THE BLACKROCK FUNDS
THE MULTI-SECTOR MORTGAGE SECURITIES PORTFOLIO III
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ANNUAL REPORT
SEPTEMBER 30, 1998
<PAGE>
THE BLACKROCK FUNDS
THE MULTI-SECTOR MORTGAGE SECURITIES PORTFOLIO III
SCHEDULE OF INVESTMENTS
SEPTEMBER 30, 1998
<TABLE>
<CAPTION>
Principal
Rating* Amount
(Unaudited) (000) DESCRIPTION Value
- ------------- ---------- --------------------------------------------------- -------------
<S> <C> <C> <C> <C>
U.S. GOVERNMENT OBLIGATIONS 1.0%
U.S. TREASURY BONDS,
$ 400 6.38%, 8/15/27 (Cost $425,129) $ 472,062
-----------
COMMERCIAL MORTGAGE - BACKED SECURITIES 72.0%
ASSET SECURITIZATION CORP.,
AA 1,000 7.36%, Series 1996-D2, Class A2, 02/14/29 1,087,796
CBA MORTGAGE CORP.,
BBB 1,000 7.76%, Series 1993-C1, Class D, 12/25/03 997,813
FDIC REAL ESTATE MORTGAGE INSURANCE CORP.,
AAA 1,000 8.45%, Series 1994-C1, Class 2C, 09/25/25 1,017,500
FIRST UNION - LEHMAN BROTHERS COMMERCIAL MORTGAGE,
BB 2,000 7.00%, Series 1997-C1, Class F, 04/18/29 1,671,771
LB COMMERCIAL CONDUIT MORTGAGE TRUST,
BBB 2,000 7.05%, Series 1995-C2, Class D, 05/25/05 2,081,039
LTC COMMERCIAL MORTGAGE PASS-THROUGH CERTIFICATES,
AA 2,125 9.50%, Series 1994-1, Class C, 06/15/26 2,159,892
MORGAN STANLEY CAPITAL INVESTMENTS, INC., PASS-THROUGH
CERTIFICATES,
AA 2,656 7.33%, Series 1997-HF1, Class B, 07/15/29 2,901,830
MORTGAGE CAPITAL FUNDING, INC.,
BB 1,000 7.15%, Series 1996-MC1, Class G, 06/15/06 907,025
A 2,000 7.41%, Series 1997-MC1, Class C, 07/20/27 2,121,763
NOMURA ASSET CAPITAL CORP.,
BBB+ 1,000 7.64%, Series 1993-M1, Class A1, 11/25/03 1,026,627
OREGON COMMERCIAL MORTGAGE,
A 3,000 7.60%, Series 1995 - 1 Class C, 06/25/23 3,035,104
PAINE WEBBER MORTGAGE ACCEPTANCE CORP.,
BBB 2,000 7.30%, Series 1995 MI, Class D, 01/15/07 2,060,555
A 2,000 6.90%, Series 1995 M2, Class C, 12/01/03 2,030,353
RESOLUTION TRUST CORP.,
A 1,785 7.10%, Series 1993-C3, Class D, 12/25/24 1,798,900
SALOMON BROTHERS MORTGAGE SECURITIES,
BBB 2,542 7.75%, Series 1996-C1, Class D, 01/20/28 2,644,245
SOUTHERN PACIFIC SECURITIES,
BBB 1,000 7.47%, Series 1996-C1, Class D, 04/25/28 1,006,875
STRUCTURED ASSET SECURITIES CORP. MULTI,
BBB+ 3,000# 7.38%, Series 1995-C1, Class D, 09/25/24 3,003,712
AA+ 1,900 7.00%, Series 1995-C4, Class C, 06/25/26 1,963,459
-----------
TOTAL COMMERCIAL MORTGAGE - BACKED SECURITIES
(COST $32,633,738) 33,516,259
-----------
SHORT-TERM INVESTMENTS 27.0%
FEDERAL HOME LOAN MORTGAGE CORP.,
12,590 5.38% Due 10/01/98 (Cost $12,590,000) 12,590,000
-----------
TOTAL INVESTMENT IN SECURITIES (COST $45,648,867) 100.0% $46,578,321
====== ===========
</TABLE>
- --------------
* Using the higher of Standard & Poor's, Moody's or Fitch's rating.
# Principal amount of securities pledged as collateral of $3,000,000 on 190
long U.S. Treasury Bonds future contracts expiring December 1998. The value of
such contracts on September 30, 1998 was $26,902,031, thereby resulting in an
unrealized gain of $520,594.
See Notes to Financial Statements.
1
<PAGE>
THE BLACKROCK FUNDS
THE MULTI-SECTOR MORTGAGE SECURITIES PORTFOLIO III
STATEMENT OF ASSETS AND LIABILITIES
SEPTEMBER 30, 1998
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<TABLE>
<S> <C>
ASSETS
Investments, at value (cost $45,648,867) $ 46,578,321
Cash 2,299
Interest receivable 193,961
Margin receivable 124,469
Other assets 20,045
------------
46,919,095
------------
LIABILITIES
Dividends payable 260,564
Accrued expenses payable 58,079
------------
318,643
------------
NET ASSETS $ 46,600,452
============
Net assets were comprised of:
Common stock, at par $ 44
Paid-in capital in excess of par 41,197,618
Accumulated net realized gain 3,952,129
Net unrealized appreciation 1,450,661
------------
Net assets $ 46,600,452
============
Net asset value per share $ 1,056.37
============
Total shares outstanding 44,114
============
</TABLE>
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See Notes to Financial Statements.
2
<PAGE>
THE BLACKROCK FUNDS
THE MULTI-SECTOR MORTGAGE SECURITIES PORTFOLIO III
STATEMENTS OF OPERATIONS
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<TABLE>
<CAPTION>
For the Year
Ended
9/30/98
---------------
<S> <C>
INVESTMENT INCOME:
Interest $6,005,315
----------
Expenses:
Investment advisory fee 196,279
Administration fee 190,354
Custodian fee 34,023
Transfer agent fee 23,944
Legal and audit 8,182
Printing 4,957
Trustees fees 6,478
Other 11,062
----------
Total expenses 475,279
Less fees voluntarily waived (184,786)
----------
Total expenses 290,493
----------
Net investment income 5,714,822
----------
REALIZED AND UNREALIZED GAIN ON INVESTMENTS:
Net realized gain on:
Investment transactions 3,438,513
Futures contracts 883,997
----------
4,322,510
----------
Net change in unrealized appreciation (depreciation) on:
Investments (3,727,274)
Futures contracts 374,272
----------
(3,353,002)
----------
Net gain on investments 969,508
----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $6,684,330
==========
</TABLE>
- --------------------------------------------------------------------------------
See Notes to Financial Statements.
3
<PAGE>
THE BLACKROCK FUNDS
THE MULTI-SECTOR MORTGAGE SECURITIES PORTFOLIO III
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
For the Year For the Year
Ended Ended
9/30/98 9/30/97
---------------- ---------------
<S> <C> <C>
INCREASE (DECREASE) IN NET ASSETS:
Operations:
Net investment income $ 5,714,822 $ 9,225,037
Net realized gain on investments 4,322,510 1,699,673
Net unrealized appreciation (depreciation) on investments (3,353,002) 4,529,570
------------ ------------
Net increase in net assets resulting from operations 6,684,330 15,454,280
------------ ------------
Distributions to shareholders from:
Net investment income (5,714,822) (9,225,037)
Net realized gain (1,765,966) (1,202,447)
------------ ------------
(7,480,788) (10,427,484)
------------ ------------
Capital share transactions:
Proceeds from shares subscribed - -
Net asset value of shares issued in reinvestment
of dividend distributions 7,985,972 10,413,147
Net asset value of shares redeemed (81,840,000) (15,927,042)
------------ ------------
(73,854,028) (5,513,895)
------------ ------------
Total decrease in net assets (74,650,486) (487,099)
------------ ------------
NET ASSETS:
Beginning of year 121,250,938 121,738,037
------------ ------------
End of year $ 46,600,452 $121,250,938
============ ============
</TABLE>
See Notes to Financial Statements.
4
<PAGE>
THE BLACKROCK FUNDS
THE MULTI-SECTOR MORTGAGE SECURITIES PORTFOLIO III
FINANCIAL HIGHLIGHTS
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<TABLE>
<CAPTION>
For the Year For the Year
Ended Ended
9/30/98 9/30/97
-------------- --------------
<S> <C> <C>
For a share outstanding
throughout the period:
PER SHARE OPERATING
PERFORMANCE:
Net asset value, beginning of period $1,056.37 $1,016.08
--------- ---------
Net investment income 74.41 73.74
Net realized and unrealized gain
(loss) on investments 15.26 49.82
--------- ---------
Net increase from investment
operations 89.67 123.56
--------- ---------
Distributions from net investment
income (74.41) (73.74)
Distributions from net realized capital
gains (15.26) (9.53)
--------- ---------
Total dividends and distributions (89.67) (83.27)
--------- ---------
Net asset value, end of period $1,056.37 $1,056.37
========= =========
TOTAL RETURN 9.06% 12.67%
Ratios / Supplemental data
Net assets, end of period
(in thousands) $ 46,600 $ 121,251
Ratio of expenses to average net
assets 0.37% 0.37%
Ratio of expenses to average net
assets (excluding waivers) 0.61% 0.62%
Ratio of net investment income to
average net assets 7.28% 7.13%
Ratio of net investment income to
average net assets (excluding
waivers) 7.04% 6.88%
Portfolio turnover 11% 52%
<CAPTION>
For the Period For the Period For the Period
4/1/96 through 7/1/95 through 10/6/94 (a) through
9/30/96 3/31/96 6/30/95
------------------- ------------------- --------------------
<S> <C> <C> <C>
For a share outstanding
throughout the period:
PER SHARE OPERATING
PERFORMANCE:
Net asset value, beginning of period $1,019.41 $1,068.11 $1,000.00
--------- --------- ---------
Net investment income 38.33 61.37 55.81
Net realized and unrealized gain
(loss) on investments (3.33) (9.06) 68.11
--------- --------- ---------
Net increase from investment
operations 35.00 52.31 123.92
--------- --------- ---------
Distributions from net investment
income (38.33) (61.37) (55.81)
Distributions from net realized capital
gains -- (39.64) --
--------- --------- ---------
Total dividends and distributions (38.33) (101.01) (55.81)
--------- --------- ---------
Net asset value, end of period $1,016.08 $1,019.41 $1,068.11
========= ========= =========
TOTAL RETURN 3.53% 5.02% 12.78%
Ratios / Supplemental data
Net assets, end of period
(in thousands) $ 121,738 $ 117,569 $ 112,810
Ratio of expenses to average net
assets 0.37%(b) 0.37%(b) 0.37%(b)
Ratio of expenses to average net
assets (excluding waivers) 0.51%(b) 0.37%(b) 0.45%(b)
Ratio of net investment income to
average net assets 7.60%(b) 7.77%(b) 7.54%(b)
Ratio of net investment income to
average net assets (excluding
waivers) 7.45%(b) 7.76%(b) 7.46%(b)
Portfolio turnover 24% 119% 215%
</TABLE>
- --------------------------------------------------------------------------------
(a) Commencement of investment operations.
(b) Annualized
See Notes to Financial Statements.
5
<PAGE>
BLACKROCK FUNDS
THE MULTI-SECTOR MORTGAGE SECURITIES PORTFOLIO III
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 1. ORGANIZATION AND ACCOUNTING POLICIES
BlackRock FundsSM (the "Fund") (formerly The Compass Capital Funds) was
organized on December 22, 1988 as a Massachusetts business trust and is
registered under the Investment Company Act of 1940, as amended, as an open-end
management investment company. The Fund currently has 35 investment portfolios.
These financial statements relate to the Fund's Multi-Sector Mortgage Securities
Portfolio III (the "Portfolio"). The Portfolio is authorized to issue an
unlimited number of shares with a par value of $0.001.
As of September 30, 1998, 99.92% of the shares of capital stock of the
Portfolio are owned by Ameritech Pension/VEBA Fund.
The following is a summary of significant accounting policies followed by
the Fund.
SECURITIES VALUATION: The Fund values mortgage-backed, asset-backed and other
debt securities on the basis of current market quotations provided by dealers or
pricing services approved by the Fund's Board of Trustees. In determining the
value of a particular security, pricing services may use certain information
with respect to transactions in such securities, quotations from dealers, market
transactions in comparable securities, various relationships observed in the
market between securities, and calculated yield measures based on valuation
technology commonly employed in the market for such securities. Exchange-traded
options are valued at their last sales price as of the close of options trading
on the applicable exchanges. In the absence of a last sale, options are valued
at the average of the quoted bid and asked prices as of the close of business. A
futures contract is valued at the last sale price as of the close of the
commodities exchange on which it trades. Any securities or other assets for
which such current market quotations are not readily available are valued at
fair value as determined in good faith under procedures established by and under
the general supervision and responsibility of the Fund's Board of Trustees.
Short-term securities which mature in more than 60 days are valued at
current market quotations. Short-term securities which mature in 60 days or less
are valued at amortized cost, if their term to maturity from date of purchase
was 60 days or less, or by amortizing their value on the 61st day prior to
maturity, if their original term to maturity from date of purchase exceeded 60
days.
In connection with transactions in repurchase agreements, the Fund's
custodian takes possession of the underlying collateral securities, the value of
which at least equals the principal amount of the repurchase transaction,
including accrued interest. To the extent that any repurchase transaction
exceeds one business day, the value of the collateral is marked-to-market on a
daily basis to ensure the adequacy of the collateral. If the seller defaults and
the value of the collateral declines or if bankruptcy proceedings are commenced
with respect to the seller of the security, realization of the collateral by the
Fund may be delayed or limited.
FUTURES TRANSACTIONS: The Portfolio invests in financial futures contracts
solely for the purpose of hedging its existing portfolio securities, or
securities the Portfolio intends to purchase, against fluctuations in fair value
caused by changes in prevailing market interest rates. The Portfolio may enter
into futures contracts subject to certain limitations. Upon entering into a
futures contract, the Portfolio is required to deposit cash or pledge U.S.
Government securities of an initial margin. Subsequent payments, which are
dependent on the daily fluctuations in the value of the underlying security or
securities, are made or received by the Portfolio each day (daily variation
margin) and are recorded as unrealized gains or losses until the contracts are
closed. When the contracts are closed, the Portfolio records a realized gain or
loss equal to the difference between the proceeds from (or cost of) the closing
transaction and the Portfolio's basis in the contracts. Risks of entering into
futures contracts include the possibility that there will not be a perfect price
correlation between the futures contracts and the underlying securities. Second,
it is possible that a lack of liquidity for futures contracts could exist in the
secondary market, resulting in an inability to close a futures position prior to
its maturity date. Third, the purchase of a futures contract involves the risk
that the Portfolio could lose more than the original margin deposit required to
initiate a futures transaction.
6
<PAGE>
SECURITY TRANSACTIONS AND INVESTMENT INCOME: Securities transactions are
recorded on the trade date. Realized and unrealized gains or losses are
calculated on the identified cost basis. Interest income is recorded on the
accrual basis and the Fund accretes premium or amortizes discount on securities
purchased using the interest method.
TAXES: It is the Fund's intention to continue to meet the requirements of the
Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to shareholders. Therefore,
no federal income or excise tax provision is required.
DIVIDENDS TO SHAREHOLDERS: Dividends from net investment income are declared
daily and paid monthly. Net realized capital gains, if any, will be distributed
at least annually.
NOTE 2. TRANSACTIONS WITH AFFILIATES AND RELATED PARTIES
Pursuant to an Investment Advisory Agreement, BlackRock Advisors, Inc.,
(formerly PNC Assets Management Group, Inc.), a wholly-owned subsidiary of
BlackRock, Inc., serves as investment advisor for the Portfolio. BlackRock
Financial Management, Inc., a wholly-owned subsidiary of BlackRock Advisors,
Inc., serves as sub-advisor to the Portfolio. BlackRock, Inc. is an indirect
wholly-owned subsidiary of PNC Bank Corporation.
For its advisory services, BlackRock Advisors, Inc. is entitled to receive
fees, computed daily and paid quarterly, at the annual rate of .25% of the
Portfolio's average daily net assets.
BlackRock Advisors, Inc. may, at its discretion, waive all or any portion
of its advisory fee for the Portfolio and may reimburse the Portfolio for
certain operating expenses. For the period ended September 30, 1998, advisory
fees and waiver for the Portfolio were as follows:
<TABLE>
<CAPTION>
GROSS NET
ADVISORY ADVISORY
FEE WAIVER FEE
---------- ---------- -----------
<S> <C> <C> <C>
Multi-Sector Mortgage
Securities Portfolio III $196,279 $21,516 $174,763
</TABLE>
PFPC Inc. ("PFPC"), an indirect wholly-owned subsidiary of PNC Bank Corp.,
BlackRock Advisors, Inc., and BlackRock Distributors, Inc. ("BDI") (formerly
Compass Distributors, Inc.) act as co-administrators for the Fund. The combined
administration fee is computed daily and payable monthly, based on a percentage
of the average daily net assets of the Portfolio, at the following annual rates:
.23% of the first $500 million, .21% of the next $500 million, .19% of the next
$1 billion and .18% of the average daily net assets in excess of $2 billion.
PFPC and BDI may, at their discretion, voluntarily waive all or any portion
of their administration fees for the Portfolio. For the year ended September 30,
1998, administration fees and waivers for the Portfolio were as follows:
<TABLE>
<CAPTION>
GROSS NET
ADMINISTRATION ADMINISTRATION
FEE WAIVER FEE
---------------- ----------- ---------------
<S> <C> <C> <C>
Multi-Sector Mortgage
Securities Portfolio III $190,354 $163,270 $27,084
</TABLE>
In addition, PNC Bank, National Association ("PNC Bank") serves as
custodian for the Portfolio. PFPC serves as transfer and dividend disbursing
agent.
BlackRock Advisors, Inc. voluntarily agreed to waive fees and reimburse
expenses to the extent necessary to cap the Portfolio's expenses (exclusive of
advisory fees) at no more than .12% of its average daily net assets for the year
ended September 30, 1998.
NOTE 3. PORTFOLIO SECURITIES
Purchases and sales of investment securities, other than short-term
investments and government securities, for the period ended September 30, 1998,
were $2,861,033 and $88,209,127, respectively.
7
<PAGE>
Purchases and sales of government securities for the period ended September 30,
1998 were $4,933,023 and $4,496,797, respectively. The federal income tax basis
of the investments of the Portfolio at September 30, 1998 was $45,648,867 and,
accordingly, as of September 30, 1998 net unrealized appreciation for federal
income tax purposes aggregated $929,454 which $967,975 related to appreciated
securities and $38,521 related to depreciated securities.
NOTE 4. CAPITAL SHARES
Transactions in capital shares were as follows:
<TABLE>
<CAPTION>
For the Year For the Year
Ended Ended
09/30/98 09/30/97
-------------- -------------
<S> <C> <C>
Shares subscribed ............................... - -
Shares issued in connection with the reinvestment
of dividends and distributions ................. 7,633 10,081
----- ------
Shares redeemed ................................. (78,300) (15,112)
------- -------
Net decrease .................................... (70,667) (5,031)
======= =======
</TABLE>
8
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Board of Trustees
of the BlackRock Funds:
In our opinion, the accompanying statement of assets and liabilities, including
the schedule of investments, and the related statement of operations and of
changes in net assets and the financial highlights present fairly, in all
material respects, the financial position of The Multi-Sector Mortgage
Securities Portfolio III of the BlackRock Funds (the "Fund") at September 30,
1998, and the results of its operations, the changes in its net assets, and the
financial highlights for the periods presented, in conformity with generally
accepted accounting principles. These financial statements and financial
highlights (hereafter referred to as "financial statements") are the
responsibility of the Fund's management; our responsibility is to express an
opinion on these financial statements based on our audit. We conducted our audit
of these financial statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audit, which included confirmation of securities owned at September 30, 1998 by
correspondence with the custodian and brokers, provides a reasonable basis for
the opinion expressed above.
PricewaterhouseCoopers LLP
2400 Eleven Penn Center
Philadelphia, Pennsylvania
November 13, 1998
9
<PAGE>
CO-ADMINISTRATOR AND DISTRIBUTOR
BlackRock Distributors, Inc.
West Conshohocken, Pennsylvania 19428
INVESTMENT ADVISER
BlackRock Advisor, Inc.
New York, New York 10154
SUB-ADVISER
BlackRock Financial Management, Inc.
New York, New York 10154
CUSTODIAN
PNC Bank, National Association
Philadelphia, Pennsylvania 19101
INDEPENDENT ACCOUNTANTS
PricewaterhouseCoopers LLP
Philadelphia, Pennsylvania 19103
CO-ADMINISTRATOR AND TRANSFER AGENT
PFPC Inc.
Wilmington, Delaware 19809
CO-ADMINISTRATOR
BlackRock Advisor, Inc.
New York, New York 10154
COUNSEL
Simpson, Thatcher & Bartlett
New York, New York 10017
(A partnership which includes professional corporations)
This report is for shareholder information. This is not a prospectus intended
for use in the purchase or sale of Fund shares.
BlackRock Funds
103 Bellevue Parkway
Wilmington, Delaware 19809
- --------------------------------------------------------------------------------
SHARES OF THE FUND ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR ENDORSED
BY PNC BANK, NATIONAL ASSOCIATION OR ANY OTHER BANK AND SHARES ARE NOT FEDERALLY
INSURED BY, GUARANTEED BY, OBLIGATIONS OF OR OTHERWISE SUPPORTED BY THE U.S.
GOVERNMENT, THE FEDERAL DEPOSIT INSURANCE CORPORATION, THE FEDERAL RESERVE
BOARD, OR ANY OTHER GOVERNMENTAL AGENCY. INVESTMENTS IN SHARES OF THE FUND
INVOLVE INVESTMENT RISKS, INCLUDING THE POSSIBLE LOSS OF PRINCIPAL AMOUNT
INVESTED.
- --------------------------------------------------------------------------------
10
