<PAGE> 1
GOVERNMENT
INCOME FUND
SEMIANNUAL REPORT
JUNE 30, 1997
Gradison Mutual Funds
580 Walnut Street
Cincinnati, Ohio 45202-3198
This material is intended for distribution to shareholders of the Gradison
Government Income Fund. It may be distributed to other persons only if it is
preceded or accompanied by a current prospectus of the Gradison Government
Income Fund. McDonald & Company Securities, Inc.--Distributor
<PAGE> 2
GOVERNMENT INCOME FUND
LETTER TO SHAREHOLDERS
August 11, 1997
Dear Shareholder:
In March of 1997, the Federal Reserve Board increased its target for the Federal
Funds rate (bank to bank overnight loan rate) from 5.25% to 5.50%. Despite this
very modest rate increase, rates rose across the complete maturity range (0 to
30 years) by about 0.60%! After several revisions, the first quarter Gross
Domestic Product figure was finalized at +4.9%, which validated the Federal
Reserve Board's March action. In the second quarter of 1997, the economy
appeared to be cooling off, allowing the Federal Reserve Board to let the
Federal Funds rate stay at 5.50%. Surprisingly, rates across the maturity range
declined by about 0.50%! The initial second quarter Gross Domestic Product
number appears to be about +2.2%, again validating the Federal Reserve Board's
decision. After all of the above, interest rates on June 30, 1997 were only
0.10% higher than at 1996 year-end. This type of investor overreaction to
economic news seems to be an important aspect of the current investment climate.
As for your Fund, the unannualized total return for the six months ending June
30, 1997, was 2.98% when purchased at net asset value. Our decision to
overweight mortgage-backed securities versus U. S. Treasuries continues to
reward the Fund; the Lehman Brothers GNMA Index had a six month total return of
4.04% compared to a total return of 2.56% for the Lehman Brothers Treasury
Index.
Purchase of U. S. Government debt by foreigners is very much on the rise which
is fortunate for U. S. borrowers since domestic demand for debt is down. Foreign
net purchases rose to a third straight year record ($244 billion in '96, $134
billion is '95, and $79 billion in '94.) It is now estimated that foreigners own
30% of all U. S. national debt which is more than double the level 20 years ago.
This "good news" carries with it the risk that if international political
considerations cause a reversal in foreign investor strategies, then rates could
rise dramatically. As Europe moves to a 1999 common currency (EMU), the U. S.
dollar valuation to other currencies could cause foreign investor strategies to
change. This bears close scrutiny in the future.
Domestically, the United States has been rewarded with the best of all worlds; a
rapidly expanding economy, low unemployment, and low inflation. The reasons for
this scenario are too numerous and complex for discussion in this letter.
Notwithstanding the apparent "picture perfect" economic indicators, we remain
concerned about the potential for increasing inflation caused by bottlenecks in
supply (just in time inventory), low (5%) unemployment, and high consumer demand
(University of Michigan Consumer Confidence Index at all time high). This
concern about inflation causes us to maintain a defensive portfolio with a lower
than normal duration,
<PAGE> 3
LETTER TO SHAREHOLDERS (CONTINUED)
4 years instead of 5, and a high mortgage-backed asset allocation, 55-60%
instead of 50%. We believe that our charter is to preserve capital rather than
attempt to create capital gains. That's what the stock market is for.
I want to take a moment to point out to you a very exciting development
regarding your Fund, which is quite beneficial to you. Effective July 7th past,
the Fund's sales load was eliminated. Now, all shareholders and prospective
shareholders can purchase shares of the Fund at its net asset value without a
sales load.
As always, we thank you for your support and patronage of the Gradison
Government Income Fund.
Sincerely,
/s/ Michael J. Link
Michael J. Link
Exec. V.P & Portfolio Manager
AVERAGE ANNUAL TOTAL RETURN PERIODS ENDED JUNE 30, 1997
<TABLE>
<CAPTION>
SINCE INCEPTION
9/16/87 5 YEARS 1 YEAR
<S> <C> <C> <C> <C>
@ Maximum Offer Price (2% Sales Charge) 7.98% 5.71% 5.55%
@ Net Asset Value (No Sales Charge)* 8.21% 6.13% 7.71%
- -----------------------------------------------------------------------------------------------------
<FN>
*Effective July 7, 1997, the sales charge on purchases of Fund shares is
eliminated. Prior to July 7, 1997 certain qualifying group retirement Fund
purchases were made without a sales charge, as were all purchases representing
reinvestment of dividends. See pages 7 and 10 of the Prospectus. This
performance data does not reflect the deduction of the sales charge which
would reduce the performance illustrated to the figure of the line above it.
The performance quoted above represents past performance. The investment
return and value of an investment in the Fund will fluctuate so that an
investor's shares, when redeemed, may be worth more or less than the original
cost. Total return includes changes in share value and reinvestment of all
distributions.
</TABLE>
See accompanying notes to financial statements.
2
<PAGE> 4
FINANCIAL HIGHLIGHTS (For a share outstanding throughout each year) (Unaudited)
<TABLE>
<CAPTION>
SIX MONTHS YEAR ENDED DECEMBER 31,
ENDED ------------------------------------------------------------
JUNE 30, 1997 1996 1995 1994 1993 1992
<S> <C> <C> <C> <C> <C> <C>
Net asset value at beginning of year $12.884 $13.214 $12.018 $13.373 $13.327 $13.553
------- ------- ------- ------- ------- -------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income .391 .778 .786 .755 .749 .856
Net realized and unrealized gain (loss)
on investments (.017) (.340) 1.232 (1.244) .239 (.050)
------- ------- ------- ------- ------- -------
Total income (loss) from investment operations .374 .438 2.018 (.489) .988 .806
------- ------- ------- ------- ------- -------
DISTRIBUTIONS TO SHAREHOLDERS:
Dividends from net investment income (.384) (.768) (.787) (.779) (.738) (.859)
Dividends in excess of net investment income - - - (.013) - -
Distributions from realized capital gains - - - (.053) (.204) (.173)
Distributions from paid-in capital - - (.035) (.021) - -
------- ------- ------- ------- ------- -------
Total distributions to shareholders (.384) (.768) (.822) (.866) (.942) (1.032)
------- ------- ------- ------- ------- -------
Net asset value at end of year $12.874 $12.884 $13.214 $12.018 $13.373 $13.327
======= ======= ======= ======= ======= =======
Total return (1) 2.98%(2) 3.51% 17.20% (3.69%) 7.52% 6.29%
======= ======= ======= ======= ======= =======
Ratios/Supplemental data:
Net assets at end of year (in millions) $152.7 $162.9 $185.4 $184.0 $266.0 $210.9
Ratio of expenses to average net assets .91%(3) .90% .92% .90% .90% .94%
Ratio of net investment income to
average net assets 6.19%(3) 6.06% 6.19% 6.03% 5.48% 6.39%
Portfolio turnover rate 2.03% 13.33% 15.84% 20.91% 133.88% 83.36%
----------------------------------------------------------------------------------------------------------------------------------
<FN>
(1) Total return is based upon an initial investment purchased without a sales
charge.
(2) Total return represents the actual return over that period and has not been
annualized.
(3) Annualized.
</TABLE>
See accompanying notes to financial statements.
3
<PAGE> 5
<TABLE>
<CAPTION>
PORTFOLIO OF INVESTMENTS JUNE 30, 1997 (UNAUDITED)
PAR COUPON
AMOUNT MORTGAGE-BACKED SECURITIES - 54.85% RATE MATURITY VALUE
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
$ 712,941 Government National Mortgage Association 6.55% 11/15/13 $ 688,656
19,149,527 Government National Mortgage Association 7.00% 4/15/23-9/15/23 18,808,426
20,212,943 Government National Mortgage Association 7.50% 4/15/23-3/15/24 20,282,425
19,492,619 Government National Mortgage Association 8.00% 7/15/02-7/15/26 20,012,388
3,762,751 Government National Mortgage Association 8.25% 6/15/35 3,882,688
8,183,355 Government National Mortgage Association 8.50% 4/15/21-11/15/22 8,510,690
2,606,836 Government National Mortgage Association 8.75% 4/15/22 2,733,104
1,947,474 Government National Mortgage Association 9.00% 1/15/20-8/15/21 2,058,236
2,847,500 Government National Mortgage Association 9.50% 10/15/02-6/15/21 3,061,516
2,547,574 Government National Mortgage Association 10.00% 5/15/12-6/15/21 2,791,186
------------
Total Mortgage-Backed Securities
(Cost $83,560,021) 82,829,315
------------
- ------------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
U.S. TREASURY OBLIGATIONS - 40.37%
<S> <C> <C> <C> <C>
10,000,000 U.S. Treasury Bond 5.88% 11/15/05 9,571,875
20,000,000 U.S. Treasury Note 6.25% 2/15/03 19,850,000
10,000,000 U.S. Treasury Note 6.38% 1/15/00 10,053,125
10,000,000 U.S. Treasury Bond 7.63% 2/15/07 10,403,125
10,000,000 U.S. Treasury Bond 8.75% 11/15/08 11,084,375
------------
Total U.S. Treasury Obligations
(Cost $62,483,750) 60,962,500
------------
- ------------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
COLLATERALIZED MORTGAGE OBLIGATION - 0.77%
<S> <C> <C> <C> <C>
1,125,733 Government National Mortgage Association 94-6 L
(Cost $1,146,313)
7.99% 8/16/99 1,146,841
------------
- -----------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
FACE INTEREST
AMOUNT REPURCHASE AGREEMENT - 4.01% RATE (1)
<S> <C> <C> <C> <C>
1,755,000 First National Bank of Chicago, dated 6/30/97,
collateral; U.S. Treasury Note, 5%; due 2/15/99
with a market value of $2,216,677 and U.S. Treasury
Note 6.25%; due 6/30/02 with a market value of
$3,976,250 (repurchase proceeds: $6,060,960)
(Cost $6,060,000) 5.78% 7/1/97 6,060,000
------------
TOTAL INVESTMENTS, at value (Note 1)
(Cost $153,250,084) - 100% $150,998,656
============
- ------------------------------------------------------------------------------------------------------------------------------------
<FN>
(1) For repurchase agreements, the rate shown reflects the actual rate of
return to the Fund.
</TABLE>
4
See accompanying notes to financial statements.
<PAGE> 6
<TABLE>
<CAPTION>
STATEMENT OF ASSETS AND LIABILITIES (UNAUDITED)
JUNE 30, 1997
<S> <C>
ASSETS
Investments in securities, at value (Note 1) (Cost $153,250,084) $150,998,656
Interest receivable 1,778,514
Receivable for Fund shares sold 118,056
Prepaid expenses 26,864
Cash 2,812
------------
TOTAL ASSETS 152,924,902
------------
LIABILITIES
Payable for Fund shares redeemed 113,945
Accrued investment advisory fee (Note 2) 60,838
Other accrued expenses payable to adviser (Note 2) 43,667
Dividend payable 30,353
Other accrued expenses and liabilities 20,845
------------
TOTAL LIABILITIES 269,648
------------
NET ASSETS $152,655,254
============
Net assets consist of:
Aggregate paid-in capital $161,155,920
Accumulated undistributed net investment income (Note 1) 24,377
Accumulated net realized loss (6,273,615)
Net unrealized depreciation of investments (2,251,428)
------------
Net Assets $152,655,254
============
Shares of capital stock outstanding
(no par value - unlimited number of shares authorized ) 11,856,930
============
Net asset value and redemption price per share (Note 1) $12.87
============
Maximum offering price per share (Note 1) $13.13
============
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to financial statements.
5
<PAGE> 7
<TABLE>
<CAPTION>
STATEMENT OF OPERATIONS (Unaudited)
SIX MONTHS ENDED JUNE 30, 1997
<S> <C> <C>
Interest income $5,502,825
Expenses:
Investment advisory fee (Note 2) $ 387,467
Distribution (Note 2) 191,134
Personnel costs (Note 2) 28,441
Data processing fee (Note 2) 20,505
Professional fees 17,163
Postage and mailing 13,208
Trustees' fees (Note 2) 11,317
Custodian fees 10,874
Registration fees 9,500
Printing 5,235
ICI dues 3,736
Other 7,201
---------
Total expenses 705,781
---------
Net investment income 4,797,044
Net realized and unrealized gain (loss) on investments:
Net realized loss on investments (339,566)
Net change in unrealized depreciation of investments 93,747
---------
Net realized and unrealized loss on investments (245,819)
----------
Net increase in net assets resulting from operations $4,551,225
==========
- --------------------------------------------------------------------------------
</TABLE>
See accompanying notes to financial statements.
6
<PAGE> 8
<TABLE>
<CAPTION>
STATEMENTS OF CHANGES IN NET ASSETS (UNAUDITED)
SIX MONTHS ENDED YEAR ENDED
JUNE 30, 1997 DECEMBER 31,1996
<S> <C> <C>
FROM OPERATIONS:
Net investment income $ 4,797,044 $ 10,442,430
Net realized loss on investments (339,566) (536,544)
Net change in unrealized appreciation/depreciation of investments 93,747 (4,448,606)
------------ ------------
Net increase in net assets resulting from operations 4,551,225 5,457,280
------------ ------------
FROM DISTRIBUTIONS TO SHAREHOLDERS FROM NET INVESTMENT INCOME (4,713,344) (10,293,237)
------------ ------------
FROM FUND SHARE TRANSACTIONS:
Proceeds from shares sold 10,420,284 28,763,172
Net asset value of shares issued as distributions 3,902,119 8,597,718
Payments for Fund shares redeemed (24,378,873) (55,084,613)
------------ ------------
Net decrease in net assets from Fund share transactions (10,056,470 (17,723,723)
------------ ------------
TOTAL DECREASE IN NET ASSETS (10,218,589) (22,559,680)
NET ASSETS:
Beginning of period 162,873,843 185,433,523
------------ ------------
End of period (including accumulated undistributed net investment income and
distributions in excess of net investment income of $24,377 and
$59,323, respectively) (Note 1) $152,655,254 $162,873,843
============ ============
NUMBER OF FUND SHARES:
Sold 814,041 2,230,737
Issued as distributions to shareholders 305,391 670,451
Redeemed (1,903,399) (4,293,141)
------------ ------------
Net decrease in shares outstanding (783,967) (1,391,953)
Outstanding at beginning of period 12,640,897 14,032,850
------------ ------------
Outstanding at end of period 11,856,930 12,640,897
============ ============
- ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to financial statements.
<PAGE> 9
NOTES TO FINANCIAL STATEMENTS JUNE 30, 1997 (UNAUDITED)
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES
Gradison Custodian Trust (the "Trust") is registered under the Investment
Company Act of 1940, as amended, as a diversified, open-end management
investment company. The Trust was created under Ohio law by a Declaration of
Trust dated June 3, 1987; it commenced investment operations and the public
offering of its shares on September 16, 1987. There is currently one series, the
Gradison Government Income Fund (The "Fund"). The Fund's investment objective is
to seek high current income through investment in U.S. Government obligations
and obligations of agencies or instrumentalities of the U.S. Government.
The following is a summary of significant accounting policies followed by the
Fund in the preparation of its financial statements. The policies are in
conformity with generally accepted accounting principles. The preparation of
financial statements requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities at the date of the
financial statements and the reported amount of income and expenses for the
period. Actual results could differ from those estimates.
SECURITIES VALUATION - Portfolio securities for which over-the-counter market
quotations are readily available are valued at the latest bid price. Debt
securities maturing within 60 days are valued at amortized cost, which
approximates market value. Portfolio securities for which market quotations are
not readily available are valued at their fair value as determined by management
using procedures approved by the Board of Trustees.
Repurchase agreements, which are collateralized by U.S. Government obligations,
are valued at cost which, together with accrued interest, approximates market.
Collateral for repurchase agreements is held in safekeeping in the customer-only
account of the Fund's custodian. At the time the Fund enters into a repurchase
agreement, the seller agrees that the value of the underlying security,
including accrued interest, will be equal to or exceed the face amount of the
repurchase agreement. In the event of a bankruptcy or other default of the
seller of a repurchase agreement, the Fund could experience both delays in
liquidating the underlying security and losses. These losses would not exceed an
amount equal to the difference between the liquidating value of the underlying
security and the face amount of the repurchase agreement and accrued interest.
To minimize the possibility of loss, the Fund enters into repurchase agreements
only with selected domestic banks and securities dealers which the Fund's
investment adviser believes present minimal credit risk. Refer to the Fund's
Portfolio of Investments for the face amount of repurchase agreements and
repurchase proceeds as of June 30, 1997.
OPTION ACCOUNTING PRINCIPLES - When the Fund writes a call option, an amount
equal to the premium received by the Fund is recorded as an asset and as an
equivalent liability. The amount of the liability is subsequently
marked-to-market to reflect the current market value of the written option. The
current market value of a traded option is the last ask price on the principal
exchange on which such option is traded. If the option expires on its stipulated
expiration date or if the Fund enters into a closing purchase transaction, the
Fund will realize a gain or loss without regard to any unrealized gain or loss
on the underlying security and liability related to such option will be
extinguished.
The risk in writing a call option on a security which the Fund owns is that the
Fund limits the profit potential from an increase in the market price of the
security. The Fund may also be subject to the additional risk of not being able
to enter into a closing transaction if a liquid secondary market does not exist.
The Fund also writes over-the-counter options where the Fund's ability to
successfully extinguish its obligation is dependent upon the credit standing of
the other party.
SECURITIES TRANSACTIONS AND INVESTMENT INCOME - Securities transactions are
accounted for on the trade date (the date the order to buy or sell is executed).
Interest income is accrued as earned. Gains and losses on sales of investments
are calculated on the identified cost basis for financial reporting and tax
purposes.
8
<PAGE> 10
NOTES TO FINANCIAL STATEMENTS JUNE 30, 1997 (UNAUDITED)
SECURITIES PURCHASED ON A WHEN-ISSUED OR DELAYED DELIVERY BASIS - When the Fund
purchases securities on a when-issued or delayed delivery basis, the transaction
may be entered into a month or more before delivery and payment are made. Such
securities are subject to market fluctuation during this period. In the event
that the seller fails to deliver the securities, the Fund could experience a
loss to the extent of any appreciation, or a gain to the extent of any
depreciation, in the price of the securities.
The Fund will maintain, in a segregated account with its custodian, cash or U.S.
Government securities having an aggregate value at least equal to the amount of
such purchase commitments. At June 30, 1997, the Fund had not committed to the
purchase of any when-issued of delayed delivery securities.
TAXES - It is the Fund's policy to comply with the provisions of the Internal
Revenue Code available to regulated investment companies. As provided therein,
in any fiscal year in which the Fund so qualifies, and distributes at least 90%
of its taxable net income, the Fund will be relieved of federal income tax on
the income distributed. Accordingly, no provision for income taxes has been
made.
In order to avoid imposition of the excise tax applicable to regulated
investment companies, it is also the Fund's intention to declare as dividends in
each calendar year, at least 98% of its net investment income (earned during the
calendar year) and 98% of its net realized capital gains, if any (earned during
the twelve months ended October 31), plus undistributed amounts from prior
years.
The tax basis of investments is substantially equal to the cost as shown on the
Statement of Assets and Liabilities.
For both financial reporting and tax purposes, gross unrealized appreciation and
gross unrealized depreciation of securities at June 30, 1997 was $1,166,251 and
$3,417,679, respectively.
As of December 31, 1996, the Fund had a capital loss carryforward for Federal
income tax purposes of approximately $5,890,000 which may be utilized to offset
future net realized capital gains through December 31, 2004 prior to
distributing such gains to shareholders.
FUND SHARE VALUATION - The net asset value per share is computed by dividing the
net asset value of the Fund (total assets less total liabilities) by the number
of shares outstanding. The maximum offering price per share is equal to the net
asset value per share plus 2.04% of net asset value (or 2% of the offering
price). The offering price per share is reduced on sales of $100,000 or more.
The redemption price per share is equal to the net asset value per share.
Effective July 7, 1997 the sales charge on purchases of fund shares is
eliminated.
DISTRIBUTIONS TO SHAREHOLDERS - Dividends arising from net investment income are
declared daily and paid monthly. Distributions of net realized short-term
capital gains, if any, are declared and paid monthly on all shares of record on
established record dates. Net realized long-term capital gains, if any, are
distributed at least annually.
NOTE 2 - TRANSACTIONS WITH AFFILIATES
The Fund's investments are managed, subject to the general supervision and
control of the Fund's Board of Trustees, by the Gradison Division of McDonald &
Company Securities, Inc. (Gradison), a registered investment adviser and
securities dealer, pursuant to the terms of an Investment Advisory Agreement
(the Agreement). Under the terms of the Agreement, the Fund pays Gradison a fee
computed and accrued daily and paid monthly based upon the Fund's daily net
assets at the annual rate of .50%.
Under the terms of the Agreement, the Fund reimburses Gradison for the cost of
furnishing personnel to perform shareholder and certain other services for the
Fund. The Agreement also provides that Gradison bear the costs of salaries and
related expenses of executive officers of the Fund who are necessary for the
management and operations of the Fund. In
9
<PAGE> 11
NOTES TO FINANCIAL STATEMENTS JUNE 30, 1997 (UNAUDITED)
addition, Gradison bears the costs of preparing, printing and mailing sales
literature and other advertising materials, and compensates the Fund's trustees
who are affiliated with Gradison. All expenses not specifically assumed by
Gradison are borne by the Fund.
Under the terms of a Data Processing Agreement between the Trust and Gradison,
the Fund pays Gradison a monthly fee at an annual rate of $8.25 per shareholder
non-zero balance account for data processing services provided to the Fund.
In accordance with the terms of a Distribution Service Plan adopted under Rule
12b-1 of the Investment Company Act of 1940, the Fund pays Gradison a
distribution service fee at an annual rate of .25% of average daily net assets.
During the period ended June 30, 1997, Gradison received sales charges
aggregating $30,362 on sales of shares of the Fund.
The officers of the Trust are also officers of McDonald & Company Securities,
Inc.
Each trustee of the Trust who is not affiliated with Gradison receives fees from
the Trust for services as a trustee. The amounts of such fees for each trustee
are as follows: (a) an annual fee of $3,500 payable in quarterly installments
for service during each fiscal quarter and (b) $500 for each Board of Trustees
or committee meeting attended.
NOTE 3 - SUMMARY OF SECURITIES TRANSACTIONS
For the period ended June 30, 1997, purchases and proceeds from the sale of
securities, excluding short-term securities, amounted to $3,032,875 and
$11,916,209, respectively. There were no transactions in written options on U.S.
Treasury Notes and Bonds for the period ended June 30, 1997.
10
<PAGE> 12
GRADISON FAMILY OF FUNDS
Increasingly, MUTUAL FUNDS are the preferred vehicle for starting and building
an investment program. And today, GRADISON is a preferred name in mutual funds
for a GROWING number of investors.
OHIO TAX-FREE INCOME FUND
An income fund which seeks to provide income exempt from regular Federal income
tax and Ohio state personal income tax.*
ESTABLISHED VALUE FUND
A common stock fund that seeks long-term capital growth by investing in
companies that are included in the Standard & Poor's 500 Index and other large
companies.
GROWTH & INCOME FUND
A common stock fund that seeks long-term capital growth, current income and
growth of income.
OPPORTUNITY VALUE FUND
A common stock fund that seeks long-term capital growth by investing in
companies that are generally smaller in size than those included in the Standard
& Poor's 500 Index.
INTERNATIONAL FUND
A common stock fund that seeks capital growth by investing in common stocks of
non-United States companies.
MONEY MARKET FUNDS
Gradison offers a full range of taxable and tax-free money market funds.
Prospectuses are available upon request by calling (800) 869-5999 and should be
read carefully before you invest. AN INVESTMENT IN THE MONEY MARKET FUNDS IS
NEITHER INSURED NOR GUARANTEED BY THE U.S. GOVERNMENT AND THERE CAN BE NO
ASSURANCE THAT THEY WILL BE ABLE TO MAINTAIN A STABLE $1.00 SHARE PRICE. The
return and principal value of an investment in other funds will fluctuate so
that an investor's shares, when redeemed, may be worth more or less than the
original cost. The returns of all funds will fluctuate.
* Investment income may be subject to the federal alternative minimum tax.
Capital gains, if any, are taxable.
