Rule 497(e)
Registration No.:33-12738
FUNDAMENTAL FIXED-INCOME FUND
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
90 Washington Street
19th Floor
New York, New York 10006
STATEMENT OF ADDITIONAL INFORMATION
Dated: April 25, 1996
As Supplemented on May 3, 1996
This Statement of Additional Information provides certain
detailed information concerning the Fundamental U.S. Government Strategic Income
Fund (the "U.S. Government Series"), a series of Fundamental Fixed-Income Fund
(the "Fund"). The U.S. Government Series' objective is to provide you high
current income with minimum risk of principal and relative stability of net
asset value. Unlike bank deposits and certificates of deposit, the U.S.
Government Series does not offer a fixed rate of return or provide the same
stability of principal. Although the U.S. Government Series' investment manager
attempts to maximize stability of net asset value, investment return and
principal value will fluctuate with interest rate changes. The U.S. Government
Series is not a money market fund and the value of your shares when you redeem
them may be more or less than your original cost. The U.S. Government Series
seeks to achieve its objective by investing primarily in U.S. Government
obligations. U.S. Government obligations consist of marketable securities issued
or guaranteed by the U.S. Government, its agencies or instrumentalities. Direct
obligations are issued by the United States Treasury and include bills,
certificates of indebtedness, notes and bonds (hereinafter "Direct
Obligations"). Obligations of U.S. Government agencies and instrumentalities
("Agencies") are issued by government sponsored agencies and enterprises acting
under authority of Congress. The U.S. Government Series may also invest in
repurchase agreements, may engage in certain options and futures transactions
only as a defensive measure (i.e., as a hedge and not for speculation) to
improve its liquidity and stabilize the value of its portfolio and may borrow
money to purchase additional portfolio securities. Under normal market
conditions, the U.S. Government Series will invest at least 65% of its total
assets in Government Securities. Of course, there can be no assurance that the
U.S. Government Series' investment objective will be achieved.
This Statement of Additional Information is not a Prospectus and
should be read in conjunction with the U.S. Government Series' current
Prospectus, a copy of which may be obtained by writing to Fundamental Service
Corporation at 90 Washington Street, 19th Floor, New York, New York 10006, or by
calling 1 (800) 322-6864.
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This Statement of Additional Information relates to the U.S.
Government Series' Prospectus dated April 25, 1996.
THIS STATEMENT OF ADDITIONAL INFORMATION IS NOT A PROSPECTUS AND
IS AUTHORIZED FOR DISTRIBUTION TO PROSPECTIVE INVESTORS ONLY IF PRECEDED OR
ACCOMPANIED BY AN EFFECTIVE PROSPECTUS.
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TABLE OF CONTENTS
INVESTMENT OBJECTIVE AND POLICIES.......................................... 4
INVESTMENT LIMITATIONS..................................................... 13
MANAGEMENT OF THE FUND..................................................... 15
MARKETING PLAN............................................................. 19
INVESTMENT MANAGER......................................................... 21
PORTFOLIO TRANSACTIONS..................................................... 23
CUSTODIAN, INDEPENDENT ACCOUNTANTS and COUNSEL............................. 25
TAXES...................................................................... 25
DESCRIPTION OF SHARES...................................................... 33
CERTAIN LIABILITIES........................................................ 33
DETERMINATION OF NET ASSET VALUE........................................... 34
PERFORMANCE INFORMATION.................................................... 34
OTHER INFORMATION.......................................................... 37
FINANCIAL STATEMENTS....................................................... 37
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INVESTMENT OBJECTIVE AND POLICIES
The Prospectus of the U.S. Government Series dated April 25,
1996 (the "Prospectus") identifies the investment objective and the principal
investment policies of the U.S. Government Series. Other investment policies,
investment limitations and a further description of certain of the policies
described in the Prospectus are set forth below.
Portfolio Turnover. Pursuit by the U.S. Government Series of its
investment objective may lead to frequent changes in the securities held in its
portfolio, which is known as "portfolio turnover." Portfolio turnover may
involve payments by the U.S. Government Series of brokerage commissions, dealer
spreads and other transaction costs relating to the purchase and the sale of
securities. Portfolio turnover rate for a given fiscal year is calculated by
dividing the lesser of the amount of the purchases or the amount of the sales of
portfolio securities during the year by the monthly average of the value of the
portfolio securities during the year.
OPTIONS, FUTURES CONTRACTS AND RELATED OPTIONS
CALL AND PUT OPTIONS
Call and put options on various U.S. Treasury notes and U.S.
Treasury bonds are listed and traded on Exchanges, and are written in
over-the-counter transactions. Call and put options on Agencies are currently
written or purchased only in over-the-counter transactions.
WRITING CALL AND PUT OPTIONS
PURPOSE. The principal reason for writing options is to obtain,
through receipt of premiums, a greater current return than would be realized on
the underlying securities alone. Such current return can be expected to
fluctuate because premiums earned from an option writing program and interest
income yields on portfolio securities vary as economic and market conditions
change. Actively writing options on portfolio securities is likely to result in
the U.S. Government Series having a substantially higher portfolio turnover rate
than that of most other investment companies. Higher portfolio involves
correspondingly greater brokerage commissions and other transaction costs, which
are borne directly by the U.S.
Government Series.
WRITING OPTIONS. The purchaser of a call option pays a premium
to the writer (i.e., the seller) for the right to buy the underlying security
from the writer at a specified price during a
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certain period. The U.S. Government Series writes call options either on a
covered basis, or for cross-hedging purposes. A call option is covered if the
U.S. Government Series owns or has the right to acquire the underlying
securities subject to the call option at all times during the option period.
Thus the U.S. Government Series may write options on Government Securities. An
option is for cross-hedging purposes if it is not covered, but is designed to
provide a hedge against a security which the U.S. Government Series owns or has
the right to acquire. In such circumstances, the U.S. Government Series will
collateralize the option by maintaining in a segregated account with the U.S.
Government Series' Custodian, cash or Government Securities in an amount not
less than the market value of the underlying security, marked to market daily,
while the option is outstanding.
The purchaser of a put option pays a premium to the writer
(i.e., the seller) for the right to sell the underlying security to the writer
at a specified price during a certain period. The U.S. Government Series would
write put options only on a secured basis, which means that, at all times during
the option period, the U.S. Government Series would maintain in a segregated
account with its Custodian, cash, money market instruments or high grade liquid
debt securities in an amount of not less than the exercise price of the option,
or would hold a put on the same underlying security at an equal or greater
exercise price.
CLOSING PURCHASE TRANSACTIONS AND OFFSETTING TRANSACTIONS. In
order to terminate its position as a writer of a call or put option, the U.S.
Government Series could enter into a "closing purchase transaction," which is
the purchase of a call (put) on the same underlying security and having the same
exercise price and expiration date as the call (put) previously written by the
U.S. Government Series. The U.S. Government Series would realize a gain (loss)
if the premium plus commission paid in the closing purchase transaction is less
(greater) than the premium it received on the sale of the option. The U.S.
Government Series would also realize a gain if an option it has written lapses
unexercised.
The U.S. Government Series can write options that are listed on
an Exchange as well as options which are privately negotiated in
over-the-counter transactions. The U.S. Government Series can close out its
position as a writer of an option only if a liquid secondary market exists for
options of that series, but there is no assurance that such a market will exist,
particularly in the case of over-the-counter options, since they can be closed
out only with the other party to the transaction. Alternatively, the U.S.
Government Series could purchase an offsetting option, which would not close out
its position as a writer, but would provide an asset of equal value to its
obligation under the option written. If the U.S. Government Series is not able
to enter into a closing purchase transaction or to purchase an offsetting option
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with respect to an option it has written, it will be required to maintain the
securities subject to the call or the collateral securing the option until a
closing purchase transaction can be entered into (or the option is exercised or
expires), even though it might not be advantageous to do so.
RISKS OF WRITING OPTIONS. By writing a call option, the U.S.
Government Series loses the potential for gain on the underlying security above
the exercise price while the option is outstanding; by writing a put option, the
U.S. Government Series might become obligated to purchase the underlying
security at an exercise price that exceeds the then current market price.
PURCHASING CALL AND PUT OPTIONS
The U.S. Government Series may purchase either listed
or over-the-counter options. The U.S. Government Series may purchase call
options to protect (i.e., hedge) against anticipated increases in the price of
securities it wishes to acquire. Since the premium paid for a call option is
typically a small fraction of the price of the underlying security, a given
amount of funds will purchase call options covering a much larger quantity of
such security than could be purchased directly. By purchasing call options, the
U.S. Government Series could benefit from any significant increase in the price
of the underlying security to a greater extent than if it had invested the same
amount in the security directly. However, because of the very high volatility of
option premiums, the U.S. Government Series would bear a significant risk of
losing the entire premium if the price of the underlying security did not rise
sufficiently, or if it did not do so before the option expired.
Conversely, put options may be purchased to protect (i.e.,
hedge) against anticipated declines in the market value of either specific
portfolio securities or of the U.S. Government Series' assets generally. The
U.S. Government Series will not purchase call or put options on securities if as
a result, more than ten percent of its net assets would be invested in premiums
on such options.
INTEREST RATE FUTURES CONTRACTS
The U.S. Government Series may engage in transactions involving
futures contracts and related options in accordance with the rules and
interpretations of the Commodity Futures Trading Commission ("CFTC") under which
the U.S. Government Series would be exempt from registering as a "commodity
pool."
An interest rate futures contract is an agreement pursuant to
which a party agrees to take or make delivery of a specified
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debt security (such as U.S. Treasury bonds, U.S. Treasury notes, U.S. Treasury
bills and GNMA Certificates) at a specified future time and at a specified
price. Interest rate futures contracts also include cash settlement contracts
based upon a specified interest rate such as the London Interbank Offering Rate
for dollar deposits ("LIBOR").
INITIAL AND VARIATION MARGIN. In contrast to the purchase or
sale of a security, no price is paid or received upon the purchase or sale of a
futures contract. Initially, the U.S. Government Series will be required to
deposit with its Custodian in an account in the broker's name an amount of cash,
money market instruments or liquid high-grade debt securities equal to not more
than five percent of the contract amount. This amount is known as "initial
margin." The nature of initial margin in futures transactions is different from
that of margin in securities transactions in that futures contract margin does
not involve the borrowing of funds by the customer to finance the transaction.
Rather, the initial margin is in the nature of a performance bond or good faith
deposit on the contract, which is returned to the U.S. Government Series upon
termination of the futures contract and satisfaction of its contractual
obligations. Subsequent payments to and from the broker, called "variation
margin," will be made on a daily basis as the price of the underlying security
fluctuates, making the long and short positions in the futures contract more or
less valuable, a process known as "marking to market."
For example, when the U.S. Government Series has purchased a
futures contract and the price of the underlying security has risen, that
position will have increased in value, and the U.S. Government Series will
receive from the broker a variation margin payment equal to that increase in
value. Conversely, when the U.S. Government Series has purchased a futures
contract and the value of the underlying security has declined, the position
would be less valuable, and the U.S. Government Series would be required to make
a variation payment to the broker.
At any time prior to expiration of the futures contract, the
U.S. Government Series may elect to terminate the position by taking an opposite
position. A final determination of variation margin is then made, additional
cash is required to be paid by or released to the U.S. Government Series, and
the U.S. Government Series realizes a loss or a gain.
FUTURES STRATEGIES. When the U.S. Government Series anticipates
a significant market or market sector advance, the purchase of a futures
contract affords a hedge against not participating in the advance at a time when
the U.S. Government Series is not fully invested ("anticipatory hedge"). Such
purchase of a futures contract would serve as a temporary substitute for the
purchase of individual securities, which may be purchased in an
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orderly fashion once the market is established. As individual securities are
purchased, an equivalent amount of futures contracts can then be terminated by
offsetting sales. The U.S. Government Series may sell futures contracts in
anticipation of, or during, a general market or market sector decline that may
adversely affect the market value of the U.S. Government Series' securities
("defensive hedge"). To the extent that the U.S. Government Series' portfolio of
securities changes in value in correlation with the underlying security, the
sale of futures contracts would substantially reduce the risk to the U.S.
Government Series of a market decline and, by so doing, provide an alternative
to the liquidation of securities positions in the U.S. Government Series.
Ordinarily, commissions on futures transactions are lower than transaction costs
incurred in the purchase and sale of Government Securities.
Transactions will be entered into by the U.S. Government Series
only with brokers or financial institutions deemed creditworthy by the Manager.
However, in the event of the bankruptcy of a broker through which the U.S.
Government Series engages in transactions in listed options, futures or related
options, the U.S. Government Series might experience delays and/or losses in
liquidating open positions purchased and/or incur a loss of all or part of its
margin deposits with the broker.
SPECIAL RISKS ASSOCIATED WITH FUTURES TRANSACTIONS. There are
several risks connected with the use of futures contracts as a hedging device.
These include the risk of imperfect correlation between movements in the price
of the futures contracts and of the underlying securities, the risk of market
distortion, the illiquidity risk and the risk of error in anticipating price
movement.
There may be an imperfect correlation (or no correlation)
between movements in the price of the futures contracts and the securities being
hedged. The risk of imperfect correlation increases as the composition of the
securities being hedged diverges from the securities upon which the futures
contract is based. If the price of the futures contract moves less than the
price of the securities being hedged, the hedge will not be fully effective. To
compensate for the imperfect correlation, the U.S. Government Series could buy
or sell futures contracts in a greater dollar amount than the dollar amount of
securities being hedged if the historical volatility of the securities being
hedged is greater than the historical volatility of the securities underlying
the futures contract. Conversely, the U.S. Government Series could buy or sell
futures contracts in a lesser dollar amount than the dollar amount of securities
being hedged if the historical volatility of the securities being hedged is less
than the historical volatility of the securities underlying the futures
contract. It is also possible that the value of futures contracts held by the
U.S.
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Government Series could decline at the same time as portfolio securities being
hedged; if this occurred, the U.S. Government Series would lose money on the
futures contract in addition to suffering a decline in value in the portfolio
securities being hedged.
There is also the risk that the price of a futures contract may
not correlate perfectly with movements in the securities underlying the futures
contract due to certain market distortions. First, all participants in the
futures market are subject to margin depository and maintenance requirements.
Rather than meet additional margin depository requirements, investors may close
futures contracts through offsetting transactions, which could distort the
normal relationship between the futures market and the securities underlying the
futures contract. Second, from the point of view of speculators, the deposit
requirements in the futures markets are less onerous than margin requirements in
the securities markets. Therefore, increased participation by speculators in the
futures markets may cause temporary price distortions. Due to the possibility of
price distortion in the futures markets and because of the imperfect correlation
between movements in futures contracts and movements in the securities
underlying them, a correct forecast of general market trends by the Manager may
still not result in a successful hedging transaction judged over a very short
time frame.
There is also the risk that futures markets may not be
sufficiently liquid. Futures contracts may be closed out only on an Exchange or
board of trade that provides a market for such futures contracts. Although the
U.S. Government Series intends to purchase or sell futures only on Exchanges and
boards of trade where there appears to be an active secondary market, there can
be no assurance that an active secondary market will exist for any particular
contract or at any particular time. In the event of such illiquidity, it may not
be possible to close a futures position and, in the event of adverse price
movement, the U.S. Government Series would continue to be required to make daily
payments of variation margin. Since the securities being hedged would not be
sold until the related futures contract is sold, an increase, if any, in the
price of the securities may to some extent offset losses on the related futures
contract. In such event, the U.S. Government Series would lose the benefit of
the appreciation in value of the securities.
Successful use of futures is also subject to the Manager's
ability to correctly predict the direction of movements in the market. For
example, if the U.S. Government Series hedges against a decline in the market
and market prices instead advance, the U.S. Government Series will lose part or
all of the benefit of the increase in value of its securities holdings because
it will have offsetting losses in futures contracts. In such cases, if the U.S.
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Government Series has insufficient cash, it may have to sell portfolio
securities at a time when it is disadvantageous to do so in order to meet the
daily variation margin.
The use of futures contracts to shorten the weighted average
duration of the U.S. Government Series' portfolio, while reducing the exposure
of the U.S. Government Series' portfolio to interest rate risk does subject the
U.S. Government Series' portfolio to basis risk. Basis refers to the
relationship between a futures contract and the underlying security. In the case
of futures contracts on U.S. Treasury Bonds, the contract specifies delivery of
a "bench-mark" 8% 20 year U.S. Treasury Bond. Any outstanding treasury with a
maturity of more than 15 years is deliverable against the contract, with the
principal amount per contract adjusted according to a formula which takes into
account the coupon and maturity of the treasury bond being delivered. This means
that at any given time there is one treasury issue that is "the cheapest to
deliver" against the contract. The supply and demand of the available float of
treasury securities determines which treasury security is cheapest to deliver at
any given time. This, combined with the supply and demand for futures relative
to the underlying cash securities markets, causes the relationship between the
cash security markets and the futures markets to exhibit perturbations of
variance from an exact one-to-one correlation. The U.S. Government Series could
experience losses if the value of the prices of the futures positions the U.S.
Government Series has entered into are poorly correlated with the U.S.
Government Series' other investments.
For example, on a day that the price on a treasury bond
deliverable against the futures contract declined by ten points, the futures
contract might decline by nine or eleven points. In this example, a nine point
decline in the price of a futures contract would not fully offset the price
decline in the cash security price. This would cause a downward fluctuation in
the value of the U.S. Government Series' portfolio. Likewise, a basis
fluctuation whereby the futures prices fell more or rose less than the cash
securities prices due to basis change would cause an upward fluctuation in the
value of the U.S. Government Series' portfolio.
CFTC regulations require, among other things, (i) that futures
and related options be used solely for bona fide hedging purposes (or that the
underlying commodity value of the U.S. Government Series' long futures positions
not exceed the sum of certain identified liquid investments) and (ii) that the
U.S. Government Series not enter into futures and related options for which the
aggregate initial margin and premiums exceed five percent of the fair market
value of the U.S. Government Series' assets. In order to minimize leverage in
connection with the purchase of futures contracts by the U.S. Government Series,
an amount of cash,
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money market instruments or liquid high grade debt securities equal to the
market value of the obligations under the futures contracts (less any related
margin deposits) will be maintained in a segregated account with the Custodian.
OPTIONS ON FUTURES CONTRACTS
The U.S. Government Series may also purchase and write options
on futures contracts. An option on a futures contract gives the purchaser the
right, in return for the premium paid, to assume a position in a futures
contract (a long position if the option is a call and a short position if the
option is a put), at a specified exercise price at any time during the option
period. As a writer of an option on a futures contract, the U.S. Government
Series would be subject to initial margin and maintenance requirements similar
to those applicable to futures contracts. In addition, net option premiums
received by the U.S. Government Series are required to be included as initial
margin deposits. When an option on a futures contract is exercised, delivery of
the futures position is accompanied by cash representing the difference between
the current market price of the futures contract and the exercise price of the
option. The U.S. Government Series can purchase put options on futures contracts
in lieu of, and for the same purpose as selling a futures contract. The purchase
of call options on futures contracts would be intended to serve the same purpose
as the actual purchase of the futures contract.
RISKS OF TRANSACTIONS IN OPTIONS ON FUTURES CONTRACTS. In
addition to the risks described above which apply to all options transactions,
there are several special risks relating to options on futures. The Manager will
not purchase options on futures on any Exchange unless in the Manager's opinion,
a liquid secondary Exchange market for such options exists. Compared to the use
of futures, the purchase of options on futures involves less potential risk to
the U.S. Government Series because the maximum amount at risk is the premium
paid for the options (plus transaction costs). However, there may be
circumstances, such as when there is no movement in the price of the underlying
security, where the use of an option on a future would result in a loss to the
U.S. Government Series whereas the use of a future would not.
ADDITIONAL RISKS TO OPTIONS AND FUTURES TRANSACTIONS
Each of the Exchanges has established limitations governing the
maximum number of call or put options on the same underlying security or futures
contract (whether or not covered) which may be written by a single investor,
whether acting alone or in concert with others (regardless of whether such
options are written on the same or different Exchanges or are held or written
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on one or more accounts or through one or more brokers). Option positions of all
investment companies advised by the Manager are combined for purposes of these
limits. An Exchange may order the liquidation of positions found to be in
violation of these limits and it may impose other sanctions or restrictions.
These position limits may restrict the number of listed options which the U.S.
Government Series may write.
Although the U.S. Government Series intends to enter into
futures contracts only if there is an active market for such contracts, there is
no assurance that an active market will exist for the contracts at any
particular time. Most U.S. futures exchanges and boards of trade limit the
amount of fluctuation permitted in futures contract prices during a single
trading day. Once the daily limit has been reached in a particular contract, no
trades may be made that day at a price beyond that limit. It is possible that
futures contract prices would move to the daily limit for several consecutive
trading days with little or no trading, thereby preventing prompt liquidation of
futures positions and subjecting some futures traders to substantial losses. In
such event, and in the event of adverse price movements, the U.S. Government
Series would be required to make daily cash payments of variation margin. In
such circumstances, an increase in the value of the portion of the portfolio
being hedged, if any, may partially or completely offset losses on the futures
contract. However, there is no guarantee that the price of the securities being
hedged will, in fact, correlate with the price movements in a futures contract
and thus provide an offset to losses on the futures contract.
Certain additional risks relate to the fact that the U.S.
Government Series might purchase and sell options on mortgage-related
securities. Since the remaining principal balance of mortgage-related securities
declines each month as a result of mortgage payments, if the U.S. Government
Series has written a call and is holding such securities as "cover" to satisfy
its delivery obligation in the event of exercise, it may find that the
securities it holds no longer have a sufficient remaining principal balance for
this purpose. Should this occur, the U.S. Government Series would purchase
additional mortgage-related securities from the same pool (if obtainable) or
replacements in the cash market in order to maintain its cover. A
mortgage-related security held by the U.S. Government Series to cover an option
position in any but the nearest expiration month may cease to represent cover
for the option in the event of a decrease in the coupon rate at which new pools
are originated. If this should occur, the option would no longer be covered, and
the U.S. Government Series would either enter into a closing purchase
transaction or replace the mortgage-related security with one which represents
cover. In either case, the U.S. Government Series may realize an unanticipated
loss and incur additional transactions costs.
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INVESTMENT LIMITATIONS
The U.S. Government Series has adopted the following policies as
"fundamental policies," which cannot be changed without the approval of the
holders of a majority of the shares of the U.S. Government Series (which, as
used in this Statement of Additional Information, means the lesser of (i) more
than 50% of the outstanding shares, or (ii) 67% or more of the shares present at
a meeting at which holders of more than 50% of the outstanding shares are
represented in person or by proxy). The U.S. Government Series may not:
1. Purchase the securities of any one issuer, other than
obligations issued or guaranteed by the U.S. Government or its agencies or
instrumentalities, if, immediately after such purchase, (i) more than 5% of the
value of its total assets would be invested in such issuer, or (ii) it would own
more than 10% of the outstanding voting securities of such issuer; except that
up to 25% of the value of its total assets may be invested without regard to
such limitations.
2. Invest 25% or more of its total assets in a single industry;
provided, however, that such limitation shall not be applicable to obligations
issued or guaranteed by the U.S.
Government, its agencies or instrumentalities.
3. Issue senior securities, as defined in the Investment Company
Act of 1940 (the "1940 Act"), except to the extent such issuance might be
involved with borrowings described under subparagraph (4) below or with respect
to hedging and risk management transactions or the writing of options within
limits described in the U.S. Government Series' current Prospectus.
4. Borrow money, except for temporary or emergency purposes, or
by engaging in reverse repurchase transactions, and then only in an amount not
exceeding one-third of the U.S. Government Series' total assets, including the
amount borrowed. The U.S. Government Series will not mortgage, pledge or
hypothecate any assets except to secure permitted borrowings and reverse
repurchase transactions. Collateral arrangements with respect to the U.S.
Government Series' permissible futures and options transactions, including
initial and variation margin, are not considered to be a pledge of assets for
purposes of this restriction.
5. Make loans of money or property to any person, other than by
entering into repurchase agreements, and except to the extent the securities in
which the U.S. Government Series may invest are considered to be loans.
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6. Buy any securities "on margin". Neither the deposit of
initial or variation margin in connection with hedging and risk management
transactions nor short-term credits as may be necessary for the clearance of
transactions is considered the purchase of a security on margin.
7. Sell any securities "short", write, purchase or sell puts,
calls or combinations thereof, or purchase or sell financial futures or options,
except as described under the heading "Certain Investment Techniques and
Policies" in the U.S. Government Series' current Prospectus.
8. Act as an underwriter of securities, except to the extent the
U.S. Government Series may be deemed to be an underwriter in connection with the
sale of securities held in its portfolio.
9. Make investments for the purpose of exercising control or
participation in management.
10. Invest in securities of other investment companies in an
amount exceeding the limitations set forth in the 1940 Act and the rules
thereunder, except as part of a merger, consolidation or other acquisition.
11. Invest in equity interests in oil, gas or other mineral
exploration or development programs.
12. Purchase or sell real estate (but this shall not prevent
investments in securities secured by real estate or interests therein),
commodities or commodity contracts, except to the extent that financial futures
and related options that the U.S. Government Series may invest in are considered
to be commodities or commodities contracts.
13. Invest more than 10% of the U.S. Government Series' total
assets in illiquid securities and repurchase agreements with remaining
maturities in excess of seven days.
Operating Policies. The U.S. Government Series has adopted the
following operating policies which are not fundamental and which may be changed
without shareholder approval: To comply with certain state statutes, the U.S.
Government Series will not: (1) make investments in oil, gas or other mineral
leases; (2) make investments in real estate limited partnerships; (3) purchase
or retain securities of an issuer when one or more officers and trustees of the
Fund or the Fund's Manager, or a person owning more than 10% of the shares of
either, own beneficially more than 1/2 of 1% of the securities of such issuer
and such persons owning more than 1/2 of 1% of such securities together own
beneficially more than 5% of the securities of such issuer;
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(4) purchase securities of other investment companies, except in connection with
a merger, consolidation, acquisition or reorganization, or by purchase in the
open market of securities of open-end or closed-end investment companies where
no underwriter or dealer's commission or profit, other than customary broker's
commission, is involved; or (5) invest more than 15% of its total assets in the
securities of issuers which together with any predecessors have a record of less
than three years continuous operation or securities of issuers which are
restricted as to disposition.
Percentage Restrictions. If a percentage restriction on
investment or utilization of assets set forth above is adhered to at the time an
investment is made or assets are so utilized, a later change in percentage
resulting from changes in the value of the portfolio securities of the U.S.
Government Series will not be considered a violation of such policy.
MANAGEMENT OF THE FUND
The Fund's Board of Trustees provides broad supervision over the
affairs of the Fund and of the U.S. Government Series. The officers of the Fund
are responsible for the operations of the U.S. Government Series. The Trustees
and executive officers of the Fund are listed below, together with their
principal occupations for at least the last five years. Each Trustee who is
considered to be an "interested person" of the Fund, as defined by the 1940 Act,
is indicated by an asterisk (*).
JAMES C. ARMSTRONG: Trustee of the Fund. Mr. Armstrong is a
partner in Armstrong/Seltzer Communications Inc., a New York management,
consulting, and public relations firm. He was formerly Executive Director,
Global Public Affairs Institute at New York University and Professor, Bell of
Pennsylvania Chair in Telecommunications, Temple University, and is a management
consultant. He was with American Telephone and Telegraph Company for 15 years.
His last position with AT&T was Director, Corporate Policy Analysis. Mr.
Armstrong previously held positions at the Institute for Defense Analysis, the
Office of the Postmaster General, and on the faculty of the University of
Maryland. He has been a consultant to government, academic and business
organizations, and has served on various government-industry task forces and
committees. Mr. Armstrong was an Officer in the United States Navy and holds a
Ph.D. in nuclear physics. Mr. Armstrong's address is 51 Mt. Pleasant Road,
Morristown, New Jersey 07960.
JAMES A. BOWERS: Trustee of the Fund. Mr. Bowers is a consultant
for Prototypes (formerly, Director of Finance and Administration), The American
Telephone and Telegraph Company, The RAND Corporation and CogniTech Services
Corporation. He was
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employed at AT&T for 23 years. His latest position with AT&T was in the Treasury
Department as District Manager-Securities and Exchange Commission Reporting. Mr.
Bowers holds Bachelor of Science and Master of Arts degrees in Economics from
Florida Atlantic University. Mr. Bowers' address is 60 East Eighth Street, New
York, N.Y. 10003.
CLARK L. BULLOCK: Trustee of the Fund. Mr. Bullock is Chairman
of the Board of Shelter Rock Investors Services Corp., a privately-held, New
York-based investment company. Mr. Bullock received a Masters of Science degree
in Mathematical Economics from Purdue University in 1972 and a Bachelor of Arts
degree in International Relations from the University of Arizona. Mr. Bullock's
address is c/o Shelter Rock Investors, 150 Hopper Avenue, Waldwick, New Jersey
07463.
L. GREG FERRONE: Trustee of the Fund. Mr. Ferrone is a
consultant with IntraNet, Inc., a provider of computer systems to the domestic
and international banking industry. Previously he was the Director of Sales &
Marketing for RAV Communications Inc., Vice President/Regional Manager with
National Westminster Bank USA and an officer at Security Pacific Bank. Mr.
Ferrone received a Bachelor of Science degree from Rensselaer Polytechnic
Institute in 1972 and studied at the Stonier Graduate School of Banking. Mr.
Ferrone's address is 83 Ronald Court, Ramsey, New Jersey 07446.
*VINCENT J. MALANGA: Chairman of the Board, Chief Executive
Officer, President and Treasurer of the Fund, The California Muni Fund and
Fundamental Funds, Inc. Mr. Malanga is President, Treasurer and a Director of
Fundamental Portfolio Advisors, Inc., Executive Vice President, Secretary and a
Director of Fundamental Service Corporation, and President of LaSalle Economics
Inc., an economic consulting firm. Mr. Malanga is Vice President, Secretary and
a 50% shareholder of LaSalle Portfolio Management, Inc., the general partner of
both LPM Financial Futures Fund I, Limited Partnership and LPM Equities Fund
Limited Partnership. Prior thereto, he was a Vice President and Senior Economist
at A. Gary Shilling & Company, Inc., an economic consulting and brokerage firm.
He previously served as an Economist at White, Weld & Co. (an investment banking
and brokerage firm) from 1976 to 1978. Prior thereto, Mr. Malanga, who holds a
Ph.D. in Economics from Fordham University, was an Economist at the Federal
Reserve Bank of New York. Mr. Malanga's address is 90 Washington Street, 19th
Floor, New York, New York 10006.
DAVID P. WIEDER: Vice President of the Fund. Secretary of
Fundamental Portfolio Advisors, Inc., and President and a Director of
Fundamental Shareholder Services, Inc. Mr. Wieder holds a Bachelor of Science
degree in Economics from Cornell
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University. Mr. Wieder's address is 90 Washington Street, 19th Floor, New York,
New York 10006.
CAROLE M. LAIBLE: Secretary of the Fund. Treasurer and Secretary
of Fundamental Shareholder Services, Inc. She was formerly a General Service
Manager for McGladrey & Pullen. Ms. Laible received a Bachelor of Science degree
from St. John's University in 1986. Ms. Laible's address is 90 Washington
Street, 19th Floor, New York, New York 10006.
All of the Trustees of the Fund are also Directors of New York
Muni Fund, Inc. and Trustees of The California Muni Fund. All of the officers of
the Fund hold similar offices with Fundamental Funds, Inc. and The California
Muni Fund.
The U.S. Government Series does not pay any salary or
compensation to any of its officers, all of whom are officers or employees of
Fundamental Portfolio Advisors, Inc. (the "Manager"). For services and
attendance at board meetings and meetings of committees which are common to the
Fund, Fundamental Funds, Inc. and The California Muni Fund (other affiliated
mutual funds for which the Manager acts as the investment advisor), each Trustee
of the Fund who is not affiliated with the Manager is compensated at the rate of
$6,500 per quarter prorated among the three funds based on their respective net
assets at the end of each quarter. Each such Trustee is also reimbursed by the
three funds, on the same basis, for actual out-of-pocket expenses relating to
his attendance at meetings. The Manager pays the compensation of the Fund's
officers and of the one Trustee that is affiliated with the Manager. For the
fiscal year ended December 31, 1995, trustees' fees totalling $25,164 were paid
by the Fund to the Trustees as a group ($468 for the High-Yield Municipal Bond
Series, $18,072 for the Tax Free Money Market Series and $6,624 for the U.S.
Government Series).
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COMPENSATION TABLE
(FOR EACH CURRENT BOARD MEMBER
RECEIVING COMPENSATION FROM
A FUNDAMENTAL FUND FOR THE
MOST RECENTLY COMPLETED FISCAL YEAR)
AGGREGATE COMPENSATION FROM FUND
AGGREGATE
COMPENSATION
PAID BY ALL
HIGH- U.S. FUNDS MANAGED
YIELD TAX- GOV'T BY
CALI- MUNI- FREE STRA- FUNDAMENTAL
FORNIA CIPAL MONEY TEGIC PORTFOLIO
NAME NY MUNI MUNI BOND MARKET INCOME ADVISORS, INC.
- ---- ------- ---- ---- ------ ------ --------------
James C. Armstrong $18,333 $1,376 $117 $4,518 $1,656 $26,000
James A. Bowers 18,333 1,376 117 4,518 1,656 26,000
Clark L. Bullock 18,333 1,376 117 4,518 1,656 26,000
L. Greg Ferrone 18,333 1,376 117 4,518 1,656 26,000
Transfer Agent
Fundamental Shareholder Services, Inc., P.O. Box 1013, Bowling
Green Station, New York, New York 10274-1013, an affiliate of Fundamental
Portfolio Advisors, Inc. and Fundamental Service Corporation, performs all
services in connection with the transfer of shares of the U.S. Government
Series, acts as its dividend disbursing agent, and as administrator of the
exchange, check redemption, telephone redemption and expedited redemption
privileges of the U.S. Government Series pursuant to a Transfer Agency and
Service Agreement dated January 31, 1992. During the fiscal year ended December
31, 1995, fees paid to the Transfer Agent by the U.S. Government Series amounted
to $62,540.
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MARKETING PLAN
As discussed in the Prospectus, the Fund has entered into a
Distribution Agreement with Fundamental Service Corporation ("FSC"). FSC is a
Delaware corporation which is owned approximately 43.7% by each of Messrs.
Thomas W. Buckingham, a consultant to the Manager, and Vincent J. Malanga, a
Trustee and officer of the Fund and a director and officer of the Manager, and
9.8% by Dr. Lance M. Brofman, an employee of the Manager. The Trustees who are
not, and were not at the time they voted, interested persons of the Fund, as
defined in the 1940 Act (the "Independent Trustees"), have approved the
Distribution Agreement. The Distribution Agreement provides that FSC will bear
the distribution expenses of the U.S. Government Series not borne by the U.S.
Government Series. The Distribution Agreement was last approved by the Board of
Trustees of the Fund on October 18, 1995.
FSC bears all expenses it incurs in providing services under the
Distribution Agreement. Such expenses include compensation to it and to
securities dealers and other financial institutions and organizations such as
banks, trust companies, savings and loan associations and investment advisors
for distribution related and/or administrative services performed for the U.S.
Government Series. FSC also pays certain expenses in connection with the
distribution of the U.S. Government Series' shares, including the cost of
preparing, printing and distributing advertising or promotional materials, and
the cost of printing and distributing prospectuses and supplements thereto to
prospective shareholders. The U.S. Government Series bears the cost of
registering its shares under Federal and state securities laws.
The Fund and FSC have agreed to indemnify each other against
certain liabilities, including liabilities under the Securities Act of 1933, as
amended. Under the Distribution Agreement, FSC will use its best efforts in
rendering services to the Fund.
The Fund has adopted a plan of distribution pursuant to Rule
12b-1 under the 1940 Act (the "Plan") pursuant to which the U.S. Government
Series pays FSC compensation accrued daily and paid monthly at the annual rate
of .25% of the U.S. Government Series' average daily net assets. The Plan was
adopted by a majority vote of the Board of Trustees, including all of the
Independent Trustees (none of whom had or have any direct or indirect financial
interest in the operation of the Plan), cast in person at a meeting called for
the purpose of voting on the Plan on January 31, 1992 and by the shareholders of
the U.S. Government Series on February 18, 1992.
Pursuant to the Plan, FSC provides the Fund, for review by the
Trustees, and the Trustees review, at least quarterly, a
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written report of the amounts expended under the Plan and the purpose for which
such expenditures were made.
No interested person of the Fund nor any Trustee of the Fund who
is not an interested person of the Fund, as defined in the 1940 Act, has any
direct financial interest in the operation of the Plan except to the extent that
FSC and certain of its employees may be deemed to have such an interest as a
result of receiving a portion of the amounts expended thereunder by the Fund.
The Plan will continue in effect until December 31, 1996. The
Plan will continue in effect from year-to-year thereafter, provided such
continuance is approved annually by vote of the Trustees in the manner described
above. It may not be amended to increase materially the amount to be spent for
the services described therein without approval of the shareholders of the Fund,
and material amendments of the Plan must also be approved by the Trustees in the
manner described above. The Plan may be terminated at any time, without payment
of any penalty, by vote of the majority of the Trustees who are not interested
persons of the Fund, and with no direct or indirect financial interest in the
operations of the Plan, or by a vote of a majority of the outstanding voting
securities of the Fund (as defined in the 1940 Act). The Plan will automatically
terminate in the event of its assignment (as defined in the 1940 Act). So long
as the Plan is in effect, the election and nomination of the Independent
Trustees shall be committed to the discretion of the Independent Trustees. In
the Trustees' quarterly review of the Plan, they will consider its continued
appropriateness and the level of compensation provided therein.
During the year ended December 31, 1995, amounts incurred by the
Fund under the plan aggregated $40,695 for advertising, and printing and mailing
of prospectuses to other than current shareholders.
The Glass-Steagall Act prohibits banks from engaging in the
business of underwriting, selling or distributing securities. Although the scope
of this prohibition under the Glass-Steagall Act has not been clearly defined by
the courts or appropriate regulatory agencies, FSC believes that the
Glass-Steagall Act should not preclude a bank from performing shareholder
support services, servicing and recordkeeping functions. FSC intends to engage
banks only to perform such functions. However, changes in Federal or state
statutes and regulations pertaining to the permissible activities of banks and
their affiliates or subsidiaries, as well as further judicial or administrative
decisions or interpretations, could prevent a bank from continuing to perform
all or a part of the contemplated services. If a bank were prohibited from so
acting, the Trustees would consider what actions, if any, would be necessary to
continue to provide
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<PAGE>
efficient and effective shareholder services. In such event, changes in the
operation of the U.S. Government Series might occur, including possible
termination of any automatic investment or redemption or other services then
provided by a bank. It is not expected that shareholders would suffer any
adverse financial consequences as a result of any of these occurrences. The U.S.
Government Series may execute portfolio transactions with and purchase
securities issued by depository institutions that indirectly receive payments
under the Plan. No preference will be shown in the selection of investments for
the instruments of such depository institutions.
INVESTMENT MANAGER
The Fund has entered into an agreement (the "Management
Agreement") with Fundamental Portfolio Advisers, Inc. (the "Manager"), 90
Washington Street, 19th Floor, New York, New York 10006, to act as its
investment adviser. The Management Agreement has been approved to continue in
effect for an initial two year period, and will continue in effect from year to
year thereafter if it is specifically approved, at least annually, by the vote
of a majority of the Board of Trustees of the Fund (including a majority of the
Board of Trustees who are not parties to the Management Agreement or interested
persons of any such parties) cast in person at a meeting called for the purpose
of voting on such renewal. The Management Agreement terminates if assigned and
may be terminated without penalty by either party by vote of its Board of
Directors or Trustees or a majority of its outstanding voting securities and the
giving of sixty days' written notice.
Under the terms of the Management Agreement, the Manager serves
as investment adviser to the U.S. Government Series and is responsible for the
overall management of the business affairs and assets of the U.S. Government
Series, subject to the authority of the Fund's Board of Trustees. The Manager
also is authorized under the Management Agreement to buy and sell securities for
the account of the U.S. Government Series, in its discretion, subject to the
right of the Fund's Trustees to disapprove any such purchase or sale. The
Manager pays all of the ordinary operating expenses of the U.S. Government
Series, including executive salaries and the rental of office space, with the
exception of the following, which are to be paid by the U.S. Government Series:
(1) charges and expenses for determining from time-to-time the net asset value
of the U.S. Government Series and the keeping of its books and records, (2) the
charges and expenses of any auditors, custodian, transfer agent, plan agent,
dividend disbursing agent and registrar performing services for the U.S.
Government Series, (3) brokers' commissions, and issue and transfer taxes,
chargeable to the U.S. Government Series in connection with securities
transactions, (4) insurance premiums, interest charges, dues and fees for
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membership in trade associations and all taxes and fees payable by the U.S.
Government Series to Federal, state or other governmental agencies, (5) fees and
expenses involved in registering and maintaining registrations of the shares of
the U.S. Government Series with the Securities and Exchange Commission and under
the securities laws or regulations of states and other jurisdictions, (6) all
expenses of shareholders' and Trustees' meetings and of preparing, printing and
distributing notices, proxy statements and all reports to shareholders and to
governmental agencies, (7) charges and expenses of legal counsel to the Fund,
(8) compensation of those Trustees of the Fund as such who are not affiliated
with or interested persons of the Manager or the Fund (other than as Trustees),
(9) fees and expenses incurred pursuant to the 12b-1 Plan and (10) such
nonrecurring or extraordinary expenses as may arise, including litigation
affecting the Fund or the U.S. Government Series and any indemnification by the
Fund of its Trustees, officers, employees or agents with respect thereto. To the
extent any of the foregoing charges or expenses are incurred by the Fund for the
benefit of each of the Fund's series, the U.S. Government Series is responsible
for payment of the portion of such charges or expenses which are properly
allocable to the U.S.
Government Series.
As compensation for the performance of its management services
and the assumption of certain expenses of the U.S. Government Series and the
Fund, the Manager is entitled under the Management Agreement to an annual
management fee (which is computed daily and paid monthly) from the U.S.
Government Series equal to the percentage of the average daily net asset value
of the U.S. Government Series as follows: .75% per annum of the U.S. Government
Series' average daily net assets up to $500 million, .725% per annum of the U.S.
Government Series' average daily net assets for the next $500 million, and .70%
per annum of the U.S. Government Series' average daily net assets above $1
billion.
However, if for any fiscal year in which the aggregate operating
expenses of the U.S. Government Series (including the management fee but
exclusive of taxes, interest expenses, brokerage fees and commissions, fees and
expenses paid pursuant to the Plan and extraordinary expenses beyond the control
of, and not caused by bad faith, negligence or malfeasance of the Manager, if
any), are in excess of the expense limitation of any state having jurisdiction
over the U.S. Government Series, the Manager will reimburse the U.S. Government
Series on a monthly basis for the amount of such excess.
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<PAGE>
PORTFOLIO TRANSACTIONS
All orders for the purchase or sale of portfolio securities are
placed on behalf of the U.S. Government Series by the Manager pursuant to
authority contained in the Management Agreement (subject to the right of the
Trustees to reverse any such transaction). The Manager is and may in the future
also be responsible for the placement of transaction orders for the other series
of the Fund and other funds for which the Manager acts as investment adviser.
Securities purchased and sold on behalf of the U.S. Government Series will be
traded on a net basis (i.e. without commission) through dealers acting for their
own account and not as brokers or otherwise involve transactions directly with
the issuer of the instrument. In selecting brokers or dealers, the Manager will
consider various relevant factors, including, but not limited to, the size and
type of the transaction; the nature and character of the markets for the
security to be purchased or sold; the execution efficiency, settlement
capability, and financial condition of the dealer; the dealer's execution
services rendered on a continuing basis; and the reasonableness of any dealer
spreads.
Dealers may be selected who provide brokerage and/or research
services to the Fund or U.S. Government Series and/or other investment companies
over which the Manager exercises investment discretion. Such services may
include advice concerning the value of securities; the advisability of investing
in, purchasing or selling securities; the availability of securities or the
purchasers or sellers of securities; furnishing analyses and reports concerning
issuers, industries, securities, economic factors and trends, portfolio strategy
and performance of accounts; and effecting securities transactions and
performing functions incidental thereto (such as clearance and settlement). The
Manager maintains a listing of dealers who provide such services on a regular
basis. However, because it is anticipated that many transactions on behalf of
the U.S. Government Series, other series of the Fund and other funds over which
the Manager exercises investment discretion are placed with dealers (including
dealers on the list) without regard to the furnishing of such services, it is
not possible to estimate the proportion of such transactions directed to such
dealers solely because such services were provided.
The receipt of research from dealers may be useful to the
Manager in rendering investment management services to the U.S. Government
Series and/or other series of the Fund and other funds over which the Manager
exercises investment discretion, and conversely, such information provided by
brokers or dealers who have executed transaction orders on behalf of such other
clients of the Manager may be useful to the Manager in carrying out its
obligations to the U.S. Government Series. The receipt of such
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<PAGE>
research has not reduced the Manager's normal independent research activities;
however, it enables the Manager to avoid the additional expenses which might
otherwise be incurred if it were to attempt to develop comparable information
through its own staff.
Dealers who execute portfolio transactions on behalf of the U.S.
Government Series may receive spreads or commissions which are in excess of the
amount of spreads or commissions which other brokers or dealers would have
charged for effecting such transactions. In order to cause the U.S. Government
Series to pay such higher spreads or commissions, the Manager must determine in
good faith that such spreads or commissions are reasonable in relation to the
value of the brokerage and/or research services provided by such executing
broker or dealers viewed in terms of a particular transaction or the Manager's
overall responsibilities to the U.S. Government Series, the Fund or the
Manager's other clients. In reaching this determination, the Manager will not
attempt to place a specific dollar value on the brokerage and/or research
services provided or to determine what portion of the compensation should be
related to those services.
The Manager is authorized to place portfolio transactions with
dealer firms that have provided assistance in the distribution of shares of the
U.S. Government Series or shares of other series of the Fund or other funds for
which the Manager acts as investment adviser if it reasonably believes that the
quality of the transaction and the amount of the spread are comparable to what
they would be with other qualified dealers.
The Funds' Trustees and brokerage allocation committee
(comprised solely of non-interested Trustees) periodically review the Manager's
performance of its responsibilities in connection with the placement of
portfolio transactions on behalf of the U.S. Government Series and the Fund and
review the dealer spreads paid by the U.S. Government Series and the Fund over
representative periods of time to determine if they are reasonable in relation
to the benefits to the Fund and its portfolios.
The Fund's Trustees have authorized the Manager to effect the
U.S. Government Series' portfolio transactions on an agency basis with
affiliated broker-dealers pursuant to certain procedures incorporating the
standards of Rule 17e-1 of the 1940 Act.
The Fund pays LAS Investments, Inc. ("LAS") commissions or
fees for effecting, or participating in the effectuation of (but not executing),
transactions in futures contracts and options thereon on behalf of the Fund
("Fund Futures and Options Transactions"). LAS is located at 190 South LaSalle
Street, Chicago, Illinois. Mr. Donald E. Newell is the chief executive officer
of LAS and the owner of all of its outstanding shares. Messrs. Malanga and
Newell are each executive officers and 50% shareholders of LaSalle Portfolio
Management, Inc. As a result of Mr. Newell's business relationship with Mr.
Malanga, certain procedures incorporating the standards of Rule 17e-1 of the
1940 Act govern the computation and review of all commissions paid and payable
to LAS. The procedures limit the commissions or fees received, or to be
received, by LAS for Fund Futures and Options Transactions to an amount which is
reasonable and fair compared to the commissions, fees or other remuneration
received by other introducing brokers in connection with comparable transactions
involving similar futures contracts or options on futures contracts, as the case
may be, being purchased or sold on a commodities exchange during a comparable
period of time. The Fund's independent Board Members determine no less
frequently than quarterly that all transactions with LAS during the quarter were
effected in compliance with such procedures.
For the years ended December 31, 1995 and 1994, the U.S.
Government Series' portfolio turnover rate was approximately 114% and 61%,
respectively.
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CUSTODIAN, INDEPENDENT ACCOUNTANTS AND COUNSEL
The Chase Manhattan Bank, N.A. (the "Bank"), 114 West 47th
Street, New York, New York, acts as Custodian of the Fund's cash and securities.
The Bank also acts as bookkeeping agent for the Fund, and in that capacity
monitors the Fund's accounting records and calculates its net asset value.
McGladrey & Pullen, LLP, 555 Fifth Avenue, New York, New York,
acts as independent public accountants for the Fund, performing an annual audit
of the Fund's financial statements and preparing its tax returns.
Kramer, Levin, Naftalis, Nessen, Kamin & Frankel, 919 Third
Avenue, New York, New York, serves as counsel to the Fund.
TAXES
The following is only a summary of certain additional tax
considerations generally affecting the U.S. Government Series and its
shareholders that are not described in the Prospectus. No attempt is made to
present a detailed explanation of the tax treatment of the U.S. Government
Series or its shareholders, and the discussions here and in the Prospectus are
not intended as substitutes for careful tax planning.
QUALIFICATION AS A REGULATED INVESTMENT COMPANY
The U.S. Government Series has elected to be taxed as a
regulated investment company under Subchapter M of the Internal Revenue Code of
1986, as amended (the "Code"). As a regulated investment company, the U.S.
Government Series is not subject to federal income tax on the portion of its net
investment income (i.e., taxable interest, dividends and other taxable ordinary
income, net of expenses) and capital gain net income (i.e., the excess of
capital gains over capital losses) that it distributes to shareholders, provided
that it distributes at least 90% of its investment company taxable income (i.e.,
net investment income and the excess of net short-term capital gain over net
long-term capital loss) for the taxable year (the "Distribution Requirement"),
and satisfies certain other requirements of the Code that are described below.
Distributions by the U.S. Government Series made during the taxable year or,
under specified circumstances, within twelve months after the close of the
taxable year, will be considered distributions of income and gains of the
taxable year and can therefore satisfy the Distribution Requirement.
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<PAGE>
In addition to satisfying the Distribution Requirement, a
regulated investment company must: (1) derive at least 90% of its gross income
from dividends, interest, certain payments with respect to securities loans,
gains from the sale or other disposition of stock or securities or foreign
currencies (to the extent such currency gains are directly related to the
regulated investment company's principal business of investing in stock or
securities) and other income (including but not limited to gains from options,
futures or forward contracts) derived with respect to its business of investing
in such stock, securities or currencies (the "Income Requirement"); and (2)
derive less than 30% of its gross income (exclusive of certain gains on
designated hedging transactions that are offset by realized or unrealized losses
on offsetting positions) from the sale or other disposition of stock, securities
or foreign currencies (or options, futures or forward contracts thereon) held
for less than three months (the "ShortShort Gain Test"). However, foreign
currency gains, including those derived from options, futures and forwards, will
not in any event be characterized as Short-Short Gain if they are directly
related to the regulated investment company's investments in stock or securities
(or options or futures thereon). Because of the Short-Short Gain Test, the U.S.
Government Series may have to limit the sale of appreciated securities that it
has held for less than three months. However, the Short-Short Gain Test will not
prevent the U.S. Government Series from disposing of investments at a loss,
since the recognition of a loss before the expiration of the three-month holding
period is disregarded for this purpose. Interest (including original issue
discount) received by the U.S. Government Series at maturity or upon the
disposition of a security held for less than three months will not be treated as
gross income derived from the sale or other disposition of such security within
the meaning of the Short-Short Gain Test. However, income that is attributable
to realized market appreciation will be treated as gross income from the sale or
other disposition of securities for this purpose.
In general, gain or loss recognized by the U.S. Government
Series on the disposition of an asset will be a capital gain or loss. However,
gain recognized on the disposition of a debt obligation purchased by the U.S.
Government Series at a market discount (generally, at a price less than its
principal amount) will be treated as ordinary income to the extent of the
portion of the market discount which accrued during the period of time the U.S.
Government Series held the debt obligation.
In general, for purposes of determining whether capital gain or
loss recognized by the U.S. Government Series on the disposition of an asset is
long-term or short-term, the holding period of the asset may be affected if (1)
the asset is used to close a "short sale" (which includes for certain purposes
the acquisition of a put option) or is substantially identical to
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another asset so used, or (2) the asset is otherwise held by the U.S. Government
Series as part of a "straddle" (which term generally excludes a situation where
the asset is stock and the U.S. Government Series grants a qualified covered
call option (which, among other things, must not be deep-in-the-money) with
respect thereto). However, for purposes of the Short-Short Gain Test, the
holding period of the asset disposed of may be reduced only in the case of
clause (1) above. In addition, the U.S. Government Series may be required to
defer the recognition of a loss on the disposition of an asset held as part of a
straddle to the extent of any unrecognized gain on the offsetting position.
Any gain recognized by the U.S. Government Series on the lapse
of, or any gain or loss recognized by the U.S. Government Series from a closing
transaction with respect to, an option written by the U.S. Government Series
will be treated as a short-term capital gain or loss. For purposes of the
Short-Short Gain Test, the holding period of an option written by the U.S.
Government Series will commence on the date it is written and end on the date it
lapses or the date a closing transaction is entered into. Accordingly, the U.S.
Government Series may be limited in its ability to write options which expire
within three months and to enter into closing transactions at a gain within
three months of the writing of options.
Transactions that may be engaged in by the U.S. Government
Series (such as regulated futures contracts, certain foreign currency contracts,
and options on stock indexes and futures contracts) will be subject to special
tax treatment as "Section 1256 contracts." Section 1256 contracts are treated as
if they are sold for their fair market value on the last business day of the
taxable year, even though a taxpayer's obligations (or rights) under such
contracts have not terminated (by delivery, exercise, entering into a closing
transaction or otherwise) as of such date. Any gain or loss recognized as a
consequence of the year-end deemed disposition of Section 1256 contracts is
taken into account for the taxable year together with any other gain or loss
that was previously recognized upon the termination of Section 1256 contracts
during that taxable year. Any capital gain or loss for the taxable year with
respect to Section 1256 contracts (including any capital gain or loss arising as
a consequence of the year-end deemed sale of such contracts) is generally
treated as 60% long-term capital gain or loss and 40% short-term capital gain or
loss. The U.S. Government Series, however, may elect not to have this special
tax treatment apply to Section 1256 contracts that are part of a "mixed
straddle" with other investments of the U.S. Government Series that are not
Section 1256 contracts. The IRS has held in several private rulings (and
Treasury Regulations now provide) that gains arising from Section 1256 contracts
will be treated for
-27-
<PAGE>
purposes of the Short-Short Gain Test as being derived from securities held for
not less than three months if the gains arise as a result of a constructive sale
under Code Section 1256.
Treasury Regulations permit a regulated investment company, in
determining its investment company taxable income and net capital gain (i.e.,
the excess of net long-term capital gain over net short-term capital loss) for
any taxable year, to elect (unless it has made a taxable year election for
excise tax purposes as discussed below) to treat all or any part of any net
capital loss, any net long-term capital loss or any net foreign currency loss
incurred after October 31 as if it had been incurred in the succeeding year.
In addition to satisfying the requirements described above, the
U.S. Government Series must satisfy an asset diversification test in order to
qualify as a regulated investment company. Under this test, at the close of each
quarter of the U.S. Government Series' taxable year, at least 50% of the value
of the U.S. Government Series' assets must consist of cash and cash items, U.S.
Government securities, securities of other regulated investment companies, and
securities of other issuers (as to which the U.S. Government Series has not
invested more than 5% of the value of the U.S. Government Series' total assets
in securities of such issuer and as to which the U.S. Government Series does not
hold more than 10% of the outstanding voting securities of such issuer), and no
more than 25% of the value of its total assets may be invested in the securities
of any one issuer (other than U.S. Government securities and securities of other
regulated investment companies), or in two or more issuers which the U.S.
Government Series controls and which are engaged in the same or similar trades
or businesses. Generally, an option (call or put) with respect to a security is
treated as issued by the issuer of the security, not the issuer of the option.
However, with regard to forward currency contracts, there does not appear to be
any formal or informal authority which identifies the issuer of such instrument.
For purposes of asset diversification testing, obligations issued or guaranteed
by agencies or instrumentalities of the U.S. Government such as the Federal
Agricultural Mortgage Corporation, the Farm Credit System Financial Assistance
Corporation, a Federal Home Loan Bank, the Federal Home Loan Mortgage
Corporation, the Federal National Mortgage Association, the Government National
Mortgage Corporation, and the Student Loan Marketing Association are treated as
U.S. Government securities.
If for any taxable year the U.S. Government Series does not
qualify as a regulated investment company, all of its taxable income (including
its net capital gain) will be subject to tax at regular corporate rates without
any deduction for distributions to shareholders, and such distributions will be
taxable to the shareholders as ordinary dividends to the extent of the U.S.
-28-
<PAGE>
Government Series' current and accumulated earnings and profits. Such
distributions generally will be eligible for the dividends-received deduction in
the case of corporate shareholders.
EXCISE TAX ON REGULATED INVESTMENT COMPANIES
A 4% non-deductible excise tax is imposed on a regulated
investment company that fails to distribute in each calendar year an amount
equal to 98% of ordinary taxable income for the calendar year and 98% of capital
gain net income for the one-year period ended on October 31 of such calendar
year (or, at the election of a regulated investment company having a taxable
year ending November 30 or December 31, for its taxable year (a "taxable year
election")). The balance of such income must be distributed during the next
calendar year. For the foregoing purposes, a regulated investment company is
treated as having distributed any amount on which it is subject to income tax
for any taxable year ending in such calendar year.
For purposes of the excise tax, a regulated investment company
shall: (1) reduce its capital gain net income (but not below its net capital
gain) by the amount of any net ordinary loss for the calendar year; and (2)
exclude foreign currency gains and losses incurred after October 31 of any year
(or after the end of its taxable year if it has made a taxable year election) in
determining the amount of ordinary taxable income for the current calendar year
(and, instead, include such gains and losses in determining ordinary taxable
income for the succeeding calendar year).
The U.S. Government Series intends to make sufficient
distributions or deemed distributions of its ordinary taxable income and capital
gain net income prior to the end of each calendar year to avoid liability for
the excise tax. However, investors should note that the U.S. Government Series
may in certain circumstances be required to liquidate portfolio investments to
make sufficient distributions to avoid excise tax liability.
U.S. GOVERNMENT SERIES DISTRIBUTIONS
The U.S. Government Series anticipates distributing
substantially all of its investment company taxable income for each taxable
year. Such distributions will be taxable to shareholders as ordinary income and
treated as dividends for federal income tax purposes, but they will not qualify
for the 70% dividends-received deduction for corporate shareholders.
The U.S. Government Series may either retain or distribute to
shareholders its net capital gain for each taxable year. The U.S. Government
Series currently intends to distribute any such
-29-
<PAGE>
amounts. Net capital gain that is distributed and designated as a capital gain
dividend, will be taxable to shareholders as long-term capital gain, regardless
of the length of time the shareholder has held his shares or whether such gain
was recognized by the U.S. Government Series prior to the date on which the
shareholder acquired his shares.
Distributions by the U.S. Government Series that do not
constitute ordinary income dividends or capital gain dividends will be treated
as a return of capital to the extent of (and in reduction of) the shareholder's
tax basis in his shares; any excess will be treated as gain from the sale of his
shares, as discussed below.
Distributions by the U.S. Government Series will be treated in
the manner described above regardless of whether such distributions are paid in
cash or reinvested in additional shares of the U.S. Government Series (or of
another fund). Shareholders receiving a distribution in the form of additional
shares will be treated as receiving a distribution in an amount equal to the
fair market value of the shares received, determined as of the reinvestment
date. In addition, if the net asset value at the time a shareholder purchases
shares of the U.S. Government Series reflects undistributed net investment
income or recognized capital gain net income, or unrealized appreciation in the
value of the assets of the U.S. Government Series, distributions of such amounts
will be taxable to the shareholder in the manner described above, although such
distributions economically constitute a return of capital to the shareholder.
Shareholders purchasing shares of the U.S. Government Series
just prior to the ex-dividend date will be taxed on the entire amount of the
dividend received, even though the net asset value per share on the date of such
purchase reflected the amount of such dividend.
Ordinarily, shareholders are required to take distributions by
the U.S. Government Series into account in the year in which they are made.
However, dividends declared in October, November or December of any year and
payable to shareholders of record on a specified date in such a month will be
deemed to have been received by the shareholders (and made by the U.S.
Government Series) on December 31 of such calendar year if such dividends are
actually paid in January of the following year. Shareholders will be advised
annually as to the U.S. federal income tax consequences of distributions made
(or deemed made) to them during the year.
The U.S. Government Series will be required in certain cases to
withhold and remit to the U.S. Treasury 31% of ordinary income dividends and
capital gain dividends, and the proceeds of
-30-
<PAGE>
redemption of shares, paid to any shareholder (1) who has provided either an
incorrect tax identification number or no number at all, (2) who is subject to
backup withholding by the IRS for failure to report the receipt of interest or
dividend income properly, or (3) who has failed to certify to the U.S.
Government Series that it is not subject to backup withholding or that it is a
corporation or other "exempt recipient."
SALE OR REDEMPTION OF SHARES
A shareholder will recognize gain or loss on the sale or
redemption of shares of the U.S. Government Series in an amount equal to the
difference between the proceeds of the sale or redemption and the shareholder's
adjusted tax basis in the shares. All or a portion of any loss so recognized may
be disallowed if the shareholder purchases other shares of the U.S. Government
Series within 30 days before or after the sale or redemption. In general, any
gain or loss arising from (or treated as arising from) the sale or redemption of
shares of the U.S. Government Series will be considered capital gain or loss and
will be long-term capital gain or loss if the shares were held for longer than
one year. However, any capital loss arising from the sale or redemption of
shares held for six months or less will be treated as a long-term capital loss
to the extent of the amount of capital gain dividends received on such shares.
For this purpose, the special holding period rules of Code Section 246(c)(3) and
(4) generally will apply in determining the holding period of shares. Long-term
capital gains of noncorporate taxpayers are currently taxed at a maximum rate
11.6% lower than the maximum rate applicable to ordinary income. Capital losses
in any year are deductible only to the extent of capital gains plus, in the case
of a noncorporate taxpayer, $3,000 of ordinary income.
FOREIGN SHAREHOLDERS
Taxation of a shareholder who, as to the United States, is a
nonresident alien individual, foreign trust or estate, foreign corporation, or
foreign partnership ("foreign shareholder"), depends on whether the income from
the U.S. Government Series is "effectively connected" with a U.S. trade or
business carried on by such shareholder.
If the income from the U.S. Government Series is not effectively
connected with a U.S. trade or business carried on by a foreign shareholder,
ordinary income dividends paid to a foreign shareholder will be subject to U.S.
withholding tax at the rate of 30% (or lower applicable treaty rate) upon the
gross amount of the dividend. Such a foreign shareholder would generally be
exempt from U.S. federal income tax on gains realized on the sale of shares of
the U.S. Government Series, capital gain dividends and amounts retained by the
U.S. Government Series that are designated
-31-
<PAGE>
as undistributed capital gains.
If the income from the U.S. Government Series is effectively
connected with a U.S. trade or business carried on by a foreign shareholder,
then ordinary income dividends, capital gain dividends, and any gains realized
upon the sale of shares of the U.S. Government Series will be subject to U.S.
federal income tax at the rates applicable to U.S. citizens or domestic
corporations.
In the case of a noncorporate foreign shareholder, the U.S.
Government Series may be required to withhold U.S. federal income tax at a rate
of 31% on distributions that are otherwise exempt from withholding (or taxable
at a reduced treaty rate), unless the shareholder furnishes the U.S. Government
Series with proper notification of its foreign status.
The tax consequences to a foreign shareholder entitled to claim
the benefits of an applicable tax treaty may be different from those described
herein. Foreign shareholders are urged to consult their own tax advisers with
respect to the particular tax consequences to them of an investment in the U.S.
Government Series, including the applicability of foreign taxes.
EFFECT OF FUTURE LEGISLATION; LOCAL TAX CONSIDERATIONS
The foregoing general discussion of U.S. federal income tax
consequences is based on the Code and Treasury Regulations issued thereunder as
in effect on the date of this Statement. Future legislative or administrative
changes or court decisions may significantly change the conclusions expressed
herein, and any such changes or decisions may have a retroactive effect.
Rules of state and local taxation of ordinary income dividends
and capital gain dividends from regulated investment companies often differ from
the rules for U.S. federal income taxation described above. Shareholders are
urged to consult their tax advisers as to the consequences of federal, state and
local tax rules with respect to an investment in the U.S. Government Series.
DESCRIPTION OF SHARES
The Fund's Declaration of Trust permits its Board of Trustees to
authorize the issuance of an unlimited number of full and fractional shares of
beneficial interest (without par value), which may be divided into such separate
series as the Trustees may establish. The Fund currently has three series of
shares: the U.S. Government Series, the Tax-Free Money Market Series and the
High-Yield Municipal Bond Series. The Trustees may establish additional series
of shares, and may divide or combine the shares into a greater or lesser number
of shares without thereby changing
-32-
<PAGE>
the proportionate beneficial interests of each series. Each share represents an
equal proportionate interest in a series with each other share. The shares of
any additional series would participate equally in the earnings, dividends and
assets of the particular series, and would be entitled to vote separately to
approve investment advisory agreements or changes in investment restrictions,
but shareholders of all series would vote together in the election and selection
of Trustees and accountants. Upon liquidation of the Fund, the shareholders of
each series are entitled to share pro rata in the net assets available for
distribution to shareholders of such series.
Shareholders are entitled to one vote for each share held and
may vote in the election of Trustees and on other matters submitted to meetings
of shareholders. Although Trustees are not elected annually by the shareholders,
shareholders have under certain circumstances the right to remove one or more
Trustees. No material amendment may be made to the Fund's Declaration of Trust
without the affirmative vote of a majority of its shares. Shares have no
preemptive or conversion rights. Shares are fully paid and non-assessable,
except as set forth below. See "Certain Liabilities."
CERTAIN LIABILITIES
As a Massachusetts business trust, the Fund's operations are
governed by its Declaration of Trust dated March 19, 1987, a copy of which is on
file with the office of the Secretary of The Commonwealth of Massachusetts.
Theoretically, shareholders of a Massachusetts business trust may, under certain
circumstances, be held personally liable for the obligations of the trust.
However, the Declaration of Trust contains an express disclaimer of shareholder
liability for acts or obligations of the Fund or any series of the Fund and
requires that notice of such disclaimer be given in each agreement, obligation
or instrument entered into or executed by the Fund or its Trustees. Moreover,
the Declaration of Trust provides for the indemnification out of Fund property
of any shareholders held personally liable for any obligations of the Fund or
any series of the Fund. The Declaration of Trust also provides that the Fund
shall, upon request, assume the defense of any claim made against any
shareholder for any act or obligation of the Fund and satisfy any judgment
thereon. Thus, the risk of a shareholder incurring financial loss beyond his or
her investment because of shareholder liability would be limited to
circumstances in which the Fund itself will be unable to meet its obligations.
In light of the nature of the Fund's business, the possibility of the Fund's
liabilities exceeding its assets, and therefore a shareholder's risk of personal
liability, is extremely remote.
The Declaration of Trust further provides that the Fund
-33-
<PAGE>
shall indemnify each of its Trustees and officers against liabilities and
expenses reasonably incurred by them, in connection with, or arising out of, any
action, suit or proceeding, threatened against or otherwise involving such
Trustee or officer, directly or indirectly, by reason of being or having been a
Trustee or officer of the Fund. The Declaration of Trust does not authorize the
Fund to indemnify any Trustee or officer against any liability to which he or
she would otherwise be subject by reason of willful misfeasance, bad faith,
gross negligence or reckless disregard of such person's duties.
DETERMINATION OF NET ASSET VALUE
The net asset value per share of the U.S. Government Series is
determined as of the close of trading on the New York Stock Exchange (currently
4:00 P.M., New York time) on each day that both the New York Stock Exchange and
the Fund's custodian bank are open for business. The net asset value per share
of the U.S. Government Series is also determined on any other day in which the
level of trading in its portfolio securities is sufficiently high that the
current net asset value per share might be materially affected by changes in the
value of its portfolio securities. On any day in which no purchase orders for
the shares of the U.S. Government Series become effective and no shares are
tendered for redemption, the net asset value per share is not determined.
PERFORMANCE INFORMATION
For purposes of quoting and comparing the performance of the
U.S. Government Series to that of other mutual funds and to stock or other
relevant indices in advertisements or in reports to shareholders, performance
will be stated both in terms of total return and in terms of yield. The total
return basis combines principal and dividend income changes for the periods
shown. Principal changes are based on the difference between the beginning and
closing net asset values for the period and assume reinvestment of dividends and
distributions paid by the U.S. Government Series. Dividends and distributions
are comprised of net investment income and net realized capital gains. Under the
rules of the Securities and Exchange Commission, funds advertising performance
must include total return quotes calculated according to the following formula:
P(1 + T)n = ERV
Where P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years (1, 5 or 10)
-34-
<PAGE>
ERV = ending redeemable value of a hypothetical
$1,000 payment made at the beginning of the
1, 5 or 10 year periods or at the end of the
1, 5 or 10 year periods (or fractional
portion thereof)
Under the foregoing formula the time periods used in advertising
will be based on rolling calendar quarters, updated to the last day of the most
recent quarter prior to submission of the advertising for publication, and will
cover one, five, and ten year periods or a shorter period dating from the
effectiveness of the U.S. Government Series' registration statement. In
calculating the ending redeemable value, the pro rata share of the account
opening fee is deducted from the initial $1,000 investment and all dividends and
distributions by the U.S. Government Series are assumed to have been reinvested
at net asset value as described in the prospectus on the reinvestment dates
during the period. Total return, or "T" in the formula above, is computed by
finding the average annual compounded rates of return over the 1, 5 and 10 year
periods (or fractional portion thereof) that would equate the initial amount
invested to the ending redeemable value.
The U.S. Government Series' aggregate unannualized total rate of
return, reflecting the initial investment and reinvestment of all dividends and
distributions, for the period from March 2, 1992 (commencement of public
offering of shares) to December 31, 1995, was 0.12%.
The U.S. Government Series may also from time to time include in
such advertising a total return figure that is not calculated according to the
formula set forth above in order to compare more accurately the U.S. Government
Series' performance with other measures of investment return. For example, in
comparing the U.S. Government Series's total return with data published by
Lipper Analytical Services, Inc. or similar independent services or financial
publications, the U.S. Government Series calculates its aggregate total return
for the specified periods of time by assuming the reinvestment of each dividend
or other distribution at net asset value on the reinvestment date. Percentage
increases are determined by subtracting the initial net asset value of the
investment from the ending net asset value and by dividing the remainder by the
beginning net asset value. The U.S. Government Series does not, for these
purposes, deduct the pro rata share of the account opening fee from the initial
value invested. The U.S. Government Series will, however, disclose the pro rata
share of the account opening fee and will disclose that the performance data
does not reflect such non-recurring charge and that inclusion of such charge
would reduce the performance quoted. Such alternative total return information
will be given no greater prominence in such advertising than the information
prescribed under the Securities and Exchange Commission's rules.
-35-
<PAGE>
In addition to the total return quotations discussed above, the
U.S. Government Series may advertise its yield based on a 30-day (or one month)
period ended on the date of the most recent balance sheet included in the U.S.
Government Series' Post-Effective Amendment to its Registration Statement,
computed by dividing the net investment income per share earned during the
period by the maximum offering price per share on the last day of the period,
according to the following formula:
a-b
YIELD 2[( ----- +1)6-1]
cd
Where: a = dividends and interest earned during
the period.
b = expenses accrued for the period (net of
reimbursements).
c = the average daily number of shares
outstanding during the period that were
entitled to receive dividends.
d = the maximum offering price per share on
the last day of the period.
Under this formula, interest earned on debt obligations for
purposes of "a" above, is calculated by (1) computing the yield to maturity of
each obligation held by the U.S. Government Series based on the market value of
the obligation (including actual accrued interest) at the close of business on
the last day of each month, or, with respect to obligations purchased during the
month, the purchase price (plus actual accrued interest), (2) dividing that
figure by 360 and multiplying the quotient by the market value of the obligation
(including actual accrued interest as referred to above) to determine the
interest income on the obligation for each day of the subsequent month that the
obligation is in the U.S. Government Series' portfolio (assuming a month of 30
days) and (3) computing the total of the interest earned on all debt obligations
and all dividends accrued on all equity securities during the 30-day or one
month period. In computing dividends accrued, dividend income is recognized by
accruing 1/360 of the stated dividend rate of a security each day that the
security is in the U.S. Government Series' portfolio. For purposes of "b" above,
Rule 12b-1 expenses are included among the expenses accrued for the period. Any
amounts representing sales charges will not be included among these expenses;
however, the U.S. Government Series will disclose the pro rata share of the
account opening fee. Undeclared earned income, computed in accordance with
generally accepted accounting principles, may be subtracted from the maximum
offering price calculation required pursuant to "d" above.
-36-
<PAGE>
Any quotation of performance stated in terms of yield will be
given no greater prominence than the information prescribed under the Securities
and Exchange Commission's rules. In addition, all advertisements containing
performance data of any kind will include a legend disclosing that such
performance data represents past performance and that the investment return and
principal value of an investment will fluctuate so that an investor's shares,
when redeemed, may be worth more or less than their original cost.
The U.S. Government Series' yield as of December 31, 1995, based
on a 30-day period, was 7.20%
OTHER INFORMATION
As of April 22, 1996, the Trustees and officers of the Fund as a
group beneficially owned less than 1% of the outstanding shares of the U.S.
Government Series. As of such date, no persons were known by Fund management to
have owned beneficially, directly or indirectly, 5% or more of the outstanding
shares of the U.S. Government Series.
FINANCIAL STATEMENTS
Audited financial statements of the U.S. Government Series for
the year ended December 31, 1995 are attached hereto.
-37-
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
(left column)
STATEMENT OF ASSETS AND LIABILITIES
December 31, 1995
- --------------------------------------------------------------------------------
ASSETS
Investment in securities, at value (cost
$19,364,775) (Notes 5 and 6) ......... $22,828,137
Interest receivable .................... 110,989
-----------
Total assets ..................... 22,939,126
-----------
LIABILITIES
Notes payable .......................... 63,000
Options written at value (premiums
received $62,325) (Note 5) ........... 93,360
Securities sold subject to repurchase
(Note 6) ............................. 7,431,045
Payables:
Capital stock redeemed ............... 7,962
Dividends declared ................... 23,784
Accrued expenses ..................... 99,265
Variation margin ..................... 26,481
-----------
Total liabilities ................ 7,744,897
-----------
NET ASSETS consisting of:
Accumulated net realized loss ......... $(18,337,748)
Unrealized appreciation of securities . 3,463,362
Unrealized depreciation of options
written .............................. (31,035)
Unrealized depreciation of open future
contracts ............................ (183,771)
Paid-in-capital applicable to
10,191,431 shares of beneficial
interest ............................. 30,283,421
------------
$15,194,229
===========
NET ASSET VALUE PER SHARE ................ $1.49
=====
(Right Column)
STATEMENT OF OPERATIONS
Year Ended December 31, 1995
- --------------------------------------------------------------------------------
INVESTMENT INCOME
Interest income, net of $455,877 of
interest expense ..................... $ 1,491,430
EXPENSES (Notes 2, 3 and 6)
Investment advisory fees ............... $ 121,770
Custodian and accounting fees .......... 47,886
Transfer agent fees .................... 62,540
Professional fees ...................... 305,365
Trustees' fees ......................... 16,893
Printing and postage ................... 2,393
Interest on bank borrowing ............. 32,761
Distribution expenses .................. 40,695
Other .................................. 60,789
Less: Expenses waived or reimbursed
by manager and affiliate ............. (162,388)
-----------
Total expenses 528,704
-----------
Net investment income ............ 962,726
REALIZED AND UNREALIZED GAIN
(LOSS) ON INVESTMENTS
Net realized loss on:
Investments .......................... (10,482,851)
Future and options on futures ........ (3,905,275) (14,388,126)
-----------
Change in unrealized appreciation
(depreciation) of investments,
options and futures contracts
for the year:
Investments ........................ 15,547,752
Open option contracts written ...... (12,178)
Open futures contracts ............. 127,400 15,662,974
----------- -----------
Net gain on investments ................ 1,274,848
-----------
NET INCREASE IN NET ASSETS
FROM OPERATIONS ........................ $ 2,237,574
===========
(Bottom)
STATEMENT OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Year Ended Year Ended
December December
31, 1995 31, 1994
-------- --------
INCREASE (DECREASE) IN NET ASSETS FROM:
OPERATIONS
<S> <C> <C>
Net investment income ................................................................... $ 962,726 $ 3,223,702
Net realized gain (loss) on investments ................................................. (14,388,126) 6,321,524
Unrealized appreciation (depreciation) on investments, options and futures contracts .... 15,662,974 (21,438,948)
------------ ------------
Net increase (decrease) in net assets from operations ............................. 2,237,574 (11,893,722)
DIVIDENDS PAID TO SHAREHOLDERS FROM
Investment income ....................................................................... (962,726) (3,223,702)
CAPITAL SHARE TRANSACTIONS (Note 4) ....................................................... (5,170,959) (28,974,362)
------------ ------------
Total decrease .................................................................... (3,896,111) (44,091,786)
NET ASSETS
Beginning of year ....................................................................... 19,090,340 63,182,126
------------ ------------
End of year ............................................................................. $ 15,194,229 $ 19,090,340
============ ============
</TABLE>
See Notes to Financial Statements.
3
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
STATEMENT OF OPTIONS WRITTEN
December 31, 1995
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Number of Expiration
Contracts++ Options Written Month Value
- ----------- --------------- ---------- --------
<S> <C> <C> <C>
25 U.S. Treasury Bonds, Call @ $122 February 1996 $ 20,703
50 U.S. Treasury Bonds, Call @ $122 March 1996 72,657
--------
$ 93,360
========
<FN>
++Each contract represents $100,000 face value of U.S. Treasury Bond Futures.
</FN>
</TABLE>
STATEMENT OF CASH FLOWS
Year Ended December 31, 1995
- --------------------------------------------------------------------------------
INCREASE (DECREASE) IN CASH
<TABLE>
CASH FLOWS FROM OPERATING ACTIVITIES
<S> <C>
Net increase in net assets from operations ............................... $ 2,237,574
Adjustments to reconcile net increase in net assets from operations to
net cash provided by operating activities:
Purchase of investment securities ........................................ (30,993,645)
Proceeds on sale of securities ........................................... 42,446,029
Premiums received for options written .................................... 1,043,355
Premiums paid to close options written ................................... (2,410,864)
Decrease in interest receivable .......................................... 372,942
Decrease in variation margin receivable .................................. 59,294
Decrease in accrued expenses ............................................. (63,798)
Net accretion of discount on securities .................................. (337,697)
Net realized (gain) loss:
Investments ............................................................ 10,482,161
Options written ........................................................ 1,016,659
Unrealized appreciation on securities and options written for the period . (15,535,574)
-----------
Total adjustments .................................................... 6,078,862
-----------
Net cash provided by operating activities ............................ 8,316,436
-----------
CASH FLOWS FROM FINANCING ACTIVITIES:*
Net repayments of note payable and securities sold subject to repurchase ... (2,177,075)
Proceeds on shares sold .................................................... 1,819,736
Payment on shares repurchased .............................................. (7,761,803)
Cash dividends paid ........................................................ (237,526)
-----------
Net cash provided by financing activities ............................ (8,356,668)
-----------
Net decrease in cash ................................................. (40,232)
CASH AT BEGINNING OF YEAR .................................................... 40,232
-----------
CASH AT END OF YEAR .......................................................... $ 0
===========
<FN>
*Non-cash financing activities not included herein consist of reinvestment of dividends of $779,070.
Cash payments for interest expense totaled $488,706 for the period.
</FN>
</TABLE>
See Notes to Financial Statements.
4
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
STATEMENT OF INVESTMENTS
December 31, 1995
- --------------------------------------------------------------------------------
Principal Interest Maturity
Amount Rate Date Value
------ ---- ---- -----
United States Treasury Securities-43.21%
United States Treasury Bonds
5,500,000 9.00% 11/15/18 $ 7,497,173
4,300,000* 0.00% 11/15/11 2,312,411
85,000* 0.00% 11/15/03 54,455
-----------
(Cost $8,098,571) 9,864,039
-----------
United States Agency Backed Securities-56.79%
Federal Home Loan Mortgage Corporation
843,718+ 9.25% 08/15/23 914,505
250,454+ 6.50% 12/15/23 223,308
FNMA-Federal National Mortgage Assoc. Collateralized Mortgage Obligations
3,671,204+ TTIB** 03/25/23 3,821,099
356,450+ 15.50% 03/25/23 362,239
490,760+ TTIB** 05/25/23 528,882
1,519,480+ TTIB** 11/25/23 1,478,879
980,392 TTIB** 11/25/23 1,088,706
1,000,000(beta) 8.75% 12/25/23 1,112,230
465,436+ 12.50% 08/25/23 470,700
953,000 9.00% 02/25/24 957,470
Department of Navy, FNMA Guaranteed
100,000+ 0.00% 04/01/09 43,189
REFCO-Resolution Funding Corporation
600,000 0.00% 07/15/10 248,994
-----------
(Cost $10,120,746) 11,250,201
-----------
FICO-Financing Corporation (U.S. Government Agency) Zero Coupon Securities
100,000* 11/02/12 34,024
100,000* 05/02/14 30,580
125,000 05/02/15 35,565
200,000+ 11/02/18 44,613
148,000* 05/11/12 52,068
99,000* 11/11/13 31,321
119,000* 11/11/14 35,042
320,000+ 11/11/17 76,269
281,000* 05/30/14 85,455
261,000* 11/30/15 71,232
164,000* 11/30/16 41,666
167,000* 08/08/17 40,477
100,000* 08/03/18 22,669
182,000* 06/06/15 51,431
109,000+ 12/06/17 25,848
137,000* 08/03/15 38,267
5
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
PORTFOLIO OF INVESTMENTS (continued)
December 31, 1995
- --------------------------------------------------------------------------------
Principal Interest Maturity
Amount Rate Date Value
------ ---- ---- -----
FICO-Financing Corporation (U.S. Government Agency) Zero Coupon Securities
(continued)
208,000 02/03/16 $ 56,114
138,000* 02/03/11 53,055
250,000 10/06/14 74,140
205,000+* 04/06/17 50,811
259,000* 10/05/15 71,453
100,000+ 10/05/17 23,991
217,000+ 04/05/18 50,272
375,000* 04/05/19 81,349
74,000 04/05/15 21,171
100,000 10/05/16 25,692
240,000* 10/06/17 60,300
135,000 04/06/04 83,230
444,000+ 08/08/16 115,387
100,000+ 02/08/17 25,050
200,000* 04/06/17 49,572
129,000 10/06/17 30,943
108,000+ 11/30/17 25,644
100,000+ 02/03/12 35,855
118,000* 08/03/16 30,698
144,000 08/03/18 32,643
-----------
(Cost $1,145,458) $ 1,713,897
-----------
Total investments (Cost $19,364,775++) $22,828,137
===========
** Two-Tiered Index Floating Rate Bonds (TTIB) are instruments whose
interest rate is fixed over various ranges of the interest rate on
another security or the value of an index, but variable within certain
ranges of the same security or index.
+ Collateral or partial collateral for securities sold subject to
repurchase (Note 6)
* Segregated, in whole or part, as initial margin for futures contracts
(Note 5)
++ Cost is the same for Federal income tax purposes
(beta) Security valued in good faith under procedures approved by the Fund's
Board of Trustees.
See Notes to Financial Statements.
6
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
NOTES TO FINANCIAL STATEMENTS
December 31, 1995
- --------------------------------------------------------------------------------
1. Significant Accounting Policies
Fundamental Fixed-Income Fund (the Fund) is an open-end management
investment company registered under the Investment Company Act of 1940. The Fund
operates as a series company currently issuing three classes of shares of
beneficial interest, the Tax-Free Money Market Series, the High-Yield Municipal
Bond Series and the U.S. Government Strategic Income Fund (the Series). Each
series is considered a separate entity for financial reporting and tax purposes.
The Fund seeks to provide high current income with minimum risk of principal and
relative stability of net asset value.
Valuation of Securities-Investments are stated at value based on prices
provided by a pricing service which takes into account appropriate factors
such as institution-size trading in similar groups of securities, yield,
quality, coupon rate, maturity, type of issue, trading characteristics and
other market data, without exclusive reliance upon exchange or
over-the-counter prices, because such valuations are believed to reflect
more accurately the fair value of such securities. Securities not priced in
this manner are valued at the mean between the most recently quoted bid and
ask prices provided by dealers. Securities for which quotations are not
readily available are valued in good faith under methods approved by the
Board of Trustees.
Futures Contracts-Initial margin deposits with respect to these
contracts are maintained by the Fund's custodian in segregated asset
accounts. Subsequent changes in the daily valuation of open contracts are
recognized as unrealized gains or losses. Variation margin payments are made
or received as daily appreciation or depreciation in the value of these
contracts occurs. Realized gains or losses are recorded when a contract is
closed.
Repurchase Agreements-The Series may invest in repurchase agreements,
which are agreements pursuant to which securities are acquired from a third
party with the commitment that they will be repurchased by the seller at a
fixed price on an agreed upon date. The Series may enter into repurchase
agreements with banks or lenders meeting the creditworthiness standards
established by the Board of Trustees. The resale price reflects the purchase
price plus an agreed upon market rate of interest which is unrelated to the
coupon rate or date of maturity of the purchased security. It is the Fund's
policy that its custodian take possession of the underlying collateral
securities the value of which exceeds the purchase price including accrued
interest earned on the underlying security. If the seller defaults, and the
value of the collateral declines, realization of the collateral by the Fund
may be delayed or limited.
Reverse Repurchase Agreements-The Series may enter into reverse
repurchase agreements with the same parties with whom it may enter into
repurchase agreements. Under a reverse repurchase agreement, the Series
sells securities and agrees to repurchase them at a mutually agreed upon
date and price. Under the Investment Company Act of 1940 reverse repurchase
agreements are generally regarded as a form of borrowing. At the time the
Series enters into a reverse repurchase agreement it will establish and
maintain a segregated account with its custodian containing securities from
its portfolio having a value not less than the repurchase price including
accrued interest.
Federal Income Taxes-It is the Series' policy to comply with the
requirements of the Internal Revenue Code applicable to "regulated
investment companies" and to distribute all of its taxable and tax exempt
income to its shareholders. Therefore, no provision for federal income tax
is required.
Distributions-The Series declares dividends daily from its net
investment income and pays such dividends on the last business day of each
month. Distributions to shareholders, which are determined in accordance
with income tax regulations, are recorded on the ex-dividend date.
Distributions of net capital gain, if any, realized on sales of investments
are anticipated to be made before the close of the Series' fiscal year, as
declared by the Board of Trustees. Dividends are reinvested at the net asset
value unless shareholders request payment in cash.
General-Securities transactions are accounted for on a trade date basis.
Interest income is accrued as earned. Realized gain and loss from the sale
of securities are recorded on an identified cost basis. Original issue
discounts and premiums are amortized over the life of the respective
securities. Premiums are charged against interest income and original issue
discounts are accreted to interest income.
Accounting Estimates-The preparation of financial statements in
conformity with generally accepted accounting principles requires management
to make estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of increases and
decreases in net assets from operations during the reporting period. Actual
results could differ from those estimates.
7
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1995
- --------------------------------------------------------------------------------
2. Investment Advisory Fees and Other Transactions With Affiliates
The Series has a Management Agreement with Fundamental Portfolio Advisors,
Inc. (the Manager). Pursuant to the agreement the Manager serves as investment
adviser to the Series and is responsible for the overall management of the
business affairs and assets of the Series subject to the authority of the Fund's
Board of Trustees. In compensation for the services provided by the Manager, the
Series will pay an annual management fee in an amount equal to .75% of the
Series' average daily net assets up to $500 million, .725% on the next $500
million, and .70% per annum on assets over $1 billion. The Manager is required
to reimburse the Series for its expenses (excluding interest, taxes, brokerage
fees and extraordinary expenses) to the extent that such expenses, including the
management fees, exceed the limits on investment company expenses prescribed in
any state in which the Series' shares are qualified for sale. The manager
voluntarily waived fees and reimbursed expenses of $121,770 for the year ended
December 31, 1995.
The Series has adopted a Distribution and Marketing Plan, pursuant to Rule
12b-1, promulgated under the Investment Company Act of 1940, under which the
Series pays to Fundamental Service Corporation (FSC), an affiliate of the
Manager, a fee which is accrued daily and paid monthly at an annual rate of
0.25% of the Series' average daily net assets. Amounts paid under the plan are
to compensate FSC for the services it provides and the expenses it bears in
distributing the Series' shares to investors. The amount incurred by the Series
pursuant to the agreement for the year ended December 31, 1995 is set forth in
the statement of operations. FSC has waived fees in the amount of $40,618.
The Fund compensates Fundamental Shareholders Services, Inc. (FSSI), an
affiliate of the Manager, for services it provides under a Transfer Agent and
Service Agreement. The amount incurred by the Series pursuant to the agreement
for the year ended December 31, 1995 is set forth in the Statement of
Operations.
3. Trustees' Fees
All of the Trustees of the Fund are also directors or trustees of two other
affiliated mutual funds for which the Manager acts as investment adviser. For
services and attendance at board meetings and meetings of committees which are
common to each fund, each Trustee who is not affiliated with the Manager is
compensated at the rate of $6,500 per quarter pro rated among the funds based on
their respective average net assets. 4. Shares of Beneficial Interest
As of December 31, 1995 there were an unlimited number of shares of
beneficial interest (no par value) authorized and capital paid-in amounted to
$30,283,421. Transactions in shares of beneficial interest were as follows:
<TABLE>
<CAPTION>
Year Ended Year Ended
December 31, 1995 December 31, 1994
----------------------------- -------------------------------
Shares Amount Shares Amount
------ ------ ------ ------
<S> <C> <C> <C> <C>
Shares sold 1,300,415 $1,819,736 7,503,044 $13,099,717
Shares issued on reinvestment of
dividends 554,101 779,070 1,398,152 2,335,836
Shares redeemed (5,559,992) (7,769,765) (26,452,420) (44,409,915)
---------- ----------- ----------- ------------
Net decrease (3,705,476) $(5,170,959) (17,551,224) $(28,974,362)
========== =========== =========== ============
</TABLE>
5. Complex Services, Off Balance Sheet Risks and Investment Transactions
Collaterialized Mortgage Obligations and Multi-Class Pass-Through Securities:
The Fund invests in collateralized mortgage obligations ("CMOs") which are
debt instruments issued by special purpose entities which are secured by pools
of mortgage loans or other mortgage-backed securities. Multi-class pass-through
securities are equity interests in a trust composed of mortgage loans or other
mortgage-backed securities. Payments of principal and interest on underlying
collateral provide the funds to pay debt service on the CMO or make scheduled
distributions on the multi-class pass-through security. The Fund may invest in
CMOs and multi-class pass-through securities issued by agencies or
instrumentalities of the U.S. Government.
8
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1995
- --------------------------------------------------------------------------------
Two-Tiered Index Floating Rate Bonds (TTIB):
The Fund invests in variable rate securities commonly called "TTIBs" which
are collateralized mortgage obligations. The interest rate on these securities
are fixed over various ranges of the interest rate on another security or the
value of an index, but variable within certain ranges of the same security or
index. Changes in interest rate on the other security or index affect the rate
paid on the TTIB, and the TTIB's price will be more volatile than that of a
fixed-rate bond.
Futures Contracts and Options on Futures Contracts:
The Fund invests in futures contracts consisting primarily of US Treasury
Bond Futures. A futures contract is an agreement between two parties to buy and
sell a security for a set price on a future date. Futures contracts are traded
on designated "contract markets" which through their clearing corporations,
guarantee performance of the contracts. In addition the fund invests in options
on US Treasury Bond Futures which gives the holder a right to buy or sell
futures contracts in the future. Unlike a futures contract which requires the
parties to the contract to buy and sell a security on a set date, an option on a
futures contract entitles its holder to decide before a future date whether to
enter into such a futures contract. Both types of contracts are marked to market
daily and changes in valuation will affect the net asset value of the Fund.
The Fund's principal objective in holding or issuing derivative financial
instruments is as a hedge against interest-rate fluctuations in its bond
portfolio, and to enhance its total return. The Fund's principal investment
objective is to maximize the level of interest income while maintaining
acceptable levels of interest-rate and liquidity risk. To achieve this
objective, the Fund uses a combination of derivative financial instruments
principally consisting of US Treasury Bond Futures and Options on US Treasury
Bond Futures. Typically the Fund sells treasury bond futures contracts or writes
treasury bond option contracts. These activities create off balance sheet risk
since the Fund may be unable to enter into an offsetting position and under the
terms of the contract deliver the security at a specified time at a specified
price. The cost to the Fund of acquiring the security to deliver may be in
excess of recorded amounts and result in a loss to the Fund. For the year ended
December 31, 1995, the Fund had daily average notional amounts outstanding of
approximately $6,687,000 and $10,787,000 of short positions on US Treasury Bond
Futures and Options Written on US Treasury Bond Futures respectively. Realized
gains and losses from these transactions are stated separately in the Statement
of Operations.
The Fund had the following open futures contracts at December 31, 1995.
Principal Expiration Unrealized
Type Amount Position Month Gain
---- ------ -------- ----- -----
U.S. Treasury Bond ....... $6,500,000 Short March 1996 $183,771
Portfolio securities with an aggregate value of approximately $3,250,000
have been segregated as collateral for this contract as of December 31, 1995.
In addition, the following table summarizes option contracts written by the
Series for the year ended December 31, 1995:
Number of Premiums Realized
Contracts Received Cost Loss
--------- -------- ---- ----
Contracts outstanding
December 31, 1994 ....... 375 $ 413,175
Options written ........... 1,230 1,043,354
Contracts closed or expired (1,530) (1,394,204) $2,410,863 $(1,016,659)
------ ----------
Contracts outstanding
December 31, 1995 ....... 75 $ 62,325
===== =========
Other Investment Transactions
For the year ended December 31, 1995, the cost of purchases and proceeds
from sales of investment securities, other than short-term obligations, were
$28,242,059 and $39,141,080, respectively.
9
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1995
- --------------------------------------------------------------------------------
As of December 31, 1995, net unrealized appreciation of portfolio securities
amounted to $3,463,362 comprised entirely of unrealized appreciation. As of
December 31, 1995, the Fund has available for federal income tax purposes an
unused capital loss carryover of approximately $15,000,000 which expires in
2002.
6. Borrowing
The Fund has a line of credit agreement with its custodian bank
collateralized by cash and portfolio securities to the extent of the amounts
borrowed. Borrowings under this agreement bear interest linked to the bank's
prime rate.
The Series enters into reverse repurchase agreements collateralized by
portfolio securities equal in value to the repurchase price. Portfolio
securities with an aggregate value of approximately $8,290,000 have been
segregated as collateral for securities sold subject to repurchase as of
December 31, 1995.
7. Selected Financial Information
<TABLE>
<CAPTION>
Year Year February 18,
Year Ended Ended Ended 1992 to
December 31, December 31, December 31, December 31,
Per share operating performance 1995 1994 1993 1992
(for a share outstanding throughout the period) ------ ------ ------ -------
<S> <C> <C> <C> <C>
Net asset value, beginning of period ....................... $ 1.37 $ 2.01 $ 2.02 $ 2.00
------ ------ ------ ------
Income from investment operations
Net investment income ...................................... 0.08 0.14 0.16 0.15
Net realized and unrealized gain/(loss) on investments ..... 0.12 (0.64) - 0.02
------ ------ ------ ------
Total from investment operations ................... 0.20 (0.50) 0.16 0.17
------ ------ ------ ------
Less distributions
Dividends from net investment income ....................... (0.08) (0.14) (0.16) (0.15)
Dividends from net realized gains .......................... - - (0.01) -
------ ------ ------ ------
Net asset value, end of period ............................. $ 1.49 $ 1.37 $ 2.01 $ 2.02
====== ====== ====== ======
Total return ............................................... 15.43% (25.57%) 8.14% 10.76%**
Ratios/supplemental data:
Net assets, end of period (000 omitted) .................... 15,194 19,090 63,182 40,500
Ratios to average net aset (annualized):
Interest expense ......................................... 0.20% 0.12% 0.05% 0.09%
Operating expenses ....................................... 3.05% 2.16% 1.39% 0.96%
------ ------ ------ ------
Total expenses ..................................... 3.25%+ 2.28% 1.44%+ 1.05%+
====== ====== ====== ======
Net investment income .................................... 5.91% 8.94% 7.85% 8.50%
Portfolio turnover rate .................................... 114.36% 60.66% 90.59% 115.39%
Borrowings
Amount outstanding at end of period (000 omitted) .......... 7,481 9,674 31,072 19,666
Average amount of debt outstanding during the period
(000 omitted) ............................................ 7,790 16,592 28,756 13,779
Average number of shares outstanding during the period
(000 omitted) ............................................ 11,571 21,436 28,922 12,683
Average amount of debt per share during the period ......... .67 .77 .99 1.09
<FN>
*Commencement of operations.
**Annualized.
+These ratios are after expense reimbursement of 1.0% for the year ended
December 31, 1995, .13% for the year ended December 31, 1993, and 1.05% for
the period of February 18, 1992 to December 31, 1992.
</FN>
</TABLE>
10
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1995
- --------------------------------------------------------------------------------
8. Contingencies
The Fund has been named as a defendant in two related class action lawsuits
alleging that the Fund invested in certain derivitive financial instruments that
were inconsistent with the Fund's stated investment objectives. The suits claim
that the defendants, which include the Fund's investment adviser, distributor,
and certain control persons, are liable for damages because there existed
material misstatements or omissions in the prospectuses that rendered them
misleading.
Management has entered into negotiations with the plaintiffs who have
consented to a series of adjournments of all operative dates in the litigation.
These negotiations have resulted in a settlement in principle with the
plaintiffs that, if consummated, would require a payment of approximately
$500,000 or more under certain future circumstances by the Fund's investment
adviser and no liability or cost to the Fund or its shareholders. The
contemplated stipulation of settlement expressly states that the settlement does
not constitute an admission of wrongdoing by the Fund or any of the other
defendants. The settlement remains subject to final documentation and agreement
by the parties and approval by the Court. If the settlement is not successfully
concluded, the Fund intends to contest the litigation vigorously. If this
litigation ever goes forward, it would involve significant complexities that
preclude a present determination of whether any liability to the Fund ultimately
would result and, if so, whether any such liability would be material to the
financial position of the Fund. Accordingly, and because the contemplated
settlement does not require any payment by the Fund, no amount has been accrued
in the financial statements with respect to this matter.
In addition, Management is cooperating in a formal investigation being
conducted by the Securities and Exchange Commission concerning the Fund, the
Fund's adviser and affiliated entities. Among other things, the investigation
concerns the sufficiency of disclosures set forth in the Fund's prior
advertising and prospectus, the consistency of the Fund's practices with those
disclosures, and the Fund's investment in inverse floating rate notes between
1993 and 1995. Currently, the Fund has no inverse floating rate notes in its
portfolio.
11
<PAGE>
INDEPENDENT AUDITOR'S REPORT
The Board of Trustees and Shareholders
Fundamental U.S. Government Strategic Income Fund
We have audited the accompanying statement of assets and liabilities
including the statement of investments and statement of options written, of the
Fundamental U.S. Government Strategic Income Fund Series of Fundamental
Fixed-lncome Fund as of December 31, 1995 and the related statements of
operations and cash flows for the year then ended, and the statement of changes
in net assets for the two years then ended and selected financial information
for the three years then ended and the period from February 18, 1992 (date of
inception) to December 31, 1992. These financial statements and selected
financial information are the responsibility of the Fund's management. Our
responsibility is to express an opinion on these financial statements and
selected financial information 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 selected
financial information are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. Our procedures included confirmation of securities
owned as of December 31, 1995 by correspondence with the custodian and brokers.
An audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements and selected financial information
referred to above present fairly, in all material respects, the financial
position of the Fundamental U.S. Government Strategic Income Fund of Fundamental
Fixed-lncome Fund as of December 31, 1995, the results of its operations,
changes in its net assets, cash flows, and selected financial information for
the periods indicated, in conformity with generally accepted accounting
principles.
S I G N A T U R E
New York, New York
February 13, 1996
12
<PAGE>
Left Col.
FUNDAMENTAL
U.S. GOVERNMENT
STRATEGIC INCOME FUND
90 Washington Street
New York, New York 10006
1-800-322-6864
Independent Auditors
McGladrey & Pullen, LLP
New York, NY 10017
Attorney
Kramer, Levin, Naftalis,
Nessen, Kamin & Frankel
919 Third Avenue
New York, NY 10022
This report and the financial statements contained
herein are submitted for the general information of
the shareholders of the Fund. The report is not
authorized for distribution to prospective investors
in the Fund unless preceded or accompanied by an
effective prospectus.
Right Col.
Annual Report
December 31, 1995
FUNDAMENTAL
U.S. GOVERNMENT
STRATEGIC INCOME FUND
FUNDAMENTAL
