributions in excess
of net investment income (1,561,813)
Accumulated net realized loss
from security transactions (2,143,673)
Unrealized appreciation of
investments 518,217
------------
$294,141,473
============
F. Tax Capital Loss Carryforward -- On October 31, 1997, there was a tax capital
loss carryforward of $2,143,673, which expires in 2005. This carryforward will
be used to offset any future net capital gains.
- --------------------------------------------------------------------------------
This report is prepared for the general information of shareholders. It is
authorized for distribution to prospective investors only when preceded or
accompanied by an effective prospectus.
For more complete information regarding any of the ISI Funds, including
charges and expenses, obtain a prospectus from your investment representative or
directly from the Fund at 1-800-955-7175. Read it carefully before you invest.
- --------------------------------------------------------------------------------
Independent Auditors' Report
The Board of Directors and Shareholders
Total Return U.S. Treasury Fund, Inc.:
We have audited the statement of net assets of the Total Return U.S.
Treasury Fund, Inc. as of October 31, 1997, and the related statements of
operations for the year then ended and 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 five-year period then ended. 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 audit 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 at October
31, 1997 by correspondence with the custodian and broker. 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, such financial statements and financial highlights present
fairly, in all material respects, the financial position of Total Return U.S.
Treasury Fund, Inc. as of October 31, 1997, the results of its operations, the
changes in its net assets and the financial highlights for the respective stated
periods in conformity with generally accepted accounting principles.
DELOITTE & TOUCHE LLP
Princeton, New Jersey
November 21, 1997
15
