AS FILED VIA EDGAR WITH THE SECURITIES AND EXCHANGE
COMMISSION ON MAY 1, 1998.
FILE NO. 33-12738
ICA NO. 811-5063
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM N-1A
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 [X]
PRE-EFFECTIVE AMENDMENT NO. _____
POST-EFFECTIVE AMENDMENT NO. 19 [X]
AND
REGISTRATION STATEMENT UNDER THE
INVESTMENT COMPANY ACT OF 1940 [X]
AMENDMENT NO. 21 [X]
FUNDAMENTAL FIXED INCOME FUND
-----------------------------
(EXACT NAME OF REGISTRANT AS SPECIFIED IN CHARTER)
90 WASHINGTON STREET
19TH FLOOR
NEW YORK, NEW YORK 10006
------------------------
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE)
(212) 635-3000
--------------
(AREA CODE AND TELEPHONE NUMBER)
COPIES TO:
VINCENT J. MALANGA CARL FRISCHLING, ESQ.
90 WASHINGTON STREET KRAMER, LEVIN, NAFTALIS & FRANKEL
19TH FLOOR 919 THIRD AVENUE
NEW YORK, NEW YORK 10006 NEW YORK, NEW YORK 10022
- --------------------------------------------------------------------------------
(Name and Address of Agent for Service)
IT IS PROPOSED THAT THIS FILING WILL BECOME EFFECTIVE:
|X| Immediately upon filing pursuant to | | on ( ) pursuant to
paragraph (b) paragraph (b)
| | 60 days after filing pursuant to | | on ( ) pursuant to
paragraph (a)(1) paragraph (a)(1)
| | 75 days after filing pursuant to | | on ( ) pursuant to
paragraph (a)(2) of paragraph (a)(2) rule 485.
IF APPROPRIATE, CHECK THE FOLLOWING BOX:
[ ] THIS POST-EFFECTIVE AMENDMENT DESIGNATES A NEW EFFECTIVE DATE FOR A
PREVIOUSLY FILED POST- EFFECTIVE AMENDMENT.
<PAGE>
FUNDAMENTAL FIXED INCOME FUND
REGISTRATION STATEMENT ON FORM N-1A
CROSS REFERENCE SHEET
Fundamental U.S. Government Strategic Income Fund
Form N-1A
Item Number
- -----------
Part A Prospectus Caption
- ------ ------------------
1. Cover Page
2. Fee Table
3. Financial Highlights
4. Investment Objective and Policies;
Certain Investment Techniques and
Policies; Other Information
5.(a) The Manager and the Management
Agreement
(b) Management
(c) *
(d) Other Information - Transfer
Agent and Shareholder Services
(e) The Manager and the Management
Agreement
(f) *
6.(a) Other Information - Description of
Shares
(b) *
(c) *
(d) *
(e) Other Information; Cover Page
(f) Tax Matters
(g) Tax Matters
7.(a) Distribution Agreement and
Marketing Plan
(b) Purchase of Shares
(c) Redemption of Shares - Exchange
Privilege
(d) Purchase of Shares - How to
Purchase Shares and Determination
of Net Asset Value
(e) *
(f) Distribution Agreement and
Marketing Plan - Marketing Plan
8. Redemption of Shares
9. *
- -----------------------
* Not Applicable
<PAGE>
Statement of
Additional Information
Part B Caption
10. Cover Page
11. Table of Contents
12. *
13. Investment Objectives; Policies
14. Management of the Fund
15. Other Information
16.(a) Management of the Fund;
Investment Manager
(b) Investment Manager
(c) *
(d) *
(e) *
(f) Marketing Plan
(g) *
(h) Custodian, Independent Accountants
and Counsel
(i) *
17.(a) Portfolio Transactions
(b) *
(c) Portfolio Transactions
(d) *
(e) *
18. Description of Shares
19.(a) See prospectus under Purchase of
Shares and Net Asset Value - How
to Purchase Shares
(b) Determination of Net Asset Value
(c) *
20. Taxes
21. Marketing Plan
22. Performance Information
23. Financial Statements
Part C Information required to be included in Part C is set
forth under the appropriate Item so numbered in Part C to
this Registration Statement.
- ----------------
*Not Applicable
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
REGISTRATION STATEMENT ON FORM N-1A
CROSS REFERENCE SHEET
High-Yield Municipal Bond Series
Tax-Free Money Market Series
Form N-1A
Item Number
- -----------
Part A Prospectus Caption
- ------ ------------------
1. Cover Page
2. Annual Operating Expenses
3. Financial Highlights
4. Investment Objective and Policies;
Investment Considerations and
Restrictions; General Information
5.(a) Management
(b) Management
(c) *
(d) General Information - Investor Services
(e) Management
(f) *
6.(a) Information About Shares - Description of Shares
(b) *
(c) *
(d) *
(e) General Information; Cover Page
(f) Information About Shares - Dividends and Taxes
(g) Information About Shares - Dividends and Taxes
7.(a) Information About Shares - Distribution Expenses
(b) Information About Shares - Purchase Price and Net Asset
Value
(c) General Information - Exchangeability of Shares
(d) Information About Shares - How to Purchase Shares
(e) *
(f) Distribution Expenses
8. Information About Shares - Redemptions
9. *
- ----------------
* Not Applicable
<PAGE>
Part B. Statement Caption
- ------- -----------------
10. Cover Page
11. Table of Contents
12. *
13. Investment Objective and Policies
14. Management of the Fund
15. Other Information
16.(a) Management of the Fund; Investment Manager
(b) Investment Manager
(c) *
(d) *
(e) *
(f) Distribution Plan
(g) *
(h) Custodian and Independent Accountants
(i) *
17.(a) Portfolio Transactions
(b) *
(c) Portfolio Transactions
(d) *
(e) *
18. Description of Shares
19.(a) See prospectus under Information About
Shares - How to Purchase Shares
(b) Determination of Net Asset Value
(c) *
20. Taxes
21. Distribution Plan
22. Calculation of Yield and Average Annual
Total Return
23. Financial Statements
Part C Information required to be included in
Part C is set forth under the
appropriate Item so numbered in Part C
to this Registration Statement.
- ---------------------
* Not Applicable
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
90 Washington Street * New York, N.Y. 10006 * 1 (800) 225-6864
Prospectus dated May 1, 1998
The objective of the Fundamental U.S. Government Strategic Income Fund (the
"Fund"), a No-Load series of Fundamental Fixed-Income Fund (the "Trust"), 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 Fund does not offer a fixed rate of return or provide the same stability of
principal. Although the Fund's investment manager attempts to maximize stability
of net asset value, investment return and principal value will fluctuate with
interest rate changes. The Fund 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. There
can be no assurance that the Fund's investment objective will be attained.
The Fund 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 (hereinafter collectively referred to as "Government
Securities"). 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. Shares of the Fund are not
insured or guaranteed by the U.S. Government, its agencies or instrumentalities
or by any other person or entity. References to Government guarantees apply to
the timely payment of principal and interest on certain Government Securities in
which the Fund may invest. The Fund may also invest in repurchase agreements
secured by Government Securities and may engage in certain options and futures
transactions only as a defensive measure (i.e., as a hedge and not for
speculation) to improve the Fund's liquidity and stabilize the value of its
portfolio. Under normal market conditions, the Fund will invest at least 65% of
its total assets in Government Securities. The Fund may borrow money to purchase
additional portfolio securities. Borrowing for investment increases both
investment opportunity and investment risk (see "Certain Investment Techniques
and Policies-Borrowing" for more information).
The Fund seeks greater share price stability than longer-term investments by
limiting the average weighted duration of its investment portfolio to three
years or less. It is the policy of the Fund to limit the duration by the use of
hedging techniques. Fundamental Portfolio Advisors, Inc. is the Fund's
investment manager (the "Manager").
The Fund is designed for investors who seek higher yield than a money market
fund and less fluctuation in net asset value than ordinary long-term bond funds.
The Fund is a diversified series of Fundamental Fixed-Income Fund, a registered,
open-end management investment company. Shares of the Fund are offered
continuously at net asset value, without any sales charge, but the Fund does
have a Rule 12b-1 Plan.
This Prospectus sets forth concisely the information you should know before
investing in the Fund.
Please read this Prospectus carefully and retain it for future reference.
The Fund's Statement of Additional Information dated May 1, 1998 has been filed
with the Securities and Exchange Commission and is incorporated herein by
reference. It is available at no charge upon request to the Fund at (800)
225-6864.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
1
<PAGE>
TABLE OF CONTENTS
(LEFT COLUMN)
Page
Highlights .................................................................. 2
Fee Table ................................................................... 3
Financial Highlights ........................................................ 4
Investment Objective and Policies ........................................... 5
Certain Investment Techniques and Policies .................................. 8
The Manager and the Management Agreement .................................... 14
Purchase of Shares .......................................................... 16
(RIGHT COLUMN)
Page
Redemption of Shares ........................................................ 17
Brokerage Allocation ........................................................ 21
Distribution Agreement and Marketing Plan ................................... 21
Performance Information ..................................................... 22
Tax Matters ................................................................. 23
Other Information ........................................................... 24
Shareholder Inquiries ....................................................... 26
HIGHLIGHTS
The Fund's Objective. The Fund seeks to provide high current income with
minimum risk of principal and relative stability of net asset value.
The Fund Attempts to Achieve High Current Income With Relative Stability of
Net Asset Value. By investing in a portfolio of Government Securities with high
current yields and limiting the weighted average duration of the portfolio to
three years or less, the Fund seeks to offer a higher yield than a money market
fund and less fluctuation in net asset value than a longer-term bond fund.
However, the Fund is not a money market fund and its net asset value will
fluctuate.
As with any bond investment, the Fund's yield and share price may be
positively or negatively affected by changes in interest rates. The potential
for such fluctuation is reduced, however, to the extent that hedging strategies
used to manage the effect of interest rates on the Fund's investments are
successful. For this reason, the Manager expects that under normal market
conditions, the value of the Fund's portfolio will not fluctuate as
significantly as a result of interest rate changes as an unhedged portfolio of
long duration fixed-rate obligations would. However, a sudden and extreme
increase in prevailing interest rates would likely cause a decline in the Fund's
net asset value. Conversely, a sudden and extreme decline in interest rates
would likely result in an increase in the Fund's net asset value. As with any
mutual fund there is no assurance that the Fund will achieve its goal.
Government Securities. The Fund will seek investment opportunities in
obligations issued or guaranteed by the U.S. Government, its agencies or
instrumentalities. It is anticipated that the portion of the distributions by
the Fund which is derived from interest income received by the Fund on Direct
Obligations will be exempt from state and local personal income taxes in many
states (see "Tax Matters").
How to Buy and Sell Shares in the Fund. This is a No-Load Fund. Shares of
the Fund are offered for sale on a continuous basis at the next determined net
asset value per share (see "Purchase of Shares-How to Purchase Shares and
Determination of Net Asset Value"). For your initial investment, there is a
$2,500 minimum. The minimum initial investment for qualified pension plans
(IRAs, Keoghs, etc.) is $2,000. The minimum subsequent investment is $100. (The
foregoing minimum investments and charges may be modified or waived at any time
at our discretion). There is no fee for purchasing shares directly from the
Fund. However, you may be charged a fee for effecting transactions in the Fund's
shares through securities dealers, banks or other financial institutions.
Shares are redeemable at your option without charge at the next determined
net asset value per share (see "Redemption of Shares"). The Fund reserves the
right, however, to liquidate an account with a value of less than $100 on 60
days' notice.
2
<PAGE>
Shareholder Services and Privileges. For shareholder convenience, the Fund
provides certain services and privileges which may be suited to your particular
needs, including Exchange, Check Redemption, Telephone Redemption and Expedited
Redemption Privileges, an Automatic Investment Plan and various Tax-Sheltered
Retirement Plans (see "Purchase of Shares" and "Redemption of Shares").
Monthly Dividends. The Fund declares dividends daily and pays them on a
monthly basis, eliminating the need for you to hold your shares until
quarter-end to receive dividend income. Dividends are automatically reinvested
at net asset value in additional Fund shares without any charge. You may elect,
however, to receive them in cash (see "Tax Matters").
Management. The Fund is a member of the Fundamental Family of Funds, a group
of five investment companies. Fundamental Portfolio Advisors, Inc. (the
"Manager") is the Fund's investment manager.
The Manager supervises and manages the Fund's investment portfolio and
directs the purchase and sales of its investment securities. The Manager
utilizes an investment committee to manage the assets of the Fund. See "The
Manager and the Management Agreement".
Exchange Privilege. The Manager also acts as investment manager to several
other mutual fund portfolios in the Fundamental Family of Funds, including New
York Muni Fund Series of Fundamental Funds, Inc., The California Muni Fund, and
the High-Yield Municipal Bond and Tax-Free Money Market Series of Fundamental
Fixed-Income Fund. Shares of such funds are exchangeable for shares of the Fund
at the respective net asset value per share without any charge and may be
exchanged by telephone (see "Redemption of Shares-Exchange Privilege").
Risk Factors. The Fund invests in a portfolio of U.S. Government securities,
and is not limited as to the maturities of the securities in which it may
invest. While U.S. Government debt obligations are generally considered to be of
the highest credit quality, to the extent that there is credit risk in U.S.
Government securities it would also affect the Fund's portfolio. Moreover, there
are additional risk considerations which may be associated with certain
investment policies of, and strategies employed by, the Fund including those
relating to borrowing as well as those relating to U.S. Government guaranteed
mortgage-related securities, futures and options transactions. Such risks may
not be incurred by other mutual funds which have similar investment objectives,
but which do not follow these policies or employ these strategies. See
"Investment Objective and Policies" and "Certain Investment Techniques and
Policies" in the Prospectus and "Investment Objective and Policies" in the
Fund's Statement of Additional Information.
FEE TABLE
Shareholder Transaction Expenses
Sales Commission on Purchase of Shares ................................... NONE
Sales Commission on Reinvestment of Dividends ............................ NONE
Redemption Fees .......................................................... NONE
Exchange Fees ............................................................ NONE
Annual Fund Operating Expenses (As a percentage of average net assets)
Management Fees .......................................................... -
12b-1 Fees1 .............................................................. -
Other Expenses, net of reimbursement .....................................
Interest ............................................................... 2.75%
Other .................................................................. 5.75%
-----
Total Fund Operating Expenses (after waiver and/or reimbursement) ....... 8.50%
Expenses Waived and/or reimbursed ........................................ 1.37%
-----
Total Fund Operating Expenses ............................................ 9.87%
=====
1As a result of distribution fees of .25% per annum of the Fund's average daily
net assets, a long-term shareholder may pay more than the economic equivalent
of the maximum front-end sales charges permitted by the Rules of the National
Association of Securities Dealers, Inc.
3
<PAGE>
Example:
You would pay the following expenses on a $1,000 investment, assuming (1) 5%
annual return and (2) redemption at the end of the time period:
1 year 3 years 5 years 10 years
------ ------- ------- --------
$84 $242 $389 $715
This example should not be considered a representation of past or future
expenses, and actual expenses may be greater or less than those shown. For a
more complete description of the Fund's various costs and expenses, including
management and distribution fees, see "The Manager and the Management
Agreement", "Distribution Agreement and Marketing Plan" and the Financial
Statements included at the end of the Fund's Statement of Additional
Information. The Manager may, from time to time, waive or reduce its fees on
assets held by the Fund. Fee waivers or reductions will cause the Fund's
expenses to go down and its yield to increase.
FINANCIAL HIGHLIGHTS
(for a share outstanding throughout the period)
The following per share income and capital changes has been audited by
McGladrey & Pullen, LLP, independent certified public accountants, whose report
thereon appears in the Statement of Additional Information.
<TABLE>
<CAPTION>
Year Ended December 31, March 2,
-------------------------------------------------------------------- 1992* to
December 31, December 31, December 31, December 31, December 31, December 31,
Per share operating performance 1997 1996 1995 1994 1993 1992
(for a share outstanding throughout ---- ---- ---- ---- ---- ----
the period)
<S> <C> <C> <C> <C> <C> <C>
Net asset value, beginning of period .... $ 1.43 $ 1.49 $ 1.37 $ 2.01 $ 2.02 $ 2.01
------ ------ ------ ------ ------ ------
Income from investment operations
Net investment income ................... 0.10 0.13 0.08 0.14 0.16 0.15
Net realized and unrealized gain/(loss)
on investments ......................... (0.02) (0.06) 0.12 (0.64) - 0.01
------ ------ ------ ------ ------ ------
Total from investment operations ...... 0.08 0.07 0.20 (0.50) 0.16 0.16
------ ------ ------ ------ ------ ------
Less distributions
Dividends from net investment
income ................................. (0.10) (0.13) (0.08) (0.14) (0.16) (0.15)
Dividends from net realized gains ....... - - - - (0.01) -
------ ------ ------ ------ ------ ------
Net asset value, end of period .......... $ 1.41 $ 1.43 $ 1.49 $ 1.37 $ 2.01 $ 2.02
====== ====== ====== ====== ====== ======
Total return (annualized) ............... 5.51% 5.02% 15.43% (25.57%) 8.14% 10.76%
Ratios/supplemental data:
Net assets, end of period
(000 omitted) .......................... $10,030 $13,224 $15,194 $19,020 $63,182 $40,500
Ratios to average net assets (annualized):
Interest expense ....................... 2.75% 2.61% 3.00% 2.01% 1.54% 1.64%
Operating expenses ..................... 5.75% 3.41% 3.05% 2.16% 1.39% 0.96%
------ ------ ------ ------ ------ ------
Total expenses(a) ..................... 8.50% 6.02%+ 6.05%+ 4.17% 2.93%+ 2.60%
====== ====== ====== ====== ====== ======
Net investment income .................. 6.83% 9.01% 5.91% 8.94% 7.85% 8.50%
Portfolio turnover rate ................. 12.55% 12.65% 114.36% 60.66% 90.59% 115.39%
</TABLE>
4
<PAGE>
<TABLE>
<CAPTION>
Year Ended December 31, March 2,
-------------------------------------------------------------------- 1992* to
December 31, December 31, December 31, December 31, December 31, December 31,
Borrowings 1997 1996 1995 1994 1993 1992
---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Amount outstanding at end of period
(000 omitted) .......................... $4,969 $6,610 $ 7,481 $ 9,674 $31,072 $19,666
Average amount of debt outstanding
during the period (000 omitted) ........ $5,967 $6,577 $ 7,790 $16,592 $28,756 $13,779
Average number of shares outstanding
during the period (000 omitted) ........ 8,433 9,764 11,571 21,436 28,922 12,683
Average amount of debt per share
during the period ...................... $ .71 $ .67 $ .67 $ .77 $ .99 $ 1.09
</TABLE>
*Commencement of public offering of shares.
+ These ratios are after expense reimbursement of 1.37%, 2.02%, 1.0% and .13%
for the years ended December 31, 1997, 1996, 1995 and 1993, respectively,
and 1.05% for the period March 2, 1992 to December 31, 1992.
(a) The ratios for each of the periods presented prior to December 31, 1997 have
been reclassified to conform with the 1997 presentation.
INVESTMENT OBJECTIVE AND POLICIES
The Fund's objective is to provide high current income with minimum risk of
principal and relative stability of net asset value. The Fund's investment
objective is deemed fundamental and may not be changed without shareholder
approval. There can, of course be no assurance that the Fund will achieve its
investment objective. In seeking its objective, the Fund invests primarily in
obligations issued or guaranteed by the U.S. Government, its agencies or
instrumentalities (collectively "Government Securities"). Government Securities
in which the Fund may invest include:
Direct obligations of the U.S. Treasury, such as U.S. Treasury bills,
certificates of indebtedness, notes and bonds ("Direct Obligations"); and
obligations of U.S. Government agencies or instrumentalities, such as Federal
Home Loan Banks, Farmers Home Administration, Federal Farm Credit Banks, Federal
National Mortgage Association ("FNMA"), Government National Mortgage Association
("GNMA"), Resolution Funding Corp. ("RFCO"), Financing Corp. ("FICO") and
Federal Home Loan Mortgage Association ("FHLMC") (hereinafter collectively
referred to as "Agencies").
The obligations of Government Securities which the Fund may buy are backed
in a variety of ways by the U.S. Government or its agencies or
instrumentalities. While the U.S. Government provides financial support to such
agencies and instrumentalities, no assurance can be given that it will always do
so, since it is not obligated by law. The Fund will invest in such securities
only when it is satisfied that the credit risk with respect to the issuer is
minimal. Some of these obligations, such as GNMA mortgage-backed securities and
obligations of the Farmers Home Administration which represent part ownership in
a pool of mortgage loans, are backed by the full faith and credit of the U.S.
Treasury. Obligations of the Farmers Home Administration are also backed by the
issuer's right to borrow from the U.S. Treasury. Obligations of Federal Home
Loan Banks and the Farmers Home Administration are backed by the discretionary
authority of the U.S. Government to purchase certain obligations of agencies or
instrumentalities. Obligations of Federal Home Loan Banks, Farmers Home
Administration, Federal Farm Credit Banks, FNMA, RFCO, FICO and FHLMC are backed
by the credit of the agency or instrumentality issuing the obligations.
5
<PAGE>
The Fund intends to minimize the risk of principal and provide relative
stability of net asset value by limiting the average weighted duration of its
investment portfolio to three years or less. It is the policy of the Fund to
limit the duration by the use of hedging techniques, so that the average
weighted duration of the Fund's portfolio is three years or less. The Fund may
engage in certain options and futures transactions only as a defensive measure
(i.e., as a hedge and not for speculation) to improve the Fund's liquidity and
stabilize the value of its portfolio. The Fund is not a money market fund and
cannot guarantee that its share price will not fluctuate. Unlike bank deposits
and certificates of deposit, the Fund does not offer a fixed rate of return or
provide the same stability of principal. The value of your shares when you
redeem them may be more or less than your original cost.
The Fund may invest in repurchase agreements, cash or money market
instruments or such other high quality debt instruments as is consistent with
its investment objective. In addition, the Fund is authorized for the purpose of
increasing its return or hedging its interest rate exposure, to engage in any
one or more of the specialized investment techniques and strategies described
below under the caption "Certain Investment Techniques and Policies".
Securities issued by the U.S. Government differ with respect to maturity and
modality of payment. The two types of payment modes are coupon paying and
capital appreciation. Coupon paying bonds and notes pay a periodic interest
payment, usually semi-annually, and a final principal payment at maturity.
Capital appreciation bonds and Treasury bills accrue a daily amount of interest
income, and pay a stated face amount at maturity. Most U.S. Government capital
appreciation bonds were created as a result of the separation of coupon paying
bonds into distinct securities representing the periodic coupon payments and the
final principal payment. This is referred to as "stripping". The separate
securities representing a specific payment to be made by the U.S. Government on
a specific date are also called "zero coupon" bonds. Current Federal tax law
requires the Fund daily to accrue as income a portion of the original issue
discount at which each zero coupon bond was purchased. Amortization of this
discount has the effect of increasing the Fund's income, although it receives no
actual cash payments. The Fund distributes this income to its shareholders as
income dividends and such income is reflected in the Fund's quoted yield. See
below for additional discussion concerning the effects of the amortization of
the discount.
The U.S. Government facilitates the "stripping" of coupon bonds by providing
for the periodic coupon payments and the principal payment to be kept separate
in the Federal Reserve and Treasury bookkeeping systems, and allows stripped
bonds to be reconstituted into coupon bonds by delivering all of the securities
representing the coupons and principal payment to the system.
Since the value of debt securities owned by the Fund will fluctuate
depending upon market factors and generally inversely with prevailing interest
rate levels, the net asset value of the Fund will fluctuate. The Fund is not
limited as to the maturities of the securities in which it may invest. Debt
securities with longer maturities generally tend to produce higher yields and
are subject to greater market fluctuation as a result of changes in interest
rates than debt securities with shorter maturities. The potential for such
fluctuation may be reduced, however, to the extent that the Fund engages in
hedging techniques. The Fund's current operating policy is to seek to achieve a
weighted portfolio duration of three years or less. Duration is expressed in
years and is that point in time representing the half-life of the present value
of all cash flows expected from a bond over its life (from coupon payments,
sinking fund, if any, principal at maturity, etc.). Duration provides a
yardstick to bond price volatility with respect to changes in rates. As maturity
lengthens or as the coupon rate or yield-to-maturity is reduced, volatility
increases. Duration captures all three factors and expresses them in a single
number.
It should be noted that there are several methods of calculating the
duration of a security or portfolio of securities. These methods may yield
different results. The Fund applies different hedging techniques resulting in
different outcomes depending on what duration is calculated. Any one method of
calculating a security's duration will in turn give different results as
interest rates change and the market value of the security changes. The duration
equivalent of
6
<PAGE>
derivatives such as bond futures contracts and options futures contracts used by
the Fund (see "Certain Investment Techniques and Policies-Futures Contracts and
Options on Futures Contracts") can vary significantly with changes in interest
rates and market prices. Such variation can significantly affect the result of a
portfolio duration calculation. For example: the Fund's management might use one
set of assumptions and method of calculating duration that would indicate that
the weighted average portfolio duration of the Fund was less than three years at
a particular point in time, while other assumptions and/or methodology could
indicate a substantially greater duration implying different steps to be taken
by Fund management. (See "Basis Risk" and "Risks of Writing Options"). Certain
U.S. Government securities such as Collateralzied Mortgage Obligations ("CMOs")
have cash flows which can vary according to the rates of principal payments
(including prepayments) on the related underlying mortgage assets. The coupon
and therefore the cash flows of CMOs can also vary either directly or inversely
according to moves of an applicable index such as LIBOR, or a multiple of the
applicable index. Since the cash flows associated with CMOs can vary with
principal payment speeds and changes in the applicable index, the calculation of
duration of a CMO depends on the assumptions for future values of the index
and/or speeds of principal payments. A particular assumption by Fund management
concerning future interest rates and prepayment rates may cause it to calculate
duration or employ a method to calculate duration that would result in a
significantly different amount of futures and options being used for hedging
purposes, than would be the case if other assumptions concerning future interest
rates were employed. (See "U.S. Government Guaranteed Mortgage-Related
Securities and the Risk Factors Relating to such Investments".)
The Fund's current operating policy of attempting to achieve a weighted
portfolio duration of three years or less through the investment policies and
strategies described above and elsewhere involve risks which may not be incurred
by other mutual funds which do not follow these policies or employ these
strategies. Specifically, there may be other mutual funds which attempt to
minimize fluctuations in net asset value by limiting the maturities of their
portfolio securities, by not using leverage and not engaging in futures and
options transactions. The policies and strategies employed by the Fund,
including the various uncertainties associated with the various methods and
assumptions required for the calculation of portfolio duration, may cause a
decline in the Fund's net asset value greater than that of other mutual funds in
response to an unanticipated change in prevailing interest rates.
At any given time, there is a relationship between the yield of a U.S.
Government obligation and its maturity. This is called the "yield curve." Since
U.S. Government debt securities are assumed to have negligible credit risk, the
main determinant of yield differential between individual securities is
maturity. When the yield curve is such that longer maturities correspond to
higher yields, the yield curve has a positive slope and is referred to as a
"normal" yield curve. At certain times shorter maturities have higher yields and
the yield curve is said to be "inverted." Even when the yield curve is "normal"
(i.e. has a positive slope), the relationship between yield and maturity for
some U.S. Government strip securities is such that yields increase with maturity
up to some point and then, after peaking, decline so that the longest maturities
are not the highest yielding. This is called a "humped" curve. The highest
yielding point on the yield curve for such securities is referred to as the
"strippers hump."
Zero coupon Treasury securities do not entitle the holder to any periodic
payments of interest prior to maturity. Accordingly, such securities usually
trade at a deep discount from their face or par value and will be subject to
greater fluctuations of market value in response to changing interest rates than
debt obligations of comparable maturities which make periodic distributions of
interest. On the other hand, because there are no periodic interest payments to
be reinvested prior to maturity, zero coupon securities eliminate the
reinvestment risk and lock in a rate of return to maturity. Current Federal tax
law requires that a holder (such as the Fund) of a zero coupon security accrue a
portion of the discount at which the security was purchased as income each year
even though the Fund received no interest payment in cash on the security during
the year. As an investment company, the Fund must pay out substantially all of
its net investment income each year. Accordingly, the Fund may be required to
pay out as an income distribution each year an amount which is greater than the
total amount of cash interest the Fund actually received. Such distributions
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will be made from the cash assets of the Fund or by liquidation of portfolio
securities, if necessary. If a distribution of cash necessitates the liquidation
of portfolio securities, the Manager will select which securities to sell. The
Fund may realize a gain or loss from such sales. In the event the Fund realizes
net capital gains from such transactions, its shareholders may receive a larger
capital gain distribution, if any, than they would in the absence of such
transactions.
The Fund is diversified and, accordingly, may not 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 the Fund's total assets would be
invested in such issuer, or (ii) the Fund would own more than 10% of the
outstanding voting securities of such issuer; except that up to 25% of the value
of the Fund's total assets may be invested without regard to such limitations.
Certain securities that may be purchased by the Fund, such as those with
interest rates that flucutate directly or indirectly (inverse floaters) based on
multiples of a stated index, are designed to be highly sensitive to changes in
interest rates.
Special Risk Factors Relating to Inverse Floating Rate Instruments
Changes in interest rates inversely affect the rate paid on inverse floating
rate instruments ("inverse floaters"). The inverse floaters' price will be more
volatile than that of a fixed rate bond. Additionally, some inverse floaters
contain a "leverage factor" whereby the interest rate moves inversely by a
"factor" to the benchmark. For example, the rates on the inverse floating rate
note may move inversely at three times the benchmark rate. Certain interest rate
movements and other market factors can substantially affect the liquidity of
inverse floaters. These instruments are designed to be highly sensitive to
interest rate changes and may subject the holders thereof to extreme reductions
of yield and possibly loss of principal.
CERTAIN INVESTMENT TECHNIQUES AND POLICIES
Futures Contracts and Options on Futures Contracts. The Fund may enter into
contracts for the purchase or sale for future delivery of fixed-income
securities or contracts based on a financial index of Government Securities
("futures contracts") and may purchase and write put and call options to buy or
sell futures contracts ("options on futures contracts"). A "sale" of a futures
contract means the acquisition of a contractual obligation to deliver the
securities called for by the contract at a specified price on a specified date.
A "purchase" of a futures contract means the incurring of a contractual
obligation to acquire the securities called for by the contract at a specified
date. The purchaser of a futures contract on an index agrees to take or make
delivery of an amount of cash equal to the difference between a specified dollar
multiple of the value of the index on the expiration date of the contract
("current contract value") and the price at which the contract was originally
struck. Although most futures contracts call for actual delivery or acceptance
of debt securities, the contracts usually are closed out before the settlement
date without the making or taking of delivery. Options on futures contracts to
be written or purchased by the Fund will be traded on an exchange or
over-the-counter. Unlike a futures contract, which requires the parties to the
contract to buy or sell a security on a set date, an option on a futures
contract, for example, merely entitles its holder to decide on or before a
future date whether to enter into such a contract. If the holder decides not to
enter into the contract, all that is lost is the premium paid for the option.
Because an option gives the buyer the right to enter into a contract at a set
price for a fixed period of time, its value will change daily. That change will
be reflected in the net asset value of the Fund. These investment techniques
will be used to hedge against anticipated future changes in interest rates which
otherwise might either adversely affect the value of the Fund's portfolio
securities or adversely affect the price of securities which the Fund intends to
purchase at a later date. Options and futures can be volatile investments and
involve certain risks. If the Fund's Manager applies a hedge at an inappropriate
time or judges interest rates incorrectly, options and futures strategies may
lower the Fund's return. The Fund could also experience losses if the prices of
its options and futures positions were poorly correlated with its other
investments, or if it could not close out its positions because of an
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illiquid secondary market. See the Fund's Statement of Additional Information
for further discussion of the use, risks and costs of futures contracts and
options on futures contracts.
In order to hedge against anticipated changes in interest rates, the Fund
will engage in the use of futures contracts and related options solely for bona
fide hedging purposes, as defined by the Commodity Futures Trading Commission,
and not for speculation.
Basis Risk. The use of futures contracts to shorten the weighted average
duration of the Fund's portfolio, while reducing the exposure of the Fund's
portfolio to interest rate risk does subject the Fund's 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 Fund could experience losses if the value of the prices of the
futures positions the Fund has entered into are poorly correlated with the
Fund's 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 Fund's
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 Fund's portfolio.
Options on Portfolio Securities. The Fund, in seeking to generate high
current income, may write covered call options on certain of its portfolio
securities at such time and from time to time as Fund management shall determine
to be appropriate and consistent with the investment objective of the Fund. A
covered call option means that the Fund owns the security on which the option is
written. Generally, the Fund expects that options written by it will be
conducted on recognized securities exchanges. In certain instances, however, the
Fund may purchase and sell options in the over-the-counter market ("OTC
Options"). The Fund's ability to close options positions established in the
over-the-counter market may be more limited than in the case of exchange-traded
options and may also involve the risk that securities dealers participating in
such transactions will fail to meet their obligations to the Fund. In addition,
the staff of the Securities and Exchange Commission has taken the position that
OTC Options and the assets used as "cover" should be treated as illiquid
securities. Accordingly, there is a current fixed limit of 10% of the Fund's
assets upon which such options may be written.
The Fund will receive a premium (less any commissions) from the writing of
such contracts, and it is believed that the total return to the Fund can be
increased through such premiums consistent with the Fund's investment objective.
The writing of option contracts is a highly specialized activity which involves
investment techniques and risks different from those ordinarily associated with
investment companies, although the Fund believes that the writing of covered
call options listed on an exchange or traded in the over-the-counter market,
where the Fund owns the underlying security, tends to reduce such risks. The
writer forgoes the opportunity to profit from an increase in the market price of
the underlying security above the exercise price so long as the option remains
open. See the Fund's Statement of Additional Information for more information.
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Risks of Writing Options
The successful use of the foregoing investment techniques depends on the
ability of Fund management to forecast interest rate movements correctly. Should
interest rates move in an unexpected manner, the Fund may not achieve the
anticipated benefits of futures or option contracts or may realize losses and be
in a worse position than if such strategies had not been used. The correlation
between movements in the price of such instruments and movements in the prices
of the securities hedged or used for cover will not be perfect and could produce
unanticipated losses. The Fund's ability to dispose of its positions in futures
contracts and options will depend on the availability of liquid markets in such
instruments. Markets in options and futures with respect to a number of
Government Securities are relatively new and still developing. It is impossible
to predict the amount of trading interest that may exist in various types of
futures and options contracts. If a secondary market does not exist with respect
to an option purchased or written by the Fund over-the-counter, it might not be
possible to effect a closing transaction in the option (i.e. dispose of the
option) with the result that (i) an option purchased by the Fund would have to
be exercised in order for the Fund to realize any profit and (ii) the Fund may
not be able to sell portfolio securities covering an option written by the Fund
until the option expires or it delivers the underlying futures contract upon
exercise. Therefore, no assurance can be given that the Fund will be able to
utilize these instruments effectively for the purposes set forth above.
Furthermore, the Fund's ability to engage in options and futures transactions
may be limited by tax considerations. See "Tax Matters".
U.S. Government Guaranteed Mortgage-Related Securities and the Risk Factors
Relating to such Investments.
Included in the U.S. Government securities the Fund may purchase are
pass-through sccurities, collateralized mortgage obligations, multi-class
pass-through securities and stripped mortgage-backed securities, all of which
are described below. Mortgages backing these securities purchased by the Fund
include, among others, conventional 30-year fixed rate mortgages, graduated
payment mortgages, 15-year mortgages and adjustable rate mortgages. All of these
mortgages can be used to create pass-through securities. A pass-through security
is formed when mortgages are pooled together and undivided interests in the pool
or pools are sold. The cash flow from the mortgages is passed through to the
holders of the securities in the form of periodic payments of interest,
principal and prepayment (net of a service fee). Prepayments occur when the
holder of an individual mortgage prepays the remaining principal before the
mortgage's scheduled maturity date. As a result of the pass-through of
prepayments of principal on the underlying securities, mortgage-backed
securities are often subject to more rapid prepayment of principal than their
stated maturity would indicate. Because the prepayment characteristics of the
underlying mortgages vary, it is not possible to predict accurately the realized
yield or average life of a particular issue of pass-through certificates.
Prepayment rates are important because of their effect on the yield and price of
the securities. Accelerated prepayments adversely impact yields for
pass-throughs purchased at a premium (i.e., a price in excess of principal
amount) and may involve additional risk of loss of principal because the premium
may not have been fully amortized at the time the obligation is repaid. The
opposite is true for pass-throughs purchased at a discount. The Fund may
purchase mortgage-related securities at a premium or at a discount. Principal
and interest payments on the mortgage-related securities are Government
guaranteed to the extent described below. Such guarantees do not extend to the
value or yield of the mortgage-related securities themselves or of the Fund's
shares.
(a) GNMA Pass-Through Securities. The Government National Mortgage
Association ("GNMA") issues mortgage-backed securities ("GNMA Certificates")
which evidence an undivided interest in a pool or pools of mortgages. GNMA
Certificates that the Fund purchases are the "modified pass-through" type, which
entitle the holder to receive timely payment of all interest and principal
payments due on the mortgage pool, net of fees paid to the "issuer" and GNMA,
regardless of whether the mortgagor actually makes the payment.
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The National Housing Act authorizes GNMA to guarantee the timely payment of
principal and interest on securities backed by a pool of mortgages insured by
the Federal Housing Administration ("FHA") or guaranteed by the Veterans
Administration ("VA"). The GNMA guarantee is backed by the full faith and credit
of the United States. GNMA is also empowered to borrow without limitation from
the U.S. Treasury if necessary to make any payments required under its
guarantee.
The average life of a GNMA Certificate is likely to be substantially shorter
than the original maturity of the mortgages underlying the securities.
Prepayments of principal by mortgagors and mortgage foreclosures will usually
result in the return of the greater part of principal investment long before the
maturity of the mortgages in the pool. Foreclosures impose no risk to principal
investment because of the GNMA guarantee, except to the extent that the Fund has
purchased the certificates at a premium in the secondary market.
(b) FHLMC Pass-Through Securities. The Federal Home Loan Mortgage
Corporation ("FHLMC") was created in 1970 through enactment of Title III of the
Emergency Home Finance Act of 1970. Its purpose is to promote development of a
nationwide secondary market in conventional residential mortgages.
FHLMC issues two types of mortgage pass-through securities ("FHLMC
Certificates"), mortgage participation certificates ("PCs") and guaranteed
mortgage certificates ("GMCs"). PCs resemble GNMA Certificates in that each PC
represents a pro rata share of all interest and principal payments made and owed
on the underlying pool. FHLMC guarantees timely monthly payment of interest on
PCs and the ultimate payment of principal.
GMCs also represent a pro rata interest in a pool of mortgages. However,
these instruments pay interest semiannually and return principal once a year in
guaranteed minimum payments. The expected average life of these securities is
approximately ten years. The FHLMC guarantee is not backed by the full faith and
credit of the United States.
(c) FNMA Pass-Through Securities. The Federal National Mortgage Association
("FNMA") was established in 1938 to create a secondary market in mortgages
insured by the FHA.
FNMA issues guaranteed mortgage pass-through certificates ("FNMA
Certificates"). FNMA Certificates resemble GNMA Certificates in that each FNMA
Certificate represents a pro rata share of all interest and principal payments
made and owed on the underlying pool. FHMA guarantees timely payment of interest
and principal on FNMA Certificates. The FNMA guarantee is not backed by the full
faith and credit of the United States.
(d) Collateralized Mortgage Obligations and Multi-Class Pass-Through
Securities. Collateralized mortgage obligations ("CMOs") 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 (collectively CMOs unless the context indicates
otherwise) issued by agencies or instrumentalities of the U.S. Government.
In a CMO, a series of bonds or certificates is issued in multiple classes.
Each class of CMOs, often referred to as a "tranche," is issued at a specific
coupon rate and has a stated maturity or final distribution date. Principal
prepayments on collateral underlying a CMO may cause it to be retired
substantially earlier than the stated maturities or final distribution dates.
The principal and interest on the underlying mortgages may be allocated among
the several classes of a series of a CMO in many ways. One or more tranches of a
CMO may have coupon rates which reset periodically at a specified increment over
an index such as the London Interbank Offered Rate ("LIBOR"). These floating
rate CMOs are typically issued with lifetime caps on the coupon rate thereon.
The Fund may also invest in inverse or
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reverse floating CMOs. Inverse or reverse floating CMOs constitute a tranche of
a CMO with a coupon rate that moves in the reverse direction to an applicable
index such as LIBOR. Accordingly, the coupon rate thereon will increase as
interest rates decrease. Inverse or reverse floating CMOs are typically more
volatile than fixed or floating rate tranches of CMOs. Investments in inverse or
reverse floating CMOs would be purchased by the Fund to attempt to protect
against a reduction in the income earned on the Fund investments due to a
decline in interest rates. The Fund would be adversely affected by the purchase
of such CMOs in the event of an increase in interest rates since the coupon rate
thereon will decrease as interest rates increase, and, like other
mortgage-related securities, the value will decrease as interest rates increase.
Many inverse floating rate CMOs have coupons that move inversely to a
multiple of an applicable index such as LIBOR. The effect of the coupon varying
inversely to a multiple of an applicable index creates a leverage factor. This
leverage factor magnifies the extent to which the successful use of hedging
techniques depends on Fund management's ability to both correctly forecast
interest movements and the relationship between long and short-term interest
rates. An accurate estimate of the amount of futures and options required to
achieve a desired weighted average portfolio duration is also extremely
sensitive to management's ability to forecast interest rate movements and
relationships. Furthermore, the markets for inverse floating rate CMOs with
highly leveraged characteristics may at times be very thin. The Fund's ability
to dispose of its positions in such securities will depend on the degree of
liquidity in the markets for such securities. It is impossible to predict the
amount of trading interest that may exist in such securities, and therefore the
future degree of liquidity. It should be noted that inverse floaters based on
multiples of a stated index are designed to be highly sensitive to changes in
interest rates and can subject the holders thereof to extreme reductions of
yield and loss of principal.
The Fund may also invest in two-tiered index floating rate bonds ("TTIBs").
The term two-tiered refers to the two coupon levels that a TTIB bond's coupon
can reset to. The "first tier" is the TTIB's fixed rate coupon, effective as
long as the underlying index is at or below the strike level. Above the strike,
the TTIB coupon resets to a formula similar to an inverse floating rate note
(see below for a discussion of the risk considerations which may be associated
with investing in inverse floating rate notes). This floating rate coupon is
referred to as the "second tier". The TTIB is designed for investors who believe
that the underlying index will stay at current levels or will increase up to the
strike level over the life of the security. The Fund would be adversely affected
by the purchase of such CMOs in the event of an increase in interest rates above
the strike level since the floating rate coupon will decrease, possibly as low
as zero, and, like other mortgage related securities, the value will decrease.
Investments in TTIBs would be purchased by the Fund to increase the income
earned by the Fund's investments in a stable interest rate environment and to
attempt to protect against a reduction in the income earned due to a decline in
interest rates. TTIBs are typically more volatile than fixed rate tranches of
CMOs.
The Fund's objective of providing high current income from U.S. Government
securities while hedging with interest rate derivatives to limit portfolio
duration requires a current operating policy in which the Fund maintains
substantial short positions in interest rate futures and options on an ongoing
basis. The prices of such interest rate futures and options are influenced by
both current market conditions and expectations of future changes in interest
rates. When the preponderance of future expectations of interest rate changes
and the relationship between current and forward levels of the interest rate
derivatives market is in one direction, the performance of a portfolio which is
long only non-derivative fixed income securities and short interest rate
derivatives could be adversely affected by the unbalance created.
Management believes this imbalance may be mitigated by purchasing securities
that tend to benefit significantly when future movements in interest rates are
in the opposite direction of what price levels indicate is the preponderance of
fututre expectation. CMO derivatives, such as TTIBs and inverse floating rate
notes, are currently the only
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securities issued by the United States Government or its agencies and
instrumentalities which have coupon setting mechanisms and other characteristics
which can counter-balance the impact of the preponderance of the expectations as
to the direction of interest rates. Thus, it can be anticipated that under
certain market conditions, CMO derivative securities, such as those mentioned
above, will comprise a substantial portion of the Fund's portfolio.
(e) Stripped Mortgage-Backed Securities. Stripped Mortgage-Backed Securities
("SMBS") are derivative multi-class mortgage securities. The Fund may invest in
SMBS issued by agencies or instrumentalities of the U.S. Government. There are
generally two classes of SMBS, one of which (the "IO class") entitles the
holders thereof to receive distributions consisting solely or primarily of all
or a portion of the interest on the underlying pool of mortgage loans or
mortgage-backed securities ("Mortgage Assets") and the other of which (the "PO
class") entitles the holders thereof to receive distributions consisting solely
or primarily of all or a portion of the principal of the underlying pool of
Mortgage Assets. The cash flows and yields on IO and PO classes are extremely
sensitive to the rate of principal payments (including prepayments) on the
related underlying Mortgage Assets. For example, a rapid or slow rate of
principal payments may have a material adverse effect on the yield to maturity
of IOs or POs, respectively. If the underlying Mortgage Assets experience
greater than anticipated prepayments of principal, an investor may incur
substantial losses. Conversely, if the underlying Mortgage Assets experience
slower than anticipated prepayments of principal, the yield on a PO class will
be affected more severely than would be the case with a traditional
mortgage-backed security.
Repurchase Agreements. The Fund may enter into repurchase agreements
involving Government Securities. Under a repurchase agreement, the Fund acquires
a debt instrument for a relatively short period (usually not more that one week)
subject to the obligation of the seller to repurchase and the Fund to resell
such debt instrument at a fixed price. The resale price is in excess of the
purchase price in that it reflects an agreed-upon market interest rate effective
for the period of time during which the Fund's money is invested. The Fund's
repurchase agreements will at all times be fully collateralized in an amount at
least equal to the purchase price including accrued interest earned on the
underlying Government Securities. The instruments held as collateral are valued
daily, and as the value of instruments declines, the Fund will require
additional collateral. If the seller defaults and the value of the collateral
securing the repurchase agreement declines, the Fund may incur a loss.
Reverse Repurchase Agreements. The Fund may enter into reverse repurchase
agreement transactions. Such transactions involve the sale of Government
Securities held by the Fund, with an agreement that the Fund will repurchase
such securities at an agreed upon price and date. The Fund will employ reverse
repurchase agreements when necessary to meet unanticipated net redemptions so as
to avoid liquidating other portfolio investments during unfavorable market
conditions, or as a technique to enhance income. At the time it enters into a
reverse repurchase agreement, the Fund will place in a segregated custodial
account high-quality liquid debt securities having a dollar value equal to the
repurchase price. The Fund will utilize reverse repurchase agreements when the
interest income to be earned from portfolio investments is greater than the
interest expense incurred as a result of the reverse repurchase transactions.
Lending of Portfolio Securities. In order to generate additional income, the
Fund may lend its portfolio securities in an amount up to 33-1/3% of total
assets to broker-dealers, major banks or other recognized domestic institutional
borrowers of securities not affiliated with the Manager. The borrower at all
times during the loan must maintain cash or cash equivalent collateral or
provide to the Fund an irrevocable letter of credit equal in value to at least
100% of the value of the securities loaned. During the time portfolio securities
are on loan, the borrower pays the Fund any dividends or interest paid on such
securities, and the Fund may invest the cash collateral and earn additional
income, or it may receive an agreed-upon amount of interest income from the
borrower who has delivered equivalent collateral or a letter of credit.
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Portfolio Turnover. The Fund has no fixed policy with respect to portfolio
turnover. The Fund may engage in short-term trading to benefit from yield
disparities among different issues of Government Securities, to seek short-term
profits during periods of fluctuating interest rates, or for other reasons the
Manager believes would be beneficial to the Fund. The Manager expects that,
under normal circumstances, the Fund's annual portfolio turnover rate will not
exceed 200%. The portfolio turnover rate is calculated by dividing the lesser of
sales or purchases of portfolio securities by the average monthly value of the
Fund's portfolio securities, excluding securities having a maturity at the date
of purchase of one year or less. While the Fund will pay commissions in
connection with its options and futures transactions, the other securities in
which the Fund invests are generally traded on a "net" basis with dealers acting
as principals for their own account without a stated commission. Nevertheless,
high portfolio turnover may involve correspondingly greater brokerage
commissions and other transaction costs which will be borne directly by the
Fund. See "Portfolio Transactions" in the Statement of Additional Information.
Borrowing. The Fund may borrow from banks and enter into reverse repurchase
agreements up to 33-1/3% of the value of its total assets (computed at the time
the loan is made) to take advantage of investment opportunities and for
temporary, extraordinary or emergency purposes. See "Reverse Repurchase
Agreements" above. The Fund may pledge up to 33-1/3% of its total assets to
secure these borrowings. If the Fund's asset coverage for borrowings falls below
300%, the Fund will take prompt action to reduce its borrowings. If the Fund
borrows to invest in securities, any investment gains made on the securities in
excess of interest paid on the borrowing will cause the net asset value of the
Fund's shares to rise faster than would otherwise be the case. On the other
hand, if the investment performance of the additional securities purchased fails
to cover their cost (including any interest paid on the money borrowed) to the
Fund, the net asset value of the Fund's shares will decrease faster than would
otherwise be the case. This is the speculative characteristic known as
"leverage." As long as the interest rate paid by the Fund for borrowing via the
use of reverse repurchase agreements is less than the interest rate the Fund can
earn on its securities investments, these transactions will represent an
essential element of the Fund's objective of achieving relatively high current
income. As discussed above, this speculative characteristic known as leverage
increases the amount of fluctuation in the Fund's price given any particular
change in the value of its securities holdings. Thus, all of the sources of risk
inherent in the Fund's strategy of reducing interest rate risk by the use of
hedging with futures contracts (see the sub-heading "Basis Risk") to bring the
weighted duration of the Fund's portfolio to three years or less, will be
magnified to the extent that the borrowing done by the Fund results in leverage.
Other Considerations
It is expected that a substantial portion of the assets of the Fund will be
derived from professional money managers and investors who intend to invest in
the Fund as part of an asset-allocation or market-timing investment strategy.
These investors are likely to redeem or exchange their Fund shares frequently to
take advantage of anticipated changes in market conditions. The strategies
employed by investors in the Fund may result in considerable assets moving in
and out of the Fund. Consequently, the Trust expects that the Fund will
generally experience significant portfolio turnover, which will likely cause
higher expenses and additional costs.
THE MANAGER AND THE MANAGEMENT AGREEMENT
The Manager. Fundamental Portfolio Advisors, Inc. (the "Manager"), which was
organized in 1986, manages the Fund's investments pursuant to a management
agreement dated January 31, 1992 (the "Agreement"). The Manager is an investment
adviser registered with the Securities and Exchange Commission, and specializes
in managing and advising mutual funds.
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The Fund's Board of Trustees approved the continuance of the Fund's current
Management Agreement for a period of sixty days following the date of its
expiration in contemplation of the consummation of a transaction pursuant to
which Tocqueville Asset Management L.P. ("Tocqueville") would assume management
of the assets of the Fund. Otherwise, the Management Agreement would have
expired on April 1, 1998. Tocqueville is the investment adviser to the
Tocqueville Funds.
It is anticipated that shareholders of the Fund will be asked to consider
and approve an Agreement and Plan of Reorganization providing for the transfer
of the Fund's assets to a separate, newly-created Tocqueville Fund having the
same investment policies and objectives as those of the Fund at a special
meeting of shareholders scheduled to be held in late Spring. Subsequent to the
filing with the Securities and Exchange Commission of preliminary proxy
solicitation materials seeking shareholder approval of the Agreement and Plan of
Reorganization at the special meeting of shareholders, the Manager filed two
preliminary proxy statements with the Securities and Exchange Commission, one
opposing the transaction pursuant to which Tocqueville would assume management
of the assets of the Fund; the second, proposing to replace the two independent
Board Members of the Fundamental Funds and the election of six new nominees to
the Fund's Board (in addition to Vincent J. Malanga, a current Board Member).
The Management Agreement. Under the terms of the Management Agreement (the
"Agreement"), the Manager serves as investment adviser and is responsible for
the overall management of the business affairs and assets of the Fund, subject
to the authority of the Trust's Board of Trustees. The Manager manages and
supervises the Fund's investment portfolio and directs the purchase and sales of
its investment securities subject to the right of the Fund's trustees to
disapprove such purchase or sale. The Manager utilizes an investment committee
to manage the assets of the Fund. The committee is currently composed of the
following members: Vincent J. Malanga, a portfolio strategist affiliated with
the Manager and Jane Tubis, a trading assistant affiliated with the Manager.
Vincent J. Malanga is, and has been for more than the past five years,
Chairman of the Board, Chief Executive Officer, President and Treasurer of the
Fundamental Family of Funds. He is, and has been for more than the past five
years, President, Treasurer, and a Director of the Manager, Executive Vice
President, Secretary and a Director of Fundamental Service Corporation (the
Distributor for certain of the Fundamental Family of Funds) and President of
LaSalle Economics, Inc., an economic consulting firm, and a managing director of
LaSalle Portfolio Management, Inc., a commodity trading adviser.
Jane Tubis is, and has been for more than the past five years, a trading
assistant with the Manager.
The Manager pays all of the ordinary operating expenses of the Fund,
including executive salaries and the rental of office space, with the exception
of the following, which are to be paid by the Fund: (1) charges and expenses for
determining from time-to-time the net asset value of the Fund 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 Fund, (3) brokers' commissions, and issue and transfer taxes,
chargeable to the Fund in connection with securities transactions, (4) insurance
premiums, interest charges, dues and fees for membership in trade associations
and all taxes and fees payable by the Fund to Federal, state or other
governmental agencies, (5) fees and expenses involved in registering and
maintaining registrations of the shares of the Fund 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
Marketing Plan and (10) such nonrecurring or extraordinary expenses as may
arise, including litigation affecting the Fund 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 Trust for
the benefit of each of its series, the Fund is responsible for payment of the
portion of such charges or expenses which are properly allocable to the Fund.
For the services it provides under the terms of the Agreement, the Manager
receives a monthly fee of .75% per annum of the Fund's average daily net assets
up to $500 million, .725% per annum on the next $500 million, and .70% per annum
on assets over $1 billion. This fee is higher than that paid by most other
mutual funds due to the complexity
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of managing the Fund. The Manager may, from time to time, voluntarily waive all
or a portion of its fees payable under the Agreement.
On September 30, 1997, the Securities and Exchange Commission (the
"Commission") instituted administrative proceedings against the Manager,
Fundamental Service Corporation, and Drs. Lance M. Brofman and Vincent J.
Malanga (the "Parties"). The Commission's Order instituting the proceedings
alleges, among other things, certain violations of the federal securities laws,
including the antifraud provisions, for failing to disclose the risks associated
with investments in inverse floating rate notes made on behalf of the Fund in
1993 and 1994, marketing the Fund in a way that was contrary to the
administration of the Fund, exceeding the Fund's portfolio duration of three
years or less as stated in its prospectus, and failing to disclose the Manager's
soft dollar practices to the Fundamental Fund Boards. A hearing has been
scheduled to determine whether the allegations against the Parties are true, and
if so, whether remedial action is appropriate. Counsel to the Parties have
indicated that the Parties intend to vigorously contest the charges. The Manager
has indicated that the institution of the proceedings against the Parties has
not adversely affected the ability of the Manager or Fundamental Service
Corporation to continue to perform the day-to-day affairs of the Fundamental
Funds.
The Manager and Fundamental Service Corporation (on behalf of certain of
their directors, officers, shareholders, employees and control persons) (the
"Indemnitees") received payments during the fiscal year ended December 31, 1997
from three of the Fundamental Funds for attorneys' fees incurred by them in
defending certain proceedings. The payments were as follows: Fundamental U.S.
Government Strategic Income Fund (approximately $232,500); New York Muni Fund
(approximately $50,000); and the California Muni Fund (approximately $4,000).
Upon learning of the payment, the independent Board Members of the Fundamental
Funds directed that the Indemnitees return all of the payments to the Funds or
place them in escrow pending their receipt of an opinion of an independent legal
counsel to the effect that the Indemnitees are entitled to receive them.
On April 30, 1998, the Indemnitees placed $106,863 into an escrow account
pending clarification of certain legal issues. The Manager and Fundamental
Service Corporation have asserted that they waived fees during the year ended
December 31, 1997 and that the amount placed in escrow should be net of any
reimbursements already made to the Funds in the form of fees forgone. Upon
learning that $106,863 was placed into an escrow account on behalf of the Funds,
the independent Board Members referred the Manager and Fundamental Service
Corporation to their prior directive and asked that the entire amount of all
payments received by such entities ($286,500) be placed into said escrow
account. For further information, see Notes to the December 31, 1997 Financial
Statements of Fundamental U.S. Government Strategic Income Fund, New York Muni
Fund and the California Muni Fund, attached to the Statement of Additional
Information.
PURCHASE OF SHARES
How to Purchase Shares and Determination of Net Asset Value. This is a
No-Load Fund. Shares of the Fund are offered for sale on a continuous basis at
the next determined net asset value per share after your order is received and
accepted. Orders received after the closing time of the New York Stock Exchange
(currently 4:00 P.M. New York time) are purchased at the net asset value
determined on the next business day. The Fund's net asset value per share is
determined by dividing the value of the Fund's net assets by the total number of
shares outstanding. The Fund determines the net asset value (NAV) of its shares
on each day that both the New York Stock Exchange and the Fund's custodian bank
are open for business and there is sufficient trading in the Fund's portfolio
securities to affect materially its NAV per share.
The Fund's portfolio securities are valued on the basis of prices provided
by an independent pricing service when, in the opinion of persons designated by
the Fund's trustees, such prices are believed to reflect the fair market value
of such securities. Prices of non-exchange traded portfolio securities provided
by independent pricing services are generally determined without regard to bid
or last sale prices but take into account institutional size trading in similar
groups of securities, yield, quality, coupon rate, maturity, type of issue,
trading characteristics and other market data. Securities traded or dealt in
upon a securities exchange and not subject to restrictions against resale as
well as options and futures contracts listed for trading on a securities
exchange or board of trade are valued at the last quoted sales price, or, in the
absence of a sale, at the mean of the last bid and asked prices. Options not
listed for trading on a securities exchange or board of trade for which
over-the-counter market quotations are readily available are valued at the mean
of the current bid and asked prices. Money market and short-term debt
instruments with a remaining maturity of 60 days or less will be valued on an
amortized cost basis. Securities not priced in a manner
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described above and other assets are valued by persons designated by the Fund's
trustees using methods which the trustees believe accurately reflects fair
value. The prices realized from the sale of these securities could be less than
those originally paid by the Fund or less than what may be considered the fair
value of such securities.
For your initial investment, there is a $2,500 minimum required. The minimum
initial investment for qualified pension plans (IRAs, Keoghs, etc.) is $2,000.
The minimum subsequent investment is $100. (The foregoing minimum investments
may be modified or waived at any time at our discretion). You may be charged a
fee for effecting transactions in the Fund's shares through securities dealers,
banks or other financial institutions. We charge no redemption fee when you
redeem your shares and there is no charge for reinvestment of dividends or
exchanges made between funds.
Conditions of Purchase. Shares of the Fund may be purchased either directly
from the Fund or through securities dealers, banks or other financial
institutions. The Fund has a minimum initial purchase requirement of $2,500 and
a minimum subsequent purchase requirement of $100. Subsequent purchases are made
in the same manner as initial purchases. After a purchase order becomes
effective, confirmation of the purchase is sent to the investor, and the
purchase is credited to the investor's account. The Fund reserves the right to
reject any purchase order, including purchases by exchange. Shares of the Fund
may be purchased only in states where the shares are qualified for sale.
Investors can purchase shares without a sales charge if they purchase shares
directly from the Fund. However, investors may be charged a fee if they purchase
shares through securities dealers, banks, or other financial institutions.
Investors opening a new account for the Fund must complete and submit an account
application along with payment of the purchase price for their initial
investment. Investors purchasing additional shares of the Fund should include
their account number with payment of the purchase price for additional shares
being purchased. Investors may reopen an account with a minimum investment of
$100 and without filing a new account application during the year in which the
account was closed or during the following calendar year if information on the
original application is still applicable. The Fund may require the filing of a
statement that all information on the original application remains applicable.
Methods of Payment
Payment of the purchase price for shares of the Fund may be made in any of
the following manners:
Payment by wire: An expeditious method of purchasing shares is the
transmittal of Federal Funds by bank wire to Firstar Trust Company. To purchase
shares by wire transfer, instruct a commercial bank to wire money to Firstar
Trust Company ABA # , Credit to: Firstar Trust Company, A/C # , Further credit
to: Fundamental Family of Funds, A/C # . The wire transfer should be accompanied
by the name, address, and social security number (in the case of new investors)
or account number (in the case of persons already owning shares of the Fund).
Payment by check: Shares may also be purchased by check. Checks should be
made payable to Fundamental Family of Funds, and mailed to Firstar Trust
Company, Agent, P.O. Box 701, Milwaukee, WI 53201-0701. If your check does not
clear, Firstar Trust Company will cancel your purchase and charge you a $20 fee.
Moreover, you could be liable for any losses incurred. The Fund reserves the
right to limit the number of checks processed at any one time and will notify
investors prior to exercising this right.
Automatic Investment Program: The Fundamental Automatic Investment Program
offers a simple way to maintain a regular investment program. The Fund has
waived the initial investment minimum for you when you open a new account and
invest $100 or more per month through the Fundamental Automatic Investment
Program. The Fundamental Automatic Investment Program allows you to purchase
shares (minimum of $50 per transaction) at
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regular intervals. Investments are made by transferring funds directly from your
checking, or bank money market account. At your option investments can be made,
once a month on either the fifth or the twentieth day, or twice a month on both
days.
To establish a Fundamental Automatic Investment Program, or to add this
option to your existing account simply complete an authorization form, which can
be obtained by calling 1-800-322-6864. You may cancel this privilege or change
the amount you invest at any time. Initial Program setup and any modifications
may take up to ten days to take effect. There is currently no charge for this
service, and the Fund may terminate or modify this privilege at any time.
REDEMPTION OF SHARES
Each investor in the Fund has the right to cause the Fund to redeem his or
her shares by making a request to Firstar Trust Company in accordance with
either the regular redemption procedure, the telephone redemption privilege, the
expedited redemption privilege, or the check redemption privilege, as described
below. If Firstar Trust Company receives a redemption request before the close
of trading on any day the New York Stock Exchange is open for trading, the
redemption will become effective on that day and be made at the net asset value
per share of the Fund, as determined at the close of trading on that day, and
payment will be made on the following business day. If Firstar Trust Company
receives a redemption request following the close of trading on the New York
Stock Exchange, or on any day the New York Stock Exchange is not open for
business, the redemption will become effective on the next day the New York
Stock Exchange is open for trading and be made at the net asset value per share
of the Fund, as determined at the close of trading on that day, and payment will
be made on the following business day.
Investors are entitled to receive all dividends on shares being redeemed
that are declared on or before the effective date of the redemption of such
shares. The net asset value per share of the Fund received by an investor on
redeeming shares may be more or less than the purchase price per share paid by
such investor, depending on the market value of the portfolio of the Fund at the
time of redemption.
Regular Redemption Procedure. Investors may redeem their shares by sending a
written redemption request to Firstar Trust Company, which request must specify
the number of shares to be redeemed and be signed by the investor of record. For
redemptions exceeding $50,000 (and for all written redemptions, regardless of
amount, made within 30 days following any change in account registration), the
signature of the investor on the redemption request must be guaranteed by an
eligible guarantor institution approved by Firstar Trust Company. Signature
guarantees in proper form generally will be accepted from domestic banks, a
member of a national securities exchange, credit unions and savings
associations, as well as from participants in the Securities Transfer Agents
Medallion Program ("STAMP"). If you have any questions with respect to signature
guarantees, please call the transfer agent at (800) 322-6864. Firstar Trust
Company may, at its option, request further documentation from corporations,
executors, administrators, trustees, or guardians. If a redemption request is
sent to the Fund, the Fund will forward it to Firstar Trust Company. Redemption
requests will not become effective until all proper documents have been received
by Firstar Trust Company. Requests for redemption that are subject to any
special condition or specify an effective date other than as provided herein
cannot be accepted and will be returned to the investor.
Telephone Redemption Privilege. An investor may, either by completing the
appropriate section of the purchase application or by making a later written
request to Firstar Trust Company containing his or her signature guaranteed by
an eligible guarantor (see above), obtain the telephone redemption privilege for
any of his or her accounts. Provided that your account registration has not
changed within the last 30 days, an investor may redeem up to $150,000 worth of
shares per day from an account for which he or she has the telephone redemption
privilege by making a telephone redemption request to Firstar Trust Company, at
(800) 322-6864. Telephone calls may be recorded. A check for the proceeds of
such a redemption will be issued in the name of the investor of record and
mailed
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to the investor's address as it appears on the records of the Fund. Both the
Fund and Firstar Trust Company reserve the right to refuse or limit a telephone
redemption request, and may modify the telephone redemption privilege upon the
giving of 60 days' prior notice.
Neither the Fund nor the transfer agent will be liable for following
instructions communicated by telephone that they reasonably believe to be
genuine. It is the Fund's policy to provide that a written confirmation
statement of all telephone call transactions be mailed to shareholders at their
address of record within three business days after the telephone call
transaction. Since you will bear the risk of loss, you should verify the
accuracy of telephone transactions immediately upon receipt of your confirmation
statement.
Expedited Redemption Privilege. An investor in any series of the Trust may,
either by completing the appropriate section of the purchase application or by
later making a written request to Firstar Trust Company, containing his or her
signature guaranteed by an eligible guarantor (see above), obtain the expedited
redemption privilege for any of his or her accounts. The expedited redemption
privilege allows the investor to have the proceeds from any redemption of shares
in an amount of $5,000 or more transferred by wiring Federal Funds to the
commercial bank or savings and loan institution specified in his or her purchase
application or written request for the expedited redemption privilege. The
commercial bank or savings and loan institution specified must be a member of
the Federal Reserve System. Firstar Trust Company charges a $12 service fee for
each payment of redemption proceeds made by Federal wire. This fee will be
deducted from your account. Expedited redemption requests may be made either by
mail to the address specified under the regular redemption procedure or by
telephone to the number specified under the telephone redemption privilege. The
proceeds from such a redemption may be subject to a deduction of the usual and
customary charge. An investor may change the account or commercial bank
designated to receive the redemption proceeds by sending a written request to
Firstar Trust Company, containing his or her signature guaranteed in the manner
described above. Both the Fund and Firstar Trust Company reserve the right to
refuse or limit an expedited redemption request and to modify the expedited
redemption privilege at any time.
Check Redemption Privilege. An investor may, either by completing the
appropriate section of the purchase application or by later making a written
request to the Fund, obtain redemption checks for any of his or her accounts.
These checks may be used by the investor in any lawful manner and may be payable
to the order of any person or company in an amount of $100 or more. When a check
is presented to Firstar Trust Company for payment, Firstar Trust Company, as
agent for the investor, will cause the Fund to redeem a sufficient number of
shares in the investor's account to cover the amount of the check. Investors
using the check redemption privilege will be subject to the same rules and
regulations that are applicable to other checking accounts at Firstar Trust
Company. There is no charge to the investor for using the check redemption
privilege, except that a fee may be imposed by Firstar Trust Company, if an
investor requests that it stop payment of a Redemption Check or if it cannot
honor a Redemption Check due to insufficient funds or other valid reasons. The
check redemption privilege may not be used to close an account. The check
redemption privilege may be modified or terminated at any time by either the
Fund or Firstar Trust Company.
At times, the Fund may be requested to redeem shares for which it has not
yet received good payment. The Fund may delay, or cause to be delayed, payment
or redemption proceeds until such time as it has assured itself that good
payment has been received for the purchase of such shares, which may take up to
15 days. In the case of payment by check, determination of whether the check has
been paid by the paying institution can generally be made within 7 days, but may
take longer. Investors may avoid the possibility of any such delay by purchasing
shares by wire. In the event of delays in paying redemption proceeds, the Fund
will take all available steps to expedite collection of the investment check.
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If shares were purchased by check, you may write checks against such shares
only after 15 days from the date the purchase was executed. Shareholders who
draw against shares purchased fewer than 15 days from the date of original
purchase, will be charged usual and customary bank fees.
The Fund reserves the right to suspend the right of redemption or postpone
the day of payment with respect to its shares (1) during any period when the New
York Stock Exchange is closed (other than customary weekend and holiday
closings), (2) during any period when trading markets that the Fund normally
uses are restricted or an emergency exists as determined by the Securities and
Exchange Commission, so that disposing of the Fund's investments or determining
its net asset value is not reasonably practicable, or (3) for such other periods
as the Securities and Exchange Commission by order may permit to protect
investors.
If an investor's account has an aggregate net asset value of less than $100,
the Fund may redeem the shares held in such account if the net asset value of
such account has not been increased to at least $100 within 60 days of notice by
the Fund to such investor of its intention to redeem the shares in such account.
The Fund will not redeem the shares of an account with a net asset value of less
than $100 if the account was reduced from the initial minimum investment to
below $100 as a result of market activity.
Transfers. An investor may transfer shares of the Fund by submitting to
Firstar Trust Company a written request for transfer, signed by the registered
holder of the shares and indicating the name, social security or taxpayer
identification number of and distribution and redemption options elected by the
new registered holder. Such request must be signature guaranteed. Firstar Trust
Company may, at its option, request further documentation from transferors that
are corporations, executors, administrators, trustees, or guardians.
Tax Sheltered Retirement Plans. We offer a Prototype Pension and Profit
Sharing Plan, including Keogh plans, IRAs, SEP-IRA Plans, IRA Rollover Accounts
and 403(b) plans. Check redemption and telephone redemption privileges are not
available to Retirement account holders. Plan support services are available by
calling us at (800)322-6864.
Exchange Privilege. For your convenience, the Exchange Privilege permits you
to purchase shares in any of the other funds for which Fundamental Portfolio
Advisors, Inc. acts as the investment manager in exchange for shares of the Fund
at respective net asset values per share. Exchange instructions may be given in
writing to Firstar Trust Company, Agent, P.O. Box 701, Milwaukee, WI 53201-0701,
the Fund's transfer agent, and must specify the number of shares of the Fund to
be exchanged and the fund into which the exchange is being made. The telephone
exchange privilege will be made available to shareholders automatically. You may
telephone exchange instructions by calling Firstar Trust Company at (800)
322-6864. Before any exchange, you must obtain, and should review, a copy of the
current prospectus of the fund into which your exchange is being made.
Prospectuses may be obtained by calling or writing the Fund. See also "Telephone
Redemption Privilege" for a discussion of the Fund's policy with respect to
losses resulting from unauthorized telephone transactions.
The Exchange Privilege is only available in those states where such
exchanges can legally be made and exchanges may only be made between accounts
with identical account registration and account numbers. Prior to effecting an
exchange, you should consider the investment policies of the fund in which you
are seeking to invest. Any exchange of shares is, in effect, a redemption of
shares in one fund and a purchase of the other fund. You may recognize a capital
gain or loss for Federal income tax purposes in connection with an exchange. The
Exchange Privilege may be modified or terminated by the Fund after giving 60
days prior notice. The Fund reserves the right to reject any specific order,
including purchases by exchange.
A Completed Purchase Application must be received by the Transfer Agent
before the Exchange, Check Redemption, Telephone Redemption or Expedited
Redemption Privileges may be used.
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BROKERAGE ALLOCATION
It is the Fund's policy to seek execution of its purchases and sales at the
most favorable prices through responsible broker-dealers and in agency
transactions, at competitive commission rates. The Fund's brokerage allocation
policy may permit the Fund to pay a broker-dealer which furnishes research
services a higher commission than that which might be charged by another
broker-dealer which does not furnish research services, provided that such
commission is deemed reasonable in relation to the value of the services
provided by such broker-dealer (see the Statement of Additional Information for
a complete discussion of the Fund's brokerage allocation policy). It is not the
Fund's practice to allocate principal business on the basis of sales of Fund
shares which may be made through brokers or dealers, although broker-dealers
effecting purchases of Fund shares for their customers may participate in
principal transactions or brokerage allocation. The Fund may, however, allocate
principal business or brokerage to obtain for the benefit of the Fund services
that the Fund would otherwise have to pay for directly.
The Fund's trustees have authorized the Manager to effect portfolio
transactions on an agency basis with affiliated broker-dealers, and has adopted
certain procedures incorporating the standards of Rule 17e-1 of the 1940 Act,
which requires that the commissions paid to any affiliated broker-dealer must be
"reasonable and fair compared to the commission, fee, or other remuneration
received, or to be received, by other brokers in connection with comparable
transactions involving similar securities during a comparable period of time."
DISTRIBUTION AGREEMENT AND MARKETING PLAN
Distribution Agreement. Fundamental Service Corporation, ("FSC") 90
Washington Street, New York, New York, the Distributor, a Delaware corporation,
which is an affiliated company of the Manager, acts as principal distributor of
Fund shares. The Distributor has the exclusive right to distribute Fund shares
directly or through other broker-dealers. The Distributor is reimbursed for
distribution expenses pursuant to a Distribution and Marketing Plan (the
"Marketing Plan"), adopted pursuant to Rule 12b-1 under the 1940 Act, which
allows it to finance activities that are primarily intended to result in the
sale of the Fund's shares, including but not limited to advertising,
commissions, and salaries paid to registered representatives and marketing
personnel of the Distributor, printing of prospectuses and reports for other
than existing shareholders, preparation and distribution of advertising material
and sales literature, and payments to dealers, banks and shareholder servicing
agents who enter into agreements with the Manager or the Distributor for
providing administrative and account maintenance services. Such services may
include, without limitation, some or all of the following: answering Fund
inquiries; assistance in changing dividend options, account registration and
addresses; performance of sub-accounting; maintenance of shareholder accounts
and records; assistance in processing purchase and redemption transactions;
providing periodic statements showing a shareholder's account balance and the
integration of such statements with those of other transactions and balances in
the shareholder's other accounts serviced by the Manager or the Distributor, if
any; and such other information and services as the Fund reasonably may request,
to the extent the Manager or Distributor is permitted by applicable statute,
rule or regulation to provide such information or services.
NASD Regulation, Inc. ("NASDR") entered into a Letter of Acceptance, Waiver
and Consent with FSC that imposed a total of $125,000 in fines and other
stipulated sanctions on FSC and two of its officers for distributing advertising
materials for the Fund that NASDR deemed to be false and misleading. FSC neither
admitted nor denied the allegations and filed a Mitigation Statement in response
to the Letter of Acceptance, Waiver and Consent.
The Fund's Board of Trustees approved the continuance of the Fund's
Distribution Agreement for a period of sixty days following the date of its
expiration in contemplation of a transaction pursuant to which Tocqueville Asset
Management L.P. would assume management of the assets of the Fund. Otherwise,
the Distribution Agreement would have expired on April 1, 1998. See ("The
Manager and The Management Agreement").
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Marketing Plan. Pursuant to the Marketing Plan, the Fund may incur
distribution expenses not to exceed .25% per annum of its average daily net
assets. The Marketing Plan will only permit payments for expenses actually
incurred by the Distributor or the Manager. The Marketing Plan allows for the
carry-over of expenses from year to year and, if the Marketing Plan is
terminated or not continued in accordance with its terms, the Fund's obligation
to make payments to the Distributor (or Manager) pursuant to the Plan will
cease and the Fund will not be required to make any payments past the date the
Marketing Plan terminates. The Fund records all accruals made under the
Marketing Plan as expenses in the calculation of its net investment income. The
Fund may not accrue the amount of distribution expenses incurred by the
Distributor that may be paid pursuant to the Marketing Plan in future periods
as a liability, because it is believed that the standards for the accrual of a
liability under generally accepted accounting principles will not have been
satisfied. Such distribution expenses are recorded as an expense in future
periods as they are accrued. Certain overhead expenses of the Distributor are
also provided for under the Marketing Plan. During the year ended December 31,
1997, FSC waived all its fees earned under the marketing plan in the amount of
$29,560. See "Distribution Agreement and Marketing Plan" in the Fund's
Statement of Additional Information.
The Fund's Board of Trustees approved the continuance of the Fund's
Marketing Plan for a period of sixty days following the date of its expiration
in contemplation of a transaction pursuant to which Tocqueville Asset Management
L.P. would assume management of the assets of the Fund. Otherwise, the Plan
would have expired on April 1, 1998. See ("The Manager and The Management
Agreement").
PERFORMANCE INFORMATION
Advertisements and communications to investors regarding the Fund may cite
certain performance and ranking information and make performance comparisons to
other funds or to relevant indices, as described below. The Fund's performance
may be calculated both in terms of total return and also on the basis of current
yield over any period of time and may include a computation of the Fund's
distribution rate.
Comparative Results. From time to time, the Fund may use hypothetical
investment examples and performance information in advertisements, shareholder
reports or other communications to shareholders. Because such performance
information is based on historical earnings, it should not be considered as an
indication or representation of the performance of the Fund in the future. From
time to time, the performance and yield of the Fund may be quoted and compared
to those of other mutual funds with similar investment objectives, unmanaged
investment accounts, including savings accounts, money market funds, (or
accounts), certificates of deposit, or other similar products and to stock or
other relevant indices or to rankings prepared by independent services or other
financial or industry publications that monitor the performance of mutual funds.
For example, the performance of the Fund may be compared to data prepared by
Lipper Analytical Services, Inc., Morningstar, Inc., and Value Line, widely
recognized independent services which monitor the performance of mutual funds.
Performance and yield data as reported in national financial publications
including, but not limited to, Money Magazine, Forbes, Barron's, The Wall Street
Journal, The New York Times, Businessweek and The Bond Buyer, or in local or
regional publications, may also be used in comparing the performance and yield
of the Fund. Additionally, the Fund may, with proper authorization, reprint
articles written about the Fund and provide them to prospective shareholders. If
a comparison of the Fund's performance to other similar funds or to relevant
indices is made, the Fund's performance will be stated in the same terms in
which such comparative data and indices are stated. Performance information will
vary from time to time and past results are not necessarily representative of
future results. The Fund's performance is a function of portfolio management in
selecting the type and quality of portfolio securities, and is affected by
operating, distribution and marketing expenses.
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Yield Information. The term "yield" refers to the income generated by an
investment over a one-month or 30 day period. The income is computed by dividing
the net investment income per share earned during such period by the maximum
public offering price per share on the last day of the period, and then
annualizing such 30-day (or one month) yield in accordance with a formula
prescribed by the Securities and Exchange Commission which provides for
compounding on a semi-annual basis.
Total Return. The Fund's performance information may also be calculated
quarterly on a total return basis. All advertisements in which such information
is included will show the average annual total return of an assumed initial
investment of $1,000, reduced by the pro rata share of the account opening fee,
at the end of one, five and ten year periods or, if such periods have not yet
elapsed, at the end of a shorter period corresponding to the life of the Fund.
These values will be calculated by multiplying the compounded average annual
total return for each time period by the amount of the assumed initial
investment, reduced by the pro rata share of the account opening fee. The total
return basis combines principal and dividend income changes for the period
shown. For purposes of computing total return, income dividends and capital
gains distributions paid on shares of the Fund are assumed to have been
reinvested when received. The Fund may also publish annual and cumulative total
return figures from time to time.
Distribution Rate. The Fund may also quote its distribution rate and/or its
effective distribution rate in sales literature or other shareholder
communications. The Fund's distribution rate is computed by dividing the most
recent monthly distribution per share annualized by the current net asset value
per share. The Fund's effective distribution rate is computed by dividing the
distribution rate by the ratio used to annualize the distribution and
reinvesting the resulting amount for a full year on the basis of such ratio. The
effective distribution rate will be higher than the assumed reinvestment. The
Fund's distribution rate may differ from its yield because the distribution rate
may contain items of capital gain and other items of income.
TAX MATTERS
The Fund intends to qualify as a regulated investment company for federal
income tax purposes by satisfying the requirements under Subchapter M of the
Internal Revenue Code of 1986, as amended (the Code), including the requirements
with respect to diversification of assets, distribution of income and sources of
income. It is the Fund's policy to distribute to shareholders all of its
investment income (net of expenses) and any capital gains (net of capital
losses) in accordance with the timing requirements imposed by the Code, so that
the Fund will satisfy the distribution requirement of Subchapter M and not be
subject to federal income taxes or the 4% excise tax.
If the Fund fails to satisfy any of the Code requirements for qualification
as a regulated investment company, it will be taxed at regular corporate tax
rates on all its taxable income (including capital gains) without any deduction
for distributions to shareholders, and distributions to shareholders will be
taxable as ordinary dividends (even if derived from the Fund's net long-term
capital gains) to the extent of the Fund's current and accumulated earnings and
profits.
Distributions by the Fund of its net investment income and the excess, if
any, of its net short-term capital gain over its net long-term capital loss are
taxable to shareholders as ordinary income. Such distributions are treated as
dividends for federal income tax purposes, but will not qualify for the 70%
dividends-received deduction for corporate shareholders. Distributions by the
Fund of the excess, if any, of its net long-term capital gain over its net
short-term capital loss are designated as capital gain dividends and are taxable
to shareholders as long-term capital gains, regardless of the length of time
shareholders have held their shares.
Distributions to shareholders will be treated in the same manner for federal
income tax purposes whether shareholders elect to receive them in cash or
reinvest them in additional shares. In general, shareholders take distributions
into account in the year in which they are made. However, shareholders are
required to treat certain
23
<PAGE>
distributions made during January as having been paid by the Fund and received
by shareholders on December 31 of the preceding year. A statement setting forth
the federal income tax status of all distributions made (or deemed made) during
the year, and any foreign taxes passed-through to shareholders, will be sent to
shareholders promptly after the end of each year.
Investors should carefully consider the tax implications of purchasing
shares just prior to the record date of any ordinary income dividend or capital
gain dividend. Those investors purchasing shares just prior to an ordinary
income or capital gain dividend 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 and such dividend economically
constitutes a return of capital to such investors.
A shareholder will recognize gain or loss upon the sale or redemption of
shares of the Fund 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.
Any loss realized upon a taxable disposition of shares within six months from
the date of their purchase will be treated as a long-term capital loss to the
extent of any capital gain dividends received on such shares. All or a portion
of any loss realized upon a taxable disposition of shares of the Fund may be
disallowed if other shares of the Fund are purchased within 30 days before or
after such disposition.
If a shareholder is a non-resident alien or foreign entity shareholder,
ordinary income dividends paid to such shareholder generally will be subject to
United States withholding tax at a rate of 30% (or lower rate under an
applicable treaty). We urge non-United States shareholders to consult their own
tax adviser concerning the applicability of the United States withholding tax.
Under the backup withholding rules of the Code, shareholders may be subject
to 31% withholding of federal income tax on ordinary income dividends, capital
gain dividends and redemption payments made by the Fund. In order to avoid
backup withholding, shareholders must provide the Fund with a correct taxpayer
identification number (which for an individual is usually his Social Security
number) or certify that the shareholder is a corporation or otherwise exempt
from or not subject to backup withholding.
The foregoing discussion of federal income tax consequences is based on tax
laws and regulations in effect on the date of this Prospectus, and is subject to
change by legislative, administrative or judicial action. As the foregoing
discussion is for general information only, shareholders should also review the
more detailed discussion of federal income tax considerations relevant to the
Fund that is contained in the Statement of Additional Information. In addition,
shareholders should consult with their own tax adviser as to the tax
consequences of investments in the Fund, including the application of state and
local taxes which may differ from the federal income tax consequences described
above.
Ordinary income dividends paid by the Fund which are derived from interest
income received by the Fund on Direct Obligations and certain Agency obligations
are either fully or partially exempt from state and local personal income taxes
in many states. The year-end tax information which the Fund will sent to
shareholders will contain the percentage of ordinary income dividends paid by
the Fund which were derived from interest received by the Fund on Direct
Obligations and certain Agency obligations and which therefore may be exempt
from state and local personal income taxes. Shareholders are advised to consult
their own tax advisers concerning the application of state and local income
taxes to an investment in the Fund.
OTHER INFORMATION
Description of Shares
The Fund is a diversified series of Fundamental Fixed-Income Fund, a
Massachusetts business trust organized on March 19, 1987. Fundamental
Fixed-Income Fund's Declaration of Trust permits its Board of Trustees to
authorize the
24
<PAGE>
issuance of an unlimited number of full and fractional shares of beneficial
interests (without par value), which may be divided into such separate series as
the Trustees may establish. The Trustees have currently established three series
of shares: the Fund, the High-Yield Municipal Bond Series and the Tax-Free Money
Market Series. The Trustees may establish additional series of shares, and may
divide or combine the shares of a series of the Fund into a greater or lesser
number of shares without thereby changing the proportionate beneficial interests
in such series. Each share of a series of the Trust represents an equal
proportionate interest in such series with each other share of such series. 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
of trustees and selection of accountants. Upon liquidation of the Fund, each
shareholder of the Fund would be entitled to share pro rata in the net assets
available for distribution to shareholders of the Fund.
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 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
in the Fund's Statement of Additional Information.
Declaration of Trust-Certain Liabilities
As a Massachusetts business trust, Fundamental Fixed-Income Fund's
operations are governed by its Declaration of Trust, a copy of which is on file
with the office of the Secretary of The Commonwealth of Massachusetts. See
"Certain Liabilities" in the Fund's Statement of Additional Information.
Code of Ethics
The Code of Ethics of Fundamental Portfolio Advisors, Inc. and the Fund
prohibits all affiliated personnel from engaging in personal investment
activities which compete with or attempt to take advantage of the Fund's planned
portfolio transactions. The objective of the Code of Ethics of both the Fund and
Fundamental Portfolio Advisors, Inc. is that their operations be carried out for
the exclusive benefit of the Fund's shareholders. Both organizations maintain
careful monitoring of compliance with the Code of Ethics.
Transfer Agent and Dividend Paying Agent
Firstar Trust Company is the transfer and dividend paying agent for shares
of the Fund. Inquiries regarding the Fund should be addressed to Firstar Trust
Company.
Firstar Trust Company maintains an account for each shareholder in the Fund
and all of the shareholder's transactions are recorded in this account.
Confirmation statements showing details of transactions are sent to shareholders
following each transaction, and each shareholder is sent a quarterly account
summary.
Annual and semi-annual reports of the Fund together with the list of
securities held by the Fund in its portfolio are mailed to each shareholder in
the Fund.
Shareholders whose shares are held in the name of an investment
broker-dealer or other party will not normally have an account with the Fund and
may not be able to use some of the services available.
Custodian and Independent Accountants
Firstar Trust Company, P.O. Box 701, Milwaukee, WI 53201-0701, acts as
Custodian of the Fund's cash and securities. Firstar Trust Company also acts as
bookkeeping agent for the Fund, and in that capacity, monitors the Fund's
accounting records and calculates its net asset value.
25
<PAGE>
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.
Counsel
Kramer Levin, Naftalis & Frankel, 919 Third Avenue, New York, New York, act
as counsel to the Fund.
SHAREHOLDER INQUIRIES
Shareholder inquiries concerning the status of an account should be directed
to your securities dealer or to the Fund at (800) 322-6864.
26
<PAGE>
(LEFT COLUMN)
FUNDAMENTAL
U.S. GOVERNMENT
STRATEGIC INCOME FUND
90 Washington Street
New York NY 10006
1-800-225-6864
Transfer Agent
Firstar Trust Company
P.O. Box 701
Milwaukee, WI 53201-0701
1-800-322-6864
Counsel to the Fund
Kramer, Levin, Naftalis & Frankel
New York, New York
Independent Auditors
McGladrey &Pullen, LLP
New York, New York
No person has been authorized to give any
information or to make any representations other
than those contained in this Prospectus and in the
Fund's official sales literature in connection
with the offer of the Fund's shares, and, if given
or made, such other information or representations
must not be relied upon as having been authorized
by the Fund. This Prospectus does not constitute
an offer in any State in which, or to any person
to whom, such offering may not lawfully be made.
USPR 042194
(RIGHT COLUMN)
FUNDAMENTAL U.S. GOVERNMENT
STRATEGIC INCOME FUND
Prospectus
May 1, 1998
(logo) FUNDAMENTAL
U.S. GOVERNMENT
STRATEGIC INCOME FUND
(logo) FUNDAMENTAL
Family of Funds
<PAGE>
(LEFT COLUMN)
Fundamental
Fixed-lncome Fund
High-Yield Municipal Bond
Series
90 Washington Street
New York, NY 10006
1-800-225-6864
Prospectus
May 1, 1998
This Prospectus pertains to the High-Yield Municipal Bond Series (High-Yield
Series) of the Fundamental Fixed-lncome Fund (the Fund), an open-end,
non-diversified management investment company (commonly referred to as a mutual
fund). The investment objective of the High-Yield Series is to provide a high
level of current income exempt from federal income taxes through investment in a
portfolio of lower quality municipal bonds (generally with maturities of 20
years or more). Although it is not entirely illustrative of lower quality
municipal bonds, lower quality bonds in general, are commonly referred to as
"junk bonds."
This Prospectus concisely sets forth information about the High-Yield Series
that you should know before investing. You should read and retain this
Prospectus for your future reference. More information about the High-Yield
Series is included in the Statement of Additional Information for the High-Yield
Series, also dated May 1, 1998, which has been filed with the Securities and
Exchange Commission and is incorporated into this Prospectus by reference. A
copy of the Statement of Additional Information may be obtained free of charge
by writing to the Fund at the address listed above, or by calling (800)
322-6864. Shareholder inquiries may also be placed through this number.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES AGENCY
NOR HAS THE COMMISSION OR ANY STATE SECURITIES AGENCY PASSED UPON
THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION
TO THE CONTRARY IS A CRIMINAL OFFENSE.
(RIGHT COLUMN)
Contents
Annual Operating Expenses 2
Financial Highlights 2
Investment Objective and Policies 4
Temporary Investments 6
Participation Interests, Variable and
Inverse Floating Rate Investments 6
When-lssued Securities 7
Futures Contracts 8
Options 10
Repurchase Agreements 11
Lending Portfolio Securities 11
Borrowings 11
Portfolio Transactions and Turnover 12
Other Considerations 12
Private Activity Bonds 12
Miscellaneous 12
Management 13
Information about Shares
of the High-Yield Series 15
Description of Shares 15
How to Purchase Shares 15
Methods of Payment 16
Purchase Price and Net Asset Value 17
Distribution Expenses 17
Redemptions 18
Transfers 20
Dividends and Tax Matters 21
Tax Matters 21
General Information 23
Investor Services 23
Calculating Yield and
Average Annual Total Return 23
Exchangeability of Shares 24
Dividend FLEXIVEST Option 24
Other Information 24
Independent Accountants 24
Statement of Additional Information 24
Appendix A-Portfolio Composition A-1
Appendix B-Description of Municipal
Bond Ratings B-1
<PAGE>
(LEFT COLUMN)
Annual Operating
Expenses
The following table sets forth the estimated annual operating expenses of the
High-Yield Series expressed as a percentage of the average net assets of the
High-Yield Series and a hypothetical illustration of the amount of operating
expenses of the High-Yield Series that would be incurred by an investor
purchasing $1000 of shares of the High-Yield Series that redeems his or her
investment at the end of one, three, five and ten years.
Annual Operating Expenses
(as a percentage of average net assets)
- --------------------------------------------------------------------------------
Management fees, net of fees waived 0%
12b-1 fees1 .50%
Other expenses, net of reimbursements 2.08%
-----
Total operating expenses (after waiver
and/or reimbursement) 2.58%
-----
Expenses waived and/or reimbursed 3.52%
-----
Total operating expenses (before waiver
and/or reimbursement) 6.10%
=====
Example: You would pay the following expenses on a $1000 investment assuming (1)
a 5% annual return and (2) redemption at the end of each time period:
1 Year 3 Years 5 Years 10 Years
- --------------------------------------------------------------------------------
$26 $80 $137 $291
1As a result of distribution fees of .50% per annum of the Fund's average daily
net assets, a long-term shareholder may pay more than the economic equivalent of
the maximum front-end sales charge permitted by the rules of the National
Association of Securities Dealers, Inc.
The purpose of the preceding table is to assist an investor in the High-Yield
Series in understanding the various costs and expenses that will be directly or
indirectly borne by such investor.
The example set forth in the above table is for information purposes only and
should not be considered as a representation of past or future expenses of the
High-Yield Series or of past or future returns on an investment in the
High-Yield
(right column)
Series. Actual expenses of the High-Yield Series and the return on an investment
in the High-Yield Series may vary significantly from the expenses and investment
return assumed in the above example.
For further information regarding management fees, 12b-1 fees, and other
expenses of the High-Yield Series, including information regarding the basis on
which management fees and 12b-1 fees are paid and expense reimbursements
provided by the High-Yield Series' investment adviser, see "Management" and
"Information about Shares of the High-Yield Series-Distribution Expenses" in
this Prospectus, and the Financial Statements included at the end of the
Statement of Additional Information.
Investors should note that absent the expense reimbursement arrangement set
forth in the High-Yield Series' Management Agreement, the High-Yield Series'
expenses would have been % of its average net assets.
Financial Highlights
The following information has been audited by McGladrey & Pullen, LLP,
independent public accountants, in connection with their audit of the High-Yield
Series' financial statements. McGladrey & Pullen's report on the High-Yield
Series' financial statements for the year ended December 31, 1997 appears at the
end of the Statement of Additional Information. The information listed below
should be read in conjunction with the High-Yield Series' full financial
statements.
Selected per share data-High-Yield Series
For the years ended December 31, 1988, 1989, 1990, 1991, 1992, 1993, 1994, 1995,
1996 and 1997, for each share outstanding throughout the period:
2
<PAGE>
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------------------------------------------------------------
1997 1996 1995 1994 1993 1992 1991 1990 1989 1988
---- ---- ---- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE
(for a share outstanding throughout the period)
Net Asset Value, Beginning of
Period ................................. $ 6.86 $ 7.07 $ 5.92 $ 7.27 $ 7.30 $ 7.29 $ 7.02 $ 8.01 $ 8.14 $ 8.69
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Income from investment
operations:
Net investment income .................... 0.37 0.47 0.34 0.43 0.39 0.43 0.42 0.53 0.61 0.81
Net realized and unrealized
gain (losses) on investments ........... 0.67 (0.21) 1.15 (1.35) (0.03) 0.01 0.27 (0.99) (0.13) (0.55)
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Total from investment
operations .................. 1.04 0.26 1.49 (0.92) 0.36 0.44 0.69 (0.46) 0.48 0.26
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Less Distributions:
Dividends from net
investment income ...................... (0.37) (0.47) (0.34) (0.43) (0.39) (0.43) (0.42) (0.53) (0.61) 0.81)
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Net Asset Value, End of Period ........... $ 7.53 $ 6.86 $ 7.07 $ 5.92 $ 7.27 $ 7.30 $ 7.29 $ 7.02 $ 8.01 $ 8.14
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Total Return (annualized) ................ 15.71% 4.05% 25.70% (12.92%) 5.11% 6.26% 10.14% (5.85%) 5.91% 3.46%
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (000) .......... 2,255 1,858 1,457 979 1,087 1,050 1,176 1,471 1,719 1,793
Ratios to Average Net Assets:
Expenses, net of
reimbursment (1) ..................... 2.58% 2.49% 2.50% 2.50% 2.50% 2.87% 2.63% 2.24% 2.61% 2.76%
Net investment income .................. 5.12% 6.85% 5.15% 6.70% 5.40% 5.89% 5.93% 6.90% 7.35% 9.28%
Portfolio turnover rate .................. 133.79% 139.26% 43.51% 75.31% 84.89% 100.21% 15.78% 17.11% 41.10% 25.05%
BANK LOANS
Amount outstanding at end of
period (000 omitted) ................... $ - $ 228 $ 379 $ - $ - $ 20 $ 103 $ - $ - $ -
Average amount of bank loans
outstanding during the
period (000 omitted) ................... $ - $ - $ 61 $ - $ - $ 57T $ 29T $ 32T $ 35T $ 10T
Average number of shares
outstanding during the
period (000 omitted) ................... 260 237 183 156 145 144T 188T 205T 226T 120T
Average amount of debt per
share during the year .................. $ - $ - $ 0.33 $ - $ - $ 0.40 $ 0.15 $ 0.16 $ 0.15 $0.08
<FN>
T Monthly Average.
(1) The Manager and others assumed certain expenses of the Fund during the years ended December 31, 1988, 1989, 1990, 1991,
1992, 1993, 1994, 1995, 1996 and 1997 equivalent to 2.13%, 2.09%, 2.27%, .11%, 4.83%, 5.76%, 6.20%, 6.22%, 4.59% and
3.52% of average net assets, respectively.
</FN>
</TABLE>
3
<PAGE>
(Left Column)
Investment Objective and Policies
The investment objective of the High-Yield Series is to provide a high level of
current income exempt from federal income taxes through the investment in a
portfolio of lower quality municipal bonds.
The policy of the High-Yield Series is to invest under normal circumstances
at least 80% of its assets in debt securities issued by, or on behalf of,
states, territories, and possessions of the United States and the District of
Columbia and their political subdivisions, agencies, or instrumentalities, the
interest on which is exempt from federal income tax (municipal bonds). As a
temporary defensive measure under certain market conditions, the High-Yield
Series may invest up to 50% of its assets in short-term taxable investments. See
Temporary Investments below.
The High-Yield Series invests at least 65% of its assets in the lower quality,
high-yield municipal bonds that are rated BB or lower by Standard & Poor's
Corporation (S&P) or Ba or lower by Moody's Investors Service, Inc. (Moody's) or
are unrated but judged by the Fund's investment adviser to be of at least
comparable quality. The High-Yield Series may not invest any of its assets in
municipal bonds that are not currently paying income or in municipal bonds that
are rated lower than C by S&P or Moody's. There is no limit on the percentage of
its assets that the High-Yield Series may invest in unrated securities that
would otherwise qualify for purchase by the High-Yield Series. Although the
High-Yield Series invests its assets predominantly in the lower quality
municipal bonds described above due to the higher yield they provide, the
High-Yield Series may under certain conditions invest in higher quality
securities. For example, certain securities with higher risk characteristics
that the Fund invests in, such as inverse floaters and previously non-rated zero
coupon bonds that have been escrowed with government securities, may have
relatively high credit ratings, but still may have higher risk characteristics
that make them appropriate for high yield investors.
The lower quality municipal bonds that comprise a majority of the High-Yield
Series' investments generally produce a higher current yield than do municipal
(right column)
bonds of higher ratings. However, these municipal bonds are considered
speculative because they involve greater price volatility and risk than do
higher rated securities and yields on these bonds will tend to fluctuate over
time. Although the market value of all fixed-income securities varies as a
result of changes in prevailing interest rates (e.g., when interest rates rise,
the market value of fixed-income securities can be expected to decline), values
of lower rated securities tend to react differently than the values of higher
rated securities. The prices of lower rated securities are less sensitive to
changes in interest rates than higher rated securities. Conversely, lower rated
municipal bonds also involve a greater risk of default by the issuer in the
payment of principal and income and are more sensitive to economic downturns and
recessions than higher rated securities. The financial stress resulting from an
economic downturn could have a greater negative effect on the ability of issuers
of lower rated municipal bonds to service their principal and interest payments,
to meet projected business goals and to obtain additional financing than on more
creditworthy issuers. In the event of an issuer's default in payment of
principal or interest on such securities, or any other securities in the
High-Yield Series' portfolio, the net asset value of the High-Yield Series will
be negatively affected. Moreover, as the market for lower rated municipal bonds
is a relatively new one which has not yet been tested in a recession, a severe
economic downturn might increase the number of defaults, thereby adversely
affecting the value of all outstanding lower rated municipal bonds and
disrupting the market for such bonds. Securities purchased by the High-Yield
Series as part of an initial underwriting present an additional risk due to
their lack of market history. These risks are exacerbated with respect to
municipal bonds rated CCC or lower by S&P or Caa or lower by Moody's. Unrated
securities generally carry the same risks as do lower rated securities.
The High-Yield Series may invest in lower rated municipal bonds that are
structured as zero coupon or pay-in-kind bonds. Such bonds may be more
speculative and subject to greater fluctuation in value due to changes in
interest rates than lower rated, income-bearing municipal bonds. In addition,
zero coupon and pay-in-kind bonds are also subject to the risk that
4
<PAGE>
(left COLUMN)
in the event of a default, a fund may realize no return on its investment,
because these bonds do not pay cash interest. Zero coupon, or deferred interest,
securities are debt obligations that do not entitle the holder to any periodic
payment of interest prior to maturity or a specified date when the securities
begin paying current interest (the "cash payment date") and therefore are issued
and traded at a discount from their face amounts or par value. Pay-in-kind bonds
are securities that pay interest through the issuance of additional bonds.
Holders of zero coupon securities are considered to receive each year the
portion of the original issue discount on such securities that accrues that year
(and, in the case of a taxable zero coupon security, must include such amount in
gross income), even though the holders receive no cash payments during the year.
Consequently, as a fund is accruing original issue discount on these securities
(whether taxable or tax-exempt) prior to the receipt of cash payment, it is
still subject to the requirement that it distribute substantially all of its
income (including tax-exempt income) to its shareholders in order to qualify as
a "regulated investment company" under applicable tax law. Therefore, such fund
may have to dispose of its portfolio securities under disadvantageous
circumstances or leverage itself by borrowing to generate the cash necessary to
satisfy its distribution requirements.
Lower rated municipal bonds are typically traded among a smaller number of
broker-dealers rather than in a broad secondary market. Purchasers of lower
rated municipal bonds tend to be institutions, rather than individuals, a factor
that further limits the secondary market. To the extent that no established
retail secondary market exists, many lower rated municipal bonds may not be as
liquid as Treasury and investment grade bonds. The ability of the High-Yield
Series to sell lower rated municipal bonds will be adversely affected to the
extent that such bonds are thinly traded or illiquid. Moreover, the ability of
the High-Yield Series to value lower rated municipal bonds becomes more
difficult, and judgment plays a greater role in valuation, as there is less
reliable, objective data available with respect to such bonds that are thinly
traded or illiquid.
(RIGHT COLUMN)
Because investors may perceive that there are greater risks associated with
the medium to lower rated municipal bonds of the type in which the High-Yield
Series may invest, the yields and prices of such securities may tend to
fluctuate more than those for securities with a higher rating. Changes in
perception of issuers' creditworthiness tend to occur more frequently and in a
more pronounced manner in the lower quality segments of the municipal bond
market than do changes in higher quality segments of the fixed-income securities
market, resulting in greater yield and price volatility.
The general legislative environment has included discussions and legislative
proposals relating to the tax treatment of high-yield municipal bonds. Any or a
combination of such proposals, if enacted into law, could negatively affect the
value of the high-yield municipal bonds in the High-Yield Series' portfolio. The
likelihood of any such legislation is uncertain.
Fund management believes that the risks of investing in such high-yielding,
municipal bonds may be minimized through careful analysis of prospective
issuers. Although the opinion of ratings services such as Moody's and S&P is
considered in selecting portfolio securities, they evaluate the safety of the
principal and the interest payments of the security, not their market value
risk. Additionally, credit rating agencies may experience slight delays in
updating ratings to reflect current events. The Fund relies, primarily, on its
own credit analysis, which includes a study of the existing debt, capital
structure, ability to service debts and to pay dividends, and the current trend
of earnings for any issuer under consideration for the High-Yield Series'
investment portfolio. This may suggest, however, that the achievement of the
High-Yield Series' investment objective is more dependent on its proprietary
credit analysis, than is otherwise the case for a fund that invests in higher
quality bonds. See Appendix A for a summary of the High-Yield Series' asset
composition, based on the monthly weighted average of credit ratings of its
portfolio securities.
The High-Yield Series normally purchases long-term municipal bonds with
maturities of 20 years or greater because such municipal bonds generally pro-
5
<PAGE>
(LEFT COLUMN)
duce higher yields than short-term municipal bonds. Although the market value of
all fixed-income securities generally varies inversely with changes in interest
rates, long-term securities are more exposed to this variation than short-term
securities and thus more likely to cause some instability in the High-Yield
Series' share price. The High-Yield Series reserves the right to vary the
average maturity of securities it holds.
A large portion of the High-Yield Series' assets may be invested in
municipal bonds whose interest payments are derived from revenues from similar
projects or whose issuers share the same geographic location. Consequently, the
asset value and performance of the High-Yield Series may be more susceptible to
certain economic, political, or regulatory developments than if the High-Yield
Series had a more diversified portfolio of investments.
In making investments, the High-Yield Series considers the advice of its
investment adviser and uses the Fund's research facilities to perform its own
credit analysis, consisting of an examination of the economic feasibility of
revenue bond project financings and general purpose borrowings; the financial
condition of the issuer or guarantor with respect to liquidity; cash flow and
ability to meet anticipated debt service requirements; and various economic,
political, industrial, and geographic trends. Through credit analysis and
portfolio diversification, investment risk can be reduced; however, there can be
no assurances that losses will not occur. For a general discussion of municipal
bonds, see the Appendix included at the end of the Statement of Additional
Information. For the ratings of S&P and Moody's for municipal bonds, see
Appendix B to this Prospectus.
Temporary Investments
The High-Yield Series anticipates that it may from time to time invest a portion
of its total assets on a temporary basis in short-term fixed-income obligations,
the interest on which is subject to federal income taxes. Such investments are
made only under conditions that, in the opinion of the investment adviser of the
High-Yield Series, make such investments advisable. For example, the High-Yield
Series
(RIGHT COLUMN)
may invest in taxable obligations pending investment in municipal bonds of the
proceeds from the sale of its shares or investments, or to ensure the liquidity
needed to satisfy redemptions of shares and the day-to-day operating expenses of
the High-Yield Series. The High-Yield Series invests in only those taxable
obligations that are (1) rated A or higher by S&P or Moody's or unrated but
judged by its investment adviser to be of at least comparable quality; (2)
obligations issued or guaranteed by the U.S. Government or its agencies or
instrumentalities; or (3) obligations of banks (including certificates of
deposit, bankers' acceptances, and repurchase agreements) with at least
$1,000,000,000 of assets. No more than 50% of the assets of the High-Yield
Series may be invested in taxable obligations at any one time, and the
High-Yield Series anticipates that on a 12-month average, taxable obligations
will constitute less than 10% of the value of its total investments.
The High-Yield Series also invests, from time to time, a portion of its assets
in higher quality municipal bonds (those rated BBB or above by S&P or Baa or
above by Moody's), such as when there is an influx of assets and sufficient
suitable lower quality municipal bonds are not available, or during a period
when yield spreads among municipal bonds are narrow and the marginally higher
yields of lower quality municipal bonds do not justify, in the judgment of the
investment adviser of the High-Yield Series, the increased risk involved.
Securities rated BBB by S&P or Baa by Moody's are considered medium grade,
neither highly protected nor poorly secured, with some elements of uncertainty
over any great length of time and certain speculative characteristics as well.
Participation Interests, Variable and
Inverse Floating Rate Instruments
The Fund may purchase participation interests from financial institutions. These
participation interests give the purchaser an undivided interest in one or more
underlying municipal obligations.
The Fund may also invest in municipal obligations which have variable interest
rates that are readjusted periodically. Such readjustment may be based either
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upon a predetermined standard, such as a bank prime rate or the U.S. Treasury
bill rate, or upon prevailing market conditions. Many variable instruments are
subject to redemption or repurchase at par on demand by the Fund (usually upon
no more than seven days' notice). All variable rate instruments must meet the
quality standards of the Fund. The Manager will monitor the pricing, quality and
liquidity of the variable rate municipal obligations held by the Fund.
The Fund may purchase inverse floaters which are instruments whose interest
rates bear an inverse relationship to the interest rate on another security or
the value of an index. Changes in the interest rate on the other security or
index inversely affect the residual interest rate paid on the inverse floater,
with the result that the inverse floater's price will be considerably more
volatile than that of a fixed-rate bond. For example, a municipal issuer may
decide to issue two variable rate instruments instead of a single long-term,
fixed-rate bond. The interest rate on one instrument reflects short-term
interest rates. Typically, this component pays an interest rate that is reset
periodically through an auction process, while the interest rate on the other
instrument (the inverse floater) pays a current residual interest rate based on
the total difference between the total interest paid by the issuer on the
municipal obligation and the auction rate paid on the auction component. This
reflects the approximate rate the issuer would have paid on a fixed-rate bond
multiplied by two, minus the interest rate paid on the short-term instrument.
Depending on market availability, the two portions may be recombined to form a
fixed-rate municipal bond. The Fund may purchase both the auction and the
residual components.
Special Risk Factors Relating to
Inverse Floating Rate Instruments
Changes in interest rates inversely affect the rate paid on inverse floating
rate instruments ("inverse floaters"). The inverse floaters' price will be more
volatile than that of a fixed rate bond. Additionally, some inverse floaters
contain a "leverage factor" whereby the interest rate moves inversely by a
"factor" to the benchmark. For example, the rates on the inverse
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floating rate note may move inversely at three times the benchmark rate. Certain
interest rate movements and other market factors can substantially affect the
liquidity of inverse floaters. These instruments are designed to be highly
sensitive to interest rate changes and may subject the holders thereof to
extreme reductions of yield and possibly loss of principal.
The Fund may invest in municipal obligations that pay interest at a coupon
rate equal to a base rate, plus additional interest for a certain period of time
if short-term interest rates rise above a predetermined level or "cap". The
amount of such an additional interest payment typically is calculated under a
formula based on a short-term interest rate index multiplied by a designated
factor.
The Fund may purchase various types of structured municipal bonds whose
interest rates fluctuate according to changes in other interest rates for some
period and then revert to a fixed rate. The relationship between the interest
rate on these bonds and the other interest rate or index may be direct or
inverse, or it may be based on the relationship between two other interest rates
such as the relationship between taxable and tax-exempt interest rates.
When-Issued Securities
The High-Yield Series purchases some municipal bonds on a when-issued basis,
which means that it may take as long as 60 days or more before they are
delivered and paid for. The commitment to purchase a security for which payment
will be made at a future date may be deemed a separate security. The purchase
price and interest rate of when-issued securities are fixed at the time the
commitment to purchase is entered into. Although the amount of municipal bonds
for which there may be purchase commitments on a when-issued basis is not
limited, it is expected that under normal circumstances not more than 50% of the
total assets of the High-Yield Series will be committed to such purchases. The
High-Yield Series does not start earning interest on when-issued securities
until settlement is made. In order to invest the assets of the High-Yield Series
immediately while awaiting deliv-
7
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ery of securities purchased on a when-issued basis, short-term obligations that
offer same-day settlement and earnings will normally be purchased. Although
short-term investments are normally in tax-exempt securities, short-term taxable
securities may be purchased if suitable short-term tax-exempt securities are not
available.
When a commitment to purchase a security on a when-issued basis is made,
procedures are established consistent with the General Statement of Policy of
the Securities and Exchange Commission concerning such purchases. Because that
policy currently recommends that an amount of the High-Yield Series' assets
equal to the amount of the purchase be held aside or segregated to be used to
pay for the commitment, cash or high-quality debt securities sufficient to cover
any commitments are always expected to be available. Although it is not intended
that such purchases would be made for speculative purposes and although the
High-Yield Series intends to adhere to provisions of the Securities and Exchange
Commission policy, purchases of securities on a when-issued basis may involve
more risk than other types of purchases. For example, when the time comes to pay
for a when-issued security, portfolio securities of the High-Yield Series may
have to he sold in order for the High-Yield Series to meet its payment
obligations, and a sale of securities to meet such obligations carries with it a
greater potential for the realization of capital gain, which is not tax-exempt.
Also, if it is necessary to sell the when-issued security before delivery, the
High-Yield Series may incur a loss because of market fluctuations since the time
the commitment to purchase the when-issued security was made. Moreover, any gain
resulting from any such sale would not be tax-exempt. Additionally, because of
market fluctuations between the time of commitment to purchase and the date of
purchase, the when-issued security may have a lesser (or greater) value at the
time of purchase than the High-Yield Series' payment obligations with respect to
the security.
Futures Contracts
A futures contract is an agreement between two parties to buy and sell a
security for a set price on a future
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date. They have been designed by boards of trade that have been designated
contracts markets by the Commodity Futures Trading Commission (the CFTC).
Futures contracts trade on these markets in a manner similar to the way a stock
trades on a stock exchange, and through their clearing corporations, the boards
of trade guarantee performance of the contracts. Presently, there are futures
contracts based on such debt securities as long-term U.S. Treasury bonds,
Treasury notes, Government National Mortgage Association modified pass-through
mortgage-backed securities, three-month U.S. Treasury bills, municipal bonds and
bank certificates of deposit. While futures contracts based on debt securities
do provide for the delivery and acceptance of securities, such deliveries and
acceptances are very seldom made. Generally, the futures contract is terminated
by the execution of an offsetting transaction. An offsetting transaction for a
futures contract sale is effected by that party entering into a futures contract
purchase for the same aggregate amount of the specified type of financial
instrument and same delivery date. If the price in the sale exceeds the price in
the offsetting purchase, that party is immediately paid the difference and thus
realizes a gain. If the offsetting purchase price exceeds the sale price, that
party pays the difference and realizes a loss. Similarly, closing out a futures
contract purchase is effected by that party entering into a futures contract
sale. If the offsetting sale price exceeds the purchase price, that party
realizes a gain; if the purchase price exceeds the offsetting sale price, that
party realizes a loss. At the time a futures contract is made, a small good
faith deposit called initial margin is required from each party to the futures
contract. The initial margin deposit is generally 1.5-5% of a contract's face
value. Thereafter, the futures contract is valued daily, and payment of
variation margin is required, so that each day, each party pays out cash in an
amount equal to any decline in the contract's value or receives cash equal to
any increase.
The High-Yield Series enters into futures contracts involving debt securities
backed by the full faith and credit of the U.S. Government. The High-Yield
Series' purpose in entering into futures contracts is to protect the High-Yield
Series from the adverse effects of fluc-
8
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tuations in interest rates without actually buy- ing or selling long-term debt
securities. For example, because the High-Yield Series owns long-term bonds, if
interest rates were expected to increase, the High-Yield Series might enter into
futures contracts for the sale of debt securities. This would have much the same
effect as selling an equivalent value of the High-Yield Series' long-term bonds.
If interest rates did increase, the value of the debt securities in the
High-Yield Series' portfolio would decline, but the value of such futures
contracts would increase at approx- imately the same rate, thereby preventing
the net asset value of the High-Yield Series from declining as much as it
otherwise would have.
Similarly, when interest rates are expected to decline, the High-Yield Series
may enter into futures contracts as a hedge against the anticipated increase in
the price of long-term bonds. Because the value of such futures contracts should
vary directly with the price of long-term bonds, the High-Yield Series could
take advantage of the anticipated rise in the value of long-term bonds without
actually buying them until the market had stabilized. At that time, futures
contracts could be liquidated and High-Yield Series cash reserves could be used
to buy long-term bonds on the cash market. The High-Yield Series could
accomplish similar results by selling bonds with long maturities and investing
in bonds with short maturities when interest rates are expected to increase.
However, because the futures market is more liquid than the cash market, using
futures contracts as an investment technique allows the High-Yield Series to
maintain a defensive position without having to sell its portfolio securities.
This technique would be particularly appropriate when the cash flow from the
sale of new shares of the High-Yield Series could have the effect of diluting
dividend earnings.
Futures contracts may also be used to protect the High-Yield Series portfolio
from shifts in value due to overvaluation or undervaluation of the municipal
bond market as compared to the taxable bond market. For instance, if the
municipal bond market appeared to be overvalued relative to the U.S. Government
bond market, a hedge could be created by executing futures contracts for the
sale of municipal bonds and for the purchase of government bonds in like
amounts.
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Investment by the High-Yield Series in futures contracts is subject to a
restriction because of CFTC regulations; the High-Yield Series may enter into
future contracts only as a temporary defensive measure for hedging purposes. If
the CFTC changes its regulations so that the High-Yield Series is permitted to
invest in futures contracts for income purposes without having to register with
the CFTC, the High- Yield Series may engage in transactions in futures contracts
for this purpose.
The High-Yield Series maintains a segregated asset account containing cash or
cash equivalents in an amount sufficient to cover its obligations with respect
to all of its futures contracts.
The ordinary spreads between prices in the cash and futures markets are
subject to distortion due to the following differences in the natures of those
markets. First, all participants in the futures market are subject to initial
deposit and variation margin requirements. Rather than meeting additional
variation margin requirements, investors may close futures contracts through
offsetting transactions, which could distort the normal relationship between the
cash and futures markets. Second, the liquidity of the futures market depends on
participants entering into offsetting transactions rather than making or taking
delivery. To the extent participants decide to make or take delivery, liquidity
in the futures market could be reduced, thus producing distortion. Third, from
the point of view of speculators, margin deposit requirements in the
futures market are less onerous than margin requirements in the securities
market. Therefore, increased participation by speculators in the futures market
may cause temporary price distortions. Due to the possibility of distortion, a
correct forecast of general interest rate trends by the Fund's investment
adviser and a corresponding purchase or sale of futures contracts may still not
adequately protect the High-Yield Series from the adverse effects of an increase
or decrease in interest rates.
In addition, to the extent that the High-Yield Series enters into futures
contracts for securities other than municipal bonds, there is a possibility that
the value of such futures contracts would not vary in direct proportion to the
value of the High-Yield Series' portfolio
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securities because the value of municipal bonds and other debt securities may
not react exactly the same to a general change in interest rates or to factors
other than changes in the general level of interest rates.
Investments in futures contracts also entail the risk that if the judgment of
the High-Yield Series' investment adviser about the general direction of
interest rates is incorrect, the High-Yield Series' overall performance may be
worse than if it had not invested in futures contracts as a hedging technique.
For example, if the High-Yield Series sold futures contracts as a hedge against
the possibility of an increase in interest rates, which would adversely affect
the price of bonds held in its portfolio, and interest rates decreased instead,
the High-Yield Series would lose part or all of the benefit of the increased
value of its bonds because it would have offsetting losses in such futures
contracts. In addition, in such situations, if the High-Yield Series has
insufficient cash, or borrowings are unavailable or undesirable, it may have to
sell bonds from its portfolio to meet daily variation margin requirements. Such
sales of bonds may have to be made at times when it is otherwise disadvantageous
to do so.
Options
Options are the right to buy or sell securities, or futures contracts, in the
future. A put option gives the holder the right to sell a designated security
for a set price within a specified time period, and a call option gives the
holder the right to buy a designated security for a set price within a specified
time period. Currently, the market for options on tax-exempt securities is very
small. There are also options on futures contracts, which entitle a holder to
enter into a futures contract, on specified terms, within a specified time
period. Unlike a futures contract, which requires parties to the contract to buy
and sell a security for a set price on a set date, an option merely entitles its
holder to decide on or before a future date whether to purchase or sell a
security at a set price or to enter into a specified futures contract. If the
holder decides not to exercise an option, all that is lost is the price, called
the premium, paid for the option. Further, because the value of the option is
fixed at the point of sale, there are no daily payments of cash to reflect the
change in the value of the underlying transaction. However,
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since an option gives the buyer the right to enter into a transaction or
contract at a set price for a fixed period of time, its value does change daily,
and that change is reflected in the net asset value of the High-Yield Series.
The High-Yield Series will buy only options listed on national securities
exchanges, except for agreements (sometimes called cash puts) that may accompany
the purchase of a new issue of bonds from a dealer.
Just as options give certain rights to their holders, they impose certain
obligations on the other party to an option, called the writer. The writer is
the party obligated to sell securities to, or purchase securities from, the
holder of an option on his or her exercise of an option to purchase or sell
s9ecurities. For undertaking such an obligation, the writer receives a premium,
less a commission charged by a broker, which the writer keeps regardless of
whether the option is exercised.
The High-Yield Series will write call options only on securities it holds in
its portfolio (which is called covered call writing) and liquid debt secured
puts, which means that the High-Yield Series maintains in a segregated account
with the custodian cash, U.S. Treasury bills, or other high-grade, liquid debt
obligations with a value equal to the exercise price of the put. A written put
may also be cash secured if the High-Yield Series holds a put on the same
security and the exercise price of such put is equal to or greater than the
exercise price of the put written by the High-Yield Series. The High-Yield
Series may not write put options unless its investment adviser determines at the
time of the transaction that the High-Yield Series desires to acquire the
underlying security at the price established in the put. Option writing can be
used advantageously to generate incremental income when the outlook is for
relatively stable bond prices; however, such income may be taxable.
The risk the High-Yield Series assumes when it buys an option is the loss of
the premium paid for the option. In order for the High-Yield Series to profit
from the purchase of an option, the price of the underlying security must change
and the change must be
10
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sufficient to cover both the premium paid for the option and any related
brokerage commissions. The risk involved in writing call options is that the
market value of the security underlying the option may increase above the option
price. If that occurred, the option would most likely be exercised and the
High-Yield Series would be obligated to sell the underlying security for a price
below its then-current market value. The risk involved in writing put options is
that the market value of the security underlying the option may decrease below
the option price and the High-Yield Series would be obligated to purchase the
security at a price above its then-current market price.
Repurchase Agreements
The High-Yield Series may enter into repurchase agreements with commercial
banks, brokers, or dealers pursuant to which the High-Yield Series acquires a
money market instrument (generally a U.S. Government obligation qualifying for
purchase by the High-Yield Series) that is subject to resale by the High-Yield
Series on a specified date (generally within one week) at a specified price
(which price reflects an agreed-on interest rate effective for the period of
time the High-Yield Series holds the investment and is unrelated to the interest
rate on the instrument). As a matter of fundamental policy, the High-Yield
Series will not enter into repurchase agreements of more than one week in length
if as a result more than 10% of the total assets of the High-Yield Series would
be invested in such agreements or other restricted or illiquid securities. The
High-Yield Series enters into repurchase agreements for the purpose of making
short-term cash investments. Risks involved in entering into repurchase
agreements include the possibility of default or bankruptcy by the other party
to the agreement. The High-Yield Series' investment adviser monitors on a
periodic basis the creditworthiness of parties with which it enters into
repurchase agreements.
Lending Portfolio Securities
The High-Yield Series may lend securities in its portfolio to brokers, dealers,
banks, or other institutional borrowers of securities for the purpose of
obtaining
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additional income, provided that the borrower maintains with the High-Yield
Series collateral in the form of cash or cash equivalents, such as Treasury
bills, equal to at least l00% of the fair market value of the securities lent.
Borrowers of portfolio securities of the High-Yield Series pay to the High-Yield
Series any income accruing on borrowed securities during the time such
securities are on loan and may also pay to the High-Yield Series a specified
amount of interest on the borrowed securities. In addition, the High-Yield
Series is entitled to earn additional income by investing the collateral it
holds. As with other extensions of credit, there are risks of delay in recovery
or even loss of rights in the collateral should the borrower of any loaned
securities fail financially. For this reason, the investment adviser of the
High-Yield Series will evaluate and monitor the creditworthiness of firms that
borrow securities from the High-Yield Series. The High-Yield Series will not
lend its portfolio securities if as a result more than 30% of its total assets
will be subject to such loans. In addition, because income derived from lending
its portfolio securities is not tax-exempt, the High-Yield Series limits lending
its securities in accordance with its investment objective. Accordingly, it is
not anticipated that the High-Yield Series will normally engage in any material
amount of portfolio lending.
Borrowings
The High-Yield Series may borrow money in an amount up to 33.33% of its total
assets. Borrowings are also subject to the restriction that the value of the
High-Yield Series' assets, less its liabilities other than borrowings, must
always be equal to or greater than 300% of all of its borrowings (including the
proposed borrowing). If this 300% coverage requirement is not met, the
High-Yield Series must, within three days, reduce its debt to the extent
necessary to meet such coverage requirement, and to do so, it may have to sell a
portion of its investments at a time when such a sale would otherwise be
unadvisable.
Interest on money borrowed is an expense of the High-Yield Series and
decreases its net earnings. While money borrowed may be used by the High-Yield
Series for investment in securities, the interest
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paid on borrowed money reduces the amount of money available for investment by
the High-Yield Series. The interest paid by the High-Yield Series on borrowings
may be more or less than the yield on the securities purchased with borrowed
funds.
The High-Yield Series may borrow in order to meet redemption requests and for
investment. Borrowing for investment increases both investment opportunity and
investment risk. Since the High-Yield Series' assets fluctuate in value, and the
obligation resulting from the borrowing is fixed, the net asset value per share
of the High-Yield Series will tend to increase more when the High-Yield Series'
investments increase in value and decrease more when the High-Yield Series'
investments decrease in value than would otherwise be the case. This is a
speculative factor known as leverage.
Portfolio Transactions and Turnover
The High-Yield Series is fully managed by purchasing and selling securities as
well as by holding selected securities to maturity. In purchasing and selling
portfolio securities, the High-Yield Series seeks to take advantage of
variations in the creditworthiness of issuers. For a description of the
strategies that may be used by the High-Yield Series in purchasing and selling
portfolio securities, see the Statement of Additional Information.
While it is not possible to predict accurately the rate of turnover of the
High-Yield Series' portfolio on an annual basis, it is anticipated that the rate
will not materially exceed 100%. A portfolio turnover of 100% would occur if all
of the securities in the portfolio were changed once in a 12-month period.
Computation of portfolio turnover excludes transactions in securities having a
maturity of one year or less at the time of acquisition. A high portfolio
turnover rate increases transaction costs of the High-Yield Series and increases
the likelihood of distributing taxable capital gains to investors.
Other Considerations
It is expected that a substantial portion of the assets of the Fund will be
derived from professional
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money managers and investors who intend to invest in the Fund as part of an
asset-allocation or market-timing investment strategy. These investors are
likely to redeem or exchange their Fund shares frequently to take advantage of
anticipated changes in market conditions. The strategies employed by investors
in the Fund may result in considerable assets moving in and out of the Fund.
Consequently, the Trust expects that the Fund will generally experience
significant portfolio turnover, which will likely cause higher expenses and
additional costs.
Private Activity Bonds
Interest from certain municipal bonds (referred to as private activity bonds) is
treated as a tax preference item under the alternative minimum tax. Thus,
corporate and individual investors may incur an alternative minimum tax
liability as a result of receiving tax-exempt dividends from the High-Yield
Series to the extent such dividends are attributable to interest from private
activity bonds. The High-Yield Series invests in private activity bonds only
when it believes that the yield disparity between private activity bonds and
other municipal bonds makes an investment in private activity bonds attractive.
In addition, because all tax-exempt dividends are included in a corporate
shareholder's adjusted current earnings (which are used in computing a separate
preference item for corporate taxpayers), corporate shareholders may incur an
alternative minimum tax liability as a result of receiving any tax-exempt
dividends from the High-Yield Series. Tax-exempt interest and income referred to
throughout this Prospectus mean interest and income that is excluded from gross
income for federal income tax purposes but that may be a tax preference item
subject to the alternative minimum tax. Further, such tax-exempt interest and
income may be subject to taxation under the tax laws of any state or local
taxing authority. See Information about Shares of the High-Yield
Series-Dividends and Tax Matters.
Miscellaneous
The High-Yield Series' investment objective of providing a high level of current
income exempt from federal income taxes and its policy of investing, under
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normal circumstances, at least 80% of its assets in municipal bonds are
fundamental policies of the High-Yield Series, which may not be changed without
the approval of a majority of the outstanding shares of the High-Yield Series.
The Statement of Additional Information includes a discussion of other
investment policies and lists specific investment restrictions that govern
High-Yield Series' investment policies. The specific investment restrictions
identified in the Statement of Additional Information may not be changed without
shareholder approval. If a percentage restriction or a rating restriction on
investments or use of assets is adhered to at the time an investment is made or
assets are so used, a later change in percentage resulting from changes in the
value of the High-Yield Series securities or from a change in the rating of a
portfolio security will not be considered a violation of policy.
Management
The Fund's board of trustees has overall responsibility for managing and
supervising the High-Yield Series. There are currently three trustees, two of
whom are not considered to be interested persons of the Fund, within the meaning
of the Investment Company Act of 1940 (the 1940 Act). The trustees meet
regularly each quarter. By virtue of the functions performed by Fundamental
Portfolio Advisors, Inc. (the Manager), the investment adviser of the High-Yield
Series, neither the Fund nor the High-Yield Series require any employees other
than the executive officers of the Fund, all of whom receive their compensation
from the Manager or other sources. The Statement of Additional Information
contains the names and general background of each trustee and executive officer
of the Fund.
The Fund's Board of Trustees approved the continuance of the Fund's current
Management Agreement for a period of sixty days following the date of its
expiration in contemplation of the consummation of a transaction pursuant to
which Tocqueville Asset Management L.P. ("Tocqueville") would assume management
of the assets of the Fund. Otherwise, the Management Agreement would have
expired on April
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1, 1998. Tocqueville is the investment adviser to the Tocqueville Funds.
It is anticipated that shareholders of the Fund will be asked to consider
and approve an Agreement and Plan of Reorganization providing for the transfer
of the Fund's assets to a separate, newly-created Tocqueville Fund having the
same investment policies and objectives as those of the Fund at a special
meeting of shareholders scheduled to be held in late Spring. Subsequent to the
filing with the Securities and Exchange Commission of preliminary proxy
solicitation materials seeking shareholder approval of the Agreement and Plan of
Reorganization at the special meeting of shareholders, the Manager filed two
preliminary proxy statements with the Securities and Exchange Commission, one
opposing the transaction pursuant to which Tocqueville would assume management
of the assets of the Fund; the second, proposing to replace the two independent
Board Members of the Fundamental Funds and the election of six new nominees to
the Fund's Board (in addition to Vincent J. Malanga, a current Board Member).
Pursuant to a Management Agreement between the Fund and the Manager, the
Manager serves as investment adviser to the High-Yield Series and is responsible
for the overall management of the business affairs and assets of the High-Yield
Series, subject to the authority of the Fund's board of trustees. The Manager's
post office address is P.O. Box 1013, Bowling Green Station, New York, New York
10274-1013. Under the terms of the Management Agreement, the Manager manages and
supervises the Fund's investment portfolio and directs the purchase and sales of
its investment securities subject to the right of the Fund's trustees, to
disapprove such purchases or sale. The Manager utilizes an investment committee
to manage the assets of the Fund. The committee is currently composed of the
following members: Vincent J. Malanga, a portfolio strategist affiliated with
the Manager and Jane Tubis, a trading assistant affiliated with the Manager.
Vincent J. Malanga is, and has been for more than the past five years,
Chairman of the Board, Chief Executive Officer, President and Treasurer of the
Fundamental Family of Funds. He is, and has been for more than the past five
years, President, Treasurer, and a Director of the Manager, Executive Vice
President, Secretary and a Director of Fundamental Service Corporation (the
Distributor for certain of the Fundamental Family of Funds) and President of
LaSalle Economics, Inc., an economic consulting firm, and a managing director of
LaSalle Portfolio Management, Inc., a commodity trading adviser.
Jane Tubis is, and has been for more than the past five years, a trading
assistant with the Manager.
The High-Yield Series pays all brokerage commissions in connection with its
portfolio transactions. The
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High-Yield Series also bears the expense, pro rata with other series of the
Fund, of maintaining the Fund's registration as an investment company under the
1940 Act and of registering its shares under the Securities Act of 1933. The
High-Yield Series also pays certain other costs and expenses, which are more
fully described in the Statement of Additional Information.
As compensation for the performance of its management services and the
assumption of certain expenses of the High-Yield 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 High-Yield Series equal to
the following percentage of the average daily net asset value of the High-Yield
Series:
Average Daily Net Asset Value Annual Fee Payable
- -------------------------------------------------------------------------------
Net asset value to $100,000,000 .80%
Net asset value of $100,000,000 or
more but less than
$200,000,000 .78%
Net asset value of $200,000,000 or
more but less than
$300,000,000 .76%
Net asset value of $300,000,000 or
more but less than
$400,000,000 .74%
Net asset value of $400,000,000 or
more but less than
$500,000,000 .72%
Net asset value of $500,000,000 or
more .70%
- -------------------------------------------------------------------------------
The preceding management fee is higher than the management fee paid by most
other mutual funds because of the extensive credit analysis performed by the
Manager with respect to the High-Yield Series. For the year ended December 31,
1997, the Manager voluntarily waived all fees and reimbursed expenses totaling
$64,243.
Under the Management Agreement and pursuant to authority granted by the
trustees, the Manager is
(RIGHT COLUMN)
authorized to place portfolio transactions with dealer firms that have provided
assistance in distributing shares of the High-Yield 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 from other qualified
dealers.
On September 30, 1997, the Securities and Exchange Commission (the
"Commission") instituted administrative proceedings against the Manager,
Fundamental Service Corporation, and Drs. Lance M. Brofman and Vincent J.
Malanga (the "Parties"). The Commission's Order instituting the proceedings
alleges, among other things, certain violations of the federal securities laws,
including the antifraud provisions, for failing to disclose the risks associated
with investments in inverse floating rate notes made on behalf of the
Fundamental U.S. Government Strategic Income Fund (the "Government Fund") in
1993 and 1994, marketing the Government Fund in a way that was contrary to the
administration of the Government Fund, exceeding the Government Fund's portfolio
duration of three years or less as stated in its prospectus, and failing to
disclose the Manager's soft dollar practices to the Fundamental Fund Boards. A
hearing has been scheduled to determine whether the allegations against the
Parties are true, and if so, whether remedial action is appropri ate. Counsel to
the Parties have indicated that the Parties intend to vigorously contest the
charges. The Manager has indicated that the institution of the proceedings
against the Parties has not adversely affected the ability of the Manager or
Fundamental Service Corporation to continue to perform the day-to-day affairs of
the Fundamental Funds.
The Manager and Fundamental Service Corporation (on behalf of certain of their
directors, officers, shareholders, employees and control persons) (the
"Indemnitees") received payments during the fiscal year ended December 31, 1997
from three of the Fundamental Funds for attorneys' fees incurred by them in
defending certain proceedings. The payments were as follows: Fundamental U.S.
Government Strategic Income Fund (approximately $232,500); New York Muni Fund
(approximately $50,000); and the California Muni Fund (approx-
14
<PAGE>
(LEFT COLUMN)
imately $4,000). Upon learning of the payment, the independent Board Members of
the Fundamental Funds directed that the Indemnitees return all of the payments
to the Funds or place them in escrow pending their receipt of an opinion of an
independent legal counsel to the effect that the Indemnitees are entitled to
receive them.
On April 30, 1998, the Indemnitees placed $106,863 into an escrow account
pending clarification of certain legal issues. The Manager and Fundamental
Service Corporation have asserted that they waived fees during the year ended
December 31, 1997 and that the amount placed in escrow should be net of any
reimbursements already made to the Funds in the form of fees forgone. Upon
learning that $106,863 was placed into an escrow account on behalf of the Funds,
the independent Board Members referred the Manager and Fundamental Service
Corporation to their prior directive and asked that the entire amount of all
payments received by such entities ($286,500) be placed into said escrow
account. For further information, see Notes to the December 31, 1997 Financial
Statements of Fundamental U.S. Government Strategic Income Fund, New York Muni
Fund and the California Muni Fund, attached to the Statement of Additional
Information.
In addition to paying a management fee to the Manager, the High-Yield Series
also pays a distribution fee in an amount up to .5% of its net asset value to
Fundamental Service Corporation, an affiliate of the Manager. See "Information
about Shares of the High-Yield Series-Distribution Expenses." The Manager also
manages and serves as investment adviser to two other investment companies, New
York Muni Fund, Inc. and The California Muni Fund. The Manager is a Delaware
corporation that was incorporated in 1986.
Information about
Shares of the High-Yield Series
Description of Shares
The Fund is an open-end, non-diversified management investment company that was
organized as a Massachusetts business trust on March 19, 1987. The High-Yield
Series is a non-diversified portfolio of the Fund and thus by itself does not
constitute a balanced investment plan. The Declaration of Trust under which the
Fund was organized authorizes the trustees of the Fund to issue an unlimited
number of shares of beneficial interest in the Fund, without par value, that may
be divided into such separate series as the trustees may establish. The Fund
currently has three series of shares: the High-Yield Series, the Tax-Free Money
Market Series and the Fundamental U.S. Government Strategic Income Fund Series.
The trustees may establish additional series of shares. As an open-end
investment company, the Fund continuously offers shares of its High-Yield Series
to the public and under normal conditions must redeem these shares on demand
from any registered holder at the then-current net asset value per share.
Each share of the High-Yield Series represents an equal proportionate interest
in the High-Yield Series
(RIGHT COLUMN)
with each other share in the series. Shares entitle their holders to one vote
per share. Investors in the High-Yield Series are entitled to vote in the
election of trustees, on the adoption of any management contract or distribution
plan, on any change in a fundamental investment policy with respect to the
High-Yield Series, and on other matters submitted to shareholder vote, as
provided in the Fund's Declaration of Trust. Shares of the Fund are voted by
individual series except (1) when required by the 1940 Act, they are voted in
the aggregate and (2) when the trustees determine that a matter affects only one
or more particular series of shares, only the shares of such series are entitled
to vote on such matter. Shares of the High-Yield Series have no cumulative
voting rights, preemptive rights, or subscription rights. Shares are freely
transferable and fully paid and except as set forth in the Statement of
Additional Information are non-assessable.
The High-Yield Series has its own assets, which are recorded on the books of
the Fund separately from assets of the Fund's other series, and held by the
Fund's trustees in trust for investors in the High-Yield Series. All income and
proceeds earned and expenses incurred by the High-Yield Series are allocated to
the High-Yield Series, and the portion of all income and expenses earned or
incurred by the Fund, rather than by an individual series of the Fund, which is
properly allocable to the High-Yield Series, is allocated to the High-Yield
Series. On liquidation of the Fund or the High-Yield Series, investors in the
High-Yield Series would be entitled to share pro rata in the net assets of the
High-Yield Series available for distribution to shareholders.
Shares will remain on deposit with the transfer agent for the High-Yield
Series and certificates will not be issued.
How to Purchase Shares
Shares of the High-Yield Series may be purchased either directly from the Fund
or through securities dealers, banks or other financial institutions. The
High-Yield Series has a minimum initial purchase requirement of $1000 and a
minimum subsequent purchase requirement of $100. Subsequent pur-
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(LEFT COLUMN)
chases are made in the same manner as initial purchases.
Investors can purchase shares without a sales charge if they purchase shares
directly from the Fund. However, investors may be charged a fee if they purchase
shares through securities dealers, banks, or other financial institutions.
Investors opening a new account for the High-Yield Series must complete and
submit a purchase application along with payment of the purchase price for their
initial investment. Investors purchasing additional shares of the High-Yield
Series should include their account number with payment of the purchase price
for additional shares being purchased. Investors may reopen an account with a
minimum investment of $100 and without filing a purchase application during the
year in which the account was closed or during the following calendar year if
information on the original purchase application is still applicable. The
High-Yield Series may require filing a statement that all information on the
original purchase application remains applicable.
A purchase order becomes effective immediately on receipt by Firstar Trust
Company, as agent for the High-Yield Series, if it is received before 4:00 P.M.
on any business day. After a purchase order becomes effective, confirmation of
the purchase is sent to the investor, and the purchase is credited to the
investor's account. The Fund, or any series thereof, reserves the right to
reject any purchase order.
The Fundamental Automatic Investment Program offers a simple way to maintain a
regular investment program. The Fund has waived the initial investment minimum
for you when you open a new account and invest $100 or more per month through
the Fundamental Automatic Investment Program. The Fundamental Automatic
Investment Program allows you to purchase shares (minimum of $50 per
transaction) at regular intervals. Investments are made by transferring funds
directly from your checking, or bank money market account. At your option
investments can be made, once a month on either the fifth or the twentieth day,
or twice a month on both days.
To establish a Fundamental Automatic Investment Program, or to add this option
to your existing account
(RIGHT COLUMN)
simply complete an authorization form, which can be obtained by calling
1-800-322-6864. You may cancel this privilege or change the amount you invest at
any time. Initial Program setup and any modifications may take up to ten days to
take effect. There is currently no charge for this service, and the Fund may
terminate or modify this privilege at any time.
Shares of the High-Yield Series may be purchased only in states where the
shares are qualified for sale.
Methods of Payment
Payment of the purchase price for shares of the High-Yield Series may be made in
any of the following manners:
Payment by wire: An expeditious method of purchasing shares is the transmittal
of federal funds by bank wire to Firstar Trust Company To purchase shares by
wire transfer, instruct a commercial bank to wire money to Firstar Trust
Company, ABA #021000021, credit to: United States Trust Company of New York, A/C
#920-1-073195. Further credit to: Fundamental Family of Funds, A/C #2073919. The
wire transfer should be accompanied by the name, address, and social security
number (in the case of new investors) or account number (in the case of persons
already owning shares of that series).
Payment by check: Shares may also be purchased by check. Checks should be made
payable to Fundamental Family of Funds and mailed to Fundamental Family of
Funds, c/o Firstar Trust Company, Agent, P.O. Box 701, Milwaukee, WI 53201-0701.
If your check does not clear, Firstar Trust Company will cancel your purchase
and charge you a $20 fee. Moreover, you could be liable for any losses incurred.
The Fund reserves the right to limit the number of checks processed at any one
time and will notify investors prior to exercising this right.
Exchange of shares: Persons holding shares of any other series of the Fund
or of any other mutual fund for which Fundamental Portfolio Advisors, Inc., the
investment adviser of the Fund, acts as the investment adviser may purchase
shares of the High-Yield Series by exchanging shares of such other series or
mutual fund. See General Information-Exchangeability of Shares.
16
<PAGE>
(LEFT COLUMN)
Purchase Price and Net Asset Value
Each share of the High-Yield Series is sold at its net asset value next
determined after a purchase order becomes effective. The net asset value per
share of the High-Yield Series is determined at 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 High-Yield 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 on
which no purchase orders for the shares of the High-Yield Series become
effective and no shares are tendered for redemption, the net asset value per
share will not be determined. The net asset value per share of the High-Yield
Series is computed by taking the amount of the value of all of its assets, less
its liabilities, and dividing it by the number of outstanding shares. For
purposes of determining net asset value, expenses of the High-Yield Series are
accrued daily and taken into account.
The High-Yield Series' portfolio securities are valued on the basis of prices
provided by an independent pricing service when, in the opinion of persons
designated by the Fund's trustees, such prices are believed to reflect the fair
market value of such securities. Prices of non-exchange traded portfolio
securities provided by independent pricing services are generally determined
without regard to bid or last sale prices but take into account institutional
size trading in similar groups of securities, yield, quality, coupon rate,
maturity, type of issue, trading characteristics and other market data.
Securities traded or dealt in upon a securities exchange and not subject to
restrictions against resale as well as options and futures contracts listed for
trading on a securities exchange or board of trade are valued at the last quoted
sales price, or, in the absence of a sale, at the mean of the last bid and asked
prices. Options not listed for trading on a securities exchange or board of
trade for which over-the-counter market quotations are readily available are
valued at the mean of the current bid and asked prices. Money market and
short-term debt instruments with a
(RIGHT COLUMN)
remaining maturity of 60 days or less will be valued on an amortized cost basis.
Municipal daily or weekly variable rate demand instruments will be priced at par
value plus accrued interest. Securities not priced in a manner described above
and other assets are valued by persons designated by the Fund's trustees using
methods which the trustees believe accurately reflects fair value. The prices
realized from the sale of these securities could be less than those originally
paid by the High-Yield Series or less than what may be considered the fair value
of such securities.
The High-Yield Series has a minimum initial purchase requirement of $1000 and
a minimum subsequent purchase requirement of $100. Subsequent purchases are made
in the same manner as initial purchases.
Distribution Expenses
The Fund has adopted a Plan of Distribution pursuant to Rule 12b-1 of the 1940
Act (the plan), under which the High-Yield Series pays to Fundamental Service
Corporation (FSC) a fee, which is accrued daily and paid monthly, at an annual
rate of 0.50% of the High-Yield Series' average daily net assets. Amounts paid
under the plan are paid to FSC to compensate it for the services it provides and
the expenses it bears in the distribution of the High-Yield Series' shares to
investors, including payment of compensation by FSC to securities dealers and
other financial institutions and organizations, such as banks, trust companies,
savings and loan associations, and investment advisers, to obtain various
distribution related and/or administrative services for the High-Yield Series.
Expenses of FSC also include the expenses of its employees, who engage in or
support distribution of shares or service shareholder accounts, including
overhead and telephone expenses; printing and distributing prospectuses and
reports used in connection with the offering of the High-Yield Series' shares;
and preparing, printing, and distributing sales literature and advertising
materials. FSC is an affiliate of the Manager. The amount of expenses which
would have been incurred by the High-Yield Series pursuant to the plan for the
year ended December 31, 1997, $9,125, was waived by FSC.
17
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(LEFT COLUMN)
The Fund's Board of Trustees approved the continuance of the Fund's Plan for a
period of sixty days following the date of its expiration in contemplation of a
transaction pursuant to which Tocqueville Asset Management L.P. would assume
management of the assets of the Fund. Otherwise, the Plan would have expired on
April 1, 1998. See ("Management").
The Fund's Board of Trustees approved the continuance of the Fund's
Distribution Agreement for a period of sixty days following the date of its
expiration in contemplation of a transaction pursuant to which Tocqueville Asset
Management L.P. would assume management of the Fund. Otherwise, the Distribution
Agreement would have expired on April 1, 1998. See ("Management").
NASD Regulation, Inc. ("NASDR") entered into a Letter of Acceptance, Waiver
and Consent with Fundamental Service Corporation that imposed a total of
$125,000 in fines and other stipulated sanctions on Fundamental Service
Corporation and two of its officers for distributing advertising materials for
Fundamental U.S. Government Strategic Income Fund that NASDR deemed to be false
and misleading. Fundamental Service Corporation neither admitted nor denied the
allegations and filed a Mitigation Statement in response to the Letter of
Acceptance, Waiver and Consent.
The Glass-Steagall Act prohibits banks from engaging in underwriting, selling,
or distributing securities, such as shares of a mutual fund. Although the scope
of this prohibition under the Glass-Steagall Act has not been fully defined, in
FSC's opinion it should not prohibit banks from being paid for performing
shareholder servicing functions under the plan. If, because of changes in law or
regulation or because of new interpretations of existing law, a bank or the Fund
were prevented from continuing these arrangements, it is expected that the
Fund's trustees would make other arrangements for these services and
shareholders would not suffer adverse financial consequences.
At any given time, FSC may incur expenses in distributing shares of the
High-Yield Series pursuant to the plan that would be in excess of the total of
payments made by the High-Yield Series pursuant to the
(RIGHT COLUMN)
plan. For example, if during a year of the plan, FSC incurs $500,000 of expenses
pursuant to the plan on sales of $100 million of the High-Yield Series and FSC
receives a distribution fee calculated at the annual rate of 0.50% of the
High-Yield Series' average daily net assets (assuming $50 million in average
daily net assets), FSC would have incurred, at the end of such year, $250,000 in
excess expenses under the plan during such year. Because there is no requirement
under the plan to reimburse FSC for all its expenses or any requirement to
continue the plan from year to year, this excess amount does not constitute a
liability of the High-Yield Series, and the High-Yield Series will not reimburse
FSC for any such excess amount. Although payments under the plan by the
High-Yield Series may not be used directly to finance distribution of shares of
other series of the Fund, under the plan and similar plans adopted by the Fund's
other series, FSC may pay for distribution expenses of any such series from any
source available to it, including any profits it may realize. Accordingly, it is
possible but not likely until the High-Yield Series has at least $150,000,000 in
net assets, that FSC may use profits it realizes from the High-Yield Series to
finance another series of the Fund.
Redemptions
Each investor in the High-Yield Series has the right to cause the High-Yield
Series to redeem his or her shares by making a request to Firstar Trust Company
in accordance with either the regular redemption procedure, the telephone
redemption privilege, the expedited redemption privilege, or the check
redemption privilege, as described below. If Firstar Trust Company receives a
redemption request before the close of trading on any day the New York Stock
Exchange is open for trading, the redemption will become effective on that day
and be made at the net asset value per share of the High-Yield Series, as
determined at the close of trading on that day, and payment will be made on the
following business day. If Firstar Trust Company receives a redemption request
following the close of trading on the New York Stock Exchange, or on any day the
New York Stock Exchange is not open for business, the redemption will become
effective on the next day the New York Stock Exchange is open for trading and be
made at the net
18
<PAGE>
(LEFT COLUMN)
asset value per share of the High-Yield Series, as determined at the close of
trading on that day, and payment will be made on the following business day.
Investors are entitled to receive all dividends on shares being redeemed that
are declared on or before the effective date of the redemption of such shares.
The net asset value per share of the High-Yield Series received by an investor
on redeeming shares may be more or less than the purchase price per share paid
by such investor, depending on the market value of the portfolio of the
High-Yield Series at the time of redemption.
Regular Redemption Procedure. Investors may redeem their shares by sending a
written redemption request to Firstar Trust Company, which request must specify
the number of shares to be redeemed and be signed by the investor of record. For
redemptions exceeding $50,000 (and for all written redemptions, regardless of
amount, made within 30 days following any changes in account registration), the
signature of the investor on the redemption request must be guaranteed by an
eligible guarantor institution appointed by Firstar Trust Company. Signature
guarantees in proper form generally will be accepted from domestic banks, a
member of a national securities exchange, credit unions and savings
associations, as well as from participants in the Securities Transfer Agents
Medal lion Program ("Stamp"). If you have any questions with respect to
signature guarantees, please call the transfer agent at (800) 322-6864. Firstar
Trust Company may, at its option, request further documentation from
corporations, executors, administrators, trustees, or guardians. If a redemption
request is sent to the High-Yield Series, the High-Yield Series will forward it
to Firstar Trust Company. Redemption requests will not become effective until
all proper documents have been received by Firstar Trust Company. Requests for
redemption that are subject to any special condition or specify an effective
date other than as provided herein cannot be accepted and will be returned to
the investor.
Telephone Redemption Privilege. An investor may, either by completing the
appropriate section of the purchase application, or by making a later written
request to Firstar Trust Company containing his or her signature guaranteed by
an eligible guarantor (see
(RIGHT COLUMN)
above), obtain the telephone redemption privilege for any of his or her
accounts. Provided that your account registration has not changed within the
last 30 days, an investor may redeem up to $150,000 worth of shares per day from
an account for which he or she has the telephone redemption privilege by making
a telephone redemption request to Firstar Trust Company, at (800) 322-6864.
Telephone calls may be recorded. A check for the proceeds of such a redemption
will be issued in the name of the investor of record and mailed to the
investor's address as it appears on the records of the High-Yield Series. Both
the High-Yield Series and Firstar Trust Company reserve the right to refuse or
limit a telephone redemption request and to modify the telephone redemption
privilege at any time.
Neither the Fund nor its transfer agent will be liable for following
instructions communicated by telephone that they reasonably believe to be
genuine. It is the Fund's policy to provide that a written confirmation
statement of all telephone call transactions will be mailed to shareholders at
their address of record within three business days after the telephone call
transaction. Since you will bear the risk of loss, you should verifty the
accuracy of telephone transactions immediately upon receipt of your confirmation
statement.
Expedited Redemption Privilege. An investor in any series of the Fund may,
either by completing the appropriate section of the purchase application, or by
later making a written request to Firstar Trust Company containing his or her
signature guaranteed by an eligible guarantor (see above), obtain the expedited
redemption privilege for any of his or her accounts. The expedited redemption
privilege allows the investor to have the proceeds from any redemption of shares
in the amount of $5000 or more transferred by wiring federal funds to the
commercial bank or savings and loan institution specified in his or her purchase
application or written request for the expedited redemption privilege. The
commercial bank or savings and loan institution specified must be a member of
the Federal Reserve System. Expedited redemption requests may be made either by
mail to the address specified under regular redemption procedure or by telephone
to the number specified under tele-
19
<PAGE>
(LEFT COLUMN)
phone redemption privilege. The proceeds from such a redemption may be subject
to a deduction of the usual and customary charge Firstar Trust Company charges a
$12 service fee for each payment of redemption proceeds made by federal wire.
This fee will be deducted from your account. An investor may change the account
or commercial bank designation to receive the redemption proceeds by sending a
written request to Firstar Trust Company containing his or her signature
guaranteed in the manner described above. Both the High-Yield Series and Firstar
Trust Company reserve the right to refuse or limit an expedited redemption
request and to modify the expedited redemption privilege at any time.
Check Redemption Privilege. An investor in any series of the Fund may, by
either completing the appropriate section of the purchase application, or by
later making a written request to the High-Yield Series, obtain redemption
checks for any of his or her accounts. These checks may be used by the investor
in any lawful manner and may be payable to the order of any person or company in
an amount of $100 or more. When a check is presented to Firstar Trust Company
for payment, Firstar Trust Company, as agent for the investor, will cause the
High-Yield Series to redeem a sufficient number of shares in the investor's
account to cover the amount of the check. Investors using the check redemption
privilege will be subject to the same rules and regulations that are applicable
to other checking accounts at Firstar Trust Company. There is currently no
charge to the investor for using the check redemption privilege, except that a
fee may be imposed by Firstar Trust Company if an investor requests that it stop
payment of a Redemption Check or if it cannot honor a Redemption Check due to
insufficient funds or other valid reasons. The check redemption privilege may
not be used to close an account. The check redemption privilege may be modified
or terminated at any time by either the High-Yield Series or Firstar Trust
Company.
At times, the High-Yield Series may be requested to redeem shares for which
it has not yet received good payment. The High-Yield Series may delay, or cause
to be delayed payment of redemption proceeds until such time as it has assured
itself that good payment
(RIGHT COLUMN)
has been received for the purchase of such shares, which may take up to 15 days.
In the case of payment by check, determination of whether the check has been
paid by the paying institution can generally be made within 7 days, but may take
longer. Investors may avoid the possibility of any such delay by purchasing
shares by wire. In the event of delays in paying redemption proceeds, the
High-Yield Series will take all available steps to expedite collection of the
investment check.
If shares were purchased by check, you may write checks against such shares
only after 15 days from the date the purchase was executed. Shareholders who
draw against shares purchased fewer than 15 days from the date of original
purchase, will be charged usual and customary bank fees.
The High-Yield Series reserves the right to suspend the right of redemption or
postpone the day of payment with respect to its shares (1) during any period
when the New York Stock Exchange is closed (other than customary weekend and
holiday closings), (2) during any period when trading markets that the
High-Yield Series normally uses are restricted or an emergency exists as
determined by the Securities and Exchange Commission, so that disposing of the
High-Yield Series' investments or determining its net asset value is not
reasonably practicable, or (3) for such other periods as the Securities and
Exchange Commission by order may permit to protect investors.
If an investor's account has an aggregate net asset value of less than $1000,
the High-Yield Series may redeem the shares held in such account if the net
asset value of such account has not been increased to at least $100 within 60
days of notice by the High-Yield Series to such investor of its intention to
redeem the shares in such account. The High-Yield Series will not redeem the
shares of an account with a net asset value of less than $100 if the account was
reduced from the initial minimum investment of $1000 to below $100 as a result
of market activity.
Transfers
An investor may transfer shares of the High-Yield Series by submitting to
Firstar Trust Company a writ-
20
<PAGE>
(LEFT COLUMN)
ten request for transfer, signed by the registered holder of the shares and
indicating the name, social security number or taxpayer identification number
of, and distribution and redemption options elected by, the new registered
holder. Firstar Trust Company may, at its option, request further documentation
from transferors that are corporations, executors, administrators, trustees, or
guardians.
Dividends and Tax Matters
The High-Yield Series declares, on each business day just prior to calculating
its net asset value, all of its net investment income (consisting of earned
interest income less expenses) as a dividend on shares of record as of the close
of business on the preceding business day. Dividends are distributed on the last
business day of each calendar month. The High-Yield Series normally distributes
capital gains, if any, before the end of its fiscal year. All dividends and
capital gains distributions by the High-Yield Series will be in the form of
additional shares unless the investor has made an election, either on his or her
purchase application or in a subsequent written request to Firstar Trust
Company, to receive such distributions in cash. An investor may change his or
her distribution election by filing a written request with Fundamental
Shareholder Services, Inc. at least four days prior to the date of a
distribution.
Tax Matters
The High-Yield Series intends to qualify as a regulated investment company
by satisfying the requirements under Subchapter M of the Internal Revenue Code
of 1986, as amended (the "Code"), including requirements with respect to
diversification of assets, distribution of income and sources of income. It is
the High-Yield Series' policy to distribute to shareholders all of its
investment income (net of expenses) and any capital gains (net of capital
losses) in accordance with the timing requirements imposed by the Code, so that
the High-Yield Series will satisfy the distribution requirement of Subchapter M
and will not be subject to Federal income tax or the 4% excise tax.
If the High-Yield Series fails to satisfy any of the Code requirements for
qualification as a regulated
(RIGHT COLUMN)
investment company, it will be taxed at regular corporate tax rates on all its
taxable income (including capital gains) without any deduction for distributions
to shareholders, and distributions to shareholders will be taxable as ordinary
dividends (even if derived from the High-Yield Series' net long-term capital
gains) to the extent of the High-Yield Series' current and accumulated earnings
and profits.
Distributions by the High-Yield Series of its tax-exempt interest income
(net of expenses) are designated as exempt-interest dividends, which are
excludable from gross income for federal income tax purposes. However,
shareholders are required to report the receipt of exempt-interest dividends,
together with other tax-exempt interest, on their federal income tax returns. In
addition, these exempt-interest dividends may be subject to the federal
alternative minimum tax and will be taken into account in determining the
portion, if any, of Social Security benefits received which must be included in
gross income for federal income tax purposes. Further, interest or indebtedness
incurred or continued to purchase or carry shares of the High-Yield Series
(which indebtedness likely need not be directly traceable to the purchase or
carrying of such shares) will not be deductible for federal income tax purposes.
Finally, a shareholder who is (or is related to) a "substantial user" of a
facility financed by industrial development bonds held by the High-Yield Series
will likely be subject to tax on dividends paid by the High-Yield Series that
are derived from interest on such bonds.
A small portion of the High-Yield Series' net investment income may under
certain circumstances be taxable, and distributions thereof, as well as
distributions of any net capital gain will be taxable to shareholders.
Distributions by the High-Yield Series of its taxable net investment income and
the excess, if any, of its net short-term capital gain over its net long-term
capital loss are taxable to shareholders as ordinary income. Such distributions
are treated as dividends for federal income tax purposes but do not qualify for
the 70% dividends-received deduction for corporate shareholders. Distributions
by the High-Yield Series of the excess, if any, of its net long-term capital
gain over its net short-term capital loss are des-
21
<PAGE>
(LEFT COLUMN)
ignated as capital gains dividends and are taxable to shareholders as
long-term capital gains, regardless of the length of time shareholders have held
their shares.
Tax-exempt interest on specified private activity bonds issued after August
7, 1986, is treated as a tax preference item for purposes of the federal
alternative minimum tax ("AMT"). Thus, corporate and individual shareholders may
incur an AMT liability as a result of receiving exempt-interest dividends from
the High-Yield Series to the extent such dividends are attributable to interest
from such private activity bonds. In addition, because all exempt-interest
dividends are included in a corporate shareholder's adjusted current earnings
(which is used in computing a separate preference item for corporations),
corporate shareholders may incur an AMT liability as a result of receiving any
exempt-interest dividends from the High-Yield Series.
Distributions to shareholders will be treated in the same manner for federal
income tax purposes whether received in cash or reinvested in additional shares
of the High-Yield Series. In general, distributions by the High-Yield Series are
taken into account by the shareholders in the year in which they are made.
However, certain distributions made during January will be treated as having
been paid by the High-Yield Series and received by the shareholders on December
31 of the preceding year. The federal income tax status of all distributions by
the High-Yield Series will be reported to investors annually.
Investors should carefully consider the tax implications of purchasing
shares just prior to the record date of any ordinary income dividend or capital
gain dividend. Those investors purchasing shares just prior to an ordinary
income or capital gain dividend 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 and such dividend economically
constitutes a return of capital to such investors.
A shareholder will recognize gain or loss upon the sale or redemption of
shares of the High-Yield Series in an amount equal to the difference between
(RIGHT COLUMN)
the proceeds of the sale or redemption and the shareholder's adjusted tax basis
in the shares. Any loss realized upon a taxable disposition of shares within six
months from the date of their purchase will be treated as a long-term capital
loss to the extent of any capital gain dividends received on such shares. All or
a portion of any loss realized upon a taxable disposition of shares of the
High-Yield Series may be disallowed if other shares of the High-Yield Series are
purchased within 30 days before or after such disposition.
If a shareholder is a non-resident alien or foreign entity shareholder,
ordinary income dividends paid to such shareholder generally will be subject to
United States withholding tax at a rate of 30% (or lower rate under an
applicable treaty). We urge non-United States shareholders to consult their own
tax adviser concerning the applicability of the United States withholding tax.
Under the backup withholding rules of the Code, certain shareholders may be
subject to 31% withholding of federal income tax on ordinary income dividends
paid by the High-Yield Series. In order to avoid this backup withholding, a
shareholder must provide the High-Yield Series with a correct taxpayer
identification number (which for most individuals is his or her Social Security
number) or certify that it is a corporation or otherwise exempt from or not
subject to backup withholding.
The foregoing discussion of federal income tax consequences is based on tax
laws and regulations in effect on the date of this Prospectus, and is subject to
change by legislative, administrative or judicial action. As the foregoing
discussion is for general information only, a prospective shareholder should
also review the more detailed discussion of federal income tax considerations
relevant to the High-Yield Series that is contained in the Statement of
Additional Information. In addition, each prospective shareholder should consult
with his own tax adviser as to the tax consequences of investments in the
High-Yield Series, including the application of state and local taxes which may
differ from the federal income tax consequences described above.
22
<PAGE>
(LEFT COLUMN)
General Information
Investor Services
Firstar Trust Company is the transfer and dividend paying agent for shares of
the High-Yield Series and acts as custodian for the High-Yield Series' assets.
Inquiries regarding the High-Yield Series should be addressed to Firstar Trust
Company.
Firstar Trust Company maintains an account for each investor in the High-Yield
Series, and all of the investor's transactions are recorded in this account.
Confirmation statements showing details of transactions are sent to investors
following each transaction, and each investor is sent a quarterly account
summary.
Annual and semi-annual reports of the High-Yield Series together with the list
of securities held by the High-Yield Series in its portfolio are mailed to each
investor in the High-Yield Series.
Investors whose shares are held in the name of an investment broker-dealer or
other party will not normally have an account with the High-Yield Series and may
not be able to use some of the services available to investors of record.
Calculating Yield and
Average Annual Total Return
The High-Yield Series may from time to time include yield information in
advertisements or information furnished to existing or proposed shareholders.
The High-Yield Series' yield is computed by dividing the High-Yield Series' net
investment income per share during a base period of 30 days, or one month, by
the net asset value per share of the High-Yield Series on the last day of such
base period. The resulting 30-day yield is then annualized pursuant to the bond
equivalent annualization method described below. The High-Yield Series' net
investment income per share is determined by dividing the High-Yield Series' net
investment income during the base period by the average number of shares of the
High-Yield Series entitled to receive dividends during the base period. The
High-Yield Series' 30-day yield (computed as described above) is then annualized
by a computation that assumes the High-Yield Series' net investment
(RIGHT COLUMN)
income is earned and reinvested for a six-month period at the same rate as
during the 30-day base period and the resulting six-month income will again be
generated over an additional six-month period.
The High-Yield Series may also from time to time advertise its taxable
equivalent yield. The High-Yield Series' taxable equivalent yield is determined
by dividing that portion of the High-Yield Series' yield (calculated as
described above) that is tax-exempt by one minus the stated marginal federal
income tax rate and adding the product to that portion, if any, of the yield of
the High-Yield Series that is not tax-exempt.
The High-Yield Series may also furnish to existing or prospective shareholders
information concerning the average annual total return on an investment in the
High-Yield Series for a designated period of time. The average annual total
return quotation for a given period is computed by determining the average
annual compounded rate of return that would cause a hypothetical investment made
on the first day of the designated period (assuming all dividends and
distributions are reinvested) to equal the resulting net asset value of such
hypothetical investment on the last day of the designated period.
Yield and average annual total return quotations of the High-Yield Series do
not take into account any required payments for federal or state income taxes.
The High-Yield Series' yield and average annual total return will vary from
time to time depending on market conditions, composition of the High-Yield
Series' portfolio, and operating expenses of the High-Yield Series. These
factors and possible differences in method used in calculating yields and
returns should be considered when comparing performance information about the
High-Yield Series to information published for other investment companies and
other investment vehicles. Yields and return quotations should also be
considered relative to changes in the value of the High-Yield Series' shares and
the risk associated with the High-Yield Series' investment objective and
policies. At any time in the future, yields and return quotations may be higher
or lower than past yields or return quotations, and there can be no assurance
that any historical yield or return quotation will continue in the future.
23
<PAGE>
(LEFT COLUMN)
The High-Yield Series may also include comparative performance information in
advertising or marketing the High-Yield Series' shares. Such performance
information may include data from Lipper Analytical Services Inc. and
Morningstar, Inc., or other industry publications.
For more information about computing yield or average annual total return
quotations, see the Statement of Additional Information.
Exchangeability of Shares
Investors may exchange shares of the High-Yield Series having an aggregate net
asset value of $1000 or more for shares of any other series of the Fund or any
other mutual fund for which the Manager acts as the investment adviser, by
either (1) delivering a written request to Firstar Trust Company, specifying the
number of shares of the High-Yield Series to be exchanged and the series of the
Fund or the mutual fund in which they wish to invest in connection with such an
exchange or (2) by making such a request by telephone. (See
"Redemption-Telephone Redemption Privilege" for a discussion of the Fund's
policy with respect to losses resulting from unauthorized telephone
transactions). The exchange is effected by redeeming the investor's shares of
the High-Yield Series and issuing to the investor shares of the series or mutual
fund in which he or she is investing. The shares of both the High-Yield Series
and the series or mutual fund being invested in are valued for purposes of this
exchange at the net asset value per share of the High-Yield Series and such
other series or fund, respectively, as next determined after receipt by Firstar
Trust Company of the exchange request.
The exchange privilege is available in only those states where such exchange
can legally be made and exchanges may only be made between accounts with
identical account registration and account numbers and is subject to the
suitability requirements, if any, for the series or fund for which an exchange
is proposed to be made. Prior to effecting an exchange, an investor should
consider the investment policies of the series or mutual fund he or she is
investing in. Any exchange is, in effect, a redemption of shares in one fund and
a purchase of the other fund. An exchange by an investor is a taxable event for
federal income tax purposes that may result in a capital gain or loss.
(RIGHT COLUMN)
Dividend FLEXIVEST Option
Shareholders of the High-Yield Series may elect to have all dividends and
distributions paid by such Series automatically reinvested in shares of the
Fund's Tax-Free Money Market Series at its net asset value on the payment date
of such dividend or distribution, provided the shareholder has: (i) a minimum
opening account balance in the Tax-Free Money Market Series of at least $1,000;
and (ii) made appropriate selection of the FLEXIVEST option in the
"Distributions" section of the Account Application Form.
Other Information
The Code of Ethics of Fundamental Portfolio Advisors, Inc. and the Fund
prohibits all affiliated personnel from engaging in personal investment
activities which compete with or attempt to take advantage of the Fund's planned
portfolio transactions. The objective of the Code of Ethics of both the Fund and
Fundamental Portfolio Advisors, Inc. is that their operations be carried out for
the exclusive benefit of the Fund's shareholders. Both organizations maintain
careful monitoring of compliance with the Code of Ethics.
Independent Accountants
The financial statements included at the end of the Statement of Additional
Information, and the informa- tion under the caption "Financial Highlights" in
this Prospectus, have been so included in reliance upon the report of McGladrey
& Pullen, LLP, independent certified public accountants, as experts in
accounting and auditing.
Statement of Additional Information
The Statement of Additional Information for the
High-Yield Series, dated the date of this Prospectus, contains more detailed
information about the High-Yield Series, including information relating to its
(1) investment policies and restrictions, (2) its investment adviser and the
Fund's trustees and officers, (3) portfolio trading, (4) various services
provided for investors in the High-Yield Series, (5) the method used to
calculate yield and average annual total return and (6) financial statements and
certain other financial information.
24
<PAGE>
Appendix A
PORTFOLIO COMPOSITION
During the fiscal year ended December 31, 1997, the asset composition of the
High-Yield Series, based on the monthly weighted average of credit ratings of
portfolio securities, was as follows:
S&P or Percentage of Percentage of assets
Moody's assets rated by unrated but determined to
Rating rating agency be of comparable quality*
------- --------------- --------------------------
AAA or Aaa 45.7% 9.9%
AA or Aa 0% 0%
A 0% 0%
BBB or Baa 9.6% 0%
BB or Ba 5.1% 0%
B 1.4% 0%
Below B 0% 28.3%
- -------------
*Based on the monthly weighted average of credit ratings, 3.82% of the
High-Yield Series' assets were invested in unrated securities during the fiscal
year ended December 31, 1997. Unrated securities are not necessarily
lower-quality securities. Issuers of municipal securities frequently choose not
to incur the expense of obtaining a rating. Please refer to Appendix B for a
more complete discussion of these ratings.
A-1
<PAGE>
Appendix B
DESCRIPTION OF MUNICIPAL BOND RATINGS
Standard & Poor's Corporation
AAA
This is the highest rating assigned by S&P to a debt obligation and
indicates an extremely strong capacity to pay interest and repay principal.
AA
Bonds rated AA also qualify as high quality debt obligations. Capacity to
repay principal and pay interest is very strong, and in the majority of
instances, they differ from AAA issues only in small degree.
A
Bonds rated A have a strong capacity to pay interest and repay principal,
although they are somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than are bonds in higher rated categories.
BBB
Bonds rated BBB are regarded as having an adequate capacity to pay interest
and repay principal. Whereas they normally exhibit adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
bonds in this category than for bonds in higher rated categories.
BB, B, CCC, CC
Bonds rated BB, B, CCC and CC are regarded, on balance, as predominantly
speculative with respect to capacity to pay interest and repay principal in
accordance with the terms of the obligation. BB indicates the lowest degree of
speculation and CC the highest degree of speculation. While such bonds will
likely have some quality and protective characteristics, these are outweighed by
large uncertainties or major risk exposures to adverse conditions.
C
The rating C is reserved for income bonds on which no interest is being
paid.
D
Bonds rated D are in default, and payment of interest and/or repayment of
principal is in arrears.
Plus (+) or Minus (\'96): The ratings from "AA" to "B" may be modified by
the addition of a plus or minus sign to show relative standing within the major
rating categories.
B-1
<PAGE>
Moody's Investors Service, Inc.
Aaa
Bonds which are rated Aaa are judged to be of the best quality. They carry
the smallest degree of investment risk and are generally referred to as "gilt
edge." Interest payments are protected by a large or by an exceptionally stable
margin and principal is secure. While the various protective elements are likely
to change, such changes as can be visualized are most unlikely to impair the
fundamentally strong position of such issues.
Aa
Bonds which are rated Aa are judged to be of high quality by all standards.
Together with the Aaa group they comprise what are generally known as high-grade
bonds. They are rated lower than the best bonds because margins of protection
may not be as large as in Aaa securities or fluctuation of protective elements
may be of greater amplitude or there may be other elements present which make
the long-term risks appear somewhat larger than in Aaa securities. Note: Those
bonds in the Aa through B groups which Moody's believes possess the strongest
investment attributes are designated by the symbols Aa1, A1 and Baa1.
A
Bonds which are rated A possess many favorable investment attributes and are
to be considered as upper medium grade obligations. Factors giving security to
principal and interest are considered adequate, but elements may be present
which suggest a susceptibility to impairment sometime in the future.
Baa
Bonds which are rated Baa are considered as medium grade obligations; i.e.,
they are neither highly protected nor poorly secured. Interest payments and
principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
Ba
Bonds which are rated Ba are judged to have speculative elements; their
future cannot be considered as well assured. Often the protection of interest
and principal payments may be very moderate and thereby not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
B
Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
Caa
Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to principal or
interest.
Ca
Bonds which are rated Ca represent obligations which are speculative in a
high degree. Such issues are often in default or have other marked shortcomings.
C
Bonds which are rated C are the lowest rated class of bonds, and issues so
rated can be regarded as having extremely poor prospects of ever attaining any
real investment standing.
B-2
<PAGE>
FUNDAMENTAL FUNDAMENTAL
FIXED INCOME FUND FIXED INCOME FUND
90 Washington Street
New York NY 10006
1-800-225-6864
High Yield
Municipal Bond Series
Transfer Agent
Firstar Trust Company
P.O. Box 701
Milwaukee, WI 53201-0701
1-800-322-6864
Prospectus
May 1, 1998
Counsel to the Fund
Kramer, Levin, Naftalis &Frankel
New York, New York
Independent Auditors
McGladrey &Pullen, LLP
New York, New York
No person has been authorized to give any
information or to make any representations
other than those contained in this Prospectus
and in the Fund's official sales literature
in connection with the offer of the Fund's
shares, and, if given or made, such other
information or representations must not be
relied upon as having been authorized by the
Fund. This Prospectus does not constitute an
offer in any State in which, or to any person
to whom, such offering may not lawfully be
made. FUNDAMENTAL
Family of Funds
<PAGE>
Fundamental
Fixed-lncome Fund
Tax-Free Money Market Series
90 Washington Street
New York, New York 10006
1-800-225-6814
Prospectus
May 1, 1998
This Prospectus pertains to the Tax-Free Money Market Series (Money Market
Series) of the Fundamental Fixed-lncome Fund (the Fund), an open-end,
non-diversified management investment company (commonly referred to as a mutual
fund). The investment objective of the Money Market Series is to provide as high
a level of current income exempt from federal income tax as is consistent with
the preservation of capital and liquidity. Shares of the Money Market Series are
neither insured nor guaranteed by the United States Government. There is no
assurance that the Money Market Series will be able to maintain a stable net
asset value of $1.00 per share or that the Money Market Series' investment
objective will be achieved.
This Prospectus concisely sets forth the information about the Money Market
Series that you should know before investing. You should read and retain this
Prospectus for your future reference. More information about the Money Market
Series is included in the Statement of Additional Information, also dated May 1,
1998, which has been filed with the Securities and Exchange Commission and is
incorporated into this Prospectus by reference. A copy of the Statement of
Additional Information may be obtained free of charge by writing to the Fund at
the address listed above, or by calling (800) 322-6864. Shareholder inquiries
may also be placed through this number. THESE SECURITIES HAVE NOT BEEN APPROVED
OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
AGENCY NOR HAS THE COMMISSION OR ANY STATE SECURITIES AGENCY PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
(Right Column)
Contents
Annual Operating Expenses 2
Financial Highlights 2
Investment Objective and Policies 4
Repurchase Agreements 4
Variable Rate Securities 5
When-lssued Securities 5
Standby Commitments 5
Temporary Investments 6
Investment Considerations
and Restrictions 6
Special Considerations 7
Private Activity Bonds 7
Miscellaneous 8
Management 8
Information about Shares
of the Money Market Series 10
Description of Shares 10
How to Purchase Shares 10
Methods of Payment 11
Purchase Price and Net Asset Value 12
Distribution Expenses 12
Redemptions 13
Transfers 15
Dividends and Tax Matters 15
General Information 17
Investor Services 17
Calculation of Yield 17
Exchangeability of Shares 17
Other Information 18
Independent Accountants 18
Statement of Additional Information 18
<PAGE>
(Left Column)
Annual Operating
Expenses
The following table sets forth the annual operating expenses of the Money Market
Series expressed as a percentage of the average net assets of the Money Market
Series and a hypothetical illustration of the amount of operating expenses of
the Money Market Series that would be incurred by an investor purchasing $1000
of shares of the Money Market Series who redeems his or her investment at the
end of one, three, five and ten years.
Annual Operating Expenses
(as a percentage of average net assets)
- --------------------------------------------------------------------------------
Management fees .50%
12b-1 fees1 .50%
Other expenses, net of reimbursements .52%
Total operating expenses (after waiver
and/or reimbursement) 1.52%
Expenses waived and/or reimbursed .02%
Total operating expenses (before waiver
and/or reimbursement) 1.54%
Example: You would pay the following expenses on a $1000 investment assuming (1)
a 5% annual return and (2) redemption at the end of each time period:
1 Year 3 Years 5 Years 10 Years
- --------------------------------------------------------------------------------
$15 $48 $83 $181
1As a result of distribution fees of .50% per annum of the Fund's average daily
net assets, a long-term shareholder may pay more than the economic equivalent of
the maximum front-end sales charge permitted by the National Association of
Securities Dealers, Inc.
(Right Column)
The purpose of the preceding table is to assist an investor in the Money
Market Series in understanding the various costs and expenses that will be
directly or indirectly borne by such investor.
The example set forth in the above table is for information purposes only and
should not be considered as a representation of past or future expenses of the
Money Market Series or of past or future returns on an investment in the Money
Market Series. Actual expenses of the Money Market Series and the return on an
investment in the Money Market Series may vary significantly from the expenses
and investment return assumed in the above example.
Financial Highlights
The following information has been audited by McGladrey & Pullen, LLP,
independent public accountants, in connection with their audit of the Money
Market Series' financial statements. McGladrey & Pullen's report on the Money
Market Series' financial statements for the year ended December 31, 1997 appears
at the end of the Statement of Additional Information. The information listed
below should be read in conjunction with the Money Market Series' full financial
statements.
Selected per share data-Money Market Series For the years ended December 31,
1988, 1989, 1990, 1991, 1992, 1993, 1994, 1995, 1996 and 1997 for each share
outstanding throughout the period:
2
<PAGE>
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------------------------------------------------------------
1997 1996 1995 1994 1993 1992 1991 1990 1989 1988
---- ---- ---- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
PER SHARE OPERATING
PERFORMANCE
(for a share outstanding
throughout the period)
Net Asset Value, Beginning of Period ...... $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Income from Investment operations:
Net investment income ..................... 0.022 0.023 0.026 0.017 0.014 0.028 0.047 0.050 0.053 0.044
Net realized and unrealized gain on
investments ............................. 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Total from investment
operations ........................ 0.000 0.023 0.026 0.017 0.014 0.028 0.047 0.050 0.053 0.044
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Less Distributions:
Dividends from net investment
income .................................. (0.022) (0.023) (0.026) (0.017) (0.014) (0.028) (0.047) (0.050) (0.053) (0.044)
Distributions from realized gain on
securities .............................. 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Total distributions ................. 0.000 (0.023) (0.026) (0.017) (0.014) (0.028) (0.047) (0.050) (0.053) (0.044)
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Net Asset Value, End of Period ............ $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
====== ====== ====== ====== ====== ====== ====== ====== ====== ======
Total Return .............................. 2.19% 2.28% 2.60% 1.69% 1.62% 2.79% 4.86% 5.14% 5.45% 4.54%
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (000) ........... 13,263 4,621 11,251 9,004 5,830 32,488 8,310 6,906 4,136 2,520
Ratios to Average Net Assets:
Expenses(1) ............................. 1.52%+ 1.54% 1.53%+ 0.91% 0.95% 0.42% 0.05% 0.91% 1.03% 1.08%
Net investment income ................... 2.10% 2.04% 2.43% 1.55% 1.25% 2.76% 4.74% 5.09% 5.31% 4.50%
BANK LOANS
Amount outstanding at end of period
(000 omitted) ........................... - $ 218 $ - $ 451 $ 290 $ 20 $ 58 $ 0 $ 10 $ 0
Average amount of bank loans
outstanding during the period (000
omitted) ................................ - $ - $ 41 $ 53 $ 111 $ 69 $124T $ 15T $ 6T $ 13T
Average number of shares outstanding
during the period (000 omitted) ......... 48,801 56,876 44,432 56,267 25,786 7,980 6,984T $4,426T $3,175T $1,657T
Average amount of debt per share
during the period ....................... - $ - $ .001 $ .001 $ .004 $ .009 $ .018 $ .003 $ .002 $ .009
<FN>
T Monthly Average.
(1) The Manager voluntarily assumed certain expenses of the Fund during the periods ended December 31, 1997, 1994, 1993,
1992, 1991, 1990, 1989 and 1988. Had such expenses not been so assumed, the ratio of expenses to average net
assets would have been 1.54%, 1.35%, 1.62%, 2.08%, 1.62%, 2.32%, 2.72% and 6.35%.
+ This ratio would have been 1.44%, 1.26% and 1.35%, net of expense offset of .08%, .14% and .18% for the years ended
December 31, 1997, 1996 and 1995, respectively.
</FN>
</TABLE>
3
<PAGE>
(Left Column)
Investment Objective and Policies
The investment objective of the Money Market Series of the Fundamental
Fixed-Income Fund is to provide as high a level of current income exempt from
federal income tax as is consistent with the preservation of capital and
liquidity. The Money Market Series will seek to achieve its objective by
investing, under normal circumstances, at least 80% of its assets in a managed
portfolio of high-quality debt securities, including bonds other than private
activity bonds issued after August 7, 1986, issued by or on behalf of states,
territories, and possessions of the United States, the District of Columbia, and
their political subdivisions, agencies, and instrumentalities, the interest from
which is exempt from federal income tax (municipal bonds). As a defensive
measure under certain market conditions, the Money Market Series may invest up
to 50% of its assets in short-term taxable investments. See Temporary
Investments.
The Money Market Series invests only in U.S. dollar-denominated securities
which are rated in one of the two highest rating categories for debt obligations
by Standard & Poor's Corporation ("S&P") and Moody's Investors Service, Inc.
("Moody's"), two nationally recognized statistical rating organizations
("NRSROs") (or one NRSRO if the instrument was rated by only one such
organization) or, if unrated, are of comparable quality as determined in
accordance with procedures established by the board of trustees of the Fund.
Under normal market circumstances the Money Market Series will invest at least
80% of its assets in high-quality municipal bonds rated AA, SP-1, or higher by
S&P or MIG-1 or Prime-1 by Moody's or are unrated but judged by the Fund's
investment adviser to be of at least comparable quality in accordance with
procedures established by the board of trustees of the Fund. At least 80% of the
Money Market Series' assets will be invested in obligations with remaining
maturities of 13 months or less. Accordingly, the securities in which the Money
Market Series will invest may not yield as high a level of current income as
longer term or lower grade securities that generally have less liquidity and
greater fluctuation in value.
(Right Column)
Investments in rated securities not rated in the highest category by these two
NRSROs (or one NRSRO if the instrument was rated by only one such organization),
and unrated securities not determined by the investment adviser, in accordance
with procedures established by the board of trustees, to be comparable to those
rated in the highest category, will be limited to 5% of the Money Market Series'
total assets, with the investment in any such issuer being limited to not more
than the greater of 1% of the Money Market Series' total assets or $1 million.
The Money Market Series may invest in obligations issued or guaranteed by the
U.S. Government without any such limitation.
Municipal bonds include debt obligations issued to obtain funds for various
public purposes, including construction of public facilities, repayment of
outstanding obligations, and payment of general operating expenses. The Money
Market Series will hold two categories of municipal bonds: general obligation
bonds, which are backed by the faith, credit, and taxing power of the issuing
municipality and considered to be the safest type of municipal bond; and revenue
bonds, which are backed by the revenues of a specific project or facility or in
some cases, by the proceeds of special excise taxes, user fees, or other
specific revenue sources. Certain revenue bonds may be issued to obtain funding
for privately operated facilities. These bonds, known as private activity bonds,
are backed by the credit and security of a private user and therefore have more
potential risk.
Repurchase Agreements
The Money Market Series may enter into repurchase agreements with commercial
banks, brokers, or dealers pursuant to which the Money Market Series acquires a
money market instrument (generally a U.S. Government obligation qualifying for
purchase by the Money Market Series) that is subject to resale by the Money
Market Series on a specified date (generally within one week) at a specified
price (which price reflects an agreed-on interest rate effective for the period
of time the Money Marke t Series holds the investment and is unrelated to the
interest rate on the instrument). As a matter of fundamental policy, the Money
Market Series will not enter into repurchase
4
<PAGE>
(Left Column)
agreements of more than one week in length if as a result, more than 10% of the
total assets of the Money Market Series would be invested in such agreements or
other restricted or illiquid securities. The Money Market Series enters into
repurchase agreements for the purpose of making short-term cash investments.
Risks involved in entering into repurchase agreements include the possibility of
default or bankruptcy by the other party to the agreement. The Money Market
Series' investment adviser will monitor the creditworthiness of parties with
which it enters into repurchase agreements.
Variable Rate Securities
The Money Market Series may invest in variable rate municipal bonds with or
without demand features. Interest rates on such securities fluctuate based on
changes in specified market rates, such as the prime rate, or are adjusted at
predetermined intervals, at least every six months. The Money Market Series'
investment adviser believes that the variable rate feature of these securities
may reduce the fluctuations possible in the market value of fixed-rate
securities. A demand feature allows the Money Market Series to demand prepayment
of the principal amount of the municipal bond prior to its maturity. Some demand
obligations are guaranteed by banks or other financial institutions, which may
enhance the quality of the underlying security.
When-lssued Securities
The Money Market Series purchases some municipal bonds on a when-issued basis,
which means that it may take as long as 60 days or more before they are
delivered and paid for. The commitment to purchase a security for which payment
will be made at a future date may be deemed a separate security. The purchase
price and interest rate of when-issued securities is fixed at the time the
commitment to purchase is entered into. Although the amount of municipal bonds
for which there may be purchase commitments on a when-issued basis is not
limited, it is expected that under normal circumstances not more than 25% of the
total assets of the Money Market Series will be committed to such purchases. The
Money Market Series does not start earning interest on when-issued securities
until settlement is made. In order to invest the
(Right Column)
assets of the Money Market Series immediately while awaiting delivery of
securities purchased on a when-issued basis, short-term obligations that offer
same- day settlement and earnings will normally be purchased. Although
short-term investments will normally be made in tax-exempt securities,
short-term taxable securities may be purchased if suitable short-term tax-exempt
securities are not available. See "Temporary Investments."
When a commitment to purchase a security on a when-issued basis is made,
procedures are established consistent with the General Statement of Policy of
the Securities and Exchange Commission concerning such purchases. Because that
policy currently recommends that an amount of the Money Market Series' assets
equal to the amount of the purchase be held aside or segregated to be used to
pay for the commitment, cash or high-quality debt securities sufficient to cover
any commitments are always expected to be available. However, although it is not
intended that such purchases will be made for speculative purposes, and although
the Money Market Series intends to adhere to the provisions of the Securities
and Exchange Commission policy, purchases of securities on a when-issued basis
may involve more risk than other types of purchases. For example, when the time
comes to pay for a when-issued security, portfolio securities of the Money
Market Series may have to be sold in order for the Money Market Series to meet
its payment obligations, and a sale of securities to meet such obligations
carries with it a greater potential for the realization of capital gain, which
is not tax-exempt. Also, if it is necessary to sell the when-issued security
before delivery, the Money Market Series may incur a loss because of market
fluctuations since the time the commitment to purchase the when-issued security
was made. Moreover, any gain resulting from any such sale would not be
tax-exempt. Additionally, because of market fluctuations between the time of
commitment to purchase and the date of purchase, the when-issued security may
have a lesser (or greater) value at the time of purchase than the Money Market
Series' payment obligations with respect to the security.
Standby Commitments
The Money Market Series may acquire standby com-
5
<PAGE>
(Left Column)
mitments with respect to municipal bonds held in its portfolio. A standby
commitment is an agreement in which a dealer agrees to purchase, at the Money
Market Series' option, specified municipal bonds at specified prices. The total
amount paid by the Money Market Series for outstanding standby commitments it
holds will not exceed one-half of 1% of the Money Market Series' total assets
calculated immediately after each standby commitment is acquired. The Money
Market Series will enter into standby commitments for the purpose of reducing
portfolio risk with respect to certain securities. The Money Market Series will
not enter into a standby commitment unless (1) the Money Market Series owns the
security subject to the standby commitment and (2) the Money Market Series'
investment adviser determines at the time the Money Market Series enters into
the standby commitment that the Money Market Series would be willing to sell the
underlying security at the price specified in the standby commitment.
Temporary Investments
The Money Market Series anticipates that it may from time to time invest a
portion of its total assets, on a temporary basis, in short-term fixed-income
obligations whose interest is subject to federal income tax. Such investments
are made only under conditions that in the opinion of the investment adviser of
the Money Market Series make such investments advisable. For example, the Money
Market Series may invest in taxable obligations pending investment in municipal
bonds of proceeds from the sale of its shares or investments or to ensure the
liquidity needed to satisfy redemptions of shares and the day-to-day operating
expenses of the Money Market Series. The Money Market Series invests in only
those taxable obligations that are (1) rated AA or higher by S&P or Aa or higher
by Moody's or unrated but judged by its investment adviser to be of at least
comparable quality, (2) obligations issued or guaranteed by the U.S. Government
or its agencies or instrumentalities, or (3) obligations of banks (including
certificates of deposit, bankers' acceptances, and repurchase agreements) with
at least $1,000,000,000 of assets. No more than 50% of the assets of the Money
Market Series may be invested in taxable obligations at any one time, and the
Money
(Right Column)
Market Series anticipates that on a 12-month average, taxable obligations will
constitute less than 10% of the value of its total investments.
Investment Considerations
and Restrictions
The Money Market Series provides investors with the ability to purchase
securities exempt from federal income tax in large denominations and to achieve
diversification of both investments and maturity schedule. However, these
advantages may be substantially reduced or eliminated during periods when
interest rates in general are declining or interest rates on the Money Market
Series' municipal bonds are lower than interest rates on municipal bonds with
maturities greater than those of the Money Market Series.
The high-quality municipal bonds in which the Money Market Series will invest
may not offer so high a yield as may be achieved from lower quality instruments
having less liquidity and greater fluctuation in value.
The ability of the Money Market Series to achieve its investment objective
depends partially on prompt payment by issuers of the interest on, and principal
of, municipal bonds held by the Money Market Series. A moratorium, default, or
other failure to pay interest or principal when due on any municipal bond, in
addition to affecting the market value and liquidity of that particular
security, could affect the market value and liquidity of other municipal bonds
held by the Money Market Series. The market for municipal bonds is smaller than
the market for taxable money market securities and can be temporarily affected
by large purchases and sales, including those by the Money Market Series.
Because the Money Market Series will invest in municipal bonds maturing in not
more than one year, portfolio turnover will be high. In addition, the Money
Market Series will attempt to increase yields by trading securities to take
advantage of short-term interest rate disparities. Because a high turnover rate
increases transaction costs and the possibility of taxable short-term gains, the
Money Market Series will carefully weigh the added cost of short-term
investments
6
<PAGE>
(Left Column)
against anticipated gains. If the Money Market Series disposes of a municipal
bond prior to maturity, it may realize a loss or a gain. The value of the Money
Market Series will generally vary inversely with the movement of interest rates.
The Money Market Series has adopted a number of investment restrictions and
policies that may help to reduce risk:
* The Money Market Series will not purchase a municipal bond if as a result
more than 25% of the assets of the Money Market Series would be invested in the
securities of a particular industry. This limitation does not apply to the
investment of its assets in banks, U.S. Government securities, or federal agency
obligations.
* The Money Market Series will not borrow money except to meet redemptions,
and then in amounts not exceeding 33.33% (taken at the lower of cost or current
value) of its total assets (including the amount borrowed) or mortgage, pledge
or hypothecate its assets except in connection with any such borrowing and in
amounts not in excess of the dollar amounts borrowed.
* At no time will the Money Market Series commit more than 10% of its assets
to illiquid securities, including repurchase agreements that mature in more than
seven days.
Borrowings are subject to the additional restriction that the value of the
Money Market Series' assets, less its liabilities other than borrowings, must
always be equal to or greater than 300% of all of its borrowings (including the
proposed borrowing). If this 300% coverage requirement is not met, the Money
Market Series must, within three days, reduce its debt to the extent necessary
to meet such coverage requirement, and to do so, it may have to sell a portion
of its investments at a time when such a sale would otherwise be inadvisable.
Interest on money borrowed is an expense of the Money Market Series.
Special Considerations
It is expected that a substantial portion of the assets of the Fund will be
derived from professional money managers and investors who intend to invest in
(Right Column)
the Fund as part of an asset-allocation or market-timing investment strategy.
These investors are likely to redeem or exchange their Fund shares frequently to
take advantage of anticipated changes in market conditions. The strategies
employed by investors in the Fund may result in considerable assets moving in
and out of the Fund. Consequently, the Trust expects that the Fund will
generally experience significant portfolio turnover, which will likely cause
higher expenses and additional costs.
Private Activity Bonds
The Internal Revenue Code of 1986, as amended (the "Code") treats interest from
certain municipal bonds (referred to as private activity bonds) as a tax
preference item under the alternative minimum tax. Thus, corporate and
individual shareholders may incur an alternative minimum tax liability as a
result of receiving tax-exempt dividends from the Money Market Series to the
extent such dividends are attributable to interest from private activity bonds.
The Money Market Series will invest in private activity bonds only when it
believes that the yield disparity between private activity bonds and other
municipal bonds makes an investment in private activity bonds attractive. In
addition, because all tax-exempt dividends are included in a corporate
shareholder's adjusted current earnings (which are used in computing a separate
preference item for corporations), corporate shareholders may incur an
alternative minimum tax liability as a result of receiving any tax-exempt
dividends from the Money Market Series. Tax-exempt interest and income referred
to throughout this Prospectus means interest and income that is excluded from
gross income for federal income tax purposes but may be a tax preference item
subject to the alternative minimum tax. Further, such tax-exempt interest and
income may be subject to taxation under the tax laws of any state or local
taxing authority. See "Information about Shares of the Money Market
Series-Dividends and Tax Matters."
Miscellaneous
The Money Market Series' investment objective of providing a high level of
current income exempt from federal income tax and its policy of investing, under
7
<PAGE>
(Left Column)
normal circumstances, at least 80% of its assets in municipal bonds are
fundamental policies of the Money Market Series, which may not be changed
without the approval of a majority of the outstanding shares of the Money Market
Series.
The Statement of Additional Information includes a discussion of other
investment policies and a listing of specific investment restrictions that
govern the Money Market Series' investment policies. The specific investment
restrictions identified in the Statement of Additional Information may not be
changed without shareholder approval. If a percentage restriction or a rating
restriction on investments or utilization of assets 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 Money Market Series' securities or
from a change in the rating of a portfolio security will not be considered a
violation of policy.
Management
The board of trustees of the Fund has the overall responsibility for the
management and supervision of the Money Market Series. There are currently three
trustees, two of whom are not considered to be interested persons of the Fund
within the meaning of the Investment Company Act of 1940 (the 1940 Act). The
trustees meet regularly each quarter. By virtue of the functions performed by
Fundamental Portfolio Advi sors, Inc. (the Manager), the investment adviser of
the Money Market Series, neither the Fund nor the Money Market Series require
any employees other than the executive officers of the Fund, all of whom receive
their compensation from the Manager or other sources. The Statement of
Additional Information contains the names and general background of each trustee
and executive officer of the Fund.
The Fund's Board of Trustees approved the continuance of the Fund's current
Management Agreement for a period of sixty days following the date of its
expiration in contemplation of the consummation of a transaction pursuant to
which Tocqueville Asset Management L.P. ("Tocqueville") would assume management
of the assets of the Fund. Otherwise, the Management Agreement would have
expired on April
(Right Column)
1, 1998. Tocqueville is the investment adviser to the Tocqueville Funds.
It is anticipated that shareholders of the Fund will be asked to consider
and approve an Agreement and Plan of Reorganization providing for the transfer
of the Fund's assets to a separate, newly-created Tocqueville Fund having the
same investment policies and objectives as those of the Fund at a special
meeting of shareholders scheduled to be held in late Spring. Subsequent to the
filing with the Securities and Exchange Commission of preliminary proxy
solicitation materials seeking shareholder approval of the Agreement and Plan of
Reorganization at the special meeting of shareholders, the Manager filed two
preliminary proxy statements with the Securities and Exchange Commission, one
opposing the transaction pursuant to which Tocqueville would assume management
of the assets of the Fund; the second, proposing to replace the two independent
Board Members of the Fundamental Funds and the election of six new nominees to
the Fund's Board (in addition to Vincent J. Malanga, a current Board Member).
Pursuant to a management agreement between the Fund and the Manager, the
Manager serves as investment adviser to the Money Market Series and is
responsible for the overall management of the business affairs and assets of the
Money Market Series, subject to the authority of the Fund's board of trustees.
The Manager's post office address is P.O. Box 1013, Bowling Green Station, New
York, New York 10274-1013. Under the terms of the management agreement, the
Manager manages and supervises the Fund's investment portfolio and directs the
purchase and sales of its investment securities subject to the right of the
Fund's trustees to disapprove such purchase or sale. The Manager utilizes an
investment committee to manage the assets of the Fund. The committee is
currently composed of the following members: Vincent J. Malanga, a portfolio
strategist affiliated with the Manager and Jane Tubis, a trading assistant
affiliated with the Manager.
Vincent J. Malanga is, and has been for more than the past five years,
Chairman of the Board, Chief Executive Officer, President and Treasurer of the
Fundamental Family of Funds. He is, and has been for more than the past five
years, President, Treasurer, and a Director of the Manager, Executive Vice
President, Secretary and a Director of Fundamental Service Corporation (the
Distributor for certain of the Fundamental Family of Funds) and President of
LaSalle Economics, Inc., an economic consulting firm, and a managing director of
LaSalle Portfolio Management, Inc., a commodity trading adviser.
Jane Tubis is, and has been for more than the past five years, a trading
assistant with the Manager.
The Money Market Series pays all brokerage commissions in connection with
its portfolio transactions.
8
<PAGE>
(Left Column)
The Money Market Series also bears the expense, pro rata with the other series
of the Fund, of maintaining the Fund's registration as an investment company
under the 1940 Act and of registering its shares under the Securities Act of
1933. The Money Market Series also pays certain other costs and expenses, which
are more fully described in the Statement of Additional Information under the
caption Investment Adviser.
As compensation for the performance of its management services and the
assumption of certain expenses of the Money Market 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 Money Market Series equal to
0.5% of the Money Market Series' average daily net asset value up to
$100,000,000 and decreasing by .02% for each $100,000,000 increase in net assets
down to 0.4% of net assets in excess of $500,000,000.
Under the management agreement and pursuant to authority granted by the
trustees, the Manager is authorized to place portfolio transactions with dealer
firms that have provided assistance in the distribution of shares of the Money
Market 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.
On September 30, 1997, the Securities and Exchange Commission (the
"Commission") instituted administrative proceedings against the Manager,
Fundamental Service Corporation, and Drs. Lance M. Brofman and Vincent J.
Malanga (the "Parties"). The Commission's Order instituting the proceedings
alleges, among other things, certain violations of the federal securities laws,
including the antifraud provisions, for failing to disclose the risks associated
with investments in inverse floating rate notes made on behalf of the
Fundamental U.S. Government Strategic Income Fund (the "Government Fund") in
1993 and 1994, marketing the Government Fund in a way that was contrary to the
administration of the Government Fund, exceeding the Government Fund's portfolio
duration of three years or less as stated in its prospectus, and failing to
disclose the Manager's soft dollar
(Right Column)
practices to the Fundamental Fund Boards. A hearing has been scheduled to
determine whether the allegations against the Parties are true, and if so,
whether remedial action is appropriate. Counsel to the Parties have indicated
that the Parties intend to vigorously contest the charges. The Manager has
indicated that the institution of the proceedings against the Parties has not
adversely affected the ability of the Manager or Fundamental Service Corporation
to continue to perform the day-to-day affairs of the Fundamental Funds.
The Manager and Fundamental Service Corporation (on behalf of certain of
their directors, officers, shareholders, employees and control persons) (the
"Indemnitees") received payments during the fiscal year ended December 31, 1997
from three of the Fundamental Funds for attorneys' fees incurred by them in
defending certain proceedings. The payments were as follows: Fundamental U.S.
Government Strategic Income Fund (approximately $286,500); New York Muni Fund
(approximately $50,000); and the California Muni Fund (approximately $4,000).
Upon learning of the payment, the independent Board Members of the Fundamental
Funds directed that the Indemnitees return all of the payments to the Funds or
place them in escrow pending their receipt of an opinion of an independent legal
counsel to the effect that the Indemnitees are entitled to receive them.
On April 30, 1998, the Indemnitees placed $106,863 into an escrow account
pending clarification of certain legal issues. The Manager and Fundamental
Service Corporation have asserted that they waived fees during the year ended
December 31, 1997 and that the amount placed in escrow should be net of any
reimbursements already made to the Funds in the form of fees forgone. Upon
learning that $106,863 was placed into an escrow account on behalf of the Funds,
the independent Board Members referred the Manager and Fundamental Service
Corporation to their prior directive and asked that the entire amount of all
payments received by such entities ($286,500) be placed into said escrow
account. For further information, see Notes to the December 31, 1997 Financial
Statements of Fundamental U.S. Government Strategic Income Fund, New York Muni
Fund and the California Muni Fund, attached to the Statement of Additional
Information.
In addition to paying a management fee to the Manager, the Money Market Series
also pays a distribution fee to Fundamental Service Corporation, an affiliate of
the Manager. See "Information about Shares of the Money Market
Series-Distribution Expenses." The Manager also manages and serves as investment
adviser to two other investment companies, New York Muni Fund, Inc. and The
California Muni Fund. The Manager is a Delaware corporation that was
incorporated in 1986.
Information about Shares
of the Money Market Series
Description of Shares
The Fund is an open-end, non-diversified management investment company that was
organized as a Massa-
9
<PAGE>
(Left Column)
chusetts business trust on March 19, 1987. The Money Market Series is a
non-diversified portfolio of the Fund and thus by itself does not constitute a
balanced investment plan. The Declaration of Trust under which the Fund was
organized authorizes the trustees of the Fund to issue an unlimited number of
shares of beneficial interest in the Fund, 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 Money Market Series, the High-Yield
Municipal Bond Series and the Fundamental U.S. Government Strategic Income Fund
Series.
The trustees may establish additional series of shares. As an open-end
investment company, the Fund continuously offers shares of its Money Market
Series to the public and under normal conditions must redeem these shares on
demand of any registered holder at the then-current net asset value per share.
Each share of the Money Market Series represents an equal proportionate
interest in the Money Market Series with each other share in the series. Shares
entitle their holders to one vote per share. Investors in the Money Market
Series are entitled to vote in the election of trustees, on the adoption of any
management contract or distribution plan, on any change in a fundamental
investment policy with respect to the Money Market Series and on other matters
submitted to shareholder vote, as provided in the Fund's Declaration of Trust.
Shares of the Fund are voted by individual series, except (1) when required by
the 1940 Act they are voted in the aggregate, and (2) when the trustees
determine that a matter affects only one or more particular series of shares,
only the shares of such series are entitled to vote on such matter. Shares of
the Money Market Series have no cumulative voting rights, preemptive rights, or
subscription rights. The shares are freely transferable and fully paid and
except as set forth in the Statement of Additional Information, are
non-assessable.
The Money Market Series has its own assets, which are recorded separately on
the Fund's books from the assets of the Fund's other series and held by the
trustees of the Fund in trust for investors in the Money Market Series. All
income and proceeds earned and
(Right Column)
expenses incurred by the Money Market Series are allocated to the Money Market
Series, and the portion of all income and expenses earned or incurred by the
Fund, rather than by an individual series of the Fund, which is properly
allocable to the Money Market Series, is allocated to the Money Market Series.
On liquidating the Fund or the Money Market Series, investors in the Money
Market Series would be entitled to share pro rata in the net assets of the Money
Market Series available for distribution to shareholders.
Shares will remain on deposit with the transfer agent for the Money Market
Series and certificates will not be issued.
How to Purchase Shares
Shares of the Money Market Series may be purchased either directly from the
Money Market Series or through securities dealers, banks, or other financial
institutions. The Money Market Series has a minimum initial purchase requirement
of $1000 and a minimum subsequent purchase requirement of $100. Subsequent
purchases are made in the same manner as initial purchases.
Investors can purchase shares without a sales charge if they purchase the
shares directly from the Money Market Series. However, investors may be charged
a fee if they purchase shares through securi ties dealers, banks, or other
financial institutions. Investors opening a new account for the Money Market
Series must complete and submit a purchase application along with payment of the
purchase price for their initial investment. Investors purchasing additional
shares of the Money Market Series should include their account number along with
payment of the purchase price for additional shares being purchased. Investors
may re-open an account with a minimum investment of $100 and without filing a
purchase application during the year in which the account was closed or during
the following calendar year if the information on the original purchase
application is still applicable. The Money Market Series may require the filing
of a statement that all information on the original purchase application remains
applicable.
10
<PAGE>
(Left Column)
For customers of certain financial institutions who offer the service,
investors may have their "free-credit" cash balances automatically invested in
shares of the Money Market Series. These investments are not subject to the
minimum purchase requirements described above.
A purchase order becomes effective immediately on receipt by Firstar Trust
Company, as agent for the Money Market Series, if it is received before 4:00
P.M. on any business day. After a purchase order becomes effective, confirmation
of the purchase is sent to the investor, and the purchase is credited to the
investor's account. The Fund, or any series thereof, reserves the right to
reject any purchase order.
The Fundamental Automatic Investment Program offers a simple way to maintain
a regular investment program. The Fund has waived the initial investment minimum
for you when you open a new account and invest $100 or more per month through
the Fundamental Automatic Investment Program. The Fundamental Automatic
Investment Program allows you to purchase shares (minimum of $50 per
transaction) at regular intervals. Investments are made by transferring funds
directly from your checking, or bank money market account. At your option
investments can be made, once a month on either the fifth or the twentieth day,
or twice a month on both days.
To establish a Fundamental Automatic Investment Program, or to add this option
to your existing account simply complete an authorization form, which can be
obtained by calling 1-800-322-6864. You may cancel this privilege or change the
amount you invest at any time. Initial Program setup and any modifications may
take up to ten days to take effect. There is currently no charge for this
service, and the Fund may terminate or modify this privilege at any time.
Shares of the Money Market Series may be purchased only in states where the
shares are qualified for sale.
Methods of Payment
Payment of the purchase price for shares of the Money Market Series may be made
in any of the following manners.
(Right Column)
Payment by Wire. An expeditious method of purchasing shares involves
transmitting federal funds by bank wire to Firstar Trust Company. To purchase
shares by wire transfer, instruct a commercial bank to wire money to Firstar
Trust Company, ABA # , credit to: United States Trust Company of New York, A/C #
further credit to: Fundamental Family of Funds, a/c # . The wire transfer should
be accompanied by the investor's name, address, and social security number (in
the case of new investors) or account number (in the case of persons already
owning shares of that series).
Payment by Check. Shares may also be purchased by check. Checks should be made
payable to Fundamental Family of Funds and mailed to Fundamental Family of
Funds, c/o Firstar Trust Company, Agent, P.O. Box 701, Milwaukee, WI 53201-0701.
If your check does not clear, Firstar Trust Company will cancel your purchase
and charge you a $20 fee. Moreover, you could be liable for any losses incurred.
The Fund reserves the right to limit the number of checks processed at any one
time and will notify investors prior to exercising this right.
Exchange of Shares. Persons holding shares of any other series of the Fund or
any other mutual fund for which Fundamental Portfolio Advisors, Inc., the Fund's
investment adviser, acts as investment adviser may purchase shares of the Money
Market Series by exchanging shares of such other series or mutual fund. See
"General Information-Exchangeability of Shares."
Social Security Direct-Deposit Privilege. A person receiving social security
benefits may purchase shares by having some or all of his or her social security
check directly deposited into his or her account. For details about this
privilege, contact the Fund by calling (800) 322-6864.
Purchase Price and Net Asset Value
Each share of the Money Market Series is sold at its net asset value next
determined after a purchase order becomes effective. It is the intention of the
Money Market Series to maintain a per share net asset value of $1, although no
such net asset value can be guaranteed. The net asset value per share of the
Money
11
<PAGE>
(Left Column)
Market 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 Money Market Series is also determined on any other
day that 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 on which no
purchase orders for the shares of the Money Market Series become effective and
no shares are tendered for redemption, the net asset value per share will not be
determined. The net asset value per share of the Money Market Series is computed
by taking the amount of the value of all of its assets, less its liabilities,
and dividing it by the number of outstanding shares. For purposes of determining
net asset value, expenses of the Money Market Series are accrued daily and taken
into account.
The portfolio securities of the Money Market Series are valued on an amortized
cost basis. Under this valuation method, a portfolio instrument is valued at
cost and any premium or discount is amortized on a constant basis until
maturity. Other assets are valued at fair value as determined in good faith by
persons des ignated by the Fund's trustees using methods determined by the
trustees.
Distribution Expenses
The Fund has adopted a plan of distribution pursuant to Rule 12b-1 of the 1940
Act (the plan), under which the Money Market Series pays to Fundamental Service
Corporation (FSC) a fee, which is accrued daily and paid monthly, at an annual
rate of .50% of the Money Market Series' average daily net assets. Amounts paid
under the plan are paid to FSC to compensate it for services it provides and
expenses it bears in distributing the Money Market Series' shares to investors,
including payment of compensation by FSC to securities dealers and other
financial institutions and organizations, such as banks, trust companies,
savings and loan associations, and investment advisers to obtain various
distribution related and/or administrative services for the Money Market Series.
Expenses of FSC also include expenses of its
(Right Column)
employees, who engage in or support distribution of shares or service
shareholder accounts, including overhead and telephone expenses; printing and
distributing prospectuses and reports used in connection with the offering of
the Money Market Series' shares; and preparing, printing, and distributing sales
literature and advertising materials. FSC is an affiliate of the Manager. Fees
to FSC amounted to $245,844 to for the year ended December 31, 1997.
The Fund's Board of Trustees approved the continuance of the Fund's Plan for a
period of sixty days following the date of its expiration in contemplation of a
transaction pursuant to which Tocqueville Asset Management L.P. would assume
management of the assets of the Fund. Otherwise, the Plan would have expired on
April 1, 1998. See ("Management").
The Fund's Board of Trustees approved the continuance of the Fund's
Distribution Agreement for a period of sixty days following the date of its
expiration in contemplation of a transaction pursuant to which Tocqueville Asset
Management L.P. would assume management of the Fund. Otherwise, the Distribution
Agreement would have expired on April 1, 1998. See ("Management").
NASD Regulation, Inc. ("NASDR") entered into a Letter of Acceptance, Waiver
and Consent with FSC that imposed a total of $125,000 in fines and other
stipulated sanctions on FSC and two of its officers for distributing advertising
materials for Fundamental U.S. Government Strategic Income Fund that NASDR
deemed to be false and misleading. FSC neither admitted nor denied the
allegations and filed a Mitigation Statement in response to the Letter of
Acceptance, Waiver and Consent.
The Glass-Steagall Act prohibits banks from engaging in the business of
underwriting, selling, or distributing securities, such as shares of a mutual
fund. Although the scope of this prohibition under the Glass-Steagall Act has
not been fully defined, in FSC's opinion it should not prohibit banks from being
paid for performing shareholder-servicing functions under the plan. If, because
of changes in law or regulation or due to new interpretations of existing law, a
bank or
12
<PAGE>
(Left Column)
the Fund were prevented from continuing these arrangements, it is expected that
the Fund's trustees would make other arrangements for these services and
shareholders would not suffer adverse financial consequences.
At any given time, FSC may incur expenses in distributing shares of the Money
Market Series pursuant to the plan that would be in excess of the total of
payments made by the Money Market Series pursuant to the plan. For example, if
during a year of the plan FSC incurs $500,000 of expenses pursuant to the plan
on sales of $100 million of the Money Market Series and FSC receives a
distribution fee calculated at the annual rate of 0.50% of the Money Market
Series' average daily net assets (assuming $50 million in average daily net
assets), FSC would have incurred, at the end of such year, $250,000 in excess
expenses under the plan during such year. Because there is no requirement under
the plan to reimburse FSC for all its expenses or any requirement to continue
the plan from year to year, this excess amount does not constitute a liability
of the Money Market Series, and the Money Market Series will not reimburse FSC
for any such excess amount. Although payments under the plan by the Money Market
Series may not be directly used to finance distribution of shares of other
series of the Fund, under the plan and similar plans adopted by other series of
the Fund, FSC may pay for distribution expenses of any such series from any
source available to it, including any profits it may realize. Accordingly, it is
possible but not likely until the Money Market Series has at least $150,000,000
in net assets, that FSC may use profits it realizes from the Money Market Series
to finance another series of the Fund.
Redemptions
Each investor in the Money Market Series has the right to cause the Money Market
Series to redeem his or her shares, by making a request to Firstar Trust Company
in accordance with the procedures of either the regular redemption procedure,
the telephone redemption privilege, the expedited redemption privilege, or the
check redemption privilege, as described in the following paragraphs. If Firstar
Trust Company receives a redemption request before the close of trading on any
day the New York Stock Exchange is open
(Right Column)
for trading, the redemption will become effective on that day and be made at the
net asset value per share of the Money Market Series, as determined at the close
of trading on that day, and payment will be made on the following business day.
If Firstar Trust Company receives a redemption request following the close of
trading on the New York Stock Exchange, or on any day the New York Stock
Exchange is not open for business, the redemption will become effective on the
next day the New York Stock Exchange is open for trading and be made at the net
asset value per share of the Money Market Series, as determined at the close of
trading on that day, and payment will be made on the following business day.
Investors are entitled to receive all dividends on shares being redeemed that
are declared on or before the effective date of the redemption of such shares.
The net asset value per share of the Money Market Series received by an investor
on redeeming shares may be more or less than the purchase price per share paid
by such investor, depending on the market value of the portfolio of the Money
Market Series at the time of redemption.
Regular Redemption Procedure. Investors may redeem their shares by sending a
written redemption request to Firstar Trust Company, which request must specify
the number of shares to be redeemed and be signed by the investor of record. For
redemptions exceeding $50,000 (and for all written redemptions, regardless of
amount, made within 30 days following any change in account registration), the
signature of the investor on the redemption request must be guar anteed by an
eligible guarantor institution approved by Firstar Trust Company. Signature
guarantees in proper form generally will be accepted from domestic banks, a
member of a national securities exchange, credit unions and savings
associations, as well as from participants in the Securities Transfer Agents
Medallion Program ("STAMP"). If you have any questions with respect to signature
guarantees, please call the transfer agent at (800) 322-6864. Firstar Trust
Company may, at its option, request further documentation from corporations,
executors, administrators, trustees, or guardians. If a redemption request is
sent to the Money Market Series, the Money Market Series will forward it to
Firstar Trust Company. Redemption
13
<PAGE>
(Left Column)
requests will not become effective until all proper documents have been received
by Firstar Trust Company. Requests for redemption that are subject to any
special condition, or specify an effective date other than as provided herein,
cannot be accepted and will be returned to the investor.
Telephone Redemption Privilege. An investor may, by either completing the
appropriate section of the purchase application, or by later making a written
request to Firstar Trust Company, containing his or her signature guaranteed by
an eligible guarantor (see above), obtain the telephone redemption privilege for
any of his or her accounts. Provided that your account registration has not
changed within the last 30 days, an investor may redeem up to $150,000 worth of
shares from an account for which he or she has the telephone redemption
privilege by making a telephone redemption request to Firstar Trust Company, at
(800) 322-6864. Telephone calls may be recorded. A check for the proceeds of
such a redemption will be issued in the name of the investor of record and
mailed to the investor's address as it appears on the records of the Money
Market Series. Both the Money Market Series and Firstar Trust Company reserve
the right to refuse or limit a telephone redemption request and to modify the
telephone redemption privilege at any time.
Neither the Fund nor its transfer agent will be liable for following
instructions communicated by telephone that they reasonably believe to be
genuine. It is the Fund's policy to provide that a written confirmation
statement of all telephone call transactions will be mailed to shareholders at
their address of record within 3 business days after the telephone call
transaction. Since you will bear the risk of loss, you should verify the
accuracy of telephone transactions immediately upon receipt of your confirmation
statement.
Expedited Redemption Privilege. An investor in any series of the Fund may,
either by completing the appropriate section of the purchase application, or by
later making a written request to Firstar Trust Company, containing his or her
signature guaranteed by an eligible guarantor (see above), obtain the expedited
redemption privilege for any of his or her accounts. The expedited redemption
privilege allows the inves-
(Right Column)
tor to have the proceeds of any redemption of shares in any amount of $5000 or
more transferred by wiring federal funds to the commercial bank or savings and
loan institution specified in his or her purchase application or written request
for the expedited redemption privilege. Expedited redemption requests may be
made by either mail (to the address specified under regular redemption
procedure) or by telephone (to the number specified under telephone redemption
privilege). The proceeds of such a redemption may be subject to a deduction of
the usual and customary charge. Firstar Trust Company charges a $12 service fee
for each payment of redemption proceeds made by federal wire. This fee will be
deducted from your account. An investor may change the account or commercial
bank designated to receive the redemption proceeds by sending a written request
to Firstar Trust Company, containing his or her signature guaranteed in the
manner just described. Both the Money Market Series and Firstar Trust Company
reserve the right to refuse or limit an expedited redemption request and to
modify the expedited redemption privilege at any time.
Check Redemption Privilege. An investor in any series of the Fund may, by
either completing the appropriate section of the purchase application, or by
later making a written request to the Money Market Series, obtain redemption
checks for any of his or her accounts. These checks may be used by the investor
in any lawful manner and may be payable to the order of any person or company in
an amount of $100 or more. When a check is presented to Firstar Trust Company
for payment, Firstar Trust Company, as agent for the investor, will cause the
Money Market Series to redeem a sufficient number of shares in the investor's
account to cover the amount of the check. Investors using the check redemption
privilege will be subject to the same rules and regulations applicable to other
checking accounts at Firstar Trust Company. There is no charge to the investor
for using the check redemption privilege, except that a fee may be imposed by
Firstar Trust Company if an investor requests that it stop payment of a
Redemption Check or if it cannot honor a Redemption Check due to insufficient
funds or other valid reasons. The check
14
<PAGE>
(Left Column)
redemption privilege may not be used to close an account. The check redemption
privilege may be modified or terminated at any time by either the Money Market
Series or Firstar Trust Company.
At times, the Money Market Series may be requested to redeem shares for which
it has not yet received good payment. The Money Market Series may delay, or
cause to be delayed, payment of redemption proceeds until such time as it has
assured itself that good payment has been received for the purchase of such
shares, which may take up to 15 days. In the case of payment by check, the
determination of whether the check has been paid by the paying institu tion can
generally be made within 7 days, but may take longer. Investors may avoid the
possibility of any such delay by purchasing shares by wire. In the event of
delays in paying redemption proceeds, the Money Market Series will take all
available steps to expedite collection of the investment check.
If shares are purchased by check, you may write checks against such shares
only after 15 days from the date the purchase was executed. Shareholders who
draw against shares purchased fewer than 15 days from the date of original
purchase, will be charged usual and customary bank fees.
The Money Market Series reserves the right to suspend the right of redemption
or postpone the day of payment with respect to its shares (1) during any period
when the New York Stock Exchange is closed (other than customary weekend and
holiday closings); (2) during any period when trading markets that the Money
Market Series normally uses are restricted or an emergency exists as determined
by the Securities and Exchange Commission, so that disposal of the Money Market
Series' investments or determination of its net asset value is not reasonably
practicable; or (3) for such other periods as the Securities and Exchange
Commission by order may permit to protect investors.
If an investor's account has an aggregate net asset value of less than $100,
the Money Market Series may redeem the shares held in such account if the net
asset value of such account has not been increased to at least $100 within 60
days of notice by the Money Market Series to such investor of its intention to
redeem the
(Right Column)
shares in such account. The Money Market Series will not redeem the shares of an
account with a net asset value of less than $100 if the account was reduced from
the initial minimum investment of $1000 or more to below $100 as a result of
market activity.
Transfers
An investor may transfer shares of the Money Market Series by submitting to
Firstar Trust Company a written request for transfer, signed by the registered
holder of the shares and indicating the name of, the social security number or
taxpayer identification number of, and the distribution and redemption options
elected by, the new registered holder. Firstar Trust Company may, at its option,
request further documentation from transferors who are corporations, executors,
administrators, trustees, or guardians.
Dividends and Tax Matters
The Money Market Series will declare on each business day just prior to the
calculation of its net asset value all of its net investment income (consisting
of earned interest income less expenses) as a dividend on shares of record at
the close of business on the preceding business day. Dividends are distributed
on the last business day of each calendar month. The Money Market Series
normally distributes capital gains, if any, before the end of its fiscal year.
All dividends and capital gains distributions by the Money Market Series will be
in the form of additional shares unless the investor has made an election,
either on his or her purchase application or in a subsequent written request to
Firstar Trust Company, to receive such distributions in cash. An investor may
change his or her distribution election by filing a written request with Firstar
Trust Company at least four days prior to the date of a distribution.
The Money Market Series intends to qualify as a regulated investment company
by satisfying the requirements under Subchapter M of the Code, including
requirements with respect to diversification of assets, distribution of income
and sources of income. It is the Money Market Series' policy to distribute to
shareholders all of its investment income (net of
15
<PAGE>
(Left Column)
expenses) and any capital gains (net of capital losses) in accordance with the
timing requirements imposed by the Code, so that the Money Market Series will
satisfy the distribution requirement of Subchapter M and will not be subject to
federal income tax or the 4% excise tax.
If the Money Market Series fails to satisfy any of the Code requirements for
qualification as a regulated investment company, it will be taxed at regular
corporate tax rates on all its taxable income (including capital gains) without
any deduction for distributions to shareholders, and distributions to
shareholders will be taxable as ordinary dividends (even if derived from the
Money Market Series' net long-term capital gains) to the extent of the Money
Market Series' current and accumulated earnings and profits.
Distributions by the Money Market Series of its tax-exempt interest income
(net of expenses) are designated as exempt-interest dividends, which are
excludable from gross income for federal income tax purposes. However,
shareholders are required to report the receipt of exempt-interest dividends,
together with other tax-exempt interest, on their federal income tax returns. In
addition, these exempt-interest dividends may be subject to the federal
alternative minimum tax and will be taken into account in determining the
portion, if any, of Social Security benefits received which must be included in
gross income for federal income tax purposes. Further, interest or indebtedness
incurred or continued to purchase or carry shares of the Money Market Series
(which indebtedness likely need not be directly traceable to the purchase or
carrying of such shares) will not be deductible for federal income tax purposes.
Finally, a shareholder who is (or is related to) a "substantial user" of a
facility financed by industrial development bonds held by the Money Market
Series will likely be subject to tax on dividends paid by the Money Market
Series that are derived from interest on such bonds.
A small portion of the Money Market Series' net investment income may under
certain circumstances be taxable, and distributions thereof, as well as
distributions of any net capital gain will be taxable to shareholders.
Distributions by the Money Market Series of its taxable net investment income
and the
(Right Column)
excess, if any, of its net short-term capital gain over its net long-term
capital loss are taxable to shareholders as ordinary income. Such distributions
are treated as dividends for federal income tax purposes but do not qualify for
the 70% dividends-received deduction for corporate shareholders. Distributions
by the Money Market Series of the excess, if any, of its net long-term capital
gain over its net short-term capital loss are designated as capital gains
dividends and are taxable to shareholders as long-term capital gains, regardless
of the length of time shareholders have held their shares.
Tax-exempt interest on specified private activity bonds issued after August 7,
1986, is treated as a tax preference item for purposes of the Federal
alternative minimum tax ("AMT"). Thus, corporate and individual shareholders may
incur an AMT liability as a result of receiving exempt-interest dividends from
the Money Market Series to the extent such dividends are attributable to
interest from such private activity bonds. In addition, because all
exempt-interest dividends are included in a corporate shareholder's adjusted
current earnings (which is used in computing a separate preference item for
corporations), corporate shareholders may incur an AMT liability as a result of
receiving any exempt-interest dividends from the Money Market Series.
Distributions to shareholders will be treated in the same manner for federal
income tax purposes whether received in cash or reinvested in additional shares
of the Money Market Series. In general, distributions by the Money Market Series
are taken into account by the shareholders in the year in which they are made.
However, certain distributions made during January will be treated as having
been paid by the Money Market Series and received by the shareholders on
December 31 of the preceding year. The federal income tax status of all
distributions by the Money Market Series will be reported to investors annually.
Investors should carefully consider the tax implications of purchasing shares
just prior to the record date of any ordinary income dividend or capital gain
dividend. Those investors purchasing shares just prior to an ordinary income or
capital gain dividend will be taxed on the entire amount of the dividend
received, even though the net asset value per share on the date of
16
<PAGE>
(Left Column)
such purchase reflected the amount of such dividend and such dividend
economically constitutes a return of capital to such investors.
A shareholder will recognize gain or loss upon the sale or redemption of
shares of the Money Market 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. Any loss realized upon a taxable disposition of shares within six
months from the date of their purchase will be treated as a long-term capital
loss to the extent of any capital gain dividends received on such shares. All or
a portion of any loss realized upon a taxable disposition of shares of the Money
Market Series may be disallowed if other shares of the Money Market Series are
purchased within 30 days before or after such disposition.
If a shareholder is a non-resident alien or foreign entity shareholder,
ordinary income dividends paid to such shareholder generally will be subject to
United States withholding tax at a rate of 30% (or lower rate under an
applicable treaty). We urge non-United States shareholders to consult their own
tax adviser concerning the applicability of the United States withholding tax.
Under the backup withholding rules of the Code, certain shareholders may be
subject to 31% withholding of Federal income tax on ordinary income dividends
paid by the Money Market Series. In order to avoid this backup withholding, a
shareholder must provide the Money Market Series with a correct taxpayer
identification number (which for most individuals is his or her Social Security
number) or certify that it is a corporation or otherwise exempt from or not
subject to backup withholding.
The foregoing discussion offederal income tax consequences is based on tax
laws and regulations in effect on the date of this Prospectus, and is subject to
change by legislative, administrative or judicial action. As the foregoing
discussion is for general information only, a prospective shareholder should
also review the more detailed discussion of federal income tax considerations
relevant to the Money Market Series that is contained in the Statement of
Additional Information. In addition, each prospective
(Right Column)
shareholder should consult with his own tax adviser as to the tax consequences
of investments in the Money Market Series, including the application of state
and local taxes which may differ from the federal income tax consequences
described above.
General Information
Investor Services
Firstar Trust Company is the transfer agent and dividend-paying agent for shares
of the Money Market Series and The Chase Manhattan Bank, N.A. acts as custodian
for assets of the Money Market Series. Inquiries regarding the Money Market
Series should be addressed to Firstar Trust Company.
Firstar Trust Company maintains an account for each investor in the Money Market
Series, and all of the investor's transactions are recorded in this account.
Confirmation statements showing details of transactions are sent to investors
following each transaction, and each investor is sent a quarterly account
summary.
Annual and semi-annual reports of the Money Market Series together with the list
of securities held by the Money Market Series in its portfolio are mailed to
each investor in the Money Market Series.
Investors whose shares are held in the name of an investment broker-dealer or
other party will not normally have an account with the Money Market Series and
may not be able to use some of the services available to investors of record.
Calculation of Yield
The Money Market Series may from time to time advertise the Money Market Series'
yield and effective yield. The Money Market Series' yield refers to the income
generated by an investment in the Money Market Series over a seven-day period
(which period will be stated in the advertisement). This income is then
annualized; that is, the amount of income generated by the investment during the
seven-day period is assumed to be generated each week over a 52-week period and
is shown as a percentage of the investment. The effective yield is calculated
similarly, but when annualized, the income earned by an investment in the
17
<PAGE>
(Left Column)
Money Market Series is assumed to be reinvested. The effective yield will be
slightly higher than the yield because of the compounding effect of the assumed
reinvestment.
The Money Market Series may also from time to time advertise its taxable
equivalent yield and taxable equivalent effective yield. The Money Market
Series' taxable equivalent yield is determined by dividing that portion of the
Money Market Series' yield (calculated as just described) that is tax-exempt by
one minus a stated marginal federal income tax rate and adding the product to
that portion, if any, of the yield of the Money Market Series that is not
tax-exempt. The Money Market Series' taxable equivalent effective yield is
determined in a similar manner.
Both yield and effective yield quotations are based on historical earnings of
the Money Market Series. Both yields will fluctuate over time and are not
necessarily representative of future income or distributions or the actual
return to be earned by an investor, nor are they necessarily a sound basis for
comparing the Money Market Series with bank deposits or other fixed-income
investments.
Exchangeability of Shares
Investors may exchange shares of the Money Market Series having an aggregate net
asset value of $1000 or more for shares of any other series of the Fund or any
other mutual fund for which the Manager acts as theinvestment adviser by either
(1) delivering to Firstar Trust Company a written request specifying the number
of shares of the Money Market Series to be exchanged and the series of the Fund
or the mutual fund in which they wish to invest after such an exchange, or (2)
in the case of those investors who have the telephone redemption privilege,
making such a request by telephone. (See "Redemption-Telephone Redemption
Privilege" for a discussion of the Fund's policy with respect to losses
resulting from unauthorized telephone transactions). The exchange is effected by
redeeming the investor's shares of the Money Market Series and issuing to the
investor shares of the series or mutual fund in which he or she is investing.
The shares of both the Money Market Series and the series or mutual fund being
invested in are valued for purposes of this exchange at the net asset value per
share of the Money Market Series and
(Right Column)
such other series or fund, respectively, as next determined after receipt by
Firstar Trust Company of the exchange request.
The exchange privilege is available only in those states where such exchange
can legally be made and exchanges may only be made between accounts with
identical account registration and account numbers and is subject to the
suitability requirements, if any, of the series or fund for which an exchange is
proposed to be made. Prior to effecting an exchange, an investor should consider
the investment policies of the series or mutual fund he or she is investing in.
Any exchange is, in effect, a redemption of shares in one fund and a pur chase
of the other fund. Therefore, an investor may recognize a capital gain or loss
for federal income tax purposes on the exchange.
Other Information
The Code of Ethics of Fundamental Portfolio Advisors, Inc. and the Fund
prohibits all affiliated personnel from engaging in personal investment
activities which com- pete with or attempt to take advantage of the Fund's
planned portfolio transactions. Theobjective of the Code of Ethics of both the
Fund and Fundamental Portfolio Advisors, Inc. is that their operations be
carried out for the exclusive benefit of the Fund's shareholders. Both
organizations maintain careful monitoring of compliance with the Code of Ethics.
Independent Accountants
The financial statements included at the end of the Statement of Additional
Information, and the information under the caption "Financial Highlights" in
this Prospectus have been so included in reliance on the report of McGladrey &
Pullen, LLP, independent certified public accountants, as experts in accounting
and auditing.
Statement of Additional Information
The Statement of Additional Information for the Money Market Series, dated the
date of this Prospectus, contains more detailed information about the Money
Market Series, including information relating to (1) its investment policies and
restrictions, (2) its investment adviser and the trustees and officers of the
Fund, (3) portfolio trading, (4) various services provided for investors in the
Money Market Series, (5) the method used to calculate yield and effective yield
and (6) financial statements and certain other financial information.
18
<PAGE>
(LEFT COLUMN)
FUNDAMENTAL
FIXED INCOME FUND
90 Washington Street
New York NY 10006
1-800-225-6864
Transfer Agent
Firstar Trust Company
P.O. Box 701
Milwaukee, WI 53201-0701
1-800-322-6864
Counsel to the Fund
Kramer, Levin, Naftalis &Frankel
New York, New York
Independent Auditors
McGladrey &Pullen, LLP
New York, New York
No person has been authorized to give any
information or to make any representations other
than those contained in this Prospectus and in the
Fund's official sales literature in connection
with the offer of the Fund's shares, and, if given
or made, such other information or representations
must not be relied upon as having been authorized
by the Fund. This Prospectus does not constitute
an offer in any State in which, or to any person
to whom, such offering may not lawfully be made.
(RIGHT COLUMN)
FUNDAMENTAL
FIXED INCOME FUND
Tax-Free
Money Market Series
Prospectus
May 1, 1998
(logo) FUNDAMENTAL
Family of Funds
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
90 Washington Street
New York, New York 10006
STATEMENT OF ADDITIONAL INFORMATION
Dated: May 1, 1998
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, New York, New York 10006, or by calling 1 (800) 322-6864.
This Statement of Additional Information relates to the U.S. Government
Series' Prospectus dated May 1, 1998.
THIS STATEMENT OF ADDITIONAL INFORMATION IS NOT A PROSPECTUS AND IS
AUTHORIZED FOR DISTRIBUTION TO PROSPECTIVE
<PAGE>
INVESTORS ONLY IF PRECEDED OR ACCOMPANIED BY AN EFFECTIVE PROSPECTUS.
- 2 -
<PAGE>
TABLE OF CONTENTS
INVESTMENT OBJECTIVE AND POLICIES.......................................... 4
INVESTMENT LIMITATIONS................................................... 11
MANAGEMENT OF THE FUND................................................... 13
MARKETING PLAN........................................................... 15
INVESTMENT MANAGER....................................................... 17
PORTFOLIO TRANSACTIONS................................................... 18
CUSTODIAN, INDEPENDENT ACCOUNTANTS and COUNSEL........................... 20
TAXES.................................................................... 21
DESCRIPTION OF SHARES.................................................... 26
CERTAIN LIABILITIES...................................................... 27
DETERMINATION OF NET ASSET VALUE......................................... 28
PERFORMANCE INFORMATION.................................................. 28
OTHER INFORMATION........................................................ 30
FINANCIAL STATEMENTS..................................................... 31
- 3 -
<PAGE>
INVESTMENT OBJECTIVE AND POLICIES
The Prospectus of the U.S. Government Series dated May 1, 1998 (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 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
- 4 -
<PAGE>
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 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
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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 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
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<PAGE>
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 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
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<PAGE>
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. 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. 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'
- 8 -
<PAGE>
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, 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
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<PAGE>
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 OF 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 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.
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<PAGE>
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.
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.
- 11 -
<PAGE>
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.
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; (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
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<PAGE>
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: Director of the Fund. Mr. Armstrong is a management
consultant. He was formerly a partner in Armstrong/Seltzer Communications Inc.,
a New York management, consulting and public relations firm. Earlier he served
as Executive Director, Global Public Affairs Institute at New York University
and Professor, Bell of Pennsylvania Chair in Telecommunications, Temple
University. 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 70 North Ravenwood Drive,
Cape May Court House, New Jersey 08210.
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
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<PAGE>
President of LaSalle Economics Inc., an economic consulting firm. 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.
All of the Trustees of the Fund are also Directors of New York Muni
Fund, Inc. and Trustees of The California Muni Fund. Mr. Malanga, an officer of
the Fund , holds 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. Some Trustees
received additional compensation at a rate of $125 per hour for services related
to serving on the Portfolio Review Committee. For the fiscal year ended December
31, 1997, trustees' fees totalling $17,912 were paid by the Fund to the Trustees
as a group, $2,413 for the High-Yield Municipal Bond Series, $10,041 for the Tax
Free Money Market Series and $5,458 for the U.S. Government Series).
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<PAGE>
COMPENSATION TABLE
(FOR EACH CURRENT BOARD MEMBER
RECEIVING COMPENSATION FROM
A FUNDAMENTAL FUND FOR THE
MOST RECENTLY COMPLETED FISCAL YEAR)
AGGREGATE COMPENSATION FROM FUND
<TABLE>
<CAPTION>
AGGREGATE
COMPENSATION
PAID BY ALL
FUNDS MANAGED
BY
HIGH-YIELD TAX-FREE U.S. GOV'T FUNDAMENTAL
CALIFORNIA MUNICIPAL MONEY STRATEGIC PORTFOLIO
NAME NY MUNI MUNI BOND MARKET INCOME ADVISORS, INC.
<S> <C> <C> <C> <C> <C> <C>
JAMES C. ARMSTRONG $29,684 $3,044 $496 $2,919 $2,207 $38,350
L. GREG FERRONE $20,124 $2,064 $336 $1,979 $1,497 $26,000
</TABLE>
Administrator, Transfer Agent, Custodian and Accounting Agent
Firstar Trust Company, P.O. Box 701, Milwaukee, WI 53201-0701 currently
acts as Administrator, Transfer Agent, Custodian and Accounting Agent for the
U.S. Government Series.
Fundamental Shareholder Services, Inc., 90 Washington Street, New York,
New York 10006, an affiliate of Fundamental Portfolio Advisors, Inc. and
Fundamental Service Corporation, previously performed 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 . During the fiscal year ended December 31, 1997, fees paid to the
Transfer Agent by the U.S. Government Series amounted to $57,038.
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
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Agreement was last approved for continuance by the Board of Trustees of the Fund
on March 25, 1998 for a period of sixty days following March 31, 1998.
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 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 for a period of sixty days following
March 31, 1998. 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
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<PAGE>
(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, 1997, FSC waived all its fees in the
amount of $29,560.
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 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
As discussed in the Fund's Prospectus, the Fund has entered into an
agreement (the "Management Agreement") with Fundamental Portfolio Advisors, Inc.
(the "Manager"), 90 Washington Street, 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 has been renewed to continue
in effect for a period of sixty days following March 31, 1998. 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.
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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 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
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<PAGE>
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, 1997, 1996 and 1995 , the U.S.
Government Series' portfolio turnover rate was approximately 12.55%, 12.65% and
114.36%, respectively.
Beginning in March 1992, all of the Fund's transactions in futures
contracts and related options on behalf of its U.S. Government Series were
effected through Sierra Securities, Inc., a broker-dealer located at 190 South
LaSalle Street, Chicago, Illinois ("Sierra"). The total
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<PAGE>
amount of commissions paid to Sierra as introducing broker on such transactions
for the U.S. Government Series' account during the years 1992 through 1995 and
during January of 1996 was $134,429. The Manager has represented that during
such period, it believes that Mr. Donald Newell was a minority shareholder of
Sierra. As a result of Mr. Newell's business relationship with Mr. Malanga (see
discussion above), all of the futures and options transactions Sierra performed
on behalf of the U.S. Government Series may have been subject to certain
standards comparable to those set forth in Rule 17e-1 of the 1940 Act (the
"Rule"). On February 1, 1996, the Manager commenced using LAS as its introducing
broker for Fund transactions in futures contracts and related options in place
of Sierra. The total commissions paid to LAS as introducing broker during the
fiscal year ended December 31, 1996 were $1,535. At a meeting held on May 2,
1996, the Fund's Board of Trustees, including a majority of the independent
Trustees, adopted new standards and procedures for the U.S. Government Series
comparable to those set forth in the Rule for transactions in futures contracts
and related options through LAS, an affiliated broker-dealer. See above
discussion pertaining to LAS.
From January 1, 1990 to January 31, 1996, the Manager directed
syndicate designations in the aggregate dollar amount of $858,094 to Capital
Institutional Services, Inc. ("CIS") in connection with the Fundamental Funds'
bond purchases through underwriting syndicates. The Manager has represented that
CIS, a third-party research provider, at the Manager's direction, paid portions
of such syndicate designations to approximately 30 different firms that provided
research services used by the Manager in managing the Fundamental Funds,
including Capital Market Services, Inc. ("CMS"). Further, that CMS was paid by
CIS $115,000 for research provided to the Manager and used by it in managing the
U.S. Government Series and the other funds in the Fundamental complex. The
$115,000 dollar amount paid by CIS to CMS for the following fiscal years of the
U.S. Government Series was: $35,000 in 1995; $55,000 in 1994; and $25,000 in
1993. The Manager has also represented that it learned in 1996 that at all times
during years 1993, 1994 and 1995, CMS was 100% owned by Mr. Newell's wife. See
above for a discussion of Mr. Newell's business relationship with Mr. Malanga.
In order to remove any appearance of impropriety concerning all of the payments
made by CIS to CMS in return for research the Manager obtained from CMS, the
Manager reimbursed the Fund (the beneficiary of the research) $37,500 out of its
own resources.
CUSTODIAN, INDEPENDENT ACCOUNTANTS AND COUNSEL
First Trust Company (the "Bank"), 615 East Michigan Street, Milwaukee,
WI 53202 acts as Custodian of the Fund's cash and securities. The Bank also acts
as transfer agent and bookeeping agent for the Fund, and, as bookeeping agent,
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 & Frankel, 919 Third Avenue, New York, New
York, serves as counsel to the Fund.
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<PAGE>
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 for federal income tax purposes 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 will therefore count
toward satisfaction of the Distribution Requirement.
If the Fund has a net capital loss (i.e., the excess of capital losses
over capital gains) for any year, the amount thereof may be carried forward up
to eight years and treated as a short-term capital loss which can be used to
offset capital gains in such years. As of December 31, 1997, the Fund has
capital loss carryforwards of $15,791,100 expiring through December 31, 2005.
Under Code Section 382, if the Fund has an "ownership change," the Fund's use of
its capital loss carryforwards in any year following the ownership change will
be limited to an amount equal to the net asset value of the Fund immediately
prior to the ownership change multiplied by the highest adjusted long-term
tax-exempt rate (which is published monthly by the Internal Revenue Service (the
"IRS")) in effect for any month in the 3-calendar-month period ending with the
calendar month in which the ownership change occurs (the rate for April 1998 is
5.04%). The Fund will use its best efforts to avoid having an ownership change.
However, because of circumstances which may be beyond the control of the Fund,
there can be no assurance that the Fund will not have, or has not already had,
an ownership change. If the Fund has or has had an ownership change, any capital
gain net income for any year following the ownership change in excess of the
annual limitation on the capital loss carryforwards will have to be distributed
by the Fund and will be taxable to shareholders as described under "Fund
Distributions" below.
In addition to satisfying the Distribution Requirement, a regulated
investment company must 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
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<PAGE>
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").
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 another asset
so used, (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)
or (3) the asset is stock and the U.S. Government Series grants an in-the-money
qualified covered call option with respect thereto. 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.
Certain transactions that may be engaged in by the U.S. Government
Series (such as regulated futures contracts and options on 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.
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<PAGE>
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 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 each of 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 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.
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
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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 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 realized from a sale of the
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 realized but undistributed income or gain,
or unrealized appreciation in the value of the assets held by the U.S.
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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.
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 provided 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 redemption of shares, paid to any
shareholder (1) who has failed to provide a correct taxpayer identification
number , (2) who is subject to backup withholding for failure properly to report
the receipt of interest or dividend income , 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 an "exempt recipient" (such as a corporation).
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. Long-term capital gain recognized by an individual shareholder will be
taxed at the lowest rates applicable to capital gains if the holder has held
such shares for more than 18 months at the time of the sale. 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. 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.
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<PAGE>
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 the shareholder will be subject to U.S.
withholding tax at the rate of 30% (or lower applicable treaty rate) on 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 or redemption
of shares of the U.S. Government Series, capital gain dividends and amounts
retained by the U.S. Government Series that are designated 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 and capital gain dividends received in respect of, 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. taxpayers.
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 subject to
withholding 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 of Additional Information. 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 may 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 these and other state
and local tax rules affecting 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
- 26 -
<PAGE>
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 of a
series into a greater or lesser number of shares without thereby changing the
proportionate beneficial interests of each series. Each share of a series
represents an equal proportionate interest in the series with each other share
of such series. 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 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
- 27 -
<PAGE>
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)
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
- 28 -
<PAGE>
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 annualized 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, 1997, was ____%.
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
purporses, 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-recurringcharge 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.
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).
- 29 -
<PAGE>
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.
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, 1997, based on a
30-day period, was ____%.
OTHER INFORMATION
As of March 31, 1998 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.
- 30 -
<PAGE>
FINANCIAL STATEMENTS
Audited financial statements of the U.S. Government Series for the year
ended December 31, 1997 are attached hereto.
- 31 -
<PAGE>
(CHART MATERIAL)
New York Muni Fund
Portfolio Composition
December 31, 1997
(unaudited)
BY TYPE
(15.8%) FCSI
(51.4%) FCLT
(20.9%) LRIB
(11.9%) INLT
BY RATING+
(4.6%) Non-income
producing bonds
(1.3%) AA
(59.6%) AAA
(19.2%) BBB
(1.9%) Not Rated
FIXED COUPON BONDS
FCLT -- Long (maturity > 15 years) (includes long zero coupons)
FCSI -- Short or Intermediate (maturity < 15 years) (includes zero coupon
bonds)
VARIABLE RATE BONDS
RIB(Residual Interest Bond) type inverse floaters. These are leveraged bonds
whose coupon varies inversely with rates on short term companion issues. The
inverse floater's price will be more volatile than that of a fixed coupon bond.
LRIB -- Long Term (maturity > 15 years)
IN (Index) based inverse floaters are bonds whose interest coupons vary
inversely with an index of short term interest rates and then revert to a fixed
rate mode. The inverse floater's price will be more volatile than that of a
fixed coupon bond.
INLT -- Long Term (maturity > 15 years)
+If a security has a split rating, the highest applicable rating is used,
including published ratings on identical credits for individual securities not
individually rated.
2
<PAGE>
(CHART MATERIAL)
$22,786
Lehman
Brothers
Municipal
Bond Index*
$15,144
Fundamental
New York
Muni
Fund, Inc.
$13,926
Consumer
Price Index
- --------------------------------------------------------------------------------
New York Muni Fund
- --------------------------------------------------------------------------------
Average Annual Total Return
Ended on 12/31/97
- --------------------------------------------------------------------------------
1 Year 5 Year 10 Year
- --------------------------------------------------------------------------------
1.46% (0.62)% 4.24%
- --------------------------------------------------------------------------------
Thousands ($)
24 22 20 18 16 14 12 10
12/31/87 12/31/88 12/31/89 12/31/90 12/31/91 12/31/92 12/31/93 12/31/94
12/31/95 12/31/96 12/31/97
Past performance is not predictive of future performance.
The above illustration compares a $10,000 investment made in the New York Muni
Fund on 12/31/87 to a $10,000 investment made in the Lehman Brothers Municipal
Bond Index on that date. All dividends and capital gain distributions are
reinvested.
The Fund invests primarily in New York municipal securities and its performance
takes into account fees and expenses. Unlike the Fund, the Lehman Brothers
Municipal Bond Index is an unmanaged total return performance benchmark for the
long-term, investment-grade tax exempt bond market, calculated by using
municipal bonds selected to be representative of the market. The Index does not
take into account fees and expenses. Further information relating to Fund
performance, including expense reimbursements, if applic able, is contained in
the Fund's Prospectus and elsewhere in this report.
*Source:Lehman Brothers.
The Consumer Price Index is a commonly used measure of inflation; it does not
represent an investment return.
3
<PAGE>
(LEFT COLUMN)
NEW YORK MUNI FUND
STATEMENT OF ASSETS AND LIABILITIES
December 31, 1997
- --------------------------------------------------------------------------------
ASSETS
Investment in securities at value
(Note 4) (cost $127,411,133)..................... $122,737,274
Receivables:
Interest......................................... 1,484,267
Fund shares sold................................. 58,146,118
-----------
Total assets.............................. 182,367,659
-----------
LIABILITIES
Notes payable (Note 6)............................. 38,177,582
Payables:
Fund shares redeemed............................. 347,948
Investment securities purchased.................. 8,826,774
Dividend declared................................ 27,444
Due to advisor................................... 24,366
Accrued expenses................................. 368,138
-----------
Total liabilities................................. 47,772,252
-----------
NET ASSETS consisting of:
Distributions in excess of net
investment income................... $ (27,444)
Accumulated net realized loss ........ (24,284,760)
Unrealized depreciation of securities. (4,673,859)
Paid-in-capital applicable to
156,836,372 shares of $.01
par value capital stock............... 163,581,470
----------
$134,595,407
============
NET ASSET VALUE PER SHARE................ $.86
====
(RIGHT COLUMN)
STATEMENT OF OPERATIONS
Year ended December 31, 1997
- --------------------------------------------------------------------------------
INVESTMENT INCOME
Interest income............................... $ 7,756,494
EXPENSES (Notes 2 and 3)
Management fee............... $640,975
Custodian and accounting fees 327,214
Transfer agent fees.......... 450,401
Professional fees............ 1,050,450
Directors' fees.............. 102,427
Printing and postage......... 31,395
Interest..................... 1,431,511
Distribution expenses........ 647,839
Operating expenses on
defaulted bonds.............. 72,000
Other........................ 143,176
---------
4,897,388
Expenses reimbursed........ (40,700)
---------
Total expenses........................ 4,856,688
----------
Net investment income................. 2,899,806
----------
REALIZED AND UNREALIZED GAIN (LOSS)
ON INVESTMENTS
Net realized loss on investments (2,367,322)
Net unrealized appreciation of
investments.............. 5,608,133
---------
Net gain on investments ...................... 3,240,811
----------
NET INCREASE IN NET ASSETS
FROM OPERATIONS.................................. $6,140,617
==========
(FULL COLUMN)
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------
Year Ended Year Ended
December 31, December 31,
1997 1996
------------ ------------
<S> <C> <C>
INCREASE (DECREASE) IN NET ASSETS FROM
OPERATIONS
Net investment income...................................................... $ 2,899,806 $ 6,229,467
Net realized loss on investments........................................... (2,367,322) (2,404,362)
Unrealized appreciation (depreciation) on investments ..................... 5,608,133 (4,292,643)
----------- -----------
Net (decrease) increase in net assets from operations...................... 6,140,617 (467,538)
DISTRIBUTIONS:
Distributions from investment income....................................... (2,899,806) (6,229,467)
Distributions in excess of net investment income........................... (27,444) --
Return of capital distribution............................................. (551,666) --
Distributions from net realized gain from investments...................... (24,556) --
CAPITAL SHARE TRANSACTIONS (Note 5)........................................ (64,787,531) (23,248,833)
----------- -----------
Total decrease............................................................. (62,150,386) (29,945,838)
NET ASSETS:
Beginning of year.......................................................... 196,745,793 226,691,631
----------- -----------
End of year................................................................ $134,595,407 $196,745,793
=========== ===========
</TABLE>
See Notes to Financial Statements.
4
<PAGE>
NEW YORK MUNI FUND
STATEMENT OF CASH FLOWS
Year Ended December 31, 1997
<TABLE>
- ---------------------------------------------------------------------------------------------------------------------
<S> <C>
Increase (Decrease) in Cash
Cash Flows From Operating Activities
Net increase to net assets from operations .................................................. $ 6,140,617
Adjustments to reconcile net increase in net assets from operations
to net cash provided by operating activities:
Purchase of investment securities ......................................................... (1,574,433,817)
Proceeds on sale of securities ............................................................ 1,659,325,144
Decrease in interest receivable ........................................................... 2,324,155
Decrease in accrued expenses .............................................................. (391,142)
Net accretion of discount on securities ................................................... (111,800)
Net realized loss:
Investments ............................................................................. 2,367,322
Unrealized appreciation on securities .................................................... (5,608,133)
-------------
Net cash provided by operating activities ............................................. 89,612,346
-------------
Cash Flows From Financing Activities:*
Increase in notes payable ................................................................. 36,846,239
Proceeds on shares sold ................................................................... 2,222,770,042
Payment on shares repurchased ............................................................. (2,348,578,756)
Cash dividends paid ....................................................................... (649,871)
-------------
Net cash used in financing activities ................................................. (89,612,346)
-------------
Net decrease in cash .................................................................. 0
Cash at beginning of year ..................................................................... 0
-------------
Cash at end of year ........................................................................... $ 0
=============
<FN>
- --------------
*Non-cash financing activities not included herein consist of reinvestment of dividends of $3,233,013.
Cash payments for interest expense totaled $1,672,606.
</FN>
</TABLE>
See Notes to Financial Statements.
5
<PAGE>
NEW YORK MUNI FUND
STATEMENT OF INVESTMENTS
December 31, 1997
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------
Principal
Amount Issue ooo Type o Rating oo Value
-------- ----- ---- ----- -----
<C> <S> <C> <C> <C>
$ 1,000,000## Amherst NY Industrial Development Agency Lease Rev, SurfaceRink Complex,
LOC Keyhawk, 5.65%, 10/01/22............................................ FCLT A $ 1,015,360
1,000,000 Metropolitan Transit Authority NY Commuter Facilities Rev, Series C-1,
FGIC Insured 5.375%, 07/01/27........................................... FCLT AAA 1,011,120
300,000 Metropolitan Transit Authority NY Transportation Facilities Rev SVC Contract
Series 8 5.375%, 07/01/21............................................... FCLT A- 300,000
14,600,000x## New York Inverse Floating Rate Notes*...................................... INLT A- 14,618,104
500,000 New York NY Series B, 5.25%,0 8/01/15...................................... FCLT A- 495,445
5,290,000x## New York City, ECF, MBIA Insured, STEP** 3.75%, 04/01/08................... FCSI Aaa 5,402,042
5,925,000x## New York City, ECF, MBIA Insured, STEP** 3.75%, 10/01/08................... FCSI Aaa 6,046,463
2,200,000x## New York City, IDA, Imclone Systems Inc Project AMT 11.25%, 07/01/04....... FCSI NR 2,296,404
2,000,000 New York City, IDA, Brooklyn Navy Yard Cogen Partners AMT 5.75%, 10/01/36 . FCLT Baa3 2,017,800
6,700,000 New York City, MWFA, Water &Sewer Systems Rev Residual Int Tr Rcpts,
Series 29, FGIC Insured, 6.562%, 06/15/30............................... LRIB Aaa 6,497,258
1,030,000 New York City, IDA, Civic Facilities Rev, Anti-Defamation League Foundation
Ser A, MBIA Insured, 5.375%, 06/01/27.................................. FCLT Aaa 1,042,226
3,500,000## New York City, IDA, Special Facilities Rev, United Airlines Inc. Project,
AMT, 5.65%, 10/01/32.................................................... FCLT Baa3 3,538,605
4,970,000## New York State, DAR, City University Systems Series C 5.00%, 07/01/17 ..... FCLT Baa1 4,784,270
850,000 New York State, DAR, City University Series F, FGIC TCRS Insured,
5.00%, 07/01/20......................................................... FCLT Aaa 827,611
7,550,000## New York State, DAR, Court Facilities Lease Series A 5.25%, 05/15/21 ..... FCLT Baa1 7,419,838
1,000,000 New York State, DAR, Nursing Home FHA, Rosalind &Joseph Gurwin
Jewish Geriatric, AMBAC Insured 5.70%, 02/01/37......................... FCLT Aaa 1,023,890
1,650,000 New York State, DAR, St. Vincent DePaul Residence, LOC Allied Banks PLC,
5.30%, 07/01/18......................................................... FCLT Aa3 1,639,803
4,500,000## New York State, DAR, City University System Residual Int Tr Recpts 27,
MBIA Insured, Liquidity The Bank of New York, 8.22%, 07/01/24........... LRIB Aaa 4,949,055
13,460,000## New York State, DAR, City University System Residual Int Tr Recpts 28,
AMBAC Insured, Liquidity The Bank of New York, 7.63%, 07/01/25.......... LRIB Aaa 14,170,553
2,510,000 New York State, DAR, Vassar Brothers Hospital, FSA Insured 5.375%, 07/01/25 FCLT Aaa 2,525,462
5,000,000 New York State, DAR, Mental Health Services Facilities Improvement
Series D, FSA Insured, 5.125%, 08/15/27................................. FCLT AAA 4,909,950
7,500,000## New York State, DAR, FHA, St Barnabas Hospital AMBAC Insured
5.45%, 08/01/35......................................................... FCLT Aaa 7,565,700
750,000 New York State, DAR, FHA, Sara Neuman Nursing Home AMBAC Insured
5.45%, 08/01/27......................................................... FCLT Aaa 755,730
1,000,000 New York State, DAR, FHA, Sara Neuman Nursing Home AMBAC Insured
5.50%, 08/01/37......................................................... FCLT Aaa 1,009,340
42,000,000 New York State, DAR, FHA, Presbyterian Hospital Series A AMBAC Insured
0.00%, 08/15/36......................................................... FCLT Aaa 5,404,560
2,000,000 New York State, DAR, FHA, Highland Hospital Rochester Series A,
MBIA Insured, 5.45%, 08/01/37........................................... FCLT Aaa 2,008,680
1,000,000 New York State, EFC, Pollution Control Rev, Ref-St Wtr-Sub-Revolving Fund
Series E, MBIA Insd, 5.00%, 06/15/11.................................... FCLT Aaa 1,009,710
2,000,000 New York State, EFC, Pollution Control Rev, Ref-St Wtr-Sub-Revolving Fund
Series E, MBIA Insd, 5.00%, 06/15/12.................................... FCLT Aaa 2,016,160
</TABLE>
6
<PAGE>
NEW YORK MUNI FUND
STATEMENT OF INVESTMENTS (continued)
December 31, 1997
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------
Principal
Amount Issue ooo Type o Rating oo Value
-------- ----- ---- ----- -----
<C> <S> <C> <C> <C>
$ 4,040,000 New York State, HFA, Service Contract Obligation Rev Series C, 5.50%, 03/15/25. FCLT Baa1 $ 4,064,644
5,000,000## New York State, MCFFA, HFA, Rev, Presbyterian Hospital
MBIA-IBC Insured 5.375%, 02/15/25........................................... FCLT Aaa 5,045,500
9,805,000x# ## Niagara County NY, IDA Falls Street Faire Project AMT, 10.00% 09/01/06
(see Note 4 to Financial Statements)........................................ FCSI NR 3,509,700
5,870,000x# ## Niagara Falls NY, URA, Old Falls Street Improvement Project, 11.00% 05/01/09
(see Note 4 to Financial Statements).............................. ......... FCSI NR 2,101,167
1,760,000 Syracuse NY, IDA, Civic Facilities Rev, Crouse Health Hospital Project,
Series A 5.375%, 01/01/23................................................... FCLT BBB 1,715,124
------------
Total Investments (Cost $127,411,133 @)............................. $122,737,274
============
<FN>
* Inverse Floating Rate Notes (IFRN) are instruments whose interest rates bear an inverse relationship to the interest rate on
another security or value of an index. Rates shown are at December 31, 1997.
** Step Bonds (STEP) are instruments whose interest rate is fixed at an initial rate and then increases ("steps up") to another
fixed rate until maturity.
@ Cost for Federal income tax purposes is $127,989,424.
# The value of these non-income producing securities has been estimated by persons designated by the Fund's Board of Directors
using methods the Director's believe reflect fair value. See Note 4 to the financial statements.
## $82,462,761 market value of securities are segregated in whole or in part as collateral securing a line of credit.
x The Fund owns 100% of the security and therefore there is no trading in the security. See Note 4 to the financial
statements.
Legend
oType FCLT --Fixed Coupon Long Term
FCSI --Fixed Coupon Short or Intermediate Term
LRIB --Residual Interest Bond Long Term
INLT --Indexed Inverse Floating Rate Bond Long Term
ooRatings If a security has a split rating the highest applicable rating is used, including published ratings on identical
credits for individual securities not individually rated.
NR--Not Rated
ooolssue AMBAC American Municipal Bond Assurance Corporation
AMT Alternative Minimum Tax
CAB Capital Appreciation Bond
CFR Civic Facility Revenue
COP Certificates of Participation
DAR Dormitory Authority Revenue
ECF Educational Construction Fund
EFC Environmental Facilities Corp.
ETM Escrowed to Maturity
FGIC Financial Guaranty Insurance Corporation
FHA Federal Housing Administration
FSA Financial Security Association
GO General Obligation
HDA Housing Development Agency
HFA Housing Financing Agency
HIC Hospital Improvement Corporation
IDA Industrial Development Authority
ITEMECF Industrial, Tourist, Education, Medical and Environmental Control Facilities
LOC Letter of Credit
MBIA Municipal Bond Insurance Assurance Corporation
MCF Medical Care Facilities
MCFFA Medical Care Facilities Finance Agency
MTA Metropolitan Transit Authority
MWFA Municipal Water Finance Authority
NHRB Nursing Home Revenue Bond
RB Revenue Bond
RDA Research and Development Authority
SWMA Solid Waste Management Authority
URA Urban Renewal Authority
See Notes to Financial Statements.
</FN>
</TABLE>
7
<PAGE>
NEW YORK MUNI FUND
NOTES TO FINANCIAL STATEMENTS
December 31, 1997
- --------------------------------------------------------------------------------
1.Significant Accounting Policies
New York Muni Fund (the Fund) is a series of Fundamental Funds, Inc. (the
"Company"). The Company is an open-end management investment company registered
under the Investment Company Act of 1940. The Fund seeks to provide a high level
of income that is excluded from gross income for Federal income tax purposes and
exempt from New York State and New York City personal income taxes. The Fund
intends to achieve its objective by investing substantially all of its total
assets in municipal obligations of New York State, its political subdivisions
and its duly constituted authorities and corporations. The Fund employs leverage
in attempting to achieve this objective. The following is a summary of
significant accounting policies followed in the preparation of its financial
statements:
Valuation of Securities--The Fund's portfolio securities are valued on
the basis of prices provided by an independent pricing service when, in the
opinion of persons designated by the Fund's directors, such prices are
believed to reflect the fair market value of such securities. Prices of
non-exchange traded portfolio securities provided by independent pricing
services are generally determined without regard to bid or last sale prices
but take into account institutional size trading in similar groups of
securities, yield, quality, coupon rate, maturity, type of issue, trading
characteristics and other market data. Securities traded or dealt in upon a
securities exchange and not subject to restrictions against resale as well
as options and futures contracts listed for trading on a securities
exchange or board of trade are valued at the last quoted sales price, or,
in the absence of a sale, at the mean of the last bid and asked prices.
Options not listed for trading on a securities exchange or board of trade
for which over-the-counter market quotations are readily available are
valued at the mean of the current bid and asked prices. Money market and
short-term debt instruments with a remaining maturity of 60 days or less
will be valued on an amortized cost basis. Municipal daily or weekly
variable rate demand instruments will be priced at par value plus accrued
interest. Securities not priced in a manner described above and other
assets are valued by persons designated by the Fund's directors using
methods which the directors believe reflect fair value.
Futures Contracts and Options Written on Future 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.
Federal Income Taxes--It is the Fund's 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 Fund declares dividends daily from its net
investment income and pays such dividends on the last business day of each
month. Distributions of net capital gains, if any, realized on sales of
investments are made annually, as declared by the Fund's Board of
Directors. 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. Premiums and original issue
discount on securities purchased are amortized over the life of the
respective securities. Realized gains and losses from the sale of
securities are recorded on an identified cost basis. Net operating expenses
incurred on properties collateralizing defaulted bonds are charged to
operating expenses as incurred. Costs incurred to restructure defaulted
bonds are charged to realized loss as incurred.
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.
8
<PAGE>
NEW YORK MUNI FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
2.Investment Advisory Fees and Other Transactions with Affiliates
Management Agreement
Under a Management Agreement, the Fund pays an investment management fee to
Fundamental Portfolio Advisors, Inc. (the Manager) equal to 0.5% of the Fund's
average daily net asset value up to $100 million and decreasing by .02% of each
$100 million increase in net assets down to 0.4% of net assets in excess of $500
million. The Manager has voluntarily agreed to reimburse the Fund an amount not
exceeding the amount of fees payable to the Manager under the agreement for any
fiscal year, if, and to the extent that the aggregate operating expenses of the
Fund for any fiscal year including the fees payable to the Manager, but
excluding interest expenses, taxes, brokerage fees and commissions, expenses
paid pursuant to the Distribution Plan, and extraordinary expenses exceeds, on
an annual basis, 1.5% of the average daily net assets of the Fund. No such
reimbursement was required for the year ended December 31, 1997 due to the
expense limitation. See Note 8.
SEC Administrative Action Against Manager
On September 30, 1997, the Securities & Exchange Commission announced that
it instituted public administrative and cease-and desist proceedings against the
Manager, the former portfolio manager of the Fund, the president of the Manager
and Fundamental Service Corporation (FSC). The proceeding arises from the
alleged failure of an affiliated mutual fund to disclose the risks of the
affiliated fund, and of the Manager's failure to disclose its soft dollar
arrangements to the Fund's Board of Directors. A hearing has been scheduled with
an admninistrative law judge to determine whether the allegations are true, and,
if so, what remedial action, if any, is appropriate.
Board's Termination of Portfolio Manager
Between April 17, 1997 and July 24, 1997, a representative of the Manager
engaged Tocqueville Securities L.P. ("Tocqueville Securities"), an affiliate of
Tocqueville (see Note 7), as agent, to effect eight separate over-the-counter
purchase transactions of municipal obligations on behalf of the Fund. The Fund's
Board has concluded that the commissions paid to Tocqueville Securities in
connection with these transactions (a portion of which was paid to the
representative) were not justified and that the Fund bore unnecessary expenses
as a result of the sale of its securities to another party and the subsequent
repurchase of them through Tocqueville Securities. Based upon a report initiated
by Tocqueville Securities and prepared by the Fund's independent auditors, and
upon the Board's own analysis, the Board directed that the Manager terminate the
representative's services as a portfolio manager. At the Board's request and in
order to reimburse the affiliated fund for all of its losses, Tocqueville
Securities, on September 15, 1997, voluntarily paid $260,000 to the Fund, an
amount which significantly exceeds the total commissions ($184,920.60) received
by Tocqueville Securities in connection with these transactions. $219,300 of the
proceeds from the reimbursement have been included in the realized gain on
investments and $40,700 have been included as an expense reimbursement in the
accompanying financial statements. The staff of the Securities and Exchange
Commission and the Department of NASD Regulation have been informed of these
events by Tocqueville Securities. See Note 7 regarding contemplated transaction
with the Tocqueville Trust.
Distribution Plan and Service Agreement
Pursuant to a Distribution Plan (the Plan) adopted pursuant to Rule 12b-1
promulgated under the Investment Company Act of 1940, the Fund may pay certain
promotional and advertising expenses and may compensate certain registered
securities dealers and financial institutions for services provided in
connection with the processing of orders for purchase or redemption of the
Fund's shares and furnishing other shareholder services. Payments by the Fund
shall not in the aggregate, in any fiscal year, exceed 0.5% of the average daily
net assets of the Fund.
Under a Service Agreement with FSC, an affiliate of the Manager, amounts
are paid under the Plan to compensate FSC for the services it provides and the
expenses it bears in distributing the Fund's shares to investors. Any cumulative
distribution expenses related to the Fund incurred by FSC in excess of the
annual maximum amount payable by the Fund under the Plan may be carried forward
for three years in anticipation of reimbursement by the Fund on a "first
in-first out" basis. If the Plan is terminated or discontinued in accordance
with its terms, the obligation of the Fund to make payments to FSC will cease
and the Fund will not be required to make payments past the termination date.
Amounts paid to FSC pursuant to the agreement totaled $307,200 for the year
ended December 31, 1997.
NASD Sanctions and Fines
On February 19, 1998, FSC and two of its executives, without admitting or
denying guilt, entered into an agreement with the National Association of
Securities Dealers, Inc. ("NASD") whereby they accepted fines totaling $125,000
and other stipulated sanctions as a result of the NASD's finding that they had
distributed advertising materials of an affiliated mutual fund which violated
NASD rules governing advertisements.
9
<PAGE>
NEW YORK MUNI FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
The Fund compensated Fundamental Shareholder Services, Inc. (FSSI), an
affiliate of the Manager, for the services it provided under a Transfer Agent
and Service Agreement which was terminated September 11, 1997. Transfer agent
fees paid to FSSI for the year ended December 31, 1997 amounted to $260,717.
3.Directors' Fees
All of the Directors 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 Director 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. The Directors also received additional
compensation for special services as requested by the Board. Additional
compensation totaled $40,923 pro rated among the funds based on their respective
average net assets.
4.Complex Securities, Concentrations of Credit Risk, and Investment Transactions
Inverse Floating Rate Notes (IFRN):
The Fund invests in variable rate securities commonly called "inverse
floaters". The interest rates on these securities have an inverse relationship
to the interest rate of other securities or the value of an index. Changes in
interest rate on the other security or index inversely affect the rate paid on
the inverse floater, and the inverse floater's price will be more volatile than
that of a fixed-rate bond. Additionally, some of these securities contain a
"leverage factor"whereby the interest rate moves inversely by a "factor" to the
benchmark rate. For example, the rates on the inverse floating rate note may
move inversely at three times the benchmark rate. Certain interest rate
movements and other market factors can substantially affect the liquidity of
IFRN's.
Concentration of Credit Risk and Transactions in Defaulted Bonds:
The Fund owned 100% of two Niagara Falls Industrial Development Agency
bonds ("IDA Bonds") due to mature on September 1, 2006, and 98.3% of a Niagara
Falls New York Urban Renewal Agency 11% bond ("URA Bond") due to mature on May
1, 2009 which are in default. The IDA Bonds are secured by commercial retail and
office buildings known as the Falls Street Faire and Falls Street Station
Projects ("Projects"). The URA Bond is secured by certain rental payments from
the Projects.
The Fund, through its investment banker and manager, negotiated the sale of
the Falls Street Station project. The net proceeds received on the sale of
approximately $2,800,000 were accounted for as a pro rata recovery of principal
of each of the bonds. The remaining principal value of the Fall Street Station
IDA Bond of approximately $3,887,000 was charged to realized loss on
investments.
The remaining two securities are being valued under methods approved by the
Board of Directors. The aggregate value of these securities is $5,610,867 (35.8%
to their aggregate face value of $15,675,000). There is uncertainty as to the
timing of events and the subsequent ability of the Projects to generate cash
flows sufficient to provide repayment of the bonds. No interest income was
accrued on these bonds during the year ended December 31, 1997. Legal,
investment banking, and other restructuring costs charged to realized loss
totaled approximately $153,000 for the year ended December 31, 1997 ($1,640,000
cumulatively from October 6, 1992 to December 31, 1997). The Fund through its
investment banker, engaged a property manager to maintain the Projects on its
behalf, and the Fund is paying the net operating expenses of the Project. Net
operating expenses related to the Projects for the year ended December 31, 1997
are disclosed in the statement of operations, and cumulatively from October 6,
1992 to December 31, 1997 totaled approximately $684,629
Additionally, the Fund owns 100% of several securities as indicated in the
Statement of Investments. As a result of its ownership position there is no
active trading in these securities. Valuations of these securities are provided
by a pricing service and are believed by the Manager to reflect fair value. The
market value of securities owned 100% by the Fund was approximately $33,973,880
(25% of net assets) at December 31, 1997.
Other Investment Transactions:
During the year ended December 31, 1997, purchases and sales of investment
securities, other than short-term obligations, were $554,177,076 and
$647,162,806, respectively.
10
<PAGE>
NEW YORK MUNI FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
As of December 31, 1997 net unrealized depreciation of portfolio securities
on a federal income tax basis amounted to $5,252,150 composed of unrealized
appreciation of $4,320,774 and unrealized depreciation of $9,572,924.
The Fund has capital loss carryforwards available to offset future capital
gains as follows:
Amount Expiration
------ ----------
$18,503,000 December 31, 2002
3,430,000 December 31, 2004
2,214,000 December 31, 2005
-----------
$24,147,000
===========
5.Capital Stock
As of December 31, 1997 there were 500,000,000 shares of $.01 par value
capital stock authorized. Transactions in capital stock were as follows:
<TABLE>
<CAPTION>
Year Ended Year Ended
December 31, 1997 December 31, 1996
-------------------------- --------------------------
Shares Amount Shares Amount
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Shares sold......................... 2,692,167,470 $2,280,916,160 3,704,110,578 $3,314,430,819
Shares issued on reinvestment
of dividends........................ 3,788,810 3,223,013 5,501,544 4,939,206
Shares redeemed .................... (2,765,077,644) (2,348,926,704) (3,714,943,217) (3,342,618,858)
-------------- -------------- -------------- --------------
Net (decrease) ..................... (69,121,364) $ (64,787,531) (5,331,095) $ (23,248,833)
============== ============== ============== ==============
</TABLE>
6.Line of Credit
The Fund has line of credit agreements with banks collateralized by cash
and portfolio securities. Borrowings under these agreements bear interest linked
to the banks' prime rate. Pursuant to these agreements $38,177,582 was
outstanding at December 31, 1997.
The maximum month end and the average borrowings outstanding during the year
ended December 31, 1997 were $82,500,000 and $20,630,505, respectively.
7. Agreement and Plan of Reorganization
On July 15, 1997 each of Fundamental's mutual funds (consisting of: New
York Muni Fund, The California Muni Fund, Fundamental Fixed Income Fund: Tax
Free Money Market Series, High Yield Municipal Bond Series, and Fundamental U.S.
Government Strategic Income Fund Series) have adopted, subject to shareholder
approval, an Agreement and Plan of Reorganization (the "Plan") under which each
fund (the "Fundamental Fund") will transfer all of its assets and liabilities to
a newly-created corresponding series of The Tocqueville Trust (the "Tocqueville
Fund") in exchange for shares of the Tocqueville Fund. Shareholders of each
Fundamental Fund will receive shares of the corresponding Tocqueville Fund equal
in value to their shares in the Fundamental Fund. Shareholders will not have to
pay a sales load upon receiving shares of the Tocqueville Fund.
The corresponding Tocqueville Fund will have investment objectives, polices
and restrictions substantially identical to those of the Fundamental Fund. The
Board of Trustees of the Tocqueville Funds is comprised of individuals other
than those who currently serve as Directors (Trustees) of the Fundamental Funds.
Tocqueville Asset Management L.P. is the investment adviser to the Tocqueville
Funds.
A majority of Fundamental's Board Members determined that the Plan would be
in the best interests of shareholders of the Fundamental Funds and recommended
that shareholders of each of the Fundamental Funds approve the Plan at a meeting
anticipated to be held in the Spring of 1998.
8. Subsequent Event
At its March 25, 1998 Board of Directors' meeting, the Board of the Fund
approved the continuation of the Management Agreement through May 30, 1998 in
contemplation of the consummation of the reorganization discussed in Note 7.
11
<PAGE>
NEW YORK MUNI FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
The Manager and FSC (on behalf of certain of their directors, officers,
shareholders, employees and control persons) (the "Indemnitees") received
payment during the fiscal year ended December 31, 1997 from the Fund in the
amount of approximately $50,230. Upon learning of the payments, the independent
Board Members of the Funds directed that the Indemnitees return all of the
payments to the Funds or place them in escrow pending their receipt of an
opinion of an inedpendent legal counsel to the effect that the Indemnitees are
entitled to receive them. The Declaration of Trust, Articles of Incorporation
and contracts that call for indemnification specify that no indemnification
shall be provided to a person who shall be found to have engaged in "disabling
conduct" as defined by applicable law. The Indemnities have undertaken to
reimburse the Fund for any indemnification expenses for which it is determined
that they were not entitled to as a result of "disabling conduct" net of any
reimbursements already made to the Fund in the form of fees forgone or other
similar payments.
FSC waived fees in the amount of $51,200 in 1998. The Manager and FSC have
asserted that they elected to forgo these fees because the Fund was paying legal
expenses pursuant to indemnification. The Fund has retained independent legal
counsel to determine whether the Indemnitees engaged in disabling conduct.
Pending clarification of the legal issues involved, the Independent Directors
have instructed the Manager to escrow the full amount incurred by the Fund of
approximately $50,230.
9. Selected Financial Information
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE
(for a share outstanding throughout the year)
Net Asset Value, Beginning of Year ....................... $0.87 $0.98 $0.88 $1.18 $1.21
----- ----- ----- ----- -----
Income from investment operations:
Net investment income .................................... .021 .035 .035 .056 .065
Net realized and unrealized gains (losses)
on investments ........................................... (.009) (.110) .101 (.290) .082
---- ----- ----- ----- -----
Total from investment operations ......................... .012 (.075) .136 (.234) .147
----- ----- ----- ----- -----
Less Distributions:
Dividends from net investment income ..................... (.019) (.035) (.035) (.056) (.065)
Return of capital distributions........................... (.003) -- -- -- --
Dividends from net realized gains ........................ -- -- (.001) (.010) (.112)
----- ----- ----- ----- -----
Total distributions ...................................... (.022) (.035) (.036) (.066) (.177)
----- ----- ----- ----- -----
Net Asset Value, End of Year ............................. $0.86 $0.87 $0.98 $0.88 $1.18
===== ===== ===== ===== =====
Total Return ............................................. 1.46% (7.73%) 15.67% (20.47%) 12.58%
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (000) ............................ $134,595 $196,746 $226,692 $212,665 $275,552
Ratios to Average Net Assets:
Interest expense ......................................... 1.10% 2.11% 2.09% 1.59% .61%
Operating expenses ....................................... 2.64% 1.66% 1.55% 1.62% 1.44%
----- ----- ----- ----- -----
Total expenses ........................................... 3.74%+ 3.77% 3.64% 3.21% 2.05%
===== ===== ===== ===== =====
Net investment income .................................... 2.23%+ 3.89% 3.81% 5.34% 5.20%
Portfolio turnover rate .................................. 399.38% 347.44% 347.50% 289.69% 404.05%
</TABLE>
12
<PAGE>
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
BANK LOANS
Amount outstanding at end of year (000 omitted) .......... $38,178 $1,200 $64,575 $20,000 $20,873
Average amount of bank loans outstanding during the year
(000 omitted) ............................................ $20,631 $49,448 $49,603 $54,479 $24,100
Average number of shares outstanding during the year
(000 omitted) ............................................ 153,535 178,456 191,692 206,323 184,664
Average amount of debt per share during the year ......... $ .134 $ .277 $ .259 $ .264 $ .131
<FN>
+These ratios are after expense reimbursement of .03% for the year ended December 31, 1997.
</FN>
</TABLE>
13
<PAGE>
INDEPENDENT AUDITOR'S REPORT
- --------------------------------------------------------------------------------
The Board of Directors and Shareholders
New York Muni Fund
We have audited the accompanying statement of assets and liabilities, including
the statement of investments, of New York Muni Fund as of December 31, 1997, and
the related statements of operations and cash flows for the year then ended, the
statements of changes in net assets for each of the two years in the period then
ended, and selected financial information for each of the five years in the
period then ended. 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, 1997 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 New York Muni Fund as of December 31, 1997 and the results of its
operations, cash flows, changes in net assets, and selected financial
information for the periods indicated, in conformity with generally accepted
accounting principles.
See Notes 2 and 8 for information regarding regulatory proceedings and
transactions with affiliates.
S I G N A T U R E
New York, New York
March 2, 1998, except for Note 8 as to which the date is April 30, 1998.
14
<PAGE>
THE CALIFORNIA MUNI FUND
(LEFT COLUMN)
STATEMENT OF ASSETS AND LIABILITIES
December 31, 1997
- --------------------------------------------------------------------------------
ASSETS
Investment in securities
at value (cost $8,917,684) ................. $ 9,183,831
Interest receivable .......................... 252,201
Receivable for fund shares sold .............. 4,962,106
-----------
Total assets ..................... 14,398,138
-----------
LIABILITIES
Loans (Note 6) ............................... 503,018
Dividend Payable ............................. 10,223
Accrued expenses ............................. 52,893
-----------
Total liabilities ................ 566,134
-----------
NET ASSETS consisting of:
Accumulated net realized gain ... $ 220,789
Unrealized appreciation of
securities .................... 266,147
Paid-in-capital applicable to
1,672,917 shares of beneficial
interest (Note 4) ............. 13,345,068
---------- -----------
$13,832,004
===========
NET ASSET VALUE PER SHARE $8.27
=====
(RIGHT COLUMN)
STATEMENT OF OPERATIONS
Year Ended December 31, 1997
- --------------------------------------------------------------------------------
INVESTMENT INCOME
Interest income .................. $1,009,193
EXPENSES (Notes 2 and 3)
Management fee ................... $63,726
Custodian and accounting fees .... 60,460
Transfer agent fees .............. 38,033
Professional fees ................ 144,918
Printing and postage ............. 16,886
Interest ......................... 53,011
Distribution expenses ............ 44,731
Trustees' fees ................... 10,471
-------
Total expenses ...... 432,236
Less: Expenses reim-
bursed by manager . (3,296)
Net expenses ........ ------- 428,940
----------
Net investment income 580,253
----------
REALIZED AND UNREALIZED GAIN ON
INVESTMENTS
Net realized gain on investments . 493,308
Unrealized appreciation of
investments for the year ....... 374,518
----------
Net gain on investments 867,826
----------
NET INCREASE IN NET ASSETS FROM
OPERATIONS ......................... $1,448,079
==========
(FULL COLUMN)
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
Year Ended Year Ended
December 31, December 31,
1997 1996
------------ ------------
<S> <C> <C>
INCREASE (DECREASE) IN NET ASSETS FROM:
OPERATIONS
Net investment income ................................................ $ 580,253 $ 694,929
Net realized gain on investments ..................................... 493,308 100,733
Unrealized appreciation (depreciation) of investments for the year ... 374,518 (876,013)
----------- -----------
Net increase (decrease) in net assets from operations ............ 1,448,079 (80,351)
DIVIDENDS PAID TO SHAREHOLDERS FROM
Net investment income ................................................ (580,253) (694,929)
CAPITAL SHARE TRANSACTIONS (Note 4) .................................... (3,287,401) 4,404,527
----------- -----------
Total increase (decrease) .................................... (2,419,575) 3,629,247
NET ASSETS:
Beginning of year .................................................... 16,251,579 12,622,332
----------- -----------
End of year .......................................................... $13,832,004 $16,251,579
=========== ===========
</TABLE>
See Notes to Financial Statements.
18
<PAGE>
THE CALIFORNIA MUNI FUND
STATEMENT OF CASH FLOWS
Year Ended December 31, 1997
- --------------------------------------------------------------------------------
Increase (Decrease) in Cash
Cash Flows From Operating Activities
Net increase to net assets from operations ................... $ 1,448,079
Adjustments to reconcile net increase in net assets from
operations to net cash provided by operating activities:
Purchase of investment securities .......................... (128,371,610)
Proceeds on sale of securities ............................. 136,362,253
Increase in interest receivable ............................ (5,768)
Decrease in accrued expenses ............................... (81,857)
Net accretion of discount on securities .................... (135,229)
Net realized gain:
Investments .............................................. (493,308)
Unrealized appreciation on securities ........................ (374,518)
------------
Net cash provided by operating activities ............. 8,348,042
------------
Cash Flows From Financing Activities:*
Increase in notes payable .................................. 503,018
Proceeds on shares sold .................................... 251,745,912
Payment on shares repurchased .............................. (260,415,184)
Cash dividends paid ........................................ (195,278)
------------
Net cash used in financing activities ................. (8,361,532)
------------
Net decrease in cash .................................. (13,490)
Cash at beginning of year ...................................... 13,490
------------
Cash at end of year ............................................ $ 0
============
- -----------
*Non-cash financing activities not included herein consist of reinvestment of
dividends of $419,765.
Cash payments for interest expense totaled $57,087.
See Notes to Financial Statements.
19
<PAGE>
THE CALIFORNIA MUNI FUND
<TABLE>
<CAPTION>
STATEMENT OF INVESTMENTS
December 31, 1997
- ---------------------------------------------------------------------------------------------------------------------
Principal
Amount Issue ooo Type Rating Value
------ ----- ---- ------ -----
<C> <S> <C> <C> <C>
$ 100,000(DD) Arvin, Development Corporation, COP, RB, 8.75%, 9/01/18 ............. FCLT NR $ 24,505
200,000 Beverly Hills, PFA, RB, IFRN*, MBIA Insured, 7.32%, 6/01/15 ......... LRIB AAA 209,428
100,000 CSAC Finance Corp, COP, Sutter County Health Facilities Project,
7.80%, 1/01/21 .................................................... FCLT Baa1 102,158
70,000 California, HFA, Home Mortgage, RB, Series A, MBIA Insured,
5.70%, 8/01/10 .................................................... FCSI Aaa 74,163
300,000+ California Statewide Communities Development Authority, Cedars
Sinai Medical Project, COP, RB, IFRN*, 6.97%, 11/01/15 ............ LRIB A1 290,166
300,000 East Bay, Wastewater System Project, RB, Refunding, AMBAC
Insured, IFRN*, 6.87%, 6/01/20 .................................... LRIB AAA 312,108
220,000 Hawthorne, CRA, TAR, 6.75%, 9/01/24 ................................. FCLT Baa 240,933
170,000 Lake Elsinore, USD, Refunding, COP, 6.90%, 2/01/20 .................. FCLT BBB 187,299
10,000 Los Angeles, Home Mortgage, RB, 9.00%, 6/15/18 ...................... FCLT A 10,200
1,505,192 Los Angeles, HFA, MFH Project C, CAB, RB, 12.00%, 12/01/29 .......... FCLT NR 1,112,291
35,000 Modesto, Valley Oak Project, RB, 10.60%, 5/01/09 .................... FCSI NR 35,792
250,000 Northern California Power Agency, Multiple Capital Facilities, RB,
MBIA Insured, IFRN*, 8.76%, 8/01/25 ............................... LRIB AAA 293,040
250,000 Northern California Transmission Agency, CA-ORE Transmission
Project, RB, MBIA Insured, IFRN*, 6.81%, 4/29/24 .................. LRIB AAA 254,042
500,000 Orange County Airport, RB, Refunding, MBIA Insured, 5.625%,
7/01/12 ........................................................... FCLT Aaa 526,415
250,000+ Orange County, LTA, RB, IFRN*, 8.01%, 2/14/11 ....................... LRIB AA 297,597
250,000 Orange County, LTA, RB, IFRN*, 7.81%, 2/14/11 ....................... LRIB AAA 289,027
185,000 Panoche, Water District, COP, 7.50%, 12/01/08 ....................... FCSI BBB 199,776
250,000 Rancho, Water District Financing Authority, RB, Prerefunded @
104, AMBAC Insured, IFRN*, 8.82%, 8/17/21 ......................... LRIB AAA 301,443
250,000 Redding, Electric System, COP, Series A, FGIC Insured, IFRN*,
7.20%, 6/01/19 .................................................... LRIB AAA 264,078
175,000 Riverside, HFA, Riverside Apartment Project, RB, 7.87%, 11/01/19 .... FCLT BB- 178,896
500,000 San Bernardino, COP, Series B. MBIA Insured, IFRN*, 6.38%,
7/01/16 ........................................................... INLT AAA 531,045
900,000 San Bernardino, COP, Series PA38, MBIA Insured, IFRN*,
11.92%, 7/01/16, Rule 144A Security (restricted as to resale
except to qualified institutions) ................................. LRIB NR 1,021,995
200,000 San Diego Water Authority, COP, FGIC Insured, IFRN*, 7.09%,
4/22/09 ........................................................... LRIB AAA 240,624
1,440,000x San Jose, CRA, Series PA-38, TAB, MBIA Insured, IFRN*, 5.83%,
8/01/16, Rule 144A Security (restricted as to resale except to
qualified institutions) ........................................... LRIB AAA 1,471,306
</TABLE>
20
<PAGE>
THE CALIFORNIA MUNI FUND
<TABLE>
<CAPTION>
STATEMENT OF INVESTMENTS (continued)
December 31, 1997
- ---------------------------------------------------------------------------------------------------------------------
Principal
Amount Issue ooo Type Rating Value
------ ----- ---- ------ -----
<C> <S> <C> <C> <C>
$ 250,000 Southern California Public Power Authority, FGIC Isured, IFRN*,
6.62%, 7/01/17 .................................................... LRIB AAA $ 248,070
55,000 Tri City, HFA, FNMA/GNMA Collateralized, AMT, 6.45%, 12/01/28 ....... FCLT AAA 59,388
30,000 Tri City, HFA, FNMA/GNMA Collateralized, AMT, Series B, 6.30%,
12/01/28 .......................................................... FCLT AAA 32,358
250,000 Tri City, HFA, FNMA/GNMA Collateralized, AMT, Series E, 6.40%,
12/01/28 .......................................................... FCLT AAA 271,518
100,000 Upland, HFA, RB, 7.85%, 7/01/20 ..................................... FCLT BBB 104,170
-----------
Total Investments (Cost $8,917,684#) ........................ $ 9,183,831
===========
<FN>
*Inverse Floating Rate Notes (IFRN) are instruments whose interest rates bear an inverse relationship to the interest
rate on another security or the value of an index. Rates shown are at December 31, 1997.
#Cost is the same for Federal income tax purposes.
xThe Fund owns 100% of the security and therefore there is no trading in the security.
(DD)Denotes non-income producing security: Security is in default.
+Segregated, in whole or part, a collateral securing a line of credit.
</FN>
</TABLE>
Legend
(LEFT COLUMN)
oType FCLT -Fixed Coupon Long Term
FCSI -Fixed Coupon Short or Intermediate Term
LRIB -Residual Interest Bond Long Term
INLT -Indexed Inverse Floating Rate Bond Long Term
ooRatings If a security has a split rating the highest applicable
rating is used, including published ratings on identicial
credits for individual securities not individually rated.
Ratings are unaudited.
NR -Not Rated
oooIssue AMBAC American Municipal Bond Assurance Corporation
AMT Alternative Minimum Tax
CAB Capital Appreciation Bond
CGIC Capital Guaranty Insurance Company
(RIGHT COLUMN)
COP Certificate of Participation
CRA California Redevelopment Agency
FGIC Financial Guaranty Insurance Corporation
FNMA Federal National Mortgage Association
FSA Financial Security Assurance, Inc.
GNMA Government National Mortgage Association
HFA Housing Finance Authority
LTA Local Transportation Authority
MBIA Municipal Bond Insurance Assurance Corporation
MFH Multi Family Housing
PFA Public Financing Authority
RB Revenue Bond
TAB Tax Allocation Bond
TAR Tax Allocation Refunding
USD Unified School District
See Notes to Financial Statements.
21
<PAGE>
THE CALIFORNIA MUNI FUND
NOTES TO FINANCIAL STATEMENTS
December 31, 1997
- --------------------------------------------------------------------------------
(LEFT COLUMN)
1. Significant Accounting Policies
The California Muni Fund (the Fund) was organized as a Massachusetts
business trust and is registered as an open end management investment company
under the Investment Company Act of 1940. The Fund's objective is to provide as
high a level of income that is excluded from gross income for Federal income tax
purposes and exempt from California personal income tax as is consistent with
the preservation of capital. The Fund employs leverage in attempting to achieve
its objective. The following is a summary of significant accounting policies
followed in the preparation of its financial statements:
Valuation of Securities-The Fund's portfolio securities are valued on the
basis of prices provided by an independent pricing service when, in the opinion
of persons designated by the Fund's trustees, such prices are believed to
reflect the fair market value of such securities. Prices of non-exchange traded
portfolio securities provided by independent pricing services are generally
determined without regard to bid or last sale prices but take into account
institutional size trading in similar groups of securities, yield, quality,
coupon rate, maturity, type of issue, trading characteristics and other market
data. Securities traded or dealt in upon a securities exchange and not subject
to restrictions against resale as well as options and futures contracts listed
for trading on a securities exchange or board of trade are valued at the last
quoted sales price, or, in the absence of a sale, at the mean of the last bid
and asked prices. Options not listed for trading on a securities exchange or
board of trade for which over-the-counter market quotations are readily
available are valued at the mean of the current bid and asked prices. Money
market and short-term debt instruments with a remaining maturity of 60 days or
less will be valued on an amortized cost basis. Securities not priced in a
manner described above and other assets are valued by persons designated by the
Fund's trustees using methods which the trustees believe accurately reflects
fair value.
Federal Income Taxes-It is the Fund's 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.
(RIGHT COLUMN)
Distributions-The Fund declares dividends daily from its net investment
income and pays such dividends on the last business day of each month.
Distributions of net capital gains, if any, realized on sales of investments are
made annually, as declared by the Fund's 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. Premiums and original issue discount on
securities purchased are amortized over the life of the respective securities.
Realized gains and losses from the sale of securities are recorded on an
identified cost basis.
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.
2. Investment Advisory Fees and Other Transactions With Affiliates
Management Agreement
Under a Management Agreement, the Fund pays an investment management fee to
Fundamental Portfolio Advisors, Inc. (the Manager) equal to 0.5% of the Fund's
average daily net asset value up to $100 million and decreasing by .02% of each
$100 million increase in net assets down to 0.4% of net assets in excess of $500
million. See Note 8.
SEC Administrative Action Against the Manager
On September 30, 1997, the Securities & Exchange Commission announced that
it instituted public administrative and cease-and desist proceedings against the
Manager, the former portfolio manager of the Fund, the president of the Manager
and Fundamental Service Corporation (FSC). The proceeding arises from the
alleged failure of an affiliated mutual fund to disclose the risks of the
affiliated Fund, and of the Manager's failure to disclose its soft dollar
arrangements to the Fund's Board of Trustees. A hearing has been sched-
22
<PAGE>
THE CALIFORNIA MUNI FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
(LEFT COLUMN)
uled with an administrative law judge to determine whether the allegations are
true, and, if so, what remedial action, if any, is appropriate.
Board's Termination of Portfolio Manager
Between April 17, 1997 and July 24, 1997, a representative of the Manager
engaged Tocqueville Securities L.P. ("Tocqueville Securities"), an affiliate of
Tocqueville (see note 7), as agent, to effect eight separate over-the-counter
purchase transactions of municipal obligations on behalf of an affiliated fund.
The affiliated fund's Board has concluded that the commissions paid to
Tocqueville Securities in connection with these transactions (a portion of which
was paid to the representative) were not justified and that the affiliated fund
bore unnecessary expenses as a result of the sale of its securities to another
party and the subsequent repurchase of them through Tocqueville Securities.
Based upon a report initiated by Tocqueville Securities and prepared by the
Fund's independent auditors, and upon the Board's own analysis, the Board
directed that the Manager terminate its representative's services as a portfolio
manager. At the Board's request and in order to reimburse the affiliated fund
for all of its losses, Tocqueville Securities, on September 15, 1997,
voluntarily paid $260,000 to the affiliated fund, an amount which significantly
exceeds the total commissions ($184,920.60) received by Tocqueville Securities
in connection with these transactions. The staff of the Securities and Exchange
Commission and the Department of NASD Regulation have been informed of these
events by Tocqueville Securities. See Note 7 regarding contemplated transaction
with the Tocqueville Trust.
Distribution Plan and Service Agreement
Pursuant to a Distribution Plan (the Plan) adopted pursuant to Rule 12b-1,
promulgated under the Investment Company Act of 1940, the Fund may pay certain
promotional and advertising expenses and may compensate certain registered
securities dealers and financial institutions for services provided in
connection with the processing of orders for purchase or redemption of the
Fund's shares and furnishing other shareholder services. Payments by the Fund
shall not in the aggregate, in any fiscal year, exceed 0.5% of the average daily
net assets of the Fund.
(RIGHT COLUMN)
Under a Service Agreement with FSC, an affiliate of the Manager, amounts are
paid under the Plan to compensate FSC for the services it provides and the
expenses it bears in distributing the Fund's shares to investors. Distribution
fees for the year ended December 31, 1997 are set forth in the Statement of
Operations of which approximately $39,200 was paid by FSC.
NASD Sanctions and Fines
On February 19, 1998, FSC and two of its executives, without admitting or
denying guilt, entered into an agreement with the National Association of
Securities Dealers Inc. ("NASD") whereby they accepted fines totaling $125,000
and other stipulated sanctions as a result of the NASD's finding that they had
distributed advertising materials of an affiliated mutual fund which violated
NASD rules governing advertisements.
Affiliated Transfer Agent
The Fund compensated Fundamental Shareholder Services, Inc. (FSSI), an
affiliate of the Manager, for the services it provided under a Transfer Agent
and Service Agreement which terminated on September 11, 1997. Transfer agent
fees paid to FSSI for the year ended December 31, 1997 aggregated $28,066.
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. The Trustees also received additional
compensation for special services as requested by the Board. Additional
compensation totaled $40,923 pro rated among the funds based on their respective
average net assets.
4. Shares of Beneficial Interest
As of December 31, 1997 there were an unlimited number of shares of
beneficial interest (no par value) authorized and capital paid in amounted to
$13,345,068. Transactions in shares were as follows:
23
<PAGE>
THE CALIFORNIA MUNI FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
(LEFT COLUMN)
Year Ended Year Ended
December 31, 1997 December 31, 1996
----------------- -----------------
Shares Amount Shares Amount
------ ------ ------ ------
Shares sold 32,632,214 $256,708,018 29,177,580 $234,552,576
Shares issued
on
reinvest-
ment of
dividends 51,101 419,765 58,802 472,727
Shares
redeemed (33,097,092) (260,415,184) (28,566,533) (230,620,776)
----------- ------------ ----------- ------------
Net increase
(decrease) (413,777) (3,287,401) 669,849 $ 4,404,527
======== ========== ======= ============
5. Complex Securities and Investment
Transactions
Inverse Floating Rate Notes:
The Fund invests in variable rate securities commonly called "inverse
floaters". The interest rates on these securities have an inverse relationship
to the interest rate of other securities or the value of an index. Changes in
interest rate on the other security or index inversely affect the rate paid on
the inverse floater, and the inverse floater's price will be more volatile than
that of a fixed rate bond. Certain interest rate movements and other market
factors can substantially affect the liquidity of IFRN's.
Investment Transactions:
During the year ended December 31, 1997, the cost of purchases and proceeds
from sales of investment securities, other than short-term obligations, were
$9,050,450 and $13,516,911, respectively.
As of December 31, 1997 the net unrealized appreciation of portfolio
securities amounted to $266,147 composed of unrealized appreciation of $744,806
and unrealized depreciation of $478,659.
(RIGHT COLUMN)
6. Line of Credit
The Fund has a line of credit agreement with its custodian bank
collateralized by portfolio securities. Borrowings under this agreement bear
interest linked to the bank's prime rate. The maximum month end and the average
borrowings outstanding during the year ended December 1997, were $2,000,000 and
$664,000, respectively.
7. Agreement and Plan of Reorganization
On July 16, 1997 each of Fundamental's mutual funds (consisting of: New York
Muni Fund, The California Muni Fund, Fundamental Fixed Income Fund: Tax Free
Money Market Series, High Yield Municipal Bond Series, and Fundamental U.S.
Government Strategic Income Fund Series) have adopted, subject to shareholder
approval, an Agreement and Plan of Reorganization (the "Plan") under which each
fund (the "Fundamental Fund") will transfer all of its assets and liabilities to
a newly-created corresponding series of The Tocqueville Trust (the "Tocqueville
Fund") in exchange for shares of the Tocqueville Fund. Shareholders of each
Fundamental Fund will receive shares of the corresponding Tocqueville Fund equal
in value to their shares in the Fundamental Fund. Shareholders will not have to
pay a sales load upon receiving shares of the Tocqueville Fund.
The corresponding Tocqueville Fund will have investment objectives, polices
and restrictions substantially identical to those of the Fundamental Fund. The
Board of Trustees of the Tocqueville Funds is comprised of individuals other
than those who currently serve as Directors (Trustees) of the Fundamental Funds.
Tocqueville Asset Management L.P. is the investment adviser to the Tocqueville
Funds.
A majority of Fundamental's Board Members determined that the Plan would be
in the best interests of shareholders of the Fundamental Funds and recommended
that shareholders of each of the Fundamental Funds approve the Plan at a meeting
anticipated to be held in the Spring of 1998.
24
<PAGE>
THE CALIFORNIA MUNI FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
8. Subsequent Event
At its March 25, 1998 Board of Trustees' meeting, the Board of the Fund
approved the continuation of the Management Agreement through May 30, 1998 in
contemplation of the consummation of the reorganization discussed in Note 7.
The Manager and FSC (on behalf of certain of their directors, officers,
shareholders, employees and control persons) (the "Indemnitees") received
payment during the fiscal year ended December 31, 1997 from the Fund in the
amount of approximately $4,000. Upon learning of the payments, the independent
Board Members of the Funds directed that the Indemnitees return all of the
payments to the Funds or place them in escrow pending their receipt of an
opinion of an independent legal counsel to the effect that the Indemnitees are
entitled to receive them. The Declaration of Trust, Articles of Incorporation
and contracts that call for indemnification specify that no indemnification
shall be provided to a person who shall be found to have engaged in "disabling
conduct" as defined by applicable law. The Indemnities have undertaken to
reimburse the Fund for any indemnification expenses for which it is determined
that they were not entitled to as a result of "disabling conduct" net of any
reimbursements already made to the Fund in the form of fees forgone or other
similar payments. Pending clarification of the legal issues involved, the
Indemnitees have placed into an escrow account $4,000 as of April 30, 1998.
9. Selected Financial Information
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE
(for a share outstanding throughout the year)
Net Asset Value, Beginning of Year ......................... $ 7.79 $ 8.91 $ 7.10 $ 9.49 $ 8.81
------- ------- ------- ------- -------
Income from investment operations:
Net investment income ...................................... .376 .409 .419 .553 .563
Net realized and unrealized gains (losses)
on investments ........................................... .480 (1.120) 1.810 (2.390) .876
------- ------- ------- ------- -------
Total from investment operations .................... .856 (.711) 2.229 (1.837) 1.439
------- ------- ------- ------- -------
Less Distributions:
Dividends from net investment income ....................... (.376) (.409) (.419) (.553) (.563)
Dividends from net realized gains .......................... - - - - (.196)
------- ------- ------- ------- -------
Total distributions ........................................ (.376) (.409) (.419) (.553) (.759)
------- ------- ------- ------- -------
Net Asset Value, End of Year ............................... $ 8.27 $ 7.79 $ 8.91 $ 7.10 $ 9.49
======= ======= ======= ======= =======
Total Return ............................................... 11.33% (8.01%) 32.02% (19.89%) 16.80%
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (000) .............................. 13,832 16,252 12,622 10,558 16,280
Ratios to Average Net Assets:
Interest expense ......................................... .42 .45% .39% .98% .39%
Operating expenses ....................................... 2.95* 2.81% 2.81% 2.50% 1.77%*
------- ------- ------- ------- -------
Total expenses ...................................... 3.37* 3.26% 3.20% 3.48% 2.16%*
======= ======= ======= ======= =======
Net investment income ............................... 4.55%* 4.88% 5.02% 6.80% 6.04%*
Portfolio turnover rate .................................... 70.86% 89.83% 53.27% 15.88% 51.26%
BANK LOANS
Amount outstanding at end of year (000 omitted) ............ $ 275 $ 0 $ 0 $1,292 $3,714
Average amount of bank loans outstanding during the year
(000 omitted) ............................................ $ 664 $ 823 $ 642 $1,620 $ 958
Average number of shares outstanding during the year
(000 omitted) ............................................ 1,609 1,768 1,635 1,711 1,517
Average amount of debt per share during the year ........... $ .41 $ .47 $ .39 $ .95 $ .63
<FN>
*These ratios are after expense reimbursement of .03%, and .50% for the years ended December 31, 1997 and 1993.
</FN>
</TABLE>
25
<PAGE>
INDEPENDENT AUDITOR'S REPORT
The Board of Trustees and Shareholders
The California Muni Fund
We have audited the accompanying statement of assets and liabilities
including the statement of investments of The California Muni Fund as of
December 31, 1997 and the related statements of operations and cash flows for
the year then ended, statements of changes in net assets for each of the two
years in the period then ended, and the selected financial information for each
of the five years in the period then ended. 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, 1997 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 California Muni Fund as of December 31, 1997, the results of its
operations, cash flows, changes in its net assets, and selected financial
information for the periods indicated, in conformity with generally accepted
accounting principles.
See Notes 2 and 8 for information regarding regulatory proceedings and
transactions with affiliates.
S I G N A T U R E
New York, New York
March 2, 1998, except for Note 8 as to which the date is April 30, 1998.
26
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
TAX-FREE MONEY MARKET SERIES
(LEFT COLUMN)
STATEMENT OF ASSETS AND LIABILITIES
December 31, 1997
- --------------------------------------------------------------------------------
ASSETS
Cash ............................................ $ 1,776,944
Investment in securities at value
(cost $75,869,410) ............................ 75,869,410
Receivables:
Fund shares sold .............................. 135,853
Interest ...................................... 270,975
-----------
Total assets .......................... 78,053,182
-----------
LIABILITIES
Payables:
Investment securities purchased ............... 1,103,151
Fund shares redeemed .......................... 63,627,947
Dividends ..................................... 9,321
Due to advisor ................................ 10,866
Accrued expenses ................................ 38,729
-----------
Total liabilities ..................... 64,790,014
-----------
NET ASSETS equivalent to $1.00 per share on
13,270,069 shares of beneficial interest
outstanding (Note 4) ............................. $13,263,168
===========
(RIGHT COLUMN)
STATEMENT OF OPERATIONS
Year Ended December 31, 1997
- --------------------------------------------------------------------------------
INVESTMENT INCOME
Interest income ................... $1,729,572
EXPENSES (Notes 2 and 3)
Investment advisory fees ..........$245,844
Custodian and accounting fees ..... 41,002
Transfer agent fees ............... 84,687
Trustees' fees .................... 10,041
Professional fees ................. 88,996
Distribution fees ................. 245,844
Postage and printing .............. 22,506
Other ............................. 12,291
--------
Total expenses .......... 751,211
Less:
Expenses paid indirectly (Note 6) . (41,002)
Expenses reimbursed by Manager .... (5,982)
--------
Net expenses ............ 704,227
----------
NET INCREASE IN NET ASSETS FROM
OPERATIONS $1,025,345
----------
(FULL COLUMN)
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
Year Ended Year Ended
December 31, December 31,
1997 1996
------------ ------------
INCREASE (DECREASE) IN NET ASSETS FROM:
OPERATIONS
Net investment income .......................... $ 1,025,345 $ 1,161,235
----------- -----------
Net increase in net assets from operations. 1,025,345 1,161,235
DIVIDENDS PAID TO SHAREHOLDERS FROM
Investment income .............................. (1,025,345) (1,161,235)
CAPITAL SHARE TRANSACTIONS (Note 4) .............. 8,642,404 (6,629,783)
----------- -----------
Total (decrease) increase ................. 8,642,404 (6,629,783)
NET ASSETS
Beginning of year .............................. 4,620,764 11,250,547
----------- -----------
End of year .................................... $13,263,168 $ 4,620,764
=========== ===========
See Notes to Financial Statements.
27
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
TAX-FREE MONEY MARKET SERIES
<TABLE>
<CAPTION>
STATEMENT OF INVESTMENTS
December 31, 1997
- ------------------------------------------------------------------------------------------------------------
Principal
Amount Issue o Value
------ ----- -----
<C> <S> <C>
$2,700,000 Ascension Parish, LA, PCR, BASF Wyandote Corp, LOC Bank of Tokyo,
VRDN*, 5.10%, 12/01/15 ..................................................... $2,700,000
1,500,000 Burke County, GA, Development Authority, VRDN*, PCR, Georgia Power Co.
Vogtle Project 5th Series, 5.00%, 7/01/24 .................................. 1,500,000
4,000,000 Burke County, GA, Development Authority, VRDN*, PCR, Georgia Power Co.
Vogtle Project 4th Series, 5.00%, 9/01/25 .................................. 4,000,000
2,800,000 Columbia AL, IDB, PCR Alabama Power Co. Project, VRDN*, Series D, 5.00%,
10/01/22 ................................................................... 2,800,000
75,000 Cuyahoga County, OH, IDR, S & R Playhouse Realty, VRDN*, LOC Marine
Midland Bank, 3.85%, 12/01/09 .............................................. 75,000
200,000 Delaware County, PA, SWDF, Scott Paper Project, Kimberly-Clark Corp
Guaranty, VRDN*, 3.65%, 12/01/18 ............................................ 200,000
200,000 Fulton County, GA, PCR, General Motors Project, VRDN*, 3.90%, 4/01/10 ........ 200,000
200,000 Garfield County, OK, PCR, Oklahoma Gas & Electric Co. Project A, VRDN*,
3.75%, 1/01/25 ............................................................. 200,000
125,000 Genesee County, NY, IDR, Orcon Industries, AMT, LOC Fleet Bank, VRDN*,
4.50%,12/01/98 ............................................................. 125,000
300,000 Illinois Educational Facility Authority, RB, Art Institute of Chicago, Northern
Trust Liquidity, VRDN*, 3.85%, 3/01/27 ..................................... 300,000
300,000 Illinois HFAR, Franciscan Sisters Project, LOC Toronto Dominion Bank,
VRDN*, 3.65%, 9/01/15 ...................................................... 300,000
2,000,000 Illinois HFAR, Healthcorp Affiliates Project, LOC Raborbank Nederland,
VRDN*, 4.05%, 11/01/20 ..................................................... 2,000,000
2,855,000 Jackson County, Miss., PCR, Chevron Corp. Project, VRDN*, 5.00%,
12/01/16 ................................................................... 2,855,000
3,700,000 Los Angeles, CA, Regional Airports Improvement Corp, LOC Societe
Generale, VRDN*, 5.00%, 12/01/25 ........................................... 3,700,000
200,000 McIntosh, AL, PCR, Ciba Geigy Project, LOC Swiss Bank Corp. VRDN*,
3.65%, 12/01/03 ............................................................ 200,000
5,000,000 Midland County, MI, Economic Development Corp, Dow Chemical Project B,
AMT, VRDN*, 5.00%, 12/01/15 ................................................ 5,000,000
300,000 Missouri, PCR, Monsanto Project, VRDN*, 3.70%, 2/01/09 ....................... 300,000
200,000 Missouri, Third Street Building Project, SPA First Chicago, VRDN*, 3.90%,
8/01/99 .................................................................... 200,000
300,000 Montgomery, AL, Baptist Medical Center, Special Care Facilities Financing
Authority, Series H, AMBAC Insured, VRDN*, 3.70%, 12/01/30 ................. 300,000
200,000 Nebraska Higher Education Loan Program, SPA, SLMA, MBIA Insured,
VRDN*, 3.65%, 12/01/15 ..................................................... 200,000
</TABLE>
28
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
TAX-FREE MONEY MARKET SERIES
<TABLE>
<CAPTION>
STATEMENT OF INVESTMENTS (continued)
December 31, 1997
- ------------------------------------------------------------------------------------------------------------
Principal
Amount Issue o Value
------ ----- -----
<C> <S> <C>
$ 5,100,000 New York City, NY, GO, LOC Chase Manhattan Bank, VRDN*, 5.00%, 8/01/23 ...... $5,100,000
2,500,000 New York City, NY, GO, Landesbank Hessen Liquidity, VRDN*, 3.60%, 2/15/20 ... 2,500,000
4,000,000 New York City, NY, Municipal Water Finance Authority, Water & Sewer System
RB, TR Receipts Series 29, The Bank of New York Liquidity, VRDN*,
3.90%, 6/15/30 ............................................................ 4,000,000
40,000 New York City, NY, New PHA, 3.38%, 01/01/98 ................................. 39,740
10,700,000x New York State, DAR, TRS 27, 3.95%, 7/01/24, City University, Floating Rate
Trust Receipts 27, MBIA Insured, Liquidity The Bank of New York ........... 10,700,000
3,000,000 New York State Energy Research & Development Authority, PCR, New York,
State Electric & Gas Co., Series D, LOC Union Bank of Switzerland,
VRDN*, 5.00%, 10/01/29 .................................................... 3,000,000
2,100,000 New York State, Job Development Authority, St. Gtd., Special Purpose Series
A-1 thru A-25, LOC Sumitomo Bank, VRDN*, 5.25%, 3/01/07 ................... 2,100,000
5,200,000 Newport Beach CA, RB, Hoag Memorial Hospital Series B, SPA Bank of
America, 5.00%, 10/01/06 .................................................. 5,200,000
50,000 North Little Rock, AR, New PHA, FGIC Insured, 3.25%, 6/01/98 ................ 49,670
1,100,000 Orange County, CA, Water District Project B, COP, LOC National
Westminister VRDN*, 4.85%, 8/15/15 ........................................ 1,100,000
4,000,000 Princeton, IN, PCR, PSI Energy, Inc., Proj., LOC Morgan Guaranty, VRDN*,
5.10%, 4/01/22 ............................................................ 4,000,000
125,000 Scioto County, OH, HFR, VHA, Central Capital Project, AMBAC Insured,
VRDN*, 3.70%, 12/01/25 .................................................... 125,000
4,500,000 Sweetwater County, WY, PCR, Idaho Power Co. Project Series C, VRDN*,
5.10%, 7/15/26 ............................................................ 4,500,000
1,600,000 Uinta County, WY, PCR, Chevron Corp Project, VRDN*, 5.00%, 8/15/20 .......... 1,600,000
4,500,000 Valdez, AK, Marine Term Revenue, Exxon Pipeline Co. Project A, VRDN*,
5.00%, 12/01/33 ........................................................... 4,500,000
200,000 Wake County, NC, PCR, Carolina Power & Light Project, LOC Sumitomo
Bank, VRDN*, 4.15%, 10/01/15 .............................................. 200,000
-----------
Total Investments (Cost $75,869,410) ........................................ $75,869,410
===========
<FN>
*Variable Rate Demand Notes (VRDN) are instruments whose interest rate changes on a specific date and/or
whose interest rates vary with changes in a designated base rate.
**Cost is the same for Federal income tax purposes.
xThe Fund owns 100% of the security and therefore there is no trading in the security.
</FN>
</TABLE>
29
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
TAX-FREE MONEY MARKET SERIES
STATEMENT OF INVESTMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
Legend
Issue AMBAC American Municipal Bond Assurance Corporation
DAR Dormitory Authority Revenue
AMT Alternative Minimum Tax
GO General Obligation
ETM Escrowed to Maturity
HFAR Health Facilities Authority Revenue
HFR Hospital Facilities Revenue
IDB Industrial Development Board
IDR Industrial Development Revenue
LOC Letter of Credit
MBIA Municipal Bond Insurance Assurance Corporation
PCR Pollution Control Revenue
PHA Public Housing Authority
RB Revenue Bond
SLMA Student Loan Marketing Association
SPA Stand By Bond Purchase Agreement
SWDF Solid Waste Disposal Facility
TRANS Tax Revenue Anticipation Notes
TRS Trust Receipt Series
See Notes to Financial Statements.
30
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
TAX-FREE MONEY MARKET SERIES
NOTES TO FINANCIAL STATEMENTS
December 31, 1997
- --------------------------------------------------------------------------------
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
acts 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 Fundamental U.S. Government Strategic Income Fund Series. Each series is
considered a separate entity for financial reporting and tax purposes. The
Tax-Free Money Market Series (the Series) investment objective is to provide as
high a level of current income exempt from federal income tax as is consistent
with the preservaton of capital and liquidity. The following is a summary of
significant accounting policies followed in the preparation of the Series'
financial statements:
Valuation of Securities:
Investments are stated at amortized cost. Under this valuation method, a
portfolio instrument is valued at cost and any premium or discount is amortized
on a constant basis to the maturity of the instrument. Amortization of premium
is charged to income, and accretion of market discount is credited to unrealized
gains. The maturity of investments is deemed to be the longer of the period
required before the Fund is entitled to receive payment of the principal amount
or the period remaining until the next interest adjustment.
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 of net
capital gains are made annually, as declared by the Fund's 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 gains and losses from the sale of
securities are recorded on an identified cost basis.
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.
31
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
TAX-FREE MONEY MARKET SERIES
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
2. Investment Advisory Fees and Other Transactions with Affiliates
Management Agreement
The Fund has a Management Agreement with Fundamental Portfolio Advisors,
Inc. (the Manager). Pursuant to the agreement, the Manager serves as investment
adviser to the Tax-Free Money Market 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 consideration for the services
provided by the Manager, the Series will pay an annual management fee in an
amount equal to 0.5% of the Series' average daily net assets up to $100 million
and decreasing by .02% for each $100 million increase in net assets down to 0.4%
of net assets in excess of $500 million. See Note 8.
SEC Administrative Proceeding Against the Manager
On September 30, 1997, the Securities & Exchange Commission announced that
it instituted public administrative and cease-and desist proceedings against the
Manager, the former portfolio manager of the Fund, the president of the Manager
and Fundamental Service Corporation (FSC), the Fund's Distributor. The
proceeding arises from the alleged failure of an affiliated mutual fund to
disclose the risks of the affiliated series, and of the Manager's failure to
disclose its soft dollar arrangements to the Fund's Board of Trustees. A hearing
has been scheduled with an administrative law judge to determine whether the
allegations are true, and, if so, what remedial action, if any, is appropriate.
Board's Termination of Portfolio Manager
Between April 17, 1997 and July 24, 1997, a representative of the Manager
engaged Tocqueville Securities L.P. ("Tocqueville Securities") an affiliate of
Tocqueville, as agent, to effect eight separate over-the-counter purchase
transactions of municipal obligations on behalf of an affiliated fund. The
Fund's Board has concluded that the commissions paid to Tocqueville Securities
in connection with these transactions (a portion of which was paid to the
representative) were not justified and that the affiliated fund bore unnecessary
expenses as a result of the sale of its securities to another party and the
subsequent repurchase of them through Tocqueville Securities. Based upon a
report initiated by Tocqueville Securities and prepared by the Fund's
independent auditors, and upon the Board's own analysis, the Board directed that
the Manager terminate the representative's services as a portfolio manager. At
the Board's request and in order to reimburse the affiliated fund for all of its
losses, Tocqueville Securities, on September 15, 1997, voluntarily paid $260,000
to the affiliated fund, an amount which significantly exceeds the total
commissions ($184,920.60) received by Tocqueville Securities in connection with
these transactions. The staff of the Securities and Exchange Commission and the
Department of NASD Regulation have been informed of these events by Tocqueville
Securities. See Note 7 regarding contemplated transaction with the Tocqueville
Trust.
Plan of Distribution
The Fund has adopted a Plan of Distribution, pursuant to Rule 12b-1
promulgated under the Investment Company Act of 1940, under which the Series
pays to FSC, an affiliate of the Manager, a fee, which is accrued daily and paid
monthly, at an annual rate of 0.5% of the Series' average daily net assets. The
amounts paid under the plan compensate FSC for the services it provides and the
expenses it bears in distributing the Series' shares to investors. Distribution
fees for the year ended December 31, 1997 are set forth in the Statement of
Operations.
NASD Sanctions and Fines
On February 19, 1998, FSC and two of its executives, without admitting or
denying guilt, entered into an agreement with the National Association of
Securities Dealers Inc. ("NASD") whereby they accepted fines
32
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
TAX-FREE MONEY MARKET SERIES
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
totaling $125,000 and other stipulated sanctions as a result of the NASD's
finding that they had distributed advertising materials of an affiliated mutual
fund which violated NASD rules governing advertisements.
Affiliated Transfer Agent
The Fund compensated Fundamental Shareholder Services, Inc., (FSSI) an
affiliate of the Manager, for the services it provided under a Transfer Agent
and Service Agreement which was terminated on September 11, 1997. Transfer agent
fees paid by the Series to FSSI for the year ended December 31, 1997 amounted to
$17,745.
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. The Trustees also received additional
compensation for special services as requested by the Board. Additional
compensation totaled $40,923 pro rated among the funds based on their respective
average net assets.
4. Shares of Beneficial Interest
As of December 31, 1997 there were an unlimited number of shares of
beneficial interest (no par value) authorized and capital paid in amounted to
$13,270,069. Transactions in shares of beneficial interest, all at $1.00 per
share were as follows:
Year ended Year ended
December 31, December 31,
1997 1996
-------------- --------------
Shares sold ..............................$2,566,332,934 $3,547,580,681
Shares issued on reinvestment of dividends 1,048,578 1,042,865
Shares redeemed ..........................(2,558,739,108) (3,555,253,329)
-------------- ----------
Net (decrease) increase ..................$ 8,642,404 (6,629,783)
============== ==========
5. Line of Credit
The Fund has a line of credit agreement with its custodian bank
collateralized by cash and portfolio securities for $500,000. Borrowings under
this agreement bear interest linked to the bank's prime rate. The Series had no
borrowing under the line of credit agreement as of or during the year ended
December 31, 1997.
6. Expenses Paid Indirectly
The Fund has an arrangement with its custodian whereby credits earned on
cash balances maintained at the custodian are used to offset custody charges.
These credits amounted to approximately $41,000 for the year ended December 31,
1997.
7. Agreement and Plan of Reorganization
On July 16, 1997 each of Fundamental's mutual funds (consisting of: New York
Muni Fund, The California Muni Fund, Fundamental Fixed Income Fund: Tax Free
Money Market Series, High Yield Municipal Bond Series, and Fundamental U.S.
Government Strategic Income Fund Series) have adopted, subject to shareholder
approval, an Agreement and Plan of Reorganization (the "Plan") under which each
fund (the "Fundamental Fund") will transfer all of its assets and liabilities to
a newly-created corresponding series of The Tocqueville Trust (the "Tocqueville
Fund") in exchange for shares of the Tocqueville Fund. Shareholders of each
Fundamental Fund will receive shares of the corresponding Tocqueville Fund equal
in value to their shares in the Fundamental Fund. Shareholders will not have to
pay a sales load upon receiving shares of the Tocqueville Fund.
33
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
TAX-FREE MONEY MARKET SERIES
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
The corresponding Tocqueville Fund will have investment objectives, polices
and restrictions substantially identical to those of the Fundamental Fund. The
Board of Trustees of the Tocqueville Funds is comprised of individuals other
than those who currently serve as Directors (Trustees) of the Fundamental Funds.
Tocqueville Asset Management L.P. is the investment adviser to the Tocqueville
Funds.
A majority of Fundamentals' Board Members determined that the Plan would be
in the best interests of shareholders of the Fundamental Funds and recommended
that shareholders of each of the Fundamental Funds approve the Plan at a meeting
anticipated to be held in the Spring of 1998.
8. Subsequent Event
At its March 25, 1998 Board of Trustees' meeting, the Board of the Fund
approved the continuation of the Management Agreement and Distribution Agreement
through May 30, 1998 in contemplation of the consummation of the reorganization
discussed in Note 7.
9. Selected Financial Information
<TABLE>
<CAPTION>
Years Ended December 31,
--------------------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
PER SHARE DATA AND RATIOS
(for a share outstanding throughout the period)
Net Asset Value, Beginning of Year ........................ $1.00 $1.00 $1.00 $1.00 $1.00
Income from investment operations:
Net investment income ..................................... 0.022 0.023 0.026 0.017 0.014
Less Distributions:
Dividends from net investment income ...................... (0.022) (0.023) (0.026) (0.017) (0.014)
Net Asset Value, End of Period ............................ $1.00 $1.00 $1.00 $1.00 $1.00
Total Return .............................................. 2.19% 2.28% 2.60% 1.69% 1.62%
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (000 omitted) ..................... 13,263 4,621 11,251 9,004 5,830
Ratios to Average Net Assets
Expenses .............................................. 1.52%(D)(D) (D) 1.54% 1.53%(D)(D) 0.91%(D) .95%(D)
Net investment income ................................. 2.10% 2.04% 2.43% 1.55% 1.25%
BANK LOANS
Amount outstanding at end of period
(000 omitted) ........................................... $ - $ 218 $ - $ 451 $ 290
Average amount of bank loans outstanding during the period
(000 omitted) ........................................... $ - $ - $ 41 $ 53 $ 111
Average number of shares outstanding during the period
(000 omitted) ........................................... 48,801 56,876 44,432 56,267 25,786
Average amount of debt per share during the period ........ $ - $ - $ .001 $ .001 $ .004
<FN>
(D)These ratios are after expense reimbursement of .02%, .44% and .67%, for each of the years ended December 31, 1997, 1994 and
1993, respectively.
(D)(D)These ratios would have been 1.44%, 1.40% and 1.35% net of expense offsets of .08%, .14% and .18% for the years ended December
31, 1997, 1996 and 1995, respectively.
</FN>
</TABLE>
34
<PAGE>
INDEPENDENT AUDITOR'S REPORT
The Board of Trustees and Shareholders
Tax-Free Money Market Series of
Fundamental Fixed-lncome Fund
We have audited the accompanying statement of assets and liabilities,
including the statement of investments, of the Tax-Free Money Market Series of
Fundamental Fixed-lncome Fund as of December 31, 1997 and the related statement
of operations for the year then ended, the statement of changes in net assets
for each of the two years in the period then ended, and the selected financial
information for each of the five years in the period then ended. 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, 1997 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 presenation. We believe that our audits provide a reasonable basis for
our opinion.
In our opinion, the financial statement and selected financial information
referred to above present fairly, in all material respects, the financial
position of the Tax-Free Money Market Series of Fundamental Fixed-Income Fund as
of December 31, 1997, and the results of its operations, changes in net assets,
and selected financial information for the periods indicated, in conformity with
generally accepted accounting principles.
See Note 2 for information regarding regulatory proceedings and transactions
with affiliates.
S I G N A T U R E
New York, New York
March 2, 1998, except for Note 8 as to which the date is March 25, 1998.
35
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
HIGH-YIELD MUNICIPAL BOND SERIES
(LEFT COLUMN)
STATEMENT OF ASSETS AND LIABILITIES
December 31, 1997
- --------------------------------------------------------------------------------
ASSETS
Investment in securities at value (Note 5)
(cost $2,739,553) ................................... $2,832,290
Interest receivable ................................... 40,346
Receivable for fund shares sold ....................... 463,520
----------
Total assets ............................. 3,336,156
----------
LIABILITIES
Payable for investments purchased ..................... 615,650
Accrued expenses ...................................... 11,735
Bank overdraft payable ................................ 452,313
Dividend payable ...................................... 1,233
Payable for fund shares redeemed ...................... 240
----------
Total liabilities ........................ 1,081,171
----------
NET ASSETS consisting of:
Accumulated net realized
loss .................................... $ (158,714)
Unrealized appreciation
of securities ........................... 92,737
Paid-in-capital applicable to
299,472 shares of
beneficial interest
(Note 4) ................................ 2,320,962
-----------
$2,254,985
==========
NET ASSET VALUE PER SHARE ............................... $ 7.53
==========
(RIGHT COLUMN)
STATEMENT OF OPERATIONS
Year Ended December 31, 1997
- --------------------------------------------------------------------------------
INVESTMENT INCOME
Interest income .................... $140,428
EXPENSES (Notes 2 and 3)
Investment advisory fees ........... $ 14,600
Custodian and accounting fees ...... 43,046
Transfer agent fees ................ 8,970
Trustee fees ....................... 2,413
Distribution fees .................. 9,125
Professional fees .................. 21,443
Postage and printing ............... 8,077
Other .............................. 3,583
--------
Total expenses .............. 111,257
Less: Expenses waived or reimbursed
by the manager and affiliates .... (64,243)
--------
Net expenses ................ 47,014
--------
Net investment income ....... 93,414
REALIZED AND UNREALIZED GAIN
(LOSS) ON INVESTMENTS
Net realized gain on investments ... 17,891
Change in unrealized appreciation of
investments for the year ........... 166,782
--------
Net gain on investments ..... 184,673
--------
NET INCREASE IN NET ASSETS FROM
OPERATIONS ......................... $278,087
========
(FULL COLUMN)
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
Years Ended December 31, 1997 and 1996
- --------------------------------------------------------------------------------------------------------
1997 1996
INCREASE (DECREASE) IN NET ASSETS FROM: ---- ----
<S> <C> <C>
OPERATIONS
Net investment income ................................................... $ 93,414 $ 108,670
Net realized gain on investments ........................................ 17,891 22,294
Unrealized (depreciation) appreciation of investments for the year ...... 166,782 (22,733)
--------- ---------
Net increase in net assets from operations ....................... 278,087 108,231
DIVIDENDS PAID TO SHAREHOLDERS FROM
Net investment income ................................................... (93,414) (108,670)
CAPITAL SHARE TRANSACTIONS (Note 4) ....................................... 212,100 401,216
--------- ---------
Total increase ................................................... 396,773 400,777
NET ASSETS:
Beginning of year ....................................................... 1,858,212 1,457,435
--------- ---------
End of year ............................................................. $2,254,985 $1,858,212
========== ==========
</TABLE>
See Notes to Financial Statements.
38
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
HIGH-YIELD MUNICIPAL BOND SERIES
<TABLE>
<CAPTION>
STATEMENT OF INVESTMENTS
December 31, 1997
- ------------------------------------------------------------------------------------------------------------
Principal
Amount Issue o Value
------ ----- -----
<C> <S> <C>
$ 40,000 Allegheny County, PA, IDA, AFR, USAir Inc., 8.88%, 3/01/21 ................................$ 40,782
40,000 Brookhaven, NY, IDA, CFR, Dowling College, 6.75%, 3/01/23 ................................. 42,730
250,000 Colorado Health Facilities Authority, RHR, Liberty Heights Project, ETM, CAB, 7/15/24 ..... 60,317
100,000 Corona, CA, COP, Vista Hospital Systems Inc. 8.38%, 7/01/11 ............................... 109,361
100,000 Escambia, FL, Housing Corporation, Royal Arms Project, Series B, 9.00%, 7/01/16 ........... 103,202
70,000 Florence County, SC, IDA, RB, Stone Container Corp., 7.38%, 2/01/07 ....................... 74,070
500,000 Foothill / Eastern TCA, Toll Road Revenue, CAB, 1/01/26 ................................... 106,500
25,000 Hildago County, TX, Health Services, Mission Hospital Inc Project, 6.88%, 8/15/26 ......... 26,567
50,000+ Illinois Development Financial Authority, Solid Waste Disposal, RB, Ford Heights Waste
Tire Project, 7.88%, 4/01/11 ............................................................ 10,582
45,000 Illinois Health Facilities Authority, Midwest Physician Group Ltd Project, RB, 8.13%,
11/15/19 ................................................................................ 48,833
35,000 Indianapolis, IN, RB, Robin Run Village Project, 7.63%, 10/01/22 .......................... 38,463
50,000 Joplin, MO, IDA, Hospital Facilities Revenue, Tri State Osteopathic, 8.25%, 12/15/14 ...... 53,674
50,000 Los Angeles, CA, Regional Airport, Continental Airlines, AMT, 9.25%, 8/01/24 .............. 59,104
630,000 Marengo County, AL, Port Authority Facilities, RB, CAB, Series A, 3/01/19 ................. 141,252
75,000 Maryland Economic Development Corporation, Nursing Facilities Mortgage RB,
Ravenwood Healthcare, Series A, 8.38%, 8/01/26 .......................................... 78,529
85,000 Montgomery County, TX, Health Facilities Development Corp., The Woodlands Medical
Center, 8.85%, 8/15/14 .................................................................. 93,171
100,000 New York City, NY, Municipal Water Finance Authority, Water & Sewer RB, TR Receipts
Series 29, 6.56%, 6/15/30 ............................................................... 96,974
100,000 New York State, DAR, City University System Residual Int Tr Recpts 27, MBIA Insured,
Liquidity The Bank of New York, 8.22%, 7/01/24 .......................................... 109,979
100,000 New York State, DAR, City University System Residual Int Tr Recpts 28, AMBAC Insured,
Liquidity The Bank of New York, 7.63%, 7/01/25 .......................................... 105,279
5,000,000 New York State, DAR, CAB, FHA Presbyterian Hospital Series A, AMBAC Insured,
8/15/36 ................................................................................. 643,400
100,000#x Niagara Falls, NY, URA, Old Falls Street Improvement Project, 11.00%, 5/01/09 ............. 35,795
50,000 Northeast, TX, Hospital Authority Revenue, Northeast Medical Center, 7.25%, 7/01/22 ....... 57,455
75,000 Perdido, FL, Housing Corporation, RB, Series B. 9.25%, 11/01/16 ........................... 75,787
30,000 Philadelphia, PA, HEHA, Graduate Health Systems Project, 7.25%, 7/01/18 ................... 31,468
60,000 Port Chester, NY, IDA, Nadal Industries Inc Project, 7.00%, 2/01/16 ....................... 61,876
75,000 San Antonio, TX, HFC, Multi Family Housing, RB, Agape Metro Housing Project, Series
A, 8.63%, 12/01/26 ...................................................................... 75,989
75,000 San Bernardino, CA, San Bernardino Community Hospital, RB, 7.88%, 12/01/19 ................ 77,531
100,000 San Bernardino County, CA, COP, Series PA-38, MBIA Insured, IFRN*, 11.92%, 7/01/16,
Rule 144A Security (restricted as to resale except to qualified institutions) ........... 113,555
</TABLE>
39
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
HIGH-YIELD MUNICIPAL BOND SERIES
<TABLE>
<CAPTION>
STATEMENT OF INVESTMENTS
December 31, 1997
- ------------------------------------------------------------------------------------------------------------
Principal
Amount Issue o Value
------ ----- -----
<C> <S> <C>
$ 35,000 San Joaquin Hills, CA, TCA, Toll Road Revenue, 7.00%, 1/01/30 ............................$ 40,033
60,000x San Jose, CA, Redevelopment Agency, Tax Allocation Bonds, IFRN*, MBIA Insured,
5.83%, 8/01/16, MBIA Insured, Rule 144A Security (restricted as to resale except to
qualified institutions) ................................................................ 61,304
150,000 Savannah, GA Economic Development Authority Revenue, ETM, CAB, 12/01/21 .................. 39,940
45,000 Schuylkill County, PA, IDA Resouce Recovery, Schuylkill Energy Res Inc. AMT, 6.50%,
1/01/10 ................................................................................ 46,040
15,000(D)# Troy, NY, IDA, Hudson River Project, 11.00%, 12/01/94 .................................... 6,150
75,000(D) (D)(D)Villages at Castle Rock, CO, Metropolitan District #4, 8.50%, 6/01/31 .................... 39,138
25,000 Wayne, MI, AFR, Northwest Airlines Inc. 6.75%, 12/01/15 .................................. 27,460
----------
Total Investments (Cost $2,739,553)** ....................................................$2,832,290
==========
<FN>
** Cost is approximately the same for income tax purposes.
* Inverse Floating Rate Notes (IFRN) are instruments whose interest rates bear an inverse relationship to the interest rate on
another security or the value of an index. Rates shown are at December 31, 1997.
# The value of this non-income producing security has been estimated by persons designated by the Fund's Board of
Trustees using methods the Trustees believe reflect fair value. See note 5 to the financial statements.
+ Non-income producing security.
(D)(D) Security in default. Interest paid on cash flow basis. Rate shown as of December 31, 1997.
x The Fund or its affiliates owns 100% of the security and therefore there is no trading in the security.
</FN>
</TABLE>
Legend
o Issue AFR Airport Facilities Revenue
AMBAC American Municipal Bond Assurance Corporation
AMT Subject to Alternative Minimum Tax
CAB Capital Appreciation Bond
COP Certificate of Participation
CFR Civic Facility Revenue
DAR Dorm Authority Revenue
ETM Escrowed to Maturity
FHA Federal Housing Authority
HEHA Higher Education and Health Authority
HFC Housing Finance Corporation
IDA Industrial Development Authority
MBIA Municipal Bond Insurance Assurance Corporation
RB Revenue Bond
RHR Retirement Housing Revenue
TCA Transportation Corridor Agency
URA Urban Renewal Agency
See Notes to Financial Statements.
40
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
HIGH-YIELD MUNICIPAL BOND SERIES
NOTES TO FINANCIAL STATEMENTS
December 31, 1997
- --------------------------------------------------------------------------------
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 Fundamental U.S. Government Strategic Income Fund Series
(the Series). Each series is considered a separate entity for financial
reporting and tax purposes. The High-Yield Municipal Bond Series (the Series)
seeks to provide a high level of current income exempt from federal income tax
through investment in a portfolio of lower quality municipal bonds, generally
referred to as "junk bonds." These bonds are considered speculative because they
involve greater price volatility and risk than higher rated bonds. The following
is a summary of significant accounting policies followed in the preparation of
the Series' financial statements:
Valuation of Securities: The Fund's portfolio securities are valued on the basis
of prices provided by an independent pricing service when, in the opinion of
persons designated by the Fund's trustees, such prices are believed to reflect
the fair market value of such securities. Prices of non-exchange traded
portfolio securities provided by independent pricing services are generally
determined without regard to bid or last sale prices but take into account
institutional size trading in similar groups of securities, yield, quality,
coupon rate, maturity, type of issue, trading characteristics and other market
data. Securities traded or dealt in upon a securities exchange and not subject
to restrictions against resale as well as options and futures contracts listed
for trading on a securities exchange or board of trade are valued at the last
quoted sales price, or, in the absence of a sale, at the mean of the last bid
and asked prices. Options not listed for trading on a securities exchange or
board of trade for which over-the-counter market quotations are readily
available are valued at the mean of the current bid and asked prices. Money
market and short-term debt instruments with a remaining maturity of 60 days or
less will be valued on an amortized cost basis. Securities not priced in a
manner described above and other assets are valued by persons designated by the
Fund's trustees using methods which the trustees believe accurately reflects
fair value.
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 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 amortized and charged against interest income and original issue discounts
are accreted to interest income.
41
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
HIGH-YIELD MUNICIPAL BOND SERIES
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
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.
2. Investment Advisory Fees and Other Transactions with Affiliates
Management Agreement
The Fund has a Management Agreement with Fundamental Portfolio Advisors,
Inc. (the Manager). Pursuant to the agreement, the Manager serves as investment
adviser to the High-Yield Municipal Bond 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 consideration for the services
provided by the Manager, the Series will pay an annual management fee in an
amount equal to 0.8% of the Series' average daily net assets up to $100 million
and decreasing by .02% for each $100 million increase in net assets down to 0.7%
of net assets in excess of $500 million. The Manager voluntarily waived fees and
reimbursed expenses of $49,643 for the year ended December 31, 1997. See Note 7.
SEC Administrative Action Against The Manager
On September 30, 1997, the Securities & Exchange Commission announced that
it instituted public administrative and cease-and desist proceedings against the
Manager, the former portfolio manager of the Fund, the president of the Manager
and Fundamental Service Corporation (FSC) the Funds distributor. The proceeding
arises from the alleged failure of an affiliated mutual fund to disclose the
risks of the Fund, and of the Manager's failure to disclose its soft dollar
arrangements to the Fund's Board of Trustees. A hearing has been scheduled to
determine whether the allegations are true, and, if so, what remedial action, if
any, is appropriate.
Board's Termination of Portfolio Manager
Between April 17, 1997 and July 24, 1997, a representative of the Manager
engaged Tocqueville Securities L.P. ("Tocqueville Securities") an affiliate of
Tocqueville, as agent, to effect eight separate over-the-counter purchase
transactions of municipal obligations on behalf of an affiliated fund. The
Fund's Board has concluded that the commissions paid to Tocqueville Securities
in connection with these transactions (a portion of which was paid to the
representative) were not justified and that the affiliated fund bore unnecessary
expenses as a result of the sale of its securities to another party and the
subsequent repurchase of them through Tocqueville Securities. Based upon a
report initiated by Tocqueville Securities and prepared by the Fund's
independent auditors, and upon the Board's own analysis, the Board directed that
the Manager terminate the representative's services as a portfolio manager. At
the Board's request and in order to reimburse the affiliated fund for all of its
losses, Tocqueville Securities, on September 15, 1997, voluntarily paid $260,000
to the affiliated fund, an amount which significantly exceeds the total
commissions ($184,920.60) received by Tocqueville Securities in connection with
these transactions. The staff of the Securities and Exchange Commission and the
Department of NASD Regulation have been informed of these events by Tocqueville
Securities. See note 7 regarding contemplated transaction with the Tocqueville
Trust.
42
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
HIGH-YIELD MUNICIPAL BOND SERIES
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
Plan of Distribution
The Fund has adopted a Plan of Distribution, pursuant to Rule 12b-1
promulgated under the Investment Company Act of 1940, under which the Series
pays to FSC, an affiliate of the Manager, a fee, which is accrued daily and paid
monthly, at an annual rate of 0.5% 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. FSC
has waived all fees in the amount of $9,125 for the year ended December 31,
1997.
NASD Sanctions and Fines
On February 19, 1998, FSC and two of its executives, without admitting or
denying guilt, entered into an agreement with the National Association of
Securities Dealers, Inc. ("NASD") whereby they accepted fines totaling $125,000
and other stipulated sanctions as a result of the NASD's finding that they had
distributed advertising materials of an affiliated mutual fund which violated
NASD rules governing advertisements.
Affiliated Transfer Agent
The Fund compensated Fundamental Shareholder Services, Inc. (FSSI), an
affiliate of the Manager, for the services it provided under a Transfer Agent
and Service Agreement which was terminated on September 11, 1997. Transfer agent
fees paid by the Series to FSSI amounted to $5,012.
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. The Trustees also received additional
compensation for special services as requested by the Board. Additional
compensation totaled $40,923 pro rated among the funds based on their respective
average net assets.
4. Shares of Beneficial Interest
As of December 31, 1997, there were an unlimited number of shares of
beneficial interest (no par value) authorized and capital paid in amounted to
$2,320,962. Transactions in shares of beneficial interest were as follows:
<TABLE>
<CAPTION>
Year Ended Year Ended
December 31, 1997 December 31, 1996
----------------------- --------------------------
Shares Amount Shares Amount
--------- ---------- --------- -----------
<S> <C> <C> <C> <C>
Shares sold .................................... 2,941,324 20,530,136 1,912,593 $12,834,095
Shares issued on reinvestment of dividends ..... 11,426 79,995 11,925 80,347
Shares redeemed ................................ (2,924,097) (20,398,031) (1,859,933) (12,513,226)
---------- ----------- ---------- -----------
Net increase ................................... 28,653 $ 212,100 64,585 $ 401,216
========== =========== ========== ===========
</TABLE>
5. Investment Transactions
The Fund invests in variable rate securities commonly called "inverse
floaters." The interest rates on these securities have an inverse relationship
to the interest rate of other securities or the value of an index. Changes in
43
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
HIGH-YIELD MUNICIPAL BOND SERIES
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
interest rate on the other security or index inversely affect the rate paid on
the inverse floater, and the inverse floater's price will be more volatile than
that of a fixed-rate bond. Certain interest rate movements and other market
factors can substantially affect the liquidity of IFRN's.
The Fund invests in lower rated or unrated ("junk") securities which are
more likely to react to developments affecting market risk and credit risk than
would higher rated securities which react primarily to interest rate
fluctuations. The Fund held securities in default with an aggregate value of
$91,665 at December 31, 1997 (4.1% of net assets). As indicated in the Statement
of Investments, the Troy, NY Industrial Revenue Bond, 11% due December 1, 2014
with a par value of $15,000 and a value of $6,150 at December 31, 1997 has been
estimated in good faith under methods determined by the Board of Trustees.
The Fund owns 1.7% of a Niagara Falls New York Urban Renewal Agency 11%
Bond ("URA Bond") due to mature on May 1, 2009 which has missed interest and
sinking fund payments. An affiliated investment company owns 98.3% of this bond
issue. The Fund was party to an agreement whereby certain related bonds owned by
an affiliate were to be subject to repayment under a debt assumption agreement.
The agreement allowed the affiliate to allocate a portion of the debt services
it receives to the URA Bond. In exchange the Fund forfeited certain rights it
had as holder of the URA bond. The debt assumption was not completed and the
timing and amount of debt service payments is uncertain. The value of this bond
is $35,795, and is valued at 35.80% of face value at December 31, 1997 under
methods determined by the Board of Trustees.
During the year ended December 31, 1997, the cost of purchases and proceeds
from sales of investment securities, other than short-term obligations, were
$2,982,245 and $2,610,195, respectively.
As of December 31, 1997 net unrealized appreciation of portfolio securities
amounted to $92,737, composed of unrealized appreciation of $225,341 and
unrealized depreciation of $132,604.
The Fund has capital loss carryforwards to offset future capital gains as
follows:
Amount Expiration
------- ----------
$23,500 12/31/1998
22,200 12/31/1999
20,500 12/31/2000
54,300 12/31/2002
40,000 12/31/2003
--------
$160,500
========
6. Agreement and Plan of Reorganization
On July 16, 1997 each of Fundamental's mutual funds (consisting of: New York
Muni Fund, The California Muni Fund, Fundamental Fixed Income Fund: Tax Free
Money Market Series, High Yield Municipal Bond Series, and Fundamental U.S.
Government Strategic Income Fund Series) have adopted, subject to shareholder
approval, an Agreement and Plan of Reorganization (the "Plan") under which each
fund (the "Fundamental Fund") will transfer all of its assets and liabilities to
a newly-created corresponding series of The Tocqueville Trust (the "Tocqueville
Fund") in exchange for shares of the Tocqueville Fund. Shareholders of each
Fundamental Fund will receive shares of the corresponding Tocqueville Fund equal
in value to their shares in the Fundamental Fund. Shareholders will not have to
pay a sales load upon receiving shares of the Tocqueville Fund.
44
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
HIGH-YIELD MUNICIPAL BOND SERIES
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
The corresponding Tocqueville Fund will have investment objectives, polices
and restrictions substantially identical to those of the Fundamental Fund. The
Board of Trustees of the Tocqueville Funds is comprised of individuals other
than those who currently serve as Directors (Trustees) of the Fundamental Funds.
Tocqueville Asset Management L.P. is the investment adviser to the Tocqueville
Funds.
A majority of Fundamental's Board members determined that the Plan would be
in the best interests of shareholders of the Fundamental Funds and recommended
that shareholders of each of the Fundamental Funds approve the Plan at a meeting
anticipated to be held in the Spring of 1998.
7. Subsequent Event
At its March 25, 1998 Board of Trustees' meeting, the Board of the Fund
approved the continuation of the Management Agreement and Distribution Agreement
through May 30, 1998 in contemplation of the consummation of the reorganization
discussed in Note 6.
8. Selected Financial Information
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------------
1997 1996 1995 1994 1993
PER SHARE OPERATING PERFORMANCE ---- ---- ---- ---- ----
(for a share outstanding throughout the period)
<S> <C> <C> <C> <C> <C>
Net asset value, beginning of period $6.86 $7.07 $5.92 $7.27 $7.30
----- ----- ----- ----- -----
Income from investment operations:
Net investment income 0.37 0.47 0.34 0.43 0.39
Net realized and unrealized gains (losses) on investments 0.67 (0.21) 1.15 1.35) (0.03)
----- ----- ----- ----- -----
Total from investment operations 1.04 0.26 1.49 (0.92) 0.36
----- ----- ----- ----- -----
Less distributions:
Dividends from net investment income (0.37) (0.47) (0.34) (0.43) (0.39)
----- ----- ----- ----- -----
Net asset value, end of period $7.53 $6.86 $7.07 $5.92 $7.27
===== ===== ===== ===== =====
Total Return 15.71% 4.05% 25.70% (12.92%) 5.11%
RATIOS/SUPPLEMENTAL DATA
Net assets, end of period (000 omitted) 2,255 1,858 1,457 979 1,087
Ratios to average net assets:
Expenses* 2.58% 2.49% 2.50% 2.50% 2.50%
Net investment income* 5.12% 6.85% 5.15% 6.70% 5.40%
Portfolio turnover rate 3.79% 139.26% 43.51% 75.31% 84.89%
BANK LOANS
Amount outstanding at end of period (000 omitted) $ - 228 379 $ - $ -
Average amount of bank loans outstanding during the period
(000 omitted) $ - $ - 61 $ - $ -
Average number of shares outstanding during the period
(000 omitted) 260 237 183 156 145
Average amount of debt per share during the period $ - $ - $0.33 $ - $ -
<FN>
**These ratios are after expense reimbursements of 3.52%, 4.59%, 6.22%, 6.20% and 5.76%, for each of the
years ended December 31, 1997, 1996, 1995, 1994 and 1993, respectively.
</FN>
</TABLE>
45
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
HIGH-YIELD MUNICIPAL BOND SERIES
INDEPENDENT AUDITOR'S REPORT
- --------------------------------------------------------------------------------
To the Board of Trustees and Shareholders
Fundamental Fixed-Income Fund
High-Yield Municipal Bond Series
We have audited the accompanying statement of assets and liabilities, including
the statement of investments, of Fundamental Fixed-Income Fund High-Yield
Municipal Bond Series as of December 31, 1997, and the related statements of
operations for the year then ended, the statement of changes in net assets for
each of the two years then ended and the selected financial information for each
of the five years in the period then ended. 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 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 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, 1997 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 Fundamental Fixed-Income Fund High-Yield Municipal Bond Series as of
December 31, 1997, and the results of its operations, changes in net assets, and
selected financial information for the periods indicated, in conformity with
generally accepted accounting principles.
See Note 2 for information regarding regulatory proceedings and transactions
with affiliates.
New York, New York
March 2, 1998, except for Note 7 as to which the date is March 25, 1998.
46
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
(LEFT COLUMN)
STATEMENT OF ASSETS AND LIABILITIES
December 31, 1997
- --------------------------------------------------------------------------------
ASSETS
Investment in securities, at value
(cost $13,023,839) (Notes 5 and 6) $15,023,792
Receivables:
Interest 67,739
Fund shares sold ................ 4,001
-----------
Total assets ................ 15,095,532
-----------
LIABILITIES
Loans ............................. 225,907
Options written at value
(premiums received $18,801)
(Note 5) ........................ 10,625
Securities sold subject to
repurchase (Note 6) ............. 4,744,054
Payables:
Dividends declared .............. 11,104
Shares redeemed ................. 9,353
Variation margin ................ 41,563
Accrued expenses ................ 22,580
-----------
Total liabilities ........... 5,065,186
-----------
NET ASSETS consisting of:
Accumulated net realized loss ..... $(17,833,560)
Unrealized appreciation of
securities ...................... 1,999,953
Unrealized appreciation of
options written ................. 8,176
Unrealized depreciation of open
future contracts ................ (103,270)
Paid-in-capital applicable to
7,116,688 shares of beneficial
interest ........................ 25,959,047
-----------
$10,030,346
===========
NET ASSET VALUE PER SHARE $1.41
=====
(RIGHT COLUMN)
STATEMENT OF OPERATIONS
Year Ended December 31, 1997
- --------------------------------------------------------------------------------
INVESTMENT INCOME
Interest income, net of $315,574
of interest expense ...................... $1,812,306
EXPENSES (Notes 2, 3 and 6)
Investment advisory fees ................. $ 88,681
Custodian and accounting fees ............ 61,165
Transfer agent fees ...................... 71,081
Professional fees ........................ 563,154
Trustees' fees ........................... 5,458
Printing and postage ..................... 9,502
Interest on bank borrowing ............... 324,872
Distribution expenses .................... 29,560
Other .................................... 14,012
---------
Total expense ...................... 1,167,485
Less: Expenses waived or
reimbursed by the
manager and affiliates ........... (162,637)
---------
Net expenses ....................... 1,004,848
----------
Net investment income .............. 807,458
----------
REALIZED AND UNREALIZED GAIN
(LOSS) ON INVESTMENTS
Net realized gain (loss) on:
Investments ............................ 1,027,730
Future and options on futures .......... (956,715) 71,015
---------
Change in unrealized appreciation
(depreciation) of investments,
options and futures contracts
for the period:
Investments .......................... 66,558
Open option contracts
written ............................ (312)
Open futures contracts ............... (339,726) (273,480)
--------- ----------
Net loss on investments .................. (202,465)
----------
NET INCREASE IN NET ASSETS
FROM OPERATIONS .......................... $ 604,993
=========
<PAGE>
(FULL COLUMN)
<TABLE>
<CAPTION>
STATEMENT OF CHANGES IN NET ASSETS
- ----------------------------------------------------------------------------------------------------------
Year Ended Year Ended
December December
31, 1997 31, 1996
-------- --------
INCREASE (DECREASE) IN NET ASSETS FROM:
OPERATIONS
<S> <C> <C>
Net investment income ...................................................... $ 807,458 $ 1,254,448
Net realized gain on investments ........................................... 71,015 433,173
Unrealized (depreciation) on investments, options and futures contracts .... (273,480) (1,070,217)
----------- -----------
Net increase in net assets from operations ........................ 604,993 617,404
DIVIDENDS PAID TO SHAREHOLDERS FROM
Investment income .......................................................... (807,458) (1,254,448)
CAPITAL SHARE TRANSACTIONS (Note 4) .......................................... (2,991,556) (1,332,818)
----------- -----------
Total decrease .................................................... (3,194,021) (1,969,862)
NET ASSETS
Beginning of year .......................................................... 13,224,367 15,194,229
----------- -----------
End of year ................................................................ $10,030,346 $13,224,367
=========== ===========
</TABLE>
See Notes to Financial Statements.
49
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
STATEMENT OF CASH FLOWS
<TABLE>
Year Ended December 31, 1997
- ---------------------------------------------------------------------------------------------
INCREASE (DECREASE) IN CASH
CASH FLOWS FROM OPERATING ACTIVITIES
<S> <C>
Net increase in net assets from operations ................................ $ 604,993
Adjustments to reconcile net increase in net assets from operations to
net cash provided by operating activities:
Purchase of investment securities ......................................... (2,228,044)
Proceeds on sale of securities ............................................ 8,312,593
Premiums received for options written ..................................... 633,904
Premiums paid to close options written .................................... (977,704)
Decrease in interest receivable ........................................... 28,925
Decrease in variation margin receivable ................................... 218,791
Decrease in accrued expenses .............................................. (93,909)
Net accretion of discount on securities ................................... (187,473)
Net realized (gain) loss:
Investments ............................................................. (1,027,730)
Options written ......................................................... 309,113
Unrealized appreciation on securities and options written for the period .. (66,246)
----------
Total adjustments ....................................................... 4,922,220
----------
Net cash provided by operating activities ............................... 5,527,213
----------
CASH FLOWS FROM FINANCING ACTIVITIES:*
Net repayments on sale of securities sold subject to repurchase ............. (1,617,934)
Net borrowings of note payable .............................................. (49,281)
Proceeds on shares sold ..................................................... 728,056
Payment on shares repurchased .............................................. (4,356,318)
Cash dividends paid ......................................................... (231,736)
----------
Net cash used in financing activities ................................... (5,527,213)
----------
Net increase in cash .................................................... 0
CASH AT BEGINNING OF YEAR .................................................. 0
----------
CASH AT END OF YEAR ......................................................... $ 0
==========
</TABLE>
*Non-cash financing activities not included herein consist of reinvestment of
dividends of $642,058. Cash payments for interest expense totaled $333,352 for
the period.
STATEMENT OF OPTIONS WRITTEN
<TABLE>
<CAPTION>
December 31, 1997
- ---------------------------------------------------------------------------------------------
Number of Expiration
Contracts++ Options Written Month Value
----------- --------------- ---------- -----
<C> <S> <C> <C>
40 U.S. Treasury Bonds, Call @ $123 ........... February 1998 $10,625
-------
$10,625
=======
</TABLE>
++Each contract represents $100,000 face value of U.S. Treasury Bond Futures.
See Notes to Financial Statements.
50
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
STATEMENT OF INVESTMENTS
December 31, 1997
- --------------------------------------------------------------------------------
Principal Interest Maturity
Amount Rate o Date Value
------ ------ ---- -----
United States Treasury Securities-49.03%
United States Treasury Bonds
85,000(2) 0.00% ZCS 11/15/03 $ 60,395
4,300,000(2) 0.00% PS 11/15/06 2,574,333
3,500,000(5) 9.00% 11/15/18 4,731,566
----------
(Cost $6,403,170) 7,366,294
----------
United States Agency Backed Securities-50.97%
Federal Home Loan Mortgage Corporation
843,718(1) 9.25% 08/15/23 928,005
285,124(1) 6.50% Z-Bond 12/15/23 261,907
750,000 13.59% IFRN 05/15/24 858,060
209,406(2) 15.30% IFRN 05/25/24 251,287
180,000 12.00% TTIB 03/15/27 180,079
FNMA-Federal National Mortgage Assoc.
356,450(4)(1) 15.50% TTIB 03/25/23 381,224
3,671,204(4)(1) 15.30% TTIB 03/25/23 4,185,686
490,760(4) 14.49% TTIB 05/25/23 544,900
----------
7,591,148
----------
FICO-Financing Corporation (U.S. Government Agency)
100,000 0.00% ZCS 11/02/12 39,284
100,000 0.00% ZCS 08/03/18 27,066
----------
(Cost $6,620,669) 66,350
----------
Total investments (Cost $13,023,839)(3) $15,023,792
----------
(1) Segregated for securities sold subject to repurchase (Note 6)
(2) Segregated, in whole or part, as initial margin for futures contracts
(Note 5)
(3) Cost is the same for Federal income tax purposes
(4) The Fund owns 100% of the security or tranche. See Note 5 to the financial
statements.
(5) Securities sold subject to repurchase (Note 6).
o Legend-IFRN: Inverse Floating Rate Notes are instruments whose interest rates
bear an inverse relationship to the interest rate on another
security or the value of an index. Rates shown are at December
31, 1997.
TTIB: Two-Tiered Index Floating Rate Bonds are instruments with two
coupon levels. The "first tier" coupon is at a fixed rate,
effective as long as the underlying index is at or below the
strike level. At the strike level, the "second tier" coupon
resets the bond to an inverse floating rate note. See discussion
above. Coupons shown are at December 31, 1997.
ZCS: Zero Coupon Securities are instruments whose interest and
principal are paid at maturity.
Z Bond: A Z Bond is an instrument whose monthly interest coupon is paid
at a fixed rate in additional principal. Principal is paid at
maturity.
PS: Principal Stripped Bonds are instruments whose principle and
coupon have been separated and sold separately.
See Notes to Financial Statements.
51
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
NOTES TO FINANCIAL STATEMENTS
December 31, 1997
- --------------------------------------------------------------------------------
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 Fundamental U.S. Government Strategic Income Fund Series
(the Series). The objective of the Series is to provide high current income with
minimum risk of principal and relative stability of net asset value. The 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
(hereunder collectively referred to as "Government Securities"). The Series also
uses leverage in seeking to achieve its investment objective. Each series is
considered a separate entity for financial reporting and tax purposes.
Valuation of Securities-The Series portfolio securities are valued on
the basis of prices provided by an independent pricing service when, in the
opinion of persons designated by the Fund's trustees, such prices are believed
to reflect the fair market value of such securities. Prices of non-exchange
traded portfolio securities provided by independent pricing services are
generally determined without regard to bid or last sale prices but take into
account institutional size trading in similar groups of securities, yield,
quality, coupon rate, maturity, type of issue, trading characteristics and other
market data. Securities traded or dealt in upon a securities exchange and not
subject to restrictions against resale as well as options and futures contracts
listed for trading on a securities exchange or board of trade are valued at the
last quoted sales price, or, in the absence of a sale, at the mean of the last
bid and asked prices. Options not listed for trading on a securities exchange or
board of trade for which over-the-counter market quotations are readily
available are valued at the mean of the the current bid and asked prices. Money
market and short-term debt instruments with a remaining maturity of 60 days or
less will be valued on an amortized cost basis. Securities not priced in a
manner described above and other assets are valued by persons designated by the
Fund's trustees using methods which the trustees believe reflect fair value.
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. The Series' repurchase agreements will at
all times be fully collateralized in an amount equal to the purchase price
including accrued interest earned on the underlying security.
52
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
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 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. Discounts and premiums are
amortized over the life of the respective securities. Premiums are charged
against interest income and 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.
2. Investment Advisory Fees and Other Transactions With Affiliates
Management Agreement
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 consideration 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 waived fees
and reimbursed expenses of $133,077 for the year ended December 31, 1997. See
Note 8.
SEC Administrative Proceeding Against the Manager
On September 30, 1997, the Securities & Exchange Commission announced that
it instituted public administrative and cease-and desist proceedings against the
Manager, the former portfolio manager of the Fund, the president of the Manager
and Fundamental Service Corporation (FSC). The proceeding arises from the
53
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
alleged failure of the Fund to disclose the risks of the Fund, and of the
Manager's failure to disclose its soft dollar arrangements to the Fund's Board
of Trustees. A hearing has been scheduled with an administrative law judge to
determine whether the allegations are true, and, if so, what remedial action, if
any, is appropriate.
Board's Termination of Portfolio Manager
Between April 17, 1997 and July 24, 1997, a representative of the Manager
engaged Tocqueville Securities L.P. ("Tocqueville Securities") an affiliate of
Tocqueville, as agent, to effect eight separate over-the-counter purchase
transactions of municipal obligations on behalf of an affiliated fund. The
Fund's Board has concluded that the commissions paid to Tocqueville Securities
in connection with these transactions (a portion of which was paid to the
representative) were not justified and that the affiliated fund bore unnecessary
expenses as a result of the sale of its securities to another party and the
subsequent repurchase of them through Tocqueville Securities. Based upon a
report initiated by Tocqueville Securities and prepared by the Fund's
independent auditors, and upon the Board's own analysis, the Board directed that
the Manager terminate its representative's services as a portfolio manager. At
the Board's request and in order to reimburse the affiliated fund for all of its
losses, Tocqueville Securities, on September 15, 1997, voluntarily paid $260,000
to the affiliated fund, an amount which significantly exceeds the total
commissions ($184,920.60) received by Tocqueville Securities in connection with
these transactions. The staff of the Securities and Exchange Commission and the
Department of NASD Regulation have been informed of these events by Tocqueville
Securities. See note 7 regarding contemplated transaction with the Tocqueville
Trust.
Plan of Distribution
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 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, 1997 is set forth in the Statement of Operations. FSC
has waived fees in the amount of $29,560.
NASD Sanctions and Fines
On February 19, 1998, FSC and two of its executives, without admitting or
denying guilt, entered into an agreement with the National Association of
Securities Dealers, Inc. ("NASD") whereby they accepted fines totaling $125,000
and other stipulated sanctions as a result of the NASD's finding that they had
distributed advertising materials relating to the Fund which violated NASD rules
governing advertisements.
Affiliated Transfer Agent
The Series compensated Fundamental Shareholders Services, Inc. (FSSI), an
affiliate of the Manager, for services it provided under a Transfer Agent and
Service Agreement which was terminated on September 11, 1997. The amount paid by
the Series to FSSI for the year ended December 31, 1997 amounted to $57,038.
Commissions Paid to Affiliate
The Series effects a significant portion of its futures and options
transactions through LAS Investments, Inc. (LAS), an affiliated broker-dealer.
Commissions paid to LAS amounted to approximately $14,591 for the year ended
December 31, 1997.
54
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
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. The Trustees also received additional
compensation for special services as requested by the Board. Additional
compensation totaled $40,923 pro rated among the funds based on their respective
average net assets.
4. Shares of Beneficial Interest
As of December 31, 1997 there were an unlimited number of shares of
beneficial interest (no par value) authorized and capital paid-in amounted to
$25,959,047. Transactions in shares of beneficial interest were as follows:
<TABLE>
<CAPTION>
Year Ended Year Ended
December 31, 1997 December 31, 1996
----------------------- --------------------------
Shares Amount Shares Amount
--------- ---------- --------- -----------
<S> <C> <C> <C> <C>
Shares sold ................................... 521,491 $ 732,057 1,209,491 $1,721,466
Shares issued on reinvestment of dividends .... 457,380 642,058 605,897 860,888
Shares redeemed ............................... (3,119,211) (4,365,671) (2,749,791) (3,915,172)
---------- ----------- --------- -----------
Net decrease .................................. (2,140,340) ($2,991,556) (934,403) ($1,332,818)
========== =========== ========= ===========
</TABLE>
5. Complex Services, Off Balance Sheet Risks and Investment Transactions
Two-Tiered Index Floating Rate Bonds (TTIB):
The Fund invests in Two-Tiered Index Floating Rate Bonds. The term
two-tiered refers to the two coupon levels that the TTIB's coupon can reset to.
The "first tier" is the TTIB's fixed rate coupon, effective as long as the
underlying index is at or below the strike level. Above the strike, the TTIB
coupon resets to a formula similar to an inverse floating rate note. See
discussion of inverse floating rate notes below. Changes in interest rate on the
underlying 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.
Additionally the Fund owns 100% of several securities as indicated in the
Statement of Investments. As a result of its ownership position there is no
active market in these securities. Valuations of these securities are provided
by a pricing service and are believed by the Manager to reflect fair value. The
market value of securities owned 100% by the Fund was approximately $5,111,810
(or 50.96% of net assets) as of December 31, 1997.
Inverse Floating Rate Notes (IFRN):
The Fund invests in variable rate securities commonly called "inverse
floaters". The interest rates on these securities have an inverse relationship
to the interest rate of other securities or the value of an index. Changes in
interest rate on the other security or index inversely affect the rate paid on
the inverse floater, and the inverse floater's price will be more volatile than
that of a fixed-rate bond. Certain interest rate movements and other market
factors can substantially affect the liquidity of IFRN's.
55
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
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 municipal
bond portfolio, and to enhance its total return. The Fund's principal 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, 1997, the Fund
had daily average notional amounts outstanding of approximately $15,136,000 and
$5,737,561 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, 1997.
Principal Expiration Unrealized
Type Amount Position Month Loss
---- ------ -------- ----- ----
U.S. Treasury Bond ............. $7,000,000 Short 3/98 ($103,270)
Portfolio securities with an aggregate value of approximately $1,389,306
have been segregated as initial margin as of December 31, 1997.
In addition, the following table summarizes option contracts written by the
Series for the year ended December 31, 1997:
Number of Premiums Realized
Contracts Received Cost Loss
--------- -------- ---- ----
Contracts outstanding
December 31, 1996 .............. 40 $53,488
Options written .................. 780 633,904
Contracts closed or expired ...... (780) (668,591) $977,704 ($309,113)
--- -------
Contracts outstanding
December 31, 1997 .............. 40 $ 18,801
=== ========
56
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
Other Investment Transactions
For the year ended December 31, 1997, the cost of purchases and proceeds
from sales of investment securities, other than short-term obligations, were
$2,228,044 and $7,702,650, respectively.
As of December 31, 1997, the Fund had no unrealized appreciation or
depreciation for tax purposes since it has elected to recognize market value
changes each day for tax purposes.
The Fund has capital loss carryforwards to offset future capital gains as
follows:
Amount Expiration
------ ----------
$15,000,500 12/31/2002
588,100 12/31/2004
202,500 12/31/2005
-----------
$15,791,100
===========
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. The reverse
repurchase agreement outstanding at December 31, 1997 bears an interest rate of
5.9%. Portfolio securities with an aggregate value of approximately $5,757,000
have been segregated for securities sold subject to repurchase as of December
31, 1997.
The maximum month-end and the average amount of borrowing outstanding under
these arrangements during the year ended December 31, 1997 were approximately
$6,329,000 and $5,967,000.
7. Agreement and Plan of Reorganization
On July 16, 1997 each of Fundamental's mutual funds (consisting of: New York
Muni Fund, The California Muni Fund, Fundamental Fixed Income Fund: Tax Free
Money Market Series, High Yield Municipal Bond Series, and Fundamental U.S.
Government Strategic Income Fund Series) have adopted, subject to shareholder
approval, an Agreement and Plan of Reorganization (the "Plan") under which each
fund (the "Fundamental Fund") will transfer all of its assets and liabilities to
a newly-created corresponding series of The Tocqueville Trust (the "Tocqueville
Fund") in exchange for shares of the Tocqueville Fund. Shareholders of each
Fundamental Fund will receive shares of the corresponding Tocqueville Fund equal
in value to their shares in the Fundamental Fund. Shareholders will not have to
pay a sales load upon receiving shares of the Tocqueville Fund.
The corresponding Tocqueville Fund will have investment objectives, polices
and restrictions substantially identical to those of the Fundamental Fund. The
Board of Trustees of the Tocqueville Funds is comprised of
57
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
individuals other than those who currently serve as Directors (Trustees) of the
Fundamental Funds. Tocqueville Asset Management L.P. is the investment adviser
to the Tocqueville Funds.
A majority of Fundamental's Board members determined that the Plan would be
in the best interests of shareholders of the Fundamental Funds and recommended
that shareholders of each of the Fundamental Funds approve the Plan at a meeting
anticipated to be held in the Spring of 1998.
8. Subsequent Event
At its March 25, 1998 Board of Trustees' meeting, the Board of the Fund
approved the continuation of the Management Agreement and Distribution Agreement
through May 30, 1998 in contemplation of the consummation of the reorganization
discussed in Note 7.
The Manager and FSC (on behalf of certain of their directors, officers,
shareholders, employees and control persons) (the "Indemnitees") received
payment during the fiscal year ended December 31, 1997 from the Fund in the
amount of approximately $232,500. Upon learning of the payments, the independent
Board Members of the Funds directed that the Indemnitees return all of the
payments to the Funds or place them in escrow pending their receipt of an
opinion of an inedpendent legal counsel to the effect that the Indemnitees are
entitled to receive them. The Declaration of Trust, Articles of Incorporation
and contracts that call for indemnification specify that no indemnification
shall be provided to a person who shall be found to have engaged in "disabling
conduct" as defined by applicable law. The Indemnities have undertaken to
reimburse the Fund for any indemnification expenses for which it is determined
that they were not entitled to as a result of "disabling conduct" net of any
reimbursements already made to the Fund in the form of fees forgone or other
similar payments.
The Manager and FSC waived fees in the amount of $96,077 and $29,560,
respectively for the year ended December 31, 1997. The Manager and FSC have
asserted that they elected to forgo these fees because the Fund was paying legal
expenses pursuant to indemnification. The Fund has retained independent legal
counsel to determine whether the Indemnitees engaged in disabling conduct.
Pending clarification of the legal issues involved, the Indemnitees have placed
into an escrow account $102,863 as of April 30, 1998. The independent trustees
have instructed the Manager to escrow the full amount incurred by the Fund of
approximately $232,500.
58
<PAGE>
9. Selected Financial Information
<TABLE>
<CAPTION>
Year Year Year Year Year
Ended Ended Ended Ended Ended
December 31, December 31, December 31, December 31, December 31,
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Per share operating performance
(for a share outstanding throughout the period)
<S> <C> <C> <C> <C> <C>
Net asset value, beginning of period .............. $ 1.43 $ 1.49 $ 1.37 $ 2.01 $ 2.02
------ ------ ------ ------ ------
Income from investment operations
Net investment income ............................. 0.10 0.13 0.08 0.14 0.16
Net realized and unrealized gain/(loss) on
investments ..................................... (0.02) (0.06) 0.12 (0.64) -
------ ------ ------ ------ ------
Total from investment operations ............ 0.08 0.07 0.20 (0.50) 0.16
------ ------ ------ ------ ------
Less distributions
Dividends from net investment income .............. (0.10) (0.13) (0.08) (0.14) (0.16)
Dividends from net realized gains ................. - - - - (0.01)
------ ------ ------ ------ ------
Net asset value, end of period .................... $ 1.41 $ 1.43 $ 1.49 $ 1.37 $ 2.01
====== ====== ====== ====== ======
Total return ...................................... 5.51% 5.02% 15.43% (25.57%) 8.14%
Ratios/supplemental data:
Net assets, end of period (000 omitted) ........... $10,030 13,224 15,194 19,020 63,182
Ratios to average net assets
Interest expense (a) ............................ 2.75% 2.61% 3.00% 2.01% 1.54%
Operating expenses .............................. 5.75% 3.41% 3.05% 2.16% 1.39%
------ ------ ------ ------ ------
Total expenses+ (a) ......................... 8.50% 6.02% 6.05% 4.17% 2.93%
====== ====== ====== ====== ======
Net investment income+ .......................... 6.83% 9.01% 5.91% 8.94% 7.85%
Portfolio turnover rate ........................... 12.55% 12.65% 114.36% 60.66% 90.59%
Borrowings
Amount outstanding at end of period
(000 omitted) ................................... $4,969 $6,610 $ 7,481 $ 9,674 $31,072
Average amount of debt outstanding during the
period (000 omitted) ............................ $5,967 $6,577 $ 7,790 $16,592 $28,756
Average number of shares outstanding during the
period (000 omitted) ............................ 8,433 9,764 11,571 21,436 28,922
Average amount of debt per share during the
period .......................................... $ .71 $ .67 $ .67 $ .77 $ .99
<FN>
+These ratios are after expense reimbursement of 1.37%, 2.02%, 1.0% and .13% for the years ended December 31,
1997, 1996, 1995 and 1993, respectively.
(a)The ratios for each of the years in the four year period ending December 31, 1996 have been reclassified to
conform with the 1997 presentations.
</FN>
</TABLE>
59
<PAGE>
INDEPENDENT AUDITOR'S REPORT
The Board of Trustees and Shareholders
Fundamental Fixed-Income Fund
Fundamental U.S. Government Strategic Income Fund Series
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, 1997 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 each of the five years in the period then ended. 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, 1997 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 Series of
Fundamental Fixed-lncome Fund as of December 31, 1997, 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.
See Notes 2 and 8 for information regarding regulatory proceedings and
transactions with affiliates.
S I G N A T U R E
New York, New York
March 2, 1998, except for Note 8 as to which the date is April 30, 1998.
60
<PAGE>
FUNDAMENTAL FIXED INCOME FUND
HIGH-YIELD MUNICIPAL BOND SERIES
90 Washington Street
New York, New York 10006
STATEMENT OF ADDITIONAL INFORMATION
May 1, 1998
This Statement of Additional Information provides certain
detailed information concerning the High-Yield Municipal Bond Series (the
"High-Yield Series") of the Fundamental Fixed Income Fund (the "Fund"). The
High-Yield Series seeks to provide a high level of current income exempt from
federal income taxes through the investment in a portfolio of lower quality
municipal bonds (generally with maturities of 20 years or more). Of course,
there can be no assurance that the investment objective will be achieved. Lower
quality municipal bonds are at times referred to as "junk bonds."
This Statement of Additional Information is not a Prospectus
and should be read in conjunction with the High Yield Series' current
Prospectus, a copy of which may be obtained by writing to Fundamental Service
Corporation at 90 Washington Street, New York, New York 10006 or by calling
(800) 322-6864.
This Statement of Additional Information relates to the
High-Yield Series' Prospectus dated May 1, 1998.
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.
<PAGE>
TABLE OF CONTENTS
Page
INVESTMENT OBJECTIVE, POLICIES AND RESTRICTIONS............................. 3
MANAGEMENT OF THE FUND...................................................... 6
DISTRIBUTION PLAN........................................................... 9
INVESTMENT MANAGER.......................................................... 12
PORTFOLIO TRANSACTIONS...................................................... 13
CUSTODIAN AND INDEPENDENT ACCOUNTANTS....................................... 15
TAXES....................................................................... 16
DESCRIPTION OF SHARES....................................................... 23
CERTAIN LIABILITIES......................................................... 23
DETERMINATION OF NET ASSET VALUE............................................ 24
CALCULATION OF YIELD AND AVERAGE
ANNUAL TOTAL RETURN......................................................... 25
OTHER INFORMATION........................................................... 28
FINANCIAL STATEMENTS........................................................ 28
APPENDIX....................................................................A-1
-2-
<PAGE>
INVESTMENT OBJECTIVE, POLICIES AND RESTRICTIONS
INVESTMENT OBJECTIVE AND POLICIES
The Prospectus of the High-Yield Series dated May 1, 1998 (the
"Prospectus") identifies the investment objective and the principal investment
policies of the High-Yield Series. Other investment policies and a further
description of certain of the policies described in the Prospectus are set forth
below.
"When-Issued" Securities. As described in the Prospectus under
"INVESTMENT OBJECTIVE AND POLICIES," the High-Yield Series may purchase new
issues of tax-exempt securities on a "when-issued" basis. In order to invest the
High-Yield Series' assets immediately, while awaiting delivery of securities
purchased on a "when-issued" basis, short-term obligations that offer same day
settlement and earnings will normally be purchased. Although short-term
investments will normally be in tax-exempt securities, short-term taxable
securities may be purchased if suitable short-term tax-exempt securities are not
available. When a commitment to purchase a security on a "when-issued" basis is
made, procedures are established consistent with the General Statement of Policy
of the Securities and Exchange Commission concerning such purchases. Because
that policy currently recommends that an amount of the assets of the High-Yield
Series equal to the amount of the purchase be held aside or segregated to be
used to pay for the commitment, cash or high-quality debt securities sufficient
to cover any commitments are always expected to be available. Nonetheless, such
purchases may involve more risk than other types of purchases, as described in
the Prospectus.
Futures Contracts. The High-Yield Series may enter into
contracts for the future acquisition or delivery of fixed-income securities
("Futures Contracts"). This investment technique is designed only to hedge
against anticipated future changes in interest rates which otherwise might
either adversely affect the value of the High-Yield Series' securities or
adversely affect the prices of long-term bonds which the High-Yield Series
intends to purchase at a later date (although the High-Yield Series may engage
in transactions in futures contracts for income purposes if Commodity Futures
Trading Commission regulations on this issue change). If interest rates move in
an unexpected manner, the High-Yield Series will not achieve the anticipated
benefits of Futures Contracts or may realize a loss.
Options. The High-Yield Series intends to both purchase and
write options on securities and Futures Contracts, within the limits described
in the Prospectus. The market for options on tax-exempt securities is a new and
developing one, and consequently the High-Yield Series faces the risk that such
options acquired by it may not be readily marketable. As the market for options
on tax-exempt securities expands, the High- Yield Series expects that its
activities with respect to options will expand also (subject to any applicable
investment restrictions).
-3-
<PAGE>
Portfolio Management. The High-Yield Series intends to fully
manage its portfolio by buying and selling securities, as well as holding
securities to maturity. In managing its portfolio, the High-Yield Series seeks
to take advantage of market developments and yield disparities, which may
include use of the following strategies:
(1) shortening the average maturity of its portfolio in
anticipation of a rise in interest rates so as to minimize depreciation of
principal;
(2) lengthening the average maturity of its portfolio in
anticipation of a decline in interest rates so as to maximize tax-exempt yield;
(3) selling one type of debt security (e.g., revenue bonds)
and buying another (e.g., general obligation bonds) when disparities arise in
the relative values of each; and
(4) changing from one debt security to an essentially similar
debt security when their respective yields appear distorted due to market
factors.
The High-Yield Series engages in portfolio trading if it
believes a transaction, net of costs (including custodian charges), will help in
achieving its investment objective.
Portfolio Turnover. Pursuit by the High-Yield 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 High-Yield Series of broker 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. Securities with maturities or expiration dates of
one year or less at the time of acquisition by the High-Yield Series are
excluded from this calculation. A high portfolio turnover rate increases
transactions costs of the High-Yield Series and increases the likelihood of the
distribution of taxable capital gains to investors. For the fiscal years ended
December 31, 1996 and 1997, the High-Yield Series' portfolio turnover rates were
approximately 139% and 134%, respectively.
INVESTMENT RESTRICTIONS
The High-Yield 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 High-Yield 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 High-Yield Series may not:
(1) issue senior securities;
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(2) borrow money in an amount not exceeding 33 1/3% of the
value of its total assets and subject to a 300% asset coverage requirement, or
pledge mortgage or hypothecate any of its assets, except to secure such
permitted borrowings;
(3) underwrite securities issued by other persons, except
insofar as the High-Yield Series may technically be deemed an underwriter under
the Securities Act of 1933 in selling a portfolio security;
(4) purchase or sell real estate (including limited
partnership interests but excluding Municipal Bonds secured by real estate or
interests therein) or interests in oil, gas or mineral leases;
(5) make loans to others except (i) through the use of
repurchase agreements, provided that not more than 10% of its total assets are
invested at any one time in repurchase agreements of more than one week in
length or in other restricted or illiquid securities, (ii) through the lending
of its portfolio securities in accordance with the limitations set forth in the
Prospectus under "INVESTMENT OBJECTIVE AND POLICIES - Lending of Portfolio
Securities" and (iii) that the purchase of debt securities in accordance with
its investment policies shall not constitute loans for purposes of this
restriction;
(6) purchase or retain the securities of any issuer, if, to
the High-Yield Series' knowledge, those individual officers, directors or
trustees of the Fund, or of the investment advisor of the High-Yield Series, who
own beneficially own more than 1/2 of 1% of the outstanding securities of such
issuer, together own beneficially more than 5% of the outstanding securities of
such issuer;
(7) purchase securities, if, as a result of such purchase, 25%
or more of its total assets would be invested in non-governmental industrial
revenue bonds, the payment of the principal and interest on which are the
responsibility of issuers in the same industry, provided that it may invest more
than 25% of its total assets in industrial revenue bonds;
(8) make short sales of securities or purchase any securities
or evidences of interests therein on margin, except that the High-Yield Series
may obtain such short-term credit as may be necessary for the clearance of
purchases and sales of securities and except that the High-Yield Series may make
deposits on margin in connection with interest rate futures contracts;
(9) purchase or sell commodities or commodities contracts
except financial futures and related options as described in the High-Yield
Series' Prospectus; or
(10) invest in securities which are restricted as to
disposition under federal securities laws or for which there is no readily
available market (i.e., market makers do not exist or will not entertain bids or
offers).
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The above restrictions, along with the fundamental policies
identified in the Prospectus under "INVESTMENT OBJECTIVE AND POLICIES -
Miscellaneous," constitute all of the fundamental policies of the High-Yield
Series.
For the purposes of the High-Yield Series' investment
restrictions, the issuer of a tax-exempt security is deemed to be the entity
(public or private) ultimately responsible for the payment of the principal and
interest on the security.
Operating Policies. The High-Yield Series has adopted the
following operating policies which are not fundamental and which may be changed
without shareholder approval. The High-Yield Series may enter into repurchase
agreements (a purchase of and a simultaneous commitment to resell a security at
an agreed upon price on an agreed upon date) only with member banks of the
Federal Reserve System and only if collateralized by U.S. Government securities.
If the vendor of a repurchase agreement fails to pay the sum agreed to on the
agreed upon delivery date, the High-Yield Series would have the right to sell
the U.S. Government securities, but might incur a loss in so doing and in
certain cases may not be permitted to sell the U.S. Government securities. As
noted in paragraph (5) on page 5, the High-Yield Series may not invest more than
10% of its assets in repurchase agreements maturing in more than seven days. In
addition, in order to comply with certain state statutes, the High-Yield Series
will not pledge, mortgage or hypothecate its portfolio securities if at the time
the value of the securities so pledged, mortgaged or hypothecated would exceed
10% of the value of the High-Yield Series. For purposes of this restriction,
collateral arrangements with respect to the writing of stock options, financial
futures, options on financial futures and collateral arrangements with respect
to margin requirements are not deemed to be a pledge of assets, and for purposes
of the restriction in paragraph (1) above, neither such arrangements nor the
purchase or sale of futures or purchase of related options are deemed to be the
issuance of a senior security.
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
High-Yield 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 High-Yield Series. The officers of the Fund
are responsible for the operations of the High-Yield Series. The Trustees and
executive officers of the Fund are listed below, together with their principal
occupations during 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 (*).
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James C. Armstrong: Director of the Fund. Mr. Armstrong is a
management consultant. He was formerly a partner in Armstrong/Seltzer
Communications Inc., a New York management, consulting and public relations
firm. Earlier he served as Executive Director, Global Public Affairs Institute
at New York University and Professor, Bell of Pennsylvania Chair in
Telecommunications, Temple University. 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 70 North Ravenwood Drive, Cape May Court House, New Jersey 08210.
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, LaSalle Economics
Inc., an economic consulting firm. 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.
All of the Trustees of the Fund are also Trustees or Directors
of Fundamental Funds, Inc. and The California Muni Fund. Dr. Malanga, an officer
of the Fund , holds similar offices with Fundamental Funds, Inc. and The
California Muni Fund.
The High-Yield 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, New York Muni
Fund, 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
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basis, for actual out-of-pocket expenses relating to his attendance at meetings.
Some Trustees received additional compensation at a rate of $125 per hour for
services related to serving on the Portfolio Review Committee. 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, 1997,
trustees' fees totalling $______ were paid by the Fund to the Trustees as a
group ($___ for the High-Yield Series, $______ for the Tax-Free Money Market
Series and $_____ for the Fundamental U.S. Government Strategic Income Fund
Series).
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<PAGE>
COMPENSATION TABLE
(FOR EACH CURRENT BOARD MEMBER
RECEIVING COMPENSATION FROM
A FUNDAMENTAL FUND FOR THE
MOST RECENTLY COMPLETED FISCAL YEAR)
AGGREGATE COMPENSATION FROM FUND
<TABLE>
<CAPTION>
AGGREGATE
COMPENSATION
PAID BY ALL
FUNDS MANAGED
BY
HIGH-YIELD TAX-FREE U.S. GOV'T FUNDAMENTAL
CALIFORNIA MUNICIPAL MONEY STRATEGIC PORTFOLIO
NAME NY MUNI MUNI BOND MARKET INCOME ADVISORS, INC.
<S> <C> <C> <C> <C> <C> <C>
JAMES C. ARMSTRONG $29,684 $3,044 $496 $2,919 $2,207 $38,350
L. GREG FERRONE $20,124 $2,064 $336 $1,979 $1,497 $26,000
</TABLE>
Administrator, Transfer Agent, Custodian and Accounting Agent
Firstar Trust Company, P.O. Box 701, Milwaukee, WI 53201-0701 currently
acts as Administrator, Transfer Agent, Custodian and Accounting Agent for the
High-Yield Municipal Bond Series.
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, previously performed all
services in connection with the transfer of shares of the High-Yield Series,
acted as its dividend disbursing agent, and as administrator of the exchange,
check redemption, telephone redemption and expedited redemption privileges of
the High-Yield Series. During the year ended December 31, 1997, $5,942 was paid
to Fundamental Shareholder Services, Inc.
DISTRIBUTION PLAN
As discussed in the Prospectus, the Fund has entered into a
Distribution Agreement with 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.
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<PAGE>
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 High-Yield Series not borne by the High-Yield Series. The Distribution
Agreement was approved by action of the Trustees of the Fund and entered into by
the Fund and FSC on March 28, 1989. The Distribution Agreement will continue in
effect from year-to-year if it is specifically approved, at least annually, in
the manner required by the 1940 Act. The Board of Trustees last approved the
Distribution Agreement on March 25, 1998 for a period of sixty days following
March 31, 1998.
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
High-Yield Series. FSC also pays certain expenses in connection with the
distribution of the High-Yield 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 High-Yield Series bears the cost of registering its shares
under federal and state securities law.
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 High-Yield Series
pays FSC compensation accrued daily and paid monthly at the annual rate of 1/2
of 1.0% of the High-Yield 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 September 29, 1987 by the then sole shareholders of the
High-Yield Series.
Pursuant to the Plan, FSC provides the Fund, for review by the
Trustees, and the Trustees review, at least quarterly, a 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 has been renewed to continue in effect for a period
of sixty days following March 31, 1998. 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
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<PAGE>
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.
All of the aggregate amount of 12b-1 fees incurred by the
High-Yield Series during the last fiscal year ($_____) was paid to FSC for
expenses incurred by it pursuant to the Plan.
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 efficient and effective shareholder services. In such event,
changes in the operation of the High-Yield 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
High-Yield 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.
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<PAGE>
INVESTMENT MANAGER
The Fund has entered into an agreement (the "Management
Agreement") with Fundamental Portfolio Advisors, Inc. (the "Manager"), 90
Washington Street, New York, New York 10006, to act as its investment adviser.
The Management Agreement will continue in effect from year to year 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 Board of Trustees last approved the continuation of the Management
Agreement on March 25, 1998 for a period of sixty days following March 31, 1998.
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 High-Yield Series and is responsible for the
overall management of the business affairs and assets of the High-Yield 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 High-Yield 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 High-Yield Series, including executive
salaries and the rental of office space, with the exception of the following,
which are to be paid by the High-Yield Series: (1) charges and expenses for
determining from time-to-time the net asset value of the High-Yield 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 High-Yield Series, (3) brokers'
commissions, and issue and transfer taxes, chargeable to the High-Yield Series
in connection with securities transactions, (4) insurance premiums, interest
charges, dues and fees for membership in trade associations and all taxes and
fees payable by the High-Yield Series to federal, state or other governmental
agencies, (5) fees and expenses involved in registering and maintaining
registrations of the shares of the High-Yield Series with the Securities and
Exchange Commission, (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 High-Yield 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
High-Yield Series is responsible for payment of the portion of such charges or
expenses which are properly allocable to the High-Yield Series.
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<PAGE>
As compensation for the performance of its management services and the
assumption of certain expenses of the High-Yield 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 High-Yield Series equal to
the following percentage of the average daily net asset value of the High-Yield
Series.
Average Daily Net Asset Value Annual Fee Payable
----------------------------- ------------------
Net asset value to $100,000,000 .80%
Net asset value of $100,000,000
or more but less than $200,000,000 .78%
Net asset value of $200,000,000
or more but less than $300,000,000 .76%
Net asset value of $300,000,000
or more but less than $400,000,000 .74%
Net asset value of $400,000,000
or more but less than $500,000,000 .72%
Net asset value of $500,000,000 or more .70%
The above management fee is higher than the management fee paid by most
other mutual funds, due to the extensive credit analysis performed by the
Manager with respect to the High-Yield Series. For the years ended December 31,
1988, 1989, 1990, 1991, 1992, 1993, 1994, 1995 , 1996 and 1997 and the Manager
waived its management fees, and reimbursed expenses of the High-Yield Series in
amounts of $73,527, $39,005, $34,589, $1,498, $50,224, $54,485, $51,925, $74,369
, $72,768 and $49,643, respectively, as expense reimbursements under the
Management Agreement.
Mr. Vincent J. Malanga, a trustee and officer of the Fund, and Dr.
Lance M. Brofman, chief portfolio strategist of the High-Yield Series, each own
approximately 48.5% of the outstanding shares of voting capital stock of the
Manager.
PORTFOLIO TRANSACTIONS
All orders for the purchase or sale of portfolio securities
are placed on behalf of the High-Yield 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 for other investment companies for which the Manager acts as
investment advisor. Securities purchased and sold on behalf of the High-Yield
Series will be traded in the over-the-counter market 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
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<PAGE>
instrument. In selecting 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 and commissions (if any).
Dealers may be selected who provide brokerage and/or research
services to the Fund or High-Yield 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 High-Yield 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 High-Yield 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 it in carrying out its obligations to the
High-Yield Series. The receipt of such 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
High-Yield 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 High-Yield 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 High-Yield 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
High-Yield Series or shares of other series of the Fund or other funds for which
the Manager acts as investment advisor if it
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<PAGE>
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.
During the years ended December 31, 1989, 1990, 1991, 1992, 1993, 1994,
1995 , 1996 and 1997, the High-Yield Series did not pay any brokerage
commissions.
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 High-Yield Series and the Fund and review the
dealer spreads paid by the High-Yield 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.
From January 1, 1990 to January 31, 1996, the Manager directed
syndicate designations in the aggregate dollar amount of $858,094 to Capital
Institutional Services, Inc. ("CIS") in connection with the Fundamental Funds'
bond purchases through underwriting syndicates. The Manager has represented that
CIS, a third-party research provider, at the Manager's direction, paid portions
of such syndicate designations to approximately 30 different firms that provided
research services used by the Manager in managing the Fundamental Funds,
including Capital Market Services, Inc. ("CMS"). Further, that CMS was paid by
CIS $115,000 for research provided to the Manager. The $115,000 dollar amount
paid by CIS to CMS for the following fiscal years of the High-Yield Series was:
$35,000 in 1995; $55,000 in 1994; and $25,000 in 1993. The Manager has also
represented that it learned in 1996 that at all times during the years 1993,
1994 and 1995, CMS was 100% owned by Mr. Donald E. Newell's wife. Mr. Vincent J.
Malanga and Mr. Donald E. Newell are each executive officers and 50%
shareholders of LaSalle Portfolio Management, Inc. In order to remove any
appearance of impropriety concerning all of the payments made by CIS to CMS in
return for research the Manager obtained from CMS, the Manager reimbursed
Fundamental U. S. Government Strategic Income Fund (the beneficiary of the
research) $115,000 out of its own resources.
CUSTODIAN AND INDEPENDENT ACCOUNTANTS
Firstar Trust Company (the "Bank"), 615 East Michigan Street, Michigan,
Milwaukee, WI 53202, acts as Custodian of the Fund's cash and securities. The
Bank also acts as transfer agent and bookeeping agent for the Fund, and, as
bookeeping agent, monitors the Fund's accounting records and calculates its net
asset value.
McGladrey & Pullen, LLP, 555 Fifth Avenue, New York, N.Y., acts as
independent public accountants for the Fund, performing an annual audit of the
Fund's financial statements and preparing its tax returns.
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<PAGE>
TAXES
The following is only a summary of certain additional federal
income tax considerations generally affecting the High-Yield 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 High-Yield 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 High-Yield Series has elected to be taxed as a regulated
investment company for federal income tax purposes under Subchapter M of the
Internal Revenue Code of 1986, as amended (the "Code"). As a regulated
investment company, the High-Yield 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) and at least 90% of its
tax-exempt income (net of expenses allocable thereto) for the taxable year (the
"Distribution Requirement"), and satisfies certain other requirements of the
Code that are described below. Distributions by the High-Yield 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 will therefore count toward satisfaction of
the Distribution Requirement.
If the High-Yield Series has a net capital loss (i.e., the
excess of capital losses over capital gains) for any year, the amount thereof
may be carried forward up to eight years and treated as a short-term capital
loss which can be used to offset capital gains in such years. As of December 31,
1997, the High-Yield Series has capital loss carryforwards of approximately
$160,500, which expire in varying amounts between December 31, 1998 and December
31, 2003. Under Code Section 382, if the High-Yield Series has an "ownership
change," the High-Yield Series' use of its capital loss carryforwards in any
year following the ownership change will be limited to an amount equal to the
net asset value of the High-Yield Series immediately prior to the ownership
change multiplied by the highest adjusted long-term tax-exempt rate (which is
published monthly by the Internal Revenue Service (the "IRS")) in effect for any
month in the 3-calendar-month period ending with the calendar month of change
occurs (the rate for April 1998 is 5.04%). The High-Yield will use its best
efforts to avoid having an ownership change. However, because of circumstances
which may be beyond the control or knowledge of the High-Yield Series, there can
be no assurance that the High-Yield Series will not have, or has not already
had, an ownership change. If the High-Yield Series has or has had an ownership
change, any capital gain net income for any year following the ownership change
in excess of the annual limitation on the capital loss carryforwards will have
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to be distributed by the High-Yield Series and will be taxable to shareholders
as described under "High-Yield Series Distributions" below.
In addition to satisfying the Distribution Requirement, a
regulated investment company must 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").
In general, gain or loss recognized by the High-Yield Series
on the disposition of an asset will be a capital gain or loss. However, gain
recognized on the disposition of a debt obligation (including municipal
obligations) purchased by the High-Yield 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 High-Yield Series held the debt obligation.
In general, for purposes of determining whether capital gain
or loss recognized by the High-Yield 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 another asset
so used, or (2) the asset is otherwise held by the High-Yield Series as part of
a "straddle" (which term generally excludes a situation where the asset is stock
and the High-Yield Series grants a qualified covered call option (which, among
other things, must not be deep-in-the- money) with respect thereto). In
addition, the High-Yield 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
High-Yield Series on the lapse of, or any gain or loss recognized by the
High-Yield Series from a closing transaction with respect to, an option written
by the High-Yield Series will be treated as a short-term capital gain or loss.
Further, the Code also treats as ordinary income a portion of
the capital gain attributable to a transaction where substantially all of the
return realized is attributable to the time value of the High-Yield Series' net
investment in the transaction and: (1) the transaction consists of the
acquisition of property by the High-Yield Series and a contemporaneous contract
to sell substantially identical property in the future; (2) the transaction is a
straddle within the meaning of section 1092 of the Code; (3) the transaction is
one that was marketed or sold to the High-Yield Series on the basis that it
would have the economic characteristics of a loan but the interest-like return
would be taxed as capital gain; or (4) the transaction is described as a
conversion transaction in the Treasury Regulations. The amount of the gain
recharacterized generally will not exceed the amount of the interest that would
have accrued on the net investment for the relevant period at a yield equal to
120% of the federal long-term, mid-term, or short-term rate, depending upon the
type of instrument at issue, reduced by an amount
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equal to: (1) prior inclusions of ordinary income items from the conversion
transaction and (2) the capital interest on acquisition indebtedness under Code
section 263(g). Built-in losses will be preserved where the High-Yield Series
has a built-in loss with respect to property that becomes a part of a conversion
transaction. No authority exists that indicates that the converted character of
the income will not be passed through to the High-Yield Series' shareholders.
Certain transactions that may be engaged in by the High-Yield
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 High-Yield 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 High-Yield Series that are not Section 1256
contracts.
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 High-Yield 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 High-Yield Series' taxable year, at least 50% of the value of the
High-Yield 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 High-Yield Series has not invested more than
5% of the value of the High-Yield Series' total assets in securities of such
issuer and as to which the High-Yield 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 High-Yield 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.
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If for any taxable year the High-Yield 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 High-
Yield 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")). (Tax-exempt interest on municipal obligations is not subject to the
excise tax.) 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 High-Yield 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 High- Yield Series may in certain
circumstances be required to liquidate portfolio investments to make sufficient
distributions to avoid excise tax liability.
High-Yield Series Distributions
The High-Yield 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 High-Yield Series may either retain or distribute to
shareholders its net capital gain for each taxable year. The High-Yield Series
currently intends to distribute any such amounts. Net capital gain that is
distributed and designated as a capital gain dividend will be
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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 High-Yield Series prior to the date on which the shareholder acquired his
shares.
The High-Yield Series intends to qualify to pay exempt-
interest dividends by satisfying the requirement that at the close of each
quarter of the High-Yield Series' taxable year at least 50% of the High-Yield
Series' total assets consists of tax-exempt municipal obligations. Distributions
from the High-Yield Series will constitute exempt-interest dividends to the
extent of the High-Yield Series' tax-exempt interest income (net of expenses and
amortized bond premium). Exempt-interest dividends distributed to shareholders
of the High-Yield Series are excluded from gross income for federal income tax
purposes. However, shareholders required to file federal income tax returns will
be required to report the receipt of exempt-interest dividends on their returns.
Moreover, while exempt-interest dividends are excluded from gross income for
federal income tax purposes, they may be subject to alternative minimum tax
("AMT") in certain circumstances and may have other collateral tax consequences
as discussed below. Distributions by the High-Yield Series of any investment
company taxable income or of any net capital gain will be taxable to
shareholders as discussed above.
AMT is imposed in addition to, but only to the extent it
exceeds, the regular tax and is computed at a maximum marginal rate of 28% for
noncorporate taxpayers and 20% for corporate taxpayers on the excess of the
taxpayer's alternative minimum taxable income ("AMTI") over an exemption amount.
Exempt-interest dividends derived from certain "private activity" municipal
obligations issued after August 7, 1986 , generally will constitute an item of
tax preference includable in AMTI for both corporate and noncorporate taxpayers.
In addition, exempt-interest dividends derived from all municipal obligations,
regardless of the date of issue, must be included in adjusted current earnings,
which are used in computing an additional corporate preference item (i.e., 75%
of the excess of a corporate taxpayer's adjusted current earnings over its AMTI
(determined without regard to this item and the AMT net operating loss
deduction)) includable in AMTI.
Exempt-interest dividends must be taken into account in
computing the portion, if any, of social security or railroad retirement
benefits that must be included in an individual shareholder's gross income and
subject to federal income tax. Further, a shareholder of the High-Yield Series
is denied a deduction for interest on indebtedness incurred or continued to
purchase or carry shares of the High-Yield Series. Moreover, a shareholder who
is (or is related to) a "substantial user" of a facility financed by industrial
development bonds held by the High-Yield Series will likely be subject to tax on
dividends paid by the High-Yield Series which are derived from interest on such
bonds. Receipt of exempt-interest dividends may result in other collateral
federal income tax consequences to certain taxpayers, including financial
institutions, property and casualty insurance companies and foreign corporations
engaged in a trade or business in the United States. Prospective investors
should consult their own tax advisers as to such consequences.
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Distributions by the High-Yield Series that do not constitute
ordinary income dividends, exempt-interest 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
realized from the sale of the shares, as discussed below.
Distributions by the High-Yield 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 High-Yield 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 High-Yield Series reflects realized but undistributed income or gain, or
unrealized appreciation in the value of assets
held by the High-Yield 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.
Ordinarily, shareholders are required to take distributions by
the High-Yield 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 High-Yield Series) on
December 31 of such calendar year provided 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)
during the year.
The High-Yield Series will be required in certain cases to
withhold and remit to the U.S. Treasury 31% of ordinary income and capital gain
dividends, and the proceeds of redemption of shares, paid to any shareholder (1)
who has failed to provide a correct taxpayer identification number , (2) who is
subject to backup withholding by the IRS for failure properly to report the
receipt of interest or dividend income , or (3) who has failed to certify to the
High-Yield Series that it is not subject to backup withholding or that it is an
"exempt recipient" (such as a corporation).
Sale or Redemption of Shares
A shareholder will recognize gain or loss on the sale or
redemption of shares of the High-Yield 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 High-Yield 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 High-Yield 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.
Long-term capital gain recognized by an individual shareholder will be taxed at
the lowest rates applicable to capital gains if the holder has held such shares
for more than 18 months at the time of the sale. However, any capital loss
arising from the sale
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or redemption of shares held for six months or less will be disallowed to the
extent of the amount of exempt-interest dividends received on such shares and
(to the extent not disallowed) 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. 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 High-Yield Series is "effectively connected" with a U.S. trade or business
carried on by such shareholder.
If the income from the High-Yield Series is not effectively
connected with a U.S. trade or business carried on by a foreign shareholder,
ordinary income dividends paid to a the shareholder will be subject to U.S.
withholding tax at the rate of 30% (or lower applicable treaty rate) on 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 or redemption
of shares of the High-Yield Series, capital gain dividends and exempt-interest
dividends and amounts retained by the High-Yield Series that are designated as
undistributed capital gains.
If the income from the High-Yield Series is effectively
connected with a U.S. trade or business carried on by a foreign shareholder,
then ordinary income and capital gain dividends received in respect of, and any
gains realized upon the sale of, shares of the High- Yield Series will be
subject to U.S. federal income tax at the rates applicable to U.S.
taxpayers.
In the case of a foreign noncorporate shareholder, the
High-Yield 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 subject
to withholding at a reduced treaty rate), unless the shareholder furnishes the
High-Yield 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 High-Yield 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
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Statement of Additional Information. Future legislative or administrative
changes or court decisions may significantly change the conclusions expressed
herein, perhaps with retroactive effect.
Rules of state and local taxation of ordinary income
dividends, exempt-interest dividends and capital gain dividends from regulated
investment companies may 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 these and other state and local tax rules affecting investment
in the High-Yield 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 High-Yield Series, the Tax-Free Money Market Series and
the Fundamental U.S. Government Strategic Income Fund 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 the proportionate
beneficial interests in the Fund. Each share represents an equal proportionate
interest in the Fund 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 High-Yield Series, each
series' shareholder is entitled to share pro rata in the net assets available
for distribution to shareholders from 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
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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 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 or for willful misfeasance, bad faith, gross
negligence or reckless disregard of such person's duties.
DETERMINATION OF NET ASSET VALUE
The net asset value of shares of the High-Yield 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. This determination is made once
during each such day as of the close of the New York Stock Exchange by deducting
the amount of the High-Yield Series' liabilities from the value of its assets
and dividing the difference by the number of its shares outstanding. Debt
securities (other than short-term obligations), including listed issues, are
valued on the basis of valuations furnished by a pricing service which utilizes
both dealer-supplied valuations and electronic data processing techniques which
take 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. Use of the pricing
service has been approved by the Board of Trustees. Short-term obligations are
valued at amortized cost, which constitutes fair value as determined by the
Board of Trustees. Portfolio securities for which there are no such valuations
are valued at fair value as determined in good faith by or at the direction of
the Board of Trustees.
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CALCULATION OF YIELD AND AVERAGE
ANNUAL TOTAL RETURN
The High-Yield Series' yield quotations and average annual
total return quotations as they may appear in the Prospectus, this Statement of
Additional Information or in advertising and sales material are calculated by
standard methods prescribed by the Securities and Exchange Commission.
The High-Yield Series' yield is computed by dividing the
High-Yield Series' net investment income per share during a base period of 30
days, or one month, by the net asset value per share of the High-Yield Series on
the last day of such base period in accordance with the following formula:
a-b 6
YIELD = 2 [(----- +1) -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
For purposes of calculating interest earned on debt obligations as provided in
item "a" above:
(i) The yield to maturity of each obligation held by the
High-Yield Series is computed based on the market value of the obligation
(including actual accrued interest, if any) 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, if any).
(ii) The yield to maturity of each obligation is then divided
by 360 and the resulting quotient is multiplied by the market value of the
obligation (including actual accrued interest, if any) to determine the interest
income on the obligation for each day of the subsequent month that the
obligation is in the portfolio. For these purposes it is assumed that each month
has 30 days.
(iii) Interest earned on all debt obligations during the
30-day or one month period is then totaled.
(iv) The maturity of an obligation with a call provision(s) is
the next call date on which the obligation reasonably may be expected to be
called or, if none, the maturity date.
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(v) In the case of a tax-exempt obligation issued without
original issue discount and having a current market discount, the coupon rate of
interest of the obligation is used in lieu of yield to maturity to determine
interest income earned on the obligation. In the case of a tax-exempt obligation
with original issue discount where the discount based on the current market
value of the obligation exceeds the then remaining portion of original issue
discount (i.e. market discount), the yield to maturity used to determine
interest income earned on the obligation is the imputed rate based on the
original issue discount calculation. In the case of a tax-exempt obligation with
original issue discount where the discount based on the current market value of
the obligation is less than the then remaining portion of the original issue
discount (market premium), the yield to maturity used to determine interest
income earned on the obligation is based on the market value of the obligation.
With respect to the treatment of discount and premium on
mortgage or other receivables-backed obligations which are expected to be
subject to monthly payments of principal and interest ("pay downs"), the
High-Yield Series accounts for gain or loss attributable to actual monthly pay
downs as an increase or decrease to interest income during the period. In
addition, the High-Yield Series may elect (i) to amortize the discount or
premium on a remaining security, based on the cost of the security, to the
weighted average maturity date, if such information is available, or to the
remaining term of the security, if the weighted average maturity date is not
available, or (ii) not to amortize the discount or premium on a remaining
security.
For purposes of computing yield, dividend income is recognized
by accruing 1/360 of the stated dividend rate of each obligation in the
High-Yield Series' portfolio each day that the obligation is in the portfolio.
The High-Yield Series does not use equalization accounting in the calculation of
yield. Expenses accrued during any base period, if any, pursuant to the
Distribution Plan are included among the expenses accrued during the base
period. Any reimbursement accrued pursuant to the Distribution Plan during a
base period, if any, will reduce expenses accrued pursuant to such Plan, but
only to the extent the reimbursement does not exceed the accrued expenses for
the base period.
The High-Yield Series' yield for the one-month period ended
December 31, 1997 determined in accordance with the above formula is ____%.
Average annual total return quotations are computed by finding
the average annual compounded rates of return that would cause a hypothetical
investment made on the first day of a designated period (assuming all dividends
and distributions are reinvested) to equal the ending redeemable value of such
hypothetical investment on the last day of the designated period in accordance
with the following formula:
P(1 + T)n = ERV
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Where: P = a hypothetical initial payment of $1000
T = average annual total return
n = number of years
ERV = ending redeemable value of a hypothetical $1000
payment made at the end of a designated period
(or fractional portion thereof)
For purposes of the above computation, it is assumed that all
dividends and distributions made by the High-Yield Series are reinvested at net
asset value during the designated period. The average annual total return
quotation is determined to the nearest 1/100 of 1%. The average annual total
return for the High-Yield Series for the year ended December 31, 1997 was ____%.
The average annual total return for the High Yield Series for the 5 year period
ended December 31, 1997 was ____% . Since inception, October 1, 1987, the
average annual total return was ____%.
In determining the average annual total return (calculated as
provided above), recurring fees, if any, that are charged to all shareholder
accounts are taken into consideration. For any account fees that vary with the
size of the account, the account fee used for purposes of the above computation
is assumed to be the fee that would be charged to the High-Yield Series' mean
account size.
The High-Yield Series may also from time-to-time advertise its
taxable equivalent yield. The High-Yield Series' taxable equivalent yield is
determined by dividing that portion of the High-Yield Series' yield (calculated
as described above) that is tax-exempt by one minus the stated marginal federal
income tax rate and adding the product to that portion, if any,of the yield of
the High-Yield Series that is not tax-exempt. The taxable equivalent yield of
the High-Yield Series for the one-month period ended December 31, 1997 was
_____% for a taxpayer whose income was subject to the then highest marginal
federal income tax rate of ____%.
The High-Yield Series' yield and average annual total return
will vary from time-to-time depending on market conditions, the composition of
the High-Yield Series' portfolio and operating expenses of the High-Yield
Series. These factors and possible differences in the methods used in
calculating yields and returns should be considered when comparing performance
information regarding the High-Yield Series' to information published for other
investment companies and other investment vehicles. Yields and return quotations
should also be considered relative to changes in the value of the High-Yield
Series' shares and the risk associated with the High-Yield Series' investment
objective and policies. At any time in the future, yields and return quotations
may be higher or lower than past yields or return quotations and there can be no
assurance that any historical yield or return quotation will continue in the
future. In addition, the yield and average annual total return figures set forth
above in this
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Statement of Additional Information should be evaluated in light of the limited
operating history of the High-Yield Series.
OTHER INFORMATION
As of March 31, 1998, the following persons were known by Fund
management to have owned beneficially, directly or indirectly, 5% or more of the
outstanding shares of the High Yield Series:
<TABLE>
<CAPTION>
NUMBER OF SHARES PERCENTAGE OF
NAMES & ADDRESS OWNED OUTSTANDING SHARES
- --------------- ----- ------------------
<S> <C> <C>
Vivian Kaufman (Trustee) 38,884.918 11.47%
Vivian Kaufman Revocable Trust
UA DTD 10-06-93
1900 South Ocean Blvd., #5-S
Pompano Beach, FL 33062
Louis J. & Frances M. Russo (Trustees) 18,062.316 5.33%
Louis J. Russo Grantor Rev. Trust
U/A DTD 04/15/95
3961 Dafilee Circle
West Palm Beach, FL 33417
Kenneth S. & Heidi G. Widelitz (Trustees) 67,697.336 19.97%
The Widelitz Family Trust
U/A DTD 04/15/94
10519 Lauriston Avenue
Los Angeles, CA 90064
</TABLE>
FINANCIAL STATEMENTS
Audited financial statements of the High-Yield Series for the year
ended December 31, 1997 are attached hereto.
-28-
<PAGE>
(CHART MATERIAL)
New York Muni Fund
Portfolio Composition
December 31, 1997
(unaudited)
BY TYPE
(15.8%) FCSI
(51.4%) FCLT
(20.9%) LRIB
(11.9%) INLT
BY RATING+
(4.6%) Non-income
producing bonds
(1.3%) AA
(59.6%) AAA
(19.2%) BBB
(1.9%) Not Rated
FIXED COUPON BONDS
FCLT -- Long (maturity > 15 years) (includes long zero coupons)
FCSI -- Short or Intermediate (maturity < 15 years) (includes zero coupon
bonds)
VARIABLE RATE BONDS
RIB(Residual Interest Bond) type inverse floaters. These are leveraged bonds
whose coupon varies inversely with rates on short term companion issues. The
inverse floater's price will be more volatile than that of a fixed coupon bond.
LRIB -- Long Term (maturity > 15 years)
IN (Index) based inverse floaters are bonds whose interest coupons vary
inversely with an index of short term interest rates and then revert to a fixed
rate mode. The inverse floater's price will be more volatile than that of a
fixed coupon bond.
INLT -- Long Term (maturity > 15 years)
+If a security has a split rating, the highest applicable rating is used,
including published ratings on identical credits for individual securities not
individually rated.
2
<PAGE>
(CHART MATERIAL)
$22,786
Lehman
Brothers
Municipal
Bond Index*
$15,144
Fundamental
New York
Muni
Fund, Inc.
$13,926
Consumer
Price Index
- --------------------------------------------------------------------------------
New York Muni Fund
- --------------------------------------------------------------------------------
Average Annual Total Return
Ended on 12/31/97
- --------------------------------------------------------------------------------
1 Year 5 Year 10 Year
- --------------------------------------------------------------------------------
1.46% (0.62)% 4.24%
- --------------------------------------------------------------------------------
Thousands ($)
24 22 20 18 16 14 12 10
12/31/87 12/31/88 12/31/89 12/31/90 12/31/91 12/31/92 12/31/93 12/31/94
12/31/95 12/31/96 12/31/97
Past performance is not predictive of future performance.
The above illustration compares a $10,000 investment made in the New York Muni
Fund on 12/31/87 to a $10,000 investment made in the Lehman Brothers Municipal
Bond Index on that date. All dividends and capital gain distributions are
reinvested.
The Fund invests primarily in New York municipal securities and its performance
takes into account fees and expenses. Unlike the Fund, the Lehman Brothers
Municipal Bond Index is an unmanaged total return performance benchmark for the
long-term, investment-grade tax exempt bond market, calculated by using
municipal bonds selected to be representative of the market. The Index does not
take into account fees and expenses. Further information relating to Fund
performance, including expense reimbursements, if applic able, is contained in
the Fund's Prospectus and elsewhere in this report.
*Source:Lehman Brothers.
The Consumer Price Index is a commonly used measure of inflation; it does not
represent an investment return.
3
<PAGE>
(LEFT COLUMN)
NEW YORK MUNI FUND
STATEMENT OF ASSETS AND LIABILITIES
December 31, 1997
- --------------------------------------------------------------------------------
ASSETS
Investment in securities at value
(Note 4) (cost $127,411,133)..................... $122,737,274
Receivables:
Interest......................................... 1,484,267
Fund shares sold................................. 58,146,118
-----------
Total assets.............................. 182,367,659
-----------
LIABILITIES
Notes payable (Note 6)............................. 38,177,582
Payables:
Fund shares redeemed............................. 347,948
Investment securities purchased.................. 8,826,774
Dividend declared................................ 27,444
Due to advisor................................... 24,366
Accrued expenses................................. 368,138
-----------
Total liabilities................................. 47,772,252
-----------
NET ASSETS consisting of:
Distributions in excess of net
investment income................... $ (27,444)
Accumulated net realized loss ........ (24,284,760)
Unrealized depreciation of securities. (4,673,859)
Paid-in-capital applicable to
156,836,372 shares of $.01
par value capital stock............... 163,581,470
----------
$134,595,407
============
NET ASSET VALUE PER SHARE................ $.86
====
(RIGHT COLUMN)
STATEMENT OF OPERATIONS
Year ended December 31, 1997
- --------------------------------------------------------------------------------
INVESTMENT INCOME
Interest income............................... $ 7,756,494
EXPENSES (Notes 2 and 3)
Management fee............... $640,975
Custodian and accounting fees 327,214
Transfer agent fees.......... 450,401
Professional fees............ 1,050,450
Directors' fees.............. 102,427
Printing and postage......... 31,395
Interest..................... 1,431,511
Distribution expenses........ 647,839
Operating expenses on
defaulted bonds.............. 72,000
Other........................ 143,176
---------
4,897,388
Expenses reimbursed........ (40,700)
---------
Total expenses........................ 4,856,688
----------
Net investment income................. 2,899,806
----------
REALIZED AND UNREALIZED GAIN (LOSS)
ON INVESTMENTS
Net realized loss on investments (2,367,322)
Net unrealized appreciation of
investments.............. 5,608,133
---------
Net gain on investments ...................... 3,240,811
----------
NET INCREASE IN NET ASSETS
FROM OPERATIONS.................................. $6,140,617
==========
(FULL COLUMN)
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------
Year Ended Year Ended
December 31, December 31,
1997 1996
------------ ------------
<S> <C> <C>
INCREASE (DECREASE) IN NET ASSETS FROM
OPERATIONS
Net investment income...................................................... $ 2,899,806 $ 6,229,467
Net realized loss on investments........................................... (2,367,322) (2,404,362)
Unrealized appreciation (depreciation) on investments ..................... 5,608,133 (4,292,643)
----------- -----------
Net (decrease) increase in net assets from operations...................... 6,140,617 (467,538)
DISTRIBUTIONS:
Distributions from investment income....................................... (2,899,806) (6,229,467)
Distributions in excess of net investment income........................... (27,444) --
Return of capital distribution............................................. (551,666) --
Distributions from net realized gain from investments...................... (24,556) --
CAPITAL SHARE TRANSACTIONS (Note 5)........................................ (64,787,531) (23,248,833)
----------- -----------
Total decrease............................................................. (62,150,386) (29,945,838)
NET ASSETS:
Beginning of year.......................................................... 196,745,793 226,691,631
----------- -----------
End of year................................................................ $134,595,407 $196,745,793
=========== ===========
</TABLE>
See Notes to Financial Statements.
4
<PAGE>
NEW YORK MUNI FUND
STATEMENT OF CASH FLOWS
Year Ended December 31, 1997
<TABLE>
- ---------------------------------------------------------------------------------------------------------------------
<S> <C>
Increase (Decrease) in Cash
Cash Flows From Operating Activities
Net increase to net assets from operations .................................................. $ 6,140,617
Adjustments to reconcile net increase in net assets from operations
to net cash provided by operating activities:
Purchase of investment securities ......................................................... (1,574,433,817)
Proceeds on sale of securities ............................................................ 1,659,325,144
Decrease in interest receivable ........................................................... 2,324,155
Decrease in accrued expenses .............................................................. (391,142)
Net accretion of discount on securities ................................................... (111,800)
Net realized loss:
Investments ............................................................................. 2,367,322
Unrealized appreciation on securities .................................................... (5,608,133)
-------------
Net cash provided by operating activities ............................................. 89,612,346
-------------
Cash Flows From Financing Activities:*
Increase in notes payable ................................................................. 36,846,239
Proceeds on shares sold ................................................................... 2,222,770,042
Payment on shares repurchased ............................................................. (2,348,578,756)
Cash dividends paid ....................................................................... (649,871)
-------------
Net cash used in financing activities ................................................. (89,612,346)
-------------
Net decrease in cash .................................................................. 0
Cash at beginning of year ..................................................................... 0
-------------
Cash at end of year ........................................................................... $ 0
=============
<FN>
- --------------
*Non-cash financing activities not included herein consist of reinvestment of dividends of $3,233,013.
Cash payments for interest expense totaled $1,672,606.
</FN>
</TABLE>
See Notes to Financial Statements.
5
<PAGE>
NEW YORK MUNI FUND
STATEMENT OF INVESTMENTS
December 31, 1997
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------
Principal
Amount Issue ooo Type o Rating oo Value
-------- ----- ---- ----- -----
<C> <S> <C> <C> <C>
$ 1,000,000## Amherst NY Industrial Development Agency Lease Rev, SurfaceRink Complex,
LOC Keyhawk, 5.65%, 10/01/22............................................ FCLT A $ 1,015,360
1,000,000 Metropolitan Transit Authority NY Commuter Facilities Rev, Series C-1,
FGIC Insured 5.375%, 07/01/27........................................... FCLT AAA 1,011,120
300,000 Metropolitan Transit Authority NY Transportation Facilities Rev SVC Contract
Series 8 5.375%, 07/01/21............................................... FCLT A- 300,000
14,600,000x## New York Inverse Floating Rate Notes*...................................... INLT A- 14,618,104
500,000 New York NY Series B, 5.25%,0 8/01/15...................................... FCLT A- 495,445
5,290,000x## New York City, ECF, MBIA Insured, STEP** 3.75%, 04/01/08................... FCSI Aaa 5,402,042
5,925,000x## New York City, ECF, MBIA Insured, STEP** 3.75%, 10/01/08................... FCSI Aaa 6,046,463
2,200,000x## New York City, IDA, Imclone Systems Inc Project AMT 11.25%, 07/01/04....... FCSI NR 2,296,404
2,000,000 New York City, IDA, Brooklyn Navy Yard Cogen Partners AMT 5.75%, 10/01/36 . FCLT Baa3 2,017,800
6,700,000 New York City, MWFA, Water &Sewer Systems Rev Residual Int Tr Rcpts,
Series 29, FGIC Insured, 6.562%, 06/15/30............................... LRIB Aaa 6,497,258
1,030,000 New York City, IDA, Civic Facilities Rev, Anti-Defamation League Foundation
Ser A, MBIA Insured, 5.375%, 06/01/27.................................. FCLT Aaa 1,042,226
3,500,000## New York City, IDA, Special Facilities Rev, United Airlines Inc. Project,
AMT, 5.65%, 10/01/32.................................................... FCLT Baa3 3,538,605
4,970,000## New York State, DAR, City University Systems Series C 5.00%, 07/01/17 ..... FCLT Baa1 4,784,270
850,000 New York State, DAR, City University Series F, FGIC TCRS Insured,
5.00%, 07/01/20......................................................... FCLT Aaa 827,611
7,550,000## New York State, DAR, Court Facilities Lease Series A 5.25%, 05/15/21 ..... FCLT Baa1 7,419,838
1,000,000 New York State, DAR, Nursing Home FHA, Rosalind &Joseph Gurwin
Jewish Geriatric, AMBAC Insured 5.70%, 02/01/37......................... FCLT Aaa 1,023,890
1,650,000 New York State, DAR, St. Vincent DePaul Residence, LOC Allied Banks PLC,
5.30%, 07/01/18......................................................... FCLT Aa3 1,639,803
4,500,000## New York State, DAR, City University System Residual Int Tr Recpts 27,
MBIA Insured, Liquidity The Bank of New York, 8.22%, 07/01/24........... LRIB Aaa 4,949,055
13,460,000## New York State, DAR, City University System Residual Int Tr Recpts 28,
AMBAC Insured, Liquidity The Bank of New York, 7.63%, 07/01/25.......... LRIB Aaa 14,170,553
2,510,000 New York State, DAR, Vassar Brothers Hospital, FSA Insured 5.375%, 07/01/25 FCLT Aaa 2,525,462
5,000,000 New York State, DAR, Mental Health Services Facilities Improvement
Series D, FSA Insured, 5.125%, 08/15/27................................. FCLT AAA 4,909,950
7,500,000## New York State, DAR, FHA, St Barnabas Hospital AMBAC Insured
5.45%, 08/01/35......................................................... FCLT Aaa 7,565,700
750,000 New York State, DAR, FHA, Sara Neuman Nursing Home AMBAC Insured
5.45%, 08/01/27......................................................... FCLT Aaa 755,730
1,000,000 New York State, DAR, FHA, Sara Neuman Nursing Home AMBAC Insured
5.50%, 08/01/37......................................................... FCLT Aaa 1,009,340
42,000,000 New York State, DAR, FHA, Presbyterian Hospital Series A AMBAC Insured
0.00%, 08/15/36......................................................... FCLT Aaa 5,404,560
2,000,000 New York State, DAR, FHA, Highland Hospital Rochester Series A,
MBIA Insured, 5.45%, 08/01/37........................................... FCLT Aaa 2,008,680
1,000,000 New York State, EFC, Pollution Control Rev, Ref-St Wtr-Sub-Revolving Fund
Series E, MBIA Insd, 5.00%, 06/15/11.................................... FCLT Aaa 1,009,710
2,000,000 New York State, EFC, Pollution Control Rev, Ref-St Wtr-Sub-Revolving Fund
Series E, MBIA Insd, 5.00%, 06/15/12.................................... FCLT Aaa 2,016,160
</TABLE>
6
<PAGE>
NEW YORK MUNI FUND
STATEMENT OF INVESTMENTS (continued)
December 31, 1997
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------
Principal
Amount Issue ooo Type o Rating oo Value
-------- ----- ---- ----- -----
<C> <S> <C> <C> <C>
$ 4,040,000 New York State, HFA, Service Contract Obligation Rev Series C, 5.50%, 03/15/25. FCLT Baa1 $ 4,064,644
5,000,000## New York State, MCFFA, HFA, Rev, Presbyterian Hospital
MBIA-IBC Insured 5.375%, 02/15/25........................................... FCLT Aaa 5,045,500
9,805,000x# ## Niagara County NY, IDA Falls Street Faire Project AMT, 10.00% 09/01/06
(see Note 4 to Financial Statements)........................................ FCSI NR 3,509,700
5,870,000x# ## Niagara Falls NY, URA, Old Falls Street Improvement Project, 11.00% 05/01/09
(see Note 4 to Financial Statements).............................. ......... FCSI NR 2,101,167
1,760,000 Syracuse NY, IDA, Civic Facilities Rev, Crouse Health Hospital Project,
Series A 5.375%, 01/01/23................................................... FCLT BBB 1,715,124
------------
Total Investments (Cost $127,411,133 @)............................. $122,737,274
============
<FN>
* Inverse Floating Rate Notes (IFRN) are instruments whose interest rates bear an inverse relationship to the interest rate on
another security or value of an index. Rates shown are at December 31, 1997.
** Step Bonds (STEP) are instruments whose interest rate is fixed at an initial rate and then increases ("steps up") to another
fixed rate until maturity.
@ Cost for Federal income tax purposes is $127,989,424.
# The value of these non-income producing securities has been estimated by persons designated by the Fund's Board of Directors
using methods the Director's believe reflect fair value. See Note 4 to the financial statements.
## $82,462,761 market value of securities are segregated in whole or in part as collateral securing a line of credit.
x The Fund owns 100% of the security and therefore there is no trading in the security. See Note 4 to the financial
statements.
Legend
oType FCLT --Fixed Coupon Long Term
FCSI --Fixed Coupon Short or Intermediate Term
LRIB --Residual Interest Bond Long Term
INLT --Indexed Inverse Floating Rate Bond Long Term
ooRatings If a security has a split rating the highest applicable rating is used, including published ratings on identical
credits for individual securities not individually rated.
NR--Not Rated
ooolssue AMBAC American Municipal Bond Assurance Corporation
AMT Alternative Minimum Tax
CAB Capital Appreciation Bond
CFR Civic Facility Revenue
COP Certificates of Participation
DAR Dormitory Authority Revenue
ECF Educational Construction Fund
EFC Environmental Facilities Corp.
ETM Escrowed to Maturity
FGIC Financial Guaranty Insurance Corporation
FHA Federal Housing Administration
FSA Financial Security Association
GO General Obligation
HDA Housing Development Agency
HFA Housing Financing Agency
HIC Hospital Improvement Corporation
IDA Industrial Development Authority
ITEMECF Industrial, Tourist, Education, Medical and Environmental Control Facilities
LOC Letter of Credit
MBIA Municipal Bond Insurance Assurance Corporation
MCF Medical Care Facilities
MCFFA Medical Care Facilities Finance Agency
MTA Metropolitan Transit Authority
MWFA Municipal Water Finance Authority
NHRB Nursing Home Revenue Bond
RB Revenue Bond
RDA Research and Development Authority
SWMA Solid Waste Management Authority
URA Urban Renewal Authority
See Notes to Financial Statements.
</FN>
</TABLE>
7
<PAGE>
NEW YORK MUNI FUND
NOTES TO FINANCIAL STATEMENTS
December 31, 1997
- --------------------------------------------------------------------------------
1.Significant Accounting Policies
New York Muni Fund (the Fund) is a series of Fundamental Funds, Inc. (the
"Company"). The Company is an open-end management investment company registered
under the Investment Company Act of 1940. The Fund seeks to provide a high level
of income that is excluded from gross income for Federal income tax purposes and
exempt from New York State and New York City personal income taxes. The Fund
intends to achieve its objective by investing substantially all of its total
assets in municipal obligations of New York State, its political subdivisions
and its duly constituted authorities and corporations. The Fund employs leverage
in attempting to achieve this objective. The following is a summary of
significant accounting policies followed in the preparation of its financial
statements:
Valuation of Securities--The Fund's portfolio securities are valued on
the basis of prices provided by an independent pricing service when, in the
opinion of persons designated by the Fund's directors, such prices are
believed to reflect the fair market value of such securities. Prices of
non-exchange traded portfolio securities provided by independent pricing
services are generally determined without regard to bid or last sale prices
but take into account institutional size trading in similar groups of
securities, yield, quality, coupon rate, maturity, type of issue, trading
characteristics and other market data. Securities traded or dealt in upon a
securities exchange and not subject to restrictions against resale as well
as options and futures contracts listed for trading on a securities
exchange or board of trade are valued at the last quoted sales price, or,
in the absence of a sale, at the mean of the last bid and asked prices.
Options not listed for trading on a securities exchange or board of trade
for which over-the-counter market quotations are readily available are
valued at the mean of the current bid and asked prices. Money market and
short-term debt instruments with a remaining maturity of 60 days or less
will be valued on an amortized cost basis. Municipal daily or weekly
variable rate demand instruments will be priced at par value plus accrued
interest. Securities not priced in a manner described above and other
assets are valued by persons designated by the Fund's directors using
methods which the directors believe reflect fair value.
Futures Contracts and Options Written on Future 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.
Federal Income Taxes--It is the Fund's 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 Fund declares dividends daily from its net
investment income and pays such dividends on the last business day of each
month. Distributions of net capital gains, if any, realized on sales of
investments are made annually, as declared by the Fund's Board of
Directors. 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. Premiums and original issue
discount on securities purchased are amortized over the life of the
respective securities. Realized gains and losses from the sale of
securities are recorded on an identified cost basis. Net operating expenses
incurred on properties collateralizing defaulted bonds are charged to
operating expenses as incurred. Costs incurred to restructure defaulted
bonds are charged to realized loss as incurred.
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.
8
<PAGE>
NEW YORK MUNI FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
2.Investment Advisory Fees and Other Transactions with Affiliates
Management Agreement
Under a Management Agreement, the Fund pays an investment management fee to
Fundamental Portfolio Advisors, Inc. (the Manager) equal to 0.5% of the Fund's
average daily net asset value up to $100 million and decreasing by .02% of each
$100 million increase in net assets down to 0.4% of net assets in excess of $500
million. The Manager has voluntarily agreed to reimburse the Fund an amount not
exceeding the amount of fees payable to the Manager under the agreement for any
fiscal year, if, and to the extent that the aggregate operating expenses of the
Fund for any fiscal year including the fees payable to the Manager, but
excluding interest expenses, taxes, brokerage fees and commissions, expenses
paid pursuant to the Distribution Plan, and extraordinary expenses exceeds, on
an annual basis, 1.5% of the average daily net assets of the Fund. No such
reimbursement was required for the year ended December 31, 1997 due to the
expense limitation. See Note 8.
SEC Administrative Action Against Manager
On September 30, 1997, the Securities & Exchange Commission announced that
it instituted public administrative and cease-and desist proceedings against the
Manager, the former portfolio manager of the Fund, the president of the Manager
and Fundamental Service Corporation (FSC). The proceeding arises from the
alleged failure of an affiliated mutual fund to disclose the risks of the
affiliated fund, and of the Manager's failure to disclose its soft dollar
arrangements to the Fund's Board of Directors. A hearing has been scheduled with
an admninistrative law judge to determine whether the allegations are true, and,
if so, what remedial action, if any, is appropriate.
Board's Termination of Portfolio Manager
Between April 17, 1997 and July 24, 1997, a representative of the Manager
engaged Tocqueville Securities L.P. ("Tocqueville Securities"), an affiliate of
Tocqueville (see Note 7), as agent, to effect eight separate over-the-counter
purchase transactions of municipal obligations on behalf of the Fund. The Fund's
Board has concluded that the commissions paid to Tocqueville Securities in
connection with these transactions (a portion of which was paid to the
representative) were not justified and that the Fund bore unnecessary expenses
as a result of the sale of its securities to another party and the subsequent
repurchase of them through Tocqueville Securities. Based upon a report initiated
by Tocqueville Securities and prepared by the Fund's independent auditors, and
upon the Board's own analysis, the Board directed that the Manager terminate the
representative's services as a portfolio manager. At the Board's request and in
order to reimburse the affiliated fund for all of its losses, Tocqueville
Securities, on September 15, 1997, voluntarily paid $260,000 to the Fund, an
amount which significantly exceeds the total commissions ($184,920.60) received
by Tocqueville Securities in connection with these transactions. $219,300 of the
proceeds from the reimbursement have been included in the realized gain on
investments and $40,700 have been included as an expense reimbursement in the
accompanying financial statements. The staff of the Securities and Exchange
Commission and the Department of NASD Regulation have been informed of these
events by Tocqueville Securities. See Note 7 regarding contemplated transaction
with the Tocqueville Trust.
Distribution Plan and Service Agreement
Pursuant to a Distribution Plan (the Plan) adopted pursuant to Rule 12b-1
promulgated under the Investment Company Act of 1940, the Fund may pay certain
promotional and advertising expenses and may compensate certain registered
securities dealers and financial institutions for services provided in
connection with the processing of orders for purchase or redemption of the
Fund's shares and furnishing other shareholder services. Payments by the Fund
shall not in the aggregate, in any fiscal year, exceed 0.5% of the average daily
net assets of the Fund.
Under a Service Agreement with FSC, an affiliate of the Manager, amounts
are paid under the Plan to compensate FSC for the services it provides and the
expenses it bears in distributing the Fund's shares to investors. Any cumulative
distribution expenses related to the Fund incurred by FSC in excess of the
annual maximum amount payable by the Fund under the Plan may be carried forward
for three years in anticipation of reimbursement by the Fund on a "first
in-first out" basis. If the Plan is terminated or discontinued in accordance
with its terms, the obligation of the Fund to make payments to FSC will cease
and the Fund will not be required to make payments past the termination date.
Amounts paid to FSC pursuant to the agreement totaled $307,200 for the year
ended December 31, 1997.
NASD Sanctions and Fines
On February 19, 1998, FSC and two of its executives, without admitting or
denying guilt, entered into an agreement with the National Association of
Securities Dealers, Inc. ("NASD") whereby they accepted fines totaling $125,000
and other stipulated sanctions as a result of the NASD's finding that they had
distributed advertising materials of an affiliated mutual fund which violated
NASD rules governing advertisements.
9
<PAGE>
NEW YORK MUNI FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
The Fund compensated Fundamental Shareholder Services, Inc. (FSSI), an
affiliate of the Manager, for the services it provided under a Transfer Agent
and Service Agreement which was terminated September 11, 1997. Transfer agent
fees paid to FSSI for the year ended December 31, 1997 amounted to $260,717.
3.Directors' Fees
All of the Directors 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 Director 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. The Directors also received additional
compensation for special services as requested by the Board. Additional
compensation totaled $40,923 pro rated among the funds based on their respective
average net assets.
4.Complex Securities, Concentrations of Credit Risk, and Investment Transactions
Inverse Floating Rate Notes (IFRN):
The Fund invests in variable rate securities commonly called "inverse
floaters". The interest rates on these securities have an inverse relationship
to the interest rate of other securities or the value of an index. Changes in
interest rate on the other security or index inversely affect the rate paid on
the inverse floater, and the inverse floater's price will be more volatile than
that of a fixed-rate bond. Additionally, some of these securities contain a
"leverage factor"whereby the interest rate moves inversely by a "factor" to the
benchmark rate. For example, the rates on the inverse floating rate note may
move inversely at three times the benchmark rate. Certain interest rate
movements and other market factors can substantially affect the liquidity of
IFRN's.
Concentration of Credit Risk and Transactions in Defaulted Bonds:
The Fund owned 100% of two Niagara Falls Industrial Development Agency
bonds ("IDA Bonds") due to mature on September 1, 2006, and 98.3% of a Niagara
Falls New York Urban Renewal Agency 11% bond ("URA Bond") due to mature on May
1, 2009 which are in default. The IDA Bonds are secured by commercial retail and
office buildings known as the Falls Street Faire and Falls Street Station
Projects ("Projects"). The URA Bond is secured by certain rental payments from
the Projects.
The Fund, through its investment banker and manager, negotiated the sale of
the Falls Street Station project. The net proceeds received on the sale of
approximately $2,800,000 were accounted for as a pro rata recovery of principal
of each of the bonds. The remaining principal value of the Fall Street Station
IDA Bond of approximately $3,887,000 was charged to realized loss on
investments.
The remaining two securities are being valued under methods approved by the
Board of Directors. The aggregate value of these securities is $5,610,867 (35.8%
to their aggregate face value of $15,675,000). There is uncertainty as to the
timing of events and the subsequent ability of the Projects to generate cash
flows sufficient to provide repayment of the bonds. No interest income was
accrued on these bonds during the year ended December 31, 1997. Legal,
investment banking, and other restructuring costs charged to realized loss
totaled approximately $153,000 for the year ended December 31, 1997 ($1,640,000
cumulatively from October 6, 1992 to December 31, 1997). The Fund through its
investment banker, engaged a property manager to maintain the Projects on its
behalf, and the Fund is paying the net operating expenses of the Project. Net
operating expenses related to the Projects for the year ended December 31, 1997
are disclosed in the statement of operations, and cumulatively from October 6,
1992 to December 31, 1997 totaled approximately $684,629
Additionally, the Fund owns 100% of several securities as indicated in the
Statement of Investments. As a result of its ownership position there is no
active trading in these securities. Valuations of these securities are provided
by a pricing service and are believed by the Manager to reflect fair value. The
market value of securities owned 100% by the Fund was approximately $33,973,880
(25% of net assets) at December 31, 1997.
Other Investment Transactions:
During the year ended December 31, 1997, purchases and sales of investment
securities, other than short-term obligations, were $554,177,076 and
$647,162,806, respectively.
10
<PAGE>
NEW YORK MUNI FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
As of December 31, 1997 net unrealized depreciation of portfolio securities
on a federal income tax basis amounted to $5,252,150 composed of unrealized
appreciation of $4,320,774 and unrealized depreciation of $9,572,924.
The Fund has capital loss carryforwards available to offset future capital
gains as follows:
Amount Expiration
------ ----------
$18,503,000 December 31, 2002
3,430,000 December 31, 2004
2,214,000 December 31, 2005
-----------
$24,147,000
===========
5.Capital Stock
As of December 31, 1997 there were 500,000,000 shares of $.01 par value
capital stock authorized. Transactions in capital stock were as follows:
<TABLE>
<CAPTION>
Year Ended Year Ended
December 31, 1997 December 31, 1996
-------------------------- --------------------------
Shares Amount Shares Amount
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Shares sold......................... 2,692,167,470 $2,280,916,160 3,704,110,578 $3,314,430,819
Shares issued on reinvestment
of dividends........................ 3,788,810 3,223,013 5,501,544 4,939,206
Shares redeemed .................... (2,765,077,644) (2,348,926,704) (3,714,943,217) (3,342,618,858)
-------------- -------------- -------------- --------------
Net (decrease) ..................... (69,121,364) $ (64,787,531) (5,331,095) $ (23,248,833)
============== ============== ============== ==============
</TABLE>
6.Line of Credit
The Fund has line of credit agreements with banks collateralized by cash
and portfolio securities. Borrowings under these agreements bear interest linked
to the banks' prime rate. Pursuant to these agreements $38,177,582 was
outstanding at December 31, 1997.
The maximum month end and the average borrowings outstanding during the year
ended December 31, 1997 were $82,500,000 and $20,630,505, respectively.
7. Agreement and Plan of Reorganization
On July 15, 1997 each of Fundamental's mutual funds (consisting of: New
York Muni Fund, The California Muni Fund, Fundamental Fixed Income Fund: Tax
Free Money Market Series, High Yield Municipal Bond Series, and Fundamental U.S.
Government Strategic Income Fund Series) have adopted, subject to shareholder
approval, an Agreement and Plan of Reorganization (the "Plan") under which each
fund (the "Fundamental Fund") will transfer all of its assets and liabilities to
a newly-created corresponding series of The Tocqueville Trust (the "Tocqueville
Fund") in exchange for shares of the Tocqueville Fund. Shareholders of each
Fundamental Fund will receive shares of the corresponding Tocqueville Fund equal
in value to their shares in the Fundamental Fund. Shareholders will not have to
pay a sales load upon receiving shares of the Tocqueville Fund.
The corresponding Tocqueville Fund will have investment objectives, polices
and restrictions substantially identical to those of the Fundamental Fund. The
Board of Trustees of the Tocqueville Funds is comprised of individuals other
than those who currently serve as Directors (Trustees) of the Fundamental Funds.
Tocqueville Asset Management L.P. is the investment adviser to the Tocqueville
Funds.
A majority of Fundamental's Board Members determined that the Plan would be
in the best interests of shareholders of the Fundamental Funds and recommended
that shareholders of each of the Fundamental Funds approve the Plan at a meeting
anticipated to be held in the Spring of 1998.
8. Subsequent Event
At its March 25, 1998 Board of Directors' meeting, the Board of the Fund
approved the continuation of the Management Agreement through May 30, 1998 in
contemplation of the consummation of the reorganization discussed in Note 7.
11
<PAGE>
NEW YORK MUNI FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
The Manager and FSC (on behalf of certain of their directors, officers,
shareholders, employees and control persons) (the "Indemnitees") received
payment during the fiscal year ended December 31, 1997 from the Fund in the
amount of approximately $50,230. Upon learning of the payments, the independent
Board Members of the Funds directed that the Indemnitees return all of the
payments to the Funds or place them in escrow pending their receipt of an
opinion of an inedpendent legal counsel to the effect that the Indemnitees are
entitled to receive them. The Declaration of Trust, Articles of Incorporation
and contracts that call for indemnification specify that no indemnification
shall be provided to a person who shall be found to have engaged in "disabling
conduct" as defined by applicable law. The Indemnities have undertaken to
reimburse the Fund for any indemnification expenses for which it is determined
that they were not entitled to as a result of "disabling conduct" net of any
reimbursements already made to the Fund in the form of fees forgone or other
similar payments.
FSC waived fees in the amount of $51,200 in 1998. The Manager and FSC have
asserted that they elected to forgo these fees because the Fund was paying legal
expenses pursuant to indemnification. The Fund has retained independent legal
counsel to determine whether the Indemnitees engaged in disabling conduct.
Pending clarification of the legal issues involved, the Independent Directors
have instructed the Manager to escrow the full amount incurred by the Fund of
approximately $50,230.
9. Selected Financial Information
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE
(for a share outstanding throughout the year)
Net Asset Value, Beginning of Year ....................... $0.87 $0.98 $0.88 $1.18 $1.21
----- ----- ----- ----- -----
Income from investment operations:
Net investment income .................................... .021 .035 .035 .056 .065
Net realized and unrealized gains (losses)
on investments ........................................... (.009) (.110) .101 (.290) .082
---- ----- ----- ----- -----
Total from investment operations ......................... .012 (.075) .136 (.234) .147
----- ----- ----- ----- -----
Less Distributions:
Dividends from net investment income ..................... (.019) (.035) (.035) (.056) (.065)
Return of capital distributions........................... (.003) -- -- -- --
Dividends from net realized gains ........................ -- -- (.001) (.010) (.112)
----- ----- ----- ----- -----
Total distributions ...................................... (.022) (.035) (.036) (.066) (.177)
----- ----- ----- ----- -----
Net Asset Value, End of Year ............................. $0.86 $0.87 $0.98 $0.88 $1.18
===== ===== ===== ===== =====
Total Return ............................................. 1.46% (7.73%) 15.67% (20.47%) 12.58%
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (000) ............................ $134,595 $196,746 $226,692 $212,665 $275,552
Ratios to Average Net Assets:
Interest expense ......................................... 1.10% 2.11% 2.09% 1.59% .61%
Operating expenses ....................................... 2.64% 1.66% 1.55% 1.62% 1.44%
----- ----- ----- ----- -----
Total expenses ........................................... 3.74%+ 3.77% 3.64% 3.21% 2.05%
===== ===== ===== ===== =====
Net investment income .................................... 2.23%+ 3.89% 3.81% 5.34% 5.20%
Portfolio turnover rate .................................. 399.38% 347.44% 347.50% 289.69% 404.05%
</TABLE>
12
<PAGE>
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
BANK LOANS
Amount outstanding at end of year (000 omitted) .......... $38,178 $1,200 $64,575 $20,000 $20,873
Average amount of bank loans outstanding during the year
(000 omitted) ............................................ $20,631 $49,448 $49,603 $54,479 $24,100
Average number of shares outstanding during the year
(000 omitted) ............................................ 153,535 178,456 191,692 206,323 184,664
Average amount of debt per share during the year ......... $ .134 $ .277 $ .259 $ .264 $ .131
<FN>
+These ratios are after expense reimbursement of .03% for the year ended December 31, 1997.
</FN>
</TABLE>
13
<PAGE>
INDEPENDENT AUDITOR'S REPORT
- --------------------------------------------------------------------------------
The Board of Directors and Shareholders
New York Muni Fund
We have audited the accompanying statement of assets and liabilities, including
the statement of investments, of New York Muni Fund as of December 31, 1997, and
the related statements of operations and cash flows for the year then ended, the
statements of changes in net assets for each of the two years in the period then
ended, and selected financial information for each of the five years in the
period then ended. 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, 1997 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 New York Muni Fund as of December 31, 1997 and the results of its
operations, cash flows, changes in net assets, and selected financial
information for the periods indicated, in conformity with generally accepted
accounting principles.
See Notes 2 and 8 for information regarding regulatory proceedings and
transactions with affiliates.
S I G N A T U R E
New York, New York
March 2, 1998, except for Note 8 as to which the date is April 30, 1998.
14
<PAGE>
THE CALIFORNIA MUNI FUND
(LEFT COLUMN)
STATEMENT OF ASSETS AND LIABILITIES
December 31, 1997
- --------------------------------------------------------------------------------
ASSETS
Investment in securities
at value (cost $8,917,684) ................. $ 9,183,831
Interest receivable .......................... 252,201
Receivable for fund shares sold .............. 4,962,106
-----------
Total assets ..................... 14,398,138
-----------
LIABILITIES
Loans (Note 6) ............................... 503,018
Dividend Payable ............................. 10,223
Accrued expenses ............................. 52,893
-----------
Total liabilities ................ 566,134
-----------
NET ASSETS consisting of:
Accumulated net realized gain ... $ 220,789
Unrealized appreciation of
securities .................... 266,147
Paid-in-capital applicable to
1,672,917 shares of beneficial
interest (Note 4) ............. 13,345,068
---------- -----------
$13,832,004
===========
NET ASSET VALUE PER SHARE $8.27
=====
(RIGHT COLUMN)
STATEMENT OF OPERATIONS
Year Ended December 31, 1997
- --------------------------------------------------------------------------------
INVESTMENT INCOME
Interest income .................. $1,009,193
EXPENSES (Notes 2 and 3)
Management fee ................... $63,726
Custodian and accounting fees .... 60,460
Transfer agent fees .............. 38,033
Professional fees ................ 144,918
Printing and postage ............. 16,886
Interest ......................... 53,011
Distribution expenses ............ 44,731
Trustees' fees ................... 10,471
-------
Total expenses ...... 432,236
Less: Expenses reim-
bursed by manager . (3,296)
Net expenses ........ ------- 428,940
----------
Net investment income 580,253
----------
REALIZED AND UNREALIZED GAIN ON
INVESTMENTS
Net realized gain on investments . 493,308
Unrealized appreciation of
investments for the year ....... 374,518
----------
Net gain on investments 867,826
----------
NET INCREASE IN NET ASSETS FROM
OPERATIONS ......................... $1,448,079
==========
(FULL COLUMN)
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
Year Ended Year Ended
December 31, December 31,
1997 1996
------------ ------------
<S> <C> <C>
INCREASE (DECREASE) IN NET ASSETS FROM:
OPERATIONS
Net investment income ................................................ $ 580,253 $ 694,929
Net realized gain on investments ..................................... 493,308 100,733
Unrealized appreciation (depreciation) of investments for the year ... 374,518 (876,013)
----------- -----------
Net increase (decrease) in net assets from operations ............ 1,448,079 (80,351)
DIVIDENDS PAID TO SHAREHOLDERS FROM
Net investment income ................................................ (580,253) (694,929)
CAPITAL SHARE TRANSACTIONS (Note 4) .................................... (3,287,401) 4,404,527
----------- -----------
Total increase (decrease) .................................... (2,419,575) 3,629,247
NET ASSETS:
Beginning of year .................................................... 16,251,579 12,622,332
----------- -----------
End of year .......................................................... $13,832,004 $16,251,579
=========== ===========
</TABLE>
See Notes to Financial Statements.
18
<PAGE>
THE CALIFORNIA MUNI FUND
STATEMENT OF CASH FLOWS
Year Ended December 31, 1997
- --------------------------------------------------------------------------------
Increase (Decrease) in Cash
Cash Flows From Operating Activities
Net increase to net assets from operations ................... $ 1,448,079
Adjustments to reconcile net increase in net assets from
operations to net cash provided by operating activities:
Purchase of investment securities .......................... (128,371,610)
Proceeds on sale of securities ............................. 136,362,253
Increase in interest receivable ............................ (5,768)
Decrease in accrued expenses ............................... (81,857)
Net accretion of discount on securities .................... (135,229)
Net realized gain:
Investments .............................................. (493,308)
Unrealized appreciation on securities ........................ (374,518)
------------
Net cash provided by operating activities ............. 8,348,042
------------
Cash Flows From Financing Activities:*
Increase in notes payable .................................. 503,018
Proceeds on shares sold .................................... 251,745,912
Payment on shares repurchased .............................. (260,415,184)
Cash dividends paid ........................................ (195,278)
------------
Net cash used in financing activities ................. (8,361,532)
------------
Net decrease in cash .................................. (13,490)
Cash at beginning of year ...................................... 13,490
------------
Cash at end of year ............................................ $ 0
============
- -----------
*Non-cash financing activities not included herein consist of reinvestment of
dividends of $419,765.
Cash payments for interest expense totaled $57,087.
See Notes to Financial Statements.
19
<PAGE>
THE CALIFORNIA MUNI FUND
<TABLE>
<CAPTION>
STATEMENT OF INVESTMENTS
December 31, 1997
- ---------------------------------------------------------------------------------------------------------------------
Principal
Amount Issue ooo Type Rating Value
------ ----- ---- ------ -----
<C> <S> <C> <C> <C>
$ 100,000(DD) Arvin, Development Corporation, COP, RB, 8.75%, 9/01/18 ............. FCLT NR $ 24,505
200,000 Beverly Hills, PFA, RB, IFRN*, MBIA Insured, 7.32%, 6/01/15 ......... LRIB AAA 209,428
100,000 CSAC Finance Corp, COP, Sutter County Health Facilities Project,
7.80%, 1/01/21 .................................................... FCLT Baa1 102,158
70,000 California, HFA, Home Mortgage, RB, Series A, MBIA Insured,
5.70%, 8/01/10 .................................................... FCSI Aaa 74,163
300,000+ California Statewide Communities Development Authority, Cedars
Sinai Medical Project, COP, RB, IFRN*, 6.97%, 11/01/15 ............ LRIB A1 290,166
300,000 East Bay, Wastewater System Project, RB, Refunding, AMBAC
Insured, IFRN*, 6.87%, 6/01/20 .................................... LRIB AAA 312,108
220,000 Hawthorne, CRA, TAR, 6.75%, 9/01/24 ................................. FCLT Baa 240,933
170,000 Lake Elsinore, USD, Refunding, COP, 6.90%, 2/01/20 .................. FCLT BBB 187,299
10,000 Los Angeles, Home Mortgage, RB, 9.00%, 6/15/18 ...................... FCLT A 10,200
1,505,192 Los Angeles, HFA, MFH Project C, CAB, RB, 12.00%, 12/01/29 .......... FCLT NR 1,112,291
35,000 Modesto, Valley Oak Project, RB, 10.60%, 5/01/09 .................... FCSI NR 35,792
250,000 Northern California Power Agency, Multiple Capital Facilities, RB,
MBIA Insured, IFRN*, 8.76%, 8/01/25 ............................... LRIB AAA 293,040
250,000 Northern California Transmission Agency, CA-ORE Transmission
Project, RB, MBIA Insured, IFRN*, 6.81%, 4/29/24 .................. LRIB AAA 254,042
500,000 Orange County Airport, RB, Refunding, MBIA Insured, 5.625%,
7/01/12 ........................................................... FCLT Aaa 526,415
250,000+ Orange County, LTA, RB, IFRN*, 8.01%, 2/14/11 ....................... LRIB AA 297,597
250,000 Orange County, LTA, RB, IFRN*, 7.81%, 2/14/11 ....................... LRIB AAA 289,027
185,000 Panoche, Water District, COP, 7.50%, 12/01/08 ....................... FCSI BBB 199,776
250,000 Rancho, Water District Financing Authority, RB, Prerefunded @
104, AMBAC Insured, IFRN*, 8.82%, 8/17/21 ......................... LRIB AAA 301,443
250,000 Redding, Electric System, COP, Series A, FGIC Insured, IFRN*,
7.20%, 6/01/19 .................................................... LRIB AAA 264,078
175,000 Riverside, HFA, Riverside Apartment Project, RB, 7.87%, 11/01/19 .... FCLT BB- 178,896
500,000 San Bernardino, COP, Series B. MBIA Insured, IFRN*, 6.38%,
7/01/16 ........................................................... INLT AAA 531,045
900,000 San Bernardino, COP, Series PA38, MBIA Insured, IFRN*,
11.92%, 7/01/16, Rule 144A Security (restricted as to resale
except to qualified institutions) ................................. LRIB NR 1,021,995
200,000 San Diego Water Authority, COP, FGIC Insured, IFRN*, 7.09%,
4/22/09 ........................................................... LRIB AAA 240,624
1,440,000x San Jose, CRA, Series PA-38, TAB, MBIA Insured, IFRN*, 5.83%,
8/01/16, Rule 144A Security (restricted as to resale except to
qualified institutions) ........................................... LRIB AAA 1,471,306
</TABLE>
20
<PAGE>
THE CALIFORNIA MUNI FUND
<TABLE>
<CAPTION>
STATEMENT OF INVESTMENTS (continued)
December 31, 1997
- ---------------------------------------------------------------------------------------------------------------------
Principal
Amount Issue ooo Type Rating Value
------ ----- ---- ------ -----
<C> <S> <C> <C> <C>
$ 250,000 Southern California Public Power Authority, FGIC Isured, IFRN*,
6.62%, 7/01/17 .................................................... LRIB AAA $ 248,070
55,000 Tri City, HFA, FNMA/GNMA Collateralized, AMT, 6.45%, 12/01/28 ....... FCLT AAA 59,388
30,000 Tri City, HFA, FNMA/GNMA Collateralized, AMT, Series B, 6.30%,
12/01/28 .......................................................... FCLT AAA 32,358
250,000 Tri City, HFA, FNMA/GNMA Collateralized, AMT, Series E, 6.40%,
12/01/28 .......................................................... FCLT AAA 271,518
100,000 Upland, HFA, RB, 7.85%, 7/01/20 ..................................... FCLT BBB 104,170
-----------
Total Investments (Cost $8,917,684#) ........................ $ 9,183,831
===========
<FN>
*Inverse Floating Rate Notes (IFRN) are instruments whose interest rates bear an inverse relationship to the interest
rate on another security or the value of an index. Rates shown are at December 31, 1997.
#Cost is the same for Federal income tax purposes.
xThe Fund owns 100% of the security and therefore there is no trading in the security.
(DD)Denotes non-income producing security: Security is in default.
+Segregated, in whole or part, a collateral securing a line of credit.
</FN>
</TABLE>
Legend
(LEFT COLUMN)
oType FCLT -Fixed Coupon Long Term
FCSI -Fixed Coupon Short or Intermediate Term
LRIB -Residual Interest Bond Long Term
INLT -Indexed Inverse Floating Rate Bond Long Term
ooRatings If a security has a split rating the highest applicable
rating is used, including published ratings on identicial
credits for individual securities not individually rated.
Ratings are unaudited.
NR -Not Rated
oooIssue AMBAC American Municipal Bond Assurance Corporation
AMT Alternative Minimum Tax
CAB Capital Appreciation Bond
CGIC Capital Guaranty Insurance Company
(RIGHT COLUMN)
COP Certificate of Participation
CRA California Redevelopment Agency
FGIC Financial Guaranty Insurance Corporation
FNMA Federal National Mortgage Association
FSA Financial Security Assurance, Inc.
GNMA Government National Mortgage Association
HFA Housing Finance Authority
LTA Local Transportation Authority
MBIA Municipal Bond Insurance Assurance Corporation
MFH Multi Family Housing
PFA Public Financing Authority
RB Revenue Bond
TAB Tax Allocation Bond
TAR Tax Allocation Refunding
USD Unified School District
See Notes to Financial Statements.
21
<PAGE>
THE CALIFORNIA MUNI FUND
NOTES TO FINANCIAL STATEMENTS
December 31, 1997
- --------------------------------------------------------------------------------
(LEFT COLUMN)
1. Significant Accounting Policies
The California Muni Fund (the Fund) was organized as a Massachusetts
business trust and is registered as an open end management investment company
under the Investment Company Act of 1940. The Fund's objective is to provide as
high a level of income that is excluded from gross income for Federal income tax
purposes and exempt from California personal income tax as is consistent with
the preservation of capital. The Fund employs leverage in attempting to achieve
its objective. The following is a summary of significant accounting policies
followed in the preparation of its financial statements:
Valuation of Securities-The Fund's portfolio securities are valued on the
basis of prices provided by an independent pricing service when, in the opinion
of persons designated by the Fund's trustees, such prices are believed to
reflect the fair market value of such securities. Prices of non-exchange traded
portfolio securities provided by independent pricing services are generally
determined without regard to bid or last sale prices but take into account
institutional size trading in similar groups of securities, yield, quality,
coupon rate, maturity, type of issue, trading characteristics and other market
data. Securities traded or dealt in upon a securities exchange and not subject
to restrictions against resale as well as options and futures contracts listed
for trading on a securities exchange or board of trade are valued at the last
quoted sales price, or, in the absence of a sale, at the mean of the last bid
and asked prices. Options not listed for trading on a securities exchange or
board of trade for which over-the-counter market quotations are readily
available are valued at the mean of the current bid and asked prices. Money
market and short-term debt instruments with a remaining maturity of 60 days or
less will be valued on an amortized cost basis. Securities not priced in a
manner described above and other assets are valued by persons designated by the
Fund's trustees using methods which the trustees believe accurately reflects
fair value.
Federal Income Taxes-It is the Fund's 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.
(RIGHT COLUMN)
Distributions-The Fund declares dividends daily from its net investment
income and pays such dividends on the last business day of each month.
Distributions of net capital gains, if any, realized on sales of investments are
made annually, as declared by the Fund's 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. Premiums and original issue discount on
securities purchased are amortized over the life of the respective securities.
Realized gains and losses from the sale of securities are recorded on an
identified cost basis.
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.
2. Investment Advisory Fees and Other Transactions With Affiliates
Management Agreement
Under a Management Agreement, the Fund pays an investment management fee to
Fundamental Portfolio Advisors, Inc. (the Manager) equal to 0.5% of the Fund's
average daily net asset value up to $100 million and decreasing by .02% of each
$100 million increase in net assets down to 0.4% of net assets in excess of $500
million. See Note 8.
SEC Administrative Action Against the Manager
On September 30, 1997, the Securities & Exchange Commission announced that
it instituted public administrative and cease-and desist proceedings against the
Manager, the former portfolio manager of the Fund, the president of the Manager
and Fundamental Service Corporation (FSC). The proceeding arises from the
alleged failure of an affiliated mutual fund to disclose the risks of the
affiliated Fund, and of the Manager's failure to disclose its soft dollar
arrangements to the Fund's Board of Trustees. A hearing has been sched-
22
<PAGE>
THE CALIFORNIA MUNI FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
(LEFT COLUMN)
uled with an administrative law judge to determine whether the allegations are
true, and, if so, what remedial action, if any, is appropriate.
Board's Termination of Portfolio Manager
Between April 17, 1997 and July 24, 1997, a representative of the Manager
engaged Tocqueville Securities L.P. ("Tocqueville Securities"), an affiliate of
Tocqueville (see note 7), as agent, to effect eight separate over-the-counter
purchase transactions of municipal obligations on behalf of an affiliated fund.
The affiliated fund's Board has concluded that the commissions paid to
Tocqueville Securities in connection with these transactions (a portion of which
was paid to the representative) were not justified and that the affiliated fund
bore unnecessary expenses as a result of the sale of its securities to another
party and the subsequent repurchase of them through Tocqueville Securities.
Based upon a report initiated by Tocqueville Securities and prepared by the
Fund's independent auditors, and upon the Board's own analysis, the Board
directed that the Manager terminate its representative's services as a portfolio
manager. At the Board's request and in order to reimburse the affiliated fund
for all of its losses, Tocqueville Securities, on September 15, 1997,
voluntarily paid $260,000 to the affiliated fund, an amount which significantly
exceeds the total commissions ($184,920.60) received by Tocqueville Securities
in connection with these transactions. The staff of the Securities and Exchange
Commission and the Department of NASD Regulation have been informed of these
events by Tocqueville Securities. See Note 7 regarding contemplated transaction
with the Tocqueville Trust.
Distribution Plan and Service Agreement
Pursuant to a Distribution Plan (the Plan) adopted pursuant to Rule 12b-1,
promulgated under the Investment Company Act of 1940, the Fund may pay certain
promotional and advertising expenses and may compensate certain registered
securities dealers and financial institutions for services provided in
connection with the processing of orders for purchase or redemption of the
Fund's shares and furnishing other shareholder services. Payments by the Fund
shall not in the aggregate, in any fiscal year, exceed 0.5% of the average daily
net assets of the Fund.
(RIGHT COLUMN)
Under a Service Agreement with FSC, an affiliate of the Manager, amounts are
paid under the Plan to compensate FSC for the services it provides and the
expenses it bears in distributing the Fund's shares to investors. Distribution
fees for the year ended December 31, 1997 are set forth in the Statement of
Operations of which approximately $39,200 was paid by FSC.
NASD Sanctions and Fines
On February 19, 1998, FSC and two of its executives, without admitting or
denying guilt, entered into an agreement with the National Association of
Securities Dealers Inc. ("NASD") whereby they accepted fines totaling $125,000
and other stipulated sanctions as a result of the NASD's finding that they had
distributed advertising materials of an affiliated mutual fund which violated
NASD rules governing advertisements.
Affiliated Transfer Agent
The Fund compensated Fundamental Shareholder Services, Inc. (FSSI), an
affiliate of the Manager, for the services it provided under a Transfer Agent
and Service Agreement which terminated on September 11, 1997. Transfer agent
fees paid to FSSI for the year ended December 31, 1997 aggregated $28,066.
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. The Trustees also received additional
compensation for special services as requested by the Board. Additional
compensation totaled $40,923 pro rated among the funds based on their respective
average net assets.
4. Shares of Beneficial Interest
As of December 31, 1997 there were an unlimited number of shares of
beneficial interest (no par value) authorized and capital paid in amounted to
$13,345,068. Transactions in shares were as follows:
23
<PAGE>
THE CALIFORNIA MUNI FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
(LEFT COLUMN)
Year Ended Year Ended
December 31, 1997 December 31, 1996
----------------- -----------------
Shares Amount Shares Amount
------ ------ ------ ------
Shares sold 32,632,214 $256,708,018 29,177,580 $234,552,576
Shares issued
on
reinvest-
ment of
dividends 51,101 419,765 58,802 472,727
Shares
redeemed (33,097,092) (260,415,184) (28,566,533) (230,620,776)
----------- ------------ ----------- ------------
Net increase
(decrease) (413,777) (3,287,401) 669,849 $ 4,404,527
======== ========== ======= ============
5. Complex Securities and Investment
Transactions
Inverse Floating Rate Notes:
The Fund invests in variable rate securities commonly called "inverse
floaters". The interest rates on these securities have an inverse relationship
to the interest rate of other securities or the value of an index. Changes in
interest rate on the other security or index inversely affect the rate paid on
the inverse floater, and the inverse floater's price will be more volatile than
that of a fixed rate bond. Certain interest rate movements and other market
factors can substantially affect the liquidity of IFRN's.
Investment Transactions:
During the year ended December 31, 1997, the cost of purchases and proceeds
from sales of investment securities, other than short-term obligations, were
$9,050,450 and $13,516,911, respectively.
As of December 31, 1997 the net unrealized appreciation of portfolio
securities amounted to $266,147 composed of unrealized appreciation of $744,806
and unrealized depreciation of $478,659.
(RIGHT COLUMN)
6. Line of Credit
The Fund has a line of credit agreement with its custodian bank
collateralized by portfolio securities. Borrowings under this agreement bear
interest linked to the bank's prime rate. The maximum month end and the average
borrowings outstanding during the year ended December 1997, were $2,000,000 and
$664,000, respectively.
7. Agreement and Plan of Reorganization
On July 16, 1997 each of Fundamental's mutual funds (consisting of: New York
Muni Fund, The California Muni Fund, Fundamental Fixed Income Fund: Tax Free
Money Market Series, High Yield Municipal Bond Series, and Fundamental U.S.
Government Strategic Income Fund Series) have adopted, subject to shareholder
approval, an Agreement and Plan of Reorganization (the "Plan") under which each
fund (the "Fundamental Fund") will transfer all of its assets and liabilities to
a newly-created corresponding series of The Tocqueville Trust (the "Tocqueville
Fund") in exchange for shares of the Tocqueville Fund. Shareholders of each
Fundamental Fund will receive shares of the corresponding Tocqueville Fund equal
in value to their shares in the Fundamental Fund. Shareholders will not have to
pay a sales load upon receiving shares of the Tocqueville Fund.
The corresponding Tocqueville Fund will have investment objectives, polices
and restrictions substantially identical to those of the Fundamental Fund. The
Board of Trustees of the Tocqueville Funds is comprised of individuals other
than those who currently serve as Directors (Trustees) of the Fundamental Funds.
Tocqueville Asset Management L.P. is the investment adviser to the Tocqueville
Funds.
A majority of Fundamental's Board Members determined that the Plan would be
in the best interests of shareholders of the Fundamental Funds and recommended
that shareholders of each of the Fundamental Funds approve the Plan at a meeting
anticipated to be held in the Spring of 1998.
24
<PAGE>
THE CALIFORNIA MUNI FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
8. Subsequent Event
At its March 25, 1998 Board of Trustees' meeting, the Board of the Fund
approved the continuation of the Management Agreement through May 30, 1998 in
contemplation of the consummation of the reorganization discussed in Note 7.
The Manager and FSC (on behalf of certain of their directors, officers,
shareholders, employees and control persons) (the "Indemnitees") received
payment during the fiscal year ended December 31, 1997 from the Fund in the
amount of approximately $4,000. Upon learning of the payments, the independent
Board Members of the Funds directed that the Indemnitees return all of the
payments to the Funds or place them in escrow pending their receipt of an
opinion of an independent legal counsel to the effect that the Indemnitees are
entitled to receive them. The Declaration of Trust, Articles of Incorporation
and contracts that call for indemnification specify that no indemnification
shall be provided to a person who shall be found to have engaged in "disabling
conduct" as defined by applicable law. The Indemnities have undertaken to
reimburse the Fund for any indemnification expenses for which it is determined
that they were not entitled to as a result of "disabling conduct" net of any
reimbursements already made to the Fund in the form of fees forgone or other
similar payments. Pending clarification of the legal issues involved, the
Indemnitees have placed into an escrow account $4,000 as of April 30, 1998.
9. Selected Financial Information
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE
(for a share outstanding throughout the year)
Net Asset Value, Beginning of Year ......................... $ 7.79 $ 8.91 $ 7.10 $ 9.49 $ 8.81
------- ------- ------- ------- -------
Income from investment operations:
Net investment income ...................................... .376 .409 .419 .553 .563
Net realized and unrealized gains (losses)
on investments ........................................... .480 (1.120) 1.810 (2.390) .876
------- ------- ------- ------- -------
Total from investment operations .................... .856 (.711) 2.229 (1.837) 1.439
------- ------- ------- ------- -------
Less Distributions:
Dividends from net investment income ....................... (.376) (.409) (.419) (.553) (.563)
Dividends from net realized gains .......................... - - - - (.196)
------- ------- ------- ------- -------
Total distributions ........................................ (.376) (.409) (.419) (.553) (.759)
------- ------- ------- ------- -------
Net Asset Value, End of Year ............................... $ 8.27 $ 7.79 $ 8.91 $ 7.10 $ 9.49
======= ======= ======= ======= =======
Total Return ............................................... 11.33% (8.01%) 32.02% (19.89%) 16.80%
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (000) .............................. 13,832 16,252 12,622 10,558 16,280
Ratios to Average Net Assets:
Interest expense ......................................... .42 .45% .39% .98% .39%
Operating expenses ....................................... 2.95* 2.81% 2.81% 2.50% 1.77%*
------- ------- ------- ------- -------
Total expenses ...................................... 3.37* 3.26% 3.20% 3.48% 2.16%*
======= ======= ======= ======= =======
Net investment income ............................... 4.55%* 4.88% 5.02% 6.80% 6.04%*
Portfolio turnover rate .................................... 70.86% 89.83% 53.27% 15.88% 51.26%
BANK LOANS
Amount outstanding at end of year (000 omitted) ............ $ 275 $ 0 $ 0 $1,292 $3,714
Average amount of bank loans outstanding during the year
(000 omitted) ............................................ $ 664 $ 823 $ 642 $1,620 $ 958
Average number of shares outstanding during the year
(000 omitted) ............................................ 1,609 1,768 1,635 1,711 1,517
Average amount of debt per share during the year ........... $ .41 $ .47 $ .39 $ .95 $ .63
<FN>
*These ratios are after expense reimbursement of .03%, and .50% for the years ended December 31, 1997 and 1993.
</FN>
</TABLE>
25
<PAGE>
INDEPENDENT AUDITOR'S REPORT
The Board of Trustees and Shareholders
The California Muni Fund
We have audited the accompanying statement of assets and liabilities
including the statement of investments of The California Muni Fund as of
December 31, 1997 and the related statements of operations and cash flows for
the year then ended, statements of changes in net assets for each of the two
years in the period then ended, and the selected financial information for each
of the five years in the period then ended. 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, 1997 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 California Muni Fund as of December 31, 1997, the results of its
operations, cash flows, changes in its net assets, and selected financial
information for the periods indicated, in conformity with generally accepted
accounting principles.
See Notes 2 and 8 for information regarding regulatory proceedings and
transactions with affiliates.
S I G N A T U R E
New York, New York
March 2, 1998, except for Note 8 as to which the date is April 30, 1998.
26
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
TAX-FREE MONEY MARKET SERIES
(LEFT COLUMN)
STATEMENT OF ASSETS AND LIABILITIES
December 31, 1997
- --------------------------------------------------------------------------------
ASSETS
Cash ............................................ $ 1,776,944
Investment in securities at value
(cost $75,869,410) ............................ 75,869,410
Receivables:
Fund shares sold .............................. 135,853
Interest ...................................... 270,975
-----------
Total assets .......................... 78,053,182
-----------
LIABILITIES
Payables:
Investment securities purchased ............... 1,103,151
Fund shares redeemed .......................... 63,627,947
Dividends ..................................... 9,321
Due to advisor ................................ 10,866
Accrued expenses ................................ 38,729
-----------
Total liabilities ..................... 64,790,014
-----------
NET ASSETS equivalent to $1.00 per share on
13,270,069 shares of beneficial interest
outstanding (Note 4) ............................. $13,263,168
===========
(RIGHT COLUMN)
STATEMENT OF OPERATIONS
Year Ended December 31, 1997
- --------------------------------------------------------------------------------
INVESTMENT INCOME
Interest income ................... $1,729,572
EXPENSES (Notes 2 and 3)
Investment advisory fees ..........$245,844
Custodian and accounting fees ..... 41,002
Transfer agent fees ............... 84,687
Trustees' fees .................... 10,041
Professional fees ................. 88,996
Distribution fees ................. 245,844
Postage and printing .............. 22,506
Other ............................. 12,291
--------
Total expenses .......... 751,211
Less:
Expenses paid indirectly (Note 6) . (41,002)
Expenses reimbursed by Manager .... (5,982)
--------
Net expenses ............ 704,227
----------
NET INCREASE IN NET ASSETS FROM
OPERATIONS $1,025,345
----------
(FULL COLUMN)
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
Year Ended Year Ended
December 31, December 31,
1997 1996
------------ ------------
INCREASE (DECREASE) IN NET ASSETS FROM:
OPERATIONS
Net investment income .......................... $ 1,025,345 $ 1,161,235
----------- -----------
Net increase in net assets from operations. 1,025,345 1,161,235
DIVIDENDS PAID TO SHAREHOLDERS FROM
Investment income .............................. (1,025,345) (1,161,235)
CAPITAL SHARE TRANSACTIONS (Note 4) .............. 8,642,404 (6,629,783)
----------- -----------
Total (decrease) increase ................. 8,642,404 (6,629,783)
NET ASSETS
Beginning of year .............................. 4,620,764 11,250,547
----------- -----------
End of year .................................... $13,263,168 $ 4,620,764
=========== ===========
See Notes to Financial Statements.
27
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
TAX-FREE MONEY MARKET SERIES
<TABLE>
<CAPTION>
STATEMENT OF INVESTMENTS
December 31, 1997
- ------------------------------------------------------------------------------------------------------------
Principal
Amount Issue o Value
------ ----- -----
<C> <S> <C>
$2,700,000 Ascension Parish, LA, PCR, BASF Wyandote Corp, LOC Bank of Tokyo,
VRDN*, 5.10%, 12/01/15 ..................................................... $2,700,000
1,500,000 Burke County, GA, Development Authority, VRDN*, PCR, Georgia Power Co.
Vogtle Project 5th Series, 5.00%, 7/01/24 .................................. 1,500,000
4,000,000 Burke County, GA, Development Authority, VRDN*, PCR, Georgia Power Co.
Vogtle Project 4th Series, 5.00%, 9/01/25 .................................. 4,000,000
2,800,000 Columbia AL, IDB, PCR Alabama Power Co. Project, VRDN*, Series D, 5.00%,
10/01/22 ................................................................... 2,800,000
75,000 Cuyahoga County, OH, IDR, S & R Playhouse Realty, VRDN*, LOC Marine
Midland Bank, 3.85%, 12/01/09 .............................................. 75,000
200,000 Delaware County, PA, SWDF, Scott Paper Project, Kimberly-Clark Corp
Guaranty, VRDN*, 3.65%, 12/01/18 ............................................ 200,000
200,000 Fulton County, GA, PCR, General Motors Project, VRDN*, 3.90%, 4/01/10 ........ 200,000
200,000 Garfield County, OK, PCR, Oklahoma Gas & Electric Co. Project A, VRDN*,
3.75%, 1/01/25 ............................................................. 200,000
125,000 Genesee County, NY, IDR, Orcon Industries, AMT, LOC Fleet Bank, VRDN*,
4.50%,12/01/98 ............................................................. 125,000
300,000 Illinois Educational Facility Authority, RB, Art Institute of Chicago, Northern
Trust Liquidity, VRDN*, 3.85%, 3/01/27 ..................................... 300,000
300,000 Illinois HFAR, Franciscan Sisters Project, LOC Toronto Dominion Bank,
VRDN*, 3.65%, 9/01/15 ...................................................... 300,000
2,000,000 Illinois HFAR, Healthcorp Affiliates Project, LOC Raborbank Nederland,
VRDN*, 4.05%, 11/01/20 ..................................................... 2,000,000
2,855,000 Jackson County, Miss., PCR, Chevron Corp. Project, VRDN*, 5.00%,
12/01/16 ................................................................... 2,855,000
3,700,000 Los Angeles, CA, Regional Airports Improvement Corp, LOC Societe
Generale, VRDN*, 5.00%, 12/01/25 ........................................... 3,700,000
200,000 McIntosh, AL, PCR, Ciba Geigy Project, LOC Swiss Bank Corp. VRDN*,
3.65%, 12/01/03 ............................................................ 200,000
5,000,000 Midland County, MI, Economic Development Corp, Dow Chemical Project B,
AMT, VRDN*, 5.00%, 12/01/15 ................................................ 5,000,000
300,000 Missouri, PCR, Monsanto Project, VRDN*, 3.70%, 2/01/09 ....................... 300,000
200,000 Missouri, Third Street Building Project, SPA First Chicago, VRDN*, 3.90%,
8/01/99 .................................................................... 200,000
300,000 Montgomery, AL, Baptist Medical Center, Special Care Facilities Financing
Authority, Series H, AMBAC Insured, VRDN*, 3.70%, 12/01/30 ................. 300,000
200,000 Nebraska Higher Education Loan Program, SPA, SLMA, MBIA Insured,
VRDN*, 3.65%, 12/01/15 ..................................................... 200,000
</TABLE>
28
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
TAX-FREE MONEY MARKET SERIES
<TABLE>
<CAPTION>
STATEMENT OF INVESTMENTS (continued)
December 31, 1997
- ------------------------------------------------------------------------------------------------------------
Principal
Amount Issue o Value
------ ----- -----
<C> <S> <C>
$ 5,100,000 New York City, NY, GO, LOC Chase Manhattan Bank, VRDN*, 5.00%, 8/01/23 ...... $5,100,000
2,500,000 New York City, NY, GO, Landesbank Hessen Liquidity, VRDN*, 3.60%, 2/15/20 ... 2,500,000
4,000,000 New York City, NY, Municipal Water Finance Authority, Water & Sewer System
RB, TR Receipts Series 29, The Bank of New York Liquidity, VRDN*,
3.90%, 6/15/30 ............................................................ 4,000,000
40,000 New York City, NY, New PHA, 3.38%, 01/01/98 ................................. 39,740
10,700,000x New York State, DAR, TRS 27, 3.95%, 7/01/24, City University, Floating Rate
Trust Receipts 27, MBIA Insured, Liquidity The Bank of New York ........... 10,700,000
3,000,000 New York State Energy Research & Development Authority, PCR, New York,
State Electric & Gas Co., Series D, LOC Union Bank of Switzerland,
VRDN*, 5.00%, 10/01/29 .................................................... 3,000,000
2,100,000 New York State, Job Development Authority, St. Gtd., Special Purpose Series
A-1 thru A-25, LOC Sumitomo Bank, VRDN*, 5.25%, 3/01/07 ................... 2,100,000
5,200,000 Newport Beach CA, RB, Hoag Memorial Hospital Series B, SPA Bank of
America, 5.00%, 10/01/06 .................................................. 5,200,000
50,000 North Little Rock, AR, New PHA, FGIC Insured, 3.25%, 6/01/98 ................ 49,670
1,100,000 Orange County, CA, Water District Project B, COP, LOC National
Westminister VRDN*, 4.85%, 8/15/15 ........................................ 1,100,000
4,000,000 Princeton, IN, PCR, PSI Energy, Inc., Proj., LOC Morgan Guaranty, VRDN*,
5.10%, 4/01/22 ............................................................ 4,000,000
125,000 Scioto County, OH, HFR, VHA, Central Capital Project, AMBAC Insured,
VRDN*, 3.70%, 12/01/25 .................................................... 125,000
4,500,000 Sweetwater County, WY, PCR, Idaho Power Co. Project Series C, VRDN*,
5.10%, 7/15/26 ............................................................ 4,500,000
1,600,000 Uinta County, WY, PCR, Chevron Corp Project, VRDN*, 5.00%, 8/15/20 .......... 1,600,000
4,500,000 Valdez, AK, Marine Term Revenue, Exxon Pipeline Co. Project A, VRDN*,
5.00%, 12/01/33 ........................................................... 4,500,000
200,000 Wake County, NC, PCR, Carolina Power & Light Project, LOC Sumitomo
Bank, VRDN*, 4.15%, 10/01/15 .............................................. 200,000
-----------
Total Investments (Cost $75,869,410) ........................................ $75,869,410
===========
<FN>
*Variable Rate Demand Notes (VRDN) are instruments whose interest rate changes on a specific date and/or
whose interest rates vary with changes in a designated base rate.
**Cost is the same for Federal income tax purposes.
xThe Fund owns 100% of the security and therefore there is no trading in the security.
</FN>
</TABLE>
29
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
TAX-FREE MONEY MARKET SERIES
STATEMENT OF INVESTMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
Legend
Issue AMBAC American Municipal Bond Assurance Corporation
DAR Dormitory Authority Revenue
AMT Alternative Minimum Tax
GO General Obligation
ETM Escrowed to Maturity
HFAR Health Facilities Authority Revenue
HFR Hospital Facilities Revenue
IDB Industrial Development Board
IDR Industrial Development Revenue
LOC Letter of Credit
MBIA Municipal Bond Insurance Assurance Corporation
PCR Pollution Control Revenue
PHA Public Housing Authority
RB Revenue Bond
SLMA Student Loan Marketing Association
SPA Stand By Bond Purchase Agreement
SWDF Solid Waste Disposal Facility
TRANS Tax Revenue Anticipation Notes
TRS Trust Receipt Series
See Notes to Financial Statements.
30
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
TAX-FREE MONEY MARKET SERIES
NOTES TO FINANCIAL STATEMENTS
December 31, 1997
- --------------------------------------------------------------------------------
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
acts 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 Fundamental U.S. Government Strategic Income Fund Series. Each series is
considered a separate entity for financial reporting and tax purposes. The
Tax-Free Money Market Series (the Series) investment objective is to provide as
high a level of current income exempt from federal income tax as is consistent
with the preservaton of capital and liquidity. The following is a summary of
significant accounting policies followed in the preparation of the Series'
financial statements:
Valuation of Securities:
Investments are stated at amortized cost. Under this valuation method, a
portfolio instrument is valued at cost and any premium or discount is amortized
on a constant basis to the maturity of the instrument. Amortization of premium
is charged to income, and accretion of market discount is credited to unrealized
gains. The maturity of investments is deemed to be the longer of the period
required before the Fund is entitled to receive payment of the principal amount
or the period remaining until the next interest adjustment.
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 of net
capital gains are made annually, as declared by the Fund's 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 gains and losses from the sale of
securities are recorded on an identified cost basis.
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.
31
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
TAX-FREE MONEY MARKET SERIES
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
2. Investment Advisory Fees and Other Transactions with Affiliates
Management Agreement
The Fund has a Management Agreement with Fundamental Portfolio Advisors,
Inc. (the Manager). Pursuant to the agreement, the Manager serves as investment
adviser to the Tax-Free Money Market 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 consideration for the services
provided by the Manager, the Series will pay an annual management fee in an
amount equal to 0.5% of the Series' average daily net assets up to $100 million
and decreasing by .02% for each $100 million increase in net assets down to 0.4%
of net assets in excess of $500 million. See Note 8.
SEC Administrative Proceeding Against the Manager
On September 30, 1997, the Securities & Exchange Commission announced that
it instituted public administrative and cease-and desist proceedings against the
Manager, the former portfolio manager of the Fund, the president of the Manager
and Fundamental Service Corporation (FSC), the Fund's Distributor. The
proceeding arises from the alleged failure of an affiliated mutual fund to
disclose the risks of the affiliated series, and of the Manager's failure to
disclose its soft dollar arrangements to the Fund's Board of Trustees. A hearing
has been scheduled with an administrative law judge to determine whether the
allegations are true, and, if so, what remedial action, if any, is appropriate.
Board's Termination of Portfolio Manager
Between April 17, 1997 and July 24, 1997, a representative of the Manager
engaged Tocqueville Securities L.P. ("Tocqueville Securities") an affiliate of
Tocqueville, as agent, to effect eight separate over-the-counter purchase
transactions of municipal obligations on behalf of an affiliated fund. The
Fund's Board has concluded that the commissions paid to Tocqueville Securities
in connection with these transactions (a portion of which was paid to the
representative) were not justified and that the affiliated fund bore unnecessary
expenses as a result of the sale of its securities to another party and the
subsequent repurchase of them through Tocqueville Securities. Based upon a
report initiated by Tocqueville Securities and prepared by the Fund's
independent auditors, and upon the Board's own analysis, the Board directed that
the Manager terminate the representative's services as a portfolio manager. At
the Board's request and in order to reimburse the affiliated fund for all of its
losses, Tocqueville Securities, on September 15, 1997, voluntarily paid $260,000
to the affiliated fund, an amount which significantly exceeds the total
commissions ($184,920.60) received by Tocqueville Securities in connection with
these transactions. The staff of the Securities and Exchange Commission and the
Department of NASD Regulation have been informed of these events by Tocqueville
Securities. See Note 7 regarding contemplated transaction with the Tocqueville
Trust.
Plan of Distribution
The Fund has adopted a Plan of Distribution, pursuant to Rule 12b-1
promulgated under the Investment Company Act of 1940, under which the Series
pays to FSC, an affiliate of the Manager, a fee, which is accrued daily and paid
monthly, at an annual rate of 0.5% of the Series' average daily net assets. The
amounts paid under the plan compensate FSC for the services it provides and the
expenses it bears in distributing the Series' shares to investors. Distribution
fees for the year ended December 31, 1997 are set forth in the Statement of
Operations.
NASD Sanctions and Fines
On February 19, 1998, FSC and two of its executives, without admitting or
denying guilt, entered into an agreement with the National Association of
Securities Dealers Inc. ("NASD") whereby they accepted fines
32
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
TAX-FREE MONEY MARKET SERIES
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
totaling $125,000 and other stipulated sanctions as a result of the NASD's
finding that they had distributed advertising materials of an affiliated mutual
fund which violated NASD rules governing advertisements.
Affiliated Transfer Agent
The Fund compensated Fundamental Shareholder Services, Inc., (FSSI) an
affiliate of the Manager, for the services it provided under a Transfer Agent
and Service Agreement which was terminated on September 11, 1997. Transfer agent
fees paid by the Series to FSSI for the year ended December 31, 1997 amounted to
$17,745.
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. The Trustees also received additional
compensation for special services as requested by the Board. Additional
compensation totaled $40,923 pro rated among the funds based on their respective
average net assets.
4. Shares of Beneficial Interest
As of December 31, 1997 there were an unlimited number of shares of
beneficial interest (no par value) authorized and capital paid in amounted to
$13,270,069. Transactions in shares of beneficial interest, all at $1.00 per
share were as follows:
Year ended Year ended
December 31, December 31,
1997 1996
-------------- --------------
Shares sold ..............................$2,566,332,934 $3,547,580,681
Shares issued on reinvestment of dividends 1,048,578 1,042,865
Shares redeemed ..........................(2,558,739,108) (3,555,253,329)
-------------- ----------
Net (decrease) increase ..................$ 8,642,404 (6,629,783)
============== ==========
5. Line of Credit
The Fund has a line of credit agreement with its custodian bank
collateralized by cash and portfolio securities for $500,000. Borrowings under
this agreement bear interest linked to the bank's prime rate. The Series had no
borrowing under the line of credit agreement as of or during the year ended
December 31, 1997.
6. Expenses Paid Indirectly
The Fund has an arrangement with its custodian whereby credits earned on
cash balances maintained at the custodian are used to offset custody charges.
These credits amounted to approximately $41,000 for the year ended December 31,
1997.
7. Agreement and Plan of Reorganization
On July 16, 1997 each of Fundamental's mutual funds (consisting of: New York
Muni Fund, The California Muni Fund, Fundamental Fixed Income Fund: Tax Free
Money Market Series, High Yield Municipal Bond Series, and Fundamental U.S.
Government Strategic Income Fund Series) have adopted, subject to shareholder
approval, an Agreement and Plan of Reorganization (the "Plan") under which each
fund (the "Fundamental Fund") will transfer all of its assets and liabilities to
a newly-created corresponding series of The Tocqueville Trust (the "Tocqueville
Fund") in exchange for shares of the Tocqueville Fund. Shareholders of each
Fundamental Fund will receive shares of the corresponding Tocqueville Fund equal
in value to their shares in the Fundamental Fund. Shareholders will not have to
pay a sales load upon receiving shares of the Tocqueville Fund.
33
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
TAX-FREE MONEY MARKET SERIES
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
The corresponding Tocqueville Fund will have investment objectives, polices
and restrictions substantially identical to those of the Fundamental Fund. The
Board of Trustees of the Tocqueville Funds is comprised of individuals other
than those who currently serve as Directors (Trustees) of the Fundamental Funds.
Tocqueville Asset Management L.P. is the investment adviser to the Tocqueville
Funds.
A majority of Fundamentals' Board Members determined that the Plan would be
in the best interests of shareholders of the Fundamental Funds and recommended
that shareholders of each of the Fundamental Funds approve the Plan at a meeting
anticipated to be held in the Spring of 1998.
8. Subsequent Event
At its March 25, 1998 Board of Trustees' meeting, the Board of the Fund
approved the continuation of the Management Agreement and Distribution Agreement
through May 30, 1998 in contemplation of the consummation of the reorganization
discussed in Note 7.
9. Selected Financial Information
<TABLE>
<CAPTION>
Years Ended December 31,
--------------------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
PER SHARE DATA AND RATIOS
(for a share outstanding throughout the period)
Net Asset Value, Beginning of Year ........................ $1.00 $1.00 $1.00 $1.00 $1.00
Income from investment operations:
Net investment income ..................................... 0.022 0.023 0.026 0.017 0.014
Less Distributions:
Dividends from net investment income ...................... (0.022) (0.023) (0.026) (0.017) (0.014)
Net Asset Value, End of Period ............................ $1.00 $1.00 $1.00 $1.00 $1.00
Total Return .............................................. 2.19% 2.28% 2.60% 1.69% 1.62%
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (000 omitted) ..................... 13,263 4,621 11,251 9,004 5,830
Ratios to Average Net Assets
Expenses .............................................. 1.52%(D)(D) (D) 1.54% 1.53%(D)(D) 0.91%(D) .95%(D)
Net investment income ................................. 2.10% 2.04% 2.43% 1.55% 1.25%
BANK LOANS
Amount outstanding at end of period
(000 omitted) ........................................... $ - $ 218 $ - $ 451 $ 290
Average amount of bank loans outstanding during the period
(000 omitted) ........................................... $ - $ - $ 41 $ 53 $ 111
Average number of shares outstanding during the period
(000 omitted) ........................................... 48,801 56,876 44,432 56,267 25,786
Average amount of debt per share during the period ........ $ - $ - $ .001 $ .001 $ .004
<FN>
(D)These ratios are after expense reimbursement of .02%, .44% and .67%, for each of the years ended December 31, 1997, 1994 and
1993, respectively.
(D)(D)These ratios would have been 1.44%, 1.40% and 1.35% net of expense offsets of .08%, .14% and .18% for the years ended December
31, 1997, 1996 and 1995, respectively.
</FN>
</TABLE>
34
<PAGE>
INDEPENDENT AUDITOR'S REPORT
The Board of Trustees and Shareholders
Tax-Free Money Market Series of
Fundamental Fixed-lncome Fund
We have audited the accompanying statement of assets and liabilities,
including the statement of investments, of the Tax-Free Money Market Series of
Fundamental Fixed-lncome Fund as of December 31, 1997 and the related statement
of operations for the year then ended, the statement of changes in net assets
for each of the two years in the period then ended, and the selected financial
information for each of the five years in the period then ended. 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, 1997 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 presenation. We believe that our audits provide a reasonable basis for
our opinion.
In our opinion, the financial statement and selected financial information
referred to above present fairly, in all material respects, the financial
position of the Tax-Free Money Market Series of Fundamental Fixed-Income Fund as
of December 31, 1997, and the results of its operations, changes in net assets,
and selected financial information for the periods indicated, in conformity with
generally accepted accounting principles.
See Note 2 for information regarding regulatory proceedings and transactions
with affiliates.
S I G N A T U R E
New York, New York
March 2, 1998, except for Note 8 as to which the date is March 25, 1998.
35
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
HIGH-YIELD MUNICIPAL BOND SERIES
(LEFT COLUMN)
STATEMENT OF ASSETS AND LIABILITIES
December 31, 1997
- --------------------------------------------------------------------------------
ASSETS
Investment in securities at value (Note 5)
(cost $2,739,553) ................................... $2,832,290
Interest receivable ................................... 40,346
Receivable for fund shares sold ....................... 463,520
----------
Total assets ............................. 3,336,156
----------
LIABILITIES
Payable for investments purchased ..................... 615,650
Accrued expenses ...................................... 11,735
Bank overdraft payable ................................ 452,313
Dividend payable ...................................... 1,233
Payable for fund shares redeemed ...................... 240
----------
Total liabilities ........................ 1,081,171
----------
NET ASSETS consisting of:
Accumulated net realized
loss .................................... $ (158,714)
Unrealized appreciation
of securities ........................... 92,737
Paid-in-capital applicable to
299,472 shares of
beneficial interest
(Note 4) ................................ 2,320,962
-----------
$2,254,985
==========
NET ASSET VALUE PER SHARE ............................... $ 7.53
==========
(RIGHT COLUMN)
STATEMENT OF OPERATIONS
Year Ended December 31, 1997
- --------------------------------------------------------------------------------
INVESTMENT INCOME
Interest income .................... $140,428
EXPENSES (Notes 2 and 3)
Investment advisory fees ........... $ 14,600
Custodian and accounting fees ...... 43,046
Transfer agent fees ................ 8,970
Trustee fees ....................... 2,413
Distribution fees .................. 9,125
Professional fees .................. 21,443
Postage and printing ............... 8,077
Other .............................. 3,583
--------
Total expenses .............. 111,257
Less: Expenses waived or reimbursed
by the manager and affiliates .... (64,243)
--------
Net expenses ................ 47,014
--------
Net investment income ....... 93,414
REALIZED AND UNREALIZED GAIN
(LOSS) ON INVESTMENTS
Net realized gain on investments ... 17,891
Change in unrealized appreciation of
investments for the year ........... 166,782
--------
Net gain on investments ..... 184,673
--------
NET INCREASE IN NET ASSETS FROM
OPERATIONS ......................... $278,087
========
(FULL COLUMN)
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
Years Ended December 31, 1997 and 1996
- --------------------------------------------------------------------------------------------------------
1997 1996
INCREASE (DECREASE) IN NET ASSETS FROM: ---- ----
<S> <C> <C>
OPERATIONS
Net investment income ................................................... $ 93,414 $ 108,670
Net realized gain on investments ........................................ 17,891 22,294
Unrealized (depreciation) appreciation of investments for the year ...... 166,782 (22,733)
--------- ---------
Net increase in net assets from operations ....................... 278,087 108,231
DIVIDENDS PAID TO SHAREHOLDERS FROM
Net investment income ................................................... (93,414) (108,670)
CAPITAL SHARE TRANSACTIONS (Note 4) ....................................... 212,100 401,216
--------- ---------
Total increase ................................................... 396,773 400,777
NET ASSETS:
Beginning of year ....................................................... 1,858,212 1,457,435
--------- ---------
End of year ............................................................. $2,254,985 $1,858,212
========== ==========
</TABLE>
See Notes to Financial Statements.
38
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
HIGH-YIELD MUNICIPAL BOND SERIES
<TABLE>
<CAPTION>
STATEMENT OF INVESTMENTS
December 31, 1997
- ------------------------------------------------------------------------------------------------------------
Principal
Amount Issue o Value
------ ----- -----
<C> <S> <C>
$ 40,000 Allegheny County, PA, IDA, AFR, USAir Inc., 8.88%, 3/01/21 ................................$ 40,782
40,000 Brookhaven, NY, IDA, CFR, Dowling College, 6.75%, 3/01/23 ................................. 42,730
250,000 Colorado Health Facilities Authority, RHR, Liberty Heights Project, ETM, CAB, 7/15/24 ..... 60,317
100,000 Corona, CA, COP, Vista Hospital Systems Inc. 8.38%, 7/01/11 ............................... 109,361
100,000 Escambia, FL, Housing Corporation, Royal Arms Project, Series B, 9.00%, 7/01/16 ........... 103,202
70,000 Florence County, SC, IDA, RB, Stone Container Corp., 7.38%, 2/01/07 ....................... 74,070
500,000 Foothill / Eastern TCA, Toll Road Revenue, CAB, 1/01/26 ................................... 106,500
25,000 Hildago County, TX, Health Services, Mission Hospital Inc Project, 6.88%, 8/15/26 ......... 26,567
50,000+ Illinois Development Financial Authority, Solid Waste Disposal, RB, Ford Heights Waste
Tire Project, 7.88%, 4/01/11 ............................................................ 10,582
45,000 Illinois Health Facilities Authority, Midwest Physician Group Ltd Project, RB, 8.13%,
11/15/19 ................................................................................ 48,833
35,000 Indianapolis, IN, RB, Robin Run Village Project, 7.63%, 10/01/22 .......................... 38,463
50,000 Joplin, MO, IDA, Hospital Facilities Revenue, Tri State Osteopathic, 8.25%, 12/15/14 ...... 53,674
50,000 Los Angeles, CA, Regional Airport, Continental Airlines, AMT, 9.25%, 8/01/24 .............. 59,104
630,000 Marengo County, AL, Port Authority Facilities, RB, CAB, Series A, 3/01/19 ................. 141,252
75,000 Maryland Economic Development Corporation, Nursing Facilities Mortgage RB,
Ravenwood Healthcare, Series A, 8.38%, 8/01/26 .......................................... 78,529
85,000 Montgomery County, TX, Health Facilities Development Corp., The Woodlands Medical
Center, 8.85%, 8/15/14 .................................................................. 93,171
100,000 New York City, NY, Municipal Water Finance Authority, Water & Sewer RB, TR Receipts
Series 29, 6.56%, 6/15/30 ............................................................... 96,974
100,000 New York State, DAR, City University System Residual Int Tr Recpts 27, MBIA Insured,
Liquidity The Bank of New York, 8.22%, 7/01/24 .......................................... 109,979
100,000 New York State, DAR, City University System Residual Int Tr Recpts 28, AMBAC Insured,
Liquidity The Bank of New York, 7.63%, 7/01/25 .......................................... 105,279
5,000,000 New York State, DAR, CAB, FHA Presbyterian Hospital Series A, AMBAC Insured,
8/15/36 ................................................................................. 643,400
100,000#x Niagara Falls, NY, URA, Old Falls Street Improvement Project, 11.00%, 5/01/09 ............. 35,795
50,000 Northeast, TX, Hospital Authority Revenue, Northeast Medical Center, 7.25%, 7/01/22 ....... 57,455
75,000 Perdido, FL, Housing Corporation, RB, Series B. 9.25%, 11/01/16 ........................... 75,787
30,000 Philadelphia, PA, HEHA, Graduate Health Systems Project, 7.25%, 7/01/18 ................... 31,468
60,000 Port Chester, NY, IDA, Nadal Industries Inc Project, 7.00%, 2/01/16 ....................... 61,876
75,000 San Antonio, TX, HFC, Multi Family Housing, RB, Agape Metro Housing Project, Series
A, 8.63%, 12/01/26 ...................................................................... 75,989
75,000 San Bernardino, CA, San Bernardino Community Hospital, RB, 7.88%, 12/01/19 ................ 77,531
100,000 San Bernardino County, CA, COP, Series PA-38, MBIA Insured, IFRN*, 11.92%, 7/01/16,
Rule 144A Security (restricted as to resale except to qualified institutions) ........... 113,555
</TABLE>
39
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
HIGH-YIELD MUNICIPAL BOND SERIES
<TABLE>
<CAPTION>
STATEMENT OF INVESTMENTS
December 31, 1997
- ------------------------------------------------------------------------------------------------------------
Principal
Amount Issue o Value
------ ----- -----
<C> <S> <C>
$ 35,000 San Joaquin Hills, CA, TCA, Toll Road Revenue, 7.00%, 1/01/30 ............................$ 40,033
60,000x San Jose, CA, Redevelopment Agency, Tax Allocation Bonds, IFRN*, MBIA Insured,
5.83%, 8/01/16, MBIA Insured, Rule 144A Security (restricted as to resale except to
qualified institutions) ................................................................ 61,304
150,000 Savannah, GA Economic Development Authority Revenue, ETM, CAB, 12/01/21 .................. 39,940
45,000 Schuylkill County, PA, IDA Resouce Recovery, Schuylkill Energy Res Inc. AMT, 6.50%,
1/01/10 ................................................................................ 46,040
15,000(D)# Troy, NY, IDA, Hudson River Project, 11.00%, 12/01/94 .................................... 6,150
75,000(D) (D)(D)Villages at Castle Rock, CO, Metropolitan District #4, 8.50%, 6/01/31 .................... 39,138
25,000 Wayne, MI, AFR, Northwest Airlines Inc. 6.75%, 12/01/15 .................................. 27,460
----------
Total Investments (Cost $2,739,553)** ....................................................$2,832,290
==========
<FN>
** Cost is approximately the same for income tax purposes.
* Inverse Floating Rate Notes (IFRN) are instruments whose interest rates bear an inverse relationship to the interest rate on
another security or the value of an index. Rates shown are at December 31, 1997.
# The value of this non-income producing security has been estimated by persons designated by the Fund's Board of
Trustees using methods the Trustees believe reflect fair value. See note 5 to the financial statements.
+ Non-income producing security.
(D)(D) Security in default. Interest paid on cash flow basis. Rate shown as of December 31, 1997.
x The Fund or its affiliates owns 100% of the security and therefore there is no trading in the security.
</FN>
</TABLE>
Legend
o Issue AFR Airport Facilities Revenue
AMBAC American Municipal Bond Assurance Corporation
AMT Subject to Alternative Minimum Tax
CAB Capital Appreciation Bond
COP Certificate of Participation
CFR Civic Facility Revenue
DAR Dorm Authority Revenue
ETM Escrowed to Maturity
FHA Federal Housing Authority
HEHA Higher Education and Health Authority
HFC Housing Finance Corporation
IDA Industrial Development Authority
MBIA Municipal Bond Insurance Assurance Corporation
RB Revenue Bond
RHR Retirement Housing Revenue
TCA Transportation Corridor Agency
URA Urban Renewal Agency
See Notes to Financial Statements.
40
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
HIGH-YIELD MUNICIPAL BOND SERIES
NOTES TO FINANCIAL STATEMENTS
December 31, 1997
- --------------------------------------------------------------------------------
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 Fundamental U.S. Government Strategic Income Fund Series
(the Series). Each series is considered a separate entity for financial
reporting and tax purposes. The High-Yield Municipal Bond Series (the Series)
seeks to provide a high level of current income exempt from federal income tax
through investment in a portfolio of lower quality municipal bonds, generally
referred to as "junk bonds." These bonds are considered speculative because they
involve greater price volatility and risk than higher rated bonds. The following
is a summary of significant accounting policies followed in the preparation of
the Series' financial statements:
Valuation of Securities: The Fund's portfolio securities are valued on the basis
of prices provided by an independent pricing service when, in the opinion of
persons designated by the Fund's trustees, such prices are believed to reflect
the fair market value of such securities. Prices of non-exchange traded
portfolio securities provided by independent pricing services are generally
determined without regard to bid or last sale prices but take into account
institutional size trading in similar groups of securities, yield, quality,
coupon rate, maturity, type of issue, trading characteristics and other market
data. Securities traded or dealt in upon a securities exchange and not subject
to restrictions against resale as well as options and futures contracts listed
for trading on a securities exchange or board of trade are valued at the last
quoted sales price, or, in the absence of a sale, at the mean of the last bid
and asked prices. Options not listed for trading on a securities exchange or
board of trade for which over-the-counter market quotations are readily
available are valued at the mean of the current bid and asked prices. Money
market and short-term debt instruments with a remaining maturity of 60 days or
less will be valued on an amortized cost basis. Securities not priced in a
manner described above and other assets are valued by persons designated by the
Fund's trustees using methods which the trustees believe accurately reflects
fair value.
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 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 amortized and charged against interest income and original issue discounts
are accreted to interest income.
41
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
HIGH-YIELD MUNICIPAL BOND SERIES
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
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.
2. Investment Advisory Fees and Other Transactions with Affiliates
Management Agreement
The Fund has a Management Agreement with Fundamental Portfolio Advisors,
Inc. (the Manager). Pursuant to the agreement, the Manager serves as investment
adviser to the High-Yield Municipal Bond 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 consideration for the services
provided by the Manager, the Series will pay an annual management fee in an
amount equal to 0.8% of the Series' average daily net assets up to $100 million
and decreasing by .02% for each $100 million increase in net assets down to 0.7%
of net assets in excess of $500 million. The Manager voluntarily waived fees and
reimbursed expenses of $49,643 for the year ended December 31, 1997. See Note 7.
SEC Administrative Action Against The Manager
On September 30, 1997, the Securities & Exchange Commission announced that
it instituted public administrative and cease-and desist proceedings against the
Manager, the former portfolio manager of the Fund, the president of the Manager
and Fundamental Service Corporation (FSC) the Funds distributor. The proceeding
arises from the alleged failure of an affiliated mutual fund to disclose the
risks of the Fund, and of the Manager's failure to disclose its soft dollar
arrangements to the Fund's Board of Trustees. A hearing has been scheduled to
determine whether the allegations are true, and, if so, what remedial action, if
any, is appropriate.
Board's Termination of Portfolio Manager
Between April 17, 1997 and July 24, 1997, a representative of the Manager
engaged Tocqueville Securities L.P. ("Tocqueville Securities") an affiliate of
Tocqueville, as agent, to effect eight separate over-the-counter purchase
transactions of municipal obligations on behalf of an affiliated fund. The
Fund's Board has concluded that the commissions paid to Tocqueville Securities
in connection with these transactions (a portion of which was paid to the
representative) were not justified and that the affiliated fund bore unnecessary
expenses as a result of the sale of its securities to another party and the
subsequent repurchase of them through Tocqueville Securities. Based upon a
report initiated by Tocqueville Securities and prepared by the Fund's
independent auditors, and upon the Board's own analysis, the Board directed that
the Manager terminate the representative's services as a portfolio manager. At
the Board's request and in order to reimburse the affiliated fund for all of its
losses, Tocqueville Securities, on September 15, 1997, voluntarily paid $260,000
to the affiliated fund, an amount which significantly exceeds the total
commissions ($184,920.60) received by Tocqueville Securities in connection with
these transactions. The staff of the Securities and Exchange Commission and the
Department of NASD Regulation have been informed of these events by Tocqueville
Securities. See note 7 regarding contemplated transaction with the Tocqueville
Trust.
42
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
HIGH-YIELD MUNICIPAL BOND SERIES
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
Plan of Distribution
The Fund has adopted a Plan of Distribution, pursuant to Rule 12b-1
promulgated under the Investment Company Act of 1940, under which the Series
pays to FSC, an affiliate of the Manager, a fee, which is accrued daily and paid
monthly, at an annual rate of 0.5% 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. FSC
has waived all fees in the amount of $9,125 for the year ended December 31,
1997.
NASD Sanctions and Fines
On February 19, 1998, FSC and two of its executives, without admitting or
denying guilt, entered into an agreement with the National Association of
Securities Dealers, Inc. ("NASD") whereby they accepted fines totaling $125,000
and other stipulated sanctions as a result of the NASD's finding that they had
distributed advertising materials of an affiliated mutual fund which violated
NASD rules governing advertisements.
Affiliated Transfer Agent
The Fund compensated Fundamental Shareholder Services, Inc. (FSSI), an
affiliate of the Manager, for the services it provided under a Transfer Agent
and Service Agreement which was terminated on September 11, 1997. Transfer agent
fees paid by the Series to FSSI amounted to $5,012.
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. The Trustees also received additional
compensation for special services as requested by the Board. Additional
compensation totaled $40,923 pro rated among the funds based on their respective
average net assets.
4. Shares of Beneficial Interest
As of December 31, 1997, there were an unlimited number of shares of
beneficial interest (no par value) authorized and capital paid in amounted to
$2,320,962. Transactions in shares of beneficial interest were as follows:
<TABLE>
<CAPTION>
Year Ended Year Ended
December 31, 1997 December 31, 1996
----------------------- --------------------------
Shares Amount Shares Amount
--------- ---------- --------- -----------
<S> <C> <C> <C> <C>
Shares sold .................................... 2,941,324 20,530,136 1,912,593 $12,834,095
Shares issued on reinvestment of dividends ..... 11,426 79,995 11,925 80,347
Shares redeemed ................................ (2,924,097) (20,398,031) (1,859,933) (12,513,226)
---------- ----------- ---------- -----------
Net increase ................................... 28,653 $ 212,100 64,585 $ 401,216
========== =========== ========== ===========
</TABLE>
5. Investment Transactions
The Fund invests in variable rate securities commonly called "inverse
floaters." The interest rates on these securities have an inverse relationship
to the interest rate of other securities or the value of an index. Changes in
43
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
HIGH-YIELD MUNICIPAL BOND SERIES
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
interest rate on the other security or index inversely affect the rate paid on
the inverse floater, and the inverse floater's price will be more volatile than
that of a fixed-rate bond. Certain interest rate movements and other market
factors can substantially affect the liquidity of IFRN's.
The Fund invests in lower rated or unrated ("junk") securities which are
more likely to react to developments affecting market risk and credit risk than
would higher rated securities which react primarily to interest rate
fluctuations. The Fund held securities in default with an aggregate value of
$91,665 at December 31, 1997 (4.1% of net assets). As indicated in the Statement
of Investments, the Troy, NY Industrial Revenue Bond, 11% due December 1, 2014
with a par value of $15,000 and a value of $6,150 at December 31, 1997 has been
estimated in good faith under methods determined by the Board of Trustees.
The Fund owns 1.7% of a Niagara Falls New York Urban Renewal Agency 11%
Bond ("URA Bond") due to mature on May 1, 2009 which has missed interest and
sinking fund payments. An affiliated investment company owns 98.3% of this bond
issue. The Fund was party to an agreement whereby certain related bonds owned by
an affiliate were to be subject to repayment under a debt assumption agreement.
The agreement allowed the affiliate to allocate a portion of the debt services
it receives to the URA Bond. In exchange the Fund forfeited certain rights it
had as holder of the URA bond. The debt assumption was not completed and the
timing and amount of debt service payments is uncertain. The value of this bond
is $35,795, and is valued at 35.80% of face value at December 31, 1997 under
methods determined by the Board of Trustees.
During the year ended December 31, 1997, the cost of purchases and proceeds
from sales of investment securities, other than short-term obligations, were
$2,982,245 and $2,610,195, respectively.
As of December 31, 1997 net unrealized appreciation of portfolio securities
amounted to $92,737, composed of unrealized appreciation of $225,341 and
unrealized depreciation of $132,604.
The Fund has capital loss carryforwards to offset future capital gains as
follows:
Amount Expiration
------- ----------
$23,500 12/31/1998
22,200 12/31/1999
20,500 12/31/2000
54,300 12/31/2002
40,000 12/31/2003
--------
$160,500
========
6. Agreement and Plan of Reorganization
On July 16, 1997 each of Fundamental's mutual funds (consisting of: New York
Muni Fund, The California Muni Fund, Fundamental Fixed Income Fund: Tax Free
Money Market Series, High Yield Municipal Bond Series, and Fundamental U.S.
Government Strategic Income Fund Series) have adopted, subject to shareholder
approval, an Agreement and Plan of Reorganization (the "Plan") under which each
fund (the "Fundamental Fund") will transfer all of its assets and liabilities to
a newly-created corresponding series of The Tocqueville Trust (the "Tocqueville
Fund") in exchange for shares of the Tocqueville Fund. Shareholders of each
Fundamental Fund will receive shares of the corresponding Tocqueville Fund equal
in value to their shares in the Fundamental Fund. Shareholders will not have to
pay a sales load upon receiving shares of the Tocqueville Fund.
44
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
HIGH-YIELD MUNICIPAL BOND SERIES
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
The corresponding Tocqueville Fund will have investment objectives, polices
and restrictions substantially identical to those of the Fundamental Fund. The
Board of Trustees of the Tocqueville Funds is comprised of individuals other
than those who currently serve as Directors (Trustees) of the Fundamental Funds.
Tocqueville Asset Management L.P. is the investment adviser to the Tocqueville
Funds.
A majority of Fundamental's Board members determined that the Plan would be
in the best interests of shareholders of the Fundamental Funds and recommended
that shareholders of each of the Fundamental Funds approve the Plan at a meeting
anticipated to be held in the Spring of 1998.
7. Subsequent Event
At its March 25, 1998 Board of Trustees' meeting, the Board of the Fund
approved the continuation of the Management Agreement and Distribution Agreement
through May 30, 1998 in contemplation of the consummation of the reorganization
discussed in Note 6.
8. Selected Financial Information
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------------
1997 1996 1995 1994 1993
PER SHARE OPERATING PERFORMANCE ---- ---- ---- ---- ----
(for a share outstanding throughout the period)
<S> <C> <C> <C> <C> <C>
Net asset value, beginning of period $6.86 $7.07 $5.92 $7.27 $7.30
----- ----- ----- ----- -----
Income from investment operations:
Net investment income 0.37 0.47 0.34 0.43 0.39
Net realized and unrealized gains (losses) on investments 0.67 (0.21) 1.15 1.35) (0.03)
----- ----- ----- ----- -----
Total from investment operations 1.04 0.26 1.49 (0.92) 0.36
----- ----- ----- ----- -----
Less distributions:
Dividends from net investment income (0.37) (0.47) (0.34) (0.43) (0.39)
----- ----- ----- ----- -----
Net asset value, end of period $7.53 $6.86 $7.07 $5.92 $7.27
===== ===== ===== ===== =====
Total Return 15.71% 4.05% 25.70% (12.92%) 5.11%
RATIOS/SUPPLEMENTAL DATA
Net assets, end of period (000 omitted) 2,255 1,858 1,457 979 1,087
Ratios to average net assets:
Expenses* 2.58% 2.49% 2.50% 2.50% 2.50%
Net investment income* 5.12% 6.85% 5.15% 6.70% 5.40%
Portfolio turnover rate 3.79% 139.26% 43.51% 75.31% 84.89%
BANK LOANS
Amount outstanding at end of period (000 omitted) $ - 228 379 $ - $ -
Average amount of bank loans outstanding during the period
(000 omitted) $ - $ - 61 $ - $ -
Average number of shares outstanding during the period
(000 omitted) 260 237 183 156 145
Average amount of debt per share during the period $ - $ - $0.33 $ - $ -
<FN>
**These ratios are after expense reimbursements of 3.52%, 4.59%, 6.22%, 6.20% and 5.76%, for each of the
years ended December 31, 1997, 1996, 1995, 1994 and 1993, respectively.
</FN>
</TABLE>
45
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
HIGH-YIELD MUNICIPAL BOND SERIES
INDEPENDENT AUDITOR'S REPORT
- --------------------------------------------------------------------------------
To the Board of Trustees and Shareholders
Fundamental Fixed-Income Fund
High-Yield Municipal Bond Series
We have audited the accompanying statement of assets and liabilities, including
the statement of investments, of Fundamental Fixed-Income Fund High-Yield
Municipal Bond Series as of December 31, 1997, and the related statements of
operations for the year then ended, the statement of changes in net assets for
each of the two years then ended and the selected financial information for each
of the five years in the period then ended. 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 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 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, 1997 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 Fundamental Fixed-Income Fund High-Yield Municipal Bond Series as of
December 31, 1997, and the results of its operations, changes in net assets, and
selected financial information for the periods indicated, in conformity with
generally accepted accounting principles.
See Note 2 for information regarding regulatory proceedings and transactions
with affiliates.
New York, New York
March 2, 1998, except for Note 7 as to which the date is March 25, 1998.
46
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
(LEFT COLUMN)
STATEMENT OF ASSETS AND LIABILITIES
December 31, 1997
- --------------------------------------------------------------------------------
ASSETS
Investment in securities, at value
(cost $13,023,839) (Notes 5 and 6) $15,023,792
Receivables:
Interest 67,739
Fund shares sold ................ 4,001
-----------
Total assets ................ 15,095,532
-----------
LIABILITIES
Loans ............................. 225,907
Options written at value
(premiums received $18,801)
(Note 5) ........................ 10,625
Securities sold subject to
repurchase (Note 6) ............. 4,744,054
Payables:
Dividends declared .............. 11,104
Shares redeemed ................. 9,353
Variation margin ................ 41,563
Accrued expenses ................ 22,580
-----------
Total liabilities ........... 5,065,186
-----------
NET ASSETS consisting of:
Accumulated net realized loss ..... $(17,833,560)
Unrealized appreciation of
securities ...................... 1,999,953
Unrealized appreciation of
options written ................. 8,176
Unrealized depreciation of open
future contracts ................ (103,270)
Paid-in-capital applicable to
7,116,688 shares of beneficial
interest ........................ 25,959,047
-----------
$10,030,346
===========
NET ASSET VALUE PER SHARE $1.41
=====
(RIGHT COLUMN)
STATEMENT OF OPERATIONS
Year Ended December 31, 1997
- --------------------------------------------------------------------------------
INVESTMENT INCOME
Interest income, net of $315,574
of interest expense ...................... $1,812,306
EXPENSES (Notes 2, 3 and 6)
Investment advisory fees ................. $ 88,681
Custodian and accounting fees ............ 61,165
Transfer agent fees ...................... 71,081
Professional fees ........................ 563,154
Trustees' fees ........................... 5,458
Printing and postage ..................... 9,502
Interest on bank borrowing ............... 324,872
Distribution expenses .................... 29,560
Other .................................... 14,012
---------
Total expense ...................... 1,167,485
Less: Expenses waived or
reimbursed by the
manager and affiliates ........... (162,637)
---------
Net expenses ....................... 1,004,848
----------
Net investment income .............. 807,458
----------
REALIZED AND UNREALIZED GAIN
(LOSS) ON INVESTMENTS
Net realized gain (loss) on:
Investments ............................ 1,027,730
Future and options on futures .......... (956,715) 71,015
---------
Change in unrealized appreciation
(depreciation) of investments,
options and futures contracts
for the period:
Investments .......................... 66,558
Open option contracts
written ............................ (312)
Open futures contracts ............... (339,726) (273,480)
--------- ----------
Net loss on investments .................. (202,465)
----------
NET INCREASE IN NET ASSETS
FROM OPERATIONS .......................... $ 604,993
=========
<PAGE>
(FULL COLUMN)
<TABLE>
<CAPTION>
STATEMENT OF CHANGES IN NET ASSETS
- ----------------------------------------------------------------------------------------------------------
Year Ended Year Ended
December December
31, 1997 31, 1996
-------- --------
INCREASE (DECREASE) IN NET ASSETS FROM:
OPERATIONS
<S> <C> <C>
Net investment income ...................................................... $ 807,458 $ 1,254,448
Net realized gain on investments ........................................... 71,015 433,173
Unrealized (depreciation) on investments, options and futures contracts .... (273,480) (1,070,217)
----------- -----------
Net increase in net assets from operations ........................ 604,993 617,404
DIVIDENDS PAID TO SHAREHOLDERS FROM
Investment income .......................................................... (807,458) (1,254,448)
CAPITAL SHARE TRANSACTIONS (Note 4) .......................................... (2,991,556) (1,332,818)
----------- -----------
Total decrease .................................................... (3,194,021) (1,969,862)
NET ASSETS
Beginning of year .......................................................... 13,224,367 15,194,229
----------- -----------
End of year ................................................................ $10,030,346 $13,224,367
=========== ===========
</TABLE>
See Notes to Financial Statements.
49
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
STATEMENT OF CASH FLOWS
<TABLE>
Year Ended December 31, 1997
- ---------------------------------------------------------------------------------------------
INCREASE (DECREASE) IN CASH
CASH FLOWS FROM OPERATING ACTIVITIES
<S> <C>
Net increase in net assets from operations ................................ $ 604,993
Adjustments to reconcile net increase in net assets from operations to
net cash provided by operating activities:
Purchase of investment securities ......................................... (2,228,044)
Proceeds on sale of securities ............................................ 8,312,593
Premiums received for options written ..................................... 633,904
Premiums paid to close options written .................................... (977,704)
Decrease in interest receivable ........................................... 28,925
Decrease in variation margin receivable ................................... 218,791
Decrease in accrued expenses .............................................. (93,909)
Net accretion of discount on securities ................................... (187,473)
Net realized (gain) loss:
Investments ............................................................. (1,027,730)
Options written ......................................................... 309,113
Unrealized appreciation on securities and options written for the period .. (66,246)
----------
Total adjustments ....................................................... 4,922,220
----------
Net cash provided by operating activities ............................... 5,527,213
----------
CASH FLOWS FROM FINANCING ACTIVITIES:*
Net repayments on sale of securities sold subject to repurchase ............. (1,617,934)
Net borrowings of note payable .............................................. (49,281)
Proceeds on shares sold ..................................................... 728,056
Payment on shares repurchased .............................................. (4,356,318)
Cash dividends paid ......................................................... (231,736)
----------
Net cash used in financing activities ................................... (5,527,213)
----------
Net increase in cash .................................................... 0
CASH AT BEGINNING OF YEAR .................................................. 0
----------
CASH AT END OF YEAR ......................................................... $ 0
==========
</TABLE>
*Non-cash financing activities not included herein consist of reinvestment of
dividends of $642,058. Cash payments for interest expense totaled $333,352 for
the period.
STATEMENT OF OPTIONS WRITTEN
<TABLE>
<CAPTION>
December 31, 1997
- ---------------------------------------------------------------------------------------------
Number of Expiration
Contracts++ Options Written Month Value
----------- --------------- ---------- -----
<C> <S> <C> <C>
40 U.S. Treasury Bonds, Call @ $123 ........... February 1998 $10,625
-------
$10,625
=======
</TABLE>
++Each contract represents $100,000 face value of U.S. Treasury Bond Futures.
See Notes to Financial Statements.
50
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
STATEMENT OF INVESTMENTS
December 31, 1997
- --------------------------------------------------------------------------------
Principal Interest Maturity
Amount Rate o Date Value
------ ------ ---- -----
United States Treasury Securities-49.03%
United States Treasury Bonds
85,000(2) 0.00% ZCS 11/15/03 $ 60,395
4,300,000(2) 0.00% PS 11/15/06 2,574,333
3,500,000(5) 9.00% 11/15/18 4,731,566
----------
(Cost $6,403,170) 7,366,294
----------
United States Agency Backed Securities-50.97%
Federal Home Loan Mortgage Corporation
843,718(1) 9.25% 08/15/23 928,005
285,124(1) 6.50% Z-Bond 12/15/23 261,907
750,000 13.59% IFRN 05/15/24 858,060
209,406(2) 15.30% IFRN 05/25/24 251,287
180,000 12.00% TTIB 03/15/27 180,079
FNMA-Federal National Mortgage Assoc.
356,450(4)(1) 15.50% TTIB 03/25/23 381,224
3,671,204(4)(1) 15.30% TTIB 03/25/23 4,185,686
490,760(4) 14.49% TTIB 05/25/23 544,900
----------
7,591,148
----------
FICO-Financing Corporation (U.S. Government Agency)
100,000 0.00% ZCS 11/02/12 39,284
100,000 0.00% ZCS 08/03/18 27,066
----------
(Cost $6,620,669) 66,350
----------
Total investments (Cost $13,023,839)(3) $15,023,792
----------
(1) Segregated for securities sold subject to repurchase (Note 6)
(2) Segregated, in whole or part, as initial margin for futures contracts
(Note 5)
(3) Cost is the same for Federal income tax purposes
(4) The Fund owns 100% of the security or tranche. See Note 5 to the financial
statements.
(5) Securities sold subject to repurchase (Note 6).
o Legend-IFRN: Inverse Floating Rate Notes are instruments whose interest rates
bear an inverse relationship to the interest rate on another
security or the value of an index. Rates shown are at December
31, 1997.
TTIB: Two-Tiered Index Floating Rate Bonds are instruments with two
coupon levels. The "first tier" coupon is at a fixed rate,
effective as long as the underlying index is at or below the
strike level. At the strike level, the "second tier" coupon
resets the bond to an inverse floating rate note. See discussion
above. Coupons shown are at December 31, 1997.
ZCS: Zero Coupon Securities are instruments whose interest and
principal are paid at maturity.
Z Bond: A Z Bond is an instrument whose monthly interest coupon is paid
at a fixed rate in additional principal. Principal is paid at
maturity.
PS: Principal Stripped Bonds are instruments whose principle and
coupon have been separated and sold separately.
See Notes to Financial Statements.
51
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
NOTES TO FINANCIAL STATEMENTS
December 31, 1997
- --------------------------------------------------------------------------------
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 Fundamental U.S. Government Strategic Income Fund Series
(the Series). The objective of the Series is to provide high current income with
minimum risk of principal and relative stability of net asset value. The 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
(hereunder collectively referred to as "Government Securities"). The Series also
uses leverage in seeking to achieve its investment objective. Each series is
considered a separate entity for financial reporting and tax purposes.
Valuation of Securities-The Series portfolio securities are valued on
the basis of prices provided by an independent pricing service when, in the
opinion of persons designated by the Fund's trustees, such prices are believed
to reflect the fair market value of such securities. Prices of non-exchange
traded portfolio securities provided by independent pricing services are
generally determined without regard to bid or last sale prices but take into
account institutional size trading in similar groups of securities, yield,
quality, coupon rate, maturity, type of issue, trading characteristics and other
market data. Securities traded or dealt in upon a securities exchange and not
subject to restrictions against resale as well as options and futures contracts
listed for trading on a securities exchange or board of trade are valued at the
last quoted sales price, or, in the absence of a sale, at the mean of the last
bid and asked prices. Options not listed for trading on a securities exchange or
board of trade for which over-the-counter market quotations are readily
available are valued at the mean of the the current bid and asked prices. Money
market and short-term debt instruments with a remaining maturity of 60 days or
less will be valued on an amortized cost basis. Securities not priced in a
manner described above and other assets are valued by persons designated by the
Fund's trustees using methods which the trustees believe reflect fair value.
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. The Series' repurchase agreements will at
all times be fully collateralized in an amount equal to the purchase price
including accrued interest earned on the underlying security.
52
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
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 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. Discounts and premiums are
amortized over the life of the respective securities. Premiums are charged
against interest income and 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.
2. Investment Advisory Fees and Other Transactions With Affiliates
Management Agreement
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 consideration 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 waived fees
and reimbursed expenses of $133,077 for the year ended December 31, 1997. See
Note 8.
SEC Administrative Proceeding Against the Manager
On September 30, 1997, the Securities & Exchange Commission announced that
it instituted public administrative and cease-and desist proceedings against the
Manager, the former portfolio manager of the Fund, the president of the Manager
and Fundamental Service Corporation (FSC). The proceeding arises from the
53
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
alleged failure of the Fund to disclose the risks of the Fund, and of the
Manager's failure to disclose its soft dollar arrangements to the Fund's Board
of Trustees. A hearing has been scheduled with an administrative law judge to
determine whether the allegations are true, and, if so, what remedial action, if
any, is appropriate.
Board's Termination of Portfolio Manager
Between April 17, 1997 and July 24, 1997, a representative of the Manager
engaged Tocqueville Securities L.P. ("Tocqueville Securities") an affiliate of
Tocqueville, as agent, to effect eight separate over-the-counter purchase
transactions of municipal obligations on behalf of an affiliated fund. The
Fund's Board has concluded that the commissions paid to Tocqueville Securities
in connection with these transactions (a portion of which was paid to the
representative) were not justified and that the affiliated fund bore unnecessary
expenses as a result of the sale of its securities to another party and the
subsequent repurchase of them through Tocqueville Securities. Based upon a
report initiated by Tocqueville Securities and prepared by the Fund's
independent auditors, and upon the Board's own analysis, the Board directed that
the Manager terminate its representative's services as a portfolio manager. At
the Board's request and in order to reimburse the affiliated fund for all of its
losses, Tocqueville Securities, on September 15, 1997, voluntarily paid $260,000
to the affiliated fund, an amount which significantly exceeds the total
commissions ($184,920.60) received by Tocqueville Securities in connection with
these transactions. The staff of the Securities and Exchange Commission and the
Department of NASD Regulation have been informed of these events by Tocqueville
Securities. See note 7 regarding contemplated transaction with the Tocqueville
Trust.
Plan of Distribution
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 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, 1997 is set forth in the Statement of Operations. FSC
has waived fees in the amount of $29,560.
NASD Sanctions and Fines
On February 19, 1998, FSC and two of its executives, without admitting or
denying guilt, entered into an agreement with the National Association of
Securities Dealers, Inc. ("NASD") whereby they accepted fines totaling $125,000
and other stipulated sanctions as a result of the NASD's finding that they had
distributed advertising materials relating to the Fund which violated NASD rules
governing advertisements.
Affiliated Transfer Agent
The Series compensated Fundamental Shareholders Services, Inc. (FSSI), an
affiliate of the Manager, for services it provided under a Transfer Agent and
Service Agreement which was terminated on September 11, 1997. The amount paid by
the Series to FSSI for the year ended December 31, 1997 amounted to $57,038.
Commissions Paid to Affiliate
The Series effects a significant portion of its futures and options
transactions through LAS Investments, Inc. (LAS), an affiliated broker-dealer.
Commissions paid to LAS amounted to approximately $14,591 for the year ended
December 31, 1997.
54
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
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. The Trustees also received additional
compensation for special services as requested by the Board. Additional
compensation totaled $40,923 pro rated among the funds based on their respective
average net assets.
4. Shares of Beneficial Interest
As of December 31, 1997 there were an unlimited number of shares of
beneficial interest (no par value) authorized and capital paid-in amounted to
$25,959,047. Transactions in shares of beneficial interest were as follows:
<TABLE>
<CAPTION>
Year Ended Year Ended
December 31, 1997 December 31, 1996
----------------------- --------------------------
Shares Amount Shares Amount
--------- ---------- --------- -----------
<S> <C> <C> <C> <C>
Shares sold ................................... 521,491 $ 732,057 1,209,491 $1,721,466
Shares issued on reinvestment of dividends .... 457,380 642,058 605,897 860,888
Shares redeemed ............................... (3,119,211) (4,365,671) (2,749,791) (3,915,172)
---------- ----------- --------- -----------
Net decrease .................................. (2,140,340) ($2,991,556) (934,403) ($1,332,818)
========== =========== ========= ===========
</TABLE>
5. Complex Services, Off Balance Sheet Risks and Investment Transactions
Two-Tiered Index Floating Rate Bonds (TTIB):
The Fund invests in Two-Tiered Index Floating Rate Bonds. The term
two-tiered refers to the two coupon levels that the TTIB's coupon can reset to.
The "first tier" is the TTIB's fixed rate coupon, effective as long as the
underlying index is at or below the strike level. Above the strike, the TTIB
coupon resets to a formula similar to an inverse floating rate note. See
discussion of inverse floating rate notes below. Changes in interest rate on the
underlying 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.
Additionally the Fund owns 100% of several securities as indicated in the
Statement of Investments. As a result of its ownership position there is no
active market in these securities. Valuations of these securities are provided
by a pricing service and are believed by the Manager to reflect fair value. The
market value of securities owned 100% by the Fund was approximately $5,111,810
(or 50.96% of net assets) as of December 31, 1997.
Inverse Floating Rate Notes (IFRN):
The Fund invests in variable rate securities commonly called "inverse
floaters". The interest rates on these securities have an inverse relationship
to the interest rate of other securities or the value of an index. Changes in
interest rate on the other security or index inversely affect the rate paid on
the inverse floater, and the inverse floater's price will be more volatile than
that of a fixed-rate bond. Certain interest rate movements and other market
factors can substantially affect the liquidity of IFRN's.
55
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
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 municipal
bond portfolio, and to enhance its total return. The Fund's principal 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, 1997, the Fund
had daily average notional amounts outstanding of approximately $15,136,000 and
$5,737,561 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, 1997.
Principal Expiration Unrealized
Type Amount Position Month Loss
---- ------ -------- ----- ----
U.S. Treasury Bond ............. $7,000,000 Short 3/98 ($103,270)
Portfolio securities with an aggregate value of approximately $1,389,306
have been segregated as initial margin as of December 31, 1997.
In addition, the following table summarizes option contracts written by the
Series for the year ended December 31, 1997:
Number of Premiums Realized
Contracts Received Cost Loss
--------- -------- ---- ----
Contracts outstanding
December 31, 1996 .............. 40 $53,488
Options written .................. 780 633,904
Contracts closed or expired ...... (780) (668,591) $977,704 ($309,113)
--- -------
Contracts outstanding
December 31, 1997 .............. 40 $ 18,801
=== ========
56
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
Other Investment Transactions
For the year ended December 31, 1997, the cost of purchases and proceeds
from sales of investment securities, other than short-term obligations, were
$2,228,044 and $7,702,650, respectively.
As of December 31, 1997, the Fund had no unrealized appreciation or
depreciation for tax purposes since it has elected to recognize market value
changes each day for tax purposes.
The Fund has capital loss carryforwards to offset future capital gains as
follows:
Amount Expiration
------ ----------
$15,000,500 12/31/2002
588,100 12/31/2004
202,500 12/31/2005
-----------
$15,791,100
===========
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. The reverse
repurchase agreement outstanding at December 31, 1997 bears an interest rate of
5.9%. Portfolio securities with an aggregate value of approximately $5,757,000
have been segregated for securities sold subject to repurchase as of December
31, 1997.
The maximum month-end and the average amount of borrowing outstanding under
these arrangements during the year ended December 31, 1997 were approximately
$6,329,000 and $5,967,000.
7. Agreement and Plan of Reorganization
On July 16, 1997 each of Fundamental's mutual funds (consisting of: New York
Muni Fund, The California Muni Fund, Fundamental Fixed Income Fund: Tax Free
Money Market Series, High Yield Municipal Bond Series, and Fundamental U.S.
Government Strategic Income Fund Series) have adopted, subject to shareholder
approval, an Agreement and Plan of Reorganization (the "Plan") under which each
fund (the "Fundamental Fund") will transfer all of its assets and liabilities to
a newly-created corresponding series of The Tocqueville Trust (the "Tocqueville
Fund") in exchange for shares of the Tocqueville Fund. Shareholders of each
Fundamental Fund will receive shares of the corresponding Tocqueville Fund equal
in value to their shares in the Fundamental Fund. Shareholders will not have to
pay a sales load upon receiving shares of the Tocqueville Fund.
The corresponding Tocqueville Fund will have investment objectives, polices
and restrictions substantially identical to those of the Fundamental Fund. The
Board of Trustees of the Tocqueville Funds is comprised of
57
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
individuals other than those who currently serve as Directors (Trustees) of the
Fundamental Funds. Tocqueville Asset Management L.P. is the investment adviser
to the Tocqueville Funds.
A majority of Fundamental's Board members determined that the Plan would be
in the best interests of shareholders of the Fundamental Funds and recommended
that shareholders of each of the Fundamental Funds approve the Plan at a meeting
anticipated to be held in the Spring of 1998.
8. Subsequent Event
At its March 25, 1998 Board of Trustees' meeting, the Board of the Fund
approved the continuation of the Management Agreement and Distribution Agreement
through May 30, 1998 in contemplation of the consummation of the reorganization
discussed in Note 7.
The Manager and FSC (on behalf of certain of their directors, officers,
shareholders, employees and control persons) (the "Indemnitees") received
payment during the fiscal year ended December 31, 1997 from the Fund in the
amount of approximately $232,500. Upon learning of the payments, the independent
Board Members of the Funds directed that the Indemnitees return all of the
payments to the Funds or place them in escrow pending their receipt of an
opinion of an inedpendent legal counsel to the effect that the Indemnitees are
entitled to receive them. The Declaration of Trust, Articles of Incorporation
and contracts that call for indemnification specify that no indemnification
shall be provided to a person who shall be found to have engaged in "disabling
conduct" as defined by applicable law. The Indemnities have undertaken to
reimburse the Fund for any indemnification expenses for which it is determined
that they were not entitled to as a result of "disabling conduct" net of any
reimbursements already made to the Fund in the form of fees forgone or other
similar payments.
The Manager and FSC waived fees in the amount of $96,077 and $29,560,
respectively for the year ended December 31, 1997. The Manager and FSC have
asserted that they elected to forgo these fees because the Fund was paying legal
expenses pursuant to indemnification. The Fund has retained independent legal
counsel to determine whether the Indemnitees engaged in disabling conduct.
Pending clarification of the legal issues involved, the Indemnitees have placed
into an escrow account $102,863 as of April 30, 1998. The independent trustees
have instructed the Manager to escrow the full amount incurred by the Fund of
approximately $232,500.
58
<PAGE>
9. Selected Financial Information
<TABLE>
<CAPTION>
Year Year Year Year Year
Ended Ended Ended Ended Ended
December 31, December 31, December 31, December 31, December 31,
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Per share operating performance
(for a share outstanding throughout the period)
<S> <C> <C> <C> <C> <C>
Net asset value, beginning of period .............. $ 1.43 $ 1.49 $ 1.37 $ 2.01 $ 2.02
------ ------ ------ ------ ------
Income from investment operations
Net investment income ............................. 0.10 0.13 0.08 0.14 0.16
Net realized and unrealized gain/(loss) on
investments ..................................... (0.02) (0.06) 0.12 (0.64) -
------ ------ ------ ------ ------
Total from investment operations ............ 0.08 0.07 0.20 (0.50) 0.16
------ ------ ------ ------ ------
Less distributions
Dividends from net investment income .............. (0.10) (0.13) (0.08) (0.14) (0.16)
Dividends from net realized gains ................. - - - - (0.01)
------ ------ ------ ------ ------
Net asset value, end of period .................... $ 1.41 $ 1.43 $ 1.49 $ 1.37 $ 2.01
====== ====== ====== ====== ======
Total return ...................................... 5.51% 5.02% 15.43% (25.57%) 8.14%
Ratios/supplemental data:
Net assets, end of period (000 omitted) ........... $10,030 13,224 15,194 19,020 63,182
Ratios to average net assets
Interest expense (a) ............................ 2.75% 2.61% 3.00% 2.01% 1.54%
Operating expenses .............................. 5.75% 3.41% 3.05% 2.16% 1.39%
------ ------ ------ ------ ------
Total expenses+ (a) ......................... 8.50% 6.02% 6.05% 4.17% 2.93%
====== ====== ====== ====== ======
Net investment income+ .......................... 6.83% 9.01% 5.91% 8.94% 7.85%
Portfolio turnover rate ........................... 12.55% 12.65% 114.36% 60.66% 90.59%
Borrowings
Amount outstanding at end of period
(000 omitted) ................................... $4,969 $6,610 $ 7,481 $ 9,674 $31,072
Average amount of debt outstanding during the
period (000 omitted) ............................ $5,967 $6,577 $ 7,790 $16,592 $28,756
Average number of shares outstanding during the
period (000 omitted) ............................ 8,433 9,764 11,571 21,436 28,922
Average amount of debt per share during the
period .......................................... $ .71 $ .67 $ .67 $ .77 $ .99
<FN>
+These ratios are after expense reimbursement of 1.37%, 2.02%, 1.0% and .13% for the years ended December 31,
1997, 1996, 1995 and 1993, respectively.
(a)The ratios for each of the years in the four year period ending December 31, 1996 have been reclassified to
conform with the 1997 presentations.
</FN>
</TABLE>
59
<PAGE>
INDEPENDENT AUDITOR'S REPORT
The Board of Trustees and Shareholders
Fundamental Fixed-Income Fund
Fundamental U.S. Government Strategic Income Fund Series
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, 1997 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 each of the five years in the period then ended. 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, 1997 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 Series of
Fundamental Fixed-lncome Fund as of December 31, 1997, 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.
See Notes 2 and 8 for information regarding regulatory proceedings and
transactions with affiliates.
S I G N A T U R E
New York, New York
March 2, 1998, except for Note 8 as to which the date is April 30, 1998.
60
<PAGE>
APPENDIX
DESCRIPTION OF MUNICIPAL BONDS
Municipal Bonds include debt obligations issued to obtain
funds for various public purposes, including the construction of a wide range of
public facilities such as bridges, highways, housing, mass transportation,
schools, streets and water and sewer works. Other public purposes for which
Municipal Bonds may be issued include refunding outstanding obligations,
obtaining funds for general operating expenses, and obtaining funds to loan to
other public institutions. In addition, certain types of private activity bonds
are issued by or on behalf of public authorities to obtain funds to provide
privately operated housing facilities, airport, mass transit, port facilities,
and certain local facilities for water supply, gas, electricity or sewage or
solid waste disposal. Such obligations are included within the term Municipal
Bonds if the interest paid thereon qualifies as exempt from federal income tax.
Other types of private activity bonds, the proceeds of which are used for the
construction, equipment, repair or improvement of privately operated industrial
or commercial facilities, may constitute Municipal Bonds, although the current
federal tax laws place substantial limitations on the volume of such issues.
The two principal classifications of Municipal Bonds are
"general obligation" and "revenue" bonds. General obligation bonds are secured
by the issuer's pledge of its faith, credit and taxing power for the payment of
principal and interest. The payment of such bonds may be dependent upon an
appropriation by the issuer's legislative body. The characteristics and
enforcement of general obligation bonds vary according to the law applicable to
the particular issuer. Revenue bonds are payable only from the revenues derived
from a particular facility or class of facilities or, in some cases, from the
proceeds of a special excise or other specific revenue source. Private activity
bonds which are Municipal Bonds are in most cases revenue bonds and do not
generally constitute the pledge of the credit of the issuer of such bonds. There
are, of course, variations in the security of Municipal Bonds, both within a
particular classification and between classifications, depending on numerous
factors.
The yields on Municipal Bonds are dependent on a variety of
factors, including general money market conditions, supply and demand and
general conditions of the Municipal Bond market, size of a particular offering,
the maturity of the obligation and rating of the issue. The ratings of Moody's
Investors Service, Inc. and Standard & Poor's Corporation represent their
opinions as to the quality of various Municipal Bonds. It should be emphasized,
however, that ratings are not absolute standards of quality. Consequently,
Municipal Bonds with the same maturity, coupon and rating may have different
yields while Bonds of the same maturity and coupon with different ratings may
have the same yield.
A-1
<PAGE>
FUNDAMENTAL FIXED INCOME FUND
TAX-FREE MONEY MARKET SERIES
90 Washington Street
New York, New York 10006
STATEMENT OF ADDITIONAL INFORMATION
May 1, 1998
This Statement of Additional Information provides certain
detailed information concerning the Tax-Free Money Market Series (the "Money
Market Series") of the Fundamental Fixed Income Fund (the "Fund"). The Money
Market Series seeks to provide as high a level of current income exempt from
federal income tax as is consistent with the preservation of capital and
liquidity through the investment in a portfolio of high-quality municipal bonds
(generally with maturities of one year or less) ("Municipal Bonds"). Of course,
there can be no assurance that the investment objective will be achieved.
SHARES OF THE MONEY MARKET SERIES ARE NEITHER INSURED NOR
GUARANTEED BY THE U.S. GOVERNMENT. THERE IS NO ASSURANCE THAT THE MONEY MARKET
SERIES WILL BE ABLE TO MAINTAIN A STABLE NET ASSET VALUE OF $1.00 PER SHARE.
This Statement of Additional Information is not a Prospectus
and should be read in conjunction with the Money Market Series' current
Prospectus, a copy of which may be obtained by writing to Fundamental Service
Corporation at 90 Washington Street, New York, New York 10006, or by calling
(800) 322-6864.
This Statement of Additional Information relates to the Money
Market Series' Prospectus dated May 1, 1998.
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.
<PAGE>
TABLE OF CONTENTS
Page
INVESTMENT OBJECTIVE AND POLICIES........................................... 3
INVESTMENT LIMITATIONS...................................................... 4
MANAGEMENT OF THE FUND...................................................... 5
DISTRIBUTION PLAN........................................................... 8
INVESTMENT MANAGER.......................................................... 10
PORTFOLIO TRANSACTIONS...................................................... 11
CUSTODIAN AND INDEPENDENT ACCOUNTANTS....................................... 13
TAXES....................................................................... 13
DESCRIPTION OF SHARES....................................................... 19
CERTAIN LIABILITIES......................................................... 20
DETERMINATION OF NET ASSET VALUE............................................ 20
CALCULATION OF YIELD........................................................ 22
OTHER INFORMATION........................................................... 23
FINANCIAL STATEMENTS........................................................ 23
APPENDIX....................................................................A-1
-2-
<PAGE>
INVESTMENT OBJECTIVE AND POLICIES
The Prospectus of the Money Market Series dated May 1, 1998
(the "Prospectus") identifies the investment objective and the principal
investment policies of the Money Market Series. Other investment policies and a
further description of certain of the policies described in the Prospectus are
set forth below.
"When-Issued" Securities. As described in the Prospectus under
"INVESTMENT OBJECTIVE AND POLICIES," the Money Market Series may purchase new
issues of tax-exempt securities on a "when-issued" basis. In order to invest the
Money Market Series' assets immediately, while awaiting delivery of securities
purchased on a "when-issued" basis, short-term obligations that offer same day
settlement and earnings will normally be purchased. Although short-term
investments will normally be in tax-exempt securities, short-term taxable
securities may be purchased if suitable short-term tax-exempt securities are not
available. When a commitment to purchase a security on a "when-issued" basis is
made, procedures are established consistent with the General Statement of Policy
of the Securities and Exchange Commission concerning such purchases. Because
that policy currently recommends that an amount of the assets of the Money
Market Series equal to the amount of the purchase be held aside or segregated to
be used to pay for the commitment, cash or high-quality debt securities
sufficient to cover any commitments are always expected to be available.
Nonetheless, such purchases may involve more risk than other types of purchases,
as described in the Prospectus.
Standby Commitments. The Money Market Series may acquire
standby commitments with respect to Municipal Bonds held in its portfolio. A
standby commitment is an agreement in which a dealer agrees to purchase, at the
Money Market Series' option, specified Municipal Bonds at specified prices. The
total amount paid by the Money Market Series for outstanding standby commitments
it holds will not exceed 1/2 of 1% of the Money Market Series' total assets
calculated immediately after each standby commitment is acquired. The
acquisition of a standby commitment will not affect the valuation of the
underlying security, which will continue to be valued in accordance with the
amortized cost method. See "DETERMINATION OF NET ASSET VALUE" below. The actual
standby commitment will be valued at zero in determining net asset value. The
cost of the standby commitment will be reflected as an unrealized loss for the
period during which the commitment is held by the Money Market Series and will
be reflected in realized gain or loss when the commitment is exercised or
expires.
Portfolio Turnover. Pursuit by the Money Market 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 Money Market Series of broker 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.
-3-
<PAGE>
INVESTMENT LIMITATIONS
The Money Market 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 Money Market 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 Money Market Series may not:
1. purchase the securities of any issuer, if, as a result of
such purchase, more than 25% of its total assets would be invested in
non-governmental industrial revenue bonds, the payment of the principal and
interest on which are the responsibility of issuers in the same industry,
provided that it may invest more than 25% of its total assets in industrial
revenue bonds, in banks or in U.S. government securities;
2. borrow money, except to meet redemptions in amounts not
exceeding 33 1/3% (taken at the lower of cost or current value) of its total
assets (including the amount borrowed);
3. commit more than 10% of its assets to illiquid securities,
including repurchase agreements that mature in more than seven days;
4. make short sales of securities;
5. purchase securities on margin;
6. write, purchase or otherwise invest in any put (except for
standby commitments, as described in the Prospectus), call, straddle or spread
option or buy or sell real estate, commodities or commodity futures contracts or
invest in oil, gas or mineral exploration or development programs;
7. make loans to any person, except by (a) the purchase of a
debt obligation in which the Money Market Series is permitted to invest and (b)
engaging in repurchase agreements;
8. knowingly purchase any security that is subject to legal or
contractual restrictions on resale or for which there is no readily available
market;
9. purchase the securities of other investment companies or
investment trusts, except as they may be acquired as part of a merger,
consolidation or acquisition of assets;
10. purchase or retain the securities of any issuer if any
officer or Trustee of the Fund or of the Fund's investment advisor is an officer
or director of such issuer and owns
-4-
<PAGE>
beneficially more than 1/2 of 1% of the securities of such issuer and all of the
officers and Trustees of the Fund and of the Fund's investment advisor together
own more than 5% of the securities of such issuer;
11. act as an underwriter, except as it may be deemed to be an
underwriter in a sale of restricted securities;
12. invest in companies for the purpose of exercising control
or management; or
13. issue senior securities.
For the purposes of the Money Market Series' investment
restrictions, the issuer of a tax-exempt security is deemed to be the entity
(public or private) ultimately responsible for the payment of the principal and
interest on the security.
Operating Policies. The Money Market Series has adopted the
following operating policy which is not fundamental and which may be changed
without shareholder approval: To comply with certain state statutes, the Money
Market Series will not pledge, mortgage or hypothecate its portfolio securities
if at the time the value of the securities so pledged, mortgaged or hypothecated
would exceed 10% of the value of the Money Market Series.
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 Money
Market 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 Money Market Series. The officers of the Fund
are responsible for the operations of the Money Market Series. The Trustees and
executive officers of the Fund are listed below, together with their principal
occupations during the last five years. Each Trustee who is considered to be an
"interested person" of the Fund, as defined by the Investment Company Act of
1940 (the "1940 Act"), is indicated by an asterisk (*).
James C. Armstrong: Director of the Fund. Mr. Armstrong is a
management consultant. He was formerly a partner in Armstrong/Seltzer
Communications Inc., a New York management, consulting and public relations
firm. Earlier he served as Executive Director, Global Public Affairs Institute
at New York University and Professor, Bell of Pennsylvania Chair in
Telecommunications, Temple University. He was with American Telephone and
Telegraph Company for 15 years. His last position with AT&T was Director,
-5-
<PAGE>
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 70 North Ravenwood Drive, Cape May Court House, New Jersey 08210.
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 New
York Muni Fund, 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, LaSalle Economics
Inc., an economic consulting firm. 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.
All of the Trustees of the Fund are also Trustees or Directors
of New York Muni Fund, Inc. and The California Muni Fund. Mr. Malanga, an
officer of the Fund , holds similar offices with Fundamental Funds, Inc. and The
California Muni Fund.
The Money Market 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, New York Muni Fund, 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. Some Trustees received additional compensation at a
rate of $125 per hour for services related to serving on the Portfolio Review
Committee. 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, 1997, trustees' fees totalling $______ were paid by the Fund to the
Trustees as a group ($___ for the High-Yield Municipal Bond Series, $______ for
the Money Market Series and $_____ for the Fundamental U.S.Government Strategic
Income Fund Series).
-6-
<PAGE>
COMPENSATION TABLE
(FOR EACH CURRENT BOARD MEMBER
RECEIVING COMPENSATION FROM
A FUNDAMENTAL FUND FOR THE
MOST RECENTLY COMPLETED FISCAL YEAR)
AGGREGATE COMPENSATION FROM FUND
--------------------------------
<TABLE>
<CAPTION>
AGGREGATE
COMPENSATION
PAID BY ALL
FUNDS MANAGED
BY
HIGH-YIELD TAX-FREE U.S. GOV'T FUNDAMENTAL
CALIFORNIA MUNICIPAL MONEY STRATEGIC PORTFOLIO
NAME NY MUNI MUNI BOND MARKET INCOME ADVISORS, INC.
<S> <C> <C> <C> <C> <C> <C>
JAMES C. ARMSTRONG $29,684 $3,044 $496 $2,919 $2,207 $38,350
L. GREG FERRONE $20,124 $2,064 $336 $1,979 $1,497 $26,000
</TABLE>
-7-
<PAGE>
Administrator, Transfer Agent, Custodian and Accounting Agent
Firstar Trust Company, P.O. Box 701, Milwaukee, WI 53201-0701
currently acts as Administrator, Transfer Agent, Custodian and Accounting Agent
for the Money Market Series.
Fundamental Shareholder Services, Inc., 90 Washington Street,
New York, New York 10006, an affiliate of Fundamental Portfolio Advisors, Inc.
and Fundamental Service Corporation, previously performed all services in
connection with the transfer of shares of the Money Market Series, acted as its
dividend disbursing agent, and as administrator of the exchange, check
redemption, telephone redemption and expedited redemption privileges of the
Money Market Series . During the year ended December 31, 1997, fees paid to the
Transfer Agent by the Money Market Series amounted to $17,745.
DISTRIBUTION PLAN
As discussed in the Prospectus, the Fund has entered into a
Distribution Agreement with 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 Money Market Series not borne by the Money Market Series. The Distribution
Agreement was approved by action of the Trustees of the Fund and entered into by
the Fund and FSC on March 28, 1989. The Distribution Agreement will continue in
effect from year-to-year if it is specifically approved, at least annually, in
the manner required by the 1940 Act. The Board of Trustees last approved the
Distribution Agreement on March 25, 1998 for a period of sixty days following
March 31, 1998.
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 Money
Market Series. FSC also pays certain expenses in connection with the
distribution of the Money Market 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 Money Market Series bears the cost of registering
its shares under federal and state securities law.
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.
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The Fund has adopted a plan of distribution pursuant to Rule
12b-1 under the 1940 Act (the "Plan") pursuant to which the Money Market Series
pays FSC compensation accrued daily and paid monthly at the annual rate of 1/2
of 1.0% of the Money Market 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 September 29, 1987 and by Messrs. Thomas W.
Buckingham and Vincent J. Malanga as the then sole shareholders of the Money
Market Series. During the year ended December 31, 1997, amounts incurred by the
Fund under the plan aggregated $245,844.
Pursuant to the Plan, FSC provides the Fund, for review by the
Trustees, and the Trustees review, at least quarterly, a 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 has been renewed to continue in effect for a period
of sixty days following March 31, 1998. 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.
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
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from so acting, the Trustees would consider what actions, if any, would be
necessary to continue to provide efficient and effective shareholder services.
In such event, changes in the operation of the Money Market 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 Money Market 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 Advisors, Inc. (the "Manager"), 90
Washington Street, New York, New York 10006, to act as its investment adviser.
The Management Agreement will continue in effect from year to year 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 Board of Trustees last approved the continuation of the Management
Agreement on March 25, 1998 for a period of sixty days following March 31, 1998.
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 Money Market Series and is responsible for
the overall management of the business affairs and assets of the Money Market
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 Money Market 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 Money Market Series, including
executive salaries and the rental of office space, with the exception of the
following, which are to be paid by the Money Market Series: (1) charges and
expenses for determining from time-to-time the net asset value of the Money
Market 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 Money Market Series,
(3) brokers' commissions, and issue and transfer taxes, chargeable to the Money
Market Series in connection with securities transactions, (4) insurance
premiums, interest charges, dues and fees for membership in trade associations
and all taxes and fees payable by the Money Market Series to federal, state or
other governmental agencies, (5) fees and expenses involved in registering and
maintaining registrations of the shares of the Money Market Series with the
Securities and Exchange Commission, (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
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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 Money Market 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 Money Market Series is responsible for payment of the
portion of such charges or expenses which are properly allocable to the Money
Market Series.
As compensation for the performance of its management services and the
assumption of certain expenses of the Money Market 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 Money Market Series equal to
the percentage listed below of the average daily net asset value of the Money
Market Series.
Average Daily Net Asset Value Annual Fee Payable
----------------------------- ------------------
Net asset value to $100,000,000 .50%
Net asset value of $100,000,000
or more but less than $200,000,000 .48%
Net asset value of $200,000,000
or more but less than $300,000,000 .46%
Net asset value of $300,000,000
or more but less than $400,000,000 .44%
Net asset value of $400,000,000
or more but less than $500,000,000 .42%
Net asset value of $500,000,000 or more .40%
For the years ended December 31, 1988, 1989, 1990, 1991, 1992 and 1993,
the Manager waived its management fees and paid on behalf of the Money Market
Series $24,639, $77,495, $37,383, $38,348, $81,068, $90,681 and $27,160,
respectively, as expense reimbursements under the Management Agreement.
Mr. Vincent J. Malanga, a trustee and officer of the Fund, and Dr.
Lance M. Brofman, each own approximately 48.5% of the outstanding shares of
voting capital stock of the Manager.
PORTFOLIO TRANSACTIONS
All orders for the purchase or sale of portfolio securities are placed
on behalf of the Money Market 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
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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 advisor. Securities purchased and sold on behalf of the Money
Market 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 Money Market 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 Money Market 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 Money Market 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
Money Market Series. The receipt of such 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
Money Market 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 Money Market
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 Money Market 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
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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 Money
Market Series or shares of other series of the Fund or other funds for which the
Manager acts as investment advisor 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.
During the years ended December 31, 1989 through 1997 the Money Market
Series did not pay any brokerage commissions.
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 Money Market Series and the Fund and review the
dealer spreads paid by the Money Market 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.
CUSTODIAN AND INDEPENDENT ACCOUNTANTS
Firstar Trust Company (the "Bank"), P.O. Box 701, Milwaukee, Wisconsin,
53201-0701 acts as Custodian of the Fund's cash and securities. The Bank also
acts as transfer agent and bookeeping agent for the Fund, and, as bookeeping
agent, 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.
TAXES
The following is only a summary of certain additional federal income
tax considerations generally affecting the Money Market 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 Money Market 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 Money Market Series has elected to be taxed as a regulated
investment company for federal income tax purposes under Subchapter M of the
Internal Revenue Code of
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1986, as amended (the "Code"). As a regulated investment company, the Money
Market 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) and at least 90% of its tax-exempt income (net of
expenses allocable thereto) for the taxable year (the "Distribution
Requirement"), and satisfies certain other requirements of the Code that are
described below. Distributions by the Money Market 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 will therefore count toward satisfaction of the
Distribution Requirement.
In addition to satisfying the Distribution Requirement, a
regulated investment company must 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").
In general, gain or loss recognized by the Money Market Series
on the disposition of an asset will be a capital gain or loss. However, gain
recognized on the disposition of a debt obligation (including municipal
obligations) purchased by the Money Market 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 Money Market Series held the debt
obligation.
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 Money Market 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 Money Market Series' taxable year, at least 50% of the value of
the Money Market 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 each of which the Money Market Series has not
invested more than 5% of the value of the Money Market Series' total assets in
securities of such issuer and 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
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than U.S. Government securities and securities of other regulated investment
companies), or in two or more issuers which the Money Market Series controls and
which are engaged in the same or similar trades or businesses.
If for any taxable year the Money Market 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 Money
Market 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")). (Tax-exempt interest on municipal obligations is not subject to the
excise tax.) 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 Money Market 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 Money Market Series may
in certain circumstances be required to liquidate portfolio investments to make
sufficient distributions to avoid excise tax liability.
Money Market Series Distributions
The Money Market 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.
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<PAGE>
The Money Market Series may either retain or distribute to
shareholders its net capital gain for each taxable year. The Money Market Series
currently intends to distribute any such 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 Money
Market Series prior to the date on which the shareholder acquired his shares.
The Money Market Series intends to qualify to pay
exempt-interest dividends by satisfying the requirement that at the close of
each quarter of the Money Market Series' taxable year at least 50% of the Money
Market Series' total assets consists of tax-exempt municipal obligations.
Distributions from the Money Market Series will constitute exempt-interest
dividends to the extent of the Money Market Series' tax-exempt interest income
(net of expenses and amortized bond premium). Exempt-interest dividends
distributed to shareholders of the Money Market Series are excluded from gross
income for federal income tax purposes. However, shareholders required to file
federal income tax returns will be required to report the receipt of
exempt-interest dividends on their returns. Moreover, while exempt-interest
dividends are excluded from gross income for federal income tax purposes, they
may be subject to alternative minimum tax ("AMT") in certain circumstances and
may have other collateral tax consequences as discussed below. Distributions by
the Money Market Series of any investment company taxable income or of any net
capital gain will be taxable to shareholders as discussed above.
AMT is imposed in addition to, but only to the extent it
exceeds, the regular tax and is computed at a maximum marginal rate of 28% for
noncorporate taxpayers and 20% for corporate taxpayers on the excess of the
taxpayer's alternative minimum taxable income ("AMTI") over an exemption amount.
Exempt-interest dividends derived from certain "private activity" municipal
obligations issued after August 7, 1986 generally will constitute an item of tax
preference includable in AMTI for both corporate and noncorporate taxpayers. In
addition, exempt-interest dividends derived from all municipal obligations,
regardless of the date of issue, must be included in adjusted current earnings,
which are used in computing an additional corporate preference item (i.e., 75%
of the excess of a corporate taxpayer's adjusted current earnings over its AMTI
(determined without regard to this item and the AMT net operating loss
deduction)) includable in AMTI.
Exempt-interest dividends must be taken into account in
computing the portion, if any, of social security or railroad retirement
benefits that must be included in an individual shareholder's gross income and
subject to federal income tax. Further, a shareholder of the Money Market Series
is denied a deduction for interest on indebtedness incurred or continued to
purchase or carry shares of the Money Market Series. Moreover, a shareholder who
is (or is related to) a "substantial user" of a facility financed by industrial
development bonds held by the Money Market Series will likely be subject to tax
on dividends paid by the Money Market Series which are derived from interest on
such bonds. Receipt of exempt-interest dividends may result in other collateral
federal income tax consequences to certain taxpayers, including financial
institutions, property and casualty insurance companies and foreign corporations
engaged in a
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trade or business in the United States. Prospective investors should consult
their own tax advisers as to such consequences.
Distributions by the Money Market Series that do not
constitute ordinary income dividends, exempt-interest 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 realized from the sale of the shares, as discussed below.
Distributions by the Money Market 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 Money Market 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 Money Market Series reflects realized but undistributed income or
gain, or unrealized appreciation in the value of the assets held by the Money
Market 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.
Ordinarily, shareholders are required to take distributions by
the Money Market Series into account in the year in which the distributions 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 Money
Market Series) on December 31 of such calendar year provided 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) during the year.
The Money Market 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 redemption of shares, paid to any
shareholder (1) who has failed to provide a correct taxpayer identification
number , (2) who is subject to backup withholding for failure properly to report
the receipt of interest or dividend income , or (3) who has failed to certify to
the Money Market Series that it is not subject to backup withholding or that it
is an "exempt recipient" (such as a corporation).
Sale or Redemption of Shares
The Money Market Series seeks to maintain a stable net asset
value of $1.00 per share; however, there can be no assurance that the Money
Market Series will do this. If the net asset value varies from $1.00 per share,
a shareholder will recognize gain or loss on the sale or redemption of shares of
the Money Market 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 Money Market 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 Money
Market Series will be considered capital gain or loss and will
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be long-term capital gain or loss if the shares were held for longer than one
year. Long-term capital gain recognized by an individual shareholder will be
taxed at the lowest rates applicable to capital gains if the holder has held
such shares for more than 18 months at the time of the sale. However, any
capital loss arising from the sale or redemption of shares held for six months
or less will be disallowed to the extent of the amount of exempt-interest
dividends received on such shares and (to the extent not disallowed) 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. 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 Money Market Series is "effectively connected" with a U.S. trade or business
carried on by such shareholder.
If the income from the Money Market Series is not effectively
connected with a U.S. trade or business carried on by a foreign shareholder,
ordinary income dividends paid to the shareholder will be subject to U.S.
withholding tax at the rate of 30% (or lower applicable treaty rate) on 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 or redemption
of shares of the Money Market Series, capital gain dividends and exempt-interest
dividends and amounts retained by the Money Market Series that are designated as
undistributed capital gains.
If the income from the Money Market Series is effectively
connected with a U.S. trade or business carried on by a foreign shareholder,
then ordinary income and capital gain dividends received in respect of, and any
gains realized on the sale of shares of, the Money Market Series will be subject
to U.S. federal income tax at the rates applicable to U.S.
taxpayers.
In the case of a foreign noncorporate shareholder, the Money
Market Series may be required to withhold U.S. federal income tax at a rate of
31% on distributions that are otherwise exempt from withholding tax (or subject
to withholding at a reduced treaty rate) unless the shareholder furnishes the
Money Market 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 Money Market Series, including the applicability of foreign
taxes.
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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 of Additional Information. 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, exempt-interest dividends and capital gain dividends from regulated
investment companies may 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 these and other state and local tax rules affecting investment
in the Money Market 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 Money Market Series, the High-Yield Municipal Bond Series
and the Fundamental U.S. Government Strategic Income Fund Series. The Trustees
may establish additional series of shares, and may divide or combine the shares
of a series into a greater or lesser number of shares without thereby changing
the proportionate beneficial interests in the series. Each share represents an
equal proportionate interest in the relevant series with each other share of
such series. 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 Fund's shareholders are entitled to share pro rata in the Fund's
net assets available for distribution to shareholders.
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."
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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 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 or for 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 Money Market 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 Money Market 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 Money Market Series become effective and no shares are
tendered for redemption, the net asset value per share is not determined.
Except as set forth in the following paragraph, the Money
Market Series' portfolio instruments are valued on each business day on the
basis of amortized cost. This technique involves valuing an instrument at its
cost and thereafter assuming a constant amortization to maturity of any discount
or premium, regardless of the impact of fluctuating interest rates on
-20-
<PAGE>
the market value of the instrument. While this method provides certainty in
valuation, it may result in periods during which value, as determined by
amortized cost, is higher or lower than the price the Fund would receive if it
sold the instrument. During periods of declining interest rates, the daily yield
on shares of the Money Market Series computed as described above may tend to be
higher than a like computation made by a fund with identical investments
utilizing a method of valuation based upon market prices and estimates of market
prices for all of its portfolio instruments. Thus, if the use of amortized cost
by the Money Market Series resulted in a lower aggregate portfolio value on a
particular day, a prospective investor in the Money Market Series would be able
to obtain a somewhat higher yield than would result from investment in a fund
utilizing solely market values and existing investors in the Money Market Series
would receive less investment income. The converse would apply in a period of
rising interest rates.
Standby commitments will be valued at zero in determining net
asset value. "When-issued" securities will be valued at the value of the
security at the time the commitment to purchase is entered into.
The valuation of the Money Market Series' portfolio
instruments based upon their amortized cost and the concomitant maintenance of
the Money Market Series' per share net asset value of $1.00 is permitted in
accordance with Rule 2a-7 under the Investment Company Act of 1940, pursuant to
which the Money Market Series must adhere to certain conditions. The Money
Market Series must maintain a dollar-weighted average portfolio maturity of 90
days or less, purchase only instruments having remaining maturities of 13 months
or less and invest only in securities determined by the Trustees to present
minimal credit risks. (See the Prospectus for additional information). The
maturities of variable rate demand instruments held in the Money Market Series'
portfolio will be deemed to be the longer of the demand period, or the period
remaining until the next interest rate adjustment, although stated maturities
may be in excess of one year. The Trustees must establish procedures designed to
stabilize, to the extent reasonably possible, the Money Market Series' price per
share as computed for the purpose of sales and redemptions at a single value. It
is the intention of the Money Market Series to maintain a per-share net asset
value of $1.00 but there can be no assurance of this. Such procedures will
include review of the Money Market Series' portfolio holdings by the Trustees,
at such intervals as they may deem appropriate, to determine whether the Money
Market Series' net asset value calculated by using available market quotations
deviates from $1.00 per share and, if so, whether such deviation may result in
material dilution or is otherwise unfair to existing shareholders. In the event
the Trustees determine that such a deviation exists, they have agreed to take
such corrective action as they regard as necessary and appropriate, including
the sale of portfolio instruments prior to maturity to realize capital gains or
losses or to shorten average portfolio maturity; withholding dividends;
redeeming shares in kind; or establishing a net asset value per share by using
available market quotations.
-21-
<PAGE>
CALCULATION OF YIELD
The Money Market Series' yield quotations as they may appear
in the Prospectus, this Statement of Additional Information or in advertising
and sales material are calculated by a standard method prescribed by the
Securities and Exchange Commission. Under this method, the yield quotation is
based on a hypothetical account having a balance of exactly one share at the
beginning of a seven-day period.
The yield quotation is computed as follows: The net change,
exclusive of capital changes (i.e., realized gains and losses from the sale of
securities and unrealized appreciation and depreciation), in the value of a
hypothetical pre-existing account having a balance of one share at the beginning
of the base period is determined by subtracting a hypothetical charge reflecting
expense deductions from the hypothetical account, and dividing the net change in
value by the value of the share at the beginning of the base period. This base
period return is then multiplied by 365/7 with the resulting yield figure
carried to the nearest 100th of 1%. The determination of net change in account
value reflects the value of additional shares purchased with dividends from the
original share, dividends declared on both the original share and any such
additional shares, and all fees that are charged to the Money Market Series, in
proportion to the length of the base period and the Money Market Series' average
account size (with respect to any fees that vary with the size of an account).
The Money Market Series also may advertise a quotation of
effective yield. Effective yield is computed by compounding the unannualized
base period return determined as in the preceding paragraph by adding 1 to the
base period return, raising the sum to a power equal to 365 divided by 7, and
subtracting one from the result, according to the following formula:
Effective Yield = [(Base Period Return + 1) 365/7] - 1.
The Money Market Series' taxable equivalent yield is
determined by dividing that portion of the Money Market Series' yield
(calculated as described above) that is tax-exempt by one minus a stated
marginal federal income tax rate and adding the product to that portion, if any,
of the yield of the Money Market Series that is not tax-exempt. The Money Market
Series' taxable equivalent effective yield is determined by dividing that
portion of the Money Market Series' effective yield (calculated as described
above) that is tax-exempt by one minus a stated marginal federal income tax rate
and adding the product to that portion, if any, of the effective yield of the
Money Market Series that is not tax-exempt. The Money Market Series' taxable
equivalent yield and taxable equivalent effective yield assume that the
proportion of income of the Money Market Series that is tax-exempt over the
seven-day period used in determining the yield and effective yield quotations is
constant over the 52-week period over which such yield quotations are
annualized.
The yield and effective yield of the Money Market Series for
the seven-day period ended December 31, 1997 was ____% and ____%, respectively.
-22-
<PAGE>
The taxable equivalent yield and taxable equivalent effective
yield of the Money Market Series for the seven-day period ended December 31,
1997 was ____% and ____%, respectively, for a taxpayer whose income was subject
to the then highest marginal federal income tax rate of ____%.
OTHER INFORMATION
As of March 31, 1998, the Trustees and officers of the Fund as
a group beneficially owned less than 1% of the outstanding shares of the Money
Market Series. As of such date, the following persons were known by Fund
management to have owned beneficially, directly or indirectly, 5% or more of the
outstanding shares of the Money Market Series:
<TABLE>
<CAPTION>
NAMES & ADDRESS NUMBER OF SHARES PERCENTAGE OF
_______________ OWNED OUTSTANDING SHARES
<S> <C> <C>
Leon Pfeffer & 258,672.320 7.15%
Jack Pfeffer JT TEN
444 Neptune Ave., Apt. 4H
Brooklyn, NY 11224-4408
Liberty Zeiger Fund LP 1,011,332.820 27.97%
7818 Orlando Avenue
Lubbock, TX 79425-1942
</TABLE>
FINANCIAL STATEMENTS
Audited financial statements of the Money Market Series for
the year ended December 31, 1997 are attached hereto.
-23-
<PAGE>
(CHART MATERIAL)
New York Muni Fund
Portfolio Composition
December 31, 1997
(unaudited)
BY TYPE
(15.8%) FCSI
(51.4%) FCLT
(20.9%) LRIB
(11.9%) INLT
BY RATING+
(4.6%) Non-income
producing bonds
(1.3%) AA
(59.6%) AAA
(19.2%) BBB
(1.9%) Not Rated
FIXED COUPON BONDS
FCLT -- Long (maturity > 15 years) (includes long zero coupons)
FCSI -- Short or Intermediate (maturity < 15 years) (includes zero coupon
bonds)
VARIABLE RATE BONDS
RIB(Residual Interest Bond) type inverse floaters. These are leveraged bonds
whose coupon varies inversely with rates on short term companion issues. The
inverse floater's price will be more volatile than that of a fixed coupon bond.
LRIB -- Long Term (maturity > 15 years)
IN (Index) based inverse floaters are bonds whose interest coupons vary
inversely with an index of short term interest rates and then revert to a fixed
rate mode. The inverse floater's price will be more volatile than that of a
fixed coupon bond.
INLT -- Long Term (maturity > 15 years)
+If a security has a split rating, the highest applicable rating is used,
including published ratings on identical credits for individual securities not
individually rated.
2
<PAGE>
(CHART MATERIAL)
$22,786
Lehman
Brothers
Municipal
Bond Index*
$15,144
Fundamental
New York
Muni
Fund, Inc.
$13,926
Consumer
Price Index
- --------------------------------------------------------------------------------
New York Muni Fund
- --------------------------------------------------------------------------------
Average Annual Total Return
Ended on 12/31/97
- --------------------------------------------------------------------------------
1 Year 5 Year 10 Year
- --------------------------------------------------------------------------------
1.46% (0.62)% 4.24%
- --------------------------------------------------------------------------------
Thousands ($)
24 22 20 18 16 14 12 10
12/31/87 12/31/88 12/31/89 12/31/90 12/31/91 12/31/92 12/31/93 12/31/94
12/31/95 12/31/96 12/31/97
Past performance is not predictive of future performance.
The above illustration compares a $10,000 investment made in the New York Muni
Fund on 12/31/87 to a $10,000 investment made in the Lehman Brothers Municipal
Bond Index on that date. All dividends and capital gain distributions are
reinvested.
The Fund invests primarily in New York municipal securities and its performance
takes into account fees and expenses. Unlike the Fund, the Lehman Brothers
Municipal Bond Index is an unmanaged total return performance benchmark for the
long-term, investment-grade tax exempt bond market, calculated by using
municipal bonds selected to be representative of the market. The Index does not
take into account fees and expenses. Further information relating to Fund
performance, including expense reimbursements, if applic able, is contained in
the Fund's Prospectus and elsewhere in this report.
*Source:Lehman Brothers.
The Consumer Price Index is a commonly used measure of inflation; it does not
represent an investment return.
3
<PAGE>
(LEFT COLUMN)
NEW YORK MUNI FUND
STATEMENT OF ASSETS AND LIABILITIES
December 31, 1997
- --------------------------------------------------------------------------------
ASSETS
Investment in securities at value
(Note 4) (cost $127,411,133)..................... $122,737,274
Receivables:
Interest......................................... 1,484,267
Fund shares sold................................. 58,146,118
-----------
Total assets.............................. 182,367,659
-----------
LIABILITIES
Notes payable (Note 6)............................. 38,177,582
Payables:
Fund shares redeemed............................. 347,948
Investment securities purchased.................. 8,826,774
Dividend declared................................ 27,444
Due to advisor................................... 24,366
Accrued expenses................................. 368,138
-----------
Total liabilities................................. 47,772,252
-----------
NET ASSETS consisting of:
Distributions in excess of net
investment income................... $ (27,444)
Accumulated net realized loss ........ (24,284,760)
Unrealized depreciation of securities. (4,673,859)
Paid-in-capital applicable to
156,836,372 shares of $.01
par value capital stock............... 163,581,470
----------
$134,595,407
============
NET ASSET VALUE PER SHARE................ $.86
====
(RIGHT COLUMN)
STATEMENT OF OPERATIONS
Year ended December 31, 1997
- --------------------------------------------------------------------------------
INVESTMENT INCOME
Interest income............................... $ 7,756,494
EXPENSES (Notes 2 and 3)
Management fee............... $640,975
Custodian and accounting fees 327,214
Transfer agent fees.......... 450,401
Professional fees............ 1,050,450
Directors' fees.............. 102,427
Printing and postage......... 31,395
Interest..................... 1,431,511
Distribution expenses........ 647,839
Operating expenses on
defaulted bonds.............. 72,000
Other........................ 143,176
---------
4,897,388
Expenses reimbursed........ (40,700)
---------
Total expenses........................ 4,856,688
----------
Net investment income................. 2,899,806
----------
REALIZED AND UNREALIZED GAIN (LOSS)
ON INVESTMENTS
Net realized loss on investments (2,367,322)
Net unrealized appreciation of
investments.............. 5,608,133
---------
Net gain on investments ...................... 3,240,811
----------
NET INCREASE IN NET ASSETS
FROM OPERATIONS.................................. $6,140,617
==========
(FULL COLUMN)
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------
Year Ended Year Ended
December 31, December 31,
1997 1996
------------ ------------
<S> <C> <C>
INCREASE (DECREASE) IN NET ASSETS FROM
OPERATIONS
Net investment income...................................................... $ 2,899,806 $ 6,229,467
Net realized loss on investments........................................... (2,367,322) (2,404,362)
Unrealized appreciation (depreciation) on investments ..................... 5,608,133 (4,292,643)
----------- -----------
Net (decrease) increase in net assets from operations...................... 6,140,617 (467,538)
DISTRIBUTIONS:
Distributions from investment income....................................... (2,899,806) (6,229,467)
Distributions in excess of net investment income........................... (27,444) --
Return of capital distribution............................................. (551,666) --
Distributions from net realized gain from investments...................... (24,556) --
CAPITAL SHARE TRANSACTIONS (Note 5)........................................ (64,787,531) (23,248,833)
----------- -----------
Total decrease............................................................. (62,150,386) (29,945,838)
NET ASSETS:
Beginning of year.......................................................... 196,745,793 226,691,631
----------- -----------
End of year................................................................ $134,595,407 $196,745,793
=========== ===========
</TABLE>
See Notes to Financial Statements.
4
<PAGE>
NEW YORK MUNI FUND
STATEMENT OF CASH FLOWS
Year Ended December 31, 1997
<TABLE>
- ---------------------------------------------------------------------------------------------------------------------
<S> <C>
Increase (Decrease) in Cash
Cash Flows From Operating Activities
Net increase to net assets from operations .................................................. $ 6,140,617
Adjustments to reconcile net increase in net assets from operations
to net cash provided by operating activities:
Purchase of investment securities ......................................................... (1,574,433,817)
Proceeds on sale of securities ............................................................ 1,659,325,144
Decrease in interest receivable ........................................................... 2,324,155
Decrease in accrued expenses .............................................................. (391,142)
Net accretion of discount on securities ................................................... (111,800)
Net realized loss:
Investments ............................................................................. 2,367,322
Unrealized appreciation on securities .................................................... (5,608,133)
-------------
Net cash provided by operating activities ............................................. 89,612,346
-------------
Cash Flows From Financing Activities:*
Increase in notes payable ................................................................. 36,846,239
Proceeds on shares sold ................................................................... 2,222,770,042
Payment on shares repurchased ............................................................. (2,348,578,756)
Cash dividends paid ....................................................................... (649,871)
-------------
Net cash used in financing activities ................................................. (89,612,346)
-------------
Net decrease in cash .................................................................. 0
Cash at beginning of year ..................................................................... 0
-------------
Cash at end of year ........................................................................... $ 0
=============
<FN>
- --------------
*Non-cash financing activities not included herein consist of reinvestment of dividends of $3,233,013.
Cash payments for interest expense totaled $1,672,606.
</FN>
</TABLE>
See Notes to Financial Statements.
5
<PAGE>
NEW YORK MUNI FUND
STATEMENT OF INVESTMENTS
December 31, 1997
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------
Principal
Amount Issue ooo Type o Rating oo Value
-------- ----- ---- ----- -----
<C> <S> <C> <C> <C>
$ 1,000,000## Amherst NY Industrial Development Agency Lease Rev, SurfaceRink Complex,
LOC Keyhawk, 5.65%, 10/01/22............................................ FCLT A $ 1,015,360
1,000,000 Metropolitan Transit Authority NY Commuter Facilities Rev, Series C-1,
FGIC Insured 5.375%, 07/01/27........................................... FCLT AAA 1,011,120
300,000 Metropolitan Transit Authority NY Transportation Facilities Rev SVC Contract
Series 8 5.375%, 07/01/21............................................... FCLT A- 300,000
14,600,000x## New York Inverse Floating Rate Notes*...................................... INLT A- 14,618,104
500,000 New York NY Series B, 5.25%,0 8/01/15...................................... FCLT A- 495,445
5,290,000x## New York City, ECF, MBIA Insured, STEP** 3.75%, 04/01/08................... FCSI Aaa 5,402,042
5,925,000x## New York City, ECF, MBIA Insured, STEP** 3.75%, 10/01/08................... FCSI Aaa 6,046,463
2,200,000x## New York City, IDA, Imclone Systems Inc Project AMT 11.25%, 07/01/04....... FCSI NR 2,296,404
2,000,000 New York City, IDA, Brooklyn Navy Yard Cogen Partners AMT 5.75%, 10/01/36 . FCLT Baa3 2,017,800
6,700,000 New York City, MWFA, Water &Sewer Systems Rev Residual Int Tr Rcpts,
Series 29, FGIC Insured, 6.562%, 06/15/30............................... LRIB Aaa 6,497,258
1,030,000 New York City, IDA, Civic Facilities Rev, Anti-Defamation League Foundation
Ser A, MBIA Insured, 5.375%, 06/01/27.................................. FCLT Aaa 1,042,226
3,500,000## New York City, IDA, Special Facilities Rev, United Airlines Inc. Project,
AMT, 5.65%, 10/01/32.................................................... FCLT Baa3 3,538,605
4,970,000## New York State, DAR, City University Systems Series C 5.00%, 07/01/17 ..... FCLT Baa1 4,784,270
850,000 New York State, DAR, City University Series F, FGIC TCRS Insured,
5.00%, 07/01/20......................................................... FCLT Aaa 827,611
7,550,000## New York State, DAR, Court Facilities Lease Series A 5.25%, 05/15/21 ..... FCLT Baa1 7,419,838
1,000,000 New York State, DAR, Nursing Home FHA, Rosalind &Joseph Gurwin
Jewish Geriatric, AMBAC Insured 5.70%, 02/01/37......................... FCLT Aaa 1,023,890
1,650,000 New York State, DAR, St. Vincent DePaul Residence, LOC Allied Banks PLC,
5.30%, 07/01/18......................................................... FCLT Aa3 1,639,803
4,500,000## New York State, DAR, City University System Residual Int Tr Recpts 27,
MBIA Insured, Liquidity The Bank of New York, 8.22%, 07/01/24........... LRIB Aaa 4,949,055
13,460,000## New York State, DAR, City University System Residual Int Tr Recpts 28,
AMBAC Insured, Liquidity The Bank of New York, 7.63%, 07/01/25.......... LRIB Aaa 14,170,553
2,510,000 New York State, DAR, Vassar Brothers Hospital, FSA Insured 5.375%, 07/01/25 FCLT Aaa 2,525,462
5,000,000 New York State, DAR, Mental Health Services Facilities Improvement
Series D, FSA Insured, 5.125%, 08/15/27................................. FCLT AAA 4,909,950
7,500,000## New York State, DAR, FHA, St Barnabas Hospital AMBAC Insured
5.45%, 08/01/35......................................................... FCLT Aaa 7,565,700
750,000 New York State, DAR, FHA, Sara Neuman Nursing Home AMBAC Insured
5.45%, 08/01/27......................................................... FCLT Aaa 755,730
1,000,000 New York State, DAR, FHA, Sara Neuman Nursing Home AMBAC Insured
5.50%, 08/01/37......................................................... FCLT Aaa 1,009,340
42,000,000 New York State, DAR, FHA, Presbyterian Hospital Series A AMBAC Insured
0.00%, 08/15/36......................................................... FCLT Aaa 5,404,560
2,000,000 New York State, DAR, FHA, Highland Hospital Rochester Series A,
MBIA Insured, 5.45%, 08/01/37........................................... FCLT Aaa 2,008,680
1,000,000 New York State, EFC, Pollution Control Rev, Ref-St Wtr-Sub-Revolving Fund
Series E, MBIA Insd, 5.00%, 06/15/11.................................... FCLT Aaa 1,009,710
2,000,000 New York State, EFC, Pollution Control Rev, Ref-St Wtr-Sub-Revolving Fund
Series E, MBIA Insd, 5.00%, 06/15/12.................................... FCLT Aaa 2,016,160
</TABLE>
6
<PAGE>
NEW YORK MUNI FUND
STATEMENT OF INVESTMENTS (continued)
December 31, 1997
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------
Principal
Amount Issue ooo Type o Rating oo Value
-------- ----- ---- ----- -----
<C> <S> <C> <C> <C>
$ 4,040,000 New York State, HFA, Service Contract Obligation Rev Series C, 5.50%, 03/15/25. FCLT Baa1 $ 4,064,644
5,000,000## New York State, MCFFA, HFA, Rev, Presbyterian Hospital
MBIA-IBC Insured 5.375%, 02/15/25........................................... FCLT Aaa 5,045,500
9,805,000x# ## Niagara County NY, IDA Falls Street Faire Project AMT, 10.00% 09/01/06
(see Note 4 to Financial Statements)........................................ FCSI NR 3,509,700
5,870,000x# ## Niagara Falls NY, URA, Old Falls Street Improvement Project, 11.00% 05/01/09
(see Note 4 to Financial Statements).............................. ......... FCSI NR 2,101,167
1,760,000 Syracuse NY, IDA, Civic Facilities Rev, Crouse Health Hospital Project,
Series A 5.375%, 01/01/23................................................... FCLT BBB 1,715,124
------------
Total Investments (Cost $127,411,133 @)............................. $122,737,274
============
<FN>
* Inverse Floating Rate Notes (IFRN) are instruments whose interest rates bear an inverse relationship to the interest rate on
another security or value of an index. Rates shown are at December 31, 1997.
** Step Bonds (STEP) are instruments whose interest rate is fixed at an initial rate and then increases ("steps up") to another
fixed rate until maturity.
@ Cost for Federal income tax purposes is $127,989,424.
# The value of these non-income producing securities has been estimated by persons designated by the Fund's Board of Directors
using methods the Director's believe reflect fair value. See Note 4 to the financial statements.
## $82,462,761 market value of securities are segregated in whole or in part as collateral securing a line of credit.
x The Fund owns 100% of the security and therefore there is no trading in the security. See Note 4 to the financial
statements.
Legend
oType FCLT --Fixed Coupon Long Term
FCSI --Fixed Coupon Short or Intermediate Term
LRIB --Residual Interest Bond Long Term
INLT --Indexed Inverse Floating Rate Bond Long Term
ooRatings If a security has a split rating the highest applicable rating is used, including published ratings on identical
credits for individual securities not individually rated.
NR--Not Rated
ooolssue AMBAC American Municipal Bond Assurance Corporation
AMT Alternative Minimum Tax
CAB Capital Appreciation Bond
CFR Civic Facility Revenue
COP Certificates of Participation
DAR Dormitory Authority Revenue
ECF Educational Construction Fund
EFC Environmental Facilities Corp.
ETM Escrowed to Maturity
FGIC Financial Guaranty Insurance Corporation
FHA Federal Housing Administration
FSA Financial Security Association
GO General Obligation
HDA Housing Development Agency
HFA Housing Financing Agency
HIC Hospital Improvement Corporation
IDA Industrial Development Authority
ITEMECF Industrial, Tourist, Education, Medical and Environmental Control Facilities
LOC Letter of Credit
MBIA Municipal Bond Insurance Assurance Corporation
MCF Medical Care Facilities
MCFFA Medical Care Facilities Finance Agency
MTA Metropolitan Transit Authority
MWFA Municipal Water Finance Authority
NHRB Nursing Home Revenue Bond
RB Revenue Bond
RDA Research and Development Authority
SWMA Solid Waste Management Authority
URA Urban Renewal Authority
See Notes to Financial Statements.
</FN>
</TABLE>
7
<PAGE>
NEW YORK MUNI FUND
NOTES TO FINANCIAL STATEMENTS
December 31, 1997
- --------------------------------------------------------------------------------
1.Significant Accounting Policies
New York Muni Fund (the Fund) is a series of Fundamental Funds, Inc. (the
"Company"). The Company is an open-end management investment company registered
under the Investment Company Act of 1940. The Fund seeks to provide a high level
of income that is excluded from gross income for Federal income tax purposes and
exempt from New York State and New York City personal income taxes. The Fund
intends to achieve its objective by investing substantially all of its total
assets in municipal obligations of New York State, its political subdivisions
and its duly constituted authorities and corporations. The Fund employs leverage
in attempting to achieve this objective. The following is a summary of
significant accounting policies followed in the preparation of its financial
statements:
Valuation of Securities--The Fund's portfolio securities are valued on
the basis of prices provided by an independent pricing service when, in the
opinion of persons designated by the Fund's directors, such prices are
believed to reflect the fair market value of such securities. Prices of
non-exchange traded portfolio securities provided by independent pricing
services are generally determined without regard to bid or last sale prices
but take into account institutional size trading in similar groups of
securities, yield, quality, coupon rate, maturity, type of issue, trading
characteristics and other market data. Securities traded or dealt in upon a
securities exchange and not subject to restrictions against resale as well
as options and futures contracts listed for trading on a securities
exchange or board of trade are valued at the last quoted sales price, or,
in the absence of a sale, at the mean of the last bid and asked prices.
Options not listed for trading on a securities exchange or board of trade
for which over-the-counter market quotations are readily available are
valued at the mean of the current bid and asked prices. Money market and
short-term debt instruments with a remaining maturity of 60 days or less
will be valued on an amortized cost basis. Municipal daily or weekly
variable rate demand instruments will be priced at par value plus accrued
interest. Securities not priced in a manner described above and other
assets are valued by persons designated by the Fund's directors using
methods which the directors believe reflect fair value.
Futures Contracts and Options Written on Future 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.
Federal Income Taxes--It is the Fund's 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 Fund declares dividends daily from its net
investment income and pays such dividends on the last business day of each
month. Distributions of net capital gains, if any, realized on sales of
investments are made annually, as declared by the Fund's Board of
Directors. 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. Premiums and original issue
discount on securities purchased are amortized over the life of the
respective securities. Realized gains and losses from the sale of
securities are recorded on an identified cost basis. Net operating expenses
incurred on properties collateralizing defaulted bonds are charged to
operating expenses as incurred. Costs incurred to restructure defaulted
bonds are charged to realized loss as incurred.
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.
8
<PAGE>
NEW YORK MUNI FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
2.Investment Advisory Fees and Other Transactions with Affiliates
Management Agreement
Under a Management Agreement, the Fund pays an investment management fee to
Fundamental Portfolio Advisors, Inc. (the Manager) equal to 0.5% of the Fund's
average daily net asset value up to $100 million and decreasing by .02% of each
$100 million increase in net assets down to 0.4% of net assets in excess of $500
million. The Manager has voluntarily agreed to reimburse the Fund an amount not
exceeding the amount of fees payable to the Manager under the agreement for any
fiscal year, if, and to the extent that the aggregate operating expenses of the
Fund for any fiscal year including the fees payable to the Manager, but
excluding interest expenses, taxes, brokerage fees and commissions, expenses
paid pursuant to the Distribution Plan, and extraordinary expenses exceeds, on
an annual basis, 1.5% of the average daily net assets of the Fund. No such
reimbursement was required for the year ended December 31, 1997 due to the
expense limitation. See Note 8.
SEC Administrative Action Against Manager
On September 30, 1997, the Securities & Exchange Commission announced that
it instituted public administrative and cease-and desist proceedings against the
Manager, the former portfolio manager of the Fund, the president of the Manager
and Fundamental Service Corporation (FSC). The proceeding arises from the
alleged failure of an affiliated mutual fund to disclose the risks of the
affiliated fund, and of the Manager's failure to disclose its soft dollar
arrangements to the Fund's Board of Directors. A hearing has been scheduled with
an admninistrative law judge to determine whether the allegations are true, and,
if so, what remedial action, if any, is appropriate.
Board's Termination of Portfolio Manager
Between April 17, 1997 and July 24, 1997, a representative of the Manager
engaged Tocqueville Securities L.P. ("Tocqueville Securities"), an affiliate of
Tocqueville (see Note 7), as agent, to effect eight separate over-the-counter
purchase transactions of municipal obligations on behalf of the Fund. The Fund's
Board has concluded that the commissions paid to Tocqueville Securities in
connection with these transactions (a portion of which was paid to the
representative) were not justified and that the Fund bore unnecessary expenses
as a result of the sale of its securities to another party and the subsequent
repurchase of them through Tocqueville Securities. Based upon a report initiated
by Tocqueville Securities and prepared by the Fund's independent auditors, and
upon the Board's own analysis, the Board directed that the Manager terminate the
representative's services as a portfolio manager. At the Board's request and in
order to reimburse the affiliated fund for all of its losses, Tocqueville
Securities, on September 15, 1997, voluntarily paid $260,000 to the Fund, an
amount which significantly exceeds the total commissions ($184,920.60) received
by Tocqueville Securities in connection with these transactions. $219,300 of the
proceeds from the reimbursement have been included in the realized gain on
investments and $40,700 have been included as an expense reimbursement in the
accompanying financial statements. The staff of the Securities and Exchange
Commission and the Department of NASD Regulation have been informed of these
events by Tocqueville Securities. See Note 7 regarding contemplated transaction
with the Tocqueville Trust.
Distribution Plan and Service Agreement
Pursuant to a Distribution Plan (the Plan) adopted pursuant to Rule 12b-1
promulgated under the Investment Company Act of 1940, the Fund may pay certain
promotional and advertising expenses and may compensate certain registered
securities dealers and financial institutions for services provided in
connection with the processing of orders for purchase or redemption of the
Fund's shares and furnishing other shareholder services. Payments by the Fund
shall not in the aggregate, in any fiscal year, exceed 0.5% of the average daily
net assets of the Fund.
Under a Service Agreement with FSC, an affiliate of the Manager, amounts
are paid under the Plan to compensate FSC for the services it provides and the
expenses it bears in distributing the Fund's shares to investors. Any cumulative
distribution expenses related to the Fund incurred by FSC in excess of the
annual maximum amount payable by the Fund under the Plan may be carried forward
for three years in anticipation of reimbursement by the Fund on a "first
in-first out" basis. If the Plan is terminated or discontinued in accordance
with its terms, the obligation of the Fund to make payments to FSC will cease
and the Fund will not be required to make payments past the termination date.
Amounts paid to FSC pursuant to the agreement totaled $307,200 for the year
ended December 31, 1997.
NASD Sanctions and Fines
On February 19, 1998, FSC and two of its executives, without admitting or
denying guilt, entered into an agreement with the National Association of
Securities Dealers, Inc. ("NASD") whereby they accepted fines totaling $125,000
and other stipulated sanctions as a result of the NASD's finding that they had
distributed advertising materials of an affiliated mutual fund which violated
NASD rules governing advertisements.
9
<PAGE>
NEW YORK MUNI FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
The Fund compensated Fundamental Shareholder Services, Inc. (FSSI), an
affiliate of the Manager, for the services it provided under a Transfer Agent
and Service Agreement which was terminated September 11, 1997. Transfer agent
fees paid to FSSI for the year ended December 31, 1997 amounted to $260,717.
3.Directors' Fees
All of the Directors 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 Director 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. The Directors also received additional
compensation for special services as requested by the Board. Additional
compensation totaled $40,923 pro rated among the funds based on their respective
average net assets.
4.Complex Securities, Concentrations of Credit Risk, and Investment Transactions
Inverse Floating Rate Notes (IFRN):
The Fund invests in variable rate securities commonly called "inverse
floaters". The interest rates on these securities have an inverse relationship
to the interest rate of other securities or the value of an index. Changes in
interest rate on the other security or index inversely affect the rate paid on
the inverse floater, and the inverse floater's price will be more volatile than
that of a fixed-rate bond. Additionally, some of these securities contain a
"leverage factor"whereby the interest rate moves inversely by a "factor" to the
benchmark rate. For example, the rates on the inverse floating rate note may
move inversely at three times the benchmark rate. Certain interest rate
movements and other market factors can substantially affect the liquidity of
IFRN's.
Concentration of Credit Risk and Transactions in Defaulted Bonds:
The Fund owned 100% of two Niagara Falls Industrial Development Agency
bonds ("IDA Bonds") due to mature on September 1, 2006, and 98.3% of a Niagara
Falls New York Urban Renewal Agency 11% bond ("URA Bond") due to mature on May
1, 2009 which are in default. The IDA Bonds are secured by commercial retail and
office buildings known as the Falls Street Faire and Falls Street Station
Projects ("Projects"). The URA Bond is secured by certain rental payments from
the Projects.
The Fund, through its investment banker and manager, negotiated the sale of
the Falls Street Station project. The net proceeds received on the sale of
approximately $2,800,000 were accounted for as a pro rata recovery of principal
of each of the bonds. The remaining principal value of the Fall Street Station
IDA Bond of approximately $3,887,000 was charged to realized loss on
investments.
The remaining two securities are being valued under methods approved by the
Board of Directors. The aggregate value of these securities is $5,610,867 (35.8%
to their aggregate face value of $15,675,000). There is uncertainty as to the
timing of events and the subsequent ability of the Projects to generate cash
flows sufficient to provide repayment of the bonds. No interest income was
accrued on these bonds during the year ended December 31, 1997. Legal,
investment banking, and other restructuring costs charged to realized loss
totaled approximately $153,000 for the year ended December 31, 1997 ($1,640,000
cumulatively from October 6, 1992 to December 31, 1997). The Fund through its
investment banker, engaged a property manager to maintain the Projects on its
behalf, and the Fund is paying the net operating expenses of the Project. Net
operating expenses related to the Projects for the year ended December 31, 1997
are disclosed in the statement of operations, and cumulatively from October 6,
1992 to December 31, 1997 totaled approximately $684,629
Additionally, the Fund owns 100% of several securities as indicated in the
Statement of Investments. As a result of its ownership position there is no
active trading in these securities. Valuations of these securities are provided
by a pricing service and are believed by the Manager to reflect fair value. The
market value of securities owned 100% by the Fund was approximately $33,973,880
(25% of net assets) at December 31, 1997.
Other Investment Transactions:
During the year ended December 31, 1997, purchases and sales of investment
securities, other than short-term obligations, were $554,177,076 and
$647,162,806, respectively.
10
<PAGE>
NEW YORK MUNI FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
As of December 31, 1997 net unrealized depreciation of portfolio securities
on a federal income tax basis amounted to $5,252,150 composed of unrealized
appreciation of $4,320,774 and unrealized depreciation of $9,572,924.
The Fund has capital loss carryforwards available to offset future capital
gains as follows:
Amount Expiration
------ ----------
$18,503,000 December 31, 2002
3,430,000 December 31, 2004
2,214,000 December 31, 2005
-----------
$24,147,000
===========
5.Capital Stock
As of December 31, 1997 there were 500,000,000 shares of $.01 par value
capital stock authorized. Transactions in capital stock were as follows:
<TABLE>
<CAPTION>
Year Ended Year Ended
December 31, 1997 December 31, 1996
-------------------------- --------------------------
Shares Amount Shares Amount
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Shares sold......................... 2,692,167,470 $2,280,916,160 3,704,110,578 $3,314,430,819
Shares issued on reinvestment
of dividends........................ 3,788,810 3,223,013 5,501,544 4,939,206
Shares redeemed .................... (2,765,077,644) (2,348,926,704) (3,714,943,217) (3,342,618,858)
-------------- -------------- -------------- --------------
Net (decrease) ..................... (69,121,364) $ (64,787,531) (5,331,095) $ (23,248,833)
============== ============== ============== ==============
</TABLE>
6.Line of Credit
The Fund has line of credit agreements with banks collateralized by cash
and portfolio securities. Borrowings under these agreements bear interest linked
to the banks' prime rate. Pursuant to these agreements $38,177,582 was
outstanding at December 31, 1997.
The maximum month end and the average borrowings outstanding during the year
ended December 31, 1997 were $82,500,000 and $20,630,505, respectively.
7. Agreement and Plan of Reorganization
On July 15, 1997 each of Fundamental's mutual funds (consisting of: New
York Muni Fund, The California Muni Fund, Fundamental Fixed Income Fund: Tax
Free Money Market Series, High Yield Municipal Bond Series, and Fundamental U.S.
Government Strategic Income Fund Series) have adopted, subject to shareholder
approval, an Agreement and Plan of Reorganization (the "Plan") under which each
fund (the "Fundamental Fund") will transfer all of its assets and liabilities to
a newly-created corresponding series of The Tocqueville Trust (the "Tocqueville
Fund") in exchange for shares of the Tocqueville Fund. Shareholders of each
Fundamental Fund will receive shares of the corresponding Tocqueville Fund equal
in value to their shares in the Fundamental Fund. Shareholders will not have to
pay a sales load upon receiving shares of the Tocqueville Fund.
The corresponding Tocqueville Fund will have investment objectives, polices
and restrictions substantially identical to those of the Fundamental Fund. The
Board of Trustees of the Tocqueville Funds is comprised of individuals other
than those who currently serve as Directors (Trustees) of the Fundamental Funds.
Tocqueville Asset Management L.P. is the investment adviser to the Tocqueville
Funds.
A majority of Fundamental's Board Members determined that the Plan would be
in the best interests of shareholders of the Fundamental Funds and recommended
that shareholders of each of the Fundamental Funds approve the Plan at a meeting
anticipated to be held in the Spring of 1998.
8. Subsequent Event
At its March 25, 1998 Board of Directors' meeting, the Board of the Fund
approved the continuation of the Management Agreement through May 30, 1998 in
contemplation of the consummation of the reorganization discussed in Note 7.
11
<PAGE>
NEW YORK MUNI FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
The Manager and FSC (on behalf of certain of their directors, officers,
shareholders, employees and control persons) (the "Indemnitees") received
payment during the fiscal year ended December 31, 1997 from the Fund in the
amount of approximately $50,230. Upon learning of the payments, the independent
Board Members of the Funds directed that the Indemnitees return all of the
payments to the Funds or place them in escrow pending their receipt of an
opinion of an inedpendent legal counsel to the effect that the Indemnitees are
entitled to receive them. The Declaration of Trust, Articles of Incorporation
and contracts that call for indemnification specify that no indemnification
shall be provided to a person who shall be found to have engaged in "disabling
conduct" as defined by applicable law. The Indemnities have undertaken to
reimburse the Fund for any indemnification expenses for which it is determined
that they were not entitled to as a result of "disabling conduct" net of any
reimbursements already made to the Fund in the form of fees forgone or other
similar payments.
FSC waived fees in the amount of $51,200 in 1998. The Manager and FSC have
asserted that they elected to forgo these fees because the Fund was paying legal
expenses pursuant to indemnification. The Fund has retained independent legal
counsel to determine whether the Indemnitees engaged in disabling conduct.
Pending clarification of the legal issues involved, the Independent Directors
have instructed the Manager to escrow the full amount incurred by the Fund of
approximately $50,230.
9. Selected Financial Information
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE
(for a share outstanding throughout the year)
Net Asset Value, Beginning of Year ....................... $0.87 $0.98 $0.88 $1.18 $1.21
----- ----- ----- ----- -----
Income from investment operations:
Net investment income .................................... .021 .035 .035 .056 .065
Net realized and unrealized gains (losses)
on investments ........................................... (.009) (.110) .101 (.290) .082
---- ----- ----- ----- -----
Total from investment operations ......................... .012 (.075) .136 (.234) .147
----- ----- ----- ----- -----
Less Distributions:
Dividends from net investment income ..................... (.019) (.035) (.035) (.056) (.065)
Return of capital distributions........................... (.003) -- -- -- --
Dividends from net realized gains ........................ -- -- (.001) (.010) (.112)
----- ----- ----- ----- -----
Total distributions ...................................... (.022) (.035) (.036) (.066) (.177)
----- ----- ----- ----- -----
Net Asset Value, End of Year ............................. $0.86 $0.87 $0.98 $0.88 $1.18
===== ===== ===== ===== =====
Total Return ............................................. 1.46% (7.73%) 15.67% (20.47%) 12.58%
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (000) ............................ $134,595 $196,746 $226,692 $212,665 $275,552
Ratios to Average Net Assets:
Interest expense ......................................... 1.10% 2.11% 2.09% 1.59% .61%
Operating expenses ....................................... 2.64% 1.66% 1.55% 1.62% 1.44%
----- ----- ----- ----- -----
Total expenses ........................................... 3.74%+ 3.77% 3.64% 3.21% 2.05%
===== ===== ===== ===== =====
Net investment income .................................... 2.23%+ 3.89% 3.81% 5.34% 5.20%
Portfolio turnover rate .................................. 399.38% 347.44% 347.50% 289.69% 404.05%
</TABLE>
12
<PAGE>
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
BANK LOANS
Amount outstanding at end of year (000 omitted) .......... $38,178 $1,200 $64,575 $20,000 $20,873
Average amount of bank loans outstanding during the year
(000 omitted) ............................................ $20,631 $49,448 $49,603 $54,479 $24,100
Average number of shares outstanding during the year
(000 omitted) ............................................ 153,535 178,456 191,692 206,323 184,664
Average amount of debt per share during the year ......... $ .134 $ .277 $ .259 $ .264 $ .131
<FN>
+These ratios are after expense reimbursement of .03% for the year ended December 31, 1997.
</FN>
</TABLE>
13
<PAGE>
INDEPENDENT AUDITOR'S REPORT
- --------------------------------------------------------------------------------
The Board of Directors and Shareholders
New York Muni Fund
We have audited the accompanying statement of assets and liabilities, including
the statement of investments, of New York Muni Fund as of December 31, 1997, and
the related statements of operations and cash flows for the year then ended, the
statements of changes in net assets for each of the two years in the period then
ended, and selected financial information for each of the five years in the
period then ended. 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, 1997 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 New York Muni Fund as of December 31, 1997 and the results of its
operations, cash flows, changes in net assets, and selected financial
information for the periods indicated, in conformity with generally accepted
accounting principles.
See Notes 2 and 8 for information regarding regulatory proceedings and
transactions with affiliates.
S I G N A T U R E
New York, New York
March 2, 1998, except for Note 8 as to which the date is April 30, 1998.
14
<PAGE>
THE CALIFORNIA MUNI FUND
(LEFT COLUMN)
STATEMENT OF ASSETS AND LIABILITIES
December 31, 1997
- --------------------------------------------------------------------------------
ASSETS
Investment in securities
at value (cost $8,917,684) ................. $ 9,183,831
Interest receivable .......................... 252,201
Receivable for fund shares sold .............. 4,962,106
-----------
Total assets ..................... 14,398,138
-----------
LIABILITIES
Loans (Note 6) ............................... 503,018
Dividend Payable ............................. 10,223
Accrued expenses ............................. 52,893
-----------
Total liabilities ................ 566,134
-----------
NET ASSETS consisting of:
Accumulated net realized gain ... $ 220,789
Unrealized appreciation of
securities .................... 266,147
Paid-in-capital applicable to
1,672,917 shares of beneficial
interest (Note 4) ............. 13,345,068
---------- -----------
$13,832,004
===========
NET ASSET VALUE PER SHARE $8.27
=====
(RIGHT COLUMN)
STATEMENT OF OPERATIONS
Year Ended December 31, 1997
- --------------------------------------------------------------------------------
INVESTMENT INCOME
Interest income .................. $1,009,193
EXPENSES (Notes 2 and 3)
Management fee ................... $63,726
Custodian and accounting fees .... 60,460
Transfer agent fees .............. 38,033
Professional fees ................ 144,918
Printing and postage ............. 16,886
Interest ......................... 53,011
Distribution expenses ............ 44,731
Trustees' fees ................... 10,471
-------
Total expenses ...... 432,236
Less: Expenses reim-
bursed by manager . (3,296)
Net expenses ........ ------- 428,940
----------
Net investment income 580,253
----------
REALIZED AND UNREALIZED GAIN ON
INVESTMENTS
Net realized gain on investments . 493,308
Unrealized appreciation of
investments for the year ....... 374,518
----------
Net gain on investments 867,826
----------
NET INCREASE IN NET ASSETS FROM
OPERATIONS ......................... $1,448,079
==========
(FULL COLUMN)
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
Year Ended Year Ended
December 31, December 31,
1997 1996
------------ ------------
<S> <C> <C>
INCREASE (DECREASE) IN NET ASSETS FROM:
OPERATIONS
Net investment income ................................................ $ 580,253 $ 694,929
Net realized gain on investments ..................................... 493,308 100,733
Unrealized appreciation (depreciation) of investments for the year ... 374,518 (876,013)
----------- -----------
Net increase (decrease) in net assets from operations ............ 1,448,079 (80,351)
DIVIDENDS PAID TO SHAREHOLDERS FROM
Net investment income ................................................ (580,253) (694,929)
CAPITAL SHARE TRANSACTIONS (Note 4) .................................... (3,287,401) 4,404,527
----------- -----------
Total increase (decrease) .................................... (2,419,575) 3,629,247
NET ASSETS:
Beginning of year .................................................... 16,251,579 12,622,332
----------- -----------
End of year .......................................................... $13,832,004 $16,251,579
=========== ===========
</TABLE>
See Notes to Financial Statements.
18
<PAGE>
THE CALIFORNIA MUNI FUND
STATEMENT OF CASH FLOWS
Year Ended December 31, 1997
- --------------------------------------------------------------------------------
Increase (Decrease) in Cash
Cash Flows From Operating Activities
Net increase to net assets from operations ................... $ 1,448,079
Adjustments to reconcile net increase in net assets from
operations to net cash provided by operating activities:
Purchase of investment securities .......................... (128,371,610)
Proceeds on sale of securities ............................. 136,362,253
Increase in interest receivable ............................ (5,768)
Decrease in accrued expenses ............................... (81,857)
Net accretion of discount on securities .................... (135,229)
Net realized gain:
Investments .............................................. (493,308)
Unrealized appreciation on securities ........................ (374,518)
------------
Net cash provided by operating activities ............. 8,348,042
------------
Cash Flows From Financing Activities:*
Increase in notes payable .................................. 503,018
Proceeds on shares sold .................................... 251,745,912
Payment on shares repurchased .............................. (260,415,184)
Cash dividends paid ........................................ (195,278)
------------
Net cash used in financing activities ................. (8,361,532)
------------
Net decrease in cash .................................. (13,490)
Cash at beginning of year ...................................... 13,490
------------
Cash at end of year ............................................ $ 0
============
- -----------
*Non-cash financing activities not included herein consist of reinvestment of
dividends of $419,765.
Cash payments for interest expense totaled $57,087.
See Notes to Financial Statements.
19
<PAGE>
THE CALIFORNIA MUNI FUND
<TABLE>
<CAPTION>
STATEMENT OF INVESTMENTS
December 31, 1997
- ---------------------------------------------------------------------------------------------------------------------
Principal
Amount Issue ooo Type Rating Value
------ ----- ---- ------ -----
<C> <S> <C> <C> <C>
$ 100,000(DD) Arvin, Development Corporation, COP, RB, 8.75%, 9/01/18 ............. FCLT NR $ 24,505
200,000 Beverly Hills, PFA, RB, IFRN*, MBIA Insured, 7.32%, 6/01/15 ......... LRIB AAA 209,428
100,000 CSAC Finance Corp, COP, Sutter County Health Facilities Project,
7.80%, 1/01/21 .................................................... FCLT Baa1 102,158
70,000 California, HFA, Home Mortgage, RB, Series A, MBIA Insured,
5.70%, 8/01/10 .................................................... FCSI Aaa 74,163
300,000+ California Statewide Communities Development Authority, Cedars
Sinai Medical Project, COP, RB, IFRN*, 6.97%, 11/01/15 ............ LRIB A1 290,166
300,000 East Bay, Wastewater System Project, RB, Refunding, AMBAC
Insured, IFRN*, 6.87%, 6/01/20 .................................... LRIB AAA 312,108
220,000 Hawthorne, CRA, TAR, 6.75%, 9/01/24 ................................. FCLT Baa 240,933
170,000 Lake Elsinore, USD, Refunding, COP, 6.90%, 2/01/20 .................. FCLT BBB 187,299
10,000 Los Angeles, Home Mortgage, RB, 9.00%, 6/15/18 ...................... FCLT A 10,200
1,505,192 Los Angeles, HFA, MFH Project C, CAB, RB, 12.00%, 12/01/29 .......... FCLT NR 1,112,291
35,000 Modesto, Valley Oak Project, RB, 10.60%, 5/01/09 .................... FCSI NR 35,792
250,000 Northern California Power Agency, Multiple Capital Facilities, RB,
MBIA Insured, IFRN*, 8.76%, 8/01/25 ............................... LRIB AAA 293,040
250,000 Northern California Transmission Agency, CA-ORE Transmission
Project, RB, MBIA Insured, IFRN*, 6.81%, 4/29/24 .................. LRIB AAA 254,042
500,000 Orange County Airport, RB, Refunding, MBIA Insured, 5.625%,
7/01/12 ........................................................... FCLT Aaa 526,415
250,000+ Orange County, LTA, RB, IFRN*, 8.01%, 2/14/11 ....................... LRIB AA 297,597
250,000 Orange County, LTA, RB, IFRN*, 7.81%, 2/14/11 ....................... LRIB AAA 289,027
185,000 Panoche, Water District, COP, 7.50%, 12/01/08 ....................... FCSI BBB 199,776
250,000 Rancho, Water District Financing Authority, RB, Prerefunded @
104, AMBAC Insured, IFRN*, 8.82%, 8/17/21 ......................... LRIB AAA 301,443
250,000 Redding, Electric System, COP, Series A, FGIC Insured, IFRN*,
7.20%, 6/01/19 .................................................... LRIB AAA 264,078
175,000 Riverside, HFA, Riverside Apartment Project, RB, 7.87%, 11/01/19 .... FCLT BB- 178,896
500,000 San Bernardino, COP, Series B. MBIA Insured, IFRN*, 6.38%,
7/01/16 ........................................................... INLT AAA 531,045
900,000 San Bernardino, COP, Series PA38, MBIA Insured, IFRN*,
11.92%, 7/01/16, Rule 144A Security (restricted as to resale
except to qualified institutions) ................................. LRIB NR 1,021,995
200,000 San Diego Water Authority, COP, FGIC Insured, IFRN*, 7.09%,
4/22/09 ........................................................... LRIB AAA 240,624
1,440,000x San Jose, CRA, Series PA-38, TAB, MBIA Insured, IFRN*, 5.83%,
8/01/16, Rule 144A Security (restricted as to resale except to
qualified institutions) ........................................... LRIB AAA 1,471,306
</TABLE>
20
<PAGE>
THE CALIFORNIA MUNI FUND
<TABLE>
<CAPTION>
STATEMENT OF INVESTMENTS (continued)
December 31, 1997
- ---------------------------------------------------------------------------------------------------------------------
Principal
Amount Issue ooo Type Rating Value
------ ----- ---- ------ -----
<C> <S> <C> <C> <C>
$ 250,000 Southern California Public Power Authority, FGIC Isured, IFRN*,
6.62%, 7/01/17 .................................................... LRIB AAA $ 248,070
55,000 Tri City, HFA, FNMA/GNMA Collateralized, AMT, 6.45%, 12/01/28 ....... FCLT AAA 59,388
30,000 Tri City, HFA, FNMA/GNMA Collateralized, AMT, Series B, 6.30%,
12/01/28 .......................................................... FCLT AAA 32,358
250,000 Tri City, HFA, FNMA/GNMA Collateralized, AMT, Series E, 6.40%,
12/01/28 .......................................................... FCLT AAA 271,518
100,000 Upland, HFA, RB, 7.85%, 7/01/20 ..................................... FCLT BBB 104,170
-----------
Total Investments (Cost $8,917,684#) ........................ $ 9,183,831
===========
<FN>
*Inverse Floating Rate Notes (IFRN) are instruments whose interest rates bear an inverse relationship to the interest
rate on another security or the value of an index. Rates shown are at December 31, 1997.
#Cost is the same for Federal income tax purposes.
xThe Fund owns 100% of the security and therefore there is no trading in the security.
(DD)Denotes non-income producing security: Security is in default.
+Segregated, in whole or part, a collateral securing a line of credit.
</FN>
</TABLE>
Legend
(LEFT COLUMN)
oType FCLT -Fixed Coupon Long Term
FCSI -Fixed Coupon Short or Intermediate Term
LRIB -Residual Interest Bond Long Term
INLT -Indexed Inverse Floating Rate Bond Long Term
ooRatings If a security has a split rating the highest applicable
rating is used, including published ratings on identicial
credits for individual securities not individually rated.
Ratings are unaudited.
NR -Not Rated
oooIssue AMBAC American Municipal Bond Assurance Corporation
AMT Alternative Minimum Tax
CAB Capital Appreciation Bond
CGIC Capital Guaranty Insurance Company
(RIGHT COLUMN)
COP Certificate of Participation
CRA California Redevelopment Agency
FGIC Financial Guaranty Insurance Corporation
FNMA Federal National Mortgage Association
FSA Financial Security Assurance, Inc.
GNMA Government National Mortgage Association
HFA Housing Finance Authority
LTA Local Transportation Authority
MBIA Municipal Bond Insurance Assurance Corporation
MFH Multi Family Housing
PFA Public Financing Authority
RB Revenue Bond
TAB Tax Allocation Bond
TAR Tax Allocation Refunding
USD Unified School District
See Notes to Financial Statements.
21
<PAGE>
THE CALIFORNIA MUNI FUND
NOTES TO FINANCIAL STATEMENTS
December 31, 1997
- --------------------------------------------------------------------------------
(LEFT COLUMN)
1. Significant Accounting Policies
The California Muni Fund (the Fund) was organized as a Massachusetts
business trust and is registered as an open end management investment company
under the Investment Company Act of 1940. The Fund's objective is to provide as
high a level of income that is excluded from gross income for Federal income tax
purposes and exempt from California personal income tax as is consistent with
the preservation of capital. The Fund employs leverage in attempting to achieve
its objective. The following is a summary of significant accounting policies
followed in the preparation of its financial statements:
Valuation of Securities-The Fund's portfolio securities are valued on the
basis of prices provided by an independent pricing service when, in the opinion
of persons designated by the Fund's trustees, such prices are believed to
reflect the fair market value of such securities. Prices of non-exchange traded
portfolio securities provided by independent pricing services are generally
determined without regard to bid or last sale prices but take into account
institutional size trading in similar groups of securities, yield, quality,
coupon rate, maturity, type of issue, trading characteristics and other market
data. Securities traded or dealt in upon a securities exchange and not subject
to restrictions against resale as well as options and futures contracts listed
for trading on a securities exchange or board of trade are valued at the last
quoted sales price, or, in the absence of a sale, at the mean of the last bid
and asked prices. Options not listed for trading on a securities exchange or
board of trade for which over-the-counter market quotations are readily
available are valued at the mean of the current bid and asked prices. Money
market and short-term debt instruments with a remaining maturity of 60 days or
less will be valued on an amortized cost basis. Securities not priced in a
manner described above and other assets are valued by persons designated by the
Fund's trustees using methods which the trustees believe accurately reflects
fair value.
Federal Income Taxes-It is the Fund's 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.
(RIGHT COLUMN)
Distributions-The Fund declares dividends daily from its net investment
income and pays such dividends on the last business day of each month.
Distributions of net capital gains, if any, realized on sales of investments are
made annually, as declared by the Fund's 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. Premiums and original issue discount on
securities purchased are amortized over the life of the respective securities.
Realized gains and losses from the sale of securities are recorded on an
identified cost basis.
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.
2. Investment Advisory Fees and Other Transactions With Affiliates
Management Agreement
Under a Management Agreement, the Fund pays an investment management fee to
Fundamental Portfolio Advisors, Inc. (the Manager) equal to 0.5% of the Fund's
average daily net asset value up to $100 million and decreasing by .02% of each
$100 million increase in net assets down to 0.4% of net assets in excess of $500
million. See Note 8.
SEC Administrative Action Against the Manager
On September 30, 1997, the Securities & Exchange Commission announced that
it instituted public administrative and cease-and desist proceedings against the
Manager, the former portfolio manager of the Fund, the president of the Manager
and Fundamental Service Corporation (FSC). The proceeding arises from the
alleged failure of an affiliated mutual fund to disclose the risks of the
affiliated Fund, and of the Manager's failure to disclose its soft dollar
arrangements to the Fund's Board of Trustees. A hearing has been sched-
22
<PAGE>
THE CALIFORNIA MUNI FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
(LEFT COLUMN)
uled with an administrative law judge to determine whether the allegations are
true, and, if so, what remedial action, if any, is appropriate.
Board's Termination of Portfolio Manager
Between April 17, 1997 and July 24, 1997, a representative of the Manager
engaged Tocqueville Securities L.P. ("Tocqueville Securities"), an affiliate of
Tocqueville (see note 7), as agent, to effect eight separate over-the-counter
purchase transactions of municipal obligations on behalf of an affiliated fund.
The affiliated fund's Board has concluded that the commissions paid to
Tocqueville Securities in connection with these transactions (a portion of which
was paid to the representative) were not justified and that the affiliated fund
bore unnecessary expenses as a result of the sale of its securities to another
party and the subsequent repurchase of them through Tocqueville Securities.
Based upon a report initiated by Tocqueville Securities and prepared by the
Fund's independent auditors, and upon the Board's own analysis, the Board
directed that the Manager terminate its representative's services as a portfolio
manager. At the Board's request and in order to reimburse the affiliated fund
for all of its losses, Tocqueville Securities, on September 15, 1997,
voluntarily paid $260,000 to the affiliated fund, an amount which significantly
exceeds the total commissions ($184,920.60) received by Tocqueville Securities
in connection with these transactions. The staff of the Securities and Exchange
Commission and the Department of NASD Regulation have been informed of these
events by Tocqueville Securities. See Note 7 regarding contemplated transaction
with the Tocqueville Trust.
Distribution Plan and Service Agreement
Pursuant to a Distribution Plan (the Plan) adopted pursuant to Rule 12b-1,
promulgated under the Investment Company Act of 1940, the Fund may pay certain
promotional and advertising expenses and may compensate certain registered
securities dealers and financial institutions for services provided in
connection with the processing of orders for purchase or redemption of the
Fund's shares and furnishing other shareholder services. Payments by the Fund
shall not in the aggregate, in any fiscal year, exceed 0.5% of the average daily
net assets of the Fund.
(RIGHT COLUMN)
Under a Service Agreement with FSC, an affiliate of the Manager, amounts are
paid under the Plan to compensate FSC for the services it provides and the
expenses it bears in distributing the Fund's shares to investors. Distribution
fees for the year ended December 31, 1997 are set forth in the Statement of
Operations of which approximately $39,200 was paid by FSC.
NASD Sanctions and Fines
On February 19, 1998, FSC and two of its executives, without admitting or
denying guilt, entered into an agreement with the National Association of
Securities Dealers Inc. ("NASD") whereby they accepted fines totaling $125,000
and other stipulated sanctions as a result of the NASD's finding that they had
distributed advertising materials of an affiliated mutual fund which violated
NASD rules governing advertisements.
Affiliated Transfer Agent
The Fund compensated Fundamental Shareholder Services, Inc. (FSSI), an
affiliate of the Manager, for the services it provided under a Transfer Agent
and Service Agreement which terminated on September 11, 1997. Transfer agent
fees paid to FSSI for the year ended December 31, 1997 aggregated $28,066.
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. The Trustees also received additional
compensation for special services as requested by the Board. Additional
compensation totaled $40,923 pro rated among the funds based on their respective
average net assets.
4. Shares of Beneficial Interest
As of December 31, 1997 there were an unlimited number of shares of
beneficial interest (no par value) authorized and capital paid in amounted to
$13,345,068. Transactions in shares were as follows:
23
<PAGE>
THE CALIFORNIA MUNI FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
(LEFT COLUMN)
Year Ended Year Ended
December 31, 1997 December 31, 1996
----------------- -----------------
Shares Amount Shares Amount
------ ------ ------ ------
Shares sold 32,632,214 $256,708,018 29,177,580 $234,552,576
Shares issued
on
reinvest-
ment of
dividends 51,101 419,765 58,802 472,727
Shares
redeemed (33,097,092) (260,415,184) (28,566,533) (230,620,776)
----------- ------------ ----------- ------------
Net increase
(decrease) (413,777) (3,287,401) 669,849 $ 4,404,527
======== ========== ======= ============
5. Complex Securities and Investment
Transactions
Inverse Floating Rate Notes:
The Fund invests in variable rate securities commonly called "inverse
floaters". The interest rates on these securities have an inverse relationship
to the interest rate of other securities or the value of an index. Changes in
interest rate on the other security or index inversely affect the rate paid on
the inverse floater, and the inverse floater's price will be more volatile than
that of a fixed rate bond. Certain interest rate movements and other market
factors can substantially affect the liquidity of IFRN's.
Investment Transactions:
During the year ended December 31, 1997, the cost of purchases and proceeds
from sales of investment securities, other than short-term obligations, were
$9,050,450 and $13,516,911, respectively.
As of December 31, 1997 the net unrealized appreciation of portfolio
securities amounted to $266,147 composed of unrealized appreciation of $744,806
and unrealized depreciation of $478,659.
(RIGHT COLUMN)
6. Line of Credit
The Fund has a line of credit agreement with its custodian bank
collateralized by portfolio securities. Borrowings under this agreement bear
interest linked to the bank's prime rate. The maximum month end and the average
borrowings outstanding during the year ended December 1997, were $2,000,000 and
$664,000, respectively.
7. Agreement and Plan of Reorganization
On July 16, 1997 each of Fundamental's mutual funds (consisting of: New York
Muni Fund, The California Muni Fund, Fundamental Fixed Income Fund: Tax Free
Money Market Series, High Yield Municipal Bond Series, and Fundamental U.S.
Government Strategic Income Fund Series) have adopted, subject to shareholder
approval, an Agreement and Plan of Reorganization (the "Plan") under which each
fund (the "Fundamental Fund") will transfer all of its assets and liabilities to
a newly-created corresponding series of The Tocqueville Trust (the "Tocqueville
Fund") in exchange for shares of the Tocqueville Fund. Shareholders of each
Fundamental Fund will receive shares of the corresponding Tocqueville Fund equal
in value to their shares in the Fundamental Fund. Shareholders will not have to
pay a sales load upon receiving shares of the Tocqueville Fund.
The corresponding Tocqueville Fund will have investment objectives, polices
and restrictions substantially identical to those of the Fundamental Fund. The
Board of Trustees of the Tocqueville Funds is comprised of individuals other
than those who currently serve as Directors (Trustees) of the Fundamental Funds.
Tocqueville Asset Management L.P. is the investment adviser to the Tocqueville
Funds.
A majority of Fundamental's Board Members determined that the Plan would be
in the best interests of shareholders of the Fundamental Funds and recommended
that shareholders of each of the Fundamental Funds approve the Plan at a meeting
anticipated to be held in the Spring of 1998.
24
<PAGE>
THE CALIFORNIA MUNI FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
8. Subsequent Event
At its March 25, 1998 Board of Trustees' meeting, the Board of the Fund
approved the continuation of the Management Agreement through May 30, 1998 in
contemplation of the consummation of the reorganization discussed in Note 7.
The Manager and FSC (on behalf of certain of their directors, officers,
shareholders, employees and control persons) (the "Indemnitees") received
payment during the fiscal year ended December 31, 1997 from the Fund in the
amount of approximately $4,000. Upon learning of the payments, the independent
Board Members of the Funds directed that the Indemnitees return all of the
payments to the Funds or place them in escrow pending their receipt of an
opinion of an independent legal counsel to the effect that the Indemnitees are
entitled to receive them. The Declaration of Trust, Articles of Incorporation
and contracts that call for indemnification specify that no indemnification
shall be provided to a person who shall be found to have engaged in "disabling
conduct" as defined by applicable law. The Indemnities have undertaken to
reimburse the Fund for any indemnification expenses for which it is determined
that they were not entitled to as a result of "disabling conduct" net of any
reimbursements already made to the Fund in the form of fees forgone or other
similar payments. Pending clarification of the legal issues involved, the
Indemnitees have placed into an escrow account $4,000 as of April 30, 1998.
9. Selected Financial Information
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE
(for a share outstanding throughout the year)
Net Asset Value, Beginning of Year ......................... $ 7.79 $ 8.91 $ 7.10 $ 9.49 $ 8.81
------- ------- ------- ------- -------
Income from investment operations:
Net investment income ...................................... .376 .409 .419 .553 .563
Net realized and unrealized gains (losses)
on investments ........................................... .480 (1.120) 1.810 (2.390) .876
------- ------- ------- ------- -------
Total from investment operations .................... .856 (.711) 2.229 (1.837) 1.439
------- ------- ------- ------- -------
Less Distributions:
Dividends from net investment income ....................... (.376) (.409) (.419) (.553) (.563)
Dividends from net realized gains .......................... - - - - (.196)
------- ------- ------- ------- -------
Total distributions ........................................ (.376) (.409) (.419) (.553) (.759)
------- ------- ------- ------- -------
Net Asset Value, End of Year ............................... $ 8.27 $ 7.79 $ 8.91 $ 7.10 $ 9.49
======= ======= ======= ======= =======
Total Return ............................................... 11.33% (8.01%) 32.02% (19.89%) 16.80%
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (000) .............................. 13,832 16,252 12,622 10,558 16,280
Ratios to Average Net Assets:
Interest expense ......................................... .42 .45% .39% .98% .39%
Operating expenses ....................................... 2.95* 2.81% 2.81% 2.50% 1.77%*
------- ------- ------- ------- -------
Total expenses ...................................... 3.37* 3.26% 3.20% 3.48% 2.16%*
======= ======= ======= ======= =======
Net investment income ............................... 4.55%* 4.88% 5.02% 6.80% 6.04%*
Portfolio turnover rate .................................... 70.86% 89.83% 53.27% 15.88% 51.26%
BANK LOANS
Amount outstanding at end of year (000 omitted) ............ $ 275 $ 0 $ 0 $1,292 $3,714
Average amount of bank loans outstanding during the year
(000 omitted) ............................................ $ 664 $ 823 $ 642 $1,620 $ 958
Average number of shares outstanding during the year
(000 omitted) ............................................ 1,609 1,768 1,635 1,711 1,517
Average amount of debt per share during the year ........... $ .41 $ .47 $ .39 $ .95 $ .63
<FN>
*These ratios are after expense reimbursement of .03%, and .50% for the years ended December 31, 1997 and 1993.
</FN>
</TABLE>
25
<PAGE>
INDEPENDENT AUDITOR'S REPORT
The Board of Trustees and Shareholders
The California Muni Fund
We have audited the accompanying statement of assets and liabilities
including the statement of investments of The California Muni Fund as of
December 31, 1997 and the related statements of operations and cash flows for
the year then ended, statements of changes in net assets for each of the two
years in the period then ended, and the selected financial information for each
of the five years in the period then ended. 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, 1997 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 California Muni Fund as of December 31, 1997, the results of its
operations, cash flows, changes in its net assets, and selected financial
information for the periods indicated, in conformity with generally accepted
accounting principles.
See Notes 2 and 8 for information regarding regulatory proceedings and
transactions with affiliates.
S I G N A T U R E
New York, New York
March 2, 1998, except for Note 8 as to which the date is April 30, 1998.
26
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
TAX-FREE MONEY MARKET SERIES
(LEFT COLUMN)
STATEMENT OF ASSETS AND LIABILITIES
December 31, 1997
- --------------------------------------------------------------------------------
ASSETS
Cash ............................................ $ 1,776,944
Investment in securities at value
(cost $75,869,410) ............................ 75,869,410
Receivables:
Fund shares sold .............................. 135,853
Interest ...................................... 270,975
-----------
Total assets .......................... 78,053,182
-----------
LIABILITIES
Payables:
Investment securities purchased ............... 1,103,151
Fund shares redeemed .......................... 63,627,947
Dividends ..................................... 9,321
Due to advisor ................................ 10,866
Accrued expenses ................................ 38,729
-----------
Total liabilities ..................... 64,790,014
-----------
NET ASSETS equivalent to $1.00 per share on
13,270,069 shares of beneficial interest
outstanding (Note 4) ............................. $13,263,168
===========
(RIGHT COLUMN)
STATEMENT OF OPERATIONS
Year Ended December 31, 1997
- --------------------------------------------------------------------------------
INVESTMENT INCOME
Interest income ................... $1,729,572
EXPENSES (Notes 2 and 3)
Investment advisory fees ..........$245,844
Custodian and accounting fees ..... 41,002
Transfer agent fees ............... 84,687
Trustees' fees .................... 10,041
Professional fees ................. 88,996
Distribution fees ................. 245,844
Postage and printing .............. 22,506
Other ............................. 12,291
--------
Total expenses .......... 751,211
Less:
Expenses paid indirectly (Note 6) . (41,002)
Expenses reimbursed by Manager .... (5,982)
--------
Net expenses ............ 704,227
----------
NET INCREASE IN NET ASSETS FROM
OPERATIONS $1,025,345
----------
(FULL COLUMN)
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
Year Ended Year Ended
December 31, December 31,
1997 1996
------------ ------------
INCREASE (DECREASE) IN NET ASSETS FROM:
OPERATIONS
Net investment income .......................... $ 1,025,345 $ 1,161,235
----------- -----------
Net increase in net assets from operations. 1,025,345 1,161,235
DIVIDENDS PAID TO SHAREHOLDERS FROM
Investment income .............................. (1,025,345) (1,161,235)
CAPITAL SHARE TRANSACTIONS (Note 4) .............. 8,642,404 (6,629,783)
----------- -----------
Total (decrease) increase ................. 8,642,404 (6,629,783)
NET ASSETS
Beginning of year .............................. 4,620,764 11,250,547
----------- -----------
End of year .................................... $13,263,168 $ 4,620,764
=========== ===========
See Notes to Financial Statements.
27
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
TAX-FREE MONEY MARKET SERIES
<TABLE>
<CAPTION>
STATEMENT OF INVESTMENTS
December 31, 1997
- ------------------------------------------------------------------------------------------------------------
Principal
Amount Issue o Value
------ ----- -----
<C> <S> <C>
$2,700,000 Ascension Parish, LA, PCR, BASF Wyandote Corp, LOC Bank of Tokyo,
VRDN*, 5.10%, 12/01/15 ..................................................... $2,700,000
1,500,000 Burke County, GA, Development Authority, VRDN*, PCR, Georgia Power Co.
Vogtle Project 5th Series, 5.00%, 7/01/24 .................................. 1,500,000
4,000,000 Burke County, GA, Development Authority, VRDN*, PCR, Georgia Power Co.
Vogtle Project 4th Series, 5.00%, 9/01/25 .................................. 4,000,000
2,800,000 Columbia AL, IDB, PCR Alabama Power Co. Project, VRDN*, Series D, 5.00%,
10/01/22 ................................................................... 2,800,000
75,000 Cuyahoga County, OH, IDR, S & R Playhouse Realty, VRDN*, LOC Marine
Midland Bank, 3.85%, 12/01/09 .............................................. 75,000
200,000 Delaware County, PA, SWDF, Scott Paper Project, Kimberly-Clark Corp
Guaranty, VRDN*, 3.65%, 12/01/18 ............................................ 200,000
200,000 Fulton County, GA, PCR, General Motors Project, VRDN*, 3.90%, 4/01/10 ........ 200,000
200,000 Garfield County, OK, PCR, Oklahoma Gas & Electric Co. Project A, VRDN*,
3.75%, 1/01/25 ............................................................. 200,000
125,000 Genesee County, NY, IDR, Orcon Industries, AMT, LOC Fleet Bank, VRDN*,
4.50%,12/01/98 ............................................................. 125,000
300,000 Illinois Educational Facility Authority, RB, Art Institute of Chicago, Northern
Trust Liquidity, VRDN*, 3.85%, 3/01/27 ..................................... 300,000
300,000 Illinois HFAR, Franciscan Sisters Project, LOC Toronto Dominion Bank,
VRDN*, 3.65%, 9/01/15 ...................................................... 300,000
2,000,000 Illinois HFAR, Healthcorp Affiliates Project, LOC Raborbank Nederland,
VRDN*, 4.05%, 11/01/20 ..................................................... 2,000,000
2,855,000 Jackson County, Miss., PCR, Chevron Corp. Project, VRDN*, 5.00%,
12/01/16 ................................................................... 2,855,000
3,700,000 Los Angeles, CA, Regional Airports Improvement Corp, LOC Societe
Generale, VRDN*, 5.00%, 12/01/25 ........................................... 3,700,000
200,000 McIntosh, AL, PCR, Ciba Geigy Project, LOC Swiss Bank Corp. VRDN*,
3.65%, 12/01/03 ............................................................ 200,000
5,000,000 Midland County, MI, Economic Development Corp, Dow Chemical Project B,
AMT, VRDN*, 5.00%, 12/01/15 ................................................ 5,000,000
300,000 Missouri, PCR, Monsanto Project, VRDN*, 3.70%, 2/01/09 ....................... 300,000
200,000 Missouri, Third Street Building Project, SPA First Chicago, VRDN*, 3.90%,
8/01/99 .................................................................... 200,000
300,000 Montgomery, AL, Baptist Medical Center, Special Care Facilities Financing
Authority, Series H, AMBAC Insured, VRDN*, 3.70%, 12/01/30 ................. 300,000
200,000 Nebraska Higher Education Loan Program, SPA, SLMA, MBIA Insured,
VRDN*, 3.65%, 12/01/15 ..................................................... 200,000
</TABLE>
28
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
TAX-FREE MONEY MARKET SERIES
<TABLE>
<CAPTION>
STATEMENT OF INVESTMENTS (continued)
December 31, 1997
- ------------------------------------------------------------------------------------------------------------
Principal
Amount Issue o Value
------ ----- -----
<C> <S> <C>
$ 5,100,000 New York City, NY, GO, LOC Chase Manhattan Bank, VRDN*, 5.00%, 8/01/23 ...... $5,100,000
2,500,000 New York City, NY, GO, Landesbank Hessen Liquidity, VRDN*, 3.60%, 2/15/20 ... 2,500,000
4,000,000 New York City, NY, Municipal Water Finance Authority, Water & Sewer System
RB, TR Receipts Series 29, The Bank of New York Liquidity, VRDN*,
3.90%, 6/15/30 ............................................................ 4,000,000
40,000 New York City, NY, New PHA, 3.38%, 01/01/98 ................................. 39,740
10,700,000x New York State, DAR, TRS 27, 3.95%, 7/01/24, City University, Floating Rate
Trust Receipts 27, MBIA Insured, Liquidity The Bank of New York ........... 10,700,000
3,000,000 New York State Energy Research & Development Authority, PCR, New York,
State Electric & Gas Co., Series D, LOC Union Bank of Switzerland,
VRDN*, 5.00%, 10/01/29 .................................................... 3,000,000
2,100,000 New York State, Job Development Authority, St. Gtd., Special Purpose Series
A-1 thru A-25, LOC Sumitomo Bank, VRDN*, 5.25%, 3/01/07 ................... 2,100,000
5,200,000 Newport Beach CA, RB, Hoag Memorial Hospital Series B, SPA Bank of
America, 5.00%, 10/01/06 .................................................. 5,200,000
50,000 North Little Rock, AR, New PHA, FGIC Insured, 3.25%, 6/01/98 ................ 49,670
1,100,000 Orange County, CA, Water District Project B, COP, LOC National
Westminister VRDN*, 4.85%, 8/15/15 ........................................ 1,100,000
4,000,000 Princeton, IN, PCR, PSI Energy, Inc., Proj., LOC Morgan Guaranty, VRDN*,
5.10%, 4/01/22 ............................................................ 4,000,000
125,000 Scioto County, OH, HFR, VHA, Central Capital Project, AMBAC Insured,
VRDN*, 3.70%, 12/01/25 .................................................... 125,000
4,500,000 Sweetwater County, WY, PCR, Idaho Power Co. Project Series C, VRDN*,
5.10%, 7/15/26 ............................................................ 4,500,000
1,600,000 Uinta County, WY, PCR, Chevron Corp Project, VRDN*, 5.00%, 8/15/20 .......... 1,600,000
4,500,000 Valdez, AK, Marine Term Revenue, Exxon Pipeline Co. Project A, VRDN*,
5.00%, 12/01/33 ........................................................... 4,500,000
200,000 Wake County, NC, PCR, Carolina Power & Light Project, LOC Sumitomo
Bank, VRDN*, 4.15%, 10/01/15 .............................................. 200,000
-----------
Total Investments (Cost $75,869,410) ........................................ $75,869,410
===========
<FN>
*Variable Rate Demand Notes (VRDN) are instruments whose interest rate changes on a specific date and/or
whose interest rates vary with changes in a designated base rate.
**Cost is the same for Federal income tax purposes.
xThe Fund owns 100% of the security and therefore there is no trading in the security.
</FN>
</TABLE>
29
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
TAX-FREE MONEY MARKET SERIES
STATEMENT OF INVESTMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
Legend
Issue AMBAC American Municipal Bond Assurance Corporation
DAR Dormitory Authority Revenue
AMT Alternative Minimum Tax
GO General Obligation
ETM Escrowed to Maturity
HFAR Health Facilities Authority Revenue
HFR Hospital Facilities Revenue
IDB Industrial Development Board
IDR Industrial Development Revenue
LOC Letter of Credit
MBIA Municipal Bond Insurance Assurance Corporation
PCR Pollution Control Revenue
PHA Public Housing Authority
RB Revenue Bond
SLMA Student Loan Marketing Association
SPA Stand By Bond Purchase Agreement
SWDF Solid Waste Disposal Facility
TRANS Tax Revenue Anticipation Notes
TRS Trust Receipt Series
See Notes to Financial Statements.
30
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
TAX-FREE MONEY MARKET SERIES
NOTES TO FINANCIAL STATEMENTS
December 31, 1997
- --------------------------------------------------------------------------------
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
acts 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 Fundamental U.S. Government Strategic Income Fund Series. Each series is
considered a separate entity for financial reporting and tax purposes. The
Tax-Free Money Market Series (the Series) investment objective is to provide as
high a level of current income exempt from federal income tax as is consistent
with the preservaton of capital and liquidity. The following is a summary of
significant accounting policies followed in the preparation of the Series'
financial statements:
Valuation of Securities:
Investments are stated at amortized cost. Under this valuation method, a
portfolio instrument is valued at cost and any premium or discount is amortized
on a constant basis to the maturity of the instrument. Amortization of premium
is charged to income, and accretion of market discount is credited to unrealized
gains. The maturity of investments is deemed to be the longer of the period
required before the Fund is entitled to receive payment of the principal amount
or the period remaining until the next interest adjustment.
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 of net
capital gains are made annually, as declared by the Fund's 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 gains and losses from the sale of
securities are recorded on an identified cost basis.
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.
31
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
TAX-FREE MONEY MARKET SERIES
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
2. Investment Advisory Fees and Other Transactions with Affiliates
Management Agreement
The Fund has a Management Agreement with Fundamental Portfolio Advisors,
Inc. (the Manager). Pursuant to the agreement, the Manager serves as investment
adviser to the Tax-Free Money Market 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 consideration for the services
provided by the Manager, the Series will pay an annual management fee in an
amount equal to 0.5% of the Series' average daily net assets up to $100 million
and decreasing by .02% for each $100 million increase in net assets down to 0.4%
of net assets in excess of $500 million. See Note 8.
SEC Administrative Proceeding Against the Manager
On September 30, 1997, the Securities & Exchange Commission announced that
it instituted public administrative and cease-and desist proceedings against the
Manager, the former portfolio manager of the Fund, the president of the Manager
and Fundamental Service Corporation (FSC), the Fund's Distributor. The
proceeding arises from the alleged failure of an affiliated mutual fund to
disclose the risks of the affiliated series, and of the Manager's failure to
disclose its soft dollar arrangements to the Fund's Board of Trustees. A hearing
has been scheduled with an administrative law judge to determine whether the
allegations are true, and, if so, what remedial action, if any, is appropriate.
Board's Termination of Portfolio Manager
Between April 17, 1997 and July 24, 1997, a representative of the Manager
engaged Tocqueville Securities L.P. ("Tocqueville Securities") an affiliate of
Tocqueville, as agent, to effect eight separate over-the-counter purchase
transactions of municipal obligations on behalf of an affiliated fund. The
Fund's Board has concluded that the commissions paid to Tocqueville Securities
in connection with these transactions (a portion of which was paid to the
representative) were not justified and that the affiliated fund bore unnecessary
expenses as a result of the sale of its securities to another party and the
subsequent repurchase of them through Tocqueville Securities. Based upon a
report initiated by Tocqueville Securities and prepared by the Fund's
independent auditors, and upon the Board's own analysis, the Board directed that
the Manager terminate the representative's services as a portfolio manager. At
the Board's request and in order to reimburse the affiliated fund for all of its
losses, Tocqueville Securities, on September 15, 1997, voluntarily paid $260,000
to the affiliated fund, an amount which significantly exceeds the total
commissions ($184,920.60) received by Tocqueville Securities in connection with
these transactions. The staff of the Securities and Exchange Commission and the
Department of NASD Regulation have been informed of these events by Tocqueville
Securities. See Note 7 regarding contemplated transaction with the Tocqueville
Trust.
Plan of Distribution
The Fund has adopted a Plan of Distribution, pursuant to Rule 12b-1
promulgated under the Investment Company Act of 1940, under which the Series
pays to FSC, an affiliate of the Manager, a fee, which is accrued daily and paid
monthly, at an annual rate of 0.5% of the Series' average daily net assets. The
amounts paid under the plan compensate FSC for the services it provides and the
expenses it bears in distributing the Series' shares to investors. Distribution
fees for the year ended December 31, 1997 are set forth in the Statement of
Operations.
NASD Sanctions and Fines
On February 19, 1998, FSC and two of its executives, without admitting or
denying guilt, entered into an agreement with the National Association of
Securities Dealers Inc. ("NASD") whereby they accepted fines
32
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
TAX-FREE MONEY MARKET SERIES
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
totaling $125,000 and other stipulated sanctions as a result of the NASD's
finding that they had distributed advertising materials of an affiliated mutual
fund which violated NASD rules governing advertisements.
Affiliated Transfer Agent
The Fund compensated Fundamental Shareholder Services, Inc., (FSSI) an
affiliate of the Manager, for the services it provided under a Transfer Agent
and Service Agreement which was terminated on September 11, 1997. Transfer agent
fees paid by the Series to FSSI for the year ended December 31, 1997 amounted to
$17,745.
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. The Trustees also received additional
compensation for special services as requested by the Board. Additional
compensation totaled $40,923 pro rated among the funds based on their respective
average net assets.
4. Shares of Beneficial Interest
As of December 31, 1997 there were an unlimited number of shares of
beneficial interest (no par value) authorized and capital paid in amounted to
$13,270,069. Transactions in shares of beneficial interest, all at $1.00 per
share were as follows:
Year ended Year ended
December 31, December 31,
1997 1996
-------------- --------------
Shares sold ..............................$2,566,332,934 $3,547,580,681
Shares issued on reinvestment of dividends 1,048,578 1,042,865
Shares redeemed ..........................(2,558,739,108) (3,555,253,329)
-------------- ----------
Net (decrease) increase ..................$ 8,642,404 (6,629,783)
============== ==========
5. Line of Credit
The Fund has a line of credit agreement with its custodian bank
collateralized by cash and portfolio securities for $500,000. Borrowings under
this agreement bear interest linked to the bank's prime rate. The Series had no
borrowing under the line of credit agreement as of or during the year ended
December 31, 1997.
6. Expenses Paid Indirectly
The Fund has an arrangement with its custodian whereby credits earned on
cash balances maintained at the custodian are used to offset custody charges.
These credits amounted to approximately $41,000 for the year ended December 31,
1997.
7. Agreement and Plan of Reorganization
On July 16, 1997 each of Fundamental's mutual funds (consisting of: New York
Muni Fund, The California Muni Fund, Fundamental Fixed Income Fund: Tax Free
Money Market Series, High Yield Municipal Bond Series, and Fundamental U.S.
Government Strategic Income Fund Series) have adopted, subject to shareholder
approval, an Agreement and Plan of Reorganization (the "Plan") under which each
fund (the "Fundamental Fund") will transfer all of its assets and liabilities to
a newly-created corresponding series of The Tocqueville Trust (the "Tocqueville
Fund") in exchange for shares of the Tocqueville Fund. Shareholders of each
Fundamental Fund will receive shares of the corresponding Tocqueville Fund equal
in value to their shares in the Fundamental Fund. Shareholders will not have to
pay a sales load upon receiving shares of the Tocqueville Fund.
33
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
TAX-FREE MONEY MARKET SERIES
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
The corresponding Tocqueville Fund will have investment objectives, polices
and restrictions substantially identical to those of the Fundamental Fund. The
Board of Trustees of the Tocqueville Funds is comprised of individuals other
than those who currently serve as Directors (Trustees) of the Fundamental Funds.
Tocqueville Asset Management L.P. is the investment adviser to the Tocqueville
Funds.
A majority of Fundamentals' Board Members determined that the Plan would be
in the best interests of shareholders of the Fundamental Funds and recommended
that shareholders of each of the Fundamental Funds approve the Plan at a meeting
anticipated to be held in the Spring of 1998.
8. Subsequent Event
At its March 25, 1998 Board of Trustees' meeting, the Board of the Fund
approved the continuation of the Management Agreement and Distribution Agreement
through May 30, 1998 in contemplation of the consummation of the reorganization
discussed in Note 7.
9. Selected Financial Information
<TABLE>
<CAPTION>
Years Ended December 31,
--------------------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
PER SHARE DATA AND RATIOS
(for a share outstanding throughout the period)
Net Asset Value, Beginning of Year ........................ $1.00 $1.00 $1.00 $1.00 $1.00
Income from investment operations:
Net investment income ..................................... 0.022 0.023 0.026 0.017 0.014
Less Distributions:
Dividends from net investment income ...................... (0.022) (0.023) (0.026) (0.017) (0.014)
Net Asset Value, End of Period ............................ $1.00 $1.00 $1.00 $1.00 $1.00
Total Return .............................................. 2.19% 2.28% 2.60% 1.69% 1.62%
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (000 omitted) ..................... 13,263 4,621 11,251 9,004 5,830
Ratios to Average Net Assets
Expenses .............................................. 1.52%(D)(D) (D) 1.54% 1.53%(D)(D) 0.91%(D) .95%(D)
Net investment income ................................. 2.10% 2.04% 2.43% 1.55% 1.25%
BANK LOANS
Amount outstanding at end of period
(000 omitted) ........................................... $ - $ 218 $ - $ 451 $ 290
Average amount of bank loans outstanding during the period
(000 omitted) ........................................... $ - $ - $ 41 $ 53 $ 111
Average number of shares outstanding during the period
(000 omitted) ........................................... 48,801 56,876 44,432 56,267 25,786
Average amount of debt per share during the period ........ $ - $ - $ .001 $ .001 $ .004
<FN>
(D)These ratios are after expense reimbursement of .02%, .44% and .67%, for each of the years ended December 31, 1997, 1994 and
1993, respectively.
(D)(D)These ratios would have been 1.44%, 1.40% and 1.35% net of expense offsets of .08%, .14% and .18% for the years ended December
31, 1997, 1996 and 1995, respectively.
</FN>
</TABLE>
34
<PAGE>
INDEPENDENT AUDITOR'S REPORT
The Board of Trustees and Shareholders
Tax-Free Money Market Series of
Fundamental Fixed-lncome Fund
We have audited the accompanying statement of assets and liabilities,
including the statement of investments, of the Tax-Free Money Market Series of
Fundamental Fixed-lncome Fund as of December 31, 1997 and the related statement
of operations for the year then ended, the statement of changes in net assets
for each of the two years in the period then ended, and the selected financial
information for each of the five years in the period then ended. 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, 1997 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 presenation. We believe that our audits provide a reasonable basis for
our opinion.
In our opinion, the financial statement and selected financial information
referred to above present fairly, in all material respects, the financial
position of the Tax-Free Money Market Series of Fundamental Fixed-Income Fund as
of December 31, 1997, and the results of its operations, changes in net assets,
and selected financial information for the periods indicated, in conformity with
generally accepted accounting principles.
See Note 2 for information regarding regulatory proceedings and transactions
with affiliates.
S I G N A T U R E
New York, New York
March 2, 1998, except for Note 8 as to which the date is March 25, 1998.
35
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
HIGH-YIELD MUNICIPAL BOND SERIES
(LEFT COLUMN)
STATEMENT OF ASSETS AND LIABILITIES
December 31, 1997
- --------------------------------------------------------------------------------
ASSETS
Investment in securities at value (Note 5)
(cost $2,739,553) ................................... $2,832,290
Interest receivable ................................... 40,346
Receivable for fund shares sold ....................... 463,520
----------
Total assets ............................. 3,336,156
----------
LIABILITIES
Payable for investments purchased ..................... 615,650
Accrued expenses ...................................... 11,735
Bank overdraft payable ................................ 452,313
Dividend payable ...................................... 1,233
Payable for fund shares redeemed ...................... 240
----------
Total liabilities ........................ 1,081,171
----------
NET ASSETS consisting of:
Accumulated net realized
loss .................................... $ (158,714)
Unrealized appreciation
of securities ........................... 92,737
Paid-in-capital applicable to
299,472 shares of
beneficial interest
(Note 4) ................................ 2,320,962
-----------
$2,254,985
==========
NET ASSET VALUE PER SHARE ............................... $ 7.53
==========
(RIGHT COLUMN)
STATEMENT OF OPERATIONS
Year Ended December 31, 1997
- --------------------------------------------------------------------------------
INVESTMENT INCOME
Interest income .................... $140,428
EXPENSES (Notes 2 and 3)
Investment advisory fees ........... $ 14,600
Custodian and accounting fees ...... 43,046
Transfer agent fees ................ 8,970
Trustee fees ....................... 2,413
Distribution fees .................. 9,125
Professional fees .................. 21,443
Postage and printing ............... 8,077
Other .............................. 3,583
--------
Total expenses .............. 111,257
Less: Expenses waived or reimbursed
by the manager and affiliates .... (64,243)
--------
Net expenses ................ 47,014
--------
Net investment income ....... 93,414
REALIZED AND UNREALIZED GAIN
(LOSS) ON INVESTMENTS
Net realized gain on investments ... 17,891
Change in unrealized appreciation of
investments for the year ........... 166,782
--------
Net gain on investments ..... 184,673
--------
NET INCREASE IN NET ASSETS FROM
OPERATIONS ......................... $278,087
========
(FULL COLUMN)
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
Years Ended December 31, 1997 and 1996
- --------------------------------------------------------------------------------------------------------
1997 1996
INCREASE (DECREASE) IN NET ASSETS FROM: ---- ----
<S> <C> <C>
OPERATIONS
Net investment income ................................................... $ 93,414 $ 108,670
Net realized gain on investments ........................................ 17,891 22,294
Unrealized (depreciation) appreciation of investments for the year ...... 166,782 (22,733)
--------- ---------
Net increase in net assets from operations ....................... 278,087 108,231
DIVIDENDS PAID TO SHAREHOLDERS FROM
Net investment income ................................................... (93,414) (108,670)
CAPITAL SHARE TRANSACTIONS (Note 4) ....................................... 212,100 401,216
--------- ---------
Total increase ................................................... 396,773 400,777
NET ASSETS:
Beginning of year ....................................................... 1,858,212 1,457,435
--------- ---------
End of year ............................................................. $2,254,985 $1,858,212
========== ==========
</TABLE>
See Notes to Financial Statements.
38
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
HIGH-YIELD MUNICIPAL BOND SERIES
<TABLE>
<CAPTION>
STATEMENT OF INVESTMENTS
December 31, 1997
- ------------------------------------------------------------------------------------------------------------
Principal
Amount Issue o Value
------ ----- -----
<C> <S> <C>
$ 40,000 Allegheny County, PA, IDA, AFR, USAir Inc., 8.88%, 3/01/21 ................................$ 40,782
40,000 Brookhaven, NY, IDA, CFR, Dowling College, 6.75%, 3/01/23 ................................. 42,730
250,000 Colorado Health Facilities Authority, RHR, Liberty Heights Project, ETM, CAB, 7/15/24 ..... 60,317
100,000 Corona, CA, COP, Vista Hospital Systems Inc. 8.38%, 7/01/11 ............................... 109,361
100,000 Escambia, FL, Housing Corporation, Royal Arms Project, Series B, 9.00%, 7/01/16 ........... 103,202
70,000 Florence County, SC, IDA, RB, Stone Container Corp., 7.38%, 2/01/07 ....................... 74,070
500,000 Foothill / Eastern TCA, Toll Road Revenue, CAB, 1/01/26 ................................... 106,500
25,000 Hildago County, TX, Health Services, Mission Hospital Inc Project, 6.88%, 8/15/26 ......... 26,567
50,000+ Illinois Development Financial Authority, Solid Waste Disposal, RB, Ford Heights Waste
Tire Project, 7.88%, 4/01/11 ............................................................ 10,582
45,000 Illinois Health Facilities Authority, Midwest Physician Group Ltd Project, RB, 8.13%,
11/15/19 ................................................................................ 48,833
35,000 Indianapolis, IN, RB, Robin Run Village Project, 7.63%, 10/01/22 .......................... 38,463
50,000 Joplin, MO, IDA, Hospital Facilities Revenue, Tri State Osteopathic, 8.25%, 12/15/14 ...... 53,674
50,000 Los Angeles, CA, Regional Airport, Continental Airlines, AMT, 9.25%, 8/01/24 .............. 59,104
630,000 Marengo County, AL, Port Authority Facilities, RB, CAB, Series A, 3/01/19 ................. 141,252
75,000 Maryland Economic Development Corporation, Nursing Facilities Mortgage RB,
Ravenwood Healthcare, Series A, 8.38%, 8/01/26 .......................................... 78,529
85,000 Montgomery County, TX, Health Facilities Development Corp., The Woodlands Medical
Center, 8.85%, 8/15/14 .................................................................. 93,171
100,000 New York City, NY, Municipal Water Finance Authority, Water & Sewer RB, TR Receipts
Series 29, 6.56%, 6/15/30 ............................................................... 96,974
100,000 New York State, DAR, City University System Residual Int Tr Recpts 27, MBIA Insured,
Liquidity The Bank of New York, 8.22%, 7/01/24 .......................................... 109,979
100,000 New York State, DAR, City University System Residual Int Tr Recpts 28, AMBAC Insured,
Liquidity The Bank of New York, 7.63%, 7/01/25 .......................................... 105,279
5,000,000 New York State, DAR, CAB, FHA Presbyterian Hospital Series A, AMBAC Insured,
8/15/36 ................................................................................. 643,400
100,000#x Niagara Falls, NY, URA, Old Falls Street Improvement Project, 11.00%, 5/01/09 ............. 35,795
50,000 Northeast, TX, Hospital Authority Revenue, Northeast Medical Center, 7.25%, 7/01/22 ....... 57,455
75,000 Perdido, FL, Housing Corporation, RB, Series B. 9.25%, 11/01/16 ........................... 75,787
30,000 Philadelphia, PA, HEHA, Graduate Health Systems Project, 7.25%, 7/01/18 ................... 31,468
60,000 Port Chester, NY, IDA, Nadal Industries Inc Project, 7.00%, 2/01/16 ....................... 61,876
75,000 San Antonio, TX, HFC, Multi Family Housing, RB, Agape Metro Housing Project, Series
A, 8.63%, 12/01/26 ...................................................................... 75,989
75,000 San Bernardino, CA, San Bernardino Community Hospital, RB, 7.88%, 12/01/19 ................ 77,531
100,000 San Bernardino County, CA, COP, Series PA-38, MBIA Insured, IFRN*, 11.92%, 7/01/16,
Rule 144A Security (restricted as to resale except to qualified institutions) ........... 113,555
</TABLE>
39
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
HIGH-YIELD MUNICIPAL BOND SERIES
<TABLE>
<CAPTION>
STATEMENT OF INVESTMENTS
December 31, 1997
- ------------------------------------------------------------------------------------------------------------
Principal
Amount Issue o Value
------ ----- -----
<C> <S> <C>
$ 35,000 San Joaquin Hills, CA, TCA, Toll Road Revenue, 7.00%, 1/01/30 ............................$ 40,033
60,000x San Jose, CA, Redevelopment Agency, Tax Allocation Bonds, IFRN*, MBIA Insured,
5.83%, 8/01/16, MBIA Insured, Rule 144A Security (restricted as to resale except to
qualified institutions) ................................................................ 61,304
150,000 Savannah, GA Economic Development Authority Revenue, ETM, CAB, 12/01/21 .................. 39,940
45,000 Schuylkill County, PA, IDA Resouce Recovery, Schuylkill Energy Res Inc. AMT, 6.50%,
1/01/10 ................................................................................ 46,040
15,000(D)# Troy, NY, IDA, Hudson River Project, 11.00%, 12/01/94 .................................... 6,150
75,000(D) (D)(D)Villages at Castle Rock, CO, Metropolitan District #4, 8.50%, 6/01/31 .................... 39,138
25,000 Wayne, MI, AFR, Northwest Airlines Inc. 6.75%, 12/01/15 .................................. 27,460
----------
Total Investments (Cost $2,739,553)** ....................................................$2,832,290
==========
<FN>
** Cost is approximately the same for income tax purposes.
* Inverse Floating Rate Notes (IFRN) are instruments whose interest rates bear an inverse relationship to the interest rate on
another security or the value of an index. Rates shown are at December 31, 1997.
# The value of this non-income producing security has been estimated by persons designated by the Fund's Board of
Trustees using methods the Trustees believe reflect fair value. See note 5 to the financial statements.
+ Non-income producing security.
(D)(D) Security in default. Interest paid on cash flow basis. Rate shown as of December 31, 1997.
x The Fund or its affiliates owns 100% of the security and therefore there is no trading in the security.
</FN>
</TABLE>
Legend
o Issue AFR Airport Facilities Revenue
AMBAC American Municipal Bond Assurance Corporation
AMT Subject to Alternative Minimum Tax
CAB Capital Appreciation Bond
COP Certificate of Participation
CFR Civic Facility Revenue
DAR Dorm Authority Revenue
ETM Escrowed to Maturity
FHA Federal Housing Authority
HEHA Higher Education and Health Authority
HFC Housing Finance Corporation
IDA Industrial Development Authority
MBIA Municipal Bond Insurance Assurance Corporation
RB Revenue Bond
RHR Retirement Housing Revenue
TCA Transportation Corridor Agency
URA Urban Renewal Agency
See Notes to Financial Statements.
40
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
HIGH-YIELD MUNICIPAL BOND SERIES
NOTES TO FINANCIAL STATEMENTS
December 31, 1997
- --------------------------------------------------------------------------------
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 Fundamental U.S. Government Strategic Income Fund Series
(the Series). Each series is considered a separate entity for financial
reporting and tax purposes. The High-Yield Municipal Bond Series (the Series)
seeks to provide a high level of current income exempt from federal income tax
through investment in a portfolio of lower quality municipal bonds, generally
referred to as "junk bonds." These bonds are considered speculative because they
involve greater price volatility and risk than higher rated bonds. The following
is a summary of significant accounting policies followed in the preparation of
the Series' financial statements:
Valuation of Securities: The Fund's portfolio securities are valued on the basis
of prices provided by an independent pricing service when, in the opinion of
persons designated by the Fund's trustees, such prices are believed to reflect
the fair market value of such securities. Prices of non-exchange traded
portfolio securities provided by independent pricing services are generally
determined without regard to bid or last sale prices but take into account
institutional size trading in similar groups of securities, yield, quality,
coupon rate, maturity, type of issue, trading characteristics and other market
data. Securities traded or dealt in upon a securities exchange and not subject
to restrictions against resale as well as options and futures contracts listed
for trading on a securities exchange or board of trade are valued at the last
quoted sales price, or, in the absence of a sale, at the mean of the last bid
and asked prices. Options not listed for trading on a securities exchange or
board of trade for which over-the-counter market quotations are readily
available are valued at the mean of the current bid and asked prices. Money
market and short-term debt instruments with a remaining maturity of 60 days or
less will be valued on an amortized cost basis. Securities not priced in a
manner described above and other assets are valued by persons designated by the
Fund's trustees using methods which the trustees believe accurately reflects
fair value.
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 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 amortized and charged against interest income and original issue discounts
are accreted to interest income.
41
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
HIGH-YIELD MUNICIPAL BOND SERIES
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
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.
2. Investment Advisory Fees and Other Transactions with Affiliates
Management Agreement
The Fund has a Management Agreement with Fundamental Portfolio Advisors,
Inc. (the Manager). Pursuant to the agreement, the Manager serves as investment
adviser to the High-Yield Municipal Bond 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 consideration for the services
provided by the Manager, the Series will pay an annual management fee in an
amount equal to 0.8% of the Series' average daily net assets up to $100 million
and decreasing by .02% for each $100 million increase in net assets down to 0.7%
of net assets in excess of $500 million. The Manager voluntarily waived fees and
reimbursed expenses of $49,643 for the year ended December 31, 1997. See Note 7.
SEC Administrative Action Against The Manager
On September 30, 1997, the Securities & Exchange Commission announced that
it instituted public administrative and cease-and desist proceedings against the
Manager, the former portfolio manager of the Fund, the president of the Manager
and Fundamental Service Corporation (FSC) the Funds distributor. The proceeding
arises from the alleged failure of an affiliated mutual fund to disclose the
risks of the Fund, and of the Manager's failure to disclose its soft dollar
arrangements to the Fund's Board of Trustees. A hearing has been scheduled to
determine whether the allegations are true, and, if so, what remedial action, if
any, is appropriate.
Board's Termination of Portfolio Manager
Between April 17, 1997 and July 24, 1997, a representative of the Manager
engaged Tocqueville Securities L.P. ("Tocqueville Securities") an affiliate of
Tocqueville, as agent, to effect eight separate over-the-counter purchase
transactions of municipal obligations on behalf of an affiliated fund. The
Fund's Board has concluded that the commissions paid to Tocqueville Securities
in connection with these transactions (a portion of which was paid to the
representative) were not justified and that the affiliated fund bore unnecessary
expenses as a result of the sale of its securities to another party and the
subsequent repurchase of them through Tocqueville Securities. Based upon a
report initiated by Tocqueville Securities and prepared by the Fund's
independent auditors, and upon the Board's own analysis, the Board directed that
the Manager terminate the representative's services as a portfolio manager. At
the Board's request and in order to reimburse the affiliated fund for all of its
losses, Tocqueville Securities, on September 15, 1997, voluntarily paid $260,000
to the affiliated fund, an amount which significantly exceeds the total
commissions ($184,920.60) received by Tocqueville Securities in connection with
these transactions. The staff of the Securities and Exchange Commission and the
Department of NASD Regulation have been informed of these events by Tocqueville
Securities. See note 7 regarding contemplated transaction with the Tocqueville
Trust.
42
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
HIGH-YIELD MUNICIPAL BOND SERIES
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
Plan of Distribution
The Fund has adopted a Plan of Distribution, pursuant to Rule 12b-1
promulgated under the Investment Company Act of 1940, under which the Series
pays to FSC, an affiliate of the Manager, a fee, which is accrued daily and paid
monthly, at an annual rate of 0.5% 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. FSC
has waived all fees in the amount of $9,125 for the year ended December 31,
1997.
NASD Sanctions and Fines
On February 19, 1998, FSC and two of its executives, without admitting or
denying guilt, entered into an agreement with the National Association of
Securities Dealers, Inc. ("NASD") whereby they accepted fines totaling $125,000
and other stipulated sanctions as a result of the NASD's finding that they had
distributed advertising materials of an affiliated mutual fund which violated
NASD rules governing advertisements.
Affiliated Transfer Agent
The Fund compensated Fundamental Shareholder Services, Inc. (FSSI), an
affiliate of the Manager, for the services it provided under a Transfer Agent
and Service Agreement which was terminated on September 11, 1997. Transfer agent
fees paid by the Series to FSSI amounted to $5,012.
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. The Trustees also received additional
compensation for special services as requested by the Board. Additional
compensation totaled $40,923 pro rated among the funds based on their respective
average net assets.
4. Shares of Beneficial Interest
As of December 31, 1997, there were an unlimited number of shares of
beneficial interest (no par value) authorized and capital paid in amounted to
$2,320,962. Transactions in shares of beneficial interest were as follows:
<TABLE>
<CAPTION>
Year Ended Year Ended
December 31, 1997 December 31, 1996
----------------------- --------------------------
Shares Amount Shares Amount
--------- ---------- --------- -----------
<S> <C> <C> <C> <C>
Shares sold .................................... 2,941,324 20,530,136 1,912,593 $12,834,095
Shares issued on reinvestment of dividends ..... 11,426 79,995 11,925 80,347
Shares redeemed ................................ (2,924,097) (20,398,031) (1,859,933) (12,513,226)
---------- ----------- ---------- -----------
Net increase ................................... 28,653 $ 212,100 64,585 $ 401,216
========== =========== ========== ===========
</TABLE>
5. Investment Transactions
The Fund invests in variable rate securities commonly called "inverse
floaters." The interest rates on these securities have an inverse relationship
to the interest rate of other securities or the value of an index. Changes in
43
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
HIGH-YIELD MUNICIPAL BOND SERIES
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
interest rate on the other security or index inversely affect the rate paid on
the inverse floater, and the inverse floater's price will be more volatile than
that of a fixed-rate bond. Certain interest rate movements and other market
factors can substantially affect the liquidity of IFRN's.
The Fund invests in lower rated or unrated ("junk") securities which are
more likely to react to developments affecting market risk and credit risk than
would higher rated securities which react primarily to interest rate
fluctuations. The Fund held securities in default with an aggregate value of
$91,665 at December 31, 1997 (4.1% of net assets). As indicated in the Statement
of Investments, the Troy, NY Industrial Revenue Bond, 11% due December 1, 2014
with a par value of $15,000 and a value of $6,150 at December 31, 1997 has been
estimated in good faith under methods determined by the Board of Trustees.
The Fund owns 1.7% of a Niagara Falls New York Urban Renewal Agency 11%
Bond ("URA Bond") due to mature on May 1, 2009 which has missed interest and
sinking fund payments. An affiliated investment company owns 98.3% of this bond
issue. The Fund was party to an agreement whereby certain related bonds owned by
an affiliate were to be subject to repayment under a debt assumption agreement.
The agreement allowed the affiliate to allocate a portion of the debt services
it receives to the URA Bond. In exchange the Fund forfeited certain rights it
had as holder of the URA bond. The debt assumption was not completed and the
timing and amount of debt service payments is uncertain. The value of this bond
is $35,795, and is valued at 35.80% of face value at December 31, 1997 under
methods determined by the Board of Trustees.
During the year ended December 31, 1997, the cost of purchases and proceeds
from sales of investment securities, other than short-term obligations, were
$2,982,245 and $2,610,195, respectively.
As of December 31, 1997 net unrealized appreciation of portfolio securities
amounted to $92,737, composed of unrealized appreciation of $225,341 and
unrealized depreciation of $132,604.
The Fund has capital loss carryforwards to offset future capital gains as
follows:
Amount Expiration
------- ----------
$23,500 12/31/1998
22,200 12/31/1999
20,500 12/31/2000
54,300 12/31/2002
40,000 12/31/2003
--------
$160,500
========
6. Agreement and Plan of Reorganization
On July 16, 1997 each of Fundamental's mutual funds (consisting of: New York
Muni Fund, The California Muni Fund, Fundamental Fixed Income Fund: Tax Free
Money Market Series, High Yield Municipal Bond Series, and Fundamental U.S.
Government Strategic Income Fund Series) have adopted, subject to shareholder
approval, an Agreement and Plan of Reorganization (the "Plan") under which each
fund (the "Fundamental Fund") will transfer all of its assets and liabilities to
a newly-created corresponding series of The Tocqueville Trust (the "Tocqueville
Fund") in exchange for shares of the Tocqueville Fund. Shareholders of each
Fundamental Fund will receive shares of the corresponding Tocqueville Fund equal
in value to their shares in the Fundamental Fund. Shareholders will not have to
pay a sales load upon receiving shares of the Tocqueville Fund.
44
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
HIGH-YIELD MUNICIPAL BOND SERIES
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
The corresponding Tocqueville Fund will have investment objectives, polices
and restrictions substantially identical to those of the Fundamental Fund. The
Board of Trustees of the Tocqueville Funds is comprised of individuals other
than those who currently serve as Directors (Trustees) of the Fundamental Funds.
Tocqueville Asset Management L.P. is the investment adviser to the Tocqueville
Funds.
A majority of Fundamental's Board members determined that the Plan would be
in the best interests of shareholders of the Fundamental Funds and recommended
that shareholders of each of the Fundamental Funds approve the Plan at a meeting
anticipated to be held in the Spring of 1998.
7. Subsequent Event
At its March 25, 1998 Board of Trustees' meeting, the Board of the Fund
approved the continuation of the Management Agreement and Distribution Agreement
through May 30, 1998 in contemplation of the consummation of the reorganization
discussed in Note 6.
8. Selected Financial Information
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------------
1997 1996 1995 1994 1993
PER SHARE OPERATING PERFORMANCE ---- ---- ---- ---- ----
(for a share outstanding throughout the period)
<S> <C> <C> <C> <C> <C>
Net asset value, beginning of period $6.86 $7.07 $5.92 $7.27 $7.30
----- ----- ----- ----- -----
Income from investment operations:
Net investment income 0.37 0.47 0.34 0.43 0.39
Net realized and unrealized gains (losses) on investments 0.67 (0.21) 1.15 1.35) (0.03)
----- ----- ----- ----- -----
Total from investment operations 1.04 0.26 1.49 (0.92) 0.36
----- ----- ----- ----- -----
Less distributions:
Dividends from net investment income (0.37) (0.47) (0.34) (0.43) (0.39)
----- ----- ----- ----- -----
Net asset value, end of period $7.53 $6.86 $7.07 $5.92 $7.27
===== ===== ===== ===== =====
Total Return 15.71% 4.05% 25.70% (12.92%) 5.11%
RATIOS/SUPPLEMENTAL DATA
Net assets, end of period (000 omitted) 2,255 1,858 1,457 979 1,087
Ratios to average net assets:
Expenses* 2.58% 2.49% 2.50% 2.50% 2.50%
Net investment income* 5.12% 6.85% 5.15% 6.70% 5.40%
Portfolio turnover rate 3.79% 139.26% 43.51% 75.31% 84.89%
BANK LOANS
Amount outstanding at end of period (000 omitted) $ - 228 379 $ - $ -
Average amount of bank loans outstanding during the period
(000 omitted) $ - $ - 61 $ - $ -
Average number of shares outstanding during the period
(000 omitted) 260 237 183 156 145
Average amount of debt per share during the period $ - $ - $0.33 $ - $ -
<FN>
**These ratios are after expense reimbursements of 3.52%, 4.59%, 6.22%, 6.20% and 5.76%, for each of the
years ended December 31, 1997, 1996, 1995, 1994 and 1993, respectively.
</FN>
</TABLE>
45
<PAGE>
FUNDAMENTAL FIXED-INCOME FUND
HIGH-YIELD MUNICIPAL BOND SERIES
INDEPENDENT AUDITOR'S REPORT
- --------------------------------------------------------------------------------
To the Board of Trustees and Shareholders
Fundamental Fixed-Income Fund
High-Yield Municipal Bond Series
We have audited the accompanying statement of assets and liabilities, including
the statement of investments, of Fundamental Fixed-Income Fund High-Yield
Municipal Bond Series as of December 31, 1997, and the related statements of
operations for the year then ended, the statement of changes in net assets for
each of the two years then ended and the selected financial information for each
of the five years in the period then ended. 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 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 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, 1997 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 Fundamental Fixed-Income Fund High-Yield Municipal Bond Series as of
December 31, 1997, and the results of its operations, changes in net assets, and
selected financial information for the periods indicated, in conformity with
generally accepted accounting principles.
See Note 2 for information regarding regulatory proceedings and transactions
with affiliates.
New York, New York
March 2, 1998, except for Note 7 as to which the date is March 25, 1998.
46
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
(LEFT COLUMN)
STATEMENT OF ASSETS AND LIABILITIES
December 31, 1997
- --------------------------------------------------------------------------------
ASSETS
Investment in securities, at value
(cost $13,023,839) (Notes 5 and 6) $15,023,792
Receivables:
Interest 67,739
Fund shares sold ................ 4,001
-----------
Total assets ................ 15,095,532
-----------
LIABILITIES
Loans ............................. 225,907
Options written at value
(premiums received $18,801)
(Note 5) ........................ 10,625
Securities sold subject to
repurchase (Note 6) ............. 4,744,054
Payables:
Dividends declared .............. 11,104
Shares redeemed ................. 9,353
Variation margin ................ 41,563
Accrued expenses ................ 22,580
-----------
Total liabilities ........... 5,065,186
-----------
NET ASSETS consisting of:
Accumulated net realized loss ..... $(17,833,560)
Unrealized appreciation of
securities ...................... 1,999,953
Unrealized appreciation of
options written ................. 8,176
Unrealized depreciation of open
future contracts ................ (103,270)
Paid-in-capital applicable to
7,116,688 shares of beneficial
interest ........................ 25,959,047
-----------
$10,030,346
===========
NET ASSET VALUE PER SHARE $1.41
=====
(RIGHT COLUMN)
STATEMENT OF OPERATIONS
Year Ended December 31, 1997
- --------------------------------------------------------------------------------
INVESTMENT INCOME
Interest income, net of $315,574
of interest expense ...................... $1,812,306
EXPENSES (Notes 2, 3 and 6)
Investment advisory fees ................. $ 88,681
Custodian and accounting fees ............ 61,165
Transfer agent fees ...................... 71,081
Professional fees ........................ 563,154
Trustees' fees ........................... 5,458
Printing and postage ..................... 9,502
Interest on bank borrowing ............... 324,872
Distribution expenses .................... 29,560
Other .................................... 14,012
---------
Total expense ...................... 1,167,485
Less: Expenses waived or
reimbursed by the
manager and affiliates ........... (162,637)
---------
Net expenses ....................... 1,004,848
----------
Net investment income .............. 807,458
----------
REALIZED AND UNREALIZED GAIN
(LOSS) ON INVESTMENTS
Net realized gain (loss) on:
Investments ............................ 1,027,730
Future and options on futures .......... (956,715) 71,015
---------
Change in unrealized appreciation
(depreciation) of investments,
options and futures contracts
for the period:
Investments .......................... 66,558
Open option contracts
written ............................ (312)
Open futures contracts ............... (339,726) (273,480)
--------- ----------
Net loss on investments .................. (202,465)
----------
NET INCREASE IN NET ASSETS
FROM OPERATIONS .......................... $ 604,993
=========
<PAGE>
(FULL COLUMN)
<TABLE>
<CAPTION>
STATEMENT OF CHANGES IN NET ASSETS
- ----------------------------------------------------------------------------------------------------------
Year Ended Year Ended
December December
31, 1997 31, 1996
-------- --------
INCREASE (DECREASE) IN NET ASSETS FROM:
OPERATIONS
<S> <C> <C>
Net investment income ...................................................... $ 807,458 $ 1,254,448
Net realized gain on investments ........................................... 71,015 433,173
Unrealized (depreciation) on investments, options and futures contracts .... (273,480) (1,070,217)
----------- -----------
Net increase in net assets from operations ........................ 604,993 617,404
DIVIDENDS PAID TO SHAREHOLDERS FROM
Investment income .......................................................... (807,458) (1,254,448)
CAPITAL SHARE TRANSACTIONS (Note 4) .......................................... (2,991,556) (1,332,818)
----------- -----------
Total decrease .................................................... (3,194,021) (1,969,862)
NET ASSETS
Beginning of year .......................................................... 13,224,367 15,194,229
----------- -----------
End of year ................................................................ $10,030,346 $13,224,367
=========== ===========
</TABLE>
See Notes to Financial Statements.
49
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
STATEMENT OF CASH FLOWS
<TABLE>
Year Ended December 31, 1997
- ---------------------------------------------------------------------------------------------
INCREASE (DECREASE) IN CASH
CASH FLOWS FROM OPERATING ACTIVITIES
<S> <C>
Net increase in net assets from operations ................................ $ 604,993
Adjustments to reconcile net increase in net assets from operations to
net cash provided by operating activities:
Purchase of investment securities ......................................... (2,228,044)
Proceeds on sale of securities ............................................ 8,312,593
Premiums received for options written ..................................... 633,904
Premiums paid to close options written .................................... (977,704)
Decrease in interest receivable ........................................... 28,925
Decrease in variation margin receivable ................................... 218,791
Decrease in accrued expenses .............................................. (93,909)
Net accretion of discount on securities ................................... (187,473)
Net realized (gain) loss:
Investments ............................................................. (1,027,730)
Options written ......................................................... 309,113
Unrealized appreciation on securities and options written for the period .. (66,246)
----------
Total adjustments ....................................................... 4,922,220
----------
Net cash provided by operating activities ............................... 5,527,213
----------
CASH FLOWS FROM FINANCING ACTIVITIES:*
Net repayments on sale of securities sold subject to repurchase ............. (1,617,934)
Net borrowings of note payable .............................................. (49,281)
Proceeds on shares sold ..................................................... 728,056
Payment on shares repurchased .............................................. (4,356,318)
Cash dividends paid ......................................................... (231,736)
----------
Net cash used in financing activities ................................... (5,527,213)
----------
Net increase in cash .................................................... 0
CASH AT BEGINNING OF YEAR .................................................. 0
----------
CASH AT END OF YEAR ......................................................... $ 0
==========
</TABLE>
*Non-cash financing activities not included herein consist of reinvestment of
dividends of $642,058. Cash payments for interest expense totaled $333,352 for
the period.
STATEMENT OF OPTIONS WRITTEN
<TABLE>
<CAPTION>
December 31, 1997
- ---------------------------------------------------------------------------------------------
Number of Expiration
Contracts++ Options Written Month Value
----------- --------------- ---------- -----
<C> <S> <C> <C>
40 U.S. Treasury Bonds, Call @ $123 ........... February 1998 $10,625
-------
$10,625
=======
</TABLE>
++Each contract represents $100,000 face value of U.S. Treasury Bond Futures.
See Notes to Financial Statements.
50
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
STATEMENT OF INVESTMENTS
December 31, 1997
- --------------------------------------------------------------------------------
Principal Interest Maturity
Amount Rate o Date Value
------ ------ ---- -----
United States Treasury Securities-49.03%
United States Treasury Bonds
85,000(2) 0.00% ZCS 11/15/03 $ 60,395
4,300,000(2) 0.00% PS 11/15/06 2,574,333
3,500,000(5) 9.00% 11/15/18 4,731,566
----------
(Cost $6,403,170) 7,366,294
----------
United States Agency Backed Securities-50.97%
Federal Home Loan Mortgage Corporation
843,718(1) 9.25% 08/15/23 928,005
285,124(1) 6.50% Z-Bond 12/15/23 261,907
750,000 13.59% IFRN 05/15/24 858,060
209,406(2) 15.30% IFRN 05/25/24 251,287
180,000 12.00% TTIB 03/15/27 180,079
FNMA-Federal National Mortgage Assoc.
356,450(4)(1) 15.50% TTIB 03/25/23 381,224
3,671,204(4)(1) 15.30% TTIB 03/25/23 4,185,686
490,760(4) 14.49% TTIB 05/25/23 544,900
----------
7,591,148
----------
FICO-Financing Corporation (U.S. Government Agency)
100,000 0.00% ZCS 11/02/12 39,284
100,000 0.00% ZCS 08/03/18 27,066
----------
(Cost $6,620,669) 66,350
----------
Total investments (Cost $13,023,839)(3) $15,023,792
----------
(1) Segregated for securities sold subject to repurchase (Note 6)
(2) Segregated, in whole or part, as initial margin for futures contracts
(Note 5)
(3) Cost is the same for Federal income tax purposes
(4) The Fund owns 100% of the security or tranche. See Note 5 to the financial
statements.
(5) Securities sold subject to repurchase (Note 6).
o Legend-IFRN: Inverse Floating Rate Notes are instruments whose interest rates
bear an inverse relationship to the interest rate on another
security or the value of an index. Rates shown are at December
31, 1997.
TTIB: Two-Tiered Index Floating Rate Bonds are instruments with two
coupon levels. The "first tier" coupon is at a fixed rate,
effective as long as the underlying index is at or below the
strike level. At the strike level, the "second tier" coupon
resets the bond to an inverse floating rate note. See discussion
above. Coupons shown are at December 31, 1997.
ZCS: Zero Coupon Securities are instruments whose interest and
principal are paid at maturity.
Z Bond: A Z Bond is an instrument whose monthly interest coupon is paid
at a fixed rate in additional principal. Principal is paid at
maturity.
PS: Principal Stripped Bonds are instruments whose principle and
coupon have been separated and sold separately.
See Notes to Financial Statements.
51
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
NOTES TO FINANCIAL STATEMENTS
December 31, 1997
- --------------------------------------------------------------------------------
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 Fundamental U.S. Government Strategic Income Fund Series
(the Series). The objective of the Series is to provide high current income with
minimum risk of principal and relative stability of net asset value. The 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
(hereunder collectively referred to as "Government Securities"). The Series also
uses leverage in seeking to achieve its investment objective. Each series is
considered a separate entity for financial reporting and tax purposes.
Valuation of Securities-The Series portfolio securities are valued on
the basis of prices provided by an independent pricing service when, in the
opinion of persons designated by the Fund's trustees, such prices are believed
to reflect the fair market value of such securities. Prices of non-exchange
traded portfolio securities provided by independent pricing services are
generally determined without regard to bid or last sale prices but take into
account institutional size trading in similar groups of securities, yield,
quality, coupon rate, maturity, type of issue, trading characteristics and other
market data. Securities traded or dealt in upon a securities exchange and not
subject to restrictions against resale as well as options and futures contracts
listed for trading on a securities exchange or board of trade are valued at the
last quoted sales price, or, in the absence of a sale, at the mean of the last
bid and asked prices. Options not listed for trading on a securities exchange or
board of trade for which over-the-counter market quotations are readily
available are valued at the mean of the the current bid and asked prices. Money
market and short-term debt instruments with a remaining maturity of 60 days or
less will be valued on an amortized cost basis. Securities not priced in a
manner described above and other assets are valued by persons designated by the
Fund's trustees using methods which the trustees believe reflect fair value.
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. The Series' repurchase agreements will at
all times be fully collateralized in an amount equal to the purchase price
including accrued interest earned on the underlying security.
52
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
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 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. Discounts and premiums are
amortized over the life of the respective securities. Premiums are charged
against interest income and 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.
2. Investment Advisory Fees and Other Transactions With Affiliates
Management Agreement
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 consideration 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 waived fees
and reimbursed expenses of $133,077 for the year ended December 31, 1997. See
Note 8.
SEC Administrative Proceeding Against the Manager
On September 30, 1997, the Securities & Exchange Commission announced that
it instituted public administrative and cease-and desist proceedings against the
Manager, the former portfolio manager of the Fund, the president of the Manager
and Fundamental Service Corporation (FSC). The proceeding arises from the
53
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
alleged failure of the Fund to disclose the risks of the Fund, and of the
Manager's failure to disclose its soft dollar arrangements to the Fund's Board
of Trustees. A hearing has been scheduled with an administrative law judge to
determine whether the allegations are true, and, if so, what remedial action, if
any, is appropriate.
Board's Termination of Portfolio Manager
Between April 17, 1997 and July 24, 1997, a representative of the Manager
engaged Tocqueville Securities L.P. ("Tocqueville Securities") an affiliate of
Tocqueville, as agent, to effect eight separate over-the-counter purchase
transactions of municipal obligations on behalf of an affiliated fund. The
Fund's Board has concluded that the commissions paid to Tocqueville Securities
in connection with these transactions (a portion of which was paid to the
representative) were not justified and that the affiliated fund bore unnecessary
expenses as a result of the sale of its securities to another party and the
subsequent repurchase of them through Tocqueville Securities. Based upon a
report initiated by Tocqueville Securities and prepared by the Fund's
independent auditors, and upon the Board's own analysis, the Board directed that
the Manager terminate its representative's services as a portfolio manager. At
the Board's request and in order to reimburse the affiliated fund for all of its
losses, Tocqueville Securities, on September 15, 1997, voluntarily paid $260,000
to the affiliated fund, an amount which significantly exceeds the total
commissions ($184,920.60) received by Tocqueville Securities in connection with
these transactions. The staff of the Securities and Exchange Commission and the
Department of NASD Regulation have been informed of these events by Tocqueville
Securities. See note 7 regarding contemplated transaction with the Tocqueville
Trust.
Plan of Distribution
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 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, 1997 is set forth in the Statement of Operations. FSC
has waived fees in the amount of $29,560.
NASD Sanctions and Fines
On February 19, 1998, FSC and two of its executives, without admitting or
denying guilt, entered into an agreement with the National Association of
Securities Dealers, Inc. ("NASD") whereby they accepted fines totaling $125,000
and other stipulated sanctions as a result of the NASD's finding that they had
distributed advertising materials relating to the Fund which violated NASD rules
governing advertisements.
Affiliated Transfer Agent
The Series compensated Fundamental Shareholders Services, Inc. (FSSI), an
affiliate of the Manager, for services it provided under a Transfer Agent and
Service Agreement which was terminated on September 11, 1997. The amount paid by
the Series to FSSI for the year ended December 31, 1997 amounted to $57,038.
Commissions Paid to Affiliate
The Series effects a significant portion of its futures and options
transactions through LAS Investments, Inc. (LAS), an affiliated broker-dealer.
Commissions paid to LAS amounted to approximately $14,591 for the year ended
December 31, 1997.
54
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
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. The Trustees also received additional
compensation for special services as requested by the Board. Additional
compensation totaled $40,923 pro rated among the funds based on their respective
average net assets.
4. Shares of Beneficial Interest
As of December 31, 1997 there were an unlimited number of shares of
beneficial interest (no par value) authorized and capital paid-in amounted to
$25,959,047. Transactions in shares of beneficial interest were as follows:
<TABLE>
<CAPTION>
Year Ended Year Ended
December 31, 1997 December 31, 1996
----------------------- --------------------------
Shares Amount Shares Amount
--------- ---------- --------- -----------
<S> <C> <C> <C> <C>
Shares sold ................................... 521,491 $ 732,057 1,209,491 $1,721,466
Shares issued on reinvestment of dividends .... 457,380 642,058 605,897 860,888
Shares redeemed ............................... (3,119,211) (4,365,671) (2,749,791) (3,915,172)
---------- ----------- --------- -----------
Net decrease .................................. (2,140,340) ($2,991,556) (934,403) ($1,332,818)
========== =========== ========= ===========
</TABLE>
5. Complex Services, Off Balance Sheet Risks and Investment Transactions
Two-Tiered Index Floating Rate Bonds (TTIB):
The Fund invests in Two-Tiered Index Floating Rate Bonds. The term
two-tiered refers to the two coupon levels that the TTIB's coupon can reset to.
The "first tier" is the TTIB's fixed rate coupon, effective as long as the
underlying index is at or below the strike level. Above the strike, the TTIB
coupon resets to a formula similar to an inverse floating rate note. See
discussion of inverse floating rate notes below. Changes in interest rate on the
underlying 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.
Additionally the Fund owns 100% of several securities as indicated in the
Statement of Investments. As a result of its ownership position there is no
active market in these securities. Valuations of these securities are provided
by a pricing service and are believed by the Manager to reflect fair value. The
market value of securities owned 100% by the Fund was approximately $5,111,810
(or 50.96% of net assets) as of December 31, 1997.
Inverse Floating Rate Notes (IFRN):
The Fund invests in variable rate securities commonly called "inverse
floaters". The interest rates on these securities have an inverse relationship
to the interest rate of other securities or the value of an index. Changes in
interest rate on the other security or index inversely affect the rate paid on
the inverse floater, and the inverse floater's price will be more volatile than
that of a fixed-rate bond. Certain interest rate movements and other market
factors can substantially affect the liquidity of IFRN's.
55
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
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 municipal
bond portfolio, and to enhance its total return. The Fund's principal 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, 1997, the Fund
had daily average notional amounts outstanding of approximately $15,136,000 and
$5,737,561 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, 1997.
Principal Expiration Unrealized
Type Amount Position Month Loss
---- ------ -------- ----- ----
U.S. Treasury Bond ............. $7,000,000 Short 3/98 ($103,270)
Portfolio securities with an aggregate value of approximately $1,389,306
have been segregated as initial margin as of December 31, 1997.
In addition, the following table summarizes option contracts written by the
Series for the year ended December 31, 1997:
Number of Premiums Realized
Contracts Received Cost Loss
--------- -------- ---- ----
Contracts outstanding
December 31, 1996 .............. 40 $53,488
Options written .................. 780 633,904
Contracts closed or expired ...... (780) (668,591) $977,704 ($309,113)
--- -------
Contracts outstanding
December 31, 1997 .............. 40 $ 18,801
=== ========
56
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
Other Investment Transactions
For the year ended December 31, 1997, the cost of purchases and proceeds
from sales of investment securities, other than short-term obligations, were
$2,228,044 and $7,702,650, respectively.
As of December 31, 1997, the Fund had no unrealized appreciation or
depreciation for tax purposes since it has elected to recognize market value
changes each day for tax purposes.
The Fund has capital loss carryforwards to offset future capital gains as
follows:
Amount Expiration
------ ----------
$15,000,500 12/31/2002
588,100 12/31/2004
202,500 12/31/2005
-----------
$15,791,100
===========
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. The reverse
repurchase agreement outstanding at December 31, 1997 bears an interest rate of
5.9%. Portfolio securities with an aggregate value of approximately $5,757,000
have been segregated for securities sold subject to repurchase as of December
31, 1997.
The maximum month-end and the average amount of borrowing outstanding under
these arrangements during the year ended December 31, 1997 were approximately
$6,329,000 and $5,967,000.
7. Agreement and Plan of Reorganization
On July 16, 1997 each of Fundamental's mutual funds (consisting of: New York
Muni Fund, The California Muni Fund, Fundamental Fixed Income Fund: Tax Free
Money Market Series, High Yield Municipal Bond Series, and Fundamental U.S.
Government Strategic Income Fund Series) have adopted, subject to shareholder
approval, an Agreement and Plan of Reorganization (the "Plan") under which each
fund (the "Fundamental Fund") will transfer all of its assets and liabilities to
a newly-created corresponding series of The Tocqueville Trust (the "Tocqueville
Fund") in exchange for shares of the Tocqueville Fund. Shareholders of each
Fundamental Fund will receive shares of the corresponding Tocqueville Fund equal
in value to their shares in the Fundamental Fund. Shareholders will not have to
pay a sales load upon receiving shares of the Tocqueville Fund.
The corresponding Tocqueville Fund will have investment objectives, polices
and restrictions substantially identical to those of the Fundamental Fund. The
Board of Trustees of the Tocqueville Funds is comprised of
57
<PAGE>
FUNDAMENTAL U.S. GOVERNMENT STRATEGIC INCOME FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1997
- --------------------------------------------------------------------------------
individuals other than those who currently serve as Directors (Trustees) of the
Fundamental Funds. Tocqueville Asset Management L.P. is the investment adviser
to the Tocqueville Funds.
A majority of Fundamental's Board members determined that the Plan would be
in the best interests of shareholders of the Fundamental Funds and recommended
that shareholders of each of the Fundamental Funds approve the Plan at a meeting
anticipated to be held in the Spring of 1998.
8. Subsequent Event
At its March 25, 1998 Board of Trustees' meeting, the Board of the Fund
approved the continuation of the Management Agreement and Distribution Agreement
through May 30, 1998 in contemplation of the consummation of the reorganization
discussed in Note 7.
The Manager and FSC (on behalf of certain of their directors, officers,
shareholders, employees and control persons) (the "Indemnitees") received
payment during the fiscal year ended December 31, 1997 from the Fund in the
amount of approximately $232,500. Upon learning of the payments, the independent
Board Members of the Funds directed that the Indemnitees return all of the
payments to the Funds or place them in escrow pending their receipt of an
opinion of an inedpendent legal counsel to the effect that the Indemnitees are
entitled to receive them. The Declaration of Trust, Articles of Incorporation
and contracts that call for indemnification specify that no indemnification
shall be provided to a person who shall be found to have engaged in "disabling
conduct" as defined by applicable law. The Indemnities have undertaken to
reimburse the Fund for any indemnification expenses for which it is determined
that they were not entitled to as a result of "disabling conduct" net of any
reimbursements already made to the Fund in the form of fees forgone or other
similar payments.
The Manager and FSC waived fees in the amount of $96,077 and $29,560,
respectively for the year ended December 31, 1997. The Manager and FSC have
asserted that they elected to forgo these fees because the Fund was paying legal
expenses pursuant to indemnification. The Fund has retained independent legal
counsel to determine whether the Indemnitees engaged in disabling conduct.
Pending clarification of the legal issues involved, the Indemnitees have placed
into an escrow account $102,863 as of April 30, 1998. The independent trustees
have instructed the Manager to escrow the full amount incurred by the Fund of
approximately $232,500.
58
<PAGE>
9. Selected Financial Information
<TABLE>
<CAPTION>
Year Year Year Year Year
Ended Ended Ended Ended Ended
December 31, December 31, December 31, December 31, December 31,
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Per share operating performance
(for a share outstanding throughout the period)
<S> <C> <C> <C> <C> <C>
Net asset value, beginning of period .............. $ 1.43 $ 1.49 $ 1.37 $ 2.01 $ 2.02
------ ------ ------ ------ ------
Income from investment operations
Net investment income ............................. 0.10 0.13 0.08 0.14 0.16
Net realized and unrealized gain/(loss) on
investments ..................................... (0.02) (0.06) 0.12 (0.64) -
------ ------ ------ ------ ------
Total from investment operations ............ 0.08 0.07 0.20 (0.50) 0.16
------ ------ ------ ------ ------
Less distributions
Dividends from net investment income .............. (0.10) (0.13) (0.08) (0.14) (0.16)
Dividends from net realized gains ................. - - - - (0.01)
------ ------ ------ ------ ------
Net asset value, end of period .................... $ 1.41 $ 1.43 $ 1.49 $ 1.37 $ 2.01
====== ====== ====== ====== ======
Total return ...................................... 5.51% 5.02% 15.43% (25.57%) 8.14%
Ratios/supplemental data:
Net assets, end of period (000 omitted) ........... $10,030 13,224 15,194 19,020 63,182
Ratios to average net assets
Interest expense (a) ............................ 2.75% 2.61% 3.00% 2.01% 1.54%
Operating expenses .............................. 5.75% 3.41% 3.05% 2.16% 1.39%
------ ------ ------ ------ ------
Total expenses+ (a) ......................... 8.50% 6.02% 6.05% 4.17% 2.93%
====== ====== ====== ====== ======
Net investment income+ .......................... 6.83% 9.01% 5.91% 8.94% 7.85%
Portfolio turnover rate ........................... 12.55% 12.65% 114.36% 60.66% 90.59%
Borrowings
Amount outstanding at end of period
(000 omitted) ................................... $4,969 $6,610 $ 7,481 $ 9,674 $31,072
Average amount of debt outstanding during the
period (000 omitted) ............................ $5,967 $6,577 $ 7,790 $16,592 $28,756
Average number of shares outstanding during the
period (000 omitted) ............................ 8,433 9,764 11,571 21,436 28,922
Average amount of debt per share during the
period .......................................... $ .71 $ .67 $ .67 $ .77 $ .99
<FN>
+These ratios are after expense reimbursement of 1.37%, 2.02%, 1.0% and .13% for the years ended December 31,
1997, 1996, 1995 and 1993, respectively.
(a)The ratios for each of the years in the four year period ending December 31, 1996 have been reclassified to
conform with the 1997 presentations.
</FN>
</TABLE>
59
<PAGE>
INDEPENDENT AUDITOR'S REPORT
The Board of Trustees and Shareholders
Fundamental Fixed-Income Fund
Fundamental U.S. Government Strategic Income Fund Series
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, 1997 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 each of the five years in the period then ended. 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, 1997 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 Series of
Fundamental Fixed-lncome Fund as of December 31, 1997, 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.
See Notes 2 and 8 for information regarding regulatory proceedings and
transactions with affiliates.
S I G N A T U R E
New York, New York
March 2, 1998, except for Note 8 as to which the date is April 30, 1998.
60
<PAGE>
APPENDIX
DESCRIPTION OF MUNICIPAL BONDS
Municipal Bonds include debt obligations issued to obtain funds for
various public purposes, including the construction of a wide range of public
facilities such as bridges, highways, housing, mass transportation, schools,
streets and water and sewer works. Other public purposes for which Municipal
Bonds may be issued include refunding outstanding obligations, obtaining funds
for general operating expenses, and obtaining funds to loan to other public
institutions. In addition, certain types of private activity bonds are issued by
or on behalf of public authorities to obtain funds to provide privately operated
housing facilities, airport, mass transit, port facilities, and certain local
facilities for water supply, gas, electricity or sewage or solid waste disposal.
Such obligations are included within the term Municipal Bonds if the interest
paid thereon qualifies as exempt from federal income tax. Other types of private
activity bonds, the proceeds of which are used for the construction, equipment,
repair or improvement of privately operated industrial or commercial facilities,
may constitute Municipal Bonds, although the current federal tax laws place
substantial limitations on the volume of such issues.
The two principal classifications of Municipal Bonds are "general
obligation" and "revenue" bonds. General obligation bonds are secured by the
issuer's pledge of its faith, credit and taxing power for the payment of
principal and interest. The payment of such bonds may be dependent upon an
appropriation by the issuer's legislative body. The characteristics and
enforcement of general obligation bonds vary according to the law applicable to
the particular issuer. Revenue bonds are payable only from the revenues derived
from a particular facility or class of facilities or, in some cases, from the
proceeds of a special excise or other specific revenue source. Private activity
bonds which are Municipal Bonds are in most cases revenue bonds and do not
generally constitute the pledge of the credit of the issuer of such bonds. There
are, of course, variations in the security of Municipal Bonds, both within a
particular classification and between classifications, depending on numerous
factors.
The yields on Municipal Bonds are dependent on a variety of factors,
including general money market conditions, supply and demand and general
conditions of the Municipal Bond market, size of a particular offering, the
maturity of the obligation and rating of the issue. The ratings of Moody's
Investors Service, Inc. and Standard & Poor's Corporation represent their
opinions as to the quality of various Municipal Bonds. It should be emphasized,
however, that ratings are not absolute standards of quality. Consequently,
Municipal Bonds with the same maturity, coupon and rating may have different
yields while Bonds of the same maturity and coupon with different ratings may
have the same yield.
A-1
<PAGE>
PART C. OTHER INFORMATION
ITEM 24. Financial Statements and Exhibits
(A) FINANCIAL STATEMENTS FOR EACH FUND:
IN PART A:
(1) Financial Highlights
IN PART B:
(1) Auditor's Report.
(2) Statements of Assets and Liabilities as of
December 31, 1997.
(3) Statements of Changes in Net Assets for the
years ended December 31, 1997 and 1996.
(4) Statements of Operations for the year ended
December 31, 1997.
(5) Schedule of Investments as of December 31,
1997.
(B) EXHIBITS:
(1) Declaration of Trust*
(2) By-Laws of Registrant*
(3) None
(4) None
(5) Form of Management Agreement*
(6) Form of Distribution Agreement*
(7) None
(8) Form of Custody Agreement*
(9) None
(10) (a) Opinion of Counsel*
(11) (a) Consent of Counsel
(b) Consent of McGladrey & Pullen
(12) None
(13) Form of Stock Purchase Agreement*
(14) None
(15) Form of Marketing Plan pursuant to Rule 12b-1*
(16) Schedule for Computation of Performance
Quotations*
(17) Financial Data Schedules.
ITEM 25. Persons Controlled by or under Common Control with
Registrant
None.
- -------------------------
* Previously filed.
<PAGE>
ITEM 26. Number of Holders of securities
The following sets forth the number of record holders of the Registrant
as of March 31, 1998:
Title of Class Number of Record Holders
- -------------- ------------------------
High-Yield Municipal Bond Series 167
Tax-Free Money Market Series 342
Fundamental U.S. Government
Strategic Income Fund Series 816
Item 27. Indemnification
Except pursuant to the Declaration of Trust, dated March 13, 1987,
establishing the Registrant as a Trust under Massachusetts law, there is no
contract, arrangement or statute under which any Trustee, director, officer,
underwriter, distributor or affiliated person of the Registrant is insured or
indemnified. The Declaration of Trust provides that no Trustee or officer will
be indemnified against any liability to which the Registrant would otherwise be
subject by reason of or for willful misfeasance, bad faith, gross negligence or
reckless disregard of such person's duties. See the Registrant's undertaking
with respect to indemnification in Item 32 below.
Item 28. Business and other Connections of Investment Advisor
All of the information required by this item is set forth in the Forms
ADV, as amended, of Fundamental Portfolio Advisors, Inc. The following sections
of such Forms ADV are incorporated herein by reference:
(a) Items 1 and 2 of Part 2; and
(b) Item 6, Business Background, of each Schedule D.
Item 29. Principal Underwriters
(a) FSC is the distributor of shares of the Fundamental
U.S. Government Strategic Income Fund Series, the
High-Yield Municipal Bond Series and the Tax-Free Money
Market Series of the Registrant, a Massachusetts
business trust, under distribution contracts entered
into pursuant to a separate 12b-1 Plan with each such
series. FSC also performs distribution services for
Fundamental Funds, Inc., a Maryland corporation, and
The California Muni Fund, a Massachusetts business
trust.
<PAGE>
(b)
<TABLE>
<CAPTION>
<S> <C> <C>
Positions and Positions and
Offices with Offices with
Name* Distributor Registrant
Thomas W. Buckingham Director and None
President
Vincent J. Malanga Director, Executive Trustee,
Vice President and President and
Secretary Treasurer
</TABLE>
Item 30. Location of Accounts and Records
The accounts, books and other documents required to be maintained by
Section 31(a) of the Investment Company Act of 1940 and the rules promulgated
thereunder are in the possession of Registrant, 90 Washington Street, 19th
Floor, New York, N.Y. and Firstar Trust Company, 615 East Michigan Street,
Milwaukee, WI 53202, the Registrant's Transfer Agent, Accounting Agent and
Custodian.
Item 31. Management Services
The Registrant is a party to one contract for each of the Fundamental
U.S. Government Strategic Income Fund Series, the Tax- Free Money Market Series
and the High-Yield Municipal Bond Series, each as described in the Prospectus
and the Statement of Additional Information of each series of the Registrant.
Under such contracts, each series of the Registrant receives management and
advisory services from FPA.
- -------------
* Address of each person listed above is 90 Washington Street, 19th
Floor, New York, New York 10006.
<PAGE>
Item 32. Undertakings
The Registrant undertakes to limit indemnification of officers and
Trustees as follows:
Indemnification
Section 1. The Registrant shall indemnify each of its Trustees and
officers (including persons who serve at the Registrant's request as directors,
trustees or officers of another organization in which the Registrant has any
interest as a shareholder, creditor or otherwise) (hereinafter referred to as a
"Covered Person") against all liabilities and expenses, including but not
limited to amounts paid in satisfaction of judgments, in compromise or as fines
and penalties, and counsel fees reasonably incurred by any Covered Person in
connection with the defense or disposition of any action, suit or other
proceeding, whether civil or criminal, before any court or administrative or
legislative body, in which such Covered Person may be or may have been involved
as a party or been threatened, while in office or thereafter, by reason of being
or having been such a Covered Person except with respect to any matter as to
which such Covered Person shall have been finally adjudicated in any such
action, suit or other proceeding (a) not to have acted in good faith in the
reasonable belief that such Covered Persons action was in the best interest of
the Registrant or (b) to be liable to the Registrant or its shareholders by
reason of willful misfeasance, bad faith, gross negligence or reckless disregard
of the duties involved in the conduct of such Covered Person's office
("disabling conduct"). Expenses, including counsel fees so incurred by any such
Covered Person (but excluding amounts paid in satisfaction of judgments, in
compliance or as fines or penalties) shall be paid from time to time by the
Registrant in advance of the final disposition of any such action, suit or
proceeding upon receipt of an undertaking by or on behalf of such Covered Person
to repay amounts so paid to the Registrant if it is ultimately determined that
indemnification of such expenses is not authorized under Sections 1, 2 and 3
hereof, provided, however, that either (a) such Covered Person shall have
provided appropriate security of such undertaking, (b) the Registrant shall be
insured against losses arising from any such advance payments or (c) either a
majority of the disinterested Trustees acting on the matter (provided that a
majority of the disinterested Trustees then in office act on the matter), or
independent legal counsel in a written opinion shall have determined, based upon
a review of readily available facts (as opposed to a full trial type inquiry)
that there is reason to believe that such Covered Person will be found entitled
to indemnification under Sections 1 and 2 hereof.
<PAGE>
Compromise Payment
Section 2. Its to any matter disposed of (whether by a compromise
payment, pursuant to a consent decree or otherwise) without an adjudication to a
court, or by any body before which the proceeding was brought, that such Covered
Person either (a) did not act in good faith in the reasonable belief that his or
her action was in the best interests of the Registrant or (b) is liable to the
Registrant or its shareholders by reason of disabling conduct, indemnification
shall be proved if (a) it is approved as in the best interests of the
Registrant, after notice that it involves such indemnification, by at least a
majority of the disinterested Trustees acting on the matter (provided that a
majority of the disinterested Trustees then in office act on the matter) upon a
determination, based upon a review of readily available facts (as opposed to a
full trial type inquiry) that such Covered Person acted in good faith in the
reasonable belief that his or her action was in the best interests of the
Registrant and is not liable to the Registrant or its shareholders Iq reasons of
disabling conduct, or (b) there has been obtained an opinion in writing of
independent legal counsel, based upon a review of readily available facts (as
opposed to a full trial type inquiry) to the effect that such Covered Person
appears to have acted in good faith in the reasonable belief that his or her
action was in the best interests of the Registrant and that such indemnification
would not protect such Covered Person against any liability to the Registrant to
which he or she would otherwise be subject by reason of disabling conduct. Any
approval pursuant to this Section shall not prevent the recovery from any
Covered Person of any amount paid to such Covered Person in accordance with this
Section as indemnification if such Covered Person is subsequently adjudicated by
a court of competent jurisdiction not to have acted in good faith in the
reasonable belief that such Covered Person's action was in the best interests of
the Registrant or to have been liable to the Registrant or its shareholders by
reason of willful misfeasance, bad faith, gross negligence or reckless disregard
of the duties involved in the conduct or such Covered Person's office.
Indemnification Not Exclusive
Section 3. The right of indemnification hereby provided shall not be
exclusive of or affect any other rights to which such Covered Person may be
entitled. As used in Sections 1, 2 and 3 hereof, the term "Covered Persons"
shall include such person's heirs, executors and administrators, and a
"disinterested Trustee" is a Trustee who is not an "interested person" of the
Registrant as defined in Section 2(a)(19) of the 1940 Act, as amended (or who
has been exempt from being an "interested person" by any rule, regulation or
order of the Commission and against whom none of such actions, suits or other
proceedings or another action, suit or other proceeding on the same or similar
grounds is then or has been
<PAGE>
pending). Nothing contained in Sections 1, 2 and 3 hereof shall affect any
rights to indemnification to which personnel of the Registrant, other than
Trustees or officers, and other persons may be entitled by contract or otherwise
under law, nor the power of the Registrant to purchase and maintain liability
insurance on behalf of any such person; provided, however, that the Registrant
shall not purchase or maintain any such liability insurance in contravention of
applicable law, including without limitation the 1940 Act, and the rules and
regulations thereunder.
Registrant undertakes to furnish to each person to whom a prospectus
relating to its Fundamental U.S. Government Strategic Income Fund Series,
Tax-Free Money Market Series or High-Yield Municipal Bond Series is delivered, a
copy of the Fund's latest annual report to shareholders, upon request and
without charge.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the
Investment Company Act of 1940, the Registrant certifies that it meets all of
the requirements for effectiveness of this Registration Statement pursuant to
Rule 485 (b) under the Securities Act of 1933 and has duly caused this
Registration Statement or Amendment to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of New York and State of New
York on the 30th day of April, 1998.
Registrant: FUNDAMENTAL FIXED INCOME FUND
By: /s/Vincent J. Malanga
---------------------
Vincent J. Malanga, Chairman
and Chief Executive Officer
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement or Amendment has been signed below by the following
persons in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURES TITLE DATE
- ---------- ----- ----
<S> <C> <C>
/s/Vincent J. Malanga Trustee, Principal April 30, 1998
- --------------------- Executive Officer and
Vincent J. Malanga
Principal Financial
and Accounting Officer
* Trustee April 30, 1998
- ------------------------
James C. Armstrong
* Trustee April 30, 1998
- ------------------------
L. Greg Ferrone
</TABLE>
*By: /s/Jules Buchwald
-----------------
Jules Buchwald, Attorney-in-Fact,
pursuant to powers of attorney
dated April 24, 1991, previously
filed with the Securities and
Exchange Commission
[LETTERHEAD OF KRAMER, LEVIN, NAFTALIS & FRANKEL]
April 30, 1998
Fundamental Fixed Income Fund
90 Washington Street
New York, New York 10006
Re: Registration No. 33-12738
-------------------------
Gentlemen:
We hereby consent to the reference to our firm as counsel in
Post-Effective Amendment No. 19 to Registration Statement No. 33-12738.
Very truly yours,
/s/ Kramer, Levin, Naftalis & Frankel
-------------------------------------
Kramer, Levin, Naftalis & Frankel
[LETTERHEAD OF MCGLADREY & PULLEN, LLP]
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
We consent to the use of our report dated March 2, 1998 (except for Note 8 as to
which the date is April 30, 1998) on the financial statements of the Fundamental
U.S. Government Strategic Income Fund series of Fundamental Fixed-Income Fund
referred to therein, and our report dated March 2, 1998 (except for Note 8 as to
which the date is March 25, 1998) on the financial statements of the Fundamental
Fixed Income Fund Tax-Free Money Market Series referred to therein, and our
report dated March 2, 1998 (except for Note 7 as to which the date is March 25,
1998) on the financial statements of the Fundamental Fixed Income Fund High
Yield Municipal Bond Series referred to therein, in Post-Effective Amendment No.
19 to the Registration Statement on Form N-1A, file No. 2-82143, as filed with
the Securities and Exchange Commission.
We also consent to the reference to our Firm in the Statement of Additional
Information under the caption "Custodian, Independent Accountants and Counsel."
We also consent to our Firm in Part 1 of the Prospectus under the caption
"Financial Highlights" and "Custodian and Independent Accountants."
/s/McGladrey & Pullen, LLP
--------------------------
McGladrey & Pullen, LLP
New York, New York
April 30, 1998
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